ACCOUNTING THEORY 1

Accounting Theory

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Question one

Accounting cycle

The process where a firm such as Abu Dhabi Commercial Bank records and

processes the accounting information from transactions that have is obtained

is referred to as accounting cycle. It involves stages from when transaction

occur to when they are included in the financial statements

Abu Dhabi Commercial Bank financial statement encompasses a summarized

financial transaction grouped into debits and credits showing how funds

entrusted by shareholders and lenders to the management of the firm are used

in the current accounting period.

An accounting cycle has several steps. They include;

i. Analyze the transactions- Abu Dhabi Commercial Bank will look at the

source documents that describe events and transactions that occurred.

The source documents are either in the form loan schedules, customer

deposit schedule, interest received schedule and interest paid schedules

ii. Journalize-this step involves the application of the double-entry concept.

Double-entry concept is a process where transactions recorded enter into

at least two accounts on the debit side and credit side. Thereafter the

transactions are recorded in the journal

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iii. Posting-this is an action that involves the transfer of information the

journal to the ledger that is a collection of all accounts that have been

made
iv. Preparation of unadjusted trial balance- a trial balance shows all

accounts and their respective balances at a particular time, either at

start of accounting period or close of the accounting period. The account

balances obtained from the ledger prepare the unadjusted trial balance.

The function of this trial balance is to confirm that the debit sides are

equal to the credit sides

v. Preparation of adjusting entries- this step involves bringing of account

balances of asset or liability account to correct the amount then update

the equivalent revenue or expense account (Alisdair McGregor, 2013).

The general ledger is used for recording of adjusted entries that are then

posted to the ledger. The process of adjusting entries is done at the end

of the accounting period

vi. Preparation of the adjusted trial balance-this trial balance verify if debit

side corresponds to credit side and also its used for preparation of the

financial statements
vii. Preparation of financial statements that should be done in a particular

order of sequence, that is; a comprehensive statement of incomes and

expenditure, a statement of retained earnings, the balance sheet and

finally a statement of cash flows.

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The order of sequence is of importance because the income statement

information is used in the preparation of the statement of retained earnings,

consequently information from the statement of retained earnings prepares the

balance sheet

viii. Preparation of closing entries- this step is done after completion of

financial statements. The main purpose of this step is preparation of accounts

to be used to record transactions and events for the next fiscal period

ix. Preparation of post-trial balance that should contain permanent

accounts debit and credit balances. This scenario exists because the

permanent accounts are the only accounts that remain after closing process

x. Reversing of entries whereby some entries will reverse some adjustments

in the next fiscal year

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Question two

Evaluation of financial performance

The process where Abu Dhabi Commercial Bank identifies its strength and

weakness by accurately establishing the relationship of the balance sheet and

profit and loss account items is termed as financial performance evaluation.

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This process helps ADCB have a better understanding of its performance and

position through the assessment of the relationship between parts of the

financial statements.

Financial performance evaluation will entail and help highlight facts and

relationships concerning the following objectives

i. performance of the management of ADCB,

ii. Efficiency of ADCB,
iii. Strength and weakness of the financial statement,
iv. Measurement of short term and long term solvency situation of Abu

Dhabi Commercial Bank,

v. determination of the future going concern of the Abu Dhabi Commercial

Bank
vi. Abu Dhabi Commercial Bank credit worthiness
vii. Measurement of utilization of assets during the accounting period

The evaluation of financial performance has the following limitations Abu

Dhabi Commercial Bank;

i. The data for evaluation is derived from past information that might not

reflect the actual result of the evaluation conducted

ii. The accuracy and reliability of evaluation of financial performance will

depend on how reliable the figures on the financial information are

iii. The results of the evaluation of financial performance may be interpreted

differently by different users

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iv. The evaluation of economic performance is prone to changes of price

levels thus reducing its validity

v. Where a change of accounting methods are frequently changed, it

becomes difficult to compare the different period evaluation of financial

performance

Question Three

Evaluation of financial performance

The process of evaluation of financial performance Abu Dhabi Commercial

Bank involves the following steps. They include;

a) Re-organizing the financial data on its entirety through the breaking

down of financial information into different components then they are

regrouped together according to their characteristics. Thus, the balance sheet

and the profit and loss account are presented differently from their original

shape

b) A relationship of individual components of balance sheet and profit and

loss accounts is established. This evaluation of financial performance is done

through the use of the following tools

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i. Ratio analysis identifies the relationship between two or more financial

items in the financial information. Ratios will interpret strengths and

weaknesses of Abu Dhabi Commercial Bank and comparison of historical

performance and current condition. Ratios are classified into the following

categories;

A measure of Abu Dhabi Commercial Bank ability to meet its current

obligations is termed as liquidity ratio

Turnover ratio shows the efficiency of activities and operations of Abu

Dhabi Commercial Bank

Profitability ratio highlights the final result of Abu Dhabi Commercial

Bank that is essential to its survival.

2012 2011
4,525,88 4,006,18
Gross profit 4 7
Sales Revenue 6,595,148 6,069,412
Gross profit
ratio 69% 66%

Earnings ratio that value shares held by shareholders of Abu Dhabi

Commercial Bank and what the stocks earn for its shareholders.
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ii. Comparative balance sheet which evaluates an Abu Dhabi Commercial

Bank financial performance over a period of years. It is used in the analysis of

the trend of same items in two or more balance sheets of different dates of Abu

Dhabi Commercial Bank.

iii. Common-size balance sheet where conversion of items is into

percentages. Items of assets are expressed to a percentage of total assets while

items on liability and capital are converted to the percentage of total capital

and liabilities. The rates computed are then compared to the corresponding

percentage of other accounting periods

iv. Trend analysis that is used to show the changes in financial and

operational data between some particular periods

Processing and analyzing of accounts transaction by use of Information

Technology

The use of computers for storage retrieval, transmission and manipulation of

data is commonly referred as Information technology. In the modern business

setup, the use of information technology is inherent in order to carry out

business efficiently and effectively. Thus, account transactions are events that

affect the finance of Abu Dhabi Commercial Bank and must be recorded on the

entitys books. The use of information technology in processing and analyzing

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accounting transactions is aided by the use of accounting packages (Alisdair

McGregor, 2013). The accounting software will contain functions that deal with

accounting such as input of customer information from source documents,

processing of the data and output of information that would assist in the

preparation of financial statements. The collected of raw data from various

source documents. The transactions are analyzed to figure out whether they

are of a financial nature and if it can be recorded or cannot be recorded. The

analysis conducted defines whether the transaction affects the accounting

equation. The use of information technology will reduce the paperwork and

time taken to process and analyze the transactions. The information technology

will also analyze and process the accounting transactions which would allow

the Abu Dhabi Commercial Bank create reports quickly and make the process

of decision making easy for the management investment decision.

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Question four

Reports issued by the managers

The Abu Dhabi Commercial Bank departmental performances are enhanced

through regulation of the employee by the management executives (Alisdair

McGregor, 2013). Department performance is benchmarked with predetermine

plans which is define the management procedures and policies that aids in

obtaining the business goals. The management substantiates the departmental

performances through issuing of reports to describe the compliance and

efficiency of the departments employees. The report issued involves;

Internal audit report

Issuing of the internal audit report by Abu Dhabi Commercial Bank executives

define the weakness and risk attached to the company departmental objectives.

Internal auditing reports heighten in unveiling the Abu Dhabi Commercial

Bank financial performances which is used as a benchmark against the

predetermine objectives (Agus & Hassan, 2011). The management issues

internal audit report to improve the presentation and valuation of accounting

report to meet the international requirements.

Internal control systems

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The management issues the internal control reports on a regular basis decking

the departmental compliance and effectiveness of internal controls to every

department. The internal control reports are generated by executive managers

to facilitate effectiveness in operations within the mission statements and

business objectives.

Stock report

The stock control is a major initiative through which the business evaluate the

movement in trade as well as determine the need of re-ordering the new stock

in case of minimal number of stock. Stock evaluation report are done based on

Abu Dhabi Commercial Bank predetermine period through which the

companys incentives and business objective. Issuing of stock report will reduce

the frauds on the stock in store hence promoting companys financial success.

Budget reports

The budgetary reports are issues by the management Abu Dhabi Commercial

Bank based on the evaluated predetermine objectives defining the business

future expectations. The budget are drafted based on the preceding

performances and the budget report are issues to departmental heads to guide

them on their expectation in achieving best of companys budget outlay.

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Question Five

Financial analysis

Financial analysis refers to pragmatic evaluation of the business financial

performances for the process of decision making. Abu Dhabi Commercial Bank

financial analysis describes the pragmatic assessment of the ADCBs financial

statement to evaluate their viability of investing in the Bank (Alisdair McGregor,

2013). Abu Dhabi Commercial Bank financial statement analysis entails the

comparison of the firms financial information in the balance sheet, cash flow,

income statement and the statement of owners equity over different periods.

The analysis can also involve the comparison of financial information of

different firms on the same financial period. Abu Dhabi Commercial Bank

analysis on the financial analysis is practicable under to major accounting

techniques such as

i) Horizontal and Vertical analysis

ii) Financial ratio

Horizontal and vertical analysis

The two types of analysis serves different purposes that give the users

alternatives to choose on which type of analysis that serves the best concerning

different accounting period, firms and the financial items analyzed. Vertical
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analysis gives a basis of making firms financial decisions on one accounting

period majorly on balance sheet items while the horizontal analysis is based on

different accounting period

Horizontal Analysis

This method of analysis compares specific items in the financial statements

over different period or within the financial period (Jay S. Rich, 2011).

Horizontal analysis can compare the account receivable over different months

in a financial year or the Abu Dhabi Commercial Bank revenue can be

compared over several accounting periods.

2012 2011 % change Increase

Sales Revenue 6,595,148 6,069,412 9%Increase
-
Expenses 2,069,264 -2,063,225 0.3% Increase
Gross profit 4,525,884 4,006,187 13%Increase

The Abu Dhabi Commercial Bank horizontal analysis describes increasing

trend of the financial aspects reveals in the Abu Dhabi Commercial Bank

revenues, Expenses as well as gross profit.

Horizontal financial analysis is conducted in the following ways;

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Dollar analysis- this type of analysis compares absolute amount of items of an

entity over different accounting periods. The analysis aids in facilitating the

Abu Dhabi Commercial Bank spending trend and also analyses the effect of

external factors such as price on the firms expenditures.

Percentage analysis- the analysis analyses the percentage change of items over

different period of time. With an aid of this analysis, Abu Dhabi Commercial

Bank performances can be compared with large firms within the same

industry.

Vertical Analysis/ common-size analysis

This involves ideal paradigm of comparing arrange of figures of different firms

to specific figure in one accounting period (Badertscher, 2012). This type of

analysis is considered of great importance in making valid business decisions.

Balance sheet vertical analysis provides a clear review on the firms financial

liabilities and equity.

Financial ratio
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Financial ratios are the useful indicators that show the companys financial

situation in relation to the information in the financial statement. Ratios aid in

analyzing the financial information and provide a benchmark of firms financial

performances. Some useful ratios used to analyze the financial information

involve:

a.) Financial leverage ratios

This is ratios provides the firms indication on its long- term solvency. It provide

a benchmark on extend to which the firm utilizes its long term debt. It involves

debt ratios and the interest coverage ratio that proofread capability of the firms

earning to settle the interest payment on the firms obligations.

b.) Profitability ratios

Profitability ratios indicate the firms effective measures on sensation of returns

generated on the turnover and the investments (Alisdair McGregor, 2013).

Profitability ratios enhances the gross profit margin that measures Abu Dhabi

Commercial Bank gross profit earned on turnover, return on assets that shows

the affectivity of the firms assets in generating income, operating profit margin

that measures the firms earnings before interest and tax expense. Net profit

margin ratio takes into account the expenses incurred to earn the profit.
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2012 2011
4,525,88 4,006,18
Gross profit 4 7
Sales Revenue 6,595,148 6,069,412
Gross profit
ratio 69% 66%

The graph above shows an increasing trend of Abu Dhabi Commercial Bank

from 66% in 2011 to 69% in financial year 2012.

c.) Liquidity Ratios

This is ratios assesses the state at Abu Dhabi Commercial Bank ability to its

current financial obligations. It assesses the firms ability in converting the net

current assets into cash and settles their financial obligation. Liquidity ratios

involve the current and acid test ratios. Acid test ratios /quick ratio facilitate

the firms ability in meeting due financial obligation while the attributed

according to the Thomson Routers rule as current assets divided by current

liabilities.

d.) Efficiency Ratios

Efficiency ratios measure the efficacy of the Abu Dhabi Commercial Bank

management in making decisions concerning investments such as turnover

and return on investment. Sales to receivable ratio evaluate the Abu Dhabi
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Commercial Bank receivable verses revenue earned that both give high

efficiency in case the ratios are higher.

Based on Abu Dhabi Commercial Bank accounting techniques used in

analyzing the financial performances Horizontal and vertical methods provide a

clear view of financial analysis since they based on detail informations in the

income statement (Alfredson, 2012). Using ratios accounting techniques in

analyzing the company financial statement is subject to changes in accounting

methods and historical data varies.

Problems of the accounting techniques use in financial analysis

The accounting paradigms use in Abu Dhabi Commercial Bank financial

analysis is subject to limitation which profoundly affects the results hence

giving despaired opinion.

The limitation is as follows;

Comparability between periods

When using both accounting methods to analyze the companys financial

performances between different accounting periods, the changes in the

companys accounting methods lead to despaired results hence unviable ADCB

shareholder investment decision.

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Comparability between companies.

The two accounting model used in evaluations of the companys financial

performances are subject to differences in accounting models. Difference

companys may use of the methods if accounting hence giving different results

which lead to inconsistent financial data used in financial analysis.

Question six

How to evaluate risk

The Abu Dhabi Commercial Bank incentives are subject to risk which can

destroy the ADCB objectives and goals. Risk subjects to business operation can

be describes as stock risk investment risk, bonds risk and other risk involves

in changes in the interest rates. Steps of evaluating risk;

i) Evaluation of the risk attached to Abu Dhabi Commercial Bank

investment to determine the type of risk attached to the investment.

ii) Determination of how the risk affects the business objectives to

determine the ease of making the investment as well as providing

measures on the risk measures.

iii) Managing the risk associated with the investment to enhance

efficiency in the business operations as well as restructuring of risk

free business activities.

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Evaluation of the return in the Abu Dhabi Commercial Bank operations is

part of financial management initiatives to describe the best project that

facilitate organizational objectives. The Abu Dhabi Commercial Bank

evaluation critique determines the management consideration in continuing

with the products or outsourcing and dropping the products (Agus &

Hassan, 2011). However, the use of the internal rate of return (IRR), Payback

Period and Return on capital employed provide clear instincts on the

viability of investment. Consequently, the management accounting define

the predetermine measure such as ratios that are used in evaluating Abu

Dhabi Commercial Bank efficiency in performances.

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References

Agus & Hassan, Z. F. (2011). Enhancing production performance and customer

performance through total quality management (TQM): strategies for

competitive advantage. Procedia-Social and Behavioral Sciences, 650-

1662.

Alfredson, K. (2012). Applying international accounting standards. John Wiley

& Sons.

Alisdair McGregor, C. R. (2013). Comparability analysis on financial statements

. Routledge.

Badertscher, B. A. (2012). Discretionary accounting choices and the predictive

ability of accruals with respect to future cash flows. Journal of

Accounting and Economics, (1), ., 53, 330-352.