What is a liability?

 WHAT IS A LIABILITY?

Liabilities are things that are owed by the business which are the obligations or debts of the business. These could be classed as:

·         Non-Current liabilities

·         Current liabilities

 

Non-Current liabilities are obligations that are owed by the business over a long period of time usually for longer than one year and these are also called long-term liabilities Examples include:

·         Long-term loans

·         Long-term credit facility arrangements

·         Long-term bond payable arrangements

 

Current liabilities are things that are owed by the business over a short period of time usually for shorter than one year and these are also called short-term liabilities. Examples include:

·         Creditors

·         Short-term debts

·         Accrued expenses

 

Your task:

Identify 3 differences between current and non-current liabilities

What is an Asset?

 WHAT IS AN ASSET?

Assets are things that are owned by the business which are used to produce economic value to the business in meeting its debts and other commitments. These could be classed as:

·         Non-Current assets

·         Current assets

 

Non-Current assets are things that are owned by the business over a long period of time usually for longer than one year and these assets cannot be converted to cash so easily. Examples include:

·         Motor vehicles

·         Property

·         Furniture

 

Current assets are things that are owned by the business over a short period of time usually for shorter than one year and these assets are more liquid than non-current assets and are cash or can be easily converted into cash. Examples include:

·         Bank

·         Debtors

·         Stock

 

Your task:

Identify 3 differences between current and non-current assets

Overhead Absorption Rates

Absorption of overheads is the process by which the total cost of a production centre is charged to the cost units within that centre. Absorption of overheads is charged to cost units based on an absorption rate and this is calculated at the beginning of the period based on budgeted activity and budgeted overheads. There are 3 methods of calculating the overhead absorption rate and the business can select the method they wish to use, depending on their production process.

1. Units of production 

It may be possible to calculate how much overhead should be absorbed by each unit of product produced within the centre, having derived all allocated or apportioned overhead costs. The formula below would be applied:

Total budgeted overheads cost / Total budgeted units of production

Application: Having derived the overhead absorption rate which is how much overhead that needs to be charged on each unit of product, the full production cost per unit can then be calculated. Total overheads chargeable to a piece of work= overhead absorption rate x number of the units of products produced.

2. Direct labour hours 

Overheads can be absorbed based on the total number of direct labour hours to be worked in the production centre and then applied to specific jobs. This is normally used where the production involves heavy use of labour hours. In such case, the formula below would be applied:

Total budgeted overheads cost / Total budgeted direct labour hours 

Application: Total overheads chargeable to a piece of work= overhead absorption rate x number of direct labour hours consumed on the task.

3. Machine hours

Overheads can be absorbed based on the total number of machine hours to be worked in the production centre and then applied to specific jobs. This is normally used where the production involves heavy use of machine time. In such case, the formula below would be applied: 

Total budgeted overheads cost / Total budgeted machine hours 

Application: Total overheads chargeable to a piece of work= overhead absorption rate x number of direct machine hours consumed on the task.

What's on a VAT return?

The boxes on the VAT return show the following information: 

Box 1 VAT due in this period on sales and other outputs

This contains the VAT charged on all sales and receipts for the period of the VAT return less any VAT on sales returns. This represents the total output tax. This total should be adjusted for any net errors (£10,000 net or less) from a previous return which increase the output tax. The credit notes should be deducted and the net error should be an addition. This box should include all VAT due to HMRC for any other reasons, such as fuel scale charge. 

Box 2 VAT due in this period on acquisitions from other EC Member States

This represents the VAT due in the period on all goods and any services directly related to those goods purchased from VAT registered businesses within the EU. Where there are any purchases from within the EU, the VAT due on such purchases will need to be calculated and disclosed in Box 2 of the tax return, whether or not VAT was paid on the invoice and whether or not VAT on EU purchases are shown in the VAT account. The business may be entitled to reclaim this amount and where this is the case, the same amount is added to Box 4 of the tax return. 

Box 3 Total VAT due (sum of boxes 1 & 2)

This box displays the sum of the values calculated in Boxes 1 and 2. It represents the total VAT that is owed for the applicable VAT period. This is calculated automatically where the online return is being used. 

Box 4 VAT reclaimed in this period on purchases and other inputs

This represents the amount of VAT to be reclaimed for payments and expenses incurred for the business use during the VAT period. It represents the total input tax. This total should be adjusted for any purchases credit notes received and any net errors (£10,000 net or less) from a previous return which increases the input tax. The credit notes should be deducted and the net error should be an addition. It also includes the value calculated for EC acquisitions and any services directly related to those goods in Box 2 and any VAT on imports from countries outside the EC. 

Box 5 Net VAT to be paid to HMRC or reclaimed by you

This is the difference between Box 3 and Box 4. This is calculated automatically where the online return is being used. If the value in Box 3 (Total VAT due) is greater than the value in Box 4 (VAT reclaimed in this period on purchases), the difference will be a positive figure in Box 5. This represents the total amount of VAT that the business must pay to HMRC for this period. The payment can be done by online bank transfer or faster payments from the company’s bank account or from HMRC’s website, by direct debit, or a cheque can be sent to HMRC. If the value in Box 3 (Total VAT due) is less than the value in Box 4 (VAT reclaimed in this period on purchases), the difference will be a negative figure in Box 5. This represents the total amount of VAT that the business can reclaim from HMRC as a rebate for the applicable VAT period. A refund will be sent to the company’s bank account once HMRC have the company’s bank details and HMRC’s checks do not indicate that there may be errors in the VAT return computations or the existence of any other reasons why the business may not be entitled to such refund; for example, if the business is previously owing HMRC.

Box 6 Total value of sales and all other outputs, excluding any VAT

This represents the total value of sales and receipts, excluding VAT for the period. This includes all despatches and exports to other countries, both EU and non-EU members and all exempt, standard and zero-rated supplies. It also includes the value in Box 8. It has to be adjusted for any credit or debit notes, but it is not adjusted for any bad debt relief. 48 The amount in this box can be the total of sales appearing in the Income Statement for the period the VAT return covers.

Box 7 Total value of purchases and all other inputs, excluding any VAT

This represents the total value of all payments and expenses, excluding VAT for the period. This includes all acquisitions and imports from other countries, both EU and non-EU members and all exempt, standard and zero-rated supplies. It also includes the value in Box 9. It has to be adjusted for any credit or debit notes.

Box 8 Total value of all supplies of goods and related costs, excluding any VAT, to other EC Member States

This represents the total value of all invoices and related services to EC member states, excluding VAT. Related services refer to items such as freight, delivery and insurance charges for the goods.

Box 9 Total value of all acquisitions of goods and related costs, excluding any VAT, from other EC Member States

This represents the total value of all invoices and related services from VAT registered suppliers in EC member states, excluding VAT. Related services refer to items such as freight, delivery and insurance charges for the goods.

FRS 18 Accounting Policies

These are defined in FRS 18 as those principles, bases, conventions, rules and practices applied by an entity that specify how the effects of transactions and other events are to be reflected in its financial statements through: 

 (i) recognising 

 (ii) selecting measurement basis for, and 

 (iii) presenting assets, liabilities, gains, losses and changes to shareholders funds. 

In other words, accounting policies define the processes whereby transactions and other events are reflected in the financial statements. FRS 18 sets out two main qualitative characteristics and four enhancing qualitative characteristics that information in the financial statements should possess in order for the content of the financial statements to be useful to its users. When an accounting policy is to be selected, its appropriateness to the business should also be considered against these qualities. These are relevance, reliability, comparability, understandability, verifiability and timeliness. 

Relevance 

Financial information must be relevant to the decision making process and should have the ability to influence the economic decision of the users by helping them evaluate past, present and future events. In making choices, businesses should select accounting policies or financial information that is useful in assessing stewardship and in making economic decisions. 

Reliability 

Financial information must be reliable in reflecting the substance and economic reliability of the transactions and other events that occurred and not merely the legal form of the events - i.e. substance over form. The information must be free from material error and bias - i.e. neutral - and it must be dependable upon by its users to represent faithfully what it claims to represent as at the date of the financial statements. This is also known as faithful representation. Financial information produced under uncertainty, where decisions have to be made on estimates e.g. allowance for doubtful debts, must exhibit a level of caution and prudence in order to be reliable. 

Comparability 

Financial information must be comparable and consistently applied over time to enable its users be able to compare similar information on the business for other periods. Financial statements must include corresponding information for the preceding periods and any changes in accounting policies used, must be notified to the users of the financial statements. 

Understandability 

Financial information must be understandable by its users who should have a reasonable knowledge of the business, its economic activities, the financial statements of the business and a willingness to study the information presented. 

Verifiability 

Financial information must be verifiable by its users from the notes to the accounts and other supporting documents or business documents and the data contained in the financial statements should be accurate and should be a true representation of the information contained in the raw data used to prepare the accounts. 

Timeliness 

Financial information must be delivered in a timely manner to its users to make it useful to them in their decision making process.

Capital vs revenue expenditure

Capital and Revenue expenses Capital expenditure occurs when a business spends money in purchasing non-current assets for the business operations or when it spends money in adding value or improving an existing non-current asset. This will include delivery and legal costs in acquiring the non-current assets.

Non-current assets are items owned by the business which have some longevity and will be used for a long period of time within the business. These are commonly known as fixed assets. Examples of these include buildings, machinery, furniture, motor vehicles etc.

When a business buys a new machine, this is classified as a capital expenditure and is accounted for in the statement of financial position over a few years, because of the longevity of the use of the machinery in the business.

Revenue expenditure are all other expenditure outside capital expenditure incurred by a business in carrying out its daily operations. Such expenditure will include costs incurred in the acquisition of current assets acquired for conversion into cash; costs incurred in purchasing and selling of goods; day-to-day administration or operating costs; and costs incurred in maintaining the revenue-earning capacity of the non-current assets.

All such expenditure is charged to the statement of profit or loss, because such expenditure are usually used up within a short period of time and don't add value to any existing non-current assets.

The differences between capital and revenue expenditure can be illustrated using a motor vehicle:

Expenditure                                         Type of expenditure 

Cost of the motor vehicle                    Capital

Petrol for the vehicle                           Revenue

Repairs to the vehicle                          Revenue

Headlights for the vehicle                   Capital

Servicing the vehicle                           Revenue

Body work & spraying the vehicle     Capital

Foot mats for the vehicle                     Revenue

The Non Current Asset Register

Non-Current Asset Register Non-current assets can turn out to be large amounts of expenditure in some businesses and these will require some control measures being put in place to ensure the costs are being monitored. 

In setting controls in place, many businesses maintain a non-current assets register in addition to the general ledger entries. The non-current assets register is used to record all relevant information of all the non-current assets owned by the business. It helps act as a control mechanism to monitor the existence of non-current assets and to act as a check on the relevant non-current assets general ledger balances. 

There is no set format for the register, as businesses can add in information useful specifically to its operations. Information contained in the non-current assets register may include: 

-Assets description 

-Assets location 

-Date of purchase 

-Purchase price 

-Depreciation method 

-Depreciation charge for the year 

-Accumulated depreciation to date 

-Estimated useful life 

-Net book value 

-Location of assets 

-Disposal date 

-Proceeds from disposal 

 -Gain or loss on disposal 

-Estimated residual value 

An example of a non-current assets register layout, could be as below;

In the non-current assets register layout above, the cost column is used to record the total capitalised cost of the asset (net amount without VAT); the depreciation charge is the yearly depreciation charged on the asset and the carrying amount is the difference between the cost and the accumulated depreciation to date, which is commonly known as the net book value of the asset. 

There needs to be regular checks put in place to ensure that the all non-current assets recorded by the business are actually still existing and in use by the business and to ensure that all non-current assets owned by the business are correctly recorded in the non-current assets register. 

These physical checks could reveal discrepancies and this could be as a result of the non current assets register not being updated with disposals, acquisitions or depreciation that could have taken place during the year. 

Where this is the case, the non-current assets register will need to be updated with the relevant information. Where it is not the case of the non-current assets register needing to be updated, it could then be a discrepancy resulting from a lack of controls in the organisation which could have led to theft or undisclosed damage. Any such discrepancies must be investigated and resolved or reported to the management for appropriate actions to be taken.