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Principle of Accounting is a service activity and it concerned with collecting, analysing and record the financial transactions of the business. Accounting can informed decision and make financially smart. Besides that, according to American Accounting Association mention that "the process of identifying, measuring and communicating economic information to permit informed judgments and decision by user of the information!" However, accounting information should be useful to anyone wishing to make decisions and plan about business, it including those who control and manage them.
In this Principle of Accounting assignment, it contains 4 tasks. In task 1, it is define the five different account users and their need for Continental Limited financial statements. Besides that, it also defines the five regulatory characteristics of these financial statements that will provide useful information to the users.
In task 2, the author need find out all the data and use the trial balance to calculate the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010.
However, in task 3 is to prepare the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010 in the accepted format for external reporting or publication.
At last, in task 4, it need use the task 2 and 3 income statement and balance sheet to 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.
2.0 Accounting user
Accounting information is helps the users to make better financial decision. Besides that, in accounting user, it define into two categories, one is the internal users while another is external users. The internal user is mean that the people within the organization and it usually in the form of budgets, financial statement and management account. In the other side, the external users is means that the people outside the organization and it usually in the form of financial statement. All this is use account to derive financial information for their needs.
2.1 The five different users
The five different users and their need for the Continental limited financial statement is manager of the company, employees of the company, investors, suppliers or creditors and customers or debtors. Besides that, in these five different users, it has 2 type of user. One is external users while another is internal users. In these five different users, manager of the company and the employees of the company are classifying at internal users while supplier or creditors, customers or debtors and investors are classify at external users.
So, the author will describe these five different users and their need for Continental Limited financial statement. First, managers of the company is analyzes the feasibility of their investment and they need accounting information about the company's financial situation and determine any future course to enable them to manage the business efficiently. However, it also to help them to make decision and plans for the business and to help them to exercise control to try to ensure that plans come to fruition. Besides that, employee of the company is the people employed by the company to carry out the business activities. They need accounting information about stability of the company because their future careers and salary are depending on it.
Normally, investor is for analyzing the possibility of investing in that company. This means that they need accounting information to know whether it is worth for them to invest their money in the business or buying shares of the Continental Limited. However, customers or debtors are purchase goods or services provided by the company. They may be dependent on the business for certain product or service. They also need accounting information about the company financial stability to survive and prosper. The last user is suppliers or creditors. They are provided trading goods and services to the company on credit. Suppliers and creditors need accounting information that help them understand the company's ability to pay its debts and assess the short-term liquidity of the business.
2.2 The five regulatory characteristics of the financial statement
It has five regulatory characteristics of these financial statements that will provide useful information to the users. The five regulatory characteristics are relevance, understandability, accuracy, reliability and comparability. These are the characteristics of useful financial statement. Besides that, these criteria must be fulfilled to make the financial statement and account that are useful to the users. So, the author will define all these five regulatory characteristics.
First, relevance is the financial account prepare base on the accounting concept and it should impact to the decision making need of the users that peruses the information. However, to be relevant, information be suppose available in time and help in predict. Therefore, the information presented by the financial accounts should be relevant to the decision making of the users. The next characteristics is understandability, it is refer to the quality of the financial information which make it understood by the users who have reasonable knowledge of business, accounting and economic activities. Besides that, understandability is requires the information presented in financial report to be clear and complete.
Accuracy is one of the characteristic that provide accurate financial information to the users for decision making. This is because, the inaccurate financial information will lead to inaccurate decision make by the users. However, the other characteristic of this financial statement is reliability; it is present reliable information to the users for decision making. The information is reliable if it is free from error and faithfully represents what it seeks to represent. Besides that, it is complete of required account information and realistic where there any uncertainty. Therefore, if all this stated points are not fulfilled, the financial account information is not reliable for the decision making of the user. The last characteristic of this financial statement is comparability; it is base on the accounting concepts should be comparable with the previous year account and comparable with the account of the other company and it is very important.
3.0 Income statement and balance sheet of Continental Limited
In this task, the author needs to find out all the data and collect it to calculate the income statement and balance sheet of Continental Limited. So, the author need to the following workings before preparing income statement and balance sheet. This income statement and balance sheet is prepared for internal use.
Working for note (a)
Closing stock should be recorded at cost or not 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 the balance sheet.
Working for note (b)
Sales (Difference) 5000 Purchase 4000
Sales in trading account of income statement =RM360000 from TB + RM5000 =RM365000
Purchase in trading account of income statement =RM200000 from TB + RM4000 =RM204000
Stationery as expense 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)
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)
Balance b/d (from TB) 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
(As expense put in P/L account)
1 Jan 2011 Balance b/d 7000
Working for note (e) and (f)
Balance b/d (from TB) 300000 Vehicle disposal a/c (cost sold) 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 60000
Depreciation as expense put in P/L 12500
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 12500
Proceeds from disposal 35000
of vehicle (TB)
Difference for Loss on disposal 2500
Provision for depreciation on premises account
Balance c/d 54000 1 Jan 2010 Opening balance b/d 40000
Depreciation as expense put 14000
in P/L account
Balance b/d 54000
Working for note (g)
Taxation charge RM 15300 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)
Proposed dividend to be deducted from net profit at the bottom of income statement
=2% x RM500000 Share capital from TB =RM10000
Then, the proposed dividend RM 10000 is recorded under current liability in balance sheet.
3.1 Income statement of Continental Limited for year ending 31 Dec 2010 for internal use
RM RM RM
Sales (RM 360000 + RM 5000) 365000
Less Return inwards (10000)
Net sales 355000
Less Cost of sales / Cost of goods sold:
Opening stock 1 Jan 2010 50000
+Purchase (RM 200,000 + RM 4,000) 204000
-Return outwards (15000)
+Carriage inwards 5000 194000
-Closing stock (65000) (179000)
Gross profit 176000
Dividend received 5000_
Office electricity & water (RM 7000 + 300) 7300
Office salaries (RM 28000 - RM2000) 26000
Sales commission (RM 18000 + RM 1500) 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
Vehicle expenses 12000
Interest charges 3000
Net profit 76500
Less Taxation charge (15300)
Less Prepaid dividend (10000)
Retained profit for the year 51200
+Retained earnings brought forward 100000
Retained earnings carried forward 151200
3.2 Balance sheet of Continental Limited as at 31 Dec 2010 for internal use
RM RM RM
Fixed assets/Non-current assets
Office premises at costs 350000
-Provision for depreciation on premises (54000)
Vehicles at cost 250000
-Provision for depreciation on vehicles (60000)
Long-term investments 100000_
Closing stock 65000
Trade debtors 70000
-Provision for bad debts (7000)
Prepaid office salary 2000
Issued share capital:
Share capital 500000
Retained earnings (carried down from income statement) 151200
Long-term liabilities/Non-current liabilities:
Trade creditors 25000
Sales commissions accrued 1500
Taxation accrued 15300
Proposed dividend 10000_
4.0 Income statement and balance sheet of Continental Limited in accepted format for external reporting or publication.
Income statement generally contains information about profits, operating cost and net income as that information has been gathered for a stated period of time. Net income occurs when profits exceed operating cost. A net loss happens when operating cost exceed profits. In addition, balance sheet is a statement of a company financial condition. Besides tha, this income statement and balance sheet is prepared for external reporting.
Distribution cost Administrative expense
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 vehicle 12500 -
Depreciation on premises - 14000
Vehicle expenses 12000 -
Total 53500 48000
Income statement of Continental Limited for year ending 31 Dec 2010 for external reporting
Net sales / Turnover 355000
Cost of sales (179000)
Gross profit 176000
Less Distribution cost 53500
Administrative expenses 48000
Operating profit 74500
Dividend received 5000_
Interest charges (3000)
Profit on Ordinary activities before taxation 76500
Taxation charges on profit (15300)
Profit on Ordinary activities after taxation 61200
Dividend Proposed (10000)
Retained profit for the year 51200
Retained earnings brought forward 100000
Retained earnings carried forward 151200
Balance sheet of Continental Limited for the year ending 31 Dec 2010 for external reporting
RM RM RM
Tangible Fixed Assets:
Long term investment 100000
Prepaid office salary 2000
Cash at bank 42000
Creditors: Amount falling due within one year
Accrued sales commissions 1500
Accrued taxation 15300
Proposed dividend 10000
Net current assets 120200
Total assets less current liabilities 706200
Creditors: Amount due after more than one year
Capital and Reserves
Called up share capital 500000
Profit and loss account 151200
5.0 The appropriate accounting ratios and compare them with the industry averages
Accounting ratios are the expressed and counted based on accounting figures derived from financial statements or final accounts of firm. Accounting ratios are used to interpret financial statements for assessing the business performance of the firm. Besides that, accounting ratio can be compared between companies, industries, different time periods for a company and a particular company and its industry average.
5.1 Table of ratio calculation
Ratio With Formula
Ratio Calculation for Year 2010
Percentage of Gross Profit on Sales:
Percentage of Operating Profit on Sales:
Return on Capital Employed (ROCE):
Stock Turnover Period:
= 3.11 times
= 117.36 days
Debtors Collection Period:
Creditors Payment Period:
5.2 Profitability of Continental Limited
The Percentage of Gross Profit on Sales for the Continental Limited is 49.58% higher than the industry averages that is 30%. The higher gross profit on sales indicates the higher gross profit earned by the Continental Limited from the sales made. It shows that the Continental Limited is effective and efficient in controlling the purchase cost by making the purchase at lower cost from supplier and it is in controlling the production cost by the effective use of material and labor to reduce the production cost as well as to increase the gross profit. Besides that, the Percentage of Operating Profit on Sales for the Continental Limited is 20.99% higher than the industry averages that is 18%. The higher Operating profit on sales indicate higher net profit earned by the Continental Limited from the sales made for effective control on expenditure, incurring lower expenses to increase the net profit earning, evidenced by lower expenses to sales ratio. However, the Return on Capital Employed (ROCE) for the Continental Limited is 11.26% higher than the industry averages that is 9%. The higher return on capital employed indicates higher net profit generated from the capital employed for the effective use of capital employed in production selling activities to increase the production and sales volume as well as to increase the net profit earning.
5.3 Liquidity of Continental Limited
The Current Ratio for the Continental Limited is 3.32:1 higher than the industry averages is 2:1. It is larger current assets can be used to finance current liabilities, indicating that the Continental Limited is financially stable and able to finance its short-term debts. The Stock Turnover Period for the Continental Limited is 117.36 days higher than the industry average is 90 days. The higher stock turnover period indicate a fast stock turnover by the Continental Limited where the goods purchased are fast taken out from stock to sell so that the stock is not accumulated and money is not tied up with the stock.
Besides that, the Debtors Collection for the Continental Limited is 64.6 days higher than the industry averages is 45 days. The higher debtor's collection period indicate that Continental Limited has given longer credit time to allow debtor owes, and it will cause longer time taken by Continental Limited to collect money slowly from debtors so that larger debtor balance is accumulated to tie up money and facing short-term financial problem. In addition, The Creditors Payment Period for the Continental Limited is 48.18 days lower than the industry averages is 60 days. The lower the creditor's payment period indicate that Continental Limited has obtained shorter credit time for owing and paying to creditors so that Continental Limited needs to pay back the creditor very fast, and it will cause smaller creditor balance accumulated and short-term financial problem for shortage of money to pay back creditor.
6.0 Conclusion and Recommendation
When doing this assignment, I can learn how to prepare the income statement and the balance sheet. Besides that, I know the five different users and the five regulatory characteristics. However, I know how to calculate the appropriate ratios and compare them with the industry averages provided to assess the profitability and liquidity of Continental Limited. So, in my conclusion, accounting is a service activity and it is very important for all business. This is because, it concerned with collecting, analysing and record the financial transactions of the business.