The price level changes are a common phenomenon and will introduce entirely new distortions into ROI and RI measures. The principal distortions occur because revenues and cash costs are measured at current prices, while the investment cost and depreciation charge are measured at historical prices used to acquire the assets. Depreciation based on historical cost underestimates what the depreciation charge would be based on the current cost. This results in overstating the firm’s income. At the same time, the firm’s investment is understated, because most of firm’s assets were acquired in precious years at lower price levels than those currently prevailing. The combination of overstated net income and understated investment causes the ROI or RI measures to be much higher than if inflation had not occurred. The increased ROI or RI is not a signal of higher profitability and it is mainly due to a Continue reading
Financial Concepts
Relationship Between Agency Theory and the Existing Accountancy Practices
The agency theory is a mixture of the relationships between principals and agents, it occurs when the principal and the agents create a delegation. The agency theory argues that in modern corporations, where share ownership is widely held, managerial actions depart from those required to maximize the shareholder’s return. In Agency theory terms, the owners are principals and the managers are agents and there is an Agency loss which is the extent to which returns to the residual claimants, the owners, fall below what they would be if the principals, and the owners, exercised direct control of the corporation. The long-term strategies for agency theory include the principle of the company, business, franchise, etc. providing incentives such as increasing commission, continuing to provide advertising, training, and motivation to increase outlet operations. Regarding the exogenous factor, outlet managers have an incentive to shirk and misrepresent their abilities because the firm is Continue reading
The Advantages and Disadvantages of Budgeting
A budget can be described as a financial plan for a business that has been prepared well in advance to demonstrate and dictate the future course of work of a business. A budget may be set in money terms or it can be expressed in terms of units. Budgets can also be put across in the form of income budgets for money received i.e. sales budget, or expenditure budgets for money spent, i.e. a purchases budget. However, a major emphasis has always been on the cash budget which combines both income and expenditure in estimating the business working capital, cash in hand and bank balance during a course of work or a time period. The budgets are usually prepared for the following financial years (budget period), and are usually broken down into shorter time periods in order to emphasize on the figures and their attainment/fulfillment. The periods are usually monthly Continue reading
Audit Quality – Meaning and Factors Affecting It
The major accounting scandals occurred worldwide has brought the focus of public to the audit profession and the audit quality. Enron and WorldCom cases in United States and Parmalat case in Europe are the example of major scandals as a result of the failure of audit services. These examples of corporate and accounting scandals that happened worldwide have indicated that the audit quality of the audit profession is not at an appropriate and acceptable level. Over years, the audit quality issue has been discussed and debated globally. Several actions have been taken by international and domestic authorized agencies to address the audit quality issue. For example, the government of United States has introduced and enacted the Sarbanes-Oxley Act in 2002 as a response to the audit failure in big major corporations, such as Enron and World Com. In addition, the Center for Audit Quality has been established in United States Continue reading
Financing of Current Assets
Current assets of enterprises may be financed either by short-term sources or long-term sources or by combination of both. The main sources constituting long-term financing are shares, debentures, and debts form banks and financial institutions. The long term source of finance provides support for a small part of current assets requirements which is called the working capital margin. Working capital margin is used here to express the difference between current assets and current liabilities. Short-term financing of current assets includes sources of short-term credit, which a firm is mostly required to arrange in advance. Short-term bank loans, commercial papers etc. are a few of its components. Current liabilities like accruals and provisions, trade credit, short-term bank finance, short-term deposits and the like warranting the current assets are also referred to a short-term term sources of finance.Spontaneous financing can also finance current assets, which includes creditors, bills payable, and outstanding receipts. Continue reading
Role of Financial Intermediaries in Economic Development
Financial intermediation is defined as the process which had been carried out by the financial intermediaries as the middleman between the borrower (spender) and lender (saver) to smooth the flow of the fund. Financial intermediation called the process of using indirect finance in the financial system, which the primary route to transfer funds from lender to borrower. Those savers who have the surplus money will deposit their funds in the financial institution, which will lend those funds to borrowers such as business firms, households, government, or foreigners who shortage of funds. Financial intermediaries are that financial institutions such as commercial banks, finance companies, or merchant banks. The financial intermediary helps to transfer the funds between the lender and borrower in the ways of borrow money from the lender-saver and then using this money to make a loan to the borrower-spender. For example, the financial institution acquires funds through the public Continue reading