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Preparation of Financial Statements Ten months ago, Tom Smith, a friend of yours from college, founded...

Preparation of Financial Statements

Ten months ago, Tom Smith, a friend of yours from college, founded Smith Sales Company, and the business is doing quite well. Tom comes to you for advice. He needs to prepare financial statements to present to a bank for an expansion loan. His bookkeeper has recorded entries in a general journal and posted the entries to T-accounts in the ledger. However, the bookkeeper does not know how to prepare financial statements. Tom does not know what financial statements are and what they are supposed to report. He has asked for your help in preparing financial statements for the bank.

Requirements:

A. 1. Prepare for Tom a critical analysis of the financial statements that need to be prepared.

2. Include in your analysis the financial statements that need to be prepared, the stakeholders involved, and the informational needs of the stakeholders.

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Answer #1

Critical analysis of the financial statements that need to be prepared in this case:

Here, for the expansion of the business Tom needs to have a loan from a bank. It would be a business loan. But without having financial statements no bank will offer a business loan. Before sanctioning business loan bank official must critically verify the profitability of the business and financial status and heath of the business, to check their credit worthiness. To judge the ability of payback of loaned amount along with specified interest availability of updated financial statements are indispensable.

Only Journal entries and T shape accounts will not solve the purpose ,because these are not enough to find out meaningful information about the business in quick time.

For the current purpose , Tom has to prepare Income statement to show net income ( or net loss if any) and Balance sheet to show the financial heath of the business.

Income statement shows how much profit the business earned during the financial year. It includes sales revenues , others incomes, direct expenses , indirect expenses , operating expenses, non operating expenses etc. When total income or revenues is higher than total expenditures then it shows net profit and when total expenditures are more than total income or revenue then it shows net loss.

Balance sheet specks about valuation of total assets, total liabilities and equity fund or shareholders fund. Furthermore it is depicting each and every assets valuation separately under current and non current assets. It also classify liabilities under current and non current liabilities for better understanding of their nature. Shareholder funds includes share capital and total amount of retained earnings belongs to the business.

Preparation of Financial statement for informational needs of the shareholders :

A stake holder is a party that has an interest in a business. They can affect business or can be effected by the business. For a sales company or Trading company stakeholders are Management, investors , customers, competitors, government , employees , Lenders etc. They need to have accounting information for taking decisions .

Management : Firm's own management need Income statement, Balance sheet and cash flow statement for taking managerial decision making.

Investors : They need to have financial statements to understand the performance of their investment. They need income statement , balance sheet to check their investment performance.

Customers : Customer wants to review income statement and Balance sheet to in order to judge the financial ability to remain in the business for long for supplying goods and services .

Competitors : They need income statement to know the current profitability of the competitors and some time to know their capital structure they derive information from the balance sheet as well .

Government : Government focusing on income statement to determine whether the firm paid the appropriate amount of taxes on their revenues and profit or not.

Employees : They need to have audited income statement , balance sheet, for understanding the operational performance of the business and their contribution.

Lender : They want to know the ability of the borrower to pay back all loaned funds and related interest charges .For these reasons they required income statement and balance sheet of the business where they will going to santion loan.

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