Introduction of Exit Value Accounting; Exit value accounting is a form of current cost accounting which is based on valuing assets at their net selling prices (exit prices) at the balance sheet date and on the basis of orderly sales. Exit value is a maximum price a currently held asset could be sold for in the market less the transactions costs of the sale (the net realizable value for the asset). What is Economic Value Added? Definition, Calculation, and Implementation.
Know and understand the Exit Value Accounting.
This normative accounting theory was developed by Raymond Chambers and labeled as Continuously Contemporary Accounting (CoCoA). The theory relies on assessments of the exit or selling price of an entity’s liabilities and assets. These values are usually calculated under the assumption that the entity which controls. The thing being valued would be going out of business and liquidating.
By contrast, real-world values for things sold by companies which remain in business can be very different. Because these companies can afford to hold out for a good price and they are not liquidating large amounts of goods. And, alerting buyers to the fact that bargains may be obtainable with a little bit of negotiation.
In addition, the profit for a certain time should also be related to the alteration of the current exit-prices of the assets and hence. Profit should reflect changes in an organization’s capacity to adapt. The benefit of exit value accounting system is the relevance of the information it provides.
With this approach, the balance sheet becomes a huge statement of the net liquidity available to the enterprise in the ordinary course of operations. It thus portrays the firm’s adaptability, or the ability to shift its presently existing resources into new opportunities.
Meaning and Definition of Exit Value Accounting:
The exit value accounting theory was developed under the following key assumptions. Firstly, firms exist to increase the owners’ wealth. Secondly, the organization’s ability to adapt to changing circumstances is the basis of successful operations and Finally, the capacity to adapt will be best reflected by the monetary value of the organization’s assets, liabilities, and equities at balance date. Where the monetary value is based on the current exit or selling prices of the organization’s resources.
All assets in the exit-price accounting should be recorded at their current cash equivalents. Which represented by the amounts expected to be generated by selling the assets and an orderly sale determine the net-sales or exit-prices. Depreciation costs would not be realized within exit-price accounting as the model is based on the current cash equivalents.
Liabilities would be similarly valued at the amounts it would take to pay them off as of the statement date. The income statement for the period would be equal to the change in the net realizable value of the firm’s net assets occurring during the period, excluding the effect of capital transactions.
Expenses for such elements as depreciation represent the decline in net-realizable value of fixed assets during the period. The exit value accounting model is based on immediate sale. Which seems under the control of the entity although some estimation of the future may be included. As a result, the asset does not contribute to an entity’s capacity to adapt to changing circumstances if it is not ready to sell (as it does not have a sales price).
What is Fair value?
As know, Fair Value; In accounting and in most Schools of economic thought, fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset.
Introduction to Exit Value Accounting, Meaning, and Definition, #Pixabay.
Explanation of Exit Value:
Exit value is the estimated price which would be received for the sale of an asset or transfer of a liability on the open market. People determine exit values for accounting purposes and these values may be used in a variety of ways. Exit values are distinct from entry values, which reflect the price which would be paid to acquire something. Several different methods can be used to think about exit value. People can look at the present value of the asset, the current selling price, or the net realizable value.
Because times are not always favorable for sales, one important thing to consider is what the current market conditions are. If the market is poor an exit value may be low because it is determined by acting. As though something needs to be sold immediately and thus a strategic wait for a better price is not possible. Exit values can be used in the assessment of a business by a valuator. A determination of a fair asking price, and a number of other settings.
When calculating exit value, third-party evaluators are often used to avoid bias. The person who owns the asset or liability under consideration may be inclined to overvalue it or otherwise fail to estimate the value properly. While someone who has no interest in the value can make a more neutral estimate.
What is the Usefulness of Cost Accounting? The shortcomings inherent in financial accounting have made the management to realize the importance of cost accounting. Meaning: Usefulness of Cost accounting is the classifying, recording and appropriate allocation of expenditure for the determination of the costs of products or services, and the presentation of suitably arranged data for purposes of control and guidance of management. Whatever may be the type of business, it involves the expenditure on labor, materials and other items required for manufacturing and disposing of the product. Moreover, big business requires delegation of responsibility, the division of labor and specialization.
Know and understand the Usefulness of Cost Accounting to Managers.
Management has to avoid the possibility of waste at each stage. Management has to ensure that no machine remains idle, efficient labor gets due initiative, proper utilization of by-products makes and costs are properly ascertained.
Besides management, creditors and employees also benefit in numerous ways by the installation of a good costing system in an industrial organization. Cost accounting increases the overall productivity of an industrial establishment and, therefore, serves as an important tool in bringing prosperity to the nation.
How to understand the Usefulness of Cost Accounting to Manager?
The various advantages derived by management on account of a good costing system can be put as follows:
Costing helps in inventory control and cost reduction.
Costing furnishes control which management requires in respect of stock of materials, work-in-progress and finished goods. Costs can reduce in the long-run when alternates try. This is particularly important in the present-day context of global competition. Cost accounting has assumed special significance beyond cost control this way.
Costing makes comparison possible.
If the costing records are regularly kept, comparative cost data for different periods and various volumes of production will be available. It will help the management by informing future lines of action.
Provides data for periodical profit and loss accounts.
Adequate costing records supply to the management such data as may be necessary for the preparation of profit and loss account and balance sheet, at such intervals as may desire by the management. It also explains in detail the sources of profit or loss revealed by the financial accounts, thus helps in the presentation of better information before the management.
Costing results in increased efficiency.
Losses due to wastage of materials, the idle time of workers, poor supervision, etc. will disclose if the various operations involved in manufacturing a product study by a cost accountant. The efficiency can measure and costs controlled and through it, various devices can frame to increase efficiency.
Useful in periods of depression and competition.
During trade depression, the business cannot afford to have leakages which pass unchecked. The management should know where economies may seek, waste elimination and efficiency increase. The business has to wage a war for its survival. The management should know the actual cost of their products. Before embarking on any scheme of reducing the prices or giving tenders. The costing system facilitates this.
It helps in pricing decisions.
Though economic law of supply and demand and activities of the competitors, to a great extent. Determine the price of the article, the cost to the producer does play an important part. The producer can take necessary guidance from his costing records.
Helps in estimates.
Adequate costing records provide a reliable basis upon which tenders and estimates may prepare. The chances of losing a contract on account of over-rating or the loss in the execution of a contract due to under-rating can minimize. Thus, “Ascertained costs provide a measure for estimates, a guide to policy, and control over current production”.
It helps in channelizing production on the right lines.
Costing makes possible for the management to distinguish between profitable and non-profitable activities. Profits can maximize by concentrating or profitable operations and eliminating non-profitable ones.
It helps in reducing wastage.
As it is possible to know the cost of the article at every stage. It becomes possible to check various forms of waste, such as time, expense, etc., or in the use of machinery, equipment, and tools.
It helps in increasing productivity.
The productivity of material and labor requires to increase to have growth and more profitability in the organization. Costing renders great assistance in measuring productivity and suggest ways to improve it.
Understand the Usefulness of Cost Accounting to Managers.
Advantages of Cost Accounting:
For better understand the Usefulness of Cost Accounting to Manager, important advantages of Cost Accounting are as follows:
Profitable and Non-profitable Activities.
It will throw light upon those activities which bring profits and those activities which result in losses. This will be done only if the cost of each product or each job ascertain and compare with the price obtained.
Support and guide in Reducing Prices.
In certain periods it becomes necessary to reduce the price even below the total cost. This will be so when there is a depression or slump. Costs, properly ascertained, will guide management in this direction.
Information for Proper Planning.
For a proper system of Costing, it is necessary to have detailed information about the facilities available about machine and labor capacity. This helps in proper planning of work so that no section overwork and no section remains idle.
Control over all Materials.
Information about the availability of stocks of various materials and stores must be constantly available if there is a good system of Cost Accounting.
This helps in two ways. Firstly, production can be planned according to the availability of materials and fresh stocks can arrange in time when old stocks are exhausted. Secondly, loss due to carelessness or pilferage or any other mischief will know and, therefore, put down.
Decision Regarding Machine or Labor.
Some of the important questions before management can solve only with the help of information about costs.
For example, if there is the problem of replacement of labor by machinery, Cost Accounting will at least guide management in finding out what the cost of production will be if either machinery or labor use.
Expansion in Production.
Sometimes it is necessary to decide whether the production of one product or the other is to increase. This problem can also be solved only if proper information about costs is available.
Reasons for Losses Detected.
Exact causes of the existence of profits or losses will reveal by a system of Cost Accounting. For example, a concern may suffer not because the cost of production is high or prices are low but because the output is much below the capacity of the concern.
It is only Cost Accounting which will reveal this reason for the loss. It also helps in distinguishing between expenditure and loss which is necessary and that which is unnecessary, that is to say, between normal and abnormal losses.
Helps in Making Decisions.
Cost Accounting inculcates the habit of making calculations with pencil and paper before taking a decision. It will certainly check recklessness. Also, some of the silly mistakes that sometimes occur can avoid if there is a good Cost Accounting system.
To give an instance, a well-known firm once quoted for the supply of mosquito nets to the Government at a very low price. It was only after the order was obtained that the firm found that, by mistake. The price of materials was not included in the quotation.
Check on Accuracy of Financial Accounts.
A good system of Cost Accounting affords an independent and most reliable check on the accuracy of financial accounts. This check operates through the reconciliation of profits shown by Cost Accounts and by Financial Accounts. Based on various advantages of Cost Accounting. It can easily say that “a good system of costing serves as a means of control over expenditure and helps to secure economy in manufacture”.
Fixation of Prices.
In many cases, a firm can fix a price for its products based on the cost of production. Such a case, the price cannot be properly fixed if no proper figures of cost are available.
In the case of big contracts, no quotation can make unless the cost of completing that contract can ascertain. If prices fixed without costing information. The price quoted may either be too high. In which case orders cannot obtain, or it may be too low, in which case order will result in a loss.
It is a mistake on the part of any management to believe that a mere increase in sales volume will result in profits; increased sales at prices lower. Then the cost may well lead the concern to the bankrupt court. Only Cost Accounting will reveal what price will be profitable.
Understand the Measurement and Improvement of Efficiency.
The chief advantage to gain is that Cost Accounting will enable a concern too. First of all, measure its efficiency and then to maintain and improve it. This is done by suitable comparisons and analysis of the differences that may observe.
For example, if materials spent upon a pair of shoes in the Year come to $ 100 and for a similar pair of the shoe, the amount is $ 120 in next Year. It is an indication of a decline in inefficiency.
Of course, the increase may only be due to an increase in the price of materials; it may also be due to greater wastage in the use of materials or inefficiency at the time of buying. So, that unnecessarily high prices were paid. Comparisons may also be made with average figures for the whole industry (if such figures are available) and with ideal figures. Which may have been determined before the head.
In any case, it is this sort of comparison which tells management about the going up or coming down of efficiency. The study will certainly indicate the steps to take to remove the causes of inefficiency or to consolidate a factor which leads to greater efficiency.
Goodwill – Meaning, Definition, Classification, Features, Types, and Accounting Concept (In Hindi). In other words, goodwill shows that a business has value beyond its actual physical assets and liabilities. Discover the meaning and significance of goodwill in business. Learn how it adds value beyond physical, identifiable assets and liabilities. Goodwill is a company’s value that exceeds its assets minus its liabilities. This value can create from the excellence of management, customer loyalty, brand recognition, favorable location, or even the quality of employees. The number of goods is the purchase price the business minus the fair market value of the tangible assets, the intangible assets that can identify, and the liabilities obtained in the purchase.
Here are explains; What is Goodwill? First Meaning, Definition, Classification, Features, Types, and finally their Accounting Concept.
The amount in the Goodwill account will adjust to a smaller amount if there is an impairment in the value of the acquired company as of a balance sheet date or accounting treatment. Goodwill in the world of business refers to the established reputation of a company as a quantifiable asset and calculate as part of its total value when it takes over or sale. It is the vague and somewhat subjective excess value of a commercial enterprise or asset over its net worth. It is a vital component for increasing a company’s customer base and retaining existing clients.
Meaning of Goodwill:
Meaning; that may describe as the aggregate of those intangible attributes of a business that contributes to its superior earning capacity over a normal return on investment. It may arise from such attributes as favorable locations, the ability, and skill of its employees and management, quality of its products and services, customer satisfaction, etc.
Definition of Goodwill:
Definition; it is an asset that has countless definitions. Accountants, Economists, Engineers, and the Courts have to define Goodwill in several ways from their respective angles. As such, they have suggested different methods for their nature and valuation. No doubt it is an intangible real asset and not a fictitious one. “It is perhaps the most intangible of intangibles.” It is a valuable asset if the concern is profitable; on the other hand, it is valueless if the concern is a losing one. Therefore, it can state that Goodwills the value of the representative firm, judged in respect of its earning capacity.
Some definitions of goodwill are:
UK Accounting Standard on Accounting for Goodwill,
“Goodwill is the difference between the value of a business as a whole and the aggregate of the fair values of its separable net assets.”
Lord Eldon by,
“Goodwill is nothing more than the profitability that the old customers will resort to the old place.”
Dr. Canning by,
“Goodwill is the present value of a firm’s anticipated excess earnings.”
Prof. Dicksee by,
“When a man pays for goodwill he pays for something which places him in the position of being able to earn more money than he would be able to do by his own unaided efforts.”
Here, the word excess indicates some special hints as to its valuation which, perhaps, is equal to earnings attributable to the rate of return on tangible and intangible assets over the normal rate of return earns by the representative firms in the same industry. In short, the excess reveals the difference between the actual profits earns minus the normal rate of return on the capital employed.
Classification of Goodwill:
The following classification by P. D. Leake as:
Dog-Goodwills: Dogs are attaching to the persons and, hence, such customers lead to personal they which is not transferable,
Cat-Goodwills: Since cats prefer the person of the old home, similarly, such customers give rise to locality goodwills.
Rat-Goodwills: The other variety of customers has an attachment neither to the person nor to the place, which, in other words, is known as fugitive goodwills.
Other Classifications:
The following classifications below are:
1] Purchased/Acquired Goodwill:
Purchased goodwills arise when a firm purchases another firm and when payment makes more than net assets acquired for that purpose; such excess payment know as Purchase Goodwills. The same has also been corroborating by AS 10 (Accounting for Fixed-Assets).
2] Treatment of Purchased Goodwills as per AS 10 (Accounting for Fixed-Assets):
In general records in the books only when some consideration in money or money’s worth has been paying for it. Whenever a business is acquired for a price (payable either in cash or in shares) that is more than the value of the net assets of the business taken over the excess is termed Goodwill. It arises from business’s reputation, connections, trade name or reputation of an enterprise, or other intangible benefits enjoyed by an enterprise. As a matter of financial prudence, goodwill written off over a period. However, many enterprises do not write off goodwill and retain it as an asset.
3] Treatment of Purchased Goodwills as per AS 14 (Accounting for Amalgamation):
They arising on amalgamation represent a payment made in anticipation of future income and it is appropriate to treat it as an asset to amortize to income on a systematic basis over its useful life. Due to the nature of goodwill, it is frequently difficult to estimate its useful life with reasonable certainty. Such estimation is, however, made on a prudent basis. Accordingly, it is considered appropriate to amortize goodwill over a period not exceeding 5 years unless a somewhat longer period can justify.
4] Inherent/Latent Goodwill:
It is practically the reputation of a firm that has been acquiring by the business over some time. It is not purchased for cash consideration. That is why; it is not recording in the books of accounts like Purchase Goodwills. This types of goodwill depends on several factors, viz, supplying goods and services at a reasonable price to the society, etc. Accountants are not concerning about it.
5] Inherent/Internally Generated Tangible Assets — As per AS 26:
Internally generated goodwill should not recognize as an asset. In some cases, expenditure is incurring to generate future economic benefits, but it does not result in the creation of an intangible asset that meets the recognition criteria in this statement.
Such expenditure is often describing as contributing to internally generated them. Internally generated and factors affecting goodwill not recognizing as an asset because it is not an identifiable resource control by the enterprise that can measure reliably at cost.
The difference between the market value of an enterprise and the carrying amount of its identifiable net assets at any point in time may be due to a range of factors that affect the value of the enterprise. However, such a difference cannot consider representing the cost of intangible assets controlled by the enterprise.
The Features of Goodwill:
The following features below are:
It is an intangible asset, it is non-visible, but it is not a fictitious asset.
It cannot separate from the business and therefore cannot sell like other identifiable and separable assets, without disposing of the business as a whole.
The value of goodwill has no relation to the amount invested or the cost incurred to build it.
Valuation of goodwill is subjective and is highly dependent on the judgment of the valuer.
It is subject to fluctuations. The value of goodwill is an intangible may fluctuate widely according to internal and external factors of the business.
Types of Goodwill:
It is generally of two types:
Purchased, and.
Non-Purchased or Inherent.
1] Purchased Goodwill:
Purchased goodwills arise when a business concern is purchased and the purchase consideration paid exceeds the fair value of the separable net assets acquired. The purchased goodwills show on the assets side of the Balance sheet. Para 36 of AS-10 “Accounting for fixed assets” states that only purchased goodwill should recognize in the books of accounts.
2] Non-Purchased Goodwill/Inherent Goodwill:
Inherent goodwills the value of the business over the fair value of its separable net assets. It is referred to as internally generated them and it arises over some time due to the good reputation of a business. The value of goodwill may be positive or negative. Positive goodwill arises when the value of the business as a whole is more than the fair value of its net assets. It is negative when the value of the business is less than the value of its net assets.
Goodwills for Accounting:
Accounting for goodwill, the various ways in which they can account for are as follows:
Carry it as an asset and write it off over years through the profit and loss account.
Write it off against profits or accumulated reserves immediately.
Retain it as an asset with no write-off unless a permanent diminution in value becomes evident.
Show it as a deduction from shareholders funds which may authorize carry forward indefinitely.
In this connection, it is important to state that they should recognize and recorded in business only when some consideration in money or money’s worth has been paying for it.
How Goodwill entry in the Accounting Book?
It is always paying for the future. A record of Goodwill in accounting makes only when it has a value. When a business is purchasing and an additional amount is paid more than the number of assets, then the additional amount calls goodwill. It treats as an asset and the payment made for it is a capital expenditure. It treats as an intangible asset and thus depreciation is not charging. The value of goodwill decreases and increases but the fluctuations are not recording in the books.
The presence of goodwill in the books is not necessarily a sign of prosperity. A prospective purchaser would agree to make any payment for the goodwill only when he is convinced that the profit likely to accrue to him from the acquired business would be more than the normal return expects in a business of a similar nature. This means that any such payment refers to the future differential earnings and is a premium to the vendor for relinquishing his right thereto in favor of the vendee.
The goodwill of a business is the intangible value to it, independent of its visible assets because the business is a well-established one having a good reputation. But at the same time, it is obvious that goodwill is inseparable from the business to which it adds value. The value of the goodwill of the business will, therefore, be the value that a reasonable and prudent buyer would give for the business as a going concern minus the value of the tangible assets.
Departmental Accounting and Departmental Accounts both are the same. The main point explains; Meaning, Concept, Objectives, Methods, Advantages, with Principles. Modern life is very mechanical, especially in big cities. The citizens of such cities expect all the goods and services just under a single roof. Such individual accounts will help to evaluate and control the different departments. So, what is the topic we are going to discuss; Departmental Accounting: Meaning, Objectives, Methods, and Advantages…Read in Hindi.
Here explains What is Departmental Accounting? Meaning, Concept, Objectives, Methods, Advantages, with Principles.
What does mean Departmental Accounting? Departmental Accounting refers to maintaining accounts for one or more branches or departments of the company. Revenues and expenses of the department record and report separately. The departmental accounts are then consolidated into accounts of the head office to prepare financial statements of the company.
The departmental stores are the example of large-scale retail selling just under a single roof. Different departments involve in different goods to sell out. To calculate the net result of the whole organization, full-fledged trading, and profit, and loss account are to prepare. But to evaluate individual department, it will be creditworthy to prepare individual trading and profit and loss account.
For example, a textile mill which is having head office and factory. Separate accounts maintain for production facilities and then the final results are sent to the head office which then incorporates by the head office in their accounts. Maintenance of separate accounts for each branch of a bank or financial institution also falls under the category of departmental accounting. The bank then prepares its financial statement after consolidating accounts of all branches.
A departmental accounting system is an accounting information system that records the activities and financial information about the department. Departmental Accounting is a vital one for large prosperous business organizations. It controls wastage & misusing, compensates the employee in terms of profit and commission, compares performance and progress of year to year or department to department or similar type of firm to firm.
Meaning of Departmental Accounting:
Where a big business with diverse trading activities conduct under the same roof the same usually divide into several departments and each department deals with a particular kind of goods or service. For example, a textile merchant may trade in cotton, woolen and jute fabrics. The overall performance for this type of business depends, however, on departmental efficiency.
As a result, it is desirable to maintain accounts in such a manner that the result of each department can be known—together with the result as a whole. The system of accounting follows for this; the purpose knows as Departmental Accounts. This system of accounting helps the proprietors to:
Compare the results among the different departments together with the previous results thereof,
Formulate policy to extend or to develop the enterprise in the proper line; and
Reward the departmental managers based on departmental results.
The Concept of Departmental Accounting:
Departmentalization enables big firms to determine the areas needing special attention to the achievement of overall objectives. The units or departments needing more funds and more attention than others and the one(s) contributing more toward goal attainment could identify with good departmentalization. The purpose is basically to find out the performance and capability of the units or departments to make adjustments for the achievement of the firm’s objectives.
Each unit, department or subsidiary gives the free use of some of the assets of the firm and some responsibilities which can be profit-making, revenue generation or cost control. As expenses incur by the firm on behalf of all its departments, indirect expenses are to apportion to the departments, if each department is to present a financial statement or if the statement is to prepare by the company on a departmental basis.
Departmental accounting is about the preparation of final accounts taking into consideration divisional performance before the overall performance. With that system of accounting, companies that departmentalize can easily conclude as they are very well’ performing units, averagely or moderately performing units. Departmental accounting aims at separating the several activities of a business to compare results and to assist the proprietors/owners in formulating policies.
Objectives of Departmental Accounting:
The main objectives of departmental accounting are:
To check out an interdepartmental performance.
To evaluate the performance of the department with the previous period result.
The gross profit of each department can ascertain.
Methods and Techniques of Departmental Accounting:
Departmental accounts prepare in such a manner that all desired information is available and departmental profit can correctly make.
Here are two methods advocate viz:
Where the individual set of books maintains, and.
Where all departmental accounts maintain columnar- wise collectively.
They explain below;
Where Individual Set of Books Maintain:
Under this method, the accounts of each department independently maintain. The departmental results of all the departments collect and take into consideration to find out the net result of the organization.
Where All Departmental Accounts Maintain Columnar-Wise Collectively:
A Departmental Trading and Profit and Loss Account open for each department in a columnar form together with a separate column for ‘Total’ to ascertain the individual result of the different departments and also as a whole. But the Balance Sheet prepares in a combining form.
And to incorporate the purchase and sale of goods, the subsidiary books and also the nominal accounts into the ledger must rule out with extra columns for each department in arriving at the desired departmental figures to prepare departmental final accounts. If there is a larger volume of cash purchases and cash sales, the Cash Book also must maintain separate columns for cash purchases and cash sales of various departments.
Appropriateness of some of the apportionment methods – key points:
It can be a very subjective process.
The best way to apportion costs base on the greatest benefit- i.e. the department who gets the greatest benefit from the cost must take the greatest amount of the cost.
This makes the apportionment process very time consuming and expensive.
The more appropriate basis may be for depreciation to base on the book value of assets in each department.
Insurance of the assets based on the book value of the assets.
Advantages of Departmental Accounting:
The most significant advantages of departmental accounts are:
Individual results of each department can know which helps to compare the performances among all the departments, i.e., the trading results can compare.
Departmental accounts help to understand or locate the success, failure, rates of profit, etc.
It helps the management to make a proper plan of action, policies to increase profit after analyzing the results of the operation of various departments.
Departmental accounting helps us to understand which department should expand further or which one should close down as per the results of the operation.
It also helps to encourage a healthy competitive spirit among the various departments which, ultimately, helps to increase the profits of the firm as a whole.
For additions or alterations of various departments, departmental accounts help a lot as it supplies the necessary information.
As detailed information about the firm is available from departmental accounting the users of accounting information, particularly, the auditors and investors widely benefit.
Since departmental accounting presents separate departmental results, the Performance, of a successful department encourages the management, employees and increases the motivation of the staff as a whole.
The percentage of gross profit on sales and stock turnover ratio of each department helps to make a comparative study among all departments.
Departmental Accounting: Meaning, Objectives, Methods, and Advantages. Image credit from #Pixabay.
Principles of Departmental Accounting:
Preparation of final accounts of a departmentalized business requires the following:
That the gross profit or loss and the net profit or loss of each department determine separately before taking. The totals to the appropriate account or the balance sheet of the business, and.
That there should be some basis of apportioning gains and expenses to the departments or units of the business. And, that should be done as fair and equitable as possible.
Sometimes control accounts have to resort to determine the creditors’ or debtors’ value to the business. In any case, as the departmental values show. The total figures, for the business as a whole, are, to sum up.
What is the Accounting Method? An accounting method is a set of rules under which revenues and expenses are reported in financial statements. The choice of accounting method can result in differing amounts of profit being reported in the short-term. Over the long-term, the choice of accounting method has a reduced impact on profitability. So, what is the topic we are going to discuss; Top 3 Accounting Methods are very Useful with Docs.
The Concept of Accounting explain; 3 Accounting Methods.
The primary accounting methods are the accrual basis of accounting and the cash basis of accounting. Under the accrual basis, revenue is recognized when earned, and expenses are recognized when consumed. Accrual basis accounting is required for publicly-held entities, and for any organization that wants to have its financial statements audited. This is considered the most theoretically correct accounting method, but also requires a greater knowledge of accounting, and so is less likely to be used by smaller organizations.
The other main accounting method is the cash basis of accounting. Under the cash basis, revenue is recognized when cash is received from customers, and expenses are recognized when cash is paid to suppliers. This method is more likely to result in lumpy profitability in any given period since a large cash inflow or outflow can sharply alter profits.
The following Methods below are;
(A) Where Separate Set of Books is Kept:
This method is particularly followed where there are large transactions, that is, the venture is a large one and is continued for a comparatively long period.
(B) Where No Separate Set of Books is Kept:
This method is applicable where the joint venture transactions are limited and the ventures reside at two different places. Under this method, each venture will record his own transactions plus the transactions relating to other co-ventures capital whereas the other venture will prepare a Joint Venture Account and the capital of the others, that is, two accounts are prepared in each party’s ledger.
(C) Where Each Co-Venture Maintains A Record of His Own Transac¬tions (or Partial Record Method) (or Memorandum Joint Venture Method):
Under this method, each co-venture keeps a record of Joint Venture transactions in which he is involved i.e. each venture records in his own book only the transactions of the joint venture which relate to him. Each party keeps his account in his own books. He will not record the transactions of other co-venture.
Top 3 Accounting Methods are very Useful with Docs. Image credit from #Pixabay.
Accounting is the systematic recordation of the financial transactions of a business. Accounting principles are built on a foundation of a few basic concepts. The meaning of accounting can be erroneously expanded to include internal and external auditing. Internal auditing involves the testing of systems to see if they operate as intended, and so falls outside of the traditional definition of accounting. External auditing involves the examination of accounting records to see if the auditor can attest to the fairness of the information presented in the financial statements; again, this task falls outside of the traditional definition of accounting. So, what is the question we going to study; How to explain the important Concept of Accounting?
Here are explained the Concept of Accounting; Important with Basic.
These concepts are so basic that most preparers of financial statements do not consciously think of them. As stated earlier, they are regarded as self-evident. Some accounting researchers and theorists argue that certain of the present accounting concepts are wrong and should be changed. Nevertheless, in order to understand accounting as it now exists, one must understand the underlying concepts currently used. Basic accounting concepts discussed herein may not be identical to those listed by other authors or groups. However, these are the concepts that are widely accepted and used in practice by preparers of financial statements and by auditors while verifying such statements.
The important accounting concepts are as follows:
The Concept of Accrual:
According to the Financial Accounting Standards Board (US):
“Accrual accounting attempts to record the financial effects on an enterprise of transactions and other events and circumstances that have cash consequences for the enterprise in the periods in which those transactions, events, and circumstances occur rather than only in the periods in which cash is received or paid by the enterprise. Accrual accounting is concerned with the process by which cash expended on resources and activities is returned as more (or perhaps less) cash to the enterprise, not just with the beginning and end of that process. It recognizes that the buying, producing, selling and other operations of an enterprise during a period, as well as other events that affect enterprise performance often do not coincide with the cash receipts and payments of the periods.”
Realization concept and matching concept are central to accrual accounting. Accrual accounting measures income for a period as the difference between the revenues recognized in that period and the expenses that are matched with those revenues. Under accrual accounting, the period’s revenues generally are not the same as the period’s cash receipts from customers, and the period’s expenses generally are not the same as the period’s cash disbursements.
Cash-Basis Accounting:
Under cash-basis accounting, sales are not recorded until the period in which they are received in cash. Similarly, costs are deducted from sales in the period in which they are paid for cash disbursements. Thus, neither the realization nor matching concept applies in cash-basis accounting. In practice, “pure” cash-basis accounting is rare. This is because a pure cash-basis approach would require treating the acquisition of inventories as a reduction in profit when the acquisition costs are paid rather than when the inventories are sold.
Similarly, costs of acquiring items of plant and equipment would be treated as profit reductions when paid in cash rather than in the later periods when these long-lived items are used. Clearly, such a pure cash-basis approach would result in balance sheets and income statements that would be of limited usefulness. Thus, what is commonly called cash-basis accounting is actually a mixture of a cash basis for some items (especially sales and period costs) and accrual basis for other items (especially product costs and long-lived assets).
This mixture is also sometimes called modified cash-basis accounting to distinguish it from a pure cash-basis method. Cash-basis accounting is seen most often in small firms that provide services and therefore do not have significant amounts of inventories. Examples include restaurants, beauty parlors, and barber shops, and income tax preparation firms. Since most of these establishments do not extend credit to their customers, cash-basis profit may not differ dramatically from accrual-basis income. Nevertheless, cash-basis accounting is not permitted by GAAP for any type of business entity.
The Concept of Conservatism:
This principle is often described as “anticipate no profit, and provide for all possible losses.” This characterization might be viewed as the reactive version of the mini-max managerial philosophy, i.e., minimize the chance of maximum losses. The concept of accounting conservatism suggests that when and where uncertainty and risk exposure so warrant, accounting takes a wary and watchful stance until the appearance of evidence to the contrary. Accounting conservatism does not mean intentionally understating income and assets; it applies only to situations in which there are reasonable doubts.
For example, inventories are valued at the lower ends of the cost or market value. In its application to the income statement, conservatism encourages the recognition of all losses that have occurred or are likely to occur but does not acknowledge gains until actually realized. The early amortization of intangible assets and the restrictions against recording appreciation of assets have also, at least to some extent, been motivated by conservatism. Failure to recognize revenue until a sale has taken place is still another manifestation of conservatism.
The Concept of Matching:
The matching concept in financial accounting is the process of matching (relating) accomplishments or revenues (as measured by the selling prices of goods and services delivered) with efforts or expenses (as measured by the cost of goods and services used) to a particular period for which the income is being determined. This concept emphasizes which items of cost are expenses in a given accounting period. That is, costs are reported as expenses in the accounting period in which the revenue associated with those costs is reported.
For example, when the sales value of some goods is reported as revenue in a year, the cost of those goods would be reported as expenses in the same year. Matching concepts need to be fulfilled only after realization concept has been completed by the accountant: first revenues are measured in accordance with the realization concept and then costs are associated with these revenues. Costs are matched with revenues, not the other way around. The matching process, therefore, requires cost allocation which is significant in historical cost accounting.
Past (historical) costs are examined and are subjected to a procedure whereby elements of cost regarded as having expired service potential are allocated or matched against relevant revenues. The remaining elements of costs which are regarded as continuing to have future service potential are carried forward in the historical balance sheet and are termed as assets. Thus, the balance sheet is nothing more than a report of unallocated past costs waiting for the expiry of their estimated future service potential before being matched with suitable revenues.
The Concept of Realization or Recognition:
The realization or recognition concept indicates the amount of revenue that should be recognized from a given sale. Realization rules help the accountant in determining that a revenue or expense has occurred so that it can be measured, recorded, and reported in financial reports. Realization refers to inflows of cash or claims to cash (e.g., accounts, receivable) arising from the sale of goods or services.
Thus, if a customer buys Rs. 500 worth of items at a grocery store, paying cash, the store realizes Rs. 500 from the sale. If a clothing store sells a suit for Rs. 3,000, the purchaser agreeing to pay within 30 days, the store realizes Rs. 3,000 (in receivables) from the sale, provided that the purchaser has a good credit record so that payment is reasonably certain (conservatism concept). The realization concept states that the amount recognized as revenue is the amount that is reasonably certain to be realized—that is, that customers are reasonably certain to pay.
Of course, there is room for differences in judgment as to how certain “reasonably certain” are. However, the concept does clearly allow for the amount of revenue recognized to be less than the selling price of the goods and services sold. The obvious situation is the sale of merchandise at a discount—at an amount less than its normal selling price. In such cases, revenue is recorded at the lower amount, not the normal price.
The Concept of Consistency:
This concept requires that once an organization has decided on one method, it should use the same method for all subsequent transactions and events of the same nature unless it has sound reasons to change methods. If accounting methods are frequently changed, comparison of financial statements for one period with those of another period would be difficult. The consistent use of accounting methods and procedures over time will check the distortion of profit and loss account and the balance sheet and the possible manipulation of these statements. Consistency is necessary to help external users in comparing financial statements of a given firm over time and in making sound economic decisions.
The Concept of Materiality:
In law, there is a doctrine called de minimis noncurative lex, which means that the court will not consider trivial matters. Similarly, the accountant does not attempt to record events so insignificant that the work of recording them is not justified by the usefulness of the results. Materiality concept implies that the transactions and events that have immaterial or insignificant effects should not be recorded and reported in the financial statements. It is argued that the recording of insignificant events cannot be justified in terms of its subsequent poor utility to users.
For example, conceptually, a brand-new pad of paper is an asset of the entity. Every time someone writes on a page of the pad, part of this asset is used up, and retained earnings decrease correspondingly. Theoretically, it would be possible to ascertain the number of parts used pads that are owned by the entity at the end of the accounting period and to show this amount as an asset. But the cost of such an effort would obviously be unwarranted, and no accountant would attempt to do this.
Accountants take the simpler, even though less exact, course of action and treat the asset as being used up (expensed) either at the time the pads were purchased or at the time they were issued from supplies inventory to the user. Unfortunately, there is no agreement on the meaning of materiality and the exact line separating material events from immaterial events.
The decision depends on judgment and common sense. It is for the preparer of accounts to interpret what is and what is not material. Probably the materiality of an event or transaction can be decided in terms of its impact on the financial position, results of operations, changes in the financial position of an organization and on evaluation or decisions made by users.
The Concept of Full Disclosure:
The full disclosure concept requires that a business enterprise should provide all relevant information to external users for the purpose of sound economic decisions. This concept implies that no information of substance or of interest to the average investors will be omitted or concealed from an entity’s financial statements.
The Concept of Entity:
The entity concept assumes that the financial statements and other accounting information are for the specific business enterprise which is distinct from its owners. Consequently, the analysis of business transactions involving costs and revenue is expressed in terms of the changes in the firm’s financial conditions. Similarly, the assets and liabilities devoted to business activities are entity assets and liabilities.
The transactions of the enterprise are to be reported rather than the transaction of the enterprise’s owners. This concept, therefore, enables the accountant to distinguish between personal and business transactions. The concept applies to the sole proprietorship, partnership, companies, and small and large enterprise. It may also apply to a segment of a firm, such as division, or several firms, such as when inter-related firms are consolidated.
The Concept of Going-Concern:
A business entity is viewed as continuing in operation in the absence of evidence to the contrary. Because of the relative permanence of enterprises, financial accounting is formulated assuming that the business will continue to operate for an indefinitely long period in the future. The going-concern concept justifies the valuation of assets on a non-liquidation basis and it calls for the use of historical cost for many valuations.
Also, the fixed assets and intangibles are amortized over their useful life rather than over a shorter period in expectation of early liquidation. The going-concern concept leads to the proposition that individual financial statements are part of a continuous, inter-related series of statements. This further implies that data communicated are tentative and that current statements should disclose adjustments to past year statements revealed by more recent developments.
The Concept of Money Measurement:
A unit of exchange and measurement is necessary to account for the transactions of business enterprises in a uniform manner. The common denominator chosen in accounting is the monetary unit. Money is the common denominator in terms of which the exchangeability of goods and services, including labor, natural resources, and capital, are measured. Money measurement concept holds that accounting is a measurement and communication process of the activities of the firm that are measurable in monetary terms. Obviously, financial statements should indicate the money used. Money measurement concept implies two limitations of accounting.
First, accounting is limited to the production of information expressed in terms of a monetary unit: it does not record and communicate other relevant but non-monetary information. Secondly, the monetary measurement concept concerns the limitations of the monetary unit itself as a unit of measure. The primary characteristics of the monetary unit—purchasing power, or the number of goods or services that money can acquire—is of concern. Traditionally, financial accounting has dealt with this problem by stating that this concept assumes either that the purchasing power of the monetary unit is stable over time or that the changes in prices are not significant. While still accepted for current financial reporting, the stable monetary unit concept is the object of continuous and persistent criticism.
The Concept of Accounting Period:
Financial accounting provides information about the economic activities of an enterprise for specified time periods that are shorter than the life of the enterprise. Normally, the time periods are of equal length to facilitate comparison. The time period is identified in the financial statements.
The time periods are usually of twelve months. Sometimes quarterly or half-yearly statements are also issued. These are considered interim and different from annual statements. For managerial use, statements covering shorter periods such as a month or a week may also be prepared.
The Concept of Cost:
The cost concept requires that assets be recorded at the exchange price, i.e., acquisition cost or historical cost. Historical cost is recognized as the appropriate valuation basis for recognition of the acquisition of all goods and services, expenses, costs, and equities. For accounting purposes, business transactions are normally measured in terms of the actual prices or costs at the time the transaction occurs, i.e., financial accounting measurements are primarily based on exchange prices at which economic resources and obligations are exchanged.
Thus, the amounts at which assets are listed in the accounts of a firm do not indicate what the assets could be sold for. The historical cost concept implies that since the business is not going to sell its asset as such there is little point in revaluing assets to reflect current values. In addition, for practical reasons, the accountant prefers the reporting of actual costs to market values which are difficult to verify.
How to explain the important Concept of Accounting? Image credit from #Pixabay.
The Concept of Dual-Aspect:
This concept lies at the heart of the whole accounting process. The accountant records events affecting the wealth of a particular entity. The question is—which aspect of this wealth is important? Since an accounting entity is an artificial creation, it is essential to know to whom its resources belong to or what purpose they serve. It is also important to know what kind of resources it controls, e.g., cash, buildings or land.
Accounts recording systems have therefore developed so as to show two main things: (a) the source of wealth, and (b) the form it takes. Suppose Mr. X decides to establish a business and transfers Rs. 1, 00,000 from his private bank account to a separate business account.
He might record this event as follows:
Clearly, the source of wealth must be numerically equal to the form of wealth. Since they are simply different aspects of the same thing, i.e., in the form of an equation: S (sources) must equal F (forms). Moreover, any transaction or event affecting the wealth of entity must have two aspects recorded in order to maintain the equality of both sides of the accounting equation.
If the business has acquired an asset, it must have resulted in one of the following:
Some other asset has been given up.
The obligation to pay for it has arisen.
There has been a profit, leading to an increase in the amount that the business owes to the proprietor.
The proprietor has contributed money for the acquisition of the asset.
This does not mean that a transaction will affect both the source and form of wealth.
There are four categories of events affecting the accounting equation:
Both, sources and forms of wealth, increase by the same amount.
Both, sources and forms of wealth, decrease by the same amount.
Some forms of wealth increase while others decrease without any change in the source of wealth.
Some sources of wealth increase while others decrease without any change in the form in which wealth is held.
The example given above illustrates category (a) since the commencing transaction for the entity results in the source of wealth, and form of wealth, cash, both increasing from zero to Rs. 1,00,000. By contrast, X might decide to withdraw Rs. 20,000 cash from the business.
The financial position of the business entity would result in:
It is essential to appreciate why both sides of the equation decrease. By taking out cash, X automatically reduces his supply of private finance to the business by the same amount. Suppose now that Mr. X buys stocks of goods for Rs. 30,000 with the available cash. His supply of capital does not change, but the composition of the business assets does.
The two aspects of this transaction are not in the same direction but compensatory, an increase in stocks of setting a decrease in cash. Similarly, sources of wealth also may be affected by a transaction. Thus, if X gives his son Y, an Rs. 20,000 share in the business by transferring part of his own interest, the effect is as follows: If, however, X gives Y; Rs. 20,000 in cash privately and Y then puts it into the business, both sides of the equation would be affected. Y’s capital of Rs. 20,000 being balanced by an extra Rs. 20,000 in cash, X’s capital remaining at Rs. 80,000.
What is the Meaning of Ratio Analysis? Ratio analysis refers to the analysis and interpretation of the figures appearing in the financial statements (i.e., Profit and Loss Account, Balance Sheet and Fund Flow statement, etc.). So, What we discussing is – Importance, Objectives, Advantages of Ratio Analysis. It is a process of comparison of one figure against another. It enables users like shareholders, investors, creditors, government, and analysts, etc. to get a better understanding of financial statements.
The Concept of Accounting explains Ratio Analysis in the points of Importance, Objectives, Advantages.
Definition of Ratio Analysis: Define the term ratio analysis as “The systematic use of ratios to interpret the financial statements so that the strengths and weaknesses of a firm, as well as its historical performance and current financial conditions, can determine.” Ratio analysis is a very powerful analytical tool useful for measuring the performance of an organization.
Accounting ratios may just use as a symptom like blood pressure, pulse rate, body temperature, etc. The physician analyses this information to know the causes of illness. Similarly, the financial analyst should also analyze the accounting ratios to diagnose the financial health of an enterprise. In this article discussing Ratio Analysis: First Importance of Ratio Analysis, then second Objectives of Ratio Analysis, and finally Advantages of Ratio Analysis.
Importance of Ratio Analysis:
The following 10 best points of Importance of Ratio Analysis below are:
Measure General Efficiency:
Ratios enable the mass of accounting data to summarize and simplify. They act as an index of the efficiency of the enterprise. As such they serve as an instrument of management control.
Measure Financial Solvency:
Ratios are useful tools in the hands of management and other concerned to evaluate the firm’s performance over some time by comparing the present ratio with the past ones. They point out the firm’s liquidity position to meet its short-term obligations and long-term solvency.
Forecasting and Planning:
Ratio analysis is an invaluable aid to management in the discharge of its basic function such as planning, forecasting, control, etc. The ratios that are derived after analyzing and scrutinizing the past result, helps the management to prepare budgets to formulate policies and to prepare the plan of action, etc.
Facilitate Decision-Making:
It throws light on the degree of efficiency of the management and utilization of the assets and that is why it is called a surveyor of efficiency. They help management in decision-making.
Corrective Action:
Ratio analysis provides the inter-firm comparison. They highlight the factors associated with successful and unsuccessful firms. If the comparison shows an unfavorable variance, corrective actions can initiate. Thus, it helps the management to take corrective action.
Intra Firm Comparison:
Intra firm comparisons are facilitating. It is an instrument for the diagnosis of the financial health of an enterprise. It facilitates the management to know whether the firm’s financial position is improving or deteriorating by setting a trend with the help of ratios.
Act as a Good Communication:
Ratios are an effective means of communication and play a vital role in informing the position of and progress made by the business concern to the owners and other interested parties. The communications by the use of simplifying and summarize ratios are more easy and understandable.
Evaluation of Efficiency:
Ratio analysis is an effective instrument that, when properly used, is useful to assess important characteristics of business—liquidity, solvency, profitability, etc. A study of these aspects may enable conclusions to draw relating to the capabilities of the business.
Effective Tool:
Ratio analysis helps in making effective control of the business- measuring performance, control of cost, etc. Effective control is the keynote of better management. The ratio ensures secrecy.
Detection of Unfavourable Factors:
Analysis of financial statements enables the analyst to find out the soundness or otherwise of the business. If the analysis reveals financial unsoundness, the factors responsible for such unsoundness can separate and corrective action was taken without loss of time.
The Objectives of Ratio Analysis:
The main objectives of ratio analysis are to show a firm’s relative strengths and weaknesses. Other objectives of ratio analysis include comparisons for a useful interpretation of financial statements, finding solutions to unfavorable financial statements and to help take corrective measures when, in comparison to other similar firms, financial conditions and performance of the firm are unfavorable.
Ratio analysis also determines the financial condition and financial performance of a firm. Using ratio analysis allows an analyst to determine the ability of the firm to meet its obligations, the overall operating efficiency, and performance of the firm and the efficiency with which the firm is utilizing its assets in generating sales.
Ratio analysis is a tool used to conduct a quantitative analysis of information in a company’s financial statements. Ratios are calculated by individuals from current year numbers and are these numbers are then used to judge the performance of the company by comparing them to previous years, other companies, the industry or even the economy.
Extra Knowledge:
Ratio analysis can help give a quick indication of how a company is doing in certain key areas and the ratios can categorize as short-term solvency ratios, debt management ratios, asset management ratios, profitability ratios, and market value ratios. Ratio analysis should only use as the first step in financial analysis.
As it is a tool that is based on accounting information, it can limit by any distortions that arise in financial statements due to historical cost accounting and inflation. It can also be difficult to draw comparisons using ratio analysis due to differences in the analysis made by other firms.
Using ratio analysis can identify areas that may need to be investigating further. Some of the advantages of ratio analysis include that it helps in credit analysis, it can help in financial performance analysis and that it simplifies a financial statement.
The basic important advantages of Ratio Analysis are also great.
Ratio analysis is an important tool for analyzing the company’s financial performance. The following are the important advantages of the accounting ratios.
Analyzing Financial Statements:
Ratio analysis is an important technique of financial statement analysis. Accounting ratios are useful for understanding the financial position of the company. Different users such as investors, management. bankers and creditors use the ratio to analyze the financial situation of the company for their decision making purpose.
Judging Efficiency:
Accounting ratios are important for judging the company’s efficiency in terms of its operations and management. They help judge how well the company has been able to utilize its assets and earn profits.
Locating Weakness:
Accounting ratios can also use in locating the weakness of the company’s operations even though its overall performance may be quite good. Management can then pay attention to the weakness and take remedial measures to overcome them.
Formulating Plans:
Although accounting ratios are using to analyze the company’s past financial performance, they can also use to establish future trends of its financial performance. As a result, they help formulate the company’s plans.
Comparing Performance:
A company needs to know how well it is performing over the years and as compared to the other firms of a similar nature. Besides, it is also important to know how well its different divisions are performing among themselves in different years. Ratio analysis facilitates such comparison.
Main Advantages of Ratio Analysis:
Ratio analysis is widely used as a powerful tool for financial statement analysis. It establishes the numerical or quantitative relationship between two figures of a financial statement to ascertain the strengths and weaknesses of a firm as well as its current financial position and historical performance. It helps various interested parties to evaluate a certain aspect of a firm’s performance.
The following 10 best points are the principal advantages of ratio analysis:
Forecasting and Planning:
The trend in costs, sales, profits, and other facts can know by computing ratios of relevant accounting figures for the last few years. This trend analysis with the help of ratios may be useful for forecasting and planning future business activities.
Budgeting:
The budget is an estimate of future activities based on experience. Accounting ratios help to estimate budgeted figures. For example, the sales budget may prepare with the help of an analysis of past sales.
Measurement of Operating Efficiency:
The analysis indicates the degree of efficiency in the management and utilization of its assets. Different activity ratios indicate operational efficiency. The solvency of a firm depends upon the sales revenues generated by utilizing its assets.
Communication:
Ratios are effective means of communication and play a vital role in informing the position of and progress made by the business concern to the owners or other parties.
Control of Performance and Cost:
Ratios may also use for control of performances of the different divisions or departments of an undertaking as well as control of costs.
Inter-firm Comparison:
A comparison of the performance of two or more firms reveals efficient and inefficient firms, thereby enabling inefficient firms to adopt suitable measures for improving their efficiency. The best way of inter-firm comparison is to compare the relevant ratios of the organization with the average ratios of the industry.
The indication of Liquidity Position:
They help to assess the liquidity position i.e., the short-term debt-paying ability of a firm. Liquidity ratios indicate the ability of the firm to pay and help in credit analysis by banks, creditors and other suppliers of short-term loans.
The indication of Long-term Solvency Position:
They also use to assess the long-term debt-paying capacity of a firm. The long-term solvency position of a borrower is a prime concern to the long-term creditors, security analysts and the present and potential owners of a business. It measures by the leverage/capital structure and profitability ratios which indicate the earning power and operating efficiency. Ratio analysis shows the strength and weaknesses of a firm in this respect.
The indication of Overall Profitability:
The management is always a concern with the overall profitability of the firm. They want to know whether the firm can meet. It is short-term as well as long-term obligations to its creditors, to ensure a reasonable return to its owners. And, secures optimum utilization of the assets of the firm. This is possible if all the ratios are considered together.
The signal of Corporate Sickness:
A company is sick when it fails to generate a profit continuously and suffers a severe liquidity crisis. Proper ratio analysis can give the signal of corporate sickness in advance. So, timely measures can take to prevent the occurrence of such sickness.
Aid to Decision-making:
They help to make decisions like whether to supply goods on credit to a firm. Whether bank loans will make available etc.
Simplification of Financial Statements:
They make it easy to grasp the relationship between various items and helps in understanding the financial statements.
Importance, Objectives, Advantages of Ratio Analysis. Image credit from #Pixabay.
Financial Statements Analysis and Explanation; What is Analysis? An analysis is a process of breaking a complex topic or substance into smaller parts to gain a better understanding of it. Financial statements are prepared primarily for decision making. The statements are not an end in themselves but are useful in decision making. Financial analysis is the process of determining the significant operating and financial characteristics of a firm from accounting data. The profit and Loss Account and Balance Sheet are indicators of two significant factors-Profitability and Financial Soundness. Analysis of statement means such a treatment of the information contained in the two statements as to afford a full diagnosis of the profitability and financial position of the firm concerned.
The concept of Cost Accounting explains Analysis and their Explanation of Financial Statements.
Financial statement analysis is largely a study of the relationship among the various financial factors in a business as disclosed by a single set of statements and a study of the trends of these factors as shown in a series of statements. This post we will discuss the analysis and interpretation of financial statements of a company.
The main function of financial analysis is the pinpointing of the strength and weaknesses of a business undertaking by regrouping and analysis of figures contained in the financial statements, by making comparisons of various components and by examining their content. The financial statements are the best media of documenting the results of managerial efforts to the owners of the business, its employees, its customers and the public at large, and thus become excellent tools of public relations. The following topic of the analysis and explanation of the financial statements is below are;
Analysis of Financial Statements:
Analysis includes:
Breaking financial statements into simpler ones.
Regrouping.
Rearranging the figures given in financial statements, and.
Finding out ratios and percentages.
Thus all processes which help in drawing certain results from the financial statements are included in the analysis. The data provided in the financial statements should methodically classify and compare with figures of the previous period or other similar firms. Thereafter, the significance of the figures is establishing. The work of an accountant in analyzing financial statements is the same as that of a pathologist, who takes a drop of blood and analyses it to point out its various components and gives a report based on his analysis.
Similarly:
An accountant makes an analysis of each item appearing in financial statements and then reports based on his analysis. The analysis only establishes a relationship between various amounts mentioned in the Balance Sheet and Profit and Loss Account. After analyzing the financial statements, the next step is to use the mind for forming an opinion about the enterprise. This is the interpretation stage. The technique is called “Analysis and Interpretation” of financial statements.
The analysis consists of breaking down a complex set of facts or figures into simple elements. Interpretation, on the other hand, consists of explaining the real significance of these simplified statements. Interpretation includes both analysis and criticism. To interpret means to put the meaning of statement into simple terms for the benefit of a person. Interpretation is to explain in such a simple language the financial position and earning capacity of the company which may understand even by a layman, who does not know to account. The analysis and interpretation of financial statements require a comprehensive and intelligent understanding of their nature and limitations as well as the determination of the monetary valuation of the items.
The analyst must grasp what represent sound and unsound relationship reflected by the financial statements. Interpretation is impossible without analysis. “Interpretation is not possible without analysis and interpretation analysis has no value”. Analysis and interpretation act as a bridge between the art of recording and reporting financial information and the act of using this information. Analysis refers to the process of fact-finding and breaking down the complex set of figures into simple components while interpretation stands for explaining the real significance of these simplified components. Interpretation is a mental process based on analysis and criticism.
Points:
George O May points out the following uses of financial statements:
Report on stewardship.
The basis for fiscal policy.
Determine the legality of dividends.
A guide to advise dividend action.
The basis for granting of credit.
Informative for prospective investors in an enterprise.
The guide to the value of investment already made.
An aid to Government supervision.
The basis for price or rate regulation, and.
A basis for taxation.
A financial analyst can adopt the following tools for analysis of the financial statements:
Comparative Financial Statements.
Common Size Statements.
Trend Ratios or Trend Analysis.
Statement of Changes in Working Capital.
Fund Flow and Cash Flow Analysis, and.
Ratio Analysis.
Procedure for Interpretation:
Ascertain the purpose and the extent of analysis and interpretation.
Study the available data contained in financial statements.
Get additional information, if needed.
Arrange the data in a useful manner.
Prepare comparative statements, ratios, etc.
Interpret the facts revealed by the analysis.
The interpretation drawn from the analysis is presented.
Objectives of Analysis and Interpretation:
The following are the main objectives of analysis and interpretation of financial statements:
To estimate the earning capacity of the firm.
To assess the financial position of the firm.
Decide about the prospects of the firm.
To know the progress of the firm.
To judge the solvency of the firm.
Measure the efficiency of operations.
Determine the debt capacity of the firm.
To assess the financial performance of the firm.
To have a comparative study.
Help in making plans.
Analysis of financial statements should always tune to the objective. People use financial statements for satisfying their particular curiosity. Financial accounts are interpreted by different persons in different ways according to their objects. For instance, the same financial statement may be very good for one; ordinarily good for the other and worst for the third. This is because of their views and objects of interpretation differ.
For instances:
A prospective shareholder would like to know whether the business is profitable and is progressing on sound lines.
A supplier who would like to transact business with the firms may interest in the company’s ability to honor its short-term commitments.
A financier would like to satisfy the safety and reliability of the return on his investment. Thus, the object of the analysis determines the extent, depth, and nature of the analysis.
Financial Statement Analysis:
Financial performance, as a part of financial management, is the main indicator of the success or failure of the companies. The performance analysis can consider as the heart of the financial decisions. Also, Rational evaluation of the performance of the companies is essential to prepare sound financial policies and to attract potential investors. Shareholders are interested in EPS, dividend, net worth and market value per share. Management is interested in all aspects of financial performance to adopt a good financial management system and for the internal control of the company.
The creditors are primarily interested in the liquidity of the company. The government is interested in the regulatory point of view. Besides, other stakeholders such as economists, trade associations, competitors, etc are also interested in the financial performance of the company. Therefore, all the stakeholders are interested in the performance of the companies but their perspective may be different. Financial statement analysis helps to highlight the financial performance of the company. It is the process of identifying the financial strength and weakness of a firm by properly establishing the relationship between the items on the Balance Sheet and those on the Profit and Loss Account.
Extra Notes:
It is a general term referring to the process of extracting and studying information in financial statements for use in management decision making, for example, financial statement analysis typically involves the use of ratios, comparison with prior periods and budget, and other such procedures. The financial appraisal is a scientific evaluation of the profitability and strength of any business concerns.
It seeks to spotlight the significant impacts and relationships concerning managerial performance, corporate efficiency, financial strength and weakness and creditworthiness of the company. The objective of financial statement analysis is a detailed cause and effect study of the profitability and financial position. Also, Financial Analysis is the process of determining the significant operating and financial characteristics of a firm from accounting data and financial statements.
The goal of such analysis is to determine the efficiency and performance of the firm’s management, as reflected in the financial records and reports. Financial statements are such records and reports, which contain the data required for performance management. As well as, it is therefore important to analyze the financial statements to identify the strengths and weaknesses of the company.
Financial Statements Analysis and Explanation of Accounting, Image credit from #Pixabay.
Financial Accounting Limitations: The financial statements reflect a combination of recorded facts, accounting conventions, and personal judgments of the preparers. Definition of Financial Accounting concerns with providing information to external users. It refers to the preparation of general-purpose reports for use by persons outside a Business Enterprise, such as Shareholders (existing and potential), Creditors, Financial analysts, Labor unions, Government authorities, and the like. So, what we were discussing: 10 Key Financial Accounting Limitations help for Better Solution.
The Concept of Financial Accounting explains their Limitations are very helpful for Better Solution.
Financial accounting is oriented towards the preparation of financial statements which summarise the results of operations for selected periods of time and show the financial position of the business at particular dates.
Simple limitations also helpful:
Financial accounting suffers from the following limitations which have been responsible for the emergence of cost and management accounting:
Does not provide detailed cost information for different departments, processes, products, jobs in the production divisions. Similarly, separate cost data are not available for different services and functions in the administration division. Management may need information about different products, sales territories, and sales activities which are also not available in financial accounting.
Recording and accounting for wages and labor does not carry out for different jobs, processes, products, departments. This creates problems in analyzing the cost associated with different activities. This also does not provide a basis for rewarding workers and employees for above-average performance.
Does not set up a proper system of controlling materials and supplies. Undoubtedly, if material and supplies are not controlled in a manufacturing concern, they will lead to losses on account of misappropriation, misutilization, scrap, defectives, etc. They may, in turn, influence the reported net income of a business enterprise.
It is difficult to know the behavior of costs in financial accounting as expenses do not assign to the product at each stage of production. Expenses are not classified into direct and indirect, and therefore, cannot classify as controllable and uncontrollable. Control of cost which is the most important objective of all business enterprises cannot achieve with the aid of financial accounting alone.
Other limitations:
Does not possess an adequate system of standards to evaluate the performance of departments and employees working in the departments. Standardization now applies to all elements of the business. Standards need to develop for materials, labor, and overheads so that a firm can compare the work of laborers, workers, supervisors, and executives with what should have been done in an allotted period of time.
Does not provide information to analyze the losses due to various factors, such as idle plant and equipment, seasonal fluctuations in the volume of business, etc. It does not help management in taking important decisions about the expansion of business, dropping a product line, starting with a new product, alternative methods of production, improvement in product, etc. Managerial decisions about these business matters have now become vital for the survival and growth of business enterprises.
Contains historical cost information which accumulates at the end of the accounting period. This accounting does not provide day-to-day information about costs and expenses. This is the reason why much dissatisfaction has been shown with external financial reporting. Historical cost is not a reliable basis for predicting future earnings, solvency, or overall managerial effectiveness. Historical cost information is relevant but not adequate for all purposes. It is now rightly contended that current cost information should report along with historical cost information.
Ten Key Financial Accounting Limitations:
The following points highlight the ten limitations of financial accounting.
They are:
Controlling Cost Impossible:
In financial accounting control of cost is not possible since the costs are known at the end of the financial year or a specified period of time whether the expense or cost has already been incurred, i.e., nothing can be done to control either the account of expense or the cost. In other words, if it even finds that a particular cost is more, it is not possible to control it. But the same is possible only when the cost accounting system introduces.
Recording Actual Cost:
The financial accounting records the actual cost only, the historical cost of the assets. The value of assets may change, but record only the cost of acquisitions of such assets. In other words, financial accounting does not record the price fluctuations or changes in the price level. As a result, it does not present the correct information.
Difficulty in Price Fixation:
We know that the total cost of a product can obtain only when all expenses relating to a product have been incurred. That is why it is not possible to ascertain the price of the product in advance for the estimated selling price. As total cost (i.e., fixed, variable, direct, and indirect cost of a product) depends on many factors, all such factors cannot supplies by financial accounting.
Unanimity about:
Although there is IASC (International Accounting Standard Committee), the accountants differ in their opinion on the application of accounting principles in the same matter. For example, some accountants prefer to use the FIFO method for valuing inventory whereas others prefer to use LIFO or some other method; or, some accountants prefer to use the Straight-line Method of depreciation but others prefer to use Diminishing Balance Method, etc.
Technical Subject:
Since financial accounting is a technical subject, a common man can’t understand it. Without the proper knowledge of principles and conventions of accounting, it is not possible to analyze the financial data to make any financial decision. Naturally, it has got little value to a person who is not conversant with the subject.
Impossible to Evaluate:
Whether the existing accounting principle is sound/correct or not, that cannot be evaluated, i.e., actual performance cannot compare with the budget figure as we can do in the case of Standard Costing/Budgetary Control. In other words, the actual result cannot compare with the budget. Financial accounting presents only the result of the business through profit and financial positions, i.e., the rate of profitability. But the profit may affect by many outside factors that not record by financial accounting.
Maybe Manipulated:
Financial accounting may manipulate, i.e., it may present as per the desire of the management. For example, profit sometimes may reduce to evade tax and to avoid bonuses to the employees. On the contrary, more profit may show to raise fresh equity shares or to pay more dividends to attract shareholders and others.
Supply Quantitative Information:
Financial accounting supplies quantitative information only through absolute figures which do not present always the required information although they are needful to the users. But relative financial information is more important and informative.
Supplies Insufficient Information:
Financial accounting provides information about the financial activities as a whole and not individual-wise, i.e., it does not record information relating to product-wise, department-wise, etc.
Historic in Nature:
Since the financial accounting records all transactions relating to a particular period, it is rather historic in nature. In short, present financial information relating to a past period and not for the future although all financial decisions take base on past financial data.
Summary:
10 Key Financial Accounting Limitations help for Better Solution.
Controlling Cost Impossible.
Recording Actual Cost.
Difficulty in Price Fixation.
Unanimity about.
Technical Subject.
Impossible to Evaluate.
Maybe Manipulated.
Supply Quantitative Information.
Supplies Insufficient Information, and.
Historic in Nature.
10 Key Financial Accounting Limitations help for Better Solution. Image Credit from #Pixabay.
What is Deferred Revenue Expenditure? Deferred Revenue Expenditure is an expenditure which is revenue in nature and incurred during an accounting period, but its benefits are to be derived in multiple future accounting periods. Such expenditure is then known as “Deferred Revenue Expenditure” and is Written off over a period of a few years and not wholly in the year in which it is incurred. So, the question is: What type of Deferred Revenue Expenditure is added to Accounting?
The Concept of Accounting explains the type of Deferred Revenue Expenditure is added.
It will be easier to understand the meaning of deferred revenue expenditure if you know the word deferred. Which means “Holding something back for a later time”. In some cases, the benefit of revenue expenditure may be available for a period of two or three or even more years. These expenses are unusually large in amount and, essentially, the benefits are not consumed within the same accounting period. Part of the amount which is charged to profit and loss account in the current accounting period is reduced from total expenditure and rest is shown in the balance sheet as an asset.
For example,
A new firm may advertise very heavily in the beginning to capture a position in the market. The benefit of this advertising campaign will last quite a few years. It will be better to write off the expenditure in three or four years and not only in the first year. When loss of a specially heavy and exceptional nature is sustained, it can also be treated as deferred revenue expenditure. If a building is destroyed by fire or earthquake, the loss may be written off in three or four years.
The amount not yet written off appears in the balance sheet. But, it should be noted, loss resulting from transactions entered into. Such as a speculative purchase or sale of a large number of commodities. Cannot be treated as deferred revenue expenditure. Only loss arising from circumstances beyond one’s control can be so treated. Suppose, at the end of 2010-2011, a company owed $ 1, 00,000, expressed in rupees at Rs 48, 00,000. Suppose in 2011-2012 the rupee was devalued to Rs 49.50 per dollar raising the liability in terms of rupees to Rs 49, 50,000. This increase is a loss unless it relates to a specific asset; it can be treated as deferred revenue expenditure and spread over a few years.
Then it is called deferred revenue expenditure. For example:
Preliminary expenses at the time of formation of new limited companies.
Heavy advertisement expenses.
Heavy Research and development expenses.
Commission on the issue of shares and debentures.
Major repair expenses.
Discount on issue of shares or debentures, and.
Expenses relating to shifting the business premises from one place to another place.
Understand Another Example,
Let’s suppose that a company is introducing a new product to the market and decides to spend a large amount on its advertising in the current accounting period. This marketing spend is supposed to draw benefits beyond the current accounting period. It is a better idea not to charge the entire amount in the current year’s P&L Account and amortize it over multiple periods.
The image shows a company spending 150K on advertising. Which is unusually large as compared to the size of their business. The company decides to divide the expense over 3 yearly payments of 50K. Each as the benefits from the spend is expected to be derived for 3 years.
What type of Deferred Revenue Expenditure is added to Accounting? Image credit from #Pixabay.
