What You Need to Know About Reserves in Accounting
In accounting (Also see What is the Purpose of Accounting?), reserves refer to the gains that a company allocates for specific purposes. Typically, companies will set up reserves for the procurement of fixed assets, to settle debts, to pay for repairs and maintenance as well as to pay bonuses to employees. After the company has decided on the types of reserves and their respective amounts, it needs to record them in the books of accounts and the financial statements. This is when it may need help from the accountants. If the business owners are unfamiliar with these accounting (Also see What are Provision and Accrual in Accounting?) procedures, they may choose to either employ an in-house accountant or hire an accounting firm in Singapore.
At the end of an accounting (Also see Things You Should Know About Accounting Estimates) period or a year, if a company has earned a profit, it may choose to retain part of the profit to prepare for the growth and development of the business or meet future demands. The sum of money that it keeps aside for this purpose is called reserves. Reserves would help a business in making sure that its financials are always in good condition. Also, the company can use the reserves to ensure that it can pay stable dividends to its shareholders. Some companies will expand their business or make investments by using the reserves.
Where are reserves in the financial statements (Also see What is a Financial Statement Review?) then? One would record reserves in the company’s balance sheet on the liability side under the “reserves and surplus” heading. In most cases, a company will not create reserves if it suffers a loss. Generally, there are three types of reserves, which are general reserves, specific reserves, as well as the revenue and capital reserves. In this article, we will look into the third type.
Business owners will create revenue reserves by using the gains that the company has earned from its business operations. This type of reserve will typically show up in the profit and loss appropriation account. While profit and loss account determines the net profit or loss of a company in a specific period, people would use profit and loss appropriation account to distribute net profit among partners, for the distribution of dividends, as well as to allocate reserves. Apart from distributing dividends, business owners can use the reserves to expand the business too.
For capital reserves, business owners would establish them by using capital profits but not the profits generated from the company’s business operations. Most of the time, they will not use capital reserves to distribute dividends to their shareholders. The premium that the company obtains from the issuance of shares and debentures is a type of capital reserve. Other examples include the gain acquired by selling the company’s fixed assets, capital redemption reserve, as well as the surplus after revaluing the assets and liabilities.
The Advantages and Limitations of Statutory Audit
Statutory audit is the audit that a company needs to do according to the requirement of law which applies to the company. The primary purpose of having a statutory audit is to let the auditors from an audit firm Johor Bahru collect all related information. Then, the auditors will be able to issue audit opinion about the true and fair view of the financial position of a company on a given date, probably the date on the balance sheet.
The statutory audit aims to let the auditors give his opinion independently, which means the auditors must not be influenced in any manner. He will assess the financial records of the company before delivering his judgment in the audit report. Thus, the stakeholders may depend on the company’s financial statements. Other than shareholders, the stakeholders will also benefit from the audit since they can make decisions by referring to the authentic and audited accounts.
Advantages
– Statutory audit increases the credibility and genuineness of the company’s financial statements as the auditor acts as an independent party that verifies the statements.
– The audit(Also see Advantages of Performing Continuous Audits) makes sure that the management has made an effort when they are carrying out their responsibilities
– The statutory audit will indicate the company’s compliance with non-statutory requirements such as corporate governance and so on.
– The auditor (Also see Audit – Checklist for the Compliance Audit) will give his feedback on the internal control an organisation is implementing as well as perform internal checks in the related areas or departments. He will also tell the management about the weakness of the internal control and the parts that are susceptible to risks. Thus, the company can minimise those risks, and this helps in improving the company’s performance.
Disadvantages
– The company may have to spend a lot on an audit. However, if the firm has engaged in an audit (Also see Audit – The Definition of Audit Assertions?) firm to let the professionals look after their daily tasks, for example, the process of preparing the accounts, then the cost of an audit will be relatively lower when compared to those companies that do not do so.
– Statutory audits may disturb the employees from performing their day to day chores as they may need to answer the query from the auditor or provide the necessary documents to him. As a result, the employees may need more time to complete their work, probably beyond office hours. Also, this can cause the employees to be stressed out at work.
– Audits (Also see How to Reduce Time Required for Audit Cycle?) have some inherent limitations, for example, the internal control of the company, the auditors need to complete it in the time given, and the auditor may have limited power, and so on.
– There are a lot of areas that the auditors (Also see How to Reduce Time Required for Audit Cycle?) can only get the information from the management. This is dangerous since if the management is involved in frauds, then they are going to give manipulated representations to the auditors.
Things You Should Know About Accounting Estimates
Accounting estimates refer to the estimations that the accountants would make on the amounts that they should debit or credit (Also see Accounting – Understanding credit and debit in the business) on the items that do not have a defined and accurate method of measuring the value. Thus, the accountants need to use their knowledge and expertise they obtain from training and experience to make the judgement. If you are doing accounting tasks on your own without having much accounting knowledge, this part can be challenging for you. Thus, the best way to solve this problem is by hiring an accounting firm in Singapore.
In some occasions, the accounting estimates that the accountants have made may change. This may happen when new information appears, and it has replaced the data that the company has used to make the decision earlier. This will cause a change in the carrying amount of a particular asset or liability. At the same time, the subsequent accounting for the recognition of assets and liabilities in the future would be different too.
When we account for business transactions, we have to consider the number of estimates we have made, as well as the things that we use our own judgment or prudence. Some examples of these items include the provisions for obsolete inventories, change in the liability, bad debt reserve, as well as a change in the useful life of some depreciable assets (Also see Introduction to Impairment of Fixed Asset). Sometimes, we may realise that our estimates or judgment are inappropriate since the basis that we use to make assumptions have changed. Thus, we will need a change in the accounting estimates so that our books of accounts will be in line with the subsequent changes.
However, some people may be confused between the change in accounting estimates and the change in accounting policies. Note that both of them are totally different. A change in the accounting estimates will cause the valuation of financial data of that company to change. On the other hand, a change in the accounting policies that a company has been using will result in a change in the way it calculates the financial statements (Also see What is a Financial Statement Review?).
An example of the change in accounting (Also see What is the Purpose of Accounting?) estimate would be a change in the salvage value of an asset. As an instance, a company that has been using the straight-line method for the depreciation of assets has predicted that the salvage value of a machine will be RM5000. However, as the trends in the marketplace has changed, the salvage value has decreased to RM2500. As this value has changed, the depreciable value will vary too. This leads to a change in the accounting estimates.
For the change in accounting policies, an example would be changing the method that the company is using for valuation of inventory. For example, a company has been using the FIFO method (first-in, first-out method) to deal with its inventories. Then, it changed to the LIFO method (last-in, first-out method) to comply with the requirement of law.
The management of a company should do their best to minimise the risk associated with the changes in accounting estimates. This can be done by implementing internal controls on this matter. For example, the management should appoint a qualified individual to make necessary adjustments on the estimates when required. It should also list out the differences between the amount before it changes the accounting estimate as well as the sums after the change is made. Also, the management needs to understand the crucial methods and assumptions that the company is using and make sure that the controls can identify unnecessary changes regularly.
What is the Purpose of Accounting?
Accounting is the key to success for every business as it helps business owners to have an in-depth understanding of the financial health of their company. The records and interpretation of business activities form the central part of accounting. If business owners (Also see Tips to Become Intelligent Business Owners) get to know the inflow and outflow of their business funds well, they will be able to make sound decisions based on the data so that their business can continue growing.
When you are planning for your business, you should never underestimate the importance of accounting. If you totally have no idea on how your money flows, you will most probably lose control of the finances of your business. However, you don’t have to be too worried if you do not know much about accounting or if your small business cannot afford to employ full-time accountants. There is an alternative to this, that is to hire an accounting firm in Singapore and let the experts complete the accounting tasks for you.
The primary purpose of accounting is to keep records of the financial activities that a business has carried out. When the business owners or the accountants want to track the revenue earned as well as the expense incurred in the normal course of business operations, they may look at the ledger. If they have kept accurate records of their financials, they will know the trends in the cash flow, and they will be able to plan for the future.
Apart from making future plans, accounting also provides information for business owners to analyse the performance of their company. This is what successful business owners would always do. By using historical records and the current data, they will be able to evaluate the company’s financial health. This helps business owners to determine the well being of their business (Also see Ways to Increase Your Business Revenue). Furthermore, referring to the historical data provides them with a chance to learn from past experience, and they will be able to make sound decisions for the future.
Besides, accounting (Also see Are Accounting and Bookkeeping the Same?) help business owners to be in compliance with the requirement of laws. If they always keep up-to-date and accurate records, they do not need to worry that they have overlooked small details, which may bring serious consequences to the business. Insufficient or unorganised records can result in errors in tax filings, which can cause the tax authorities to audit your company. This can bring you some unnecessary legal problems if not properly managed.
Without a doubt, all business owners hope that their business can be successful and can sustain for a long time. If they want to achieve this, accounting is something they should never leave behind. Apart from tracing business transactions, business owners will be able to prepare financial (Also see What is a Financial Statement Review?) reports that help in decision making with the help of accounting too.
What is a Financial Statement Review?
A financial statement review refers to a service where the company’s accountants get a limited assurance which means that the accountants do not have to make any material modifications on the company’s financial statement for it to comply with the financial reporting frameworks. For financial statement reviews, the accountants do not need to understand the internal control, evaluate the fraud risks, or conduct any audit procedures. As a result, the accountants will not obtain an assurance that they are aware of all the crucial issues which the auditors will typically discover and disclose in an audit (Also see Checklist for the Workplace Audits).
A financial statement review costs more than a compilation, but it is cheaper than an audit. The business owners (Also see Characteristics of Successful Business Owners) whose creditors and lenders will let them use a review will prefer using this approach since they can save the cost of employing an audit firm in Johor Bahru to perform an audit for them.
In a financial statement review, the company’s management is responsible for preparing and presenting its financial statements. On the other hand, the accountants need to possess sufficient knowledge about the company and the industry it is involved in so that they are capable of reviewing the financial statements.
In a review, the company’s accountants (Also see How Do Accountants Carry Out the Accounting Process?) need to conduct the procedures required to give them a reasonable basis for acquiring a limited assurance by which the company does not have to make any material adjustments to let its financial statements to be compliant with the pertinent financial reporting frameworks. The focus of these procedures is mainly on the areas with a high risk of having misstatements. Listed below are the procedures that the accountants may use to conduct a financial statement review.
– Review the reports that the management has issued about any accountants who have completed a review or an audit (Also see How to Reduce Time Required for Audit Cycle?) on the company’s financial statements in the previous accounting periods
– Continue examining or observing the issues that arose in the last review
– Assess the communication between the company and the regulatory agencies
– Inspect any notable transactions that happen near the end of the company’s accounting period
– Ask about the material activities which occurred after the date of the company generating the financial statements
– Ask about the procedures the staff takes when they record accounting transactions
– Go through the company’s financial statements to determine whether they comply with the pertinent financial reporting frameworks
– Perform ratio analysis with the forecasted and historical result.
– Inspect complicated or abnormal situations which may influence the reported results
– Inspect inconsistent findings
– Inspect notable journal entries
If the accountants have conducted the financial statement review and they think that the company has materially misstated its financial statements, they need to conduct more procedures so that they can get a limited assurance that the company does not have to make material adjustments on those statements. If the company has materially misstated the statements, the accountant should either disclose that matter in the report or withdraw from the review.
What Can You Find in an Income Statement?
When you outsource your accounting tasks to an accounting firm in Johor Bahru, the accountants will not only record business transactions timely but also prepare the essential financial statements for you. The income statement (Also see What is an Income Statement?) is one of the crucial financial reports that all businesses should generate. It provides the summary for all revenue earned and expenses incurred in a specific timeframe.
The income statement aims to determine the company’s profit or loss, and it acts as a measure of the business activities that it has carried out. Thus, the main purpose of studying the company’s income statement (Also see Why Do We Need the Income Statement?) is to let the readers get a clear picture of the revenue and expenses of the company in that accounting period. By looking at this statement, one will be able to determine whether the company is profitable and whether it can earn recurring revenues from its continuous operations.
The first line item in the income statement (Also see The Income Statement and the Balance Sheet) is the total sales revenue. This amount shows the sum of money that the sales of products or services have brought to the business. Note that business owners who apply the accrual basis of accounting should recognise the revenue (Also see Ways to Increase Your Business Revenue) earned in their books of accounts even though they have not received cash from the sale to be in line with the revenue recognition principle.
Some companies may include sales discount and sales returns in their income statement. Sales discount refers to a price reduction that the company offers to its customers if they pay the bills early. Sales returns are the goods that the customers send back to the company due to reasons such as defective products, products sent are not what they have ordered, the company has sent extra goods to them, and so on. After deducting the amounts of sales discounts or sales returns from gross sales, we will get the sum of net sales.
In the income statement, you will see the cost of goods sold too. This is the sum of money the company pays for the merchandise sold in the accounting period. To calculate the gross profit earned, one should deduct the cost of goods sold from the company’s net sales. The gross profit and gross profit margin are both useful in helping the management to understand the performance of the company and plan for future business operations.
The income statement will also show the selling and administrative costs incurred in the normal course of business. Both are the operating expenses of the business. After knowing the sum of operating expenses incurred, one will be able to work out the operating income of a business by calculating the difference between the gross profit and the operating expenses. This is the income that the company has generated from its core business activities.
Also, you may see interest income and interest expense in the income statement. Interest income refers to the interest earned by the company by keeping their excess cash in the bank accounts. As against, interest expense is the interest that the company needs to pay on the money that they have borrowed from the banks or financial institutions.
There will be a part that records the income before tax of the business too. This is the sum of money the company has earned from its operating and non-operating activities before including the sum of income taxes the business should pay. In some cases, people may choose to compare two companies by comparing their income before tax because their tax rates may not be the same.
Finally, net income is the line item that will appear as the bottom line in the income statement. The is the amount remaining after the company has added other revenues to it, as well as has deducted operating expenses, other expenses and income taxes from it. This is the final figure, and the accountant will transfer it to the company’s retained earnings.