Use Of Financial Statements example essay topic

To: Elizabeth Bruce - Line Manager From: Charvin Ebanja - Accountant Date: 7 November 2002 Subject: Introduction and discussion of Directors (Pentium plc) concerns about the use of published financial statements for evaluating the success of a company. You should discuss the purpose of financial statements for various stakeholders. You should also discuss the impact the different accounting policies have on the final published figures. The company we have chosen to focus on is the Selfridges Group plc. In this report we will look at the published financial statements to analyse their financial performance and positioning.

We will also focus on the objectives, limitations and users of financial statements. As well as the how the various accounting policies impact on these statements. Before discussing directors concerns we must look at the objectives of the financial statements. The ASB states in their statement of principles, that the objective of financial statements To provide information about the reporting entity's financial performance and financial position that is useful to a wide range of users for assessing the stewardship of management and for making economic decisions.

It can usually be presumed that this objective can be met by focusing exclusively on the information needs of the defining class of user, investors. Investors need information about the reporting entity's financial position and performance that is useful to them in evaluating the entity's ability to generate cash (including the timing and the certainty of its generation) and assessing the entity's financial adaptability Financial information regarding the operations of and resources controlled by an entity will be of interest to a wide range of stakeholders (user groups). Although, various stakeholders will be able to obtain bespoke financial information to suit their particular requirements the vast majority will have to rely on the published financial statements. Although the various user groups will have different requirements it does not follow that financial statements are not designed to meet the specific needs of all interested parties. The Statement of Principles identifies seven user groups. These being, investors, customers, employees, lenders and other creditors, suppliers, governments and their agencies and the public.

Each of these user groups (stakeholders) and their particular needs will be considered in turn. Investors as providers of capital, their principle interest is in assessing the risk inherent in, and return provided by their investment or potential investment. Also the organisations ability to generate cash and its financial adaptability. Government and their agencies main interest lie in the entities allocation of resources, which constitutes looking at all the activities of the organisation. In order to do this they require information to assist them in regulating the activities and assessing the taxation. A lot of their information is acquired through special purpose financial reports as well as the published general-purpose financial statements.

Customers require the use of financial statements because they are interested in the companies continued survival. This is especially so if they rely on the company or have a long-standing relationship with the company. Employees are users because they require information in order to assess the stability and profitability of the business. Attention is especially paid to any activity or change that will affect their sector of the business. They are also interested in assessing their employers' ability to provide remuneration, pensions and any other benefits. Lenders and any other creditors are interested in information that helps them assess whether their debts will be paid in due time.

They are also concerned with information that helps them to decide whether or what conditions to borrow to the organisation. Suppliers and other creditors are concerned with the information that helps them to decide whether or not to sell to a company and whether they are likely to be paid on time. The publics' interest in financial statement lies in the fact that, entities often provide employment, bring commerce, use local suppliers and generally make contributions to the area. The local area and general public often use financial information to assess developments and trends. When assessing Selfridges financial performance and position we can see that there have been improvements to Selfridges turnover from lb 392.1 million last year to lb 402.2 m this year respectively. While Net profit has fallen by lb 5.1 m.

Our analysis shows us that although turnover has increased there has been a loss in profitability this is notable due to increases in cost of sales and costs. Selfridges have attributed this increase in costs to the opening and operating of a new store. Liquidity has fallen but is not at a level that is cause for concern. Due to this fall in profitability and liquidity, the earnings per share has fallen from 20.5 p to 18.2 p. Gearing also slightly increased to 1.38% from 0.63% both of which are extremely low. Selfridges attribute the increase last year as being a transition year in which there was a lot of investment that is due to make returns in the following year.

The ACCA defines accounting policies as "the specific accounting bases judged by business enterprises to be the most appropriate to their circumstances and the adopted by them for the purpose of preparing their financial accounts". The effect that accounting policies have on the financial statements is apparent in three main areas, recognition, presentation and selecting measurement bases. In other words these policies determine how a transaction is recognised (as an expense, asset or liability) measured (the process of calculation) presented (which financial statement). Accounting policies are not to be confused with estimation techniques.

Accounting policies determine the basis of how an item will be measured, while estimation techniques will determine the amount within the policy's boundaries. For example a change in the method or rate of depreciation is a change in estimation technique not accounting policy. Within the Selfridges financial statement the impact of accounting policies is prevalent throughout, I have looked at the relevant accounting policies. The Accounting Convention policy, in which assets are recorded at the cost the company incurred to bring them into the business rather than at the replacement cost. All except the Oxford street freehold property that has been re-valued at current market price. The Basis of Consolidation policy, Acquisition accounting expresses the results of the parent company and any subsidiary company in a single set of financial statements.

As opposed to a different set of financial statements under merger accounting. Turnover (SSAP 5) is shown as sales to a third party less any value added tax (VAT). This is because VAT is not bought into the business but rather a government contribution; the business just acts as an agent. To: Elizabeth Bruce - Line Manager From: Charvin Ebanja - Accountant Date: 7 November 2002 Subject: Identify and explain 2 specific areas in the accounts where alternative methods permitted by UK GAAP might cause alternative figures to be reported in the financial statements. (Each accounting standard allows more than one way of calculating figures for presentation in the financial statements. Your task is to identify 2 of these differences) The two areas that I will focus on in this section of the report are SSAP 9 Stock and Work-in-Progress and SSAP 20 Foreign Currency Translation.

In order to determine the end of year value for closing stock, when a company has numerous homogeneous items that have been purchased at different times and therefore has led to differences in the unit costs, this leads to problems calculating stock, cost of sales and gross profit. SSAP 9 Stock and Work-in-Progress was produced to combat this problem. It requires stock to be calculated by one of three different methods, the 'first in first out method' (FIFO), 'last in first out' (LIFO) or the weighted average cost. The size of Selfridges stock turnover is likely to have been the main contributing factor in their adoption of the weighted average cost method. This method reduces the amount of calculation involved. To calculate the weighted average cost the total purchases for the month or the quarter (period is chosen at the discretion of the company) is divided by the total number of units purchased, this gives the average cost.

Using this method Selfridges calculated their Stock as 23.2 m. If we use some hypothetical figures, I can show how using the different methods will alter the figure you are left with. Purchases: June 20 units at lb 50 July 30 units at lb 60 September 40 units at lb 70 Sales: August 30 units at lb 100 October 36 units at lb 120 First In, First Out Method (F.I.F. O) C.O. SJune 20 at lb 50 = 1000 July 30 at lb 60 = 1800 July Total Stock 50 2800 Less August 20 at lb 50 (June) = 1000 10 at lb 60 (July) = 600 = 1600 Closing St. August 20 at lb 60 = 1200 September 40 at lb 70 = 2800 Sept. Total Stock 60 4000 Less October 16 at lb 70 = 112020 at lb 60 = 1200 = 2320 October Total 24 at lb 70 = 1680 3920 Sales 7320 Purchases 5600 Closing Stock 1680 Cost Of Sales 3920 Gross Profit 3400 Last In, First Out Method (L.I.F. O) C.O. SJune 20 at lb 50 = 1000 July 30 at lb 60 = 1800 July Total Stock 50 = 2800 Less August Sales 30 at lb 60 = 1800 1800 Closing St. August 20 at lb 50 = 1000 September 40 at lb 70 = 2800 September Total Stock 60 = 3800 Less October Sales 36 at lb 70 = 2520 2520 October 4 at lb 35 1280 20 at lb 50 4320 Sales 7320 Purchases 5600 Closing Stock 1280 6880 Gross Profit 440 Weighted Average Stock Method C.O. SJune 20 at lb 50 = 1000 July 30 at lb 60 = 1800 July Total Stock 50 at lb 56 = 2800 Less August Sales 30 at lb 56 = 1800 1800 Closing St. August 20 at lb 56 = 1120 September 40 at lb 70 = 2800 September Total Stock 60 at lb 65.3 = 3920 Less October Sales 36 at lb 65.3 = 2352 2352 October 24 at lb 65.3 1567 4152 Sales 7320 Purchases 5600 Closing Stock 1567 7167 Gross Profit 153 As you can see each of the different methods of stock calculation give us a different figure for gross profit, although all the same figures are used. The characteristic of the companies's tock turnover usually defines which method they adopt. Although Selfridges principle interest is retailing in their department store, which are all based in the UK.

They hold some foreign assets and liabilities. These assets and liabilities still have to be accounted for in the financial statements. SSAP 20 Foreign Currency Translation states that there are two methods in which to calculate transactions in foreign currency. These are the closing rate method and the Temporal Method. The temporal method says that all non-monetary items that are recorded in foreign currency are translated at the historical rates of when the transaction occurred. It also states that any revaluation on these non-monetary items will be recorded at the rate the date of the revaluation, and all monetary items are recorded at the closing rate.

The closing rate method says that all assets and liabilities are recorded at the closing rate. In this instance Selfridges annual report has not disclosed exactly what their foreign assets and liabilities are, so for this example I will have to use hypothetical figures. Selfridges set up a subsidiary company in Europe, Euroself. Selfridges invested 24000 when the exchange rate was 2 = lb 1. Euroself then borrowed 72000 and bought a non-monetary asset for 96000.

When Selfridges were preparing their accounts the exchange rate had increased to 3 = lb 1. Euroself decided to sell their asset for 96000. With the return they repaid their loan, and returned Selfridges initial investment of 24000 at an exchange rate of 3 = lb 1. This can be calculated using both methods: Temporal Closing Rate lb 000 lb 000 Non-Monetary Asset Exchange Rate ( 2 = lb 1) 48 ( 3 = lb 1) 32 Share Capital 24 8 Loan ( 3 = lb 1) 24 2448 32 Exchange gain/ (loss) 12 (4) Under the temporal method Selfridges will receive lb 8000 back of their original investment and will show a loss lb 16000. While under the Closing rate method the company receive nothing back and Euroself would still be lb 4000 behind in the deal. Again we see how the different methods demonstrate how a different outcomes can be depending on the method of calculation.

Bibliography

'Financial Reporting' 6th Edition, Alexander & Britton " ACCA Study Text, Advanced Corporate Reporting' BPP Publishing " ACCA Accounting Handbook 1999/2000'GAAP Handbook 1999/2000'The Magic Circle' Accountancy June " Good Report For Governance' Accountancy December 2001.