Accounting

In this category, Topics related to Accounting will be available

Meaning and Scope of Accounting

by

Need of Accounting: Every businessman is interested to know the information about their business such as profit or loss of the year, amount invested as capital in the business, amount to be received from debtors & amount to be paid to creditors. These information can be received through complete records of their transactions which can be measured in terms of money.

Every individual performs some kind of economic activity [ activities which are performed for earning livelihood and to acquire wealth]. In business such activities are performed through transactions & events.

Transaction is an agreement buyer and seller while event is a consequence of transactions, a result. Therfore, all business transactions are recorded through accounting.

Meaning of Book-keeping: It is consist of two words i.e, Book + Keeping. In accounting, book means accounting books in which business traansactions are recorded & keeping means writing or maintaining business transactions in books of accounts.

Note: Financial data relating to business operation are recorded in book-keeping & book-keeping is the part of accounting.

Definition of Book-keeping: According to North Cott, “Book-keeping is the art of recording in the books of accounts the monetary aspects of commercial or financial transactions.”

Meaning of Accounting :

Accounting is the process used by business entities in which business transactions in monetary form are recorded by which profit or loss can be known by a busines person who invests money in the business.

Definition of Accounting: According to American Institute of Certified Public Accountants [ICPA], ” Accounting is the art of recording, classifying and summarising in a significant manner and in terms of money , transactions and events, in part, at least, of a financial character and interpreting the result thereof.”

Characteristics/Nature/Features of Accounting:

  1. Recording: This is the basic function of accounting and those business transactions which can be measured in terms of money are recorded in the books of account. Further, the book in which transactions are recorded is called “Journal” and the journal may be divided into subsidiary books as per size of business.
  2. Classifying: After recording business transactions in original books, transactions are classified according to nature and then record one nature in one place. The book in which transactions are classified is called a “ledger”. In a ledger, separate accounts of individuals, separate expenses, incomes, liabilities and assets etc. maintain. 
  3. Summarising: Summarizing is concerned with the preparation and presentation of financial statements that are useful to the internal & external users of financial statements. Under this, a trial balance is prepared. That is the basis of preparation of financial statements [Trading A/c, Profit & Loss A/c and balance sheet]. 
    • Accounting Cycle/ Accounting Process: Transactions-Journal-Ledger-Trial Balance-Trading A/c-Profit & Loss A/c-Balance Sheet………………………………………Journal

4. Analyzing:

Analysis means classification of data of financial statements as the figures given in the financial statements will not understand by anyone unless they are in simplified form.

  • For example, all items relating to fixed assets and current assets are put at different place. Furthermore, Profit and Loss A/c and Balance Sheet provide the basis for interpretation.

5. Interpreting: Interpreting means the financial statements are interpreted in such a manner that the end users can make a meaningful judgement about the financial condition and profitability of the busines entities.

Difference between Book-keeping and Accounting

Sr. NoBook-keepingAccounting
1.It is the first step which is concerned with recording of transaction.This is the second step which starts where book-keeping ends.
2.It is a base for accounting.It is considered as a language of the business.
3. The purpose is to primary recording of business transactions.The purpose is to ascertain profit & loss and balance sheet.
4.Book-keeping has no sub-field.It has several sub-fileds like financial, cost accounting etc.
5.It does not include final accountsIt includes final accounts.
6.With the help of these records, management cannot take decision relating to business. With the help of these records, managerial decision can be taken.

Branches/Types of Accounting

  1. Financial Accounting: It covers the preparation of financial statements [mainly profit & loss A/c and balance sheet] and interpreting thereof.
  2. Cost Accounting: It prepares Cost sheet and ascertain cost of production [manufacturing A/c]. In brief, it helps the management to control cost.
  3. Management Accounting: It is concerned with internal reporting to the managers. In fact, tools and techniques are used for analyzing financial statements such as ratio analysis, common size statements, trend analysis, fund flow analysis etc.

Objects/functions/Advantage of Accounting

  1. Keep Systematic Records: The first function of accounting is to keep a systematic records of business transactions.
  2. Ascertaining Profit/Loss: accounting helps to ascertain profit or loss for any period because profit & loss account is prepared at the end of every year.
  3. Showing the Financial Position of the Business: Financial position as on or at a particular date is known throgh balance sheet because balance sheet is a true picture of financial position. Besides, how much the business has to receice from and how much the business has to pay, assets and how much capital was in the begining & how much is at the end of the year. These all are known with the help of balance sheet.
  4. Protecting & Controlling Business Properties: Accounting furnishes information about money due from and due to various parties. Therefore, accounting helps in disposal of any property of the business entity.
  5. Providing Information to various Parties: This is one of the main objective of accounting to provide the information to the interested parties like owners, creditors, management, employees, customers, government etc.
  6. Helps in decision making: Accounting information relating to financial or cost helps the management in planning & decision making.
  7. Evidence in Legal matters: Acounting information can be used as evidence in a court.
  8. Comparison of Results: Accounting information is used to compare the results of different years.

9. Helps in Taxation matters: With the help of accounting information, tax authorities draw a conclusion about the taxation matter.

Limitation of Accounting

  • Incomplete Information: Transactions which are of financial character and expressed in terms of money are recorded only.
  • Accounting Information may be Biased: The accountant has to take decison regarding different methods of valuation of inventory , methods of depreciation, provision for doubful debts, treatment of capital and revenue items etc.
    • Hence, the income cannot be treated as correct.
  • Accounting can be Malipulated: Accounting information can be manipulated because owner does not express information in books of account which are of his own interest.
  • Fixed Assets are Recorded at the original Cost: The value of fixed assets change oover time and so there may be difference between original cost and current cost..
  • Unsuitable for forecasting: Factors like demand of goods, policy of firm, level of competition etc. are not considered in accounts.
  • Accounting Ignores Time value of Money: Accounting ignores some money factors like inflation.
  • Conflict in Accounting principles: There are occasions where accounting principles conflict with each other.

Capital and Revenue Expenditures | Difference between Capital and Revenue Expenditures

by

Capital Expenditure: – Capital expenditure is that expenditure which incurs to increases the revenue earning capacity of a business.

Example: –

  • Purchase of land, buildings, furniture and machinery etc.

Revenue Expenditure: – Revenue expenditure is that expenditure which incurs to generate revenue for a particular accounting period.

Example: –

  • Salaries, Rent, wages, carriage of goods, repair, insurance etc.

Difference Between Capital And Revenue Expenditure :-

Sr. NoCapital ExpenditureRevenue Expenditure
1.This expenditure is incurred to provide a benefit over a long period of time.This expenditure is incurred to provide a benefit during the current period.
2. This increases the earning capacity of the business. This maintains the earning capacity of business.
3. This is normally a non-recurring.This is usually a recurring features.
4. It appears in the balance sheet and small part is charged as depreciation to income statement. It doesn’t appear in balance sheet but charged against profit and appears in income statement.
5.Purchase of land, building, machine, car, furniture etc.Salary, wages, repairs and maintenance, interest, insurance etc.

Accounting Concepts, Principles and Conventions

by

Accounting: -Accounting is a language of business by which financial statements communicate to the various stakeholders for decision making purpose.

Accounting Concepts: – Accounting concepts are the basic assumptions and conditions which work as the basis of recording of business transactions and preparing accounts.

The following are the widely accepted accounting concepts: –

Entity Concept: -According to this concept, business enterprise is a separate entity from its owners. All the business transactions are recorded in the books of business from the point of view of business.

In addition to this, entity concepts help to identify how much amount of money is due to the owner in form of his capital and share of profits.

For example: – Mr. Ram started business investing ₹ 5,00,000, out of this he purchased machinery for ₹ 3,00,000 and maintained the balance in the hand. The financial position will be as under:

Capital₹ 5,00,000
Machinery₹ 3,00,000
Cash₹ 2,00,000
As a result,

The business owes to Mr. Ram ₹ 5,00,000 but if Mr. Ram spends ₹ 5,000 to meet his personal expenses from the business fund then it should not be taken as business expenses and would be charged to his capital account [investment would be reduced by ₹ 5,000].

Here, the entity concept will revise the financial position. This would be as under:-

Liability₹₹
Capital
Less : Drawings		5,00,000
5000		4,95,000
Machinery 3,00,000
Cash1,95,000

Going Concern Concept: –

It means the business will have an indefinite life [ it will continue for a long time]. The valuation of assets of a business is based on this assumption.

It is because of this concept that fixed assets are valued on the basis of cost less proper depreciation by considering expected useful life ignoring fluctuations in the prices of these assets.

Money Measurement Concept: –

According to money measurement, transactions and events which can be expressed in terms of money are recorded in the books of account. Consequently, events which cannot be expressed in terms of money do not find place in the books of account.

For example: – employees of the organization are the assets of the organizations but they cannot measure in monetary terms.

Accounting Period Concept: –

As per this concept, accounts should be prepared after every period [usually period is calendar year]. We generally follow 1st April to 31st March.

Moreover, period of one year takes up for the performance measurement and appraisal of financial position.

Cost Concept: –

Under this concept, assets are to be recorded at historical cost or at acquisition cost [purchase price + all expenses incurred to put the asset to use].

for example, if an enterprise buys a machine for ₹ 2,00,000, the asset [machine] would be recorded in the books of account at ₹ 2,00,000 even if its market value at that time happens to be ₹ 2,50,000.

The cost concept does not mean that the assets will always be shown at cost. The fixed asset will be recorded at cost at the time of its purchase but it may systematically be reduced in its value by charging depreciation.

Dual Aspect Concept: –

it means every transaction has two aspects. For every debit there is a corresponding and equal credit. This concept is based on double entry system.

Matching Concept: –

According to this concept, all expenses matched with revenue of that relevant period should only be taken into consideration. This concept states that if any revenue recognizes then expenses related to earn that revenue should also be recognized.

Further, this concept is based on accrual concept as it considers the occurrence of expenses and income. Accounting period concept or periodicity concept has also been followed while applying matching concept.

As per this concept, various adjustments should be made for outstanding expenses, accrued incomes, unexpired expenses and unearned incomes etc.

Realisation Concept: –

According to this concept, normally, revenue is recognized when it is realized i.e., when the ownership of goods passes to the buyer and the buyer becomes legally liable to pay.

It covers all the probable losses but do not consider probable gain until it is realized.

Accrual Concept: –

Under this concept, all the transactions and events are recognized on the basis of their occurrence [i.e., mercantile basis] not on the basis of cash received or paid.

As per Accrual Concept:-

Profit = Revenue–Expenses

Accounting Conventions: –

  1. Consistency: – This implies that same accounting policies should be followed from one period to another. A change in accounting policy is made only in exceptional circumstances. For example, methods of depreciation, methods of valuation of inventories.
    • Note:- As per consistency, enterprise should follow consistently same method of depreciation and valuation of inventories which is chosen by the enterprise.
  2. Materiality: – According to this convention, all the material information should disclosed in the books of account. All the items have significant economic effect on business enterprise should be disclosed and ignored the insignificant items and should not be disclosed.
  3. Conservatism :- Convention of conservatism is the policy of “playing safe“. As per this, accountant should not anticipate any future income but should take all possible losses while recording business transaction in the books of account.

Fundamental Accounting Assumptions: –

There are three fundamental accounting assumptions: –

  1. Going Concern
  2. Consistency
  3. Accrual.

Buy-back of Securities

by

Buy-back of securities/Buy-back of shares:-

What is buy-back of shares?

Buy-back of shares means purchase of its own shares by the company from existing shareholders.

Buy-back represents cancellation of shares and decrease of share capital. It means when company buy back of its own shares then, the purpose is to cancel the already issued shares and decrease the share capital and company can not buy its own shares for the purpose of investment.

Advantages/Objectives of Buy-back

  1. To increase the earnings per share.
  2. To reduce the capital.
  3. To increase promoters holding.
  4. To enhance consolidation of stake in the company.
  5. To prevents others to make bid for take over the company.
  6. To support the share price on stock exchange.
  7. To improve return on capital and return on net worth.
  8. To return surplus cash to shareholders.
  9. To achieve optimum capital structure.
  10. To enhance the long-term value for shareholders.

According to section 68(1) of the Companies Act 2013, companies are allowed to buy-back their own shares and other specified securities out of: –

  1. Its free reserves: or
  2. the securities premium account; or
  3. the proceeds of the issue of any shares or other specified securities.

Note: – No buy-back of any kind of shares or other specified securities shall be made out of the proceeds
of an earlier issue of the same kind of shares or same kind of other specified securities.

The important conditions for buy back

According to section 68(2) of the Companies Act, 2013, following conditions must be satisfied if the companies purchase its own shares or other specified securities:

(a). The buy back must be authorized by its articles of association.

(b). A special resolution has been passed at a general meeting relating to the buy back.

however, the above conditions do not apply when the buy back is 10% or less of the paid up equity capital and free reserves and authorized by a board resolution.

(c). The buy back must be ≤ 25% of total paid up capital and free reserves of the company.

(d). The buy back must not be >25% of total paid up capital and free reserves in any financial year.

(e). After buy back, the debt equity ratio should be 2:1, it means the debt should not be more than twice of its equity [paid up capital and its free reserves].

(f). All the shares or other specified securities for buy-back are fully paid-up.

(g). The buy back of listed shares or other specified securities will be in accordance with the regulations made by the Securities and Exchange Board of India.

(h). Buy back in respect of shares or other specified securities other than those specified specified in (f) will be in accordance with the guidelines as may be prescribed.

Note: -The buy back can not be more than in one year.

Explanatory Statement

As per section 68(3), additional requirements are as follows: –

The notice of meeting at which the special resolution is supposed to be passed must be accompanied by an explanatory statement stating: –

  • (a) a full and complete disclosure of all material facts.
  • (b) the necessity for the buy-back
  • (c) the class of shares or securities intended to be purchased under the buy-back.
  • (d) the amount to be invested under the buy-back.
  • (e) the time-limit for completion of buy-back.

3. Every buy back shall be completed within 12 months from the date of passing the special resolution.

4. The buy back may be:

(a) from the existing shareholders or security holders on a proportionate basis; or

(b) from the open market; or

(c) by purchasing the securities issued to employees of the company pursuant to a scheme of stock
option or sweat equity.

5. Solvency declaration– Before making such buy-back, it has to be filed with the Registrar a declaration of solvency signed by at least two directors of the company, one of whom shall be the managing director, if any, and Form as may be prescribed and verified by an affidavit to the effect that the Board of Directors of the company has made a full inquiry into the affairs of the company, as a result of which they have formed an opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year from the date of declaration adopted by the Board of Directors.

Note: – Company whose shares are not listed on any recognized stock exchange shall not be filled declaration of solvency with Securities and Exchange Board of India.

6. When a company buys-back its own securities, it shall extinguish and physically destroy the shares or securities so bought back within seven days of the last date of completion of buy-back.

7. When a company completes a buy-back of its shares or other specified securities, it shall not make a further issue of the same kind of shares or other securities including allotment of new shares or other specified securities within a period of six months except by way of:

a. issue of bonus ; or

b. in discharging of subsisting obligations, such as conversion of warrants, stock option schemes, sweat
equity or conversion of preference shares or debentures into equity shares.

8. When company buys-back its securities, company shall maintain a register of the shares or securities
so bought, the consideration paid for the shares or securities bought back, the date of cancellation of shares
or securities, the date of extinguishing and physically destroying the shares or securities.

9. A company shall, after the completion of the buy-back under this section, file with the Registrar a return containing such particulars relating to the buyback within thirty days of such completion.

Note: – Companies whose shares are not listed on any recognized stock exchange, no return shall be filled.

10. If a company makes a default in complying with the provisions of this section, company shall be punishable with a fine which shall not be less than one lakh rupees and which may extend to three lakh rupees and every officer of the company who defaults shall be punishable with imprisonment for a term which may extend to three years or with a fine which shall not be less than one lakh rupees and which may extend to three lakh rupees, or with both.

11. Where a company purchases its own shares out of free reserves or securities premium account, a sum equal to the nominal value of the shares so purchased shall be transferred to the capital redemption reserves account and details of such transfer shall be disclosed in the balance sheet.

12. Buy-back shares must be fully paid-up.

13. The capital redemption reserve account may be applied by the company, in paying up unissued
shares of the company to be issued to its members as fully paid bonus shares.

Amalgamation| Absorption| External Reconstruction

by

Meaning of Amalgamation:-

Amalgamation means where two or more companies are merged to form a single entity.

Example: – Company X and Company Y merge to form Company Z. This is called as amalgamation. Here, company X and company Y are called transferor companies and company Z is called as transferee company. In addition to this, transferor company is also called as vendor company and transferee company is also called as vendee company.

Absorption:- When company takes over the other by outright purchase.

Example: – Company X taken over [purchased] by company Y. This is called as absorption. Here, Company X is called as transferor company and company Y is called as transferee company.

External Reconstruction:- When new company is formed to take over the business of an existing company which is wound-up.

Example: – Company Y is formed to take over the business of X. This is called as external reconstruction.

Note: – External reconstruction can be seen where company has been suffering from losses for past years.

Differences among Amalgamation, Absorption and External Reconstruction:-

Sr. No.BasisAmalgamationAbsorptionExternal Reconstruction
1.MeaningWhen two or more companies are combined to form a new company or entity.
Old companies are wound up.		When one existing company takes over the business of another existing company.
Old company is wound up and the new company will continue in business.		When new company is formed to take over the business of an existing company.
One company takes over the business of an existing loss making company.
2.ExampleX Company + Y Company = Z Company [New Company].X company taken over by Y company
Y company will continue in business. 		Y company is formed to take over the business of X.
3.Minimum number of companies requiredAt least three.At least two.only two.
4.ResultOne company is formed, two companies are wound up.No new company is formed.New company is formed to take over business of existing.
5.ReasonEliminate competition/Economies of large scale operations.Eliminate competition/Economies of large scale operations.Reorganize the financial structure of the company.

Types of Amalgamation:- As per AS 14, there are two types of amalgamation.

  1. Amalgamation in the nature of merger: – Amalgamation which satisfies the following conditions is called as ‘amalgamation in the nature of merger‘.
    • After amalgamation, all the assets and liabilities of transferor company become the assets and liabilities of the transferee company.
    • Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held by the transferee company or its subsidiaries or their nominees immediately before the amalgamation) become equity shareholders of the transferee company by virtue of the amalgamation.
    • The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect of any fractional shares.
    • After the amalgamation, the intention of the transferee company is to be carried on the business of the transferor company.
    • No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies.
  2. Amalgamation in the nature of purchase: – Amalgamation which doesn’t satisfy one one or more of the above conditions, then, such amalgamation is called as amalgamation in the nature of purchase.

Difference between amalgamation in the nature of merger and amalgamation in the nature of purchase

BasisAmalgamation in the nature of MergerAmalgamation in the Nature of Purchase
Transfer of Assets & LiabilitiesAll the assets and liabilities are to be transferred by transferor company to transferee company.No need to transfer all the assets & liabilities.
ShareholdersEquity shareholders holding at least 90% equity shares in transferor company become shareholders of the transferee company.Equity shareholders of transferor company need not become shareholders of the transferee company.
Same businessThe transferee company is intended to be carried on the same business of transferor company.The transferee company need not be intended to be carried on the business of the transferor company.
Purchase considerationPC is discharged wholly by issue of equity shares.PC need not be discharged wholly by issue of equity shares.
Recording of Assets & LiabilitiesAt net cost as reflected in a company’s book. [except where adjustment is required to bring uniformity].At net cost or fair values.
Method of AccountingPooling of interest method.Purchase method.
Methods of calculating Purchase Consideration: – these are the following methods to compute purchase consideration: –
  1. Lumpsum method:– as the name suggests, in this method, the transferee company agrees to pay a fixed/lumpsum amount to shareholders of the transferor company.
  2. Net payment method: – under this method, the transferee company makes payments to the equity and preference shareholders.
  3. Net asset method: – in this method, purchase consideration is calculated by subtracting the outside liabilities [except share capital and reserves] from the value of assets taken over by the transferee company [book value/agreed value].
  4. Intrinsic value: – Under this method, purchase consideration is calculated at the intrinsic value of shares.

Differentiating Between Cash and Accrual Accounting Methods

by

Introduction:- Primarily there are two methods that are commonly used i.e. cash accounting and accrual accounting.

These methods differ in how they recognize revenue and expenses, impacting the timing and accuracy of financial reporting.

Cash Accounting:–

a. Definition and Principles:

  • Cash accounting is a method of recording transactions when cash is received or disbursed.
  • Emphasis on the immediate recognition of revenue when received and expenses when paid.

b. Application and Suitability:

  • Situations where cash accounting is typically used, such as small businesses, sole proprietors, and certain service-based industries.
  • Limitations and potential challenges of cash accounting in complex business scenarios.

c. Impact on Financial Statements:

  • Income Statement: Revenue and expenses are recognized only when cash is received or paid, providing a snapshot of cash flow.
  • Balance Sheet: Assets, liabilities, and equity reflect actual cash balances at a specific point in time.
  • Cash Flow Statement: Cash flows from operating, investing, and financing activities are directly reported.

2. Accrual Accounting:

a. Definition and Principles:

  • Accounting is a method of recognizing revenue when earned and expenses when incurred, regardless of cash flow. Emphasis on the matching principle and the concept of accruals and deferrals.
b. Application and Suitability:
  • Where accrual accounting is generally preferred, such as larger businesses, corporations, and industries with long-term projects or contracts.

  • Advantages of accrual accounting in providing a more accurate representation of financial performance and obligations.
c. Impact on Financial Statements:

  • Income Statement: Revenue and expenses are matched to the period in which they are earned or incurred, providing a more comprehensive view of profitability.
  • Balance Sheet: Assets, liabilities, and equity reflect economic resources and obligations, including accounts receivable, accounts payable, and accrued expenses.
  • Cash Flow Statement: Cash flows are reported based on operating, investing, and financing activities, considering changes in working capital.

Key Differences:

a. Timing of Revenue and Expenses:

  • Cash accounting recognizes revenue and expenses when cash is received or disbursed.

  • Accrual accounting recognizes revenue when earned and expenses when incurred, irrespective of cash flow.
b. Accuracy of Financial Statements:
  • Cash accounting may provide a simplified view of financial performance and obligations. Accrual accounting offers a more comprehensive and accurate representation of financial position and results.
c. Compliance and Reporting Requirements:

4. Choosing the Right Method:

  • Factors to consider when selecting the appropriate accounting method, such as business size, industry, legal requirements, and financial objectives.
  • Importance of consulting with accounting professionals to assess the suitability of each method for your specific situation.

Conclusion: Cash accounting and accrual accounting are distinct methods of recording financial transactions, each with its benefits and limitations. Cash accounting provides simplicity and a focus on cash flow, accrual accounting offers a more accurate depiction of financial performance and obligations. Understanding the differences between these methods is crucial for businesses and individuals to make informed decisions, comply with accounting standards, and interpret financial statements effectively. Consider your unique circumstances and consult with accounting professionals to determine the most appropriate method for your financial reporting needs.

Understanding Depreciation and Amortization: Impact on Financial Statements

by

Introduction:- Depreciation and amortization are essential accounting concepts that play a crucial role in accurately representing the value of long-term assets and intangible assets on financial statements.

Depreciation:-

a. Definition and Purpose of Depreciation:

  • Explanation of depreciation as the systematic allocation of the cost of tangible assets over their useful lives.
  • Importance of recognizing the decrease in value due to wear and tear, obsolescence, or other factors.

b. Methods of Depreciation:

  • Straight-line method: Calculation and advantages of evenly distributing depreciation expenses over the asset’s useful life.
  • Accelerated methods (e.g., declining balance, sum-of-the-years’-digits): Explanation of methods that allocate more depreciation in earlier years.
  • Choosing the appropriate method based on asset characteristics and tax considerations.

c. Impact on Financial Statements:

  • Income Statement: How depreciation expenses reduce net income, impacting profitability.
  • Balance Sheet: Depreciation’s effect on the carrying value of assets and accumulated depreciation.
  • Cash Flow Statement: Non-cash depreciation expense and its influence on cash flows.

Amortization:-

a. Definition and Purpose of Amortization:

  • Introduction to amortization as the systematic allocation of the cost of intangible assets over their estimated useful lives.
  • Examples of intangible assets subject to amortization (e.g., patents, copyrights, trademarks).

b. Methods of Amortization:

  • Straight-line method: Even distribution of amortization expenses over the asset’s estimated useful life.
  • Other methods based on specific asset characteristics or contractual agreements.

c. Impact on Financial Statements:

  • Income Statement: How amortization expenses affect net income, operating margins, and overall profitability.
  • Balance Sheet: Amortization’s impact on the carrying value of intangible assets and accumulated amortization.
  • Cash Flow Statement: Non-cash amortization expenses and their influence on cash flows.

3. Reporting Requirements and Disclosures:

  • Compliance with accounting standards and reporting requirements for depreciation and amortization.
  • Notes to financial statements: Disclosures related to depreciation and amortization policies, significant assets, and their carrying values.

4. Importance of Depreciation and Amortization Analysis:

  • Evaluating asset values and their impact on financial performance.
  • Understanding the implications for tax planning, asset replacement, and investment decisions.
  • Analyzing depreciation and amortization trends to assess asset efficiency and potential obsolescence.

Conclusion: Depreciation and amortization are essential concepts in accounting that allow businesses to accurately allocate costs and reflect the value of long-term assets and intangible assets over time. By understanding their impact on financial statements, you can gain insights into a company’s financial health, profitability, and asset management strategies. Whether you’re a business owner, investor, or accounting professional, a solid understanding of depreciation and amortization is crucial for making informed decisions and interpreting financial statements effectively.

Difference between Financial Accounting and Cost Accounting

by

Financial Accounting and Cost Accounting:-

Sr. No.BasisFinancial AccountingCost Accounting
1.MeaningRecording, classifying and summarizing of financial transactions and events.Recording, classifying and summarizing of Cost data.
2.CoversPreparation and interpretation of financial statements and communication to the users of accounts.Preparation of periodical statements and reports for ascertaining cost of production.
3.ObjectiveTo prepare financial statements i.e. profit & loss a/c and balance sheet etc. To ascertain cost of production, reduce the cost, control the cost and prepare cost statements and reports.
4. NeedFinal accounts are prepared as per Companies and Income Tax Act, 1961.Cost accounts are prepared as per the requirement of management.
5.Information TypeQuantitative.Quantitative.
6.PeriodFinancial accounting is done for definite period.No definite period. Cost reports are prepared according to the requirement of management.
7. Analysis of profitReveals the profit of whole business. Reveals the profit of each product, job or process.
8UsersShareholders and stakeholders.Internal management.
9. Stock valuation As per AS-2 stocks are valued at cost or net realizable value whichever is less.Stocks are valued at cost.
10.Relative EfficiencyDo not reveal the relative efficiency of each department. Provide information on the relative efficiencies of various Plant and Machinery.

Models|Methods of Valuation of Human Resources

by

Models of Valuation of Human Resources–

Human resources have much importance in the service sector. That’s why for quantify the knowledge, skills and workforce of employees, various models were suggested by various experts.

Some of the models of valuation of human resources are:-

  • Cost based Model
  • Economic Value based Model

Cost based models focused on the cost of employees i.e., expenses incurred by enterprises on employees.

Historical Cost Method

This method was developed by Payle Brummet, Flumholts. Firstly, this was adopted by R.G Bary Corporation, a leisure footwear company in Colombus, Ohio, U.S.A.

Under this method actual cost incurred on recruitment, selection, training and development are capitalized and amortized over the future expected useful life of human resources.

Merits:-

1. This method is simple to use and easily understandable.

2. This is based on old accounting techniques.

3. This follows the matching concept (i.e., cost is related to revenue).

4. This evaluates both human and physical asset in the same manner.

5. This method is helpful in the evaluation of return on investment in human resources.

Demerits:-

1. Difficult to estimate the exact life of human resources.

2. It covers only acquisition and development cost not potentiality.

3. Difficult to determine rate of amortization.

4. It does not cover the economic value of human resources.

5. It is not helpful in taking right decision.

Replacement Cost Method:-

  • Replacement Cost method- This method was propounded by Rensis Likert and Eric G. Flamholtz. Under this method, cost is to be calculated on the basis of replacement i.e., value of employee is estimated on the cost of replacement with a new employee of equivalent knowledge and experience. Cost includes:-
    • Cost of Recruitment
    • Cost of Selection
    • Cost of Training
    • Cost of Development
    • Advantages:-
      • It signifies the current value of human resources.
      • It is considered more realistic in comparison of historical cost approach.
      • It takes into account individual skills of every employee
    • Disadvantages:-
      • Difficult to calculate replacement cost.
      • difficult to replace employee with equivalent knowledge and exxperience.
      • It is irelevant.

Opportunity Cost Method

This method was advocated by Hekimian and Jone. This method is based on Economic concept of Opportunity cost. Under this method cost is to be determined on the basis of alternative use of employees. If employees are not scarce then there will not be opportunity cost. It implies that employees who are scarce can be included in human asset.

Example– Mrs. Sheetal Nahar works in ABC Co. Ltd. as an accounts manager and gets a monthly salary of Rs. 45000/- and other company offers her Rs. 48000/- for the same post. Hence, the opportunity cost would be Rs. 3000/-

  • Advantages:-
    • It is easy to apply.
    • It is suitable for scarce employees.
    • it encourages employees.
    • It is helpful in proper distribution of human resources.
  • Disadvantages:-
    • It discourages other employees.
    • It is subjective method.
    • It can not be adopted by every business enterprise.
    • It considers competitive bid price that may misleading and inaccurate.

Standard Cost Method

This method was suggested by David Watson. Under this method Companies use standard cost for the valuation of human asset. Standard cost is predetermined and fixed cost for each category of employees. Every year cost of recruitment, training and development of employees are determined.

  • Advantages:-
    • It is easy and simple to use.
    • It is determined by team of experts.
    • It is helpful in controlling because of variances.
  • Disadvantages:-
    • It is not realistic.
    • This makes categories of employees.
    • It may lower the morale of employees.
Economic Value based Methods

These methods are based on present value of human resources and determination of future contribution of employees.

  • Present value of Future Earning Method:- This method was developed by Lev & Schwartz. Under this method present value of future earning of human resources in an organization are determined. This is also known as Lev & Schwartz model.
    • Important Points:-
      • The employees are classified in specific group based on their age and skill.
      • Average earning are determined for various range of age.
      • Total earnings upto retirement age for each group are determined.
      • Total earnings are discounted @ rate of cost of capital and result would be the value of human resources.
        • Formula– Vr=I (t)/(1+R)t-r
          • Where
          • Vr = Value of individual r year old.
          • I(t) = The individual annual earning upto the age of retirement.
          • t= retirement age.
          • r= present age of employees.
          • R = Discount rate
        • Advantages:-
          • It considers the time value of money.
          • It considers the expected future earnings.
          • It considers the discount rate on the basis of cost of capital which is justifiable.
        • Disadvantages:-
          • It is based on future i.e., no accuracy and precision.
          • It ignores the possibility that employees may leave the organization before death or retirement.
          • It does not consider the progress of employees and salary that does not remain same over a period of time.
Harmonson’s Model

This model had given by Roger H. Hermonson. Under this method earning is calculated by applying discount rate. This is also called Adjusted Discount Future Wage Model. The key point of this model is efficiency ratio.

Efficiency Ratio- is the weightage average of return on investment of firm to the return of all firms of the industry.

Flamholtz Model

This model was developed by Flamholtz in 1971. This is an improvement on present value of future earning model, it takes into consideration the possibility that employee may leave the organization before the death or retirement and move from one role to another. Under this model the ultimate measure of employee’s value is expected realizable value depend on conditional value and probability of remain stay in the organization. The following steps suggested in this model:-

  • Period is determined for which an employee is expected to serve in the organization.
  • Estimate the circumstances under which employee may retain or leave the organization.
  • value can be determined either by multiplying the price of services to rendered or expected income derived from the service rendered.
  • Total value of service is determined.
  • Total value of services is discounted with a certain rate to find out the present value of human resources.

Aggregate Average Payment Model

This model was advocated by Prof. S.K Chakraborty in 1976. Under this model value of human resources is determined in aggregate not an individual basis and classified the manpower in two parts. The average salary of the group is multiplied by average period of employment.

Unpurchased Goodwill Model

This model was discussed by Hermonnson. As per this model the value of human resources can be assessed by taking into consideration the excess profit over normal profit i.e., super profit and super profit is capitalized at normal rate of return.

Giles and Robinson’s Human Asset Multiplier Model

This model emphasized that human resources may be valued at going concern like other assets. Remuneration of employee of a particular category is multiplied by the factor of their contribution in the organization.

Morse Net Benefit Model

This model was propounded by Morse in 1973. Under this model value of human resources is determined on present value of net benefits derived from the services of employees.

This method suggested the following steps:-

  • The gross value of services of employees is determined.
  • The value of future payments is determined.
  • The excess value of human resources over the value of payment is determined.
  • The present value of net benefits derived is calculated with the help of discount rate.

Human Resource Accounting |Definition |Objectives |Importance

by

In every business organization, human plays a vital role because there is nothing beyond a human being. Every business concern requires land, building, Plant & Machinery etc. but the important thing is that without human these are useless.

According to Alfered Marshall the most important asset in any business is human. Just like other resources, human also is a resource. This is considered one of the valuable resources in business because success of business enterprise depends on capable person.

HRA is a accounting for human resources by which cost can be determined.

HRA is the process of identifying and measuring data about human resources and communication to interested parties.

Objectives of HRA:-

  • To determine cost of recruitment, training & development etc. of human resources.
  • To enable management to monitor and assess efficiency of human resources.
  • To assist in developing effective management practices.
  • To provide information about human resources to investors for decision purpose.
  • To evaluate the return on investment in human resources.
  • To provide qualitative information about human resources.
  • To find out whether human resources have been used properly or not.
  • To analyze human assets whether these assets are to conserved, depleted and appreciated.
  • To help in better control.

Importance:-

Human resources provide useful information to the management, financial analysts and employees etc.

  • To assist company in identifying investment on employees and expected return on inestment.
  • To provide useful information about cost and value of human resources.
  • To give base for planning for physical assets and human resources.
  • To help in making personnel policies. For example recruitment, selection, promotion and retrenchment etc.
  • To provide useful information to investors and other interested users.
  • To assist management in best utilization of human resources.
  • To motivate employees.
  • To resolve industrial disputes.
  • To identify the causes of high labor turnover ratio and suggest for preventive measures.