Understanding Financial Statements and Accounting Principles

This assignment provides a comprehensive understanding of financial statements, accounting principles, and various items included in them. It covers topics such as balance sheets, income statements, adjustments, long-lived assets, and liabilities. The assignment is relevant for students pursuing accounting and finance careers.

Running head: ACCOUNTING
Accounting
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Executive summary
Purpose of the assignment is to learn about different items included in the financial statements of
any entity. The assignment was great way for providing real world experience in the classroom
environment. In this particular assignment I have learnt how to read the financial statement and
obtaining better understanding regarding various financial statements like income statements and
balance sheet and various items included in those statements like liabilities, long lived tangible
as well as intangible assets and shareholder’s equity and cash flows. I have further gathered
knowledge regarding managerial accounting, cost concepts, relevant costs, budgeting and cost
volume profit analysis. Skills required for completing the assignment was the basic knowledge of
accounting, ability to understand the financial statement ability to depict what was learnt by me
and skills of critical thinking. Difficulty I faced while competing the assignment was explaining
the evidence those I found. Further, the assignment required lot of writing and was time
consuming.
The assignment is relevant for my intended career as in future I expect to have the career in
accounts and finance. I found the assignment interesting as it includes financial and managerial
accounting. Personally I enjoy financial and managerial accounting and planning to become
either financial accountant or managerial accountant. However, the assignment challenged my
abilities and skills in accounting. I had tough time in understanding the financial statements and
different cost concepts of managerial accounting. However, in overall aspect I have enjoyed the
assignment as it felt more like real world project and I felt that I have learnt lot from the
assignment that will assist me in future for my accounting career. Further, I developed the skills
for my accounting knowledge that will assist me in analysing the business to see whether the
investment is worth for. It will further enable to explain the same to any other person with or
without the accounting knowledge regarding my findings.

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1. Business decision and financial accounting
Financial accounting is the specialized branch for accounting that enables the business in
keeping track of all the financial transactions. As per my understanding, it is the procedure where
the entity reports and records all financial data involved in the business operations. Accounting
data is reported by the entity on series of the financial statements that includes cash flow, income
statement and balance sheet.
Income statement that is also known as profit and loss statement covers the particular
time period and represent net income of the entity for the particular period after deducting all the
expenses from revenues. Balance sheet represents assets, liabilities and shareholder’s equity
where shareholders equity is the amount of assets reduced by the amount of liabilities. Cash flow
statement represents actual inflow and outflow of the cash and includes cash from operations,
investing and financing activities.
Apart from these statements another important statement that I came across is the
retained earnings statement that represents the details regarding payment of dividend. Further, I
have found that series of accounting principles are there those are adhered by the entity in the
process of financial accounting. I have adapted the knowledge that there are 3 major areas where
the financial accounting assists in taking decisions, these are – (i) it offers the investors with the
baseline for analysis and comparison for financial health of the entity (ii) it assists the creditor in
assessing the liquidity, creditworthiness and solvency (iii) it helps in taking decisions regarding
resource allocation.
Further, providing the up-to-date and steady financial reporting the business is able
making appropriate decisions regarding cost reductions, increasing the sales, increasing
profitability, purchasing new capital assets and finding best source for the finance and its
duration. Apart from that the managers as well as owners can make the informed choices
regarding allocation of human resources, renting or purchasing certain equipment those are used
for the purpose of producing services or goods and taking decisions regarding continuance or
discontinuance of certain business activities.

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Hence, I can make out from the above that the financial accounting is the way for the
business in keeping track for the operations and providing snapshots for financial health. Though
providing data in various statements including cash flow, income statement and balance sheet the
entity may provide the lenders and investors with more power in the decision making procedure.
2. Balance sheet
Balance sheet is 1 of the 3 fundamental financial statements and is considered as key to
accounting as well as financial modeling. Balance sheet represents the total assets, liabilities and
shareholder’s equity. As stated by Stice & Stice, (2014), under Intermediate Accounting
elements of balance sheet includes (i) Measurement and identification of the liabilities as well as
assets those are fundamental to the accounting practices (ii) Liabilities and the assets are
generally segregated into non-current and current (iii) Current items are expected to be paid or
used within 1 year whereas the non-current items are expected to be paid or used beyond 1 year
(iv) It presents the listing of organization’s liabilities and assets at certain point of the time (v)
Difference among the assets and liabilities is known as the equity (vi) It is designed through
using the basis accounting equation as “Assets = Liabilities + shareholder’s equity”
From the article I have learnt that balance sheet is the snapshot that represents the entity’s
financial position at particular point of time. Assets are recorded for the item from where
estimated future economic benefit will be obtained or will be controlled by the entity as a result
of the past events or transactions. Regarding liability I have learnt that it is estimated future
sacrifice for the economic benefit that is arising from the present obligation to transfer the assets
or provide the services in future owing to past events or transactions.
I further learnt that the equity is residual interest in assets of the organization that remains
even after deducting the assets and under business, equity is ownership interest. The article
further given me the idea that balance sheet is used along with other major financial statements
to conduct the fundamental analysis or to compute the financial ratios.
Apart from the above, I have learnt that amount of total liabilities can be compared with
the amount of total equity that gives the idea regarding the leverage of the company. In other
words, it provides useful information to the creditors and lenders those are interested in knowing
whether extension of the additional credit will be resulted in good debt or bad debt.

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3. Income statement
As per my understanding, income statement is one of the major financial statements that
represent the profit or loss over the period of time. Further, I have understood that the profit or
loss is established through considering all the revenues and deducting all the expenses from
operating as well as non-operating activities. I have experienced that the income statement is one
such statement that is used under accounting as well as corporate finance. It displays the
revenues, COGS, gross profit, administration and selling expenses, interest expenses, tax
expenses, other incomes and net profit for the entity.
I have further noticed that the income statement of the entity is segregated into the time
periods that logically follow the operations of the entity. However, the most common for
periodic division is the monthly reporting and these periodic statements are aggregated into the
total values for annual or quarterly results. I have learnt that the income statement is great place
for starting financial model as the income statement requires least information from cash flows
statement and balance sheet.
Further, I have noticed that the income statement is considered as crucial as it represents
the entity’s profitability for the time interval that is specified in heading. However, the time
period for which the income statement is to be presented is chosen by the business and it varies
with company to company. Heading for the income statement may state – ‘income statement for
the year ended 31st March 2019’. Primary expenses and revenues provide insights regarding
how well the entity is performing whereas the secondary expenses and revenues represent the
entity’s management expertise and non-core activities.
Further, I have learnt that the income statement can be prepared in 2 methods – (i) single
step income statement that uses the simpler approach while totalling the revenues and subtracting
the expenses for reaching in the bottom line (ii) multi-step income statement that is more
complex and uses numerous steps for finding the bottom line. It starts with gross profit and then
calculates the operating expenses that are deducted from gross profit to arrive at operational
profit/loss. From the operational profit/loss financial and interest expenses are deducted to arrive
at net profit/loss.

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4. Adjustments
After going through various journals I am able to understand adjusting procedure of
financial statements for the given period with regard to the ledger entries or trial balance. I have
adapted imperative idea regarding adjusting entries. Financial statements record those
transactions only which are pertained to the period for which the statements are prepared. If
some of the recorded transactions those are not pertained to the particular accounting period,
they are required to be excluded through adjusting entries.
In the same way some left out transactions those are pertained to the particular
accounting period are required to be included through adjusting entries. It is required for
computing correct loss or profit and representing the financial statement in true and fair manner.
Further, as per the matching principle expenses and revenues shall be matched for introducing
precise picture of business profitability. Basically the adjustment entries are used under accrual
accounting method. Some of the accounting adjustments those I came across are (i) Changing of
the amount for reserve account like reserve for inventory obsolescence allowance for the
doubtful debts accounts (ii) Deferring the revenue recognition that has already been billed but
not yet been earned (iii) Revenue recognition that has not been billed yet (iv) Recognition of
prepaid expenses as the expenses (v) Recognition of expenses for the supplier’s invoice that has
not been received yet (vi) Deferring expenses recognition that has already been billed but for
which the amount has not yet been expensed.
I further learnt that some of the accounting adjustments are pertinent to the prior periods
when the entity has adopted any changes in the accounting principle. When such changes are
there, it is carried back through the previous accounting periods, so that financial results for the
multiple periods become comparable. However, going through the adjusting entries for different
organization I have learnt that the nature and number of adjustment for different organizations
vary. Generally it depends on the nature and volume of activities in the organization.
5. Long Lived Tangible and Intangible Asset
Going through various articles and journals I have learnt that long lived assets are the
assets those are used by the business for more that 1 year time period. These assets are not sold
to the customers and are used by business for earning revenues. I have further identified that the

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long lived assets are segregated into intangible as well as tangible assets. Tangible long lived
assets are those that I can feel or touch, in other words, that have physical existence and it
represents those assets of the entity from which it can be benefitted for more than 1 year.
Examples for the above are furniture, computer, machinery, land and building. Further, I
have learnt that the cost for long lived tangible assets are computed through considering the
purchasing price along with the cost incurred for bringing the same in ready condition for the
intended use. These assets lose the value over time owing to its use and depletion that is known
as depreciation.
On the other hand, I have understood that the intangible long lived assets are those I
cannot feel or touch in other words they do not have physical existence. Examples for the same
are goodwill, trademark, copyright or intellectual property. I found that the long lived intangible
assets can be developed by the entity in-house or can be purchased while acquiring any other
entity. Intangible assets are recorded at the cost including the purchase price, filling fees and
legal fees.
Intangible assets are write-off through amortization based on its useful life. However, the
amortization is same as depreciation the only difference is it is used for intangible assets. I found
that trademarks and goodwill are not amortized as they have indefinite lifetime. From the
financial statement I have learnt that the entry for recording amortization is passed through
debiting the amortization expense account and crediting the particular intangible asset.
6. Liabilities
Going through the balance sheet of different organizations I came to know that liability is
the obligation that arises from any past business event. Further, I noticed that the liabilities are
paid off over the time through transferring the economic benefits that includes services, goods
and money. Some of the liabilities I came across are loans payable, accounts payable, interest
payable, wages payable, customer deposits, interest payable, mortgages and deferred revenues.
Liabilities which are payable within the period of 12 months are known as current
liabilities whereas Liabilities which are payable after the period of 12 months are known as non-
current liabilities. However, the most common liabilities that I found in almost all balance sheets

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are accounts payable. Liabilities are considered as vital aspect of any entity as they are used for
the purpose of financing the operations and paying for the large expansions.
Generally, liability is referred to being responsible for something and this may include
service or money owed to any other party. For instance, tax liability may refer to the liability
towards government or the income tax authority. I have further adapted the knowledge that the
liabilities shall not be confused with the expenses. Expenses are reported on income statement
whereas the liabilities are reported under balance sheet. Another difference is that the liabilities
are obligations of the entity whereas the expenses are costs of operation.
Apart from the current as well as non-current liabilities one more type of liability that I
came across is the contingent liabilities. Contingent liabilities are may take place based on the
outcome of any future event. Hence, the contingent liabilities are considered as the potential
liabilities. I can explain the same through following example – if an entity faces the lawsuit
amounting to $ 50,000, the entity will record it as liability on the event of lawsuit becoming
successful. Hence, the contingent liability is reported only when it is probable and the amount
involved can be estimated reasonably.
7. Shareholder’s equity and cash flows
As per my understanding, shareholder’s equity is the account represented in the balance
of any entity including the share capital and retained earnings. I also adapted the knowledge that
the shareholder’s equity is represented by total assets reduced by total liabilities. While going
through different balance sheet I noticed that the shareholder’s equity delivers information those
are highly useful while analysing the financial statement. Further, in case of liquidation, equity
holders are paid their dues after making payment to the debt holders. Hence, the debt holders
were not found to be bothered regarding equity value beyond determining the solvency of the
entity.
However, the shareholders were concerned regarding equities as well as liabilities as the
shareholder’s equity can be paid only after the payment of bondholders. Various components of
stockholder’s equity that I found are (i) share capital that includes the amount received by the
entity from the transactions with the owners (ii) retained earnings that is the amount earned

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through the income referred as retained earnings (iii) net income and the dividends where
retained earnings goes up with the net income and reduced with payment of dividend.
On the other hand, knowledge I have gathered regarding the cash flow is that it reduced
or goes up with the amount a business has. In finance, the term cash flow is used for describing
the cash amount consumed or generated in the given period of time. Different types of cash
flows those I came across have significant uses in the business operation and carrying out the
financial analysis. These cash flows include – (i) cash from operation – it is generated through
core business activities of the entity (ii) cash from investment – it includes cash generated or
expensed from selling or purchasing of assets (iii) cash from financing – it includes payment of
dues, interests, mortgage payments and cash generated through loan and mortgages.
8. Managerial accounting and cost concepts
I have gained the knowledge regarding managerial accounting that it can be used in daily
life. I gathered the knowledge that it is different from the financial accounting. Basically the
managerial accounting offers financial and economic information for the managers and for other
internal users. 3 types of managerial costs are there those are segregated as manufacturing
overheads, direct labour and direct material. Going through various journals I am now able to
indicate how cost of the goods manufactured is concluded. Apart from that, I am now able to
calculate the COGS as well as cost of the goods manufactured.
Different topics those I have learnt under managerial accounting are beneficial for the
purpose of controlling and planning for the business and assisting the management in making
financial decisions. Topics which I have learnt are – (i) understanding the cost behaviour and
analysis for the cost volume profit (ii) capital budgeting and operational budgeting (iii) activity
based costing (iv) variance analysis and standard costing (v) pricing of the individual services
and products (vi) evaluating profitability for the customers, product lines and territories.
On the other hand, regarding cost concepts I have learnt that cost is the foregoing that is
measured in the monetary terms and is incurred or to be incurred for achieving any particular
objective. Cost is the monetary measure for the resource amount that is sacrificed or used for any
particular purpose. I have learnt that the costs can be segregated in various ways.

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There may be manufacturing costs as well as non-manufacturing costs, direct as well as
indirect costs, controllable as well as uncontrollable costs, product as well as period costs and
fixed as well as variable costs. I have adapted the idea that management accountants shall
understand the cost concepts as they are crucial in different areas for control, planning and
decision making.
9. Budgeting
Budgeting involves a procedure for creating the plan for spending the money. It allows in
advance to determine whether the organisation have sufficient money to fulfill the required
things. I have learnt about budgeting that without sufficient money the entity will have to plan
the process for prioritizing the spending and focussing the money for the most important things.
As per my understanding, budgeting is considered important as it allows creating the spending
plan and further assures that the entity will have sufficient amount for fulfilling the required
things. Budgeting process involves the planning for the purpose of future profitability as earnings
of the reasonable return from the used resources is primary objective for any entity. The entity
shall devise some methods for dealing with future uncertainty.
Any entity that does not have any planning for the future will be able to react to any event
only after it taking place. However, most of the businesses devise the plan for the actions they
will take in case of foreseeable event that may take place. I have gathered the knowledge that
budget (i) represents the operating plan of the management for future periods (ii) formalizes the
plan of management in the quantitative terms (iii) forces management from all level to think for
the future, anticipate the results and taking actions accordingly for eliminate the expected poor
outcomes and (iv) motivate the individuals to struggle for achieving the set goals.
Further, I found that the entities use the budget to compare with actual results for
analysing the performance. Various other benefits that I found from budget preparation are – (i)
business can coordinate the activities in better way (ii) managers can be aware of the plans made
by other managers (iii) managers may foster the vision that may not be developed otherwise (iv)
the entity may review the organizational plan and may review it or change it, whenever
necessary (v) employees may become conscious about cost and try to safeguard the resources.

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10. Cost-Volume-Profit analysis
For any of the entity, cost-volume-profit (CVP) analysis is required to enable it to
determine the break-even point and for determining the short-term decisions. I found that for
small businesses, nothing is more important as the CVP offers minimum product volume
required for selling with the objective of not experiencing loss or gain. However, I found that for
entrepreneurs it is extremely important to be efficient and effective while utilizing the CVP
accounting procedure. It will provide framework to analyse the importance of CVP to the
entrepreneurship.
If properly defined, CVP analysis is ‘study of effects for changes in cost as well as
volume on the profits’. I gathered the knowledge that CVP analysis helps in minimizing the
failure risk and loss of profit. I learnt that, if adequate data is available that may reflect the fixed
as well as variable cost properly it may allow the entrepreneurs in determining whether the
product will maximize the profit. Although CVP analysis is considered as an important tool that
may be utilized by different entrepreneurs to take sound business decisions that is known as
break-even-analysis. It allows the entrepreneur in determining whether the idea is profitable or
not accurately.
Further, I have adapted the knowledge that CVP analysis assists in recognizing the
impact on financial result of the entity for the given production volume at certain costs.
Eventually the price and cost also play major role while deciding profit margin which is the
major factor for any organization. It further helps to identify the product mix, break-even point,
sales volume required for attaining the targeted profits, decisions regarding increasing of the
profits, assessing the entity’s operating risk, discretionary expenses on the budget and usage of
specific type of technology.
One more thing I have learnt is creating CVP in spreadsheet and the advantages derived
from creating the same with separate section for input is that the additional CVP analysis can be
performed easily through changing the input data. Further, it can be used for determining the
impact of changes in the sales mix on the results.

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11. Relevant cost
Relevant cost is the cost that is only related to the particular decision for management
which is expected to be changed in future owing to the decision. I have adapted the knowledge
that the concept of relevant cost is exceptionally useful to eliminate the extraneous information
from the particular process of decision making. Further, through eliminating the irrelevant cost
from any decision, the management is prevented in focussing on the information that may
otherwise affect the decision incorrectly.
However, I have found that the concept is applicable only for the activities of
management accounting and is not useful for financial accounting. The reason behind that is no
spending related decisions are involved while preparing the financial statements. I can explain
the same through the following example –
ABC Ltd is considering purchase of equipment for its factory. If the equipment is
purchased by ABC, it will remove 6 labours those were doing it manually. Wages for these
employees are relevant cost as they will be eliminated in future if the equipment is purchased.
However, the corporate overhead cost will not be relevant as it will not change owing to the
decisions.
Different types of relevant costs those I came across are – (i) future cash flow – cash
expenses incurred in future owing to any decision taken (ii) avoidable costs – it includes the
costs those are relevant to the decision and can be avoided if decision is not implemented (iii)
incremental cost – here different alternatives are considered and the relevant cost is incremental
cost or the differential costs among different alternatives considered (iv) opportunity cost – it is
the cash inflow that is to be sacrificed owing to particular management decision.
However, I have learnt that though the relevant costing is considered as a useful tool for
taking short-term financial decisions, it cannot be used as a base for taking pricing decisions. The
reason behind this that for being sustainable in long-run it shall charge the price that will provide
sufficient profit above total cost and not just the relevant cost.

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Appendix
Balance sheet

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Income statement
Cost – volume – profit