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FINANCIAL

Statements

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FINANCIAL
ACCOUNTING: I

INTRODUCTION TO
FINANCIAL STATEMENTS
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FINANCIAL
STATEMENTS
¯ The State of affairs of the organization:
BALANCE SHEET
¯ Working results for a given period:
PROFIT AND LOSS ACCOUNT
¯ Cash receipts & payments during a
period:
CASH FLOW STATEMENT
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ACCOUNTING
¯ An information system -
communicating the financial
position of a company, sometimes
known as the language of business
¯ Accounting is expected to give the
true and fair view of
– The state of affairs of the
organization and
– Its working results for a given period
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EXERCISE
¯ Ram Kumar is a professional
¯ In his first three years of service, he
earned Rs. 2 lakhs, 2.2 lakhs and
2.5 lakhs respectively
¯ His expenses in these three years
were Rs. 1.2 lakhs, 1.6 lakhs and
1.8 lakhs, respectively
- What do you understand from
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EXERCISE
LET US LOOK AT THESE EXPENSES IN
SOME MORE DETAIL:
¯ In the first year (Y 1) Ram stayed in a lodge
¯ In Y 2 he rented an apartment, paying a
deposit of Rs.15,000. His expenses for the
year included this amount of deposit and
payment towards furniture of Rs. 15,000.
The furniture had an expected life of 5
years.
- How will you interpret this information
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EXERCISE
¯ In Y3 he invested in a plot of land
costing Rs. 2 lakhs. This was funded
by borrowing Rs.1.6 lakhs from a
bank

- How will you interpret this


information?
- What do you think of the financial
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BUSINESS ACTIVITY
¯ Money is invested in a commercial enterprise
with a view to earning profits and being
sustainable
¯ Money circulates in a business and is used for
a variety of purposes
– Capital expenditure, other expenditure,
returned to lenders, distributed to
shareholders, invested etc
¯ Profits may be earned immediately
(ITES/Consulting/Service) or some time into
the future (Manufacturing/Biotech)
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MEASURES OF SUCCESS
IN BUSINESS
¯ How does one measure whether a
business is successful or not
¯ One needs to have a system of
measurement of the financials of a
business
¯ These need to be comparable, over time
and across companies
- What do you think could be some
measures of success in a business?
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MEASURES OF
PERFORMANCE
¯ Some measures
– Revenue compared to others
companies, in country, in same
industry
– Profits, gross and net after taxes
– Number of employees
– Revenue per employee
– Growth in same company from one
period to the next
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ANNUAL REPORTS
¯ Business entities bring out annual
reports which contain financial and
non financial information
¯ Reports are made available to
shareholders, government and
other interested persons
¯ There are guidelines to be followed
and statutory compliances to be
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ANNUAL REPORTS
Users
¯ Internal

– Owners and managers


¯ External
– Investors, lenders, suppliers and
creditors, customers, government
and its agencies, public, analysts,
advisors
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KEY CONTENT OF
ANNUAL REPORTS
¯ Financial statements – balance
sheet, profit and loss account,
cash flow statement, consolidated
financial statements
¯ Letter to shareholder
¯ Director’s report
¯ Management discussion and
analysis
¯ Auditors’ report www.biZkul.com 13
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OTHER CONTENT OF
ANNUAL REPORTS
¯ Some companies provide
additional information, this
includes
¯ Value reporting
¯ Brand valuation
¯ Human resource accounting

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ANNUAL REPORTS
You have an annual report with
you;
what information would you seek
as:
¯ A short term investor
¯ A long term investor
¯ An employee
¯ A customer
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ANNUAL REPORTS

Do you think that one set of


financial statements and other
information in the Annual Report
can meet the requirements of all
users/readers?

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FINANCIAL
STATEMENTS
¯Used for
– Measurement, forecasting, decision
making, evaluation, control,
stewardship, government and
statutory regulation
¯ Characteristics
– Understandable
– Reliable
– Relevant
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FINANCIAL
ACCOUNTING: I

BALANCE SHEET

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BALANCE SHEET
¯ Sources of funds
– Shareholders funds
– Loan funds
¯ Application of funds
– Fixed assets
– Investments
– Current assets less current liabilities
and provisions
– Miscellaneous expenses
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BALANCE SHEET
¯ Sources of funds
– Share capital (equity,
preference)
– Reserves and surplus (specific
reserves, surplus profit not
appropriated to any specific
reserve)
– Secured loans (from financial
institutions, commercial
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banks) 20
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BALANCE SHEET
¯ Sources of funds (contd.)
– Unsecured loans (fixed deposits,
promoters, intercorporate loans)
– Current liabilities and provisions
(dues to suppliers, payments
received in advance, expenses
accrued for rent, salary, pension,
etc.)
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BALANCE SHEET
¯ Application of funds
– Fixed assets (Long term assets
not for resale, land, buildings,
machinery, vehicles, computers,
office equipment, furniture)
– Investments (long term or short
term)

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BALANCE SHEET
¯ Application of funds (contd.)
– Current assets, loans and advances
(Bank and cash balance, fixed deposits,
debtors net of bad debts, inventories
raw material, work-in-progress, finished
goods, pre-paid expenses, advance to
employees, advance for service/goods
to be received, travel advances,)
– Miscellaneous expenses (preliminary
expenses, heavywww.biZkul.com
expenditure) 23
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FINANCIAL
ACCOUNTING: I

PROFIT AND LOSS


ACCOUNT
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PROFIT AND LOSS
ACCOUNT
¯ Income
– Sales (gross sales)
– Other income (interest, dividend,
rental income, miscellaneous sales)

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PROFIT AND LOSS
ACCOUNT
¯Expenditure
– Manufacturing (Raw material costs, direct
factory expenses)
– Sales and general administration (SG&A)
– Other miscellaneous
– Depreciation (non-cash expense, amortisation
of fixed asset cost over a period)
¯ Prior year adjustments, appropriation

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KEY EQUATIONS
¯ Shareholders Stake =
Assets – Liabilities
¯ Profit =
Sales – Costs

( Costs of material used =


Opening stock + purchases –
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QUESTION
¯ You are a finance professional in a company
¯ I am also a finance professional in the same
company
¯ We both independently prepare the financial
statements in our company
¯ Will you and I arrive at the same numbers in
terms of
– Sales?
– Profits?
Why? Why not?
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EXERCISE
¯ C & Co. purchases the following:
– LOT A: Jan 10th, 200 units at Re 1 each
– LOT B: Jan 15th, 100 units at Re 1.1 each
– LOT C: Jan 25th, 150 units at Re 1.2 each

¯ 400 units were consumed in January

What is the cost of the material


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EXERCISE
¯ Methods of calculating cost of material
consumed:
– LIFO: Last in first out
– FIFO: First in first out
– Weighted average

¯ These are accounting methods for


calculating costs

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EXERCISE
¯ C & Co. purchases the following:
– LOT A: Jan 10th, 200 units at Re 1 each
– LOT B: Jan 15th, 100 units at Re 1.1 each
– LOT C: Jan 25th, 150 units at Re 1.2 each
– LOT D: Feb 10th, 300 units at Re 1.2 each

¯ 400 units were consumed in January


¯ 200 units were consumed in February

What is the cost of the material


consumed in the months of Jan and Feb
under the FIFO and LIFO methods?
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ASSIGNMENT
¯ Jan sales – Rs. 1000
¯ Feb sales – Rs. 1000
¯ Other costs in Jan – Rs. 500
¯ Other costs in Feb – Rs. 500

For Jan and Feb, under the FIFO and LIFO


methods:
- What is profit
- What is the inventory balance,
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GAAP and
ACCOUNTING STANDARDS

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GAAP

Generally Accepted Accounting


Principles

¯ Refer to rules, conventions, principles,


procedures
¯ To be followed by enterprises in
preparation of financial statements
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ACCOUNTING
STANDARDS
¯Set of broad guidelines regarding
accounting policies adopted by
organisations in preparation of financial
statements
¯ Select set of accounting policies
¯ Confirm to applicable laws, custom,
business environment
(Refer www.icai.org - Web site of Institute of Chartered
Accountants of India for detailed Accounting Standards)

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Framework of
Accounting
Fundamental accounting assumptions

¯ Going concern
¯ Consistency
¯ Accrual

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Key Accounting
Concepts
¯Entity
¯ Money measurement
¯ Cost concept
¯ Realisation
¯ Periodicity
¯ Matching
¯ Dual aspect
¯ Conservatism
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CASELET
¯ Ramesh Vyas, the CFO of Case Co. Ltd
tells his finance manager, Prema John that
the profits this year have been unusually
bad and that the will pick up in the next
year. Previous years profits have been
reasonable. Ramesh wants to change the
accounting policy and show reduced profits
in this year (Big bath method).
¯ FIFO method for inventory valuation is
followed; prices of inventory have been
steadily increasing in the past few years.
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CASELET
¯ Prema is not comfortable with Ramesh’s
suggestion as she feels that this is
unethical and that this may backfire
¯ Profits under FIFO:
– in the past three years: 10, 13, 15
– Current year : 12
– Expected in next year : 16
What change in policy is Ramesh
suggesting? Do you agree with Prema or
not? Why or why not?
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ACCOUNTING
¯ Rules are not absolutely rigid and
provide some flexibility within a
framework, keeping in mind
– Economic position
– Social needs
– Regulatory frameworks
– Technical developments
¯ GAAP in India is influenced by ICAI,
SEBI, RBI, DCA etc.
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FORMS OF BUSINESS
ORGANISATIONS
¯ Sole Proprietorship
¯ Partnership
¯ Limited Co
– Private
– Public
¯ Statutory Bodies
¯ Mutual Funds
¯ Trusts
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ACCOUNTING BASICS
¯ Transaction occurs
– With funds in flow
– Without funds flow
¯ Transactions are recorded in accounts,
eg.
– Cash/bank
– Debtors
– Advance accounts
– Capital
– Accruals
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ACCOUNTING PROCESS
¯ Accounts periodically summarised
¯ Rectification entries may be passed
¯ Adjustment entries may be passed (eg
accruals, advances settled)
¯ Trial Balance is prepared
¯ Trial Balance has to tally
Concept of double entry book keeping
¯ Financial statements are prepared
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ACCOUNTING PROCESS

Entry
Data Passe Account
d

Final Trial Trial Rectification


Entry
Balance Balance Passed

Final Financial
Financial Statement
Statement s
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