Introduction To Financial Accounting

INTRODUCTION TO FINANCIAL ACCOUNTING
PRESENTED BY PROF. (C.A.) SWATI GODBOLE
09/24/10
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
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
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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
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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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

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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

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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Contd.
REAL
Debit What Comes In

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Credit What Goes Out

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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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Ledger Folio = Page no.
Journal Folio
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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
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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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
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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
1500 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

For recording return inwards or sales return

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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
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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
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
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

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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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
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
*******
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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
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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

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

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5,00,000 Cash 80,000 Plant Inventory
Retained Earnings Total

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10,000 Accounts receivable 5,90,000

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
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
Total 5,10,000
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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

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

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?
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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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KEY CONCEPTS RELATED TO F.M

ASSESSMENT OF CURRENT
BUSINESS FINANCIAL ANALYSIS ASSESSMENT OF FUTURE FINANCING REQUIREMENTS FINANCIAL PROJECTIONS
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CONTD..
ISSUES RELATED TO LONG TERM
FINANCING DECISION COST OF CAPITAL , CAPITAL BUDGETING AND STRUCTURE DECISIONS ISSUED RELATED TO INVESTMENTS
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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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DIFFERENT TOOLS USED FOR FINANACIAL ANALYSIS

RATIO ANALYSIS CASH FLOW & FUND FLOW ANALYSIS
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RATIO ANALYSIS
It is a systematic use of ratios to interpret/
assess the performance and status of the firm
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MEANING - RATIO
Ratio is a comparison between two
variable
It may be presented in the form of % or
times or :
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TYPES OF RATIOS
Liquidity ratios Capital Structure ratios Profitability ratios Activity ratios
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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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CURRENT RATIO
Is a measure of liquidity calculated by
dividing current assets by current liabilities

Formula : Current Assets / Current
Liabilities
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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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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

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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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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.
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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.
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)
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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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COVERAGE RATIO
Measure the firms ability to pay certain
fixed charges.
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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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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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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 equityholders?
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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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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
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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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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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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.
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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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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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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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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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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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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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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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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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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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
09/24/10
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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Topics for Today

Introduction to Cost Accounting Meaning Different Elements of Cost Classification of Cost Cost Sheet
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INTRODUCTION
Financial Accounting
Management Accounting
Cost Accounting
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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Cost Sheet
Prime Cost Factory Cost Cost of Production Cost of goods sold Cost of Sales
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
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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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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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.
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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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;
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.
09/24/10
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;
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.
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
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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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.
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

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
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
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
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
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
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

09/24/10
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
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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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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
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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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Introduction To Financial Accounting

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Introduction To Financial Accounting

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INTRODUCTION TO FINANCIAL ACCOUNTING

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

PROF. (C.A.) SWATI GODBOLE

BACKGROUND AND MEANING

BUSINESS IS ALL ABOUT

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

Post mortem of Business transactions

Accounting For management

Cost estimation, Cost control

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

FINANCIAL ACCOUNTING BASIC PRINCIPLES

Business entity Going concern

BUSINESS AND OWNERS ARE SEPARATE BUSINESS = ARTIFICIAL LEGAL ENTITY

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

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

Revenue recognized only when it is realizable or earned or realized

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

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

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

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

The immediate recognition of loss is

supported by the underlying principle of

Matching Consistency Judgment Conservatism

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

The determination of the expenses for

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

Cost Consistency Matching Time period

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

The Business entity concept

Assigning revenues to the accounting

Accounting period Continuity assumption Matching rule Revenue recognition

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

Generally accepted accounting

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

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

REAL AND NOMINAL

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

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

Classify the following into Personal, Real

THREE GOLDEN RULES FOR DEBIT AND CREDIT

Debit The Receiver

Credit The Giver

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

Debit What Comes In

Credit What Goes Out

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

Contd. The same example

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

Debit All Expenses And Losses

Credit All Incomes And Gains

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

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

transactions we follow certain steps

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

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

and Sons Rs.20000

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

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

Point out the accounts which will be

debited and credited for each one of the following transactions

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

BOOK OF PRIME ENTRY

Amount **