Impact of Depreciation Method Different Financial Statements

Question: Discuss about the Impact of Depreciation Method for Different Financial Statements. Answer: 1(b) The information on depreciation is disclosed in three different financial statements namely the income statement, the balance sheet and the cash flow statements. All these transmit valuable knowledge to the reader of the annual report of a company. The same is enumerated below: Income Statement: The amount of depreciation calculated is reflected in the income statement of a company for the reporting period under the head operating expenses. The readers of the income statement come to know about the amount of non-cash expense the company has incurred and the benefit it has made in terms of savings in tax. Further it also proves that the company is running into profits and has adequate funds for replacement of the asset in future (Merritt, 2015). Cash Flow Statement: The readers of a cash flow statement are interested to know about the actual liquidity status of the company thus the depreciation amount forms an -integral part of the said statement. It is a non-cash item hence elimination of the same becomes mandatory so as to know the actual cash profit the company has made. The cash flow statement also focuses on the impact that the depreciation amount has over the liquidity position of the firm. Balance Sheet: The next important statement where the disclosure of depreciation is important for the readers knowledge is the balance sheet of a company. The balance sheet clearly shows the total depreciation charged since the acquisition of the asset and the present residual value expected of the same (Murray, 2016). Also the matching concept used in accountancy clearly shows that the cost of an asset will be attributed as an expense over a period of time. 2. The Marsupial Family, owner of Kangaroo Express a medium sized company is eyeing at raising capital for expansion. The three alternatives that the company can look at are bank overdraft facilities, mortgages and alternative investment market or second tier market floatation. However each method has attached with it certain risks and returns which are enumerated as under: BANK OVERDRAFT: This form of financing is the easiest that a medium sized firm can avail wherein the bank would provide the firm with a limit of withdrawing cash over and above the actual amount in the firms bank account. Availing of the bank OD facility ensures that the liquidity flow is not hampered and thus enables maintenance of a healthy payment track. This mode of finance is easy to avail as well as cost effective. Its flexible nature does not force a person to take the entire OD amount if not required. The company would benefit in terms of interest expense as it would be charged interest only on the amount of OD facility availed and not the OD limit given by the respective bank. However the risk involved with this kind of facility is that the rate of interest charged is very high and there always is a risk of a decrease in the OD limit set by the bank since it is temporary in nature and a regular revisit of the same is done (Fontinelle, 2014). MORTGAGE LOAN: This form of financing for expansion enables a company to secure loan against any asset such as building, land or plant and machinery backed by personal guarantee of the owner of the medium sized company. The biggest risk is that failure to pay would make the personal assets of the guarantor also liable for making good for the loan (Palermo, 2014). Further there is a liability to repay monthly even though the company does not perform well. However apart from the same the said kind of financing enables a lower rate of interest and larger tenure (Matic et.al. 2012). ALTERNATIVE INVESTMENT MARKET: The said mode of raising capital allows a sub market wherein the small and medium sized companies can raise funds by floating shares in a more flexible yet regulated system. From the past 20 years the Australian corporate houses have increased the use of the bond markets for the purpose of debt financing. The increase accessibility to the international market has enabled the development of the secondary bond market (Lepone, Wright, 2014). 3. Decision making within a company is highly influenced by the information published by management accountants. The rules and regulations spelt out by management accounting guidelines is not as strict as financial accounting, thus giving the leverage of presenting the information in a more detailed manner. It is used for only internal business processes. Thus adequate ethical standards should be maintained during managerial accounting. The APES110 Code of Ethics for Professional Accountants has the code of ethics for the professional accountants as is issued by the International Ethics Standard Board for Accountants (IESBA) (Charteredaccountants.com, 2016). Its importance can be viewed to the context of development of adequate trust in an employer-employee relationship and the managers who assure ethics in their behavioural pattern provide guaranteed and quality information to the decision makers (Taicu, 2007). The lack of business ethics has led to various corporate scandals and scams and affected huge number of investors and customers as in the case of The national Australia Bank which failed due to a lack in the performance of the management accountants and weak internal governance controls (Thomson, Jain, 2006). The management accountants stands in a fiduciary relationship with the client as well the employer and therefore it is their moral duty to maintain confidentiality of information, honesty in their performance and commitment towards presenting the true picture to the decision makers. They should also not support the wrongs being done by the decision makers and ensure to take a stand against the same since they have a duty to wards the investors also. Therefore as a management accountant, a professional should adhere to the highest standards of ethics and ensure that the information presented to the decision makers are true and fair. Thus they have a legitimate responsibility towards the society as well along with the employees and the investors. Thus there access to sensitive and confidential database automatically entails them with a responsibility of due diligence and care (Lohrey, 2016). 4. A companys financial statements portray some strengths as well as weaknesses of a company which assist in making decisions whether to opt for the particular company as a supplier or not. First and foremost the financial statement enables one to know whether the company is running into profits or not and its inventory and accounts receivable turnover ratio. These ratios are very important for determining the stability of a company. Thus the biggest strength of a financial statement is that it provides adequate data for calculation of financial ratios. Further the notes to financial statements are also acting as a strength in using the same for deciding whether to act upon a particular company as a viable supplier, since these notes clarify data about certain contingent liabilities of the firm which is important in determining the going concern theory. But it has certain weaknesses also which may act as a hindrance in assisting stability and potential growth of possible suppliers. I t does not portray the economic conditions in monetary terms and thus fails to account for the unrest that exists in its area of operations. This is where the stability of the firm cannot be judged via financial statements only. A standard set of financial statements enables one to know about the liquidity position of a company basis its cash flow statement. The income statement enables one to know about the profitability of a company as well as its operational efficiency and a balance sheet enables to deliver the position for the company as on a particular date with regards it assets and liabilities and the capital structure composition (Loth, 2015). The limitations of financial statements are: The financial statements do not portray the final picture of an entity which can be understood only once the same goes into liquidation. Historical cost method ensures that the financial statements do not account for the present economic scenario in vogue. There are some factors which are very important for the financial readers for enabling decision making but the same cannot be measured in financial terms hence do not form a part of the financial statements (Yongkui, 2013). Therefore, I would look at the liquidity ratio, inventory turnover ratio, debtors turnover ratio and such similar financial ratios which would enable to determine the financial and liquidity stability of the firm. Further to the same the interest coverage ratio, profitability ratios and the capital structure ratios would enable me to judge whether the company ahs the potential to attract further capital for growth. If it has not been servicing its interest component on time or there has been consistent failures in adhering to the terms and conditions posed by the financial institutions or the investors are not getting the adequate returns as expected and promised then the same may face problems in attracting fresh capital. References: Boundless, (2016), Impact of Depreciation Method.,Boundless Accounting Available at : https://www.boundless.com/accounting/textbooks/boundless-accounting-textbook/controlling-and-reporting-of-real-assets-property-plant-equipment-and-natural-resources-6/depreciation-of-assets-44/impact-of-depreciation-method-244-11162/ (Accessed 30th August 2016) Charteredaccountants.com, (2016), The regulatory and co-regulatory framework in Australia, Available at https://www.charteredaccountants.com.au/Industry-Topics/Practice-management/Certificate-of-Public-Practice/The-regulatory-and-co-regulatory-framework-in-Australia (Accessed 15th September 2016) Lepone, A., Wright, D., (2014), Capital Market Structure Comparisons, Available at https://www.fsc.org.au/downloads/file/policyresearch/_FSC_Report_Market_Structure.pdf (Accessed 15th September 2016) Lohrey, J., (2016), Summarizing the Role of Ethics in Managerial Accounting, Available at https://yourbusiness.azcentral.com/summarizing-role-ethics-managerial-accounting-27684.html (Accessed 15th September 2016) Loth, R., (2015), Understanding the Income Statement, Available at https://www.investopedia.com/articles/04/022504.asp, (Accessed 30th August 2016) Matic, M., Gorajek, A., Stewart, C., (2012), Small Business Funding in Australia, Available at https://www.rba.gov.au/publications/workshops/other/small-bus-fin-roundtable-2012/pdf/02-small-bus-funding-aus.pdf (Accessed 15th September 2016) Merritt, C., (2015), What is the Impact of Depreciation Expense on Profitability, Available at https://smallbusiness.chron.com/impact-depreciation-expense-profitability-55349.html (Accessed 30th August 2016) Murray, J., (2016), How is Depreciation Shown on Financial and Tax Documents,? Available at https://www.thebalance.com/how-is-depreciation-shown-on-financial-and-tax-documents-397880 (Accessed 30th August 2016) Palermo, E., (2014), Debt vs Equity Financing : Whats the Best Choice For Your Business?, Business News Daily, Available at https://www.businessnewsdaily.com/6363-debt-vs-equity-financing.html (Accessed 30th August 2016) Taicu, M., (2007), Ethics in Management Accounting, Scientific Bulletin Economic Sciences- Accounting , Statistics and Financial Analysis, Vol. 9, no. 15, pp. 93-98 The Forbes, (2013, June 3), Depreciation: Straight Line Vs. Double Declining Methods, Available at https://www.thisismoney.co.uk/money/investing/article-2886138/Winners-losers-alternative-investment-market.html (Accessed 30th August 2016) Thomson, D., Jain, A., (2006), Corporate Governance Failure and its impact on National Australia Banks Performance, Journal of Business Case Studies, vol.2, no.1, pp. 41-56 Yongkui, Z., (2013), Limitations of Financial Statements and Disclosure of Core Information, Journal of Applied Sciences, vol. 13, no. 13, pp. 2505-2511