Confidential Presentation

Accounting Training

SIB The School of Investment Banking

Mumbai: 103, Embassy Centre, Nariman Point
Delhi / NCR: B-133, Sector 2, Noida
Info@schoolofib.com
www.schoolofib.com
Basic Accounting Concepts
Book Keeping
Book keeping and Accountancy
Book keeping is an art or system of keeping and maintaining record of
business transactions in a regular and systematic manner
It is a continuous process of collecting, analyzing, summarizing and
recording the different types of transactions
Book keeping involves the following:
Book Keeping - Objectives
To maintain permanent records of business transactions

To ascertain the profit earned or loss incurred in the business

To know financial position of the business i.e. capital invested in the

business, assets accumulated and acquired, liability owed etc
To detect and prevent errors and frauds committed by others in the
business
To take decisions on significant business matters
Accounting Terms
Transaction: An exchange of goods or services either for cash or on credit
basis
Entry: Means the recording of a business transaction. Entry can be made only
for those transactions which can be measured in terms of money
Goods: Includes all items and commodities purchased by a company for resale.
For a particular commodity to be known as goods, it should satisfy following
two conditions:
Must be purchased for the purpose of selling, and
Must be part of regular business
Debtor: Is a person from whom the company has to recover money or moneys
worth for goods sold on credit or cash advanced. Thus, a debtor has to repay
the company. It is an asset for the company
Creditor: Is a person to whom a company has to pay money or moneys worth
for any benefit received from him in cash or kind. Thus, a creditor has to
receive cash from the company. It is a liability for the company
Accounting Terms
Fixed Assets: Properties of every description owned by the company are
called assets e.g. machinery, building etc. A property to be called as fixed
asset, has to fulfill the following two conditions:
It should be owned by the company
It should be held for the purpose of using in the business and not for
selling e.g. T.V. set for an electronic dealer will be goods but for others
it will be an asset
Fixed assets can be tangible like plant, building, motor-car or
intangible like goodwill, patents, copy-rights etc.
Current Assets: Refers to short term assets that can be liquidated for cash
easily and are held by the company for a short term purpose (typically not
more than one year). Current assets are usually presented in order of their
liquidity
Accounting Terms
Liabilities: A liability is what a company owes to outsiders. Liabilities
finance various assets. A liability arises when:
Goods are purchased on credit: Current liabilities
Loan is taken: Long term loans / debt
Expenses are unpaid: Current liabilities
Contingent Liability: A liability whose occurrence depends upon the
happening of a certain events which may or may not take place, as at the
balance sheet date. These liabilities are presented in Notes to accounts
and do not appear in the Balance Sheet
Capital: Excess of assets over liabilities is known as capital. It is the
amount invested by a businessman in company, add the profits earned by
the company less the money drawn for personal use

CAPITAL = ASSETS LIABILITIES

Accounting Terms
Bad Debts: Debts which become irrecoverable are treated as bad debts. In
anticipation of some debts which may turn bad in the future, the company
creates a provision for bad and doubtful debts
Capital Expenditure: Expenditure which is incurred for
Purchase of new assets
Putting a new asset into working condition
Acquiring a benefit which will last for a long period of time
Deferred Revenue Expenditure: Heavy expenditure which is incurred in the
current year, but benefit of which may be received or accrue to the business in
the following two to three years is called deferred revenue expenditure e.g.
heavy amount spent on advertisement and publicity is a deferred revenue
expenditure
Reserves: Profits earned by the company belong to shareholders. However, a
part of the profits need to be re-invested in the business for further expansion.
These accumulate over time and are called reserves. Reserves are a liability to
be paid to shareholders at the time of liquidation
Accounting Terms
Depreciation: An asset is procured with a view to use it over a period of
time. Its life cuts across many financial years and hence expenditure on
acquiring the asset is spread over its useful life instead of just treating it as
an expense for the year. This ensures comparability of revenue & cost.
There are different methods of providing for depreciation, the most
common being:
Straight line method: Written off equally over the life of the asset
Written down value method: Written off at a fixed percentage at written
down value of the asset
Units of production method: Asset is written off based on production
during the period and total production target
Provisions: Provisions are liabilities arising out of past events, the amount
and timing of which are uncertain. However, it can be reliably measured
and hence the company should recognize an expense and a liability for
such a provision e.g. provision for taxes, provision for bad debts etc.
Double Entry System
Following are the main principles of double entry system:
Every transaction must have two parties
Every transaction has two aspects
One aspect gives the benefit
Other aspect receives the benefit
Both the aspects are recorded in the books of accounts

EVERY DEBIT HAS A CORRESPONDING CREDIT

i.e., in every transaction, one account is debited and other account is
credited at the same time with an equal amount. If this does not
happen, then the books of accounts (i.e. trial balance and balance sheet)
will not tally
Accounting Principles
Going Concern: Accounts are prepared assuming the business is a going
concern, and that it will continue operations for the foreseeable future. The
enterprise has neither the intention nor the necessity for liquidation
Accrual Principle: All incomes and costs are recognized as they are
earned or incurred. The accrual principle stems from the going concern
principle, that any expense incurred will be liable to be paid in future and
any income earned will be receivable in future. Hence, transactions should
be accounted when they happen, and not when cash is received or paid
E.g. Goods sold and purchased on credit
Prudence / Conservatism: Anticipate no profits, but recognize all losses.
It requires that in situations of uncertainty and doubt, transactions should
be recorded in such a manner that profits and assets are not overstated and
losses and liabilities are not understated
E.g. Closing stock is valued at cost or net realizable value, whichever is
lower
 Classification of Accounts
Classification of
Accounts
Personal Account Impersonal Account

Accounts of a person or Real Account Nominal Account

accounts relating to a
person are called An account of property Anything relating to
Personal Accounts. or anything owned and business expenses,
Persons includes possessed by a losses, income and gain.
(a) Natural and living business. In other In other words, these
persons words, it is that account accounts are business
(b) Legal and artificial which relates to assets, income or business
persons e.g. companies objects etc. which can expenses which cannot
be seen, touched, felt, be seen, touched and
measured, purchased hence they are unreal
and sold
Golden Rules of Accountancy Journal Entries
Personal A/c:
DEBIT THE RECEIVER OF THE BENEFIT
CREDIT THE GIVER OF THE BENEFIT
Real A/c:
DEBIT WHAT COMES IN
CREDIT WHAT GOES OUT
Nominal A/c:
DEBIT ALL EXPENSES OR LOSSES
CREDIT ALL INCOME

Proper recording of a transaction in accordance with these rules is called

Journal Entry. It is the starting point of accounting and one must be very
clear about accurately recording journal entries.
Ledger Posting
A ledger account is defined as a summary of all the transactions relating to assets,
liabilities, expenses and revenue, which have taken place during a given period of
time and show their net effect. When any transaction occurs, they are first
recorded in journal and then posted to their respective accounts in the ledger
Specimen of a ledger account:
Dr. Mr.X A/c Cr.
Date Particulars LF Amount Date Particulars LF Amount
To..a/c By..a/c

Balancing of ledger account means finding the difference between heavier total
and lighter total of the account and recording that difference on lighter side. At the
end of the accounting year, all the accounts operated in the ledger are totaled and
balanced
Trial Balance
At the end of the accounting year, all the ledgers are closed, totaled and balanced.
Some ledger account will show a debit balance while others would show a credit
balance. After this process, a statement is prepared wherein the net balances shown
by every ledger account is systematically recorded to ascertain arithmetical
accuracy. This statement is known as Trial Balance
General rules of the Trial Balance:
Accounts of assets, properties will always show a debit balance. Generally all
real accounts have debit balances
Accounts of liabilities like capital account, bank overdraft, loan received,
creditors and all other payable accounts will have a credit balance
Accounts of income and gains like sales, commission received etc. will always
have a credit balances
Accounts of expenses and losses like purchases, rent, wages, loss incurred on
sale of fixed assets etc will always have a debit balances
DEBIT BALANCE and CREDIT BALANCE COLUMN SHOULD ALWAYS BE
EQUAL
Financial Statements
Final Accounts
Final accounts are the group of three different accounts
Trading account Income Statement / Profit and Loss
Profit and Loss
Balance Sheet Position Statement
This group of three accounts is called Final Accounts because it gives final
result of the business done in the accounting year. It refers to two important
accounting statements prepared by the business at the end of the financial year.
They are
Income statement: means and includes, Trading account and Profit and
Loss account
Statement of financial position: means and includes Balance Sheet
Preparation of Trading account and Profit and Loss account gives the result of
business operations done in the entire financial year. Balance Sheet shows the
financial position of assets and liabilities of the business as on a particular date
Final Accounts
Trading account: Trading account is a part of final account which is prepared
on the basis of direct expenses and direct incomes to ascertain the gross result
of the business done in the accounting year. Expenses and incomes which are
directly connected to production and sales are called direct expenses and direct
income. Specimen of Trading account:
Particular Amount Particular Amount
To Opening stock By Sales
To Purchases Less : Return inward
Less: Return outward By Goods destroyed by fire
To Carriage inward By Drawings (Goods withdrawn by
proprietor)
To Wages
To Factory expenses By Closing stock
To Power and Fuel
To Custom duty on purchase By Gross loss (Balancing amount)
To Manufacturing expenses
To Gross profit (Balancing amount)
TOTAL TOTAL
Final Accounts
Profit and Loss account: It is prepared on the basis of indirect expenses and
indirect incomes of the business to ascertain the net result of the business. These
are the expenses which do not have the direct relationship with the production
Specimen of Profit and Loss account
Particular Amount Particular Amount
To Gross Loss b/d By Gross Profit b/d
To Office salaries By Rent received
To Conveyance By Interest earned
To Printing and stationery By Commission received
To Bad debts By Income from investment
To Audit fees
To Loss on sale of fixed assets
To Commission paid By Net Loss ( Bal figure )
To Bank charges
To Interest paid
To Net Profit ( Bal figure )
TOTAL TOTAL
Final Accounts
The income statement provides us with the following metrics:
Particular Amount
Sales / Turnover / Revenue XXXX
Less: Cost of goods sold XXXX
Gross profit XXXX
Less: Selling, general and administrative expenses (SG&A) XXXX
EBITDA XXXX
Less: Depreciation and Amortization (D&A) XXXX
EBIT XXXX
Less: Net interest XXXX
Profit Before Tax (PBT) XXXX
Less: Taxes XXXX
Profit After Tax (PAT) / Net Income XXXX
Less: Dividends XXXX
Retained Earnings XXXX
Final Accounts
Balance Sheet: It is a positional statement showing the financial position of a
company as on a particular date. Balance Sheet is divided into two parts:
Left hand side of the Balance Sheet are Liabilities
Right hand side of the Balance Sheet are Assets

Liabilities Amount Assets Amount

Share Capital Land & Building
Add : Profit Plant & Machinery
Reserves and surplus Furniture & Fixture
Loan taken Investments
Bank loan Bills receivables
Sundry creditors Sundry debtors
Outstanding expenses payable Closing stock
Loan given
Deposits with banks
Cash in hand
TOTAL TOTAL
Cash Flow Statement
For any business, CASH IS KING. The balance sheet or the profit and loss statement
does not provide us a picture of the cash generated and utilized by the company
Analysts and users of financial statements often want to know how the company
generates cash and uses cash. Cash flow information enables the user to evaluate
changes in net assets, financial structure and other items
Common terms:
Cash: Cash comprises cash in hand and demand deposits with the banks
Cash Equivalents: Cash equivalents are short term, highly liquid investments that
are readily convertible into known amounts of cash, incurring minimal cost
Operating Activities: Operating activities are the principal revenue producing
activities of the enterprise and other activities that are not investing or financing
activities
Investing Activities: Investing activities are the acquisition and disposal of long
term assets and other investments not included in cash equivalents
Finance Activities: Financing activities are activities that result in change in the
size and composition of the owners capital including preference share capital and
borrowings of the enterprise
Cash Flow Statement
Where is the money coming from and where is it going?

Opening Cash and Cash Equivalents

Operating Cash flow Investing Cash flow Financing Cash flow

Cash generated in Cash paid out in Cash received & paid

regular course of making fresh out in raising money
business net of taxes investments in long (equity and debt) for
and net of increase in term assets or cash the business & their
inventories & realized from sale of service cost
receivables investments

Closing Cash and Cash Equivalents

Cash Flow Statement
Cash flow statement can be prepared by two methods
Direct method: Income statement items are converted to cash flows individually
Indirect method: Net income or loss is adjusted for accruals such as accounts
receivable and payable, and for non-cash expenses such as depreciation. It is a
reconciliation of the accrual based and cash based accounting
Only operating activities section is different between the methods. Investing and
financing sections are the same
Cash flow from operations - Direct method
Cash receipts from customers XXXX
-- Cash paid to supplier and employees XXXX
-- Cash expenses paid XXXX
Cash generated from operations XXXX
-- Income tax paid XXXX
Cash flow before extraordinary items XXXX
Extraordinary items XXXX
Cash flow from operating activities XXXX
Cash Flow Statement
Cash Flow from operations - Indirect method
Net income XXXX
+ Non cash items (depreciation and amortization) XXXX
+ Non operating items (loss on sale of assets) XXXX
+/- Increase (Decrease) in current liabilities XXXX
+/- Decrease (Increase) in current assets XXXX
- Non operating gains (gain on sale of assets) XXXX
Cash flow from operating activities XXXX
Cash Flow Statement
Cash Flow Statement
Cash flow from Operating activities XXXX
(Direct method or Indirect method)
Cash flow from Investing activities
Purchase of fixed assets / Investments XXXX
Sale of fixed assets or investments XXXX
Interest / Dividend received XXXX
XXXX
Cash flow from Financing activities
Issue of shares or debentures XXXX
Redemption of preference shares or debentures XXXX
Loan taken / repaid XXXX
Dividend / Interest paid XXXX
XXXX
Net Increase / Decrease in Cash and Cash Equivalents XXXX
Financial Statements Comparison
Financial
Nature Focus Key Information
Statement
Composition of
Stock Statement Financial position assets (resources)
Balance Sheet
on a particular date & liabilities
(sources)
Profitability during
Income Statement Flow Statement Revenues & costs
a financial period

Cash inflows
arising from
Cash inflows &
Cash Flow Flow Statement revenue &
outflows during a
Statement liabilities and cash
financial period
outflows arising
from costs & assets
Forms of Business Organization
There are different forms of business organizations:
Proprietary concern: One man show. Unlimited liability
Partnership firm: Small group of people. Unlimited liability
Limited liability partnerships (LLPs): Partnership with limited
liability for others and unlimited liability for general partner
Private limited company: Small group of people with limited liability
Public limited company (unlisted): Large group with limited liability
Public limited company (listed): Large group with limited liability
and high liquidity
Lease Accounting
What is a Lease?
A lease is a contractual agreement between the lessor (owner of the asset)
and the lessee (tenant of the asset)
It gives the lessee the right to use specific property, for a specific duration
and in return for lease payments
Why is Lease accounting important?
Consider an asset which can either be purchased for Rs.10 million today or
Rs.1.2 million paid over ten years. The life of the asset is 10 years
Person A who purchases the asset for cash records asset of Rs.10
million, and depreciates this over ten years
Person B would record asset of Rs.12 million and depreciate this over
ten years
Why should the same asset be recorded at two different prices because
of financing decisions? Is Rs.2 million not on account of interest for
taking loan for the asset?
Operating Lease
Depending on the nature of the agreements, a lease can be classified as an
operating lease or a finance lease
Assets subject to a finance lease are recognized on the lessee's balance
sheet along with the effect of payments due to the lessor
Assets subject to an operating lease are shown on the lessor's balance
sheet
A lease is classified as a finance lease if it transfers substantially all the risks
and rewards incident to ownership, from the lessor to the lessee
Leases that are not finance leases are operating leases: An operating lease is a
lease whose term is shorter compared to the useful life of the asset which is
being leased and is commonly used to acquire equipment on a relatively short-
term basis
As the lessee does not assumes the risk of ownership, the lease expense is
treated as an operating expense in the income statement of the lessee and
the lease does not affect his balance sheet. Hence, it is an off balance sheet
source of financing
Finance Lease
A lease is classified as a finance lease if any of the following conditions are
satisfied:
Lease term is for a major part of the economic life of the asset, even if title
is not transferred. The lease period is at least 75% of asset life
At the inception of the lease, the present value of the minimum lease
payments amounts to at least 90% of the fair value of the leased asset
The lease transfers ownership of the asset to the lessee by the end of the
lease term
A bargain purchase option exists that allows the lessee to buy the leased
asset or provides a financial incentive to purchase the asset
The lease, when signed, is recognized both as an asset and as a liability (for the
lease payments) on the balance sheet of the lessee
The present value of the lease payments are treated as debt and an asset
Interest is calculated on this amount and shown as part of the interest
expense
Accounting for Lessor
If the lease is an operating lease:
Record rental income for rental receipts from lessee
Depreciate the asset leased as per accounting policies and the asset
continues to be on its balance sheet
If the lease is a finance lease:
Recognize a sale of asset and calculate the profit / loss on sale of asset
Remove the asset from books and replace it with a receivable (present
value of all lease payments)
Treat rental receipts as consisting of interest and principal (interest
income is recognized over the period of the lease and principal is
deducted from the receivable)
Accounting for Lessee
If the lease is an operating lease:
Do not record asset or liability
Record rental expense as rental payments are made to lessor
If the lease is a finance lease:
Record an asset (leased equipment) and a liability (lease obligation)
equal to the present value of all the rental payments
Record depreciation for the asset over the life of the asset / lease
period, whichever is less
Finance lease payments should be apportioned between the interest
expense and principal repayment (reduction of the outstanding
liability)
Accounting for Taxes
Accounting for Taxes
There are two types of tax expense:
Current taxation
Deferred taxation
Current taxation: During each accounting period, the company must estimate
how much tax is due to be paid to the government on the profits earned during
the year. Thus, current taxation is the amount of income tax determined to be
payable / recoverable in respect of the taxable income / tax loss for a period

Profit before tax (Accounting profit) XXXX

Add: - Disallowances XXXX
- Accounting depreciation XXXX
- Non cash expenses XXXX Current Tax = Taxable Profit
* Tax Rate
Less: Tax depreciation XXXX
- Cash expenses XXXX
Taxable profit (Chargeable to tax) XXXX
Accounting for Taxes
The difference between accounting profits and taxable profit are of two types.
These differences are as follows:
Temporary Differences: Differences that will reverse in future years e.g.
depreciation, cash expense etc
Permanent Differences: Differences that will never reverse in the future
e.g. fines and penalties, donations
Deferred taxes represent an estimate of the actual tax effects due to temporary
differences
A deferred tax may be recorded as an asset and an income, if it is the
result of temporary difference that will result in a future tax deduction
A deferred tax may be recorded as a liability and an expense, if it is the
result of a temporary difference that will result in future tax payable
Any deferred tax recorded as an asset or a liability will be reversed when the
temporary difference reverses
Accounting for Taxes Example
Particulars Year 1 Year 2 Total
Profit before tax 100,000 100,000 200,000
Add: Accounting depreciation 20,000 20,000 40,000
Less: Tax depreciation 30,000 10,000 40,000
Taxable Income 90,000 110,000 200,000
Current Tax (Tax rate of 30%) (27,000) (33,000) (60,000)
Temporary Difference (10,000) 10,000 0
Tax Effect (At tax rate of 30%) (3,000) 3,000 0
Tax Expense (Current + Deferred) (30,000) (30,000) (60,000)
Net Income 70,000 70,000 140,000
Deferred Tax Liability (3,000) 0 0
Impairment of Assets
The financial statements record fixed assets at historical cost, less accumulated
depreciation
If the fair value of the asset > historical cost, prudence / conservatism principle
does not allow us to record the unrealized gain
If the fair value of the asset < historical cost, the same principle requires us to
write off the difference. This difference is called as Impairment
Valuing the fixed assets is not an easy task, as the fair value is not easily available
Fair value and book value of the assets are compared at Cash Generating Unit
(CGU) level
Represents the lowest level within the entity which has independent operations
and monitored for internal management purposes; and
Is not larger than a reporting segment
Every year, management will have to check assets for impairment
Assets are impaired in the following order:
Goodwill
Intangibles
Other Assets (CGU)
Impairment of Assets - Test
Book Value of CGU
(including goodwill) versus
Higher of
Fair value less cost to
sell
Amount obtainable from
the sale of the asset or
CGU in an arms length
transaction less cost of
disposal external
(market) value
Recoverable amount of
CGU
Value in Use
Present value of future
cash flows from the use
of the asset internal
value (from use) for the
entity
Employee Benefits
Accounting for Employee Benefits
Employee benefit schemes are of two types:
Defined Contribution Plans: Scheme defines the contributions that the
employer will make to the fund on behalf of the employee where the
residual risk remains with the employee. The contribution is expressed as a
percentage of gross salary. No actuarial valuation is required in this case.
Accounting of these schemes involves charging the contributions as an
operating expense e.g. provident fund, superannuation
Defined Benefit Plans: Scheme defines the target benefits to be paid to
employees on retirement in the future. The target is expressed as a fraction
of final salary. The fraction changes as extra years of service are
completed. Actuarial valuation is required as there are many assumptions
involved. The risk is uncontrollable as there are many uncertainties
associated with the ultimate outcome. There is a need to recognize assets
and liabilities in balance sheet. These benefits can either be funded or
unfunded e.g. pension and other retirement benefits
Defined Benefit Schemes
Funded pension schemes:
It means that any contribution that the actuary determines must be made to a
separate funding vehicle
This scheme has both a fund (cash invested to satisfy future obligation) and an
obligation (the amount paid to the employee at the retirement)
Unfunded pension schemes:
The employer promises to provide an employee with benefits under a scheme,
but makes no advance funding in the scheme for those benefits
Benefits are then paid directly by the employer when it becomes due
The level of funding is determined by the actuary on the basis of following factors:
Salary level
Retirement age
Life expectancy
Employee turnover
Investment performance of the fund assets
Defined Contribution Plans

Accounting for defined contribution schemes:

Balance Sheet Income Statement

If contribution due = contribution paid, Contribution for the year, to be

no liability or asset to be recognized recognized as an expense

If contribution due > contribution paid,

recognize the difference as a liability

If contribution due < contribution paid,

recognize the difference as an asset
Defined Benefit Plans
Accounting for defined benefit schemes:
Determine benefits earned by employees in return for their service
Discount the benefits earned to arrive at present value of those benefits and
current service cost
Determine fair value of plan assets (if funded)
Determine total amount of actuarial gains / losses and the amount of gains /
losses to be recognized
Defined Benefit Plans Accounting
Balance Sheet Impact Amount
Projected benefit obligation XXXX
Less: Fair Value of plan assets (if funded) (XXXX)
Deficit / (Surplus) XXXX
Add / (Less) unrecognized actuarial gains / losses XXXX
Balance Sheet Asset / Liability XXXX

Income Statement Impact Amount

Current service cost XXXX
Add: Interest on present benefit obligation XXXX
Less: Return on plan assets (if funded) (XXXX)
Add/(Less): Amortization of gains / losses XXXX
Net pension cost XXXX
Ratio Analysis
Ratio Analysis
Ratio analysis is a very useful tool for financial analysis. It helps comparison of
different time periods for the same company or comparing different companies
for the same time period. Ratios look at the relationships between individual
value and relate them to how a company has performed in past and might
perform in the future. They are best interpreted in comparison with
Historical data
Competition
Industry norms
Types of Ratios:
Liquidity: How solvent is the business?
Shareholders / Investors : What have the owners earned?
Gearing : How is the company financed?
Profitability : What did the company earn?
Turnover : How efficiently assets are deployed by the firm?
Liquidity Ratios
Ratio Formula Numerator Denominator Interpretation

High ratio indicates,

Cash & Bank Sundry Creditors assets are tied up in
Receivables / Accruals Outstanding Expenses unproductive activities
Current Assets
Current Inventories Short Term Loans Too low ratio
Current
Ratio Short terms Loans Bank Overdraft implies the risk of not
Liabilities
Marketable Securities Provision for taxation being able to pay
Prepaid Expenses Proposed Dividend current obligations
Ideal Ratio is 2:1

Quick Ratio Quick Assets Current Assets Ability to meet

Current Liabilities immediate liabilities
or Acid Test Quick Less : Inventories
Ratio Liabilities Less : Bank Overdraft
Less : Prepaid Expenses Ideal Ratio is 1:1
Shareholder / Investors Ratios
Ratio Formula Numerator Denominator Interpretation

Earnings attributable to
Earnings Per Profit After Tax Profit excludes Weighted average each share
Share (EPS) No. of Equity Shares preference dividend number of shares
Higher the better

Dividend Per Dividends Profits distributed to Weighted average Amount of Profits

Share (DPS) No. of Equity Shares Equity Shareholders number of shares distributed per share

Dividend X 100 Dividend per share Dividend paid as

Dividend Yield Current market price
Share Price (Interim + Final) percentage of Share Price
Dividend Dividend X 100 Dividend per share What % of EPS is paid
Earning per share
Payout Ratio EPS (Interim + Final) out as dividend
Denotes price investors
Price Earnings Share Price Current market are ready to pay per Re 1 of
Earning per share earnings
Ratio EPS price
Useful valuation multiple
Gearing Ratios

Ratio Formula Numerator Denominator Interpretation

Equity Share Capital Denotes the financing

All Interest bearing Reserves & Surplus mix of the company
Debt Equity Debt
debt Preference Share Credit rating is
Ratio Equity
Capital Less: adversely affected, if
Accumulated Losses ratio is too high

Denotes the total

Assets assets held per equity
Leverage Total Assets Equity
Equity High ratio denotes
higher risk
Indicates ability to
Interest EBIT Earnings before meet interest obligations
Interest on Debt
Coverage Ratio Interest Expense interest & taxes
Higher ratio is better
Interest on Debt Indicates ability to
EBIT
Debt Coverage Earnings before Installment of Debt meet commitments &
(Interest + Debt
Ratio interest & taxes (principal repaid) outflow towards
repayments)
installment & interest
Profitability Ratios

Ratio Formula Numerator Denominator Interpretation

Total Sales Indicator of basic

Gross Profit Gross Profit X 100 Total Sales profitability
Less: Cost of Sales
Margin Net Sales Less: Sales Return
Higher the better

Total Sales Indicator of overall

Net Profit Net Profit X 100 Total Sales profitability
Less: All Cost
Margin Net Sales Less: Sales Return
Higher the better

Return on Equity Indicates the return on

EBIT X 100
Capital Earnings before Plus: Debt the total capital employed
Average Capital
Employed interest & taxes (Calculate average of
Employed
(ROCE) opening & closing) Higher the better

Shows how effective

(Opening Equity + the firm is using its
Return on PAT X 100
Profit After Tax Closing Equity)/ 2 capital to generate profit
Equity (ROE) Average Equity
Higher the better

Note: All Profitability ratios are expressed in Percentages

Turnover Ratios

Ratio Formula Numerator Denominator Interpretation

Opening Stock Indicates how fast

Stock Turnover COGS Add: Purchases (Opening Stock + inventory is used / sold
Ratio (STR) Average Stock Add: Direct Expense Closing Stock)/ 2
Less: Closing Stock Higher the better

It means the days of

365 days 360 days can also be Stock Turnover sales held as stock
Stock Days
STR used Ratio
Shorter the better

Debtors Indicates speed of

Credit Sales Total Sales (Opening Debtors + collection of credit sales
Turnover Ratio
Average Debtors Less: Cash Sales Closing Debtors)/ 2
(DTR) Higher the better
Measures how quickly
365 days 360 days can also be Debtors Turnover cash is being collected
Debtor Days from debtors
DTR used Ratio
Shorter the better

Note: All Turnover ratios are expressed in Times

Turnover Ratios

Ratio Formula Numerator Denominator Interpretation

Creditors Total purchases (Opening Creditors Indicates velocity of credit

Credit Purchases payment
Turnover Ratio Less: Cash + Closing
Average Creditors
(CTR) Purchases Creditors)/ 2 Lower the better

365 days 360 days can Creditors Turnover Gives no. of payment days
Creditor Days
CTR also be used Ratio Higher the better
Ability to generate sales
Asset Turnover Turnover (Opening Assets + per rupee of Asset
Net Sales
Ratio Average Assets Closing Assets)/ 2
Higher the better
Duration of time required
to complete the sequence of
events, right from purchase
Working Stock days + Debtor of raw materials to
NA NA
Capital Cycle days Creditor days realization of sales in cash
Also, called Operating
cycle
Note: All Turnover ratios are expressed in Times
Consolidation Accounting
Amalgamation
Amalgamation

External
Amalgamation Absorption
Reconstruction

Dull Ltd., a loss making

A Ltd. and B Ltd. come A Ltd. acquires / takes
company is acquired by a
together to form AB Ltd. over B Ltd.
newly formed company

An existing company
Two companies go into running into losses whose
It is a liquidation of one
liquidation and one new assets and liabilities are
company (target
company comes into acquired by a newly
company)
existence formed company
Amalgamation
Legally speaking, amalgamation, absorption and external reconstruction
are three different terms but from accounting point of view they are all one
and the same. In short, it is sale of one company and acquisition by the
another
Purchase Consideration (PC): The buying company has to pay cash,
shares, etc to the selling company for the business (assets-liabilities) taken
over. The amount payable by the buyer to the seller is known as Purchase
Consideration. There are three different ways to calculate it:
Lumpsum method: PC is given, without reference to value of assets
& liabilities
Net Asset method / Intrinsic method: Agreed value of assets and
agreed value of goodwill less agreed value of liabilities
Net Payment method: The payment made to equity and preference
shareholders in form of cash, shares, etc. are calculated
Goodwill
Goodwill: Goodwill is the excess of the purchase consideration over the fair
value of identifiable net assets acquired. In simple words, it is the residual
value after the cost of the business combination has been allocated to the
identifiable assets, liabilities and contingent liabilities
At acquisition date, goodwill is recognized as an asset
Goodwill is not amortized, but is tested annually for impairment as it does
not generate independent cash flows (based on IFRS)
A company pays excess because the combination will have synergies,
unquantifiable benefits or because it is getting a control over the company
There can also be negative goodwill, which means consideration paid is less
than fair value of assets acquired. It is recognized as capital reserve on
liabilities side. However, as per IFRS, negative goodwill should be recognized
as income in the Income Statement
If purchase consideration is calculated using lumpsum or net payment method,
then goodwill needs to be calculated. In net asset method, it is already known
Accounting for Target company
All the balance sheet items, assets and liabilities are transferred to
realization account at their book values
Shareholders equity (capital and reserves) are transferred to equity
shareholders account
Consideration received is credited to realization account
Any liquidation expenses are debited to realization account
Realization account balance is transferred to equity shareholders account
Equity shareholders account is balanced by paying off the consideration
Accounting for Acquirer company
There are two methods of accounting in acquirers books:
Pooling of Interest: Assets and liabilities, including reserves are taken over
at book value of old company. Difference between PC and book value is
adjusted through the reserve account. This method is generally not used
Purchase Method: Assets and liabilities are taken over at agreed value.
Difference between PC and agreed value is recognized as goodwill / capital
reserve (either of the two will appear). This method is most widely used.
Even as per IFRS, it is the widely used method (IFRS 3 Business
Combinations)
Accounting under purchase method:
Assets and liabilities taken over are recognized at their fair value. The
difference (balancing figure) is goodwill or capital reserve
The PC is discharged by cash, stock etc. In case of issue of stock, issue
price less face value is credited to securities premium account
Any intercompany balance is set off
Accounting for Investments
Holding Holding Holding
Level of Investment
0 < 20% 20% < 50% > 50%

Extent of influence None Significant Control

Accounting Associated Subsidiary

Investment
term undertaking undertaking

Accounting
No consolidation: Equity method or
treatment / Full consolidation:
Held at cost less Proportional
Consolidation Purchase method
impairments method
technique
Small Investments

At the Time of
Post transaction
transaction

Test book value for

Debit Investment impairment, if it is the
(Financial asset) case:
B/S
Credit Cash/Financial Credit Provision for
debt Diminution in
investment

Receive dividends
(finance income) which
P/L No impact increase cash (B/S)
Potential impact from
impairment
Accounting for Subsidiaries
Consolidated financial statements are prepared by combining the financial
statements of the parent and all its subsidiaries on a line-by-line basis, adding
together those items of assets, liabilities, equity, income and expenses that are
alike
The following procedures are applied to present the group as a single entity:
The parent's investment in subsidiary and the parent's share of equity in
subsidiary is eliminated and goodwill / capital reserve is created
The minority's share of the net income in the consolidated subsidiaries is
identified based on the minority's interest in each subsidiary and presented
as an allocation of net income
The minority's share of consolidated subsidiaries' net assets is identified
and presented in the balance sheet, within equity but separate from the
parent shareholders' equity
All intra-group balances and transactions and resulting unrealized profits
or losses are eliminated in full
Accounting for Subsidiaries
Method Example

Aggregate the balance A (Parent Co. Accounts) B A+B

sheets
(sum each line) B Shares: 100 SE 150 Fixed Assets: 75 SE 100 Fixed Assets: 175 SE 150
Cancel the Investment in Other FA: 100 Debt 100 Current Asset: 25 Debt 0 Current Assets: 75 Debt 100
the Acquirer with the A acquires 100% Current Assets: 50
Shareholders Equity in of B for 100
the Target
Eliminate inter-company
accounts

A (Parent Co. Accounts) B A+B

A acquires 100% B Shares: 200 SE 150 Fixed Assets: 75 SE: 100 Fixed Assets: 175 SE 150
Recognise Goodwill on
of B for 200 Other FA: 100 Debt 200 Current Asset: 25 Debt 0 Goodwill: 100 Debt 200
acquisition
Current Assets: 50 Current Assets: 75

A (Parent Co. Accounts) B A+B

Recognise minority A acquires 75% B Shares: 200 SE 150 Fixed Assets: 75 SE: 100 Fixed Assets: 175 SE 150
Other FA: 100 Debt 200 Current Asset: 25 Debt 0 Goodwill: 125 Minority 25
interests of B for 200
Current Assets: 50 Current Assets: 75 Debt 200
Accounting for Subsidiaries
Method Example
Sum all income A acquires 100% A (Parent Co. Accounts) B A+B
statements captions of B for 100
Sales Sales Sales
Omit intercompany
dividends 200 100 300
Eliminate impact of any COGS COGS COGS
intercompany trading
(100) (50) (150)
(sales, profit, etc) SG&A SG&A SG&A

(50) (25) (75)

EBIT A (Parent Co. Accounts) EBIT B EBIT A+B
Test Goodwill for A acquires 100%
impairment and potential of B for 200 50 25 75
exceptional amortisation Sales
Dividend B Sales Sales
change if necessary Assuming Financing Cost Financing Cost
200
10 100 300
creates Goodwill
COGS
Financing Cost (1) COGS
(10) COGS
(30)
of 100 which
results in PBT PBT
(100)
(20) (50) (150)
impairment of 25 SG&A SG&A SG&A
PBT 15 45
Tax Charge Tax Charge
(50)
40 (25) (75)
EBIT
Tax A (Parent Co. Accounts)
Charge EBIT
(6) B EBIT
(18) A+B
Recognise minority A acquires 75%
interests of B for 200 Net Income Net Income
50
(12) 25 75
Sales
Dividend B Sales Sales
GW
Net Income 9 27 Impairment
Assuming Financing Cost
creates Goodwill 200
10 100 300
(25)
28
COGS
Financing Cost (1) COGS
(10) COGS
Financing Cost
of 100 which
results in PBT
(100)
(20) (50) (150)
(30)
impairment of SG&A SG&A SG&A
PBT 15 PBT
Rs.25 Tax Charge
(50)
40 (25) (75)
20
EBIT
Tax Charge EBIT
(6) EBIT
Tax Charge
Net Income
50
(12) 25 75
(18)
Dividend B
Net Income 9 GW Impairment
Net Income
Financing Cost
10
28 (25)
2
Accounting for Associates
There is a need for understanding the resources and earnings over which the
parent has influence. These investments are referred to as associates
Associates are a form of inter-corporate investment. Such investments possess
the following characteristics:
Long term investment
Investing company exercises significant influence
Typically involves at least 20% ownership, but less than 50% ownership
In determining whether or not significant influence exist, Investments in
Associates states that the following may be indicative:
Representation on the board of directors
Participation in policy-making process
Material transactions between investor and investee
Interchange of managerial personnel
Provision of essential technical information
Accounting for Associates
As per the equity method of accounting for associates, the entity presents its
interest in the associate's net assets and net income in a single line in the balance
sheet and income statement respectively
The following procedures are applied to recognize the results of associates using
the equity method :
The investment in associate is initially recognized at cost of acquisition.
Cost includes goodwill and book value of assets and liabilities identified on
the date of acquisition
The investors share of net income is recorded as a separate line item in the
income statement as Income from equity investments
Any dividends from the associate are a reduction of the associate's carrying
value of investments. Hence it is reduced from Investments in the Balance
Sheet and not accounted in the Income Statement
There is no minority interest to be considered
The entity should record its share of its associates' losses until the carrying
amount of its investment is reduced to nil
Accounting for Associates
On 31st December 2005, Entity A acquired a 30% interest in Entity B and
achieved significant influence. The cost of investment was Rs 4,000 and the
equity of B on that date was Rs10,000. How will the transaction be recorded in
the books of A
A will record investment of Rs 4,000 in its books (which includes goodwill
of Rs 1,000)
Entity A recognized an impairment charge of Rs 20 during 2006, regarding the
investment in B. During 2006, B recognized profit before tax of Rs130 and a
tax charge of Rs 30. What will be entity As share in Bs profits?
A will record profit of Rs. (100X30%)-20 = Rs 10 in its books. The
investment at the end of year will stand at Rs 4,000+30-20 = Rs 4,010
Accounting for Joint Ventures
A company can enter into a joint venture with another company. In standalone
books, such investments are shown in investments and any dividend received is
credited to the account. For a proper disclosure, it needs to be consolidated. It
can either be done by equity method (same as associates accounting) or it can
be proportional consolidation
Proportional consolidation involves consolidating the investing companys
share of each item in the balance sheet and income statement on a line by line
basis
The advantage of this approach is that it disaggregates the equity
investment and provides analysts with more information
US GAAP does not allow for proportional consolidation. IFRS allows for
equity method or proportional consolidation. Indian GAAP only allows for
proportional consolidation

Book Value of CGU
(including goodwill)
Higher of
Fair value less cost to
sell
Amount obtainable from
the sale of the asset or
CGU in an arms length
transaction less cost of
disposal
external (market) value
Impairment of Assets - Test
Recoverable Amount of
versus CGU
Value in Use
Present value of future
cash flows from the use of
the asset
internal value (from use)
for the entity
 US GAAP, IFRS and Indian GAAP
Item IFRS US GAAP Indian GAAP
Historical cost Uses historical cost, No revaluations, Uses historical cost,
but assets may be except for certain but assets may be
revalued to fair value types of financial revalued to fair value
instruments
Components of Two years Three years required Single entity parent
financial statements consolidated BS, P/L, for public companies company standalone
cash flow and change (only consolidated BS, P/L and cash flow.
in equity statements) for all Public listed
statements expect BS companies are
required to prepare
consolidated
statements
Inventory valuation LIFO method of LIFO method is Similar to IFRS
valuation is prohibited permitted
 US GAAP, IFRS and Indian GAAP
Item IFRS US GAAP Indian GAAP
Cash flow statements Direct or indirect Direct or indirect Similar to IFRS,
method is used method is used. however indirect
Flexibility for SEC encourages method is required
treatment of interest direct method for listed companies
expense and Interest expense Interest expense
interest income and and income and classified as
dividend dividend income are financing activity,
operating activities and interest and
dividend received as
investing activity

Consolidation of JVs Both equity and Equity method is used Proportional

proportional consolidation method
consolidation method is used
is used
 US GAAP, IFRS and Indian GAAP
Item IFRS US GAAP Indian GAAP
Provisions Provisions are Similar to IFRS Similar to IFRS,
discounted to present except that
value where the effect discounting is not
of the time value of permitted
money is material
Preference shares Mandatorily Mandatorily All preference shares
redeemable redeemable are disclosed
preference shares are instruments with a separately as share
classified as liabilities date or event certain capital under
redemption are shareholders funds
classified as liabilities
Convertible debt It is accounted for on Is usually recognized Recognized as a
a split basis, with as a liability, unless liability based on its
proceeds allocated there is a beneficial legal form without any
between debt and conversion feature split
equity
 US GAAP, IFRS and Indian GAAP
Item IFRS US GAAP Indian GAAP
Purchase of own Shown as deduction Similar to IFRS Purchase is permitted
shares Treasury from equity in limited
shares circumstances. Such
shares purchased are
required to be
cancelled i.e. cannot
be kept as treasury
stock
Dividend on ordinary Dividends are Similar to IFRS Dividends are
shares accounted in the year accounted in the year
when declared when proposed
Research and Research costs are Research and Similar to IFRS
Development costs expensed as incurred. development costs are
Development costs expensed as incurred
capitalized and
amortized