Major Accounting Principles - Assignment Example

Principles of Accounting List and define three generally accepted accounting concepts principles Ans: a) Going Concern Concept: An organization preparing financial statements as per GAAP is assumed to consider its business running for an unforeseeable future and that the business is not going to cease abruptly. b) Accrual basis of accounting International Accounting Standard 1 requires following accrual basis of accounting. Accrual basis accounting implies recording of the transactions as and when those occur and not when those become due or encashed. For example rent may not become due or paid at the end of month but it gets accrued and thus be recorded at date of its accrual. c) Concept of Materiality GAAP recognizes the concept of materiality that implies that the significance and appropriateness of transactions, accounting principles and convention being applied be judged in relation to entity and its objectivity. 2. Rubotics Corporation issued $1,000,000 of 6.5%, 8-year bonds dated June 30, 20X5, with semiannual interest payments on December 31 and June 30. The bonds were issued on June 30, 20X5, for $1,033,750. Rubotics Corporation’s year-end is December 31. a) Were the bonds issued at a premium, a discount, or at par? Ans: Rubotics Corporation has issued the bonds at premium calculated as under: $ Issuance proceeds 1033750.00 Present value of principal of 1000000 for 8 years at 6.5% rate 604231.19 Present value of ordinary annuity of interest of $32500 for 16 periods at 3.25% rate 400541.62 1004772.81 Premium received 28977.19 b) Was the market rate of interest higher, lower, or the same as the contract rate of interest? Ans: Market rate is the yield effective rate of interest. When bonds are issued at premium, the market (yield) rate is lower than the stated rate. Stated rate here is 6.5% per annum and the bonds are issued at premium. Accordingly the market rate will be lower than stated 6.5% p.a. as the bonds are issued at premium. c) If the company uses the straight-line method of amortization, what is the amount of interest expense Rubotics Corporation will show for the year ended December 31, 20X5? (round to the nearest dollar) Ans: Under straight line method of amortization, the premium or discount is divided by the number of periods such that amortization will remain constant each period during the term of the bond. As amortization will start from December 31, 2005, the interest expense under this method is calculated as under: Carrying amount as at 1st July 2005 1033750 Interest Expense @ 3.25% from 1/7/05 to31/12/05 on carrying Amount at 01/07/05 33597 Total Interest Expense for year ended December 31, 2005 33597 d) What is the carrying value of the bonds on December 31, 20X5? Ans: $ Carrying amount as at 1st July 2005 1033750 Less premium amortized on December 31,2005 (28977/16) = 1811 Carrying value of bonds on December 31, 2005 1031939 Discuss the characteristics of a corporation. Indicate, wherever appropriate, if the characteristic is an advantage or a disadvantage of the corporate form of business Ans: Characteristics of a corporation Corporation is a legal entity that is separate from its owners called stockholders. It is treated like a ‘person’ but cannot hold any office or vote like other persons. Corporation is an artificial but legal person. To get its legal status a corporation has get registered with the state by filing its articles of association and paying a fee, and under a name approved under the state legislation. Stockholders who own the corporation have limited liability up to the unpaid amount on stocks held by them. Stocks can be sold and are easily transferable without seeking permission from corporation. Corporation has a perpetual existence. That means life span of a corporation is unlimited and not connected with period till different stockholders hold the stock. Of course, its life can be culminated upon its legal winding up. Investors and stockholders do not manage a corporation but it is managed by the board of directors appointed by the stockholders having voting rights in general meetings, and also in accordance with regulations framed under its registered articles of association. Some time state enforces laws to appoint its representative at the board of a corporation. Capital is raised by a corporation by selling stocks and issuing bonds and other securities. These securities are traded in stock exchanges when the corporation is registered as a public company. Advantages of a corporation Limited liability of stockholders up to the unpaid amount on stocks held by them is a big advantage in the sense that shareholders do not become responsible for the actions of the management. Corporate structure of business attracts best management talent available in the market, as stockholders do not interfere in day- to- day affairs of the company. Professional management is at ease under such situations and bring out their best for the company to grow. Perpetual existence of the company encourages other businesses to enter into business contracts with corporations as they are sure that corporation’s business will not end abruptly. Fund raising in the shape of owned capital and debt capital becomes easy for corporations as banks, financial institutions, and investors feel secure in dealings with corporations than any other form of business organization. Corporation taxation does not affect the earnings of stockholders or other investors. As stocks are easily transferable the stockholders feel free and secured when they need funds or otherwise do not want to keep stock of a corporation. Public corporation’s stocks are traded in stock exchanges making stock selling very competitive in the capital market. Disadvantages of a corporation Incorporation fee on registration with state is normally high and sometime aspirant business promoters get discouraged to incorporate a business. A lot of formalities are required not only for registration but also for executing normal business of the corporation. This is because corporation is an artificial person and its actions are recognized only through resolutions passed in board meeting, and thus for every business and other activity a board meeting is required to be called for approving the action through a board resolution. Also a majority is required to get through a resolution and this many a times hampers genuine business moves and activities. Management gets penalized under state legislations for illegal actions and nit the owners, as owners are not involved in the day to day working of corporation. This discourages good talent to participate in corporate management. A corporation can be dissolved voluntarily or involuntarily. This makes the corporations form of organization vulnerable at the hands of a group of minority owners or creditors and other groups interacting with corporations. Corporation sometime faces the brunt of double taxation on same income. Not only the company is taxed on its income but shareholders also pay taxes on dividend income received from corporation’s already taxed income. For each of following items, show how the ratio mentioned is calculated and explain its significance: e) a decrease in the current ratio Ans: Current ratio is calculated by dividing total current assets with current liability. Current ratio indicates liquidity position of the entity, and thus a barometer of short term solvency of the entity. A decrease in current ratio indicates that entity is suffering liquidity problems and may find it difficult to meet its short term obligations when those become due. f) an increase in inventory turnover Ans: Inventory turnover is calculated by dividing the cost of good sold by the average amount of inventory held in a period. Inventory turnover measures the activity of an entity’s inventory. Increase in inventory turnover indicates that efficiency in inventory management in converting the inventory to finished products and is an appreciable act. g) an increase in the days’ sales in receivables Ans: This is called the average collection period and is calculated as per the following formula: Accounts Receivables ------------------------------- Annual sales/ 365 The average collection period is concerned with the entity’s credit terms. Increase in average collection period indicates inefficiency in collecting the receivables. h) a decrease in the debt ratio Ans: There are many concepts of debt ratio but as per most common concept debt ratio is calculated by dividing total liabilities by total assets. “The debt ratio measures the proportion of total assets financed the firm’s creditors. The higher the ratio, the greater the amount of other peoples money being used to generate profits”.(Lawrence J. Gitman,2006, page 64)1 Therefore a decrease in debt ration indicates that there is reduction of debt capital used in financing total assets of the firm. Also the capital gearing of the firm is getting lower than earlier. i) an increase in the rate of return on net sales Ans: Rate of return or return on investments is calculated as under: Earning available for common stockholders ---------------------------------------------------- Total Assets This ratio reflects the overall efficiency of management in generating profits for the common shareholders. Increase in rate of return is a progressive sign as the entity increases its available profitability for shareholders while employing assets effectively than earlier. Read More