Financial Accounting - Essay Example

Financial accounting People buy stocks or invest in the companies after thorough analysis of the performance and prospect’s of the company they are investing in. In doing so, investors study every aspect of the target company and analyze every financial statement ranging from the balance sheet to the auditor’s report on the financial health of the firm. Financial statements are simply formal records that detail specific activities of a business associated with finance, accounting or business administration. In fact, financial statements are simply referred to as accounts in the UK. The importance of financial statements stems from the fact that they help detail the financial health of the firm both in the long and the short term. They comprise four different types of statements namely the balance sheet, income statement, statement of retained earnings and the cash flow statement (Costales, 2001). Amongst these different financial statements, the balance sheet is often the one most studied as it helps determine the financial position of the firm by providing a detailed overview of assets, liabilities and equity for a specific period of time. In this context, assets are resources of economic value owned by a business organzation. Irrespective of whether such a resource is tangible or intangible, any resource that is considered appropriate to pay for a debt is regarded as an asset. In other words, assets are valuable entities that can be converted into cash. The balance sheet serves the purpose of recording the monetary value of all such resources owned by the firm. Assets can be classified as tangible or intangible. While tangible assets refer to physical assets owned by a firm at any given point, intangible assets are abstract resources that can provide any benefit to the firm within the market (Leopold Bernstein, 2000). Copyrights, financial assets or goodwill are examples of intangible assets. It is these intangible assets that are not accounted for in the first place. A balance sheet primarily consists of the ‘visible’ part, which details the monetary value of all material resources owned by the firm. Listing all material assets provides for a way to show how such assets were financed. These tangible assets which can be clearly mapped to their physical presence can be found in the relevant annual report for a company (James Bandler, 1999). These tangible assets provide further information on which assets were borrowed in the firm of long-term loans and which were financed through shareholder capital. However, the annual report projects only a very small part of the whole business scenario. Consider the case of a publicly traded company, whose stock price trades at a particular value. Many a times, one often gets to hear that an interested investor was willing to pay more than the existing share price in a bid to acquire or gain a relevant share in the company. Such an offer in turn raises the overall market capitalization of the company, which is collectively owned by the shareholders. However, the annual report does not provide any reference to this discrepancy between the actual value and the amount paid for the shares (David Cunningham, 2007). The difference between this market value and the net book value is known as ‘Goodwill’, which is a tangible asset. Thus, a company trying to acquire such a firm with adequate goodwill would have to pay by the current market value that includes this goodwill. How does one account for this value when it is not recorded in the balance sheet? The deficit between the market and book values needs to be balanced. These invisible assets of the balance sheet that are not recorded specifically can be categorized along three different branches. The internal structure is used to denote any patents, models or software systems that are created and owned by entities within the organization and the firm as well. Sometimes, such assets are sourced from external sources but owned by the company in question thereafter. Any decision involving the development of such assets can be done in-house or sought externally. In fact, the overall structure of the organization that consists of employees working in specific responsibilities is one such asset that we call the ‘organization’. Likewise, a company has an external structure that forms the core of its relationships and engagements with customers and partners, trademarks and the general reputation of the firm in the market. Some of these entities have a legal attribute although this is not as strict as the terms associated with the internal structure of the company (Thomas Ittlson, 1998). The value and appreciation of these assets is dependent on the level of customer satisfaction in dealing with the firm and the level of uncertainty associated with such relationships as such elements can change over time. As such, intangible assets are not specifically liquid and need not be owned by the firm. The reluctance among banks to lend money to banks for investing in intangible assets stems from the fact that such assets are often self-financed. This means that invisible assets can be matched on a balance sheet only through relevant invisible finance, which constitutes the invisible equity. A services company that operates little machinery and relies more on contribution from employees is an example of the importance of their competence in generating revenues and solving issues of customers. This outwards initiative towards fostering and maintaining relationships comprises the company’s external structure. Consider the case of brand names. In the case of the Sony corporation, the company had to consider a lot of legal expenses in a bid to stop the Sari-sari store from using the name Sony. However, the local courts ruled that the store had the right to use Sony as the owner had a birth name bearing resemblance. The only way Sony could have prevented the store from using its brand name would be to offer monetary compensation for preventing any such use. However, since such a value cannot be arrived at through any mathematical estimation, the value of a brand name is not considered a valid candidate for inclusion in a balance sheet. The competence of individuals is the relative ease with which they can act in different scenarios. gaining this competence involves a combination of education, experience, ethical values and social skills. Competence is not an asset that can be owned by anyone and stays and changes with the person who possesses them (Stewart McMullen, 1957). One can say that the competence of employees can be included in the balance sheet as an organization is simply a collection of competent employees. This is also the reason a company pays retires a requisite compensation by recognizing their preceding contributions to the growth and well-being of the firm. Intangible assets vary in nature and change over time with changes in employees, companies, customers and the markets they operate in. As such attributes can never be measured towards a specific value; these cannot be compared for appropriate monetary values, which eliminate the possibility of specifying them on the balance sheet. References 1. Costales (2001), The guide to understanding financial statements. New York: McGraw Hill. 2. Leopold Bernstein (2000), Analysis of financial statements. New York: McGraw Hill. 3. James Bandler (994), How to use financial statements: a guide to understanding the numbers. New York: McGraw Hill. 4. David Cunningham (2007), Financial Statements Demystified. London: Allen & Unwin. 5. Thomas Ittlson (1998), Financial statements: a step-by-step guide to understanding and creating financial reports. Cornell University. 6. Stewart McMullen (1957), Financial statements: form, analysis, and interpretation. University of Virginia.   Read More