AIM 1004 BUSINESS ACCOUNTING & FINANCIAL STATEMENT

HOE HUI XIN 930423-05-5398

OCTOBER 2012

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1.0 CONTENT NO 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 TOPIC CONTENT INTRODUCTION THE OBJECTIVE of FINANCIAL RATIO Calculate the profitability, solvency and capital structure ratios Explain situation (a) by using calculated ratios Explain situation (b) by calculate appropriate ratio CONCLUSION REFERENCE COURSEWORK PAGES 2 3-6 7-8 9-12 13 14-16 17-18 19 20-28

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2.0 Introduction 2.1Financial Statement

First of all,a financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity. In British English including United Kingdom company lawa financial statement is regularly referred to as an account, although the term financial statement is also used, predominantly by accountants. Besides, for large corporations, these statements are often complex and may include an extensive set of notes to the financial statements and explanation of financial policies and management discussion and analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail.

In a nutshell for a business enterprise, all the relevant financial information, presented in a structured manner and in a form effortless to understand, are called the financial statements. They classically include four basic financial statements, accompanied by a management discussion and analysis:Balance sheet - statement of financial position at a given point in time.Income statement revenues minus expenses for a given time period ending at a specified date.Statement of Changes in Equity explains the changes of the company's equity throughout the reporting periodStatement

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of cash flows - reports on a company's cash flow activities, particularly its operating, investing and financing activities. ,

2.2Content in Balance Sheet

First and foremost,in financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership, a corporation or other business organization, such as an LLC or an LLP. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year. Futhermore, Another way to look at the same equation is that assets equals liabilities plus owner's equity. Looking at the equation in this way shows how assets were financed: either by borrowing money (liability) or by using the owner's money (owner's equity). Balance sheets are usually presented with assets in one section and liabilities and net worth in the other section with the two sections "balancing." In addition,a standard company balance sheet has three parts: assets, liabilities and ownership equity. The main categories of assets are usually listed first, and typically in order of liquidity. Assets are followed by the liabilities. The difference between the assets and the liabilities is known as equity or the net assets or the net

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worth or capital of the company and according to the accounting equation, net worth must equal assets minus liabilities. A part of that a business operating entirely in cash can measure its profits by withdrawing the entire bank balance at the end of the period, plus any cash in hand. However, many businesses are not paid immediately; they build up inventories of goods and they acquire buildings and equipment. In other words, businesses have assets and so they cannot, even if they want to, immediately turn these into cash at the end of each period. Often, these businesses owe money to suppliers and to tax authorities, and the proprietors do not withdraw all their original capital and profits at the end of each period. In other words businesses also have liabilities.

2.3 Content in Income Statement

Firstly,Net Sales appearing in the Income Statement is the sum of the Invoice price of the goods sold and services rendered during the period. Sales Inward represents the invoice value of the goods rendered by the customers. Excise duty refers to the amount paid to the government. Next, profit before tax is this is obtained by deducting interest from profits before Interest and Taxes. Tax means income tax expense for the year. Profit after Tax is this is the difference between Profit before Tax and the Tax for the year.Dividends is this represents the amount earmarked for distribution to shareholders

Inadditiono,perating Expenses is the difference between gross profit and the operating expenses and depreciation..Operating Profit is the difference between gross profit and operating expenses. As a measure of profit it reflects operating performance and is not affected by non-operating gains/losses, financial leverage and the tax factor.
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Besides,earnings before Interest and Taxes (EBIT) is the sum of operating profit and non-operating surplus/deficit. Referred to also as earnings before Interest and Taxes, this represents a measure of profits which is not influenced by financial leverage and the tax factor. Hence, it is pre-eminently suited for inter-firm comparison..Interest is the expense incurred on borrowed funds such as term loans, debentures, public deposits and working capital advances. Lastly,non Operating Surplus represents gains arising from sources other than normal operations of the business. Its major components are incomes from investments and gains from disposal of assets. Retained Earnings is this represents the difference between profit after tax and dividends.

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3.0 The objective of financial ratios

First and foremost,in assessing the significance of various financial data, managers often use ratio analysis, the process of determining and evaluating financial ratios. A financial ratio indicates a relationship between a company's activities, for example, the ratio between the company's current assets and current liabilities or between its accounts receivable and its annual sales. The basic source for these ratios is the company's financial statements that contain figures on assets, liabilities, profits, and losses. Then,ratios are only meaningful when compared with other information. Since they are often compared with industry data, ratios help managers understand their company's performance relative to that of competitors and are often used to trace performance over time. Ratio analysis can reveal much about a company and its operations. However, there are several points to keep in mind about ratios. Actually, a ratio is just one number divided by another. Financial ratios are only "flags" indicating areas of strength or weakness. One or even several ratios might be misleading, but when combined with other knowledge of a company's management and economic circumstances, ratio analysis can tell much about a corporation. In addition,there is no single correct value for a ratio. The observation that the value of a particular ratio is too high, too low, or just right depends on the perspective of the analyst and on the company's competitive strategy.

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The next is a financial ratio is meaningful only when it is compared with some standard, such as an industry trend, ratio trend, a ratio trend for the specific company being analyzed, or a stated management objective. Last but not least,the objective of ratio analysis is to judge the earning capacity, financial soundness and operating efficiency of a business organization. The use of ratio in accounting and financial management analysis helps the management to know the

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4.0 Financial Ratio

The director of KK Ltd appointed a new sales manager towards the end of 2010. This manager advised a plan to increase revenue and profit by means of a reduction in selling price and extended credit term to customers. This involved considerable investment in new machinery early in 2011 in order to meet the demand which the change in sales policy has created. The financial statement for the years ended 31 December 2010 and 2011 are shown next page. The sales manager has argued that the new policy has been a resounding success because revenue and, more importantly, profits have increase dramatically. You are required: (a) Explain whether you believed that the performance for the year ended 31 December 2011 and the financial position at that date have improve as a result of the new policies adopt by the company. You should support your answer with appropriate ratios. (b) All of KK Ltd sales on credit. The finance director has asked you to calculate the immediate financial impact of reducing the credit period offered to customers. Calculate the amount of cash which would be released if company could impose a collection period of 45 days.

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Income Statement 2011 RM000 Revenue Cost of sales Gross profit Selling expenses Bad debt Depreciation Interest Net profit 2800 (1680) 1120 (270) (140) (208) (192) 310 2010 RM000 900 (3600) 540 (150) (18) (58) (12) 302

Note: the balance on the retained profits reserve at the end of 2010 was RM 327000. Balance Sheet 2011 RM000 Non-current assets Factory Machinery 441 1791 2232 Current assets Inventory Account Receivable Bank 238 583 30 83 12
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2010 RM000 RM000 RM000

821 Total assets 3053

125 1065

Current liabilities Account Payable Bank 175 11 186 Non-current liabilities 36 36

Borrowing

1600 (1786) 1267

100 (136) 929

Equity Share capital Retain profits 328 393 1267

Gross Profit margin = Net Profit margin = Return on Capital Employed (ROCE) = Current Ratio =
( )

300 629 929

Acid test or Quick ratio =

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Profitability ratio Gross profit : revenue Net profit : revenue ROCE

2010 60% 34% 31%

2011 40% 11% 18%

Solvency Current ratio Acid test ratio 3.47 : 1 2.64 ;: 1 4.41 : 1 3.13 : 1

Capital Structure Capital gearing 10% 56%

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5.0 Explain situation (a) by using calculated ratios

Firstly,profitability ratio decreases. The next is gross and net profit margin also decreases. The likely reason is price reduction or changes in cost.Theb, it should not decline after the implementation of the new system.Furthermore, ROCE fell from 31% to 18%, because the companies increase their investment, but not so fast to see results and effects.It leads to the increase in market demand or the prices of goods can obtain higher rate of return. Lastly,capital gearing represents the company's funds in the debt component, the company is likely to lend money in the future.

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6.0 Explain situation (b) by calculate appropriate ratio

First of all, Some people find that the accounts receivable turnover figure is easier to understand if it is expressed in terms of the average number of days that accounts receivable are outstanding, which is the collection period. This format is particularly useful when it is compared to the standard number of days of credit granted to customers. For example, if the average collection period is sixty days and the standard days of credit is thirty, then customers are taking twice as long as they should to pay their invoices. A sign of good performance is when the average receivable collection period is only a few days longer than the standard days of credit. An excellent way to use this measurement is to track it on a trend line, to spot any sudden worsening of the collection period. Formula: To calculate the collection period, divide annual credit sales by 365 days, and divide the result into average accounts receivable. The formula is as follows: Average Accounts Receivable Annual Sales/365 day Several accounts receivable analysis techniques are noted below. Accounts Receivable Analysis One of the easiest methods for analyzing the state of a company's accounts receivable is to print an accounts receivable aging report, which is a standard report in any accounting software package. This report divides the age of the accounts receivable into various buckets,
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which you can sometimes alter within the accounting software to match your billing terms. The most common time buckets are from 0-30 days old, 31-60 days old, 61-90 days old, and older than 90 days. Any invoices falling into the time buckets representing periods greater than 30 days are cause for an increasing sense of alarm, especially if they drop into the oldest time bucket. There are several issues to be aware of when you analyze based on an aging report, which are individual credit terms. Management may have authorized unusually long credit terms to specific customers, or perhaps only for particular invoices. If so, these items may appear to be severely overdue for payment when they are, in fact, not yet due for payment at all.

In addition,time bucket size. You should approximately match the duration of the time buckets in the report to the company's credit terms. For example, if credit terms are just ten days and the first time bucket spans 30 days, nearly all invoices will appear to be current.

Furthermore,distance from billing date. In many companies, the majority of all invoices are billed at the end of the month. If you run the aging report a few days later, it will likely still show outstanding accounts receivable from one month ago for which payment is about to arrive, as well as the full amount of all the receivables that were just billed. In total, it appears that receivables are in a bad state. However, if you were to run the report just prior to the month-end billing activities, there would be far fewer accounts receivable in the report, and there may appear to be very little cash coming from uncollected receivables. Another accounts receivable analysis tool is the trend line. You can plot the outstanding accounts receivable balance at the end of each month for the past year, and use it to predict the amount of receivables that should be outstanding in the near future. This is a particularly
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valuable tool when sales are seasonal, since you can apply seasonal variability to estimates of future sales levels. Trend line analysis is also useful for comparing the percentage of bad debts to sales over a period of time. If there is a strong recurring trend in this percentage, management may want to take action. For example, if the percentage of bad debt is increasing, management may want to authorize tighter credit terms to customers. Conversely, if the bad debt percentage is extremely low, management may elect to loosen credit in order to expand sales to somewhat more risky customers. This is a particularly useful tool when you run the bad debt percentage analysis for individual customers, since it can spotlight problems that may indicate the imminent bankruptcy of a customer. There are several issues to be aware of when you use trend line analysis, which are Change in credit policy. If management has authorized a change in the credit policy, this can lead to sudden changes in accounts receivable or bad debt levels.Change in products or business lines. If a company adds to or deletes from its mix of products or business lines, this may cause profound changes in the trend of accounts receivable.A third type of accounts receivable analysis is ratio analysis. The most commonly used ratio is the accounts receivable collection period, which reveals the number of days that an average customer invoice remains outstanding before it is paid. The formula is: Average accounts receivable Annual sales/365 Days

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7.0 Conclusion
Fisrtly,financial statements are the product of the financial accounting process. They are the means of communicating economic information about the entity to individuals who want to make decisions and informed judgments about the entitys financial position, results of operations, and cash flows. Although each of the four principal financial statements has a unique purpose, they are inter related, and all must be considered in order to get a complete financial picture of the reporting entity. Analysis and interpretation of financial statements help in determining the liquidity position, long term solvency, financial viability and profitability of a firm. Ratio analysis shows whether the company is improving or deteriorating in past years. Moreover, Comparison of different aspects of all the firms can be done effectively with this. It helps the clients to decide in which firm the risk is less or in which one they should invest so that maximum benefit can be earned. Users cannot make meaningful interpretations of financial statement data without understanding the concepts and principles that relate to the entire financial accounting process. It is also important for users to understand that these concepts and principles are broad in nature; they do not constitute an inflexible set of rules, but instead serve as guidelines for the development of sound financial reporting practices. In a nutshell,in financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business

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partnership, a corporation or other business organization, such as an LLC or an LLP. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year.

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8.0 Reference
1. Eg. Text book (Business Accounting and Financial Statement Edition 4, 1997, Robin Hood & Jack Rose) 2. 3. 4. 5. 6.
http://agbssem1.webs.com/accounting/financial%20ratio%20analysis%20i.pdf http://library.stritch.edu/research/subjects/business/businessGuides/financialRatios.asp http://en.wikipedia.org/wiki/Financial_statement http://www.studymode.com/essays/Analysis-Of-Financial-Statements-4-633792.html http://www.scribd.com/doc/32533320/Project-Report-on-Financial-Analysis-of-RelianceIndustry-Limited

7.

http://www.tutorsonnet.com/homework_help/macro_economics/introduction_and_natio nal_income/national_income_accounting_assignment_help_online_tutoring.htm

8. 9.

http://www.accountingtools.com/receivables-collection-period http://www.accountingtools.com/accounts-receivable-analysis

10. http://ethesis.nitrkl.ac.in/1953/1/10605038.pdf

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AIM 1004 BUSINESS ACCOUNTING & FINANCIAL STATEMENT COURSEWORK

HOE HUI XIN 930423-05-5398

OCTOBER 2012

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Coursework
Types of social accounting Social accounting can be divided into five general areas:
(a) (b) (c) (d) (e)

national social income accounting; social auditing; financial social accounting in profit-oriented organizations; managerial social accounting in profit-oriented organizations; Financial and/or managerial social accounting for non-profit organizations.

National social income accounting National social income accounts have now been in existence for many years. The measure of the nation's productivity recorded in the accounts - basically in sales terms - gives an income called the gross national product, usually referred to as GNP. To an outsider, an increase in GNP would seem to indicate a betterment or progress in the state of affairs existing in the country. This is not necessarily so. The following example illustrates this point. A new chemical factory is built in a town. Fumes are emitted during production which causes houses in the surrounding areas to suffer destruction of paintwork and rotting woodwork, and it also causes extensive corrosion of bodywork on motor vehicles in the neighborhood. In addition it also affects the health of the people living nearby. An increase in GNP results because the profit elements in the above add to GNP. These profit elements include:

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To construction companies and suppliers of building materials. Profit made on

construction of plant;

to house paint dealers and paint manufacturers, painters and decorators, joiners and

carpentries profit made on all work effected in extra painting, woodwork, etc.;

to garages and car paint manufacturers: profit made on all extra work needed on motor

vehicles;

to chemists and medical requirement manufacturers: profit made on dealing with

effects on residents' health, because of extra medical purchases, etc However, in real terms one can hardly say that there has been progress. Obviously, the quality of life has been seriously undermined for many people. As national income accounts do not record the 'social' well-being of a country, other national measures have been proposed. The one most often mentioned is a system of social indicators'. These measure social progress in such ways as:

national life expectancies living conditions levels of disease nutritional levels amount of crime road deaths

Thus, if national life expectancies rose, or road deaths per 100,000 people decreased, there could be said to be social progress, while the converse would apply were the opposite signals found to be occurring.

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The main difficulty with this approach is that (given present knowledge and techniques) it cannot be measured in monetary terms. Because of this, the national social income accounts cannot be adjusted to take account of social indicators. On the level of an individual organization, however, social indicators similar to the above are used in Planning, Programming, and Budgeting Systems (PPBS). This will be discussed in more detail in Section 4.10. Social auditing While national social accounting would measure national social progress, many individuals and organizations are interested in their own social progress. This form of social progress is usually called 'social responsibility'. To identify activities to be measured, a 'social audit' is required, investigating:
(a) (b) (c)

which of their activities contribute to, or detract from, being socially responsible; measurement of those activities; A report on the results disclosed by the investigation.

An example of this might be to discover how the organization had performed in respect of such matters as:

employment of women employment of disabled people occupational safety occupational health benefits at pensionable age air pollution
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water pollution charitable activities help to developing countries.

Social audits may be carried out by an organization's own staff or by external auditors. The reports may be for internal use only or for general publication.

Financial social accounting in profit-oriented organizations

Financial social accounting is an extension to normal financial accounting. The objective may either be to show how the social actions have affected financial performance, or otherwise to put a social value on the financial statements of the organizations. The two main types of financial social accounting envisaged to date are those of human resource accounting and how the organization has responded to governmental or professional bodies' regulations concerning environmental matters.

Human resource accounting One of the main limitations of normal' financial accounting is the lack of any inclusion of the 'value' of the workforce to an organization. The value may be determined by:
(a)

capitalizing recruitment and training costs of employees and apportioning value over

employees' period of employment; or

(b)

calculating the 'replacement cost' of the workforce and taking this as the value of

human resources; or
(c)

Extending either of the above to include the organization's suppliers and customers.

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It is contended that such measurements have the benefits that (1) financial statements are more complete, and (2) managerial decisions can be made with a fuller understanding of their implications. For instance, suppose that a short-term drop in demand for a firm's goods led to a manufacturer lying off part of the workforce. This might mean higher profits in the short term, because of wages and salaries saved. In the long term, it could do irreparable damage, as recruitment could then be made difficult, or because of the effect on the morale of the rest of the workforce, or changes in attitudes of suppliers and customers.

Compliance costs of statutory/ professional requirements

As the effects of organizations upon societies are more widely recognized there will be more and more regulations with which to comply. The costs of compliance will obviously then become a basic and essential part of financial statements.

Managerial social accounting in profit-oriented organizations All that has been described has an effect upon the information systems of an organization. They will have to be established on an ongoing basis, rather than be based purely on adjustments such as those made to the financial accounts at the year end. The information will be used to affect the day-to-day decisions needed to run the organizations.

Financial and/or managerial social accounting for non-profit organizations

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As profit is not a measure in these organizations it can be difficult to measure how well they are performing. Two approaches to measurement have been used, planning, programming, budgeting systems (PPBS) and social programmed measurement. Both of these approaches can be said to be part of what politicians in recent years have called 'value for money'. The general attitude is that while there may be a need for all sorts of social programmers, including health, there is a great need for ensuring that money is not wasted in doing this. The demand is that we should ensure that we get 'value for money' in that the outputs from such schemes should be worth the amount of money expended in carrying them out. Planning, programming, budgeting systems (PPBS) It has been said that in the past there was a great deal of confusion between planning and budgeting. Annual budgeting takes a short-term financial view. Planning, on the other hand, should be long term and also be concerned with strategic thinking. PPBS enable management of non-profit organizations to make decisions on a better informed basis about the allocation of resources to achieve their overall objectives. PPBS works in four stages:
1 2 3 4

Review organizational objectives. Identify programmers to achieve objectives. Identify and evaluate alternative ways of achieving each specific programmer.

On the basis of cost/benefit principles, select appropriate programmers. PPBS necessitate the drawing up of a long-term corporate plan. These shows that the

objectives which the organization is aiming to achieve. Such objectives may not be in accord with the existing organizational structure.
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For instance, suppose that the objective of a local government authority, such as a city, is the care of the elderly. This could include providing:

services to help them keep fit medical services when they are ill old people's housing sheltered accommodation recreational facilities Educational facilities. These services will usually be provided by separate departments, e.g. housing, welfare,

education. PPBS relate the total costs to the care of the elderly, rather than to individual departmental budgets. Management is therefore forced by PPBS to identify exactly which services or activities should be provided, otherwise the worthiness of the programmer could not be evaluated. PPBS also provides information which enables management to assess the effectiveness of their plans, such as giving them a base to decide whether, for every thousand pounds, they are giving as good a service as possible.

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As the structure of the programmer will not match up with the structure of the organization, e.g. the services provided will cut across departmental borders; a specific individual must be made responsible for controlling and supervising the programmer. Social programmer measurement The idea that governmental social programmers should be measured effectively is, as yet, in its infancy. A government auditor would determine whether the agency had complied with the relevant laws, and had exercised adequate cost controls. The auditor would determine whether or not the results expected were being achieved and whether there were alternatives to the programmers at a lower cost. There should be cost/benefit analyses to show that the benefits are worth the costs they incur. However, the benefit side of the analysis is often very difficult to measure. How, for instance, do you measure the benefits of not dumping a particular substance or an obsolete oil rig into the sea? As a consequence, most social programmers do not measure results (benefits). Instead they measure 'outputs', e.g. how many prosecutions for dumping waste: a high number of prosecutions is 'good', a low number 'bad'. This is hardly a rational way of assessing results, and quite a lot of research is going into better methods of audit.

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