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Principles of Accounting is a subject of study the foundational concepts used in Financial Accounting. In this subject, we can learn the method of prepare financial statements, to create double entry for recording business transactions and to show the information that regarding to the financial status of the business.
In this assignment, it has divided into four tasks. First task discuss about the five different accounting users and their needs for Continental Limited's financial statements. The accounting users of Continentals Limited are shareholders, suppliers, customers, finance providers, and government agencies. Apart from that, we need to describe the five regulatory characteristics of the financial statements which can present functional information to the users. These characteristics include relevance, timely, accuracy, reliability and understandability.
Based on the assignment, Task 2 is to prepare the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010. Income statement is a report that displays all of the financial information about the capital, revenue and expenses of the company while balance sheet refers to a financial statement that contain of the assets and liabilities of the company. In addition, Continental Limited's directors and management will utilize these income statement and balance sheet for internal use.
In Task 3, we need to prepare Continental Limited's income statement and balance sheet for year ending 31 Dec 2010 in accepted format. It is because the income statement and balance sheet that we need to prepare in this task is for external reporting and publication.
Task 4 is regard to the accounting ratios. We are required to calculate the appropriate accounting ratios for year ending 31 Dec 2010 based on the income statement and balance sheet that already prepared in Task 2 and Task 3. Finally, we have to compare them with the industry averages provided to assess the profitability and liquidity of Continental Limited.
Accounting Users and Characteristics of Financial Statements
It has two types of accounting users which are internal users and external users. Internal users refer to the people within the company such as managers while external users refer to the outsider of the company such as creditors. Management Accounting Text And Cases (Singhvi, N. & Bodhanwala, R., 2006) demonstrated that "managerial users need detailed information on a timely basis for forecasts of cash need for the next year while public needs information to understand the trends and recent developments in the prosperity of enterprise." On the other hand, financial statement is a report that including all of the financial results and situation of an organization. In order to prepare a useful financial statement for the accounting users, the financial statement should be relevance, timely, accuracy, reliability and understandability.
2.1 Five Different Accounting Users and Their Needs for Continental Limited
One of the accounting users for Continental Limited financial statements is shareholders or owners of the company. "The owners of a business, who have invested capital, are naturally interested in knowing the return they would get in their capital." (Anon, 2009, p.1-5). The shareholders and the owners of Continental Limited need accounting information to make sure the company can perform their business effectiveness and efficiently. Moreover, they need accounting information to assess how much profit that the company had earned or how much the company had loss in the particular year.
Another accounting user in Continental Limited is suppliers. Suppliers also known as creditors, they are the people who provide goods and services to Continental Limited. The suppliers need to understand the accounting information because they want to ensure they can collect back the money of the goods and services they provided to Continental Limited and to avoid bad debt.
The other accounting user of Continental Limited is the customers who purchase goods and services from the company. According to Users of Accounting Information websites (2012), it recommended that "Customers need accounting information in order to determine the continuity of a business" Furthermore, customer can compare the prices of the goods and services between Continental Limited and others company in order to know whether the prices that the company charges is reasonable or not through accounting information.
The providers of finance to Continental Limited also are the accounting users in the company. Finance providers usually refer to the bank, government loan and other financial institution. Finance providers require accounting information of the company because they are the people who offer overdraft and loan for the company and they want to guarantee the company is capable to pay the interest on the loan and overdraft in the future.
Finally, government agencies need accounting information too. It is because "the government needs accounting information to assess the amount of tax to be paid by a business or an individual." (Users of Accounting Information websites, 2012). Once the government knows the accounting information of Continental Limited, they can distribute the national statistics and resources easier.
2.2 Five Regulatory Characteristics of Financial Statements
Financial statements refer to the reports that provide finance information. Alexander, D. & Archer, S.'s International Accounting/ Financial Reporting Standards Guide 2009 stated that "the objective of financial statements is to provide information that is useful to a wide range of users in make economic decisions." Therefore, a useful financial statement must consist of the characteristics that can provide functional information to the accounting users and avoid the accounting users making wrong economic decision. Now, let's discuss the characteristics of useful financial statements.
First of all, financial statement that can provide useful information to accounting users should consist of the characteristics of relevance. Earlier research (What are the qualitative characteristics of financial statements? website, 2011) demonstrated that "The information must be relevant to the needs of the users, which is the case when the information influences the economic decisions of users." So, the information in financial statement must be relevant to the accounting user's decision.
The second characteristic of useful financial statements is timely. When the accounting users would like to making decision, the financial account information has to submit in time. Moreover, the relevance of the financial account information to the decision making is related to timely. It is because once the financial account information cannot submit on time, the information will not relevance to the decision making of the users and it will become a useless financial statements.
In order to ensure the accounting users can make precise decision, the financial account should possess the characteristic of accuracy. This is because imprecise account information will cause the accounting users can't make right decision.
Besides accuracy, reliability also known as the characteristic of financial account information. Rajasekaran, V. & Lalitha, R. (2011, p.8) have proposed that "accounting information is reliable, when it is free from material error and personal bias." Therefore, we must notice that financial account information that is incomplete or consist of personal bias is undependable and it will lead the accounting users making wrong decision.
Lastly, financial account information supposed to be understandability and the accounting users need to understand the information in the financial statements. It is because the information is nothing for the accounting users since they do not understand it.
Income Statement and Balance Sheet for year ending 31 Dec 2010 for Internal Use
Accounting users utilize income statement to assess the revenue and expenses of a company in a particular time while balance sheet is another financial statement that used to evaluate the net profit of the company. In balance sheet, it had list out the assets, liabilities and the equity of the company.
In order to prepare the income statement and balance sheet for year ending 31 December 2010 of Continental Limited, we need to do the following working on the information that provided first.
Working for note (a) of question:
Closing stock should be recorded at cost or net resale value which one is lower. Since cost RM65000 < net resale value RM70000, the cost RM 65000 should be closing stock value put in the trading account of income statement under the current asset in balance sheet.
Working for note (b) of question:
Sales (Differences) 5000 Purchase 4000
Sales in trading account of income statement
= RM360000 + RM5000 = RM36500
Purchase in trading account of income statement
= RM200000 + RM4000 = RM204000
Stationery as expenses put in P/L account of income statement
Electricity & Water in P/L account of income statement
= RM7000 + RM 300 = RM7300
Working for note (c) of question:
Sales commission as expenses put in P/L account of income statement
= RM18000 paid + RM1500 accrued at the end of year = RM19500
Then, accrued sales commission RM1500 is recorded under current liability in balance sheet.
Office salaries as expenses put in P/L account of income statement
= RM28000 paid - RM2000 prepaid at end of year = RM26000
Then, prepaid office salary RM2000 is recorded under the current asset in balance sheet.
Working for note (d) of question:
Balance b/d 75000 (-) Bad debts 5000
Balance c/d 70000
Balance b/d 70000
Bad debts Account
Debtor 5000 P/L account 5000
Provision for bad debts closing balance
= 10% x Debtor closing balance RM70000 = RM7000
Provision for bad debts account
31 Dec 2010 Closing balance c/d 7000 1 Jan 2010 Opening balance b/d 5000
Increase difference 2000
1 Jan 2011 Balance c/d 7000
Working for note (e) & (f) of question:
Balance b/d 300000 Vehicle disposal a/c 50000
Balance c/d 250000
Balance b/d 250000
Provision for depreciation on vehicle account
Vehicle disposal account 12500 1 Jan 2010 Opening balance b/d 6000
(Cost sold RM50000 x 5% x 5 years
from 1 Jan 2005 to 1 Jan 2010 ) Depreciation as expenses 12500
put in P/L account
(Vehicle closing balance RM25000 x 5%)
31 Dec 2010 Balance c/d 60000
1 Jan 2011 Balance b/d 60000
Vehicle disposal account
Vehicle cost sold 50000 Provision for depreciation on vehicle sold 12500
Proceeds from disposal of vehicle 35000
Difference for Loss on disposal of vehicle 2500
Provision for depreciation on premises account
Balance c/d 54000 1 Jan 2010 Opening Balance b/d 40000
Depreciation as expenses put in P/L account 14000
(Premises cost from TB RM350000 x 4%)
Balance b/d 54000
Working for note (g) of question:
Taxation charge RM15300 is deducted from net profit at the bottom of income statement. It is also recorded as accrued taxation RM15300 under the current liability in balance sheet.
Working for note (h) of question:
Proposed dividend to be deducted from net profit at the bottom of income statement
= 2% x RM500000 Share capital = RM10000
Then, the proposed dividend RM10000 is recorded under current liability in balance sheet.
Income Statement of Continental Limited for year ending 31 Dec 2010 for Internal Use
After finished the working for the note of question, let's prepare the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010 for internal use.
Income Statement of Continental Limited for year ending 31 Dec 2010 for internal use
RM RM RM
Less Return inwards 10000
Net Sales 355000
Less Cost of sales:
Opening Stock 50000
(+) Purchase 204000
(-) Return outwards (15000)
(+) Carriage inwards 500 194000
Less Closing stock 65000 179000
Gross profit 176000
Dividend received 5000
Office electricity & water 7300
Office Salaries 26000
Sales commission 19500
Bad debts 5000
Increase in provision for bad debts 2000
Loss on disposal of vehicle 2500
Depreciation on vehicle 12500
Depreciation on premises 14000
Vehicle expenses 12000
Interest charge 3000 (104500)
Net Profit 76500
Less Taxation charge (15300)
Less Proposed dividend (10000)
Profit for the year 51200
Add Retained earnings brought forward 100000
Retained earnings carried forward 151200
3.2 Balance sheet of Continental Limited at 31 Dec 2010 for Internal Use
Balance sheet of Continental Limited at 31 Dec 2010 for Internal Use
RM RM RM
Fixed assets/ Non-current assets
Office premises at cost 350000
(-) Provision for depreciation on premises (54000) 296000
Vehicle at cost 250000
(-) Provision for depreciation on vehicles (60000) 190000
Long-term investments 100000
Closing stock 65000
(-) Provision for bad debts (7000) 63000
Prepaid office salary 2000 172000
Issued share capital
Share capital 500000
Retained earnings carried forward 151200
Shareholder's equity 651200
Add Long-term liabilities/ Non-current liabilities
Add Current Liabilities
Accrued sales commission 1500
Accrued taxation 15300
Proposed dividend 10000 51800
Income Statement and Balance Sheet for year ending 31 Dec 2010 for External Reporting
After finished the income statement and balance sheet of Continental Limited for internal use, we have to prepare the other income statement and balance sheet for year ending 31 Dec 2010 for external reporting such as publishing in company report, magazine, newspaper and journals.
Before prepare the income statement and balance sheet, we need to classify the expenses from income statement of Task 2 into distribution cost and administrative expenses as follow.
Distribution Cost Administrative Expenses
Stationery - 700
Office electricity & water - 7300
Office Salaries - 26000
Sales Commission 19500 -
Bad debts 5000 -
Increase in provision for bad debts 2000 -
Loss on disposal of vehicle 2500 -
Depreciation on vehicles 12500 -
Depreciation on premises - 14000
Vehicle expenses 12000 -
Total 53500 48000
4.1 Income Statement of Continental Limited for year ending 31 Dec 2010 for External Reporting
Below is the income statement of Continental Limited for year ending 31 Dec 2010 for external reporting.
Income Statement of Continental Limited for year ending 31 Dec 2010 for External Reporting
Cost of sales (179000)
Gross profit 534000
Distribution costs 53500
Administrative expenses 48000
Operating profit 74500
Dividend received 5000
Interest charges 3000
Profit on ordinary activities before taxation 76500
Taxation charge 15300
Profit on ordinary activities after taxation for the year 61200
Proposed dividend 10000
Retained profit for the year 51200
Retained profit brought forward (100000)
Retained profit carried forward 151200
4.2 Balance Sheet of Continental Limited for year ending of 30 Dec 2010 for External Reporting
The balance sheet of Continental Limited for year ending of 30 Dec 2010 for external reporting is showing below:
Balance Sheet of Continental Limited for the year ending 31 Dec 2010 for External Reporting
RM RM RM
Long term investment 100000
Prepaid office salary 2000
Cash at bank 42000
Less Creditors: Amounts Falling Due Within One Year
Accrued sales commission 1500
Accrued taxation 15300
Proposed dividend 10000
Net Current Assets 120200
Total Assets Less Current Liabilities 706200
Less Creditors: Amounts Falling Due After More Than One Year
Capital and Reserves
Called up share capital 500000
Profit and Loss account 151200
Accounting ratios are using to deduce financial statements of a company for evaluate the business performance of the company. Accounting ratios are grouped into three different categories for evaluate three different aspects of business performance of the company which are effectiveness, efficiency and profitability of the company, liquidity and ability of the company to pay back its short-term debts and long term debts of the company. In order to evaluate the business performance of the firm, accounting ratios must be compared over two different periods or between two different companies or with the company averages.
Accounting Ratio for year ending 31 Dec 2010 between Continental Limited and Industry Averages
Below is the table of calculation of the accounting ratio between Continental Limited and the industry averages for year ending 31 Dec 2010.
Ratio with formula Ratio calculation Industry
for year 2010 averages
Percentage of gross profit on sales 17600 x 100 30%
= Gross profit x 100 355000
Net sales = 49.58%
Percentage on operating profit on sales 74500 x 100 18%
= Operating profit x 100 355000
Net sales = 20.99%
Return on capital employed 9%
= Net profit before interest x 100 (76500 + 3000) x 100
and taxation 158000-51800
Total assets-current liability =11.26%
Current ratio 2:1
= Current assets 172000
Current liabilities 51800
= 3.32 : 1
Stock turnover period 90 days
= 365 days 365 days/3.11 times
Stock turnover in
Times = 117.36 days
Stock turnover = Cost of sales
Average stock value
Average stock = (Opening stock value + Closing stock value) / 2
= (50000 + 65000) /2
Stock turnover = 179000
Debtor collection period 0.177 x 365 days 45days
= Debtor ratio x 365 days = 64.6 days
Debtor ratio = Debtor
Net credit sales
= 0.177 : 1*
Creditor payments period 0.132 x 365 days 60 days
= Creditor ratio x 365 days = 48.18 days
Creditor ratio = Creditor
Net credit purchase
=0.132 : 1
5.2 Comparison between Continental Limited and Industry Averages to Assess Profitability
From the above calculation, it stated that the gross profit margin of Continental Limited is 49.58% while the gross profit margin of the industry averages is 30%. It had shown that Continental Limited is effective and efficient in allocating the company resources and the profit that earned by Continental Limited is higher than the industry averages.
Besides that, the operating profit margin of the industry averages is 18% while Continental Limited's operating profit margin is 20.99%, indicating that Continental Limited can control their expenditure well than the industry averages.
Finally, return on capital employed of Continental Limited is 11.26% and industry average's return on capital employed is 9%. It shows that the return on capital employed of Continental Limited is higher than the industry averages, indicating that it is higher net profit generated from the capital employed.
5.3 Comparison between Continental Limited and Industry Averages to Assess Liquidity
Based on the calculation, the current ratio of Continental Limited is 3.32:1 while industry average's current ratio is 2:1. It is refers to Continental Limited is financially stable than the industry average and indicate it is able to finance its' short term debts.
Next, the turnover period of Continental Limited is 117.36days while the turnover period of industry averages is 90 days. Due to the stock turnover period of Continental Limited is longer than the industry averages, it may cause short-term financial problem in Continental Limited.
Look in the debtor collection period, Continental Limited shows 64.6 days while industry average shows 45 days. We indicate that Continental Limited allow its debtor owing for a longer period than the industry averages and the money is tied up with its' debtor.
Lastly, the creditors payment period of Continental Limited is shorter than the industry average, indicating that Continental Limited has make payments to its creditors on time and it may causing short-term financial problem of lack of money.
Conclusion and Recommendation
After finished Task 1, I had learned about internal accounting users who are inside the organization and external accounting users who are outside the organization. I also had stated that the accounting users in Continental Limited are shareholders, suppliers, customers, finance providers and government agencies. On the other hand, I had learned that the characteristics of useful financial statements include relevance, timely, accuracy, reliability and understandability.
In task 2, I had learned how to prepare a completed and correct income statement and balance sheet for internal use. Before prepare the income statement and balance sheet, I had done the working of calculation based on the note that is given.
Task 3 also need to prepare an income statement and balance sheet. However, it is different from task 2 because the income statement and balance sheet in this task is for external reporting and publication. Therefore, we need to classify the expenses from income statement of task 2 into distribution costs and administrative expenses first.
I had learned different accounting ratio in Task 4. I found out that it has a lot of different accounting ratio such as current ratio, debtor collection period, return on capital employed and so on. Finally, I had learned the calculation for calculate the different accounting ratio.