What is Financial Reporting?

If “accounting is the language of finance” then financial reporting is the “communication of

financial information useful for making investment, credit, and other business decisions” Such
communications include general purpose financial statements such as income statements,
balance sheets, equity reports, cash flow reports, and notes to these statements. Additionally,
items such as SEC filings, press releases, meeting minutes, and auditor’s reports are also
included in financial reporting. Many financial reports, or the accounts and data they represent,
are subject to various regulations and standards from organizations such as the Securities
Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), and the
International Accounting Standards Board (IASB). Much like any language, financial statements
could have their own “dialect” so to speak. For example, knowing about the use of cash-based
accounting versus accrual based accounting could impact some very serious business or
investment decisions. The various regulations, standards, and Generally Accepted Accounting
Principles (GAAP) helps to make sure we’re all on the same page.

Some financial statements are prepared on regular basis and equal intervals and some are
prepared as and when needed. Some financial reports are meant only for management and some
are communicated to people outside the entity as well.

Financial statements:

Usually financial statements refer to either a statement included in the complete set of
general purpose financial statement. And due the same reason whenever the term financial
statement is used, it is often assumed that a report is about entity’s financial position, financial
performance, cash flows or fluctuations in equity.

The term financial statement is usually used for all or any of the following statements:

1. A statement of financial position (Balance Sheet) at the end of the period.

2. A statement of comprehensive income for the period (or an income statement and a
statement of comprehensive income).
3. A statement of changes in equity for the period;
4. A statement of cash flows for the period;
5. Notes, comprising a summary of accounting policies and other explanatory notes.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

In order to maintain uniformity and consistency in accounting records throughout the world,
certain rules and principles have been developed which are generally accepted by the accounting
profession. These rules/ principles are called by different names such as principles, concepts,
conventions, postulates, assumptions. These rules/principles are judged on their general

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acceptability rather than universal acceptability. Hence, they are popularly called Generally
Accepted Accounting Principles (GAAP).

The term “generally accepted” means that these principles must have support that generally
comes from the professional accounting bodies.

Thus, Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines
adopted for recording and reporting of business transactions of financial statements. These
principles have evolved over a long period of time on the basis of past experiences, usages or
customs, etc. These principles are also referred as concepts and conventions, which have already
been discussed.

1-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.

Let us take an example. Suppose Mr. Sahoo started business investing Rs100000. He purchased
goods for Rs40000, Furniture for Rs20000 and plant and machinery of Rs30000. Rs10000
remains in hand. These are the assets of the business and not of the owner. According to the
business entity concept Rs100000 will be treated by business as capital i.e. a liability of business
towards the owner of the business. Now suppose, he takes away Rs5000 cash or goods worth
Rs.5000 for his domestic purposes. This withdrawal of cash/goods by the owner from the
business is his private expense and not an expense of the business. It is termed as Drawings.
Thus, the business entity concept states that business and the owner are two separate/distinct
persons. Accordingly, any expenses incurred by owner for himself or his family from business
will be considered as expenses and it will be shown as drawings.

2- 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.

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For example, sale of goods worth Rs.200000, purchase of raw materials Rs.100000, Rent Paid
Rs.10000 etc. are expressed in terms of money, and so they are recorded in the books of
accounts. But the transactions which cannot be expressed in monetary terms are not recorded in
the books of accounts. For example, sincerity, loyalty, honesty of employees are not recorded in
books of accounts because these cannot be measured in terms of money although they do affect
the profits and losses of the business concern. Another aspect of this concept is that the records
of the transactions are to be kept not in the physical units but in the monetary unit. For example,
at the end of the year 2006, an organization may have a factory on a piece of land measuring 10
acres, office building containing 50 rooms, 50 personal computers, 50 office chairs and tables,
100 kg of raw materials etc. These are expressed in different units. But for accounting purposes
they are to be recorded in money terms i.e. in rupees. In this case, the cost of factory land may be
say Rs.12 crore, office building of Rs.10 crore, computers Rs.10 lakhs, office chairs and tables
Rs.2 lakhs, raw material Rs.30 lakhs. Thus, the total assets of the organization are valued at
Rs.22 crore and Rs.42 lakhs. Therefore, the transactions which can be expressed in terms of
money is recorded in the accounts books, that too in terms of

money and not in terms of the quantity.

3- 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.

4- 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 financial 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 calendar year or a

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financial year. Year that begins from 1st of January and ends on 31st of December, is known as
Calendar Year. The year that begins from 1st of April and

ends on 31st of March of the following year, is known as financial year. As per accounting
period concept, all the transactions are recorded in the books of accounts for a specified period of
time. Hence, goods purchased and sold during the period, rent, salaries etc. paid for the period
are accounted for and against that period only.

5- 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 was 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.

6- 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 owner’s equity and
that of outsiders, as liabilities or creditors’ equity. The knowledge of dual aspect helps in

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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. Let us analyze some more business transactions in terms of their dual
aspect:

The interpretation of the Dual aspect concept is that every transaction has an equal effect on
assets and liabilities in such a way that total assets are always equal to total liabilities of the
business.

7- REALISATION CONCEPT:

This concept states that revenue from any business transaction should be included in the
accounting records only when it is realized. The term realization means creation of legal right to
receive money. Selling goods is realization, 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
was 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.

Now, let us analyse the above examples to ascertain the correct amount of

Revenue realised for the year ending 31st December 2005.

(i) The revenue for the year 2005 for N.P. Jewelers is Rs.200000. Mere getting an order is not
considered as revenue until the goods have been delivered.

(ii) The revenue for Bansal for year 2005 is Rs.1,00,000 as the goods have been delivered in the
year 2005. Cash has also been received in the same year.

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(iii) Akshay’s revenue for the year 2005 is Rs.50,000, because the goods have been delivered to
the customer in the year 2005. Revenue became due in the year 2005 itself. In the above
examples, revenue is realized when the goods are delivered to the customers.

The concept of realization states that revenue is realized at the time when goods or services are
actually delivered. In short, the realization occurs when the goods and services have been sold
either for cash or on credit. It also refers to inflow of assets in the form of receivables.

8- 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 recognized
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. The accrual concept
under accounting assumes that revenue is realized at the time of sale of goods or services
irrespective of the fact when the cash is received.

For example, a firm sells goods for Rs 55000 on 25th March 2005 and the payment is not
received until 10th April 2005, the amount is due and payable to the firm on the date of sale i.e.
25th March 2005. It must be included in the revenue for the year ending 31st March 2005.
Similarly, expenses are recognized at the time services provided, irrespective of the fact when
actual payments for these services are made. For example, if the firm received goods costing
Rs.20000 on 29th March 2005 but the payment is made on 2nd April 2005 the accrual concept
requires that expenses must be recorded for the year ending 31st March 2005 although no
payment has been made until 31st March 2005 though the service has been received and the
person to whom the payment should have been made is shown as creditor.

In brief, accrual concept requires that revenue is recognized when realized and expenses are
recognized when they become due and payable without regard to the time of cash receipt or cash
payment.

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 IAS-1 Presentation of Financial Statements
Objectives of IAS 1
The objectives of IAS 1 (2007) are to ensure comparability both with the entity’s financial
statements of previous periods and with the financial statements of other entities.

Scope
IAS applies to all General purpose financial statements based on international financial
reporting standards.

Types of financial statements:

1-General purpose financial statements:

General purpose financial statements are prepared for general users keeping general needs in
mind and thus may not provide all such information those users may want.

Objective of General purpose financial statements:

The objective of General purpose financial statements is to provide information about the
financial position, financial performance, and cash flows of an entity that is useful to a wide
range of users in making economic decisions. To meet that objective, financial statements
provide information about an entity’s:

 Assts;
 Liabilities;
 Equity;
 Income and expenses, including gains and losses;
 Contributions by and distributions to owners;
 Cash flows.

That information, along with other information in the notes, assists users of financial statements
in predicting the entity’s future cash flows and, in particular, their timing and certainty.

Asset: is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity. Example debtors plan building etc…

Liabilities: a liability is a present obligation of the entity arising from past events, the settlement
of which is expected to result in an outflow of economic benefits. Fore example creditors, bank
loan etc….

Equity: equity is the residual interest in the assets of the entity after deducting all its liabilities.
For example share capital, retained earnings and reserves.

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Income: income Is increases in economic benefits during the accounting period in the form of
inflows that result in increases in equity.

Expenses: expenses are decreases in economic benefits during the accounting period in the form
of outflows or depletions of assets or incurrence’s of liabilities that result in decreases in equity.

2-Special purpose financial statements:

These are prepared keeping the information needs of certain users and may proved such
additional information which general purpose financial statements may not contain. Usually
special purpose statements focus a particular area and provide information in that regard. Special
purpose financial statements may be or may not be prepared under the same accounting
framework which is used to prepare general purpose financial statements. Examples include;
financial statements prepared for Bank to request for loan.

As Special purpose financial statements are mostly tailor- made and thus are of different varieties
which we cannot discuss all here. However, we can discuss the general purpose financial
statements.

Users of financial statements:

The financial statements are used by different categories of people for different purposes. The
various users of financial statements are classified and detailed as follows:

Internal Users:

Managers and Owners: For the smooth operation of the organization the managers and owners
need the financial reports essential to make business decisions. So as to provide a more
comprehensive view of the financial position of an organization, financial analysis is performed
with the information supplied in the financial statements. The financial statement is used to
formulate contractual terms between the company and other organizations, contractual terms
between the company and other organizations.

Employees: The financial reports or the financial statements are of immense use to the
employees of the company for making collective bargaining agreements. Such statements are
used for discussing matters of promotion, rankings and salary and benefits.

External users:

The external users comprise of:

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Institutional Investors: The external users of financial statements are basically the investors
who use the financial statements to assess the financial strength of a company. This would help
them to make logical investment decisions.

Financial Institutions: The users of financial statements are also the different financial
institutions like banks and other lending institutions who decide whether to help the company
with working capital or to issue debt security to it.

Government: The financial statements of different companies are also used by the government
to analyze whether the tax paid by them is accurate and is in line with their financial strength.

Vendors: The vendors who extend credit to a business require financial statements to assess the
creditworthiness of the business.

General Mass and Media: The common people as well as media also make part of the users of
financial statements.

Guide line for the preparation of Financial Reports (Statements)

1- Fair presentation and compliance with IFRSs:

The financial statements must “present fairly” the financial position, financial performance and
cash flows of an entity. Fair presentation requires the faithful representation of the effects of
transactions, other events, and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, income and expenses set out in the IFRS.

2- Consistency of Presentation.

The presentation and classification of items in the financial statements shall be retained from one
period to the next unless a change is justified either by a change in circumstances or a
requirement of a new IFRS.

3- Materiality and Aggregation:

Each material class of similar items must be presented separately in the financial statements.
Dissimilar items may be aggregated only if they are individually immaterial.

Offsetting, assets and liabilities, and income and expenses, may not be offset unless required or
permitted by an IFRS.

4- Comparative Information

IAS 1 requires that comparative information shall be disclosed in respect of the previous period
for all amounts reported in the financial statements, both face of financial statements and notes.

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Financial information of last year which is included in current year financial statement for
comparison purpose are called comparative financial statements.

5- Structure and Content of Financial Statements in General:

Clearly indentify:

The financial statements;

1. The reporting enterprise

2. Whether the statements are for the enterprise of for a group
3. The date or period covered
4. The presentation currency
5. The level of precision. (Thousands, millions, etc.)

6- Accrual basis accounting:

IAS1 requires that an entity prepare its financial statements, except for cash flow information,
using the accrual basis accounting.

Difference between cash basis and accrual basis accounting:

Cash basis: An accounting method in which income is recorded when cash is received, and
expenses are recorded when cash is paid out. In financial reporting the cash basis of accounting
is used when accounting records revenue when cash from customers is received, and records
expenses when they are paid in cash.

Accrual basis: a system of accounting based on the accrual principal, under whom revenue is
recognized (recorded) when earned, and expenses are recognized when incurred. Total of
revenues are expenses are shown in the financial statements (prepared at the end of an
accounting period) whether or not cash was received or paid out in that period.

“OR”

The most commonly used accounting method, which reports income when earned and expenses
when incurred, as opposed to cash basis accounting, which reports income when received and
expenses when paid.

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Question # 1:

For the sake of understanding, let’s suppose. ABC Company has two incomes and two
expenses.

During the year ended 31st 2005, company sold goods for cash Rs. 20000 and on credit Rs
10,000. Company let out a building on rent for Rs. 1000 per month and during the year company
received rent for 8 months only that was Rs. 8000 and rent for 4 months Rs. 4000 is still to be
received. Whereas, expenses were salary and purchases; during the year company purchased
goods on cash Rs. 15000 and on credit Rs. 8000 and salaries of 10 months were paid in cash Rs.
5000 ( Rs. 5000 per month) and salaries of 2 months are still to be paid i.e. Rs. 1000.

Required: Calculate profit for the business under cash basis and accrual basis.

Question # 2:

ABC Company has sales for 2005 of Rs. 800,000 and its CGS was Rs. 500,000 other details
of expenses for the year are as under:

1) Salaries paid Rs. 20,000 and salaries of Rs. 10,000 are still to be paid i.e. outstanding for
year 2005.
2) Rent expense of Rs. 60,000 was paid in cash and rent of Rs. 5000 still to be paid.
3) Insurance of Rs. 24,000 was paid for two years i.e. 12000 are paid for 2006.
4) Carriage was paid during the year Rs. 30,000 and 10,000 is still to pay in 2005.

REQUIRED:

Calculate net income for the year of 2005 for ABC Ltd. If company uses

1. Cash basis of accounting;

2. Credit basis of accounting.

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 International Accounting Standard 7

Statement of Cash Flows

Purposes of Statement of Cash Flow

(a) To provide information about the cash receipts and cash payments of an entity during a
period. Important information for financial statement users because many feel that
accrual accounting does not present true picture.
(b) To summarize the cash inflows and outflows from operating, investing and Financing
activities of the business.

Cash Flows: Cash flows are inflows and outflows of cash and cash equivalents

Cash Inflows: (Source of Cash) (Incoming cash in business)

Cash Outflows: (Use of Cash) (Outgoing cash from business)

Uses of Statement of Cash Flows

1) Whether sufficient cash flow is generated from activities?

2) Will the company be able to meet its financial obligations?
3) Will the company be able to pay dividend to shareholder?
4) Why there is a difference between Net Income reported and net cash flow in the
business?
5) What amounts of Funds were generated by the issuance of shares, bonds and sale of fixed
assets etc…?
6) What were spent during the year on Purchase of Fixed assets, Retirement of Bonds,
Repayment of Debt, Repurchase of Shares etc..?

Classification of Source and Use of Cash

Source of Cash Use of Cash

Net Profit
Decrease in Non-Cash Asset
Increase in Liabilities
Increase in Capital Stock
Net Loss
Increase in Non-Cash Asset
Decrease in Liabilities
Decrease in Capital Stock
Dividend paid to Shareholders

Division of Activities
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 1- Operating Activities
2- Investing Activities
3- Financing Activities

1- Operating Activities: Operating activities are the principal revenue-producing activities

of the enterprise. Therefore they generally result from the transactions and other events
that enter into the determination of net profit or loss.
 The net result of income statement in the shape of Net Profit or Loss is reported in
the operating activities.
 All those transactions which are relevant with current assets and current liabilities
are reported in operating activities.
 All those transactions which affect non-current assets and non-current liabilities
and reported in income statement such as Depreciation, Depletion and
Amortization of Discount on bonds, Amortization of Premium on bonds are also
included in operating activities,
 Gain or loss on disposal of non-current assets is also reported in operating
activities.
2- Investing Activities: All those transactions that are related with the acquisition or
disposal of Long-term assets are reported in Investing Activities.
3- Financing Activities: Transactions relevant with long term liabilities and owner’s equity
are reported in financing activities. For example Purchase of Treasury Stock, Issue of
Shares. Cash proceeds from issuing Bonds, debentures etc.

Question: Whether the direct exchange transactions are reported in cash flow statement?

Ans: The direct exchange transactions are not reported in cash flow statement. These
transactions should be reported as a foot note in cash flow statement.

Examples of Direct Exchange Transactions:

 Shares issued against purchase of building, land and other fixed assets.
 Shares may be issued for retirement of Bond, Debt etc.
 Land and building may be received as a gift.

FORMAT OF CASH FLOW STATEMENT

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 $ $
CASHFLOWS FROM OPERATING ACTIVITIES
Profit before Tax xxx
Add / (Less) : Adjustment for:
Depreciation xxx
Interest Expense xxx
Interest Income (xxx)
Depletion xxx
Amortization of Discount on Bonds Payable xxx
Amortization of Premium on Bonds Payable (xxx)
Gain on disposal of Non-Current Assets (xxx)
Loss on disposal of Non-Current Assets xxx xxx
Operating Profit before Working Capital Changes xxx
Add/ (Less) : Working Capital Changes
Increase in Receivables (xxx)
Increase in Inventory (xxx)
Decrease in Receivables xxx
Decrease in Inventory xxx
Increase in Payables xxx
Decrease in Payables (xxx) xxx
Cash Generated from operations xxx
Add / (Less):
Interest Paid (xxx)
Interest Received xxx
Tax Paid (xxx)

Net Cash Flow From Operating Activities xxx

CASHFLOWS FROM INVESTING ACTIVITIES
Purchase of Fixed Assets (xxx)
Sale of Fixed Assets xxx
Purchase of Investment (xxx)
Receipt of Govt. Grant xxx
Net Cash Used in Investing Activities (xxx)
CASHFLOWS FROM FINANCING ACTIVITIES
Increase In Long-term Liabilities xxx
Decrease in Long-term Liabilities (xxx)
Increase in Capital Stock xxx
Decrease in Capital Stock (Treasury Stock) (xxx)
Share Premium xxx
Dividend Paid (xxx)
Net Cash Flows From Financing Activities xxx
Net Increase/ (Decrease) in Cash and Cash Equivalents xxx
Add: Opening Cash Balance xxx
Cash and Cash Equivalents - - End of Period xxx

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Class Activities:

1- Equipment with a cost of $4,000 and accumulated Depreciation of $2,900 was sold for
$800 cash.
2- Machinery that initially cost $90,000 and had a book value of $25,000 was sold for
$60,000
3- Redemption of Debentures worth $ 250,000.
4- Decrease in debtors worth Rs. 5000
5- Increase in creditors worth Rs. 7000
6- Interest Expense during the year was Rs.10, 000. While interest Payable was increased by
2000. Calculate interest paid.
7- Interest Expense during the year was Rs.76, 000. While interest Payable was decreased
by 4000. Calculate interest paid.
8- Income Tax expenses reported in the income statement was $ 18,000. And income Tax
Payable was $3000 and $3500 respectively in 2010 and 2011. Calculate Income tax paid
during the year.
9- During the year Land was acquired for $35,000 in exchange for Capital Stock, Par
$35,000.
10- Preferred Stock was retired during the year worth $100, 000 at 5% Premium.
11- The Company sold marketable securities costing $50 for $65.
12- Inventory increased by $60.
13- Mortgage Payable increased by $30,000.
14- Notes Payable decrease by $45,000.
15- Amortization of Goodwill Rs.25,000.

Practice Questions

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Question # 1
Company balance sheets of the Uniliver Company at the end of 2010 and 2011 follows:

Assets 2010 2011

Cash $ 20,000 $15,000

Accounts receivable (net) 45,000 50,000

Merchandise inventory 40,000 65,000

Prepaid expenses 10,000 5000

Building and equipments 70,000 85,000

Less allowances for equipment (7500) (17,500)

Land 45,000 80,000

Total $ 222,500 $282,500

Liabilities and owner‘s equity

Account payable $ 40,000 $ 50,000

Accrued interest 12500 10000

Notes payable 30,000 -----------

Mortgage payable --------- 30,000

Capital stock $ 10 par 150,000 185,000

Retained earnings (deficit) (10,000) 7500

Total $222,500 $285,000

During the year, land was acquired for $35,000 in exchange for capital stock, par $35, 000, and
equipment of $15,000 was acquired for cash. Cash dividends of $ 10,000 were charged during
the year; the transfer of net income to retained earnings was the only other entry in this account.
Interest expenses and income tax expenses reported in the income statement were $ 10,000 and
$18,000 respectively.

Prepare statement of cash flows

Question # 2
Condensed balance sheet data for Wallace, inc. for the year end 2010 and 2011 follow:

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Assets 2010 2011

Cash $30,000 $10,000

Accounts receivables 50,000 60,000

Inventory 60,000 75,000

Prepaid expenses 10,000 12,500

Buildings and equipment 85,000 125,000

Less allowances for depreciation (25,000) (30,000)

Total $210,000 $252,500

Liabilities and shareholder’s equity

Accrued interest $ 2,000 $ 4,000

Income tax payable 3,000 3,500

Dividend payable 10,000 ---------

Accounts payables 40,000 52,500

Bonds payable 40,000 40,000

Capital stock at par 100,000 125,000

Additional paid in capital 10,000 15,000

Retained earnings 5,000 12,500

Total $ 210,000 $ 252,500

Land and buildings for $ 30,000 were acquired during the year in exchange for capital stock;
while equipment for $ 10,000 was acquired on cash. Net income for the year transferred to
retained earnings was $ 25,000.income tax expenses and interest expenses were reported in the
income statement $ 15,000 and $ 4,000 respectively.

Prepare statement of cash flows

Question # 3
Comparative balance sheet data for the firm Bay and Bay are given below:

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 Bay and Bay comparative Balance sheets

Assets 2010 2011

Cash $ 3,600 $ 4,500

Accounts receivables 10,500 8,800

Inventory 31,600 45,000

Prepaid expenses 1,650 1,200

Furniture and fixtures 16,000 23,500

Less allowance for depreciation (11,450) (13,050)

Totals $ 51,900 $ 69,950

Liabilities and capital

Accrued expenses $ 2,200 $ 2,600

Accounts payables 8,250 8,100

Long term payables --------- 6,000

Paul Bay capital 20,600 17,700

Thomas Bay capital 20,850 35,550

Totals $51,900 $ 69,950

Net income for the year was $ 15,000 which was transferred in equal amounts to the partner’s
capital accounts. Further changes in the capital accounts arose from additional investments and
withdrawals by the partners. The change in the furniture and fixtures accounts arose from
purchase of additional furniture; part of the purchase price was paid in cash and a long term note
was issued for the balance.

Prepare statement of cash flows

Question # 4
The following data were obtained from the books and records of the Walsh Co. for the year
ended 2011
Financial Reporting Page 18
 Net changes in 2011

Dr Cr

Cash $ 6,500

Other current assets 45,000

Goodwill $ 20,000

Account payables 30,000

Other current liabilities 15,000

Bonds payable 100,000

Bonds discount 3,800

Preferred stock 100,000

Common stock 50,000

Retained earnings 9,700

Appraisal capital 25,000

Net income for the year was $ 53,800. Ten years bonds of $ 100,000 were issued on July 1,
2011 at 96. Land cost $ 30,000 and recorded on the books at an appraisal value of $ 55,000 was
sold for $ 65,000. The cash proceeds from the sale were applied to the construction of new
buildings costing $ 88,000. Increase in common stock was due to issuance of additional shares
by way stock dividend. Depreciation recorded for the year was $ 8,000. Preferred stock was
retired during the year at 105. Interest expenses were recorded $ 5,000 and income tax expense
was reported $ 28,970 for the year. Retained earnings balance on January 1st 2011 was $ 55,000
and on Dec 31st 2011 were 45,300.

Prepare statement of cash flows

Question # 5
The following data were taken from the books and records of the Thomas Company:

Balance sheet

Financial Reporting Page 19

Assets 2010 2011

Cash $ 5,000 $ 10,000

Other current assets (net) 143,300 155,200

Plant and equipment 96,000 100,500

Less allowance for depreciation (30,000) (34,000)

Investment in stock & bonds 30,000 27,000

Good will 25,000 1

Total $ 269,300 $ 258,701

Liabilities and owner’s Equity

Interest payable $ 2,000 $ 6,000

Taxes payable 3,800 2,800

Accounts payable 40,000 50,000

Bonds payable 50,000

Unamortized bond discount (1,250)

Preferred stock 50,000

Common stock 100,000 150,000

Additional paid up capital 30,000

Retained earnings 24,750 19,901

Total $ 269,300 $ 258,710

Net income for the year 2011 was $ 10.151. A fully depreciated equipment original cost $ 10,500
was traded in on new equipment costing $ 15,000; $ 1,500 was allowed by the vendor on the
trader in. one hundred shares of bank Co, preferred stock, cost $ 15,000 held as a long term

Financial Reporting Page 20

investment, were sold for $ 12,500 at the beginning of the year. Additional changes in the
investment account resulted from purchase of Carl Co. bonds.

The company issued common stock in April, and part of the proceeds was used to retire
preferred stock at $ 102 shortly thereafter. On July 1 the company called in its bonds
outstanding, paying a premium of 5% on the call. Discount amortization on the bonds to the date
of call was $ 250. Depreciation for the year on plant and equipment was $14,500 interest expense
of $ 7,500 and income tax expense of $ 5,000 were reported in the income statement.

Prepare statement of cash flows

Question # 6
The following information is assembled for the Benson Corporation:

Balance sheet

Assets 2010 2011

Cash (over draft in 2010) ($ 5,625) $ 45,875

Accounts receivable 68,625 50,000

Inventories 62,000 80,000

Plant and equipment 95,000 130,000

Less allowance for depreciation (20,000) (21,500)

Investment in securities 20,000 8,000

Patents 30,000 ---------

Total $ 250,000 $292,375

Liabilities and stock holder equity

Interest payable $ 4,000 $ 2,000

Dividend payable 6,000 3,000

Accounts payable 30,000 40,000

Bonds payable 20,000 50,000

Premium on bonds payable ------------- 2,375

Financial Reporting Page 21

Preferred stock ($100 par) 50,000 ---------

Common stock ($ 10 par) 100,000 150,000

Premium on common stock -------- 20,000

Retained earnings 40,000 25,000

Total $ 250,000 $292,375

Net loss for the year 2011 was $2,500. Equipment, cost $10,000, book value $ 4,000 was
scrapped, salvage of $500 being recovered on the disposal. Additional equipment, cost $ 45,000
was acquired during the year. Securities, cost $ 12,000, were sold for $ 15,000. Patents of $
30,000 were written off against profits. On July 1st 2011, 7% bonds, face value $ 20,000 were
called in at $ 105, and new 10-year, 5% bonds of $50,000 were issued at $105. Preferred stock
was retired at 110 while 5000 common shares were issued at $14 during the year. Depreciation
on plant and equipment for the year was $ 7,500. Interest expense reported in the income
statement $ 7,000.

Prepare statement of cash flows

Financial Reporting Page 22

 International Accounting Standard 23
Borrowing Costs

Accounting literature says that the cost of an asset should include all the costs necessary to get
the asset set up and functioning properly for its intended use in the place it is to be used. There
has long been, however, a debate about whether borrowing costs should be included in the
definition of all costs necessary, or whether instead such costs should be treated purely as a
period expense. Revised IAS-23(2007) states that all borrowing costs must be capitalized if they
are directly attributable to the acquisition, construction or production of a 'qualifying asset' (one
that necessarily takes a substantial period of time to get ready for its intended use or sale). Other
borrowing costs are recognized as an expense. However, borrowing costs cannot be capitalized
in respect of inventories that are manufactured, or otherwise produced, in large quantities on a
repetitive basis, even if they take a substantial period of time to get ready for their intended use
or sale.

Objective of IAS 23
The objective of IAS 23 is to prescribe the accounting treatment for borrowing costs. Borrowing
costs include interest on bank overdrafts and borrowings, amortization of discounts or premiums
on borrowings, finance charges on finance leases and exchange differences on foreign currency
borrowings where they are regarded as an adjustment to interest costs.

Qualifying Assets: Those assets, which take substantial period of time to get ready for their
intended use or sale. They may include the assets, which are used by the enterprise itself like
buildings, plant and machinery. Contra-wise they may be the assets for sale that have been
manufactured/ produced specifically on order of customers like ships or real estate developments
like housing projects or commercial plazas.

Borrowing Costs: Borrowing costs mainly include;

 Interest on bank drafts and loans.
 Amortization of discounts or premium on issue and retirement of loans.
 Exchange differences arising from foreign currency borrowings.

Borrowing costs eligible for capitalization, directly attributable to the acquisition, construction or
production of a qualifying asset, are those borrowing costs that would have been avoided if the
expenditures on this asset had not been made. They include actual borrowing costs incurred less
any investment income on the temporary investment of these borrowings.

Financial Reporting Page 23

 Practice Questions

Question # 1
Suppose a company has obtained following general borrowings:

16% - 4 Years loan Rs. 500,000

14% - 6 Years loan Rs. 1000,000
10% - 8 Years loan Rs. 1200,000
Required: Calculate Capitalized rate.

Question # 2
The statement of financial position of a company at year ended 31st December 2000 reflects the
following status:
Amount (Rs)
Plant under installation 2000,000
Other assets 8000,000
10,000,000
Loans

Bank Loan 18% 2,000,000

Bank Loan 20% 2,500,000

Bank Loan 22% 1,500,000

6,000,000
Shareholder’s Equity 4,000,000
10,000,000

Bank loan of 20% was taken on April 1, 2000. Other loans were brought forward from 1999.
Expenditures incurred on plant under installation:

May 01, 2000 1,000,000

July 01, 2000 700,000

November 01, 2000 300,000

2,000,000

Required: Calculate borrowing cost and total capitalized cost of asset at 2000.
Question # 3

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On 1-1-2006 Stream co. borrowed $1.5 million to finance the production of two assets, both of
which were expected to take a year to build. Work started during 2006. The loan facility was
drawn down and incurred on 1-1-2006, and was utilized as follows.
Asset A ($) Asset B ($)
1-1-2006 250,000 500,000
1-7-2006 250,000 500,000
The loan rate was 9% and Steam co. can invest surplus fund at 7%.
Required: (a). Calculate borrowing cost, which may be capitalized for each asset 31-12-2006
(b).Total cost of each asset at 31-12- 2006.
Question # 4
Acruni Co. had following loans in place at the beginning and end of 2006.

1-1-2006 31-12-2006
10% Bank loan repayable in 2008 120,000 120,000
9.5% Bank loan repayable in 2009 80,000 80,000
8.9% debentures repayable in 2007 ---- 150,000
The 8.9% debenture was issued to fund the construction of qualifying asset a piece of mining
equipment, construction of which began on 1-7-2006.
On 1-1-2006, Acruni Co, began construction of a qualifying asset, a piece of machinery for
hydroelectric plant, using existing borrowings. Expenditure drawn down for the construction
was: $30 Millions on 1-1-2006 and $20 Millions on 1-10-2006.
Required:
i) Calculate borrowing cost can be capitalized for the piece of mining equipment
ii) Calculate borrowing cost can be capitalized for hydroelectric plant.
Question # 5
The management of Power Limited decided to establish power facilities of its own. The period of
completion of facilities was estimated to be two years. For this purpose, a bank agreed to finance
the project and initially disbursed $25 million on July 01, 2001. The total finance to be provided
by the bank carried interest @ 18% per annum. The bank agreed to disburse the balance of funds
as and when the cost was to be incurred.
The management of the company revised its plan and changed location of power generation
facilities that delayed the commencement of work by 3 months. The work finally started on 1-8-
2001.

Financial Reporting Page 25

In the absence of other good investment opportunity, the management decided to temporarily
utilize $25 million to reduce existing overdraft obtained to meet working capital requirement on
which company paid interest @ 20% per annum. Funds were borrowed and used as follows.
Date $ Millions
October 01, 2001 35
January 01, 2002 25
May 01, 2002 10
$35 million include initial disbursement made by the bank.
The work on the facilities was stopped from February 01, 2002 to April 30, 2002 due to
company’s internal problems.
Required: Compute the cost of power generation facilities as at June 30, 2002.
Question # 6
PEL limited also wants to construct a plant which will cost Rs.110 Million. BOD decided to
utilize the available funds for the construction of the plant. Company has the following loans
taken, four years before from different banks at different rates.
Banks Name Amount in Rs Rate
HBL 80 Million 8.5%
UBL 60 Million 9.7%
MCB 40 Million 13.2%
Construction of the plant was started on 1st Oct 2006 and funds were used by the company as
follows,
Date Amount in Rs
1.10.2006 45 Million
1.05.2007 30 Million
1.11.2007 35 Million
Construction was completed on 31st March 2008.
Required:
i) Calculate borrowing cost to be capitalized
ii) Total cost of Plant.
IAS-2 INVENTORIES
Objective of IAS 2:

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The objective of IAS 2 is to describe the accounting treatment for inventories. It provides
guidance for determining the cost of inventories and for subsequently recognizing an expense,
including any write-down to net realizable value. It also provides guidance on the cost formulas
that are used to assign costs to inventories.
Scope
The standard applies to all in inventories, except
 Work in process arising under construction contracts (IAS 11 Construction Contracts
 Biological assets related to agricultural activity ( IAS 41 Agriculture).
1-Definitions
Inventories are assets:
 Held for sale for example finished goods
 In process of production(WIP)
 In the form of material and supplies to be consumed in production.
Fundamental Principle of IAS 2
Inventories are required to be stated at the lower of cost and net realizable value (NRV).
2-Net realizable value (NRV)
Estimated selling price
Less: estimated cost required for completion
Less: selling cost
3-Cost should include all:
 Costs of purchase (including taxes, transport, and handling) net of trade discounts
received
 Costs of conversion (including fixed and variable manufacturing overheads) and
 Other costs incurred in bringing the inventories to their present location and condition
Inventory cost should not include:
 Abnormal waste
 Storage costs
 Administrative overheads unrelated to production
 Selling costs
 Interest cost when inventories are purchased with deferred settlement terms.

4-Non-Intercchangable inventories
For inventory items that are not interchangeable, specific costs are attributed to the specific
individual items of inventory. (Specific identification method)
5-Interchangeable inventories
For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas.
The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer
allowed.
6-Expense Recognition
IAS 18 Revenue, addresses revenue recognition for the sale of goods. When inventories are sold
and revenue is recognized, the carrying amount of those inventories is recognized as an expense
(often called cost-of-goods-sold).
7-Disclosure
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Required disclosures:
 Accounting policy used
 Carrying amount of any inventories
 Net realizable value
 Carrying amount of inventories pledged as security for liabilities
 Cost of inventories recognized as expense (cost of goods sold).

Practice Questions

Question # 1
Inventory 2000 units
Material cost per unit $ 285
Labour cost per unit $ 50
FOH during the period (Fixed) 100,000
FOH during the period (Variable) 150,000
Normal Production 9000 units
Actual Production 8000 Units

Required: Calculate the value of closing inventory.

Question # 2
Inventory 2000 units
Material cost per unit $ 285
Labour cost per unit $ 50
FOH during the period (Fixed) 100,000
FOH during the period (Variable) 150,000
Normal Production 9000 units
Actual Production 10,000 Units

Required: Calculate the value of closing inventory.

Financial Reporting Page 28

Question # 3
Inventory 2000 units

Material cost per unit $ 285

Labour cost per unit $ 50

FOH during the period (Fixed) 100,000

FOH during the period (Variable) 150,000

Normal Production 9000 units

Required: Calculate the value of Closing inventory if

1) Actual Production is 10,000 Units
2) Actual Production is 8,000 Units
Question # 4
Sarah Hughes, trading as serina fashions, ends her financial year on 31stdec. at 01 Jan 2000 she
had goods in stock valued at 21500. During the year to 31stdec 2000, she purchased goods
costing $73000 fashioned goods which cost 4300 were still held in stock at 31stdec 2000, and
Sarah Hughes believe that these could only now be sold at a sale price of $800. The goods still
held in stock at 31stdec 2000.(including the fashion goods) had an original purchase cost $18700.
Sales for the year were $132500
Required: Calculate the value of stock at the year end.

Question # 5
Jackson Limited’s statement of financial position includes a stock figure of $ 28,850. On
investigation it was discovered that goods included at their cost of $460 had deteriorated. They
could still be sold at their normal selling price $800 once repair work costing $270 was
complete. Is write down required?

Question # 6
$
Sale price per Unit 50
Cost of raw material per Unit 20
Cost of direct labour per Unit 10
Overheads per unit 10
Selling exp (5% of S.P)
Calculate the NRV of the item of inventory which are in process if these are:

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80% complete as to material
50% complete as to labour
20% complete as to overhead

Question # 7
$
Sale Price Per unit 32
Cost of product
Material 12
Conversion Cost 18
Replacement cost of material 09

Required: Carrying value of inventory of raw material.

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