Table of Contents
Level: BBA (1st Semester) | Chapter-3: Word Processor
Subject: Computer & IT Application
For: PU (Pokhara University)
1. What are the two principal differences between the statement of Cash flows and income statements? Explain.
Ans: Both the cash flow statement and the income statement are essential components of financial statements. Both statements are prepared at the end of each accounting periods. They also satisfy the primary objective of financial statements i.e. to provide information for the managerial decision making. The cash flow statements is the statements which shows the cash inflows and outflows of an entity during an accounting period under various business activities whereas the income statements shows the profitability situation of the entity for a particular period. The basic difference in between two statements can be studied in the following ways:
Cash basis vs. accrual basis
The cash flows statement follows the cash basis of an accounting system. In cash basis, all the expenses are recognized only when they are paid and all the incomes are recognized only when they are earned. Time factor in happening of an event is not considered if there is no involvement of cash. Unless cash is not paid the transaction are not recorded as expenses and not accounted as outflow of cash on cash flow statement and unless cash is not received the transactions are not recorded as incomes and not accounted as cash inflows. But in income statement expenses are recognized when they incurred whether the cash has been paid or not and incomes are recognized when they earned whether the cash has been received or not. Thus income statement follows an accrual basis as accounting system.
Business activities vs. revenue activities
The cash flow statement accounts all the business activities in cash basis. It covers all the aspects of business activities classifying as operating activities, investing activities and financing activities. But the income statement addresses only those activities which are operating in nature or it accounts those all cash as well as non cash transactions which are related to the trade-able items and day to business operation. In other word, the cash flow statement covers all the aspects of business activities i.e. capital as well as revenue incomes and expenditure like sales revenue, sale of plant, issue of capital etc. whereas income statements cover only the revenue activities like purchase of merchandise, salary expenses, gain on sale of machine and so on.
2. What are the objectives of financial statements? Explain.
Financial statements are the summary reports of the company’s financial transactions or affairs. They report the end results of accounting activities during a given period of time. They provide the profitability and financial position of the company. So they are also called as historical records of the company.
Financial statements include
- Income statements
- Statement of retained earnings
- Balance sheet
- Statement of cash flows
- Statement of changes in stockholders’ equity.
Objectives of financial statements
The users of financial information are the main reason that the financial statements are prepared. Some objectives are listed below:
a. The primary objectives: (Provide information for decision making) The primary objectives of financial reporting is to provide economic information to permit user of the information to make informed decision. User includes both the management of company(internal users) and other not involved in the daily operations of the business (external users)
b. The secondary objectives:
i. To reflect the profitability: Income statement provides information regarding the profitability. It is very essential for investors and creditors to know the income statement.
ii. To reflect the cash flows: The cash flows statement shows the total inflow and outflow of cash through operating inverting and financial activities which allows the entrepreneurs to know the sources and users of funds.
iii. To reflect claim over its resources: The FASB emphasizes the role of the balance sheet and the income statement and providing useful information. These financial statements should reflect what resources the company has, what and how those resources can be claimed by the shareholders of the company and the effect of transactions and events that change those resources and claim.
3. What do you understand by “Annual report” of a company? Briefly explain the major elements of the annual report.
Ans: An annual report of the business entity is the end product of the accounting processes. All types of organizations need to prepare annual reports at the end of their accounting period but the requirement to be fulfilled may be different in organization to organization according their nature. Annual reports are prepared at the end of each accounting period and normally presented at the time of their annual general meeting (AGM). Annual reports are the summary reports about the financial as well as operational performance of the organization during an accounting period, comparative study with the past performance effects of environment to the performance and set of achievements to be made in the upcoming period. The annual reports have the following components.
- Financial statements: The financial statements are the major components of annual report. The components of financial statements are income statement retained earnings statements, balance sheet, statements of cash flow, statement of change in shareholders equity which provide profitability, financial position and cash flow situation under different activities and changes in the value of shareholders contribution as capital for the time being respectively.
- Chair person’s report: Chairperson’s report comprises all the aspects of financial results, the composition of the board directors, and discussion about the external environment, specially the financial situation of the country and the impact to the business as summary and presented by the chairperson of the organization addressing to the shareholders. This also comprises the target set by the organization for the upcoming periods and greeting to all the role players for their contribution to get the organization to the state.
- Managerial responsibility for the financial reporting: Managements responsibility for financial reporting address dos and don’ts followed by the organization according to standards.
- Management discussion and analysis: Management discussion and analysis cover all the aspects of the operation during the period and analyzes whether or not the targets where achieved. In this the management team discusses the financial statements and provides vital explanation for the amounts reported in the financial statements. /this simplifies the information in reports, provides back-up of the information and also discusses about the plan and strategies of the organization.
- Financial summary: Financial summary provides a highlight of the major economic indicates in a graphical way like pie charts, graphs, pictures, bar diagrams etc.
- Notes to financial statements: Notes to financial statements provides significant non quantifiable matters at the bottom of the financial statements to the shown or adopted by organization.
- Reports of independent auditors: Report of the independent auditor gives the validity, recognition or proves authenticity about the accounting procedures adopted. This must be signed by an independent auditor recognized by concerned authority.
4. What do you mean by finical statements? Explain the importance of financial statements.
Ans: Financial statements
The shareholders and other stakeholders are those who have at least some level of stake over the performance of the organization directly or indirectly. Financial statements are the principal means of communicating important accounting information to the various internal and external users. Accountant report about its stock of resources in the form of a balance sheet and the flows are reported through the income statement, statement of changes in retained earnings and a cash flow statement. Consequently, a business entity prepares and issues four statement, which are generally accompanied by a number of supporting schedules and explanatory materials- all of them compiled in to an annual report. Shareholders and other stakeholders of the business are normally communicated through different components of financial statements.
The major components of financial statements are income statement, statement of retained earnings, balance sheet, statement of cash flow and statement of changes in stockholders’ equity. They are mentioned below.
Income statement reports the result of company operations during a particular period of time. In other words, it depicts the success or failure of a company’s operation. It consists of the income with the expenses occurring during a period. The incomes and expenses are finally matched to as certain operating income or loss.
As income statements provides useful information for predicting future income. It is useful for current as well as prospective investors. Likewise creditors use the income statement to predict the company’s profitability to repay the debt on time.
Statement of retained earning
Retained earnings are the net income retained by the company. In other words, it is the position of net profit which is not distributed as dividend. It shows the change in retained earn in cause. The following is the format of retained earnings statement.
The users of the financial statements evaluate the dividend and reserve transfer practices through retained earnings statement. The investors prefer to invest in such a company that has a high dividend payout ratio in the past. However, the creditors prefer a low dividend payout ratio since it increase their clients’ ability to pay back the debt on time.
It is the statement that reports the assets and claim to the assets on a specific point of time. The claim can be categorized into claim of creditors and claim of owners. The claim of creditors is called liabilities whereas the claims of owners are called stockholders equity.
The analysis of balance sheet is useful for company mainly due to the following points.
- Nature of company’s assets and liabilities
- Relationship between debt and stockholders’ equity.
Statement of changes in shareholders’ equity
The statement of changes in shareholder’ equity shows the changes in equity over reporting period. The owner’s equity changes by two factors as investment by the owner and net income. The investment by the owners and net income increase the owner’s equity whereas the net loss and withdrawals decrease the owner’s equity.
Statement of Cash flows
A statement that shows the cash receipts and payment (also called inflow and outflow) during a particular period of time is called a cash flow statement. It shows the effects on the position of cash under operating, investing and financing activities. A cash flow statement attempts to answer the following questions.
- Where did cash come from?
- How was cash used?
- What was the change in cash balance?
5. List the major financial statement. What information do they contain? How are they different?
Ans: The shareholders and other stakeholders are those who have a least some kind of stake over the performance of the organization directly or indirectly. Financial statements are the principal means of communicating important accounting information to the various internal and external users. Accountant report about its stock of resources in the form of a balance sheet and the flows are reported through the income statement. Statement of changes in retained earnings and a cash flow statement. Consequently, a business entity prepares and issues four statements, which are generally accompanied by a number of supporting schedules and explanatory materials- all of them compiled in to an annual report. Shareholders and other stakeholders of the business are normally communicated through different components of financial statements thus; they are regarded as the language of the business.
Balance sheet: It communicates the resources of an organization and claim of the shareholders over those resources in organization. The resources are reflected as assets and the claim are reflected as obligations or the liabilities and the owner’s equity, which is the amount invested in the business by the owners in the balance sheet. The balance sheet shows the financial position of the company in an accounting period.
The income statement: It communicates profitability situation of the organization during an accounting period. The net income is the excess of income over expenses and the net loss is the excess of expenses over incomes. This statement reflects the operating performance of the organization and deals with the tradable items.
The statement of cash flows: This statement reflects the amount of cash receipts and disbursed by the firm in different business activities which are classified as operating, investing and financing. The statement of cash flows describes the sources and uses of cash for an accounting period. It also reports the amount of cash at both beginning and end of a period. It simply shows the cash increases and decreases during a year due to different activities in comparison with last year.