Finance leases are in other words also called capital leases. Shortly of the meaning of finance lease – it’s an arrangement where the borrower chooses an asset, the finance company will purchase the asset and the borrower will use the selected asset during the period of lease. During this very same period the borrower pays to the finance company series of installments for the use of the asset. Usually the borrower will also have an option to acquire the asset, but that’s not relevant at the moment to the interest calculation methods.
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Author Archives: Karl
Simple interest calculation
Regardless of the fact that in Medieval Ages charging for interest was not well looked upon to say the least, in nowadays interest is something we all agree that makes sense. Moreover, it makes sense in the form that you are giving or you are given the ability to use someone else’s asset (whether its money, car or something else). From such activities interest is considered to be as compensation to the lender as he or she could have done something else with the asset, but instead it was given for you to use. As it is reasonable to believe that assets should always earn income or give value, giving it to someone else for use is just another means of an asset generating income really.
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Change in estimates
Two major areas where estimates are used in accounting for property, plant and equipment as well as intangibles are their useful lives and residual values. They are important mainly because although they are determined right from the initial recognition, unlike the cost value, they are subject to change when conditions do. The amount you paid in for the property shall rarely change and if so, it’s because you bought some additions to it. But for how long you’ll use the asset and what shall you actually get from selling it – they are subject to change in correlation with macro-economic performance as well as business-wise changes. It’s often ignored however and unintentionally I might add.
There are two sides to the story however. First off the management needs to determine and set their best estimates at the initial recognition. What are the sources of information to use? There is no right or wrong answer here. Usually the estimate for useful lives is done based on the previous experience, industry-wide knowledge and possibly for residual value you’d use the information available in selling ads or similar sources. So, pretending now that you have revisited those estimates (as you are supposed to do as a minimum annually), you understand that both or one of these values needs to be changed. Now what?
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Understanding the residual value
When first recognizing an asset on the balance sheet as a part of property, plant and equipment or part of intangibles, you should come across with the term ‘residual value’. I say that you ‘should’ because most accounting standards (at least the ones based on IFRS) are referring to the need to determine one.
The general rule is that the difference between cost and residual value is charged as depreciation over the useful life on an asset. When cost value is something that is easier to grasp as a definition, the term ‘residual value’ is too many times misinterpreted.
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Accruals – why do we need them?
As you no doubt may already know, accounting in most countries and companies is accruals based. The other method of choice is to recognize everything based on cash movement, but this usually applies to self-employed people and is very strictly regulated in most countries. Anyhow, as most of us need to use the accruals based accounting, the key thing about which is the accruals – what are they and why would you need one?
The key principle to accruals based accounting is the period in which the events and conditions happened that either resulted in an expense or an income for the company. Consequently, it’s this very same period in which those transactions and their effect needs to be recognized.
Recording accounts payables and receivables is one thing. They are based on invoices or similar source for exact amount and due time for the payment. But when it comes to liabilities or income that we are currently exactly not aware of simply because we haven’t received or sent out an invoice it gets mote trickier. To be honest, it’s not that difficult and more just about remembering things.
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Classification of loan payable balances
Loan payables obviously are recognized under liabilities on the balance sheet, there’s no doubt about it. However, what often gets either forgotten, misstated or confusing, is proper classification of those balances inside liabilities. As with assets, there are current and non-current liabilities on the balance sheet. Classification of loans as ones is depending on three things – scheduled payments, any additional extraordinary payments and any restrictions in terms of covenants or similar conditions that have to be met.
First off the scheduled payments – the installments due in next 12 months are ‘current’ on the balance sheet. It’s this easy and straightforward. We suggest making the necessary accounting entries every month so you wouldn’t forgot them eventually at year end.
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Non-cash movements on the statement of cash flows
The statement of cash flows as the name suggests is a presentation form for cash flows and none other. All cash related movements are disclosed on this statement to show the company’s ability to generate cash and of course the consumption of cash in the process. When preparing the statement of cash flows, the number one question is ‘Did actual cash move for this transaction?’ If the answer is ‘No’, it’s not on the statement. Not directly anyway.
We have discussed the general meaning of presentation of cash flows, but what we’d like to point out as we see this happening too often in real life, is the simple fact that all non-cash related balances should be removed when using the indirect method of presenting the cash flows.
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