“Appraising the effect of the different classes of securities on the content of financial reports”
Financial statements are the tools through which the performance of the company is being evaluated. In the financial reporting of the company, financial securities have very crucial role as the transactions carry monetary value that impacts the overall presentation of financial performance in financial reports. There are mainly three different classes of securities, Equity securities, Debt securities and Derivative securities. The detailed descriptions of the securities and their impact on the content of financial reports like as Balance sheet, cash flow statement and Income statement are here under:
Equitable Securities and its effect on the content of financial reports
Equitable securities are the ownership of the company and these are issued by any company, either for the expansion purpose or to retire the medium or long-term debts. The financial statements have different impacts of the kind of transaction of the security, as surplus is recorded in the equity portion of the balance sheet that shows thecompany has much high owning as compared to liabilities.
As the company issues common stock, the case is debitedfrom the cash account, and equity account is credited with the same balance. It increases bank balance, as well as equity, thus shows a dual impact on the financial statements (Shin, 2014).This is not done if some transactions do not affect balance sheet such as stock splits and reverse stock splits as the higher number of shares in the outstanding and the value goes to tandem. Whenever the company issues its equity and raises cash, it reflects in cash flow statement and balance sheet without impacting the income statement. Although, in the income statement, nothing is required to mention about the equities since income statement is concerned only about the sales, expenses and profit. But, payback on equities comes out of the profits of the company which need to be reflected in the income statement. On the flip side, if the payment is made out of the retained earnings, it will also impact the net income of the company and its income statement. So, this is how equities affect the net income and profitability level of business thus affects financial statements (Christensen et al., 2017).
The other part of financial statement which is balance sheet reflects about the status of assets, liabilities and the capital (owner’s equity) of a business. As per the accounting equation, an asset equals the addition of liabilities and owner’s equity which impacts both the areas of equation whenever any company issues equity (Eser and Schwaab, 2016). For example, if company issues equity, it increases the owner’s equity as the stock issued, raises cash as an asset by the money received, increases the common stock and also raises the paid up capital of the company from its issuance.The cash flow statement reflects how the activities of the company affect its cash generation and outflow. Cash Flow Statement is mainly classified into three activities: operating, investing and financing activities. Among the three, financing is the one which largely affects the issuance or distribution of equities. Typically, it indicates the movement of cash between the company and its owners. Further, financing activity reflects both negative and positive balance of cash. For example, when company purchases or repurchases shares, it reduces the flow of cash in the company, also certain companies believe in making adividend payment to its investors which again outflows the fund of the respective company and thus shows the negative balance in the financing activity (Gitman, Juchau and Flanagan, 2015). On the other hand, when company sells its shares, it results in aninflow of cash in the company from its investors which impact the financing activity of cash flow positively. Therefore, these are the factors which bring huge impact on the cash flow statement of the company.
Debt Securities and its effect on the content of financial reports
Debt securities are the significant sources of raising capital for business when a company issues debt, which is always in the form of bonds or debentures, this becomes a liability. Thus, it is recorded in a long-term section of the balance sheet. For example, in case a business issues bonds, the organisation debit cash and credit bonds payable in the similar fashion, capital-lease transactions are shown in the same format. Whenever company enters into a capital-lease arrangement, fixed-asset is debited, and account shows an economic control of the leased asset. Simultaneously, a capital-lease obligation account is credited for offsetting economic liability (Christensen et al., 2017). For starting up, setting up and for the smooth running of the business operations, assets play a significant role. Therefore, to maintain these assets and other resources, companies take help of financial institution, banks and other creditors by taking loans. These secured loans are the financial obligation of the company, but it helps in fulfilling the day-to-day activities of the business as well as it helps in acquiring the additional economic resources.The loan usually comes under the liability section in the balance sheet, when companies secure a loan; its entry has recorded an increase in the particular asset account as well as the corresponding increase in loan account. In case the company has more than one loan, the increase is recorded in the specific loan account. By the time, business starts to repaying its loan through which debt begins to reduce and those results in decreasing loan account with the assets which arebeing taken in used to pay the loan (Begley and Purnanandam, 2016).
Loans are the liabilities of the company,and it gives impact on both the assets and liabilities portion. For illustration, if any company borrows $21,000 in cash, so that amount is recorded in the asset account as an increase amount to track the cash and at the same time, it is recorded in the liability side to control the loan (Nobes, 2014). And for this matter, loan gives equal impact on both sides of the equation of accounting.
However, companies should always make a balance in the debt and equity section to show strong financial health of the business. The increase in the debt of thecompany is a sign of inclining company towards the shakier financial ground. The other factor, monitoring the balance sheet is also a very tool for the company regarding assessing its leverage. In case if the company carries a significant amount of debt in comparison with equity, then it is less capable of providing are turn to their investors than the less-leveraged company (Leuz and Wysocki, 2016). However, there must be an equal balance between the debt and leverages because it will result in expansion and growth of the company. The financial statements of the company greatly impacted on the chances of business to get finances. If the financial numbers of the company are not good, it will negatively impact the chances of business to borrow money because bad numbers lead to present a negative outlook for the company.
Derivative Securities and its effect on the content of financial reports
Derivatives are the financial securities which get the profit or loss value from the variation in the value of other derivatives. For example, a stock option is a financial derivative that gains or losses value because stock option itself has a profit or losses value. Derivatives are usually taken into consideration to hedging risk factor. The hedge helps in reducing the risk level as its value shifts in the opposite direction of the risky assets (Warren and Jones, 2018). Like for example, when the asset price goes down, the price of hedge hikes up which helps in maintaining the financial loss from the falling value.
Many companies issue debt securities regarding bond to finance the operations of the company. A bondlargely impacts the financial statements of the company. Bond is a debt product which is offered to investors by the company. In the balance sheet, the record of bond issuance is as; the corporate book keeperdebits its cash account and at the same time credits the payable bond account (De Pooter, Martin and Pruitt, 2018). Suppose, if the bonds are being issued at par value, it increases the corporate cash, an asset account and it also raises the bond payable account (long-term debt).
In the income statement, bond transaction gives impact on two accounts that is interest expenses and amortisation expense account. In the same series, equity statement is also impacted by the financial derivatives including dividends, accumulated profits, common stocks and the preferred shares. The issuance of thebond is affected by the amortisation and interest expenses as it reduces the net income which at last flows into account of retained earnings (an equity item). However, in the cash flow statement, bond transaction affects various records of entries including interest payment, principal remittance and issuance in both the operating cash flow as well as in the financing cash flows (Arena and Julio, 2015).
The other financial derivative is stock; the stock dividend earned is recorded in the stockholder’s equity section in the balance sheet as it uplifts the earning of the company. On the other hand, the retained earnings account is the cost of dividend, and common stock account presents the hike for asmall portion or for the whole dividend cost as stock dividend impacts the statement of the retained earnings. There is a strong connection between theissue of stock and income statement when company wind up its books; the accountants shift the net income into the retained earning account same as the common stock and the additional paid-up-capital (Gitman, Juchau and Flanagan, 2015). Furthermore, the issuance of stock to shareholders has its impact onboth the assets and liabilities side in the balance sheet to record the transaction. In this manner, financial derivatives give impact on the various financial statements of the company.
In a nutshell, it can be concluded that financial securities play a very important role in the financial activities and reporting of the companies. There are various equities, loans, bonds, and shares etc. which bring huge impact not only in cash flow statement, Income statement and the balance sheet but also impacts on the overall performance and profitability of the company. If the financial statement of the company is not sound, it will impact negatively on the goodwill of the company.
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