Nature of Fixed Assets

Fixed assets are permanent in nature. The characteristics of fixed assets includes,

1. They are physical and tangible in nature.
2. Fixed assets are owned and are meant for performing a firm’s day-to-day activities.
3. Fixed assets are not meant for sale as a part and parcel of their daily activities.
4. Fixed assets accounts for a major part of firm’s total assets and require a substantial part of investment to acquire them.

Importance/Significance of Fixed Assets

Fixed assets acts as the major and primary facilities of a firm in order to perform the business operations. They play a vital role in a firm. without which the business activities cannot be carried out. Fixed assets are classified into different types on the basis of their importance in the firm. They are very significant and plays a crucial role in measurement, evaluation and presentation of the firm’s performance and it’s financial position. It is quite essential necessary to determine the expenditure that have incurred on fixed asset as it holds a considerable effect on the firm’s operations.

A firm‘s main objective behind investing in fixed assets is.

1. To expand the firm’s operations in order to meet the market demand.
2. To cope up with the advanced technology in the industry to reduce costs. increase quality of operations and to gain competitive advantage.
3. To offer provide secondary business requirements like warehouses. distribution centres and so on. Thus, it is quite clear that the fixed assets forms the core facilities of a firm and plays a crucial role in the successful accomplishment of the firm’s objectives.

Determination of Value of Fixed Assets

The following are the principles and procedure for the determination of value of fixed assets,

1. The cost of fixed assets include purchase price, trade discounts, import duties and non-refundable taxes, direct costs associated with the assets such as installation costs, delivery costs etc.,
2. While determining value of fixed assets, one should consider the changes in the prices and exchange rates as they have substantial effect on the value of fixed assets.
3. The administration and other general overhead expenses that are associated with the project construction such as start-up costs, commission, experimental production costs.
4. While determining the value/cost of self-constructed fixed assets and outsourced fixed assets. one should consider the direct costs associated with assets and construction of general assets for the functioning of special asset.
5. For an asset that is exchanged for acquiring another one, the cost can be determined based on fair market value or net book value with reference to either of the exchanged asset. It should be adjusted with associated payments and receipts.
6. For the cost of fixed assets one should add additional expenses associated with it which can generate high profits in future.

Revaluation of Fixed Assets

Sometimes the historical costs of financial statements can be replaced by the fixed assets costs. These revalued amounts will form basis for the calculation of depreciation on these assets. The guidelines for the revaluation accounting are.

1. The book value of different categories of fixed assets can be determined based on different valuation criteria. The valuation methods include indexation with price indices and reference to current prices. The revaluated fixed assets should be continuously assessed using appraisal by competent valuer method.
2. Net book value should be equal to net revalued amount. For which, firms need to restate the gross book value and accumulated depreciation along with the revalued fixed asset value.
3. Firm should revaluate the whole class/category of assets in a systematic way.
4. If the net book value is hither than the recoverable amount of assets of a class then the revaluation of fixed assets of that class does not yield their net book value.
5. The rise in the net book value as a result of revaluation should be credited under revaluation reserves and it is not meant for allocation.
6. The increased value can be credited under profit and loss account if it offsets the previous decline in net book value due to revaluation. Similarly, the decline in the net book value as a result of revaluation should be debited under profit and loss account.

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The following are the objectives of trial balance.

1. Trial balance is one of the methods/techniques to assure that the books of account are being scientifically maintained according to double entry bookkeeping system.
2. It helps to summarize all the ledger accounts at one place.
3. It serves as a method/technique to identify the mistakes which are done by the accountants while recording the transactions in j oumaL1subsidiary books and ledger postings.
4. It serves as a foundation in preparing the Trading and Profit and Loss account and Balance Sheet (i.e., final accounts).

Features of Trial Balance

The following are the features of trial balance.

1. It is a statement prepared in a tabular form.
2. Trial balance is a statement of closing balance but is not an account.
3. It is prepared to verify the arithmetical accuracy.
4. Preparation of trial balance leads to the preparation of final accounts.

Limitations of Trial Balance

The accountants must take into consideration. the following limitations while maintaining proper accounts.

1. Trial balance alone cannot be regarded as the main factor for achieving the arithmetic accuracy of the account books. Quite a few times inspite of there being a balanced trial balance, the accountant may commit mistakes or errors in trial balance. which are not being shown by balances. Even then the trial balance would be balanced with few hidden errors.
2. Trial balance is useful only for those finns that implement double-entry bookkeeping. The small firms which do not implement double-entry bookkeeping cannot prepare a trial balance.
3. The correct trial balance would show the correct financial position of the firm. The trial balance with mistakes or errors would also result in mistakes or errors in the financial statement which would therefore not show the true and fair position of the firm.

Methods of Preparing Trial Balance

Trial balance can be prepared by using three different methods. Under all the three methods. the total of debit and credit columns should be equal. The three methods used for preparing trial balance are as follows.

1. Balance method
2. Total method
3. Total and balance method.

Balance Method

The trial balance is basically prepared by taking into consideration balances of the ledger accounts. All the ledger accounts have a debit and credit side which are balanced at the end of a particular time period. In case, when the total of the debit side of an account is more than the total of the credit side then that balance is called as debit balance and it appears on the debit column of time trial balance. Similarly, in case when the credit side of an account is more than its debit side. it appears on the credit side of trial balance and is known as credit balance. In trial balance. the total of debit and credit side should be equal.

Total Method

Under this method, total of the debit side is written in the debit column and the total of credit side is written in the credit column of the trial balance. The balance of debit and credit side should be equal. If in case it is not equal then it indicates that there exists few errors which needs to be identified and corrected.

Total and Balance Method

Under this method. the balance and total method of the trial balance are shown in the same trial balance. This method divides/segregates the amount column between total and balance methods. Both the methods have two columns of debit and credit. However, under each method the total of debit and credit side should be equal. Both the methods would have totals but the total of debit and credit side must be equal.

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Fund flow statement possess the following features,

1. It is a dynamic representation of an enterprise over a period of time.
2. It acts as a link between the two successive balance sheets, thereby maintaining the relationship between the two.
3. It represents cash inflows and outflows in a specified manner.
4. It acts as a separate statement which is not a part of double entry system of accounts.
5. It is prepared on yearly basis.

Importance/Uses/Significance/Advantages of Fund Flow Statement

The significance of fund flow statement can be easily understood from the following points,

1. Analysis of Financial Operations

Balance sheet gives a static view of resources and does not reveal the reasons for changing the assets and liabilities at different points of time. In this situation funds flow statement is useful as it explains the reasons for changes and the impact of such changes on the liquidity position of the company.

2. Evaluates Use of Working Capital

The funds flow statement enables the management in understanding the effective utilization of working capital and also the adoption of different methods for improving the working capital position of a firm.

3. Future Guide

The forecasted funds flow statement acts as a future guide for the management. Funds flow statement is useful in identifying the problems relating to funds which may arise in future. Depending on such fore castings, firm can make arrangement which helps them either in overcoming or reducing the frequency of occurrence of such problems.

4. Proper Allocation of Resources

As there is an availability of limited resources with the firm, it is necessary to make best use of it. A firm prepares a forecasted funds flow statement for future which helps in decision-making, planning the optimal allocation and utilization of resources.

5. Solves Complicated Questions

Funds flow statement helps in solving complicated questions which is a very difficult task. These questions were related with the sources of repayment of debt, net profit, sources of financing the Marking capital, distribution of dividends and so on.

Limitations of Fund Flow Statement

Funds flow statement is useful in many ways but it is also associated with certain limitations. Some of them include,

1. It does not acts as a substitute for an income statement or balance sheet as it only explains about the working capital position of the business but doesn’t give any idea about the amount of earnings or profits of a firm.
2. It does not give any information about the actual profits gained by the organization.
3. As funds flow statements are historical in nature it is not possible to prepare accurate projected funds flow statement as the same historical limitations are also carried forward in future.
4. It is not possible for funds flow statement to disclose continuous changes encountered in an organization.
5. Funds flow statement is prepared based on the information of balance sheet and income statement. But this statement is also subjected to certain further limitations such as,

(i) It reveals only monetary transactions.

(ii) It depends on accounting concepts and conventions.

(iii) It is historical in nature, unless projected funds flow statement is prepared to plan for the future, it is not of much use.

Need/Purpose of Fund Flow Statement

Funds flow statement/analysis or statement of changes in the financial position of a firm serves the following purposes:

1. It helps the investors to determine the most significant factors which are responsible for facilitating changes in financial position
2. It helps to identify internal factors (i.e. internal operations) and external sources through which changes has been made.
3. It helps to focus on the factors that are responsible for estimating the differences in equity assets and liabilities.
4. It IS useful to emphasize the changes which took place in the investment assets.
5. It also depicts the changes which have been made while collecting funds for investing in business.

Objectives of Fund Flow Statement

The main objectives of funds flow statement or analysis are as follows:

1. To represents the changes in the financial position of a firm during the accounting period.
2. To estimate and measure the funds generated or depleted through internal operations.
3. To determine the various sources from which the funds can be collected and also the different strategies the help of which such funds can be utilized.
4. To disclose hidden information which is not clear either in profit and loss account or in balance sheet.
5. To represent the effect of entire transactions on the working capital of enterprise during the accounting period.

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Working capital can also be defined as excess of current assets over current liabilities or difference between the inflow and outflow of funds.

Concepts of Working Capital

Working capital concepts are being categorized into two main heads as follows,

1. Balance sheet concept and
2. Operating cycle (or) circular flow concept.

1. Balance Sheet Concept

The balance sheet concept explains the working capital in two ways as follows,

1. Gross working capital and
2. Net working capital.

Gross Working Capital

Gross working capital helps in solving the problem of managing individual current assets in two aspects,

(i) A firm must finance only those current assets which are useful and does not result in idle investment and inadequate return on investment in current assets, ultimately increases the risk. If investment made in current assets which are not productive then they block the capital which leads to insufficient capital to meet current obligations of the firm. Hence, firm must maintain only adequate working capital which is required for its business.

(ii) It is necessary for management to secure some amount of funds in order to finance the current assets. Firm must maintain adequate funds to meet additional working capital if business is increased. Financial manager must have knowledge of evaluating the level of current assets required and different sources of financing current assets.

Net Working Capital

The concept of net working capital is useful for management in identifying the permanent sources for financing the working capital requirements. It represents the liquidity position of the firm. Net working capital explains that every firm must have current assets more than current liabilities to meet current obligations effectively. In order to maintain a margin of current assets, it must be device of current liabilities. Quality of current assets implies the structure of current assets. The quality of current assets reflects the liquidity position of the firm. If a firm maintains high level of current assets but if its quality is not appropriate then it may lead to inadequate liquidity position which have impact on solvency of the firm. When current liabilities are more than current assets it leads to negative net working capital which is harmful for the firm.

2. Operating Cycle (or) Circular Flow Concept

The time period needed to convert sales into cash is known as an operating cycle. In a manufacturing company, operating cycle consists of three stages,

1. Purchase of resources which are required in a manufacturing company such as raw material, labor, power and fuel etc.
2. Manufacturing of the product involves production process is a conversion of raw material into work-in-progress and then transform into finished goods.
3. The ultimate stage is, sale of the product which can be in cash or credit. Credit sales usually create account receivable for collection.

Firm must retain liquid assets for purchase of raw materials and payment of expenses like salaries and wages, taxes, operating expenses, etc. Gross operating cycle is the sum of inventory conversion period and debtors conversion period.

The inventory conversion period is the time period required for producing and selling the product.

The debtor’s conversion period is the time period needed to acquire the outstanding amount from customers to whom goods are sold on credit.

Figure: Operating Cycle.

Gross operating cycle = Inventory conversion period + Debtors conversion period

Net operating cycle = Gross operating cycle – payables deferral period

The need for working capital results in the growth and expansion of business of a firm.

Need for Working Capital

Each and every company needs working capital in order to perform/carry out the day-to-day activities inspective of its size whether small (or) big because without working capital the company would shut down.

Usually, mainly due to the time period taken between production and realization of cash from sales gives rise to the need for working capital wherein, an operating cycle is engaged in raising cash from sales due to time lapse in purchase of raw-materials and production, production and sales and so on.

Therefore, working capital is required due to the following reasons/purposes,

1. To purchase the raw-materials, components and spare parts.
2. For paying the wages and salaries.
3. For meeting daily expenses and overhead costs like fuel, power, office expenses so on.
4. For incurring/making selling expenses like packing, advertising so on.
5. For enabling, credit facilities to the customers.
6. For maintaining the inventories such as raw-material, work in progress, stores and spares and finished stock.

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Cash flow statement identifies the impact of different business transactions on cash and its equivalents and considers the receipts and payments of cash. A cash flow statement is used to identify all the factors which lead to changes in the cash position of a business enterprise between the opening and closing dates of balance sheets. Usually, cash flow statement is referred to as a “postmortem exercise” or a method of historical financial analysis. A cash budget is a method used for financial forecasting.

The main aim of preparing cash budget is to determine the estimated excess of receipts over payments or vice-versa, in order to make plans regarding the investment of excess of cash or to make arrangements for the future deficits of cash.

Advantages of Cash Flow Statement

Cash flow statement plays an important role in financial management. It is mainly used for short-term planning and acts as an important tool of financial analysis. The main advantages of cash flow statement are as follows,

1. As cash flow statement is prepared on cash basis of accounting, it is useful in ascertaining the cash position of a firm.
2. Analysis can be done by comparing the historical cash flows with the projected cash flows to identify the variations and deficiency in the performance so that firm can take effective measures to avoid it.
3. Cash flow statement is prepared in a standard format prescribed by AS-3 (Revised) which can be effectively used for making comparisons with other firms.
4. In order to identify whether the firm’s liquidity position is improving or deteriorating a series of intra-film and interfirm cash flow statements are prepared for specific period of time.
5. Cash flow statement is an effective tool which helps in planning the repayment of loans, replacement fixed assets and it is also useful in capital budgeting decisions.
6. As cash flow statement takes very less time to analyze the ability of firm to meet its obligations, it is more suitable than funds flow statement is conducting short-tern financial analysis.
7. Cash flow statement reveals all the information relating to operating investing and financing activities of the firm whereas, finds flow statement does not reveal information about these activities separately.
8. It helps in identifying the reasons which leads to poor cash position inspite of the generation of sufficient profits by a firm. It is mainly emphasizing on the different application of cash made by the firm.
9. An estimated cash flow statement is prepared for forecasting the future cash position of a concern to help the firm in effectively planning and organizing its financial operations.
10. A projected cash flow statement helps in identifying the inflows and outflows of cash so that firm can plan for its future requirements of cash.

Disadvantages of Cash Flow Statement

1. Apart from its advantages it is also associated with several limitations such as.
2. Cash flow statement is prepared on cash basis of accounting which makes the firm to neglect the accrual basis of accounting.
3. As working capital is a wider concept of funds than cash. funds flow statement represents a complete financial picture of a firm which is not possible through time cash flow statement.
4. A cash flow statement is not a replacement of an income statement, it is referred to as complementary statement to it.
5. Usually, a comparative study of cash flow statement gives fallacious (false) results.
6. A cash flow statement is not appropriate in determining the profitability of a firm because all the noncash items are not included while evaluating the cash flows obtained from operating activities.
7. A cash flow statement cannot be replaced with funds flow statement which explains about the reasons of increase or decrease in working capital.

Features of Cash Flow Statement

The important features of cash flow statement are as follows,

1. Cash flow statement acts as an important device which is being used in the financial planning.
2. Cash flow statement basically relies upon the past information i.e., the actual cash receipts and cash payments for a specified time period.
3. Cash flows comprise of both cash inflows and cash outflows and the information derived out of the Cash flow statement is useful in preparing the cash budget.
4. Cash flow statement is prepared yearly once as it is drawn from income statement and balance sheet of two successive years.
5. It is prepared and introduced by the listing companies.
6. Cash flow statement helps/assists in evaluating the ability of an enterprise to achieve its future obligations with the use of cash inflows out of the future operations.
7. It is necessary to understand the movement of cash flows in a precise manner with an aim to avoid short-comings of the financial liquidity of an enterprise. It is well-known that cash is a blood of any business for which it is essential to take proper actions to make optimum utilization of it.
8. Soon after the issues and major areas are recognized, Cash flow statement enables in taking future decisions.
9. Cash flow statement helps in evaluating the company’s ability to pay taxes, dividends, bonds, interest on bonds and debentures, obligations to employees and suppliers and so on.
10. Cash flow statement assists in evaluating the main reasons of difference/variation between net profit and net cash flow out of the operations.
11. It helps in evaluating the long-term bookings and its repayment, capital transactions and other factors which effects the liquidity of an enterprise.
12. Financial strength of the company from both the views i.e., cash and non-cash investing and financing transactions which takes place during the accounting period is also being evaluated with the help of Cash flow statement.
13. Cash flow statement also helps in evaluating the present and future status of cash with which the management can easily plan for future such as: from the desired cash for what purposes the fund can be utilized and so on.
14. Cash flow statement assists in presenting out the cash and non-cash effects of investing and financing activities during particular accounting period of time.
15. In case of any differences between the expected cash flows and the actual cash flows, Cash flow statement assists the management in taking appropriate decisions.
16. Cash flow statement is also helpful to the management both internally as well as to the investor and creditors extremely as it helps in evaluating the capability of an enterprise to manage cash flows in paying their obligations (or) to pay interests (or) dividends.

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Mostly single entry system is used by small business organizations iii order to maintain some important records. The performance of single entry system is not dependable.

Importance of Single Entry System

Following are the salient features of Incomplete records system.

1. An incomplete records system is suitable for sole trading concerns. Limited companies cannot tise this systems due to legal requirements.
2. Only personal accounts are maintained in this system.
3. This system maintains one single cash book which comprises a mix-up of business and private transactions.
4. It does not have uniformity in maintaining the records. It may change from industry to industry as per the firm’s requirements.
5. In this system, systematic and scientific method of accounting recording transactions are not accurate.
6. The data is not recorded in subsidiary books and relevant information can only be stored in vouchers.
7. The determination of profit loss is based on estimates. It does not show the true status of the firms. (i.e. Financial position of the firm).

Reasons of Single Entry System

The incompleteness of Accounting records could be due to the following reasons.

1. The business persons may not maintain proper accounts intentionally so as to avoid taxation.
2. Damage of account books due to flood or fire etc.
3. The business person may be unaware of the separate legal entity assumptions.
4. The business persons may not be aware of double entry accounting principles.

Advantages of Single Entry System

The various advantages of single entry system are as follows.

1. The system is economical to small business entities with few assets and liabilities and limited transactions.
2. Single entry system is quite a simple method for the organizations who do not involve in the complexity of double entry system.
3. Some businessmen intentionally tise this system to avoid taxation.
4. Using this system. it is easier to determine profit or loss.
5. Unlike double entry system, this system does not require practical knowledge of the principles of book keeping.
6. Accounting records can be easily maintained under this system.

Disadvantages of Single Entry System

The following are the disadvantages of single entry system.

1. Single entry system does not record both debit and credit of every transaction. Therefore, it is called “Incomplete Records System”.
2. Frauds can be easily committed due to the absence of proper control and checks.
3. Under this system, The financial position of the business cannot be ascertained because of the absence of real accounts.
4. Joint stock companies do not adopt this system because of legal requirements.
5. This system does not maintain nominal accounts which makes it difficult to prepare the P & L A/c and determine the net profit or net loss of the business.
6. At the time of assessment. it becomes difficult to manage the tax authorities regarding the profit/loss of the business.

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