Understanding Financial Statement Accounts and Performance Assessment

This article explains the classification and definitions of financial statement accounts and their importance in assessing business management. It provides guidance on defining and classifying accounts into an Income Statement or Balance Sheet. It also assesses the performance of a company in terms of COGS markup and capital structure. The article includes a list of accounts and their classification, an Excel Spreadsheet, and expert insights on Desklib.

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Understanding the classification and definitions of financial statement accounts is a fundamental
requirement in assessing business management. Assessment of financial data provides the
quantitative measures allowing managers to use past and present data to make effective
decisions.
Directions
In Part 1 of this Assessment, you will define and classify accounts into an Income Statement or
Balance Sheet. In Parts 2 and 3 you will assume the role of a financial manager who has been
tasked to report to senior management in an upcoming finance meeting. Senior management is
particularly interested in learning the performance of the company in two particular areas. The
first focus of your discussion with management, Part 2 of this Assessment, relates to the markup
on Cost of Goods Sold (COGS). The second focus of your discussion with management, Part 3
of this Assessment, relates to capital structure.
Part 1
To properly measure financial statements managers must know account definitions and
classifications. Using the accounts below, define each and classify each as an Income Statement
or Balance Sheet account.
1. Cash
Cash is an asset for the company and it is present in the physical form such as notes, coins.
In concept of bookkeeping, cash is classified as an asset and therefore it is recorded in the
balance sheet (Duijm & Wierts, 2016).
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2. Notes payable/Short term debt
Notes payable is a liability account in which the company records the amount that is
payable within one year. This is a liability, and it is shown in the balance sheet.
3. Inventory
Inventory is accounting term that is referred to as the goods underlying at the end of the
financial year. The inventory is recorded in the income statement on the credit side and in
the balance sheet as well under the heading assets (Bauman & Shaw, 2016).
4. Property, plant, and equipment
Property, plant and Equipment is inclusive of the long term assets of the fixed nature and
hence, they are recorded in the balance sheet.
5. Long term note-debt
The long term debt is the debt that is any amount that a company holds that a maturity of
12 months or longer is required. It is classified as the non-current liability and hence it is
recorded in the balance sheet (Lessambo, 2018).
6. Stockholder’s equity
The stockholder’s equity is the amount of the assets which are remaining in a business
after each and every liability is settled. It is the accumulation of the capital and the
earnings generated by the operation of the business. It is recorded in the balance sheet
side.
7. Interest and taxes
The terms like interest and the taxes are the expenses that recorded in the different manner
as they cannot be clubbed with any other expense. These are recorded in the income
statement.
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8. Sales
The sales are also known as the revenue that is referred to the activities of selling off the
goods and services for a given time frame. The sales are recorded on the credit side of the
income statement.
9. Cost of Goods Sold
Cost of goods sold, is termed as the direct costs attributable over the production of the
goods sold in the company. This amount also includes the cost of materials used and the
same is reflected in the income statement (Rakićević, Milošević, Petrović & Radojević,
2016).
10. Selling and general administrative expenses
The selling and general administrative expenses are those expenses that are generally
associates with the activities related to the sales or the general nature. As per the
accounting treatment the selling expenses are recorded in income statement under the head
expenses.
11. Gross profit
The gross profit is the profit that is recorded after deducing the cost of goods sold to
analyze the raw position of the company. The gross profit is recorded in the income
statement of the company (Poonawala & Nagar, 2019).
12. Earnings before interest and taxes
Earnings before interest and taxes are the earnings which are exclusive of the interest if
any on bank loan and the adjustment of the taxes to analyze the position of the company.
EBIT is shown in the income statement.
13. Net income
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The net income is the total income which is earned by the company after deducting all the
expenses. The net income is shown in the income statement and in the balance sheet under
the head capital (Namusonge, LYANI & SAKWA, 2016).
14. Accounts receivable
Accounts receivables which are also known as debtors are considered as an asset to the
organization as the materials, good or services are sold on the credit notion in anticipation
of money. Accounts receivables are shown in the balance sheet.
15. Accounts payable
Accounts payable is the considered as liability for the company as the materials are
purchased from accounts payable on credit terms and the payment is required to be made
in near future. Accounts payable are shown on the liabilities side of balance sheet.
Before you move on to Part 2 and Part 3 below, you must first complete the following Excel
Spreadsheet. You must complete the Income Statement tab and the Balance Sheet tab. Then,
answer the following questions in Part 2 and Part 3 below.
Part 2
After completing the Income Statement, you should be able to measure a company’s COGS and
its effect on the Gross Profit Margin (GPM). Based on your assessment of the firm’s Income
Statement, you are to report to senior management on these key components:
a. What is the markup on COGS?
The markup on cost of the goods sold is 67% as per the calculation by dividing the cost
of goods sold of $80000 by sales value of $120000.
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b. Compare this company’s markup to a COGS industry standard of 70%. What is the
result?
As per the comparison against the industry benchmark the COGS is 70% and that of the
company is the 67% which reflects the company is maintaining the low margins and
this is also positive as beyond that the company will start to incur the losses. Hence, it
is the feasible situation for the company (Fan & Liu, 2017).
c. Explain how the difference in this company’s markup and industry markup rates affect
profitability, or levels of the GPM?
The difference in the company’s mark up and the industry markup can be observed as
when the COGS is 70% the gross profit tends to be $36000 whereas in case of the
company’s margin the gross profit is $40000. This creates a difference of $4000
overall. In case of net profit, the net income comes to $6000 and when the industry
benchmark is used the net profit is half of the company.
Part 3
After completing the Balance Sheet in the Excel Spreadsheet hyperlinked above, you should be
able to measure a company’s capital structure. Based on your assessment of the firm's Balance
Sheet, you are to report to senior management on these key components:
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a. What is the nature of this company's capital structure? Include percentages in your
commentary?
Capital structure Amount
Debt $
160,000
Total assets $
187,000
86%
The capital structure of the company defines that the debt component of the company is
acquired to finance the assets. Further the capital structure is inclusive of both debt and
equity, and the balance is required between the debt and equity so that capital structure
is maintained properly. Too much debt component will create problems for the
company and it will create more leverage for the company.
b. Compare this capitalization structure percent to an Industry Standard of 50%. What is
the result?
As per the current policy of 50% in the industry, the capital structure of the company is
86%. This states that the company is taking too much leverage on its head and this will
reduce the solvency position of the company. The company must bring down the ratio
within the bracket of 50% to keep a nominal as well as optimal capital structure
(Serfling, 2016).
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c. To what extent is this company 'leveraged'?
Capital structure Amount
Debt $ 160,000
equity $ 27,000
5.93
The extent to which the company is leveraged is 5.93 times as the debt is more than
equity. The judicious use of the financial leverage can lead to the advantage of the
deduction of the debt component at the time of tax deduction. This will result in
lowering down the cost of the debt. This also helps in the reduction of the cost of the
capital (Serfling, 2016).
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References
Bauman, M. P., & Shaw, K. W. (2016). Balance sheet classification and the valuation of deferred
taxes. Research in Accounting Regulation, 28(2), 77-85.
Duijm, P., & Wierts, P. (2016). The effects of liquidity regulation on bank assets and
liabilities. International Journal of Central Banking (IJCB).
Fan, Y., & Liu, X. (2017). Misclassifying core expenses as special items: Cost of goods sold or
selling, general, and administrative expenses?. Contemporary Accounting Research, 34(1), 400-
426.
Lessambo, F. I. (2018). Long-Term Assets: Plant, Property, and Equipment. In Financial
Statements 81-93. Palgrave Macmillan, Cham.
Namusonge, G. S., LYANI, M. N., & SAKWA, M. (2016). Accounts receivable risk
management practices and growth of SMEs in Kakamega County, Kenya. Expert Journal of
Finance, 4(1).
Poonawala, S. H., & Nagar, N. (2019). Gross profit manipulation through classification
shifting. Journal of Business Research, 94, 81-88.
Rakićević, A., Milošević, P., Petrović, B., & Radojević, D. G. (2016). DuPont financial ratio
analysis using logical aggregation. In Soft computing applications (pp. 727-739). Springer,
Cham.
Serfling, M. (2016). Firing costs and capital structure decisions. The Journal of Finance, 71(5),
2239-2286.
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