Accounting & Financial Accounting & Financial AnalysisAnalysis

An IntroductionAn Introduction

Mr. AKHILESH SHARMAMr. AKHILESH SHARMA

What is accountingWhat is accounting

Accounting is the art of identifying, Accounting is the art of identifying, recording, classifying and recording, classifying and summarizing in a significant manner summarizing in a significant manner and in terms of money transactions and in terms of money transactions and events which are, in part at least and events which are, in part at least of a financial character and of a financial character and interpreting the result thereof.interpreting the result thereof.

Accounting is a system in which all the Accounting is a system in which all the financial transaction are recorded in a financial transaction are recorded in a proper and system way.proper and system way.

Characteristics of Characteristics of financial accountingfinancial accounting Accounting is an art- Art is that part of knowledge which helps Accounting is an art- Art is that part of knowledge which helps

us in attaining our aim. Accounting helps us in attaining our us in attaining our aim. Accounting helps us in attaining our aim of ascertaining the financial results by showing the best aim of ascertaining the financial results by showing the best way of recording, classifying and summarizing the business way of recording, classifying and summarizing the business transaction.transaction.

Recording, Classifying and summarizing- It provides Recording, Classifying and summarizing- It provides information about all the transactions of financial in nature, information about all the transactions of financial in nature, recorded in journal, classifying in forms of ledgers, recorded in journal, classifying in forms of ledgers, preparation of trial balance for checking the accuracy of preparation of trial balance for checking the accuracy of accounts.accounts.

In terms of money-Only those transaction are recorded which In terms of money-Only those transaction are recorded which are in terms of money.are in terms of money.

Interpreting the results- It provide the tools for their analysis, Interpreting the results- It provide the tools for their analysis, through which various parties of business obtain information through which various parties of business obtain information related to them. related to them.

Objectives or functions Objectives or functions of accountingof accounting

Knowledge of sales and purchaseKnowledge of sales and purchase Providing information of closing stockProviding information of closing stock Knowledge of financial positionKnowledge of financial position Information related for working capitalInformation related for working capital Knowledge of profit & loss of the businessKnowledge of profit & loss of the business Provide information to various partiesProvide information to various parties Provide Information about embezzlement & fraudsProvide Information about embezzlement & frauds Evidence in court.Evidence in court.

Functions of Functions of AccountingAccounting It keeps a complete record of business transactions.It keeps a complete record of business transactions. It provides complete information concerning the It provides complete information concerning the

businessbusiness.. It provides a check on the arithmetical accuracy of It provides a check on the arithmetical accuracy of

books of accounts.books of accounts. It discloses the operating results .It discloses the operating results . It makes possible a meaning full comparison of It makes possible a meaning full comparison of

operating and financial performance over a period of operating and financial performance over a period of time and enable the businessman to evaluate the time and enable the businessman to evaluate the progress of his business.progress of his business.

It also enables a business man to plan and control his It also enables a business man to plan and control his operations.operations.

It reduces the chances of committing fraud.It reduces the chances of committing fraud. Past details with regard to any account are easily and Past details with regard to any account are easily and

accurately obtainable in this system. accurately obtainable in this system.

Accounting Accounting ProcessProcess

TransactionTransaction

IdentifyingIdentifying

Recording of transaction (Journal entry)Recording of transaction (Journal entry)

Classification (Ledger Posting)Classification (Ledger Posting)

Summarizing (Trial balance)Summarizing (Trial balance)

Interpreting (Income &position statement)Interpreting (Income &position statement)

Analysis of transactionsAnalysis of transactions

Branches of Branches of AccountingAccounting Financial Accounting:- It is Financial Accounting:- It is

concerned with recording and concerned with recording and processing the financial processing the financial transactions which affect the transactions which affect the financial position of the business. financial position of the business. It leads to the preparation of It leads to the preparation of income statement & position income statement & position statement of the business.statement of the business.

Cost accountingCost accounting

Cost accounting is the process of Cost accounting is the process of accounting for costs. It is a accounting for costs. It is a systematic procedure for systematic procedure for determining the unit cost of output determining the unit cost of output produced or services rendered. The produced or services rendered. The primary functions of cost accounting primary functions of cost accounting are to ascertain the cost of a product are to ascertain the cost of a product and to help the management in the and to help the management in the control of cost. control of cost.

Management Management accountingaccounting It is concerned with the collecting It is concerned with the collecting

systematically and regularly all systematically and regularly all such information as will help to such information as will help to the management in discharging the management in discharging its functions of planning, control, its functions of planning, control, decision making, etc. this is also decision making, etc. this is also named as accounting for named as accounting for management. management.

Users of accounting Users of accounting informationinformation

Internal sources Internal sources

OwnersOwners

ManagementManagement

EmployeesEmployees

External PersonsExternal Persons

CreditorsCreditors GovernmentGovernment

InvestorsInvestors ResearchesResearches

LendersLenders ConsumerConsumer

Tax DepartmentTax Department

Cont…Cont…

Owner – A person who is interested Owner – A person who is interested in accounting information to know in accounting information to know about the profit or loss of the about the profit or loss of the business, financial position, amount business, financial position, amount of expenses, amount of capital and of expenses, amount of capital and its size, value of obligations, its size, value of obligations, amount to be paid to the suppliers, amount to be paid to the suppliers, details of purchase or sale.details of purchase or sale.

ManagementManagement

The management needs The management needs information from accounting for information from accounting for successful, efficient and smooth successful, efficient and smooth running of business operations. running of business operations. The management can evaluate The management can evaluate the progress and future plans the progress and future plans based on accounting information. based on accounting information. Shot term and long term plans Shot term and long term plans can be prepared on the basis of can be prepared on the basis of financial information.financial information.

EmployeesEmployees

Employees are interested in Employees are interested in accounting information of the accounting information of the business as their welfare scheme business as their welfare scheme like bonus, salaries, fringe like bonus, salaries, fringe benefits, provident funds, benefits, provident funds, Gratuity etc. Gratuity etc.

Creditors / Supplier Creditors / Supplier

Creditors are those parties that Creditors are those parties that provide a firm with raw materials, provide a firm with raw materials, goods and services on credit way. goods and services on credit way. They are interested to know They are interested to know about the credit worthiness about the credit worthiness status, financial positions of the status, financial positions of the current year.current year.

GovernmentGovernment

Government has collected sales Government has collected sales tax, income tax, excise duty and tax, income tax, excise duty and other taxes from the business. other taxes from the business. For this it is necessary that proper For this it is necessary that proper accounts are made available to accounts are made available to the government.the government.

investorsinvestors

Investors provide risk capital to Investors provide risk capital to the business. They are interested the business. They are interested in accounting information to know in accounting information to know about the survival, prosperity, about the survival, prosperity, profitability, and ability to pay profitability, and ability to pay dividend. dividend.

Researchers Researchers

The researchers are interested in The researchers are interested in interpreting the financial interpreting the financial statements of the concern for a statements of the concern for a given objective.given objective.

LendersLenders

Lenders are the persons who Lenders are the persons who provide the loan to the business. provide the loan to the business. They are interested to know They are interested to know about the use of money, interest about the use of money, interest and how safe the funds are?and how safe the funds are?

consumersconsumers

Consumers are interested in Consumers are interested in buying goods at the reasonable buying goods at the reasonable price. price.

Generally Accepted Generally Accepted Accounting principles Accounting principles (GAAP)(GAAP)

Business Entity ConceptBusiness Entity Concept Going Concern conceptGoing Concern concept Dual Aspect ConceptDual Aspect Concept Cost conceptCost concept Money measurement ConceptMoney measurement Concept Accounting period ConceptAccounting period Concept Matching ConceptMatching Concept Accrual conceptAccrual concept

Business entity Business entity conceptconcept Business is treated as a unit or entity Business is treated as a unit or entity

apart from its owner. The owner of apart from its owner. The owner of an organization is always considered an organization is always considered to be separate and distinct from the to be separate and distinct from the business which he controls. that is business which he controls. that is why, the capital of the owner is why, the capital of the owner is always entered in liability side of always entered in liability side of balance sheet. It is considered as the balance sheet. It is considered as the creditor of the business.creditor of the business.

Going concern conceptGoing concern concept

It is assumed that the business will It is assumed that the business will exist for the foreseeable future and exist for the foreseeable future and transactions are recorded from this transactions are recorded from this point of view. It should continue to point of view. It should continue to operate at its present scale in the operate at its present scale in the foreseeable future. foreseeable future.

Dual Aspect Concept Dual Aspect Concept

Financial accounting has dual Financial accounting has dual aspect of recording. Every debit aspect of recording. Every debit has its corresponding credit & has its corresponding credit & every credit has its corresponding every credit has its corresponding debit. The modern accounting debit. The modern accounting system basically based on dual system basically based on dual aspect of accounting. aspect of accounting.

Cost concept Cost concept

The underlying idea of cost concept is The underlying idea of cost concept is that-that-

Assets is recorded at the price paid to Assets is recorded at the price paid to acquire it, that is, at cost, and..acquire it, that is, at cost, and..

This cost is the basis for all subsequent This cost is the basis for all subsequent accounting for the asset. accounting for the asset.

The change in the real worth of an asset The change in the real worth of an asset with the passage of time is not ordinarily with the passage of time is not ordinarily recorded in the account books.recorded in the account books.

Money measurement Money measurement conceptconcept The money concept underlines the The money concept underlines the

fact that in accounting every worth fact that in accounting every worth recording event, happening or recording event, happening or transaction is recorded in terms of transaction is recorded in terms of money. In other words, a fact or a money. In other words, a fact or a happening which cannot be happening which cannot be expressed in terms of money is not expressed in terms of money is not recorded in the accounting books.recorded in the accounting books.

Accounting period Accounting period conceptconcept

Accounts choose some shorter Accounts choose some shorter and convenient time for the and convenient time for the measurement of income. Twelve-measurement of income. Twelve-month period is normally adopted month period is normally adopted for this purpose. this time interval for this purpose. this time interval is called accounting period.is called accounting period.

Matching conceptMatching concept

It is based on the determination of the It is based on the determination of the profit & loss of a particular accounting profit & loss of a particular accounting period is the process of matching the period is the process of matching the revenue earned during the period and revenue earned during the period and the expenses incurred during the the expenses incurred during the period to obtain such revenue.period to obtain such revenue.

Accrual concept Accrual concept

Under this method revenue Under this method revenue recognition depends on its realization recognition depends on its realization and not actual receipt. Likewise costs and not actual receipt. Likewise costs are recognized when they are are recognized when they are incurred and not when paid. incurred and not when paid.

Accounting conventionsAccounting conventions

ConsistencyConsistency Full disclosureFull disclosure ConservatismConservatism

ConsistencyConsistency

The convention of consistency aims The convention of consistency aims at making the financial statements at making the financial statements more comparable and useful. The more comparable and useful. The convention holds that in accounting convention holds that in accounting processes, all concepts, principles processes, all concepts, principles and measurement approaches and measurement approaches should be applied in a similar or should be applied in a similar or consistent way from one period to consistent way from one period to another period.another period.

Full disclosureFull disclosure

This convention specifies that there This convention specifies that there should be complete and understandable should be complete and understandable reporting in the financial statements of reporting in the financial statements of all significant information relating to the all significant information relating to the economic affairs of the entity. All economic affairs of the entity. All information which is of material interest information which is of material interest to the users of the accounting to the users of the accounting information should be disclosed in information should be disclosed in accounting statements. accounting statements.

ConservatismConservatism

This is the policy of playing safe. This is the policy of playing safe. Accounting permits for making Accounting permits for making reserves to face the uncertainty reserves to face the uncertainty situations of the business.situations of the business.

Double entry systemDouble entry system

It is a common system of book-keeping It is a common system of book-keeping whereby the two aspects of every transaction whereby the two aspects of every transaction i.e., It is based on the dual aspect concepti.e., It is based on the dual aspect concept. . This method of writing every transaction in This method of writing every transaction in two different accounts on opposite sides for two different accounts on opposite sides for equal value is known as the double entry equal value is known as the double entry system of book keeping. This is the most system of book keeping. This is the most accurate, complete and scientific system of accurate, complete and scientific system of accounting.accounting.

Advantages of double entry Advantages of double entry systemsystem

It keeps a complete record of business transactions.It keeps a complete record of business transactions. It provides complete information concerning the businessIt provides complete information concerning the business.. It provides a check on the arithmetical accuracy of books It provides a check on the arithmetical accuracy of books

of accounts.of accounts. It discloses the operating results .It discloses the operating results . It makes possible a meaning full comparison of operating It makes possible a meaning full comparison of operating

and financial performance over a period of time and enable and financial performance over a period of time and enable the businessman to evaluate the progress of his business.the businessman to evaluate the progress of his business.

It also enables a business man to plan and control his It also enables a business man to plan and control his operations.operations.

It reduces the chances of committing fraud.It reduces the chances of committing fraud. Past details with regard to any account are easily and Past details with regard to any account are easily and

accurately obtainable in this system. accurately obtainable in this system.

Some common terms Some common terms in accountancyin accountancy

Book-Keeping:-It means recording of business Book-Keeping:-It means recording of business transactions in the books of accounts in transactions in the books of accounts in accordance with the principles of accounting.accordance with the principles of accounting.

Account:- It is a statement of various dealings Account:- It is a statement of various dealings

that occur between a customer and the firm.that occur between a customer and the firm.

Classification of Classification of accountsaccounts In order to understand the rules of double In order to understand the rules of double

entry system, it is essential to know which entry system, it is essential to know which classes of accounts are affected by a classes of accounts are affected by a particular transaction. For this purpose, all particular transaction. For this purpose, all accounts are classified into two classes: accounts are classified into two classes:

1) personal accounts1) personal accounts 2) Impersonal accounts2) Impersonal accounts A) real accountA) real account B) nominal account B) nominal account

JournalJournal

The journal records all daily transactions of a business in the The journal records all daily transactions of a business in the order in which they occur. It is the book in which the transactions order in which they occur. It is the book in which the transactions are recorded first of all under the double entry system. Thus, are recorded first of all under the double entry system. Thus, Journal is a book of original record. A journal does not replace but Journal is a book of original record. A journal does not replace but precedes the Ledger.precedes the Ledger.

The process of recording transactions in a journal is termed as The process of recording transactions in a journal is termed as journalizing Performa of journal is given below.journalizing Performa of journal is given below.

DATDATEE

PARTICULARSPARTICULARS L.FL.F AMOUNAMOUNTT

AMOUNAMOUNTT

ExplanationExplanation

1. Date: The date on which the transaction was 1. Date: The date on which the transaction was entered is recorded here.entered is recorded here.

2. Particulars: The two aspect of transaction are 2. Particulars: The two aspect of transaction are recorded in this column,i.e, the details regarding recorded in this column,i.e, the details regarding accounts which have to be debited and credited.accounts which have to be debited and credited.

L.F: It means ledger folio. The transactions entered in L.F: It means ledger folio. The transactions entered in the journal are later on posted to the ledger. the journal are later on posted to the ledger. Procedure regarding posting the transactions in the Procedure regarding posting the transactions in the ledger has been explained in the succeeding chapter.ledger has been explained in the succeeding chapter.

Debit. In this column, the amount to be debited is Debit. In this column, the amount to be debited is enteredentered

Credit. In this column, The amount to be credited is Credit. In this column, The amount to be credited is shownshown

Golden rules of Golden rules of accountingaccounting

Real account- Debit what comes Real account- Debit what comes in, Credit what goes out.in, Credit what goes out.

Personal account- Debit the Personal account- Debit the receivers, Credit the givers.receivers, Credit the givers.

Nominal account- Debit the Nominal account- Debit the expenses & losses, Credit the expenses & losses, Credit the incomes & gains.incomes & gains.

Trial balanceTrial balance

A trial balance is a statement of A trial balance is a statement of debit and credit balances debit and credit balances extracted from all ledgers with a extracted from all ledgers with a view to ascertain arithmetic view to ascertain arithmetic accuracy of the posting of all accuracy of the posting of all transactions into the respective transactions into the respective ledgers. ledgers.

DefinitionDefinition

The first list of balances, which is added The first list of balances, which is added and totaled, called a trial balance.and totaled, called a trial balance.

A trial balance is a list of all the balances A trial balance is a list of all the balances standing on the ledger accounts of the standing on the ledger accounts of the concern at any given date.concern at any given date.

Objectives of trial Objectives of trial balancebalance Test of arithmetical accuracy of ledger Test of arithmetical accuracy of ledger

accountsaccounts To observe the application of the rules To observe the application of the rules

of double entry systemof double entry system Summary of ledger accountSummary of ledger account Basis for preparing final accountsBasis for preparing final accounts Useful for making adjustmentsUseful for making adjustments

Errors disclosed by Errors disclosed by trial balancetrial balance If books of accounts are properly If books of accounts are properly

maintained according to the principles maintained according to the principles of double entry system both the debit of double entry system both the debit and credit side of the trial balance must and credit side of the trial balance must equal to each other. In case both sides equal to each other. In case both sides are not equal, there is bound to be are not equal, there is bound to be certain error in accounting. The trial certain error in accounting. The trial balance in case of disagreement is said balance in case of disagreement is said to be out of balance. Following errors to be out of balance. Following errors are responsible for disagreement of are responsible for disagreement of trial balance.trial balance.

Cont..Cont..

Errors of additions and subtractions- these Errors of additions and subtractions- these errors make trial balance ‘out of balance’. errors make trial balance ‘out of balance’. Errors of additions and subtractions may Errors of additions and subtractions may occur in the subsidiary books or in the ledger occur in the subsidiary books or in the ledger account or even in the trial balance itself. account or even in the trial balance itself. The trial balance will disclose the errors. The trial balance will disclose the errors. These errors may be enumerated as under-These errors may be enumerated as under-

Errors in the amount column of cash book.Errors in the amount column of cash book. Errors in the balancing of cash bookErrors in the balancing of cash book Errors in the subsidiary booksErrors in the subsidiary books Wrong totaling and balancing of ledger Wrong totaling and balancing of ledger

accounts accounts Wrong totaling in trial balance. Wrong totaling in trial balance.

Cont….Cont….

Posting at the wrong side of an account-Posting at the wrong side of an account- In case the posting is made at the wrong side In case the posting is made at the wrong side of any specific account, the trial balance will of any specific account, the trial balance will not tally.not tally.

Entering incorrect amount-Entering incorrect amount- This error may This error may occur, when we copy wrong figures, in any occur, when we copy wrong figures, in any type of book of account. Ex. Writing 59 in type of book of account. Ex. Writing 59 in place of 95 or 123 in place of 321.place of 95 or 123 in place of 321.

Cont..Cont..

Errors of omission-Errors of omission- All the omissions taking All the omissions taking place in posting or in the trial balance will place in posting or in the trial balance will throw out the trial balance. Following are the throw out the trial balance. Following are the examples of such errors: examples of such errors:

1. If an item has not been posted at all from 1. If an item has not been posted at all from subsidiary books to ledger.subsidiary books to ledger.

2. If the balance of any ledger account has 2. If the balance of any ledger account has not been posted to trial balance.not been posted to trial balance.

Wrong posting in the trial balance- Wrong posting in the trial balance- IfIf the the debit balance of an account has been posted debit balance of an account has been posted at the credit side of trial balance or the credit at the credit side of trial balance or the credit balance has been posted at the debit side of balance has been posted at the debit side of the trial balance.the trial balance.

Limitations of trial balanceLimitations of trial balanceErrors not disclosed by trial Errors not disclosed by trial balancebalance Trial balance is taken as test of arithmetical Trial balance is taken as test of arithmetical

accuracy. If both the side of trial balance are accuracy. If both the side of trial balance are equal to each other, we assume that there is equal to each other, we assume that there is no mistake in the posting of journal and no mistake in the posting of journal and subsidiary books to ledger accounts, in subsidiary books to ledger accounts, in carrying forward balances of ledger accounts carrying forward balances of ledger accounts to trial balance and even in the balancing of to trial balance and even in the balancing of ledger accounts. This assumption is correct but ledger accounts. This assumption is correct but should never be taken as conclusive proof of should never be taken as conclusive proof of accuracy. It means that there are certain errors accuracy. It means that there are certain errors which remain undetected by trial balance. Both which remain undetected by trial balance. Both the debit and credit side of trial balance may the debit and credit side of trial balance may be equal in spite of certain mistakes of be equal in spite of certain mistakes of omissions and principles. There are as….omissions and principles. There are as….

Cont..Cont..

Errors of omission in the original record-TheErrors of omission in the original record-The entire transaction is not recorded in the books of entire transaction is not recorded in the books of accounts, we omit to the transaction. Ex – goods accounts, we omit to the transaction. Ex – goods returned by Mohan were taken into the stock but the returned by Mohan were taken into the stock but the return was not entered in the books. return was not entered in the books.

Errors of principle- Errors of principle- Errors of principles may be Errors of principles may be committed, if we debit or credit a wrong account due committed, if we debit or credit a wrong account due to our ignorance. The accountant does not have the to our ignorance. The accountant does not have the understanding of the accounting concepts and understanding of the accounting concepts and commits errors. Ex- purchase of building is capital commits errors. Ex- purchase of building is capital expenditure and building account should be debited expenditure and building account should be debited but if the accountant debits purchases account but if the accountant debits purchases account instead of building account, errors of principles will be instead of building account, errors of principles will be there in account.there in account.

Cont..Cont..

Compensating errors- Compensating errors- It is justIt is just possible that the effect possible that the effect of certain error is neutralized by the effect of another of certain error is neutralized by the effect of another error. the combined effect of the two errors will equalize error. the combined effect of the two errors will equalize the debit and credit side of trial balance in spite of errors. the debit and credit side of trial balance in spite of errors. Ex-sale of goods to Mohan for Rs. 100 was debited to Ex-sale of goods to Mohan for Rs. 100 was debited to Mohan‘s account with Rs. 10 only. Rs. 100. received from Mohan‘s account with Rs. 10 only. Rs. 100. received from Sohan was credited to Sohan’s account with Rs. 10 only. Sohan was credited to Sohan’s account with Rs. 10 only. In the first error, Mohan’s account was debited with Rs. In the first error, Mohan’s account was debited with Rs. 10 only, whereas it should have been debited with Rs. 10 only, whereas it should have been debited with Rs. 100. it means that Rs. 90 was debited short. The effect of 100. it means that Rs. 90 was debited short. The effect of the error in the trial balance will be that the total of the the error in the trial balance will be that the total of the debit side will be Rs.90 lesser. The second error Sohan’s debit side will be Rs.90 lesser. The second error Sohan’s account has been credited with Rs. 10. whereas it should account has been credited with Rs. 10. whereas it should have been credited with Rs. 100. it shows that Rs. 90 have been credited with Rs. 100. it shows that Rs. 90 have been written lesser at the credit side of Sohan’s have been written lesser at the credit side of Sohan’s account. As per the effect of this error, the total of the account. As per the effect of this error, the total of the credit column of trial balance will becredit column of trial balance will be lesser by Rs. 90.. lesser by Rs. 90..

Cont…Cont…

In correct account in the original book-In correct account in the original book- If If the name of wrong account are used in the journal or the name of wrong account are used in the journal or subsidiary books, trial balance will not be able to subsidiary books, trial balance will not be able to direct it . Ex- sale of goods to Amit Rs. 100. was direct it . Ex- sale of goods to Amit Rs. 100. was debited in the books of amitabh.debited in the books of amitabh.

Posting to wrong account- Posting to wrong account- If the posting If the posting from the debit side or credit side of cash book or from from the debit side or credit side of cash book or from purchases book or sales book or returns book is made purchases book or sales book or returns book is made to wrong account but at the correct amount, both the to wrong account but at the correct amount, both the debit and credit side of trial balance will equal in spite debit and credit side of trial balance will equal in spite of these errorsof these errors..

Depreciation Depreciation

Loss in the value and utility of assets due Loss in the value and utility of assets due to their constant use of and expiry of time to their constant use of and expiry of time is termed as depreciation.is termed as depreciation.

Depreciation is gradual and permanent Depreciation is gradual and permanent decrease in the value of assets from any decrease in the value of assets from any cause.cause.

Depreciation may be defined as Depreciation may be defined as permanent and continuing diminution in permanent and continuing diminution in the quality, quantity or the value of an the quality, quantity or the value of an asset. asset.

Special features of Special features of depreciationdepreciation

Depreciation is loss in the value of assets.Depreciation is loss in the value of assets. Loss should be gradual and constant.Loss should be gradual and constant. Depreciation is the exhaution of the Depreciation is the exhaution of the

effective life of business.effective life of business. Depreciation is the normal feature.Depreciation is the normal feature. Maintenance of assets is not depreciation.Maintenance of assets is not depreciation. It is continuing decrease in the value of It is continuing decrease in the value of

assets..assets..

Word related with Word related with depreciationdepreciation Obsolescence – Sometimes new inventions throw Obsolescence – Sometimes new inventions throw

away the existing machine and equipments as away the existing machine and equipments as obsolete (useless) although the old machines and obsolete (useless) although the old machines and equipments are not completely useless. Loss due to equipments are not completely useless. Loss due to the useless of old machine and equipment is known as the useless of old machine and equipment is known as obsolescence.obsolescence.

Depletion – the firm may possess certain minerals Depletion – the firm may possess certain minerals wealth such as coal, oil, ore etc. The more we extract wealth such as coal, oil, ore etc. The more we extract mineral wealth from these mines the more mines are mineral wealth from these mines the more mines are depleted. Decrease in mineral wealth of the mines is depleted. Decrease in mineral wealth of the mines is termed as depletion.termed as depletion.

Amortization – the word amortization is used to show Amortization – the word amortization is used to show loss in the value of intangible assets. These assets are loss in the value of intangible assets. These assets are goodwill , patents and preliminary expenses etc. these goodwill , patents and preliminary expenses etc. these assets are written off over certain period. assets are written off over certain period.

Fluctuation Fluctuation

Increase and decrease in the Increase and decrease in the market value of assets is known market value of assets is known as fluctuation. as fluctuation.

Causes of depreciationCauses of depreciation

By constant useBy constant use By expiry of timeBy expiry of time By obsolescenceBy obsolescence By depletionBy depletion Permanent fall in price Permanent fall in price By accidentsBy accidents

Need for charging Need for charging depreciationdepreciation

For determining of net profit or net lossFor determining of net profit or net loss For showing assets at fair and true For showing assets at fair and true

value in the balance sheet value in the balance sheet Provisions of funds for replacement of Provisions of funds for replacement of

assetsassets Ascertaining accurate cost of productionAscertaining accurate cost of production Distribution of dividend out of profit onlyDistribution of dividend out of profit only Avoiding over payment of income taxAvoiding over payment of income tax

Methods of Methods of depreciationdepreciation Fixed installment / straight line / original Fixed installment / straight line / original

cost methodcost method – – it is a very simplest method it is a very simplest method of charging depreciation. The depreciation is of charging depreciation. The depreciation is calculated of on the original cost of the calculated of on the original cost of the machine at the specified rate, so the value of machine at the specified rate, so the value of asset is fully split over the useful life of asset.asset is fully split over the useful life of asset.

Diminishing or reducing or written down Diminishing or reducing or written down value method- value method- under this method, the value under this method, the value of asset upon which depreciation is to be of asset upon which depreciation is to be calculated goes on diminishing, so the amount calculated goes on diminishing, so the amount of depreciation to be charged every year also of depreciation to be charged every year also goes on declining. goes on declining.

Difference between fixed Difference between fixed installment and diminishing installment and diminishing methodmethod

Equal amount of depreciation is Equal amount of depreciation is charged.charged.

Depreciation is charged on the Depreciation is charged on the original cost of assets.original cost of assets.

The value of assets can be The value of assets can be written down to zero.written down to zero.

The initial year of the life of the The initial year of the life of the asset bear lesser amount as asset bear lesser amount as depreciation and repairs but depreciation and repairs but final years bear the same final years bear the same amount of depreciation but amount of depreciation but more repairs and maintenance more repairs and maintenance charges.charges.

This method is useful for assets This method is useful for assets of lesser value such as patents, of lesser value such as patents, furniture and fixture. furniture and fixture.

..

The amount of depreciation The amount of depreciation goes on reducing year after goes on reducing year after year.year.

Depreciation is calculated Depreciation is calculated on the reducing balance of on the reducing balance of assets.assets.

The value of assets can not The value of assets can not be written down to zerobe written down to zero

Every year bears almost the Every year bears almost the same charges. Depreciation same charges. Depreciation goes on declining, whereas goes on declining, whereas repairs and maintenance repairs and maintenance charges go on increasing.charges go on increasing.

The method is suitable for The method is suitable for assets having longer life assets having longer life and more value such as and more value such as land and building, plant and land and building, plant and machinery.machinery.

ACCOUNTING ACCOUNTING STANDARDSSTANDARDS

Accounting bodies all over the world Accounting bodies all over the world have tried to achieve some uniformity have tried to achieve some uniformity in the accounting policies by in the accounting policies by prescribing certain accounting prescribing certain accounting standards in order to narrow the standards in order to narrow the range of alternatives available to an range of alternatives available to an organization in respect of collection organization in respect of collection and presentation of accounting and presentation of accounting information.information.

International International accounting standardaccounting standard Accounting bodies throughout the world are Accounting bodies throughout the world are

striving to achieve a reasonable degree of striving to achieve a reasonable degree of uniformity in the accounting policies by uniformity in the accounting policies by prescribing certain accounting standards with prescribing certain accounting standards with respect to the collection and presentation of respect to the collection and presentation of accounting information. To formulate the accounting information. To formulate the accounting standards, they have established a accounting standards, they have established a committee called the International Accounting committee called the International Accounting standards committee (IASC) in standards committee (IASC) in 1973.Accounting bodies of most of the 1973.Accounting bodies of most of the countries, including the institute of chartered countries, including the institute of chartered accountants of India, are the members of this accountants of India, are the members of this bodies. bodies.

Objectives of Objectives of committeecommittee

i) formulating, publishing and i) formulating, publishing and promoting the use of the accounting promoting the use of the accounting standards worldwide,standards worldwide,

ii) To work for improvement.ii) To work for improvement.

The IASC has so far issued forty one The IASC has so far issued forty one accounting standardaccounting standard

Indian accounting Indian accounting standardsstandards

Recognizing the need to harmonized the Recognizing the need to harmonized the diverse accounting policies and practices diverse accounting policies and practices prevalent in India. The institute of chartered prevalent in India. The institute of chartered accountants of India constituted an accounting accountants of India constituted an accounting standard board (ASB) on 21standard board (ASB) on 21stst april,1977.The april,1977.The main function of ASB is to frame accounting main function of ASB is to frame accounting standards which would be formally issued standards which would be formally issued under the authority of the council of the under the authority of the council of the institute of chartered accountants.institute of chartered accountants.

Importance of accounting Importance of accounting

standardsstandards

The role of mandatory accounting The role of mandatory accounting standards in presenting clear-cut account standards in presenting clear-cut account on a uniform basis can not on a uniform basis can not overemphasized. The standards overemphasized. The standards represent the ideal practice of accounting represent the ideal practice of accounting and ensure comparability of accounts and ensure comparability of accounts because of uniformity in the presentation. because of uniformity in the presentation. Hence, such accounts are bound to show Hence, such accounts are bound to show the clear position of the state of affairs.the clear position of the state of affairs.

Accounting standards Accounting standards issued by ASB of ICAIissued by ASB of ICAI

The ASB of the institute of The ASB of the institute of chartered accountants of India, chartered accountants of India, has in line with the international has in line with the international standards, issued twenty nine standards, issued twenty nine standards to be followed by its standards to be followed by its members while auditing the members while auditing the accounts of companies. These accounts of companies. These are – are –

IASIAS (AS 1) Disclosure of accounting policies(AS 1) Disclosure of accounting policies (AS 2) Valuation of Inventories(AS 2) Valuation of Inventories (AS 3) Cash flow statements(AS 3) Cash flow statements (AS 4) Contingencies and events occurring after the (AS 4) Contingencies and events occurring after the

balance sheet datebalance sheet date (AS 5) Net profit or loss for the period, prior period and (AS 5) Net profit or loss for the period, prior period and

extraordinary items and changes in accounting policiesextraordinary items and changes in accounting policies (AS 6) Depreciation accounting (AS 6) Depreciation accounting (AS 7) Construction contract(AS 7) Construction contract (AS 8) Accounting for research and development(AS 8) Accounting for research and development (AS 9) Revenue recognition(AS 9) Revenue recognition (AS 10) Accounting for fixed assets(AS 10) Accounting for fixed assets (AS 11) (Revised 2003) The effects of changes in foreign (AS 11) (Revised 2003) The effects of changes in foreign

exchange rateexchange rate (AS 12) Accounting for government grants(AS 12) Accounting for government grants

Cont…Cont…

(AS13) Accounting for Investments.(AS13) Accounting for Investments. (AS14) Accounting for Amalgamations.(AS14) Accounting for Amalgamations. (AS15) Accounting for retirements benefits in the (AS15) Accounting for retirements benefits in the

financial statement of employers.financial statement of employers. (AS16) on borrowing costs(AS16) on borrowing costs (AS17) Segment Reporting(AS17) Segment Reporting (AS18) Related party Disclosures(AS18) Related party Disclosures (AS19) Leases(AS19) Leases (AS20) Earning per share(AS20) Earning per share (AS21) Consolidated financial Statements(AS21) Consolidated financial Statements (AS22) Accounting for taxes on Income(AS22) Accounting for taxes on Income (AS23) Accounting for investments in associates in (AS23) Accounting for investments in associates in

consolidated financial Statements.consolidated financial Statements.

Cont…Cont…

((AS24) Discontinuing OperationsAS24) Discontinuing Operations (AS25) Interim financial Reporting(AS25) Interim financial Reporting (AS26) Intangible Assets(AS26) Intangible Assets (AS27) Financial Reporting of Interests (AS27) Financial Reporting of Interests

in joint venturesin joint ventures (AS28) Impairment of assets(AS28) Impairment of assets (AS29) Provisions, Contingent (AS29) Provisions, Contingent

Liabilities and contingent AssetsLiabilities and contingent Assets

Final AccountsFinal Accounts Final accounts refers to the final Final accounts refers to the final

statements of accounts prepared in statements of accounts prepared in order to ascertain and report the results order to ascertain and report the results of the financial activities of a business. of the financial activities of a business. Having prepared the trial balance, which Having prepared the trial balance, which establishes the accuracy of books of establishes the accuracy of books of accounts, the next step is to ascertain accounts, the next step is to ascertain the operating result and financial the operating result and financial position of the business. For this position of the business. For this purpose, the final accounts are purpose, the final accounts are prepared, which include mainly the prepared, which include mainly the trading and profit and loss account, also trading and profit and loss account, also called as income statement and balance called as income statement and balance sheetsheet

Objectives of preparing final Objectives of preparing final accountsaccounts

To calculate profit or loss at the end of To calculate profit or loss at the end of accounting year.accounting year.

To ascertain financial position of the To ascertain financial position of the business at the end of the year.business at the end of the year.

To make a comparative study of changes To make a comparative study of changes taken place in assets and liabilities.taken place in assets and liabilities.

To calculate or decide capital employed .To calculate or decide capital employed . Legal compulsion of preparing final Legal compulsion of preparing final

accounts.accounts.

Trading accountTrading account

Trading account is an account Trading account is an account through which it is ascertained as through which it is ascertained as to how much profit has been to how much profit has been earned or losses have been earned or losses have been sustained through purchase and sustained through purchase and sale of goods within specified sale of goods within specified period. The result of trading period. The result of trading account is named as gross profit or account is named as gross profit or gross loss. gross loss.

Profit and loss accountProfit and loss account

Profit and loss account is an account, which Profit and loss account is an account, which is prepared to calculate the final profit and is prepared to calculate the final profit and loss of the business. All operating expenses loss of the business. All operating expenses and other non operating income and and other non operating income and expenditure and losses are charged to P&L expenditure and losses are charged to P&L account to find out the net profit. Operating account to find out the net profit. Operating expenses such as office and administration expenses such as office and administration expenses, selling and distribution expenses expenses, selling and distribution expenses and financial charges are in direct in nature and financial charges are in direct in nature and incurred to carry on business profitably. and incurred to carry on business profitably. Non operating income such as a dividends Non operating income such as a dividends received and interest received etc. and non received and interest received etc. and non operating expenses such as donation paid operating expenses such as donation paid are also charged to P/L accountare also charged to P/L account

Balance sheetBalance sheet

A balance sheet may be defined as ‘a A balance sheet may be defined as ‘a statement drawn upon a given date, statement drawn upon a given date, generally at the end of each generally at the end of each accounting year, to measure the exact accounting year, to measure the exact financial position of the business, financial position of the business, setting forth the various assets and setting forth the various assets and liabilities of the concern at this date’. liabilities of the concern at this date’. On the other hand “The balance sheet On the other hand “The balance sheet is a statement at a particular date is a statement at a particular date showing on one side the trader’s showing on one side the trader’s property and possessions and on the property and possessions and on the other hand liabilities” other hand liabilities”

Difference b/w Difference b/w balance sheet and balance sheet and

trial balancetrial balance Trial balancesTrial balances It is a list of It is a list of

balances of all balances of all ledgerledger

Its object is to Its object is to check the check the arithmetical arithmetical accuracy of the accuracy of the ledger.ledger.

Balance sheetBalance sheet It is a statement It is a statement

of assets and of assets and liabilities.liabilities.

Its object is to Its object is to reveal at a reveal at a glance the glance the financial position financial position of the business of the business concerns.concerns.

Cont…Cont…

It includes the opening It includes the opening stockstock

It is prepared whenever It is prepared whenever desireddesired

It does not give It does not give information about the information about the net profit or net loss.net profit or net loss.

It is not necessary to It is not necessary to prepare the trial prepare the trial balance. balance.

It includes the closing It includes the closing stock stock

It is usually prepared at It is usually prepared at the end of a trading the end of a trading period or accounting period or accounting year.year.

It gives information It gives information about the profits and about the profits and the capital balance the capital balance includes the profit.includes the profit.

Preparation of balance Preparation of balance sheet is necessary to sheet is necessary to complete the complete the accounting process.accounting process.

Cont..Cont..

It is generally It is generally prepared without prepared without giving effect to giving effect to any adjustment.any adjustment.

It contains the It contains the heading debit heading debit and credit.and credit.

It can not be It can not be prepared without prepared without making making adjustmentsadjustments

It contains the It contains the headings headings liabilities and liabilities and assets. assets.

AdjustmentsAdjustments Closing stock – As the value of closing Closing stock – As the value of closing

inventories is ascertained at the inventories is ascertained at the accounting year, it appears as an accounting year, it appears as an adjustment. It should be credited to adjustment. It should be credited to trading a/c and shown in the assets side trading a/c and shown in the assets side of the B/S. of the B/S.

Outstanding – these are the expenses Outstanding – these are the expenses incurred within the accounting year but incurred within the accounting year but the payment has not been made or the payment has not been made or expenses just payable but not paid. expenses just payable but not paid. Outstanding or unpaid expenses should Outstanding or unpaid expenses should be added to the concerned item in be added to the concerned item in trading and profit and loss a/c and will be trading and profit and loss a/c and will be shown in liability side of balance sheet.shown in liability side of balance sheet.

Prepaid expensesPrepaid expenses These are the expenses, which These are the expenses, which

have been paid in advance have been paid in advance extends to the next year. It is also extends to the next year. It is also called as Un expired expenses. called as Un expired expenses. Advanced amount paid should be Advanced amount paid should be deducted from the concerned deducted from the concerned expenses and be shown as a expenses and be shown as a current assets in the Assets side current assets in the Assets side of B/S. of B/S.

Accrued Income Accrued Income It is the income that has already It is the income that has already

been earned (the service has been earned (the service has already been rendered) but the already been rendered) but the money has not received. This money has not received. This type of income should be added type of income should be added in the concerned item in the in the concerned item in the credit side of P/L a/c and also will credit side of P/L a/c and also will shown in the assets side of shown in the assets side of balance sheet. balance sheet.

Unaccrued Unaccrued income income The income which are received in The income which are received in

advance relates to the next year advance relates to the next year is named as un accrued or un is named as un accrued or un earned income. Such amount earned income. Such amount must be deducted from the must be deducted from the concerned item in the credit side concerned item in the credit side of P/L a/c and also will show in the of P/L a/c and also will show in the liability side of balance sheet.liability side of balance sheet.

Depreciation on AssetsDepreciation on Assets

Depreciation means diminution or fall in Depreciation means diminution or fall in value of an asset due to its constant value of an asset due to its constant use. It may also arise on account of use. It may also arise on account of wear and tear, lapse of time, and wear and tear, lapse of time, and obsolescence. It is a loss of business. It obsolescence. It is a loss of business. It is usually calculated at a certain % on is usually calculated at a certain % on the value of asset and the amount so the value of asset and the amount so obtained is first shown on the debit side obtained is first shown on the debit side of the P/L a/c and then deducted from of the P/L a/c and then deducted from the original value of asset in the asset the original value of asset in the asset side of balance sheet. side of balance sheet.

Bad debts.Bad debts.

Bed debts represent money due Bed debts represent money due from debtors ( i.e., uncollected from debtors ( i.e., uncollected portion of the credit sales ) when portion of the credit sales ) when debts become irrecoverable, it debts become irrecoverable, it becomes bad debts and treated becomes bad debts and treated as a loss. The amount of bad as a loss. The amount of bad debts is debited to P/L a/c and is debts is debited to P/L a/c and is deducted from sundry debtors in deducted from sundry debtors in the B/S. the B/S.

Provisions for bad Provisions for bad debts doubtful debtsdebts doubtful debts

Every business has a lot of dealings by Every business has a lot of dealings by way of credit transactions. This gives way of credit transactions. This gives rise to a sizable amount of book debts rise to a sizable amount of book debts or debtors. But it is seldom that 100% of or debtors. But it is seldom that 100% of these debts will be recovered. The these debts will be recovered. The object of making bad debts provisions is object of making bad debts provisions is to bring down the balance of debtors to to bring down the balance of debtors to its true position, the usual practice is to its true position, the usual practice is to calculate as provision or reserve for calculate as provision or reserve for doubtful debts. doubtful debts.

Provision for discount on Provision for discount on debtors debtors

Cash discounts are allowed to Cash discounts are allowed to debtors in order to encourage them debtors in order to encourage them to make prompt payments. After to make prompt payments. After providing for bad and doubtful providing for bad and doubtful debts, the balance of debtors debts, the balance of debtors represents debts due from sound represents debts due from sound parties. They may try to pay their parties. They may try to pay their dues on time and avail themselves dues on time and avail themselves of the cash discounts permissible. of the cash discounts permissible.

Provision for discount on Provision for discount on creditorscreditors Creditors represents the amount owed by the Creditors represents the amount owed by the

business to suppliers for goods on credit. business to suppliers for goods on credit. Sound business concerns make it a practice Sound business concerns make it a practice to settle accounts with creditors in time to to settle accounts with creditors in time to earn goodwill of the creditors and also the earn goodwill of the creditors and also the discount allowed by them. In that case the discount allowed by them. In that case the liability in respect of sundry creditors can be liability in respect of sundry creditors can be reduced to the extent of discounts reduced to the extent of discounts anticipated. A certain % on creditors is anticipated. A certain % on creditors is calculated and should be entered in the calculated and should be entered in the credit side of P/L a/c and then after reduced credit side of P/L a/c and then after reduced from the creditors in liability side of balance from the creditors in liability side of balance sheet sheet

Interest on capital Interest on capital

Interest on a normal rate is Interest on a normal rate is allowed on the capital of the allowed on the capital of the proprietor employed in the proprietor employed in the business. It is treated as business business. It is treated as business expenditure. Such expense is expenditure. Such expense is debited in P/L a/c and also added debited in P/L a/c and also added to the capital in the balance to the capital in the balance sheet. sheet.

Interest on Drawing Interest on Drawing

Drawing are money withdrawn by Drawing are money withdrawn by the proprietor from his capital. It the proprietor from his capital. It charges interest on drawings. It is charges interest on drawings. It is treated as business incomes. So treated as business incomes. So that the amount of interest is that the amount of interest is entered in the credit side of P/L entered in the credit side of P/L a/c and then added in drawing a/c and then added in drawing also. also.

Drawing of goods by the Drawing of goods by the proprietor for personal proprietor for personal use use When the proprietor withdraws or When the proprietor withdraws or

takes away some goods from the takes away some goods from the business for his personal use or business for his personal use or consumption, the goods so taken consumption, the goods so taken are deducted from purchases on the are deducted from purchases on the debit side of the trading account debit side of the trading account and included in proprietor’s drawing and included in proprietor’s drawing account or deducted from capital on account or deducted from capital on the liability side of the balance the liability side of the balance sheet.sheet.

Manager’s commission Manager’s commission on net profiton net profit In some cases, the manager of a In some cases, the manager of a

business may be given a commission business may be given a commission based on a fixed % of the net profits based on a fixed % of the net profits earned by the business. In such a earned by the business. In such a case, the total net profits are case, the total net profits are calculated and then the % of the calculated and then the % of the commission is applied. Outstanding commission is applied. Outstanding manager’s commission will be shown manager’s commission will be shown on the debit side of profit and loss on the debit side of profit and loss account and as a liability on the account and as a liability on the liabilities side of the balance sheet. liabilities side of the balance sheet.

Unit 3Unit 3 Ratio Analysis Ratio Analysis

Ratio analysis is an important Ratio analysis is an important technique of meaningful analysis technique of meaningful analysis of financial statements. It implies of financial statements. It implies financial analysis of a business by financial analysis of a business by establishing relationship between establishing relationship between items or group of items of the items or group of items of the same financial statements. same financial statements.

Definition Definition

Ratio analysis is a process of determining Ratio analysis is a process of determining and presenting the relationship of items and presenting the relationship of items and group of items in the statements. It and group of items in the statements. It involves calculations, comparisons and involves calculations, comparisons and interpretation of ratios between two or interpretation of ratios between two or more items of financial statements for more items of financial statements for some specified purpose. As compared to some specified purpose. As compared to other tools of financial analysis, the ratio other tools of financial analysis, the ratio analysis highlights more useful facts analysis highlights more useful facts about various aspects of the working about various aspects of the working (financial position, solvency, stability, (financial position, solvency, stability, liquidity and profitability)liquidity and profitability)

Uses or advantages of Uses or advantages of Ratio analysisRatio analysis

Aid in business forecasting - ratio analysis Aid in business forecasting - ratio analysis assists in business forecasting. Trend in assists in business forecasting. Trend in relation to financial statements can be relation to financial statements can be ascertained on the basis of figures of past ascertained on the basis of figures of past years, they assists in forecasting.years, they assists in forecasting.

Aid in the management – Ratio analysis has Aid in the management – Ratio analysis has great relevance for management. It assists great relevance for management. It assists management in formulation of policies and management in formulation of policies and budgets. On the basis of ratio analysis budgets. On the basis of ratio analysis manager establishes co – ordination between manager establishes co – ordination between various activities and achieves the targets. various activities and achieves the targets.

Cont..Cont..

Aid in cost control – waste expenditure Aid in cost control – waste expenditure and losses can be controlled through and losses can be controlled through ratio analysis, which reduces cost. This ratio analysis, which reduces cost. This is helpful in establishing control on costs is helpful in establishing control on costs in period of competition.in period of competition.

To know efficiency – operating To know efficiency – operating profitability and efficiency can be profitability and efficiency can be measured on the basis of various measured on the basis of various results, obtained through ratio analysis.results, obtained through ratio analysis.

Cont…Cont…

To know liquidity and solvency To know liquidity and solvency position–Through ratio analysis, position–Through ratio analysis, important information related to important information related to liquidity and solvency position of an liquidity and solvency position of an organization is obtained. Working organization is obtained. Working capital is determined on the basis of capital is determined on the basis of liquidity and on the basis of liquidity and on the basis of solvency proper utilization of capital solvency proper utilization of capital is ensured. is ensured.

Cont…Cont…

Useful for decision making – Ratio analysis is Useful for decision making – Ratio analysis is immense help, in reaching to a conclusion immense help, in reaching to a conclusion through evaluations of various data's.through evaluations of various data's.

Investment decision – Ratio analysis provides Investment decision – Ratio analysis provides various in formations to investors in relation various in formations to investors in relation to maximum rate of return and security of to maximum rate of return and security of their investments.their investments.

Aid in comparison – Inter firm comparison Aid in comparison – Inter firm comparison becomes becomes possible through ratio becomes becomes possible through ratio analysis. It is useful for managers in analysis. It is useful for managers in comparing departmental working comparing departmental working performance, as a result, efficiency of performance, as a result, efficiency of departments can be measured easily. departments can be measured easily.

Cont…Cont…

Aid in trend analysis – Trends of figures Aid in trend analysis – Trends of figures are interpreted on the basis of various are interpreted on the basis of various past records, thereafter corrective past records, thereafter corrective measures are taken after interpretation of measures are taken after interpretation of trends.trends.

Better utilization of resources – through Better utilization of resources – through ratio analysis various information, dates ratio analysis various information, dates and facts are collected and better and facts are collected and better utilization of physical and natural utilization of physical and natural resources is ensured.resources is ensured.

Limitations of Ratio Limitations of Ratio AnalysisAnalysis

Though ratio analysis is a precious Though ratio analysis is a precious technique of financial analysis but it technique of financial analysis but it is not a full proof technique. Its is not a full proof technique. Its utilities depends upon its proper utilities depends upon its proper use. Mishandling of ratios and using use. Mishandling of ratios and using them without proper context may them without proper context may mislead the analyst and wrong mislead the analyst and wrong conclusions may be drawn. Hence, conclusions may be drawn. Hence, its users must know its limitations. its users must know its limitations. Some main limitations are given as Some main limitations are given as under.under.

Limited use of a single Limited use of a single RatioRatio

A single ratio has limited value in A single ratio has limited value in ratio analysis because trend is ratio analysis because trend is more significant in the analysis. A more significant in the analysis. A change in a particular ratio is change in a particular ratio is meaningful only when it is meaningful only when it is interpreted with reference to interpreted with reference to other related ratio. other related ratio.

Lack of qualitative Lack of qualitative analysis of the problemanalysis of the problem

Ratio analysis is an instrument of Ratio analysis is an instrument of quantitative analysis. It overlooks quantitative analysis. It overlooks qualitative factors of the problem qualitative factors of the problem even if they are more important even if they are more important than quantitative factors. than quantitative factors.

Effect of inherent Effect of inherent limitations of the limitations of the

accountingaccounting As ratio are calculated from As ratio are calculated from

figures obtained from historical figures obtained from historical accounting records, hence, they accounting records, hence, they will posses all those weaknesses will posses all those weaknesses and errors which the accounting and errors which the accounting record possess.record possess.

Arithmetical window Arithmetical window dressing dressing

In ratio analysis arithmetical In ratio analysis arithmetical window dressing is possible. window dressing is possible. During this course of action, During this course of action, actual facts are concealed and actual facts are concealed and with the help of figures with the help of figures manipulations.manipulations.

Accounting limitationsAccounting limitations

As ratio analysis is calculated on As ratio analysis is calculated on the basis of figures and the basis of figures and sometimes actual datas and sometimes actual datas and figures are not available due to figures are not available due to limitations of accounting, this has limitations of accounting, this has a adverse affects on decision a adverse affects on decision making and interpretation. making and interpretation.

Changing conditionsChanging conditions

As ratio analysis is done on the As ratio analysis is done on the basis of past figures and facts, basis of past figures and facts, during constantly changing during constantly changing conditions it is not possible to conditions it is not possible to practically accommodate affects practically accommodate affects in accounting, which has a in accounting, which has a adverse effects on results. adverse effects on results.

Ignoring the Ignoring the backgroundsbackgrounds During inter firm evaluation in During inter firm evaluation in

ratio analysis, at times ratio analysis, at times background of firms is ignored, as background of firms is ignored, as a result true conditions are not a result true conditions are not ascertained.ascertained.

Bios of the analystBios of the analyst

Ratio analysis can be affected Ratio analysis can be affected through bias of the analyst also. through bias of the analyst also. In this case, analyst can collect In this case, analyst can collect and interpret data for his own and interpret data for his own interest and use, consequently interest and use, consequently results are affected.results are affected.

Limited useLimited use

Ratio analysis is used only for Ratio analysis is used only for interpretation of financial interpretation of financial statements it is not used for any statements it is not used for any other purpose of accounting, thus other purpose of accounting, thus it has a limited scope.it has a limited scope.

Price level effectPrice level effect

In comparative study of financial In comparative study of financial statements change in price level statements change in price level are ignored due to which utility of are ignored due to which utility of comparative ratio for various comparative ratio for various periods is adversely affected.periods is adversely affected.

Unit-4Unit-4fund flow statementfund flow statement

Fund flow statement is a Fund flow statement is a statement in the summary form statement in the summary form that indicates the changes in that indicates the changes in items of financial position items of financial position between two different balance between two different balance sheet dates showing clearly the sheet dates showing clearly the sources and application of funds.sources and application of funds.

DefinitionsDefinitions

A statement of sources and applications of A statement of sources and applications of funds is a technical device designed to funds is a technical device designed to analyse the changes in the financial analyse the changes in the financial condition of a business enterprise condition of a business enterprise between two dates.between two dates.

A funds flow statement is prepaid in A funds flow statement is prepaid in summary form indicate changes occurring summary form indicate changes occurring in the items of financial conditions in the items of financial conditions between two different balance sheet between two different balance sheet dates. dates.

Concept -Concept -

The term funds as cash and they The term funds as cash and they concern themselves with the concern themselves with the movements in cash account. The movements in cash account. The statement showing the changes in statement showing the changes in cash balances is termed as cash cash balances is termed as cash flow statement. In other word the flow statement. In other word the term fund refers to working capital term fund refers to working capital i.e., excess of current assets over i.e., excess of current assets over current liabilities. current liabilities.

Concept-Concept-

The term flow refers to change or The term flow refers to change or transfer, and therefore, the flow transfer, and therefore, the flow of funds means transfer of of funds means transfer of economic values from one assets economic values from one assets to another, or the utilizations of to another, or the utilizations of funds. funds.

Objectives of fund flow Objectives of fund flow statementstatement

From what sources finance has been From what sources finance has been provided for increase in working provided for increase in working capital.capital.

From what sources cash has been From what sources cash has been obtained for payment of loan and obtained for payment of loan and redemption of debenture.redemption of debenture.

In what manner, amount received from In what manner, amount received from sale of fixed assets has been utilized.sale of fixed assets has been utilized.

In what manner fixed assets have In what manner fixed assets have been expanded.been expanded.

Cont…Cont…

How and where the amount of net How and where the amount of net profit has been utilized.profit has been utilized.

What are the other sources of What are the other sources of funds and how they are utilized.funds and how they are utilized.

Importance of fund Importance of fund flowflow

Helpful in financial analysis – this Helpful in financial analysis – this statement is an important tool for statement is an important tool for financial analysis. The statement financial analysis. The statement provides information to finance provides information to finance manager about the sources and manager about the sources and utilizations of working capital in utilizations of working capital in past accounting years. past accounting years.

Cont…Cont…

Comparative study is possible - With Comparative study is possible - With the help of fund flow statement it the help of fund flow statement it becomes possible to compare the becomes possible to compare the balance sheet and P/L account for the balance sheet and P/L account for the past years along with this.past years along with this.

Helpful in future planning – with the Helpful in future planning – with the analysis of fund flow statement, finance analysis of fund flow statement, finance manager is able to collect information manager is able to collect information about various facts which helpful in about various facts which helpful in preparing future financial plans.preparing future financial plans.

Cont…Cont…

Effective use and management of Effective use and management of working capital – it provides the working capital – it provides the information of the use of working information of the use of working capital.capital.

Helpful in borrowing operations. Helpful in borrowing operations.

Source and uses of Source and uses of fundfund Sources of funds – all items related to Sources of funds – all items related to

business transactions of organizations business transactions of organizations which increase working capital are which increase working capital are known as sources of funds. These are known as sources of funds. These are as under-as under-

Profit from operation, loan taken from Profit from operation, loan taken from bank, sale of fixed assets, issue of bank, sale of fixed assets, issue of shares and debentures, income from shares and debentures, income from the receipt of interest etc. the receipt of interest etc.

Applications or uses of Applications or uses of fundsfunds

Transaction which result in decrease Transaction which result in decrease in working capital are known as in working capital are known as application of funds. these are as – application of funds. these are as –

Operating losses, purchases of fixed Operating losses, purchases of fixed assets, repayment of loan, assets, repayment of loan, redemptions of shares and redemptions of shares and debentures, payment of interest, debentures, payment of interest, taxes and dividends. taxes and dividends.

Preparation of funds Preparation of funds flow statementflow statement

Mainly two comparative balance sheet Mainly two comparative balance sheet at the beginning and at the end of a at the beginning and at the end of a period are used for preparing a funds period are used for preparing a funds flow statement. This analysis is flow statement. This analysis is classified into three categories. These classified into three categories. These are as – are as –

Schedule of change in working capitalSchedule of change in working capital Calculation of operating profitCalculation of operating profit Fund flow statement Fund flow statement

Schedule of changes in Schedule of changes in working capitalworking capital The schedule prepared to depict The schedule prepared to depict

changes, in current assets and changes, in current assets and current liabilities which, arise due to current liabilities which, arise due to flow of fund is known as schedule of flow of fund is known as schedule of changes in working capital. This changes in working capital. This schedule depicts the changes taking schedule depicts the changes taking place in individual items of current place in individual items of current assets and current liabilities between assets and current liabilities between balance sheet of two accounting balance sheet of two accounting periods. periods.

Fund from operations Fund from operations or operating profitor operating profit

Operating profit refers to the profit Operating profit refers to the profit from business activities. In general from business activities. In general practice the profit provided in profit practice the profit provided in profit and loss account having so many and loss account having so many items of non operating incomes items of non operating incomes and expenditures. the calculation of and expenditures. the calculation of operating profit we have the operating profit we have the following formula….following formula….

Calculation of fund Calculation of fund from operationsfrom operations Profit and loss from current year Profit and loss from current year

………………………………………… - Profit and loss from current year - Profit and loss from current year

………………………………………… Profit for the year -----------------------Profit for the year ----------------------- + non operating items or expenses+ non operating items or expenses A) current year depreciation ……………….A) current year depreciation ………………. B) transfer to general reserve ………………B) transfer to general reserve ……………… C) loss on sale of fixed assets ……………..C) loss on sale of fixed assets …………….. D) good will, discount on shares and debenture preliminary D) good will, discount on shares and debenture preliminary

expenses written off expenses written off …………….…………….

E) provisions for taxations andE) provisions for taxations and proposed dividend …………….proposed dividend ……………. Less – profit on sale of fixed assets ……………Less – profit on sale of fixed assets …………… -------------------------------------------------- Fund from operations ------------------- Fund from operations -------------------

Fund flow statementFund flow statement

Sources of fundSources of fundIssue of shares and Issue of shares and

debenture.debenture.

LoanLoan taken from bank taken from bank

Sale of fixed assetsSale of fixed assets

profit from operationsprofit from operations

Other receiptsOther receipts

Applications of Applications of fundfund

Redemption of shares and Redemption of shares and debenturesdebentures

Repayment of loansRepayment of loans

Purchase of fixed asstsPurchase of fixed assts

Loss from operationLoss from operation

Other paymentsOther payments

Cash flow statementCash flow statement

Cash flow statement is the Cash flow statement is the statement which shows the inflow statement which shows the inflow and flow of cash and cash equa and flow of cash and cash equa