Non-cash expenditure Essay Example for Free

Non-cash expenditure Essay CASE 1 The effectiveness of the conceptual framework for the Financial Accounting Standards Board is high. Unfortunately, its effect to outsiders is limited. As already stated, the conceptual framework will aid in the setting of accounting standards. However, only internal persons of the Financial Accounting Standards Board are involved in the standard setting process. Therefore such yardstick will only beneficial to them, because outsiders like accountants will have to abide with the standard issues. Indeed it is a normal trend that standards issued are adjusted in the future due to industrial factors that they omitted to consider or did not tackle properly. An argument in favor of the conceptual framework with respect to outsiders is that it enhanced the credibility of financial statements through the issue of objectives and concepts in such framework (Foster M. J. et al 2001, p 2). CASE 2 a) The cash basis of accounting is based on the premise that a transaction is recorded once cash inflow or cash outflows arises on cash and cash equivalents (Randall H 1999, p 247). On the contrary the accrual basis of accounting is based on the concept that revenue and expenditure are recorded once incurred and not when the cash receipt or payment arises (Randall H. 1999, p 191). For example, if license of a motor vehicle of $1,200 is paid in the beginning of November and the financial year-end is 31st December. Under the cash basis $1,200 is deducted. However, under the accruals basis only expenditure of $200 is recorded representing the expense incurred in November and December. b) The bank should always lend money in good faith. That is the money ought to be lend to persons who are financially capable to repay it in a given time frame. We should bear in mind that the money lent by the bank is coming from the depositors’ funds, which have in turn trusted the bank with their money. A fundamental principle of the code of ethical conduct of professionals states that the decisions taken by such parties should deter from providing harm to other parties and ought respect the rights of others (Association of Accounting Technicians 2007, p 7). Therefore if the bank manager of Ernest Banks knows that if the financial reports of the firm at hand are prepared on an accruals basis, which will eventually lead to lower profits. There is the risk that the financial ability of the company to pay the interest and capital commitments concerning the loan diminish. They should therefore take remedial action in order to mitigate such risk and thus safeguard the resources entrusted by depositors. c) The problem at hand identified in the previous question necessitates that the owner is informed of this issue as soon as possible. They ought to explain that the cash balance reported in the monthly bank statements does not represent the actual profit made by the business enterprise. Such illustration should be made in light of the weaker financial ability of the company to pay interest and capital commitments on the present loan that the firm will face in the nearby future. Since the business is experiencing growth there is still potential for the firm to mitigate the problem at hand. This stems the importance of informing the owner of such issue, who will take remedial action to solve it. However, the bank should refrain from providing specific solutions, since liabilities may arise if such solutions do not solve or possible even worsen the present financial performance of the company. CASE 3 1) The net increase in cash and cash equivalents originating in the cash flow statement is different from the net income portrayed in the income statement due to the different principles followed that where contrasted in the previous question of the former case. The reason for such disparity stem from a number of factors. For example, in the cash flow statement only the cash received from cash sales and debtors is recorded. In the income statement, all the sales incurred are taken into account. Similarly the cash payments for purchases, expenditure and to creditors are shown in the cash flow statement. However, in the income state all expenditure and purchases incurred in that time frame are taken into account (Lewis R. et al 1996, p 317). Non-cash expenditure like provision for depreciation and provision for slow moving stock are deducted from the profit figure. These are omitted from the cash flow statement since they do not represent cash outflows. Further more, capital expenditure incurred and paid during the period is recorded under the investing activities of the cash flow statement. This even though incurred is not portrayed in the income statement, but is recorded in the balance sheet due to its materiality and long-term effect. Hence it will affect cash flow but not net income. This thus clarifies the reason why the net income of $100,000 significantly differs from the actual cash flow balance depicted in the cash flow statement. 2) The operating cash flow, which eventually portrays the cash inflow or outflow from operating activities is very important for the organization, since it should the net cash generated/lost from the firm’s operations. From the differences noted previously it is important that a company not only makes profit but also generates sufficient cash from its operations to be able to meet its financial obligations (Weetman P. 2003, p 185-186). The operating cash flow should be considered as the lifeblood of the firm. Without cash from the operating activities the firm cannot operate for long. It is therefore important that a consistent net cash inflow from operating activities is shown in the financial statements. 3) The sources of cash flow that can be replaceable by new growth are long-term debts that mature and are taken back to finance new growth prospects. Fixed assets classified under investing activities can also be renewed once they finish their possible economic benefits by purchasing similar or better ones. Redeemable share capital, both ordinary and preference can also be renewed by another issue of such finance instruments (Lewis R. et al 1996, p 321). 4) The first basic solution of improving cash flow in view of the cash issue outlined is by focusing on sales and inventory management. By increasing the inventory turnover and diminishing the money tied up in stock by reducing stock levels can be useful remedies in order to free up some cash and enhance the liquidity of the James Spencer Corporation. Cash sales can also be boosted through the introduction of cash discounts. It is also pertinent that present debtors are properly chased by the credit control department to ensure that cash is collected on time (Bernabucci B.2005). Financial managers can also alleviate cash by reducing the debtors collection period through effective credit control policies and procedures put in practice and increase the creditors collection period from the present and potential suppliers. The factoring services provided by factor companies can be another viable solution to enhance cash flow from debtors. Factoring basically comprises the forwarding of a debt to a factor company at a reduced rate than the face value of such debt in exchange of a cash receipt of that account receivable (Ccassociates). For example a debtor of $10,000 of Company A is transferred to a factor company at 85%. Company A will receive $8,500 from such account receivable and then it is the responsibility of the factor company to collect the $10,000 from the trade debtor. James Spencer Corporation can also cushion its cash by either opting for an overdraft facility or increasing the present overdraft. This will act as a buffer against any unforeseen events that may weaken the cash flow of the firm. Even though bank overdraft is payable on demand by the bank, such debt medium is extremely flexible. This is due to the fact that the company can utilize how much of the debt it seems fit (Washington State University). For example if the overdraft facility is of $50,000, the company may take only $20,000 of such overdraft. References: Association of Accounting Technician (2007). Professional Ethics. Berkshire: Kaplan Publishing. Bernabucci B. (2005). Improving you Cash Flow Problems, Entrepreneur. com (on line). Available from: http://www. entrepreneur. com/money/moneymanagement/financialanalysis/article79084. html (Accessed 15th November 2007). Ccassociates. The Factoring Solution (on line). Available from: http://www. ccassociates. com/factoring_solution_accounts_receivable_factoring_explained. html (Accessed 15th November 2007). Foster M. J. ; Johnson L. T. (2001). Why does the FASB have a Conceptual Framework? Financial Accounting Standards Board (on line). Available from: http://www. fasb. org/articlesreports/conceptual_framework_uti_aug_2001. pdf (Accessed 16th November 2007) IAS 17 (2000). Leases. London: International Accounting Standards Committee. International Accounting Standards (2000). Framework for the Preparation and Presentation of Financial Statements. London: International Accounting Standards Committee. Lewis R. ; Pendrill D. (1996). Advanced Financial Accounting. Fifth Edition. London: Pitman Publishing. Washington State University. Short Term Sources of Finance (on line). Available from: http://cbdd. wsu. edu/kewlcontent/cdoutput/TOM505/page36. htm (Accessed 15th November 2007). Weetman P. (2003). Financial and Management Accounting. Third Edition. Essex: Pearson Education Limited.