Accounting Fundamentals: Income Statement, Financial Position, Ratios, and User of Company Accounts

This document provides an overview of accounting fundamentals, including the preparation of income statements and financial positions. It also includes the calculation of ratios for a specific company and discusses the importance of accounting information for different groups of users, including internal users such as owners, managers, and employees.

ACCOUNTING
FUNDAMENTALS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
Question 1........................................................................................................................................3
Income Statement of the Wales plc for the year ended 31st December 2019..............................3
Statement of the financial position of Wales plc for the year ended 31st December 2019..........4
QUESTION 2..................................................................................................................................5
a) Calculation of Ratios for Jerry plc for year 2019 and 2018....................................................5
b) Situation being revealed by the ratios.....................................................................................6
Question 3........................................................................................................................................8
A) Three different group of user of company accounts and reason behind user interested in
information provided by financial statements.............................................................................8
B) Advantages and disadvantages of financial reporting regime for perspective from both user
and prepare of financial statements...........................................................................................10
C) Limitation of Financial statement.........................................................................................12
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................14

INTRODUCTION
Business management is important process which involves arrangement of sufficient
resources such financial and human to complete particular task and delivered qualitative services
to customers. Accounting fundamental majorly includes five main parts like recording,
classifying, interpretation, analysis and formulation of financial reports to know about actual
amount of amount and operating expense within specific period of time. Therefore it is complex
process that includes crucial information of business that are need by all internal and external
stakeholders for their respective decision making. The report has prepared income and financial
statements of Wales Plc’s on 31 December 2019. Various ratio of Jerry Plc has been calculated
in the report on basis of income and financial statements of company to get important
information about company. At last it has explained about use, limitation of financial statements
or income statements of company.
Question 1
Income Statement of the Wales plc for the year ended 31st December 2019
Income statement, 31st December 2019
Particulars £’000 £’000
Sales 30,300
Cost of sales 16,220
Add: depreciation on plant 2,560 18,780
Gross profit 11,520
Revaluation income (land) 5000
Administration expenses 2920
Add: Bad debts written off 240
Add: Discount on account receivables 160
Add: Depreciation on building 320
Add: Outstanding insurance fees 500 4140
Distribution expenses 2160
Debenture interest paid 240
Dividends paid 560
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Tax paid 1600
Net profit 7,820
With the above statement it can be seen that that the net profit of the year was 7820 and the
income of the company was 30300 and the direct expenses were 18780. After deducting the
direct expenses from the income the gross profit of 11520. Further after deducting all the indirect
expenses from the gross profit the net profit was 7820.
Statement of the financial position of Wales plc for the year ended 31st December 2019
Statement of position as at 31st December 2019
Liabilities £’000 Assets £’000
Share capital 29000 Bank 320
Retained profit 8380 Land at cost 20000
Share premium 5000 Buildings at cost 16000
Net profit 7,820
Less: Accumulated
depreciation (4260 +
320) 4580 11420
12% debentures 2024 4000 Plant at cost 25600
Outstanding insurance fees 500
Less: Accumulated
depreciation (4960 +
2560) 7520 18080
Trade payables 4480
Trade receivables
(8240-240- 160) 7840
Income tax liability 1600 Inventory 3120
Total liabilities 60780 Total assets 60780
Workings
Working note
Building cost 16000
Depreciation (2% * 16000) 320
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Plant cost 25600
Depreciation (10% * 25600) 2560
From the above table it can be interpreted that the total liabilities of the company amounts to
60780 and the asset as well the same. In the liabilities the major liability is towards the trade
payable and the debentures. In case of the asset the bigger asset is the land and thereafter the
plant and many other different set of assets.
QUESTION 2
a) Calculation of Ratios for Jerry plc for year 2019 and 2018
Particulars Formula
2018 2019
Earnings before interest and taxes 29.7 23
Total assets 293.8 286.1
Current liabilities 148.4 151
Capital employed Total assets-Current liabilities 145.4 135.1
Return on capital
employed
Earnings before interest and
taxes/Capital employed 20% 17%
Net income 18.3 12.9
Shareholders equity or funds 80.3 93.2
Return on equity Net income/Shareholders equity 23% 14%
Net income 18.3 12.9
Average outstanding shares 17.8 17.8
Earning per share
Net income/Average outstanding
shares 1.03 0.72
Gross profit 186.9 191.8
Net sales 486.8 501.3
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Gross profit ratio Gross profit/Net sales*100 38% 38%
Net sales 486.8 501.3
Average total assets 293.8 286.1
Asset turnover ratio Net sales/Average inventory 1.66 1.75
Cost of goods sold 299.9 309.5
Inventory 41.1 38.8
Stock holding period Cost of goods sold/Inventory 7.3 8.0
Debtors 114.7 114.9
Sales 486.8 501.3
Debtors collection
period Debtors/Sales*365 86.0 83.7
Current assets 156.5 153.9
Current liabilities 148.4 151
Current ratio Current assets/ Current liabilities 1.05 1.02
Debt (Long term funds) 65.1 41.9
Equity (owners fund) 17.8 17.8
gearing ratio Debt/Equity 0.27 0.42
Earnings before interest and taxes 29.7 23
Interest expense 3.5 0.2
Interest coverage ratio
Earnings before interest and
taxes/Interest expense 8.49 115.00
b) Situation being revealed by the ratios
 Return of capital employed- the return on capital employed is a ratio which states that
how much return the company is getting on the capital employed (Laitinen, 2017). This is
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very essential for the company to analyse the return which the company is getting as if
the return is not good then this is not beneficial for the company. From the above
calculation it is clear that in the year 2018 the return on capital employed was 20 % but in
the year 2019 the return reduced to 17 % which means that the return has reduced. Thus,
this means that the amount which the company is using as the capital is not enough for
the company to get back the worth.
 Return on equity- the return on equity is referred to as the return which the shareholders
are getting in against of the amount which they have invested in the company. It is very
essential for the company to give good return to the shareholders as if they will not be given
much then the shareholders will take back their investment from the company. With the
interpretation of the above ratio it can be seen that in the year 2018 the return was 23 % but
in the next year the return reduced to 14 % it means that the business and the profitability of
the company has reduced. Due to this reason the company is facing loss.
 Earnings per share- this is referred to as what the shareholder or the company is earning
on the single share that is the income per share. This is essential to be studied as if the per
share earnings will be low then this will affect the working of the company to a great extent.
In the calculation above it is clear that the EPS has decreased of the company from the year
2018 to 2019. In the year 2018 the EPS was 1.03 which reduced to 0.72 in the year 2019.
 Gross profit ratio- this is the ratio which states the changes in the gross profit of the
company. This is essential to be studied as this ratio states the rate at which the company is
earning the profit. In the year 2018 the gross profit ratio was 38 % which was same in the
year 2019 as well. Thus, for this it is very essential for the company to keep on increasing
the profit margin as this will also increase the profitability of the company.
 Asset turnover ratio- this is the type of ratio which assist the company and the user of
financial statements to evaluate the company’s ability in generating sales from the asset
of the company. This help in assessing the fact that how much the company is able to
manage and utilise all the resources of the company and bring out maximum of the
profits from the company. Presently the company is having the ratio of 1.75 which is high
in comparison with last year that is 1.66. This means that company is effective in the
proper management of the asset and earn good sort of income from the assets of the
company (Selvam, Dhamotharan and Sankarkumar, 2020).
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 Stock holding period- this is the ratio which is also known as inventory turnover ratio and
this ratio illustrates the average time which is taken by the company in converting the
inventory into sales. In the year 2018 the ratio was 7.3 and in 2018 this increased to 8.
Thus, it can be stated that the company need to work in the direction of minimising the
ratio so that in shorter time the inventory will be converted in cash (Martins, 2017).
 Debtor’s collection period- this is the ratio which states that in how much time the
company will collect all the dues and credit from the customers and other people. In the year
2018, this period was 86 days and in 2019 it was 84 days and this states that the time has
reduced which is good for the company but it has to reduce it more.
 Current ratio- this is the ratio which states that how much liquid is the company. In the
year 2018 the current ratio was 0.27 and in present year it was 0.42. This means that there
has been increasing move in the trend of current ratio which suggests that the company has
increased more towards the debt which is not good for the company and they need to reduce
it.
 Gearing ratio- this is the ratio which is essential for the company as this assist the
company in evaluating the ratio of debt and equity in comparison with the overall capital of
the business. In the present year that is 2019 the ratio was 0.42 and in 2018 it was 0.27. This
has increased as compared to the last year and this states that the debt has increased and this
will result in the financial risk of the company.
 Interest coverage ratio- this is the ratio which measures the company’s ability in making
and clearing all the payments relating to the interest of loans. In the present year the ratio
was 115 which was 8.49 in the last year. This suggest that the ability of the company has
increased with respect to the payment of the interest (Coulon, 2020).
Question 3
A) Three different group of user of company accounts and reason behind user interested in
information provided by financial statements
There are various group of people that are interested in financial statements of company
can be termed as external, internal and government or IRS. It can be stated that each group
analysis and make use of accounting information for different purpose thus present it in different
or unique way (Cheong and SHI, 2018). Therefore, three identified group of people that are
interested in financial statements of company are explained in detail below:
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Internal users
These are primary user of accounting information so includes management, owners and
employees of firm. Such as:
 Owners: It can be illustrated that owner of business required financial information or
company accounts in order to know overall profitability in particular year. At the same
time they are able to know about associated risk and total expenditure in financial year so
that various strategies can be planned to cope with future circumstances. Therefore it
helps owners to know or assess level of stability of business during various periods so
that it can make accurate decision to further invest in specific area to get better outcome.
 Managers: Company manager require information related to company accounts for
planning, monitoring and evaluating of performance of business during specific financial
year. Accounting information contributed manager to take decision to prepare budget of
company by monitoring and analysing information of past performance of company and
key indicators which may lead to growth and success of enterprise (Lin, 2020). So, it can
be illustrated that manager requires accounting information to take business decision
likes setting prices and investments or finance for smooth operation of business.
 Employees: These are other internal parties of company that are interested in company
accounts to know how well company is performing in market so that they can feel secure
and safe. On the other hand employees that are working in financial department of firm
used company account as part of their respective duties to prepare financial statement at
the end of year.
External user of company accounts
There are different types of external user of account information such as Investors,
suppliers, customers, tax authorities, auditors and general public. Like:
 Investors: These are people that have invested their money or capital in business so by
evaluating and analysis financial statements they are able to know how well their
investment is performing. Thus, they are able to know amount of risk, profitability and
current value of investment that are useful in taking accurate decision to further invest in
business or not for better return on capital.
 Suppliers/ lender/ creditors: Company needs various raw material or goods in order to
manufactured finished products that can be renders to end customers. Therefore,
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suppliers before lending credit need to analysis financial position that is total profit, sales
volume and market position in order to know credit worthiness of its customers (Faccia
and Mosco, 2019). So, it helps them to take decision regarding whether credit need to be
given or not and amount to which it should be allocated.
 Customers/ public: They are people or industrial customers which required financial
information to know about that it will have steady supply of goods in future circumstance
or not. People that are activist, academics, analysts or interest in knowing financial
statements of company to know the way these firm have contributed in economic growth
and development.
 Auditors: It can be stated that auditors are responsible for creating audit report of
company based on its financial accounts so that external parties such as investors and
customers or interest stakeholder can trust the report and make decision accordingly.
Government/ IRS
It is third group of user of company accounts as government agencies in order to
evaluate or track tax record of company make use of business accounts. This helps government
to know that whether companies have pay tax as per current tax law or not (Maisuradze, 2018).
Tax auditors also review amount of money that needs to be paid by firm as tax which can
contribute economic growth and sustainability.
B) Advantages and disadvantages of financial reporting regime for perspective from both
user and prepare of financial statements
Financial statements are used by investor or market research to know about healthy
financial position of firm in competitive market condition. Regime financial report has both
advantages and disadvantages as per view of user and prepare of financial statements that can be
illustrated as follows:
Advantages of Financial report
 Monitor and evaluation of operation procedure: It can be stated that regime or
standard financial report helps in effectively evaluating whether business in running
better or not (Mistary, 2020). It helps in identifying key performance indicators of
business thus contributed in building strong brand image of firm.
 Manager can easily control operation of business: Accurate financial report helps
management of business to take corrective action to improve performance of business.
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Manager by analysing financial statements is able to find areas in which company lack
thus able to find better strategies for growth and success of enterprise.
 Helps in improving performance of employees: It can be stated that maintenance of
financial as per standard helps in raising morale and motivation level of individual to
work hard so that company can gain competitive advantages. Employees by knowing
good financial position of firm are motivated to put their best so that it can easily expand
its business operation across worldwide.
 Customers or user are more satisfied: People while selecting particular company
products and services rely on brand image, financial position of firm so that they can get
best qualitative products at reasonable rates (Faccia and Mosco, 2019). Therefore
accurate financial statement helps in building trust and motivating people to select
specific products and services of firm for satisfaction of their basic requirements.
 Evaluation of investment: Regime financial statement provides ease and comfort to
investors to easily evaluates various alternative options of investment that company have
used in past. So, by evaluating investment alternative investors is able to take decision to
invest in particular field to get maximum outcome.
Thus, company can easily find strategies that it can use in future circumstances to gain
competitive advantages or expand overall profitability, market share of firm.
Disadvantages of Financial report
Despite of various advantages of regime financial report that are certain disadvantages of
financial report of company that are illustrated as follows:
 Record only monetary transaction: Financial statements mainly includes transaction
that can be measured or enumerated in terms of money so there is no record of non-
financial transaction that have contributed in effective growth and success of enterprise
(Pelekh, Khocha and Holovchak, 2020). Therefore it hides qualitative information of
business such as hard working employees that are more important than quantitative data.
 Time consuming: Another disadvantage of regime financial record is that it involves lot
of time, money and efforts to be invested to present correct statement to interested
parties. At the same time it is too expensive or lead to addition of cost as company in
order to prepared accurate financial statement have to hired people that have highly
skilled, knowledge and experienced.
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 Difficult to understand: Sometimes technical financial reports of business are difficult
to understand by individual or stakeholders that are interested in operation of company.
Therefore it may act as disadvantages for user of financial records of firm for respective
purposes.
C) Limitation of Financial statement
Manager or any individual need to be aware of limitation of financial statement before
making use of its for different purposes such as based on historical cost, personal judgements and
inflation effects. Therefore various limitation of financial statement are discussed as follows:
 Historical cost: It can be illustrated that financial statements are mostly based on
original or historical cost which contributed in decreasing value of asset over passage of
time because it have not considered actual or current prices of assets (Chen and et.al.,
2018). Sometimes income statement shows increase in profitability of company which
may be due to increased in prices or abnormal cause. Therefore it might state that
financial statements are unable to state accurate or fair pictures of total profit earned
during particular financial year.
 Only interim report: Most of the data given in financial report are approximately so
accurate position of business can only find in case of liquidation or dissolution of
business. Individual on basis of its personal judgement may allocate cost and incomes to
different period with objectives to determine or represent more profit margins. Therefore
they are just interim report as they hide actual or final picture of firm in competitive
market.
 Inflation: Another limitation of financial statement is that it does not consider effects or
impact of inflation on liabilities and assets of firm that are showed in balance sheet
(Malau and Murwaningsari, 2018). Thus, in case of high inflation balance show
sustainable low value thus mislead user of financial statements.
 Specific time period: There are various or several changes in environment that needs to
be adapted by business in order to retain its market share and profitability. These
statements are prepared by enterprise for specific time period that is one month or year so
considering such period only may mislead as there are different changes in environment.
 Not comparable: Companies in order to know their position in market make use of
financial statements so it is just an indication which means it does not depict true picture
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that helps in comparison between two companies. At the same time each firms use
different accounting practices to make financial statements of firm so it is difficult to
compare them.
 Prone to fraud: There are various circumstance which stated that financial statements is
a tool that has committed as fraud (Mistary, 2020). Manipulation of financial statement
can be made in case majority of stakeholder of firm are from directors and managements
team so they can easily show high prices in order to influence stock market prices of
enterprise.
 Figures are distorted: The information that is present in financial statement are either
based on financial status or historical result of specific dates so they does not predict
future value of company.
 Ignored intangible assets: Financial statement do not records intangible assets of firm
but charged any expenditure that is made in order to create intangible assets as expense.
Thus, it lead to undervaluation of business so it is major limitation for company that have
spend their large or maximum amount of capital in building and maintain strong brand
image in market.
CONCLUSION
It can be concluded from above report and analysis that income and financial statement
helps to identify overall expense and profit margin, market share of Wales plc on December
2019. Through several ratios, income and statement of financial position gross profit margin,
stock holding period, return on capital employed and equity of Jerry plc is able to find that helps
manager to take correct action for growth and expansion of business in future. It can also be
stated that there are three interested groups in company accounts for different objectives or
purpose. So each individual make use of financial statement created by enterprise to know about
total profit earned during financial years. At last it can be concluded that there are numerous
limitation of financial statement which needs to be understand by user while making use of it to
avoid mistakes or errors.
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REFERENCES
Books and Journals
Chen, C. W and et.al., 2018. Financial statement comparability and the efficiency of acquisition
decisions. Contemporary Accounting Research, 35(1). pp.164-202.
Cheong, M. L. and SHI, W., 2018. Customer level predictive modeling for accounts receivable
to reduce intervention actions.
Coulon, Y., 2020. Efficiency Ratios. In Rational Investing with Ratios (pp. 31-45). Palgrave
Pivot, Cham.
Faccia, A. and Mosco, D., 2019. Understanding the Nature of Accounts Using Comprehensive
Tools to Understand Financial Statements. Financial Markets, Institutions and
Risks, 3(3). pp.18-27.
Laitinen, E.K., 2017. Profitability ratios in the early stages of a startup. The Journal of
Entrepreneurial Finance. 19(2). pp.1-28.
Lin, H., 2020. Evaluation of Financial Position of a Chosen Company.
Maisuradze, M., 2018. Application of the Entity Assets Measurement Methods in Preparing the
Financial Statements. Ecoforum Journal, 7(3).
Malau, M. and Murwaningsari, E., 2018. The effect of market pricing accrual, foreign
ownership, financial distress, and leverage on the integrity of financial
statements. Economic Annals, 63(217). pp.129-139.
Martins, C.J.L., 2017. DTER and DTTER as high-frequency trading efficiency ratios. The
Journal of Trading. 12(4). pp.39-55.
Mistary, V., 2020. Fundamentals of Financial Analysis And Control.
Pelekh, U., Khocha, N. and Holovchak, H., 2020. Financial statements as a management
tool. Management Science Letters, 10(1). pp.197-208.
Selvam, M., Dhamotharan, D. and Sankarkumar, A.V., 2020. Intellectual Capital And
Profitability Ratios Of Foreign Banks Operating In India: A Structural Equation Model
Approach. Available at SSRN 3640093.
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