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.
