Accounting for Non-Accountants Course

1. Generally accepted accounting principles

Generally accepted accounting principles (GAAP) provide guidelines for financial accounting and reporting. These accounting principles are prepared by Federal Accounting Standards Board and SEC authorizes companies to adhere to GAAP while reporting their performance in the shape of their financial statements (Carmichael, Whittington & Graham, 2007, p.

28). It is because of following these principles that there remains uniformity in financial reporting for all the companies; hence when third parties analyze the companies’ performances while comparing them with others in the industry, the comparison remains realistic and provides a clearer picture (Carmichael, Whittington & Graham, 2007, p. 28).

1. Double Entry Accounting

It is a method of keeping records which works on the basic premise that money is neither gained nor lost during business, but it simply transfers from one account to another (Eisen, 2007, p. 54). This transfer is known as transaction which involves a point of cash issued and point of cash received, in other words debit or credit. Standard financial accounting method supports double entry system because it reduces the probability of errors.

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An example of double entry accounting is recording an equipment bought on cash for $10,000, hence accountants will debit equipment by $10,000 and credit cash by $10,000.

1. Historical cost

It is simply the original cost at which an item was bought (Carmichael, Whittington & Graham, 2007, p. 106). For example a machine bought 10 years ago for $ 200,000; this is its historical cost. It is vital to mention here that when accountants employ historical cost to value assets and liabilities, it gives an inaccurate measure of the company’s financial strengths and weaknesses, because historical cost does not account for increasing inflation, rather assumes that the assets still worth the same amount at which they were originally bought.

This assumption is utterly misleading, because historical cost is not the market value and does not allow measuring the loss of monetary value of assets with the passage of time (Carmichael, Whittington & Graham, 2007, p. 106).

1. Accrual Basis vs. Cash Basis Accounting

Accrual basis of accounting records the effects of financial transaction or a business activity in the time period during which the effect occurs (Eisen, 2007, p. 88). In other words, revenue is recorded in the fiscal period when it is earned irrespective of the cash received for the services or products. And expenses are recorded in the fiscal period in which their benefit is received. Hence, it allows matching of revenues and expenses which are incurred to generate the revenue during the same fiscal period. Moreover, if an activity takes more than one fiscal period, then accountants make year-end adjustments so as to make sure that revenue is recorded when it is earned and expenses are recorded when their benefit is received.

On the contrary, cash basis of accounting records revenues and expenses when cash flows in and out of the business (Eisen, 2007, p. 88). In other words, revenue will be recorded only when cash for revenue will be received and expenses will be recorded only when cash has been paid for those expenses. This method of accounting is obviously very simple but is misleading because it does not allow matching of revenue and expense, which might result in overstating or understating of income and expenses during a fiscal period (Eisen, 2007, p. 88).

1. Current Assets and Liabilities vs. Non-Current Items.

Current assets are those assets that can be converted into cash within a short time period, usually less than one year. (Eisen, 2007, p. 31) Generally, these include cash, marketable securities, accounts receivables, inventory and prepaid expenses. Current liabilities are payable within a time period of less than one year which are preferably retired by employing current assets (Eisen, 2007, p. 31).

Investors assess liquidity position of a company by analyzing the company’s ability to meet its short term obligations with its current assets and the level of net working capital available during a fiscal period (Eugene, 2007, p. 84). However, noncurrent assets are those that cannot be converted into cash within a year and noncurrent liabilities are those that are payable for a period greater than a year (Eisen, 2007, p. 31).

Part II

Samsung Electronics Company limited

Samsung Electronics Company limited is principally involved in manufacturing electronic communication products. It has four business segments namely, digital media which contributes 35% to the total revenue, telecommunication network contributes 29%, semiconductors segment contributes 18% and liquid crystal display (LCD) segment contributes 18% to the total revenue (Annual report, 2008).

A brief analysis of its balance sheet makes it evident that the company has had 12.7% increment in total assets to become $ 83,771, 400 with 13% increment in total liabilities to become $ 33, 712, 536 and 12.4% increase in total equity to become $50, 058,834 in FY 2008. Analysis of income statements highlights the fact that it had an increase in sales by 23% to become $96,494,083.

However its operating profit decreased by 32% to in FY 2008, as a result of which, its net income declined by 2.5%. Analysis of cash flow statements identifies that cash flow from operating activities has decreased by 9.5% to become 13, 360 billion KW, cash flow from investing activities increased by 9.38% to become 13,128 billion KW and cash flow from financing activities 20.9% to become 1934 billion KW.

The company’s future performance can be predicted by analyzing the trend of its profitability indicators, like Return on equity (ROE), Asset turnover, and Net profit margin (NPM). Its ROE was 9.3% in FY 2008 which has declined from 14.3% primarily because of economic recession. Similarly its asset turnover and NPM were 1.22 times and 5% respectively in FY 2008; both of which have been decreased. However, it is believed by the top management that with recession ending and economy getting into expansionary phase, the company will bring back its growth revenue and implement cost control measures to improve its margins.

Lockheed Martin

It is a global security company which provides services like research, design, development, manufacture and integration of advanced technology systems (Annual report, 2009). It operates in four business key areas namely, aeronautics, electronic systems and information systems and global solutions, contribute 27% each to the total revenue and the remaining 19% is contributed by space systems segment. Analysis of balance sheet for FY 2009 makes it evident that the company holds $ 35,111 million of assets, $ 5052 million of debt and $4129 million of equity.

The income statement shows that the company made $45,189 million of sales in FY 2009; however its operating profit decrease by 12% to become $ 4,466 million, consequently its net income decreased by 6% to become $ 3,024 million. The company had 28% decline in net cash flow from operating activities which clearly highlights the decrease in operational efficiency primarily due to increased inflation in economic recession. If the company follows the trend of its profitability indicators like Return on capital employed (ROCE), net profit margin and asset turnover, its future performance is predicted to be promising.

The ROCE in FY 2009 was 19.6% which has decreased from 21.7% in FY 2008. Moreover, it net profit margin was 6.6%  which has been decreased from 7.5% in FY 2008 and asset turnover was 1.28 times which has increased slightly from being at 1.27 times in FY 2008. Hence, with economy getting to expansionary phase in near future, it can very well be predicted that if the company can cut cost to improve its operational efficiency, its assets will be able to generate greater revenue and in turn higher net profit so that its returns and margins can improve.

RTL Group

The company is the leading European entertainment network which provides services in 22 countries with 45 television channels and 31 radio stations. RTL Group’s 91% shares are held by Bertelsmann AG and 9% are held by public. It has seven business segments namely, Mediangruppe RTL Deutschland which contributes 40.4% to the total revenue, Fremantle Media contributes 27.6%, RTL Netherland contributes 8.7%, Five Group contributes 7.1%, RTL Belgium contributes 4.7%, French Radio contributes 4.1% and other segments which contribute 7.3% to total (Annual report, 2009).

Analysis of its financial statements makes it evident that the company has €8,716 million of investment in total assets, €3,186 million of total liabilities along with €5,530 million of equity. Income statement shows that the company has had a 6.3% decrease in revenues in FY 2009 to become €5,140 million. It has had 1.6% increase in EBIT along with very slight 0.67% increase in net income to become €298 million. Cash flow from operations has decreased by 28% in FY 2009 which highlights operational inefficiency, along with its cash flow from investing and financing activities which have decreased by 69% and 25% respectively.

The major profitability indicators like ROE, NPM and Asset turnover were 5.3%, 5.5% and 0.62 times respectively. These indictors have been showing an upward trend which is impressive because not many companies were able to keep up their profitability in the last couple of years because of recession hitting the economy. Hence I believe that if the company will be able to control cost and improve operational efficiency it will have greater revenues, operating profit and in turn net profit margin in the coming years.

In the end it is vital to mention that for all the three companies’ financial analysis, it is vital to dig into operational efficiency which is represented by EBIT and cash flow from operating activities. Analyzing cash flows gives a better picture because they are not affected by any accounting policy adopted by the company (White, Fried & Sondhi, 2003, p. 90). Hence, cash flows exactly identify how much money the company made during a fiscal year. On the contrary balance sheet and income statement items are affected by accounting standards for e.g. FIFO inventory valuation method understates the inventory which in turn affects the liquidity analysis of the company (White, Fried & Sondhi, 2003, p. 198).

References

Carmichael, D., Whittington, R. & Graham, L. (2007). Accountants Handbook. 11^th ed. New     Jersey: John Wiley & Sons.

Eisen, P. (2007). Accounting. 5^th ed. New York: Barron’s education.

Lockheed Martin. Annual Report, 2009. Retrieved July 11, 2010, from             http://www.lockheedmartin.com/data/assets/corporate/documents/ir/2010/2009-Annual- report.pdf

RTL Group. Annual Report, 2009. Retrieved July 11, 2010, from

            http://rtlgroup.com/www/htm/annualreport.aspx

Samsung Electronics Company Ltd. Annual Report, 2008. Retrieved July 11, 2010, from            http://www.samsung.com/us/aboutsamsung/corporateprofile/ourperformance/annualrepor           ts.html

White, G. Fried, D. & Sondhi, A. (2003). The Analysis and Use of Financial Statements. 7^th ed.             New Jersey: John Wiley & Sons