Accounting Principles And Practice

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Accounting Principles and Practice

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ACCOUNTING PRINCIPLES AND PRACTICE 2

ACCOUNTING PRINCIPLES AND PRACTICE

Introduction

One of the critical objectives of accounting is to prepare financial statements and

report financial data to stakeholders and other users of financial information. Financial

statements are important elements in evaluating an organization’s performance and therefore

each organization must prepare them. Performance measurement and evaluation are done by

examining changes in financial statements over time. Financial statements are formal records

and/reports that show the financial activities, transactions, events, and the position of an

enterprise over a given period of time or on a specific date (Hoyle, 2015). The most

commonly used financial statements are the statement of financial position (Balance sheet)

and the income statement. The balance sheet shows the financial condition of an entity as at a

certain date usually the year-end while the income statement shows the financial operations

and/or performance of a company over a specified duration of time usually one year. The

purpose of preparing financial statements is to provide useful data on the financial position,

performance, and changes in financial condition of an entity.

IKEA Group Financial Statements Analysis

Overview

Financial statements of a company present an account of a company’s historical

performance, an image of its current performance, and an indication of the future potential of

the company. However, this is clearly established through financial statements analysis. This

is done by analyzing the elements within the financial statements using a variety of tools

and/or techniques (Hoyle, 2015). This review of financial statements of a company helps the

statements users to make an even better economic decision. This paper will present the

financial statement analysis of IKEA group and determine the financial performance of the

ACCOUNTING PRINCIPLES AND PRACTICE 3

company for a period of two years. IKEA (Ingvar Kamprad Elmtaryd Agunnaryd) group is a

global company founded in 1943 in Sweden (IKEA Group, 2017). The company creates and

trades in ready to assemble furniture, kitchen appliances, and home fittings. The company, as

of 2017, had more than 415 stores with operations in more than 49 countries worldwide.

Importance of Financial Statements Analysis

The sole essence of conducting financial statement analysis is to establish the

financial performance and efficiency of an entity over time. It is also important to note that

through financial statement analysis, a company is able to identify areas of potential

weaknesses and put in place systems and mechanisms to suppress such weaknesses (Wahlen,

2014). The purpose of this study was to establish the financial performance of IKEA group

for the periods ended 2016 and 2017 through conducting financial statement analysis.

Specifically, two financial statement will be analyzed, that is, consolidated income statement,

and consolidated balance sheet. The analysis will be presented in terms of changes in gross

profit, net profit, current assets, and return on equity of the company in the two-year period.

The importance of using these four variables is to assess the ability of the company to create

wealth for its shareholders while at the same time remain profitable and liquid enough to

meet its daily operational needs.

Consolidated Income Statement

The income statement is a financial statement that presents a company’s financial

performance over a specific period of time. It reports, in monetary terms, the sum of revenue

made, the value of expenses incurred and the subsequent net profit or loss for the said period

(Wahlen, 2014). The financial performance here is determined by assessing the dollar value

of the net profit or loss made in a certain period compared to other previous periods. The

ACCOUNTING PRINCIPLES AND PRACTICE 4

consolidated income statement is simply a single income statement for a group of companies,

that is, parent and its subsidiaries after conducting a couple of adjustments.

Consolidated Balance Sheet

The balance sheet, also known as the statement of financial position, is a financial

statement the presents, in monetary terms, the assets, liabilities, and owners’ equity of a

company at a specific date. The financials presented in the balance sheet provide a basis for

calculating rates of returns and capital structure evaluation (Hoyle, 2015). Financial

performance using the balance sheet is done by assessing what the company owns, what it

owes others, as well as the total sum of investment from its owners. The consolidated

balance is an amalgamation, with few adjustments, of the balance sheets of the parent and its

subsidiaries.

Users of Financial Statements

Financial statements are relied upon by various users to make informed economic

decisions. These users can be grouped into internal and external users. The internal users

comprise of the company’s management who utilize the results generated from financial

statement to make operational decisions (Accounting Tools, 2018). External users, on the

other hand, include all those users who do not necessarily belong to the company but have

some form of financial interest in the company affairs. These users are explained in further

details below:

1. Management: The management, especially top-level management, use financial

statement reports and/or analysis results to make informed decisions about the overall

financial performance of the company. For example, they may use financial statement

analysis to assess the liquidity of the company and make decisions on what ought to

be done from these results.

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2. Investors: Shareholders and other investors of the company have a specific interest in

the financial well-being of the company. They rely on the financial statement to

determine the earning capacity of the company and to forecast the future growth

potential of their investments in the company.

3. Creditors: Creditors and providers of loan capital have interest on the ability of the

company to promptly honor its obligations. The usually rely on the balance sheet and

the statement of cash flow to assess the liquidity, solvency, and stability of the

company’s cash flows which in turn help them in deciding whether to extend credit

facilities to the company or not.

4. Government: The general performance of the economy is dependent on how well the

businesses and companies within that economy are performing. The government,

therefore, needs financial statements to design the fiscal and monetary policies.

Similarly, the government needs financial statements to determine the level and

amount of tax to charge the company.

5. General Public: This includes students, financial analysts, researchers, customers,

and the media. They are interested in how well the company utilizes its available

resources to generate income while minimizing costs. They may also have an interest

in the contribution of the company to the growth of the economy and its

responsiveness to environmental changes.

Gross Profit

This is the profit that a company makes after deducting selling related costs.

For the year ended 31

August 2016;

Sales revenue (€2176 Million) less Cost of goods sold (€1292 Million) = €884 Million

For the year ended 31

December 2017;

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Sales revenue (€22,878 Million) less Cost of goods sold (€18,688 Million) = €4190 Million.

The results indicate an increase in gross profit increased of €3306 million or a

whopping 373%. This indicates that the company was able to increase its sales revenue while

keeping its cost of sales low.

Net Profit

This is equivalent to gross profit plus other incomes apart from sales revenue less

operating expenses, non-operating expenses, and income tax expense.

For the year ended 31

August 2016; €258 Million

For the year ended 31

December 2017; €912 Million

There was a relatively reduced improvement in the net profit (€654 Million or 253%)

compared to the increase in gross profit (357%) mainly because the company incurred huge

operating expenses and attracted a significant amount of income tax expense in 2017 as

compared to 2016.

Current Assets

These include cash and other liquid assets, that is, all assets that can be converted into

cash within a year.

As at 31

August 2016: €8369

As at 31

August 2017: €8717

The current assets of the company increased by approximately 4% from 2016 to 2017.

However, this increase is mostly attributed to an increase in accounts receivables and is

therefore not a good indicator of performance. Cash and inventories decreased putting the

company at risk of running out of cash or inventory stockout.

ACCOUNTING PRINCIPLES AND PRACTICE 7

Return on Equity

This is a financial ratio that measures the number of dollars of profit generated per

dollar of shareholders equity or investment. It is calculated as net income (after tax) divided

by total shareholders’ equity.

2016: €258 Million ÷ €4258 Million = 0.06 or 6%

2017: € 912 ÷ €4194 = 0.22 or 22%

From the analysis above its apparent that the return on equity increased by 16% from

2016 to 2017. This means that the company was able to increase its ability to generate more

profits without the need for additional capital from its shareholders. It also shows that the

management was able to better deploy the shareholders’ fund to profitable activities.

Conclusion

In conclusion, financial statements are very crucial financial reports that are used by a

wide range of users in making informed financial and economic decisions. To better

understand financial statements and to clearly delineate what they are trying to communicate,

financial statement analysis is carried out by comparing historical data with current data to

project future possibilities (Wahlen, 2014). This essay analyzed the financial statements of

IKEA group for the years 2016 and 2017 using gross profit, net profit, current assets and

return on equity. The results indicate a tremendous improvement in the overall financial

performance of the company by more still needs to be done.

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References

Accounting Tools. (2018, February). Users of financial statements. Retrieved June 26, 2018,

from https://www.accountingtools.com/articles/users-of-financial-statements.html

Hoyle, J. B., Schaefer, T., & Doupnik, T. (2015). Advanced accounting. McGraw Hill.

IKEA Group. (2017). Inter IKEA Group Financial Summary FY17. Retrieved June 26, 2018,

from https://newsroom.inter.ikea.com/publications/inter-ikea-group-financial-

summary-fy17/s/479be39c-71f3-45bc-9162-cc95cca48ede

Wahlen, J., Baginski, S., & Bradshaw, M. (2014). Financial reporting, financial statement

analysis, and valuation. Nelson Education.

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