The initial line item is operating profit when generating a cash flow statement using the indirect method. The idea behind using this amount is ‘’we need to convert accrual-based profit/loss to the cash balance’’. For this purpose, we divide the cash flow statement into three categories. Operating activities Adjustments for non-cash items We add up…

The following are considered limitations of the cash flow statement. 1-Non-cash transactions are ignored The cash flow statement does not consider non-cash transactions. For instance, depreciation, impairment, provisions, and other non-cash expenses are ignored. Hence, essential accounting concepts are ignored, leading to questions about the cash flow statement’s usability. 4-Classification may not be objective The…

Asset management ratios are designed to measure a business’s ability to use assets. They help understand whether the business has been able to efficiently utilize the assets and generate revenue/earnings for its investors and other stakeholders. In other words, it’s a measure of a business’s capacity for utilizing assets and generating revenue/earnings for its stakeholders….

In a production facility with multiple products, it’s challenging to determine production overheads for each product. So, we use the concept of overhead allocation using a predetermined overhead rate. Overhead allocation enables us to trace the cost of each product. So we can analyze product profitability and make informed decisions using absorption costing. Let’s understand…

The financing is considered for the short term when the business is bound to make repayment within the next 12 months. This type of financing is classified in the short-term liability section of balance sheet. The interest paid on the short terms financing is taken to the profit and loss statement as finance expense. Let’s…

Year one-year comparison means comparing numbers in the financial statement with the last year’s numbers. So, it’s about analyzing the numbers in series and concluding on the performance. Increase/decrease can have different interpretations for the numbers when compared with last year. For instance, an increase in revenue is considered good, and an increase in expenses…

The realization concept states the business should only recognize the revenue when earned. The revenue is earned when goods are delivered to the customer or services are rendered for them. In other words, the realization concept states revenue should only be recognized when the legal process related to revenue earning has been completed. If the…

Bank reconciliation is the process of reconciling the balance in the accounting/cash/bank ledger with the bank statement. In simple words, we compare transactions in the bank statement with accounting records. So, if we can see that the total balance of the bank/cash ledger is the same as the closing balance of the bank statement, it…

This article extends to discuss accounting treatment for addition/purchase, sales, provision, and write-off for the inventory. Accounting for the purchase of inventory The following journal entry is posted when inventory is purchased from the vendor/supplier. Description Debit Credit Inventory (assets) XXX   Accounts payable (liability)/ cash (asset)   XXX The debit impact of the given…

Substance over form means financial transactions should be recorded & disclosed based on their substance/economic reality rather than legal form. Substance/economic reality means the real purpose/intent of transactions should be identified and measured rather than a value given in the documents (form). So, presenting real economic value is the goal of this concept. It’s important…