Let us understand what a lease agreement and a rent agreement are, before learning about their differences.Lease agreementAccording to section 105 of transfer of property Act, 1882 “lease is defined as transfer of a right to enjoy a property, made for a certain time, express or implied or in perpetuity, in consideration of a price paid or promised, or of money, a share of crops/service or any other thing of value, to be rendered periodically or on specific occasions, to the transferor by the transferee, who accepts the transfer on such terms”.The conditions for rent agreement as a lease are ... Read More

Let us estimate the total income of the project by using percentage of completion method, if revenue estimated is $300000, estimated costs is $60000 and costs to date is $7000.SolutionThe solution is as follows −Step 1 -Percentage of completion = costs to date / estimated cost of project = 7000/60000 = 11.67 % (rounded to two digits)Step 2 -Total income (estimated) = revenue estimated – estimated costs = $300000 – 60000 = $240000Step 3 -Income recognition = percentage of completion * total income (estimated) = 11.67% * $240000 = $28008Percentage of completion method accountingLet’s say, the business has a project, ... Read More

Let us consider two examples for the percentage of completion method.Example 1Calculate by using percentage of completion method, if estimated cost of project is $700000 and costs to date are $85000, total revenue estimated = $2000000).SolutionThe solution is as follows −Step 1Percentage of completion = costs to date / estimated cost of project = 85000/700000 ⇒ 12.14 % (rounded to two digits)Step 2Revenue recognition = percentage of completion * total revenue estimated = 12.14% * 2000000 ⇒ $ 242800Step 3Income recognition = recognized revenue – costs to date = 242800 – 85000 ⇒ $157800Example 2A construction is building a maintenance facility and the ... Read More

In this method, all the revenues are recognized based on the percentage of work completed over a period of time through a cost to cost method.Journal entriesThe journal entries for the percentage of completion method are as follows −ParticularsDebitCreditIncurring costsConstruction in progressCash or accounts payableBillingAccounts receivableConstruction in progress (Bill)Receiving paymentsCashAccounts receivablePeriod end adjustments for revenueConstruction expenseConstruction in progressConstruction revenueCompleting the projectConstruction in progress (Bill)Construction in progressExampleConsider the following table for understanding how to write journal entries. Here, all numbers are used for understanding purposes only.Particulars2001 ($ IN MILLION)2002 ($ IN MILLION)2003 ($ IN MILLION)Cumulative cost incurred ($)4915Total cost (estimated) $151515Billings3105Collected2115SolutionThe ... Read More

The percentage of completion method recognizes all the revenue and profit associated with long-term projects on proportion/percentage of work completed.In this method, revenue is recognized yearly. Sellers can recognize gain/loss in a project in every accounting year. This method estimates stages of project completion or estimates costs of remaining costs. This method falls in IFRS 15.The formula for the percentage of completion method is as follows −Revenue (to recognized) = percentage of completed work * total contract valueTypesThe types of the percentage of completion method are as follows −Cost to cost methodPercentage of work completed = total expenses incurred (accounting ... Read More

In this method, all revenue and expenses will not be recognized, until the completion of the contract. If there is any unpredictability in collecting funds from customers, then this method is used. This method is easy to determine and simple.Journal entriesThe journal entries for completed contract method are as follows −ParticularsDebitCreditIncurring costsConstruction in progressCash or accounts payableBillingAccounts receivableConstruction in progress (Bill)Receiving paymentsCashAccounts receivableRecording revenueConstruction in progress (Bill)Construction revenueRecording expenseConstruction costConstruction in progressExampleConsider the following table for understanding how to write journal entries −Particulars199519961997Cumulative cost incurred ($)2000000500000012000000Total cost (estimated) $120000001200000012000000Billings200000040000007000000Collected100000050000007000000SolutionThe journal entries by using the completed contract method for the above-mentioned ... Read More

In complete contract method, recognize all the revenue and profit associated with a project only after completion of project. This method results in deferred tax liability.Also, this method is used, where there is uncertainty in collecting funds from customers under contract terms.Businesses can defer recognition of income taxes, if there is any delay in income recognition. Deferment of tax and payments and their benefits can have a positive or negative effect on working capital.Revenue recognition timing is delayed and irregular. In this method, bills issued and costs incurred are recorded in the balance sheet and the respective amounts are transferred ... Read More

Free cash flow to firm (FCFF) represents the available cash flow for equity holders of the firm. The cash is the remaining cash after paying all its expenses including both operating and capital expenditures (taxes, interest, expenditures etc.). Measures the cash return by a firm to its shareholders.FormulaThe formulae to calculate the FCFE is as follows −Free cash flow of equityCash (operations) – capital expenditures + net debt (repaid)Free cash flow of equity (with net income)Net income + D&A + changes in working capital + capital expenditures + net borrowingsFree cash flow of equity (with EBIT)EBIT – I – T ... Read More

Free cash flow to firm (FCFF) represents the available cash flow for both debt and equity holders of the firm. The cash is remaining cash after paying all its expenses including both operating and capital expenditures (taxes, interest, expenditures etc.).FCFF is calculated by intrinsic valuation method and terminal value of business.FormulaeThe formulae to calculate the FCFF are as follows − Free cash flow of firm (Net profit)Net profit (operating) + expenses (Depreciation and amortization) – capital expenditure – changes in net working capital. Free cash flow of firm (Operations)Cash flow (operations) + Interest expenses* (1-T) – capital expenditures Free cash flow of firm ... Read More

The performance ratios help in understanding the financial statements and give a better view of business.Company calculates these ratios regularly to see how well they are using their own resources and gives their performance.Some of the advantages of performance ratios for a company are forecasting, budget estimation and determination of the firm’s liquidity and long term solvency.Some of the disadvantages are it is more complicated and comparison becomes ambiguous because companies mostly work in different environments, market, regulation etc.Performance ratiosThe various performance ratios in company are as follows−Cash flow to revenue (CFr) = Ratio between cash flows generated (CFg) from ... Read More