Accounting & Financial concepts

Working Capital & Matching concept:

a) We can breakdown balance sheet into investment side which consist of working capital and fixed assets and resources side which consist of first, debt financing which must be repaid according to a designated pattern, second, equity financing with uncertain return and no legal obligation to pay dividends.

The higher the debt to capital structure the higher the risk & the higher the equity to capital structure the lower the risk.

b) Matching concepts says the short term investment to be financed by short term resources and long term investment to be financed by long term resources whether debt or equity.

c) The higher the percentage of total investment (assets) to the debt financing the more secured creditors are said to be and the firm is more solvent as it can survive in the long term by settling its long term obligations.

d) Net working capital is the difference between current assets and current liabilities. The higher the netting the more liquid and flexible the firm in paying short term obligations.

Common stock dividends treatment:

All dividends are paid from the retained earnings and all dividends except stock dividends reduce the stockholders equity. There are many types of common stock dividends the most common is cash dividends which affect the ratio analysis as follows:

a) Cash Dividends:

when the cash dividends is approved and declared by the board of directors it becomes a liability on the organization.

The working capital and liquidity ratios are reduced by the declaration of cash dividends.

Dr. Retained Earnings (cash dividends declared)                       

Cr. Dividends payable.

The payment of cash dividends does not affect net working capital but liquidity ratios.

Dr. Dividends Payable

Cr. Cash                                      

Preferred stock dividends treatment:

a) Preferred stock is classified under the owner's equity in the balance sheet. While it is not considered as legal obligation on the   firm like debt, it enjoys certain privileges over common shares in respect to dividends and liquidation.

b) Preferred stock may enjoy many features; one of them is the cumulative feature by which cumulative preferred stock dividends that was not paid in any year must be made up in a latter year before any dividends can be distributed to common stockholders. These unpaid dividends are called dividends in arrears. Because no liability exists until the board of directors declares dividends, dividends in arrears are not recorded as a liability but it must be disclosed in a note to the financial statements and must also be taken into consideration while calculating the ratios such as ROE,  Net profit margin, EPS ---.

Basic  / Diluted Earning Per Share:

a) The corporation is said to have a complex capital structure if it have convertible debt , options, warrants or other rights that upon conversation or exercise could dilute earning per share.

Basic earning per share =   Net income available to common stock holders

           Weighted average common shares outstanding.

Companies occasionally engage in non-cash transactions. Examples include asset exchanges, acquisitions made in exchange for stock of the parent company, or the exchange of convertible bonds into shares.

Since such transactions do not involve cash, they are not reported on the face of the statement of cash flows. However, significant non-cash transactions must be disclosed in the financial statement notes or a supplement to the cash flow statement.

International Accounting Standard (IAS) No. 1, Presentation of Financial Statements, sets out the following general requirements.

Required Financial Statements

A complete set of financial statements includes a balance sheet, an income statement, a statement of changes in shareholders’ equity, a cash flow statement, and notes summarizing significant accounting policies and other explanatory notes.

Fundamental Principles of Preparation

Fair presentation requires faithful representation of the effects of transactions, events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework.

Financial statements are prepared on the basis of the firm being an ongoing entity (going concern). If the firm is being liquidated or will cease business, this must be disclosed.

Financial statements will be prepared on the accrual basis of accounting.

Presentations and classifications should be consistent from one period to the next.

Omissions or misstatements are material if they could influence the economic decisions taken by financial statement users. Material items should be presented separately.

Presentation Requirements

Each material class of similar items is presented separately, as are dissimilar items unless they are immaterial.

Assets and liabilities, or income and expenses, shall not be offset unless specifically required or permitted by an IFRS.

The balance sheet should distinguish between current and non-current assets and liabilities unless a liquidity-based presentation provides more relevant and reliable information.

IAS No. 1 outlines the minimum information that must be presented on each financial statement and in the notes.

All amounts reported in a financial statement should have comparable information for the prior period.

Detecting Creative Revenue Accounting in Financial Reports

Analyzing financial reports is difficult enough, but the tricks used for reporting revenue add another layer of complexity. You can see through many common creative accounting tactics by carefully analyzing the financial reports, but you'll have to play detective and crunch some numbers.
Reviewing revenue recognition policies

Some companies recognize revenue before they deliver the product or before they perform the service. If you come across this scenario, try to find details in the notes to the financial statements that indicate how the company really earned its revenue. If you can't, call the company's investor relations department to clarify the company's revenue-recognition policies, and be sure that you understand why it may be justified in recognizing revenue before delivery or performance has been completed.

When a company indicates in the notes to the financial statements that it recognizes revenue at the time of delivery or performance that timing may seem perfect to you, but you must look further to see if there are other policies that might negate a sale. Dig deeper into the revenue-recognition section of the notes to find out what the company's rights-of-return policy is and how it determines pricing. Some companies may allow a price adjustment or have a liberal return policy that may cancel out the sale.

Take note if you find that the company recently changed its revenue-recognition policies. Just the fact that the company is changing those policies can be a red flag. Many times this change comes about because the company is having difficulty meeting its Wall Street expectations. The company may decide to recognize revenue earlier in the sales process, which could mean that more of this revenue reported on the income statement may have to be subtracted in later reporting periods. Scour the revenue-recognition section of the financial report until you understand how the change impacted the company's revenue recognition. You may want to review the annual reports from the past few years to compare the old revenue policies with the new ones.
Evaluating revenue results

Reported revenue results for the current period don't tell the whole financial story. You need to review the revenue results for the past five quarters (at least) or past three years to see whether any inexplicable swings in seasonal activity exist. For example, extremely high numbers for retail outlets in the last quarter of the year (October to December) aren't unusual. Many retailers make about 40 percent of their profits during that quarter due to holiday sales.

Be sure that you understand the fluctuations in revenue for the company you're investigating and how its results compare with those of similar companies and the industry as a whole. If you see major shifts in revenue results that normal seasonal differences can't explain, an alarm should go off in your head. Take the time to further investigate the reason for these differences by reading reports by analysts who cover the company and by calling the company's investor relations office. Large shifts in revenue can be a sign of revenue management.
Monitoring accounts receivable

Accounts receivable tracks customers who buy on credit. You want to be sure that customers are promptly paying for their purchases, so closely watch the trend in accounts receivable. Compare the turnover ratio, which measures how quickly customers pay their bills, for at least the past five quarters to see whether a change in trend has occurred. If you notice that customers are taking longer to pay their bills, it can be a sign of trouble collecting money, but it can also indicate revenue management. Either way, this should raise a red flag for you as a financial report reader.

While you're investigating, check the percentage rate of change for accounts receivable versus the percentage rate of change for net revenue over the same period. For example, if the balance in accounts receivable increases by 10 percent and net revenues increase by 25 percent, that may be a sign of game-playing. Normally, these two accounts increase and decrease by similar percentages year to year unless the company offers its customers a significant change in credit policies. If you see significant differences between these two accounts, it may be another sign of revenue management.

Check to see if the changes you're seeing match trends for similar companies or the industry as a whole. If not, ask investor relations people to explain what's behind the differences. If you don't like the answers or can't get answers that make sense to you, don't buy the stock or consider selling the stock you already have.
Assessing physical capacity

Evaluating physical capacity, the number of facilities the company has and the amount of product the company can manufacture, is another way to judge whether or not the company is accurately reporting revenue. You need to find out if the company truly has the physical capacity to generate the revenue that it's reporting. You do so by comparing the following ratios:

* Revenue per employee (Revenue divided by Number of employees): If the annual report doesn't mention the number of employees, you can call investor relations or find it in a company profile on one of the financial Web sites, such as Yahoo! Finance.

* Revenue per dollar value of property, plant, and equipment (Revenue divided by Dollar value of property, plant, and equipment): You can find the dollar value of property, plant, and equipment on the financial report's balance sheet.

* Revenue per dollar value of total assets (Revenue divided by Dollar value of total assets): You can find the number for total assets on the financial report's balance sheet.

* Revenue per square foot of retail or rental space, if appropriate (Revenue divided by Square foot of retail space): You can find details about retail or rental space in the managers' discussion and analysis or the notes to the financial statement sections of the annual report or in the profile on a financial Web site.

Compare these ratios for the past five quarters and also compare the ratios to ones of similar companies and ones for the industry as a whole. If you see major differences from accounting period to accounting period or between similar companies, it may be a sign of a problem. For example, if revenue per employee is much higher, or if revenue per dollar value of property, plant, or equipment far exceeds that of similar companies or that of previous periods, this may be a sign of abusive revenue management.

Understanding Accounting Methods

Officially, there are two types of accounting methods, which dictate how the company's transactions are recorded in the company's financial books: cash-basis accounting and accrual accounting. The key difference between the two types is how the company records cash coming into and going out of the business. Within that simple difference lies a lot of room for error — or manipulation. In fact, many of the major corporations involved in financial scandals have gotten in trouble because they played games with the nuts and bolts of their accounting method.
Cash-basis accounting

In cash-basis accounting, companies record expenses in financial accounts when the cash is actually laid out, and they book revenue when they actually hold the cash in their hot little hands or, more likely, in a bank account. For example, if a painter completed a project on December 30, 2003, but doesn't get paid for it until the owner inspects it on January 10, 2004, the painter reports those cash earnings on her 2004 tax report. In cash-basis accounting, cash earnings include checks, credit-card receipts, or any other form of revenue from customers.

Smaller companies that haven't formally incorporated and most sole proprietors use cash-basis accounting because the system is easier for them to use on their own, meaning they don't have to hire a large accounting staff.
Accrual accounting

If a company uses accrual accounting, it records revenue when the actual transaction is completed (such as the completion of work specified in a contract agreement between the company and its customer), not when it receives the cash. That is, the company records revenue when it earns it, even if the customer hasn't paid yet. For example, a carpentry contractor who uses accrual accounting records the revenue earned when he completes the job, even if the customer hasn't paid the final bill yet.

Expenses are handled in the same way. The company records any expenses when they're incurred, even if it hasn't paid for the supplies yet. For example, when a carpenter buys lumber for a job, he may very likely do so on account and not actually lay out the cash for the lumber until a month or so later when he gets the bill.

All incorporated companies must use accrual accounting according to the generally accepted accounting principles (GAAP). If you're reading a corporation's financial reports, what you see is based on accrual accounting.
Why method matters

The accounting method a business uses can have a major impact on the total revenue the business reports as well as on the expenses that it subtracts from the revenue to get the bottom line. Here's how:

* Cash-basis accounting: Expenses and revenues aren't carefully matched on a month-to-month basis. Expenses aren't recognized until the money is actually paid out, even if the expenses are incurred in previous months, and revenues earned in previous months aren't recognized until the cash is actually received. However, cash-basis accounting excels in tracking the actual cash available.

* Accrual accounting: Expenses and revenue are matched, providing a company with a better idea of how much it's spending to operate each month and how much profit it's making. Expenses are recorded (or accrued) in the month incurred, even if the cash isn't paid out until the next month. Revenues are recorded in the month the project is complete or the product is shipped, even if the company hasn't yet received the cash from the customer.

The way a company records payment of payroll taxes, for example, differs with these two methods. In accrual accounting, each month a company sets aside the amount it expects to pay toward its quarterly tax bills for employee taxes using an accrual (paper transaction in which no money changes hands, which is called an accrual). The entry goes into a tax liability account (an account for tracking tax payments that have been made or must still be made). If the company incurs $1,000 of tax liabilities in March, that amount is entered in the tax liability account even if it hasn't yet paid out the cash. That way, the expense is matched to the month it is incurred.

In cash accounting, the company doesn't record the liability until it actually pays the government the cash. Although the company incurs tax expenses each month, the company using cash accounting shows a higher profit during two months every quarter and possibly even shows a loss in the third month when the taxes are paid.

To see how these two methods can result in totally different financial statements, imagine that a carpenter contracts a job with a total cost to the customer of $2,000. The carpenter's expected expenses for the supplies, labor, and other necessities are $1,200, so his expected profit is $800. He contracts the work on December 23, 2004, and completes the job on December 31, 2004. But he isn't paid until January 3, 2005. The contractor takes no cash upfront and instead agrees to be paid in full at completion.

If he uses the cash-basis accounting method, because no cash changes hands, the carpenter doesn't have to report any revenues from this transaction in 2004. But say he lays out the cash for his expenses in 2004. In this case, his bottom line is $1,200 less with no revenue to offset it, and his net profit (the amount of money the company earned, minus its expenses) for the business in 2004 is lower. This scenario may not necessarily be a bad thing if he's trying to reduce his tax hit for 2004.

If you're a small-business owner looking to manage your tax bill and you use cash-basis accounting, you can ask vendors to hold off payments until the beginning of the next year to reduce your net income, if you want to lower your tax payments for the year.

If the same carpenter uses accrual accounting, his bottom line is different. In this case, he books his expenses when they're actually incurred. He also records the income when he completes the job on December 31, 2004, even though he doesn't get the cash payment until 2005. His net income is increased by this job, and so is his tax hit.

Internal control

The internal control of a company are an important part of it’s overall  operations .A strong internal control system will provide many benefits to a company including :

• Lowe external audit costs


• Better control over the assets of the company  and ,


• Reliable information for use in decision – making

A company with weak internal controls is putting itself at risk for employee risk, loss of control over the information relating to operations, and other inefficiencies in operations and decision making that can damage its business.

Internal controls is method ,or progress ,that is carried out by an entity’s board of directors , management and other personnel that is designed to provide reasonable assurance  that objectives in the following three categories will be achieved:

• Effectiveness and efficiency of operations ,or the extent to which the company’s operations objectives are being achieved. These include performance goals, profitability goals and safeguarding of resources.


• Reliability of financial reporting,   including operations of all published financial information. in addition to the full set of financial statements, this includes interim and condensed financial statements and any selected financial data from those statements ,such as earning releases, that are reported publicity.


• Compliance with applicable laws and regulations, encompassing  all laws and regulations to which the company is subject.

Thus, internal control is effective if members of management have reasonable assurance that they understand the extent to which 1) the entities operational objectives are achieved    ;2)published financial information is reliability prepared  and 3) applicable laws and regulations are complied with .

As a process, internal control is a means to an end, not an end itself. Internal controls can provide reasonable assurance but not a guarantee, that these objectives will be met. people, not policy manuals or forms , carry out internal control.

I hope I have clarified the concept .. What is your comment on that term and what is your opinion?

our accounting career starts here. Here's the qualifications you need to become a qualified accountant in the next 3 or so years whether you want to specialise as a tax accountant or study for the Chartered Institute of accountants or the other bodies such as ACCA or CIMA.

What is an accountant ?

Most people think of a grey boring man or a glorified bookkeeper counting beans but in reality a good accountant will keep the cash flow positive and ensure the whole organisation understands profitability. Only qualified accountants can legally approve accounts (see below) and you can have a career as a finance director or an auditor. It depends on what excitement you want ! Other accountants specialise in tax planning, insolvency or small businesses.

Why Become an Accountant ?

Accountants are rarely unemployed as every business needs to have their accounts prepared and approved. Larger businesses employ a Finance Director (CFO - chief financial officer) to manage not only monthly account preparation but also longer term financial planning.

The role of an accountant

Accounting Qualifications

To become an accountant you'll generally need a reasonable degree although it's not essential but a degree will get you exemptions from some of the exams. The first part though is to choose which accounting body you wish to study towards and what type of accountant you want to be.

There are three main accounting bodies - The Institute of Chartered Accountants in England and Wales (ICAEW), the Chartered Institute of Management Accountants (CIMA) and Chartered Association of Certified Accountants (ACCA).

Which one you follow is dependent on where you wish to end up in life. ICAEW and ACCAs are allowed to sign off audited accounts so if you want to go into practice (eg: PriceWaterhouse etc) then these are for you. The ICAEW is always the preferred option and they have a higher standing.

CIMA folks can not sign off audited accounts and people studying for this generally target commerce (ie: a Finance Director in a company) but many people who are qualified for the others end up as Finance Directors as well.

• Institute of Chartered Accountants in England and Wales (ICAEW) is the oldest and most well known accounting body. Generally people who want to run their own accounting firms will study these exams. The institute was incorporated in 1880 by royal charter and now has over 170,000 members around the world. Qualified members have the initials ACA or FCA after their name. To achieve the ACA qualification you must complete a training contract that runs between 3 and 5 years and pass the professional and advanced state of the examinations. Additionally you must complete work experience requirements.
  
  The ACA qualification is widely recognised globally as the accounting standard and 70% of FTSE 100 CEOs, FDs and company secretaries are ACAs.
  
  Many students work with an accountancy practice with most firms employing less than 40 people. The training may be basic and you will likely be auditing small companies but this training will provide an excellent foundation in all of your future work. You can find more about the ICAEW at their website here



• Chartered Association of Certified Accountants (ACCA) is the second most widely known accounting body representing 122,000 members and 325,000 students spanning over 100 years in existence. The study route is similar to ICAEW in that it's a mix of exam and experience and you need to pass 14 exams (nine of which are eligible for exemption) gain relevant practical experience, with a minimum of three years and pass a Professional Ethics module.
  
  Once qualified you'll get the initials ACCA after your name. You can get more information on this qualification on the ACCA website here



• Chartered Institute of Management Accountants (CIMA) is the third body of accountants more aimed at people who want to work in commerce (or be finance directors in business rather than accountants in practice). Even on their own website they say "By using finance skills to focus on future success rather than past performance, they help to drive the world’s successful organisations" so it's clear they see the accountant's role as more than a bookkeeper and focusing on managing an organisation financial performance.
  
  As with the other two above the qualification method is similar although the subjects are focused on business rather than numbers. The modules covered are management accounting, business management and financial management and you'll need three years relevant experience as well. You can get more information on this qualification on the CIMA website here

Accountant exams

If you join one of the big auditing companies you'll generally be sponsored to take your exams, have time off to revise and get paid as well.

It's a hard slog and takes about 3 years to complete all the exams but worth it in the end.

Accounting work

Working as an accountant in your early years may seem boring but it will give you a thorough grounding in how accounts work, what's required for an audit and how to manage finances and how to interact with clients and how you inform clients how their accounts have been developed. Your work will evolve and before long you'll be managing your own junior and trainee accountants so they get to do the administration duties.

As you move up your career you will take on vast responsibilities. It's not unusual for a 30 year old to be a Finance Director of a fairly major organisation and upon qualification your salary should increase by 30% as most companies know you can move and demand more.

The great thing these days is many business people are doing their own accounts either using computer software by Sage or other accounting systems or using online small business accounting software such as Kashflow. This makes your job a little easier although many small business owners simply provide papers that you have to sort out and make sense of.

Good luck with your accounting career - it's one of the best and is recession proof and your earnings and professional standing will be far above average.