Monday, 26 December 2011

ACCOUNTING CONCEPTS AND CONVENTIONS


ACCOUNTING PRINCIPLES 
Accounting is nothing more than the measurement of the processes to reflect what has happened to a business over a relevant period of time. The assets are measured by the Balance Sheet, while the profit and cash parts are measured by the Income Statement / Profit and Loss Account and the Cash Flow Statement respectively. For measuring them, accounting principles are used which are segregated into Accounting Concepts and Conventions

ACCOUNTING CONCEPTS AND CONVENTIONS

ACCOUNTING CONCEPTS

 In order to make the accounting language convey the same meaning to all people & to make it more meaningful, most of the accountants have agreed on a number of concepts which are usually followed for preparing the financial statements. These concepts provide a foundation for accounting process. No enterprise can prepare its financial statements without considering these concepts.

1) BUSINESS ENTITY CONCEPT : According to this concept, Business is treated as separate & distinct from its members  Separate set of books are prepared.  Proprietor is treated as creditor of the business.  For other business of proprietor different books are prepared.
2) MONEY MEASUREMENT CONCEPT:  Only those transactions, which are expressed in monetary terms are recorded in the books of accounting. Money is the common unit, which enables various items of diverse nature to be summed up together and dealt with.
3) GOING CONCERN CONCEPT: According to this concept, it is assumed that the business will exist for a long time and transactions are recorded on this basis. This concept forms the basis for the distinction between expenditure that will yield benefit over a long period of time and expenditure whose benefit will be exhausted in the short-term.
4) ACCOUNTING PERIOD CONCEPT:  Business firms prepare their income statements for a particular period. This period, known as the accounting period, is usually the calendar year (January 1 to December 31) or the financial year (April 1 to March 31). Some firms, like trading firms have shorter periods such as a month or less, while others may have longer terms. The Companies Act, 1956 has set a maximum limit of 15 months for the accounting period.
5) COST CONCEPT:  The transactions are recorded at the amounts actually involved. For instance, a piece of land may have been purchased at Rs.1,50,000, whereas the company considers it to be worth Rs.3,00,000. The land is recorded in the books of accounts at Rs.1,50,000 only. Thus, an arbitrary valuation of the company’s assets is avoided by recording the value at the actual amount involved. Since this amount would have been mutually agreed upon by both the parties involved in the transaction, it is an objective valuation.
6) DUAL ASPECT CONCEPT: Every transaction recorded in books affects at least two accounts.  If one is debited then the other one is credited with same amount.  This system of recording is known as “DOUBLE ENTRY SYSTEM”.  This gives rise to the statement
            ASSETS = LIABILITIES + CAPITAL
7) REALISATION CONCEPT: Every transaction in accounting need to be recorded basing on its realization. Accounting records transactions from the historical perspective, i.e. it records transactions that have already occurred. It does not attempt to forecast events; this prevents the business from presenting inflated profits based on their expectations.  A transaction is recorded only on receipt of cash or a legal obligation to pay. Until then, no income or profit can be said to have arisen.
8) MATCHING CONCEPT: All the revenue of a particular period will be matched with the cost of that period for determining the net profits of that period. Accordingly, for matching costs with revenue, first revenue should be recognised & then costs incurred for generating that revenue should be recognised.
  Following points must be considered while matching costs with revenue-:
Outstanding expenses though not paid in cash are shown in the P&L a/c.
Prepaid expenses are not shown in the P&L a/c.
Closing stock should be carried over to the next period as opening stock.
Income receivable should be added in the revenue & income received in advance should be deducted from revenue.
9) ACCRUAL CONCEPT:  In this concept revenue is recorded when sales are made or services are rendered & it is immaterial whether cash is received or not. Same with the expenses i.e. they are recorded in the accounting period in which they assist in earning the revenues whether the cash is paid for them or not.
10) OBJECTIVE EVIDENCE CONCEPT: Accounting transactions should be recorded in an objective manner, free from the personal bias of either management or the accountant who prepares the accounts. It is possible only when each transaction is supported by verifiable documents & vouchers such as cash memos, invoices.

ACCOUNTING CONVENTIONS
An accounting convention may be defined as a custom or generally accepted practice which is adopted either by general agreement or common consent among accountants. It refers to common practices which are universally followed in recording and presenting accounting information of the business entity. They are followed like customs, tradition, etc. in a society. Accounting conventions are evolved through the regular and consistent practice over the years to facilitate uniform recording in the books of accounts. Accounting Conventions help in comparing accounting data of different business units or of the same unit for different periods. These have been developed over the years
1) CONVENTION OF FULL DISCLOSURE
Information relating to the economic affairs of the enterprise should be completely disclosed which are of material interest to the users. Proforma & contents of balance sheet & P&L a/c are prescribed by Companies Act. It does not mean that leaking out the secrets of the business.
2) CONVENTION OF CONSISTENCY
Accounting method should remain consistent year by year. This facilitates comparison in both directions i.e. intra firm & inter firm. This does not mean that a firm cannot change the accounting methods according to the changed circumstances of the business.
3) CONVENTION OF CONSERVATISM
All anticipated losses should be recorded but all anticipated gains should be ignored. It is a policy of playing safe. Provisions are made for all losses even though the amount cannot be determined with certainty.
4) CONVENTION OF MATERIALITY
According to American Accounting Association, “An item should be regarded as material if there is reason to believe that knowledge of it would influence decision of informed investor.”
It is an exception to the convention of full disclosure. Items having an insignificant effect to the user need not to be disclosed.

Friday, 2 December 2011

FUNDS FLOW STATEMENT


FUNDS FLOW STATEMENT
Definition of fund flow statement

Fund flow statement is a statement which shows the inflow and out flow of funds between two dates of balance sheet. So, it is known as the statement of changes in financial position. We all know that balance sheet shows our financial position and inflow and outflow of fund affects it. So, in company level business, it is very necessary to prepare fund flow statement to know what the sources are and what are applications of fund between two dates of balance sheet. Generally, it is prepare after getting two year balance sheet.

According to Prof. Anthony, “The funds flow statement describes the sources from which additional funds were derived and the use of which these funds were put.”

Fund flow statements are known with different names
 
1.      Statement of source and uses of funds
2.      Summary of financial operations
3.       Movement of working capital statement
4.      Fund received and distributed statement
5.      Fund generated and expended statement
6.      A Funds Statement
7.      A statement of sources and application of fund
8.      Where got and where gone statement
9.      Inflow and outflow of fund statement

Objectives of Fund Flow Statement
The main purposes of FFS are:]
·         To help to understand the changes in assets and asset sources which are notreadily evident in the income statement or financial statement.
·         To inform as to how the loans to the business have been used.
·         To point out the financial strengths and weaknesses of the business.


According to Robert Anthony the funds flow statement describes the sources fromwhich additional funds were derived and the uses to which these funds were put.In short, it is a technical device designed to highlight the changes in the financialcondition of a business enterprise between two balance sheets.




·         Format of Fund Flow Statement


Sources
Applications
Fund from operation
Fund lost in operations
Non-trading incomes
Non-operating expenses
Issue of shares
Redemption of redeemable preferenceshare
Issue of debentures
Redemption of debentures

Borrowing of loans
Repayment of loans 
Acceptance of deposits
Repayment of deposits
Sale of fixed assets
Purchase of fixed assets
Sale of investments(Long Term)
Purchase of long term investments
Decrease in workingcapital
Increase in working capital




Steps in Preparation of Fund Flow Statement.
1. Preparation of schedule changes in working capital (taking current items only).
2. Preparation of adjusted profit and loss account (to know fund from or fund lost inoperations).
3. Preparation of accounts for non-current items (Ascertain the hidden information).(2 & 3 collectively can be shown as Statement showing the fund from operation)
4. Preparation of the fund flow statement


First Step: Making of statement of Changes of Working Capital

For making of fund flow statement. It is very necessary to make statement of changes of working capital. Because net increase in working capital is use of fund and net decrease in working capital is source of fund. So, it is duty of accountant to make statement of changes of working capital. Making of statement of changes working capital is very easy and simple.

We take two balance sheets, one is current year balance sheet and other is previous year balance sheet. Then we separate current assets and current liabilities.

If current assets are more than previous year current assets, it means increase in working capital.
If current assets are less than previous year current assets, it means decrease in working capital. Because, relationship between current assets and working capital is positive and if any changes in current assets, working capital will change in same direction.
If current liabilities are more than previous year current liabilities, it means decrease in working capital.
If current liabilities are less than previous year current liabilities, it means increase in working capital. Relationship between working capital and current liabilities are inverse.

Statement or schedule of changes in working capital

----------------------------------------------------------------------------------------
Particular--------------- ↓ previous year ↓ Current year ↓ Effect on working capital
-----------------------------------------------------------------------------------------
-----------------------------------------------------------↓ Increase ↓ Decrease
----------------------------------------------------------------------------------------
Current Assets

             Cash in hand
             Bills receivable
             Sundry debtors
             Temporary investments
             Stocks / inventories
             Prepaid expenses
             Accrued incomes
--------------------------------------------------------------------------------------------
Total current assets----------- ↓xxxx ↓ xxxxx↓
----------------------------------------------------------------------- -----------------

Current liabilities

             Bills payables
             Sundry creditors
             Bank overdraft
             Short term advances
             Dividends payables
             Provision for taxation
---------------------------------------------------------------------------------------
Total current Liabilities ----------↓xxxx ↓xxxx ↓
------------------------------------------------------------------ -------------------
Working capital
CA- CL
---------------------------------------------------------------------------

Net increase or decrease in working capital =

Increase in working capital – Decrease in working capital

2nd Step: Statement showing the fund from operation

Because is the source of fund and will show in fund flow statement’s source side. So before making fund flow statement, we must make statement showing the fund from operation.

Operation means business activity and fund from operation means profit from business activity. So, you will easy understand that profit from business activity between two accounting period must be the source of fund.


Statement of fund from operations
------------------------------------------------------------------------------------------
------------------------------------------------------------------------>↓ Amount ↓
-------------------------------------------------------------------------------------------

Closing balance of profit and loss account or retained earning as
Given in the Balance sheet
Add non –fund and non operating items which have been already
Debited to profit and loss account
1. depreciation
2. amortization of fictitious and intangible assets

             goodwill
             patents
             trade marks
             preliminary expenses
             discount on issue of shares

3. Appropriation of retained earning such as

             Transfer to general reserve
             Dividend equalization fund
             Transfer to sinking fund
             Contingency reserve etc.

4. Loss on sale of any non current or fixed assets such as

             Loss on sale of land and building
             Loss on sale of machinery
             Loss on sale of furniture
             Loss on sale of long term investments

5. Dividends including

             Interim dividend
             Proposed dividend

(If it is an appropriation of profit and not taken as current liability)
6. Provision for taxation (if it is not taken as current liability)
7. Any other non fund / non operating items which have been debited to P/L account

-----------------------------------------------------------------------------------

Total ( A)-------------------------------------------------------> ↓ XXXXX ↓
-------------------------------------------------------------------------------------
Less Non –Fund or non operating items which have already been credited to profit and loss account
1. Profit or gain from the sale of non current / fixed assets such as

            Profit on sale of land and building
            Profit on sale of plant and machinery
            Profit on sale of long term investment etc.

2. Appreciation in the value of fixed assets such as increase in the value of land if it has been credited to profit and loss account
3. Dividends received
4. excess provision retransferred to profit and loss account or written back .
5. any other non operating item which has been credited to profit and loss account
6. opening balance of profit and loss account or retained earnings as given in the balance sheet
-------------------------------------------------------------------------------------
Total ( B)--------------------------------------------------------------> ↓ XXXXX ↓
----------------------------------------------------------------------------------------
Funds received from operation or business activities = total ( A) – Total ( B)

You can make also above statement in t shape adjusted profit and loss account form .

3rd Step: Fund flow statement

--------------------------------------------------------------------------------------
-------------------------------------------------------------------> ↓ Amount ↓

-------------------------------------------------------------------------------------
A ) Source of funds
  1. fund from operation ( balance of second step )
  2. issue of shares capital
  3. issue of debentures
  4. raising of long term loans
  5. receipts from partly paid shares , called up
  6. amount received from sales of non current or fixed assets
  7. non trading receipts such as dividend received
  8. sale of investments ( Long term )
  9. decrease in working capital as per schedule of changes in working capital
    ----------------------------------------------------------------------------------
    total -------------------------------------------------------------> ↓ XXXXX ↓
    ---------------------------------------------------------------------------------
    Applications or uses of funds
    1. Funds lost in operations ( Balance negative in second step )
2. redemption of preference share capital
3. redemption of debentures
4. repayment of long term loans
5. purchase of long term loans
6. purchase of long term investments
7. non trading payments
8. payment of tax
9. payment of dividends
10. increase in working capital ( As per positive balance of ist step )
-------------------------------------------------------------------------------------
total --------------------------------------------------------> ↓ XXXXX ↓
--------------------------------------------------------------------------------------

Limitations of the funds flow statement:
The funds flow statement suffers from the following limitations
1.      It does not include non-fund transactions
2.      It does not add any new item but the financial data appearing in the income statement and the position statement are simply arranged
3.      It is historical in nature as it summarises the sources and uses of working capital already reported by the final accounts but does not estimate the sources and uses of funds for near future.
4.      It does not disclose changes in management policy regarding investment in current assets and short term financing.