How to Prepare Financial Statements in Accounting and Analysis [With Examples]

Part A: Preparation and presentation of Financial Statements

  1. A Reporting entity

A reporting entity can be defined as an organization or company that is under obligation to prepare financial reports as stipulated under international account standards. This information can be relied on by investors and those who are seeking to make decisions based on the financial history and performance of the company (Fridson & Alvarez, 2012). The existence of dependents of this financial information is what makes an organization a reporting entity. Small companies that are managed by their owners are not under any obligation to prepare financial reports and as a result of that, they are not classified as reporting entities. Super Repairs is not a reporting entity and this is because it is a sole proprietorship owned by Clark Kent and has only 3 employees.

  1. Transaction worksheet for the month June
SUPERIORS REPAIRS
Transaction Worksheet
June 30th 2015
Acco N0 Account title Debit Credit
1 Vehicle Lease $4,200
2 5 month Rent $10,000
3 Supplies for Repair $1,500
4 Bank Loan Application $20,000
5 Computer Repair ($2,500)
6 Computer Repairs $4,100
7 Advertisement Expense $400
8 Revenue Earned $1,900
9 Withdrawal $200
10 Personal use $100
11 Wages $500
12 Cash Revenue Earned $350
13 Customer Pay $2,000
14 Petrol Expenses $85
15 Computer Supplies $850
16 Electricity Bill; $750
TOTAL $13,535 $30,900

 

  1. Statements

Based on the transactions that have been provided in this particular instance and the manner in which the above transaction sheet has been prepared, the data contained in it can be useful when it comes to preparation of Income Statements for the company and also the balance sheet.

  1. Income Statement for June

Below is an income statement for Superior Repairs for the month of June

SUPERIORS REPAIRS
INCOME STATEMENT
Jun-15
REVENUE (Income)
Initial Capital $18,000
Vehicle Lease $4,200
Bank Loans $20,000
Computer Repairs $4,100
Revenue Earned $1,900
Cash revenue $350
Customer pay $2,000
Computer Supplies $850
TOTAL REVENUES (Income) $51,400
EXPENSES
Electricity Bill $750
Rent $10,000
Withdrawal $200
Personal Use $100
Wages $500
Petrol $85
TOTAL EXPENSES $11,635
NET INCOME (Loss) $39,765

 

  1. Balance Sheet for June (Statement of financial position)
SUPERIORS REPAIRS
Balance Sheet
Jun-15
ASSETS LIABILITIES
Current Assets Current Liabilities
Petty Cash $18,000 Accounts Payable $11,635
Accounts receivable $39,765 Long Term Debt $20,000
Prepaid Expenses $10,000
Total Current Assets $67,765
Fixed Assets
Buildings $120,000
Furniture & Fixtures $19,000
Total Fixed Assets $139,000
TOTAL ASSETS $206,765 TOTAL LIABILITIES $31,635
LIQUIDITY RATIO 6.535957

 

  1. Relationship between statements and equity

There is a huge difference that can be noted when we look at the income statement and balance sheets as well as the change in equity and liquidity ratio in this particular task. First of all, there are elements that are both available in the income statement as well as in the balance sheet but have been documented differently. Income statement documents the income of Superior repairs over a certain period of time as a way of making it possible to understand the challenges that and opportunities as far as its performance is concerned (Foster, 2006). The income statement has revenue documented in the credit account while expenses are documented in the debit account of the same.
There is also a difference when it comes to the purpose of these two. The income statement is a profit and loss statement and it used to determine the amount of money a company earned or lost over a certain period of time. The balance sheet on the other hand gives investors and managers a financial overview of the company and where it stands financially. There is a relationship that can be noted in terms of the liquidity when the amount of total assets is divided by the total liabilities that the company has. The liquidity ratio is an indicator of the financial standing of the company and the manner in which it is able to service its debts. Financial statements such as Income statements as well as balance sheets are very important when it comes to informing investors of the status of the company and the manner in which different aspects come into interplay in shaping its financial stability

Part B: Discussions

Discussion A
In June 2002 WorldCom, a US telecommunications firm, announced that it had misreported financial information in previous accounting periods – to the sum of USD $3.9 billion – by recording routine operating expenses as capital expenditure.
Discuss
(a). The impact of the treatment on the financial statements.
This is one of the largest ever expenditure to ever appear on the income statement of the company and the impact of the treatment on the financial statement was seen in the huge difference between revenue that was generated and the amount of expenditure at the same time. This approach can be termed as having been ineffective and negatively impacting investor judgment of the financial statements presented to them.
(b). the possible reasons for management’s accounting policy choice.
There are several possible reasons that could have led to this situation and the management choosing to report this in the statement as they did. The first possible reason could have been to cover up for financial improprieties from stakeholders and other potential investors in terms of understanding how the company was performing financially. There were also no supporting documents to this and poor financial record keeping could have also been blamed. The standards that were being adhered to at the time of this kind of reporting. The Passage of SAB model of reporting can be seen as having been a major milestone in the way things were done and also the structure of of reporting was shaped.
(c). whether any party is likely to suffer from the misrepresentation
There are several parties that were likely to suffer from this kind of misinterpretation and the first group is that of shareholders because this was not a true reflection of how things looked like for the company in terms of its financial performance. Financial records are very important when it comes to making decisions in the case of investors and as a result of that, there is always need to make sure that it is done in a proper way and information contained in the document can easily be interpreted. Potential investors are likely to make decisions that are misleading in the event that this report is put to use and decisions made based on it. Looking at the history of the company, it filed for bankruptcy and thereafter investors lost a lot of money leading to prosecution of those who were in the top management of the company.
Discussion B
The core business of Greenlantern Ltd involves the sale of anti-virus software. The following took place during the financial year ended 30 June 20X0. The company earned $25,000,000 from the sale of software; $3,000,000 from update downloads; and $50,000 in interest from investing on the short-term money market. The company also received a $2000 discount arising out of the early settlement of a liability; and issued shares in exchange for $500,000 cash during the year.
(a). Discuss whether the foregoing five financial items would meet the definition of income to the company during the year? Give reasons for your answer.
The five items that have been listed here all amount to revenue for the company but not all of them can be categorized as income for the company because of the source where they originated. As stated, the main business of the company is selling antivirus software which means that it generates income whenever there is a sale of a software related item. Income and revenue are defined differently based on the financial school that one subscribes to and this can be seen in the scenario above. Earnings that were as a result of software downloads, updates and other related activities are what qualify to be termed as income because of the category in which they fall. Income can be termed as a positive cash flow and this is because of the fact that it contributes to the income statement of the company over a given period of time. The primary operations of the company greatly determined the manner of activities that are engaged in when it comes to generating income.
(b)Which, if any, of the items would meet the definition of revenue to the company for the year? Give reasons for your answer.
All the above items meet the definition of what is revenue to the company and this is because of the fact that revenue is termed as the total cash flow that is calculated after adding together all the cash flows that are as a result of the company’s activities when generating income. Whenever we are analyzing a company’s financial statement, revenue is always placed at the top and this is because of the fact that it occupies a central role in determining the financial patterns and trends. Revenue can be termed as the total income from different activities that are carried out by the company (Bernstein, 2008).
Discussion C
Describe the nature and impact of factors that may play a role in influencing the format and content of the income statement which is also known as the statement of comprehensive income?
Income statement is one of the three important financial statements that investors need when it comes to familiarizing themselves with the financial status of the company that they are about to invest in (Stickney, 2010). Income statements may take different shapes depending on a number of factors. It is also important to note that two formats of financial reporting are normally used when it comes to generating income statements and they include multi-step and single step format.  The format and content of income statements is influence by the following factors.

  1. Available data

The nature of financial data that is available greatly determines the kind of income statement that is used when it comes to financial reporting. For example Material and production data available leads to a single step financial statement while on the other hand, availability of the cost of sales makes it easier to come up with income statements that are mult-steps in nature.

  1. Measures of profitability

The measure of profitability that is used by an organization greatly determines the kind of income statement that will be adopted by that particular organization. The multistep format of income statement uses four measures of profitability while the single one uses a single measure of the level of profitability in the company.

References
Bernstein, L. (2008). Financial statement analysis. Homewood, Ill.: R.D. Irwin.
Foster, G. (2006). Financial statement analysis. Englewood Cliffs, N.J.: Prentice-Hall.
Fridson, M. and Alvarez, F. (2012). Financial statement analysis. New York: John Wiley & Sons.
Gibson, C. and Frishkoff, P. (2006). Financial statement analysis. Boston, Mass.: Kent Pub. Co.
Stickney, C. (2010). Financial statement analysis. San Diego: Harcourt Brace Jovanovich.
Wild, J., Bernstein, L. and Subramanyam, K. (2010). Financial statement analysis. Boston, Mass.: McGraw-Hill.