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In 1941, the American Institute of Certified Public Accountants (AICPA) defines accounting as "the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character and interpreting the results hereof" (Caldwell, et al., 1990, p.2).
This report consists of four tasks. In task 1, it defines the five different account users which are manager of the company, customers or debtors, supplier or creditors, tax authorities or income tax department of government and investors. Moreover, task 1 will explain the needs of these five users for Continental Limited financial statement. In Task 1, it also identified the five regulatory characteristics of useful financial statements.
While in Task 2, it used to prepare the income statement and balance sheet of Continental Limited for year ending 31 December 2010 for internal use by company director and management. The necessary working is shown in the report.
In Task 3, the expenses from income statement of task 2 into distribution costs and administrative expenses has been classified. For task 3, it used to prepare the income statement and balance sheet of Continental Limited for year ending 31 December 2010 in the accepted format for external reporting and publication. The necessary working is shown in the report.
Last but not least, task 4 is actually a calculation on accounting ratio for years 31 December 2010 based on the income statement and balance sheet made in task 2 and task 3. Besides, it also compared them with the industry average provided to access the profitability and liquidity of Continental Limited.
2.0 Five different users and their needs for Continental Limited financial statements
There are internal users which mean people within the organization and also external users which mean people outside the organization who use accounts to derive financial information for their needs.
2.0.1 Managers of the company
Managers have the responsibility of make the organization perform and to achieve the goals it is set. These are people appointed by the company's owners to supervise the day-to-day activities of the company. They have a much greater need for accounting information about the latest company's financial situation and expected to be in the future to enable them to manage the business efficiently and to take effective control and planning decisions.
2.0.2 Customers or Debtors
These are people who purchase products or services from the company. They need accounting information about the company's financial stability to ensure that the company is a secure source of supply and no danger of having to close down. Customers have an interest in information about the continuance of an entity, especially when they have a long-term involvement with, or are dependent upon, its prosperity. In particular, customers need information concerning the current and future supply of goods and services offered, price and other product details, and conditions of sale. Much of this information may be obtained from sales literature or from sales staff of the enterprise, or from trade and consumer journals
2.0.3 Suppliers or Creditors
Creditors are important users of financial statements because many organizations borrow large sums of money and obtain credit to finance their activities. Whether these people are providers of goods or services, or bankers or other lenders of money, they are mainly interested in the financial stability and future prospects of an organization. This is of special concern when they are asked to increase their contribution, in money or credit, towards the operations of an organization. They will be particularly interested in the liquidity of the organization which means the ability of the organization to pay its debts at short notice. They will also be interested in the amount of security that exists to cover the advances they have made to the organization. The size of debts owed to other creditors and their priority in terms of repayment are also important factors for this group of users.
2.0.4 Tax authorities or income tax department of government
Our governments are financed through the collection of taxes. Under federal, state, and local laws, companies and individuals pay many kinds of taxes. Among these levies are federal, state, and city income taxes, social security and other payroll taxes, excise taxes, and sales taxes. Each tax requires special tax returns and often a complex set of records as well. Proper reporting is generally a matter of law and can be very complicated. The Internal Revenue Code of the federal government, for instance, contains thousands of rules governing preparation of the accounting information used in computing federal income taxes. (Caldwell, et al., 1990, p.8) They need accounting information about business profit earned by the company in order to assess the tax payable by the company.
Those who are thinking of investing in a company and those such as financial analysts who advise investors are interested in the past success of the business and its potential earning in the future. A thorough study of the company's financial statement will help potential investors judge the prospects for a profitable investment. (Caldwell, et al., 1990, p.8) After investing in a company, investors must continually review their commitment. They need accounting information to know whether it is worth for them to invest their money in the business or buying shares of the company.
2.1 Five regulatory characteristics of useful financial statement
These are the criteria to be fulfilled for selecting and adopting accounting concepts or accounting policies in preparing business financial accounts. These criteria must be fulfilled to make the financial statements and accounts that are useful to the users.
Account reports should be expressed the accounting concept as clearly as possible and should be understood by those at whom the information is aimed especially the users who have reasonable knowledge of business, economic activities and accounting. Hence, the financial accounts prepared based on the accounting concepts should be capable of being understood by the users are expected to have reasonable background in financial reporting and are assumed to have reasonable knowledge of the reporting entity .
Financial accounts should present reliable information to the users for decision making.
The financial account information is reliable if
It reflects the substance of transaction to present faithfully and truly what has already happened
It is free from bias and neutral
It is free from error
It is complete of required account information
It is prudent and realistic where there is any uncertainty
If the above stated points are not fulfilled, the financial account information is not reliable for the decision making of user.
Stakeholders should be given enough information to be able to compare the activities of an organization with other similar organizations. Besides that, this establishes benchmarks to use in judging how well the organization is performing in comparison to others. It may also help stakeholders to decide which entity they prefer to deal with. Stakeholders should also be able to identify trends by comparing the similarities and differences between the activities of the same organization over several accounting periods. Thus, the financial accounts made based on accounting concepts should be comparable with the previous year accounts and comparable with the accounts of other companies.
Relevance implies that information contained in financial statements must have an impact on the decisions of users when they make economics decisions about the entity. The financial accounts prepared based on accounting concepts and policies should present relevant financial information which is capable of influencing the economic decision of the users. Therefore, the information presented by the financial accounts should be relevant to the decision making of the users.
Whether the financial account information is relevant or not to the decision making of users, it depends on whether the financial accounts are made to present information in time or not when it is needed for decision making. If the accounts are prepared to provide required information in time, it is relevant to the decision making of the user. If the accounts are not prepared to provide information in time, it is not relevant to the decision making of the user.
2.2 Conclusions & Recommendations
As a conclusion, the different users such as managers of the company, customers, suppliers, tax authorities and investors need accounting information about the company's financial situation to derive financial information for their needs. Furthermore, in order to provide a useful financial statement to users, the 5 elements such as reliability, relevance, comparability, timely, and understandability should exist in the financial statement. Company should seek to satisfy the following criterias when selecting and adopting the accounting concepts in preparing business financial accounts.
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 RM 65000 < net resale value RM 70000, the cost RM 65000 should be closing stock value put in the trading account of income statement and under the current asset in balance sheet.
3.1 Working for note (b) of question:
Sales (Difference) 5000 Purchase 4000
Sales in trading account statement = RM 360000 from TB + RM 5000 = RM 365000
Purchase in trading account of income statement = RM 200000 from TB + RM 4000 = RM 204000
Stationery as expense put in P/L account of income statement = RM 700
Electricity & water in P/L account of income statement = RM 7000 from TB + RM 300 = RM 7300
3.3 Working for note (c) of question:
Sales commission as expense put in P/L account of income statement = RM 18000 paid from TB + RM 1500 accrued at end of year = RM 19500
Then, accrued sales commission RM 1500 is recorded under the current liability in balance sheet.
Office salaries as expense put in P/L account of income statement = RM 28000 paid from TB - RM 2000 prepaid at end of year = RM 26000
Then, prepaid office salary RM 2000 is recorded under the current asset in balance sheet.
3.4 Working for note (d) of question:
Balance b/d (from TB) 7500 0 (-) Bad debts 5000
Balance c/d 70000
Balance b/d 70000
Bad debts account
Debtor 5000 P/L account 5000
(Bad debts as expense put in P/L account)
Provision for bad debts closing balance = 10% x Debtor closing balance RM 70000 = RM 7000
Provision for bad debts account
31 Dec 2010 Closing balance c/d 7000 1 Jan 2010 Opening balance b/d 5000
Increase difference 2000
(As expense put in
1 Jan 2011 Balance b/d 7000
(Deducted from debtor under current asset in balance sheet)
3.5 Working for note (e) & (f) of question:
Balance b/d (from TB) 300000 Vehicle disposal a/c 50000
Balance c/d 250000
Balance b/d 250000
(Vehicles at cost put under fixed asset in balance sheet)
Provision for depreciation on vehicles account
Vehicle disposal account 12500 1 Jan 2010 Opening balance b/d 60000
(Cost sold RM 50000 X 5% X 5years Depreciation as 12500
from 1 Jan 2005 to 1 Jan 2010) expenses put in P/L account (Vehicles closing balance RM 250000x5%)
31 Dec 2010 Balance c/d 60000
1 Jan 2011 Balance b/d 60000
(Deducted from vehicle cost under fixed asset in balance sheet)
Vehicle disposal Account
Vehicle cost sold 50000 Provision for depreciation 12500
on vehicle sold
Proceeds from disposal of 35000
Difference for Loss on 2500
disposal of vehicles
( As expense put in P/L account)
Provision for depreciation on premises account
Balance c/d 54000 1 Jan 2010 Opening balance b/d 40000
Depreciation as expense put in 14000
(Premises cost RM 350000x4%)
Balance b/d 54000
(Deducted from premises cost under fixed asset in balance sheet)
3.6 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.
3.7 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.
3.8 Income Statement of Continental Limited for year ending 31 Dec 2010 for internal use
RM RM RM
(-) Return inwards (10000)
Net sales 355000
(-) Cost of sales:
Opening stock 50000
(+) Purchases 204000
(-) Return outwards (15000)
(+) Carriage inwards 5000 194000
(-) 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 vehicles 2500
Depreciation on vehicles 12500
Depreciation on premises 14000
Vehicles expenses 12000
Interest charge 3000 104500
Net profit 76500
(-) Taxation charge (15300)
(-) Proposes dividend (10000)
Profit for the year 51200
(+) Retained earnings brought forward 100000
Retained earnings carried forward 151200
3.9 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 for depreciation on vehicles (60000) 190000
Long-term investment 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
Shareholders' equity 651200
(+) Long-term liabilities/ Non-current liabilities
(+) Current liabilities
Accrued sales commission 1500
Accrued taxation 15300
Proposed dividend 10000 51800
4.0 Distribution Costs and Administrative Expenses
Distribution costs 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 vehicles 2500 --
Depreciation on vehicles 12500 --
Depreciation one premises -- 14000
Vehicles expenses 12000 --
Total 53500 48000
4.1 Income statement of Continental Limited for year ending 31 Dec 2010 for external reporting
Cost of sales (179000)
Gross profit 176000
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 the year ending 31 Dec 2010 for external reporting
RM RM RM
Long term investment 100000
Prepaid office salary 2000
Cash at bank 42000
(-) 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
(-) Creditors: Amounts Falling Due After More Than One Year
Capital and Reserves
Called up share capital 500000
Profit and Loss account 151200
5.0 Table of ration calculation
Ration with formula
Ration calculation for year 2010
Percentage of gross profit on sales
= Gross profit / Net profit x 100
176000 / 355000 x 100 = 49.57%
Percentage of operating profit on sales
= Operating / Net profit x 100
74500 / 355000 x 100 = 20.99%
Return on capital employed
(76500+3000)/706200 x 100% = 11.26%
= Current asset / current liabilities
172000 / 51800 = 3.32:1
Stock turnover period
= 365 days / stock turnover
365days/stock turnover in times
Debtors collection period
= Debtor ratio x 365days
63000 / 355000 x 365 days = 64.7 days
Creditor payment period
= creditor ratio x 365 days
25000 / 189000 x 365 days = 48.28 days
5.0.1 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
5.0.2 Working for (f)
Debtor collection period = (debtor / net credit sales) x 365 days
= [63000 / (365000-10000)] x 365 days
= (63000 / 355000) x 365 days
= 64.7 days
5.0.3 Working for (g)
Creditor payment period = (creditor / net credit purchase) x 365 days
= (25000 / 189000) x 365 days
= 48.28 days
5.1 Profitability of Continental Limited
(a) Percentage of gross profit on sales in the ratio calculation for year 2010 which is 49.57% higher percentage than the industry average 30%. With this statistic, it shows that the gross profit on sales in ratio calculation for year 2010 is more effective and efficient than the industry averages, because it can control its purchase cost by making the purchase at lower cost from supplier and efficient in controlling its production cost by the effective use of materials and labour to reduce its production cost rather than industry average.
(b) Percentage of operating profit on sales in the ratio calculation for year 2010 is 20.99% which is 18% higher than industry average. From the ratio comparison, the higher expenses to sales ratio shows that company is ineffective in its expenditure control causing higher expenses incurred to reduce its net profit earning. Conversely, the industry average ratio is low expense to sales ratio indicates that company is effective in costs control causing lower expenses result in increasing its net profit earning.
(c) Return on capital employed (ROCE) in the industry average is 9% and the ROCE in the ratio calculation 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 return on capital employed indicates higher net profit generated from the capital employed in production and business activities to increase the production and sales volume as well as to increase the net profit earning. Besides, the lower of the industry average is low return on capital employed indicates low net profit generated from the capital employed for ineffective use of capital employed in production and business activities to reduce production and sales volume as well as to reduce net profit earning.
5.2 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. The current ratio is a widely used measure for evaluating an entity's liquidity short-term debt-paying ability. (Chalmers, et al., 2007, p.795) Due to this, 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. Stock turnover measures the number of times on average the inventory sold during the period. (Chalmers, et al., 2007, p.798) Generally, the faster the inventory turnover, the less cash that is tied up in inventory and the less the chance of inventory obsolescence. Thus, it may cause 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 period for year end 31 December 2010 indicate that company has given longer credit time to allow debtor owning, causing longer time taken by company to collect money slowly from debtors, so that larger debtor balance is accumulated to tie up money, bringing to shortage of money for paying back liabilities and facing short-term financial problem.
(g) The result ratio for year ended 31 December 2010 is 48.28 days which is shorter than the industry average which is 60 days. Therefore, 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 time which will be causing smaller creditor accumulated and short-term financial problem for shortage of money to pay back creditor.
5.3 Conclusions and recommendations
Ratio Analysis expresses the relationship among selected items of financial statement data. A ratio expresses the mathematical relationship between one quantity and another. (Chalmers, et al., 2007, p.794) Profitability ratio is used for measuring the profit or operating success of an entity for a given period of time. It will be affected by changes in expenses ratio, gross profit margin and so on. While liquidity ratio is refers to measure the short-term ability of the entity to pay its maturing obligations and to meet unexpected needs for cash. In another word, liquidity is the ability to pay bills when they are due and to meet unexpected needs for cash. (Caldwell, et al., 1990, p.807) Liquidity ratio will be affect by changes in current ratio, inventory turnover and so on.
6.0 Conclusions and Recommendations
In my opinion, accounting information is very important for the accounting users such as managers of the company, customers, suppliers, tax authorities and investors. They need accounting information about the company's financial situation to derive financial information for their needs. Furthermore, the criterias such as relevance, timely, reliability, comparability and understandability must be fulfilled to make the financial statements and accounts that are useful to the users. Moreover, income statement and balance sheet also very significant to accounting users. Income statement is a financial statement that summarizes the amount of revenues earned and expenses by a business over a period of time. (Caldwell, et al., 1990, p.24) while balance sheet is prepared to show the financial position of the business with respect to its assets, liabilities and owner's equity at that date. (Li, et al., 2001, p.235) Last but not least, an entity's liquidity and profitability is dependent on its efficient management of inventory and debtors. (Chalmers, et al., 2007, p.809) The interrelationships between ratios are depicted, see Appendix A. This provides a useful template to use when conducting ratio analysis.