Finance Tips

I would like to start speaking about this topic with defining what accounting is. So accounting is keeping financial records, recording income & expenditure, valuing assets& liabilities, eleberation of budjets & so on. We can devide accounting into two large groups.

Accounting:

Financial accounting

preparing financial statements of various kinds

- financial statements

- tax reterns -

is used for:

Managerial accounting

preparing financial information,

necessary for the company itself;

- controlling

- marketing & management

- pricing

- negotiations

- analyzing the flows of capital

But also there are a lot of other kinds of accounting, such as:

Cost accounting – working out the unit cost of products, including materials, labour & all othe expenses.

Tax accounting – calculating an individual’s or a company’s liability for tax.

“Creative accounting” (or “window dressing”) – using all available accounting procedures & tricks to disguise the true financial position of a company.

Also at the begining of the topic I would like to stress, that we shouldn’t muddle accounting with bookkeeping. Bookkeeping is just writing down (recording) all the details of transactions (debits & credits). Bookkeepers have to record every purchase and sale that a business makes, in the order that they take place, in journals. At a later date, these temporary records are entered in or posted to the relevant account book or ledger. At the end of an accounting period, all the relevant totals are transferred to the profit and loss account. Double-entry bookkeeping records the dual effect of every transaction – a value both receives and parted with. Payments made or debits are entered of the left-hand (debtors) side of an account, and payments received or credits on the right-hand side. Bookkeepers periodically do a trial balance to test whether both sides of an account book match. Continue reading ‘Accounting & balance sheet’ »

What is goodwill? Depending on whom you ask you may find many different answers to this question. If you were to ask an accountant what goodwill is he or she would exclaim that goodwill is the amount an entity pays in acquiring a business that is in excess of the acquisition’s fair market value of its net assets (Goodwill = Purchase Price of an Entity – The Entity’s Fair Market Value of Net Assets of the business). What this basically means is that goodwill represents a value of an entity above what the current fair market value of the acquired firm’s net assets. Some examples of goodwill would be: future profitability of the acquired firm, client lists, brand name etc… Goodwill is considered an intangible asset and once the value of goodwill is established this amount is listed as an asset on the acquiring firm’s balance sheet.

In the past, firms had to account for goodwill by abiding by the Accounting Principles Board (APB) Opinion 17 issued in 1970. In this opinion, when a firm was purchasing another entity, the purchasing firm could account for any goodwill involved in the transaction as an asset on their balance sheet and amortize the asset over a maximum of 40 years. If the purchasing firm did not want to amortize the value of the goodwill involved in the purchase of another organization it could also use the Pooling-of-Interest accounting method. The Pooling-of-Interests accounting method combines the book value of each firm’s assets and liabilities to create the new entities’ combined balance sheet. In this transaction, it is hard, if not impossible, to figure out which entity is the purchasing entity and which entity is being purchased. The Pooling-of-Interests method basically negated the need to account for goodwill at all. However, the Pooling-of- Interests method was superseded and is no longer an option of merging firms as of the issuance of FAS 141 by the Financial Accounting Standard Board (FASB). The Accounting Principles Board (APB) opinion 17 was also superseded when the Financial Accounting Standards Board (FASB) issued SFAS 142, Goodwill and Other Intangible Assets, in June 2001. In this statement the FASB laid out the new rules when accounting for goodwill. In this statement, amortization of all goodwill stopped regardless of when it was originated. According to this statement goodwill amounts are still to be treated as intangible assets (and listed on the purchasing firms balance sheet), but instead of amortizing this asset over a maximum of 40 years, each firm that records goodwill on their balance sheet must annually test the value of goodwill for impairment. To test goodwill for impairment an organization has to take the book value of the goodwill on their balance sheet (the carrying value), and compare it against the current fair value of this goodwill (using the present value of future cash flows). If the fair value of the goodwill in question were to decrease to a value lower than the book value (carrying value), then the firm must impair (or write off) the difference in the value of the current goodwill asset. An example of this would be if XYZ firm purchased ABC firm, and the transaction involved $100,000 worth of goodwill, this goodwill would have to be tested at least annually to make sure it does not decrease in fair value. If it were to decrease in fair value the amount that the $100,000 was reduced by would need to be impaired (written off). For the purposes of our example let’s say the fair value of the goodwill in question were to decrease by $10,000 and the fair value of this goodwill would now be $90,000 the $10,000 would be impaired (written off). That is, the $10,000 would be reduced from XYZ assets (goodwill) on its balance sheet, and this $10,000 would show up as a loss (expense) on XYZ income statement. SFAS 142 also states that if in the following accounting periods test of goodwill for impairment, the $90,000 in goodwill now on XYZ balance sheet were to increase in value the firm is not allowed to increase the goodwill asset; XYZ is only able to impair the value of the goodwill asset if it were to decrease in value. Continue reading ‘Accounting for Goodwill’ »