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