Financial Accounting and Reporting

Financial Accounting

Financial accounting is the branch of accounting concerned with recording, classifying and summarising business transactions in a systematic manner and presenting the results in the form of financial statements — mainly the Statement of Financial Position (Balance Sheet) and the Statement of Profit or Loss — for a defined period. It follows generally accepted accounting principles (GAAP) and the applicable financial reporting framework (NFRS/NAS in Nepal), follows the double-entry system, and is governed by statutory requirements such as the Companies Act and the Income Tax Act. Its primary users are external parties: shareholders, creditors, banks, suppliers, government and regulatory bodies.

Management Accounting

Management accounting is the branch of accounting concerned with collecting, analysing, interpreting and communicating financial and non-financial information to internal management for planning, controlling, decision-making and performance evaluation. It is not governed by any statutory format or prescribed standards; the form, frequency and content of reports are determined by the needs of management. Tools used include budgeting, standard costing, variance analysis, CVP analysis, relevant costing and responsibility accounting.

Scope of Financial Accounting

1. Recording and classifying transactions through journals, ledgers and subsidiary books.
2. Preparation of the Trial Balance to test arithmetical accuracy.
3. Preparation of the Trading and Profit & Loss Account to ascertain profit or loss.
4. Preparation of the Balance Sheet to show financial position.
5. Preparation of the Cash Flow Statement and, where applicable, consolidated statements.
6. Statutory reporting, audit and disclosure to external stakeholders.

Scope of Management Accounting

1. Planning: formulation of budgets, forecasts and target setting.
2. Controlling: standard costing, budgetary control and variance analysis.
3. Decision-making: make-or-buy, product mix, pricing, capital budgeting and shut-down decisions.
4. Performance evaluation: divisional performance, responsibility centres and transfer pricing.
5. Cost ascertainment and cost control for products, processes and services.
6. Strategic support: analysis of cost structure, profitability and resource allocation.

Conclusion

Financial accounting is historical, rule-based and externally oriented, while management accounting is forward-looking, flexible and internally oriented. They are complementary: the data generated by financial accounting serves as the base for management accounting, and together they support both accountability to outsiders and effective managerial decision-making.

NAS 16 – Property, Plant and Equipment: Capitalization of Building-Related Expenditure

Recognition principle (NAS 16, paras 7 & 9): The cost of an item of property, plant and equipment shall be recognized as an asset if, and only if, (a) it is probable that future economic benefits associated with the item will flow to the entity, and (b) the cost of the item can be measured reliably. Para 16 provides that the cost of an item of PPE comprises its purchase price, any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management, and the initial estimate of dismantling/restoration costs. Para 21 lists examples of directly attributable costs (site preparation, delivery and handling, installation and assembly, professional fees, etc.) and excludes general and administrative overheads, training costs, and costs incurred after the asset is ready for use.

Applying the above to each item:

a) Compensation paid for purchasing the building Capitalize — Yes. This is the purchase price / acquisition cost of the building itself. It is the primary element of cost under para 16(a). It is reliably measurable and directly brings the asset into the entity's control. It should be capitalized in full (net of any trade discounts or rebates, if any).

b) Insurance premium paid during construction Capitalize — Yes (only the portion relating to the construction period). Insurance on the building during construction is a cost directly attributable to bringing the asset to the location and condition necessary for its intended use (para 16(b)). Premium relating to the period after the building is ready for use is not capitalizable; it is charged to profit or loss as a period cost. Hence, apportion the premium between the construction period (capitalize) and the post-completion period (expense).

c) Legal expenses Capitalize — Yes. Legal fees incurred for acquiring title, drafting and registering the purchase/sale deed, and completing the legal transfer of the building are directly attributable to the acquisition. These are professional fees of the type contemplated by para 21 and form part of the cost of the asset. (Legal costs relating to disputes arising after the asset is in use would be expensed.)

d) Architect consulting fee for designing the building Capitalize — Yes. The architect's fee for designing the building is a professional fee directly attributable to bringing the asset to the condition necessary for its intended use (para 21). It is an essential design-stage cost without which the building cannot be constructed to its intended specification. Hence, it is capitalized as part of the cost of the building.

e) Building construction permission fee paid to municipality Capitalize — Yes. The construction permit fee paid to the municipality is a mandatory, directly attributable cost that must be incurred before construction can lawfully commence. It is therefore part of the cost of bringing the asset to the location and condition necessary for its intended use and is capitalized under para 16(b).

Summary

Conclusion: All five expenditures qualify for capitalization as part of the cost of the building, provided they are incurred up to the date the building is ready for its intended use and are reliably measurable. Costs of a general administrative nature, or those incurred after the building is ready for use (e.g., post-completion insurance, routine repairs), must be charged to profit or loss.

(a) Does NAS 16 allow the revaluation surplus to be credited to income (profit or loss)?

No. Under NAS 16 Property, Plant and Equipment, a revaluation surplus arising on an upward revaluation is not allowed to be credited to the Statement of Profit or Loss. Crediting NPR 3 million (8 − 5) directly to income is incorrect treatment.

Why not:

• NAS 16 follows the revaluation model, under which an increase in carrying amount is recognised in Other Comprehensive Income (OCI) and accumulated in equity under a separate reserve called Revaluation Surplus.
• The Conceptual Framework and NAS 16 treat such gains as unrealised holding gains; recognising them in profit or loss would overstate distributable profit and allow dividend distribution out of unrealised gains.
• Profit or loss is reserved for realised gains (i.e., on disposal) or for reversal of a previous revaluation decrease of the same asset that had been charged to profit or loss.

Exception (the only case where credit to P&L is permitted): To the extent that the increase reverses a revaluation decrease of the same asset previously recognised in profit or loss, that portion is credited to profit or loss. Any excess above that amount goes to OCI.

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(b) Correct treatment of revaluation gains under NAS 16

Journal entries for the given case:

On revaluation (land 5 → 8, gain NPR 3 million):

Land (5,000,000 → 8,000,000)          Dr. 3,000,000
     Revaluation Surplus (OCI/Equity)      Cr. 3,000,000

Presentation:

• Statement of Profit or Loss: no effect.
• Statement of Other Comprehensive Income: "Gain on revaluation of land — NPR 3,000,000".
• Statement of Financial Position: Land at NPR 8,000,000; Revaluation Surplus under equity NPR 3,000,000.

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(c) If the land is subsequently sold for NPR 9 million

Carrying amount at sale = NPR 8,000,000; Sale proceeds = NPR 9,000,000.

1. Gain on disposal (NPR 1,000,000) — recognised in profit or loss:

Bank / Cash                          Dr. 9,000,000
     Land                                  Cr. 8,000,000
     Gain on Disposal of Land (P&L)        Cr. 1,000,000

2. Transfer of the related revaluation surplus (NPR 3,000,000) — NOT through P&L:

Revaluation Surplus (Equity)         Dr. 3,000,000
     Retained Earnings                     Cr. 3,000,000

Clarification:

• The NPR 1,000,000 gain is the difference between net disposal proceeds and the revalued carrying amount, and is reported in profit or loss as a realised gain.
• The NPR 3,000,000 revaluation surplus is not recycled through profit or loss; NAS 16 permits (and in practice requires, as a reserve transfer) its transfer directly to Retained Earnings. This is a movement within equity only.
• Hence total amount ultimately recognised in equity/retained earnings is NPR 4 million (3 + 1), but only NPR 1 million passes through the Statement of Profit or Loss.
• Had the revaluation surplus not been transferred, it would remain as a frozen reserve; the transfer makes it available for distribution as realised profit.