Tag: Accounts Receivable

The objective of Ind AS 24 is to ensure that an entity’s financial statements contain the disclosures necessary to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances, including commitments, with such parties.

A related party transaction is a transfer of resources, services or obligations between RE (reported entity) and related party regardless of whether a price is charged or not.

Entity is related to another entity if:

• Entity and RE are members of same group (i.e., Parent, Subsidiary, fellow subsidiary) A Group is a parent and all its subsidiaries.
• Associate or JV of the entity covered under (i) (i.e., associate or JV of member of group)
• Both entities are JV of same third party
• JV and Associate of the same third party
• Entity is post-employment benefit plan of either the RE or an entity related to RE. If RE is itself such a plan, the sponsoring employers are also related to RE.
• Entity is controlled / jointly controlled by Person identified under a)
• Person identified in a(i) has significant influence over the entity; or Person is a member of KMP of the entity or parent of the entity
• Entity (or any member of the group of entity is part) provides KMP services to RE or parent of RE.

Related party disclosure requirements as laid down in this Standard do not apply in circumstances where providing such disclosures would conflict with the reporting entity’s duties of confidentiality as specifically required in terms of a statute or by any regulator or similar competent authority.

In case a statute or a regulator or a similar competent authority governing an entity prohibits the entity to disclose certain information which is required to be disclosed as per this Standard, disclosure of such information is not warranted. For example, banks are obliged by law to  maintain confidentiality  in respect of their customers’ transactions and this Standard would not override the obligation to preserve the confidentiality of customers’ dealings.

This standard shall be applied to:

• Identifying outstanding balance and commitments between the reporting entity and related parties.
• Identifying related parties and transactions with them.
• Determine the disclosures to be made.
• Recognising the circumstances in which disclosures will be required in the above-stated situations.

Related Party Transactions: A transaction of transfer of resources, services or obligations between a reporting entity and a related party regardless of whether a price is charged Government: Government, government agencies and similar bodies whether local, national or international Government-related entity is controlled, jointly controlled or significantly influenced by a government 5. The following are not related parties two entities because they have director or other member of key management personnel in common two joint venturers simply because they share joint control providers of finance trade unions public utilities departments and agencies of government that does not control, jointly control or significantly influence the reportiing entity a customer supplier franchisor distributor general agent 6. Following disclosures are to be made Relationships between a parent and its subsidiaries should be disclosed irrespective of whether there have been transactions between them An entity shall disclose key management personnel compensation in total and for each of the following categories:

• Post-employment benefits
• Short-term employee benefits
• Other long-term benefits
• Termination benefits and
• Share based payment.
• If key management personnel services are obtained from another entity, the above requirements need not be disclosed.
• If an entity has had related party transactions during the periods covered by financial statements, it shall disclose the nature of the related party relationship as well as information about those transactions (i.e amount, terms and conditions, provisions, expense) and outstanding balances, including commitments.
• The disclosures required above shall be made separately for each of the parent, entities with joint control or significant influence over the entity, subsidiaries, associates, joint ventures, key management personnel, other related parties
• Amounts incurred by the entity for the provision of key management personnel services that are provided by a separate management entity.

Some of the examples of transactions to be disclosed if done with related party;

Purchases or sales of goods or assets, rendering or receiving services, leases, transfer of research and development and so on

Disclosures to be made

• An entity must report the compensation to the key management personnel in total and each of the categories such as short term employee benefits, post-employment benefits, termination benefits, share-based payment, and other long-term benefits.
• Relationships between parent and subsidiaries should be disclosed irrespective of whether there have been any transactions or not. If the entity’s parent or the ultimate controlling party does not produce consolidated financial statements, then the next senior parent must be named in the consolidated financial statements for public use.
• If key management services are obtained from another entity, then only the amounts incurred for the provision of such services shall be disclosed.
• The above disclosures will be made separately in respect of a parent, subsidiaries, associate, entities with joint control or significant influence over the other entity, joint ventures in which the entity is the venturer, and key management personnel of the entity or parent and other related parties.
• If the entity has transactions with the related party during the financial year, then it shall disclose the nature of such transactions, and also all the details such as amount, outstanding balances including commitments, provision for doubtful debts, and the expense recognised in respect of bad and doubtful debts.

Government related entities Reporting entity is exempt from the disclosures requirements in relation to related party transactions and outstanding balances including commitments with government who has control or joint control or significant influence over the reporting entity and another entity that is related party because the same government has control or joint control of or significant influence over both the reporting and other entity If the above exemption is applied by the reporting entity then it shall disclose the following about the transactions and related outstanding balances.

• Name of the government and nature of its relationship
• The nature and amount of each individually significant transaction and for other transactions that are collectively but not individually significant a qualitative or quantitative indication of their extent.

Accounting controls consists of the methods and procedures that are implemented by a firm to help ensure the validity and accuracy of its financial statements. The accounting controls do not ensure compliance with laws and regulations, but rather are designed to help a company operate in the best possible manner for all stakeholders.

Accounting Controls are the measures and controls adopted by an organization that leads to increased efficiency and compliance across the organization and ensures that financial statements are accurate when presented to auditors, bankers, investors, and other stakeholders.

The purpose of implementing accounting controls in a firm is to ensure that all areas in an organization avoid fraud and other issues, improve efficiency, accuracy, and compliance. Every firm will have different accounting controls in place, depending on their type of business, however, there are three traditional areas that are the most common when it comes to accounting controls: detective controls, preventive controls, and corrective controls.

Corrective Controls

As the name suggests, corrective controls are put in place to fix any issues found through detective controls. These can also include remedying any issues made on accounting books after the audit process has been completed by an accountant.

Preventive Controls

Preventive controls are simply the controls that have been put in place by an organization to avoid any inaccuracies or incorrect practices. These are the policies and procedures that all employees must follow.

An example of a preventive control would be limiting management’s involvement in the preparation of financial statements. Sometimes it’s helpful for management to be involved since they generally know the company better than anyone. But final say on numbers should be in the hands of an accountant, because management may have the incentive to distort numbers to inflate the company’s performance.

Detective Controls

The controls in this category are meant to seek out any current practices that don’t align with the policies and procedures in place. The goal here is to find any areas that are not functioning as they ought to, if employees are accidentally or purposefully practicing incorrect or illegal actions, or detecting any errors in systems or accounting practices. Examples of detective controls would include inventory checks and internal audits.

Advantages of Accounting Internal Controls

• Accuracy of financial statements and funds application.
• The action log identifies the person responsible for any error.
• Efficient use of the resources for the intended purpose.
• A strong foundation for a more significant growth.
• Helpful in audit facilitation.
• Saving of cost and resources.
• Identification and rectification of any discrepancy identified.

Disadvantages:

• The high cost of maintaining controls and standards.
• Sometimes irritating and time-consuming for employees.
• Duplication of work.
• Overdependent for financial statements and audit.

Procedures:

Approval Authority Requirements

Requiring specific managers to authorize certain types of transactions can add a layer of responsibility to accounting records by proving that transactions have been seen, analyzed and approved by appropriate authorities. Requiring approval for large payments and expenses can prevent unscrupulous employees from making large fraudulent transactions with company funds, for example.

Daily or Weekly Trial Balances

Using a double-entry accounting system adds reliability by ensuring that the books are always balanced. Even so, it is still possible for errors to bring a double-entry system out of balance at any given time. Calculating daily or weekly trial balances can provide regular insight into the state of the system, allowing you to discover and investigate discrepancies as early as possible.

Physical Audits of Assets

Physical audits include hand-counting cash and any physical assets tracked in the accounting system, such as inventory, materials and tools. Physical counting can reveal well-hidden discrepancies in account balances by bypassing electronic records altogether. Counting cash in sales outlets can be done daily or even several times per day. Larger projects, such as hand counting inventory, should be performed less frequently, perhaps on an annual or quarterly basis.

Separation of Duties

Separation of duties involves splitting responsibility for bookkeeping, deposits, reporting and auditing. The further duties are separated, the less chance any single employee has of committing fraudulent acts. For small businesses with only a few accounting employees, sharing responsibilities between two or more people or requiring critical tasks to be reviewed by co-workers can serve the same purpose.

Periodic Reconciliations in Accounting Systems

Occasional accounting reconciliations can ensure that balances in your accounting system match up with balances in accounts held by other entities, including banks, suppliers and credit customers. For example, a bank reconciliation involves comparing cash balances and records of deposits and receipts between your accounting system and bank statements. Differences between these types of complementary accounts can reveal errors or discrepancies in your own accounts, or the errors may originate with the other entities.

Standardized Financial Documentation

Standardizing documents used for financial transactions, such as invoices, internal materials requests, inventory receipts and travel expense reports, can help to maintain consistency in record keeping over time. Using standard document formats can make it easier to review past records when searching for the source of a discrepancy in the system. A lack of standardization can cause items to be overlooked or misinterpreted in such a review.

Accounting System Access Controls

Controlling access to different parts of an accounting system via passwords, lockouts and electronic access logs can keep unauthorized users out of the system while providing a way to audit the usage of the system to identify the source of errors or discrepancies. Robust access tracking can also serve to deter attempts at fraudulent access in the first place.

Accounting income is an income resulting from business transactions arising from the cash-to-cash cycle of business operations. It is derived from a periodic matching of revenue (sales) with associated costs. Accounting income is an expost measure that is, measured ‘after the event.’

The accounting income recognises income only when they have been realised. On the other hand, the economic income, because it is based on valuations of all anticipated future benefits, recognises these flows well before they are realised. This means that, at the point of original investment, economic capital will exceed accounting capital by an amount equivalent to the difference between the present value of all the anticipated benefit flows and the value of those resources transacted and accounted for at that time.

The difference represents an unrealized gain which will, over time, be recognised and accounted for in computing income as the previously anticipated benefit flows are realised.

Accounting income and economic income basically differ in terms of the measurement used.

As Boulding observes:

“Accountants measure capital in terms of actualities, as the primary by-product of the accounting income measurement process; and that economist in terms of potentialities, in order to measure economic income.”

The accountant uses market prices (either past or current) in measuring income based upon recorded transactions which may be verified. Current values, if used in accounting income, utilise the historic cost transactions base before updating the data concerned into contemporary value terms.

The economist, on the other hand, uses predictions of future flows stemming from the resources which have the subject of past transactions. The accountant basically adopts a totally backward-looking or expost approach, and consequently ignores potential capital value changes.

The economist, on the other hand, is forward looking in his model and bases his capital value on future events. Under accounting income, the accountant aims to achieve objectivity maximization while measuring income for reporting purposes. The economist is free of such a constraint and is quite content in his model which may have large-scale subjectivity.

As a result, the two income concepts appear to be poles apart in concept and measurement certainly the accountant would find the economic model almost impossible to put into practice in financial reporting, despite its great theoretical qualities. On the other hand, the economist would not find the accounting model relevant as a guide to prudent personal conduct.

Conventional accounting income possess a limited utility for decision-making purposes because of the historical cost and realisation principle which govern the measurement of accounting income. Changes in value are not reported as they occur. Economic concept of income places emphasis on value and value changes rather than historical costs. Economic income stresses the limitations of accounting income for financial reporting and decision-making purposes.

Similarities:

• Both involve measurement and valuation procedures.
• Both use the transactions for income measurement.
• Capital is an essential ingredient in income determination.
• In a world of certainty and with perfect knowledge, accounting income and economic income as measures of better-offness would be readily determinable and would be identical. With such knowledge, earnings for a period would be the change in the present value of the future cash flows, discounted at an appropriate rate for the cost of money.
• Under current cost accounting, the reported income equals economic income in a perfectly competitive market system. During periods of temporary disequilibrium and imperfect market conditions, current cost income may or may not approximate economic income.

Basis of Accounting refers to the method by which financial transactions are recorded and recognized in the accounting system. There are two primary types: Accrual Basis and Cash Basis. Under the accrual basis, revenues and expenses are recognized when they are earned or incurred, regardless of cash flow. The cash basis, on the other hand, records transactions only when cash is received or paid. The choice of accounting basis affects how financial performance and position are reported and can impact decision-making and analysis.

Cash basis

Cash Basis Accounting is a simple method where revenues and expenses are recorded only when cash is actually received or paid. In this system, income is recognized when cash is collected, and expenses are recognized when payments are made, regardless of when the transaction occurred. It is commonly used by small businesses and individuals due to its simplicity and focus on actual cash flow. However, it may not provide a complete picture of a business’s financial health, as it ignores receivables, payables, and other non-cash transactions.

Functions of Cash basis:

• Simple and Easy to Use:

One of the main functions of cash basis accounting is its simplicity. It requires no complex financial tracking or extensive knowledge of accounting principles. Businesses record income when cash is received and expenses when payments are made. This ease of use makes it particularly attractive for small businesses, freelancers, and sole proprietors with limited accounting resources.

• Focuses on Cash Flow:

Cash basis accounting emphasizes actual cash flow, helping businesses closely monitor their available cash. Since it records only when cash is received or spent, businesses can easily see how much cash they have on hand. This is critical for small businesses or startups that rely on maintaining positive cash flow for their day-to-day operations and short-term decision-making.

• Immediate Recognition of Transactions:

In cash basis accounting, transactions are recognized immediately upon receipt or payment of cash. This function simplifies financial record-keeping, as there is no need to track receivables, payables, or adjust for accruals. As a result, business owners can directly link their bank statements to their accounting records, creating a clear and straightforward financial picture.

• Lower Administrative Costs:

Cash basis accounting typically requires less administrative effort and fewer resources than accrual accounting. It eliminates the need for tracking accounts receivable, accounts payable, and making complex adjustments. This function reduces bookkeeping time and costs, making it an affordable option for small businesses without the need for extensive accounting departments.

• Tax Benefits:

In many tax systems, cash basis accounting can offer potential tax benefits. Since income is recognized only when cash is received, businesses may be able to defer income tax liability if payments from customers are delayed until the next tax year. This can help manage tax obligations and smooth out cash flow, especially for businesses with fluctuating income.

• Provides a Clear Picture of Immediate Liquidity:

Cash basis accounting gives an accurate view of a company’s current liquidity. Since it only records cash transactions, it shows exactly how much cash is available at any given time. This function is particularly useful for businesses needing to make short-term decisions based on available resources.

• Reduces Complexity in Financial Reporting:

With cash basis accounting, there are no complex financial reports to prepare. There are no accruals, prepayments, or provisions to account for, reducing the complexity of financial statements. For smaller businesses, this function means less reliance on professional accountants or financial experts, simplifying reporting and compliance.

• Better for Small or Cash-Based Businesses:

Cash basis accounting functions well for businesses that operate primarily on a cash basis, such as retail stores, food service providers, and small service-oriented businesses. Since these businesses receive payments immediately and have minimal credit sales or long-term receivables, cash basis accounting aligns well with their operations, making financial management straightforward and efficient.

Cash basis Book entry:

Accrual Basis:

Accrual Basis Accounting is a method where revenues and expenses are recorded when they are earned or incurred, regardless of when cash is actually received or paid. Under this system, revenue is recognized when goods or services are delivered, and expenses are recorded when obligations arise. This method provides a more accurate picture of a company’s financial performance by matching revenues with related expenses within the same accounting period. While more complex than cash basis accounting, it is widely used by larger businesses and follows generally accepted accounting principles (GAAP).

Functions of Accrual basis:

• Matching Principle:

One of the primary functions of accrual basis accounting is the matching principle, which states that revenues should be matched with the expenses incurred to generate them within the same accounting period. This function allows businesses to accurately assess profitability by linking income with its associated costs, providing a clearer picture of financial performance.

• Comprehensive Financial Reporting:

Accrual accounting enhances financial reporting by providing a complete view of a company’s financial activities. It includes not only cash transactions but also accounts receivable and payable, ensuring all financial obligations and rights are recognized. This comprehensive reporting is crucial for stakeholders who need to evaluate a company’s performance over time.

• Improved Financial Forecasting:

By recognizing revenue and expenses when they occur, accrual basis accounting allows for better financial forecasting and planning. Businesses can analyze trends and patterns based on actual performance rather than cash flow timing. This function is particularly beneficial for long-term strategic planning and investment decisions.

• Enhanced Creditworthiness:

Companies using accrual accounting can present a more accurate picture of their financial health, improving their creditworthiness. Lenders and investors often prefer accrual basis financial statements because they reflect all obligations and income, not just cash transactions. This transparency can lead to better financing options and terms.

• Facilitates Compliance with Standards:

Accrual basis accounting complies with generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). Many public companies are required to use this method for financial reporting. This function ensures that businesses meet regulatory standards and enhances the reliability and comparability of financial statements.

• Management of Receivables and Payables:

Accrual accounting requires businesses to track accounts receivable and accounts payable, providing insights into outstanding debts and future cash inflows. This function helps businesses manage cash flow more effectively, ensuring they can meet their obligations while maximizing revenue collection.

• Historical Financial Analysis:

Accrual basis accounting enables more effective historical financial analysis by providing a consistent view of revenues and expenses over time. Businesses can analyze trends, assess long-term performance, and make informed decisions based on historical data, leading to more strategic growth initiatives.

• Supports Investment Decisions:

Investors rely on accrual basis financial statements for making informed investment decisions. The recognition of revenue and expenses at the time they are earned or incurred provides a more accurate representation of a company’s operational performance. This function helps investors assess potential risks and returns effectively.

Accrual basis Book entry:

Key differences between Cash basis and Accrual Basis

When accounting for business transactions, there will be times when an estimate must be used. In some cases, those estimates prove to be incorrect, in which case a change in accounting estimate is warranted. A change in estimate is needed when there is a change that:

• Alters the subsequent accounting for existing or future assets or liabilities.
• Affects the carrying amount of an existing asset or liability.

Changes in estimate are a normal and expected part of the ongoing process of reviewing the current status and future benefits and obligations related to assets and liabilities. A change in estimate arises from the appearance of new information that alters the existing situation. Conversely, there can be no change in estimate in the absence of new information.

Applying changes in accounting policies

(i) An entity shall account for a change in accounting policy resulting from the initial application of an Ind AS in accordance with the specific transitional provisions, if any, in that Ind AS; and

(ii) when an entity changes an accounting policy upon initial application of an Ind AS that does not include specific transitional provisions applying to that change, or changes an accounting policy voluntarily, it shall apply the change retrospectively.

Examples of Changes in Accounting Estimate

All of the following are situations where there is likely to be a change in accounting estimate:

• Reserve for obsolete inventory
• Allowance for doubtful accounts
• Changes in the useful life of depreciable assets
• Changes in the amount of expected warranty obligations
• Changes in the salvage values of depreciable assets

Changes in accounting estimates

As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgements based on the latest available, reliable information. For example, estimates may be required of:

(a) Bad debts

B) Inventory obsolescence

(c) The fair value of financial assets or financial liabilities

(d) The useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets

 (e) Warranty obligations.

When there is a change in estimate, account for it in the period of change. If the change affects future periods, then the change will likely have an accounting impact in those periods, as well. A change in accounting estimate does not require the restatement of earlier financial statements, nor the retrospective adjustment of account balances.

If the effect of a change in estimate is immaterial (as is usually the case for changes in reserves and allowances), do not disclose the alteration. However, disclose the change in estimate if the amount is material. Also, if the change affects several future periods, note the effect on income from continuing operations, net income, and per share amounts.

Accounts receivable (AR) is the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Accounts receivables are listed on the balance sheet as a current asset. AR is any amount of money owed by customers for purchases made on credit.

Accounts receivable refers to the outstanding invoices a company has or the money clients owe the company. The phrase refers to accounts a business has the right to receive because it has delivered a product or service. Accounts receivable, or receivables represent a line of credit extended by a company and normally have terms that require payments due within a relatively short time period. It typically ranges from a few days to a fiscal or calendar year.

Accounts receivable, abbreviated as AR or A/R, are legally enforceable claims for payment held by a business for goods supplied or services rendered that customers have ordered but not paid for. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame. Accounts receivable is shown in a balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. These may be distinguished from notes receivable, which are debts created through formal legal instruments called promissory notes

Companies record accounts receivable as assets on their balance sheets since there is a legal obligation for the customer to pay the debt. Furthermore, accounts receivable are current assets, meaning the account balance is due from the debtor in one year or less. If a company has receivables, this means it has made a sale on credit but has yet to collect the money from the purchaser. Essentially, the company has accepted a short-term IOU from its client.

Good accounting requires that an estimate should be made for any amount in Accounts Receivable that is unlikely to be collected. The estimated amount is reported as a credit balance in a contra-receivable account such as Allowance for Doubtful Accounts. This credit balance will cause the amount of accounts receivable reported on the balance sheet to be reduced. Any adjustment to the Allowance account will also affect Uncollectible Accounts Expense, which is reported on the income statement.

Special uses

Companies can use their accounts receivable as collateral when obtaining a loan (asset-based lending). They may also sell them through factoring or on an exchange. Pools or portfolios of accounts receivable can be sold to third parties through securitization.

For tax reporting purposes, a general provision for bad debts is not an allowable deduction from profit a business can only get relief for specific debtors that have gone bad. However, for financial reporting purposes, companies may choose to have a general provision against bad debts consistent with their past experience of customer payments, in order to avoid over-stating debtors in the balance sheet.

Accounts receivables process

While the process of accounts receivables differs from business to business, we have listed common things that you will get to see in accounts’ receivables process followed by most businesses.

• Capturing or recording the credit days or due date.
• Invoicing the customer on credit as per the credit policy.
• Follow-up and collection schedule.
• If there are any cash discount for early payment, the relevant adjustment to receivables account needs to be made.
• Sending reminder letter with the details of bills that are pending.
• Generating the overdue bills and the ones that are pending from the longer time.
• On receiving payment, account the receipt and adjust the receivables accordingly.

Risks of Outstanding Accounts Receivable Balances

Cash flow deficiencies: A business needs cash flow for its operations. Selling on credit may boost revenue and income, but it offers no actual cash inflow. In the short term, it is acceptable, but in the long term, it can cause the company to run short on cash and have to take on other liabilities to fund operations.

Uncollected debt: High A/R that goes uncollected for a long time is written off as bad debt. This situation occurs when customers who purchase on credit go bankrupt or otherwise do not pay the invoice.