Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

Double-Entry Bookkeeping


Father of modern accounting – Luco Pacioli
...




Debit & Credit aspects

Accounting-Meaning


Systematically writes economic history in quantitative terms
...




Shows financial position of business on a particular date
...




AMERICAN ACCOUNTING ASSOCIATION (AAA):
Accounting as “the process of identifying, measuring and communicating economic
information to permit informed judgment and decision by users of the information”
...


To find out the net profit or net loss or surplus or deficit
...


To find out the positions of assets and liabilities on a particular date
...


To check the frauds and misappropriations of money
...


To confirm about the arithmetical accuracy of the books of accounts
...


To help the management formulate policies for controlling cost, preparation of quotation
...


To furnish information regarding Purchases and Sales, both Cash and Credit
...


Nature of Accounting
i
...


ii
...


iii
...


iv
...


v
...


vi
...
Recording
...
Classifying
...
Summarizing
...
Analysis and Interprets
...
Reporting/Communicate
...


Financial Accounting

ii
...


Management Accounting

iv
...


Tax Accounting

vi
...

Financial Accounting: concerned with the summary, analysis and reporting of financial
transactions pertaining to a business
...


Management Accounting: managers use the provisions of accounting information in order to
better inform themselves before they decide matters within their organizations
...

It is process of reporting on responsible business performance to stakeholders
...


Forensic Accounting: form of investigative accounting which examines financial records in order
to find evidence for a lawsuit or criminal prosecution
...


Focuses on future for
decision making purposes
...


Entire as wells segment wise
reporting
...
Proprietors, Partners, and Shareholders
2
...
Banks
4
...
General Public
6
...
Tax-authorities
8
...
People’s Representatives
10
...


Cash system: entries made only when cash is paid or received
...


Accrual or mercantile system: entries made on basis of amounts due for payment or
receipt
...


Mixed system: incomes based on cash & expenses on accrual basis
...


Records only Financial Transactions

ii
...


Historical in nature

iv
...


v
...


vi
...

 Accounting: “Language of business“
...

 Account: A record which is used to collect and store similar information
...


UIM Alappuzha(B)

 Accountant: a person concerned with the maintenance of books of accounts
...

 Business Transaction: any event that affects the financial position of an organization
and requires recording
...

Examples:
 Land& buildings
 Equipment
 cash in bank
 Cash in hand
 Investments and accounts receivable
...
Any type of borrowing from
persons or banks
...

It varies between businesses and countries
...

O In India 1st April ends 31st March
O In USA 1st Oct ends 30th Sept
O In UAE 1st Jan ends 31st Dec
O In Pak 1st July ends 30th June
 Revenue: or Turnover is income that a company receives from its normal business
activities
...

 Profit : is realized when the amount of revenue gained from a business activity exceeds
the expenses, costs and taxes needed to sustain the activity
...


UIM Alappuzha(B)

 Financial Statements: or financial report is a formal record of the financial activities
and position of a business, person, or other entity
...


Income statement : Profit and Loss report
...


ii
...


iii
...


iv
...


LEDGER
 It may be defined as “ A summary statement of all the transactions relating to a
person, asset, expense or income which have taken place during a given period of
time and shows their net effect”
...

 Net result of all transactions in respect of a particular account on a given date can
be ascertained only from ledger
...

 It can be done :
A
...

B
...

C
...

Its advisable to follow the last method
...

 Balancing:
The process of finding the difference between the totals of Debit & Credit side of an
account
...

It can be done :
i
...


Ascertain the difference btwn totals

iii
...
Debit side-To Balance C/d
& Credit side- By balance c/d
...


For the next period the balance is brought forward
...


If ‘By balance c/d’ then it is forward on debit side as ‘To balance B/d’
...

O The primary purpose of a trial balance is to prove debits = credits after ledger
posting
...

The rules to prepare the Trial Balance
Total Debit Entries = Total Credit Entries

UIM Alappuzha(B)

Debit

Assets account’s balance
Expenses account balance
Loss account ‘s balance
Investment account balance
Drawing account’s balance
Purchase account
Sale return Account

Credit

Liabilities account’s balance
Incomes account‘s balance
Provision account’s balance
Capital account’s balance
Reserve and surplus account’s balance
Sale account
Purchase return account

Steps to preparing the Trial Balance:
1) Balance/cast ALL the ledger accounts in the books
...

3) List all the Credit balances on the credit side and add them up
...
All other items whose account is not made in proper ledger
will not shown in trial balance
...

O Trial balance is not an account
...

O Trading, profit and loss account and the balance sheet are prepared with the help of trial
balance only
...
For example sold
goods to Mr
...
We neither entered this transaction in sales account nor have we
entered in Mr
...

 Error of commission
Kind of error where we have entered the correct amounts but in wrong person’s account
...
A were entered in Mr
...

 Error of principle
This type of error takes place when an item is entered in wrong head or class of accounts
...

 Error of compensation
Errors that cancel the effects of each other
...
20 as well
...
20 to both debit and credit sides of trial balance, the agreement of trial balance is still intact
...

For example sales amount to Rs
...
321
...
72 was entered as Rs
...

 Errors Of Duplication
The errors of duplication are also not revealed by the trial balance
...
500 paid for the
month of June 2010 was recorded twice in cash book
...

O Provides the opportunity for the business to monitor its own activities
O Provides transparency to enable the firm to attract investment
O Reduces the chance for fraud – not 100% successful!!
O Every business man interested in knowing 2facts:
O Whether he earned Profit or suffered Loss during the period
...

Trading and Profit & Loss Account- Income statement
Balance sheet- Position statement

1
...

O It is the final summary, which discloses the profit or loss of the business
...

O It has 2parts :
A
...
Profit & Loss Account
Trading Account
O Prepared to know the trading results or gross margin
...

O Gross profit : If Sales is higher than Cost of goods sold
...


UIM Alappuzha(B)

Closing Entries for Trading Account
O Closing entries are passed in journal proper
...

O Mainly Incomes, Expenses, Gains and Losses for items in Trading and Profit & loss
account
...

O For transfer of opening stock, net purchases and direct expenses :
Trading A/c

Dr

To Opening stock A/c
To Purchases A/c
To Direct Expenses A/c
O For transfer of Net sales & closing stock:
Sales A/c

Dr

Closing Stock A/c

Dr

To Trading A/c
O For The transfer of Profit or Loss
 Gross Profit : Trading A/c

Dr

To Profit &Loss A/c


Gross Loss: Profit & loss A/c

Dr

To Trading A/c

Financial Terminology –Trading Account
Items appearing in Debit side of Trading Account
...
It is available form
Trial balance
...

O Purchases : Include both cash & credit
...

 Purchase returns & any discounts
 Withdrawal by Proprietors
...

 Freight Inwards, Carriage In
 Royalty: Amount paid to the owner for using his rights
...

Items appearing in Credit side of Trading Account

 Sales : include cash & credit
...

Goods sent on Hire purchase or consignment separately shown
...

 Closing stock :Amount of goods at the end of period
...

It also includes: Raw materials
Work in progress
Finished goods

UIM Alappuzha(B)

Profit & Loss Account
O Prepared to calculate the Net profit of the business
...

O Indirect expenses : concerning the whole business and relating to activities done to make
goods available to the consumers
...

Features of P&L A/c


Second stage in preparation of Final Accounts
...




Accrual basis of accounting is followed
...




Balance of account is either Net profit or Net loss
...




Comparison with the previous year’s profit
...


Financial Terminology – Profit & Loss Account
Items appearing in Debit side
Selling & Distribution expenses :These are incurred for promotion of sales and distribution
of goods
...

 Insurance of goods(RM,WIP & FG)
...

 Establishment expenses
 Office salaries
 Office rent and rates
 Lighting
 Printing and stationery
 Postage and telephone charges
 Legal expenses
 Audit fees
 Trade expenses
...

 Interest on loan
 Interest on capital
 Discounts
Abnormal losses: these are losses occurred due to theft, fire, accidents etc
...

 Loss by fire not covered by insurance
...

Other Incomes: during the course of business, other than income from sale of goods
...

 Interest from bank
 Income from Investments
 interest on debentures
 Dividend received
Abnormal Gains : these may be capital gains arising during the course of the year
...


Expenses Not to be shown in Profit & Loss Account
 Domestic and household expenses
 Income tax
 Life Insurance premium

Closing Entries for Profit & Loss Account
O For the items in debit side :
Profit & Loss Account Dr
To Expenses/ loss Account
O For Gross profit :

UIM Alappuzha(B)

Trading Account Dr
To Profit & loss account
O For items in Credit side :
Incomes/abnormal gains Dr
To Profit & loss account
O For Gross loss:
Profit & Loss Account Dr
TO Trading account

 "Customs duty comes in two types: Import Duty & Export Duty
...





Duty paid on goods imported from Abroad is known as Import Duty and is
debited to the Trading A/c
...
“

Debited to Trading A/c

 Octroi : when goods purchased within the municipality limits, it has to be paid
...

 Clearing charges

Balance sheet
O The American Institute of Certified Public Accountants defines balance sheet as “a
tabular statement of summary of balances (debits and credits) carried forward after an
actual and constructive closing of books of account and kept according to the principles
of accounting
...

Need for preparing a Balance sheet is as follows:

UIM Alappuzha(B)



To know the nature and value of assets of the business



To ascertain the total liabilities of the business
...


GROUPING & MARSHALLING


All information appeared in balance sheet need to be informed and presented to the users
...




Arrangement of Assets and Liabilities in a particular order is called Marshaling
...
In order of Liquidity
2
...

In order of Permanence: Fixed assets and Long term liabilities are shown first
...
These assets will be sold or such long term liability will be paid
only in the time of insolvency
...




Current Asset



Fixed asset



Current Liabilities



Fixed Liabilities

Balance sheet gives following Advantages (Uses)


It is helpful in ascertaining the financial position of the business by showing assets and
liabilities of the concern on a specific date
...


UIM Alappuzha(B)



It also disclose the proprietary interest of owner
...




It helps in comparison of assets and liabilities of business on two dates to ascertain the
progress being made by business
...


Types of Balance sheet
 Horizontal Balance sheet : A horizontal balance sheet presents assets on one side and
liabilities and owners equity on the another side of the page
...


ADJUSTMENTS FINAL ACCOUNTS
 An accounting adjustment is a business transaction that has not yet been included in the
accounting records of a business as of a specific date
...

 An adjusting journal entry is typically made just prior to issuing a company's financial
statements
...


UIM Alappuzha(B)

 a company may have paid for six-months of insurance coverage, but the accounting
period is only one month
...
)
1
...
Outstanding expenses
3
...
Outstanding income
5
...
Depreciation
7
...
Reserve for doubtful debts
9
...
Interest on Drawings
11
...
Reserve for discount on debtors
13
...
Goods lost by fire
15
...
Closing stock
 Unsold goods lying in stock at the end of the accounting period are called Closing stock
...

2fold-effect if its in adjustment:
1
...

2
...

Adjustment entry:

UIM Alappuzha(B)

Closing stock A/c Dr
To Trading A/c
If its only in Trial balance:
 It will be shown only on the Asset side of balance sheet
...
Outstanding expenses(Pending)
 It refers to those expenses which have become due during the accounting period for
which Final accounts prepared, but not yet been paid
...
Outstanding expense will be shown in debit side of Trading or P&L A/c by way of
addition to the expense
...
The same amount will be shown in the Liability side of Balance sheet
...

3
...

 The benefit will be available in future
...
It will be shown in Debit side of P&L A/c, deduct from the concerned expense
...
The same deducted amount will be shown in Asset side of balance sheet
...


4
...


 2fold-effect if its in adjustment:
1
...

2
...

Adjustment entry:
Accrued Income A/c Dr
To Income A/c
If its in Trial balance only: Taken in Asset side
...
Income received in Advance(Unearned)


Income received but not yet earned during the accounting year
...


 2fold-effect if its in adjustment:
1
...

2
...

Adjustment entry:
Income A/c Dr
To income received in advance
If its in trial balance only: its shown in Liability side
...
Depreciation
 Indian Accounting Standard (AS 6) states that “Depreciation is allocated so as to
charge a fair proportion of the depreciable amount in each accounting period during the
expected useful life of the asset
...

 Depreciation means the reduction in value of assets which has to be considered for
determining revenue
...
Furniture, Motor Vehicles etc
...

 (ii) Depletion (or exhaustion) : The utility or resources of wasting assets (like mines etc
...

External or Economic causes
 A
...

 B
...

 C
...
copy-rights etc
...
The word
“amortization” is a better term to speak for the gradual fall in their values
...
Abnormal occurrences : An Accident, fire or natural calamity can damage the
service potential of an asset partly or fully
...


2fold-effect if its in adjustment:
1
...
It is shown on the Asset side by way of deduction from the concerned value of asset
...

To Fixed Asset(concerned asset)
 If it is given in Trial balance only: debited in P&L A/c

7
...
If any interest payable on
such claims is Interest on capital
...

 2fold-effect if its in adjustment:
1
...

2
...

Adjustment entry:
Interest on capital A/c Dr
To Capital A/c
If its in Trial balance only : Debited to Profit & Loss A/c

8
...

 Withdrawals from the business are considered as Drawings
...

 So business charges interest on such drawings: It is a gain to the business
...
It appears on the Credit side of the Profit and Loss Account
...
It is deducted from the Capital Account in the Balance Sheet
...
Bad debts
 Due to the financial difficulty, death or insolvency or dishonesty of a Debtor, full or part
amount due from them may not be recovered
...

 The process of cancellations of balance in the account of a debtor is called ‘writing off’
bad debts
...

 2fold-effect if its in adjustment:
1
...
It will shown on Asset side of balance sheet by way of deduction from total debtors
...
Provision for doubtful debts
 It is provision created to meet any loss
...

 It is generally made on some percentage based on past experiences
...
It will be shown in debit side of P&L A/c by way addition to Bad debts(old provision in
Trial balance will deducted)
2
...

UIM Alappuzha(B)

 To Bad debts (old)
Add :Bad Debts (further)
Add :Provision for Bad Debts (New)
(Less) Provision for Bad Debts (Old)
 Sundry debtors
(Less) Bad debts(further)
(less) Provision for Bad Debts (New)

11
...

 Since discount is a loss for the business, we can keep a provision for the same discount
...

 It is created only for those Good debtors
...
It will be shown in debit side of P & L A/c
2
...

Note : Provision for discount should made after deducting bad debts & provision for
doubtful debts
...

To Provision for discount on debtors

UIM Alappuzha(B)

12
...

 Provision is made on discount which is expected to be received in the next year from
creditors
...
It will be shown in Credit side of P&L A/c, since it is a gain
...
It will appear on the Liabilities side of balance sheet by way of deduction from Sundry
Creditors
...
Goods used by proprietor for personal use
 2fold-effect if its in adjustment:
1
...

2
...

 some goods are produced & distributed as free samples
...
It is deducted from the Purchases
2
...

Adjustment entry:
Advertisement A/c

Dr

To Purchases A/c

UIM Alappuzha(B)

14
...

 Position of business may be :
a)

All stock is fully insured

b)

Stock is partly insured

c)

Stock is not at all insured

A
...
It will be shown on the credit side of Trading account
...
Shown as asset side of balance sheet
...
Stock is partly insured:
Dual effect :
1
...
And shown
on the debit side of P&L A/c for that part is not insured
...
Loss of stock by Fire on the Asset side of Balance sheet with the amount which is
to be realized from the Insurance Company
...
Stock is not at all insured: Whole amount will become loss for the company
...
It is shown on the credit side of Trading account
...
It is shown on the debit side of P&L A/c
...
Manager’s commission
 Sometimes the manager is entitled to a commission on profits
...

(b) Fixed percentage on net profits- after charging such commission
...
Commission will be shown on Debit side of P&L A/c
2
...

 Changes in assets, liabilities and equity items are recorded chronologically in accounts
...

T-Account Format
 T-Account is the most common type of accounts
...
It has three parts:
1
...
The Debit: on the left side
3
...

Types of Accounts

UIM Alappuzha(B)

1
...
It include the following:
i
...
Example: Mohan’s A/C,
Shyam’s A/c etc
...


Artificial persons: Accounts which relate to a group of persons or firms or
institutions
...


iii
...
For example,
outstanding salary account, prepaid
insurance account etc
...
Impersonal Accounts: All those accounts which are not personal accounts
...
, Real and Nominal accounts
...
Real Accounts: Accounts relating to properties and assets which are owned by the business
concern
...

Examples : Tangible : Cash, Land, Building, Furniture etc
...

B
...
They do not have any
existence, form or shape, exist only in name
...

i
...


ii
...


UIM Alappuzha(B)

Examples

NOMINAL ACCOUNTS

PERSONAL ACCOUNTS

RENT A/C

PREPAID RENT A/C,OUTSTANDING RENT A/C

INTEREST A/C

INTEREST RECVD IN ADVANCE A/C, O/S
INTEREST A/C

SALARY A/C

O/S SALARIES A/C

INSURANCE A/C

PREPAID INSURANCE A/C , O/S

COMMISSION A/C

PREPAID COMMISSION A/C, O/S

Debits and Credits
 Most familiar accounting terms are “debits and credits
...

 Debit (from the Latin word debere) assumes as "Left
...
”
Credit (from the Latin word credere) assumes as “Right
...
”

UIM Alappuzha(B)

GOLDEN RULES FOR DEBIT AND CREDIT(ACCOUNTING)
 1
...
Real Accounts -

a) Debit what comes in
b) Credit what goes out

 3
...

Normal balances — assets & liabilities
Assets
Increase (NORMAL BALANCE)
Debit

Decrease
Credit

Liabilities
Decrease
Debit

Increase (NORMAL BALANCE)
Credit

Summarizing Rules of Debits and Credits
Normal
Increase

Decrease

Balance

Assets

DR

CR

DR

Expenses

DR

CR

DR

Liabilities

CR

DR

CR

Owners’ equity

CR

DR

CR

Revenues

CR

DR

CR

UIM Alappuzha(B)

THE JOURNAL
Transactions are initially recorded (journalized) in chronological order before they are
transferred to the ledger accounts
...


credit amounts for each entry can be

Many types of journals and the following are the important ones:
1
...

2
...

3
...

4
...

5
...

6
...

7
...

8
...


TECHNIQUE OF JOURNALIZING
The date of the transaction is entered into the date column
...
The credit account title is indented on the next line
...
The year is written and in the
next line, month and date of the first entry are written
...

 Ledger Folio: column is meant to record the reference of the main book, i
...
, ledger and
is not filled in when the transactions are recorded in the journal
...


Examples
1
...
Rasheed started business with Rs
...

Jan2
...
8,000
...
Goods sold costing Rs
...

Jan10
...
10,000
...
Paid salary Rs
...

Jan31
...
800
...


CREDIT Rs
...
Ram Kumar commenced business Rs
...
in June 1st,2010
...
5,000
June 6 sold goods to Hari Rs
...
3,600
June 10 received cash from Hari Rs
...
3,000

June 18 paid for office rent Rs
...
1,700
June28 cash paid to Rajan Rs
...
250
...


CREDIT Rs
...


June 18

Rent A/c
To Cash A/c

June 24

Purchase A/c

500
Dr

1,700

Dr

700

1,700

To Rajan A/c
June 28

Rajan A/c

700

To Cash A/c
June 30

Cash A/c

Dr

250

250

To commission A/c

3
...

 Jan
...
3 Amount deposited in S
...
I 5,000
 Jan
...
10 Furniture purchased from Chinmoy 5,000
 Jan
...
13 Goods sold to Ashim Das 2,000
 Jan
...
31 Salaries paid 800

UIM Alappuzha(B)

4
...
Anoop :
2014 Jan 1
...
50,000
...
Bought Goods for cash Rs
...
Sold Goods for cash Rs
...
Deposited in Dena Bank Rs
...
Bought goods from Janaki Rs
...
Purchased Furniture for cash Rs
...
Sold goods to Mr
...
20,000
9
...
Shejeek Rs
...
Returned goods by Kumar worth Rs
...
Paid advertisement charges Rs
...
Returned goods to Janaki Rs
...
Withdrawn cash from bank Rs
...
bought a motor car for office use Rs
...
Received commission Rs
...
Withdrawals for personal use Rs
...
Electricity paid Rs
...
1500
25
...
189
31
...
4000

UIM Alappuzha(B)

Returns
Return outward is purchase return
...

Example : Purchased Goods from Mr
...
25,000
...
5000
...
X’s A/c
Mr
...
return A/c

5,000

Return inwards is sales return, which means that a person who bought goods from your
business is does not want them or they do not meet his/her standards he can return the good to
you
...
1,00,000 on credit
...


Initial Sales :XYZ A/c

Dr

1,00,00

To sales A/c
Sales Return’s A/c
To XYZ A/C

1,00,000
Dr

1,00,000
1,00,000

Compound Entry
 A compound journal entry is an accounting entry which effects more than two account
heads
...

 Writing a compound/combined entry in place of two or more simple entries reduces the
task involved in recording the transactions
...
Following are types of
discounts :
1
...

An allowance given to Customers is known as Discount Allowed and
An allowance made by creditors off the amount owing is called Discount Received
...
Trade Discount :
Deduction allowed by the manufacturer to wholesaler on the list of price of goods
...

The discount/allowance given is meant for higher/bulk purchase of goods and services
...

 A wholesaler, on the other hand, might order 1,000 t-shirts at a time and could receive a
12%discount
...
Purchased goods worth Rs
...
Received cash from Annie Rs
...
150
...


Paid cash Rs
...
1,000
...

 In which he shows all the opening balance of assets and all the liabilities include capital
...

Benefits:
 To activate next session of accounting
...

 Assets Account (opening balance) Dr
...

To Capital account Cr
...

 Liabilities are more than the value of all assets, then this excess will be Goodwill and it
will be debited
...


UIM Alappuzha(B)

Example

 On 31st March 2013, books of Nancy showed the following balances :
 Cash in Hand – 600
 Cash at bank – 2800
 Sundry debtors- 3000(Bindhu-1500, Sindhu-500 & Indu- 1000)
 Sundry creditors – 1500(Mini-800 & Cini- 700)
 Stock – 2000
 Furniture- 1500
Give journal entry to record the above transactions on 1st April 2013

Entries
 Cash A/c

Dr

600

 Bank A/c

Dr

2800

 Bindhu A/c

Dr

1500

 Sindhu A/c

Dr

500

 Indu A/c

Dr

1000

 Stock A/c

Dr

2000

 Furniture A/c Dr

1500

To Mini A/c 800
To Cini A/c

700

To Capital

8400(balancing figure)

UIM Alappuzha(B)

Trial balance
 The trial balance is a list of accounts and their balances at a given time
...

 If debits and credits do not agree, the trial balance can be used to uncover errors in
journalizing and posting
...
”
Accounting Principles
 Rules of action or guidelines which adopted by accountants universally
...

 Changes from time to time
...

 GAAP : accounting principles that are generally recognised by the accountants and
represent accepted accounting practices at a particular time
...

 ACCOUNTING CONVENTIONS- reporting standards customs or traditions for
the preparation of accounting statements
...
Separate
entity concept
2
...
Going
Concern
4
...
Dual Aspect
concept

1
...
Accounting
period concept

2
...
Realisation
Concept

3
...
Matching
Concept

4
...
Separate entity concept
 It implies that ownership and business unit is separate and distinct
...

 For sole proprietor or partnership only for accounting purpose consider separate
entity
...
Money measurement concept
 Only monetary transactions, not qualitative aspects
...

Example :
A business unit has following assets as on 31st March:
Cash in hand

Rs
...
50,000

Motor cars

5

Stock

5,000 tons

Furniture

100chairs & 20 tables

 Different units of measurement cannot be added together
...
25,000

Debtors

Rs
...
1,15000

Stock

Rs
...
15,000

TOTAL

Rs
...


UIM Alappuzha(B)

3
...

 Neither intention nor necessity to wind up
...

 Depreciation- appropriation is done in the future period
...
Cost concept
 Basis of this concept:
i
...


ii
...


iii
...
Purchased a Land/Plot costing Rs
...
8lakhs(MP)
2
...
25,000 : 15,000

5
...

 Accounting equation is based on this concept:
Assets = Equities( Owner’s equity + Liabilities)
 Effect of transaction are entered into at least two items or accounts, this system is called
‘Double Entry system of accounting’

UIM Alappuzha(B)

6
...

 Usually over 1year
 Helps to take any corrective actions, pay income-tax
...

 Few companies chose Calendar year also
...
Realisation Concept
 Deals with the determination of Point of time when the Revenue is recognized
...

 Example:
1
...
Firm produces and
delivers the Goods to him on 1st Feb on a 1month credit
...

2
...
5,000 in Jan for supplying Goods in April
...
Revenue is realized neither on Jan Nor March, its on Feb when firm actually delivers the
Goods to the customer
...
Rs
...


8
...

 All cost incurred during a period is not taken, but only cost related to the accounting
period is taken with the revenue realised
...

UIM Alappuzha(B)

Examples
 Commission
...
The commission of $5,000 is paid in February
...

 If a company purchases an elaborate office system for Rs
...
3,000 of expense each month to its monthly
income statement
...
Full Disclosure
 Financial statement must provide complete & fair disclosure of relevant information
...

 No detailed disclosure of items may exaggerate the Profit
...


2
...

 ‘Risk- proof jacket’ or ‘Playing safe’ by accountants
...

 Mitigate the errors or omissions-reject correct data or accept wrong
...

 R&D expenses charged to period in which it incurred
...

 Criticism :


Violation of full disclosure: Secret reserves, Huge provision for bad debts
...


3
...

 External consistency : Financial statement of 1firm should compare with another firm
...

 Auditors are concerned that their clients follow the consistency principle, so that the
results reported from period to period are comparable
...
Materiality
 Materiality depends on the amount involved in the transaction
...

 Only round figures(to nearest rupee)
 For taxation its rounded to nearest ten rupee
...

 It is treated as Expense only
...
100 of rent on a post office box that covers the next six
months
...


UIM Alappuzha(B)

 However, the amount of the expense is so small that no reader of the financial statements
will be misled if you charge the entire Rs
...


Accounting Equation
 An Accounting Equation is a mathematical expression which shows that the assets and
liabilities of a firm are equal
...
e
...

 It holds that for every debit there is a credit of equal amount and vice versa
...
e
...

The claims, also known as equities
...
Owner's equity or capital, and
2
...

We can express Accounting Equation as follows:
a) Assets = Liabilities + Capital
b) Liabilities = Assets – Capital or
c) Capital = Assets – Liabilities

UIM Alappuzha(B)

 Assets may include land and buildings, machinery, motor vehicles, fixtures, cash on
hand and money in the bank, as well as debts owed by customers
...

 Capital is the amount of resources supplied by the owner
...


Transactions from the Accounting Equation viewpoint, can be divided into two, i
...
,
I
...

B
...


Transactions affecting opposite sides
...


I
...
Transactions affecting opposite sides
i
...
Similarly, loans from bank increase
asset (cash) and also increase liability (loan)
...


Decrease in Liability, Decrease in Asset: Transaction of payment to a creditor
decreases liability (creditor) and also reduces asset (cash or bank)
...


Increase in Asset, Increase in Owner's Equity: Introduction of capital by the proprietor
increases asset (cash or bank) and also liability (capital)
...


Decrease in Owner's Capital, Decrease in Asset: Drawings by the proprietor decreases
liability (capital) and also asset (cash or bank)
...
(b)Transactions affecting same side but in opposite direction
i
...


ii
...

UIM Alappuzha(B)

EXAMPLES
Mohan commenced business with cash Rs
...
30,000
(B) Mohan gives this cash in the form of capital = Owner's equity will be Rs
...
Mohan Purchased furniture for cash Rs
...
10000
...

(B) Our furniture asset will increase in business, so we add Rs
...
There will no effect on liability side of accounting equation
...
Mohan Purchased Goods from Sham on credit of Rs
...
No effect on cash but asset will increase
...
So,
we will show more Rs
...

We have to pay to sham Rs
...
This will increase our liability
...
Give Accounting Equation for the following transaction of ABS Ltd,2010
...
Started business with capital Rs
...
Purchased furniture Rs
...
Purchased Goods for cash Rs
...
Bought Goods from Ram on credit Rs
...
Sold Goods for cash Rs
...
Sold Goods for Shyam on credit Rs
...
Paid cash to Ram Rs
...
Received cash from Shyam Rs
...
Paid cash into bank Rs
...
Withdrawn from bank Rs
...


UIM Alappuzha(B)

a
...
Cash:75,000 + Furniture :25,000

Capital : 1,00,000

c
...
Cash:55,000 + Furniture :25,000 +
Goods:25,000

Capital : 1,00,000+ Ram:5,000

e
...
Cash :70,000 + furniture:25,000 +
Goods:2,000+ Shyam :8,000

Capital : 1,00,000+ Ram:5,000

g
...
Cash :71,000 + furniture:25,000 +
Goods:2,000+ Shyam :3,000

Capital : 1,00,000+ Ram:1,000

i
...
Cash :56,000 + furniture:25,000 +
Goods:2,000+ Shyam :3,000 + Bank :15,000

Capital : 1,00,000+ Ram:1,000

UIM Alappuzha(B)

Total Assets

=

Total Liabilities + Capital

Cash

56,000

Capital

Bank

15,000

Ram

Furniture

25,000

Goods

2,000

Shyam

3,000
Rs
...
1,01,000

UIM Alappuzha(B)

Ratio Analysis
Analysis of financial statements
 It is the process of systematic and careful examination of accounting information given in
the financial statements with specific purposes
...
Myer “ Financial statement analysis is largely a study of
relationships among the various financial factors in a business, as disclosed by a single
set of statements and study of the trend of these factors as shown in a series of
statements”
...

 2nd step involved in financial analysis is to arrange the information in a way to highlight
significant relationships
...
In brief,
financial analysis is the process of selection, relation, and evaluation
...
On the basis of nature of analyst and material used
2
...
On the basis of Modus operandi of the analysis
On the basis of nature of analyst and material used
 External analysis: The external analysis is done on the basis of published financial
statements by those who do not have access to the accounting information, such as, stock
holders, banks, creditors, and the general public
...

The objective of such analysis is to provide the information to the top management, while
assisting in the decision making process
...


UIM Alappuzha(B)

 Short term Analysis: It is concerned with the working capital analysis
...

On the basis of Modus operandi(method of operation) of the analysis
 Horizontal Analysis: The comparative financial statements are an example of horizontal
analysis, as it involves analysis of financial statements for a number of years
...

 Vertical Analysis: it is performed when financial ratios are to be calculated for one year
only
...

TECHNIQUES(TOOLS) OF ANALYSIS & INTERPRETATION
1
...
Statement of Changes in Working Capital:
3
...
Trend Analysis:
5
...
Fund flow analysis
7
...

 It is defined : as the systematic use of ratio to interpret the financial statements so that the
strengths and weaknesses of a firm as well as its historical performance and current
financial condition can be determined
...

Purpose/Importance/Advantages
 Useful in analysis of Financial Position
 Useful in simplifying of Accounting Figures
 Assessment of Operational Efficiency
 Determining Trends in the long-run

UIM Alappuzha(B)

 Identification of Strength & Weakness
 Taking Remedial Measures
 Comparison of Performance
Limitations of Ratio Analysis
 Based on Historical data
 Ignores change in Real Value of money
 No standard interpretation
 Ignoring Qualitative aspects
 Difference in accounting methods make comparison difficult
 Wrong results if based on incorrect data
Classification of Ratios
A
...
Solvency Ratios
C
...
Profitability Ratios
E
...
Liquidity Ratios
 Used to study the ability of the organization in meeting short-term payments or
obligations
...

 It also help to ascertain the effectiveness of the working capital
...
)
1) Current Ratio
2) Acid Test Ratio or Quick ratio
3) Absolute liquid or super quick ratio

UIM Alappuzha(B)

Current Ratio
 Fundamental measure of a company’s financial condition
...

 Most widely used ratio
...

 absolute liquidity ratio relates cash, bank and marketable securities to the current
liabilities
...
50:1(1:2)
 i
...


UIM Alappuzha(B)

B
...
These are meant for testing long term
financial soundness of any unit
...

 Implications:
1
...
Retain the control by owners
3
...

 Primarily these establish and study relationship between owned funds and loaned funds
...
This reflects the extent to
which borrowed capital is used in place of equity capital
...
capital +Capital Reserves+ Revenue Reserves+
accumulated profit)-(accumulated losses+ deferred expenses+ fictitious assets)

 If the D/E ratio is high, the owners are putting up relatively less money of their own
...

A low D/E ratio has just the opposite implications, it indicate that a company is using less
leverage and has a stronger equity position
...


Proprietary Ratio(Equity)
Variant to debit- equity is the proprietary ratio which indicates the relationship between owner’s
equity and total assets
...


Shareholde rsFunds

TotalAsset s
Shareholders funds or Proprietary funds are equity share capital, preference share capital,
undistributed profits, reserves and surpluses
...

Total assets on other hand denote total resources of the concern
...

 A company with a very high proprietary ratio may not be taking full advantage of debt
financing for its operations that is also not a good sign for the stockholders
...
A large portion of debts in the total capital may reduce creditors interest,
increase interest expenses and also the risk of bankruptcy
...

 Since financial management advocates that fixed assets should be purchased out of long
term funds only
...

A low ratio is indicative of greater solvency because the lower the ratio becomes, the more funds are
available to meet current obligations
...

 The purpose of this ratio is to show the percentage of proprietor’s fund investment in current
assets
...


Interest Coverage Ratio
 The ratio measures debts servicing capacity of a business so far as interest on long-term loans is
concerned
...

 The interest coverage ratio (ICR) is a measure of a company's ability to meet its interest
payments
...
0 indicates the business is having difficulties generating the cash
necessary to pay its interest obligations
...

 It means less earnings are available to meet interest payments and that the business is more
vulnerable to increases in interest rates
...

 A high ICR may suggest a company is "too safe" and is neglecting opportunities to magnify
earnings through leverage

Capital Gearing Ratio
 The degree to which a company acquires assets or to which it funds its ongoing operations with
long- or short-term debt
...
e
...

 Fixed cost bearing securities include debentures, long term mortgage loans etc
...

 This ratio measures the extent of capitalization by the funds raised by the issue of fixed cost
securities
...

 Highly geared mean lower proportion of equity
...


UIM Alappuzha(B)

C
...

 These ratios are important in determining whether a company's management is doing a good
enough job of generating revenues, cash, etc
...

 Rise in this ratio indicates the firm is expanding quickly and sale also increasing rapidly
...

 Sometimes it referred as ‘Operating ratios or Management ratios’ measure the efficiency with
which a business uses its assets, such as inventories, accounts receivable, and fixed (or capital)
assets
...

Hence these ratios are called as turnover ratios
...

 It measures how many times the company has sold and replaced its inventory during a certain
period of time
...


UIM Alappuzha(B)

CostofGoodsSold
AverageStock
•

Cost of goods sold = (opening stock+ Purchases+ Manufacturing expenses) -Closing stock
or = Net sales- Gross profit

•

Average Stock = (Opening Stock + Closing Stock) / 2

•

Higher ratio is better, it shows finished stock is rapidly turned over
...


•

If both numerator and denominator are unknown, the formula would be written as follows:

•

Inventory turnover ratio = Sales / Inventory

•

It also provides some indication as to the adequacy of a company's inventory for the volume
of business being handled
...

 This ratio simply measures how many times the receivables are collected during a particular
period
...


CreditSale s

AverageDebtors
Average debtors = (Debtors + Bills receivables )/2
•

Sometimes opening receivables may not be given in that case closing balance of receivables
should be used as denominator
...

 It indicates on an average that credit sales are pending
...

 The average number of days for which a firm has to wait before its receivables are converted
into cash
Interpretation Of Debtor Turnover Ratio & Average Collection Period
 Ideal ratio: 10 to 12 times; debt collection period of 30 to 36 days is considered ideal
...

 A low ratio is a sign of less liquid receivables and chance of bad debt is very high
...

 It measures the number of times, on average, the accounts payable are paid during a period
...

Average accounts payable =(Trade creditors + Bills)/2

UIM Alappuzha(B)

Significance and Interpretation:
 Accounts payable turnover ratio indicates the creditworthiness of the company, also depends
on the credit terms allowed by suppliers
 A high ratio means prompt payment to suppliers for the goods purchased on credit
...


Average payment period
 Average payment period means the average period taken by the company in making
payments to its creditors
...




365(Year )or12(months)
CreditorsT urnoverRatio

A shorter payment period indicates prompt payments to creditors
...


Total Assets Turnover Ratio
 It is an activity ratio that measures the efficiency with which assets are used by a company to
generate sales
...


NetSales

TotalAssets
 Higher turnover ratios means the company is using its assets more efficiently
...


UIM Alappuzha(B)

Working capital turnover ratio(Capital Turnover
Ratio)
 This ratio indicates the number of times the working capital is turned over in the course of the
year
...


NetSales

Workingcapital (CA  CL)
 A higher ratio indicates efficient utilization of working capital
...


Fixed Assets Turnover Ratio
 The fixed (or capital) assets turnover ratio measures how intensively a firm's fixed assets such
as land, buildings, and equipment are used to generate sales
...

 If a business shows a weakness in this ratio, its plant may be operating below capacity and the
manage should be looking at the possibility of selling the less productive assets
...
Profitability ratios
 Profit is the primary objective of all businesses
...
A business that continually suffers losses
cannot survive for a long period
...

 These ratios indicate the success or failure of a business enterprise for a particular
period of time
...

 A strong profitability position ensures common stockholders a higher dividend income
and appreciation in the value of the common stock in future
...

 Management needs higher profits to pay dividends and reinvest a portion in the
business to increase the production capacity and strengthen the overall financial
position of the company
...

Profitability Ratios
1) Gross Profit Ratio
2) Net Profit Ratio
3) Return on Total Assets
4) Return on Equity

Gross Profit Ratio
This profitability ratio that shows the relationship between gross profit and total net sales
revenue
...


UIM Alappuzha(B)

GrossProfi t

X 100
Net Sales
This ratio measures how profitable a company sells its inventory or merchandise
...

This is the pure profit from the sale of inventory that can go to paying operating expenses
...


Net Profit Ratio
Net Profit is equal to total income minus total expenses during a period; Revenue is income
earned from the principal business activities
...

It is computed by dividing the net profit (after tax) by net sales
...
It is
one of the two elements that determine the return on assets, the other element being the sales
turnover ratio
...

 ROA measures how efficiently a company can manage its assets to produce profits
during a period
...

 It is the return on equity ratio shows how much profit each dollar of common
stockholders' equity generates
...
The variants of expenses
ratios are:
Material consumed ratio =

Material consumed x 100
Net sales

Manufacturing expenses ratio = manufacturing expenses x 100
Net sales
Administration expenses ratio = administration expenses x 100
Net sales

UIM Alappuzha(B)

Selling expenses ratio = Selling expenses x 100
Net sales

Operating ratio = cost of goods sold +operating expenses x 100
Net sales

Financial expense ratio = financial expenses x 100
Net sales

DuPont Analysis
 DuPont analysis also called the DuPont model is a financial ratio based on the return on
equity ratio that is used to analyze a company's ability to increase its return on equity
...

 The DuPont Corporation developed this analysis in the 1920s
...
Shareholder’s Ratio
1) Earning per Share (EPS)
2) Dividend per share (DPS)
3) Dividend Yield Ratio
4) Dividend Pay-out Ratio

Earning per Share (EPS)
 This ratio measures the profit available to the equity shareholders on a per share basis
...


UIM Alappuzha(B)

Earnings per share =

net profit after tax – preference dividend
Number of equity shares

Dividend per share (DPS)
 This ratio shows the dividend paid to the shareholder on a per share basis
...


Dividend per share =
Dividend paid to ordinary shareholders
Number of equity shares

Dividend Yield Ratio
 It refers to the percentage or ratio of dividend paid per share to the market price per
share
...


Dividend yield ratio =

Dividend paid per equity share
Market price per equity share

UIM Alappuzha(B)

Dividend Pay-out Ratio
 This ratio measures the relationship between the earnings belonging to the ordinary
shareholders and the dividend paid to them
...

 It is prepared to ascertain the cost of goods manufactured during an accounting period
or cost of production
...


Divisions of costs
 In a manufacturing business the costs are divided into different types
...
Prime cost
Direct materials
Direct labour
Direct expenses
2
...
Total cost
Plus - Administration expenses
Selling and distribution expenses
Financial charges
The prime cost item and the production cost item are shown in the manufacturing account
...


UIM Alappuzha(B)

Format
 Manufacturing account section
Put into series of steps by:
1
...
Add in all the direct costs to get the prime cost
3
...

4
...

Format of Manufacturing Account
Particulars

Amount

Particulars

amount

To Work in progress(opening)

Xxx

By work in progress(closing)

Xxx

To Raw materials consumed :

Xxx

Opening stock

xxx

Xx

Xxx

By sale of scrap

xxxxx

add: Purchases of RM xx

Xx

less: closing stock of RM xx

Xx

By cost of production of finished
goods transferred to Trading A/c

To Direct or productive wages

Xx

To Factory overheads:

Xx

Power & Fuel
Repairs of plant
Depreciation on plant
Factory rent

xxxxx

xxxxx

UIM Alappuzha(B)

Format of Trading Account
Particulars

Amount

Particulars

Amount

To opening stock of Finished
goods

XX

By Sales XXX

XXX

XXX

less : Returns XX

XX

XX

By closing stock of finished goods

XX

By gross Loss c/d

To cost of production from
manufacturing account
To Purchases of Finished
goods XX

XXX

Less: Returns XX
To carriage charges on goods
purchased
To Gross Profit c/d

UIM Alappuzha(B)

FUND FLOW STATEMENT
 Fund to refer to cash, and cash equivalents or to Working Capital
...

 Robet N
...


Objectives
 To help to understand the changes in assets and its sources
...

 To point out the financial strengths and weakness of the business
...


Preparation of fund flow statement
 Fund flow statement can be prepared monthly but usually it is prepared for 1 or more
years
...

 Summarized income statement with items required for computing funds
from operation
 Statement of retained earnings
 Supplementary information regarding Fixed assets, share capital,
debentures etc

---