Review of Accounting Process and Financial Statements
Review of Accounting Process and Financial Statements
This case study is organized into two parts. Part 1 is a review of various accounting concepts and their importance to financial statements. The concepts that will be discussed include GAAP, double entry accounting, accrual and cash basis accounting, current and non-current assets and liabilities as well as historical costs. Part II aims to use financial information from three companies (Lockheed Martin, RTL Group and Samsung) to discuss organization of balance sheet, statement of cash flows and income statement.
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Generally Accepted Accounting Principles (GAAP)
GAAP refer to a set of regulations, procedures and conventions that are used in the preparation of financial reports (Weygandt, 2009, p.8). They have evolved out of reason, experience, application, custom, practical need and experience. GAAP are important because they offer accountants with a guide on how to account for a variety of transactions, how to record these transactions in the financial statements and the kind of disclosures to be included in the statements.
Double entry accounting
This term is an expression of the relationship that exists among capital, liabilities and assets in terms of an accounting equation. It is based on specific procedures of debit and credit as well as the accounting equation (Assets = Liabilities + Capital), which holds that every time a transaction occurs, there is always a two-sided consequence (Weygandt, 2009, p.53). From the equation, it is evident that claims against the assets of a business are by creditors and investors and as such, total assets at any time should equal total liabilities and owner’s equity. The term is significant to financial statements because it ensures accuracy of recording of business transactions as it shows the effect of each transaction on the statements.
This means the cost at acquisition time and forms the basis of accounting valuations. It provides the foundation upon which assets should be prized in the amount that was paid for them (Weygandt, 2009, p.9). Put in another way, an asset is initially reported in financial statements at its cost and the cost turns out to be the base for successive bookkeeping for the asset. It is important in accounting as it provides uniformity in financial statements under situations of stable prices.
Accrual basis vs. cash basis accounting
Both concepts provide basis for recording expenses and revenues in the financial statements. Under accrual basis, expenditures for a particular period are matched against associated revenues. In addition, the revenues and expenses are recognized as they are receives or incurred respectively regardless of the date of receipt or payment. It is an important concept to financial records as it provides a means to determine the correct net profit or loss associated with the current accounting period, which is the reason that accrual basis is the recommended method under GAAP (Weygandt, 2009, p.99).
On the other hand, in cash basis accounting, expenses are reported when they are settled for in cash and revenues are reported when cash payment is received. This implies that the income might be in one accounting period and the associated expense in another fiscal period. Its use leads to misleading financial statements; a reason why is not recommended under GAAP. However, it is important to financial statements as it provides a way to determine the actual amount of cash received and paid during a particular financial period.
Current assets and liabilities vs. Non-current items
Current assets are business resources that are expected to be transformed into cash or used up within a single fiscal period. Common resources in this category include cash, receivables, prepaid expenses and inventories. In a similar manner, current liabilities can be defined as obligations that a business intends to settle down within the next fiscal period. Classical examples include salaries, accounts payable, loan interests and taxes. Both concepts are vital to financial statements because they provide a way to account for resources and debts that have business tenure of one year (Weygandt, 2009, p.168-170).
Non-current items have business tenure of more than one year and include fixed assets and long-term liabilities. Items classified as fixed assets include intangible assets (goodwill, copyrights and patents etc), property, land and equipment etc. On the other hand, examples of long-term liabilities include mortgages, long-term loans, lease and pensions etc. Their importance to financial statements is to provide means for accounting business transactions that cover more than one accounting period.
For the three companies, the balance sheet (statement of financial position for RTL Group) is organized into two broad sections, assets at one section and liabilities and owner’s equity at the other part. Assets section is further organized into current and non-current assets with items included in current assets section being cash and its equivalents, prepaid expenses and inventories and in non-current section being property, equipment and goodwill etc. On the other hand, liabilities and shareholder’s equity part is divided into current and long term obligations and owner’s equity subsections. In all the companies, the two sections are equal in term of monetary value.
Consolidated Income Statement
It is organized into two parts; revenues and expenses sections. Revenue or income part is composed of sales and other sources of non-operating income such as interest and dividend revenues while the expenses section comprises of cost of sales, interest expense and income tax expense. The difference between the two sections is recorded as net profit. There is an additional section that shows earnings per share that is divided into basic and diluted earnings.
Statement of Cash Flows
The statements from the three firms are organized into cash flow from operating and investing activities as well as cash flow in financing activities. Cash flow from operating activities comprises net income, depreciation and amortization etc while that from investing operations include acquisitions of businesses and expenses for fixed assets etc. On the other hand, cash flow in financing activities shows repurchases of common stocks, dividends and loan repayments etc.
Usefulness of net income and cash from operating activities
Using the 2009 consolidated statement of cash flows, net income seems to be the most useful source of revenue for Lockheed Martin Corporation while cash from operating activities is useful to RTL Group. For the Lockheed firm, net income is useful as it is the chief financier ($3024 million) of business operations compared to cash from operating activities ($149 million) (Lockheed Martin Corporation, 2010). For RTL Group, most of business transactions are financed by cash from operating expenses (₤465 million) (RTL Group, n.d.). For Samsung, both net income and cash flow from operating expenses are useful as both sources of income are high and show only a slight difference (Samsung, 2010).
Future predictions and Conclusion
Based on the 2008 and 2009 financial statements for Samsung, it is possible that its net income will be higher than that realized in 2009 because the company saw a tremendous increase in its net profits after the 2007-2008 economic depression. RTL Group is not likely to experience any substantial increases in its net profits in the future because its net income for 2008 and 2009 are almost equal. However, it’s not possible to predict future profits for Lockheed Martin as it seems that net income is characterized by unstable trend (decreasing and increasing). It can also be said that much of Samsungs financial success is based on its effective global marketing strategy as compared to the other two companies. Although the companies operate as conglomerates, information relevant to the individual segments can be found by looking at services and products offered by the segments.
Weygandt, J.J. (2009). Financial accounting. (7th ed.). Hoboken, NJ: John Wiley and Sons.
Lockheed Martin Corporation. (2010). Annual reports. Lockheed Martin. July 25, 2010. <http://www.lockheedmartin.com/investor/general_information/annual_reports.html>
Annual report 2009. (n.d.). RTL Group. July 25, 2010. <http://www.rtlgroup.com/www/htm/annualreport.aspx>
Samsung. (2010). Earnings release. Samsung. July 25, 2010. <http://www.samsung.com/us/aboutsamsung/ir/financialinformation/earningsrelease/IR_Earnings2007.html>