1 introduction to financial statements
TRANSCRIPT
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INTRODUCTION TO
FINANCIAL STATEMENTS
FINANCIAL
ACCOUNTING: I
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FINANCIAL STATEMENTS The State of affairs of the organization:
BALANCE SHEET
Working results for a given period:
PROFIT AND LOSS ACCOUNT
Cash receipts & payments during a period:
CASH FLOW STATEMENT
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ACCOUNTING
An information system -communicating the financial position of a company, sometimes known as the language of business
Accounting is expected to give the true and fair view of
–The state of affairs of the organization and
– Its working results for a given periodwww.biZkul.com
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EXERCISE
Ram Kumar is a professional
In his first three years of service, he earned Rs. 2 lakhs, 2.2 lakhs and 2.5 lakhs respectively
His expenses in these three years were Rs. 1.2 lakhs, 1.6 lakhs and 1.8 lakhs, respectively
- What do you understand from this?
- How will you interpret this information?
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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 now?
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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
position of Ram at the end of Y 3?
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BUSINESS ACTIVITY
Money is invested in a commercial enterprise with a view to earning profits and being sustainable
Money circulates in a business and is used for a variety of purposes
– Capital expenditure, other expenditure, returned to lenders, distributed to shareholders, invested etc
Profits may be earned immediately (ITES/Consulting/Service) or some time into the future (Manufacturing/Biotech)
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MEASURES OF SUCCESS IN BUSINESS
How does one measure whether a business is successful or not
One needs to have a system of measurement of the financials of a business
These need to be comparable, over time and across companies
- What do you think could be some
measures of success in a business?
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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
MEASURES OF PERFORMANCE
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ANNUAL REPORTS
Business entities bring out annual reports which contain financial and non financial information
Reports are made available to shareholders, government and other interested persons
There are guidelines to be followed and statutory compliances to be met while preparing these reports
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ANNUAL REPORTS
Users
Internal
–Owners and managers
External
– Investors, lenders, suppliers and creditors, customers, government and its agencies, public, analysts, advisors
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KEY CONTENT OF ANNUAL REPORTS Financial statements – balance
sheet, profit and loss account, cash flow statement, consolidated financial statements
Letter to shareholder
Director’s report
Management discussion and analysis
Auditors’ reportwww.biZkul.com
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OTHER CONTENT OF ANNUAL REPORTS Some companies provide
additional information, this includes
Value reporting
Brand valuation
Human resource accounting
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ANNUAL REPORTS
You have an annual report with you;
what information would you seek as:
A short term investor
A long term investor
An employee
A customer
A vendor
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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
–Comparable
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BALANCE SHEET
FINANCIAL
ACCOUNTING: I
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BALANCE SHEET
Sources of funds–Shareholders funds
– Loan funds
Application of funds–Fixed assets
– Investments
–Current assets less current liabilities and provisions
–Miscellaneous expenses
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BALANCE SHEET
Sources of funds–Share capital (equity, preference)
–Reserves and surplus (specific reserves, surplus profit not appropriated to any specific reserve)
–Secured loans (from financial institutions, commercial banks)
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BALANCE SHEET
Sources of funds (contd.)
–Unsecured loans (fixed deposits, promoters, intercorporate loans)
–Current liabilities and provisions (dues to suppliers, payments received in advance, expenses accrued for rent, salary, pension, etc.)
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BALANCE SHEET
Application of funds–Fixed assets (Long term assets not for resale, land, buildings, machinery, vehicles, computers, office equipment, furniture)
–Investments (long term or short term)
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BALANCE SHEET
Application of funds (contd.)
–Current assets, loans and advances (Bank and cash balance, fixed deposits, debtors net of bad debts, inventories raw material, work-in-progress, finished goods, pre-paid expenses, advance to employees, advance for service/goods to be received, travel advances,)
–Miscellaneous expenses (preliminary expenses, heavy expenditure)www.biZkul.com
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PROFIT AND LOSS
ACCOUNT
FINANCIAL
ACCOUNTING: I
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PROFIT AND LOSS ACCOUNT Income
–Sales (gross sales)
–Other income (interest, dividend, rental income, miscellaneous sales)
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PROFIT AND LOSS ACCOUNT Expenditure
– Manufacturing (Raw material costs, direct factory expenses)
– Sales and general administration (SG&A)
– Other miscellaneous
– Depreciation (non-cash expense, amortisation of fixed asset cost over a period)
Prior year adjustments, appropriation
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KEY EQUATIONS
Shareholders Stake =
Assets – Liabilities
Profit =
Sales – Costs
( Costs of material used =
Opening stock + purchases –
closing stock)
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QUESTION
You are a finance professional in a company
I am also a finance professional in the same company
We both independently prepare the financial statements in our company
Will you and I arrive at the same numbers in terms of
– Sales?
– Profits?
Why? Why not?www.biZkul.com
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EXERCISE
C & Co. purchases the following:
– LOT A: Jan 10th, 200 units at Re 1 each
– LOT B: Jan 15th, 100 units at Re 1.1 each
– LOT C: Jan 25th, 150 units at Re 1.2 each
400 units were consumed in January
What is the cost of the material consumed?
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EXERCISE
Methods of calculating cost of material consumed:
– LIFO: Last in first out
– FIFO: First in first out
– Weighted average
These are accounting methods for calculating costs
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EXERCISE
C & Co. purchases the following:– LOT A: Jan 10th, 200 units at Re 1 each– LOT B: Jan 15th, 100 units at Re 1.1 each– LOT C: Jan 25th, 150 units at Re 1.2 each– LOT D: Feb 10th, 300 units at Re 1.2 each
400 units were consumed in January 200 units were consumed in February
What is the cost of the material consumed in the months of Jan and Feb under the FIFO and LIFO methods?
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ASSIGNMENT
Jan sales – Rs. 1000
Feb sales – Rs. 1000
Other costs in Jan – Rs. 500
Other costs in Feb – Rs. 500
For Jan and Feb, under the FIFO and LIFO methods:
- What is profit
- What is the inventory balance,
What do you infer from this?www.biZkul.com
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GAAP and
ACCOUNTING STANDARDS
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GAAP
Generally Accepted Accounting Principles
Refer to rules, conventions, principles, procedures
To be followed by enterprises in preparation of financial statements
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ACCOUNTING STANDARDS Set of broad guidelines regarding
accounting policies adopted by organisations in preparation of financial statements
Select set of accounting policies
Confirm to applicable laws, custom, business environment
(Refer www.icai.org - Web site of Institute of Chartered Accountants of India for detailed Accounting Standards)
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Framework of Accounting
Fundamental accounting assumptions
Going concern
Consistency
Accrual
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Key Accounting Concepts Entity
Money measurement
Cost concept
Realisation
Periodicity
Matching
Dual aspect
Conservatism
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CASELET
Ramesh Vyas, the CFO of Case Co. Ltd tells his finance manager, Prema John that the profits this year have been unusually bad and that the will pick up in the next year. Previous years profits have been reasonable. Ramesh wants to change the accounting policy and show reduced profits in this year (Big bath method).
FIFO method for inventory valuation is followed; prices of inventory have been steadily increasing in the past few years.
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CASELET
Prema is not comfortable with Ramesh’s suggestion as she feels that this is unethical and that this may backfire
Profits under FIFO:
– in the past three years: 10, 13, 15
– Current year : 12
– Expected in next year : 16
What change in policy is Ramesh suggesting? Do you agree with Prema or not? Why or why not?
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ACCOUNTING
Rules are not absolutely rigid and provide some flexibility within a framework, keeping in mind
– Economic position
– Social needs
– Regulatory frameworks
– Technical developments
GAAP in India is influenced by ICAI, SEBI, RBI, DCA etc.
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FORMS OF BUSINESS ORGANISATIONS Sole Proprietorship
Partnership
Limited Co –Private
–Public
Statutory Bodies
Mutual Funds
Trusts
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ACCOUNTING BASICS
Transaction occurs– With funds in flow
– Without funds flow
Transactions are recorded in accounts, eg.– Cash/bank
– Debtors
– Advance accounts
– Capital
– Accruals
– Expenseswww.biZkul.com
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ACCOUNTING PROCESS
Accounts periodically summarised
Rectification entries may be passed
Adjustment entries may be passed (eg accruals, advances settled)
Trial Balance is prepared
Trial Balance has to tally
Concept of double entry book keeping
Financial statements are prepared
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ACCOUNTING PROCESS
Data
Final Trial
Balance
Financial
Statements
Trial
Balance
Account
Final
Financial
Statements
Entry
Passed
Rectification
Entry
Passed