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Introduction to accounting information system
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Importance of income statement
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Lenders have no use for the Income statement and the Balance sheet with information relating to past transactions or events for making decisions unless they are accurate.
The Balance sheet is a “statement at one point in time, which shows all the resources controlled by the entity and all the obligations due by the entity.” (Bazely, 2007, p90) Hence it merely provides an outline of the financial strength and asset liquidity of an entity.
The Income statement “summarizes certain transactions that take place during a period of time.” (Bazely, 2007, p125) Hence the income statement provides some of the basic financial information for rational decisions to be made.
Lenders are “people and organizations who lend money in order to earn a return on that money.” (Bazely, 2007, p8) Therefore they are interested in ensuring whether the entity is going to provide with a return due to the entity making sufficient profit.
Therefore even if the balance sheet and income statement provides financial information relating to past transactions or events, lenders will not include the balance sheet and income statement in making decisions as many limitations of these statements affect the decisions to be made.
Lenders are interested in the entities controlled resources and what it owes. Therefore the limitations of the balance sheet clearly affect the accuracy of the statement. These include: the representation of the position of an entity at one particular point. The statement is only relevant at that particular point in time; the utility of the statement diminishes as time passes for providing relevant measures of assets and liabilities of an entity as the values assigned are usually historical cost; and, the valuation method of assets need to be appropriately measured as certain cases lead to an incorrectly stated figure.
Lenders use a variety of approaches to arrive at a lending decision. Therefore the accuracy of the income statement limits the decisions made by lenders. First, the organizational structure, size and type of activity limit the accuracy of the statement as it affects what is being reported and how it should be reported which may omit certain important aspects of the organization. Second, the income statement is normally prepared for internal use by an organization with which these internal reports are generally more detailed than the reports produced for external users, limiting sufficient accuracy of information needed to make a decision.
Even though companies develop balance sheets and income statements they are mainly for internal use.
Balance sheet lists assets, liabilities and owner’s equity. The assets listed on the balance sheet are acquired either by debt (liabilities) or equity. “Companies that use more debt than equity to finance assets have a high leverage ratio and an aggressive capital structure. A company that pays for assets with more equity than debt has a low leverage ratio and a conservative capital structure. That said, a high leverage ratio and/or an aggressive capital structure can also lead
2. A business's balance sheet cannot be used to accurately predict what the business might be sold for
A strong balance sheet gives an investor an idea of how financially stable the company really is. Many professionals consider the top line, or cash, the most important item on a company’s balance sheet. The big three categories on any balance sheet are “assets, liabilities, and shareholder equity.” Evaluating Barnes & Noble’s assets for the time 2014 at $3,537,449, 2013 at $3,732,536 and 2012 at $3,774,699, the company’s performance summarizes that it is remaining stable. These numbers reflect a steady rate over the three year period. Like assets, liabilities are current or noncurrent. Current liabilities are obligations due within a year. Key investors look for companies with fewer liabilities than assets. Analyzing this type of important information, informs a potential investor that if the company owes more money than they are bringing in that this company is in financial trouble. Assessing the liabilities of the balance sheet, for the same time period, it is also consistent with the assets. The cash flow demonstrates a stable performance in the company’s assets and would be determined that the liabilities of this company are also stable. Equity is equal to assets minus liabilities, and it represents how much the company’s shareholders actually have a claim to. Investors customarily observe closely
The times interest earned ratio uses a company’s income statement to assess its ability to meet long-...
A balance sheet can be given at any point in time but only shows a particular date. There are two other names for a balance sheet, statement of condition or statement of financial position. The main characteristic of for the balance sheet is that it assesses liquidity. Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset 's price (Investopedia.com). In order to fully understand a balance sheet you must first understand the relationship of every account and the financial statements simultaneously. The balance sheet informs us that asset equals liabilities plus stockholders’ equity. Assets are items possessing service or use potential to owner (Fraser & Ormiston, 2012). Liabilities are lawful dues or obligations that organizations have while doing business. Stockholder’s equity is represents the capital obtained from investors in order to receive stock. There are two main sources that stockholders’ equity comes from and that is money and retained earnings that was accumulated over time
In reviewing the company’s balance sheet, the current assets and liabilities were reviewed and liquidity ratios were calculated. The capital structure and the fixed and intangible asset accounting of the company were also reviewed. Off-balance sheet items such as leases and contingent liabilities were reported and noted. All of these aspects of the balance sheet were reviewed in order to do a proper analysis of the company’s balance sheet.
According to the conceptual framework, the potential users of financial statements are investors, creditors, suppliers, employees, customers, governments and agencies, and the general public (Financial Accounting Standards Board, 2006). The primary users are investors, creditors, and those who advise them. It goes on to define the criteria that make up each potential user, as well as, the limitations of financial reporting. The FASB explicitly states that financial reporting is “but one source of information needed by those who make investment, credit, and similar resource allocation decisions. Users also need to consider pertinent information from other sources, and be aware of the characteristics and limitations of the information in them” (Financial Accounting Standards Board, 2006). With this in mind, it is still particularly difficult to determine whom the financials should be catered towards and what level of prudence is necessary for quality judgment.
By its very nature of being difficult, or in some cases impossible to identify, non-purchased goodwill is unable to be included on the balance sheet.
The Purpose of Financial Statements The financial statements of a business are used to provide information about the status of the business, set performance targets and impose restrictions on the managers of the firm as well as provide an easier method for financial planning. The financial statements consist of the Profit and Loss Account, Balance Sheet and the Cash Flow Statement. There are four areas of information, which we can collect from a company's financial statements. They are: Ÿ Profitability - This information comes from the Profit and Loss account. Were we can compare this year's profit with the previous years.
There are two kind of transactions that have been recorded in the cash book (bank column) but may not have been recorded in the bank statement.
Internal Controls must assist the accounting information system in reaching its objectives. It must not hinder the organization in any way. The concepts must be woven into the day-to-day responsibilities of managers and their staff and also into the AIS of the organization.
The statement of the financial position is also known as balance sheet has shown the accounting equation, Assests = Liabilities + Equity. The statement of the financial position shows the current assets, liabilities and equity owned by a business during an accounting period.
Balance sheet-: Balance sheet is a statement at the book value of all of the assets and liabilities of a business or other organization present a particular date such as the end of the financial year. It is known as a balance sheet because it reflection accounting identity the components of the balance sheets. The balance sheet must follow the following formula:
Balance sheet is a financial statement which is widely used by accountants for businesses. Balance sheet is also known as the statement of financial position because it helps us to present company’s financial position at the end of a specified period. (fresh books, 2016)
Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently."