Financial Accounting - Consolidated Statements and Financial Performance Analysis - Assignment Example

Financial Accounting Consoli d ments and Financial Performance Analysis by Contents Page Introduction 2 Task Reconciliation of profit 2 Task 2: Statement of Changes in equity 5 Task 3: Purpose of the IASB’s conceptual framework 5 Qualitative characteristics of the IASB’s conceptual framework 6 Relevance 6 Faithful representation 6 Task 4: Intangible Asset 6 a) Defining an intangible asset 6 b) Two examples of an intangible asset 6 c) Three key elements of an intangible asset. 7 Task 5: International Accounting Standard 7 Conclusion 9 References 10 Introduction The process of describing every part of financial statements is essential in ensuring accurate communication of information as this same information will play a critical role in addressing the objectives for self-reporting. Several frameworks are used to realize these objectives. This will be evident in the analysis that follows below. An example of the framework that will be used is the IASB’s conceptual framework, which sets out the concepts that are used to prepare and present financial statements (Frankwood, 2011). From IASB’s perspective, this framework aids companies to determine the right concept to use in the development and revision of IFRSs. Task 1: Reconciliation of profit A reconciliation of profit from operations to net cash from operating activities for Knowhow Ltd for the year ended 31st March 2014 Profit from operations 1,780 Add back: Finance costs 693 Tax 412 Dividends paid 350 Less : gain on disposal (112) Net operating cash flows 3123 Statement of cash flows for Knowhow Ltd for the year ended 31st March 2014 Particulars £000 Profit before tax 1150 Adjustment for non-cash items Depreciation 727 Gain on disposals (112) Financing cost 693 Cash flow before working capital changes 2395 Working capital changes Decrease in inventory 251 Increase in trade receivables (309) Increase in bank overdraft 417 Increase in trade payables 918 Cash flow received from operating activities 3672 Less : taxation paid (277) Net operating cash flows 3123 Cash flow from investing activities Purchase of PPE (2237) Disposal of PPE 185 Cash flow from investing activities (2052) Cash flow from financing activities Issue of new ordinary shares 1000 Repayment of bank loan (1750) Share premium 200 Dividends paid to members (350) Cash flow from financing activities (900) Net changes in cash and cash equivalent (312) Cash and cash equivalent at the beginning of the year 312 Cash and cash equivalent at the end of the year 0 Workings Profit before tax= (6566-6043) =523 Add: dividends paid 350 Tax paid 277 Profit before tax 1150 Steps followed in the above calculations. Step 1. Adjust the profit from the operations to get the net operating cash flows. This is done by adding back the finance costs, dividends, tax and finally deducting gain on disposal. 1780+ (693+412 +350-112)=3123 Step 2. Adjust before tax by adjusting the non-cash items. This is done by; profit before tax +depreciation-gain on disposal+ financing costs to get the cash flows before working capital changes. Step 3.add the working capital changes. That is; decrease in inventory less increase in trade receivables add increase in bank overdraft and increase in trade payables to get cash flow received from operating activities les tax to get the net operating cash flows. Step 4.add cash flow from investing activities. That is; disposal of PPE-purchase of PPE to get net cash flow from investing activities. (Jury, 2012) Step 5.add cash flow from financing activities. This is by; issue of ordinary shares-repayment of bank loans + share premium-dividends paid to members. Step 6.add cash and cash equivalent at the beginning of the year to get cash and cash equivalent at the end of the year. Task 2: Statement of Changes in equity Knowhow Ltd changes in equity Statement for the year ended 31st March 2014 Share Capital Other Reserves Retained Earnings Total Equity £000 £000 £000 £000 Opening balance 1500 210 6043 7753 Issue of additional shares 1000 1000 Share premium on share issue 200 200 Retained earnings for the year 523 523 Closing balance 2500 410 6566 9496 Step 1.record the opening balances in the table for ordinary share capital, other reserves, retained earnings and sum them to get the total. Step 2.add the additional issue of shares to ordinary share capital to get the closing balance. Step 3.add the share premium on issue of shares to other reserves to get the closing balance. Step 4.add the retained earnings for the year to the retained earnings to get the closing balance. (Epstein & Jermakowicz, 2008) Task 3: Purpose of the IASB’s conceptual framework The IFRS framework helps in the improvement of financial reporting. This is achieved through the provision of complete and up-to-date concepts to IASB, that can be used effectively in the revision and development of standards (Frankwood, 2011). This framework focuses on the preparation and presentation of the financial statements for external users. It guides the IASB in developing future accounting standards not addressed by the IAS and IFRS and their interpretation. The managers consider a number of factors that are outlined in the IFRS framework to ensure they meet the fundamental quality of relevance and reliability in the absence of a standard or interpretation applicable to a given class of transaction while making judgments (Flynn, 2005). The IASB conceptual framework is also used to ensure that the set standards are rigorously applied in addition to working actively with those who set the national standards to ensure that the national accounting standards and IFRS converge to yield high quality outcomes. The IFRS Framework ensures that pertinent information is available for users in making economic decisions and not only placing reliance on general purpose financial reports. This information enables assessment of the entity’s potential for future net inflows based on effective resource utilization (Albrecht, 2007). Qualitative characteristics of the IASB’s conceptual framework These qualitative attributes are used to identify the kind of information that the users are likely to rely on when making economic decisions based on the financial reports of a given entity. These quality characteristics have equal chances of application of general purpose financial information. The fundamental qualitative aspects of financial information need to be both relevant and faithful representations. Relevance Information is useful and relevant if it’s capable of meeting the needs of the users in making decisions. Relevant financial information has the capability of making a difference in decision making because it is predictive (Flynn, 2005). The confirmatory value coupled with the predictive ability facilitates materiality and the nature of its magnitude. On the contrary, information that does not meet the needs of the users is irrelevant for decision making. Faithful representation Information is not only required to be relevant for usefulness, but also needs to be represented faithfully in accordance with the economic situation (Albrecht, 2007). These two attributes magnify completeness, neutrality and lack of error if relevant and faithfully disclosed. Unfaithful representations lower the credibility of the organization and the integrity of corporate governance. Task 4: Intangible Asset a) Defining an intangible asset An Intangible asset refers to an identifiable asset which is non-monetary without any physical substance. These assets are non-current since they are presumed to have a useful life of more than one year and thus recorded under the fixed assets schedule (Frankwood, 2011). An entity derives economic benefits from this asset over its useful life. b) Two examples of an intangible asset There are numerous examples of intangible assets not limited to: Goodwill - this is recognized when a business is purchased above its fair market value due to an already established reputation of the acquired company. The acquiring entity gains economic benefits due to this reputation, for instance, there is already an established market and customers (Penner, 2004). Royalty – this refers to periodic payment for use of another individual’s property as a percentage of receivable revenues thereto. This is recognized as an intangible asset in the statement of financial position (Rich et. al, 2012). c) Three key elements of an intangible asset. Intangible assets form part of the fixed assets of a company together with tangible assets which include plant, property and equipment. The intangible assets are subject to amortization and impairment the same way the tangible assets are subjected to depreciation over their useful life (Frankwood, 2011). However, the intangible assets have three key elements that distinguish it from other assets which include: Identifiability- intangible assets are identifiable owing to the fact they arise from contractual agreement or available legal rights not considering whether the rights can be transferred from one individual to another or can be separated from rights and obligations while the other assets are purchased and form part of the capital of the entity (Penner, 2004). Control- the owner of the assets has power to derive economic and other benefits attributable to the asset as long as he is in possession of it or has rights and obligations to the identifiable asset under consideration. With the tangible assets, the owner has the physical control of the assets and the benefits thereto. Future economic benefits-the owner of the intangible asset is entitled to the future economic benefits brought about by the use of the asset in terms of revenue or future reduction in costs among others. The owner of the tangible asset derives utility from the daily use of the asset in the production process (Albrecht, 2007). Task 5: International Accounting Standard a) In the context of International Accounting Standard 37, contingent assets and liabilities, also referred to as inflow of economic benefits, are cash receivables and any other assets that might occur as a result of ordinary activities in organization’s operation (Penner, 2004). Contingent liability presents a probable obligation in the future following uncertain events, and a contingent asset is a possible asset that would rise from occurrence or non-occurrence of uncertain events in the future. These contingencies are likely to lead to some economic benefits flowing to the entity. b) IAS 2 Inventories focuses on the accounting treatment for different types of inventory. This standard demands that the inventories be measured using the lesser of the cost and net realizable value. Inventories in this context refer to assets that are held for sale, assets being utilized in the production process, called working in progress, materials and other consumable supplies (Kolitz, Quinn, & Mcallister, 2009). The cost of the inventory includes all costs for purchasing inclusive of taxes, transportation and handling costs, conversion costs and any expenditure directly related to the inventory. Inventory costs do not include abnormal wastage, storage costs, selling costs and administration overheads not related to the inventory produced (Penner, 2004). IAS 2 commends usage of either FIFO or weighted average costs of interchangeable commodities. For inventory R, S and T, the amount to be recorded in the financial statement is 3400, 1950 and2450 which is the lower of FIFO and NRV. c) A finance lease refers to a lease agreement where all risks and rewards associated with owning are substantially transferred to the lessee. The control over the use of the asset is entirely on the lessee. In a finance lease agreement, the lessee records the asset under the corresponding liability in accordance with substance over form, which accounts for the economic reality of the asset as opposed to the legal status. The asset and liability will be recorded at the asset’s fair value given that it’s not lower than the lease rentals payable and residual value guaranteed (Delaney & Whittington, 2005). The asset after the initial recognition will be depreciated over its useful life or the lease duration whichever is higher. The obligation liability component will be amortized using the relative rate of interest over the lease period (Albrecht, 2007). This rate equates the present value of the payable lease rentals without exclusion of the guaranteed and unguaranteed residual value to the asset cash price. The rate allocates the finance charge as a constant percentage of the outstanding amount (Delaney & Whittington, 2005). d) IAS 16, Property, Plant & Equipment This standard prescribes how property, plant and equipment are treated. The carrying amount, depreciation and impairment losses are recorded in the financial statements. They are recognized as asset when there are expected future economic benefits and the costs can be reliably measured (Kolitz, Quinn, & Mcallister, 2009). These costs should include those incurred to acquire the item and those related to any replacement of its parts or servicing. They include purchase cost, site preparation, installing costs, professional fees incurred and delivering and handling costs. In the WatchworldPlc only the administration cost of 600 should not be recorded in the financial statements. The plant should be reported at (21000-600) = 19400. e) Measurement of revenue according to IAS 18 Revenue defined as the inflow of economic benefits out of an entity’s ordinary activities not limited to sale of goods, services, receipts from interest and royalties. To measure revenue, fair value of any consideration already received or that is receivable is used. Exchange for items that are similar is not regarded as a transaction that generates revenue. Given that the inflow of cash is deferred, the fair value of the consideration to be received will be less of the nominal value of the receipts discounted appropriately (Penner, 2004). f) An Adjusting event refers to the event providing further evidence existing at the end of the balance sheet date and other events that demonstrate the going concern of a business. For instance, a major customer who has a large outstanding debt owing to Watchword Plc. at the end of the financial year is declared bankrupt (Albrecht, 2007). These events provide further evidence of the debtor that existed on the reporting date in relation to current assets. A non-current asset has had to be replaced at considerable cost and is a non-adjusting event since it occurred after the reporting date and thus need not be adjusted (Delaney and Whittington, 2005). Conclusion From the outset, it is worth noting that the reporting of organizational performance is entirely done through financial statements. For this financial information to communicate adequately, it must adhere to set financial standards (Rich et. al, 2012). Essentially, any organization that does not consider these regulations will mean that its financial communication will not be valid. In addition, improper presentation of information might cause unrecoverable errors which in the long run might cost the organization’s performance. However, the mission statement that defines the core reason for the company’s existence also provides additional information to its performance as dictated by the Service Charter. Thus, the effectiveness of communication and performance is determined by the corporate governance that is in place (Delany, 2005). References Books ALBRECHT, W. S. (2007). Accounting, concepts & applications. Mason, Ohio, Thomson/South-Western. DELANEY, P. R., & WHITTINGTON, R. (2005). Wiley CPA exam review. Hoboken, NJ, Wiley. FLYNN, D. (2005). Fundamental accounting. Kenwyn, Juta. Frankwood, M. (2011). Advanced Financial Reporting Concepts: New York: Free press KOLITZ, D. L., QUINN, A. B., & MCALLISTER, G. (2009). A concepts-based introduction to financial accounting. Lansdowne, Juta. PENNER, S. J. (2004). Introduction to health care economics & financial management: fundamental concepts with practical applications. Philadelphia, Penns, Lippincott Williams & Wilkins. RICH, J. S., JONES, J. P., MOWEN, M. M., & HANSEN, D. R. (2012). Cornerstones of financial accounting. Mason., OH, South-Western. EPSTEIN, B. J., & JERMAKOWICZ, E. K. (2008). Wiley IFRS 2008: interpretation and application of international accounting and financial reporting standards 2008. Hoboken, N.J., Wiley. JURY, T. (2012). Cash Flow Analysis and Forecasting the Definitive Guide to Understanding and Using Published Cash Flow Data. Hoboken, John Wiley & Sons. Read More