Essay On Users Of Accounting Cycle
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AFM 311 Advanced Financial Accounting
PART A
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.
Busn 2011 management accounting
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. Many lenders do not include these reports for making
decisions because of the many underlining limitations for accuracy in the
reports.
PART B
A stock broking firm does not include a new computer system worth $12,000 as an
expense on the income statement as it fails to satisfy the recognition criteria
of the AASB Framework of a decrease in future economic benefit. Therefore the
new computer system is recognized as an asset as it satisfies both definition
and recognition criteria of the AASB Framework.
As stated in the AASB Framework an expense is defined as “decreases in economic
benefits during the accounting period in the form of outflows or depletions of
assets or incurrence of liabilities that result in decreases in equity other
than those relating to distributions to equity participants.” Consequently the
definition of an expense must satisfy two characteristics. There must be: a
reduction in assets or increase in liabilities apart from distributions to
owners; and, a decrease in equity. As an item meets the definition of an
expense, to be recognized in the income statement it must meet recognition
criteria of the AASB Framework. These include: the probability that decreases
in economic benefits have occurred; and, the amount can be reliably measured.
An asset “..future economic benefits controlled by the entity as a result of
past transactions or other past events. ” The new computer system needs to meet
three characteristics to satisfy the definition of an asset. There must be a
past transaction or event; control by the business; and, future economic
benefit. Though the definition of an asset is satisfied by an item, to be
included in the income statement it must also satisfy the recognition criteria.
That is, there must be a probability greater than 50% likelihood that future
economic benefits will eventuate; and, the amount is reliably measured.
The characteristics of an expense are satisfied by the new computer system as
there is a reduction in assets with the outlay of cash for purchase (money
sacrifice or liability). This results in a reduction of the asset account
(wealth), which in turn creates a corresponding reduction in the equity
account. However the new computer system does not decrease in economic benefit,
which cannot be reliably measured and fails to satisfy recognition criteria.
As a result, for the computer system to be included in the income statement it
must satisfy the AASB Framework’s asset definition and recognition criteria.
First, the purchasing of the computer system is a past transaction or event.
Secondly, benefits obtained and access denied to others of the new computer
system through control of the entity. Finally, more efficient and effective
reports are prepared as the new computer system provides future economic
benefits, thus bringing increased cash inflow. The new computer system must
also satisfy the recognition criteria. The probability of greater than 50% to
provide a future economic benefit and reliable measure is achieved as the
overall running and management of the business improves quality and efficiency
which in turn has fewer employees to pay and/or more customers paying.
Therefore this implies that the new computer system satisfies all definition
and recognition criteria of an asset in the AASB Framework.
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