UNIT I

Accounting Standards &Financial Reporting

Q1) What is a lease? Explain its benefits.

A1) A lease is a contract that allows an asset / asset owner to use the asset / asset in exchange for something, usually money or other asset, by another party. The two most common types of leases in accounting are operating leases and finance (capital leases) leases. This step-by-step guide covers all the basics of lease accounting.

Benefits of leasing

1. Leasing has many advantages that can be used to attract customers.
2. Payment schedules are more flexible than loan contracts.
3. After-tax costs are lower because the tax rates are different for lenders and borrowers.
4. The lease includes financing 100% of the value of the asset.
5. For operating leases, the company creates expenses instead of debt, allowing the company to obtain funding. This is often referred to as "off-balance sheet financing."

Q2 ) What is a finance lease?

A2) Finance leasing is a way of providing finance. In effect, a leasing company (lessor or owner) buys asset for a user (usually called an employer or lessee) and rents them to them for an agreed period of time.

Finance leases are a statement of Standard Accounting Practice 21.

"Practically all risks and rewards of ownership of an asset to a lessee."

This basically means that the lessee is in much the same position as if he had bought the asset.

The lessor charges rent as compensation for hiring the property to the lessee. The lessor retains ownership of the asset, while the lessee uses the asset exclusively (if the terms of the lease are complied with).

The lessee pays a rent that covers the original cost of the asset during the initial or major period of the lease. You are obliged to pay all of these rents, including balloon payments at the end of the contract. When all of this is paid, the lender will recover the investment in the asset.

The customer promises to pay these rents during this period and technically the finance lease is defined as non-cancellable, although it may be possible to terminate early. At the end of the lease

What happens at the end of the primary finance lease term is different and depends on the actual contract, but the possible options are:

1. The lessee acts on behalf of the lessor and sells the asset to a third party.
2. Assets will be returned to the lessor for sale
3. Customer enters secondary lease term

When an asset is sold, the customer may be given a rent rebate equivalent to the majority of the sale price (minus disposal costs), as agreed in the lease agreement. If the asset is held, the lease enters the second period.

Secondary rentals can be much lower than primary rentals (“pepper cone” rentals). Alternatively, the same rental may continue to be leased monthly.

Q2) Give an example of Finance lease.

A3) Finance lease example

Finance leases are commonly used to finance vehicles, especially hard-working commercial vehicles. The company wants the benefits of leasing, but does not want the responsibility to return the vehicle to the lender in good condition.

Besides commercial vehicles, finance leases can be used for many other assets. An example is shown below.

The Health Club was considering investing in new gym equipment. The total loan amount is £ 20,000 and the contract is set to pay for 60 months without deposits. Importantly, the balloon payment was set to £ 0. This means that the client (or most likely a gym user!) Is free to sweat the device, knowing that they are not responsible when concluding the contract. After 60 months the option is to sell the equipment –   keep the money made or enter the peppercorn (secondary) rental period in a relatively small amount.

Q3) Define Operating lease

A4) In contrast to finance leases, operating leases do not transfer virtually all risks and rewards of ownership to the lessee. It usually runs for less than the full economic life of the asset, and the lessor expects the asset to have resale value (known as residual value) at the end of the lease term.

This residual value is predicted at the beginning of the lease and the lessor bears the risk of whether the asset will achieve this residual value at the end of the contract.

Operating leases are common when assets such as aircraft, vehicles, construction plants, and machinery have residual value. Customers can use the asset for the agreed term in exchange for rent payment. These payments do not cover the full cost of the asset as in the case of a finance lease.

The operating lease may include other services included in the contract. Vehicle maintenance contract.

Ownership of the asset remains with the lessor and the asset is returned at the end of the lease when the leasing company rehires it under another contract or sells it to release the residual value. Alternatively, the lessee may continue to rent the asset at the fair market rent agreed at that time.

Accounting rules are currently under consideration, but at this time operating leases are off-balance sheet arrangements and finance leases are on the balance sheet. For accounting under international accounting standards, IFRS 16 will bring operating leases to the balance sheet. Learn more about IFRS16.

A common form of operating lease in the vehicle sector is contract employment. This is the most common way to fund company cars and is growing steadily.

Q4) Why choose one sort of lease over the other?

A5) This is a complex question, and each asset investment needs to be considered individually to see which type of financing is most beneficial to the organization. However, there are two important considerations. The type and lifetime of the asset, and the way the leased asset is reflected within the organization's account.

Asset type and lifespan

As mentioned above, it is important to remember that in operating leases the risks and rewards of owning an asset remain with the lessor, and in finance leases these are primarily transferred to the lessee.

Very generally, if an asset has a relatively short service life within the business, an operating lease may be a more commonly selected option before it needs to be replaced or upgraded. This is because the asset is likely to hold a significant portion of its value at the end of the contract, thus lowering the rent during the lease term. This is priced to the overall cost of the contract, as the lessor bears the risk in terms of the residual value of the asset.

This “cost of risk” can be significantly reduced for assets that can affect their condition at the time of return to the lessor and therefore have a high degree of certainty in estimating the residual value. Asset types to which this applies include automobiles, commercial vehicles, and IT equipment.

If an asset is likely to have a longer useful life in the business, its residual value consideration is less important as it is likely to be a much smaller percentage of its original value. This may mean that the lessee is willing to take this risk internally rather than paying the lessor. Here, finance leasing is a more obvious choice.

Because the rent paid on a finance lease pays off all or most of the capital, it is often possible to set a secondary lease period and maintain the use of the asset at a significantly reduced cost.

Q5) Difference between Financial Leasing and Operating Leasing

A6) As you can see, there are some differences between financial and operating leases. Let's look at the important differences between them –

1. A financial lease is a type of lease that allows the lessor to use the former asset instead of a long-term, recurring payment. An operating lease, on the other hand, is a type of lease that allows the lessee to use the former asset in exchange for short-term recurring payments.
2. Financial leases are leases that need to be recorded under the accounting system. Operating leases, on the other hand, are a concept that does not need to be recorded in any accounting system. For this reason, operating leases are also known as "off-balance sheet leases."
3. In a financial lease, ownership is transferred to the lessee. In an operating lease, ownership isn't transferred to the lessee.
4. Contracts based on financial leases are called loan contracts / contracts. Contracts based on operating leases are called rental contracts / contracts.
5. Once both parties have signed the contract, it is generally not possible to cancel the financial lease. Even after an agreement between the parties, the operating lease can only be revoked during the initial period.
6. Financial leasing provides tax credits for depreciation and financing costs. Operating leases provide tax credits for rent payments.
7. Financial leases offer asset purchase options at the end of the contract period. With operating leases, there are no such offers.

Q6) Define Hire Purchase System

A7) If you purchase a TV for cash, you pay, say, Rs. 15,000. But if you wish to make the payment by instalments of say, Rs. 3,000 each, every year, you may be required to pay four instalments, that is Rs. 20,000 in all. The extra amount of Rs. 3,000 is for interest. If you choose the latter mode of the payment, you should debit Rs. 5,000 to interest and treat the TV as valued at Rs. 15,000 (and not at Rs. 20,000). In case payment is to be made by instalments, there may be two kinds of arrangements. Each instalment may be treated as a ‘hire’ the purchaser becoming the owner only if he pays all the instalments. In other words, property does not pass to him even if one instalment remains unpaid. The seller will have the right to take away the goods in case of default in respect of any instalment. This is known as ‘Hire Purchase’ system.

The other arrangement may be that property passes immediately on the signing of the contract. The seller will not have the right to repossess the goods in case an instalment is not paid. His right will be to sue the purchaser for the money due. This is known as the Instalment System.

Q7) What are the Benefits of Employment Purchase and Installment Systems?

A8)

1. Rental purchase and installment payment schemes allow buyers to purchase items that are out of reach.

2. It also allows businesses to find buyers for their products. Companies are not always able to find a cash party for products that are inherently expensive.

3. It expands the market.

4. Middlemen are excluded

5. It helped financial companies develop their business. Today's financial companies are widely funding several articles under the job purchase and installment payment system.

6. The price will be stable.

7. By renting and selling convenient items and luxury items in instalments, people's living standards will improve.

8. Sellers can increase their sales. In addition, rental purchases and installment sales are more profitable.

9. Nowadays, most business houses offer many offers, like free gifts, exclusively for rental purchase customers.

Q8) Explain disadvantages of employment purchase and installment payment system

A9) 1. Employment purchase and installment payment systems tempt buyers to purchase products that go beyond their means. So, it will be a luxury.

2. The buyer pays a very high price for the article under such a scheme. This is because he has to pay interest on his unpaid balance.

3. The need for time is a savings. Plans like buying jobs waste people.

4. Employment purchase price is higher than cash price. Interest is charged to the purchaser of the employment purchase system. Interest rates are often high.

5. If the buyer fails to pay, the goods sold in the rental purchase system will be reclaimed by the rental vendor. Buyers incur huge losses on seized goods.

6. Employment purchases and installment transactions are tedious. You need to conclude a contract and give a guarantee. More legal proceedings are to be passed.

7. The default rate under the employment purchase and installment payment system is higher. This is because only people with inadequate means buy under this system.

8. The purchaser must carry out some legal proceedings. He may have to find a guarantor. The contract must be prepared and signed by both the seller and the buyer, and it must be witnessed. The ownership document remains with the vendor / financial company until the employer liquidates the membership fee.

Q9) ABC Ltd. Purchases a machinery for Rs. 30 lakhs with a useful life of 5 years and ‘Nil’ salvage value. It gets Rs. 10 lakhs as a grant from the government for this machinery.

A10)

a) The gross value of machinery will be shown as Rs. 20 lakhs (30 lakhs – 10 lakhs) in the balance sheet

b) Rs. 4 lakhs (20 lakhs / Useful life i.e. 5 years) will be charged to profit and loss account each year as a depreciation on this machinery.

Q10) Define Cash flow.

A11) Cash flows are recorded on the company's cash flow statement. This statement (one of the company's key statements) shows the actual inflows and outflows of cash (or cash-like assets) from its investment activities. This is a mandatory report under generally accepted accounting principles (GAAP)

This is different from the income statement, which records data and transactions that may not be fully realized, such as uncollected income and unpaid income. On the other hand, this information is already entered in the cash flow statement, which gives you a more accurate picture of how much cash your company is generating.

Q11) Classify cash flow statement.

A12) The cash flow statement allows you to classify cash flow sources into three different categories:

1. Cash Flow from Operating Activities: Cash generated from the general or core business of the business is listed in this category.
2. Cash Flows from Investing Activities: This section describes the cash flows spent on investments such as new equipment.
3. Cash Flows from Financing Activities: This category includes all transactions involving the debtor, such as income from new debt and dividends paid to investors.

Q12) Draw the specimen of Cash flow

A13)   Specimen of Cash Flow

Cash flow statement for XYZ business

For the year ended 31st December 2020

CASH FLOW FROM OPERATING ACTIVITIES

Cash receipts from customer

Cash paid to supplier

Cash paid to employees

Cash paid for other operating expenses

Cash generated from operations

Dividend received *

Interest received

Interest paid

Tax paid

Net cash flow from operating activities

CASH FLOW FROM INVESTING ACTIVITIES

Proceeds from capital contributed

Proceeds from loan

Payment of loan

Net cash flow from financing activities

CASH FLOW FROM FINANCING ACTIVITIES

Proceeds from capital contributed

Proceeds from loan

Payment of loan

Net cash flow from financing activities

NET INCREASE /DECREASE IN CASH

Cash at the beginning of the period

Cash at the end of period

A company receives an inflow of cash income from selling goods, providing services, selling assets, earning interest on investments, renting, acquiring loans, or issuing new shares. Cash outflows can result from purchases, loan repayments, business expansions, payroll payments, or dividend distributions.

Investors and lenders have liquidity and cash on hand because the Securities and Exchange Commission (SEC) requires all listed companies to use accrual accounting and largely ignores the actual balance of cash on hand. It relies on cash flow statements to evaluate flow management. It's a more reliable tool than the metrics companies use to dress up their earnings, such as interest, taxes, depreciation, and earned before interest (EBITDA)

Q13) Define Cash and cash equivalents

A14) Cash equivalents are held by a corporation to satisfy its short-term cash commitment on behalf of an investment or other such purpose. For investments that qualify as cash equivalents:

1. The investment must be easily convertible to cash

2. Must be exposed to a really low level of risk regarding changes in its value

Therefore, an investment is taken into account a debt instrument as long as such investment features a short maturity within 3 months from the date of acquisition.

The AS 3 income statement states that movements between items that form a part of cash or cash equivalents should be excluded because they are part of a company's cash management, not business, financing, and investment activities. Cash management consists of investing surplus take advantage cash equivalents.

Q14) What is Investment activities. Give some examples.

A15) Cash flows from investing activities represent outflows for cash flows and resources aimed toward generating future income. For example:

• Cash purchased the acquisition of fixed assets
• Cash received from the disposal of fixed assets (including intangible assets)
• Cash paid to accumulate shares, warrants or debt certificates of other companies and equity interests in joint ventures

Q15) Explain Income from investment and financing activities.

A16) An entity must separately record all major classes of money receipts and payments resulting from financial and investment activities, except people who got to be reported on a net basis.

1. Net-based income

Cash flows from any of the subsequent operating, financing or investing activities could also be reported in net form.

• Cash income and payments on behalf of the client if the cash flows reflect the activities of such clients instead of the activities of the corporate itself.
• Revenue and cash payments for products with large amounts, fast sales and short maturities

Cash flows from each of the subsequent activities of a financial company could also be reported in net form.

1. Cash income and payments for receipt and repayment of fixed-maturity deposits
2. Placement and withdrawal of deposits from other financial companies
3. Loans and cash advance payments are provided to Customer / Customer and repayment of such loans and advance payments.

B.    Foreign currency cash flow

Cash flows from transactions in foreign currencies should be recorded in the company's reporting currency using the following methods:

Foreign currency amount * FX rates the exchange rate between the cash flow date report and the foreign currency.

If the result is similar to using the cash flow date rate, you can use a rate that is close to the actual rate.

The impact of exchange rate fluctuations on cash and cash equivalents held in foreign currencies must be reported as a separate and separate part of the adjustment of changes in cash and cash equivalents during the period.

Q16) Write short note on Acquisition and disposal of business divisions including subsidiaries.

A17) Total cash flows from acquisitions and disposals of business units, including subsidiaries, must be viewed as investment activity and reported separately.

An entity must provide a complete of the subsequent for both acquisitions and disposals of other business units, including subsidiaries, within the subsequent period:

(A) Total purchase or disposal

(B) Purchase or disposal price discharged as cash and cash equivalents

Q17) Explain Cash flow as per accounting standards.

A18) Cash flow as per accounting standards:

1. Applicability of AS3 income Statement

The applicability of the income statement is defined under the businesses Act 2013. As defined by the law, financial statements include:

I. Record

Ii. Profit and Loss Account / Balance Account

Iii. Income statement

Iv. Statement of changes in shareholders' equity, etc.

v. Annotation

Therefore, the income statement must be prepared by all companies, but the law also specifies certain categories of companies that are exempt from an equivalent.

For eg: One Person Company (OPC), Small Company, and Dormant Company.

• OPC means a corporation with just one member.
• SMEs are private companies with a maximum paid-up capital of Rupees. The utmost sales are 500,000 rupees. 2 rolls.
• A dormant company is an inactive company that's established for future projects or simply to carry assets and has no significant transactions.

2.     Cash and cash equivalents

Cash equivalents are held by a corporation to satisfy its short-term cash commitment on behalf of an investment or other such purpose. For investments that qualify as cash equivalents:

1. The investment must be easily convertible to cash

2. Must be exposed to a really low level of risk regarding changes in its value

Therefore, an investment is taken into account a debt instrument as long as such investment features a short maturity within 3 months from the date of acquisition.

The AS 3 income statement states that movements between items that form a part of cash or cash equivalents should be excluded because these are a part of a company's cash management, not business, financing, and investment activities.

Cash management consists of investing surplus take advantage cash equivalents.

3.     View income

The income statement must represent the cash flows within the amount during which they're categorized as follows:

A. Sales activities

B. Investment

C. Financing activities

Companies got to prepare and present cash flows from operations, financing, and investment activities during a way that suits their business.

Grouping activities provides information that permits users to assess the impact of such activities on the company's overall financial position and to assess the worth of money and cash equivalents.

A. Sales activities

Cash flow from operating activities comes primarily from activities that generate the company's main revenue. For example:

• Cash received from the sale of products and services
• Cash received in fees, royalties, commissions, and various other sorts of revenue
• Cash paid to suppliers of products and services

B. Investment activities

Cash flows from investing activities represent outflows for cash flows and resources aimed toward generating future income. For example:

• Cash purchased the acquisition of fixed assets
• Cash received from the disposal of fixed assets (including intangible assets)
• Cash paid to accumulate shares, warrants or debt certificates of other companies and equity interests in joint ventures

C. Financing activities

Financing activities are activities that change the composition and size of the owner's capital and therefore the company's debt. For example:

• Cash received from the issuance of shares or other similar securities
• Cash received from the issuance of loans, corporate bonds, bonds, bills, and other short-term or long-term debt
• Repayment of debt

4.     Income from operating activities

Companies should report cash flows from operating activities using:

1. Direct method-if all major classes of money receipt and payment are presented. Or

2. Indirect method – If net or loss is adjusted as follows:

a) Impact of non-cash transactions like depreciation, deferred taxes and provisions.

b) Income or deferral of future or past operating cash income or payments

c) Expenses or income related to income financing or investment

5.     Income from investment and financing activities

An entity must separately record all major classes of money receipts and payments resulting from financial and investment activities, except people who got to be reported on a net basis.

C.            Net-based income

Cash flows from any of the subsequent operating, financing or investing activities could also be reported in net form.

• Cash income and payments on behalf of the client if the cash flows reflect the activities of such clients instead of the activities of the corporate itself.
• Revenue and cash payments for products with large amounts, fast sales and short maturities

Cash flows from each of the subsequent activities of a financial company could also be reported in net form.

d.     Cash income and payments for receipt and repayment of fixed-maturity deposits

e.     Placement and withdrawal of deposits from other financial companies

f.        Loans and cash advance payments are provided to Customer / Customer and repayment of such loans and advance payments.

D.   Foreign currency cash flow

Cash flows from transactions in foreign currencies should be recorded in the company's reporting currency using the following methods:

Foreign currency amount * FX rates the exchange rate between the cash flow date report and the foreign currency.

If the result is similar to using the cash flow date rate, you can use a rate that is close to the actual rate.

The impact of exchange rate fluctuations on cash and cash equivalents held in foreign currencies must be reported as a separate and separate part of the adjustment of changes in cash and cash equivalents during the period.

6.     Special items, dividends and profits

Cash flows related to special items should be categorized as originating from operating, financing, or investing activities, as appropriate and clearly disclosed.

Cash flows from receiving and paying dividends and interest must be disclosed separately. For financial companies, cash flows from receiving and paying dividends and interest should be categorized as cash flows from operating activities.

For other companies, cash flows from interest expense should be categorized as cash flows from financing activities, while dividends and interest received should be categorized as cash flows from investing activities.

7.     Tax on income

Income tax cash flows must be disclosed separately and reported as cash flows from operating activities unless they may be explicitly related to investment and financing activities.

8.     Acquisition and disposal of business divisions including subsidiaries

Total cash flows from acquisitions and disposals of business units, including subsidiaries, must be viewed as investment activity and reported separately.

An entity must provide a complete of the subsequent for both acquisitions and disposals of other business units, including subsidiaries, within the subsequent period:

(A) Total purchase or disposal

(B) Purchase or disposal price discharged as cash and cash equivalents

9.     Non-cash transaction

Financing and investment transactions that do not require cash or cash equivalents should not be included in the cash flow statement. These transactions must be presented elsewhere in the financial statements in a way that provides relevant information regarding such financing and investment activities.

10. Disclosure

An entity must disclose the amount of substantial unusable cash and cash equivalents it holds, along with management commentary. Commitments that may result from discounted bills of exchange and other similar obligations undertaken by an entity are usually disclosed in the financial statements by note, even if the likelihood of loss is low.