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FINANCIAL ACCOUNTING FOR MANAGERS FINANCIAL ACCOUNTING FOR MANAGERS

WHAT IS ACCOUNTING ? n n n Accounting is the language of business Accounting WHAT IS ACCOUNTING ? n n n Accounting is the language of business Accounting is an Information System a) For Insiders b) For Outsiders Accounting provides reports to stakeholders about the economic activities and condition of a business

WHAT IS ACCOUNTING ? n Accounting refers to measurement of economic events and summarising WHAT IS ACCOUNTING ? n Accounting refers to measurement of economic events and summarising and reporting them in the form of financial statements for use by the stakeholders i. e. bankers, creditors, shareholders, public and Govt. Reporting is thus the end function of accounting

BRANCHES OF ACCOUNTING n n n Financial accounting is the preparation and communication of BRANCHES OF ACCOUNTING n n n Financial accounting is the preparation and communication of financial information mainly for those outside the organisation Management Accounting is the preparation and communication of financial and other information for the internal use of management Cost Accounting is the collation of data for inventory valuation

CONCEPTUAL FRAMEWORK Purpose The purpose is to create a base for financial statements and CONCEPTUAL FRAMEWORK Purpose The purpose is to create a base for financial statements and provide assistance to : 1. Preparers 2. Auditors 3. Users 4. The Accounting Standards Board of the ICAI n

COMPONENTS OF FINANCIAL STATEMENT n n Balance Sheet Income Statement Cash Flow Statement Notes COMPONENTS OF FINANCIAL STATEMENT n n Balance Sheet Income Statement Cash Flow Statement Notes to Accounts and Accounting Policies

OBJECTIVE OF FINANCIAL STATEMENTS n n n n n To provide information about the OBJECTIVE OF FINANCIAL STATEMENTS n n n n n To provide information about the financial position, performance and cash flow of an enterprise However they do not provide all the information because 1. They largely portray the financial effects of past events 2. They do not provide information of non-financial nature Financial Position Economic Resources Financial Structure Liquidity and solvency Performance Cash Flows

USERS OF FINANCIAL STATEMENTS n n n n n Present and Potential Investors Employees USERS OF FINANCIAL STATEMENTS n n n n n Present and Potential Investors Employees Lenders Security Analysts and Advisers Suppliers and Creditors Customers Governments and Regulatory agencies Public Management

Assumptions Underlying Preparation of Financial Statements n n n Accrual Basis: The effects of Assumptions Underlying Preparation of Financial Statements n n n Accrual Basis: The effects of transactions and other events are recognised when they occur and reported in the financial statements of the period to which they relate Going Concern: The enterprise will continue for a forseeable future and has no intention to liquidate or curtail its operation materially. Consistency: The accounting policies are followed consistently from year to year.

Qualitative characteristics of Financial Statements n n Understandability Relevance Materiality Reliability -- Faithful representation Qualitative characteristics of Financial Statements n n Understandability Relevance Materiality Reliability -- Faithful representation -- Substance over form -- Neutrality -- Prudence -- Completeness -- Comparability

Financial Position n Assets --- Assets are the resources controlled by an enterprise as Financial Position n Assets --- Assets are the resources controlled by an enterprise as a result of past events, from which future economic benefits are expected to flow to the enterprise. Liabilities – Liabilities are the present obligations of the enterprise , arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits. Equity – Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.

ACCOUNTING EQUATION The relationship among asset , liability and equity can be expressed by ACCOUNTING EQUATION The relationship among asset , liability and equity can be expressed by the following equation Assets = Liabilities + Owner’s Equity The effect of all business transactions is reflected in this equation.

Elements of Financial Statements Financial Position -- Assets -- Liabilities --Equity. Performance -- Income Elements of Financial Statements Financial Position -- Assets -- Liabilities --Equity. Performance -- Income -- Expenses. Cash Flows n

Characteristics Assets 1. They represent potential to contribute , directly or indirectly, to the Characteristics Assets 1. They represent potential to contribute , directly or indirectly, to the flow of cash or cash equivalents to the enterprise. 2. Physical form not essential to the existence of the asset. 3. Legal right of ownership not essential in establishing the existence of asset. 4. Purchasing or producing not always essential to obtain asset. 5. Expenditure incurred for seeking future economic benefits may not result in asset. n

Characteristics Liabilities 1. It’s a present obligation to be settled in future 2. Obligations Characteristics Liabilities 1. It’s a present obligation to be settled in future 2. Obligations may be due to a binding contract or statutory requirement 3. A present obligation and a future commitment differ from each other 4. Careful estimates are required to measure provisions. n

Characteristics n 1. 2. Equity It is dependent on the measurement of assets and Characteristics n 1. 2. Equity It is dependent on the measurement of assets and liabilities A change in net assets results in a change in the equity

PERFORMANCE n 1. 2. Elements: Income : - It represents the increase in economic PERFORMANCE n 1. 2. Elements: Income : - It represents the increase in economic benefits in the form of increase in assets or decrease in liabilities Expenses: - It represents decrease in economic benefits in the form of outflows or depletion of assets or increase in liabilities ( Expense vs.

Characteristics Income; 1. Both revenue and gains 2. Revenue arises in the ordinary course Characteristics Income; 1. Both revenue and gains 2. Revenue arises in the ordinary course of business 3. Gains may or may not arise in the ordinary course of business n

Characteristics Expenses 1. It includes both expenses and losses. 2. It arises in the Characteristics Expenses 1. It includes both expenses and losses. 2. It arises in the ordinary course of business. 3. Losses may or may not arise in the ordinary course of business. n

RECOGNITION n 1. 2. Condition for Recognition It is probable that future economic benefits RECOGNITION n 1. 2. Condition for Recognition It is probable that future economic benefits will flow to or from the enterprise. The item can be measured reliably.

MEASUREMENT n n Historical Cost Current Cost Realisable Value Present Value MEASUREMENT n n Historical Cost Current Cost Realisable Value Present Value

Accounting Concepts n n n Dual Aspect Concept Business Entity Concept Accrual Concept Cost Accounting Concepts n n n Dual Aspect Concept Business Entity Concept Accrual Concept Cost Concept Money Measurement Concept Realisation Concept

GAAP n n n Conceptual Framework of Financial Statements Accounting Concepts Requirements of Companies’ GAAP n n n Conceptual Framework of Financial Statements Accounting Concepts Requirements of Companies’ Act Accounting Standards Requirements of Income Tax Act

Requirements of Companies Act n 1. 2. 3. 4. Books of Accounts ( Sec. Requirements of Companies Act n 1. 2. 3. 4. Books of Accounts ( Sec. 209 ) All sums of money received and expended by the company All Sales and Purchases of goods by the company All assets and liabilities of the company Cost records in case of companies engaged in production, manufacturing , processing, mining activities

Requirements of Companies Act Annual Accounts ( Sec. 210 ) 1. A balance sheet Requirements of Companies Act Annual Accounts ( Sec. 210 ) 1. A balance sheet and 2. A profit and loss account at every AGM Form and Contents 1. Balance sheet to exhibit true and fair view of the state of affairs of the company and to comply with part I of schedule VI 2. Profit and loss account to give a true and fair view of the profit and loss of the company and to comply with part II of schedule VI 3. Every balance sheet and Profit and loss account to comply with accounting standards n

Requirements of Companies Act n 1. 2. 3. Company not complying with AS to Requirements of Companies Act n 1. 2. 3. Company not complying with AS to disclose Deviation from AS Reasons for such deviation Financial effect

ACCOUNTING STANDARDS n n n Accounting Standards Board Applicability of AS Scope of AS ACCOUNTING STANDARDS n n n Accounting Standards Board Applicability of AS Scope of AS Details of AS Authority attached to AS

Requirements of Income Tax Act n n I. T. Act allows both cash as Requirements of Income Tax Act n n I. T. Act allows both cash as well as mercantile system of accounting Companies Act allows only mercantile system of accounting

ACCOUNTING PROCESS n n Documentation Recording Classifying Summarising ACCOUNTING PROCESS n n Documentation Recording Classifying Summarising

ACCOUNTING PROCESS n n n Account : - An account is an individual record ACCOUNTING PROCESS n n n Account : - An account is an individual record of increases or decreases in an item that is likely to be of interest or importance. Ledger : - It is a book which contains accounts. Journal : - The journal is a chronological record of transactions entered into by a business.

CLASSIFICATION OF ACCOUNTS ACCORDING TO NATURE n n n Personal account : - Accounts CLASSIFICATION OF ACCOUNTS ACCORDING TO NATURE n n n Personal account : - Accounts of persons or firms with whom the firm enters into transactions. It includes both natural persons’ accounts and artificial persons’ accounts. Real account : - Accounts of properties under the control of the firm. Nominal account : - Accounts of revenue , gains, expenses and losses.

PRINCIPLES OF DEBIT AND CREDIT n n n Personal account: -Debit the receiver credit PRINCIPLES OF DEBIT AND CREDIT n n n Personal account: -Debit the receiver credit the giver Real account: -Debit what comes in credit what goes out Nominal account: -Debit all expenses and losses credit all incomes and gains

THE ACCOUNTING CYCLE To record opening entries in the general ledger To record transactions THE ACCOUNTING CYCLE To record opening entries in the general ledger To record transactions and events in the journal To post journal entries in appropriate accounts in the general ledger To balance the accounts in the general ledger To prepare the trial balance To pass adjustment entries To prepare the revised trial balance To pass closing entries to prepare financial statements

TYPES OF JOURNALS n n n Purchase Day Book Sales Day Book Purchase Return TYPES OF JOURNALS n n n Purchase Day Book Sales Day Book Purchase Return Book Sales Return Book Cash Book Journal Proper

MATCHING PRINCIPLE n n Revenues have to be matched and correlated with all the MATCHING PRINCIPLE n n Revenues have to be matched and correlated with all the expenses of a particular year In other words , profit is determined after charging the expenses of a period with the revenues earned in the same period

PRINCIPLE OF CONSERVATISM n n This principle requires the accountants not to anticipate gains PRINCIPLE OF CONSERVATISM n n This principle requires the accountants not to anticipate gains but to provide for all possible losses Example : “Lower of cost or market price” policy is adopted while valuing inventory.

MATERIALITY n n n Information is material if its misstatement could influence the decisions MATERIALITY n n n Information is material if its misstatement could influence the decisions of users taken on the basis of financial statements Materiality depends on the size and nature of the item or error It is necessitated by practicability and feasibility

ADJUSTMENT PROCESS Why Adjustment Is Necessary ? It ensures that revenues and expenses are ADJUSTMENT PROCESS Why Adjustment Is Necessary ? It ensures that revenues and expenses are recorded or recognised in the period to which they relate to. 1. It affects both Balance Sheet and Income Statement. 2. It never affects the cash account. 3. Adjustments are required when transactions affect revenue and expense of more than one accounting year. n

ADJUSTMENT PROCESS n 1. 2. Adjusting Entries Result In: Deferral : A deferral is ADJUSTMENT PROCESS n 1. 2. Adjusting Entries Result In: Deferral : A deferral is a delay in the recognition of an expenditure or of a revenue already received Accrual : An accrual is the recognition of an expense that has not been paid or of a revenue that has not been received

Trial Balance Features n Closing balances of accounts in the ledger as well as Trial Balance Features n Closing balances of accounts in the ledger as well as cash balance are taken n It tests the arithmetical accuracy of ledger balances n It can be prepared monthly, quarterly and yearly n It is a source document for preparing financial statement

CLOSING ENTRIES n 1. 2. 3. STEPS Transfer balances in revenue accounts to the CLOSING ENTRIES n 1. 2. 3. STEPS Transfer balances in revenue accounts to the Profit & Loss account Transfer balances in the expense account to the Profit & Loss account Transfer balances in the Profit & Loss account to Profit & Loss Appropriation account

Balance Sheet Asset side Items under Fixed Asset 1. Land 2. Building 3. Plant Balance Sheet Asset side Items under Fixed Asset 1. Land 2. Building 3. Plant and Machinery 4. Furniture and Fixture 5. Vehicles n

Balance Sheet n 1. 2. 3. 4. Investment bonds Investment partnership in govt. securities Balance Sheet n 1. 2. 3. 4. Investment bonds Investment partnership in govt. securities in shares , debentures and in immovable properties in the capital of firms

Balance Sheet Current Assets, Loans, and Advances Current Assets --- Inventories --- Sundry debtors Balance Sheet Current Assets, Loans, and Advances Current Assets --- Inventories --- Sundry debtors --- Cash and bank balances Loans and Advances --- Advances recoverable in cash or in kind or for value to be received ---Advance income tax --- Advance deposit of sales tax and excise --- Inter-corporate deposits n

BALANCE SHEET n n Miscellaneous Expenditure Debit balance in Profit and Los account BALANCE SHEET n n Miscellaneous Expenditure Debit balance in Profit and Los account

Balance Sheet Liabilities side Share Capital --- Equity Share Capital --- Preference Share Capital Balance Sheet Liabilities side Share Capital --- Equity Share Capital --- Preference Share Capital Reserves and Surplus --- Capital reserves --- General reserve --- Capital redemption reserve --- Debenture redemption reserve n

Balance Sheet Loan Funds Secured Loans -- Term Loans -- Debentures --Working capital loans Balance Sheet Loan Funds Secured Loans -- Term Loans -- Debentures --Working capital loans Unsecured Loans -- Fixed deposits --Debentures --Security deposits n

Balance Sheet Current Liabilities and Provisions Current Liabilities --- Sundry Creditors --- Expenses Payable Balance Sheet Current Liabilities and Provisions Current Liabilities --- Sundry Creditors --- Expenses Payable --- Advances from customers --- Unclaimed dividends --- Interest accrued but not due Provisions --- Provision for taxation --- proposed dividend --- provision for contingencies n

PROFIT & LOSS ACCOUNT n n n Domestic Sales Exports others PROFIT & LOSS ACCOUNT n n n Domestic Sales Exports others

PROFIT AND LOSS ACCOUNT Expenditure --- Materials Consumed ---Salaries, wages, bonus ---Staff welfare expenses PROFIT AND LOSS ACCOUNT Expenditure --- Materials Consumed ---Salaries, wages, bonus ---Staff welfare expenses ---Power and fuel ---Repairs and maintenance ---Rent, rates and taxes ---Freight, transportation ---Travelling exp. ---Interest ---Excise duty ---Depreciation ---Provision for taxation ---Extraordinary items n

PROFIT & LOSS ACCOUNT n n 1. 2. 3. 4. 5. Profit After Tax PROFIT & LOSS ACCOUNT n n 1. 2. 3. 4. 5. Profit After Tax : It is measured as excess of revenues over expenses. Profit & Loss Appropriation Account : From the PAT following appropriations take place Prov. for dividend to Pref. Shareholders Interim dividend Provision for final dividend Prov. for Corp. dividend tax Transfer to general reserve, debenture redemption reserve

CASH FLOW STATEMENT Features 1. Prepared for a given period 2. Comparative position for CASH FLOW STATEMENT Features 1. Prepared for a given period 2. Comparative position for each element of cash flow is given. 3. Cash inflows and outflows for operating , investing and financing activities are disclosed. 4. It shows the reconciliation between opening and closing cash balances. 5. It’s a derived statement. n

CASH FLOW STATEMENT n n n Operating Activity – The principal revenue producing activity CASH FLOW STATEMENT n n n Operating Activity – The principal revenue producing activity Investing Activity– Refers to acquisition and disposal of long-term assets and other investments Financing Activity– Those activities that result in changes in the size and composition of the owners’ capital including preference capital

CASH FLOW STATEMENT n 1. 2. 3. 4. Operating Activities Cash receipts from sale CASH FLOW STATEMENT n 1. 2. 3. 4. Operating Activities Cash receipts from sale of goods or services Cash receipts from royalties, fees, commission Cash payments to suppliers, employees Cash payments or refunds of income tax

CASH FLOW STATEMENT n 1. 2. 3. 4. 5. 6. Investing Activities Cash payments CASH FLOW STATEMENT n 1. 2. 3. 4. 5. 6. Investing Activities Cash payments to acquire fixed assets Cash receipts from disposal of fixed asset and intangibles Cash payments to acquire shares, warrants or debt instruments Cash receipts from disposal from shares, warrants or debt instruments Cash advances and loans made to third parties Cash receipts from the repayment of advances and loans made to third parties

CASH FLOW STATEMENT n 1. 2. Financing Activities Cash proceeds from issue of shares, CASH FLOW STATEMENT n 1. 2. Financing Activities Cash proceeds from issue of shares, debentures, loans, bonds Cash repayments of amount borrowed

VALUATION OF INVENTORIES Meaning of Inventories consist of assets held : a) For Sale VALUATION OF INVENTORIES Meaning of Inventories consist of assets held : a) For Sale ( finished goods ) b) In the process of production for such sale ( raw material and W. I. P ) c) In the form of materials or supplies to be consumed in the production process ( stores, spares, consumables, raw material) n

VALUATION OF INVENTORIES Applicability AS-2 does not cover the following 1. W. I. P VALUATION OF INVENTORIES Applicability AS-2 does not cover the following 1. W. I. P arising under construction contract 2. W. I. P arising in case of service providers 3. Shares, debentures, bonds held as stock-in-trade 4. Livestock, agricultural and forest n

VALUATION OF INVENTORIES Valuation Policy Inventories are valued at lower of cost or net VALUATION OF INVENTORIES Valuation Policy Inventories are valued at lower of cost or net realisable value NRV means estimated selling price minus estimated costs of completion and costs necessary to make the sale n

VALUATION OF INVENTORIES n 1. 2. 3. Cost of Inventory includes--Cost of purchase Cost VALUATION OF INVENTORIES n 1. 2. 3. Cost of Inventory includes--Cost of purchase Cost of conversion Other costs incurred in bringing the inventories to their present location and condition

VALUATION OF INVENTORIES n 1. 2. 3. 4. 5. Exclusion of certain costs Abnormal VALUATION OF INVENTORIES n 1. 2. 3. 4. 5. Exclusion of certain costs Abnormal amounts of wasted materials, labour, other production costs Storage cost Administrative overhead Selling and distribution cost Interest and borrowing cost

VALUATION OF INVENTORIES Cost Formulas 1. Specific Identification Method : -It means directly linking VALUATION OF INVENTORIES Cost Formulas 1. Specific Identification Method : -It means directly linking the cost with specific item of inventories 2. FIFO ( First In First Out ) or Weighted Average cost Where specific identification method is not applicable the cost of inventories is valued by either of the above two formulas. n

FINANCIAL REPORTS A Company’s annual report contains the following : 1. Auditors’ Report 2. FINANCIAL REPORTS A Company’s annual report contains the following : 1. Auditors’ Report 2. Directors’ Report, and 3. Corporate Governance Report

FINANCIAL REPORT Auditors’ Report Sec. 227 of the Companies’ ACT requires the auditor : FINANCIAL REPORT Auditors’ Report Sec. 227 of the Companies’ ACT requires the auditor : 1. To make a report to the members on the accounts examined by him, and on every balance sheet and profit and loss account and on every other document forming part of B/S and P/L 2. To express an opinion whether the accounts a) give the information required by the Companies’ Act in the manner so required b) give a true and fair view 1. In the case of balance sheet, of the state of affairs of the company 2. In the case of profit and loss account, of the profit or loss for the financial year

FINANCIAL REPORT Auditors’ Report 3. The report shall also state : a) Whether all FINANCIAL REPORT Auditors’ Report 3. The report shall also state : a) Whether all the information and explanations were obtained for the purpose of audit b) Whether proper books of account as required by law have been kept and whether adequate reports from branches not visited by him have been received c) Whether the B/S and P/L are in agreement with the books of account d) Whether the B/S and P/L comply with the accounting standard e) Whether any director is disqualified u/s 274

FINANCIAL REPORT Directors’ Report (sec. 217) The report shall state : 1. The state FINANCIAL REPORT Directors’ Report (sec. 217) The report shall state : 1. The state of the company’s affairs 2. The proposed amount of transfer to any reserves 3. Amount recommended for dividend 4. Material changes taken place between the end of financial year and the date of report 5. Conservation of energy, technological absorption, foreign exchange earnings and outgo n

FINANCIAL REPORT Directors’ Responsibility Statement It shall state the following: 1. All relevant accounting FINANCIAL REPORT Directors’ Responsibility Statement It shall state the following: 1. All relevant accounting standards have been followed in the preparation of annual accounts 2. The directors have selected proper accounting policies and applied them consistently and made reasonable judgments and estimates so as to give a true and fair view of the state of affairs 3. The directors have taken proper and adequate care for maintenance of accounting records and safeguarding of assets and preventing and detecting fraud 4. The accounts have been prepared on a going concern basis n

FINANCIAL REPORT n 1. 2. 3. The directors’ report shall further include Information and FINANCIAL REPORT n 1. 2. 3. The directors’ report shall further include Information and explanation on every qualification, or adverse remark in the auditors’ report Reasons for delay in completing buy-back process a) A statement showing name of employees who are in receipt of Rs. 24 lacs or more per annum, if employed throughout the year b) If employed for part of the year Rs. 2 lacs per month c) If employed throughout or part of the year, was in receipt of remuneration in excess of that drawn by M. D. or whole-time director or manager and holds by himself or together with spouse not less than 2% of equity shares of the company

FINANCIAL REPORT Corporate Governance Report Objectives: 1. To protect the interest of small investors FINANCIAL REPORT Corporate Governance Report Objectives: 1. To protect the interest of small investors 2. To promote transparency within business and industry 3. To develop a high level of public confidence through increase in shareholders’ wealth n

FINANCIAL REPORT Corporate Governance : Clause 49 Audit Committee: 1. It shall have minimum FINANCIAL REPORT Corporate Governance : Clause 49 Audit Committee: 1. It shall have minimum three members, all being non-executive directors 2. At least one director should have financial and accounting knowledge 3. The chairman of the committee shall be an independent director 4. The company secretary is the secretary of the committee n

FINANCIAL REPORT Audit committee 5. The Chairman shall be present at AGM to answer FINANCIAL REPORT Audit committee 5. The Chairman shall be present at AGM to answer shareholders’ queries 6. At least three meetings should be held in a year 7. Quorum is either two members or one third of the members of the committee w. e. is higher and minimum of two independent directors n

FINANCIAL REPORT n 1. 2. 3. Powers of the Audit Committee To investigate any FINANCIAL REPORT n 1. 2. 3. Powers of the Audit Committee To investigate any matter within its area of activity To seek information from any employee To obtain legal or professional advice

FINANCIAL REPORT n 1. 2. 3. 4. 5. 6. Role of Audit Committee To FINANCIAL REPORT n 1. 2. 3. 4. 5. 6. Role of Audit Committee To review the financial reporting process and to ensure that the financial statement is correct Recommending the appointment and removal of external auditor and their fees To review the financial statements before submission to the board in order to ensure compliance with accounting standards To review the internal audit function and the adequacy of internal control system To discuss any significant findings by the I. A. To look into the reasons for default in the payment to the depositors, debenture holders, shareholders

FIXED ASSETS ACCOUNTING n 1. 2. 3. 4. Meaning and Significance of Fixed Assets FIXED ASSETS ACCOUNTING n 1. 2. 3. 4. Meaning and Significance of Fixed Assets Fixed assets are used for production or providing goods or services They are not meant for resale in the ordinary course of business They constitute a significant portion of total assets Proper allocation between revenue and capital expenditure necessary to recognise and measure fixed asset

FIXED ASSETS ACCOUNTING n 1. 2. 3. 4. 5. Cost of Fixed Assets Purchase FIXED ASSETS ACCOUNTING n 1. 2. 3. 4. 5. Cost of Fixed Assets Purchase price inclusive of import duties less trade discount, rebates Any directly attributable cost incurred to bring the asset to its present working condition Admin. and general overhead charges specifically attributable to construction of a project Cost to be adjusted for exchange fluctuation If acquired in exchange for another asset , the cost is recorded either at FMV or net book value of the asset given up

FIXED ASSETS ACCOUNTING n 1. 2. Cost of fixed assets is affected by two FIXED ASSETS ACCOUNTING n 1. 2. Cost of fixed assets is affected by two following factors Government grants Borrowing costs

FIXED ASSETS ACCOUNTING Accounting for Govt. grants Grants related to specific asset 1. The FIXED ASSETS ACCOUNTING Accounting for Govt. grants Grants related to specific asset 1. The grant is shown as a deduction from the gross value of asset. Where the grant equals the entire cost of the asset , the asset is shown at a nominal value 2. A) Grants related to depreciable asset are treated as deferred income B) Grants related to non-depreciable asset are credited to capital reserve n

FIXED ASSETS ACCOUNTING Borrowing costs are interest and other costs incurred relating to borrowing FIXED ASSETS ACCOUNTING Borrowing costs are interest and other costs incurred relating to borrowing of funds. Borrowing costs attributable directly to the acquisition or construction of fixed asset are capitalised. Conditions for capitalisation 1. Borrowing costs are incurred 2. Activities essential to prepare the asset for its intended use are in progress 3. Expenditure for the acquisition or construction of asset is incurred n

DEPRECIATION n Definition: - Depreciation is a measure of the wearing out, consumption or DEPRECIATION n Definition: - Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. In other words depreciation is nothing but distribution of total cost of an asset over its useful life.

DEPRECIATION Significance 1. It represents the charge of a fair proportion of the depreciable DEPRECIATION Significance 1. It represents the charge of a fair proportion of the depreciable amount to P&L account over the useful life of an asset. 2. Depreciable amount is the historical cost or revalued amount of the asset less residual value. 3. It plays a significant role in determining the financial performance of an enterprise. 4. It is charged in each accounting year. n

DEPRECIATION n 1. 2. 3. 4. Depreciable Asset means an Asset which Is held DEPRECIATION n 1. 2. 3. 4. Depreciable Asset means an Asset which Is held by an enterprise for use in the production or supply of goods and services. Is not meant for resale in the ordinary course of business. Is expected to be used during more than one accounting period Has limited useful life.

DEPRECIATION Methods of Depreciation 1. Straight Line Method: - Under this method depreciation is DEPRECIATION Methods of Depreciation 1. Straight Line Method: - Under this method depreciation is charged equally over the useful life of the asset. Formula: Depreciation = Cost of asset- Estimated residual value ---------------------------Estimated useful life n

DEPRECIATION 2. Written down value method: - Under this method depreciation is charged at DEPRECIATION 2. Written down value method: - Under this method depreciation is charged at a fixed rate on the reduced balance of the asset every year. Rate of Estimated residual Depreciation = 1 - n value -------------Cost of asset

DEPRECIATION Requirements of Companies Act Sec. 205 and 350 deal with depreciation 1. Sec. DEPRECIATION Requirements of Companies Act Sec. 205 and 350 deal with depreciation 1. Sec. 205 states that no dividend shall be declared or paid out of profits without providing for depreciation. 2. Depreciation has to be provided a) as provided in sec. 350, or b) as arrived at by dividing 95% of the original cost of the asset by the specified period 3. Sec. 350 provides that depreciation has to be charged as per schedule XIV to the Companies Act. n

DEPRECIATION n 1. 2. 3. Provisions of Income Tax Act Only WDV method is DEPRECIATION n 1. 2. 3. Provisions of Income Tax Act Only WDV method is recognised Block of assets method is followed 100% dep. Is allowed if the asset is used for 180 days or more. 50% dep. if used for less than 180 days

DEPRECIATION Consistency Principle It requires that a method of dep. , once adopted , DEPRECIATION Consistency Principle It requires that a method of dep. , once adopted , should be applied consistently unless 1. The statute requires the adoption of a new method. 2. It is required to comply the provisions of an accounting standard 3. The change is necessary for a more appropriate preparation and presentation of the financial statements. n

FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. 4. Objectives of Analysis To know whether FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. 4. Objectives of Analysis To know whether the company is making enough profit or not To evaluate the financial strength of the company To judge the ability of the company to generate enough cash and cash equivalents and their timing To know the future growth prospects

FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. 4. 5. Tools available for analysis Multi-step FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. 4. 5. Tools available for analysis Multi-step income statement Horizontal analysis Common-sized analysis Trend analysis Analytical balance sheet

FINANCIAL STATEMENT ANALYSIS Multi-step Income Statement From the reported statement , it is necessary FINANCIAL STATEMENT ANALYSIS Multi-step Income Statement From the reported statement , it is necessary to segregate information and break-up of manufacturing, administrative and selling expenses which will show the profitability and disclose the following a) Gross Profit—GP b) Profit before depreciation, interest and tax—PBDIT c) Operating Profit—OP or PBIT d) Profit before tax and extraordinary items—PBTEOT e) Profit before tax—PBT f) Net profit--PAT n

FINANCIAL STATEMENT ANALYSIS Horizontal Analysis The percentage analysis of increase or decrease in each FINANCIAL STATEMENT ANALYSIS Horizontal Analysis The percentage analysis of increase or decrease in each item of comparative balance sheet and profit and loss account is known as horizontal analysis Formula: (Current year’s fig. - Previous year’s fig. )*100 -----------------------------Previous year’s fig. n

FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. Common-sized Analysis The tool is useful in FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. Common-sized Analysis The tool is useful in comparing the performance and financial position of two companies within the same industry or in different industries In case of balance sheet , each item is restated taking the total sources of fund or application of fund as 100 Similarly, in case of income statement, all items are expressed as a percentage of net sales which is taken at 100

FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. 4. Analytical Balance Sheet It is a FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. 4. Analytical Balance Sheet It is a modified version of vertical balance sheet It starts with ‘Application of funds’ side as against the vertical balance sheet that starts with ‘Sources of Funds’ side It proves the basic accounting equation : Assets outside liabilities= Owners’ Funds It shows that equity shareholders are the residual claimants on the assets of the company

FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. Trend Analysis It is an extension of FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. Trend Analysis It is an extension of horizontal analysis Unlike in horizontal analysis, trend analysis compares position for more than two years, say, five years Analysis for a longer period confirms the findings of horizontal analysis

FINANCIAL STATEMENT ANALYSIS Ratio Analysis: Ratio refers to relationship between two variables expressed either FINANCIAL STATEMENT ANALYSIS Ratio Analysis: Ratio refers to relationship between two variables expressed either in percentages or in multiples and seeks to establish the cause and effect relationship. It assists in the following cases 1. Inter-firm comparison 2. Intra-firm comparison 3. Comparison against industry benchmark 4. Analysis of performance over a long period n

FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. 4. 5. 6. 7. Classification of Ratios FINANCIAL STATEMENT ANALYSIS n 1. 2. 3. 4. 5. 6. 7. Classification of Ratios Return on Investment ( ROI ) ratios Solvency ratios Liquidity ratios Efficiency or Turnover ratios Profitability ratios Du Pont Analysis Capital Market ratios

FINANCIAL STATEMENT ANALYSIS Return on Investment (ROI) ratios This ratio seeks to measure the FINANCIAL STATEMENT ANALYSIS Return on Investment (ROI) ratios This ratio seeks to measure the efficiency of performance or otherwise of the company. Higher the ratio, greater is the financial security for investors. Maximisation of ROI is the ultimate objective of any company. Under this group, the following ratios are computed 1. Return on Net Worth 2. Earnings per Share n

FINANCIAL STATEMENT ANALYSIS Return on Net Worth (RONW) The ratio measures the net profit FINANCIAL STATEMENT ANALYSIS Return on Net Worth (RONW) The ratio measures the net profit earned on equity shareholders’ funds. It is the measure of overall profitability of a company. Formula: (PAT-Pref. dividend)*100 -----------------------------Net Worth (Equity capital + Reserves & Surplus. Misc. expenditure not written off) n

FINANCIAL STATEMENT ANALYSIS Earning per Share ( EPS) The ratio measures the overall profitability FINANCIAL STATEMENT ANALYSIS Earning per Share ( EPS) The ratio measures the overall profitability in terms of per equity share of capital contributed. This is the most widely used ratio across industries. Formula: PAT-Pref. Dividend -----------------------------n

FINANCIAL STATEMENT ANALYSIS Solvency Ratios The capacity of a company to discharge its long-term FINANCIAL STATEMENT ANALYSIS Solvency Ratios The capacity of a company to discharge its long-term obligation indicates its financial strength and solvency position. Under this group, the following ratios are computed. 1. Debt-Equity ratio 2. Interest coverage ratio 3. Debt-service coverage ratio n

FINANCIAL STATEMENT ANALYSIS Debt-Equity ratio ( times ) The ratio measures the proportion of FINANCIAL STATEMENT ANALYSIS Debt-Equity ratio ( times ) The ratio measures the proportion of debt and capital – both equity and preference in the capital structure of a company. It helps in knowing whether a company is relying more on debt or capital for financing its assets. Higher the debt , more is the financial risk. Formula: Long term debt ---------------------------------Total net worth( Eq. shareholders’ funds+Pref. cap) n

FINANCIAL STATEMENT ANALYSIS Interest Coverage Ratio ( times ) The ratio measures the ability FINANCIAL STATEMENT ANALYSIS Interest Coverage Ratio ( times ) The ratio measures the ability of a company to service the interest obligations out of its cash profits. Higher the ratio, greater is the ability. Formula: PAT+Int. on long-term debt+Non-cash charges -----------------------------Interest on long-term debt n

FINANCIAL STATEMENT ANALYSIS Debt Service Coverage Ratio (times) This ratio helps in assessing whether FINANCIAL STATEMENT ANALYSIS Debt Service Coverage Ratio (times) This ratio helps in assessing whether a company has the ability to service its instalments of the principal due and the interest obligations out of the revenues generated. Higher the ratio, greater is the ability. Formula: PAT+Int. on long term debt+Non-cash charges --------------------------------Int. on long term-debt +Instalments of principal n

FINANCIAL STATEMENT ANALYSIS Liquidity Ratio Liquidity refers to the capacity a company to meet FINANCIAL STATEMENT ANALYSIS Liquidity Ratio Liquidity refers to the capacity a company to meet its day to day expenses and discharge short-term obligations of suppliers and other creditors smoothly. Following ratios are calculated under this head. 1. Current Ratio 2. Quick Ratio 3. Collection period 4. Suppliers Credit 5. Inventory Holding period n

FINANCIAL STATEMENT ANALYSIS Current Ratio ( times ) The ratio measures the ability of FINANCIAL STATEMENT ANALYSIS Current Ratio ( times ) The ratio measures the ability of a company to discharge its day to day obligations. A company should possess adequate level of current assets over current liabilities to be able to do so. A current ratio of more than 1 indicates that value of short-term assets is more than short-term liabilities. A current ratio of less than 1 indicates poor liquidity. Formula: Current Assets, loans and advances+short-term Investme nts ---------------------------------------Current Liabilities+Provisions+Short-term debt n

FINANCIAL STATEMENT ANALYSIS Quick Ratio ( times ) The ratio measures as to how FINANCIAL STATEMENT ANALYSIS Quick Ratio ( times ) The ratio measures as to how fast the company is able to meet its current obligations as and when they fall due. This is also known as acid-test ratio. Inventory and working capital limits are taken out of current assets and current liabilities respectively. A quick ratio of 1: 1 is indicates highly solvent position. Formula: Current Assets, Loans and Advances-Inventories ----------------------------------Current Liabilities+Provisions-Working Capital Limits n

FINANCIAL STATEMENT ANALYSIS Collection Period ( days ) The ratio measures how fast the FINANCIAL STATEMENT ANALYSIS Collection Period ( days ) The ratio measures how fast the company is able to realise the dues from the customers on credit sales. It helps to understand the credit policy of the company. Formula: Receivables *365 -------------Credit sales n

FINANCIAL STATEMENT ANALYSIS Suppliers’ Credit ( days ) The ratio measures the average credit FINANCIAL STATEMENT ANALYSIS Suppliers’ Credit ( days ) The ratio measures the average credit period enjoyed by the company from its suppliers. It also helps to understand the credit policy extended to a company by the suppliers. Formula: Payables*365 -----------Credit Purchases n

FINANCIAL STATEMENT ANALYSIS Inventory Holding Period( days ) The ratio measures the average period FINANCIAL STATEMENT ANALYSIS Inventory Holding Period( days ) The ratio measures the average period for which cash is blocked in inventory. In other words the ratio explains how fast the company is able to convert its inventory into cash. Formula: Inventory*365 ----------Cost of goods sold n

FINANCIAL STATEMENT ANALYSIS Turnover Ratios These ratios indicate how efficiently the assets of the FINANCIAL STATEMENT ANALYSIS Turnover Ratios These ratios indicate how efficiently the assets of the company are used to generate revenue. Following ratios are calculated under this group. 1. Overall Efficiency Ratio 2. Fixed Assets Turnover Ratio 3. Debtors Turnover Ratio 4. Inventory Turnover Ratio 5. Creditors Turnover Ratio n

FINANCIAL STATEMENT ANALYSIS Overall Efficiency Ratio ( times ) It shows how effectively the FINANCIAL STATEMENT ANALYSIS Overall Efficiency Ratio ( times ) It shows how effectively the capital employed has helped in revenue generation. Higher the ratio greater is the efficiency. Formula: Sales -----------------------Capital Employed n

FINANCIAL STATEMENT ANALYSIS Fixed Assets Turnover Ratio ( times ) The ratio measures the FINANCIAL STATEMENT ANALYSIS Fixed Assets Turnover Ratio ( times ) The ratio measures the sales revenue per rupee of fixed assets. It plays an important role in improving the overall profitability and financial position of the company. Formula : Sales ------------------------n

FINANCIAL STATEMENT ANALYSIS Debtors Turnover Ratio ( times ) It represents the number of FINANCIAL STATEMENT ANALYSIS Debtors Turnover Ratio ( times ) It represents the number of times average dues from customers are realised. Higher the ratio, the better is the position. Formula: Credit Sales ------------------------Average Debtors n

FINANCIAL STATEMENT ANALYSIS Creditors Turnover Ratio ( times ) The ratio shows the average FINANCIAL STATEMENT ANALYSIS Creditors Turnover Ratio ( times ) The ratio shows the average time taken to pay for goods and services. Longer the credit period achieved the better. Formula: Credit Purchase --------------------------Average Creditors n

FINANCIAL STATEMENT ANALYSIS Inventory Turnover Ratio The ratio measures the amount of capital tied FINANCIAL STATEMENT ANALYSIS Inventory Turnover Ratio The ratio measures the amount of capital tied up in raw material, W. I. P. and finished goods Formula: Cost of Goods Sold -------------------Average Inventory n

FINANCIAL STATEMENT ANALYSIS Profitability Ratios The purpose of study of these ratios is to FINANCIAL STATEMENT ANALYSIS Profitability Ratios The purpose of study of these ratios is to assess the adequacy or otherwise of the profit earned by the company. The following ratios are calculated under this group. 1. Multi-step Profit Margin to Sales 2. Individual Cost and Expense to Sales 3. Other Income , Extraordinary Items and Prior Period Adjustments to PBT or Sales 4. Effective Tax Rate n

FINANCIAL STATEMENT ANALYSIS Multi-step Profit Margin to Sales Ratios(%) These ratios measure several profit FINANCIAL STATEMENT ANALYSIS Multi-step Profit Margin to Sales Ratios(%) These ratios measure several profit margin indicators. All these ratios are computed in relation to Sales. 1. Gross Profit Margin-GP 2. Profit Before Depreciation, Interest and Tax-PBDIT 3. Operating Profit-OP 4. Profit Before Tax and Extra-ordinary Items-PBTEOT 5. Profit Before Tax-PBT 6. Net Profit Margin-PAT n

FINANCIAL STATEMENT ANALYSIS Gross Profit Margin (%) This reflects the efficiency with which management FINANCIAL STATEMENT ANALYSIS Gross Profit Margin (%) This reflects the efficiency with which management produces each unit of output. It also indicates the spread between the cost of goods sold and the sales revenue. Formula: Sales-Cost of Goods Sold ------------------- x 100 Sales n

FINANCIAL STATEMENT ANALYSIS Operating Profit Margin (%) This ratio indicates profitability from operating activities. FINANCIAL STATEMENT ANALYSIS Operating Profit Margin (%) This ratio indicates profitability from operating activities. A higher margin implies better sales realisation and effective cost control. Formula: Operating Profit ----------- X 100 Sales n

FINANCIAL STATEMENT ANALYSIS Net Profit Margin( % ) The ratio is the overall measure FINANCIAL STATEMENT ANALYSIS Net Profit Margin( % ) The ratio is the overall measure of the firm’s ability to earn profit per rupee of sales. It also establishes relationship between manufacturing, administering and selling the products. Formula: Profit After Tax ----------- x 100 Sales n

FINANCIAL STATEMENT ANALYSIS Individual Costs and Expenses to Sales Ratios (%) These ratios measure FINANCIAL STATEMENT ANALYSIS Individual Costs and Expenses to Sales Ratios (%) These ratios measure the proportion of individual items of cost and expense in relation to sales. They also assist the analyst in cost minimisation and cost reduction. Formula: Raw Materials Consumed -------------------- x 100 Net Sales n

FINANCIAL STATEMENT ANALYSIS Other Income, Extraordinary Items and Prior Period Adjustments to PBT or FINANCIAL STATEMENT ANALYSIS Other Income, Extraordinary Items and Prior Period Adjustments to PBT or Net Sales (%) These ratios seek to measure the impact of the above items on PBT or net sales. Formula: Extraordinary Item ------------- x 100 PBT n

FINANCIAL STATEMENT ANALYSIS Effective Tax Rate(%) The ratio measures the actual effective rate at FINANCIAL STATEMENT ANALYSIS Effective Tax Rate(%) The ratio measures the actual effective rate at which a company pays income tax as against the statutory rate. Formula: Current Income Tax -------------- x 100 PBT n

FINANCIAL STATEMENT ANALYSIS DU PONT Analysis RONW is a function of Net Profit Margin FINANCIAL STATEMENT ANALYSIS DU PONT Analysis RONW is a function of Net Profit Margin and Net worth Turnover. DU PONT analysis seeks to measure and establish this relationship between the two determinants. Through these ratios a firm can devise suitable remedies to overcome the weak area of overall performance. Formula: (PAT-Pref. Div)X 100 Net Sales --------------X-------------------Net Sales Net Worth n

FINANCIAL STATEMENT ANALYSIS Capital Market Ratios Following ratios are computed under this group. 1. FINANCIAL STATEMENT ANALYSIS Capital Market Ratios Following ratios are computed under this group. 1. EPS 2. Price Earning Ratio-P/E 3. Market Capitalisation 4. Yield to Investors n

FINANCIAL STATEMENT ANALYSIS Price Earning Ratio ( times ) P/E multiple is an important FINANCIAL STATEMENT ANALYSIS Price Earning Ratio ( times ) P/E multiple is an important indicator of the premium that the market wishes to put on a firm’s earnings. It can be used to price a share and value a firm. Formula: Market Price of Equity Share ---------------------EPS n

FINANCIAL STATEMENT ANALYSIS Market Capitalisation (Rs. ) The ratio measures the total market value FINANCIAL STATEMENT ANALYSIS Market Capitalisation (Rs. ) The ratio measures the total market value of the number of equity shares outstanding. Formula: No. of Equity Shares O/S X Market Price n

FINANCIAL STATEMENT ANALYSIS Yield to Investors (%) The ratio measures the total gain or FINANCIAL STATEMENT ANALYSIS Yield to Investors (%) The ratio measures the total gain or loss suffered by investors in relation to their investment in equity shares of a company. Dividend recd. + Market Appreciation -----------------------x 100 Initial Investment n