Understanding financial statements ppt @ mba finance

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Understanding financial statements ppt @ mba finance

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  • Understanding financial statements ppt @ mba finance

    1. 1. Understanding Financial Statements
    2. 2. Why Accounting Informational requirement of a number of stakeholders in the business  Internal Stakeholder  Owners  Management  Employees  External Stakeholders  Government/ Tax department  Investors  Banks/Lenders  Suppliers/Creditors  NGOs/ Industry associations  Researchers Accounting is the tool for providing financial information to various stakeholders
    3. 3. Financial Accounting Information Predominately used by external stakeholders though managers also use it for decision making To ensure that the accounting information is `true & fair’  Generally Accepted Accounting Principles (GAAP)  Accounting Standards  Unification of Accounting Standards (IFRS) Accounting principles are not `exact’  Some latitude with the management
    4. 4. GAAP GAAP  Good accounting practices evolved by the profession over a period of time  Most of these practices have been adopted explicitly in the Accounting Standards Accounting Standards  Mandatory accounting/ disclosure principles prescribed by an authority  In India Accounting Standards are prescribed by the Institute of Chartered Accountants of India  So far 32 accounting standards have been issued by the ICAI
    5. 5. Please note Financial Statement are prepared in accordance with the applicable GAAP/ Accounting Standards The format is prescribed by the Companies Act 1956 They are audited by the `external auditors’ The audit report is addressed to the shareholders In case of listed companies – periodic disclosure (quarterly basis) is required to be made. Annual accounts are required to be presented to the shareholders’ for approval within six months of the close of the year
    6. 6. Basic Financial Statements To answer the three basic questions  How much profit was generated by the business over a particular period?  What are the assets and liabilities of the business at the end of a particular period?  What were the sources and uses of cash over a particular period? Financial Statements  Profit & Loss Account  Balance Sheet  Cash Flow Statement
    7. 7. Income Statement
    8. 8. Profit and Loss Account of XYZ Ltd. for the Year ended March 31st 20XXIncome Sched Previous Current Sales ule Year Year Other Income No. xxxExpenditure xxx Material and OtherProfit Before Tax xxxExpenditure Provision for Tax xxx xxxProfit After Tax xxx Interest Prior period adjustments xxx xxx Depreciation Extra Ordinary Items xxx xxxProfit available for appropriations xxxAppropriations Dividend xxx Dividend Distribution Tax xxx General Reserve xxxSurplus carried to Balance Sheet
    9. 9. Revenue Recognition Revenue  Sales of Goods  Rendering of Services  Use by others of enterprise resources yielding interest, royalties and dividends Sales of Goods  Seller has transferred property in goods to the buyer for a consideration  Transfer of significant risk and rewards of ownership to the buyer
    10. 10. Revenue Recognition Rendering of Services Recognise revenue when services are performed  Proportionate Completion Method  Performance consists of a series of acts  Revenue recognised proportionately by reference to performance of each act  Completed Service Contract Method  Performance consists of a single act; or  Performance can’t be deemed to be completed unless fully executed
    11. 11. Revenue Recognition Interest  On a time proportion basis taking into account amount outstanding and the interest rate Royalties  On an accrual basis with the terms of the relevant agreement Dividend  When the right to receive payment is established
    12. 12. Impact of uncertainties If there is uncertainty regarding the amount of the consideration at the time of sale or rendering of services  Postpone revenue recognition till it is reasonably certain If uncertainty arises subsequently  Make a separate provision to reflect uncertainty rather than adjust the amount of revenue originally recorded
    13. 13. Depreciation (AS 6) Most of the Fixed Assets have limited useful life The cost of a Fixed Assets needs to appropriated on a systematic basis over its useful life This process of appropriation is called depreciation Based upon the `Matching Principle’ Different Terms  Depreciation  Real Assets with limited useful life  Depletion  Natural resources  Amortization  Intangible assets
    14. 14. Determinants of Depreciation Amount of depreciation depends upon  Cost of Acquisition  Expected Useful Life  Estimated Residual Value Expected Useful Life  Period / Production Units  Physical Life  Extent of use  Legal / Contractual Requirements  Technological Changes – Obsolescence  Past experience
    15. 15. Determinants of Depreciation Estimated Residual Value  Amount expected to be realized on disposal  If considered insignificant – taken as Nil  Otherwise based upon the past experience Depreciable Value  Cost of Acquisition – Estimated Residual Vale Depreciation Cost of Acquisition – Residual Value Useful Life
    16. 16. Depreciation Methods Method of allocating the cost of assets over its useful life  Straight Line Method (SLM)  Written Down Value Method (WDV)  Unit of Production Method  Sum of Digits Method The Management is free to use any method The method chosen must be applied consistently from period to period
    17. 17. Straight Line Method Depreciable amount is amortized equally over the useful life of the asset Depreciation = Cost – RV Useful Life Depreciation charge in each period remains same over the useful life of the asset Simple to operate / understand
    18. 18. Accelerated Methods Written Down Value (WDV) Method  Higher depreciation in the earlier years  Depreciation is calculated by applying a rate to the net book value in the beginning of the year Sum of years’ digit Method  Depreciation for 1st year = n/SYD  SYD = n(n+1)/2
    19. 19. Depreciation Rates - Schedule XIV of the Companies Act WDV SLMBuilding - Factory 10.00 3.34 Other 5.00 1.63 Temporary 100.00 100Plant & Machinery- Single shift 13.91 4.75 Double Shift 20.87 7.42 Triple Shift 27.82 10.4Electrical Fittings 13.91 4.75Vehicles (Motor Carr, Motor cycles, scooters) 25.89 9.50Buses & Lorries (other than used for hire) 30.00 11.31Furniture & Fittings 18.10 6.33Individual assets costing less than Rs.5000 100% 100%
    20. 20. Inventory AS 2 `Valuation of Inventories’ issued by the ICAI in June 1981 What is inventory  Assets  Held for sale in the ordinary course of business  In the process of production for such sale  In the form of materials or supplies to be consumed in the production process or in the rendering of services
    21. 21. Importance Profit = Sales - COGS Cost of Goods Sold = (Opening Stock + Purchases – Closing Stock)  Opening Stock + Purchases = Closing Stock + COGS Closing Stock (inventories) appears in the Balance Sheet as Current Assets Inventories often constitute (except in case of a Services Company) a significant portion of the total assets of a company Problem  How to apportion goods available for sale between ending inventory and cost of good sold ?
    22. 22. Valuation of Inventory Inventories should be valued at the lower of cost and net realisable value Valuation process  Ascertain cost  Ascertain net realisable value  Value at lower of cost and net realisable value
    23. 23. Cost of Inventories Comprises of cost of purchase, costs of conversion and other cost incurred to bring inventories to their present location and condition Cost of Purchases  Includes purchase price, duties and taxes, freight inwards and other expenses directly attributable to the acquisition  Trade discounts, rebates, duty drawbacks etc are deducted
    24. 24. Cost of Conversion Cost directly related to the production Systematic allocation of fixed and variable production overheads Costs not to be considered for valuation  Interest & borrowing costs  Abnormal wastages  Storage costs (unless necessary in the production process before further production)  Administrative overheads  Selling & Distribution Overheads
    25. 25. Cost Formulas For identifying the cost  Specific Identification  FIFO  LIFO  Weighted Average Method AS 2 permits use of Specific Identification, FIFO and Weighted Average Cost Method
    26. 26. Specific Identification Methods Cost of inventories, that are not ordinarily interchangeable and can be identified or for specific project Not practical when a large number of inventory items which are interchangeable Some form of approximation is used  The formula used should reflect the fairest possible approximation to the cost incurred
    27. 27. Methods First in First Out (FIFO)  Assumes that the items of inventory purchased or produced first are consumed or sold first  Items remaining in the inventory are those that were purchased or produced recently Last in First Out (LIFO)  Assumes that the items of inventory purchased or produced recently are consumed or sold first  Items remaining in the inventory are those that were purchased or produced first Weighted Average Method  Weighted average of the cost of similar items at the beginning of a period and cost of similar item produced or purchased during the period  Either on a periodic basis or for each shipment
    28. 28. Net Realisable Value Estimated selling price in the ordinary course of business less the estimated cost of completion and estimated cost to make the sale  On an item to item basis  Estimate based upon the most reliable evidence that may be available at the time estimates are being made Material are not written down below cost if the finished products in which they will be used are expected to be sold above cost.
    29. 29. Disclosure Accounting policies and cost formula used Total carrying amount of inventory and its classification  Raw Material, Components, WIP, Finished Goods, Stores and Spares, Loose Tools
    30. 30. Prior Period Adjustments and Extra-ordinary Items Disclose separately on the face of the Profit & Loss Statement  Result of Ordinary Activities  Extra Ordinary Items  Prior Period Items  Impact of Change in Accounting Policies
    31. 31. Prior Period Adjustments and Extra-ordinary Items Ordinary activities  Activities which are undertaken as part of its business and related activities Extraordinary items  Income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities  Not expected to recur frequently or regularly. Prior period items  Income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods
    32. 32. Summary Profit & Loss A/c is an account showing income and expenses Revenue/ Income is recognised when earned Expenses are recorded when incurred Basic Concepts  Accounting Period  Conservatism  Accrual  Matching  Consistency  Materiality Show the result of ordinary activities, extra-ordinary items, prior-period items and impact of change of accounting policies separately
    33. 33. Balance Sheet
    34. 34. Schedule VI – Part I Accounts must be maintained on an accrual basis and according to double entry book keeping system (section 209) The Balance Sheet and the Profit & Loss account must be prepared for every financial year The financial statements must be laid before the Annual General Meeting of the shareholders for approval within six months of the close of the year (Section 210) The balance sheet of a company shall be either in horizontal form or vertical form The Balance Sheet must show figures for the current year and comparative figures for the previous year Information required under any head may be given in separate `Schedule’
    35. 35. Balance Sheet of XYZ Limited as at ………….. Schedule Figures as at the Figures as at Number end of current the end of financial year previous financial yearSources of Funds 1 Shareholders’ Funds: (a) Capital (b) Reserve & Surplus 2. Loan Funds (a) Secured Loan (b) Unsecured Loan TOTALII. Application of Funds 1. Fixed Assets 2. Investments 3. Current Assets, loans and advances Less : Current Liabilities & Provisions Net Current Assets 4. a) Miscellaneous Expenditure to the extent not written off or adjusted b) Profit & Loss Account TOTAL
    36. 36. Sources of Funds
    37. 37. 1. Share Capital Authorized, Issued, Subscribed, and Called up for each class of shares Calls unpaid to be deducted from the Called up capital to arrive at Paid up Capital Add: Forfeited Shares (amount paid up) Terms of redemption/conversion of redeemable preference shares to be stated with date redemption/conversion Shares issued for consideration other than cash to be identified Shares allotted by way of bonus shares to be shown Sources from which bonus shares have been issued to be specified Calls unpaid by the Directors to be separately indicated
    38. 38. Type of Capital Preference Capital  Preference for payment of dividend at a fixed rate and repayment of Capital Equity Capital  Perpetual  Last preference for dividend and repayment of capital
    39. 39. Type of Capital Authorized Share Capital – The maximum amount that the company may raise by issuing capital is mentioned in the Memorandum of Association Issued Share Capital – Part of Authorized Share Capital that is offered by the company for subscription Subscribed Share Capital – Part of the Issued Share Capital that is subscribed by the shareholders Called up Share Capital – Part of the Subscribed Share Capital that has been called up by the Company Calls in Arrear – call amount not paid by the shareholders Paid up Capital – Called up share capital minus calls in arrear Forfeited Shares – amount paid up on the shares forfeited due to non payment of call money
    40. 40. Share Capital - Example Authorized Share Capital  1,00,00,000 Equity Shares of Rs.10 each Issued Share Capital  50,00,000 Equity Shares of Rs.10 each Subscribed Share Capital  49,90,000 Equity Shares of Rs.10 each Called up Share Capital  49,90,000 Equity shares Rs.8 called up Calls in Arrear  Rs.5 on 1,00,000 shares
    41. 41. Share Capital - Example Called up Share Capital  49,90,000 Equity shares (Rs.8 called up) : 3,99,20,000 Less : Calls in Arrear  1,00,000 shares @ Rs.5 each : 5,00,000 Paid up Share Capital : 3,94,20,000
    42. 42. Share Capital - Example If share are forfeited Paid up Share Capital 48,90,000 Equity shares of Rs. 10 each, (Rs.8 called up) : 3,91,20,000 Add: Forfeited Shares (1,00,000 x 3) 3,00,000  Total 3,94,20,000
    43. 43. Reserve & Surplus Earnings not distributed to shareholders  II. Reserve & Surplus  Capital Reserve  Share Premium Account  Other Reserves Less: Debit balance in Profit & Loss Account  Surplus – balance in profit & loss account  Sinking Funds
    44. 44. Reserve & Surplus Addition and deductions since the last balance sheet to be shown under each specified head `Fund’ in relation to any `Reserve’ should be used only where such reserve is specifically represented by earmarked investments
    45. 45. 2. Loan Funds Secured Loans (1) Debentures (2) Loans & Advances from Banks (3) Loan & Advances from subsidiaries (4) Other Loans & Advances Loans from Directors should be shown separately Interest accrued and due on secured loans should also be included The nature of security to be specified in each case Terms of redemptions/ conversions of debentures together with the date if redemption or conversion
    46. 46. Loan Funds Unsecured Loans (1) Fixed Deposits (2) Loans & Advances from subsidiaries (3) Short term loans and advances (a) From Banks (b) From Others (4) Other Loans and Advances (a) From Banks (b) From Others Loans from Directors should be shown separately Interest accrued and due on un-secured loans should also be included Short term loans will include those which are due for not more than one year from the date of the Balance Sheet
    47. 47. Deferred Tax Liability/Assets Relevant Accounting Standard – AS 22 Due to difference between taxable income (as per Income Tax Act) and accounting profit  Permanent Difference  Don’t reverse subsequently  Expenses disallowed, exempt income  Timing Difference  Reversed in the subsequent period  Expenses allowed on payment basis, depreciation
    48. 48. Deferred Tax Liability/AssetsCause Effect AccountingAccounting Tax on Accounting Create DeferredIncome > Taxable Income > Tax Tax LiabilityIncome payable as per Income Tax ActAccounting Tax on Accounting Create DeferredIncome < Taxable Income < Tax Tax AssetIncome payable as per Income Tax Act
    49. 49. Application of Funds
    50. 50. 1. Fixed Assets Show, to the extent possible, under the following headings  Goodwill  Land  Building  Leaseholds  Railway Sidings  Plant & Machinery  Furniture & fittings  Development of Property  Patents, Trade Marks and Design  Livestock  Vehicles
    51. 51. Fixed Assets Under each head show the original cost, addition and deduction during the year and total depreciation written off up to the end of the year  Original Cost – Gross Block  Less Accumulated Depreciation – Net Block Relevant Accounting Standards  AS 10 : Fixed Assets  AS 26 : Intangible Assets  AS 6 : Depreciation Accounting
    52. 52. Fixed Assets Show at cost of acquisition less depreciation  The cost comprise purchase price and any attributable cost of bringing the asset to its working condition for its intended use. (AS-10)  Capitalize borrowing cost up-to the point the asset us ready for its intended use (AS-16)  Import duties, taxes, delivery & handling costs, site preparations, installation cost, professional fees, start up & commissioning, test runs  Subsequent expenditures to be added to its book value only if they increase the future benefits from the existing asset  Improvement  Repairs
    53. 53. Fixed Assets Intangible Assets (AS 26)  Identifiable, non-monetary assets without physical substance  Acquired intangible assets are recorded at their cost of acquisition  Self-generated goodwill/brand value is not recognized  Research cost – inventing or creating a new product, method or system – is not capitalized  Development cost – converting the result of research into a marketable product – can be capitalized  Expenses that provide future economic benefits but no intangible assets is created – treat as expense when incurred e.g. start up costs, launching new product, training etc.
    54. 54. 2. Investments Distinguish between  Investment in Government Securities  Investment in shares debentures and bonds  Showing separately fully paid up/partly paid up  Investment in Subsidiary Companies  Investment in Immovable properties  Investment in the capital of partnership firms Aggregate amount of quoted investments and their market value should be shown Aggregate amount of unquoted investments to be shown
    55. 55. Investments Relevant Accounting Standard : AS 13  Distinguish between Current Investments and Long Term Investments  Current Investments – Intended to be held for not more than one year Cost of Investment includes all the related costs Valuation (Carrying Amount)  Current Investment – at Lower of Cost or Fair Value – preferably on individual basis  Long Term Investments – at Cost subject to any non-temporary diminution Profit or Loss on disposal of investment to be shown in Profit & Loss Account Significant restriction on right of ownership, remittance of income or proceeds of disposal to be disclosed
    56. 56. 3. Current Assets, Loans & Advances(A) Current Assets(2) Interest accrued on Investments(3) Stores and Spare parts(4) Loose Tools(5) Stock in Trade(6) Work in Progress(7) Sundry Debtors (a) Balance outstanding for a period exceeding 6 months (b) Other Debts Less : Provisions(7A) Cash balance on hand(7B) Bank Balances (a) With Scheduled Banks (b) with others
    57. 57. Current Assets, Loans & Advances Mode of valuation of stock shall be stated Lowe of Cost or Realizable Value In respect of debtors  Debt considered good where company is fully secured  Debt considered good otherwise  Debt considered doubtful or bad  Debt due from directors or other officers of the company or firms of private companies in which any director is a partner or a director  Debt due from companies under the same management  Maximum amount due from a director or other officers of the company any time during the year
    58. 58. Current Assets, Loans & Advances(B) Loans & Advances(8) Advances & loans to subsidiaries(9) Bills of Exchange(10)Advance recoverable in cash or in kind or for value to be received(11) Balances with customs, port trust etc.Less : Current Liabilities and Provisions
    59. 59. Current Liabilities & ProvisionsA. Current Liabilities (1) Acceptance (2) Sundry Creditors (3) Subsidiary Companies (4) Advance payments (5) Unclaimed dividends (6) Other Liabilities (7) Interest accrued but not due on loans
    60. 60. Current Liabilities & ProvisionsB. Provisions (8) Provision for Taxation (9) Proposed dividends (10) For contingencies (11) For Provident Fund scheme (12) For insurance, pension and similar staff benefit schemesNet Current Assets
    61. 61. 4. Miscellaneous Expenditure To the extent not written off or adjusted (1) Preliminary Expenses (2) Expenses on Issue of Shares/ Debentures (3) Discount on Issue of Shares or Debentures (4) Interest paid out of capital during construction (5) Development expenditure (6) Other Expenditure Profit & Loss Account (Debit Balance)
    62. 62. Contingent Liabilities Contingency (Accounting Standard 4/29)  A condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence, or nonoccurrence, of one or more uncertain future events.  Restricted to conditions or situations at the balance sheet date  The estimates of the outcome and of the financial effect of contingencies are determined by the judgment of the management of the enterprise.
    63. 63. Contingent Liabilities Accounting treatment of a contingent loss  If it is likely that a contingency will result in a loss to the enterprise, then it is prudent to provide for that loss in the financial statements.  If there is conflicting or insufficient evidence for estimating the amount of a contingent loss, then disclosure is made of the existence and nature of the contingency.  Provisions for contingencies are not made in respect of general or unspecified business risks since they do not relate to conditions or situations existing at the balance sheet date.
    64. 64. Contingent Liabilities The following information should be provided in respect of contingent liability  the nature of the contingency  the uncertainties which may affect the future outcome  an estimate of the financial effect, or a statement that such an estimate cannot be made.
    65. 65. Contingent LiabilitiesCompany Year Contingent Net Worth CL as a % ended Liability of NWSPIC 2004 126.48 2.15 5882Hindustan Motors 2004 137.04 15.09 908Essar Steel 2004 3108.64 589.01 528Sakthi Sugars 2003 177.19 37.92 467HCC 2004 833.97 238.74 349Gammon India 2004 581.58 184.07 316Ispat Industries 2004 2145.41 833.29 257Esab India 2003 28.28 12.40 24Skansha 2003 513.41 91.58 561Cementation
    66. 66. Cash Flow StatementAccounting Standard - 3
    67. 67. Why Cash Flow Statement To assess the ability of the business to generate cash and its utilization P&L based upon accrual concept doesn’t reveal cash from operations Other sources and uses of cash impact balance sheet To have an overview of sources and uses of cash in the accounting period a Cash Flow Statement is prepared
    68. 68. What is Cash Cash comprises cash on hand and deposits with banks Cash Equivalents  Short term, highly liquid investments  Readily convertible into cash  Insignificant risk of changes in value
    69. 69. Cash Flow Statement To be prepared and presented for each period for which financial statements are prepared Cash flow should be classified into  Operating Activities  Investing Activities  Financing Activities The sum of cash flow from these activities should explain change in cash balance over the accounting period
    70. 70. Operating Activities Principal revenue-generating activities Generally result from the transactions and other events that enter into the determination of net profit or loss Examples  Receipts from sale of goods or rendering of services  Payments to suppliers for goods and services  Payment to employees  Payment of income tax
    71. 71. Investing Activities Acquisition and disposal of long-term assets and other investments For acquiring resources intended to generate future income and cash flow Examples  Payment to acquire fixed assets  Receipts from disposal of fixed assets  Payments for acquiring investments  Cash advances and loans made  Recovery of cash advances and loans  Receipt of dividend/ interest on investments
    72. 72. Financing Activities That result in changes in the size and composition of the owners’ capital and borrowings of the enterprises Useful to predict claim on future cash flow by the providers of funds Examples  Cash proceeds from issue of shares  Cash proceeds from issuing debentures and other long term borrowings  Cash repayments of amount borrowed  Payment of interest / dividend
    73. 73. Extra-Ordinary Items Cash flow from extra-ordinary items should be separately disclosed classified into operating, investing and financing activities
    74. 74. Taxes on Income Tax paid to be classified as cash flow from operating activities unless they can be specifically identified with financing and investing activities
    75. 75. Non Cash Transactions Investing and Financing Transactions that do not require use of cash Exclude from cash flow statement Disclose separately elsewhere in the financial statements
    76. 76. Cash From Operations Direct Method  Major classes of receipts and payments for operating activities are considered Indirect Method  Adjust Net profit or Loss  non-cash items  changes in current assets and liabilities  Items that can be classified as financing or investing cash flows
    77. 77. Disclosure Components of Cash and cash equivalents Reconciliation of amounts in the Cash Flow Statement with the items reported in the Balance Sheet Amount of significant cash and cash equivalents held by the enterprise that are not available for use by it

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