Possible Objectives of Financial Reporting
There are several possible objectives for general purpose financial reporting. Explain what these objectives might be, and which one you think best applies to Amazon’s financial reporting (based on the information in the case study). Make sure that you fully explain your answer.
The objective of financial reporting is to make the stakeholders aware of the financial performance of an organization. The various types of stakeholders include customers, managers, shareholders and regulatory bodies. Shareholders need financial statements to understand, whether the organization is capable of returning their investments. The parameters, which highlights the financial standings of a company comprise income per share along with return on capital employed and net profit (EY, 2010). Financial reporting tends to explain the facts that on whether the standards of the final reports have been complied with the legislations passed by the accounting bodies (Crown Copyright, 2015).
Managers use financial statements making important business decisions. For example, the present trend of costs and profits enable them to ascertain that the business operations are running smoothly and are scheduled as per the plans. In case, if the profit level is observed to be low, then cost rises. Hence, it becomes reasonable to revise the entire process of cost control. The managers use income statement for the preparation of cash flow accounts. It reflects about the movement of cash that exists in the organization. Apart from determining the present status, the financial standards of reporting often enables the managers to take right decisions regarding future activities. Budgets can also be considered to be a product that allows the managers and top level executives to keep their costs under control. Other than investors, creditors often use financial statements to know that whether a business is capable enough to return the loans and advances. It includes the suppliers and banks (McGraw-Hill Global Education Holdings, LLC, 2017).
The given case study explains that one of the prime objectives of the financial reporting pertaining to Amazon is to create awareness among the investors regarding the performance of the company. This is mostly because there has been an extensive focus on the return to investors. During 9/22/2017, Amazon experienced a fall with respect to its stock price by 1.05%. Such instances are can lower the confidence of investors. It led to further shrinkage in the value of shares of the company. The shrinkage in the stock price was much lower than expected, which enhanced issues for the Chief Executive Officer (CEO). Such instances are observed to make the investors impatient. Investors were observed to be reluctant in making further investments until there has been rise in the amount of gross profit to the level of operating income. Operating income is calculated by deducting depreciation from gross profit. Concerns of the CEO-Jeff Bezos, of Amazon believed that further investments is supposed to cause decline in the levels of earnings and profits resulting to shrink the share price. This clearly indicates that the key intention of financial reporting was to create awareness among the shareholders (Schaefer, 2014).
Amazon’s Financial Reporting Objectives
The case study mentions regarding the fact that there has been a rise in the revenue earnings of Amazon during 2014, but it has not been possible to gain confidence of the investors. It is thus observed that although, Amazon has provided a return of 700% to the investors over the last ten years but retardation in the level of profit and revenue has created a significant problem for the investors. Therefore, the company’s company also mentioned about the initiatives that are likely to increase the share price of the online retailer. For example, the CEO has focused on concentrating its resources in the areas of grocery delivery, as it provides opportunities for rise in profit level and earnings. The CEO appears to be quite tensed regarding the facts that share prices are not always in a bullish situation. The initial public offering (IPO) done by Alibaba is supposed to curtail down investments, as investors tend to shift stock trading from Amazon. To conclude, it can be asserted that the management of Amazon uses financial related reporting to reveal the investors about its performance (Schaefer, 2014).
From the case study, it appears that the CEO of Amazon, Jeff Bezos, might be receiving bonus company stock based on accounting outcomes (reported profit, for example, or share price performance). Let us assume for now that this is true. Would Jeff Bezos or Amazon’s shareholders prefer Amazon to use conservative accounting methods such as historical cost? Fully explain the likely preferences of both parties.
The CEO of Amazon, Jeff Bezos is observed to receive bonus or stock option plan, as it is mentioned that he obtained an income of $29.3billion from the company as on 2014. His return is observed to decrease due to fall in the share price caused by declining profit and earnings (Schaefer, 2014).
Conservative methods of accounting clearly states that that there is a proper requirement of maintaining scrutiny, so that all the probable chances are easily detected. It further mentions that the financial statements must contain information relating to expenses and revenues of a particular period. It is clearly depicted that losses must be recorded and there is no such need of including the expenses. This is because timely measures can be taken for mitigating away the losses that is to be incurred in the future. Thus, it can be concluded that the principle of conservatism is truly applicable from perspective of shareholders and the CEO. In a situation, when there has been a fall in the share price due to slump in operating profit, making it essential for making a detailed account for the losses that are faced by Amazon. This in turn will assist in reducing the chances of losses that can be faced by Amazon (VLE, n.d).
Preferences for Conservative Accounting Methods
Precisely, it is important for the management to focus on the factors, which are responsible for lowering the revenue, profits and shareholders’ return of the company during the year 2014. It can be due to rise in operating costs, enhancement in tax rate or ineffective expenditures made on promotions. Thereafter, the management has to take remedial steps, which are effective in covering the costs by earning large revenue. The various aspects of losses that have to be considered by Amazon, while preparing the financial statements include providing provision on account of bad debts, loss on issue of debentures, which have been issued at discount. Depreciation of assets is also to be considered by the management while preparing the financial statements. Even a small amount of expenses that are incurred on purchase of stationery have to be recorded in the books of accounts as per the theory of conservatism (VLE, n.d.).
Amazon has to record even the minute things, which can lead to loss in the share prices. For instance, IPO by other online retailers such as Alibaba is responsible for paving away investments to the competing business. There are however, certain limitations of conservatism theory of accounting, which makes it inappropriate to use. For example, excessive recording of expenses can cause fall in the recorded profit margin by a large amount. As a result of this, the management can take certain remedial steps, which are unnecessary. It eventually would decline the profit available to shareholders along with reducing the price of the company stock. Additionally, such fall in the level of stock prices is depicted to reduce investor’s confidence and make them reluctant to invest in the stocks in future. As a result, it would have been difficult for Amazon to raise funds from the equity market. Scarcity of funds is further depicted to reduce the ability of Amazon to expand and improvise its existing online retailing services. Thus, there is a need to use the conservatism principle of accounting in the most judicious manner, so that the level of profits are neither overstated or understated (VLE, n.d.). Historical cost method of accounting can be stated as a particular conservatism rule, wherein cost of an asset is recorded at the time of purchased purchasing. Pertaining to Amazon, it can clearly be inferred that the method is not suitable. This is because the approach does not involve any significant alterations s in the overall assets’ value based on the current conditions of the market. As a result of it, effects on the share prices cannot be determined exactly (Rich & Jones, 2017).
Limitations of the Conservatism Principle of Accounting
Use Capital Markets Research (CMR) to explain the reaction of Amazon’s shareholders to Amazon’s earnings announcement.
The situations prevailing in the market clearly explains that the level of profit had been lowered down for Amazon during the year 2014. This particular situation reduced the price of shares in the stock market and turned down willingness of the investors to invest further in Amazon. The fall in the prices of shares during the year was 11%. Investors were already anticipating that such downturns are depicted to reduce the stock prices (Schaefer, 2014).
The research on capital market, which explains the phenomenon of the stock markets clearly state that there has been loss in the value of the share as expected by the analysts. The management of Amazon reported that such anticipations were not rational, as the analysts expected higher sales revenue as compared to the expected amount. The earnings announcement of the online retailer clearly mentioned that there has been a loss of 95 cents in each share in 2014, whereas in the previous year the loss was only 9 cents. On the contrary, it was evident that there was a rise in the revenue earnings in 2014 in comparison with 2013. Similarly, it was also observed during the year 2014, cash inflow with respect to the operations hiked than the previous year of 2013. The CEO was observed not to be bothered regarding the decisions taken by the investors after earnings announcement in 2014 (Rosenfield, 2014).
Investors are observed to be quite tensed about the fall in share price that was noted after loss reported by Amazon. This was because of the anticipation that Amazon did not take any initiative for upgrading its performance. The total loss that was evitable to Amazon for was estimated to be over $15billion. This was mostly due to of low investment or withdrawal of the investors in the equity market. Investors perceived that though the online retailer would provide return on investment at an appropriate rate, but it would have been difficult to offer the same within the due time. Investors paved away with their decision to invest in the shares of Amazon despite the fact that the online retailer disclosed about its initiative to expand its operations in new areas such as television and modern electronic gadgets (Mac, 2014).
The analysts of the leading market research group USB stated after the declaration of results for 2014, the investors still had the intention to invest, when the gross profit will at least be equal to the operating income. This is because rise in gross profit to the level of operating income indicates the hike in the profit available to the shareholders. It can thus be considered as a situation of neutrality, when there is no such trade-off between profit level and income available to the equity shareholders. The research on capital markets indicates that despite of rise in the volume of trade in shares of Amazon, there has been low amount of investment. This was mostly because there has been low amount of returns pertaining to each individual shares of Amazon. Investors just ignored the fact that the market has been in bullish conditions on a long term basis, especially after declaration of the earnings report by Amazon (Schaefer, 2014).
Historical Cost Method and Amazon
The reluctance and pessimistic views of the shareholders was also due to fall in the price-earnings ratio in 2014. As per the reports mentioned by the capital markets research it was observed that there has low investment rate despite the rise in the revenue earnings of Amazon. The same applies in this case and the problem was coupled when it the report that profit level decreased. It was reported that shares were reduced by 10% in 2014 (Stewart, 2014).
Explain how an Amazon investor might use heuristics to decide whether to buy, sell, or hold Amazon shares. To answer this, you should explain the various categories of heuristics available to the investor.
Heuristic refers to use of intelligence for taking any decisions on particular aspects. The method is observed to give practical solutions to any problem. It is however not necessary that the method will always provide an accurate result. This is because results are obtained with the support of a learning approach or studying trends (Rouse, 2017; Carvalho, Savransky & Wei, 2004). In the present case, it is clearly evident that the share price of Amazon fell in 2014 by considerable extent due to fall in the profit level despite of rise in the revenue earnings. Investors were mostly reluctant to invest further in the shares of Amazon, as they anticipated that it would cause fall in the return available to shareholders. The use of heuristics methods can be used to understand about the various decisions that an investor can take to base his/her future decisions pertaining to investment in Amazon. An investor can make three types of decisions after noting the trend of falling share price of Amazon. It can be hold, sell or invest further in the shares of Amazon. The decisions can be taken by perceiving the views of experts or studying the reports that is published by the market research organizations providing detailed information on situation of the capital markets and their future trends (Kliger & Kudryavtsev, n.d.).
The investors can hold or sell the shares rather than making further investments. Infact, there are various factors which has to be considered by the investors pertaining to making investments in the shares of Amazon. Foremostly, it depends on the risk taking attitude of the investors that whether they intend to buy shares. In case, the investors are observed to have low risk taking attitude, then it is beneficial to reduce investments in the shares. On the contrary, the investors must sell the shares, so that chances of future losses due to low return can be mitigated. The heuristics do not explain that investors will be in a better off position on selling the shares. This is because unanticipated rise in the stock price can be regarded as the opportunity cost of selling the shares (Forbes, Hudson, Skerratt & Soufian, 2015; Wustenhagen & Menichetti, 2012).
Capital Markets Research and Shareholders’ Reaction
In case the investors are risk takers, then they can hold the shares of Amazon. Later on, when the market will be in a bullish situation then there is a need to make further investments or sell away the shares of Amazon. It is supposed to provide large gains to the investors. For example, in case, if it is observed that the share prices of Amazon increases by more than 20%, then there will be high rise in the level of profit that is apportioned to the shareholders. Moreover, in situations when the investors focuses on taking high risks, then there is a need of buying shares of Amazon when the market was at extremely bullish situation during 2014. Applying the rule of heuristics, it can be stated that rise in the share price in future will lead to profit to the shareholders. On the contrary, fall in the share price can lead to significant losses (Venkatapathy & Sultana, 2016; Ali, 2011).
The risk taking attitude can also be dependent on the thorough study of the market. In case, it is found that the trend of online retailing shows that share prices rise after a period of downturn, then it is evitable to invest further in the shares or hold investment (Su, Chang & Chuang, 2010; Kempf, Merkle & Niessen-Ruenzi, 2012). On the other hand, in case, if the trend analysis discloses a fall in the share price after down turns then it is important to hold further investments. The technique of heuristics can also be applied by taking suggestion from experts or other investors (Smith,Harrison & Mason, 2010).
Critical theorists view accounting very differently to positive or normative theorists. Use critical theory to explain how Amazon uses accounting and accountants for its own purposes.
Accounting is generally done to gather insights about the financial performance of the organizations. In other words, it can be stated that accounting enables to trace the issues existing in the organizational strategies, which is lowering down the level of profit (Garg, n.d.). The positive theory of accounting states that financial statements must be made in the most rational manner. In other words, it explains regarding the need of considering a particular method of accounting, which helps in creating value for the business. It further states that the stakeholders must be able to draw meaningful inferences from the financial statements. For example, the shareholders must be aware of the earnings per share and profit available to stockholders. Positivist theory of accounting considers the need of mentioning about the reasons for which a particular method has been chosen for preparation of the financial statements. It mandates the need of disclosing vital information on the financial statements. Debts along with the payments for expenses are considered t be essential factors, which are to be included in the financial statements (Watts & Zimmerman, 1990; Locus RAGS, 2014).
Normative theory of accounting states the need of developing a conceptual framework that for getting insights about the manner in which entries is to be included with the company’s financial statements. The normative theory with respect to accounting focuses on describing the need for changes, which are evitable during the preparation of financial statements. For instance, changes in the external environment often make it necessary to bring about alterations in the accounting policies that are followed by an organization. This calls for developing a new conceptual framework (Locus RAGS, 2014). Another form of accounting is the critical method that looks at the method of for preparing the organization’s financial statements in a different way. The primary argument of the critical theorists with respect to accounting is mostly related to reflecting key areas of improvements that are needed for bringing about changes in the organizational performance. Unlike, positive or normative theory of accounting, critical theorists does not directly focus on the logic behind the use of different methods of accounting. It reflects the need for preparing the financial statements by considering the political and economic situations that prevails in the market (Haslam & Sikka, 2016).
Pertaining to Amazon, it is clearly evitable that critical accounting theory is practiced by the accountants of the organization. It is because the case study repeatedly mentions about the fact that the share prices of the organization had been decreased significantly and continuously in the year 2014. It infers that apart from mentioning the daily expenditures and revenues, the accountants prepare the financial statements in an effective manner, so that it can be easily understood by the stakeholders. The case study therefore highlights the consideration for return, which is available to the stakeholders after attaining profit. Most of the accounting in case of Amazon is done by considering the present information. For instance, calculation of inventory is done at the market price and there is also a need to consider the features of taxation (Schaefer, 2014; Stock Analysis, 2017).
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