Provision and Contingent Liability difference

Provision and Contingent Liability difference

Provision and contingent liabilities are quite different concept. Provision is liability of an estimated amount, where contingent liability totally depends on future event and may not be regarded as liability unless such event happens. Difference between contingent liability and provision has been explained below;

1.    Past Event

Provision depend on the past event (event has already occurred), where contingent liability may be based on the future event. Examples of past event sales made during year, purchased made during year.

2.    Reasonable Estimates

In case of provision a reliable or reasonable estimate can be made about the liability, where in case of contingent liability such estimate cannot be made. Reasonable estimates for provisions can be made on the bases of relevant historical data, or industry practices.

3.    Recognition

Provisions are recognized in books of account as liability, where contingent liabilities are not recognized in book of account, rather disclosed in financial statement. It is important to note that disclosure is included in the financial statements for user information only and does not affect the financial performance (profit) or financial position.

4.    Examples

Examples of provision are provision for bad debts, provision for warranty against sales made. Examples of contingent liabilities include an outcome of lawsuit filed against company for damages, an expected fine by the regulator of uncertain amount etc.

Par Value and Market Value

Par Value and Market Value

Par value and market value of shares are two different concepts, company receives par value and issue shares at par value, then shares are traded in stock exchange at market value and these both concepts has been explained below in details.

1.    Issue Price

Shares are ordinarily issued at par value. It is important to note that sometime share is issue at below price i.e. discounted price (price lower that par value) and above price at premium price (above the par value).

2.    Price Determination

Par value is determined by the company in accordance of regulator guidelines (if any) and does not change during the life of company, where market price is determined by the market forces in stock exchange and changes regularly.

3.    Trading of Shares

Shares are traded in stock exchange at market price of shares, and par values of shares have no significance or role in the shares trading.

4.    Declaration of Dividend

Dividend is declared in relation to par value. If 20% dividend is declared and par value is 100 rupees, then it means that dividend declared is 20 $.

5.    Books of Accounts

Par value is used to record the transaction in books of account; market value has no role in the transaction recording of shares. The recording of transaction has been explained in detail in my other blog article.

6.    Limited Liability

Limited liability concept in case of companies is associated with par value paid by the equity holder, and limited liability does not calculated in relation to market value.

Types of Share Capital

Types of Share Capital

Share capital may be categorized into authorized capital, issued capital, subscribed capital, called up capital, and issued capital. Difference types of capital have been explained in logical sequence below;

1.    Authorized Capital

Authorized capital is the amount of capital, which a company can raise during its life. Authorized capital is normally mentioned in creation document of company. Authorized capital is used to calculate the license fee for company registration.

2.    Issued Capital

Company may not necessarily interest to raise all of its authorized capital at once. Therefore management may decide to issue some of its authorized capital for subscription.

3.    Subscribed Capital

Public may not be interested to take all the issued capital and may subscribed to a certain amount of shares. This amount shall not exceed the issued capital.

4.    Call up Capital

Companies may not be interested to take all the subscribed capital at once and may take the subscribed capital in installment. The amount which called from the shareholder is known called up capital. This capital does not exceed the subscribed Capital.

5.    Paid up Capital

The amount of called up capital, which is actually paid by the shareholder are known as paid up capital. This capital is paid in response of company called up capital; most of the time called up & paid up capital coincides.

Types of Ordinary Shares

Types of Ordinary Shares

Ordinary shares are issued to the General public, and these shares are entitled to receive dividend declared by the company. Ordinary shares can be classified into three classes in term of issuance. It is to be noted that after issuance of ordinary shares, all types of ordinary shares become ordinary shares.

1.    Initial Ordinary Shares

Ordinary shares are initially issued to General public against public subscription (deposit of funds). The people apply for these shares against initial public offer made by the companies in the newspaper. The people apply through prospectus (document carries application for shares used by companies’ for shares)

2.    Right Shares

Right share are issued to existing shareholder in proportion to shares held by them. The unaccepted or unsubscribed right shares by existing equity holder may be issued to other investors by stock exchange. Right shares become ordinary shares, once these are issued.

3.    Bonus Shares

Bonus shares are issued to existing shareholder in lieu of cash dividend. These shares become ordinary shares once issued.

Characteristics of Liability

Characteristics of Liability

1.    Present Obligations

Liability is a present obligation of the organization arising from the past event. For example entity has purchase goods on credit, it is liability because this is present obligation of the organization arises from the past event, but a plan to purchase in next year does not give rise to a liability because it is future event.

2.    Settlement

A liability can be settled in number of ways i.e. payment of cash , transfer of other asset, providing a service, replacement of liability , convert liability into equity i.e. share issue, liability can be settled by writing of the liability.

3.    Measurement

Some liabilities are measured with accuracy i.e. payable; however, some liabilities cannot be measured with ultimate accuracy, rather calculated by making a reasonable estimated i.e. provision for bad debt or provision of warranty.

4.    Provision as liability

Provision is liabilities because they arise from the event which has already taken place, for example provision for bad debt and warranty arises due to the sales which have already taken place. If there were no sales there would be no provision.

Characteristics of Asset

Characteristics of Asset

1.    Controlled Resource

Asset is resource controlled by the organization. For example plant, machinery, cash Asset is control by the entity. Control is a concept associated with risk reward. An asset is said to be controlled by entity, if organization is responsible for risks and reward of asset associated with asset.

2.    Future Benefit

It is expected the benefit flow from the asset. It means that asset must have capacity to produce or generate economic benefit for the organization. An asset, which does not have that capacity, cannot be treated as asset; rather it is expense of the organization.

3.    Present asset

Asset is controlled by the organization now. There is no concept of future asset.  There are only present asset arising from the past.

4.    Acquired & Gifted

Assets are normally created by acquisition (purchase) or gift. A government may gift land to some investor to invest at under develop area.

5.    Types of assets

Assets can be categorized using different criteria i.e. tangibility, function, timing,

Tangibility – Tangible and non tangibly asset

Timing – current and noncurrent assets

Function – plant, machinery, vehicles

6.    Tangible & non Tangible asset

Assets which can be touched are known as tangible asset. Examples of tangible asset plant, machinery. While that asset which cannot be touched is known as intangible asset, examples of intangible asset goodwill, patents

7.    Current & Non Current Asset

Asset which has less than one year useful life is regarded as current asset, while asset has more than one year’s life is regarded as noncurrent asset.

Qualitative Factors of Financial Statements

Qualitative Factors of Financial Statements

The quality of financial statement information is determined by the four factor i.e. understandability, relevance, comparability and reliability of information is being furnished by the financial statement.

1.    Understandability 

The financial statement should be presented in a way that it can be readily understandable by the user. In this context user are assumed to have necessary business and economic knowledge. The information shall not be excluded from the financial statement on the ground that it is difficult to understand.

2.    Reliability

Financial statement should present reliable and information that can be entrusted. Therefore Financial statements information must free from error, accurate, complete, and neutral.  Financial statement meets the decision making requirement of many user, therefore, reliability a fundamental qualitative requirement of financial statement.

3.    Comparability 

The information of financial statement must be comparable with other period information and financial statement of the industry .Comparability is important aspect because it helps in determining the trend over the period of time and evaluating the performance of the entity.

Comparability in financial statement can be achieved by consistent presentation of financial information and presenting the corresponding figures i.e. last year figures.

Advantages of Double Entry

Advantages of Double Entry

Advantages of double entry system can be explained in terms of standard rules, mistake identification, accurate reporting.

1.    Standard Rules

First advantage of double entry system is its standard rule of processing. In double entry system information is processed through standard rules. These rules are commonly known as debit & credit rules.

2.    Mistake Identification

Second advantage of double entry system is it’s in built facility of identifying some mistakes i.e. mistakes with single effect. For example only one aspect is recorded, or one side (debit or credit) is wrongly recorded.

3.    Financial Result

Third advantage of double entry system is its accurate reporting of financial results. Double entry is deemed to produce accurate financial result, if appropriately applied.

4.    Large Scale Organization.

Fourth advantage of double entry system is management of large scale organization. In small organization system, record can produce accurate results. However, in case of large scale organization double entry system is a must requirement.

Limitations of Double Entry System

Limitations of Double Entry System

Limitations of double entry system can be explained in terms of high cost, limited scale operation, technical job, not error free.

1.    High Cost Option

First limitation of double entry system is its high cost. Double entry system involves number of cost i.e. cost of experience manager, cost of accounting software, stationary cost etc. Thus this system is not recommended /feasible for small businesses.

2.    Does not Suit Small Scale Organization

Double entry system does not suit to a limited operation, because it involves a lot of costs, and small scale organization cannot afford such system. Thus double entry system on one side is a basic requirement for both small and large organization, However , only large organization can afford this system.

3.    Complex System

Third limitation of double entry system is its complexity. Double entry system can only be handled by an experience manager; otherwise, it can produce horrible results. An experienced and technical sound accountant would be required to maintain the the double entry system.

4.    Not Error Free

Double entry system cannot be considered a 100% error free option. There are number of mistakes which cannot be detected by the double entry system. This system can only detect single impact mistakes (which effect one side of trial balance).

Limitations of Single Entry System

Limitations of Single Entry System

Limitations of single entry system may be explained in terms of lack of structure, lack of standard rules, lack of reliablity, lack of accaptablity etc. These limitations have been explained below

1.    Lack of  Structure

Single entry system is not a structure system; rather it is a practice of people to maintain the record in accordance with their convenience & knowledge. Thus this single entry system does not have any proper structure.

2.    Lack of Standard Rules

Single entry system lack standard rules. In fact single entry system is no system, rather a self maintained book keeping. Small businessman keep the record as per their understanding knowledge and convenience. Thus single entry record of every businessman vary from other businessman.

3.    Lack of Reliability

Single entry System cannot produce accurate results. Single entry system is not based on principles and therefore no reliance can be placed on the information produce by the single entry system.

4.    No Acceptability

Single entry system is not an acceptable or recognized system. This is not an standard system, and every organization maintain such system according to his own choice and formats.

5.    Financial Reporting not Possible

Financial results cannot be easily calculated from single entry system. A lot of effort and assumption are required for preparing financial statement, even then, those financial statement are not reliable.

Fair presentation Concept

Fair presentation Concept

Fair presentation of financial statement can be achieved by applying following guidelines in the preparation of financial statements.

1.    Faith full Representation

Fair presentation may be achieved by representing or recognizing the transaction in accordance with the recognition criteria.

2.    Appropriate Accounting Policies

Fair representation may also be achieved by adopting the appropriate and reasonable accounting policies. IAS 8 provides guideline for policy selection.

3.    Presentation of Information

Fair representation may also be achieved by presentation information in a way that it provides reliable, comparable and understandable information.

4.    Additional Disclosures

Additional disclosure should be provided, when the requirement of international accounting standard are not sufficient to explain the financial impact of the transaction (element) of financial statement.

Reasons for Change in Presentation

Reasons for Change in Presentation

 Change in presentation is allowed due to more appropriate presentation, disposal or acquisition of business and regulatory requirement.

1.    More Appropriate

Change in presentation may result in more appropriate & logical presentation. It means that new presentation would be more relevant to user information needs.

2.    Disposal or Acquisition

Change in presentation may also be result due to disposal of substantial portion of business operations. An acquisition of new business (operation) may also require change in presentation.

3.    Regulatory Requirement

Change in presentation may be due to regulatory requirement. In this case entity has no option other than to apply change as required by regulator of the country.

4.    International Accounting Standard

International accounting standard may also require change in presentation. Management is supposed to comply the requirement of international accounting standard.

Going Concern Concept

Going Concern Concept

Going concern assumption has fundamental importance for user of financial statement, because going concern assumption has great influence on economic decision making.

1.    Continue to Exist

Going Concern means that organization would continue to exist in future. In the context of going concern, future means at least 12 months from the balance sheet date.

2.    Management Assessment

Management shall make an assessment about entity ability to continue or exist as Going Concern. Management shall make such assessment after detailed analyses about the entity.

3.    Not Going Concern

Organization is not regarded as going concern, when either management is planning for shut down (liquidate) or cease trading or there are such circumstance, which would result in closure of organization automatically (for example high losses).

4.    Financial Statement

If going concern assumption is valid i.e. entity will continue to exist for foreseeable future (at least 12 month from balance sheet), then financial statement are prepared on normal bases i.e. historical cost.  While going concern assumption is not valid, then financial statement are prepared on suitable bases i.e. recoverable amount.

5.    Profitability & Going Concern

Profitability and Going concern has close link, and ordinarily a profitable organization is deemed to be a going concern. However, management may like to make a detail assessment about going concern. In detail assessment management would look into different aspect like sources of funding, liquidity, future cash flows, future profitability.

Financial Statements Comparability Concept

Financial Statements Recognition Concept

Measurement Concept
Going Concern Concept