1 introduction to financial statements

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FINANCIALStatements

Anjana Vivek

www.bizkul.com

anjana@bizkul.com

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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