Definition: The Capital Employed Turnover Ratio shows how efficiently the sales are generated from the capital employed by the firm. This ratio helps the investors or the creditors to determine the ability of a firm to generate revenues from the capital employed and act as a key decision factor for lending more money to the asking firm.

The formula to compute this ratio is:

Capital Employed Turnover Ratio = Net Sales/ Capital Employed

Where, Capital Employed = Net worth + Long-term Borrowings
Net Worth = Share Capital + All Reserves

Higher the ratio better is the utilization of capital employed and shows the ability of the firm to generate maximum profits with the minimum amount of capital employed.

Example: Suppose a firm has a net sales of Rs 50,000 and reported a net worth of Rs 4,00,000 and the long term borrowings amounting to Rs 20,000 in the balance sheet of the firm. The capital employed turnover Ratio will be:

Capital Employed Turnover Ratio = 50,000/4,20,000 = 0.12 times

Capital employed = 4,00,000 + 20,000 = 4,20,000

Definition: The Aging Schedule is a tabular representation of all the bills and invoices along with their respective ages, i.e. the date on which these become due. Simply, all the bills receivables and bills payable are classified along with their date of maturity, to keep a check on which payment or receivable is behind its due date and by how many days.

The ranks are assigned to each bill receivable/payable according to their ages. The aging schedule categorizes the accounts as Current account – under 30 days, and Past dues account – 1-30 days, 31-60 days, 61-90 days and so on. It is ideal to have more current accounts than the past due accounts because the risk of bad debt is higher in the case of the latter.

Through aging schedule, a company can identify the bills that are overdue on its part and to which customer the payment reminder is to be sent if he is way behind the due date. Also, a firm can project its cash flows by evaluating the liabilities that need to be paid at the earliest and can anticipate the income on the basis of the invoices sent to the customers days back.

Thus, aging schedule is an important working capital management tool that helps in projecting the cash flow pattern, both inflows, and outflows, and helps in estimating the doubtful debts.

Definition: The Authorized Capital is the maximum amount of capital that a company can raise through the issue of shares to the shareholders. In other words, the capital amount with which a company is registered with the registrar of the company (as stated in the article of incorporation) is called the authorized capital.

Thus, authorized capital is the limit to which the companies can raise shares to the shareholders and not beyond it. Therefore, the companies get registered with capital, which is quite above their current needs of financing, so that the capital can be further raised when the need arises.

Often, the authorized capital is not fully used by the management; a safety buffer is maintained that can be used to raise the additional capital whenever the need arises. Also with the issue of shares the ownership in the company gets diluted, and therefore, the full amount of capital is not raised with the intent to have limited control over the affairs of the company.

For Example: Suppose a firm has an authorized capital of Rs 50,00,000, then it can issue shares worth up to Rs 50,00,000 to its shareholders and cannot issue anything beyond it. But however, if the company issued shares worth up to Rs 25,00,000 only, then the remaining capital amount will be held as an unused capital and can be used anytime by the firm in the future.

The authorized capital can be increased anytime a firm wants, provided the shareholders approve it. Thus, in order to increase the limit, along with the shareholder’s approval, an additional fee has to be paid to the registrar of the companies.

Definition: The Issued Capital refers to the number of shares issued by the company to the shareholders. In other words, the shares allotted or subsequently held by the shareholders is called the issued capital.

The Issued capital represents that part of an authorized capital, which a company is authorized to sell through the shares. A company can either sell all its shares or a portion of it depending on the need for finance. It is also called as a subscribed capital, as the number of shares purchased by the shareholders represents the amount of money invested in the firm.

For Example: If a firm has an authorized capital of Rs 50,00,000, where the price of each share is Rs 10. If a company receives an application for 10,00,000 shares, but instead the company issued 8,00,000 shares of Rs 10 each. Then the issued capital will be Rs 80,00,000 (8,00,000 x 10).

The Issued Capital represents the shares that have been issued to the shareholders and which still remains unpaid. Any share redeemed or repurchased by the company itself for the purpose of keeping it in the stock is not a part of such capital.

The value of the share capital changes with the issue of new shares to the existing or new shareholders. Also, the company may repurchase or redeem its shares that result in the change in the value of the subscribed capital.

Definition: The Paid-up Capital refers to the amount that has been received by the company through the issue of shares to the shareholders. Simply, the money injected into the firm by the shareholders in exchange for the shares purchased by them is called the paid-up capital.

The Paid-up capital can be equal to or less than the authorized capital, since, the company may issue fewer shares against the maximum capital limit, it is authorized to sell. If the paid-up capital is equal to the authorized capital, then a company cannot raise its additional capital requirements through the issue of shares, unless the authorized capital is increased. Or otherwise, may resort to the external borrowings to finance its business requirements.

For Example, A firm has an authorized capital of Rs 10,000,000, where the value of each share is Rs 10. The firm received applications for 8,00,000 shares, but it issued only 10,00,000 shares of Rs 8 each. All the calls have been met by the shareholders; then the paid-up capital will be Rs 80,00,000 (10,00,000 x 8).

Thus, the firm’s capital has been funded by Rs 80,00,000 by the shareholders against the number of shares purchased by them. The remaining capital worth Rs 20,00,000 can be raised anytime a firm wants.

Definition: Cash Flow Statement refers to an Analytical Reconciliation Statement, which shows the changes in the position of cash and cash equivalents between two periods. In addition to this, it emphasizes the reasons for such movement of cash. Cash equivalents are those investments which are short term as well as highly liquid in nature, that can be easily transformed into cash.

It is prepared in accordance with the provisions of International Accounting Standard (IAS) – 7 and in India, as per Accounting Standard – 3 (Revised).

From a financial point of view, the cash flow statement is an important part of the financial statement, along with the Balance Sheet and Income Statement. It is concerned with the inflow and outflow of cash to/from the business. It specifies the sources of cash to the firm, from various activities and the uses of cash during a time interval.

Classification of Cash Flow Statement By Activity

The classification of cash flows, allows the users to evaluate the effect of such activities on the company’s financial position. The link between these activities can also be assessed with the help of the information provided by the statement.

• Operating Activities: These activities take into consideration, the firm’s core revenue-producing activities. It includes the production or purchase and sale of goods and services, receipt of royalty, fee, commission, etc., payment of insurance premium and receipt of claims, payment to suppliers, payment to or on behalf of employees and so on.
  The reporting of cash flow from operating activities can be done in two ways, i.e. by using a direct method or indirect method. Both methods are used for converting net profit into net cash flows.
• Investing Activities: The activities which involve the procurement and disposal of long-term fixed assets, buying and selling of investments such as shares, warrants, and debentures, etc. and disbursement and collection of advances and loans are investing activities.
• Financing Activities: The activities that can change the size and composition of the shareholder’s equity and borrowed funds of the firm are financing activities. Such activities include payment/receipt of interest and dividend, raising funds from lenders and shareholders, repayment of loans and redemption preference share capital.

These three sections present the net change in the balance of cash in hand and at the bank of the firm. It is an important tool for short term analysis especially, its ability to pay bills. It is a summary, which helps the users of financial statement to know the firm’s performance in generation and utilization of cash. It also helps managers in budgeting and business planning.

Definition: Depreciation is the reduction in the utility of the fixed asset like plant & machinery, furniture & fixtures, vehicles, buildings, etc. because of obsolescence through technology or market conditions, natural wear and tear, the passage of time, exhaustion of subject matter and so on.

Depreciation is a measure which calculates loss in the value of the non-current asset. It is an accounting convention which allocates the cost of depreciable assets over its useful economic life, to ensure that a fair proportion of depreciable amount is written off every year.

Depreciable Asset

Depreciable assets mean, the assets whose expected useful life is limited but are expected to provide their services for more than one accounting year and are held by the company for the purpose of production or administration rather than resale.

Scrap Value

Every asset has some scrap value, also known as residual value, i.e. the amount at which the asset can be resold at the end of its expected useful life. Therefore, the amount charged as depreciation should be such that it will reduce the book value of the depreciable asset to its residual value, at the end of its useful life.

Objectives of Charging Depreciation

• It is charged to ensure that there is a proper estimation of business income.
• The value of fixed assets, net of depreciation shows the true financial position of the enterprise.
• To generate adequate funds in the business, for replacing the assets, after it becomes obsolete.
• It is charged to determine the actual cost of production.

Methods of Providing Depreciation

There are a number of methods of depreciation which are explained as under:

• Straight Line Method: Also known as Fixed Installment Method, an equal amount is charged as depreciation every year throughout the working life of the asset, with the view of reducing the cost of the asset to zero, at the end of its economic life.
• Written Down Value Method: In this method, a fixed percentage of the written down value of the depreciable asset is charged as depreciation, so that the value of the asset equals its break-up value at the end of its working life. This method is also known as the diminishing value method, reducing balance method.
• Sum of Years of Digit Method: This method is a variation of written down value method and is used to accelerate the depreciation.
• Annuity Method: This method is mainly concerned with the cost recovery and a uniform rate of return on any depreciable asset. In the annuity method, along with the value of the asset, interest lost over its life is also written off.
• Sinking Fund Method: Under this method, a certain amount is written off as depreciation every year and placed to the credit of sinking fund account. Further, Government Securities are purchased with the equivalent amount and the interest received, is reinvested and credited to the sinking fund account.
• Machine Hour Method: When a record of actual running hours of each machinery is kept, the calculation of depreciation is based on hours, machines worked.
• Production Units Method: In this method, the depreciation is ascertained by making a comparison of actual production with the estimated production.
• Depletion Method: As the name suggests, the depletion method is used when there is the exhaustion of natural resources like oil reserves, coal deposits and so on.

Depreciation is a non-cash expenditure, and so, it does not result in cash outflow from the business. Moreover, it does not create funds rather it highlights the fact that a fixed amount should be retained from the profits, for the replacement of asset, to continue operations.

Definition: The accrual concept is one of three basic accounting concept, others are going concern and consistency. As per this concept, the recognition of the transactions and events as and when they arise, i.e. on mercantile basis, rather than on cash basis in which the transaction is recorded in the books of accounts when the cash is received/paid against it.

In business parlance, accrual implies the recognition of revenue and expenses as they are earned or incurred and not when they are received or paid. Revenue implies the overall cash inflow, receivables and other consideration, that arises out of regular business activities, from the sale of products or rendering of services. On the other hand, expenses connote the cost incurred in relation to the business operations in a particular financial year.

In business, it is not necessary that the instant payment is received or made against any transaction in cash. That is why the recognition of accrued revenues and expenses is done as they are earned or incurred and not when they are received or paid. So, it clarifies the difference between receipt of cash and the right to receive it, and disbursement of cash and obligation to disburse it.

In short, in accrual concept, the recording and reporting of the transactions in the financial statements is carried out in the accounting year to which they belong.

When a firm follows accrual concept, it helps the readers of the financial statement to get information about the past and future events, i.e. the transactions on which receipt is due or received and obligations that are paid or yet to be paid.

Adjustment entries concerning outstanding expenses, prepaid expenses, accrued income and income received in advance etc. are made on the basis of this concept, which affects the profit and loss account and balance sheet of the company.

Example

Alex purchases a machinery for Rs. 1,00,000, paying cash Rs. 60,000 and sold it to Joseph for Rs. 1,10,000. Out of Rs. 1,10,000, Joseph paid only Rs. 70,000. In this case, the revenue of Alex is Rs. 1,10,000 and not 70,000. Expense is Rs. 1,00,000 and not 60,000. So, the profit earned will be 1,10,000 (Revenue) – 1,00,000 (Expenses) = 10,000 (Profit).

Accrual concept is the foundation of the present accounting system, called as accrual system of accounting, as it helps in the measurement of income and expenses, and identification of assets and liabilities.

Definition: Cost Sheet, as the name signifies, is a periodical statement that reflects a detailed overview of the cost incurred on various components during the process of production. It is used to determine the cost of a cost object, i.e. product, service, or a cost unit.

Specimen of Cost Sheet

Cost Sheet helps in the classification and analysis of the cost components of a product or service.

Classification of Cost Elements

• Direct Material Cost
• Direct Wages
• Direct Expenses
• Production Overheads
• Research and Development Cost
• Administration Overheads
• Selling and Distribution Overheads

The elements of cost are classified on the functional basis. However, it can be classified on another basis too, as per the requirements of the firm.

Cost Heads

• Prime Cost: Prime Cost, refers to the total direct cost involved in the production process. It includes direct material cost, direct labour cost and direct expenses.
  The direct material cost represents the total direct material consumed. Direct labour cost, represents the wages, salaries, bonus, overtime pay, allowances and incentives, paid to the workers and production manager.
  Direct Expenses takes into account all the expenses such as rent paid for using machinery, the royalty paid for the provision of service etc.
• Factory Cost: Otherwise called as works cost is an aggregate of prime cost and factory or works overheads. Factory overheads include indirect material, indirect wages and indirect expenses.
  Adjustment for opening and closing work in progress is also made to compute the net factory cost. Work in progress refers to the units that remain incomplete at the end of the period.
• Cost of Production: As it is evident from the name, cost of production, implies the total cost incurred in the process of production, which includes quality control cost, research and development cost, administrative overheads, packing cost etc. All these items included in the process of production must be related to the process only.
• Cost of Goods Sold: After arriving at the cost of production, adjustments are made for opening and closing stock of finished goods, which results in the cost of goods sold.
• Cost of Sales: Cost of Sales denotes the total cost incurred by the entity to make the product available for sale to the customer. It takes into account the cost of goods sold, administrative overheads, selling and distribution expenses.

Cost sheet provides a snapshot of the total cost and per unit cost involved in the production. It helps in the comparison of costs, between current and previous year, as well as between estimated costs and actual costs.

For the submission of tenders, cost sheet is primarily used to ascertain the total cost expected to be incurred on a project.

Definition: In Double entry system, due to its dual aspect, every transaction affects two accounts, one of which is debited and other is credited. To record the transactions in the journal, in a sequential way, certain rules are required, and these rules are called as Golden Rules of Accounting.

Types of Account

To understand the golden rules of accounting, one should know the types of accounts. Basically, there are two types of accounts, namely:

• Personal Account: Accounts that deals with persons, i.e. human beings and artificial judicial persons such as companies, government organisations, HUF, etc.
  
  • Natural Personal Account: Accounts that are concerned with natural human beings are called natural personal account. It includes accounts of debtors, creditors, proprietor, etc.
  • Artificial Personal Account: All the business concern has a separate legal identity in the eyes of the law, and so the entities are different from its members. Therefore, the accounts of clubs, charitable trust, company, bank, etc are covered under this category.
  • Representative Personal Account: The accounts which represent persons or group thereof, are called representative personal accounts, such as capital A/c, drawings A/c, prepaid A/c, outstanding liability A/c.
• Impersonal Account: As the name suggests, the accounts which are not personal are called impersonal account.
  • Real Account: Real accounts covers all the accounts related to firm’s assets. It includes both tangible real account, such as cash A/c, building A/c, furniture A/c, investment A/c, etc. and intangible real account, such as goodwill A/c, patent A/c, intellectual property A/c.
  • Nominal Account: These are fictitious accounts, that are associated with expenses, losses, revenues and gains of the firm, such as rent and rates account, travelling expenses A/c, the commission received A/c, interest paid A/c.

As far as the business transactions are concerned, they are divided into three categories:

• Personal transactions.
• Transactions related to business assets.
• Transactions related to expenses, losses, incomes and gains.

Personal Transactions are recorded in a personal account, transactions concerning assets and properties are covered in real account. Lastly, transactions related to expenses losses incomes and gains are considered in the nominal account. In short, the golden rules of accounting are provided for these three accounts only.

Golden Rules of Accounting

• Personal Account
  Debit the Receiver, Credit the Giver
• Real Account
  Debit what comes in, Credit what goes out
• Nominal Account
  Debit all expenses and losses, Credit all incomes and gains

Example

• Commenced business with cash Rs. 5,00,000

• Purchased goods from Alex Rs. 25,000

• Sold goods worth Rs. 10,000 to Sam for cash

• Office Rent paid Rs. 12,000

The Golden rules of Accounting are the mainstay of the entire process of accounting. These are the rules for debit and credit, that helps in the preparation and presentation of financial statement in a systematic manner.