Accounting
Unit 1
Accounting: a general introduction
1.1 Definition of accounting
1.2 The accounting system
1.3 Recording business transactions
Accounting
1.1 Definition of accounting
Accounting is often called “the
language of business”, as one of the oldest
profession; accounting is as old as the
civilization of human.
But some people often misunderstand
accounting as booking, which is a process
of accounting, the means of recording
transactions and keeping records.
Accounting
1.1.1 Users of accounting information
1.The direct users include the present and
potential investors.
2.Tax Authorities Governments are financed
through the collection of taxes, such as
income taxes, social security and payroll
taxes.
Accounting
1.1.2 Accounting profession
1.public accounting (Public accountants who
usually are Certified Public Accountants
work in their own business or work for
accounting firms that provide accounting
services to individuals, businesses, and
governments. )
2.government accounting (Government
accountants may work for the local or state
level. Their main tasks are to administer and
formulate budgets, to track costs and to
analyze programs. )
Accounting
3.management accounting (Management
accountants work in companies and help the
management make decisions. They provide the
management advice about capital budgeting and
business analysis. )
4.internal auditing (Internal auditors their main
tasks are: take training to keep skills up to date;
create and develop auditing systems for companies
or individual; determine and record the value of
real property. )
Accounting
1.1.3 The accounting standards setting
bodies
the Financial Accounting Standards Board
(FASB)
the Securities Exchange Commission (SEC)
the American Institute of Certified Public
Accountants (AICPA)
the American Accounting Association (AAA)
Accounting
The most fundamental concepts underlying the
accounting process are (1)an economic entity
assumption,(2)a going-concern assumption,(3)a
monetary unit assumption, and (4)a periodicity
assumption.
The basic principles followed by accountants in
recording business transactions can be
classified as (1) the historical cost
principle,(2)the
revenue
realization
principle,(3)the
matching
principle,(4)the
consistency principle,(5)the full disclosure
principle, and (6)the objectivity principle.
Accounting
1.2 The accounting system
1.2.1 Accounting elements
1. Assets
2. Liabilities
3. Owner's Equity
4. Revenues
5. Expenses
Accounting
1.2.2 Accounting equation and the trial
balance
Economic resources =equities
Economic resources= creditors’ equity
+owner’s equity
Assets =liabilities +owner’s equity
Accounting
1.2.3 Types of business organizations
the proprietorship (A business owned by one
person is called a sole proprietorship or a
single proprietorship. )
the partnership (Partnership is an organization
which is formed by at least 2 persons and
does not need to corporate in the
registration centre. )
Accounting
the corporation (The procedure of the
registration is most complex and the
requirements are most strict. )
Accounting
1.2.4 The effects of business transactions on
the accounting equation
Each transaction alters the expressions forming
the equation in such a way that the accounting
equation is satisfied even after such an alteration.
The values forming the various terms of the
expressions within the equation are altered in such
a way that the basic fact\rule\ equation (i.e.
capital+ liabilities=assets) is always satisfied.
Accounting
1.3 Recording business transactions
1.3.1 The double-entry system-the basic method of accounting
• Advantages of Double Entry System
• (i) It enables to keep a complete record of business transactions.
• (ii) It provides a check on the arithmetical accuracy of books of
accounts based on equality of debit and credit.
• (iii) It gives the results of business activities either profit or loss during
the accounting period.
• (iv) It tells the financial position of the business at a point of time.
Total resources of the business, claims of the outsiders, amount due by
outsiders etc. are revealed by a statement known as Balance Sheet.
• (v) It makes possible comparison of the current year with those of
previous years helping the owner to manage his business on better
lines.
• (vi) It reduces the chances of errors creeping in the accounting records
because of its equality principle. .
• (vii) It helps to ascertain the details regarding any account easily and
accurately. Other systems of book-keeping. In addition to the double
entry system, there is also single entry system.
Accounting
1.3.2 Recording business transaction
1. Define key accounting terms:
2. Apply the rules of debit and credit.
3. Record transactions in the journal.
4. Post from the journal to the ledger.
5. Prepare a trial balance
6. Set up a chart of accounts for a business
Accounting
1.3.3 Illustrative problem
Accounting
Unit 2
The accounts
2.1 Introduction
2.1.1 The accounts
2.1.2 The ledger accounts
Accounting
2.2 The classification of accounts
• 2.2.1 Introduction
• 2.2.2 Application of journals
• 2.2.3 Application of special journals
Accounting
2.3 Transaction analysis illustrated
• Recording a business transaction in a
journal includes two steps:
• (1)Analyze transactions from source
documents.
• (2) Record transactions in a journal under
the double-entry system. Business
transactions will be recorded in the journal
in chronological order.
Accounting
2.4 Journalizing and posting transactions
• 2.4.1 The journal
• An accounting journal may be one of a group
of special journals or it may be a general
journal. The general journal is a relatively
simple record in which any type of business
transaction can be recorded. In contrast to the
general journal, a special journal is designed to
record a specific type of frequently occurring
business transaction. Most firms use, in
addition to a general journal, at least the
following special journal:
Accounting
2.4.2 Journalizing
• Journalizing is the process to record the transactions in the
journal. The following discussion will help in diagnosing
the transaction with a view to find out which accounts are
relevant for passing the journal entry.
• 1. Treatment of cash/credit transaction.
• 2. Treatment of payment on personal/expenses account.
• 3. Treatment of receipt on personal/ income account.
• 4. Treatment of trade discount.
• 5. Treatment- of cash discount (full settlement).
• 6. Treatment of Bad debts (debtor becoming insolvent).
• 7. Treatment of Bad debts recovered
• 8. Treatment of personal expenses of the owner
Accounting
• 9. Treatment of payment/ receipt on behalf of customer or
supplier.
• 10. Treatment or exchange or new asset with old one.
• 11. Treatment of goods given as charity/ advertisement.
• 12. Treatment of goods lost in accident/ fire.
• 13. Treatment of depreciation charged on fixed assets.
• 14. Treatment of payment/ receipt of representative
personal accounts.
Accounting
2.4.3 Posting
• 2.5 Adjusting procedure
• 2.5.1 Accrual basis and cash basis of accounting
• Two primary accounting methods, cash and accrual basis,
are used to calculate taxable income for U.S. federal
income taxes. According to the Internal Revenue Code, a
taxpayer may compute taxable income by:
• the cash receipts and disbursements method;
• an accrual method;
• any other method permitted by the chapter; or
• any combination of the foregoing methods permitted under
regulations prescribed by the Secretary.
Accounting
2.5.2 Adjusting entries
• Adjusting entries made to align revenue and
expense with the appropriate periods consist of
four types:
• (1) Apportioning recorded costs to periods
benefited.
• (2) Apportioning recorded revenue to periods in
which it is earned.
• (3) Accruing unrecorded expenses.
• (4) Accruing unrecorded revenue.
Accounting
Unit 3
The accounting process
• 3.1 Accounting cycle
• 3.1.1 Introduction
• The primary objectives of the accounting function in an
organization are to process financial information and to
prepare financial statements at the end of the accounting
period. Companies must systematically process financial
information and must have staff who prepare financial
statements on a monthly, quarterly, and/or annual basis. To
meet these primary objectives, a series of steps is required.
Collectively these steps are known as the accounting cycle.
The steps, applicable to a manual accounting system, are
described below. Later, there will be a brief discussion of a
computerized processing system.
Accounting
3.1.2 Preparation of the work sheet
• At the end of accounting period, after all current
transactions have been recorded in the journal and
then posted to the ledger; a listing of all the
general accounts is prepared on a sheet----called
worksheet. A worksheet accomplishes this broad
purpose by bringing accounting information
together in one place in an orderly way. The
format of the worksheet can be set up by entering
the appropriate column heading as follows:
Accounting
3.1.3 Uses of the work sheet
• The work sheet is used frequently as a
preliminary step in the preparation of
financial statements. using a work sheet
lessens the possibility of ignoring an
adjustment, aids in checking the
arithmetical accuracy of the accounts, and
facilitates the preparation of financial
statements. It is a useful tool for the
accountant.
Accounting
3.1.4 Closing the accounts
• Revenue and expense accounts are temporary
accounts used to accumulate data related to a
specific accounting year. These temporary
accounts are maintained to facilitate preparation of
the income statement. At the end of each
accounting year, these temporary accounts will be
closed. Their balances are transferred to the
income summary account. After the financial
statements are completed and the adjusted entries
are recorded, we must journalize and post our
closing entries.
Accounting
3.2 The operation cycle for a merchandising
business
• 3.2.1 Accounting record of the operating cycle
• The accounting cycle for a merchandising
business includes the following process:(1) The
adjusting and closing process for a merchandising
business;(2)Work sheet of a merchandising
business;(3)Financial statements of a
merchandising business;(4)Adjust and close the
accounts of a merchandising business.
Accounting
• 3.2.2 The accounting cycle for a merchandising
business
• 3.2.3 Income statement for a merchandising concern
Accounting
Unit 4
Financial statements
• 4.1 Balance sheet and income statement
• 4.1.1 The measurement of business
income
Accounting
4.1.2 Some generally accepted accounting
principles
• Generally Accepted Accounting
Principles (GAAP) is the term used to refer
to the standard framework of guidelines for
financial accounting used in any given
jurisdiction. GAAP includes the standards,
conventions, and rules accountants follow
in recording and summarizing transactions,
and in the preparation of financial
statements.
Accounting
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Principles derive from tradition, such as the concept of matching. In any report
of financial statements (audit, compilation, review, etc.), the preparer/auditor
must indicate to the reader whether or not the information contained within the
statements complies with GAAP.
Principle of regularity: Regularity can be defined as conformity to enforced
rules and laws.
Principle of consistency: The consistency principle requires accountants to
apply the same methods and procedures from period to period.
Principle of sincerity: According to this principle, the accounting unit should
reflect in good faith the reality of the company's financial status.
Principle of the permanence of methods: This principle aims at allowing the
coherence and comparison of the financial information published by the
company.
Principle of non-compensation: One should show the full details of the
financial information and not seek to compensate a debt with an asset, a
revenue with an expense, etc.
Principle of prudence: This principle aims at showing the reality "as is" : one
should not try to make things look prettier than they are. Typically, a revenue
should be recorded only when it is certain and a provision should be entered
for an expense which is probable.
Accounting
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Principle of continuity: When stating financial information, one should
assume that the business will not be interrupted. This principle mitigates the
principle of prudence: assets do not have to be accounted at their disposable
value, but it is accepted that they are at their historical value (see depreciation).
Principle of periodicity: Each accounting entry should be allocated to a given
period, and split accordingly if it covers several periods. If a client pre-pays a
subscription (or lease, etc.), the given revenue should be split to the entire
time-span and not counted for entirely on the date of the transaction.
Principle of Full Disclosure/Materiality: All information and values
pertaining to the financial position of a business must be disclosed in the
records.
In the U.S., generally accepted accounting principles, commonly
abbreviated as US GAAP or simply GAAP, are accounting rules used to
prepare, present, and report financial statements for a wide variety of entities,
including publicly-traded and privately-held companies, non-profit
organizations, and governments. Generally GAAP includes local applicable
Accounting Framework, related accounting law, rules and Accounting
Standard.
Accounting
• History
• Auditors took the leading role in developing
GAAP for business enterprises. Circa 2008, the
FASB issued the FASB Accounting Standards
Codification, which reorganized the thousands of
US GAAP pronouncements into roughly 90
accounting topics In 2008, the Securities and
Exchange Commission issued a preliminary
"roadmap" that may lead the U.S. to abandon
Generally Accepted Accounting Principles in the
future (to be determined in 2011), and to join more
than 100 countries around the world instead in
using the London-based International Financial
Reporting Standards.
Accounting
• Basic objectives
• Financial reporting should provide information
that is:
• useful to present to potential investors and
creditors and other users in making rational
investment, credit, and other financial decisions.
• helpful to present to potential investors and
creditors and other users in assessing the amounts,
timing, and uncertainty of prospective cash
receipts.
• about economic resources, the claims to those
resources, and the changes in them.
Accounting
• Basic concepts
• To achieve basic objectives and implement
fundamental qualities GAAP has four basic
assumptions, four basic principles, and four
basic constraints.
Accounting
• Assumptions
• Business Entity: assumes that the business is separate
from its owners or other businesses. Revenues and
expenses should be kept separate from personal expenses.
• Going Concern: assumes that the business will be in
operation indefinitely. This validates the methods of asset
capitalization, depreciation, and amortization. Only when
liquidation is certain this assumption is not applicable.
• Monetary Unit principle: assumes a stable currency is
going to be the unit of record. The FASB accepts the
nominal value of the US Dollar as the monetary unit of
record unadjusted for inflation.
• The Time-period principle implies that the economic
activities of an enterprise can be divided into artificial time
periods.
Accounting
• Principles
• Cost principle requires companies to account and report based on
acquisition costs rather than fair market value for most assets and
liabilities. This principle provides information that is reliable
(removing opportunity to provide subjective and potentially biased
market values), but not very relevant. Thus there is a trend to use fair
values. Most debts and securities are now reported at market values.
• Revenue principle requires companies to record when revenue is (1)
realized or realizable and (2) earned, not when cash is received. This
way of accounting is called accrual basis accounting.
• Matching principle. Expenses have to be matched with revenues as
long as it is reasonable to do so. Expenses are recognized not when the
work is performed, or when a product is produced, but when the work
or the product actually makes its contribution to revenue. Only if no
connection with revenue can be established, may cost be charged as
expenses to the current period (e.g. office salaries and other
administrative expenses). This principle allows greater evaluation of
actual profitability and performance (shows how much was spent to
earn revenue). Depreciation and Cost of Goods Sold are good
examples of application of this principle.
Accounting
• Disclosure principle. Amount and kinds of information disclosed
should be decided based on trade-off analysis as a larger amount of
information costs more to prepare and use. Information disclosed
should be enough to make a judgment while keeping costs reasonable.
Information is presented in the main body of financial statements, in
the notes or as supplementary information Constraints
• Objectivity principle: the company financial statements provided by
the accountants should based on objective evidence.
• Materiality principle: the significance of an item should be
considered when it is reported. An item is considered significant when
it would affect the decision of a reasonable individual.
• Consistency principle: It means that the company uses the same
accounting principles and methods from year to year.
• Prudent principle: when choosing between two solutions, the one that
will be least likely to overstate assets and income should be picked
Accounting
4.1.3 Adjustments to the accounts
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People use adjusting entries to apply the accrual accounting to transactions to
allocate revenues and expenses to the period in which they actually belong to.
Adjusting entries are journal entries that are made at the end of the accounting
period, usually at the end of the month.
Apportioning recorded expenses
Companies often make payments that span more than one period. These
payments are debited to an asset account. At the end of the accounting period,
the amount expired is transferred from the asset account to the expense
account.
Prepaid expenses.
Some expenses are paid before the service is shared. These payments are
called prepaid expenses, for example, prepaid insurance, and prepaid supplies.
At the end of an accounting period, such as a month, apart of these items
expire. The potion of the expenditure that expires is considered as an expense
of the month. The rest that hasn’t expired is still considers assets that will be
used up in the future. If the prepaid expenses are not adjusted, the assets will
be exaggerated and the expenses will be understated.
Accounting
4.1.4 Adjusted trial balance
• Prepare an accounting worksheet; the accounting cycle is
the process by which the accountants produce the financial
statements for a special period of time. The cycle starts
with the beginning account balances. During the period，
the business journalizes transactions & posts them to the
ledger accounts. At the end of the period, the trail balance
is prepared, and the accounts are adjusted in order to
measure the period’s net income or net loss. Completion of
the accounting cycle is aided by use of a work sheet. This
multicolumn document summarizes the effects of all the
activity of the period.
Accounting
4.1.5
Preparing the financial statements from the
adjusted trial balance
• Financial statements provide information of value to company officials
as well as to various outsiders, such as investors and lenders of funds.
Publicly owned companies are required to periodically publish
general-purpose financial statements that include a balance sheet, an
income statement, and a statement of cash flows. Some companies also
issue a statement of stockholders' equity and a statement of
comprehensive income, which provide additional detail on changes in
the equity section of the balance sheet. Financial statements issued for
external distribution are prepared according to generally accepted
accounting principles (GAAP), which are the guidelines for the content
and format of the statements. In the United States, the Securities and
Exchange Commission (SEC) has the legal responsibility for
establishing the content of financial statements, but it generally defers
to an independent body, the Financial Accounting Standards Board
(FASB), to determine and promote accepted principles.
Accounting
4.2 Cash flow statement
• A typical cash flow statement is divided into three
parts: cash from operations (from daily business
activities like collecting payments from customers
or making payments to suppliers and employees);
cash from investment activities (the purchase or
sale of assets); and cash from financing activities
(the issuing of stock or borrowing of funds). The
final total shows the net increase or decrease in
cash for the period.
Accounting
• In contrast to nonrecurring cash inflows or
outflows, most recurring cash inflows or outflows
occur (often frequently) within each cash cycle
(i.e., within the average time horizon of the cash
cycle). The cash cycle (also known as the
operating cycle or the earnings cycle) is the series
of transactions or economic events in a given
company whereby:
• Cash is converted into goods and services.
• Goods and services are sold to customers.
• Cash is collected from customers.
Accounting
Unit 5
Current assets
• 5.1 Cash and its control
• 5.1.1 Control of cash receipts and cash disbursements
In accounting, the term cash means paper money, coins,
checks, money orders and bank deposits – all items that are
acceptable for deposit in a bank. IOUs, postdated checks
(checks dated in the future) and uncollected customers’
checks returned by the bank stamped “NSF” (not sufficient
funds) are not considered cash but are normally classified
as receivables. Notes sent to the bank for collection remain
classified as notes receivable until notification of collection
is received from the bank.
Accounting
5.1.2 Bank transactions and petty cash
• Almost invariably, the ending balance on the bank statement differs
from the balance in the company’s cash in Bank account. Some
reasons for differences are:
• 1) Outstanding checks—checks written and deducted in arriving at
the book balance, but not yet presented to the bank for payment.
• 2) Deposits not yet credited by the bank—deposits made near the
end of month, processed by the bank after the monthly statement has
been prepared. They will appear on next month’s statement.
• 3) Charges made by the bank but not yet reflected on the depositors
books—for example, service and collection charges, NSF checks,
repayments of depositor’s bank loans.
• 4) Credits made by the bank but not yet reflected on the depositor’s
book—collections of notes and drafts for the depositor by the bank.
• 5) Accounting errors made either by the depositor or the bank.
Accounting
5.2 Receivables
• 5.2.1 Accounts receivable
• Methods used in estimating the
allowance
• 1. Percentage of credit sales method
• 2. Accounts receivable aging method
• 3. Percentage of receivables method
Accounting
5.2.2 Notes receivable
• Use the allowance method of accounting for uncollectible.
Credit sales create receivables. Accounts receivable are
usually current assets, and notes receivable may be current
or long-term. Uncollectible receivables are accounted for
by the allowance method or the direct write-off method.
The allowance method matches expenses to sales revenue
and also results in a more realistic measure of net accounts
receivable.
• Estimate uncollectible by the percentage of sales and the
aging approaches. The percentage of sales method and the
aging of accounts receivable method are the two main
approaches to estimating bad debts under the allowance
method.
Accounting
5.2.3 Illustrated accounting entries
• Maturity date
• The maturity date can be calculated according to
the following three methods:
• 1. a specific date, such as “November 11th, 2006
• 2. a specific number of months after the date of
the note, such as “2 months after date”
• 3. a specific number of days after the date of the
note,
• for example, “60 days after date”
Accounting
5.3 Inventories
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5.3.1 Pricing the Inventory at cost
1. Specific Identification Method
2. Weighted-Average-Cost Method
3.First-In, First-Out Method
4.Last-In, First-Out Method
Accounting
5.3.2 Valuing the inventory estimation
• Inventory key features:
• Scan computers by IP range, by domain, single computers, or
computers, defined by the Global Network Inventory host file.
Reliable IP detection and identification of network appliances such as
switches, network printers, document centers, and other devices.
Scan only items that you need by customizing scan elements.
View scans results, including historic results for all scans, individual
machines, or selected number of addresses.
Fully customizable layouts and color schemes on all views and reports.
Export data to HTML, XML, Microsoft Excel, and text formats.
Customizable printing.
Accounting
5.3.3 Periodic and perpetual inventory systems
• Account for inventory by the perpetual and
periodic systems. Accounting for inventory plays
an important part in merchandisers' accounting
systems because selling inventory is the heart of
their business. Inventory is generally the largest
current asset on their balance sheet, and inventory
expense--called cost of goods sold--is usually the
largest expense on the income statement.
Accounting
Unit 6
Non-current assets
• 6.1 Property, plant and equipment
• 6.1.1 Plant assets and their depreciation
• Both accountants and business people are
grappling with the controversial accounting term
known as depreciation. When financial statements
are prepared the depreciation figure can be
confusing. It can be too high at times, or too low,
or just not properly done at times.
Accounting
6.1.2 Intangible assets and their amortization
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Among the various types of intangible assets to which Appraisal Economics has
assigned value are:
Patent valuation, copyrights and licenses
Customer lists and relationships
Non-compete agreements
Favorable financing
Software
Trained and assembled workforces
Contracts
Leasehold interests
Unpatented proprietary technology
In-process R&D
Databases
Trademark valuation, trade names
Accounting
6.2 Acquisition cost of property, plant and
equipment
• 6.2.1 accounting for depreciation
• Objects of making provision for depreciation
• For attaining following objects, depreciation accounting is a must for
every business:
• (1) Recovery of cost incurred on fixed assets over their useful life so as
to keep owner's capital intact;
• (2) Provision is for replacement cost on the retirement of original
assets ;
• (3) to include the depreciation in the cost of production to find out the
correct cost of production;
• (4) to find out correct profit for the year ;
• (5) to find out the correct financial position through balance sheet.
Accounting
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Causes of Depreciation
Depreciation may be of two types :(1) Internal-Depreciation which occurs for certain inherent normal causes is
known as internal depreciation. The causes of internal depreciation are :
(1) Wear and Tear-An asset declines on account of continued use e.g. building,
plant, machinery etc. such decline depends upon quantum of use of an asset. If
a factory works double-shift instead of single shift, depreciation on plant and
machinery will be doubled. It is obvious that such loss is unavoidable. An
asset may be kept in proper working conditions through repairs for the time
being, but it can not be done so permanently: At one time the asset will
become unfit for repairs, when it will no longer be suitable.
(1) Depletion-Some assets decline in value proportionate to the quantum of
production, e.g. mines, quarry etc. With the raising of coal etc. from coal mine,
the total deposit reduces gradually and after some time it will be fully
exhausted. Then its value will be nil.
(2) External-Depreciation caused by some external reasons is called external
depreciation.
Accounting
• The causes of external depreciation are:
• (1) Obsolescence
• Some assets, though in proper working order, may become obsolete.
For example old machine becomes obsolete with the invention of more
economical and sophisticated machine, whose productive capacity is
generally higher and cost of production is lesser. In order to survive in
the competitive market the manufacturer must install new machine
replacing the old one.
• (2) Passage of time
• Some assets diminish in value on account of sheer passage of time,
even though they are not used e.g. lease hold property, patent rights,
copy rights etc.
• (3) Accidents
• Assets may be destroyed by abnormal reasons such as fire, earth quake,
flood etc. In such a case the destroyed asset may be written-off as loss
and a new one purchased.
Accounting
• Need for Provision of Depreciation
• The need for provision for depreciation arises for the following reasons:
• (1) Ascertainment of true profit or loss-Depreciation is a loss. So
unless it is considered like all other expenses and losses, true
profit/loss cannot be ascertained. In other words, depreciation must be
considered in order to find out true profit/loss of a business.
• (2) Ascertainment of true cost of production-Goods are produced with
the help of plant and machinery which incurs depreciation in the
process of production. This depreciation must be considered as a part
of the cost of production of goods. Otherwise, the cost of production
would be shown less than the true cost. Sale price is normally fixed on
the basis of cost of production. So, if the cost of production is shown
less by ignoring depreciation, the sale price will also be fixed at a low
level resulting in loss to the business;
• (3) True Valuation of Assets-Value of assets gradually decreases on
account of depreciation. If depreciation is not taken into account, the
value of asset will be shown in the books at a figure higher than its true
value and hence the true financial position of the business will not be
disclosed through Balance Sheet.
Accounting
• (4) Replacement of Assets-After some time an asset will be completely
exhausted on account of use. A new asset then be purchased requiring
large sum of money. If the whole amount of profit is withdrawn from
business each year without considering the loss on account of
depreciation, necessary sum may not be available for. buying the new
assets. In such a case the required money is to be collected by
introducing fresh capital or by obtaining loan by selling some other
assets. This is contrary &0sound commercial policy.
• (5) Keeping Capital' Intact-Capital invested in buying an asset,
gradually diminishes on account of depreciation. If loss on account of
depreciation is not considered in determining profit/ loss at the year
end, profit will be shown more. If the excess profit is withdrawn, the
working capital will gradually reduce, the business will become weak
and its profit earning
capacity will also fall.
• (6) Legal Restriction-According to Sec. 205 of the Companies Act,
1956 dividend cannot be declared without charging depreciation on
fixed assets. Thus in "Case of joint stock companies charging of
depreciation is compulsory.
Accounting
6.2.2 Methods of computing depreciation
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Characteristics of Depreciation
Depreciation has the following characteristics:
(1) Depreciation is charged in case of fixed assets only, e.g., Building, Plant
and Machinery, Furniture 'etc. There is no question of depreciation in case of
current assets-such as Stock, Debtors, Bills Receivable etc.
(2) Depreciation causes perpetual, gradual and continuous fall in the value of
asset
(3) Depreciation occurs till the last day of the estimated working life of asset
(4) Depreciation occurs on account of use of asset In certain cases, however,
depreciation may occur even if the assets are not used, e.g., Leasehold
Property, Patent right, Copyright etc.
(5) Depreciation is a charge against revenue of an accounting period.
(6) Depreciation does not depend on fluctuations in market value of asset
(7) The amount of depreciation of an accounting year cannot be determined
precisely-it has to be estimated. In certain cases, however, it may be
ascertained exactly, e.g., Leasehold Property, Patent Right, Copyright etc.
(8) Total depreciation of an asset cannot exceed its depreciable value (cost less
scrap value).
Accounting
• Basic factors of determination of depreciation
• (1) original cost of fixed asset i.e., purchase price plus
freight and installation expenses;
• (2) estimated amount of expenditure on repairs during the
useful life;
• (3) estimated useful life of asset after which it will be
discarded;
• (4) estimated residual or scrap value;
• (5) interest on investment-the amount invested on purchase
of asset, if it had been invested in some other investment
what interest would have been earned;
• (6) possibility of obsolescence.
Accounting
• 1. Fixed Installment or Original Cost or Straight
Line Method, reducing/Diminishing Balance
method
• 2. Accelerated Depreciation Methods
• 3. Depreciation Fund method or Sinking Fund
method
• 4. Insurance Policy Method
• 5. Revaluation Method
• 6. Depletion Method
• 7. Machine Hour Rate
• 8. Mileage Method
• 9. Global Method
Accounting
6.3 Long-time investment
• Real estate is an asset that you see and touch, is insured, and produces
monthly income. Historically it is one of the safest investments
available and there are several ways to get started. Here's a few:
• 1) The "Speculator" Approach - you could become a real estate
"speculator" and buy properties with the hope that they will go up in
value and allow you to reap windfall profits when you sell. Of course,
this type of approach has a large amount of risk which has left large
numbers of speculators who were consumed with "Flipping Frenzy"
over the last few years in a very tough place when the market turned
and did not favor their investment approach.
• 2) The Landlord Approach - on a more traditional level, you could buy
a home, duplex, or small apartment building and rent the property out.
Over time as you collect rent your tenants will pay off your mortgage.
This does take some time, work, and experience. This approach is
rather safe and can result in a good return in both the short and long
term. The downside is that there can be a large amount of time required
to make this work.
Accounting
• 3) The Passive Method - this style of investing is
known as making "Private Mortgage Loans".
Private Mortgage Loans, when set up properly,
can provide your portfolio with a great return in
any real estate market. Up, down, flat...it doesn't
really matter.
• Investment in gold and in real estate both has their
fair share of pros and cons. Following are some of
the advantages and disadvantages of investing in
gold and real estate.
Accounting
• Gold: Gold is best suited for a long time investment. The demand for
gold has always been robust. The process of buying and selling with
gold is quite quick. It offers near zero risk of value depreciation.
• One can even invest in gold online, nowadays. Investors can now buy,
sell and virtually trade in gold commodity just like any other stock or
equities. This has been a driving factor for many to invest in gold
because investing online reduces the risk of actually owning the metal.
• Gold prices are generally not affected by the fluctuation in the currency.
The gold price does not rely on potency of the currency. Also, the price
of gold is not influenced by any kind of political instabilities or crisis.
• However, gold doesn't provide any immediate appreciable income. The
value of the income has to be seen over the long term.
Accounting
• Real Estate: There are multiple ways of earnings in real estate.
Investment in real estate can be long term and short term. It also
ensures regular inflows by way of rentals. It can be used as collateral
to secure a loan and to counterbalance taxable incomes. The profits
earned from property resale are apparent.
• But like any other investment option this too comes with a tag of risk.
The real estate market is unpredictable and comes with no guarantee.
Although a large number of investors have been successful and earned
huge profits with real estate investing, there is no guarantee that it is
going to be same for everyone. However, one can be and should be
careful and aware. Take time to familiarize yourself with the real estate
market, the market terminology and investment options and processes.
• Investing is a crucial decision, it has money on stake. The risk factor is
common. But knowledge, awareness and clarity of your own
requirements are the keys to decide upon which investment to opt for.
Both of the stated investments can offer lucrative returns. Choosing
one of them as an investment option requires assessment of the money
one can outlay and the objective of the investment. Understanding of
the market is very important.