The Industry Averages Provided For Comparison Accounting Essay

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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 2012 for the internal use by company directors and management and also in the accepted format for external reporting or publication. You are given the company records as follows:

Trial Balance as at 31 Dec 2010

RM

Opening stocks 1 Jan 2010

50000

Sales

360000

Purchase

200000

Return inwards

10000

Return outwards

15000

Carriage inwards

5000

Office salaries

28000

Office electricity & water

7000

Sales commission

18000

Vehicle expenses

12000

Interest charges

3000

Dividends received

5000

Office premises at costs

350000

Vehicles at costs

300000

Provision for depreciation 1 Jan 2010

: Office premises

40000

: Vehicles

60000

Bank

42000

Trade debtors

75000

Provision for bad debts 1 Jan 2010

5000

Proceeds from disposal of vehicle

35000

Trade debtors

25000

Loan

55000

Capital

500000

1200000

1200000

Other information provided as follows:

Closing stocks at 31 Dec 2010 were valued at cost RM65000 and net resale value RM70000.

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.

Task 1

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 users.

Task 2

Prepare the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010 for the internal use by company directors and management. Show the necessary workings.

Task 4

Based on the income statement and balance sheet made in task 2, 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.

Followings are the Industry Averages provided for comparison

: Percentage of gross profit on sales 30%

: Percentage of operating profit on sales 18%

: Return on capital employed (ROCE) 9%

: Current ratio 2: 1

: Stock turnover period 90 days

: Debtors collection period 45 days

: Creditors payment period 60 days

References:

Frank Wood & Alan Sangster, Business Accounting 1, 10th edition, 2005, Prentice Hall, UK Koh Seng Tiam & Lian Koh, Financial & Managerial Accounting Volume 2, 2nd edition, 1997, Fajar Bakti, Malaysia.

Certified Accounting Technician, Drafting Financial Statements, 2nd, 2004, BPP Professional Education, UK.

Table of Content

TITLE

PAGE

Introduction

Task 1

Task 2

Task 4

Conclusion

Bibliography

Introduction

Accounting can be defined as the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information. Accounting began because people needed to record business transactions, know if they were being financially successful, and know well in their cash flow.

Accounting has many objectives, including letting people and organization know if they are making a profit or a loss, what their business is worth, what a transaction was worth to them, how much cash they have, how wealthy they are, how much they are owed, how much they owed to someone else, and enough information so that they can keep a financial check on the things they do. However, the primary objective of accounting is to provide information for decision-making.

Accounting is something that affects people in their personal lives just as much as it affects very large businesses. We all use accounting ideas when we plan what we are going to do with our money. We have to plan how much of it we will spend and how much we will save. We may write down a plan, known as a budget, or we may simply keep it in our minds.

Accounting is concerned with the recording data, classifying and summarizing data, and lastly communicating what has been learnt from the data.

Task 1: 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 users.

Businesses report information in the form of financial statements issued on a periodic basis. There is requires the four financial statements which are balance sheet, income statement, statement of owner's equity and statement of cash flows. Balance sheet is the statement of financial position at a given point in time. Besides that, income statement is the revenues minus expenses for a given time period ending at a specified date. Statement of owner's equity also known as statement of retained earnings or equity statement whereas statement of cash flows is help to summarizes sources and uses of cash; indicates whether enough cash is available to carry on routine operations.

There are a few of users of financial statements and they need the financial statements for running their work. First of all, there is investors group of the business. This group would comprise both existing and potential shareholders. They would consider whether to invest or disinvest in the business. Equity investors consider two elements to their investment, income and gain. Income is in the form of dividends and gain is in the form of share price. If the investor takes a short-term view then current dividends are of interest whereas a longer-term view would concern future earnings. A guide to the future can to some extent be seen in company reports with the chairman's statement, although based on current performance; company forward strategy is often included. The investor group would also be interested in profitability and its trend over a period of time.

Besides that, the employees in the company also are included as the users of financial statements. It is encouraging to note that some companies produce a separate employees report. Employees and their representatives require information on business performance for two principal reasons which are wage and salary negotiation, 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.

Lenders are also one of the users of financial statements in the company. This is often referred to as the loan creditor group. It would include the long, medium and short term lenders of money. The concern of the existing and/or potential loan creditor is "will they get their money back?" A short-term loan creditor will immediately consider cash flow and the Cash Flow Statement. 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.

Suppliers are the group that comprises the trade creditors an important element in the supply of a business's working capital. 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. An interest in the company's future strategy is also likely as they would need to consider how they, as suppliers, fit with the strategy.

Customers also consider as the users of financial statements. This group will be interested in the business's short and longer term financial stability and its potential to supply high quality goods and services, with where appropriate, sound after sales service. They may also have interest in the environmental policy of the business.

The government departments require published financial information for the purposes of taxation - company taxation and VAT (Value Added Tax).The government are decision makers and their forward 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.

The public are often referred to as "shareholders" and businesses do not exist solely in isolation. Businesses are part of society at large and as such generate much public interest. At local and national level factors as employment and the environment are often key interests. Some of these issues are included in their financial information and longer term strategy.

As the understanding there is different users require financial information for assistance in their economic decisions. Entities publish financial statements so that users can get their information needs fulfilled. The dependence of users' economic decision on financial statements is crucial and if the financial information is not accurate or is not true and fair then users may end up making wrong decisions. Therefore, financial statements need to have certain qualitative characteristics in order to be useful to its users which are understandability, relevance, reliability and comparability.

Users cannot use such financial information that they cannot understand. Problems in understanding may arise due to user's inabilities or because of the information itself. Definitely entity cannot do anything about users and it's upon the user to have at basic level of understanding about financial statements. Also, users are not required to be professional accountants and that is why where we expect to have complex information then it's neither fault on part of user nor from the side of the entity preparing financial statements. However, entity can present information in such a manner that it helps in understanding. Also with proper explanation financial statements can be made more understandable. Therefore, entity is required to take reasonable measures in order to make financial statements easy to understand. However, it does not mean that complex information which is also of material nature should be excluded from the financial statements on the basis that it is creating problems in overall understandability of financial statements.

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 such as making correct decisions. Information is also said to be relevant when it is capable of confirming or correcting the existing thought process and information. Information may be considered relevant either because of its nature (e.g.: employee benefit expenses) or because it is material. Financial information is material if its omission could affect the economic decisions of users.

Information is reliable when it is dependable and this is possible if it is free from errors, especially material errors. Besides that, it is complete and free from bias. 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. There are many other factors that contribute towards the reliability of the financial information. In view of the inherent difficulties in identifying certain transactions or in finding appropriate methods of measurement or presentation, financial statements cannot be perfectly "accurate", hence faithful representation might be regarded as describing the closest that accountants can come towards the absolute of total accuracy. Reliability is enhanced when few of principles are observed in the preparation of financial statements which are substance over form, neutrality, prudence and completeness.

Comparability of information refers to its ability to stand useful overtime and against the financial information from other sources. Users cannot evaluate different aspects of entity's financial position and financial performance if they are unable to compare the financial information of one period with another or financial information of one entity with another entity's financial information. In order to have comparable information entities prepare their financial statements by following a uniform pattern of presentation which is usually as instructed by the International or Local Accounting Standards and after they adopt a particular style they remain consistent in its application. However, comparability does not require that one stays uniform even if there are other ways to make financial statements even more reliable and relevant.

By the above discussion we can observe one fact that all four principal characteristics are interrelated and higher level is achieved in one area at the expense of the other. For example, in order to make financial statements more reliable entity may include such financial information which is complex thus higher level of reliability is achieved at the expense of understandability. It is the responsibility of the management to have an optimum mix of all four important qualitative characteristics of financial statements. The Accounting Framework defines qualitative characteristics of financial statements as "the attributes that make the information in financial statements useful to users." The four principal attributes rely on fundamental accounting assumptions such as consistency and fair presentation.

As a conclusion, it is important to know and understand the theoretical framework for accounting. Sometimes, accounting students ignore this in favor of methods. It is also noteworthy that sometimes a trade-off exists between or among these attributes (a classic example being prudence versus accruals). In such cases, a financial accountant usually exercises discretion in resolving such conflicts.

(1488 words)

Task 2: Prepare the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010 for the internal use by company directors and management. Show the necessary workings.

Continental Limited

Income Statement as at 31 Dec 2010

 

RM

RM

Sales

 

360,000

Return Inwards

 

(10,000)

 

 

350,000

Less Cost of Goods Sold :

 

 

Opening Stocks

50,000

 

Purchases

200,000

 

Closing Stocks

(65,000)

 

Return Outwards

(15,000)

 

Carriage Inwards

5,000

 

 

 

(175,000)

Gross Profit

 

175,000

Dividend Received

 

5,000

 

 

180,000

Proceeds from Disposal of Vehicles (35,000-3,000)

 

32,000

 

 

212,000

Less Expenses :

 

 

Office Salaries (28,000-3,000)

4,000

 

Office Electricity & Water

26,000

 

Sales Commission (18,000+1,500)

19,500

 

Goods

4,000

 

Vehicles Expenses

12,000

 

Interest Charges

3,000

 

Stationery

700

 

Electricity Bill

300

 

Provision for Bad Debts

7,000

 

Depreciation : 1). Office Premises

15,000

 

2). Vehicles

14,000

 

 

 

(108,500)

Net Profit

 

103,500

Continental Limited

Balance Sheet as at 31 Dec 2010

 

RM

RM

Fixed Assets

 

 

Office Premises

350,000

 

Depreciation

(54,000)

 

 

 

296,000

Vehicles

300,000

 

Depreciation

(75,000)

 

 

 

225,000

 

 

521,000

Current Assets

 

 

Trade Debtors

70,000

 

Provision for Bad Debts (5,000+7,000)

(12, 000)

 

 

 

58,000

Stocks

 

65,000

Bank (42,000-3,000)

 

39,000

Prepayment

 

2,000

Total Assets

 

685,000

Current Liabilities

 

 

Trade Creditors

25,000

 

Accrued

1,500

 

 

26,500

 

Long-term Liability

 

 

Loan

55,000

 

Total Liabilities

 

(81,500)

Net Assets

 

603,500

Capital

 

500,000

Net Profit

 

103,500

 

 

603,500

Task 4

Based on the income statement and balance sheet made in task 2, 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.

Followings are the Industry Averages provided for comparison

: Percentage of gross profit on sales 30%

: Percentage of operating profit on sales 18%

: Return on capital employed (ROCE) 9%

: Current ratio 2: 1

: Stock turnover period 90 days

: Debtors collection period 45 days

: Creditors payment period 60 days

1).

Percentage of Gross Profit on Sales =

Gross Profit

x 100

Sales

175,000

x 100

360,000

49%

2).

Percentage of Net Profit on Sales =

Net Profit

x 100

Sales

103,500

x 100

360,000

29%

3).

ROCE

(Return On Capital Employed) =

Net Profit

x 100

Capital Employed

103,500

x 100

500,000 + 603,500

103,500

x 100

1,103,500

9%

4).

Current Ratio =

Current Asset

Current Liability

174,000

25,000

6.96 : 1

5).

Stock Turnover =

Sales - Gross Profit

x 30 Days

(Opening Stock + Closing Stock) / 2

360,000 - 175,000

x 30 Days

(50,000 + 65,000) / 2

185,000

x 30 Days

115,000 / 2

185,000

x 30 Days

57,500

3.21 x 30 Days

96 Days

6).

Debtors Collection Period =

Debtor

x 365 Days

Sales

70,000

x 365 Days

360,000

0.19 x 365 Days

69 Days

7).

Creditors Collection Period =

Creditors

x 365 Days

Purchases

25,000

x 365 Days

360,000

0.069 x 365 Days

25 Days

From the calculation of the accounting ratio above, observed that the percentage of gross profit on sales and the percentage of net profit on sales of Continental Limited is higher than the one in Industry Averages which is 30% and 18 % ; 49% and 29% respectively. This is proved that Continental Limited is gain higher profit than the Industry Averages. This may because of the performance of the employees and the level of output is different.

Besides that, the ROCE (Return on Capital Employed) for both Continental Limited and Industry Averages is the same which is 9%. This may say as the decision making on investment for both industry and Continental Limited is almost the same and accurate.

Current ratio of both industry and Continental Limited also quite high which is 2:1 and 6.96:1 respectively. The higher the current ratio, the more capable the company is of paying its obligation. So, Continental Limited is more capable to pay back its short-term liabilities than Industry Averages. This may because of Continental Limited have higher ability to manage the financial problems and to get the best solution for it.

Stock turnover period of Industry Averages and Continental Limited is difference of about six days which is 90 days and 96.3 days respectively. This is means that Continental Limited needs to use longer time period to sell out their stocks compared to Industry Averages. This may because of the lack of training for the employees in the marketing department in the company.

The debtors' collection period and creditor's payment period for both companies have greater difference compared to others accounting ratio had explained above. The debtors' collection period and creditors' payment period of Industry Averages are 45 days and 60 days respectively. However, the Continental Limited has the amount of 69 days of debtors' collection period and 25 days of creditors' payment period.

(311 words)

Conclusion

As a conclusion, accounting provides information for a wide variety of different users and purposes, and its practices can only be properly understood and assessed in relation to the economic and social environment in which they are applied. There is a few aspects in accounting which are the techniques for recording, calculation, classification and reporting of accounting information. Besides that, the legal and institutional background associated with accounting information and the economic and administrative problems which the information is required to solve also are the important aspects.

Accounting follows a certain framework of core principles which makes the information generated through an accounting system valuable. Without these core principles accounting would be irrelevant and unreliable. These principals include: Accrual Concept, Going Concern Concept, Business Entity Concept, Monetary Unit Assumption, Time Period Principle, Revenue Recognition Principle, Full Disclosure Principle, Historical Cost Concept, Matching Principle, Relevance and Reliability, Materiality Concept, Substance over Form, Prudence Concept, Understandability Concept, Comparability Principle and Consistency Concept. These principles are the building blocks that form the basis of more complex and specialized principles called GAAP or generally accepted accounting principles such as the International Financial Reporting Standards, US GAAP, etc. They deal with matters like accounting for revenue, accounting for income taxes, accounting for business combinations, etc.

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