What is the overriding criterion by which accounting information can be judged of?

What is the distinction between accounting policies and accounting basis?

A layman's answer. Policies provides guidance on how something is handled, judged, rated, ranked, executed, etc. Policy provides all concerned with direction on how to proceed. Example: my policy is to answer all questions in a layman's term. Basis amounts to "what is", or "to be", developed in order to comply with policy. For instance; the basis for our nation's policy on ransom is that to allow payment for acts involving hijacking/terrorism has been shown to encourage further activity of this nature. Our policy is to not pay ransom since it might contribute to further hijacking/terrorism acts. In accounting, such an example would be written as such: accounting policy allows for us of a two-year verses five-year depreciation schedule on the purchase of capital equipment. The accounting basis for this policy is that it would 1) decrease tax burden in the short term 2) retaining more company funds for use in capital improvements while 3) encouraging expenditure to expand the economy 4) providing job growth to 5) stimulate the economy.

Explain the concept of responsibility accounting?

Collection, summarization, and reporting of financial information about various decision centers (responsibility centers) throughout an organization; also called activity accounting or profitability accounting. It traces costs, revenues, or profits to the individual managers who are primarily responsible for making decisions about the costs, revenues, or profits in question and taking action about them. Responsibility accounting is appropriate where top management has delegated authority to make decisions. The idea behind responsibility accounting is that each manager's performance should be judged by how well he or she manages those items under his or her control.Responsibility and Cost CentersThe concept of responsibility accounting has emerged to accommodate the need for management information at a more specific level of detail than can be provided by financial accounting procedures. Responsibility accounting attempts to report results (actual performance) in such a way that: (1) significant variances from planned performance can be identified, (2) reasons for variances can be determined, (3) responsibility can be fixed, and (4) timely action can be taken to correct problems.Under this approach, pertinent costs and revenues are assigned to various organizational units--departments, bureaus, and programs--designated as responsibility centers. In the private sector, responsibility centers may take several forms:(1) A cost center is the smallest segment of activity or area of responsibility for which costs are accumulated.(2) A profit center is a segment of a business, often called a division, that is responsible for both revenue and expenses.(3) An investment center, like a profit center, is responsible for both revenue and expenses, but also for related investments of capital.Outside of relatively large corporations, the cost center is the most common building block for responsibility accounting. In fact, the terms cost center and responsibility center are often used interchangeably. Responsibility accounting placing emphasis on specific costs in relation to well-defined areas of responsibility. Managers often inherit the effects of their predecessors' decisions. Long-term effects of such costs as depreciation, long-term lease arrangements, and the like, seldom qualify as controllable costs on the performance report of a specific manager.Most models that measure performance in the private sector are tied to profits--for example, profit percentage (profit divided by sales), return on investment (profit divided by initial investment), or residual income (profit minus a deduction for capital costs). Profits are seldom a viable measure at the cost center level, however. Rather, performance is most often measured by comparing actual costs against a budget. A variance is defined as the difference between the amount budgeted for a particular activity and the actual cost of carrying out that activity during a given period.Variances may be positive (under budget) or negative (over budget).Performance data can be developed for management purposes independent of the budget and control accounts. This kind of performance reporting has been used in the justification of resource requests and in the assessment of cost and work progress where activities are fairly routine and repetitive. Under this approach, units of work are identified, and changes in quantity (and, on occasion, quality) of such units are measured as a basis for analyzing financial requirements. The impact of various levels of service can be tested, and an assessment can be made of changes in the size of the client groups to be served. This approach is built on the assumption that certain fixed costs remain fairly constant regardless of the level of service provided and that certain variable costs change with the level of service or the size of the clientele group served. Marginal costs for each additional increment of service provided can be determined through such an approach. With the application of appropriate budgetary guide-lines, these costs can then be converted into total cost estimates.Variances, budgeted results, and other techniques of responsibility accounting are relatively neutral devices. When viewed positively, they can provide managers with significant means of improving future decisions. They can also assist in the delegation of decision responsibility to lower levels within an organization. These techniques, however, are frequently misused as negative management tools--as means of finding fault or placing blame. This negative use stems, in large part, from a misunderstanding of the rationale of responsibility accounting.Passing the buck is an all-too-pervasive tendency in many large organizations. This tendency is supposedly minimized, however, when responsibility is firmly fixed. Nevertheless, a delicate balance must be maintained between the careful delineation of responsibility, on the one hand, and an overly rigid separation of responsibility, on the other. Many activities may fall between the cracks when responsibility is too strictly prescribed. This problem is particularly evident when two or more activities are interdependent. Under such circumstances, responsibility cannot be delegated too far down in the organization, but must be maintained at a level that will ensure cooperation among the units that must interact if the activities are to be carried out successfully.

What is the internal control procedure for the credit sales?

Usually, the internal control procedure for credit sales is a credit check by the seller. Other methods used for control include an aging of accounts receivable. Returning customers are judged on their ability to pay by how fast they paid in previous transactions.

Are accrued liabilities considered current liabilities?

In general, yes, accrued liabilities are considered current because a formal request (e.g., invoice, tax bill, etc.) from the entity who is owed the debt will make the debt current. Since there are few creditors who will wait more than a year to let an organization know that they would like to be paid (for the first time), accrued liabilities should be considered current. Exceptions sometimes occur in legal cases lasting longer than one year where a company may have a judgment for money against them. In these cases, the liability may not be current until there is more clarity as to (1) when the case will be judged and (2) what amount is to be requested.

How do the financial information useful?

Financial statements are summaries of monetary data about an enterprise. The most common financial statements include the balance sheet, the income statement, the statement of changes of financial position and the statement of retained earnings. These statements are used by management, labor, investors, creditors and government regulatory agencies, primarily. Financial statements may be drawn up for private individuals, non-profit organizations, retailers, wholesalers, manufacturers and service industries. The nature of the enterprise involved dramatically affects the kind of data available in the financial statements. The purposes of the user dramatically affects the data he or she will seek.KINDS OF FINANCIAL STATEMENTSThe balance sheet provides the user with data about available resources as well as the claims to those resources. The income statement provides the user with data about the profitability of the enterprise detailing sources of revenue and the expenses which reduce profit. The statement of changes of financial position shows the sources and uses of a firm's financial resources, demonstrating trends in the alteration of its capital structure. The statement of retained earningsreconciles the owners' equity section of successive balance sheets, showing what has happened to generated revenue.COMPARABILITY OF FINANCIAL STATEMENTSComparison of financial statements forms the basis for much financial analysis. Four main types of comparison are made: (1) comparison of statements for the enterprise between successive years (2) comparison of a firm's statements with those of a specific competitor (3) comparison of a firm against an industry standard and (4) comparison with a target, such as a company's budget. Comparisons between different organizations may be difficult or even meaningless because of differences in (1) size of the organization (2) type of organization and (3) accounting methods used by the organization. Often, both the size and type of organization will dictate the kind of accounting methods used.CHARACTERISTICS OF ENTITIES HAVING FINANCIAL STATEMENTSNon-profit organizations such as government and charities typically present statements which exhibit their resources and the way those resources are distributed or held. Stewardship and responsibility are the focus for these statements. Financial statements for private individuals focus on resources and obligations -- helping the person to assess his or her financial condition and to plan financial affairs (or obtain a bank loan) [Rosenfield, 1981]. Retailers are typically highly mortgaged, rely on credit to wholesalers (following a desire for a large and varied stock), often offer extensive credit to customers (or no credit, on a strictly cash basis) and reside in high-rent locations. Wholesalers tend to be characterized by large inventories, large sales volume (with small profit margin) and chronic credit problems with retailers. Manufacturers tend to have a substantial investment in fixed assets (machinery, equipment and buildings) and often face major problems due to a large work-force [Costales,1979]. Service industries -- such as railroads, airlines and public utilities -- have less of a problem with flow of inventory. Their focus tends to be on balancing operating revenue against operating expenses dominated by fixed assets (depreciation, repairs, replacement, maintenance, etc.). Companies with high proportions of current assets tend to be financed through short-term borrowing and shareowner investment. Industrial corporations tend to be financed primarily through shareowners, whereas public utilities and railroads are more often financed by long-term borrowing (bonds) [Holmes, et al,1970].TYPES OF RATIO ANALYSISCareful financial statement analysis usually means the extraction of meaningful ratios from the statements. These ratios have been classified as measuring (1) liquidity (current ratio, acid-test ratio, etc.) (2) activity(receivables turnover, inventory turnover, etc.) (3) profitability(profit margin on sales, rate of return on assets, earnings per share, etc.) and (4) leverage (debt to total assets, times interest earned, etc.) [Kiesco and Weygandt,1982]. Ratios are often used to assess performance or as diagnostic tools to point up potential problem areas. Given the extremely varied entities for which financial statements are made -- and even the extreme variation between industries of an entity type -- the most productive use of these ratios is probably made either against industry standards or against ratios for previous years of the entity in question.CURRENT RATIO--THE PATRIARCH RATIOCurrent ratio (the ratio of current assets to current liabilities) was perhaps the earliest ratio to gain widespread use as a measure of solvency. On the theory that $2 in current assets could safely cover $1 of current liabilities (with enough remaining to operate) a 2-to-1 value became an inflexible standard. But inventories can vary greatly in their liquidities. Oil, for example, can be rapidly liquidated, but inventories of service parts could take years to sell -- hardly "current assets". Also, small businesses can often liquidate their inventories more rapidly than large ones, indicating that current ratio may not be comparable for different size firms. Moreover, the relative investment in inventory rose from 77% of working capital to 83% of working capital between 1950 and 1962 for American corporations [Miller,1966]. Just-In-Time (JIT) inventory control using computers has dramatically decreased the amount of inventory held. Thus, indicators from the past might not be useful for the future. A 1-to-1 "acid-test" ratio which excluded inventory from current assets was a suggested replacement for current ratio, but the liquidity of the receivables portion of current assets is still open to question without information on collectability. In a strike or a recession, the business might have to pay its current liabilities by liquidating its current assets. Yet it is questionable if this could be done without a loss in operating capacity -- especially serious in a recession. In the case of an airline, cash flows are more a function of its current assets than of its non-current assets.EXAMPLES OF RATIO VARIATION BETWEEN BUSINESSESA five-year average (1960-1964) of current ratio stands at 4.56 for hardware stores, 1.95 for grocery stores, 4.11 for cotton cloth mills and 1.70 for building construction contractors. Note the variation between types of retailer and manufacturer. These industry standards are not unhealthy. Another interesting ratio is fixed assets (depreciated book value) per tangible net worth. Five year percentages for this ratio are 5.7% for manufacturers of womens' coats, 80.1% for manufacturers of bakery goods, 59.9% for grocery stores and 10.2% for furniture stores. In general, this ratio is best kept low for new businesses, which should rent land and buildings until the future of the business is ensured. Experience has shown that small businesses should attempt not to exceed 66% and large businesses should avoid exceeding 75% [Foulke,1968].EXAMPLE OF RATIO ANALYSIS USERatios are useful to indicate various symptoms. Usually those symptoms require more detailed analysis. For example, ratio analysis may reveal an increase in sales volume relative to inventory and receivables. But inventories could have increased less rapidly than sales due to reduced cost of goods, inability to replace inventory items, change in inventory policy or a change in inventory valuation. Receivables could have increased less rapidly than sales because of a more efficient collection policy, a larger proportion of cash sales or a change in policy with regard to the extension of credit. Sales volume could have increased due to plant expansion, an aggressive sales campaign, price increase, price decrease or extension of sales territories. Ratio changes lead managers to ask pointed questions.WHAT DIFFERENT CLASSES OF STATEMENT USERS LOOK FORGovernment officials are generally concerned that reporting and valuation regulations have been complied with -- and that taxable income is fairly represented. Labor leaders pay particular attention to sources of increased wages and the strength and adequacy of pension plans (which tend to be chronically underfunded). Owners, shareholders and potential investors tend to be most interested in profitability. Many investors look for a high payout ratio (cash dividend/net income). Speculators pay more attention to stock value insofar as growth companies tend to have a low payout ratio because they reinvest their earnings. Bondholders are inclined to look for indicators of long-run solvency. Short-term creditors, such as bankers, pay special attention to cash flow and short-term liquidity indicators, such as current ratio. Both classes of creditors prefer lending to firms with low (usually no higher than 40-50%) leverage ratios, such as debt to total assets.As indicated earlier, management can use financial statements for diagnostic purposes -- with different managers paying attention to different ratios. A buyer may look closely at inventory turnover. Too much inventory may mean excessive storage space and spoilage, whereas too little inventory could mean loss of sales and customers due to stock shortages. A credit manager may be more interested in the accounts receivable turnover to assess the correctness of her credit policies. A high sales-to-fixed-assets ratio reflects efficient use of money invested in plant and in other productive or capital assets. Higher levels of management, as with investors, tend to look at overall profitability ratios as the standards by which their performance is judged [Tamari,1978].DIFFERING ACCOUNTING METHODSMuch of the incomparability of financial statements between businesses can be traced to different accounting methods. The most striking differences occur in (1) inventory valuation (FIFO, weighted average, etc.) (2) depreciation (straight-line, sum-of-the-years'-digits, etc.) (3) capitalization versus expense of certain costs, eg. leases and developmentof natural resources (4) investments in common stock carried at cost, equity, and sometimes market (5) definition of discontinued operations and extraordinary items [Kieso and Weygandt,1982].EXAMPLES OF STRIKING EFFECTS OF ACCOUNTING METHODSSuperior Oil Company owned 1.4% of Texaco, Inc. which was carried at a cost of $64 million, despite its market value of $118 million. A major brewery using LIFO inventory valuation revealed that the average cost method would increase inventory value by $33 million [Kiesco and Weygandt,1982]. High interest rates and a drop in oil prices caused Texaco, Inc. to reduce its LIFO-valued inventories by 16%, netting $454 million. A loss year was thereby turned into a profit year. General Motors doubled its net earnings in 1981 by changing its "assumed rate of return" on its pension plan from 6% to 7% [Bernstein,1982]. With its many old and historical-cost undervalued plants and buildings, Ford Motor Company showed historical cost earnings of $9.75 per share in 1979, despite a current cost income of $1.78 [Greene,1980].Patents may represent unrecorded assets insofar as their true earning value far exceeds their costs. Goodwill is another asset with a true value which is hard to assess.WINDOW DRESSINGIf these methodological variations are not enough to make the would-be investor wary, he or she should be aware that those who prepare financial statements often have an intention to misinform rather than to inform. Reduction in discretionary costs (research, adverstising, maintenance, training, etc.) can increase net income while having a detrimental effect on future earnings potential. A new management may similarly write-down the value of assets to reduce depreciation and amortization expenses for future years. A businessman may avoid replenishing inventory during the period prior to closing the books so as to increase his current ratio. Temporary payment of a current debt just prior to the financial statement date will achieve the same result. Retained earnings can be appropriated for future inventory price decline and later reported as net profit. Often an analysis of a series of annual statements, rather than those of a single year, will highlight such methods. More extreme practices are generally avoided by firms that must answer to regulatory agencies to be quoted on the stock exchange.FOOTNOTESThere are generally two kinds of footnotes. The first type identifies and explains the major accounting policies of the business. The second type provides additional disclosure, such as details of long-term debts, stock option plans, details of pension plans, previous errors, lack of internal control and law suits in progress. Although the footnotes are required, there are no standards for clarity or conciseness. Footnotes often seem intentionally legalistic and are awkwardly written [Tracy,1980].EMPIRICAL STUDIES -- SOLVENCYA survey of bank lending officers revealed that half of them would refuse to loan to a company that did not submit financial statements, even though these might not be explicitly requested. Bank lending officers exhibited no preference for inventory or depreciation methods, but believed that consistency in the use of accounting methods is important [Stephens,1980].Another study attempted to compare General Price Level (GPL) and traditional ratios in the prediction of bankruptcy. GPL data was found to be neither more nor less accurate than historical data. To justify the expense of preparing GPL statements, GPL data would have to be more useful. The investigators noted that GPL data may or may not be of value for other uses of accounting data [Norton and Smith,1979].An extensive study was made of ratio tests in the prediction of bankruptcy. All nonliquid asset ratios performed better than any of the liquid asset ratios -- including the highly-touted current ratio and acid-test ratio -- for anywhere from one to five years in advance of bankruptcy. The researcher explains that a firm with good profit prospects in a poor liquid asset position rarely has trouble obtaining necessary funds. Another surprising discovery was that the failed firms tended to have less rather than more inventory -- contrary to what the literature might suggest [Beaver,1968].EMPIRICAL STUDIES -- INVESTORSExtensive studies were conducted of three categories of investors: individual investors, institutional investors and financial analysts. Both individual and institutional investors regarded long-term capital gains as more important than dividend income which was more important than short-term capital gains. Both individual and institutional investors with portfolios under $10,000 rated short-term capital gains higher than investors with large portfolios [Most and Chang,1979].All groups in the USA regarded financial statements as the most important source of information for investment decisions. In the United Kingdom, only institutional investors made that judgement. Financial analysts regarded communications with management as the most important source, whereas individual investors preferred newspapers and magazines. Financial statements were found to be equally important for "buy decisions" as for "hold/sell decisions" [Chang and Most,1981].EMPIRICAL STUDIES -- CONTROLLERSQuestionnaires were sent to controllers of the 500 largest American industrial firms with a 53.8% response. The accountants were asked to evaluate the adequacy of current reporting procedures. The disclosure rated as more deficient, accounting for human resources, was ranked fifth in importance. Effects of price-level changes were deemed the second largest deficiency, but ranked sixth in importance. The rate of return on investment was rated third in deficiency, but first in importance [Francia and Strawser,1972].QUALIFICATION ON THE USEFULNESS OF FINANCIAL STATEMENTSAlthough financial statements provide information useful to decision-makers, there is much relevant information that they omit. Factors of market demand, technological developments, union activity, price of raw materials, human capital, tariffs, government regulation, subsidies, competitor actions, wars, acts of nature, etc. can have a dramatic effect on a company's prospects.CONCLUSIONA critical assumption in the use of financial statements (aside from stewardship), is often made that the past will predict the future. For trends that have continued for many years this will usually be true, at least for the near future. Ratio analysis for a single company or within an industry using similar accounting methods will be the most fruitful way of using the data provided by financial statements.

What is the overriding criterion by which accounting information can be judged of?

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What is the distinction between accounting policies and accounting basis?

Explain the concept of responsibility accounting?

What is the internal control procedure for the credit sales?

Are accrued liabilities considered current liabilities?

How do the financial information useful?

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