Financial Accounting and Management Accounting: Concept and Scope

1. Concept (2 marks)

Financial Accounting is the branch of accounting that records, classifies and summarises business transactions in monetary terms and prepares financial statements — the Statement of Financial Position (Balance Sheet), Statement of Profit or Loss, and Cash Flow Statement — to disclose the financial position and operating results of an organisation to external users. It is governed by statutory rules such as NFRS/NAS in Nepal and the Companies Act, 2063.

Management Accounting is the branch of accounting that collects, analyses and interprets accounting and non-accounting information to assist management in planning, controlling, decision-making and performance evaluation. It is not governed by any statutory format; its reports are prepared as and when required, for internal users only.

2. Scope of Financial Accounting (3 marks)

1. Recording of transactions — systematic journalising, posting to ledger and preparation of trial balance of all monetary transactions.
2. Preparation of financial statements — Trading and Profit & Loss Account, Balance Sheet and Cash Flow Statement at the end of the accounting period.
3. Statutory compliance — maintenance of books as required by the Companies Act, 2063, Income Tax Act, 2058 and NFRS/NAS; audit by a registered auditor.
4. Reporting to external users — shareholders, creditors, banks, government and the public.
5. Determination of profit/loss and financial position — measurement of periodic income and assets, liabilities and capital.
6. Distribution of profit — basis for dividend declaration, tax payment and reserve creation.

3. Scope of Management Accounting (5 marks)

1. Cost ascertainment and cost control — costing of products/services, standard costing, budgetary control and variance analysis.
2. Planning — formulation of short-term and long-term plans, budgets, sales and production forecasts, and capital budgeting decisions.
3. Controlling — comparison of actual with budgeted performance, responsibility accounting and corrective action.
4. Decision-making — make-or-buy, accept-or-reject special order, shut-down or continue, product mix, pricing and investment decisions using techniques like CVP analysis, marginal costing and discounted cash flow.
5. Performance evaluation — divisional performance, ROI, residual income, balanced scorecard and management reporting.
6. Interpretation of financial statements — ratio analysis, fund flow and cash flow analysis for managerial use.
7. Strategic and non-financial information — market share, customer satisfaction, quality cost and social/environmental cost information.

Distinction in brief: Financial accounting is statutory, historical, monetary and external-user oriented; management accounting is optional, future-oriented, both monetary and non-monetary, and internal-user oriented.

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 recognised as an asset if, and only if:

1. it is probable that future economic benefits associated with the item will flow to the entity; and
2. the cost of the item can be measured reliably.

Cost principle (NAS 16, para 15): The cost of an item of PPE comprises:

• its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates;

2. 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
3. the initial estimate of dismantling, removal and site restoration costs, where an obligation exists.

Directly attributable costs (NAS 16, para 17) include, among others: costs of employee benefits arising directly from construction/installation, site preparation, initial delivery and handling, installation and assembly, and professional fees; and, in principle, costs of testing whether the asset functions properly. Items such as administration and general overhead, and start-up losses, are not capitalizable.

Application to the five items:

Conclusion: All five expenditures (a) to (e) qualify for capitalization as part of the cost of the building under NAS 16, because each is either the purchase price or a cost directly attributable to bringing the building to the location and condition necessary for its intended use, and each is reliably measurable. CAAN's practice of capitalizing these expenditures is therefore in conformity with NAS 16.

Points to note (examiner's value additions):

• Only non-refundable taxes/fees are capitalized; refundable ones are excluded.
• Trade discounts and rebates must be deducted from the purchase price.
• Costs incurred after the building is ready for intended use (e.g., routine repairs, operating insurance, administration overhead) are expensed, not capitalized.
• If any amount is received/test output sold during construction, it is deducted from cost (para 17).

Question: A company has revalued its land holdings. A plot of land previously recorded at NPR 5 million was revalued to NPR 8 million. The revaluation was directly credited to income in the Statement of Profit or Loss. Does Nepal Accounting Standard (NAS) 16 Property, Plant and Equipment allow revaluation surplus to be credited to profit or loss? Why or why not? What is the correct treatment of revaluation gains under NAS 16? If the land was subsequently sold for NPR 9 million, how should the gain be treated? Clarify. (4+3+3=10)

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1. Does NAS 16 allow the revaluation surplus to be credited to profit or loss? (4 marks)

No. NAS 16 does not allow an increase in the carrying amount of land arising on revaluation to be credited directly to the Statement of Profit or Loss.

Why not:

• NAS 16 follows the revaluation model, under which a revaluation increase is a change in the carrying amount of an asset, not a realised earning of the reporting period. Profit or loss is reserved for income that has been earned; an unrealised holding gain on land is not earned income.
• Crediting the surplus to profit or loss would overstate profit and distributable earnings without any increase in realised wealth, and would allow dividends to be paid out of unrealised gains, defeating the purpose of capital maintenance.
• It would also distort comparability and open the door to profit smoothing/manipulation, since revaluation is optional and its timing and valuation are management-driven.
• Therefore NAS 16 requires the increase to be recognised in Other Comprehensive Income (OCI) and accumulated in equity under a separate revaluation reserve, not in profit or loss.

Conclusion: The company's treatment — crediting NPR 3 million (8 − 5) directly to income in the Statement of Profit or Loss — is incorrect and non-compliant with NAS 16.

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2. Correct treatment of revaluation gains under NAS 16 (3 marks)

Under NAS 16 (revaluation model), the accounting for a revaluation increase is:

Journal entry for the given case (land 5m → 8m):

(Being increase in carrying amount of land on revaluation recognised in OCI and accumulated in equity.)

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 shown at NPR 8,000,000; Revaluation Surplus of NPR 3,000,000 shown under equity.
• Disclosure: NAS 16 requires disclosure of the date of revaluation, method used, and whether an independent valuer was involved.

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3. Treatment if the land is subsequently sold for NPR 9 million (3 marks)

Step 1 — Determine the carrying amount at disposal: NPR 8,000,000 (revalued amount).

Step 2 — Compute the gain on disposal:

$\text{Gain on disposal} = 9{,}000{,}000 - 8{,}000{,}000 = \text{NPR } 1{,}000{,}000$

Step 3 — Recognise the gain in profit or loss. The gain on disposal of NPR 1,000,000 is recognised in the Statement of Profit or Loss in the period of disposal (as "Gain on disposal of property, plant and equipment" or netted within other income).

Step 4 — Transfer the revaluation surplus to retained earnings. The accumulated revaluation surplus of NPR 3,000,000 relating to that land is transferred directly from Revaluation Surplus to Retained Earnings (a reserve-to-reserve transfer within equity). It is not routed through profit or loss — this is only a reclassification within equity and does not affect total equity or profit.

Journal entries on disposal:

(Being transfer of realised revaluation surplus to retained earnings — a movement within equity only.)

Key clarification: The total economic benefit realised on sale is NPR 4,000,000 (9m − 5m original cost). Of this, NPR 3,000,000 was already recognised in OCI at the time of revaluation and is now merely transferred within equity; only the additional NPR 1,000,000 is recognised in profit or loss on disposal. Thus the surplus is never credited to profit or loss as a revaluation gain — it is recycled through equity, and only the disposal gain goes to P&L.