Fixed Assets: Purchased for permanent i.e.

long term use and these help the business to earn revenue. E.g. Building, Machinery, Motor Vehicle, etc. These assets are not for sale in ordinary course of business but can be disposed off, if no more needed for business use.Credit Purchase and Credit Sale of fixed Assets Machinery, Furniture. While charging depreciation on fixed assets or valuing unsold stock, once a particular method is used it should be followed year after year so that the financial statements can be analysed and compared provided the depreciation on fixed assets is charged or unsold stock is valued by using particular method year after year. Fixed assets are recorded in the accounting records at the original cost. Actual amount spent on the assets like building, machinery, plus all incidental charges is recorded. In this way the effect of rise in prices not taken into consideration. As a result the Balance Sheet does not represent the true financial position of the business.

Accounting Conventions: An accounting convention refers to common practices which are universally followed in recording and presenting accounting information of the business entity. They are followed like customs, tradition, etc. in a society. Accounting conventions are evolved through the regular and consistent practice over the years to facilitate uniform recording in the books of accounts. Accounting Conventions help in comparing accounting data of different business units or of the same unit for different periods. These have been developed over the years. The most important conventions which have been used for a long period are : l Convention of consistency. l Convention of full disclosure. l Convention of materiality. l Convention of conservatism. Convention of consistency The convention of consistency means that same accounting principles should be used for preparing financial statements year after year. A meaningful conclusion can be drawn from financial statements of the same enterprise when there is comparison between them over a period of time. But this can be possible only when accounting policies and practices followed by the enterprise are uniform and consistent over a period of time. If different accounting procedures and practices are used for preparing financial statements of different years, then the result will not be comparable. CONVENTION OF FULL DISCLOSURE Convention of full disclosure requires that all material and relevant facts concerning financial statements should be fully disclosed. Full disclosure means that there should be full, fair and adequate disclosure of accounting information. Adequate means sufficient set of information to be disclosed. Fair indicates an equitable treatment of users. Full refers to complete and detailed presentation of information. Thus, the convention of full disclosure suggests that every financial statement should fully disclose all relevant information. Let us relate it to the business. The business provides financial information to all interested parties like investors, lenders, creditors, shareholders etc. The shareholder would like to know profitability of the firm while the creditor would like to know the solvency of the business. In the same way, other parties would be interested in the financial information according to their requirements. This is possible if financial statement discloses all relevant information in full, fair and adequate manner. CONVENTION OF CONSERVATISM This convention is based on the principle that Anticipate no profit, but provide for all possible losses . It provides guidance for recording transactions in the books of accounts. It is based on the policy of playing safe in regard to showing profit. The main objective of this convention is to show minimum profit. Profit should not be overstated. If profit shows more than actual, it may lead to distribution of dividend out of capital. This is not a fair policy and it will lead to the reduction in the capital of the enterprise. Convention of materiality: An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. Where decisions are required about the

appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts. An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts. FIFO method valuation of stock First-In, First-Out (FIFO) This method assumes that the first unit making its way into inventory is the first sold. For example, let's say that a bakery produces 200 loaves of bread on Monday at a cost of $1 each, and 200 more on Tuesday at $1.25 each. FIFO states that if the bakery sold 200 loaves on Wednesday, the COGS is $1 per loaf (recorded on the income statement) because that was the cost of each of the first loaves in inventory. The $1.25 loaves would be allocated to ending inventory (appears on the balance sheet). Last-In, First-Out (LIFO) This method assumes that the last unit making its way into inventory is sold first. The older inventory, therefore, is left over at the end of the accounting period. For the 200 loaves sold on Wednesday, the same bakery would assign $1.25 per loaf to COGS, while the remaining $1 loaves would be used to calculate the value of inventory at the end of the period. FIFO gives us a better indication of the value of ending inventory (on the balance sheet), but it also increases net income because inventory that might be several years old is used to value the cost of goods sold. Increasing net income sounds good, but remember that it also has the potential to increase the amount of taxes that a company must pay. LIFO isn't a good indicator of ending inventory value because the leftover inventory might be extremely old and, perhaps, obsolete. This results in a valuation that is much lower than today's prices. LIFO results in lower net income because cost of goods sold is higher. Deferred tax liability : An account on a company's balance sheet that is a result of temporary differences between the company's accounting and tax carrying values, the anticipated and enacted income tax rate, and estimated taxes payable for the current year. This liability may or may not be realized during any given year, which makes the deferred status appropriate. Because there are differences between what a company can deduct for tax and accounting purposes, there will be a difference between a company's taxable income and income before tax. A deferred tax liability records the fact that the company will, in the future, pay more income tax because of a transaction that took place during the current period, such as an installment sale receivable. Depreciation: Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. 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. Permanent Decrease in the value of a fixed asset, A portion of the total cost of fixed asset used/consumed. Within an accounting period. Different accounting policies for depreciation are adopted by different enterprises. Disclosure of accounting policies for depreciation followed by an enterprise is necessary. Quantum of depreciation involves the exercise of judgment by management in the light of technical, commercial, accounting and legal requirements. Need for Depreciation: Learning Objectives: Why does the need for calculating and charging depreciation arise.

The Need for depreciation arises for the following reasons: Ascertainment of True Profit or Loss: Depreciation is a loss. So Unless it is considered like all other expenses and losses, true profit or loss cannot be ascertained. In other words, depreciation must be considered in order to into out true profit or loss of a business. Ascertainment of True Cost of Production: Goods are produced with the help of plant and machinery which incurs depreciation in the process of production. This depreciation must be considered as a part of the cost of production of goods. Otherwise, the cost f production would be shown less than the true cost. Sales price is fixed normally on the basis of cost of production. So, if the cost of production is shown less by ignoring depreciation, the sale price will also be fixed at low level resulting in a loss to the business. True Valuation of Assets: Value of assets gradually decreases on account of depreciation, if depreciation is not taken into account, the value of asset will be shown in the books at a figure higher than its true value and hence the true financial position of the business will not be disclosed through balance sheet. Replacement of Assets: After sometime an asset will be completely exhausted on account of use. A new asset must then be purchased requiring a large sum of money. If the whole amount of profit is withdrawal from business each year without considering the loss on account of depreciation, necessary sum may not be available for buying the new asset. In such a case the required money is to be collected by introducing fresh capital or by obtaining loan or by selling some other assets. This is contrary to sound commerce policy. Straight-line depreciation Straight-line depreciation is the simplest and most-often-used technique, in which the company estimates the salvage value of the asset at the end of the period during which it will be used to generate revenues (useful life) and will expense a portion of original cost in equal increments over that period. The salvage value is an estimate of the value of the asset at the time it will be sold or disposed of; it may be zero or even negative. Salvage value is also known as scrap value or residual value. Straight-line method: \mbox{Annual Depreciation Expense} = {\mbox{Cost of Fixed Asset} - \mbox{Residual Value} \over \mbox{Useful Life of Asset} (years)} For example, a vehicle that depreciates over 5 years, is purchased at a cost of US$17,000, and will have a salvage value of US$2000, will depreciate at US$3,000 per year: ($17,000 $2,000)/ 5 years = $3,000 annual straight-line depreciation expense. In other words, it is the depreciable cost of the asset divided by the number of years of its useful life. This table illustrates the straight-line method of depreciation. Book value at the beginning of the first year of depreciation is the original cost of the asset. At any time book value equals original cost minus accumulated depreciation. book value = original cost accumulated depreciation Book value at the end of year becomes book value at the beginning of next year. The asset is depreciated until the book value equals scrap value. Book value at beginning of year Depreciation expense Accumulated depreciation Book value at end of year $17,000 (original cost) $3,000 $3,000 $14,000 $14,000 $3,000 $6,000 $11,000

$11,000 $3,000 $9,000 $8,000 $8,000 $3,000 $12,000 $5,000 $5,000 $3,000 $15,000 $2,000 (scrap value) If the vehicle were to be sold and the sales price exceeded the depreciated value (net book value) then the excess would be considered a gain and subject to depreciation recapture. In addition, this gain above the depreciated value would be recognized as ordinary income by the tax office. If the sales price is ever less than the book value, the resulting capital loss is tax deductible. If the sale price were ever more than the original book value, then the gain above the original book value is recognized as a capital gain. If a company chooses to depreciate an asset at a different rate from that used by the tax office then this generates a timing difference in the income statement due to the difference (at a point in time) between the taxation department's and company's view of the profit. Declining-balance method (or Reducing balance method) Depreciation methods that provide for a higher depreciation charge in the first year of an asset's life and gradually decreasing charges in subsequent years are called accelerated depreciation methods. This may be a more realistic reflection of an asset's actual expected benefit from the use of the asset: many assets are most useful when they are new. One popular accelerated method is the declining-balance method. Under this method the book value is multiplied by a fixed rate. Annual Depreciation = Depreciation Rate * Book Value at Beginning of Year The most common rate used is double the straight-line rate. For this reason, this technique is referred to as the double-declining-balance method. To illustrate, suppose a business has an asset with $1,000 original cost, $100 salvage value, and 5 years useful life. First, calculate straight-line depreciation rate. Since the asset has 5 years useful life, the straight-line depreciation rate equals (100% / 5) 20% per year. With double-declining-balance method, as the name suggests, double that rate, or 40% depreciation rate is used. The table below illustrates the double-decliningbalance method of depreciation. Book value at beginning of year Depreciation rate Depreciation expense Accumulated depreciation Book value at end of year $1,000 (original cost) 40% $400 $400 $600 $600 40% $240 $640 $360 $360 40% $144 $784 $216 $216 40% $86.40 $870.40 $129.60 $129.60 $129.60 - $100 $29.60 $900 $100 (scrap value) When using the double-declining-balance method, the salvage value is not considered in determining the annual depreciation, but the book value of the asset being depreciated is never brought below its salvage value, regardless of the method used. The process continues until the salvage value or the end of the asset's useful life, is reached. In the last year of depreciation a subtraction might be needed in order to prevent book value from falling below estimated Scrap Value. Since double-declining-balance depreciation does not always depreciate an asset fully by its end of life, some methods also compute a straight-line depreciation each year, and apply the greater of the two. This has the effect of converting from declining-balance depreciation to straight-line depreciation at a midpoint in the asset's life. It is possible to find a rate that would allow for full depreciation by its end of life with the formula: \mbox{depreciation rate} = 1 - \sqrt[N]{\mbox{residual value} \over \mbox{cost of fixed asset}},

where N is the estimated life of the asset (for example, in years). Contingent liability : Contingent liabilities are liabilities that may or may not be incurred by an entity depending on the outcome of a future event such as a court case. These liabilities are recorded in a company's accounts and shown in the balance sheet when both probable and reasonably estimable. A footnote to the balance sheet describes the nature and extent of the contingent liabilities. The likelihood of loss is described as probable, reasonably possible, or remote. The ability to estimate a loss is described as known, reasonably estimable, or not reasonably estimable.

AS 1 Disclosure of accounting policy: he objective of financial statements is to provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of users, in making economic decisions. T Financial statements portray the effect of past events and transactions. Accounting policies and methods adopted by an enterprise, in turn, influence the effect of past events and transactions. Users must be able to compare the: financial statements of any one enterprise through time so that trends and movements in performance and position can be identified, and status of different enterprises for an evaluation of relative financial position and performance. The disclosure by an entity of its accounting policies, enable users tounderstand the past extrapolate to the future. A critical qualitative characteristic of comparability is that users be informed of not merely the accounting principles and methods adopted by the enterprises, but the changes in such policies introduced and the monetary effect of such changes, as well. This standard deals with the disclosure of significant accounting policies followed in preparation and presentation of financial statements. The purpose is to promote a better understanding of financial statements by establishing through an Accounting Standard (AS), a mandatory requirement that all significant accounting policies ought to be disclosed as also the manner in which such accounting policies are to be disclosed in the financial statements. Accounting Policies Accounting policies refer to: a) Specific accounting principles, and b) Methods adopted by enterprises, in applying these principles in the preparation and presentation of financial statements. AS 12 accounting for government grants Government grants are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistancewhich cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the enterprise. The receipt of government grants by an enterprise is significant for preparation of the financial statements for two reasons. Firstly, if a government grant has been received, an appropriate method of accounting therefor is necessary. Secondly, it is desirable to give an indication of the extent to which the enterprise has benefited from such grant during the reporting period. This facilitates comparison of an enterprise s financial statements with those of prior periods and with those of other enterprises.