Showing posts with label Accounting. Show all posts
Showing posts with label Accounting. Show all posts

Monday, October 27, 2014

Cash Flow Statements : Accounting Basics Day 9

Introduction

Cash flow statement provides considerable information about what is really happening in a business beyond that contained in either the income statement or the balance sheet. Analyzing this statement will quickly become obvious that the benefits of understanding the sources and uses of a company’s cash far outweigh the costs of undertaking some very straightforward analyses. In this chapter we are going to learn about the preparation of the cash flow statements.

What are Cash Flow Statements?

Cash flow statement, which shows inflows and outflows of the cash and cash equivalents. This statement is usually prepared by a company as a tool to know about the sources and uses of cash and cash equivalents of an enterprise over a period of time from various activities of an enterprise. It has gained substantial importance in the last decade because of its practical utility to the users of financial information.

Who Requires a Cash Flow Statement?


  • Executives require knowing if the cash generated by the company will be sufficient to fund their expansion strategy
  • Stockholders will be able to know if the firm is generating enough cash to pay dividends
  • Suppliers would be interested to know if their customers will be able to pay, on offering credit

Division of Cash Flow Statements

The cash flow statement is divided into three sections

  1. Operating activities - Converts the items reported on the income statement from the accrual basis of accounting to cash. Shows the results of cash inflows and outflows related to the fundamental operations of the basic line or lines of business in which the company engages. (Example: cash receipts from the sale of goods or services and cash outflows for purchasing inventory and paying rent and taxes.)
  2. Investing activities - Reports the purchase and sale of long-term investments and property, plant and equipment.
  3. Financing activities - Reports the issuance and repurchase of the company's own bonds and stock and the payment of dividends.

Detecting changes in cash with change in various accounts


  • When an asset (other than cash) increases, the Cash account decreases.
  • When an asset (other than cash) decreases, the Cash account increases.
  • When a liability increases, the Cash account increases.
  • When a liability decreases, the Cash account decreases.
  • When owner's equity increases, the Cash account increases.
  • When owner's equity decreases, the Cash account decreases.

The differences in a company's balance sheet accounts will provide much of the needed information. For example, if the statement of cash flows is for the year 2009, the balance sheet accounts at December 31, 2009 will be compared to the balance sheet accounts at December 31, 2008. The changes—or differences—in these account balances will likely be entered in one of the sections of the statement of cash flows.

Cash Provided From or Used By Operating Activities

Operating activities are the activities that constitute the primary or main activities of an enterprise, for example, for a company manufacturing garments, procurement of raw material, incurrence of manufacturing expenses, sale of garments, etc. These are the principal revenue producing activities (or the main activities) of the enterprise and other activities that are not investing or financing activities. By Operating Activities This section of the cash flow statement reports the company's net income and then converts it from the accrual basis to the cash basis by using the changes in the balances of current asset and current liability accounts, such as:

Accounts Receivable
Inventory
Supplies
Prepaid Insurance
Other Current Assets
Notes Payable (generally due within one year)
Accounts Payable
Wages Payable
Payroll Taxes Payable
Interest Payable
Income Taxes Payable
Unearned Revenues
Other Current Liabilities

In addition to using the changes in current assets and current liabilities, the operating activities section has adjustments for depreciation expense and for the gains and losses on the sale of long-term assets.

Cash Provided From or Used By Investing Activities

Investing activities relate to purchase and sale of long-term assets or fixed assets such as machinery, furniture, land and building, etc. Transactions related to long-term investment are also investing activities.
This section of the cash flow statement reports changes in the balances of long-term asset accounts, such as:

Long-term Investments
Land
Buildings
Equipment
Furniture & Fixtures
Vehicles
In short, investing activities involve the purchase and/or sale of long-term investments and property, plant, and equipment.

Cash provided from or used by financing activities

Financing activities relate to long-term funds or capital of an enterprise, e.g. cash proceeds from issue of equity shares, debentures, raising long-term bank loans, redemption of bank loan, etc
This section of the cash flow statement reports changes in balances of the long-term liability and stockholders' equity accounts, such as:

Notes Payable (generally due after one year) Bonds Payable
Deferred Income Taxes
Preferred Stock
Paid-in Capital in Excess of Par-Preferred Stock
Common Stock
Paid-in Capital in Excess of Par-Common Stock
Paid-in Capital from Treasury Stock
Retained Earnings
Treasury Stock

In short, financing activities involve the issuance and/or the repurchase of a company's own bonds or stock. Dividend payments are also reported in this section.
Where to enter the balance sheet changes
Below are the changes where balance sheet accounts should be entered on Statement of cash flows:


A change in this...is reported in this section
balance sheet categoryof the cash flow statement
Current Assets Operating Activities
Current Liabilities Operating Activities
Long-term Assets Investing Activities
Long-term Liabilities Financing Activities
Stockholders' EquityFinancing Activities

*This refers to current assets other than Cash.


--Coming Soon -- Preparation of Cash Flow Statement  --

Wednesday, October 15, 2014

The Treatment given to Adjusting entries

Below is the chart to identify how adjusting entities are marked in accounting.

Tuesday, October 14, 2014

Adjusting Entries : Accounting Basics Day 8

Introduction 

Adjusting Entries are journal entries made at the end of the accounting period to allocate revenue and expenses to the period in which they actually are applicable. The Adjusting entries emphasize that while ascertaining the profitability, the revenues be considered as they are earned and not based on receipts, and the expenses be considered as they are incurred and not when they are paid Hence, many items need some adjustment while preparing the financial statements. In this chapter we’ll discuss all items which require adjustments and the way these are brought into the books of account and incorporated in the final accounts

What are adjusting entries?

Adjusting entries are accounting journal entries that convert a company's accounting records to the accrual basis of accounting(we have learnt about the accrual basis of accounting in the previous chapters) .An adjusting journal entry is typically made just prior to issuing a company's financial statements.
There are two scenarios where adjusting journal entries are needed before the financial statements are issued:


  • Nothing has been entered in the accounting records for certain expenses or revenues, but those expenses and/or revenues did occur and must be included in the current period's income statement and balance sheet.
  • Something has already been entered in the accounting records, but the amount needs to be divided up between two or more accounting periods.

Adjusting entries almost always involve a

  • Balance sheet account (Interest Payable, Prepaid Insurance, Accounts Receivable, etc.) and an Income statement account (Interest Expense, Insurance Expense, Service Revenues, etc.)

Types of Adjusting Entries

Some important and common items, which need to be adjusted at the time of preparing the final accounts, are discussed below.

  1. Closing stock
  2. Outstanding expenses
  3. Prepaid Expenses
  4. Accrued incomes
  5. Incomes received in advance
  6. Interest on capital
  7. Interest on drawings
  8. Interest on loan
  9. Interest on investment
  10. Depreciation
  11. Bad Debts
  12. Provision for bad and doubtful debts
  13. Provision for discount on debtors
  14. Provision for discount on creditors.

Note: All adjustments will be given outside the trial balance.

Closing Stock

The unsold goods in stock at the end of the accounting period is called as closing stock. This is to be valued at cost or market price whichever is lower.

Outstanding Expenses

Expenses which have been incurred but not yet paid during the accounting period for which the final accounts are being prepared are called as outstanding expenses.

Prepaid Expenses

Expenses which have been paid in advance are called as prepaid (Unexpired) expenses

Accrued Incomes or Outstanding Incomes

Income which has been earned but not received during the accounting period is called as accrued income.

Incomes Received in Advance

Income received during a particular accounting period for the work to be done in future period is called as income received in advance.

Interest on Capital

In order to see whether the business is really earning profit or not, it is desirable to charge interest on capital at a certain rate.

Interest on Drawings

Amount withdrawn by the owner for his personal use is called as drawings. When interest on capital is allowed, then interest on drawings is charged from the owner. Interest on drawings is an income for the business and will reduce the capital of the owner

Interest on Loan (Outstanding)

Borrowings from banks, financial institutions and outsiders for business are called loans. Amount payable towards interest on loan is an expense for the business

Interest on Investment:

Interest receivable on investments is an income for the business

Depreciation

Depreciation is the reduction in the value of fixed assets due to its use or obsolescence. Generally depreciation is charged at some percentage on the value of fixed asset.

Bad Debts

Debts which cannot be recovered are called bad debts. It is a loss for the business.

Provision for Bad and Doubtful Debts 

Every business suffers a percentage of bad debts over and above the debts definitely known as irrecoverable and written off as Bad (Bad debts written off). If Sundry debtors figure is to be shown correctly in the Balance sheet provision for bad and doubtful debts must be adjusted.
This Provision for bad and doubtful debts is generally provided at a certain percentage on Debtors, based on past experience. While preparing final accounts, the bad debts written off given in adjustment is first deducted from the Sundry debtors then on the balance amount (Sundry debtors – Bad debt written off) provision for bad and doubtful debts calculated
Provision for Discount on Debtors
To motivate the debtors to make prompt payments, cash discount may be allowed to them. After providing provision for bad and doubtful debts, the remaining debtors are called as good debtors. They may pay their dues in time and avail themselves of the cash discount Permissible. So a provision for discount on good debtors at a certain percentage may have to be created.
Provision for Discount on Creditors
Similar to cash discount allowed to debtors, the firm may have a chance to receive the cash discount from the creditors for prompt payment. Provision for discount on Creditors is calculated at a certain percentage on Sundry Creditors.

Treatment Given to Adjusting Entries



Click here to go back to Accounting Basics Day 7
Click here to go to Accounting Basics Day 9


Sunday, October 12, 2014

Balance sheet

A Balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a snapshot of a company's financial condition. Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business calendar year.

The purpose of preparing a Balance sheet is

  • To know the nature and value of assets of the business
  • To ascertain the total liabilities of the business.
  • To know the position of owner’s equity. 

The Balance Sheet consists of the assets and liabilities of a company, the format of the Balance Sheet is shown below

Format:

Balance Sheet As on xx-xx-20xx of Ms.XX


Assets

Assets represents everything which a business owns and has money value. In other words, asset includes possessions and properties of the business. Assets are classified as follows:

Tangible Assets:
Assets which have some physical existence are known as tangible assets. They can be seen, touched and felt, e.g. Plant and Machinery Tangible assets are classified into

  • Fixed assets: Assets which have long period of life and cannot be converted into cash in a short period are termed as fixed assets.
  • Current assets: Assets which can be converted into cash in the ordinary course of business and are held for a short period are known as current assets. For example, cash in hand, cash at bank, sundry debtors etc.
Intangible Assets
The assets which have no physical existence and cannot be seen or felt. They help to generate revenue in future, e.g. goodwill, patents, trademarks etc.

Liabilities

The amount which a business owes to others is liabilities. Credit balances of personal and real accounts together with the capital account are liabilities.

  • Long Term Liabilities : Liabilities which are repayable after a long period of time are known as Long Term Liabilities. For example, capital, long term loans etc.
  • Current Liabilities : Current liabilities are those which are repayable within a year. For example, creditors for goods purchased, short term loans etc.
  • Contingent liabilities : It is an anticipated liability which may or may not arise in future. For example, liability arising for bills discounted. Contingent liabilities will not appear in the balance sheet.
From the following Trial Balance of M/s. Arjun & Sons, prepare trading and profit and loss account for the year ending on 31st March 2008 and the balance sheet as on the date:






Saturday, October 11, 2014

Profit and Loss Account


After calculating the gross profit or gross loss the next step is to prepare the profit and loss account. To earn net profit a trader has to incur many expenses apart from those spent for purchases and manufacturing of goods. If such expenses are less than gross profit, the result will be net profit. When total of all these expenses are more than gross profit the result will be net loss.

The aim of profit and loss account is to ascertain the net profit earned or net loss suffered during a particular period.

The Format of Profit and Loss Account is shown below


Items appearing in the debit side

Those expenses which are chargeable to the normal activities of the business are recorded in the debit side of profit and loss account.
They are termed as Indirect expenses.

  • Office and Administrative Expenses: Expenses incurred for the functioning of an office are office and administrative expenses – office salaries, office rent, office lighting, printing and stationery, postages, telephone charges etc.
  • Repairs and Maintenance Expenses: These expenses relates to the maintenance of assets - repairs and renewals, depreciation etc.
  • Financial Expenses: Expenses incurred on borrowings –Interest paid on loan
  • Selling and Distribution Expenses: All expenses relating to sales and distribution of goods - advertising, travelling expenses, salesmen salary, commission paid to salesmen, discount allowed, repacking charges etc.

Items appearing in the credit side

Besides the gross profit, other gains and incomes of the business are shown on the credit side. The following are some of the incomes and gains.

  • Interest received on investment
  • Interest received on fixed deposits.
  • Discount earned.
  • Commission earned.
  • Rent Received

Example


Let us now prepare Trading and Profit Loss Account for the year ending 31st March 2002
from the books of Mr. Sree Ram


Balancing of Income statement

The difference between the two sides of profit and loss account indicates either net profit or net loss. If the total on the credit side is more the difference is called net profit. On the other hand if the total of debit side is more the difference represents net loss. The net profit or net loss is transferred to capital account.

Closing Entries

Profit and loss account should be closed by transferring the net profit or net loss to capital account.

If net profit
Profit and Loss A/c.............DrXXX
To Capital A/c (Net profit transferred to capital A/c)XXX
If net loss
Capital A/c....................Dr.XXX
To Profit and loss A/c (Net loss transferred to Capital A/c)XXX

Friday, October 10, 2014

Trading Account


Trading means buying and selling. The trading account shows the result of buying and selling of goods.
At the end of each year, it is necessary to ascertain the net profit or net loss. For this purpose, it is first necessary to know the gross profit or gross loss. The trading account is prepared to ascertain this. The difference between the selling price and the cost price of the goods is the gross earning of the business concern. Such gross earning is called as gross profit. However, when the selling price is less than the cost of goods purchased, the result is gross loss.
Let us now look at the format of the trading account

We’ll now see the explanation for each entity in the trading account.

Items appearing in the debit side of trading account

  1. Opening stock: Stock on hand at the beginning of the year is termed as opening stock. The closing stock of the previous accounting year is treated as the opening stock of the current accounting year. In the case of new business, there will not be any opening stock.
  2. Purchases: Goods Purchased during the year are included in Purchases, this includes both cash and credit purchases of goods. All the Purchases which have been purchased and returned back to the dealers due to some defects or excess are called as purchase returns. Purchase returns must be deducted from the total purchases to get net purchases.
  3. Direct Expenses: Expenses which are incurred from the stage of purchase to the stage of making the goods in saleable condition are termed as direct expenses. Some of the direct expenses are:



  • Wages: It is the amount paid to workers for the amount of labor they do for the organization.
  • Carriage or carriage inwards: It means the transportation charges paid to bring the goods from the place of purchase to the place of business.
  • Octroi Duty: Amount paid to bring the goods within the municipal limits.
  • Customs duty, dock dues, clearing charges, import duty etc.: These expenses are paid to the Government on the goods imported.
  • Other expenses: Fuel, power, lighting charges, oil, grease, waste related to production and packing expenses.

Items appearing in the credit side

Sales: This includes both cash and credit sale made during the year. Net sales are derived by deducting sales return from the total sales.
Closing stock: Closing stock is the value of goods which remain in the hands of the trader at the end of the year. It does not appear in the trial balance. It appears outside the trial balance. (As it appears outside the trial balance, first it will be recorded in the credit side of the trading account and then shown in the assets side of the balance sheet)

Let us prepare a Trading Account from the following information of a trader.

Total purchases made during the year 2003 Rs.2,00,000.

Total sales made during the year 2003 Rs.2, 50,000


ParticularsRsParticularsRs
To Purchases2,00,000By sales2,50,000
To Gross Profit c/d50,000
2,50,0002,50,000

Let us also try to go through another example and try to learn about the Trading account in detail
The following example the information given for the year ending 31st March 2002
Opening stock Rs. 1, 70,000
Purchases return Rs. 10,000
Sales Rs.2, 50,000
Wages Rs. 50,000
Sales return Rs. 20,000
Purchases Rs. 1, 00,000
Carriage inward Rs. 20,000
Closing stock Rs. 1, 60,000


Click here to go back to Accounting Basics Day 7


Thursday, October 9, 2014

Final Accounts : Accounting Basics Day 7

Introduction

The Stakeholders of a company will be interested in knowing whether the business has resulted in profit or loss and what the financial position of the company is at a given period. The company can ascertain these by preparing the final accounts. The final accounts are prepared at the end of the year from the trial balance. In this chapter we are going to learn in detail about the preparation of Final accounts

What are Final Accounts?

The businessman is interested in knowing whether the business has resulted in profit or loss and what the financial position of the business is at a given period. In short, he wants to know the profitability and the financial soundness of the business. The trader can ascertain these by preparing the final accounts. The final accounts are prepared at the end of the year from the trial balance. Hence the trial balance is said to be the connecting link between the ledger accounts and the final accounts.
The final Accounts generally include two statements known as balance sheet and income statement which are required for external reporting and also for internal needs of the management like planning, decision-making and control.



Trading and Profit and Loss Accounts (Income statement):

The profit and loss account is the accounting report which summarizes the revenues and expenses and ascertains the profit/loss for a specified accounting period. It also represents the changes in the owner’s equity between two successive periods

Balance Sheet:

The purpose of balance sheet is to show its resources and obligations for acquiring its resources i.e., assets and liabilities. According to American Institute of Public Accountants, balance sheet is “a tabular statement of summary of balances (debits and credits) carried forward after an actual and constructive closing of books of accounts and kept according to principles of Financial Statements of a Company accounting”. Balance sheet is the statement prepared on a particular date and shows classified properties and assets on the right hand side and obligations or liabilities on the left hand side

Assets

Real accounts and Personal accounts (which we have learnt about in the previous chapters) are capable of being called assets. Any element (account) that is capable of being liquidated (that is capable of being converted to cash by giving it away) indicates an asset. Machinery, Furniture, Cash, etc are real accounts that can be called assets. Debtors represent the persons and organizations who owe to the organization. They would clear their dues by paying out either in cash or in some other form. Thus Debtors get liquidated and as such can be called assets.

Liabilities

All elements representing liabilities are Personal accounts. An element that is capable of being cleared by paying out indicates a liability.
Creditors represent the persons and organization to whom the organization owes. The organization would clear its due by paying them either in cash or in some other form. Thus creditors are cleared by paying out and as such can be called liabilities.

How to enter the entries into Balance sheet and Income statements?

Before learning to enter the accounts into the Income Statement let us first distinguish the entries and learn to enter them into the financial statements.
As we know that the ledger accounts maintained within an organizational accounting system are classified into three as Personal, Real and Nominal.

Nominal Accounts

Nominal accounts are related to expenses, losses, incomes and gains. Since ascertaining profits or losses involves dealing with incomes, gains, expenses and losses we can conclude that all the nominal accounts together would give us the information relating to the profits or losses made by the organization.

Real Accounts

Real accounts are related to tangible aspects. In general we can identify that all asset accounts are real accounts.

Personal Accounts

Personal accounts are related to persons and organizations. These are persons/organization which owe the organization or to whom the organization owes. In effect they either form creditors (liabilities) or debtors (assets).

Since all the nominal accounts have been dealt with in deriving the information relating to profits and we are left with only the real and personal accounts which represent either assets or liabilities we can conclude that all the real and personal accounts together give us the information relating to the position of the organization.






Wednesday, October 8, 2014

Profit or Loss on sale of asset


Some times, a business may dispose an asset when it is worn out. In that case, it is advisable to find the profit or loss on sale of asset. This is done by comparing the selling price with the book value of the asset.

Book value = Cost Price - Total Depreciation provided till the date of sale,

If the selling price is more than the book value, then it is Profit on Sale. If the selling price is less than the book value, it is Loss on Sale.

Let Us now solve a problem to find out the profit or Loss on sale of machinery. Ram manufacturing company purchased on 1st April 2007, Machinery for Rs.2, 00,000. After having used it for three years it was sold for Rs. 160,000. Depreciation is to be provided every year at the rate of 10% per annum on the fixed instalment method. Books are closed on 31st March every year.

Book value on the date of sale is Rs. 140,000 As book value is less than selling price the difference is Profit.
= 160,000-140,000
Profit on sale of machinery = Rs. 20,000.

Illustration:

Srinivas & Co. purchased machinery on 1st April 2007 for Rs.75, 000. After having used it for three years it was sold for Rs.35, 000. Depreciation is to be provided every year at the rate of 10% per annum on Diminishing balance method. Accounts are closed on 31st March every year. Find out the profit or loss on sale of machinery.


Book value on the date of sale = Rs.54,675.
As book value is greater than selling price the difference is loss.
= 54,675 – 35,000
Loss on sale of Machinery = Rs.19, 675.





Tuesday, October 7, 2014

Recording Depreciation

Depreciation is directly charged against the asset by debiting Depreciation account and crediting the Asset account. Depreciation account is closed by transferring to Profit and Loss account at the end of the year. The entries will be as under:

1) For the amount of depreciation to be provided at the end of the Year:
                        Depreciation A/c….. Dr.
                        To Asset A/c.

2) For transferring the amount of depreciation at the end of the year.
                        Profit and Loss A/c….. Dr.
                        To Depreciation A/c.

Asset Account will be shown at cost less depreciation i.e., written down value at the end of the year in the Balance sheet

Now Let Us look at an example and learn about passing journal entries and preparing fixed asset account and depreciation account for three years.

Ram & sons purchased a fixed asset on 1.4.2006 for Rs.3, 00, 000. Depreciation is to be provided at 10% annually according to the Straight line method. The books are closed on 31st March every year.

Amount of Depreciation = 300,000 * (10/100)
                                          = 30,000




In the Books of Rajesh & Co.
Journal Entries
Date Particulars L.F.  Debit  Credit
1-Apr-06 Fixed asset A/c Dr 3,00,000
To Bank A/c 3,00,000
31-Mar-07 Depreciation A/c Dr 3,00,000
To Fixed asset A/c 3,00,000
(Depreciation provided)
31-Mar-07 Profit & Loss A/c Dr 3,00,000
To Depreciation A/c 3,00,000
(Depreciation transferred
to Profit & Loss A/c)
31-Mar-08 Depreciation A/c Dr 3,00,000
To Fixed asset A/c 3,00,000
(Depreciation provided)
31-Mar-08 Profit & Loss A/c Dr 3,00,000
To Depreciation A/c 3,00,000
(Depreciation transferred
to Profit & Loss account)
31-Mar-09 Depreciation A/c Dr 3,00,000
To Fixed asset A/c 3,00,000
(Depreciation provided)
31-Mar-09 Profits & Loss A/c Dr
To Depreciation A/c
(Depreciation transferred
to Profit & Loss A/c)



Ledger Account
Fixed Asset Account
Date.  Particulars  Rs.  Date  Particulars  Rs
1-Apr-06 To Bank A/c 3,00,000 31-Mar-07 By Depreciation A/c 30,000
By Balance c/d 2,70,000
3,00,000 3,00,000
1-Apr-07 To Balance b/d 2,70,000 31-Mar-08 By Depreciation A/c 30,000
By Balance c/d 2,40,000
2,70,000 270,000
1-Apr-08 To Balance b/d 2,40,000 31-Mar-09 By Depreciation A/c 30,000
By Balance c/d 2,10,000
2,40,000 2,40,000
By Depreciation A/c 30,000
1-Apr-09 To Balance b/d 2,10,000 By Balance c/d 2,10,000

Depreciation A/c
Date.  Particulars  Rs.  Date  Particulars  Rs
31-Mar-07 To Fixed Asset A/c 30000 31-Mar-07 By Profit & Loss A/c 30,000
30000 30000
31-Mar-08 To Fixed Asset A/c 30000 31-Mar-08 By Profit & Loss A/c 30000
30000 30000
31-Mar-09 To Fixed Asset A/c 30000 31-Mar-08 By Profit & Loss A/c 30000
30000 30000




Friday, October 3, 2014

Written Down Value Method of Depreciation

This method is also called as Diminishing Balance Method. In this method depreciation is charged at a fixed percentage each year on the reducing balance (i.e., cost less depreciation) of asset. The amount of depreciation goes on decreasing every year.
For example, If the asset is purchased for Rs.2, 00,000 and depreciation is to be charged at 10% p.a. on reducing balance method, then

Depreciation for the 1st year      = 10% on Rs.2, 00,000, i.e., Rs.20,000
Depreciation for the 2nd year    = 10% on Rs.1, 80,000 (Rs.2, 00,000 –– Rs.20, 000)
                                                       = Rs. 18,000
Depreciation for the 3rd year    = 10% on Rs.162, 000 (Rs.180, 000 - Rs.18, 000)
                                                      = Rs.16, 200 and so on.

Merits

In earlier years the amount of depreciation is more and the amount of repairs and renewals is less whereas in later years the amount of depreciation is less and the amount of repairs and renewals is more therefore the total charge (i.e., depreciation plus repairs and renewals) remains almost uniform year after year, since,
This method is recognized by the Income Tax authorities
It is a logical method as the depreciation is calculated on the diminished balance every year.

Demerits

It is very difficult to determine the rate by which the value of asset could be written down to zero.

Click here to go back to Depreciation: Day 6


Thursday, October 2, 2014

Straight Line Method for Calculating Depreciation

This method is also called as Fixed Instalment Method .In this method the same amount of depreciation is charged every year throughout the life of the asset. The amount and rate of depreciation is calculated as under.

Amount of depreciation = ( Total cost – Scrap value ) / Estimated Life

Rate of depreciation = ( Amount of Depreciation / Original Cost ) * 100

Let us now look at a simple example to calculate amount of depreciation and Rate of depreciation, given a company purchased Machinery for Rs.2, 00,000. Its installation costs amounted to Rs.10, 000. Its estimated life is 5 years and the scrap value is Rs.10, 000. Calculate the amount and rate of depreciation
Total cost = Purchase Price + Installation Charges
= Rs.2, 00,000 + Rs.10, 000
= Rs. 2, 10,000

Amount of depreciation = ( Total cost – Scrap value ) / Estimated Life

                                          = ( Rs.2, 10,000 – Rs.10, 000 ) / 5
                                          = Rs. 40,000

Rate of depreciation = ( Amount of depreciation/Original cost ) * 100

                                   = ( Rs 40,000/Rs. 210,000 ) * 100
                                   = 19.04%

Under straight line method, for each of the five years, the amount of depreciation to be charged will be Rs.40, 000

Merits:


  • It is very simple and easy to understand.
  • The amount and rate of depreciation is easy to calculate
  • Under this method, the book value of the asset becomes zero or equal to its scrap value at the expiry of its useful life.

Demerits

The amount of depreciation is same in all the years, although the usefulness of the machine to the business is more in the initial years than in the later years

Click here to go back to Depreciation: Day 6

Wednesday, October 1, 2014

Depreciation : Accounting Basics Day 6

Introduction

Depreciation is a term used in accounting, economics and finance to spread the cost of an asset over the span of several years. In common, depreciation is the reduction in the value of an asset used for business purposes during certain amount of time due to usage, passage of time .In this chapter we are going to learn about depreciation in detail and also about the methods to calculate depreciation.

Learning Objectives 

After studying this Chapter, you will be able to:

  • Understand the meaning and definition of depreciation. 
  • Recognize the reasons and causes for providing depreciation. 
  • Identify various methods of depreciation. 
  • Determine the profit or loss at the time of sale of asset.

Depreciation

All assets whose benefits are derived for a long period of time, usually more than one year period are called as Fixed Assets. These assets decrease in value year after year due to wear and tear or as time passes by. This reduction in value of Fixed Assets is called Depreciation.
For instance, a factory owner owns machinery worth Rs.5, 00,000, may estimate the life of the machinery as ten years. This means that the value of the asset is reducing every year. Hence, it is necessary to spread the cost over five years during which the benefit of the asset is derived. Thus depreciation Rs.50,000 (Rs.5, 00,000 /10 years) is to be treated as an expense, which is debited to Profit and Loss account.
In the words of Spicer and Pegler, “Depreciation is the measure of the exhaustion of the effective life of an asset from any cause during a given period”.

Causes of Depreciation


The causes of depreciation may be internal or external. The internal causes arise from properties inherent in the asset itself. External causes arise from forces outside the business. These are being discussed below:

Internal Causes 

  • Wear and tear: Wear and tear means decrease in assets value, arising from its use in business operations
  • Disuse: When a machine is kept continuously idle, it becomes potentially less useful.
  • Maintenance: when the machine is not maintained properly its condition deteriorates
  • Depletion: depletion physical reduction of natural resources by exhaustion e.g., mines, quarries, oil wells etc.

External Causes

  • Obsolescence:  Decrease in value of property as the result of technological advancement.
  • Effluxion of time: When assets are exposed to forces of nature, like weather, wind, rain, etc., the value of such assets may decrease even if they are not put into any use.
  • Time Factor: Lease, copy-right, patents are acquired for a fixed period of time. On the expiry of the fixed period of time, the assets cease to exist.

Methods of Calculating Depreciation


Tuesday, September 30, 2014

Accounting Principles : Accounting Basics Day 5

Introduction

The accounting principles are accounting rules used to prepare, present, and report financial statements for a wide variety of entities, including publicly-traded and privately-held companies, non-profit organizations, and governments. In this chapter we are going to learn about these accounting procedures which form the guidelines to prepare the financial statements.


Learning Objectives

By the time you finish Day 3 you would have learnt about

  • Basic accounting conventions. 
  • Concepts. 
  • Assumption

Why Accounting Principles?


Imagine that you are a business owner, and you take copies of your financial records to six different accountants. You ask each one to calculate your profit for the year. A fortnight later they each provide you with their answers. There are six different profit figures, with very wide variations between them. What impression do you now have of the accounting profession?
To avoid this kind of situation arising various rules, or accepted ways of going about things have evolved. These rules are known as 'concepts' and 'conventions' To support the application of the "true and fair view", accounting has adopted certain concepts and conventions which help to ensure that accounting information is presented accurately and consistently.


Assumptions

The basic assumptions of accounting are like the foundation pillars on which the structure of accounting is based. The four basic assumptions are as follows:

Business Entity Assumption

The concept of business entity assumes that business has a distinct and separate entity from its owners. It means that for the purposes of accounting, the business and its owners are to be treated as two separate entities. Keeping this in view, when a person brings in some money as capital into his business, in accounting records, it is treated as liability of the business to the owner. Here, one separate entity (owner) is assumed to be giving money to another distinct entity (business unit). Similarly, when the owner withdraws any money from the business for his personal expenses (drawings), it is treated as reduction of the owner’s capital and consequently a reduction in the liabilities of the business.

Money Measurement Assumption

The concept of money measurement states that only those transactions and happenings in an organization which can be expressed in terms of money such as sale of goods or payment of expenses or receipt of income, etc. are to be recorded in the book of accounts. All such transactions or happenings which cannot be expressed in monetary terms, for example, the appointment of a manager, capabilities of its human resources or creativity of its research department or image of the organization among people in general do not find a place in the accounting records of a firm.

Accounting Period Assumption

The users of financial statements need periodical reports to know the operational result and the financial position of the business concern. Hence it becomes necessary to close the accounts at regular intervals. Usually a period 52 weeks or 1 year is considered as the accounting period.

Going Concern Assumption

As per this assumption, the business is assumed to continue for a never ending period and therefore transactions are recorded from this point of view. There is neither the intention nor the necessity to wind up the business in the foreseeable future.

Basic Concepts of Accounting

These concepts guide how business transactions are reported. On the basis of the above four assumptions the following concepts (principles) of accounting have been developed.

Dual Aspect Concept

Dual aspect is the foundation or basic principle of accounting. It provides the very basis for recording business transactions into the book of accounts. This concept states that every transaction has a dual or two-fold effect and should therefore be recorded at two places. In other words, at least two accounts will be involved in recording a transaction. This can be explained with the help of an example. Ram started business by investing in a sum of Rs. 50, 00,000 the amount of money brought in by Ram will result in an increase in the assets (cash) of business by Rs. 50, 00,000. At the same time, the owner’s equity or capital will also increase by an equal amount. It may be seen that the two items that got affected by this transaction are cash and capital account.All business transactions recorded in accounts have two aspects - receiving benefit and giving benefit. For example, when a business acquires an asset (receiving of benefit) it must pay cash (giving of benefit).

Realization Concept

The concept of revenue recognition requires that the revenue for a business transaction should be included in the accounting records only when it is realized. Here arise two questions in mind. First, is termed as revenue and the other, when the revenue is realized. Let us take the first one first. Revenue is the gross inflow of cash arising from (i) the sale of goods and services by an enterprise; and (ii) use by others of the enterprise’s resources yielding interest, royalties and dividends. Secondly, revenue is assumed to be realized when a legal right to receive it arises, i.e. the point of time when goods have been sold or service has been rendered. Thus, credit sales are treated as revenue on the day sales are made and not when money is received from the buyer. As for the income such as rent, commission, interest, etc. these are recognized on a time basis. For example, rent for the month of March 2005, even if received in April 2005, will be taken into the profit and loss account of the financial year ending March 31, 2005 and not into financial year beginning with April 2005. Similarly, if interest for April 2005 is received in advance in March 2005, it will be taken to the profit and loss account of the financial year ending March 2006.

Historical Cost Concept

Under this concept, assets are recorded at the price paid to acquire them, which includes cost of acquisition, transportation, installation and making the asset ready to use . For example, if a piece of land is purchased for Rs.50,00,000 and its market value is Rs.70,00,000 at the time of preparing final accounts the land value is recorded only for Rs.50,00,000. Thus, the balance sheet does not indicate the price at which the asset could be sold for.

Matching Concept

The earnings and expenses shown in an income statement must both refer to the same goods transferred or services rendered during the accounting period. The matching concept requires that expenses should be matched to the revenues of the appropriate accounting period.
Profit is an excess of revenue over expenditure therefore it becomes necessary to bring together all revenues and expenses relating to the period under review so we must determine the revenue earned during a particular accounting period and the expenses incurred to earn these revenues

Verifiable and Objective Evidence Concept

The concept of objectivity requires that accounting transaction should be recorded in an objective manner, free from the bias of accountants and others. This can be possible when each of the transaction is supported by verifiable documents or vouchers. For example, the transaction for the purchase of materials may be supported by the cash receipt for the money paid, if the same is purchased on cash or copy of invoice and delivery challan, if the same is purchased on credit. Similarly, receipt for the amount paid for purchase of a machine becomes the documentary evidence for the cost of machine and provides an objective basis for verifying this transaction.

Conventions

To make the accounting information useful to various interested parties, the basic assumptions and concepts discussed earlier have been modified. These modifying principles are as under.

Convention of Full Disclosure

The principle of full disclosure requires that all material and relevant facts concerning financial performance of an enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes. This is to enable the users to make correct assessment about the profitability and financial soundness of the enterprise and help them to take informed decisions.

Convention of Materiality

The materiality principle requires all relatively relevant information should be disclosed in the financial statements. Unimportant and immaterial information are either left out or merged with other items.
For example, money spent on creation of additional capacity of a theatre would be a material fact as it is going to increase the future earning capacity of the enterprise. Similarly, information about any change in the method of depreciation adopted or any liability which is likely to arise in the near future would be significant information. All such information about material facts should be disclosed through the financial statements and the accompanying notes so that users can take informed decisions.

Convention of Consistency

The aim of consistency principle is to preserve the comparability of financial statements. The rules, practices, concepts and principles used in accounting should be continuously observed and applied year after year. Comparisons of financial results of the business among different accounting period can be significant and meaningful only when consistent practices were followed in ascertaining them.
To illustrate, an investor wants to know the financial performance of an enterprise in the current year as compared to that in the previous year. He may compare this year’s net profit with that in the last year. But, if the accounting policies adopted, say with respect to depreciation in the two years are different, the profit figures will not be comparable. Because the method adopted for the valuation of stock in the past two years is inconsistent. It is, therefore, important that the concept of consistency is followed in preparation of financial statements so that the results of two accounting periods are comparable.

Convention of Conservatism

The concept of conservatism requires that profits should not to be recorded until realized but all losses, even those which may have a remote possibility, are to be provided for in the books of account. This principle takes into consideration all prospective losses but leaves all prospective profits. The essence of this principle is “anticipate no profit and provide for all possible losses”. For example, while valuing stock in trade, market price or cost price whichever is less is considered.


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Monday, September 29, 2014

Bills Payable Book

Bills payable book is used to record bill accepted by us. When a bill drawn by our creditor is accepted particulars of the same are recorded in this book.

Posting:

In the ledger, the account of each person whose bill has been accepted is debited with the amount of the bill. The monthly total of the bills accepted is credited to the bills payable account ledger.

Format of Bills Receivable Book:

The following is the ruling and format of bills payable book:

Dr
Bills Payable Book
Cr
No. of BillsDateTo whom GivenDrawerPayeeP/ble AtTermDue DateL.F.AmtRemarks

2)

Dr
Bills Payable Book
Cr
DateTo whom givenTermDue DateL.F.Amount


From the following transactions of a trader let us prepare the bills receivable book and post it into ledger

Date
January 5,2009Accepted a bill at 3 m/d for $200 drawn by Rahmat & Co
" 20gave acceptance at 2 m/d for $500 to Kamal.
" 30Acceptance at 1 m/d for $ 500 given to Feroz & Co.

Solution

DateFrom whom receivedTermDue DateL.F.Amount
Jan 5,2009Rahmat & Co.3 m/dApril 8200
Jan 20Kamal3 m/dMarch 23500
Jan 30Feroz & Co.1 m/dMarch 30500
Total : 1200

Now the individual entries are posted in their respective Ledgers as shown below:

Dr
Purchases Return Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount



January 31,2005By Sundry as per Bills Payable Book1200


Dr
Rahmat & Co. Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January 8,2005By Bills Payables200



Dr
Kamal Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January 20,2005By Bills Payables500



Dr
Feroz and Co. Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January31,2005By Bills Payables500



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Sunday, September 28, 2014

Bills Receivable book

This book is used to record the bills received from debtors. When a bill is received, details of it are recorded in the bills receivable book.

Posting:

In the ledger the account of the person from whom each bill is received is credited with the amount of that bill and the periodical total of the book is posted to the debit of bills receivable account.
The bills receivable book is ruled according to the requirements of a particular account. The following is the format of bills receivable book:

1)


Dr
Bills Receivable Book
Cr
No. of BillsDateR/ved FromDrawerAceptorP/ble AtTermDue DateL.F.AmtRemarks

2)

Dr
Bills Receivable Book
Cr
DateFrom whom receivedTermDue DateL.F.Amount


From the following transactions of a trader let us prepare the bills receivable book and post it into ledger

Date
January 5,2009Drew a bill on Abishek & Co. at 2 m/d for $600
" 10Acceptance received from Ravi at 3 m/d for $ 900.
" 20A. Riaz gives his acceptance at 3 m/d for $700.
" 30Bill at 2 m/d for $100 is drawn on Basker

Solution


DateFrom whom receivedTermDue DateL.F.Amount
Jan 5,2009Abishek & Co2 m/dMarch 8600
Jan 10Ravi3 m/dApril 13900
Jan 20A. Riaz3 m/dApril 21700
Jan 30Basker2 m/dMarch 30100
/td>Total : 2300

Dr
Bills Receivables Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Jan 30,2009 By Sundry as per B/R Book2300



Dr
Abishek & Co. Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 5,2014By Bills Receivables600


Dr
Ravi Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 10,2014By Bills Receivables900

Dr
A. Riaz Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 20,2014By Bills Receivables700

Dr
Abishek & Co. Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 30,2014By Bills Receivables100


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