Financial Accounting Standards Board - Assignment Example

Finance and Accounting

Question one

The major policy setting bodies include the Financial Accounting Standards Board which is the body that operates in full view of the public and is responsive to the entire economic community. It is crucial to note that it is a non-profit organization. The second body is the Securities and Exchange Commission which is established by the federal government. Its main role is to enforce the federal security laws, regulate the securities industry, and propose the securities rules. The third is the Governmental Accounting Standards Board that provides the Generally Accepted Accounting Principles (GAAP) that is applied by the Local and State governments. Accounting standards include auditing standards and the Generally Accepted Accounting Principles. The Generally Accepted Accounting Principles refers to the body of procedures, conventions, and rules that describe practices in accounting at a particular time. Their purpose is to ensure that the financial statements that are prepared by the certified public accountant are comparable, relevant, and reliable. Finally, there is the International Accounting Standards Board which is a private sector body that develops and approves international financial reporting standards.

Specific roles of the bodies in the standard setting process include; development, interpretation, and setting of accounting principles. Accounting standards are regarded as authoritative declarations on how particular types of transactions and events should be recorded and reflected in financial statements. They provide companies with a foundation upon which to provide users of financial statements with the information they need to make decisions. They also have the role of modification and elimination of existing ambiguous standards. Due to changes in business conditions and new researches carried out, some standards have been deemed irrelevant and thus, they are eliminated from the systems. They play a crucial role in regulating the accounting profession and determining of appropriate practices and narrow the differences and inconsistencies in the practice. The Securities and Exchange Commission has the role of monitoring the activities of corporate enterprises whose stock is publicly held and ensures all file annual audited financial statements and encouraged the need for a private standard-setting body. The Securities and Exchange Commission also exercises authority over all companies. The standard setting process also has the role of issuing emerging issues task force statements. For example, the FASB is also tasked with issuing of statements on emerging issues and trends in the accounting sector. Finally, it has the role of making sure that there is efficient functioning of capital markets (Porter, 2009). By setting high-quality standards which have already been tested and deemed fit for global use in accounting systems, it helps to ensure better and accurate financial information is generated by organizations.

Question Two

Financial reporting refers to the language used to communicate information about the financial conditions and standings of the organization whether public or private, government or non-profit organization, for example, financial notes and disclosures, profit and loss statements, and balance sheets etc. Challenges that are faced during financial reporting include; fraud which has become rampant in many organizations and it involves the use of financial information as a means of deception. Often companies’ give out the wrong financial information so as to attract investors. It involves intentional distortion of numbers or disclosures. The second challenge is globalization which is an emerging and growing trend which seeks to unite the world systems. Today’s complex economic world requires a break from the auditing and financial reporting traditions from the early days (Needles, 2006).

Lack of independence of auditors has also become a challenge where in some situations the boards may deem financial statements fair yet in the eyes of auditors they may disagree. Auditors encounter various hurdles in carrying out their tasks as the management or boards of the companies may derail the auditor's activities if they do not want him to succeed in his task. The process of financial reporting also faces the challenge related to expectation gap. It refers to what accountants actually do in comparison with what they are expected to do by the general public and it is relatively difficult to close this gap. Development of knowledge economy also introduces new challenges in financial reporting because the process currently focuses on tangible assets and hence is not able to detect developments in the acquisition of intangible assets.

Other challenges include the complexity of accounting rules that hampers users from understanding the reported numbers. However, the regulatory bodies encourage the use of normal man's language instead of professional language in the presentation of financial statements to ease the burden of interpretation on the general public. Frequent changes in accounting rules can also result in challenges because due to these changes in rules, it becomes hard and cumbersome for users to keep track of the new rules being put in place. Another challenge is ambiguity because the imperfection of reporting rules leads to lack of focus and decisiveness. Some of the rules are too general thus leaving a lot of questions to be asked on how to properly apply them in day-to-day reporting. Intentional and unintentional audit errors also result in challenges because these are error encountered in the recording process and auditing processes which affect the entire financial statements.

Reliability which is the inability to report the actual state of affairs of an entity also presents challenges. Using current accounting rules does not meet the users’ requirements for most reliable information. It is virtually impossible to report the 100% true state of affairs of an entity using current accounting methods. The other challenge that is commonly seen is transparency where many entities prefer secrecy in financial reporting and do not adhere to the regulator's requirements for disclosure. Entities try to use all available loopholes undesired disclosure of information deemed to be confidential. Finding professional and skilled personnel can also present challenges .To handle changes in the economic and financial environment, hiring strategies will emphasize on specific key areas, activities, and qualifications. Finding the right employee for your company is quite hard and at times one may end up hiring incompetent personnel, it is also hard to find a competent person with the right skill set and experience required. Organizations may also be forced to create new positions for emerging tasks which need to be attended to. Poor forecasting value of financial reports can result in challenges especially is some of the financial statements lack the precise information needed for the construction of forecasts crucial for investment purpose. Another challenge is the lack of adequate technology and know-how. Various companies lack the most recent technology and software as they are expensive hence, they resort to other previous less efficient versions which may derail the accounting processes. The last challenge is difficulties in managing of internal controls. Due to changing standards, internal controls have to adapt to fit or the risk of material weaknesses and internal deficiencies increases exponentially. Some changes may result in revamping of processes, retraining of staff and reassessing of risks.

Question Three

The basic assumption used in accounting includes the following;

Economic (accounting) entity concept

It declares that a corporation or business is considered separate from its owners and is expected to keep financial records of transactions separate for accounting purposes even for a sole-proprietorship.

The monetary measure concept

It states that accounts will only deal with items that have monetary value such as machinery and stock of goods. It also states that a stable currency unit is to be applied as the unit of record, generally accounting ignores inflation and deflation and generally looks at a currency as relatively stable.

The Going concern concept

It implies that a business will continue to be in operational existence for the foreseeable future and that there is no intention to put the company into liquidation or to initiate cutbacks on the scale of operations. Directors should disclose details of any doubts in the company's future when they arise.

The time period assumption

It indicates that a company's continuous life can be divided into measured periods of time in which there is the preparation of the financial statements.

The cost principle

It states that financial statements should report a company's resources at historical or initial acquisition cost.

The Accrual concept

It indicates that transactions are to be recorded using the accrual basis of accounting, where the recognition of expenses and revenues arises when earned or used, respectively.

The Consistency assumption

The assumption states that similar method of accounting and reporting is to be used for all periods unless it can be replaced by a more relevant method. If this assumption is not applied, the financial statements produced over certain periods may not be comparable.

The Reliability assumption

It indicates that only transactions that can be adequately proven and accounted for should be recorded, for example, those that can be traced back to receipts and invoices.

The full disclosure principle

It states that one is to include all of the information that may impact an investor's understanding of financial statements inside or along the statements.

The Materiality principle

It advises that it is necessary to record every transaction that is capable of altering the decision-making process of individuals’ interpretation the financial statements of the company. This has led controllers to record even the smallest transactions.

The matching principle

This concept institutes that, when people record revenue, they need to record all related expenses at the same time for example charge inventory to the cost of goods sold at the same time that they record the revenue from the sale of those items in inventory. This is also used on the accrual basis of accounting.

Conservatism principle

It states that in a situation where there are two acceptable alternatives for reporting an item, this principle directs the user to choose the alternative that will result in less net income and/or less asset amount. Conservatism helps the accountant to be unbiased and objective and helps one anticipate or disclose losses, but it does not allow a comparable action for the gains, such as, potential losses will be reported on the financial statements, but potential gains will not be reported. Also, one may write inventory down to an amount that is lower than the original cost, but would not write the inventory up to the amount that is higher than the original cost.

Question Four

Part A

• Gross profit percentage

It measures how profitable a company is at selling its merchandise.

= (gross profit/ sales)*100

For 2015 = ($32400000/$108000000)* 100

= 30%

For 2014 = ($24000000/$64000000)*100

= 37.5%

The gross profit has decreased meaning that its profitability is reducing.

• Current ratio and quick ratio

These two are liquidity ratios that evaluate whether a business enterprise has enough cash on a daily (regular) basis to meet its operational obligations.

Current ratio= current assets/current liabilities

Current ratio also known as working capital ratio measures the ability of a firm to meet short term liabilities for example payables, taxes, accrued expenses and notes payable, with short term assets such as cash, marketable securities, receivables, inventory and cash equivalents. It is a useful indicator of cash flows.

For 2015= ($2000000+$14000000+$10000000)/($9400000+$5000000+$6000000)

= ($31000000/$20400000)

= 155/102

= 1.52

For 2014= [($1400000+$10500000+$12000000)/($6800000+$3400000+$4000000)

= ($23900000)/$14200000)

=239/142

=1.68

Quick ratio= (cash+ accounts receivable+ marketable securities)/ current liabilities

Quick ratio is also known as acid test ratio, it deals with a company’s most liquid assets and it shows how well a company can convert its assets into cash in order to pay off its current liabilities without selling its inventory. It differs with current ratio as some current assets are excluded from the quick ratio e.g. inventory because it may not be converted into cash quickly.

For 2015=($2000000+$14000000+$10000000)/($9400000+$5000000+$6000000)

= ($26000000/$20400000)

=65/51

=1.27

For 2014= ($1400000+$10500000+$6000000)/($6800000+$3400000+$4000000)

= ($17900000/$14200000)

=179/142

=1.26

• Accounts receivable collection period in days

Accounts receivable collection period in days = (average accounts receivable/annual sales)*365

It looks at customer repayment habits in comparison with payment terms and it is useful if majority of sales are on credit terms. It generally tells us the number of days it takes to collect on accounts receivables.

For 2015= average accounts receivable= ($14000000+$10500000)/2

= $12250000

= ($12250000/$108000000) *365 =41.40

=42days.

For 2014= average accounts receivable =($10500000+$0)/2 = $5250000

= ($5250000/$64000000)*365 =29.34

=30days.

• Trade accounts payable payment in days.

Trade accounts payable payment in days = (average accounts payable/cost of goods sold)*365

It is an efficiency ratio that checks on how efficiently a company’s management is at utilizing assets and managing liabilities (Ramachandran, 2008). It establishes the length of time it takes to clear all outstanding accounts payable. These ratios are used to compare the performance of an entity over multiple financial periods.

For 2015=purchases =cost of sales-expenses

= $75600000-$12400000= 63200000

Average accounts payable= ($9400000+$6800000)/2 = $8100000

= ($8100000/$63200000)*365 = 46.78

=47days

For 2014= purchases = $40000000-$10000000= $30000000

Average accounts payable= ($6800000+$0)/2 = $3400000

= ($3400000/$30000000)*365

=41.37 =42days

• Gearing ratio

This ratio indicates the level of debt a company has and its level of risk. Most lenders use this to determine ability of the company to repay the debt.

= (long term liabilities/ [loans+ capital employed (equity)])*100

For 2015= $60000000/($60000000+$49000000)*100

=6000/109

=55.05

For 2014 = $60000000/($60000000+$26000000)*100

=3000/43

=6

Part B

From the analysis above, it is clear that there is a decrease in the gross profit percentage indicating that there were more expenses incurred in the year 2015 compared to 2014 hence the decrease in expected profit as per the sales. There is also an increase in the number of accounts receivable days from 30 days in 2014 to 42 days in 2015. This shows that there are poor credit payment policies in place and also poor credit collection practices.

It is also evident that there is an increase in accounts payable days is noticed from 42 days in 2014 to 47 days in 2015. This indicates a favorable change in supplier repayment terms and also favorable cash flows in the company. The quick ratio for the company ranges between 1.26 in 2014 and 1.27 in 2015. These ratios can be relatively associated with the 1:1 ratio that indicates that a company is able to pay its bills without having to sell its inventory. Finally, the current ratio in 2015 is at 1.52 compared to 1.68 in 2014 and this ratio is sufficient to enable the company to meet its short-term obligations with its short-term assets.

Part C

Two points that are likely to have caused the movement in the percentages of the gross profit are Carriage inwards. It refers to the cost of transporting the purchases or raw materials from the supplier to our company. It generally affects the cost of sales as it is added to the cost of the purchases as it is to be compensated for by revenue from the sale of the goods. The purchase of goods results in two charges, the cost of having the goods delivered to our business premises and the cost of the goods purchased.

The second thing is return inwards, also known as sales returns, refers to goods return to our company after sale to customer. It may be due to defectiveness of the goods or delivery of wrong goods to the customer. It affects the sales revenue value as these goods are deducted from the overall sales figure or net sales.

Part D

Section I

I agree that these short-term liquidity ratios help to assess whether a company is able to meet its debts as they fall due as they measure if a company has enough cash on an on-going basis to meet its operational obligations. They are useful in checking the financial health of a company. The quick ratio specifically shows whether a company can pay its bills without having to sell their inventory (Gibson, 2012). A quick ratio of 1:1 shows that a company is able to pay its bills without having to sell its inventory. The current ratio helps indicate level of liquidity e.g. in a case where the ratio is less than 1 it indicates there are liquidity issues and a very high ratio indicates that the company has excess cash. A current ratio ranging from 1.2 to 2 is sufficient. A company needs to ensure that it can pay its bills, expense and employee salaries on time. High liquidity ratios also indicate that cash is accumulated and idle and it is advisable to reinvest it or put it into productive use.

Section II

I agree that a high gearing ratio is advantageous if the company is able to grow profits and generate positive cash flows to service the debt. A high gearing ratio also allows for expansion of the business by using the funds from the loans. A high gearing ratio of above 50% indicates a great risk to the company as a brief period of reduced profits would lead to bankruptcy and loan default.