Introduction to Financial Accounting

Introduction to
Financial Accounting
ACCOUNTING FOR MANAGERS
SESSION 1-2
1

Objective
At the end of this session you should be able to understand
◦ Distinction among Financial Accounting, Cost Accounting and
Management Accounting
◦ Evolution of Accounting
◦ Basic Concepts of Financial Accounting
◦ Conventions of Accounting
◦ Stages of Preparing Accounting Statements
◦ From Input to Output
◦ Users of Financial Statements
◦ Advantages of Accounting
◦ Generally Accepted Accounting Principles
2

What is Accounting
Accounting is the process of identifying, measuring and
communicating economic information, to permit informed
judgments and decisions by a user of the information.
Accounting information is used both by external users as well
as internal users.
Financial Accounting involves identifying and recording
business transactions and summarizing them in rupee terms.
3

What is Accounting
Cost Accounting may be defined as “Accounting for costs
classification and analysis of expenditure as will enable the
total cost of any particular unit of production to be ascertained
with reasonable degree of accuracy and at the same time to
disclose exactly how such total cost is constituted”.
Management Accounting collects and provides accounting,
cost accounting, economic and statistical information to the
men at various managerial levels to assist them in the
performance of managerial functions and their evaluations.
4

Evolution of Accounting
15th Century - In the 15th century, Italian mathematician Luca
Pacioli first established the “language of business”, now considered
to be the spearhead of modern bookkeeping.
19th Century - The first accounting organization was established in
New York in 1887, which later became the American Institute of
Certified Public Accountants.
20th Century - The evolution of accounting was revolutionized with
computer technology, which meant bookkeeping no longer had to
be done with paper and pencil.
The Future of Accounting - Businesses now have the option of
using cloud-based accounting.
6

Basic Concepts of Financial
Accounting
Separate Entity – The accounts are kept for the business entity
which is distinct from the owner
Q. Ram Manohar & Sons is a proprietorship firm owned by Mr
Ram Manohar. During the year 2010, the firm bought goods
worth Rs.1,000,000 were consumed by Mr Ram Manohar for
personal purposes. The remaining goods were sold for Rs.
9,60,000. What is the profit or loss for the year?
7

Accounting
Accounting Period – is usually a period of 12 months.
Additionally, interim reports are prepared to meet the
requirement of users for more concurrent information.
Q. Hindustan Boiler Limited, an Indian subsidiary of a US
company, prepares its accounts using financial year as the
accounting period. The US parent company prepares its
accounts on calendar year basis. What kind of problem the US
company would face to present consolidated results?
8

Accounting
Money Measurement – makes it possible to aggregate different
types of assets, liabilities, revenues and expenses by
expressing them in a common unit of reporting
Q. After the death of the promoter of E-Sport Limited, there is
fierce battle between his two sons for succession. How will this
be reflected in the books of accounts of the company?
9

Accounting
Going Concern – requires a longer term view to be taken for
recording business transactions as if the business will continue
to operate for an indefinite period of time
Q. Healthcare Pharmaceutical Ltd has three plants located at
Delhi, Mumbai and Pune. The company has decided to shut
down the Pune plant and sell its assets either as a running unit
or in a piecemeal manner. What is the implication of such
decision in the books of accounts of the company?
10

Accounting
Cost Concept – lends objectivity to the financial statements as
a long-term asset will continue to be shown at its historical cost
irrespective of fluctuation in the market price. However a
permanent fall in value is recognized.
Q. Industrial Lab Limited bought a piece of land for Rs. 5
million in the year 1970. The company had used the land to set
up an industrial unit. The current market price of the land is Rs.
20 million. At what value of this asset should be shown in the
financial statements of the company?
11

Accounting
Conservatism – prefers accounting policies that understate
rather than overstate profits; ignore probable gains but account
for probable losses.
Q. Reliable Ltd sells goods on credit basis. On 31st March
2011, it has a total outstanding of Rs. 120 million from its
customers. The past experience shows that about 5% of the
customers invariably default. How do we account for this
anticipated loss?
12

Accounting
Materiality – provides for all information that is relevant to the
users but avoid unnecessary details
Q. In the P&L statement of Tee Ltd. about 60% of the
expenses have been clubbed under the heading
‘miscellaneous expenses’, whereas Cee Ltd has reported all
heads of expenses separately including about 100 different
types of expenses which together constitute only 10% of the
total expenses in rupee terms. What are your views?
13

Accounting
Consistency – facilitates inter-period comparison by requiring
that same accounting policies are followed period after period.
Change in accounting policies, if any, must be adequately
disclosed
Q. Red Swan Auto Ltd. is proposing to change its accounting
policy for the valuation of inventories, as the management feels
that it would lead to better estimation of cost of inventories.
Can they do so?
14

Accounting
Matching – concept for correct ascertainment of profits, expenses
incurred to earn revenue are matched against the revenue earned.
Both revenue and related expenses must be accounted for in the
same accounting period
Q. During the year 2010-11, Smart Trading Ltd bought goods worth
Rs. 1,350,000. It also had goods worth Rs. 200,000 bought during
the year 2009-10. At the end of 2010-11, goods costing Rs. 450,000
are still unsold. Remaining goods have been sold during the year
for Rs.1,400,0000. Ascertain the cost of goods sold during the year
2010-11 and profit or loss for the year.
15

Accounting
Accrual – Revenue are recorded when earned while expense are
recorded when incurred irrespective of when received or paid
Cash – Transactions are recorded on receipt and payment of cash
Q. ABC Diagnostic Ltd. has the practice of paying the monthly
salary on the 7th of next month. Accordingly, salary for the month of
March 2011 was paid on 7th April 2011. If the company follows cash
basis of accounting, when would the expenses be recognized?
What if the company follows accrual basis of accounting?
16

Accounting
Dual – Every transaction affects at least two accounts in such
a way that Assets = Capital + Liabilities
Q. Mr Ramesh Jha started a new business on 1st April 2011
contributing Rs. 1,000,000 in cash as capital. The firm bought
some furniture for Rs. 200,000 in cash and bought machinery
from XYZ Ltd for Rs. 700,000 on credit. How would these
transactions affect the transaction equation?
17

Accounting
Substance over Form – Accountants often face situations
where the real intent of a transaction is totally different from the
form in which the transaction is entered into.
Q. On 1st May 2011, Moneywise Bank sold some securities to
KM Bank for Rs. 100 million with an agreement to buy them
back at Rs. 101 million after a month. The securities were
delivered to KM Bank on 1st May 2011. On 1st June,
Moneywise Bank paid Rs. 101 million and bought back the
securities. How should the transactions be recorded in the
books of Moneywise Bank.
18

Stages of Preparing Accounting
Statements – Accounting Cycle
ANALYSIS
Trend Analysis,
Common Size,
Ratios Analysis
FINANCIAL
STATEMENTS
Profit & Loss
Statement,
Balance Sheet,
Cash Flow
Statement
THROUGHPUT
Recording,
Classification,
Balancing, Trial
Balance
INPUT
Vouchers or
Supporting
Documents
19

From Input to Output - Financial
Statements
The financial statement aim to answer three basic questions
about a business entity:
1. How much profit was earned by the business during a
particular time period? Statement of Profit and Loss
2. What are the assets and liabilities of the business at the end
of the period? Balance Sheet
3. What were the sources and uses of cash during a particular
period? Cash Flow Statement
20

Problem 1: Identify Relevant
Accounting Principle
Curewell Pharmaceutical Ltd is facing a law suit wherein it may
be liable to pay a fine of Rs. 10 million. The lawyer of the
company has advised that there is a high probability of the
company losing the law suit.
How should the company record this transaction in the books
of accounts? What accounting principle is involved?
21

Solution 1:
Curewell Pharmaceutical is advised to make appropriate
provision for the loss as there is a reasonable probability of
company losing the case.
It is based upon the principle of conservatism.
22

Shivam Limited borrowed a sum of Rs. 50 million from the SBI
on 1st August 2010 for a period of one year. The loan matured
on 30th July 2011 and was duly repaid on due date with interest
amounting to Rs. 5 million.
The company maintains its books on financial year basis.
In which accounting year the interest expenses should be
recorded? Why?
23

Solution 2:
The interest of Rs. 5 million is for a period of 12 months from
1st August 2010 to 30th July 2011. Interest accrues on a day-to-
day basis. Interest from 1st August 2010 to 31st March 2011
should be accounted for in the year 2010-11, whereas interest
for the period 1st April 2011 to 30th July will be treated as an
expense for the year 2011-12.
Accordingly, interest of Rs. 5 million will be split two-third: one-
third between the two accounting years.
24

Which of the following transactions are subject matter of accounting:
A. Purchase of 200 kg of goods by the firm on credit for Rs. 1,00,000
B. Resignation of one of the key salesman of the firm
C. A pharmaceutical company has filed application for patent of a new
drug
D. A construction company has won a major contract from the
government
E. A telecom company has paid Rs. 200 million as a security deposit to
the government
25

Solution 3:
A. Yes: Rs. 1,00,000 will be recorded as purchase but not the
quantity
B. No: Cannot be expressed in money terms
C. No: Filing an application cannot be expressed in terms of
money
D. No: Winning a contract cannot be expressed in monetary
terms
E. Yes: Amount of security deposit is an accounting transaction
26

Free Flow Oil Limited, an Indian company, set up an office in
Sri Lanka for executing a specific contract. Due to some
reasons, the Sri Lankan government put a ban on the company
to operate in the country.
How will it impact the valuation of assets of the Sri Lankan
operations of the company?
27

Solution 4:
As there is evidence to believe that the Sri Lankan Operation
of the company are no longer viable, these operations can no
longer be viewed as going concern.
Accordingly, valuation of assets of Sri Lankan operations
should reflect their realizable value.
28

Users of Financial Information
Suppliers of Capital
◦ Shareholders
◦ Leading Banks and Financial Institutions
◦ Bond Holders
◦ Other Lenders
Credit Rating Agencies
Tax Authorities
RBI, IRDA
Employees and Trade Unions
Academicians and Researchers
29

Generally Accepted Accounting
Principles - GAAP
Accounting is a management discipline and not an exact
science
Accounting principles and standards make financial statements
prepared by various entities comparable by reducing
management’s discretion in choice of accounting treatment.
The need for comparability led to the evolution of GAAP
Accounting Standards are mandatory requirements to be
followed while preparing financial statements
30

Conclusion
In this session we learnt about
◦ Distinction among Financial Accounting, Cost Accounting and
Management Accounting
◦ Evolution of Accounting
◦ Basic Concepts of Financial Accounting
◦ Conventions of Accounting
◦ Stages of Preparing Accounting Statements
◦ From Input to Output
◦ Users of Financial Statements
◦ Advantages of Accounting
◦ Generally Accepted Accounting Principles
31

Introduction to Financial Accounting

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