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UnderstandingCorporate FinancialStatements

Ashok Banerjee

Indian Institute of Management Calcutta

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Why Accounting?

Every business entity is exposed to three

types of risks of varying degree: Market Risk

Credit Risk

Operational Risk

Accounting help reduce operational risks.

Accountants ideally should not be toocreative!

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Functions of Accounting

System Internal routine reporting to managers for costplanning and cost control of operations, andperformance evaluation of people andactivities.

Internal routine reporting to managers on theprofitability of products, brand categories,customers etc.

Internal non-routine reporting to managers for

strategic and tactical decisions. External reporting through financial

statements.

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Corporate Reporting SupplyChain Management: responsibility to be honest, direct, and

transparent.

Board: responsibility of oversight.

Auditors: responsibility to investigate and provideassurance.

Analysts: responsibility to be independent.

Media: responsibility to report fairly. Investor: responsibility to do his/her homework. Regulator:responsibility to frame accounting guidelines

and reporting practices.

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Basic Accounting Concepts

An understanding of accounting concepts is

vital to understand the process of accounting.

Accounting concepts underlying the

recording of transactions: Entity Concept

Money Measurement Concept

Accrual Concept Matching Concept

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Accruals

What is an accrual?

It is the recognition of an expense or revenue

that has arisen but has not yet been

recorded.

Expenses or revenues are recorded before

the cash settlement.

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Distinguish accrual-basisaccounting from cash-basis accounting.

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The Two Bases of Accounting:

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Accrual Versus Cash Example

In January 2003, Prism Insurance sells a

three-year health insurance policy to a

business client.

The contract specifies that the client had topay Rs.150,000 in advance.

Yearly expenses amount to Rs. 20,000.

What is the income or loss?

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Accrual Basis of Accounting

(000 omitted) 2003 2004 2005

Income Rs. 50 Rs. 50 Rs. 50

Expenses Rs. 20 Rs. 20 Rs. 20

Net Income (Loss) Rs. 30 Rs. 30 Rs. 30

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Cash Basis of Accounting

(000 omitted) 2003 2004 2005

Income Rs. 150 0 0

Expenses Rs. 20 Rs. 20 Rs. 20

Net Income (Loss) Rs. 130 (Rs. 20) (Rs. 20)

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Cash basis Vs. Accrual basis

XYZ Ltd. sold goods for cash worth Rs. 20 million during theyear and collected cash of Rs. 100 million from its wholesalers(whom XYZ Ltd sells on credit) during the same period. Thewholesalers owed the company Rs. 10 million at the beginning ofthe year and still owes Rs.15 million at the end of the year. How

much is the revenue of XYZ Ltd. during the year? ABC Ltd. invested its surplus fund of Rs. 30 million in a three-

year fixed deposit at an interest rate of 7% p.a. calculated on ahalf yearly basis and paid within next fifteen days. Investmentwas made at the beginning of the year. How much is the interest

income of ABC Ltd. during the year?

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Financial Statements:Objective To provide information about the financial

position, performance and cash flows of an

enterprise that is useful to a wide range of

users in making economic decisions. Financial statements do not necessarily

provide non-financial information.

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Financial Statements:Elements Elements measuring financial position:

Assets

Liabilities

Equity

Elements measuring performance Income (includes gains)

Expenses (includes losses)

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Corporate FinancialStatements What are the corporate financial statements?

Balance Sheet Shows the financial position (position of assets, liabilities

and equity) as on the reporting date. Profit & Loss Account

Shows the financial results (profit or loss) for an

accounting period.

Cash Flow Statement Shows the net increase /decrease in cash and cash

equivalents during the accounting period.

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Balance Sheet Format:

Sources of Funds Shareholders Funds Loan Funds

Application of Funds Net Block (Gross Block Accumulated Depn.) Investments Net Current Assets (Current Assets, Loans and

Advances Current Liabilities & Provisions) Misc. Expenditure (to the extent not yet written off) Profit & Loss Account (losses)

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Balance Sheet as at 31 March 2010(contd.)

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Profit & Loss Account: No specificformat Sample format:

INCOME Operating income Non-operating income

EXPENDITURE Manufacturing expenses Administration expenses Selling & distribution expenses Depreciation Interest expenses

Profit before tax (INCOME- EXPENDITURE) Provision for tax

Profit after tax (Profit before tax Provision for tax)

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P&L (contd.)

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Additional FinancialStatements Segment Reporting.

Earning per share statement.

Consolidated Financial Statements.

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Segment Report

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Operating Segments