Financial Accounting I-Case Study
1. Determine your role and analyze the real required
2. Identify the users and their information needs
There are two main users, Jason Chen the Telco Corporation (Telco) owner and CIBC World Markets. Jason Chen, owner of Telco, has to indicate his company is in a profitable situation in order to obtain an opportunity to issue stocks to public by maximizing the assets and shareholders’ equity of the company.
CIBC World Markets will analysis the ability and financial situation of Telco for knowing if they are able to bring profit to the shareholders’ or not. Accurate financial statements of Telco will be needed in order to predict Telco’s future ability as precise as possible.
3. Identify the constraints and opportunities
In order to obtain the loan from Metro Bank for company’s growth, the financial statements have to be using IFRS standard. It provides precise information such as assets and debts to the bank for analysis.Receiving the loans helps Telco to grow more rapidly and gain the trust of CIBC World Markets.Therefore, the debt to equity ratio of the company cannot be more than 1 as the Metro Bank required. The ratio shows the aspect of whether the company’s assets are owned by debtors or owners.
4. Determine, list and rank issues
• The constraint of prudence
• Accrual basis vs. Cash basis
• The revenue recognition principle
• Matching principle
• Format of financial statements
5. Analyze each issue by providing valid alternatives. Integrate the case facts in your analysis and tie to the constraints you identified
Once the equipment is sold, the revenue should be recognized immediately. Using accrual basis is one of the requirements of the IFRS standard instead of using cash basis principle. The revenue and profit therefore will increase. However, Telco should realise they need to create two contra accounts, allowance for doubtful account and sales return, which are used to estimate the amount of goods that the customers return. It will bring down the assets and profits but still there is a chance that the debt to equity ratio will decrease due to the early recognized revenue. According to revenue recognition principle, the revenue is not yet recognized because the ownership has not fully transferred.
The equipment that is refurbished needs to be considered as equipment instead of inventory. The company recorded them in acquisition cost is correct because it is the historical cost of them. However, they will depreciate over time. Also, the wages of the technicians should be included as an expense of cost of goods sold when the equipment is able to be resold. According to matching principle, the expenses that needed to generate revenues have to be considered. Therefore, the company’s has an underrated expense, overrated shareholders’ equity and overrated assets. The debt to equity ratio will increase since expense increases.
The internal used equipment should be considered as office equipment but not inventory. By treating them as office equipment will create a depreciate expense. Therefore, the company right now has an underrated expense, overrated shareholders’ equity and overrated assets. Profit will decrease after editing and raise the debt to equity ratio. The company should not underrate liability and overrate assets and shareholders’ equity under the constraint of prudence.
The prepaid expense should be amortized over a month only instead of two years. Therefore the expense is underrated and the assets are overrated since the prepaid expense should be spent within a month but not lasting for two years. The debt to equity ratio will go up due to the advertising expense is spent in 2012. Same as the last error, the company need to state the amount of assets, liability andshareholders’ equity under the constraint of prudence.
6. Provide recommendation.
Chen should follow the matching principle, revenue recognition principle and the constraint of prudence closely. These principles can prevent the overstating and understating issue occurred in the financial statements. As long as the company follows the principle tightly and stays in a profitable situation, the loan will be proven and gain the opportunity of issuing shares in the short future.