Accounting and financial analysis


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Accounting and financial analysis(MB103) Unit 1 MTU

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Accounting and financial analysis

  1. 1. Dr. Akansha Jain email: 1
  2. 2. Accounting is the language of business. Theaffairs and the results of the business arecommunicated to others through accountinginformation, which has to be systematicallyrecorded and presented. Dr. Akansha Jain email: blog – 2
  3. 3. Accounting can be defined as the process ofidentifying, measuring, recording andcommunicating the economic events of anorganization to the interested users of theinformation. Dr. Akansha Jain email: blog – 3
  4. 4.  American Institute of certified Public Accountants( AICPA) defined Accounting as “ Accounting is art of recording, classifying and summarizing in terms of money transactions and events of financial character and interpreting the result thereof.” (1941) American Accounting Association(AAA) defined accounting as “ Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of information.” (1966) Dr. Akansha Jain email: blog – 4
  5. 5.  Economic events Identification of transactions Measuring of transactions Recording of transactions Classifying of transactions Summarizing Analysis and Interpretation Communication to interested users. Dr. Akansha Jain email: blog – 5
  6. 6. An economic event has been defined as „ahappening of consequence‟ to a businessentity. Economic events are classified into• External types• Internal types. Dr. Akansha Jain email: blog – 6
  7. 7. An external event which involves thetransfer or exchange of something of valuebetween two or more entities. Dr. Akansha Jain email: blog – 7
  8. 8. Sale of goods to customers.• Payment of monthly rent to the landlord. Purchase of raw materials by an enterprise from some other business enterprise. Rendering of services to customers, etc. Dr. Akansha Jain email: blog – 8
  9. 9. An internal event is an economic event thatoccurs entirely within one enterprise.Eg : Supply of raw materials or equipment by the stores department to the manufacturing department. Dr. Akansha Jain email: blog – 9
  10. 10. It means determining what to record, i.e. toidentify recordable events. It involvesobserving activities and selecting thoseevents that are considered to be evidence ofeconomic activityActivities are of two types1) Monetary2) Non monetary Dr. Akansha Jain email: blog – 10
  11. 11. It means quantification, including estimatesof business transactions into financial terms,i.e. rupees and paise. If an event cannot bequantified in monetary terms, it is notconsidered for recording in financialaccounts. Dr. Akansha Jain email: blog – 11
  12. 12. Once the economic events are identifiedand measured in financial terms, they arerecorded, i.e. a chronological diary of thesemeasured events is kept in an orderly andsystematic manner( Journal) Dr. Akansha Jain email: blog – 12
  13. 13.  After recording transactions in journal or subsidiary book, the transactions are classified by grouping similar transactions at one place. ( Ledger) Dr. Akansha Jain email: blog – 13
  14. 14.  Itis art of presentation of classified data in a manner which is understandable and useful to management and other users. It involves preparation of Trial Balance, Income statement and Balance Sheet. Dr. Akansha Jain email: blog – 14
  15. 15.  The recorded transaction is analyzed to make useful interpretations. This process provides meaningful conclusion from information Dr. Akansha Jain email: blog – 15
  16. 16. The information is communicated throughthe preparation and distribution ofaccounting reports to the interested usersso that they can make suitable decisions. Dr. Akansha Jain email: blog – 16
  17. 17.  Maintenance of business records Protecting properties of business Communicating the results Fulfillment of legal requirement To facilitate decision making Evidence in court of law Replaces memory Dr. Akansha Jain email: blog – 17
  18. 18. Different categories of users need differentkinds of information for making decisions.These users can be divided into :•Internal Users; and•External Users. Dr. Akansha Jain email: blog – 18
  19. 19. These are the persons who manage thebusiness, i.e. management at the top,middle, and lower levels. Their requirementsof information are different because theymake different types of decisions. Dr. Akansha Jain email: blog – 19
  20. 20. All persons other than internal users comein the group of external users. Externalusers can be divided into two groups: those having direct interest; and those having indirect interest in a business organization. Dr. Akansha Jain email: blog – 20
  21. 21. Owners Researchers management Users of accountingGovernment creditors Potential Employees investors Dr. Akansha Jain email: blog – 21
  22. 22.  Financial Accounting Cost Accounting Management Accounting Dr. Akansha Jain email: blog – 22
  23. 23.  Keeping systematic records Preparation of financial statements Comparison of results Decision making Evidence in courts Provides information to interested parties Taxation benefits Dr. Akansha Jain email: blog – 23
  24. 24.  Records only monetary transactions Data based on estimates Valuation of fixed assets Inventory valuation Window dressing is possible Dr. Akansha Jain email: blog – 24
  25. 25.  Bookkeeping represents a process of recording actual transactions of a business. Bookkeeping does not involve any analysis of the accounting data. Bookkeeping is an integral part of accounting, and thus, it prepares necessary financial information for accounting. Bookkeeping includes recording, classifying and summarizing data . Dr. Akansha Jain email: blog – 25
  26. 26. Dr. Akansha Jain blog – 26
  27. 27. Assets are things of value or economic resourcesused by the business in its operations. Fixed Assets : Fixed Assets are assets heldon a long-term basis. Ex:-Land, Building,Machinery, Plant, Furniture and Fixtures, etc Current Assets : Current Assets are assetsheld on a short-term basis. Ex:-Debtors, Billsreceivable, Stock(Inventory), Cash and Bankbalances etc. Dr. Akansha Jain email: blog – 27
  28. 28. These are obligations or debts that theenterprise must pay in money or services atsome time in the future.• Long-term liabilities are those that areusually payable after a period of one year• Short-term liabilities are obligations thatare payable within a period of one year. Dr. Akansha Jain email: blog – 28
  29. 29. Investment by the owner for use in the firmis known as capital. Owner‟s equity is theownership claim on total assets. It is equalto total assets minus total liabilities. Dr. Akansha Jain email: blog – 29
  30. 30. These are the amounts the business earnsby selling its products or providing servicesto customers. Sources of revenue commonto many businesses are: sales, fees,commission, interest, dividends, royalties,rent received, etc. Dr. Akansha Jain email: blog – 30
  31. 31. These are costs incurred by a business inthe process of earning revenue. Generally,expenses are measured by the cost ofassets consumed or services used during anaccounting period. Example :- depreciation,rent, wages, salaries, interest, costs of lightand water, telephone, etc. Dr. Akansha Jain email: blog – 31
  32. 32. Purchases are total amount of goods procuredby a business on credit and for cash, for useor sale. In a trading concern, purchases are made ofmerchandise for resale with or withoutprocessing.In a manufacturing concern, raw materials arepurchased, processed further into finishedgoods and then sold.Purchases may be cash purchase or creditpurchase. email: Dr. Akansha Jain blog – 32
  33. 33. Sales are total revenues from goods orservices sold or provided to customers.Sales may be cash sales or credit sales. Dr. Akansha Jain email: blog – 33
  34. 34. Stock (Inventory) is a measure ofsomething in hand – goods, spares andother items – in a business.Goods which have not been sold on thedate on which the balance sheet is preparedare called closing stock. Dr. Akansha Jain email: 34 blog –
  35. 35. Debtors are persons and/or other entities whoowe to an enterprise an amount for receivinggoods and services on credit.The total amount standing against such personsand/or entities on the closing date, is shown in theBalance Sheet as Sundry Debtors on the assetside. Dr. Akansha Jain email: blog – 35
  36. 36. Creditors are persons and/or other entities whohave to be paid by an enterprise an amount forproviding the enterprise goods and services oncredit.The total amount standing to the favour of suchpersons and/or entities on the closing date, isshown in the Balance Sheet as Sundry Creditorson the liability side. Dr. Akansha Jain email: blog – 36
  37. 37. Accounting principles can be subdivided intotwo categories: Accounting Concepts; and Accounting Conventions. Dr. Akansha Jain email: blog – 37
  38. 38. Accounting Concepts Accounting ConventionsThe term „concept‟ is used to connoteaccounting postulates, that is necessaryassumptions and conditions upon whichaccounting is based. The term „convention‟is used to signify customs and traditions asa guide to the presentation of accountingstatements. Dr. Akansha Jain email: blog – 38
  39. 39. Accounting Concepts• Business Entity Concept• Money Measurement Concept• Cost Concept• Going Concern Concept• Dual Aspect Concept• Realization Concept• Accounting Period Concept Dr. Akansha Jain email: blog – 39
  40. 40. Accounting Conventions• Convention of Consistency• Convention of Full Disclosure• Convention of Conservation• Convention of Timeliness Dr. Akansha Jain email: blog – 40
  41. 41. Accounting Concepts The term „concept‟ is used to connoteaccounting postulates, that is necessaryassumptions and conditions upon whichaccounting is based. Dr. Akansha Jain email: blog – 41
  42. 42. Business is treated as a separate entity orunit apart from its owner and others. All thetransactions of the business are recorded inthe books of business from the point of viewof the business as an entity and even theowner is treated as a creditor to the extentof his/her capital. Dr. Akansha Jain email: blog – 42
  43. 43. In accounting, we record only thosetransactions which are expressed in termsof money. In other words, a fact which cannot be expressed in monetary terms, is notrecorded in the books of accounts. Dr. Akansha Jain email: blog – 43
  44. 44. Transactions are entered in the books ofaccounts at the amount actually involved.Suppose a company purchases a car forRs.1,50,000/- the real value of which isRs.2,00,000/-, the purchase will be recordedas Rs.1,50,000/- and not any more. This isone of the most important concept and itprevents arbitrary values being put ontransactions. Dr. Akansha Jain email: blog – 44
  45. 45. It is persuaded that the business will existsfor a long time and transactions arerecorded from this point of view. Dr. Akansha Jain email: blog – 45
  46. 46. Each transaction has two aspects, that is,the receiving benefit by one party and thegiving benefit by the other. This principle isthe core of accountancy. Dr. Akansha Jain email: blog – 46
  47. 47. For example, the proprietor of a businessstarts his business with Cash Rs.1,00,000/-,Machinery of Rs.50,000/- and Building ofRs.30,000/-, then this fact is recorded attwo places. That is Assets account (Cash,Machinery & Building) and Capital accounts.The capital of the business is equal to theassets of the business. Dr. Akansha Jain email: blog – 47
  48. 48. Thus, the dual aspect can be expressed asunderCapital + Liabilities = AssetsorCapital = Assets – Liabilities Dr. Akansha Jain email: blog – 48
  49. 49. Accounting is a historical record oftransactions. It records what has happened.It does not anticipate events. This is ofgreat important in preventing business firmsfrom inflating their profits by recording salesand income that are likely to accrue. Dr. Akansha Jain email: blog – 49
  50. 50. Strictly speaking, the net income can bemeasured by comparing the assets of thebusiness existing at the time of itsliquidation. But as the life of the business isassumed to be infinite, the measurement ofincome according to the above concept isnot possible. So a twelve month period isnormally adopted for this purpose. This timeinterval is called accounting period. Dr. Akansha Jain email: blog – 50
  51. 51. Accounting Conventions The term „convention‟ is used to signifycustoms and traditions as a guide to thepresentation of accounting statements. Dr. Akansha Jain email: blog – 51
  52. 52. In order to enable the management to drawimportant conclusions regarding the workingof the company over a few years, it isessential that accounting practices andmethods remain unchanged from oneaccounting period to another. Thecomparison of one accounting period withthat of another is possible only when theconvention of consistency is followed. Dr. Akansha Jain email: blog – 52
  53. 53. This principle implies that accounts must behonestly prepared and all materialinformation must be disclosed therein. Thecontents of Balance Sheet and Profit andLoss Account are prescribed by law. Theseare designed to make disclosure of allmaterial facts compulsory. Dr. Akansha Jain email: blog – 53
  54. 54. Financial statements are always drawn upon rather a conservative basis. That is,showing a position better than what it is,not permitted. It is also not proper to showa position worse than what it is. In otherwords, secret reserves are not permitted. Dr. Akansha Jain email: blog – 54
  55. 55. • Keeping systematic records• Protecting properties of the business• Communicating the results• Meeting legal requirements Dr. Akansha Jain email: blog – 55
  56. 56. The first function of accounting is to keep asystematic record of financial transactions,to post them to the ledger accounts andultimately prepare final statements. Dr. Akansha Jain email: blog – 56
  57. 57. The second important function is to protectthe property of the business. The systemaccounting is designed in such a way that itprotects its assets from an unjustified andunwarranted use. Dr. Akansha Jain email: blog – 57
  58. 58. The fourth and the last function ofaccounting is to meet the legalrequirements under the Companies Act,Income Tax Act, Sales Tax Act and so on. Dr. Akansha Jain email: blog – 58
  59. 59. Recording transactions in subsidiary books.Classifying data by posting from subsidiarybooks to the accounts.Closing the books and preparation of finalaccounts. Dr. Akansha Jain email: blog – 59
  60. 60. • Cash System• Single Entry System• Double Entry System Dr. Akansha Jain email: blog – 60
  61. 61. This system takes into account only cashreceipts and payments on the assumptionthat there are no credit transactions. Even ifthere are any, they will not be recorded.This system may be suitable for charitableinstitutions like schools, colleges, socialclubs, etc. Dr. Akansha Jain email: blog – 61
  62. 62. As the name itself implies, it deals with onlyone aspect of transaction. This systemrecognizes cash and personal items of thetransactions and it ignores the impersonalitems. So it is incomplete, inaccurate andunscientific. Dr. Akansha Jain email: blog – 62
  63. 63. This is the most scientific system thatrecognizes both the aspects of eachtransaction and also records each aspect.This system takes into account everybusiness transaction in its double aspect,i.e., receiving benefit by one party andgiving the like benefit by another. So itrecords the two-fold aspect of everybusiness transaction. Jain email: Dr. Akansha blog – 63
  64. 64. Example: When „A‟ purchases a car, hereceives the benefit in the form of a car andgives the benefit in the form of money.Similarly, the car seller receives the benefitin the form of money and gives the benefitin the form of a car. Dr. Akansha Jain email: blog – 64
  65. 65. DefinitionThe process by which the dual aspects ofbusiness transactions are recorded is knownas the double entry book-keeping. It is acomplete book-keeping in the sense that itrecords all the two aspects, debit and creditin each business transaction, in equal value. Dr. Akansha Jain email: blog – 65
  66. 66. Every business deal with other “Person”, possesses“Assets”, pay “Expenses” and receive “Income”.So from the above, we can see every businesshas to keep• An account for each person• An account for each asset and• An account for each expense or income. Dr. Akansha Jain email: blog – 66
  67. 67. • Accounts in the names of persons are known as “Personal Accounts”• Accounts in the names of assets are known as “Real Accounts”• Accounts in respect of expenses and incomes are known as “Nominal Accounts” Dr. Akansha Jain email: blog – 67
  69. 69. Accounts in the name of persons are known aspersonal accounts.Eg: Babu‟s A/C, Babu & Co.‟s A/C, Outstanding Salaries A/C, etc. Dr. Akansha Jain email: blog – 69
  70. 70. These are accounts of assets or properties. Assetsmay be tangible or intangible. Real accounts areimpersonal which are tangible or intangible innature.Eg:- Cash a/c, Building a/c, etc are Real Accounts related to things which we can feel, see and touch. Goodwill a/c, Patent a/c, etc Real Accounts which are of intangible in nature. Dr. Akansha Jain email: blog – 70
  71. 71. These accounts are impersonal, but invisible andintangible. Nominal accounts are related to thosethings which we can feel, but can not see andtouch. All “expenses and losses” and all “incomesand gains” fall in this category.Eg:- Salaries A/C, Rent A/C, Wages A/C, Interest Received A/C, Commission Received A/C, Discount A/C, etc. Dr. Akansha Jain email: blog – 71
  72. 72. Each accounts have two sides – the left side andthe right side. In accounting, the left side of anaccount is called the “Debit Side” and the rightside of an account is called the “Credit Side”. Theentries made on the left side of an account iscalled a “Debit Entry” and the entries made on theright side of an account is called a “Credit Entry”. Dr. Akansha Jain email: blog – 72
  73. 73. Debit the Receiver Personal Account Credit the Giver Debit what comes inReal Accounts Credit what goes out Debit all Expenses Nominal and Losses Accounts Credit all Incomes and Gains Dr. Akansha Jain email: 73 blog –
  74. 74. • Find out the two accounts involved in the transaction.• Check whether it belongs to Personal, Real or Nominal account.• Apply the debit and credit rules for the two accounts. Dr. Akansha Jain email: blog – 74
  75. 75. • General Journal• Special Journals • Purchase Book • Sales Book • Purchase Return Book • Sales Return Book • Bills Receivable Book • Bills Payable Book • Cash Book • Petty Cash Book Dr. Akansha Jain email: blog – 75
  76. 76. Journal is the prime or original book of entry inwhich all transactions are recorded in the form ofentries. Journalising is an act of recording orentering transactions in a Journal in the order ofdate.Date Particulars LF Debit Credit Amount Amount Dr. Akansha Jain email: blog – 76
  77. 77. Jan 1, 2012 Prakash Started a business Rs.15,000/-Date Particulars L Debit Credit F Amount Amount2012 Cash a/c Dr. 15,000Jan 1 To Capital a/c 15,000 (Being business started with cash.) Dr. Akansha Jain email: blog – 77
  78. 78. Dr. Akansha Jain blog – 78
  79. 79. Dr. Akansha Jain blog – 79
  80. 80. a) Started business with Rs50000b) Purchase goods for cash Rs16000c) Paid rent for cash Rs2000d) Paid rent for the month Rs6000e) Purchase equipments for cash Rs6000f) Paid miscellaneous expense Rs2600g) Paid creditors Rs11000 Dr. Akansha Jain email: blog – 80