Submit Express Inc.Search Engine Marketing

what is accounting?

Accounting is defined by the American Institute of Certified Public Accountants (AICPA) as "the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof

Etymology

The word "Accountant" is derived from the French word Compter, which took its origin from the Latin word Computare. The word was formerly written in English as "Accomptant", but in process of time the word, which was always pronounced by dropping the "p", became gradually changed both in pronunciation and in orthography to its present form

History of accounting

The earliest accounting records were found amongst the ruins of ancient Babylon, Assyria and Sumeria, which date back more than 7,000 years. The people of that time relied on primitive accounting methods to record the growth of crops and herds. Because there is a natural season to farming and herding, it is easy to count and determine if a surplus had been gained after the crops had been harvested or the young animals weaned

Islamic accounting

In the Qur’an, the word "account" (Arabic: hesab) is used in its generic sense, relating to one's obligation to account to God on all matters pertaining to human endeavour. According to the Qur’an, followers are required to keep records of their indebtedness (Sura 2, ayah 282), thus Islam thus provides general approval and guidelines for the recording and reporting of transactions

Accounting systems

Accounting systems are becoming increasingly granular. Early accounting systems would record access to specific computing systems. Modern accounting systems are able to record access to specific menu items or database cells.

16 Okt 2010

the difference between short-term notes payable and bonds payable

06.30 iphand

A liability is created when a company signs a note for the purpose of borrowing money or extending its payment period credit. A note may be signed for an overdue invoice when the company needs to extend its payment, when the company borrows cash, or in exchange for an asset. An extension of the normal credit period for paying amounts owed often requires that a company sign a note, resulting in a transfer of the liability from accounts payable to notes payable. Notes payable almost always require interest payments. Short-term notes payable are notes that must be repaid with 12 months.


One source of financing available to corporations is long-term bonds. (Bonds are almost never short-term). Bonds represent an obligation to repay a principal amount at a future date and pay interest, usually on a semi-annual basis. Unlike notes payable, which normally represent an amount owed to one lender, a large number of bonds are normally issued at the same time to different lenders. These lenders, also known as investors, may sell their bonds to another investor prior to their maturity.

Capital Lease Criteria

06.27 iphand

  Transfers ownership of the property
               --> to the lessee by the end of the lease term.

       Contains a bargain purchase option.

       Lease term is
               --> equal to 75 percent or more
                     of economic life of leased property.

       Present value of the minimum lease payments
              ( at the beginning of the lease term)
              --> equals or exceeds 90 percent of
                    the excess of the fair value of the leased property
               [SFAS 13, Para. 7]

International Financial Reporting Standards

06.23 iphand

In the over 100 countries that govern accounting using International Financial Reporting Standards, the controlling standard is IAS 17, "Leases". While similar in many respects to FAS 13, IAS 17 avoids the "bright line" tests (specifying an exact percentage as a limit) on the lease term and present value of the rents. Instead, IAS 17 has the following five tests. If any of these tests are met, the lease is considered a finance lease:
  • ownership of the asset is transferred to the lessee at the end of the lease term;
  • the lease contains a bargain purchase option to buy the equipment at less than fair market value;
  • the lease term is for the major part of the economic life of the asset even if title is not transferred;
  • at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.
  • the leased assets are of a specialised nature such that only the lessee can use them without major modifications being made.

Finance lease

06.22 iphand

A finance lease or capital lease is a type of lease. It is a commercial arrangement where:
  • the lessee (customer or borrower) will select an asset (equipment, vehicle, software);
  • the lessor (finance company) will purchase that asset;
  • the lessee will have use of that asset during the lease;
  • the lessee will pay a series of rentals or installments for the use of that asset;
  • the lessor will recover a large part or all of the cost of the asset plus earn interest from the rentals paid by the lessee;
  • the lessee has the option to acquire ownership of the asset (e.g. paying the last rental, or bargain option purchase price);

The finance company is the legal owner of the asset during duration of the lease.
However the lessee has control over the asset providing them the benefits and risks of (economic) ownership.


A finance lease differs from an operating lease in that:
  • in a finance lease the lessee has use of the asset over most of its economic life and beyond (generally by making small 'peppercorn' payments at the end of the lease term).
In an operating lease the lessee only uses the asset for some of the asset's life.
  • in a finance lease the lessor will recover all or most of the cost of the equipment from the rentals paid by the lessee.
In an operating lease the lessor will have a substantial investment or residual value on completion of the lease.
  • in a finance lease the lessee has the benefits and risks of economic ownership of the asset (e.g. risk of obsolescence, paying for maintenance, claiming capital allowances/depreciation).
In an operating lease the lessor has the benefits and risks of owning the asset.
The U.S. Financial Accounting Standards Board and the International Accounting Standards Board announced in 2006 a joint project to comprehensively review lease accounting standards. The boards' stated intention is to recognize an asset and obligation for all leases (in essence, making all leases finance leases). The projected completion of the project is now mid-2011

Capital Lease vs Operating Lease

06.19 iphand

Firms often choose to lease long-term assets rather than buy them for a variety of reasons - the tax benefits are greater to the lessor than the lessees, leases offer more flexibility in terms of adjusting to changes in technology and capacity needs. Lease payments create the same kind of obligation that interest payments on debt create, and have to be viewed in a similar light. If a firm is allowed to lease a significant portion of its assets and keep it off its financial statements, a perusal of the statements will give a very misleading view of the company's financial strength. Consequently, accounting rules have been devised to force firms to reveal the extent of their lease obligations on their books.
There are two ways of accounting for leases. In an operating lease, the lessor (or owner) transfers only the right to use the property to the lessee. At the end of the lease period, the lessee returns the property to the lessor. Since the lessee does not assume the risk of ownership, the lease expense is treated as an operating expense in the income statement and the lease does not affect the balance sheet. In a capital lease, the lessee assumes some of the risks of ownership and enjoys some of the benefits. Consequently, the lease, when signed, is recognized both as an asset and as a liability (for the lease payments) on the balance sheet. The firm gets to claim depreciation each year on the asset and also deducts the interest expense component of the lease payment each year.  In general, capital leases recognize expenses sooner than equivalent operating leases. 
Since firms prefer to keep leases off the books, and sometimes prefer to defer expenses, there is a strong incentive on the part of firms to report all leases as operating leases. Consequently the Financial Accounting Standards Board has ruled that a lease should be treated as an capital lease if it meets any one of the following four conditions -
     (a) if the lease life exceeds 75% of the life of the asset
     (b) if there is a transfer of ownership to the lessee at the end of the lease term
     (c) if there is an option to purchase the asset at a "bargain price" at the end of the lease term.
     (d) if the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of the fair market
         value of the asset.
The lessor uses the same criteria for determining whether the lease is a capital or operating lease and accounts for it accordingly. If it is a capital lease, the lessor records the present value of future cash flows as revenue and recognizes expenses. The lease receivable is also shown as an asset on the balance sheet, and the interest revenue is recognized over the term of the lease, as paid.
From a tax standpoint, the lessor can claim the tax benefits of the leased asset only if it is an operating lease, though the revenue code uses slightly different criteria for determining whether the lease is an operating lease.
When a lease is classified as an operating lease, the lease expenses are treated as operating expense and the operating lease does not show up as part of the capital of the firm. When a lease is classified as a capital lease, the present value of the lease expenses is treated as debt, and interest is imputed on this amount and shown as part of the income statement. In practical terms, however, reclassifying operating leases as capital leases can increase the debt shown on the balance sheet substantially especially for firms in sectors which have significant operating leases; airlines and retailing come to mind.
We would make the argument that in an operating lease, the lease payments are just as much a commitment as lease expenses in a capital lease or interest payments on debt. The fact that the lessee may not take ownership of the asset at the end of the lease period, which seems to be the crux on which the operating/capital lease choice is made, should not be a significant factor in whether the commitments are treated as the equivalent of debt.
Converting operating lease expenses into a debt equivalent is straightforward. The operating lease payments in future years, which are revealed in the footnotes to the financial statements for US firms, should be discounted back at a rate that should reflect their status as unsecured and fairly risky debt. As an approximation, using the firm’s current pre-tax cost of debt as the discount rate yields a good estimate of the value of operating leases. Note that capital leases are accounted for similarly in financial statements, but the significant difference is that the present value of capital lease payments is computed using the cost of debt at the time of the capital lease commitment, and is not adjusted as market rates change

Long term liabilities

06.15 iphand

Long term liabilities are those that are due to be paid in more than an year. Those due in less than a year or on demand are current liabilities.
The most important type of long term liability is debt. Preference shares are not debt, but given that they are "debt like" this is often something investors should adjust for.
Similarly, some short term debt can keep being renewed, so it in fact provides long term funding. This sometimes happens with overdrafts: they are repayable on demand and therefore short term debt, but a company may maintain an overdraft for many years.
Conversely debt instruments that originally had a long term that are now close to expiry are short term debt, and shown as such in the accounts.
Long term liabilities are looked at by investors assessing a company's financial health using ratios such as interest cover. Because of gearing high debt enhances the benefits of growth.
Like shareholders, the holders of long term debt (i.e. banks and bondholders) are suppliers of funds to a company. They rank higher than shareholders in getting their money back if a company fails and therefore their money is safer, but they do not gain if the company performs better than the minimum necessary to pay back its debt.

Common Stock

06.11 iphand


As already mentioned in discussing the stock market, a stock is a share in the ownership of a company. Stock represents a claim on the company's assets and earnings. The more stock you are holding, the greater is your ownership stake in the company. Being a shareholder, however does not mean you have any input in the day-to-day running of the business. Instead, the degree of influence of a person holding the stock is restricted to one vote per share to elect the board of directors at annual meetings. Although meaning of the stock is quite easy to grasp, all the variations of the stock can make investing in the stock market somewhat confusing.
Common stock is the most typical type of stock. When people discuss investing in stocks in general they are most likely referring to this type of stock. In fact, the greatest number of stock issued is in this form. Common shares represent ownership in a company and a claim (dividends) on a portion of profits. Investing persons or firms get one vote per stock share to elect the board members, who oversee the major decisions made by management.
Study of investing and stock market has revealed that in the long term, common stock, by means of capital growth, yields higher returns than almost every other investment. This higher return comes at a cost, because common stock carries the greatest risk. In case the company goes bankrupt and liquidates, the investor holding common stock shares will not receive money until the creditors, bondholders, and preferred shareholders are paid.