The cost method of accounting for investments is used to determine the profit and loss of any investment. Apart from that, this method is also used to compute the return on investment of a certain investment. To know more about this approach of accounting, read on…
The specialty of cost method of accounting for investments is that, it gives us an idea of how much money is actually being invested, how much money is being earned as a return, and also the exact return over investment. This approach of accounting can be adopted for almost any kind of investment, such as mutual funds, investment into gold and silver, etc. Cost method of accounting is also used in the corporate and business world, in order to maintain records and accounts for the following:
- Investments into a partnership firm.
- Investment into subsidies companies and business
- Investments into specific contracts and agreements of a business.
The actual computation and cost accounting for the aforementioned 3 cases is pretty difficult and involves some complex accounting calculations. Cost method of accounting can be used for small investments. Here’s how you can do it…
Note: The word ‘returns’ that is mentioned in the following article implies the total amount of income derived from the investment. Principal amount is the total amount invested, less charges and fees as applicable in some cases.
Cash Statement and Cost Sheet
A statement presented in a simple and easy-to-understand manner is the core of cost method of accounting. Unlike the statements of financial accounting method, which have credit and debit factions, the statements of cost accounting methods have just one faction. A general cash statement and cost sheet are the two primary types of cost accounting statements used to account for investments. We shall be taking a look at both formats in due course. It is a common convention to make one statement per investment, however, companies sometimes make one superseding or collective statement.
When it comes to cost accounting statements for investments, there are three major elements included in the statement:
- The first one is the total volume of money that you have invested. It is known as the ‘principal amount’ of investment.
- The second one is the total expenditure incurred to make the investment. This includes broker fees, taxes, loads, charges, etc. Note that, this element does not include any direct loss incurred in the investment, for example, the loss of market price of stock equity.
- The third element is basically the return which you have received after the lifecycle of the investment gets completed.
There are two more elements which can be optionally included in the statement:
- Current realization cost is the total money which you would receive if you sell off your investment. This kind of element is usually used for investments such as gold, silver and stock equity, denoting the current market value.
- The next one is the return on investment which is a percentage, that indicates the percentage profit derived from the entire investment.
The decision to use a cost sheet or a cash statement, depends upon the situation at hand. For example, if it is a mutual fund with variable returns, then all premium payments on an annual basis and the relevant returns along with (%) return, on investment of that very year are recorded. At the end of the mutual fund’s life, the total returns minus the invested ‘principal amount’ are recorded as a profit. In such a situation, a cost sheet is used. Another example which can be taken is again of the mutual fund with a ‘Net Asset Value’, that is you don’t get returns paid on an annual basis, but at the end of the total term of the fund, you withdraw the fund which is represented by a Net Asset Value or an NAV, which is essentially the total return amount. This type of statement can also be used for market based investments such as gold, silver and stock equity.
Cost Method of Accounting for Investments: Formats
Now to illustrate the two types of statements, the two aforementioned examples have been used. Take a look…
|1.||Total cost of buying one share of the fund|
|2.||Premium for 2001-2002|
(add) Return for 2001-2002
|3.||Premium for 2002-2003|
(add) Return for 2002-2003
|4.||Premium for 2003-2004|
(add) Return for 2003-2004
|5.||Premium for 2004-2005|
(add) Return for 2004-2005
|6.||Premium for 2005-2006|
(add) Return for 2005-2006
|7.||Premium for 2006-2007|
(add) Return for 2006-2007
|8.||Premium for 2007-2008|
(add) Return for 2007-2008
|9.||Premium for 2008-2009|
(add) Return for 2008-2009
|10.||Premium for 2009-2010|
(add) Return for 2009-2010
|11.||Therefore total premiums||…||…|
|12.||Therefore total returns||…||…|
|13.||Therefore total return on Investment (%)||…||…|
|14.||Therefore total rate of return||…||…|
|15.||Therefore total profit||…||…|
You can use the following formulas for the computation of the last 3 elements.
|1. Total Return on Investment (%): A.R (×) 100 ÷ A.I|
where, A.R = total amount received back as returns and A.I = principal amount invested
|2. Total Rate of Return:|
A.R = A.I (×) number of years of the investment (×) R ÷ 100
where, R is the rate of return. In this case, you will need to substitute the remaining figures in the formula and then derive the ‘R’ figure, which is percentage return which you have received annually.
|3. Total Profit|
Total profit is simply the total returns (-) total premiums
|1.||Total principal amount invested in mutual fund share|
(total cost of buying one share of the fund)
(less) loads / charges / fees
|2.||(add) Gain in net asset value||…|
|3.||(less) Loss of net asset value||…|
|4.||Withdrawal of mutual fund at NAV||…|
|5.||Return on investment (%)||…|
|6.||Total rate of return||…|
Depending upon the situation and case of investment, you can apply any of the two methods and their respective statements. The first one works better for long-term investments, essentially the ones that exceed 12 months. The cash statement, on the other hand, works better for smaller, market-based investments.