Maintaining Financial Recorder - Report Example

Maintaining Financial Recorder Maintaining Financial Recorder PART A Executive Summary In thisreport different accounting perspectives of fixed assets are discussed to determine procedures involved in the authorization of the purchase of fixed assets by raising orders for fixed assets. These would also be assessed for internal controls and audit trail of all steps involved in the payment for fixed assets. Finally, accounting records for fixed assets are discussed and different methods for calculating depreciation charge on fixed assets are evaluated. In order to support the following discussion support excerpts from relevant accounting standards are also part of this report. Procedures for the authorization of the purchase of fixed assets All business require tangible fixed assets which are defined by IAS 16 as “tangible items that a) are held for use in the production or supply of goods or services for rental to others or for administrative purposes and b) are expected to be used during more than one period” (IASB 2008). Typically these include land, building, office, fixtures and fittings etc. which are deemed necessary to operate and carry out different activities. The fixed assets are for long term and their acquisition involves large amounts of funds which companies need to raise either through internal equity or by borrowing from financial institutions. Therefore, the authorization of the purchase of fixed assets requires delegation of authority to individuals who may be involved in maintaining fixed asset system or overlooking the entire purchase process. The procedures for the authorizing individuals of the purchase of fixed assets should be part of the company’s policy that should clearly set out the positions and authority levels of individuals who can direct purchase of fixed assets. The delegation of authority depends upon the structure of the company and also relies on the nature of the business that the company is operating in. Capital expenditures which are beyond limits of individuals at departmental levels have to be authorized by the higher management. In addition to tangible fixed assets there are also intangible assets which include goodwill, brand, trademarks, copyrights which are purchase and authorize Procedures for raising orders for fixed assets Asset acquisition typically initiates from the departmental manager assessment of the requirements of his / her department in terms of fixed assets to be purchased. These involve either purchase of a new asset or replace an existing one. The authorization of departmental managers is assigned and managed according to the price level of fixed assets that could be ordered. Departmental managers can authorize purchase of fixed assets without seeking approval from higher authority which falls below certain value limits. The procedures for placing an order for fixed asset therefore depend upon the budgetary controls of the company. If the management has a stricter budgetary layout for its company then the delegated authority is somewhat limited and decision for purchase of fixed assets remains with the top management of the company. This is the case in small companies however in large companies individual departments are given their respective authority to place an order for fixed assets with vendors. Orders from different departments are collected and submitted to the fixed asset department which confirms the authority signing the order and places the orders to suppliers. Procedures for internal controls and audit trail from receipt of invoice to payment authorization for fixed assets Companies develop master budgets for fixed assets which are short, medium and long term. These budgets should be authorized only by the top management. However, consultation with personnel at lower levels is carried out to prepare these budgets. The budgets can be used to determine variances between expenditures and budgetary values. It is important that different levels of authority are developed to follow the requisitions for new assets, their approval and payments. Internal controls should be placed so that no single authority exercises beyond the assigned limits. Important controls should be in place to assess whether expenditure on assets should be treated as impairment or purchase of new assets. The fixed asset department prepares purchase order that should be checked from request report submitted by different departments. Once order is delivered and assets are received, they should be inspected and specifications should be compared with those in the purchase order. Also the details of invoice are to be checked with purchase order and other terms and conditions regarding payments. Once accuracy is assured the payment for the asset should be authorized by assigned authority. Data in fixed asset register should be entered and authorized by different individuals. Also the computerized system should have red tags to identify any internal foul play (Hall, 2008). Audit trail could be traced from the stage where request is placed by the department to the point a purchase order is placed and assets are received, checked, paid and installed at the site. Different internal controls enusre that transactions are genuine, accurate and complete (Gray and Manson 2007). Fixed Asset registers Fixed assets register is the main accounting record which provides complete details of fixed assets held by the company and its various departments. Fixed asset register is maintained usually at the company’s head quarters and contains information on land, buildings, motor vehicles, machinery, trademarks, copyrights etc that a company may hold any time. It also contains information regarding assets which are leased by the company. Fixed asset registers are either maintained manually or in a computerized accounting system. The reports prepared by computerized accounting system are in the form which could be easily understood by the management and could be used for tax purposes. The fixed asset register is an important element of fixed assets system which is concerned with three principal areas of accounting and recording including authorization, supervision and independent verification. Thus, it could be stated that the fixed asset registers record all acquisitions, maintenance and disposal activities of the fixed assets by businesses. Fixed asset registers contain information pertaining to fixed assets including name, purchase invoice details, technical information, location, identification number, depreciation method, depreciation amount, residual value, accumulated depreciation, revaluation amount, insurance details and amount, disposal dates and details etc. The extent of information placed in fixed asset register depends on the size and structure of the company. For all businesses fixed asset register may be the only accounting record which serves as the control document for their fixed assets. Controls are typically placed at levels to ensure that the entries made to the fixed asset register are fully authorized and any material omission or error could be easily traced to physical examination and valuation of fixed asset to which the entry pertains to. Depreciation calculation FRS 15 Tangible Fixed Assets superseded SSAP 12 Accounting for Depreciation in 2009 and lays out guidelines for provisioning of depreciation ‘which is the measure of wearing out, consumption or other loss of value of a fixed asset whether arising from use, effluxion of time and obsolescence through technology and market changes . The accounting standard sets out the accounting treatment for depreciation that clearly states that depreciation should be charged for fixed assets having finite useful life by allocation of their cost less reasonably assessed residual value of the asset at the end of the useful life over the period of their use. A common issue which is faced by businesses is the revision of the economic life of a fixed asset. In this case the unamortized cost should be spread over the remaining years according to the revision in the useful economic life. Furthermore, if the unamortized amount is considered irrecoverable then it should be immediately written down to the recoverable amount and spread over remaining useful life (ASB 2009). There are different methods for calculating depreciation. These methods are distinguished on the basis of time or the use of asset. The depreciation methods based on time include straight line method that has already been discussed in the previous paragraph other methods include reducing balance and Sum-of-the-years-digits method (AccountingInfo 2009). Accelerated depreciation is an example of depreciation method based on the use of the asset. FRS 15 only allows change of depreciation method if fairer representation can be ascertained by other methods. Furthermore, if fixed assets are revalued in the balance sheet then the depreciation should be based on the revalued amount and disclosure should be made in the financial statement. FRS 15 does not apply to investment properties and does not require depreciation on land. The disclosure is required from businesses regarding depreciation methods, useful economic life, depreciation rates, accumulated depreciation and gross amount of depreciable assets. Procedure for disposal of assets (looking at control & authorization) Disposal of fixed asset involves either selling off of fixed assets or replacement of existing assets with new ones. Large companies maintain fixed asset registers that are the only accounting records which may be used to control over disposal of fixed assets. The disposal of fixed assets by the user department should be traced back to the fixed asset register through unique identification numbers allotted to fixed assets at the time of purchase. This would also allow asset managers to determine the unallocated cost of the fixed asset and eventually calculate the profit or loss on the disposal of fixed assets. The disposal or sale of fixed assets is recorded in the accounting books at the price which is received in return. If the amount received is more than its NBV then a profit is recorded whereas if the amount received is less than its NBV then a loss should be recorded. Companies should formulate policies and procedures for disposal of each class of fixed assets. The disposal of fixed asset should initiate with a report detailing reasons for disposals. The reasons may include assets not being require any longer, existence of surplus, replacement required, economically irreparable or obsolescence due to technology. The disposals of fixed assets should be authorized to individuals according to their authority limits. These authority limits are assigned according to the position of individual in the department or the company along with defined monetary levels. These monetary levels are based on the expected market value of the asset. The officers in different departments should assess the need of replacing assets by disposal and prepare disposal report indicating the assets which are to be disposed off and the report should be authorized by the department head that allows fixed assets department to remove the fixed asset which is no longer required by its users. The importance of controls over disposal of assets is undeniable as it has been suggested that the sale proceeds from disposals could easily be misappropriate if sufficient controls are not in place (Gray and Manson 2007). PART B Double entry To develop an understanding of double entry it is important to present the accounting equation which is given as follows: Capital = Assets – Liabilities This could be interpreted as the value of the owners’ investment in the business is equal to the value of what is owned by the owners (Randall 1996). All business transactions affect two items in the accounting equation that is a positive change in one time and a negative change in the other item. The bookkeeping stage of recording transactions is known as double entry that shows two items which are affected by business entering into a transaction. Double entry bookkeeping is maintained in T-accounts which has debit and credit sides to record changes in different items of accounting equation. A typical double entry account is represented as follows: Title of Account Debit Side Credit Side Closing stock adjustment on ETB The difference between two sides of the stock account represents the cost of the goods at a specific. Increase in stock of goods is managed through two accounts purchase and returns inward accounts. While decrease in stock of goods is maintained through two accounts sale and returns outward accounts. Increase in stock is a debit entry and decrease in stock is a credit entry (Randall 1996). The ETB requires closing stock adjustments to extend the entries to more than one accounting period. The debit entries in stock account are adjusted with a balancing credit entry which represents the value of stock unsold at year end. This will result in cost of goods sold for the year which is shown in the profit and loss account. The closing adjustment is shown in the following Stock Debit Side Credit Side 20X9 $ 20X9 $ Dec 31 Trading 1,000 Dec 31 Balance c/d 1,000 20X0 20X0 Jan 1 Balance b/d 1,000 Dec 31 Trading 1,000 Dec 31 Trading 1,500 Dec 31 Balance c/d 1,500 2,500 2,500 From this it could be extracted that the cost of goods sold for the year ending 20X0 is as follows: $ Opening Balance 1,000 Purchases 1,500 Less: Closing Balance (1,500) Cost of Goods Sold 1,000 Bad debt write off adjustment on ETB Bad debts are recorded if sale made on credit is not collected and are considered as an expense. A bad debt arising from non collection of receivables is shown as a debit entry in bad debts accounts (Randall 1996). This is transferring from customer balance to income statement as an expense. The closing entry of bad debt write off requires adjustments that appear outside the trial balance. Two entries are required including an expense in the income statement and also a deduction from the receivables / debtors amount in the balance sheet (ACCA 2005). Consider a customer account which is not collectible and adjusting entry is made to debtor account and bad debts account for bad debts as follows: Customer Debit Side Credit Side 20X9 $ 20X9 $ Jan 8 Sales 500 Dec 31 Bad Debts 500 Bad Debts Debit Side Credit Side 20X9 $ 20X9 $ Dec 31 Customer 500 Dec 31 Profit and Loss 500 Profit and Loss Account (extract) for the year ended 31 December 20X9 $ Gross Profit xxx Less: Bad Debts (500) Accruals adjustment on ETB Accruals are expenses which have been incurred but not paid for (Investopedia 2009). Income statement includes all expenses whether they are paid for or not. Income statement would show accrued expense as a deduction. Unpaid amount is shown in the balance sheet as a liability. The closing adjustment entry of accruals pertaining to rent would therefore involve the following adjustment entries: Rent Debit Side Credit Side 20X9 $ 20X9 $ Jan 31 Cash 1,000 Dec 31 Profit and Loss 4,000 Apr 30 Cash 1,000 Oct 31 Cash 1,000 Dec 31 Accrued c/d 1,000 4,000 4,000 20X0 Jan 1 Accrued b/d 1,000 Prepayments adjustment on ETB Prepayments are payments for expenses which are made in advance (Investopedia 2009). This will be a deduction in profit and loss account however the amount paid in advance will appear in the balance sheet as an asset. The closing adjustment of prepayments would require the following entry: Insurance Debit Side Credit Side 20X9 $ 20X9 $ Jan 31 Cash 800 Dec 31 Profit and Loss 2,000 Apr 30 Cash 1,000 Dec 31 Prepaid c/d 800 Oct 31 Cash 1,000 2,800 2,800 20X0 20X0 Jan 1 Prepaid b/d 800 Depreciation adjustment on the ETB Depreciation is a charge recorded to allocate a tangible asset’s cost over its useful life (ASB 2009). It is non cash expense deducted from earnings. The depreciation is posted into cumulative provision for depreciation account i.e. accumulated depreciation which is deducted from the book value of assets. The closing adjustment for depreciation is shown as follows: Accumulated Depreciation Debit Side Credit Side 20X6 $ 20X6 $ Jan 31 Bal c/d 500 Dec 31 Profit and Loss 500 20X7 $ 20X7 $ Jan 31 Bal c/d 1,000 Jan 1 Bal b/d 500 Dec 31 Profit and Loss 500 1,000 1,000 Profit and Loss Account (extract) for the year ended 31 December 20X6 $ Gross Profit xxx Less: Depreciation (500) Profit and Loss Account (extract) for the year ended 31 December 20X7 $ Gross Profit xxx Less: Depreciation (500) Balance sheet (extract) at 31 December 20X6 $ Fixed Asset 5,000 Less: Accumulation Depreciation (500) 4,500 Balance sheet (extract) at 31 December 20X7 Fixed Asset 4,500 Less: Accumulation Depreciation (500) 4,000 List of References ACCA (2005) Adjustments to financial statements. London: ACCA AccountingInfo (2009) Depreciation Methods [online] Available from AccountingInfo: [accessed on 25 August 2009] ASB (2009) FRS 15 Tangible fixed assets London: Accounting Standards Board. Gray, I. and Manson, S. (2007) The audit process: principles, practice and cases. New York: Cengage Learning EMEA Hall, J. A. (2008) Accounting information systems New York: Cengage Learning EMEA. IASB. (2008) International financial reporting standards. London: International Accounting Standards Board Investopedia (2009) Accrued expense [online] Available from Investopedia: [accessed on 25 August 2009] Investopedia (2009) Prepayment [online] Available from Investopedia: [accessed on 25 August 2009] Randall, H. (1996) Accounting Letts International: London Read More