Category: Accounting

Cost Concept:

According to cost concept, the various assets acquired by a concern or firm should be recorded on the basis of the actual amounts involved or spent.The fixed asset will be recorded at cost at the time of its purchase but it may systematically be reduced in its value by charging depreciation. Example, When a machine is acquired by paying Rs.5,00,000 following cost concept the value of the machine is taken as Rs. 5,00,000.

The Cost Concept creates a lot of distortion too as outlined below:

In an inflationary situation when prices of all commodities go up on average, acquisition cost loses its relevance.

Many assets do not have acquisition costs. Human assets of an enterprise are an example. The cost concept fails to recognise such asset although it is a very important asset of any organization.

Going Concern Concept: 

The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future.

Business transactions are recorded on the assumption that the business will continue for a long-time.

Fixed assets are valued on the basis of cost less proper depreciation keeping in mind their expected useful life ignoring fluctuations in the prices of these assets.When an enterprise liquidates a branch or one segment of its operations, the ability of the enterprise to continue as a going concern is not impaired. But the enterprise will not be considered as a going concern if it goes into liquidation or it has become insolvent.

Mx.X purchased a machine for his business paying Rs. 10,00,000 out of Rs. 7,00,000 invested by him. He also paid transportation expenses and installation charges amounting to Rs.70000, If he is still willing to continue the business, his financial position will be as follows.

Money Measurement Concept 

As per this concept, only those transactions, which can be measured in terms of money are recorded.

Transactions and events that cannot be expressed in terms of money are not recorded in the business books. Non-monetary events like, death, dispute, sentiments, efficiency etc. are not recorded in the books, even though these may have a great effect.

This concept ignores that money is an inelastic yardstick for measurement as it is based on the implicit assumption that purchasing power of the money is not of sufficient importance as to require adjustment. Entity and money measurement are viewed as the basic concepts on which other procedural concept hinge.

Accounting Period Concept 

As per the Going Concern Concept an indefinite life of the entity is assumed. For a business entity it causes incovenience to measure performance achieved by the entity in the ordinary course of business.

The Periodicity Concept facilitates in:

1) Comparing of financial statements of different periods

2) Uniform and consistent accounting treatment for ascertaining the profit and assets of the business

3) Matching periodic revenues with expenses for getting correct results of the business operations.

Accrual Concept: 

Normally all transactions are settled in cash but even if cash settlement has not taken place, it is proper to record the transaction or the event concerned into the books. Expense is a cost relating to the operations of an accounting period or tot the revenue earned during the period or the benefits of which do not extend beyond that period.

Accrual means recognition of revenue and costs as they are earned or incurred and not as money is received or paid. The accrual concept relates to measurement of income, identifying assets and liabilities.

As per Accrual Concept: Revenue – Expenses = Profit 

Accrual Concept provides the foundation on which the structure of present day accounting has been developed.

Balance Sheet and Statement of Affairs

Both balance sheet and statement of affairs show the financial position of a business on a particular date. However, they differ from each other in several ways:

(i) A balance sheet is prepared from the Trial Balance extracted on the basis of ledger accounts. While a statement of affairs is prepared from ledger accounts and several additional information available from other sources.

(u) Balance sheetis assumed to show the true financial position of the business while it may not be the case in case of statement of affairs.

(iii) The omissions of assets and liabilities cannot be easily traced in a statement of affairs while such omissions can be traced in a balance sheet.

(iv) A balance sheet is basically prepared to show the financial position of a business on a particular date. While a statement of affairs helps in ascertaining not only the financial position but also the profit made by the business during a particular period.

(v) The capital account balance shown in the balance sheet is taken from the ledger. While the capital account balance in case of a statement of affairs is the excess of assets over liabilities on a particular date.

 

Importance Profit and Loss Account 

The Profit and Loss Account Provides information regarding the following matters:

1.  It provides information about the net profit or net loss earned or suffered by the business during a particular period. Thus, it is an index of the profitability or otherwise of the business.

(ii) The Profit figure disclosed by the Profit and Loss Account for a particular period can be compared with that of the other period. Thus, it helps in ascertaining whether the business is being run efficiently or riot.

(iii) An analysis of the various expenses included in the Profit and Loss Account ant their comparison with the expenses of the previous period or periods helps in taking steps for effective control of the various expenses.

(iv) Allocation of profit among the different periods or setting aside a part of the profit for future contingencies can be done. Moreover, on the basis of profit figures .

Specific Identification Method 

According to this method each item of inventory is identified with its cost. The total of the various costs so identified constitute the value of inventory. This method is generally used when the materials or goods have been purchased for a specific job or customer. Such materials or goods when received are earmarked for the job or customer for whom they are purchased and are issued or sold to the particular job or customer whenever demanded.

This technique of inventory valuation can be adopted only by a company which is handling a small number of items. In case of a manufacturing company having a number of inventory items, it is almost impossible to identify the cost of each individual item of inventory. Thus, this method is inappropriate in most cases on account of practical considerations. Moreover, the method opens door to income manipulation when like items are purchased at different prices. For example, a company purchases.10.000 unitE of an item in equal lots of 2,500 each at costs of Rs 2.50, Rs 3, Ps 3.50 and P.s 4 per unit It sells 7,500 units at Rs 4 per unit. In case the management follows this method for valuation of inventory, it can deiemtine the income reported for the period by selecting that lot of units which will produce the desired objective. If it is assumed that the inventory consists of the last lot purchased, the value of the inventory would be a sum of Rs 10,000 as compared to the presumption that the inventory consists of units purchased in the first lot in which case the value of inventory would be Rs 6,250.

First In First Out Method (FIFO)

Under this method, it is assumed that the materials/goods first received are the first to be issued/sold. Thus, according to this method, the inventory on a particular date is presumed to be composed of the items which have been acquired most recently

Advantages. The FIFO method has the following advantages:

1. It values stock nearer to current market prices since stock is presumed to be consisting of the most recent purchases.

2. It is based on cost and, therefore, no unrealised profit enters into the financial accounts of the company.

3. The method is realistic since it takes into account the normal procedure of utilisinglselling those materials/goods which have been longest in stock.

Disadvantages. The method suffers from the following disadvantages:

Last In First Out Method (LIFO) 

This method is based on the assumption that last item of materials/goods purchased are the first to be issued/sold. Thus, according to this method, inventory consists of items purchased at the earliest cost.

Illustration 4,3. Calculate the value of the inventory of January 31 from the following data using (i) periodic inventory system and (ii) perpetual inventory system.

Advantages: The method has the following advantages:

1. It takes into account the current market conditions while valuing materials issued to different jobs or calculating the cost of goods sold.

2. The method is based on cost and, therefore, no unrealised profit or loss is made on account of use of this method.

The method is most suitable for materials which are of a bulky and non-perishable type. 

Adjustment for Goodwill

Since the new partner gets a share in the profits of the rum, he should compensate the old partners for sharing the earning of the firm on account of the reputation or goodwill earned by the partnership firm so fan The problem of goodwill on admission of a new partner can be dealt in two different ways:

1. When the goodwill account already appears in the books.

2. When the goodwill account is not appearing in the books at the time of admission of a partner.

If the goodwill account is already appearing in the books. There can be three situations:

The goodwill account is appearing at a proper value. In such an event no adjustment will be required for goodwill.

A and B are sharing profits in the ratio 3 : 2. They admit a new partner C with 1/5 share in the profits. At the time of admission of C, goodwill is appearing in the firm’s books at Ps 10,000 and it is agreed by all partners (including C) that it is properly valued. Should C pay anything for goodwill?

Solution: 

Since goodwill is already appearing in the books, it shows that the old partners have already got credit to their capital accounts with the value of goodwill. Moreover, it is properly valued and hence C will not be required to pay anything for goodwill nor any further adjustment will be required.

(ii) The goodwill account is to be revalued. In such an event entry will be made only with the difference. The amount of over or under-valued goodwill is debited or credited to the old partners in the old ratio and credited or debited to goodwill account.

JOINT VENTURE AND PARTNERSHIP

According to the Indian Partnership Act. “Partnership is the relations between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.” Thus, both in joint venture and partnership there is some business activ,ity whose profit (or loss) is agreed to be shared by two or more than two persons. As a matter of fact in law, a joint venture is treated as a partnership. Of course, a partnership covers or is meant to cover a long period whereas ajoint venture is only for a limited purpose sought to be achieved in a short period. On account of this reason, joint venture is also sometimes termed as a temporary partnership’ or ‘partnership for a specific venture’ or ‘particular partnership’.

Joint Venture and Consignment

The following are the points of distinction between joint venture and consignment:

(1) .Relalionslnp: In case of a consignment transaction, the relationship between the consignor and the consignee is that of a principal and an agent. While in case of joint venture, the relationship amongst various venturers is that of partners, i.e., mutual agency. Each venturer is a principal as well as an agent for the other venturer.

(II) Sharing of profits: In case of consignment, the consignee gets only a commission on the goods sold by him on behalf of the consignor while in case of joint venture each venturer gets a share in the profits of the venture,

(iii) Transfer of risk: tn case of consignment, till the goods are sold the risk continues to be of consignor while ajoint venture is a temporary partnership hence the risk continues of all venturers.

METHODS OF VALUATION OF INVENTORIES

According to International Accounting Standard: 2 (lAS: 2), the inventories should be valued at the lower of “historical cost” and “net realisable value”.

Historical Cost

Historical cost of inventories is the aggregate of costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Thus Historical cost includes not only the price paid for acquisition of inventories but also all costs incurred for bringing and making them fit for jise in production or for sale e.g. transportation costs, duties paid, insurance-in-transit, manufacturing expenses,wages paid or manufacturing expenses incurred for converting raw materials into finished products etc. Selling expenses such an advertisement expenses r storage costs should not be included.

A major objective of accounting for inventories is the proper determination of income thmugh the process of matching appropriate costs against revenues. It requires assigning of proper costs to inventory as well as goods sold.

However, it should be noted that assigning of such costs need not conform to the physical flow of goods.

The various methods for assigning historical costs to inventory and goods sold are being explained below.

I. Proforma invoice. It is a statement prepared by the consignor stating quantity, quality and price of goods. It is sent with goods despatched to consignee.

A proforma invoice is different from Invoice.

Invoice implies that a sale has taken place. It is a statement describing the goods despatched to the buyer and showing the total amount due by him to the seller. A proforma invoice is simply a statement of information in the form of invoice to apprise the party, who has not bought the goods but shall be having their possession, or dealing with them, of certain essential particulars of the goods. Such an invoice is sent by the intending seller to his agent or the intending buyer before the sale actually takes place. It does not show that the person to whom it is sent is indebted to the sender.

2. Account sales. It is a periodical statement rendered by the Consignee to the Consignor containing details of goods received, sales made, expenses incurred, commission charged, remittances made and balance due by him to the consignor. The following is a specimen of an Account Sales.

ACCOUNTING PROBLEMS

The accounting problems on admission of a new partner can be put as follows:

(i) Adjustment in the profit sharing ratio.

(ii) Adjustment for goodwill.

(iii) Adjustment for revaluation of assets and liabilities.

(iv) Adjustment for reserves and other accumulated profits.

(v) Adjustment for capital.

Each of the above problems are being discussed in the following pages.

Adjustment in the Profit Sharing Ratio

A newly admitted partner will be entitled to share the profits or bear the losses with the other partners. Hence the profit sharing ratio of the partners will change. There can be two situations.

The new partner may be given a certain proportion of the total profit or required to bear a certain proportion of the total loss and the old partners continue to share the balance of profit or bear the balance of loss in the old ratio in between themselves.