Relevance Materiality Quantitative the Financial Year/Accounting Period

¶ … Relevance

Materiality

Quantitative

The Financial Year/Accounting Period Concept

Application of Literature Review into practice for IKEA's 3-year (2009-2010-2011) financial reports

What is missing and ok in the reports? The good and bad points of Reports based on Literature Review.

103-year comparative ratio analysis and their interpretations

Literature Review of "Strategic Management Accounting Concept" and its application to facilitate the IKEA's ambitions for the future.

The concept of financial reporting is important to each and every organization. The information contained in financial reports is important since it helps in the reduction of financial risks while also acting as a tool for corporate governance (Kothari,2000; Berndt,2007).Financial report must have a series of desirable characteristics. In this paper, we use IKEA's financial reports in evaluating the desirable characteristics of financial reports. Also discussed is the possible effects of using the concepts of strategic management accounting and its methods in the promotion and facilitation of the future ambitions of the company.

Company profile

IKEA is an international company that retails home product. It specializes in the sale of furniture as well as other household items and accessories items. As of financial year 2011, the company had a grand total of two hundred and eighty seven stores scattered across twenty six countries. The company has its headquarters in Deft, Netherlands and has a total of 131,000 employees (Datamonitor,2012).

In the 2011 financial year (FY2011), the company recorded revenue of $34,960.3 million which was a 6.9% increase over the 2010 financial year revenue. IKEA's FY2011 operating profits was about $4,989 million, which was 12.4% increase over the FY2011 amount. The company's FY2011 net profit was $4,119.2 million which was a 10.3% increase of the FY2010 amount (Datamonitor,2012).

Literature Review

Extant literature has been dedicated to the evaluation and identification of the characteristics of company financial statements that are desirable, the users of financial statements, the financial year/accounting period concept as well as the analysis and interpretation of financial reports with ratios and percentages. In this section, we employ an in-depth analysis of peer-reviewed journals in exploring the above-mentioned concepts. That is; the aspects of financial statements that are deemed desirable, the users of corporate financial statements, the financial year/accounting period concept as well as the analysis and interpretation of financial reports with ratios and percentages.

The Desirable Characteristics of Financial Statements

Qualitative

According to Tulsian (2002), the qualitative characteristics of financial statements are the specific attributes that make the data or information that is contained in financial statements that can be of use to company stakeholders. In this section, we present an elaborate literature review of these attributes.

Extant literature has been dedicated to the analysis and discussion of the qualitative characteristics of financial statements. The work of Spiceland, Sepe and Nelson (2011) provided an almost similar account and a description of these characteristics as the ones presented by Tulsian (2002). According to these authors, the desirable qualitative characteristics of financial statements can be represented by the diagram below (Figure 1).

Figure 1: The desirable qualitative characteristics of financial statements

Understandability

According to Tulsian (2002), an essential characteristic of the information that is contained in financial statements is that it must be readily understandable to virtually all users and stakeholders. For this reason, the users are often assumed to possess a reasonable knowledge of the business, economic activities, accounting as well as willingness to clearly study information contained with a reasonable degree of diligence. It is however important that information regarding complex issues is included in the financial reports due to its relevance to the users' decision-making process.

Relevance

In order for the information contained in the financial reports to be of value, it must be able to positively influence the decision-making process and address the needs of the stakeholders and users. Any information has the attribute of relevance when it is capable of influencing the economic decisions of the various users by aiding them in the evaluation of the past, present and future vents as well as confirming and even correcting all or certain instances of past evaluation. The productive as well as confirmatory roles of financial information are closely interrelated. The work of Tulsian (2002) for instance provides an example in which the financial information on the current level as well as structure asset-holding for a company has value to the users when they strive to predict an enterprise's ability to take advantage of various opportunities as well as its ability to effectively react to all sorts of adverse situations. This information can further be used in confirming past predictions about the company.

Materiality

According to Tulsian (2002), the relevance of any piece of information is highly affected by the nature as well as materiality of the information. Information is referred to be material if mis-statement or omission. The level of materiality is noted by the author to depend on the size of the error or item when judged in the exact circumstance of its mis-statement or omission.

Fair representation (formerly referred to as reliability)

Tulsian (2002) noted that for information to be useful, it must be reliable. Information is therefore noted to have a high degree of reliability if it is completely free of any material error or bias and can therefore be depended upon by users to be a true representation of the purported fact.

According to Filipovi? (2012,p.86) fair representation is one of the most important basic characteristics of financial statements.The mission of fair representation is to enable financial reports to be presented without any sort of prejudice or material miss-statements. The 2010 Framework indicates that accounting information that possesses fair representation must be neutral, complete and be without any form of material misstatements. Other important characteristics are substance over form, neutrality, prudence and completeness

Financial statements must be free from any form of bias (Van Beest at al,2009). An annual report is however, noted by Van Beest at al (2009) to contain some form of bias that can never be completely eliminated. This is due to the fact that economic phenomena in these reports are often measured under uncertain circumstances. Even though a complete lack of bias ca never be attained, a certain degree of accuracy is required for financial statement information to be useful for the decision-making process (IASB,2008).This therefore, makes it necessary to examine the type and level of argumentation that is provided for the various assumptions and estimates in the annual reports as noted by Jonas and Blanchet (2000).

If a valid argument has been provided for the estimates and assumptions, then they are most likely to be representative of the economic phenomena without any form or degree of bias. Additionally, valid and solid arguments that are provided for the employed accounting principles are noted to increase the chances that the preparers completely understand the method of measurement. This therefore reduces the possibility of encountering unintentional material errors in the final financial statement as noted by Maines and Wahlen (2006) and Jonas and Blanchet (2000).

Neutrality is defined as the total absence of distortion or prejudice that is intended gear towards a predetermined outcome or behavior. Neutral financial information is noted by OASB (2008,p.37) to have no degree of influence on the image that it communicates. Faithful representation on the other hand refers to the nature of auditor's report. Extant literature has investigated the impact of the auditors' report and audit on a firm's economic value (Kim et

al., 2007' Gaeremynck & Willekens, 2003; Kim et al., 2007).The reports concluded that an auditor's report does indeed add some value to the financial reporting information through the provision of a reasonable level of assurance and the degree to which the annual financial report faithfully represent the actual economic phenomena (Maines & Wahlen, 2006).

The final element of faithful representation is the issue of corporate governance statement. Corporate governance and its link with the quality of financial reporting has been a subject of academic inquiry. The association between corporate governance, financial reporting, internal controls, manipulation of earnings and corporate fraud has been investigated by various researches. Poor corporate governance and poor internal control mechanisms are associated with reduced quality of the financial statements (Rezaee, 2003; Dechow et al., 1996; Beasley, 1996; McMullen, 1996).

Quantitative

The quantitative characteristics of financial statements has been covered in literature in regard to the use of financial ratio analysis.. The basic attributes however are; clarity, reliability, relevance and comparability. The work of Salmi and Martikainen (2004) explored the empirical and theoretical basis of financial ratio analysis.Reilly and Brown (2006) indicated that financial ratio analysis is important since it helps analysts to make up meanings of numbers. They therefore help the analysts in establishing a meaningful relationship between financial values contained in financial statements. They noted that a single number sourced from a financial statement is meaningless. Relative financial ratios are therefore the most important.

The Users of corporate/company Financial Statements

Several researchers have documented the various users of financial statements and their desires. The work of Jesswein (2010) indicated that company management is some of the users of financial report information and they can use the information in the assessment of how well a company performs. In the process of analyzing the financial conditions of a company, the company management is noted to have an upper hand. Franco et al. (2009) on the other hand indicated that users use financial information for comparability purposes. They use it for comparing the performance of an organization to its competitors' performance. The users in this case can be shareholders and company management. Financial reports can also be used for corporate governance. In this case, management, shareholders and regulatory authorities can use it in evaluating the level of corporate governance and accountability (Dabor and Adeyemi,2009).

Financial Year/Accounting Period Concept

The concept of financial year is not widely explored in existing literature.

The Analysis and interpretation of financial reports with Ratios and percentages

Application of Literature Review into practice for IKEA's 3-year (2009-2010-2011) financial reports

A review of the FY2009,FY2010 and FY2011 financial statements for IKEA indicates the following;

IKEA financial statements are understandable. As indicated in the work of Tulsian (2002), an essential characteristic of the information that is contained in financial statements is that it must be readily understandable to virtually all users and stakeholders. For the sake of this, financial statement users are then assumed to possess a reasonable knowledge of the business, economic activities, accounting as well as willingness to clearly study the provided information with a reasonable degree of diligence.

IKEA financial statements have a high degree of relevance. In order for the information contained in financial reports to be useful, information contained within must be effectively inform decision-making process (Tulsian,2002). Any information has the attribute of relevance when it is capable of influencing the economic decisions of the various users by aiding them in the evaluation of the past, present and future vents as well as confirming and even correcting all or certain instances of past evaluation.IKEA financial statements have a high degree of comparability. This is however internal comparability since it compares the performance of the company with the previous financial year performance

3-year comparative ratio analysis and their interpretations

Profitability ratios

Gross Profit Margin

2009 GPM = (21,846-11,878)/21,846=0.46 or 45.6%

2010 GPM=(23,539-12,454) / 23,539=0.47 or 47%

2011 GPM = (25,173-13,773) / 25,173=0.452 or 45.2%

IKEA's gross profit margin improved between 2009 and 2010 but significantly deteriorated in 2011.This metric can be used in comparing IKEA with its competitors. Companies that are more efficient would have higher profit margins. In 2011, IKEA became less efficient.

Operating Profit Margin/margin ratio

2009 Operating Profit Margin= 2,770 / 21,846=0.127 or 12.7%

2010 Operating Profit Margin= 3,197/23,539=0.136 or 13.6%

2011 Operating Profit Margin=3,592/25,173=0.143 or 14.3%

IKEA's operating profit margin progressively improved over the years from 2009 to 2011. This means that the quality of the company is high because the operating margin gives us the idea of what IKEA makes before interests and taxes on each and every dollar of sale.

Net Profit Margin

2009 Net Profit Margin = 2,538 / 21,846=0.116 or 11.6%

2010 Net Profit Margin = 2,688/23,539=0.114 or 11.4%

2011 Net Profit Margin =2,966/25,173=0.118 or 11.8%

IKEA's net profit margin deteriorated between 2009 and 2010 but improved in 2011.

This is a ratio of profitability that is calculated by dividing net income by revenues, or by dividing net profits by sales. A higher profit margin suggests a more profitable firm that has a better control over its costs. The figures indicate that in 2011, IKEA gained better control over its costs.

Return on Equity (ROE)

Return on Equity = Net Income/Shareholder's Equity

But

2009 Return on Equity (ROE)= 2,538 / 19,726=0.129 or 12.9%

2010 Return on Equity (ROE)= 2,688 / 22,841=0.118 or 11.8%

2011 Return on Equity (ROE)= 2,966 / 25,411=0.117 or 11.7%

IKEA's ROE deteriorated between 2009 and 2010 but slightly increase in 2011.This ratio helps in showing how much profit a corporation generates with the funds the shareholders have invested.

Liquidity ratios

Current Ratio

2009 Current Ratio= 20,247 / 11,426=1.77

2010 Current Ratio= 22,608 / 12,811=1.76

2011 Current Ratio= 23,292 / 11,878=1.96

This ratio measures IKEA's ability to meet its short-term obligations. Its current ratio deteriorated between 2009 and 2010 but improved between 2010 and 2011.This indicates that IKEA is becoming more and more able to meet its short-term obligations.

What is missing or ok in the reports?

On the basis of the literature review, we see that IKEA financial statements lack reliability/fair representation.As noted in the work of Filipovi? (2012,p.86) fair representation is one of the most important basic characteristics of financial statements. The mission of fair representation is to enable the financial reports to be presented without any sort of prejudice or material miss-statements. The 2010 Framework indicates that accounting information that possesses fair representation must be neutral, complete and be without any form of material misstatements. Other important characteristics are substance over form, neutrality, prudence. Neutral financial information is noted by OASB (2008,p.37) to have no degree of influence on the image that it communicates. The reports are self-praising and make no reference to any external auditor in regards to the sustainability efforts of the company.

Literature Review of "Strategic Management Accounting Concept" and its application to facilitate the IKEA's ambitions for the future.

According to Simmonds (1981), the concept of strategic management accounting (SMA) has been employed in describing the process of providing as well as analyzing the management accounting data about an organization and its competitors for use in development and monitoring of the business strategy. Roslender and Hart (2010) traced the origin and controversies surrounding the concept of strategic management accounting (SMA).

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