Tuesday, 20 March 2012

Budgeting Process & Types

Definition :
A budget can be defined as a quantitative economic plan in respect of a period of time.

Functions of a budget:

Budgets can fulfil one or more of the following functions:
Different budgeting methodologies allow the budget to perform these roles in different ways and to differing extents. For example, the planning programming approach (see section 4.3) can be clearly seen as underpinning the decision-making function. Conversely, one of the criticisms of the incremental approach is that it does not allow for full consideration of proposed changes in action as it is a more backward-looking method; it could be argued that incremental budgeting does not support decision making very well.
1.Incremental Budgeting :

Public sector budgets in Northern Ireland and elsewhere in the UK typically rely on the incremental approach (although the Comprehensive Spending Review 2007 process did involve a series of departmental baseline reviews). The previous year’s budget for a department or division is carried forward for the next annual budget. It is adjusted for known factors such as new legislative requirements, additional resources, service developments, anticipated price and wage inflation and so on.

>>It is known as incremental budgeting because the process is mainly concerned with the incremental (or marginal) adjustments to the current budgeted allowance. In that respect it is rather similar to the NI block funding: any changes are up or down from the existing funding for particular activities.
>>According to the Chartered Institute for Public Finance and Accounting (CIPFA), a key characteristic of the approach is that budget preparation is a process of negotiation and compromise. "Incremental budgeting is therefore based on a fundamentally different view of decision making than more rational approaches."
>>This is because negotiated settlements between interested parties require a willingness to compromise. If consensus breaks down, compromise cannot be reached and the incremental process becomes invalid. According to CIPFA, use of this model, therefore, requires a relatively stable form of representative government.
Advantages of incremental budgeting
·  easily understood (as it is retrospective), makes marginal changes and secures agreement through negotiation;
·  administratively straightforward (and therefore cheap);
·  allows policy makers to concentrate of the key areas of change. Ministers, elected representatives and senior officials are not required to study long and detailed budgetary documents;
·  particularly useful where outputs are difficult to define/quantify; and,
·  stable and, therefore, changes are gradual.

Disadvantages of incremental budgeting
·  backward looking – focus more on previous budget than future operational requirements and objectives;
·  does not allow for overall performance overview;
·  does not help managers identify budgetary ‘slack’;
·  often underpinned by data or service provision which is no longer relevant or is inconsistent with new priorities;
·  encourages systemic inertia and ‘empire building’;
·  tends to be reactive rather than proactive; and,
·  assumes existing budget lines are relevant and satisfactory.

2. Zero-Based Budgeting :

Zero-based budgeting – unlike the incremental approach – starts from the basis that no budget lines should be carried forward from one period to the next simply because they occurred previously. Instead,
  before the budget is allocated. It is, therefore, less ‘how should we deliver this service with the money available’ and more ‘here’s what we have to achieve, different options for achieving it and the budget required for each of those options’.

The approach relies upon the involvement of all executive managers. It requires the organisation’s objectives to be clearly stated – as with any budget process – but also considers and assesses different ways of delivering those objectives

The process requires specification of minimum levels of service provision, the current level, and an ‘incremental’ level – either between the minimum and the current or an improvement over the current level. Options for delivering at each level can then be evaluated and a justification put forward along with the request for resources.

Advantages of zero-based budgeting
·  allows questioning of the inherited position and challenge to the status quo;
·  focuses the budget closely on objectives and outcomes;
·  actively involves operational managers rather than handing them down a budget from above;
·  can be adaptive to changes in circumstances and priorities; and,
·  can lead to better resource allocation.

Disadvantages of zero-based budgeting
·  more time consuming than incremental budgeting (i.e. it may become overly bureaucratic and produce excessive paperwork);
·  need for specialised skills/training;
·  difficulties can arise in the identification of suitable performance measures and decision/prioritisation criteria (if there is insufficient information in some areas ranking them could also be problematic);
·  the specification of a minimum level of service provision (if below the current level) may demotivate managers;
·  questioning of the inherited position can be seen as threatening to organisations and their people (so careful management of the people element is essential); and,
·  may be difficult to cost and estimate resource requirements for options different from the current practice (giving rise to greater uncertainty).

Thursday, 15 March 2012

Meger,Amalgamation,Acquisition/Takeover,Jointventure,Strategic Alliance Strategies

Merger Strategy :
A merger takes place two or more companies join together to form a single company.

Types of Mergers:

Horizontal Mergers:
The combining companies are of the same business.
Vertical Mergers: The joining companies are at different stages of the production process of the same product.

Concentric Mergers:
The Joining companies are from similar businesses. They however, have no buyer seller relationship.

Conglomerate Mergers:
In Conglomerate Mergers the combining companies are from unrelated or completely different businesses.

Reverse Merger:
When profit making company merges with the financially weaker company.

Merger Vs. Amalgamation :
"Very often, the two expressions "merger" and "amalgamation" are taken as synonymous. But there is, in fact, a difference.
>>Merger is restricted to a case where the assets and liabilities of the companies get vested in another company, the company which is merged losing its identity and its shareholders becoming shareholders of the other company.
>>On the other hand, amalgamation is an arrangement, whereby the assets and liabilities of two or more companies become vested in another company (which may or may not be one of the original companies) and which would have as its shareholders substantially, all the shareholders of the amalgamating companies."

Takeover Strategy :
Takeovers or Acquisitions happen when one company acquires ownership or the controlling stake in the other company.
Companies looking for rapid growth opportunities often adopt the takeover strategy.

>>Takeovers may be of two kinds, hostile and friendly.
>>Hostile takeovers, as the name suggests, are against the wishes acquired company. Friendly takeovers involve negotiation and mutual consent.

Joint Venture Strategy:
In Joint Ventures or JVs two or more companies come together and form a new entity to pursue some business activity.
It may be uneconomical for a company to pursue a business activity all alone. This is why it may go in for a JV.
In a JV, the two companies can combine their capabilities and strengths and share the business risks. This way they can overcome all difficulties and hurdles effectively.

>> JV Strategy is a Profit Motive Strategy

Strategic Alliance Strategy:
Strategic Alliance: The companies collaborate with each other to pursue a business activity. In a Strategic Alliance new company is not formed.
>>The companies remain independent after the formation of the alliance.
>>Strategic Alliances can help companies in many ways such as to get access to foreign technology and to enter new markets.
>> Strategic Alliance  Strategy is a Non Profit Motive Strategy

Saturday, 10 March 2012

Amortization

Amortization:

In accounting, amortization refers to the periodic expensing of the value of an intangible asset. Similar to depreciation of tangible assets, intangible assets are typically expensed over the course of the asset’s useful life. Amortization represents reduction in value of the intangible asset due to usage or obsolescence. Basically, intangible assets decrease in value over time, and amortization is the method of accounting for that decrease in value over the course of the asset’s useful life. A company’s long-term capital expenditures can also be amortized over time.


Amortization Treatment:

Intangible assets are recorded on the balance sheet. Over time, as these assets are amortized, the amortized amount accumulates in a contra-asset account thereby diminishing the net value of the intangible assets. The periodic amortization amounts are expensed on the income statement as incurred. On the statement of cash flows, amortization expenses are added back to net income in the operating section because they represent non-cash expenses.


Intangible Asset Amortization:

Examples of intangible assets that a company may amortize include: trademarks, patents, copyrights, brand names, goodwill, and other intellectual property. Depending on the circumstances, some brand names or goodwill items may not decrease in value over time and therefore may not be amortized.


Amortization Regulations:

In International Financial Reporting Standards (IFRS), the rules and standards for intangible asset amortization are described in International Accounting Standard 38: Intangible Assets. In the United States, according to General Accepted Accounting Principles (GAAP), the rules and standards for intangible asset amortization are described in Statement of Financial Accounting Standards No. 142: Goodwill and Other Intangible Assets.


Amortization of Loans:

Amortizing a loan consists of spreading out the principal and interest payments over the life of the loan. The amortized loan is spread out and paid down based on an amortization schedule or amortization table. There are different types of amortization schedule, such as straight line, declining balance, annuity, and increasing balance amortization tables. Amortization of mortgages is common.

Journal Entry For Amortization:
Amortization a/c  Dr.
       TO Asset(patent)  a/c

Formula for Amortization:

Amortization = Cost of asset/Life of asset      (Straight line method )

Friday, 9 March 2012

Dividend Analysis

Dividend Analysis:
Dividend:
1. A distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. The dividend is most often quoted in terms of the dollar amount each share receives (dividends per share). It can also be quoted in terms of a percent of the current market price, referred to as dividend yield.

Also referred to as "Dividend Per Share (DPS)."

2. Mandatory distributions of income and realized capital gains made to mutual fund investors.

Explanation:
1. Dividends may be in the form of cash, stock or property. Most secure and stable companies offer dividends to their stockholders. Their share prices might not move much, but the dividend attempts to make up for this.

High-growth companies rarely offer dividends because all of their profits are reinvested to help sustain higher-than-average growth.

2. Mutual funds pay out interest and dividend income received from their portfolio holdings as dividends to fund shareholders. In addition, realized capital gains from the portfolio's trading activities are generally paid out (capital gains distribution) as a year-end dividend.

Interim Dividend:

A dividend payment made before a company's AGM and final financial statements. This declared dividend usually accompanies the company's interim financial statements.
>>This is used more frequently in the United Kingdom, where it is usual for dividend payments to occur semi-annually. The interim dividend is generally the smaller of the 2 payments made to shareholders.

Cum Dividend:

When a buyer of a security is entitled to receive a dividend that has been declared, but not paid.
>>Cum dividend means "with dividend." A stock trades cum-dividend up until the ex-dividend date. On or after this point, the stock trades without its dividend rights.

Declaration Date:

1. The date on which the next dividend payment is announced by the directors of a company. This statement includes the dividend's size, ex-dividend date and payment date. It is also referred to as the "announcement date".

2. The last day on which the holder of an option must indicate whether he or she will exercise the option.

Explanation :
1. Once it is authorized, the dividend is known as a declared dividend and it becomes the company's legal liability to pay it.

2. The declaration date of all listed stock options in the U.S. is on the third Friday of the listed month. If there is a holiday on the Friday, the declaration date falls on the third Thursday.

Board Of Directors - B Of D:

A group of individuals that are elected as, or elected to act as, representatives of the stockholders to establish corporate management related policies and to make decisions on major company issues. Such issues include the hiring/firing of executives, dividend policies, options policies and executive compensation. Every public company must have a board of directors.

Explanation :
Board Of Directors - B Of D'In general, the board makes decisions on shareholders' behalf. Most importantly, the board of directors should be a fair representation of both management and shareholders' interests; too many insiders serving as directors will mean that the board will tend to make decisions more beneficial to management. On the other hand, possessing too many independent directors may mean management will be left out of the decision-making process and may cause good managers to leave in frustration.

Vertical Integration Vs. Horizontal Integration

Vertical Integration:
When a company expands its business into areas that are at different points of the same production path.
>>A car company that expands into tire manufacturing would be an example of vertical integration. A company such as this is often referred to as vertically integrated.

Backward Integration:
A form of vertical integration that involves the purchase of suppliers in order to reduce dependency.
>>A good example would be if a bakery business bought a wheat farm in order to reduce the risk associated with the dependency on flour.

Forward Integration:
A business strategy that involves a form of vertical integration whereby activities are expanded to include control of the direct distribution of its products.

>> A good example of forward integration is when a farmer sells his/her crops at the local market rather than to a distribution center.
Horizontal Integration :
The acquisition of additional business activities that are at the same level of the value chain in similar or different industries. This can be achieved by internal or external expansion. Because the different firms are involved in the same stage of production, horizontal integration allows them to share resources at that level. 

If the products offered by the companies are the same or similar, it is a merger of competitors. If all of the producers of a particular good or service in a given market were to merge, it would result in the creation of a monopoly. Also called lateral integration.

>>Examples of horizontal integration include an oil company's acquisition of additional oil refineries, or an automobile manufacturer's acquisition of a light truck manufacturer.

Horizontal integration offers several advantages, including favorable economies of scale, economies or scope, increased market power and reduction in the costs associated with international trade by operating in foreign markets. Horizontal integration is in contrast to vertical integration, where firms expand into different activities, known as upstream or downstream activities.

Tuesday, 6 March 2012

LEASE AGREEMENTS: CAPITAL LEASE/FINANCIAL LEASE & OPERATING LEASE

CONCEPT 0F LEASE FINANCING:
Lease financing denotes procurement of assets through lease. The subject of leasing falls in the category of finance. Leasing has grown as a big industry in the USA and UK and spread to other countries during the present century. In India, the concept was pioneered in 1973 when the First Leasing Company was set up in
Madras and the eighties have seen a rapid growth of this business.

Lease as a concept involves a contract whereby the ownership, financing and risk taking of any equipment or asset are separated and shared by two or more parties. Thus, the lessor may finance and lessee may accept the risk through the use of it while a third party may own it. Alternatively the lessor may finance and own it while the lessee enjoys the use of it and bears the risk. There are various combinations in which the above characteristics are shared by the lessor and lessee.

MEANING 0F LEASE FINANCING:
A lease transaction is a commercial arrangement whereby an equipment owner or Manufacturer conveys to the equipment user the right to use the equipment in return for a rental. In other words, lease is a contract between the owner of an asset (the lessor) and its user (the lessee) for the right to use the asset during a specified period
in return for a mutually agreed periodic payment (the lease rentals). The important feature of a lease contract is separation of the ownership of the asset from its usage.
Lease financing is based on the observation made by Donald B. Grant: “Why own a cow when the milk is so cheap? All you really need is milk and not the cow.”

IMPORTANCE 0F LEASE FINANCING:
Leasing industry plays an important role in the economic development of a country by providing money incentives to lessee. The lessee does not have to pay the cost of asset at the time of signing the contract of leases. Leasing contracts are more flexible so lessees can structure the leasing contracts according to their needs for finance. The lessee can also pass on the risk of obsolescence to the lessor by acquiring those appliances, which have high technological obsolescence. To day, most of us are familiar with leases of houses, apartments, offices, etc.
 
TYPES OF LEASE AGREEMENTS:
FINANCIAL LEASE:
Long-term, non-cancellable lease contracts are known as financial leases. The essential point of financial lease agreement is that it contains a condition whereby the lessor agrees to transfer the title for the asset at the end of the lease period at a nominal cost. At lease it must give an option to the lessee to purchase the asset he has
used at the expiry of the lease. Under this lease the lessor recovers 90% of the fair value of the asset as lease rentals and the lease period is 75% of the economic life of the asset. The lease agreement is irrevocable. Practically all the risks incidental to the asset ownership and all the benefits arising there from are transferred to the lessee who bears the cost of maintenance, insurance and repairs. Only title deeds remain with the lessor. Financial lease is also known as ‘capital lease’. In India, financial leases are very popular with high-cost and high technology equipment.

OPERATING LEASE:
An operating lease stands in contrast to the financial lease in almost all aspects. This lease agreement gives to the lessee only a limited right to use the asset. The lessor is responsible for the upkeep and maintenance of the asset. The lessee is not given any uplift to purchase the asset at the end of the lease period. Normally the lease is for a
short period and even otherwise is revocable at a short notice. Mines, Computers hardware, trucks and automobiles are found suitable for operating lease because the rate of obsolescence is very high in this kind of assets.

SALE AND LEASE BACK:
It is a sub-part of finance lease. Under this, the owner of an asset sells the asset to a party (the buyer), who in turn leases back the same asset to the owner in consideration of lease rentals. However, under this arrangement, the assets are not physically exchanged but it all happens in records only. This is nothing but a paper transaction.
Sale and lease back transaction is suitable for those assets, which are not subjected depreciation but  appreciation, say land. The advantage of this method is that the lessee can satisfy himself completely regarding the quality of the asset and after possession of the asset convert the sale into a lease arrangement. The sale and lease back trasaction can be expressed with the help of the following figure.

Under this transaction, the seller assumes the role of a lessee and the buyer assumes the role of a lessor. The seller gets the agreed selling price and the buyer gets the lease rentals. It is possible to structure the sale at agreed value (below or above the fair market price) and to adjust difference in the lease rentals. Thus the effect of profit/loss on sale of assets can be deferred.

LEVERAGED LEASING:
Under leveraged leasing arrangement, a third party is involved beside lessor and lessee. The lessor borrows a part of the purchase cost (say 80%) of the asset from the third party i.e., lender and the asset so purchased is held as security against the loan. The lender is paid off from the lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to the lessor. The lessor, the owner of the asset is entitled to depreciation allowance associated with the asset.

DIRECT LEASING:
Under direct leasing, a firm acquires the right to use an asset from the manufacturer directly. The ownership of the asset leased out remains with the manufacturer itself. The major types of direct lessor include manufacturers, finance companies, independent lease companies, special purpose leasing companies etc.

ADVANTAGES OF LEASING:There are several extolled advantages of acquiring capital assets on lease:

(1) SAVING OF CAPITAL:
Leasing covers the full cost of the equipment used in the business by providing 100% finance. The lessee is not to provide or pay any margin  money as there is no down payment. In this way the saving in capital or financial resources can be used for other productive purposes e.g. purchase of inventories.

(2) FLEXIBILITY AND CONVENIENCE:
The lease agreement can be tailor- made in respect of lease period and lease rentals according to the convenience and requirements of all lessees.

(3) PLANNING CASH FLOWS:
Leasing enables the lessee to plan its cash flows properly. The rentals can be paid out of the cash coming into the business from the use of the same assets.

(4) IMPROVEMENT IN LIQUADITY:
Leasing enables the lessee to improve their liquidity position by adopting the sale and lease back technique.

Under leveraged leasing arrangement, a third party is involved beside lessor and lessee. The lessor borrows a part of the purchase cost (say 80%) of the asset from the third party i.e., lender and the asset so purchased is held as security against the loan. The lender is paid off from the lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to the lessor. The lessor, the owner of the asset is entitled to depreciation allowance associated with the asset.

Lease agreements are basically of two types. They are (a) Financial lease and (b) Operating lease. The other variations in lease agreements are (c) Sale and lease back (d) Leveraged leasing and (e) Direct leasing.

Monday, 5 March 2012

Accounting Standards issued by ICAI

Accounting:
Accounting is the art of recording transactions in the best manner possible, so as to enable the reader to arrive at judgments/come to conclusions, and in this regard it is utmost necessary that there are set guidelines. These guidelines are generally called accounting policies. The intricacies of accounting policies permitted Companies to alter their accounting principles for their benefit. This made it impossible to make comparisons. In order to avoid the above and to have a harmonised accounting principle, Standards needed to be set by recognised accounting bodies. This paved the way for Accounting Standards to come into existence.
Accounting Standards in India are issued By the Institute of Chartered Accountanst of India (ICAI). At present there are 30 Accounting Standards issued by ICAI.

The Institute of Chartered Accountants of India (ICAI):
The Institute of Chartered Accountants of India (ICAI) is a statutory body established under the Chartered Accountants Act, 1949 (Act No. XXXVIII of 1949) for the regulation of the profession of Chartered Accountants in India. During its 61 years of existence, ICAI has achieved recognition as a premier accounting body not only in the country but also globally, for its contribution in the fields of education, professional development, maintenance of high accounting, auditing and ethical standards.ICAI now is the second largest accounting body in the whole world.

 
Objective of Accounting Standards:
Objective of Accounting Standards is to standarize the diverse accounting policies and practices with a view to eliminate to the extent possible the non-comparability of financial statements and the reliability to the financial statements.
The institute of Chatered Accountants of India, recognizing the need to harmonize the diversre accounting policies and practices, constituted at Accounting Standard Board (ASB) on 21st April, 1977.

Compliance with Accounting Standards issued by ICAI:
Sub Section(3A) to section 211 of Companies Act, 1956 requires that every Profit/Loss Account and Balance Sheet shall comply with the Accounting Standards. 'Accounting Standards' means the standard of accounting recomended by the ICAI and prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards(NACAs) constituted under section 210(1) of companies Act, 1956.

                                                                                                                                                                    


Accounting Standards mandatory as on July 01, 2012

AS 1 Disclosure of Accounting Policies
AS 2 Valuation of Inventories
AS 3 Cash Flow Statements
AS 4 Contingencies and Events Occuring after the Balance Sheet Date
AS 6 Depreciation Accounting
AS 7 Construction Contracts (revised 2002)
AS 9 Revenue Recognition
AS 10 Accounting for Fixed Assets
AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003),
AS 12 Accounting for Government Grants
AS 13 Accounting for Investments
AS 14 Accounting for Amalgamations
AS 15 Employee Benefits (revised 2005)
AS 16 Borrowing Costs
AS 18 Related Party Disclosures
AS 19 Leases
AS 21 Consolidated Financial Statements
AS 22 Accounting for Taxes on Income.
AS 23 Accounting for Investments in Associates in Consolidated Financial Statements
AS 24 Discontinuing Operations
AS 25 Interim Financial Reporting
AS 26 Intangible Assets
AS 27 Financial Reporting of Interests in Joint Ventures
AS 28 Impairment of Assets
AS 29 Provisions,Contingent` Liabilities and Contingent Assets


Accounting Standards not mandatory as on July 01, 2012

Sources :

http://www.icai.org/post.html?post_id=8660
http://www.icai.org/post.html?post_id=8659



ECONOMIC ORDER QUANTITY (EOQ)

ECONOMIC ORDER QUANTITY (EOQ) MODEL

The economic order quantity (EOQ) is the order quantity that minimizes total holding and ordering costs for the year. Even if all the assumptions don’t hold exactly, the EOQ gives us a good indication of whether or not current order quantities are reasonable.

What is the EOQ Model?

  • Cost Minimizing “Q”
  • Assumptions:
    • Relatively uniform & known demand rate
    • Fixed item cost
    • Fixed ordering and holding cost
    • Constant lead time
(Of course, these assumptions don’t always hold, but the model is pretty robust in practice.)

What Would Holding and Ordering Costs Look Like for the Years?


A = Demand for the year
Cp = Cost to place a single order
Ch = Cost to hold one unit inventory for a year

Total Relevant* Cost (TRC)

Yearly Holding Cost + Yearly Ordering Cost

* “Relevant” because they are affected by the order quantity Q

Economic Order Quantity (EOQ)


EOQ Formula:



A = Demand for the year
Cp = Cost to place a single order
Ch = Cost to hold one unit inventory for a year

Example:

Pam runs a mail-order business for gym equipment. Annual demand for the TricoFlexers is 16,000. The annual holding cost per unit is $2.50 and the cost to place an order is $50. What is the economic order quantity?

 

Follow by Email