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Accounting for Managers
key areas in financial accounting where 2 .Executive Summary The financial statements are used for providing information on the financial position of a company to various stakeholders. This makes it necessary for the financial statements to be accurate and verifiable and the essay discourses some judgement is required to be applied. who are associated to the company directly or indirectly. These statements help them to make decisions about their future association with the company.
2008. three factors go into consideration. Therefore. Therefore depreciation is charged as a non-cash expense. Most importantly. government and statutory authorities for taxes and other compliance of various provisions of law. its estimated useful life and residual value realisable at the end of life period. This means that the information should not be provided in a way to influence the decision or judgement to receive a favourable outcome (Abraham et al.11). Certain judgements and assessments need to be applied by the management of the enterprise while preparing the financial statements. these financial statements sometimes do not represent true or complete picture. the income statement also known as the profit and loss statement summarises the revenues and expenditures incurred during a specified period (year / half year / quarter) and statement of cash flows. reliable and comparable. However. While calculating the depreciation charge. one of the areas the management’s estimation and judgement is applied is the useful life and the residual value of various assets used in the operation of the company.The financial statements of an enterprise comprises of primarily the balance sheet that summarises the assets. the information provided should be unbiased. Understanding of 3 . Therefore.342-343). There are various stakeholders who are interested in the financial statements. banks & financial institutions who have lent money. performance and changes in financial position of an enterprise to enable stakeholders in taking decisions or forming opinion keeping in view the kind of relationship they have with the enterprise. relevant. pp. A shorter expected life would increase depreciation charge and consequently lower the profit and vice versa. If these assets are used to generate economic benefits during a given financial year.). 2008. the cost of the asset. the objective of financial statements is to provide information about the financial position. Fixed assets and charging of depreciation Most assets depreciate on usage and have to be replaced at the end of its useful life. then cost of their use must also be reported (Abraham et al. trade creditors who have supplied material to the organisation. Some of the areas that require such considerations are discussed below. Stakeholders can be shareholders. p. It is generally acknowledged that most of the users are nonaccountants and therefore necessary for the information to be understandable. liabilities and shareholder’s equity at the end of a year or a specified period (quarter / half year etc.
Abraham. a company might undertake revaluation of assets.69).69). has depreciated more. a company using the Usage based depreciation method will show profits in its initial years (p. the Reducing balance method uses a depreciation rate that is applied to the book value at the start of each period. there will be creation of revaluation reserve showing better financials. p. as per assessment. who will not be able to judge on what basis the depreciation has be calculated (Abraham et al. except land. if the valuation has increased. One of the methods to calculate depreciation is the Straight-line method. Depreciation can also be calculated using the Usage based method where depreciation is charged each year based on the usage of the asset (Abraham et al. 2008. which will reduce the profits. This impacts the readers' understanding of the financial statements. it is therefore important to include an amount representing the depreciation of the fixed assets during that period. Another method. 2008. it could result in acquisitions. In order to determine the expenses for a given period. In case of 4 . Valuation of assets Though an annual depreciation is charged on the fixed assets. According to the matching principle in accounting.the classes of assets and rationality of the applied depreciation is necessary to understand the reliability of the reported profit or loss figures. due to its simplicity. If the value of assets. However. It calculates depreciation based on the estimated useful life of the asset and not on its usage. for instance. In case the management chooses not to revalue the assets. p. particularly in the case of land. Glynn. the revenues of a particular period should be matched with the corresponding expenses.70). companies use different methods for computing depreciation and each method results in a different value of depreciation and consequently a different amount of profit or loss. Murphy & Wilkinson (2008) stated that. 2008. the company will have to provide more depreciation or write off.344). The revaluations of assets being reflected in the balance sheet obviously causes a degree of subjectivity (Abraham et al. Definitely the method selected has a considerable impact on financial figures. the cost of assets shown in the books may not represent the realistic or realisable value. Unless the asset is sold its true value cannot be estimated. This method is most commonly used. p. Therefore in order to have a realistic value. On the other hand. The management can choose any of these methods to calculate the depreciation on their assets. This brings us to another area of judgement that has impact on the financial statements.
Even though there are methods to value intangible assets. a portion of the original cost to be expensed every year. Intangibles with an indefinite life (such as goodwill) cannot be liquidated. Accounting of intangibles The expenditure of a company on Research and Development. discrepancies or inability to pay. these sundry debtors accumulate due to disputes. but can be accounted by estimating their residual value (pp. The company therefore has to make allowances for doubtful debts based on an assessment of recoverability.. it is critical to know the recoverability of sundry debtors and the company’s policy on making adequate provisions. Credit transactions create accounts receivables or sundry debtors. and management takes a call on the value to be associated with the asset. pp. Hence. which add value to the business is accounted under intangible assets.land. Thus. Businesses can operate on cash basis or credit basis. if the company is not sincere and does not make adequate provision could result in overstating the profit. 95-107). 10-12).. It is suggested that. “. management can take this as an advantage to show profitability. This calls for a judgement on the financial position based on additional information. Wyatt and Abernethy (2008) state that. an intangible asset can be capitalised or charged to the profit and loss account as an expense. patents and copyrights. therefore they should be accounted for in the financial statements. Recoverability of receivables The current assets of the company are the assets that will get converted to cash normally within 12 months of the balance sheet date.. which may or may not correspond to the stage of completion. the value can be estimated by the professionals. This. But there are certain assets that cannot be evaluated easily. Therefore. Over a period. Recognition of revenues in construction contracts The revenues from a construction contract may be realised as per agreed payment terms.the recognition and measurement of intangible assets must be evaluated on a case by case basis” (Quilligan 2008. these methods still involve considerable amount of estimates. any kind of investment involves expenditure and that stands true for intangible assets as well. Intangibles with a fixed life (such as contracts) can be liquidated against income over the lifetime of the asset. The stage of 5 . licensing contracts and goodwill etc.
resulting in closing stocks and requirement of valuation thereof. Valuation of inventory Goods sold or used during an accounting period may not exactly correspond to the goods bought or produced. Significant estimation is required in determining the stage of completion. the assumption is that in the sale or manufacture. the analyser of financial statements has to look into the methodology of valuation of inventory to have a fairer understanding of the true nature of reported profit or loss. incurring of which is dependent on happening or 6 . This method helps them to spread the cost over specific period of time. There are three methods of inventory valuation. The third method is an average of the two. This judgement has impact on the stated profit or loss of the company. Accordingly. If FIFO method is used. the cost is taken in the order from the oldest. Therefore. It simply means that the company delays the recognition of expenses by recording the expense as long-term assets.completion method is used to represent the contract revenue and expenses in the profit and loss statement. Therefore. cost of oldest material is taken. the cost from last and backwards is taken. wherein the company assumes the oldest stocks are used first. In Last-in-first-out (LIFO) method. Policy on capitalisation of assets The company has to make judgements on the capitalisation policy of its expenditure as assets. in calculation of cost. The stage of completion is determined by the proportion of contract costs incurred for the work performed to date. the latest stocks are used first and go backward. These estimations are based on past experiences and evaluation by the experts. This is reverse in LIFO. in calculating the cost of goods sold. First-in-first-out (FIFO). there is a likelihood of overstating the profit as against current sales revenues. The third method is an averaging method. the contract costs and expenses. The decision lies with the company as to what level they want to make an expense an asset. to the estimated total contract costs. here the average cost of the total stock is recalculated each time a new stock arrives. Contingent liabilities Contingent liabilities are those liabilities.
. Probable. there are situations where the company has to make estimations in accounting in order to avoid acquisitions. Making adjustments in the depreciable life of an asset to reduce profits. in order to overstate or understate the net income. However. Liquidated damages for not meeting agreed performance parameters of machinery supplied will becomes payable only if the machinery supplied does not meet the parameters. These liabilities needed to be recognised in the company's balance sheet. or remote are used to describe the likelihood of loss. A footnote generally provides their details. The guarantee enforcement will depend on happening of certain events. A guarantee given by the company to any other person or entity is also a contingent liability. to reflect a better position in the financial statements. are some of the ways the management attempts to mislead stakeholders with its accounting. under-accruing expenses.not happening of an event or a set of events. 7 . inconsistent inventory valuation methods etc.e. Management attempts to use these areas of judgement to their favour. but also figures that are based on estimation and judgement. like in the case of understating their fixed assets. for instance lawsuits. the liability is contingent on happening if that situation arises. The ability to estimate the happening of the event(s) is important to assess the likelihood of incurring the liability. i. reasonably possible. This leaves us to understand that a company's financial statements are prepared with not just fact and figures that are verifiability. under assessment of contingent liabilities.
2. 4th edn. Australian Accounting Review. 'Accounting for Intangible investments'.no. L 2008. 'Intangible Assets identification and valuation under IFRS 3'. London.pp. Quilligan. vol.no.Reference list Abraham. Murphy. B 2008. Wyatt. A. Accounting For Managers.pp. 10-12. vol. J. 3. M & Wilkinson.M 2008.Cengage Learning EMEA. Glynn. 38. 18. A & Abernethy. 95-107. 8 . Accountancy Ireland.