Free Essay - Financial Statements and Accounting Methods

Financial statements can be termed as the reports that organizations' managements prepare to present their existing financial position and performance at a point in time. Financial statements include the balance sheet, statement of owners' equity, income statement, and cash flow. These statements are developed to highlight the information on the company's financial position to stakeholders, such as the investors, suppliers, creditors, and other interested entities, like the government. Public companies are required to provide these financial statements to the regulator agencies often. Besides showing the financial positions, these statements are used to make significant decisions; thus, they must be accurate, reliable, and relevant. This paper will review two financial statements; a balance sheet, and an income statement, their components, and the most important accounting methods to be used in developing each.

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Balance Sheet

Statement of the financial position, or a balance sheet is financial statement that lists an organization's assets, liabilities, and stakeholders' equity at a certain point in time. The statement also provides the fundamentals for calculating the rate of return, and assessment of an organization's capital structure. It provides a snapshot of what an organization owes and owns, and the total amount invested by all the shareholders (Szydelko & Biadacz, 2016). The statement of the financial statement is primarily used with other financial statements like the income statement to conduct the fundamental analysis and computation of the financial ratios ‌(Hayes & James, 2020).

The balance sheet has various components including, the assets, categorized as the current and the noncurrent. The current assets have high liquidity, meaning they can be converted easily into cash, while the noncurrent ones are hard to convert (Hayes & James, 2020). These categories are organized from top to bottom in the order of their liquidity.

Liabilities, on the other hand, refers to the value in terms of money that a company owes, including bills, bonds, rent, utilities, and salaries. Liabilities are also divided into two; the current and long-term. The current liabilities are the ones which are due within a year while the long-term are the ones that exceed a year.

The last component is the statement of the stakeholders' equity, referring to the value in terms of money, which can be attributed to the owners or key stakeholders (Hayes & James, 2020). It is also referred to as the net assets since it must be equivalent to the organization's assets minus the liabilities the owners owe the non-shareholders.

The formulae used for the statement of the financial statement is

Assets = Liabilities + Shareholders Equity or Assets – Liabilities = Shareholder’s Equity (Hayes & James, 2020).

The formula is intuitive: a company must pay for everything it owns (assets) either by getting it from investors(equity) or borrowing(liabilities).

For example, if the investors brought vehicles worth $3,000,000, the shareholders' equity will increase by the same amount, while the company will have assets in terms of vehicles worth $3,000,000. If the same company proceeds to take a loan of $ 11 million, the company will have assets in terms of money worth $ 11 million and the vehicles worth three million dollars totaling to assets worth $14 million. On the other hand, the company will have a liability of $11 million and $3,000,000 capital totaling to $14,000,000.

The four most important accounting methods for the development of this statement are the cash method, or the cash basis, accrual accounting, hybrid, and the uniform capitalization (Spaulding, 2018).

Income Statement

Incomes statements, on the other hand, covers a varied period, mainly, quarterly, mid, or annual income statement. It mainly provides an overview of the net income computed from the difference between the organizations' revenue and expenses.

i.e., Net Income = Revenues – Expenses.

The components of an income statement are revenue, expenses, and income. The revenues refer to the sales for a particular period (Murphy & James, 2019). There are two types of revenue; Operative revenue, which is earned through selling the organization's services or products. For example, the revenues for an executive barbershop would be earned through services such as haircuts, and sale of hair care products. The second type is the non-operative, which is gained from non-core activities such as interest earned on money in the bank, royalties, and services like an advertisement (Murphy & James, 2019).

The expenses fall under various categories including, the direct costs, which are the ones incurred in the daily running of the business, such as the electricity bills, barbers' payments, and wear and tear (Murphy & James, 2019). Secondary expenses include the interests paid on loans or the losses made from the sale of an asset.

The income statement serves to convey the details of profits, and the financial results of the various business activities (Szydelko & Biadacz, 2016). It is also useful in displaying whether particular sales are increasing when compared with similar statement over a period. The investors are then able to determine how well the management is controlling the expenses, and develop ways of mitigating the losses.

X company had total revenue of $ 100,000; $89000 from operating revenue, income from equity affiliates of $9,000 and other incomes $2,000. The company also had total expenses of $57,600 divided in salaries amounting to $57,000 and loss from the sale of land of $600.

Penman (2007) article

The questions Penman (2007) was seeking to answer are, when is fair value accounting appropriate, and when is it not? Or, in terms of my charge for this paper, under what circumstances is fair value a plus or a minus? The questions raised by Penman can be described as relevant because they focus on the central issues in accounting. They are also clear as they use understandable language that someone with the most basic accounting knowledge can understand them, and lastly, they are precise. Penman concluded that the scorecard to the primary research issue is mixed. Several quality aspects of accounting were identified, and the inevitable issues were mainly due to the measurement limitations as a quality warning to the investors and analysts (Penman, 2007). Numerous GAAP and financial disclosure were also identified and, if not recognized and addressed, will promote momentum investments and the stock market bubble.

Conclusion

Financial statements from a critical part of the business going concern analysis as well as its operating health. They are mainly used by stakeholders to make investment decisions and by the government to determine taxes. Thus, these statements should be concise, accurate, reliable, and present relevant information.

References

‌Hayes, A., & James, M. (2020, May 13). Understanding Balance Sheets. Investopedia. https://www.investopedia.com/terms/b/balancesheet.asp

Murphy, C., B., & James, M. (2019). How to Interpret Financial Statements. Investopedia. https://www.investopedia.com/terms/f/financial-statements.asp

Penman, S. H. (2007). Financial reporting quality: is fair value a plus or a minus? Accounting and business research, 37(sup1), 33-44.

Spaulding, W. C. (2018). Accounting Methods: Cash, Accrual, and Hybrid. Thismatter.Com. https://thismatter.com/money/tax/accounting-methods.htm

Szydelko, A., & Biadacz, R. (2016). The Role of Financial Statements in Performance Management. Modern Management Review, 21(23 (4)), 205-214.