Definition of CAMELS ratings Sunk Cost Comparability and Consistency Limitation of CVP Analysis Break-even point The Basel Accords assumptions of CVP analysis

Q9. Definition of CAMELS ratings, Sunk Cost, Comparability and Consistency, Limitation of CVP Analysis, Break-even point, The Basel Accords, assumptions of CVP analysis.

(1) CAMELS ratings: The CAMELS ratings is a United States supervisory rating of the bank's overall condition used to classify the nation’s fewer than 8,000 banks. This rating is based on financial statements of the bank and on-site examination by regulators like the Federal Reserve.

The components of a bank's condition that are assessed (C) Capital adequacy, (A) Asset quality, (M) Management, (E) Earnings, (L) Liquidity and (S) Sensitivity to Market Risk

(2) Sunk Cost: Sunk cost is a cost that has already been incurred and cannot be recovered. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken. Both retrospective and prospective costs may be either fixed or variable costs.

For example, if a firm sinks one million on an enterprise software installation that cost is "sunk" because it was a one-time thing and cannot be recovered once expended.

(3) IFRS: International Financial Reporting Standards (IFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries. They are a consequence of growing international shareholding and trade and are particularly important for companies that have dealings in several countries. They are progressively replacing the many different national accounting standards. The rules to be followed by accountants to maintain books of accounts which is comparable, understandable, reliable and relevant as per the users internal or external.

IFRS began as an attempt to harmonize accounting across the European Union but the value of harmonization quickly made the concept attractive around the world. They are sometimes still called by the original name of International Accounting Standards (IAS). IAS was issued between 1973 and 2001 by the Board of the International Accounting Standards Committee (IASC). On April 1, 2001, the new IASB took over from the IASC the responsibility for setting International Accounting Standards. During its first meeting the new Board adopted existing IAS and Standing Interpretations Committee standards (SICs). The IASB has continued to develop standards calling the new standards International Financial Reporting.

(4) Comparability and Consistency: Information about a particular enterprise gains greatly in usefulness if it can be compared with similar information about other enterprises and with similar information about the same enterprise for some other period or some other point in time.  Comparability between enterprises and consistency in the application of methods over time increases the informational value of comparisons of relative economic opportunities or performance.  The significance of information, especially quantitative information, depends to a great extent on the user's ability to relate it to some benchmark.

(5) Limitation of CVP Analysis: CVP is a short run, marginal analysis, it assumes that unit variable costs and unit revenues are constant, which is appropriate for small deviations from current production and sales, and assumes a neat division between fixed costs and variable costs, though in the long run all costs are variable. For longer-term analysis that considers the entire life-cycle of a product, one therefore often prefers activity-based costing or throughput accounting.

(6) Break-even point: The break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain, and one has "broken even". A profit or a loss has not been made, although opportunity costs have been "paid", and capital has received the risk-adjusted, expected return.

For example, if a business sells fewer than 200 tables each month, it will make a loss, if it sells more, it will be a profit. With this information, the business managers will then need to see if they expect to be able to make and sell 200 tables per month.

The figure is givenbelow

Fig (a): Break-even point

(7) The Basel Accords: The Basel Accords  refer to the banking supervision Accords (recommendations on banking regulations)—Basel I, Basel II and Basel III—issued by the Basel Committee on Banking Supervision (BCBS). They are called the Basel Accords as the BCBS maintains its secretariat at the Bank for International Settlements in Basel, Switzerland and the committee normally meets there.

(8) Assumptions of CVP analysis: Cost-Volume-Profit (CVP) analysis assumption are given below:-

(a) Selling price is constant. The price of a product or service will not change as volume changes.

(b) Costs are linear and can be accurately divided into variable and fixed elements. The variable element is constant per unit, and the fixed element is constant in total over the relevant range.

(c) In multi-product companies, the sales mixis constant.

(d) In manufacturing companies, inventories do not change. The number of units produced equals the number of units sold.

(9) Off-balance sheet (OBS): Off-balance sheet (OBS) usually means an asset or debt or financing activity not on the company's balance sheet.

Some companies may have significant amounts of off-balance sheet assets and liabilities.

For example, financial institutions often offer asset management or brokerage services to their clients. The assets in question (often securities) usually belong to the individual clients directly or in trust, while the company may provide management, depository or other services to the client. The company itself has no direct claim to the assets, and usually has some basic fiduciary duties with respect to the client. Financial institutions may report off-balance sheet items in their accounting statements formally, and may also refer to "assets under management," a figure that may include on and off-balance sheet items.

(10) Tangible & Intangible asset: Assets that have a physical form. Tangible assets include both fixed assets, such as machinery, buildings and land, and current assets, such as inventory. The opposite of a tangible asset is an intangible asset. Nonphysical assets, such as patents, trademarks, copyrights, goodwill and brand recognition, are all examples of intangible assets.

(11) Current Assets vs Non-current Assets: Current Assets are those assets which are held for short time generally a year’s time only. The balance of these assets usually, keeps on changing.

For example: 

(1) the balance of cash in hand may change so many times during the day. 

(2) Cash in hand and Cash at Bank.

Non-current Assets are those assets which are acquired for long term use in the business. These assets increase the profit earning capacity of the business. Expenditure on these assets is not regular in nature. Examples. Building, Furniture, Machinery, etc.

(12) Accrued revenues vs deferred revenue:

Accrued revenues: Revenues earned but not yet received in cash or recorded. Accrued revenues are used for transactions in which goods and services have been provided, but cash hasn't yet been received. In many cases, these revenues are included in the accounts receivable listing, and accountants don't need to look for them or to book them separately. A common accrued revenue situation is interest that has been earned but not yet received. The journal entry is to debit (increase) interest receivable, an asset account, and to credit (increase) interest revenue, which is reported in the income statement. When the interest is received, the entry is to debit cash, increasing it, and to credit interest receivable, zeroing it out. The end result is to recognize the revenue in the income statement before the money is actually received.

Deferred revenues: Deferred revenues reflect situations in which money has been received, but goods and services haven't been provided. These revenues are also known as deposits, and they are not recognized as revenues in the income statement. Deferred revenues are not "real revenues" -- they don't affect net income or loss at all. Rather, they report on the balance sheet as liabilities. The journal entry to recognize deferred revenue is to debit (increase) cash and credit (increase) a deposit or another liability account. When services or goods are provided, the entry is to debit (decrease) the deposit account and credit (increase) the revenue account -- the "real" one, which reports in the income statement and impacts net income or loss.