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Unit 10 Financial Accounting and Reporting Assignment
1.1. Legal and regulatory influence on financial statements
Issues of finance and economics of all countries in the world in itself is a one joint structure thought we may be divided by boundaries, borders, factors like sex, creed, language etc but the real fact is that all of it is bound in one common structure and that is ‘need’. For example, a professor needs stationery for teaching his various students. Now this stationery shall be procured from several suppliers. These suppliers would procure them from manufacturers national or international, the essence of this example is that need of the professor and his students is indeed the inception of this hierarchy of inter dependence for satisfying there need. This has led to national and international financial transactions. The concept of globalisation has further fuelled this need based orientation of financial and economical transactions intra country (Hussain 1989). Seeing the rise in transactions and the sectors of the society, which are the ultimate receivers of benefits have came in several statutory and regulatory bodies which are concerned with safeguarding of the interest of the bona fide end stakeholders and the society at large. The society expects transparency in operations because they allow business to use their resources i.e. either in form of investments or inputs. The regulatory bodies thus, enact towards ensuring the same.
The best medium of communicating or dissipating information about any organisations operational activity is its financial statements. The financial statements depict the overview of the organisations activity and the impacts of the same in monetary terms. Thus, there are several statutory guidelines which monitor the preparation of these financial statements so as to ensure that interests of stakeholders are never ever compromised. An organisation operating in UK needs to adhere to regulations for preparation and representation of financial statements set out by,
- The companies act 2006,
- UK Accounting standards, issued by accounting standards board, and
- International accounting standards and International financial reporting standards issued by IASB.
This further needs to be stated that the regulations as set out by the monitoring and issuing agencies varies upon the size and nature of the business organisation like, a sole proprietorship firm, a partnership firm and companies (listed and non listed) formed under the companies act, 2006. To further understand the impact and extent of these regulations we shall take an insight into the guidelines set out by the regulatory bodies.
Regulatory guidelines issued by Companies act, 2006:
For Sole Proprietorship firm: The companies act, 2006 does not sets out any specific regulation with regards to preparation of financial statements by the sole proprietorship firms. The companies act gives leverage to the owners and managers of such entities to choose and keep whatever accounting records suiting them. Howsoever, if a sole proprietor firm is registered for Value Added Tax they will need to keep adequate records that satisfy the requirements of the same. They in that case would also need to maintain proper financial statements as they would have to file tax returns and should also be able to furnish the details of the same to HMRC. (Rice 2011) Sole proprietors would be required to include any profit due to them (from their business) on their own personal income tax return. Thus most businesses have to keep some basic accounting records and to compile a profit and loss account once a year. The choice of format and content of such records remains at their disposal.
For Partnership firms: Partnership firms are also not strictly regulated under any specific norms set by the companies act, 2006. Howsoever, they are also required to maintain same records as sole proprietorship firms in cases where they are registered with VAT and are required to file individual tax returns.
In case of the limited liability partnership, the scenario is quite different and the preparation of accounts for such organisations is somewhat similar to companies registered under companies act, 2006.
For Companies: Companies registered under companies act, 2006 are required to maintain accounts and records as specified in part 15 of the act. The act classifies companies into ‘small’, ‘medium’ and ‘large’ categories. This classification is based on a requirement to satisfy two out of three criteria: turnover, balance sheet totals and number of employees. The actual figures are also prescribed in the act but they are subject to amendments from time to time.
The act for the purpose of setting out the specific guidelines for preparation of accounts, classifies guidelines on the basis of,
- Publicly traded companies –Public limited companies are the ones whose stocks are traded on a stock exchange, must prepare their books of accounts in accordance with International accounting standards (IAS’s) In case of companies which are operating in all of the European Union, are required to prepare consolidated accounts complying with IAS’s.
- Non Publicly traded companies -While companies which are non-listed and non-publicly traded are having an option in regards to prepare their accounts complying with either the accounting guidelines set out by companies act, 2006 and UK accounting standards or International accounting standards (IAS’s).
Role and regulations set out by the UK accounting standards: The UK accounting standards are issued by the Accounting standards board of the Institute of Chartered Accountants in England and Wales. The accounting standards board was established to develop regulations and guidelines that could enable preparation of accounts which keeps into accordance the benefit of users, prepares and auditors of financial information. The accounting standards board operates under the monitoring and funding of the financial reporting council. The accounting standards issued by the ASB are called financial reporting standards and ASB has issued 30 financial reporting standards till date. These are designed to facilitate adequate and proper reporting of financial information by the organisation which is expected to prepare the financial statements (Fraser and Orminston 2010).
Role of International accounting standards board: Globalisation has given a wing to the way organisations work throughout the globe. It has created a sort of network amongst the nations trading and thus has created a new pool of stakeholders internationally as well. Thus, it becomes important to ensure that their expectations too are properly taken heed of. To ensure uniformity in arena of financial reporting, was established the International accounting standards board, which aims at developing uniform and unilateral accounting standards that could ensure uniformity of financial information’s amongst organisations operating anywhere around the globe.
The financial standards issues by the IASB are known as International financial reporting standards (IFRS) and since 2005 the EU in approach towards international harmonisation in matter pertaining to transparency and uniformity of financial statements has mandated the usage of IFRS for listed and publicly traded organisations operating in the EU howsoever these regulations are only statutorily applicable while preparing group financial statements, they are free at their will to choose the adequate standards while preparing individual standalone reports. While in case of non public trading organisations, these organisations are not compulsorily bound to adhere to IFRS in any scenario howsoever they are permitted to use the same.
Differences between the UK accounting standards and IFRS:
Since, we have already discussed about the applicability of the financial accounting standards and the IFRS in applicable scenarios, it still is a matter of discussion to understand the fundamental differences between UK accounting standards and the IFRS,
- Both of the standards did not always deal with the same problem though they may appear same in outlook but at times there details and purpose is not identical.
- In case UK ASB and IASB issue a standard in similar reference it is observed that the guidelines of IASB are more generalised and not problem specific.
The role of accounting and reporting standards in dealing with laws and regulations: In our analysis so far, we have been able to understand the implications of regulatory and legal influences upon financial statements. Now it is worth mentioning that, the influences in it have helped in creation of standards that satisfy the legal and regulatory requirements. For an instance, as stated above in the case of companies, the Companies act 2006 requires preparation of accounts in accordance to section 15. Citing the same the regulatory bodies designed Conceptual framework standards which guide principles of preparation of accounts.
It needs to be understood that all the accounting standard framing bodies discussed above are into existence only because they need to ensure that organisations are reporting in a form which helps in dealing with laws and regulations. They achieve this by framing appropriate standards.
Conclusion: After having an in depth analysis of regulatory and legal influences upon financial reporting. It may be said that the regulations set out in this regard are a better source of ensuring transparency and stakeholder accountability. Legal provision like that set out in FRS 1 which requires organisation to prepare a cash flow statement is a perfect example to explain how these regulations impact financial reporting, obviously for the good reasons.
1.2. Users of financial statements and there needs
As already discusses about the inter dependency of different bodies in order to satisfy their ‘needs’ it remains to be stated that there does exists ‘need’ for all the parties involved in a business transaction howsoever their nature and way differs in a large extent. The same logic applies to the financial statements as well wherein the financial statements which are prepared by an organisation under strict guidelines for ensuring better transparency and intimation of relevant and meaningful information to the stakeholders of the organisation. Howsoever the type of information needed by the various stakeholders differs to a great extent and the same is being analysed underneath,
- Customers: Customers are the ones which are the most crucial point in a business cycle. Customer are usually interested in information that is capable of influencing there buying decisions or their outlook regarding the market like, their belief in the brand and there association towards the same. This usually involves assessment of organisations ability to exist in the business and meeting its needs. (Adams 1977)
- Competitors: Competitors are the lot which are majorly concerned about the issues influencing there market existence, so as to reinforce their strategies in order to compete with us. This usually involves the comparison of their performance with the benchmark performance of the best player in the industry. Assessment of financial strength of our organisation is also one way out for them to understand our strategies regarding the conduct of business operations.
- Employees: Employees are a part of internal bodies of the organisation and they are majorly concerned with matters related to their job security or payments. They seek information for analysing issues like whether to continue working for us and, if so, whether to demand higher rewards for doing the same (Atrill 2011). The basis of their decision making is evidently from the organisations future plans, profit status and the overall financial stability which are derived from organisations financial statements.
- Government: Government seeks information’s for a much wider purpose. It looks to adjudge the overall market situation, ensuring welfare of one and of all. Government looks for looking information that helps them in assessing factors like whether we should pay tax and, if so, how much, whether it complies with agreed pricing policies, whether financial support is needed. For deriving this information government looks at the organisations profit status, sales revenues and the overall financial strength.
- Community: Community or the society is another indispensible lot that should be taken due care of to ensure sustainable market existence. Community at large seeks for information like the capability of the organisation to continue to provide employment opportunities for the community, the extent to which it is likely to use the resources of the community and its likely willingness to help fund for CSR initiatives (Drysdale 2010).
- Suppliers: Suppliers seek information that helps them to form decisions regarding, whether to continue to maintain the supply of raw materials/utilities to the organisation, Should there be any change in the existing or demanded credit line. Usually suppliers derive these information’s from the financial strength and the short term liquidity position of the organisation.
- Lenders: Lenders look for information that helps them in deriving a decision as to whether to lend money to the organisation, or not. This decision is usually made by checking the organisations capability to pay the debts as and when they would have arisen in short and long term.
- Managers: Managers lookout for information that helps them analyse, the status of the business operations and whether is required any improvement in the same. This is usually made by analysing current financial performance and status with the past performances of the organisation. Managers also look out for developing a basis for decision making in order to design the strategies of the organisation.
- Owners: Owners are the decision making nodes in the organisational hierarchy hence, all information whether financially influencing or non-influencing have an impact on the modus operandi of the organisation. Howsoever owners make decisions like whether to invest more or dispose of the investment currently held. This usually involves assessment of risk and return factors with the stake ownership of the organisation.
A. Ella’s income statement for the year ended 30th June, 2011
Ella's Jewelers Shop
For the year ending 30 June 2011
Less: Cost of Goods Sold (Refer Working Note)
Rent Stall License
Depreciation (Refer Working Note)
Insurance Expense (Refer Working Note)
Computation of Cost of Goods Sold
Cost of Goods Sold = Opening Stock + Purchases - Closing Stock
|Nil + 54140 - 7120|
Computation of Depreciation Expenses
Depreciation on Motor Van
Depreciation on Display Equipment
Less: Prepaid Insurance
Total Insurance Expense
B. Ella’s financial statement for the year ended 30th June, 2011
Display Equipment (Net)
Motor Van (Net)
Statement of Owner Equity:
Add: Net Profits
A. Income Statement for the year 31 January 2011:
For the year ending 31 January 2011
Add: Non Operating Profits
Profit on Revaluation of Property
Interest on Debentures
Payment of Dividend to Preference Shareholders
Payment of Dividend to Ordinary Shareholders
Provision on Taxation
A. Statement of Comprehensive Income for the year ended on 31 January 2011
Statement of Comprehensive Income
For the year ending 31 January 2011
Other Income: Profit on Revaluation of Property
Profit for the Year
C. Statement of financial position and Statement of changes in Equity
Plant and Equipment
Provision for Taxation
4% Preference Shares
For the year ending 31 January 2011
Ordinary Shares of 1 each
Add: Retained Profits
Add: Profits for the year 2011
Add: Share Premium
D. Impact of issuance of 10 million shares at £ 1.5 each, upon:
- The bank account – Upon issuance of shares Atlas would receive an amount of 15 million in cash. This would increase the balance at bank by £15 million. This would help the organisation to overcome the bank overdraft and the balance at bank would be shown on the assets side of the statement of financial position. Upon the issuance the balance of bank would be standing at £13.153 million.
- The ordinary share capital - With a fresh issuance of stocks the balance of Ordinary Share of Atlas Plc in the owner’s equity portion of the balance sheet would increase by 10million. The issue price is £1.5 per share howsoever the face value of shares is £1 per share and the remaining portion £0.5 is the share premium.
- The share premium – The face value of the ordinary share of Atlas Plc is £1 per share but in the scenario where 10 million shares are issued at premium of £1.5 per share, the balance of share premium account would increase by £ 5 million. This would be reflected with an increase in the Owner’s equity by £ 5 millions.
Consolidated Profit Loss Account
Less: Cost of sales
Consolidated Balance Sheet of H Plc with Y Plc Ltd. As at 31 Mar 2010
Equity And Liability
Consolidated Retained Profits
Less : Contra
Less : Depr.
Less : Unrealized Profit
Less : Contra
Less : Cheque in Transit
Cheque in Transit
Cost of capital:
Less: Share capital
Less: Pre acquisition profits
Consolidated Retained profits:
Share of H PLC
Add: Post acquisition profits
Less: Unrealised profit
Analysis Of profit
Add: Interim dividend
Less: Interim dividend
Add: Revaluation Profit
A. Determination of ratios for Ager Limited for the year ended 30th September 2013
- Current Ratio:
= 43.48 Days
Where, Cost of Sales = Purchases + Opening Stock – Closing Stock
= 612,000+ 82,000- 98,000
- Current Ratio: Current ratio is a relationship between the current assets and current liabilities held by the organisation for a period under consideration. This ratio is a determinant of the short term solvency position and the capability of the organisation to pay its debt as and when they become due (Dowd 2002). It may be seen in the table above that Ager Ltd’s Current ratio has slightly to 1.56 reduced over the position in 2012 i.e.1.6. The ideal standard for this ratio is suggested to be 2, though the ratio of Ager is less than 2 still it cannot be said to be bad and in fact the fall over the year is not radical that it can be said to be a matter of concern for the organisation. Still, if Ager could take some initiative to sort away its short term trade liabilities in the quickest possible time it shall certainly be advisable in lieu of a better liquidity risk management and corresponded by a higher current ratio.
- Acid Test Ratio: Acid test ratio is another important determinant of short term solvency position of an organisation. Acid test ratio depicts the organisation capability to pay off its short term debts as and when they become due. The ideal acid test ratio is expected to be around 1. In case of Ager ltd it can be seen that the ratio for Ager has fallen over 1.2 in 2012 to 0.98 in 2013 which is near to the ideal ratio and hence is a good signage for the liquidity risk management norms of the organisation.
- Trade Receivable Days: Trade receivable days depicts the time duration taken by trade debtors to settle their bills. This ratio denotes the fact that whether or not the debtors are allowed excessive credit and is usually analysed in sight with industry standards/figures (Hussain 1989). In case of Ager it has been seen that the Trade receivable day’s period has risen sporadically over the year 2012. This certainly is not good sign at first instance comparatively because organisation is taking approximately 2 months to receive its payments that 1.5 months it used to take previously. Howsoever a better verdict can only be given if the figures for industry standards are also available.
- Trade Payable Days: Trade payable days depicts the time duration taken by the organisation to settle its creditors bills. This ratio denotes the fact that whether or not the organisation is taking full advantage of the credit facility available to it. In the purview of Ager it may be seen that the duration taken by the organisation to repay its debts has relatively remained unchanged over the year 2013 and 2012, it is usually advisable for the organisation to take the maximum possible time to repay the debts so as to maximise its cash flows. But, there remains some risk associated to the same. One is the loss of goodwill and the other is the contingent legal threat due to the delays caused.
- Inventory Days: Inventory days represents the ability of the organisation to fully sell its stock. It represents the number of days an organisation takes to sell its stock fully. Lesser is always better in this regards. Howsoever it is worth mentioning that industry average Inventory days varies from one industry to other. In case of Ager it may be seen that the organisation takes more days to sell its inventory that it used to take in 2012. This is certainly not a good signage and efforts to expedite the process of sales planning should be taken.
- Memorandum Report: Cash and bank balance are one of the most liquid assets that the organisation has. These assets are the ones which are capable of helping the organisation in priority to sail through any stages of liquidity crunches. Hence, measures to ensure adequate balances of the same are extremely necessary for an organisation. As, stage of cash crisis may force an organisation to the stage of bankruptcy as well. While evaluating the financial statements of Ager Limited it has been seen that the organisation has a bank overdraft of £ 17,000. Ager should certainly try to come over such states of negative cash balance so as to ensure a better short term liquidity risk management and ensure adequate management of working capital.
The major ways which Ager can adopt to sort this state of negative bank balance may be,
- Debtor’s management – Ager should take initiative to reschedule its terms of agreements with its trade debtors because it appears that the organisation is having a lot of funds locked in with its debtors which are received by the organisation in periods as much as 2 months. An expedited process of collection from debtors will certainly make available to the organisation the necessary funds. This would certainly help to reduce the bank overdraft.
- Creditors management –Ager should also try to extend its credit terms with suppliers so that it could get some more time for repayment of debts which as of now is less than the period in which it receives the payments i.e. 50.84 days for receipt of payments against 43.48 days for the payment to creditors. The availability of funds in this form will also be helpful in managing the bank overdraft situation.
Thus, if organisation is able to properly manage the activities, it shall certainly be able to manage its counterfeits and manage the problems concerned with liquidity risk management.
Computation and analysis of Ratios:
Dividend Yield Ratio: Dividend yield ratio depicts that how much an organisation pays out as dividend in relation to its share prices. It is computed as follows,
= (Annual Dividends Per Share)/(Price Per Share)
= 7p/ £3.5
= 0.02 or 2%
The dividend yield represents how much yield is being generated out of every pound invested on the equity position.
Dividend Cover Ratio:Dividend cover ratio depicts the relationship between company’s earning over the dividend paid to shareholders. It is computed as follows,
=(Earnings Per Share)/(Dividend Paid to Ordinary Shareholders)
Dividend cover ratio depicts that a healthy company will have a high coverage ratio, indicating its ability to pay off its dividends. In this case where dividend cover ratio is21, it depicts that Hedge limited has sufficient earning to pay dividend equivalent to twice the present dividend declared.
Earnings per Share: Earnings per share represent the profit of the company allocated to each outstanding share of a common stock. It is an indicator of organisation’s profitability. It is computed as,
=(Net Income-Dividends on Preffered Stock)/(Average Outstanding Shares)
= 70,000- (Nil) / 500,000
= 0.14 or 14p
EPS serves to be one of the most crucial variables in deciding the price of a share. Hedge limited’s EPS is determined to be 14p.
Price Earnings Ratio:
Price earnings ratio is the most tried and tested methodology for organisation’s valuation. A price earnings ratio depicts the relationship between the current share price and the per share earnings. It is computed as,
=(Market Value Per Share)/(Earnings Per Share)
=£ 3.5/ 0.14p
P/E is one of the most popular stock analysis metrics (Watson and Head 2013).
The P/E ratio for Hedge Limited is observed to be 25. This suggests that, investors in the stock of Hedge limited are willing to contribute £ 25 for every £ 1 of the income generated by the stock.
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