Basic of Accounting

Basics of Accounting:

Recording, analyzing and compiling business affairs and illustrating results is accounting. Accounting is actually, a system of information and its purpose is to describe, compile, measure and relates data about commercial units to those with concern in the units. It allows reasoning and selection to information users. We can say accounting as a business language as it deals with profit and loss of business. History of present accounting is related to 15th century when Luca Pacioli in 1494 stated the terms “Debits” & “Credits”, both these terms are the basis of today’s accounting. Equation for accounting can be written as:

Assets = Liabilities + Capital

As we can see from above equation that sum of liabilities and business owner’s capital are equal to assets for any business. In simple we can say that these are liabilities and capital that provide funding for the purchase of assets for any company. This is the basic equation of accounting.

Branches:

There are various branches of accounting that are:

  • Management branch
  • Auditing branch
  • Tax branch
  • Fund branch
  • Forensic branch

There are following functions of accounting:

Purpose of accounting:

There are following objectives of accounting which are very important to keep business running and are also responsible for the best future of any business.

To keep analytical records:

Through accounting we keep analytical record of financial dealings. There are two purpose of accounting here, the first purpose is that we collect analytical data for a specific business and then record it analytically to acquire accurate and beneficial results for business reports. This show that accounting is of great help in keeping analytical records and resolving fruitful results in our business dealings.

To determine business efficiency:

Accounting also helps us we can determine rise and fall that occurred in a particular accounting duration. We can also calculate the loss and the profit of a specific firm through accounts such as profit & loss and trading account. So in business accounting is the key to success as due its calculation one can easily manage the business in a way which is beneficial for business owner and vice versa.

To check economic status of the firm or business:

Accounting is very important to determine the economic status of any business by taking into consideration the outcome, investment and other factors influencing that business. For this purpose proper balance sheet is prepared which shows the economic status of a specific business. This balance sheet gives us information about the cost of belongings, the nature and rate of accountability. Through this balance sheet business owners can take steps toward the success of business

To aid in making choice:

To take proper decision for future of a company or a firm one must have known accurate economic status and value of projects of the company. In this regard,  accounting helps in making right decisions for the best future of the company. Thus accounting tells and guides us to proper direction for future and making a business more profitable and also saves from loss if proper steps have taken by studying the calculated reports of accounting.

To accomplishment of law:

There are different senatorial acts in different countries for companies, societies and trusts, acts are even different for different types of firms or trusts within same country. Each and every company has to follow these parliamentary acts and accounting is responsible for accomplishment of these laws on firms and trusts. There are also different taxation laws for each type of business and accounting helps us to keep business running by accomplishing these laws in a proper way.

 

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Going for IPO

Implications of going for IPO

Many time students are required to identify the competency of going for equity finance option. Students are required to be very careful reading the case facts, environment and circumstances presently face by the company. Examine all relevant indicators like consistent profitability and growth factors related to previous years. Students should go in more depth of the issue and discuss all relevant factors before jumping to go for the decision. See the following possible factors from Accounting, Finance, Audit and Taxation perspectives.

 Look into the existing business environment, bottom line and future prospectus for the company, SWOT analysis and or MD & A will be useful tools for managerial decision. Examine the implication form long term and short term point of view

 Need to check about loss of control on account of issue of new shares

 From audit perspective, audit cost will increase on account of more users and reporting of extra requirement due to IFRS. This is also on account of preparation of prospectus and consent of auditor before publishing interim financial statements. More accurate and reliable
financial information is required due to more users. IT system may need to be updated
and or revised.
 High cost of underwriter, advertisement, and cost related with listing requirement

 Applicability of IFRS, comparative information for earlier year and requirement of additional

information in the notes to Financial Statements
 Option for fair valuation of Property, Plant and Equipment and its impact on financial statements and on share price
 Tax payable method of accounting is not allowed in IFRS, and as such future lax assets/liability will be worked out and recorded in FS

 Small business deduction will not be available which may impact higher income tax rate

 

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Problem Solving and Professional Judgment

This is one of the competency, CPA had to come across in real work situation. As a controller or as a CEO, CPA had to take several decisions to run the company smoothly to reward its stakeholders.
He is required to use professional judgment from the variety of collected information. CPA students will face this competency in their final exam in case analysis.

Following process is important for resolving this issue-

• Define the problem and obtain initial understanding around the issue
• Divide the problem in different parts or sub-heading to facilitate in-depth analysis
• Exercise professional judgment in order of priority. Examine the sensitivity of the issue and
its material impact
• Evolve multiple options and or a single option
• Perform appropriate analysis
• Collect variety of relevant information
• Integrate information to find the right solution
• Recommend and then justify the conclusion from the collected case facts, develop decision
criteria and then finally recommend the right solution to take correct management decision

Student should follow above approach for solving this competency in the exam. Problem should be with integrative effect affecting other course area if any from financial and non-financial information.

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CFE MAY 2016/ SEPT 2016

Many students across Canada are thinking to appear in the final exam either in May or in September 2016 to get the designation of CPA. Some are repeater, some are for the first time, some are from either CGA or CMA.

The big question is how to get through this exam? Exam is not as easy as your earlier courses. It requires hard work to understand conceptual technical knowledge of all six competency area i.e. Financial Accounting, Management Accounting, Audit, Finance, Taxation, Strategy and Governance. Exam is evaluated on the basis of case analysis approach through depth and breadth of related competency. You should plan out your schedule of taking Capston1, Capston2 and CFE exam. You should also plan out your availability of time to cover all above courses.

Students should not jump out in writing case analysis directly. They must go through all important concepts related to technical subjects and ensure its accuracy through practice of related MCQ. Many students who failed in this exam are on account of lack of technical knowledge. Once if you are strong in technical concepts, it will be easier for you to write any case analysis effectively.

Students should also know the effective writing skill and approach to write the case analysis.
I am publishing one book exclusively for CFE shortly which contains all technical course concepts with lot of high value MCQ. On line lectures will also available for students to get confidence in the exam. For latest updates visit CFE CPA Tutor Home Page.

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CHARTERED PROFESSIONAL ACCOUNTANT

Some Excerpts from the CPA CANADA Website in Nutshell

A unique and very impressive designation for accountancy profession in Canada. Three big

accounting bodies CGA, CMA and CA has now merged into a single accounting entity for global

development of the profession in Canada.

Summary of course content:

1. CPA-PREP

2. CPA-PEP

3. CPA-CFE

A student either a under graduate or graduate in any discipline can select respective step 1 or 2

to start with the program. An under graduate student need to complete related modules in

CPA-PREP if he has not done in his earlier educational courses.

CPA- PEP consists of core 1, core 2 and any two of available four elective modules. Core 1 is

related with Financial Reporting and core 2 is related with Management Accounting.Four

elective module consists of Finance, Performance Accounting, Assurance and Taxation.

Assurance and Taxation are must for Public Accounting practice. Student need to pass all four

exams at the end of each module. Exam is related with about 25 % with MCQ and short

questions and 75 % with case analysis

CPA-CFE consists of three day exam and is must for all students to pass and get the designation

of CPA

Capstone one and Capstone 2 are a part for preparation for CFE

Day-1 include one case analysis of 4 hour duration based on enabling competencies related

with ethics , problem solving, leadership and communication skill.

Day-2 include 5 hour of one big case analysis in which student need to select core area of his

choice and need to provide response

Day-3 include 3 hour of exam consists of three short case analysis of a different nature

Student need to pass individually day 1 to day three exam

CFE exam is related with 25 % with MCQ and 75 % with case analysis

In short student should be competent enough in related technical course concepts and solving

MCQ to pass CPA

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Activity Base Costing

ACTIVITY-BASED COSTING

 Activity-based costing is a two-stage costing method that creates a cost pool for each major activity in an organization (such as setups required, purchase orders issued, and so on). Overhead costs are assigned to products and services on the basis of the number of iterations of each activity involved in manufacturing the product or providing the service.

 Activity-based costing (ABC) is a better, more accurate way of allocating overhead.

The steps to product costing are:

1.  Identify the cost object;

2.  Identify the direct costs associated with the cost object;

3.  Identify overhead costs;

4.  Select the cost allocation base for assigning overhead costs to the cost object;

5.  Develop the overhead rate per unit for allocating overhead to the cost object.

Activity-based costing refines steps #3 and #4 by dividing large heterogeneous cost pools into multiple smaller, homogeneous cost pools. ABC then attempts to select, as the cost allocation base for each overhead cost pool, a cost driver that best captures the cause and effect relationship between the cost object and the incurrence of overhead costs. Often, the best cost driver is a nonfinancial variable.

ABC can become quite elaborate. For example, it is often beneficial to employ a two-stage allocation process whereby overhead costs are allocated to intermediate cost pools in the first stage, and then allocated from these intermediate cost pools to products in the second stage. Why is this intermediate step useful? Because it allows the introduction of multiple cost drivers for a single overhead cost item.

ABC focuses on activities. A key assumption in activity-based costing is that overhead costs are caused by a variety of activities, and that different products utilize these activities in a non-homogeneous fashion. Usually, costing the activity is an intermediate step in the allocation of overhead costs to products, in order to obtain more accurate product cost information. Sometimes, however, the activity itself is the cost object of interest.

Activity base costing system is more useful where the proportion of fixed expenses are higher in total cost of manufacturing.

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CAPITAL INVESTMENT ALTERNATIVES

EVALUATION OF CAPITAL INVESTMENT ALTERNATIVES

Capital investment proposals are evaluated based on following financial tools.

Methods used include:

  • Net Present Value (NPV)
  • Internal Rate of Return (IRR)
  • Payback Period and Discounted Payback Period
  • Profitability Index (PI)

INTERNAL RATE OF RETURN

The IRR is the discount rate at which the PV of future benefits exactly equals the PV of the investment (in other words, a zero NPV)

  • All the relevant cash flows discussed in the  calculation of the NPV are also relevant here however the rate at which we are discounting the cash flows is unknown
  • The only way (even for a computer) is to substitute different discount rates into the equation until the resultant NPV comes to zero (this is known as trial and error)

NPV VS IRR

If the IRR is greater than the WACC, the project should be accepted.

  • This decision will always be compatible with the decision obtained from NPV analysis because a positive NPV automatically means that the IRR is greater than the WACC
  • A difficulty arises when comparing two mutually exclusive projects
  • There is an important and close relationship between NPV and IRR. The NPV is greater than zero if and only if the IRR is greater than the discount rate. This relationship implies that if a single proposed capital investment is considered in isolation, both NPV and IRR will provide the same answer to the question of whether or not the investment should be undertaken. However, NPV and IRR need not provide the same answer if projects that require different investments are compared. In conclusion, NPV and IRR need not rank projects equivalently, if the projects differ in size.
  • The project with the highest NPV may not have the highest IRR
  • Under such circumstances, the NPV is always the criteria to use

PAY BACK PERIOD

A simple approach to capital budgeting that is designed to tell you how many years it will take to recover the initial investment.

  • It is often used by financial managers as one of a set of investment screens, because it gives the manager an intuitive sense of the project’s risk.
  • The calculation can be performed without considering the time value of money or by considering time value (discounted payback).

PROFITABILITY INDEX (PI)

Another measure that can help in ranking the projects when several are involved is the profitability index (PI)

  • Uses exactly the same figures as are needed for the NPV and is calculated as the ratio of the PV of net cash benefits to the PV of the investment.
  • A ratio greater than 1.0 will always result when the NPV is positive
  • When the NPV is zero, the PI will be exactly 1.0

All three measurements (NPV, IRR and PI) will result in the same decision for a particular investment

 

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LONG TERM FINANCE

LONG TERM FINANCE

Ideal capital structure is composing of mixture of debt and equity finance. Debt is a cheaper source of finance as interest cost is tax deductible, while dividend on equity is taxable. However one cannot opt for exclusive debt finance on account of restriction by lenders and availability of sufficient amount of cash flow to service the debt.

Following are the pros and cons of various long term source of finance. For ideal capital structure one need to evaluate all these options before making the final selection.

COMMON SHARES

Advantages:

  • Right to vote
  • Right to transfer through sale of shares
  • Right of earning
  • Limited liability

Disadvantages:

  • Least priority in profit
  • High cost while floating in public
  • Dividend is not tax deductible

PREFERENCE SHARES

Preferred shares with redemption privileges are very similar to debt with a fixed payment each year- the accounting for such shares is to treat them as debt and not equity. Preference shares without redemption privilege are treated as equity.

Advantages:

  • Diviend can be differed for future years
  • Debt equity ratio may improve
  • No dilution of control on account of non-voting power
  • No charge on assets like bank loan

Dis-advantages:

  • In case of liquidity, last priority but before common shares
  • Return is limited and fixed
  • No voting right
  • Dividend is not tax deductible

 BANK LOAN

Advantages:

  • Easy form of finance, obtained quickly
  • Less costly compare to other finance as interest cost is tax deductible

Disadvantages:

  • Have to observe bank convent
  • Charge on assets by bank
  • Debt to equity ratio may go up

Bonds

Bonds will require regular cash outflows to pay the interest expense but this differs from a loan in that no principal repayments are required before the bond is due. The interest expense is deductible for tax purposes. It will increase debt equity ratio.

Fully Convertible bonds

The fully convertible debentures are comprised of two components: a financial liability with a contractual arrangement to deliver cash at a specified time and an equity instrument where the holder is to convert it into a fixed number of shares at the end of X years. For accounting purposes, it would be required to record the liability and equity components separately. This will impact the debt-to-equity ratio by the amount recorded under each component and could result in a breach of the debt covenant. It will also be required to clearly disclose the specific characteristics of the fully convertible debt in the financial statements.

 

 

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IT System and Audit Risk

IT System and Audit Risk

Audit risk has a direct co-relation with IT system in an organisation.  Whenever organisation is planning and implementing new IT system or upgrading the present one, control risk will increase on account of change in flow of activities. Following are the possible scenario where IT system needs improvement or an implementation of a new or revise version of the present system.

  • In case of merger
  • In case of expansion by issue of equity shares
  • In case of expansion in foreign subsidiaries
  • In NFPO( Not For Profit Organisation), where present system is a manual one or needs upgrade  due to problems in the existing system
  • In case of old and out dated present IT system

In all above situation, control risk will increase and as such audit risk will decrease. Auditor will require collecting more evidences with substantive testing.

Audit and IT Environment

Due diligence and care is required while performing an audit with IT environment in an organisation. All accounting transactions are processed now a day through computer program and as such it will be difficult for the auditor to track and verify the accuracy. Auditor can do audit around the computer and audit within the computer through certain techniques. He can verify input record and output records, can do analysis, perform reasonability check and or do computation on calculators. He can verify management policies and procedures. He can also check programing by entering sample transaction in his own software to ensure accuracy and reliability of financial data.

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INTERNAL CONTROL

INTERNAL CONTROL

It is defined as establishment of policies and procedures by the management to achieve the management objectives. It is the management who is responsible to see that proper policies and procedures are being employed in the organisation and also to regularly monitoring the same to avoid any fraudulent activities within the organization.

Generally policies and procedures are for

  1. 1.       Finance and Accounts Department
  2. 2.       Human Resource Department
  3. 3.       IT Department
  4. 4.       Administration Department
  5. 5.       Production Department

Internal Audit or External Audit should regularly audit or verify the various policies in the organisation and prepare action oriented reports for Board of Directors for taking managerial decision for updating various policies and procedures

Budget and Budgetary control system also ensures effective control on various activities. Variance analysis and forecasting analysis will also help to achieve this

 

 

 

 

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