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Role of Accounting Information and Concept: A Practical Approach

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ROLE OF ACCOUNTING INFORMATION AND CONCEPT: A

PRACTICAL APPROACH

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Table of Contents

INTRODUCTION ............................................................................................................................... 1

TASK 1 ............................................................................................................................................. 1

Solution: ...................................................................................................................................... 2

TASK 2 ............................................................................................................................................. 3

Solution. ...................................................................................................................................... 4

Content. ................................................................................................................................... 6

Purpose .................................................................................................................................... 7

Calculations. ............................................................................................................................. 7

Comparison and analysis of the ratios for the two companies calculated in task 2. ................... 7

Efficiency ratio. ........................................................................................................................ 8

Liquidity ratio .......................................................................................................................... 8

CONCLUSION ................................................................................................................................. 10

REFERENCE ................................................................................................................................... 11



INTRODUCTION

Accounting or better the financial accounting is the heart of any business as by this the

supply of life blood to the rest of the organization is controlled. Accounting information and

concepts provides the ground for any financial analysis. By knowing the importance of any

entity, thought process can be improvised. Here, in the present report, attempt is made to explain

the role and importance of accounting information and concepts. This is done by applying the

concepts in a practical problem. In the course, different computer packages such as MS-excel etc

are being applied for data processing. Different performance measures in terms of ratios are

being calculated and interpreted. For these calculations and interpretations, a detailed report has

been draft indicating the analysis findings. Entire work has been segregated in three tasks. In the

first one, method of carving out financial statements from the trial balance is demonstrated with a

real time question. Task 2 deals with calculation of different ratios. In the last task i.e. task 3, a

detailed report for both the above task findings has been drafted.

TASK 1

Trial balance extracted from the accounting books of Mr Sunshine as on 31 December 2011

Trial balance as on 31st Dec, 2011

Purchases

DR

150,000

CR

Capital 213,000

Long term Loan 80,000

Printing and Stationery 5,000

Drawings 16,000

General expenses 50,000

Sales 452,000

Trade Receivables 95,000

Trade Payables 40,000

Bank overdraft 13,000

Selling and distribution expenses 10,000

Light and Heat 7,000



Interest Paid

Furniture

Motor Vehicles

Allowances for Trade receivables

Wages and Salaries

Rent and Rates

Inventory at 1 January 2011

Given Additional Information:

5,000

Cost 300,000

Accumulated Depreciation 90,000

50,000 Cost

Accumulated Depreciation 15,000

3,000

86,000

52,000

80,000

906,000 906,000

1. Inventory as at 31 December 2011 was valued at 60,000.

2. Depreciation is to be charged as follows:-

Furniture: 30% on reducing balance basis.

Motor vehicles: 30% on straight-line basis.

3. The allowances for trade receivables should be made equal to 5% of outstanding trade

receivables as at 31 December 2011. st

4. Included in rent and rates is one months rent paid in advance amounting to 4,000.

5. General expenses amounting to 5,000 are still outstanding for the year ending 31

December 2011.

Solution:

Income Statement for Mr Sunshine for the year ended 31 December 2011

Particular

Sales revenue

cost of goods sold

raw material

Light and Heat

Note Amount () Amount ()

452000

(311000)

1 170000

7,000



Outstanding general expenses 5 (5,000)

Provision for receivables 6 3,000

Noncurrent liabilities

Long term Loan 80,000

Capital 213,000

Net profit (earnings) 7 60,000

Total Liabilities and capital 404,000

Notes:

1. Raw Material consumed:

Inventory as on Jan 1st, 2011 = 80000

Inventory as on Dec 1st, 2011 = 60000

Total purchase during the year = 150000

Raw material consumed = 170000 (80000+150000-70000)

2. Rent paid during the year = 52000

Rent paid advance for the next year = 4000

3. Furniture worth = 300000

Depreciation = 90000 (30% with written down method)

Current worth of furniture = 210000

4. Motor vehicle price = 50000

Depreciation = 15000 (30% with written down method)

Current worth of vehicle = 35000

5. Outstanding general expenses = -5000 (given)

6. Provision for trade receivables = 3000

As given that the allowance must be 5% of the total outstanding receivables but that will

be charged in the coming years liability side.

7. Net profit = 55000

(Taken from the income statement after adjusting the drawings)

TASK 2

Given accounts for the two businesses are shown in the below tables:

Income Statement for the year ended 31 December 2011



Sales Revenue

Cost of goods sold

Gross profit

Administration expenses

Distribution expenses

Sundry expenses

Net Profit before Interest

Oliver

000s

1,200

(900)

300

(128)

(56)

(40)

76

Stan

000s

1,700

(1,248)

452

(106)

(110)

(40)

196

Statement of Financial Position as at 31 December 2011

Oliver

000s

Stan

000s

Non Current Assets

Current Assets

Inventory

Accounts receivables

Bank

Total Assets

Capital & Liabilities

Capital plus profits

Long term loan

Accounts payables

Total liabilities and capital

124

140

180

16

460

200

180

80

460

263

104

134

1

502

320

10

172

502

Solution

Ratios calculated for both Oliver and Stan are as given below:-

Gross Profit Margin

Net profit margin

Return on Capital Employed

Oliver

25.00%

6.33%

0.61

Stan

26.59%

11.53%

1.58




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income statements cover business proceedings for three months period. Time frame for which

the statement has been prepared should clearly be mentioned on the income statement (Brigham

and Hrharted, 2004). Here, in the task 1, an income statement for Mr. Sunshine has been

prepared for the duration of one year i.e. for 1 Jan, 2011 to 31 Dec, 2011. Contrasting with the st st

income statement, the balance sheet reflects the financial condition of the business at a specified

point of time. Balance sheet always contains a specific date not a time period and the values

expressed in this are applicable and accurate for that date only. Here, in the task 1, balance sheet

i.e. statement of position has been prepared as on 31 Dec, 2011 on the basis of the provided st

information and trial balance. Thus, both statements prepared above differ as far as the time

frame is considered.

Content

Income statement covers all the income and expenses of any business accrued during a

period of time. If the two sided of the book keeping system are considered, revenues are recorded

at the credit side in income statement whereas expenses at the debit side. Here, in the task 1,

sales revenue has been the income whereas the rent and rates, light and heat, wages and salaries,

raw material consumption, interest payment, general expenses and other operating expenses such

as stationary etc are the costing or the expenditure for Sunshine. Balance sheet gives a picture of

finances in a company (Gazely and Lambert, 2006). Largely, it portrays 3 items i.e. assets,

liabilities and owners' equity or capital. Assets further can be current or noncurrent. Assets are

basically the properties belonging to the company. Liabilities are monetary obligations in

account of the company. Capital or the owners' equity is the aggregate worth of a company.

Profits become parts of the capital at the end of an accounting period. Here, the balance sheet

prepared contains the current assets in the form of trades receivables, advance payments and

inventories and the noncurrent assets are the fixed or long-lasting assets such as the motor

vehicles, furniture etc. As far as the constituents of the liability side are considered, current

liabilities include trade payables, bank over drafts, outstanding expenses, allowances for

receivables etc. while the non current liability is the long term loan of the business. Capital is the

total capital plus the current years retained profit.



Purpose

Purpose behind preparation of the income statement is to determine the profits earned or

losses made by a company over a period of time. In income statement, earnings and expenses are

broken down into categories, which makes it much clear for the manager to comprehend

bottleneck items of expenses and sources of profits and losses. As in the above prepared income

statement, profit has been segregated in three parts, i.e. gross profit, operating profit and net

profit. Gross profit is the raw profit after considering the functional expenses only whereas the

operating profit is the profit adjusted for the operating expenses. Net profit comes after making

adjustments for interest payments, depreciations, taxes etc. Purpose behind preparation of

balance sheet is to have an overview of companys current standing in terms of financing

(Bagad, 2004).

Calculations

For preparing the income statement, just a simple set of calculations are required. For

this, company's revenue are added up and at the same time the expenses also. By subtracting

expenses from revenue will give company's profit or loss. Net retained profit in the business is

added in the capital side of the balance sheet. Also some basic calculations are also required for

the balance sheet as well (Bagad, 2004).

Thus on the basis of above given points, both, statement of financial position and

statement of income differ from each other.

Comparison and analysis of the ratios for the two companies calculated in task 2

In finance, ratio expresses the relationship existing b/w different financial variable

concerning the company's activities or financial position. Ratios are generally calculated on the

basis of data supplied by the financial statements such as income statement, balance sheet or the

cash flow statement (Rudas, 1997). The ratios, basically, aid in identifying the strength or

soundness of firm in financial terms. Ratio analysis is considered as the strongest tool for

Financial Management decisions and to comprehend the financial viability of a business.

Different ratios are suits different purposes (Reimers, 2007).

Ratios calculated are as described below:

Gross Profit Margin

Oliver

25.00%

Stan

26.59%



Efficiency ratio

Inventory turnover: This ratio measures the time (days) required to convert the inventory in cash

i.e. the average time of keeping the inventory in a business. Low value is better for the business.

Formula for this ratio is as given:

365 =

Receivables turnover: This ratio measure the time required for converting the credit sales in cash.

The lower the value better is for the business. Formula for calculating this ratio is:

365 =

Payables turnover: This ratio measure the time required for keeping the trade credit (Mayes and

Shank, 2011). The higher the value better is for the business. Formula for calculating this ratio is:

365 =

Here, the inventory turnover for Oliver is 42.54 4 3 days and for Stan it is 22.33 22

days. Also, Accounts receivable turnover for Stan is 22.77 23 days, whereas the same for

Oliver has been calculated to be 54.75 55 days. The accounts payable turnover for Oliver, as

calculated is 28.08 28 days and the same for Stan is 46.43 46 days. After analyzing all the

three efficiency ratios, it can be observed that, Stan holds a better position.

Liquidity ratio

Current ratio: This ratio indicates the ability of business to meet its current liabilities. It is

calculated by dividing the current assets by the current liabilities. Current assets cover the

inventory, accounts receivables, cash, bank balance etc. Current liabilities cover the accounts

payable, overdrafts, other provisions etc. Standard value of this ratio lays b/w 1 to 1.5 (Reimers,

2007).

Quick ratio: Quick ratio is the modified form of current ratio, representing the real time liquidity

in the business. Here, the quick assets, i.e. the cash plus accounts receivables and bank balance

are divided by the current liabilities. Standard value of the ratio lays b/w 0.5 to 1 (Reimers,

2007).




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Here, Current ratio for Oliver has been calculated to be 4.2 and for Stan it is 1.39. Also

the Quick ratio for Oliver is 2.45 and the same for Stan is 0.78. Thus it is obvious that Stan is

holding better liquid position than Oliver. Oliver is having significantly higher liquidity which is

a dangerous thing for any business.

Stan.

On the ground of entire analysis, it is obvious that, Sunshine should preferably invest in

CONCLUSION

From the above entire, analysis and work it is clear that accounting concepts and

accounting information plays a vital role in financial management. For preparing a financial

statement, strong background of accounting and book keeping is a must. Here, in the present

report, the role and importance of accounting information and concepts are demonstrated by a

real time question of Mr. Sunshines business. Also, different computer packages such as MS-

excel etc are quite important. Different performance measures in terms of ratios are being

calculated and interpreted. Ratio analysis clears the picture of any businesss performance, which

can be seen in the above report.



REFERENCE

Bagad, V. S., 2004. Management and Finance, Pune: Pragati Book House.

Brigham, E. F. and Hrharted, M. C., 2004. Financial management theory and practice. USA: southern-western Cengage learning.

Chadwick, L., 1998. Management Accounting. 2 ed. London: International Thomson Business

nd

Press.

Gazely, M. A., and Lambert, M., 2006. Management Accounting. SAGE.

Lucey, T., 2003. Management Accounting. 5th ed. Cengage Learning EMEA.

Mayes, T. R., and Shank, T. M., 2011. Financial Analysis with Microsoft Excel. 6 ed. Cengage th

Learning.

Reimers, A., 2007. Financial Accounting. India: Pearson Education.