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Advanced Financial Accounting

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Advance Financial Accounting (FIN-611)
VU
LESSON # 24
RETURNS ON FINANCIAL SOURCES
Company style of business entity obtains finances from two sources; Owners' Capital
and Lenders' Capital. Both of the financers are paid in terms of returns on their
respective capitals. Return on owners' capital is known as dividend and return on
lenders' capital is known as interest/markup.
Dividends
Company style of business entity does not allow its owners (shareholders) to draw
cash or non cash resources from the entity like sole proprietorship and partnership
business organizations. As a replacement for drawings the shareholders are paid
dividends.
Dividend is the return on finances received from the equity participants (ordinary
shareholders). Dividends may be paid after declaration of the current year's profits
and may also be paid during the accounting year as interim dividend based on
expectation of the profits.
Declaration of dividends depends upon the availability of profits where as payment of
dividends depends upon the availability of cash resources. So, in order to pay
dividends, the company must have sufficient distributable profits as well as cash
resources. Therefore, it is only the board of directors who takes decision that how
much dividends should be paid to the shareholders. Although the decision of
dividends is taken by the directors but it is formally approved by the shareholder in
the annual general meeting after they have gone through the annual report.
Calculation of dividends
Amount of dividend can be determined in either of the two ways:
1. As a percentage of the amount of issued and paid-up share capital
2. As rupees/paisa per number of issued and paid-up share capital
Example:
Ordinary share capital of a company is 100,000 number of ordinary share of Rs. 10
each and dividend is paid to shareholders either; as 7% of the ordinary share capital
issued or as Paisa 50 per share.
If dividend is paid as a percentage
The amount of dividend is Rs. 1,000,000 x 7%
= Rs. 70,000
If dividend is paid as paisa per share
The amount of dividend is 100,000 x 0.50
= Rs. 50,000
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Advance Financial Accounting (FIN-611)
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Accounting for dividends
For dividends paid (interim dividends and previous year's proposed dividends)
Dividends a/c
Bank a/c
Debit to the dividend a/c is recognized as a decrease in equity (retained earnings) and
is presented in the statement of changes in equity.
Credit to bank a/c is recognized as a decrease in cash resources kept in the bank.
For dividends proposed by the directors
Where directors of an entity propose dividends after the balance sheet date (closing
date of the year), such dividends are not recognized as a liability and so are not
recognized as a decrease in equity. This is so because such proposed dividends do not
meet the criterion of a present obligation to be a liability. Such dividends are disclosed
in the notes in accordance with the requirements of IAS 1 and IAS 10.
Example:
Pleasure Co. Ltd paid Rs. 55,000 during the year ending on December 31, 2009 as
interim equity dividends.
On March 21st, 2010, directors of the company proposed and declared final equity
dividends of Rs. 135,000 in addition to the already paid.
Presentation:
Statement of changes in equity
For the year ended 31-12-2009
(Extract)
Rupees
Opening balances (retained profits)
???????
Dividend paid
(55,000)
Balance Sheet
As on 31-12-2009
(Extract)
Rupees
Current Assets
Bank balance (decreases by Rs. 55,000)
???????
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Advance Financial Accounting (FIN-611)
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Notes
For the year ended 31-12-2009
(Extract)
Proposed Dividends
Dividends proposed for the year is Rs. 135,000.
Interest on Debentures/Loan notes
Debentures, loan notes, loan bonds, or loan stocks are the lenders' capital. These are
the long term loans and have charge on the non-current assets of the entity through a
trust. Money against these loan certificates is collected from the general public.
Against the capital money received, the company pays interest to the lenders.
A company style of business entity also receives money from the financial institutions
as loan. This loan is also a long term loan and is subject to interest on it. This loan is
secured against non-current assets or inventories of the entity either through
mortgage, pledge, or hypothecation.
Interest on these sources of finance is calculated on the amount due for the period
(time) dues. It means that if the loan was of Rs. 200,000 and an installment of Rs.
50,000 has been paid, the interest will be calculated on the amount due i.e. Rs. 150,000.
It further means that if the loan was taken on 1st of October, 2009 and the accounting
year ends on 31st of December, 2009, the interest will be calculated for the three (3)
months i.e. October, November, & December.
Calculation of interest/markup
Basic Scenario
Rupees
5% Debentures
opening balance 1-1-09
25,000
Issued during the year
20,000
Closing balance 31-12-09
45,000
Scenario I
If the fresh issue of 5% Debentures took place on January 1st, 2009
Interest on debentures 5% of Rs. 25,000 for full year
1,250
Interest on debentures 5% of Rs. 20,000 for full year
1,000
Financial charges for the year
2,250
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Advance Financial Accounting (FIN-611)
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Scenario II
If the fresh issue of 5% Debentures took place on July 1st, 2009
Interest on debentures 5% of Rs. 25,000 for full year  1,250
Interest on debentures 5% of Rs. 20,000 for six months
500
Financial charges for the year
1,750
Changed Scenario
Rupees
5% Debentures
opening balance 1-1-09
25,000
Redemption during the year
15,000
Closing balance 31-12-09
10,000
Scenario III
If the redemption of 5% Debentures took place on January 1st, 2009
Interest on debentures 5% of Rs. 10,000 for full year
500
Financial charges for the year
500
Scenario IV
If the redemption of 5% Debentures took place on July 1st, 2009
Interest on debentures 5% of Rs. 10,000 for full year
500
Interest on debentures 5% of Rs. 15,000 for six months
375
Financial charges for the year
875
Scenario V
If the redemption of 5% Debentures took place on December 31st, 2009
Interest on debentures 5% of Rs. 25,000 for full year
1,250
Financial charges for the year
1,250
Accounting for Interest/markup
For the amount of interest/markup paid during the year
Financial charges a/c
Bank a/c
Debit to the financial charges a/c is recognized as an expense in the incomes statement
and is presented as deduction form operating profits before charging income tax.
Credit to bank a/c is recognized as a decrease in cash resources kept in the bank.
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Advance Financial Accounting (FIN-611)
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For the amount of interest/markup due on balance sheet date
Financial charges a/c
Accrued/owing financial charges a/c
Debit to the financial charges a/c is included in the interest/markup paid and then
recognized as an expense in the incomes statement. Total financial charges, paid and
due, are presented as deduction form operating profits before charging income tax.
Credit to accrued/owing financial charges a/c is recognized as a current liability in
balance sheet, as it meets all the criteria to be a liability.
Example:
Pleasure Co. Ltd paid Rs. 25,000 during the year ending on December 31, 2009 as
interest on loan. On closing date Rs. 10,000 interest on loan is still due.
Presentation:
Income Statement
For the year ended 31-12-2009
(Extract)
Profit from operations
*****
Other incomes
*****
Financial charges
35,000
Profit before tax
*****
Income tax
(****)
Profit after tax
*****
Balance Sheet
As on 31-12-2009
(Extract)
Rupees
Current Assets
Bank balance (decreases by Rs. 25,000)
???????
Current Liabilities
Interest accrued/owing
10,000
Income Tax Expense
Income tax expense is a charge on the realized profits earned by an entity. This is
calculated in accordance with the Income Tax Ordinance 2001 and its accounting
treatments are set out in IAS 12.
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Advance Financial Accounting (FIN-611)
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Income tax expense for the year comprises of:
Current tax, and
Deferred tax
1) Current tax
Current tax is the income tax on current year's taxable profits that is levied by the
income tax authorities. The income tax authorities come to know the profits of an
entity when the income tax return is submitted. Income tax return for the year is
prepared by the tax accountant of the entity after the financial statements have been
approved and published, obviously in these financial statements the current year's
income tax expense is calculated on estimated bases. Such estimated amount of
income tax is known as provision for income tax. Hence, in the income statement, the
income tax expense representing current tax will be an estimated amount with an
adjustment of the difference between actual and estimated amount of previous year's
income tax expense.
Example:
Years
2007
2008
2009
Rupees
Rupees
Rupees
Profit before tax
50,000
60,000
40,000
Income Tax rate
40%
40%
40%
Provision for tax
20,000
24,000
16,000
Actual Tax levied
22,000
23,000
Accounting Entries
For the year 2007
Income tax expense a/c
20,000
Provision for tax a/c
20,000
It is assumed that the year 2007 is first year of the business and for the profits of the
year 2007 the estimated amount of the income tax expense is worked out as Rs. 20,000.
Debit to the income tax expense a/c is subtracted from the profit before tax. Whereas,
credit to provisions for tax a/c is recognized as a current liability, because the entity
has a present obligation to pay tax in future against current year's profits.
For the year 2008
Provision for tax a/c
20,000
Income Tax expense a/c
2,000
Bank a/c
22,000
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Advance Financial Accounting (FIN-611)
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Income tax expense a/c
24,000
Provision for tax a/c
24,000
Income statement a/c
26,000
Income tax expense a/c
26,000
Obligation against the previous year's income tax expense is settled in the current
year. Amount of income tax paid in excess to the previous years' estimated (provision
for) income tax is charged to the current year's income statement as a part of current
year's income tax expense.
In the above case Rs. 22,000 income tax was paid against the provision for income tax
Rs. 20,000 created last year, the excessive amount of income tax paid during the
current year for the previous year is Rs. 2,000 known as under-provision. This Rs.
2,000 (under-provision) is closed into the income statement for the current year along
with the current year's provision of Rs. 24,000 as an expense. So, the total amount of
income tax expense for the year 2008 is Rs. 26,000.
For the year 2009
Provision for tax a/c
24,000
Income Tax expense a/c
1,000
Bank a/c
23,000
Income tax expense a/c
16,000
Provision for tax a/c
16,000
Income statement a/c
15,000
Income tax expense a/c
15,000
When the amount of income tax paid in the current year is lesser than the previous
years' estimated (provision for) income tax the difference is known as over provision,
which is subtracted from the current year's provision for income tax as an adjustment.
In the above case Rs. 23,000 income tax was paid against the provision for income tax
Rs. 24,000 created last year, the lesser amount of income tax paid is Rs. 1,000. This
under-provision of Rs. 1,000 is subtracted form the current year's provision for income
tax of Rs. 16,000 and the balance of Rs. 15,000 is closed into the income statement for
the current year as an expense.
Working in support of the above accounting:
2007
2008
2009
Rupees
Rupees
Rupees
Income Statement
Provision for current year's tax
20,000
24,000
16,000
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Advance Financial Accounting (FIN-611)
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Add Under provision
2,000
Less Over provision
(1,000)
Income tax expense for the year
20,000
26,000
15,000
Balance Sheet
Current Liabilities
Provision for income tax
20,000
24,000
16,000
Deferred tax
Deferred tax is an accounting adjustment that is used to match the tax effects with
accounting profits.
Accounting entries
For creating provision for deferred tax
Income tax expense a/c
Deferred tax liability a/c
For increasing the provision for deferred tax
Income tax expense a/c
Deferred tax liability a/c
For decreasing the provision for deferred tax
Deferred tax liability a/c
Income tax expense a/c
Presentation in Financial Statements
Balance Sheet
As on 31-12-2009
(Extract)
Liabilities
Non-Current Liabilities
Deferred tax liability
****
Current Liabilities
Provision for income tax
****
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Advance Financial Accounting (FIN-611)
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Income Statement
For the year ended 31-12-2009
(Extract)
Profit before tax
****
Income tax expense
Current tax
Provision for current year's tax
***
Add under-provision
***
Less over-provision
(***)
****
Deferred tax
Deferred tax liability increased by
****
Deferred tax liability decreased by
(***)
(****)
Profit after tax
****
Solved Problem:
Q.1:
Amjad Ltd. is preparing its accounts for 20X2. A summarized trial balance is noted
below:
Rs. 000
Rs. 000
Profits before tax and dividends
1,036
Total assets
2,292
Sundry current liabilities
241
Income tax
25
Provision for deferred tax
47
200
Long-term loan
Ordinary shares
100
693
Opening retained earnings
_____
2,317
2,317
Notes:
a. No dividends have been paid or proposed.
b. Last year's income tax was settled at Rs. 238,000. The under provision is noted
on the trial balance.
c. The provision for deferred tax should be adjusted to a closing balance of Rs.
33,000.
Required:
Prepare an income statement, statement of changes in equity and balance sheet with
for Amjad Ltd. for 20X2.
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Advance Financial Accounting (FIN-611)
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Solution:
Amjad Ltd.: Income Statement for 20X2
Rs. 000
Profit before tax
1,036
Taxation
(Note 1)
(364)
Profit after tax
672
Amjad Ltd.: Statement of changes in equity (extract)
Rs. 000
Opening retained earnings
693
Profit for the year
672
Closing retained earnings
1,365
Balance Sheet for 20X2
Rs. 000
Rs. 000
Total Assets
2,292
Equity and Liabilities
Equity
Ordinary shares
100
Retained earnings
1,365
1,465
Non-Current Liabilities
Deferred tax (Note 2)
33
Long-term loan
200
233
Current Liabilities
Sundry
241
Income tax
353
594
2,292
Note 1 ­ Tax Charge
Rs. 000
Income tax charge on the profits for the year at XX %
353
Under (over) provision for tax in previous years
25
Deferred tax charge (credit)
(14)
364
Note 2 ­ Provision for deferred tax
Rs. 000
Opening provision
47
Charge (credit) for the year
(14)
Closing provision
33_
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Advance Financial Accounting (FIN-611)
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Practice Questions:
Q 1:
TAXATION ­ X LTD
X Ltd. is preparing its accounts for the year ended 31 December 20X6. The deferred tax
account as at 31 December 20X5 was Rs. 50,000. A provision of Rs. 70,000 for deferred
tax will be required at the year-end. The current income tax charge provision for the
year is Rs. 60,000. Prepare the relevant extracts from the income statement, balance
sheet and the notes to the accounts.
Solution:
TAXATION ­ X LTD
Extract from the income statement
For the year ended 31 December 20X6
Rs.
Rs.
Taxation
Income tax at X%
60,000
Deferred taxation
20,000
Tax charge
80,000
Extract from balance sheet
As at 31 December 20X6
Rs.
Non-current liabilities
Deferred taxation (Note 1)
70,000
Current liabilities
Income tax
60,000
Notes to the accounts
1.
Deferred taxation
Rs.
Balance brought forward
50,000
Transfer from income statement
20,000
Balance carried forward
70,000
Q 2:
TAXATION ­ UNITED LTD
An extract from the trial balance of United Ltd. as at 31 December 20X8 shows:
a.
The tax provision for the year is estimated at Rs. 170,000.
b.
The income tax rate is 30%.
c.
A provision for deferred taxation of Rs. 45,000 will be required at the year-end.
d.
The directors are not proposing a final dividend.
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Advance Financial Accounting (FIN-611)
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Required
Prepare the figures to appear in the income statement and statement of changes in
equity.
Solution:
TAXATION ­ UNITED LTD
Income statement
For the year ended 31 December 20X8
Rs.
Revenues
1,500,000
Expenses
(950,000)
Profit from operations
550,000
Investment income
8,000
Profit before tax
558,000
Taxation (Note 1)
(187,500)
Profit for the financial year
370,500
Statement of changes in equity
Rs.
Opening retained earnings
650,000
Profit for the financial year
370,500
Dividends
22,500
Closing retained earnings
998,000
Note 1 ­ Taxation
Rs.
On profits of the year
170,000
Under-provision in prior year (1)
2,500
Deferred taxation (2)
15,000
187,500
Notes
1. The trial balance shows an under provision in last year's income statement for
tax of Rs. 2,500 (22,500 ­ 20,000). This is accounted for by increasing this year's
tax charge by Rs. 2,500.
2. The double entry for the transfer to deferred taxation for the year is:
Dr.
Tax charge in the income statement
Rs. 15,000
Cr.
Deferred taxation provision in the balance sheet
Rs. 15,000
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Table of Contents:
  1. ACCOUNTING FOR INCOMPLETE RECORDS
  2. PRACTICING ACCOUNTING FOR INCOMPLETE RECORDS
  3. CONVERSION OF SINGLE ENTRY IN DOUBLE ENTRY ACCOUNTING SYSTEM
  4. SINGLE ENTRY CALCULATION OF MISSING INFORMATION
  5. SINGLE ENTRY CALCULATION OF MARKUP AND MARGIN
  6. ACCOUNTING SYSTEM IN NON-PROFIT ORGANIZATIONS
  7. NON-PROFIT ORGANIZATIONS
  8. PREPARATION OF FINANCIAL STATEMENTS OF NON-PROFIT ORGANIZATIONS FROM INCOMPLETE RECORDS
  9. DEPARTMENTAL ACCOUNTS 1
  10. DEPARTMENTAL ACCOUNTS 2
  11. BRANCH ACCOUNTING SYSTEMS
  12. BRANCH ACCOUNTING
  13. BRANCH ACCOUNTING - STOCK AND DEBTOR SYSTEM
  14. STOCK AND DEBTORS SYSTEM
  15. INDEPENDENT BRANCH
  16. BRANCH ACCOUNTING 1
  17. BRANCH ACCOUNTING 2
  18. ESSENTIALS OF PARTNERSHIP
  19. Partnership Accounts Changes in partnership firm
  20. COMPANY ACCOUNTS 1
  21. COMPANY ACCOUNTS 2
  22. Problems Solving
  23. COMPANY ACCOUNTS
  24. RETURNS ON FINANCIAL SOURCES
  25. IASBíS FRAMEWORK
  26. ELEMENTS OF FINANCIAL STATEMENTS
  27. EVENTS AFTER THE BALANCE SHEET DATE
  28. PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS
  29. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 1
  30. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 2
  31. BORROWING COST
  32. EXCESS OF THE CARRYING AMOUNT OF THE QUALIFYING ASSET OVER RECOVERABLE AMOUNT
  33. EARNINGS PER SHARE
  34. Earnings per Share
  35. DILUTED EARNINGS PER SHARE
  36. GROUP ACCOUNTS
  37. Pre-acquisition Reserves
  38. GROUP ACCOUNTS: Minority Interest
  39. GROUP ACCOUNTS: Inter Company Trading (P to S)
  40. GROUP ACCOUNTS: Fair Value Adjustments
  41. GROUP ACCOUNTS: Pre-acquistion Profits, Dividends
  42. GROUP ACCOUNTS: Profit & Loss
  43. GROUP ACCOUNTS: Minority Interest, Inter Co.
  44. GROUP ACCOUNTS: Inter Co. Trading (when there is unrealized profit)
  45. Comprehensive Workings in Group Accounts Consolidated Balance Sheet