Purpose Of Financial Statements Accounting Essay

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Introduction

Accounting is the process of recording, reporting, and interpreting financial information pertaining to an organisation about a business entity to users such as shareholders and managers. The process starts by first identifying transactions and events that affect the financial position and performance of the company.

Purpose of Financial Statements

The objective of financial statements is to provide information. The financial position,performance and changes in financial position of an enterprise that is useful awide range of users in making economic decisions. The financial statements provideuseful information to a wide range of users:

2.1.1 Managers of the company

 Financial Statements to manage the affairs of the company by assessing its financial performance and position. and taking important business decisions.

2.1.2 Shareholders 

Financial Statements to assess the risk and return of their investment in the company and take investment decisions based on their analysis.

2.1.3 Prospective Investors

Financial Statements to assess the viability of investing in a company. Investors may predict future dividends based on the profits disclosed in the Financial Statements. Furthermore, risks associated with the investment may be gauged from the Financial Statements. For instance, fluctuating profits indicate higher risk. Therefore, Financial Statements provide a basis for the investment decisions of potential investors.

2.1.4 Financial Institutions 

Financial Statements to decide whether to grant a loan or credit to a business. Financial institutions assess the financial health of a business to determine the probability of a bad loan. Any decision to lend must be supported by a sufficient asset base and liquidity.

2.1.5 Suppliers

 Financial Statements to assess the credit worthiness of a business and ascertain whether to supply goods on credit. Suppliers need to know if they will be repaid. Terms of credit are set according to the assessment of their customers' financial health.

2.2.1 Accounting Concept and Principles

Accounting Concepts and Principles are a set of broad conventions that have been devised to provide a basic framework for financial reporting. As financial reporting involves significant professional judgments by accountants, these concepts and principles ensure that the users of financial information are not mislead by the adoption of accounting policies and practices that go against the spirit of the accountancy profession. Accountants must therefore actively consider whether the accounting treatments adopted are consistent with the accounting concepts and principles.

In order to ensure application of the accounting concepts and principles, major accounting standard-setting bodies have incorporated them into their reporting frameworks such as the IASB Framework.

2.2.2 Relevance

Information should be relevant to the decision making needs of the user. Information is relevant if it helps users of the financial statements in predicting future trends of the business or confirming or correcting any past predictions they have made. Same type of information which assists users in confirming their past predictions may also be useful in forming future forecasts.

2.2.3 Reliability

Information is reliable if a user can depend upon it to be materially accurate and if it faithfully represents the information that it purports to present. Significant misstatements or omissions in financial statements reduce the reliability of information contained in them. The financial account information is reliable if,

Neutrality

Faithful Representation

Prudence

Completeness

2.2.4 Accuracy

The financial accounts should provied accurate financial information to the users for decision making because the inaccurate account information will lead to innacurate decision made by the user.

2.2.5 Comparability/Consistency

The financial accounts made based on accounting concepts should be comparable with the previous year accounts and comparable with the accounts of other compan

2.2.6 Understandability

Transactions and events must be accounted for and presented in the financial statements. Accounting concepts should be understandable by a user who possesses a reasonable level of knowledge of the business, economic activities and accounting.

Task 2

3.0 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 RM65000 should be closing stock value put in the trading account of income statement and under the current asset in balance sheet.

Working for note (b) of question:

Cash account

RM RM

Sales (Difference) 5000 Purchase 4000

Stationery 700

Electricity 300

5000 5000

Sales in trading account of income statement = RM 360000 from TB + RM5000 = RM365000.

Purchase in trading account of income statement =RM200000 from TB+ RM4000 =RM204000.

Stationery as expence put in P/L account of income statement = RM700.

Electricity & water in P/L account of income statement = RM7000 from TB + RM300 = RM7300.

Working for note (c) of question:

Sales commission as expense put in P/L account of income statement = RM18000 paid from TB + RM1500 accrued at end of year = RM19500.

Then, accrued sales commission RM1500 is recorded under the current liability in balance sheet.

Office salaries as expense put in P/L account of income statement

= RM28000 paid from TB - 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:

Debtor account

RM RM

Balance b/d (from TB) 75000 (-) Bad debts 5000

Balance c/d 70000

75000 75000

Balance b/d 70000

(Debtor put under current asset in balance Sheet)

Bad debts account

RM RM

Debtor 5000 P/L account 5000

(Bad debts as expense put in P/L account)

Provision for bad debts closing balance = 10% Debtor closing balance RM70000 = RM7000.

Provision for bad debts account

RM RM

31 Dec 2010 Closing balance c/d 7000 1 Jan 2010 Opening balance b/d 5000

(from TB)

Increase difference 2000

(As expense put in P/L account

7000 7000

1 Jan 2011 Balance b/d 7000

(Deducted from debtor under current asset in balance sheet)

Working for note (e) & (f) of question:

Vehicles account

RM RM

Balance b/d (from TB) 300000 Vehicle disposal a/c (cost sold) 50000

Balance c/d 250000

300000 300000

Balance b/d 250000

(Vehicles at cost put under fixed asset in balance sheet)

Provision for depreciation on vehicle account

RM RM

Vehicle disposal account 12500 1 Jan 2010 Opening balance b/d (fromTB) 60000

(Cost sold RM50000 x 5% x 5 years Depreciation as expense put in P/L account 12500

from 1Jan 2005 to1Jan 2010) (Vehicles closing balance RM250000 X 5%)

31Dec 2010 Balance c/d 60000

72500 72500

1 Jan 2011 Balance b/d 60000

(Deducted from vehicle cost under fixed asset in balance sheet)

Vehicle disposal account

RM RM

Vehicle cost sold 50000 Provision for depreciation on vehicle sold 12500

Proceeds from disposal of vehicle (TB) 35000

Difference for Loss on disposal of vehicle 2500

(As expense put in P/L account)

50000 50000

Provision for depreciation on premises account

RM RM

Balance c/d 54000 1 Jan 2010 Opening balance b/d (from TB) 40000

Depreciation as expense put in P/L account 14000

(Premises cost from TB RM350000 x 4 %)

54000 54000

Balance b/d 54000

(Deducted from premises cost under fixed asset in balance sheet)

Working for note (g) of question:

Taxation charge RM 15300 is deducted from net profit at the bottom of income statement. It is also recorded as accrued taxation RM 15300 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 RM 500000 Share capital from TB = RM 10000.

Then, the proposed dividend RM 10000 is recorded under current liability in balance sheet.

Income statement of Continental Limited for year ending 31 Dec 2010 for internal use.

RM

RM

RM

RM

RM

RM

RM

RM

RM

Sales

365000

Less Return inwards

10000

Net sales

355000

Less Cost of sales:

Opening stock

50000

+ Purchases

204000

- Return outwards

15000

+ Carriage inwards

5000

194000

Less Closing stock

65000

179000

Gross profit

176000

Add Income :

5000

Dividend received

181000

Less 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

Interest charges

3000

104500

Net profit

76500

Less Taxation charge

15300

Less Proposed dividend

10000

Profit for the year

51200

Add Retained earnings brought

100000

Retained earnings carried forward

151200

( Put under reserve added to share capital in balance sheet)

Balance sheet of Continental Limited as 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

Vehicles at cost

250000

( -) Provision from depreciation on vehicles

60000

190000

Long - terms investments

100000

586000

Currents assets

Closing stock

65000

Debtors

70000

(-) Provision for bad debts

7000

63000

Bank

42000

Prepaid office salary

2000

172000

758000

Issued share capital

Share capital

500000

Add Reserve

Retained earnings carried forward

151200

Shareholders' equity

651200

Add Long -term liabilities / Non current liabilities

Loan

55000

Add Current liabilities

Creditors

25000

Accrued sales commision

1500

Accrued taxation

15300

Proposed dividend

10000

51800

758000

Task 3

4.0 Distribution costs and administrative expenses as follows.

Distribution costs

and

Administrative expences

RM

RM

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 vehicle

2500

-

Depreciation on vehicles

12500

-

Depreciation on premises

-

14000

Vehicles expences

12000

-

Total

53500

48000

Income statement of Continental Limited for year ending 31 Dec 2010 for external reporting

RM

RM

Turnover

355000

Cost of sales

179000

Gross profit

176000

Distribution costs

53500

Administritive

48000

101500

Operating profit

74500

Dividend received

5000

79500

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

Balance sheet of Continental Limited for the year ending 31 Dec 2010 for external reporting

RM

RM

RM

Fixed Assets

Tangible Assets:

Premises

296000

Vehicles

190000

486000

Investment:

Long term investment

100000

586000

Current Assets

Stock

65000

Debtors

63000

Prepaid office salary

2000

130000

Cash at bank

42000

172000

Less Creditors: Amounts Falling Due Within One Year

Creditors

25000

Accurued sales commision

1500

Accurued taxation

15300

Proposed dividend

10000

51800

Net Current Assets

120200

Total Assets Less Current Liabilities

706200

Less Creditors: Amounts Falling Due After More Than One Year

Loan

55000

651200

Capital and Reserves

Called up share capital

500000

Profit and Loss account

151200

651200

Task 4

5.1Table of ration calculation

Ration with formula

Ration calculation for year 2010

Industry average

Percentage of cross profit on sales

= Gross profit / Net profit x 100

176000 / 355000 x 100 = 49.57%

>

30%

Percentage of operating profit on sales

= Operating / Net profit x 100

74500 / 355000 x 100 = 20.99%

>

18%

Return on capital employed

(76500+3000)/706200 x 100% = 11.26%

>

9%

Current ratio

= Current asset / current liabilities

172000 / 51800 = 3.32:1

>

2:1

Stock turnover period

= 365 days / stock turnover

365days/stock turnover in times

= 365/3.11=117.36days

>

90 days

Debtors collection period

= Debtor ratio x 365days

63000 / 355000 x 365 days = 64.7 days

>

45 days

Creditor payment period

= creditor ratio x 365 days

25000 / 189000 x 365 days = 48.28 days

<

60 days

Working for (e)

Stock turnover = cost of sales / average stock value

= cost of sales / (opening stock + closing stock) / 2

= 179000 / (50000 + 65000) / 2

= 179000 / (115000/2)

= 179000/ 57500

= 3.11times

Working for (f) = (debtor / net credit sales) x 365 days

= [63000 / (365000-10000)] x 365 days

= (63000 / 355000) x 365 days

= 64.7 days

Working for (g) = (creditor / net credit purchase) x 365 days

= (25000 / 189000) x 365 days

= 48.28 days

Profitability of Continental Limited

(a) Percentage of gross profit on sales in the ratio calculation for year 2010 which is 49.57%. Its higher percentage than the industry average 30%. In this case can show that, the gross profit on sales in ratio calculation for year 2010 is more than effective and efficient than the industry averages, because it can overcomes its purchase cost by making the purchase at lower cost from supplier and efficient in controlling its outcomes cost by the effective use of materials and labour to control its production cost rather than industry average.

(b) Percentage of operating profit on sales in the ratio calculation of year 2010 is 20.99% which more than industry average that is 18%. From the ratio comparison, the huge expenses to sales ratio indicates that company is ineffective in its expenditure control causing higher expenses incurred to reduce its net profit earning. Other than that, the industry average ratio is lower expense to sales ratio indicates that company is effective in costs control causing down expenses to incurred to increase its net profit earning.

(c) Return on capital employed in the industry average is 9% and the ROCE in the ratio overole for year 2010 is 11.26% where is higher than the industry average percentages. In this ratio calculation for year 2010 showed that the higher comes on capital employed indicates higher net profit generated from the capital employed in production and business supplies to increase the outcomes and sales ratio as well as to in higher the net profit earning. More than that, the lower of the industry average is the lower comes on capital employed indicates down net profit generated from the capital employed for ineffective use of capital employed in production and business supplies to reduce production and sales volume as well as to reduce net profit earning.

Liquidity of Continental Limited

(d) The comparison between the ratio for year ending 31 December 2010 and the industry averages which the former is higher than the latter. Because, the current ratio of the year ending 31 December 2010 is 3:.32: 1 higher than industry average which is 2:1.

(e) The stock turnover period for the year ending 31 December 2010 is 117.36 days which more than the industry average because it only 90 days. Obviously, the longer stock turnover period indicate low stock turnover in the business where things purchased are kept in stock for long period and then lower taken out for resale so that the stock is accumulated to tie up money, causing short term problem.

(f) The calculation ratio for the year end 31 December 2010 is 64.7 days which longer than the industry average which is 45 days only. From the ratio comparison, the longer debtor collection time for year end 31 December 2010 indicate that company has given longer credit time to allow outcomes owning, causing longer period taken by company to collect cost slowly from debtors, so that larger debtor balance is accumulated to tie up cost, bringing to shortage of money for paying back liabilities and facing short term financial problem.

(g) The result ratio of year end 31 December 2010 is 48.28 days which is shorter than the company average which in 60 days. Thus, the shorter creditor payment period indicate that company has obtained shorter credit time for owning and paying to creditors so that company needs to pay creditor in period, causing smaller creditor accumulated and short term financial problem for shortage of money to pay back creditor.

5.2 Conclusion.

The conclusion of this assignment showing us the Principle of Accounting and the important purpose of accounting.Beside that,it also teach us how information provide can help them make decision and take any action. We also learn wheter to expand the businness,source for cheaper supplies or intensify sale campaigns..As we know the has a five basic types of accounting flows Transactions, Records, Report, Interpretation of financial statements and Decision by internal/external users. We also learn the purcase of cash is a typical businness transaction. Other than that Goverment and other interested parties may keep a close watch on the performance of the business for various reasons. Apart from that creditors oncial obligations. We also learn the accounting ratios are the ratios expressed and counted based on accounting figures derived from financial statements or final accounts of the firm. Accoumting ratios must be compared over two different periods or between two different companies or with the industry average to measure business performance of the firm.

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