E-LESSON-3, 4

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M.B.A 2 All right are reserved with CU-IDOL FINANCIAL REPORTING AND ANALYSIS Course Code: MBA604 Semester: 1 SLM UNITS : 3&4 E-Lesson: 2 www.cuidol.in Unit-3 & 4 (MBA604)

UNDERSTANDING FINANCIAL 33 STATEMENT OBJECTIVES INTRODUCTION Student will be able to : In this unit we are going to learn about the nature of items within financial statement. Understand the requirement for preparing financial statement.. Explain the meaning of assets and classify Under this unit you will also understand the different types of assets.. purpose for which financial statement are being prepared. Understand the salient features of new AS10 and Ind AS16 with respect to property, plant and This Unit will also make us to understand the equipment Uses of financial statement. Calculate depreciation expense using different methods. www.cuidol.in Unit-3 & 4 (MBA604) INSATIlTl UrTigEhOt FarDeISrTeAsNerCvEeAdNwDithONCLUIN-IEDOLELARNING

TOPICS TO BE COVERED > Definition & Characterstics of Assets. 4 > Objectives of Asset Valuation. > Types of Assets > Lease > Accounting problems if long term assets. > Nature of depreciation & depreciation methods > Degree of acceleration in depreciation methods > Disposal of fixed assets > Evaluation of accelerated method > Factors influencing the selection of depreciation method www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

DEFINITION Financial Accounting has basic elements like assets, liabilities, owner's equity, revenue, expenses and net income (5or net loss) which are related to the economic resources, economic obligations, residual changes and interest in them. Similarly, balance sheet which displays financial position of a business enterprise, has basic elements like assets, liabilities and owners equity. Assets denote economic resources of an enterprise that are recognized and measured in conformity with generally accepted accounting principles. Assets also include certain deferred charges that are not resources but that are recognized and measured in conformality with generally accepted accounting principles. The Institute of Chartered Accountants of India defines assets as - “tangible objects or intangible rights owned by an enterprise and carrying probable future benefits” www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

CHARACTERSTICS OF ASSETS 6 Assets have the following main characteristics: i. Future economic benefits. ii. Control by a particular enterprise. iii. Occurrence of a past transaction or event. iv. Assets may be acquired at a cost and they amy be tangible, exchangeable or legally enforceable. www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

OBJECTIVES OF ASSET VALUATION 7 FINANCIAL STATEMENT i. Income determination ii. Determination of financial position. iii. Managerial decisions - asset valuation concept a) historical cost b) replacement cost(currently entry price) c) current exit price(net realizable value) d) present value of expected cash flows www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

TYPES OF ASSETS (AS10) 8  FIXED ASSETS: are tangible assets and refer to a firm’s property, plant and equipment. These are tangible items that : a) are held for use in the production or supply of goods and services, for rental to others, or for administrative purposes; b) are expected to be used during more than a period of 12 months.  INVESTMENTS: are created by a firm through purchase of shares and other securities. www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

TYPES OF ASSETS 1) INTANGIBLE ASSETS: do not have physical substance but they are the resources that benefits and 9 enterprise’s operations. As stated, intangible assets are of different types such as : a) goodwill b) patents c) copyrights d) trademark e) franchises f) deferred charges 2) CURRENT ASSETS: include cash and assets that will be converted into cash or used up during the normal operating cycle of the business or one year, whichever is longer. Within the classification of current assets, one typically finds the followings: a) cash b) receivable c) marketable securities d) inventories e) prepaid expenses www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

LEASE 10 A business firm, while deciding to procure fixed assets, can use any of the following choices to use the asset: i. By purchasing the fixed asset whether with owned or loaned funds; ii. By purchasing fixed asset on instalment basis; iii. By purchasing on hire purchase basis; iv. By getting the asset on lease. The lease is an agreement whereby the lessor transfer to the lessee, in return for rent, the right to use an asset for an agreed period of time. Lessor is a person, who under an arrangement, provides to another person. The lessee, the right to use an asset for an agreed period of tune in return for rent. As per the agreement, the lessor remains the owner of the leased goods whereas lease, for all practical purposes, is the user of the asset. www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

LEASE TYPES OF LEASE: The AS19 titled ‘lease’ issued by the Institute of Chartered Accountant of India mentions two 11 types of leases: A. FINANCE LEASE - the following are the features of finance lease  The lessor transfers the title to the lessee at the end of the lease period at the price agreed at the beginning of the lease.  The lessee has the option to buy the asset at the end of the lease period.  The lease cannot normally be cancelled.  The full cost of the asset will generally be rapid by the lessee to the lessor.  Lessee is responsible for insouciance and maintenance of the asset.  Lessee has the right for uninterrupted use of the asset till lease payment is made.  At the end of the lease term the lessor can take back the possession of the asset from the lessee or there can be a purchase or renewal option. www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

LEASE B. OPERATING LEASE: 12 All right are reserved with CU-IDOL The following are the circumstances:  When the lease transfers ownership of the asset to the lessee by the end of the lease term.  When the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value of the asset at the date, when such option is to be exercised.  The lease tern is for major part of economics life of the asset even if title is not transferred.  When at the inception of the lease the present value of the minimum lease payments amount to at least substantially the fair value of the leased asset; and  When the leased asset is of a specialized nature and only the lessee can use it without the major modifications being made. www.cuidol.in Unit-3 & 4 (MBA604)

ACCOUNTING PROBLEMS IN LONG –TERM 13 ASSETS  Basically, there are two problems relating to accounting of long-term assets. • First, what is the original acquisition cost of a particular long-term asset? • Second, how, should the amount of expense or periodic write-off be determined to allocate it against yearly revenue to reflect the asset’s consumption.  The other related issues are how should subsequent expenditures such as repairs, maintenance and additions be treated, how should disposal of long-term assets be recorded. www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

NATURE OF DEPRICIATION 14 DEPRICIATION: “Depreciation is a measure of the wearing out, consumption or other loss of value of depreciable asset arising from me, effluxion of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortization of assets whose useful life is predetermined” ---------- ICAI To determine the amount of depreciation three main items needed: i. Actual acquisition cost ii. Estimated net residual value iii. Estimated useful life. www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

DEPRECIATION METHODS 15 THERE ARE BASICALLY TWO MAIN METHODS OF DEPRECIATION: 1) Straight-line method 2) Accelerated method a) written down value method also known as diminishing balance method b) sum of the years digit method c) double decline method Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL www.cuidol.in

DEPRECIATION METHODS STRAIGHT LINE METHOD: 16 With the straight line depreciation method, the value of an asset is reduced uniformly over each period until it reaches its salvage value. Straight line depreciation is the most commonly used and straightforward depreciation method for allocating the cost of a capital asset. It is calculated by simply dividing the cost of an asset, less its salvage value, by the useful life of the asset. Straight Line Depreciation Formula The straight line depreciation formula for an asset is as follows: www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

DEPRECIATION METHODS 17 Accelerated depreciation It is a depreciation method whereby an asset loses book value at a faster rate than the traditional straight-line method. Generally, this method allows greater deductions in the earlier years of an asset and is used to minimize taxable income. The following methods are known as accelerated methods of depreciation: i. Written down value method also known as diminishing balance method. ii. Sum of the years digit method. iii. Double declining method. Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL www.cuidol.in

DEGREE OF ACCELERATION IN DEPRECIATION 18 METHODS The degree of accelerations depends upon the method of providing depreciation, viz., straight line, diminishing balance or sum of the year digits methods. The following table provides a comparative view of the pattern of write- off of the cost of an asset under simple and accelerated methods, viz., written down value, straight line and sum of the year digits method. www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

DISPOSAL OF FIXED ASSETS 19 A business enterprise may sell a fixed asset or trade in on the purchase of new plant and equipment if the asset is no longer useful in the business. In this case, depreciation must be recorded up to the disposal date; regardless of the manner of the assets disposal. whenever sale of plant or any other fixed asset takes place, there are likely to the three possibilities: i. Sale of the fixed asset for more than book value; ii. Sale of the fixed asset for lss than the book value; iii. Sale of the fixed asset exactly equal to its book or carrying value. In the first case, the sale proceeds exceeds the carrying value of the asset and thus, gain(difference between the sale proceeds and carrying value) is recorded and added to net income of the period. In the second case, since the sale proceeds are less than the carrying value, the loss will be recorded and deducted from the net income of the period. In the third case, there is neither gain or loss. www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

EVALUATION OF ACCELERATED METHODS 20 1) Cash flow 2) Tax advantage 3) Benefits of growing company 4) Replacement of assets www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

FACTORS INFLUENCING THE SELECTION 21 OF DEPRECIATION METHOD 1) Legal provisions 2) Financial reporting 3) Effect on managerial decisions 4) Inflation 5) Technology www.cuidol.in Unit-3 & 4 (MBA604) 6) Capital maintenance All right are reserved with CU-IDOL

SUMMARY Definition and Characteristics of Asset :Financial Accounting has basic elements like assets, liabilities, owner's 22 equity, revenue, expenses and net income (or net loss) which are related to the economic resources, economic obligations, residual changes and interest in them. Objectives of Asset Evaluation : i. Income determination ii. Determination of financial position. iii. Managerial decisions - asset valuation concept Types of Assets : Tangible, Intangible Lease and its types : The lease is an agreement whereby the lessor transfer to the lessee, in return for rent, the right to use an asset for an agreed period of time. Lessor is a person, who under an arrangement, provides to another person.The lessee, the right to use an asset for an agreed period of tune in return for rent Depreciation : “Depreciation is a measure of the wearing out, consumption or other loss of value of depreciable asset arising from me, effluxion of time or obsolescence through technology and market changes. Types of Depreciation :  Straight line Method  Written down value Method www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

MULTIPLE CHOICE QUESTIONS Q1. Which of the following is an essential characteristic of an asset? 23 a) The claim to an assets benefits are b) An asset is tangible legally enforceable d) An asset provides future benefits c) An asset is obtained at a cost Q2. As generally used in accounting, what is depreciation? a) It is a process of asset valuation b) It applies only to long-lived intangible assets for balance sheet purposes d) It is an accounting process which allocates long-lived c) It is used to indicate a decline in asset cost to accounting periods market value of a long lived asset Q3. Which of the following statements is the assumption on which straight line depreciation is based? a) The operating efficiency of the asset b) Service value declines as a function of time decreases in later years rather than use c) Service value declines as a function d) Physical wear and tear are more important than of obsolescence rather than time economic obsolescence Ans: 1 (d) 2. (d) 3.(b) Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL www.cuidol.in

FREQUENTLY ASKED QUESTIONS Q1. Define Assets. What are the characteristics of Assets 24 Ans. The Institute of Chartered Accountants of India defines assets as - “tangible objects or intangible rights owned by an enterprise and carrying probable future benefits” Assets have the following main characteristics: i. Future economic benefits. ii. Control by a particular enterprise. iii. Occurrence of a past transaction or event. iv. Assets may be acquired at a cost and they may be tangible, exchangeable or legally enforceable. For further detail Refer to SLM Q3. What are the different types of intangible assets? What are the factors influencing the selection of depreciation method Ans. Intangible assets are of different types such as - a) goodwill b) patents c) copyrights d) trademark e) franchises f) deferred charges. i) Legal provisions ii) Financial reporting iii) Effect on managerial decisions iv) Inflation v) Technology vi) Capital maintenance For further detail Refer to SLM www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

REFERENCES 25  Accounting Principles Board, Statement No 4, Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises, NewYork: AICPA, 1970, p.50  Financial Accounting Standards Board, Concept No 6, Elements of Financial Statements, Stamford: FASB, December 1985, p 35  The Institute of Chartered Accountants of India, Guidance note on Terms Used in Financial Statements, New Delhi, ICAI September 1983, p. 19  Ahmed Belkaoi, Accounting Theory, Thomson Learning, 2000, p. 168  Eldon S Hendriksen, Accounting Theory, Irwin, 1984, p. 459  American Institute of Certified Public Accountants, Accounting Research Bulletin, No 43, AICPA, 1968. www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL

26 THANK YOU For queries Email: [email protected] www.cuidol.in Unit-3 & 4 (MBA604) All right are reserved with CU-IDOL