FINAL PROJECT OF ADVANCED FINANCIAL ACCOUNTING

          ADJUSTING ENTRIES:
                         
                         '' An accounting entry made at the end of accounting period to allocate items between accounting periods''   
                 Adjusting entries are recorded at the end of accounting period to adjust ledger accounts for any changes that relate to the current accounting period but have not yet been recorded. The main purpose of adjusting entries is to match revenues and expenses to the current accounting period which is a requirement of the matching principle of accounting.
                
          ''Adjustments are necessary for items that have either been deferred or accrued.''


CHARACTERISTICS OF ADJUSTMENTS:

                 Adjusting entries will always have the following characteristics:

•. 

• Adjusting entries are internal transactions,,no new source document exists for the adjustment.
• Adjusting entries are non-cash transactions,,the Cash account will never be used in an adjusting entry. 
• Adjusting entries will always involve at least,,one income statement account and one balance sheet account.

REASON FOR ADJUSTMENT:


                  It can be inefficient and costly to account for certain types of transactions on daily basis.


TYPES OF ADJUSTMENTS:

• Deferrals 
• Accruals

DEFERRALS:


DEFERRED EXPENSES:
                                   These are the expenses in which cash is paid before the expenses are fully recognized.


DEFERRED REVENUES:
                                   These are the revenues in which cash is received before the revenue is fully earned.


ACCRUALS:


ACCRUED EXPENSES:
                                  These are the expenses in which cash is paid after the expense is fully recognized.


ACCRUED REVENUES:
                                  These are the revenues in which cash is received  after the revenue is earned.






             IAS 16 PROPERTY PLANT    


                   AND EQUIPMENT:              




INTRODUCTION:


International accounting standards 16 property, plant and equipment (IAS 16) replaces IAS 16  property, plant and equipment (revised in 1998), and should be applied for annual periods beginning on or after 1 January 2005. Earlier application is encouraged.
              
OBJECTIVES OF IAS 16:                  

The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment. The principal issues are the recognition of assets, the determination of their carrying amounts, and the depreciation charges and impairment losses to be recognised in relation to them. 


SCOPE:

IAS 16 does not apply to:

• assets classified as held for sale in accordance with IFRS 5
• exploration and evaluation assets.
• biological assets related to agricultural activity or
• mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources.

The standard does apply to property, plant, and equipment used to develop or maintain the last two categories of assets.

RECOGNITION:


                      Items of property, plant, and equipment should be recognised as assets when it is probable that:

• it is probable that the future economic benefits associated with the asset will flow to the entity, and
• the cost of the asset can be measured reliably. 

INITIAL MEASUREMENT:

• An item of property, plant and equipment should initially be recorded at cost. 
• Cost includes all costs necessary to bring the asset to working condition. 
• This would include not only its original purchase price but also costs of site preparation, delivery and handling, installation, related professional fees for architects and engineers, and the estimated cost of dismantling and removing the asset and restoring the site.

REVALUATION MODEL:

• Under the revaluation model, revaluations should be carried out regularly, so that the carrying amount of an asset does not differ materially from its fair value at the balance sheet date.
•  If an item is revalued, the entire class of assets to which that asset belongs should be revalued. 
• Revalued assets are depreciated in the same way as under the cost model.
• If a revaluation results in an increase in value, it should be credited to other comprehensive income and accumulated in equity under the heading "revaluation surplus" unless it represents the reversal of a revaluation decrease of the same asset previously recognised as an expense, in which case it should be recognised as income. 

DEPRECIATION ( COST & REVALUATION METHOD):

For all depreciable assets:

• The depreciable amount (cost less residual value) should be allocated on a systematic basis over the asset's useful life.
• The residual value and the useful life of an asset should be reviewed at least at each financial year-end and, if expectations differ from previous estimates, any change is accounted for prospectively as a change in estimate under IAS 8.
• The depreciation method used should reflect the pattern in which the asset's economic benefits are consumed by the entity.
• The depreciation method should be reviewed at least annually and, if the pattern of consumption of benefits has changed, the depreciation method should be changed prospectively as a change in estimate under IAS 8.
• Depreciation should be charged to the income statement, unless it is included in the carrying amount of another asset.
• Depreciation begins when the asset is available for use and continues until the asset is derecognised, even if it is idle. 

DE RECOGNITION:


                          An asset should be removed from the balance sheet on disposal or when it is withdrawn from use and no future economic benefits are expected from its disposal. The gain or loss on disposal is the difference between the proceeds and the carrying amount and should be recognised in the income statement.


                          If an entity rents some assets and then ceases to rent them, the assets should be transferred to inventories at their carrying amounts as they become held for sale in the ordinary course of business. 

                IAS 2 INVENTORIES:

INTRODUCTION:

                                                International accounting standards 2 inventories ( IAS 2 ) revised in 1993, should be applied for annual periods beginning on or after 1 january 2005. The early application was encouraged.

REASONS FOR REVISING IAS 2:

                                                The International Accounting Standards Board developed this revised IAS 2 as a part of its project on improvements to International Accounting Standards. Project was taken in the light of queries & criticisms raised by securities regulators, professional accountants & other interested parties.
The objectives of the project were:

• To reduce or eliminate alternatives
• Redundancies & conflicts within the Standards
• To deal with some convergence issues
• To make other improvement

SCOPE:

               Inventories includes:

• Assets held for sale in the ordinary course of business (finished goods)
• Assets in the production process for sale in the ordinary course of business (work in process) 
• Materials & supplies that are consumed in production (raw material)

IAS excludes certain inventories from its scope: (IAS 2.2)

• Work in process arising under construction contracts (IAS 11)
• Financial instruments (IAS 39)
• Biological assets related to agricultural activity & agricultural produce at the point of harvest (IAS 41)

The standard clarifies that some types of inventories are outside its scope while certain other types of inventories are exempted only from the measurement requirements in the Standard.



FUNDAMENTAL PRINCIPLE OF IAS 2:

                                  Inventories are required to be stated   at the lower cost and net realisable value (NRV).

                                 

                                    NRV = Estimated selling price - cost to sell in company

MEASUREMENT OF INVENTORIES:

                      Cost should include all:

• Costs of purchase (including taxes, transports and handling) net of trade discounts received
• Costs of conversion (including fixed and variable manufacturing overheads)
• Other costs incurred in bringing the inventories to their present location and condition 

                   IAS 23 Borrowing costs identifies some limited circumstances where borrowing costs (interest) can be included in cost of inventories that meet the definition of a qualifying asset.

Inventory cost should not include:

• Abnormal waste
• Storage costs
• Administrative overheads unrelated to production 
• Selling costs
• Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency
• Interest cost when inventories are purchased with deferred settlements terms

Cost formulas allowed: 

IAS 2 allows the FIFO or Weighted average cost formulas.

Cost formulas not allowed:

The LIFO formula, which had been allowed prior to 2003 revision of IAS 2 is no longer allowed.

                                                 The same cost formula should be used for all inventories with similar characteristics as to their nature & use to the entity. For groups of inventories that have different characteristics, different cost formulas may be justified (IAS 2.25)

WRITE-DOWN TO NET REALISABLE VALUE:

                 NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale (IAS 2.6). Any write-down to NRV should be recognised as an expense in the period in which the write-down occurs. Any reversal should be recognised in the income statement in the period in which the reversal occurs.

RECOGNITION AS AN EXPENSE: 

                          IAS 18 Revenue, addresses revenue recognition for the sale of goods. When inventories are sold & revenue is recognised, the carrying amount of those inventories is recognised as an expense (often called cost-of-goods-sold). Any write-down to NRV & any inventory losses are also recognised as an expense when they occur (IAS 2.34).

DISCLOSURE:

                                         The Standard requires the following disclosures:

1. Accounting policy for inventories
2. Carrying amount, generally classified as merchandise, supplies, materials, work in progress & finished goods. The classification depends on what is appropriate for the entity.
3. Carrying amount of any inventories carried at fair value less costs to sell 
4. Amount of any write-down of inventories recognised as an expense in the period
5. Amount of any reversal of a write-down to NRV and the circumstances that led to such reversal
6. Carrying amount of inventories pledged as security for liabilities
7. Cost of inventories recognised as expense (cost of goods sold).

APPROVAL OF IAS 2 BY THE BOARD:

                   International Accounting Standard 2 Inventories was approved for issue by the fourteen members of the International Accounting Standards Board.

         
            CASH FLOW STATEMENT:


INTRODUCTION:


                             The official name for the cash flow statement is the statement of cash flows. The statement of cash flows is one of the main financial statements. The other financial statements are the balance sheet, income statement, and statement of stockholders' equity. The cash flow statement organizes and reports the cash generated.
                               It has following categories:

• Operating activities
• Investing activities
• Financing activities

OPERATING ACTIVITY:

                              It converts the items reported on the income statement from the accrual basis of accounting to cash.Operating activities shows how much cash is generated from products or services of the business. Changes in cash, account receivable, depreciation, account payable etc are shown in cash from operating activities.

INVESTING ACTIVITY:

                             It reports the purchase and sale of long-term investments and property, plant and equipment.Cash changes from investing are due to purchase of new equipment, buildings or other assets that are short term such as marketable securities.

FINANCING ACTIVITY:

                            It reports the issuance and repurchase of the company's own bonds and stock and the payment of dividends.Changes in cash from financing activities are when the capital is increased, it is cash inflows. If a company issues a bond to the public, the company receives cash.

CHANGES IN CASH:

                When a transaction is made, following changes in cash may occur:

• When an asset (other than cash) increases, the Cash account decreases.
• When an asset (other than cash) decreases, the Cash account increases.
• When a liability increases, the Cash account increases.
• When a liability decreases, the Cash account decreases.
• When owner's equity increases, the Cash account increases.
• When owner's equity decreases, the Cash account decreases.

PREPARATION OF CASH FLOW STATEMENT:

                   Cash flow statement can be prepared by two methods:

• Direct method 
• Indirect method

DIRECT METHOD:

                             Using the direct method, we are basically analyzing our cash and bank accounts to identify cash flows during the period. Cash flows under the direct method is Used to prepare a worksheet for each major line item, and eliminate the effects of accrual basis accounting in order to arrive at the net cash effect for that particular line item for the period.  Some examples for the operating activities section include:

• Cash receipts from customers
• Cash payments for inventory
• Cash paid to employees
• Cash paid for operating expenses
• Taxes paid
• Interest paid

INDIRECT METHOD:

                            Indirect method starts with net income and converts it to net cash flow from operating activities. To compute net cash flows from operating activities, non cash changes in the income statement are added back to net income, and net cash credits are deducted. 

                             Explanation to the two adjustments to net income is given below:


INCREASE IN ACCOUNTS RECEIVABLES:

                            When accounts receivable increase during the year, revenues on an accrual basis are higher than on a cash basis because goods sold on account are reported as revenues. In other words, operations for the period led to increased revenues, but not all of these revenues resulted in an increase in cash. Some of the increase in revenues resulted in an increase in accounts receivable.

INCREASE IN ACCOUNT PAYABLE:

                           When accounts payable increase during the period, expenses on an accrual basis are higher than they are on a cash basis because expenses are incurred for which payment has not taken place. 

Bank Reconciliation Statement

BANK RECONCILIATION STATEMENT:
                                    A Bank reconciliation is a process that explains the difference between the bank balance shown in an organisation's Bank statement, as supplied by the bank, and the corresponding amount shown in the organisation's accounting records at a particular point in time. 

RECORDING:

                                            A transaction relating to bank has to be recorded in both the books i.e.  Cash Book and Pass Book but sometimes it happens that a  bank transaction is recorded only in one book and not recorded simultaneously in other book causing difference in the two balances.

EXAMPLE:

                   We operate a bank account in which we deposit money and withdraw money from time to time. We maintain a record with ourselves of these deposits and withdrawals. One day we get our pass-book (statement issued by the bank) updated but are surprised to find that the balance shown by the pass book was different from what it should have been as per our records.

                                                                              Then it is obvious that we will compare the two sets of records and find out items which are recorded in one but not in the other. Similar situation may arise in case of a business concern which operates a bank account. These business concerns maintain record of all of their banking transactions in their bank column of the cash book.

DIFFERENCES BETWEEN BANK STATEMENT AND 

CASH BOOK BALANCES:

                                                                        On any particular date the bank balance shown by the bank column cash book and that shown by the pass book should be the same. But if there is difference between the two, the business concern will find out the reasons to reconcile the balance.

Following Points are considered;

• Compare transactions that appear on both Cash Book and Bank Statement
• Update Cash Book from details of transactions appearing on Bank Statement
• Balance the bank columns of the Cash Book to calculate the revised balance
• Enter correct date of the statement
• Enter the balance at bank as per the Cash Book
• Enter details of unpresented cheques
• Enter sub-total on reconciliation statement
• Enter details of bank lodgements
• Calculate balance as per Bank Statement

Summary of IAS 2 Inventories

INTRODUCTION:
                                                International accounting standards 2 inventories ( IAS 2 ) revised in 1993, should be applied for annual periods beginning on or after 1 january 2005. The early application was encouraged.

REASONS FOR REVISING IAS 2:
                                                                                     The International Accounting Standards Board developed this revised IAS 2 as a part of its project on improvements to International Accounting Standards. Project was taken in the light of queries & criticisms raised by securities regulators, professional accountants & other interested parties.
The objectives of the project were:

• To reduce or eliminate alternatives
• Redundancies & conflicts within the Standards
• To deal with some convergence issues
• To make other improvement

SCOPE:
               Inventories includes:

• Assets held for sale in the ordinary course of business (finished goods)
• Assets in the production process for sale in the ordinary course of business (work in process) 
• Materials & supplies that are consumed in production (raw material)

IAS excludes certain inventories from its scope: (IAS 2.2)

• Work in process arising under construction contracts (IAS 11)
• Financial instruments (IAS 39)
• Biological assets related to agricultural activity & agricultural produce at the point of harvest (IAS 41)

The standard clarifies that some types of inventories are outside its scope while certain other types of inventories are exempted only from the measurement requirements in the Standard.


FUNDAMENTAL PRINCIPLE OF IAS 2:

                                                                                                            Inventories are required to be stated   at the lower cost and net realisable value (NRV).

                                 NRV = Estimated selling price - cost to sell in company

MEASUREMENT OF INVENTORIES:

                                                                    Cost should include all:

• Costs of purchase (including taxes, transports and handling) net of trade discounts received
• Costs of conversion (including fixed and variable manufacturing overheads)
• Other costs incurred in bringing the inventories to their present location and condition 

    IAS 23 Borrowing costs identifies some limited circumstances where borrowing costs (interest) can be included in cost of inventories that meet the definition of a qualifying asset.

Inventory cost should not include:

• Abnormal waste
• Storage costs
• Administrative overheads unrelated to production 
• Selling costs
• Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency
• Interest cost when inventories are purchased with deferred settlements terms

Cost formulas allowed: 
IAS 2 allows the FIFO or Weighted average cost formulas.
Cost formulas not allowed:
The LIFO formula, which had been allowed prior to 2003 revision of IAS 2 is no longer allowed.

                                                           The same cost formula should be used for all inventories with similar characteristics as to their nature & use to the entity. For groups of inventories that have different characteristics, different cost formulas may be justified (IAS 2.25)

WRITE-DOWN TO NET REALISABLE VALUE:
                                                                                                                                NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale (IAS 2.6). Any write-down to NRV should be recognised as an expense in the period in which the write-down occurs. Any reversal should be recognised in the income statement in the period in which the reversal occurs.

RECOGNITION AS AN EXPENSE:
                                                                                           IAS 18 Revenue, addresses revenue recognition for the sale of goods. When inventories are sold & revenue is recognised, the carrying amount of those inventories is recognised as an expense (often called cost-of-goods-sold). Any write-down to NRV & any inventory losses are also recognised as an expense when they occur (IAS 2.34).

DISCLOSURE:
                                         The Standard requires the following disclosures:

1. Accounting policy for inventories
2. Carrying amount, generally classified as merchandise, supplies, materials, work in progress & finished goods. The classification depends on what is appropriate for the entity.
3. Carrying amount of any inventories carried at fair value less costs to sell 
4. Amount of any write-down of inventories recognised as an expense in the period
5. Amount of any reversal of a write-down to NRV and the circumstances that led to such reversal
6. Carrying amount of inventories pledged as security for liabilities
7. Cost of inventories recognised as expense (cost of goods sold).

APPROVAL OF IAS 2 BY THE BOARD:
                                                                                                          International Accounting Standard 2 Inventories was approved for issue by the fourteen members of the International Accounting Standards Board.

Accounting cycle

ACCOUNTING CYCLE:
                                          ''Accounting cycle is a sequence of accounting procedures which are used to record, classify and summarize accounting information''...

STEPS INCLUDED IN ACCOUNTING CYCLE:
                Following steps are included in accounting cycle:

• Journal
• Ledger
• Trial balance
• Adjusting entries
• Adjusted trial balance
• Financial statements
• Closing entries
• After closing trial balance

JOURNAL: 

                             ''Day to day recording of business transactions is done in journal''

                            The first step of accounting cycle is recording of transactions in the journal. As any type of business transaction occured; they are entered in the journal. This procedure completes the recording step in the accounting cycle. Two accounts are involved in it. One a/c is debited and the other is credited.

LEDGER:

                          ''It is a book in which the entries from journal is transferred''

                          The debit and credit entries in account balances are posted from journal to ledger. This procedure classifies the effects of the business transactions on terms of specific assets, liabilities, owner's equity, revenue and expense account.

TRIAL BALANCE:

                                              ''A statement of all debit and credit items in double entry ledger, made to test their equality''

                             A trial balance proves and authenticates the equality of debit and credit entries in the ledger. The purpose of this procedure is to verify the accuracy of posting process and the computation of the ledger account balances. In the nutt shell debit and credit sides are balanced at the end in the trial balance. It is made under the instructions provided by the IAS.

ADJUSTING ENTRIES:

                                      '' An accounting entry made at the end of accounting period to allocate items between accounting periods''

                                 Adjusting entries are recorded at the end of accounting period to adjust ledger accounts for any changes that relate to the current accounting period but have not yet been recorded. The main purpose of adjusting entries is to match revenues and expenses to the current accounting period which is a requirement of the matching principle of accounting.

ADJUSTED TRIAL BALANCE:

                                        An adjusted trial balance is a list of the balances of ledgers which is made after the adjusting entries are done. Adjusted trial balance contains balances of revenues and expenses along with of assets, liabilities and equities after the changes occur due to adjusting entries.

FINANCIAL STATEMENTS:

                                             It is the step of accounting cycle in which exact figures from trial balance are summarized up to prepare the financial statements. These financial statements demonstrate the position of the business at the specific date.

It includes:

• Income statement
• Balance sheet 
• Statement of cash flow
• Statement of changes in equity
• Notes & other disclosures

CLOSING ENTRIES:

                                             It is necessary to close the temporary accounts in order to make their balances zero at the end of accounting period. Closing entries are based on the balances of accounts in the adjusted trial balance.

Temporary accounts include:

• Revenues
• Expenses
• Dividends
• Income summary

AFTER CLOSING TRIAL BALANCE:

                                             Post closing trial balance is a list of balances of ledgers prepared after passing adjusting entries and their postings to the ledgers. Post closing trial balance is prepared in the last step of the accounting cycle and its purpose is to assure that sum of debits equal the sum of credits before the new accounting period starts.