chapter 4 accruals accounting
Post on 05-Jan-2016
67 Views
Preview:
DESCRIPTION
TRANSCRIPT
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
CHAPTER 4Accruals accounting
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Contents Accruals basis of accounting Credit transactions Recognition of revenue Period costs Inventories and profit measurement Accounting techniques Manufacturing accounts Net realisable value Working capital
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accruals basis of accounting
Accruals are those costs and revenues which distinguish profit from net cash flow
Accounting needs to capture all the economic events when they take place, and the cash movement is usually only part of the picture of an economic event
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Allocation of revenue and expenses - Example
Case 115/12 purchase
(delivery) five washing machines (cost €300 each)
06/1 washing machines sold on credit for €400 each
18/1 receipt of customer
31/1 payment of supplier
Case 215/12 purchase (delivery)
five washing machines (cost €300 each)
20/12 washing machines sold on credit for €400 each
18/1 receipt of customer31/1 payment of supplier
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IASB - Accruals
“In order to meet their objectives, financial statements are prepared on the accrual basis of accounting. Under this basis, the effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. Financial statements prepared on the accrual basis inform users not only of past transactions involving the payment and receipt of cash but also of obligations to pay cash in the future and of resources that represent cash to be received in the future. Hence, they provide the type of information about past transactions and other events that is most useful to users in making economic decisions.”
IASB, Framework for the Preparation and Presentation of Financial Statements, par.22
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accrual accounting
Two fundamentals: Revenue recognition rules Matching principle
Revenue and expenses relating to the same business transaction should be recognized in the same accounting period (the period when the transaction took place)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Credit transactions
Purchase and sale of goods frequently take place on credit, i.e. cash payment follows delivery often with a delay of 30 to 60 days
Suppliers and customers trading on ‘open account’
Credit terms may lead to tension between financial management and procurement / marketing
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Purchases on credit
1. Purchase inventory on credit
2. Settle debt to supplier
Assets = Liabilities + Equity
+ Inventory 100 = + Debt to supplier 100
- Cash 100 = - Debt settlement 100
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Purchases on credit
0–100+100SuppliersLiabilities
+100+100Inventory–100–100Cash
AssetsFinal21
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Definition of creditor
A creditor is an individual or another company to whom the firm owes money.
Examples of creditors: Trade creditors:
Suppliers of raw materials, other inventories, equipment and services which are purchased in the course of business for resale, for which payment has not yet been made.
Other creditors: Amounts owing to outsiders for various other reasons, such as interest payable; usually routine recurring debts for services and supplies ancillary to trading operations.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounts payable ledger General ledger carries an account which
aggregates all the amounts owed to suppliers Subsidiary ledger (‘accounts payable ledger’)
duplicates all the movements on the total supplier account (a ‘control account’) but holds a separate account for each supplier with all details of purchases and payments
The sum of all individual balances in the subsidiary ledger should equal the amount in the corresponding general ledger control account
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Sales on credit
1. Sale – recognition of revenue
2. Receipt from customer
Assets = Liabilities + Equity
+ Receivable 200 = + Revenue 200
- Receivable 200 + Cash 200 = 0
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Sales on credit
Profit or lossEquity
0 –200+200Receivables
+200+200CashAssets
Final21
+200+200Sales
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounts receivable ledger General ledger carries an account which
aggregates all the amounts due from customers Subsidiary ledger (‘accounts receivable ledger’)
duplicates all the movements on the total customer account (a ‘control account’) but holds a separate account for each customer with all details of sales and receipts
The sum of all individual balances in the subsidiary ledger should equal the amount in the corresponding general ledger control account
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Revenue recognition
Definition of revenue Revenue versus gains Timing of revenue recognition Long-term contracts
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Defition of revenue
IAS 18 Revenue
"Revenue is the gross inflow of economic benefits in the period arising in the course of the ordinary activities of an entity when these inflows result in increases in equity, other than increases relating to contributions from equity participants "
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Revenue versus gains
Income = an inflow of economic benefits during the period that result in increases in shareholders’ equity
= Revenue + Gains Revenue is income that arises in the
course of the ordinary activities of the company
Revenues are reported as gross amounts, gains are reported net of related expenses
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Timing of revenue recognition
Revenue is recognised in income statement when it is ‘earned’ Implies a certain degree of
performance on part of supplier Critical event to decide that earning
process is complete? Timing of revenues becomes an
issue
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Typical revenue cycle for the sale of goods
1) Customer places order
2) Sales order is recognized after credit approval and inventory check
3) Goods ordered are shipped to customer
4) Customer accepts delivery of goods
5) Sales invoice is prepared and sent to customer
6) Customer pays invoice
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 18 - Revenue Most critical event criteria:
the company has transferred the significant risks and rewards of ownership of the goods to the buyer
the company has neither managerial involvement nor effective control over the goods
In most cases fulfilment of these criteria coincides with the transfer of legal title, or the passing of possession to the buyer, which
normally takes place at delivery
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Sale of Goods – Complete list of recognition criteria (IAS 18)
1. The significant risks and rewards of ownership of the goods have been transferred to the buyer
2. The seller does not retain control over the goods, neither does he retain continuing managerial involvement incidental to ownership
3. The amount of revenue can be measured reliably4. It is probable that the economic benefits associated
with the transaction will flow to the seller, and5. The costs incurred or to be incurred in respect of the
transaction can be measured reliably
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Long-term contracts Recognise revenue by reference to the stage
of completion of the transaction at the balance sheet date, provided that revenue, related costs and progress can be measured reliably.
= ‘Percentage-of-completion method’ (in contrast to the ‘completed-contract method’).
This method uses the amount of services performed within the single accounting period as a percentage of total services to be performed as a base for allocating revenue, irrespective of cash payments
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Period costs Time-based expenses (associated with a
certain accounting period) which are not traceable to any specific revenue generating transactions
Overhead costs of head office activities Insurance costs
These costs should be allocated in a systematic way among the accounting periods in which the business benefits from these costs
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Inventories and profit measurement
Treatment of inventories Cost of goods sold Calculation of inventory value Relevant costs
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Treatment of inventories
The treatment of inventories in the accounting system is one of the most straightforward applications of the matching-principle of revenue and expenses
Inventories (assets) are ‘expensed’ when the goods are actually sold and revenue is recognised
IAS 2 Inventories
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Inventory categories
Categories of inventory Goods purchased for resale Raw materials and consumables Work in progress Finished goods
We will first treat “goods purchased for resale” and extend to other categories later
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cost of goods sold
The cost of goods sold is the amount paid by the company for the goods it sold to customers in the accounting period
Gross profit = Sales – Cost of goods sold
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cost of goods sold (cont.)
Inventory available at 1/1/X1 XXX
plus goods purchased during year XXX
Goods available for resale in 20X1 XXX
less cost of inventory on hand 31/12/X1 XXX
= Cost of goods sold during year XXX
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Calculation of inventory value
Periodical inventory measurement (valuation) as a pragmatic approach
Opening inventory+ Purchases during the period- Closing inventory to be
determined= Cost of goods sold
How to attach individual costs to inventory items?
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Relevant costs Purchase price as appropriate reflection of
the inventory asset – two considerations:1. Inventory measure should not overstate the
value of the inventory Risk of overstating inventory values when prices
fluctuate rapidly Net realizable value
2. Value increments in addition to purchase price IAS 2 Inventories specifies the notions of
“purchase cost” and “cost of inventory”
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Purchase cost Purchase cost =
Purchase price+ import duties / other non-recoverable
taxes+ transport / handling costs+ other costs directly attributable to
acquisition- trade discounts / rebates
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cost of inventory Cost of inventory =
Cost of purchases+ costs of conversion+ other costs incurred in bringing the inventory
to the present location and condition Does not include wastage, administrative
overheads and selling costs Conversion costs relate to manufacturing
processes
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting techniques Continuous inventory Measurement methods that rely on
assumptions about inventory movements (but do not increase inventory value by adding in any associated costs)
Methods used where the inventory value of goods for resale includes costs other than the initial purchase price
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Continuous inventory
Individual goods are valued at the actual cost of acquiring them
Used in a business dealing in a small volume of high-value items which are not homogeneous
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting assumptions Inventory value is determined on the basis of
assumptions about inventory movements Assumptions are used to allocate the costs of
inventory items between the cost of goods sold (expense) and the inventory asset carried forward to the next year
Not necessarily identical to actual physical inventory movements
Three generally accepted systems within a historical cost framework FIFO, LIFO, weighted average
Principle of consistency!
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
FIFO
First In First Out Assumes that the first item to be
sold will be the first item delivered to the stores
Inventory is measured at the most recent prices
Consistent with good housekeeping
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
LIFO
Last In First Out Assumes that the first item to be
sold will be the last item delivered to the stores
Inventory is measured at the oldest prices
Banned by IAS 2 as from January 1, 2005
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Weighted average
Cost of goods sold is measured based on the average cost of all the items of that type which are on hand at the time of sale
A new average is computed each time a sale takes place
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Example inventory valuation rules (1)
Inventory of video cameras01/1 Number of items in inventory = 007/1 Purchase of 20 items at 100015/1 Purchase of 30 items at 120027/1 Sale of 40 items at 150031/1 Inventory valuation and profit
calculation
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Example inventory valuation rules (2)
31/1 Closing inventory = 10 items Number sold = 40 items
Weighted average 20 x 1000 + 30 x 1200 = 1120/ item 50
40 items sold 40 x 112010 items in closing inventory 10 x 1120
FIFO40 items sold 20 x 1000
20 x 120010 items in closing inventory 10 x 1200
LIFO40 items sold 30 x 1200
10 x 100010 items in closing inventory 10 x 1000
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Manufacturing accounts Matching principle: all costs of manufacturing a
product should be recorded as an asset until the moment the product is sold
Distinction between direct costs and overhead (indirect costs) Direct costs: raw material, labour cost,… Overhead: supervisory production staff, cost of factory
building, cost of general management,… IAS 2: Cost of inventory includes a systematic
allocation of production overheads that are incurred in converting materials into finished goods
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Net realisable value
Inventory is valued at historical cost unless its net realisable value (NRV) is lower
NRV = net amount that a company expects to realise from the sale of inventory in the ordinary course of business
Inventory value is written down to NRV, if NRV < historical cost
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Net realisable value (cont.) The amount of any write-down of
inventories to net realisable value will be recognised as an expense in the period the write-down occurs
Net realisable value is an entity-specific value Takes into account the specific purpose for
which the inventory is held by the company (specific sales contracts, expected use in the production of finished goods)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 2 – Net realisable value
6. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
9. Inventories shall be measured at the lower of cost and net realisable value.
34. When inventories are sold, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised. The amount of any write-down of inventories to net realisable value and all losses of inventories shall be recognised as an expense in the period the write-down or loss occurs. The amount of any reversal of any write-down of inventories, arising from an increase in net realisable value, shall be recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs.
Source: IAS 2 - Inventories
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Working capital Accrual accounting leads to a number of short-
term assets and liabilities which are linked to the operating cycle (or working capital cycle): trade payables, trade receivables, inventories, ...
The working capital cycle is the average time it takes to acquire materials, services and labour, manufacture the product, sell it and collect the proceeds from the customers
It stresses the economic link between current assets and current liabilities
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Figure 4.1 - The working capital cycle
Inventory
Production Sales
ReceiptsPayments
Purchases
Trade payables
InventoryTrade
receivables
Cash
top related