Accounting Users And Characteristics Of Financial Statement Accounting Essay

Category: Accounting

1.0 Introduction

Sai Kim, T. et al., 2001, pg 1, said that "accounting is the process of recording, reporting, and interpreting financial information pertaining to an organization. Accounting is often confused with book-keeping, which involves only the recording of economic events and is therefore just one part of the accounting process".

Task 1 is about the different users and their needs for Continental Limited financial statements. Accounting users divided into two users, it is internal users (people within the organization) and also external users (people outside the organization) who use account to derive financial information for their needs. Besides that, the characteristics of these financial statements will provide useful information to the users.

Continental Limited has an authorized share capital of 1 million ordinary shares RM1 each. It operates wholesale and retail business of selling a consumers product. In task 2, prepare the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010 for the internal use by company director or publication. Income statement it is made by company at the end of each year to calculate the profit and loss incurred in business during the year. While, balance sheet it is made by company at the end of each year to record the capital, assets, and liabilities of company at the end of the year.

In task 3, 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. Distribution cost usually defined as the costs incurred to deliver the product from the production unit to the end user. Besides that, administrative expenses is refer to the costs of operating a business that are not directly attributable to the production of goods or services.

In task 4, must base on the income statement and balance sheet made in task 2 and 3. Then, calculate the appropriate accounting rations for year ending 31 Dec 2010 and also need to compare them with the industry averages provided to assess the profitability and liquidity of Continental Limited.

2.0 Accounting users and Characteristics of financial statement

Accounting information helps users to make better financial decisions in the organization. There have two different types of users in the financial information, there are internal users (people within the organization such as management, employees, and owners) and also external users (people outside the organization such as creditor, tax authorities, investors, and customers) who use account to derive financial information for their needs.

There also have five regulatory characteristics of financial statement that will provide useful information to the users. These criteria must be fulfilled to make the financial statements and accounts that are useful to the users. Therefore, company should seek to satisfy the following criteria when selecting and adopting the accounting concepts in preparing business financial accounts.

2.1 Accounting users

There have five different users and their need for Continental Limited financial statements. The financial accounts provide a wealth of information that is useful to various users of financial information. Investor is worried about risk and return in relation to their investments. They need accounting information to know whether it is worth for them to invest in a business or buying shares of the company.

In addition, customer and debtor are the people who purchase goods and services provided by 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. As a customers of the company's products, they have a long-term concentration in the company's range of the products and services. They may even have to depend on the business for certain products and services.

Besides that, a manager is the person appointed by the company owners to responsible for planning and directing the work of a group of individuals, monitoring the day-to-day work of the company. They need accounting information about the company's financial situation as it is currently and as it is expected to be the future to enable them to manage the business efficiently and to make effective control and planning decisions.

Another accounting user is suppliers or creditor, the people who provide trading goods and services to the company on credit. So, they need accounting information about the company's ability to pay its debts for ensuring their collection from the company. The creditors include suppliers as well as lenders of the finance such as banks.

Moreover, employee of the company is people employed by the company to carry out business activities. Therefore, they need accounting information about the company's financial situation. This is because, their future careers and the size of their wages and salaries depend on it. Therefore, employees need information concerning the stability and continuing profitability of the organization.

In the conclusion, accounting users is important to the organization. This is because, the financial accounts provide information that is useful to various users of financial information.

2.2 Characteristics of financial statement

First is understandability, it means that the financial statements must easily to comprehensible. Users of financial statements are assumed to have enough knowledge of business, economic activities and accounting to study the information properly. According to Helium.com (2010), said that "understandability ensures that a user equipped with the basic knowledge can discern information pertaining to the performance and financial position of an enterprise".

Besides that, the characteristic of the financial statement is comparability. The financial accounts made based on accounting concepts should be comparable within the entity and across entities. Comparability within the entity is means that the financial statements can be compared with the previous year financial statements of the same company. While, comparability across entities is means the financial statement can be comparable with the account of other company.

Another characteristic of the financial statement is relevance. 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, financial statements are for users to make economic decisions, the information must be relevant to the decisions that those users have to make. In addition, relevant financial statements are timely, if the accounts are prepared to provide required information in time, it is relevant to the decision making of the user. Contrary, if the accounts are no prepared to provide information in time, it is not relevant to the decision making of the user.

Moreover, the characteristic of financial statement is reliability. Financial account must present reliable information to the users for decision making. According to SpiffyD (2012), mention that "according to ACCA, "reliable" information does not contain errors that affect the economic decisions of users, nor is it biased or partial. This attribute is linked to faithful representation, since users should be able to treat with it as such. Users have confidence in reliable financial statements. Such statements are not misleading or deliberately constructed in a manner that could skew decisions or perception of the financial position or performance of an entity. It is worth noting that the importance of auditing is increasing because it reinforces reliability".

In addition, the characteristic of the financial statement is accuracy. The financial account must provide accurate financial information to the users for decision making. The reason is, the inaccurate account information will lead to inaccurate decision made by the user.

3.0 Income Statement and Balance Sheet

Income statement it is made by company at the end of each year to calculate the profit and loss incurred in business during the year. According to Steven Mark , L., 2003, pg 25, he said that "the income statement also referred to as a profit-and-loss statement, summarizes the company's revenues, expenses, gains, and losses for a period of time, such as three months or one year". While balance sheet it is made by company at the end of each year to record the capital, assets, and liabilities of company at the end of the year.

3.1 Working for note question a to h

Closing stock should be recorded at cost or net resale value which one is lower. Since cost RM65000 < net resale value RM70000, the cost RM65000 should be closing stock value put in the trading account of income statement and under the current asset in balance sheet.

Cash Account

RM RM

Sales 5000 Purchase 4000

Stationery 700

Electricity 300

5000 5000

Sales in trading account of income statement = RM360000 from TB + RM5000 = RM365000

Purchase in trading account of income statement = RM200000 from TB + RM 4000

= RM 204000

Stationery as expense put in P/L account of income statement = RM7000 from TB + RM300 = RM7300

Sales commission as expense put in P/L account of income statement = RM18000 paid from TB + RM1500 accrued at end of year = RM 19500

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 - RM 2000 prepaid at end of year = RM26000

Then, prepaid office salary RM2000 is recorded under the current asset in balance sheet

Debtor Account

RM RM

Balance b/d 75000 (-) Bad debts 5000

Balance c/d 70000

75000 75000

Balance b/d 70000

Bad Debts Account

RM RM

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 RM70000

= RM7000

Provision for Bad Debts Account

RM RM

31 Dec 2010 Closing balance c/d 7000 1 Jan 2010 Opening balance b/d 5000

Increase different 2000

(As expense put in P/L account)

7000 7000

1 Jan 2010 Balance b/d 7000

and f)

Vehicles Account

RM RM

Balance b/d 300000 Vehicles Account a/c (cost sold) 50000

Balance c/d 250000

300000 300000

Balance b/d 250000

Provision for Depreciation on Vehicle Account

RM RM

Vehicle disposal account 12500 1 Jan 2010 Opening balance b/d 60000

(Cost sold RM50000 x 5% x 5 year

from 1 Jan 2005 to 1 Jan 2010)

31 Dec 2010 Balance c/d 60000 Depreciation as expense put in P/L 12500

account

(Vehicles closing balance

RM250000 x 5%)

72500 72500

1 Jan 2011 Balance b/d 60000

Vehicle Disposal Account

RM RM

Vehicle cost sold 50000 Provision for depreciation on 12500

vehicle sold

Proceeds from disposal of vehicle 35000

Difference for Loss on disposal of 2500

vehicle

(As expense put in P/L account)

50000 50000

Provision for Depreciation on Premises Account

RM RM

Balance c/d 5400 1 Jan 2010 Opening balance b/d 40000

Depreciation as expense put in 14000

P/L account

(Premises cost from TB RM350000

x 4%)

54000 54000

Balance b/d 54000

g) Taxation charge RM15300 is deducted from net profit at the bottom of income statement. It is also recorded as accrued taxation RM15300 under current liability in balance sheet

h) Proposed divided to be deducted from net profit at the bottom of income statement = 2% x RM500000 Share capital from TB = RM 10000

Then, the proposed divided RM10000 is recorded under current liability in balance sheet.

3.2 Income statement of Continental Limited for year ending 31 Dec 2010 for internal use

Income Statement of Continental Limited for Year Ending 31 Dec 2010 for Internal Use

RM RM RM

Sales 365000

Less Return inwards 10000

Net sales 355000

Less Cost of sales:

Opening stock 50000

+ Purchases 204000

- Return outwards 15000

+ Carriage inwards 5000 194000

Less Closing stock 65000 179000

Gross profit 176000

Add Income:

Dividend received 5000

181000

Less 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 vehicles 12500

Depreciation on premises 14000

Vehicle expense 12000

Interest charges 3000 104500

Net profit 76500

Less Taxation charge 15300

Less Proposed dividend 10000

Profit for the year 51200

Add Retained earnings brought forward 100000

Retained earnings carried forward 151200

3.3 Balance sheet of Continental Limited as at 31 Dec 2010 for internal use

Balance Sheet of Continental Limited as at 31 Dec 2010 for Internal Use

RM RM

Fixed assets / Non-current assets

Office premises at cost 350000

(-) Provision for depreciation on premises 54000 296000

Vehicle at cost 250000

(-) Provision for depreciation on vehicle 60000 190000

Long-term investments 100000

586000

Current assets

Closing stock 65000

Debtors 70000

(-) Provision for bad debts 7000 63000

Bank 42000

Prepaid office salary 2000 172000

758000

Issued share capital

Share capital 500000

Add Reserve

Retained earnings carried forward 151200

Shareholders' equity 6512000

Add Long-term liabilities / Non-current liability

Loan 55000

Add Current liabilities

Creditors 25000

Accrued sales commission 1500

Accrued taxation 15300

Proposed divided 10000 51800

758000

4.0 Distribution costs and Administrative expenses

Distribution costs also known as distribution expenses. Distribution cost usually defined as the costs incurred to deliver the product from the production unit to the end user. The distribution cost is items such as sales staff's salaries and commission, carriage outwards, depreciation of delivery vans, advertising and display expenses.

According to Readyratios.com (2011), mention that "administrative expenses refer to the costs of operating a business that are not directly attributable to the production of goods or services. Administrative expenses are related to the organization as a whole as opposed to the individual departments". Administrative expenses consist of such items as salaries, legal and accountancy charges, the depreciation of accounting machinery, utilities, rent, and housekeeping charges.

4.1 Classify the expenses into distribution cost and administrative expenses

Distribution costs Administrative expenses

RM RM

Stationery - 700

Office electricity - 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

4.2 Income statement of Continental Limited for year ending 31 Dec 2010 for external reporting

Income Statement of Continental Limited for Year Ending 31 Dec 2010 for External Reporting

RM RM

Turnover 355000

Cost of sales 179000

Gross profit 176000

Distribution cost 53500

Administrative expenses 48000

101500

Operating profit 74500

Dividend received 5000

79500

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 bought forward 100000

Retained profit carried forward 151200

4.3 Balance sheet of Continental Limited for the year ending 31 Dec 2010 for external reporting

Balance Sheet of Continental Limited for the Year Ending 31 Dec 2010 for External Reporting

RM RM RM

Fixed Assets

Tangible Assets:

Premises 296000

Vehicle 190000

486000

Investment:

Long term investment 100000

586000

Current Assets

Stock 65000

Debtors 63000

Prepaid office salary 2000

130000

Cash at bank 42000

172000

Less Creditors: Amounts Falling Due Within One Year

Creditor 25000

Accrued sales commission 1500

Accrued taxation 15300

Proposed dividend 10000

(51800)

Net current Assets 120200

Total Assets Less Current Liabilities 706200

Less Creditor: Amounts Falling Due After More Than One Year

Loan (55000)

651200

Capital and Reserve

Called up share capital 500000

Profit and Loss account 151200

651200

5.0 Accounting ratios

Accounting ratios is used to define important relationship between the figures shown on a balance sheet, in a profit and loss account or in any other part of accounting organization. Therefore, accounting ratios shows the relationship between accounting data.

5.1 Table of ratio calculation

Ratio with formula Ratio calculation for year 2010 Industry average

Percentage of gross

profit on sales

= Gross profit x 100 176000 x 100 = 49.58% 30%

Net sales 355000

Percentage of operating

profit on sales

= Operating profit x 100 74500 x 100 = 20.99% 18%

Net sales 355000

Capital employed = Closing capital + Long-term liabilities = (Fixed assets + Current assets)-Current liabilities

= (RM586000+RM172000)-RM51800

= RM758000-RM51800

= RM706200

Return on capital

employed (ROCE)

= (Net profit + Interest

charges) x 100 76500 + 3000 x 100 9%

Total assets - Current liabilities 758000 - 51800

= 79500 x 100

706200

= 11.26%

Current ratio

= Current assets = 172000 2 : 1

Current liabilities 51800

= 3.32 : 1

Stock turnover

= Cost of sales

Average stock value

= Cost of sales = 179000

(Opening stock + Closing stock) / 2 (50000 + 65000) / 2

= 179000

57500

=3.11times

Stock turnover period

365 days = 365 days 90 days

Stock turnover 3.11 times

= 117.36 days

Debtor collection period

= Debtor = RM63000

Net credit sales RM365000 - RM 10000

= Debtor = RM63000

Sales - return inwards RM355000

= 0.1777 : 1

Debtors collection period

= Debtor ratio x 365 days =0.177 x 365 days 45 days

=64.6 days

Creditor ratio

= Creditor = 25000

Net credit purchase 204000 - 15000

= Credit = 25000

Purchase - Return outwards 189000

= 0.132 : 1

Creditors payment period

= Creditor ratio x 365 days = 0.132 x 365 days 60 days

= 48.18 days

5.2 Profitability of Continental Limited

The percentages of gross profit on sales is 49.58% is higher than industry average is 30% because the company is ineffective and inefficient in purchasing goods and services from the suppliers causing higher purchase cost and also ineffective use of material and labour causing higher production cost to decrease gross profit. In addition, percentage of operating profit on sales is 20.99% and industry average is 18%. Higher percentage of operating profit on sales indicates that company is ineffective in its expenditure control. Besides that, ROCE also higher than industry average is 20.99% and 18%. This is because, it is indicating the lower net profit generated in relation to the capital employed.

5.3 Liquidity of Continental Limited

Current ratio of company is higher than industry average is 3.32 : 1 and 2 : 1which is much that the idea ratio of 2 : 1, the current ratio is higher or equal to 2 : 1, the larger amount of current assets can be used to finance current liabilities, indicating that company is financially stable and able to finance its short-term debts. Moreover, the stock turnover period is higher than the industry average is 117.36 days and 90 days. The higher stock turnover period indicate fast stock turnover in business where the goods and services purchased are kept in stock for a short time and the fast stock for short time and then fast taken out from stock for resale. In addition, debtor collection period is higher than industry average is 64.6 days and 45 days. Higher of debtor collection period indicate that company has given longer credit time to allow debtor's owing, causing, longer time taken by company to collect money. While, the creditor payment period is lower than industry average is 48.18 days and 60 days. The lower creditor payment period show that company has obtained shorter credit time for owning and paying creditors.

6.0 Conclusion and Recommendation

In the conclusion, doing this principle of accounting assignment I have learnt a lot of knowledge about the principle of account. I already know the different types of accounting users and also the characteristics of the financial statement. Besides that, doing this assignment also has learnt how to prepare the income statement and balance sheet. The benefit I get from this assignment is learning accounting will help us to makes business or personal financial decisions. Another benefit is accounting knowledge will help us to understand the meaning of the financial information.