Introduction
This report provides insights into the process of generating the financial statements (FS), what each statement communicates, and the company’s performance. It also looks at future growth opportunities and how the company can optimize its inventory and asset accounting. The (FS) covered in this report are the income statements, the balance sheet, and the statement of owner’s equity. The income statement shows the company’s profitability over a specific period. The balance sheet shows the business’s financial position, including assets and liabilities, on a particular day (Andal et al., 2020). Lastly, the statement of owner’s equity shows changes in what owners own from the opening period to the end of the period.
Process
The process of generating accurate FS began by posting the transactions to the general journals, adhering to the rules of double-entry accounting. Afterward, the transactions were transferred to their respective ledgers/T-accounts, where each transaction adhered to the rules of double entry. The ledger account balances were then posted to the unadjusted trial balance. The unadjusted trial balance ensures that the rules of double entry have been observed in all the entries, and, therefore, it must balance. The trial balance was then adjusted for any adjusting entries, such as prepayments and accumulated depreciation.
To begin with, balances are moved to their corresponding financial statements. Transactions that generate revenues and expenses are transferred to the income statement. Also, transactions that affect the company’s financial position, such as payables and assets, are recorded in the balance sheet. In conclusion, any transaction that either increases or decreases the owner’s equity is included in the statement of owner’s equity, such as cash injections or withdrawals from the business.
The FS (income statement, statement of equity, and balance sheet) provides different types of information for those involved in the business. The income statement shows whether the business has made a profit or a loss during the period being reported. This information is important for planning, as investors can review the income statement to identify ways to minimize expenses and maximize revenue to become more profitable.
Net profit that is earned and retained in a business over a period of time reflects the statement of owner’s equity. Determining the value or price also helps potential investors understand how much they can invest to acquire a specific stake in the company. It also shows the amount of money owners have invested in the business or withdrawn from the business.
Lastly, the balance sheet shows what the company owns versus what it owes. This is vital information that helps potential investors determine whether the business is at risk of sinking into debt. The information is also important in planning the debt level the business can take on without risking becoming a going-concern.
Financial Statement Analysis
The FS shows the business’s health. The key points for any potential investor or stakeholder are whether the business is profitable and able to meet its obligations. The income statements of this business show that the company is operating profitably. The business reported net income of $ 2,565.00 during the month. The percentage of revenue that resulted in net income was 46.42%. This is a healthy net profit margin for the business.
The liquidity of the company can be determined by looking at the company’s ability to pay off short-term liabilities/obligations. One of the most powerful tools for determining liquidity is the current ratio. This company’s current ratio is 129.78. The ratio indicates that the company can cover its current liabilities using its current assets 129.78 times. Therefore, the company is liquid and at no risk of becoming a going concern.
Internal Controls
Internal control systems are important for any business, as they protect assets, improve accuracy, and ensure that the business operates in accordance with the rules and regulations set. One simple internal control that this business can implement to protect assets and increase accuracy is segregating duties. This can be done by allocating the roles of recording, authorization, and asset custody to different individuals (Kim et al., 2020). Segregation of duties reduces the risk of conflict of interest.
Additional controls that can help the business with its growth and expansion include regular asset reconciliations and the integration of IT controls. Regular asset reconciliation requires a physical inspection to ensure accuracy. Integrating IT controls in place and making them critical as the business expands, especially when physical monitoring/control is not feasible.
Looking to the Future
Business growth and expansion increase the complexity of the accounting methods required for the business’s success. Before acquiring a long-term asset, the business needs to consider factors such as the asset’s useful life, the risk of obsolescence, and its salvage value. These factors help the business to decide between leasing and buying the asset. In merchandise inventory, the business needs to consider factors such as obsolescence, storage costs, and required personnel. This helps the business determine the optimal inventory level.
If the entity acquires a long-term asset, it should decide how to amortize its cost over its useful life. There are two methods to consider: straight-line depreciation or double-declining depreciation. The straight-line method allocates the asset’s cost evenly over its useful life (Hajiyev, 2021). It is ideal for assets that have a consistent output over their useful life. In contrast, double-declining depreciation accelerates depreciation by applying more depreciation in the asset’s early years (Hajiyev, 2021). This method is appropriate for assets that produce high output in their early years, then decline.
The addition of merchandise inventory alters accounting because goods held for sale do not necessarily have the same value. The business might have bought some portion of the goods at a higher cost than the rest. Therefore, the business needs to select the appropriate inventory costing method: FIFO, LIFO, or average. The FIFO method means that the inventory acquired first is sold first. This type of inventory costing is appropriate when goods are perishable, and the old stock is sold first (Teplická & Seňová, 2020). For example, a grocery store uses the FIFO method to sell the older groceries first.
The LIFO method means the last-in, first-out. It is mainly used when the prices of goods are increasing. This method increases the cost of goods sold (COGS) on the income statement and reduces taxable income (Teplická & Seňová, 2020). For instance, in selling petroleum products such as gasoline, if the price of recent stock is high, the business might use LIFO to reduce taxable income. Lastly, the average method takes the cost of the entire stock and assigns the average cost to determine COGS and the stock left (Teplická & Seňová, 2020). This method is common in merchandise inventory that is not distinguishable or perishable. For example, a brick business can use the average cost method to determine the cost of each brick.
References
Andal, D. V., Suganya, D. S., & Shree, V. (2020). Financial performance analysis of PUMA. International Journal of Management (IJM), 10(6), 2019.
Hajiyev, H. (2021). Accounting and tax accounting for the accrual of depreciation of fixed assets and ways of convergence. In SHS Web of Conferences, 92.
Kim, R., Gangolly, J., Ravi, S. S., & Rosenkrantz, D. J. (2020). Formal analysis of segregation of duties (SoD) in accounting: A computational approach. Abacus, 56(2), 165-212.
Teplická, K., & Seňová, A. (2020). Inventory valuation methods and their impact on the company s profit generation. Acta Logistica, 7(3), 201-207.