Accounting Definations 3

General Reserves: These reserves which are not created for any specific purpose and are available for any future contingency or expansion of the business.

SpecificReserves: These reserves which are created for a specific purpose and can be utilized only for that purpose.

                                   Ex: Dividend Equilisation Reserve

                                        Debenture Redemption Reserve

Provisions: There are many risks and uncertainities in business. In order to protect from risks and uncertainities, it is necessary to provisions and reserves in every business.

Reserve: Reserves are amounts appropriated out of profits which are not intended to meet any liability, contingency, commitment in the value of assets known to exist at the date of the B/S.

Creation of the reserve is to increase the working capital in the business and strengthen its financial position. Some times it is invested to purchase out side securities then it is called reserve fund.

Types:

            1: Capital Reserve: It is created out of capital profits like premium on the issue of shares, profits and sale of assets, etc…This reserve is not available to distribute as dividend among shareholders.

            2: Revenue Reserve:  Any Reserve which is available for distribution as dividend to the shareholders is called Revenue Reserve.

Provisions V/S Reserves:

1.      Provisions are created for some specific object and it must be utilised for that object for which it is created.

   Reserve is created for any future liability or loss.

2.      Provision is made because of legal necessity but creating a Reserve is a matter of financial strength.

3.      Provision must be charged to profit and loss a/c before calculating the net profit or loss but Reserve can be made only when there is profit.

4.      Provisions reduce the net profit and are not invested in outside securities Reserve amount can invested in outside securities.        

Goodwill: It is the value of repetition of a firm in respect of the profits expected in future over and above the normal profits earned by other similar firms belonging to the same industry.

            Methods: Average profits method

                            Super profits method

                            Capitalisatioin method

Depreciation: It is a perminant continuing and gradual shrinkage in the book value of a fixed asset.

           Methods: 

1. Fixed Instalment method or Straight line method

Dep. = Cost price – Scrap value/Estimated life of asset.

2. Diminishing Balance method: Under this method, depreciation is calculated at a certain percentage each year on the balance of the asset, which is bought forward from the previous year.

3. Annuity method: Under this method amount spent on the purchase of an asset is regarded as an investment which is assumed to earn interest at a certain rate. Every year the asset a/c is debited with the amount of interest and credited with the amount of depreciation.

EOQ: The quantity of material to be ordered at one time is known EOQ. It is fixed where minimum cost of ordering and carrying stock.

 Key Factor: The factor which sets a limit to the activity is known as key factor which influence budgets.

              Key Factor = Contribution/Profitability

              Profitability =Contribution/Key Factor

Sinking Fund: It is created to have ready money after a particular period either for the replacement of an asset or for the repayment of a liability. Every year some amount is charged from the P&L a/c and is invested in outside securities with the idea, that at the end of the stipulated period, money will be equal to the amount of an asset.

Revaluation Account: It records the effect of revaluation of assets and liabilities. It is prepared to determine the net profit or loss on revaluation. It is prepared at the time of reconstitution of partnership or retirement or death of partner.  

Realisation Account: It records the realisation of various assets and payments of various liabilities. It is prepared to determine the net P&L on realisation.

Leverage: - It arises from the presence of fixed cost in a firm capital structure.

                        Generally leverage refers to a relationship between two interrelated variables.

These leverages are classified into three types.

1.             Operating leverage

2.             Financial Leverage.

3.             Combined leverage or total leverage.

1.             Operating Leverage: It arises from fixed operating costs (fixed costs other than the financing costs) such as depreciation, shares, advertising expenditures and property taxes.

When a firm has fixed operating costs, a change in 1% in sales results in a change of more than 1% in EBIT

                         %change in EBIT 

                         % change in sales                  

The operating leverage at any level of sales is called degree.

Degree of Operating Leverage= Contribution/EBIT

Significance: It tells the impact of changes in sales on operating income.

 If operating leverage is high it automatically means that the break- even point would also be reached at a high level of sales.