# Accounting information for decision making

Essay by v0504University, Master's January 2007

PART 1 - Problem Solving (5%)

The six ratios (i.e. Profitability, Efficiency, Liquidity, Gearing (leverage), Investment and Finance Strength (stability)) shall be used to provide the best analysis possible for the directors of Helena Beauty Products Ltd.

The formula and the guides to analyze the ratios are credited to a dedicated investment website www.investopedia.com/university/ratio. The website provides information for those whom seek basic understanding and usage of ratios for managerial consideration.

-PROFITABILITY RATIO

Return on Assets (ROA) =

2006 ROA =

2007 ROA =

ROA is used to show how much income that generated from the total assets / invested capital. According to the calculation, there's a slight improvement in the profitability from 2006 to 2007. From the managerial perspective, the company should try to increase the net profit and reduce the total investment. Simply put, the company must try to optimize the utilization of the assets owned / already invested by the company in order to obtain higher profits.

In general, the company is in good shape as the ROA is stable and have a trend toward positive increase.

Return in Owner's Equity (ROE) =

2006 ROE =

2007 ROE =

ROE informs the rate of how much the shareholders earned from what their share to the company's capital. The company shows a positive trend in 2006 to 2007. This shows that the shareholders' earnings are increasing although very slowly. Positive movement in ROE will give positive impression to more investors who interested to invest some capital in the company. For a company that relies heavily on investors, positive and strong growing of ROE is very important. Current shareholders also feel safe and will have intention to keep the money in the same company.

Net Profit Margin =

2006 Net Profit Margin =

2007 Net Profit Margin =

Gross Profit Margin =

2006 Gross Profit Margin =

2007 Gross Profit Margin =

By observing the Net Profit Margin & Gross Profit Margin as shown above, the company has a very little grow from 2006 and 2007. From the Gross Profit side, we can see that the company made a very big % profit - more than 40%. And it even grows in 2007. However, after the expenses, the company has too many expenses that virtually kill the profit earned by the company. From management perspective, the company must cut-cost through out the company in order to increase the profit margin.

-EFFICIENCY RATIO

This ratio is to measures the efficiency of the company in using the inventory to generate profits for the company. In General, the lower the turnover (in days) means the company performs better.

For Helena Beauty Products Ltd., the company should have very low turn over because the nature of the product (although not specifically mentioned) that is categorized as consumptive product and has a regular usage daily. Thus the inventory should re-stock and sold in a regular basis and considered short time. Based on the financial statement available, the amount of the closing inventory is increased by USD 100,000 in 2007. However, the ration between the closing inventories to the opening inventory stays in 0.8. Ideally, the company should have less closing inventory in 2007 in order to generate higher profit. Otherwise, the company will have to bear higher warehouse / inventory cost due to the increasing number of stocks.

Efficiency ratio is not just measured from the inventory but also from how much sales generated by the sales people of the company. The higher the sales per employee means the company has a efficient sales force and tend generate high profit for the company. However, based on the available information, the sales force seems not improving significantly in 2007. From the managerial perspective, the company should further train, motivate, and perhaps add more sales force to increase the number of inventory sold.

-LIQUIDITY

Current Ratio =

2006 Current Ratio =

2007 Current Ratio =

Current Ratio or Working Capital tells the capability of the company able to take care or accommodate the short term liabilities with its short term assets. According to www.investopedia.com, normally accepted current ratio is between 1.2 - 2.0 times. Helena Beauty Products Ltd, has current ratio more than 3 times in 2007 that shows the company have current assets (i.e. savings in banks, short term loan, and fast-to-sell inventories) three times more than its liabilities. In other words, in emergency the company can sell its short term assets to cover its urgent liabilities.

Should the company want to try not to sell or give up the short-term assets which basically the heart of the company, then we can use Quick or Acid Ratio. This ration will tell how well / bad the company can cover its urgent liabilities without selling off the short-term assets.

Quick or Acid Ratio =

2006 Quick or Acid Ratio =

2007 Quick or Acid Ratio =

Based on the Quick Ratio results, again here there's a positive trend of increasing Quick or Acid Ratio. Should the company experiencing a sudden money withdrawn from shareholders due to some reasons, this company has enough quick fund without risking selling the inventories.

-GEARING (LEVERAGE)

Interest Cover Ratio =

This ratio tells the usage of outsource finance (i.e. loans from banks or other loan institutions that charge the company some interest for the service). The available data doesn't provide such information, thus some assumptions had to be drawn.

We can assume that the company grouped the interest expense into Expense. Looking at such high expense in the information, the company could have very high loan from outside party. However, nothing is certain as the information is not provided in the financial statement. It's safer not to assume without the proper information as it could lead to misleading information to the reader and especially to the shareholders.

-INVESTMENT RATIO

Earning Per Share (EPS) =

This ratio tells the amount of generated profit on a per share basis. The company didn't provide the information such as the number of shares in the public. Without this information, the EPS cannot be found. There was an increase by 7% in the paid up capital. This can be interpreted by managers that the company is seen positive by shareholders, because with this increment means there is more investors trusting their money to be invested in the company.

Dividend Payout Ratio =

This ratio indicates the proportion of earnings used to pay dividends to shareholders. The company didn't provide the required information to make the dividend payout ration. From the available data, the company has stable retained profit between the two years. This shows the company has a solid dividend policy that issued and authorized by the company's board of directors.

Perhaps it's safe to assume that the company doesn't give any dividend to the shareholders at the moment. And perhaps the retained profits are used to add more capital for expansion / growth of the company.

-FINANCIAL STRENGTH (STABILITY) RATIO

Debt-to-Asset Ratio =

2006 Debt to Asset Ratio =

2007 Debt to Asset Ratio =

The company has a ratio that less than 1, this means the assets are majority financed through equity. In other words, the company performs very well with the liabilities only about 12-13% from the total assets. However, it's important for the managers to keep on the look out for this specific ratio. There's an increase on the ratio in these two years which means the company is having more liabilities compared to having assets.

Shareholders' Equity to Assets Ratio =

2006 Shareholders' Equity to Assets Ratio =

2007 Shareholders' Equity to Assets Ratio =

Basically this is the opposite to Debt-to-Asset Ratio. If we sum the results of Shareholder's Equity to Assets Ratio with Debt to Asset Ratio of the same year, the result will become 1. So, the company's majority finance source comes from the shareholders' equity.

Debt-to-Equity Ratio =

2006 Debt-to-Equity Ratio =

2007 Debt-to-Equity Ratio =

This ratio indicates there was an increase about 1% which slightly further expose the company to debt. Because this ratio shows the proportion of how much the company's assets financed through debt and shareholders' equity.

In overall, based on all the ratios explained that the company is in a very good finance shape. However, also from the ratios, the company is not performing too greatly as there's only a very small growth in one year duration. This can be seen from the comparison of ratios the year 2007 and 2006. From the managerial perspective, the company should increase the efficiency of the sales, reduce the turnover time, and reduce the expense. Only by doing this, the company can has a higher profits and finally attract new and more investors to store capital. Further, the company can use the additional capital to do some expansions or anything that can grasp more market and increase sales.

PART 2 - THEORY (10%)

This following report is to discuss the harmonization of Australian accounting standard with the international equivalent accounting standard. In the past decade, there have been a numerous researches and developments to make an internationally accepted accounting standards (IASs).The harmonization has positive results for both Australian companies and the overseas companies or in contrary it turns out to be dis-harmonization. Harmonization is a term where there are two or more standards that need to be 'harmonized' or 'convergence'.

There are few potential advantages and disadvantages of this harmonization or convergence. Some examples taken from a various literature or journals from different industry will be provided when necessary.

HISTORY

One of the accounting standards that often controversial but yet still discussed from time to time is about the treatment of goodwill. Seetharaman (n/a) believes that the precise definition of goodwill itself is yet to be decided, further, different country will have different types of treatment of goodwill. As also mentioned by Seetharaman (n/a), that back in 1973 the International Accounting Standards Committee was founded. The goals are to harmonize / uniform the accounting regulation, standards, and procedures that often contradicts / differs from one regulation of a country to another.

Seetharaman (n/a) believes that the International Accounting Standard 22 (IAS 22) Accounting for Business Combinations (International Accounting Standards Committee, 1983) were published for one reason that is the international disharmony of goodwill accounting regulation. This shows that how complex the convergence process throughout the year.

Accountants since many years ago have realized that they might need to know international dimensions (Peter 1971; Carnegie & Napier (1996)).

IASC (International Accounting Standard Committee) which was found in 1974 (Seetharaman n/a) is the constitution in Australia that should carry the responsibility to take care the harmonization international standards and world-wide harmonization., To overcome all the disharmony and to avoid any possible conflicts, the accountant professionals. Every country ideally should have an association of its own to prepare and to continuously develop standardization to the accounting. For example: Malaysian Accounting Standard Board (MASB) for Malaysia.

DISCUSSION

Not just in accounting, but international standardization like EDI (Electronic Data Interchange) that was discussed by Mulligan (1999) is discussing about to harmonize the system in the foreign trade industry. Mulligan emphasizes that the two companies that conduct EDI must have the same EDI, other systems, and skilled people, otherwise the company will not be able to stand in the market for too long.

This paper will firstly discuss about the potential advantages then the disadvantages. According to Mulligan (1999), reducing cost and increasing accuracy and efficiency, processing incoming data, and reducing document delay, etc.

Carnegie & Napier (2002) strongly suggests the following steps to overcome problems for international accounting: Period, Places, People, Practice, Propagation, Products, and Profession. One unified standard will avoid misunderstanding / misinterpretation of technical term.

Ortiz et al. (2003) argued that with IASs, accountants can avoid having to produce two different financial reports - one for domestic standard and the other one for capital market. These double financial statements are costly, often confusing, and sure the integrity between the two reports is often doubted. Peasnell (1993) believed that a country that uses an international accounting standard would have an advantage of cost effectiveness compared to another country.

According to the EU Lisbon Summit in 2000, by adopting IASs, Australia can benefits to have a sustainable economic growth and more and better jobs and greater social cohesion (EC 2000). With IASs, comparing financial statements between companies are becoming easier to be done. This will effect on the companies in Australia, so investors can compare and decide faster whether the company is clean and profitable or not PricewaterhouseCoopers (2000).

The Internet is also a key contributing in the IASs realization in all over the world (PricewaterhouseCoopers 2000). With Internet, people all over the world are no longer bounded by countries and distance. Thus, with the IASs realized, virtually no obstructions for investors. As for now, investors are at risk misinterpreting the accounting technical terms.

Harmonization or convergence that is happening in many parts of the world that highly anticipate the realization of the IASs, is not without challenges and disadvantages. Despite with all the hypes, Nobes and Parker (2001) are not too sure and not too excited with the harmonization or convergence. According to them, the most basic problem to this harmonization is the different in size of the present with the accounting practices in applied by other country.

Quite unexpected, Nobles and Parker (2001) supported the idea of having two sets of financial statement (i.e. domestic using national standard and international using IASs). They also believed that infrastructure or readiness a country in anticipating the IASs, some countries that cannot meet the standard, then it will become an even greater to the dreamed harmonization.

According to De Bryjne (1980), financial statement or financial information is basically a form of a language. Simply put, if there's a any misunderstanding or misinterpretation, then it could lead any company to a difficult position. Many accountants also argued that harmonization will not be happening, but actually this can be done if the if there's other countries that will apply IASs in their accounting system.

PART 3 - CASE STUDY (15%)

Rosemary who is the sole owner of Private Gym is experiencing a dilemma with her business. This case study is to provide solution for Kate on her problems and justify the recommendations accordingly. The solutions provided are based on management control that basically allow a business to runs smoothly, efficiently, effectively, productively, and the last but not the least, profitably.

The following are Rosemary's requests related to her business (i.e. Private Gym). She is a health instructor that finally decided to open a gym on her own. She built the gym and had it runs for a few months. To overview the business, she hired a long & best friend from beginning - Kate. She is an experienced gym tutor and trusted by Rosemary to run the business while Rosemary at home attending her responsibilities as a mother to her children.

Rosemary didn't have too much experience in managing / controlling a business, thus she thought she could let her best friend - Kate to take care everything. This is where Rosemary made a mistake / poor decision without proper control management prior to assigning someone to run a business.

Kate was stealing money from the company by conduct a personal training session with a client without storing the money to the company's revenue. She thought she could get away with it because basically she was the highest position in the company with Rosemary hardly visit the gym.

Rosemary's further requests are that she wants to ensure that she will receive all the revenue that she supposed to receive. About Kate, Rosemary is not sure whether she should fire Kate and hire another people or not? Should Rosemary decided to hire a new people, she also needs to decide whether it's better to hire a person to be the manager is an instructor or non-instructor. The last but not the least, Rosemary also wants her business to be protected from thievery or any corruption.

From the requests, the goals can be summarized as below:

-decision to lay off Kate or to keep her

-if Kate is fired, then the replacement should be non-instructor or instructor

-if Kate is kept, then what is the recommended control to avoid future thievery

-Regardless the decision, what is the recommended control to ensure Rosemary's business is protected even though she will not be physically be there all the time.

Simply put, the goal is to give the right management control to Rosemary's problems.

The next step after determining the goal is to formulate the strategy and then finally implement the strategy. Shank and Govindarajan (1989), and Anthony et al. (1992) aggress to this steps as they described the first as the introduction of flexibility and multi-layered sets of strategies and systems.

It will be wise from the management perspective to review the implemented strategy and compare the results with the goals. Ahearn (1994) agrees that performance evaluation is needed to do both short and long term programs.

There are three main issues that can be addressed in the Private Gym, they are Lack of Direction, Motivation and Personal Limitations. Basically the control always refers to the People, in this case it's Kate. Each of the issue is to be discussed below:

-Lack of Direction

Kate is lack of direction shown that she's only handle day-to-day basis. For a while it's okay, but after some time, a person is easily get bored with repeated task. Thus, Kate might look for another task to do. If the company recognized earlier about this, then Rosemary could add more task while increasing the compensation to Kate.

-Motivation

As Kate is accepted by the company through the close relationship with the owner (Rosemary), virtually there's no motivation or effort from Kate to keep the job as she would have feel it was easy in getting the job.

-Personal Limitations

Kate is either to be too talented or not talented enough to do her job. Based on the data provided, Kate seems to be a very talented person and energetic. However, she is lacking in the integrity and honesty to the company.

Basically there are three controls: Detector, Assessor, and Effector. Each control will be discussed as below:

-Detector

This is a control to measure the performance. Based on the goals and the available data, this control is not appropriate at the moment, so it's better to leave this control for a little while. The right moment is after the Effector control is done and the human resource issue is solved.

In the long run, the detector control is the most efficient and effective because it measures the performance of the company, sales people, and in overall. Thus strategy and tactic can be done before anything major happened.

The company should install a camera system in strategic points of the gym, so it will give impression to the employees / guests that they are being watched. This should be presented to the employees & guests in positive way by putting the right marketing material or reading material. Otherwise, they will think that they are being watched because they cannot be trusted by the company.

Further, the company also can install a membership system with barcode system. The member can swipe the card every time she / he enter the gym. This way, it's automatically charge the customer with a certain amount for every service that he / she consume.

Administratively, the cashier and the instructors should be separated. All the guests and the employees should be informed that there's a new payment system in the company. This way, it will prevent a 'under table' money transaction between the personal instructor with the client.

-Assessor

This is a control to compare with the pre-set standard. Private Gym could use this control system once the company has runs for some time and running smoothly. And there are more managers that can easily review based on the sales / performance conducted.

The assessor control is the most standard control system, because it can be done in time-period basis (i.e. weekly, monthly, quarterly, annually, etc). By comparing the current performance with the pre-set standard (can be adjusted per period of time to stay updated / competitive).

-Effector

This is a control to take corrective action, as for now, Rosemary should take Effector control as she needs to take corrective actions as the company has experienced some setback due to the incident caused by Kate. Rosemary could either fire or keep her. Based on the provided data and for the sake of the company and supported Ahearn (1994), this is done for the best of the company and for the future's sake of the company.

Cost wise, effector control system is the most expensive and the harshest way. Because this is the system to correct something that is happening or had happened with the company. Correct and appropriate action should be carefully conducted and monitored to prevent further damage.

In conclusion, Private Gym should immediately conduct effector control and once everything settled down and runs smoothly, the company should change to Detector control. And once the company grows to much large capacity, the company can consider to use assessor control system. This shift of control system will ensure the profits that obtained by the company is given 100% to the company without any worry for any thievery.

There are three more controls: Results, People and Cultural controls.

-Results

This control will motivate the employees by rewarding at the end of period with money, award, and promotion.

-People

Human resource people are always facing the same task of getting the right people at the right place and at the right time. This way the company will be benefited with maximum effort that can be given by an employee to the company.

-Cultural

Cultural control is basically a tradition or way of doing that has become so normal among employees and customers to monitor one to another.

Private Gym should adapt the all these three controls (multiple controls) right after the effector control is done conducted. These three controls will require an additional professional Human Resource specialist to be effective in optimizing / utilizing the assets of the company. Indeed there will be an increase in capital invested, but this is justified with the expected return that can be expected.

REFERENCES

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