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ACCOUNTING BASICS

1. Balance Sheet A balance sheet or statement of financial position is a summary of the financial balances of a business organization (proprietorship, partnership or corporation). A balance sheet summarizes an organization or individual's assets, equity and liabilities at a specific point in time.

Assets

Liabilities

Equity

2. Assets a. Current Assets: It is an asset, which can either be converted to cash or used to pay current liabilities within 12 months. For example: i. Cash and Cash equivalents Cash and cash equivalents are the most liquid assets found within the asset portion of a company's balance sheet. Cash equivalents are assets that are readily convertible into cash, such as money market holdings, short-term government bonds or Treasury bills1, marketable securities, preferred stock acquired before its redemption date and commercial paper. Another important condition a cash equivalent need to satisfy is that the investment should have insignificant risk of change in value; thus, common stock cannot be considered cash equivalent, but preferred stock acquired shortly before its redemption date can be. ii. Short-term investments iii. Accounts receivable Accounts receivable are a legally enforceable claim for payment to a business by its customer/ clients for goods supplied and/or services rendered in execution of the customers order. These are generally in the form of invoices raised by the business and delivered to the customer for payment within an agreed time frame. Accounts receivable are shown in the balance sheet as asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. These may be distinguished from notes receivable, which are debts created through formal legal instruments called promissory notes.

ACCOUNTING BASICS

iv. Stock inventory v. The portion of prepaid liabilities, and vi. Prepaid expenses Prepaid expenses are future expenses that a business pays for in advance before it actually incurs them, such as insurance coverage for next year or rent paid for next month. Before prepaid expenses are consumed, businesses consider them assets that can provide future benefits. Prepaid expenses expire either with the passage of time or through use and consumption.

b. Non Current Assets or Long Term Assets or Fixed Assets: Assets such as property, plant, and equipment (PP&E), are a term used in accounting for assets and property that cannot easily be converted into cash. While these non-current assets have value, they are not directly sold to consumers and cannot be easily converted to cash. It is pertinent to note that the cost of a fixed asset is its purchase price, including import duties and other deductible trade discounts and rebates. In addition, cost attributable to bringing and installing the asset in its needed location and the initial estimate of dismantling and removing the item if they are eventually no longer needed on the location. For example, assets for a Baking Firm can be: Current Assets Non Current Assets

Inventory (Flour, Yeast), Value of sales Baking ovens, Motor vehicles, Cash owed to a firm via credit (debtors and registers, Land & Buildings, Furniture and accounts receivable), Cash in bank Office equipment, plant and machinery. i. Property, plant and equipment PP&E is a term used in accounting for assets and property that cannot easily be converted into cash. This can be compared with current assets such as cash or bank accounts, which are described as liquid assets. In most cases, only tangible assets are referred to as fixed ii. Investment property, such as real estate held for investment purposes Real estate is "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of

ACCOUNTING BASICS

this nature; an interest vested in this; (also) an item of real property; (more generally) buildings or housing in general. Also: the business of real estate; the profession of buying, selling, or renting land, buildings or housing. iii. Intangible assets Intangible assets have been argued to be one possible contributor to the disparity between company value as per their accounting records, and company value as per their market capitalization. iv. Financial assets v. Investments accounted for using the equity method In finance, investment is putting money into an asset with the expectation of capital appreciation, dividends, and/or interest earnings. This may or may not be backed by research and analysis. vi. Biological assets, which are living plants or animals. vii. Deferred Tax Asset An asset on a company's balance sheet that may be used to reduce any subsequent period's income tax expense. Deferred tax assets can arise due to net loss carryovers, which are only recorded as assets if it is deemed more likely than not that the asset will be used in future fiscal periods. It must be determined that there is more than a 50% probability that the company will have positive accounting income in the next fiscal period before the deferred tax asset can be applied. If, for example, a company has a deferred tax asset of $25,000 on its balance sheet, and then the company earns $75,000 in before-tax accounting income, accounting tax expense will be applied to $50,000 ($75,000 - $25,000), instead of $75,000. 3. Liabilities In financial accounting, a liability is defined as an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future. Simply put, "a liability is anything that takes money out of your pocket. A liability is defined by the following characteristics:

Any type of borrowing from persons or banks for improving a business or personal income that is payable during short or long time;

ACCOUNTING BASICS

A duty or responsibility to others that entails settlement by future transfer or use of assets, provision of services, or other transaction yielding an economic benefit, at a specified or determinable date, on occurrence of a specified event, or on demand; A duty or responsibility that obligates the entity to another, leaving it little or no discretion to avoid settlement; and, A transaction or event obligating the entity that has already occurred. a. Current Liabilities A company's debts or obligations those are due within one year. Current liabilities appear on the company's balance sheet and include short-term debt, accounts payable, accrued liabilities and other debts. Essentially, these are bills that are due to creditors and suppliers within a short period of time. Normally, companies withdraw or cash current assets in order to pay their current liabilities. i. Accounts payable Accounts payable is money owed by a business to its suppliers shown as a liability on a company's balance sheet. It is distinct from notes payable liabilities, which are debts created by formal legal instrument documents.

b. Non-current Liabilities i. Long-Term Debt. This represents money the company has borrowed, typically by issuing bonds, that doesn't need to be paid back for several years. ii. Provisions for warranties or court decisions In financial accounting, a provision is an account, which records a present liability of an entity to another entity. The recording of the liability affects both the current liability side of an entity's balance sheet as well as an appropriate expense account in the entity's income statement. iii. Financial liabilities (excluding provisions and accounts payable), such as promissory notes and corporate bonds A promissory note is a legal instrument (more particularly, a financial instrument), in which one party (the maker or issuer) promises in writing to pay a determinate sum of money to the other (the payee). iv. Liabilities and assets for current tax v. Deferred tax liabilities and deferred tax assets

ACCOUNTING BASICS

Deferred tax is an asset that may be used to reduce any subsequent period's income tax expense. Deferred tax assets can arise due to net loss carryovers, which are only recorded as assets if it is deemed more likely than not that the asset will be used in future fiscal periods. vi. Deferred Income tax A liability recorded on the balance sheet that results from income already earned and recognized for accounting, but not tax, purposes. In other words, this would mean that income has been realized, but the tax on that income has not. For example, let's say that the amount of tax that a business should pay is $100,000, but due to tax laws, the amount actually payable for this fiscal year is $85,000. The additional $15,000 would be a deferred income tax liability that the company would need to pay later on.

vii. Unearned revenue for services paid for by customers but not yet provided 4. Equity The net assets, which are shown by the balance sheet equals the third part of the balance sheet, and are known as the shareholders' equity. a. Issued capital and reserves attributable to equity holders of the parent company (controlling interest) b. Non-controlling interest in equity In accounting, minority interest (or non-controlling interest) is the portion of a subsidiary corporation's stock that is not owned by the parent corporation. The magnitude of the minority interest in the subsidiary company is generally less than 50% of outstanding shares, otherwise the corporation would generally cease to be a subsidiary of the parent. 5. Net Book Value Net book value of an asset is basically the difference between the historical cost of that asset and its associated depreciation. 6. Depreciating a fixed asset Depreciation is, simply put, the expense generated by the uses of an asset. It is the wear and tear of an asset or diminution in the historical value owing to usage. Further to this; it is the cost of the asset less any salvage value over its estimated useful life. It is an expense because it is matched against the revenue generated through the use of the same asset.

ACCOUNTING BASICS

Depreciation is usually spread over the economic useful life of an asset because it is regarded as the cost of an asset absorbed over its useful life. Invariably the depreciation expense is charged against the revenue generated through the use of the asset. 7. Depreciation In accountancy, depreciation refers to two aspects of the same concept: 1. The decrease in value of assets (fair value depreciation), and 2. The allocation of the cost of assets to periods in which the assets are used (depreciation with the matching principle). The former affects the balance sheet of a business or entity, and the latter affects the net income that they report. Depreciation is systematic allocation the cost of a fixed asset over its useful life. It is a way of matching the cost of a fixed asset with the revenue (or other economic benefits) it generates over its useful life. Without depreciation accounting, the entire cost of a fixed asset will be recognized in the year of purchase. This will give a misleading view of the profitability of the entity. The observation may be explained by way of an example. Example ABC LTD purchased a machine costing $1000 on 1st January 2001. It had a useful life of three years over which it generated annual sales of $800. ABC LTD's annual costs during the three years were $300. If ABC LTD expensed the entire cost of the fixed asset in the year of purchase; its income statement would present the following picture the end of the three years: Income Statement 2001 $ Sales Cost of Sales Fixed Asset Cost Net Profit (Loss) 800 (300) 2002 $ 800 (300) 2003 $ 800 (300) 500

(1000) (500) 500

As you can see, income statement of ABC LTD shows net loss in the first year even though it earned the same revenue as in the subsequent years. Conversely, no fixed asset will appear in ABC LTD's balance sheet although it had earned revenue from the machine's use through out its useful life of 3 years. If ABC LTD, instead of charging the entire cost of fixed asset at once, depreciates the capital expenditure over its useful life, its income statement and balance sheet would present the following picture at the end of the three years:

ACCOUNTING BASICS Income Statement 2001 $ Sales Cost of Sales Fixed Asset Cost Net Profit (Loss) Balance (Extract) Sheet 800 (300) (333.3) 166.7 2001 $ Fixed Assets Accumulated Depreciation Net Book Value 1,000 (333.3) 666.7 2002 $ 800 (300) (333.3) 166.7 2002 $ 1,000 (666.7) 333.3 2003 $ 800 (300) (333.3) 166.7 2003 $ 1,000 (1,000) Nill

As you can see, the process of relating cost of a fixed asset to the years in which the economic benefits from its use are realized creates a more balanced view of the profitability of the company. Hence, depreciation is an application of the matching principle whereby costs are matched to the accounting periods to which they relate rather than on the basis of payment. Accounting Entry Double entry involved in recoding depreciation may be summarized as follows: Debit Credit Depreciation Expense (Income Statement) Accumulated Depreciation (Balance Sheet)

Every accounting period, depreciation of asset charged during the year is credited to the Accumulated Depreciation account until the asset is disposed. Accumulated depreciation is subtracted from the asset's cost to arrive at the net book value that appears on the face of the balance sheet. Using the last example, following double entries will be recorded in respect of depreciation: Depreciation Expense Account Debit 2001 2002 Accumulated Depreciation Accumulated Depreciation $ 333.3 333.3 2001 2002 Credit Income Statement Income Statement $ 333.3 333.3

ACCOUNTING BASICS 2003 Accumulated Depreciation 333.4 2003 Income Statement 333.4

Accumulated Depreciation Account Debit 2001 Balance c/d $ 333.3 333.3 2002 Balance c/d 666.6 2002 2002 666.6 2003 Balance c/d 1000 2003 2003 1000 Balance b/d Depreciation Expense Balance b/d Depreciation Expense Credit 2001 Depreciation Expense $ 333.3 333.3 333.3 333.3 666.6 666.6 333.4 1000

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