Professional Documents
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Following are the various accounting concepts that have been discussed in the
following sections :
Business entity concept
Money measurement concept
Going concern concept
Accounting period concept
Accounting cost concept
Duality aspect concept
Realisation concept
Accrual concept
Matching concept
This concept assumes that, for accounting purposes, the business enterprise and its
owners are two separate independent entities. Thus, the business and personal
transactions of its owner are separate. For example, when the owner invests money in
the business, it is recorded as liability of the business to the owner. Similarly, when
the owner takes away from the business cash/goods for his/her personal use, it is not
treated as business expense. Thus, the accounting records are made in the books of
accounts from the point of view of the business unit and not the person owning the
business. This concept is the very basis of accounting.
Significance
All the transactions are recorded in the books of accounts on the assumption that
profits on these transactions are to be ascertained for a specified period.
This is known as accounting period concept. Thus, this concept requires that a balance
sheet and profit and loss account should be prepared at regular intervals. This is
necessary for different purposes like, calculation of profit, ascertaining financical
position, tax computation etc.
Further, this concept assumes that, indefinite life of business is divided into parts.
These parts are known as Accounting Period. It may be of one year, six months, three
months, one month, etc. But usually one year is taken as one accounting period which
may be a calender year or a financial year.
As per accounting period concept, all the transactions are recorded in the books of
accounts for a specified period of time.
Accounting cost concept states that all assets are recorded in the books of accounts at their
purchase price, which includes cost of acquisition, transportation and installation and not at
its market price. It means that fixed assets like building, plant and machinery, furniture, etc
are recorded in the books of accounts at a price paid for them. For example, a machine was
purchased by XYZ Limited for Rs.500000, for manufacturing shoes. An amount of Rs.1,000
were spent on transporting the machine to the factory site. In addition, Rs.2000 were spent on
its installation. The total amount at which the machine will be recorded in the books of
accounts would be the sum of all these items i.e. Rs.503000. This cost is also known as
historical cost. Suppose the market price of the same is now Rs 90000 it will not be shown at
this value. Further, it may be clarified that cost means original or acquisition cost only for
new assets and for the used ones, cost means original cost less depreciation. The cost concept
is also known as historical cost concept. The effect of cost concept is that if the business
entity does not pay anything for acquiring an asset this item would not appear in the books of
accounts. Thus, goodwill appears in the accounts only if the entity has purchased this
intangible asset for a price.
Significance
This concept requires asset to be shown at the price it has been acquired, which can be
verified from the supporting documents.
It helps in calculating depreciation on fixed assets.
The effect of cost concept is that if the business entity does not pay anything for an asset, this
item will not be shown in the books of accounts.
Dual aspect concept
Dual aspect is the foundation or basic principle of accounting. It provides the very basis of
recording business transactions in the books of accounts. This concept assumes that every
transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides.
Therefore, the transaction should be recorded at two places. It means, both the aspects of the
transaction must be recorded in the books of accounts. For example, goods purchased for
cash has two aspects which are (i) Giving of cash (ii) Receiving of goods. These two aspects
are to be recorded.
Thus, the duality concept is commonly expressed in terms of fundamental accounting
equation :
Assets = Liabilities + Capital
The above accounting equation states that the assets of a business are always equal to the
claims of owner/owners and the outsiders. This claim is also termed as capital or owners
equity and that of outsiders, as liabilities or creditors equity. The knowledge of dual aspect
helps in identifying the two aspects of a transaction which helps in applying the rules of
recording the transactions in books of accounts. The implication of dual aspect concept is that
every transaction has an equal impact on assets and liabilities in such a way that total assets
are always equal to total liabilities.
Realisation concept
This concept states that revenue from any business transaction should be included in the
accounting records only when it is realised. The term realisation means creation of legal right
to receive money. Selling goods is realisation, receiving order is not.
In other words, it can be said that :
Revenue is said to have been realised when cash has been received or right to receive cash on
the sale of goods or services or both has been created.
Let us study the following examples :
(i) N.P. Jeweller received an order to supply gold ornaments worth Rs.500000. They supplied
ornaments worth Rs.200000 up to the year ending 31st December 2005 and rest of the
ornaments were supplied in January 2006.
(ii) Bansal sold goods for Rs.1,00,000 for cash in 2006 and the goods have been delivered
during the same year.
(iii) Akshay sold goods on credit for Rs.50,000 during the year ending 31st December 2005.
The goods have been delivered in 2005 but the payment was received in March 2006.
Accrual concept
The meaning of accrual is something that becomes due especially an amount of money that is
yet to be paid or received at the end of the accounting period. It means that revenues are
recognised when they become receivable. Though cash is received or not received and the
expenses are recognized when they become payable though cash is paid or not paid. Both
transactions will be recorded in the accounting period to which they relate. Therefore, the
accrual concept makes a distinction between the accrual receipt of cash and the right to
receive cash as regards revenue and actual payment of cash and obligation to pay cash as
regards expenses.
Matching concept
The matching concept states that the revenue and the expenses incurred to earn the revenues
must belong to the same accounting period. So once the revenue is realised, the next step is to
allocate it to the relevant accounting period. This can be done with the help of accrual
concept.
Qualitative characteristics are the attributes that make the information provided in accounting
statements useful to users. The four principal qualitative characteristics are:
Understandabilit
y Relevance Reliability Comparability
Ascertaining net profit or loss: Summarisation in form of Profit and Loss Account
provides business income over a period of time.
2) Real account. All the assets of the company are Tangible = land a/c
included.(tangible and in-tangible
In-tangible = goodwill a/c.
assets.)
3) Nominal account. All the income and expenses will Expenses: purchase a/c.
come under this account.
Loss or loss by fire account.
Those account related to loss,
Profit and gain sales a/c.
profit and gains.
Discount received a/c .
ASSETS:
An asset is a resource controlled by the enterprise as a result of past event and form which
future economic benefits are expected to flow to the enterprise. An enterprise usually
employs its assets to produce goods or services capable of satisfying the wants or needs of
customers.
Since these goods or services can satisfy wants or needs ,the customer are prepared to pay
for them and hence contribute to the cash flow of the enterprise .cash itself renders several
services to the enterprise because of its command over other resources .the future economic
benefits embodied in an asset may flow to the enterprise in a number of ways : (A) an asset
may be used singly or in combination with other assets in the production of goods or services
to be sold by the enterprise ;(b) exchanged for other assets ;(c) used to settle a liability ; or
(d) distribute to the owners of the enterprise
Many assets have a physical form. For example, land and building ,plants ,equipments etc
.are of physical form .however, physical form is not necessary for the existence of an asset.
Patents, copyright, etc. are assets from which future economic benefits are expected to flow
to the enterprise and so these are assets to the enterprise although, they do not have any
physical form, if controlled by the enterprise.
Many assets for example, receivables and property are associated with legal rights, including
ownership. In determining the existence of assets the right of ownership is not essential. For
example, if a property held on lease, it is an asset to the enterprise if it is controls the benefits
which are expected to flow from the property. Thus always legal right of ownership is not a
characteristics feature for identifying an asset. What is essential is the controlling right of the
benefit emerging from such asset.
The asset of an enterprise results from the past transaction or other past events. For example
plant and machinery acquired in a past transaction from which an asset occurred. But the
transaction or event expected to occur in future do not give rise to asset. For example, an
intension to purchase the machine does not meet the definition of an asset. There is close
relationship between incurring expenditure and generating assets, which may not necessarily
coincide. For acquiring a piece of plant the enterprise needs to incurs the cost. So when
expenditure is incurred, this gives an evidence of the existence of an asset. But, when the
asset is donated to the enterprise, although no expenditure is incurred, an asset is created.
LIABILITY:
A liability is a present obligation of the enterprise arising from past events, the settlement of
which is expected to result in an outflow from the enterprise of resources embodying
economic benefits. An essential characteristic has a present obligation. An obligation is a
duty or responsibility to act or perform in certain way. An obligation may be legally
enforceable as consequences of a binding contract or statutory requirements. Obligations also
arise, however, from business practice, custom and a desire to maintain good business
relation or to act in an equitable manner.
A distinction needs to be drawn between a present obligation and a future commitment. A
decision by the management of the enterprise to acquire assets in future does not of itself give
rise to a present obligation. An obligation normally arises only when the asset is delivered or
the enterprise entries into an irrevocable agreement to acquire the assets.
The statement of a present obligation usually involves the enterprise giving up resources
embodying economic benefit in order to satisfy the claim of the other party. The settlement of
a present obligation may be done by: (a) payment of cash, (b) transfer of other assets, (c)
provision of services, (d) replacement of that obligation with another obligation, (e)
conversion of obligation to equity. The obligation may also be extinguished when the creditor
waives the liability.
Liabilities results from past transactions or other past events. Some liabilities can be
measured only by using a substantial degree of estimation. For example, income tax liability
of a year may not be exactly known at the time of preparation of financial statement. This
will be known only when the assessment will be over at some future date. Some enterprise
describes these liabilities as provisions.
Equity
Equity is a residual interest in the assets of the enterprise after deducting its liabilities. In a
corporate enterprise equity is suitable sub classification in the balance sheet. For example,
in India equity is classified as Share Capital & Reserve and Surplus. Under each head further
details are provided. The creation of reserves sometimes required by statute or other law in
order to give the enterprise and its creditors added measure of protection from future losses.
Creation of some reserve may be necessary as per tax law of the country. In India creation of
Export Profit Reserve is one such requirenment. Normally equity is shown at it paid up value.
INCOME
Income is increase in economic benefits during the accounting period in the form of inflows
or enhancement of assets or decreases of liabilities that result in increase in equity, other than
those relating to contribution from equity participants. The definition of income encompasses
both revenue and gains. Revenue arises in the course of the ordinary activities of an
enterprise and is rendered by a variety of different names, including fees, interest, dividends
and rent. Gains represent other items that meet the definition of income and may or may not
arise in the course of ordinary activities of an enterprise. Gains include, for example, those
arising in disposal of non-current assets. The definition of income also includes unrealized
gains. For example, those arising on the revaluation of marketable securities and those
resulting from increase in the value of fixed assets. When gains are recognized in the income
statement they are usually displayed separately because knowledge of them is useful for
making economic decisions. Gains are often reported net of related expenses. Income may
also result from settlement of liabilities.
Expenses
Expenses are decreases in economic benefit during the accounting period in the form of
outflows or depletions of assets or incurrence in liabilities that results in decrease in equities
other than those relating to distribution of equity participants. The definition of expenses
encompasses losses as well as those expenses that rise in the course of the ordinary activities
of the enterprise. Expenses in the course of the ordinary activities of the enterprise include,
for example, cost of sale, wages, manufacturing expenses, depreciation. They usually take the
form of an outflow or depletion of an asset such as cash and cash equivalent, inventory,
property, plant and equipment.
Losses represent other items that meet the definition of expenses and may or may not arise in
the course of the ordinary activities of the enterprise. Loose include, for example, those
resulting from disasters such as fire and flood as well as those arising on disposal of non-
current assets. The definition of expenses also includes unrealized losses for example, those
arising from the effects of increase in the rate of foreign currency. When losses are
recognized in the income statement, they are usually displayed separately because such
knowledge is useful for the income of making economic decisions. Losses are often reported
net of related income.
(1) Clerical error: This type of error may occur while preparation of vouchers, recording
transaction:
(a) Error of Omissions: Occurs when a transaction are omitted while recording in books. It is
further bifurcated in to two types Partial and Complete Omission. The Partial Omission
occurs when transaction is recorded only one side i.e. Debit side or Credit side. While total
omission indicates the entire transaction was not recorded in books of accounts.
(b) Error of Commission: In this type of error the transaction is recorded twice.
(c) Error of Compensation: In this type of error the figures may have posted wrongly,
however coincidentally compensated by opposite or in the same side of account in another or
same ledger by another mistake with the same value.
(d) Error of Posting: This type of error may occur when an entry one effect is given in correct
side of an account however the second effect is posted in another account for e.g. Cash
received Rs. 2000 from Mr. A the cash account is properly debited and instead of posting in
account A it may be posted in another account say Mr. B.
(2) Casting Error: Casting means total. This type of error may occur while balancing ledger
accounts or carried forward of total from one page to another page.
(3) Error of Principle: This errors are technical error which may occur while preparing
financial statements. The following are the e.g. of error of principle:
(a) Capital Expenditure may be treated as Revenue or vice versa.
(b) Method of valuation of stock stated may at cost however may be valued at market price.
(c) Method of Depreciation adopted may be different than stated in notes to accounts.
The Trial Balance will not tally in case of following types of error:
(1) Error due to Partial Omission &
(2) Casting error.
While other error effect either on both sides or in the same side with compensation. The error
of principle never effects the tally of trial balance, since they are effected only after
preparation of trial balance. They effect the Profit or Loss account and Financial Position of
the Company.
The term standard denotes a discipline, which provides both guidelines and yardsticks for
evaluation. As guidelines, accounting standard provides uniform practices and common
techniques of accounting. As a general rule, accounting standards are applicable to all
corporate enterprises. They are made operative from a date specified in the standard. The
Institute of Chartered Accountant of India (ICAI) constituted the Accounting Standards
Board (ASB) in April, 1977 for developing accounting standards. However, the International
Accounting Standards Committee (IASC) was set up in 1973, with its headquarter in London
(U.K.).
The Accounting Standards Board is entrusted with the responsibility of formulating standards
on significant accounting matters keeping in view the international developments, and legal
requirements in India.
The main function of the ASB is to identify areas in which uniformity in standards is required
and to develop draft standards after discussions with representatives of the Government,
public sector undertaking, industries and other agencies. In the initial years the standards are
of recommendatory in nature. Once an awareness is created about the benefits and relevance
of accounting standards, steps are taken to make the accounting standards mandatory for all
companies. In case of non compliance, the companies are required to disclose the reasons for
deviations and its financial effect.
The IASB then decided to introduce one set of globally acceptable accounting standards
across all the European countries. It announced that the new accounting standards issued by
the IASB would be designated International Financial Reporting Standards (hereinafter
IFRS), at the same time as the existing standards would continue to be designated
'International Accounting Standards (IAS). Presumably, this change was made in order to
enable the Board to distinguish between the new standards issued by them, and those that
they had inherited from the former International Accounting Standards Committee Board.
As per the European Commission's regulation, all European (EU) Companies listed on a
regulated market should prepare their consolidated accounts in accordance with the IFRS, by
2005 at the latest. This implies that the much-talked-about notion of harmonized financial
reporting under a single set of accounting standards is now a practical reality. Clearly,
Europe's decision has encouraged several other countries to adopt a similar path.
Academic research shows that foreign investors are more likely to invest in firms whose
accounting is similar to accounting of the country of the investors. Thus we can attract more
foreign capital and lower the cost of capital for our firms by adopting IFRS. It is time for
corporate India to lobby for the early and quick adoption of IFRS. This will benefit not only
Indian businesses and capital markets but also labor. Job opportunities for Indian accountants
will jump once the world realizes and recognizes that accounting in India is identical to that
in Western Europe, which adopted IFRS in 2005.
A single system of financial reporting would benefit a host of constituents. With quality
standards, consistently applied, investor understanding and confidence rises. That translates
to strong, stable, liquid markets. With quality reporting, investors wouldnt need to
compensate for a lack of under- standing by demanding a risk premium. With consistent
application and the resulting comparability investors and analysts have an easier time
knowing how to best allocate capital. Having one financial language reduces preparation and
audit costs. No longer is there a need to learn different standards, or keep current in them, at
the expense of more fruitful pursuits. Regulation can be easier if properly coordinated.
Education and training become easier and more focused.
Benefits of adopting IFRS
1. Improved access to International capital markets
Many Indian entities are expanding or making significant acquisitions in the global arena
for which huge capital is required. Majority of stock exchanges require financial information
prepared under IFRS. Migration to IFRS will enable Indian entities to have access to
international capital markets, without the risk premium involved in Indian GAAP financial
statements.
2. Lower cost of capital
Migration to IFRS will lower the cost of raising funds, as it will eliminate the need for
preparing a dual set of financial statements. It will also reduce accountants fees, abolish risk
premium and will enable access to all major capital markets as IFRS is globally acceptable.
3. Enable benchmarking with global peers and improve brand value
Adoption of IFRS will enable companies to gain a broader and deeper understanding of the
entitys relative standing by looking beyond country and regional milestones. Further,
adoption of IFRS will facilitate companies to set targets and milestones based on global
business environment, rather than merely local ones.
4. Escape Multiple Reporting
Convergence to IFRS, by all group entities, will enable company managements to get all
components of the group on one financial reporting platform. This will eliminate the need for
multiple reports and significant adjustment for preparing CFS or filing financial statements in
different stock exchanges.
5. Reflects true value of acquisitions
In Indian GAAP, business combinations, with few exceptions, are recorded at carrying values
and not at fair values of net assets taken over. Purchase consideration paid for intangible
assets not recorded in the acquirers books is usually not reflected separately in the financial
statements; instead the amount gets added to goodwill. Hence, true value of the business
combination is not communicated through financial statements. IFRS will overcome this flaw
as it mandates accounting for net assets taken over in a business combination at fair value. It
also requires recognition of intangible assets, even though they have not been recorded in the
acquirers financial statements.
Adopting IFRS in India: Challenges
In India, the convergence of GAAP (generally accepted accounting principles) with
International Financial Reporting Standard (IFRS) will pose various challenges on the tax and
regulatory front which companies, investors and regulators will have to grapple with. In
substance, for IFRS to become a reality in India by 2011, significant changes in the
regulatory framework will be required. The following major challenges are there to adopting
IFRS in India.
1. Shortage of Resources
With the convergence to IFRS, implementation of SOX1, strengthening of corporate
governance norms, increasing financial regulations and global economic growth, accountants
are most sought after globally. Accounting resources is a major challenge globally and will
remain so in the short-term. India, with a population of more than 1 billion, has only
approximately 145,000 Chartered Accountants, which is far below its requirement.
2. Training
If IFRS has to be uniformly understood and consistently applied, training needs of all
stakeholders, comprising CFOs, auditors, audit committees, teachers, students, analysts,
regulators, and tax authorities need to be addressed. It is crucial that IFRS is introduced as a
full subject in universities and Chartered Accountancy syllabus.
3. Information systems
Financial accounting and reporting systems must be able to produce robust and consistent
data for reporting financial information. The systems must also be capable of capturing new
information for required disclosures, such as segment information, fair values of financial
instruments, and related party transactions. As financial accounting and reporting systems are
modified and strengthened to deliver information in accordance with IFRS, entities need to
enhance their IT security in order to minimize the risk of business interruptionparticularly
to address potential fraud, cyber terrorism, and data corruption.
4. Taxes
IFRS convergence will have a significant impact on financial statements and consequently
tax liability. Tax authorities should ensure that there is clarity on the tax treatment of items
arising out of convergence to IFRS. For example, will government authorities tax unrealized
gains arising out of the accounting required by the standards on financial instruments? From
an entitys point of view, a thorough review of existing tax planning strategies is essential to
test their alignment with changes created by IFRS. Tax and other regulatory issues as well as
the risks involved will have to be considered by the entities.
5. Communication
IFRS may significantly change reported earnings and various performance indicators.
Managing market expectations and educating analysts will therefore be critical. A companys
management must understand the differences in the way the entitys performance will be
viewed, both internally and in the market place, and agree on key messages to be delivered to
investors and other stakeholders. Reported profits may be different from perceived
commercial performance due to the increased use of fair values and the restriction on existing
practices such as hedge accounting. Consequently, the indicators for assessing both, business
and executive performance, will need to be revisited.
6. Management compensation and debt agreement
The amount of compensation calculated and paid under performance-based executive and
employee compensation plans may be materially different under IFRS, as the entitys
financial results may be considerably different. Significant changes to the plan may be
required to reward an activity that contributes to an entitys success within the new regime.
Re-negotiating contracts that referenced reported accounting amounts, such as bank
covenants, may be required on convergence to IFRS.
7. Distributable profits
IFRS is fair value driven, which results very often in unrealized gains and losses. Whether
this can be considered for the purpose of computing distributable profits will have to be
debated, in order to ensure that distribution of unrealized profits will not eventually lead to
reduction of share capital.
8. Information availability and reliability
Until recently, financial accounting data for many firms were unavailable for a lot of
countries. Many of these detailed data may not be provided for companies in other countries.
Either the data providers do not collect the information or firms do not disclosure them. The
causes of this not-collected information can be demand, which not justify the costs. Failure
by data providers to supply reported information can be overcome by the researcher through
additional information collection efforts. Experience in providing the data should lead to a
more reliable product, and users should have a clearer understanding of how the information
are provided. The information collection and presentation for other countries are relatively
new and may not be fully understood by researchers.
The accuracy of this accounting information depends on the level of countrys development.
Thats why the reliability of the results is another challenge for international accounting
research. Researchers may have the economic resources needed to purchase international
information and May also be well trained in econometric and other methods needed to
perform statistical tests. Anyway, having the data and being able to provide a series of
statistical tests may not lead to productive research. Unless the researchers have an
understanding of the unique national characteristics and how they impact the research
question, incorrect inferences can be made.
9. Exporting theories and accepted business practices to other countries
without considering the relation between national characteristics and the research question
being investigated, like: culture, accounting tales, legal system, auditing, tax system,
ownership structure, financing sources, political factors, because they differ a lot in many
countries suggest that accounting research theories should, be examined in countries other
than those in which they were developed. Such studies can either support or deny the
universality of each theory." In this purpose we are questioning the appliance of the IFRSs in
the Muslim countries where because of sharias law the interest on money loan is prohibited.
So being a sin how will adjust the IFRS their concept of value in time of the money in a
country which do not consider moral that money have a price in time through interest?
10. Relevance of the results.
The importance of the international accounting research is to offer new understanding to the
existing body of research. When we discuss of the accounting globalization, we have to
analyze the importance of international factors on accounting information. So, we can speak
firsts about growth in international equity and bond markets, resulting in the expansion of
international investment by investors and globalization of capital markets. Investors who
want to diversify their portfolios to international markets must understand foreign financial
statement. They are familiar with their accounting measurement and reporting rules and are
also familiar with understanding how the local business environment interacts with financial
accounting information to indicate firm value.
11. Different perception of the financial information.
There are many issues that can arise when performing analyses of foreign companies,
because some financial statement analysis techniques may not be appropriate in other
countries. For sample, a high debt-to-asset ratio indicates higher risk for U.S. companies, but
can mean lower risk for Japanese companies. Even with these difficulties investors seem
more willing than ever to venture into foreign markets. International accounting research can
provide insights into understanding how current financial statements relate to future
performance and overall firm value. In addition, the evidence is clear that capital markets are
more globalize than ever. Events such as the Asian and Russian financial crises and
September 11, 2001 show that national economies have become increasingly tied to one
another. Factors affecting firm performance and value in one country may have an impact in
other countries. The world no longer operates in single country or regionally segmented
markets. International factors directly impact national investments.
12. Non-existence of functional professional accounting organizations.
For all practical purposes more than a half of all African countries do not have functional
accounting organizations. In these countries, therefore, existence of IFAC 2 and
implementation of IFRS are out of question. IFAC faces the daunting task of assisting these
countries to first develop functional professional accounting organizations. A plethora of
accounting standards, methodologies and reporting formats following the practices of
metropolitan mother companies are found in countries without a functional accounting
profession.
10. Who are the users of accounting information, and why do the users need
accounting information? How this information helpful to the users?
Investors and leaders are the most obvious users of accounting information. Their
decisions and uses of information have been studied and described to a much greater
extent than those of other user group. Therefore For reasons that are largely
pragmatic, financial reports focus on providing information for investment and loan
and rely on them as their major source of financial information. Following are the
users of accounting information.
1. Investors.
2. Lenders.
3. Security analysts, Rating and other information specialists
4. Managers
5. Employees and Trade Unions
6. Suppliers and Trade financiers
7. Customers
8. Government and Regulatory authorities
1. Investors :-
Investors are the major recipients of the financial statements of business enterprises.
They may be retail investors with small shareholdings or large mutual funds and
private equity firms. Main aim of accounting information for investors is, whether the
company is capable to give return or not.
Need of accounting information:-
2. Lenders :-
Lenders such as banks and debenture holders want to know about the financial
stability of a business that approaches them for funds. They are interested in
information that would enable them to determine their borrowers will be able to repay
the loan and pay the related interest on time.
They are recurring financial information for the decision making behalf of
their clients whether to buy, sell or hold their investments.
4. Managers:-
Managers produce financial information for use by others and also use it in many of
their decisions.
They need this information for planning and controlling operations, for
making special decision, and for formulating major plans and policies.
Employees are keen to know about their employers general operations, stability and
profitability. Current employees have a natural interest in the financial condition of
the enterprise because often their compensation will depend on financial performance
of the firm.
Potential employees may need this information in order to gauge the enterprise
prospect.
Helpfulness of accounting information:-
They use this information for negotiating enhancements in wages, bonus and
other benefits.
6. Suppliers and trade financers:-
Suppliers regard the enterprise as an outlet for their product or services.
Helpfulness of accounting information:-
They use this information to assess the likelihood of the enterprise continuing
to buy from them especially if it is a major customer
7. Customers :-
Customer would like to be certain that they can count on their suppliers for future
purchases and after sales support. This is particularly important for product and
services that are proprietary.
Need of accounting information:-
Insurance policy holder needs confidence that their insurer will have the
financial resources to pay their claims.
Helpfulness of accounting information:-
The three levels of govt. in India are central state and local- allocate resources and are
concerned with the activities of enterprises.
These agencies use financial report order to identify abuse and violations and
to protect the interests of the investors and consumers.
11) QUESTION: Explain the meaning and important features of inflation accounting and
briefly explain the effects of inflation on financial statements?
ANSWER:-
INTRODUCTION:
Conclusion:
The inflation spares none and equally influenced the Business like the
people. Inflation accounting has removed this drawback by providing method for adjusting
the figure according to general or specific price levels. Historical cost accounting does not
take into account the changes in the rise in the value of assets and its impact on Balance Sheet
and P&L Account due to inflation and does not reflect the real worth of the business which is
very required for effective decision making.
12) What is a Trial Balance? State the objectives of Trial Balance.
Trial Balance is a statement, which shows debit balances and credit balances of all the
accounts in the ledger.
As per the rules of double entry, every debit must have a corresponding credit.
Hence, the total of all debit entries must be equal to that of all credit entries in the
ledger.
The total of the debit balances and credit balances must be equal.
In case any difference arises, that is, the total of debit balances and credit balances do
not tally, the correctness of the balances brought forward from the respective accounts
must be checked by preparing this statement. This process is known as preparation of
a Trial Balance.
Trial Balance is a statement, prepared with the debit and credit balances of ledger
accounts to test the arithmetical accuracy of the books.
13) Write a short note on Accounting Conventions (also refer the notes given in the
class)
The most commonly encountered convention is the "historical cost convention". This requires
transactions to be recorded at the price ruling at the time, and for assets to be valued at their
original cost.
Under the "historical cost convention", therefore, no account is taken of changing prices in
the economy.
The other conventions you will encounter in a set of accounts can be summarised as follows:
Monetary measurement
Accountants do not account for items unless they can be quantified in monetary terms. Items
that are not accounted for (unless someone is prepared to pay something for them) include
things like workforce skill, morale, market leadership, brand recognition, quality of
management etc.
Separate Entity
This convention seeks to ensure that private transactions and matters relating to the owners of
a business are segregated from transactions that relate to the business.
Realisation
With this convention, accounts recognise transactions (and any profits arising from them) at
the point of sale or transfer of legal ownership - rather than just when cash actually changes
hands. For example, a company that makes a sale to a customer can recognise that sale when
the transaction is legal - at the point of contract. The actual payment due from the customer
may not arise until several weeks (or months) later - if the customer has been granted some
credit terms.
Materiality
An important convention. As we can see from the application of accounting standards and
accounting policies, the preparation of accounts involves a high degree of judgement. Where
decisions are required about the appropriateness of a particular accounting judgement, the
"materiality" convention suggests that this should only be an issue if the judgement is
"significant" or "material" to a user of the accounts. The concept of "materiality" is an
important issue for auditors of financial accounts.
14) What is ledger? What is posting? Illustrate an example for the same
MEANING OF LEDGER:-
In journal, each transaction was dealt separately. They do not provide complete information
at a glance. The net result of transactions relating to a particular account to be collected at one
place, a separate book is to be maintained. This is book, which is call ledger.
A ledger is a book, which contains all the accounts in a summarized and classified form. A
ledger is a permanent record of all business transaction transferred from journal or other
books of original entry. The ledger is also referred to as the book of final entry.
STANDARD FORM OF LEDGER AND ITS CONTENTS
A ledger in the traditional way, is normally kept in the form of bound note books. In
bigger business enterprises, it is not easy to maintain a large and variety of
transactions in a single book.
To overcome this difficulty, loose leap sheets take the place of bound books.
MEANING OF POSTING:-
Business transaction are usually first recorded in the books of original entry or
subsidiary books. Only then they are transferred to the ledger. This process of
transferring from the books of original entry in the concerned accounts to the ledger is
called posting.
The main object of posting is to make classified and summarized record of various
transactions during a specified period on a particular account. Net effect of
transactions can be had from the ledger at a glance.
For eg :
Journal entry :
Dr Bank A/c Cr
Dr Cash A/c Cr
The elements or accounts which represent natural persons, artificial persons and
representative persons are called Personal Accounts.
The elements or accounts which represent the tangible and intangible real assets
are called Real Accounts.
The elements or accounts which represent the losses, profit and gains are called
Nominal Accounts.
This Standard deals with the disclosure of significant accounting policies followed in
preparing and presenting financial statements.
The view presented in the financial statements of an enterprise of its state of affairs
and of the profit or loss can be significantly affected by the accounting policies
followed in the preparation and presentation of the financial statements. The
accounting policies followed vary from enterprise to enterprise. Disclosure of
significant accounting policies followed is necessary if the view presented is to be
properly appreciated.
The disclosure of some of the accounting policies followed in the preparation and
presentation of the financial statements is required by law in some cases. The Institute
of Chartered Accountants of India has, in Standards issued by it, recommended the
disclosure of certain accounting policies, e.g., translation policies in respect of foreign
currency items.
In recent years, a few enterprises in India have adopted the practice of including in
their annual reports to shareholders a separate statement of accounting policies
followed in preparing and presenting the financial statements.
In general, however, accounting policies are not at present regularly and fully
disclosed in all financial statements. Many enterprises include in the Notes on the
Accounts, descriptions of some of the significant accounting policies. But the nature
and degree of disclosure vary considerably between the corporate and the non-
corporate sectors and between units in the same sector.
Even among the few enterprises that presently include in their annual reports a
separate statement of accounting policies, considerable variation exists. The statement
of accounting policies forms part of accounts in some cases while in others it is given
as supplementary information.
The purpose of this Standard is to promote better understanding of financial
statements by establishing through an accounting standard the disclosure of
significant accounting policies and the manner in which accounting policies are
disclosed in the financial statements. Such disclosure would also facilitate a more
meaningful comparison between financial statements of different enterprises.
Wear and tear. Any asset will gradually break down over a certain usage period,as
parts wear out and need to be replaced.Eventually,the asset can no longer be repaired,
and must be dispose of. This cause is most common for production equipment, which
typically has a manufacturers recommended life span that is based on a certain
number of units produced. Other assets, such as buildings, can be repaired and
upgraded for long period of time.
Perishability .some assets have an extremely short life span.This condition is most
applicable to inventory, rather than fixed assets.
Usage rights .A fixed asset may actually be a right to use something for a certain
period of time.If so, its life span terminets when the usage rights expire, so
depreciation must be completed by the end of the usage period.
Efflux of time mere passage of time will cause a fall in the value of an asset even if
it is not used.
Obsolescene a new invention or a permanent change in demand may render the
asset useless.
Accident.
Fall in market price.
There are various methods of providing depreciation on fixed assets which are listed
below:
Introduction
For the purpose of this AS, Revenue includes revenue arising from-
(i) Sale of goods,
(ii) Rendering of services, and
(iii)Use of resources of the organisation by others yielding interest, royalties and
dividends.
The AS does not deal with revenue recognition aspects of revenue arising from
(i) Construction contracts,
(ii) Hire-purchase and
(iii)Lease agreements,
(iv) Government grants and
(v) Other similar subsidies and revenue of insurance companies from insurance contracts.
(vi) Profit on sale of fixed assets and appreciation in the value of fixed assets,
(vii) Appreciation in the value of current assets and natural increase in herds and
agricultural and forest products,
(viii) Gain from exchange rate fluctuations (realised or unrealised); and
(ix) Excess provisions and write back of liabilities.
Accounting Standards Interpretation (ASI) 14 has been issued in respect of the manner of
disclosure of excise duty in the presentation of revenue from sales transactions (turnover)
in the statement of profit and loss. Accordingly, the amount of turnover should be
disclosed in the following manner on the face of the statement of profit and loss:
Turnover (Gross) XX
Less: Excise Duty XX
Turnover (Net) XX
Examples of application of AS 9-
Sr. Circumstances When revenue should be
No. recognised
[A] Sale of Goods
1. Delivery is delayed at buyers request and buyer At the designated time of
takes title and accepts billing. delivery, provided the goods are
on hand, identified as to be
delivered to the buyer and ready
for delivery.
2. Delivery subject to conditions
(i) Goods are subject to installation, Only after goods have been
inspection, etc. installed and inspection
approves the delivery of goods.
(ii) On approval Only after goods have been
formally accepted by the buyer
or the buyer has done an act
indicating his acceptance (use
of goods) or the time period
fixed for rejecting the goods or
reasonable time has elapsed.
(iii)Guaranteed sales, i.e., delivery is made giving Money back guarantee
buyer an unlimited right of return Immediately on sale, after
making suitable provision for
returns based on previous
experience.
Other cases as per (d) below.
(iv)Consignment sales i.e. a delivery is made When goods are sold to a third
whereby the recipient undertakes to sell the goods party.
on behalf of the consignor.
(v)Cash on delivery sales When cash is received.
3. Instalment sale, where goods are delivered only After delivery of goods.
after receipt of final payment
4. Special order and shipments i.e. where payment Goods are manufactured,
(or partial payment) is received for goods not identified and ready for delivery
presently held in stock e.g. the stock is still to be to the buyer by the third party.
manufactured or is to be delivered directly to the
customer from a third party
5. Sale/repurchase agreements i.e. where seller This is a financing agreement
concurrently agrees to repurchase the same goods and not sale.
at a later date
6. Sales to intermediate parties i.e. where goods are When significant risks of
sold to distributors, dealers or others for resale. ownership have passed.
7. Subscriptions for publications Revenue should be deferred and
recognised on a straight line
basis over time or if the items
delivered vary in value from
time to time , proportionately
on the basis of sale value of
items delivered to total sales
value.
8. Instalment Sales Revenue attributable to sale
price exclusive of interest
should be recognised at the time
of sale. Interest should be
recognised on time basis,
proportionate to unpaid balance
due to the seller.
[B] Rendering of Services
1. Installation fees When product is installed and
accepted by the buyer.
2. Advertising and insurance agency commissions Media commissions when
related advertisement or
commercial appears in media.
Product commission after
completion of project.
Insurance commission
effective commencement or
renewal dates of the related
policies.
3. Sales of tickets for event/s Single event when the event
takes place.
Number of events
proportionately on a systematic
and rational basis.
4. Tuition fees Over period of tuitions.
5. Entrance and membership fees Entrance fees- capitalised.
Annual membership fees- over
period of membership on
straight line basis.
AS-10 is Valuation of Fixed Assets. A fixed asset is an asset that is held for the
purpose of producing or supplying goods or services and not for sale in the normal
course of business. Unlike inventories, fixed assets are meant for use by an enterprise
for conducting its business, and not for resale. A manufacturing enterprise's fixed
assets would often include land, buildings, machinery, furniture and fixtures, and
office equipment.
Whether an asset is a fixed asset or not depends on the purpose for which it is held.
For example, the land on which a company's factory is built its fixed asset. However it
is plans to use its land for property development, it will be current asset. So the
intention of the owner in holding an asset determines its classification as a fixed asset
or as a current asset. This classification provides basis for its therefore important.
Fixed assets also referred to as long-lived assets or long-term assets are often divided
into several categories:
1. Property, plant and equipment: These are intangible items, i.e. they have
physical existence and can be seen and felt. An enterprise
(a) Holds these asset for use in the production or supply of goods or services, for
rental purpose; and
(b) Expects to use them during more than one period
Examples: Land buildings, machinery, ships, aircraft, vehicles, fixtures, and office
equipment
2. Intangible asset: Unlike intangible assets, these have no physical existence;
rather, they represent legal rights with associated economic benefits. Also, these are
separately identifiable. Intangible assets exclude monetary assets such as receivables
and investments.
Examples: Brand names, mastheads and publishing titles, patents, and franchises,
copyrights, and designs.
3. Natural resources: These constitute a category by themselves because of their
special characteristics
Examples: oil, natural gas, minerals, and forest.
MEANING OF INVENTORIES:
Inventories encompass goods purchased and held for resale, for example, merchandise
purchased by retailer and held for resale, computer software held for resale, or land and other
property held for resale. Inventories also encompass finished goods produced, or work in
progress being produced, by the enterprise and include materials, maintenance suppliers,
consumables and loose tools awaiting use in the production process. Inventories do not
include machinery spares which can be used only in connection with an item of fixed assets
and whose use is expected to be irregular , such machinery spares are accounted for in
accordance with Accounting Standard (AS) 10, Accounting for fixed assets.
The Inventories of a trading concern primarily consist of the finished goods purchased for
resale, whereas the inventories of a manufacturing concern consist of raw materials, work in
progress, finished goods, stores and spares. The significance of valuation of inventory arises
mainly because it serves two purposes:
1. To determine true income, and
2. To determine true financial position.
Now, the us discuss the meaning of cost of purchase, cost of conversion and other
costs.
(a) Cost Of Purchase:
Cost of purchase consist of the purchase including duties and taxes (other than those
subsequently recoverable by the enterprise from the taxing authorities), freight inwards and
other expenditure directly attributable to the acquisition, less trade discounts, rebates, duty
drawbacks and subsidies in the year in which they are accounted, whether immediate or
deferred, in respect of such purchase.
Now, let us know the meaning of fixed overheads, variable overheads and absorption
costing method.
Fixed Overheads:
Fixed production overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, such as depreciation and maintenance of
factory buildings and the cost of factory management and administration.
Variable Overheads:
Variable production overheads are those indirect costs of production that vary directly, or
nearly directly, with the volume of production, such as indirect materials and indirect labour.
Absorption Of Production Overheads:
The Allocation of fixed production overheads for the purpose of their inclusion in the costs of
conversion is based on the normal capacity of the production facilities. Normal capacity is the
production expected to be achieved on an average over a number of periods or seasons under
normal circumstances, taking into account the loss of capacity resulting from planned
maintenance. Variable overheads are assigned to each unit of production on the basis of
actual use of production facilities.
(c) Other Costs:
Costs other than production overheads are sometimes incurred in bringing inventories to their
present location and condition, for example, expenditure incurred in designing products for
specific customers. On the other hand, selling and distribution expenses, general
administration overheads, research and development costs and interest are usually considered
not to relate to putting the inventories in their present location and condition. They are,
therefore, excluded from determining the valuation of inventories.
a) Cash
b) An equity instrument of another entity
c) A contractual right to receive cash or another financial asset from another
entity
The owner of a financial asset has a contractual claim on the entity that has
issued the financial instrument.
The instrument may be a debt instrument (another financial liability) that gives
its owner a right to periodical interest payments and principal repayment, or an equity
instrument (another entitys equity share capital)that carries a right to any dividends
distributed and residual assets.
Equity and Debt Instruments
A company may have cash for which it has no immediate use and may invest
it in order to earn a return.
Some enterprises, such as banks, are in the business of lending.
The intention in making such investments is to earn a financial return in the
form of interest, dividend and capital appreciation.
Think of these as financial investment.
Accountable classify financial assets into four categories:
It is easy for a business to acquire tangible assets such as buildings and equipment.
Hence, having such assets cannot give a business edge over its rivals. Intangible
assets, such as the reputation of a brand, strength of research and development, and
highly trained and motivated employees, are much more difficult to develop, acquire
or copy. The competitive advantage that gives a firm the ability earn better rate of
return relative to its industry peers comes mainly from intangible assets.
Today, much of a firms worth is represented by intangible assets. As the role of
service industries with a large number of intangible assets continues to rise, the
question of recognizing these assets is becoming important for a large number of
companies and the users of their financial statements. Efforts are on to develop more
objective methods of valuing intangible assets. Accounting for intangibles is likely to
occupy the agenda of accounting regulators in the coming decades in many countries,
including India.
The general principle is that an enterprise can recognize an intangible asset only if it
meets two criteria:
It is probable that it will give future economic benefits to the enterprise.
The cost of the asset can be measured reliably.
The first step in accounting for an intangible asset is to arrive at its cost of acquisition.
The principles are the same an those for tangible assets. Thus, the cost of an
intangible asset comprises its purchase price, import duties and other taxes, and any
attributable costs of bringing the asset to working condition for its intended use.
Directly attributable cost include cost of employee benefits, e.g. salaries, pensions
and other benefits, professional fees, such as lawyers fees, and cost of testing
whether the asset is functioning properly. Trade discounts, rebates and refundable
taxes are deducted in arriving at the purchase price.
Exhibit
Accounting for Intangible Assets
The owner's legal rights over, and commercial value of, the asset determines the accounting.
Trademark, -Marks or other signs that are capable of -Record at cost of acquisition
Brand Name identifying products/services as those of a - Amortize cost over the
estimated useful life.
particular producer and distinguishing -Do not recognize internally
generated them from those of its competitors. brands.
-The registration is initially for 10 years but
renewable indefinitely for successive periods of 10 years each.
Franchise, - A contractual right to trade in an exclusive -Record a lump sum payment to the
Licence area or to manufacture using a special process. franchiser.
-Amortize over the period of
franchise
licence.
8. What are the causes of depreciation? Explain any one method of providing
depreciation with imaginary figures.
Causes of Depreciation
Wear and tear. Any asset will gradually break down over a certain usage period,as
parts wear out and need to be replaced.Eventually,the asset can no longer be repaired,
and must be dispose of. This cause is most common for production equipment, which
typically has a manufacturers recommended life span that is based on a certain
number of units produced. Other assets, such as buildings, can be repaired and
upgraded for long period of time.
Perishability .some assets have an extremely short life span.This condition is most
applicable to inventory, rather than fixed assets.
Usage rights .A fixed asset may actually be a right to use something for a certain
period of time.If so, its life span terminets when the usage rights expire, so
depreciation must be completed by the end of the usage period.
Efflux of time mere passage of time will cause a fall in the value of an asset even if
it is not used.
Obsolescene a new invention or a permanent change in demand may render the
asset useless.
Accident.
Fall in market price.
Straight line method: Same depreciation is charged over the entire useful life.
Example: On April 1,2001, Company a purchased an equipment at the cost of 140000.
This equipment is estimated to have 5 years useful life at the end of 5 th year, the
salvage value will be 20000.Company A recognizes depreciation to the nearest whole
month. Calculate the depreciation expences for 2011,2012 and 2013 using SLM.
Depreciation for 2011: (140000-20000)*1/5*9/12=18000
Depreciation for 2012: (140000-20000)*1/5*12/12=24000
Depreciation for 2013: (140000-20000)*1/5*12/12=24000
Introduction
Financial statements disclose certain information relating to fixed assets. In many
enterprises these assets are grouped into various categories, such as land, buildings,
plant and machinery, vehicles, furniture and fittings, goodwill, patents, trademarks
and designs. This standard deals with accounting for such fixed assets except as
described below.
This standard does not deal with the specialised aspects of accounting for fixed assets
that arise under a comprehensive system reflecting the effects of changing prices but
applies to financial statements prepared on historical cost basis.
This standard does not deal with accounting for the following items to which special
considerations apply:
forests, plantations and similar regenerative natural resources;
wasting assets including mineral rights, expenditure on the
exploration for and extraction of minerals, oil, natural gas and similar non-
regenerative resources;
expenditure on real estate development; and
livestock.
Expenditure on individual items of fixed assets used to develop or maintain the
activities covered in above, but separable from those activities, are to be accounted
for in accordance with this Standard.
This standard does not cover the allocation of the depreciable amount of fixed assets
to future periods since this subject is dealt with in Accounting Standard 6 on
Depreciation Accounting.
This standard does not deal with the treatment of government grants and subsidies,
and assets under leasing rights. It makes only a brief reference to the capitalisation of
borrowing costs and to assets acquired in an amalgamation or merger. These subjects
require more extensive consideration than can be given within this Standard.
Definitions
The following terms are used in this Standard with the meanings specified:
Fixed asset is an asset held with the intention of being used for the purpose of
producing or providing goods or services and is not held for sale in the normal
course of business.
Fair market value is the price that would be agreed to in an open and unrestricted
market between knowledgeable and willing parties dealing at arms length who are
fully informed and are not under any compulsion to transact.
Gross book value of a fixed asset is its historical cost or other amount substituted
for historical cost in the books of account or financial statements. When this
amount is shown net of accumulated depreciation, it is termed as net book value.
Explanation
Fixed assets often comprise a significant portion of the total assets of an enterprise,
and therefore are important in the presentation of financial position. Furthermore, the
determination of whether an expenditure represents an asset or an expense can have a
material effect on an enterprises reported results of operations.
3. Examples of items not included within the definition of revenue for the purpose of this
Standard are:
(i) Realized gains resulting from the disposal of, and unrealized gains resulting from the
holding of, non-current assets e.g. appreciation in the value of fixed assets;
(ii) Unrealized holding gains resulting from the change in value of current assets, and the
natural increases in herds and agricultural and forest products;
(iii) Realized or unrealized gains resulting from changes in foreign exchange rates and
adjustments arising on the translation of foreign currency financial statements;
(iv) Realized gains resulting from the discharge of an obligation at less than its carrying
amount;
(v) Unrealized gains resulting from the restatement of the carrying amount of an obligation.
Definition:
Revenue is the gross inflow of cash, receivables or other consideration arising in the course
of the ordinary activities of an enterprise from the sale of goods, from the rendering of
services, and from the use by others of enterprise resources yielding interest, royalties and
dividends. Revenue is measured by the charges made to customers or clients for goods
supplied and services rendered to them and by the charges and rewards arising from the use
of resources by them.
Sale of goods:
In the business enterprise when revenue of sale of good should be recognized it is depends up
on satisfying following conditions. All these conditions must be satisfied to recognize income
in books of accounts.
Seller should have transferred the ownership of goods to purchaser for the consideration or
all significant risk & rewards of ownership should have transferred to buyer.
There should not be any kind of uncertainty for collection or receipt of cash, consideration
or receivable etc.
Seller does not retain any direct or effective control on such goods transferred.
Rendering of Services
Revenue from service transactions is usually recognized as the service is performed either
by the proportionate completion method or by the completed service contract method.
(i) Proportionate completion method the revenue recognized under this method would be
determined on the basis of contract value, associated costs, number of acts or other suitable
basis. For practical purposes, when services are provided by an indeterminate number of acts
over a specific period of time, revenue is recognized on a straight line basis over the specific
period unless there is evidence that some other method better represents the pattern of
performance.
The Use by Others of Enterprise Resources Yielding Interest, Royalties and Dividends
The use by others of such enterprise resources gives rise to:
(i) interestcharges for the use of cash resources or amounts due to the enterprise;
(ii) Royaltiescharges for the use of such assets as know-how, patents, trademarks and
copyrights;
(iii) Dividendsrewards from the holding of investments in shares.
Main Principles
If at the time of rising of any claim it is unreasonable to expect ultimate collection, revenue
recognition should be postponed.
Explanation: The amount of revenue from sales transactions (turnover) should be disclosed in
the following manner on the face of the statement of profit and loss:
Turnover (Gross) XX
Less: Excise Duty XX
Turnover (Net) XX
The amount of excise duty to be deducted from the turnover should be the total excise duty
for the year except the excise duty related to the difference between the closing stock and
opening stock. The excise duty related to the difference between the closing stock and
opening stock should be recognized separately in the statement of profit and loss.
Disclosure
Introduction:-
1. Financial statements disclose certain information relating to fixed assets. In many
enterprises these assets are grouped into various categories, such as land, buildings, plant and
machinery, vehicles, furniture and fittings, goodwill, patents, trade marks and designs. This
standard deals with accounting for such fixed assets except as described in paragraphs 2 to 5
below.
2. This standard does not deal with the specialized aspects of accounting for fixed assets that
arise under a comprehensive system reflecting the effects of changing prices but applies to
financial statements prepared on historical cost basis.
3. This standard does not deal with accounting for the following items to
which special considerations apply:
(i) forests, plantations and similar regenerative natural resources;
(ii) wasting assets including mineral rights, expenditure on the
exploration for and extraction of minerals, oil, natural gas and similar
non-regenerative resources;
(iii) expenditure on real estate development; and
(iv) livestock.
Expenditure on individual items of fixed assets used to develop or maintain the activities
covered in (i) to (iv) above, but separable from those activities, are to be accounted for in
accordance with this Standard.
4. This standard does not cover the allocation of the depreciable amount of fixed assets to
future periods since this subject is dealt with in Accounting Standard 6 on Depreciation
Accounting.
5. This standard does not deal with the treatment of government grants and subsidies, and
assets under leasing rights. It makes only a brief reference to the capitalisation of borrowing
costs and to assets acquired in an amalgamation or merger. These subjects require more
extensive consideration than can be given within this Standard.
Definitions
6. The following terms are used in this Standard with the meanings specified:
6.l Fixed asset is an asset held with the intention of being used for the purpose of producing
or providing goods or services and is not held for sale in the normal course of business.
6.2 Fair market value is the price that would be agreed to in an open and unrestricted market
between knowledgeable and willing parties dealing at arms length who are fully informed
and are not under any compulsion to transact.
6.3 Gross book value of a fixed asset is its historical cost or other amount substituted for
historical cost in the books of account or financial statements. When this amount is shown net
of accumulated depreciation, it is termed as net book value.
Explanation
7. Fixed assets often comprise a significant portion of the total assets of an enterprise, and
therefore are important in the presentation of financial position. Furthermore, the
determination of whether an expenditure represents an asset or an expense can have a
material effect on an enterprises reported results of operations.
The cost of a fixed asset may undergo changes subsequent to its acquisition or construction
on account of exchange fluctuations, price adjustments, changes in duties or similar factors.
9.2 Administration and other general overhead expenses are usually excluded from the cost of
fixed assets because they do not relate to a specific fixed asset. However, in some
circumstances, such expenses as are specifically
attributable to construction of a project or to the acquisition of a fixed asset or bringing it to
its working condition, may be included as part of the cost of the construction project or as a
part of the cost of the fixed asset.
9.3 The expenditure incurred on start-up and commissioning of the project, including the
expenditure incurred on test runs and experimental production, is usually capitalised as an
indirect element of the construction cost. However,
the expenditure incurred after the plant has begun commercial production, i.e., production
intended for sale or captive consumption, is not capitalised and is treated as revenue
expenditure even though the contract may stipulate that the plant will not be finally taken
over until after the satisfactory completion
9.4 If the interval between the date a project is ready to commence commercial production
and the date at which commercial production actually begins is prolonged, all expenses
incurred during this period are charged to the profit and loss statement. However, the
expenditure incurred during this period is also sometimes treated as deferred
revenue expenditure to be amortised over a period not exceeding 3 to 5 years after the
commencement
17. Disclosure
17.1 Certain specific disclosures on accounting for fixed assets are already required by
Accounting Standard 1 on Disclosure of Accounting Policies and Accounting Standard 6 on
Depreciation Accounting.
17.2 Further disclosures that are sometimes made in financial statements
include:
(i) gross and net book values of fixed assets at the beginning and end of an accounting period
showing additions, disposals, acquisitions and other movements;
(ii) expenditure incurred on account of fixed assets in the course of construction or
acquisition; and
18. The items determined in accordance with the definition in paragraph 6.1 of this Standard
should be included under fixed assets in financial statements.
19. The gross book value of a fixed asset should be either historical cost or a revaluation
computed in accordance with this Standard. The method of accounting for fixed assets
included at historical cost is set out in paragraphs 20 to 26; the method of accounting of
revalued assets
20. The cost of a fixed asset should comprise its purchase price and any attributable cost of
bringing the asset to its working condition for its intended use.
21. The cost of a self-constructed fixed asset should comprise those costs that relate directly
to the specific asset and those that are attributable to the construction activity in general and
can be all
22. When a fixed asset is acquired in exchange or in part exchange for another asset, the cost
of the asset acquired should be recorded either at fair market value or at the net book value of
the asset given up, adjusted for any balancing payment or receipt of cash or
other consideration. For these purposes fair market value may be determined by reference
either to the asset given up or to the asset acquired, whichever is more clearly evident.Fixed
asset acquired in exchange for shares or other securities in the enterprise should be recorded
at its fair market value,or the fair market value of the securities issued, whichever is more
clearly evident.
23. Subsequent expenditures related to an item of fixed asset should be added to its book
value only if they increase the future benefits from the existing asset beyond its previously
assessed standard of performance.
24. Material items retired from active use and held for disposal should be stated at the lower
of their net book value and net realisable value and shown separately in the financial
statements.
25. Fixed asset should be eliminated from the financial statements on disposal or when no
further benefit is expected from its use and disposal.
26. Losses arising from the retirement or gains or losses arising from disposal of fixed asset
which is carried at cost should be recognised in the profit and loss statement.
27. When a fixed asset is revalued in financial statements, an entire class of assets should be
revalued, or the selection of assets for revaluation should be made on a systematic basis. This
basis should be disclosed.
28. The revaluation in financial statements of a class of assets should not result in the net
book value of that class being greater than the recoverable amount of assets of that class.
29. When a fixed asset is revalued upwards, any accumulated depreciation existing at the date
of the revaluation should not be credited to the profit and loss statement.
30. An increase in net book value arising on revaluation of fixed assets should be credited
directly to owners interests under the head of revaluation reserve, except that, to the extent
that such increase is related to and not greater than a decrease arising on revaluation
previously recorded as a charge to the profit and loss statement, it may be credited to the
profit and loss statement. A decrease in net book value arising on revaluation of fixed
asset should be charged directly to the profit and loss statement except that to the extent that
such a decrease
is related to an increase which was previously recorded as a credit to revaluation reserve and
which has not been subsequently reversed or
31. The provisions of paragraphs 23, 24 and 25 are also applicable to fixed assets included in
financial statements at a revaluation.
32. On disposal of a previously revalued item of fixed asset, the difference between net
disposal proceeds and the net book value should be charged or credited to the profit and loss
statement except that to the extent that such a loss is related to an increase which was
previously recorded as a credit to revaluation reserve and which has not been subsequently
reversed or utilized, it may be charged directly to that account.
33. Fixed assets acquired on hire purchase terms should be recorded at their cash value,
which, if not readily available, should be calculated by assuming an appropriate rate of
interest. They should be shown in the balance sheet with an appropriate narration to indicate
that the enterprise does not have full ownership thereof.
34. In the case of fixed assets owned by the enterprise jointly with others, the extent of the
enterprises share in such assets, and the proportion of the original cost, accumulated
depreciation and written down value should be stated in the balance sheet. Alternatively, the
pro rata cost of such jointly owned assets may be grouped together with
similar fully owned assets with an appropriate disclosure thereof.
35. Where several fixed assets are purchased a business is acquired for a price (payable in
cash or in shares or
otherwise) which is in excess of the value of the net assets of the business taken over, the
excess should be termed as goodwill.
Disclosure
37. The following information should be disclosed in the financial statements:
(i) gross and net book values of fixed assets at the beginning and end of an accounting period
showing additions, disposals, acquisitions and other movements;
(ii) expenditure incurred on account of fixed assets in the course of construction or
acquisition; and
(iii) revalued amounts substituted for historical costs of fixed assets, the method adopted to
compute the revalued amounts, the nature of indices used, the year of any appraisal made,
and whether an external valuer was involved, in case where fixed assets are stated at revalued
amounts
Q12) What is Investments according to AS-13? How is it classified? How is the cost of
investment determined?
Definition: Investments are assets held by an enterprise for earning income by way of
dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing
enterprise.
Classification of Investments:
Investments are classified as Long Term Investments and Current Investments.
Current Investments: A current investment is an investment that is by its nature readily
realisable and is intended to be held for not more than one year from the date on which such
investment is made.
It is thus , Any investment which is converted in to cash within one year
Valuation of Current investments: All current investments will be calculated on cost or fair
market price which is less.
Long Term Investments: A long term investment is an investment other than a current
investment.
Valuation of long term investments: Long term investments are valued at its original cost for
recording in the books of accounts.
Cost of Investments
The cost of an investment includes acquisition charges such as brokerage, fees and duties.
Current Investments should be carried in the financial statements at the lower of cost and fair
value determined either on an individual investment basis or by category of investment, but
not on an overall basis.
Any reduction in the carrying amount and any reversals of such reductions should be charged
or credited to the profit and loss statement.
Disposal of Investments
When any investments is sold, the difference between the carrying amount and net sale
proceeds should be charged or credited to the profit and loss statement.
When disposing of a part of the holding of an individual investment, the carrying amount to
be allocated to that part is to be determined on the basis of the average carrying amount of the
total holding of the investment.
Disclosures
This Accounting Standard includes paragraphs set in bold italic type and plain type,
which have equal authority.
Paragraphs in bold italic type indicate the main principles.
This accounting standard should be read in the context of its objective and the General
instructions contained in part A of the Annexure to the notification.
Objectives:-
A primary issue in accounting for inventories is the determination of the value at
which inventories are carried in the financial statements until the related revenues are
recognised.
This Standard deals with the determination of such value, including the ascertainment
of cost of inventories and any write-down thereof to net realisable value.
The FIFO Method, LIFO Method and Weighted Average Cost (WAC)
The FIFO method, LIFO method and Weighted Average Cost method are three ways
of valuing your inventory. In this we're going to look at all three methods.
At the end of each period (month or year) one should do a physical inventory count to
determine the number of inventory on hand.
Then you need to place a value on the goods. One would think this would be easy -
the value of the goods is simply how much they originally cost.
There are three methods used when valuing the goods that you have on hand at
the end of the period.
It is very common to use the FIFO method if one trades in foodstuffs and other goods that
have a limited shelf life, because the oldest goods need to be sold before they pass their sell-
by date.
Thus the first-in-first-out method is probably the most commonly used method in small
business. Well, probably.
The value of our closing inventories in this example would be calculated as follows:
Using the First-In-First-Out method, our closing inventory comes to $1,100. This equates to a
cost of $1.10 per lollypop ($1,100/1,000 lollypops).
The value of our closing inventories in this example would be calculated as follows:
The LIFO method is commonly used in the U.S.A.
Using the Last-In-First-Out method, our closing inventory comes to $1,000. This equates to a
cost of $1.00 per lollypop ($1,000/1,000 lollypops).
3. The Weighted Average Cost Method
This method assumes that we sell all our inventories simultaneously.
The weighted average cost method is most commonly used in manufacturing businesses
where inventories are piled or mixed together and cannot be differentiated, such as chemicals,
oils, etc.
Chemicals bought two months ago cannot be differentiated from those bought yesterday, as
they are all mixed together.
So we work out an average cost for all chemicals that we have in our possession. The method
specifically involves working out an average cost per unit at each point in time after a
purchase.
Revised AS-2 recognized FIFO and weighted average cost method of inventory
valuation.
Q14) Discuss the various determinants considered for valuation of Fixed Assets as given
by A.S. 10 Accounting for Fixed Assets.
They lead to generation of operational revenue, which speaks of their crucial importance.
Hence the need for proper valuation.
Fixed assets represents assets held with the intention of being used for the purpose of
producing or providing good or services and are not held for sale in the normal course
of business.
Significant portion of total assets.
Effect on reported results-Expense as fixed assets or revenue expense.
Deals with land, building, plant and machinery, vehicle, furniture and fittings except
Regenerative natural resources like forests and plantation
Expenditure on the exploration and extraction of non-regenerative sources like
minerals, oil and natural gas
Mineral rights
Expenditure on the real estate development
Livestock
Leased assets
The standard however, covers the individual items of those fixed assets which are used to
develop or maintain the above mentioned assets and are separable from them.
Principle on Revaluation
Revalued amounts are restated in the financial statement by both gross book values
and accumulated depreciation
When revalued, an entire class of assets should be revalued, or on a systematic basis
Should not result in the net book values greater than recoverable amount of assets
Increase in net book values on revaluation is credited to owner interests under the
heading revaluation reserves and are not available for distribution. At time reversal
of previous recorded decrease in P&L account
Decrease is charged to P&L unless it reserve a corresponding reserve related to a
previous increase on revaluation
Jointly owned fixed assets-the extent of the enterprise share in such assets, and
proportion of original cost, accumulated depreciation and written down value should
be stated in the BS
Basket purchase-apportioned on a fair basis as determined by a competent value
Stated at the lower of their net book value and NRV and shown separately
Eliminated from statement on disposal or no further benefit is expected
Any Loss/gain is charged/credited to P&L
Loss/gain of revalued assets-P&L or reserved with revaluation reserve
Amount in revaluation reserve after disposal/retirement-general reserve
Disclosures
Gross and net book value at the beginning and at the end of the accounting period
showing additions, disposal, acquisitions and other movements
Expenditure incurred towards fixed assets in the course of construction or acquisition
Additional disclosures where fixed assets are stated at revalued amounts
Module 3
1) What is Balance Sheet? Draw a pro forma in vertical shape of it. Explain its
significance. How does it differ from a Trial Balance?
A balance sheet is one of the financial statements of assets & liabilities of an enterprise at a
given date it is called a balance sheet of balance those ledger accounts which have not been
closed till the preparation of the trading & profit & Loss accounts.
Vertical shape of balance sheet :-
Details Sch. Rs. Rs.
(1)Share holders funds
(a)capital A
(b)Reserve & surplus
(2)Loan Funds
(a)Secured loans
(b)Unsecured loans
(Sources of funds) ............
Total
Application of funds
(a)Fixed Assets E
(b)Investments
(c)Net current Assets
(current assets-current
liabilities)
A+B+C .......... ..
Significance of trial balancesheet :-
(1) To ascertain the nature & value of a business.
(2) To ascertain the nature & amount of a liabilities of a business.
(3) To find out the financial solvency of an enterprise. An enterprise is considered to be a
solvent if its assets exceed its external liabilities.
Balance sheet differs from trial balance because only assets and liabilities are reflected in
balance sheet and trial balance is rough sheet showing the balances of all the accounts.
2) Show format of balance sheet in horizontal form for a Company.
Rs. Rs.
Land and Buildings 3,25,000 Patents
Plant and Machinery 2,90,000 Investments
Sundry Debtors 65,000 Preliminary Expenses
8,000 Equity Shares of Rs. 100 Securities premium
each Rs. 50 called up 4,00,000 Provision for Income tax
15% debentures 1,00,000 Closing Stock
Debenture Redemption Reserve 50,000 Cash
Prepaid Insurance 4,800 Advance Income Tax
Profit & Loss (Cr.) 1,13,000 Sundry Creditors
Bills Payable 15,000 Outstanding expenses
General Reserve 1,00,000 Proposed Dividend
Investments are in partly-paid shares on which calls of Rs. 10,000 have not been made.
Solution:
BALANCE SHEET OF GUJARAT EXPORTS LTD.
As at in horizontal form
Liabilities Rs. Assets Rs.
SAHRE CAPITAL: FIXED ASSETS:
Authorized Capital ______?___ Land and Building 3,25,000
Issued Capital Plant and Machinery 2,90,000
8,000 Equity shares of Patents 7,200
Rs.100 each
Subscribed Capital 8,00,000 INVESTMENTS: 20,000
8,000 Equity shares of
Rs.100 each, Rs. 50 called up 4,00,000
CURRENT ASSETS, LOANS AND
RESERVES AND SURPLUS: ADVANCES:
Securities Premium 20,000 (A) Current assets:
General Reserve 1,00,000 Closing Stock 1,28,000
Profit & Loss A/c 1,13,000 Sundry Debtors 65,000
Debenture Redemption Reserve 50,000 Cash 12,000
(B)Provisions
Provision for Income tax 24,000
Proposed dividend 16,000
8,58,000 8,58,000
Balance sheet is the position statement which shows the position of assets and liabilities. It
has got the following special features:
2. Prepared on a specified date. Balance Sheet is prepared on a specific date, i.e., at the
end of accounting period. It is common practice and also legal requirement to prepare
Balance. Sheet together with Trading and profit and loss account at the end of the
accounting year. It may be prepared after every six months if the proprietors so desire.
Accounting year may consist of calendar year or assessment year or its own
accounting year. Companies are required to adopt assessment year (April 1 to 31st
March) as per legal requirement. Sole proprietorship and partnership can adopt
accounting year which suits them, i.e., Diwali to Diwali or Dussehra to Dussehra or
assessment or calendar year.
3. It is a statement of assets and liabilities. Though the Balance sheet has debit and
credit balance but its sides are named as assets and liabilities. The left hand side is a
liability representing credit balance. Right hand side is assets representing debit
balances.
4. Knowledge about the nature of assets and liabilities. Balance sheet categories
assets as liquid assets, current assets, fixed assets and fictitious assets. Knowledge of
liabilities as current liabilities, fixed liabilities and reserve and funds can be gained
from Balance sheet.
5. Knowledge of financial position. Balance sheet depicts true financial position of the
business. The position can be ascertained by study of the Balance sheet. We can
calculate short term and long term financial ratios, proprietary and other ratios to have
the knowledge of the financial soundness of the business.
6. Assets and liabilities tally each other. The total of assets must be equal to liabilities.
According to accounting equation, assets are always equal to creditors, and
proprietors equity. If the total of assets and liabilities are not equal, there is likely to
be certain mistake.
Balance sheet is a vital part of final account. It has to be compulsorily prepared as per legal
provisions. Objects of the Balance sheet have been summarized as under :
The main object of Balance sheet is to assess the financial position of the firm. It is the list of
assets and liabilities of the firm on a specific date. The short term and long term financial
position of the firm can be obtained from the analysis of the Balance sheet.
Balance sheet is rightly said to be a mirror reflecting the true value of assets and liabilities on
particular date.
Profitability ratios measure the degree of operating success of company. The only reason why
investors are interested in a company is that they think they will earn reasonable return in the
form of capital gain and dividends on their investment.
Profit margin
Return on assets
Return on Equity
2 Return On Assets :
3 Return on Equity :
Price earning ratio : This is a popular measure extensively used in investment analysis. A
High price earnings ratios indicates the stock markets confidence in the companys future
earnings growth
Average stock price
Earnings per Share
Horizontal Analysis
Trend analysis
Vertical Analysis
Ratio analysis
1. Horizontal Analysis
Financial statements present comparative information for at least two years. Horizontal
analysis calculate the amount in % changes from the previous year to the current year. It is
simple but useful exercise. While an amount change in itself may mean something converting
it to percentages is more useful in appreciating the order of magnitude of the change
change change
2010 2009 amount percent
Trend analysis
TREND
ANALYSIS
to illustrate below using 2005 as the base year the sales value in 2010 becomes 154 as shown
below
this means that from 2005 to 2010 sales increase 54% over a period net profit increased 59%
better then sales the growth of 54% and fixed assets match the sales growth . and the whole
the three moved in tandem
Vertical Analysis
2010 2009
Sales and other
incomes 100 100
Expenses 84.98 85.59
profit before tax 15.02 14.41
tax 3.4 2.56
profit after tax 11.62 11.85
exceptional items 0.33 0.07
profit after tax 11.95 11.92
2010 2009
SHAREHOLDERS FUNDS AND LIABILITIES
SHARE CAPITAL 2.25 2.52
RESERVES AND SURPLUS 25.23 22.18
MINORITY INTEREST 0.11 0.09
SECURED LOANS 0.11 1.81
UNSECURED LOANS 0 3.21
CURRENT ;IABILITIES AND PROVISON 70.17 67.99
DEFFRED TAX LIABILITIES 2.13 2.2
TOTAL FUNDS 100 100
ASSETS
FIXED ASSETS 28.82 24.68
INVESTMENTS 12.61 3.32
INVENTORIES 22.92 29.82
SUNDRY DEBTORS 7.12 6.48
CASH AND BANK BALANCES 20.72 21.54
OTHER CURRENT ASSETS 0.2 0.23
LOANS AND ADVANCES 6.07 8.8
DEFERRED TAX ASSETS 4.69 5.13
TOTAL ASSETS 100 100
RATIO ANALYSIS
Advantages
4. What is Trend analysis? State its objectives and advantages of using the same.
A trend analysis is a method of analysis that allows traders to predict what will
happen with a stock in the future. Trend analysis is based on historical data about the
stock's performance given the overall trends of the market and particular indicators
within the market.
"With the past, we can see trajectories into the future - both catastrophic and creative
projections.
Objectives Of Trend Analysis
On the trends that can have an impact on their organization, and facilitate
continued success of their enterprise. Trend Analysis allows you to plot aggregated
response data over time. This is especially valuable, if you are conducting a long
running survey and would like to measure differences in perception and responses
over time.
Thus Trend Analysis provides an insight into the following:
i. Changes and trends in customers needs and behavior, and shifts in the
customers' perception of value.
ii. Trend in price changes and cost drivers for the industry and/or specific
segments.
iii. Change and evolution of the industry in terms of new entrants, and
competition, threat of substitutes and relationship with buyers and suppliers.
Funds flow statement is the statement which shows flow of funds (CASH AND
BANK) for the given period (generally year). it shows the "HOW" fund inflows from
various activities like operating and non-operating their "WHERE" they are been
applied i.e out flows. In other words it is the statement showimg inflows and outflows
of fund of business from operating and non-operating activities. Hence it is also called
as " HOW COMES & WHERE GO STATEMENT ".It is blue print of cash book
containing all transaction through cash and book during the given period.
It is prepared by comparing two year financial statement and additional
information. it is based on Principle of "Every asset is represented by liability"
ADVANTAGES.
i. Operating Profit : It helps to segregate from profit and loss account the
business (operating) profit and non-business (non-operating) profit.it is important
since laymen will only consider overall profit, which may be due to non-business
activity. For e.g. an enterprises may have earned profit Rs.25 lakhs as per profit and
loss account. which includes profit on sale of Land Rs 1 crore i.e. the actual business
loss of Rs.75 lakhs
ii. Efficiency of operation : it segregates and set criteria for judging efficiently
operating the business activity is only operating profit according to the nature of
business. It set its own benchmark without comparing the result with other enterprises
dealing in same line of business activity.
iii. Fills the Understanding gap : The financial statements are unable how the
assets are raised or the reason for liquidity crisis in spite of huge profit shown in profit
and loss account.
iv. Utilisation of working capital : It helps to analysis the movement of current
assets and current liabilities and effect on working capital. It also guides management
for further utilisation.
v. Further Financial Assistance: It helps the enterprises to claim loans and other
financial assistance either from public or from private financial institutions. as it from
basis of judging the policy adopt by the management in utilisation of fund by the
enterprises.
DISADVANTAGES .
i. Historical in Nature : The fund flow statement are based on passed data
prepared from financial statement the value of the transaction do not present the
current prices. It makes difficult to analyse the current and future position of the
business.
ii. Unreliable to changes in policies : The fund flow statement are unreliable due
to changes in the re-grouping and rearrangement of figures of financial statement. The
errors crept while preparing financial statement also effect the fund flow statement. if
the financial statement are manipulated the fund flow.
iii. Fails to resolve liquidity problem : The fund flow statement show the sources
and application of fund during the given period. However it fails to resolve the
enterprises problem of liquidity crunch. it fails to indicate when the was liquidity
crunch or surplus exited by enterprises during the given period.
6. Explain the purpose of operating profit ratio and net profit ratio. When is
ROCE greater than RONW?
The purpose of operating profit ratio is to know the profitability before interest and
tax liability whereas net profit ratio depicts the profitability after interest payment and
tax.
When loan funds are less than or equal to networth at that point of time ROCE will be
greater than RONW
The ultimate financial objective of all companies is to create wealth for their
shareholders. Equity investors in a company embark on the highest risk. One cannot
assume with any certainty that returns will be generated for them as they earn only
residual returns left after the company fulfils all its other financial obligations. In such
a scenario, isn't it fair on the part of investors to analyse the company's past returns
generated for the equity shareholders before investing in it? One such return metric is
return on equity. Return on equity comprises two things. One, the returns generated
by the company on the funds raised by the shareholders and second, the returns
generated by the company on the reinvested earnings.
TREND
ANALYSIS
to illustrate below using 2005 as the base year the sales value in 2010 becomes 154 as shown
below
this means that from 2005 to 2010 sales increase 54% over a period net profit increased 59%
better then sales the growth of 54% and fixed assets match the sales growth . and the whole
the three moved in tandem
A market assessment tool designed to provide a business with an idea of the complexity of a
particular industry. Industry analysis involves reviewing the economic, political and market
factors that influence the way the industry develops. Major factors can include
the power wielded by suppliers and buyers, the condition of competitors, and
the likelihood of new market entrants.
Industry analysis enables a company to develop a competitive strategy that best defends
against the competitive forces or influences them in its favour. The key to developing a
competitive strategy is to understand the sources of the competitive forces. By developing an
understanding of these competitive forces, the company can:
So along with financial analysis if all the above mentioned aspects are considered then it
will definitely show a better understanding for the operation of a particular firm.
9) Question : Which are the ratios to be worked out to study the long term solvency of a
concern?
Solvency ratios deal with entitys ability to meet its long term obligations.
Solvency refers to the firms ability to meet its long term indebtedness.
The following are important solvency ratios:
Net assets value ratio (NAV)
Debt equity ratio (D/E)
Interest cover ratio
Debt service coverage ratio (DSCR)
The capacity of the company to discharge its obligations towards long term
lenders indicates its financial strength and ensures its long term survival. It is
important for an analyst to study the solvency position, or gearing structure, or
leveraging capacity of a company.
It is important to analyses the capacity of a company to raise further capital
and borrowings. This is done by analyzing the net asset value (NAV), debt equity
(D/E), interest cover and debt service coverage ratio (DSCR) are computed and
analyzed within this broad group.
These are particularly useful for financial institutions, banks and other lenders
to assess the credit-worthiness of a company and the attendant financial default risk.
1] NAV (Rs.)
Function:-
This ratio measures the net worth or net asset value per equity share. It thus seeks to assess as
to what extent the value of equity share of a company contributed at a premium has grown or
the value/wealth has been created for the share holders. It is also known as net worth per
share or book value per share.
Computation:-
NAV (Rs.) =
Equity shareholders funds
------------------------------------
No. of equity shares O/S
Where,
No. of equity shares O/S here are with reference to year end figure and not their
weighted average since the NAV calculation is as at the year end.
Analytical value and Aid to decision making:-
This ratio indicates the efficiency or otherwise of the company management in
building up a back up of reserves and surplus to fall back upon. Prudent management of
finances requires the ploughing back of net profit after paying adequate dividends on equity.
Assessment/bench marking:-
A) Industry NAV
B) NAVs of the ledger and laggard in the industry
C) Growth in NAV over previous year and longer term past
D) Industry trends
Where,
Total net worth means
(Equity shareholders fund + preference capital)
Analytical value and Aid to decision making:-
The ratio helps in assessing whether a company is relying more on debt or capital for
financing its assets. Higher the debt more is the financial risk of default in interest and debt
service. It also hampers the capacity of a company to raise chapter funds. High capital
content means not passing the cost differential of debt (which is cheaper) and equity to the
equity holders. Companies, therefore, need to have an optimum capital structure.
Assessment/bench marking:-
A) Institutional norms, which generally take into account a debt equity ratio of 1.5:1
while financing projects. The norms stipulate higher ratios for capital intensive and
infrastructure projects.
B) Decline in the ratio over previous year and longer term past.
C) As mentioned in points (b) to (d) in RONW.
Strategic key drivers:-
a) RONW and EPS
b) Dividend policy
c) Share premium
d) NAV
e) Borrowing policy
4] DSCR (times):-
Function:-
The ratio measures the capacity of a company to pay the installments of the principal
due and the interest liability it has incurred on its long term borrowings, out of its cash
profits. It is also known as times-debt service covered.
Computation:-
DSCR (times) =
10) What is ratio analysis? State its objectives and advantages of using the same.
Introduction
The term ratio refers to the mathematical relationship between any two inter-related
variables. In other words, it is establishes relationship between two items expressed in
quantitative form.
Accounting J. Batty, Ratio can be defined as the term accounting ratio is used to describe
significant relationships which exist between figures shown in a balance sheet and profit and
loss account in a budgetary control system or any other part of the accounting management.
Though both horizontal and vertical analysis are done by the companies for the purpose of
analysis of financial statements, and both are useful in analysis of trends for the financial
statements of the company, however they both are different in following ways.
Under horizontal analysis an analyst compares the financial statement of the company for two
more accounting periods, it can be used on any item in the financial statement company so if
company wants to see whether its sales for current year is good or not it will compare the
sales for the year 2010 with sales for year 2009 or for previous years. It is a time series
analysis in the sense that it shows comparison of financial data for several years against a
chosen base year. It is also called dynamic analysis of the financial statements.
Vertical analysis is done to review and analysis the financial statements for a year only and
therefore it is also called static analysis. Under this method each entry for assets, liabilities
and equities in a balance sheet is represented as a percentage of the total account. So if in
asset side of balance sheet cash is $200, building is $400 and machinery is $600 and total of
balance sheet is $1000, then cash will be 20 percent of total of balance sheet building will be
40 percent and machinery will be 60 percent. One of the advantages of using this method is
that one gets an idea of composition of the balance sheet and then it can compared with
previous years to see the relative annual changes in companys balance sheet.
Horizontal Analysis = calculating the Rupee change and% change in financial statement
amounts across time
Vertical Analysis (Common Size Analysis) = changing all rupee values for accounts to %
values.
12 ) Briefly Explain IFRS
Meaning
International Financial Reporting Standards (IFRS) are designed as a
common global language for business affairs so that company accounts
are understandable and comparable across international boundaries.
They are consequence of growing international shareholding and trade
and are particularly important for companies that have dealings in
several countries.
The rules to be followed by accountants to maintain books of accounts
which is comparable, understandable, reliable and relevant as per the
users internal or external.
Adoption of IFRS
IFRS are used in many parts of the world, including the European
Union, India, Hong kong, Australia, Malaysia, Pakistan, GCC
countries, Russia, Chile, South Africa, Singapore and Turkey.
As more than 113 countries around the world, including all of Europe,
currently require or permit IFRS reporting and 85 require IFRS
reporting for all domestic, listed companies, according to the U.S
Securities and Exchange.
Benefits
Increase credibility and reliability of financial statements especially in
cross-border transactions.
Comparability of financial statement at both national and international
levels.
Easy access to technical support given the widespread adoption around
the world.
Career mobility of accounting professionals.
Extensive disclosures useful for a wide variety of stakeholders
including shareholders, lenders, regulators, customers, suppliers, etc.
Improves quality of information necessary for management decision.
Q13) What is IFRS ( International Financial Reporting Standards )? What are the
advantages of converting to IFRS ?
Ans - IFRS( International Financial Reporting Standards ) represent a
set of generally accepted accounting principles ( GAAP ) used by companies to prepare
financial statements, a critical source of information published annually, at a minimum and
useful to various stakeholders ( shareholders, debtors, clients, employees and governments )
in understanding a companys financial performance and managements stewardship of the
companys resources.
It is developed by the International Accounting Standards
Board ( IASB ), these are a set of accounting rules followed by, or being adopted by, more
than 100 countries. All member states of the EU are required to use IFRS as adopted by the
EU for listed companies since 2005.
The Institute of Chartered Accountants of India ( ICAI ) has
announced that IFRS will be mandatory in India for financial statements for the periods
beginning on or after 1 April 2012. This will be done by revising existing accounting
standards to make them compatible with IFRS. The ICAI has also stated that IFRS will be
applied to companies above Rs.1000 crores ( Rs. 10 billion ) from April 2011.
Advantages of converting to IFRS:
1) To develop a single set of high quality, understandable, enforceable and globally
accepted international financial reporting standards ( IFRS ) through its standard-
setting body, the IASB.
2) To promote the use and rigorous application of those standards.
3) To take account of the financial reporting needs of emerging economics and SMEs (
small and medium-sized entities).
4) To bring about convergence of national accounting standards and IFRSs to high
quality solutions.
5) By adopting IFRS, a business can present its financial statements on the same basis as
its foreign competitors, making comparisons easier.
6) Companies with subsidiaries in countries that require or permit IFRS may be able to
use one accounting language company-wide.
7) Companies also may need to convert to IFRS if they are a subsidiary of a foreign
company that must use IFRS, or if they have a foreign investor that must use IFRS.
8) Companies may also benefit by using IFRS if they wish to raise capital abroad.
Benefits
Significance
Consistency
Adhering to GAAP guidelines can help you implement proper controls and safeguards. The
fact that the GAAP guidelines suggest using a consistent basis that professionals can apply to
accounting transactions illustrates this fact. Consistency leads to a more fair presentation and
helps in comparing financial statements across multiple periods. This helps you determine
your companys overall performance, identify areas that need improvement and judge the
benefits of changes that you implement.
Stakeholder's Trust
Presenting your information using GAAP also helps to instill trust in those with an interest in
your company. There are many possible ways to manipulate the financial information of a
company, and many times, a simple modification to the way things are presented changes the
face of financial statements. These changes can cause the reader to interpret the statements
differently than if the modifications were not applied. Complying with GAAP guidelines
gives assurance to anyone interested in your company that your financial statements were
prepared using standard guidelines.
Comparable Statements
Investors and other interested parties can compare financial information of across different
companies because GAAP provides standardized guidelines that accounting, auditing and
financial professionals follow. This means that you can draw realistic conclusions about your
companys performance, as the accounting principles that you use are consistent with those of
your competitors. If GAAP guidelines were not applied, a high profit shown by one company
might not be comparable to a company showing lesser returns because of a difference in the
revenue-recognition method. One company might have higher profits than another in true
terms; however, the lack of standardization makes comparing the two results difficult
1. Useful to present to potential investors and creditors and other users in making rational
investment, credit, and other financial decisions
2. Helpful to present to potential investors and creditors and other users in assessing the
amounts, timing, and uncertainty of prospective cash receipts about economic resources,
the claims to those resources, and the changes in them
3. Helpful for making financial decisions
4. Helpful in making long-term decisions
5. Helpful in improving the performance of the business
6. Useful in maintaining recordsBetter understanding of overhead components
7. Both acquisition and renewal Additional information of profitability of products Early
warning of inappropriate pricing?
8. If not already preparing embedded values, ensures good experience investigations
performed
9. Further check on quality of valuation data
10. Better base fr implementation of IAS
Strength
The generally accepted accounting principles form a set of broad and specific
principles, procedures and standards that regulate the preparation and reporting of
financial statements. The major financial statements governed by GAAP include
the income statement, balance sheet and cash flow statement. Large and small
companies implement GAAP, but the Securities and Exchange Commission only
requires publicly traded companies to use them. Small business owners and
managers should understand the strengths of GAAP to decide whether to
implement the principles within their accounting practices.
Broad Guidelines
GAAP principles provide broad accounting guidelines. Companies may apply these broad
guidelines to many accounting situations when no specific information is given. Four
important principles that apply to all transactions focus on reliability, cost, matching and
revenue recognition. They apply to all publicly traded companies, regardless of size or
industry. The broad guidelines of GAAP allow for greater financial consistency within
companies.
Consistency in Reporting
Professional Judgment
GAAP does not provide detailed rules concerning every financial situation a company may
experience. An advantage of GAAP is that it allows accountants to use their professional
judgment when interpreting and applying the rules and procedures of GAAP. Therefore,
companies depend on the expertise of their accounting professionals to make sound decisions
on behalf of the company. The flexibility provided by GAAP allows companies to make
certain financial decisions in confidence and not suffer penalties by the Financial Accounting
Standards Board or the SEC.
Transparency
The SEC requires that public companies undergo a financial audit by a certified public
auditor. One of the strengths of GAAP is that it enables auditors and legislators to better audit
financial statements and other important financial information of public companies. The SEC
requires that companies are audited to verify that a companys financial reports accurately
reflect its financial position. The transparency provided by GAAP allows investors to place a
certain level of confidence in a companys financial statements because an investor knows
that the reports pass the meticulous requirements of the SEC.