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INTRODUCTION TO FINANCIAL ACCOUNTING

PRESENTED BY PROF. (C.A.) SWATI GODBOLE

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PROF. (C.A.) SWATI GODBOLE

BACKGROUND AND MEANING

BUSINESS IS ALL ABOUT

MONEY

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PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

BRANCHES OF ACCOUNTING
Process of Communicating social And environmental impacts Of business actions
FINANCIAL ACCOUNTING

Post mortem of Business transactions

SOCIAL ACCOUNTING

ACCOUNTING

COST ACCOUNTING

Accounting For management


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Cost estimation, Cost control


MANAGEMENT ACCOUNTING

PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

FINANCIAL ACCOUNTING BASIC PRINCIPLES


PRINCIPLES

CONCEPTS
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CONVENTIONS
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CONCEPTS
Means basic rules & regulations Different concepts

Business entity Going concern

BUSINESS AND OWNERS ARE SEPARATE BUSINESS = ARTIFICIAL LEGAL ENTITY

BUSINESS HAS A LONG , INDEFINITE LIFE EVERY THING OF BUSINESS HAS TWO EQUAL SIDES / TWO EQUAL FOLD IMPACT 5
5

Dual aspect

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CONTD..

Accounting period

Standard Period of 12 Months at The end of which evaluation will Be done

Matching

Expenses are recognized in the same accounting period when the related revenue is recognized

Money measurement
PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

Accounts only deal with items to which a monetary value can be attributed

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CONTD..

Cost

An asset is entered into the accounting records at the price paid to acquire it.

Accrual

The idea that income and expense items must be included in financial statements as they are earned or incurred.

Revenue recognition

Revenue recognized only when it is realizable or earned or realized

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PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

CONVENTIONS
Means basic assumptions

Disclosure

to inform both current and potential investors of the accounting strategies and methods used when developing periodic corporate Be consistent = no change in method Unless forced

Consistency

Conservatism Materiality

Play Safe relating to the importance/significance of an amount, transaction, or discrepancy. 8


8

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The immediate recognition of loss is

supported by the underlying principle of


Matching Consistency Judgment Conservatism

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The determination of the expenses for

an accounting period is based largely on the application in which principle?


Cost Consistency Matching Time period

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The Business entity concept

Refers to the name of the company required in the heading of the financial statements Refers to the owners of the entity, who must account for their interest in the entity their personal holdings Indicates that the accounting unit on which the financial reports are based is the business itself, separate from its owners Holds that the business is made up of many separate components that are accounted for separately but reported collectively in the financial statements
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Assigning revenues to the accounting

period in which the goods were delivered or the services performed and expenses to the accounting period in which they were used to produce revenues is known as the

Accounting period Continuity assumption Matching rule Revenue recognition

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Generally accepted accounting

principles

Define accounting practice at a point in time Are similar in nature to the principles of chemistry or physics Are rarely changed Are not affected by changes in the way business operate

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ACCOUNT
Personal Impersonal

Accounts of Individuals And Artificial persons E.g. Mr. A , B , C , ABC Ltd. Z Ltd. etc.

Accounts of Others i.e. those who are not individuals and artificial persons. Further classified into two types. Real and Nominal

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REAL AND NOMINAL


Real

Nominal

Accounts of things that can be seen, touched i.e. which are real. E.g. Cash , Furniture , Car , Mobile , Machinery etc.

Accounts of things that can only be felt, imagined but cannot be seen or touched. E.g. Wages , Salary , Electricity charges , Telephone Charges etc.

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Classify the following into Personal, Real

and Nominal.

Stationery Account Cash Account Goodwill Account Capital Account Freight Account Rent Account Interest Account Account of Govind, a customer Bank Loan Account Depreciation
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THREE GOLDEN RULES FOR DEBIT AND CREDIT


PERSONAL

Debit The Receiver


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Credit The Giver


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Example
Received cash Rs.500 from Mr. A Mr. A a Personal account A is the giver of the money So As account will be credited.

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20

Contd.
REAL

Debit What Comes In


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Credit What Goes Out


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PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

Contd. The same example


Cash is a real account Cash is coming in the business Cash will be debited applying the rule.

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Contd.
NOMINAL

Debit All Expenses And Losses

Credit All Incomes And Gains

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Example
Received cash from Mr. A as

Commission Here commission is a nominal account In the given transaction Commission is Income Applying the rule commission will be credited.

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Business transactions
In order to record the business

transactions we follow certain steps

Identify the nature of transaction i.e. Cash or Credit If Cash transaction then one account getting affected is Cash or Bank (Cheque) Next question WHY? If no answer to the previous question then next question WHOM?

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Contd.
In case of Credit Transaction

One account getting affected is Personal account Next question WHY? Example

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Example
Purchased Furniture from Furniturewala

and Sons Rs.20000

Credit Transaction as no money coming in or going out So Furniturewala and Sons Account getting affected WHY = Purchase of Furniture Second account getting affected is Furniture

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Point out the accounts which will be

debited and credited for each one of the following transactions


Cash received from X Cash paid to Y Credit sale to Z. Salary paid to clerk by means of cheque. Payment of cash to Landlord for Rent.

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JOURNAL
Meaning

BOOK OF PRIME ENTRY

JOUR = a day Recording of transaction on a daily basis Specific format in which transactions are recorded Format

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30

Ledger Folio = Page no.

Journal Folio

120

Date

PARTICULARS

L.F. DEBIT AMT.

CREDIT AMT.

2010 Cash A/c. Dr To Sales A/c. 1st April (Being Goods sold on Cash) Rent A/c. Dr To Cash A/c. 7th April (Being Rent paid by cash) NARRATION
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05 10

1500 1500

15 05

850 850

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Certain Terms
Assets Liabilities Capital Drawings Goods
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Means Properties , something that the business owns Means something that does not belongs to business or something that you owes Investment made by the owner in the business which can be in cash or kind Money or any thing withdrawn by owner from business for personal use Means the product in which the business deals
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Contd.
Fixed Assets Current Assets Current Liabilities Fixed Liabilities
Assets that remains with us for long time Assets the value of which keeps on changing Liabilities the value of which keeps on changing Liabilities that remains with us for long time ie. As long as the life of the business

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33

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34

Journalize the following transactions for

the month of January 2010



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R started the business with cash Rs.150000 Deposited Cash Rs.100000 in Bank Purchase Goods worth Rs.50000 from C Sold goods worth Rs.70000 to D Paid Cash Rs.2500 to Rashmi Received Cheque from Sawant for Rs.6000 towards commission Issued a cheque for Rs.7500 to Sanjay towards courier charges Received cash from Sudhir as Interest Paid by cheque to C Rs.25000 Received from D by cheque Rs.45000
PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

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LEDGER
Meaning

Summary of transactions entered into with one party, one person, one asset, one expenditure etc. Format

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DR

CASH ACCOUNT

CR

D at e

Particulars

J. Amt F

D at e

Particulars

J Amt F

2010 To Sales A/c. 1/4

120

1500

2010 By Rent A/c. 5/4 2010 30/4 By Balance C/d.

120

850

650

1500
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1500 37
37

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Refer slide no. 34 and prepare various

ledger account and find out the balance

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Subsidiary Books
Books kept for each type of transaction Various types are

Purchase Book Sales Book

For recording credit purchase of goods For recording credit sales of goods
For recording returns outwards or purchase return

Purchase Return Book Sales Return Book


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For recording return inwards or sales return


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40

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Contd.
Cash Book
For recording receipts & payments of cash and cheque For recording Bills receivable received
For recording Bills payable accepted

Bills receivable Book Bills payable Book Journal Proper Book

For recording any other transaction which could not be recorded in any of the above books

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Topics for Today


Revision Certain important terms related to

Subsidiary books Depreciation Stock And its Valuation Bank Reconciliation

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Certain terms
Trade Discount
Discount offered at the time of bulk purchase.

Cash Discount

Discount offered in order to receive the money quickly from customers

Debit Note

Note which is issued when we debit a party in our books of accounts

Credit Note
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Note which is issued when we credit a party in our books of accounts

PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

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Contd.
Depreciation
Reduction in the value of a Fixed assets due to wear and tear or usage

Stock

The unsold goods lying with us at any given point of time

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Depreciation
Meaning What is Original Cost of an Asset? Various methods of charging

Depreciation the popular one are

Fixed installment method or Straight line method Reducing balance method or Written down value method

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Example
Fixed Installment

Original Cost 100 Less: Depreciation @10% P.a. 10 Written down value 90 Less: Depreciation @10% 10 Written down value 80 So on and so forth Depreciation is calculated on Original Cost of the asset till the asset exists.
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Example
Reducing Balance Method

Original Cost Less: Depreciation @10% P.a. Written down value Less: Depreciation @10% Written down value So on and so forth

100 10 90 9 81

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Formula Original Cost method


Depreciation = (Original Cost Salvage)

Life of the asset


Salvage = Expected realizable Value for

an asset at the end of its life.

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Stock or Inventory
Various methods of inventory verification

Perpetual

Under this method the stock verification is done by keeping continual track of additions or deletions in materials

Periodic
Under this method physical stock taking is done periodically

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Methods of stock valuation


Various methods of stock valuation

popular ones are

FIFO LIFO

First in First Out Last In First Out

Weighted or Moving Average Method


Weighted average is taken as a base for valuation

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Example - FIFO
Date 01/04/2010 02/04/2010 1200 @ Rs. 20.25 500 @ Rs.21 250 @ Rs.20.25 600 @ Rs.21.75 Receipt (Units) Issue (Units) Balance (Units) 500 @ Rs. 21 500 @ Rs.21 1200 @ Rs. 20.25 950 @ Rs. 20.25 950 @ Rs.20.25 600 @ Rs. 21.75 700 @ Rs.20.25
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03/04/2010

04/04/2010

05/04/2010

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250 @ Rs. 20.25 600 @ Rs.21.75

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Example - LIFO
Date 01/04/2010 02/04/2010 1200 @ Rs. 20.25 750 @ Rs.20.25 600 @ Rs.21.75 Receipt (Units) Issue (Units) Balance (Units) 500 @ Rs. 21 500 @ Rs.21 1200 @ Rs. 20.25 500 @ Rs.21 450 @ Rs. 20.25 500 @ Rs.21 450 @ Rs.20.25 600 @ Rs. 21.75 500 @ Rs.21 350 @ Rs. 20.25

03/04/2010

04/04/2010

05/04/2010
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600 @ Rs.21.75 100 @ PROF. (C.A.) SWATI PROF. (C.A.) SWATI GODBOLE Rs.20.25 GODBOLE

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Example weighted average


Date 01/04/2010 02/04/2010 03/04/2010 04/04/2010 600 @ Rs.21.75 1200 @ Rs. 20.25 750 @ Rs.20.47 Receipt (Units) Issue (Units) Balance (Units) 500 @ Rs. 21 1700 Rs.34800 950 Rs.19447 1550 @ Rs.32497

05/04/2010

700 @ Rs.20.9658

850 Rs.17820

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Bank Reconciliation statement


A statement which is prepared to tally

the bank balance as per Cash book and Bank book or Bank Statement Various reasons due to which there is difference between two books such as

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Cheque issued not presented for payment Cheque deposited but not yet clear Interest , Commission , Bank charges charged by bank not recorded in cash book Human Errors
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Topics for Today


Revision Trial Balance Meaning, Format,

Preparation etc. Financial Statements Meaning, Parts etc.

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TRIAL BALANCE
Meaning

Is a list of balances of various ledger accounts Prepared at the end of the year. Only ledger accounts with balances are reflected in the trial balance Format

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TRIAL BALANCE

Particulars
Cash Account Plant and machinery Bank Loan Creditors

L.F Debit
12 15 25 32 2500 10700

Credit

11600 1600

Total
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13200

13200

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Backbone of Trail Balance


All expenses and losses
Debit Balance

All Income and gains

Credit Balance

All assets

Debit Balance

All Liabilities & Capital


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Credit balance
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Prepare a Trial Balance


Capital Furniture Return inward Courier Charges Cash in hand Creditors Bank Overdraft Bills receivable
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125000 45000 1250 1485 12879 10265 12850 20000

Rent & taxes Purchases Return Outward Opening stock Debtors Sales Salaries Bills Payable 60

12500 85000 1465 20355 35121 110000 27410 1420


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PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

Answer
Particulars Capital Furniture Return Inward Courier charges Cash In hand Creditors Bank Overdraft Bills Receivable
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LF Debit 45000 1250 1485 12879

Credit 125000

10265 12850 20000


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Contd.
Particulars Rent & taxes Purchases Return Outward Opening Stock Debtors Sales Salaries Bills Payable Total
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LF Debit 12500 85000

Credit

1465 20355 35121 110000 27410 1420 261000


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261000

FINANCIAL STATMENTS
INCOME STATEMENT BALANCESHEET
POSITION POSITION STATEMENT STATEMENT STATEMENT STATEMENT SHOWING ASSETS SHOWING ASSETS AND LIABILITIES AND LIABILITIES POSITION POSITION REVENUE REVENUE STATEMENT STATEMENT STATEMENT STATEMENT SHOWS A SHOWS A COMPARISON COMPARISON BETWEEN BETWEEN INCOME & INCOME & EXPENSES EXPENSES

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PARTS OF INCOME STATEMENT


HIGHLIGHTS THE HIGHLIGHTS THE TRADING RESULTS OF TRADING RESULTS OF AN ORGANISATION AN ORGANISATION CALLED CALLED HIGHLIGHTS THE NET RESULT HIGHLIGHTS THE NET RESULT OF AN ORGANISATION AT THE OF AN ORGANISATION AT THE END OF A YEAR CALLED END OF A YEAR CALLED

NET PROFIT OR NET LOSS NET PROFIT OR NET LOSS

GROSS PROFIT OR GROSS PROFIT OR GROSS LOSS GROSS LOSS

TRADING ACCOUNT

PROFIT & LOSS ACCOUNT

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Format
Particulars To Opening Stock To Net Purchases To Wages To Carriage Inward To Gross Profit C/d.

Trading Account for the year ending 31.03.2010

Amount ****** ****** ****** ****** ******

Particulars By Net Sales By Closing stock

Amount ****** ******

Total
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******* Total
PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

*******
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Question
From the following details prepare Trading Account.

Sales Return Opening Stock Sales Insurance

200 Purchases 25000 Wages 300200 Carriage Inward 3000 Bad debts recovered

240000 21000 900 800

CLOSING STOCK COST PRICE Rs.20000, MARKET VALUE RS.22000

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Answer

To Opening Stock To Purchase Less: Returns To Wages To Carriage Inward To Gross Profit c/d. Total
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25000 By Sales Less: Returns 240000 By Closing stock 21000 900 33100 320000 Total
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300000 20000

320000

Format
To Indirect Expenses Salaries Advertisement ***** *****

Profit & Loss account for the year ending 31.03.2010 By Gross Profit B/d. By Discount Received By Dividend Recd. ****** ***** *****

Postage & Courier ***** Printing & Stationery Depreciation To Net Profit C/d. Total ***** ***** ***** ***** Total *****

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Question
Rent & Taxes Bad debts recovered Interest received Advertisement Internet expenses 4000 Insurance 800 Commission received 1500 Salaries 3500 Postage, Courier 2450 Discount Allowed 3000 4000 7500 2250 225

PROVIDE DEPRECIATION ON MACHINERY RS.25000 @ 10% P.A.

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Answer
To Rent & Taxes To Insurance To Salaries To Advertisement To Postage & courier To Internet Exp. To Discount allowed To Depreciation To Net Profit c/d. Total 09/24/10 4000 By Gross Profit 3000 By Bad Debts Recovered 7500 By Commission 3500 2250 2450 225 2500 12475 37900 PROF. (C.A.) SWATI GODBOLE Total 70 37900 33100 800 4000

Format
Liabilities Capital Account Bank Loan or overdraft Sundry Creditors Bills payable Outstanding Expenses Amount **** **** **** **** **** Assets Fixed Assets Plant & machinery Less Depreciation Furniture & fixture Less Depreciation Land & Building Less Depreciation Investments Current assets Sundry Debtors Cash & Bank balance Total
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Amount **** **** **** **** **** **** **** **** *****

*****

Total

PROF. (C.A.) SWATI PROF.(C.A.) SWATI GODBOLE GODBOLE

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Question
Cash in Hand Sundry Debtors Plant & Machinery Furniture Bills Receivable Advance Tax 4975 Capital 110000 Bills payable 25000 Sundry Creditors 40000 Bank Overdraft 30000 95500 200000 40000 48000 22500

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Answer
Liabilities Capital Add: Net Profit Bank Overdraft Sundry Creditors Bills Payable Amount Assets Amount 25000 (2500) 22500 Furniture 48000 Sundry Debtors 40000 Bills Receivable Cash In Hand Closing Stock Advance Tax Total 322975 Total 40000 110000 30000 4975 20000 95500 322975 200000 Plant & Machinery 12475 Less: Depreciation

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Certain Terms
Shares , Debentures, Bonds Equity & Preference Shares Authorized Capital, Paid Up Capital etc Partly Paid up Shares, Fully Paid up etc Bonus Share Reserves & Surplus Secured & Unsecured Loan

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A Typical Manufacturing Company Starts Operation


Two promoters deposit Rs 5 lakhs in the company account as equity XYZ Private Limited Balance Sheet at April 1, 2006 Liabilities Equity Total
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Amount

Assets

Amount 5,00,000 Total


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5,00,000 Cash 5,00,000


PROF. (C.A.) SWATI GODBOLE

5,00,000

A Machine is bought on cash basis

Owner pays Rs 3 lakhs from the bank acount

Liabilities Equity

Amount

Assets

Amount 2,00,000 3,00,000 Total 5,00,000

5,00,000 Cash Plant Total 5,00,000

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Raw material worth Rs 80,000 bought on a 60 day credit basis


No payment is done so cash position does not change Liabilities Equity Amount Assets Amount 2,00,000 3,00,000 80,000 Total 5,80,000

5,00,000 Cash Plant

Account Payable

80,000 Inventory Total 5,80,000

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Raw material worth Rs 40,000 processed and sold for Rs 50,000 with a 30 day credit

No payment is done so cash position does not change, but inventory is reduced Liabilities Equity
Accounts Payable

Amount

Assets

Amount 2,00,000 3,00,000 40,000 50,000 Total 5,90,000


78

5,00,000 Cash 80,000 Plant Inventory

Retained Earnings Total


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10,000 Accounts receivable 5,90,000


PROF. (C.A.) SWATI GODBOLE

Customer pays up after 20 days

Payment deposited in bank so cash position changes Liabilities Equity


Accounts Payable

Amount

Assets

Amount 2,50,000 3,00,000 40,000 00,000 Total 5,90,000


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5,00,000 Cash 80,000 Plant 10,000 Inventory Accounts receivable Total 5,90,000
PROF. (C.A.) SWATI GODBOLE

Retained Earnings

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Supplier credit period is over and raw material is paid for after 60 days

Payment done from bank so cash balance reduces Liabilities Equity


Accounts Payable

Amount 5,00,000 00,000

Assets Cash Plant Inventory Accounts receivable

Amount 1,70,000 3,00,000 40,000 00,000

Retained Earnings 10,000

Total
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5,10,000
PROF. (C.A.) SWATI GODBOLE

Total 5,10,000
80

A new promoter buys 10,000 shares of Rs 10 face value at a premium of Rs 20

Payment done to bank so cash balance increases Liabilities Equity Retained Earnings Share Premium a/c
Accounts payable

Amount 6,00,000

Assets Cash

Amount 4,70,000 00,000 3,00,000 40,000 Total 8,10,000


81

10,000 Accounts receivable 2,00,000 Plant 00,000 Inventory 8,10,000


PROF. (C.A.) SWATI GODBOLE

Total
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Topics for Today


Introduction to financial Management Financial Analysis

Ratio Analysis Cash Flow

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MEANING
CASH IS KING F.M- MANAGEMENT OF CASH WHY ONE SHOULD MANAGE CASH? HOW ONE SHOULD DO SO?

WHAT AMOUNT OF FINANCING IS REQUIRED FOR THE FIRM? HOW SHOULD THE REQUIRED FINANCING BE RAISED?
PROF. (C.A.) SWATI GODBOLE 83

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CONTD..

WHAT INVESTMENTS SHOULD THE FIRM MAKE? HOW CAN THE FINANCIAL DECESIONS HELP TO ADD VALUE TO THE FIRM AND ITS SHAREHOLDERS?

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84

KEY CONCEPTS RELATED TO F.M


ASSESSMENT OF CURRENT

BUSINESS FINANCIAL ANALYSIS ASSESSMENT OF FUTURE FINANCING REQUIREMENTS FINANCIAL PROJECTIONS

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85

CONTD..
ISSUES RELATED TO LONG TERM

FINANCING DECISION COST OF CAPITAL , CAPITAL BUDGETING AND STRUCTURE DECISIONS ISSUED RELATED TO INVESTMENTS

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86

Financial Statement Analysis


Meaning

Is the process of evaluating the relationship between components/ parts of financial statements Objective is to obtain a better understanding of the firms position and performance.

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87

DIFFERENT TOOLS USED FOR FINANACIAL ANALYSIS


RATIO ANALYSIS CASH FLOW & FUND FLOW ANALYSIS

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88

RATIO ANALYSIS
It is a systematic use of ratios to interpret/

assess the performance and status of the firm

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89

MEANING - RATIO
Ratio is a comparison between two

variable
It may be presented in the form of % or

times or :

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90

TYPES OF RATIOS
Liquidity ratios Capital Structure ratios Profitability ratios Activity ratios

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91

LIQUIDITY RATIOS
Is the ability of a firm Types

to satisfy its short term obligations as they become due.

Current ratio Quick Ratio/ Acid Test

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92

CURRENT RATIO
Is a measure of liquidity calculated by

dividing current assets by current liabilities


Formula : Current Assets / Current

Liabilities

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93

QUICK / ACID TEST RATIO


Is a measure of liquidity calculated

dividing current assets minus inventory and prepaid expenses by current liabilities
Formula: C. assets- Stock & prepaid

exp./ C. Liabilities

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94

CAPITAL STRUCTURE RATIOS


Ratios that throws light on the long term

solvency of the firm is reflected in its ability to assure the long term lenders with regard to payment of the interest and repayment of principal on maturity. Two types

For ability to repay the principal For regular repayment of interest


PROF. (C.A.) SWATI GODBOLE 95

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Contd.
Ability to repay Regular repayment

principal

of interest- Coverage ratio

Debt Equity Ratio Proprietary Ratio

Interest coverage ratio Dividend coverage ratio Debt service capacity

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96

DEBT-EQUITY RATIO
Measures the ratio of long term or total

debt to shareholders equity. Formula: Long term debt / Shareholders Equity or Total debts / Shareholders equity Total debts = long term debts + current liabilities Shareholders equity = Equity, Preference Share Capital & Reserves less Miscellaneous Expenses.
09/24/10 PROF. (C.A.) SWATI GODBOLE 97

Contd.
Imp. From the point of view of creditors,

owners and the firm High ratio= more share of financing by the creditors Low ratio = less share of financing by the creditors Ratio say is 1:2 means for every rupee of the creditors the firm has two rupees of owners.
09/24/10 PROF. (C.A.) SWATI GODBOLE 98

Contd.
For firm a high ratio is not good as that may

lead to interference from the creditors in management due to high stake For the shareholders a high ratio is good or a gain as

Their investment is low or limited but they can retain the control The returns to them can be magnified. (trading on equity)
PROF. (C.A.) SWATI GODBOLE 99

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PROPRIETORY RATIO
Indicates the extent to which assets are

financed by owners funds. Formula: Proprietors fund / Total assets *100 Proprietors fund = Equity capital + Preference capital + Reserves & surplus

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100

COVERAGE RATIO
Measure the firms ability to pay certain

fixed charges.

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101

INTEREST COVERAGE ( TIME INTEREST EARNED ) RATIO


Measures the firms ability to make

contractual interest payments. Interest is a charge on profits Formula: EBIT / Interest

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102

DIVIDEND COVERAGE RATIO


The ability of the firm to pay dividend on

preference shares Preference dividend = appropriation of profits Formula: EAT / Preference Dividend

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DEBT SERVICE CAPACITY


Is the ability of a firm to make the

contractual payments required on a scheduled basis over the life of the debt Formula: EAT+ Interest+ Depreciation+ other non- cash expenditure / installment

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104

PROFITABILITY RATIOS
Are designed to provide answers to questions

such as

Is the profit earned by the firm adequate? What rate of return does it represent? What is the rate of profit for the various segments of the firm? What are the earnings per share? What was the amount paid in dividends? What is the rate of return to equity- holders?
PROF. (C.A.) SWATI GODBOLE 105

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GROSS PROFIT MARGIN


Measures the percentage of each sales

rupee remaining after the firm has paid for its goods
Formula: Gross profit / Net sales * 100

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106

NET PROFIT MARGIN


Measures the percentage of each sales

rupee remaining after all costs and expenses including interest and taxes have been deducted Three Types

Operating profit ratio Pre tax profit ratio Net profit ratio
PROF. (C.A.) SWATI GODBOLE 107

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Contd.
Formula:

Operating profit ratio = EBIDT/ Net Sales Pre tax profit ratio = EBT / Net Sales Net Profit ratio = EAT / Net Sales

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108

RETURN ON INVESTMENTS (ROI)


Measures the overall effectiveness of

management in generating profits with its available assets. Three types


Return on assets (ROA) Return on capital employed (ROCE) Return on shareholders Equity

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109

RETURN ON ASSETS
Relationship between net profits and

assets. Profit to asset ratio Formula: EAT + (Interest- tax on interest) / average total assets Interest is considered as the assets are financed by both owners fund as well as borrowers fund.
09/24/10 PROF. (C.A.) SWATI GODBOLE 110

RETURN ON CAPITAL EMPLOYED


Profits are related to capital employed

and not with assets. Capital employed is equal to owners fund and borrowed funds (long term funds supplied by lenders) Formula: EBIDT / Total capital employed * 100

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111

RETURN ON SHARHOLDERS EQUITY


Measures the return on the owners (both

pref. and equity shareholders) investment in the firm.


Two types

Return on shareholders equity Return on ordinary shareholders equity

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112

Contd.
Return on total shareholders equity reveals

how profitably the owners fund have been utilized by the firm. Formula: Net profit after taxes / shareholders equity * 100 Shareholders equity = Entire share capital + reserves and surplus accumulated losses

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113

RETURN ON ORDINARY SHARHOLDERS EQUITY


Ordinary shareholders = Equity

shareholders Indicates whether the firm has earned a satisfactory return for its equity holders or not. Formula: (NPAT Pref. Dividend) / ordinary shareholders equity

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114

EARNINGS PER SHARE (EPS)


Measures the profit available to the

equity shareholders on a per share basis. Formula: Net profit available to equityholders / no. of equity shares outstanding

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115

DIVIDEND PER SHARE


Dividend paid to the equity shareholders

per share Formula: dividend paid to ordinary shareholders / no. of shares outstanding

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116

DIVIDEND PAYOUT RATIO (D/P)


Measure the proportion of dividends paid

to earning available to shareholders


Formula : dividend paid to holders / total

net profit belonging to equity-holders

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117

PRICE/EARNINGS RATIO (P/E)


Measures the amount investors are

willing to pay for each rupee of earnings; the higher the ratio , the larger the investors confidence in the firms future.

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118

ACTIVITY RATIOS
Measure the speed with which various

accounts/assets are converted into sales or cash

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119

INVENTORY/ STOCK TURNOVER


Measures the activity/liquidity of

inventory of a firm; the speed with which inventory is sold. Formula: COGS / Average inventory

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120

DEBTORS TURNOVEER RATIO


Is the average amount of time needed to

collect accounts receivable Shows how quickly debtors are converted into cash. Two ways of calculation

Debtors turnover = Credit Sales / (Debtors + B.R.) Average collection period = days / months in a year / debtors turnover ratio
PROF. (C.A.) SWATI GODBOLE 121

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CREDITORS TURNOVER RATIO


Is the average amount of time needed to

pay accounts payable Creditors Turnover ratio = Credit Purchase / (Creditors + Bills payable)

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122

Topics for Today


Introduction to Cost Accounting Meaning Different Elements of Cost Classification of Cost Cost Sheet

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123

INTRODUCTION

Financial Accounting

Management Accounting

Cost Accounting
09/24/10 PROF. (C.A.) SWATI GODBOLE 124

MEANING & OBJECTS


The Amount of Expenditure attributable to

a given thing.
To Know the cost of a product , to

evaluate the cost of a product , to control the cost and to determine the selling price or profit of a product.

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CLASSIFICATION

Element-wise classification Functional classification Classification based on Cost Behavior

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126

Cost Sheet
Prime Cost Factory Cost Cost of Production Cost of goods sold Cost of Sales
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Format
Particulars Opening Stock Raw Material Add: Purchase of Raw Material Less: closing Stock Raw Material Prime Cost Add: Factory Overheads Add: Opening Stock WIP
09/24/10 PROF. (C.A.) SWATI GODBOLE

Amount **** **** ****

Amount

**** **** ****


128

Contd.
Less: Closing stock WIP Factory Cost Add: Office & Administration O/H. Cost Of Production Add: Opening stock of Finished Goods Less: Closing stock of Finished Goods **** **** **** **** **** ****

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129

Contd.
Cost of Goods Sold Add: Selling & distribution O/H. Cost of Sales Add: Profit Sales ***** ***** ***** ***** *****

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Topics for Today


Marginal Costing

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Marginal Costing
Marginal Costing is an important tool for decision

making.

Definition Marginal cost is the change in total cost for the

change in activity by one unit. In actual cost, Marginal cost = Variable cost.

Therefore, Marginal Costing is a decision making

technique by use of calculation of marginal costs.

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132

Contd.
Marginal costing involves ascertaining marginal costs.

Since marginal costs are direct cost, this costing technique is also known as direct costing; In marginal costing, fixed costs are never charged to production. Once marginal cost is ascertained contribution can be computed. Contribution is the excess of revenue over marginal costs. The marginal cost statement is the basic document/format to capture the marginal costs.
09/24/10 PROF. (C.A.) SWATI GODBOLE 133

Contd.
Features of Marginal Costing System: It is a method of recording costs and reporting profits; All operating costs are differentiated into fixed and variable costs; Variable cost are charged to product and treated as a product cost while Fixed cost treated as period cost and written off to the profit and loss account

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134

Contd.
Advantages of Marginal Costing: It is simple to understand re: variable versus fixed cost

concept; A useful short term survival costing technique particularly in very competitive environment or recessions where orders are accepted as long as it covers the marginal cost of the business and the excess over the marginal cost contributes toward fixed costs so that losses are kept to a minimum; Its shows the relationship between cost, price and volume;
09/24/10 PROF. (C.A.) SWATI GODBOLE 135

Contd.
Under or over absorption do not arise in marginal

costing; Stock valuations are not distorted with present years fixed costs; Its provide better information hence is a useful managerial decision making tool; It concentrates on the controllable aspects of business by separating fixed and variable costs The effect of production and sales policies is more clearly seen and understood.
PROF. (C.A.) SWATI GODBOLE 136

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Contd.
Disadvantages Of Marginal Costing Marginal cost has its limitation since it makes use of

historical data while decisions by management relates to future events; It ignores fixed costs to products as if they are not important to production; Stock valuation under this type of costing is not accepted by the Inland Revenue as it ignore the fixed cost element; It fails to recognize that in the long run, fixed costs may become variable;
09/24/10 PROF. (C.A.) SWATI GODBOLE 137

Contd.
Its oversimplified costs into fixed and variable as if it

is so simply to demarcate them; Its not a good costing technique in the long run for pricing decision as it ignores fixed cost. In the long run, management must consider the total costs not only the variable portion; Difficulty to classify properly variable and fixed cost perfectly, hence stock valuation can be distorted if fixed cost is classify as variable.
09/24/10 PROF. (C.A.) SWATI GODBOLE 138

Contd
Marginal Cost Table Total Sales

(-) Variable Cost Contribution (-) Fixed Costs Profits/Loss Total Sales (-) Variable Cost Contribution (-) Fixed Costs Profits/Loss
09/24/10

X XX X XX X XX X XX X XX 100000 60000 40000 30000 10000


139

PROF. (C.A.) SWATI GODBOLE

Contd.
Contribution = Difference in sales and

variable cost at any level. = Sales variable cost = Qty x (SP) Qty (Variable cost per unit) = Qty x (SP variable cost per unit) PV Ratio = Profit Volume Ratio = Contribution/Sales *100 Note Contribution and sales should always be taken for the same activity level.

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140

Contd.
PV Ratio does not change due to

(a) Qty (b) Fixed Costs (c) Change in both in same proportion PV Ratio changes when (a) Selling Price is Changed (Sales are affected due to change in SP. Thus denominator in the ratio changes) (b) Variable Cost changes (Numerator changes due to change in Variable cost) (c) Change in both at differential proportion.
09/24/10 PROF. (C.A.) SWATI GODBOLE 141

Contd.
Break Even Point The production level at

which there is no profit or loss.

Contribution at BEP = Fixed Costs Break Even Qty = Fixed cost/Contribution per

unit

Margin of Safety = Actual level BEP


09/24/10 PROF. (C.A.) SWATI GODBOLE 142

Contd.
Q1. X ltd sells product P having SP of Rs 150 and

variable cost/per unit of Rs 60. The fixed cost for year is 3,60,000 and the total sales Rs 12 lakhs. (a) Calculate (i) PV Ratio (ii) BEP (in Qty and Sales Value) (iii) Margin of Safety (iv) Profit at present level (b) Calculate profit or loss if activity is 950 units (c) Find out how the activity for (i) How many units to be sold for a profit of Rs. 90000
09/24/10 PROF. (C.A.) SWATI GODBOLE 143

Contd.
Sol: - (a)

Sales = 1200000/150 = 8000 Units Fixed Cost per unit = 360000/8000 = 45 Contribution = SP Variable Cost = 150 60 = 90 Table Per Unit Total Sales 150 1200000 (-) Variable cost 60 480000 Contribution 90 720000 (-) Fixed Costs 45 360000 Profits 45 360000 (i) PV Ratio = Contribution /Sales = 90/150 = 0.60
09/24/10 PROF. (C.A.) SWATI GODBOLE 144

Contd.
(ii) BEP Contribution = Fixed Cost

(90 x BEP) = 360000 BEP = 360000/90 BEP = 4000 units = 150x4000 = Rs 600000 (iii) Margin of Safety Actual Level BEP 8000 4000 = 4000 1200000 600000 = 600000 (iv) Profit at present level Profit = (SP-Fixed Cost Var Costs)x Qty = (150 45 60) x 8000 = 45 x 8000 = 360000
09/24/10 PROF. (C.A.) SWATI GODBOLE 145

Contd.
(b) Profit or loss if activity is 950 units

Contribution per unit = 90 Total contribution = Contribution per unit x total units 90 x 950 = 85000 Loss = Fixed cost contribution = 360000 85000= 274000 Profit or loss for sales of Rs 450000 Total Contribution = PV Ratio x Sales = 0.60 x 450000 = 270000 Loss = Fixed cost contribution Loss = 360000 270000 = 90000
09/24/10 PROF. (C.A.) SWATI GODBOLE 146

Contd.
(c) (i) Activity for profit of Rs 90000

Total Contribution = Profit + Fixed Costs = 90000 + 360000 = 450000 Contribution per unit = 90 Total contribution = No of units x contribution per unit 450000 = 90 x X X = 5000
09/24/10 PROF. (C.A.) SWATI GODBOLE 147

Contd.
Q.

The management is expecting an increase of Rs 60000 in fixed costs with the decrease in selling price by 20% and decrease in Variable cost/unit by 10%. Calculate what would be change in profit/loss. ( Consider the basic data from the sum above)

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Sol: -

Sales (unit SP) = 120 (-) Var Costs = 54 Contribution = 66 (-) Fixed Costs= Profit (New) Profit (Old) Change in profit

528000 420000 108000 360000 252000

The new Selling Price = 150 30 = 120

The new Variable Cost = Rs 60 6 = Rs 54


PROF. (C.A.) SWATI GODBOLE 149

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Contd.
New contribution per unit = New SP New Variable

Cost = 120 54 = 66 No of units sold earlier = Earlier Sales/Earlier SP = 1200000/150 = 8000 Total Contribution = 8000 x 66 = 528000 New fixed cost = 360000 +60000 = 420000 New profit = New cost New Fixed Cost = 528000 420000 = 108000 Reduction in profit = Earlier profit new profit = 360000 108000 = 252000
PROF. (C.A.) SWATI GODBOLE 150

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Contd.
Q. Under the new circumstances the

management wants to achieve same sales value. How much would be the effect on profits?

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151

Answer
Sol. Sales Qty = Sales Value/SP per unit

= 1200000/120 = 10000 Units Total Contribution = Contribution per unit x no of units = 66 x 10000 = 660000 New Profit = New Contribution New fixed costs = 660000 420000 = 240000 Reduction in profits = Old Profit New Profit = 360000 240000 = 120000
PROF. (C.A.) SWATI GODBOLE 152

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Contd.
Q. How much should be the sales level under the

changed circumstances to earn the same profit as before? = 360000 + 420000 = 780000 Contribution per unit = 66 No of units = 780000/66 = 11819 Sales Value = No of units x SP = 11810 x 120 = 1418280

Desired Contribution = Desired Profit + New fixed cost

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153