Understanding Financial Accounting

Ashok Kumar Malhotra, FCA Professor of Finance & Chairperson of Center for Business Management June 2013

Basics of Financial Accounting

Introduction Types of business/Structure of business Accounting equation GAAP Conventions Sample Transactions Trial Balance

Situation - 1

Infotech was incorporated long back with help of four friends of Mr. Sahil Gandotra. Infotech has bank balance of Rs. 200 crores as of 18th June 2010.

1.

Is Infotech a wealthy company?

What is the net-worth of an organisation at a point of time?

2.

Situation - 2

Infotech has a plant & machinery worth of Rs. 50 lakhs. Infotech is unable to make payment of electricity bills for the last so many months. What is the main problem?

Situation - 3

Infotech is managed by five software professionals including Mr. Sahil Gandotra and able to generate revenue of Rs. 45000 every month consistently for the so many years but without significant bank balance.
Is it a good company to work with?

Situation - 4

Infotech has sales of $25/- lakhs and expenses of Rs. 10/- lakhs and Capital of 50 lakhs, liabilities 25 lakhs and assets 150 lakhs. The data is for the period 201112.

What do understand by about profitability of Infotech for the period?

Situation 5

Infotech is a consistently profitable company. 100% of each years profit is withdrawn in the form of profit by owner including Mr. Sahil Gandotra. Can the company achieve sustainable growth in future?

Situation - 7

Car purchased by Infotech should be recorded in accounts at:

Market Price Value Cost

While analyzing a fin. St. one must consider

Take now & pay later
i. ii. iii.

iv. v.

Cash versus Credit Cost, Price, Value Capital Expenditure versus Revenue Expenditure Tangible & Intangible Assets Real accounts, Personal accounts & Nominal accounts

Pay now & take later

Financial Statements
vi.

vii.
viii. ix. x. xi.

Accrual vs. Cash Basis Long-term vs. short term Current versus non-current Debt and owners capital Debit means Expense, Assets or Recoverable Credit means Revenue/Gain, Liabilities or Reserve

Types of Businesses
Manufacturing Business
Product

Maruti Suzuki HCL Infosys Bata Coca-Cola Philips

Cars, trucks, vans Computer chips Athletic shoes and apparel Beverages Stereos and television

Types of Businesses
Merchandising Business
Product

Big Bazar Land Mark Reliance Digital Amazon.com

General merchandise Toys books etc. Consumer electronics Internet books, music, video retailer

Types of Businesses
Service Business
Product

Appu Ghar Jaipur Golden Taj Hotels PVR Karvy Consultants Bharti Airtel

Entertainment Transportation Hospitality and lodging Entertainment Financial advice Telecommunication

There are three types of business organizations

Proprietorship Partnership Company

A partnership is owned by two or more individuals.

Advantages More financial resources than a proprietorship. Additional management skills.

Disadvantage Unlimited liability.

JM & Co

A company is organized under state or federal statutes as a separate legal entity.

Advantage The ability to obtain large amounts of resources by issuing stocks. Disadvantage Double taxation.

JM & Co

Cash cycle of a firm

The Accounting Equation

Revenue
Sales

Expenses = Profit
R>E Profit else loss

Material Consumption + Expenses incurred

Who has to enjoy profit? Who has to bear loss?

The Accounting Equation

Assets = Liabilities + Owners Capital The rights of the creditors, which represent debts of the business

The resources owned by a business

The rights of the owners

Stock Equation (Quantity & Cost)

Opening Stock + Purchases = Consumption + Closing Stock

Inventory at the beginning

Consumption, Wastages etc. of inventory

Inventory Purchased during the period

Closing based on physical inventory at the end of period

Vouchers & Supporting Documents Verification/ approval Enter the Primary Books Filed in Voucher file

Enter into Secondary Books

Compile Trial Balance Final Accounts Audited Statements of Account

Chart of Accounts

Income accounts Expense accounts Asset accounts Liability accounts Capital accounts

Generally Accepted Accounting Principles

Matching principle Period Cost Entity There are four more GAAPs, we cover as we progress

Economic Transaction Vouchers

1. 2. 3.

4. 5. 6.

Date Amount Nature Capital (Exp. Or gain) Revenue (Exp. Or gain) Head of account Nominal, personal, real Cash / bank / otherwise Increase / decrease