ACCOUNTING NOTES
First Published 6 February 2016
1. Deferred Tax:
a. Deferred Tax is a concept that arises due to the timing difference between the accounting of income and expenses as per GAPP and Tax laws.
b. It is recognized that Accounting Profit should record the Tax impact on the Accounting Profit in the year it is earned, and if the Tax profit is lower, then the unpaid Tax should be treated as Deferred Tax Liability.
c. The above results mostly in the cases of Depreciation and Annual Charge difference. While the Depreciation is normally on the expected life of the assets and charged on the Straight line method, the Annual Charge (Depreciation under the Income Tax Act) is charged on given rates, and normally under Diminishing Balance Method.
d. During the life of the asset, Depreciation under both systems will be the same, but initial years will see enhanced allowance under Income Tax Act whereas in later years the same will be reduced. Thus, the portion of the Depreciation charge as per accounting practices in initial years which the Income Tax allows as an enhanced deduction, the Income-tax is deferred to later years and this is Deferred Tax Liability.
e. When a business incurs losses, such losses are carried over to future years for adjustment against the profits thereby reducing the tax liability of that future year. Thus, the tax benefit that business is expected to derive in the future due to loss in the current year is a Deferred Tax Asset.
2. Prepaid expenses / Prepayments
a. Prepaid expenses are expenses that are paid in cash before the balance sheet date but the benefit of the same is derived in the following accounting year. Following the basic accounting concept of Matching Concept, such expenses are treated as Prepaid expenses and are amortized during the period to which the expenses relate.
b. The most common example of Prepaid is Insurance premiums, Municipal License fees, Lease Rentals (operating).
c. For illustration, the Municipal License fee paid for the calendar year, but the balance sheet date is mid of the year, say 30th June. In such a case, half of the Municipal License fee is amortized half before 30th June and the balance in the next accounting year.
d. In the cases where the organizations are drawing monthly/quarterly accounts, they conduct this exercise for every such period.
3. Assets
a. Assets are the expenditures by the organizations whose benefits are destined to be derived much beyond the accounting year in which they are paid. Normally, assets represent rights of the organization which have defined and ascertained future economic value.
b. Tangible assets are the real assets that are created to exist for much longer and have defined economic lives. Buildings, land, plants are examples of tangible assets. These assets are written off during their economic lives and are also revalued at times due to substantial and measurable increase/decrease in the economic value of the assets. Normally, an increase in valuation is taken to the Balance Sheet as Revaluation Reserve and is treated as part of Net Worth whereas if there is any impairment, then the impairment loss is written off in the income statement, after adjusting any existing revaluation reserve.
c. Intangible assets are not real assets, but whose valuation are derived due to business turnover and brand building and includes Goodwill, Patent etc. These are also sold at valuations mutually agreed and purchased Intangible are also written off in accounts.
d. Actionable claims are claims against trading partners or other institutions created during the business, due to Sales or investment.
e. Actionable claims against others arising out of normal trading is called Accounts Receivable or Sundry Debtors.
f. Where a business entity is having liquid funds which it can invest outside, then it does so and these actionable claims are investment outside for earning interest/dividend.
g. Securities purchased out of such funds are also traded in the market and price fluctuation results in gains or losses.
h. Investments are classified as Held to Maturity, (Non-current) or Held as stock (current).
i. Asset accounting has gained importance due to the enormity of funds involved in the creation of assets which makes the control over the assets mandatory. Besides, a business can look forward to sustaining the market on a long term basis only if it keeps eye on its assets for the purpose of renewal and replacement also and that increases the importance of the Asset Accounting as a separate stream itself which becomes part of the Financial Statements.
j. IFRS requires impairment exercise to be done a continuous basis and it is prudent for the entities to do revaluation also as the historical value in Financial Statements is unable to reflect to the true value of the assets.
4. Reconciliation
a. Accounting is a historical record of the transaction in a business entity and since transactions are always between two or more parties, all persons involved in transactions do their own accounting, and invariably, there is some timing difference in the time of recording of the transaction.
b. The need of finding out the differences in the balances of two such entities is called reconciliation.
c. The entities can be different organizations or even separate departments of offices within the same organization, separated either functionally or geographically.
d. The Reconciliation lists all the items which are causing the difference in balances shown by two mutually dealing entities and such items are at times called open items.
e. The entities have either to take effect of such items in their books after reconciliation or have to take up the resolution of outstanding items with the other entity involved.
f. After one of the entities involved makes an entry of such an open item in its books, the items are closed.
g. Example of such reconciliation exercise are numerous, predominantly by an entity doing Bank Reconciliation, AR/AP reconciliation, Inter Branch reconciliation, and a lot of it
5. Manufacturing Accounting
a. Manufacturing accounting deals with huge data which need to be consolidated to present valuation of each and every process or part of it to enable the entity to identify the operational efficiency of each such part. While at the Macro Level, manufacturing accounting ends in Trading and Profit and Loss Account, at a micro level, it includes cost accounting, cost center/profit center accounting, inventory accounting, raw material accounting, Work in Progress Accounting, finished good accounting, waged and direct expense allocation and indirect expenses allocation, identifying and allocating variable and fixed expenses, as also semi-variable It involves matching the revenue for each accounting period
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