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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

ATHARVA INSTITUTE OF
MANAGEMENT STUDIES

Financial Accounting Report


On
ACCOUNTING STANDARD - 2
AND
ACCOUNTING STANDARD - 6
By
Vivek Jadhav ()
Kiran Jadhav ()
Ajit Hirekar (13)
Vipul Dhorajiwala ()
Nilesh Isal (15)

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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

MMS 1st Year Division A

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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

Introduction
Accounting Standard-2: Valuation of
Inventories
Objective:
A primary issue in accounting for inventories is the determination
of the value at which inventories are carried in the financial
statements until the related revenues are recognized. This
Statement deals with the determination of such value, including
the ascertainment of cost of inventories and any write-down
thereof to net realizable value.

Scope:
1. This Standard should be applied in accounting for inventories
other than:
(a) Work in progress arising under construction contracts,
including directly related service contracts
(b) Work in progress arising in the ordinary course of
business of service providers;
(c) Shares, debentures and other financial instruments held
as sk-in-trade; and
(d) Producers' inventories of livestock, agricultural and forest
products, and mineral oils, ores and gases to the extent that
they are measured at net realizable value in accordance with
well established practices in those industries.

The inventories referred to in paragraph 1 (d) are measured at


net realizable value at certain stages of production. This occurs,
for example, when agricultural crops have been harvested or
mineral oils, ores and gases have been extracted and sale is
assured under a forward contract or a government guarantee, or
when a homogenous market exists and there is a negligible risk of
failure to sell. These inventories are excluded from the scope of
this Standard.
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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

Definition:
The following terms are used in this Statement with the meanings
specified:

Inventories are assets:


(a) Held for sale in the ordinary course of business;
(b) In the process of production for such sale; or
(c) In the form of materials or supplies to be consumed in the
production process or in the rendering of services.

Net realizable value is the estimated selling price in the ordinary


course of business less the estimated costs of completion and the
estimated costs necessary to make the sale.

Measurement of Inventories
Inventories should be valued at the lower of cost and net
realizable value.

A. Cost of Inventories:

1. Costs of Purchase
The costs of purchase consist of the purchase price including
duties and taxes (other than those subsequently recoverable by
the enterprise from the taxing authorities), freight inwards and
other expenditure directly attributable to the acquisition. Trade
discounts, rebates, duty drawbacks and other similar items are
deducted in determining the costs of purchase.

2. Costs of Conversion
The costs of conversion of inventories include costs directly
related to the units of production, such as direct labour. They also
include a systematic allocation of fixed and variable production
overheads that are incurred in converting materials into finished
goods. Fixed production overheads are those indirect costs of
production that remain relatively constant regardless of the
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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

volume of production, such as depreciation and maintenance of


factory buildings and the cost of factory management and
administration. Variable production overheads are those indirect
costs of production that vary directly, or nearly directly, with the
volume of production, such as indirect materials and indirect
labour.
The allocation of fixed production overheads for the purpose of
their inclusion in the costs of conversion is based on the normal
capacity of the production facilities. Normal capacity is the
production expected to be achieved on an average over a number
of periods or seasons under normal circumstances, taking into
account the loss of capacity resulting from planned maintenance.
The actual level of production may be used if it approximates
normal capacity. The amount of fixed production overheads
allocated to each unit of production is not increased as a
consequence of low production or idle plant. Unallocated
overheads are recognized as an expense in the period in which
they are incurred. In periods of abnormally high production, the
amount of fixed production overheads allocated to each unit of
production is decreased so that inventories are not measured
above cost. Variable production overheads are assigned to each
unit of production on the basis of the actual use of the production
facilities.
A production process may result in more than one product being
produced simultaneously. This is the case, for example, when
joint products are produced or when there is a main product and
a by-product. When the costs of conversion of each product are
not separately identifiable, they are allocated between the
products on a rational and consistent basis. The allocation may be
based, for example, on the relative sales value of each product
either at the stage in the production process when the products
become separately identifiable, or at the completion of
production. Most by-products as well as scrap or waste materials,
by their nature, are immaterial. When this is the case, they are
often measured at net realizable value and this value is deducted
from the cost of the main product. As a result, the carrying
amount of the main product is not materially different from its
cost.

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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

3. Other Costs
Other costs are included in the cost of inventories only to the
extent that they are incurred in bringing the inventories to their
present location and condition. For example, it may be
appropriate to include overheads other than production
overheads or the costs of designing products for specific
customers in the cost of inventories.
Interest and other borrowing costs are usually considered as not
relating to bringing the inventories to their present location and
condition and are, therefore, usually not included in the cost of
inventories.

Exclusions from the Cost of Inventories

In determining the cost of inventories in accordance with


paragraph 6, it is appropriate to exclude certain costs and
recognize them as expenses in the period in which they are
incurred. Examples of such costs are:
(a) Abnormal amounts of wasted materials, labour, or other
production costs;
(b) Storage costs, unless those costs are necessary in the
production process prior to a further production stage;
(c) Administrative overheads that do not contribute to bringing
the inventories to their present location and condition; and
(d) Selling and distribution costs.

Cost formula
I. FIFO (first in first out)

When a merchant buys goods from inventory, the value of the


inventory account is reduced by the cost of goods sold (COGS).
This is simple where the COGS have not varied across those held
in stock; but where it has, then an agreed method must be
derived to evaluate it. For commodity items that one cannot track
individually, accountants must choose a method that fits the
nature of the sale. Two popular methods that normally exist are:
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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

FIFO and LIFO accounting (first in - first out, last in - first out).
FIFO regards the first unit that arrived in inventory as the first one
sold. LIFO considers the last unit arriving in inventory as the first
one sold. Which method an accountant selects can have a
significant effect on net income and book value and, in turn, on
taxation. Using LIFO accounting for inventory, a company
generally reports lower net income and lower book value, due to
the effects of inflation. This generally results in lower taxation.
Due to LIFO's potential to skew inventory value, UK GAAP and IAS
have effectively banned LIFO inventory accounting.

2. Weighted average

Inventory valuation method used where different quantities of


goods are purchased at different unit costs. Under this method,
weights are assigned to the cost price on the basis of the quantity
of each item at each price. It takes Cost of Goods Available for
Sale and divides it by the total amount of goods from Beginning
Inventory and Purchases. This gives a Weighted Average Cost per
Unit. A physical count is then performed on the ending inventory
to determine the amount of goods left. Finally, this amount is
multiplied by Weighted Average Cost per Unit to give an estimate
of ending inventory cost.

3. Standard cost accounting

It uses ratios called efficiencies that compare the labour and


materials actually used to produce a good with those that the
same goods would have required under "standard" conditions. As
long as similar actual and standard conditions obtain, few

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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

problems arise. Unfortunately, standard cost accounting methods


developed about 100 years ago, when labour comprised the most
important cost in manufactured goods. Standard methods
continue to emphasize labor efficiency even though that resource
now constitutes a (very) small part of cost in most cases.

Standard cost accounting can hurt managers, workers, and firms in several ways.
For example, a policy decision to increase inventory can harm a manufacturing
manager's performance evaluation. Increasing inventory requires increased
production, which means that processes must operate at higher rates. When (not if)
something goes wrong, the process takes longer and uses more than the standard
labor time. The manager appears responsible for the excess, even though s/he has
no control over the production requirement or the problem.

In adverse economic times, firms use the same efficiencies to downsize, right size,
or otherwise reduce their labor force. Workers laid off under those circumstances
have even less control over excess inventory and cost efficiencies than their
managers.

Many financial and cost accountants have agreed for many years on the desirability
of replacing standard cost accounting. They have not, however, found a successor.

4. Retail method

It is generally used in retail business, when it is difficult to


ascertain cost of individual item. It is applicable when items of
inventories are rapidly changing items and have similar margins
and for which it is impracticable to use other costing method.
Under this method, the cost of inventory is determined by
reducing from the sale of inventories the approximate percentage
of gross margin. The percentage used takes into consideration
the inventory that has been marked down o below its original
selling price.

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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

Determination of net realizable value of


inventories

Net realizable value means the estimated selling price in ordinary


course of business, less estimated cost of completion and
estimated cost necessary to make the sale. NRV is estimated on
the basis of the most realizable evidence at the time of valuation.
Estimation of net realizable value also takes into account the
purpose for which the inventory is held. Estimation of net
realizable value is made as at each balance sheet date.

Estimation of net realizable value:

- if the finished product in which raw materials and supplies used


is sold at cost or above cost, then the estimated realizable value
of raw materials and supplies is considered more than its cost.

- if finished product in which raw material and supplies used is


sold below cost, then the estimated realizable value of raw
material or supplies is equal to replacement price of raw material
or supplies.ss

Comparison between cost and net realizable


value
The comparison between cost and NRV should be made item by
item or by group of items. The value between the two, whichever
is lower should be taken for the computation of inventories.

Disclosure in financial statement


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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

Following should be disclosed:

• Accounting policy adopted in measuring inventories


• Cost formula used
• Classification of inventories like finished goods, WIP, raw
material, spare parts and its carrying amount.

Accounting standard-6: Depreciation Accounting


Introduction
This Statement deals with depreciation accounting and applies to
all depreciable assets, except the following items to which special
considerations apply:—

(i) Forests, plantations and similar regenerative natural


resources;

(ii) Wasting assets including expenditure on the


exploration for and extraction of minerals, oils, natural
gas and similar non-regenerative resources;

(iii) Expenditure on research and development;

(iv) Goodwill;

(v) Live stock.

This statement also does not apply to land unless it has a limited
useful life for the enterprise.

Different accounting policies for depreciation are adopted by


different enterprises. Disclosure of accounting policies for
depreciation followed by an enterprise is necessary to appreciate
the view presented in the financial statements of the enterprise.

Definitions

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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

Depreciation is a measure of the wearing out, consumption or


other loss of value of a depreciable asset arising from use, efflux
ion of time or obsolescence through technology and market
changes.

Depreciation is allocated so as to charge a fair proportion of the


depreciable amount in each accounting period during the
expected useful life of the asset. Depreciation includes
amortization of assets whose useful life is predetermined.

Company profile : TWENTYFIRST CENTURY MANAGEMENT


SERVICES LIMITED

TWENTYFIRST CENTURY MANAGEMENT SERVICES LIMITED (TCMS)


was founded by Robert Bullemer in 1986. The California
Corporation is headquartered in Santa Barbara, California. The
company has four major product/service divisions:

• Computer systems

• Hotel systems

• Loan systems

• Partnership systems

The PARTNERSHIP SYSTEMS division's primary product, the


PARTNERS SYSTEM, is a comprehensive administration system for
hedge funds and syndicators of real estate, oil & gas, movie
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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

production. The HOTEL SYSTEMS division produces a


comprehensive property management system for hotels, motels
and resorts. The LOAN SYSTEMS division offers a series of
products for loan origination, servicing, portfolio management,
and pipeline tracking.

TCMS plans to develop more products for specialized vertical


market applications. The product development strategy is a
focused approach which targets specific vertical markets with a
fully integrated set of functional applications.

TCMS, after its inception in India in 1995, is listed in the following


stock exchanges:
• Madras Stock Exchange Ltd.,
• National Stock Exchange of India Ltd.
• The Stock Exchange, Mumbai.

BALANCE SHEET OF TCMS:

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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

Financial Ratios

Current Ratio
Current Ratio = _Current Assets_
Current Liabilities

It is also known as solvency ratio as it indicates solvency position


of the company. It is also known as Working Capital Ratio as it
represents working capital. It indicates the sources available to
meet current obligations. Hence, it is expected that current ratio
should be higher. The ideal current ratio is 2:1.

The current ratio of TCMS is 1.82 for 2009 and 2.05 for 2010. This
is the ideal ratio and is a good indication for the company.

Quick Ratio
Quick Ratio = _Quick Assets__
Quick Liabilities

It is also known as acid test ratio. This ratio indicates the


immediate ability of a company to pay off its current obligations.
It indicates the solvency and the financial soundness of the
business.

The ideal quick ratio is 1:1.

The quick ratio of TCMS is 1.08 for 2009 and 1.32 for 2010.

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Debt to Assets Ratio


Debt to Assets Ratio = Total Assets
Total Debts
Where,
Debts = Loan Funds + Current Liabilities

Assets = Fixed Assets + Current Assets

This ratio indicates the share of debts in creating the total assets
of the firm.

The Debt to Assets Ratio of TCMS is 0.21 for 2009 and 0.33 for
2010.

If the ratio is less than 0.5, it means most of the company's assets
are financed through equity.

Debt Equity Ratio


Debt Equity Ratio = _Debt_
Equity

Where,

Debt = All liabilities including long-term and short-term.

Equity = Net worth + Preference Capital

Higher the ratio, less secure are the creditors. In the times of
distress or difficulty, they suffer more than the owners. Contrary
to this, lower the ratio, creditors enjoy higher degree of safety.

The Debt Equity Ratio of TCMS is 0.27 for 2009 and 0.5 for 2010.

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Financial Accounting Report – Cash Flow and Analysis of Balance Sheet

Earnings Per Share

Earnings Per Share = Net Profit After Tax - Preference Dividend


No of Equity Shares

This ratio expresses the amount of earnings per share after taxes
and preference dividend during certain period. As this ratio
indicates the overall performance of the organization, such ratio
calculated for the year-to-year proves to be very helpful to the
shareholders and the investors to take investment decisions. It
also affects the market prices of the shares.

The Earnings Per Share of TCMS for 2009 is 14.95% and 16.35%
for 2010.

This indicates better returns for shareholders.

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