Accounting is a language of business through which normally a business communicates with the outside world. In order to make this language intelligible and commonly understood by all, a massive number of concepts are being used. This Concept Book covers a wide area of Accounting in a logical sequence for ease of understanding of any reader.
2.0 Separate Entity Concept
In accounting, business is considered to be a separate entity from the owners. It may appear to be ridiculous that one person can sell goods to himself but this concept is extremely helpful in keeping business affairs strictly free from the effect of private affairs of the owners.
The concept of separate entity is applicable to all forms of business organizations. For example, in case of a partnership business or sole proprietorship business, though the partners or sole proprietor are not considered as separate entities in the eyes of law, but for accounting purposes they will be considered as separate entities.
Example: When a person invests Rs. 100,000/- into business, it will be deemed that the proprietor has given that much of money to the business which will be shown as a 'liability' in the books of the business.
3.0 Money Measurement Concept
Accounting records only monetary transactions. Events or transactions which cannot be expressed in money do not find place in the books of accounts though they may be very useful for the business. Measurement of business event in money helps in understanding the state of affairs of the business in a much better way.
Example 1: if a business has got a team of dedicated and trusted employees, it is definitely an asset to the business but since their monetary measurement is not possible, they are not shown in the books of the business.
Example 2: if a business owns Rs. 100,000/- of cash, 600kg. of raw materials, two trucks, 1,000 square feet of building space etc. these amounts cannot be added together to produce a meaningful total of what the business owns. However, if these items are expressed in monetary terms such as Rs. 100,000/- of cash, Rs. 120,000/- of raw materials, Rs. 2,000,000/- of trucks and Rs. 500,000/- of building, all such items can be added and much more intelligible estimate about the assets of the business will be available.
4.0 Going Concern Concept
According to this concept it is assumed that the business will continue for a fairly long time to come. There is neither the intention nor the necessity to liquidate the particular business venture in the foreseeable future. On account of this concept, the accountant while valuing the asset does not take into account forced sale value of assets.
This concept applies to the business as a whole. When an enterprise liquidates a branch or one segment of its operation, the ability of the enterprise to continue as a going concern is not impaired normally. The business will not be considered as a going concern when it has gone into liquidation or it has become insolvent.
Example: The business charges depreciation on fixed assets on the basis of their expected lives rather than on their market values.
5.0 Cost Concept
This concept is closely related to going concern concept. According to this concept, an asset is ordinarily entered in the accounting records at the price paid to acquire it and this cost is the basis for all subsequent accounting for the assets. The cost concept does not mean that the asset will always be shown at cost. It means that assets are recorded at cost at the time of its purchase but it may systematically be reduced in its value by charging depreciation.
Cost concept has the advantage of bringing objectivity in the preparation and presentation of financial statements. In the absence of this concept the figure shown in the accounting records would have depended on the subjective views of a person. However, on account of continued inflationary tendencies the preparation of financial statements on the basis of historical costs, has become largely irrelevant for judging the financial position of the business.
Example: If a business buys a plot of land for Rs. 100,000/-, the asset would be recorded in the books at Rs.100,000/- even if its market value at that time happens to be Rs. 125,000/-. In case a year later the market value of this asset comes down to Rs. 85,000/-, it will continue to be shown at Rs.100,000/-.
6.0 Accounting period Concept
According to this concept, the life of the business is divided into appropriate segments for studying the results shown by the business after each segment. This is because though the life of the business is considered to be indefinite (according to going concern concept), the measurement of income and studying the financial position of the business after a very long period would not be helpful in taking proper corrective steps at the appropriate time. It is therefore necessary that after each segment or time interval the businessmen must 'stop and 'see back', how things are going. In according such a segment or time interval is called 'accounting period'. It is usually of a year.
At the end of each accounting period, an income statement and a balance sheet are prepared. The statement discloses the period or loss made by the business during the accounting period while the balance sheet depicts the financial position of the business as on the last day of the accounting period. While preparing these statements a proper distinction has to be made between capital and revenue expenditures.
7.0 Periodic matching of cost and revenues concept
This is based on the accounting period concept. The paramount objective of running a business is to earn profit. In order to ascertain the profit made by the business during a period, it is necessary that 'revenues' of the period should be matched with the cost (expenses) of the period. The term matching, means appropriate association of related revenues and expenses. In other words, income made by the business during a period can be measured only when the revenue earned during a period is compared with the expenditure incurred for earning that revenue. The question when the payment was received or made is "irrelevant".
Example: if a salesman is paid a commission in January, 1989, for sales made by him in December 1988, the commission paid to the salesman in January, 1989 should be taken as the cost for sales made by him in December, 1988.This means that revenues of December, 1988(i.e. Sales) should be matched with the cost incurred for earning that revenue (i.e. Salesman's commission) in December 1988 (though paid in January, 1989).
8.0 Realisation Concept
According t this concept revenue is recognized when a sale is made. Sale is considered to be made at the point when the property in goods passes to the buyer and he becomes legally liable to pay.
Example: A places an order with B for supply of certain goods yet to be manufactured. On receipt of order, B purchases raw materials, employs workers, produces the goods and delivers them to A. A makes payment on receipt of goods. In this case the sale will be presumed to have been made not at the time of receipt of the order for the goods that but at the time when goods are delivered to A.
However, there are certain expectations to this concept:
In case of hire purchase, ownership of the goods passes to the buyer only when the installment is paid, but sales are presumed to have been made to the extent of installment received and installments outstanding. (i.e. installment due but not received)
In case of contracts accounts, though the contractor is liable to pay only when the whole contract is completed as per terms of the contract, the profit is calculated on the basis of work certified year after year as per certain accepted accounting norms.
9.0 Conservatism/ Prudence Concept
In the initial stage of accounting certain anticipated profits which were recorded, did not materialize. This resulted in less acceptability of accounting figures by the end-users. On account of this reason, the accounts follows the rule 'anticipate on profit but provide for all possible losses' while recording business transactions. In order words, the account follows the policy of 'playing safe'.
Example: The inventory is valued 'at cost or market price whichever is less'. Similarly, a provision is made for possible bad and doubtful debts out of current year's profits. This concept affects principally the category of current assets.
10.0 Full Disclosure Concept
According to this convention accounting reports should disclose fully and fairly the information they purport to represent. They should be honestly prepared and sufficiently disclose information, which is of material interest to proprietors, present and potential creditors and investors. The convention is gaining more importance because most of big businesses are run by joint stock companies where ownership is divorced from management. The companies Act, not only requires that income statement and Balance sheet of a company must give a true and fair view of the state of affairs of the company but it also gives the prescribed forms in which these statement are to be prepared! The practice of appending notes of the accounting statements (such as about contingent liabilities or market value of investments) is in pursuant to the convention of full disclosure.
11.0 Consistency Concept
According to this convention accounting practices should remain unchanged from one period to another. For example, if stock is valued at "cost or market price whichever is less", this principle should be followed year after year. Similarly, if depreciation is charged on fixed assets according to diminishing balance method, it should be done year after year. This is necessary for the purposes of comparison. However, consistency does not mean inflexibility. It does not forbid introduction of improved accounting techniques. However, if adoption of such a technique results in inflating or deflating the figures of profit as compared to the previous period, a note to that effect should be given in the financial statements.
12.0 Materiality Concept
According to this concept, the accountant should attach importance to material details and ignore insignificant details. This is because otherwise accounting will be unnecessarily overburdened with minute details. The question what constitutes a material details are left to the discretion of the accountant. Moreover item may be material for one purpose while immaterial for another.
Thus, the term 'materiality' is a subjective term. The account should regard an item as material if there is reason to believe that knowledge of it would influence the decision of the informed investor. According to Kohler "materiality means the characteristic attaching to a statement, fact or item whereby its disclosure or method of giving it expression would be likely to influence the judgment of a reasonable person."
Example: For tax purposes, the income has to be rounded to nearest ten.
13.0 Dual Aspect Concept
According to this concept, every business transaction has a dual effect.
Example: If A starts a business with a capital of Rs. 100,000/- there are two aspects of the transaction. On the one hand, the business has an asset of Rs. 100,000/- while on the other hand the business has to pay to the owner a sum of Rs. 100,000/- which is taken as the owner's capital.
14.0 Single-Entry Bookkeeping
An incomplete double entry can be termed as a single entry system. According to Kohler," it is a system of book-keeping in which as a rule only records of cash and personal accounts are maintained, it is always incomplete double entry, varying with circumstances". This system has been developed by some business houses, who for their convenience keep only some essential records. Since no records are kept, the system is not reliable and can be used only by small business firms.
15.0 Double-Entry Bookkeeping
The system of 'double entry' bookkeeping which is believed to have originated with the Venetian merchant s of the fifteenth century is the only system of recording the two-fold aspect of the transaction. The system recognizes that every transaction have a two-fold effect. If someone receives, something then either some other person must have given it, the first mention person must have lost something, or he must have rendered some service etc.
16.0 Cash System of Accounting
It is a system in which accounting entries are made only when cash is received or paid. No entry is made when a payment or receipt is merely due. Government system of accounting is mostly on the cash system. Certain professional people record their income on cash basis, but while recording expenses they take into account the outstanding expenses also. In such a case, the financial statement prepared by them for determination of their income is termed as Receipts and Expenditure Account.
17.0 Accrual System of Accounting
It is a system in which accounting entries are made based on amounts having become due for payment or receipt. This system recognizes the fact that if a transaction or an event has occurred: its consequences cannot be avoided and therefore should be brought into books in order to present a meaningful picture of profit earned and loss suffered and of the financial position of the firm concerned.
18.0 Assets
An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. In other words, an asset is something valuable that an entity owns, benefits from, or has use of, in generating income. In accounting, an asset is something an entity has acquired or purchased, and which has money value (its cost, book value, market value, or residual value). Assets shown on their owner's balance sheet are usually classified according to the ease with which they can be converted to cash.
An asset can be,
Something physical, such as cash, machinery, inventory, land and building
An enforceable claim against others, such as accounts receivable
A right, such as copyright, patent, trademark
An assumption, such as goodwill
Assets shown on their owner's balance sheet are usually classified according to the ease with which they can be converted into cash.
19.0 Liabilities
Liability is an obligation to pay to another party an amount in money, goods, or services. Liabilities are settled over time through the transfer of economic benefits including money, goods or services. Liabilities include loans, accounts payable, mortgages, deferred revenues and accrued expenses. Liabilities are a vital aspect of a company's operations because they are used to finance operations and pay for large expansions. They can also make transactions between businesses more efficient. For example, the outstanding money that a company owes to its suppliers would be considered a liability. Total Liabilities include all the Current Liabilities, Long Term Debt, and any other miscellaneous liabilities the company may have.
20.0 Working Capital
Working capital means the excess of current assets over current liabilities. If current assets are equal to current liabilities then according to this concept, working capital will be zero and in case current liabilities are more than current assets, the working capital will be called negative working capital.
Working Capital= Current Assets-Current Liabilities
Current assets are those assets, which could be converted into cash within one accounting period, for example, stock, debtors, bills receivables, prepaid expenses, cash and bank balance. Similarly, current liabilities are those liabilities, which have to be paid within an accounting year, for example, creditors bills payables, short term loans etc.
Working capital can also be defined in another manner. Working capital is the part of current assets, which has been financed from long-term funds. It is, therefore also called circulating capital.
21.0 Income
International Accounting Standards Board defines Income as, "Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants." (IFRS Framework). For the average individual, income is earned through earning wages by working and/or making investments into financial assets. In most countries, the amount of income that an individual receives is taxed by the government before it is received.
22.0 Capital Expenditure
Expenditure means the amount spent. Any expenditure incurred for the following purposes is capital expenditure:
For acquiring fixed assets such as land, building, plant and machinery, furniture and fitting and motor vehicles. These assets should not be acquired with a view to resell them at a profit but to retain in the business. The cost of fixed asset would include all expenditure up to the asset becomes ready for use.
For making improvement and extensions to the fixed asset, for example, additions to buildings
For increasing the earning capacity of a business or for reducing the cost of manufacture, administration or distribution in a business. For example, expenditure incurred in removing the business to a central locality or compensation paid to retrenched employee. .
For raising capital monies for the business such as brokerage paid for arranging loans, discount on issue of shares and debentures, underwriting commission etc.
All capital expenditures represent either an asset or liability and are shown in the balance sheet.
Examples: Cost of lease, Cost of car & lorry, Cost of installation of lights & fans, Cost of trademarks, patents & copy rights.
23.0 Revenue Expenditure
Expenditures will be treated as revenue expenditures if it is incurred for the following purposes:
Expenditure for purchasing floating assets i.e., assets meant for resale at a profit or for being converted into saleable goods, such as the cost of goods, raw materials and stores.
Expenditures incurred by maintaining assets in proper working order e.g., repairs to plant and machinery, building furniture etc.
Expenditures incurred for meeting day-to-day expenses of carrying on a business e.g., salaries, rent, rates, taxes, stationery, postage etc.
Al l revenue expenditures have to be deducted from the income earned by the firm. That is to say, all revenue items will be taken to the profit and loss account.
Examples: Cost of goods for resale, Wages paid for manufacture of goods for sale, Depreciation of lease, etc
24.0 Journal/ Day Book
The word "journal" has been derived from the French word "jour". Jour means day. So journal means daily. Transactions are recorded daily in journal and hence it has been named so. It is a book of original entry to record chronologically (i.e. in order of date) and in detail the various transactions of a trader. It is also known as "Day Book" because it contains the account of every day's transactions. it is the book in which the transactions are recorded first of all under the double entry system. Thus, Journal is the books, of original record. A Journal does not replace but precede the Ledger. The process of recording transaction in a Journal is termed as 'Journalizing'.
25.0 Postings
The term "posting" means transferring the debit and credit items from the Journal to their respective accounts in the Ledger. It should be noted that the exact names of accounts used in the Journal should be carried to the Ledger.
Example: If the Journal, Expenses Account has been debited, it would not be correct to debit the Office Expenses Account in the Ledger. The correct course would have been to record the amount to the Office Expenses Account in the Journal as in the Ledger.
Postings may be done at anytime. However, it should be completed before the financial statements are prepared. It is advisable to keep the more active accounts posted to date.
Example: Few accounts that are more active are, cash account, personal accounts of various parties etc.
26.0 Petty Cash Book
Petty Cash is a predetermined amount of cash on hand. The purpose of having a petty cash fund is to provide easy and quick access to a cash source in order to pay for small expenses "on the fly". Petty cash is also known as an "Imprest fund", whereby the fund is replenished in exactly the amount that is expended from it. Petty Cash Book is maintained by the business to record petty cash expenses of the business, such as postage, stationery and cleaning charges. In every business, there are many payments like the above which are of small amounts. In case all these transactions are recorded in the Main Cash Book, their recording will not only be inconvenient but also consume a lot of valuable time of the cashier and the posting clerk.
The Petty Cash Book is usually maintained on the basis of Imprest System. According to this system, a fixed amount is advanced to the Petty Cashier at the beginning of the period by the Chief Cahier. He submits his accounts at the end of the period and the Chief Cashier after examining his accounts gives him a fresh advance equivalent to the amount spent by him, during the period. Thus, in the beginning of each period, the Petty Cashier has a fixed balance. The amount so advanced to him is termed as "Imprest" or "Float".
27.0 Balancing of an Account
In business, there may be several transactions relating to one particular account. In Journal, these transactions appear on different pages in an order while they appear in a classified form under that particular account in the Ledger. At the end of a period (say a month or a year), the businessman will be interested in knowing the position of a particular account. This means, he should total the debits and credits of the account separately and find out the net balance. Y=this technique of finding out the net balance of an account, after considering the totals of both debits and credits appearing in the account is known as 'Balancing the Account'.
The balance is put on the side of the account which is smaller and reference is given that it has been carried forward or carried down (c/f or c/d) to the next period. On the other hand, in the next period a reference is given that the opening balance has been brought forward or brought down (b/f or b/d) from the previous period.
28.0 Trial Balance
In case, the various debit balances and the credit balances of the different accounts are taken down in a statement, the statement so prepared is termed as a "Trial Balance". In other words, Trial Balance is a statement containing the various ledger balances on a particular date. The two sides of the Trial Balance tally. It means the books of accounts are arithmetically accurate.
The main objectives of preparing a Trial Balance are,
Checking of the arithmetical accuracy if the accounting entries
To use as the basis for preparing financial statements such as the Profit and Loss account, Balance Sheet.
To use as a summerised ledger
29.0 Trading Account
Trading Account gives the overall result of trading, i.e. purchasing and selling of goods. In other words, it explains whether purchasing of goods and selling them has proved to be profitable for the business or not. It takes into account on the one hand the cost of goods sold and on the other the value for which they have been sold away. In case the sales value is higher than the cost of goods sold, there will be a profit, while in a reverse case, there will be a loss. The profit disclosed by the Trading Account is termed as Gross Profit. Similarly, the loss disclosed by the Trading Account is termed as Gross Loss.
30.0 Profit and Loss Account
The Trading Account simply tells us about the gross profit or loss made by a businessman on purchasing and selling of goods. It does not take into account the other operating expenses incurred by him during the course of running the business. For example, Businessman has to maintain an office for getting orders and executing them taking policy decision and implementing them. All such expenses are charged to the Profit and Loss Account.
Besides this, a businessman may have other sources of income. For example, he may receive rent from some of his business properties. He might be getting interest or dividends from such investments. In order to ascertain the true profit or loss which the business has made during a particular period, it is necessary that all such expenses and incomes should be considered. Profit and Loss Account considers all such expenses and incomes and gives the net profit made or loss suffered by a business during a particular period.
31.0 Manufacturing Account
A person may manufacture goods by himself for selling them at a profit. In case of such a person, i.e. a manufacturer, it will be necessary to ascertain the cost of manufacturing the goods. In this case, the profit or loss made by him will be ascertained by preparing Manufacturing Account, Trading Account and the Profit and Loss Account.
32.0 Balance Sheet
Having prepared the Manufacturing, Trading and Profit and Loss Account, a businessman will like to know the financial position of his business. For this purpose, he prepares a statement of his assets and liabilities as on a particular date. Such a statement is termed as "Balance Sheet". According to the American Institute of Certified Public Accountants, Balance Sheet is "a list of balances of the asset and liability accounts. This list depicts the position of assets and liabilities of a specific business at a specific point of time".
Balance sheet is not an account but only a statement containing the assets and liabilities of a business on a particular date. It is actually a classified summary of the various remaining accounts after accounts relating to incomes and expenses have been closed by transfer to Manufacturing, Trading, Profit and Loss Account.
33.0 Cash Flow Statement
A cash flow statement should list its cash flows for the period under standard headings which are, operating activities, investing activities and financing activities. When preparing cash flow statement, following items are treated in a logical manner in terms of cash
Increase in stock is treated as negative. This is because it represents a cash outflow; cash is being spent on stock
An increase in debtors would be treated as negative for the same reasons; more debtors mean less cash
By contrast, an increase in creditors is positive because cash is being retained and not used to pay off creditors. There is therefore more of it.
34.0 Notes to the Accounts
Notes to the balance sheet and profit and loss account could be,
Disclosure of Accounting policies
Notes to the Balance sheet or
Notes to the Profit and Loss Account
A note to the accounts must disclose the accounting policies adopted by the company (including the policy used to account for depreciation or the fall in value of assets). Companies must also now state that all relevant accounting standards have been complied with and if not, what the departures are and the reasons for the departure.
35.0 Stakeholder Concept
In recent years, a wider variety of goals have been suggested for a business. These include the traditional objective of profit maximization. However, they also include goals relating to earnings per share, total sales, numbers employed, measures of employee welfare, manager satisfaction, environmental protection and many others.
A major reason for increasing adoption of a Stakeholder Concept in setting business objectives is the recognition that businesses are affected by the 'environment' in which they operate. Businesses come into regular contact with customers, suppliers, government agencies, families of employees and special interest groups. Decisions made by a business are likely to affect one or more of these 'stakeholder groups'.
The stakeholder concept suggests that the managers of a business should take into account their responsibilities to other groups, not just the shareholder group, when making decisions. The concept suggests that businesses can benefit significantly from cooperating with stakeholder groups, incorporating their needs in the decision making process.
36.0 Shareholder
Shareholder is the owner of one or more shares of stock in a corporation, commonly also called a "stockholder."
The benefits of being a shareholder include
Receiving dividends for each share as determined by the Board of Directors
The right to vote (except for certain preferred shares) for members of the board of directors to bring a derivative action (lawsuit) if the corporation is poorly managed
Participate in the division of value of assets upon dissolution and winding up of the corporation, if there is any value.
A shareholder should have his/her name registered with the corporation, but may hold a stock certificate, which has been signed over to him/her. Before registration the new shareholder may not be able to cast votes represented by the shares.
37.0 Limited Liability
Limited Liability is a concept whereby a person's financial liability is limited to a fixed sum, most commonly the value of a person's investment in a company with limited liability. In other words, if a company with limited liability is sued, then the plaintiffs are suing the company, not its owners or investors. A shareholder in a limited company is not personally liable for any of the debts of the company, other than for the value of his investment in that company. This usually takes the form of that person's dividends in the company being zero, since the company has no profits to allocate. The same is true for the members of a limited liability partnership and the limited partners in a limited partnership. By contrast, sole proprietors and partners in general partnerships are each liable for all the debts of the business (unlimited liability).
Although a shareholder's liability for the company's actions is limited, the shareholder may still be liable for its own acts. For example, the directors of small companies (who are frequently also shareholders) are often required to give personal guarantees of the company's debts to those lending to the company. They will then be liable for those debts in the event that the company cannot pay, although the other shareholders will not be so liable. This is known as co-signing.
38.0 Profit
In general, the term 'profit' stands for the difference between revenue and costs. However, for the same activity, profit does not necessarily have to be the same number under different points of view. Different accounting standards or special regulations for taxation make organizations display different profits in financial statements for different purposes.
On top of that, profit from the accountant's point of view is not equal to profit from the economists' point of view. This difference is not based in different principles on what to evaluate how, but in fundamentally different understandings of costs and profits.
39.0 Reserves
Any part of shareholder's equity is commonly described as reserves except for basic share capital. Sometimes, the term is used instead of the term provision; such a use, however, is inconsistent with the terminology suggested by International Accounting Standards Board.
Equity reserves are created from several possible sources:
Reserves created from shareholders' contributions, the most common examples of which are:
Legal reserve fund - it is required in many legislations and it must be paid as a percentage of share capital
Share premium - amount paid by shareholders for shares in excess of their nominal value
Reserves created from profit, especially retained earnings, i.e. accumulated accounting profits.
However, profits may be distributed also to other types of reserves, for example:
Legal reserve fund from profit - many legislations require creation of the fund as a percentage of profits
Remuneration reserve - will be used later to pay bonuses to employees or management
Translation reserve - arises during consolidation of entities with different reporting currencies
40.0 Depreciation
According to Pickles, "Depreciation or the permanent and continuing diminution in the quality, quantity or value of an asset". For example, if someone purchases a truck for his business, the truck loses value the minute you drive it out of the dealership. The truck is considered an operational asset in running your business. Each year that you own the truck, it loses some value, until the truck finally stops running and has no value to the business. Measuring the loss in value of an asset is known as depreciation.
Depreciation is considered an expense and is listed in the Profit and Loss Account under expenses. In addition to vehicles that may be used in your business, you can depreciate office furniture, office equipment, any buildings you own, and machinery you use to manufacture products. Land is not considered an expense, nor can it be depreciated. Land does not wear out like vehicles or equipment.
To find the annual depreciation cost for your assets, you need to know the initial cost of the assets. You also need to determine how many years you think the assets will retain some value for your business. In the case of the truck, it may only have a useful life of ten years before it wears out and loses all value.
41.0 Drawings
Drawings" (also known as withdrawals) is a basic concept in financial accounting that governs the relationship between the owner or owners of a business and the business' operations. It refers to anything that the owner takes from the business, regardless of what the owner calls it. As such, there are two important aspects of that definition:
Anything: This means that whether the owner takes cash, stock or equipment is immaterial. Any withdrawal of items of material value should constitute drawings.
Regardless of what the owner calls it: Sometimes, owners work within the business and pay themselves a salary or wage. Perhaps the owner takes a "loan" from the business. It does not matter what the form of the withdrawal is; the substance is critical. Therefore, the "wages" or the "loan" would effectively be a withdrawal as well.
42.0 Rights Issue
Issuing rights to a company's existing shareholders to buy a proportional number of additional securities at a given price (usually at a discount) within a fixed period is called a rights issue. This is called a right issue because members may obtain new shares in right of their existing holdings.
A rights issue is directly offered to all shareholders of record or through broker dealers of record and may be exercised in full or partially. Subscription rights may either be transferable, allowing the subscription-right-holder to sell them privately, on the open market or not at all. Because the company receives shareholders' money in exchange for shares, a rights issue is a capital raising source.
Following need s to be considered when opting for a rights issue:
Engaging a Dealer-Manager or Broker Dealer to manage the Offering processes
Selling Group and broker dealer participation
Subscription price per new share
Number of new shares to be sold
The value of rights vs. trading price of the subscription rights
The effect of rights on the value of the current share
The effect of rights to shareholders of record and new shareholders and right-holders
43.0 Bonus Issue
Based upon the number of shares that the shareholder already owns, bonus shares are issued to them. While the issue of bonus shares increases the total number of shares issued and owned, it does not increase the value of the company. The ratio of number of shares held by each shareholder remains constant while the total number of shares increases.
Key impacts of a bonus issue are:
The level of reserves available for distribution by way of dividends is reduced. However, in practice, the size of any bonus issue is unlikely to be so large as to adversely affect the company's dividend payment capability
The 'permanent capital' to satisfy creditors is increased
There will be more shares to issue which will have an arithmetical impact on the shares' market price. However, in practice the price is unlikely to go down proportionately because of the new issue. Market sentiment is likely to look favorably on a bonus issue and often the share price will effectively be boosted
44.0 Share Split
A share split is where a company's existing shares are divided into multiple shares. Although the number of shares outstanding increases by a specific multiple, the total rupee value of the shares remains the same compared to pre-split amounts, because no real value has been added as a result of the split. Growth in market price is a main reason as to why stock splits are performed in a company as the shares are too expensive to buy in round lots.
Example: If a company's shares were worth Rs 10/- each, Rs 1,000/- would be needed in order to own 100 shares. If each share was worth Rs 1/-, investors would only need to pay Rs 100/- to own 100 shares.
45.0 Underwriting
The underwriter's is to guarantee that the funds sought by the company will be raised. The agreement between the underwriter and the company is set out in a formal underwriting agreement. Typical terms of an underwriting require the underwriter to subscribe for any shares offered but not taken up by shareholders. Underwriters may be financial institutions, stock-brokers, major shareholders of the company or other related or unrelated parties.
46.0 Stewardship
Stewardship means, the responsibility of agents to act in the best interests of their principals, by keeping adequate records of transactions and by acting to maintain or increase both the capital and income from the capital. (Fonseka, 2003)
A traditional approach of accounting that places an obligation on stewards or agents, such as directors, to provide relevant and reliable financial information relating to resources over which they have control but which are owned by others, such as shareholders. Not only are stewards responsible for providing information, but they must also submit to an audit. (A Dictionary of Accounting, Oxford University Press, - Market House Books Ltd 1999)
47.0 Window Dressing
A key component to understanding the concept of window-dressing is to realize that using accounting tricks of this type usually do not involve the presentation of a fabrication. Instead of being built on a foundation of lies, most types of window-dressing involve emphasizing positive facts beyond their actual importance, while selectively soft-pedaling or even omitting other information that is less positive. Thus, the information contained in the presentation is real information that can be verified. However, the presentation is not properly balanced in the way the particulars are portrayed.
Window dressing may be employed as a means of minimizing the impact of negative aspects of the investment. For example, a company that wishes to secure a new investor may place a great deal of emphasis on the success of one particular product, while failing to mention that another product that is more costly to produce is barely breaking-even; By accentuating the positive, the window-dressing increases the interest of the potential investor, making an actual transaction more likely.
Using window dressing when presenting information to the public is common. A company may choose to only briefly mention weak stocks or mutual funds that are performing be1ow par, and focus the attention on increased demand for a product or service, or a significant return that was realized from the recent maturation of a bond issue. Window-dressing may also be used as part of the strategy in advertising campaigns, as well as in presenting financial data to current and prospective investors.
48.0 Financial Audit
An audit is an independent assessment of the fairness by which a company's financial statements are presented by its management. It is performed by competent, independent and objective person(s) known as auditors and then they issue a document based on the results of the audit.
Such systems must adhere to generally accepted standards set by governing bodies regulating businesses; these standards simply provide assurance for third parties or external users that such statements present a company's financial condition and results of operations "fairly."
Traditionally, audits were mainly associated with gaining information about financial systems and the financial records of a company or a business. However, recent auditing has begun to include other information about the system, such as information about security risks, information systems performance (beyond financial systems), and environmental performance. As a result, there are now professions conducting security audits and IS audits.
49.0 Conclusion
The above book contain basic assumptions or conditions upon which the science of accounting is based. It also includes those customs or traditions, which guide the accountant while preparing the accounting statements.
