Generally Accepted Accounting Principles – consist of a number of principles that financial accounts to external users should abide with. Examples of such principles encompass the principle of consistency, prudence, accruals, integrity in report and going concern. It is imperative that organizations abide with such principles in their reporting in order to ensure that the qualitative characteristics of financial statements are met.
Indeed an important function of the external auditor during his assessment is to provide reasonable assurance that the annual report complies with these generally accepted accounting principles. Failure to abide will lead to a qualified audit report that will shake the confidence of external stakeholders in the management of the organization.
Historical Cost – this accounting concept states that assets should be valued at their historical cost in the accounts. Such historical cost comprises the acquisition price charged the date the transaction occurred. In the accounting environment this premise led to substantial debate among authors hindering its applicability. For instance, it is contended that long-term resources like land and buildings appreciate in value over time and if they are reported at historical cost, they would not reflect their true economic value.
In this respect, the accounting profession had to allow revaluation of such assets, provided the valuation was carried out by a technically competent and independent individual to abide with the qualitative feature of reliability. In addition, tangible fixed assets, like machinery and motor vehicles lose their value over time due to wear and tear. Therefore again, allowance was granted to depreciate such assets on a systematic basis over their useful life in order to ensure accurate reporting. Another measurement basis put in practice, which is also hindering the utility of the historical cost concept is fair value accounting.
The official definition of fair value accounting comprises that assets are valued at the amount at which an asset could be exchange, or a liability settled, between knowledgeable willing parties in an arm’s length transaction. Such method is getting considerable importance in accounting. Indeed financial instruments that have reliable markets are nowadays valued at their fair value.
Accrual Basis vs. Cash Basis Accounting – the accruals premise states that revenue and expenditure are recorded in the period in which they occur and not when their respective cash is received or paid. In this respect, the net income reported in the income statement does not match the increase in cash and cash equivalents. For example, not only cash sales and purchases are recorded in the income statement, but also credit sales and purchases.
This accounting treatment, however led to an important problem, which encompasses neglection of the cash element, which is very important in financial analyses and reporting. In view of such element an additional statement was provided in the annual report, which entails the Cash Flow Statement. Such statement examines the movement in cash and cash equivalents, by looking at movements in cash during the period, classified between operating, investing and financing activities.
Current Assets and Liabilities vs. Non-Current Items – Non-Current Assets encompass resources owned by the organization or have the right to access, with the objective of gaining future economic benefits in the long-term. Non-current assets encompass machinery, equipment, buildings and motor vehicles. Current assets also fall under the category of resources, but they are held with the objective of converting them into cash and cash equivalents during the business cycle of the organization.
Examples of current assets include prepaid expenditure, accounts receivable, inventory of raw materials, work-in-process and finished goods, accounts receivables and even cash at bank and in hand. Non-current and current liabilities are also distinguished between themselves in accordance to their respective duration. However, these encompass liabilities, which are obligations that the firm has to settle. Examples of non-current liabilities are debentures and long-term loans, while current liabilities include accounts payable, accrued expenditure and taxation payable.
General Motors Corporation page 83 of the 2007 Annual Report
Home Depot Incorporation page 35 of the 2007 Annual Report
Billabong International Limited page 26 of the 2006 Annual Report
General Motors Corporation page 82 of the 2007 Annual Report
Home Depot Incorporation page 34 of the 2007 Annual Report
Billabong International Limited page 25 of the 2006 Annual Report
The Statement of Cash Flows:
General Motors Corporation page 84 of the 2007 Annual Report
Home Depot Incorporation page 37 of the 2007 Annual Report
Billabong International Limited page 28 of the 2006 Annual Report
The increase in sales trend in percentage terms diminished from 2007 to 2006 in comparison to the previous year. This shed lights to the fact that in the future the increase in sales revenue will not be so drastic unless the organization is capable to attain competitive advantage via an innovative measure or a good competitive move.
The sales revenue of the organization commenced decreasing from 2006 to 2007. It is predicted that such decreasing trend will continue, probably at a greater pace in view of the economic recession that the target markets of the company are facing.
Billabong International Limited is experiencing drastic rises in revenue income. If the management continue such effective operations, it is envisaged that next year’s revenue shall also increase.
The drastic turnaround conducted in the cash from operations of General Motors Corporation from 2006 to 2007 will definitely leave a positive effect on the cash and cash equivalents of the company. Indeed the firm had more cash available for other business purposes.
Home Depot Incorporation repurchased a substantial amount of common stock as outlined in the Financing Activities of the Consolidated Statements of Cash Flows. This will therefore lead to lower dividend payments by the organization in the foreseeable future.
Billabong International Limited is attaining a considerable amount of debt finance as portrayed in the Cash Flow Statement under the financing activities section. The higher the debt the greater the financial commitments stemming from such finance mediums. Therefore in the forthcoming year the interest expenditure of the company will be higher.
Organization of Financial Statements
The Annual Report, basically encompasses the Income Statement, Balance Sheet, Statement of Cash Flows and accompanying notes and disclosures. These are linked together, because overall they portray the financial health of the organization. The profitability is depicted under the Income Statement in accordance to the accruals premise. The Statement of Cash Flows outlines the cash movements during the year together with the respective cash balances. The Balance Sheet provides a photo of the balances at a particular date, normally the end of the financial year, of the assets, liabilities and equity capital and reserves of the corporation.
Net Income or Cash Flow from Operations
When a financial analyst is considering the financial health of a firm, both the profitability (net income) and liquidity (cash flow + working capital management) are important and should be meticulously considered. Yet if a choice is necessary, the cash flow from operations is more important than the net income. This result from the fact that a company can survive a year or two without profits, however in the absence of cash the firm will perish in the short-term.
McKenzie W. (2003). Using and Interpreting Company Accounts. Third Edition. London: Prentice Hall.
Weetman P. (2003). Financial and Management Accounting. Third Edition. New York: Prentice Hall.