Accounting Concepts and Conventions Business is a going concern but financial transactions are summarised periodically - Accounting Period
Match Expenses with revenues of the period
Accounting Standards require the firms to treat accounting items in a specified manner. Accounting Standards on various accounting items
Depreciation Accounting Prior Period, Extraordinary items and changes in AP Investments, Amalgamation, Retirement Benefits Valuation of Inventories Changes in Financial Positions
M.S.Narasimhan, Indian Institute of Management Bangalore
AS - P & L Account
Profit is determined by subtracting expenses of the period from revenue of the period Accounting Standards are pronounced on three important items of P&L Account
Revenue Recognition Inventory Valuation Depreciation
Revenue Recognition
Activities in Revenue Generation Process
Firm receives order and produce or produce and sell Receives advance with orders in some cases Despatch goods and raise invoice may happen simultaneously or different points of time Goods are accepted or returned by the customer Receives payment in full or part, retention money, discount availed for advancing payment, payment not received or not to be received.
M.S.Narasimhan, Indian Institute of Management Bangalore
Revenue Recognition
When to recognise the revenue?
The operating cycle explains profit is being earned over the cycle and it is realized in cash form at the end of the cycle (when cash is received) Since there is no objective way to measure profit earned at different process, profit is recognized at one single point (Objectivity principle)
No significant uncertainty exists regarding collection of consideration Under accrual basis, revenue is recognised when a firm
has performed all or substantial portion of service it expects to provide and has received cash, a receivable or some other asset whose cash equivalent value can be measured objectively
M.S.Narasimhan, Indian Institute of Management Bangalore
India, US, Germany, France, Japan and Canada, both methods are allowed. In Austria, CSCM alone is allowed.
M.S.Narasimhan, Indian Institute of Management Bangalore
Franchisers
after the commencement of franchising operation
US GAAP too prefers this method when there is no uncertainty relating to cash collection
M.S.Narasimhan, Indian Institute of Management Bangalore
Instalment sale but delivery after the receipt of all instalments - wait for the receipt of all instalments Advance received in a special order -wait for delivery Sale and repurchase - not a sale & hence not a revenue Dealers & distributors: sale if title of goods is passed Subscriptions for publication
M.S.Narasimhan, Indian Institute of Management Bangalore
Revenue Recognition - Service Installation Fee: Wait for completion of installation Advertising: Wait for publication of advertisement Insurance agency commission: Wait for commencement or renewal of policy Financial Service Commission
One-time Fee - Recognise when service is completed On-going service - Recognise over the years.
Inventory Valuation
Components of Inventory
Raw Material, Components, Merchandise Work-in-process Finished Goods Miscellaneous items (e.g. packing materials)
Impact of FIFO, LIFO, WA method of Valuation FIFO vs. LIFO In Rising Price In Falling Price FIFO More Profit Less Profit LIFO Less Profit More Profit Weighted Average method moderates the distortion in profit under different price trends LIFO price attached to the physical units may significantly differ (LIFO layers) Sometimes, LIFO affects purchasing behaviour
M.S.Narasimhan, Indian Institute of Management Bangalore
Material cost is traceable and valued under any of the methods used for valuation of materials Conversion cost has to be charged or allocated Total Cost or Variable/Direct Cost alone? Cost Accounting System does the computation once the choice is made
M.S.Narasimhan, Indian Institute of Management Bangalore
If by-products are recognised at the time of production, the closing stock is recognised based on net realisable value. If by-products are recognised at the time of sale, the value of closing stock is not recognised.
M.S.Narasimhan, Indian Institute of Management Bangalore
Inventory Valuation - AS 2
Cost or Net Realisable Value, whichever is less Cost: Cost incurred to bring inventory to its present location and condition; excludes duties recoverable subsequently from taxing authority Specific cost if the cost of the item is identifiable FIFO or Weighted Average Method Storage, interest, abnormal wastage, Administration and selling & distribution costs are excluded Refer: http://www.icai.org for the recent AS 2.
M.S.Narasimhan, Indian Institute of Management Bangalore
Accounting Treatment
Not treated as expense of the period but allowed to remain in the books of accounts
Depreciation
Reasons for providing depreciation
Value decline over the years or due to wear and tear; failure to provide depreciation will affect true picture Product cost has to bear the cost of using the assets Lenders and other creditors would prefer that the firm recover the capital over the years for repayment
Depreciation Methods
Based on Usage of the Asset
Units-of-production method (e.g. Mould) Machine hours can also be used as a basis of charge
Depreciation Accounting
Allocate depreciable value of the asset systematically over the useful life of the assets Normally, depreciation is provided as a provision in P&L account Accumulated depreciation are transferred to assets once the asset is not in existence (sold or destroyed) Loss or gain on sale of assets is treated as nonoperating income or expenses Revaluation of Fixed Assets
increases the value of asset & Capital (Revaluation) reserve a part of depreciation come from P&L a/c and balance from Revaluation Reserve
M.S.Narasimhan, Indian Institute of Management Bangalore
Failure to recognise a liability often increase the profit Managers thus prefer to delay the recognition of obligation in the books
M.S.Narasimhan, Indian Institute of Management Bangalore
Different Forms of Liabilities Obligations with fixed payment dates and value
e.g. Repayment Schedule along with interest dues
Obligation arising out of advances from customers Obligation under mutually unexecuted contracts
e.g. long-term supply contract or Conbon supply
Contingent Obligations
M.S.Narasimhan, Indian Institute of Management Bangalore
Liabilities not recognised may need to be given in notes to financial statement, if the amount is large
M.S.Narasimhan, Indian Institute of Management Bangalore
Dividend to be declared has to be adjusted Contingent gains should not be recognised in the financial statements Refer AS 4 (www.icai.org)
M.S.Narasimhan, Indian Institute of Management Bangalore
Sale of receivables with recourse Promote a subsidiary, which buys material and then sell the same to the firm Promote a subsidiary, which perform R&D Take or pay contract - power purchase agreements Derivative transactions - hedging and trading Retirement Benefit and post-retirement obligations
M.S.Narasimhan, Indian Institute of Management Bangalore
Liability Recognition - Special Cases Leased Assets and Lease Rental Obligations
Operating Lease Financial or Capital Lease