Accounting Issues

Matching Principle The Revenue and Expenses must be matched to ensure the correct profit measurement. Questions You would need to Ask? –Did the EXPENSE actually incur (happen) to earn the revenue. –Was the revenue earned?

Depreciation There are two methods to calculate Depreciation 1.Straight-Line Method 2.Reducing Balance Method

Straight-Line Method Depreciation = (Original Cost-Scrap Value)/Useful Life Depreciation can also be calculated by using a Depreciation Rate. –Find the depreciation of Equipment which cost $10,000 using straight-line method of depreciation where the depreciation rate is 20%. –Answer: Dep. = x 0.20 = $2000

Straight-Line Method It is called a Straight-Line Method because the depreciation is the same for every one full year.

Straight-Line Method

Reducing Balance Method Depreciation is calculated on the reduced balance of the asset using a depreciation rate. Reduced Balance is the same as Carrying Cost. –It is the balance of the asset after subtracting the accumulated Depreciation.

Reducing Balance Method Example: –The Historical Cost of Equipment is $ Find Depreciation using the Reducing balance Method at a Depreciation rate of 20%. –Answer: Year 1:15000 x 0.20 = $3000 Year 2:12000 x 0.20 = $2400 Year 3:9600 x 0.20 = $1920 Year 4: 7680 x 0.02 = $1536

Reducing Balance Method

Which Method to Use? Depends on the Revenue generated by the asset. –If the revenue is high in the initial years and lower in later years – use reducing balance method. –If the revenue generated is same for all the years – use straight line method.

Which Method to Use? Straight Line Reducing Balance

Comparability For the sake of the Qualitative characteristic of ‘Comparability’ You can not change from one method to another from year to year. Stick to the one you chose

Historical Cost Non Current Assets are reported at historical cost (the actual price paid) –Why? It is reliable. The documents provide a proof. Is there any Problem with using historical cost?

Historical Cost A business bought a building in 1950 for $20,000. It still owns it. (2003)

Historical Cost Do you think this is reliable? (2003) (Extract from the this years Statement of Financial Position) Do you think this is Relevant?Do you think this is Relevant?

Historical Cost The building was valued this year to be worth $230,000. Record shows a value of $20,000 Which one is a fair value? Which value is reliable? $230,000/20,000 Which value is relevant? This is an issue? What should we do?

Revalue the Asset Revaluation of Asset upward By how much? – = Dr Asset Cr Asset Revaluation Reserve

Ledgers

Statement of Financial Position Extract Only BEFORE AFTER REVALUATION

Can a Asset be adjusted downward? Yes –It is called Revaluation Decrement

Relevance and reliability Registered Valuers must be used to value. Three Valuations must be sought. –If all three valuations are different – use the principle of ‘Conservatism’ – choose the lower of the three.

What Type of Account is “Asset Revaluation Reserve”? Owner’s Equity Increase CREDIT Decrease DEBIT

Depreciation of Revalued Asset! Depreciation must be based on the new Fair Value. –New Estimate of Residual Value (Scrap Value) is necessary.

Third Issue: Recognition of Revenue When to recognise revenue to have been earned when goods are sold on credit! (when to record as sale has taken place) When the goods are sold When Goods are delivered When the invoice is issued When the Cash is Received –Some of these events may occur at the same time.

Two Common Methods Recognise At POS (Point of sale) 0r Point of cash received POS is for Accrual Accounting POC is for cash accounting –We are dealing with accrual accounting

Points to Note In either case: Goods should have been delivered Proof must be available to verify the sale