FINANCIAL ACCOUNTING

Prof. Ranjan Kumar Bal Utkal University

What is Common?
Lakshmi Niwas Mittal Kumar Mangalam Birla Indra Nooyi Osama Bin Laden

COURSE OUTLINE: F.A.

Conceptual Knowledge Mechanics Financial Statements Analysis & Decision Making

F. A.: WHY TO READ ? Personal Life Professional Life An Investment for Future Strategy

BUSINESS ORGANISATIONS
Merchandising (Trading) Organisations Manufacturing Organisations Service Organisations

Business organisations are cash machines.

BUSINESS ORGANISATIONS Private Limited Company Public Limited Company Limited Liability Partnership

ACCOUNTING IS THE LANGUAGE OF BUSINESS.

Serves as a means of communication Communicates / reports the events

Anthony & Reece: Accounting is not exactly a foreign language; the problem of learning it is more like that of an American learning to speak English as it is spoken in Great Britain. Language evolve and change in response to the changing needs of society, and so does Accounting.

ACCOUNTING IS AN INFORMATION SYSTEM

INPUT (Raw Data)

SYSTEM

PROCESSES (Men & Equipment) OUT PUT (Reports & Information)

OUTPUTS Financial Statements Tax Returns Managerial Data and Reports Special Reports

USERS OF ACCOUNTING INFORMATION Management Shareholders and Investors

Lenders Creditors
Employees Customers Govt. and Regulatory Agencies

General Public
Others: Media, Consumer Organizations, Researchers & Analysts, etc.

EVOLUTION OF ACCOUNTING

Stewardship Accounting Financial Accounting Cost Accounting Management Accounting

Financial Accounting Vs. Managerial Accounting

DEFINITIONS
AAA:
Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of information.

AICPA:
Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part, at least of a financial character and interpreting the results thereof.

FINANCIAL ACCOUNTING

Recording Classifying Summarizing Analyzing & Interpreting Communicating

OBJECTIVES : F.A.
To keep systematic records.

To ascertain the net effects of the business operations.

To ascertain the financial position of the organisations.

To provide accounting information to interested parties.

ACCOUNTING PRINCIPLES
Principles to be observed at the recording stage Accounting Entity Money Measurement Objective Evidence Dual Aspect Realisation Cost Accrual Principles to be observed at the reporting stage Going concern Accounting Period Matching Conservative Consistency Materiality Full Disclosure

CASH BASIS Vs. ACCRUAL BASIS OF ACCOUNTING

Accounting Framework:
Includes GAAP on the basis of which accounting data is processed, analyzed and reported.

GAAP
A set of concepts, conventions, rules, and procedures Accepted by accountants over a period of time Guides in the preparation and presentation of financial reports

ACCOUNTING STANDARDS
Specifies acceptable accounting methods Uniformity Harmonization ASB of the ICAI AS Vs. Ind AS IASB - IFRS FASB

ACCOUNTING EQUATION
Economic Resources = Sources of Resources or Claims.

Assets = Liabilities
Equity + Liabilities = Assets

Analysing the Effects of Business Transactions. Investment by Owner Receipt of Loan Purchase of Office Equipment
EQUITY & LIABILITIES Creditors Rs.20,000 Suresh, Equity 50,000 ----------70,000 -----------

ASSETS Cash Rs.12,000 Equipments Rs.58,000 ---------70,000 ----------

BALANCE SHEET
as at 31st March, 2011 LIABILITIES Share Capital Reserve and Surplus Secured Loans Unsecured Loans Current Liabilities and Provisions ASSETS Fixed Assets Investments Current Assets And Loans & Advances Miscellaneous Expenditures Profit & Loss A/C

BALANCE SHEET
as at 31st March, 2011
SOURCES OF FUNDS Shareholders Fund Loan Funds APPLICATION OF FUNDS Fixed Assets Investments Current Assets, Loans & Advances Less Current Liabilities & Provision Miscellaneous Expenditure

BALANCE SHEET
as at 31st March, 2012
EQUITY AND LIABILITIES Note No. Shareholders Fund Share Application Money pending allotment Non-current Liabilities Current Liabilities ASSETS Non-current Assets
Fixed Assets Non-current Investments Deferred Tax Assets (net) Long term loans and advances Other non-current assets Current Investments Inventories Trade receivables Cash and cash equivalents Short-term loans and advances Other current assets

Current

Previous

Current Assets

PROFIT & LOSS A/C

for the year ending 31st March 2011.

Income II. Expenditure III. Profit before Tax IV. Provision for Taxation V. Profit after Tax VI. Balance b/f from last year VII. Profit available for appropriation Appropriations: Dividends, Reserves VIII. Balance transferred to Balance Sheet
I.

PROFIT & LOSS STATEMENT

Revenue from operations II. Other income III. Total Revenue IV. Expenses . V. Profit before exceptional and extraordinary items and tax VI. Exceptional Items VII. Profit before extraordinary items and tax VIII. Extraordinary items IX. Profit before tax X. Tax expense: Current tax, Deferred tax XI. Profit/(loss) for the period from continuing operations XII. Profit/(loss) from discontinuing operations XIII. Tax expense of discontinuing operations XIV. Profit/(loss) from discontinuing operations (after tax) XV. Profit/(loss) for the period XVI. Earnings per equity share: Basic, Diluted
I.

for the year ending 31st March 2012

CASH FLOW STATEMENT

for the period ending on March 31, 2012 Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities Net cash increase (decrease) in cash & CE Cash & CE at beginning of the period Cash & CE at the end of the period.

CAPITAL MARKET FORCES Investors, Lenders

FINANCIAL STATEMENTS AND REPORTS

PRODUCT MARKET FORCES Competitors, Customers

LABOUR MARKET FORCES Managers, Employees

REGULATORY FORCES Government, Securities Regulator

LIMITATIONS OF FINANCIAL STATEMENTS

Vegetable Accounting Focus on past / historical data Postmortem Analysis Ignore non-financial information Ignore HR Fails to provide all information to
stake-holders for their decision making

QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS.

Relevance Reliability Understandability Comparability Consistency Neutrality Materiality Timeliness Verifiability Prudence

RECORDING BUSINESS TRANSACTIONS

Accounts Ledger Chart of Accounts: Assets

Liabilities Shareholders Equity Revenues Expenses

DOUBLE ENTRY SYSTEM

Luca Pacioli 1494 Dual Aspect Debit & Credit

LEDGER
T Account : A Ledger account in simplified form.
TITLE OF ACCOUNT Left or Debit side Right or Credit side

ANY ASSET / EXPENSE ACCOUNT

(Debit) Increase

(Credit) Decrease

Ledger
ANY LIABILITY / OWNERS EQUITY / REVENUE ACCOUNT (Debit) Decrease (Credit) Increase

Standard Form of Accounts

ANY ACCOUNT

Date

Explanation

Ref

Debit

Credit Balance

JOURNAL
GENERAL JOURNAL
DATE ACCOUNT TITLE & EXPLANATION L.F DEBIT Rs. CREDIT Rs.

2009 June 1

Cash Share Capital Invested Cash Office Equipment Cash Creditors Purchase of office equipment on part payment

1,00.000

1,00,000

June 2

50,000 20,000 30,000

SUB-DIVISION OF JOURNAL
1. 2. 3. 4. 5. 6. 7. 8. Cash Book Purchases Journal Sales Journal Purchases Return Journal Sales Return Journal Bills Receivable Journal Bills Payable Journal Journal Proper

ADVANTAGES
1. Classification of transactions 2. Reference becomes easy 3. Facilitate division of work 4. More particulars 5. Responsibility can be fixed 6. Facilitates checking

PURCHASES JOURNAL
Date Name of the Supplier Invoice No. L.F. Amount Remarks

SALES JOURNAL
Date Name of the Customer Out ward Invoice No L.F Amount Remarks

THREE COLUMN CASH BOOK

Date Partic -ulars L.F. Disco Cash -unt Rs. Allow -ed Rs. Bank Date Partic -ulars Rs. L.F. Disco Cash -unt Rs. Rece -ived Rs. Bank Rs.

BANK RECONCILATION
Cash Book Vs. Pass Book
What is shown on the debit side of the Cash Book, appears on the credit side of the Customers A/c in Banks ledger and vice versa.
OVERDRAFT:

When cash book shows a credit balance or when pass book shows a debit balance.

CAUSES OF DIFFERENCE:
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Cheques issued but not yet presented for payment Cheques deposited into the bank but not collected Bank charges Interest allowed by the bank, if any. Interest on overdraft. Amount collected by bank on standing instructions Payment made by bank as per standing instructions Direct payments into the bank made by customers Dishonor of cheques or bill Errors

BRS
Rs. Balance as per cash Book Add: Items: 1, 4, 6, 8 Rs. *** *** *** *** ***

***

Less:
Items: 2, 3, 5, 7, 9

***

Balance as per pass Book

TRIAL BALANCE
To check arithmetical accuracy Equality of Debits & Credits

 A debit posted in an A/C as a credit or vice versa An A/C balance incorrectly computed An A/C balance incorrectly recorded in TB A debit balance incorrectly recorded as credit balance in TB or vice versa A balance omitted entirely The TB incorrectly added Partial omission of an entry

LOCATING ERRORS

ERRORS NOT DISCLOSED BY TB

Omission from Books of Accounts Recording at a wrong amount Compensating Errors Posting in correct side but wrong A/C Recording twice in subsidiary books Errors of Principle

CORRECTING ERRORS

Correcting Entries Suspense Account

MEASURING BUSINESS INCOME

Profits: Life blood survival & growth Accountants prefer the term Net Profit instead of Income NP = Revenues Expenses Gains & Losses Accounting Period Accrual Accounting Matching principle

Measuring Income Cont.

Adjustment process
Outstanding Expense Prepaid Expense Accrued Income Income Received in Advance

CAPITAL AND REVENUE

RULES: Items of revenue nature : Income Statement. Items of Capital nature : Balance Sheet.

NEEDS: Calculation of true Profit. Determination of true Financial Position.

Capital & Revenue Cont.

CAPITAL EXPENDITURE
Acquisition of F.A. Expenditure on F.A. to increase life Exp. On development of land or mines Cost of experiment: Patent Legal charges for F.A. Exp. on day-to-day conduct of business Exp. For buying goods Exp. For maintaining F.A. & Depreciation on F.A. Interest on Loan Regular legal charges

REVENUE EXPENDITURE

DEFERRED REVENUE EXPENDITURE

Exp. on advertisement for a new product Preliminary Expenses Brokerage & Underwriting Commission Cost of shifting plants to a new site

Capital & Revenue Receipts

CAPITAL RECEIPTS
Capital introduced Loan received Sale proceeds of F.A.

REVENUE RECEIPTS
Sale proceeds of goods Other Income (Commission, Rent, Interest, etc)

PROFIT & LOSS A/C

I.

for the year ending 31st March 2012. Revenue from operations
Other income Total Revenue Expenses . Profit before exceptional and extraordinary items and tax Exceptional Items Profit before extraordinary items and tax Extraordinary items Profit before tax Tax expense: Current tax, Deferred tax Profit/(loss) for the period from continuing operations Profit/(loss) from discontinuing operations Tax expense of discontinuing operations Profit/(loss) from discontinuing operations (after tax) Profit/(loss) for the period Earnings per equity share: Basic, Diluted

II. III. IV. V. VI. VII. VIII. IX. X. XI. XII. XIII. XIV. XV. XVI.

ACCOUNTING FOR MERCHANDISING TRANSACTIONS Revenues from Sales Cost of Goods Sold Gross Profit = S COGS Operating Expenses PBIT = GP Op. Exp. PBT = PBIT Int. Exp. NP = PBT Income Tax

MERCHANDISING COMPANY

Classified P & L A/C Classified Balance Sheet

INVENTORIES
Raw Materials WIP Finished Goods

Inventories
Physical Inventory Pricing the Inventory - Specific Identification - FIFO - LIFO - Weighted Average Cost

Inventories
Conservatism Consistency Inventory Turnover

MANUFACTURING COMPANY
Cost of Goods Manufactured - Raw Material Consumed - Direct Labour - Manufacturing Overhead - WIP MANUFACTURING ACCOUNT

MANUFACTURING COMPANY
COGS
- Finished Goods: Opening - Cost of Goods Manufactured - Cost of Goods Available for Sale - Finished Goods: Closing

FIXED ASSETS
Investment in Long-lived Assets Source of Future Revenue Potential Fixed Assets Vs. Current Assets
Intention TANGIBLE Vs. INTANGIBLE Natural Resources

ACQUISITION OF F.A.
Cost: Purchase price, Duties & taxes on purchase, and Directly attributable cost Purchase price: After Trade Discount & Rebates Directly Attributable Cost: Registration fees, Lawyers fees, Brokerage, Freight, Installation cost, Professional fees, Pre-production exp.

 Capitalisation of borrowing costs Directly attributable Stop capitalisation: When the F.A. is complete & ready for use Basket Purchases: Fair Values Professional valuers L. & B. Donated Assets: AS 20 Grant & Asset Recorded at fair value or nominal value Self-constructed Assets: Costs attributable

F.A.

DEPRECIATION
Depreciation represents the expired portion of the cost of an asset.

Depreciation and Depletion Depreciation and Amortization Depreciation and Obsolescence Depreciation and Fluctuation

CAUSES

1. 2. 3. 4.

Wear and Tear Lapse of Time Obsolescence Depletion

OBJECTIVES OF PROVIDING DEPRECIATION

Ascertaining the true profit Ascertaining the true cost of production Presentation of true financial position Funds for replacement of assets

FACTORS INFLUENCEING DEPRECIATION

1. Cost of the asset 2. Estimated working life 3. Estimated scrap/residual/salvage value

Depreciable Base = Cost (Residual value Cost of disposal)

DEPRECIATION METHODS
1. Fixed Installment Method or Straight-line Method: Depreciation (p.a.) = (C S) / N 2. Written-down-Value Method or Diminishing Balance Method: Depreciation Rate = 1- (Residual value / Cost)1/n

SPECIAL PROBLEMS
Depreciation for partial periods Revision of depreciation rates Assets of low unit costs Changing the depreciation method Group depreciation Depreciation for Income Tax Disposal of F.A. Revaluation of F.A.

INTANGIBLE ASSETS
Amortisation of I.A. Goodwill Brands R. & D. costs Computer software costs Deferred costs IMPAIRMENT OF ASSETS Impairment Loss = Carrying Amt. Recoverable Amt.

NATURAL RESOURCES

Wasting Assets - Depletion

LIABILITIES
Obligations for future payment Current Vs. Long-term Secured Vs. Unsecured Contingent liabilities

CURRENT LIABILITIES
Definite liabilities Vs. Estimated liabilities Definite Liabilities
Trade Creditors Bills Payable VAT Payable Current portions of Long-term Debt Accrued Liabilities Unearned Revenues

Estimated Liabilities
Provision
Income Tax Product Warranties Dividends Payable

LONG-TERM LIABILITIES

Debentures or Bonds Lease Liabilities Pension Liabilities Deferred Tax Liabilities

DEBENTURES
Secured & Unsecured Registered & Unregistered Term & Serial Convertible Callable bonds Zero-coupon bonds Debenture Rating Debenture issued at a Premium/Discount

SHAREHOLDERS EQUITY
Share Capital
Authorised Capital Issued, Subscribed & Paid-up Capital Par Value or Face Value

Dividends

Accounting for Share Capital

Issue at par Issue at premium Issue for non-cash assets Rights Issue Forfeiture of Shares

PREFERENCE SHARE
Cumulative & Non-cumulative Participating & Non-participating Redeemable & Non-redeemable Convertible & Non-convertible

RESERVES
Capital Reserve & Revenue Reserve Share Premium Capital Redemption Reserve Debenture Redemption Reserve Investment Allowance Reserve APPROPRIATIONS

Buy-back of Shares Bonus Shares Stock-based Compensation EPS

CASH FLOW STATEMENT

Shows the historical changes in Cash & CE During a particular period Operating, Investing & Financing activities

C.F.S. Benefits
Ability to generate Cash & CE Needs to utilise cash flows Assess Liquidity & Solvency Indicator of future cash flow Relationship: Profitability & Net Cash Flow

Cash Flow from Operating Activities-Direct

Cash receipts from Customers Cash paid to Suppliers & Employees Cash generated from Operation - Income taxes paid Cash flow before Extra-ordinary items - Extra-ordinary items Net cash from Operating Activities

Cash Flow from Operating Activities-Indirect

N.P. before Tax & Extra-ordinary item Adjustments for:
Depreciation Foreign Exchange Loss Interest & Dividend Income Interest Expense

Op. Profit before W.C. changes

Changes in S. Drs. & Inventory Changes in S. Crs.

Cash generated from Operation

Income Taxes paid

Cash flow before Extra-ordinary item

Extra-ordinary Items

Net Cash from Operating Activities

Cash Flow from Investing Activities

Purchase of Fixed Assets Sale of F.A. Purchase of other Investments Sale of other Investments Interest Received Dividend Received Net cash from(used in) Investing Activities

Cash Flow from Financing Activities

Proceeds from issue of Share Capital Proceeds from Long-term Borrowings Repayments of Long-term Borrowing Interest Paid Dividend Paid Net Cash from(used in) Financing Activities

CASH FLOW STATEMENT

Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities Net cash increase(decrease) in cash & CE Cash & CE at beginning of the period Cash & CE at the end of the period.

BALANCE SHEET
LIABILITIES AND EQUITY Share capital Reserves Profit and Loss balance Long-term borrowings Current liabilities Provisions for tax Proposed dividend TOTAL
ASSETS Gross fixed assets Less: Accumulated depreciation Net fixed assets Investment (all long-term) Inventories Debtors Cash and bank balance Loans and advances TOTAL

(Figures in Lakhs)

March 31, 2012 550 200 135 300 135 120 55 1495

March 31, 2011 500 100 125 250 100 75 50 1200

750 390 360 250 190 120 50 525 1495

600 300 300 200 100 80 30 490 1200

PROFIT AND LOSS STATEMENT FOR THE YEAR ENDED MARCH 31, 2012
INCOME Sales Other income Stock adjustment Total EXPENDITURE Raw materials consumed Manufacturing expenses Administration expenses Selling and distribution expenses Depreciation Interest Total Profit before tax (PBT) Provision for tax Profit after tax (PAT) Profit and loss balance at the beginning of the year Profit available for appropriation Transfer to reserves Proposed dividend (including dividend tax) Balance of profit carried to balance sheet (Figures in Lakhs) 1260 152 18 1430

715 140 80 65 90 55 1145 285 120 165 125 290 100 55 135

i. Loans and advance include income tax paid Rs.120 lakhs (previous year Rs.75 lakhs). Ii. During 2008-2009, 5,00,000 equity shares of Rs.10 each were issued at par. Iii. Long-term loan Rs.30 lakhs repaid during the year. Long term loan raised during the years Rs.80 lakhs. Prepare Cash flow statement.

FINANCIAL STATEMENT ANALYSIS

OBJECTIVES
Liquidity Solvency Profitability Efficiency Health & Performance

PROCESS
Select Relate Evaluate

STANDARDS OF COMPARISONS

Rule-of-thumb Past Performance Industry Standards

SOURCES OF INFORMATION

Company Reports Stock Exchanges Business Periodicals Information Services

TECHNIQUES OF FSA
Horizontal Analysis Trend Analysis Vertical Analysis Ratio Analysis

RATIO ANALYSIS
Profitability Ratios Liquidity Ratios Solvency Ratios Capital Market Ratios

LIQUIDITY RATIOS
Current Ratio Quick Ratio Debtor Turnover Inventory Turnover

SOLVENCY RATIOS
Debt-to-Equity Ratio Interest Coverage Ratio

CAPITAL MARKET RATIOS Price-Earnings Ratio Dividend Yield Price-to-Book Ratio

PROFITABILITY RATIOS
Profit Margin Asset Turnover Return on Assets or ROI Return on Equity EPS

CORPORATE DISCLOSURE

Annual Reports Financial Reports / Special Reports

ANNUAL REPORTS
To inform the Share Holders: Performance & Health To provide information to other users

Annual Report: Contents

Chairmans Report Directors Report Auditors Report Profit & Loss Statement Balance Sheet Cash Flow Statement Segment Reports

Annual Report: Contents

Highlights Financial & Production Statistics EVA Reporting HRA Reporting Environmental Reporting Social Reporting Value Added Statement Inflation Accounting

The woods are lovely, dark and deep. But I have promises to keep. And miles to go before I sleep, And miles to go before I sleep.
Robert Frost

Arise, awake and stop not till the goal is reached.