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Interpretation of FinancialStatements
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DEFINITION OF ACCOUNTING Accounting is the process of
identifying, measuring and
Communicatingeconomic information to permit
informed judgements anddecisions by users of theinformation.
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USERS OF FIN. ST.
PRESENT & POTENTIAL SHAREHOLDERS /TRUSTEES / MEMBERS EMPLOYEES
LENDERS SUPPLIERS & OTHER CREDITORS CUSTOMERS
GOVERNMENT & ITS AGENCIES PUBLIC
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OBJECTIVE OF FSUSERS INFORMATION NEEDS 1) Liquidity 2) Profitability
3) Solvency
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TYPES OF ACCOUNTING
Financial accounting Income-tax accounting
Cost accounting Management Accounting (Management
Control Systems) Management Reporting
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ACCOUNTING
MECHANICS
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ACCOUNTING EQUIVALENCAssets = Owners Equity +
Outside Liabilities
A = OE + OL
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DOUBLE ENTRY SYSTEM
AA = OE + OL= OE + OL
In the double-entry accounting system,every transaction is recorded by equal
amounts of debits and credits.
In the double-entry accounting system,every transaction is recorded by equal
amounts of debits and credits.
DebitDebit == CreditCredit
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ACCOUNTANTS LIFEAA = OEOE + OL
ASSETSASSETS
Debit
forIncrease
Credit
forDecrease
EQUITIESEQUITIES
Debit
forDecrease
Credit
forIncrease
LIABILITIESLIABILITIES
Debit
forDecrease
Credit
forIncrease
Debit Credit
ASSETS
+ -
LIABILITIES
- +Debit Credit
EQUITIES
- +Debit Credit
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ACCOUNTING CYCLE1. Business Transaction
2. Transaction is recorded in document(Voucher / Receipt)3. Analyze the transaction location ?4. Journal Entry5. Ledger Accounts (or T account)6. Trial Balance7. Balance Sheet, P&L A/c, Cash Flow
Statement
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Balance Sheet
P & L A/c
Cash Flow
Prepare a trial
balance
Post to theledger
Journal Entry
SourcedocumentsTransaction Analyze
ACCOUNTANTS ROUTINE
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Post to theledger
Sourcedocuments
Journal EntryPrepare a trial
balance
Balance Sheet
P & L A/c
Cash Flow
Transaction Analyze
ACCOUNTANTS ROUTINE
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TRANSACTION-1Chirag started business with cash Rs.30,000.
The accounts involved are:The accounts involved are:(1) Cash ((1) Cash ( assetasset ))(2) Owner(2) Owner s Equity (s Equity ( equityequity ))
Assets = OE + OL
Cash Supplies EquipmentAccountsPayable
Note sPayabl
Owne rs'Capital
(1) 30000 30000
30000 0 0 0 0 30000
30000 = 30000
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TRANSACTION-1Chirag started business with cash Rs.30,000.The accounts involved are:The accounts involved are:
(1) Cash ((1) Cash ( assetasset ))
(2) Owner(2) Owner s Equity (s Equity ( equityequity ))
JOURNAL ENTRY Page 1Date Particulars LF Debit Credit2001Dec. 1 Cash 30,000
To Capital 30,000 Investment by owner
Debit Credit
EQUITIES
- +Debit Credit
ASSETS
+ -
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INTRODUCTION Companies need a way to measure
performance over discreet time periods. The most popular period for measuring
income is fiscal year. The fiscal year ends on 31 ST March.
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BASIS OF A/C Accrual basis - recognizes the impact
of transactions for the time periodswhen revenues and expenses occureven if no cash changes hands
Cash basis - recognizes the impact oftransactions only when cash isreceived or disbursed
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MATCHING CONCEPT Fundamental Accounting Concept
Matching Concept is:Expenses incurred in earning revenue
must be matched with therevenue earned during the current accountingperiod for determining results of operations
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MANUFACTURING CO. Trading v/s Manufacturing
Kind of Inventory Nature of Costs Inventory in Manufacturing Co.
Raw Materials Work in Process (WIP) Finished Goods
Stores & Spares Costs in Manufacturing Direct Costs
Indirect Costs
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COSTS Direct Costs
are costs which can be traced to thecost object in economically feasible way.
Indirect Costs are costs which cannot be traced to thecost object in economically feasible way.
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COGM Cost of Good Manufactured (COGM)
= Direct Cost + Indirect Costs
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COGM Cost of Good Manufactured (COGM)
= Direct Cost + Indirect Costs
Cost of Good Manufactured (COGM)= Cost of RM Consumed+ Other Direct Cost of Manufacturing+ Indirect Cost of Manufacturing+ Opening Stock of WIP- Closing Stock of WIP
Skip Next
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COST OF RM CONSUMED Cost of RM Consumed =
Opening Stock of RM+ RM Purchased
+ Directly Attributable Cost for RMPurchase- Purchase Returns of RM
- Closing Stock of RM
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COGS Cost of Good Sold (COGS)
= Cost of Good Manufactured (COGM)+ Opening Stock of Finished Goods- Closing Stock of Finished Goods
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COSTS
Product costs - those linked withrevenue earned in the same period Cost of goods sold or sales commissions
Without sales there is no cost of goods soldor sales commissions.
Period costs - those linked with the
time period itself Rent or other administrative expenses Rent is paid even if no sales are made.
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MATCHING OF EO EXPD. MATCHING OF EXTRA ORDINARY
EXPENDITURE Depreciation Large Advertisement Expenditure Personnel Training & Development Research & Development
Unusual Expenses, Natural Calamities
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INVENTORY
AS 2:Inventories are defined as assetsi. held for sale in ordinary course of
business, orii. in the process of production for such
sale, oriii. in the form of materials of supplies to be
consumed in the production process orin the rendering of services
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INVENTORY VALUATION FIRST-IN-FIRST-OUT (FIFO)
LAST-IN-FIRST-OUT (LIFO) SIMPLE AVERAGE
WEIGHTED AVERAGE
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P & L A/C The income statement is really just a
way of explaining changes that occurbetween one balance sheet date andanother.
The balance sheet equation can bemanipulated to show that revenuesand expenses are subparts of ownersequity. The income statement collects the
changes and combines them in oneplace.
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P & L A/C The income statement must always
indicate the exact period covered (monthended, quarter ended, year ended).
Decision makers inside and outside the
company use the income statement toassess the companys performance overa span of time.
By tracking net income from period toperiod, decision makers can evaluatethe success of the periods operations.
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FIXED ASSETS
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FIXED ASSETS Fixed Assets (FA)are very importantcomponent of the business.
FA is an asset held with the intention of being used for the purpose of producing or providing goods or services and
is not held for sale in normalcourse of business.
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TEST OF FA How to test whether it is a FA or not? Test is made at the time when the
expenditure is incurred by considering
whether the asset or benefit acquiredby the expenditure will be convertedinto cash in the near future, OR
whether it will primarily be used forconducting the operations of
business
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TYPES OF FA FA may be
TANGIBLE FAphysical items that can be seen and touched,such as land, natural resources, buildings,
and equipment - also known as fixed assetsor plant assets
INTANGIBLE FA
rights or economic benefits, such asfranchises, patents, trademarks, copyrights,and goodwill that are not physical in nature
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Allocation of CostsTerms for allocation of costs over time: Depreciation - allocation of the cost of
tangible assets Depletion - allocation of the cost of natural
resources
Amortization - allocation of the cost of
intangible assetsLand is never depreciated because itdoes not wear out or become obsolete.
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Cost of AcquisitionThe acquisition cost of long-livedassets is the purchase price,including incidental costs requiredto complete the purchase, totransport the asset, and to
prepare it for use.
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DepreciationDepreciation is a form of allocating thecost of an asset to periods when theasset is used.Depreciation is one key factor thatdistinguishes accrual accounting fromcash basis accounting. Under the accrual basis, the cost of the
asset is allocated to the periods benefited. Under the cash basis, the cost of the
asset would be expensed immediately.
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Expected LifeUseful life - the time period overwhich an asset is depreciated The useful life is the shorter of the
physical life of the asset before itwears out or the economic life of theasset before it becomes obsolete.
The useful life can be measured interms other than time. For example,
the life of a truck can be measured in
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Depreciation (contd.)Depreciation does not generate cash. Depreciation allocates the original cost
of an asset to the periods when theasset is used.
Accumulated depreciation is merely thetotal amount that an asset has been
depreciated throughout its life.
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Depreciation (contd.)Depreciation is a non-cash expense.
Therefore, depreciation basically has noeffect on ending cash balancesBefore taxes, changes in the depreciationmethod affect only the accumulateddepreciation and retained earnings
account.
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The Decision to CapitalizeNo rules about when to expense orcapitalize an expenditure are written instone. An accountant might want to expense
something that a tax auditor might want tocapitalize.
The tendency in practice is to chargean expense for repairs, parts, andsimilar items. Most of these expenditures are minor, so
the cost-benefit and materiality concepts justify this choice.
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METHODS OF DEPRECIATION Straight Line Method Declining Balance Method (WDV) Sum-of-the-years Digits Method Units of Production Method
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PROFIT & LOSSACCOUNT
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Introduction Annual Report Financial Statement
Balance Sheet Profit & Loss Account
Balance Sheet is a position statement. P&L A/c is a flow statement. Companies Act:
A Balance Sheet as on the last day of thefinancial year A Profit & Loss Account for the financial
year.
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P & L A/c P&L A/c is also called Income
Statement. Income is calculated as the difference
between revenues and expenses. Revenues: from operations
Expenses: specific product/service/period
Accountants have agreed to use theaccrual basis of accounting rather thanthe cash basis.
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Revenues and ExpensesRevenues - gross increases in
owners equity arising frombusiness operations/delivery ofgoods-services to customers
Expenses - decreases in owners equitythat arise because goods or services aredelivered to customers
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TRANSACTION
INCOME EXPENDITURE
RevenueIncome
CapitalIncome
RevenueExpendi
ture
CapitalExpend
iture
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TRANSACTION
INCOME EXPENDITURE
RevenueIncome
CapitalIncome
RevenueExpendi
ture
CapitalExpend
iture
P & L A/cIncome (Revenue Income)Less
Expenditure (Revenue Expenditure)NET PROFIT/LOSS
BALANCE SHEET
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TRANSACTION
INCOME EXPENDITURE
RevenueIncome
CapitalIncome
RevenueExpendi
ture
CapitalExpend
iture
BALANCE SHEETSOURCES OF FUNDS (Liabilities)(Capital Income)
APPLICATION OF FUNDS (Assets)(Capital Expenditure)
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P & L A/c CONCEPTS ACCOUNTING PERIOD
Expenditure during A/c period which arealso expenses of that period.
Expenditure during the A/c period whichwill become expense only in future periods
Expenditure during the previous A/c periodwhich will become expenses during thecurrent A/c period
Expense of the current A/c period whichhave not yet been paid
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The Accounting Time PeriodCompanies also prepare statements
for interim periods , generally on aquarterly or monthly basis.
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Recognition of Revenues Recognition - a test to determine whether
revenues should be recorded in thefinancial statements
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THE DUET: BS & P&L BS provides a snapshot of an entitys
financial position at an instant in time. The P&L A/c provides a moving picture of
events over a span of time and explainsthe changes that have taken placebetween BS dates.
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BALANCE SHEET
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BALANCE SHEET
BS is a position statement.
BS describes the financial position of assets & liabilities of the firm as on a particular date
DEFINITION BS
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DEFINITION: BS
Balance Sheet is defined as
a statement of the financial position of an enterprise as at a given date, which exhibits assets, liabilities, capital, etc.
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WHY BS ?
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WHY BS ?
The legal rules (Companies Act)
A Balance Sheet as on the last day of thefinancial year A Profit & Loss Account for the financial year.
BS should reflect true and fair view.
Balance Sheet
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OwnersEquity
OwnersEquity
Owners Investment
Revenues
Owners Withdrawal
Expenses
Balance Sheet
LOOKS/FORM OF BS
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LOOKS/FORM OF BS
1. HORIZONTAL
2. VERTICAL Except in the first BS, it is required to give
the corresponding amounts for thepreceding financial year (Comparatives)for all the items shown in the BS.
HORIZONTAL FORM OF BS
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XYZXYZ
XX Inventories (Stock)XX Accounts Payable (Creditors)
XX Bills Receivable)XX Bank Overdraft
XX Accounts Receivable(Debtors)XX
Outstanding Expenses
XX Cash / Bank B/sCurrent LiabilitiesCurrent AssetsXXLoan taken
XXFixed Assets-Land, Bldg,XXCapital
AmountASSETSAmountLIABILITIES
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Assets = Owners Equity +
Outside Liabilities
A = OE + OL
A = OE + OL
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A OE + OLAssets are properties or economic
resources owned by a business. They areexpected to provide future benefits to the
business.
Assets are properties or economicresources owned by a business. They areexpected to provide future benefits to the
business.
Liabilities areobligations of thebusiness. They
are claimsagainst the
assets of thebusiness.
Liabilities areobligations of thebusiness. They
are claimsagainst the
assets of thebusiness.
Equity is theowners claim onthe assets of thebusiness. It is the
residual interest inthe assets after
deductingliabilities.
Equity is theowners claim onthe assets of thebusiness. It is the
residual interest inthe assets after
deductingliabilities.
A = OE + OL
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A OE + OL
XYZ
XYZXXInventories (Stock)XX
Accounts Payable
(Creditors)
XXBills Receivable)XXBank Overdraft
XXAccounts Receivable(Debtors)
XXOutstanding Expenses
XXCash / Bank B/sCurrent Liabilities
Current AssetsXXLoan taken
XXFixed Assets-Land, Bldg,XXCapital
Amoun
tASSETSAmount
LIABILITIES
A = OE + OL
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XYZ
XYZXXInventories (Stock)XX
Accounts Payable(Creditors)
XXBills Receivable)XXBank Overdraft
XXAccounts Receivable(Debtors)
XXOutstanding Expenses
XXCash / Bank B/sCurrent Liabilities
Current AssetsXXLoan taken
XXFixed Assets-Land, Bldg,XXCapital
AmountASSETSAmountLIABILITIES
A = OE + OL
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A OE OL
Miscellaneous ExpenditureLoans & AdvancesCurrent Assets Current LiabilitiesInvestment
Amount
cy
AmountpyAPPLICATION OF FUNDS
Fixed Assets Gross Block- Depreciation
XXXXUnsecured LoansXXSecured Loans
AAReserves & Surplus
XXAAShare Capital
Amountcy
AmountpySOURCES OF FUNDS
Financial Statements
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Financial StatementsPrepare the Financial Statements reflecting
the transactions we have recorded.
Income Statement
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Scoxs netincome is the
differencebetween
Revenues andExpenses.
The net income ofRs.2,200
increases Scoxsequity byRs.2,200.
Revenues: Consulting revenue 3000Expenses: Salaries expense 800Net income 2200
Scox CompanyIncome Statement
For Month Ended March 31, 2001
Owners' equity, 1st April 2000 0Plus: Investment by owners 20000 Net income 2200Ow ners' equity, 31st March 200 22200
Scox CompanyStatement of Changes in Owners' Equity
For Month Ended March 31, 2001
Balance Sheet
Scox Company
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Accounts payable 1200 Cash 10200Notes payable 4000 Supplies 1200Total liabilities 5200 Equipment 16000Owners' equity 22200
Total liabilitiesand owners'equity 27400 Total asset 27400
AssetsLiabilities & Owners' Equity
Scox CompanyBalance SheetMarch 31, 2001
Owners' equity 0Investment by owners 20000 Net income 2200
Owners' equity, March 31 2001 22200
p y
Statement of Changes in Owners' EquityFor Month Ended March 31, 2001The balance sheet
reflects Scoxsfinancial position at
March 31 2001
The balance sheetreflects Scoxs
financial position at
March 31 2001
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CASH FLOW CASH FLOW
STATEMENT STATEMENT
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CASH FLOW STATEMENT CF Statement is a flow statement.
CFS indicates changes that took placebetween tow successive BalanceSheets.
The statement of cash flows providesa thorough explanation of the changes
that occurred in a firms cash balanceduring the entire accounting period.
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Why CFS? Balance Sheet P&L A/c insufficient. It shows the relationship of net income to changes in
cash balances. It reports past cash flows as an aid to:
Predicting future cash flows Evaluating the way management generates and uses cash Determining a companys ability to pay interest and
dividends and to pay debts when they are due It identifies changes in the mix of productive assets.
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Why CFS? . . . The statement of cash flows, along
with the income statement,explains why balance sheet itemshave changed during the period.
Legal rules.
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Why CFS? The relationship among the balance sheet,
income statement, and statement of cashflows:
Balance Sheet31 st March 2009Balance Sheet
31 st March 2009
Balance Sheet31 st March 2008
Income Statement
Statement of Cash Flows
Activities Affecting Cash
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Operating activities - transactions thataffect the income statement
Investing activities - activities thatinvolve (1) providing and collectingcash as a lender or as an owner ofsecurities and (2) acquiring and
disposing of plant, property,equipment, and other long-termproductive assets
Activities Affecting Cash . . .
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Financing activities - activities that
include obtaining resources as aborrower or issuer of securities andrepaying creditors and owners
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Investing Activities
Cash inflows
Sale of property, plant,and equipment
Sale of securities that
are not cashequivalents Receipt of loan
repayments
Cash outflows
Purchase of property, plantequipment
Purchase of securities thatare not cash equivalents
Making loans
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Financing Activities
Cash inflows Borrowing cash from
creditors
Issuing equity shares Issuing debt securities
Cash outflows Repayment of amounts
borrowed
Repurchase of equityshares Payment of dividends***