The Legal Requirement For Financial Reporting Accounting Essay

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Financial statements are very important for managers. It helps them to make many internal and external decisions. So, financial statements should be very accurate and reliable to managers. Any kind of financial decision is very sensitive to the organization. It also helps managers to be more effective and work in the company, competing with the other companies among the industry and even in the international aspects. Financial specialist also helps the managers by many financial tools. It helps manager to make decision about any financial or investing decision using capital budgeting and working capital managing tools.

Requirement 1:

The purpose of financial record keeping:

For all company even for individual record keeping is very important. There are some reasons and purposes of keeping financial records.

The main reason for keeping financial records is to help in any further decision making of the company. Company can make better decision about their further spending, savings and investment.

Again for any legal reasons, it is very important to keep records. Some cases these records are presented as proves.

Many kinds of stake holder are related with the company. They use the information of the company very frequently. So record keeping is very necessary to company for providing them.

Records are also needed any kinds of internal decision making purpose of the managers or board of directors.

Requirements for keeping financial records:

The records that are kept should be kept meaningfully. Like for a company, they should keep records in various forms. They are: a cash book statement, banks account statements and bank related documents, employment records, sales record, purchase records, expanse records, depreciation records, capital gains details, stock hand details debtor creditor list etc.

Technique for recording financial reporting analyses:

There are some basic techniques for financial reporting analyses. The financial recorded should be done by regular basis. The financial statement should be publishing after a certain time period like quarterly, semi-annually or annually. Sometimes company recruit external accountant along with the internal one. Financial Statements should be audited.

The legal requirement for Financial Reporting:

It is very important to reporting financial statement under common law. Side by side the company should follow IRS (International Reporting Standard) and GAAP (General Accounting Accepted Principles). There are two issues that should be taken care of.

Scandals: When there is any Scandal of the company arises then it is financial reporting that helps company to move out.

Complexity: The more the company extended the more the complexity come. So, to be simple and clear company should use general standard and keep all records.

Organizational requirement for Financial Reporting:

There are different kinds of organization. The ways of their keeping records are also different. Like, in case of sole proprietary organization it is not required to maintain all the standards and follow GAAP. They just keep a record. For the partnership business there are partnership deed, they follow the deed and partnership law to maintain their financial records. But companies follow the laws, accounting standards and principals very strictly.

Usefulness of Financial statement to stake holders:

There are different stake holders for a company. They use company's financial statement for different reasons.

Shareholders, investors, security analyst: They use the financial statements for investment decision making purpose. They use it to ensure the minimization of wastage of fund and to manage portfolio.

Managers: The manager of the company takes many important decisions based on financial statements. They want to reduce the agency conflict. Some cases they use it as they get some portion of profit or stock option.

Employee: They want to know their salaries as company expanses. Sometimes employees get the portion of the profit, so they use it.

Lender and suppliers: There are huge amounts of their money stuck in the company. So they want to know the use of their money. The investment and profit is very important to them.

Customers: They are the core component of any company. The sustainability of the company is very important to them.

Government and regulatory agency: They always keep eyes on the financial statements of the companies for maintaining rules and regulation and the betterment of the economy.

Difference between management and financial accounting:

The differences between management and financial accounting are:

Managerial accounting helps in inter organization decision making where as financial accounting helps to take decisions both internally and externally.

Financial account always works with past data but managerial accounting uses future or forecasted data for decision making.

Financial accounting maintains laws and accounting standards but managerial accounting need not.

Managerial accounting is not mandatory for organization, it is done when necessary. But financial accounting is must for all organization.

Financial accounting is done for the overall company, where managerial accounting can be done for a specific product or service or for any cost center etc.

The result for financial accounting should be more specific but some cases managerial accounting round up data for the simplicity of decision making purpose.

Managerial accounting has less emphasis on precision than financial accounting.

Budgetary Control process:

Budgetary control process is a process leads by the manager by monitoring, evaluating and controlling expenditure and income to manage cash and borrowings. There are four steps of budget prepare and control. They are:

Formation of policies: Long term and short term policies should be determined for the budget. Policies are very important for projection of cash, sale, income, expanse, inventory etc.

Preparation of forecast: Analyzing the policies, manager then forecast the future position of the company using the past and present data. Scientific methods are adopted here to forecast.

Preparation of budgets: The next step is to form a written document of the budget. For the co- ordination purpose this written document can be used.

Forecast combination: After developing the master budget various combination process are prepared.

After the budget is prepared, the manager compares the budgeted amount with the actual amount. If the actual amount is better than the budgeted then it would be said the company is on right trap. If the budgeted amount is better that means the company cannot able to catch the budgeted amount. In this case the manager should control the situation and reduce wastage, create more efficiency and more effectiveness. Some cases managers changed the policy to achieve more.

Different Costing Methods:

For pricing purpose the most used costing methods are -

Variable costing method: under variable costing only variable manufacturing costs are treated as product cost. This includes direct materials, direct labors and variable portion of manufacturing overhead.

To illustrate let, variable costs per unit:

particles

amount

Direct materials

£2

Direct labor

£4

Variable manufacturing overhead

£1

Fixed manufacturing overhead

£30000

Unit produced 6000.

Under variable costing unit product cost = 2 + 4 + 1

= £7

Absorption costing method: includes all manufacturing costs either fixed or variable.

For the previous illustration, Under absorption costing

Unit production cost = total variable cost + per unit fixed cost

= 7 + (30000/6)

= £12

Requirement 2 :

Particulars

Actual amount

(for 1100 unit)

Budgeted amount

(for 1000 unit)

per unit

total

per unit

total

Sales

63.55

69900

62

62000

direct material

(19.80)

(23260)

(20)

(20000)

direct labor

(22.72)

(24420)

(22)

(22000)

factory overhead

(5.82)

(6400)

(6)

(6000)

Profit

15.21

15820

14

14000

From the above calculation, we can see than the actual profit is more than the budgeted profit. So the manufacturing process and selling process are going good. They can fulfill their targeted budget last month. But here, basically the profit is higher than the budgeted because they are able to sell their product £ 1.55 more than the budgeted selling price.

Variance

Decision

material price variance

(AQ*AP)-(AQ*SP)

=(1100*19.80)-(1100*20)

220

Favorable

(standard price is more than actual price)

material quantity variance

(AQ*SP)-(SQ*SP)

=(1100*20)-(1000*20)

2000

Unfavorable

(actual quantity is more than standard quantity)

labor rate variance

(AH*AR)-(AH*SR)

=(1075*22.72)-(1075*22)

774

Unfavorable

(actual price is more than standard price)

labor efficiency variance

(AH*SR)-(SH*SR)

=(1075*22)-(1000*22)

1650

Unfavorable

(actual quantity is more than standard quantity

overhead spending variance

(AH*AR)-(AH*SR)

=(1075*5.82)-(1075*6)

1935

Favorable

(standard price is more than actual price)

overhead efficiency variance

(AH*SR)-(SH*SR)

=(1075*6)-(1000*6)

450

Unfavorable

(actual quantity is more than standard quantity)

Here, only the material price variance and the overhead spending variance are favorable. Other variances are unfavorable. So, they should control their material and labor quantity along with the labor and overhead price. The wastage of material should reduce. The labor force should be more efficient.

Requirement 3

Accounting rate of return:

For project 1,

annual depreciation = (200000 − 14000) / 3 = 62000

Year

1

2

3

Cash flow

58000

(2000)

4000

Salvage value

14000

Depreciation

(62000)

(62000)

(62000)

Accounting income

(4000)

(64000)

(44000)

Average Accounting Income = - (4000 + 64000 + 44000) / 3

= - 37333

Average book value* = (200000 + 14000) / 2

= 107000

Accounting Rate of Return = - (37333) / 107000

≈ - 0.35

For project 2

Annual Depreciation = (120000 − 12000) / 3 = 36000

Year

1

2

3

Cash flow

36000

(4000)

8000

Salvage value

12000

Depreciation

(36000)

(36000)

(36000)

Accounting income

0

(40000)

(16000)

Average Accounting Income = - (40000 + 16000) / 3

= - 18666

Average book value* = (120000 + 12000) / 2

= 66000

Accounting Rate of Return = - (18666) / 66000

≈ - 0.28

*Average book value = (Beginning book value + Ending book value)/2

Normally the decision rule for mutually exclusive projects is to accept the one with highest ARR. But here both of the projects face a huge amount of loss, as average accounting income for both projects come negative. So my opinion is to the board of directors not to accept any of the projects.

Payback Period:

For Project 1 the accumulated cash inflow is £60000 = (58000-2000+4000), which is less than its initial investment.

Again for Project 2 the accumulated cash inflow is £40000 = (36000-4000+8000), which is also less than its initial investment.

So, no project will ever payback between these two. The decision rule for Payback Period is to accept a project if the actual payback is lesser or equal to predetermined standard payback. But none of the Project 1 or 2 will payback even at the end of the projects. In calculation of payback period, my opinion is to the board of directors to reject both of the projects.

Net Present value (NPV):

For project 1

NPV = - 200000 + 58000/1.10 - 2000/1.102 + 4000/1.103

= - 200000 + 52727 - 1653 + 3005

= - 145921

For Project 2

NPV = - 120000 + 36000/1.10 - 4000/1.102 + 8000/1.103

= - 120000 + 32727 - 3305 + 6011

= - 84567

In capital budgeting NPV is one of the most reliable method to make investment decisions. According to NPV method project should be accepted with a positive NPV and should be rejected if negative. Here I recommend to reject both projects as they have negative NPV.

Internal Rate of Return:

To calculate IRR I assume the two discounting rate.

The lower rate is 9% and higher rate is 11%

For project 1

IRR= 0.09+ [{ (58000/1.09) - ( 2000/ 1.092) + (4000/ 1.093)}- 200000] / [ { (58000/1.09) - ( 2000/ 1.092) + (4000/ 1.093)} - 58000/1.11) - ( 2000/ 1.112) + (4000/ 1.113)}] * ( .11 -.09)

= 0.9 + { ( 54616.38 - 200000) / (54161.38 -53553.77 -)} * .02

= .09 - 2.74

= -2.65 %

For project 2

IRR= 0.09+ [{ (36000/1.09) - ( 4000/ 1.092) + (8000/ 1.093)}- 120000] / [ { (36000/1.09) - ( 4000/ 1.092) + (8000/ 1.093)} - 36000/1.11) - ( 4000/ 1.112) + (8000/ 1.113)}] * ( .11 -.09)

= 0.9 + { ( 35838.27 - 120000) / ( 35838.27 - 35035.47)} * .02

= .09 - 2.10

= - 2.01%

IRR is the most important alternative of NPV. IRR rule is an investment is acceptable if the calculated IRR exceeds the required return. Here, both the projects show the negative percentage of IRR. So as an analyst I suggest forgoing both the project.

Sources of Finance:

The methods of making investment decisions are applied here don't suggest investing in Project 1 or 2. But if the board wants to raise fund for both business projects they can evaluate different sources of finance including internal and external. Different sources of finance are described bellow in short -

Internal sources:

Equity capital - invested by the founder

Personal sources: This is very important source of finance to start any business.

Borrowing from friends and family: Due to no interest payment is required borrowing from friends and family is very popular.

Credit cards: As money transfer, collection or payment is fast and easy, credit cards have become very popular.

Retained profits: Retained profit is the generated profit through business activities which provide finance.

External sources:

A bank loan: Bank loan provides the largest share of financing around the world.

A bank overdraft: Bank provides finance by letting its customer withdrawing excess of deposits.

Equity capital: that means outside investors Business angels: Business angels are one of the important sources of finance in a start-up company.

Business angels are professional investor who generally invest £10k - £750k and prefer business with high growth prospects.

Government sources: The government provides funds, especially to high technology industries and in areas of high unemployment as part of its policy to help national development, in the form of cash grants and other forms of direct assistances.

Franchising: Franchising is a method of expanding business on less capital than would otherwise be needed. [Johan Marx, 2002].

By the calculation of variance I can tapped that point that, If actual production cost can be minimized the company will be able to finance more working capital.

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