FAIS Assignment

Home Assignment 1

Question 1
Do the terms financial reporting and financial statements mean the same thing? Explain.

No. They do not mean the same thing.

Financial reporting provides information that is used for decision making (mainly by managers in most
cases). Financial statements, on the other hand, are a product of financial reporting that showcase the
company’s financial position to not only internal users but external uses as well.

Question 2
Is externally reported financial information always precise and accurate?

No, the above statement is not true.

The main reason for this is the fact that externally reported financial information is based on a lot of different
factors including assumptions, estimates, etc. for the past and the future of the company.

Question 3
Why is the balance sheet a logical place to begin a discussion of financial statements?

Balance sheet is termed as the statement of financial position of the company for the particular year. This
is because it actually highlights the financial health of the company at a glance, unlike other statements
which actually focuses on specific aspects of the balance sheet.

Furthermore, since it showcases the financial position of the year, it is beneficial for comparison as well.

Question 4
Why is a going concern assumption an important consideration in understanding financial statements?

Going concern assumption basically states that the business entity will continue to operate in the foreseeable
future. The two main reason for this assumption to be an important consideration in understanding the
financial statements are given below:

- Financial statements are actually prepared using this assumption because it provides a sound basis
for the measurement of income and profits. This means that the product that can be used in the
business for more than a year (having future economic benefits) is recognized as a fixed asset, not
as an expense.
- This assumption is also used to differentiate assets and the liabilities into long term or short term,
valued at the cost price not at the market price because the intention of the entity is not to sell the
asset but to use it in the furtherance of the business.

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 FAIS Assignment

Question 5
Explain the effect of operating profitability on the balance sheet of a business entity. Does it necessarily
enhance the size of balance sheet?

Operating profit refers to profitability of the business, before taking into account interest and taxes.
It shows the value of income earned from the core operations of a business, excluding any financing or tax-
related issues. Moreover, this is a measure of efficiency, so higher the operating profit, the more profitable
a company's core business is.

This is show in the extract below:

Revenue xxx
Less: Cost of Good Sold xxx
Gross Profit xxx
Less: Expenses xxx
Operating Profit (Earnings before Interest and Tax) xxx
Less: Interest xxx
Less: Taxes xxx
Net Profit xxx

So, the operating profitability helps the business calculate net profit/income which is an increase in owners'
equity. It shows the value of income earned from the core operations of a business, excluding any financing
or tax-related issues.

Question 6
Does net income represent supply of cash that could be distributed to shareholders in the form of dividend?
Explain.

No, the statement is not true.

As mentioned in the above answer, net income is the increase in owner’s equity. This is basically the profit
earned from the activities of the business after accounting for all the expenses. It is basically computation
of the value generated from all the business transaction, not in the form of cash or asset.

Question 7
When do accountants consider revenue to be realized? What basic question about recording revenue in
accounting records is answered by the realization principle?

Accountants consider revenue to be recognized only when the related goods or services associated with the
revenue have been delivered or rendered, respectively. Hence, revenue can only be recognized after it has
been earned. This is the realization principle. This answers the basic question as to when to recognize the
revenue.

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 FAIS Assignment

Question 8
Listed here are three common business situations involving revenue. At what point the business should
recognize revenue?
1. Airline ticket revenue
The revenue should be recognized in the period in which the ticket is sold. The transaction can be
recorded on the basis of accruals (if paid in advance), and then recognized for once it is earned.

2. Magazine Subscription revenue

The revenue should be recognized in the period for which the subscription is sold. The transaction
can be recorded on the basis of accruals (if paid in advance), and then recognized for each period
once it is earned.

3. Prepaid Telephone Card revenue

The revenue should be recognized for the period it was sold. The transaction can be recorded on
the basis of accruals (since it is paid in advance), and then recognized once it is earned.

Question 9
Listed below are four items that may or may not require disclosure in the notes that accompany financial
statements.
1. MC Ltd uses percentage of completion method to recognize revenue on long term construction
contracts. This is one of the two acceptable methods of accounting for such projects. Over the life
of the project, both methods produce the same result; but annual results may differ substantially.
MC Ltd should disclose the accounting method that is being followed in the notes for the
corresponding financial statement so that the users of the financial statements know the methods
for interpretation and analysis.

2. One of the important employees is leaving the company and going to work for a competitor.
The changes in employee’s status do not require a disclosure since they do not have a direct impact
on the financial statement. The users also do not need this information as it would not be valid for
their analysis or interpretation.

3. Shortly after the balance sheet date, but before the financial statements are issued, one the two food
processing plants was damaged in an earthquake. The plant will be out of service for at least three
months.
This should be disclosed in the notes because this will have an impact on the business activity and
revenue. Since the plant will be out of service, the company’s ability to generate revenue for the
time being is compromised.

4. The management of Software Systems believes that the company has developed systems software
that make Windows virtually obsolete. If they are correct, the company’s profits could increase by
10-fold or more.
This should not be disclosure in the notes, because any statements about the financial impact of this
new software would lead to speculation. Management may voluntarily disclose that it has
developed the new software, but it should avoid speculations as to the impact on the financial health
of the company.

For each case, explain what, if any, disclosure is required by the company in its financial statements.

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 FAIS Assignment

Question 10
Assume you have the opportunity to purchase some shares in OV Auto Ltd from a member of the company.
The member suggests that the company’s profitability is really stronger that closing numbers indicate
because advertising expense should have been capitalized. The member argues that the Rs. 13.9 million
advertising cost will generate future revenues and showing it as an asset would have met the requirements
of matching principle. How would you respond?

Advertising costs are normally recorded as expenses. In this case, they can be also recorded as a prepaid
expense on the balance sheet (assets) and then moved to the income statement when sales that are directly
related to those costs come in. This would align with all the principles of the accounting standards as well
as the assumptions.

Mariam Jabbar - 07288