OBJECT OF ACCOUNTING ASSETS AND LIABILITIES

CHAPTER 2 Key terms OBJECT OF ACCOUNTING ASSETS AND LIABILITIES Asset, liability, equity, not-own-capital, temporary accounts, intangible and tangible assets, net profit/loss of current period, fixed assets, inventory, depreciation policy. Basic structure of assets Assets consist from following separated segments: A Receivables for subscription Receivables of accounting unit to owners for subscribed unpaid capital. B Fixed assets a) their acquisition cost is high (according to the importance of such assets from the view of the business or to national law), and b) usage of them (their economic lifetime) > one year. B1 Intangible fixed assets Examples (in accordance with Czech accounting legislation): incorporation expenses, research and development, software, valuable rights (patents, licences, know-how), goodwill. B2 Tangible fixed assets B21 Depreciable tangible fixed assets Examples: a) Unmovable: buildings, halls, structures, b) Movable: cars, treasures, PC s, 1

B22 Non-depreciable tangible fixed assets Examples: land, works of art and collections. B3 Long-term financial assets (financial investments) Examples: shares and ownership interests (long-term, purchased), intercompany loans (long-term), bonds (long-term, purchased). C. Current assets Assets with low acquisition cost (in accordance with Czech income tax legislation it means < or = 40 000/60 000 CZK) and/or usage of them < one year. C1 Inventories C11 Materials C12 Internally produced inventory (work-in-progress, semi-finished products, finished products) C13 Merchandise (goods for re-sale) C2 Receivables Examples: trade receivables, receivables from partners and participants in an association, receivables from employees, tax receivables, state subsidy C3 Financial assets (short-term) C31 Cash on hand C32 Bank account C33 Short-term financial assets (shares and bonds for sale) D. Other assets temporary accounts of assets Deferred expenses, accrued revenues 2

Fixed assets Fixed assets are 1) intangible fixed assets, 2) tangible fixed assets and, 3) financial investments (long-term financial assets). Account class Fixed Assets is also used for: a) acquisition of fixed assets, b) advance payments for fixed assets, c) accumulated depreciation of TIFA, d) adjustments to fixed assets. Description of some items of intangible fixed assets: Incorporation expenses They are expenses connected with the setting up of a new enterprise, e.g. court expenses, notary fees and other fees, travelling expenses, wages, commissions, rents, if their total exceeds certain amount. Acquisition of fixed assets or inventory shall not qualify as incorporation expenses! Research and development They shall be such results of successfully completed projects-work not falling under intangible industrial and other valuable rights. They have been acquired separately or they have been developed by the accounting unit for the purpose of sale. Software It has to be acquired as a separate item, i.e. it is not part of the acquired hardware and included in its valuation; or it has been produced internally for the purpose of sale, but it is not SW made to order or part of the delivery of HW. Valuable rights Account is used to account particularly for production and technical know-how, licences, intangible industrial rights and other results of intellectual creative activities that may constitute valuable rights both acquired from, and provided to, other parties. 3

Goodwill When the accounting unit buys another company and pays more than the fair value of its individual assets. Value of goodwill is the amount by which the purchase price exceeds the value of these assets. It is representing the value of the name, reputation, clientele, or similar intangible resources of the purchased company. Depreciable tangible fixed assets are buildings, individual movable assets and sets of movable assets, perennial crops, breeding and draught animals and others. Non-depreciable tangible fixed assets consist from: Land Works of art and collections Account is used to account for works of the visual and plastic arts and other works of art in the meaning of the Copyright Act if such works of art are parts of buildings or if they are financial investments; or collections, e.g. a set of objects depicting historic or technical progress in business activities, movable cultural antiquities and objects - articles having a cultural value, unless they are financial investments. Long term financial assets mean that accounting unit has invested into another accounting unit in the form of: investment securities and ownership interests held by the acc. unit for longer than one year, i.e. participation certificates and ownership interests in enterprises in which the accounting unit has a controlling influence (more than 50 %) or substantial influence (20-50 %) or minority interest, other investment securities and participations, such as bonds/debentures, treasury bills, certificates of deposit and term deposits, which mature after one year. Fixed assets could be acquired: by purchase, manufactured (i.e. through own activity), 4

received donation (gift), by having been invested by another person, by transfer from personal to business use. Depreciation / amortization of fixed assets Fixed asset is depreciated according to the depreciation / amortization policy; depreciation / amortization is accounted for in accordance with the rules which are set by the accounting unit. The net book value is determined by making use of the accumulated depreciation / amortization of TIFA calculated in accordance with the depreciation / amortization policy. Depreciation / amortization is calculated from the cost at which the asset is valued in the accounting records; it may not exceed that amount. The depreciation rates are set by the accounting unit with regard to useful economic lifetime, or with regard to capacity. Study case AMORTIZATION POLICY The company acquires new economic software. Acquisition cost for it is 96000 CZK, company decides to use it four years. It prepares following amortization policy: Description of the asset: amortization yearly = acquisition cost / time of usage = 96000 / 4 = 24000 amortization monthly = one year amortization / 12 = 2000 Year Acquisition Amortization / Net book value cost year 200X 96000 24000 72000 200X+1 X 24000 48000 200X+2 X 24000 24000 200X+3 X 24000 0 total X 96000 X 5

Inventories Inventory consists of: 1. purchased inventory (materials in store and merchandise in store), 2. internally produced inventory (work-in-progress, semi-finished products, finished products and animals). Materials are raw materials, auxiliary and operating materials, spare parts, packing materials, etc., defined as follows: raw materials are those which, during the production process, are fully or partially converted into products, and form their substance; auxiliary materials are materials which are also directly converted into a product, but which do not form its substance (e.g. paints and dyes); operating materials are materials which are needed for the on-going operations of the organization as a whole (e.g. lubricants, fuels, cleaning materials); spare parts are objects used to restore tangible fixed assets to their original condition; packing materials are used for the protection and transportation of purchased material, merchandise and own products. Non-returnable packing materials are delivered to a customer, or delivered internally within the accounting unit, together with their contents; small tangible fixed assets that accounting unit does not consider to be fixed assets; movable assets whose useful economic lifetime does not exceed one year, regardless of acquisition cost. Work-in-progress represents products that have gone through one or more stages of production and are no longer raw materials but are not yet finished products. Work-in-progress also includes other unfinished activities (i.e. non-production, such as services), where no tangible products are created. 6

Internally produced semi-finished products are separately stored products that have not yet gone through all the stages of production and have still to be finished by a further production process of the accounting unit. Products are internally-produced objects designated for sale outside the accounting unit. Merchandise is everything that the organization purchases for the purpose of sale, as well as own products that have been capitalized and transferred to own retail shop. Basic structure of equities and other liabilities Liabilities (equity and other liabilities) consist from following separated segments: A. Equity means claims of owners (description of how much value (amount) of assets is owned by owners of the company). A1 Capital (legal, registered) a) Public limited company (Joint stock company) total amount of nominal value of issued shares common stock at par, Equity at par. b) Limited liability company total amount paid in ownership interests. A2 Other equity accounts (Reserves) A21 Additional paid in capital (share premium) A22 Other paid in capital (gifts and subsidies of the capital from outside parties) A3 Reserves created from net profit A31 Statutory reserve account A32 Other reserves 7

A4 Retained earnings or accumulated losses (retained earnings deficit) from previous years A5 + Profit / - Loss of current period Net income / Net loss This item is described in details in Profit and Loss Account or Income statement. Study case LEGAL CAPITAL AND ADDITIONAL PAID INTO CAPITAL Capital companies in the Czech Republic, minimal required capital: Plc. (Joint stock companies) without public subscription: 2 000 000 CZK Plc. (Joint stock companies) with public subscription: 20 000 000 CZK Ltd. - Limited liability companies: 200 000 CZK The company is subscribing 1 000 pieces shares per nominal value 2 000 CZK for one piece. (So required capital is covered: 1 000 x 2 000 = 2 000 000 CZK.) But shareholders are opened to pay 2 500 CZK for every share; then: 2 000 000 CZK is legal capital registered officially by the judge court, 500 000 CZK is additional paid into capital share premium. B Not-own-capital (other, current liabilities) are claims of outside parties, it means description of how much value (amount) of assets is used by company but is owed (= not owned by a business) to the creditors (i.e. suppliers, banks, employees, ). B1 Allowances (provisions) amounts retained for planed future expenses: B11 Tax deductible allowances B12 Other non-tax deductible allowances (i.e. for enterprise risks,..) 8

B2 Payables B21 Long-term liabilities i.e. bonds issued, long term bills of exchange to be paid, intercompany long term liabilities, payables under lease contracts. B22 Short-term current liabilities, trade payables, payables to partners, to employees, to social security, taxes payable. B23 Bank loans, long-term and current bank loans, short-term financial assistance. C Other liabilities temporary accounts of liabilities Accrued expences, Deferred (unearned) revenue Study case ALLOWANCES *) The businessman plans to repair the building. The needs for repair will take effect in the year 2012. The businessman is expecting the cost for this repair for 2500000 CZK. The business is able to make profit 2000000 CZK every year, so the risk of the loss is discovered for the year 2012. For these reasons the businessman is preparing the policy of allowances: Year Amount of allowance / yearly Accumulated amount of allowance 2007 500000 500000 2008 500000 1000000 2009 500000 1500000 2010 500000 2000000 2011 500000 2500000 Total in 2012 2500000 x Businessman divides the total planned amount of repair cost to five portions which will reduce the profit for 500000 CZK every year (that means 2000000 minus 500000 is 1500000, but still profit!!!) The effects: 1. Reduced profit (before taxation) is covered against the owners to outflow it (in the form of dividends or interests). 2. Allowance is related liability to same value of asset (cash, bank account) which will be used for payment of the claim of the supplier of the repair in the year 2012. *) According to Czech income tax and accounting law, it is possible to create allowances for repair the fixed assets). 9

Temporary accounts of assets and liabilities Accounting is focused on EXPENSE x REVENUE and their connection with the proper accounting period which does not depend on outflows and inflows of the money (payment made for the expense and payment received from the revenue). Study case TEMPORARY ACCOUNTS OF ASSETS AND LIABILITIES - LEASE OF THE OFFICE Rent paid/received in advance Rent paid/received later Accounting of the renter (leaseholder) Rent is paid in current period for the expense (cost) of next accounting period (in December we pay for the January's rent). DEFERRED EXPENSE (asset) For the rent of this accounting period (this year expense) we will pay next year. ACCRUED EXPENSE (liability) Accounting of the Lessor (owner of the office) We receive payment for the January's rent in December, that means received payment from the next year revenue. DEFERRED REVENUE (liability) Revenue from this year rent will be received as a payment next accounting period. ACCRUED REVENUE (asset) 10

EXERCISE 2.1 Put the cross in the right box. Define item in details!!! Material Item Fixed Assets Current Assets Other Assets Buildings Purchased licence Semi-finished products Bonds with 2 years maturity Motor vehicles Receivables to customers Bank account Work-in-progress Ownership interests Software (a.c. = 115000 CZK) Finished products Shares for sale Receivables for subscription Bills of exchange to be collected Cash on hand Deferred expenses Valuable rights Advance payments made Merchandise in store Receivables to employees Accrued revenue Land PC (a. c. = 39 900,- CZK) PC (a. c. = 74 300,- CZK) Accumulated depreciationbuildings Stamps and vouchers Research and development 11

EXERCISE 2.2 Put the cross in the right box. Define item in details!!! Item Equity Not-own capital Other liabilities Payables to suppliers Short-term bank credit Registered capital Unpaid income taxes Statutory reserve account Bonds issued with 3 years maturity Payables to employees Long-term bank credit Retained earnings deficit Dividend to be paid Retained earnings from previous years Accrued expenses Profit of current period Deferred revenue Other paid in capital - gift Property tax to be paid Allowance for enterprise risks Amounts payable to partner Share premium Credits for discounted securities VAT to be paid Tax deductible allowances Due to social security institutions Advance payments received Salaries and wages Net income Other reserves 12

EXERCISE 2.3 Put the cross in the right box. Define item in details!!! Lorry Item Statutory reserve account Payables to suppliers Receivables to customers Legal capital Merchandise in store Work-in-progress Other equity accounts Payables to employees Allowances for repair of fixed assets Receivables to employees Bank account Deferred revenue Receivables for subscription Bonds issued with 6 months maturity Bills of exchange to be collected Deferred expenses Retained earnings from prev. years Shares for sale Accrued expenses Material on stock Other amounts payable to partners Loss of current period Finished products Personal computer, a.c.=29900 CZK Share premium Equipment, a.c. = 600000 CZK Provisions for enterprise risks ASSETS F. A. C. A. Other Equity LIABILITIES Not- Own Other 13

Income tax to be paid Buildings Accrued revenue VAT to be paid Cash on hand Bank loans Software, a.c. = 65 000 CZK Dividends to be paid Other reserves Advance payments received Ownership interests Advance payments made Credits for discounted securities Incorporation expenses Accumulated amortization software Semi-finished products Subsidies from the state budget Due to health insurance institutions Sole proprietor's account 14