Midterm druga parcijala

ACCOUNTING - Cost accounting

Learning Objectives
1. Natural types of costs

2. Cost calculation systems

3. Cost calculation methods

4. Accounting monitoring of costs

ACCOUNTING FOR INVENTORY

Consumption of material may be valued with the application of:

a)FIFO method,

b)method of average weighted acquisition prices (acquisition cost),

c)method of specific identification.

FIFO method assumes earliest goods purchased are the first to be sold/consumed.

Average cost method assumes that goods available for sale/consume are homogeneous.

AMORTIZATION/DEPRECIATION

• Useful life of capital assets: limited or unlimited.

• Assets with limited useful life should be followed by amortization/depreciation

• Amortization is the process of allocating to expense the cost of an intangible capital asset over its
useful (service) life in a rational and systematic manner.

• Depreciation is the process of allocating to expense the cost of a tangible capital asset over its
useful (service) life in a rational and systematic manner.

• Cost allocation is designed to provide for the proper matching of expenses with revenues in
accordance with the matching principle.

FACTORS IN COMPUTING AMORTIZATION/DEPRECIATION

1. Cost: all expenditures necessary to acquire the asset and make it ready for intended use.

2. Useful life: estimate of the expected life based on need for repair, service life, and vulnerability to
obsolescence.

3. Residual value: estimate of the asset’s value at the end of its useful life.
AMORTIZATION/DEPRECIATION METHODS

1. Straight-line,

2. Units of activity,

3. Declining-balance.

STRAIGHT-LINE

• Under the straight-line method, amortization/depreciation is the same for each year of the asset’s
useful life.

•In order to compute A/D expense, it is necessary to determine A/D cost.

• A/D cost = Cost of Asset - Residual Value

The formula for computing annual A/D expense is: A/D Cost / Useful Life (in years) = A/D Expense

DECLINING-BALANCE

• The declining-balance method produces a decreasing annual D/A expense over the useful life of
the asset.

• The calculation of periodic is based D/A on a declining book value (cost less accumulated D/A) of
the asset.

• Annual D/A expense is calculated by multiplying the book value at the beginning of the year by
the declining-balance D/A rate.

• The D/A rate remains constant from year to year, but the net book value to which the rate is
applied declines each year.

• The net book value for the first year is the cost of the asset since accumulated D/A has a zero
balance at the beginning of the asset’s useful life.

• In subsequent years, net book value is the difference between cost and accumulated D/A at the
beginning of the year.

• The formula for computing D/A expense is:

Net Book Value (at beginning of year)xStraight-line Rate (x declining balance rate multiplier)= D/A Expense

FORMULA FOR DECLINING-BALANCE METHOD

Unlike the other amortization methods, salvage value is ignored in determining the amount to which
the declining balance rate is applied.

A common application of the declining-balance method is the double-declining-balance method, in

which the declining-balance rate is double the straight-line rate.
UNITS-OF-ACTIVITY

• Under the units-of-activity method, service life is expressed in terms of the total units of
production or expected use from the asset, rather than time.

• The formulas for computing D/A expense are:

• D/A Cost / Total Units of Activity = D/A Cost per Unit

• D/A Cost per Unit * Units of Activity During the Year = D/A Expense

• In using this method, it is often difficult to make a reasonable estimate of total activity.

• When the productivity of an asset varies significantly from one period to another, this method
results in the best matching of expenses with revenues.

To use the units-of-activity method,

1) the total units of activity for the entire useful life are estimated,

2) the amount is divided into D/A cost to calculate the D/A cost per unit,

3) the D/A cost per unit is then applied to the units of activity during the year to calculate the annual
D/A.

D/A Cost / Total Units of Activity = D/A Cost per Unit

Costs of employees
 salaries, as compensation for work;

 salary fees (during annual leave, sick leave, education and professional training, public holidays,
etc.);

 other costs of employees (meal allowance, transport to work, allowance for annual leave, etc.).

• According to the existing regulations, calculation and payment of salaries and salary fees for
employer always implies obligation for calculation and payment of income tax, as well as
contributions for social insurance of employees (contributions for pension - disabled insurance,
health insurance and unemployment insurance).

• All the outgoing payments carried out on those basis will be shown as its cost (payments to
employees + payments of all other related liabilities).

• Income of employee is reduced in the account of net salary (liability towards employees), for the
deducted amount for the purpose of: credit, court decisions, alimonies, etc.

Accounts for book-entry:

• Costs of salaries • Liabilities for net salaries • Liabilities for tax on salaries • Liabilities for
contributions related to salaries
Services costs:

Costs of services related to final processing of outputs

Costs of transport services

Costs of maintenance services

Costs of lease

Costs of fairs

Costs of advertising services and sponsorship services

Costs of research

Costs of representation

Costs of insurance premiums

Costs of postage and telecommunication services

Costs of other services

Costing system:
A cost accounting system/product costing system/costing system is a framework used by firms to
estimate the cost of their products for inventory valuation.

Main cost accounting systems:

• job order costing (cost accounting system that accumulates manufacturing costs separately for
each job. It is appropriate for firms that are engaged in production of unique products and special
orders)

• process costing (cost accounting system that accumulates manufacturing costs separately for each
process. It is appropriate for products whose production is a process involving different departments
and costs flow from one department to another).

Costing system
• Traditional costing system  Total costing sistem  Variable costing system  Direct costing system
 Absorption costing system

• Modern costing system  Activity-based costing  Target costing system

Calculation methods
Calculation is a calculating procedure for calculating prices.

Document on calculated prices is called calculation.

Two basic methods of calculation are: a) divisional calculations b) additional calculations.

Within divisional calculations, depending on technological process of production, we may use:

• pure / simple / ordinary divisional calculation,

• multi-phase divisional calculation,

• calculation based on equivalent numbers (of relations),

• calculation of linked products.

Additional calculation methods are classified into • summary and • selective.

Accounting of equity and liabilities

Learning Objectives

• Concept, importance and business book records General Journal and Special Journals General
Ledger and Subsidiary Ledgers

• Bookkeeping errors and methods of correction of bookkeeping errors  crossing out, 

cancellation and  supplementary book entry

• Accounting of equity and liabilities Definition of main forms Identification of transactions in

relation with them

BUSINESS BOOKS
A) MAIN RECORDS

journal

general ledger;

B) SUB-LEDGER RECORDS

sub-ledger records

other ancillary books

Journal is the main business book which records business events with chronological order.
Organization:

• single business book

• several specialized books Journal of financial bookkeeping – general journal

journal of sub-ledger book-keepings – special journal

• journal of purchasers,

• journal of suppliers, etc..

The types of special journals used depend largely on the types of transactions that occur frequently
in a business enterprise.

The journal makes several significant contributions to the recording process:

1. It discloses, in one place, the complete effect of a transaction.

2. It provides a chronological record of transactions.

3. It helps to prevent or locate errors because the debit and credit amounts for each entry can be
readily compared.

4. Total debit turnover at the end of the page of day-book shall be equal to the total credit turnover.
5. Journal has a significant control function which arises from the fact that the same business events
are simultaneously recorded also in general ledger: Value of business events recorded in journal
should be equal to the value of events recorded in general ledger.

General ledger
General ledger - “systemic records” – “comprehensive records”

For each position of balance, a separate ledger account is opened which records business events
during the reporting period.

General ledger represents a group of ledger accounts.

Sub–ledger business books

Sub-ledger records - supplement some accounts of ledger records.

sub-ledger records – subsidiary ledger (material, production, final products, goods, employees’
salaries, customers, suppliers)

other ancillary records. (cash book, book of inward invoices, book of outward invoices, book of
foreign exchange currencies, book of shareholder’s equity)
SUBSIDIARY LEDGERS AND CONTROL ACCOUNT

A subsidiary ledger is a group of accounts with a common characteristic.

The general ledger account that summarizes subsidiary ledger data is called a control account.

Each general ledger control account balance must equal the composite balance of the individual
accounts in the subsidiary ledger.

SUBSIDIARY LEDGERS
Advantages of using subsidiary ledgers are that they:
1. Show transactions affecting one position (customer, creditor, inventory) in a single account.
2. Free the general ledger of excessive details.
3. Help locate errors in individual accounts by reducing the number of accounts combined in one
ledger and by using controlling accounts.
4. Create a division of labour in posting by allowing one employee to post to the general ledger and a
different employee to post to the subsidiary ledger.

BOOKKEEPING ERRORS AND METHODS OF THEIR CORRECTIONS

• Error vs. Fraud

• Types of errors: formal Material

• Methods for correcting bookkeeping errors:

 crossing out,  cancellation and  supplementary book entry.

• Crossing out method is normally used when there is wrongly recorded amount in journal and
general ledger, then errors in recording if detected immediately, soon after their occurrence.
Crossing out method corrects an error in a way that the falsely recorded amount is crossed out, but
in a way that it is visible, and a correct amount is recorded above it with the initials of a person who
corrected it.

• Cancellation method of bookkeeping errors may be performed in two manners:

 black cancellation method  red cancellation method.

Method of cancellation of bookkeeping errors represents neutralization of its effect, while the error
itself still remains visible.

• Supplementary book entry method – this method is most often used with material errors, when,
in both corresponding accounts, smaller amounts are recorded than the actual ones. We do the
correction by adding certain difference and at doing this, the balance remains correct.
Definitions

 Assets are resources owned by a business. They are things of value used in carrying out such
activities as production and exchange.

 Liabilities are claims against assets. They are existing debts and obligations.

 Owner’s equity is the residual interest in the assets of the entity after deducting all its liabilities.

 Owner’s Equity represents the ownership claim on total assets.

 Subdivisions of Owner’s Equity:

subscribed paid-in equity (original equity/ shareholders’ equity/ owner’s equity)

earned equity (retained earning / accumulated profit and reserves).

Equity: original equity, subscribed unpaid equity, reserves, revaluation reserves, non-allocated
profit, loss up to the amount of equity, repurchased own shares.

Investments by owner are the assets put into the business by the owner.

Drawings are withdrawals of assets by the owner for personal use.

• Investments by owners may be in the form: Cash Other assets.

• Investments by owners in form assets: cost is the fair market value of them.

Reasons for redemption of own shares may be:

to reduce the volume of business activity of joint-stock company,

to reduce the danger from competition take over,

to reduce the number of own shares with the aim of increasing profit (earning) per share and
market value per share,

to redeem ownership interests of one or several shareholders,

to maintain favorable market for shares of joint-stock company.

Liabilities are recognized in business books if the following conditions are met:

obligation is present,

there is reasonable assessment by managers,

i.e. accountant that outflow of cash or other assets or provision of services will occur on the exactly
set date,

obligation is a result of past events..

From aspect of maturity, liabilities are classified as:

1) current (short-term) liabilities

2) non-current (long-term) liabilities.

The most frequent long-term liabilities: • liabilities for received long-term loans • liabilities for issued
long-term bonds, • other long-term financial liabilities and • long-term accruals and provisions.

• Bonds are a form of interest-bearing notes payable issued by corporations, governments, and
governmental agencies.

• Bonds, like common shares, can be sold in small denominations, and as a result they attract
investors.

From the standpoint of the corporation seeking long-term financing, bonds offer the following
advantages over common shares:

1. Shareholder control is not affected.

2. Income tax savings result.

3. Earnings per share may be higher.

The major disadvantages resulting from the use of bonds are that

• interest must be paid on a periodic basis,

• principal (face value) of the bonds must be paid at maturity.

The most frequent and most important current (short-term) liabilities:

• liabilities for received short-term loans (trade, financial),

• liabilities towards suppliers,

• liabilities for issued short-term securities,

• current maturity of long-term liabilities,

• liabilities for dividends,

• liabilities for interests,

• liabilities for taxes,

• liabilities for salaries to employees,

• short-term accruals (accruals and deferred income).

ESTIMATED LIABILTIES
• Obligation that exists but for which the amount and timing is uncertain.

• However, the company can reasonably estimate the liability.

• Example: warranty liabilities.

• Warranty contracts may lead to future costs for replacement or repair of defective units.

• Using prior experience with the product, the company estimates what the cost of servicing the
warranty will be.

• Estimated warranty costs are accrued with a debit to warranty expense and a credit to estimated
warranty liability.

ACCOUNTING OF REVENUES

Learning Objectives

1. Definition of revenues

2. Structure of revenues

3. Measurement and recognition of revenues

• Revenues are the elements of measurement of performance of business operations of legal

entities.

• Revenues are an increase of economic benefits during the accounting period in a form of inflow or
increase of assets or decrease of liabilities, which leads to the equity increase, except for those
linked with the payments of equity participants.

STRUCTURE OF REVENUES
• Operating revenues, • Financial revenues, • Other revenues

OPERATING REVENUES

• Revenues from sale of products

• Revenues from sale of goods

• Revenues from sale of services

• Other operating revenues,

FINANCIAL REVENUES

• revenues from interests realized on the basis of given loans,

• positive foreign exchange rate,

• dividends,

• other financial revenues

OTHER REVENUES

• surpluses;

• revenues from sale of current assets;

• revenues from sale of non-current assets

• revenues from subsidies, grants, subventions, incentives, etc.;

• revenues from penalties, fines, rewards, withdrawal fees, etc.;

• revenues from written off liabilities;

• collected written-off receivables;

• revenues from collection from insurance company;

• revenues from cancellation of long-term provisions;

• other revenues.

• Revenue is measured at the fair value of received fee and receivables.

• Fair value is the amount for which the asset could be exchanged or settle the liabilities between
informed and ready persons in transaction before bargain.

• Revenues include only those gross inflows of economic benefits, which a legal entity receives or
claims for own account. Amounts collected for the account of third persons are not recognized as
revenue
Conditions for recognition the revenues from sale:

• legal entity transferred to the customer all significant risks and benefits of ownership over the
products, that is, goods

• legal entity does not retain the effect on management to the extent which is normally related with
the ownership, nor control over sold products, that is, goods;

• amount of revenues may be reliably measured;

• it is probable that transaction will be followed by inflow of economic benefit into legal entity;

• costs which incurred or will incur in relation with transaction, may be reliably measured.

Discounts after invoice issue reduce the revenues and they are recorded in books with:

• cancellation of revenues and receivables (if book entry is performed in the same accounting
period),

• by debiting other expenses (if they are credited and entered into books in the following year).

With the sale of products on loan, we should distinguish revenue from sale of products from
revenue from interests.

• Revenue from sale of products is recognized entirely at the point of products delivery to the
customer, regardless of payment method.

• Revenue from interest should be recognized in time lag period, so that the actual yield on assets is
taken into account.

EXPENSES AND REVENUES

Learning Objectives

1. Definition of expenses in comparation with revenues

2. Structure of expenses in comparation with revenues

3. Measurement and recognition of expenses in relationship with revenues

DEFINITION OF EXPENSES (compare and contrast with revenues)

• Revenues are the elements of measurement of performance of business operations of legal

entities.

• Expenses are the elements of measurement of performance of business operations of legal

entities.

• Revenues and expenses are the elements of measurement of performance of business operations
of legal entities.
• Revenues are an increase of economic benefits during the accounting period in a form of inflow or
increase of assets or decrease of liabilities, which leads to the equity increase, except for those
linked with the payments of equity participants.

• Expenses are decreases in economic benefits during the accounting period in the form of outflows
or depletions of assets or incurrence of liabilities that result in decreases in owner’s equity, other
than those relating to distributions to equity participants.

• Gains represent other items that meet the definition of income and may, or may not, arise in the
course of the ordinary activities of an entity. For example, gains those arising on the disposal of non-
current assets.

• 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 entity.

For example, losses include those resulting from disasters such as fire or flood, as well as those
arising on the disposal of non-current assets.

OPERATING EXPENSES (compare and contrast with revenues)

Revenues from sale of goods

Costs of sold goods

Revenues from sale of products

Costs of sold products

Revenues from provide of services

Costs of provided services

Other operating revenues

Other operating expenses

Costing system

A cost accounting system/product costing system/costing system is a framework used by firms to

estimate the cost of their products for inventory valuation.

Main cost accounting systems:

• job order costing (cost accounting system that accumulates manufacturing costs separately for
each job. It is appropriate for firms that are engaged in production of unique products and special
orders)

• process costing (cost accounting system that accumulates manufacturing costs separately for each
process. It is appropriate for products whose production is a process involving different departments
and costs flow from one department to another).
• Traditional costing system

 Total costing system

 Variable costing system

 Direct costing system

 Absorption costing system

• Modern costing system

 Activity-based costing

 Target costing system

Calculation methods

Calculation is a calculating procedure for calculating prices.

Document on calculated prices is called calculation.

Two basic methods of calculation are: a) divisional calculations b) additional calculations.

Within divisional calculations, depending on technological process of production, we may use: •

pure / simple / ordinary divisional calculation, •

multi-phase divisional calculation, •

calculation based on equivalent numbers (of relations), •

calculation of linked products.

Additional calculation methods are classified into • summary and • selective.

FINANCIAL EXPENSES (compare and contrast with revenues)

revenues from interests realized on the basis of given loans,

expenses from interests realized on the basis of taken loans,

positive foreign exchange rate,

negative foreign exchange rate,

dividends,

expenses from relations with other related legal entities

other financial revenues

other financial expenses

OTHER EXPENSES (compare and contrast with revenues)

• Revenues / expenses from donations;

• Revenues from written off liabilities /expenses from written off receivables;

• Collected written-off receivables;

• Surpluses / shortages

• Revenues / expenses from sale of other assets;

• Expenses from write-offs of assets

• Revenues / expenses from (non)collection from insurance company;

• Revenues / expenses from penalties, fines, rewards, withdrawal fees, etc.;

• Revenues from cancellation of long-term provisions / expenses in relationship with long-term

provisions;

• Other revenues / expenses

DETERMINATION OF FINANCIAL RESULT

• Gross financial result (profit or loss before tax) is determined in the account – Difference between
revenues and expenses.

• In accounting-technical terms, total amounts of realized revenues and total amounts of realized
expenses are transferred from the account of revenues and account of expenses to the aggregate
account – the difference between revenues and expenses.

• When total revenues exceed total expenses, so the difference of revenues over expenses has been
transferred to the account – Profit before tax.

• When expenses exceed revenues of the accounting period, the difference of expenses over
revenues represents loss of the current year and it is transferred into the account - Loss.

Financial statements

Learning Objectives

• Phases and main characteristics of accounting process

• Definition and content of financial statements

• Definition, conducting and purpose of inventory

• Definition, preparation and purpose of trial balance

• Charts of accounts
FINANCIAL STATEMENTS

After transactions are identified, recorded, and summarized, financial statements are prepared from
the summarized accounting data:

1. An income statement presents the revenues and expenses and resulting net income or loss of a
company for a specific period of time.

2. A statement of owner’s equity summarizes the changes in owner’s equity for a specific period of
time.

3. A balance sheet reports the assets, liabilities, and owner’s equity of a business enterprise at a
specific date.

4. A cash flow statement summarizes information concerning the cash inflows (receipts) and
outflows (payments) for a specific period of time.

5. The notes are an integral part of the financial statements.

BOOKKEEPING ACCOUNTS

 Italian word “conto” - translate into “account”.

 An account is an individual accounting record of increases and decreases in a specific asset,

liability, owner’s equity item, expenses or revenues.

Chart of Accounts

• Chart of accounts - written document - a code and name of accounts.

• Applicable systematization criteria:  decade,  alphabetic and  combined system.

• Decade criteria:

 chart of accounts has 10 classes, from 0 to 9;

 each class has 10 groups of accounts, from 00 to 99;

 each group of accounts has 10 ledger accounts, from 000 to 999;

 each ledger account encompasses 10 sub-ledger accounts, from 0000 to 9999;

 each sub-ledger account encompasses 10 sub sub-ledger accounts, from 00000 to99999; etc.

• Alphabetic system criteria - accounts are systematized in accordance with the first letter of
alphabet (from A to Z).

• Combined system
Opening of bookkeeping accounts

• Newly established legal entity: accounts based on the inventory

• Legal entity with business continuity account is balance of the previous period

• Accounts of revenues and expenses cannot be transferred from one business year into another

Closing of bookkeeping accounts

Closure of accounting accounts is conducted.

• At the end of reporting year

• in cases of statutory changes

Procedure of closing the account depends on the type, i.e. category which the account identifies.

• Accounts of revenues and expenses are closed with mutual matching when determining
performance of business operations.

• Accounts of assets and liabilities are closed in the following manner: first debit and credit turnover
of accounts is determined, and after that, settlement balance is determined as a difference between
debit and credit side

RELATIONSHIP OF JOURNAL AND GENERAL LEDGERS

• Journal and general ledger present the same business events - the values of presented in those
records must be identical.

• Trial balance represents a recapitulation of balance and turnover of all accounts of general ledger.

• Inventory is list of all the assets at the end of a business year.

INVENTORY

Inventory is performed in the following cases:

• at the beginning of business operations,

• at the end of each business year,

• once statutory changes occur,

• when change in prices of products or goods occur,

• in case of opening the procedure of bankruptcy and liquidation.

Inventory procedure is performed in several phases:

 preparatory activities;

 determining real balance and its comparison with the balance in bookkeeping records;

 preparing inventory reports;

 consideration and making decisions regarding inventory reports.

Preparatory activities

• organization of inventory commissions,

• preparation of inventory lists,

• preparation of warehouse for inventory

• Inventory of borrowed assets, goods in the commission...

• Inventory of receivables from customers of liabilities towards suppliers...

• Reports on performed inventory...

TRIAL / GROSS BALANCE

Gross balance represents presentation of balance and turnover of all accounts of general ledger.
Gross balance comprised of names of accounts and following columns:

 balance at the beginning of reporting period (opening balance),

 turnover during the reporting period,

 total turnover

 balance of accounts at the end of the reporting period (closing balance).

LIMITATIONS OF A TRIAL BALANCE

A trial balance does not prove that all transactions have been recorded or that the ledger is correct.
Numerous errors may exist even though the trial balance columns agree. The trial balance may
balance even when

1. a transaction is not journalized,

2. a correct journal entry is not posted,

3. a journal entry is posted twice,

4. incorrect accounts are used in journalizing or posting,

5. offsetting errors are made in recording the amount of the transaction.