Notes - Accounting for Specific Business and Transaction

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Accounting for Specific Business and Transaction

23.1 Consignment

It is an arrangement, whereby one person sends goods to another person on the basis that the goods can be sold on behalf and at the risk of the former, for a commission. Accounts maintained in the books of consignor (sender of goods) are.

Consignment account (to find profit or loss on consignment).

Consignee’s personal account (to find the amount due from/to consignee).

Goods sent on consignment account (to find the value of stock lying with the consignee).

Del-credre Commission is an additional commission paid to consignee who guarantees the payment in case of credit sales.

Over-riding Commission is extra commission allowed to consignee to motivate him to sell goods over and above the invoice price.

23.1.1 Joint Venture

It is a temporary partnership between two or more persons without the use of a firm name, for a specific purpose. The persons who have agreed to undertake a joint venture are known as co-ventures.

It is a short duration special purpose partnership. Going concern approach is not applicable for joint venture.

23.1.2 Depreciation Accounting

Depreciation is decrease in the value of fixed asset due to use, passage of time, obsolescence, market changes or any other similar cause. The factors to be considered while ascertaining the amount of depreciation to be charged to profit and loss account are historical cost of asset, estimated useful life and estimated scrap value.

Different Methods to Calculate Depredation

Straight Line Method

Under this method, a fixed and equal amount in the form of depreciation, according to a fixed percentage on the original cost, is written-off during each accounting period over the expected useful life of the asset.

Depreciation

\[=\frac{Cost+Installation\text{ }Expenses-Scrap\text{ }Value}{Useful\text{ }Life}\]

Depreciation Rate =\[\frac{Depreciation}{Cost\,of\,Asset}\times 100\]

Reducing Balance Method

Depreciation according to a fixed percentage is calculated upon the original cost (for first year) and on written down value (in subsequent years) of an asset in this method.

Depreciation = Cost/ WDV\[\times \frac{Rate\,of\,Depreciation}{100}\]

Sum of Digit Method

In this method, depreciation is apportioned in the ratio of the estimated life of the asset.

Depreciation = (Original Cost - Scrap Value)

\[\times \frac{Number\text{ }of\text{ }Years\text{ }of\text{ }Remaining\text{ }Life\text{ }of\text{ }the\text{ }Assets}{Total\text{ }of\text{ }all\text{ }Digits\text{ }of\text{ }Life}\]

Annuity Method

This method takes into account the interest on capital outlay and seeks to write-off the value of asset and the interest lost over the life of the asset.

\[Depreciation=Cost\text{ }of\text{ }the\text{ }Asset\times Rate\text{ }of\text{ }Annuity\]

Sinking Fund Method

Sinking fund is a fund created by the regular investment of a fixed amount to accumulate the amount of money required to replace an asset at a set date in the future. The following points related to this method should be kept in mind. (a) The asset is shown in the balance sheet every year, at its original value, (b) Sinking fund is shown on the liabilities side. (c) Sinking fund investment is shown on the assets side of the balance sheet.

\[Depreciation=Cost\text{ }of\text{ }Asset\times Rate\text{ }of\text{ }Annuity\]

Machine Hour Method

In this method, depreciation is calculated on, the basis of the expected number of hours, a machine is expected to operate.

\[Depreciation=\frac{Machine\text{ }Hours\text{ }Worked}{Total\text{ }Estimated\text{ }Number\text{ }of\,Machine\text{ }Hours\text{ }during\text{ }Useful\text{ }Life}\]

Production Units Method

In this method, depreciation is calculated on the basis of the expected number of products, a machine is expected to produce.

\[Depreciation=\frac{Unit\text{ }Produced}{Total\text{ }Estimated\text{ }Number\text{ }of\,Units\,to\text{ }be~Produced\text{ }during\text{ }Useful\text{ }Life}\]

\[Depreciation=\frac{Depreciable\text{ }Amount\times Actual\,Production\text{ }during\text{ }the\text{ }Period}{Estimated\text{ }Total\text{ }Production}\]

Depletion Method

This method is used for wasting assets such as mines, quarries etc. The distinguishing feature of these types of assets is that they cannot be depreciated but can gradually be depleted. The formula to be used is

\[Depreciation=Quantity\text{ }Extracted\times Rate\text{ }of\text{ }Depreciation\text{ }Per\text{ }Unit\]

Provision for Repair and Renewal Method

In this method, provision for repairs and renewals is also considered while providing for depreciation.

\[Depreciation=\frac{\left( Original\text{ }Cost-Residual\text{ }Value \right)+\text{ }Estimated\text{ }Total\text{ }Cost\text{ }of\text{ }Repairs}{Useful\text{ }Life\text{ }of\text{ }the\text{ }Asset}\]

23.2 Bank Reconciliation Statement

It is a statement prepared on a particular date reconciling the bank balance in the cash book with the balance as per bank statement or pass book showing the reasons or causes of difference between the two balances.

Preparation of Bank Reconciliation Statement

After identifying the causes of difference, a bank reconciliation statement can be prepared by taking the balance as per cash book or the balance as per passbook as the starting point. If the starting point is balance as per cash book, the answer arrived at will be the balance as per pass book and vice-versa.

The simplest and most common format is given below

Bank Reconciliation Statement

as on......

Particulars	Plus (`)	Minus (`)

A summarised view of transactions related to BRS
Particulars		Cash book-Starting balance		Pass book-Starting balance
Particulars		Favourable balance (Dr balance) (written in plus column)	Overdraft (Cr balance)	Favourable balance (Cr balance)	Overdraft (Dr balance)
(a)	Cheques issued but not yet presented for payment.	+	\[-\]	\[-\]	+
(b)	Cheques deposited into the bank but not yet collected.	\[-\]	+	+	\[-\]
(c)	Interest allowed by the bank but not entered in the cash book.	+	\[-\]	\[-\]	+
(d)	Bank charges not entered in the cash book.	\[-\]	+	+	\[-\]
(e)	Direct deposit into the bank by a customer.	+	\[-\]	\[-\]	+
(f)	Direct payments from the bank not entered in the cash book.	\[-\]	+	+	\[-\]
(g)	Direct collections made by the bank not entered in the cash book.	+	\[-\]	\[-\]	+
(h)	Cheque issued and payment received by the creditor but not entered in the cash book.	\[-\]	+	+	\[-\]
(i)	Cheque paid into the bank but omitted to be entered in the cash book.	+	\[-\]	\[-\]	+
(j)	Dishonour of a cheque and bill discounted with the bank.	c	+	+	\[-\]
(k)	Cheque entered in the cash book but not sent to the bank.	\[-\]	+	+	\[-\]

23.3 Bills of Exchange

According to Section 5 of the Negotiable Instruments Act, 1881; a bill of exchange is defined as an instrument in writing containing an unconditional order, signed by the maker directing a certain person to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instrument. A bill of exchange is generally drawn by the creditor upon his debtor. It has to be accepted by the drawee (debtor) or someone on his behalf.

Parties to a Bill of Exchange

There are three parties to a bill of exchange

(i) Drawer

The maker of the bill of exchange is the drawer, i.e. the person who draws the bill. He is the person who has granted credit to the person on whom the bill of exchange is drawn.

(ii) Drawee

The person upon whom the bill of exchange is drawn for his acceptance is a drawee. Drawee is the person to whom credit has been granted.

(iii) Payee

He is the person to whom the payment is to be made, i.e., the person in whose favour the bill is made.

Types of Bills of Exchange

Trade Bill A bill drawn and accepted for a business transaction.
Accommodation Bill A bill drawn and accepted for mutual help.
Bill at Sight It means a bill of exchange payable on demand.
Bill after Date Where a bill is payable at a fixed period after date, the period begins from date of drawing the bill. 3 days of grace are allowed on such bills.
Bills after Sight In bills of exchange ‘after sight’ means accepting. Where a bill is payable at a fixed period after sight the period begins from the date of acceptance. 3 days of grace are allowed on such bills.

Important Terms

Term of a Bill It is the period intervening between the date on which a bill is drawn and that on which it becomes due.
Due Date It is the date on which the payment of the bill is due.
Days of Grace These are three extra days added to the period of the bill.
Date of Maturity The date which comes after adding three days to the due date.
Discounting of the Bill A bill may be presented to a bank and amount received against it. It is known as discounting of bill.
Endorsement of Bill It means transferring the bill of exchange to another person.
Bill Sent for Collection Drawer may deposit the bill with the bank, with instructions to collect payment on the due date. This is known as ‘bill sent for collection’.
Noting of a Bill Bill when sent through a notary public and is dishonoured is known as ‘noting of a bill’.
Noting Charges It is the fee paid to notary public for noting and protesting the bill of exchange of its dishonour.
Retirement of the Bill When the drawee pays the bill before its due date, it is termed as retirement of the bill. The drawee is given rebate.

23.4 Rectification of Errors

Errors whether affecting the trial balance or not, must be detected and corrected. The procedure followed to rectify the errors and to set right the accounting records is called rectification of errors. Errors can be rectified in either of the three stages.

Before the preparation of trial balance
After the preparation of trial balance but before preparing the find accounts (through suspense account)
After the preparation of final accounts (through profit and loss adjustment account)

Types of Errors

Errors can be broadly categorised as clerical errors and errors of principle

Clerical Errors These are those errors which the accountants commit while posting the entry. These errors are of the following types

Error of Commission These are the errors which are committed due to wrong posting of transactions, wrong totalling or balancing of accounts, wrong casting of the subsidiary books or wrong recording of the amount in the books of original entry. These errors affect the accuracy of the trial balance.

Error of Ommission These errors are committed at the time of recording the transactions in the books of original entry. These can be of two types

(a) Error of Complete Ommission It results when a transaction is completely omitted to be recorded in the books of original entry. These errors do not affect the trial balance.

(b) Error of Partial Ommission It results when a transaction is partially omitted to be recorded in the books of original entry. These errors affect the trial balance.

Compensating Errors When two or more errors are committed in such a way that the net effect of these errors on the debit and credit of accounts is nil, then such errors are called compensating errors.

Errors of Principle These are those errors which occur due to incorrect classification of expenditure or receipt between capital and revenue. These errors do not affect the tallying of the trial balance.

Capital transactions are those which result in the change in the position of assets and liabilities.

Revenue transactions are those which neither affect the assets nor the liabilities. They affect the profit or loss position of a business.

23.5 Accounts from Incomplete Records

Accounting records which are not maintained in accordance with the principles of double entry system are known as accounts from incomplete records or single entire system of accounting.

Under this system, both the aspects are recorded for certain transactions only, while for others only one aspect is recorded. Some transactions are ignored and not recorded at all.

Features of Incomplete Records

(i) It is an inaccurate, unscientific and unsystematic method of recording business transactions.

(ii) Generally, records for cash transactions and personal accounts are properly maintained and there is no information regarding revenues and/or gains, expenses and/or losses, assets and liabilities.

(iii) This system is suitable for small size business where the number of transactions are less.

Ascertainment of Profit or Loss Under the Incomplete Records

In case of organisations maintaining incomplete records the amount of profit or loss can be ascertained as follows

(i) By Statement of Affairs or Net Worth Method i.e. by preparing the statement of affairs as at the beginning and as at the end of the accounting period.

(ii) By Conversion Method i.e. by preparing trading a profit and loss account and the balance sheet by putting the accounting records in proper order.

Statement of Affairs

A statement of affairs is a statement of all assets and liabilities. In this method, assets are shown on one side and the liabilities on the other, just as in case of a balance sheet.

It is also based on accounting equation, viz.

\[Capital=Assets-Liabilities\]

The format of Statement of Affairs is given below

Statement of Affairs

as at ……….

Liabilities	Amt (`)	Assets	Amt (`)
	……….	Cash in Hand	……….
Bank Overdraft	……….	Cash at Bank	……….
Bills Payable	……….	Bills Receivable	……….
Sundry Creditors	……….	Sundry Debtors	……….
Outstanding Expenses	……….	Stock	……….
Incomes Received in Advance	……….	Prepaid Expenses	……….
Capital (Balancing Figure)		Accured Expenses	……….
		Furniture	……….
		Plant and Machinery etc.	……….
	……….		……….

Calculation of Profit or Loss by Statement of Affairs or Net Worth Method

For the calculation of profit or loss, given below steps should be followed

Step 1 Firstly, prepare the statement of affairs at the beginning, of the year for calculating opening capital.

Step 2 Then, prepare the statement of affairs at the end, to calculate the closing capital.

Step 3 Prepare statement of profit or loss to find profit earned or loss incurred during the year.

The format of statement of profit and loss is given below

Statement Showing Profit or Loss

for the year Ended...

Particulars	Amt (`)
Capital at the End of the Year (Computed from statement of affairs as at the end of year)	……….
(+) Drawings During the Year	……….
(-) Additional Capital Introduced During the Year	(……….)
Adjusted Capital at the End of Year	……….
(-) Capital in the Beginning of Year (Computed from statement of affairs as at the beginning of year)	(……….)
Profit or Loss Made During the Year	……….
Profit or Loss Made During the Year	……….

The same computation can be done in the form of an equation as follow

\[\mathbf{Formula}-Profit\text{ }or\text{ }Loss=Capital\text{ }at\text{ }the\text{ }End-Capital\text{ }in\text{ }the\text{ }Beginning+Drawings\text{ }During\text{ }the\text{ }Year\]

\[~-Capital\text{ }Introduced\text{ }During\text{ }the\text{ }Year~\]

23.6 Human Resource Accounting

The American Accounting Association’s Committee on Human Resource Accounting (1973) has defined Human Resource Accounting as “the process of identifying and measuring data about human resources and communicating this information to interested parties”.

The concept of human resource accounting can be basically examined from two dimensions

The investment in human resources
The value of human resources

Basically, Human Resource Accounting (HRA) is an information system that tells management, what changes are occurring over the time to the human resource of the business.

HRA also involves accounting for investment in people and their replacement cost, it also involves economic value of people in the organisation. It is a process of identifying and reporting the investment made in human resource of the organisation that is not accounted for in current conventional accounting system.

There are a few organisations that do recognise the value of their human resources and furnish the related information in their annual reports.

In India, some of these companies are as follow

Infosys, Bharat Heavy Electricals Ltd (BHEL), The Steel Authority of India Ltd (SAIL)
The Minerals and Metals Trading Corporation of India Ltd (MMTC)
The Southern Petrochemicals Industries Corporation of India (SPIC)
The Associated Cement Companies Ltd.

Objectives of Human Resource Accounting

The main objectives of a HR Accounting system are as follows

· To furnish cost value information for making proper and effective management decisions about acquiring, allocating, developing and maintaining human resources in order to achieve cost effective organisational objectives.

· To monitor effectively the use of human resources by the management.

· To have an analysis of the human asset i.e., whether such assets are conserved, depleted or appreciated.

· To aid in the development of management principles and proper decision-making for the future by classifying financial consequences of various practices.

In all, it facilitates valuation of human resources, recording the valuation in the books of account and disclosure of the information in the financial statement.

Further, it is to help the organisation in decision-making in the following areas

(i) Direct Recruitment Vs Promotion.

(ii) Transfer Vs Retention.

(iii) Retrenchment Vs Retention.

(iv) Impact on budgetary controls of human relations and organisational behaviour.

(v) Decision on reallocation of plants, closing down existing units and developing overseas subsidiaries etc.

Methods of Human Resource Accounting

Quite a few models/have been suggested in the past for the human resource accounting and these can be classified into two parts each having various models;

Some of the important ones are as follows

Cost Based Models

The various moderns under cost based models are as follows

Capitalisation of Historical Costs Model

Under this method, the sum of all costs i.e. recruitment, acquisition, formal training, informal training, informal familiarisation, experience and development is taken together to indicate the value of the human resources.

The value is amortised annually ever the expected length of the service of individual employees and the unamortised cost is shown as investments in the human assets. If an employee leaves the firm (i.e. human assets expire) before the expected service life period, then the net value to that extent is charged to the current revenue.

Replacement Cost Model

As the historical cost method only takes into account the sunk costs, which are irrelevant for decision-making. A new model for human resource accounting was conceptualized, which took into account, the costs that would be incurred to replace its existing human resources by an identical one.

Individual Replacement Costs It refers to the cost, which is to be incurred in replacing an individual by a substitute, who can provide the same set of services as that of the individual being replaced,

Positional Replacement Costs It refers to the cost of replacing the set of services referred by an official in a defined position, the positional replacement cost takes into account the position in the organisation currently held by the employee and also the future positions expected to be held by him.

Opportunity Cost Model

This model was advocated by Hekiman and Jones in the year 1967 and is also known as the market value method.

This model is based on the concept of opportunity cost i.e. the value of an employee in its alternative best use, as a basis of estimating the value of human resources.

This method was advocated for a company with several divisional heads bidding for the services of various people, the need among themselves and then include the bid price in the investment cost.

There is no opportunity coy for those employees that are not scarce and also those at the top will not be available for auction. As such, only scarce people should comprise the value of human resources.

Value Based Model

The various models under value based models are as follows

Present Value of Future Earnings Model

This model of human resource accounting was developed by Lev and Schwartz in the year 1971 and involves determining the value of human resources as per the present value of estimated future earnings discounted by the Rate of Return on Investment (Cost of Capital). This method helps in determining what an employee’s future contribution worth today.

As per this valuation model of human resource accounting, the value of human capital embodied in a person, who is ‘y’ years old, is the present value of his/her remaining future earnings from employment and can be calculated by using the following formula

\[E\left( {{V}_{y}} \right)=\sum {{P}_{y}}\left( t+1 \right)\text{ }S\text{ }I\left( T \right)/{{\left( I+R \right)}^{t-y}}\]

where E\[\left( {{V}_{y}} \right)\]= Expected value of a ‘y’ year old person’s human capital

T = The person’s retirement age

\[{{P}_{y}}\](t) = Probability of the person leaving the organisation

I (t) = Expected earnings of the person in period

IR = Discount Rate

Reward Valuation Model/Flamholtz Model

This model was advocated by Flamholtz. It says that an individual’s value to an organisation is determined by the services, he is expected to render. This model of human resource accounting is an improvement to the “Present Value of Future Earnings Model” as it takes into account the probability that an individual is expected to move through a set of mutually exclusive organisational roles or service states during a time interval.

Such movement can be estimated by using the following formula

\[E(S)=\sum\limits_{i=1}^{n}{{{S}_{\,i}}P({{S}_{i}})}\]

Valuation on Group Basis

The proper valuation as per human resources accounting is not possible unless the contributions of the individuals as a group are taken into consideration. An individual’s expected service tenure in the organisation is difficult to estimate, but on a group basis it is relatively easier to estimate the percentage of people in a group likely to leave the organisation in the future.

This model of human resource accounting attempted to calculate the present value of all existing employees in such rank.

23.7 Inflation Accounting

Inflation accounting is a system of accounting, which shows the effect of changing costs and prices on affairs of a business unit during an accounting year. While the cost in the traditional accounting refers to the historical cost, in inflation accounting, it represents the cost that prevails at the type of reporting. The different ways, through which financial accounts can be adjusted for changing prices is studied under the subject ‘Inflation Accounting’. Given that price changes can also be downward, it is more appropriately called ‘accounting for price level changes’.

Effects of Inflation on Accounts

Profit and loss account will show more profit than actual as depreciation is inadequate and closing stock is valued at higher amount.
More amount of income tax and dividend. So, acute shortage of working capital.
Balance sheet would not show true and fair view.
Depreciation is inadequate so, when required to replace another source of long-term fund is required to seek.

Needs of Inflation Accounting

In the traditional accounting, assets are shown at historical cost, year after year.

Also during the inflationary period, historical cost based depreciation would be highly insufficient to replace the existing assets at current cost. Moreover current revenues for the period are not properly matched with the current cost of operation.

Therefore, the problems created by price changes in the historical cost based accounts necessitates some method to take care of inflation into the accounting system.

Techniques of Inflation Accounting

The techniques of inflation accounting are as follows

Current Purchasing Power (CPP) Method, based on changes in general price level changes.
Current Cost Accounting (CCA) Method, based on changes in prices of specific assets.

Current Purchasing Power (CPP) Method

In this method, all items in the financial statements are restated in terms of a constant unit of money i.e. in terms of general purchasing power. In order to measure changes in the price level and incorporate changes in the financial statements we use general price index, which is considered to be a barometer for this purpose. The index is used to convert the values of various items in the financial statements. This method takes into account the changes in the general purchasing power of money and ignores the actual rise or fall in the price of the given item.

CPP method involves the refurnishing of historical figures at current purchasing power. For this, historical figures are converted into value of purchasing power at the end of the period. Two index numbers are required one showing the general price level, at the end of the period and the other reflecting the same at the date of the transaction. Profit under this method is an increase in the value of the net asset over a period, all valuations being made in terms of current purchasing power.

Current Cost Accounting (CCA) Method

This method is an alternative to the current purchasing power method. The current cost accounting method matches current revenues with the current cost of the resources, which are consumed in earning them. Changes in the general price level are measured by index numbers. Specific price change occurs, if price of a particular asset changes without any general price change. Under this method, asset are valued at current cost, which is the cost at which asset can be replaced on a date.

While the Current Purchasing Power (CPP) method is known as the General Price Level Approach, the Current Cost Accounting (CCA) method is known as Specific Price Level Approach or Replacement Cost Accounting.

23.8 Social Responsibility Accounting

It is a systematic assessment of and reporting on those parts of a companies activities that have a social impact. Social responsibility accounting would therefore, describe the impact of corporate decisions on environmental pollution, the consumption of non-renewable- resources and ecological factors, on the rights of the individuals and groups, on the maintenance of public safety, on health and education and many other such social concerns.

It is the process of identifying, measuring and communicating the social effects of business decisions to permit informed judgement and decisions by the users of information. It is accounting for social responsibility aspects of a business. Management is held responsible for what it contributes to the social well being and progress.

Accounting for environment and ecology is part of social responsibility accounting.

It is also referred to as sustainability accounting and corporate social responsibility accounting.

Information Reported Under Social Responsibility Accounting

Companies that employ social responsibility accounting may report on some or all of the following issues

Statistics regarding employee health and job-related accidents.

Emission rates, spills and volume of hazardous waste generated.

Use of scarce resources such as water or lumber.

Information about ethical initiatives within the company, such as labour practices, education, philanthropic efforts, human rights and diversity.

Links between executive pay and sustainability criteria.

Corporate Social Responsibility Under The Companies Act-2013: Section 135

Applicability

Every company having

Net worth of ` 500 crore or more, or

Turnover of ` 1000 crore of more, or

Net profit of ` 5 crore or more,

During any financial year shall constitute a Corporate Social Responsibility Committee of the Board.

Committee Members

Three or more directors, out of which at least one director shall be an independent director. So, minimum directors should be three and at least one director should be independent director.

Functions of CSR Committee

Formulate and recommend of the board, CSR Policy which shall indicate the activities to be undertaken by the company.

Recommend the amount of expenditure to be incurred on the activities and Monitor the Corporate Social

Responsibility Policy of the company from time-to-time.

BOD Responsibility

The board of the company after taking into account the recommendations made by the CSR Committee, approve the CSR policy for the company and disclose contents of such policy in its report and also place it on the company’s website, if any, in such manner as may be prescribe and ensure that the activities as are included in CSR policy of the company are undertaken by the company.

The board of the company shall ensure that the company spends in every financial year, at least 2% of the average net profits of the company made during the three immediately preceding financial years, in pursuance of its CSR policy.

Evaluation in Social Science

Notes - Accounting for Specific Business and Transaction

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