Conceptual Framework for Preparation and Presentation of Financial Statements Paper 5 : Advanced Accounting, Chapter : 1

Transcription

1 Conceptual Framework for Preparation and Presentation of Financial Statements Paper 5 : Advanced Accounting, Chapter : 1 CA. D. Suresh Kumar

2 AGENDA 1 Introduction 2 Purpose of the framework 3 Status and Scope of the Framework 4 Components of Financial Statements 5 Objectives of Financial Statements 6 Fundamental Accounting Assumptions 7 Qualitative Characteristics 8 Elements of Financial Statements 9 Measurement of Elements of Financial Statements 10 Capital Maintenance 2

3 Introduction Accounting Standards Board (ASB) of the ICAI has issued a framework which provides the fundamental basis for development of new standards as also for review of existing standards 3

4 Principal Areas Covered by the Framework Components of Financial Statements Objectivities of Financial Statements Assumptions Underlying Financial Statements Qualitative Characteristics of Financial Statements 4

5 Principal Areas Covered by the Framework Contd.. Elements of Financial Statements Criteria for Recognition of Elements in Financial Statements Principles of Measurement of Financial Elements Concepts of Capital and Capital Maintenance 5

6 Purpose of the framework To assist the enterprise in preparation of financial statements. To assist ASB in its task of development and review of accounting standards 6

7 Purpose of the framework To assist ASB in promoting harmonization To assist auditors in forming an opinion as to whether financial statements conform to the accounting standards To assist the users in interpretation of financial statements 7

8 8 Status and Scope of the Framework

9 Status and Scope of the Framework Financial Statements are prepared annually for external use. Special purpose financial reports are outside the scope of the framework Ex: Tax Purposes Framework never overrides any specific Accounting Standard. 9

10 10 Components of Financial Statements

11 Components of Financial Statements Balance Sheet 1 Profit & Loss A/c 2 Cash Flow Statement 3 Notes and Schedules 4 11

12 1. Balance Sheet Common-size Balance Sheet of X-Company As of Dec. 31, 1997 (Rs. 000's) Liabilities and Owner's Equity Accounts Payable Short-term Notes Payable Other Current Liabilities Total Current Liabilities Long-term Debt Total Liabilities Common Stock Retained Earnings Total Shareholder's Equity Total Liabilities and Owner's Equity Assets Cash and Equivalents Accounts Receivable Inventory Total Current Assets Plant & Equipment Accumulated Depreciation Net Fixed Assets Total Assets

13 2. Profit & Loss Common-size Income Statement of X Ltd For the Year Ended Dec. 31, 1997 (Rs. 000's) Particulars Sales Cost of Goods Sold Gross Profit Selling and G&A Expenses Fixed Expenses Depreciation Expense EBIT Interest Expense Earnings Before Taxes % Net Income

14 3. Cash Flow Statement X- Company Statement of Cash Flows For the Year Ended Dec. 31, 1997 (000's) Cash Flows from Operations Net Income Depreciation Expense Change in Accounts Receivable Change in Inventories Change in Accounts Payable Change in Short-term Notes Payable Change in Other Current Liabilities 4.00 Total Cash Flows from Operations Cash Flows from Investing Change in Plant & Equipment Total Cash Flows from Investing Cash Flows from Financing Change in Long-term Debt Cash Dividends Paid to Shareholders Total Cash Flows from Financing Net Change in Cash Balance

15 15 Objectives of Financial Statements

16 Users of Financial Statements Investors Public Employees Govt. Users Lenders Customers Suppliers & Creditors 16

17 17 Fundamental Accounting Assumptions

18 Fundamental Accounting Assumptions Going Concern Accrual Basis of Accounting Consistency 18

19 Note: Audio for remaining slides will be updated shortly Going Concern An enterprise will continue in operation in the foreseeable future and neither there is intention, nor there is need to materially curtail the scale of operations 19

20 Going Concern Example Balance sheet of a trader on 31/03/10 is given below: Liabilities Rs. Assets Rs. Capital 60,000 Fixed Assets 65,000 Profit & Loss A/c 25,000 Stock 30,000 10% Loan 35,000 Trade receivables 20,000 Trade Payables 10,000 Deferred costs 10,000 Bank 5,000 1,30,000 1,30,000 20

21 Additional Information The remaining life of fixed assets is 5 years. The use pattern of the asset is even. The net realizable value of fixed assets as on 31/03/11 was Rs.60,000. The trader s purchases & sales in amounted Rs.4 Lakhs and Rs.4.5 Lakhs. The cost and net realizable value of stock at the end of 31/03/11 were Rs. 32,000 and Rs. 40,000. Expenses for the year amounted to Rs. 14,900. Deferred cost is amortized equally over 4 years. Closing debtors is Rs.25,000, of which Rs.2,000 is doubtful. Collection of another Rs.4,000 depends on successful re-installation of certain product supplied to the customer. Closing trade payable is Rs.12,000, which is likely to be settled at 5% discount. Balance of closing cash is Rs.37,100. There is an early repayment penalty for the loan Rs.2,500. Prepare P&L and Balance sheet assuming (i) Going Concern (ii) Not Going Concern 21

22 Profit and Loss A/c for the Year Ended Particulars Case (i) Rs. Case (ii) Rs. Particulars Case (i) Rs. Case (ii) Rs. To Opening Stock 30,000 30,000 By Sales 4,50,000 4,50,000 To Purchases 4,00,000 4,00,000 By Closing Stock 32,000 40,000 To Expenses 14,900 14,900 By Trade Payables To Depreciation 13,000 5,000 To Provision for doubtful debt 2,000 6,000 To Deferred Cost 2,500 10,000 To Loan - 25,000 To Net Profit 19,600 22,200 4,82,000 4,90,600 4,82,000 4,90,600 22

23 Balance Sheet as on Liabilities Case (i) Rs. Case (i) Rs. Assets Case (i) Rs. Case (i) Rs. Capital 60,000 60,000 Fixed Assets 52,000 60,000 Profit & Loss A/c 44,600 47,200 Stock 32,000 40,000 10% Loan 35,000 37,500 Trade Receivables (less provisions) 23,000 19,000 Trade Payables 12,000 11,400 Deferred Costs 7,500 Nil Bank 37,100 37,100 1,56,100 1,56,100 1,51,600 1,51,600 23

24 Consistency Using same accounting policies for similar transactions in all accounting periods. Reason for Changes in Accounting Policies By a Statute By an Accounting Standard For more appropriate presentation 24

25 Accrual Basis of Accounting Transactions are recorded as soon as they occur irrelevant of the amount received/paid. Gives better matching between revenue and cost and profit/loss. More logical approach to profit determination. 25

26 Accrual Basis of Accounting A trader purchased article A on credit in period 1 for Rs.50,000. He also purchased article B in period 1 for Rs.2,000 cash. The trader sold article A in period 1 for Rs.60,000 in cash He also sold article B in period 1 for Rs. 2,500 on credit Prepare P&L on the basis of accrual and cash basis. 26

27 Profit & Loss A/c (Cash) Rs. Rs. Period 1 To Purchase 2,000 By Sale 60,000 To Net Profit 58,000 60, Period 2 To Purchase 50,000 By sale 2,500 By Net Loss 47, PROFIT & LOSS A/C (ACCRUAL) Rs. Rs. Period 1 To Purchase 52,000 By Sale 62,500 To Net Profit 10,500 62,500 62,500 27

28 28 Qualitative Characteristics

29 Qualitative Characteristics 1 Understandability 2 Relevance 3 Reliability 4 Comparability 5 True and Fair view 29

30 30 Elements of financial statements

31 Elements of financial statements 1 Assets 2 Liabilities 3 Equity 4 Income 5 Expenses 31

32 32 Measurement of Elements of Financial Statements

33 Measurement of Elements of Financial Statements Present Value Historical Cost Current Cost Realizable Cost 33

34 Historical Cost Acquisition Price of Asset Liabilities are recorded at the amount of proceeds received in exchange for the obligation. 34

35 Historical Cost Example A machine was acquired in exchange of an old car and Rs. 20,000 paid in cash. The carrying amount of the car was Rs. 1,75,000. The fair value of the car on the date of exchange was Rs. 1,50,000. Give accounting entries. Rs. Rs. Machinery A/c 1,70, Loss on disposal of car A/c 25, To Car A/c 1,75,000 To Bank A/c 20,000 Historical Cost of the Machine = Fair value of car given on exchange + Cash Paid 35

36 Current Cost The amount that would have been paid if the same or equivalent asset was acquired currently. Liabilities are carried at undiscounted amount that would be required to settle the obligation currently 36

37 Current Cost Example A machine was acquired for $10,000 on deferred payment basis. The rate of exchange on the date of acquisition was Rs. 49 /$. The payments are to be made in 5 equal annual installments together with 10% interest per year. The current market value of similar machine in India is Rs. 5 Lakhs. Rs. Rs. Machinery A/c Dr. 5,00,000 To Deferred Payment Obligation 4,90,000 To Revaluation Reserves 10,000 Current Cost of the machine=current Market Price= Rs.5,00,000 By historical cost convention the machine would have been recorded at Rs.4,90,

38 Realizable (Settlement) Value Currently realizable value on sale of the asset in an orderly disposal. Liabilities, the amount to be paid on settlement of liability in the normal course of business 38

39 Present Value Present value of an amount A, after n years is the amount P, one has to invest on current date to have A after n years. If the rate of interest is R then, A = P (1+R) n 39

40 40 Capital Maintenance

41 Capital Maintenance P = ( CA CL ) ( OA OL ) C + D P Profit OA Opening Assets and OL Opening Liabilities CA Closing Assets and CL Closing Liabilities Introduction of capital = C and Drawings/Dividends = D Retained Profit = P D = ( CA CL ) ( OA OL ) C Retained Profit = Closing Equity ( Opening + Capital Introduced) 41

42 Financial Capital Maintenance Historical Cost Current Purchasing Power Physical Capital Maintenance at Current Cost 42

43 Example for Capital Maintenance A trader commenced business on with Rs.12,000 represented by 6,000 units of a certain product at Rs.2 per unit. During the year 2010 he sold these units at Rs.3 per unit and had withdrawn Rs Compute the retained profit under Historical Cost Current Purchasing Power Physical Maintenace 43

44 Financial Capital Maintenance at Historical Costs Rs. Rs. Closing capital ( At historical cost) 12,000 Less: Capital to be maintained Opening capital ( At historical Cost) 12,000 Introduction ( At historical Cost) Nil 12,000 Retained Profit Nil 44

45 Financial Capital Maintenance at Current Purchasing Power Rs. Rs. Closing capital ( At closing Price) 12,000 Less: Capital to be maintained Opening capital ( At closing Price) 14,400 Introduction ( At closing Price) Nil 14,400 Retained Profit (2,400) 45

46 Financial Capital Maintenance at Historical Costs Rs. Rs. Closing capital ( At Current Cost) 12,000 Less: Capital to be maintained Opening capital ( At Current Cost) Introduction ( At Current Cost) Nil 15,000 Retained Profit (3000) 46

47 Lesson Summary 47

48 Thank You