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Solution of Part 1

  1. As described in Frame for Preparation and Presentation of Financial Statements, the users of financial statements include present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public. Their information needs would be specified respectively as below:
  2. Present and potential investors try to gain profits by investing in economic entities with the upward revaluation anticipation of capital or withdrawing from economic entities with the downward revaluation anticipation of capital. They also have to make sure the investment risks in the future are in keeping with their risk appetites. As a result, the information they need is what could help them to precisely form the anticipated earnings and risks in the future. 
  3. Employees and potential employees need the information which enables them to expect their future salaries, stability, promotion opportunities, retirement plans and so on.
  4. Lenders and potential lenders are interested in the information to help them assess the safety of principle and interests attached. 
  5. Suppliers and other trade creditors usually care about the information which is related to possibility and time of amount owing to them being paid back, like sales, profits, available cash flows, receivable turnover ratio and so on.
  6. Customers are interested in the information which helps them to assess the quality of goods and service, the assurance of after-sale service, the continuance and the reputation of an enterprise and so on.
  7. Governments and their agencies have a vast demand in firms’ information, from scope of business, allocated resource, waste treatment to operation activities, accounting policies, connected transactions. With the information, they would assess legality of business, applied taxation policies, faithfulness of profits, protection for customers, responsibilities for environment and so on.
  8. The public require information for assessing like firm’s contribution for economy, revolution of technique, trends of general prosperity, and appetites for commodity and services, and so on. 

 

  1. With the aim to present the basis for presentation of general purpose financial statements, IAS 1 sets out requirements for the presentation of financial statements in four aspects: overall considerations, basic assumptions, qualities of information, and structure and content.

For overall considerations, financial statements should present fairly and reliably the financial position, performance and cash flows of a corporation on one hand, and should be presented in compliance with International Accounting Standards on the other hand.

For basic assumptions, financial statements should be prepared based on: a) the going concern assumption by assessing an enterprise’s ability to continue running; b) the accrual basis of accounting by recognizing transactions and events when they occur and recording and reporting them in the related periods; c) the consistency assumption by retaining the presentation and classification of items in the financial statements from one period to the next unless a significant change in activities and operation of the enterprise; d) the accounting period assumption by separating the continuousness of an enterprise into specific shorter periods for being reported and presented.

For qualities of information, with the aim to provide useful information to both internal and external users, financial statements should provide the information characterized by relevance, faithful representation, comparability, timeliness and understandability.

For structure and content, minimum content and certain disclosures are required either on the face of the financial statements or in the notes, and some formats of financial statements are recommended as an appendix to the standard, like balance sheet, income statement, cash flow statement and changes in equity.

There are more detailed requirements in IAS 1, like offsetting, materiality and aggregation, and all these requirements form the basis for financial accounting and statements, and provide a framework for detailed IASs of specific accounting items.

 

Solution of Part 2

  1. Some errors could cause a Trial Balance not to balance, and here are six types as below:
  2. The number posted on debit side is not equal to the number on credit side in a journal entry. For example, to debit Cash Account the amount of £200,000 while to credit Short-term Loan the amount of £220,000 by mistake in a journal entry when to journalize a loan activity between the enterprise and a bank.
  3. To omit an account from the trial balance, like the Account of Intangible Asset or Long-term Loan is not included in the trial balance by mistake.
  4. The opening balance of debit side is not equal to the opening balance of credit side. For example, if the amounts of debit side and credit side incurred in current period are balanced at £1000,000, and the opening balances of debit side and credit side are not balanced at £900,000 and £1000,000 respectively, the closing balances of debit side and credit side surely will not be balanced at £1900,000 and £2000,000.
  5. The amount of an account incurred in current period is miscalculated while others are correct. For example, if the amount of Management Cost Account is miscalculated by increasing £200, and others are correct, the trial balance will not be balanced by the closing balance of debit side£200 more than that of credit side.
  6. The closing balance of an account is miscounted while others are correct, like the closing balance of Interest Receivable is calculated by the sum of credit side minus the sum of debit side rather than the sum of debit side minus the sum of credit side.
  7. Either debit side or credit side is omitted in a journal entry, so that the debit side and the credit side are not balanced which would affect the trail balanced being balanced, like only to debit Cash Account without crediting in a journal entry for recording a sale activity.

 

  1. Numerous errors may exist even though the trial balance is balanced, and here are six types of them as below:
  2. A transaction is failed to be journalized, like a sale activity is not journalized, neither the Cash Account or Accounts Receivable is debited nor the Income Accounting is credited, but the trail balance is still balanced.
  3. To omit posting a correct journal entry, like debiting Income Accounts and crediting Accounts Receivable in a sale activity.
  4. To post a journal entry more than once, like journaling one sale transaction twice with the amount of debit and credit accounts increasing equally.
  5. To use incorrect accounts in journalizing or posting, like debiting Notes Receivable instead of Accounts Receivable in a sale transaction.
  6. To make offsetting error in recording the amount of a transaction. For example, when there are both sale activities and purchase activities happening between Enterprise A and B, A journalizes these activities with net amount by offsetting the amount of Accounts Payable from the amount of Accounts Receivable.
  7. To post the wrong amount in a journal entry, like debiting Fixed-Assets Account and crediting Cash Account the amount of £200,000 instead of £100,000 when the purchase price of the fixed asset is £100,000.

 

Solution of Part 3

The selected corporation is Air China Limited Company (named “Air China”), the largest airline company in China, and I would try to analysis its operation performance during the year 2009 and 2010 for the available financial information in this solution.

 

  1. As required by question 1, these ratios would be calculated as below:

Table A: The Ratios at December 31, 2009 and December 31, 2010

Ratios

Formulas

2009

2010

ROCE

net profit before interest and taxation / share capital and long term loans * 100%

9.36%

13.85%

EBT MARGIN

net profit before interest and taxation / sales revenue * 100%

12.76%

17.89%

ACID TEST RATIO

current assets (excluding inventories) / current liabilities

0.17

0.40

DEBT EQUITY RATIO

debt / equity *100%

344.50%

272.24%

INTEREST COVER

net profit before interest and taxation / interest payable

21.51

46.72

INVENTORY TURN

sales revenue / average inventory

58.59

86.89

RECERIVABLES DAYS

average receivables / sales revenue *360

15.06

11.97

PAYABLES DAYS

average payables /  operating costs *360

63.96

48.80

P/E RATIO

market value per share / earnings per share

23.12

12.90

DIVIDEND YEILD

annual dividends per share / price per share

0%

0.79%

 

  1. Compared with the operation achievement in 2009, Air China showed a significant growth in 2010 (as Air China said in the 2010 annual report that they achievedthe best-ever operation results), and improved its financial appearance in many aspects, such as efficiency of operation, debt paying ability, capital structure, profitability, and financial management capability. Certain analysis and interpretation would be represented to support this argument as below.

The improvement of efficiency of operation can be seen from Inventory Turnover ratio. The inventories in an airline company are mainly consumables used in airplanes, and Inventory Turnover ratio is a measure of the number of times inventory is used in a year. In an airline company, if the service time of airplanes increases, the speed of inventories consuming would increases, so does the Inventory Turnover ratio. So the Inventory Turnover ratio is positively related to the service time of airplanes. Meanwhile, the service time of airplanes is positively connected with operation efficiency, so it can be got that the Inventory Turnover ratio is positively related to the efficiency of operation. From 2009 to 2010, the Inventory Turnover ratio increases by 28.3 times from 58.59 times, from which it can be reasonably concluded that the efficiency of operation is improved. Off course, there are some specific indexes in airline field representing the operation efficiency like ASK (available seat kilometers), passenger load factor and average ticket price, and these indexes listed in the 2010 annual report also support our argument.

With the improvement in operation efficiency, it usually can be predicted the profitability would be raised, because with the service time of airplanes increasing, the revenue and variable costs increase, and margin contribution would increase, by subtracting the invariable fixed costs, the profit would increase. This argument can be back up by ROCE and EBT MARGIN to some extent. ROCE (return on capital employed) shows the percentage of each dollar of capital employed can be created, and EBT MARGIN (earnings before interests and taxation divided by sales revenue) represents the percentage of each dollar of sales revenue left after all expenses being removed. Both of them are usually used as the measures to assess enterprises’ profitability, and the relation between them probably is positive. It can be seen in Table A that, from 2009 to 2010, the ROCE had increased from 9.36% to 13.85% and EBT MARGIN had increased from 12.76% to 17.89%, so the profitability can be considered as improved.

At the same time, Air China also enhanced its financial management capability in 2010, which can be seen from that the Receivable Days and Payable Days are both decreasing in 2010. Receivable Days is a measure of the average time that a company’s customers take to pay for purchases, and Payable Days is a measure of the average time a company takes to pay back costs. The shorter the Receivable Days is, the quicker the cash is got and the less possible the asset becomes doubtful. And a shorter Payable Days not only represents the company has the financial capability to pay back costs, but also means the company has less possibility to be punished for violating contracts and more possibility to enjoy favorable terms included in contracts like cash discount.

With enhancement both in profitability and financial management capacity, the capital structure and debt paying ability of Air China got improved in 2010. By keeping more profit available, the company would have more money at hand to pay debts and interests attached. And by improving financial management, the company could control the capital structure to a desirable level so as to decrease risks attached to high debt ratio. As described in Table A, from 2009 to 2010, the Interest Cover (and ACID TEST RATIO), as the indexes of debt paying ability, increased from 21.51 (0.17) times to 46.72 (0.40) times respectively, and DEBT EQUITY RATIO, as the index of capital structure, increased from 344.50% to 272.24%.

If to assess the company’s performance in market aspect, the argument would not change. The market probably had anticipated that Air China would have great operation results in 2009, because P/E RATIO in 2009 with 23.12 is much higher than P/E RATIO in 2010 with 12.9. A higher P/E Ratio means investors are willing to pay more for each of net income, which represents the stock is more expensive than the one with lower P/E Ratio, because investors are expecting higher earnings growth in the future compared to companies with a lower P/E. And Air China did not fail its investors, because it paid dividends to its investors in 2010 compared to none in 2009. At the same time, Air China also became more attractive in stock market with DIVIDEND YIELD rising from 0 in 2009 to 0.79% in 2010.

 

Reference:

Air China Annual Report (2009)

 

Air China Annual Report (2010)

 

IASB (International Accounting Standards Board). (1997). IAS 1 Presentation of Financial Statements (revised 1997)

 

IASC (International Accounting Standards Committee). (1989). Frame for Preparation and Presentation of Financial Statements

 

Stice, Earl K., Stice, James D. & Skousen, K. Fred (2008). Intermediate Accounting. 17th edition. USA: South – Western Cengage Learning.

 

Scott, William R. (2005). Financial Accounting Theory. 4th edition. Toronto: Pearson Education.

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