FINANCIAL REPORTING AND ANALYSIS



Chapter 1

FINANCIAL REPORTING AND ANALYSIS

Objectives of financial reporting are :

1. To furnish information that is useful in making investment and credit decisions: Financial reporting should offer information that can help current and potential investors and creditors make rational investment and credit decisions. The reports should be in a form that makes sense to those who have some understanding of business and are willing to study the information carefully.

2. To provide information that can be used to assess cash flow prospects : Financial reporting should supply information to help current and potential investors and creditors predict the amounts, timing and risk of cash receipts from dividends or interest and proceeds from the sale, redemption or maturity of stocks or loans.

3. To provide information about business resources claims to those resources and changes in them: Financial reporting should give information about company’s assets, liabilities and stockholders’ equity and the effects of transactions on the company’s assets, liabilities, and stockholders’ equity.

Conventions that help in the interpretation of financial information:

Accounting Conventions: Accounting conventions means the guide lines or general principles for recording transactions and preparing financial statements.

The Accounting conventions are as follows.

1) Comparability and consistency: Comparability means that the information is presented in such way that decision maker can recognize similarities, differences and tends over different periods or between different companies.

Consistency convention requires that once an accounting procedure is adopted by a company, it remain in use from one period to the next unless users of the financial statements are informed of the change.

2) Materiality: Materiality refers to the relative importance of an item or event in financial statement and its influence on the decisions of the users of financial statements.

3) Conservatism: The convention that when faced with two equally acceptable alternatives, the accountant must choose the one least likely to overstate assets and income.

4) Full Disclosure: The convention requiring that financial statements and their foot notes present all information relevant to the users understanding of the statements;

5) Cost benefit: The convention that the benefits gained from providing accounting information should be greater than the costs of providing that information.

Financial statements include :

1. Income statement and

2. Balance sheet

Income statement: An Income statement is a summary of accounts that affects the profit or loss of an enterprise. Accounts that increase the profit are shown on one side while accounts that decrease the profit i.e, losses and expenses are shown on the other side. The statement so prepared is known as an “Income Statement”.

An Income Statement has two parts, namely,

1. Trading Account: It reveals gross profit or gross loss during the accounting period.

Contents of a Trading Account

1. Opening stock

2. Purchases and purchase returns

3. Direct expenses: Examples Freight inward, or carriage or cartage inwards, wages, power and fuel, factory lighting, Duty on purchases.

4. Sales and sales return

5. Closing Stock.

Exercise 1: Prepare a Trading Account for the year ending December 31, 2017: from the following balances.

Stock(1st January 2008) $10,000 Purchases $100,000

Wages 5,000 Carriage Inwards 1,000

Sales 155,000 Return Inwards 5,000

Purchase returns 8,000 Octroi Duty 2,500

Freight 500

Closing Stock as on December 31, 2017 was valued at $20,000

Exercise 2: Prepare a Trading Account for the year ending December 31, 2017from the following balances.

$

Stock (January 1, 2009) ---------------------------- 10,000

Sales --------------------------------------------------- 200,000

Purchases ---------------------------------------------- 200,000

Carriage inwards------------------------------------- 1,500

Freight Inwards -------------------------------------- 2,500

Sales Returns ---------------------------------------- 5,000

Factory Expenses------------------------------------ 11,000

Purchases returns -------------------------------- 2,500

Carriage outwards ----------------------------------- 3,000

The closing Stock of goods as at 31, December 2017 is $ 20,000.

PROFIT AND LOSS ACCOUNT

“A profit and loss account is an account into which all gains and losses are collected in order to ascertain the excess of gains over the losses or vice versa.”

Exercise 1; From the following information prepare the profit and Loss account of a sole proprietor for the year ended December 31, 2015

$

Gross Profit---------------------------------------200,000

Salaries----------------------------------------------10,000

Commission Paid----------------------------------- 5,000

Commission received------------------------------ 2,500

Interest paid----------------------------------------- 3,500

Interest received------------------------------------ 2,000

Carriage Outwards---------------------------------- 1,250

Discount Allowed---------------------------------- 750

Discount received--------------------------------- 250

Rent Paid------------------------------------------ 1,900

Depreciation on Machines----------------------- 6,000

Miscellaneous Incomes-------------------------- 7,000

Exercise ; 2 From the following information prepare the profit and Loss account of a sole proprietor for the year ended December 31, 2015

$

Gross Profit---------------------------------------440,000

Salaries----------------------------------------------178,000

Advertising-----------------------------------------12,000

General expenses------------------------------ 1,400

Interest received------------------------------------ 6,000

Loss on sale of furniture----------------------------35,000

Carriage Outwards---------------------------------- 4800

Gain on sale machine------------------------------- 50,000

Discount received--------------------------------- 250

Rent Paid------------------------------------------ 1,900

Depreciation on Machines----------------------- 6,000

Miscellaneous Incomes-------------------------- 7,000

Exercise:3 From the following balances extracted from the books of Saleh on 31st December, 2017, Prepare income statement and Balance sheet.

| | | | |

| | | | |

| | | | |

| | | | |

|Opening Stock |9,600 |Sales |24,900 |

|Wages and salaries |3,200 |Capital |5,000 |

|Freight |500 |Bills payable |500 |

|Purchases |11,850 |Loan |900 |

|Trade expenses |30 |Commission |400 |

|Bills receivable |600 |Accounts payable |2,340 |

|Rent |200 | | |

|Plant |2,000 | | |

|Bad debts |500 | | |

|Repairs to plant |160 | | |

|Cash in hand |200 | | |

|Accounts Receivable |4,000 | | |

|Drawings |1,200 | | |

| |_________ | |_______ |

| | | | |

| |34,040 | |34,040 |

| | | | |

| | | | |

| | | | |

| | | | |

Value of closing stock as at 31st December 2017, $10,000

Exercise: 4

The following is the Trial Balance of Lubna Company on 31st December, 2017 Prepare the Trading and Profit and Loss Accounts for the year ending 31st December, 2017

TRIAL BALANCE

As at 31st December, 2015

| | | |

|Particulars |Dr($) |Cr($) |

| | | |

|Owners’ equity ---------------------------------------------------- | |10,000 |

|Stock (1st january, 2017)----------------------------------------- |2,000 | |

|Cash at Bank------------------------------------------------------ |1,000 | |

|Cash in hand------------------------------------------------------- |440 | |

|Machinery-------------------------------------------------------- |6,000 | |

|Furniture and Fittings------------------------------------------ |1,360 | |

|Purchases-------------------------------------------------------- |15,000 | |

|Wages------------------------------------------------------------ |10,000 | |

|Fuel and power------------------------------------------------- |3,000 | |

|Factory lighting------------------------------------------------ |200 | |

|Discount Allowed-------------------------------------------- |500 | |

|Discount Receives--------------------------------------------- | |300 |

|Salaries----------------------------------------------------------- |7,000 | |

|Advertising----------------------------------------------------- |5,000 | |

|Office expenses--------------------------------------------------- |4,000 | |

|Accounts receivable-------------------------------------------- |8,500 | |

|Accounts payable------------------------------------------------- | |3,700 |

|Sales---------------------------------------------------------------- | |50,000 |

| | | |

| |------------- |--------------- |

| |64,000 |64,000 |

Value of closing stock as at 31st December $ 2,700.

Balance Sheet

A Balance sheet is a screen picture of the financial position of a business at a certain moment.

A balance sheet is prepared from the Real Accounts and Personal Accounts.

Assets

A company’s assets are divided into four categories:

1) Current Assets: Current Assets are cash and other assets that are reasonably expected to be converted to cash with in one year.

Examples: Cash, Short term Investments, noted and accounts receivable, inventory, prepaid expenses, short term investments or marketable securities.

2) Investments: The investments include assets usually long term that are not used in the normal operation of the business.

Examples: Securities held for long term investment, long term notes receivable.

3) Property, Plant and Equipment: Property, plant, and equipment are tangible long term assets used in the continuing operation of the business.

4) Intangible Assets: Intangible assets are long term assets with no physical substance.

Examples: Patents, copyrights, goodwill, franchises and trade marks.

Liabilities: are divided into two categories

1) Current Liabilities: consists of obligations due to be paid with in one year.

Examples: notes payable, accounts payable, salaries and wages payable, taxes payable.

2) Long term liabilities: The debts of a business that fall due more than one year in the future.

Examples: Mortgages payable, long term notes, bonds payable, employee obligations.

Owner’s Equity: Owner’s equity accounts show the sources of and claims on assets.

Examples: contributed capital (the face, or par, value of issued stock) Retained earnings.

Exercise: 1

Using the following accounts prepare a classified balance sheet at the year end, 31, December 2018

Accounts payable $400, Accounts receivable $550 :Accumulated depreciation equipment $350, ;cash $100, Equipment $2,000, Franchise $100, Investments (long term) $250, Inventory $ 300,

Notes payable (long term) $200, R Strong capital $2300, outstanding wages $50.

Exercise: 2

The following data pertain to a corporation;

Cash, $31,200; investments in six month government securities $16,400; Accounts receivable, $38,000; Inventory $40,000; prepaid rent $1200 Investments in corporate securities (long term) $20,000; land $8,000 Building $70,000 Accumulated depreciation building $14,000; Equipment $152,000; Accumulated depreciation equipment $17,000; copyright$ 6,200; Accounts payable $51,000, Revenue received in advance $2,800; Bonds payable $60,000; Common stock issued $100,000, paid in capital in excess par value $50,000 and retained earnings, $ 88,200.

Prepare a classified balance sheet.

Exercise: 3

From the following Trial Balance, Prepare Trading and a Profit and Loss Account for the year ending 31st December 2017 and a Balance sheet as on that date..

TRIAL BALANCE as at 31 December 2017

| | | |

|Particulars |Dr(RO) |Cr(R0) |

|Owners’ equity---------------------------- | |150,000 |

|Stock(1st Jan 2017)----------------------- |30,000 | |

|Cash at Bank----------------------------- |10,000 | |

|Cash in hand----------------------------- |5,000 | |

|Machinery------------------------------- |100,000 | |

|Furniture----------------------------------- |13,000 | |

|Purchases--------------------------------- |200,000 | |

|Wages------------------------------------ |50,000 | |

|Carriage----------------------------------- |33,000 | |

|Salaries---------------------------------- |70,000 | |

|Discount Allowed--------------------- |4,000 | |

|Discount received-------------------------- | |5,000 |

|Advertising---------------------------------- |50,000 | |

|Office |40,000 | |

|expenses-----------------------------Sales-------------------| |500,000 |

|----------------------- |90,000 | |

|Accounts receivable----------------------- | |40,000 |

|Accounts payable------------------------- |_________ |__________ |

| |695,000 |695,000 |

Value of Closing stock as at 31st December 2017 was RO 50,000.

Chapter : 2

INTRODUCTION TO MANAGEMENT ACCOUNTING

Management Accounting is concerned with providing information to managers that is people inside an organization who direct and control its operation.

Definitions

According to National Association of Accountants(USA) Management accounting is the process of identification, measurement, accumulation, analysis, preparation and communication of financial information used by the management to plan, evaluate and control with in the organization and to assure appropriate use and accountability for its resources.

According to Chartered Institute of Management Accountants (CIMA) of UK

“Management accounting is an integral part of management concerned with identifying, presenting and interpreting information used for

1) Formulating Strategy

2) Planning and control Activities

3) Decision making

4) Optimizing the use of resources

5) Disclosure to shareholders and others external to the entity

6) Disclosure to employees and

7) Safeguarding assets.

Comparison of Financial and Management Accounting

| |Financial Accounting |Managerial Accounting |

| | | |

|1. |Financial accounting reports are prepared for external |Management accounting reports are prepared for managers |

| |parties. |inside the organization. |

| | | |

| | |Management accounting has a strong future orientation. |

|2. |Financial accounting provides summaries of past | |

| |financial transactions. | |

| | |In management accounting only relevant information is used. |

| |Financial accounting data are expected to be objective | |

|3. |and verifiable. | |

| | |Management Accounting may apply monetary or non-monetary |

| |Financial accounting provides information in terms of |units of measurement. |

| |money only | |

|4. | |Management Accounting focuses much more on the parts, or |

| | |segments of company |

| |Financial accounting is primarily concerned with | |

| |reporting for the company as a whole. | |

|5. | |Management Accounting is not prepared according to GAAP |

| | |managers set their own rules concerning the content and form |

| |Financial Accounting statements prepared must be |of internal reports. |

| |prepared in accordance with GAAP. | |

| | | |

|6. | |Management accounting is not mandatory. A company is |

| | |completely free to do as much or as little as it wishes. |

| |Financial accounting is mandatory. | |

| | | |

| | | |

| | | |

|7. | | |

Functions of management Accounting

The main functions of management accounting are as follows:

1. Planning: Information and data provided by management accounting helps management to forecast and prepare short term and long term plans for the future activities of the business.

2. Coordinating: Management accounting techniques of planning also help in coordinating various business activities.

3. Controlling: Controlling is a very important function of management and management accounting helps in controlling performance by control techniques.

4. Financial analysis and interpretation: In order to make accounting data easily understandable, the management accounting offers various techniques of analyzing, interpreting, and presenting the data.

5. Qualitative information: A part from monetary and quantitative data, management accounting provides qualitative information which helps in taking better decisions.

6. Tax policies: Management accounting system is responsible for tax policies and procedures and supervises and coordinates the reports prepared by various authorities.

7. Decision making: Correct decision making is essential to the success of business.

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