Tag: Accounting

Influence of Culture on Accounting Procedures

Influence of Culture on Accounting Procedures
Influence of Culture on Accounting Procedures

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Influence of Culture on Accounting Procedures

                                                                      Introduction

    Culture can be defined in relation to accounting procedures as the communal encoding of mind which differentiates a group of people from another. Culture puts into consideration factors such as the groups beliefs, morals, their background knowledge, the groups laws and customs, and any other abilities and habits that individuals from that particular society posses. Some of these cultural elements have been known to have a great influence on the labor circumstances of many organizations and business institutions.

Accounting procedures are structured set of handbook and programmed accounting techniques, systems and control methods that are introduced to collect, record, analyze, and present financial information to guide in decision making processes. Several theories have been used to illustrate the relationship and interconnections between cultural values and accounting procedures.

The theories can be categorized into two large groups which are economical and sociological approaches. Economical theories includes; principle agent theory, transaction cost theory and managerial accounting system design approach. Accounting systems may include; internal and external tax accounting and expense accounting procedures. Cultural behaviors have influenced the operations of businesses globally.

Influence of Culture on Accounting Procedures

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Problem Statement

       Cultural values have not been completely embraced by many organizations in their financial and accounting systems. Business organizations need to incorporate important cultural values that will influence accounting procedures positively. Professionalism of individuals needs to be given priority when it comes to making decisions. Organizations have to create room for independent expert judgments by individuals with enough knowledge on the subject matter.

Their decision must be respected as long as they adhere to the set legislations that govern accounting procedures and at the same time the judgments they make should promote fairness to all workers ( Gregg, 2005). Cultural knowledge need to be used more in businesses since it provides valuable cultural information that can influence the making and implementation of more informed decisions.

        Businesses will need to employ accounting secrecy and transparency to limit the disclosure of valuable financial information to competitors. Professional individuals must therefore create assurance for the security of any important financial information that may be used by competitors to their advantage. At the same time, transparency and accountability need to be practiced in the accounting and financing systems to avoid cases of a business losing money for individual gains.

Certain cultural beliefs and some set code of ethics promote transparency since they prohibit individuals from certain societal backgrounds from activities that may discredit them in providing financial results that lack accountability (Rand, 2006). Therefore, organizations need to employ workers with cultural values that promote accountability and transparency in the financial systems.

There is need for all businesses to ensure transparency and accountability in all its departments which can be achieved more efficiently by embracing set societal beliefs and morals. Both the managers and stakeholder should be in the forefront to in making sure that transparency and accountability is observed among all workers. They should be the role models to all other employees.

Influence of Culture on Accounting Procedures

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       Organizations also need to employ conservatism which is one of the most ancient ways of valuing accounting procedures. The concept can be associated with uncertainty- avoidance aspect which tries to avoid the uncertain outcomes in the future. Conservative measures need to be taken that will help in the adapting of careful measures that will deal with uncertain results happening in the future.

A company that values its cultural conservatism highly is in most cases able to predict future outcomes thus avoiding occurrence of uncertain events in the future. An organization may opt for a lesser conservative theory to achieve consistency with short- term goals since the expected results are attained within their estimated time. Furthermore, this approach is more optimistic when adopted where the organization is trying to conserve its resources and investing these resources to achieve their long- term goals (Newing, 1995).

This is clearly shown when determining the total value of the business. In addition, the approach has tried to outline how various cultural values such as good behavior and customs can be used within an organization to facilitate good accounting and financial systems.

Influence of Culture on Accounting Procedures

Effect of cultural values and societal rule on accounting procedures

 Written laws which can include societal rules need to be incorporated in the structural working of organizations to achieve uniformity in accounting and financial systems. Individualism is an aspect where culture has influenced both accounting and financial systems greatly, since it motivates individual performance towards realization of goals of an organization.

Further, this aspect has increased individual contribution towards the teams that runs various departments (Khan, 2002). Furthermore, an organization that chooses a more uniform financial and accounting theory, it is associated greatly with avoiding incidences of uncertainty. This has resulted to a lot of concern in matters pertaining laws and regulations which have forced these bodies to come up with strict code of ethics that monitors accounting and financial systems in any business organization.

These codes of ethics should go hand in hand with cultural morals that must be adhered to by all individuals. The organization also has role of ensuring that all set regulations of the firm must be followed to the letter without favors. For any business to be successful in the future consideration of individualism must be given more weight and priority since personnel’s with high cultural values will be more committed towards working with the sets regulations (Becker, 1991).

Influence of Culture on Accounting Procedures

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       Economic theories of organizations control, makes the assumption that the firm is a lawful body that is composed of the manufacturing procedures whose information is accessible by other organizations. Executives are responsible for choosing a certain manufacturing process and provide a suitable environment for maximization of the present and the future revenues. In addition, it is also the responsibility of the managers and stakeholders to offer all required material and financial resources and also equip employees with required skills by offering training courses (Anthony, 2001).

Economic theories that have been discussed to help managers in business operations include; the principle agent theory, the transaction cost theory and the management accounting system design. The three theories all focuses on profit maximization where executives, workers, stakeholders and accounting controllers works together to achieve the organizations common goal of increasing the firms total output.

Economic theories should always try to adapt to mechanisms that describes the organization. On the other hand, non- economic approaches need to work towards filling the existing gap and expound on the firms’ knowledge behavior (Mullins, 2002). 

Influence of Culture on Accounting Procedures

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      There has been concern on whether principal agent theory helps in understanding the concept of profit maximization by the management. The approach refers to a point where the owners of the business are interested in capitalizing on profit or are concerned in functions that add value to their enterprise. The theory is also referred to as principle agent problem, since senior staffs may exploit subordinate staffs by for instance, installing financial programs that these junior staffs do not have skills to operate.

On the other hand, managers, concentrates on exploiting the available resources that include their salary and money to maximize on profit which is the main functions of their business (Warren, 2005). As managers tries to maximize on profits, it results to an argument of concern on how managers should be controlled in the way they should run their commerce and at the same time do their best to capitalize on  the state of ownership.

For example, managers must consult investors on a certain decision before implementing so as to get the approval of the stakeholders. This facilitates effective decision making and implementation, since there thorough research on matters of concern and enough consultation is conducted before making a conclusive and final decision ( Harrison, 2004).  

Influence of Culture on Accounting Procedures

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   Despite managerial power system in relation to organizational activities not encouraging executives to express their open behavior, stakeholder do not have much information on managers day to day activities and the available information on profits. Ownership can therefore not force the management to work towards achieving the companies’ objectives by just highlighting the objective purpose. The solution to this is to design an efficient scheme that aligns the objectives of the stakeholder and those of the management (Whiting, 1986).

The scheme will tend to carry more weight on the objectives of the managers in comparison to those of the stakeholders. On the contrary, despite the approach trying to close on the gap within organizations, it faces a problem in that executive tend to utilize their power to enforce rules that may oppress the subordinates. For instance, the manager may authorize the purchase of an expensive machine for production to favor the seller while on the other hand; the manager is oppressing the subordinates who do not understand how to operate the machines.

It can be seen that the theory helps managers to maximize on profits as the management is given freedom to exploit resources at their disposal without stakeholders’ interruption. Further, the manager is given the mandate to set the rules and goals of an organization in order to maximize on profits (Bryan, 1999).

Influence of Culture on Accounting Procedures

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Effect of social cultural factors on profit maximization

  Social cultural factors also influence the extent to which are managers able to maximize on profits from signing the right contracts which are cheaper compared to their market price. According to the transaction cost theory, a firms’ existence is validated by the ability of the entrepreneur to agree on contracts at lower price than the market price which can be negotiated. 

The number of contracts that can be negotiated within the firm is always less than the number outside. The contract should only state the power limits of the entrepreneurs and the details of the contract should only be defined after the two parties have agreed on all matters. Due to this, there is a possibility of the firm emerging in cases where short term agreements are not satisfactory.

Further, the approach would be seen as the expense incurred while trying to cater for goods by purchasing from the market instead of the organization providing from within. In addition, many organization tend to provide for their needs from within which allows the organization to save more on production cost, thus maximizing on the total income generated (Laffont, 2002).

Influence of Culture on Accounting Procedures

       According to this theory, the control of an organization is related to the control that the firm has over the marketing expenses. In addition, the theory claims that issues relating to organizations details play a vital role in defining the firms’ nature which is determined by the optimal production of available workers which is most likely promoted by the already existing inputs within the firm (Gebert, 2014).

In fact, resources with lesser value are priced at a lower cost since they can only generate products with lesser value, whereas, resources of high value are priced at a higher cost due to the high profit incomes that they generate. The approach faces a problem where, before managers undertake any transaction in the market, they have to know who are the willing seller/ buyer in order to initiate a bargain to get into contract and to conduct an inspection required to ascertain the validity o the contract.

The long processes involved in acquiring of industrial goods and services delays production by an organization since a lot of time is consumed/ lost between the time of identifying the needed resource and the time of acquiring the good. In addition, time may be also lost as the managers tries to fulfill legal procedures that are required for acquisition and installation of equipment (Flamholtz, 1996).

Influence of Culture on Accounting Procedures

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     According to the theory, it can be seen that market prices determines the interactions between organizations. Furthermore, managers are responsible for making and implementing business set rules. For example, when a manager wants to purchase a machine that will be used in production department, he first of all consults an expert, then finds a willing seller, bargains, signs contract and finally makes the purchase (Chandler, 1992).

The approach involves three types of costs which are, “search and information cost “,”bargain and decision costs” and “policing and enforcement cost”. Without taking into consideration the transaction cost, managers will not understand well how the economic system work therefore making it hard to implement economic policies. The theory proves that managers are able to strike the right deals when they agree contracts before going to the market to strike at a market price.

Influence of Culture on Accounting Procedures

                       Effect of team work and organization culture on profit maximization

  In the current business world, most organizations are using accounting and financial data in making critical decisions which in most cases is provided by management agents and controllers. The only question in this is whether the agents and the controllers have different perceptions with the managers on variable designs and the output quality (Chenhall, 2003).

Therefore, there is a need for the integration of the accounting controllers and the management involved in the decision making which would result in a consistent accounting language which benefits both the manager and the controllers.

      The controllers do not seem to understand how vital their work relies on business success since they provide intangible and harmonizing information to the management. Therefore there exists a gap between the accounting controllers and the executives concerning on how to put into use the financial information. By providing information that promotes the growth of the organization, they improve their position as business consultants thus gaining highly influential positions within the enterprise.

On the other hand, managers must be transparent on the type of details they require and use while the controllers should not see themselves as specialists but instead be just like any other employee with the aim of realizing the organizations set targets (Sautet, 2000). Further, when both mangers and controllers agree to examine the policy that runs the business together, they tend to understand the matters concerning the social- economic factors m, thus leading to faster goal achievement of the organization within a short time.

In addition, managerial designs have assisted managers in maximizing on profits as decisions made by the two parties, when they work as a team, are implemented as agreed. When both the managers and the accounting controllers work together, it can be seen from the approach that there is quick goal achievement and higher profit maximization.

Influence of Culture on Accounting Procedures

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         The above three discussed approaches do interrelate as all are aimed at realizing the long term profit maximization of the firm. First, Principal Agent theory illustrate on a scheme that is aimed at having the management and the stakeholders aligning their objectives so as make and implement efficient decisions that will enhance overall productivity.  Though the senior staffs have a higher hand of determining the best course since they understand better the business environment, they still need to consult the investors.

The transaction cost theory explains on how managers need to give priority to contracts that can be implemented at lower costs than the market price. The management there focuses on resources that can be acquired at a cheaper cost but at the end yield more products which can generate more incomes. Lastly, the managerial accounting system design like the other two approaches focuses on making decisions that are aimed at maximizing the firms’ profits (Radebaugh, 2005).

The theory tries to integrate the company’s management with the accounting controllers so as to enhance the making of more informed decisions that would increase the firms’ total revenue. The three theories therefore summarize the role of different firm organs and departments in the realization of the goals of an organization which are to increase the total income revenue.

Influence of Culture on Accounting Procedures

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Sociological theories of organizational control are approaches that try to describe managerial behavior by stressing on main affinity of teams. Sociologists do not concentrate more on understanding individuals’ psychology and how they interact with others but emphasize more on group interactions.

According to the theory, managerial control is executed by set laws, policies and the chain of command (Klewes, 2008). Further, the sociological approach has been described using several other theories that include; functionalism, general system theory approach, contingency theory and theory of bureaucracy.

     The theory of functionalism is based on the hypothesis that the social world has a strong, genuine continuation, and an orderly trait oriented to come up with a structured and maintained state affairs. The theory has been applied in social sciences and how they relate to the business world.  According to the approach, the organization can be approached in two dimensions; from an internal view and an external perspective.

The internal view distinguishes the managerial, the technical and the institutional level. The managerial section takes part in the administration section of the organization (Chenhall, 1990). The technical level focuses on the activities involving practical work. The institutional part has to make sure that the objectives of the company are at par with the social goals.

   The second approach is the General system theory approach studies an organization as a program of parts interconnected to each other but each specialized to perform a specific task towards achieving the goals of the organization. Further, the theory explains the common principles and regulations that an organization operates under. The principles must be in agreement with the cultural norms of the involved communal groups.

In addition to this, environmental laws must also be adhered to regardless of the firms’ laws and regulations. The cultural values of the society will therefore play a bigger role on the organization during its making of financial and accounting decisions (Bryan, 1999).

       Another approach that is used by sociologists is the contingency theory which argues that, individuals cannot be expected to just follow set gestures unless they can respond to own worth and interest. The theory therefore recognizes enabling factors that facilitates capacity building within the firm. Capacity building in an organization can be limited by business environmental factors which always need to be addressed so as to enhance business productivity. 

Organizations variables have to match with environmental traits so as to ensure an excellent working condition (Klewes, 2008). In addition, the approach also shows that the most successful firms are connected with administrative practices which best matches environmental circumstances with the techniques used for production.

Influence of Culture on Accounting Procedures

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     The last approach is the theory of bureaucracy which is based on the official area of jurisdiction, the hierarchy of command, written agreement, training of the office management, the capacity of the employees and lastly the general rules by the management. In addition, the theory emphasizes on the rule of law which focuses on all formal structures of the firm. All employees have equal rights as does the consumers. All customers have to be provided with equal services regardless of their cultural beliefs, morals and the principles that monitor and maintain their behaviors (Radebaugh, 2005).

     In conclusion, the impact of cultural values on accounting procedures can be seen clearly in the context. Various theories that include; principle agent theory, transaction cost theory and managerial accounting system design approach have all tried to explain the success of organizations based on how managers makes and implements decisions.

Further, sociological theories, such as, functionalism, general system theory approach, contingency theory and theory of bureaucracy have also been used by scholars to explain how cultural values influences financial systems in a business. Cultural values that influences these accounting procedures includes; cultural beliefs, morals, individual habits and the customs of the groups.

The above approaches have successfully been able to solve the gap that exists in many business organizations.  Further, the study explains more on cultural behaviors which includes; professionalism, secrecy and transparency, conservatism and individualism. These concepts illustrates how cultural values affects the accounting systems and designs.

Influence of Culture on Accounting Procedures

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References

Gregg, G. S (2005). The Middle East. A cultural psychology. Oxford; Oxford University Press

Radebaugh, L. H., & Gray, S. J. (1997). International accounting and multinational enterprises. New York; John Wiley & sons.

Khan, A., & Hildreth, W. B. (2002). Burdget theory in the public sector. Westport, Conn: Quuorum Books.

Becker, R., & burmeister, E. (1991). Growth theory. Aldershot, Hants, England; E. Elgar.

McChail, K (2013). Accounting ethics

Rand, S, Kouris, H, & Apex Art ( Galley) (2006). On cultural influence Collection papers fro Apexart international conferences 1999-2006. New York Apexart

Laffont, J-J, & Martimort, D. (2002). The theory of incentives: The principal- agent model. Princenton, N. J: Princenton University Press

Chandler AD Jr (1992). Strategy and structure: Chapters in the history of the American industrial enterprise. MIT Press, Cambridge, MA

Anthony, R. N., & Govindarajan, V. (2001). Management control systems. Boston

Marchant, K. A., (2012). Management control systems; Performance measurement, evaluation and incentives. Harlow, England 

Chenhall R. (1990). Financial and accounting systems .Boston, MA; Auerbach

Gebert, K. (2014). Performance control in buyer- supplier- relationship; the design and use of  formal management control systems. Wiesbaden; Springer Gabler.

Newing, R, & Ring, T. (1995). Financial and accounting systems. Chorleywood; Prime marketing.

Harrison, W. T, & Horngen, C. T. (2004). Financial accounting. Upper Saddle River, N J; Prentice Hall.

Chenhall, R.H,. (2003). Management control system design within its organizational context:

Warren, C. S, & Fess, P. E. (2005). Financial accounting. Mason, Ohio; Thomson/ South- Western.

Whiting, E. (1986). A guide to business performance measurement. London ; Macmillan.

Flamholtz, E. G. (1996). Effective organizational control. A framework, applications, and implications.

Sautet, Fa. E. (2000). An entrepreneurial theory of the firm. London; Routledge

Mullins, L. J. (2002). Management and organizational behavior. Harlow; Financial Times Prentice Hall.

Bryan, L. L. (1999). Race for the world. Strategies to build a greater global firm. Boston, Mass; Harvard Business School Press.

Klewes, J., & Langen, R. (2008). Beyond organizational transformation. Berlin; Springer

Influence of Culture on Accounting Procedures

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Balance sheet Financial Reporting

Balance sheet Financial Reporting
Balance sheet Financial Reporting

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Balance sheet Financial Reporting

The balance sheet captures the current financial position of the NGO. Net assets should balance with the liabilities and equity since the each of the asset is funded by the resources contributed by members and other sponsors. The statement should provide a snapshot of the assets, liabilities, and net assets as the specified date. Gabel’s statement of financial position gives detailed information about the financial position of the company as indicated by the figures. It has the assets section, the liabilities section, and the equity section.

Each fixed asset should have its book value minus the depreciation to get the current net value. By giving the value of the asset in a different line with its total depreciation value makes the balance sheet untidy and crowded making it hard to analyze (Elizabeth, 2010). The net of the fixed asset is the one used to analyze the current financial position of the organization. It is therefore important to indicate the net of the fixed assets to avoid confusion. Deductions and accruals should just indicate the total amounts instead of individual amounts since the receipts will be attached to the statement to avoid congesting the statement.

Since the company is a non-profit, the balance sheet should only indicate the assets and the liabilities. The assets and liabilities are the values used to indicate the financial position of the organization and not the equity hence the net income and equity are not inclusive.

Also, it is important for the accountants to indicate the previous year’s balance sheet values for comparison purposes. The current values should be shown against the previous year’s or, at least, the past three years to make the analysis of the statement viable. When the values of two periods are shown, it makes it easy for analysts to make comparisons and understand the changes that may have taken place to get the current balance sheet values.

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Income Statement

The statement is used to give information regarding the operating activities of the organization from one date to another. It gives information pertaining the revenues and expenses during a particular time, and it’s useful to forecast future activities. For NGOs, activities are measured as received and used contributions. The statement is divided between temporary, restricted, unrestricted, and permanently restricted activities.

Recorded revenues should be classified into one of the four activities based on the donor’s intent. Expenses should be divided into the program, administrative, and fundraising expenses. Revenues are either in the form of activities, membership dues, program revenues, special event and investment income. By categorizing revenues and expenses in the different classification, it provides for better analysis as well as being in line with the global accounting standards.

Gabel’s statement does not give columns for the different activities under income and expenses. By generalizing the revenues and expenses and indicating their categories randomly makes it hard for analysis and is not in line with the required reporting standards. It is also important that the statement also records prior year values for comparison purposes. Categorizing each activity and expense into the section they fall helps stakeholders identify gaps in the company for improvement.

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Statement of cash flows

Statement of cash flow is used to record the cash inflows and cash outflows over a specified period. The statement is divided into three sections: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities (Ron, 2013). The total amount from the three sections gives an explanation of how the cash flow from the beginning of the period was converted to the balance at the end of the operating period.

Gabel’s statement should show the net cash for each of the sections and sum up the amounts resulting from same activity instead of detailing each activity. The statement is supposed to provide an overview of the cash flows to make it easy for reporting.

Accrual accounting

NGOs have a stringent requirement of using the accrual method of accounting as per the Generally Accepted Accounting Standards (Elizabeth, 2010). The accrual method records revenues when earned and expenses when they have been incurred. By using the accrual method, an organization can indicate its current financial position in a pronounced manner than the cash accounting method.

As an NGO, it is possible to get donors that offer to donate at a later period and when the amount is recorded, it gives the organization a stronger financial position. If Gabel uses the accrual methods, it can recognize pledges of donations and income when they have been made and record cash when it has been received making the income higher than if it used the cash accounting. Cash accounting only considers income when cash has been paid and expense when the amount has been disbursed making it hard to present the current financial position of the organization.

As long as a transaction is to take place and all the necessary conditions have been met then it should be recorded in the financial statements. With addition of statement of activities to the three financial statements, the company should apply accrual accounting to all its recordings not only to meet the required regulations but also to enable stakeholders have a correct view of the current financial position of the firm.

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Recommendations

1.    Gabel’s Company should increase its campaigns to reach to more people hence increase its chances of donations. Though the company has net profit, it has a lot of activities it requires to attend to and perform using its wide assets base. Through fundraising campaigns, more donors will be attracted to pay and if they are followed up, they may end up increasing the contributions amount hence increasing the net realized income.

2.    Another method the company can use is to increase member’s contributions and subscription fees as well as holding part of dividends to investment in rentals. The amount contributed by members can be added up at a small percentage with respect to individual member’s contribution and set of activity. If each member’s contributions is increased by a small margin, the total amount will subsequently increase helping to cover up for the administrative and other expenses to have a high income at the end of the period.

3.    The company should also dispose of some of its unused assets before they lose their value. The amount generated can then be used to invest in some of its productive investment activities. There is a lot of available assets that may be disposed of to increase the net income. Some of the depreciating assets should be sold and a portion of the land rented out or even sold to raise extra income for the company to facilitate its daily operations.

References

Elizabeth, 2010. How to assess non-profit financial performance. Retrieved from: http://www.nasaa-arts.org/Learning-Services/Past-Meetings/Reading-5-Understanding-Financial-Statements.pdf

Ron, 2013. Cash flow statement for NGOs. Retrieved from: http://smallbusiness.chron.com/purpose-cash-flow-statement-nonprofit-organization-11283.html

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Principles of Financial Accounting

Principles of Financial Accounting
Principles of Financial Accounting

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Principles of Financial Accounting

Major accounting concepts and conventions used in accountancy form the major guidelines and rules of the accountant’s life. Historical cost accounting convention is a technique in accounts that ensures valuation of an existing benefit for the balance sheet at the cost of the asset at its purchase.

Assets, revenue, and expenditures are recorded at the money’s worth that was historically paid to complete the transaction (Deegan 2013). All the items in the financial statements are recorded at what cost the company for an item and not the fair market value and not what the company could currently sell the item.

The major criticism of historical cost is that it considers the cost of acquisition despite this cost of an asset not recognizing the current market value. It only interests itself in the cost allocated and not in an asset’s value. It tells the acquisition value and decrease in succeeding years but ignores the likelihood of the present market worth of the asset being elevated or lower than its suggestion (Miles 2015).

Historical costs also exhibit an obvious fault during times of inflation. Its validity rests on an assumption that currencies for recording the transactions remain stable or stagnation of the purchasing power. During inflation, the price of an asset rises, however, the corporate finance model’s objective centers on creating value for shareholders.

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The main advantage of historical cost is that the accounts are straightforward in producing them. The original value of the asset is known and recorded thus based on an actual value and not an estimation of value. Historical costs do not also record gains to the company until full realization is realized thus, presenting the actual performance of a company. Historical cost accounts further are still utilized under many accounting systems such as the GAAP that requires the value of an asset recorded at its historical costs with an exception of marketable securities (DRURY 2013).

The alternative methods or bases introduced by IASB is the Capital Maintenance in Units of Constant Purchasing Power, that allows for the quantification of financial assets maintenance in ostensible monetary units or in units of purchasing control that can be constant regardless of deflation or inflation levels (Kaplan et al., 2015). The major advantage of this technique is that it allows the management to make a judgment when applying or developing an accounting policy when there is an absence of interpretation applying to a transaction.

The major disadvantage of this system is that it provides no applicable international standard for financial reporting with regards to the assessment of invariable but real value items that are non-monetary. These may include share capital that has been issued and capital reserved. It is also not chosen by accountants in non-hyperinflationary economies despite its automatic maintenance of the actual worth of non-monetary items with steady genuine value (Van Dooren et al., 2015).

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An analysis of the qualitative analysis indicates that historical cost accounts are easily understood because it is based on original costs. The values are relevant because it is a true representation. The values can however not be reliable on the verge of hard economic times.

However, comparability is possible depending on the underlying assumptions and the judgment of the management. Alternative bases by IASB are relevant because they represent the current economic conditions (DeVellis 2012). They are easy to understand and compare the figures hence, reliable as a tool for financial reporting.

Historical cost is the most appropriate basis for measurement in financial reporting. The underlying factor here is that it is free of any bias information and is follows the GAAP procedures. It is also simple and a more conventional method and helps in leading to absolute certainty by fitting perfectly with the statement of cash flow.

References

Deegan, C. (2013). Financial accounting theory. McGraw-Hill Education Australia.

Miles, L. D. (2015). Techniques of value analysis and engineering. Miles Value Foundation.

DRURY, C. M. (2013). Management and cost accounting. Springer.

Kaplan, R. S., & Atkinson, A. A. (2015). Advanced management accounting. PHI Learning.

Van Dooren, W., Bouckaert, G., & Halligan, J. (2015). Performance management in the public sector. Routledge. DeVellis, R. F. (2012). Scale development: Theory and applications (Vol. 26). Sage publications

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Management Accounting at Toyota

Management Accounting
Management Accounting

Management Accounting

Abstract

Management accounting is also commonly denoted as managerial accounting. It is in practice the process of handing over accounting data belonging to the firm to its board or executives so that they can make progress reports and quality decisions for growth. How well-kept books are determines the success in the projects a company sets out to do and often results in the growth of the business or empire.

Consequently, accountants and other persons in the finance department are mandated with the task of ensuring that management accounting is properly done and that all records are and neatly kept. In line with international accounting principles, management accounting must ensure that accounts are audited before they are brought for review and analysis by management.

This practice of audit is crucial to the sanctification of erroneous accounting data in order for there to be accountability and credibility. The information computer in management accounting portfolio is often done with the aid of computerized management information system. It draws data from smaller transaction processing systems and often affects the way activities are performed in an organization. Here is a look at how the Toyota Company applies management information to conduct management accounting and how that benefits the company moving forward.

1. Introduction

1.1  Background on Change Management at Toyota

The Toyota Motor Corporation is a leading automobiles manufacturer headquartered in Toyota, Japan. The company boasts of the largest fleet of automobiles in the world with the brand even splitting to accommodate space entities affiliated to the mother plant. Toyota manufactures virtually all sorts of vehicle; from cheap salon cars to low consumption SUVs, Toyota even has a luxury automobile; the Lexus.

The company was founded by Japanese engineer Kiichiro Toyoda in 1937 and from its humble beginning; the company has grown over time to become the most successful in the automobiles industry. The Toyota brand currently sells its products in a host of nations outside Asia, especially Africa, Europe and the Americas. Due to her success in manufacturing, Toyota has grown internationally renowned. As shall later be discussed, the Toyota Production System is known as one of the most efficient systems globally (Yang, Yeh & Yang, 2012).

1.2  Why Toyota invests in change management

The fleet of cars under the Toyota name is all made in a unique way that takes advantage of low fuel consumption and comfort. Toyota is extensively involved in research and often releases models every few years. This is, however, as subject to consumer demand for its products. It is necessary to note that the company manufactures a large fleet of models and keeps remodeling and reselling to profit from every successful model. For this reason, every Toyota model in the past has had improvements.

The company encourages renovation and development as it incorporates the sleek and beautiful outline of its vehicles within a well-designed package that sees the consumer fork out less money but for more commodities. Fuel efficiency and concern over the environment are other factors that have made the company favorite among most Non-governmental organization (Helper & Henderson, 2014).

1.3 Factors that promote change at Toyota

Toyota’s motto is; ‘always a better way’. There indeed is a better way in the way Toyota conducts its policies and manufacturing processes. The company is very crucial on its need to cut waste. Using its esteemed Toyota Production System, the company ensures that they cut losses and always register a profit margin. Save for the time of the global recession, the company has consistently made profits.

That said; there need be mention that the company is sufficiently geared towards consumer satisfaction. The company has a declared aim to; “ever have better products ….To achieve our goal we design parts with good features, and standardize these for each region, spanning different platforms. This provides better efficiency and cost reduction, with the resulting savings used to improve products further.

This virtuous cycle for building better cars leads to sustained growth.” This is the working principle behind the production system that looks to cement the Toyota values into its work force. The company maintains a highly industrious work ethic that sees its employees always take their work with utmost seriousness and pride (Becker, Carbo & Langella, 2010).

2.  Literature review

2.1 Employment culture and practices at Toyota

Toyota is aware of the need to maintain high credibility standards in its work force. This calls for the vetting and rigorous interviewing of its work force. However, the same hardly calls for bureaucracy and other measures than instigate discrimination. The company ensures that they get the qualified staff to undertake all the activities and functions required of them. This creates an industrious staff that is committed and dedicated to its role at the company. The success of Toyota has taken years of history, investment in product development and a strong culture.

What is more important is that the company has always learned from its mistakes and done better to improve an unfortunate situation. According to Sui Pheng & Shang (2011); even with challenges in testing that have led to the recalling of some of its major brands, the company has ultimately managed to maintain its customers. The Toyota brand keeps growing among its competitors due to the ability to utilize human labor and machine efficiency in a completely effective model.

Toyota’s work force has over 300,000 employees. This has made the company especially get great popularity and prominence across the world. Management accounting enables employees to justify their actions and often account for excesses every once in a while (Abdel-Maksoud, Cerbioni, Ricceri & Velayutham, 2010). Management thus takes advantage of the fact that most of the activities undertaken in the firm can be accounted for. Employees have to be accountable to management for their actions and activities in a company.

To achieve this in the best way, companies that have methods such as performance contracting often finds themselves on the receiving end with most employees being resistant to this form of accountability. However, as employees become used to their efforts and how to exercise their efforts towards growth, the company grows substantially. This leads to an increased appreciation for the management accounting practices and principles.

According to Yamao & Sekiguchi (2015); employees are often resistant to management accounting. This is because most persons are unable to account for the use of miscellaneous resources. Processes such as auditing and the confirmation of accounts can be really scary and thus often, they are afraid of them. Managers thus ensure that the systems in a working environment are enough to ensure that employees essentially account for their work.

Managerial reports, transaction processing systems, as well as registers, are some of the key areas of accountability in a firm. The use of these extensively can ensure that no single employee is complacent in their work. Toyota especially practices this form of accountability to have all employees reporting to a higher authority and that failure to prove productive can lead in dismissal. While employees may work under pressure due to such constraints, they need to be as practical as possible in what they do.

2.2 The Manufacturing process at Toyota

According to Hibadullah, Fuzi, Desa & Zamri (2013); the manufacturing process at Toyota can be underlined by one singular word; Monozukuri. Basically, the word stands for ‘manufacturing things’. It is a Japanese principle that decries complacency and advocates for consistent innovation. Toyota has been on the forefront of manufacture in Japan. The company has continued to uphold the Monozukuri culture thus verily coming up with new models and designs every financial year.

The investment in research and development is quite large. This allows for there to be consistency in development and innovation throughout the entire automobile industry. With time, accelerated development has lessened cost of production since the templates have grown in volumes. The expertise and experience of the engineers have also augmented. That is why the Monozukuri culture is not only for Toyota, but for Japan.

According to Helper & Henderson (2014) manufacturing at Toyota is one of the most efficient waste management practices ever developed by the organization. Indeed, the company is very particular about the lean manufacturing model. Toyota prides in manufacturing for the larger market. With very few luxury car models and brands; the concentration is on developing products for the larger consumer market without having to minimize on quality.

The balance between quality and volume is achieved by precise designing. The design process takes consideration of change factors such as engine capacity, steering capability, brake system improvements and the development of better safety measures with each model. All these changes are made without necessarily affecting the cost of the vehicle to a point that may make the vehicle unaffordable. 

2.3 Lean Manufacturing Strategy

Toyota has redefined Monozukuri as the art of translating design data into finished products. This has been necessitated by the development of these designs through research. The company prides itself in understanding the market well. Researchers go to extend of even hiring houses around the target areas so as to monitor their movements, their taste as well as what would suite them best. Toyota car designers and engineers work together to put the beautiful car designs into perspective.

This is so as to have a great final product that is as well feasible to manufacture and importantly, leave room for improvement (Prakash & Kumar, 2011). While there may actually be little room for this improvement, the company has often written records with new inventions that have suited the market, against a tide that was not on their side. In essence, pulling market forces towards it has been a result that inevitably happened as a consequence of proper planning and implementation of the Monozukuri culture and principle.

            The Toyota Production system is a designed working system that seeks to eliminate; muri, mura and muda. Muri is the overburdening of personnel with redundant work. It is singled out as one of the activities that lead to inefficiency in a firm. Mura, on the other hand, is the waste that accrues from activities that are done in excess. The system seeks to reduce these wastes in a number of ways as shall be later identified in this paper. Muda is the process of eliminating waste.

The system identifies seven types of wastes; waste due to overproduction, waste due to time on hand (wastage of time), waste due to inefficient transportation, waste that occurs in the processing itself, waste due to unutilized stock or property at hand, movement and defective products. Having identified these wastes, the system proposes methods to ensure that they are eliminated; therefore, the company can become more productive. The rest is a look at some principles that help in waste reduction and proper utilization of resources (Hibadullah, Fuzi, Desa & Zamri, 2013).

2.3.1 Kaizen

The Kaizen is a Japanese principle for continuous improvement. Toyota production system uses the Kaizen to eliminate wastes that result from time wasting, defective products and unutilized stock. Indeed, the kaizen is a very crucial value for most Japanese companies. Those who abide by it work with deadlines to ensure that they have products ready for a waiting market. Knowing that the desire for new and better automobiles is insatiable, Toyota invests in the redevelopment of models of very kind each year.

It is only inevitable that as this practice continues, the company finds it easy to come up with a new product to compete against other market leaders. There is indeed no market front that Toyota cannot venture. This is because they do not just enter the market to produce a similar product; they offer cheaper yet better products thus entirely convincing the consumer. With the spirit of Kaizen, the company always scales new heights in automobile development (Hibadullah, Fuzi, Desa & Zamri, 2013).

In the company’s hiring practices; Kaizen is also practiced. For instance; Toyota is very efficient in the company’s interviewing. Eliminating non-valuable processes in an organization is crucial to the growth and development of an institution. This is because; the non-value-adding processes are costly just like the operational expenses incurred by any other process in the organization or business. They impose an extra cost to the business yet do not offer any benefit. For instance, the process of hiring new employees is very elaborate. It includes vetting, sifting through applications and choosing the most appropriate candidate.

However, it may be unnecessary to have four or five interviews. Minimizing the interviews to one often makes the interviewing process effective. For efficiency, a company would choose to have aptitude tests to minimize the number of applicants to interview. Value addition thus does not have to have a lot of bureaucratic processes that may not be necessary. It is all about saving time and minimizing cost, effectively leading to efficiency (Senge, 2014).

2.3.2 Just in Time

Just-in-time policy ensures that products are delivered to the consumer on demand and within a specified period of time. Toyota believes that if a product is delivered late, then it is as good as not delivered. The same applies to all departments within the company; no one is allowed the luxury of time. Employees are consistently on their toes trying to meet very strict deadlines and often do so in order to live by this principle. The just-in-time policy ensures that the waste of time is eliminated for good.

It involves aspects of punctuality in job reporting, delivery of goods, development of new designs and even the completion of the manufacturing process (Prakash & Kumar, 2011). Essentially, these time limits are set even before the employee embarks on the task. Working to meet deadlines is a great policy that ensures that work is done in a convenient time. The result is that the company is successful in its undertakings and pushes the employment to higher limits. Even for the employees, the just-in-time policy makes better employees out of them as they continue to observe punctuality.

2.3.3 Jidoka

Jidoka is the intelligent automation of automobiles. As much as possible, Toyota cars are made to accept easy human instructions using levers and gears. With the introduction of the auto cars from the use of the manual cars, Jidoka was extensively applied. Indeed, the issue of intelligence in automobiles is a grey area, as cars are just machines. However, with time, these machines have evolved to understand danger situations, accident safety and haptic response.

In the process of troubleshooting erroneous machines and defective system, four steps are applied using the Jidoka principle; detecting the abnormality, stopping the entire production process, fixing the problem and finding ways to ensure that the problem never recurs. This ensures perfection to a great extent but mostly, it leads to elimination of the waste due to production errors that result in defective products (Prakash & Kumar, 2011).

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2.4 Quality challenges at Toyota Corporation

Toyota has been on the center stage of quality development using its Production System. The Jidoka principle of continuous manufacture ensures that with time, the company masters the art through practice. Toyota has however its fair share of quality issues and strategy failures has. These emanate from circumstances that the company has ever been challenged with dealing.

The most pressing of the company’s major quality concerns has to do with the product testing bit. Toyota has thus been on the receiving end of most critic auto magazines and general media over faulty brake systems and air bags. This has often led to the recalling of her products from the market. Only in 2010, the company has to recall volumes of its SUV models for the faulty brake systems. The company has since made efforts to rectify their manufacturing and testing errors with little success.

According to Dedoussis & Littler (2010), strategies put in place by Toyota to deal with her challenges have been communicated by the management on the various occasions the company has been called upon to account for their weaknesses. Mr. Akiyo Toyoda did mention in 2010 that the company was making plans to increase its testing facilities in order to accommodate larger volumes of test cases.

The company also thrives in the fact that it is market specific thus most of its problems hardly affect the entire market. This has been a contributing factor to the company’s growth over the years. Aside from that, the fact that the company has a great consumer appreciation and compensation policy makes it achieve great success with regard to popularity ratings. The company has thus dealt with all its suits and managed to ensure consumer satisfaction even with the defects and challenges with its models from time to time.  

            With the myriads of success and milestones covered by the company, it would be argued that the company would relent and bask in the glory of her successes. However, there are no limits to what the Japanese auto dealer can achieve. Indeed, with the introduction of relatively cheap automobiles, other manufacturers thought that the practice would be unsustainable. On the contrary, Toyota has continued to prove critics wrong. Not only has the company grown to be more successful, it has consistently led the way in automobile innovations.

Over the last decade, the car that was initially thought of as low class has continued to attract favorites across the globe. Toyota demonstrates that, with proper management accounting principles, any company can achieve success, even with the least amount of time possible. This success nonetheless gets addictive as it sets the benchmark for the next target. As long as the company continuously invests in bettering its products, there are no limits to the amount of income that can be accrued from the same (Zubir, Habidin, Conding, Jaya & Hashim, 2012).

3. Concepts of Change management at Toyota USA

3.1 History of Toyota USA

The Toyota Corporation maintains a subsidiary in the United States dedicated to North American sales. This subsidiary is refered to as the Toyota Motor Sales, USA Inc. The company was founded as an offset of the Toyota Corporation in 1957, and headquartered in Torrance, California. Initially, the American motor market had been controlled by three major market players, General Motors, Ford and Chrysler. Toyota as an entrant began by attempting market domination with a fleet of luxury cars under the brand ‘Lexus.’

The Lexus model was however not as successful in the United States as it had been in the United Kingdom. Sales for many Toyota brands were also low. The company had to come up with a strategy to guarantee market penetration. This was however not a significant challenge to the mother company as the models from Japan were more popular in Asian and European markets than any other Auto manufacturer. Capturing the United States market would mean a little more investment in research (Bunkley, 2016).

In the early 2000s, the USA subsidiary of Toyota Corporation released a new model into the market. The model dubbed ‘Prius’ to target a different market segment; the young drivers. The sleek design and the fairly low cost gained a lot of traction among American teenagers. The fleet of ‘Prius’ vehicles was so successful that Toyota leased the brand to a subsidiary manufacturer to work on developing the brand; which Toyota still owns to date.

The company (Toyota USA) managed to penetrate the American market using lean management and the incorporation of the concept of economies of scale. Although Toyota did not capture the high-end market and still does not make the most revenue out of the United States market, the company continues to research further and is driven by the principles that drive the mother company; Jidoka, Kaizen and Monozukuri. Toyota USA C.E.O; Jim Lentz has on various occasions hinted on the research into the next generation cars ongoing at Toyota USA. However, not many models have been presented by the company (Undercoffler, 2015). 

3.2 Lean Management at Toyota USA

Toyota USA has continued to thrive and achieve unprecedented success due to its management accounting practices. The company has consistently devised new ways to improve productivity thus hardly make any wastage. Toyota can be praised for the great turnaround after the recession of 2009. The company posted a net loss of $4.2 billion but was soon able to emerge successful the following year. The management has been interchanged successfully every few year, but that has not changed the company’s management system.

Consistency in the management of resources and basic management accounting has enabled the company to be efficient in spending and utilization of resources. The trickle effect has been the growth of the company to have subsidiaries and affiliates. However, there has been a consistent focus on development more than management policies. Nonetheless, the management has been on the forefront in driving development agenda for the company (Muller, 2016).

Toyota can well manage its fleet as it ensures that no management wastes are recorded. Fleet management is important since it helps the company know how to maintain a consumer base as well as a consistent demand and supply ratio. The gap in demand is always met by supply. With time, the company has increased fleet production to a record high of 10.1 million in the 2013 financial year. In the automobiles business, mistakes cannot be condoned in the development of vehicles as they have to attract a particular design.

The company has a policy to get it right the first time. There is thus little if any room for improvement. The consequence is that the company develops a highly competitive model every time it releases the same onto the market. These models thus have very high demand even years after they have been released. This is very essential as it certifies that its models can often be recalled and resold to other markets if they do not meet the threshold demand for a particular market (Truett, 2016).

3.3 Impediments to Change management in America

While it is necessary to improve a system or process, this improvement does not come automatically. There is need to identify areas where the change process or areas to make the organization better can be isolated for investment. Opportunities for improvement are not easy to identify. There are many factors that impede the identification of the opportunities to improvement. However, two main factors impede the identification of opportunities for improvement.

The investment in these opportunities is first impeded by the financial cost of changing processes. There is significant financial investment involved in making processes efficient. There is also need for research to identify these areas for improvement. Such research desires that there be funds to actualize the same. This is why it is necessary to consider financial implications (Cummings & Worley, 2014).

The second impediment which is a major concern to the process of improvement is the presence of bureaucratic laws and procedures. Many organizations have very rigid structures that seem to be difficult to change or alter. This is why investment in the change process or identification of change areas may be unnecessary or impossible. Where the change process is impeded by a lengthy process, it has time constraints that may not be in the interest of the organization.

It is thus important review organizational processes and laws in order to ensure that they do not affect the organization’s ability to change. Change is important and as such, should be encouraged within the realms of company law and constitution (Senge, 2014).

3.4 Defects and quality problems at Toyota Motor Sales

3.5 Justification of the case study

Toyota indeed presents a lot of challenges to other corporations not only in the automobiles industry, but the rest of the world economy, as well. Toyota being a leading brand; it would suffice that some of the practices that the company boasts of be borrowed elsewhere. This has been demonstrated by the vast acknowledgement of the Toyota Production System as an international standard in management and overall production. The company prides itself in virtues that have seen it grow over the years.

The management and the staffs are indoctrinated into a tradition that appreciates the significance of hard work, determination and progress in everything they do. This has been the cornerstone behind the company’s success. The leadership style is impeccable, and the management has always been accountable for its decisions. Even when there are numerous complaints due to defects, the management never shifts blame to the production teams but instead owns up and cleans its house internally.

In management accounting, the only success that can be derived from the same has to be tangible evidence of growth in the area of concern. In production and automobile development, Toyota continues to set the pace among other leaders in car and motor developers. The central positioning of the company in a highly industrious economy; Japan also gives it an edge over the rest.

The company consistently manufactures models that fit a particular market. Toyota has specially been credited with the development of cheap brands to suit a low income economy, as well as suffice for the third world markets. Toyota’s efficiency in manufacture has enabled its brand of vehicles to be sold cheaper in comparison to other models, at the same category. This has especially popularized its brands for there is always value for money in the same and more so, the re-sale value for most Toyota cars still remains high.

Toyota is a great case study topic. It has been deemed one of the most successful companies of our time and continues to set the pace in automobile development. Aside from being a corporation that upholds high ethics and moral standards, the company prides itself in being the pioneer behind low energy consumption vehicles. This was achieved by development of electron fuel injection model that allowed the vehicle to run on the battery while the fuel maintained the battery charged.

Toyota models are thus mostly manual and affordable despite the effort in the technology used. Toyota has thus essentially lowered the production through consistent management accounting. This has with time been extended to the consumers who have in turn enjoyed reduced prices and affordable cars for them. It is the greatest illustration of proper application of management accounting principles.

The choice of the case study could not have been better. Despite the numerous challenges Toyota faces, it has proved to the world that none of these is insurmountable. With regular changes being made to their production process, the testing bit has often proved to be a challenge. This has especially occurred due to the sampling methods used in the testing process that have often been unfruitful.

This has led to the development of faulty fleets of models from the same plant. Toyota has nonetheless often taken responsibility about the matter and the company Chief Executive; Akio Toyoda has often come under fire, even as far as the company being accused of being ‘lazy’ in its testing policies. Nevertheless, the company has been ranked the 14th most successful corporation in the world as far as revenue development is concerned (Horngren et al, 2012).

It, therefore, should not come as a surprise that this would be the company to base the study on. Being that only a few companies across the globe match up to the prowess and success record of Toyota, it was an inevitable choice that would be inherently natural. More so, there is a need to appreciate that the company has ever been on an upward trend with its management seeing that no one has entirely exclusive executive powers for an entire decade. This has formed the basis for proper management accounting in the company thus pushing the corporation higher the success ladder.

References

Abdel-Maksoud, A., Cerbioni, F., Ricceri, F., & Velayutham, S. (2010). Employee morale, non-financial performance measures, deployment of innovative managerial practices and shop-floor involvement in Italian manufacturing firms. The British Accounting Review, 42(1), 36-55.

Becker, W. S., Carbo, J. A., & Langella, I. M. (2010). Beyond self-interest: integrating social responsibility and supply chain management with human resource development. Human Resource Development Review, 9(2), 144-168.

Bunkley, N. (2016). Carter: Toyota’s bullish on U.S. sales. Automotive News, (6720).

Dedoussis, V., & Littler, C. R. (2010). Understanding the Transfer of Japanese Management Practices. Global Japanization?: The Transnational Transformation of the Labour Process, 4, 175.

Helper, S., & Henderson, R. (2014). Management practices, relational contracts, and the decline of General Motors. The Journal of Economic Perspectives, 28(1), 49-72.

Hibadullah, S. N., Fuzi, N. M., Desa, A. F. N. C., & Zamri, F. I. M. (2013). Lean manufacturing practices and environmental performance in Malaysian automotive industry. Asian Journal of Finance & Accounting, 5(1), 462-471.

Horngren, C. T., Datar, S. M., & Rajan, M. V, (2012). Cost accounting: a managerial emphasis (14th ed.). Upper Saddle River, N.J.: Pearson/Prentice Hall

Muller, J. (2016). Toyota Recharges. Forbes, 197(7), 50-56.

Prakash, D., & Kumar, C. (2011). Implementation of lean manufacturing principles in auto industry. Industrial Engineering Letters, 1(1), 56-60.

Senge, P. M. (2014). The dance of change: The challenges to sustaining momentum in a learning organization. Crown Business.

Sui Pheng, L., & Shang, G. (2011). Bridging Western management theories and Japanese management practices: Case of the Toyota Way model. Emerald Emerging Markets Case Studies, 1(1), 1-20.

Truett, R. (2016). 5 minutes with … Ed Laukes, vice president of marketing, performance and guest experience, Toyota Motor Sales U.S.A. Automotive News, (6712).

Undercoffler, D. (2015). Toyota targets big leap in U.S. sales for RAV4. Automotive News, (6702).

Yamao, S., & Sekiguchi, T. (2015). Employee commitment to corporate globalization: The role of English language proficiency and human resource practices. Journal of World Business, 50(1), 168-179.

Yang, C. C., Yeh, T. M., & Yang, K. J. (2012). The implementation of technical practices and human factors of the toyota production system in different industries. Human Factors and Ergonomics in Manufacturing & Service Industries, 22(6), 541-555.

Zubir, A. F. M., Habidin, N. F., Conding, J., Jaya, N. A. S. L., & Hashim, S. (2012). The development of sustainable manufacturing practices and sustainable performance in Malaysian automotive industry. Journal of Economics and Sustainable Development, 3(7), 130-138.

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Assessing the Financial Health of a Company

Financial Health of a Company
Financial Health of a Company

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Financial health of a company

1. Depending on your review of the financial statements, suggest a fundamental insight about the financial health of the company. Speculate on the likely reaction to the financial statements from various stakeholder groups (employee, investors, shareholders). Provide support for your rationale

Universal Health Services is a publicly traded company and know for operating acute care hospitals, surgical and behavioral health centers. The firm also operates in ambulatory surgery as well as radiation centers. The company is recognized as the largest hospital management in the United States having more than 240 acute care hospitals and employing more than 74,000 workers (UHS, 2016).

Based in Pennsylvania, the firm is known to register billions in earnings enabling it to be classified as a top performer. This has also allowed the company to create franchises in rapidly-growing markets. However, the efforts are owed to its management which works on the principle of integrity to effectively be competent and compassionate. As such, most of its revenues are gotten from its various departments with acute care hospitals bringing in 73% of income (UHS, 2016).

Nonetheless, it is believed that behavioral health services bring in more than hospitals due to the high occupancy rate. In other words, it could be said that the behavioral centers bring in the highest amount of revenue than hospitals. The fact that the health management is large in size, there are bound to be numerous accounting concepts.

Since the financial statement is helpful in monitoring the financial health of a company, integrity should be applied. Accurate financial information gives the position of the firm in the market. According to the recorded UHS’S financials, the company’s revenue have been increasing.

Nonetheless, the business should make correct entries on the financial statements especially when recognizing income and expenses. Therefore, it could be said that the financial health of the company is stable but may be complicated with the numerous acquisitions. However, the higher returns on investments have been attracting investors.  

Current Industry Trends

There is no doubt that firms get into business in a bid to make money rather than meeting the full needs of the market. This is no different from the health care industry where the industry players are focusing on financial aspects instead of providing quality care to their patients (UHS, 2016). More so, what is taught in schools also involve economic aspects as part of its curriculum.

What people fail to apprehend is that quality care attracts more people and eventually increasing the amount of revenues. At the same time, having more patients and clients raises the spending of resources raising the overall costs (Kaplan & Witkowski, 2014). Besides, hospitals are turning to technology, and this also increases the overall costs and stakeholders are not left behind (Jena & Philipson, 2013). 

In fact, they are behind every planning, developing, and implementation of hospital projects. Therefore, the trend that hospitals are now following is not new but something that is rapidly gaining acclamation in the industry. Additionally, the future health direction the industry players are taking is gaining momentum (Gengler, 2011). All in all, what is more, important is that lack of quality care in hospitals affects the firm’s financial performance.

Sadly developing sound business practices does not stick with the industry players. Gambling with people’s health in a bid to reduce hospital costs is undesirable and a recipe for disaster. It is, therefore, essential for hospitals and health care providers to practice good business ethics that entails focusing on providing quality care to patients.

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3. As the CFO, suggest one (1) basic strategy that you might use in order to improve the financial performance of the organization. Recommend an approach to implementing the proposed plan. Provide support for your recommendation.

For the above reasons, it is my responsibility as the CFO to ensure that individual and organizational goals are aligned. In turn, this translates to increased revenues since both employees and the employers would be satisfied. Better still, there would be increased customer loyalty and brand image. It is crucial to note that stimulating individual motives will lead to greater motivation and will to work efficiently.

This, therefore, means that core values have to be instilled as a culture that appreciates everyone’s efforts is cultivated (Baker & Baker, 2013). This is so because formal business policies will integrate both individual and organizational goals towards one direction. Still, group objectives should be recognized as essential for success and continuity of business growth. In turn, the organization’s missions and vision will be met entirely as the strategies would be linked to the goals.

In essence, if personal objectives would be fulfilled, group goals would be easy to attain. For instance, if UHS decides to align its overall goal of increasing revenue with individual needs of providing quality care, there would be smooth operations. As such, the strategy is found to be useful in all types of organizations. While little is being done on performance, the critical focus is lost. In our case, the focus should be on creating a balance between providing good quality health care and make more revenues at the same time.

In as much, as it is a medical institution, it operates as a business and requires funding as other firms do. However, even though there is no harm in wanting more money, it should be made clear that patient health outcomes matter. In supporting this performance program, the health care provider should ensure they include customer and business profitability is achieved through proper alignment of goals and strategies. As a result, there will be reduced costs, increased efficiency, and increased income levels.

References

Baker, J. J., & Baker, R. W. (2013). Health care finance. Jones & Bartlett Publishers. Retrieved from https://books.google.co.ke/books?hl=en&lr=&id=yfuBAAAAQBAJ&oi=fnd&pg=PR1&dq=Baker,+J.+J.,+%26+Baker,+R.+W.+(2013).+Health+care+finance.+Jones+%26+Bartlett+Publishers.&ots=Jeyce1VgVc&sig=ZHe-D_48p6mJ4JmRSbBGEDEAyNg&redir_esc=y#v=onepage&q&f=false

Gengler, A. (2011). The future of your health care. Retrieved from http://money.cnn.com

Jena, A. B., & Philipson, T. J. (2013). Endogenous cost-effectiveness analysis and health care technology adoption. Journal of health economics, 32(1), 172-180. Retrieved from http://www.sciencedirect.com/science/article/pii/S0167629612001555

Kaplan, R. S., & Witkowski, M. L. (2014). Better accounting transforms health care delivery. Accounting Horizons, 28(2), 365-383. Retrieved from http://www.aaajournals.org/doi/abs/10.2308/acch-50658

UHS, (2016). 2014 Annual Report- Universal Health Services. UHS. Retrieved from http://www.uhsinc.com/media/288196/2014-annual-report.pdf

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Return on Equity: Financial Statement Interpretation

Return on Equity
Return on Equity

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Return on Equity: Financial Statement Interpretation

Volkswagen

The German automobile company was created in 1937 under the Volkswagen group of companies and is recognized as one of the top-selling automakers in the entire world. In fact, it is considered to be the second largest automobile manufacturing company in the automotive industry. As such, three of its products are in the top ten of bestselling cars. Better still, the company recorded $244.985 billion in revenues as of 2014. With a workforce of 588,902 employees and $424.982 billion in total assets, the company generated $13.393 billion profits (Morrow, 2016).

The company has focused its primary goal to double its market share in the United States. Through this, the firm would be focusing on its vision of becoming the world’s largest manufacturer of automobiles by the year 2018. In keeping faithful to this vision, they are expanding to bigger markets with the major ones being Germany and China (Morrow, 2016).

Return on Equity

Return on equity checks the return on the shareholders’ equity. In simpler terms, it measures the firm’s efficiency in earning profits from every unit of the shareholder’s equity. This means that a company needs to invest funds in an appropriate manner for them to get growth in their earnings. It is essential to note that measuring consistent margins in earnings per share does not sufficiently explain the performance. Therefore, Return on equity serves to be the best profitability ratio in measuring efficiency in performance. In this case, Volkswagen’s Return on equity ROE using the Du Point analysis for the last two years would be;

ROE using the DuPont method = (net income/revenue) * (income/assets) * (assets/equity)

Or

ROE = (RNOA) + Return on debt

2015 = -1.67

2016; (10271.714922/227011) * (227011/429031.72385) * (429031.72385/97714.633) = 10.51

High return on equity mean that firms are not capital intensive. However, even if there are high returns with leverage in 2016, there is still a solid balance sheet. This means that the firm has utilized little of its capital this year on income-generating investing as opposed to 2015. All in all, it is critical to invest in firms with high Return on equity as they fluctuate due to company earnings or cycles when looking at long-term investments. For that reason, investors should look at investing in this year’s company ventures for them to get high returns.

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Microsoft

Microsoft is an American technology company that deals with the manufacture and distribution of computer software, electronics, as well as services. It is also recognized as the world’s largest software company and the most valuable. Founded in 1975, the company had its headquarters in Washington and recorded a revenue of $93.58 billion by 2015. It is also noted that the company has produced billionaires and millionaires from its 118,584 employees. More so, the firm is known to register high profits with a net income of $12.19 in 2015. As such, the company continues to grow to be a major player in the computer and electronics industry.

Return on Equity

ROE using the DuPont method = (net income/revenue) * (revenues/assets) * (assets/equity)

(Net profit margin) * (Asset turnover) * (Leverage)

2014; (25.42%) * (0.50) * (1.92) = 24.59%

2015; (13.03%) * (0.53%) * (2.20) = 15.23%

As stated earlier, firms that have registered high ROE often generate more cash rather than investing it. Even though, higher Return on equity show that the company is making good use of their equity in making more income, they are not exhausting their full potential in investments. In this case, Microsoft’s 2015’s Return on equity is lower than in 2014 by 9.36%. This means that they have been investing more rather than making profits. As a result, their balance sheet is not rigid since cash is always flowing in and out of investments. Better still, the higher rates of ROE show that the company is making good use of efficiency in utilizing their capital or shareholders’ equity in generating more income.

Walmart

In the same sense as Microsoft, Walmart is an American company but classified under the retail industry where it manages hypermarkets, departmental stores, and groceries. The firm has grown to establish 11,543 stores in 28 countries with its main operations being in the United States and Canada. The company has a registered revenue of $482.13 billion by 2016 thereby being recognized as the world’s largest firm by revenue. The family-owned business is also the most valuable enterprise through its attractive market value.

Being the biggest grocery retailer in the United States, its net income adds up to $14.694 billion even though it has employed 2.2 million people in all its global branches. However, it struggles to get a bigger market share by venturing into the growing and emerging Chinese and another Asian market. Also, they set low prices for their products in order to get a large customer base. Additionally, since the business is the biggest private employer in the United States, its turnover rate significantly affects the unemployment rates. In the same regard, they have faced numerous charges ranging from lawsuits to labor strikes.

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Return on Equity

ROE using the DuPont method = (net income/revenue) * (income/assets) * (assets/equity)

(Net profit margin) * (Asset turnover) * (Leverage)

2016; (3.07%) * (2.40%) * (2.48%) = 18.24%

2015; (3.39%) * (2.37%) * (2.50%) = 20.10%

Businesses that have higher returns on equity are focused on protecting their net income in facing the competition. This is so since they generate more income with little need of reinvesting it yet they have the ability to increase their business value. Still, higher Return on equity means having good business value since the stock prices will appreciate in a bid to trade with the firm’s growing value.

But, is having more shares worthwhile than investing the gained income? In the above recordings, it is clear that Walmart is making god use of their shareholders’ equity in generating more income for the business. However, the generated income is to place the company at the top of their rivals and in the stock market. Fortunately, the Return on equity decreased from 20.10% in 2015 to 18.24% in 2016 due to further reinvestment of their gained earnings.

From the above statistics, it is clear that both Microsoft and Walmart understand the importance of reinvesting their income in profitable ventures rather than having a solid balance sheet. On the other hand, Volkswagen is increasing their Return on equity perhaps to recapture their market position. The firm might also have decided not to reinvest their earnings probably to increase their value and better trading stocks in the stock market.

Company Analysis

Current Ratio

The current ratio measures a organization’s ability to offset its short-term debts or meeting its obligations. It gives the efficiency of a company’s operations to turn the product into cash. This is understood through the fact that businesses that are unable to pay their short-term debts often have liquidity problems.

 It is given as; Total current liabilities/total current liabilities

For the first quarter in 2016;

Volkswagen – 179895.323/177672.61 = 1.01

Walmart – 59097/70282 = 0.84

Microsoft – 128421/44354 = 2.90

(Financials are given in millions)

The higher the ratio is, the more likely a company is able to pay its short-term debt. Therefore, a current ratio that is under 1 means that the establishment is having difficulties in paying off its obligations. Even though this is an indication the firm is not in good financial vigor, it does not inevitably mean that they will go broke (Christensen, Baker & Cottrell, 2014).

This means that Walmart’s first quarter performance is not good since they are having difficulties paying off their short-term debt. However, if the company has satisfying long-term projections, it may be able to borrow and pay off its obligations. In the same sense, Microsoft proves to be most efficient in paying off its short-term liabilities compared to the rest.

Quick Ratio

Though almost similar to current ratios, quick ratios show the practice’s ability to meet its short-term debt through its most liquid assets such as cash. As a result, inventories are excluded since they are less liquid.

For that reason, it is given through;

(Total current assets – portfolio)/ total current liabilities

For the first quarter in 2016;

Volkswagen – (179895.322 – 39936.526)/ 177672.606 = 0.79

Walmart – (59097 – 44513)/ 70282 = 0.21

Microsoft – (128421 – 2450)/ 44354 = 2.84

(Financials are given in millions)

Generally, a low quick ratio is an indication that a company is over-leveraged or is finding it hard to increase its sales, pay bills or is collecting their income slowly. From the other perspective, a higher quick ratio shows that a business is able to meet its financial obligations (Christensen, Baker & Cottrell, 2014). As such, they often have a faster inventory with fast conversion cash cycles. In this regard, Both Volkswagen and Walmart and struggling to meet their financial obligations. They cannot fully pay their current debt. Conversely, Microsoft shows good financial strength in its short term.

Net Profit Margin

Net margin is often used in assessing a company’s profitability and value estimation but is not entirely reliable. This is so because they can be easily manipulated by changing the methods of depreciation or altering the standard accounting practices. They are given through;

Net profit margin – net income/revenue

For the first quarter in 2016;

Volkswagen – 2630.290/56752.784 = 4.63

Walmart – 3079/115904 = 2.66

Microsoft – 3756/20531 = 18.29

(Financials are given in millions)

In this case, Microsoft company is the most profitable firm in the sense has it has the highest net profit margin with Walmart having the least profit margin.  Microsoft is, therefore, ranked as having a net margin higher than 79% of the companies in the global software and infrastructure industry. In the same regard, Walmart was 68% higher in the retail industry while Volkswagen was 83% higher in net margins in the automotive industry.

Asset Utilization

Asset utilization involves the calculation of returns on Assets which measures the efficiency in which a firm uses their assets to generate income (Christensen, Baker & Cottrell, 2014). In short, it shows how well a company uses what it has to generate income. Therefore, it is given by;

Asset utilization – (net income/revenue) * (revenue/average total assets)

For the first quarter in 2016;

Volkswagen – (10521.1581/227011.136) * (227011.136/429031.724)= 2.45

Walmart – (12316/463616) * (463616/199143) = 6.18

Microsoft – (15024/82124) * (82124/180983) = 8.30

Similar to the return on equity, asset utilization can be affected by dynamic business cycles. Due to this, the ratio becomes crucial when looked at in the long-term perspective. Due the many factors such as stock buyback, may make the ROA not reflect the specific earning authority of the assets. ROA and ROE should not be used in the comparison of firms that are in different industries (Christensen, Baker & Cottrell, 2014). Microsoft’s ROA is higher than the rest of the companies even though they are in different industries.

Financial leverage

Financial leverage is recognized as the ability of an enterprise to use its debt in acquiring assets. It is also commonly known as trading on equity. It is given through;

Financial leverage – average of the total assets/average of the total equity

For the first quarter in 2016;

Volkswagen – 429031.724 / 97714.633 = 4.391

Walmart – 199143/77864.5 = 2.558

Microsoft – 180983.5/75793 = 2.388

When the value of assets falls, the financial leverage may fail to be beneficial. They do not guarantee the success of any business (Christensen, Baker & Cottrell, 2014). Volkswagen is, therefore, risking due to its high financial leverage in the event of having a decline in sales. From the above recordings, Microsoft is taking less risky investments of using debt to acquire assets as opposed to Walmart and Volkswagen.

Conclusion

Comparing companies in different industries is not always easy due to the variety of factors that involve the various operations that are undertaken. As stated above, ROE and ROA will not be useful when comparing the companies since they are from various industries (Christensen, Baker & Cottrell, 2014). In the same regard, manufacturing companies will have different accounting methods.

The allocation of resources and elements will be different. The service industry often has little overhead costs that lead to higher revenues that are converted to profit. On the other hand, manufacturing companies have higher revenues due to the variety of products and the costs. It is also to note that the difference in accounting is due to the standards applied. Inventory costs in IFRS are not allowed as opposed to GAAP standards.

Similarly, write-downs are reversed under the IFRS while it is not allowed in under GAAP. The IFRS are based on principles while the U.S. GAAP focus on rules. Therefore, IFRS better present economic transactions. However, all companies have shown efficiency in using their working capital even though they are done in different degrees (Christensen, Baker & Cottrell, 2014). All in all, Microsoft proves to be most efficient and having more financial strength.  

References

Christensen, T. E., Baker, R. E., & Cottrell, D. M. (2014). Advanced Financial Accounting. The McGraw-Hill Companies, Inc.

http://www.gurufocus.com/term/ROE/MSFT/Return-on-Equity/Microsoft-Corp

http://www.gurufocus.com/term/ROE/VLKAY/Return-on-Equity/Volkswagen-AG

http://www.gurufocus.com/term/ROE/WMT/Return-on-Equity/Wal-Mart-Stores-Inc

Hurd, J., Lawman, M., Salkowski, Z., Sampson, H., & Stellato, A. (2014). Wal-Mart Case Study.

Morrow, R. (2016). Corporate Social Responsibility and Corporate Financial Performance: An Empirical Analysis. Available at SSRN.

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Cash Flow Analysis Report

Cash Flow Analysis
Cash Flow Analysis

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Cash Flow Analysis

Business Analysis Report:

Abstract

This report provides an exhaustive comparative appraisal of the fiscal position, cash flow, performance, and evaluation of Bellway PLC and Redrow PLC. These are two companies that both operate in United Kingdom’s real estate industry. The report sought to answer the following questions: Is Bellway in a better financial position than Redrow? Which company is more profitable for investors between Bellway and Redrow? Which of these two companies is better positioned to exploit the opportunities in its environment? The results indicate that Bellway is better positioned fiscally than Redrow in case an emergency situation comes up. All the same, Redrow is better positioned to exploit the opportunities in its environment than Bellway.

Business analysis report

Introduction

This report provides an in-depth comparative appraisal of the fiscal position, cash flows, performance, and evaluation of two companies that operate within the same industry. In analyzing the main financial statement of the two companies, the researcher uses ratio analysis, vertical analysis, and horizontal/trend analysis. The selected firms are Bellway PLC and Redrow PLC. Both of these companies operate in the United Kingdom’s home construction industry. This appraisal comprises SWOT analysis for both Bellway and Redrow.

The two selected companies are described briefly in the introduction section and a fuller description is found at the Study section. Redrow PLC is an organization that is based in Britain and is involved in residential development. Redrow PLC own’s Harrow Estates, which is focused on property and land solutions (Redrow 2016; Cahill 2012). Bellway PLC is a holding company also based in Britain. It owns subsidiary undertakings and it mainly engages in building houses in Britain (Bellway 2016).

Research questions

  • Is Bellway in a better financial position than Redrow?
  • Which company is more profitable for investors between Bellway and Redrow?
  • Which of these two companies is better positioned to exploit the opportunities in its environment? 

Literature Review

The selected companies: Redrow PLC and Bellway PLC

Redrow PLC is a firm that is based in the United Kingdom. It is engaged in residential development. Redrow PLC own’s Harrow Estates, which is focused on property and land solutions (Redrow 2016). Redrow PLC is involved primarily in construction and building of residential properties. It provides its services only within the United Kingdom. Redrow PLC has a land bank of over 12,000 development lots giving the firm about 4-year supply of buildable land, which provides a buffer against abrupt increases in land prices (Redrow 2016).

Bellway PLC is a holding company that is based in the United Kingdom. It owns subsidiary undertakings and it largely engages in contructing houses in the United Kingdom (Bellway 2016). Bellway PLC has quite a few subsidiaries the main one being Bellway Properties Limited. Bellway PLC operates in England, Scotland and Wales only. It does not have operations in Northern Ireland. The land bank owned and controlled by Bellway PLC is roughly 34,070 plots (Bellway 2016).

In the 2015 financial year, Bellway sold in excess of 7,760 houses at an average price of roughly £224,000; about eighty percent of which were sold privately and the remainder being sold as social housing. Bellway PLC gives emphasis to sales volume growth and it frequently buys land particularly at low-cost at locations where it can develop (Bloomberg 2016).

Industry: Home Construction / Real Estate

Bellway PLC and Redrow PLC both operate in the United Kingdom’s home construction industry. This is because both companies are engaged in the construction of buildings: that is, they build and develop houses and homes. They construct and develop houses and homes of different types and sizes for diverse markets (Cave 2015; Lai 2013). The housing market in the United Kingdom has been growing steadily (Willer 2016). This steady growth is largely attributed to the aging UK population which increases demand for property overall (Everett & Duval 2010; Stewart 2013).

The long-term trend for house prices in Britain is upwards, although changes in the prices of houses are very cyclical (Cave 2015; Brennan 2013). In the housing market of the United Kingdom, about 250,000 new homes are needed to be built annually in order to stay abreast of the demand (Bourke 2012; Elliot 2013). Even though the construction sector in general in Britain has slowed down, the homebuilding sub-sector has seen a rise in the construction of new homes (Canocchi 2016; Cunningham 2012; Roxburgh 2011).

SWOT analysis

SWOT – strength, weakness, opportunity and threat – analysis is utilized in evaluating a company’s position and guide strategy going forward. Strengths – these are the qualities which determine a company’s success. Strengths allow an organization to attain its mission. Strengths could be intangible or tangible and include qualities and traits that staff members have as well as their flair which offers the company consistency (Everett 2014). Examples of strengths include no debt, workers who are committed, and huge monetary resources.

Weaknesses – these refer to the qualities which impede the productivity of a company preventing the company from attaining its mission and achieving its full potential. Even so, weaknesses can be controlled and the impact and magnitude of the damage could be decreased. SWOT analysis helps not just to identify the weaknesses of a company, but also provides a chance of reversing those weaknesses (Everett 2014).

Opportunities – there are an extensive range of opportunities present in the environment where the company operates. An organization could always benefit from such opportunities, which could arise out of the market, technology or competition. It is notable that existing opportunities could be the utilization of novel technology, exploiting the company’s untapped resources, and failure of a competitor (Fine 2011).

Threats – these are the elements of vulnerability which could jeopardize the organization’s profitability and reliability. They are unavoidable and cannot be controlled. They have to be addressed so as to find a practicable solution (Pickton & Wright 2014).

Fine (2011) noted that a SWOT analysis is a vital part of the strategic planning process of an organization as offers a good all-round perspective of the forward-looking and current situation of the business. The Weaknesses and Strengths sections provide a look at the current position of the company whereas the Threats and Opportunities sections help in projecting challenges as well as possibilities going forward (Bensoussan 2013). SWOT analysis is a suitable tool for strategic planning.

As a result of the analysis, the business owner would be able to set organizational goals and objectives and obtain a clearer picture for basing his decisions on (Lu 2010). In addition, SWOT analysis helps the business owner to utilize a strategy to match the company’s opportunities and threats, and utilize those strategies to convert the threats and weaknesses of the company into its opportunities and threats (Bensoussan 2013). Although a SWOT analysis allows a business owner to identify and understand important issues that affect the company, SWOT analysis does not essentially provide solutions (Fine 2011).

Ratio Analysis Theory

This theory is relevant to the present research paper. Analysis of fiscal reports necessitates skill of statistical tools, accountancy, and mathematics. There are several fundamental ratios that could help anyone in analyzing an organization’s Profit & Loss Account and Balance Sheet for instance current ratio, provisioning coverage ratio, credit deposits ratio, debtors turnover ratio among others. A wide range of fiscal data could be obtained from Annual Reports, Profit and Loss Account, Audit Report, Balance Sheet, Bank Loan Statement, Bank Account Statement, and Income Tax Return.

Financial Statements

Common fiscal statements include cash flow statement, balance sheet, and income statement, and they are all interconnected. The cash flow statement explains cash outflows as well as cash inflows, and it reveals the amount of money which the business has available on hand, which is reported in the balance sheet also. The income statement is used in describing the way liabilities and assets were utilized in the stated accounting period (Routh 2014).

Every financial statement by themselves only offer a portion of the story of the fiscal condition of the business. When taken together however, the fiscal statements offer a more comprehensive picture (Putra 2015). Potential creditors and stockholders usually analyze the fiscal statements of a business organization and compute several fiscal ratios with the data they contain with the aim of identifying the fiscal weaknesses and strengths of the company and establish whether or not the firm is actually a good investment/credit risk (Kumara 2012). In addition, the fiscal statements of a company are usually utilized by the managers as it aids them in making decisions (Routh 2014).

One particular significant way in which the three fiscal statements are utilized together is in calculating free cash flow (FCF). Investors who are smart prefer business organizations which generate lots of FCFs. This is primarily because it signals the ability of the firm to pay off its debt as well as dividends, facilitate the company’s growth, and buy back stock – all vital undertakings from the perspective of an investor (Routh 2014). Even so, whilst free cash flow is an essential gauge of the health of the business, it actually has its limits; as Lan (2014) pointed out, free cash flow is really not immune to accounting trickery.   

Financial Statement Analysis

Financial analysis or financial statement analysis is the process in which the fiscal statements of a company are reviewed in order to make better financial decisions. Financial analysis focuses on analyzing a company’s income statement and balance sheet to interpret the business as well as the company’s fiscal ratios for fiscal forecasting, business evaluation, and even fiscal representations (Grimm & Blazovich 2016).

The main fiscal statements include Statement of Cash Flows, Balance Sheet, and Income Statement (Routh 2014). Financial analysis is a process or technique that involves certain methods for assessing fiscal health, performance, risks, as well as the company’s future prospects.

Financial statement analysis is utilized by many stakeholders including equity and credit investors, decision-makers with the company, the public, and even the government. These different stakeholders have various interests and they apply dissimilar techniques in meeting their needs (Lan 2014). Creditors, for example, want to ensure the principal and interest is paid on the debt securities of the organization whenever due.

Equity investors are interested in the organization’s long-term earnings power and the growth and sustainability of dividend payments. Some of the common financial analysis methods include DuPont analysis, fundamental analysis, vertical and horizontal analysis, as well as the use of financial ratios. To project performance of the future, historical information combined with several adjustments and suppositions to the fiscal information might be utilized.

Methods of financial analysis

Ratio analysis

Financial ratios are essential tools for performing analysis of financial statements quickly. There are 4 different classifications of financial ratios: leverage, activity, profitability, and liquidity ratios. These financial ratios are usually analyzed across competitors within the industry and over time (Routh 2014). In analyzing the financial statement of a company using the ratio analysis method, various types of ratios are used.

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Liquidity Ratios: these are utilized in determining how fast an organization is able to turn its assets into cash in the event that the business faces insolvency or fiscal challenges. In essence, liquidity ratios are a measure of the capacity of an organization to remain in business (Routh 2014). Some of the liquidity ratios include the liquidity index and the current ratio.

Current ratio is used to measure the current assets of an organization against the organization’s current liabilities (Altman 2012). The current ratio is used in measuring the amount of liquidity that is available to pay for liabilities (Lan 2014). It is notable that the current ratio indicates whether or not the corporation is capable of paying off its short-term liabilities during a situation of emergency through liquidating its current assets (Lan 2014).

A low current ratio means that the company might find it difficult to pay its current liabilities within the short run hence it should be investigated more. If the current ratio is less than one for example, it indicates that even when the firm liquidates its entire current assets, it will still not be able to pay off its current liabilities (Routh 2014).

Quick ratio helps to compare the accounts receivable, short-term marketable securities, and the cash to the company’s current liabilities. If quick ratio is 0.55 for example, it means that the firm is only able to cover 55 percent of current liabilities by monetizing accounts receivable, liquidating short-term marketable securities, and utilizing all cash-on-hand (Lan 2014).

Cash ratio is computed as cash and short-term marketable securities divided by organization’s current liabilities. It is worth mentioning that a cash ratio of 0.31 will mean that the firm could only pay off 31 percent of its current liabilities with the use of its short-term marketable securities as well as cash.

Liquidity index is also one of the liquidity ratios although is not very popular. It is used to measure the period of time that is needed for converting assets into cash (Batta, Ganguly & Rosett 2014).

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Activity Ratios: these ratios essentially demonstrate how well the company’s top executives are managing the resources of the organization. Accounts receivable turnover and accounts payable turnover are some of the common activity ratios. They show the period it takes for an organization to get payments and how long it takes for an organization to pay off its accounts payable (Routh 2014). Other activity ratios include sales to working capital ratio, fixed asset turnover ratio, working capital turnover ratio, and inventory turnover ratio.

Profitability Ratios: these are ratios which show how profitable an organization is. The gross profit ratio and the breakeven point are some of the common profitability ratios. The breakeven point is used in computing the amount of money which the organization has to generate in order for it to break even with its start up costs (Knežević, Rakočević & Đurić 2011). The gross profit ratio shows a quick snapshot of the anticipated revenues.

Leverage Ratios: these show how much an organization depends on its debt in funding its operations. The debt-to-equity ratio is a popular leverage ratio utilized in analyzing financial statements (Johnson 2013). The debt-to-equity ratio depicts the degree to which the company’s top executives are willing to utilize debt in funding the company’s operations. It is computed as follows: (Leases + Short-term debt + Long-term debt) / Equity (Lan 2014).

Vertical analysis

Besides ratio analysis, the other method that can be used to analyze financial statements is the use of vertical and horizontal analysis. Vertical analysis, as Lan (2014) pointed out, reiterates every figure in the income statement as a percentage of net sales. Vertical analysis is important as it allows the top managers to understand if expenses such as Cost of Goods Sold (COGS) are very high in comparison to sales (Andrijasevic & Pasic 2014).

In essence, vertical analysis is the proportional analysis of a fiscal statement in which every line item on the fiscal statement is listed as a percentage of another item (Routh 2014). This essentially implies that each line item on the balance sheet is stated as a percentage of total assets whilst on the income statement, each line item is stated as a percentage of gross sales (Teodor & Radu 2013). All in all, vertical analysis brings about common-size fiscal statements. Boyd et al. (2014) noted that common-size income statements present each of the amount in the income statement as a proportion of sales.

Horizontal/trend analysis

This is used to compare ratios and account balances over various periods of time. It can be used, for instance, in comparing a company’s sales in 2012 to the company’s 2013 sales (Boyd et al. 2014).The financial analysis for the two companies is illustrated exhaustively in the Study section. The analysis includes the horizontal/trend analysis, vertical analysis, and ratio analysis (Monea 2013). The horizontal analysis entails comparing fiscal information over a number of reporting periods. Horizontal analysis is therefore the review of the results of several periods of time (Luypaert, Van Caneghem & Van Uytbergen 2016).

Financial statement analysis is important due to several advantages it presents to an organization. Firstly, financial analysis offers an idea to investors about deciding on investing their money in a certain business organization (Damjibhai 2016). Secondly, various regulatory authorities such as IASB could ensure that the business organization is in fact following the necessary accounting standards (Routh 2014).

Therefore, the analysis enables the company to remain compliant (Ednlister 2012). Thirdly, the analysis of financial statements helps government agencies to analyze the taxation that is owed to the company (Beutler 2014). Fourthly, financial statement analysis enables the company to analyze its own performance over a certain period of time (Routh 2014).

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Monea, M 2013, ‘Information system of the financial analysis’, Annals Of The University Of Petrosani Economics, 13, 2, pp. 149-156, Business Source Complete, EBSCOhost, viewed 30 June 2016.

Pickton, D, & Wright, S 2014, ‘What’s swot in strategic analysis?’, Strategic Change, 7, 2, pp. 101-109, Business Source Complete, EBSCOhost, viewed 30 June 2016.

Putra, LD 2015, Horizontal vs vertical analysis of financial statements. Accounting and Financial Tax, 2(9): 11-19

Redrow PLC 2016, Key Financial Information. Retrieved from http://investors.redrowplc.co.uk/key-financial-information

Robinson, TR 2011, International Financial Statement Analysis, Hoboken, N.J.: Wiley, eBook Collection (EBSCOhost), EBSCOhost, viewed 30 June 2016.

Routh, B 2014, Financial statement analysis: Vertical analysis. Oxford, England: Oxford University Press.

Roxburgh, H 2011, ‘Builders seek £840m to fix finances’, Estates Gazette, 938, p. 46, Business Source Complete, EBSCOhost, viewed 30 June 2016.

Stewart, A 2013, ‘The storm before the calm’, Estates Gazette, 831, p. 37, Business Source Complete, EBSCOhost, viewed 30 June 2016.

Teodor, H, & Radu, M 2013, ‘Diagnosis of financial position by balance sheet analysis – case study’, Annals Of The University Of Oradea, Economic Science Series, 22, 2, pp. 530-539, Business Source Complete, EBSCOhost, viewed 30 June 2016.

The Financial Times 2016, Bellway PLC: (BWY:LSE). Retrieved from http://markets.ft.com/research/Markets/Tearsheets/Business-profile?s=BWY:LSE

The Wall Street Journal 2016, Bellway PLC. Retrieved from http://quotes.wsj.com/UK/XLON/BWY/financials/annual/cash-flow 

Willer, J 2016, ‘Who’s hot property?’, Lawyer, 30, 7, pp. 34-36, Academic Search Premier, EBSCOhost, viewed 30 June 2016.

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Financial Statement Analysis: Business Analysis Report

Financial Statement Analysis
Financial Statement Analysis

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Financial Statement Analysis

Business Analysis Report:

Abstract

This report provides an exhaustive comparative appraisal of the fiscal position, cash flows, performance, and evaluation of Bellway PLC and Redrow PLC. These are two companies that both operate in United Kingdom’s real estate industry. The report sought to answer the following questions: Is Bellway in a better financial position than Redrow? Which company is more profitable for investors between Bellway and Redrow? Which of these two companies is better positioned to exploit the opportunities in its environment? The results indicate that Bellway is better positioned fiscally than Redrow in case an emergency situation comes up. All the same, Redrow is better positioned to exploit the opportunities in its environment than Bellway.

Business analysis report

Introduction

This report provides an in-depth comparative appraisal of the fiscal position, cash flows, performance, and evaluation of two companies that operate within the same industry. In analyzing the main financial statement of the two companies, the researcher uses ratio analysis, vertical analysis, and horizontal/trend analysis. The selected firms are Bellway PLC and Redrow PLC. Both of these companies operate in the United Kingdom’s home construction industry. This appraisal comprises SWOT analysis for both Bellway and Redrow.

The two selected companies are described briefly in the introduction section and a fuller description is found at the Study section. Redrow PLC is an organization that is based in Britain and is involved in residential development. Redrow PLC own’s Harrow Estates, which is focused on property and land solutions (Redrow 2016; Cahill 2012). Bellway PLC is a holding company also based in Britain. It owns subsidiary undertakings and it mainly engages in building houses in Britain (Bellway 2016).

Research questions

  • Is Bellway in a better financial position than Redrow?
  • Which company is more profitable for investors between Bellway and Redrow?
  • Which of these two companies is better positioned to exploit the opportunities in its environment? 

Literature Review

The selected companies: Redrow PLC and Bellway PLC

Redrow PLC is a firm that is based in the United Kingdom. It is engaged in residential development. Redrow PLC own’s Harrow Estates, which is focused on property and land solutions (Redrow 2016). Redrow PLC is involved primarily in construction and building of residential properties. It provides its services only within the United Kingdom. Redrow PLC has a land bank of over 12,000 development lots giving the firm about 4-year supply of buildable land, which provides a buffer against abrupt increases in land prices (Redrow 2016).

Bellway PLC is a holding company that is based in the United Kingdom. It owns subsidiary undertakings and it largely engages in contructing houses in the United Kingdom (Bellway 2016). Bellway PLC has quite a few subsidiaries the main one being Bellway Properties Limited. Bellway PLC operates in England, Scotland and Wales only. It does not have operations in Northern Ireland. The land bank owned and controlled by Bellway PLC is roughly 34,070 plots (Bellway 2016).

In the 2015 financial year, Bellway sold in excess of 7,760 houses at an average price of roughly £224,000; about eighty percent of which were sold privately and the remainder being sold as social housing. Bellway PLC gives emphasis to sales volume growth and it frequently buys land particularly at low-cost at locations where it can develop (Bloomberg 2016).

Industry: Home Construction / Real Estate

Bellway PLC and Redrow PLC both operate in the United Kingdom’s home construction industry. This is because both companies are engaged in the construction of buildings: that is, they build and develop houses and homes. They construct and develop houses and homes of different types and sizes for diverse markets (Cave 2015; Lai 2013). The housing market in the United Kingdom has been growing steadily (Willer 2016). This steady growth is largely attributed to the aging UK population which increases demand for property overall (Everett & Duval 2010; Stewart 2013).

The long-term trend for house prices in Britain is upwards, although changes in the prices of houses are very cyclical (Cave 2015; Brennan 2013). In the housing market of the United Kingdom, about 250,000 new homes are needed to be built annually in order to stay abreast of the demand (Bourke 2012; Elliot 2013). Even though the construction sector in general in Britain has slowed down, the homebuilding sub-sector has seen a rise in the construction of new homes (Canocchi 2016; Cunningham 2012; Roxburgh 2011).

SWOT analysis

SWOT – strength, weakness, opportunity and threat – analysis is utilized in evaluating a company’s position and guide strategy going forward. Strengths – these are the qualities which determine a company’s success. Strengths allow an organization to attain its mission. Strengths could be intangible or tangible and include qualities and traits that staff members have as well as their flair which offers the company consistency (Everett 2014). Examples of strengths include no debt, workers who are committed, and huge monetary resources.

Weaknesses – these refer to the qualities which impede the productivity of a company preventing the company from attaining its mission and achieving its full potential. Even so, weaknesses can be controlled and the impact and magnitude of the damage could be decreased. SWOT analysis helps not just to identify the weaknesses of a company, but also provides a chance of reversing those weaknesses (Everett 2014). 

Opportunities – there are an extensive range of opportunities present in the environment where the company operates. An organization could always benefit from such opportunities, which could arise out of the market, technology or competition. It is notable that existing opportunities could be the utilization of novel technology, exploiting the company’s untapped resources, and failure of a competitor (Fine 2011).

Threats – these are the elements of vulnerability which could jeopardize the organization’s profitability and reliability. They are unavoidable and cannot be controlled. They have to be addressed so as to find a practicable solution (Pickton & Wright 2014).

Fine (2011) noted that a SWOT analysis is a vital part of the strategic planning process of an organization as offers a good all-round perspective of the forward-looking and current situation of the business. The Weaknesses and Strengths sections provide a look at the current position of the company whereas the Threats and Opportunities sections help in projecting challenges as well as possibilities going forward (Bensoussan 2013). SWOT analysis is a suitable tool for strategic planning.

As a result of the analysis, the business owner would be able to set organizational goals and objectives and obtain a clearer picture for basing his decisions on (Lu 2010). In addition, SWOT analysis helps the business owner to utilize a strategy to match the company’s opportunities and threats, and utilize those strategies to convert the threats and weaknesses of the company into its opportunities and threats (Bensoussan 2013). Although a SWOT analysis allows a business owner to identify and understand important issues that affect the company, SWOT analysis does not essentially provide solutions (Fine 2011).

Ratio Analysis Theory

This theory is relevant to the present research paper. Analysis of fiscal reports necessitates skill of statistical tools, accountancy, and mathematics. There are several fundamental ratios that could help anyone in analyzing an organization’s Profit & Loss Account and Balance Sheet for instance current ratio, provisioning coverage ratio, credit deposits ratio, debtors turnover ratio among others. A wide range of fiscal data could be obtained from Annual Reports, Profit and Loss Account, Audit Report, Balance Sheet, Bank Loan Statement, Bank Account Statement, and Income Tax Return.

Financial Statements

Common fiscal statements include cash flow statement, balance sheet, and income statement, and they are all interconnected. The cash flow statement explains cash outflows as well as cash inflows, and it reveals the amount of money which the business has available on hand, which is reported in the balance sheet also. The income statement is used in describing the way liabilities and assets were utilized in the stated accounting period (Routh 2014).

Every financial statement by themselves only offer a portion of the story of the fiscal condition of the business. When taken together however, the fiscal statements offer a more comprehensive picture (Putra 2015). Potential creditors and stockholders usually analyze the fiscal statements of a business organization and compute several fiscal ratios with the data they contain with the aim of identifying the fiscal weaknesses and strengths of the company and establish whether or not the firm is actually a good investment/credit risk (Kumara 2012). In addition, the fiscal statements of a company are usually utilized by the managers as it aids them in making decisions (Routh 2014).

One particular significant way in which the three fiscal statements are utilized together is in calculating free cash flow (FCF). Investors who are smart prefer business organizations which generate lots of FCFs. This is primarily because it signals the ability of the firm to pay off its debt as well as dividends, facilitate the company’s growth, and buy back stock – all vital undertakings from the perspective of an investor (Routh 2014). Even so, whilst free cash flow is an essential gauge of the health of the business, it actually has its limits; as Lan (2014) pointed out, free cash flow is really not immune to accounting trickery.   

Financial Statement Analysis

Financial analysis or financial statement analysis is the process in which the fiscal statements of a company are reviewed in order to make better financial decisions. Financial analysis focuses on analyzing a company’s income statement and balance sheet to interpret the business as well as the company’s fiscal ratios for fiscal forecasting, business evaluation, and even fiscal representations (Grimm & Blazovich 2016).

The main fiscal statements include Statement of Cash Flows, Balance Sheet, and Income Statement (Routh 2014). Financial analysis is a process or technique that involves certain methods for assessing fiscal health, performance, risks, as well as the company’s future prospects.

Financial statement analysis is utilized by many stakeholders including equity and credit investors, decision-makers with the company, the public, and even the government. These different stakeholders have various interests and they apply dissimilar techniques in meeting their needs (Lan 2014). Creditors, for example, want to ensure the principal and interest is paid on the debt securities of the organization whenever due. Equity investors are interested in the organization’s long-term earnings power and the growth and sustainability of dividend payments. Some of the common financial analysis methods include DuPont analysis, fundamental analysis, vertical and horizontal analysis, as well as the use of financial ratios. To project performance of the future, historical information combined with several adjustments and suppositions to the fiscal information might be utilized.

Methods of financial analysis

Ratio analysis

Financial ratios are essential tools for performing analysis of financial statements quickly. There are 4 different classifications of financial ratios: leverage, activity, profitability, and liquidity ratios. These financial ratios are usually analyzed across competitors within the industry and over time (Routh 2014). In analyzing the financial statement of a company using the ratio analysis method, various types of ratios are used.   

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Liquidity Ratios: these are utilized in determining how fast an organization is able to turn its assets into cash in the event that the business faces insolvency or fiscal challenges. In essence, liquidity ratios are a measure of the capacity of an organization to remain in business (Routh 2014). Some of the liquidity ratios include the liquidity index and the current ratio.    

Current ratio is used to measure the current assets of an organization against the organization’s current liabilities (Altman 2012). The current ratio is used in measuring the amount of liquidity that is available to pay for liabilities (Lan 2014). It is notable that the current ratio indicates whether or not the corporation is capable of paying off its short-term liabilities during a situation of emergency through liquidating its current assets (Lan 2014).

A low current ratio means that the company might find it difficult to pay its current liabilities within the short run hence it should be investigated more. If the current ratio is less than one for example, it indicates that even when the firm liquidates its entire current assets, it will still not be able to pay off its current liabilities (Routh 2014).

Quick ratio helps to compare the accounts receivable, short-term marketable securities, and the cash to the company’s current liabilities. If quick ratio is 0.55 for example, it means that the firm is only able to cover 55 percent of current liabilities by monetizing accounts receivable, liquidating short-term marketable securities, and utilizing all cash-on-hand (Lan 2014).

Cash ratio is computed as cash and short-term marketable securities divided by organization’s current liabilities. It is worth mentioning that a cash ratio of 0.31 will mean that the firm could only pay off 31 percent of its current liabilities with the use of its short-term marketable securities as well as cash.

Liquidity index is also one of the liquidity ratios although is not very popular. It is used to measure the period of time that is needed for converting assets into cash (Batta, Ganguly & Rosett 2014).

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Activity Ratios: these ratios essentially demonstrate how well the company’s top executives are managing the resources of the organization. Accounts receivable turnover and accounts payable turnover are some of the common activity ratios. They show the period it takes for an organization to get payments and how long it takes for an organization to pay off its accounts payable (Routh 2014). Other activity ratios include sales to working capital ratio, fixed asset turnover ratio, working capital turnover ratio, and inventory turnover ratio.

Profitability Ratios: these are ratios which show how profitable an organization is. The gross profit ratio and the breakeven point are some of the common profitability ratios. The breakeven point is used in computing the amount of money which the organization has to generate in order for it to break even with its start up costs (Knežević, Rakočević & Đurić 2011). The gross profit ratio shows a quick snapshot of the anticipated revenues.

Leverage Ratios: these show how much an organization depends on its debt in funding its operations. The debt-to-equity ratio is a popular leverage ratio utilized in analyzing financial statements (Johnson 2013). The debt-to-equity ratio depicts the degree to which the company’s top executives are willing to utilize debt in funding the company’s operations. It is computed as follows: (Leases + Short-term debt + Long-term debt) / Equity (Lan 2014).

Vertical analysis

Besides ratio analysis, the other method that can be used to analyze financial statements is the use of vertical and horizontal analysis. Vertical analysis, as Lan (2014) pointed out, reiterates every figure in the income statement as a percentage of net sales. Vertical analysis is important as it allows the top managers to understand if expenses such as Cost of Goods Sold (COGS) are very high in comparison to sales (Andrijasevic & Pasic 2014).

In essence, vertical analysis is the proportional analysis of a fiscal statement in which every line item on the fiscal statement is listed as a percentage of another item (Routh 2014). This essentially implies that each line item on the balance sheet is stated as a percentage of total assets whilst on the income statement, each line item is stated as a percentage of gross sales (Teodor & Radu 2013). All in all, vertical analysis brings about common-size fiscal statements. Boyd et al. (2014) noted that common-size income statements present each of the amount in the income statement as a proportion of sales.

Horizontal/trend analysis

This is used to compare ratios and account balances over various periods of time. It can be used, for instance, in comparing a company’s sales in 2012 to the company’s 2013 sales (Boyd et al. 2014).The financial analysis for the two companies is illustrated exhaustively in the Study section. The analysis includes the horizontal/trend analysis, vertical analysis, and ratio analysis (Monea 2013). The horizontal analysis entails comparing fiscal information over a number of reporting periods. Horizontal analysis is therefore the review of the results of several periods of time (Luypaert, Van Caneghem & Van Uytbergen 2016).

Financial statement analysis is important due to several advantages it presents to an organization. Firstly, financial analysis offers an idea to investors about deciding on investing their money in a certain business organization (Damjibhai 2016). Secondly, various regulatory authorities such as IASB could ensure that the business organization is in fact following the necessary accounting standards (Routh 2014).

Therefore, the analysis enables the company to remain compliant (Ednlister 2012). Thirdly, the analysis of financial statements helps government agencies to analyze the taxation that is owed to the company (Beutler 2014). Fourthly, financial statement analysis enables the company to analyze its own performance over a certain period of time (Routh 2014).

References

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Andrijasevic, M, & Pasic, V 2014, ‘A blueprint of ratio analysis as information basis of corporation financial management’, Problems Of Management In The 21St Century, 9, 2, pp. 117-123, Business Source Complete, EBSCOhost, viewed 30 June 2016.

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Bensoussan, BE 2013, Analysis without paralysis: 12 tools to make better strategic decisions. Oxford, England: Oxford University Press.

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Boyd, K., Epstein, L., Holtzman, M., & Loughran, M 2014, Horizontal and vertical analysis. Coventry, England: John Wiley & Sons.

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Lu, W 2010, ‘Improved SWOT Approach for Conducting Strategic Planning in the Construction Industry’, Journal Of Construction Engineering & Management, 136, 12, pp. 1317-1328, Business Source Complete, EBSCOhost, viewed 30 June 2016.

McClary, S 2014, ‘Redrow doubles net debt’, Estates Gazette, 1436, p. 54, Business Source Complete, EBSCOhost, viewed 30 June 2016.

Monea, M 2013, ‘Information system of the financial analysis’, Annals Of The University Of Petrosani Economics, 13, 2, pp. 149-156, Business Source Complete, EBSCOhost, viewed 30 June 2016.

Pickton, D, & Wright, S 2014, ‘What’s swot in strategic analysis?’, Strategic Change, 7, 2, pp. 101-109, Business Source Complete, EBSCOhost, viewed 30 June 2016.

Putra, LD 2015, Horizontal vs vertical analysis of financial statements. Accounting and Financial Tax, 2(9): 11-19

Redrow PLC 2016, Key Financial Information. Retrieved from http://investors.redrowplc.co.uk/key-financial-information

Robinson, TR 2011, International Financial Statement Analysis, Hoboken, N.J.: Wiley, eBook Collection (EBSCOhost), EBSCOhost, viewed 30 June 2016.

Routh, B 2014, Financial statement analysis: Vertical analysis. Oxford, England: Oxford University Press.

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Stewart, A 2013, ‘The storm before the calm’, Estates Gazette, 831, p. 37, Business Source Complete, EBSCOhost, viewed 30 June 2016.

Teodor, H, & Radu, M 2013, ‘Diagnosis of financial position by balance sheet analysis – case study’, Annals Of The University Of Oradea, Economic Science Series, 22, 2, pp. 530-539, Business Source Complete, EBSCOhost, viewed 30 June 2016.

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Accounting Standards

Accounting Standards
Accounting Standards

Accounting Standards

Abstract

Globalization has closely linked different markets. With the rise in globalization and market integration, there is a quest to establish a set of global accounting standards. Though progress has been made in establishing a common set of accounting standards, the process still faces challenges that have made it impossible to establish common accounting standards. This paper addresses there benefits of having converging the accounting standards and goes ahead to look at the challenges that make it difficult to converge the accounting standards.

Accounting

Introduction

The rise in globalization has led to the quest to achieve common international accounting standards. Financial users around the world are working towards establishing a common set of worldwide accounting standards though it is yet to be accomplished. This is unfortunate given the many benefits of adopting common accounting standards all over the world.  Establishing the same accounting standards would mean that each organization prepares financial statement using the same rules.

This would make it easier for users of financial statements to compare the financial position of different companies. The use of a similar set of global standards would improve the quality of financial reporting. Companies around the world would follow the same high-quality standards and they would have to adhere to these rules hence the quality of financial reporting would improve around the globe.  Using a similar set of global standards would enhance efficiency and reduce the cost of capital.

The allocation of funds of companies around the globe would reduce the cost of and enhance efficiency. However, even in light of these benefits of having global accounting standards, the world is yet to achieve common accounting rule. For the last two decades, financial experts have been working towards achieving similar accounting standards without success. Progress has been made but there are still notable differences in financial reporting between countries. Part of the reason the common global accounting standards have not been achieved is due to sovereignty of nations.

Countries feel that having one set of accounting standards would undermine the sovereignty of a nation. This termed as westernization by various nations who feel that the western countries have a tendency to impose rules on other countries. The second challenge is lack international regulatory body that would be used to implement the international accounting standards. Despite the challenges, the world needs to look for a workable solution and converge the accounting standards to enjoy the benefits of a common set of global accounting standards.

Reason the world Need International Accounting Standards

Financial reporting standards around the globe are different, and this creates inconsistency in financial reporting. Today, the world economy has become integrated. Globalization is on the rise, and every market is connected to the other market.  Globalization closely links markets together, and effects felt in one market are felt in other markets in different countries (Albrecht, Stice, Stice, & Swain, 2014).

Furthermore, countries are coming together to create economic blocs as each country is realizing the need to integrate and form a single market without barriers. As the world is converging and becoming one market each day, financial expert are also looking for a way to remove the inconsistency in financial reporting. The inconsistencies are a major setback to the users of financial reports. Investors rely on financial statements to make investments decisions.  Globalization has encouraged investors to invest in global companies.

However, inconsistency in financial reporting makes it difficult to get the right information. A company located in different countries follows different accounting standards to prepare its financial reports hence it becomes difficult to make sense out of different financial reports provided. There is a need to achieve consistency and ensure that investors are provided with the right information when making decisions around the globe.

International convergence is a concept that was established in the 1950s after the Post World War. It was round this time that countries started creating strong economic blocs that eliminated tariffs and reduced the requirements to move across nations. The integration and diversity of the world increased the cross-border capital flows increasing the need to converge the accounting standards.

Previously, the world had been working towards harmonization of accounting standards but with the integration, it was clear that convergence was appoint of urgency (Horton, Serafeim, & Serafeim, 2013).  Different countries sought to come up with the same reliable accounting standards that would be used to represent information of organizations operating in major capital markets.

This led to the formation of the International Accounting Standards Committee which is the modern day International Accounting Standards Board. IASB has made progress in the quest for a unified global accounting standard. This board came up with international financial reporting standards (IFRS). The IFRS is used in more than 100 countries most of them are European Union member states.

Benefits of Having Common Accounting Standards

Comparability

Comparability is one of the greatest advantages of using financial statements. Financial statements are used to indicate the performance of an organization. A person wishing to evaluate the performance of an organization should critically look at the financial records. Financial statements provide a summary of financial position making it possible for investors to understand the position of a company.

However, when companies use different accounting standards, it becomes difficult to understand the financial reports (Atrill & McLaney, 2012). A company in China and a company in the United States will use different accounting standards making it difficult for financial reports users to compare the performance of companies. Using global accounting standards would make comparability a reality.

Items located in financial reports would be similar, and an individual comparing the performance of different companies would compare the essential parts of the reports (Christensen, Lee, Walker, & Zeng, 2015). Users of financial reports can be able to compare important aspects of a business such as liquidity, credit worthiness, profitability, and solvency.

Comparability is not limited to different companies. There are companies operating in different countries. For instance, General Motors, and Mac Donald are operating in different parts of the world. The multinationals have many subsidiaries around the world that use different accounting standards. The companies must adhere to the local accounting standards of each country that they operate in (Drury, 2013).

This makes it difficult for organizations to compare the financial reports of same organization but located in different countries. With international accounting standards, the organizations can be able to measure the performance of each entity regardless of its geographical location. Additionally, the companies would be able to consolidate the financial reports easily and understand how each of entity contributed to the overall performance of the organization.

Improve Quality of Financial Reports

At the top of agenda of the ISAB is to improve the quality of financial standards. The IFRS was established to enhance the quality of financial reports across the world. A global set of accounting standards would be high quality standards (Crosson & Needles, 2013). As much as countries are willing to converge to same accounting standards, they are not willing to compromise the quality of financial reports.

Quality financial reports would provide the user of financial reports with the right information. Investors can make the right investment decision when provided with the right information. If companies across the world would follow high-quality accounting standards, then the financial information provided would be clear, useful and relevant to the users of financial reports.

The cases of the financial crisis of 2008 make it critical to have reliable and quality accounting standards. The financial crisis which affected the world’s strongest economies was caused by lack of adequate regulation where companies provided misleading financial information. A single set of global standards would improve the quality of accounting standards. Companies would not find a loophole to mislead users of financial reports since the global standards are clear and target to ensure that financial report represent the true position of a company.

Companies that have embraced the IFRS have improved the quality of financial reporting. A report released by the IASB indicated that the IFRS has improved the quality of financial reports (Crosson & Needles, 2013). The report further indicated that capital market participants and investors who use information prepared using the IFRS standards get the right information and can be able to evaluate the financial position of different companies use the international standards.

Simplification

Implementing unified financial reporting standards would not only enhance comparability, but it would simplify financial reporting. This is especially true for organizations that have subsidiaries around the world. The companies prepare different financial reports that adhere to local standards but at the end of the day the organizations have to consolidate the financial reports (Becker, Schäffer, & Thaten, 2015). It is difficult to consolidate financial reports prepared using different rules. This is because the items are not represented and accounted for the same way.

The items represent in one financial report in one country may differ from the items of another country making it difficult for multinationals to consolidate the financial reports. Additionally, without converged financial accounting standards, the countries are forced to prepare financial reports using different currencies such as yens, pounds, and dollars depending on the locality they operate (Brochet, Jagolinzer, & Riedl, 2013). It becomes difficult to consolidate the financial reports because they have to consider the foreign exchange rates. 

Financial reports simplify the process of mergers and acquisition. Companies are looking to make strategic mergers and acquisition to increase their market share. Mergers and acquisition are becoming prevalent today as companies globalize (Bradshaw, 2010). Companies are establishing mergers to launch products successfully in new markets. Using global accounting standards would enable companies to make the right mergers and acquisition. The companies can be able to look at financial reports comprehensively and compare the results with ease enabling them to make sound decisions.

Reduction in Cost of Capital

Shifting from locally accepted principles to international reporting standards will reduce the cost of capital. Research conducted on the EU nations showed that using a the same accounting standards has boosted the net income by 25%. Companies recorded a rise in earnings before taxes and depreciation. A second study that focused on 30 European organizations showed that the application of the same accounting standards increased profits by $30 billion (Albu & Alexander, 2014).

Implementing similar accounting standards across the world indicates that companies allocate capital more efficiently, and the markets would be more efficient. International accounting standards would also converge the regulation of financial reports hence companies would strive to be efficient. To be ahead of competitors and to attract investors companies would enhance efficiency hence global market would be more efficient.

Challenges

Differences in Accounting Practices in Different Countries

Publicly held countries use the generally accepted accounting principles. Different countries have accepted various accounting principles which are recognized by the different nationals. Research indicates that over 132 countries have so far embraced the IFRS, but there is still a difficult in implementation (Wang, 2014). Countries are not implementing the IFRS standards in the same manner because they have national accounting standards. For instance, the U.S. has U.S. Generally Accepted Accounting Principles (GAAP) and the U.K. use the U.K. GAAP.

Since 2005 Japan started converting to the IFRS from the Japanese Generally Accepted Accounting Principles. However, there are still notable differences between the ways countries treat financial reports. For instance, the United States and United Kingdom accounting standards are stock market oriented because the foreign companies based in these countries rely on the stock exchange as a source of finance.

On the other hand, the accounting standards of Japan are bank oriented because companies rely on bank loans and not willing to participate in stock markets. Japan and the U.K. are guided by different accounting laws. For instance, the United Kingdom is guided by the common legal system while Japan is guided by the code and civil legal system. The differences in accounting practices make it difficult to find one single accounting standards. Countries are not willing to abandon their way of doing things to adopt a new single set of accounting.

For instance, the United States was hard hit by the financial crisis. The country established the Sarbanes Oxley law which increase regulation and specifically focuses on financial reporting. This means that companies in the United States must follow the U.S. GAAP and meet the legal requirements in financial reporting as stipulated by various laws concerning financial reporting (Arnold, 2013). It is difficult for companies to adopt a common set of accounting standards because there are local accounting standards that are unique to each country and laws that must be met.

The generally accepted accounting standards and the International accounting standards treat items of financial reports differently. For instance, there is a distinction in the way the U.K GAAP and IFRS treat leases. The IFRS requires a company to capitalize leases as long as the lease term is major part of the assets economic life. Conversely, the U.K. GAAP requires a company to capitalize a lease as long as the term of the lease is equivalent to 75% of the asset’s economic life (Horton, Serafeim, & Serafeim, 2013).

Converging the different accounting practices of different countries is a big challenge. Countries already have their accounting principles and the way they treat different items such as the lease in the example above is different. It is a big challenge to harmonize the accounting standards and find a set of standards that will be accepted by different countries (DeMiguel, Nogales, & Uppal, 2014).

Sovereignty

The politics of the pride of a nation and sovereignty has worsened the chance of achieving global accounting standards. Establishing a global set of standards would impose accounting standards on countries. The global set of accounting standards has already come under criticism because it undermines the sovereignty of nations. Financial experts in the United States released a report that revealed that a global set of financial standards would impact on the quality of financial report negatively (Weil, Schipper, & Francis, 2013).

The experts argued that global set of accounting standards replaces comparability with quality. The report indicates that the current accounting standards in the United States focus on the quality of financial reports and adopting other standards would undermine the sovereignty of the nation and at the same time lower the quality of financial reports.

The global accounting set of standards has been criticized as western dominance.  The Western countries have often been criticized of imposing rules and regulations on countries. The wave of democratization, for instance, has been cited as a move by West to dominate (Arrow & Lind, 2014). When coming up with the global accounting standards, the West is actively involved and poor countries do not get to contribute adequately. When the accounting standards are imposed on other countries, it strips them the ability to establish different accounting standards that are unique to the situation.

Lack of Regulatory Body

Though more than 130 countries have adopted the IFRS, there are notable differences financial reports. This is because there is no regulatory body that ensures that each country strictly follows the accounting standards. There is no international regulatory body that can mandate countries to adhere to accounting process. According to Scott (2012), to achieve consistency in the preparation of financial report, there must be an international regulatory body. The regulatory body should oversee the implementation of converged accounting standards.

Additionally, it would be in-charge of dealing with companies that fail to comply with the accounting standards.  The regulatory body should be endowed with the authority to regulate both public and private entities to ensure that financial reports meet the international standards. Without the regulatory body, it is impossible to achieve consistency and ensure that all companies are using the same set of global standards.

The Costs of having Global Set of Standards

Having a worldwide accepted  accounting standards would increase the cost of accounting in various companies. First, establishing a global set of standards would require that accountants worldwide are retrained. The accountants must be trained on how to prepare the financial accountants using the new accounting standards (Brigham & Ehrhardt, 2013).

Companies would have to incur the costs of retraining the accountants in order to adhere to the new set of accounting standards. The second cost is that failure in the accounting system would cause a worldwide failure. Leiwy and Perks (2013) stipulate that a failure in the accounting standards would cause accounting standards at the same time.

Conclusion

Getting a set of global accounting standards has definitely been at the top of agenda of the IASB in the last decade. Amidst the challenges this course changes there are doubts as to whether it is still possible to attain the global accounting standards. The pride of nationalism and politics of sovereignty make it difficult every day to achieve a single set of global accounting standards.

Every country wants to maintain certain aspects of its accounting standards making it difficult to come up with a common set international accounting standard that will be widely accepted. The world lacks an international regulatory body that will be in charge of implementation and ensuring companies comply with the laws. Lastly, the differences in accounting practices across countries make it impossible to establishing similar accounting standards.

However, there are numerous benefits of applying the same accounting standards. They include comparability, enhancing market efficiency, simplification and improving the quality of financial accounts. In light of these benefits, countries should work together to find a solution and establish a common set of international accounting standards.

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