eco unit 5

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UNIT V

FINANCIAL ACCOUNTING

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It is the art of recording,classifying, summarizing, analyzing andreporting of business transactions andinterpreting their effect on the affairs ofthe business concerns.

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Branches of accounting

FINANCIALACCOUNTING

Cost AccountingManagement Accounting

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Financial accounting gathers and summarizes financialdata to prepare financial reports such as balance sheetand income statements for the firm’s management

investors , lenders, suppliers, tax authorities, and other

stakeholders

It involves the recording and summarization of businesstransactions and events. Financial accounting relates to

the preparation of financial statements for externalusers such as creditors, investors, and suppliers. Thefinancial statements include the balance sheet, incomestatement, and statement of changes in financial

position.

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FINANCIAL STATEMENTS

“ The financial statements provide a

summary of the accounts of a business

enterprise, the balance sheet reflecting the

assets, liabilities and capital as on ascertaindate and the income statement showing the

results of operations during a certain period”

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Financial Statements

Balance

sheetProfit & Loss

Account

Statement of

changes in

Owner’s equity

Statement of

changes in financial

position

Funds

flow

Cash

flow

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Trading, Profit & Loss A/c of …….

For the year ended………. To Opening Stock

To Purchase

Less: Returns Outwards

To Wages

To Freight

To Carriage

Inwards

To Clearing

Charges

To Packing chargesTo Dock dues

To Power

To Gross Proft (to be

transferred to P & L A/c)

xxx

xxx

Xxx

Xxx

xxx

Xxx

Xxx

Xxx

Xxx

Xxx

XxxXxx

Xxx

Xxx

By Sales

Less: Returns Inwards

By Closing Stock

By Gross Loss (to

be transferred to

P&L A/c)

Xxx

xxxxxx

Xxx

xxx

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To Trading A/c

(Gross Loss)

To Salaries

To Rent & Taxes

To Stationeries

To Postage expenses

To InsuranceTo Repairs

To Trading expenses

To office expenses

To InterestTo Bank charges

To Establishmentexpenses

To Sundry expenses

To Commission

Xxx

Xxxx

Xxx

Xxx

XxxXxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

By Trading A/c

(Gross Profit)

By Commissionearned

By Rent received

By Interest received

By Discountsreceived

By Net Loss

(Capital A/c)

Xxxxxx

Xxx

Xxx

Xxx

Xxx

xxx

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To Discount

To Advertisement

To Carriage

outwards

To Travelingexpenses

To Distributionexpenses

To Bad debt

provision

To Net Profit

(transferred to

Capital A/c)

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

xxxx xxxx

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Liabilities

Sundry Creditors

Bills Payable

Bank overdraft

LoansMortgage

Reserve Fund

Outstanding exp.

Capital

Add: Net Profit

(or)

Less : Net Loss

Less Drawings

Less: Income tax

Xxx

Xxx

Xxx

xxx

Xxx

Xxx

Xxx

XxxXxx

Xxx

Xxx

xxxx

Assets

Cash in hand

Cash at bank

Bills receivable

Sundry Debtors

Closing Stock

Furniture & Fittings

Investments

Plant & Machinery

Loose toolsLand & Buildings

Business premises

Horses & carts

Prepaid exp.

Patents & Trademarks

Xxx

Xxx

Xxx

XxxXxxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

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Meaning & Concept of Funds:

1.

Cash2. Money Values

3. Working Capital

Funds flow Statement - meaning:

- Statement which shows movement of funds- Indicates various means by which funds were obtained

during a particular period and the ways in which these

funds were employed

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List of Non Current or Permanent Capital Accounts

Non Current or permanent

Liabilities

Equity Share Capital

Preference Share Capital

Redeemable Preference Share

Capital

Debentures

Long Term Loans

Share Premium Account

Shares Forfeited Account

Profit & Loss Account

Capital Reserve

Capital Redemption Reserve

Provision for Depreciation Against

Fixed Assets

Non Current or permanent Assets

Goodwill

Land

Buildings

Plant & Machinery

Furniture & Fittings

Trade Marks

Patent Rights

Long- Term Investments

Profit & Loss Account

Discount on issue of Shares

Discount on issue of Debentures

Preliminary Expenses

Other Deferred Expenses

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Appropriation of Profits

(a) General Reserve

(b) Dividend Equalization Fund

(c) Insurance Fund(d) Compensation Fund

(e) Sinking Fund

(f) Investment fluctuation Fund

(g) Provision for Taxation

(h) Proposed Dividend

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Differences Between funds Flow & income Statement

Funds Flow

Shows changes in financial position

Complementary to income statement

Both capital and revenue items are

considered

No prescribed format

Income Statement

It depicts the items of expenses &

income and arrive at profit or loss

Not prepared from funds flow

statement

Only revenue items are considered

Prepared in prescribed format

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Differences between Funds flow statement & Balance Sheet

Funds Flow statement

Statement of financial changes

Shows sources of funds & uses of funds

Tool of Management for financial analysis

and helps in making decisions Usually Schedule of changes in working

Capital has to be Prepared before

preparing fund flow statement

Balance Sheet

Statement of financial position on a

particular Date

Depicts the assets & Liabilities at a

particular point of time

Not much of help to Management indecision Making

No such Statement is prepared. Rather

P&L a/c is prepared.

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Statement/Schedule of Changes In Working Capital

Effect in Working capital

Particulars Previous Current Increase Decrease

Year Year

Current

Assets:

Total CA

Current

Liabilities:

Total CL

Net increase

In WC

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Funds Flow Statement

Sources

Funds From Operations

Issue of Share of Capital

Issue Of Debentures

Raising of Long- term Loans

Receipts From Partly Paid Capitals

Sale Of non-current assets

Non-Trading receipts like dividend

Sale of Long term Investments

Net decrease in Working Capital

Application

Funds lost in Operations

Redemption of Preference Share

Capital

Redemption of Debentures

Repayment of Long term Loans

Purchases of Long Term

investments

Non-Trading Investments

Payment of Dividends*

Payment Of Tax*

Net Increasein Working Capital

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Adjusted Profit & Loss Account

To Depreciation, Depletion & Amortizationof fictitious & Intangible assets such asGoodwill, Patents, Trade Marks,Preliminary Expenses etc

To Appropriation of Retained Earnings(Transfers to General Reserve, DividendEqualisation Fund, Sinking Fund….. Etc)

To sale on loss of any non-current assetsTo Dividends (including interim dividends)

To Discount on Issue of Shares

To Proposed dividend*

To Provision For taxation*

To Closing Balance of (P&LA/c)

To Funds Lost in operations (b/f)

By Opening Balance of P&L A/c

By Transfer from excess Provisions

By appreciation in the value of Fixed Assets

By Dividends received

By Profit on Sale of Fixed Assets or Non-

Current AssetsBy Funds From Operations (b/f)

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RATIO ANALYSIS

Ratio- one number expressed in terms of another.

It describes in Mathematical terms the quantitative

relationship between two numbers

J.Batty Defines “Accounting ratio is used to describe

significant relationship between figures shown on balance

sheet, in a profit & loss account, in a budgetary control

system or in any other part of the accounting organisation”

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CURRENT ASSETS CURRENT LIABILITIES

Cash in Hand

Cash at bank

Stock

Sundry debtors Bills receivables

Short term Investments

Marketable securities

Accrued Income

Prepaid Expenses

Bank Overdraft

Sundry creditors

Bills Payable

Income Received inadvance

Outstanding Expenses

Bad debts provision

Provision for tax Dividend payable

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ADVANTAGES OF RATIO ANALYSIS

Simplifies Financial Statements

Facilitates Intra-firm Comparison

Planning & Forecasting

Aids to inter-firm Comparison

Facilitates Decision Making

Helps in Corrective action

Aids to Co-ordination

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LIMITATIONS OF RATIO ANALYSIS

Limitations of Financial statements

No fixed standards

Qualitative factors Ignored

Lack of Standard Formulae

It is not substitute for personal judgment

Problems of price level changes

Ratios alone are not adequate

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CLASSIFICATION OF RATIOS

Functional

Classification

Liquidity ratios

Long Term

Solvency

And

Leverage Ratio

Activity ratios Profitability Ratios

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LIQUIDITY RATIO

Current Ratio = Current Assets (ideal ratio is 2:1)

Current Liabilities

Quick/ Acid Test =Liquid/quick Assets (ideal ratio is 1:1)

/liquid ratios Current Liabilities

(Liquid Assets =Current Assets-(inventories + prepaid expenses)

Absolute Liquid Ratio = Absolute Liquid Assets (ideal Ratio is 0.5 : 1)

Current Liabilities(Cash in hand, cash at bank and Marketable Securities)

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Inventory Turnover Ratio= Cost of Goods sold

Average Inventory at Cost

Inventory Conversion Period = Days in a Year

Inventory Turnover Ratio Debtors (Receivables) Turnover Ratio = Net Credit Annual Sales

Average Trade Debtors

[ Average Trade Debtors = (Opening Drs + Closing Drs)/2]

Average Collection Period = No.of working Days

Debtors Turnover Ratios

Creditors (payables) Turnover Ratio = Net Credit Annual Purchases

Average Trade Creditors

Average Payment Period = No.Of Working Days

Creditors Turnover Ratio

Working Capital Turnover Ratio = Cost Of sales

Average Working Capital

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Debt- Equity ratio = Outsiders’ Funds

Share holders’ funds

Funded debt to total Capitalisation = Funded Debt x 100

Total Capitalisation

Ratio of long term debt to

Shareholders funds = Long Term Debt

Shareholders’ funds

Proprietary or Equity Ratio = Shareholders’ funds

Total assets

Fixed Assets Ratio = Fixed Assets( After Dep)

Total Long- Term Funds

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Fixed Asset Net Worth Ratio = Fixed Assets( After Depreciation)

Shareholders’ funds

Solvency Ratio = Total Liabilities to outsiders

Total Assets

Ratio Of Current Assets = Current Assets

to proprietors Funds Share Holders Funds

Debt- Service or = Net Profit ( Before Interest & Tax)Interest coverage Ratio Fixed Interest charges

Total Coverage or = EBIT

Fixed charge Coverage Total Fixed Charges

Preference Dividend Coverage Ratio = Net Profit( Before Interest & Tax)Preference Dividend annual cash flow

(Before Interest & Taxes)

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ANALYSIS OF PROFITABILITY

(I) GENERAL PROFITABILITY

Gross profit ratio = Gross profit x 100

Net sales

Operating Ratio = Operating Cost X 100

Net sales

Net Profit Ratio = Net Profit x 100

Net Sales

Expenses Ratio= Particular expenses x 100Net sales

Operating Profit Ratio = Operating Profit x 100

Net Sales

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(II) OVERALL PROFITABILITY RATIOS

Return on Shareholders Investments = Net Profit (After interest & tax) x 100

(or) Net worth (R.O.I) Shareholders Funds

Return on Equity Capital = Net profit after Tax – Preference Dividend x 100Paid up equity capital

Earnings per Share = Net Profit after tax and Preference dividend

(E.P.S) Number of Equity share

Return on Gross Capital Employed = Adjusted Net profit x 100

Gross Capital Employed

Return on Net Capital Employed = Adjusted Net profit x 100

Net Capital Employed

Capital Turnover Ratio = Sales or cost of sales

Capital Employed

Dividend Yield Ratio = Dividend per Share

Market Value per share

Dividend Pay out ratio = Dividend per equity share

or pay out ratio EPS

P i i R i M k P i E i Sh

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Price- earning Ratio = Market Price per Equity Share

(P/E ratio) EPS

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