Tag: Financial Statements

Bangalore University B.com Notes

Financial Accountancy Bangalore University B.com 1st Semester NEP Notes

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Unit 1 Introduction to Accountancy
Accountancy Introduction, Meaning, Definition of Accounting VIEW VIEW
Uses & Users of Accounting VIEW
Accounting Principles VIEW
Accounting process VIEW
Types of Reconciliation (Concepts) VIEW VIEW
Recognition of Capital & Revenue VIEW
Problems on Accounting Equation (Operating in Spreadsheet) VIEW
Unit 2 Consignment Accounts
Consignment Accounts Introduction, Meaning of Consignment VIEW
Consignment Vs Sales VIEW
Proforma Invoice, Accounts Sales, Types Commission VIEW
Accounting for Consignment Transactions & Events in the books of Consignor only VIEW
Treatment of Normal & Abnormal Loss VIEW
Valuation of Closing Stock VIEW
Goods sent at Cost Price VIEW
Goods sent at Invoice Price VIEW
Unit 3 Accounting for Branches
Introduction, Meaning, Objectives, Types of Branches VIEW VIEW
Meaning and features of Branches VIEW
Meaning and features of Dependent Branches VIEW
Independent Branches, Foreign Branches VIEW
Methods of Maintaining books of Accounts by Head office VIEW
Meaning & Feature of Debtor system, stock & Debtor system VIEW
Wholesale branch system and Final Account system VIEW
Supply of Goods at Cost Price VIEW
Supply of Goods at Invoice Price VIEW
Unit 4 Leasing & Hire Purchase
Leasing, Elements of lease, Major Components of Lease Agreement, VIEW
Types of Leasing VIEW
Leasing Financial institution in India. (Theory) VIEW
Meaning of Hire Purchase and Instalment Purchase System difference between Hire Purchase and Instalment Purchase VIEW VIEW
Important Definitions: Hire Purchase Agreement VIEW
Hire Purchase Price VIEW
Hire Purchase Charges VIEW
Net Hire Purchase Price VIEW
Cash Price, Net Cash Price VIEW
Calculation of Interest VIEW
Calculation of Cash Price VIEW
Journal Entries and Ledger Accounts in the books of Hire Purchaser (Asset Accrual Method only). VIEW
Unit 5 Emerging Trends in Accounting
Digital Transformation of Accounting VIEW
Big Data Analytics in Accounting VIEW
Accounting through Cloud Computing VIEW
Green Accounting VIEW VIEW
Human Resource Accounting VIEW
Inflation Accounting VIEW
Database Accounting VIEW

 

Management Notes

Investment Accounting for Debentures/Preference Shares (fixed income bearing securities)

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A debt security is an investment in bonds issued by the government or a corporation. At the time of purchasing a bond, the acquisition costs are recorded in an asset account, such as “Debt Investments.” Acquisition costs include the market price paid for the bond and any investment fees or broker’s commissions. For example, if Computers Galore purchases five of the 10%, ten‐year Rs. 1,000 bonds issued by VEI on April 1 for Rs. 5,500 and pays broker’s fees of Rs. 50, the entry to record the purchases would include both the purchase price and broker’s fees in the cost of the investment.

General Journal
Date Account description Ref. Debit Credit
20…        
April1 Debt investments   5,500  
  Cash     5,500
  Bond Purchase      

Preferred stock is a type of stock that usually pays a fixed dividend prior to any distributions to the holders of the issuer’s common stock. This payment is typically cumulative, so any delayed prior payments must be paid to the preferred stockholders before distributions can be made to the holders of common stock. However, the holders of preferred stock usually gain this advantage in exchange for giving up their right to share in any additional earnings generated by the company, which limits the amount by which the shares can appreciate in value over time.

Preferred Stock Characteristics

In the event of liquidation, the holders of preferred stock must be paid off before common stock holders, but after secured debt holders. Preferred stock holders can have a broad range of voting rights, ranging from none to having control over the eventual disposition of the entity.

Preferred stock dividends may be stated as a fixed amount (such as $5) or as a percentage of the stated price of the preferred stock. For example, a 10% dividend on $80 preferred stock is an $8 dividend. However, if the preferred stock trades on the open market, then the market price will fluctuate, resulting in a different dividend percentage. For example, the investment community believes that a 10% dividend on a stated share price of $80 is higher than the market rate, so it bids up the price of the stock, so that an investor pays $100 per share. This means that the actual dividend on the preferred stock is still $8, but it has now declined to 8% of the amount paid by the investor. Conversely, if the investment community believes that the dividend is too low, then it bids down the price of the preferred stock, thereby effectively increasing the rate of return for new investors.

Preferred Stock Features

Unlike common stock, there are several features that can be added to preferred stock to either increase its attractiveness to investors or make it easier for the issuing company to buy back. You may elect to use just one of the following features, or several at once in order to achieve the company’s goals and meet the needs of investors:

Callable. This feature gives a company the ability to buy back preferred stock on specific dates and at predetermined prices. This feature is useful for those companies anticipating that they can secure lower-interest financing elsewhere in the near future. It is opposed by the buyers of preferred stock, who do not want to sell back their shares and then have to presumably use the funds to obtain lower-return investments elsewhere.

Convertible. This feature gives investors the option to convert their preferred stock into a predetermined number of shares of the company’s common stock at some point in the future. The conversion feature is initially set at a conversion ratio that is not attractive to investors at the point of purchase. However, if the price of the common stock increases, then investors can convert to common stock, and may then sell the stock to realize an immediate gain. For example, an investor pays $100 for a share of preferred stock that converts to four shares of the company’s common stock. The common stock initially sells for $25 per share, so an investor would earn no profit by converting. However, it later increases to $35 per share, so an investor would be inclined to convert to common stock and sell his four shares of common stock for a total of $140, thereby reaping a profit of $40 per share of preferred stock purchased. This is considered a valuable feature if there is an expectation that a company’s value will increase over time.

Cumulative. If the company is unable to pay dividends to its preferred shareholders, then these dividends are said to be “in arrears,” and the cumulative feature forces the company to pay them the full amount of all unpaid dividends before it can pay dividends to its common shareholders. This is a common feature of preferred stock.

Participative. Investors may want the ability to participate in whatever additional company earnings are left after their preferred dividends have been paid. This feature can cut deeply into the earnings available to common stockholders, and so is opposed by them. The participative feature is usually only granted by companies that have no other means of raising capital.

Example of the Accounting for Preferred Stock

Davidson Motors sells 10,000 shares of its Series A preferred stock, which has a par value of $100 and pays a 7% dividend. The investment community believes that the dividend rate is somewhat above the current market rate on similar investments, so it bids the price of the stock up to $105 per share. Davidson Motors records the share issuance with the following entry:

Debit

Credit
Cash 1,050,000  
     Series A preferred stock ($100 par value)   1,000,000
     Paid-in capital in excess of par value   50,000

Management Notes

Cost Control (Operating Cycle, Budgets & Allocations)

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Cost control is the task of overseeing and managing project expenses and preparing for potential financial risks. This is typically the project manager’s responsibility. Cost control involves managing the budget, as well as planning, and preparing for potential risks. Risks can set projects back and sometimes even require unexpected expenses. Preparation for these setbacks can save your team time and potentially, money. Cost control is necessary to keep a record of monetary expenditure for purposes such as:

  • Minimising cost where possible;
  • Revealing areas of cost overspend.

Cost control information is fundamental to the lessons learned process, as it can provide a database of actual costs against activities and work packages that be used to inform future projects.

Cost Control Techniques

Following are some of the valuable and essential techniques used for efficient project cost control:

Planning the Project Budget

You would need to ideally make a budget at the beginning of the planning session with regard to the project at hand. It is this budget that you would have to help you for all payments that need to be made and costs that you will incur during the project life cycle. The making of this budget therefore entails a lot of research and critical thinking.

Like any other budget, you would always have to leave room for adjustments as the costs may not remain the same right through the period of the project. Adhering to the project budget at all times is key to the profit from project.

Keeping a Track of Costs

Keeping track of all actual costs is also equally important as any other technique. Here, it is best to prepare a budget that is time-based. This will help you keep track of the budget of a project in each of its phases. The actual costs will have to be tracked against the periodic targets that have been set out in the budget. These targets could be on a monthly or weekly basis or even yearly if the project will go on for long.

This is much easier to work with rather than having one complete budget for the entire period of the project. If any new work is required to be carried out, you would need to make estimations for this and see if it can be accommodated with the final amount in the budget. If not, you may have to work on necessary arrangements for ‘Change Requests’, where the client will pay for the new work or the changes.

Effective Time Management

Another effective technique would be effective time management. Although this technique does apply to various management areas, it is very important with regard to project cost control.

The reason for this is that the cost of your project could keep rising if you are unable to meet the project deadlines; the longer the project is dragged on for, the higher the costs incurred which effectively means that the budget will be exceeded.

The project manager would need to constantly remind his/her team of the important deadlines of the project in order to ensure that work is completed on time.

Project Change Control

Project change control is yet another vital technique. Change control systems are essential to take into account any potential changes that could occur during the course of the project.

This is due to the fact that each change to the scope of the project will have an impact on the deadlines of the deliverables, so the changes may increase project cost by increasing the effort needed for the project.

Use of Earned Value

Similarly, in order to identify the value of the work that has been carried out thus far, it is very helpful to use the accounting technique commonly known as ‘Earned Value’.

This is particularly helpful for large projects and will help you make any quick changes that are absolutely essential for the success of the project.

It is advisable to constantly review the budget as well as the trends and other financial information. Providing reports on project financials at regular intervals will also help keep track of the progress of the project.

This will ensure that overspending does not take place, as you would not want to find out when it is too late. The earlier the problem is found, the more easily and quickly it could be remedied.

All documents should also be provided at regular intervals to auditors, who would also be able to point out to you any potential cost risks.

Operating Cycle

An operating cycle refers to the time it takes a company to buy goods, sell them and receive cash from the sale of said goods. In other words, it’s how long it takes a company to turn its inventories into cash. The length of an operating cycle is dependent upon the industry. Understanding a company’s operating cycle can help determine its financial health by giving them an idea of whether or not they’ll be able to pay off any liabilities.

For example, if a business has a short operating cycle, this means they’ll be receiving payment at a steady rate. The faster the company generates cash, the more it’ll be able to pay off any outstanding debts or expand its business accordingly.

The flow of a cash operating cycle is as follows:

  • Obtaining raw material
  • Producing goods
  • Having finished goods
  • Having receivables from making a sale
  • Obtaining cash (receiving payment from customers)

Factors Impacting the Operating Cycle:

  • The payment terms extended to the company by its suppliers. Longer payment terms shorten the operating cycle, since the company can delay paying out cash.
  • The order fulfillment policy, since a higher assumed initial fulfillment rate increases the amount of inventory on hand, which increases the operating cycle.
  • The credit policy and related payment terms, since looser credit equates to a longer interval before customers pay, which extends the operating cycle.

Budgets

The budget for a project is the sum of costs of individual activities that the project must accomplish.

Budgeting is important in the development of any major business project. Without a well-planned budget, projects can scatter and be left incomplete. Budgeting is not an easy process. It provides a number of different advantages that a project manager should consider.

Establishing Guidelines: Project budget allows you to establish the main objectives of a project. Without proper budgeting, a project may not be completed on time. It allows the project manager to know how much he can spend on any given aspect of the project.

Cost Estimating: Once a budget is in place, the project manager can determine how much money can be spent on each component of the project. Hence it also determines what percentage of the available funds can be allocated to the remaining elements of the project. It gives the chance to decide whether or not the project can be completed in the available budget.

Prioritizing: Another advantage of having a project budget is that it helps you to prioritize the different tasks of the project. Sometimes it might seem to be completed at once, but it doesn’t happen due to some inefficiency. A budget will allow you to prioritize which parts of the project can be completed first.

Allocations

Cost allocation is the distribution of one cost across multiple entities, business units, or cost centers. An example is when health insurance premiums are paid by the main corporate office but allocated to different branches or departments.

When cost allocations are carried out, a basis for the allocation must be established, such as the headcount in each branch or department.

Cost Allocation Methods

The very term “allocation” implies that there is no overly precise method available for charging a cost to a cost object, so the allocating entity is using an approximate method for doing so. Thus, you may continue to refine the basis upon which you allocate costs, using such allocation bases as square footage, headcount, cost of assets employed, or (as in the example) electricity usage. The goal of whichever cost allocation method you use is to either spread the cost in the fairest way possible, or to do so in a way that impacts the behavior patterns of the cost objects. Thus, an allocation method based on headcount might drive department managers to reduce their headcount or to outsource functions to third parties.

Cost Allocation and Taxes

A company may allocate costs to its various divisions with the intent of charging extra expenses to those divisions located in high-tax areas, which minimizes the amount of reportable taxable income for those divisions. In such cases, an entity usually employs expert legal counsel to ensure that it is complying with local government regulations for cost allocation.

Reasons Not to Allocate Costs

An entirely justifiable reason for not allocating costs is that no cost should be charged that the recipient has no control over. Thus, in the African Bongo Corporation example above, the company could forbear from allocating the cost of its power station, on the grounds that none of the six operating departments have any control over the power station. In such a situation, the entity simply includes the unallocated cost in the company’s entire cost of doing business. Any profit generated by the departments contributes toward paying for the unallocated cost.

Process for Performing Cost Allocations

Using a basis for allocation, costs are spread to each business unit or cost center that incurred the cost based on their proportional share of the cost. For example, if headcount forms the basis of allocation for insurance costs, and there are 1000 total employees, then a department with 100 employees would be allocated 10% of the insurance costs.

While there are numerous ways cost allocations can be calculated, it is important to ensure the reasoning behind them is documented. This is often done by establishing allocation formulas or tables.

Once the calculation is established and cost distributions are calculated, journal entries are created to transfer costs from the providing or paying entity to the appropriate consuming entities. During each financial period, as periodic expenses are incurred, this calculation is repeated and allocating entries are made.

Management Notes

Credit and Debit notes (Sec 34)

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(1) Where one or more tax invoices have been issued for supply of any goods or services or both and the taxable value or tax charged in that tax invoice is found to exceed the taxable value or tax payable in respect of such supply, or where the goods supplied are returned by the recipient, or where goods or services or both supplied are found to be deficient, the registered person, who has supplied such goods or services or both, may issue to the recipient one or more credit notes for supplies made in a financial year containing such particulars as may be prescribed.

(2) Any registered person who issues a credit note in relation to a supply of goods or services or both shall declare the details of such credit note in the return for the month during which such credit note has been issued but not later than September following the end of the financial year in which such supply was made, or the date of furnishing of the relevant annual return, whichever is earlier, and the tax liability shall be adjusted in such manner as may be prescribed:

Provided that no reduction in output tax liability of the supplier shall be permitted, if the incidence of tax and interest on such supply has been passed on to any other person.

Conditions on issue of credit note:

  1. The supplier may issue one or more credit notes for supplies made in a financial year through one or more tax invoices which have been issued by him earlier.
  2. The credit note cannot be issued at any time after either of the following 2 events.
  • Annual return has been filed for the FY in which the original tax invoice was issued.
  • September of the FY immediately succeeding the FY in which the original tax invoice was issued.

(3) Where one or more tax invoices have been issued for supply of any goods or services or both and the taxable value or tax charged in that tax invoice is found to be less than the taxable value or tax payable in respect of such supply, the registered person, who has supplied such goods or services or both, shall issue to the recipient one or more debit notes for supplies made in a financial year containing such particulars as may be prescribed

(4) Any registered person who issues a debit note in relation to a supply of goods or services or both shall declare the details of such debit note in the return for the month during which such debit note has been issued and the tax liability shall be adjusted such manner as may be prescribed.

The GST Law mandates that a registered supplier may issue one or more debit notes for supplies made in a financial year through one or more tax invoices which has been issued by him earlier under the following circumstances:

  1. Actual value of supply is higher than that stated in the original tax invoice.
  2. Tax charged in the original tax invoice is lower than that applicable on the supply.
  3. The debit note needs to be linked to the original tax invoice(s).
  4. The debit note contains all the applicable particulars as specified in Rule 53(1A) of the CGST Rules, 2017.
  5. A debit note issued under Section 74, 129 or 130 would not entitle the recipient to avail credit in respect thereof, and the supplier shall specify prominently, on such debit note the words “INPUT TAX CREDIT NOT ADMISSIBLE”; as provided in Rule 53(3).
  6. It may also be noted that no time limit has been prescribed for issuing debit notes. Meaning, a debit note may be raised and uploaded subsequently, with no restriction as to the time period for doing so.
Management Notes

Ind AS-28: Investments in Associate and Joint Ventures

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IAS 28 Investments in Associates and Joint Ventures (as amended in 2011) outlines how to apply, with certain limited exceptions, the equity method to investments in associates and joint ventures. The standard also defines an associate by reference to the concept of “Significant Influence“, which requires power to participate in financial and operating policy decisions of an investee (but not joint control or control of those polices).

Objective of IAS 28

The objective of IAS 28 (as amended in 2011) is to prescribe the accounting for investments in associates and to set out the requirements for the application of the equity method when accounting for investments in associates and joint ventures. [IAS 28(2011).1]

Scope of IAS 28

IAS 28 applies to all entities that are investors with joint control of, or significant influence over, an investee (associate or joint venture). [IAS 28(2011).2]

Important Definition:

Significant influence: The power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies.

Associate: An entity over which the investor has significant influence.

Joint arrangement: An arrangement of which two or more parties have joint control.

Joint venture: A joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.

Joint ventures: A party to a joint venture that has joint control of that joint venture.

Equity method: A method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets. The investor’s profit or loss includes its share of the investee’s profit or loss and the investor’s other comprehensive income includes its share of the investee’s other comprehensive income.

Joint control: The contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.

Significant influence

Where an entity holds 20% or more of the voting power (directly or through subsidiaries) on an investee, it will be presumed the investor has significant influence unless it can be clearly demonstrated that this is not the case. If the holding is less than 20%, the entity will be presumed not to have significant influence unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an entity from having significant influence. [IAS 28(2011).5]

The existence of significant influence by an entity is usually evidenced in one or more of the following ways: [IAS 28(2011).6]

  • Participation in the policy-making process, including participation in decisions about dividends or other distributions.
  • Representation on the board of directors or equivalent governing body of the investee.
  • Material transactions between the entity and the investee.
  • Provision of essential technical information.
  • Interchange of managerial personnel.

The equity method of accounting

Distributions and other adjustments to carrying amount. The investor’s share of the investee’s profit or loss is recognised in the investor’s profit or loss. Distributions received from an investee reduce the carrying amount of the investment. Adjustments to the carrying amount may also be necessary for changes in the investor’s proportionate interest in the investee arising from changes in the investee’s other comprehensive income (e.g. to account for changes arising from revaluations of property, plant and equipment and foreign currency translations.) [IAS 28(2011).10]

Basic principle. Under the equity method, on initial recognition the investment in an associate or a joint venture is recognised at cost, and the carrying amount is increased or decreased to recognise the investor’s share of the profit or loss of the investee after the date of acquisition. [IAS 28(2011).10]

Potential voting rights. An entity’s interest in an associate or a joint venture is determined solely on the basis of existing ownership interests and, generally, does not reflect the possible exercise or conversion of potential voting rights and other derivative instruments. [IAS 28(2011).12]

Classification as non-current asset. An investment in an associate or a joint venture is generally classified as non-current asset, unless it is classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. [IAS 28(2011).15]

Interaction with IFRS 9. IFRS 9 Financial Instruments does not apply to interests in associates and joint ventures that are accounted for using the equity method. An entity applies IFRS 9, including its impairment requirements, to long-term interests in an associate or joint venture that form part of the net investment in the associate or joint venture but to which the equity method is not applied. Instruments containing potential voting rights in an associate or a joint venture are accounted for in accordance with IFRS 9, unless they currently give access to the returns associated with an ownership interest in an associate or a joint venture. [IAS 28(2011).14-14A]

Application of the equity method of accounting

Basic principle. In its consolidated financial statements, an investor uses the equity method of accounting for investments in associates and joint ventures. [IAS 28(2011).16] Many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in IFRS 10. Furthermore, the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate or a joint venture. [IAS 28. (2011).26]

Exemptions from applying the equity method. An entity is exempt from applying the equity method if the investment meets one of the following conditions:

The entity is a parent that is exempt from preparing consolidated financial statements under IFRS 10 Consolidated Financial Statements or if all of the following four conditions are met (in which case the entity need not apply the equity method): [IAS 28(2011).17]

  • The entity is a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the investor not applying the equity method
  • The investor or joint venturer’s debt or equity instruments are not traded in a public market
  • The entity did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market
  • The ultimate or any intermediate parent of the parent produces financial statements available for public use that comply with ifrss, in which subsidiaries are consolidated or are measured at fair value through profit or loss in accordance with ifrs 10.

Classification as held for sale. When the investment, or portion of an investment, meets the criteria to be classified as held for sale, the portion so classified is accounted for in accordance with IFRS 5. Any remaining portion is accounted for using the equity method until the time of disposal, at which time the retained investment is accounted under IFRS 9, unless the retained interest continues to be an associate or joint venture. [IAS 28(2011).20]

Management Notes

Ind AS-16: Property, Plant and Equipment

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Ind AS 16 Property Plant Equipment is applicable to all Property and P&E (Plant & Equipment) unless and until any other accounting standard asks for a different treatment. Ind AS 16 Property Plant Equipment is not applicable in the following cases:

  • Biological assets which are related to agricultural activities except bearer plants.
  • Property and P&E (Plant & Equipment) which are classified as held for sale as per Ind AS 105.
  • Mineral rights and reserves like oil, natural gas and other such non-regenerative resources.
  • The measurement and recognition of exploration and evaluation assets.

Constituents of cost

The cost of the item of PPE includes:

(a) Costs which are directly attributable to bringing assets to the condition and location essential for it to operate in a manner as intended by the management.

(b) The purchase price, which includes the import duties and any non-refundable taxes on such purchase, after deducting rebates and trade discounts.

(c) Initial estimate of costs of removing and dismantling an item and restoring a site where it is located.

Recognition

Recognition simply means incorporation of item in the business’s accounts, in this case as a non-current asset. The recognition of property, plant & equipment depends on two criteria:

a) It is probable that future economic benefits associated with these assets will flow to the entity.

b) Cost can be measured reliable.

Initial Measurement

The cost of items of Property, plant & equipment compromises:

  • Purchase price, including import duties, non-refundable purchase taxes, less trade discount & rebate.
  • Initial estimates of cost of dismantling/decommissioning removing, & site restoration at present value if the entity has an obligation that it incurs on acquisition of the asset or as a result of using the asset other than to produce inventories.
  • Cost directly attributable to bringing the asset to the location & condition necessary for it to be used in a manner intended by management.

Measurement subsequent to initial recognition

The standard offers two possible treatments here, essentially a choice between keeping an asset recorded at cost model or revaluation model. However, the same policy must be applied to each entire class of property, plant and equipment.

Cost Model carry the asset at its cost less depreciation and any accumulated impairment losses.

Revaluation Model carry the assets at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses.  The revised IAS 16 makes clear that the revaluation model is available only if the fair value of the item can be measured reliably.

Revaluation Model

The market value of Land & Buildings usually represents the fair value, assuming existing use and line of business. Such valuations are usually undertaken by professionally qualified valuers.

In case of plant & equipment, fair value is usually market value. If the market value is not available, fair value is estimated using depreciated replacement cost.

The frequency of valuation depends on the volatility of the fair values of the individual items of property, plant and equipment. The more volatile the fair value, the more frequently revaluations should be carried out. Where the current fair value is very different from the carrying amount then a revaluation should be carried out. Most importantly, when an item of property, plant & equipment is revalued, the whole class of assets to which it belongs should be revalued.

All the items within a class should be revalued at the same time, to prevent selective revaluation of the certain assets and to avoid disclosing a mixture of costs and values from different dates in the financial statements. Items within a class may be revalued on a rolling basis within short period of time provided revaluation are kept upto date.

Accounting for a revaluation

How should any increase in value to be treated when a revaluation takes place? The debit will be the increase in value in the statement of financial position, but what about the credit? IAS 16 required the increase to be credited to other comprehensive income and accumulated in a revaluation surplus (part of owner’s equity).

Debit: Assets Value (Statement of financial position)

Credit: Other comprehensive income (revaluation surplus)

Retirement & Disposals

When the assets are permanently withdrawn from the use, or sold or scrapped, and no future economic benefits are expected from its use or disposal, it should be withdrawn from the financial position. Gains or losses are the difference between the net disposal proceeds and the carrying amount of the asset. They should be recognized as income or expense in profit or loss.

Derecognition

Any entity is required to derecognize the carrying amount of an item of property, plant or equipment that it disposes of on the date the criteria for the sale in IFRS 15 would be met. This also applies to part of assets. An entity cannot classify as revenue a gain which it realizes on the disposal of an item of property, plant & equipment.

Depreciation

IAS 16 requires the depreciable amount of a depreciable asset to be allocated on a systematic basis to each accounting period during the useful life of the asset. Every part of an item of property, plant & equipment with a cost that is significant in relation to the total cost of the item must be depreciated separately.

There are situations where, over a period, an asset has increased in value, i.e. its current value is greater than the carrying amount in the financial statements. You might think that in such situation it would not be necessary to depreciate the asset. The standard states, however, that this is irrelevant, and that depreciation should still be charged to each accounting period, based on the depreciable amount, irrespective of a rise in value.

An entity is required to begin depreciating an item of property, plant and equipment when it is available for use and to continue depreciating it until it is derecognized even if it is idle during the period.

The following factors should be considered when estimating the useful life of a depreciable asset:

  • Expected physical wear and tear.
  • Legal or other limits on the use of the assets.

Disclosure Requirement

  • Depreciation method used.
  • Measurement bases used for determining gross carrying amount.
  • Useful lives or the depreciation rate used.
  • Reconciliation of carrying amount at the beginning and end of period.
  • Property, plant and equipment pledged as security for liabilities.
  • Amount of compensation from third parties for items of property, plant and equipment.
  • Amount of expenditure recognized in the course of construction
  • Contractual commitments for the acquisition of property, plant and equipment.
  • Gross carrying amount and accumulated depreciation at beginning and end of the period. Accumulated impairment losses are aggregated with accumulated depreciation.

Disclosure for revalued assets:

  • Whether an independent valuer was involved.
  • Effective date of revaluation.
  • Revaluation surplus, including movement and any restrictions on distribution of balance to shareholders.
  • Carrying amount of each class of revalued property, plant and equipment if the cost model had been applied.
Management Notes

Ind AS-17: Leases

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Ind AS-17: Leases Lessee Accounting:

Initial recognition:

  • A Lessee is required to recognise a right of use asset representing its right to use the underlying leased asset and a lease liability representing its obligations to make lease payments.
  • A Lessee will recognise assets and liabilities for all leases for a term of more than 12 months, unless the underlying asset is of low value.
  • A lessee will measure right-of-use assets similarly to other non-financial assets (such as property, plant and equipment) and lease liabilities similarly to other financial liabilities.
  • Lease liability = Present value of lease rentals + present value of expected payments at the end of lease. The lease liability will be amortised using the effective interest rate method.
  • Lease term = non-cancellable period + renewable period if lessee reasonably certain to exercise.
  • Right to use asset = Lease liability + lease payments (advance)-lease incentives to be received if any initial + initial direct costs + cost of dismantling/ restoring etc. The asset will be depreciated as per IND AS 16 Property plant and equipment.
  • A lessee recognises depreciation of the right-of-use asset and interest on the lease liability (as per IND AS 17 the same was classified as rent in case of operating lease on a straight-line basis)

Presentation:

A lessee shall either present in the balance sheet, or disclose in the notes:

  • Lease liabilities separately from other liabilities.
  • Right-of-use assets separately from other assets.

Lessor Accounting:

  • A lessor shall classify each of its leases as either an operating lease or a finance lease.
  • A lease is classified as a finance lease if it transfers substantially all the risks and rewards, incidental to ownership of an underlying asset. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.
  • For operating leases, lessors continue to recognize the underlying asset.
  • For finance leases, lessors derecognize the underlying asset and recognize a net investment in the lease.
  • Any selling profit or loss is recognized at lease commencement.

Classification of leases

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. All other leases are classified as operating leases. Classification is made at the inception of the lease. [IAS 17.4]

Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following: [IAS 17.10]

  • The lease transfers ownership of the asset to the lessee by the end of the lease term.
  • The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised.
  • The lease term is for the major part of the economic life of the asset, even if title is not transferred at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.
  • The lease assets are of a specialised nature such that only the lessee can use them without major modifications being made.

Other situations that might also lead to classification as a finance lease are: [IAS 17.11]

  • If the lessee is entitled to cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee
  • Gains or losses from fluctuations in the fair value of the residual fall to the lessee (for example, by means of a rebate of lease payments).
  • The lessee has the ability to continue to lease for a secondary period at a rent that is substantially lower than market rent.

Accounting by lessees

The following principles should be applied in the financial statements of lessees:

  • Finance lease payments should be apportioned between the finance charge and the reduction of the outstanding liability (the finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability) [IAS 17.25]
  • At commencement of the lease term, finance leases should be recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease, if practicable, or else at the entity’s incremental borrowing rate) [IAS 17.20]
  • For operating leases, the lease payments should be recognised as an expense in the income statement over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user’s benefit [IAS 17.33]
  • The depreciation policy for assets held under finance leases should be consistent with that for owned assets. If there is no reasonable certainty that the lessee will obtain ownership at the end of the lease the asset should be depreciated over the shorter of the lease term or the life of the asset [IAS 17.27]

Accounting by lessors

The following principles should be applied in the financial statements of lessors:

  • At commencement of the lease term, the lessor should record a finance lease in the balance sheet as a receivable, at an amount equal to the net investment in the lease [IAS 17.36] the lessor should recognise finance income based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment outstanding in respect of the finance lease [IAS 17.39]
  • Assets held for operating leases should be presented in the balance sheet of the lessor according to the nature of the asset. [IAS 17.49] Lease income should be recognised over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern in which use benefit is derived from the leased asset is diminished [IAS 17.50]

Sale and leaseback transactions

For a sale and leaseback transaction that results in a finance lease, any excess of proceeds over the carrying amount is deferred and amortised over the lease term. [IAS 17.59]

For a transaction that results in an operating lease: [IAS 17.61]

  • If the sale price is below fair value: Profit or loss should be recognised immediately, except if a loss is compensated for by future rentals at below market price, the loss should be amortised over the period of use.
  • If the transaction is clearly carried out at fair value: The profit or loss should be recognised immediately.
  • If the fair value at the time of the transaction is less than the carrying amount a loss equal to the difference should be recognised immediately [IAS 17.63]
  • If the sale price is above fair value: The excess over fair value should be deferred and amortised over the period of use.
Management Notes

Ind AS-24: Related Party Disclosures

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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.
Management Notes

General Accounting System controls

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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.

Management Notes

Accounting and economic concepts of value and income

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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.
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