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Under departmental form of organisation, a public enterprise is run as a separate full-fledged ministry or as a major sub-division of a department of the Government.

For example, the Indian Railways are managed by the Ministry of Railways. Post and Telegraph services are run as a department, in the Ministry of Communication.

The Delhi Milk Scheme, All India Radio, Doordarshan are other examples of departmental undertakings.

Features of Departmental Undertaking:

The salient features of a departmental undertaking are as follows:

(i) Formation:

A departmental undertaking is established either as a separate full-fledged ministry or as a sub-division of a ministry (i.e. department) of the Government.

(ii) No Separate Entity:

A departmental undertaking does not have an independent entity distinct from the Government.

(iii) Ultimate Responsibility with the Minister:

The ultimate responsibility for the management of a departmental undertaking lies with the minister concerned; who is responsible to the Parliament or State Legislature for the affairs of the departmental undertaking. The minister, in turn, delegates his authority downwards to various other management levels, in the departmental undertaking.

(iv) Governmental Financing:

The departmental undertaking is financed through annual budget appropriations by the Parliament or the State Legislature. The revenues of the undertaking are paid into the treasury.

(v) Accounting and Audit etc. as Applicable to Government Departments:

The departmental undertaking is subject to the normal budgeting, accounting and audit procedures, which are applicable to Government departments.

(vi) Managed by Civil Servants:

The departmental undertaking is managed by civil servants, who are subject to same service conditions as applicable to civil servants of the Government.

(vii) Sovereign Immunity:

A departmental undertaking cannot be sued at all, without the consent of the Government.

Advantages of Departmental Undertaking:

Following are the advantages of the departmental undertaking:

(i) Easy Formation:

It is easy to set up a departmental undertaking. The departmental undertaking is created by an administrative decision of the Government, involving no legal formalities for its formation.

(ii) Direct and Control of Parliament or State Legislature:

The departmental undertaking is directly responsible to the Parliament or the State legislature through its overall head i.e. the minister concerned.

(iii) Secrecy Maintained:

The departmental undertaking can maintain secrecy of important policy matters; as the Government can withhold any information, in public interest.

(iv) Lesser Burden of Tax on Public:

Earnings of departmental undertaking are paid into Government treasury, resulting in lesser tax burden on the public.

(v) Instrument of Social Change:

Government can promote economic and social justice through departmental undertakings. Hence, a departmental undertaking can be used by the Government, as an instrument of social change.

(vi) Lesser Risk of Misuse of Public Money:

As the departmental undertaking is subject to budgeting, accounting and audit procedures of the government; the risk of misuse of public money is relatively less.

(vii) Guided by Rules and Regulations of the Ministry:

The officers of the departmental undertaking are under the direct administrative control of the ministry. They are guided by the rules and regulations of the ministry, framed with a focus on public welfare.

Limitations of Departmental Undertaking:

Following are the major limitations of the departmental undertaking:

(i) Read-Tape and Bureaucracy:

Departmental undertaking is run in a way other department of the Government are run. Its management and functioning are subject to excessive red-tap and bureaucracy. (Red-tape means unnecessary and complicated officials rules which prevent things from being done quickly). As a result, the departmental undertaking loses all flexibility desired of a business enterprise.

(ii) Incidence of Additional Taxation:

Losses incurred by a departmental enterprise are met out of the treasury. This very often necessitates additional taxation the burden of which falls on the common man.

(iii) Lack of Competition:

A departmental undertaking often enjoys monopoly in its field. As a result, it tends to become indifferent to the quality and price of its goods and services; and may not hesitate to exploit the society.

(iv) Casual Approach to Work:

As officers of a departmental undertaking are subject to frequent transfers; they develop a sense of casual approach to work. As a result, the operational efficiency of the undertaking suffers a lot.

(v) Political Influence:

A departmental undertaking is subject to excessive political influence. Its fate depends on the balance of power between the ruling party and the opposition. As such, a departmental undertaking becomes a political organisation rather than an economic or business organisation.

(vi) Lack of Professional Management and Fear of Criticism:

A departmental undertaking is managed by civil servants, who do not possess professional management skills. Moreover, these managers could not afford to be innovative, because of a fear of criticism by the minister or the Parliament.

(vii) Financial Dependence:

A departmental undertaking is financially dependent on the Government’s budgetary allocations. As such, it cannot have its own independent long range investment decisions, which may bring enormous prosperity to the undertaking.

Under Section 78 of the Act, Securities Premium Reserve may be used wholly or in part for:

(a) Issuing fully paid bonus shares to the members.

(b) Writing off preliminary expenses.

(c) Writing off the expenses of or the commission paid or discount allowed on any issue of shares or debentures of the company.

(d) Providing for the premium payable on the redemption of preference shares or debentures of the company.

(e) In purchasing its own shares i.e. Buy Back u/s 77 A

It is to be noted here that any utilization of the amount of premium except in any of the modes specified above, can only be done by way of reduction of capital and this will require the compliance of the provisions laid down in Section 100 of the Act.

Accounting Treatment:

Securities Premium Reserve may be demanded by company on application, allotment or calls.

In case it is received by the company on application, then the following treatment is followed:

(1) When Premium is received on application:

(i) Bank A/c ….Dr. (With the App. Money & Securities Premium)

To Share Application A/c

(ii) Share Application A/c ….Dr.

To Share Capital A/c

To Securities Premium Reserve A/c

(Being the application money transferred to share capital and securities premium account)

Note:

Students should note that Securities Premium Reserve Account is not credited when the application money is received. It is due to the reason that at the time of receiving the application money it is treated as deposit and the company is not certain whether the amount received would be accepted or rejected.

(2) When Premium is received on allotment:

Securities Premium Reserve Account is credited with Full Amount at the Time of Making the Allotment Due:

(i) Share Allotment A/c …Dr. (With the amount of allotment and Securities Premium)

To Share Capital A/c

To Securities Premium Reserve A/c

(ii) For Allotment (including premium) Received:

Bank A/c … Dr.

To Share Allotment A/c

It is important to note that surplus application money retained for allotment should first be applied towards the adjustment of nominal value of allotment money and the balance, if any, will be adjusted towards securities premium payable.

Purchase Consideration refers to the consideration payable by the purchasing company to the vendor company for taking over the assets and liabilities of Vendor Company.

If one company purchases another business as a going concern (that is, the business will continue to operate for eternity), it can pay for it using one or more of the following methods:

• Cash: The entire amount is paid in cash. This is a rare scenario as the following two methods are more common.
• Shares: The limited liability company offers some of its shares to the owners of the business that is being purchased.
• Debentures: The limited liability company may offer some of its debentures to the owners of the business.

The following two things must be kept in mind when the price of the business is being determined:

• The assets bought are stated at different values in the books of the limited company and the books of the selling business. This is because they are revalued to reflect their current worth in the market. This value is known as the fair value of the assets.

The price paid by the limited company for the business is known as the purchase consideration. In many cases, the purchase consideration is not the same as the net assets bought and the difference must be recorded in the books of account.

If the purchase consideration is greater than net assets, the difference is known as positive goodwill. However, if the purchase consideration is lower than the net assets, the difference is known as negative goodwill. The accounting treatment for each of these types of goodwill is different.

Accounting Standard–14 defines the term purchase consideration as the “aggregate of the shares and other securities issued and the payment made in the form of ach or other assets by the transferee company to the shareholders of the transferor company”. Although, purchase consideration refers to total payment made by purchasing company to the shareholders of Vendor Company, its calculation could be in different methods, as explained below:

1. Lump sum method
2. Net Assets method
3. Net Payment Method

Lump sum Method:

Under this method purchase consideration will be paid in lump sum as per the valuation of purchasing companies’ valuation. E.g., if it is stated that A Ltd. takes over the business of B Ltd. for Rs.15, 00,000 here the sum of the Rs.15, 00,000 is the Purchase Consideration.

Net Assets Method:

(1) The value of goodwill will be ascertained.

(2) Fixed assets of the company, disclosed or undisclosed in Balance Sheet, are taken at their realisable values.

(3) Floating assets are to be taken at market value.

(4) Remember to exclude fictitious assets, such as Preliminary Expenses, Accumulated Losses etc.

(5) Provision for depreciation, bad debts provision etc. must be considered.

(6) Find out the external liabilities of the company payable to outsiders including contingent liabilities.

Under this method P.C. shall be computed as follows:

Net Payment Method:

Under this method P.C. should be calculated by aggregating total payments made by the purchasing company. E.g.: A Ltd. had taken over B Ltd. and for that it agreed to pay Rs.5, 00,000 in cash 4, 00,000 Equity Shares of Rs.10 each fully paid at an agreed value of Rs.15 per share then the P.C. will be ascertained as follows:

Except for the Assumed Liabilities, the Buyer shall not be responsible for, assume, pay, perform, discharge, or accept any liabilities, debts or obligations of the Seller of any kind whatsoever, whether actual, contingent, accrued, known or unknown, including, without limitation, any relating to accounts payable, interest-bearing debt, notes to Affiliates or other related Persons, interest and termination penalties on indebtedness, taxes, employee compensation, severance, pension, profit-sharing, vacation, health insurance, disability insurance or other employee benefit plans and programs, worker’s compensation, breach or negligent performance of any contract, or breach of warranty relating thereto, liabilities resulting from breach of contract, torts (including, without limitation, product liability claims), illegal activity, unlawful employment or business practice, infringement of intellectual property rights, claim for environmental liability or remediation or any other liability or obligation whatsoever. All such non-assumed liabilities, debts and obligations shall remain the responsibility of the Seller which shall pay and discharge the same when and as due.

Assumption of a liability

In a sale of business transaction, it is common for the purchaser to assume certain existing or future obligations of the vendor to make payments to third parties.  As explained in the Draft Ruling:

The following types of liabilities are commonly assumed by a purchaser:

• Trade creditors/accounts payable;
• Product warranties;
• Long service leave obligations of employees;
• Environmental rehabilitation;
• Rates;
• Land tax;
• Plant and equipment or property leases; and
• Hire purchase obligations.

As the ATO identifies in the Draft Ruling, to determine the GST consequences, it is necessary to focus on the contractual arrangements entered into between the vendor and purchaser.  The focus is on what is agreed by the parties and the GST consequences that flow from this agreement.

Supply and consideration

It is a fundamental requirement of making a taxable supply that an entity makes a “supply” for “consideration”.  The essence of a sale of business transaction is that the vendor supplies certain assets of a business to a purchaser for consideration.  In circumstances where the purchaser assumes certain liabilities of the vendor as part of this transaction, a key issue is whether the purchaser’s assumption of a liability is simply part and parcel of the main transaction, or whether it has any separate GST implications.

It has been a concern of some tax advisers that, in agreeing to assume the vendor’s liability to third parties, the purchaser makes a supply to the vendor for consideration.  The basis for this concern is in the extremely wide definitions of “supply” and “consideration”.  Relevantly:

The definition of supply includes “an entry into, or release from, an obligation” to do anything and

The definition of consideration includes “any payment, or any act or forbearance, in connection with a supply of anything”.

Taken together, on one view, the line of analysis would be as follows:

• In assuming, for example, the liability to pay trade creditors, the purchaser makes a supply constituted by the entry into an obligation the vendor; and
• the vendor provides consideration for that supply equal to the amount required to be paid by the vendor in respect of the entitlements or, more typically, allowed by the vendor as an adjustment to the purchase price.

There are four general case law exceptions to the rule of buyer non-liability in asset transactions:

• The buyer assumes the seller’s liabilities expressly or impliedly.
• The transaction in substance constitutes a merger or consolidation of the buyer and seller (de facto merger).
• The buyer is “a mere continuation” of the seller.
• The intent of the transaction is to defraud the seller’s creditors.

The de facto merger theories are the most commonly cited by courts. Facts which support those theories include:

• Continuity of management.
• Same physical location.
• Same general business operations.
• Common equity ownership.
• Assumption seller’s ordinary course business trade debt.
• Seller’s dissolution following the sale.

Journal is a book of original entry. All day-to-day transactions of business are recorded first in it in a chronological order with the help of vouchers like cash receipts, cash memos, invoices, etc. Journal is also called a ‘Day Book’. The process of recording business transactions in the journal is called ‘Journalising’ and the entries passed in this book are called ‘Journal Entries’.

The ruling of Journal is given below:

Journal: 

The Journal consists of five columns. The first column is used for recording date of the transaction with year. In the second column i.e., ‘Particulars’, the journal entry is made by mentioning the two accounts affected by the transaction. The accounting entry is passed following the ‘Accounting Equation’ or ‘Dual Aspect Concept’.

The two accounts affected by the transaction are debited and credited by the same amount. The third column LP, i.e. Ledger Polio is used for writing the page number of the ledger on which the particular account appears. The fourth and fifth columns of journal are meant for writing respectively ‘Debit’ and ‘Credit’ amounts of the transaction.

The Journal consists of five columns. The first column is used for recording date of the transaction with year. In the second column i.e., ‘Particulars’, the journal entry is made by mentioning the two accounts affected by the transaction. The accounting entry is passed following the ‘Accounting Equation’ or ‘Dual Aspect Concept’.

The two accounts affected by the transaction are debited and credited by the same amount. The third column LP, i.e., Ledger Polio is used for writing the page number of the ledger on which the particular account appears. The fourth and fifth columns of journal are meant for writing respectively ‘Debit’ and ‘Credit’ amounts of the transaction.

Account

In simple words, an account is a summarised record of all transactions relating to a particular person, a thing or an item of income or expense. You will know more about the ruling of an account under the next context titled Ledger 32.6.

An account resembles the shape of the English alphabet ‘T’ as follows:

Classification or Types of Accounts:

All business transactions relate to three accounts, namely, (i) Personal Accounts, (ii) Real Accounts, and (iii) Nominal Accounts. When real and nominal accounts are taken together, these are called ‘Impersonal Accounts.”

(i) Personal Accounts:

Accounts relating to persons and organisations representing to persons are called ‘Personal Accounts.’ Examples are Chinmoy’s Account, Mazumdar’s Account, The State Bank of India Account, Tanmoy & Sons’ Account, Carnal Paper Mills’ Account, Salaries Outstanding Account, etc.

(ii) Real Accounts:

Accounts which are related to properties or assets are called ‘Real Accounts.’ They are called Real Accounts because they represent things of value owned by the business. Cash Account, Furniture Account, Building Account, etc. are the popular examples of Real Accounts.

(iii) Nominal Accounts:

Accounts relating to expenses, losses, incomes, gains, profits are called ‘Nominal Accounts.’ Examples of nominal accounts are Wages Account, Salaries Account, Commission Received Account, Interest Received Account, etc.

Rules for Debit and Credit:

The rules applicable for debiting and crediting the three types of accounts are summarised

Rules for Debit and Credit:

1. Interest and Dividend:

Cash flows from interest and dividends received and paid should be disclosed separately and classified on the basis of nature of the enterprise as shown below:

For Financial enterprises:

(i) Interest paid and received; dividend received as operating activities.

(ii) Dividend paid as financing activities.

For Other enterprises:

(i) Interest and dividend received as investing activities.

(ii) Interest and dividend paid as financing activities.

2. Extra Ordinary Items:

The cash flows associated with extraordinary items should be classified as arising from operating, investing or financing activities as appropriate. It should be disclosed separately.

Few examples of such items are:

(i) Claim for loss of Stock: Operating activity

(ii) Claims for loss of assets: Investing activity

(iii) Recovery of bad debts: Operating activity

(iv) Damages paid/received for breach of contract: Operating activity

(v) Winnings from lotteries: Investing activity

(vi) Cost of legal action to protect property title: Investing activity.

3. Taxes on Income:

Cash flows arising from taxes on income should be separately disclosed and should be classified as cash-flows from operating activities under they can be specifically identified with financing and investing activists.

For instance:

(i) Provision for Taxation for the current year: Non-cash charge under operating activity

(ii) Tax paid: Operating cash out flow

(iii) Income tax refund: Cash inflow from operating activity

(iv) Capital gains tax: Cash out flow from investing activity

(v) Corporate dividend tax: Cash out flow from financing activity.

4. Foreign Currency Cash Flows:

Foreign currency cash flows should be converted at the exchange rate of the date of cash flow. Exchange gain/loss on cash and cash equivalents held in foreign currency will be reported as part of reconciliation of change in cash and cash equivalents for the period and hence, not reported in cash flow statement.

5. Non-Cash Transactions:

Investing and financing transactions that do not require the use of cash or cash equivalents are not shown in the cash flow statement.

Examples of such non-cash transactions are:

(i) Issue of shares or debentures for a consideration other than cash i.e. against building, machinery etc.

(ii) Conversion of debentures into equity shares.

(iii) Purchase of business by issue of shares.

AS-3 (Revised) recommends that such transactions may be disclosed under footnote to cash flow statement.

6. Investments in Subsidiaries, Associates and Joint Venture:

Acquisition of interest in any subsidiary, associates or in any joint venture is treated as “Investing Activity”. Similarly, sale or disposal of such interest and receipt of interest or dividends on such investments is treated as “Investing Activity”.

The following points will highlight the treatment of seven items in the cash flow statement.

1. Extraordinary Items:

Any cash flow relating to extraordinary items should be as far as possible, be classified into operating, investing or financing activities and those items should be separately disclosed in the cash flow statement.

Some of the examples for extraordinary items are bad debts recovered, claims from insurance companies, winning of a law suit or lottery etc.

2. Interest Received:

(a) It should be considered as cash inflow under investment activities when it is received from long-term investment.

(b) It should be treated as cash inflow under operating activities when it is received from short-term investment classified as cash equivalents.

3. Interest Paid:

(a) Interest paid on debentures and other long-term loans should be classified as cash outflow from financing activities.

(b) Interest paid on working capital loan e.g., bank overdraft, should be classified as cash outflow under operating activities.

4. Dividend Received:

(a) Dividend received by a financial enterprise should be in operating activities.

(b) For companies other than financial enterprises, dividend received should be classified as cash flows from investment activities.

5. Dividend Paid:

Dividends paid should be always considered as cash outflows from financing activities regardless of the nature of the enterprise.

6. Taxes on Income:

Cash outflows arising from taxes on income should be separately disclosed and should be classified as cash outflows from operating activities unless they can be specifically identified with financing and investing activities.

7. Non-cash Transactions:

Investing and financing transactions not involving the use of cash or cash equivalents i.e., the acquisition of an enterprise by means of issue of shares or conversion of debt to equity etc., should be excluded from cash flow statement.

Account Carried Down

Balance carried down represents the monetary balance of a real or personal ledger account that carried forward to the subsequent accounting period. In other words, this is the closing balance of the ledger account.

Once balance brought down and all debit and credit entries for the accounting period are posted to the ledger account, it is balanced. This is done at the end of the accounting period. In case of nominal ledger accounts, the balancing figure is transferred to the income statement. In case of real and personal accounts, the balancing figure is carried on to the subsequent accounting period as balance carried down.

Brought Down

Balance brought down represents the monetary balance of a real or personal ledger account that is brought in to the books from a previous accounting period. In other words, this is the opening balance of the ledger account.

Balances of nominal ledger accounts are transferred to the income statement each year and are thus not continued into subsequent accounting periods. Balance brought down is thus present only in real and personal accounts that are continued in consecutive accounting periods. Balance brought down is derived from the ledger accounts/trial balance of the previous accounting period.

Carried Forward

Balance carried down is the closing balance of a ledger account that is carried forward to the next accounting period. The other hand is the last posting (balancing) to the ledger that is done at the the accounting period Balance carried down is calculated after balancing the debits and credits posted to a ledger account. It becomes the balance brought down of the next accounting period.

Balance carried down is reflected on the left side in case of ledger accounts with credit balance and on the right side in case of ledger accounts with debit balance. Balance carried down is transferred to the trial balance of the entity.

Brought Forward

At the beginning of a new journal page, the opening balance is quoted from the previous page, this balance pulled forward from the previous page to the current page is termed as “Balance B/F” or “Total B/F” (Brought Forward).

Balance b/f can appear in two places in a T-account.

• It is the term showing the opening balance of the account on a certain date. It is the balance that has been brought forward to the current period from the previous period.
• It is also used to show the closing balance of the account, meaning the balance we will bring forward to the next period.

In most European countries, public entities are subject to IFRS and must prepare their accounts accordingly. While local GAAP is aligned to IFRS, it is here and in taxation that key differences emerge.

The European Union’s alignment to the International Financial Reporting Standard (IFRS) for accounting purposes makes financial reporting in Europe quite streamlined for companies. Private entities need to follow the local GAAP (Generally Accepted Accounting Principles), but in most European countries it is aligned to IFRS.

Differences do exist however, and one source of difference is the fact that IFRS as adopted by the EU is sometimes behind the actual IFRS standards. This is because the EU goes through an endorsement process, and this can result in a gap of approximately six months between the implementation of a new standard, and implementation in practice.

With regard to private entities and local GAAP, it is in the few European countries where this is not aligned to IFRS, in which differences occur. For example, in Italy, goodwill should be amortised, revaluation is not allowed, there are specific capitalisation rules and useful lives and only operating leases are recognised.

Efforts to align

There are various initiatives in Europe that look to align tax regulation. The EU is making moves to harmonise VAT legislation, making the rules more similar across member countries. And the common tax base is a recent initiative that would see companies with activities in various EU countries cumulate their expenses and revenues for a consolidated calculation of the profits. These would then be split among countries depending on the level of activity. While there are these initiatives intended to make tax more consistent, there is at the end of the day, a distinct national, local, flavour.

Financial reporting checklist

When it comes to financial reporting in different jurisdictions, there are several aspects you need to consider.

• The format of the financial report country-to-country and specific requirements, which can vary in complexity.
• Differences in terms of the accounting treatment. Usually the difference areas are in, for example, foreign exchange rates, fixed assets and how depreciation is calculated, inventory valuation.

Japanese GAAP

Japanese Accounting Standards (‘Japanese GAAP’) are developed by the Accounting Standards Board of Japan (ASBJ), which was established in 2001. Under an agreement between the ASBJ and the International Accounting Standards Board (IASB) entered into in August 2007, known as the Tokyo Agreement, the ASBJ had been working towards converging the requirements of Japanese Accounting Standards with International Financial Reporting Standards (IFRSs). The achievements under the agreement were jointly announced in June 2011 by the ASBJ and the IASB.

Voluntary adoption of IFRSs by public companies

Since 2010, eligible listed companies in Japan have been permitted to use IFRSs as designated by the Financial Services Agency of Japan (FSA) in their consolidated financial statements, in lieu of Japanese GAAP. As the FSA has designated all IFRSs as issued by the IASB before the effective date without an exception, the designated IFRSs are identical IFRSs as issued by the IASB.

Based on the most recent ordinances that govern eligibility requirements, Japanese listed companies or those applying for a listing to use designated IFRSs in their consolidated financial statements on a voluntary basis must establish internal processes to ensure appropriate reporting under designated IFRSs, with officers or employees who have sufficient knowledge of the subject being in place. There are filing requirements for eligible entities to disclose the fact designated IFRS have been used, and the basis of eligibility.

IFRSs are not permitted to be used in statutory separate financial statements in Japan.

Possible mandatory adoption of IFRSs in Japan

While Japan has considered the possible mandatory adoption of IFRS by public companies for some time, a decision to that effect is yet to be made. Currently, Japan is promoting greater use of IFRSs on a basis of voluntary adoption as explained above.

On 20 June 2013, the Japanese Business Accounting Council (BAC) released its final report titled “The Present Policy on the Application of International Financial Reporting Standards (IFRS)”. The report recommended a number of measures to contribute to greater, but not mandatory, use of IFRSs in Japan. Among others, the key recommendations in the final BAC report were:

• Increase the number of companies that can adopt designated IFRSs on a voluntary basis by eliminating certain eligibility requirements (already implemented in October 2013).
• The introduction of endorsement process and ‘endorsed IFRSs’ in Japan, which may include limited amendments to IFRSs based on specific criteria. The ‘endorsed IFRS’ would be promulgated by the Accounting Standards Board of Japan (ASBJ) and to be approved by the FSA. The ‘endorsed IFRS’ would be available for voluntary adoption by Japanese companies.
• Simplification of disclosure requirements in separate financial statements under Japanese GAAP

Inventory

Inventory is a very significant current asset for retailers, distributors, and manufacturers. Inventory serves as a buffer between:

1) A company’s sales of goods

2) It’s purchases or production of goods.

Companies strive to find the proper amount of inventory so that it can meet the fluctuating demand of its customers, avoid disruptions in production, and minimize holding costs.

Since the costs of the items purchased or produced are likely to change (especially with inflation), companies must elect a cost flow assumption for valuing its inventory and its cost of goods sold. In the U.S. the common cost flow assumptions are FIFO, LIFO, and average.

A company’s cost of inventory is related to the company’s cost of goods sold that is reported on the company’s income statement.

Manufacturers will have three or four categories of inventories:

• Raw materials
• Work-in-process
• Finished goods
• Manufacturing and packaging supplies

Manufacturers are required to report the amounts of each inventory category on its balance sheet or in the notes to the financial statements.

These basic inventory accounting activities are expanded upon in the following bullet points:

• Determine ending unit counts. A company may use either a periodic or perpetual inventory system to maintain its inventory records. A periodic system relies upon a physical count to determine the ending inventory balance, while a perpetual system uses constant updates of the inventory records to arrive at the same goal.
• Improve record accuracy. If a company uses the perpetual inventory system to arrive at ending inventory balances, the accuracy of the transactions is paramount.
• Conduct physical counts. If a company uses the periodic inventory system to create ending inventory balances, the physical count must be conducted correctly. This involves the completion of a specific series of activities to improve the odds of counting all inventory items.
• Estimate ending inventory. There may be situations where it is not possible to conduct a physical count to arrive at the ending inventory balance. If so, the gross profit method or the retail inventory method can be used to derive an approximate ending balance.
• Assign costs to inventory. The main role of the accountant on a monthly basis is assigning costs to ending inventory unit counts. The basic concept of cost layering, which involves tracking tranches of inventory costs, involves the first in, first out (FIFO) layering system and the last in, first out (LIFO) system. A different approach is the assignment of a standard cost to each inventory item, rather than a historical cost.
• Allocate inventory to overhead. The typical production facility has a large amount of overhead costs, which must be allocated to the units produced in a reporting period.

Incomes

Income is the revenue a business earns from selling its goods and services or the money an individual receives in compensation for his or her labor, services, or investments.

Accounting income is the profit a company retains after paying off all relevant expenses from sales revenue earned. It is synonymous with net income, which is most often found at the end of the income statement. The metric differs from gross income in that the latter accounts for only direct expenses, whereas accounting income also takes into consideration all indirect expenses.

One meaning of income refers to revenue or sales. Revenue is the money that a company receives from selling goods or services throughout the course of business. Revenue is an equity account that has a credit balance. Throughout the year sales are recorded in the revenue accounts and posted to trial balance. The revenue is then reported on the first line of the income statement. This is often called gross income, total sales, or top line sales since it includes all the company income and sales before deducting expenses.

Another meaning of income refers to net income. Net income is completely different than gross income. Net income appears at the bottom of the income statement after all of the cost of goods sold and operating expenses have been subtracted out. Net income equals the total company revenues minus total company expenses.

Expenses

An expense is the reduction in value of an asset as it is used to generate revenue. If the underlying asset is to be used over a long period of time, the expense takes the form of depreciation, and is charged ratably over the useful life of the asset. If the expense is for an immediately consumed item, such as a salary, then it is usually charged to expense as incurred.

The accounting for an expense usually involves one of the following transactions:

• Debit to expense, credit to cash. Reflects a cash payment.
• Debit to expense, credit to accounts payable. Reflects a purchase made on credit.
• Debit to expense, credit to asset account. Reflects the charging to expense of an asset, such as depreciation expense on a fixed asset.
• Debit to expense, credit to other liabilities account. Reflects a payment not involving trade payables, such as the interest payment on a loan, or an accrued expense.

An expense is defined in the following ways:

• Office supplies use up the cash (asset)
• Depreciation expense, which is a charge to reduce the book value of capital equipment (e.g., a machine or a building) to reflect its usage over a period.
• A prepaid expense, such as prepaid rent, is an asset that turns into a cash expense as the rent is used up each month

Types of Expenses

Expenses affect all financial accounting statements but exert the most impact on the income statement. They appear on the income statement under five major headings, as listed below:

1. Cost of Goods Sold (COGS)

Cost of Goods Sold (COGS) is the cost of acquiring raw materials and turning them into finished products. It does not include selling and administrative costs incurred by the whole company, nor interest expense or losses on extraordinary items.

• For manufacturing firms, COGS include direct labor, direct materials, and manufacturing overhead.
• For a service company, it is called a cost of services rather than COGS.
• For a company that sells both goods and services, it is called cost of sales.

Examples of COGS include direct material, direct costs, and production overhead.

2. Operating Expenses: Selling/General and Admin

Operating expenses are related to selling goods and services and include sales salaries, advertising, and shop rent.

General and administrative expenses include expenses incurred while running the core line of the business and include executive salaries, R&D, travel and training, and IT expenses.

3. Financial Expenses

They are costs incurred from borrowing from lenders or creditors. They are expenses outside the company’s core business. Examples include loan origination fees and interest on money borrowed.

4. Extraordinary Expenses

Extraordinary expenses are costs incurred for large one-time events or transactions outside the firm’s regular business activity. They include laying off employees, selling land, or disposal of a significant asset.

5. Non-Operating Expenses

These are costs that cannot be linked back to operating revenues. Interest expense is the most common non-operating expense. Interest is the cost of borrowing money. Loans from banks usually require interest payments, but such payments don’t generate any operating income. Hence, they are classified as non-operating expenses.

Non-Cash Expenses

Under the accrual method of accounting, non-cash expenses are those expenses that are recorded in the income statement but do not involve an actual cash transaction. Depreciation is the most common type of non-cash expense, as it reduces net profit, but is not a result of a cash outflow.   The accounting transaction and its impact on the financial statements are outlined below.:

• A debit to a depreciation expense account and a credit to a contra asset account called accumulated depreciation
• On the balance sheet, the book value of the asset is decreased by the accumulated depreciation.

Expenses are income statement accounts that are debited to an account, and the corresponding credit is booked to a contra asset or liability account.

Creditors

A creditor could be a bank, supplier or person that has provided money, goods, or services to a company and expects to be paid at a later date. In other words, the company owes money to its creditors and the amounts should be reported on the company’s balance sheet as either a current liability or a non-current (or long-term) liability.

Some creditors, such as banks and other lenders, have lent money to the company and will require the company to sign a written promissory note for the amount owed. When a promissory note is required, the company borrowing the money will record and report the amount owed as Notes Payable.

If the creditor is a vendor or supplier that did not require the company to sign a promissory note, the amount owed is likely to be reported as Accounts Payable or Accrued Liabilities.

Other creditors include the company’s employees (who are owed wages and bonuses), governments (who are owed taxes), and customers (who made deposits or other prepayments).

Some creditors are referred to as secured creditors because they have a registered lien on some of the company’s assets. A creditor without a lien (or other legal claim) on the company’s assets is an unsecured creditor.

Debtors

A debtor is a person, company, or other entity that owes money. In other words, the debtor has a debt or legal obligation to pay the amount owed.

A debtor is an individual or entity that owes money to a creditor. The concept can apply to individual transactions, so that someone could be a debtor in regard to a specific supplier invoice, while being a creditor in relation to its own billings to customers. Even a very wealthy person or company is a debtor in some respects, since there are always unpaid invoices payable to suppliers. The only entity that is not a debtor is one that pays up-front in cash for all transactions. Thus, an entity could be a debtor in relation to specific payables, while being flush with cash in all other respects.

A debtor is considered to be in default if it does not pay a debt within the payment terms of the debt agreement. Thus, a short payment or late payment could trigger a default.

The liability owed by a debtor can be discharged in bankruptcy, or with the agreement of the counterparty. In either case, if the liability is no longer valid, the entity involved is no longer a debtor in relation to that liability.

Each general journal entry lists the date, the account titles to be debited and the corresponding amounts followed by the account titles to be credited and the corresponding amounts. The accounts to be credited are indented.

A journal entry is used to record a business transaction in the accounting records of a business. A journal entry is usually recorded in the general ledger; alternatively, it may be recorded in a subsidiary ledger that is then summarized and rolled forward into the general ledger. The general ledger is then used to create financial statements for the business.

The logic behind a journal entry is to record every business transaction in at least two places (known as double entry accounting). For example, when you generate a sale for cash, this increases both the revenue account and the cash account. Or, if you buy goods on account, this increases both the accounts payable account and the inventory account.

The structure of a journal entry is:

• A header line may include a journal entry number and entry date.
• The first column includes the account number and account name into which the entry is recorded. This field is indented if it is for the account being credited.
• The second column contains the debit amount to be entered.
• The third column contains the credit amount to be entered.
• A footer line may also include a brief description of the reason for the entry.

Thus, the basic journal entry format is:

Types of Journal Entries

There are several types of journal entries, including the following:

• Adjusting entry. An adjusting entry is used at month-end to alter the financial statements to bring them into compliance with the relevant accounting framework, such as Generally Accepted Accounting Principles or International Financial Reporting Standards. For example, you could accrue unpaid wages at month-end if the company is on the accrual basis of accounting.
• Compound entry. A compound journal entry is one that includes more than two lines of entries. It is frequently used to record complex transactions, or several transactions at once. For example, the journal entry to record payroll usually contains many lines, since it involves the recordation of numerous tax liabilities and payroll deductions.
• Reversing entry. This is typically an adjusting entry that is reversed as of the beginning of the following period, usually because an expense was to be accrued in the preceding period, and is no longer needed. Thus, a wage accrual in the preceding period is reversed in the next period, to be replaced by an actual payroll expenditure.

Rules of Journal Entry

When a business transaction takes place and we have to make a journal entry, we must follow these rules:

• In a double-entry bookkeeping system, a journal entry must affect at least 2 accounts. Also, one of the accounts must be debited and the other one must be credited.
• The debit amounts and the credit amounts must be equal.

Most popular classification is the Personal, Real & Nominal account and the rules of these are as follows:

1. Personal Account

A personal account is that of a person, company, an organization such as a bank, and so on.

• Debit the Receiver, Credit the giver
• Accounts that fall in this category are: Debtors, Creditors and so on

2. Real Account

Real Account is the account of tangible and intangible items such as inventory, cash, bank account, plant and machinery and so on

• Debit what comes in, Credit what goes out
• Accounts that fall in this category are: Cash, bank balance, stock of goods, Purchase, Sales, Plant & Machinery and so on

3. Nominal Account

This account is the account of profits, losses, incomes, and gains.

• Debit all losses and expenses, Credit all incomes and gains.
• Accounts that fall in this category are Profit, Interest, Dividend, Depreciation.