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Module 1

1. State the difference between Accounting Vs. Book Keeping.

Book keeping differs from accounting in following respects:


Basics of distinction Book keeping Accounting
Scope Book keeping involves: Accounting in addition to
book keeping involves-
1.) Identifying
summarizing the classified
transactions
2.) Measuring the transactions, analyzing the
identified transactions summarized results,
3.) Recording the interpreting the analysed
measured transactions results and communicating
4.) Classifying the the interpreted information
recorded transactions to the interested parties.
Stage Book keeping is primary stage. Accounting is the
secondary stage. It stars
where book keeping ends.
Basic objective Basic objective of book keeping is Basic objective of
to maintain systematic records of accounting is to ascertain
financial transactions. net results to operations
and financial position and
to communicate
information to the
interested parties.
Who performs It is performed by junior staff. It is performed by senior
staff.
Knowledge level Book keeper is not required to Accountant is required to
have higher level of knowledge have higher level of
than that of accountant. knowledge than that of
book keeper.
Analytical skills The book keeper may or may not An accountant is required
possess any analytical skill. to possess analytical skill.
Nature of job The job of book keeper is often The job of an accountant is
routine and clerical in nature. analytical in nature.
Designing of accounting It does not cover designing of It covers designing of
system accounting system. accounting system.
Supervising and checking The book keeper does not An accountant supervises
supervise and check the work of and checks the work of a
an accountant. book keeper.

2. Name and explain various accounting concepts.

Following are the various accounting concepts that have been discussed in the
following sections :
Business entity concept
Money measurement concept
Going concern concept
Accounting period concept
Accounting cost concept
Duality aspect concept
Realisation concept
Accrual concept
Matching concept

Business entity concept

This concept assumes that, for accounting purposes, the business enterprise and its
owners are two separate independent entities. Thus, the business and personal
transactions of its owner are separate. For example, when the owner invests money in
the business, it is recorded as liability of the business to the owner. Similarly, when
the owner takes away from the business cash/goods for his/her personal use, it is not
treated as business expense. Thus, the accounting records are made in the books of
accounts from the point of view of the business unit and not the person owning the
business. This concept is the very basis of accounting.

Money measurement concept


This concept assumes that all business transactions must be in terms of money, that
is in the currency of a country. In our country such transactions are in terms of rupees.
Thus, as per the money measurement concept, transactions which can be expressed in
terms of money are recorded in the books of accounts.

Going concern concept


This concept states that a business firm will continue to carry on its activities for an
indefinite period of time. Simply stated, it means that every business entity has
continuity of life. Thus, it will not be dissolved in the near future. This is an important
assumption of accounting, as it provides a basis for showing the value of assets in the
balance sheet; For example, a company purchases a plant and machinery of
Rs.100000 and its life span is 10 years.
According to this concept every year some amount will be shown as expenses and the
balance amount as an asset. Thus, if an amount is spent on an item which will be used
in business for many years, it will not be proper to charge the amount from the
revenues of the year in which the item is acquired. Only a part of the value is shown
as expense in the year of purchase and the remaining balance is shown as an asset.

Significance

The following points highlight the significance of going concern concept;


This concept facilitates preparation of financial statements.
On the basis of this concept, depreciation is charged on the fixed asset.
It is of great help to the investors, because, it assures them that they
will continue to get income on their investments.
In the absence of this concept, the cost of a fixed asset will be treated as an expense
in the year of its purchase.
A business is judged for its capacity to earn profits in future.

Accounting period concept

All the transactions are recorded in the books of accounts on the assumption that
profits on these transactions are to be ascertained for a specified period.
This is known as accounting period concept. Thus, this concept requires that a balance
sheet and profit and loss account should be prepared at regular intervals. This is
necessary for different purposes like, calculation of profit, ascertaining financical
position, tax computation etc.
Further, this concept assumes that, indefinite life of business is divided into parts.
These parts are known as Accounting Period. It may be of one year, six months, three
months, one month, etc. But usually one year is taken as one accounting period which
may be a calender year or a financial year.
As per accounting period concept, all the transactions are recorded in the books of
accounts for a specified period of time.

Accounting cost concept

Accounting cost concept states that all assets are recorded in the books of accounts at their
purchase price, which includes cost of acquisition, transportation and installation and not at
its market price. It means that fixed assets like building, plant and machinery, furniture, etc
are recorded in the books of accounts at a price paid for them. For example, a machine was
purchased by XYZ Limited for Rs.500000, for manufacturing shoes. An amount of Rs.1,000
were spent on transporting the machine to the factory site. In addition, Rs.2000 were spent on
its installation. The total amount at which the machine will be recorded in the books of
accounts would be the sum of all these items i.e. Rs.503000. This cost is also known as
historical cost. Suppose the market price of the same is now Rs 90000 it will not be shown at
this value. Further, it may be clarified that cost means original or acquisition cost only for
new assets and for the used ones, cost means original cost less depreciation. The cost concept
is also known as historical cost concept. The effect of cost concept is that if the business
entity does not pay anything for acquiring an asset this item would not appear in the books of
accounts. Thus, goodwill appears in the accounts only if the entity has purchased this
intangible asset for a price.
Significance
This concept requires asset to be shown at the price it has been acquired, which can be
verified from the supporting documents.
It helps in calculating depreciation on fixed assets.
The effect of cost concept is that if the business entity does not pay anything for an asset, this
item will not be shown in the books of accounts.
Dual aspect concept
Dual aspect is the foundation or basic principle of accounting. It provides the very basis of
recording business transactions in the books of accounts. This concept assumes that every
transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides.
Therefore, the transaction should be recorded at two places. It means, both the aspects of the
transaction must be recorded in the books of accounts. For example, goods purchased for
cash has two aspects which are (i) Giving of cash (ii) Receiving of goods. These two aspects
are to be recorded.
Thus, the duality concept is commonly expressed in terms of fundamental accounting
equation :
Assets = Liabilities + Capital
The above accounting equation states that the assets of a business are always equal to the
claims of owner/owners and the outsiders. This claim is also termed as capital or owners
equity and that of outsiders, as liabilities or creditors equity. The knowledge of dual aspect
helps in identifying the two aspects of a transaction which helps in applying the rules of
recording the transactions in books of accounts. The implication of dual aspect concept is that
every transaction has an equal impact on assets and liabilities in such a way that total assets
are always equal to total liabilities.

Realisation concept

This concept states that revenue from any business transaction should be included in the
accounting records only when it is realised. The term realisation means creation of legal right
to receive money. Selling goods is realisation, receiving order is not.
In other words, it can be said that :
Revenue is said to have been realised when cash has been received or right to receive cash on
the sale of goods or services or both has been created.
Let us study the following examples :
(i) N.P. Jeweller received an order to supply gold ornaments worth Rs.500000. They supplied
ornaments worth Rs.200000 up to the year ending 31st December 2005 and rest of the
ornaments were supplied in January 2006.
(ii) Bansal sold goods for Rs.1,00,000 for cash in 2006 and the goods have been delivered
during the same year.
(iii) Akshay sold goods on credit for Rs.50,000 during the year ending 31st December 2005.
The goods have been delivered in 2005 but the payment was received in March 2006.

Accrual concept

The meaning of accrual is something that becomes due especially an amount of money that is
yet to be paid or received at the end of the accounting period. It means that revenues are
recognised when they become receivable. Though cash is received or not received and the
expenses are recognized when they become payable though cash is paid or not paid. Both
transactions will be recorded in the accounting period to which they relate. Therefore, the
accrual concept makes a distinction between the accrual receipt of cash and the right to
receive cash as regards revenue and actual payment of cash and obligation to pay cash as
regards expenses.

Matching concept

The matching concept states that the revenue and the expenses incurred to earn the revenues
must belong to the same accounting period. So once the revenue is realised, the next step is to
allocate it to the relevant accounting period. This can be done with the help of accrual
concept.

3. Discuss qualitative characteristics of accounting information.

Qualitative characteristics are the attributes that make the information provided in accounting
statements useful to users. The four principal qualitative characteristics are:

Qualitative characteristics of accounting Information

Understandabilit
y Relevance Reliability Comparability

Understandability:- An essential quality of the information provided in accounting


statements is that is readily understandable by the users. For this purpose, users are assumed
to have a reasonable knowledge of business and economic activities and accounting and a
willingness to study the information with reasonable diligence. Information about complex
matters should be included in financial statements.

Relevance:- To be useful, information must be relevant to the decision making needs of


users. Information has the quality of relevance when it influences the economic decisions of
the users by helping them to evaluate past, present or future events or confirming or
correcting their past evaluation. The productive and confirmatory roles of information are
interrelated.

Materiality:- The relevance of information is affected by its nature and materiality.


Materiality depends on the size of the item or error judge in the particular circumstances of its
omission or mis-statement. Thus materiality provides a threshold or a cut-off point rather than
being a primary qualitative characteristics which information must have if it is to be useful.
Reliability:- To be useful, information must also be reliable. Information has the quality of
reliability when it is free from material error and bias. Reliability of the financial statements
is dependent on the following:
i. Faithful representation:- To be reliable, information must represent faithfully the
transactions and other events which either purports to represent or could reasonably be
expected to represent.
ii. Sequence over form:- If information is to represent faithfully the transactions and other
events that is purports to represent, it is necessary that they are accounted for and presented in
accordance with their substance and economic reality and not merely by their legal forms.
iii. Neutrality:- To be reliable the information contained in financial statements must be
neutral. If the financial statements are not neutral they influence the making of a decision or
judgement in order to achieve a predetermined result or outcome.
iv. Prudence:- The preparersof financial statements have to contend with uncertainties that
inevitably surround many events and circumstances. Such uncertainties are recognized by the
disclosure of their nature and extent and by exercise of prudence in the financial statements.
Prudence is the inclusion of a degree of caution.
v. Completeness:- To be reliable the information in the financial statements must be
complete within the bounds of materiality and cost.

Comparability:- Users must be able to compare the financial statements of an enterprise


through time to identify trends in its financial position and performance. Users must also be
able to compare the financial statements of different enterprises in order to evaluate their
relative financial position, performance and changes in financial position.

4. What is a role of accounting? Explain the steps involved in accounting.

Role of accounting is as follows:-

Finding out various balances: Systematic recording of business transactions


provides vital information about various balances like cash balance, bank balance,
etc.

Providing knowledge of transactions: Systematic maintenance of books provides


the details of every transactions.

Ascertaining net profit or loss: Summarisation in form of Profit and Loss Account
provides business income over a period of time.

Depicting financial position: Balance sheet is prepared to depict financial position


of business means what the business owns and what owes to others.
Information to all interested users: After analysis and interpretation, business
performance and position are communicated to the interested users.
Fulfilling legal obligations: Vital accounting information helps in fulfilling legal
obligations e.g. sales tax, income tax etc.

Steps involved in accounting process are as follows:-

Analyses of business transactions


Documentation
Voucher (Documentary or written evidence of the business transaction
Recording
Journal Day book chronological write the accounts
Classifying
Ledger Books of accounts in which different accounts are maintained
Summarizing
Trial Balance Net effect of all the transactions
Bifurcating
Trial Balance into profit and loss a/c and balance sheet

5. Explain Real, personal and nominal accounts with examples


An account is a summary of relevant transactions at one place relating to a particular head. It
records not only the amount of transnsactions but also their effect and directions.
TRADITIONAL CLASSIFICATION OF ACCOUNT.

There are broadly 3 types of account.They are as follows:


1) Personal account.
2) Real account.
3) Nominal account.

TYPES OF MEANING EXAMPLES


ACCOUNT
1) Personal account. This account relates to natural Natural-rams a/c.
persons, artificial persons, and
Artificial-rams a/c.
representative persons. (All the
outstanding expenses, outstanding Representative-outstanding salary a/c.
income, prepaid expenses and pre
received income are included.)

2) Real account. All the assets of the company are Tangible = land a/c
included.(tangible and in-tangible
In-tangible = goodwill a/c.
assets.)
3) Nominal account. All the income and expenses will Expenses: purchase a/c.
come under this account.
Loss or loss by fire account.
Those account related to loss,
Profit and gain sales a/c.
profit and gains.
Discount received a/c .

EXAMPLES OF REAL ACCOUNT :


Land and building a/c, cash received, cash paid, printing and stationary brought, furniture and
fixtures, plant and machinery, debtors, motor car, Goodwill a/c , etc.

6. Discuss the various components of a financial statement.

Components of financial accounting

Elements of financial statement

Relating to measurement of Relating to measurement


financial position of profit

Asset Liability Equity Income Expense

ASSETS:
An asset is a resource controlled by the enterprise as a result of past event and form which
future economic benefits are expected to flow to the enterprise. An enterprise usually
employs its assets to produce goods or services capable of satisfying the wants or needs of
customers.
Since these goods or services can satisfy wants or needs ,the customer are prepared to pay
for them and hence contribute to the cash flow of the enterprise .cash itself renders several
services to the enterprise because of its command over other resources .the future economic
benefits embodied in an asset may flow to the enterprise in a number of ways : (A) an asset
may be used singly or in combination with other assets in the production of goods or services
to be sold by the enterprise ;(b) exchanged for other assets ;(c) used to settle a liability ; or
(d) distribute to the owners of the enterprise
Many assets have a physical form. For example, land and building ,plants ,equipments etc
.are of physical form .however, physical form is not necessary for the existence of an asset.
Patents, copyright, etc. are assets from which future economic benefits are expected to flow
to the enterprise and so these are assets to the enterprise although, they do not have any
physical form, if controlled by the enterprise.
Many assets for example, receivables and property are associated with legal rights, including
ownership. In determining the existence of assets the right of ownership is not essential. For
example, if a property held on lease, it is an asset to the enterprise if it is controls the benefits
which are expected to flow from the property. Thus always legal right of ownership is not a
characteristics feature for identifying an asset. What is essential is the controlling right of the
benefit emerging from such asset.
The asset of an enterprise results from the past transaction or other past events. For example
plant and machinery acquired in a past transaction from which an asset occurred. But the
transaction or event expected to occur in future do not give rise to asset. For example, an
intension to purchase the machine does not meet the definition of an asset. There is close
relationship between incurring expenditure and generating assets, which may not necessarily
coincide. For acquiring a piece of plant the enterprise needs to incurs the cost. So when
expenditure is incurred, this gives an evidence of the existence of an asset. But, when the
asset is donated to the enterprise, although no expenditure is incurred, an asset is created.

LIABILITY:
A liability is a present obligation of the enterprise arising from past events, the settlement of
which is expected to result in an outflow from the enterprise of resources embodying
economic benefits. An essential characteristic has a present obligation. An obligation is a
duty or responsibility to act or perform in certain way. An obligation may be legally
enforceable as consequences of a binding contract or statutory requirements. Obligations also
arise, however, from business practice, custom and a desire to maintain good business
relation or to act in an equitable manner.
A distinction needs to be drawn between a present obligation and a future commitment. A
decision by the management of the enterprise to acquire assets in future does not of itself give
rise to a present obligation. An obligation normally arises only when the asset is delivered or
the enterprise entries into an irrevocable agreement to acquire the assets.
The statement of a present obligation usually involves the enterprise giving up resources
embodying economic benefit in order to satisfy the claim of the other party. The settlement of
a present obligation may be done by: (a) payment of cash, (b) transfer of other assets, (c)
provision of services, (d) replacement of that obligation with another obligation, (e)
conversion of obligation to equity. The obligation may also be extinguished when the creditor
waives the liability.
Liabilities results from past transactions or other past events. Some liabilities can be
measured only by using a substantial degree of estimation. For example, income tax liability
of a year may not be exactly known at the time of preparation of financial statement. This
will be known only when the assessment will be over at some future date. Some enterprise
describes these liabilities as provisions.

Equity
Equity is a residual interest in the assets of the enterprise after deducting its liabilities. In a
corporate enterprise equity is suitable sub classification in the balance sheet. For example,
in India equity is classified as Share Capital & Reserve and Surplus. Under each head further
details are provided. The creation of reserves sometimes required by statute or other law in
order to give the enterprise and its creditors added measure of protection from future losses.
Creation of some reserve may be necessary as per tax law of the country. In India creation of
Export Profit Reserve is one such requirenment. Normally equity is shown at it paid up value.

INCOME
Income is increase in economic benefits during the accounting period in the form of inflows
or enhancement of assets or decreases of liabilities that result in increase in equity, other than
those relating to contribution from equity participants. The definition of income encompasses
both revenue and gains. Revenue arises in the course of the ordinary activities of an
enterprise and is rendered by a variety of different names, including fees, interest, dividends
and rent. Gains represent other items that meet the definition of income and may or may not
arise in the course of ordinary activities of an enterprise. Gains include, for example, those
arising in disposal of non-current assets. The definition of income also includes unrealized
gains. For example, those arising on the revaluation of marketable securities and those
resulting from increase in the value of fixed assets. When gains are recognized in the income
statement they are usually displayed separately because knowledge of them is useful for
making economic decisions. Gains are often reported net of related expenses. Income may
also result from settlement of liabilities.
Expenses
Expenses are decreases in economic benefit during the accounting period in the form of
outflows or depletions of assets or incurrence in liabilities that results in decrease in equities
other than those relating to distribution of equity participants. The definition of expenses
encompasses losses as well as those expenses that rise in the course of the ordinary activities
of the enterprise. Expenses in the course of the ordinary activities of the enterprise include,
for example, cost of sale, wages, manufacturing expenses, depreciation. They usually take the
form of an outflow or depletion of an asset such as cash and cash equivalent, inventory,
property, plant and equipment.
Losses represent other items that meet the definition of expenses and may or may not arise in
the course of the ordinary activities of the enterprise. Loose include, for example, those
resulting from disasters such as fire and flood as well as those arising on disposal of non-
current assets. The definition of expenses also includes unrealized losses for example, those
arising from the effects of increase in the rate of foreign currency. When losses are
recognized in the income statement, they are usually displayed separately because such
knowledge is useful for the income of making economic decisions. Losses are often reported
net of related income.

7. Explain the impact of errors on Trial Balance by giving suitable examples


errors disclosed and errors not disclosed by Trial Balance.
Difference in Trial Balance:
The Trial Balance may not tally due to errors. Error may be defined as unintentional mistakes
while preparing voucher or posting the transaction in books of accounts. The Errors in Trial
Balance may be due to various reasons:
(1) Clerical error: Omission, Commission, Compensating, Posting.
(2) Casting error: Wrong total calculation or carried forward.
(3) Error of Principle: Wrong method of treatment, calculation.

(1) Clerical error: This type of error may occur while preparation of vouchers, recording
transaction:
(a) Error of Omissions: Occurs when a transaction are omitted while recording in books. It is
further bifurcated in to two types Partial and Complete Omission. The Partial Omission
occurs when transaction is recorded only one side i.e. Debit side or Credit side. While total
omission indicates the entire transaction was not recorded in books of accounts.

(b) Error of Commission: In this type of error the transaction is recorded twice.
(c) Error of Compensation: In this type of error the figures may have posted wrongly,
however coincidentally compensated by opposite or in the same side of account in another or
same ledger by another mistake with the same value.

(d) Error of Posting: This type of error may occur when an entry one effect is given in correct
side of an account however the second effect is posted in another account for e.g. Cash
received Rs. 2000 from Mr. A the cash account is properly debited and instead of posting in
account A it may be posted in another account say Mr. B.

(2) Casting Error: Casting means total. This type of error may occur while balancing ledger
accounts or carried forward of total from one page to another page.
(3) Error of Principle: This errors are technical error which may occur while preparing
financial statements. The following are the e.g. of error of principle:
(a) Capital Expenditure may be treated as Revenue or vice versa.
(b) Method of valuation of stock stated may at cost however may be valued at market price.
(c) Method of Depreciation adopted may be different than stated in notes to accounts.
The Trial Balance will not tally in case of following types of error:
(1) Error due to Partial Omission &
(2) Casting error.
While other error effect either on both sides or in the same side with compensation. The error
of principle never effects the tally of trial balance, since they are effected only after
preparation of trial balance. They effect the Profit or Loss account and Financial Position of
the Company.

8. Discuss in brief the various levels of categories of enterprises with reference to


applicability of Accounting Standards.

The term standard denotes a discipline, which provides both guidelines and yardsticks for
evaluation. As guidelines, accounting standard provides uniform practices and common
techniques of accounting. As a general rule, accounting standards are applicable to all
corporate enterprises. They are made operative from a date specified in the standard. The
Institute of Chartered Accountant of India (ICAI) constituted the Accounting Standards
Board (ASB) in April, 1977 for developing accounting standards. However, the International
Accounting Standards Committee (IASC) was set up in 1973, with its headquarter in London
(U.K.).
The Accounting Standards Board is entrusted with the responsibility of formulating standards
on significant accounting matters keeping in view the international developments, and legal
requirements in India.
The main function of the ASB is to identify areas in which uniformity in standards is required
and to develop draft standards after discussions with representatives of the Government,
public sector undertaking, industries and other agencies. In the initial years the standards are
of recommendatory in nature. Once an awareness is created about the benefits and relevance
of accounting standards, steps are taken to make the accounting standards mandatory for all
companies. In case of non compliance, the companies are required to disclose the reasons for
deviations and its financial effect.

9. Why do we need global standardization of financial reporting? Is it feasible? Is it


required? Why or Why not?

The IASB then decided to introduce one set of globally acceptable accounting standards
across all the European countries. It announced that the new accounting standards issued by
the IASB would be designated International Financial Reporting Standards (hereinafter
IFRS), at the same time as the existing standards would continue to be designated
'International Accounting Standards (IAS). Presumably, this change was made in order to
enable the Board to distinguish between the new standards issued by them, and those that
they had inherited from the former International Accounting Standards Committee Board.
As per the European Commission's regulation, all European (EU) Companies listed on a
regulated market should prepare their consolidated accounts in accordance with the IFRS, by
2005 at the latest. This implies that the much-talked-about notion of harmonized financial
reporting under a single set of accounting standards is now a practical reality. Clearly,
Europe's decision has encouraged several other countries to adopt a similar path.

Need for global standards

Academic research shows that foreign investors are more likely to invest in firms whose
accounting is similar to accounting of the country of the investors. Thus we can attract more
foreign capital and lower the cost of capital for our firms by adopting IFRS. It is time for
corporate India to lobby for the early and quick adoption of IFRS. This will benefit not only
Indian businesses and capital markets but also labor. Job opportunities for Indian accountants
will jump once the world realizes and recognizes that accounting in India is identical to that
in Western Europe, which adopted IFRS in 2005.

A single system of financial reporting would benefit a host of constituents. With quality
standards, consistently applied, investor understanding and confidence rises. That translates
to strong, stable, liquid markets. With quality reporting, investors wouldnt need to
compensate for a lack of under- standing by demanding a risk premium. With consistent
application and the resulting comparability investors and analysts have an easier time
knowing how to best allocate capital. Having one financial language reduces preparation and
audit costs. No longer is there a need to learn different standards, or keep current in them, at
the expense of more fruitful pursuits. Regulation can be easier if properly coordinated.
Education and training become easier and more focused.
Benefits of adopting IFRS
1. Improved access to International capital markets
Many Indian entities are expanding or making significant acquisitions in the global arena
for which huge capital is required. Majority of stock exchanges require financial information
prepared under IFRS. Migration to IFRS will enable Indian entities to have access to
international capital markets, without the risk premium involved in Indian GAAP financial
statements.
2. Lower cost of capital
Migration to IFRS will lower the cost of raising funds, as it will eliminate the need for
preparing a dual set of financial statements. It will also reduce accountants fees, abolish risk
premium and will enable access to all major capital markets as IFRS is globally acceptable.
3. Enable benchmarking with global peers and improve brand value
Adoption of IFRS will enable companies to gain a broader and deeper understanding of the
entitys relative standing by looking beyond country and regional milestones. Further,
adoption of IFRS will facilitate companies to set targets and milestones based on global
business environment, rather than merely local ones.
4. Escape Multiple Reporting
Convergence to IFRS, by all group entities, will enable company managements to get all
components of the group on one financial reporting platform. This will eliminate the need for
multiple reports and significant adjustment for preparing CFS or filing financial statements in
different stock exchanges.
5. Reflects true value of acquisitions
In Indian GAAP, business combinations, with few exceptions, are recorded at carrying values
and not at fair values of net assets taken over. Purchase consideration paid for intangible
assets not recorded in the acquirers books is usually not reflected separately in the financial
statements; instead the amount gets added to goodwill. Hence, true value of the business
combination is not communicated through financial statements. IFRS will overcome this flaw
as it mandates accounting for net assets taken over in a business combination at fair value. It
also requires recognition of intangible assets, even though they have not been recorded in the
acquirers financial statements.
Adopting IFRS in India: Challenges
In India, the convergence of GAAP (generally accepted accounting principles) with
International Financial Reporting Standard (IFRS) will pose various challenges on the tax and
regulatory front which companies, investors and regulators will have to grapple with. In
substance, for IFRS to become a reality in India by 2011, significant changes in the
regulatory framework will be required. The following major challenges are there to adopting
IFRS in India.
1. Shortage of Resources
With the convergence to IFRS, implementation of SOX1, strengthening of corporate
governance norms, increasing financial regulations and global economic growth, accountants
are most sought after globally. Accounting resources is a major challenge globally and will
remain so in the short-term. India, with a population of more than 1 billion, has only
approximately 145,000 Chartered Accountants, which is far below its requirement.
2. Training
If IFRS has to be uniformly understood and consistently applied, training needs of all
stakeholders, comprising CFOs, auditors, audit committees, teachers, students, analysts,
regulators, and tax authorities need to be addressed. It is crucial that IFRS is introduced as a
full subject in universities and Chartered Accountancy syllabus.

3. Information systems
Financial accounting and reporting systems must be able to produce robust and consistent
data for reporting financial information. The systems must also be capable of capturing new
information for required disclosures, such as segment information, fair values of financial
instruments, and related party transactions. As financial accounting and reporting systems are
modified and strengthened to deliver information in accordance with IFRS, entities need to
enhance their IT security in order to minimize the risk of business interruptionparticularly
to address potential fraud, cyber terrorism, and data corruption.
4. Taxes
IFRS convergence will have a significant impact on financial statements and consequently
tax liability. Tax authorities should ensure that there is clarity on the tax treatment of items
arising out of convergence to IFRS. For example, will government authorities tax unrealized
gains arising out of the accounting required by the standards on financial instruments? From
an entitys point of view, a thorough review of existing tax planning strategies is essential to
test their alignment with changes created by IFRS. Tax and other regulatory issues as well as
the risks involved will have to be considered by the entities.
5. Communication
IFRS may significantly change reported earnings and various performance indicators.
Managing market expectations and educating analysts will therefore be critical. A companys
management must understand the differences in the way the entitys performance will be
viewed, both internally and in the market place, and agree on key messages to be delivered to
investors and other stakeholders. Reported profits may be different from perceived
commercial performance due to the increased use of fair values and the restriction on existing
practices such as hedge accounting. Consequently, the indicators for assessing both, business
and executive performance, will need to be revisited.
6. Management compensation and debt agreement
The amount of compensation calculated and paid under performance-based executive and
employee compensation plans may be materially different under IFRS, as the entitys
financial results may be considerably different. Significant changes to the plan may be
required to reward an activity that contributes to an entitys success within the new regime.
Re-negotiating contracts that referenced reported accounting amounts, such as bank
covenants, may be required on convergence to IFRS.
7. Distributable profits
IFRS is fair value driven, which results very often in unrealized gains and losses. Whether
this can be considered for the purpose of computing distributable profits will have to be
debated, in order to ensure that distribution of unrealized profits will not eventually lead to
reduction of share capital.
8. Information availability and reliability
Until recently, financial accounting data for many firms were unavailable for a lot of
countries. Many of these detailed data may not be provided for companies in other countries.
Either the data providers do not collect the information or firms do not disclosure them. The
causes of this not-collected information can be demand, which not justify the costs. Failure
by data providers to supply reported information can be overcome by the researcher through
additional information collection efforts. Experience in providing the data should lead to a
more reliable product, and users should have a clearer understanding of how the information
are provided. The information collection and presentation for other countries are relatively
new and may not be fully understood by researchers.
The accuracy of this accounting information depends on the level of countrys development.
Thats why the reliability of the results is another challenge for international accounting
research. Researchers may have the economic resources needed to purchase international
information and May also be well trained in econometric and other methods needed to
perform statistical tests. Anyway, having the data and being able to provide a series of
statistical tests may not lead to productive research. Unless the researchers have an
understanding of the unique national characteristics and how they impact the research
question, incorrect inferences can be made.
9. Exporting theories and accepted business practices to other countries
without considering the relation between national characteristics and the research question
being investigated, like: culture, accounting tales, legal system, auditing, tax system,
ownership structure, financing sources, political factors, because they differ a lot in many
countries suggest that accounting research theories should, be examined in countries other
than those in which they were developed. Such studies can either support or deny the
universality of each theory." In this purpose we are questioning the appliance of the IFRSs in
the Muslim countries where because of sharias law the interest on money loan is prohibited.
So being a sin how will adjust the IFRS their concept of value in time of the money in a
country which do not consider moral that money have a price in time through interest?
10. Relevance of the results.
The importance of the international accounting research is to offer new understanding to the
existing body of research. When we discuss of the accounting globalization, we have to
analyze the importance of international factors on accounting information. So, we can speak
firsts about growth in international equity and bond markets, resulting in the expansion of
international investment by investors and globalization of capital markets. Investors who
want to diversify their portfolios to international markets must understand foreign financial
statement. They are familiar with their accounting measurement and reporting rules and are
also familiar with understanding how the local business environment interacts with financial
accounting information to indicate firm value.
11. Different perception of the financial information.
There are many issues that can arise when performing analyses of foreign companies,
because some financial statement analysis techniques may not be appropriate in other
countries. For sample, a high debt-to-asset ratio indicates higher risk for U.S. companies, but
can mean lower risk for Japanese companies. Even with these difficulties investors seem
more willing than ever to venture into foreign markets. International accounting research can
provide insights into understanding how current financial statements relate to future
performance and overall firm value. In addition, the evidence is clear that capital markets are
more globalize than ever. Events such as the Asian and Russian financial crises and
September 11, 2001 show that national economies have become increasingly tied to one
another. Factors affecting firm performance and value in one country may have an impact in
other countries. The world no longer operates in single country or regionally segmented
markets. International factors directly impact national investments.
12. Non-existence of functional professional accounting organizations.
For all practical purposes more than a half of all African countries do not have functional
accounting organizations. In these countries, therefore, existence of IFAC 2 and
implementation of IFRS are out of question. IFAC faces the daunting task of assisting these
countries to first develop functional professional accounting organizations. A plethora of
accounting standards, methodologies and reporting formats following the practices of
metropolitan mother companies are found in countries without a functional accounting
profession.

13. The standards must be translated into the native languages.


Many of these countries do not well developed languages that can conveniently be used as a
vehicle for translating IFAC and IFRS standards. In addition, many countries use more than
one language and a choice may have to be made regarding the language to be used for
financial reporting. Translation and use of accounting terminology can be confusing,
rendering the original intent of the standard incomprehensible and irrelevant. This language
barrier is also pertinent to translation of training materials and other resources. These
translations must also be sensitive to the rapidly changing nature of IFRS and communicate
modifications in a timely manner.

14. The effective execution


The effective execution of these standards also requires a preexisting solid accounting
infrastructure with corporate governance and financial reporting practices already in place.
This is not always the case in developing nations.

15. Contradiction in professional accounting and local laws


A contrasting problem is encountered in some of the countries with well-established
professional accounting organizations and national laws and regulations that are difficult to
reconcile with the very different standards imposed by IFRS. These nations frequently have
social customs and political systems that also operate counter to IFRS dictates. This attempt
to erase the local in the interest of harmonizing with the global is not always successful.
Enforcement concerns are also dependent on the laws of the lands involved and these vary
widely by country and are virtually nonexistent in some nations. To be effective locally,
international standards need the force of law and this is often lacking as is the mechanism to
establish a legal framework by which to ensure compliance and disciplining of offenders.

16. Change in existing business model


For companies, the requirement to adopt IFRS is not merely a technical exercise involving
the reordering of information and rearrangement of the financial statements. Conversion to
IFRS will often challenge fundamentally a company's existing business model. It will provide
a unique opportunity for the company to re examine and reengineer the way it looks at itself
through its internal management reporting. It will affect the way the company presents itself
to investors and other users of its financial statements.
17. Failure may lead to competitive disadvantage
It is vital that company managements recognize the far-reaching impact that IFRS will have
on their businesses. Failure to do so could place their companies at a competitive
disadvantage. The adoption of IFRS is not simply a matter of choosing different accounting
policies; it involves the adoption of an entirely different system of performance measurement
and communication with the markets. There will be substantially increased levels of
transparency for many companies for example, through expanded segmental disclosures
and the recognition of derivatives on balance sheets at fair value.
18. Company can not hide its weakness
From the users' perspective, analysts will perhaps for the first time have truly transparent and
comparable data about all companies within a particular industry on a global basis.
Companies will be benchmarked against their cross-border competitors and key performance
indicators will be compared. As a result, companies presently operating in less than
transparent and semi-protected financial reporting environments will soon have no place to
hide.
Although entities are frequently required to adopt new accounting standards under their
national Generally Accepted Accounting Principles (GAAP), adopting IFRS, an entirely
different basis of accounting, poses a distinct set of problems:
o The sheer magnitude of the effort involved in adopting a large number of new
accounting standards.
o The requirements of individual standards will often differ significantly from those
under an entity's previous GAAP.
o Information may need to be collected that was not required under the previous GAAP.
o Practical experience of applying a principles-based system of financial reporting
standards such as IFRS does not exist in many entities.
Adopting IFRS in India: Opportunities
Benefits from the IFRS wave will not be restricted to Indian corporate. In fact, it will open up
a host of opportunities in the services sector. With a wide pool of accounting professionals,
India can emerge as an accounting services hub for the global community. As IFRS is fair
value focused, it will provide significant opportunities to professionals, including,
accountants, valuers and actuaries, which in-turn will boost the growth prospects for the BPO
segment in India. The following are the main opportunities for adopting IFRS
o Valuation: IFC and many lenders find that IFRS improve the key metrics that
analysts use to measure and evaluate clients performance and price shares. Under
IFRS, all equity and quasi equity instruments are fair valued.
o Transparency: The extensive requirements under IFRS lead to greater transparency
a new feature for many organizations, especially in emerging markets. Transparency
will give small companies in underdeveloped and developing nations a better chance
of raising capital.
o Comparability: With widespread use, the common standards of IFRS will enable
capital providers throughout the world to analyze and compare companies, making the
process of raising capital less expensive and more competitive.

10. Who are the users of accounting information, and why do the users need
accounting information? How this information helpful to the users?

Investors and leaders are the most obvious users of accounting information. Their
decisions and uses of information have been studied and described to a much greater
extent than those of other user group. Therefore For reasons that are largely
pragmatic, financial reports focus on providing information for investment and loan
and rely on them as their major source of financial information. Following are the
users of accounting information.
1. Investors.
2. Lenders.
3. Security analysts, Rating and other information specialists
4. Managers
5. Employees and Trade Unions
6. Suppliers and Trade financiers
7. Customers
8. Government and Regulatory authorities
1. Investors :-
Investors are the major recipients of the financial statements of business enterprises.
They may be retail investors with small shareholdings or large mutual funds and
private equity firms. Main aim of accounting information for investors is, whether the
company is capable to give return or not.
Need of accounting information:-

Accounting information gives idea about investment opportunities.


Investors need information to decide which investment to buy, retain or sell, as
well as the timing of the purchase or sales of the investments.
It is also helpful for monitor managers performance and to assess the ability
of the enterprise to pay dividends.

Helpfulness of accounting information:-

To evaluate the performance of company from the perspective of the investors.


It will give idea about dividend whether company will pay or not.

2. Lenders :-

Lenders such as banks and debenture holders want to know about the financial
stability of a business that approaches them for funds. They are interested in
information that would enable them to determine their borrowers will be able to repay
the loan and pay the related interest on time.

Need of accounting information:-

Banks use credit evolution benchmarks based on information derived from


financial statements.
At a time of deciding loan amount, interest rate, repay period and security they
are using financial information.
They are also use financial information of company for monitoring the
financial condition.

Helpfulness of accounting information:-


Here lender such as a bank and debenture holder uses financial information for knows
that the company/firm is solvent to repay the amount any payment of interest time to
time.
3. Security analysts, Rating and other information specialists :-

Investors and creditors seek the assistance of information specialists in assessing


prospective return. Equity analysts and bond analysts, stockbrokers and credit rating
agencies offer a wide array of information services. These information specialists
serve the need of investors by providing them skilled analyses and interpretation of
financial report. They collect information face-to-face meeting and conference call
with company executives and field visit.
Need of accounting information:-

They are recurring financial information for the decision making behalf of
their clients whether to buy, sell or hold their investments.

Helpfulness of accounting information:-

Financial information is helpful to get final conclusion about research,


investment, brokerage houses.

4. Managers:-

Managers produce financial information for use by others and also use it in many of
their decisions.

Need of accounting information:-

They need this information for planning and controlling operations, for
making special decision, and for formulating major plans and policies.

Helpfulness of accounting information:-

To evaluate potential investment projects.


To monitor the key financial indicators that appear in the financial report.
To compare their firms performance with that of their competitors.

5. Employees and trade union:-

Employees are keen to know about their employers general operations, stability and
profitability. Current employees have a natural interest in the financial condition of
the enterprise because often their compensation will depend on financial performance
of the firm.

Need of accounting information:-

Potential employees may need this information in order to gauge the enterprise
prospect.
Helpfulness of accounting information:-

They use this information for negotiating enhancements in wages, bonus and
other benefits.
6. Suppliers and trade financers:-
Suppliers regard the enterprise as an outlet for their product or services.
Helpfulness of accounting information:-
They use this information to assess the likelihood of the enterprise continuing
to buy from them especially if it is a major customer

7. Customers :-

Customer would like to be certain that they can count on their suppliers for future
purchases and after sales support. This is particularly important for product and
services that are proprietary.
Need of accounting information:-

Insurance policy holder needs confidence that their insurer will have the
financial resources to pay their claims.
Helpfulness of accounting information:-

This is helpful when the company is suffering from scandal.

8. Government and regulatory authorities:-

The three levels of govt. in India are central state and local- allocate resources and are
concerned with the activities of enterprises.

Need of accounting information:-

They require this information in order to regulate the business practices of


enterprise determine taxation policies and provide a basis for national income and
similar statistics.

Helpfulness of accounting information:-

These agencies use financial report order to identify abuse and violations and
to protect the interests of the investors and consumers.

11) QUESTION: Explain the meaning and important features of inflation accounting and
briefly explain the effects of inflation on financial statements?
ANSWER:-
INTRODUCTION:

The basic purpose of preparing financial statement is to present a true and


fair view of the operating results and financial position of the business. Inflation accounting
is a system of accounting where there is a built in mechanism to report transaction at current
cost. Inflation accounting represents the cost existing on the date of reporting.
MEANING:

Inflation accounting is a term describing a range of accounting models


designed to correct problems arising from historical cost accounting in the presence of the
high inflation and hyper inflation.
For eg: In countries experiencing hyper inflation the international Accounting Standers Board
requires corporation to implement financial capital maintenance in units constant purchasing
power in terms of monthly published consumer price index. This does not result in capital
maintenance in units of constant purchasing power since that can only be achieved in terms
of a daily index.
IMPORTANCE FEARTURES:
(1) The inflation accounting has an inbuilt and automatic recording procedure.
(2) The unit of measurement is not stable like traditional or historical
accounting.
(3) It takes into consideration all the elements of financial statements for
reporting.
(4) The realization principle is not rigidly followed, particularly in the case of
recording fixed assets and long-term loans.

Briefly explain the effects of inflation on financial statements:


(1) Many of the historical numbers appearing on financial statements are not
economically relevant because prices have changed since they were incurred.
(2) Since the numbers on financial statements represent dollars expended at different
points of time and, in turn, embody different amounts of purchasing power they
are simply not additive.
(3) Reported profits may exceed the earnings that could be distributed to
shareholders without impairing the companys ongoing operations.
(4) The future earnings are not easily projected from historical earnings. Future
capital needs are difficult to forecast and may lead to increase leverage, which
increased the risk to the business.
(5) The asset values for inventory, equipment and plant do not reflect their economic
value to the business.

Conclusion:

The inflation spares none and equally influenced the Business like the
people. Inflation accounting has removed this drawback by providing method for adjusting
the figure according to general or specific price levels. Historical cost accounting does not
take into account the changes in the rise in the value of assets and its impact on Balance Sheet
and P&L Account due to inflation and does not reflect the real worth of the business which is
very required for effective decision making.
12) What is a Trial Balance? State the objectives of Trial Balance.

Meaning of Trial Balance

Trial Balance is a statement, which shows debit balances and credit balances of all the
accounts in the ledger.
As per the rules of double entry, every debit must have a corresponding credit.
Hence, the total of all debit entries must be equal to that of all credit entries in the
ledger.
The total of the debit balances and credit balances must be equal.
In case any difference arises, that is, the total of debit balances and credit balances do
not tally, the correctness of the balances brought forward from the respective accounts
must be checked by preparing this statement. This process is known as preparation of
a Trial Balance.
Trial Balance is a statement, prepared with the debit and credit balances of ledger
accounts to test the arithmetical accuracy of the books.

Objectives of a Trial Balance

1. To check the arithmetical accuracy of the ledger account,


2. To locate the errors and rectify them,
3. To provide basis for the preparation of final accounts,
4. To serve as a ready reckoner (it provides a summary of all transaction during an
accounting period at one place, i.e. this statement)

13) Write a short note on Accounting Conventions (also refer the notes given in the
class)

The most commonly encountered convention is the "historical cost convention". This requires
transactions to be recorded at the price ruling at the time, and for assets to be valued at their
original cost.

Under the "historical cost convention", therefore, no account is taken of changing prices in
the economy.

The other conventions you will encounter in a set of accounts can be summarised as follows:

Monetary measurement

Accountants do not account for items unless they can be quantified in monetary terms. Items
that are not accounted for (unless someone is prepared to pay something for them) include
things like workforce skill, morale, market leadership, brand recognition, quality of
management etc.

Separate Entity

This convention seeks to ensure that private transactions and matters relating to the owners of
a business are segregated from transactions that relate to the business.

Realisation

With this convention, accounts recognise transactions (and any profits arising from them) at
the point of sale or transfer of legal ownership - rather than just when cash actually changes
hands. For example, a company that makes a sale to a customer can recognise that sale when
the transaction is legal - at the point of contract. The actual payment due from the customer
may not arise until several weeks (or months) later - if the customer has been granted some
credit terms.

Materiality

An important convention. As we can see from the application of accounting standards and
accounting policies, the preparation of accounts involves a high degree of judgement. Where
decisions are required about the appropriateness of a particular accounting judgement, the
"materiality" convention suggests that this should only be an issue if the judgement is
"significant" or "material" to a user of the accounts. The concept of "materiality" is an
important issue for auditors of financial accounts.

14) What is ledger? What is posting? Illustrate an example for the same

MEANING OF LEDGER:-
In journal, each transaction was dealt separately. They do not provide complete information
at a glance. The net result of transactions relating to a particular account to be collected at one
place, a separate book is to be maintained. This is book, which is call ledger.
A ledger is a book, which contains all the accounts in a summarized and classified form. A
ledger is a permanent record of all business transaction transferred from journal or other
books of original entry. The ledger is also referred to as the book of final entry.
STANDARD FORM OF LEDGER AND ITS CONTENTS
A ledger in the traditional way, is normally kept in the form of bound note books. In
bigger business enterprises, it is not easy to maintain a large and variety of
transactions in a single book.
To overcome this difficulty, loose leap sheets take the place of bound books.
MEANING OF POSTING:-

Business transaction are usually first recorded in the books of original entry or
subsidiary books. Only then they are transferred to the ledger. This process of
transferring from the books of original entry in the concerned accounts to the ledger is
called posting.

The main object of posting is to make classified and summarized record of various
transactions during a specified period on a particular account. Net effect of
transactions can be had from the ledger at a glance.

It is prepared periodically (daily, weekly, fortnightly, monthly, quarterly), depending upon


the needs and requirements of the respective business concerns.

For eg :

Transaction: Deposited cash of Rs. 50,000 in bank

Journal entry :

Bank A/c Dr. 50,000

To Cash A/c 50,000

(Being cash deposited in bank)

Ledger account to be prepared for this transaction

Bank A/c and Cash A/c

Dr Bank A/c Cr

DATE PARTICULARS LF AMT DATE PARTICULARS LF AMT


To Cash A/c 50,000

Dr Cash A/c Cr

DATE PARTICULARS LF AMT DATE PARTICULARS LF AMT


By Bank A/c 50,000

15) Which are the 3 types of accounts? Explain with examples.

There are mainly 3 types of accounts:-


(a) Personal accounts;
(b) Real accounts;
(c) Nominal accounts.
(A) Personal Accounts

The elements or accounts which represent natural persons, artificial persons and
representative persons are called Personal Accounts.

Example of Personal Accounts


Mrs. Vimal a/c representing Mrs. Vimal a person
M/s Bharat & Co a/c representing M/s Bharat & Co, an organization
Capital a/c representing the owner of the business, a person or organization
Bank a/c representing Bank, an organization

(B) Real Accounts

The elements or accounts which represent the tangible and intangible real assets
are called Real Accounts.

Example of Real Accounts


Tangible assets - Land A/c, Plant & Machinery A/c, Vehicle A/c, Building A/c
etc.
Intangible assets - Patents A/c, Trademark A/c, Goodwill A/c etc.

(C) Nomial Accounts

The elements or accounts which represent the losses, profit and gains are called
Nominal Accounts.

Examples of Nominal Accounts


Purchase A/c, loss by fire A/c, sales A/c, discount received A/c etc.
Module 2

1. Name accounting standard 1 and explain it in detail


OR
Explain Disclosure of Accounting Policies (AS-1) giving suitable examples.

This Standard deals with the disclosure of significant accounting policies followed in
preparing and presenting financial statements.
The view presented in the financial statements of an enterprise of its state of affairs
and of the profit or loss can be significantly affected by the accounting policies
followed in the preparation and presentation of the financial statements. The
accounting policies followed vary from enterprise to enterprise. Disclosure of
significant accounting policies followed is necessary if the view presented is to be
properly appreciated.
The disclosure of some of the accounting policies followed in the preparation and
presentation of the financial statements is required by law in some cases. The Institute
of Chartered Accountants of India has, in Standards issued by it, recommended the
disclosure of certain accounting policies, e.g., translation policies in respect of foreign
currency items.
In recent years, a few enterprises in India have adopted the practice of including in
their annual reports to shareholders a separate statement of accounting policies
followed in preparing and presenting the financial statements.
In general, however, accounting policies are not at present regularly and fully
disclosed in all financial statements. Many enterprises include in the Notes on the
Accounts, descriptions of some of the significant accounting policies. But the nature
and degree of disclosure vary considerably between the corporate and the non-
corporate sectors and between units in the same sector.
Even among the few enterprises that presently include in their annual reports a
separate statement of accounting policies, considerable variation exists. The statement
of accounting policies forms part of accounts in some cases while in others it is given
as supplementary information.
The purpose of this Standard is to promote better understanding of financial
statements by establishing through an accounting standard the disclosure of
significant accounting policies and the manner in which accounting policies are
disclosed in the financial statements. Such disclosure would also facilitate a more
meaningful comparison between financial statements of different enterprises.

Fundamental Accounting Assumptions


Certain fundamental accounting assumptions underlie the preparation and
presentation of financial statements. They are usually not specifically stated because
their acceptance and use are assumed. Disclosure is necessary if they are not
followed.
The following have been generally accepted as fundamental accounting
assumptions:
a. Going Concern
The enterprise is normally viewed as a going concern, that is, as continuing in
operation for the foreseeable future. It is assumed that the enterprise has neither the
intention nor the necessity of liquidation or of curtailing materially the scale of the
operations.
b. Consistency
It is assumed that accounting policies are consistent from one period to another.
c. Accrual
Revenues and costs are accrued, that is, recognised as they are earned or incurred (and
not as money is received or paid) and recorded in the financial statements of the
periods to which they relate. (The considerations affecting the process of matching
costs with revenues under the accrual assumption are not dealt with in this standard.)

Areas in Which Differing Accounting Policies are Encountered


The following are examples of the areas in which different accounting policies may
be adopted by different enterprises.
(a) Methods of depreciation, depletion and amortisation
(b) Treatment of expenditure during construction
(c) Conversion or translation of foreign currency items
Disclosure of Accounting Policies 43
(d) Valuation of inventories
(e) Treatment of goodwill
(f) Valuation of investments
(g) Treatment of retirement benefits
(h) Recognition of profit on long-term contracts
(i) Valuation of fixed assets
(j) Treatment of contingent liabilities.
The above list of examples is not intended to be exhaustive.

2. Name accounting standard 6 and explain it in detail

AS-6 stands for Depreciation on Fixed Assets.


Depreciation is reduction in the value of fixed assets and depreciation is to be
provided for the following reasons:

Wear and tear. Any asset will gradually break down over a certain usage period,as
parts wear out and need to be replaced.Eventually,the asset can no longer be repaired,
and must be dispose of. This cause is most common for production equipment, which
typically has a manufacturers recommended life span that is based on a certain
number of units produced. Other assets, such as buildings, can be repaired and
upgraded for long period of time.
Perishability .some assets have an extremely short life span.This condition is most
applicable to inventory, rather than fixed assets.
Usage rights .A fixed asset may actually be a right to use something for a certain
period of time.If so, its life span terminets when the usage rights expire, so
depreciation must be completed by the end of the usage period.
Efflux of time mere passage of time will cause a fall in the value of an asset even if
it is not used.
Obsolescene a new invention or a permanent change in demand may render the
asset useless.
Accident.
Fall in market price.

There are various methods of providing depreciation on fixed assets which are listed
below:

Straight Line Method


Written Down Value Method
Sum of Years Digit Method
Physical Units of measurement method.
The accounting treatment of depreciation is reduction in the value of fixed assets on
the assets side of the balance sheet and second it is considered as non cash
expenditure on the debit side of profit and loss account

3. Name accounting standard 9 and explain it in detail

Introduction
For the purpose of this AS, Revenue includes revenue arising from-
(i) Sale of goods,
(ii) Rendering of services, and
(iii)Use of resources of the organisation by others yielding interest, royalties and
dividends.

The AS does not deal with revenue recognition aspects of revenue arising from
(i) Construction contracts,
(ii) Hire-purchase and
(iii)Lease agreements,
(iv) Government grants and
(v) Other similar subsidies and revenue of insurance companies from insurance contracts.
(vi) Profit on sale of fixed assets and appreciation in the value of fixed assets,
(vii) Appreciation in the value of current assets and natural increase in herds and
agricultural and forest products,
(viii) Gain from exchange rate fluctuations (realised or unrealised); and
(ix) Excess provisions and write back of liabilities.

Special considerations apply to these cases.


Revenue recognition means determining when the revenue should be recognised as income in
the Profit and Loss Account of an organisation. This is usually determined by agreement
between the parties involved.
Revenue from sales should be recognised at the time when risks and rewards of ownership
are transferred to the buyer for a consideration and when effective control of the seller as the
owner is lost and no uncertainty exists regarding the amount of consideration. Generally the
risks and rewards are transferred at the time of handing over the possession. However, the
buyer and seller may agree that the risk will pass at a different time.
In case of rendering of services, revenue must be recognised as the service is performed,
either on completed service method or proportionate completion method by relating the
revenue with work accomplished and certainty of considerable receivable.
(a) Proportionate Completion Method: When the performance consists of the
execution of more than one act. Revenue, in such cases, is recognised proportionately
by reference to the performance of each act. When services involve performance of
many acts over a specified period of time, revenue is recognised on a straight line
basis over the period of contract, e.g. when the service involves design of a large
plant, it may be divided into small parts of the plant on some logical basis and
revenue proportionate to each part may be recognised on delivery of the design for
that part. Alternatively, if it is not possible to divide into parts, but the performance is
estimated to be spread over a period of, say, three years, the total revenue may be
divided by three and recognised in each year.
(b) Completed Service Contract Method: This method is used when the performance
consists of the execution of a single act or some services are so significant in relation
to the transaction that the performance cannot be deemed to have been completed
until the execution of those services. Example of the first category of services may be
delivery of goods at a certain destination. The example of the second category of
service may be audit services, where the attestation of the financial statements and
issuance of audit report are considered to be so significant that even though vouching
and verification is completed the audit cannot be said to be complete till performance
of these acts. Under this method, revenue is recognised only after performance of the
single act or the significant acts.
(c) Interest is recognised on time basis, royalties on the basis of agreement and dividend
when owners right to receive payment is established. When such income from
foreign countries require exchange permissions and uncertainty in remittance is
anticipated, revenue recognition may be postponed till uncertainties are removed.
(d) When uncertainties exist in relation to measurement or collectability of revenue,
revenue recognition should be postponed. If such uncertainties arise after the revenue
has been recognised, provision should be made in respect of uncertainty.
Circumstances in which revenue recognition has been postponed pending the
resolution of significant uncertainties should be disclosed.

Accounting Standards Interpretation (ASI) 14 has been issued in respect of the manner of
disclosure of excise duty in the presentation of revenue from sales transactions (turnover)
in the statement of profit and loss. Accordingly, the amount of turnover should be
disclosed in the following manner on the face of the statement of profit and loss:
Turnover (Gross) XX
Less: Excise Duty XX
Turnover (Net) XX

Examples of application of AS 9-
Sr. Circumstances When revenue should be
No. recognised
[A] Sale of Goods
1. Delivery is delayed at buyers request and buyer At the designated time of
takes title and accepts billing. delivery, provided the goods are
on hand, identified as to be
delivered to the buyer and ready
for delivery.
2. Delivery subject to conditions
(i) Goods are subject to installation, Only after goods have been
inspection, etc. installed and inspection
approves the delivery of goods.
(ii) On approval Only after goods have been
formally accepted by the buyer
or the buyer has done an act
indicating his acceptance (use
of goods) or the time period
fixed for rejecting the goods or
reasonable time has elapsed.
(iii)Guaranteed sales, i.e., delivery is made giving Money back guarantee
buyer an unlimited right of return Immediately on sale, after
making suitable provision for
returns based on previous
experience.
Other cases as per (d) below.
(iv)Consignment sales i.e. a delivery is made When goods are sold to a third
whereby the recipient undertakes to sell the goods party.
on behalf of the consignor.
(v)Cash on delivery sales When cash is received.
3. Instalment sale, where goods are delivered only After delivery of goods.
after receipt of final payment
4. Special order and shipments i.e. where payment Goods are manufactured,
(or partial payment) is received for goods not identified and ready for delivery
presently held in stock e.g. the stock is still to be to the buyer by the third party.
manufactured or is to be delivered directly to the
customer from a third party
5. Sale/repurchase agreements i.e. where seller This is a financing agreement
concurrently agrees to repurchase the same goods and not sale.
at a later date
6. Sales to intermediate parties i.e. where goods are When significant risks of
sold to distributors, dealers or others for resale. ownership have passed.
7. Subscriptions for publications Revenue should be deferred and
recognised on a straight line
basis over time or if the items
delivered vary in value from
time to time , proportionately
on the basis of sale value of
items delivered to total sales
value.
8. Instalment Sales Revenue attributable to sale
price exclusive of interest
should be recognised at the time
of sale. Interest should be
recognised on time basis,
proportionate to unpaid balance
due to the seller.
[B] Rendering of Services
1. Installation fees When product is installed and
accepted by the buyer.
2. Advertising and insurance agency commissions Media commissions when
related advertisement or
commercial appears in media.
Product commission after
completion of project.
Insurance commission
effective commencement or
renewal dates of the related
policies.
3. Sales of tickets for event/s Single event when the event
takes place.
Number of events
proportionately on a systematic
and rational basis.
4. Tuition fees Over period of tuitions.
5. Entrance and membership fees Entrance fees- capitalised.
Annual membership fees- over
period of membership on
straight line basis.

4. Name accounting standard 10 and explain it in detail

AS-10 is Valuation of Fixed Assets. A fixed asset is an asset that is held for the
purpose of producing or supplying goods or services and not for sale in the normal
course of business. Unlike inventories, fixed assets are meant for use by an enterprise
for conducting its business, and not for resale. A manufacturing enterprise's fixed
assets would often include land, buildings, machinery, furniture and fixtures, and
office equipment.
Whether an asset is a fixed asset or not depends on the purpose for which it is held.
For example, the land on which a company's factory is built its fixed asset. However it
is plans to use its land for property development, it will be current asset. So the
intention of the owner in holding an asset determines its classification as a fixed asset
or as a current asset. This classification provides basis for its therefore important.
Fixed assets also referred to as long-lived assets or long-term assets are often divided
into several categories:
1. Property, plant and equipment: These are intangible items, i.e. they have
physical existence and can be seen and felt. An enterprise
(a) Holds these asset for use in the production or supply of goods or services, for
rental purpose; and
(b) Expects to use them during more than one period
Examples: Land buildings, machinery, ships, aircraft, vehicles, fixtures, and office
equipment
2. Intangible asset: Unlike intangible assets, these have no physical existence;
rather, they represent legal rights with associated economic benefits. Also, these are
separately identifiable. Intangible assets exclude monetary assets such as receivables
and investments.
Examples: Brand names, mastheads and publishing titles, patents, and franchises,
copyrights, and designs.
3. Natural resources: These constitute a category by themselves because of their
special characteristics
Examples: oil, natural gas, minerals, and forest.

PROPERTY, PLANT AND EQUIPMENT


Accounting for property, plant and equipment involves the following issue:
Determining the cost of acquisition of an item of property, plant and
equipment.
Allocating the cost of the item to several accounting periods.
Recording the disposal of the item.

DETERMINING COST OF ACQUISITION


Traditionally, the accounting profession has placed considerable emphasis on the
objectivity of valuation. Recall from chapter 1 that the case for the historical cost
system springs from the going concern assumption. Accounts prefer cost as the basis
of valuation of property, plant and equipment because cost is easier to measure and
verify than any other base, such as market value. Also, cost would often approximate
the service value of an asset in an arms-length transaction. The general principle is
that an enterprise can recognized a property, plant and equipment items an asset only
if it meets the following criteria:
It is probable that the item will give future economic benefits to the enterprise.
The cost of the item can be measured reliably.
Property, plant and equipment items acquired for safety or environmental reasons,
such as electrostatic precipitators used in a cement plant, also qualify for recognition
as assets because without them it will not possible to use the cement plant.

The cost of property, plant and equipment comprises the following:


1. Its purchase price, including import duties and purchase taxes;
It excludes refundable or adjustable taxes, such as goods and service tax, value
added tax and duty drawback.
Trade discounts and rebates are deducted in arriving at the purchase price.
2. Any directly attributable cost of bringing the asset to the location and
condition for its intended use;
3. Estimated costs of the obligation for dismantling and removing the item and
restoring the site on which it is located.
Examples of directly attributable costs include:
a) Stamp duty and registration fees for transfer of title to land or building
b) Professional fees, e.g. fees of architects, engineers and lawyers
c) Commission and brokerage for purchase.
d) cost of sight preparation
e) Freight, transit insurance, and handling costs
f) Cost of testing
g) Installation costs, such as special foundations for plant
The principle is that expenditures that result in future economic benefit should be
capitalized, i.e., they should be treated as part of the asset's and expenditures that do
not result in improving the service potential of the asset are charged to current
income. Often, some expenditure on start-up and trial production is necessary to
bring a plant to its working condition. Such pre-production expenditure is included in
its cost. For example, customs duty paid on a machine is capitalized because it has to
be necessarily paid to acquire that machine. But, if a machine damaged during
installation, the related repair expense should not be capitalized. This is because it
should be possible to install the machine without damaging it and the repair does not
make the machine more useful than it was when it arrived in good condition. Costs of
opening a new store and administration and other general overhead costs do not
specifically relate to acquiring an asaet or bringing it to the location and working
condition for its intended use, and should not capitalized.

5. Name accounting standard 2 and explain it in detail

Accounting standard 2 means valuation of inventories

MEANING OF INVENTORIES:

Inventories are assets:


(a) Held for sale in the ordinary course of business, or
(b) In the process of production for such sale, or
(c) In the form of materials or supplies to be consumed in the production process or in the
rendering of services.

Inventories encompass goods purchased and held for resale, for example, merchandise
purchased by retailer and held for resale, computer software held for resale, or land and other
property held for resale. Inventories also encompass finished goods produced, or work in
progress being produced, by the enterprise and include materials, maintenance suppliers,
consumables and loose tools awaiting use in the production process. Inventories do not
include machinery spares which can be used only in connection with an item of fixed assets
and whose use is expected to be irregular , such machinery spares are accounted for in
accordance with Accounting Standard (AS) 10, Accounting for fixed assets.
The Inventories of a trading concern primarily consist of the finished goods purchased for
resale, whereas the inventories of a manufacturing concern consist of raw materials, work in
progress, finished goods, stores and spares. The significance of valuation of inventory arises
mainly because it serves two purposes:
1. To determine true income, and
2. To determine true financial position.

MEANING OF COST FOR INVENTORY VALUATION:


For inventory valuation, cost may mean historical, current (replacement) or standard cost.
Historical cost represents the cost actually incurred at the date of acquisition. Current
replacement cost represents the replacement price on date of its consumption. Standard cost
represents the predetermined cost that should be incurred at a given level of efficiency and
capital utilization. But with regard to the objectivity, verifiability and effectiveness in line
with the realization concept, the historical cost basis is almost universally accepted and used;
Historical cost represents an appropriate combination of:
(a) The cost of purchase;
(b) The cost of conversion; and
(c) The other cost incurred in the normal course of business in bringing the inventories
upto their present location and condition.

Now, the us discuss the meaning of cost of purchase, cost of conversion and other
costs.
(a) Cost Of Purchase:

Cost of purchase consist of the purchase including duties and taxes (other than those
subsequently recoverable by the enterprise from the taxing authorities), freight inwards and
other expenditure directly attributable to the acquisition, less trade discounts, rebates, duty
drawbacks and subsidies in the year in which they are accounted, whether immediate or
deferred, in respect of such purchase.

(b) Cost Of Conversion:

Cost of conversion consists of:


(1) Costs which are specifically attributable to units of production i.e., direct labour,
direct expenses and sub-contracted work, and
(2) Production overheads, ascertained in accordance with adsorption costing method,
production overheads exclude expenses which relate to general administration,
finance, selling and distribution.

Now, let us know the meaning of fixed overheads, variable overheads and absorption
costing method.

Fixed Overheads:
Fixed production overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, such as depreciation and maintenance of
factory buildings and the cost of factory management and administration.

Variable Overheads:
Variable production overheads are those indirect costs of production that vary directly, or
nearly directly, with the volume of production, such as indirect materials and indirect labour.
Absorption Of Production Overheads:
The Allocation of fixed production overheads for the purpose of their inclusion in the costs of
conversion is based on the normal capacity of the production facilities. Normal capacity is the
production expected to be achieved on an average over a number of periods or seasons under
normal circumstances, taking into account the loss of capacity resulting from planned
maintenance. Variable overheads are assigned to each unit of production on the basis of
actual use of production facilities.
(c) Other Costs:

Costs other than production overheads are sometimes incurred in bringing inventories to their
present location and condition, for example, expenditure incurred in designing products for
specific customers. On the other hand, selling and distribution expenses, general
administration overheads, research and development costs and interest are usually considered
not to relate to putting the inventories in their present location and condition. They are,
therefore, excluded from determining the valuation of inventories.

METHODS OF VALUATION OF INVENTORIES:


The various methods for assigning the cost between sold and unsold goods include the
following:
1. First In First Out (FIFO) Method
2. Average Cost Method
3. Last In First Out (LIFO) Method
4. Base Stock Method
5. Specific Identification Method
6. Standard Cost
7. Adjusted Selling Price (or Retail Inventory Method)
8. Latest Purchase Price
9. Next In First Out (NIFO) Method
10. Highest In First Out (HIFO) Method

REQUIREMENTS OF ACCOUNTING STANDARD 2 AS TO METHOD:


According to revised Accounting Standard 2 issued by the Institute of Chartered Accountants
of India:
(a) The cost of inventories of items that are ordinarily interchangeable and goods or
services produced and segregated for specific projects should be assigned by Specific
Identification of their individual costs.
(b) The cost of inventories, other than those for which specific identification of
individual costs is appropriate should be assigned by using the First-in, First-out
(FIFO), or Weighted average cost formula. The formula used should reflect the
fairest possible approximation to the cost incurred in bringing the items of inventory
to their present location and condition.

6. Name accounting standard 13 and explain it in detail

AS-13 is Accounting for Investments


Investment in Perspective

A business enterprise may hold investments for earning an income and


benefiting from increase in their value or for acquiring a say in the running of
companies with which it intends to have business relations.
What is set apart an investment from other assets is that it is not intended to be
available for the investors production, selling or administrative activities.
Investments may be financial claims on other enterprises, such as equity
shares for debt instruments or land and building held for the purpose of earning a
rental income and a possible rise in their market value.
Financial Claims may be held for the purpose of short-term gain or for
strengthening long-term business interests.
Accounting for investments should reflect to investors intension and time
horizon.
Financial Instruments and Financial Assets

A financial instruments is any contract that gives rise to a financial asset of


one entity and a financial liability or equity instruments of another equity.
Thus a financial instrument may be a financial asset, a financial instrument
may be a financial liability or equity.
A financial asset is any of the following:

a) Cash
b) An equity instrument of another entity
c) A contractual right to receive cash or another financial asset from another
entity
The owner of a financial asset has a contractual claim on the entity that has
issued the financial instrument.
The instrument may be a debt instrument (another financial liability) that gives
its owner a right to periodical interest payments and principal repayment, or an equity
instrument (another entitys equity share capital)that carries a right to any dividends
distributed and residual assets.
Equity and Debt Instruments

A company may have cash for which it has no immediate use and may invest
it in order to earn a return.
Some enterprises, such as banks, are in the business of lending.
The intention in making such investments is to earn a financial return in the
form of interest, dividend and capital appreciation.
Think of these as financial investment.
Accountable classify financial assets into four categories:

1. Financial Assets at Fair Value through Profit and Loss Account


2. Held-to-Maturity Investment
3. Loans and Receivables
4. Available for Sale Financial Assets

Financial Assets at Fair Value through Profit and Loss Accounts


A financial asset at fair value through profit and a loss accounts in
a) classified as held for trading or
b)designated as a financial asset at fair value
through profit and loss account at the time of initial recognition.
A financial assets can b classified as Held-for-Trading is acquired principally
for the purpose of selling it to the near term.
An entity holding financial asset for trading intends to current profit from
short-term price fluctuations by active and frequent buying and selling of the asset.
Held for-trading financial assets are also known as Trading security. Since
the investor intends to sell these securities as part of the business, these are worth just
the amount they are expected to fetch in the market when will be accountants measure
them at Fair Value; the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an units length transaction.
If there is an active market for share meaning that the asset is bought and sold
regularly, the quoted market price is usually fair value. For this reason, the valuation
principle is commonly known as Market-to-Market Accounting.
Investments in equity and debt instruments held by mutual funds are example
of financial assets at fair value through profit and loss account.
On initial recognition , financial assets at fair value through profit and loss
account are measured at fair value. Transaction costs, such as brokerage as are
considered.
The investor recognizes in its profit and loss account (a) any related as
unrealized gains and losses, measured as the change in the fair value of that securities
since their purchase or the last balance sheet date, and (b) any dividend or interest
income earned during a period.
If an equity instrument does not have a quoted market price in an active
market accountants use valuation techniques to establish the fair value.
If it is not possible to establish the fair value of an equity instrument reliably,
it cannot be designed as a financial asset at fair value through profit and loss account.
Instead, which instruments are measured tcost. This method is followed for
unlisted or unburied equity instruments.
For financial assets carried at cost, the investors recognize to the profit and
loss account any dividend income during a period
Debt investments carry contractual rights to payment of interest and
repayment of principal. Equity securities do not carry such rights.
Accounting for instruments in debt instruments at fair value through profit and
loss account is broadly similar to that for equity investments.

7. Name accounting standard 26 and explain it in detail


OR
Explain Accounting for Intangibles (AS-26).Also state the conditions to be
satisfied for an intangible asset to be recognized in the balance sheet as an asset.

AS-26 means ACCOUNTING FOR INTANGIBLE ASSETS


An intangible asset is an identifiable non-monetary asset, without physical
substance. Intangible assets are long-term assets that can generate future earnings.
The value of an intangible asset arises from the long-term rights, privileges, or
advantages it confers its owner. Identifiability, control, and future benefits are
necessary in order to recognize an item as intangible asset. An intangible asset meets
the identifiability criterion when it (a) can be separated or divided from the enterprise
and sold or transferred, and (b) arises from contractual or other legal rights. A
copyright is an intangible asset because its owner can identify it separately from his
other assets and it arises from a legal right, he has exclusive control over its use, and
he expects future benefits from it. Other examples of intangible assets are aircraft
landing rights, brand names, mastheads, trademarks, customer lists, computer
software, patents, motion picture films, customer lists, fishing licences, mobile
phone licences, web site development costs, carbon credits, import quotas, and
franchises. An enterprise certainly benefits from supplier relationships, customer
loyalty, employee skills, and market share. Unfortunately, these do not meet the
definition of an intangible asset (particularly, identifiability and control) and hence
enterprise cannot recognize them in the financial statements.

Intangible Assets and Competitive Advantage


Professor Baruch Lev of New York University, a leading authority on intangible
assets, says:
Wealth and growth in today's economy are primarily driven by intangible
(intellectual) assets. Physical and financial assets are rapidly becoming commodities,
yielding an average return on investment. Abnormal profits, dominant competitive
positions, and sometimes even temporary monopolies are achieved by the sound
deployment of intangibles, along with other types of assets.

It is easy for a business to acquire tangible assets such as buildings and equipment.
Hence, having such assets cannot give a business edge over its rivals. Intangible
assets, such as the reputation of a brand, strength of research and development, and
highly trained and motivated employees, are much more difficult to develop, acquire
or copy. The competitive advantage that gives a firm the ability earn better rate of
return relative to its industry peers comes mainly from intangible assets.
Today, much of a firms worth is represented by intangible assets. As the role of
service industries with a large number of intangible assets continues to rise, the
question of recognizing these assets is becoming important for a large number of
companies and the users of their financial statements. Efforts are on to develop more
objective methods of valuing intangible assets. Accounting for intangibles is likely to
occupy the agenda of accounting regulators in the coming decades in many countries,
including India.

Recording Acquisition of Intangible Assets

The general principle is that an enterprise can recognize an intangible asset only if it
meets two criteria:
It is probable that it will give future economic benefits to the enterprise.
The cost of the asset can be measured reliably.
The first step in accounting for an intangible asset is to arrive at its cost of acquisition.
The principles are the same an those for tangible assets. Thus, the cost of an
intangible asset comprises its purchase price, import duties and other taxes, and any
attributable costs of bringing the asset to working condition for its intended use.
Directly attributable cost include cost of employee benefits, e.g. salaries, pensions
and other benefits, professional fees, such as lawyers fees, and cost of testing
whether the asset is functioning properly. Trade discounts, rebates and refundable
taxes are deducted in arriving at the purchase price.

Amortization of Intangible Assets

Amortization is the systematic allocation of the depreciable amount of intangible


asset over its useful life." Amortization is the terms used for depreciation of
intangible assets have finite useful lives. A number of factors, such as likely
obsolescence, competitors actions, and contractual and legal terms on the use of the
asset, determine the useful life of an intangible asset. For example, the useful life of a
patent for a CT scanner will depend on its typical product life cycle (introduction,
growth, maturity, decline and exit), likely technological developments, competitors
products, legal requirements, and so on. The method used for amortization is usually
the straight-line method though other methods such as the written-down-value method
and the production-units method may be appropriate in some cases.

Exhibit
Accounting for Intangible Assets
The owner's legal rights over, and commercial value of, the asset determines the accounting.

Asset Accounting Procedure Description


Patent - A monopoly right granted by the government - Record at cost of
acquisition.
to an inventor to make, use, exercise, sell - If the patent is the result of
in-house or distribute exclusively an invention research,
capitalize the direct costs of
consisting of a new product or employing development.
a new process for a period of 20 years. - Amortize cost over the lower
of the
estimated useful life and the
legal life.

Copyright - An exclusive right granted by the government - Record at cost of acquisition


in relation to a literary, dramatic, artistic, -Amortize cost over the lower
of the musical or other expression ordinarily for estimated useful life,
and the legal life. the lifetime of the author and a period 60
years following the death of the author
(50 years in India).

Trademark, -Marks or other signs that are capable of -Record at cost of acquisition
Brand Name identifying products/services as those of a - Amortize cost over the
estimated useful life.
particular producer and distinguishing -Do not recognize internally
generated them from those of its competitors. brands.
-The registration is initially for 10 years but
renewable indefinitely for successive periods of 10 years each.

Franchise, - A contractual right to trade in an exclusive -Record a lump sum payment to the
Licence area or to manufacture using a special process. franchiser.
-Amortize over the period of
franchise
licence.
8. What are the causes of depreciation? Explain any one method of providing
depreciation with imaginary figures.

Causes of Depreciation

Wear and tear. Any asset will gradually break down over a certain usage period,as
parts wear out and need to be replaced.Eventually,the asset can no longer be repaired,
and must be dispose of. This cause is most common for production equipment, which
typically has a manufacturers recommended life span that is based on a certain
number of units produced. Other assets, such as buildings, can be repaired and
upgraded for long period of time.
Perishability .some assets have an extremely short life span.This condition is most
applicable to inventory, rather than fixed assets.
Usage rights .A fixed asset may actually be a right to use something for a certain
period of time.If so, its life span terminets when the usage rights expire, so
depreciation must be completed by the end of the usage period.
Efflux of time mere passage of time will cause a fall in the value of an asset even if
it is not used.
Obsolescene a new invention or a permanent change in demand may render the
asset useless.
Accident.
Fall in market price.

Straight line method: Same depreciation is charged over the entire useful life.
Example: On April 1,2001, Company a purchased an equipment at the cost of 140000.
This equipment is estimated to have 5 years useful life at the end of 5 th year, the
salvage value will be 20000.Company A recognizes depreciation to the nearest whole
month. Calculate the depreciation expences for 2011,2012 and 2013 using SLM.
Depreciation for 2011: (140000-20000)*1/5*9/12=18000
Depreciation for 2012: (140000-20000)*1/5*12/12=24000
Depreciation for 2013: (140000-20000)*1/5*12/12=24000

9. Short note on the accounting for fixed assets:

Introduction
Financial statements disclose certain information relating to fixed assets. In many
enterprises these assets are grouped into various categories, such as land, buildings,
plant and machinery, vehicles, furniture and fittings, goodwill, patents, trademarks
and designs. This standard deals with accounting for such fixed assets except as
described below.
This standard does not deal with the specialised aspects of accounting for fixed assets
that arise under a comprehensive system reflecting the effects of changing prices but
applies to financial statements prepared on historical cost basis.
This standard does not deal with accounting for the following items to which special
considerations apply:
forests, plantations and similar regenerative natural resources;
wasting assets including mineral rights, expenditure on the
exploration for and extraction of minerals, oil, natural gas and similar non-
regenerative resources;
expenditure on real estate development; and
livestock.
Expenditure on individual items of fixed assets used to develop or maintain the
activities covered in above, but separable from those activities, are to be accounted
for in accordance with this Standard.
This standard does not cover the allocation of the depreciable amount of fixed assets
to future periods since this subject is dealt with in Accounting Standard 6 on
Depreciation Accounting.
This standard does not deal with the treatment of government grants and subsidies,
and assets under leasing rights. It makes only a brief reference to the capitalisation of
borrowing costs and to assets acquired in an amalgamation or merger. These subjects
require more extensive consideration than can be given within this Standard.

Definitions
The following terms are used in this Standard with the meanings specified:
Fixed asset is an asset held with the intention of being used for the purpose of
producing or providing goods or services and is not held for sale in the normal
course of business.
Fair market value is the price that would be agreed to in an open and unrestricted
market between knowledgeable and willing parties dealing at arms length who are
fully informed and are not under any compulsion to transact.
Gross book value of a fixed asset is its historical cost or other amount substituted
for historical cost in the books of account or financial statements. When this
amount is shown net of accumulated depreciation, it is termed as net book value.

Explanation
Fixed assets often comprise a significant portion of the total assets of an enterprise,
and therefore are important in the presentation of financial position. Furthermore, the
determination of whether an expenditure represents an asset or an expense can have a
material effect on an enterprises reported results of operations.

Identification of Fixed Assets


The definition in paragraph gives criteria for determining whether items are to be
classified as fixed assets. Judgement is required in applying the criteria to specific
circumstances or specific types of enterprises. It may be appropriate to aggregate
individually insignificant items, and to apply the criteria to the aggregate value. An
enterprise may decide to expense an item which could otherwise have been included
as fixed asset, because the amount of the expenditure is not material.
Stand-by equipment and servicing equipment are normally capitalised. Machinery
spares are usually charged to the profit and loss statement as and when consumed.
However, if such spares can be used only in connection with an item of fixed asset
and their use is expected to be irregular, it may be appropriate to allocate the total cost
on a systematic basis over a period not exceeding the useful life of the principal item.
In certain circumstances, the accounting for an item of fixed asset may be improved
if the total expenditure thereon is allocated to its component parts, provided they are
in practice separable, and estimates are made of the useful lives of these components.
For example, rather than treat an aircraft and its engines as one unit, it may be better
to treat the engines as a separate unit if it is likely that their useful life is shorter than
that of the aircraft as a whole.
Components of Cost
The cost of an item of fixed asset comprises its purchase price, including import
duties and other non-refundable taxes or levies and any directly attributable cost of
bringing the asset to its working condition for its intended use; any trade discounts
and rebates are deducted in arriving at the purchase price. Examples of directly
attributable costs are:
site preparation;
initial delivery and handling costs;
installation cost, such as special foundations for plant; and
professional fees, for example fees of architects and engineers.
The cost of a fixed asset may undergo changes subsequent to its acquisition or
construction on account of exchange fluctuations, price adjustments, changes in duties
or similar factors.
Administration and other general overhead expenses are usually excluded from the
cost of fixed assets because they do not relate to a specific fixed asset. However, in
some circumstances, such expenses as are specifically attributable to construction of a
project or to the acquisition of a fixed asset or bringing it to its working condition,
may be included as part of the cost of the construction project or as a part of the cost
of the fixed asset.
The expenditure incurred on start-up and commissioning of the project, including the
expenditure incurred on test runs and experimental production, is usually capitalised
as an indirect element of the construction cost. However, the expenditure incurred
after the plant has begun commercial production, i.e., production intended for sale or
captive consumption, is not capitalized and is treated as revenue expenditure even
though the contract may stipulate that the plant will not be finally taken over until
after the satisfactory completion If the interval between the date a project is ready to
commence commercial production and the date at which commercial production
actually begins is prolonged, all expenses incurred during this period are charged to
the profit and loss statement. However, the expenditure incurred during this period is
also sometimes treated as deferred revenue expenditure to be amortized over a period
not exceeding 3 to 5 years after the commencement
Self-constructed Fixed Assets
In arriving at the gross book value of self-constructed fixed assets,
in the gross book value are costs of construction that relate directly to the specific
asset and costs that are attributable to the construction activity in general and can be
allocated to the specific asset. Any internal profits are eliminated in arriving at such
costs.
Non-monetary Consideration
When a fixed asset is acquired in exchange for another asset, its cost is usually
determined by reference to the fair market value of the consideration given. It may be
appropriate to consider also the fair market value of the asset acquired if this is more
clearly evident. An alternative accounting treatment
It may be noted that this paragraph relates to all expenses incurred during the
period. This expenditure would also include borrowing costs incurred during the said
period. Since Accounting Standard (AS) 16, Borrowing Costs, specifically deals with
the treatment of borrowing costs, the treatment provided by AS 16 would prevail over
the provisions in this respect contained in this paragraph as these provisions are
general in nature and apply to all expenses. that is sometimes used for an exchange
of assets, particularly when the assets exchanged are similar, is to record the asset
acquired at the net book value of the asset given up; in each case an adjustment is
made for any balancing receipt or payment of cash or other consideration.
When a fixed asset is acquired in exchange for shares or other securities in the
enterprise, it is usually recorded at its fair market value, or the fair market value of the
securities issued, whichever is more clearly evident.
Improvements and Repairs
Frequently, it is difficult to determine whether subsequent expenditure related to
fixed asset represents improvements that ought to be added to the gross book value or
repairs that ought to be charged to the profit and loss statement. Only expenditure that
increases the future benefits from the existing asset beyond its previously assessed
standard of performance is included in the gross book value, e.g., an increase in
capacity.
The cost of an addition or extension to an existing asset which is of a capital nature
and which becomes an integral part of the existing asset is usually added to its gross
book value. Any addition or extension, which has a separate identity and is capable of
being used after the existing asset is disposed of, is accounted for separately.
Amount Substituted for Historical Cost
Sometimes financial statements that are otherwise prepared on a historical cost basis
include part or all of fixed assets at a valuation in substitution for historical costs and
depreciation is calculated accordingly. Such financial statements are to be
distinguished from financial statements prepared on a basis intended to reflect
comprehensively the effects of A commonly accepted and preferred method of
restating fixed assets is by appraisal, normally undertaken by competent valuers.
Other methods sometimes used are indexation and reference to current prices which
when applied are cross checked periodically by appraisal method.
The revalued amounts of fixed assets are presented in financial
statements either by restating both the gross book value and accumulated
depreciation so as to give a net book value equal to the net revalued amount or by
restating the net book value by adding therein the net increase on account of
revaluation. An upward revaluation does not provide a basis for crediting to the profit
and loss statement the accumulated depreciation existing at the date of revaluation.
Different bases of valuation are sometimes used in the same financial statements to
determine the book value of the separate items within each of the categories of fixed
assets or for the different categories of fixed assets. In such cases, it is necessary to
disclose the gross book value included on each basis.
Selective revaluation of assets can lead to unrepresentative amounts being reported in
financial statements. Accordingly, when revaluations do not cover all the assets of a
given class, it is appropriate that the selection of assets to be revalued be made on a
systematic basis. For example, an enterprise may revalue a whole class of assets
within a unit.
It is not appropriate for the revaluation of a class of assets to result in the net book
value of that class being greater than the recoverable amount of the assets of that
class.
An increase in net book value arising on revaluation of fixed assets is normally
credited directly to owners interests under the heading of revaluation reserves and is
regarded as not available for distribution. A decrease in net book value arising on
revaluation of fixed assets is charged to profit and loss statement except that, to the
extent that such a decrease is considered to be related to a previous increase on
revaluation that is included in revaluation reserve, it is sometimes charged against that
earlier increase. It sometimes happens that an increase to be recorded is a reversal of a
previous decrease arising on revaluation which has been charged to profit and loss
statement in which case the increase is credited to profit and loss statement to the
extent that it offsets the previously recorded decrease.
Retirements and Disposals
An item of fixed asset is eliminated from the financial statements on disposal.
Items of fixed assets that have been retired from active use and are
held for disposal are stated at the lower of their net book value and net realisable
value and are shown separately in the financial statements. Any expected loss is
recognised immediately in the profit and loss statement.
In historical cost financial statements, gains or losses arising on disposal are
generally recognised in the profit and loss statement.
On disposal of a previously revalued item of fixed asset, the difference between net
disposal proceeds and the net book value is normally charged or credited to the profit
and loss statement except that, to the extent such a loss is related to an increase which
was previously recorded as a credit to revaluation reserve and which has not been
subsequently reversed or utilised, it is charged directly to that account. The amount
standing in revaluation reserve following the retirement or disposal of an asset which
relates to that asset may be transferred to general reserve.
Valuation of Fixed Assets in Special Cases
In the case of fixed assets acquired on hire purchase terms, although legal ownership
does not vest in the enterprise, such assets are recorded at their cash value, which, if
not readily available, is calculated by assuming an appropriate rate of interest. They
are shown in the balance sheet with an appropriate narration to indicate that the
enterprise does not have full ownership thereof.
Where an enterprise owns fixed assets jointly with others (otherwise than as a partner
in a firm), the extent of its share in such assets, and the proportion in the original cost,
accumulated depreciation and written down value are stated in the balance sheet.
Alternatively, the pro rata cost of such jointly owned assets is grouped together with
similar fully owned assets. Details of such jointly owned assets are indicated
separately in the fixed assets register.
Where several assets are purchased for a consolidated price, the
Consideration is apportioned to the various assets on a fair basis as determined by
competent valuers.
Fixed Assets of Special Types
Goodwill, in general, is recorded in the books only when some
Consideration in money or moneys worth has been paid for it. Whenever a business
is acquired for a price (payable either in cash or in shares or otherwise) which is in
excess of the value of the net assets of the business taken over, the excess is termed as
goodwill. Goodwill arises from business connections, trade name or reputation of an
enterprise or from other intangible benefits enjoyed by an enterprise.
As a matter of financial prudence, goodwill is written off over a period. However,
many enterprises do not write off goodwill and retain it as an asset.
Q10: Discuss income Recognition & Accrual income (AS-9) and When can revenue be
recognized as per AS-9, in the case of transaction of sale of goods?
A: Introduction:
1. This Standard deals with the bases for recognition of revenue in the statement of profit
and loss of an enterprise. The Standard is concerned with the recognition of revenue
arising in the course of the ordinary activities of the enterprise from
The sale of goods,
The rendering of services, and
The use by others of enterprise resources yielding interest, royalties and dividends.
2. This Standard does not deal with the following aspects of revenue recognition to which
special considerations apply:
(i) Revenue arising from construction contracts;
(ii) Revenue arising from hire-purchase, lease agreements;
(iii) Revenue arising from government grants and other similar subsidies;
(iv) Revenue of insurance companies arising from insurance contracts.

3. Examples of items not included within the definition of revenue for the purpose of this
Standard are:
(i) Realized gains resulting from the disposal of, and unrealized gains resulting from the
holding of, non-current assets e.g. appreciation in the value of fixed assets;
(ii) Unrealized holding gains resulting from the change in value of current assets, and the
natural increases in herds and agricultural and forest products;
(iii) Realized or unrealized gains resulting from changes in foreign exchange rates and
adjustments arising on the translation of foreign currency financial statements;
(iv) Realized gains resulting from the discharge of an obligation at less than its carrying
amount;
(v) Unrealized gains resulting from the restatement of the carrying amount of an obligation.
Definition:
Revenue is the gross inflow of cash, receivables or other consideration arising in the course
of the ordinary activities of an enterprise from the sale of goods, from the rendering of
services, and from the use by others of enterprise resources yielding interest, royalties and
dividends. Revenue is measured by the charges made to customers or clients for goods
supplied and services rendered to them and by the charges and rewards arising from the use
of resources by them.
Sale of goods:
In the business enterprise when revenue of sale of good should be recognized it is depends up
on satisfying following conditions. All these conditions must be satisfied to recognize income
in books of accounts.
Seller should have transferred the ownership of goods to purchaser for the consideration or
all significant risk & rewards of ownership should have transferred to buyer.
There should not be any kind of uncertainty for collection or receipt of cash, consideration
or receivable etc.
Seller does not retain any direct or effective control on such goods transferred.

Rendering of Services
Revenue from service transactions is usually recognized as the service is performed either
by the proportionate completion method or by the completed service contract method.

(i) Proportionate completion method the revenue recognized under this method would be
determined on the basis of contract value, associated costs, number of acts or other suitable
basis. For practical purposes, when services are provided by an indeterminate number of acts
over a specific period of time, revenue is recognized on a straight line basis over the specific
period unless there is evidence that some other method better represents the pattern of
performance.

(ii) Completed service contract methodPerformance consists of the execution of a single


act. The completed service contract method is relevant to these patterns of performance and
accordingly revenue is recognized when the sole or final act takes place and the service
becomes chargeable.

The Use by Others of Enterprise Resources Yielding Interest, Royalties and Dividends
The use by others of such enterprise resources gives rise to:
(i) interestcharges for the use of cash resources or amounts due to the enterprise;
(ii) Royaltiescharges for the use of such assets as know-how, patents, trademarks and
copyrights;
(iii) Dividendsrewards from the holding of investments in shares.

Main Principles
If at the time of rising of any claim it is unreasonable to expect ultimate collection, revenue
recognition should be postponed.
Explanation: The amount of revenue from sales transactions (turnover) should be disclosed in
the following manner on the face of the statement of profit and loss:

Turnover (Gross) XX
Less: Excise Duty XX
Turnover (Net) XX
The amount of excise duty to be deducted from the turnover should be the total excise duty
for the year except the excise duty related to the difference between the closing stock and
opening stock. The excise duty related to the difference between the closing stock and
opening stock should be recognized separately in the statement of profit and loss.

In a transaction involving the sale of goods, performance should be regarded as being


achieved when the following conditions have been fulfilled:
(i) the seller of goods has transferred to the buyer the property in the goods for a price or
all significant risks and rewards of ownership have been transferred to the buyer and
the seller retains no effective control of the goods transferred to a degree usually
associated with ownership; and
(ii) No significant uncertainty exists regarding the amount of the consideration that will
be derived from the sale of the goods.
In a transaction involving the rendering of services, performance should be measured either
under the completed service contract method or under the proportionate completion method,
whichever relates the revenue to the work accomplished. Such performance should be
regarded as being achieved when no significant uncertainty exists regarding the amount of
the consideration that will be derived from rendering the service.
Revenue arising from the use by others of enterprise resources yielding interest, royalties and
dividends should only be recognized when no significant uncertainty as to measurability or
collectability exists. These revenues are recognized on the following bases:
(i) Interest: on a time proportion basis taking into account the amount outstanding and
the rate applicable.
(ii) Royalties: on an accrual basis in accordance with the terms of the relevant agreement.
(iii) Dividends from : when the owners right to receive pay investments in ment is
established
Shares

Disclosure

In addition to the disclosures required by Accounting Standard 1 on Disclosure of


Accounting Policies (AS 1), an enterprise should also disclose the circumstances in which
revenue recognition has been postponed pending the resolution of significant uncertainties.
Q11) Explain the important provision of AS-10 (accounting for fixed assets)
(You can also refer the handout provided)

Introduction:-
1. Financial statements disclose certain information relating to fixed assets. In many
enterprises these assets are grouped into various categories, such as land, buildings, plant and
machinery, vehicles, furniture and fittings, goodwill, patents, trade marks and designs. This
standard deals with accounting for such fixed assets except as described in paragraphs 2 to 5
below.

2. This standard does not deal with the specialized aspects of accounting for fixed assets that
arise under a comprehensive system reflecting the effects of changing prices but applies to
financial statements prepared on historical cost basis.

3. This standard does not deal with accounting for the following items to
which special considerations apply:
(i) forests, plantations and similar regenerative natural resources;
(ii) wasting assets including mineral rights, expenditure on the
exploration for and extraction of minerals, oil, natural gas and similar
non-regenerative resources;
(iii) expenditure on real estate development; and
(iv) livestock.
Expenditure on individual items of fixed assets used to develop or maintain the activities
covered in (i) to (iv) above, but separable from those activities, are to be accounted for in
accordance with this Standard.

4. This standard does not cover the allocation of the depreciable amount of fixed assets to
future periods since this subject is dealt with in Accounting Standard 6 on Depreciation
Accounting.

5. This standard does not deal with the treatment of government grants and subsidies, and
assets under leasing rights. It makes only a brief reference to the capitalisation of borrowing
costs and to assets acquired in an amalgamation or merger. These subjects require more
extensive consideration than can be given within this Standard.

Definitions
6. The following terms are used in this Standard with the meanings specified:
6.l Fixed asset is an asset held with the intention of being used for the purpose of producing
or providing goods or services and is not held for sale in the normal course of business.
6.2 Fair market value is the price that would be agreed to in an open and unrestricted market
between knowledgeable and willing parties dealing at arms length who are fully informed
and are not under any compulsion to transact.
6.3 Gross book value of a fixed asset is its historical cost or other amount substituted for
historical cost in the books of account or financial statements. When this amount is shown net
of accumulated depreciation, it is termed as net book value.

Explanation

7. Fixed assets often comprise a significant portion of the total assets of an enterprise, and
therefore are important in the presentation of financial position. Furthermore, the
determination of whether an expenditure represents an asset or an expense can have a
material effect on an enterprises reported results of operations.

8. Identification of Fixed Assets


8.1 The definition in paragraph 6.1 gives criteria for determining whether items are to be
classified as fixed assets. Judgement is required in applying the criteria to specific
circumstances or specific types of enterprises. It may
be appropriate to aggregate individually insignificant items, and to apply the criteria to the
aggregate value. An enterprise may decide to expense an item which could otherwise have
been included as fixed asset, because the amount of the expenditure is not material.
8.2 Stand-by equipment and servicing equipment are normally capitalised. Machinery spares
are usually charged to the profit and loss statement as and when consumed. However, if such
spares can be used only in connection with an item of fixed asset and their use is expected to
be irregular, it may be appropriate to allocate the total cost on a systematic basis over a period
not exceeding the useful life of the 8.3 In certain circumstances, the accounting for an item of
fixed asset may be improved if the total expenditure thereon is allocated to its component
parts, provided they are in practice Sep
9.1 The cost of an item of fixed asset comprises its purchase price, including import duties
and other non-refundable taxes or levies and any directly attributable cost of bringing the
asset to its working condition for its intended
use; any trade discounts and rebates are deducted in arriving at the purchase price. Examples
of directly attributable costs are:
(i) site preparation;
(ii) initial delivery and handling costs;
(iii) installation cost, such as special foundations for plant; and
(iv) professional fees, for example fees of architects and engineers.

The cost of a fixed asset may undergo changes subsequent to its acquisition or construction
on account of exchange fluctuations, price adjustments, changes in duties or similar factors.

9.2 Administration and other general overhead expenses are usually excluded from the cost of
fixed assets because they do not relate to a specific fixed asset. However, in some
circumstances, such expenses as are specifically
attributable to construction of a project or to the acquisition of a fixed asset or bringing it to
its working condition, may be included as part of the cost of the construction project or as a
part of the cost of the fixed asset.
9.3 The expenditure incurred on start-up and commissioning of the project, including the
expenditure incurred on test runs and experimental production, is usually capitalised as an
indirect element of the construction cost. However,
the expenditure incurred after the plant has begun commercial production, i.e., production
intended for sale or captive consumption, is not capitalised and is treated as revenue
expenditure even though the contract may stipulate that the plant will not be finally taken
over until after the satisfactory completion

9.4 If the interval between the date a project is ready to commence commercial production
and the date at which commercial production actually begins is prolonged, all expenses
incurred during this period are charged to the profit and loss statement. However, the
expenditure incurred during this period is also sometimes treated as deferred
revenue expenditure to be amortised over a period not exceeding 3 to 5 years after the
commencement

10. Self-constructed Fixed Assets


10.1 In arriving at the gross book value of self-constructed fixed assets, the same principles
apply as those described in paragraphs 9.1 to 9.5. Included in the gross book value are costs
of construction that relate directly to the specific asset and costs that are attributable to the
construction activity in general and can be allocated to the specific asset. Any internal profits
are eliminated in arriving at such costs.

11. Non-monetary Consideration


11.1 When a fixed asset is acquired in exchange for another asset, its cost is usually
determined by reference to the fair market value of the consideration given. It may be
appropriate to consider also the fair market value of the asset
acquired if this is more clearly evident. An alternative accounting treatment
1 It may be noted that this paragraph relates to all expenses incurred during the period. This
expenditure would also include borrowing costs incurred during the said period. Since
Accounting Standard (AS) 16, Borrowing Costs, specifically deals with the treatment of
borrowing costs, the treatment provided by AS 16 would prevail over the provisions in this
respect contained in this paragraph as these provisions are general in nature and apply to all
expenses.that is sometimes used for an exchange of assets, particularly when the
assets exchanged are similar, is to record the asset acquired at the net book value of the asset
given up; in each case an adjustment is made for any balancing receipt or payment of cash or
other consideration.
11.2 When a fixed asset is acquired in exchange forshares or othersecurities in the enterprise,
it is usually recorded at its fair market value, or the fair market value of the securities issued,
whichever is more clearly evident
12. Improvements and Repairs
12.1 Frequently, it is difficult to determine whether subsequent expenditure related to fixed
asset represents improvements that ought to be added to the gross book value or repairs that
ought to be charged to the profit and loss statement. Only expenditure that increases the
future benefits from the existing asset beyond its previously assessed standard of performance
is included in the gross book value, e.g., an increase in capacity.
12.2 The cost of an addition or extension to an existing asset which is of a capital nature and
which becomes an integral part of the existing asset is usually added to its gross book value.
Any addition or extension, which has a separate identity and is capable of being used after the
existing asset is disposed of, is accounted for separately.

13. Amount Substituted for Historical Cost


13.1 Sometimes financial statements that are otherwise prepared on a historical cost basis
include part or all of fixed assets at a valuation in substitution for historical costs and
depreciation is calculated accordingly. Such financial statements are to be distinguished from
financial statements prepared on a basis intended to reflect comprehensively the effects of

14. Retirements and Disposals


14.1 An item of fixed asset is eliminated from the financial statements on disposal.
14.2 Items of fixed assets that have been retired from active use and are held for disposal are
stated at the lower of their net book value and net realisable value and are shown separately
in the financial statements. Any expected loss

15. Valuation of Fixed Assets in Special Cases


15.1 In the case of fixed assets acquired on hire purchase terms, although legal ownership
does not vest in the enterprise, such assets are recorded at their cash value, which, if not
readily available, is calculated by assuming an
appropriate rate of interest. They are shown in the balance sheet with an appropriate narration
to indicate that the enterprise does not have full ownership thereof.

16. Fixed Assets of Special Types


16.1 Goodwill, in general, is recorded in the books only when some consideration in money
or moneys worth has been paid for it. Whenever a business is acquired for a price (payable
either in cash or in shares or otherwise) which is in excess of the value of the net assets of the
business taken over, the excess is termed as goodwill. Goodwill arises from
business connections, trade name or reputation of an enterprise or from other
intangible benefits enjoyed by an enterprise.

17. Disclosure

17.1 Certain specific disclosures on accounting for fixed assets are already required by
Accounting Standard 1 on Disclosure of Accounting Policies and Accounting Standard 6 on
Depreciation Accounting.
17.2 Further disclosures that are sometimes made in financial statements
include:
(i) gross and net book values of fixed assets at the beginning and end of an accounting period
showing additions, disposals, acquisitions and other movements;
(ii) expenditure incurred on account of fixed assets in the course of construction or
acquisition; and

18. The items determined in accordance with the definition in paragraph 6.1 of this Standard
should be included under fixed assets in financial statements.

19. The gross book value of a fixed asset should be either historical cost or a revaluation
computed in accordance with this Standard. The method of accounting for fixed assets
included at historical cost is set out in paragraphs 20 to 26; the method of accounting of
revalued assets

20. The cost of a fixed asset should comprise its purchase price and any attributable cost of
bringing the asset to its working condition for its intended use.

21. The cost of a self-constructed fixed asset should comprise those costs that relate directly
to the specific asset and those that are attributable to the construction activity in general and
can be all

22. When a fixed asset is acquired in exchange or in part exchange for another asset, the cost
of the asset acquired should be recorded either at fair market value or at the net book value of
the asset given up, adjusted for any balancing payment or receipt of cash or
other consideration. For these purposes fair market value may be determined by reference
either to the asset given up or to the asset acquired, whichever is more clearly evident.Fixed
asset acquired in exchange for shares or other securities in the enterprise should be recorded
at its fair market value,or the fair market value of the securities issued, whichever is more
clearly evident.

23. Subsequent expenditures related to an item of fixed asset should be added to its book
value only if they increase the future benefits from the existing asset beyond its previously
assessed standard of performance.
24. Material items retired from active use and held for disposal should be stated at the lower
of their net book value and net realisable value and shown separately in the financial
statements.

25. Fixed asset should be eliminated from the financial statements on disposal or when no
further benefit is expected from its use and disposal.

26. Losses arising from the retirement or gains or losses arising from disposal of fixed asset
which is carried at cost should be recognised in the profit and loss statement.

27. When a fixed asset is revalued in financial statements, an entire class of assets should be
revalued, or the selection of assets for revaluation should be made on a systematic basis. This
basis should be disclosed.
28. The revaluation in financial statements of a class of assets should not result in the net
book value of that class being greater than the recoverable amount of assets of that class.

29. When a fixed asset is revalued upwards, any accumulated depreciation existing at the date
of the revaluation should not be credited to the profit and loss statement.

30. An increase in net book value arising on revaluation of fixed assets should be credited
directly to owners interests under the head of revaluation reserve, except that, to the extent
that such increase is related to and not greater than a decrease arising on revaluation
previously recorded as a charge to the profit and loss statement, it may be credited to the
profit and loss statement. A decrease in net book value arising on revaluation of fixed
asset should be charged directly to the profit and loss statement except that to the extent that
such a decrease
is related to an increase which was previously recorded as a credit to revaluation reserve and
which has not been subsequently reversed or

31. The provisions of paragraphs 23, 24 and 25 are also applicable to fixed assets included in
financial statements at a revaluation.

32. On disposal of a previously revalued item of fixed asset, the difference between net
disposal proceeds and the net book value should be charged or credited to the profit and loss
statement except that to the extent that such a loss is related to an increase which was
previously recorded as a credit to revaluation reserve and which has not been subsequently
reversed or utilized, it may be charged directly to that account.

33. Fixed assets acquired on hire purchase terms should be recorded at their cash value,
which, if not readily available, should be calculated by assuming an appropriate rate of
interest. They should be shown in the balance sheet with an appropriate narration to indicate
that the enterprise does not have full ownership thereof.

34. In the case of fixed assets owned by the enterprise jointly with others, the extent of the
enterprises share in such assets, and the proportion of the original cost, accumulated
depreciation and written down value should be stated in the balance sheet. Alternatively, the
pro rata cost of such jointly owned assets may be grouped together with
similar fully owned assets with an appropriate disclosure thereof.

35. Where several fixed assets are purchased a business is acquired for a price (payable in
cash or in shares or
otherwise) which is in excess of the value of the net assets of the business taken over, the
excess should be termed as goodwill.
Disclosure
37. The following information should be disclosed in the financial statements:
(i) gross and net book values of fixed assets at the beginning and end of an accounting period
showing additions, disposals, acquisitions and other movements;
(ii) expenditure incurred on account of fixed assets in the course of construction or
acquisition; and
(iii) revalued amounts substituted for historical costs of fixed assets, the method adopted to
compute the revalued amounts, the nature of indices used, the year of any appraisal made,
and whether an external valuer was involved, in case where fixed assets are stated at revalued
amounts
Q12) What is Investments according to AS-13? How is it classified? How is the cost of
investment determined?

Definition: Investments are assets held by an enterprise for earning income by way of
dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing
enterprise.

Assets held as stock-in-trade are not investments.

Classification of Investments:
Investments are classified as Long Term Investments and Current Investments.
Current Investments: A current investment is an investment that is by its nature readily
realisable and is intended to be held for not more than one year from the date on which such
investment is made.
It is thus , Any investment which is converted in to cash within one year
Valuation of Current investments: All current investments will be calculated on cost or fair
market price which is less.

Long Term Investments: A long term investment is an investment other than a current
investment.
Valuation of long term investments: Long term investments are valued at its original cost for
recording in the books of accounts.

It is very necessary to disclose the method of valuation of investments in the financial


statements because of other investors interest are affected from this point.

Cost of Investments

The cost of an investment includes acquisition charges such as brokerage, fees and duties.

If an investment is acquired or partly acquired by the issue of shares or other


securities, the acquisition cost is the Fair value of the securities issued and if it is
acquired in exchange or part exchange, for another asset, the acquisition cost of the
investment will be the Fair Value of the asset given up. Alternatively the acquisition
cost of the investment may be determined with reference to the fair value of the
investment acquired if it is more clearly evident.
Interest, dividend and rentals receivable in respect of such investments are treated as
income except where such interest or dividend relates to pre-acquisition period, in
which case, such interest or dividend received is reduced from the acquisition cost.
The cost of the right shares, if subscribed to is added to the carrying amount of
original shares but if rights are sold, the sale proceeds are treated as income and
credited to profit and loss statement.

Carrying Amount of Investments

Current Investments should be carried in the financial statements at the lower of cost and fair
value determined either on an individual investment basis or by category of investment, but
not on an overall basis.

Long Term Investments should be carried at cost.


However, provision for diminution shall be made to recognise a decline, other than
temporary, in the value of the investments, such reduction being determined and made for
each investment individually.

Any reduction in the carrying amount and any reversals of such reductions should be charged
or credited to the profit and loss statement.

Disposal of Investments

When any investments is sold, the difference between the carrying amount and net sale
proceeds should be charged or credited to the profit and loss statement.

When disposing of a part of the holding of an individual investment, the carrying amount to
be allocated to that part is to be determined on the basis of the average carrying amount of the
total holding of the investment.

Disclosures

1. Classification of investments, the accounting policies for determination of carrying


amount of investments.
2. The amounts included in profit and loss statement for interest, dividends, rentals,
profits and losses on disposal of investments, and changes in the carrying amount of
investments
3. Significant restriction on the right of ownership, realisability of investments or the
remittance of income and proceeds of disposal.
4. The aggregate amount of quoted and unquoted investments, giving the aggregate
market value of quoted investments.
5. Other disclosures specifically required by the relevant statute.
Q13) Accounting Standard (AS) 2 - Valuation of Inventories :-
(also refer the handouts provided)

This Accounting Standard includes paragraphs set in bold italic type and plain type,
which have equal authority.
Paragraphs in bold italic type indicate the main principles.
This accounting standard should be read in the context of its objective and the General
instructions contained in part A of the Annexure to the notification.

Objectives:-
A primary issue in accounting for inventories is the determination of the value at
which inventories are carried in the financial statements until the related revenues are
recognised.
This Standard deals with the determination of such value, including the ascertainment
of cost of inventories and any write-down thereof to net realisable value.

The FIFO Method, LIFO Method and Weighted Average Cost (WAC)

The FIFO method, LIFO method and Weighted Average Cost method are three ways
of valuing your inventory. In this we're going to look at all three methods.

At the end of each period (month or year) one should do a physical inventory count to
determine the number of inventory on hand.

Then you need to place a value on the goods. One would think this would be easy -
the value of the goods is simply how much they originally cost.

Unfortunately there is a bit more to it than just this.

There are three methods used when valuing the goods that you have on hand at
the end of the period.

1. The First-In-First-Out Method (FIFO)


This method assumes that the first inventories bought are the first ones to be sold, and that
inventories bought later are sold later.

It is very common to use the FIFO method if one trades in foodstuffs and other goods that
have a limited shelf life, because the oldest goods need to be sold before they pass their sell-
by date.
Thus the first-in-first-out method is probably the most commonly used method in small
business. Well, probably.

The value of our closing inventories in this example would be calculated as follows:

Using the First-In-First-Out method, our closing inventory comes to $1,100. This equates to a
cost of $1.10 per lollypop ($1,100/1,000 lollypops).

{EXAMPLES HAS BEEN TAKEN FROM WEBSITES}

2. The Last-In-First-Out Method (LIFO)


This method assumes that the last inventories bought are the first ones to be sold, and that
inventories bought first are sold last.

The value of our closing inventories in this example would be calculated as follows:
The LIFO method is commonly used in the U.S.A.

Using the Last-In-First-Out method, our closing inventory comes to $1,000. This equates to a
cost of $1.00 per lollypop ($1,000/1,000 lollypops).
3. The Weighted Average Cost Method
This method assumes that we sell all our inventories simultaneously.

The weighted average cost method is most commonly used in manufacturing businesses
where inventories are piled or mixed together and cannot be differentiated, such as chemicals,
oils, etc.

Chemicals bought two months ago cannot be differentiated from those bought yesterday, as
they are all mixed together.

So we work out an average cost for all chemicals that we have in our possession. The method
specifically involves working out an average cost per unit at each point in time after a
purchase.

Revised AS-2 recognized FIFO and weighted average cost method of inventory
valuation.

Q14) Discuss the various determinants considered for valuation of Fixed Assets as given
by A.S. 10 Accounting for Fixed Assets.
They lead to generation of operational revenue, which speaks of their crucial importance.
Hence the need for proper valuation.

Meaning and Significance

Fixed assets represents assets held with the intention of being used for the purpose of
producing or providing good or services and are not held for sale in the normal course
of business.
Significant portion of total assets.
Effect on reported results-Expense as fixed assets or revenue expense.

Scope and Coverage

Deals with land, building, plant and machinery, vehicle, furniture and fittings except
Regenerative natural resources like forests and plantation
Expenditure on the exploration and extraction of non-regenerative sources like
minerals, oil and natural gas
Mineral rights
Expenditure on the real estate development
Livestock
Leased assets
The standard however, covers the individual items of those fixed assets which are used to
develop or maintain the above mentioned assets and are separable from them.

Principle on Revaluation
Revalued amounts are restated in the financial statement by both gross book values
and accumulated depreciation
When revalued, an entire class of assets should be revalued, or on a systematic basis
Should not result in the net book values greater than recoverable amount of assets
Increase in net book values on revaluation is credited to owner interests under the
heading revaluation reserves and are not available for distribution. At time reversal
of previous recorded decrease in P&L account
Decrease is charged to P&L unless it reserve a corresponding reserve related to a
previous increase on revaluation

Valuation in Special Cases

Jointly owned fixed assets-the extent of the enterprise share in such assets, and
proportion of original cost, accumulated depreciation and written down value should
be stated in the BS
Basket purchase-apportioned on a fair basis as determined by a competent value

Retirements and Disposal

Stated at the lower of their net book value and NRV and shown separately
Eliminated from statement on disposal or no further benefit is expected
Any Loss/gain is charged/credited to P&L
Loss/gain of revalued assets-P&L or reserved with revaluation reserve
Amount in revaluation reserve after disposal/retirement-general reserve

Disclosures

Gross and net book value at the beginning and at the end of the accounting period
showing additions, disposal, acquisitions and other movements
Expenditure incurred towards fixed assets in the course of construction or acquisition
Additional disclosures where fixed assets are stated at revalued amounts
Module 3
1) What is Balance Sheet? Draw a pro forma in vertical shape of it. Explain its
significance. How does it differ from a Trial Balance?

A balance sheet is one of the financial statements of assets & liabilities of an enterprise at a
given date it is called a balance sheet of balance those ledger accounts which have not been
closed till the preparation of the trading & profit & Loss accounts.
Vertical shape of balance sheet :-
Details Sch. Rs. Rs.
(1)Share holders funds
(a)capital A
(b)Reserve & surplus
(2)Loan Funds
(a)Secured loans
(b)Unsecured loans
(Sources of funds) ............
Total
Application of funds
(a)Fixed Assets E

(b)Investments
(c)Net current Assets
(current assets-current
liabilities)
A+B+C .......... ..
Significance of trial balancesheet :-
(1) To ascertain the nature & value of a business.
(2) To ascertain the nature & amount of a liabilities of a business.
(3) To find out the financial solvency of an enterprise. An enterprise is considered to be a
solvent if its assets exceed its external liabilities.
Balance sheet differs from trial balance because only assets and liabilities are reflected in
balance sheet and trial balance is rough sheet showing the balances of all the accounts.
2) Show format of balance sheet in horizontal form for a Company.

FORMAT OF THE DETAILED BLANCE SHEET IN A HORIZONTAL FORM


Horizontal Form of Balance Sheet
Balance Sheet of .(Name of the Company) as on ..
Figures Figures Figures Figures
for the Liabilities for the for the Assets for the
previou current previou current
s year year s year year
Rs. Rs. Rs. Rs.
Share Capital Fixed Assets:
Authorised Goodwill
shares of Rs. Each Land
Preference Building
Equity Leasehold Premises
Issued: Railway Sidings
Preference Plant and Machinery
Equity Furniture
Less: Calls Unpaid: Patents and Trademarks
Add: Forfeited Live Stock
Shares Vehicles
Reserves and Investments:
Surplus: Government or Trust
Capital Reserve Securities, Shares, Debentures,
Bonds
Capital Redemption Reserve
Securities Premium Current Assets, Loans and
Advances:
Other Reserves
(A) Current Assets:
Profit and Loss Account
Interest Accrued
Secured Loans:
Stores and Spare parts
Debentures
Loose Tools
Loans and Advance from
Stock in Trade
Banks
Work in Progress
Loans and Advance from
Sundry Debtors
Subsidiary Companies
Cash and Bank balances
Other Loans and Advances
(B) Loans and Advances:
Unsecured Loans:
Advances and Loans to
Fixed Deposits Subsidiary
Loans and Advances from Bills Receivable
Subsidiaries Advance Payments
Companies Miscellaneous-Expenditure:
Short Term Loans and Preliminary Expenses
Advances
Other Loans and Advances Discount on Issue of Shares
Current Liabilities and and other Deferred Expenses
Provisions: Profit and Loss Account
A. Current Liabilities (debit Balance: if any)
Acceptances
Debentures
Sundry Creditors
Outstanding Expenses
B. Provisions:
For Taxation
For Dividends
For Contingencies
For Provident Fund Schemes
For Insurance, Pension and
Other similar benefits

EXAMPLE OF HORIZONTAL BLANCE SHEET:


Illustration . From the following balances taken from the books of Gujarat Exports Ltd.
prepare Companys Balance Sheet in Horizontal Form:

Rs. Rs.
Land and Buildings 3,25,000 Patents
Plant and Machinery 2,90,000 Investments
Sundry Debtors 65,000 Preliminary Expenses
8,000 Equity Shares of Rs. 100 Securities premium
each Rs. 50 called up 4,00,000 Provision for Income tax
15% debentures 1,00,000 Closing Stock
Debenture Redemption Reserve 50,000 Cash
Prepaid Insurance 4,800 Advance Income Tax
Profit & Loss (Cr.) 1,13,000 Sundry Creditors
Bills Payable 15,000 Outstanding expenses
General Reserve 1,00,000 Proposed Dividend

Investments are in partly-paid shares on which calls of Rs. 10,000 have not been made.
Solution:
BALANCE SHEET OF GUJARAT EXPORTS LTD.

As at in horizontal form
Liabilities Rs. Assets Rs.
SAHRE CAPITAL: FIXED ASSETS:
Authorized Capital ______?___ Land and Building 3,25,000
Issued Capital Plant and Machinery 2,90,000
8,000 Equity shares of Patents 7,200
Rs.100 each
Subscribed Capital 8,00,000 INVESTMENTS: 20,000
8,000 Equity shares of
Rs.100 each, Rs. 50 called up 4,00,000
CURRENT ASSETS, LOANS AND
RESERVES AND SURPLUS: ADVANCES:
Securities Premium 20,000 (A) Current assets:
General Reserve 1,00,000 Closing Stock 1,28,000
Profit & Loss A/c 1,13,000 Sundry Debtors 65,000
Debenture Redemption Reserve 50,000 Cash 12,000

SECURED LOANS: (B) Loans and Advances


15% Debentures 1,00,000 Prepaid Insurance 4,800
Advance Income Tax 4,000
UNSECURED LOANS: 15,000
-- MISCELLANEOUS 2,000
CURRENT LIABILITIES AND EXPENDITURE:
PROVISIONS: Preliminary Expenses
(A) Current liabilities 15,000
Bills payable 15,200
Sundry Creditors 4,800
Outstanding Expenses

(B)Provisions
Provision for Income tax 24,000
Proposed dividend 16,000

8,58,000 8,58,000

Q3 Features of Balance Sheet

Balance sheet is the position statement which shows the position of assets and liabilities. It
has got the following special features:

1. Balance sheet is a statement. Though Balance sheet is an integral part of double


entry system, but it is not an account. It has got the balance of certain ledger accounts.
The balance of all ledger accounts are not shown in it.

2. Prepared on a specified date. Balance Sheet is prepared on a specific date, i.e., at the
end of accounting period. It is common practice and also legal requirement to prepare
Balance. Sheet together with Trading and profit and loss account at the end of the
accounting year. It may be prepared after every six months if the proprietors so desire.
Accounting year may consist of calendar year or assessment year or its own
accounting year. Companies are required to adopt assessment year (April 1 to 31st
March) as per legal requirement. Sole proprietorship and partnership can adopt
accounting year which suits them, i.e., Diwali to Diwali or Dussehra to Dussehra or
assessment or calendar year.

3. It is a statement of assets and liabilities. Though the Balance sheet has debit and
credit balance but its sides are named as assets and liabilities. The left hand side is a
liability representing credit balance. Right hand side is assets representing debit
balances.

4. Knowledge about the nature of assets and liabilities. Balance sheet categories
assets as liquid assets, current assets, fixed assets and fictitious assets. Knowledge of
liabilities as current liabilities, fixed liabilities and reserve and funds can be gained
from Balance sheet.

5. Knowledge of financial position. Balance sheet depicts true financial position of the
business. The position can be ascertained by study of the Balance sheet. We can
calculate short term and long term financial ratios, proprietary and other ratios to have
the knowledge of the financial soundness of the business.

6. Assets and liabilities tally each other. The total of assets must be equal to liabilities.
According to accounting equation, assets are always equal to creditors, and
proprietors equity. If the total of assets and liabilities are not equal, there is likely to
be certain mistake.

Need and Purpose of Balance Sheet

Balance sheet is a vital part of final account. It has to be compulsorily prepared as per legal
provisions. Objects of the Balance sheet have been summarized as under :

Main objectives of Balance Sheet

The main object of Balance sheet is to assess the financial position of the firm. It is the list of
assets and liabilities of the firm on a specific date. The short term and long term financial
position of the firm can be obtained from the analysis of the Balance sheet.
Balance sheet is rightly said to be a mirror reflecting the true value of assets and liabilities on
particular date.

A balance sheet looks like this


Module 4
1. Which are the ratios to be calculated to check the profitability of a concern?

Profitability ratios measure the degree of operating success of company. The only reason why
investors are interested in a company is that they think they will earn reasonable return in the
form of capital gain and dividends on their investment.

Profit margin

Return on assets

Return on Equity

Earning per share

1 profit margin ratio (Gross profit/Operating profit/Net Profit):

PROFIT AFTER TAX x100


SALES

2 Return On Assets :

Profit after tax x100


Average total assets

3 Return on Equity :

Profit after Tax x100


Average shareholders Equity

4 Earning Per Share :

Net profit x100


number of equity shares

Price earning ratio : This is a popular measure extensively used in investment analysis. A
High price earnings ratios indicates the stock markets confidence in the companys future
earnings growth
Average stock price
Earnings per Share

2. Describe the various tools used for doing financial analysis.


OR
Discuss various methods of financial statement analysis in brief (tools &
techniques).

Horizontal Analysis
Trend analysis
Vertical Analysis
Ratio analysis

1. Horizontal Analysis

Financial statements present comparative information for at least two years. Horizontal
analysis calculate the amount in % changes from the previous year to the current year. It is
simple but useful exercise. While an amount change in itself may mean something converting
it to percentages is more useful in appreciating the order of magnitude of the change

change change
2010 2009 amount percent

sales 177642 164009 13633 8


other income 3440 4465 -1025 -23
total revenue 181082 159544 12608 7
expenses 153802 143985 9817 7
pbit 27280 15559 2791 11
interest expense 75 211 -136 7
profit before tax 27205 15348 2927 12
tax 6153 4314 1839 43
profit after tax 21052 11034 1088 5
exceptional items 594 116 478 412
net profit 20458 10918 1566 8

Trend analysis

Involves calculation of percentage changes in financial statements. Items for a number of


successive year. It is an extension of horizontal analysis to many years. We first assign a
value of hundred to the financial statement item in a past financial year is as the base year and
then express the amount in the following year as percentage of the base year value

2010 2009 2008 2007 2006

SALES 177642 164008 139134 124109 115658


Net profit 21646 20080 19188 18942 13586
fixed assets 24943 21358 17477 15852 16205

TREND
ANALYSIS

NET SALES 154 142 120 107 100


net
profit 159 148 141 139 100
fixed assets 154 132 108 98 100

to illustrate below using 2005 as the base year the sales value in 2010 becomes 154 as shown
below

index in 2006 = 2010 sales x100


2005 sales

177642 x100 = 154


115658

this means that from 2005 to 2010 sales increase 54% over a period net profit increased 59%
better then sales the growth of 54% and fixed assets match the sales growth . and the whole
the three moved in tandem

Vertical Analysis

profit and loss account

2010 2009
Sales and other
incomes 100 100
Expenses 84.98 85.59
profit before tax 15.02 14.41
tax 3.4 2.56
profit after tax 11.62 11.85
exceptional items 0.33 0.07
profit after tax 11.95 11.92

Common size balance sheet

2010 2009
SHAREHOLDERS FUNDS AND LIABILITIES
SHARE CAPITAL 2.25 2.52
RESERVES AND SURPLUS 25.23 22.18
MINORITY INTEREST 0.11 0.09
SECURED LOANS 0.11 1.81
UNSECURED LOANS 0 3.21
CURRENT ;IABILITIES AND PROVISON 70.17 67.99
DEFFRED TAX LIABILITIES 2.13 2.2
TOTAL FUNDS 100 100

ASSETS
FIXED ASSETS 28.82 24.68
INVESTMENTS 12.61 3.32
INVENTORIES 22.92 29.82
SUNDRY DEBTORS 7.12 6.48
CASH AND BANK BALANCES 20.72 21.54
OTHER CURRENT ASSETS 0.2 0.23
LOANS AND ADVANCES 6.07 8.8
DEFERRED TAX ASSETS 4.69 5.13
TOTAL ASSETS 100 100

RATIO ANALYSIS

Ratio Analysis involves establishing a relevant financial relationship between components of


financial statements. Two companies may have earned the same amount of profit in a year ,
but unless the profit is related to sales or total assets, it is not possible to conclude which of
them is more profitable. Ratio analysis helps in identifying significant relationship between
financial statements items for further investigation. If used with understanding of industry
factors and general economic conditions, it can be powerful tool for recognizing a companys
strengths as well as its potential trouble spots. Commonly used financial ratios and their
interpretation are discussed in the following section
3. State advantages and limitations of ratio analysis.

Accounting ratios are very significant in analysing the financial statements.


Through accounting ratios, it will be easy to know the true financial position and financial
soundness of a business concern. However, despite the advantages of ratio analysis, it suffers
from a number of disadvantages which are listed later on

Advantages

Measuring the profitability


The main objective of a business is to earn a satisfactory return on the funds invested in it.
Financial analysis helps in ascertaining whether adequate profits are being earned on the
capital invested in the business or not. It also helps in knowing the capacity to pay the interest
and dividend.
Indicating the trend of Achievements
Financial statements of the previous years can be compared and the trend regarding various
expenses, purchases, sales, gross profits and net profit etc. can be ascertained. Value of assets
and liabilities can be compared and the future prospects of the business can be envisaged.
Assessing the growth potential of the business
The trend and other analysis of the business provides sufficient information indicating the
growth potential of the business.
Comparative position in relation to other firms
The purpose of financial statements analysis is to help the management to make a
comparative study of the profitability of various firms engaged in similar businesses. Such
comparison also helps the management to study the position of their firm in respect of sales,
expenses, profitability and utilising capital, etc.
Assess overall financial strength
The purpose of financial analysis is to assess the financial strength of the business. Analysis
also helps in taking decisions, whether funds required for the purchase of new machines and
equipments are provided from internal sources of the business or not if yes, how much? And
also to assess how much funds have been received from external sources.
Assess solvency of the firm
The different tools of an analysis tell us whether the firm has sufficient funds to meet its short
term and long term liabilities or not.

The following are the main limitations of accounting ratios.


Ignorance of qualitative aspect
The ratio analysis is based on quantitative aspect. It totally ignores qualitative aspect
which is sometimes more important than quantitative aspect.
Ignorance of price level changes
Price level changes make the comparison of figures difficult over a period of time.
Before any comparison is made, proper adjustments for price level changes must be
made.
No single concept
In order to calculate any ratio, different firms may take different concepts for different
purposes. Some firms take profit before charging interest and tax or profit before tax
but after interest tax. This may lead to different results.
Misleading results if based on incorrect accounting data
Ratios are based on accounting data. They can be useful only when they are based on
reliable data. If the data are not reliable, the ratio will be unreliable.
No single standard ratio for comparison
There is no single standard ratio which is universally accepted and against which a
comparison can be made. Standards may differ from Industry to industry.
Difficulties in forecasting
Ratios are worked out on the basis of past results. As such they do not reflect the present
and future position. It may not be desirable to use them for forecasting future events.

4. What is Trend analysis? State its objectives and advantages of using the same.

A trend analysis is a method of analysis that allows traders to predict what will
happen with a stock in the future. Trend analysis is based on historical data about the
stock's performance given the overall trends of the market and particular indicators
within the market.
"With the past, we can see trajectories into the future - both catastrophic and creative
projections.
Objectives Of Trend Analysis
On the trends that can have an impact on their organization, and facilitate
continued success of their enterprise. Trend Analysis allows you to plot aggregated
response data over time. This is especially valuable, if you are conducting a long
running survey and would like to measure differences in perception and responses
over time.
Thus Trend Analysis provides an insight into the following:
i. Changes and trends in customers needs and behavior, and shifts in the
customers' perception of value.
ii. Trend in price changes and cost drivers for the industry and/or specific
segments.
iii. Change and evolution of the industry in terms of new entrants, and
competition, threat of substitutes and relationship with buyers and suppliers.

Importance of Trend Analysis


Data analysis including Trend Analysis is essential for a firm's competitive
intelligence program. The ability to accurately gauge customers' response to changes
in business and other environmental parameters is a powerful competitive advantage.
Trend Analysis Methods allow business users to make analytical decisions about
those business processes that maximize revenue from core customers.
With the information explosion, an incredible amount of information is
available to organizations; which being raw data does not provide useful information.
It is the conversion of this raw data into significant facts, relationships, trends, and
patterns that could otherwise go unobserved.
This makes Trend Analysis Methods integral to running an organization's
value chain and acquiring and consolidating corporate success. It allows business
owners to take analytical decisions about the direction in which their business should
head, how to use their resources optimally, and how to focus on business processes to
maximize revenue from core customers.

5. Discuss in brief Fund and importance of Fund Flow Statement.

Funds flow statement is the statement which shows flow of funds (CASH AND
BANK) for the given period (generally year). it shows the "HOW" fund inflows from
various activities like operating and non-operating their "WHERE" they are been
applied i.e out flows. In other words it is the statement showimg inflows and outflows
of fund of business from operating and non-operating activities. Hence it is also called
as " HOW COMES & WHERE GO STATEMENT ".It is blue print of cash book
containing all transaction through cash and book during the given period.
It is prepared by comparing two year financial statement and additional
information. it is based on Principle of "Every asset is represented by liability"

ADVANTAGES.
i. Operating Profit : It helps to segregate from profit and loss account the
business (operating) profit and non-business (non-operating) profit.it is important
since laymen will only consider overall profit, which may be due to non-business
activity. For e.g. an enterprises may have earned profit Rs.25 lakhs as per profit and
loss account. which includes profit on sale of Land Rs 1 crore i.e. the actual business
loss of Rs.75 lakhs
ii. Efficiency of operation : it segregates and set criteria for judging efficiently
operating the business activity is only operating profit according to the nature of
business. It set its own benchmark without comparing the result with other enterprises
dealing in same line of business activity.
iii. Fills the Understanding gap : The financial statements are unable how the
assets are raised or the reason for liquidity crisis in spite of huge profit shown in profit
and loss account.
iv. Utilisation of working capital : It helps to analysis the movement of current
assets and current liabilities and effect on working capital. It also guides management
for further utilisation.
v. Further Financial Assistance: It helps the enterprises to claim loans and other
financial assistance either from public or from private financial institutions. as it from
basis of judging the policy adopt by the management in utilisation of fund by the
enterprises.

DISADVANTAGES .
i. Historical in Nature : The fund flow statement are based on passed data
prepared from financial statement the value of the transaction do not present the
current prices. It makes difficult to analyse the current and future position of the
business.
ii. Unreliable to changes in policies : The fund flow statement are unreliable due
to changes in the re-grouping and rearrangement of figures of financial statement. The
errors crept while preparing financial statement also effect the fund flow statement. if
the financial statement are manipulated the fund flow.
iii. Fails to resolve liquidity problem : The fund flow statement show the sources
and application of fund during the given period. However it fails to resolve the
enterprises problem of liquidity crunch. it fails to indicate when the was liquidity
crunch or surplus exited by enterprises during the given period.

6. Explain the purpose of operating profit ratio and net profit ratio. When is
ROCE greater than RONW?

The purpose of operating profit ratio is to know the profitability before interest and
tax liability whereas net profit ratio depicts the profitability after interest payment and
tax.
When loan funds are less than or equal to networth at that point of time ROCE will be
greater than RONW

RoCE is a good measure to guage operational efficiency of a company - to understand


how much operating profit (earnings before interest and tax) a company is able to
generate from the total capital employed (shareholder funds plus borrowed funds).

The ultimate financial objective of all companies is to create wealth for their
shareholders. Equity investors in a company embark on the highest risk. One cannot
assume with any certainty that returns will be generated for them as they earn only
residual returns left after the company fulfils all its other financial obligations. In such
a scenario, isn't it fair on the part of investors to analyse the company's past returns
generated for the equity shareholders before investing in it? One such return metric is
return on equity. Return on equity comprises two things. One, the returns generated
by the company on the funds raised by the shareholders and second, the returns
generated by the company on the reinvested earnings.

7. What do you understand by Trend Analysis? Explain in brief with hypothetical


example.
A trend analysis is a method of analysis that allows traders to predict what will
happen with a stock in the future. Trend analysis is based on historical data about the
stock's performance given the overall trends of the market and particular indicators
within the market.
"With the past, we can see trajectories into the future - both catastrophic and creative
projections.

TREND
ANALYSIS

NET SALES 154 142 120 107 100


net
profit 159 148 141 139 100
fixed assets 154 132 108 98 100

to illustrate below using 2005 as the base year the sales value in 2010 becomes 154 as shown
below

index in 2006 = 2010 sales x100


2005 sales

177642 x100 = 154


115658

this means that from 2005 to 2010 sales increase 54% over a period net profit increased 59%
better then sales the growth of 54% and fixed assets match the sales growth . and the whole
the three moved in tandem

8. Financial ratio analysis by itself does not provide an understanding of the


operation of the firm. Financial analysis should be integrated with industry analysis, analysis
of the economy, and analysis of the firms strategy. Analyse the statement.

A market assessment tool designed to provide a business with an idea of the complexity of a
particular industry. Industry analysis involves reviewing the economic, political and market
factors that influence the way the industry develops. Major factors can include
the power wielded by suppliers and buyers, the condition of competitors, and
the likelihood of new market entrants.

Competition within an industry is grounded in its underlying economic structure. It goes


beyond the behaviour of current competitors.
The state of competition in an industry depends upon five basic competitive forces. The
collective strength of these forces determines profit potential in the industry. Profit potential
is measured in terms of long-term return on invested capital. Different industries have
different profit potentialjust as the collective strength of the five forces differs between
industries.

Industry analysis enables a company to develop a competitive strategy that best defends
against the competitive forces or influences them in its favour. The key to developing a
competitive strategy is to understand the sources of the competitive forces. By developing an
understanding of these competitive forces, the company can:

Highlight the companys critical strengths and weaknesses (SWOT analysis)


Animate its position in the industry
Clarify areas where strategic changes will result in the greatest payoffs
Emphasize areas where industry trends indicate the greatest significance as
either opportunities or threats

So along with financial analysis if all the above mentioned aspects are considered then it
will definitely show a better understanding for the operation of a particular firm.

9) Question : Which are the ratios to be worked out to study the long term solvency of a
concern?
Solvency ratios deal with entitys ability to meet its long term obligations.
Solvency refers to the firms ability to meet its long term indebtedness.
The following are important solvency ratios:
Net assets value ratio (NAV)
Debt equity ratio (D/E)
Interest cover ratio
Debt service coverage ratio (DSCR)
The capacity of the company to discharge its obligations towards long term
lenders indicates its financial strength and ensures its long term survival. It is
important for an analyst to study the solvency position, or gearing structure, or
leveraging capacity of a company.
It is important to analyses the capacity of a company to raise further capital
and borrowings. This is done by analyzing the net asset value (NAV), debt equity
(D/E), interest cover and debt service coverage ratio (DSCR) are computed and
analyzed within this broad group.
These are particularly useful for financial institutions, banks and other lenders
to assess the credit-worthiness of a company and the attendant financial default risk.
1] NAV (Rs.)
Function:-
This ratio measures the net worth or net asset value per equity share. It thus seeks to assess as
to what extent the value of equity share of a company contributed at a premium has grown or
the value/wealth has been created for the share holders. It is also known as net worth per
share or book value per share.
Computation:-
NAV (Rs.) =
Equity shareholders funds
------------------------------------
No. of equity shares O/S
Where,
No. of equity shares O/S here are with reference to year end figure and not their
weighted average since the NAV calculation is as at the year end.
Analytical value and Aid to decision making:-
This ratio indicates the efficiency or otherwise of the company management in
building up a back up of reserves and surplus to fall back upon. Prudent management of
finances requires the ploughing back of net profit after paying adequate dividends on equity.
Assessment/bench marking:-
A) Industry NAV
B) NAVs of the ledger and laggard in the industry
C) Growth in NAV over previous year and longer term past
D) Industry trends

Strategic key drivers:-


a) RONW and EPS
b) Dividend policy
c) Share premium

2] Debt equity (times)


Function:-
The ratio measures the proportion of debt and capital- both equity and preference. In
the capital structure of a company. In the words, it measures the extent of assets financed
though long term borrowings.
Computation:-
Debt equity (times) =
Long term debt
---------------------
Total net worth

Where,
Total net worth means
(Equity shareholders fund + preference capital)
Analytical value and Aid to decision making:-
The ratio helps in assessing whether a company is relying more on debt or capital for
financing its assets. Higher the debt more is the financial risk of default in interest and debt
service. It also hampers the capacity of a company to raise chapter funds. High capital
content means not passing the cost differential of debt (which is cheaper) and equity to the
equity holders. Companies, therefore, need to have an optimum capital structure.
Assessment/bench marking:-
A) Institutional norms, which generally take into account a debt equity ratio of 1.5:1
while financing projects. The norms stipulate higher ratios for capital intensive and
infrastructure projects.
B) Decline in the ratio over previous year and longer term past.
C) As mentioned in points (b) to (d) in RONW.
Strategic key drivers:-
a) RONW and EPS
b) Dividend policy
c) Share premium
d) NAV
e) Borrowing policy

3] Interest covers (times):-


Function:-
The ratio measures the capacity of a company to pay the interest liability it has
incurred on its long term borrowings, out of its cash profits. It is also known as times- interest
covered.
Computation:-
Interest cover (times) =

PAT + interest on long-term debt + non-cash charges


-----------------------------------------------------------------------
Interest on long-term debt

Analytical value and Aid to decision making:-


The ratio helps in assessing whether a company is comfortably placed to service its
interest obligations out of revenues it is generating. Higher the ratio, greater the ability of a
company to service interest, lesser the financial risk of default and higher the comfort level of
the lenders.
Assessment/bench marking:-
a) Institutional norms, which generally look for an interest cover of 2:1 while financing
projects.
b) As mentioned in points (a) to (d) in RONW.
Strategic key drivers:-
a) RONW
b) Debt equity
c) Cost of long term borrowings
d) Proportion on non-cash charges in the expense structure of the company.

4] DSCR (times):-
Function:-
The ratio measures the capacity of a company to pay the installments of the principal
due and the interest liability it has incurred on its long term borrowings, out of its cash
profits. It is also known as times-debt service covered.
Computation:-
DSCR (times) =

PAT + interest on long term debt + non-cash charges


------------------------------------------------------------------------------
Interest on long term debt + installments of principal due
Analytical value and Aid to decision making:-
The ratio helps in assessing whether a company is comfortably placed to service its
due outstanding long term loans and interest obligations thereon out of revenues it is
generating. Higher the ratio, greater the ability of a company in debt service, lesser the
financial risk of default and higher the comfort level of the lenders.
Assessment/bench marking:-
a) Institutional norms, which generally look for a DSCR of 1.6 and above while
financing projects
b) As mentioned in point (a) and (d) in RONW
Strategic key drivers:-
a) RONW
b) Debt equity
c) Tenure of loans
d) Cost of long term borrowings
e) Proportion of non-cash charges in the expense structure of the company.

10) What is ratio analysis? State its objectives and advantages of using the same.

Introduction

The analysis of the financial statements and interpretations of


financial result of a Particular period of operations with the help of ratio is termed as ratio
analysis. Ratio analysis used to determine the financial soundness of a business concern.

Meaning and Definition

The term ratio refers to the mathematical relationship between any two inter-related
variables. In other words, it is establishes relationship between two items expressed in
quantitative form.
Accounting J. Batty, Ratio can be defined as the term accounting ratio is used to describe
significant relationships which exist between figures shown in a balance sheet and profit and
loss account in a budgetary control system or any other part of the accounting management.

Objectives of Ratio analysis:

Objectives of Ratio analysis are as follows:-

1. Assessment of past performance: Past performance is a good indicator of future


performance. Investors or creditors are interested in the trend of past sales, cost of goods sold,
operating expenses, net income, cash flows and return on investment. These trends offer a
means for judging managements past performance and are possible indicators of future
performance.
2. Assessment of current Position: Ratio analysis shows the current position of the firm in
terms of the types of assets owned by a business firm and the different liabilities due against
the enterprise.
3. Prediction of profitability and growth prospects: Ratio analysis helps in assessing and
predicting the earning prospects and growth rates in earning which are used by investors
while comparing investment alternatives and other users in judging earning potential of
business enterprise.
4. Prediction of bankruptcy and failure: Ratio analysis is an important tool in assessing and
predicting bankruptcy and probability of business failure.
5. Assessment of the operational efficiency: Ratio analysis helps to assess the operational
efficiency of the management of a company. The actual performance of the firm which are
revealed in the financial statement can be compared with some standards set earlier and the
deviation of any between standards and actual performance can be used as the indicator of
efficiency of the management.

Advantages of ratio analysis:-

Ratio analysis is necessary to establish the relationship between two accounting


figures to highlight the significant information to the management or users who can analysis
the business situation and to monitor their performance in a meaningful way. The following
are the advantages of ratio analysis:
1. It facilitates the accounting information to be summarized and simplified in a required form.
2. It highlights the inter-relationship between the facts and figures of various segments of
business.
3. Ratio analysis helps to remove all type of wastages and inefficiencies.
4. It provides necessary information to the management to take prompt decision relating to
business.
5. It helps to the management for effectively discharge its functions such as Planning,
Organizing, Controlling, Directing and Forecasting.
6. Ratio analysis reveals profitable and unprofitable activities. Thus the management is able to
concentrate on unprofitable activities and consider improving the efficiency.
7. Ratio analysis is used as a measuring rod for effective control of performance of business
activities.
8. Ratio is an effective means of communication and informing about financial soundness made
by the business concern to the proprietors, investors, creditors and other parties.
9. Ratio analysis is an effective tool which is used for measuring the operating result of the
enterprises.
10. It facilitates control over the operation as well as resources of the business.
11. Effective co-operation can be achieved through ratio analysis
12. Ratio analysis provides all assistance to the management to fix responsibilities.
13. Ratio analysis helps to determine the performance of liquidity, profitability and solvency
position of the business concern.

11) Differences between Horizontal and Vertical Analysis

Though both horizontal and vertical analysis are done by the companies for the purpose of
analysis of financial statements, and both are useful in analysis of trends for the financial
statements of the company, however they both are different in following ways.

Under horizontal analysis an analyst compares the financial statement of the company for two
more accounting periods, it can be used on any item in the financial statement company so if
company wants to see whether its sales for current year is good or not it will compare the
sales for the year 2010 with sales for year 2009 or for previous years. It is a time series
analysis in the sense that it shows comparison of financial data for several years against a
chosen base year. It is also called dynamic analysis of the financial statements.

Vertical analysis is done to review and analysis the financial statements for a year only and
therefore it is also called static analysis. Under this method each entry for assets, liabilities
and equities in a balance sheet is represented as a percentage of the total account. So if in
asset side of balance sheet cash is $200, building is $400 and machinery is $600 and total of
balance sheet is $1000, then cash will be 20 percent of total of balance sheet building will be
40 percent and machinery will be 60 percent. One of the advantages of using this method is
that one gets an idea of composition of the balance sheet and then it can compared with
previous years to see the relative annual changes in companys balance sheet.

Horizontal Analysis = calculating the Rupee change and% change in financial statement
amounts across time

Vertical Analysis (Common Size Analysis) = changing all rupee values for accounts to %
values.
12 ) Briefly Explain IFRS

IFRSs are the accounting standards published by the International Accounting


Standards Board (IASB).The IASB was established in 2001 by its forerunner,
the International Accounting Standards Committee, which itself was establish
in 1973. Leading accounting experts anticipate that IFRSs will be accepted for
financial reporting, in place of US GAAP, for all companies listed in US stock
market, as early as 2016.

Meaning
International Financial Reporting Standards (IFRS) are designed as a
common global language for business affairs so that company accounts
are understandable and comparable across international boundaries.
They are consequence of growing international shareholding and trade
and are particularly important for companies that have dealings in
several countries.
The rules to be followed by accountants to maintain books of accounts
which is comparable, understandable, reliable and relevant as per the
users internal or external.

Adoption of IFRS
IFRS are used in many parts of the world, including the European
Union, India, Hong kong, Australia, Malaysia, Pakistan, GCC
countries, Russia, Chile, South Africa, Singapore and Turkey.
As more than 113 countries around the world, including all of Europe,
currently require or permit IFRS reporting and 85 require IFRS
reporting for all domestic, listed companies, according to the U.S
Securities and Exchange.

Benefits
Increase credibility and reliability of financial statements especially in
cross-border transactions.
Comparability of financial statement at both national and international
levels.
Easy access to technical support given the widespread adoption around
the world.
Career mobility of accounting professionals.
Extensive disclosures useful for a wide variety of stakeholders
including shareholders, lenders, regulators, customers, suppliers, etc.
Improves quality of information necessary for management decision.

Some Key Challenges to Implementation


1. Amendments in the law -
IFRS will have a bearing on the legal provisions as are presently set out
in the Indian Income Tax Act, Companies Act, etc.

2. Impact on financial results -


Financial reports will experience a lot of changes. For example
treatment of depreciation differs, Hence, the value of assets as well as
the probability of the organization may swing, which in turn, may
impact the net worth.

3. User awareness and training -


Many people are yet not aware of IFRS, their complexities and impact.
A change in the reporting format will require awareness of these new
norms and systems, training and education, both professional as well
the user.
India and IFRS
In India, there will be two sets of Accounting Standards-
The existing Indian Accounting Standards (AS)
Applicable to all companies which are not required to adopt IFRS
converged standards.

Indian Accounting Standards as compared with IFRS (Ind-AS) -


Applicable in companies operating in India in phased manner. The date of
implementation of the Ind-AS is expected to be with effect from
Financial Year 2016-17.

Q13) What is IFRS ( International Financial Reporting Standards )? What are the
advantages of converting to IFRS ?
Ans - IFRS( International Financial Reporting Standards ) represent a
set of generally accepted accounting principles ( GAAP ) used by companies to prepare
financial statements, a critical source of information published annually, at a minimum and
useful to various stakeholders ( shareholders, debtors, clients, employees and governments )
in understanding a companys financial performance and managements stewardship of the
companys resources.
It is developed by the International Accounting Standards
Board ( IASB ), these are a set of accounting rules followed by, or being adopted by, more
than 100 countries. All member states of the EU are required to use IFRS as adopted by the
EU for listed companies since 2005.
The Institute of Chartered Accountants of India ( ICAI ) has
announced that IFRS will be mandatory in India for financial statements for the periods
beginning on or after 1 April 2012. This will be done by revising existing accounting
standards to make them compatible with IFRS. The ICAI has also stated that IFRS will be
applied to companies above Rs.1000 crores ( Rs. 10 billion ) from April 2011.
Advantages of converting to IFRS:
1) To develop a single set of high quality, understandable, enforceable and globally
accepted international financial reporting standards ( IFRS ) through its standard-
setting body, the IASB.
2) To promote the use and rigorous application of those standards.
3) To take account of the financial reporting needs of emerging economics and SMEs (
small and medium-sized entities).
4) To bring about convergence of national accounting standards and IFRSs to high
quality solutions.
5) By adopting IFRS, a business can present its financial statements on the same basis as
its foreign competitors, making comparisons easier.
6) Companies with subsidiaries in countries that require or permit IFRS may be able to
use one accounting language company-wide.
7) Companies also may need to convert to IFRS if they are a subsidiary of a foreign
company that must use IFRS, or if they have a foreign investor that must use IFRS.
8) Companies may also benefit by using IFRS if they wish to raise capital abroad.

Q14 ) State strength and benefits of USGAAP

Benefits

Significance

GAAP guidelines help businesses maintain consistency in their presentation of financial


information, reduce the risk of misrepresentation and avoid fraud. GAAP was created to
safeguard the rights of stakeholders, including investors. It holds companies responsible for
their financial reporting activities, thus providing greater assurance to all interested parties.
Through the use of GAAP guidelines, companies provide true and fair presentation of
financial information.

Consistency

Adhering to GAAP guidelines can help you implement proper controls and safeguards. The
fact that the GAAP guidelines suggest using a consistent basis that professionals can apply to
accounting transactions illustrates this fact. Consistency leads to a more fair presentation and
helps in comparing financial statements across multiple periods. This helps you determine
your companys overall performance, identify areas that need improvement and judge the
benefits of changes that you implement.
Stakeholder's Trust

Presenting your information using GAAP also helps to instill trust in those with an interest in
your company. There are many possible ways to manipulate the financial information of a
company, and many times, a simple modification to the way things are presented changes the
face of financial statements. These changes can cause the reader to interpret the statements
differently than if the modifications were not applied. Complying with GAAP guidelines
gives assurance to anyone interested in your company that your financial statements were
prepared using standard guidelines.

Comparable Statements

Investors and other interested parties can compare financial information of across different
companies because GAAP provides standardized guidelines that accounting, auditing and
financial professionals follow. This means that you can draw realistic conclusions about your
companys performance, as the accounting principles that you use are consistent with those of
your competitors. If GAAP guidelines were not applied, a high profit shown by one company
might not be comparable to a company showing lesser returns because of a difference in the
revenue-recognition method. One company might have higher profits than another in true
terms; however, the lack of standardization makes comparing the two results difficult

1. Useful to present to potential investors and creditors and other users in making rational
investment, credit, and other financial decisions
2. Helpful to present to potential investors and creditors and other users in assessing the
amounts, timing, and uncertainty of prospective cash receipts about economic resources,
the claims to those resources, and the changes in them
3. Helpful for making financial decisions
4. Helpful in making long-term decisions
5. Helpful in improving the performance of the business
6. Useful in maintaining recordsBetter understanding of overhead components
7. Both acquisition and renewal Additional information of profitability of products Early
warning of inappropriate pricing?
8. If not already preparing embedded values, ensures good experience investigations
performed
9. Further check on quality of valuation data
10. Better base fr implementation of IAS

Strength

The generally accepted accounting principles form a set of broad and specific
principles, procedures and standards that regulate the preparation and reporting of
financial statements. The major financial statements governed by GAAP include
the income statement, balance sheet and cash flow statement. Large and small
companies implement GAAP, but the Securities and Exchange Commission only
requires publicly traded companies to use them. Small business owners and
managers should understand the strengths of GAAP to decide whether to
implement the principles within their accounting practices.

Broad Guidelines

GAAP principles provide broad accounting guidelines. Companies may apply these broad
guidelines to many accounting situations when no specific information is given. Four
important principles that apply to all transactions focus on reliability, cost, matching and
revenue recognition. They apply to all publicly traded companies, regardless of size or
industry. The broad guidelines of GAAP allow for greater financial consistency within
companies.

Consistency in Reporting

Investors depend on financial statements to make decisions on whether to invest money in a


company. The consistency in financial statement reporting allows for easier financial analysis
by investors. Comparing a companys financial statements with those of its competitors is
also easier because the same general accounting principles apply to both companies. The
consistency in preparation and reporting helps to prevent companies from manipulating
accounting records.

Professional Judgment

GAAP does not provide detailed rules concerning every financial situation a company may
experience. An advantage of GAAP is that it allows accountants to use their professional
judgment when interpreting and applying the rules and procedures of GAAP. Therefore,
companies depend on the expertise of their accounting professionals to make sound decisions
on behalf of the company. The flexibility provided by GAAP allows companies to make
certain financial decisions in confidence and not suffer penalties by the Financial Accounting
Standards Board or the SEC.

Transparency

The SEC requires that public companies undergo a financial audit by a certified public
auditor. One of the strengths of GAAP is that it enables auditors and legislators to better audit
financial statements and other important financial information of public companies. The SEC
requires that companies are audited to verify that a companys financial reports accurately
reflect its financial position. The transparency provided by GAAP allows investors to place a
certain level of confidence in a companys financial statements because an investor knows
that the reports pass the meticulous requirements of the SEC.