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UNIT - I
INTRODUCTION TO ACCOUNTING
CONCEPTS
Synopsis:
1. Introduction
2. Objectives and Principles
3. Accounting Concepts and conventions
4. Principles of accountancy according to GAAP
5. Double entry system
6. Classification of accounts
7. Accounting cycle
8.
1. INTRODUCITON
FINANCIAL ACCOUNTING
The main object of any business is to make profits. It is may be a business
engaged in the purchase and sales of goods or it may be engaged in the production of
goods or provision of services whatever be it’s nature, the main object is to earn
profits.
A businessman enters into business in order to earn profits. in the
businessman wishes to find out how much profit he has made during a given period, he
must be able to remember all the transactions that have taken place in his business. But
it is not possible for any businessman to remember all the transactions that have takes
place in his business. So he has to record them in his books of accounts.
History of Accounting:
Accounting is as old as civilization itself. From the ancient relics of Babylon, it
can be will proved that accounting did exist as long as 2600 B.C. However, in modern
form accounting based on the principles of Double Entry System came into existence
in 17th Century. Fra Luka Paciolo, a Fransiscan monk and mathematician published
a book De computic et scripturies in 1494 at Venice in Italyl. This book was translated into
English in 1543. In this book he covered a brief section on ‘book-keeping’.
Accounting in India is now a fast developing discipline. The two premier
Accounting Institutes in India viz., chartered Accountants of India and the Institute of
Cost and Works Accountants of India are making continuous and substantial
contributions. The international Accounts Standards Committee (IASC) was
established as on 29th June. In India the ‘Accounting Standards Board (ASB) is
formulating ‘Accounting Standards’ on the lines of standards framed by International
Accounting Standards Committee.
Book-keeping is the art of recording all business transactions in the books of
account maintained by businessman for that purpose.
Keeping a separate book to recording all the business transaction by using
principle of accounting is also called Book-keeping.
Accounting is an art as well as sciences of identifying, analyzing, recording,
classifying and summarizing of business transactions which are of a financial character
and are expressed in terms of money. It also includes interpretation aspect of the
recorded information.
American Institute of Certified Public Accountants (AICPA): “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.”
Thus, accounting is an art of identifying, recording, summarizing and
interpreting business transactions of financial nature. Hence accounting is the
Language of Business.
OBJECTIVES OF BOOK KEEPING & ACCOUNTANCY
To ascertainment of financial position of the business organization.
To determine the profit and loss of organization
To knowing the information about capital employed in the business.
To know the value of asset of the organization
To Calculation of amounts due to and due by others.
To know how much tax to pay to the government
To comparison between the current year and the previous year’s records.
To plan the organization
To know the financial information of the other organization
To preparation of financial statements
BASIC ACCOUNTING CONCEPTS
Accounting is a system evolved to achieve a set of objectives. In order to
achieve the goals, we need a set of rules or guidelines. These guidelines are termed here
as “BASIC ACCOUNTING CONCEPTS”. The term concept means an idea or
thought. Basic accounting concepts are the fundamental ideas or basic assumptions
underlying the theory and profit of FINANCIAL ACCOUNTING. These concepts
help in bringing about uniformity in the practice of accounting. In accountancy
following concepts are quite popular.
1. Business Entity Conept: In this concept “Business is treated as separate from the
proprietor”. All the Transactions recorded in the book of Business and not in the
books of proprietor. The proprietor is also treated as a creditor for the Business.
2. Going Concern Concept: This concept relates with the long life of Business. The
assumption is that business will continue to exist for unlimited period unless it is
dissolved due to some reasons or the other.
3. Money Measurement Concept: In this concept “Only those transactions are
recorded in accounting which can be expressed in terms of money, those transactions
which cannot be expressed in terms of money are not recorded in the books of
accounting”.
4. Cost Concept: Accounting to this concept, can asset is recorded at its cost in the
books of account. i.e., the price, which is paid at the time of acquiring it. In balance
sheet, these assets appear not at cost price every year, but depreciation is deducted and
they appear at the amount, which is cost, less classification.
5. Accounting Period Concept: every Businessman wants to know the result of his
investment and efforts after a certain period. Usually one-year period is regarded as an
ideal for this purpose. This period is called Accounting Period. It depends on the
nature of the business and object of the proprietor of business.
6. Dual Ascept Concept: According to this concept “Every business transactions has
two aspects”, one is the receiving benefit aspect another one is giving benefit aspect.
The receiving benefit aspect is termed as“DEBIT”, where as the giving benefit aspect
is termed as “CREDIT”. Therefore, for every debit, there will be corresponding credit.
7. Matching Cost Concept: According to this concept “The expenses incurred during
an accounting period, e.g., if revenue is recognized on all goods sold during a period,
cost of those good sole should also Be charged to that period.
8. Realisation Concept: According to this concept revenue is recognized when a sale
is made. Sale is Considered to be made at the point when the property in goods posses
to the buyer and he becomes legally liable to pay.
ACCOUNTING CONVENTIONS
Accounting is based on some customs or usages. Naturally accountants here to adopt
that usage or custom.They are termed as convert conventions in accounting. The
following are some of the important accounting conventions.
1. Full Disclosure: According to this convention accounting reports should disclose
fully and fairly the information. They purport to represent. They should be prepared
honestly and sufficiently disclose information which is if material interest to
proprietors, present and potential creditors and investors. The companies ACT, 1956
makes it compulsory to provide all the information in the prescribed form.
2.Materiality: Under this convention the trader records important factor about the
commercial activities. In the form of financial statements if any unimportant
information is to be given for the sake of clarity it will be given as footnotes.
3.Consistency: It means that accounting method adopted should not be changed from
year to year. It means that there should be consistent in the methods or principles
followed. Or else the results of a year Cannot be conveniently compared with that of
another.
4. Conservatism: This convention warns the trader not to take unrealized income in to
account. That is why the practice of valuing stock at cost or market price, which ever is
lower is in vague. This is the policy of “playing safe”; it takes in to consideration all
prospective losses but leaves all prospective profits.
DOUBLE ACCOUNTING SYSTEM
Double entry system of Book-keeping is simple and universal in its application.
It has the test of four hundred years continuous use. It may be claimed that it is the
only system worthy of adoption by the practical businessman. To understand the
system of double entry system of book-keeping all that we need to remember is the
fundamental rule:
“Debit the account which receives the benefit.”
“Credit the account which gives the benefit”
Types of account
1) Personal Account
2) Real Account
3) Nominal Account
RULES FOR DEBIT & CREDIT.
1) Personal Account: - This account deals with the individuals of the organization
these includes accounts of natural persons in varied capacities likes suppliers
and buyers of goods, lenders and borrowers of loans etc.
“Debit the receiver”
“Credit the giver”
2) Real Account: - This account deals with the group of individuals of the
organization these include combinations of the properties or assets are known as real
account.
“Debit what comes in”
“Credit what goes out”
3) Nominal Account: - Nominal accounts relate to such items which exist in name
only. These items pertain to expenses and gains like interest, rent, commission,
discount, salary etc,
“Debit all expenses and losses”
“Credit all incomes and gains”
Branches/classification of Accounting:
The important branches of accounting are:
1. Financial Accounting: The purpose of Accounting is to ascertain the
financial results i.e. profit or loass in the operations during a specific period. It
is also aimed at knowing the financial position, i.e. assets, liabilities and equity
position at the end of the period. It also provides other relevant information
to the management as a basic for decision-making for planning and controlling
the operations of the business.
2. Cost Accounting: The purpose of this branch of accounting is to ascertain
the cost of a product / operation / project and the costs incurred for carrying
out various activities. It also assist the management in controlling the costs.
The necessary data and information are gatherr4ed form financial and other
sources.
3. Management Accounting: Its aim to assist the management in taking
correct policy decision and to evaluate the impact of its decisions and actions.
The data required for this purpose are drawn accounting and cost-accounting.
UNIT - II
INTRODUCTION TO ACCOUNTING VALUATION OF FIXED ASSETS & INVENTORY
CONCEPTS
1. Introduction Journal
2. Journal Entries
3. Ledgers
4. Cash book
5. Trial Balance
6. Final Accounts With adjustments
7. Tangible Vs Intangible Asset
8. Reasons for Depreciation
9. provision for depreciation
10. Methods of Depreciation
11. Inventory valuation
12. Methods of inventory valuation
13. Problems on Depreciation & Inventory
JOURNAL
In the early evaluation of book-keeping traders used to record the business
transactions in a simple manner in the Waste book or Rough book. The waste book
is a book in which a businessman briefly notes down each transaction as soon as it
takes place. Transaction is writing in this very first so it is also called Book of Prime or
First Entry Book The Proforma of Journal is given below.
Date Date Particulars L.F. no Debit
RS.
Credit
RS.
LEDGER
Ledger is the secondary book of accounts all business transactions are
recorded in the first instance in the journal, but they must find their place ultimately in
the accounts in the ledger in a duly classified form. This ledger are also called final
entry book. OR Transferring of all journals in to accounts by using accounting
principles is called ledger.
CASH BOOK
Cash book plays an important role in accounting. Whether transactions made are in the
form of cash or credit, final statement will be in the form of receipt or payment of
cash. So, every transaction finds place in the cash book finally.
Cash book is a principal book as well as the subsidiary book. It is a book of original
entry since the transactions are recorded for the first time from the source of
documents. It is a ledger in a sense it is designed in the form of cash account and
records cash receipts on the debit side and the cash payments on the credit side. Thus,
a cash book fulfils the functions of both a ledger account and a journal.
Cash book is divided into two sides. Receipt side (debit side) and payment side (credit
side). The method of recording cash sample is very simple. All cash receipts will be
posted on the debit side and all the payments will be recorded on the credit side.
Types of cash book: cash book may be of the following types according to the needs of
the business.
Simple cash book
Double column or two column cash book
Three column cash book
SINGLE COLUMN CASH BOOK: The simple cash book is a record of only cash
transactions. The model of the cash book is given below.
Date Particulars Lf no Amount Date Particulars Lf no Amount
CASH BOOK
TWO COLUMN CASH BOOK: This book has two columns on each side one for
discount and the other for cash. Discount column on debit side represents loss being
discount allowed to customers. Similarly, discount column on credit side represents
gain being discount received.
Discount may be two types.
(i)Trade discount
(ii)cash discount
TRADE DISCOUNT: when a retailer purchases goods from the wholesaler, he allows
some discount on the catalogue price. This discount is called as Trade discount. Trade
discount is adjusted in the invoice and the net amount is recorded in the purchase
book. As such it will not appear in the book of accounts.
CASH DISCOUNT: When the goods are purchased on credit, payment will be made in
the future as agreed by the parties. If the amount is paid early as promptly a discount by
a way of incentive will be allowed by the seller to the buyer. This discount is called as
cash discount. So cash discount is the discount allowed by the seller to encourage
prompt payment from the buyer. Cash discount is entered in the discount column of
the cash book. The discount recorded in the debit side of the cash book is discount
allowed. The discount recorded in the credit side of the cash book is discount received.
CASH DISCOUNT COLUMN CASH BOOK
Date particulars Lf
no
Disc.
Allo
wed
cash Date Particulars Lf
No
Disc
Recei
Ved.
cash
Date Partic
ulars
Lf no Amount Date Particulars Lf no Amo
unt
THREE COLUMN CASH BOOK: This book has three columns on each side one for
discount, cash and the other for bank. Discount column on debit side represents loss
being discount allowed to customers. Similarly, discount column on credit side
represents gain being discount received.
CASH DISCOUNT COLUMN CASH BOOK
TRAIL BALANCE
The first step in the preparation of final accounts is the preparation of trail balance. In
the double entry system of book keeping, there will be credit for every debit and there
will not be any debit without credit. When this principle is followed in writing journal
entries, the total amount of all debits is equal to the total amount all credits.
A trail balance is a statement of debit and credit balances. It is prepared on a particular
date with the object of checking the accuracy of the books of accounts. It indicates that
all the transactions for a particular period have been duly entered in the book, properly
posted and balanced. The trail balance doesn’t include stock in hand at the end of the
period. All adjustments required to be done at the end of the period including closing
stock are generally given under the trail balance.
Characteristic of a Trial Balance:
1. It is a statement prepared in tabular form.
2. Trial balance is a statement of closing balance but it is not an account. It is prepared to verify the arithmetical accuracy.
3. Preparation of trial balance will leads to preparation of final accounts.
PROFORMA FOR TRAIL BALANCE:
Trail balance for MR…………………………………… as on …………
Date particulars Lf
no
Disc.
Allo
wed
Cash Bank Date Particulars Lf
No
Disc
Recei
Ved.
Cash Bank
NAME OF ACCOUNT
(PARTICULARS)
DEBIT
AMOUNT(RS.)
CREDIT
AMOUNT(RS.)
Debit Balances Purchases
XXXX
Carriage inwards wages All factory & manufacturing exp (factory rent factory Insurance factory lighting.) Oil, water. Gas. Coal. Fuel, power excise duty.octroi trade expenses Salaries Rent rates & taxes Advertising Audit fees, legal charges Insurance Bad debts Repairs Discount allowed Printing& stationary Postage& telegrams Commission paid (dr) Interest on capital Interest on loan Carriage outwards All depreciations All management exp All office exp General exp Discount on debtors Selling exp Cash in hand Cash at bank Debtors Furniture Buildings Good will patents Copy rights. Bills receivable Machinery Motor car Freehold premises All fixed variable assets Credit balances Sales Commission receive bad debts reserve interest received commission receiv interest on drawing discount on creditors Capital Bank loan Bank overdraft
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Classification of capital and revenue expenses
1 Capital Credit Loan
2 Opening stock Debit Asset
3 Purchases Debit Expense
4 Sales Credit Gain
5 Returns inwards Debit Loss
6 Returns outwards Debit Gain
7 Wages Debit Expense
8 Freight Debit Expense
9 Transport expenses Debit Expense
10 Royalities on production Debit Expense
11 Gas, fuel Debit Expense
12 Discount received Credit Revenue
13 Discount allowed Debit Loss
14 Bas debts Debit Loss
15 Dab debts reserve Credit Gain
16 Commission received Credit Revenue
17 Repairs Debit Expense
18 Rent Debit Expense
19 Salaries Debit Expense
20 Loan Taken Credit Loan
21 Interest received Credit Revenue
22 Interest paid Debit Expense
23 Insurance Debit Expense
24 Carriage outwards Debit Expense
25 Advertisements Debit Expense
26 Petty expenses Debit Expense
27 Trade expenses Debit Expense
28 Petty receipts Credit Revenue
29 Income tax Debit Drawings
30 Office expenses Debit Expense
31 Customs duty Debit Expense
32 Sales tax Debit Expense
Income received in advance Creditors Bills payable All other loans
XXXX
XXXX
XXXX
XXXX
TOTAL XXXX XXXX
33 Provision for discount on debtors Debit Liability
34 Provision for discount on creditors Debit Asset
35 Debtors Debit Asset
36 Creditors Credit Liability
37 Goodwill Debit Asset
38 Plant, machinery Debit Asset
39 Land, buildings Debit Asset
40 Furniture, fittings Debit Asset
41 Investments Debit Asset
42 Cash in hand Debit Asset
43 Cash at bank Debit Asset
44 Reserve fund Credit Liability
45 Loan advances Debit Asset
46 Horse, carts Debit Asset
47 Excise duty Debit Expense
48 General reserve Credit Liability
49 Provision for depreciation Credit Liability
50 Bills receivable Debit Asset
51 Bills payable Credit Liability
52 Depreciation Debit Loss
53 Bank overdraft Credit Liability
54 Outstanding salaries Credit Liability
55 Prepaid insurance Debit Asset
56 Bad debt reserve Credit Revenue
57 Patents & Trademarks Debit Asset
58 Motor vehicle Debit Asset
59 Outstanding rent Credit Revenue
FINAL ACCOUNTS In every business, the business man is interested in knowing whether the
business has resulted in profit or loss and what the financial position of the business is
at a given time. In brief, he wants to know (i)The profitability of the business and (ii)
The soundness of the business.
The trader can ascertain this by preparing the final accounts. The final accounts
are prepared from the trial balance. Hence the trial balance is said to be the link
between the ledger accounts and the final accounts. The final accounts of a firm can be
divided into two stages. The first stage is preparing the trading and profit and loss
account and the second stage is preparing the balance sheet.
TRADING ACCOUNT
The first step in the preparation of final account is the preparation of trading
account. The main purpose of preparing the trading account is to ascertain gross profit
or gross loss as a result of buying and selling the goods.
PROFIT AND LOSS ACCOUNT
The business man is always interested in knowing his net income or net profit.Net
profit represents the excess of gross profit plus the other revenue incomes over
administrative, sales, Financial and other expenses. The debit side of profit and loss
account shows the expenses and the credit side the incomes. If the total of the credit
side is more, it will be the net profit. And if the debit side is more, it will be net loss. PROFORMA OF TRADING AND PROFIT & LOSS A/C
As on …………………………in the books of Mrs. ………………………….
Trading and Profit & Loss A/C Dr Cr
Particulars Amount Particulars Amount
To Opening stock
To Purchases
Less: Pur. Returns
To Carriage inwards
To Wages
Add. Out standings
To All factory & manufacturing
exp (factory rent factory
insurance factory lighting.)
To Oil, water. Gas.
To Freight
To Coal. Fuel, power
To Excise duty.octroi
To Trade expenses
To Gross profit (transfer to
P & L A/C Cr side)
To Gross Loss
To Salaries
Add: outstanding
To Rent rates & Taxes
To Advertising
To Audit fees, legal charges
To Insurance
Less: prepaid insurance
By Sales
Less: Sales returns
By Stolen goods
By Closing stock
By Gross loss (Transfer
to P & L A/C Dr side)
By Gross Profit
By commission received
By bad debts reserve
By interest received
By commission received
By interest on drawings
By discount on creditors
To Bad debts
To Repairs
To Discount allowed
To Printing& Stationary
To Postage& Telegrams
To Commission paid (Dr)
To Interest on capital
To Interest on loan
To Carriage outwards
To All depreciations
To All management exp
To All office exp
To General exp
To Discount on debtors
To Selling exp
To Net profit (transfer to
capital A/C)
By Net loss (transfer to capital
A/C)
BALANCE SHEET The second point of final accounts is the preparation of balance sheet. It is
prepared often in the trading and profit, loss accounts have been compiled and closed.
A balance sheet may be considered as a statement of the financial position of the
concern at a given date.
Thus, Balance sheet is defined as a statement which sets out the assets and liabilities of
a business firm and which serves to as certain the financial position of the same on any
particular date. On the left-hand side of this statement, the liabilities and the capital are
shown. On the right-hand side all the assets are shown. Therefore, the two sides of the
balance sheet should be equal. Otherwise, there is an error somewhere. PROFORMA OF BALANCE SHEET
As on …………………………in the books of Mrs. ………………………….
Balance Sheet
Liabilities Amouts Assets Amounts
Capital
Add :Int on cap
Add :Net profit
or
Less: Net loss
Less: drawings
Less: Int on drawings
Bank loan
Bank overdraft
Income received in
advance
Creditors
Less Discount on
creditors
Bills payable
All other loans
Outstanding wages,
salaries
Cash in hand
Cash at bank
Debtors
Less Bad debts
Furniture
Less depreciation
Buildings
Less depreciation
Good will patents
Copy rights.
Bills receivable
Machinery
Less Depreciation
Motor car
Less depreciation
Prepaid expenses(insurance)
Freehold premises
All fixed variable assets
Closing stock
FINAL ACCOUNTS -- ADJUSTMENTS
We know that business is a going concern. It has to be carried on indefinitely.
At the end of every accounting year. The trader prepares the trading and profit and loss
account and balance sheet. While preparing these financial statements, sometimes the
trader may come across certain problems .The expenses of the current year may be still
payable or the expenses of the next year have been prepaid during the current year. In
the same way, the income of the current year still receivable and the income of the next
year have been received during the current year. Without these adjustments, the profit
figures arrived at or the financial position of the concern may not be correct. As such
these adjustments are to be made while preparing the final accounts.
The adjustments to be made to final accounts will be given under the Trial Balance.
While making the adjustment in the final accounts, the student should remember that
“every adjustment is to be made in the final accounts twice i.e. once in trading, profit
and loss account and later in balance sheet generally”. The following are some of the
important adjustments to be made at the time of preparing of final accounts:-
1. CLOSING STOCK :-
(i)If closing stock is given in Trail Balance: It should be shown only in the balance sheet
“Assets Side”.
(ii)If closing stock is given as adjustment :
1. First, it should be posted at the credit side of “Trading Account”.
2. Next, shown at the asset side of the “Balance Sheet”.
2. OUTSTANDING EXPENSES:-
(i)If outstanding expenses given in Trail Balance: It should be only on the liability side of
Balance Sheet.
(ii)If outstanding expenses given as adjustment :
1. First, it should be added to the concerned expense at the
debit side of profit and loss account or Trading Account.
2. Next, it should be added at the liabilities side of the Balance Sheet.
3.PREAPID EXPENSES :-
(i)If prepaid expenses given in Trial Balance: It should be shown only in assets side of the
Balance Sheet.
(ii)If prepaid expense given as adjustment :
1. First, it should be deducted from the concerned expenses at the debit side of profit
and loss account or Trading Account.
2. Next, it should be shown at the assets side of the Balance Sheet.
4.INCOME EARNED BUT NOT RECEIVED [OR] OUTSTANDING INCOME [OR]
ACCURED INCOME :-
(i)If incomes given in Trial Balance: It should be shown only on the assets side of the Balance
Sheet.
(ii)If incomes outstanding given as adjustment:
1. First, it should be added to the concerned income at the credit side of profit and loss
account.
2. Next, it should be shown at the assets side of the Balance sheet.
5. INCOME RECEIVED IN ADVANCE: UNEARNED INCOME:-
(i)If unearned incomes given in Trail Balance : It should be shown only on the liabilities side of
the Balance Sheet.
(ii)If unearned income given as adjustment :
1. First, it should be deducted from the concerned income in the credit side of the profit
and loss account.
2. Secondly, it should be shown in the liabilities side of the
Balance Sheet.
6.DEPRECIATION:-
(i)If Depreciation given in Trail Balance: It should be shown only on the debit side of the
profit and loss account.
(ii)If Depreciation given as adjustment
1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deduced from the concerned asset in the Balance sheet assets
side.
7.INTEREST ON LOAN [OR] CAPITAL :-
(i)If interest on loan (or) capital given in Trail balance :It should be shown only on debit side
of the profit and loss account.
(ii)If interest on loan (or)capital given as adjustment :
1. First, it should be shown on debit side of the profit and loss account.
2. Secondly, it should added to the loan or capital in
the liabilities side of the Balance Sheet.
8. BAD DEBTS:-
(i)If bad debts given in Trail balance :It should be shown on the debit side of the profit and
loss account.
(ii)If bad debts given as adjustment:
1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deducted from debtors in the assets side of the Balance Sheet.
9.INTEREST ON DRAWINGS :-
(i)If interest on drawings given in Trail balance: It should be shown on the credit side of the
profit and loss account.
(ii)If interest on drawings given as adjustments :
1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be deducted from capital on liabilities
side of the Balance Sheet.
10.INTEREST ON INVESTMENTS :-
(i)If interest on the investments given in Trail balance :It should be shown on the credit side of
the profit and loss account.
(ii)If interest on investments given as adjustments :
1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be added to the investments on assets side of the Balance Sheet
Indian Accounting Standards
Accounting is the art of recording transactions in the best manner possible, so as to enable the reader to arrive at judgments/come to conclusions, and in this regard it is utmost necessary that there are set guidelines. These guidelines are generally called accounting policies. The intricacies of accounting policies permitted Companies to alter their accounting principles for their benefit. This made it impossible to make comparisons. In order to avoid the above and to have a harmonised accounting principle, Standards needed to be set by recognised accounting bodies. This paved the way for Accounting Standards to come into existence.
Accounting Standards in India are issued By the Institute of Chartered Accountanst of India (ICAI). At present there are 30 Accounting Standards issued by ICAI.
Objective of Accounting Standards
Objective of Accounting Standards is to standarize the diverse accounting policies and practices with a view to eliminate to the extent possible the non-comparability of financial statements and the reliability to the financial statements.
The institute of Chatered Accountants of India, recognizing the need to harmonize the diversre accounting policies and practices, constituted at Accounting Standard Board (ASB) on 21st April, 1977.
Compliance with Accounting Standards issued by ICAI
Sub Section (3A) to section 211 of Companies Act, 1956 requires that every Profit/Loss Account and Balance Sheet shall comply with the Accounting Standards. 'Accounting Standards' means the standard of accounting recommended by the ICAI and prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards (NACAs) constituted under section 210(1) of companies Act, 1956.
Accounting Standards Issued by the Institute of Chatered Accountants of India are as below:
AS 01.Disclosure of accounting policies: AS 02.Valuation Of Inventories: AS 03.Cash Flow Statements AS 04.Contingencies and events Occurring after the Balance sheet Date AS 05.Net Profit or loss For the period, Prior period items and Changes in accounting
Policies. AS 06.Depreciation accounting. AS 07.Construction Contracts. AS 08.Revenue Recognition. AS 09.Accounting For Fixed Assets. AS 10.The Effect of Changes In Foreign Exchange Rates. AS 11.Accounting For Government Grants. AS 12.Accounting For Investments.
AS 13.Accounting For Amalgamation. AS 14.Employee Benefits. AS 15.Borrowing Cost. AS 16.Segment Reporting. AS 17.Related Party Disclosures. AS 18.Accounting For Leases. AS 19.Earning Per Share. AS 20.Consolidated Financial Statement. AS 21.Accounting For Taxes on Income. AS 22.Accounting for Investment in associates in Consolidated Financial Statement. AS 23.Discontinuing Operation. AS 24.Interim Financial Reporting. AS 25.Intangible assets. AS 26.Financial Reporting on Interest in joint Ventures. AS 27.Impairment Of assets. AS 28.Provisions, Contingent, liabilities and Contingent assets. AS 29.Financial instrument. AS 30.Financial Instrument: presentation. AS 31.Financial Instruments, Disclosures and Limited revision to accounting standards.
Disclosure of Accounting Policies: Accounting Policies refer to specific accounting principles and the method of applying those principles adopted by the enterprises in preparation and presentation of the financial statements.
Valuation of Inventories: The objective of this standard is to formulate the method of computation of cost of inventories / stock, determine the value of closing stock / inventory at which the inventory is to be shown in balance sheet till it is not sold and recognized as revenue.
Cash Flow Statements: Cash flow statement is additional information to user of financial statement. This statement exhibits the flow of incoming and outgoing cash. This statement assesses the ability of the enterprise to generate cash and to utilize the cash. This statement is one of the tools for assessing the liquidity and solvency of the enterprise.
Contigencies and Events occuring after the balance sheet date: In preparing financial statement of a particular enterprise, accounting is done by following accrual basis of accounting and prudent accounting policies to calculate the profit or loss for the year and to recognize assets and liabilities in balance sheet. While following the prudent accounting policies, the provision is made for all known liabilities and losses even for those liabilities / events, which are probable. Professional judgement is required to classify the likehood of the future events occuring and, therefore, the question of contingencies and their accounting arises.Objective of this standard is to prescribe the accounting of contigencies and the events, which take place after the balance sheet date but before approval of balance sheet by Board of Directors. The Accounting Standard deals with Contingencies and Events occuring after the balance sheet date.
Net Profit or Loss for the Period, Prior Period Items and change in Accounting Policies : The objective of this accounting standard is to prescribe the criteria for certain items in the profit and loss account so that comparability of the financial statement can be enhanced. Profit and loss account being a period statement covers the items of the income and expenditure of the particular period. This accounting standard also deals with change in accounting policy, accounting estimates and extraordinary items.
Depreciation Accounting : It is a measure of wearing out, consumption or other loss of value of a depreciable asset arising from use, passage of time. Depreciation is nothing but distribution of total cost of asset over its useful life.
Construction Contracts : Accounting for long term construction contracts involves question as to when revenue should be recognized and how to measure the revenue in the books of contractor. As the period of construction contract is long, work of construction starts in one year and is completed in another year or after 4-5 years or so. Therefore question arises how the profit or loss of construction contract by contractor should be determined. There may be following two ways to determine profit or loss: On year-to-year basis based on percentage of completion or On cpmpletion of the contract.
Revenue Recognition : The standard explains as to when the revenue should be recognized in profit and loss account and also states the circumstances in which revenue recognition can be postponed. Revenue means gross inflow of cash, receivable or other consideration arising in the course of ordinary activities of an enterprise such as:- The sale of goods, Rendering of Services, and Use of enterprises resources by other yeilding interest, dividend and royalties. In other words, revenue is a charge made to customers / clients for goods supplied and services rendered.
Accounting for Fixed Assets : It is an asset, which is:- Held with intention of being used for the purpose of producing or providing goods and services. Not held for sale in the normal course of business. Expected to be used for more than one accounting period.
The Effects of changes in Foreign Exchange Rates : Effect of Changes in Foreign Exchange Rate shall be applicable in Respect of Accounting Period commencing on or after 01-04-2004 and is mandatory in nature. This accounting Standard applicable to accounting for transaction in Foreign currencies in translating in the Financial Statement Of foreign operation Integral as well as non- integral and also accounting for For forward exchange.Effect of Changes in Foreign Exchange Rate, an enterprises should disclose following aspects:
Amount Exchange Difference included in Net profit or Loss; Amount accumulated in foreign exchange translation reserve; Reconciliation of opening and closing balance of Foreign Exchange translation reserve
Accounting for Government Grants : Governement Grants are assistance by the Govt. in the form of cash or kind to an enterprise in return for past or future compliance with certain conditions. Government assistance, which cannot be valued reasonably, is excluded from Govt.
grants,. Those transactions with Governement, which cannot be distinguished from the normal trading transactions of the enterprise, are not considered as Government grants.
Accounting for Investments : It is the assets held for earning income by way of dividend, interest and rentals, for capital appreciation or for other benefits.
Accounting for Amalgamation : This accounting standard deals with accounting to be made in books of Transferee company in case of amalgamtion. This accounting standard is not applicable to cases of acquisition of shares when one company acquires / purcahses the share of another company and the acquired company is not dissolved and its seperate entity continues to exist. The standard is applicable when acquired company is dissolved and seperate entity ceased exist and purchasing company continues with the business of acquired company
Employee Benefits : Accounting Standard has been revised by ICAI and is applicable in respect of accounting periods commencing on or after 1st April 2006. the scope of the accounting standard has been enlarged, to include accounting for short-term employee benefits and termination benefits.
Borrowing Costs : Enterprises are borrowing the funds to acquire, build and install the fixed assets and other assets, these assets take time to make them useable or saleable, therefore the enterprises incur the interest (cost on borrowing) to acquire and build these assets. The objective of the Accounting Standard is to prescribe the treatment of borrowing cost (interest + other cost) in accounting, whether the cost of borrowing should be included in the cost of assets or not.
Segment Reporting : An enterprise needs in multiple products/services and operates in different geographical areas. Multiple products / services and their operations in different geographical areas are exposed to different risks and returns. Information about multiple products / services and their operation in different geographical areas are called segment information. Such information is used to assess the risk and return of multiple products/services and their operation in different geographical areas. Disclosure of such information is called segment reporting.
Related Paty Disclosure : Sometimes business transactions between related parties lose the feature and character of the arms length transactions. Related party relationship affects the volume and decision of business of one enterprise for the benefit of the other enterprise. Hence disclosure of related party transaction is essential for proper understanding of financial performance and financial position of enterprise.
Accounting for leases : Lease is an arrangement by which the lesser gives the right to use an asset for given period of time to the lessee on rent. It involves two parties, a lessor and a lessee and an asset which is to be leased. The lessor who owns the asset agrees to allow the lessee to use it for a specified period of time in return of periodic rent payments.
Earning Per Share :Earning per share (EPS)is a financial ratio that gives the information regarding earning available to each equiy share. It is very important financial ratio for assessing the state of market price of share. This accounting standard gives computational methodology for the
determination and presentation of earning per share, which will improve the comparison of EPS. The statement is applicable to the enterprise whose equity shares or potential equity shares are listed in stock exchange.
Consolidated Financial Statements : The objective of this statement is to present financial statements of a parent and its subsidiary (ies) as a single economic entity. In other words the holding company and its subsidiary (ies) are treated as one entity for the preparation of these consolidated financial statements. Consolidated profit/loss account and consolidated balance sheet are prepared for disclosing the total profit/loss of the group and total assets and liabilities of the group. As per this accounting standard, the conslidated balance sheet if prepared should be prepared in the manner prescribed by this statement.
Accounting for Taxes on Income : This accounting standard prescribes the accounting treatment for taxes on income. Traditionally, amount of tax payable is determined on the profit/loss computed as per income tax laws. According to this accounting standard, tax on income is determined on the principle of accrual concept. According to this concept, tax should be accounted in the period in which corresponding revenue and expenses are accounted. In simple words tax shall be accounted on accrual basis; not on liability to pay basis.
Accounting for Investments in Associates in consolidated financial statements : The accounting standard was formulated with the objective to set out the principles and procedures for recognizing the investment in associates in the cosolidated financial statements of the investor, so that the effect of investment in associates on the financial position of the group is indicated.
Discontinuing Operations : The objective of this standard is to establish principles for reporting information about discontinuing operations. This standard covers "discontinuing operations" rather than "discontinued operation". The focus of the disclosure of the Information is about the operations which the enterprise plans to discontinue rather than dsclosing on the operations which are already discontinued. However, the disclosure about discontinued operation is also covered by this standard.
Interim Financial Reporting (IFR) : Interim financial reporting is the reporting for periods of less than a year generally for a period of 3 months. As per clause 41 of listing agreement the companies are required to publish the financial results on a quarterly basis.
Intangible Assets : An Intangible Asset is an Identifiable non-monetary Asset without physical substance held for use in the production or supplying of goods or services for rentals to others or for administrative purpose
Financial Reporting of Interest in joint ventures : Joint Venture is defined as a contractual arrangement whereby two or more parties carry on an economic activity under 'joint control'. Control is the power to govern the financial and operating policies of an economic activity so as to obtain benefit from it. 'Joint control' is the contractually agreed sharing of control over economic activity.
Impairment of Assets : The dictionary meanong of 'impairment of asset' is weakening in value of asset. In other words when the value of asset decreases, it may be called impairment of an asset. As per AS-28 asset is said to be impaired when carrying amount of asset is more than its recoverable amount.
Provisions, Contingent Liabilities And Contingent Assets : Objective of this standard is to prescribe the accounting for Provisions, Contingent Liabilitites, Contingent Assets, Provision for restructuring cost.Provision: It is a liability, which can be measured only by using a substantial degree of estimation.Liability: A liability is present obligation of the enterprise arising from past events the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
Financial Instrument: Recognition and Measurement, issued by The Council of the Institute of Chartered Accountants of India, comes into effect in respect of Accounting periods commencing on or after 1-4-2009 and will be recommendatory in nature for An initial period of two years. This Accounting Standard will become mandatory in respect of Accounting periods commencing on or after 1-4-2011 for all commercial, industrial and business Entities except to a Small and Medium-sized Entity. The objective of this Standard is to establish principles for recognizing and measuring Financial assets, financial liabilities and some contracts to buy or sell non-financial items. Requirements for presenting information about financial instruments are in Accounting Standard.
Financial Instrument: presentation : The objective of this Standard is to establish principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities. It applies to the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments; the classification of related interest, dividends, losses and gains; and the circumstances in which financial assets and financial liabilities should be offset. The principles in this Standard complement the principles for recognising and measuring financial assets and financial liabilities in Accounting Standard Financial Instruments:
Financial Instruments, Disclosures and Limited revision to accounting standards: The objective of this Standard is to require entities to provide disclosures in their financial statements that enable users to evaluate:
the significance of financial instruments for the entity’s financial position and performance; and
the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks.
DEPRECIATION The depreciation accounting is mainly based on the concept of income. The
concept of income is matching of revenues with expenses. The goods purchased are
frequently matched through immediate sale or within a year. The crux of the concept
of income is that the expenses are to be matched against the revenues. The ultimate
aim of matching is done in order to determine the volume of profit or loss of the
transaction. If the assets are nothing but long term assets procured by the enterprise
should be matched against the revenues of them. The matching of expenditure of the
assets incurred by the firm at the time of purchase against the revenues is the hard core
task of the firm. Why it is being considered as a cumbersome task in matching ? The
benefits/revenues of the fixed assets expected to accrue for many number of years but
not within a year. The
initial investment on the assets at the time of purchase should be matched against the
revenue pattern of the same year after year in order to find out the profitability of the
long term investment. To have an effective matching against the revenues on every
year, the amount of purchase has to be stretched. The stretching of expenses into many
years is known as depreciation.
The ultimate purpose of the depreciation is to replace the fixed assets only at the
moment of becoming useless through the current revenues.
According to Dickens, “depreciation is the permanent and continuous diminution in
the quality /quantity / value of the asset. ”
In simple words to understand the terminology depreciation is the permanent decrease
in the value of the fixed assets.
4.3.1 Reasons for Depreciation
(1) Wear and Tear of the Asset: The long term assets are becoming less efficient and
poor quality in operations due to the continuous usage of the asset.
(2) Exhaustion: Nothing will be remaining due to the continuous extraction of
resources. The resources in the oil wells, mine fields will become nothing due to
continuous extraction should be replaced by new exploration. To invest on the new
exploration in order to have continuous exploration which requires the depreciation as
a charge against the revenues of the fields?
Example, Oil & Natural Gas Corporation Ltd. (ONGC) indulges in the process of new
oil exploration projects through research projects. Then the new projects should be
identified and invested by huge initial investment outlay through the current revenues
out of the existing projects on account of replacement due to depletion of resources..
(3) To Face Technological Obsolescence: To replace the old machinery with new
machinery before the expiry of the economic life period of the asset in order to
maintain the efficiency and economy of the asset. The type writer was replaced by the
electronic typewriter during the yester periods of office automation. To replace the old
type writer which is not efficient as well as economical, should be replaced by the new
electronic typewriter through the depreciation charge on the old one.
(4) Accident: The value of the asset mainly depends upon the efficiency and
economy;which gets affected due to the accident.
(5) To Implementing New Technology in the Business Organization
(6) Passage of time:Some assets diminish in value on account of sheer passage of time,
even though they are not used e.g. lease hold property, patent rights, copy rights etc.
(7) Depletion: Some assets decline in value proportionate to the quantum of
production, e.g. mines, quarry etc. With the raising of coal etc. from coal mine, the total
deposit reduces gradually and after some time it will be fully exhausted. Then its value
will be nil.
The need for provision for depreciation arises for the following reasons:
(1) Ascertainment of true profit or loss-Depreciation is a loss. So unless it is
considered like all other expenses and losses, true profit/loss cannot be ascertained. In
other words, depreciation must be considered in order to find out true profit/loss of a
business.
(2) Ascertainment of true cost of production-Goods are produced with the help of
plant and machinery which incurs depreciation in the process of production. This
depreciation must be considered as a part of the cost of production of goods.
Otherwise, the cost of production would be shown less than the true cost. Sale price is
normally fixed on the basis of cost of production. So, if the cost of production is
shown less by ignoring depreciation, the sale price will also be fixed at a low level
resulting in loss to the business;
(3) Actual Value of Assets-Value of assets gradually decreases on account of
depreciation. If depreciation is not taken into account, the value of asset will be shown
in the books at a figure higher than its true value and hence the true financial position
of the business will not be disclosed through Balance Sheet.
(4) Replacement of Assets-After some time an asset will be completely exhausted on
account of use. A new asset then be purchased requiring large sum of money. If the
whole amount of profit is withdrawn from business each year without considering the
loss on account of depreciation, necessary sum may not be available for. buying the
new assets. In such a case the required money is to be collected by introducing fresh
capital or by obtaining loan by selling some other assets. This is contrary &0sound
commercial policy.
(5) To Implementing New Technology in the Business Organization
(6) Keeping Capital' Intact-Capital invested in buying an asset, gradually diminishes
on
account of depreciation. If loss on account of depreciation is not considered in
determining profit/ loss at the year end, profit will be shown more. If the excess profit
is withdrawn, the working capital will gradually reduce, the business will become weak
and its profit earning
capacity will also fall.
(7) Legal Restriction-According to Sec. 205 of the Companies Act, 1956 dividend
cannot be declared without charging depreciation on fixed assets. Thus in "Case of
joint stock companies charging of depreciation is compulsory.
METHODS OF DEPRECIATION
Straight line method
Diminishing Balance or Written down method
Annuity method
Depletion or Output method
Machine hour rate method
Sum of digits method
Sinking fund method
Insurance policy method
ACCOUNTING ENTRIES FOR DEPRECIATION 1) Purchasing of assets Asset A/c ……………. Dr To Bank A/c (Being the furniture is purchased) 2) Providing depreciation for asset Depreciation A/c ……….Dr To Asset A/c (Being Depreciation provided) 3) Sale of Asset (loss) Profit& Loss A/c……….Dr To Asset A/c (Being Loss on Asset) 4) Sale of Asset (Profit) Asset A/c …………..Dr To Profit& Loss A/c (Being Profit on Asset) STRAIGHT LINE METHOD/FIXED INSTALLMENT METHOD
This method, depreciation is calculated as a fixed proportion on the original
value of the asset. The depreciation is charged as fixed in volume on the original value
of the asset at which it was purchased. The original value of the asset is nothing but the
purchase value of the asset.
DIMINISHING BALANCE/WRITTEN DOWN VALUE METHOD
This method also having the same methodology in charging depreciation on the
fixed assets like fixed percentage Though it is bearing similar approach in charging
depreciation but different in application from the straight line method. Under this
method, the depreciation is charged on the value of the asset available at the beginning
of the year.
ANNUITY METHOD:-
The annuity method of depreciation is also commonly referred to as the
compound interest method of depreciation. If the cash flow of the asset being
depreciated is constant over the life of the asset, then this method is called the
annuity method.
A method of depreciation centered on cost recovery and a constant rate of
return upon any asset that is being depreciated. This method requires the
determination of the internal rate of return (IRR) on the cash inflows and
outflows of the asset. The IRR is then multiplied by the initial book value of the
asset, and the result is subtracted from the cash flow for the period in order to
find the actual amount of depreciation that can be taken.
DEPRECIATION FUND METHOD:-
A method of depreciation under which the depreciation expense is an
amount of an Annuity so that the amount of the annuity at the end of the useful
life would equal the Acquisition Cost of the asset. Theoretically, the depreciation
charge should include interest on accumulated depreciation at the beginning of
the period. This method is rarely used in practice.
INVENTORY
The raw materials, work-in-process goods and completely finished goods that
are considered to be the portion of a business's assets that is ready or will be ready for
sale. Inventory represents one of the most important assets that most businesses
possess, because the turnover of inventory represents one of the primary sources
of revenue generation and subsequent earnings for the company's
shareholders/owners.
METHODS OF INVENTORY MANAGEMENTS:
First In First Out (FIFO) Method
Last In First Out (LIFO) Method
Average Cost (AC)Method
1)FIRST IN FIRST OUT (FIFO) METHOD:
The first in first out (FIFO) method of costing is used to
introduce the subject of materials costing. The FIFO method of costing issued
materials follows the principle that materials used should carry the actual experienced
cost of the specific units used. The methods assumes that materials are issued from the
oldest supply in stock and that the cost of those units when placed in stock is the cost
of those same units when issued. However, FIFO costing may be used even though
physical withdrawal is in a different order.
Advantages claimed for first in first (FIFO) out costing method are:
1. Materials used are drawn from the cost record in a logical and systematic
manner.
2. Movement of materials in a continuous, orderly, single file manner represents a
condition necessary to and consistent with efficient materials control,
particularly for materials subject to deterioration, decay and quality are style
changes.
Limitations of FIFO Method
FIFO method is definitely awkward if frequent purchases are made at different prices
and if units from several purchases are on hand at the same time. Added costing
difficulties arise when returns to vendors or to the storeroom occur.
2) LAST IN FIRST OUT (LIFO) METHOD:-
The last in first out (LIFO) method of costing materials
issued is based on the premise that materials units issued should carry the cost of the
most recent purchase, although the physical flow may actually be different. The method
assumes that the most recent cost (the approximate cost to replace the consumed units)
is most significant in matching cost with revenue in the income determination
procedure.
Under LIFO procedures, the objective is to charge the cost of current
purchases to work in process or other operating expenses and to leave the oldest costs
in the inventory. Several alternatives can be used to apply the LIFO method. Each
procedure results in different costs for materials issued and the ending inventory, and
consequently in a different profit. It is mandatory, therefore, to follow the chosen
procedure consistently.
The advantages of the last in first out method are: Materials consumed are priced
in a systematic and realistic manner. It is argued that current acquisition costs are
incurred for the purpose of meeting current production and sales requirements;
therefore, the most recent costs should be charged against current production and
sales.
Unrealized inventory gains and losses are minimized, and reported operating profits are
stabilized in industries subject to sharp materials price fluctuations.
Inflationary prices of recent purchases are charged to operations in periods of rising
prices, Thus reducing profits, resulting in a tax saving, and therewith providing a cash
advantage through deferral of income tax payments. The tax deferral creates additional
working capital as long as the economy continues to experience an annual inflation rate
increase.
The disadvantages or limitations of the last in first out costing method are:
1. The election of last in first out for income tax purposes is binding for all
subsequent years unless a change is authorized or required by the Internal
Revenue Service (IRS)
2. This is a "cost only" method with no right down to the lower of cost or market
allowed for income tax purposes.
3. LIFO must be used in financial statements if it is elected for income tax
purposes. However, for financial reporting purposes, the lower of LIFO cost or
market can be used without violating IRS LIFO conformity rules.
4. Record keeping requirements under this method, as well as FIFO, are
substantially greater than those under alternative costing and pricing methods.
5. Inventories may be depleted due to unavailability of materials to the point of
consuming inventories costed at older or perhaps the oldest prices. This
situation will create a miss matching of current revenue and cost,
6. In standard number 411 "accounting for acquisition costs of materials, " the
cost accounting standards board "CASB" precludes the use of LIFO except
when applied currently on a specific identification basis. As a result, the use of
this method, when an annual LIFO adjustment is made, is ruled out for
government contracts to which CASB regulations apply.
3) AVERAGE COSTING METHOD:-
Issuing materials at an average cost assumes that each
batch taken from the storeroom is composed of uniform quantities from each
shipment in stock at the date of issue. Often it is not feasible to mark or label each
materials item with an invoice price in order to identify the used units with its
acquisition cost. It may be reasoned that units are issued more or less at random as for
as the specific units and the specific costs are concerned and that an average cost of all
units in stock at the time of issue is satisfactory measure of materials cost. However,
average costing may be used even though the physical withdrawal is an identifiable
order. If materials tend to be made up of numerous small items low in unit cost and
especially if prices are subject to frequent changes.
Advantages of Average Costing Method:
Average costing method has the following main advantages:
1. It is a realistic costing method useful to management in analyzing operating
results and appraising future production.
2. It minimizes the effect of unusually high or low materials prices, thereby making
possible more stable cost estimates for future work.
3. It is practical and less expensive perpetual inventory system.
The average costing method divides the total cost of all materials of a particular class
by the number of units on hand to find the average price. The cost of new invoices are
added to the total in the balance column; the units are added to the existing quantity;
and the new total cost is divided by the new quantity to arrive at the new average cost.
Materials are issued at the established average cost until a new purchase is recorded.
Although a new average cost may be computed when materials are returned to vendors
and when excess issues are returned to the storeroom, for practical purposes, it seems
sufficient to reduce or increase the total quantity and cost, allowing the unit price to
remain unchanged. When a new purchase is made and a new average is computed, the
discrepancy created by the returns will be absorbed.
a)Simple Average Method, issue price of materials are fixed at average unit price.
Simple average is an average of price without considering the quantities involved. The
average price is calculated by dividing the total of the rates of the materials in the stores
by the number of rates of prices.
Advantages Of Simple Average Method
Main advantages of simple average method are as follows:
1. Simple average method is very suitable when materials are received in uniform lot
quantities.
2. Simple average method is very easy to operate.
3. Simple average method reduces clerical work.
Disadvantages Of Simple Average Method
Major disadvantages of simple average method are as follows:
1. If the quantity in each lot varies widely, the average price will lead to erroneous costs.
2. Costs are not fully recovered.
3. Closing stock is not valued at the current assets.
b)Weighted Average Method:- The final method is called weighted average. This is a
"method in calculation in which the weighted average cost per unit for the period is the
cost of the goods available for sale divided by the number of units available for sale"
(Barron Education System). In this method, the order in which goods are purchased
does not matter. The costs of the goods are averaged at the end of the year to find your
cost of goods sold. The weighted average cost method is most commonly used in
manufacturing businesses where inventories are piled or mixed together and cannot be
differentiated, such as chemicals, oils, etc. Chemicals bought two months ago cannot
be differentiated from those bought yesterday, as they are all mixed together.
Main Reports:-
Materials ledger cards commonly show the account number, description or type of
material, location, unit measurement, and maximum and minimum quantities to carry.
These cards are the materials ledger with new cards prepared and old ones discarded as
changes occur in the types of materials carried in stock. The ledger card arrangement is
basically the familiar debit, credit, and balance columns under the description of
received, issued, and balance. Following is an example of material ledger card:
Example | Sample of materials ledger card:
Piece or Part No.____________________ Reorder
Point___________________
Description________________________ Reorder
Quantity_________________
Maximum Quantity__________________
Received Issue Balance
Date Res.
No Qty Amount Date
Res.
No Qty Amount Qty Unit cost Amount
Bin cards or stock cards are effective ready references that may be attached to
storage bins, shelves, racks, or other containers. Bin cards usually show quantities of
each type of materials received, issued, and on hand. They are not a part of the
accounting records as such, but they show the quantities on hand in the storeroom at
all times and should agree with the quantities on the materials ledger cards in the
accounting department.
Illustration: I Journalize the following transactions and prepare a cash ledger.
1. Ram invests Rs. 10, 000 in cash. 2. He bought goods worth Rs. 2000 from shyam. 3. He bought a machine for Rs. 5000 from Lakshman on account. 4. He paid to Lakshman Rs. 2000
5. He sold goods for cash Rs.3000 6. He sold goods to A on account Rs. 4000 7. He paid to Shyam Rs. 1000 8. He received amount from A Rs. 2000
Illustration II Journalize the following transactions and post them into Ledgers Jan 1. Commenced business with a capital of Rs. 10000 ,, 2. Bought Furniture for cash Rs. 3000 ,, 3. Bought goods for cash from ‘B’ Rs. 500 ,, 4. Sold goods for cash to A Rs. 1000 ,, 5. Purchased goods from C on credit Rs.2000 ,, 6. Goods sold to D on credit Rs. 1500 ,, 8. Bought machinery for Rs. 3000 paying Cash ,, 12. Paid trade expenses Rs. 50 ,, 18. Paid for Advertising to Apple Advertising Ltd. Rs. 1000 ,, 19. Cash deposited into bank Rs. 500 ,, 20. Received interest Rs. 500 ,, 24. Paid insurance premium Rs. 200 ,, 30. Paid rent Rs. 500 ,, 30. Paid salary to P Rs.1000 Illustration-III During January 2003 Narayan transacted the following business.
Date Transactions Amount
2003 Jan.1 ,, 2 ,, 3 ,, 4 ,, 5 ,, 6 ,, 7 ,, 8 ,, 9 , 10 , 11 , 12
Commenced business with cash Purchased goods on credit from Shyam Received goods from Murthy as advance for goods ordered by him Paid Wages Goods returned to shyam Goods sold to Kamal Goods returned by Kamal Paid into Bank Goods sold for Cash Bought goods for cash Paid salaries
40000 30000 3000 500 200 10000
500 500 750
1000. 700
1000
Journalize the above transactions and prepare cash Account
Illustration IV:
From the following list of balances prepare a Trial Balance as on 30-6-2003
i Opening Stock 1800 xiii Plant 750
ii Wages 1000 xiv Machinery tools 180
Illustration V Prepare a Trial Balance from the following Data for the year 2003.
Rs. Rs.
Freehold property 10800 Discount received 150
Capital 40000 Returns inwards 1590
Returns outwards 2520 Office expenses 5100
Sales 80410 Bad debts 1310
Purchases 67350 Carriage outwards(sales exp) 1590
Depreciation on furniture 1200 Carriage inwards 1450
Insurance 3300 Salaries 4950
Opening stock 14360 Book debts 11070
Creditors for expenses 400 Cash at bank 2610
Creditors 4700
Illustration: VI The following is the Trial Balance of Abhiram, was prepared on 31st March 2006. Prepare Trading and Profit& Loss Account and Balance Sheet.
Debit Rs. Credit Rs.
Capital
------ 22000
Opening stock 10000 ------
Debtors and Creditors 8000 12000
Machinery 20000 -------
Cash at Bank 2000 -------
Bank overdraft ------ 14000
Sales returns and Purchases returns 4000 8000
Trade expenses 12000 -------
Purchases and Sales 26000 44000
Wages 10000 -------
Salaries 12000 -------
Bills payable ------- 10600
Bank deposits 6600 -------
TOTAL Closing Stock was valued at Rs.60, 000
110600 110600
Illustration VII Prepare Trading and Profit &Loss A/C for the year ended 31.12.2001 and a Balance Sheet as on that date from the following Trial Balance.
iii Sales 12000 xv Lighting 230
iv Bank loan 440 xvi Creditors 800
v Coal coke 300 xvii Capital 4000
vi Purchases 7500 xviii Misc. receipts 60
vii Repairs 200 xix Office salaries 250
viii Carriage 150 xx Office furniture 60
ix Income tax 150 xxi Patents 100
x Debtors 2000 xxii Goodwill 1500
xi Leasehold premises 600 xxiii Cash at bank 510
xii Cash in hand 20
Dr, Rs. Cr, Rs.
Furniture 6500
Plant and machinery 60000
Buildings 75000
Capital 125000
Bad debts 1750
Reserve for bad debts 3000
Sundry debtors 40000
Sundry creditors 24000
Stock(1.1.2001) 34600
Purchases 54750
Sales 154500
Bank over draft 28500
Sales returns 2000
Purchase returns 1250
Advertising 4500
Interest 1180
Commission received 3750
Cash in hand 6500
Salaries 33000
General expenses 7820
Car expenses 9000
Taxes and insurance 3500
340000 340000
Closing stock valued at Rs. 50000 Illustration VIII The following figures have been extracted from the records of Fancy Stores a proprietary concern as on 31.12.2003.
Rs. Rs.
Furniture 15000 Insurance 6000
Capital A/C 54000 Rent 22000
Cash in hand 3000 Sundry debtors 60000
Opening stock 50000 Sales 600000
Fixed deposits 134600 Advertisement 10000
Drawings 5000 Postages & Telephone 3400
Provision for bad debts
3000 Bad debts 2000
Cash at Bank 10000 Printing and stationary 9000
Purchases 300000 General charges 13000
Salaries 19000 Sundry creditors 40000
Carriage inwards 41000 Deposit from customers 6000
Illustration IX
Prepare Trading, Profit and loss account and Balance sheet after taking into
consideration the following information.
a) Closing stock as on 31st March was Rs. 10000.
b) Salary of Rs. 2000 is yet to be paid to an employee.
Prepare Trading and Profit &Loss A/C for the year ended 31.12.2001 and a Balance Sheet as on that date from the following Trial Balance.
Debit Rs. Credit Rs.
Purchases 45000
Debtors 60000
Interest earned 1200
Salaries 9000
Sales 96300
Purchase returns 1500
Wages 6000
Rent 4500
Sales returns 3000
Bad debts return off 2100
Creditors 36600
Capital 31800
Drawings 7200
Printing and stationary 2400
Insurance 3600
Opening stock 15000
Office expenses 3600
Furniture and fittings 6000
GRAND TOTAL 167400 167400
Adjust the following a) Closing stock Rs.20000 b) Write off furniture @ 15% per annum.
UN IT – III
ISSUE OF SHARES AND DEBENTURES
CONCEPTS
Introduction
Company meaning, characteristics types
Share valuation, Issue of shares
Issue of shares premium & discount
Share forfeiture
Debenture valuation, Issue of Debenture
Issue of Debenture Premium & Discount
A company is a voluntary association of individuals formed to carry on business
to earn profits or for non profit purposes. These persons contribute towards the capital
by buying its shares in which it is divided. A company is an association of individuals
incorporated as a company possessing a common capital i.e. share capital contributed
by the members comprising it for the purpose of employing it in some business to earn
profit.
As per Companies Act 1956, a company is formed and registered under the
Companies Act or an existing company registered under any other Act”.
Characteristics of a Company
Following are the main characteristics of a company:
1) Artificial legal person
A company is an artficial person as it is created by law. It has almost all the
rights and powers of a natural person. It can enter into contract. It can sue in its own
name and can be sued.
2) Incorporated body
A company must be registered under Companies Act. By virtue of this, it is
vested with corporate personality. It has an identity of its own. Although the capital is
contributed by its members called shareholders yet the property purchased out of the
capital belongs to the company and not to its shareholders.
3)Capital divisible into shares
The capital of the company is divided into shares. A share is an indivisible unit
of capital. The face value of a share is generally of a small denomination which may be
of Rs 10, Rs 25 or Rs 100.
4) Transferability of shares
The shares of the company are easily transferable. The shares can be bought and sold
in the stock market.
5) Perpetual existence
A company has an independent and separate existence distinct from its share holders.
Changes in its membership due to death, insolvency etc. does not affect its existence
and its continuity.
6) Limited Liability
The liability of the shareholders of a company is limited to the extent of face value of
shares held by them. No shareholder can be called upon to pay more than the face
value of the shares held by them. At the most the shareholders may be asked to pay the
unpaid value of shares.
7) Representative Management
The number of shareholders is so large and scattered that they cannot manage the
affairs of the company collectively. Therefore they elect some persons among
themselves to manage and administer the company. These elected representatives of
shareholders are individually called the ‘directors’ of the company and collectively the
Board of Directors.
8) Common seal
A common seal is the official signature of the company. Any document bearing the
common seal of the company is legally binding on the company.
On the basis of ownership
On the basis of ownership, companies can be catagorised as :
(a) Private Company
A private company is one which by its Articles of Association :
(i) restricts the right of members to transfer its shares;
(ii) limits the number of its members to fifty (excluding its past and present employees);
(iii) prohibits any invitation to the public to subscribe to its shares, debentures.
(iv) The minimum paid up value of the company is one lakh rupees (Rs 100000).
The minimum number of shareholders in such a company is two and the company is
to add the words ‘private limited’ at the end of its name. Private companies do not
involve participation of public in general.
(b) Public Copmpany
A company which is not a private company is a public company. Its Articles of
association does not contain the above mentioned restrictions.
Main features of a public company are :
(i) The minimum number of members is seven.
(ii) There is no restriction on the maximum number of members.
(iii) It can invite public for subscription to its shares.
(iv) Its shares are freely tansferable.
(v) It has to add the word ‘Limited’ at the end of its name.
(vi) Its minimum paid up capital is five lakhs rupees (Rs 500,000).
SHARE VALUATION
A joint stock company divides its capital into units of equal denomination. Each
unit is called a share. These units i.e. shares are offered for sale to raise capital. This is
termed as issuing shares. A person who buys share/ shares of the company is called a
shareholder and by acquiring share or shares in the company he/she becomes one of
the owners of the company Thus, a share is an indivisible unit of capital. It expresses
the proprietary relationship between the company and the shareholder. The
denominated value of a share is its face value. The total capital of a company is divided
into number of shares.
Kinds of shares
According to the Companies Act1956, a company can issue the following types
of Shares:
(i) Equity shares (ii) Preference shares(iii)Deferred Shares
1) Equity shares
All shares which are not preference shares are equity shares. Holders of these shares
receive dividend out of the profits of the company after the payment of dividend has
been made to the preference shareholders. Equity shareholders have the right to elect
directors of the company. Equity shares are the permanent source of capital
2) Preference shares
A preference share is one which carries following preferential rights over
other type of shares called equity shares in regard to the following: Payment
of dividend Repayment of capital at the time of winding up of the company.
3) Deferred Shares
Deferred shares are a form of stock that is sometimes issued to key people
within the issuing company. Usually, executives or directors of the company are
eligible to receive deferred shares of stock. As part of a deferred share issue, the
holders of the shares may not redeem them as long as they are in the employ of the
company.
ISSUE OF SHARES
Issue of Shares for cash
In general, shares are issued for cash. The company may call the share money either in
one installment or in two or more installments. But company always collects this
money through its bankers.
The company may receive the share money in one installment along with
application. In this case the following journal entries are made in the books of the
company
Selling of application
1. On Receipt of Application Money (selling of applications )
Bank A/c Dr
To Share Application A/c
(Being Application money received)
2. On transferring the Application Money
Share Application A/c Dr
To Share Capital A/c (Application money transferred to share capital A/c) On allotment of shares
After receiving the application for shares within the prescribed time, the Board
of Directors of the company proceed to allot shares. On allotment of shares the
applicaion money is transferred to Share Capital A/c. For this the following journal
entry is made :
3. On allotment of Share
Share Allotment A/c Dr
To Share Capital A/c
(Being Share allotment money due shares are allotted
4. Receipt of allotment money
Bank A/c Dr
To Share Allotment A/c.
(Receipt of the amount due on allotment of … shares)
Calls on shares
After the receipt of application and allotment money the money that remains unpaid
can be called up by the company as and when required. Thus a call is a demand made
by the company asking the shareholders to remit the called up amount on shares
allotted to them.
The company may demand the remaining money in more than two instalments. The
amount called after the allotment is known as call money. There may be one or more
calls, depending on the funds requirements of the company.
5) When only one call is made Call Money is Due :
Share First and Final Call A/c Dr
To Share Capital A/c.
(Being share capital money called up).
6) Receipt of call money The following journal entry is made for receipt of call money
Bank A/c Dr
To Share First & Final call A/c
(Being share capital Call money received)
Note: If the company makes more than one call the same accounting treatment is
followed for recording the second call or third call money due and their receipt. The
last call made is termed as final call.
ISSUE OF SHARES AT PREMIUM
A company can issue its shares at their face value. When company issues its shares at
their face value, the shares are said to have been issued at par. Company can also issue
its shares at more than or less than its face value i.e, at ‘Premium’ or at ‘Discount’
respectively. When shares are issued at premium or at discount an accounting treatment
different from shares issued at par is
If a company issues its shares at a price more than its face value, the shares are
said to have been issued at Premium. The difference between the issue price and face
value or nominal value is called ‘Premium’. If a share of Rs 10 is issued at Rs 12, it is
said to have been issued at a premium of Rs 2 per share. The money received as
premium is transferred to Securities Premium A/c. A company issues its shares at
premium only when its financial position is very sound. It is a capital gain to the
company. The Premium money may be demanded by the company with application,
allotment or with calls. The Companies Act has laid down certain restrictions on the
utilization of the amount of premium.
According to Section 78 of this Act, the amount of premium can be utilized for :
(i) Issuing fully-paid bonus shares;
(ii) Writing off preliminary expenses, discount on issue of shares, Underwriting
commission or expenses on issue;
Accounting Treatment of premium on Issue of Shares
Following is the accounting treatment of Premium on issue of shares:
(a) Share premium collected with share Application wd money:
Share Application A/c Dr
To Share Capital A/c
To Share Premium A/c
(Being Share application money transferred to share capital A/c and securities)
( b) allotment of shares with Premium
Share Allotment A/c Dr
To Share Capital A/c
(Being Share are allotted)
(c) Premium collected with Allotment money or Calls.
Bank A/c Dr
To Share Capital A/c
To Share Premium A/c
(Being Share allotment money is received )
ISSUE OF SHARES AT DISCOUNT
When the issue price of share is less than the face value, shares are said to have been
issued at discount. For example if a company issues its shares of Rs 100 each at Rs. 90
each, the shares are said to be issued at discount. The amount of discount is Rs 10 per
share (i.e. Rs 100 – Rs 90). Discount on shares is a loss to the company. Section 79 of
Companies Act 1956 has laid down certain conditions subject to which a company can
issue its shares at a discount. These conditions are as follows :
(i) At least one year must have elapsed from the date of commencement of business;
(ii) Such shares are of the same class as had already been issued;
(iii) The company has sanctioned such issue by passing a resolution in its General
meeting and the approval of the court is obtained.
(iv) Discount should not be more than 10% of the face value of the share and if the
company wants to give discount more than 10%, it will have to obtain the sanction of
the Central Government.
Accounting Treatment of Shares Issued at Discount
The amount of discount is generally adjusted towards share allotment money and the
following journal entry is made:
Share Allotment A/c Dr
Discount on issue of shares A/c Dr
To Share Capital A/c
(Being shares are Allotment on discount )
FORFEITURE OF SHARES MEANING AND PROCEDURE
If a shareholder fails to pay the due amount of allotment or any call on shares
issued by the company, the Board of directors may decide to cancel his/her
membership of the company. With the cancellation, the defaulting shareholder also
loses the amount paid by him/her on such shares. Thus,
when a shareholder is deprived of his/her membership due to non payment of calls, it
is known as forfeiture of shares.
Forfeiture of shares issued
When shares issued at par are forfeited the accounting treatment will be as follows:
(i) Debit Share Capital Account with amount called up (whether received or not)
per share up to the time of forfeiture.
(ii) Credit Share Forfeited A/c. with the amount received up to the time of
forfeiture.
(iii) Credit ‘Unpaid Calls A/c’ with the amount due on forfeited shares. This cancels
the effect of debit to such calls which take place when the amount is made due.
The journal entry is :
Share capital A/c Dr
To share forfeited A/c
(Being shares are Forfeiture)
ISSUE OF DEBENTURES
A Debenture is a unit of loan amount. When a company intends to raise the
loan amount from the public it issues debentures. A person holding debenture or
debentures is called a debenture holder. A debenture is a document issued under the
seal of the company. It is an acknowledgment of the loan received by the company
equal to the nominal value of the debenture. It bears the date of redemption and rate
and mode of payment of interest. A debenture holder is the creditor of the company.
As per section 2(12) of Companies Act 1956, “Debenture includes debenture stock,
bond and any other securities of the company whether constituting a charge on the
company’s assets or not”.
1. Debentures issued for cash at par :
(i) Application money is received
Bank A/c Dr
To Debentures Application A/c
(Application money received for Debentures)
(ii) Transfer of debentures application money to debentures account on their
allotment
Debentures Application A/c Dr To Debentures A/c
(Being Application money transferred to debenture account on allotment)
(iii) Money due on allotment
Debentures Allotment A/c Dr
To Debentures A/c
(Being Allotment money made due)
(iv) Money due on allotment is received
Bank A/c Dr To Debentures Allotment A/c
(Receipt of Debenture allotment money) (v) First and final call is made
Debentures First and Final call A/c Dr To Debentures A/c
(Being First and Final call money made due on ............... debentures) (vi) Debentures First and Final call money is received
Bank A/c Dr
To Debentures First and Final call A/c
(Being Receipt of Amount due on call)
Note : Two calls i.e. first call and second call may be made
Journal entries will be made on the lines made for first and final call.
ISSUE OF DEBENTURES AT PREMIUM
Debentures are said to be issued at premium when these are issued at a value
which is more than their nominal value. For example, a debenture of Rs 100 is issued at
Rs 110. This excess amount of Rs 10 is the amount of premium. The premium on the
issue of debentures is credited to the Securities Premium A/c as per section 78 of the
Companies Act, 1956.
Journal entry will be as follows :
Debentures Allotment A/c Dr To Debentures Account To Debentures s Premium A/c
(being Amount due on allotment alongwith premium of Rs ....)
ISSUE OF DEBENTURES AT DISCOUNT
When debentures are issued at less than their nominal value they are said to be
issued at discount. For example, debenture of Rs 100 each is issued at Rs 90 per
debenture. Companies Act, 1956 has not laid down any conditions for the issue of
debentures at a discount as have been laid down in case of issue of shares at discount.
However, there should be provision for issue of such debentures in the Articles of
Association of the Company.
Journal entry for issue of debentures at discount (at the time of allotment)
Debentures Allotment A/c Dr Discount on issue of debentures A/c Dr
To Debentures A/c (Being Debentures are Allotted at Discount)
UNIT – IV
FINANCIAL STATEMENTS – I Introduction
Meaning & Objectives of Fund & Cash Flow Statement Analysis
Statement, Schedule of Changes in Working Capital
Advantages of Preparing Fund Flow Statement
Cash Flow Statement Vs Fund Flow Statement
Statement, Schedule of Funds from operations
Advantages of Preparing Cash Flow Statement
INTRODUCTION
Every business establishment usually prepares the balance sheet at the end of the fiscal
year which highlights the financial position of the yester years It is subject to change in the
volume of the business not only illustrates the financial structure but also expresses the value
of the applications in the liabilities side and assets side respectively. Normally, Balance sheet
reveals the status of the firm only at the end of the year, not at the beginning of the year. It
never discloses the changes in between the value position of the firm at two different time
periods/dates. The method of portraying the changes on the volume of financial position is
the statement fund flow statement. To put them in nutshell, fund between two different time
periods. It is further illustrated that the changes in the financial position or the movement or
flow of fund.
To have smoothness in the operations of the enterprise, the firm should have an
appropriate volume of cash resources at speedier rate as well as more than the financial
commitments of the firm. This smoothness could be attained by way of an appropriate
planning analysis on the cash resources of the firm. The meaningful analysis is only possible
through cash flow statement analysis which facilitates the firm to identify the possible sources
of cash as well as the expenses and expenditures of the firm.
MEANING & OBJECTIVES OF FUND FLOW STATEMENT ANALYSIS
The term flow denotes the change. Flow of funds means the change in funds or in
working capital. The change on the working capital leads to the net changes taken place on the
working capital i.e., especially due to either increase or decrease in the working capital. The
change in the volume of the working capital due to numerous transactions. Some of the
transactions may lead to increase or decrease the volume of working capital. Some other
transactions neither registers an increase nor decrease in the volume of working capital.
According Foulke “A statement of source and application of funds is a technical device
designed to analyse the changes to the financial condition of a business enterprise in between
two dates”
Objectives of fund flow statement analysis:
(1) It pinpoints the mobilization of resources and the further utilization of resources
(2) It highlights the financing of the general expansion of the business firms
(3) It exemplifies the utilization of debt finance in the structure of financing
(4) It portrays the relationship between the financing, investment, liquidity and dividend
decision of the firm during the given point of time.
MEANING & OBJECTIVES OF CASH FLOW STATEMENT ANALYSIS
The cash flow statement is being prepared on the basis of an extracted information of
historical records of the enterprise. Cash flow statements can be prepared for a year, for six
months , for quarterly and even for monthly. The cash includes not only means that cash in
hand but also cash at bank.
Objectives of preparing the cash flow statement:
(1) To identify the causes for the cash balance changes in between two different time periods,
with the help of corresponding two different balance sheets.
(2) To enlist the factors of influence on the reduction of cash balance as well as to indicate the
reasons though the profit is earned during the year and vice versa.
(3)To identify the reasons for the reduction or increase in the cash balances irrespective level
of the
Profits earned by the firm.
(4)l It facilitates the management to maintain an appropriate level of cash resources.
CASH FLOW STATEMENT VS FUND FLOW STATEMENT
CASH FLOW STATEMENTS FUND FLOW STATEMENTS
Cash inflow and outflow are only considered Increase or decrease in the working capital is
registered
Causes & changes of cash position Causes & changes of working capital position
Considers only most liquid assets pertaining
to cash resource ; which fosters only for very
short span of planning
Considers in general i-e current assets ; the
duration of the liquidity of the current assets
are longer in gestation than the liquid assets ;
which paves way for long span of planning
Opening and closing balances of cash
resources are considered for the preparation
Increase or decrease of working capital is
considered but not the opening and closing
balance for preparation
The flow in the statement means real cash
flow
The flow in the statement need not be real
cash flow
It helps the management to understand its
capacity at the moment of borrowing for
any further capital budgeting decisions
It helps the management to the mobilization
of resources and the further utilization of
resources
It facilitates the management to maintain an
appropriate level of cash resources
It exemplifies the utilization of debt finance in
the structure of financing
METHODS OF PREPARING FUND FLOW STATEMENT
Steps in the preparation of Fund Flow Statement:
1) First and fore most method is to prepare the statement of changes in working capital
i.e., to identify the flow of fund / movement of fund through the detection of changes
in the volume of working capital.
2) Second step is the preparation of Non- Current A/c items-Changes in the volume of
Non current a/cs have to be prepared only in order to quantify the flow fund i-e either
sources or application of fund.
3) Last step is the preparation of fund flow statement.
SCHEDULE OF CHANGES IN WORKING CAPITAL
The ultimate purpose of preparing the schedule of changes in the working capital is to
illustrates the changes in the volume of net working capital which envisages either sources or
application of fund. The schedule of changes is focused as follows:
FUND FLOW FROM OPERATIONS (FFO) Fund from operations can be determined in two different ways .The first method is through the statement format
PARTICULARS AMOUNTS AMOUNTS
Net Profit from the Profit & Loss A/c (Add: ) Non Funding Expenses: Loss on Sale of Fixed Assets Loss on Sale of Long Term Investments Loss on Redemption Debentures/Preference Shares Discount on Debentures /Share Depreciation of fixed Assets Amortization of Goodwill Amortization of Patent Amortization of Trade Mark Writing off Preliminary expense Writing off Discount on Shares/Debentures Add Non Operating Expenses
Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx
Xxxx
Xxx
_____________ XXXX
Less: Non Funding Incomes Profit on Sale of Fixed Assets Profit on Sale of Long Term Investments Profit on Redemption Debentures/Preference Shares Dividend Received Interest Received Rent Received Profit & loss a/c profit Fund From operations / Fund Lost in Operations
Xxx Xxx Xxx Xxx Xxx Xxx Xxx
Xxxx
XXXXX
ADVANTAGES OF PREPARING FUND FLOW STATEMENT
It is a statement which highlights the role of various kinds of financing not only in the
dimension of project development and expansion but also growth rate of the organization.
To fulfill the Primary Objective of the Financial Management
It not only elucidates the mode of financing but also the application of resources after raising.
It answers to the following queries viz:
1) How the outsider's liabilities are redeemed?
2) What is the role of the fund from operation generated?
3) How the raised funds applied into business?
4) How the decrease in working capital was applied?
5) What is the mode of raising of financial resources for an increase in the working
capital?
Facilitation through Financial Planning
The projected fund flow statement from the past performance facilitates the firm to anticipate
the future requirement of financial resources. It guides the management to prioritize the
application in the future to the tune of scarce resources.
Guide to Working Capital Management
It acts as a guide to the management to maintain the working capital at optimum level through
either purchase or sale of marketable securities during the periods of adequate and inadequate
working capital respectively.
Indicator of Yester Track Path of the Firm
The insight on the financial performance of the firm can be had by the lending institutions
through fund flow statement at the time of extending financial assistance to the firm.
Limitations:
1) It is an extension of financial statements but it cannot be leveled with the emphasis of them.
2) It is not a resultant of the transaction instead it is an arrangement of among the available
information.
3) Projected fund flow statement ever only to the tune of financial statements which are
historic in feature.
ADVANTAGES OF PREPARING CASH FLOW STATEMENT
Utility of cash flow statements are as follows:
1) To identify the reasons for the reduction or increase in the cash balances irrespective
level of the profits earned by the firm.
2) It facilitates the management to maintain an appropriate level of cash resources.
3) It guides the management to take futuristic decisions on the prospective demands and
supply of cash resources through projected cash flows.
4) How much cash resources are required?
5) How much cash requirements could be internally settled?
6) How much cash resources are to be raised through external sources?
7) Which type of instruments is going to be floated for raising the required resources?
8) It helps the management to understand its capacity at the moment of borrowing for
any further capital budgeting decisions.
9) It paves way for scientific cash management for the firm through maintenance of an
appropriate cash levels i-e optimum level cash of resources
10) It avoids in holding excessive or inadequate cash resources through proper planning
of cash resources.
11) It moots control through identification of variations occurred in the cash expenses and
expenditures.
FORMAT OF FUNDS FLOW STATEMENT
PARTICULARS AMOUNTS
Sources:
Funds from operations
Issue of shares
Issue of Debentures
Long term loans
Sale of assets
No trading incomes
Decresing in working capital
Applications:
Redemption of debenture
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
_____________
_____________
Xxx
Xxx
Repayment of long term loans
Purchase of fixed assets
Payment of dividend
Payment of tax
Increase in working capital
Xxx
Xxx
Xxx
Xxx
Xxx
Xxxx
Format for Cash flow Statement (i) Cash flow from operating activities A. Operating cash receipts
Cash sales xxx Cash received from customers xxx Trading commission received xxx Royalties received xxx
B. Less : Operating cash payment
Cash purchase xxx Cash paid to the supplier xxx Cash paid for business expenses like xxx office expenses, Manufacturing expenses, selling and distribution expenses
C. Cash generated from operation ( A – B) xxx D. Less Income tax paid (Net of tax refund received) xxx E. Cash flow before extraordinary items xxx F. Adjusted extraordinary items (+/–)/Receipt/payment xxx G. Net cash flow from (or used in) operating activities xxx (ii) Cash flow from investing activities (calculation same as xxx
under indirect method)
(iii) Cash flow from financing activities xxx
(Calculation same as under indirect method)
(iv) Net increase/decrease in cash and cash equivalents (i + ii + iii) xxx
(v) Add cash and cash equivalent in the beginning of the year xxx
(same as under indirect method)
(vi) Less cash under cash equivalent in the end of the year xxx
xxx
UNIT - V
INTRODUCTION TO RATIO ANALYSIS
CONCEPTS
Synopsis:
Introduction
Advantages & Disadvantages o ratios
Types of ratios
Liquidity ratio
* Current ratio
* Quick ratio
Leverage ratio
* Debt and equity ratio
* Interest coverage ratio
Profitability ratio
* Gross profit ratio
* Net profit ratio
* Operating ratio:
* Earnings per share (EPS)
Ratio analysis is a very important of financial data. It is the process of establishing a
significant relationship between the items of financial statement to provide a meaningful
understanding of the performance and financial position of a firm.
A ratio is a simple mathematical expression. It is a number expressed in terms of
another number expressing the quantitative relationship between the two. Ratio analysis is the
technique of inter petition of financial statements with the help of various meaningful ratio’s.
Ratios do not add to any information that is already available but they show the
relationship between two items in a more meaningful way, which help us to draw certain
conclusions and comparison with
Comparison of past data
Comparison of one firm with another firm
Comparison of one firm with the industry
Comparison of an achieved performance with pre-determined standards.
Comparison of one department of a concern with other departments.
“The Ratios can be expressed as percentage or properties or times based on the nature of
ratio.”
Importance /Advantages
Ratio analysis simplifies the understanding of financial statements.
Ratios serve as effective control tools.
Ratio facilitate inter firm and intra firm comparisons.
Ratio contributes significantly towards effective planning and forecasting.
Ratio brings out the inter-relationship among various financial figures and brings to
light their financial significance and it is a device to analyses and interprets the financial
health of the enterprise.
Useful in locating the weak spots of the business.
Useful in comparison of performance.
Useful in simplifying accounting figures.
LIMITATIONS:
Ratio analysis is very important in reveling the financial position and soundness of the
business. But in spite of its advantages it has some limitations, which restrict its use these
limitations should be kept in mind making use of ratio analysis for interprets.
False results it based on incorrect accounting data.
No idea of probable happenings in future.
Ratio analysis suffers from lack of consistency.
Ratio is volatile and can be influenced by a single transaction with extreme value.
Ratio is based on past data and hence cannot be reliable guide to future performance.
Ratio is only indicators they need a proper analysis by a capable management. They
are only the means. And not an end in the interpretation of financial statements.
Ratio can be calculated only on the basis on the data. If the original data is not reliable
then ratio will be misleading.
Ratios fail to reflect the impact of price level change and hence can be misleading.
Types of Ratios
Under liquidity (or) short term ratio:
Current ratio (or) working capital ratio:
Current ratio is the ratio of current assets and current liabilities current assets are assets, which
can be converted in to cash with in one year and include cash in hand and at bank bills R/B,.
Net sundry debtors, stock of raw materials, finished goods etc.
Current liabilities are liabilities, which are repaid with in a period of one year and include bills
payable, sundry creditors’ band over draft. Etc.
Current ratio = Current Assets /Current Liabilities.
Quick Ratio:
Quick ratio is the ratio of quick assets to quick liabilities. Quick assets are
assets, which can be converted into cash very quickly with out much loss.
Quick liabilities are liabilities, which have to be necessarily paid with in short
period of time.
Quick ratio = Quick assets.
Quick liabilities.
Quick assets = Current Assets- (stock + prepaid exp)
Quick liabilities = Current Liabilities -- Bank overdraft.
Under capital structure ratio (or) leverage:
Leverage ratios indicate the relative interests of owners and creditors in a business.
Debt and equity ratio:
Debt usually refers to long term liabilities equity includes equity and preference
share capital and reserves.
Debt and Equity Ratio = Long term Liabilities
Share Holders Funds.
Long-term liabilities (debentures, bands, and loans.)
Interest coverage ratio or debt service ratio:
This ratio indicates whether a business is earning sufficient profits to pay the interest charges.
Interest coverage ratio = PBIT/Fixed Interest charges.
PBIT = profit before interest and taxation.
Under Activity Ratio (Or) Turnover Ratios:
Activity ratio measures the efficiency or effectiveness with which a
firm manages its resources or assets.
Inventory turnover ratio:
Stock turnovers ratio indicates the number of times the stock has turned over into sales in
a year.
Inventory turnover ratio = Cost of goods sold/Average stock.
Cost of goods sold = sales – gross profit.
Average stock = opening stock (or) c.s/2.
Debtor’s turnover ratio:
Debtor turnover ratio expresses the relationship between debtors and sales.
Debtors turnover ratio = net credit sales/average debtors
Profitability ratio:
Profitability ratios measure the profitability of a concern generally
they are calculated either in relation to sales or in relation to investment.
Gross profit ratio:
It reveals the result of trading operations of the business.
Gross profit ratio = Gross profit/Net sales.
Gross profits = net sales – cost of goods sold.
Net sales = total sales – sales returns.
Net profit ratio:
It indicates the results of over all operations of the firm.
Net profit ratio = Profit after tax/Net sales.
Operating ratio:
It expresses the relationship between expenses incurred for punning the business and
the resultant net sales.
Operating ratio = operating cost/net sales.
Operating cost= cost of goods sold + office all exp.
Earnings per share (eps)
Earnings per share are the net profit after tax and preference dividend, which is earned
on the capital reprehensive of one equity share.
E p s = profit after tax – preference dividend/No. Of equity shares.
Price earnings ratio:
It expresses the relationship between market price of share of a company and the
earnings per share of that company.
Price earnings ratio = market price of equity share/earnings per share.
1. Discuss the importance of Ratio Analysis for inter firm and intra-firm comparison, including circumstances responsible for its limitations, if any.
2. How are ratios classified for the purpose of financial analysis? With assumed data, illustrate any two types of ratios under each category?
3. Write a brief note on the importance of ratio analysis to different category of users. 4. What are the limitations of Ratio Analysis? Does ratio analysis really measure the
financial performance of a company? 5. following is the Profit and Loss account and Balance Sheet of Jai Hind Ltd. Calculate
the following ratios: a) Gross Profit Ratio b) Current Ratio Profit and Loss Account c) Quick ratio
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