Download OU (Osmania University) MBA (Master of Business Administration) Financial Accounting and Analysis 2 Study Material (Important Notes)
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words of Finny and Miller, ?Liabilities are debts? they are amounts owed to creditors? thus the
claims of those who ate not owners are called liabilities?.
In simple terms, debts repayable to outsiders by the business are known as liabilities.
Long term Liabilities: Liabilities repayable after specific duration of long period of time are
called long term liabilities.
Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities
FINANCIAL STATEMENT ANALY SIS
Financial Statement : A financial statement is an organized collection of data according to
logical and consistent accounting procedures
Purpose: To understand the financial aspects of a business form.
Financial Statement
Income Statement Balance Sheet Statement of retained earnings Statement of changes in
financial position
Analysis : MethodicalClassificationofdatagiveninthe financialstatements nsimplifiedform.
Interpretation: Explainingthemeaningandsignificanceofdatasosimplified.
Financial statement Analysis: To analyze the firm?s profitability & financial soundness
The following are the types of Financial Statement Analysis.
1.On the basis of Material used : According to the material used.
External Analysis Internal Analysis
External Analysis: This analysis is done by the outsiders like Investors /Credit
agencies/Government agencies and other Creditors.
Internal Analysis: This analysis is done by the internal executives / employees of the
organization.
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words of Finny and Miller, ?Liabilities are debts? they are amounts owed to creditors? thus the
claims of those who ate not owners are called liabilities?.
In simple terms, debts repayable to outsiders by the business are known as liabilities.
Long term Liabilities: Liabilities repayable after specific duration of long period of time are
called long term liabilities.
Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities
FINANCIAL STATEMENT ANALY SIS
Financial Statement : A financial statement is an organized collection of data according to
logical and consistent accounting procedures
Purpose: To understand the financial aspects of a business form.
Financial Statement
Income Statement Balance Sheet Statement of retained earnings Statement of changes in
financial position
Analysis : MethodicalClassificationofdatagiveninthe financialstatements nsimplifiedform.
Interpretation: Explainingthemeaningandsignificanceofdatasosimplified.
Financial statement Analysis: To analyze the firm?s profitability & financial soundness
The following are the types of Financial Statement Analysis.
1.On the basis of Material used : According to the material used.
External Analysis Internal Analysis
External Analysis: This analysis is done by the outsiders like Investors /Credit
agencies/Government agencies and other Creditors.
Internal Analysis: This analysis is done by the internal executives / employees of the
organization.
2.On the basis of modus operandi : According to the method of operation followed in the
analysis.
Dynamic / Horizontal Analysis Static / Vertical Analysis
Dynamic / Horizontal Analysis: This analysis refers to the financial data of a company for
several years. The figures of various years are compared with the base year. It helps to focus
attention on items that have changed significantly during the period under review. Changes in
different elements of cost and sales over no . of years.
Tools employed are comparative statements and trend percentages.
Static / Vertical Analysis: A study is made of the quantitative relationship of the various items in
the financial statements in a particular date.
Percentage of each element of cost to sales.
Tools employed are common?size financial statements and financial ratios.
Ex: Item based
Particular period and in the same company
One division ? FMCG goods
Another division ? Medicines than
So the ratio is measured & compared the performance of one division to another division
Particular period and with different companies
One company ? FMCG goods
Another company ? FMCG goods
So the ratio is measured and compared the performance of one company to another company.
Methods and Devices of Financial Analysis:
A number of methods or devices are used to study the relationship between different statements
and to analyze the position of the enterprise.
The following are the methods:
1.Comparative statements
2.Trend Analysis
3.Common?size statements
4.Funds Flow Analysis
5.Cash Flow Analysis
6.Ratio Analysis
7.Cost?Volume?Profit Analysis
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FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words of Finny and Miller, ?Liabilities are debts? they are amounts owed to creditors? thus the
claims of those who ate not owners are called liabilities?.
In simple terms, debts repayable to outsiders by the business are known as liabilities.
Long term Liabilities: Liabilities repayable after specific duration of long period of time are
called long term liabilities.
Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities
FINANCIAL STATEMENT ANALY SIS
Financial Statement : A financial statement is an organized collection of data according to
logical and consistent accounting procedures
Purpose: To understand the financial aspects of a business form.
Financial Statement
Income Statement Balance Sheet Statement of retained earnings Statement of changes in
financial position
Analysis : MethodicalClassificationofdatagiveninthe financialstatements nsimplifiedform.
Interpretation: Explainingthemeaningandsignificanceofdatasosimplified.
Financial statement Analysis: To analyze the firm?s profitability & financial soundness
The following are the types of Financial Statement Analysis.
1.On the basis of Material used : According to the material used.
External Analysis Internal Analysis
External Analysis: This analysis is done by the outsiders like Investors /Credit
agencies/Government agencies and other Creditors.
Internal Analysis: This analysis is done by the internal executives / employees of the
organization.
2.On the basis of modus operandi : According to the method of operation followed in the
analysis.
Dynamic / Horizontal Analysis Static / Vertical Analysis
Dynamic / Horizontal Analysis: This analysis refers to the financial data of a company for
several years. The figures of various years are compared with the base year. It helps to focus
attention on items that have changed significantly during the period under review. Changes in
different elements of cost and sales over no . of years.
Tools employed are comparative statements and trend percentages.
Static / Vertical Analysis: A study is made of the quantitative relationship of the various items in
the financial statements in a particular date.
Percentage of each element of cost to sales.
Tools employed are common?size financial statements and financial ratios.
Ex: Item based
Particular period and in the same company
One division ? FMCG goods
Another division ? Medicines than
So the ratio is measured & compared the performance of one division to another division
Particular period and with different companies
One company ? FMCG goods
Another company ? FMCG goods
So the ratio is measured and compared the performance of one company to another company.
Methods and Devices of Financial Analysis:
A number of methods or devices are used to study the relationship between different statements
and to analyze the position of the enterprise.
The following are the methods:
1.Comparative statements
2.Trend Analysis
3.Common?size statements
4.Funds Flow Analysis
5.Cash Flow Analysis
6.Ratio Analysis
7.Cost?Volume?Profit Analysis
Comparative Statements:
The comparative financial statements are statements of the financial position at different periods,
of time. The elements of financial position are shown in a comparative form so as to give an idea
of financial position at two or more periods. The following are the two types of comparative
statements.
1.Comparative Balance Sheet: The analysis is the study of the trend of the same items, groups of
items and computed items in two or more balance sheets of the same business enterprise on
different dates. The changes in periodic balance sheet items reflect the conduct of a business. It
has four columns and the fourth column is used for giving percentages of increases or decreases.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?Current financial position and liquidity position
?Long?term financial position
?Profitability of the concern
?For studying current financial position or short?term financial position of a concern, should see
the working capital in both the years.
2.Comparative Income Statement: The income statement gives the results of the operations of a
business. It gives an idea of the progress of a business over a period of time. Like comparative
balance sheet it also has 4 columns and the fourth column is used to show increase or decrease in
figures, in absolute amounts and percentages respectively.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?The increase or decrease in sales should be compared with the increase or decrease in cost of
goods sold.
?To analyze the study of operational profits.
?The increase or decrease in net profit will give an idea about the overall profitability of the
concern.
?Should mention whether the overall profitability is good or not.
Trend Analysis:
The financial statements may be analyzed by computing trends of series of information. This
method determines the direction upwards or downwards and involves the computation of the
percentage relationship that each statement item bears to the same item in base year.
Procedure for calculating trends.
?One year is taken as a base year. Generally the first or the last is taken as base year.
?The figures of base year are taken as 100.
?Trend percentages are calculated in relation to base year. If a figure in one year is less than the
figure in base year the trend percentage will be less than 100 and it will be more than 100 if
figure is more than base year figure. Each year?s figure is divided by the base year?s figure.
COMMON?SIZE STATEMENT ANALY SIS
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words of Finny and Miller, ?Liabilities are debts? they are amounts owed to creditors? thus the
claims of those who ate not owners are called liabilities?.
In simple terms, debts repayable to outsiders by the business are known as liabilities.
Long term Liabilities: Liabilities repayable after specific duration of long period of time are
called long term liabilities.
Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities
FINANCIAL STATEMENT ANALY SIS
Financial Statement : A financial statement is an organized collection of data according to
logical and consistent accounting procedures
Purpose: To understand the financial aspects of a business form.
Financial Statement
Income Statement Balance Sheet Statement of retained earnings Statement of changes in
financial position
Analysis : MethodicalClassificationofdatagiveninthe financialstatements nsimplifiedform.
Interpretation: Explainingthemeaningandsignificanceofdatasosimplified.
Financial statement Analysis: To analyze the firm?s profitability & financial soundness
The following are the types of Financial Statement Analysis.
1.On the basis of Material used : According to the material used.
External Analysis Internal Analysis
External Analysis: This analysis is done by the outsiders like Investors /Credit
agencies/Government agencies and other Creditors.
Internal Analysis: This analysis is done by the internal executives / employees of the
organization.
2.On the basis of modus operandi : According to the method of operation followed in the
analysis.
Dynamic / Horizontal Analysis Static / Vertical Analysis
Dynamic / Horizontal Analysis: This analysis refers to the financial data of a company for
several years. The figures of various years are compared with the base year. It helps to focus
attention on items that have changed significantly during the period under review. Changes in
different elements of cost and sales over no . of years.
Tools employed are comparative statements and trend percentages.
Static / Vertical Analysis: A study is made of the quantitative relationship of the various items in
the financial statements in a particular date.
Percentage of each element of cost to sales.
Tools employed are common?size financial statements and financial ratios.
Ex: Item based
Particular period and in the same company
One division ? FMCG goods
Another division ? Medicines than
So the ratio is measured & compared the performance of one division to another division
Particular period and with different companies
One company ? FMCG goods
Another company ? FMCG goods
So the ratio is measured and compared the performance of one company to another company.
Methods and Devices of Financial Analysis:
A number of methods or devices are used to study the relationship between different statements
and to analyze the position of the enterprise.
The following are the methods:
1.Comparative statements
2.Trend Analysis
3.Common?size statements
4.Funds Flow Analysis
5.Cash Flow Analysis
6.Ratio Analysis
7.Cost?Volume?Profit Analysis
Comparative Statements:
The comparative financial statements are statements of the financial position at different periods,
of time. The elements of financial position are shown in a comparative form so as to give an idea
of financial position at two or more periods. The following are the two types of comparative
statements.
1.Comparative Balance Sheet: The analysis is the study of the trend of the same items, groups of
items and computed items in two or more balance sheets of the same business enterprise on
different dates. The changes in periodic balance sheet items reflect the conduct of a business. It
has four columns and the fourth column is used for giving percentages of increases or decreases.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?Current financial position and liquidity position
?Long?term financial position
?Profitability of the concern
?For studying current financial position or short?term financial position of a concern, should see
the working capital in both the years.
2.Comparative Income Statement: The income statement gives the results of the operations of a
business. It gives an idea of the progress of a business over a period of time. Like comparative
balance sheet it also has 4 columns and the fourth column is used to show increase or decrease in
figures, in absolute amounts and percentages respectively.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?The increase or decrease in sales should be compared with the increase or decrease in cost of
goods sold.
?To analyze the study of operational profits.
?The increase or decrease in net profit will give an idea about the overall profitability of the
concern.
?Should mention whether the overall profitability is good or not.
Trend Analysis:
The financial statements may be analyzed by computing trends of series of information. This
method determines the direction upwards or downwards and involves the computation of the
percentage relationship that each statement item bears to the same item in base year.
Procedure for calculating trends.
?One year is taken as a base year. Generally the first or the last is taken as base year.
?The figures of base year are taken as 100.
?Trend percentages are calculated in relation to base year. If a figure in one year is less than the
figure in base year the trend percentage will be less than 100 and it will be more than 100 if
figure is more than base year figure. Each year?s figure is divided by the base year?s figure.
COMMON?SIZE STATEMENT ANALY SIS
The common?size statements, balance sheet and income statement are shown in analytical and
percentages. The figures are shown as the percentage of total assets, total liabilities and total
sales. These statements are also known as components percentage or 100 percent statement.
1.The total of assets or liabilities are taken as 100.
2.The individual assets are expressed as percentage of total assets.
Ex: Total assets = Rs.5,00,000, nventory value = Rs.50,000
If total assets are taken as 100
Calculation: 50000 x 00
???????????????? = 10%
5,00,000
Common?size Balance sheet: A statement in which balance sheet items are expressed as the ratio
of each asset to total assets and the ratio of each liabilities to total liabilities is called common?
size balance sheet.
Common?size Income Statement: The items in income statement can be shown as percentage of
sales to show the relation of each item to sales. A significant relationship can be established
between items of income statement and volume of sales.
Sales increases selling expenses increases ? there will be no affect on other administrative
expenses
Sales decreases selling expenses decreases ? there will be no affect on other administrative
expenses
If sales increase to a considerable extent then administrative and financial expenses go up.
So a relationship is established between sales and other items in income in evaluating operational
activities of the enterprise.
Funds Flow Statement : The term flow means movement and includes both inflow and outflow.
The term flow of funds means transfer of economic values from one asset to another.
Source of funds: If the effect of transaction results in the increase of funds, it is called a source of
funds.
Application of funds: If the effect of transaction results in the decrease of funds, it is called
application of funds.
Cash Flow Statement : Cash flow statement is a statement which describes the inflows and
outflows of cash and cash equivalents in an enterprise period of time.
Cash: Cash comprises cash on hand and demand deposits at bank.
Cash Equivalents: Cash Equivalents are short term, high liquid investments that are readily
convertible into known as amount of cash.
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words of Finny and Miller, ?Liabilities are debts? they are amounts owed to creditors? thus the
claims of those who ate not owners are called liabilities?.
In simple terms, debts repayable to outsiders by the business are known as liabilities.
Long term Liabilities: Liabilities repayable after specific duration of long period of time are
called long term liabilities.
Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities
FINANCIAL STATEMENT ANALY SIS
Financial Statement : A financial statement is an organized collection of data according to
logical and consistent accounting procedures
Purpose: To understand the financial aspects of a business form.
Financial Statement
Income Statement Balance Sheet Statement of retained earnings Statement of changes in
financial position
Analysis : MethodicalClassificationofdatagiveninthe financialstatements nsimplifiedform.
Interpretation: Explainingthemeaningandsignificanceofdatasosimplified.
Financial statement Analysis: To analyze the firm?s profitability & financial soundness
The following are the types of Financial Statement Analysis.
1.On the basis of Material used : According to the material used.
External Analysis Internal Analysis
External Analysis: This analysis is done by the outsiders like Investors /Credit
agencies/Government agencies and other Creditors.
Internal Analysis: This analysis is done by the internal executives / employees of the
organization.
2.On the basis of modus operandi : According to the method of operation followed in the
analysis.
Dynamic / Horizontal Analysis Static / Vertical Analysis
Dynamic / Horizontal Analysis: This analysis refers to the financial data of a company for
several years. The figures of various years are compared with the base year. It helps to focus
attention on items that have changed significantly during the period under review. Changes in
different elements of cost and sales over no . of years.
Tools employed are comparative statements and trend percentages.
Static / Vertical Analysis: A study is made of the quantitative relationship of the various items in
the financial statements in a particular date.
Percentage of each element of cost to sales.
Tools employed are common?size financial statements and financial ratios.
Ex: Item based
Particular period and in the same company
One division ? FMCG goods
Another division ? Medicines than
So the ratio is measured & compared the performance of one division to another division
Particular period and with different companies
One company ? FMCG goods
Another company ? FMCG goods
So the ratio is measured and compared the performance of one company to another company.
Methods and Devices of Financial Analysis:
A number of methods or devices are used to study the relationship between different statements
and to analyze the position of the enterprise.
The following are the methods:
1.Comparative statements
2.Trend Analysis
3.Common?size statements
4.Funds Flow Analysis
5.Cash Flow Analysis
6.Ratio Analysis
7.Cost?Volume?Profit Analysis
Comparative Statements:
The comparative financial statements are statements of the financial position at different periods,
of time. The elements of financial position are shown in a comparative form so as to give an idea
of financial position at two or more periods. The following are the two types of comparative
statements.
1.Comparative Balance Sheet: The analysis is the study of the trend of the same items, groups of
items and computed items in two or more balance sheets of the same business enterprise on
different dates. The changes in periodic balance sheet items reflect the conduct of a business. It
has four columns and the fourth column is used for giving percentages of increases or decreases.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?Current financial position and liquidity position
?Long?term financial position
?Profitability of the concern
?For studying current financial position or short?term financial position of a concern, should see
the working capital in both the years.
2.Comparative Income Statement: The income statement gives the results of the operations of a
business. It gives an idea of the progress of a business over a period of time. Like comparative
balance sheet it also has 4 columns and the fourth column is used to show increase or decrease in
figures, in absolute amounts and percentages respectively.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?The increase or decrease in sales should be compared with the increase or decrease in cost of
goods sold.
?To analyze the study of operational profits.
?The increase or decrease in net profit will give an idea about the overall profitability of the
concern.
?Should mention whether the overall profitability is good or not.
Trend Analysis:
The financial statements may be analyzed by computing trends of series of information. This
method determines the direction upwards or downwards and involves the computation of the
percentage relationship that each statement item bears to the same item in base year.
Procedure for calculating trends.
?One year is taken as a base year. Generally the first or the last is taken as base year.
?The figures of base year are taken as 100.
?Trend percentages are calculated in relation to base year. If a figure in one year is less than the
figure in base year the trend percentage will be less than 100 and it will be more than 100 if
figure is more than base year figure. Each year?s figure is divided by the base year?s figure.
COMMON?SIZE STATEMENT ANALY SIS
The common?size statements, balance sheet and income statement are shown in analytical and
percentages. The figures are shown as the percentage of total assets, total liabilities and total
sales. These statements are also known as components percentage or 100 percent statement.
1.The total of assets or liabilities are taken as 100.
2.The individual assets are expressed as percentage of total assets.
Ex: Total assets = Rs.5,00,000, nventory value = Rs.50,000
If total assets are taken as 100
Calculation: 50000 x 00
???????????????? = 10%
5,00,000
Common?size Balance sheet: A statement in which balance sheet items are expressed as the ratio
of each asset to total assets and the ratio of each liabilities to total liabilities is called common?
size balance sheet.
Common?size Income Statement: The items in income statement can be shown as percentage of
sales to show the relation of each item to sales. A significant relationship can be established
between items of income statement and volume of sales.
Sales increases selling expenses increases ? there will be no affect on other administrative
expenses
Sales decreases selling expenses decreases ? there will be no affect on other administrative
expenses
If sales increase to a considerable extent then administrative and financial expenses go up.
So a relationship is established between sales and other items in income in evaluating operational
activities of the enterprise.
Funds Flow Statement : The term flow means movement and includes both inflow and outflow.
The term flow of funds means transfer of economic values from one asset to another.
Source of funds: If the effect of transaction results in the increase of funds, it is called a source of
funds.
Application of funds: If the effect of transaction results in the decrease of funds, it is called
application of funds.
Cash Flow Statement : Cash flow statement is a statement which describes the inflows and
outflows of cash and cash equivalents in an enterprise period of time.
Cash: Cash comprises cash on hand and demand deposits at bank.
Cash Equivalents: Cash Equivalents are short term, high liquid investments that are readily
convertible into known as amount of cash.
Cash flow: Cash flows are inflows and outflows of cash and cash equivalents.
Cash flows from operating activities: Operating activities are the principal of revenue?producing
activities of the enterprise and other activities that are not investing or finance activities.
Cash flow from investing activities: The cash flow represent the extent to which expenditures
have been made for resources intended to generate future income and cash flows.
Cash flows from financing activities: Financial activities are activities that result in changes in
the size and composition of the owner?s capital and borrowings of the enterprise.
Cost?volume?profit analysis: Cost?Volume?Profit (CVP) analysis is a managerial accounting
technique that is concerned with the effect of sales volume and product costs on operating profit
of a business. It deals with how operating profit is affected by changes in variable costs, fixed
costs, selling price per unit and the sales mix of two or more different products.
CVP analysis has following assumptions:
?All cost can be categorized as variable or fixed.
?Sales price per unit, variable cost per unit and total fixed cost are constant.
?All units produced are sold.
RATIONALE:
Explanation of the logical reasons or principles employed in consciously arriving at a decision or
estimate rationales usually document
why a particular choice was made,
how the basis of its selection was developed,
why and how the particular information or assumptions were relied on and
why the conclusion is deemed credible or realistic.
RATIO ANALY SIS :
It is a technical of analysis and interpretation of financial statements. It is the process of
establishing and interpreting various ratios for helping in making the certain decisions.
According to Accountants? Handbook of Wixon, Kell and Bedford a ratio is an
?Expression of the quantitative relationship between two numbers?.
Accounting ratios
Traditional Functional
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FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words of Finny and Miller, ?Liabilities are debts? they are amounts owed to creditors? thus the
claims of those who ate not owners are called liabilities?.
In simple terms, debts repayable to outsiders by the business are known as liabilities.
Long term Liabilities: Liabilities repayable after specific duration of long period of time are
called long term liabilities.
Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities
FINANCIAL STATEMENT ANALY SIS
Financial Statement : A financial statement is an organized collection of data according to
logical and consistent accounting procedures
Purpose: To understand the financial aspects of a business form.
Financial Statement
Income Statement Balance Sheet Statement of retained earnings Statement of changes in
financial position
Analysis : MethodicalClassificationofdatagiveninthe financialstatements nsimplifiedform.
Interpretation: Explainingthemeaningandsignificanceofdatasosimplified.
Financial statement Analysis: To analyze the firm?s profitability & financial soundness
The following are the types of Financial Statement Analysis.
1.On the basis of Material used : According to the material used.
External Analysis Internal Analysis
External Analysis: This analysis is done by the outsiders like Investors /Credit
agencies/Government agencies and other Creditors.
Internal Analysis: This analysis is done by the internal executives / employees of the
organization.
2.On the basis of modus operandi : According to the method of operation followed in the
analysis.
Dynamic / Horizontal Analysis Static / Vertical Analysis
Dynamic / Horizontal Analysis: This analysis refers to the financial data of a company for
several years. The figures of various years are compared with the base year. It helps to focus
attention on items that have changed significantly during the period under review. Changes in
different elements of cost and sales over no . of years.
Tools employed are comparative statements and trend percentages.
Static / Vertical Analysis: A study is made of the quantitative relationship of the various items in
the financial statements in a particular date.
Percentage of each element of cost to sales.
Tools employed are common?size financial statements and financial ratios.
Ex: Item based
Particular period and in the same company
One division ? FMCG goods
Another division ? Medicines than
So the ratio is measured & compared the performance of one division to another division
Particular period and with different companies
One company ? FMCG goods
Another company ? FMCG goods
So the ratio is measured and compared the performance of one company to another company.
Methods and Devices of Financial Analysis:
A number of methods or devices are used to study the relationship between different statements
and to analyze the position of the enterprise.
The following are the methods:
1.Comparative statements
2.Trend Analysis
3.Common?size statements
4.Funds Flow Analysis
5.Cash Flow Analysis
6.Ratio Analysis
7.Cost?Volume?Profit Analysis
Comparative Statements:
The comparative financial statements are statements of the financial position at different periods,
of time. The elements of financial position are shown in a comparative form so as to give an idea
of financial position at two or more periods. The following are the two types of comparative
statements.
1.Comparative Balance Sheet: The analysis is the study of the trend of the same items, groups of
items and computed items in two or more balance sheets of the same business enterprise on
different dates. The changes in periodic balance sheet items reflect the conduct of a business. It
has four columns and the fourth column is used for giving percentages of increases or decreases.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?Current financial position and liquidity position
?Long?term financial position
?Profitability of the concern
?For studying current financial position or short?term financial position of a concern, should see
the working capital in both the years.
2.Comparative Income Statement: The income statement gives the results of the operations of a
business. It gives an idea of the progress of a business over a period of time. Like comparative
balance sheet it also has 4 columns and the fourth column is used to show increase or decrease in
figures, in absolute amounts and percentages respectively.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?The increase or decrease in sales should be compared with the increase or decrease in cost of
goods sold.
?To analyze the study of operational profits.
?The increase or decrease in net profit will give an idea about the overall profitability of the
concern.
?Should mention whether the overall profitability is good or not.
Trend Analysis:
The financial statements may be analyzed by computing trends of series of information. This
method determines the direction upwards or downwards and involves the computation of the
percentage relationship that each statement item bears to the same item in base year.
Procedure for calculating trends.
?One year is taken as a base year. Generally the first or the last is taken as base year.
?The figures of base year are taken as 100.
?Trend percentages are calculated in relation to base year. If a figure in one year is less than the
figure in base year the trend percentage will be less than 100 and it will be more than 100 if
figure is more than base year figure. Each year?s figure is divided by the base year?s figure.
COMMON?SIZE STATEMENT ANALY SIS
The common?size statements, balance sheet and income statement are shown in analytical and
percentages. The figures are shown as the percentage of total assets, total liabilities and total
sales. These statements are also known as components percentage or 100 percent statement.
1.The total of assets or liabilities are taken as 100.
2.The individual assets are expressed as percentage of total assets.
Ex: Total assets = Rs.5,00,000, nventory value = Rs.50,000
If total assets are taken as 100
Calculation: 50000 x 00
???????????????? = 10%
5,00,000
Common?size Balance sheet: A statement in which balance sheet items are expressed as the ratio
of each asset to total assets and the ratio of each liabilities to total liabilities is called common?
size balance sheet.
Common?size Income Statement: The items in income statement can be shown as percentage of
sales to show the relation of each item to sales. A significant relationship can be established
between items of income statement and volume of sales.
Sales increases selling expenses increases ? there will be no affect on other administrative
expenses
Sales decreases selling expenses decreases ? there will be no affect on other administrative
expenses
If sales increase to a considerable extent then administrative and financial expenses go up.
So a relationship is established between sales and other items in income in evaluating operational
activities of the enterprise.
Funds Flow Statement : The term flow means movement and includes both inflow and outflow.
The term flow of funds means transfer of economic values from one asset to another.
Source of funds: If the effect of transaction results in the increase of funds, it is called a source of
funds.
Application of funds: If the effect of transaction results in the decrease of funds, it is called
application of funds.
Cash Flow Statement : Cash flow statement is a statement which describes the inflows and
outflows of cash and cash equivalents in an enterprise period of time.
Cash: Cash comprises cash on hand and demand deposits at bank.
Cash Equivalents: Cash Equivalents are short term, high liquid investments that are readily
convertible into known as amount of cash.
Cash flow: Cash flows are inflows and outflows of cash and cash equivalents.
Cash flows from operating activities: Operating activities are the principal of revenue?producing
activities of the enterprise and other activities that are not investing or finance activities.
Cash flow from investing activities: The cash flow represent the extent to which expenditures
have been made for resources intended to generate future income and cash flows.
Cash flows from financing activities: Financial activities are activities that result in changes in
the size and composition of the owner?s capital and borrowings of the enterprise.
Cost?volume?profit analysis: Cost?Volume?Profit (CVP) analysis is a managerial accounting
technique that is concerned with the effect of sales volume and product costs on operating profit
of a business. It deals with how operating profit is affected by changes in variable costs, fixed
costs, selling price per unit and the sales mix of two or more different products.
CVP analysis has following assumptions:
?All cost can be categorized as variable or fixed.
?Sales price per unit, variable cost per unit and total fixed cost are constant.
?All units produced are sold.
RATIONALE:
Explanation of the logical reasons or principles employed in consciously arriving at a decision or
estimate rationales usually document
why a particular choice was made,
how the basis of its selection was developed,
why and how the particular information or assumptions were relied on and
why the conclusion is deemed credible or realistic.
RATIO ANALY SIS :
It is a technical of analysis and interpretation of financial statements. It is the process of
establishing and interpreting various ratios for helping in making the certain decisions.
According to Accountants? Handbook of Wixon, Kell and Bedford a ratio is an
?Expression of the quantitative relationship between two numbers?.
Accounting ratios
Traditional Functional
P&L A/c Profitability Coverage Turnover
Financial
Balance Sheet Ratio Ratio Ratio Ratio
Composite Ratio
Overall profitability ratio Fixed interest coverage ratio Fixed assets turnover
ratio
Return on Investment Fixed dividend coverage ratio Working capital
turnover ratio
Equity per Share (EPS) Debt service coverage ratio Working capital
leverage
Price Earning Ratio
Gross Profit ratio
Net Profit ratio
Operating Expenses ratio
Payout ratio
Dividend Yield ratio
Liquidity Ratio and Stability Ratio
Current Ratio Fixed assets ratio
Change in current ratio Capital Structure ratio
Quick ratio Capital gearing ratio
Super quick ratio Debt?equity ratio
Defensive interval ratio
CLASSIFICATION, CALCU LATIONANDINTERPRETATIONOF RATIOS
SL
NO
RATIO
CLASSIFICATION
COMPUTATION
FORMULA
PURPOSE
Traditional Functional
1 Gross Profit Ratio
P&L A/c or
Revenue
Statement
Ratio
Probability
Ratio
Gross Profit
Indicates the efficiency of the
production / trading operations
x100
Net Sales
2 Net Profit Ratio ? ? Net Profit Indicates net margin on sales
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words of Finny and Miller, ?Liabilities are debts? they are amounts owed to creditors? thus the
claims of those who ate not owners are called liabilities?.
In simple terms, debts repayable to outsiders by the business are known as liabilities.
Long term Liabilities: Liabilities repayable after specific duration of long period of time are
called long term liabilities.
Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities
FINANCIAL STATEMENT ANALY SIS
Financial Statement : A financial statement is an organized collection of data according to
logical and consistent accounting procedures
Purpose: To understand the financial aspects of a business form.
Financial Statement
Income Statement Balance Sheet Statement of retained earnings Statement of changes in
financial position
Analysis : MethodicalClassificationofdatagiveninthe financialstatements nsimplifiedform.
Interpretation: Explainingthemeaningandsignificanceofdatasosimplified.
Financial statement Analysis: To analyze the firm?s profitability & financial soundness
The following are the types of Financial Statement Analysis.
1.On the basis of Material used : According to the material used.
External Analysis Internal Analysis
External Analysis: This analysis is done by the outsiders like Investors /Credit
agencies/Government agencies and other Creditors.
Internal Analysis: This analysis is done by the internal executives / employees of the
organization.
2.On the basis of modus operandi : According to the method of operation followed in the
analysis.
Dynamic / Horizontal Analysis Static / Vertical Analysis
Dynamic / Horizontal Analysis: This analysis refers to the financial data of a company for
several years. The figures of various years are compared with the base year. It helps to focus
attention on items that have changed significantly during the period under review. Changes in
different elements of cost and sales over no . of years.
Tools employed are comparative statements and trend percentages.
Static / Vertical Analysis: A study is made of the quantitative relationship of the various items in
the financial statements in a particular date.
Percentage of each element of cost to sales.
Tools employed are common?size financial statements and financial ratios.
Ex: Item based
Particular period and in the same company
One division ? FMCG goods
Another division ? Medicines than
So the ratio is measured & compared the performance of one division to another division
Particular period and with different companies
One company ? FMCG goods
Another company ? FMCG goods
So the ratio is measured and compared the performance of one company to another company.
Methods and Devices of Financial Analysis:
A number of methods or devices are used to study the relationship between different statements
and to analyze the position of the enterprise.
The following are the methods:
1.Comparative statements
2.Trend Analysis
3.Common?size statements
4.Funds Flow Analysis
5.Cash Flow Analysis
6.Ratio Analysis
7.Cost?Volume?Profit Analysis
Comparative Statements:
The comparative financial statements are statements of the financial position at different periods,
of time. The elements of financial position are shown in a comparative form so as to give an idea
of financial position at two or more periods. The following are the two types of comparative
statements.
1.Comparative Balance Sheet: The analysis is the study of the trend of the same items, groups of
items and computed items in two or more balance sheets of the same business enterprise on
different dates. The changes in periodic balance sheet items reflect the conduct of a business. It
has four columns and the fourth column is used for giving percentages of increases or decreases.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?Current financial position and liquidity position
?Long?term financial position
?Profitability of the concern
?For studying current financial position or short?term financial position of a concern, should see
the working capital in both the years.
2.Comparative Income Statement: The income statement gives the results of the operations of a
business. It gives an idea of the progress of a business over a period of time. Like comparative
balance sheet it also has 4 columns and the fourth column is used to show increase or decrease in
figures, in absolute amounts and percentages respectively.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?The increase or decrease in sales should be compared with the increase or decrease in cost of
goods sold.
?To analyze the study of operational profits.
?The increase or decrease in net profit will give an idea about the overall profitability of the
concern.
?Should mention whether the overall profitability is good or not.
Trend Analysis:
The financial statements may be analyzed by computing trends of series of information. This
method determines the direction upwards or downwards and involves the computation of the
percentage relationship that each statement item bears to the same item in base year.
Procedure for calculating trends.
?One year is taken as a base year. Generally the first or the last is taken as base year.
?The figures of base year are taken as 100.
?Trend percentages are calculated in relation to base year. If a figure in one year is less than the
figure in base year the trend percentage will be less than 100 and it will be more than 100 if
figure is more than base year figure. Each year?s figure is divided by the base year?s figure.
COMMON?SIZE STATEMENT ANALY SIS
The common?size statements, balance sheet and income statement are shown in analytical and
percentages. The figures are shown as the percentage of total assets, total liabilities and total
sales. These statements are also known as components percentage or 100 percent statement.
1.The total of assets or liabilities are taken as 100.
2.The individual assets are expressed as percentage of total assets.
Ex: Total assets = Rs.5,00,000, nventory value = Rs.50,000
If total assets are taken as 100
Calculation: 50000 x 00
???????????????? = 10%
5,00,000
Common?size Balance sheet: A statement in which balance sheet items are expressed as the ratio
of each asset to total assets and the ratio of each liabilities to total liabilities is called common?
size balance sheet.
Common?size Income Statement: The items in income statement can be shown as percentage of
sales to show the relation of each item to sales. A significant relationship can be established
between items of income statement and volume of sales.
Sales increases selling expenses increases ? there will be no affect on other administrative
expenses
Sales decreases selling expenses decreases ? there will be no affect on other administrative
expenses
If sales increase to a considerable extent then administrative and financial expenses go up.
So a relationship is established between sales and other items in income in evaluating operational
activities of the enterprise.
Funds Flow Statement : The term flow means movement and includes both inflow and outflow.
The term flow of funds means transfer of economic values from one asset to another.
Source of funds: If the effect of transaction results in the increase of funds, it is called a source of
funds.
Application of funds: If the effect of transaction results in the decrease of funds, it is called
application of funds.
Cash Flow Statement : Cash flow statement is a statement which describes the inflows and
outflows of cash and cash equivalents in an enterprise period of time.
Cash: Cash comprises cash on hand and demand deposits at bank.
Cash Equivalents: Cash Equivalents are short term, high liquid investments that are readily
convertible into known as amount of cash.
Cash flow: Cash flows are inflows and outflows of cash and cash equivalents.
Cash flows from operating activities: Operating activities are the principal of revenue?producing
activities of the enterprise and other activities that are not investing or finance activities.
Cash flow from investing activities: The cash flow represent the extent to which expenditures
have been made for resources intended to generate future income and cash flows.
Cash flows from financing activities: Financial activities are activities that result in changes in
the size and composition of the owner?s capital and borrowings of the enterprise.
Cost?volume?profit analysis: Cost?Volume?Profit (CVP) analysis is a managerial accounting
technique that is concerned with the effect of sales volume and product costs on operating profit
of a business. It deals with how operating profit is affected by changes in variable costs, fixed
costs, selling price per unit and the sales mix of two or more different products.
CVP analysis has following assumptions:
?All cost can be categorized as variable or fixed.
?Sales price per unit, variable cost per unit and total fixed cost are constant.
?All units produced are sold.
RATIONALE:
Explanation of the logical reasons or principles employed in consciously arriving at a decision or
estimate rationales usually document
why a particular choice was made,
how the basis of its selection was developed,
why and how the particular information or assumptions were relied on and
why the conclusion is deemed credible or realistic.
RATIO ANALY SIS :
It is a technical of analysis and interpretation of financial statements. It is the process of
establishing and interpreting various ratios for helping in making the certain decisions.
According to Accountants? Handbook of Wixon, Kell and Bedford a ratio is an
?Expression of the quantitative relationship between two numbers?.
Accounting ratios
Traditional Functional
P&L A/c Profitability Coverage Turnover
Financial
Balance Sheet Ratio Ratio Ratio Ratio
Composite Ratio
Overall profitability ratio Fixed interest coverage ratio Fixed assets turnover
ratio
Return on Investment Fixed dividend coverage ratio Working capital
turnover ratio
Equity per Share (EPS) Debt service coverage ratio Working capital
leverage
Price Earning Ratio
Gross Profit ratio
Net Profit ratio
Operating Expenses ratio
Payout ratio
Dividend Yield ratio
Liquidity Ratio and Stability Ratio
Current Ratio Fixed assets ratio
Change in current ratio Capital Structure ratio
Quick ratio Capital gearing ratio
Super quick ratio Debt?equity ratio
Defensive interval ratio
CLASSIFICATION, CALCU LATIONANDINTERPRETATIONOF RATIOS
SL
NO
RATIO
CLASSIFICATION
COMPUTATION
FORMULA
PURPOSE
Traditional Functional
1 Gross Profit Ratio
P&L A/c or
Revenue
Statement
Ratio
Probability
Ratio
Gross Profit
Indicates the efficiency of the
production / trading operations
x100
Net Sales
2 Net Profit Ratio ? ? Net Profit Indicates net margin on sales
x100
Net Sales
3
Operating or
Expenses ratio
? ? x100
Operating cost
A measure of management?s
ability to keep operating
expenses properly controlled f
level of sales achieved
Net Sales
4
Net Profit to Total
Assets
Composite
Ratio
?
Net profit after
tax + Interest
A measure of productivity of
Total
Assets x100
Total assets
5
Return on
Shareholders?
funds
? ?
Profit available for
equity shareholders
Shows the amount of earnings
attributable to each equity shar
x100
Average equity
shareholders?s funds
6
Earning per equity
share
Profit available for
equity shareholders
Shows the amount of earnings
attributes to each equity share.
? ? x100
No. of Equity
Shares
7 Dividend yield
? ?
Market
Dividend per share Shows the rate of return to
shareholders in the form of
dividends based on the market
price of the share.
x100
price per
share
8 Price Earning ratio ? ?
Market price of a
share
A measure for determining the
value of a share. May also be
used to measure the rate of retu
expected by investors.
x100
Earning per share
9
Fixed Interest
Cover
P&L or
Revenue
Statement
Ratio
Profitability
Ratio
Operating Income
Shows the margin of coverage
interest requirements Annual Interest
Expense
10
Fixed Dividend
Cover
Net Income
Shows the extent to which curr
are available to pay
dividends on preference shares.
? ? earnings
Annual Preference
Dividends
11 Inventory Turnover ?
Turnover or
Efficiency
ratio
Cost of goods sold Evaluation of the liquidity of
inventory and adequacy of
inventory controls. Average Inventory
12
Accounts
Receivable
Turnover
Composite
ratio
?
Net Sales on Credit Measures liquidity of accounts
receivable and the effectivenes
of credit policy. Average Receivable
13 Current ratio
Balance
sheet ratio
Financial
ratio
Current Assets
Measures short?term debt payi
ability.
Current Liabilities
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MBA DEPARTMNET
FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words of Finny and Miller, ?Liabilities are debts? they are amounts owed to creditors? thus the
claims of those who ate not owners are called liabilities?.
In simple terms, debts repayable to outsiders by the business are known as liabilities.
Long term Liabilities: Liabilities repayable after specific duration of long period of time are
called long term liabilities.
Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities
FINANCIAL STATEMENT ANALY SIS
Financial Statement : A financial statement is an organized collection of data according to
logical and consistent accounting procedures
Purpose: To understand the financial aspects of a business form.
Financial Statement
Income Statement Balance Sheet Statement of retained earnings Statement of changes in
financial position
Analysis : MethodicalClassificationofdatagiveninthe financialstatements nsimplifiedform.
Interpretation: Explainingthemeaningandsignificanceofdatasosimplified.
Financial statement Analysis: To analyze the firm?s profitability & financial soundness
The following are the types of Financial Statement Analysis.
1.On the basis of Material used : According to the material used.
External Analysis Internal Analysis
External Analysis: This analysis is done by the outsiders like Investors /Credit
agencies/Government agencies and other Creditors.
Internal Analysis: This analysis is done by the internal executives / employees of the
organization.
2.On the basis of modus operandi : According to the method of operation followed in the
analysis.
Dynamic / Horizontal Analysis Static / Vertical Analysis
Dynamic / Horizontal Analysis: This analysis refers to the financial data of a company for
several years. The figures of various years are compared with the base year. It helps to focus
attention on items that have changed significantly during the period under review. Changes in
different elements of cost and sales over no . of years.
Tools employed are comparative statements and trend percentages.
Static / Vertical Analysis: A study is made of the quantitative relationship of the various items in
the financial statements in a particular date.
Percentage of each element of cost to sales.
Tools employed are common?size financial statements and financial ratios.
Ex: Item based
Particular period and in the same company
One division ? FMCG goods
Another division ? Medicines than
So the ratio is measured & compared the performance of one division to another division
Particular period and with different companies
One company ? FMCG goods
Another company ? FMCG goods
So the ratio is measured and compared the performance of one company to another company.
Methods and Devices of Financial Analysis:
A number of methods or devices are used to study the relationship between different statements
and to analyze the position of the enterprise.
The following are the methods:
1.Comparative statements
2.Trend Analysis
3.Common?size statements
4.Funds Flow Analysis
5.Cash Flow Analysis
6.Ratio Analysis
7.Cost?Volume?Profit Analysis
Comparative Statements:
The comparative financial statements are statements of the financial position at different periods,
of time. The elements of financial position are shown in a comparative form so as to give an idea
of financial position at two or more periods. The following are the two types of comparative
statements.
1.Comparative Balance Sheet: The analysis is the study of the trend of the same items, groups of
items and computed items in two or more balance sheets of the same business enterprise on
different dates. The changes in periodic balance sheet items reflect the conduct of a business. It
has four columns and the fourth column is used for giving percentages of increases or decreases.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?Current financial position and liquidity position
?Long?term financial position
?Profitability of the concern
?For studying current financial position or short?term financial position of a concern, should see
the working capital in both the years.
2.Comparative Income Statement: The income statement gives the results of the operations of a
business. It gives an idea of the progress of a business over a period of time. Like comparative
balance sheet it also has 4 columns and the fourth column is used to show increase or decrease in
figures, in absolute amounts and percentages respectively.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?The increase or decrease in sales should be compared with the increase or decrease in cost of
goods sold.
?To analyze the study of operational profits.
?The increase or decrease in net profit will give an idea about the overall profitability of the
concern.
?Should mention whether the overall profitability is good or not.
Trend Analysis:
The financial statements may be analyzed by computing trends of series of information. This
method determines the direction upwards or downwards and involves the computation of the
percentage relationship that each statement item bears to the same item in base year.
Procedure for calculating trends.
?One year is taken as a base year. Generally the first or the last is taken as base year.
?The figures of base year are taken as 100.
?Trend percentages are calculated in relation to base year. If a figure in one year is less than the
figure in base year the trend percentage will be less than 100 and it will be more than 100 if
figure is more than base year figure. Each year?s figure is divided by the base year?s figure.
COMMON?SIZE STATEMENT ANALY SIS
The common?size statements, balance sheet and income statement are shown in analytical and
percentages. The figures are shown as the percentage of total assets, total liabilities and total
sales. These statements are also known as components percentage or 100 percent statement.
1.The total of assets or liabilities are taken as 100.
2.The individual assets are expressed as percentage of total assets.
Ex: Total assets = Rs.5,00,000, nventory value = Rs.50,000
If total assets are taken as 100
Calculation: 50000 x 00
???????????????? = 10%
5,00,000
Common?size Balance sheet: A statement in which balance sheet items are expressed as the ratio
of each asset to total assets and the ratio of each liabilities to total liabilities is called common?
size balance sheet.
Common?size Income Statement: The items in income statement can be shown as percentage of
sales to show the relation of each item to sales. A significant relationship can be established
between items of income statement and volume of sales.
Sales increases selling expenses increases ? there will be no affect on other administrative
expenses
Sales decreases selling expenses decreases ? there will be no affect on other administrative
expenses
If sales increase to a considerable extent then administrative and financial expenses go up.
So a relationship is established between sales and other items in income in evaluating operational
activities of the enterprise.
Funds Flow Statement : The term flow means movement and includes both inflow and outflow.
The term flow of funds means transfer of economic values from one asset to another.
Source of funds: If the effect of transaction results in the increase of funds, it is called a source of
funds.
Application of funds: If the effect of transaction results in the decrease of funds, it is called
application of funds.
Cash Flow Statement : Cash flow statement is a statement which describes the inflows and
outflows of cash and cash equivalents in an enterprise period of time.
Cash: Cash comprises cash on hand and demand deposits at bank.
Cash Equivalents: Cash Equivalents are short term, high liquid investments that are readily
convertible into known as amount of cash.
Cash flow: Cash flows are inflows and outflows of cash and cash equivalents.
Cash flows from operating activities: Operating activities are the principal of revenue?producing
activities of the enterprise and other activities that are not investing or finance activities.
Cash flow from investing activities: The cash flow represent the extent to which expenditures
have been made for resources intended to generate future income and cash flows.
Cash flows from financing activities: Financial activities are activities that result in changes in
the size and composition of the owner?s capital and borrowings of the enterprise.
Cost?volume?profit analysis: Cost?Volume?Profit (CVP) analysis is a managerial accounting
technique that is concerned with the effect of sales volume and product costs on operating profit
of a business. It deals with how operating profit is affected by changes in variable costs, fixed
costs, selling price per unit and the sales mix of two or more different products.
CVP analysis has following assumptions:
?All cost can be categorized as variable or fixed.
?Sales price per unit, variable cost per unit and total fixed cost are constant.
?All units produced are sold.
RATIONALE:
Explanation of the logical reasons or principles employed in consciously arriving at a decision or
estimate rationales usually document
why a particular choice was made,
how the basis of its selection was developed,
why and how the particular information or assumptions were relied on and
why the conclusion is deemed credible or realistic.
RATIO ANALY SIS :
It is a technical of analysis and interpretation of financial statements. It is the process of
establishing and interpreting various ratios for helping in making the certain decisions.
According to Accountants? Handbook of Wixon, Kell and Bedford a ratio is an
?Expression of the quantitative relationship between two numbers?.
Accounting ratios
Traditional Functional
P&L A/c Profitability Coverage Turnover
Financial
Balance Sheet Ratio Ratio Ratio Ratio
Composite Ratio
Overall profitability ratio Fixed interest coverage ratio Fixed assets turnover
ratio
Return on Investment Fixed dividend coverage ratio Working capital
turnover ratio
Equity per Share (EPS) Debt service coverage ratio Working capital
leverage
Price Earning Ratio
Gross Profit ratio
Net Profit ratio
Operating Expenses ratio
Payout ratio
Dividend Yield ratio
Liquidity Ratio and Stability Ratio
Current Ratio Fixed assets ratio
Change in current ratio Capital Structure ratio
Quick ratio Capital gearing ratio
Super quick ratio Debt?equity ratio
Defensive interval ratio
CLASSIFICATION, CALCU LATIONANDINTERPRETATIONOF RATIOS
SL
NO
RATIO
CLASSIFICATION
COMPUTATION
FORMULA
PURPOSE
Traditional Functional
1 Gross Profit Ratio
P&L A/c or
Revenue
Statement
Ratio
Probability
Ratio
Gross Profit
Indicates the efficiency of the
production / trading operations
x100
Net Sales
2 Net Profit Ratio ? ? Net Profit Indicates net margin on sales
x100
Net Sales
3
Operating or
Expenses ratio
? ? x100
Operating cost
A measure of management?s
ability to keep operating
expenses properly controlled f
level of sales achieved
Net Sales
4
Net Profit to Total
Assets
Composite
Ratio
?
Net profit after
tax + Interest
A measure of productivity of
Total
Assets x100
Total assets
5
Return on
Shareholders?
funds
? ?
Profit available for
equity shareholders
Shows the amount of earnings
attributable to each equity shar
x100
Average equity
shareholders?s funds
6
Earning per equity
share
Profit available for
equity shareholders
Shows the amount of earnings
attributes to each equity share.
? ? x100
No. of Equity
Shares
7 Dividend yield
? ?
Market
Dividend per share Shows the rate of return to
shareholders in the form of
dividends based on the market
price of the share.
x100
price per
share
8 Price Earning ratio ? ?
Market price of a
share
A measure for determining the
value of a share. May also be
used to measure the rate of retu
expected by investors.
x100
Earning per share
9
Fixed Interest
Cover
P&L or
Revenue
Statement
Ratio
Profitability
Ratio
Operating Income
Shows the margin of coverage
interest requirements Annual Interest
Expense
10
Fixed Dividend
Cover
Net Income
Shows the extent to which curr
are available to pay
dividends on preference shares.
? ? earnings
Annual Preference
Dividends
11 Inventory Turnover ?
Turnover or
Efficiency
ratio
Cost of goods sold Evaluation of the liquidity of
inventory and adequacy of
inventory controls. Average Inventory
12
Accounts
Receivable
Turnover
Composite
ratio
?
Net Sales on Credit Measures liquidity of accounts
receivable and the effectivenes
of credit policy. Average Receivable
13 Current ratio
Balance
sheet ratio
Financial
ratio
Current Assets
Measures short?term debt payi
ability.
Current Liabilities
14
Quick (Acid Test)
ratio
? ? term
(i) Quick Assets
Current Liabilities
(ii) Quick Assets
Quick Liabilities
A refined measure of the short-
debt paying ability by
measuring short?term liquidity.
15 Proprietary ratio
Total Shareholders?
Funds
Measures conservatism of capi
structure and shows the extent
funds in the total
assets employed in the busines
? ?
shareholders?
Total Tangible Assets
1 6 Debt?Equity ratio
? ??
(ii)
(i) External Equities
Indicates the percentage of fun
being financed through
borrowings? a measure of the
extent of trading on equity.
Internal Equities
Total Long?term
Debt
Total Lon?term
Funds
U TILITYOF RATIONANALY SIS
Ratios are of immense importance in the analysis and interpretation of financial statements as
they bring strength or weaknesses of the firm.
The following are the types of utility of ratio analysis.
1.Managerial uses of ratio analysis: This analysis helps in decision making through information
provided in financial statements, financial forecasting and planning like looking ahead and ratios
calculated are used as a guide for future , helps in communication like understanding financial
strengths and weaknesses, co?ordination helps in effective business management, control like
comparing actual with standards & other uses like budgetary control and standard costing.
2.Utility to Shareholders / Investors: Ratio analysis is used in making up investor mind whether
present financial position of the concern, warrants further investment or not.
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FINANCIAL ACCOU NTINGANDANALY SIS
Accounting:
The systematic and comprehensive recording of financial transactions pertaining to a business.
Accounting also refers to the process of summarizing, analyzing and reporting these transactions.
The financial statements that summarize a large company's operations, financial position and
cash flows over a particular period are a concise summary of hundreds of thousands of financial
transactions it may have entered into over this period. Accounting is one of the key functions for
almost any business? it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at larger companies.
Objectives of Accounting:
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions that
take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit
earned or loss suffered in business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and Expenditure account
which shows the profit or loss of the business by matching the items of revenue and expenditure
of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must
know his financial position i.e., availability of cash, position of assets and liabilities etc. This
helps the businessman to know his financial strength. Financial statements are barometers of
health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how
an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its
capital transactions, cash dividends and other distributions of resources by the enterprise to
owners and about other factors that may affect an enterprise?s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about the various
assets that the firm possesses and the liabilities the firm owes, so that nobody can claim a
payment which is not due to him.
vi) To facilitate rational decision ? making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be
taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Journal:
When the business transactions take place, the first step is to record the same in the books of
original entry or subsidiary books or books of prime or journal. Thus journal is a simple book of
accounts in which all the business transactions are originally recorded in chronological order and
from which they are posted to the ledger accounts at any convenient time. Journalsing refers to
the act of recording each transaction in the journal and the form in which it is recorded, is known
as a journal entry.
LEDGER:
Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose?leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.
SU BSIDIARYBOOKS
Journal is subdivided into various parts known as subsidiary books or subdivisions of journal.
Each one of the subsidiary books is a special journal and a book of original or prime entry.
There are no journal entries when records are made in these books. Recording the transactions in
a special journal and then in the ledger accounts is the practical system of accounting which is
also referred to as English System. Though the usual type of journal entries are not passed in
these sub?divided journals, the double entry principles of accounting are strictly followed.
Cash Book:
Cash Book is a sub?division of Journal recording transactions pertaining to cash receipts and
payments. Firstly, all cash transactions are recorded in the Cash Book wherefrom they are posted
subsequently to the respective ledger accounts. The Cash Book is maintained in the form of a
ledger with the required explanation called as narration and hence, it plays a dual role of a
journal as well as ledger. All cash receipts are recorded on the debit side and all cash payments
are recorded on the credit side. All cash transactions are recorded chronologically in the Cash
Book. The Cash Book will always show a debit balance since payments cannot exceed the
receipts at any time.
Accounting concepts:
The term ?concept? is used to denote accounting postulates, i.e., basic assumptions or conditions
upon the edifice of which the accounting super?structure is based. The following are the
common accounting concepts adopted by many businessconcerns .
Business Entity Concept:
A business unit is an organization of persons established to accomplish an economic goal.
Business entity concept implies that the business unit is separate and distinct from the persons
who provide the required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself
owns the assets and in turn owes to various claimants.
Money Measurement Concept:
In accounting all events and transactions are recode in terms of money. Money is considered as
a common denominator, by means of which various facts, events and transactions about a
business can be expressed in terms of numbers. In other words, facts, events and transactions
which cannot be expressed in monetary terms are not recorded in accounting. Hence, the
accounting does not give a complete picture of all the transactions of a business unit. This
concept does not also take care of the effects of inflation because it assumes astable value for
measuring.
Going Concern Concept:
Under this concept, the transactions are recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of valuing the assets at
historical cost or replacement cost. This concept also supports the treatment of prepaid expenses
as assets, although they may be practically unsaleable.
Dual Aspect Concept:
According to this basic concept of accounting, every transaction has a two?fold aspect, Viz.,
1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry
system is that every debit has a corresponding and equal amount of credit. This is the underlying
assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets ? Liabilities, will further clarify this concept, i.e., at any point of time the total
assets of the business unit are equal to its total liabilities. Liabilities here relate both to the
outsiders and the owners. Liabilities to the owners are considered as capital.
Periodicity Concept:
Under this concept, the life of the business is segmented into different periods and accordingly
the result of each period is ascertained. Though the business is assumed to be continuing in
future (as per goingconcern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking corrective steps at the
appropriate time. Each segmented period is called ?accounting period? and the same is normally
a year. The businessman has to analyse and evaluate the results ascertained periodically. At the
end of an accounting period, an Income Statement is prepared to ascertain the profit or loss made
during that accounting period and Balance Sheet is prepared which depicts the financial position
of the business as on the last day of that period. During the course of preparation of these
statements capital revenue items are to be necessarily distinguished.
Historical Cost Concept:
According to this concept, the transactions are recorded in the books of account with the
respective amounts involved. For example, if an asset is purchases, it is entered in the accounting
record at the price paid to acquire the same and that cost is considered to be the base for all
future accounting. It means that the asset is recorded at cost at the time of purchase but it may be
methodically reduced in its value by way of charging depreciation. However, in the light of
inflationary conditions, the application of this concept is considered highly irrelevant for judging
the financial position of the business.
Matching Concept:
The essence of the matching concept lies in the view that all costs which are associated to a
particular period should be compared with the revenues associated to the same period to obtain
the net income of the business. Under this concept, the accounting period concept is relevant and
it is this concept (matching concept) which necessitated the provisions of different adjustments
for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in
advance, etc., during the course of preparing the financial statements at the end of the accounting
period.
Realisation Concept:
This concept assumes or recognizes revenue when a sale is made. Sale is considered to be
complete when the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this concept, viz., 1. Hire
purchase system where the ownership is transferred to the buyer when the last instalment is paid
and 2 . Contract accounts, in which the contractor is liable to pay only when the whole contract is
completed, the profit is calculated on the basis of work certified each year.
Accrual Concept:
According to this concept the revenue is recognized on its realization and not on its actual
receipt. Similarly the costs are recognized when they are incurred and not when payment is
made. This assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs. But under cash accounting system, the revenues
and costs are recognized only when they are actually received or paid. Hence, the combination
of both cash and accrual system is preferable to get rid of the limitations of each system.
Objective Evidence Concept:
This concept ensures that all accounting must be based on objective evidence, i.e., every
transaction recorded in the books of account must have a verifiable document in support of its,
existence. Only then, the transactions can be verified by the auditors and declared as true or
otherwise. The verifiable evidence for the transactions should be from the personal bias, i. e . ,
it should be objective in nature and not subjective. However, in reality the subjectivity cannot be
avoided in the aspects like provision for bad and doubtful debts, provision for depreciation,
valuation of inventory, etc., and the accountants are required to disclose the regulations followed.
Manufacturing Account:
Manufacturing concerns which convert raw material into finished product is required to prepare
manufacturing account and then prepare trading and profit and loss account. This is necessary
because they have to ascertain cost of goods manufactured, gross profit and net profit.
Trading account:
Trading account is prepared for an accounting period to find the trading results or gross margin
of the business i.e., the amount of gross profit the concern has made from buying and selling
during the accounting period. The difference between the sales and cost of sales is gross profit.
For the purpose of computing cost of sales, value of opening stock of finished goods, purchases,
direct expenses on purchasing and manufacturing are added up and closing stock of finished
goods is reduced. The balance of this account shows gross profit or loss which is transferred to
the profit and loss account.
Profit and Loss Account:
In the words of Prof. Carter ?Profit and loss account is an account into which all gains and losses
are collected in order to ascertain the excess of gains over the losses or vice versa.?
Balance sheet:
?Balance sheet is a screen picture of the financial position of a going business concern at a
certain moment? ? Francis.
Asset:
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
They are classified on the basis of their nature. Different types of assets are as under:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in
the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realised within an operating cycle of
one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence? they
can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both
fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt but
have value are called intangible assets. Goodwill, patents, trade marks and licences are examples
of intangible assets. They are usually classified under fixed assets.
(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalised for the time being, expenses for promotion of organisations (preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
Liability:
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words of Finny and Miller, ?Liabilities are debts? they are amounts owed to creditors? thus the
claims of those who ate not owners are called liabilities?.
In simple terms, debts repayable to outsiders by the business are known as liabilities.
Long term Liabilities: Liabilities repayable after specific duration of long period of time are
called long term liabilities.
Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities
FINANCIAL STATEMENT ANALY SIS
Financial Statement : A financial statement is an organized collection of data according to
logical and consistent accounting procedures
Purpose: To understand the financial aspects of a business form.
Financial Statement
Income Statement Balance Sheet Statement of retained earnings Statement of changes in
financial position
Analysis : MethodicalClassificationofdatagiveninthe financialstatements nsimplifiedform.
Interpretation: Explainingthemeaningandsignificanceofdatasosimplified.
Financial statement Analysis: To analyze the firm?s profitability & financial soundness
The following are the types of Financial Statement Analysis.
1.On the basis of Material used : According to the material used.
External Analysis Internal Analysis
External Analysis: This analysis is done by the outsiders like Investors /Credit
agencies/Government agencies and other Creditors.
Internal Analysis: This analysis is done by the internal executives / employees of the
organization.
2.On the basis of modus operandi : According to the method of operation followed in the
analysis.
Dynamic / Horizontal Analysis Static / Vertical Analysis
Dynamic / Horizontal Analysis: This analysis refers to the financial data of a company for
several years. The figures of various years are compared with the base year. It helps to focus
attention on items that have changed significantly during the period under review. Changes in
different elements of cost and sales over no . of years.
Tools employed are comparative statements and trend percentages.
Static / Vertical Analysis: A study is made of the quantitative relationship of the various items in
the financial statements in a particular date.
Percentage of each element of cost to sales.
Tools employed are common?size financial statements and financial ratios.
Ex: Item based
Particular period and in the same company
One division ? FMCG goods
Another division ? Medicines than
So the ratio is measured & compared the performance of one division to another division
Particular period and with different companies
One company ? FMCG goods
Another company ? FMCG goods
So the ratio is measured and compared the performance of one company to another company.
Methods and Devices of Financial Analysis:
A number of methods or devices are used to study the relationship between different statements
and to analyze the position of the enterprise.
The following are the methods:
1.Comparative statements
2.Trend Analysis
3.Common?size statements
4.Funds Flow Analysis
5.Cash Flow Analysis
6.Ratio Analysis
7.Cost?Volume?Profit Analysis
Comparative Statements:
The comparative financial statements are statements of the financial position at different periods,
of time. The elements of financial position are shown in a comparative form so as to give an idea
of financial position at two or more periods. The following are the two types of comparative
statements.
1.Comparative Balance Sheet: The analysis is the study of the trend of the same items, groups of
items and computed items in two or more balance sheets of the same business enterprise on
different dates. The changes in periodic balance sheet items reflect the conduct of a business. It
has four columns and the fourth column is used for giving percentages of increases or decreases.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?Current financial position and liquidity position
?Long?term financial position
?Profitability of the concern
?For studying current financial position or short?term financial position of a concern, should see
the working capital in both the years.
2.Comparative Income Statement: The income statement gives the results of the operations of a
business. It gives an idea of the progress of a business over a period of time. Like comparative
balance sheet it also has 4 columns and the fourth column is used to show increase or decrease in
figures, in absolute amounts and percentages respectively.
Guidelines for interpretation : nterpreter is expected to study the following aspects
?The increase or decrease in sales should be compared with the increase or decrease in cost of
goods sold.
?To analyze the study of operational profits.
?The increase or decrease in net profit will give an idea about the overall profitability of the
concern.
?Should mention whether the overall profitability is good or not.
Trend Analysis:
The financial statements may be analyzed by computing trends of series of information. This
method determines the direction upwards or downwards and involves the computation of the
percentage relationship that each statement item bears to the same item in base year.
Procedure for calculating trends.
?One year is taken as a base year. Generally the first or the last is taken as base year.
?The figures of base year are taken as 100.
?Trend percentages are calculated in relation to base year. If a figure in one year is less than the
figure in base year the trend percentage will be less than 100 and it will be more than 100 if
figure is more than base year figure. Each year?s figure is divided by the base year?s figure.
COMMON?SIZE STATEMENT ANALY SIS
The common?size statements, balance sheet and income statement are shown in analytical and
percentages. The figures are shown as the percentage of total assets, total liabilities and total
sales. These statements are also known as components percentage or 100 percent statement.
1.The total of assets or liabilities are taken as 100.
2.The individual assets are expressed as percentage of total assets.
Ex: Total assets = Rs.5,00,000, nventory value = Rs.50,000
If total assets are taken as 100
Calculation: 50000 x 00
???????????????? = 10%
5,00,000
Common?size Balance sheet: A statement in which balance sheet items are expressed as the ratio
of each asset to total assets and the ratio of each liabilities to total liabilities is called common?
size balance sheet.
Common?size Income Statement: The items in income statement can be shown as percentage of
sales to show the relation of each item to sales. A significant relationship can be established
between items of income statement and volume of sales.
Sales increases selling expenses increases ? there will be no affect on other administrative
expenses
Sales decreases selling expenses decreases ? there will be no affect on other administrative
expenses
If sales increase to a considerable extent then administrative and financial expenses go up.
So a relationship is established between sales and other items in income in evaluating operational
activities of the enterprise.
Funds Flow Statement : The term flow means movement and includes both inflow and outflow.
The term flow of funds means transfer of economic values from one asset to another.
Source of funds: If the effect of transaction results in the increase of funds, it is called a source of
funds.
Application of funds: If the effect of transaction results in the decrease of funds, it is called
application of funds.
Cash Flow Statement : Cash flow statement is a statement which describes the inflows and
outflows of cash and cash equivalents in an enterprise period of time.
Cash: Cash comprises cash on hand and demand deposits at bank.
Cash Equivalents: Cash Equivalents are short term, high liquid investments that are readily
convertible into known as amount of cash.
Cash flow: Cash flows are inflows and outflows of cash and cash equivalents.
Cash flows from operating activities: Operating activities are the principal of revenue?producing
activities of the enterprise and other activities that are not investing or finance activities.
Cash flow from investing activities: The cash flow represent the extent to which expenditures
have been made for resources intended to generate future income and cash flows.
Cash flows from financing activities: Financial activities are activities that result in changes in
the size and composition of the owner?s capital and borrowings of the enterprise.
Cost?volume?profit analysis: Cost?Volume?Profit (CVP) analysis is a managerial accounting
technique that is concerned with the effect of sales volume and product costs on operating profit
of a business. It deals with how operating profit is affected by changes in variable costs, fixed
costs, selling price per unit and the sales mix of two or more different products.
CVP analysis has following assumptions:
?All cost can be categorized as variable or fixed.
?Sales price per unit, variable cost per unit and total fixed cost are constant.
?All units produced are sold.
RATIONALE:
Explanation of the logical reasons or principles employed in consciously arriving at a decision or
estimate rationales usually document
why a particular choice was made,
how the basis of its selection was developed,
why and how the particular information or assumptions were relied on and
why the conclusion is deemed credible or realistic.
RATIO ANALY SIS :
It is a technical of analysis and interpretation of financial statements. It is the process of
establishing and interpreting various ratios for helping in making the certain decisions.
According to Accountants? Handbook of Wixon, Kell and Bedford a ratio is an
?Expression of the quantitative relationship between two numbers?.
Accounting ratios
Traditional Functional
P&L A/c Profitability Coverage Turnover
Financial
Balance Sheet Ratio Ratio Ratio Ratio
Composite Ratio
Overall profitability ratio Fixed interest coverage ratio Fixed assets turnover
ratio
Return on Investment Fixed dividend coverage ratio Working capital
turnover ratio
Equity per Share (EPS) Debt service coverage ratio Working capital
leverage
Price Earning Ratio
Gross Profit ratio
Net Profit ratio
Operating Expenses ratio
Payout ratio
Dividend Yield ratio
Liquidity Ratio and Stability Ratio
Current Ratio Fixed assets ratio
Change in current ratio Capital Structure ratio
Quick ratio Capital gearing ratio
Super quick ratio Debt?equity ratio
Defensive interval ratio
CLASSIFICATION, CALCU LATIONANDINTERPRETATIONOF RATIOS
SL
NO
RATIO
CLASSIFICATION
COMPUTATION
FORMULA
PURPOSE
Traditional Functional
1 Gross Profit Ratio
P&L A/c or
Revenue
Statement
Ratio
Probability
Ratio
Gross Profit
Indicates the efficiency of the
production / trading operations
x100
Net Sales
2 Net Profit Ratio ? ? Net Profit Indicates net margin on sales
x100
Net Sales
3
Operating or
Expenses ratio
? ? x100
Operating cost
A measure of management?s
ability to keep operating
expenses properly controlled f
level of sales achieved
Net Sales
4
Net Profit to Total
Assets
Composite
Ratio
?
Net profit after
tax + Interest
A measure of productivity of
Total
Assets x100
Total assets
5
Return on
Shareholders?
funds
? ?
Profit available for
equity shareholders
Shows the amount of earnings
attributable to each equity shar
x100
Average equity
shareholders?s funds
6
Earning per equity
share
Profit available for
equity shareholders
Shows the amount of earnings
attributes to each equity share.
? ? x100
No. of Equity
Shares
7 Dividend yield
? ?
Market
Dividend per share Shows the rate of return to
shareholders in the form of
dividends based on the market
price of the share.
x100
price per
share
8 Price Earning ratio ? ?
Market price of a
share
A measure for determining the
value of a share. May also be
used to measure the rate of retu
expected by investors.
x100
Earning per share
9
Fixed Interest
Cover
P&L or
Revenue
Statement
Ratio
Profitability
Ratio
Operating Income
Shows the margin of coverage
interest requirements Annual Interest
Expense
10
Fixed Dividend
Cover
Net Income
Shows the extent to which curr
are available to pay
dividends on preference shares.
? ? earnings
Annual Preference
Dividends
11 Inventory Turnover ?
Turnover or
Efficiency
ratio
Cost of goods sold Evaluation of the liquidity of
inventory and adequacy of
inventory controls. Average Inventory
12
Accounts
Receivable
Turnover
Composite
ratio
?
Net Sales on Credit Measures liquidity of accounts
receivable and the effectivenes
of credit policy. Average Receivable
13 Current ratio
Balance
sheet ratio
Financial
ratio
Current Assets
Measures short?term debt payi
ability.
Current Liabilities
14
Quick (Acid Test)
ratio
? ? term
(i) Quick Assets
Current Liabilities
(ii) Quick Assets
Quick Liabilities
A refined measure of the short-
debt paying ability by
measuring short?term liquidity.
15 Proprietary ratio
Total Shareholders?
Funds
Measures conservatism of capi
structure and shows the extent
funds in the total
assets employed in the busines
? ?
shareholders?
Total Tangible Assets
1 6 Debt?Equity ratio
? ??
(ii)
(i) External Equities
Indicates the percentage of fun
being financed through
borrowings? a measure of the
extent of trading on equity.
Internal Equities
Total Long?term
Debt
Total Lon?term
Funds
U TILITYOF RATIONANALY SIS
Ratios are of immense importance in the analysis and interpretation of financial statements as
they bring strength or weaknesses of the firm.
The following are the types of utility of ratio analysis.
1.Managerial uses of ratio analysis: This analysis helps in decision making through information
provided in financial statements, financial forecasting and planning like looking ahead and ratios
calculated are used as a guide for future , helps in communication like understanding financial
strengths and weaknesses, co?ordination helps in effective business management, control like
comparing actual with standards & other uses like budgetary control and standard costing.
2.Utility to Shareholders / Investors: Ratio analysis is used in making up investor mind whether
present financial position of the concern, warrants further investment or not.
3.Utility to Creditors: Ratio analysis is used to know whether current assets are quite sufficient to
current liabilities.
4.Utility to Employees: Profitability of financial statements like Gross?profit, Net?profit,
Operating?profit will enable the employees to put forward their view point for the increase of
their wages and benefits.
5.Utility to Government: Government also interested to know overall strength of the industry.
So the ratio act as an indicator to know the overall strength of the public and private sector.
6. Tax?audit requirements: Ratios are used to analyze the Gross?profit/turnover, Net?
profit/turnover, Stock?in?trade/turnover and material consumed/finished goods product.
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This post was last modified on 06 January 2020