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Notes Financial Accounting BBA - II
Notes Financial Accounting BBA - II
Ans Depreciation is defined as the reduction of recorded cost of a fixed asset in a systematic
manner until the value of the asset becomes zero or negligible.
An example of fixed assets are buildings, furniture, office equipment, machinery etc.. A land is
the only exception which cannot be depreciated as the value of land appreciates with time.
Depreciation allows a portion of the cost of a fixed asset to the revenue generated by the fixed
asset. This is mandatory under the matching principle as revenues are recorded with their
associated expenses in the accounting period when the asset is in use. This helps in getting a
complete picture of the revenue generation transaction.
An example of Depreciation – If a delivery truck is purchased a company with a cost of Rs.
100,000 and the expected usage of the truck are 5 years, the business might depreciate the
asset under depreciation expense as Rs. 20,000 every year for a period of 5 years.
AS -6 deals with depreciation accounting and applies to all depreciable assets, except the
following items to which special considerations apply:—
(i) forests, plantations and similar regenerative natural resources;
(ii) wasting assets including expenditure on the exploration for and extraction of minerals, oils,
natural gas and similar non-regenerative resources;
(iii) expenditure on research and development;
(iv) goodwill and other intangible assets;
(v) live stock.
22. The useful life of a depreciable asset should be estimated after considering the following
factors:
(i) expected physical wear and tear;
(ii) obsolescence;
(iii) legal or other limits on the use of the asset.
23. The useful lives of major depreciable assets or classes of depreciable assets may be
reviewed periodically. Where there is a revision of the estimated useful life of an asset, the
unamortised depreciable
amount should be charged over the revised remaining useful life.
24. Any addition or extension which becomes an integral part of the existing asset should be
depreciated over the remaining useful life of that asset. The depreciation on such addition or
extension may also be
provided at the rate applied to the existing asset. Where an addition or extension retains a
separate identity and is capable of being used after the existing asset is disposed of,
depreciation should be provided
independently on the basis of an estimate of its own useful life.
25. Where the historical cost of a depreciable asset has undergone a change due to increase or
decrease in long term liability on account of exchange fluctuations, price adjustments, changes
in duties or similar
factors, the depreciation on the revised unamortised depreciable amount should be provided
prospectively over the residual useful life of the asset.
26. Where the depreciable assets are revalued, the provision for depreciation should be based
on the revalued amount and on the estimate of the remaining useful lives of such assets. In
case the revaluation has
a material effect on the amount of depreciation, the same should be disclosed separately in the
year in which revaluation is carried out.
27. If any depreciable asset is disposed of, discarded, demolished or destroyed, the net surplus
or deficiency, if material, should be disclosed separately.
28. The following information should be disclosed in the financial
Statements:
(i) the historical cost or other amount substituted for historical cost of each class of depreciable
assets;
(ii) total depreciation for the period for each class of assets; and
(iii) the related accumulated depreciation.
29. The following information should also be disclosed in the financial statements alongwith the
disclosure of other accounting policies:
(i) depreciation methods used; and
(ii) depreciation rates or the useful lives of the assets, if they are different from the principal
rates specified in the statute governing the enterprise.
Q8) Write a note on Inventory Valuation
Ans Because of the minute by minute change in finances, accurate record keeping is critical.
Computerizing a business’s general ledger, payroll, and other accounting tasks increases office
efficiency. With a computer, you can request and receive an in house balance sheet, an income
statement, or other accounting reports at a moment’s notice. While keeping your checkbook on a
computer may not be practical, computers are great for handling complex home financial
records. You can get statements on net worth and year’s tax deductible expenses within minutes.
A. Spreadsheets
Electronic spreadsheets allow you to do anything that you would normally do with a calculator,
pencil and columnar scratch pad.. A typical integrated double entry accounting system will
contain some or all of the following components: accounts receivable, accounts payable, general
ledger, inventory, order entry, payroll, time, and billing.
It takes its name from the accountant’s spreadsheet—a sheet of paper with rules for rows and
columns—on which such work was usually done. Spreadsheet programs are much faster, more
accurate, and easier to use than traditional accounting techniques. The programs are widely used
on personal computers for keeping sales, expense and inventory records, and for budgeting and
forecasting future sales and expenses. As a result of these and many other applications, computer
spreadsheets have become the most important of all software tools for modern businesses.
B. General Ledger
General Ledger is a labor saving device for the preparation of financial statements and for
establishing multiple income and cost entries.
C. Accounts Receivable
Accounts receivable, when computerized, can get your bills out the same day you’ve performed
a service. An accounts receivable module prepares invoices and customer accounts, adds credit
charges where appropriate, handles incoming payments, flags your attention to customers that
are delinquent, and produces dunning notices. It allows you to have daily cash control. You get
out the bills on time, yet you avoid errors such as billing a customer twice for the same item. The
further advantage is that debits and credits are posted automatically to the general ledger, order
entry, and in some instances inventory, once they are entered in accounts receivable.
D. Accounts Payable
Accounts payable, when computerized, will provide for purchase order control, invoice
processing, payment selection and handling, check writing and control, cash-requirements,
forecasting, and Form 1099 preparation. It will also double-check the accuracy of the vendor’s
invoice, and some software systems will cross-check it against the purchase order and the
inventory module.
E. Inventory Control
Inventory Control module has multiple functions, including tracking inventory for both costing
and tax purposes, controlling purchasing (and the overall level of expenditure) and minimizing
the investment in inventory (and subsequent loss of cash flow). The payroll module prepares and
prints payroll checks, including all itemized deductions. It is integrated with the general ledger so
you automatically set aside the correct amount for FICA and withholding.
F. Point of Sale
Point of sale module captures all sales information at (or in place of) the cash register, including
salesperson, date, customer, credit information, items, and quantity sold. It can produce sales
slips or sales invoices, plus it reports on items, customer, and salesperson activity.
Purchasing and receiving module can represent an invaluable addition. It can generate purchase
orders and track their fulfillment. You can find out which vendors are delivering on time and
saving you the expense of having to follow up on partial and incomplete orders.
Time and billing module reduces manual and clerical work, simplifies the billing process,
prompts you and your partners to bill on time, reduces unbilled work-in progress, minimizes
unreported time, reduces unbilled time, measures and analyzes nonchargeable time and provides
criteria to analyze staff performance. Because a computerized accounting system is basically a
computerized data management system, the disposition of labor is almost the same. One staff
member must serve as a data-base manager and be in charge of setting up the chart of accounts,
establishing the interrelationships among the files and establishing and maintaining an audit trail.
The most important advantage of using the computer is the speed with which we can get
Accounting done. In addition, we find that it is very easy to do accounting functions. Posting to
the ledger, a tedious task of double entry, when done directly from the general ledger module,
can be largely automated when done through special purpose modules like accounts payable or
accounts receivable. With an accounts receivable module, you just need to enter the actual cash
totals of items purchased and the software distributes these amounts to the general ledger so they
become credits to corresponding revenue accounts. At the same time, an offsetting entry is made
automatically to the accounts receivable account.
With a computer, one can receive a balance sheet, income statement or other accounting reports
at a moment’s notice. We also find that some day to day data entry can be turned over to
relatively unskilled workers.
When you use a computer, it is possible that data can be lost because of hardware or software
damage. Since the computer has no judgement of its own, it does not pick up on errors as a
human being does. There can be loss of data due to accidents like fire etc.. There can be loss of
data or change of data due to fraud or embezzlement. There can be loss or unavailability of data
due to loss of staff. Inaccurate data may be due to clerical error or mistakes in programming.
Total security is economically unachievable and some failures must be expected. The right level
of expenditure on security measures will minimize the sum of the cost of the measures and the
expected loss. There will always be some risks that are best shared through insurance, rather than
prevented or avoided.
Dispersion, which is designed to minimize losses in the event of deliberate or accidental threat,
can be used. Duplication is designed to ensure that the system survives damage to any individual
part. Duplication is also the fundamental method of detecting errors in processing. Defense in
depth is designed to make the attacker overcome a series of barriers before he can damage any
vital part of the system. In addition, most companies have computer auditors who ensure the
integrity and accuracy of the organizations records, protect and conserve the organization’s
assets and prevent fraud, theft and error. These auditors also ensure that systems will survive the
hazards to which they are exposed.
Ans . Depreciation is a ratable reduction in the carrying amount of a fixed asset. Depreciation is
intended to roughly reflect the actual consumption of the underlying asset, so that the carrying
amount of the asset has been greatly reduced to its salvage value by the time its useful life is over.
But why do we need depreciation at all? The causes of depreciation are:
Wear and tear. Any asset will gradually break down over a certain usage period, as parts wear out
and need to be replaced. Eventually, the asset can no longer be repaired, and must be disposed of.
This cause is most common for production equipment, which typically has a manufacturer's
recommended life span that is based on a certain number of units produced. Other assets, such as
buildings, can be repaired and upgraded for long periods of time.
Perishability. Some assets have an extremely short life span. This condition is most applicable to
inventory, rather than fixed assets.
Usage rights. A fixed asset may actually be a right to use something (such as software or a
database) for a certain period of time. If so, its life span terminates when the usage rights expire,
so depreciation must be completed by the end of the usage period.
Natural resource usage. If an asset is natural resources, such as an oil or gas reservoir, the
depletion of the resource causes depreciation (in this case, it is called depletion, rather than
depreciation). The pace of depletion may change if a company subsequently alters its estimate of
reserves remaining.
Inefficiency/obsolescence. Some equipment will be rendered obsolete by more efficient
equipment, which reduces the usability of the original equipment.
The basic need of depreciation is to ascertain the true income. If depreciation is ignored, the
loss that is occurring in respect of fixed assets will be ignored. So, depreciation should be
debited to Profit and Loss Account before profit is ascertained.
The function of the Balance Sheet is to show the true and correct view of the state of affairs of
a business. If no depreciation is charged and when assets are shown at the original cost year
after year, Balance Sheet will not disclose the correct state of affairs of a business.
possible to determine the useful life of assets. But, in certain cases, machine often becomes,
obsolete long before it wears out because of rapid changes in tastes and technology. It is a
permanent loss in value of the asset. When an asset is continuously used, a time will come
when the asset is to be given up and hence its replacement is essential.
Therefore, if no depreciation is charged against the profit, during the life time of the asset, it
will be very difficult to find cash to replace the asset and if replaced it may cripple resources.
Therefore, it is necessary to make provision and create funds to replace such assets, in proper
time.
Depreciation is a tax deductible expense. As such, it is permitted by the prevailing taxation laws
to be deducted from profit. Consequently, the owner of a business may avail himself of this
benefit by charging depreciation to his profit and reducing his tax liability.
Financial position can be studied from the Balance Sheet and for the preparation of the Balance
Sheet fixed assets are required to be shown at their true value. If assets are shown in the
Balance Sheet without any charge made for their use, (that is, depreciation) then their value
must have been overstated in the Balance Sheet and will not reflect the true financial position
of the business. Therefore, for the purpose of reflecting true financial position, it is necessary
that depreciation must be deducted from the asset and then at such reduced value may be
shown in the Balance Sheet.
If depreciation is not accounted for, the profit of the company is overstated, in turn; it is
distributed among the shareholders. Thus there is no provision for replacement of machine.
It must be pointed out that depreciation by itself does not create funds; it merely draws
attention to the fact that out of gross revenue receipts a certain amount should be retained
to replace the asset used for carrying on activities. The Companies Act of 1956 now makes it
compulsory to write off depreciation on fixed assets before declaring dividend.
Direct labor , Direct materials ,Factory overhead , Freight Handling ,Import duties
Inventory Valuation Methods
When assigning costs to inventory, one should adopt and consistently use a cost -flow
assumption regarding how inventory flows through the entity. Examples of cost -flow are:
The specific identification method, where you track the specific cost of individual items of
inventory
The first in, first out method, where you assume that the first items to enter the inventory
are the first ones to be used
The last in, first out method, where you assume that the last items to enter the inventory
are the first ones to be used
The weighted average method, where an average of the costs in the inventory is used in
the cost of goods sold whichever method you choose will affect the inventory valuation
recorded at the end of the reporting period.
Inventory valuation is important for the following reasons:
Impact on cost of goods sold. If you record a higher valuation in ending inventory, this
leaves less expense to be charged to the cost of goods sold, and vice versa. Thus, inventory
valuation has a major impact on reported profit levels.
Loan ratios. If an entity has been issued a loan by a lender, the agreement may include a
restriction on the allowable proportions of current assets to current liabilities. If the entity
cannot meet the target ratio, the lender can call the loan. Since inventory is frequently the
largest component of this current ratio, the inventory valuation can be critical.
Income taxes. The choice of cost-flow method used can increase or reduce the amount
of income taxes paid. The LIFO method is commonly used in periods of rising prices to
reduce income taxes