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Use regulatory framework to prepare financial statements from company records for internal use and external reporting or publication. Continental Limited has an authorized share capital of 1 million ordinary shares RM1 each. It operates wholesale and retail business of selling a consumer product. As the company assistant accountant, you are required to prepare financial statements for the financial year ending 31 Dec 2010 for the internal use by company director and management and also in the accepted format for the external reporting or publication. You are given the company records as follows:
Trial Balance as at 31 Dec 2010
Opening stocks 1 Jan 2010
Office electricity & water
Office premises at costs
Vehicles at costs
Provision for depreciation 1 Jan 2010
: Office premises
Provision for bad debts 1 Jan 2010
Proceeds from disposal of vehicle
Other information provided as follows:
Closing stocks at 31 Dec 2010 were valued at cost RM65000.
No record for the receipt from cash sales, out of which payments were made for purchase of goods RM4000, stationery RM700 and electricity bill RM300.
Accrual for a salesman's commission RM1500 and prepayment for an office staff salary RM2000 at 31 Dec 2010.
A customer who owed RM5000 has gone into bankruptcy during the year. Provision for bad debts is made to 10% on other trade debtors at end of the year.
A vehicle costs RM50000 purchased on 1 Jan 2005 was sold for RM35000 at 1 Jan 2010. No record for this transaction except the proceeds from disposal was entered in bank.
All the vehicles are charged depreciation 5% per annum on cost for each month of ownership and premises depreciate 4% per annum on cost.
Describe FIVE (5) different users and their needs for Continental Limited financial statements. Explain five regulatory characteristics of these financial statements that will provide useful information to the user.
Prepare the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010 for internal use by company directors and management. Show the necessary workings.
Based on the income statement and balance sheet made in task 2 and 3, calculate the appropriate accounting ratios for year ending 31 Dec 2010 and compare them with the industry averages provided to assess the profitability and liquidity of Continental Limited.
Following are the Industry Average provided for comparison:
Percentage of gross profit on sales:-
Percentage of operating profit on sales:-
Return on capital employed (ROCE):-
Stock turnover period:-
Debtor's collection period:-
Creditor's payment period:-
TABLE OF CONTENT
Table of content
Accounting is something that affects people in their personal lives just as much as it affects very large business. We use accounting when we plan what we are going to do with the money. Besides that, accounting is simply the means by which we measure and describe the results of economic activities. Normally, people refer to accounting as used by business and other organizations. Organization not only record cash received and paid out but also record goods bought and sold. This part of accounting usually called recording of data.
Accounting often is called the 'language of business' because it is so widely used in describing all types of business activities. Every investor, manager and business decision maker needs a clear understanding of accounting terms and concepts if they are to participate and communicate effectively in the business community. The basic purpose of accounting is to provide decision maker with information useful in making economic decision.
Introduction of Financial Statement
Financial statements are a collection of reports about an organization's financial results and condition. This includes income statement, balance sheet, and cash flow statement. The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions. Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income and expenses are directly related to an organization's financial position.
Users for Continental Limited Financial Statement
Financial statement may be used by different users for different purpose. There are 6 different users of financial statement which is investor, employees, supplier, government, customers and lender.
Investor is the one who invest the money into a business. Investors are concerned about risk and return in relation to their investments. Investor requires information to decide whether they should invest in a business. Shareholders also interested in financial statement which enables them to review the ability of a company to pay dividends. Investors consider two elements in their investment, which is income in the form of dividends and gain in the share price.
If the investor takes on a short-term view, the current dividends are the interest. But, a longer-term view would concern on future earnings. The investor group would also be interested in profitability and its trend over a period of time.
Employees and their representatives require information on business performance which about the stability and continuing profitability of the business. Employees require financial statement for two principal reasons which is wage and salary negotiation and also the assessment of current and forward opportunity in terms of employment. They would be interested in both the current financial stability and the longer-term financial viability of the business. They need information in a clear, simple and understandable form.
Suppliers and other creditors of a company need information concerning the financial position of a company. They would be interested in the financial stability of the business in terms of cash flow and the firm's ability to meet its short-term liabilities. They would consider current and future cash flow together with current and future profitability. They need to be convinced that the company is liquid enough to meet with her obligations upon maturity. An interest in the company's future strategy is also likely as they would need to consider how they, fit with the strategy.
There are many government agencies and departments that are interested in accounting information. The government departments require published financial information for the purposes of taxation. The governments are decision makers and their economic plans are influenced by the performance of all businesses within various sectors in the economy. The current financial reports will be used as a base in their economic models for assessing future performance.
Customers will be interested in the business's short and longer term financial stability and its potential to supply high quality of goods and services. Customers require the information about the ability of a business to survive and prosper. They interested in information about the continuance of a company, especially when they have a long-term involvement with. They may even be dependent on the business for certain products or services. They may also have interest in the environmental policy of the business.
Lenders often referred to as the loan creditor group such as banks and other financial institutions who lend money to a business with require information that helps them to determine whether loans and interest will be paid. It would include the long, medium and short term lenders of money. A short-term loan creditor will immediately consider cash flow. Whereas, medium and long-term creditor groups will review the future cash flow potential of the business. A further consideration would be on the priority of claims on the business's resources. They would have interest in current and future profitability and growth prospects of the entity.
Characteristic of Financial Statement
Different users require financial statement for different purpose to assist in their decisions. The user is depending on the financial statement to make decision, if the financial information is not accurate, the users may end up making wrong decisions. Hence, financial statements need to have certain qualitative characteristics to be useful to the users.
Understandability means the financial statements should be easily understand. Understandability ensures financial statements are reported in a simple manner, which even the public and consumers can understand. Problems in understanding may happen due to the abilities of users or information itself. Accounting is complicated, so it is important to simplify financial statements to avoid unnecessary delays and misunderstanding of financial data.
Relevance refer to financial statements should be material to the business firm. Relevance is the ability of an item to influence a decision. Information is considered relevant which adds value to the decision making process by providing the required bits and pieces of past, present and future times. Through relevant information users can evaluate whether they are moving along the right path or making the right decisions.
In accounting, "reliable" information is free from material error, errors that affect the economic decisions of users and bias. Information is reliable if it can be depended upon by users to represent faithfully what it either purports to represent or is reasonably expected to represent and therefore reflects the substance of the transactions and other events that have taken place. It is free from deliberate or systematic bias and material error and is complete, and in its preparation under conditions of uncertainty, a degree of caution has been applied in exercising the necessary judgments'. Information may be relevant but this alone does not suffice for reliability as well. Information must be reliable as well as relevant in order to be useful for decision making.
Comparability of information refers to its ability to stand useful overtime and against the financial information from other sources. Users must be able to compare the financial statements of an entity through time to identify the trends in its financial position and performance, and also to compare the financial statements of different entities to evaluate their relative financial position, cash flows and performance. Therefore, the measurement and display of the financial effects like transactions and other events and conditions must be carried out in a consistent way throughout an entity and over time for that entity, and in a consistent way across entities.
Closing stock:- RM 65,000
Purchases of goods:- RM4,000, stationery:- RM700
Office electricity and water + Electricity bill = RM 7,000+RM300
= RM7, 300
Sales commission = RM18,000+RM1,500
= RM19, 500
Office salaries = RM28, 000-RM2, 000
= RM26, 000
Accrual:- RM1,500, Prepayment:- RM2,000
Debtors = RM70,000-RM5,000
Provision for bad debt = RM70,000Ã-10%
Total provision for bad debt = RM5,000+RM7,000
Depreciation = (RM50,000-RM35,000)/5 years
= RM15,000/5 years
Proceeds from disposal of vehicle = RM35,000-RM3,000
Bank = RM42,000-RM3,000
Depreciation of vehicle = RM300,000Ã-5%
Provision for depreciation of vehicle = RM60,000+RM15,000
Depreciation of premises = RM350,000Ã-4%
Provision for depreciation of premises = RM40,000+RM14,000
Income Statement for year ending 31 Dec 2010
LessCost of Goods Sold (COGS):
Add Carriage inwards
Add Dividend received
Proceed from disposal of vehicle
Office electricity &water
Provision for bad debts
Provision for depreciation:
Purchases of Goods
Balance Sheet as at 31 Dec 2010
-Depreciation of Office Premises
-Depreciation of Vehicles
-Provision for bad debts
Capital Employed = capital + balance answer in balance sheet
Current Asset = debtors + bank + stock
Current Liabilities = creditors
Cost of Sales = Sales - Gross Profit
Average Stock = (opening stock + closing stock)/2
Percentage of Gross Profit on Sales
Percentage of Net Profit on Sales
Return on Capital Employed (ROCE)
Stock Turnover Period
Cost of Sales
Debtors Collection Period
Creditors Payment Period
From the table above show that the difference of accounting ratio between Industry Averages and Continental Limited. The percentage of gross profit on sales and net profit on sales for Industry Averages is 30% and 18% but, for Continental Limited is 48.61% and 28.75%. This shown that the Continental Limited is gained more profit then Industry Averages. This is because the employees of Continental Limited is work more efficiency and effective in finding new customers. They use the minimum expenses to maximize the profit. Return on capital employed for Industry Averages is 9%, whereas for Continental Limited is 9.38%. This means that the efficiency and profitability of Continental Limited capital investments is good. This might because of leader of the company had made the right decision.
Current ratio is a financial ratio that measures whether a firm has enough resources to pay its debts. The current ratio of Continental Limited is higher than Industry Averages; 6.96:1 and 2:1. Continental Limited is having higher liquidity of money than Industry Averages to pay for their debts over the next 12 month. Stock turnover period is to calculate the days it takes to sell the inventory on hand. The stock turnover period for Industry Averages is 90 days and Continental Limited is 96.52 days, which means the stock of Continental Limited keep in hand before sell it is longer than Industry Averages.
Debtor collection period indicates the average time taken to collect trade debts. In average, Continental Limited has used longer period which is 70.97 days to collect their debts if compare to Industry Averages that used 45 days to collect the debts. This happen might because of the delay of debtors to pay. Creditors Payment Period is to measure how quickly a business pays its debts to the suppliers and other short term creditors. Industry Averages used 60 days to pay their debts to creditor, whereas, Continental Limited used 25.35 days to pay their debts to the creditors. This show that Continental Limited has more capacity and capital to cover their debts compare to Industry Averages. In overall, the management of Continental Limited is good than Industry Averages, although they doesn't good in collecting debts and inventory management.
As a conclusion, account is a very important aspect in any business operation. It's involves the measurement and provision of financial information to managers, investors, lenders, and other stakeholders to help them make decisions about how they should allocate the resources of a company, organization, or public agency. To increase efficiency, management of accounting firms should always be ahead of everyone else when it comes to innovating and updating their knowledge and technology. In addition, there is a need for these companies to invest on their employees or workforce, as these people hold the key towards building lasting relationships with clients. A proper accounting system is essential to any business whether big or small in order to manage its daily functions and keep the businesses running successfully.