UNIT II

Business Income

2.1 Accounting for Non-Profit Organisations

Meaning, Characteristics and Accounting of non-profits

A non-profit organization is an organization established for the purpose of social welfare and the promotion of social arts and culture. These are usually founded as charities with a motive for service. The trustee manages these organizations. Members of the organization elect a trustee. Non-profits raise funds from their members and the general public to achieve their goals.

The main motivation for these organizations is to provide services. But they may eventually benefit. In general, these organizations do not manufacture, buy, sell, or provide services for goods. Therefore, they do not need to prepare trading and P & L A / c. They credit the funds they receive to the Capital Fund or the General Fund A / c.

Accounting for non-profit organizations

As we know, non-profits do not trade goods or provide profitable services. However, they also need to keep good records of income, expenses, assets, and liabilities. Their main sources of income are donations, subscriptions and grants. Therefore, most of their transactions are done through cash or bank accounts.

Appropriate books, firstly because members and contributors are accountable, and secondly because the law requires the government to maintain adequate books so that they can manage grants appropriately. Must be maintained. Proper accounting also reduces the risk of fraud and embezzlement. In addition to your ledger and cash book, you also need to maintain an inventory ledger. The stock ledger also maintains a complete record of all fixed assets and consumables.

In non-profit accounting, instead of maintaining Capital A / c, these organizations maintain Capital Fund or General Fund A / c. They deposit surpluses, lifetime membership fees, donations, heritage, etc. into this account.

Non-profits are also required to prepare final accounts or financial statements at the end of the fiscal year in accordance with accounting principles. The final account for these organizations consists of:

Receipts and payments A / c: An overview of cash and bank transactions. This will help you create a balance sheet A / c and a balance sheet. You must also submit it to the Social Registration Bureau along with your balance sheet A / c and balance sheet.

Balance A / c: Similar to P & L A / c, check for any surplus or deficiency.

Balance Sheet: Create in the same way as the balance sheet for profit motivation concerns.

Example

Ashraya is an organization working to improve and improve the welfare of street children. It sponsors their food and clothing. We also provide basic education to children. Its sources of income are donations, subscriptions and government grants. Identify the type of organization that states the reason. Also mention the accounting procedures you should follow.

Solution:

Ashraya is a non-profit organization. It works for the well-being of children and society. The sources of income are donations, grants and subscriptions from members. Therefore, it is clear that it works for service purposes, not for commercial purposes.

However, non-profits also need to maintain proper accounting books. Financial statements help to win donations from current and future contributors. Financial statements also help you receive grants from various authorities.

Below are the financial statements they prepare at the end of the year.

1. Receipts and payments A / c
2. Balance A / c
3. Balance sheet

Characteristics or characteristics of non-profit organizations

Entity: There is a separate legal entity promoted by an individual.

Purpose: To promote cultural, educational, religious and professional purposes and to serve the general public.

Ownership: Established as a charity or trust. Therefore, it is owned by an individual or a group of individuals.

Financial Statements: Every year, we prepare financial statements that include balance sheets, balance sheets, and balance sheets.

Funds: The members and donors will provide the necessary items for operation as admission fees, membership fees, subscription fees, and donations. It is supplemented by surplus from the business.

Receipts and payment accounts: An overview of cash and bank transactions over a specific period. Created from a cashbook at the end of the fiscal year. All cash receipts are entered on the debit side and all cash payments are entered on the credit side.

Feature:

1. An overview of cash and bank transactions
2. You can infer that receipt and payment accounts are similar to cash accounts
3. No distinction is made between capital and revenue items, and all non-cash items are excluded.
4. Records all cash and banking transactions, whether related to the current period, the previous period, or the next period.

Format of Receipts and payment Account

Features:

1. This is a revenue account created to determine a surplus or deficit at the end of the accounting period.
2. Period costs and revenues are collated to determine a deficit or surplus.
3. Both cash and non-cash items are considered.
4. The surplus of this account will not be distributed to the members, but will be added to the capital stock.
5. Excess income for spending is in the black and excess expenditure for income is in the red.

Format of Income and Expenditure

Example 1:

Create a balance account for the same period from the following balance accounts for the year ending March 31, 2017 at People's Club.

Receipt and Payment Account

Dr.                                                                                                                                  Cr.

The following information is available:

1. Unpaid salary
2. Unpaid entertainment expenses
3. Bank interest income
4. Incurred subscription
5. Capitalize 50% of admission
6. Furniture is depreciated at an annual rate of 10%

Solution:

Income and Expenditure A/C

Balance sheet overview

Balance preparation for non-trade or non-profit concerns is the same as balance sheet preparation for trading companies. You have all the liabilities and assets as of the date the organization created the balance sheet. Excess assets that exceed liabilities are called capital funds or general funds. Creating a balance sheet for non-profits.

Non-profit Balance Sheet: General Financial Resources

For non-profits, capital is accumulated during the year along with receipts and receipts of capital capitalized by further increasing the surplus or reducing the deficit. At the beginning of non-trading concerns, there is no formal capital fund. In such cases, the surplus earned that year constitutes a year-end capital fund.

Non-profit balance sheets are created in the same way as companies do. Organizational assets are recorded on the right and liabilities are recorded on the left. Non-profits do not use the term capital. Instead, general or cumulative funds are displayed on the balance sheet.

NPOs may also create special funds such as prizes and match funds. Its purpose is to meet the costs associated with the purpose for which it was created. The amount of income invested from these funds is generated only in the funds, not in the balance account.

Accounting for general financial resources and preparation of balance sheet

1. Creating a balance sheet begins with general financial resources. You need to add each surplus or deficit to the amount.
2. In addition, add a lifetime membership fee or heritage at this stage.
3. Place all fixed assets on the asset side of the balance sheet.
4. Introducing the amount paid in advance and the unpaid amount on the asset and liability side.
5. Post the closing balances of assets and liabilities to each side of the balance sheet.
6. To calculate the amount of a fund, subtract the value of total liabilities from the value of assets.

Let's understand the format of the non-profit balance sheet from the following figure, which we will consider in the below question.

Example 2

How do you view your subscription amount on your non-profit balance sheet from the following Receipt and Payment accounts and additional information?

Additional Information:

1. Unpaid subscriptions from the previous year Rs.2000
2. Unpaid subscriptions for this year Rs.1500
3. Subscriptions are Rs received in advance at the end of the previous year. 1000
4. Subscription is Rs received in advance at the end of this year. 1200

Solution:

Start of Balance Sheet

Closing the Balance Sheet

Example 3

Calculate sports material debited to Income & Expenditure a / c. Yearly. It ended on March 31, 2007, based on the following information. The amount paid for sports material during the year. It was Rs.19,000

1. Rs.20300            
2. Rs.20700
3. Rs.20000
4. Rs.20500

Solution:

Option 2. Rs.20700

Description: Amount debited to income and expenditure as consumption of sports materials = payment amount + starting inventory-ending inventory-starting creditor + ending creditor. Amount debited to income and expenses = 19000 + 7500-6400-2000 + 2600 = Rs. 20,700

Example 4

The non-profit has received Rs.10,000 as an admission fee for new members. If 20% of the fee needs to be capitalized, what is the amount of the fee that needs to be displayed in the balance account?

1. Rs.9000
2. Rs.8000
3. Rs.2000
4. Rs.5000

Solution:

Option 2 Rs.8000

Description: These are the fees collected from all members upon enrolment in membership. Once you become a member of society or a club, you will only be paid once by new entrants. It is treated in two ways: -when capitalized, it appears on the debt side's balance sheet. -If it is considered a receipt for income, it will be displayed in the income and expenditure account on the income side. Therefore, Rs. 20% means Rs. 2000 (10,000 * 20%) appears on the balance sheet on the debt side and the balance of Rs. 8000 is displayed in the income and expenditure account on the income side.

Example 5:

Prize Rs.10000, Prize Investment Interest Rs.1000, Prize Payment Rs.2000, Prize Investment Rs.8000. What will happen to that treatment?

1. Rs.20000, Rs on the debt side. 8000 on the asset side
2. Rs.1000, Rs on the responsible side. 8000 on the asset side
3. Responsible side Rs.1700, Rs. 8000 on the asset side
4. Rs.9000, Rs on the debt side. 8000 on the asset side

Solution:

Option 4. Rs.9000, Rs on the debt side. 8000 on the asset side

Description: The balance sheet calculation looks like this: -Prize-9000 Addition: -Interest 1000 deduction for prize investment: -Prize payment 2000 Debt side amount = Rupee. 9000 prize investment Rs. 8000 is displayed on the asset side.

Example 6

Bell, a non-governmental non-profit organization, received special pledged funding from a donor to another non-governmental non-profit medical organization during its annual campaign. How does Bell need to record these funds?

1. Increased assets and increased profits
2. Increased assets and increased liabilities
3. Increased assets and increased deferred income.
4. Decrease in assets and decrease in funds balance.

Solution:

Option 2. Increased assets and increased liabilities

Description: Bell, a non-governmental NPO, is responsible for the funds for the annual campaign and is recorded on the balance sheet. And if the organization pledges this fund to another non-governmental NPO, it becomes a property of the Bernon government. Organisation recorded on the asset side of the balance sheet.

Example 7

From the information below, we will calculate the amount of stationery that will be posted to the Income and Expenditure account of the Cultural Association of India for the year ending March 31, 2018.

Stationery purchased in the year ended March 31, 2018 was Rs 75,000. Also, please present relevant items on the social balance sheet as of March 31, 2018.

Solution:

Stationery Account

Balance sheet as of March 31, 2018

Example 8

From the information below, we will calculate the amount of the subscription that will be credited to the 2007-2008 balance account.

Solution:

Example 9

Find out the cost of drugs consumed in 2015-16 from the following information:

Solution:

Example 10

From the following receipt and payment accounts for the Cricket Club and the additional information provided, prepare the balance sheet for the year ending December 31, 2018 and the balance sheet for that date.

Receipt and Payment Accounts

Year ending December 31, 2018

Additional Information:

1. Unpaid salary is rupees. 1000.
2. The initial balance of the stock of stamps, stationery and cricket gods is Rs. 3210 each for 750 rupees. The same closing price is Rs. 900 and rupees. 2800 each.
3. Unpaid subscriptions for 2017 and 2018 are Rs. 6600 and Rs. 8000 each.

Solution:                   

Cricket Club Income and Expenditure Account

Year ended December 31, 2018

Balance sheet

As of December 31, 2018

Key takeaways:

1. Organizations and businesses need to evaluate the trade-offs of becoming a tax-exempt non-profit organization or for-profit business.
2. Non-profit organizations represent a variety of organizations, including places of worship, campus societies, public school foundation boards, chambers of commerce, and non-governmental organizations.
3. The hybrid business model, successfully used by large companies like Tesla, has both non-profit and commercial weapons.
4. Instead of incorporating the entire segment of the business as a nonprofit, another route is when the nonprofit and the nonprofit choose to work together.
5. Partnerships between brands and nonprofits can be mutually beneficial.
6. Many nonprofits have much in common with commercial organizations and operate their businesses using similar business tactics and management techniques.
7. All nonprofits must maintain compliance with state agencies that regulate their base charities.

2.2 Depreciation

The nature of Depreciation

Depreciation can be defined as a measure of the depletion of an asset's lifetime due to any cause during a particular time period. -Spicer and Pegler.

“Depreciation is a measure of the consumption, consumption, or other loss of value of a depreciable asset resulting from use, time wasted, or obsolescence due to changes in technology or market. During that time, you will be assigned to charge a significant portion of the depreciation amount for each accounting period. Depreciation expense includes the depreciation of assets with a predetermined useful life. "

-Accounting Standard-6 (revised), issued by ICAI.

Depreciation features:

(I) Depreciation is a decline in the value of fixed assets (excluding land). The decline in the value of an asset is inherently permanent. Once shrunk, it cannot be restored to its original value.

(Ii) Depreciation is a gradual and continuous process because the value of an asset decreases due to the use of the asset or the expiration of time.

(Iii) It is not an asset valuation process. This is the process of allocating the cost of an asset to its lifetime.

(Iv) Depreciation reduces the book value, not the market value of an asset.

(V) Depreciation is only used for property, plant and equipment. It is not used to waste intangible assets such as amortization of goodwill and depletion of natural resources.

Causes of depreciation:

1. Normal physical wear and tear:

The normal use of an asset causes it to physically deteriorate, resulting in a decrease in the value of the asset.

2. Time outflow:

Certain intangible assets, such as trademarks, patents and copyrights, have a fixed lifespan. The value of these assets diminishes over time, whether or not they are used by a company.

3. Obsolescence:

R & D brings innovation in the form of better, technologically advanced machines that dispose of older machines, even if they can be physically performed.

In that case, the market price of certain assets such as computers and automobiles may fall permanently. This reduces the value of older machines. Obsolescence is the loss that results from aging an existing asset and replacing it with a new and improved model of that asset.

4. Accident:

Accidental destruction or damage can reduce the value of an asset.

The accounting concept of Depreciation

Fixed assets are long-term assets. They help produce goods and services. However, when an asset is in use, normal wear, time spills, and obsolescence reduce the value of the asset. This reduction in the value of fixed assets is known as depreciation. Understand the concept of depreciation.

Assets owned by a company for the production and supply of goods and services, expected to be used for more than a fiscal year, and have a limited useful life are called depreciable assets.

When you purchase a fixed asset, it is recorded in your books at its original cost or purchase price. Organizations use this fixed asset to earn or generate revenue for several fiscal years before selling or discarding the asset.

Therefore, you must allocate a portion of your purchase or acquisition costs by fiscal year until you use it. This allocation of costs is called depreciation. Depreciation is an organizational expense.

For example, a Setu company buys a machine for £ 2,000,000, uses it for 10 years and then sells it for £ 400,000. Therefore, the cost of a machine for business use is £ 1600,000 (£ 2000000-400000). Now, for every 10 fiscal years you've been using this machine, you need to allocate this £ 1600,000 cost as a project cost. This cost is a depreciation cost of £ 160,000 (1600000/10).

In other words, the concept of depreciation is the cost of getting a service from the use of an asset. You need to match the depreciation cost of a fixed asset with the revenue for the year in which it was used. Therefore, depreciation is charged as an income statement expense.

Factors in the measurement of Depreciation

As already mentioned, depreciation is not an attempt to record changes in the market value of an asset, but a systematic allocation of the total cost of the depreciable asset (capital investment) to the expense (income and expenditure) over the useful life of the asset. The value of some assets can increase in the short term, but the depreciation process continues. Based on the principle of matching, a reasonable portion of capital expenditure (that is, the cost of an asset) should be charged to revenue during the useful life of the asset.

Depreciation

The calculation of depreciation expense for the accounting period is affected as follows:

(I)                The actual cost of the asset

(II)             Estimated useful life of the asset

(III)           Estimated residual value of the asset.

It is worth mentioning here that of the three factors, two are based on mere estimation and only one is actually based. Therefore, the depreciation calculation is an estimated loss on the value of the asset, not the actual exact reduction in the value of the asset.

The following is a detailed description of each of the above elements.

1. Actual cost of the asset:

The actual cost or acquisition cost means the acquisition cost of the asset and includes all incidental costs required to return the asset to its current state and location. Examples of such costs are installation costs, internal transportation, or capital-based costs incurred to improve such assets.

2. Estimated useful life of the asset:

The estimated useful life of an asset is one of the following:

(I) The period during which the depreciable asset is expected to be used by the entity or

(Ii) The number of production or similar units expected to be derived from the use of assets by a company.

3. Estimated residual value or scrap value of the asset:

The salvage value or scrap value is the expected value that may be realized when an asset is sold or exchanged at the end of its estimated useful life. If residual value is important, it should be considered in the depreciation calculation. However, insignificant residual value can be ignored in the depreciation calculation.

Depreciation is an ongoing process, but we do not record depreciation daily. In fact, the total depreciation expense charged on an asset is the prepaid expense paid by the entity at the time of acquisition of the asset.

In other words, this expense should be treated like a deferred expense, and only adjustment entries should be passed each year to claim reasonable and appropriate depreciation for income statement revenue.

Here are some other factors that influence the measurement of depreciation:

(I)                Original cost of the asset: The cost includes all costs incurred to acquire the asset. In other words, the purchase price includes shipping and installation costs, if any.

(II)             When an asset is added during the year, taking into account the date the addition was made.

(III)           Estimated useful life of the asset.

(IV)          Scrap or residual value of an asset.

(V)             Obsolescence, that is, the possibility of assets becoming obsolete

(VI)          Repairs and updates.

(VII)        Operator skills to handle assets.

(VIII)     Legal provisions or other restrictions related to depreciation.

(IX)           Working hours of the asset.

Methods of computing depreciation: Straight line method and Diminishing Balance Method; Disposal of Depreciable assets – change of method.

Straight line method

What is the straight-line method?

The straight-line method is the default method used to evenly recognize the carrying amount of fixed assets over their useful lives. This is used when there is no particular pattern in how an asset is used over time. The straight-line method is the easiest depreciation method to calculate and is highly recommended for use as it causes few calculation errors. The procedure for flat-rate calculation is as follows.

1. Determines the initial cost of an asset recognized as a fixed asset.
2. Subtract the estimated residual value of the asset from the amount recorded in the books.
3. Determines the estimated useful life of an asset. It is easiest to use the standard useful life for each class of asset.
4. Divide the estimated useful life (yearly) by 1 to calculate the depreciation rate using the straight-line method.
5. Multiply the depreciation rate by the cost of assets (minus salvage value).
6. Once calculated, depreciation expense is recorded in accounting records as a depreciation expense account and a credit to the accumulated depreciation account. Accumulated depreciation is against assets. That is, it is paired with the fixed asset account and the depreciation is reduced.

Formula:

Depreciation = (Asset Cost – Net Residual Value) / Service Life

Depreciation rate = (annual depreciation cost x 100) / cost of capital

Straight-line Journal Entries:

1. Purchase of Assets A / c Dr.       xx

To cash / bank / creditor A / c                      xx

(Purchasing assets)

2. Depreciation of assets A / c Dr.       xx

To asset A /c                                                           xx

(Assets are subject to depreciation)

3. Transfer depreciation gains / losses A / c Dr.                 xx

To depreciation of asset A / c                                                                xx

(Asset depreciation is transferred to the profit and loss account)

Example 1

Pensive Corporation will purchase a Procrastinator Deluxe machine for $ 60,000. It has an estimated salvage value of $ 10,000 and a useful life of 5 years. Pensive calculates the machine's annual flat-rate depreciation as follows:

Solution

$ 60,000 Purchase Cost – $ 10,000 Estimated Residual Value = $ 50,000 Depreciable Asset Cost

1/5-year useful life = 20% annual depreciation rate

20% depreciation rate x $ 50,000 depreciation asset cost = $ 10,000 annual depreciation

Diminishing Balance Method

The various depreciation methods are based on mathematical formulas. This formula is derived from a study of asset behaviour over a period of time. One such depreciation method is the depreciation method. Learn more about this method.

According to the depreciation method, depreciation is charged at a fixed percentage of the book value of the asset. It is also known as depreciation or depreciation because its book value decreases each year.

Since the book value decreases every year, the depreciation amount also decreases every year. This way, the value of the asset never goes to zero.

If you plot the depreciation amount billed this way and the corresponding period on the graph, the line will move down.

This method was previously based on the assumption that the cost of repairing an asset is low and therefore more depreciation costs must be charged. In addition, depreciation costs will decrease as repair costs increase in later years. Therefore, this method puts an equal burden on profits each year for the life of the asset.

However, this method may not provide full depreciation at the end of the asset's useful life if the applicable depreciation rate is not appropriate.

In addition, when applying this method, it is necessary to consider the period of use of the asset. If the asset is used for only two months in a year, depreciation will only be charged for two months.

However, if the asset is used for more than 180 days for income tax purposes, you will be charged full-year depreciation. Income tax rules also allow you to depreciate using the depreciation method.

The formula is:

Amount of depreciation= Book Value x Rate of Depreciation

100

Disposal of Depreciable assets – change of method

Accounting policies and principles need to be applied consistently when recording financial transactions. This is the principle of consistency.

At the end of each fiscal year, management should consider depreciation methods. If there are significant changes in the pattern of future economic returns from the asset, the depreciation method will also need to change.

Accounting Standard 1-According to the disclosure of accounting policies, changes in depreciation methods are changes in accounting estimates. Therefore, footnote quantification and full disclosure are required. You also need to disclose the legitimacy of the change and its economic impact.

Therefore, the depreciation method can be changed without or with a retroactive effect. The lack of retroactive impact means that no adjustments have been made to past entries and only future depreciation will be billed in the new way. While having a retroactive effect, it means that the depreciation amount charged will be adjusted from the date of purchase of the asset.

Example 2

On July 1, 2008, a company bought a machine for Rs 3,90,000 and spent Rs 10,000 on its installation. We have decided to provide depreciation at 15% per year using the write-down method. On November 30, 2011, the machine was dismantled at a cost of 5,000 rupees and then sold for 1,00,000 rupees.

On December 1, 2011, the company acquired a new machine and put it into operation at a total cost of Rs 7,60,000. The new machine was depreciated on the same basis as the previous machine. The company closes its books on March 31st each year.

Solution

Example 3

The cost of the machine used by the company on April 1, 2011 was Rs 250,000, while the depreciation cost for that day was Rs 1,05,000. The company provided depreciation at 10% of the reduced value.

Two machines purchased on December 31, 2011 and October 1, 2008, Rs. 15,000 and Rs. 12,000, respectively, were discarded due to damage and replaced with two new machines, Rs. 20,000 and Rs. 15,000, respectively. I had to.

One of the discarded machines sold for Rs 8,000. On the other hand, the Rs 3,000 was expected to be feasible.

Shows the accounts related to the company's ledger for the year ended March 31, 2012.

Example 4

Metropol Ltd. Purchased the machine on April 1, 2009 for Rs 5,40,000. Depreciation is billed at an annual rate of 20% on a straight-line basis.

On October 1, 2011, a change was made to improve technical efficiency at a cost of 50,000 rupees, which was expected to extend the useful life of the machine by two years. At the same time, important components of the machine were replaced at a cost of 10,000 rupees due to excessive wear.

The cost of regular maintenance during the fiscal year ending March 31, 2012 is Rs 7,500.

Shows for the year ending March 31, 2012:

(I)                Machine account

(II)             Reserve for depreciation account and

(III)           The relevant part of the income statement showing the revenue and expense associated with the machine.

Example 5

X Co. Ltd. Purchased the machine on April 1, 2008 for Rs 1,60,000. On October 1, 2009, another machine was acquired. For Rs 1,40,000. On October 1, 2010, the first machine sold for Rs 1,20,000. On the same day, another machine was purchased for Rs 1,00,000. On October 1, 2011, the second machine sold for Rs 92,000.

The depreciation rate on March 31 was 10% of the original cost. On March 31, 2011, the depreciation billing method was changed to the depreciation method, with a rate of 15%.

Prepare machine accounts for the years ending March 31, 2009, 2010, 2011, and 2012.

Example 6

The lease will be purchased on April 1, 2007 for 5 years at a cost of Rs 1,00,000. It is proposed to depreciate the lease by the pension law, which charges 12% interest. Shows the 5-year lease account and related entries in the P & L account.

Solution:

A reference to the pension table indicates that Re will be depreciated. Under the 15-year pension law, you must claim 12% interest and amortize the total of Re. 0.277410. To amortize Rs 1,00,000, you need to amortize Rs 1,00,000 x 0.277410, or Rs 27,741 each year.

From the example above, you can see that the amount depreciated as depreciation is higher than in the straight-line or instalment payments, but because of the interest, it does not ultimately affect the income statement. Assets that are debited are credited to the income statement. Therefore, the pension law only pays attention to the amount of money spent on the use of assets: lost costs and interest.

Example 7

A company purchased a four-year lease for Rs 10,00,000 on April 1, 2008. By establishing a depreciation fund, it has been decided to offer a lease exchange at the end of four years. The investment is expected to be of interest at 12%. The table of the sinking fund is Re. Investing 0.209234 each year will generate Re. 12% per year at the end of 4 years 1. The investment was made in a 12% bond of Rs 100 available at par. Interest was received on March 31st of each year.

On March 31, 2012, the investment was sold for Rs 6,98,940. On April 1, 2012, the same lease was renewed for another four years with a payment of Rs 12,00,000.

View journals and specify important ledger accounts to record the above.

Example 8

A company bought a three-year lease on April 1 for Rs 3,000,000. In 2009, we decided to offer a replacement under an insurance policy of Rs 3,000,000. The annual premium is 89,500 rupees.

On April 1, 2012, the lease will be renewed for another 3 years at Rs 330,000. Display the required ledger accounts.

Example 9

Experts estimated that the mine contained a total of 160,000 tonnes of minerals. On July 1, 2007, P leased the mine for eight years and paid the owner Rs 96,00,000 with the above estimate in mind.

P has decided to offer depreciation at an annual rate of 12.5% on a straight-line basis. However, in April 2009, we decided to switch to the depreciation method because we thought it would be more appropriate. He passed the required adjustment entry on April 14, 2009.

The output for the first five fiscal years of the lease is as follows:

Solution

Example 10

Companies whose financial year purchased on April 1, 2003 may be a civil year. The worth of the machine is 30,000 rupees.

I bought another machine for 20,000 rupees on October 1, 2003 and 10,000 rupees on Dominion Day, 2004.

One-third of the machines installed on January 1, 2005 and April 1, 2003 were abolished and sold for Rs 3,000.

Shows how machine accounts appear within the company's books. The machine may be a fixed instalment method @ 10% p.a. Depreciated by.

Solution

Example 11

The 32,000-rupee plant purchased on January 1, 2003 has an estimated lifespan of 8 years.

Further purchases of plants are:

1. As of March 31, 2003, the value of the plant is 15,000 rupees and therefore the estimated life is 10 years.

2. On September 30, 2004, the factory cost is 12,000 rupees and therefore the estimated life is 6 years.

3. On April 30, 2005, the factory cost is 20,000 rupees and therefore the estimated life is 8 years.

Of the first plant acquired on January 1, 2003, one machine of Rs 5,000 was sold for Rs 4,700 on June 30, 2005.

The residual value of every asset is 10% of the first cost.

Prepare a plant account for the primary three years.

Solution:

Example 12

The balance of the plant and machinery accounts on New Year's Eve , 2003 was Rs 19,515 after depreciation for the year. (The total cost of the plant was 35,800 rupees and eight ,900 rupees including the plant purchased in 1995.)

In January 2004, a substitute factory was purchased at a price of Rs 2,950, and in 1980 a machine costing Rs 550 was sold as scrap of Rs 35.

In January 2005, there was an addition of 1,800 rupees, and in 2001 a 700-rupee machine was sold for 350 rupees.

You need to make machine accounts for 2004 and 2005. All calculations are displayed.

On January 1, 2003, the machine was purchased for Rs 80,000. On January 1, 2004, a machine of 40,000 rupees was added. On March 31, 2005, a machine of Rs 12,000 purchased on January 1, 2004 was sold for Rs 11,000 and 32,000 purchased on June 30, 2005 on January 1, 2003. The rupee machine was sold for 26,700 rupees. On October 1, 2005, an amount of Rs 20,000 was added. Depreciation was provided at an annual rate of 10%. About the reduction balance method.

Shows machine accounts for the three years from 2003 to New Year's Eve, 2005.

Solution:

Example 13

A company bought a second hand machine for Rs 37,000 on January 1, 2002 and immediately spent Rs 2,000 for repairs and Rs 1,000 for construction. I bought another machine for Rs 10.000 on Dominion Day, 2003 and sold the primary machine I bought in 2002 on Dominion Day, 2004 for Rs 28,000. On an equivalent day, I bought the machine for 25,000 rupees. The second machine, which was purchased for 10,000 rupees, was also sold for 2,000 rupees on Dominion Day, 2005.

Depreciation was provided to the machine on December 31st annually at a rate of 10% of the first cost. However, in 2003, we changed the depreciation method and adopted a depreciation method with a rate of depreciation of 15%.

We will offer you a machine account for 4 years from January 1, 2002.

                                   Salient features of Accounting Standard (AS): 6 (ICAI)

The key features of accounting standards are:

a. Written:

This is a document of a descriptive nature regarding a particular accounting policy that is essential for editing financial statements.

b. Contents:

In addition to drafting financial statements, the accounting standards include rules regarding the recognition, measurement and disclosure of this financial information.

c. Issuing authority:

Almost every country in the world has established statutory accounting institutions that have been entrusted with the sole authority to issue accounting standards.

d. Flexible in nature:

Accounting standards are not strict, but they are inherently flexible to continually develop amendments to existing accounting standards and ensure the issuance of new accounting standards.

e. Reliable guidelines:

Accounting standards provide credible principles that serve as guidelines for accounting and drafting financial statements.

Key takeaways:

1. According to accounting matching principles, depreciation links the value of employing a tangible asset with the profits gained over its useful life.
2. There are differing types of depreciation, including the straight-line method of depreciation and various sorts of accelerated depreciation.
3. Accumulated depreciation is that the sum of all depreciation recorded on an asset up to a specific date.
4. The value of an asset on the record is that the acquisition cost minus all accumulated depreciation.
5. The carrying amount of an asset in any case depreciation has been made is named its salvage value.
6. The straight-line method of depreciation may be a method of calculating depreciation and is that the process of paying an asset for a extended period of your time than when it had been purchased.
7. Straight-line bases are popular because they're easy to calculate and understand, but they even have some drawbacks.

2.3 Inventories: Meaning. Significance of inventory valuation. Inventory Record Systems: periodic and perpetual. Methods: FIFO, LIFO and weighted Average. Salient features of Accounting Standard (AS):2 (ICAI)

Meaning of inventory evaluation:

Inventory usually refers to stocks or stocks in trade. Trading concerns ask products that are resold or unsold. Manufacturing concerns include items like raw materials, semi-finished products, and finished products.

The Institute of Chartered Accountants of India (ICAI) defines inventory in accounting principle 2 as a tangible asset held.

(A) Sale within the normal business process, or

(B) within the process of production for such sale; or

(C) For consumption within the production of products or services purchasable, including maintenance supplies and consumables aside from mechanical parts

Inventory valuation takes place at the top of every financial year to assess performance (that is, find profits or losses) and therefore the financial position of a business (along with other businesses through the balance sheet).

Inventory is usually valued at cost or market value, whichever is lower. The idea of the stock valuation adopted must be consistent over a period of your time so as for the comparative valuation to be meaningful.

Purpose of inventory evaluation:

(A) Determination of transaction profit:

Inventory is a crucial item for checking transaction profit or gross profit margin. Gross profit margin is sales that exceed the value of sales.

Cost of products sold is calculated by adjusting the beginning and end stocks for the acquisition as follows:

Cost of sales = Start inventory + Purchase – End inventory.

From the formula above, we will see that the worth of a stock affects costs, which successively affects gross profit margin. For instance, overestimating the price reduces costs, increases current profits, and reduces profits for the subsequent year. The reverse is additionally true.

(B) Determining financial status:

Inventory plays a crucial role in checking a company's financial position. Year-end inventory appears as current assets on the record. Overvaluation and undervaluation of stocks presents a misleading situation regarding the situation of capital and therefore the overall financial position of the business.

3] Liquidity analysis

Inventory may be a liquid asset because it's not expected to be held by the corporate for an extended period of your time. When it involves inventory, we've tons of sales. Therefore, inventory actually accounts for a big portion of a company's capital. It's important to gauge correctly in order that the present and liquid ratios are often calculated accurately. These ratios are important for checking the liquidity of a corporation.

4] Compliance with laws and regulations

Inventory valuation isn't statutory compliance under the businesses Act 2013. Consistent with Accounting Standards (AS2), all companies are now required to disclose the valuation of every class of inventory. Disclosure must include:

Accounting policy adopted for inventory valuation

Total amount and classification of inventory (raw materials, add process, finished products, etc.)

Types of Inventories

According to the inventory definition, there are many different types of inventory and each is accounted for slightly differently. Retailers are the easiest to account for because they typically only have one kind of goods called merchandise. They purchase it from wholesalers or manufacturers as finished products to sell to their customers.

Manufacturers, on the other hand, define inventory a little bit differently because they produce their own products to sell to customers. Thus, they need to account for the inventory at every stage of production. The three categories are raw materials, work-in-process, and finished goods. Let’s take a look at each of these categories in the Ford car plant.

Raw materials – Raw materials are the building blocks to make finished goods. Ford purchases sheet metal, steel bars, and tubing to manufacture car frames and other parts. When they put these materials into produce and start cutting the bars and shaping the metal, the raw materials become work in process inventories.

Work in process – Work in process inventory consists of all partially finished products that a manufacturer produces. As the unfinished cars make their way down the assembly line, they are considered a work-in-progress until they are finished.

Finished goods – Finished goods are exactly what they sound like. These are the finished products that can be sold to wholesalers, retailers, or even the end users. In Ford’s case, they are finished cars that are ready to be sent to dealers.

Each of these different categories is important and managing them is key to any business’ survival. Inventory control is one of the most important concepts for any business especially retailers. Since they purchase goods from manufacturers and resell them to consumers at small margins, they have to manage their purchasing and control the amount of cash that is tied up in merchandise.

Cost for Inventory Valuation

Inventory valuation is the cost associated with an entity's inventory at the end of a reporting period. It forms a key part of the cost of goods sold calculation, and can also be used as collateral for loans. This valuation appears as a current asset on the entity's balance sheet. The inventory valuation is based on the costs incurred by the entity to acquire the inventory, convert it into a condition that makes it ready for sale, and have it transported into the proper place for sale. Do not add any administrative or selling costs to the cost of inventory. The costs that can be included in an inventory valuation are:

• Direct labour
• Direct materials
• Factory overhead
• Freight in
• Handling
• Import duties

Under the lower of cost or market rule, you may be required to reduce the inventory valuation to the market value of the inventory, if it is lower than the recorded cost of the inventory. There are also some very limited circumstances where you are allowed under international financial reporting standards to record the cost of inventory at its market value, irrespective of the cost to produce it (generally limited to agricultural produce).

**Inventory should be valued at Cost or Market Value (Net Realisable Value), whichever is lower

Inventory Control Systems

Inventory control systems are technology solutions that integrate all aspects of an organization’s inventory tasks, including shipping, purchasing, receiving, warehouse storage, turn-over, tracking, and reordering. While there is some debate about the differences between inventory management and inventory control, the truth is that a good inventory control system does it all by taking a holistic approach to inventory and empowering organizations to utilize lean practices to optimize productivity and efficiency along the supply chain while having the right inventory at the right locations to meet customer expectations.

That being said, there are two different types of inventory control systems available today: perpetual inventory systems and periodic inventory systems. Within those systems, two main types of inventory management systems – barcode systems and radio frequency identification (RFID) systems – used to support the overall inventory control process:

Main Inventory Control System Types:

1. Perpetual Inventory System
2. Periodic Inventory System

Types of Inventory Management Systems within Inventory Control Systems:

1. Barcode System
2. Radio Frequency Identification (RFID) System

Inventory control systems helps to track inventory and provides the data needed to control and manage it. No matter which type of inventory control system is chosen, the company should make sure that it includes a system for identifying inventory items and their information including barcode labels or asset tags; hardware tools for scanning barcode labels or RFID tags; a central database for all inventory in addition to the ability to analyse data, generate reports, and forecast demand; and processes for labelling, documenting, and reporting inventory along with a proven inventory methodology like just-in-time, ABC analysis, first-in, or first out (FIFO), or last-in-first-out (LIFO).

Perpetual Inventory System

Perpetual Inventory System may be defined as ‘a system of records maintained by the controlling department, which reflects the physical movements of stocks and their current balance’. Thus, it is a system of ascertaining balance after every receipt and issue of materials through stock records to facilitate regular checking and to avoid closing down the firm for stock taking. To ensure the accuracy of the perpetual inventory records (bin card and Stores ledger), physical verification of stores is made by a programme of continuous stock taking.

The operation of the perpetual inventory system may be as follows:-

1. The stock records are maintained and up to date posting of transactions are made there in so that current balance may be known at any time.
2. Different sections of the stores are taken up by rotation for physical checking. Every day some items are checked so that every item may be checked for a number of times during the year.
3. Stores received but awaiting quality inspection are not mixed up with the regular stores at the time of physical verification, because entries relating to such stores have not yet been made in the stock records.
4. The physical stock available in the store, after counting, weighing, measuring or listing as the case may be, is properly recorded in the bin cards / Inventory tags and stock verification sheets.

Perpetual inventory system should not be confused with continuous stock taking; Continuous stock taking is an essential feature of perpetual inventory system. Perpetual inventory means the system of stock records and continuous stock taking, where as continuous stock taking means only the physical verification of the stock records with actual stocks.

In continuous stock taking, physical verification is spread throughout the year. Everyday 10 to 15 items are taken at random by rotation and checked so that the surprise element in stock verification may be maintained and each item may be checked for a number of times each year. On the other hand, the surprise element is missing in case of periodical checking, because checking is usually done at the end of year.

Advantages of perpetual inventory system:

1. The system obviates the need for the physical checking of all items of stock and stores at the end of the year.
2. It avoids the dislocation of the routine activities of the organisation including production and dispatch.
3. A reliable and detailed check on the stores is maintained.
4. Errors, irregularities and loss of stock through other methods are quickly detached and through necessary action recurrence of such things in future is minimised.
5. As the work is carried out systematically and without undue haste the figures are readily available.
6. Actual stock can be compared with the authorised maximum and minimum levels, thus keeping the stocks within the prescribed limits. The disadvantages of excess stocks are avoided and capitalised up in stores materials cannot exceed the budget.
7. The recorder levels of various items of stores are readily available thus facilitating the work of procurement of stores.
8. For monthly or quarterly financial statements like Profit and Loss Account and Balance Sheet   the stock figures are readily available and it is not necessary to have physical verification of the balances.

Periodic Inventory System

Periodic Inventory System do not track inventory on a daily basis; rather, they allow organizations to know the beginning and ending inventory levels during a certain period of time. These types of inventory control systems track inventory using physical inventory counts. When physical inventory is complete, the balance in the purchases account shifts into the inventory account and is adjusted to match the cost of the ending inventory. Organizations may choose whether to calculate the cost of ending inventory using LIFO or FIFO inventory accounting methods or another method; keep in mind that beginning inventory is the previous period’s ending inventory.

There are a few disadvantages of using a periodic inventory system. First, when physical inventory counts are being completed, normal business activities nearly become suspended. As a result, workers may hurry through their physical counts because of time constraints. Periodic inventory systems typically don’t use inventory trackers, so errors and fraud may be more prevalent because there is no continuous control over inventory. It also becomes more difficult to identify where discrepancies in inventory counts occur when using a periodic inventory control system because so much time passes between counts. The amount of labour that is required for periodic inventory control systems make them better suited to smaller businesses.

Barcode Inventory Systems

Inventory management systems using barcode technology are more accurate and efficient than those using manual processes. When used as part of an overall inventory control system, barcode systems update inventory levels automatically when workers scan them with a barcode scanner or mobile device. The benefits of using barcoding in your inventory management processes are numerous and include:

• Accurate records of all inventory transactions
• Eliminating time-consuming data errors that occur frequently with manual or paper systems
• Eliminating manual data entry mistakes
• Ease and speed of scanning
• Updates on-hand inventory automatically
• Record transaction histories and easily determine minimum levels and reorder quantities
• Streamline documentation and reporting
• Rapid return on investment (ROI)
• Facilitate the movement of inventory within warehouses and between multiple locations and from receiving to picking, packing, and shipping

Radio Frequency Identification (RFID) Inventory Systems

Radio frequency identification (RFID) inventory systems use active and passive technology to manage inventory movements. Active RFID technology uses fixed tag readers throughout the warehouse; RFID tags pass the reader, and the movement is recorded in the inventory management software. For this reason, active systems work best for organizations that require real-time inventory tracking or where inventory security has been an issue. Passive RFID technology, on the other hand, requires the use of handheld readers to monitor inventory movement. When a tag is read, the data is recorded by the inventory management software. RFID technology has a reading range of approximately 40 feet with passive technology and 300 feet with active technology.

RFID inventory management systems have some associated challenges. First, RFID tags are far more expensive than barcode labels; thus, they typically are used for higher value goods. RFID tags also have been known to have interference issues, especially when tags are used in environments with a lot of metal or liquids. It also costs a great deal to transition to RFID equipment, and your suppliers, customers, and transportation companies need to have the required equipment as well. Additionally, RFID tags carry more data than barcode labels, which means your system and servers can become bogged down with too much information.

When choosing an inventory control system for the organization, one should first decide whether a perpetual inventory system or periodic inventory system is best suited to the organisation needs. Then, choose a barcode system or RFID system to use in conjunction with the inventory control system for a complete solution that will enable visibility into their inventory for improved accuracy in scanning, tracking, recording, and reporting inventory movement.

Valuation: Meaning & Importance

The Institute of Chartered Accountants of India (ICAI) defines in Accounting Standard 2 inventories as tangible properties held:

(a) For sale in the ordinary course of business, or

(b) In the process of production for such sale; or

(c) For consumption in the production of goods or services for sale, including maintenance supplies and consumables other than machinery parts

The inventory valuation is done at the end of each financial year in order to assess the operating performance (i.e., to find out profit or loss) and the financial position of the business (along with others of the business through the balance sheet).

Generally, inventory is valued at cost or market price, whichever is lower. The basis of stock valuation adopted should be consistent over a period in order to make comparative evaluation meaningful.

Importance of Inventory Valuation

Inventory valuation is important for the following reasons:

• Impact on cost of goods sold: When a higher valuation is recorded for ending inventory, this leaves less expense to be charged to the cost of goods sold, and vice versa. Thus, inventory valuation has a major impact on reported profit levels.
• Loan ratios: If an entity has been issued a loan by a lender, the agreement may include a restriction on the allowable proportions of current assets to current liabilities. If the entity cannot meet the target ratio, the lender can call the loan. Since inventory is frequently the largest component of this current ratio, the inventory valuation can be critical.
• Income taxes: The choice of cost-flow method used can alter the amount of income taxes paid. The LIFO method is commonly used in periods of rising prices to reduce income taxes paid.

Objectives of Inventory Valuation:

(a) Determination of Trading Profit: Inventory is an important item for ascertaining the trading profit or gross profit. Gross profit is the excess of sales over cost of goods sold.

Cost of goods sold is computed by adjusting the opening and closing stocks to purchases, as shown follows:

Cost of goods sold = Opening stock + Purchases – Closing stock.

From the above equation it may be understood that the values of stocks influence the cost and thereby affect the gross profit. For example, over valuation of closing stock will reduce the cost and increase the current profit and reduce profits of subsequent years and vice versa.

(b) Determination of Financial Position: Inventory plays an important role in the ascertainment of the financial position of a business. Closing stock is shown as a current asset in the balance sheet. Over and under valuation of stock will give a misleading picture about the working capital position and the overall financial position of the business.

The method of inventory valuation is very important because it determines the amount of firm’s investment in inventory and it influences the firm’s reported income. In Financial accounting, the inventory is traditionally valued at lower of the cost or market value. On the other hand, in Cost accounting it is valued at cost of production.

Hence, the valuation of socks in two sets of books will be different and there will be difference in profits shown by financial and cost accounting records. This difference will be reconciled through a Reconciliation Statement.

Historical Cost:

The actual cost of raw materials, Work in Progress, and Finished Goods is the most logical method of valuing inventory. Cost Accounting (Records) Rules also provide that the inventory should be valued ‘at cost’. Historical cost of inventories is the expenditure incurred for bringing inventory in a saleable condition.

Accounting Standard 2 of the Institute of Chartered Accountants of India states that historical cost represents an appropriate combination of cost of purchase, cost of conversion, and other costs incurred in the normal course of business bringing the inventory up to the present location and condition.

Lower of the Cost or Market Price (LCM):

Under this method, the inventory is valued at cost or market price whichever is lower. The market price may be lower than the cost when the price levels of declining (during deflation) and the inventory may become obsolete because of technological and other changes, it is a conservative method. It shows a lower income than the income shown under the cost method.

However, when prices fluctuate, this method switches to period by period from cost to market price and vice versa. This reduces the usefulness of cost data for managerial analysis. It expects only losses but not gains.

Net Realizable Value Method:

This method is used for inventories, which are damaged or partly obsolete. Net realizable value means the estimated selling price less cost of completion. Normally the stock is valued at historical cost as the selling price will be less.

The loss incurred by writing down the stock to the net realizable value is adjusted to the profit and loss account. The inventory value, under this method, should not exceed the expected realizable value.

Replacement Cost Method:

Under this method, the inventories are valued at a price, which is equal to the current acquisition cost either by production or at a price that would have to be paid for those items at the inventory date. Or simply the replacement value may be taken as ‘market value’ or ‘reproduction value’. This method is a conservative method since it takes into consideration all possible losses but not expected profits.

Hence, the inventory is valued at the minimum of:

(a) Historical cost;

(b) Replacement value; and

(c) Net realizable value.

This method is not approved by Income Tax Authorities. Similarly, the accountants also do not follow this method in practice.

First in First Out Method of Valuation (FIFO)

Definition and Explanation:

The first in first out (FIFO) method assumes that goods are used in the order in which they are purchased. In other words, it assumes that the first goods purchased are the first used (in manufacturing concerns) or the first goods sold (in the merchandising concerns). The inventory remaining must therefore represent the most recent purchases.

Example: Assume that a company had the following transactions in the first month of operations.

Periodic Inventory System: Assume that the company uses the periodic inventory system (amount of inventory computed only at the end of the month). The cost of the ending inventory is computed by taking the cost of the most recent purchase and working back until all units in the inventory are accounted for. The ending inventory and cost of goods sold are determined as shown below:

Perpetual Inventory System: If a perpetual inventory system in quantities and dollars is used, a cost figure is attached to each withdrawal. Then the cost of the 4,000 units removed on march 19 would be made up of the items purchased on March 2 and March 15. The inventory on a FIFO basis perpetual system for the company is shown below:

The ending inventory in this situation is Rs. 27,100, and the cost of goods sold is Rs. 16,800 [(2,000 @ Rs. 4.00) + (2,000 @ Rs. 4.40)].

Notice that in these two FIFO examples, the cost of goods sold and ending inventory are the same. In all cases where first in first out method (FIFO Method) is used, the inventory and cost of goods sold would be the same at the end of the month whether a perpetual or periodic system is used. This is true because the same costs will always be first in and, therefore, first out - whether cost of goods sold is computed as goods are sold throughout the period (the periodic system).

Objectives and Advantages of FIFO Method:

One objective of FIFO is to approximate the physical flow of goods. When the physical flow of goods is actually first-in, first-out, the FIFO method closely approximates specific identification. At the same time, it does not permit manipulation of income because the enterprise is not free to pick a certain cost item to be charged to expense.

Another advantage of the FIFO method is that the ending inventory is close to current cost. Because the fist goods in are the first goods out, the ending inventory amount will be composed of the most recent purchases. This is particularly true where the inventory turnover is rapid. This approach generally provides a reasonable approximation of replacement cost on the balance sheet when price changes have not occurred since the most recent purchases.

Disadvantages of FIFO Method:

The basic disadvantages of first in first out method (FIFO Method) are that costs are not matched against current revenues on the income statement. The oldest costs are charged against the more revenue, which can lead to distortion in gross profit and net income.

Weighted Average Method of Valuation

As the name implies, the average cost method prices items in the inventory on the basis of the average cost of all similar goods available during the period.

Example: Assume that a company had the following transactions in the first month of operations.

Assume the company used the periodic inventory method, the ending inventory and cost of goods sold would be computed as follows using a weighted average method.

If the company has a beginning inventory, it is included both in the total units available and in the total cost of goods available in computing the average cost per unit.

Another average cost method is moving average method, which is used with perpetual inventory records. The application of the average cost method for perpetual records is shown below:

In this method a new average unit cost is computed each time a purchase is made. On 15 March, after 6,000 units are purchased for Rs. 26,400, 8,000 units costing Rs. 34,400 (Rs. 8,000 plus Rs. 26,400) are on hand. The average unit cost is Rs. 34,400 divided by 8,000, or Rs. 4.30. This unit cost is used in costing withdrawals until another purchase is made, at which time a new average unit cost is computed. Accordingly, the cost of the 4,000 units withdrawn on March 19 is shown at Rs. 4.30, a total cost of goods sold of Rs. 17,200. On March, following the purchase of 2,000 units for Rs. 9,500, a new unit cost of Rs. 4.45 is determined, resulting in an ending inventory of Rs. 26,700.

The use of average cost methods is usually justified on the basis of practical rather than conceptual reasons. These methods are simple to apply, objective and not as subject to income manipulation as some of the other inventory pricing methods. In addition, proponents of the average cost methods argue that it is often impossible to measure a specific physical flow of inventory, and therefore it is better to cost items on an average price basis. This argument is particularly persuasive when the inventory involved is relatively homogeneous in nature.

Salient features of Accounting Standard (AS):2 (ICAI)

The characteristics of accounting standards

1. Recognize financial events.

2. Measure financial transactions.

3. Presentation of financial statements in a fair manner.

4. Corporate disclosure requirements to prevent erroneous information from being provided to stakeholders.

5. Improve the reliability of financial statements.

6. Check your company's progress and market position with comparability.

7. Required disclosure requirements and evaluation methods for various financial transactions.

Key takeaways:

1. Inventory is that the merchandise which will be sold and therefore the raw materials that are wont to produce the merchandise which will be sold.
2. There are three sorts of inventors: raw materials, work-in-process, and finished products.
3. Inventories are classified as current assets on the record and are valued in one among three ways: FIFO, LIFO, and weighted average.
4. The last-in, first-out (LIFO) method assumes that the last unit available or newer is sold first.
5. The first-in first-out (FIFO) method assumes that the oldest unit of measure is sold first.
6. LIFO isn't feasible for several companies because it doesn't leave old inventory idle as inventory.
7. FIFOs are the foremost logical choice because companies usually use the oldest inventory first within the production of products.
8. Inventory accounting determines a specific value of an asset at a specific stage of asset development and production
9. This accounting method guarantees an accurate representation of the worth of all assets company-wide.
10. Careful consideration of those values by a corporation can improve profitability at each stage of the merchandise.
11. The permanent inventory system uses a point-of-sale system to instantly track product sales.
12. The perpetual inventory method doesn't attempt to maintain the number of physical products.
13. Permanent inventory systems are in contrast to regular inventory systems. During a recurring inventory system, the number of recurring products is employed for records management.

Example 14

A company has a practice of valuing inventory as per FIFO. In the current year the company changed the valuation method to weighted average method. Value of inventory as per FIFO is Rs. 2 lakhs and as per weighted average method is Rs. 1.8 lakhs. How will the company disclose such matter in the financial statements as per AS 1-Disclosure of Accounting Policies?

Solution:

A simple disclosure that an accounting policy has been changed is not of much use for a reader of a financial statement. The effect of change should therefore be disclosed wherever ascertainable. The company has switched over to weighted average formula for ascertaining cost of inventory, from the earlier practice of using FIFO. If the closing inventory by FIFO is Rs.  2 lakhs and that by weighted average formula is Rs. 1.8 lakhs, the change in accounting policy pulls down profit and value of inventory by Rs.  20,000. The company may disclose the change in accounting policy in the following manner:

‘The company values its inventory at lower of cost and net realisable value. Since net realisable value of all items of inventory in the current year was greater than respective costs, the company valued its inventory at cost. In the present year the company has changed to weighted average formula, which better reflects the consumption pattern of inventory, for ascertaining inventory costs from the earlier practice of using FIFO for the purpose. The change in policy has reduced profit and value of inventory by Rs.  20,000’.

A change in accounting policy is to be disclosed if the change is reasonably expected to have material effect in future accounting periods, even if the change has no material effect in the current accounting period.

Example 15

In the books of M/s Sagar Ltd., closing inventory as on 31.03.2015 amounts to Rs.  1,63,000 (on the basis of FIFO method).

The company decides to change from FIFO method to weighted average method for ascertaining the cost of inventory from the year 2014-15. On the basis of weighted average method, closing inventory as on 31.03.2015 amounts to Rs.  1,47,000. Realisable value of the inventory as on 31.03.2015 amounts to Rs.  1,95,000.

Discuss disclosure requirement of change in accounting policy as per AS-1.

Solution:

As per AS 1 “Disclosure of Accounting Policies”, any change in an accounting policy which has a material effect should be disclosed in the financial statements. The amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount   is not ascertainable, wholly or in part, the fact should be indicated. Thus Sagar Ltd. Should disclose the change in valuation method of inventory and its effect on financial statements. The company may disclose the change in accounting policy in the following manner:

‘The company values its inventory at lower of cost and net realisable value. Since net realisable value of all items of inventory in the current year was greater than respective costs, the company valued its inventory at cost. In the present year i.e. 2014-15, the company has changed to weighted average method, which better reflects the consumption pattern of inventory, for ascertaining inventory costs from the earlier practice of using FIFO for the purpose. The change in policy has reduced current profit and value of inventory by Rs.  16,000.

Example 16

ABC Ltd. Was making provision for non-moving inventories based on issues for the last 12 months up to 31.3.2016. The company wants to provide during the year ending 31.3.2017 based on technical evaluation:

Total value of inventory     Rs. 100 lakhs

Provision required based on 12 months issue  Rs. 3.5 lakhs

Provision required based on technical evaluation  Rs. 2.5 lakhs

Does this amount to change in Accounting Policy? Can the company change the method of provision?

Solution:

The decision of making provision for non-moving inventories on the basis of technical evaluation does not amount to change in accounting policy. Accounting policy of a company may require that provision for non-moving inventories should be made. The method of estimating the amount of provision may be changed in case a more prudent estimate can be made.

In the given case, considering the total value of inventory, the change in the amount of required provision of non-moving inventory from Rs. 3.5 lakhs to Rs. 2.5 lakhs is also not material. The disclosure can be made for such change in the following lines by way of notes to the accounts in the annual accounts of ABC Ltd. For the year 2016-17:

“The company has provided for non-moving inventories on the basis of technical evaluation unlike preceding years. Had the same method been followed as in the previous year, the profit for the year and the corresponding effect on the year end net assets would have been lower by Rs. 1 lakh.”

Example 17

The company deals in three products, A, B and C, which are neither similar nor interchangeable. At the time of closing of its account for the year 2016-17, the Historical Cost and Net Realisable Value of the items of closing stock are determined as follows:

Calculate the value of closing stock.

Solution:

As per AS 2 (Revised) on ‘Valuation of Inventories’, inventories should be valued at the lower of cost and net realisable value. Inventories should be written down to net realisable value on an item-by-item basis in the given case.

Hence, closing stock will be valued at Rs.  76 lakhs.

Example 18

X Co. Limited purchased goods at the cost of Rs. 40 lakhs in October, 2016.  Till March, 2017, 75% of the stocks were sold. The company wants to disclose closing stock at Rs. 10 lakhs. The expected sale value is Rs. 11 lakhs and a commission at 10% on sale is payable to the agent. The company needs your advice on the correct value of closing stock to be disclosed as at 31.3.2017.

Solution:

As per AS 2 (Revised) “Valuation of Inventories”, the inventories are to be valued at lower of cost or net realisable value.

In this case, the cost of inventory is Rs. 10 lakhs. The net realisable value is 11,00,000 x 90% = Rs. 9,90,000. So, the stock should be valued at Rs. 9,90,000.

Example 19

In a production process, normal waste is 5% of input. 5,000 mtr of input were put in process resulting in wastage of 300 mtr. Cost per mtr of input is Rs. 1,000. The entire quantity of waste is on stock at the year end. State with reference to Accounting Standard, how will you value the inventories in this case?

Solution:

As per AS 2 (Revised), abnormal amounts of wasted materials, labour and other production costs are excluded from cost of inventories and such costs are recognised as expenses in the period in which they are incurred.

In this case, normal waste is 250 mtr and abnormal waste is 50 mtr. The cost of 250 mtr will be included in determining the cost of inventories (finished goods) at the year end. The cost of abnormal waste (50 mtr x 1,052.6315 = Rs. 52,632) will be charged to the profit and loss statement.

Cost per mtr (Normal Quantity of 4,750 mtr) = 50,00,000 / 4,750 = Rs. 1,052.6315

Total value of inventory = 4,700 mtr x Rs. 1,052.6315 = Rs. 49,47,368.

Example 20

The Board of Directors decided on 31.3.2017 to increase the sale price of certain items retrospectively from 1st January, 2017. In view of this price revision with effect from 1st January 2017, the company has to receive Rs. 15 lakhs from its customers in respect of sales made from 1st January, 2017 to 31st March, 2017. Accountant cannot make up his mind whether to include Rs. 15 lakhs in the sales for 2016-2017.Advise.

Solution:

Price revision was affected during the current accounting period 2016-2017. As a result, the company stands to receive Rs. 15 lakhs from its customers in respect of sales made from 1st January, 2017 to 31st March, 2017. If the company is able to assess the ultimate collection with reasonable certainty, then additional revenue arising out of the said price revision may be recognised in 2016-2017.

Example 21

Y Ltd., used certain resources of X Ltd. In return X Ltd. Received Rs. 10 lakhs and Rs. 15 lakhs as interest and royalties respective from Y Ltd. During the year 2016-17. You are required to state whether and on what basis these revenues can be recognised by X Ltd.

Solution:

As per AS 9 on Revenue Recognition, revenue arising from the use by others of enterprise resources yielding interest and royalties should only be recognised when no significant uncertainty as to measurability or collectability exists. These revenues are recognised on the following bases:

(i) Interest: on a time proportion basis taking into account the amount outstanding and the rate applicable.

(ii) Royalties: on an accrual basis in accordance with the terms of the relevant agreement.

Example 22

A claim lodged with the Railways in March, 2015 for loss of goods of Rs. 2,00,000 had been passed for payment in March, 2017 for Rs. 1,50,000. No entry was passed in the books of the Company, when the claim was lodged. Advise P Co. Ltd. About the treatment of the following in the Final Statement of Accounts for the year ended 31st March, 2017.

Solution:

AS 9 on ‘Revenue Recognition’ states that where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, revenue recognition is postponed to the extent of uncertainty involved. When recognition of revenue is postponed due to the effect of uncertainties, it is considered as revenue of the period in which it is properly recognised. In this case it may be assumed that collectability of claim was not certain in the earlier periods. This is supposed from the fact that only Rs. 1,50,000 were collected against a claim of Rs. 2,00,000. So, this transaction cannot be taken as a Prior Period Item.

In the light of AS 5, it will not be treated as extraordinary item. However, AS 5  states that when items of income and expense within profit or loss from ordinary activities are of such size, nature, or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately. Accordingly, the nature and amount of this item should be disclosed separately.

Example 23

Prepare a statement showing the pricing of issues, on the basis of

(a)         FIFO and

(b)        Weighted Average methods from the following information pertaining to Material-D

2016 March 1 Purchased 100 units @ Rs 10 each

2 Purchased 200 units @ Rs 10.2 each.

5 Issued 250 units to Job X vide M.R.No.12

7 Purchased 200 units @ Rs 10.50 each

10 Purchased 300 units @ Rs 10.80 each

13 Issued 200 units to Job Y vide M.R.No.15

18 Issued 200 units to Job Z vide M.R.No.17

20 Purchased 100 units @ Rs 11 each

25 Issued 150 units to Job K vide M.R.No.25

Solution:

1. FIFO Method

Stores Ledger

b.    Weighted Average Method

Stores Ledger

Working Notes:

Calculation of price for Issue on March 5th

= 3040/300 = Rs 10.13

Calculation of price for Issue on March 13th

= 5847/550 = Rs 10.63

Calculation of price for Issue on March 18th

= 3721/350 = Rs 10.63

Calculation of price for Issue on March 25th

= 2695/250 = Rs 10.78

Example 24

The stock of material held on 1-4-2015 was 400 units @ 50 per unit. The following receipts and issues were recorded. You are required to prepare the Stores Ledger Account, showing how the values of issues would be calculated under Base Stock Method, through FIFO base being 100 units.

Solution:

Stores Ledger Account [under Base Stock through FIFO Method]

Example 25

Adnan Naeem Imports, Ltd has the following information about the inventory of electronic components for October 2016.

As at the end of October, 220 components remained in inventory.

Required:

1. If the company uses FIFO method of allocating inventory, what would is the cost of goods sold for October?
2. If the company uses FIFO method of allocating inventory costs, what would be the ending inventory?
3. If the company uses average cost method of allocating inventory costs, what would is the ending inventory for October?

Solution:

1. Cost of Goods Sold

b.    Cost of Closing Inventory

c.     Cost of Closing Inventory

Average rate = 28450/900 = Rs 31.61 per unit

Example 26

The stock of material held on 1-4-2015 was 400 units @ 50 per unit. The following receipts and issues were recorded. You are required to prepare the Stores Ledger Account, showing how the values of issues would be calculated under Base Stock Method, through FIFO base being 100 units.

Also calculate the Cost of Goods Sold and the Gross Profit.

Solution:

Stores Ledger Account [under Base Stock through FIFO Method]

Calculation of Cost of Goods Sold

COGS   = Opening Inventory + Purchases – Closing Inventory

= 5,000 + 1,88,500 – 24,000

= Rs. 1,69,500

Calculation of Gross Profit

References:

1. Https://www.vedantu.com/commerce/accounting-for-non-profit-organisation
2. Https://www.accountingtools.com/articles/nonprofit-accounting.html
3. Https://byjus.com/commerce/meaning-and-characteristics-of-not-for-profit-organisation/
4. Https://www.freshbooks.com/hub/accounting/non-profit-accounting
5. Https://www.accountingnotes.net/cost-accounting/depreciation-cost-accounting/depreciation-concept-definition-and-causes/8099
6. Https://www.dummies.com/business/accounting/straight-line-depreciation-practice-questions/
7. Https://www.freshbooks.com/hub/accounting/straight-line-depreciation
8. Https://www.investopedia.com/terms/i/inventory-management.asp
9. Https://www.caclub.in/list-of-accounting-standards-of-icai-as/