Introduction to Financial

Accounting & Analysis

Dr.P..R.Ramakrishnan
Rajalakshmi School of Business
 Learning Objectives
Understanding the role of accounting in an
organization
Learn how accounting information is used by
different users
Learn the concepts and conventions followed in
preparing accounting statements
Learn Key Accounting Term
Learn mechanics of accounting and financial
statement preparation
 Financial Reports
Why should an organisation report its financial
transactions to the stakeholders?
Managers - need information for operating and
strategic decisions - detailed financial reporting
Investors and Creditors - need information on
financial performance and base their investment
and lending decisions
Govt. - needs information for computing tax
Regulations govern both accounting and financial
reporting
 Financial Accounting and Reporting

Accounting is internal activity that traces

monetary transactions of the organisation
Accounting system of an organisation is
fairly developed and in many cases
automated
Financial reports are summary of
accounting transactions
Information is summarised at different
levels depending on the users needs
 Accounting System
Accounting is the language of business.
It primarily involves in recording, measuring,
gathering and communicating historical business
data to others.
Steps in Accounting System
System Design
Book-keeping
Internal Auditing
External Auditing
Reporting
 Quiz # 1
Which is not an accounting statement?
A) Bank Passbook statement

B) Finance Budget statement of GOI

C) Credit card statement

D) Provident Fund Statement

 Accounting Process
Accounting system classifies the resources spent
into specific heads such as purchases, salary,
rent, travelling expenses, etc.
Normally, separate code numbers are assigned to
each of the items in a computerized system.
The purpose is whenever any amount is spent or
expended, they are recorded or charged to the
appropriate heads.
Recording is done based on double entry book-
keeping.
 Double Entry Book-keeping

Each monetary transaction affects the firm in two

ways
Ex: Borrowing funds from a bank
Cash balance increases
Liability of the firm also increases
Accountants records both the effect and hence it is
called double-entry book-keeping
Fundamental Accounting Equation

Assets = Shareholders Equity + Liabilities

 Internal Control System

Accounting records monetary transactions

Internal control systems are developed to make
sure that no money is paid or liability is accepted
without proper verification
Normally two or more persons involved in verifying
each accounting transactions before they are
allowed to be recorded in the books of accounts
Ex. Payment of Invoices requires verification of
purchase order, goods receipt and inspection note
and invoice
 Quiz # 2
Accounting records historic information for
the sake of users. Whereas, companies often
fudge accounts. Who is most benefited?

A) Equity Shareholders
B) Managers
C) Lenders
D) Mutual Funds
 Need for Regulatory Interference
Agency relationship between managers (or
promoters) and owners and other stakeholders
Scope for agents pursuing their personal interest
Managers are rewarded on the basis of financial
performance
Accounting information can be easily changed -
window dressing
Regulatory interference aims to ensure
adequate internal control systems
financial reports give a true and fair view
 Regulations on Financial Reporting
Companies Act, 1956
Section 209 to 223 (Books to be maintained)
Schedule VI (Financial Reports Format)
ICAI
Accounting Standards
Guidance Notes and Statements
Stock Exchanges and SEBI (mainly on
reporting)
Income Tax Act, 1961
Generally Accepted Accounting Principles
 Language Requires Grammar
Recall the statement that Accounting is the
language of business
When a huge set of financial transactions are
processed and communicated, firms need to
follow certain uniformity
To Achieve Consistency
To Achieve Good Communication
Accountants use certain concepts, conventions
and accounting standards in the preparation of
accounting statement.
 Accounting Concepts/Conventions
Entity concept
Going Concern concept
Money measurement concept
Historical Cost concept
Conservatism concept
Materiality concept
Matching concept
Accrual concept
Consistency concept
 Quiz # 6
On March 10, ABC Ltd. sold goods worth of Rs.
10 lakhs on a 6-month credit. The company
accountant showed the profit arising out of the
sales for the year ending March 31. Which one of
the following accounting concept/convention that
the accountant has applied?
1) Conservatism
2) Materiality
3) Accrual
4) Consistency
 Accounting Standards

Accounting standards require the accountants to

treat certain major items in a specific manner in
the preparation of financial reports.
Accounting standards include -
(a) Measurement standards
(b) Reporting or disclosure standards
Accounting Standard Board of ICAI prepares
Accounting Standards in India
ASB has prepared 28 Accounting Standards so far
 Fundamental Accounting terms

Assets
Liabilities
Equity or Shareholders Equity or Fund
Revenue
Expense
Profit or Loss
 Fundamental Accounting terms

Assets are economic resources that are

expected to generate future revenues

Liabilities are the entitys economic obligations

to outsiders (non-owners)

Equities are the owners claims against, or

interests in, the assets of the organization

Assets = Liabilities + Equities

 Fundamental Accounting terms

Owners equity or simply Equity is the

excess of the assets over the liabilities .

The owners equity of a corporation

is called stockholders equity or Net Worth

Assets - Liabilities = Equities

 Fundamental Accounting terms

Revenues are increases in ownership claims

arising from the delivery of goods or services.

Expenses are decreases in ownership claims

arising from delivering goods or services or
using up assets.

Profits (or earnings or income) are

the excess of revenues over expenses.
 Quiz # 3
Which one of the following is not an
asset
1) Bank Balance
2) Dues from Customers
3) A letter received from patent office
recognizing Patent
4) Deposit with Sales Tax Department
 Quiz # 4
The postman delivered the following covers
today. Which one of the following is not a
liability?
1) Tax Deducted at Source Certificate from your
bank
2) Telephone Bill
3) Credit Card Statement
4) Electricity Bill
 Balance Sheet

The balance sheet (also called statement

of financial position or statement of
financial condition or statement of wealth)
is a snapshot of the financial status of an
organization at a point in time.
 Income Statement

The income statement measures the

performance of an organization by
matching its revenue (which is usually
called sales) and its cost
 Income Statement

Balance
Balance Sheet
Sheet Balance
Balance Sheet
Sheet Balance
Balance Sheet
Sheet
February
February 28
28 March
March 31
31 April
April 30
30
207
207 207
207 208
208

Income Income
Statement Statement
Time for March for April Time
 Cash Flow Statement

Cash flow statement shows how much

cash has moved during the period and
in what form the cash has moved
Cash flow from operations, investing
and financing activities are reported
 Preparing Financial Statements
Suppose we start a trading company by investing
Rs. 10 lakhs and purchased goods worth of Rs. 15
lakhs (10 lakhs by paying cash and 5 lakhs on
credit) and sold them for Rs. 18 lakhs for cash.
What is the profit we will make in the business.

Profit - 3 Lakhs, Cash - 18 Lakhs, Liability - 5

Lakhs, Equity - 10 Lakhs)
 Profit and Loss Account

P&L Account of X co. for the year ended...(Rs. Lakhs)

Purchases 15 Sales 18

Profit 3

18 18
 Balance sheet

Balance sheet of X Co. Ltd. for the year ended

(Rs. Lakhs
Equity & Liabilities Assets
Equity 10 Cash 18
Profit 3
Liability 5

18 18
 Quiz # 5
Which of the following statements is
incorrect?
A) Assets - Equity = Liabilities
B) Liabilities + Assets = Capital
C) Liabilities + Equity = Assets
D) Assets - Liabilities = Capital
 Business Transactions

A transaction is any event that affects

the financial position of an
organization and requires recording.
 Quiz # 7
Which one of the following events /
transactions is recorded in the accounting
statement?
1) You purchased an asset last year and its current value
is 70% of the purchase price due to usage of the asset.
2) You have made a claim for insurance for the lost
vehicle, which you purchased at Rs. 6 lakhs last month.
3) One of your workers, who used to produce 100 units
per hour is now producing 70 units per hour.
4) You bid for a 5-year supply contract with a
government hospital and the same has been accepted.
 Accounting Equation
Assets = Liabilities + Stockholders Equity
Liabilities and stockholders equity
represent source of funds
Assets represent uses of funds
The above equation also represents the
Balance Sheet - a principal financial
statement
 Quiz #8
Every accounting transaction is recorded into two
accounts under double-entry book-keeping. ABC
Ltd. purchased raw materials worth of Rs. 5 lakhs
from XYZ Ltd. on credit basis. Which of the
following pairs of accounts in which the above
transaction is recorded.
A) Raw Material Purchase & Cash
B) Raw Material Purchase & XYZ Ltd.
C) Raw Material Purchase & ABC Ltd.
D) XYZ Ltd. & ABC Ltd
 Example

Suppose you start a company with Rs 10,000

invested in the business, then the accounting
equation will be as follows

Cash (10,000) = Shareholders Equity (10,000)

Cash is an Asset
 Example contd.

Assume now you borrow another 5000 from SBI,

your accounting equation now will be as follows

Cash (15000) = Equity (10000) + Loan (5000)

 Example contd.

Assume now you buy a machine worth of Rs. 8000.

Accounting equation will be now as follows

Machine (8000) + Cash (7000) = Equity (10000) + Loan (5000)

 Example contd.
You are now buying material worth of Rs. 2000 for cash
and spent another Rs. 1000 for labour and Rs. 500 for
electricity. You have produced 1 unit of a product and sold
for Rs. 5000 and collected the cash.
How much profit have you earned?

Cash (?) + Machine (8000) =

Equity (10000)+ Profit (?) + Loan (5000)

Cash = 8500 Profit = 1500

 Expanded Accounting Equation
The accounting equation can be expanded
further
Cash + Accounts Receivable (Debtors) +
Inventory+. = Paid up capital +Profit
(Retained Income) + Accounts Payable
(Creditors)+
Accounts receivable are the amounts due from
customers for sales on open accounts.

Accounts payable are the amounts owed to

vendors for purchases on open accounts.
 Basic Accounting Exercise

Three R&D Executives of top pharmaceutical

company along with five other friends have started
a pharma company Pharmasia Ltd. by contributing
Rs. 10 lakhs each as share capital.
Pharmaventure Ltd. - a venture capital fund has
contributed Rs. 200 lakhs towards equity capital
See the rest of the transactions in the Excel File
Complete the Accounting Equation given in Sheet 2
and prepare P&L Account and Balance Sheet
 Quiz # 9
Which one of the following statements is
incorrect? Effect upon
Asset Liabilities

A) Paid our supplier by cheque -Bank - Supplier

B) Customer paid his due by cheque +Bank - Customer

C) HDFC bank lends us Rs. 20 Cr. +Bank - Loan

D) Purchased goods on credit +Goods +Customer

 Quiz # 10
Given the following, what is the amount of
equity? Premises Rs. 20; Plant Rs. 80; Cash
Rs. 20; Loan Rs. 40; Dues to Suppliers Rs. 40
A) Rs. 20
B) Rs. 40
C) Rs. 60
D) Rs. 80
 Quiz # 11
Which one of the following is correct?

A) Profit does not alter Equity

B) Profit reduces Equity

C) Capital can come only from profit

D) Profit increases Equity

 Annual Report

Details on Board of Directors, Banker, Auditors, ..

Chairmans and Directors Report
Management Discussion and Analysis
Corporate Governance Report
Shareholders Information
Auditors Report
BS, P&L A/C and Cash Flow Statement
Schedules and Notes (including segment reporting)
Consolidated Financial Statements
 Financial Statements and Information Gap

Information is an asset and time value

Management is reluctant to share information on
time (reason: losing competitive advantage)
Shareholders and others need timely information
Regulations need to be balanced in resolving the
conflict both on content and time
Existence of information gap leads to imperfection
in valuation and several other ill-effects like insider
trading
 Summary
Book keeping is done based on double entry basis
Impact of business transaction could be explained
easily by the Accounting equation -
Assets = Liabilities + Equity
Balance sheet and Profit and loss account or
income statement are two principal financial
statements
Understanding financial statements is critical for
managerial function than preparation of financial
statements.