Cost Method of Accounting for Investments

 Accounting  No Responses »
Aug 052011
 

The specialty of cost method of accounting for investments is that, it gives us an idea of how much money is actually being invested, how much money is being earned as a return, and also the exact return over investment. This approach of accounting can be adopted for almost any kind of investment, such as mutual funds, investment into gold and silver, etc. Cost method of accounting is also used in the corporate and business world, in order to maintain records and accounts for the following:

Investments into a partnership firm.
Investment into subsidies companies and business
Investments into specific contracts and agreements of a business.

The actual computation and cost accounting for the aforementioned 3 cases is pretty difficult and involves some complex accounting calculations. Cost method of accounting can be used for small investments. Here’s how you can do it…

Note: The word ‘returns’ that is mentioned in the following article implies the total amount of income derived from the investment. Principal amount is the total amount invested, less charges and fees as applicable in some cases.

Cash Statement and Cost Sheet

A statement presented in a simple and easy-to-understand manner is the core of cost method of accounting. Unlike the statements of financial accounting method, which have credit and debit factions, the statements of cost accounting methods have just one faction. A general cash statement and cost sheet are the two primary types of cost accounting statements used to account for investments. We shall be taking a look at both formats in due course. It is a common convention to make one statement per investment, however, companies sometimes make one superseding or collective statement.

When it comes to cost accounting statements for investments, there are three major elements included in the statement:

The first one is the total volume of money that you have invested. It is known as the ‘principal amount’ of investment.
The second one is the total expenditure incurred to make the investment. This includes broker fees, taxes, loads, charges, etc. Note that, this element does not include any direct loss incurred in the investment, for example, the loss of market price of stock equity.
The third element is basically the return which you have received after the lifecycle of the investment gets completed.

There are two more elements which can be optionally included in the statement:

Current realization cost is the total money which you would receive if you sell off your investment. This kind of element is usually used for investments such as gold, silver and stock equity, denoting the current market value.
The next one is the return on investment which is a percentage, that indicates the percentage profit derived from the entire investment.

The decision to use a cost sheet or a cash statement, depends upon the situation at hand. For example, if it is a mutual fund with variable returns, then all premium payments on an annual basis and the relevant returns along with (%) return, on investment of that very year are recorded. At the end of the mutual fund’s life, the total returns minus the invested ‘principal amount’ are recorded as a profit. In such a situation, a cost sheet is used. Another example which can be taken is again of the mutual fund with a ‘Net Asset Value’, that is you don’t get returns paid on an annual basis, but at the end of the total term of the fund, you withdraw the fund which is represented by a Net Asset Value or an NAV, which is essentially the total return amount. This type of statement can also be used for market based investments such as gold, silver and stock equity.

Cost Method of Accounting for Investments: Formats

Now to illustrate the two types of statements, the two aforementioned examples have been used. Take a look…

Cost Sheet for 10 Year Mutual Fund

Sr. No.     Particulars     Calculation     Amount
1.     Total cost of buying one share of the fund
less:

Load
Charges
Taxes
Fees

…     …
2.     Premium for 2001-2002
(add) Return for 2001-2002     …     …
3.     Premium for 2002-2003
(add) Return for 2002-2003     …     …
4.     Premium for 2003-2004
(add) Return for 2003-2004     …     …
5.     Premium for 2004-2005
(add) Return for 2004-2005     …     …
6.     Premium for 2005-2006
(add) Return for 2005-2006     …     …
7.     Premium for 2006-2007
(add) Return for 2006-2007     …     …
8.     Premium for 2007-2008
(add) Return for 2007-2008     …     …
9.     Premium for 2008-2009
(add) Return for 2008-2009     …     …
10.     Premium for 2009-2010
(add) Return for 2009-2010     …     …
11.     Therefore total premiums     …     …
12.     Therefore total returns     …     …
13.     Therefore total return on Investment (%)     …     …
14.     Therefore total rate of return     …     …
15.     Therefore total profit     …     …

You can use the following formulas for the computation of the last 3 elements.

1. Total Return on Investment (%): A.R (×) 100 ÷ A.I
where, A.R = total amount received back as returns and A.I = principal amount invested
2. Total Rate of Return:
A.R = A.I (×) number of years of the investment (×) R ÷ 100
where, R is the rate of return. In this case, you will need to substitute the remaining figures in the formula and then derive the ‘R’ figure, which is percentage return which you have received annually.
3. Total Profit
Total profit is simply the total returns (-) total premiums

Cash Statement for N.A.V Mutual Fund

Sr. No.     Particulars     Amount
1.     Total principal amount invested in mutual fund share
(total cost of buying one share of the fund)
(less) loads / charges / fees     …
2.     (add) Gain in net asset value     …
3.     (less) Loss of net asset value     …
4.     Withdrawal of mutual fund at NAV     …
5.     Return on investment (%)     …
6.     Total rate of return     …
7.     Total profit     …

Depending upon the situation and case of investment, you can apply any of the two methods and their respective statements. The first one works better for long-term investments, essentially the ones that exceed 12 months. The cash statement, on the other hand, works better for smaller, market-based investments.

 Posted by at 2:58 pm

Hybrid Method of Accounting

 Accounting  No Responses »
Aug 012011
 

Within the field of accounting, there are several systems and sub-methods. These different methods have evolved overtime and have been used as per necessity. Simply put, larger the size of the business the greater is the volume and number of transactions. A large number of transactions, means the need of a sophisticated method of accounting. In any case, the principle need and significance of accounting can be summed up on 3 words, “keeping track of money”.

Hybrid accounting, as the name itself suggests is a modern off-shoot of accounting, where more than one method of accounting is used. The use of several methods, and types of accounting together in an integrated manner is termed as hybrid method of accounting. The hybrid method of accounting usually works with the help of both accrual method (book-entry before the transaction) and cash method (book entry during/after the transaction) of transactional entries.

If the cash basis method is used for recording transactions, then the accounting entries are passed in the books of accounts only after a transaction is physically completed or is being completed. In other words, the entry is passed when money changes hands, that is either when you actually pay or you receive money.
In contrast, when one is using the accrual basis method, the entry is passed after the contract to purchase or sale is finalized. That is, you have sold goods today and the purchaser plans to pay you tomorrow, you do not wait till tomorrow to pass the accounting entry. You do that immediately. Money does not necessarily have to change hands immediately, but still you pass the entry.

The Publication 538, of the Internal Revenue Service (IRS) prescribes some terms and conditions which apply to hybrid method or combination method of accounting. These rules have to be followed for income assessment.

Now, one must take into note that the hybrid accounting is used as per need. That is, there is no exact established system of accountancy. It clearly implies that rather than being a single discipline, it is an integrated form of several methods and systems of accounting. Usually in hybrid method of accounting, a mixture of cost accounting (often also known as costing), common financial accounting (based upon the double entry system) and managerial accounting is used.

How does the Hybrid Method of Accounting Work?

As mentioned above, the hybrid method is an integration of several other methods. In the absence of an established hybrid method, businesses and companies basically formulate and improvise their own hybrid systems of accountancy. The existence of financial accounting software makes the formulation, development, improvisation and operation of a hybrid system quite easy. The following is the usual way in which the hybrid method works.

Anticipation and Costing: This is the first step. Any business organization needs to spend money to produce goods or provide services. The business then resorts to the costing of the product, that is, the expenditure is assessed, considering the per unit cost that the company incurs.
Actual Transaction, Journal, Ledger: In case if the transaction is sanctioned by the accounts and finance department, it is entered and recorded on a cash transactional basis. All the entries throughout the year go through the journal and ledger. In cases where the direct cash is used, a cash book entry is done.
Tax and Duties: This is a salient feature of the hybrid method. Every transaction is taxed or something needs to be paid to the government. Instead of ascertain tax at the year-end, it is calculated right during the transaction. Often a monetary provision for such tax is made as soon as the transaction is made.
Predictable Expenditures: This one is similar to the tax provision. There are certain expenditures which can be predicted. In such cases, cost analysis of expenditures such as raw material procurement, maintenance charges, power consumption, liability payoffs is done and provision for the same is made. This also helps in cost and profit ascertainment.
Inventory Analysis: The inventory and its worth is frequently analyzed as it is a crucial part of the asset side of the balance sheet.
Consolidation of Accounts: Consolidation of accounts is done by companies which own and operate several businesses and establishments. Different accounts, incomes, expenditures, assets and liabilities and other significant accounts are consolidated on a daily basis, so that management personnel can view the entire thing as a single individual company’s statements.
Cost Analysis Statements: Preparation of cost analysis statements is a salient feature where financial accounting and costing brilliantly mix. In a said company, there are several processes working at the same time. A statement indicating the expenditures of each process, per unit and per minute/hour is calculated. The total sales and profit figures of every process are also calculated and indicated on the statement. This is done on a daily basis.
Final Accounts: The final accounts are often prepared on a daily basis, these usually include an income and expenditure account, a balance sheet and a cash flow statement (which hints the rise and fall in cash flow). Now, these statements are strictly accrual in nature, and contain market prices of all assets and liabilities. The statement indicates the financial status of the company on a daily basis.
Indexes: Due to the highly dynamic nature of modern businesses, graphs indicating, three chief components, namely, assets, liabilities, income and expenditures, are updated every day.

This entire process is possible only due to the existence of superior quality financial software. Most of the entries are automated, due to which statements can be prepared on everyday.

Benefits of using Hybrid Accounting

There are a significant number of benefits of this accounting system. One of the best merit though is that you can modify it as you want, as there are no hard and fast rules.

Hybrid accounting is a perfect tool that gives us a macro and micro view of the financial status of the business.
This kind of system uses pre-transactional as well as post-transactional analysis, which helps in not just keeping track of money, but also rationalizes all finance related decisions.
The third factor is that the hybrid accounting successfully combines multiple accounting methods, which indirectly combines all the merits.
Hybrid accounting also provides daily updates, which are both cash based and accrual based, and hence while taking decisions, the management do not have to worry about things like, ‘how much are we going to spend on maintenance this year’, or ‘how much tax are we going to owe this year’, or ‘how much is the worth of our inventory or assets’. This eagle eye’s view ensures the precision in decision-making by the management. All the crucial data is precisely analyzed and is present right under their noses.
Last but not the least, such a system is capable of providing information and resourceful and precise data, regarding every possible cent and dollar that the company deals with, every single day. It’s a prefect system, and enables the company to be prepared financially, for any problem as the system in itself is an early warning system.

These benefits can be used to make well-informed and successful decisions. Since the data presented is accurate, the decision can be taken confidently with a well thought out logic, to derive a precise result.

Hybrid method of accounting can be potentially used by almost everybody, from small establishments to giant corporations. However, the significance and need is felt more in larger companies since the number of transactions and the volume of finances is giant. Another significant way in which the companies use this method is, disclosing the financial status and all relevant figures to the shareholders, investors and creditors, on a daily basis. To sum up the hybrid accounting method in one sentence, one can say: “income, expenditure, assets and liabilities, per unit, per minute, per hour, per day, per month, per quarter and per year”. You can have these figures right under your nose.

 Posted by at 2:38 pm

Internal Controls in Accounting

 Accounting  No Responses »
Jan 102011
 

There are many statutory compliance that have to be fulfilled by companies worldwide. Accounting standards and internal controls in accounting are some of the essential compliance that not only help the companies in managing their finances well, but also help the companies to keep track of liabilities, duties and taxes. The laws regarding internal controls in public corporations and companies are especially stringent due to the fact that public money and the common man’s interest is to be safeguarded with the help of such controls and compliance.

Need of Internal Controls in Accounting
As mentioned above, internal control in accounting is a statutory compliance. These controls are also subject to an annual audit, that is conducted by authorized and certified chartered accountants. The following is a small list of factors that explains the need for such internal controls and also the audit of such controls.

It is extremely essential for any company to keep track of all accounting records and financial statements that are transacted and authenticated by the company in one financial year. This kind of control ensures that the public finances are not misused.
Internal controls are also required to ensure timely payment of liabilities and taxes. These controls are required to uphold the reputation and credit rating of the company.
Internal controls are needed to reduce frauds and criminal activities in the corporate world.
The government, and agencies of the government, can demand financial records of the company, without any notice. These controls, once implemented, help the accounting and finance department of the company to produce financial records in such a short period.
Such internal controls are also required in order to increase the efficiency and effectiveness of financial planning and management.

Elements of Internal Controls in Accounting
There are several elements or policies that are implemented by companies in order to ensure effective internal control:

Segregation of Duties: There are several functions that are always going on in the accounts department of a company, which have to be monitored with the help of internal controls. Segregation of duties is an excellent policy where two different people handle the accounts and physical operation of assets. This policy also involves a series of cross checks and tallies. The double entry system is a very crucial instrument for such a process.
Transactional Authorization: All the transactions are authorized and definition of pricing is also implemented. It means that, during sale and purchase, employees need to follow a particular upper and lower limit policy, regarding prices.
Documentation and Records: There are several different documentations and records that are stored in the company’s computer systems with the help of accounting software. These systems basically ensure a simple functionality, easier cross checks, and reliable audits.
Independent Checks: Internal or external auditors of the company can conduct audits and surprise checks within the organization, in order to ensure that the internal controls are effectively working or not.

Read more on:

Purpose of Accounting
Glossary of Accounting Terms and Definitions

Many directors, owners and managers of companies make public statements regarding the follow-up of internal controls in accounting. Public statements also carry the internal control checklist, that is used by the employees and auditors. Internal controls audit is conducted by appointing a certified chartered accountant. It must be noted that internal controls in accounting have become a statutory compliance, and directives are issued by the government from time to time for their implementation

 Posted by at 3:06 pm
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