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