Tuesday, 23 September 2014

What is a liability? Nature and Classification of Liabilities

Liability is something which a person owes to another. It is an obligation which can be the result of some activity or transaction entered into by the two parties.

Sometimes, a liability can be merely a responsibility or sense of feeling shown by one person to another in lieu of  sheer love or gratitude. For example, performing the marriage of a daughter or donating money to social causes periodically or very often.

But for accounting purpose, a liability can be defined as an obligation or responsibility of a person or any business entity to the other party of any transaction or contract. It is some unavoidable obligation to be fulfilled by the party concerned to his creditors or other party on maturity of some period or on occurrence of some event or on achievement of some goal or target.

Classification of Liabilities
Liabilities are of three major types-
1) Current Liabilities
2) Long term Liabilities
3) Contingent Liabilities

Now let us have a look at the nature and identification of these three classes of liabilities.

Current Liabilities
Current liabilities are also known as short term liabilities due to its short period nature. A current liability signifies the priority involved in clearance of the liability. Such liability is considered to be cleared within some short period, say within 3 months or 6 months. You will have to clear them within that short range of period. Some of them may even become due within days, say within 3 days, 7 days, or a month like that. Any type of borrowing or credit taken to meet your daily requirements of business fall under this category and they require to be cleared first. Salaries and taxes payable are such urgently payable short term liabilities. Besides, Bank overdraft, short term credits like credit cards, credit purchases are also examples for this category.

Long Term Liabilities 
From the name itself, you are able to see that these liabilities are of long term or for longer durations. Normally such liabilities are cleared in many years and the terms of repayments are set forth at the time of obtaining the fund or during execution of the contract. Bank loans for long periods, mortgages, etc. fall under this category.

Contingent Liabilities 
This category of liability is dependant on some contingency. That is, its clearance is related to the occurrence of an event or incident. If such and such event takes place, it becomes due to be paid immediately upon that happening. If the stated incident does not take place at all it will not be required to be cleared. So it is a contingent liability, meaning that it will be paid only on occurrence of certain incident which is not known or certain when it may take place. Some other unexpected incidents like breach of contract, damage due to accidents and court cases are also cases of contingent liability.

For accounting purpose, only current liabilities and long term liabilities are considered in the Balance sheets. Contingent liabilities are merely mentioned in the notes to the Balance Sheet.

Saturday, 13 September 2014

Assets : Definition and types of assets

What is an Asset?
Any goods of important value and are of durable nature and which are saleable in market may be treated as assets.

But sometimes, in ordinary lay man's perspective anything considered as very important for him is considered as asset to him. So he may regard his child as his asset. Or some gift received from his sweetheart can be a great asset for him. Or even his hands or limbs or brain can be treated as an asset by him which are important for his earning and sustenance

But, generally for accounting purpose, an asset is considered as some goods having significant importance with money value and can last for a durable period and can be easily sold in market or can be exchanged for other goods.

Definition of Asset

Different definitions are there for describing an asset. But the essence of all definitions is more or less the same.

"So an asset may be any goods or resource or property having value for some durable period and which generates income or aids in production of other goods and services which generate income to the holder of that asset."

So from above definition, you are able to see that-
  • An asset has to be of some value. 
  • It should be marketable or exchangeable for other items in market. 
  • It should be of some considerable duration. 
  • And finally it can be anything that generates income for a duration of period.
Types of Assets
From above definition you are able to see that assets have different qualities. So accordingly assets have been classified according to their nature and tangibility.

1) Liquidity or Convertibility:

One classification of assets is into Current Assets and Fixed Assets based on their conversion capacity into easy money.
  • Current Assets are more easily convertible into cash or other goods within short span of time with no legal barriers and procedures. Goods in stock or trade, cash and bank balances and other sundry advances or deposits fall in this category of Current Assets. Current assets mostly are of shorter time span and may become obsolete after a certain period.
  • Fixed Assets are more of a fixed nature and last for many years like Land, Road, Building, Plant and Machinery, etc. Further, they can not be easily sold or converted. They require adequate legal formalities and considerable time to dispose off. 
2) Usage or Utility:
Another classification based on the utility or usage of assets divides the assets into Operating and Nonoperating.
  • Operating Assets are those which are required for daily operations of the business as well as for use in the different production procedures so that the business can generate income. So naturally, the working capital like Cash and Bank balance, inventory in use, stock of semi-finished and finished goods, Building and Plant and machinery used for running the business all these items are termed as Operating assets.
  • Non-Operating Assets are assets of not any importance for running the business but still held for future plans or disposal. The business production and activities do not get hindered by disposing those assets. Such assets can include any excess land or buildings kept for future plans and extra cash or funds invested unnecessarily. Some inventory of old and obsolete items no longer used for production and inoperative dead balances lying since long can also be treated as non-operating assets.
3) Tangibility or Physical Nature:
According to the physical or non-physical existence of assets, they are classified into Physical assets and Non-physical assets.
  • Physical or Tangible Assets are those which have physical quality and can be seen and felt. All fixed assets, cash and bank balances, inventory items, debtors all these are tangible assets.
  • Intangible Assets can be anything that can not be touched or felt like company's Brand name, patent, copyrights, logo, goodwill and trade mark etc. Even though not physical, these are very useful and important as they promote business and help in increasing sales and profits.

Wednesday, 10 September 2014

Three Branches of Accounting: Costing. Financial Accounting and Management Accounting

Business and trade needs keeping of records for different purposes. The owner of business wants to know how much profit he is making and what are assets and liabilities at any time. The government requires proper filing of records and tax payments. The manager is worried about how to control costs and bring profit to the company. So accounting needs to satisfy all these people with accurate information. To satisfy these needs of different groups of people, different types of accounting branches have come into being. The three most important and main branches of accounting are known as Cost Accounting, Financial Accounting and Management Accounting.

Let us now discuss these branches one by one.

Cost Accounting

Cost accounting deals with the identification of the cost of production. It analyses the cost of finished product through various intermediary and final output stages. For example, it deals with the cost of the raw material, semi finished goods and finished goods one-by-one and side-by-side. Finished product cost includes other costs also like administrative cost, marketing cost and selling expenses and some other elements like interest and depreciation. So all the required information needs to be kept accurately to determine the cost at each stage. This is possible through cost accounting records.

The total costs incurred like salaries, wages, administration expenses are maintained product wise and stage wise for each process and product to calculate costs at different stages and for different products individually. Only then can the management control the costs at each level and determine the price for selling the product.

Financial Accounting

This branch deals with maintenance of accounting records like Cash book, Bank book, Main ledger (General Ledger), Customers and Sales Books and Purchase Ledger, etc. All these records are to be perfectly maintained accurately to prepare the Profit & Loss Account and Balance Sheets of the company which enable the Taxman to verify whether tax is being properly calculated and deposited. It also enables the management and Board of Directors to know about the financial position of the company.

Management Accounting

This also is an important accounting branch. This branch deals with preparation of various monthly, weekly and yearly reports of Cash Flow, Funds Flow and Budget estimates compared with actual expenses. These reports give the management from time to time, the information regarding progress of the company, its financial status, and makes them take important decisions for efficient running of the business.

Besides these main branches of accounting, there are other branches like Government accounting, Tax accounting, Audit accounting, Fiduciary accounting (dealing with accounts on behalf of other minors) and Fund accounting, etc.