Assignment 01
Part A
1(a). A stakeholder is any individual or entity that has an interest in the success or failure of an enterprise or venture. Stakeholders have a significant influence on decisions relating to the financial and operational aspects of an organization (Smart, Awan & Baxter, 2013). Some of the notable stakeholders who have an interest in accounting information include owners and investors, managers, creditors and lenders, employees, and the government.
1(b)
1(c). Current and Prospective Investors
Current and prospective investors are interested in the profitability and risk of their investments. Current investors will use this information to decide whether to increase or decrease their investment in the venture while the prospective investors will rely on this information when deciding the fitness of the intended investment in their portfolio.
1(d). Managers have three general information need, that is, to plan, monitor, and make strategic decisions. Planning involves the allocation of resources towards achieving the business objectives such as through the budgetary process (Smart, Awan & Baxter, 2013). Monitoring involves ensuring that the allocated resources are not only used well but effectively. Making long-term decisions entails forecasting future events and their effects and making sure the business doesn’t sink because of such occurrences. Managers use accounting information to perfect these three critical aspects of management and to ensure the decisions they make are backed by reliable estimates.
1(e). Solvency refers to the ability of a business to meet its long-term financial obligations. It determines the ability of the business to continue operations into the foreseeable future. If the business is having solvency problems, it could be declared insolvent in the foreseeable future, and the creditors will lose their loaned funds. Security, on the other hand, relates to the size and value of assets that can act as collateral for the credit facilities extended (Smart, Awan & Baxter, 2013). If the assets have low market value or the business lack title to them, the creditors will not be able to recoup their loaned funds if the business is liquidated or declared insolvent.
2. General Purpose Vs. Special Purpose Financial Statements
A special purpose financial statement is prepared and presented to a limited number of users and for a special purpose. Tax reporting, bank reporting, and industry-specific reporting are some of the specific purposes for which specific-purpose financial statements. General purpose financial statement, on the other hand, are prepared and presented to an open-ended number of users and for the provision of financial information about the reporting entity (Garrison, 2010). They are issues throughout the year and include statement of financial position, income statement, statement of changes in equity, and cash flow statement. The significance of this distinction is to ensure the businesses not only meets its reporting requirements but provide relevant information to all and intended stakeholders.
3. Steps to Ensure Reliability of Financial Statements
To ensure financial statements are reliable, they should be presented free of errors. Training of accounting staff is the first step in ensuring the financial statements are accurate and free of errors. After training, the staff should be monitored, and their work regularly reviewed to avoid erroneous financial reporting (Collins, 2012). This two steps will ensure the process of capturing transactional data is accurate, the codification of the data is reliable, and competency of those reviewing the codified data is professional.
4. Implications of Following Assumptions/Principles
5. Accounting Entity Concept
The business and its owners are treated as two separate parties in accounting. As such the entity concept states that transactions relating to the business owners should be recorded and reported separately from those of the business entity. This has the implication of dictating that different accounting records should be used to maintain the transactions of the business and those of its owners and the assets and liabilities of owners are entirely excluded from the business’ financial reports (Garrison, 2010). On the positive side, this concept has the implication of ensuring records of the business and the owners are not intermingled therefore easing the process of discerning the financial and taxable results of the business.
6. Monetary Convention
The monetary convention in accounting refers to the requirement that only monetary transactions ought to be recorded in the financial statements, and such transactions should be recorded in the same monetary unit to avoid confusion. The main advantage of this convention is to ensure the balance of transactions by converting all transactions into a single currency using a specified exchange rate (Needles, 2013). The rationale is that every transaction must have a value, that value should be converted into money, and the money must be converted into a single monetary unit.
7. Internal Control Measures
Part C
1. Cash Vs. Accrual Basis of Accounting
The dissimilarity between cash and accrual basis of accounting rests in the timing of when revenues and expenses are recorded in the financial reports. Under the cash basis of accounting, revenues and expenses are only recorded when money is received or paid out. Accrual accounting, on the other hand, recognizes revenue when earned irrespective whether cash is received or not, and expenses when incurred but not necessarily paid for (Weil, 2013). The cash method is usually used by small businesses with annual profits of less than $5 million and for personal financial management. The accrual basis is a requirement under tax law for companies making more the $5 million in profits per year and only accounts prepared under accrual basis can be audited.
2. Capital Vs. Revenue Expenditure
The difference between capital and revenue expenditure lies in the usage of the assets, that is, whether they will be used over an extended period or a short period. Capital expenditure includes all fixed assets that are projected to be productive assets over a long period. Revenue expenditure, on the other hand, includes costs related to specific items or operating periods such as repairs and maintenance costs (Warren, 2013). While revenue expenditures are expensed in the current accounting period, capital expenditures are depreciated over a long period
The distinction between revenue and capital expenditures is very crucial since the way these expenditures are treated and classified can adversely affect the financial health of a company (Warren, 2013). For instance, purchase of a production plant is a capital expenditure and the purchase cost should not be expensed in the year of purchase but should be gradually expensed via depreciation over the useful life of the plant. Expensing such an expenditure in the year of purchase may lead to a company reporting a net loss when in essence it made profits.
3. Accrual Accounting
Accrual accounting requires businesses to record revenues when they are earned (when a sale occur) and expenses when incurred (when billed). The timing of actual payment or receipt of money in these transactions is not essential (Weil, 2013). That is, revenues and expenses are recorded in the accounting period when they are earned or incurred, and the actual payments and receipt of cash may be in a different accounting period. Similarly, companies are required by GAAP to match their expenses with revenues, that is the matching principle. Under this principle revenues and expenses should be recorded at the same time.
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