Financial Statements

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FINANCIAL Statements

1

FINANCIAL ACCOUNTING: I

INTRODUCTION TO FINANCIAL STATEMENTS www.biZkul.com www.biZkul.com

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FINANCIAL STATEMENTS ¯

The State of affairs of the organization:

BALANCE SHEET ¯

Working results for a given period:

PROFIT AND LOSS ACCOUNT ¯

Cash receipts & payments during a period:

CASH FLOW STATEMENT www.biZkul.com www.biZkul.com

3

ACCOUNTING ¯

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An information system communicating the financial position of a company, sometimes known as the language of business Accounting is expected to give the true and fair view of – The state of affairs of the organization and – Its working results www.biZkul.com for a given period www.biZkul.com

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EXERCISE ¯ ¯

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Ram Kumar is a professional In his first three years of service, he earned Rs. 2 lakhs, 2.2 lakhs and 2.5 lakhs respectively His expenses in these three years were Rs. 1.2 lakhs, 1.6 lakhs and 1.8 lakhs, respectively - What do you understand from this? www.biZkul.com www.biZkul.com

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EXERCISE ¯ ¯

LET US LOOK AT THESE EXPENSES IN SOME MORE DETAIL: In the first year (Y 1) Ram stayed in a lodge In Y 2 he rented an apartment, paying a deposit of Rs.15,000. His expenses for the year included this amount of deposit and payment towards furniture of Rs. 15,000. The furniture had an expected life of 5 years. - How will you interpret this information www.biZkul.com www.biZkul.com

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EXERCISE ¯

In Y3 he invested in a plot of land costing Rs. 2 lakhs. This was funded by borrowing Rs.1.6 lakhs from a bank - How will you interpret this information? - What do you think of the financial www.biZkul.com www.biZkul.com

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BUSINESS ACTIVITY ¯

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Money is invested in a commercial enterprise with a view to earning profits and being sustainable Money circulates in a business and is used for a variety of purposes – Capital expenditure, other expenditure, returned to lenders, distributed to shareholders, invested etc

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Profits may be earned immediately (ITES/Consulting/Service) or some time into the future (Manufacturing/Biotech) www.biZkul.com www.biZkul.com

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MEASURES OF SUCCESS IN BUSINESS ¯

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How does one measure whether a business is successful or not One needs to have a system of measurement of the financials of a business These need to be comparable, over time and across companies - What do you think could be some measures of success in a business? www.biZkul.com www.biZkul.com

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MEASURES OF PERFORMANCE ¯

Some measures – Revenue compared to others companies, in country, in same industry – Profits, gross and net after taxes – Number of employees – Revenue per employee – Growth in same company from one period to the next www.biZkul.com www.biZkul.com

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ANNUAL REPORTS ¯

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Business entities bring out annual reports which contain financial and non financial information Reports are made available to shareholders, government and other interested persons There are guidelines to be followed and statutory compliances to be www.biZkul.com www.biZkul.com

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ANNUAL REPORTS Users ¯ Internal – Owners and managers ¯

External – Investors, lenders, suppliers and creditors, customers, government and its agencies, public, analysts, advisors www.biZkul.com www.biZkul.com

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KEY CONTENT OF ANNUAL REPORTS ¯

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Financial statements – balance sheet, profit and loss account, cash flow statement, consolidated financial statements Letter to shareholder Director’s report Management discussion and analysis Auditors’ report www.biZkul.com 13 www.biZkul.com

OTHER CONTENT OF ANNUAL REPORTS ¯

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Some companies provide additional information, this includes Value reporting Brand valuation Human resource accounting

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ANNUAL REPORTS

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You have an annual report with you; what information would you seek as: A short term investor A long term investor An employee A customer www.biZkul.com www.biZkul.com

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ANNUAL REPORTS Do you think that one set of financial statements and other information in the Annual Report can meet the requirements of all users/readers?

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FINANCIAL STATEMENTS Used for ¯

– Measurement, forecasting, decision making, evaluation, control, stewardship, government and statutory regulation ¯

Characteristics – Understandable – Reliable – Relevant www.biZkul.com www.biZkul.com

17

FINANCIAL ACCOUNTING: I

BALANCE SHEET

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BALANCE SHEET ¯

Sources of funds – Shareholders funds – Loan funds

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Application of funds – Fixed assets – Investments – Current assets less current liabilities and provisions – Miscellaneous expenses www.biZkul.com www.biZkul.com

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BALANCE SHEET ¯

Sources of funds – Share capital (equity, preference) – Reserves and surplus (specific reserves, surplus profit not appropriated to any specific reserve) – Secured loans (from financial institutions, commercial banks) www.biZkul.com www.biZkul.com

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BALANCE SHEET ¯

Sources of funds (contd.) – Unsecured loans (fixed deposits, promoters, intercorporate loans) – Current liabilities and provisions (dues to suppliers, payments received in advance, expenses accrued for rent, salary, pension, etc.) www.biZkul.com www.biZkul.com

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BALANCE SHEET ¯

Application of funds – Fixed assets (Long term assets not for resale, land, buildings, machinery, vehicles, computers, office equipment, furniture) – Investments (long term or short term) www.biZkul.com www.biZkul.com

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BALANCE SHEET ¯

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

FINANCIAL ACCOUNTING: I

PROFIT AND LOSS ACCOUNT www.biZkul.com www.biZkul.com

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PROFIT AND LOSS ACCOUNT ¯

Income

– Sales (gross sales) – Other income (interest, dividend, rental income, miscellaneous sales)

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PROFIT AND LOSS ACCOUNT Expenditure ¯

– Manufacturing (Raw material costs, direct factory expenses) – Sales and general administration (SG&A) – Other miscellaneous – Depreciation (non-cash expense, amortisation of fixed asset cost over a period) ¯

Prior year adjustments, appropriation www.biZkul.com www.biZkul.com

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KEY EQUATIONS ¯

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Shareholders Stake = Assets – Liabilities Profit = Sales – Costs ( Costs of material used = Opening stock + purchases – www.biZkul.com www.biZkul.com

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QUESTION ¯ ¯

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You are a finance professional in a company I am also a finance professional in the same company We both independently prepare the financial statements in our company Will you and I arrive at the same numbers in terms of – Sales? – Profits? www.biZkul.com Why? Why not? www.biZkul.com

28

EXERCISE ¯

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

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400 units were consumed in January

What is the cost of the material www.biZkul.com www.biZkul.com

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EXERCISE ¯

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

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These are accounting methods for calculating costs www.biZkul.com www.biZkul.com

30

EXERCISE ¯

C & Co. purchases the following: – – – –

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LOT LOT LOT LOT

A: Jan 10th, 200 units at Re 1 each B: Jan 15th, 100 units at Re 1.1 each C: Jan 25th, 150 units at Re 1.2 each D: Feb 10th, 300 units at Re 1.2 each

400 units were consumed in January 200 units were consumed in February What is the cost of the material consumed in the months of Jan and Feb under the FIFO and LIFO methods? www.biZkul.com www.biZkul.com

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ASSIGNMENT ¯ ¯

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Jan sales – Rs. 1000 Feb sales – Rs. 1000 Other costs in Jan – Rs. 500 Other costs in Feb – Rs. 500

For Jan and Feb, under the FIFO and LIFO methods: - What is profit - What is the inventory balance, www.biZkul.com www.biZkul.com

32

GAAP and ACCOUNTING STANDARDS

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GAAP Generally Accepted Accounting Principles ¯

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Refer to rules, conventions, principles, procedures To be followed by enterprises in preparation of financial statements www.biZkul.com www.biZkul.com

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ACCOUNTING STANDARDS Set of broad guidelines regarding ¯

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accounting policies adopted by organisations in preparation of financial statements Select set of accounting policies Confirm to applicable laws, custom, business environment (Refer www.icai.org - Web site of Institute of Chartered Accountants of India for detailed Accounting Standards) www.biZkul.com www.biZkul.com

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Framework of Accounting Fundamental accounting assumptions ¯ ¯ ¯

Going concern Consistency Accrual

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Key Accounting Concepts Entity ¯ ¯ ¯ ¯ ¯ ¯ ¯ ¯

Money measurement Cost concept Realisation Periodicity Matching Dual aspect Conservatism www.biZkul.com www.biZkul.com

37

CASELET ¯

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Ramesh Vyas, the CFO of Case Co. Ltd tells his finance manager, Prema John that the profits this year have been unusually bad and that the will pick up in the next year. Previous years profits have been reasonable. Ramesh wants to change the accounting policy and show reduced profits in this year (Big bath method). FIFO method for inventory valuation is followed; prices of inventory have been steadily increasing in the past few years. www.biZkul.com www.biZkul.com

38

CASELET ¯

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Prema is not comfortable with Ramesh’s suggestion as she feels that this is unethical and that this may backfire Profits under FIFO: – in the past three years: 10, 13, 15 – Current year : 12 – Expected in next year : 16

What change in policy is Ramesh suggesting? Do you agree with Prema or not? Why or why not? www.biZkul.com 39 www.biZkul.com

ACCOUNTING ¯

Rules are not absolutely rigid and provide some flexibility within a framework, keeping in mind – – – –

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Economic position Social needs Regulatory frameworks Technical developments

GAAP in India is influenced by ICAI, SEBI, RBI, DCA etc. www.biZkul.com www.biZkul.com

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FORMS OF BUSINESS ORGANISATIONS ¯ ¯ ¯

Sole Proprietorship Partnership Limited Co – Private – Public

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Statutory Bodies Mutual Funds Trusts www.biZkul.com www.biZkul.com

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ACCOUNTING BASICS ¯

Transaction occurs – With funds in flow – Without funds flow

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Transactions are recorded in accounts, eg. – – – – –

Cash/bank Debtors Advance accounts Capital Accruals www.biZkul.com www.biZkul.com

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ACCOUNTING PROCESS ¯ ¯ ¯

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Accounts periodically summarised Rectification entries may be passed Adjustment entries may be passed (eg accruals, advances settled) Trial Balance is prepared Trial Balance has to tally Concept of double entry book keeping Financial statements are prepared www.biZkul.com www.biZkul.com

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ACCOUNTING PROCESS Data

Entry Passe d

Account

Final Trial Balance

Trial Balance

Final Financial Statement

Financial Statement s

Rectification Entry Passed

44

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