Question

4. “ A Going Concern Assumption in accounting” is a very powerful determinant whether a company has a future. By examining the financial statements of a company, what 6 signs can your glean from the financial statements that suggest the danger? E.g. very small cash balance relative to other assets in the balance sheet.

1. Reporting Entity assumption states that a business enterprise is a legally and economically distinct from its owner or owners. How has the accounting profession respected and perpetuated this assumption. Give examples.

2. The Conceptual Frame Work of FASB identified FIVE specific financial statements that are the sources of useful financial information. List these five statements but do not discuss them.

Answer 1

4- By examining the financial statements of a company, 6 signs extracted from the financial statements that suggest the danger are as follows:

1- level of liquidity in the company is one of important aspect of financial position of the company. This can be identified with the liquidity ratios like current ratio, quick ratio and cash ratio A low level of liquidity will show a sign of upcoming financial problems in the future.

2- Utilization of assets in the company is another area from where we can know the level of financial problem. if company does not use its assets properly and contribution of assets is revenue generatio is low. This can be measure with the help of various activity or efficiency ratios and poor performance of the company on the parameters like total asset turnover, fixed asset turnover, inventory turnover and accounts receivable turnover shows an ineffective utilization of assets in the company

3- Profitability is the another area which shows the concerns for company's upcoming problems. A low level of various profitability ratios and amount of operating income, net income and aspects of return on various parameters like return to equity stockholders, return on assets and return on capital invested or employed are some of example to know the problem related to earning revenue and this can be checked with the information related to income statement and balance sheet.

4- Capital structure or capital gearning is another area where problem related to solvency of the company can be identified. A high level of debt coverage in the company and proportion of earning in relation to interest expense can put a picture of leverage position of solvency of the company. various ratios related to solvency of the company can be caluclated with the help of information from financial statement and will clear the picture of solvency position of the company. Leverage ratios like debt ratio, debt to equity ratio and interest coverage ratio are the examples of measures of solvency position of the company

5- Market ralted ratio like market to book value ratio, price earning ratio, earning per share ratio, payout ratio and retention ratio are the ratios which are used to measure the management of the earning of the company. A poor performance of company on the ground of payout ratio, market to book value ratio, earning per share indicates the poor management of earnings and a sign of upcoming trouble.

6- With the help of Common size income statement proportion of expense in respect to sales can be calculated and this will help in comparing the level of expenses and high ratio between the sales and expenses. A high degree of ratio shows the causes of low profitability.

So from the above point we can check the current and upcoming financial problem with the help of financial statement.

2- Entity assumption of accounting suggest that owner and business two are legal seperate entity. Accountants follow the accounting concept by keeping transaction of owner and business seperate and only accounting transaction of business are recorded in the books of accounts. For example personal expense of the owner will keep seperate from the business expense and assets of business will be keep seperate from the assets of the owner.

3- Five specific financial Statement

(1) Income statement (2) Balance Sheet (3) cash flow statement (4) statement of retained earning (5) statement of shareholders equity