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Importance of Accounting for Managers: Purpose of Income Statement and Balance Sheet

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Section A: Importance of accounting information in managerial tasks

  1. Planning- accounting information helps in business planning for long term and short term. It helps to make plan before business operation. Previous accounting information tells that where and how they can improve it in the future.
  2. Budget- Business managers often use accounting information to make budget for the company. They can check that previously where they have spent money for business operations. They can make sure that the company should not face any fund problems in future.
  3. Decision- it helps to management or owner to make the important decision of business. The income statement describes the current position of business. Management can take decisions regarding purchasing new equipment or cut down employee wages and benefits to control operating expenses.
  4. Measurement – it helps to measure the performance of the business. A manager can compare his own company performance with other companies that are in same business. It helps to improve company policy regarding product price and market trend.

Following are four Users of financial reports

  1. Investors- investors are external users of financial information and they are main source of business capital. They always keep eye on financial reports to ensure that their investments in the business are safe. They are interested to know that how the business will perform in future so they can take decision regarding investment for buy, sell or hold.
  2. Owners- owners are internal users of financial data. They invest capital to run business for profit. They are interested in financial data to know that how much they earn or lose during a particular period. So they can make a decision that they should expand or close business in future. They want to know how stable their business for the particular time period.
  3. Manager- Manager is an internal user of financial reports. This information helps him in future planning, decision making and controlling on business. Managers can do a comparison between the current and previous performance of business. It helps him in making effective budget for achieving a business goal. They are interested to know that where they are spending more money so they can control in future.
  4. Employees- employees, they do not directly involve in management so they considered external users of financial reports. They always examine the financial reports to check that how the business performing. Business success and profitability secure their job, give better remuneration.

Sec-B Profitable business structure

(1) Sole Proprietorship- this form of business run and operated by one person. He/she responsible for his/her business activities such as debts and liabilities.

Accounting implications for sole proprietorship:-

  • (A) No legal entity- this form of business has not a legal entity. The sole business not separate from the business owner.
  • (B) Unlimited liability- the owner of sole proprietors has unlimited liability. He/she is personally responsible for all debts of business. He is liable to pay business debts from his own money.
  • (C) Financial regulation- sole proprietor business not separated from his owner for tax and legally. So owner is responsible to pay individual tax. He will show sole proprietorship income in his personal income tax return.

(2) Partnership- this is an economic activity where two or more people start or run a business for profit. They are co-owner of a partnership business.

Accounting implications for partnership

  • (A) Unlimited liability- all partners has unlimited personal liability. They are personally responsible to pay all losses, liabilities and debts of the business.
  • (B) Legal entity – The partnership is not separate from his partner. All partners are responsible to pay liabilities, losses and debts of business from their personal income.
  • (C) Partnership regulation- all partner share the profit and loss of business. They will adjust the partnership profit or loss in a personal income tax return and they can deduct business expenses under individual return.

(3) Limited company- it is distinct from the owner and the company has its own legal entity.

The owners and shareholders are not responsible to pay any losses, liabilities, and debts of the company. They have to pay what they have invested in the company. A company is a legal person and it has name and seal. For example, Auckland international airport limited.

Accounting implication for the limited company:

  • (A) Limited liability- the business has its own GST number. The owner has limited liability up to they have invested in the business.
  • (B) Legal entity- Company is a separate legal person according to the company act. It has a registered name and it can buy and sell products on his name.
  • (C) Accounting entity- the company has to pay it own tax. It is liable to pay tax on company profit. Owner will fill their own individual income tax return IR3.

Sec-C comprehensive income statement

Following are the main elements of the income statement and characteristics

  1. Income- income is the growing economic benefits of the organization. Income can make an effect on increasing assets and decreasing the liability of an organization and more income will help to increase the equity of the entity.
  2. Expenses- it is reducing economic benefits of the organization. Expenses put negative effects on assets. It decreases the value of assets and increases the liability of the organization. It can decrease equity.

Accounting concepts to prepare a financial income statement

  1. Accounting period- income statement source of financial information and performance of a company for the particular time period. Normally accounting period for any company for twelve months. Some organizations issue quarterly or half-yearly. It helps to recognize expenses and income for a specified period.
  2. The matching concept- it is most important principle of the income statement. According to concept, all expenses should be relating with revenue for a specified period in which that revenue is generated due to that expenses. For instance, if we entered revenue from sale of goods sold than we should enter cost of goods for the same period.
  3. Realization- this principle allows to identify sum of income that should be entered at low price than selling or service price. Amount should be entered after discount.
  4. Consistency- Company has to select one accounting method for all transactions, income statements and balance sheet. If Company changes accounting methods regularly than it will be difficult to do a comparison between two periods. The company should have a valid reason to change its accounting method.

Purpose of the income statement

  1. Measure Profit/lose- income statement help to measure how much profit or lose is generated during a specified period. Management can compare the current year earning with last years. If a company under lose so they can make a better planning to get profit in future.
  2. Comparison with others- financial position statement helps to compare with other competitors in same industry. For example, company discount policy and cost of goods purchase.
  3. Expenses- it helps to check, how much you have spend on operating expenses such as salary. Benefits. Advertising etc. if operating expenses increasing rapidly than profit. You should control expenses and compare your budget with actual performance.

Sec- D Purpose of balance sheet

Balance sheet provides the financial position of an organization for a specified time. It reveals that how much a company has assets and liabilities. It also shows investment (equity) of company. The purpose of balance sheet different for every user and they want to know that how is the company performing.

Main elements of balance sheet and its characteristics

  1. Assets- as result of previous transactions or events, company obtained or controlled something that is for future economic benefits. Assets should be measurement in money value. Assets can be divided into two categories, current assets and non-current assets. Assets can be intangible, for example patents or trademarks.
  2. Liabilities- liabilities are existing contract between two entities from past transactions or events. Liability must be measurement in monetary term. Entity has to pay service, money or goods in future. Liabilities can be divided into two category current liability and non-current liability.
  3. Equity- it is residual interest of any entity after liabilities deducted from assets. It has main two type’s common stock and preferred stock.

Accounting equation- accounting equation means entity total assets equal to total liabilities and equity. According to accounting equations, balance sheet should be remaining balanced.

Assets = liabilities + equity

For example, balance sheet of Auckland international airport limited

As on 30 June 2018 $ (m)

Non-current assets 8081.4

Current assets 178.4

Total assets 8196.8

Non-current liabilities 2185.6

Current liabilities 329.1

Total liabilities 2514.7

Total Equity 5682.1

Assets = liabilities + equity

8196.8 = 2514.7+5682.1

8196.8=8196.8

Accounting concepts to prepare balance sheet

  1. The business entity- balance sheet entered the information of entity for a specified period and it is separated from its owners and employees
  2. istorical cost- assets must be recorded in account book on actual value paid of assets and not on current value or market value.
  3. Prudence concept- profit and revenue should be recorded in balance sheet when they are recognised and liability can be included when it is arise.
  4. Accounting period- Company follow a specified time to prepare a balance sheet. Usually it is for twelve months. It records only that transaction incurred during that period.

Sec-E purpose of cash flow statement-

it describes the cash position of an entity and provides information, how cash produced and where it is spent for a particular time.

Major activities of cash flow statement

  1. Operating activities- it includes all cash collected and spent while business common operating activities. It makes change in value of current assets and current liabilities. For instance, account payable, sale.
  2. Investing activities- it includes sale and buy of property, machinery, plant and all long term investments.
  3. Financial activities- it provides the information regarding company financial activities. It includes pay dividend, issue or buyback stock.

The income statement, cash flow and balance sheet are connected and depend on each others. Net earnings or loss from income statement connected to balance sheet and cash flow statement. Net earnings will be added in shareholder equity in balance sheet and cash flow statement. Closing cash balance of cash flow statement will be added on assets side in balance sheet.

Task 2.

Section A

Serial no. Measures formula 2018 2017 2016

1 Growth in sale Current sale – previous year sale/ previous year sale * 100 683.9-629.3/629.3*100

= 8.68 % 629.3-573.9/573.9*100

= 9.65 % 573.9-508.5/508.5*100

=12.86 %

2 Operating profit margin Operating profit/sale *

100 883.1/683.9*100

= 129.13 % 509/629.3*100

=80.88 % 416.9/573.9*100

=72.64 %

3 Net profit margin Net profit after tax/sale *100 650.1/683.9*100

= 95.06 % 332.9/629.3*100

= 52.90 % 262.4/573.9*100

=45.72 %

4 Return on assets Earnings before interest and tax / average total assets*100 883.1/(8196.8+6503.5/2)*100

=883.1/7350.15*100

=12.01% 509/(6503.5+6141.5/2)*100

=509/6322.5*100

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=8.05 % 416.9/(6141.5+5101.5/2)*100

=416.9/5621.5* 100

= 7.42%

5 Age of account receivable Average account receivable/credit sale*365 (71.5+55.5/2)/683.9*365

=63.5/683.9*365=33.89 days (55.5+42.3/2)/629.3*365

=48.9/629.3*365

=28.36 days (42.3+36.6/2)/573.9*365

=39.45/573.9*365

=25.10 days

6 Total assets turnover Net sale/total assets 683.9/8196.8

= 0.08 times 629.3/6503.5

= 0.10 times 573.9/6141.5

= 0.09 times

7 Fixed assets turnover Net sales/ fixed assets(P.P.E) 683.9/6378

= 0.11 times 629.3/4947.8

= 0.13 times 573.9/4708.1

= 0.12 times

8 Cash flow from operation ration Operation cash flow / current liabilities 321.2/329.1

= 0.98 times 307.1/563.5

=0.54 times 270.5/492.2

=0.55 times

9 Current ration Current assets/ current liabilities 178.4/329.1

= 0.54:1 104/563.5

=0.18:1 102.9/492.2

=0.21:1

10 Quick ratio Current assets-(inventories + prepayments)/ current liabilities 178.4-(0.2+18) / 329.1

= 178.4-18.2 / 329.1

= 0.49:1 104-(0.1+11.6) / 563.5

= 104-11.7/ 563.5

=0.16:1 102.9-(0.1+10.4)/ 492.2

=102.9-10.5/492.2

=0.19:1

11 Gearing ratio Long term liabilities / share capital+ reserves+ long term liabilities 218.6/ 404.2+ 4296.6 + 2186.6

=2185.6/6886.4

= 0.32:1 1911/348.3 + 3100.1+1911

=1911/5359.4

= 0.36:1 1768.6/332.7 + 3075.6+1768.6

=1768.6/5176.9

=0.34:1

12 Interest cover ratio Earnings before interest and tax / interest 883.1/77.2

= 11.44 times 509/72.8

= 6.99 times 416.9/79.1

=5.27 times

Profitability

Profitability ration disclose the success of any business and percentages of profitability ratio shows the earning by using main figures in financial statements and other business resources. In Auckland international airport ltd, the growth of sale was 12.86 % in 2016 and increased up to 9.65 % in 2017 and it is also slightly grew up to 8.68 % in 2018. As positive result in growth of sale, company doing well in getting good net profit percentages was 45.72 % in 2016, 52.77% was in 2017 and it dramatically increased up to 95.06 % in 2018. Operating profit margin also increased every year, it was 72.64% in 2016, 80.88% in 2017 and it highly increased up to 129.13% in 2018. A rich net profit margin means that company has ability to converting sale in to actual profit. Auckland international airport Ltd gave returns to the shareholders from 2016 to 2018 because company got enough profit for three years. They paid final dividend 11 cents per share for the year ending 30 June, 2018. It all depends on selling price of tickets or service and control on expenses. According to the income statement of Auckland international airport Ltd, operation expenses also increased up to 13 % in 2018 as compare to 2017. They should control the expenses to get more net profit in future.

Management efficiency

Management efficiency ratio computes the capability of a business to utilize assets and liabilities to produce sale. Fixed assets and total assets ratio improved in 2018 as compared to previous year. But age of account receivable ratio increased badly in 2018, it was 25.10 days in 2016 and 28.36 days in 2017 but it increased up to 33.89 days in 2018. So it takes approximately 34 days to recover money from customers. It means, it restricts the fund and it is not available for business purpose and it also increase the cash flow issue. Cash flow from operation ratio was remaining steady in 2016 and 2017 but it has increased to 0.98 times in 2018. It means business generating more money to pay its liabilities. Fixed assets ratio tells that how much sale producing by using fixed assets of business. Fixed assets ratio was 0.11 times in 2018. It shows that fixed assets producing fewer sales. Auckland international airport getting enough profit and cash flow operation ratio increased in 2018 that reduce the cash flow problem. Auckland airport should review their credit policy to reduce age of account receivable ratio problem.

Liquidity and gearing ratios

Liquidity ratio describe that how much business has cash and how they can easily convert currents assets in cash to pay off all current liabilities and obligations. The current ratios of Auckland international airport not up to benchmark. It was 0.21 in 2016 and 0.18 in 2017 but it slightly increased to 0.54 in 2018. It showing that business has more current liabilities than current assets. In event of emergency, business cannot pay their current obligation and it will not be easy to convert current assets into cash. Overall, it is means business has illiquidity problem. Gearing ratio helps to calculate risk and fitness of a business. According to the gearing ratio of Auckland international airport, they have low risk level. Business has taken fewer funds from creditors as compare to the owner’s capital. Interest cover ratio also improved just because of low gearing ratio. It was 5.27 and 6.99 respectively in 2016 and 2017. It increased to 11.44 in 2018. It shows that business has enough profit to pay his interest after deducted operation expenses.

References:

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Importance of Accounting for Managers: Purpose of Income Statement and Balance Sheet. (2022, September 27). Edubirdie. Retrieved November 26, 2022, from https://edubirdie.com/examples/importance-of-accounting-for-managers-purpose-of-income-statement-and-balance-sheet/
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Importance of Accounting for Managers: Purpose of Income Statement and Balance Sheet [Internet]. Edubirdie. 2022 Sept 27 [cited 2022 Nov 26]. Available from: https://edubirdie.com/examples/importance-of-accounting-for-managers-purpose-of-income-statement-and-balance-sheet/
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