Accounting For Business – Assignment SP1 2015

Accounting For Business – Assignment SP1 2015 ACCOUNTING FOR BUSINESS – ASSIGNMENT

The assignment requires preparing financial statements based on trial balance adjustments, analyzing a bond valuation under different interest rate scenarios, and calculating present values and yields for various cash flow streams. The tasks include completing a worksheet, preparing income statements, balance sheets, and cash flow statements, as well as explaining accounting concepts such as depreciation, asset valuation, and the differences between written down value and market value. Additionally, the assignment involves calculating the present value of uneven cash flows, understanding the effects of compounding frequency on future value, computing effective annual interest rates, and analyzing bond pricing and yields, including the impact of inflation expectations on bond values.

Paper For Above instruction

Finance and accounting are fundamental components of business management and analysis, providing insights into a company's financial health, investment potential, and value assessments. This paper explores the key concepts and practical applications relevant to the given assignment, including financial statement preparation, bond valuation, time value of money calculations, and fundamental accounting principles such as depreciation and asset valuation.

Financial Statement Preparation and Analysis

The task of consolidating unadjusted trial balances into formal financial statements is essential for accurate reporting. The case of Harry's Hardware demonstrates this process, where adjustments such as depreciation, accrued expenses, inventory valuation, and prepaid expenses are necessary. These adjustments ensure compliance with accounting standards and provide a true view of the company's financial position.

For example, depreciation on warehouse and equipment assets must be allocated over their useful lives. The warehouse, with an estimated useful life of ten years and residual value of $1,000, requires annual depreciation of ($16,000 - $1,000) / 10 = $1,500. Similarly, equipment with five years life and residual value of zero warrants annual depreciation of $4,000 / 5 = $800. These depreciation expenses are deducted in the income statement, reducing profit, and are accumulated in the balance sheet as accumulated depreciation. Accurate adjustments ensure that the financial statements reflect the true asset values and expenses incurred during the period.

The income statement provides an overview of profitability, including sales, cost of goods sold, expenses, and net profit. The balance sheet presents the financial position at a specific point in time, detailing assets, liabilities, and equity. The statement of changes in equity shows how retained earnings and other reserves evolve over the period, influenced by net profit and owner transactions like drawings or additional capital contributions.

Understanding Key Accounting Concepts and Principles

Depreciation is a systematic allocation of the cost of a long-term asset over its useful life. It reflects the consumption of economic benefits from assets like equipment or vehicles. The straight-line depreciation method spreads an asset’s cost evenly, providing simplicity and consistency in financial reporting. Accurate depreciation accounting avoids misleading overstatement of profits and ensures compliance with the going concern assumption, which presumes the entity's continuity in the foreseeable future.

Asset valuation, particularly for equipment, can involve different measures: cost, market value, and written down value. Cost refers to the initial purchase price; market value is the current price if the asset were sold; while the written down value (also called book value) is the net amount after accumulated depreciation. It is crucial to distinguish that written down value signifies the remaining accounting value on the books, not the asset's actual market worth, which can fluctuate significantly due to market conditions.

The measurement problem in accounting refers to the challenge of assigning precise monetary values to assets and liabilities, especially when market prices are unavailable or unreliable. This can lead to inconsistencies and subjectivity in financial statements, highlighting the importance of transparent policies and recognition criteria in financial reporting standards.

Time Value of Money and Bond Valuation

The concepts of the time value of money (TVM) are central to financial decision-making. The present value (PV) of uneven cash flows, such as -$50, $100, $75, and $50 over four years at 10% interest, is calculated by discounting each cash flow back to the present:

• PV = -$50 / (1.10)^0 + $100 / (1.10)^1 + $75 / (1.10)^2 + $50 / (1.10)^3

which results in approximately $240.09. This exercise illustrates how future cash flows are valued today, enabling comparisons and investment assessments.

The phenomenon whereby higher compounding frequencies increase the future value of a sum, given the interest rate is held constant, stems from interest-on-interest effects. For instance, compounding semiannually yields a slightly higher future value compared to annual compounding because interest is calculated more frequently, thereby accumulating more interest over the same period.

The effective annual rate (EAR) for various compounding frequencies can be calculated using EAR = (1 + i/m)^m - 1, where i is the nominal rate and m is the number of compounding periods per year. For 12% nominal rate:

• Semiannual (m=2): EAR = (1 + 0.12/2)^2 -1 ≈ 12.36%
• Quarterly (m=4): EAR ≈ 12.55%
• Monthly (m=12): EAR ≈ 12.68%
• Daily (m=365): EAR ≈ 12.75%

These calculations demonstrate how more frequent compounding effectively increases the annual interest earned, which is critical for investors and financial planners when evaluating different investment options.

Using the compound interest formula, depositing $100 at an 11.33463% nominal rate compounded daily over nine months yields a future value of approximately $108.87, illustrating the power of compounding over shorter periods.

Bond Valuation and Yield Analysis

The valuation of bonds under varying market conditions highlights the relationship between interest rates, inflation expectations, and bond prices. An issued bond with a 10-year maturity, $1,000 par, and 10% coupon can be valued differently depending on the required rate of return (YTM). When the required return increases to 13%, the bond's value decreases below face value to around $837, indicating a discount bond. Conversely, if interest rates fall to 7%, the bond's value rises to approximately $1,210, reflecting a premium bond.

The calculation employs present value formulas for the coupon payments and the face value, discounted at the new market rate. These relationships are inverse; as interest rates rise, bond prices fall, and vice versa. This sensitivity underscores bond investors' need to monitor interest rate trends as part of fixed income investing strategies.

Calculating the yield to maturity (YTM) involves solving for the discount rate that equates the present value of future cash flows to the current market price. For bonds selling at a discount (e.g., $887), the YTM exceeds the coupon rate of 9%, reflecting the investor's required return. Conversely, bonds at a premium (e.g., $1,134.20) have a YTM below the coupon rate. Understanding these dynamics aids investors in assessing whether a bond's market price aligns with their yield expectations.

Returns and Yield Components

The total return on bonds comprises the current yield and capital gains yield. The current yield is the annual coupon payment divided by the current market price, serving as a measure of income return. For a bond priced at $887 with a $90 annual coupon, the current yield is approximately 10.15%. The capital gains yield, representing the expected change in price if held to maturity, can be estimated by considering the difference between the purchase price and face value and the remaining time to maturity. For example, the approximate capital gains yield for a bond purchased at $887 and redeemed at $1,000 over ten years is about 0.84% annually, assuming no default risk.

These calculations illustrate the importance of considering both income and capital appreciation when evaluating bond investments, aligning investment strategies with risk tolerance and income needs.

Conclusion

In sum, understanding the intricacies of financial reporting, asset valuation, time value of money, and bond calculations is essential for effective financial analysis and decision-making. Accurate accounting practices, coupled with a deep comprehension of market dynamics, enable managers, investors, and analysts to make informed decisions that enhance business performance and investment returns.

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