PROVISION

PROVISION

Provisions are recorded when the group has a legal of constructive obligation on the basis of a past event, the realisation of the payment Publication is probable and the amount of the obligation can be reliable is estimated. Provisions are measure at the present value of the expenditure required to settle the obligation. If reimbursement for some or all of the obligations can be received from a third party, the reimbursement is recorded as a separate asset, but only when it is practically certain that said reimbursement will be received. Provisions are recognized for 1 rows contact when the obligate tree expenditure required to meet obligation exceed the economic benefit expected to be received from the contract. The amount of the warranty provision is set on the basis of experience of the realization of these commitments. Provisions for restructuring are recognized when the Camry and group has made a detailed structuring plan and initiated implementation of the plan for has communicated about it. Provisions are not recognised for the continuing operation of the Caverion group

The recognition of provisions in walls estimate concerning Probability and quantity. Provisions are recognised for 1 rows contract when the unavoidable cost required to meet the obligation exceeds the benefit expected to be received under the contract. The amount of the warranty provision is set on the basis of experience of the realisation of this commitment. As at December 31 2016 and 2015 the provisions amounted to you are 37.2 million and you are 26.7 million.

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THE BALANCE SHEET

The Balance Sheet

A balance sheet lays out the ending balances in a company's asset, liability, and equity accounts as of the date stated on the report.  The most common use of the balance sheet is as the basis for ratio analysis, to determine the liquidity of a business. Liquidity is essentially the ability to pay one's debts in a timely manner. The information listed on the report must match the following formula:

                         Total assets = Total liabilities + Equity

The balance sheet is one of the key elements in the financial statements, of which the other documents are the income statement and the statement of cash flows. A statement of retained earnings may sometimes be attached.

The format of the balance sheet is not mandated by accounting standards, but rather by customary usage. The two most common formats are the vertical balance sheet (where all line items are presented down the left side of the page) and the horizontal balance sheet (where asset line items are listed down the first column and liabilities and equity line items are listed in a later column). The vertical format is easier to use when information is being presented for multiple periods.

The line items to be included in the balance sheet are up to the issuing entity, though common practice typically includes some or all of the following items:

Current Assets:

Cash and cash equivalents

Trade and other receivables

Investments

Inventories

Assets held for sale

Non-Current Assets:

Property, plant, and equipment

Intangible assets

Goodwill

Current Liabilities:

Trade and other payables

Accrued expenses

Current tax liabilities

Current portion of loans payable

Other financial liabilities

Liabilities held for sale

Non-Current Liabilities:

Loans payable

Deferred tax liabilities

Other non-current liabilities

Equity:

Capital stock

Additional paid-in capital

Retained earnings

Here is an example of a balance sheet:

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SUBLEDGER

Subledger

Definition: A subledger is a ledger containing all of a detailed sub-set of transactions. The total of the transactions in the subledger roll up into the general ledger. For example, a subledger may contain all accounts receivable, or accounts payable, or fixed asset transactions. Depending on the type of subledger, it might contain information about transaction dates, descriptions, and amounts billed, paid, or received. A summary-level entry is periodically recorded in the general ledger. If someone is researching information in the general ledger in an account that contains this summarized level of information, he or she must then access the subledger to review transaction-specific information.

As part of their year-end tests, auditors may trace transactions from a subledger to the general ledger and from there to the financial statements, to ensure that transactions are being recorded properly in the accounting system.

In an accounting software package, a subledger is a database, rather than a manually-maintained book.

Similar Terms

A subledger is also known as a subsidiary ledger.

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ACCOUNTING JOURNAL ENTRIES

Accounting Journal Entries Definition

An accounting journal entry is the method used to enter an accounting transaction into the accounting records of a business. The accounting records are aggregated into the general ledger, or the journal entries may be recorded in a variety of sub-ledgers, which are later rolled up into the general ledger. This information is then used to construct financial statements as of the end of a reporting period.

There must be a minimum of two line items in a journal entry, though there is no upper limit to the number of line items that can be included. A two-line journal entry is known as a simple journal entry, while one containing more line items is called a compound journal entry. A company may use a great many journal entries in just a single accounting period, so it is better to use a larger number of simple journal entries than a smaller number of compound journal entries, in order to clarify why the entries are being made. This is useful when journal entries are being researched at a later date, and especially when they are being reviewed by auditors.

Whenever you create an accounting transaction, at least two accounts are always impacted, with a debit entry being recorded against one account and a credit entry against the other account.

The totals of the debits and credits for any transaction must always equal each other, so that an accounting transaction is always said to be "in balance." If a transaction were not in balance, then it would not be possible to create financial statements. Thus, the use of debits and credits in a two-column transaction recording format is the most essential of all controls over accounting accuracy.

In a smaller accounting environment, the bookkeeper may record journal entries. In a larger company, a general ledger accountant is typically responsible for recording journal entries, thereby providing some control over the manner in which journal entries are recorded.

Format of the Journal Entry

At a minimum, an accounting journal entry should include the following: 

• The accounts into which the debits and credits are to be recorded
• The date of the entry
• The accounting period in which the journal entry should be recorded
• The name of the person recording the entry
• Any managerial authorization(s)
• A unique number to identify the journal entry
• Whether the entry is a one-time entry, a recurring entry, or a reversing entry.
• It may be necessary to attach extensive documentation to the journal entry, to prove why it is being recorded; at a minimum, provide a brief description of the journal entry.

SOURCE BY: ACCOUNTING TOOLSⓇ

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WHAT IS THE PURPOSE OF ACCOUNTING..?

What is the purpose of accounting?

The purpose of accounting is to accumulate and report on financial information about the performance, financial position, and cash flows of a business. This information is then used to reach decisions about how to manage the business, or invest in it, or lend money to it.

This information is accumulated in accounting records with accounting transactions, which are recorded either through such standardized business transactions as customer invoicing or supplier invoices, or through more specialized transactions, known as journal entries.

Once this financial information has been stored in the accounting records, it is usually compiled into financial statements, which include the following documents: 

• Income statement
• Balance sheet
• Statement of cash flows
• Statement of retained earnings
• Disclosures that accompany the financial statements

Financial statements are assembled under certain sets of rules, known as accounting frameworks, of which the best known are Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The results shown in financial statements can vary somewhat, depending on the framework used. The framework that a business uses depends upon which one the recipient of the financial statements wants. Thus, a European investor might want to see financial statements based on IFRS, while an American investor might want to see statements that comply with GAAP.

The accountant may generate additional reports for special purposes, such as determining the profit on sale of a product, or the revenues generated from a particular sales region. These are usually considered to be managerial reports, rather than the financial reports issued to outsiders.

Thus, the purpose of accounting centers on the collection and subsequent reporting of financial information.

SOURCE BY: ACCOUNTING TOOLS®

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UNDERSTANDING ACCOUNTING BASICS (ALOE AND BALANCE SHEETS)

Understanding Accounting Basics (ALOE and Balance Sheets)

In accounting, the math usually isn't worse than multiplication. But accounting isn't about math -- it's about concepts, and some had me confused. Accounting has simple and surprisingly elegant ways to track a business.

So What's Accounting About, Anyway?

To be blunt, accounting is about tracking stuff (yes, there's more to it, but hang with me). What kind of stuff can we track? 

• Assets: Stuff inside the company
• Liabilities: Stuff that belongs to others
• Owner's Equity (aka Capital): Stuff that belongs to the owners

Simple enough. Now how are these related?

Assets = Liabilities + Owner's Equity

In layman's terms, everything the company has belongs to the owners or someone else. Think of the equation like this:

• assets = liabilities + owner's equity
• stuff the company has = other people's stuff + owner's stuff

This formula (also called ALOE) might seem strange at first. Why do we add liabilities? Because we're looking from the point of view of the company, not the shareholders. If the company has something, it could be owed to someone else.

From the owner's point of view, owner's equity = assets - liabilities. This equation looks more natural, but often we aren't interested in the owner's point of view. We want to know about the company.

What's a balance sheet?

A balance sheet is a document that tracks a company's assets, liabilities and owner's equity at a specific point in time. As you know, if the company's has something, it belongs to someone. The sides must balance. So let's do an example. Suppose we start a company with $100 cash:

The company has $100 in short-term investments, and the owners have $100 worth of stock (how ownership is represented in a company).

Now suppose we take a bank loan for $150. The balance sheet becomes this:

Now our company has $250, but $150 belongs to the bank and $100 belongs to the owners. Sorry guys -- you can't take out a loan and make your share of the company more valuable.

Next, let's buy a building for $200:

Buying a building doesn't make our company more valuable: we re-arranged our assets. Instead of $250 in cash, we have $50 in cash and $200 in "building". Our share of the company ($100) didn't change a lick. And we still owe the bank $150.

That's not how it really works, is it?

It is. Well, real accountants use fancier terms ("accounts receivable" vs "deadbeats who owe me"), and have a bigger, badder balance sheet. But the core idea is the same: show what the company's worth, and who owns what.

Take a look at the balance sheet for a small internet company:

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STANDARD COSTING

Standard Costing Overview

Standard costing is the practice of substituting an expected cost for an actual cost in the accounting records, and then periodically recording variances showing the difference between the expected and actual costs. This approach represents a simplified alternative to cost layering systems, such as the FIFO and LIFO methods, where large amounts of historical cost information must be maintained for items held in stock.

Standard costing involves the creation of estimated (i.e., standard) costs for some or all activities within a company. The core reason for using standard costs is that there are a number of applications where it is too time-consuming to collect actual costs, so standard costs are used as a close approximation to actual costs.

Since standard costs are usually slightly different from actual costs, the cost accountant periodically calculates variances that break out differences caused by such factors as labor rate changes and the cost of materials. The cost accountant may also periodically change the standard costs to bring them into closer alignment with actual costs.

Advantages of Standard Costing

Though most companies do not use standard costing in its original application of calculating the cost of ending inventory, it is still useful for a number of other applications. In most cases, users are probably not even aware that they are using standard costing, only that they are using an approximation of actual costs. Here are some potential uses:

• Budgeting. A budget is always composed of standard costs, since it would be impossible to include in it the exact actual cost of an item on the day the budget is finalized. Also, since a key application of the budget is to compare it to actual results in subsequent periods, the standards used within it continue to appear in financial reports through the budget period.
• Inventory costing. It is extremely easy to print a report showing the period-end inventory balances (if you are using a perpetual inventory system), multiply it by the standard cost of each item, and instantly generate an ending inventory valuation. The result does not exactly match the actual cost of inventory, but it is close. However, it may be necessary to update standard costs frequently, if actual costs are continually changing. It is easiest to update costs for the highest-dollar components of inventory on a frequent basis, and leave lower-value items for occasional cost reviews.
• Overhead application. If it takes too long to aggregate actual costs into cost pools for allocation to inventory, then you may use a standard overhead application rate instead, and adjust this rate every few months to keep it close to actual costs.
• Price formulation. If a company deals with custom products, then it uses standard costs to compile the projected cost of a customer’s requirements, after which it adds on a margin. This may be quite a complex system, where the sales department uses a database of component costs that change depending upon the unit quantity that the customer wants to order. This system may also account for changes in the company’s production costs at different volume levels, since this may call for the use of longer production runs that are less expensive.

Nearly all companies have budgets and many use standard cost calculations to derive product prices, so it is apparent that standard costing will find some uses for the foreseeable future. In particular, standard costing provides a benchmark against which management can compare actual performance.

Problems with Standard Costing

Despite the advantages just noted for some applications of standard costing, there are substantially more situations where it is not a viable costing system. Here are some problem areas: 

• Cost-plus contracts. If you have a contract with a customer under which the customer pays you for your costs incurred, plus a profit (known as a cost-plus contract), then you must use actual costs, as per the terms of the contract. Standard costing is not allowed.
• Drives inappropriate activities. A number of the variances reported under a standard costing system will drive management to take incorrect actions to create favorable variances. For example, they may buy raw materials in larger quantities in order to improve the purchase price variance, even though this increases the investment in inventory. Similarly, management may schedule longer production runs in order to improve the labor efficiency variance, even though it is better to produce in smaller quantities and accept less labor efficiency in exchange.
• Fast-paced environment. A standard costing system assumes that costs do not change much in the near term, so that you can rely on standards for a number of months or even a year, before updating the costs. However, in an environment where product lives are short or continuous improvement is driving down costs, a standard cost may become out-of-date within a month or two.
• Slow feedback. A complex system of variance calculations are an integral part of a standard costing system, which the accounting staff completes at the end of each reporting period. If the production department is focused on immediate feedback of problems for instant correction, the reporting of these variances is much too late to be useful.
• Unit-level information. The variance calculations that typically accompany a standard costing report are accumulated in aggregate for a company’s entire production department, and so are unable to provide information about discrepancies at a lower level, such as the individual work cell, batch, or unit.

The preceding list shows that there are a multitude of situations where standard costing is not useful, and may even result in incorrect management actions. Nonetheless, as long as you are aware of these issues, it is usually possible to profitably adapt standard costing into some aspects of a company’s operations.

Standard Cost Variances

A variance is the difference between the actual cost incurred and the standard cost against which it is measured. A variance can also be used to measure the difference between actual and expected sales. Thus, variance analysis can be used to review the performance of both revenue and expenses.

There are two basic types of variances from a standard that can arise, which are the rate variance and the volume variance. Here is more information about both types of variances: 

• Rate variance. A rate variance (which is also known as a price variance) is the difference between the actual price paid for something and the expected price, multiplied by the actual quantity purchased. The “rate” variance designation is most commonly applied to the labor rate variance, which involves the actual cost of direct labor in comparison to the standard cost of direct labor. The rate variance uses a different designation when applied to the purchase of materials, and may be called the purchase price variance or the material price variance.
• Volume variance. A volume variance is the difference between the actual quantity sold or consumed and the budgeted amount, multiplied by the standard price or cost per unit. If the variance relates to the sale of goods, it is called the sales volume variance. If it relates to the use of direct materials, it is called the material yield variance. If the variance relates to the use of direct labor, it is called the labor efficiency variance. Finally, if the variance relates to the application of overhead, it is called the overhead efficiency variance.

Thus, variances are based on either changes in cost from the expected amount, or changes in the quantity from the expected amount. The most common variances that a cost accountant elects to report on are subdivided within the rate and volume variance categories for direct materials, direct labor, and overhead. It is also possible to report these variances for revenue.

It is not always considered practical or even necessary to calculate and report on variances, unless the resulting information can be used by management to improve the operations or lower the costs of a business. When a variance is considered to have a practical application, the cost accountant should research the reason for the variance in considerable detail and present the results to the responsible manager, perhaps also with a suggested course of action.

Standard Cost Creation

At the most basic level, you can create a standard cost simply by calculating the average of the most recent actual cost for the past few months. In many smaller companies, this is the extent of the analysis used. However, there are some additional factors to consider, which can significantly alter the standard cost that you elect to use. They are: 

• Equipment age. If a machine is nearing the end of its productive life, it may produce a higher proportion of scrap than was previously the case.
• Equipment setup speeds. If it takes a long time to setup equipment for a production run, the cost of the setup, as spread over the units in the production run, is expensive. If a setup reduction plan is contemplated, this can yield significantly lower overhead costs.
• Labor efficiency changes. If there are production process changes, such as the installation of new, automated equipment, then this impacts the amount of labor required to manufacture a product.
• Labor rate changes. If you know that employees are about to receive pay raises, either through a scheduled raise or as mandated by a labor union contract, then incorporate it into the new standard. This may mean setting an effective date for the new standard that matches the date when the cost increase is supposed to go into effect.
• Learning curve. As the production staff creates an increasing volume of a product, it becomes more efficient at doing so. Thus, the standard labor cost should decrease (though at a declining rate) as production volumes increase.
• Purchasing terms. The purchasing department may be able to significantly alter the price of a purchased component by switching suppliers, altering contract terms, or by buying in different quantities.

Any one of the additional factors noted here can have a major impact on a standard cost, which is why it may be necessary in a larger production environment to spend a significant amount of time formulating a standard cost.

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ACCOUNTING INVENTORY METHODS

Accounting Inventory Methods

Inventory includes the raw materials, work-in-process, and finished goods that  a company has on hand for its own production processes or for sale to customers. Inventory is considered an asset, so the accountant must consistently use a valid method for assigning costs to inventory in order to record it as an asset.

The valuation of inventory is not a minor issue, because the accounting method used to create a valuation has a direct bearing on the amount of expense charged to the cost of goods sold in an accounting period, and therefore on the amount of income earned. The basic formula for determining the cost of goods sold in an accounting period is:

     Beginning inventory + Purchases - Ending inventory = Cost of goods sold

Thus, the cost of goods sold is largely based on the cost assigned to ending inventory, which brings us back to the accounting method used to do so. There are several possible inventory costing methods, which are: 

• Specific identification method. Under this approach, you separately track the cost of each item in inventory, and charge the specific cost of an item to the cost of goods sold when you sell the specific item to which that cost has been assigned. This approach requires a massive amount of data tracking, so it is only usable for very high-cost, unique items, such as automobiles or works of art. It is not a viable method in most other situations.

When you buy inventory from suppliers, the price tends to change over time, so you end up with a group of the same item in stock, but with some units costing more than others. As you sell items from stock, you have to decide on a policy of whether to charge items to the cost of goods sold that were presumably bought first, or bought last, or based on an average of the costs of all items in stock. Your choice of a policy will result in using either the first in first out method (FIFO), the last in first out method (LIFO), or the weighted average method. The following bullet points explain each concept:

• First in, first out method. Under the FIFO method, you are assuming that items bought first are also used or sold first, which also means that the items still in stock are the newest ones. This policy closely matches the actual movement of inventory in most companies, and so is preferable simply from a theoretical perspective. In periods of rising prices (which is most of the time in most economies), assuming that the earliest units bought are the first ones used also means that the least expensive units are charged to the cost of goods sold first. This means that the cost of goods sold tends to be lower, which therefore leads to a higher amount of operating earnings, and more income taxes paid. Also, it means that there tend to be fewer inventory layers than under the LIFO method (see next), since you will continually use up the oldest layers.
• Last in, first out method. Under the LIFO method, you are assuming that items bought last are sold first, which also means that the items still in stock are the oldest ones. This policy does not follow the natural flow of inventory in most companies; in fact, the method is banned under International Financial Reporting Standards. In periods of rising prices, assuming that the last units bought are the first ones used also means that the cost of goods sold tends to be higher, which therefore leads to a lower amount of operating earnings, and fewer income taxes paid. There tend to be more inventory layers than under the FIFO method, since the oldest layers may not be flushed out for years.
• Weighted average method. Under the weighted average method, there is only one inventory layer, since the cost of any new inventory purchases are rolled into the cost of any existing inventory to derive a new weighted average cost, which in turn is adjusted again as more inventory is purchased.

Both the FIFO and LIFO methods require the use of inventory layers, under which you have a separate cost for each cluster of inventory items that were purchased at a specific price. This requires a considerable amount of tracking in a database, so both methods work best if inventory is tracked in a computer system.

Articles are also available that provide more inventory accounting detail related to the specific identification method, FIFO method, LIFO method, and weighted average method.

SOURCE BY: ACCOUNTING TOOLS(R)

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THE CHART OF ACCOUNTS

The Chart of Accounts

The chart of accounts is a listing of all accounts used in the general ledger of an organization. The chart is used by the accounting software to aggregate information into an entity's financial statements.

The chart is usually sorted in order by account number, to ease the task of locating specific accounts. The accounts are usually numeric, but can also be alphabetic or alphanumeric.

Accounts are usually listed in order of their appearance in the financial statements, starting with the balance sheet and continuing with the income statement. Thus, the chart of accounts begins with cash, proceeds through liabilities and shareholders' equity, and then continues with accounts for revenues and then expenses. Many organizations structure their chart of accounts so that expense information is separately compiled by department; thus, the sales department, engineering department, and accounting department all have the same set of expense accounts.

Typical accounts found in the chart of accounts are:

Assets: 

• Cash
• Marketable Securities
• Accounts Receivable
• Prepaid Expenses
• Inventory
• Fixed Assets
• Accumulated Depreciation (contra account)
• Other Assets

Liabilities:

• Accounts Payable
• Accrued Liabilities
• Taxes Payable
• Wages Payable
• Notes Payable

Stockholders' Equity:

• Common Stock
• Retained Earnings

Revenue:

• Revenue
• Sales returns and allowances (contra account)

Expenses:

• Cost of Goods Sold
• Advertising Expense
• Bank Fees
• Depreciation Expense
• Payroll Tax Expense
• Rent Expense
• Supplies Expense
• Utilities Expense
• Wages Expense
• Other Expenses

There are a number of ways to structure the chart of accounts. Click here for an example of three-digit codes, here for an example of five-digit codes, and here for an example of seven-digit codes.

Chart of Accounts Best Practices

The following points can improve the chart of accounts concept for a company: 

• Consistency. It is of some importance to initially create a chart of accounts that is unlikely to change for several years, so that you can compare the results in the same account over a multi-year period. If you start with a small number of accounts and then gradually expand the number of accounts over time, it becomes increasingly difficult to obtain comparable financial information for more than the past year.
• Lock down. Do not allow subsidiaries to change the standard chart of accounts without a very good reason, since having many versions in use makes it more difficult to consolidate the results of the business.
• Size reduction. Periodically review the account list to see if any accounts contain relatively immaterial amounts. If so, and if this information is not needed for special reports, shut down these accounts and roll the stored information into a larger account. Doing this periodically keeps the number of accounts down to a manageable level.

If you acquire another company, a key task is shifting the acquiree's chart of accounts into the parent company's chart of accounts, so that you can present consolidated financial results. This process is known as mapping the acquiree's information into the parent's chart of accounts.

SOURCE BY: ACCOUNTING TOOLS(R)

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CASH CONVERSION CYCLE

CASH CONVERSION CYCLE

The cash conversion cycle measures the time period required to convert resources into cash. The intent behind the measurement is to determine how long it takes for funds paid to buy resources to be converted into cash by selling the resulting goods and being paid by customers.

The factors used to derive the cash conversion cycle are as follows: 

• The average time required to pay supplier invoices
• The average time required to convert raw materials into finished goods
• The average time required to collect receivables from customers

The resulting cash conversion cycle formula is:

Days inventory outstanding + Days sales outstanding - Days payables outstanding

Of these elements of the cycle, the one most amenable to significant change is the days of inventory outstanding. Receivables figures tend to vary little, while payables payment terms are dictated by existing contracts with suppliers. Consequently, an astute management team will focus its attention on shrinking the investment in inventory.

The cash conversion cycle is typically used as part of an analysis of how the investment in working capital can be reduced. This can result in a number of operational and policy decisions, such as:

• Outsource production, to avoid an investment in inventory
• Install a just-in-time production system, to reduced the inventory investment
• Cancel poorly selling products, thereby eliminating the associated amount of supporting inventory
• Lengthen delivery times, so that the amount of finished goods kept on hand can be reduced
• Tighten the credit policy, to reduce billings to customers less likely to pay on time
• Alter the collection procedures to enforce more rapid customer contacts regarding overdue accounts
• Negotiate with suppliers to lengthen payment terms

A short conversion cycle is considered highly desirable, since it means that a business can be operated with a reduced amount of cash. A company with a shorter conversion cycle than its peer group probably has reached this point due to a continual review of the entire process over a long period of time. At a minimum, a responsible manager may want to track the conversion cycle on a trend line, and take action whenever the cycle indicates that it is taking longer to convert invested funds back into cash.

The cycle is also closely monitored in smaller organizations that have minimal amounts of equity or debt funding. These businesses have so little excess cash that they must be mindful of how their cash is being used. This is a particular problem for nonprofit entities, since they usually have small cash reserves.

SOURCE BY: ACCOUNTING TOOLS(R)

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THE FAIR VALUE OPTION

The fair value option

The fair value option is the alternative for a business to record its financial instruments at their fair values. GAAP allows this treatment for the following items: 

• A financial asset or financial liability
• A firm commitment that only involves financial instruments
• A loan commitment
• An insurance contract where the insurer can pay a third party to provide goods or services in settlement, and where the contract is not a financial instrument (i.e., requires payment in goods or services)
• A warranty in which the warrantor can pay a third party to provide goods or services in settlement, and where the contract is not a financial instrument (i.e., requires payment in goods or services)

The fair value option cannot be applied to the following items:

• An investment in a subsidiary or variable interest entity that will be consolidated
• Deposit liabilities of depository institutions
• Financial assets or financial leases recognized under lease arrangements
• Financial instruments classified as an element of shareholders’ equity
• Obligations or assets related to pension plans, postemployment benefits, stock option plans, and other types of deferred compensation

When you elect to measure an item at its fair value, do so on an instrument-by-instrument basis. Once you elect to follow the fair value option for an instrument, the change in reporting is irrevocable. The fair value election can be made on either of the following dates:

• The election date, which can be when an item is first recognized, when there is a firm commitment, when qualification for specialized accounting treatment ceases, or there is a change in the accounting treatment for an investment in another entity.
• In accordance with a company policy for certain types of eligible items.

It is acceptable not to apply the fair value option to eligible items when reporting the results of a subsidiary or consolidated variable interest entity, but to apply the fair value option to these items when reporting consolidated financial statements.

It is much easier to apply the fair value option for both subsidiary-level and consolidated financial results, so do not attempt separate treatment, even though it is allowed by GAAP.

In most cases, it is acceptable to choose the fair value option for an eligible item, while not electing to use it for other items that are essentially identical.

If you take the fair value option, report unrealized gains and losses on the elected items at each subsequent reporting date.

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FAIR VALUE ACCOUNTING

FAIR VALUE ACCOUNTING

Fair value accounting uses current market values as the basis for recognizing certain assets and liabilities. Fair value is the estimated price at which an asset can be sold or a liability settled in an orderly transaction to a third party under current market conditions.

This definition includes the following concepts: 

• Current market conditions. The derivation of fair value should be based on market conditions on the measurement date, rather than a transaction that occurred at some earlier date.

• Intent. The intention of the holder of an asset or liability to continue to hold it is irrelevant to the measurement of fair value. Such intent might otherwise alter the measured fair value. For example, if the intent is to immediately sell an asset, this could be inferred to trigger a rushed sale, which may result in a lower sale price.

• Orderly transaction. Fair value is to be derived based on an orderly transaction, which infers a transaction where there is no undue pressure to sell, as may be the case in a corporate liquidation.

• Third party. Fair value is to be derived based on a presumed sale to an entity that is not a corporate insider or related in any way to the seller. Otherwise, a related-party transaction might skew the price paid.

The ideal determination of fair value is based on prices offered in an active market. An active market is one in which there is a sufficiently high volume of transactions to provide ongoing pricing information. Also, the market from which a fair value is derived should be the principal market for the asset or liability, since the greater transaction volume associated with such a market should presumably lead to the best prices for the seller. The market in which a business normally sells the asset type in question or settles liabilities is assumed to be the principal market.

Under fair value accounting, there are several general approaches permitted for deriving fair values, which are:

• Market approach. Uses the prices associated with actual market transactions for similar or identical assets and liabilities to derive a fair value. For example, the prices of securities held can be obtained from a national exchange on which these securities are routinely bought and sold.

• Income approach. Uses estimated future cash flows or earnings, adjusted by a discount rate that represents the time value of money and the risk of cash flows not being achieved, to derive a discounted present value. An alternative way to incorporate risk into this approach is to develop a probability-weighted-average set of possible future cash flows.

• Cost approach. Uses the estimated cost to replace an asset, adjusted for the obsolescence of the existing asset.

GAAP provides a hierarchy of information sources that range from Level 1 (best) to Level 3 (worst). The general intent of these levels of information is to step the accountant through a series of valuation alternatives, where solutions closer to Level 1 are preferred over Level 3. The characteristics of the three levels are as follows:

• Level 1. This is a quoted price for an identical item in an active market on the measurement date. This is the most reliable evidence of fair value, and should be used whenever this information is available. When there is a bid-ask price spread, use the price most representative of the fair value of the asset or liability. This may mean using a bid price for an asset valuation and an ask price for a liability. When you adjust a quoted Level 1 price, doing so automatically shifts the result into a lower level.

• Level 2. This is directly or indirectly observable inputs other than quoted prices. An example of a Level 2 input is a valuation multiple for a business unit that is based on the sale of comparable entities. This definition includes prices for assets or liabilities that are (with key items noted in bold):
•  For similar items in active markets; or
•  For identical or similar items in inactive markets; or
•  For inputs other than quoted prices, such as credit risks, default  rates, and interest rates;  or
•  For inputs derived from correlation with observable market data.

• Level 3. This is an unobservable input. It may include the company’s own data, adjusted for other reasonably available information. Examples of a Level 3 input are an internally-generated financial forecast and the prices contained within an offered quote from a distributor.

These three levels are known as the fair value hierarchy. Please note that these three levels are only used to select inputs to valuation techniques (such as the market approach). The levels are not used to directly create fair values for assets or liabilities.

SOURCE BY: ACCOUNTING TOOLS(R)

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BANK RECONCILIATION STATEMENT

BANK RECONCILIATION STATEMENT (BRS)

A bank reconciliation is the process of matching the balances in an entity's accounting records for a cash account to the corresponding information on a bank statement. The goal of this process is to ascertain the differences between the two, and to book changes to the accounting records as appropriate. The information on the bank statement is the bank's record of all transactions impacting the entity's bank account during the past month.

A bank reconciliation should be completed at regular intervals for all bank accounts, to ensure that a company's cash records are correct. Otherwise, it may find that cash balances are much lower than expected, resulting in bounced checks or overdraft fees. A bank reconciliation will also detect some types of fraud after the fact; this information can be used to design better controls over the receipt and payment of cash.

If there is so little activity in a bank account that there really is no need for a periodic bank reconciliation, you should question why the account even exists. It may be better to terminate the account and roll any residual funds into a more active account. By doing so, it may be easier to invest the residual funds, as well as to monitor the status of the investment.

At a minimum, conduct a bank reconciliation shortly after the end of each month, when the bank sends the company a bank statement containing the bank's beginning cash balance, transactions during the month, and ending cash balance. It is even better to conduct a bank reconciliation every day, based on the bank's month-to-date information, which should be accessible on the bank's web site. By completing a bank reconciliation every day, you can spot and correct problems immediately. In particular, a daily reconciliation will highlight any ACH debits from the account that you did not authorize; you can then install a debit block on the account to prevent these ACH debits from being used to withdraw funds from the account without your permission.

It is extremely unlikely that a company's ending cash balance and the bank's ending cash balance will be identical, since there are probably multiple payments and deposits in transit at all times, as well as bank service fees (for accepting checks, recording deposits, and so forth), penalties (usually for overdrafts), and not sufficient funds deposits that the company has not yet recorded.

The essential process flow for a bank reconciliation is to start with the bank's ending cash balance, add to it any deposits in transit from the company to the bank, subtract any checks that have not yet cleared the bank, and either add or deduct any other items. Then, go to the company's ending cash balance and deduct from it any bank service fees, NSF checks and penalties, and add to it any interest earned. At the end of this process, the adjusted bank balance should equal the company's ending adjusted cash balance.

BANK RECONCILIATION TERMINOLOGY

The key terms to be aware of when dealing with a bank reconciliation are:

Deposit in transit. Cash and/or checks that have been received and recorded by an entity, but which have not yet been recorded in the records of the bank where the entity deposits the funds. If this occurs at month-end, the deposit will not appear in the bank statement, and so becomes a reconciling item in the bank reconciliation. A deposit in transit occurs when a deposit arrives at the bank too late for it to be recorded that day, or if the entity mails the deposit to the bank (in which case a mail float of several days can cause a delay), or the entity has not yet sent the deposit to the bank at all.

Outstanding check. A check payment that has been recorded by the issuing entity, but which has not yet cleared its bank account as a deduction from cash. If it has not yet cleared the bank by the end of the month, it does not appear on the month-end bank statement, and so is a reconciling item in the month-end bank reconciliation.

NSF check. A check that was not honored by the bank of the entity issuing the check, on the grounds that the entity's bank account does not contain sufficient funds. NSF is an acronym for "not sufficient funds." The entity attempting to cash an NSF check may be charged a processing fee by its bank. The entity issuing an NSF check will certainly be charged a fee by its bank.

BANK RECONCILIATION PROCEDURES

The following bank reconciliation procedure assumes that you are creating the bank reconciliation in an accounting software package, which makes the reconciliation process easier:

1. Enter the bank reconciliation software module. A listing of uncleared checks and uncleared deposits will appear.
2. Check off in the bank reconciliation module all checks that are listed on the bank statement as having cleared the bank.
3. Check off in the bank reconciliation module all deposits that are listed on the bank statement as having cleared the bank.
4. Enter as expenses all bank charges appearing on the bank statement, and which have not already been recorded in the company's records.
5. Enter the ending balance on the bank statement. If the book and bank balances match, then post all changes recorded in the bank reconciliation, and close the module. If the balances do not match, then continue reviewing the bank reconciliation for additional reconciling items. Look for the following items:

• Checks recorded in the bank records at a different amount from what is recorded in the company's records.
• Deposits recorded in the bank records at a different amount from what is recorded in the company's records.
• Checks recorded in the bank records that are not recorded at all in the company's records.
• Deposits recorded in the bank records that are not recorded at all in the company's records.
• Inbound wire transfers from which a lifting fee has been extracted.

BANK RECONCILIATION PROBLEMS

There are several problems that continually arise as part of the bank reconciliation, and which you should be aware of. They are:

• Uncleared checks that continue to not be presented. There will be a residual number of checks that either are not presented to the bank for payment for a long time, or which are never presented for payment. In the short term, you should treat them in the same manner as any other uncleared checks - just keep them in the uncleared checks listing in your accounting software, so they will be an ongoing reconciling item. In the long term, you should contact the payee to see if they ever received the check; you will likely need to void the old check and issue them a new one.

• Checks clear the bank after having been voided. As noted in the preceding special issue, if a check remains uncleared for a long time, you will probably void the old check and issue a replacement check. But what if the payee then cashes the original check? If you voided it with the bank, the bank should reject the check when it is presented. If you did not void it with the bank, then you must record the check with a credit to the cash account and a debit to indicate the reason for the payment (such as an expense account, or an increase in a cash account or decrease in a liability account). If the payee has not yet cashed the replacement check, you should void it with the bank at once to avoid a double payment. Otherwise, you will need to pursue repayment of the second check with the payee.

• Deposited checks are returned. There are cases where the bank will refuse to deposit a check, usually because it is drawn on a bank account located in another country. In this case, you must reverse the original entry related to that deposit, which will be a credit to the cash account to reduce the cash balance, with a corresponding debit (increase) in the accounts receivable account.

Another possibility that may be causing problems is that the dates covered by the bank statement have changed, so that some items are included or excluded. This situation should only arise if someone at the company requested the bank to alter the closing date for the company's bank account.

BANK RECONCILIATION EXAMPLES

ABC International is closing its books for the month ended April 30. ABC's controller must prepare a bank reconciliation based on the following issues:

• The bank statement contains an ending bank balance of $320,000.
• The bank statement contains a $200 check printing charge for new checks that the company ordered.
• The bank statement contains a $150 service charge for operating the bank account.
• The bank statement rejects a deposit of $500 due to not sufficient funds, and charges the company a $10 fee associated with the rejection.
• The bank statement contains interest income of $30.
• ABC issued $80,000 of checks that have not yet cleared the bank.
• ABC deposited $25,000 of checks at month-end that were not deposited in time to appear on the bank statement.

he controller creates the following reconciliation:

		Item #	Adjustment to Books
Bank balance	$320,000	1
- Check printing charge	-200	2	Debit expense, credit cash
- Service charge	-150	3	Debit expense, credit cash
- NSF fee	-10	4	Debit expense, credit cash
- NSF deposit rejected	- 500	4	Debit receivable, credit cash
+ Interest income	+ 30	5	Debit cash, credit interest income
- Uncleared checks	- 80,000	6	None
+ Deposits in transit	+ 25,000	7	None
Book balance	$264,170

BANK RECONCILIATION STATEMENT

When the bank reconciliation process is complete, you should be able to print a report through your accounting software that shows the bank and book balances, the identified differences between the two (mostly uncleared checks), and any remaining unreconciled difference. You should retain a copy of this report for each month. The auditors will want to see it as part of their year-end audit. The format of the report will vary by software package; a simplistic layout is:

Bank Reconciliation Statement For Month Ended March 31, 20X3		Notes
Bank balance	$850,000
Less: Checks outstanding	-225,000	See detail
Add: Deposits in transit	+100,000	See detail
+/- Other adjustments	0
Book balance	$725,000
Unreconciled difference	$0

BANK RECONCILIATION RECORD KEEPING

If you complete the bank reconciliation at month-end, then also print the bank reconciliation report and file it in the monthly journal entries binder. This gives the auditors ready access to the information if they want to examine the reconciliations at a later date.

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