afm unit 1 total notes

8/12/2019 Afm Unit 1 Total Notes

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UNIT-5 FINANCIAL ACCOUNTING

INTRODUCTION

Accounting is the process of identifiying, measuring and communicating economic

information to permit informed judgments and decisions by users of information.

Meaning and Scope of Accounting

Accounting is the language of business. The main objective of Accounting is to

safeguard the interest of the business, its properties and others connected with the business

transactions. This is done by providing suitable information to the owners, creditors,

shareholders, Government, financial institutions and others related agencies.

Definition of Accounting

The American Accounting Association defines accounting as the process ofidentifying,

measuring and communicating economic information to permit informed judgment and decisions

by the users of the information.

According to AICPA (American Institute of Certified Public Accountants) it is defined as

the the art of recording, classifying and summarizing in a significant manner and in terms of

money, transactions and events which are in part at least of a financial character and interpreting

the result thereof.

Accounting principles:

Accounting principles are guidelines & standards, which have been accepted by the

accounting profession in preparation and presentation of accounts of the business. It is approved

and normally accepted by the government bodies & controlling authorities.

Accounting principles are not universal and permanent as they are not discovered but are

developed by man from time to time. Thus the development of accounting principles is a

continuous process.

Accounting principles are of two parts,

Concepts

Conventions


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Characteristics of Accounting Concepts:-

1. Accounting concepts are continuously changing and evolving: In the event of rapidly changing

economic activities, accounting concepts also undergo frequent changes. This is a healthy sign

for the accounting fields.

This is because of the following two main reasons.

It is relatively a new field and hence it is developing with time.

Some aspects tend to change with the changes in social, economic and commercial

conditions.

2. Another important feature of accounting concepts is the interrelationship among the different

concepts. Most of the concepts do not stand by themselves; they depend on the other concepts to

a large extent.

Golden Rules of Accounting:

Personal Account: Debit the Receiver and Credit the Giver.

Real Account: Debit what Comes In and Credit what Goes Out.

Nominal Account: Debit all Expenses and Losses and Credit all Gains and Incomes.

Understanding of financial statements:

Finance may be defined as the art and science of managing money. A financial statement

is an organized collection of data according to logical and consistent accounting procedures.

Financial statements are final results of accounting work done during the accounting period.

Financial management: Concerned with the duties of the financial managers in the business

firm.

Financial managers: Actively manage the financial affairs of any type of business, namely,

financial and non-financial, private and public, large and small, profit seeking and not-for-profit.

Financial statement:Financial statement provides a summarized view of the financial position

and operations of a firm. Therefore, much can be learnt about a firm from careful examination of

its financial statements as invaluable documents/performance reports. The analysis of financial

statement is, thus, an important aid to financial analysis.


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Journal:-

Journal is the book of Original Entry or First Entry which is used for recording

of all business transaction in chronological order. Then it is posted to ledger. This process is

known as Entering. In other words record of the each transaction is called as Journal Entry.

The process of recording in the journal is called as Journalizing.

Ledger:-

A Ledger Account may be defined as a Summary statement of all transactions

relating to a person, asset, expense or income which have taken place during a given period of

time and showing their net effect. From the above definition, we can observe that Ledger is

designed as the book of second stage in the accounting cycle which is used for recorded

transactions which are classified and grouped into different head of accounts.

Trial Balance:-

To ensure the proof of completion and arithmetical correctness of the books of

account, it is essential to prepare the trial balance. In the first stage of accounting all business

transactions are recorded in Journal or Subsidiary books. Then they are transferred to ledger by

posting to relevant accounts. The fundamental principles of double entry system of accounting is

that for every debit, there must be a corresponding and equal credit. Therefore, when all the

accounts of a concern are thus balanced in the ledger at the end of the period, a statement is

prepared to show the list of debit balances on one side and credit balances on the other side. This

list so prepared is called as Trial Balance. Accordingly the total of the debit side of trial

balance must be equal to that of its credit side.

MANAGEMENT ACCOUNTING

MEANING

The term management accounting refers to accounting for the management (i.e.) accounting

which provides necessary information to the management for discharging its function. The

functions of the management are Planning, Organizing, Directing and Controlling of business

operations can be done in an orderly and effective manner.

DEFINITION

Thedefinition given by the American Accounting Association is as follows;

Management Accounting is the application of appropriate techniques and concepts in

processing historical and projected economic data of an entity to assist management in


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establishing plans for reasonable economic objectives and in the making of rational decisions

with a view towards achieving these objectives.

FUNCTIONS

A) PLANNING B) IMPLEMENTATION C) CONTROL

Planning

It is the process of deciding what action should be taken in the future. A plan may be made for

any segment or for the organization as the whole.

An important form of planning is budgeting. Budgeting is the process of planning the overall activities

Implementation

Implementation involves specific actions planned in advance to fulfill the budgets. It requires

supervision on the part of the managers. A key managerial responsibility is to change previous

plans appropriately to adjust for new conditions.

Control

It is the process to ensure that employees perform properly. Accounting information is used in

the control process as a means of communication, motivation getting attention and for appraisal.

FINANCIAL ACCOUNTING

Meaning

Financial Accounting has a single, unified structure in the sense that the information relating to

the operations of various enterprise is presented on a more or less uniform basis.

Financial Accounting designed to serve parties external to the operating responsibility of the

firm. Eg Creditors, Investors, Employees, Banks etc.It is basically concerned with the recording,

classifying and summarizing in a significant manner and in terms of money transactions and

events which are in part at least of a financial character and interpreting the result there of.

FUNCTIONS

Recording

Financial accounting ensures that all financial transactions are properly recorded. Recording

done in the book of JOURNAL.

Classifying

Classification is concerned with the systematic analysis of the recorded data with a view to group

transactions or entries of nature at one place. The work of classification done in the book of

LEDGER.


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Summarising

This involves presenting the classified data in a manner which is understandable and useful to

the internal as well as external end users of accounting statements. This process lead to the

preparation of following statements.

a) Trial balance b) Income statement c) Balance sheet.

LIMITATIONS

1) Provides only limited information

2) Treats figures as single, simple and silent items.

3) Provides only a post-modem record of business transaction

4) Covers only quantifiable information

5) Fails to provide information needs of different levels of management.

COST ACCOUNTING

Cost Accounting refers to the process of determining the cost of particular product or activity. It

provides useful data for both internal and external reporting. Internal report present details of

cost information regarding cost of specific product or services while external reports contain cost

data in a summarized and aggregate form.

E.g.: Internal report refers to manufacturing cost of product; External cost refers to sales volume

of the company

OBJECTS AND FUNCTIONS OF COST ACCOUNTINGThe main objects or functions of costing are as follows:

1) Analysis and Ascertainment of costs:

The main object of costing is to ascertain the cost of each product, process, department, service

or operation. For the ascertainment of costs it involves further the study, analysis and

classification of costs such as Prime cost, works cost, production costs,etc.Various methods,

systems and techniques of costing have been developed for the purpose of recording and

determining costs.

2)

Presentation of costs for cost reduction and cost control:

Another important function of costing is to control and reduce costs. Unless efficiently

controlled,costs have a tendency to increase and cross the limits. Properly collected cost data

helps in controlling and maintaining cost at the lowest. The right and appropriate cost


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information is made available to the right man, who needs them, at the right time and in a proper

form.

3) Planning and Decision making

Cost accounting has developed beyond its traditional function of cost determination and

cost control. It has now developed as a tool in the hands of the management for planning

and taking crucial decisions like pricing of products, introduction of a new product in the

market, make or buy decisions, expansion or contraction, replacement of machinery, shut

down decisions, wages compensation plan, choice among various alternatives,etc.

IMPORTANCE AND ADVANTAGES OF COST ACCOUNTING

a) Cost accounting as an Aid to Management:

Cost accounting helps the management in carrying out its functions, i.e.planning,

organizing, controlling, decision-making, budgeting and pricing efficiently by providing

cost information to the management.

b) Advantages to Employees

An efficient costing system reduces the cost and increases the profits of concern thus

ensuring greater security of service and increased wages to the employees. cost accounting

also helps in introducing incentive wage schemes and bonus plans which bring more

reward to efficient employees.

c) Advantages to the creditors, investors and bankers

Creditors, investors, bankers and others who lend money to the business are also benefited

by the introduction of cost accounting in a concern. It enables the creditors, bankers and

investors to judge the financial position and solvency of a concern by providing the reliable

cost data.

d) Advantages to the government and the society

Cost accounting increases the efficiency of a concern, reduces cost and increases the

profits.thus,it promotes the overall economic development of the country.

LIMITATIONS

1) It isnot an independent system of accounts.


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2) It is based largely on estimates like absorption of indirect expenses or apportionment

of expenses on estimate basis.

3) There is a scope for subjectivity on items like depreciation, valuation of closing stock

etc.

4) It does not take into consideration all items of expenses and incomes example: items

of purely financial nature such as interest, finance charges,etc.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAPs)

Financial accounting is prepared in accordance with the GAPPs. Accounting is thelanguage of

business as it is the principal means by which information about a business is communicated to

those interested in it. If therefore, the information is to be communicated effectively and

understood properly, it should be prepared in accordance with a mutually understood set of rules.

These ground rules are referred to as GAPPs.

Accounting principles are classified into two categories as i) Accounting concepts ii)

Accounting conventions.

I) ACCOUNTING CONCEPTS

The term accounting concepts is used to connot basic accounting postulates, i.e., necessary

assumptions and a condition upon which accounting is based. Some of the important accounting

concepts are as follows:

1)

BUSINESS ENTITY CONCEPTIn accounting business is treated as a separate entity from its owners. Accounts are

prepared to give information about the business and not those who own it. A distinction is

made between business transactions and personal transaction and also between business

property and personal property of the owners. The business entity concept is necessary to

ascertain the results of business operations. In case the private and business transactions

are not segregated, it will not be possible to determine true protitability of the concern.

2) GOING CONCERN CONCEPT

It is presumed that the business concern will continue to exist indefinitely or at least in

the near future. The present resource of the concern is utilized to attain the long term

objectives of the business. This concept is very important in relation to the recording of

transactions and preparation of financial statements. For example, it is only this


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assumption that while preparing final accounts of the concern, fixed assets are shown in

the balance sheet at diminishing balance method, i.e. going concern value

3) THE COST CONCEPT

The accounting records are based on cost concept. This concept is closely related to the

going concern concept. The assets and liabilities of a business are shown at a cost which

has been paid or agreed upon between parties. The figures are recorded on objectivity

basis. There is no room for personal assessment or bias in showing the figures. If

subjectivity is followed in records then same assets will be valued at different figures by

different individuals. Everybody will have his own view about various assets.so cost

concept is helpful in making truthful records. The records become more reliable and

comparable.

4)

DUEL ASPECT CONCEPT

This concept lies at the heart of whole accounting system. Modern accounting system is

based on dual aspectconcept. It is based on the principle that for every debit transaction.

There must be giver of benefit and also a taker of it. Suppose A purchase a building of

Rs.20,000,he will get building and will part with the cash for similar amount. So one

account will be debited another account will be credited The debits will be equal to

credits. The dual aspect concept has credited the system of double entry book-keeping. It

is because of this concept that the total claims of outsiders and owners are always equal

to total assets of the concern. In form of accounting or balance sheet equation. External

Liabilities + capital =Total Assets or, Total Liabilities = Total Assets or, Assets

Liabilities=Capital.

5) MONEY MEASUREMENT CONCEPT

According to this concept only those transactions are recorded in accounting which can

be expressed in terms of money. Money provides a mechanism by which real resources

can be transferred among different individuals. Money is accepted as a medium of

exchange for goods and services. One is prepared to sell ones property in exchange for

money. The debtors and creditors are willing to pay and receive money in near future.

Thus, money acts as a medium for immediate exchange for goods and services and also

as a standard for deferred payments. It is because of this concept that quantitative or non-


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monetary things/transactions are either omitted or recorded separately and do not find any

place in the financial statements of a firm.

6) ACCOUNTING PERIOD/ACCURAL CONCEPT

Financial position and profitability of a concern are assessed at a interval called

Accounting period. While preparing profit and loss account of a concern all revenue

items related to that period are taken into consideration irrespective of the fact that

whether these items are paid or payable. Similarly, a balance sheet is prepared to reveal

the financial position of the concern on a particular date.

7) REALISATION CONCEPT

This concept is related to the realization of revenue. The revenue is realized either from

sale of products or from rendering of services. The sale involves a number of stages such

as receipt of order, production or assembling of goods, dispatch of goods, transfer of

ownership, and receipt of money. A question arises as to when should the revenue be

considered ? As a general principle, sales or profit on sales will be considered to be

realized when either money (cash) is realized or legal obligation is created, i.e. ownership

or title to the goods is transferred.

8) MATCHING OF COST AND REVENUE CONCEPT

As a general principle, the costs are matched to revenues to measure the profits .A

distinction between present, past and future expenditure as well as capital and revenue

expense is necessary. The revenues and cost of the same period, product or service are

matched. Similarily, the expense whose utility is to be derived over a number of years are

taken to the balance sheet as deferred revenue expenditure. Capital expenditures become

a part of cost over a number of years through depreciation.

ACCOUNTING CONVENTIONS

Accounting Conventions are the traditions, usage and customs which are in use since long. The

most important conventions which have been in use are disclosure, consistency, conservation

and materiality.

1. Convention of Disclosure:

The disclosure of all significant information is one of the important accounting conventions.

It implies that accounts should be prepared in such a way that all material information is

clearly disclosed to the reader. This information should not only include figures given in the


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final accounts but also information which occurs after the preparation of balance sheet but

before the presentation of financial statements. The idea behind this convention is that

anybody who wants to study the financial statements should not be prejudiced by

concealing any facts. He should be able to make a free judgment.

2. Convention of Consistency:

The convention of consistency means that same accounting principles should be used for

preparing financial statements for different periods. It enables management to draw

important conclusions regarding the working of the concern over a longer period. It allows a

Comparison in the different periods. If different accounting procedures and processes are

Used for preparing financial statements of different years then the results will not be

comparable because these will be based on different postulates.

3.

Convention of Conservatism:

The conversion of conservatism means cautious approach or policy of play safe. This

convention ensures that the uncertainties and risks inherent in business transactions should

be given proper consideration. If there is possibility of loss, it should be taken into account

at the earliest. On the other hand, a prospect of profit should be ignored upto the time it does

not materialize.

4. Convention of Materiality:

According to this convention only those events should be recorded which have a significant

bearing and insignificant things should be ignored. The avoidance of insignificant things

will not materiality affects the records of the business. It should be seen that the efforts

involved in recording the events should be worth the labour involved in it. There is no

formula in making a distinction between material and immaterial events. It is a matter of

judgment andit isleft to the accountant for taking a decision.

BALANCE SHEET AND RELATED CONCEPTS

The balance sheet is a statement, which shows the financial position of a business on a particular

date. It is a statement of balance of all the accounts real, personal, Debit balances of all such

accounts represent assets and credit balances represent the liabilities. Thus, balance sheet shows

the assets and liabilities grouped properly classified and arranged in a specific manner.


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Objectives of Preparing a Balance Sheet

Principal objective: The main purpose of preparing balance sheet is to know the

financial position of the business at a particular date.

Subsidiary Objectives:Though the main aim is to know the exact financial position of

the firm at a particular date, yet it serves other purpose as well.

It gives information about the actual and real owners equity, yet some other liabilities

are to be accounted for against it also.

It helps the firm to make provisions against possible future losses. A provision is made in

the form of the reser

What information does it convey to an outsider?

Balance sheet is prepared with a view to measure the true financial position of a businessconcern at a particular point in time. It shows the financial position of a business in a systematic

form.

The various groups interested in the company can draw useful inferences from an analysis of the

information contained in the balance sheet.

Similarly, other interested parties like regulatory and developmental agencies of the government,

consumer, and welfare organizations can derive useful conclusions from a study of the balance

sheet about the working of the corporate sector and its contribution to the national economy.

CLASSIFICATION OF BALANCE SHEET ITEMS:

Owners Equity

Assets Fixed Assets

Accrued Liabilities

Contingent liability

Accounts Receivables

Owners Equity

Owners equity is the residual interest in the assets of the enterprise. Therefore the owners

equity section of the balance sheet shows the amount the owners have invested in the entity.

However, the terminology Owners Equity varies with different forms of organization

depending upon whether the enterprise is a joint stock company or sole

proprietorship/partnership concern.


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Assets

The entire property of all kinds possessed by or owing to a person or organization is called

Assets.Assets are valuable resources owned by a business and acquired at a measurable money

cost. They may be

Fixed Assets:

These are those assets, which are acquired for relatively long periods for carrying on the

business of the enterprise. Such assets are not meant for resale. For example, Land and Building,

plant and machinery etc.

Current Assets:

These assets are also termed as Floating or Circulating Assets. Such assets are acquired with

the intention of converting them into their values constantly. The essential difference between

Current Assets and Fixed Assets is that the current assets are held essentially for a short

period and they are meant for converting into cash. Unsold stock, debtors bills receivables, bank

balance, cash in hand, etc are some of the examples of current Assets.

Fictitious Assets:

Assets of no real value but included in the balance sheet for legal or technical reasons, e.g.,

preliminary expenses.

Tangible and Intangible Assets:

Tangible assets are those assets, which can be seen and touched i.e. assets having their physical

existence e.g. assets having their physical existence e.g. land and building, plant and machinery,

furniture and fixtures, stock-in-trade, cash, etc.

Intangible assets cannot be normally soli in the open market since they are not having any

physical existence e.g. Good will, patents, trademarks, prepaid expenses etc.

Liquid Assets:

Assets that can be easily converted into cash like Bank account, Bills receivable, etc. As a matter

of fact, all current assets excluding stock-in-hand and prepaid expenses are called liquid assets.

Wasting Assets:

These are the assets which are exhausted with, or which lose themselves in, the goods they

produce. Mines and quarries are common examples of such assets. Copyright, patents,

trademarks, etc. are also classified as wasting assets since they get exhausted with the lapse of

time.


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FIXED ASSETS

These are those assets, which are acquired for relatively long periods for carrying on the

business of the enterprise. Such assets are not meant for resale. For resale. For example, Land

and Building, plant and machinery, etc. Current Assets provide benefits to the organization by

their exchange into cash. In the case of fixed assets, value addition arises by facilitating the

process of production or trade.

Fixed assets normally include assets such as land, building, plant, machinery, etc. All these

items, with exception of land are depreciated. Land is not subject to depreciate and hence shown

separately from other fixed assets.

ACCRUED LIABILITIES

Accrued Liabilities represents expenses or obligations incurred in the previous accounting

period but the payment for the same will be made in the next period. In many cases where

payments are made periodically, such as wages, rent and similar items, the last months payment

many appear as accured liabilities.(especially if the practice is to pay the same on the first

working day of a month. This obligation shown on the balance sheet indicates that the firm owed

the said amount on the balance sheet date.

ACCOUNTS RECEIVABLES

Accounts receivables are amounts owed to the company by debtors. This is the reason why we

also use the term sundry debtors to denote the amounts owed to the firm. This represents

amounts usually arising out of normal commercial transactions. In other words, accounts

receivable or sundry debtors represents unpaid customer accounts. These are also known as

trade receivables, since they arise out of normal trading transactions. Trade receivables arise

directly from credit sales and as such provide important information for management and

outsiders. In most situations these accounts are unsecured and have only the personal security of

the customer.

PROFIT AND LOSS ACCOUNT CONCEPT

The determination of Gross profit or gross loss is done by preparation of Trading account. But

it does not reveal the Net profit or Net loss of a concern during the particular period. This is the

second part of the income statement and is called as Profit and Loss account. The purpose of

preparing the profit and loss account to calculate the Net profit or Net loss of a concern. Net

profit refers to the surplus which remains after deducting related trading expenses from the gross


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profit. The trading expenses refer to inclusive of office and administrative expenses, selling and

distribution expenses.

In other words, all operating expenses such as office and administrative expenses, selling and

distribution expenses and non operating expenses are shown on the debit side and all operating

and non operating gains and incomes are shown on the credit side of the profit and loss account.

The difference of two sides is either Net profit or Net loss. Accordingly, when total of all

operating and non-operating expenses is more than the Gross profit and other non-operating

incomes, the difference is the Net profit and in the reverse case it is known as Net loss. This Net

profit or Net loss is transferred to the capital account of balance sheet.

PROFIT AND LOSS ACCOUNT RELATED CONCEPTS

Components appearing on debit side of the profit and loss A/c

Those expenses incurred during the manufacturing process of convention of raw materials into

finished goods will be treated as direct expenses which are recorded in the debit side of the

Trading account. Any expenditure incurred subsequent to that will be known as indirect expenses

to be shown in the debit side of the profit and loss account. The indirect expenses may be

classified into 1) Operating Expenses and 2) Non-Operating expenses.

1) Operating Expenses:

It refersthose expenses as the day-to-day expenses of operating a business include office

& administrative expenses, selling and distribution expenses.

2) Non-Operating Expenses:

These expenses incurred other than operating expenses. Non-operating expenses which

are related to a financial nature. For example, interest payment on loans and overdrafts,

loss on sale of fixed assets, writing off fictitious assets such as preliminary expenses,

under writing commission etc.


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Components appearing on credit side of profit & loss account

The following are the components are shown on the credit side:

1) Gross profit brought down from Trading Account

2) Operating Income: It refers to income earned from the operation of the business

excluding Gross profit and Non-operating incomes.

3) Non-Operating Income:

Non-Operating incomes refer to other than operating income. For example, interest on

investment of outside business, Profit on sale of fixed assets and dividend received etc.

FORMAT

TRADING ACCOUNT FOR THE YEAR ENDED------------------

Particulars Amt Amt Particulars Amt Amt

To Opening stock By sales

To Purchase (-) sales returns

(-) Purchase return By closing stock

To carriage inward By gross loss

To Freight (balancing figure)

To clearing charges

To wages

To Direct Expenses

To Gross Profit

(Balancing Figure)


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P&L ACCOUNT FOR THE YEAR ENDED------------------

PARTICULARS Amt Amt Amt Amt

To gross loss By gross profit

To salaries By interest received

To office rent By discount received

To office expenses/general By commission received

Expenses/Administrative By bad debts recovered

expense/

Sundry expenses By net loss transferred to

To telephone charges/rents Balance sheet

To rent and taxes

To insurance

To printing and stationary

To audit fees

To postage and telegram

To interest paid

To bank charges

To commission paid

To discount allowed

To advertisement

To bad debts

To carriage outward

To depreciation

To net profit transferred

To balance sheet


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BALANCE SHEET

LIABILITIES ASSETS

Capital Goodwill

(+)Net profit Land

(-)Net loss Building

Drawing House holds

Reserves and surplus Railway sidings

Debentures Plant and machinery

Equity share Patents and trademarks

Preference shares Livestock

Loan and advances Vehicles

Short term loans Stock

Sundry creditors Sundry debtors

Bills payable cash and bank balance

Outstanding expenses Prepaid expenses

Provision for taxation Preliminary expenses

Prepaid dividend Closing stock


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INFLATION ACCOUNTING

INTRODUCTION

The basic objective of Accounting is the preparation of financial statements is a way that

they give a true and fair view of the operating results and the financial position of the business to

its various users, namely investors, creditors, management, Government, trade unions, research

institutions etc. These financial statements are prepared based on certain accounting concepts

and conventions. The money measurement concept is a basic attribute of accounting.

The money measurement concept states that only those business transactions that are

capable of being expressed in terms of money can be recovered in the books of account. It also

assumes that the monetary unit used for recording the transaction is stable in nature. However,

this is not true in practice as many countries, developed as well as developing, have been

experiencing inflation of high magnitude in recent times. Inflation refers to state of continuous

rise in prices. It brings downward changes in the purchasing power of monetary unit. Thus,

financial statements prepared without taking into account the change in purchasing power of the

monetary unit lose their significance. There is a demand that business enterprises should prepare

inflation adjusted financial statements. The different ways through which financial accounts can

be adjusted for changing prices is studied under the subject Inflation Accounting. Given that

price changes can also be downward, it is more appropriately called Accounting for price level

changes.

METHODS OF ACCOUNTING FOR PRICE LEVEL CHANGES

There is no consensus on the method to be adopted for adjusting the financial statements

for price level changes. Price level changes can be broadly classified into general price level

changes and specific price changes. General Price changes reflect the overall increase or

decrease in the value of monetary unit. The changes in wholesale price index (WPI) or the

consumer price index (CPI) are examples of such price level changes. Specific price refer to

changes in the price of a specific asset. It is important to note that the price of a particular asset

may not follow the same trend as WPI or CPI.

They are:


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1. Current Purchasing Power (CPP) method, based on changes in general price level changes

2. Current Cost Accounting (CCA) method, based on changes in prices of specific assets.

1. Current Purchasing Power method:

a) Conversion Factor

b) Calculation of Net Monetary Gain/Loss

c) Impact of change in price level on Monetary Items

d) Calculation of Monetary Gain/Loss

e) Valuation of Inventory and Cost of goods sold

i) FIFO

ii) LIFO

f) Fixed Assets and Depreciation

g) Other Points

i) Taxation

ii) Interest on Debentures

iii) Dividends

iv) Capital

Current Purchasing Power (CPP):

CPP Method of inflation accounting seeks to use general purchasing power price of money rather

than specific indices to convert the historical figures into relevant figures of purchasing power

for the end of the period in review.

In simple terms, the conversion process of historical figures into CPP figures involves two steps:

Multiplying the Historical Cost figures by the price index at the end of the

period;

Dividing the figures obtained in Step (i) above by the index which existed at the

date of original transaction.

e.g. : Historical Cost figures

1.1.85 - Fixed Assets - Rs. 2,00,000/-

Index on 1.1.85 - 120


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Index on 31.12.87 - Date of review150

Conversion = 2,00,000 X 150 = Rs. 2,50,000

120

The conversion process is discussed below in following 3 sections:

a. Balance Sheet at the beginning of the year;

b. Profit and Loss a/c for the year and

c. Balance sheet at the end of the year

a. Balance sheet at the beginning of the year:

For the sake of convenience, the Balance Sheet is viewed as comprising of 3 parts:

1. Monetary Assets;

2. Non-Monetary Asset and

3. Shareholders Fund

1. Monetary Assets:

They comprise of Debtors, cash, creditors etc. The CPP method assumes that the value of

these assets on the Balance sheet date reflect the CPP as at the end of the previous year.

These figures are converted into CPP figures as follows:

Index at the end

Historical Cost X ------------------------------------------------

Index on the date of Balance Sheet

2. Non-Monetary Assets

These are discussed in 3 heads:


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i. Fixed Assets

Index at the end

Historical Cost figures X ------------------------------------------------

Index on the date of Acquisition

ii. Depreciation

Index at the end

Accumulated Depreciation X ------------------------------------------------

Index on the date of Acquisition

If assets are acquired over a period of time, calculations would have to be made

separately for each of the acquisition.

iii.Stock

In converting Historical cost figures of stock, the first step is to identify the period

during which the items in stock were purchased and then a price index representative

of the price level during such period is identified.

iv.Shareholders Funds:

It is not possible to convert shareholders funds i.e. share capital + Accumulated

Reserves on historic cost figures into CPP figure by multiplying with any specific

index. It is arrived at by subtracting all liabilities at CPP from the assets both fixed

and current at CPP.

b. Profit and Loss Account:

Discussed under four sections:

1. Stock at the beginning of the year

2. Transactions during the year


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3. Depreciation written off for the year and

4. Loss of purchasing power during the year because of holding monetary assets.

1. Stock at the beginning of the year:

Same as discussed under Non-Monetary Assets.

2. Transactions during the year:

Normally the CPP assumes transactions occur evenly throughout the year. In such cases, average

price index for the year is used. But in cases where the transactions occur unevenly, it is

necessary to use a weighted average index or to convert for eg. Using each quarters transactions

separately.

3. Depreciation written off for the year:

First Step: Value assets on CPP basis

Second Step:Apply rates of depreciation to cost of assets expressed in CPP terms.

4. Loss of purchasing power for holding net monetary assets:

Step I: Loss on opening balance of net monetary assets i.e. Debtors + CashCreditors

(Index at the endIndex at the beginning of

the year)

Non Monetary Assets at the X ---------------------------------------------------------------

----------

Beginning of the year Index at the beginning of the year

Step II: Increase / Decrease in Net Monetary assets

Net Monetary assets at beginningNet Monetary assets at the end of the year

Step III: Loss on increase / Decrease in Net Monetary Assets

(Index at the endAverage Index for the year)

Figure in Step II X -------------------------------------------------------------------------

Average Index for the year

Step IV: Add figure in Step I to figure in Step III


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The above process of calculation assumes that the figure of net monetary assets at the end of the

year comprises of 2 parts:

i. Opening balance of net monetary assets and

ii. Increase / Decrease in Net Monetary assets during the year.

c. Balance Sheet at the end of the year:

Discussed under 3 heads:

i. Non-Monetary assets:

a) Fixed Assets & Depreciation - Same treatment as in the case of opening

balance sheet

b) StockMethod adopted in Profit and Loss A/c

ii. MonetaryNo need for conversion since monetary assets at the end

of the year are already expressed in terms of CPP.

iii. Shareholders funds = Assets(CPP) Liabilities(CPP)

Human Resource Accounting

Human Resource Accounting is a method to measure the effectiveness of personnel

management activities and the use of people in an organization.

Approaches to Human resource accounting was first developed 1691 the next stage was during

1691-1960 and third phase post-1960. There are two approaches to HRA. Under the cost

approach, also called human resource cost accounting method or model, there is a) Acquisition

cost model and b)replacement cost model. Under the value approachthere are a) present value

of future earnings method, b) discounted future wage model, c) competitive bidding model.

Cost approach

This approach is also called as acquisition cost model.This approach is developed by Brummet,

Flamholmay tz and Pyle but the first attempt towards employee valuation made by a foot ware


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This approach measures the cost of replacing an employee. According to Likert (1985)

replacement cost include recruitment, selection, compensation, and training cost (including the

income foregone during the training period). The data derived from this method could be useful

in deciding whether to dismiss or replace the staff.

Limitations

Substitution of replacement cost method for historical cost method does little more than

update the valuation, at the expense of importing considerably more subjectivity into the

measure. This method may also lead to an upwardly biased estimate because an

inefficient firm may incur greater cost to replace an employee (Cascio 3-4).

Present Value of Future Earnings

Lev and Schwartz (1971) proposed an economic valuation of employees based on the present

value of future earnings, adjusted for the probability of employees death/separation/retirement.

This method helps in determining what an employees future contribution is worth today.

According to this model, the value of human capital embodied in a person who is y years old, is

the present value of his/her future earnings from employment and can be calculated by using the

following formula:

E(Vy) = Py(t+1) I(T)/(I+R)t-y

T=Y Y

where E (Vy) = expected value of a y year old persons human capital T = the persons

retirement age Py(t) = probability of the person leaving the organisation I(t) = expected earnings

of the person in period I r = discount rate

Limitations

The measure is an objective one because it uses widely based statistics such as census

income return and mortality tables.


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The measure assigns more weight to averages than to the value of any specific group or

individual (Cascio 4-5).

Value to the organization

Hekimian and Jones (1967) proposed that where an organization had several divisions seeking

the same employee, the employee should be allocated to the highest bidder and the bid price

incorporated into that divisions investment base. For example a value of a professional athletes

service is often determined by how much money a particular team, acting in an open competitive

market is willing to pay him or her.

Limitations

The soundness of the valuation depends wholly on the information, judgment, and

impartiality of the bidder (Cascio 5).

Expense model

According to Mirvis and Mac, (1976) this model focuses on attaching dollar estimates to the

behavioral outcomes produced by working in an organization. Criteria such as absenteeism,

turnover, and job performance are measured using traditional organizational tools, and then costsare estimated for each criterion. For example, in costing labor turnover, dollar figures are

attached to separation costs, replacement costs, and training costs.

afm unit 1 total notes

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