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The Role of Financial Accounting and Management Accounting

Management accounting is the only relevant aspect of accounting skills Managers must have. Other aspects, such as Financial accounting knowledge is important for professional accountants only.”  Do you agree? Discuss.

I do not agree with the fact that management accounting is the only relevant aspect of the accounting skills managers needs to have. I feel that a manager must have sufficient knowledge of both management and the accounting, since both plays key role in the business organization’s success.

Financial accounting is referred as the preparation of the financial reports for external users to analyze the company’s financial position. Management accounting is usually concerned with providing economic information for internal users of a company being owners and management. Management accounting is often a lot broader than financial accounting in that it is less proscriptive and can include non-financial information to assist with making policies and strategies for the company (Silviu-Virgil 2014).  Dauderis et al (2020) state that the financial statements of the entities are often accompanied by the auditor’s report and a section titled “Management’s Responsibility for the Financial Statements.”

While preparing the company’s financial statements, the management undertakes some estimates, judgements, and assumptions relating to the recognition and value of the assets, liabilities, expenses, and income. Birt et al (2019) states that management is expected to apply GAAP, which provide accounting standards for preparing the financial statements. When applying GAAP, management estimates can have the material impact on an entity’s economic outcomes. The management is held responsible for the the financial statements’ preparation and fair presentation as per the GAAP, and to have in place internal controls to facilitate the financial statements’ preparation, which are free from any material misstatements, whether because of fraud or error. Dauderis et al (2020) state that the application of GAAP can present some challenges when the judgment needs to be be applied in the case of the materiality and cost-bene?t decisions.

The managers can use their knowledge of managerial accounting in the long-term and the short-term decisions that involves entity’s financial health. It assists the managers in making internal planning and operational decisions that are intended to assist in making the long-term decisions of investment. The skills of management accounting enable the managers to assess the progress through assessing the failure or success of the business efforts in meeting its goals (Doorasamy 2015). On the other hand, if we talk about the financial accounting, its knowledge and skills are valuable, since it measures whether an entity was financially successful or not, and based on which analysis can be done regarding the gap in the forecasted figures and the actual figures, and also future estimates can be made. In this way, the skills and knowledge of both management accounting and financial accounting is required. This help not only managers, but also the investors to understand the health of an entity, and plan accordingly (Kotane 2015).

Executing the accounting equation perfectly while recording the financial transactions during the reporting period guarantees the accuracy of the information presented in the various financial reports.” Discuss the statement.

Challenges in Applying GAAP

I feel that perfectly execution of the accounting equation while recording the financial transactions during the reporting period does not completely guarantees the information’s presented in the different financial reports.

The accounting equation is a fundamental accounting principle and important element of the BS. The equation is: Assets = Liabilities + Equity.

The aforementioned equation forms the basis of double-entry accounting and determines the structure of the BS. The accounting equation is mainly based on the double entry accounting system, which assumes there are two aspects of every transaction, which are credit and debit, and for every debit, there is opposite and equal credit. Double-entry accounting captures every transaction and the corresponding effect on both sides of the accounting equation. For example, whenever there is a change to the asset account, there must be a corresponding and equal change to the liability or the equity account. A company may take a loan from a bank – this would be shown in its BS as both an increase in the entity’s assets as well as the rise in its loan liability (Juárez 2016).

An important relationship exists between the financial statements in recording and analyzing accounting equation. The P/L statement is related to the statement of changes in equity. The revenues and expenses are recorded on the PL statement. Further, the resulting net income results in the equity to change and is subsequently recorded on the changes in equity statement. Further, the changes in equity statement are related to the BS. Changes to the balance of equity and the retained earnings recorded on the state of the changes in equity are then recorded to the section of equity of the BS. This shows that the financial statements are linked with each other in some or the other way (Warren, Jonick and Schneider 2020).

It is therefore, requires to record every single transaction accurately. Duaderis (2020) has outlined the journalizing process to be used by the accountant. Recording accurate journal entries at the time of the transaction is critical for companies to show their correct financial status to both internal and external parties. Poorly maintained journals, and failures to execute the accounting equation can result in perceived increases or decreases in profit or debt than what is actually the case. This may lead management, creditors and investors to make decisions based on flawed information (Kimmel, Weygandt and Kieso 2020). However, sometimes the managers are involved in the fraudulent activities, where they intentionally manipulate the accounting figures to make rosy picture of the entity’s financial statements. Hence, even though debit and credit are matched by using the double-entry system, and the accounting equation is used, manipulations can be done, and it is quite difficult to spot such manipulation. For instance, the corporate failure of Enron and WorldCom are some of the examples, where it took years to identify the manipulations done by the accountants of the company (Sadaf et al. 2018). 

An operating expense must be recorded when paying for any current liability such as Trade Creditors”. Do you agree? Discuss.

Linkage between Financial Statements

I do not agree with the statement that an operating expense must be recorded when paying for any current liability, such as trade creditors. 

The "current liabilities" is referred to a entity’s short-term financial debts, which are due within a year or during the day-to-day operational cycle, such as interest payable, accounts payable, the sales tax payable, and others. One of the current liabilities is the trade payable.  It is referred as the short-term liability, where an entity owes money to the creditors (Paul and Rahman 2021). On the other hand, operating expenses refers to the costs that are incurred by the business for its operational activities. Operating expenses are the costs that a company must make to perform its operational activities. For calculating a company’s operational expenses, the operational activities need to be identified. These are the primary revenue-producing activities of the business that are not financing or investing activities. The operating expenses includes, equipment, rent, inventory costs, marketing, payroll, and monies allocated for research and development (Pehlivan, Gerekan and Kocan 2020).

Both expenses and liability results in the outflow of cash. Operating activities are reported in the PL statement and are adjusted from an accrual to the cash basis. Profit and loss lead to revenue and expenses which impact the cashflow statement. Further, the income statement keeps a record of revenue and the expenses. Moreover, there is a association between cash flow statement and the balance sheet which covers CA and CLs. In Australia and New Zealand, entities are encouraged to use direct method when preparing the cashflows statement (Jeppson, Ruddy and Salerno 2016).

Assuming trade payable as the operational expenses of the entity’s core operations, is incorrect. Expenses and liabilities must not be confused with each other, as one is listed on the entity’s PL statement, and the other is listed on the balance sheet. Operating expenses are the costs of the company’s operations, and liabilities are debts and obligations an entity owes. Current liabilities are accrued till one year and then paid off, but the operating expenses are paid off in the real-time, since it can affect the company’s operations. If liability is not paid then it may lead to default, but if expenses are not paid, then it may lead to misfunctioning of the operations of the entity (Chen, Harford and Kamara 2019).

Date

Assets

=

Liabilities

+

Equity

Notes

Current

Noncurrent

Current

Noncurrent

Capital/Reserve

Income

Expenses

Dec. 1, 2021

Cash in Bank

Accounts Payable

Samantha, Capital

$50,000.00

$20,000.00

$30,000.00

To record Sam's initial capital

Dec. 1, 2021

Prepaid Rent

$4,000.00

Cash in Bank

-$4,000.00

To record advance payment of rental

Dec. 2, 2021

Office Equipment

Accounts Payable

$8,000.00

$8,000.00

To record purchase of office equipment on account

Dec. 29, 2021

Accrued Repairs & Maintenance

Repairs & Maintenance

$6,500.00

-$6,500.00

To record unpaid repairs

Dec. 30, 2021

Prepaid Advertising

Accrued Advertising

$500.00

$500.00

To record unpaid and unincurred advertising

Dec. 30, 2021

Accrued Utilities Expense

Utilities Expense

$550.00

-$550.00

To record billed expenses

Jan. 8, 2022

Cash in Bank

Accrued Repairs & Maintenance

-$6,500.00

-$6,500.00

To record payment of repairs

Jan. 10, 2022

Cash in Bank

Toys & Playground Equipment

Accounts Payable

-$1,000.00

$5,000.00

$4,000.00

To record purchase of toys and playground equipment

Jan. 10, 2022

Cash in Bank

Accrued Advertising

-$500.00

-$500.00

To record unpaid advertising

Jan. 15, 2022

Cash in Bank

Accrued Utilities Expense

-$550.00

-$550.00

To record payment of utilities

Jan. 24, 2022

Accounts Payable

$4,000.00

Loan Payable

-$4,000.00

Jan. 28, 2022

Accrued Utilities Expense

Utilities Expense

$500.00

-$500.00

Jan. 31,2022

Cash in Bank

Unearned Income

$2,000.00

$2,000.00

To record payment of services not yet rendered

Jan. 31,2022

Cash in Bank

Salaries & Wages

-$2,000.00

-$2,000.00

To record payment of staff's salaries

The Balance Sheet shows the “Profit for the year” as well as the “Cash balance”, hence it is the only statement really needed to communicate the health of the business.” Do you agree? Discuss.

I do not agree with the fact that the balance sheet is the only statement that shows ‘cash balance’ and ‘profit for the year’, and really needed to communicate the health of the business, since there are other statements, for instance, income statement and cash flow statement, which also helps in providing key information regarding the company’s performance and cash position at the financial year end. Balance sheet is the statement that mainly reports the company’s assets, shareholder equity, and the liabilities, and provides information regarding the company’s financial position at the financial year end (Koonce, Leitter and White 2019).

Importance of Accurate Journal Entries and Execution of the Accounting Equation

An entity’s financial statements (PL statement, BS, and the Cash Flow statement) helps in providing the financial information, which the investors, creditors and the analysts use to assess an entity’s financial performance. The entity’s financial statements are considered to be the key tools for the top managers to communicate the past successes and the likely future expectations. It is through publishing the financial statements, the management can be able to communicate with the interested parties, for instance, investors, creditors and the industry analysts regarding its the company’s performance (Osadchy et al. 2018).

The investors and creditors depend on the company’s financial reports to understand the profitability, liquidity and solvency positions of the company. The BS lists the entity’s components of outstanding debt and the equity, and so that the relative capital mix of debt and equity used by the company over the financial year, can be better understood by the investors (Herciu and Ogrean 2017). By using the PL statement, the investors can assess an entity’s past performance and assess the future cash flows uncertainty (Hasanaj and Kuqi 2019).

The cash flow statement’s importance is that it indicates the inflow and outflow of the cash of the entity during the period. Hence, the investors can understand if the entity has sufficient cash to pay for the expenses, purchases of asset, and payment of debts. The detailed information of the cash cannot be found in the PL statement and the BS, since they do not provide direct information regarding the entity’s cash position during the period. Further, an entity also incurs the inflows and outflows of cash during the period from the operating, investing and financing activities, all of which are shown in the cash flow statement (Mileti? 2014). Further, the shareholders' equity statement is particularly important for the equity investors because it depicts the changes in different components of the equity, including the retained earnings, during the period (Radu and Mihai 2018).

Therefore, it can be said that financial statements, which include income statement, changes in equity statement, BS, and the cash flow statement, are required by shareholders and other stakeholders to make investment decisions (Hamilah 2020).

To expand your market share, you plan to reach out to a few new large businesses. As your potential clients, if you had access to their financial reports, which relevant financial ratios/aspects you would consider first while shortlisting them and why?

These are financial ratios that are used to find out the entity’s ability to pay/settle its short-term obligation when they fall due. There are two main types of liquidity ratios namely: quick ratio, and current ratio (Noor and Lodhi 2015).

  • Quick ratios= (CA- inventory)/CL
  • Current ratio=CA/CL

I will look at these liquidity ratios because it will enable me to understand whether an entity is able to meet its short-term debts as and when it becomes due from its short-term assets.

This is the type of financial ratio that shows the ability of the company to make profits against its sales or operations, BS assets, or the shareholders' equity at a specific period of time. I will use these types of ratios to understand how often does a certain company generate profits.

  • Profit Margin ratios are used to measure the ability of the entity to generate profit after meeting its costs and expenses. They include; gross margin, the operating margin, pretax margin, and the net profit margin.
  • Return on Assets=net income/total assets

Possible Manipulations in Accounting Figures

This profitability ratio is evaluated against costs and expenses and analyzed in comparison to the assets so as to see the effectiveness of an entity in using assets to produce sales and profits.

  • Return on equity= net income/ shareholders' equity

It is the ratio that indicates the ability of a company to generate net profit from the funds of the shareholders during the given period (Agusta and Hati 2018).

This is a financial ratio that is used to measure the efficiency of the company in using its assets to generate sales. For instance, the efficiency ratio looks at different aspects of an entity, such as the time taken by the company to collect cash from its customers or the time taken to convert inventory into cash (Urbanek 2016).

  • Receivables Turnover Ratio= company's net credit sales/average AR.
  • Asset Turnover Ratio= company's Sales/total assets
  • Inventory Turnover Ratio= cost of goods sold/average inventory.
  • Working Capital Turnover Ratio = Sales or Cost of Goods Sold / Working Capital

This is a financial ratio, which measures the company’s ability to meet its long-term financial obligations when they fall due.

These ratios are important to me since they will tell me whether the company in question has the ability to repay its debts or it will get default. More debts are quite risky for the company, however, if an entity is able to pay back its debts within agreed time, then more debts will help to stimulate its growth in the long run. The company must use a perfect balance of both debt and equity (Brîndescu-Olariu 2016).

  • DE Ratio=total liabilities divided/total equity
  • Interest Coverage Ratio= (EBIT)/total amount of the interest expense on the entity’s outstanding debts.

This ratio helps to show the entity’s ability to pay all its interest payments. Further, when an entity seeks a loan from bank, a cost to loan the money is charged by the bank to the company, and that cost is referred as interest.

  • Debt Ratio= total liabilities/total assets.

References:

Agusta, R.F. and Hati, S.W., 2018. Calculation of Liquidity, Solvency and Profitability Ratio in Manufacturing Company. Journal of Applied Accounting and Taxation, 3(2), pp.110-116.

Atrill, Peter et al. Accounting. Melbourne: Pearson Education Australia, 2020. Print.

Bettner, Mark S. Using Accounting & Financial Information?: Analyzing, Forecasting & Decision Making. First edition. New York, New York (222 East 46th Street, New York, NY 10017): Business Expert Press, 2015. Print.

Birt, J., Chalmers, K., Maloney, S., Brooks, A., Oliver, J. and Bond, D., 2020. Accounting: business reporting for decision making. 7th ed. Milton: John Wiley & Sons Australia, pp.302-305.

Brîndescu-Olariu, D., 2016. Assessment of the bankruptcy risk based on the solvency ratio. Theoretical & Applied Economics, 23(3).

Chen, Z., Harford, J. and Kamara, A., 2019. Operating leverage, profitability, and capital structure. Journal of financial and quantitative analysis, 54(1), pp.369-392.

Doorasamy, M., 2015. Theoretical developments in environmental management accounting and the role and importance of MFCA. Foundations of Management, 7(1), pp.37-52.

Duaderis, H, Annand, D, and Jensen, T. “Introduction to Financial Accounting – 2021A.” Lyryx Learning Inc. (2020). Web.

Hamilah, H., 2020. The Effect of Commissioners, Profitability, Leverage, and Size of the Company to Submission Timeliness of the Financial Statements Tax Avoidance as an Intervening Variable. Systematic Reviews in Pharmacy, 11.

Hasanaj, P. and Kuqi, B., 2019. Analysis of financial statements. Humanities and Social Science Research, 2(2), pp.p17-p17.

Herciu, M. and Ogrean, C., 2017. Does Capital Structure Influence Company Profitability?. Studies in Business & Economics, 12(3).

Hussey, Roger, and Audra Ong. Accounting for Business?: Practicalities and Strategies. First edition. New York, New York (222 East 46th Street, New York, NY 10017): Business Expert Press, 2021. Print.

Jeppson, N.H., Ruddy, J.A. and Salerno, D.F., 2016. The statement of cash flows and the direct method of presentation. Management Accounting Quarterly, 17(3), pp.1-1.

Juárez, F., 2016, August. The accounting equation and claims on assets value change. In 2016 Third International Conference on Mathematics and Computers in Sciences and in Industry (MCSI) (pp. 246-251). IEEE.

Kimmel, P.D., Weygandt, J.J. and Kieso, D.E., 2020. Financial accounting: tools for business decision-making. John Wiley & Sons.

Koonce, L., Leitter, Z. and White, B.J., 2019. Linked balance sheet presentation. Journal of Accounting and Economics, 68(1), p.101237.

Kotane, I., 2015. Evaluating the importance of financial and non-financial indicators for the evaluation of company’s performance. Management Theory and Studies for Rural Business and Infrastructure Development, 37(1), pp.80-94.

Mileti?, D.B., 2014. Cash Flow Statement: Assesment of Situation and Application problems in Serbia. Industrija, 42(4).

Nobes, Christopher W, and Christian Stadler. “The Qualitative Characteristics of Financial Information, and Managers’ Accounting Decisions: Evidence from IFRS Policy Changes.” Accounting and business research 45.5 (2015): 572–601. Web.

Noor, A. and Lodhi, S., 2015. Impact of liquidity ratio on profitability: An empirical study of automobile sector in Karachi. International Journal of Scientific and Research Publications, 5(11), pp.639-646.

Osadchy, E.A., Akhmetshin, E.M., Amirova, E.F., Bochkareva, T.N., Gazizyanova, Y. and Yumashev, A.V., 2018. Financial statements of a company as an information base for decision-making in a transforming economy.

Paul, S.C. and Rahman, M.A., 2021. Current Assets, Current Liabilities and Profitability: A Cross Industry Analysis. Journal of Asian Business Strategy, 11(1), pp.55-68.

Pehlivan, A., Gerekan, B. and Kocan, M., 2020. The Effect of Operating Expenses on Growth and Performance: An Empirical Analysis of the Petroleum and Chemistry Industry in Turkey. Asian Economic and Financial Review, 10(11), pp.1299-1308.

Radu, R.I. and Mihai, I.O., 2018. Financial Performance and Shareholders' Equity Dynamics-Case of Industry and Constructions Listed Companies. Annals of the University Dunarea de Jos of Galati: Fascicle: I, Economics & Applied Informatics, 24(1).

Sadaf, R., Olah, J., Popp, J. and Mate, D., 2018. An investigation of the influence of the worldwide governance and competitiveness on accounting fraud cases: A cross-country perspective. Sustainability, 10(3), p.588.

Silviu-Virgil, C., 2014. The importance of the accounting information for the decisional process. THE ANNALS OF THE UNIVERSITY OF ORADEA, p.591.

Tracy, John A, and Tage C Tracy. The Comprehensive Guide on How to Read a Financial Report: Wringing Vital Signs Out of the Numbers. New York: John Wiley & Sons, Incorporated, 2014. Print.

Urbanek, G., 2016. The links between the Intellectual Capital Efficiency Ratio (ICER) and the performance of Polish listed companies from the food industry sector. Electronic Journal of Knowledge Management, 14(4), pp.pp220-230.

Warren, C.S., Jonick, C. and Schneider, J., 2020. Financial accounting. Cengage Learning.

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