Understanding Corporate Financial Statements

Ashok Banerjee Indian Institute of Management Calcutta

Why Accounting?

Every business entity is exposed to three types of risks of varying degree:

Market Risk Credit Risk Operational Risk

Accounting help reduce operational risks. Accountants ideally should not be too creative!
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Functions of Accounting System Internal routine reporting to managers for cost

planning and cost control of operations, and performance evaluation of people and activities. Internal routine reporting to managers on the profitability of products, brand categories, customers etc. Internal non-routine reporting to managers for strategic and tactical decisions. External reporting through financial statements.
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Corporate Reporting Supply Management: responsibility to be honest, direct, and Chain

transparent.

Board: responsibility of oversight. Auditors: responsibility to investigate and provide

assurance.

Analysts: responsibility to be independent. Media: responsibility to report fairly. Investor: responsibility to do his/her homework. Regulator: responsibility to frame accounting guidelines

and reporting practices.

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Basic Accounting Concepts

An understanding of accounting concepts is vital to understand the process of accounting. Accounting concepts underlying the recording of transactions:

Entity Concept Money Measurement Concept Accrual Concept Matching Concept

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Accruals

What is an accrual? It is the recognition of an expense or revenue that has arisen but has not yet been recorded. Expenses or revenues are recorded before the cash settlement.

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Distinguish accrual-basis accounting from cashbasis accounting.

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The Two Bases of Accounting:

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Accrual Versus Cash Example

In January 2003, Prism Insurance sells a three-year health insurance policy to a business client. The contract specifies that the client had to pay Rs.150,000 in advance. Yearly expenses amount to Rs. 20,000. What is the income or loss?

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Accrual Basis of Accounting

(000 omitted) Income Expenses Net Income (Loss) 2003 Rs. 50 Rs. 20 Rs. 30 2004 Rs. 50 Rs. 20 Rs. 30 2005 Rs. 50 Rs. 20 Rs. 30

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Cash Basis of Accounting

(000 omitted) Income Expenses Net Income (Loss) 2003 Rs. 150 Rs. 20 Rs. 130 2004 0 Rs. 20 (Rs. 20) 2005 0 Rs. 20 (Rs. 20)

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Cash basis Vs. Accrual basis

XYZ Ltd. sold goods for cash worth Rs. 20 million during the year and collected cash of Rs. 100 million from its wholesalers (whom XYZ Ltd sells on credit) during the same period. The wholesalers owed the company Rs. 10 million at the beginning of the year and still owes Rs.15 million at the end of the year. How much is the revenue of XYZ Ltd. during the year? ABC Ltd. invested its surplus fund of Rs. 30 million in a threeyear fixed deposit at an interest rate of 7% p.a. calculated on a half yearly basis and paid within next fifteen days. Investment was made at the beginning of the year. How much is the interest income of ABC Ltd. during the year?

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Financial Statements: Objective

To provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of users in making economic decisions. Financial statements do not necessarily provide non-financial information.

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Financial Statements: Elements

Elements measuring financial position:

Assets Liabilities Equity Income (includes gains) Expenses (includes losses)

Elements measuring performance

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Corporate Financial Statements

What are the corporate financial statements?

Balance Sheet

Shows the financial position (position of assets, liabilities and equity) as on the reporting date. Shows the financial results (profit or loss) for an accounting period. Shows the net increase /decrease in cash and cash equivalents during the accounting period.

Profit & Loss Account

Cash Flow Statement

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Balance Sheet Format:

Sources of Funds

Shareholders Funds Loan Funds Net Block (Gross Block Accumulated Depn.) Investments Net Current Assets (Current Assets, Loans and Advances Current Liabilities & Provisions) Misc. Expenditure (to the extent not yet written off) Profit & Loss Account (losses)

Application of Funds

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Balance Sheet as at 31 March 2010 (contd.)

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Profit & Loss Account: No specific format

Sample format:

INCOME

Operating income Non-operating income Manufacturing expenses Administration expenses Selling & distribution expenses Depreciation Interest expenses Provision for tax

EXPENDITURE

Profit before tax (INCOME- EXPENDITURE)

Profit after tax (Profit before tax Provision for tax)

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P&L (contd.)

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Additional Financial Statements

Segment Reporting. Earning per share statement. Consolidated Financial Statements.

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Segment Report

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Operating Segments

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