FINANCIAL ACCOUNTING Prof. Ranjan Kumar Bal Utkal University
What is Common? • Lakshmi Niwas Mittal • Kumar Mangalam Birla • Indra Nooyi • Osama Bin Laden
COURSE OUTLINE: F.A. • Conceptual Knowledge • Mechanics • Financial Statements • Analysis & Decision Making
F. A.: WHY TO READ ? • Personal Life • Professional Life • An Investment for Future • Strategy
BUSINESS ORGANISATIONS • Merchandising (Trading) Organisations • Manufacturing Organisations • Service Organisations Business organisations are cash machines.
BUSINESS ORGANISATIONS • Private Limited Company • Public Limited Company • Limited Liability Partnership
ACCOUNTING IS THE LANGUAGE OF BUSINESS. • Serves as a means of communication • Communicates / reports the events
Anthony & Reece: “Accounting is not exactly a foreignlanguage; the problem of learning it is more like that of an American learning to speak English as it is spoken in Great Britain.”“Language evolve and change in response to the changing needs of society, and so does Accounting.”
ACCOUNTING IS AN INFORMATION SYSTEM INPUT (Raw Data) SYSTEM PROCESSES (Men & Equipment) OUT PUT (Reports & Information)
OUTPUTS • Financial Statements • Tax Returns • Managerial Data and Reports • Special Reports
USERS OF ACCOUNTING INFORMATION • Management • Shareholders and Investors • Lenders • Creditors • Employees • Customers • Govt. and Regulatory Agencies • General Public • Others: Media, Consumer Organizations, Researchers & Analysts, etc.
EVOLUTION OF ACCOUNTING • Stewardship Accounting • Financial Accounting • Cost Accounting • Management Accounting Financial Accounting Vs. Managerial Accounting
DEFINITIONS AAA: “Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of information.” AICPA: “Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part, at least of a financial character and interpreting the results thereof.”
FINANCIAL ACCOUNTING • Recording • Classifying • Summarizing • Analyzing & Interpreting • Communicating
OBJECTIVES : F.A. • To keep systematic records. • To ascertain the net effects of the business operations. • To ascertain the financial position of the organisations. • To provide accounting information to interested parties.
Principles to be observed at the recording stage Accounting Entity Money Measurement Objective Evidence Dual Aspect Realisation Cost Accrual Principles to be observed at the reporting stage Going concern Accounting Period Matching Conservative Consistency Materiality Full Disclosure ACCOUNTING PRINCIPLES
CASH BASISVs.ACCRUAL BASIS OF ACCOUNTING Accounting Framework: Includes GAAP on the basis of which accounting data is processed, analyzed and reported.
GAAP • A set of concepts, conventions, rules, and procedures • Accepted by accountants over a period of time • Guides in the preparation and presentation of financial reports
ACCOUNTING STANDARDS • Specifies acceptable accounting methods • Uniformity • Harmonization • ASB of the ICAI – AS Vs. Ind AS • IASB - IFRS • FASB
ACCOUNTING EQUATION • Economic Resources = Sources of Resources or Claims. • Assets = Liabilities • Equity + Liabilities = Assets
EQUITY & LIABILITIES Creditors Rs.20,000 Suresh, Equity 50,000 ----------- 70,000 ----------- ASSETS Cash Rs.12,000 Equipments Rs.58,000 ---------- 70,000 ---------- Analysing the Effects of Business Transactions. Investment by OwnerReceipt of LoanPurchase of Office Equipment
LIABILITIES Share Capital Reserve and Surplus Secured Loans Unsecured Loans Current Liabilities and Provisions ASSETS Fixed Assets Investments Current Assets And Loans & Advances Miscellaneous Expenditures Profit & Loss A/C BALANCE SHEETas at 31st March, 2011
BALANCE SHEETas at 31st March, 2011 SOURCES OF FUNDS • Shareholders’ Fund • Loan Funds APPLICATION OF FUNDS • Fixed Assets • Investments • Current Assets, Loans & Advances Less Current Liabilities & Provision • Miscellaneous Expenditure
BALANCE SHEETas at 31st March, 2012 EQUITY AND LIABILITIES Note No. Current Previous • Shareholders’ Fund • Share Application Money pending allotment • Non-current Liabilities • Current Liabilities ASSETS • Non-current Assets • Fixed Assets • Non-current Investments • Deferred Tax Assets (net) • Long term loans and advances • Other non-current assets • Current Assets • Current Investments • Inventories • Trade receivables • Cash and cash equivalents • Short-term loans and advances • Other current assets
PROFIT & LOSS A/Cfor the year ending 31st March 2011. I. Income II. Expenditure III. Profit before Tax IV. Provision for Taxation V. Profit after Tax VI. Balance b/f from last year VII. Profit available for appropriation Appropriations: Dividends, Reserves VIII. Balance transferred to Balance Sheet
PROFIT & LOSS STATEMENTfor the year ending 31st March 2012 I. Revenue from operations II. Other income III. Total Revenue IV. Expenses ……………. V. Profit before exceptional and extraordinary items and tax VI. Exceptional Items VII. Profit before extraordinary items and tax • Extraordinary items • Profit before tax • Tax expense: Current tax, Deferred tax • Profit/(loss) for the period from continuing operations • Profit/(loss) from discontinuing operations • Tax expense of discontinuing operations • Profit/(loss) from discontinuing operations (after tax) • Profit/(loss) for the period • Earnings per equity share: Basic, Diluted
CASH FLOW STATEMENTfor the period ending on March 31, 2012 • Cash flow from operating activities • Cash flow from investing activities • Cash flow from financing activities • Net cash increase (decrease) in cash & CE • Cash & CE at beginning of the period • Cash & CE at the end of the period.
PRODUCT MARKET FORCES Competitors, Customers CAPITAL MARKET FORCES Investors, Lenders FINANCIAL STATEMENTS AND REPORTS REGULATORY FORCES Government, Securities Regulator LABOUR MARKET FORCES Managers, Employees
LIMITATIONS OF FINANCIAL STATEMENTS • Vegetable Accounting • Focus on past / historical data • Postmortem Analysis • Ignore non-financial information • Ignore HR • Fails to provide all information to stake-holders for their decision making
QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS. • Relevance • Reliability • Understandability • Comparability • Consistency • Neutrality • Materiality • Timeliness • Verifiability • Prudence
RECORDING BUSINESS TRANSACTIONS • Accounts • Ledger • Chart of Accounts: Assets Liabilities Shareholders’ Equity Revenues Expenses
DOUBLE ENTRY SYSTEM • Luca Pacioli – 1494 • Dual Aspect • Debit & Credit
LEDGER ‘T’ Account : A Ledger account in simplified form. TITLE OF ACCOUNT Left or Debit side Right or Credit side ANY ASSET / EXPENSE ACCOUNT (Debit) (Credit) Increase Decrease
Ledger ANY LIABILITY / OWNER’S EQUITY / REVENUE ACCOUNT (Debit) (Credit) Decrease Increase Standard Form of Accounts ANY ACCOUNT Date Explanation Ref Debit Credit Balance
JOURNAL GENERAL JOURNAL DATE ACCOUNT TITLE & EXPLANATION L.F DEBIT CREDIT Rs. Rs. 2009 June 1 Cash 1,00.000 Share Capital 1,00,000 Invested Cash June 2 Office Equipment 50,000 Cash 20,000 Creditors 30,000 Purchase of office equipment on part payment
SUB-DIVISIONOF JOURNAL • Cash Book • Purchases Journal • Sales Journal • Purchases Return Journal • Sales Return Journal • Bills Receivable Journal • Bills Payable Journal • Journal Proper
ADVANTAGES • Classification of transactions • Reference becomes easy • Facilitate division of work • More particulars • Responsibility can be fixed • Facilitates checking
PURCHASES JOURNAL Date Name of the Supplier Invoice No. L.F. Amount Remarks
SALES JOURNAL Date Name of the Customer Out ward Invoice No L.F Amount Remarks
BANK RECONCILATION Cash Book Vs. Pass Book What is shown on the debit side of the Cash Book, appears on the credit side of the Customer’s A/c in Bank’s ledger and vice versa. OVERDRAFT:When cash book shows a credit balance or when pass book shows a debit balance.
CAUSES OF DIFFERENCE: • Cheques issued but not yet presented for payment • Cheques deposited into the bank but not collected • Bank charges • Interest allowed by the bank, if any. • Interest on overdraft. • Amount collected by bank on standing instructions • Payment made by bank as per standing instructions • Direct payments into the bank made by customers • Dishonor of cheques or bill • Errors
TRIAL BALANCE • To check arithmetical accuracy • Equality of Debits & Credits
LOCATING ERRORS • A debit posted in an A/C as a credit or vice versa • An A/C balance incorrectly computed • An A/C balance incorrectly recorded in TB • A debit balance incorrectly recorded as credit balance in TB or vice versa • A balance omitted entirely • The TB incorrectly added • Partial omission of an entry
ERRORS NOT DISCLOSED BY TB • Omission from Books of Accounts • Recording at a wrong amount • Compensating Errors • Posting in correct side but wrong A/C • Recording twice in subsidiary books • Errors of Principle
CORRECTING ERRORS Correcting Entries Suspense Account
MEASURING BUSINESS INCOME • Profits: Life blood – survival & growth • Accountants prefer the term “Net Profit” instead of “Income” • NP = Revenues – Expenses • Gains & Losses • Accounting Period • Accrual Accounting • Matching principle
Measuring Income – Cont. • Adjustment process • Outstanding Expense • Prepaid Expense • Accrued Income • Income Received in Advance
CAPITAL AND REVENUE RULES: • Items of revenue nature : Income Statement. • Items of Capital nature : Balance Sheet. NEEDS: • Calculation of true Profit. • Determination of true Financial Position.