What often needs to be assessed is whether certain possible outflows need to be recognized as expense. We have already covered the period in which a certain expense is recognized, but what comes into the equation, is the possibility of this not being an expense later on. We know the period, but since we are not sure of this expense really happening, does it have to be recognized?
Continue reading
Author Archives: Karl
In which period is this expense recognized?
An expense is recognized on an income statement. That’s a fact, right. Well, what almost always raises questions, is the proper period the expense needs to be disclosed in. It’s not always this easy, you know … What I am trying to do now, is bring some insight to this situation. You have an expense and you’re not sure whether it needs to be in current, next or even prior period.
Continue reading
Why would someone recognize a ‘share premium’?
It’s another question, which I have received in real life. As it happens, when I first started in accounting, it was somewhat a mystery to me as well. As the name suggests, it’s related to ‘share capital’ and any change within is related to any transaction with shares. But the question, why would someone create this premium, still remains.
In short the theory behind the ‘share premium’ is as follows: in case issuing new shares one can determine the face and the nominal value of a new share. The difference between is shown as a ‘share premium’. The reason why those two values differ and are essentially used comes from legal requirements and not in what you may be thinking now. By law no-one can oblige you to pay more than the nominal value stated but in case the face value or the price to be paid is determined by the shareholders to be different from the nominal value, it’s the amount that needs to be paid. Just for clarification, to put things into figures, if a nominal value of a share is 100 and the face value is 150, than the 150 is the amount that needs to be paid.
Continue reading
Why would a company want to give its shares to someone else?
Just the other day I was asked the following question ‘Why would a company want to give up its shares to someone else? It would lose control over itself.’ At first I was stunned. Never had I been asked such a question and never had I thought about this way. But to put that aside, if already one asked, there may be others out there with the same question. So I thought, I’ll give it a try and clarify the terms ‘share’ and ‘shareholders’ a bit.
To begin with the answer I’d like to state that ‘a company’ is not a physical person with its wills and wishes. A company is a legal body, which operates solely based on the actions performed by people. People are the ones who also ‘own’ the company.
Continue reading
Why use the ‘indirect method’ for presenting operational cash flows?
The other option of presenting the cash flows on the statement of cash flows is using the ‘indirect’ method. However, as previously stated, it’s only allowed and applicable in case of displaying the cash flows from operating activities. The other cash flows, namely from financing and investing activities are presented using the ‘direct’ method and you’ll soon see why.
The ‘indirect’ method of showing the cash flows is in a nutshell changes in balances added to operating profit. The result on the income statement which is accrual based is adjusted to show cash based result. This is to put things in very short explanation.
The changes themselves can be both negative and positive mathematically, but how are they affecting the cash flows? If for an example, the receivables balances have increased compared to prior date, it means we have money held up somewhere, so a negative net cash flow has occurred over the period. On the contrary, if we have acquired fewer inventories over the period between the two dates than we have actually sold over the same period, this results in a decrease of the balance, hence giving us a positive cash flow. The same logic also applies to all operating activities related payables meaning that when the balance has increased, we have been holding more money to ourselves resulting in a positive cash flow. Continue reading
Present your cash flows using the ‘direct method’
When we talk about cash flows, the words of ‘direct’ and ‘indirect’ are often spoken. Yes, the first and only requirement for the statement of cash flows is that real cash had to move, but there are two ways of showing the movement. With this post we’ll cover the ‘direct’ method. The direct showing of cash flows is something that is more widely used since it has a fairly easier concept as opposed to ‘indirect’.
The cash flows from investing and financing activities are always presented using the direct method meaning that they are not changes of certain balances but real proceeds or charges from certain activities. This in a nutshell is what the direct method really is – an actual cash movement from an activity. A company bought a truck and as a result the price paid is the ‘direct’ cash outflow. If another truck was sold, then the proceeds are ‘direct’ inflow of cash.
Continue reading
Cash flows from ‘financing activities’
One of those three groups cash flows are presented on the statement of cash flows is ‘Financing activities’. The ‘in’ and ‘out’ flows are both presented using the direct method, which we’ll cover later on in more detail, but for now, just keep it in mind. So, which cash movements are presented under financing activities and what should you look out for?
When the meaning of ‘operating’ and ‘investing’ is more clear, ‘financing’ is something that is sometimes confused with ‘investing’. I have encountered in practice that the ‘proceeds from share issuing’ are presented under ‘Investing’ rather than under ‘Financing’ activities.
What should help someone in classifying those flows is a simple rule. If the company itself uses its resources to acquire something and consequently sells this something, it’s investing. However, if a company first off receives money from someone in the form of proceeds from shares, bonds or loans, it’s financing. All this is done from one perspective – the company’s one. So as a company, if it gives someone its resources, the company is investing it’s assets to acquire new ones. If someone is giving money to the company, they are yes investing, but the company gets financing from investors. It’s really this simple. For an example as a result, loans granted by the company are under ‘Investing activities’ and borrowings granted to the company are under ‘Financing activities’. Continue reading