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Financial Accounting and Analysis Book PDF
Financial Accounting and Analysis Book PDF
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COURSE DESIGN COMMITTEE
Content Reviewer
Ms. Purva Shah
Assistant Professor, NMIMS Global
Access - School of Continuing Education
Specialization: Finance
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Copyright:
2018 Publisher
ISBN:
978-93-5119-748-5
Address:
4435/7, Ansari Road, Daryaganj, New Delhi–110002
Only for
NMIMS Global Access - School for Continuing Education School Address
V. L. Mehta Road, Vile Parle (W), Mumbai – 400 056, India.
2 Accounting Process 29
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4 Accounting Standards I 105
c u rr i c u l u m
Introduction to Financial Accounting: Nature and Scope of Financial Accounting, Difference be-
tween Financial and Management Accounting ,Basic Accounting Concepts ,Advantages and Lim-
itations of Financial Accounting
Accounting Process: Accounting Process, Journal, Ledger, Meaning of Subsidiary Books, Bills of
Exchange
Trial Balance to Final Accounts: Preparing a Trial Balance ,Rectifying Errors, Final Accounts
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Accounting Standards I: Accounting , Constitution of Accounting Standards Board in India, Pro-
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cedure of Issuing Accounting Standards, Compliance with Accounting Standards
Cash Flow Statement: Cash Flow Statement , Cash Flow Statements ( AS-3)
Financial Statement Analysis I: Financial Statements, Profit and Loss Account, Balance Sheet
Financial Statement Analysis II: Ratio Analysis, Types of Ratio, The DuPont Equation
Financial Statement Analysis III: Common Size Analysis, Trend Analysis, Percentage Change
Analysis, Management’s Analysis and Discussion: Thinking beyond Numbers
CONTENTS
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1.1 Introduction
1.2 Nature and Scope of Financial Accounting
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1.2.1 Objectives of Accounting
Self Assessment Questions
Activity
1.3 Financial Accounting, Management Accounting and Cost Accounting
Self Assessment Questions
Activity
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Introductory Caselet
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Mr. Laxmi Das is the owner of Laxmi Das Ltd., which was set up
in 1975. The company is into various business operations, such
as construction, hotel, entertainment and media business. There-
fore, consolidating the various business transactions into one
book of accounts was a major challenge for the company.
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Withdrawals by Mr. Laxmi Das for personal use were shown at
their market price
Depreciation on assets were charged at their market value
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General reserve maintained by the organisation was not
shown in the balance sheet
realities.
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learning objectives
1.1 INTRODUCTION
Accounting is an important and an old concept in business manage-
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ment. The concept of accounting came into existence with the growth
of business, economics and banking. Accounting has become synon-
ymous with the “language of business”. However, there have been
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several modifications in the concepts, conventions, policies and stan-
dards of accounting over the years.
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Organisations conduct their activities by acquiring resources – man-
power, materials and various services, land, buildings, plant and ma-
chinery and equipment. These resources have to be financed or paid
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for. The main purpose of financial accounting is to record the finan-
cial transactions occurring in an organisation at a given time peri-
od to prepare financial statements and present this information in a
comprehensive manner. The importance of accounting to a business
is to provide information about an organisation’s financial result or
position.
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In this chapter, you will study about the nature and scope of financial
accounting. Thereafter, the difference between financial and manage-
ment accounting has been discussed. In addition, the unit discusses
the basic accounting concepts. Towards the end, the advantages and
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stakeholders. Figure 1.1 shows the various aspects that comprise the
nature and scope of financial accounting:
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Financial Accounting as Information System
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Figure 1.1: Nature and Scope of Financial Accounting
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Business Output
Input (Data) Processing To the Users
Activities (Information)
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1.2.1 Objectives of Accounting
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profit and loss. These reports further enable a firm to take correc-
tive actions as and when required.
Proper utilization of financial resources: Accounting data is also
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useful to conduct internal analysis of various resources and it pro-
vides clear picture regarding usage of resources. After conducting
this analysis an organisation can minimise wastage by assigning
budget to various activities and this budget limits the usage of re-
sources in various resources and hence, efficiency in resource util-
isation can be achieved.
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Activity
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FINANCIAL Accounting, MANAGEMENT
1.3
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ACCOUNTING ANd cost accounting
Although management accounting and financial accounting are often
used interchangeably, it should be noted that management account-
ing is simply an off-shoot of financial accounting. In simple terms,
management accounting uses the financial data provided by financial
accounting by the management of an organisation to improve the ef-
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ficiency.
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the data is used by external
users.
Time span In this, reports are pre- In this, reports are pre-
pared annually, semi-an- pared depending on man-
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nually & quarterly on a agement’s need. Some are
regular basis. daily while others may
be prepared only when
needed.
Audit Independent certified pub- There are no independent
lic accountants audit the audits verifying the infor-
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financial information.
Unit of The financial information is Besides, monetary units,
measurement usually expressed in mon- management accounting
etary terms. This is to help uses measures such as
in making comparisons machine hours, labour
between different data. hours, product units, etc.
for the purpose of analy-
sis and decision making.
Reporting Report is about the com- Management determines
purpose pany’s performance at a the contents and format
whole, which is consolidat- of a report according
ed in financial statements. to company’s products,
The standards to use for customers, geographical
financial reporting are de- regions, departments,
termined IFRS or GAAP. divisions. Reports are
generally prepared only
when management
believes the benefit of
using the report exceeds
the cost of preparing the
report.
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and control within an entity and to assure appropriate use of and ac-
countability for its resources. Management accounting also comprises
the preparation of financial reports for non-management groups such as
shareholders, creditors, regulatory agencies and tax authorities.
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Cost accounting is a part of financial accounting used to calculate
and control the cost of different business operations. Cost account-
ing involves the analysis of variable cost, fixed cost, overheads and
capital cost in business operations. However, there are certain points
of difference between the two, which are summarised in Table 1.2:
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Regulatory The structure of financial There is no regulatory
framework accounting reports is tightly framework governing
governed by either gener- cost accounting reports.
ally accepted accounting
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principles or international
financial reporting stand-
ards.
Content of It contains an aggregation It contains both financial
report of the financial informa- and operational informa-
tion recorded through the tion. Operational infor-
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c. AAA
d. Indian GAAP
5. Which of the following involves the analysis of variable cost, fixed
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cost, overheads and capital cost in business operations?
a. Financial costing
b. Cost accounting
c. Management accounting
d. Fundamentals of costing
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Activity
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Entity Concept
Cash and Accrual Concept
Matching Concept
Double Entry Accounting System
Money Measurement Concept
Going Concern Concept
Historical Cost Concept
Accounting Period Concept
Conservatism
Realisation
Consistency
Materiality
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Figure 1.3 Accounting Concepts
Let us discuss these accounting concepts in detail in the following
section:
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1.4.1 ENTITY CONCEPT
its owners are two separate entities. Therefore, even the owner is re-
garded as a creditor of business. Accounting is done for entities, rath-
er than for the persons who own or are associated with them.
sumed that the owner has given the money and the business has re-
ceived the money. Similarly, cash or goods withdrawn by the owner
from business for his/her personal use are considered as the personal
expense instead of a business expense. In such a case, the personal
expense of the owner is debited from the withdrawal account. There-
fore, all the transactions of the business are recorded in the account-
ing books of an organisation from the point of view of the business
unit and not that of the owner. The concept of separate entity is appli-
cable in all forms of business organisations.
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November, 2012 books of account.
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cept, every transaction has a two-fold effect, namely receiving and giv-
ing. These are the two aspects of every business transaction. These
are known as Debit (Dr) and Credit (Cr) entries. This implies that for
every debit entry, there will always be an equal credit entry. This is
known as the duality principal of accounting. It implies that a single
transaction would affect at least two accounts.
80,000 80,000
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Some of the common rules of debit and credit entries are as follows:
Apart from this, the dual aspect concept is called the double entry
system of book keeping, which implies that the total assets and total
liabilities of an organisation should be equal. The equality between
assets and liabilities represents the balance sheet equation or the
accounting equation, which is discussed in detail in the subsequent
chapters.
The money measurement concept underlines the fact that only those
transactions and events would be recorded in the books of account-
ing that are financial or monetary in nature. The financial statements
report only those transactions which can be measured in terms of
money or can be accounted as monetary amounts. For example, an
organisation has a cash balance of `10,000, a building containing 10
rooms, a piece of land of 1000 meters, and 10 tables. In such a case, it
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1.4.6 GOING CONCERN
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concept is defined as, any enterprise which is expected to continue op-
erating indefinitely in the future.
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The cost concept is historical in nature as the prices recorded for the
assets are the past prices, the prices paid at the time of acquisition.
One of the important aspects of the cost concept is that if the organi-
sation does not pay anything for acquiring the asset, it is not record-
ed in the books of accounts. The cost assumption does not mean that
the assets would always be shown at the same cost price every year,
but the cost price of the asset would reduce systematically using the
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process of depreciation. Therefore, after a certain period, these assets
disappear from the balance sheet as their economic tenure completes,
which signifies that they have fully depreciated and would be sold as
scrap.
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1.4.8 ACCOUNTING PERIOD
income statement.
1.4.9 CONSERVATISM
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1.4.10 REALISATION
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tant should record the business transactions only when it is realised.
1.4.11 CONSISTENCY
1.4.12 MATERIALITY
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For instance, suppose the profit and loss account has been affected
due to a change in the basis of accounting, such as the depreciation
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methods and basis of valuation of stock. In such a case, the changed
amount must be disclosed if it is material in relation to the total amount
charged and have an impact on the profit or loss of the organisation.
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Materiality is relative to the size and particular circumstances of indi-
vidual organisations.
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Activity
Make a group of your friends and discuss the basic accounting con-
cepts. Present your discussion points in a short note.
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Advantages and Limitations of
1.5
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Financial Accounting
We have previously discussed that accounting is the art and science of
recording business transactions. It records data and further analyses
it to reduce it to accounting reports. These reports help in facilitat-
ing the dissemination of important information among the different
groups of users to take the appropriate decisions. Following are some
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Itobtains biased information from the accountant if he/she will-
ingly makes inappropriate estimations.
Itshows fixed asset at a particular cost, which would depreciate
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over time. Hence, there is a significant difference between the
original cost at which assets were purchased and the current re-
placement cost.
Itprovides accounting information on a yearly basis only, while
the information can also be required for a shorter duration.
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interested parties?
a. Owners
b. Creditors
c. Management
d. All of the above
10. Financial accounting focuses only on _________transactions
or events while ignoring the non-monetary items.
a. Barter
b. Financial
c. Valuable
d. Only (a) and (b)
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Activity
1.6 Summary
Accounting is a very important and old concept in business man-
agement.
Accounting has become synonymous with the “language of busi-
ness”.
With the expansion of the market and the size of the business or-
ganisations, the shareholders, creditors, suppliers, potential buy-
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ers and various government agencies seek to get the financial dis-
closure of the organisation.
In simple words, accounting refers to the process of identifying,
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of an organisation in a systematic manner.
In today’s business world, accounting plays the crucial role of pro-
viding important financial information to the interested parties.
Financial accounting refers to the process of systematic record-
ing of financial transactions aimed at preparing profit and loss ac-
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key words
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debit entry, there will always be an equal credit entry.
Expenses: The total money spent by an organisation for reve-
nue generation.
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Income: The excess of revenue over expenses which is also
known as earnings or profits.
Liability: The financial debt or obligation which arises as a re-
sult of regular business operations.
Overheads: All ongoing expenses in a business, which are not
included or related to direct labour, direct materials or third-par-
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ty expenses.
Owner’s equity: The total investment made in the company
which is calculated by deducting liabilities from assets.
Revenue: The amount of money received by a company by sell-
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cial Accounting
2. d. American Accounting Asso-
ciation
Financial Accounting, Man- 3. b. Management
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agement Accounting and
Cost Accounting
4. a. IFRS
5. b. Cost accounting
Basic Accounting Concepts 6. c. Entity Concept
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cost, which would depreciate over time, etc. Refer to Section
1.5 Advantages and Limitations of Financial Accounting.
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1.9 SUGGESTED READINGs & REFERENCEs
Suggested Readings
Debarshi, B. (2011). Management Accounting (pp. 1-10). Noida:
Dorling Kindersley India Pvt. Ltd.
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E-REFERENCES
Icaiknowledgegateway.org. (2014). ICAI Knowledge Gateway. Re-
trieved from, http://www.icaiknowledgegateway.org/
AccountingCoach.com. (2014). Accounting Basics | Explanation |
Accounting Coach. Retrieved from, http://www.accountingcoach.
com/accounting-basics/explanation
Accounting-simplified.com.(2014). Accounting Concepts & Prin-
ciples | Accounting-Simplified.com. Retrieved from, http://ac-
counting-simplified.com/financial-accounting/accounting-con-
cepts-and-principles/
Case study
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Mr. Rakesh Goyal, owns a small road side food stall in the out-
skirts of Delhi in Najafgarh. Initially 1994, at the time of starting
up, his business was quite small and he does not practice record-
ing transactions. Then in 2000, he bought a shop in a semi urban
locality and started providing 3 time meals for minimal charges
per plate. With this move he opened a small family restaurant
named ‘Goyal Rasoi’ with a serving capacity of 25 customers at
once. He also allowed some customers to buy on credit basis. Due
to lack of recording and book keeping Mr. Rakesh Goyal mostly
forgot many transactions and started suffering losses. He used to
forget to whom he had to pay (Lender) and from whom he had to
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take (borrower). On the other hand, there are many other factors,
such as underestimation and overestimation of demand, wastage
of food, number of cooks employed, etc. due to which he suffered
losses.
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By the year 2002, the losses were too high and he started thinking
about winding up. One day, one of the friends of Mr. Goyal named
Rahul Sheety came to meet him. Mr. Goyal made his friend aware
about the conditions of ‘Goyal Rasoi’ and Mr. Sheety suggested
him to start recording all the transactions on the daily basis. How-
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ever, Mr. Goyal was not financially literate and therefore he hired
a commerce graduate as clerk for recording transactions.
Purchase book, etc. Then, within just 3-4 months of recording, Mr.
Goyal got clear picture of his restaurant and now it was easy to
track borrowers and lenders of the business. With the help of his
clerk, he further identified many loopholes such as, wastage of
resources, actual requirement of labour, inventory level to meet
regular and seasonal demand, etc. As all the data was available in
recorded form, so it became more convenient to analyse various
costs, their components and methods to control them.
In 2005, at the end of third year of recording, Mr. Goyal got finan-
cial statements of ‘Goyal Rasoi’ for three years. By analysing these
statements, Mr. Goyal was now able to do comparative analysis of
his restaurant with past position and as well as with competitors.
They also identified many new investment opportunities in the
related field. As a result by 2015, ‘Goyal Rasoi’ established its 20
‘Chain Restaurants’ in Delhi NCR and became a prominent lead-
er in small restaurant industry.
Case study
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questions
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Accounting Process
CONTENTS
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2.1 Introduction
2.2 Accounting Process
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2.2.1 Stages in Accounting Process
2.2.2 Traditional Approach for Recording Transactions
2.2.3 Transaction Analysis
2.2.4 Debit and Credit Rules
Self Assessment Questions
Activity
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2.3 Journal
2.3.1 Format of Journal
2.3.2 Process of Journalising
Self Assessment Questions
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Activity
2.4 Ledger
2.4.1 Format of Ledger
2.4.2 Ledger Balancing
Self Assessment Questions
Activity
2.5 Meaning of Subsidiary Books
2.5.1 Cash book
2.5.2 Purchases Book
2.5.3 Sales Book
2.5.4 Purchases Return Book
2.5.5 Sales Return Book
Self Assessment Questions
Activity
2.6 Summary
CONTENTS
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Introductory Caselet
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the challenge to overcome the problems faced in its accounts de-
partment. The company hired a new Finance Director who decid-
ed to focus his attention to the issues in the accounts department.
The findings were as follows:
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Financial statements did not reflect the correct or actual fi-
nancial figures.
The financial reports lacked accuracy and consistency.
Tax information lacked details.
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learning objectives
2.1 INTRODUCTION
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Accounting process constitutes one of the most fundamental con-
cepts of accounting. The accounting process helps in maintaining
systematic records of all financial transactions to avoid any possible
errors. In simple words, accounting process determines the economic
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impact of the transactions on the business. The accounting process
contains identifying, measuring and communicating financial infor-
mation to the interested parties. The accounting process needs to be
followed properly to avoid any confusion or errors while recording
financial transactions. Therefore, deployment of a proper accounting
process helps in the efficient functioning of financial activities of an
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organisation.
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Prime Document }
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Invoices for Purchases }
Invoices of Sales }
Credit and Debit Notes } Sources of Accounting
Bank Pay-in-Slips } Information
Cheques Issued
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}
Cash Payments for Expenses
Invoices for Fixed Assets Purchases
Trial Balance
Arithmetic checking of
A summary of all the balances at the
double entry book keeping
end of the accounting period
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Identification of Financial
Transactions
Preparation of Vouchers
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Recording Entries in the Books of
Original Entry
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Posting to the Ledger
Financial Statements
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organisation to get information related to total purchases, total
sales, total expenses, creditors and debtors.
5. Preparation of trial balance and financial statements: In this
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step, a balance in each ledger account is determined and the trial
balance is prepared. In the trial balance, the debit and credit
balances of each account are put in their respective columns. The
total of the debit balance and the credit balance must tally. This
would indicate arithmetic accuracy. The financial statements are
prepared with the help of the trial balance.
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Golden rule for personal accounts: Debit the receiver and credit the
giver.
Real accounts refer to the accounts related to the assets and liabilities
including capital accounts of owners. These accounts may be tangible
or intangible in nature. Real accounts are further divided into the fol-
lowing two sub categories:
Tangible real accounts are those accounts which are related to
those items that can be touch and feel. For example, building, plant
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and machinery, land, stock, etc.
Intangible real accounts are those accounts which are related to
intangible things that cannot be touch or feel. For example, good-
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Golden rule for real accounts: Debit what comes in and credit what
goes out.
Nominal accounts are those accounts which exist in name only and
do not have any physical form. Monetary transaction is involved be-
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Golden rule for nominal accounts: Debit all expenses and losses and
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2.2.3 TRANSACTION ANALYSIS
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` 1 lakh.
Transaction 3: Purchased raw material inventory on credit worth
` 1 lakh.
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Impact on Balance Sheet
Assets side will increase with the inventory of ` 1 lakh.
Liabilities side will increase with creditors of ` 1 lakh.
Transaction 4: Sold finished goods inventory for cash ` 1 lakh.
Impact on Balance Sheet
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2.2.4 Debit and Credit Rules
The debit and credit are the most fundamental concepts of account-
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ing, which represent two sides of each individual transaction recorded
in the books of accounts. Business processes in organisations include
numerous business processes. As explained earlier, every transaction
has receiving and giving aspects. The aspect of receiving is known as
the debit aspect and the aspect of giving is known as the credit aspect.
The debit and credit aspects of a transaction form the basis of the dou-
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ble entry bookkeeping system and are two opposite actions. The debit
is recorded at the left side of the account and the credit is recorded at
the right side, as depicted in Table 2.1:
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There are three types of accounts, namely personal account, real ac-
count and nominal account. Let us now study how the rules of debit
and credit are used in these different types of accounts, which is de-
scribed as follows:
In case of personal accounts: A debit in the personal account im-
plies that the person whose account is debited becomes a debtor.
Thus, when goods are sold on credit to a customer, then he/she
becomes the debtor of the business. If the account of a creditor is
debited, then the debit would be regarded as the amount due to
that person has decreased.
A credit in the personal accounts implies that the person whose
account is credited becomes a creditor. Whenever goods are pur-
chased on credit from suppliers, then he/she becomes the creditor
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Debit: what comes in
Credit: what goes out
In
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case of nominal account: A debit in a nominal account implies
that either an expenditure has been incurred, some loss has taken
place, or some income has diminished by the amount of the debit.
Whenever any expenditure on account of salary, rent, and interest,
is incurred, the nominal accounts would be debited. Credit in a
nominal account signifies that income or profit is earned.
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In short:
Debit: all expenses and losses
Credit: all incomes and gains
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Let us summarise the rules of debit and credit in different types of ac-
counts. These rules are also termed as three golden rules of account-
ing, which are shown in Table 2.2:
Let us discuss the application of the three golden rules with the help
of examples. These examples would help in understanding a single
transaction to be recorded in the account separately.
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Solution:
a. The transaction that involves in starting a business increases the
cash and capital of the organisation. The increase in cash (asset)
is debited while the increase in the capital (liability) is credited.
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The entries can be made as follows:
Cash Account Capital Account
Debit Credit Debit Credit
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4,00,000 4,00,000
b. When cash is deposited in banks, the amount in the bank
increases and the cash account decreases. The increase in the
asset is debited and the decrease in the asset is credited, which
can be represented as follows:
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decrease in the cash (asset) is credited, which is shown as follows:
Rent Account Cash Account
Debit Credit Debit Credit
10,000
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g. Depreciation of an asset would increase the non-cash expense.
So a depreciation account would be opened up and debited with
the depreciated value of asset. As a result, the value of asset
would be diminished. Therefore, the depreciated value would be
credited to the asset account.
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1. ‘Debit the receiver and credit the giver’ is the accounting rule
for___________.
(a) Real account
(b) Personal account
(c) Nominal account
(d) Both (a) and (c)
2. XYZ Ltd. purchased goods for credit. What will be the impact
of this transaction on the balance sheet?
(a) Assets decrease and liabilities increase
(b) Assets increase and liabilities also increase
(c) Assets increase and liabilities decrease
(d) Assets decrease and liabilities also decrease
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Activity
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Ram commenced his computer business on 1st Apr, 2009 with a
capital of `3,00,000. On 31st March, 2010, the cost of assets were
worth `5,00,000 and the liabilities were worth `1,00,000. Calculate
his closing capital and profit gain during this year.
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2.3 Journal
A journal refers to a primary book of accounts in which all transac-
tions of a business are recorded. A journal can also be defined as a
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July 15- Purchased goods on credit for ` 50000 from Rajesh.
July 15- Sold Goods for Cash ` 126000.
July 21- Sold goods for ` 70000 to Mohan on credit.
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July 23- Purchased machinery for cash ` 80000.
July 23- Cash withdraw for personal use ` 25000.
July 27- Rent paid in cash ` 4000.
July 31- Wages paid in cash ` 4500.
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Table 2.4 shows the journal entries corresponding to the above men-
tioned transactions:
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Mohan Dr. 70,000
To Sales A/c 70,000
(Being goods sold to Mohan on
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Machinery A/c Dr. 80,000
To Cash A/c 80,000
(Being machinery purchased for
cash)
Drawings A/c Dr. 25,000
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account gives the benefits. The following steps are performed to enter
a transaction in the journal:
1. Ascertaining that the accounts are affected by the transaction.
2. Ascertaining the nature of the account which is affected.
3. Ascertaining the account to be debited and the account to be
credited by applying the rules of debit and credit.
4. Ascertaining the amount by which the accounts are to be debited
and credited.
5. Recording the date and month of the transaction in the date
column and the year at the top.
6. Recording in the particular column the name of the account to
be debited. Along with the name of the account, the abbreviation
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“Dr.” also should be written in the same line against the name of
the account. Write the amount to be debited in the debit amount
column.
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7. Recording in the “Particular” column the name of the account
to be credited. The name of the account to be credited should
be written in the next line preceded by the word “To”. The word
“To” is written towards the right after leaving a few spaces. Write
the amount to be credited in the credit amount column.
8. Recording a brief description of the transaction starting from the
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Illustration 2
Transaction number 1: A new firm issues 1,000 shares of common
stock and receives `7,50,000 cash.
The journal entry steps are as follows:
Step 1: The firm raises capital by issuing shares of its stock on
January 6, 2013.
Accounts Affected:
Assets – Cash is increased.
Share capital – Common stock is increased.
Step 2: The journal entry would be as follows:
Cash `7, 50,000
Common Stock `7, 50,000
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Journal (No. 1)
Date Particulars L.F. Debit Credit
Amount(`) Amount(`)
Jan 6, CashDr. 1 7, 50,000
2013 To Common Stock 7, 50,000
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Accounts Affected:
Share Capital – Expense is increased
Assets – Cash is decreased
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Step 2: The journal entry would be as follows:
Salaries Expense `1, 00,000
Cash `1, 00,000
Journal (No. 2)
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Activity
2.4 Ledger
A ledger refers to a book or register in which financial transactions
are permanently recorded after being summarised and classified. We
need to arrange the ledger accounts under particular headings. Led-
gers help in preparing a trial balance, after which the final statement
is prepared. A ledger is also known as the principal book. It is import-
ant to note here that although a journal provides a complete listing
of the daily transactions of a business, it does not provide informa-
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tion about a specific account in one place. For example, if an accoun-
tant needed to know how much cash balance the organisation is left
with, he/she would have to check all the journal entries involving cash,
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which is a time consuming task involving numerous entries. To avoid
such instances, debit and credit entries from a journal are transferred
to a single ledger account.
In a ledger, each account is divided into two sides, the debit side and
the credit side. The left side of the ledger is called the debit side;
whereas, the right side of the ledger is called the credit side. Each side
is further divided into four columns. The following is a brief descrip-
tion of these columns:
Date: It records the date on which a transaction is made.
Particulars: It records the names of the accounts to be credited
on the debit side and the accounts to be debited on the credit side.
Journal Folio (J.F.): It records the page number of the journal on
which the posting of the ledger takes place.
Amount: It records the amount of each transaction.
A ledger is often referred to as T-account due to its resemblance to
the letter T. The left side of the ledger is debit, whereas the right
side is credit.
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entry.
5. Beginning the debit side with “To” and the credit side with “By”.
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6. Entering the page number of the journal from where the
transaction is transferred to the ledger in the J.F. column.
Journal
Date Particulars L.F. Dr. Cr.
Amount (`) Amount (`)
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The preceding entry can be posted to the ledger in the following way:
n o t e s
In the preceding example, two accounts are opened in the ledger, Sal-
ary account and Cash account. The Salary account, which is debited
in the journal entry, is credited in the ledger entry; whereas, the Cash
account, which is credited in the journal entry, is debited in the ledger
entry. The Salary account shows the debited amount and the Cash
account shows the credited amount in the ledger.
December, 2013
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December 5. He purchased furniture for `20,000
Solution:
To Capital 11
(Being capital brought in)
5 Furniture A/C Dr. 13 20000 20000
To Cash A/C 9
(Being furniture purchased
for cash)
12 Purchases A/C Dr. 15 60000 60000
To Cash A/C 9
(Goods purchased for cash)
16 Cash A/C Dr. 9 80000 80000
To Sales A/C 17
(Sold goods for cash)
28 Salaries A/C Dr. 19 10000 10000
To Cash A/C 9
(Salaries paid)
n o t e s
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Capital Account (No. 11)
Date Particulars J.R. Amount (`) Date Particulars J.R. Amount (`)
Dec Dec
2013
IM 2013
28 To Balance 1,00,000 3 By Cash A/C 1 1,00,000
c/d
Total 1,00,000 Total 1,00,000
Date Particulars J.R. Amount (`) Date Particulars J.R. Amount (`)
Dec Dec
2013 2013
5 To Cash A/C 1 20,000 28 By Balance 20,000
c/d
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n o t e s
Date Particulars J.R. Amount (`) Date Particulars J.R. Amount (`)
Dec Dec
2013 2013
2.4.2 Ledger Balancing
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side and the debits side) of the account and writing the difference to
the side whose total is less. For example, if the credit side is greater
than the debits side, then the difference of both sides is recorded in
the debit side. On the other hand, on the debit side is greater than the
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credit side, the difference is recorded in the credit side.
it means that the balance is nil. If the total of the debit side is
greater than the total of the credit side, the difference is written
on the credit side; and if the total of the credit side is greater than
the total of the debit side, the difference is written on the debit
side.
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Note that the closing balance of the previous period of an account ap-
pears as the opening balance for the next period of the account. The
closing balance of the previous period is written in the opposite side of
the next period as To Balance b/d or By balance b/d.
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(a) Debit side only (b) Credit side only
(c) Opposite side (d) On both sides
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Activity
2.5.1 Cash Book
Cash Book includes the records of all the receipts and payments made
by cash and cheques. The Cash Book, which is used to record cash as
well as bank transactions, is known as Bank Book. The Cash Book has
two sides, namely the left side, which records all the cash receipts and
the right side, records all the cash payments. The special feature of the
Cash Book is that it functions as a Journal and a Ledger with regard
to the cash and bank transactions respectively.
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However, the cash purchases of goods or the credit purchases of as-
sets are not recorded in this book. The format of the Purchase Book is
shown in Table 2.7:
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Table 2.7: Format of the Purchase Book
Purchase Book of Jagat & Co.
Date Name of Suppliers Ledger Folio Inward Amount (`)
Invoice No.
2011
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2.5.3 Sales Book
Sales Book involves the records of all the credit sales of goods. How-
ever, it does not record the cash sales of goods or credit sales of assets.
It is also known as Sales Journal.
The format of the Sales Book is shown in Table 2.8:
n o t e s
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Total 1,15,000
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specific point in time.
(a) Profit and loss account
(b) Balance sheet
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(c) Trial balance
(d) Book of balancing
Activity
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2.6 Summary
Accounting process is one of the most fundamental concepts of ac-
counting. The accounting process helps in maintaining systematic
records of all financial transactions to avoid any possible errors.
The accounting process starts when any financial transaction is
made in an organisation. The accounting process results in var-
ious financial statements, such as balance sheet, profit and loss
account and other statements.
The steps involved in the accounting process are 1) Identification
of financial transactions. 2) Preparation of Vouchers 3) Posting to
the ledger and 4) Preparing the trial and financial statements.
The traditional approach is also known as the British approach. In
this approach, various accounts are classifies as personal account,
real account and nominal account.
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A ledger refers to a book or register in which financial transactions
are permanently recorded after being summarised and classified.
After we have posted and recorded the transactions, it is necessary
IMto balance each account prepared in a ledger.
Some of the subsidiary books are cash book, petty cash book, pur-
chase book, sales book, purchase return book and sales return
book.
key words
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n o t e s
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Accounting Process 1. b. Personal account
2. b. Assets increase and lia-
bilities also increase
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3. b. Representative personal
accounts
Journal 4. a. Ledger folio
Ledger 5. a. Ledger
Basic Accounting Concepts 6. a. Trial balance
7. c. Opposite side
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n o t e s
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` 100000. Make a journal entry for this transaction.
Solution:
Ram’s Journal for January 2017
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Date Particulars L.F. Amount Amount
Debit (`) Credit (`)
January Cash A/C Dr. 9 100000 100000
04, 2017 To Capital 11
(Being capital brought in to
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start busniss)
2. On January 15, 2017, Ram draws ` 1000 for personal use make a
journal entry for this transaction.
Solution:
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n o t e s
Then on January 10, 2017, he bought furniture for office use and
its impact on balance sheet will be as follows:
Capital (`100000) + Liability (`0) = Assets (Cash= ` 90000 +
Furniture = `10000)
4. With reference of question No. 3, On April 15, 2017, Ram takes
loan from Bank for ` 50000. Elaborate its impact on balance sheet
using Transaction analysis.
Solution:
Initially Ram has,
Then on January 10, 2017, Capital (` 100000) + Liability (`0) =
Assets (Cash= ` 90000 + Furniture = `10000). Then on April
15, 2017, Ram takes loan from Bank for ` 50000. its impact on
balance sheet will be as follows:
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Capital (` 100000) + Liability (`1050000) = Assets (Cash=
` 140000 + Furniture = ` 10000)
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5. Consider the following Journal entry and post it into Ledger.
Ram’s January 2017
Date Particulars L.F. Amount Amount
Debit (`) Credit (`)
January Cash A/C Dr. 9 100000 100000
15, 2017 To Capital 11
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Cash Account
Capital Account
Date Particulars JF Amount Date Particulars JF Amount
Jan. To Balance 100000 Jan. By Cash A/c 11 100000
15, c/d 15,
2017 2017
Total 100000 Total 100000
n o t e s
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9. Withdrawn from bank for office use ` 20,500.
10. Paid Salaries ` 18,000.
11. Withdrawn for personal use ` 2,500.
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12. Goods returned to Anwar ` 10,000.
13. Paid for office furniture ` 10,500 by cheque.
14. Received ` 34,500 cash from Abu and discount allowed ` 500.
15. Paid Anwar on account ` 39900 and discount allowed by him
`100.
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Solution:
n o t e s
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Abu)
Rent A/c Dr. 4500 4500
To Cash A/c
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(Being rent paid)
Cash A/c Dr. 20500 20500
To Bank A/c
(Being cash drawn for official
purposes)
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To Cash A/c
(Being cash drawn for per-
sonal use)
Anwar Dr. 10000 10000
To Purchase Return A/c
(Being goods returned to
Anwar)
Furniture A/c Dr. 10500 10500
To Bank A/c
(Being furniture purchased
through cheque)
Cash A/c Dr. 34500 40000
Discount A/c Dr. 500
To Abu
(Being cash payment re-
ceived from Abu and dis-
count allowed ` 500)
n o t e s
Ledger of Pratik
Cash Account
Date Particulars JF Amount Date Particulars JF Amount
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To Capital A/c 200000 By Bank 50000
To Sales A/c 20000 A/c 4500
To Bank A/c 20500 By Rent A/c 18000
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To Abu 34500 By Salary
A/c
2500
By Draw-
ings A/c 39900
By Anwar
By Balance 160100
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c/d
Total 275000 Total 275000
Capital Account
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Bank Account
Date Particulars JF Amount Date Particulars JF Amount
To Cash A/c 50000 By Cash A/c 20500
By Balance
c/d 29500
n o t e s
Plant Account
Date Particulars JF Amount Date Particulars JF Amount
To Modi and 100000 By Balance 100000
Company c/d
Total 100000 Total 100000
Purchase Account
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Date Particulars JF Amount Date Particulars JF Amount
To Anwar 50000 By Balance 50000
c/d
Total 50000
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Anwar Account
Date Particulars JF Amount Date Particulars JF Amount
To Purchase 10000 By Purchase 50000
Return A/c A/c
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Sales Account
Date Particulars JF Amount Date Particulars JF Amount
To Balance 60000 By Abu 40000
c/d By Cash 20000
A/c
Total 60000 Total 60000
Abu Account
Date Particulars JF Amount Date Particulars JF Amount
To Sales A/c 40000 By Sales
Return A/c 5000
By Cash A/c 34500
By Discount
A/c
500
Total 40000 Total 40000
n o t e s
Rent Account
Date Particulars JF Amount Date Particulars JF Amount
To Cash A/c 4500 By Balance 4500
c/d
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Salary Account
Date Particulars JF Amount Date Particulars JF Amount
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To Cash A/c 18000 By Balance 18000
c/d
Drawings Account
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Furniture Account
Date Particulars JF Amount Date Particulars JF Amount
To Bank A/c 10500 By Balance 10500
c/d
n o t e s
Discount Account
Date Particulars JF Amount Date Particulars JF Amount
To Abu 500 By Anwar 100
By Balance 400
c/d
Total 500 Total 500
Sales Account
Date Particulars JF Amount Date Particulars JF Amount
To Balance 40000 By Abu 40000
c/d
Total 40000 Total 40000
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2.10 Suggested Readings & References
SUGGESTED READINGS
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Agtarap, D., & Juan, S. (2007). Fundamentals of Accounting: Basic
Accounting Principles Simplified for Accounting Students (1st ed.,
pp. Ch 3-5). Bloomington: Author House.
Gilbertson, C., Lehman, M., & Gentene, D. (2014). Fundamentals of
Accounting: Course 1 (10th ed., pp. Ch. 3-4). Mason: South Western
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Cengage Learning.
Maheshwari, S., & Maheshwari, S. (2009). Fundamentals of Ac-
counting for Cpt, 2E (2nd ed., pp. 1.62 -1.106). Vikas Publishing
House: Noida.
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E-references
AccountingCoach.com. (2014). Accounting Equation | Explanation
| Accounting Coach. Retrieved from, http://www.accountingcoach.
com/accounting-equation/explanation
AccountingCoach.com. (2014). What is a general ledger account? |
Accounting Coach. Retrieved from, http://www.accountingcoach.
com/blog/what-is-a-general-ledger-account
AccountingCoach.com. (2014). What is a journal? | Accounting
Coach. Retrieved from, http://www.accountingcoach.com/blog/
what-is-a-journal
Case study
n o t e s
ACCOUNTING PROCESS
Let’s start the case study with a brief introduction of the main
character of this case Mr. AK Shrivastava, an MBA graduate who
was working as an auditor in one of the prominent audit firms. Af-
ter working for more than 3 years in that auditing firm, Mr. Shri-
vastava decides to start his own venture as Business to Business
(B2B) software solutions provider, named as AKSI Enterprises.
He meets many venture capitalists and one of them finds his idea
profitable and agrees to invest in ‘AKSI’ by providing `10 lakh
as venture capital. On April 5, 2017, he got funds from venture
capitalists and following are some transactions done during the
month of April 2017:
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On April 7, 2017, Mr. Shrivastava started business with ven-
ture capital of `15 lakh and 5 lakhs from personal savings.
On 7, 2017, Mr. Shrivastava acquired commercial space on a
IMmonthly rental basis for `10 thousand.
On April 10, 2017, he spends `1 lakh for office furniture and
`1.5 lakh for computers and other essentials.
On April 12, 2017, ‘AKSI’ got their first order to develop a web-
site for a water park for the total cost of ` 10000 and receives `
5000 immediately in advance and remaining `5000 at the time
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advance.
On April 26, 2017, the 1st project is completed and details re-
garding the same have been sent through invoice for the pay-
ment of remaining `5000.
On April 27, 2017, he receives payment of remaining of `5000.
On April 30, 2017, receives the remaining payment for the sec-
ond project.
Case study
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questions
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accounting equation, i.e. Assets = Liabilities + Share
Capital)
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CONTENTS
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3.1 Introduction
3.2 Preparing a Trial Balance
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Self Assessment Questions
Activity
3.3 Rectifying Errors
3.3.1 Errors of Principle
3.3.2 Errors of Omission
3.3.3 Errors of Commission
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Introductory Caselet
n o t e s
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short debit of `10,000 to sales returns account. Later, the company
realised that this incident was a case of two errors compensating
each other’s effect. Credit entry on one side was nullified by the
debit entry of equal amount on the other side which set off the net
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effect of these two errors without reflecting on the trial balance.
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n o t e s
learning objectives
3.1 INTRODUCTION
Under the double-entry system of accounting, the Trial Balance is an
important statement. Trial Balance is a report which is a listing of all
the closing debit and credit balances at the end of a particular peri-
od-usually a month, quarter, half-year or year i.e. annual.
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A trial balance is prepared when the accounts in the ledger are bal-
anced. You can say a trial balance to be a simple listing of all general
ledger accounts and their respective balances. Therefore, trial bal-
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ance includes the summary of all ledger balances outstanding on a
given date.
In this chapter, you will study about the structure and preparation
of Trial Balance using the ledger accounts, the rectification of errors
while balancing of Trial Balance and the different types of Financial
Statements in an organisation.
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upon the stage in which we generate the Trial Balance, it can be
used as a worksheet for planning and passing adjustment entries
which are basically Journal Entries.
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c. For serving as a source report for preparation of financial
statements
The Trial Balance is the source report for the preparation of the
Financial Statements i.e. both the Balance Sheet as well as The
Profit & Loss Account. It is important to note that the agreement of
credit and debit balances on a trial balance is not a conclusive proof
of the absence of errors. There is always a chance of hidden errors
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n o t e s
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Modern method of preparing Trial Balance is as follows:
Modern method: This method is more widely used. The modern
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method has been derived from the traditional method. In this
method, instead of writing down the sub total of debit and cred-
it entries on the trial balance, these are set off and only the net
balance is indicated at the end of the trial balance. In this meth-
od, ledger accounts are balanced. The brought down balances are
then brought to a sheet as follows:
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note
n o t e s
Solution:
Ravi’s Ledger
Cash Account (No. 5)
Date References JF Debit (`) Credit (`) Balance (`)
2013 Dr. Cr.
Jan. 1 Capital A/C 5 8,00,000 8,00,000
Jan 8 Sales A/C 5 4,60,000 12,60,000
Jan 16 Vinay A/C 5 98,000 13,58,000
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Date References JF Debit (`) Credit (`) Balance (`)
2013 Dr. Cr.
Jan 1 Capital A/C 5 2, 00,000 2, 00,000
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Capital Account (No. 9)
Date References JF Debit (`) Credit (`) Balance (`)
2013 Dr. Cr.
Jan 1 Cash A/C 5 8,00,000 8,00,000
Jan 1 Furniture A/C 5 2,00,000 10,00,000
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n o t e s
From the above ledgers in Ravi’s books, the trial balance can be
prepared as follows:
Ravi’s books
Ravi’s Trial Balance as on January 31, 2013 (Amount in `)
S. No. Account Name A/C No. Debit (`) Credit (`)
1 Cash Account 5 13,58,000
2 Furniture Account 7 2, 00,000
3 Capital Account 9 10, 00,000
4 Purchases Account 11 3,00,000
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5 Kartik Account 13 3, 00,000
6 Sales Account 15 5, 60,000
7 Vinay Account 17
8 Discount Account
IM 19 2000
Total 18, 60,000 18, 60,000
Solution:
n o t e s
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To Sales A/C 12000
(Being goods sold for cash)
16 Ankit Dr. 2000
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To Cash A/c 2000
(Being cash paid to Ankit)
25 Salary A/c Dr. 4000
Rent A/c Dr. 1200
To Cash A/c 5200
(Being salary and rent paid for cash)
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Cash Account
Particulars JF Amount Particulars JF Amount
To Capital A/c 50000 By Purchase A/c 58000
To Bank Loan A/c 20000 By Ankit 2000
To Sales A/c 12000 By Salary A/c 4000
By Rent A/c 1200
By Drawings A/c 3500
By Balance c/d 13300
Total 82000 Total 82000
n o t e s
Capital Account
Particulars JF Amount Particulars JF Amount
To Capital A/c 50000 By Cash A/c 50000
Total 50000 Total 50000
Purchase Account
Particulars JF Amount Particulars JF Amount
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To Cash A/c Dr. 58000 By Balance 58000
c/d
Total 58000 Total 58000
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Stationary and office Supplies Account
Particulars JF Amount Particulars JF Amount
To Cash A/c 2000 By Balance 6000
c/d
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To Ankit 4000
Total 6000 Total 6000
Ankit Account
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Sales Account
Particulars JF Amount Particulars JF Amount
To Balance c/d 20000 By Cash A/c 12000
By Debtors 8000
A/c
Total 20000 Total 20000
n o t e s
Salary Account
Particulars JF Amount Particulars JF Amount
To Cash A/c 4000 By Balance 4000
b/d
Total 4000 Total 4000
Rent Account
Particulars JF Amount Particulars JF Amount
To Cash A/c 1200 By Balance 1200
c/d
Total 1200 Total 1200
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Debtors Account
Particulars JF Amount Particulars JF Amount
To Sales A/c 8000 By Balance 8000
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Total 8000 Total 8000
Drawings Account
Particulars JF Amount Particulars JF Amount
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n o t e s
note
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2. The total of all the __________ balances in a trial balance must
always be equal to the total of __________balances.
(a) Assets; liabilities (b) Debit; credit
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(c) Income; expenditure (d) Both (b) and (c)
3. As per__________ approach, ledger accounts are not balanced
for each debit and credit entry and are simply summed up and
the total of debit side and credit side should be equal to each
other.
(a) Modern Approach (b) Miller model
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Activity
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n o t e s
The errors in a trial balance may occur at the time of recording, clas-
sifying, or summarising a financial transaction.
It should be noted that even when the trial balance is correct, some
errors may remain in the accounting records. For example, if the cred-
it purchases are not recorded in the purchase book, it would not af-
fect the agreement of the trial balance because the entry is not made
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in either sides of the book. Therefore, clearly two types of errors are
committed: errors that affect the trial balance and the errors that do
not affect the trial balance.
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However, we need to identify and rectify both types of errors. The pro-
cess of rectifying the errors and correcting the accounting records is
termed as rectification of errors.
Errors of Errors of
Omission Commission
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n o t e s
between capital and revenue, then it will lead to rise of the error of
principle. These errors may occur; when the entry of a transaction
is made on the wrong side of the related account or in the wrong ac-
count. However, the value of entry or the amount of the transaction
is correct. The rectification of such errors is very important as they
directly affect financial statements. Such errors may occur due to the
following reasons:
In case, there is lack of understanding, classification and hence the
distinction between the revenue and capital items. The revenue
receipt may be taken as capital receipt or vice versa.
In case, there is lack of distinction between the business expenses
and personal expenses.
In case, there is lack of distinction between the productive and
non-productive expenses.
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Let us comprehend the process of rectification of errors of principle
with the help of an example.
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Illustration 3: Rectify the following errors:
1. Paid wages for the construction of office debited to wages account
`2,000.
2. Paid cartage for newly purchased furniture `500, is posted to
cartage account.
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n o t e s
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Let us understand the error of omission with the help of an example.
Suppose the recording of goods worth `1000 purchased on credit from
Arun Lal is omitted from the purchase book. In such a case, it would
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be omitted from being posted in the ledger as well. Consequently, the
transaction is not found in the trial balance. Besides this, now suppose
a particular transaction is recorded in relevant subsidiary book but
it was omitted to be recorded in ledger. This is the case of partial
omission. In this scenario, the agreement of trial balance also gets
affected and hence accuracy of accounts is also diminished.
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n o t e s
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5. On 31st March, 2007, the goods worth `30,000 were returned by
Ram and were taken into stock on the same date, but no entry
was passed in the books.
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Solution:
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the same type of error may take place in another account. In such
a case, it is not easy to detect the error. For example, Amit’s A/c was
debited with `1000 instead of `10000 while Sandip’s A/c was debited
with `10000 instead of `1000. Therefore, Amit’s A/c, which was debited
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by `9000, was compensated by another error in Sandip’s A/c, whose
account was debited excess of `9000. Errors of compensation do not
affect the trial balance.
n o t e s
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(d) Error of compensation
9. In case of errors of _____, an error is nullified with errors of
equal proportion.
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(a)
Omission (b)
Commission
(c)
Principle (d)
Compensation
Activity
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n o t e s
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financial position at the right time and in the right manner. There are
mainly three types of Financial Statements in an organisation which
are shown in Figure 3.2:
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Financial
Statements
n o t e s
Let us now discuss the components of the profit and loss account
which are given as follows:
Revenue: Revenue is the total amount of money received by a
business entity after selling its products or services. Generally,
revenue is also known as sales revenue or net sales and it can be
calculated by deducting sales return, discounts and allowances
from total sales. It is recorded at the top of the income statement
and because of this it is also known as ‘top line’.
Cost of goods sold (COGS): COGS includes all direct costs in-
volved in the process of production. For example, raw material, la-
bour, factory overheads, depreciation on plant and machinery, etc.
Gross profit or gross loss: It is the difference between the revenue
received and cost of goods sold for a particular period of time.
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Operating expenses: Operating expenses are the amount of ex-
penses that a business entity has to bear in day-to-day business
operations. For example, amortisation of intangible assets, ad-
vertising and sales expenses, research and development, rent of
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building, etc.
Administrative expenses: Administrative expenses are those ex-
penses which are not directly related with the process of produc-
tion and these expenses are related to management and support-
ing activities of a business organisation. For example, depreciation
on corporate office building, salary of top level managers, legal
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n o t e s
All above items appear in debit or credit side of ‘profit and loss
account’. The items that appear on the debit side of the Profit and
Loss Account are as follows:
Expenses incurred in a business: This is divided into two parts:
Direct expenses: These are recorded in income statement.
Indirect expenses: These are recorded on the debit side. Indi-
rect expenses are further categorised as follows:
Selling expenses: These include all expenses relating to sales such
as carriage outwards, travelling expenses, advertising, distribution
costs, etc.
Office expenses: These include all expenses incurred on run-
ning an office such as office salaries, rent, tax, postage, statio-
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nery etc.
Maintenance expenses: These include all expenses related to
the maintenance of assets such as repairs and renewals, depre-
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ciation, etc.
Financial expenses: These include all expenses related inter-
est paid on loan, discount allowed, etc.
The items that appear on the credit side of the profit and loss account
are as follows:
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Gross profit
Other gains and incomes of the business such as interest received,
rent received, discounts earned and commission earned.
The format of a Profit and Loss Account is as follows:
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n o t e s
Particulars Amount
= Operating income/Earnings before Interest and Tax (EBIT)
(-) Interest paid
=Profit before tax (PBT)
(-) Income tax
= Net profit
Apart from this, you will also study the components of the profit and
loss account in chapter 9. Let us understand the preparation of a Profit
and Loss Account with the help of the following illustrations:
Illustration 5: Prepare the profit and loss account from the following
particulars of ABC Limited for the year ending March 31, 2017:
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Particulars Amount (`)
Net Sales 75000
Administrative expenses 4000
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Interest received 1200
Profit on sale of old machinery 1400
Operating expenses 14000
Income tax paid 0.00
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n o t e s
Particulars Amount in `
Profit on sale of old machinery 1400 2600
(-) Operating expenses 14000
(-) Administrative expenses 4000
(-) Distribution costs 4800
(-) Other expenses 1900
= Operating income/ Earnings before Interest and Tax 18900
(EBIT)
(-) Interest paid 1700
=Profit before tax (PBT) 17200
(-) Income tax 0.00
= Net profit 17200
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3.4.2 Balance Sheet
to the trading and profit and loss account. Next, the personal accounts
of customers are grouped under the heading of sundry debtors, the
entities from whom the amounts of sold goods and services are due.
Similarly, we need to group all balances of the suppliers under the sin-
gle heading of sundry creditors, the entity to whom the organisation
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owes money or payment. In the end, the real and personal accounts
are grouped as assets and liabilities and are arranged in a proper way.
The resultant statement obtained is called the balance sheet.
In the balance sheet, assets are represented on the right side and lia-
bilities are shown on the left side. It is also known as the statement of
sources of funds and application of funds. The financial position of the
organisation includes its economic resources (assets), economic obli-
gations (liabilities), and owner’s equity. As discussed in previous chap-
ters, a balance sheet is the detailed summary of the basic accounting
equation:
Assets = Liabilities + Owner’s Equity
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The pro forma of the balance sheet is shown in the following table:
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(a) Share capital
(b) Reserves and surplus
(c) Money received against share
warrants
(2) Share application money pending
allotment
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(3) Non-current liabilities
(a) Long-term borrowings
(b) Deferred tax liabilities (Net)
(c) Other Long term liabilities
(d) Long-term provisions
(4) Current liabilities
(a) Short-term borrowings
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Non-current assets
(1) (a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
(iv) Intangible assets under
development
(b) Non-current investments
(c) Deferred tax assets (net)
(d) Long-term loans and
advances
(e) Other non-current assets
(2) Current assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and
advances
(f) Other current assets
TOTAL
n o t e s
Illustration 6: Prepare the profit and loss account and the balance
sheet from the following particulars of Rajan Associates on 31st
March, 2017:
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Distribution costs 14600
Other expenses 3800
Interest paid 6200
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Bills Receivable 16200
Creditors 23300
Machinery 52700
Plant 55600
Cash in Hand 22000
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Solution:
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Particulars Amount in `
(-) Distribution costs 14600
(-) Other expenses 3800
= Operating income/ Earnings before Interest and Tax (EBIT) 90700
(-) Interest paid 6200
=Profit before tax (PBT) 84500
(-) Income tax 8800
= Net profit 75700
BALANCE SHEET
Rajan Associates
Balance sheet for the year ended March 31, 2017
S. No. Particulars Amount in `
Capital
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Share capital 80000
Add: Net profit 75700
Less: Drawings 6500
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149200
Liabilities
Loan9000
Bills Payable 5000
Creditors23300
37300
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TOTAL 186500
ASSETS
Plant55600
Machinery52700
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cash, investment in government bonds, etc.
Financing activities are those activities which are related to the
financial transactions of a business and these activities provide the
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overview of cash used in business financing. For example, loan re-
ceived, issue of shares, payment of dividend, repayment of loan,
issue of debentures, etc. Apart from all, this you will study ‘cash
flow statement’ in detailed manner in chapter 8.
Balance Sheet
The profit and loss account reflects the financial performance of the
company by analysing the overall profitability of the entity. It shows
how much amount of gain or loss has taken place during a particular
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time period. On the other hand, a balance sheet reflects the financial
health of an entity by providing a pathway to ratio analysis. In other
words, balance sheet shows owes (liabilities) and owns (assets) of the
entity.
However, both the financial health and financial performance are
interrelated via equity investment in the balance sheet and net profit
on the profit and loss account. The connection between the balance
sheet and profit and loss account can also be determined with changes
in the equity of the entity. For example, suppose ABC Enterprise has
owners’ equity of ` 1 crore at the year ending March 31, 2016 and `1.25
crore for the year ending March 31, 2017. During this time period the
owner did not brought in any new investment and nor he withdrew
anything for personal use. So in this case we can say that the company’s
owner equity has been raised by ` 25 lakh due to retained earnings or
net profit.
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ing stock in the following accounting year.
Purchase can be defined as the overall cost of inventory, asset or
an item, that is possessed by an organisation to carry out its var-
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ious operations. In simple words, purchase is a transaction that
means exchange of money with goods or services.
Sales can be defined as the transfer of ownership of a particular
asset, item good or service to the buyer, for a certain amount of
money.
Direct expenses are those expenses which are directly related to
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n o t e s
11. In a profit and loss account, all indirect revenue expenses are
shown in the __________side and the indirect revenue incomes
are shown in the ___________ side.
(a) Debit; credit (b) Credit; Debit
(c) Profit; loss (d) Both (b) and (c)
12. A _______ refers to a statement that summarises and presents
the financial position of an organisation on any given date.
(a) Profit and loss statement (b) Income statement
(c) Balance sheet (d) Principle book
13. In a balance sheet, the ______________ balances are reflected
by assets.
(a)
Credit (b)
Debit
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(c)
Positive (d)
Expenditure
14. As per the reverse order of liquidity format of balance sheet
which of the following comes under the heading of fixed asset?
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(a) Tangible assets (b) Intangible assets
(c) Capital work-in-progress (d) All of the above
Activity
31st March, 2010, prepare the profit and loss account as well as the
balance sheet:
Debit Balances Amount (`) Credit Balances Amount (`)
Opening Stock 2,00,000 Sundry Creditors 1,50,000
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n o t e s
3.5 Summary
After we have posted transactions in a ledger account and bal-
anced the ledger, a statement is prepared to show the debit and
credit balances separately. This statement is called trial balance.
A trial balance tests the arithmetical accuracy of the posting of
transactions into the ledger.
The balance in an account refers to the difference between the
totals of the debit side and the credit side.
There are two methods of preparing a trial balance: total method
and balance method.
In case the trial balance does not agree, we need to locate the er-
rors committed.
When financial transactions are recorded in violation of the ac-
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counting principles, the error is called the error of principle.
Errors of omission occur when any transaction is not completely
or partially recorded in the books of accounts.
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In case of errors of compensation, an error is nullified with errors
of equal proportion. In other words, it means one type of error is
compensated by another error.
The profit and loss account is prepared to ascertain the net profit
earned and net loss suffered by a business over a given accounting
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period.
A balance sheet refers to a statement that summarises and pres-
ents the financial position of an organisation on any given date.
key words
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n o t e s
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4. What do you mean by errors of compensation?
5. a. Statement
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9. a. Compensation
13. b. Debit
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3.8 Solved Numerical Illustrations
1. Old machinery was sold for `10000 and credited to sales. Rectify
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the error from this information and also mention the type of
error.
Solution:
This is the error of principle and rectifying entry will be:
Date Particulars L.F. Dr. Amount Cr. Amount
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(`) (`)
Sales A/c Dr. 10000
To Machinery A/c 10000
(Being old machinery sold
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n o t e s
3. Amount of ` 10000 received from M/s Gupta and Co. was credited
to M/s Gopal and Co. Rectify the error from this information and
also mention the type of error.
Solution:
This is the error of commission and rectifying entry will be:
Date Particulars L.F. Dr. Amount Cr.
(`) Amount (`)
M/s Gopal and Co. A/c Dr.
To M/s Gupta and Co. A/c 1000
(Cash received from M/s Gupta
and Co. wrongly credited to M/s 1000
Gopal and Co., now rectified)
4. Wages of `2000 paid for the installation of machinery was debited
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to wages account. Rectify the error from this information and
also mention the type of error.
Solution:
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This is the error of principle and rectifying entry will be:
Date Particulars L.F. Dr. Amount Cr. Amount
(`) (`)
Machinery A/c Dr. 2000
To Wages A/c 2000
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Purchases 210000
Sales 450000
n o t e s
Solution:
For the calculation of gross profit, we need to calculate:
Cost of Goods Sold (CoGS) = Opening Stock + (Purchases –
Return outward) – Closing stock
= 290000
Now,
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= (450000 - 10000) – 290000
Suggested Readings
Debarshi, B. (2011). Management Accounting (1st ed., pp. 12-18).
Delhi: Dorling Kindersley India.
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Goyal, V., & Goyal, R. (2013). Corporate Accounting (1st ed., pp.
261-332). Delhi: Prentice Hall India.
Ramachandran, N., & Kakani, R. (2010). How to Read a Cash Flow
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E-references
AccountingCoach.com. (2014). Balance Sheet | Explanation |
AccountingCoach. Retrieved from, http://www.accountingcoach.
com/balance-sheet/explanation/1
Zeepedia.com. (2014). Rectification of Error Financial Account-
ing Commerce Accounting. [Retrieved from, http://www.zeepe-
dia.com/read.php?rectification_of_error_financial_account-
ing&b=23&c=28
n o t e s
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Case study
n o t e s
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2013
Jan 1: Amita purchased the secret recipe from Gaurav for `10,
00,000
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Jan 12: Amita started the restaurant with cash `12, 00,000 and fur-
niture `4, 00,000.
Jan 15: She purchased utensils, crockery, gas stoves, etc. on credit
worth `6, 00,000 from Aggarwal Associates.
Jan 8: Sold soup for cash worth `60,000.
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questions
Accounting Standards I
CONTENTS
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4.1 Introduction
4.2 Accounting Standards
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4.2.1 Types of Accounting Standards
4.2.2 Applicability of Accounting Standards
4.2.3 Objectives and Scope of Accounting Standards
Self Assessment Questions
Activity
4.3 Constitution of the Accounting Standards Board of India
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Activity
4.5 Compliance with Accounting Standards
Self Assessment Questions
Activity
4.6 Summary
4.7 Descriptive Questions
4.8 Answers and Hints
4.9 Suggested Readings & References
Introductory Caselet
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There has been a paradigm shift in the Indian economy in the last
two decades. This led to the announcement of several accounting
standards. Accounting standards were formulated with the view
of harmonising various accounting policies and treatment across
a section of business. The objective is to reduce flexibility in the
norms of preparation of financial accounts and ensure compara-
bility of financial statements.
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Taxes on Income”) on deferred tax accounting within the frame-
work of the Constitution. The apex court rendered the decision
that the deferred tax liability is nothing but accrual of tax due
to a divergence between accounting and taxable profits. In the
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Woodward Governor`s case, the apex court affirmed the decision
of the Delhi HC for deducting revenue expenditure resulting from
liability due to foreign exchange rates.
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learning objectives
4.1 INTRODUCTION
In the previous chapter, you studied about trial balance, rectification
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of errors and final accounts. Now, let us move forward and study about
accounting standards.
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The financial statements prepared by an organisation are accessed and
used by a diverse range of users. These users include various stake-
holders, such as the owners, investors and the government. There-
fore, it is absolutely essential that the different users of accounting
information interpret the accounting standards in the similar manner.
Therefore, uniformity needs to be maintained in the preparation of
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n o t e s
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nancial year 2007-08. The main purpose of ASB is to develop stan-
dards in the areas in which uniformity is required. The accounting
standards can be compared with a “lighthouse” which offers guidance
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and a disciplined path for the preparation of financial statements.
As per the Section 133 of The Companies Act, 2013, the union gov-
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n o t e s
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It ensures uniformity in accounts in all types of businesses irre-
spective of their industry and size.
It provides flexibility by facilitating an organisation to freely adopt
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any of the practices with a suitable disclosure.
AS Number Title
AS-1 Disclosure of Accounting Policies
AS-2 Valuation of Inventories (revised )
AS-3 Cash Flow Statements (revised)
AS-4 Contingencies and Events Occurring After the Bal-
ance Sheet Date (revised)
AS-5 Net Profit or Loss for the period, Prior Period Items
and extraordinary items and changes in accounting
policies
AS-6 Depreciation Accounting (revised)
AS-7 Accounting for Construction Contracts
AS-9 Revenue Recognition
AS-10 Accounting for Fixed Assets
AS-11 Accounting for the Effect of Changes in Foreign Ex-
change Rates (revised)
AS-12 Accounting for Government Grants
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AS-23 Accounting for Investments in Associates in Consoli-
dated Financial Statements
AS-24 Discounting Operations
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AS-25 Interim Financial Reporting
AS-26 Intangible Assets
AS-27 Financial Reporting of Interests in Joint Ventures
AS-28 Impairment of Assets
AS-29 Provisions, Contingent Liabilities and Contingent
Assets
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Source: http://www.icai.org/post.html?post_id=474
note
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For the purpose of relaxation to the Small and Medium sized Enter-
prises (SMEs), the ICAI have notified in October, 2003 certain relax-
ation in the applicability of accounting standards after due consider-
ation of the representations from various professionals and advisors.
For the purpose of applicability of accounting standards, enterprises
are classified into the following:
Level I Enterprise: These include either of the following:
Enterprise whose equity or debt securities are listed whether
in India or outside India.
Enterprises, which are in the process of listing their equity or
debt securities as evidenced by the board of directors’ resolu-
tion in this regard.
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Level II Enterprise: These include either of the following:
All commercial, industrial and business reporting enterpris-
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es, whose turnover for the immediately preceding accounting
period on the basis of audited financial statements exceeds
`40 lakhs but does not exceed `50 crores. Turnover does not
include ‘other income’.
All commercial, industrial and business reporting enterpris-
es having borrowings, including public deposits, in excess of
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`1 crore but not in excess of `10 crores at any time during the
accounting period.
Level III Enterprise: Enterprises, which are not covered under
Level I and Level II, are considered as Level III enterprises.
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n o t e s
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standards while interpreting the reported figures. Once users be-
come accustomed to these assumptions, they may use this knowl-
edge to interpret the financial statements of different organisa-
tions with ease.
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In its Preface to the Statements of Accounting Standards, the ASB
has outlined the scope of accounting standards. These are as follows:
Efforts will be made to issue Accounting Standards which are in
conformity with the provisions of the applicable laws, customs, us-
ages and business environment in India. However, if a particular
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n o t e s
The Institute will use its best endeavours to persuade the govern-
ment, appropriate authorities, industrial and business community
to adopt the Accounting Standards in order to achieve uniformity
in preparation and presentation of financial statements.
In formulation of Accounting Standards, the emphasis would be
on laying down accounting principles and not detailed rules for
application and implementation thereof.
The standards formulated by the ASB include paragraphs in bold
italic type and plain type, which have equal authority. Paragraphs
in bold italic type indicate the main principles. An individual stan-
dard should be read in the context of the objective stated in that
standard and this preface.
The ASB may consider any issue requiring interpretation on any
Accounting Standard. Interpretations will be issued under the au-
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thority of the council. The authority of interpretation is the same
as that of Accounting Standard to which it relates.
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self assessment Questions
n o t e s
Activity
Make a list of countries that mandate the use of GAAP for prepa-
ration and reporting of the financial statements of their corporate
bodies.
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CONSTITUTION OF the ACCOUNTING
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4.3
STANDARDS BOARD of INDIA
In India, the Accounting Standards are issued by the Council of the
ICAI. ICAI set up the Accounting Standards Board in the year 1977.
The ASB has also been assigned with the responsibility to propagate
the Accounting Standards and persuade the corporations to adopt
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vironment.
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5. In India, the Accounting Standards are issued by the Council
of the_________.
(a) Institute of Chartered Accountants of India (ICAI)
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(b) National Advisory Committee on Accounting Standards
(NACAS)
(c) National Financial Reporting Authority (NFRA)
(d) Both (a) and (c)
6. __________ formulates Accounting Standards with a view to
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Activity
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Institute of Cost and Works Accountants of India (ICWAI), Insti-
tute of Company Secretaries of India (ICSI), and Central Board of
Direct Taxes (CBDT). The representatives of these bodies are also
invited at a meeting of the ASB for discussion.
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Issuing the exposure draft in order to invite comments from the
members of institutes and public at large. Next, the draft is pub-
lished in the journal of the institute. Following are the basic points
of the exposure draft:
a. Comprises a statement of concepts and fundamental account-
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n o t e s
Figure 4.1 shows the sequence of the procedure for issuing accounting
standards in India:
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n o t e s
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Activity
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Visit the website of ICAI and list the Accounting Standards that are
currently under revision status by the Accounting Standards Board.
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ments of each applicable standard.
(c) Rule 4
(d) Rule 7
12. The financial statements of different companies cannot
be compared if the statements are not in compliance with
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the_____________.
(a) Indian Accounting Standards
(b) Rules of Posting
(c) Financial Statement Preparation Rules
(d) None of the above
13. The mandate for compliance with Accounting Standards by
Indian corporates has been outlined by the ________________.
(a) Institute of Charted Accountants of India (ICAI)
(b) International Financial Reporting Standards (IFRS)
(c) National Financial Reporting Authority (NFRA)
(d) Both (a) and (c)
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Activity
Visit the website of ICAI and note the manner of making a disclo-
sure in the audit report in the case of non-compliance with any of
the accounting standards. Present your findings in a brief note.
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4.6 SUMMARY
The financial statements prepared by an organisation are accessed
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and used by a diverse range of users. The users include various
stakeholders, such as the owners, investors, and the government.
In simple words, we can define accounting standards as the writ-
ten statements regularly issued by accounting institutes. The stan-
dards are used to consolidate the various accounting principles
that are generally accepted.
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n o t e s
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key words
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Constitution of the 5. True
Accounting Standards 5. d. Both (a) and (c)
Board of India
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(ASB)
7. d. All of the above
Procedure of Issuing Ac- 8. c. Section 132
counting Standards
9. a. 300
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4.9 SUGGESTED Readings & References
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SUGGESTED READINGS
Bhattacharyya, A. (2006). Indian Accounting Standards: Practices,
Comparisons, and Interpretations (2nd ed., pp. 4.1-4.5). Delhi: Tata
McGraw Hill.
Chowdhury, A. (2007). Fundamentals of Accounting and Financial
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Analysis (For U.P.T.U.) (1st ed., pp. 31-39). Delhi: Dorling Kinders-
ley.
Rajasekaran, V., & Lalitha, R. (2011). Financial Accounting (1st ed.,
pp. 30-37). Delhi: Dorling Kindersley.
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E-REFERENCES
My Accounting Course. (2014). GAAP | Accounting Principles and
Objectives. Retrieved from, http://www.myaccountingcourse.com/
accounting-principles/generally-accepted-accounting-principles
Objectives of Accounting - The Accounting Concept. (2014).
Boundless. Retrieved from, https://www.boundless.com/account-
ing/textbooks/boundless-accounting-textbook/introduction-to-ac-
counting-1/the-accounting-concept-18/objectives-of-account-
ing-114-1525/
Rbi.org.in.
(2014). Reserve Bank of India. Retrieved from, http://
www.rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=194
Saralaccounts.com. (2014). Accounting Standards. Retrieved from,
http://www.saralaccounts.com/resources/accounting-std.php
Case study
n o t e s
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brothers to Aurora Loan Services Inc., SIB Mortgage. Its head-
quarters were in New York along with regional Headquarters in
London (UK) and Tokyo (Japan).
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During 2003 and 2004 (period of housing bubble), Lehman Broth-
ers received five mortgage lenders such as, BNC Mortgage and
Aurora Loan services, which provides loans without complete
documentation. Lehman brothers had invested huge amount of
funds in property market and the decline in real estate prices
pushes Lehman Brothers to bankruptcy. At the same time com-
pany had manipulated many of accounting principles.
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The top executives and auditors (E & Y) at Lehman are the main
players in the scandal and they uses Repo 105 scheme to manip-
ulate various accounting rules. Repo 105 is an accounting trick
which works as repurchase agreement and this trick allows com-
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Case study
n o t e s
Jones Index closed with 500 points falls in a single day trading.
On the next day, September 16, 2008, Barclays, announced to ac-
quire Lehman Brothers Holdings. However, the Securities and
Exchange Commission did not initiate the process due to the lack
of evidence.
In March 2010, the committee appointed by the US Federal court
submitted its report. This report described that at the end of each
quarter Lehman’s top decision makers had used many fraud ac-
counting tricks to make its financial position more attractive. As
per the federal law, Lehman was not allowed to get lawyers in the
USA for the closing of the real deal with outsiders. So, they did it
through British Subsidiary, which comes under the British legal
system. The investigators commented that if Lehman remained
in the US only, using the US accounting laws, it would fail in the
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scheme. In the same manner if the firm had followed Internation-
al accounting rules, it would also fail.
questions
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1. Discuss some of the measures to reduce the risk of frauds
in context with financial accounting.
(Hint: Consider some measures such as, employee’s
backgrounds, set up reporting system and
communicate them to employees, internal controls, take
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Accounting Standards II
CONTENTS
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5.1 Introduction
5.2 Implementation of Accounting Standards
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Self Assessment Questions
Activity
5.3 Financial Statements Reporting
5.3.1 Accounting Standards: 1 and 2
5.3.2 Accounting Standards: 4 and 5
5.3.3 Accounting Standards: 9, 10, 16 and 26
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5.4 Summary
5.5 Descriptive Questions
5.6 Answers and Hints
5.7 Solved Numerical Illustrations
5.8 Suggested Readings & References
Introductory Caselet
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standards would be mandatory from the Financial Year 2016-17
(The word “Financial Year, hereinafter referred to as “FY” for the
sake of brevity). How
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ever, organisations may voluntarily adopt this by FY 2015-16. The
company law experts in India believe that the new accounting
standards would further strengthen the capital markets. Howev-
er, experts also assess the possibility of several challenges in the
implementation of the new accounting standards.
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Source: http://economictimes.indiatimes.com/industry/services/consultancy-/-audit/
budget-2014-proposes-convergence-of-indian-accounting-standards-with-ifrs/article-
show/38140064.cms
n o t e s
learning objectives
5.1 INTRODUCTION
In the previous chapter, you studied various accounting standards fol-
lowed in India. Now, let us move forward and study about these stan-
dards in detail.
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Council of Institutes of Charted Accountants of India (ICAI). ASB is
responsible for the development of accounting standards in India.
The standards are formulated in consultation with the members and
various institutions.
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Accounting standards are those set of principles that work as a bench-
mark for accounting practices and financial reporting. Accounting
standards determine rules to record various events (or transactions)
occurred in organisations.
implementation issues.
n o t e s
parable. The list of various Indian accounting standards (Ind AS) pre-
scribed by the ICAI given below:
1. Ind AS 101 First-time Adoption of Indian Accounting Standards
2. Ind AS 102 Share based Payment
3. Ind AS 103 Business Combinations
4. Ind AS 104 Insurance Contracts
5. Ind AS 105 Non current Assets Held for Sale and Discontinued
Operations
6. Ind AS 106 Exploration for and Evaluation of Mineral Resources
7. Ind AS 107 Financial Instruments: Disclosures
8. Ind AS 108 Operating Segments
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9. Ind AS 1 Presentation of Financial Statements
10. Ind AS 2 Inventories
11. Ind AS 7 Statement of Cash Flows
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12. Ind AS 8 Accounting Policies, Changes in Accounting Estimates
and Errors
13. Ind AS 10 Events after the Reporting Period
14. Ind AS 11 Construction Contracts
15. Ind AS 12 Income Taxes
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n o t e s
Currently, the government and other parties involved are taking var-
ious measures to integrate the Indian accounting standards with the
global accounting standards and the International Financial Report-
ing Standards (IFRS). This will help in better aligning the Indian cap-
ital markets with the international markets. In addition, this will help
the market participants by way of giving them more reliable market
information.
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In this chapter, you will study the implementation of the accounting
standards in India. In addition, the unit discusses about the reporting
of financial statements based on various accounting standards.
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IMPLEMENTATION OF ACCOUNTING
5.2
STANDARDS
Proper implementation of accounting standards by Indian enterprises
implies that the financial statements and disclosures of the enterpris-
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This clause states that the entire responsibility for the implementa-
tion of accounting standards rests with the directors of an enterprise.
The auditor’s responsibility is restricted to form his opinion and to
n o t e s
For discharging its functions, the ASB will keep in view the purposes
and limitations of financial statements and the attest function of the
auditors.
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ments and suggest improvements in the terminology wherever
necessary. The ASB will examine the various current alternative
practices in vogue and endeavour to eliminate or reduce alterna-
IMtives within the bounds of rationality.
Accounting Standards are designed to apply to the general pur-
pose financial statements and other financial reporting, which are
subject to the attest function of the members of the ICAI.
The term ‘General Purpose Financial Statements’ includes balance
sheet, statement of profit and loss, a cash flow statement (wherev-
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Statements.
Responsibility for the preparation of financial statements and for
adequate disclosure is that of the management of the enterprise.
The auditor’s responsibility is to form his opinion and report on
such financial statements.
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Exhibit
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implementation of Indian Accounting Standards converged
with IFRS.
To take adequate steps to enhance knowledge of the members
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and other stakeholders for proper implementation of Indian Ac-
counting Standards converged with IFRS by conducting work-
shops, seminars, IFRS Certificate Course in India and abroad,
and train the trainers programmes.
To develop course material for the Certificate Course and
e-learning.
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n o t e s
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(c) Institute of Charted Accountants of India
(d) None of the above
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4. AS 1 deals in _____________ and is mandatory to be followed
by all enterprise.
(a) Valuation of inventories
(b) Net profit/loss for the period
(c) Disclosure of financial statements
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Activity
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Visit the website of ICAI. List the main items covered under the
Preface to the Statements of Accounting Standards (revised 2004).
The ICAI issued Accounting Standard (AS) 1 which deals with ‘Disclo-
sure of Accounting Policies’ and is a mandatory to be followed by all
n o t e s
In India, generally the accounting policies are not regularly and fully
disclosed in the financial statements. Many enterprises include some
notes in accounts, which provide a description of some of the sig-
nificant accounting policies. There is again a considerable variation
among the very few enterprise which includes a separate statement of
accounting policies on financial statements. The main objective of the
statement of accounting policies is promoting a better understanding
of the financial statements by disclosing significant accounting poli-
cies.
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An enterprise should disclose all significant accounting policies
that are adopted while preparing and presenting the financial
statements: This is required because the accounting policies differ
across organisations which makes it inevitable to provide guide-
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lines and rules that are followed right from the recording of trans-
actions till their presentation on the financial statements. Such
disclosures should form a part of the financial statements and the
significant accounting policies should normally be disclosed in one
place.
An enterprise should disclose in case the fundamental account-
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n o t e s
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any write-down to net realisable value. It also deals with the cost for-
mulas that are used to assign costs to inventories. According to AS 2,
inventories should be measured and valued at the lower of cost and
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net realisable value.
Costs of Purchase
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Costs of Conversion
Other Costs
n o t e s
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statements of
i. Contingencies
ii. Events occurring after the balance sheet date
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The following terms are used in AS 4:
Contingency: This refers to a condition or situation, the ultimate
outcome of which, gain or loss, will be known or determined only
on the occurrence, or non-occurrence, of one or more uncertain
future events.
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Events occurring after the balance sheet date: These refer to sig-
nificant events, both favourable and unfavourable, that occur be-
tween the balance sheet date and the date on which the financial
statements are approved by the Board of Directors in the case of
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Accounting Standard 5 (AS 5) deals with “Net Profit/Loss for the Pe-
riod, Prior Period Items and Changes in Accounting Policies”. The
objective of AS 5 is to recommend the classification and disclosure of
certain items in the profit and loss statement so that all organisations
prepare and present the statement uniformly. This improves the com-
parability of the financial statements of an enterprise over time and
n o t e s
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The definitions covered in AS 5 are as follows:
Ordinary activities: It refers to those activities which are under-
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taken by an organisation as part of its business and such related
activities in which the organisation engages in furtherance of, in-
cidental to, or arising from, these activities.
Extraordinary items: It refers to income or expenses arising from
events or transactions that are clearly distinct from the ordinary
activities of the enterprise and thus, do not recur frequently or
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regularly.
Prior period items: It refers to income or expenses arising in the
current period as a result of errors or omissions in the preparation
of the financial statements of one or more prior periods.
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n o t e s
S
c. Proportionate completion method: It refers to the method of
accounting which recognises revenue in the statement of profit
and loss in proportion to the degree of completion of services
under a contract.
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ACCOUNTING STANDARD (AS 10): PROPERTY, PLANT AND
EQUIPMENT
n o t e s
note
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A qualifying asset: It refers to an asset that necessarily takes a con-
siderable amount of time to get ready for its intended use or sale
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Accounting Standard (AS 26): Intangible Assets
n o t e s
S
c. Mutual funds and venture capital funds and/or the related asset
management companies, banks and public financial institutions
formed under a central or state government ACT or so declared
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under the Companies Act, 1956.
n o t e s
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of an organisation that is engaged in providing products or services
within a particular economic environment and that is subject to
risks and returns that are different from those of components
IM operating in other economic environments. Aspects that should
be considered in identifying geographical segments include:
Similarity of economic and political conditions
Relationships between operations in different geographical
areas
Proximity of operations
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n o t e s
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Standards
n o t e s
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AS 14 - Accounting for Amalgamations: He made many good in-
vestments and his business started making a considerable amount
of profits. As a result, he got an offer of amalgamation from one of
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the reputed Multinational Corporations (MNCs).
AS 15 - Employee Benefits: When employees got information
about the said amalgamation deal, they started protesting for the
settlement of their outstanding employee benefits.
AS 16 - Borrowing Costs: For the settlement of employee benefits,
Farid borrowed some money from a bank and due to this his bor-
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n o t e s
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AS 27 - Financial Reporting of Interests in Joint Ventures: Due
to the goodwill of the business he got many offers from reputed
many MNCs to start a new project through joint venture.
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AS 28 - Impairment of Assets: After initiating the new project un-
der joint venture, he recognised that the book value of assets was
not justified and as a result there was an impairment of assets.
AS 29 - Provisions, Contingent Liabilities and Contingent As-
sets: Under the project of joint venture an accident took place and
one of the labour got injured and he filed a case for compensa-
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n o t e s
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(d) None of the above
9. _____________ is the systematic allocation of the depreciable
IM amount of an intangible asset over its useful life.
(a) Amortisation
(b) Depreciation
(c) Cost of usage
(d) None of the above
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n o t e s
13. __________ recommends the accounting treatment for
intangible assets.
(a) Accounting Standard 26
(b) Accounting Standard 34
(c) Accounting Standard 36
(d) Accounting Standard 38
14. What is the total number of Accounting Standards notified by
the Ministry of Corporate Affairs?
(a) 33
(b) 37
(c) 41
(d) 45
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Activity
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Visit the website of Ministry of Corporate Affairs and make a list of
the mandatory and non-mandatory AS.
5.4 Summary
The Accounting Standard Board (ASB) is responsible for formu-
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n o t e s
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key words
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Attest function: The independent review of an audit conducted
by a Certified Public Accountant (CPA).
Book value: The value at which an asset is carried on to a bal-
ance sheet.
Contingency: A future event or situation which is probable but
cannot be predicted with certainty.
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n o t e s
S
answers for Self Assessment Questions
Errors
7. b. Indian Accounting Standard 7
8. a. Fixed asset
9. a. Amortisation
10. b. Indian Accounting Standard
20
11. a. Proportionate completion
method
12. b. Indian Accounting Standard
33
13. d. Accounting Standard 38
14. c. 41
n o t e s
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Assets’. Refer to Section 5.3 Financial Statements Reporting.
5. Accounting Standard 16 is applied in accounting for borrowing
costs and does not deal with the actual or imputed cost of owners’
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equity, including preference share capital not classified as a
liability. Accounting Standard 26 recommends the accounting
treatment for intangible assets not covered in another Accounting
Standard. Refer to Section 5.3 Financial Statements Reporting.
6. As per AS 17, a business segment is a distinguishable component
of an organisation engaged in providing an individual product
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n o t e s
S
10 percent per annum.
3. Suppose, XYZ Ltd. has a net profit of `1 crore and preferred
dividends of `10 lakh. Calculate its basic and diluted EPS if the
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total number of outstanding shares is 900000.
Solution:
According to AS 20, Earning Per Share (EPS) should be
calculated as follows:
Diluted EPS = (Net profit-prefferred dividends)/(Weighted
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n o t e s
note
5. Suppose the ABC Ltd has an annual inventory of 1000 units and
the current market price of each unit is `20 and ABC limited sold
all 1000 units for `22 per unit. Calculate the net realisable value
and fair value of inventory per unit.
Solution:
In the above situation the net realisation value for inventory will
be `22 per unit and fair value will be `20 per unit.
6. In February 2016, a teller at the billing counter of XYZ Ltd. thefts
`5 lack from company’s wallet and it was not noticed until June
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2016. Explain where this amount of `5 lakh will be adjusted at
the end of financial year in March 2016.
Solution:
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Para 13 of Accounting Standard 4 provides the provision of
‘Contingencies and Events Occurring after the Balance Sheet
Date’. It means in such a situation mentioned above the monetary
value of loss or theft occurred can be adjusted in the balance sheet
of the concerned year. However, there is one condition that the
financial statements of thee concerned year are not approved by
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the board of directors. So, in this case XYZ limited can adjust the
theft value of `5lakh if its financial statements are not approved
by the board of directors.
= (10000000 – 1000000)/90000
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= `100
Basis EPS = (Net profit) / (Weighted average common stock)
= (1000000)/90000
= `111.11
SUGGESTED READINGS
Bhattacharyya, A. (2006). Indian Accounting Standards: Practices,
Comparisons, and Interpretations (2nd ed., pp. 4.15-22.38). New
Delhi: Tata McGraw Hill.
Godfrey, J., & Chalmers, K. (2008). Globalisation of Accounting
Standards (2nd ed., pp. 253-256). Massachusetts: Edward Elgar
Publications.
n o t e s
V., R., & R., L. (2011). Financial Accounting (1st ed., pp. 30-39). Noi-
da: Dorling Kindersley (India).
E-REFERENCES
ICAI. (2014). ICAI - The Institute of Chartered Accountants of
India. Retrieved from, http://www.icai.org/new_post.html?post_
id=2805&c_id=221
Mca.gov.in. (2014). Ministry of Corporate Affairs - Standards. Re-
trieved from, http://www.mca.gov.in/MinistryV2/standards.html
Ey.com. (2014). Overview: IFRS becomes mandatory in India. Re-
trieved from, http://www.ey.com/IN/en/Issues/IFRS/Overview--IF-
RS-becomes-mandatory-in-India
India,P. (2014). Ready with updated Indian accounting standards:
S
ICAI. Business-standard.com. Retrieved from, http://www.busi-
ness-standard.com/article/economy-policy/ready-with-updat-
ed-indian-accounting-standards-icai-114071300140_1.html
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Case study
n o t e s
The rapid integration of capital markets over the past decade has
underlined the appeal of developing a single set of international
accounting standards. The growing acceptance of international
standards has provided momentum for the work of the Interna-
tional Accounting Standards Board (IASB) and has increased the
possibility that international standards might be the foundation
of global markets.
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mation
Reducing the costs of preparing financial statements
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Providing access to higher quality
Making better decisions owing to rigorous and consistent ap-
plication of the accounting standards
Allocating funds more efficiently
Achieving lower cost of capital
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Case study
n o t e s
As these are different for each nation across the globe, the critics
argue that accounting standards should be developed tailored to
the needs of particular economies.
questions
1. With the help of the case, discuss the benefits that arise
for the market participants in case companies use IFRS.
(Hint: Improving comparability and transparency of
financial information, reducing the costs of preparing
financial statements, providing access to higher quality,
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making better decisions owing to rigorous and consistent
application of the accounting standards, allocating funds
more efficiently, etc.)
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2. According to you, what are the possible disadvantages of
having a global accounting standard?
(Hint: The adoption of single form of accounting system
has the risk of severely restricting the different forms of
capitalism that might develop across the globe. It also
privileges one particular way of doing business over
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alternative forms.)
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CONTENTS
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6.1 Introduction
6.2 Generally Accepted Accounting Principles (GAAP)
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6.2.1 Objectives of GAAP
6.2.2 Characteristics of GAAP
6.2.3 Difference between GAAP & International Accounting Standards
Self Assessment Questions
Activity
6.3 International Financial Reporting Standards (IFRS)
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Activity
6.5 Difference between IGAAP, IFRS and Ind AS
Self Assessment Questions
Activity
6.6 Summary
6.7 Descriptive Questions
6.8 Answers and Hints
6.9 Suggested Readings & References
Introductory Caselet
n o t e s
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and Business Process Outsourcing (BPO) that together accounted
for more than 30% of the total revenue of the company. All these
businesses were expected to be the major growth drivers for the
company in the future. The company prepared its consolidated
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financial statements, under Indian GAAP in accordance with the
requirements of Accounting Standards AS 21, AS 23, and AS 27
issued by the Institute of Chartered Accountants of India (ICAI).
The company also prepared its consolidated financial statements
in accordance with the US GAAP to meet the requirements
of the Securities and Exchange Commission (SEC) in the US.
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n o t e s
learning objectives
6.1 INTRODUCTION
In the previous chapter, you studied several accounting standards, the
recommendations and definitions under these accounting standards.
Now, let us discuss the accounting conventions under the Generally
S
Accepted Accounting Principles (hereinafter referred to as “GAAP”
for the sake of brevity).
n o t e s
It should be noted that GAAP are simple guidelines and principles for
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accounting. Therefore, it is subject to amendments. At times, certain
specific principles need to be altered and some new principles add-
ed to adapt to the changing economic circumstances and changing
business practices. Moreover, various accounting principles originate
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from changes in law, tax regulations, new business organisational ar-
rangements, or new financing or ownership techniques.
n o t e s
6.2.1 OBJECTIVES OF GAAP
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It
helps various stakeholders in interpreting the financial state-
ments in the same manner.
Itprovides various stakeholders from different jurisdiction in un-
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derstanding the accounts prepared in other jurisdictions.
It clarifies issues and confusions regarding various accounting issues.
6.2.2 CHARACTERISTICS OF GAAP
Figure 6.1:
Simple Guidelines
Characteristics of GAAP
Ensure Uniformity
Relevance
Objectivity
Feasibility
n o t e s
S
lines set by the International Accounting Standard Committee (IASC),
located in London. The International Accounting Standard Board
(IASB) is the standard-setting body of the IASC. GAAP on the other
hand, are accounting standards followed in any country. GAAP dic-
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tates the rules or standards, as well as the conventions to be followed
when organisations in a country, records, summarises, transact and
prepare their financial statements. Although IASC is a powerful com-
mittee, it has no direct control for setting the rules for GAAP. Howev-
er, GAAP are influenced by IAS e.g. the set of rules principles, con-
ventions and the Accounting Standards followed in India would be
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n o t e s
Activity
With the help of the Internet, compare Indian GAAP with the US
GAAP. Present your findings in a short note.
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INTERNATIONAL FINANCIAL
6.3
REPORTING STANDARDS (IFRS)
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Accounting standards need to be established at the national and the
international level. However, different countries follow different ac-
counting standards. This presents a significant challenge in the global
business environment. Several standards setting bodies and organisa-
tions are engaged in standardising the accounting practices. For pro-
moting the standardisation of the accounting standards, the Interna-
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n o t e s
Exhibit
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Source: “IFRS”, http://media.cpa2biz.com/Publications/IFRS/1924_IFRS_Background_v3_
web_FINAl_06-09-09.pdf,2008
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n o t e s
Activity
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IFRS. Present your findings in a short note.
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6.4 INDIAN ACCOUNTING STANDARDS (AS)
In any country, the accounting standards comprise a system of mea-
surement and disclosure for the preparation and the presentation
of the financial statements. The Institute of Chartered Accountants
of India (ICAI) is the apex accounting body in India. ICAI set up the
ASB in April 1977 to formulate accounting standards. The board at-
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of the IASC. The ASB gives due consideration to the International Ac-
counting Standards (IAS) issued by IASC and tries to integrate them
to the maximum extent in the light of the conditions and practices
prevailing in India. The accounting standards are issued under the
authority of the council.
n o t e s
As per Section 132 of Companies Act, 2013, the Union Government has
constituted a financial regulatory authority named as National Finan-
S
cial Reporting Authority (NFRA). NFRA is responsible for providing
recommendations to the central government on accounting standard,
accounting policies, auditing standard and inspection of auditors and
there are three committees under NFRA, namely accounting stan-
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dard committee, auditing standard Committee and enforcement com-
mittee. NFRA has its chairperson as the highest level of authority and
he should have expert knowledge of accounting, auditing, finance or
law. The authority comprises maximum 15 members from various de-
partments, such as Accounting, Auditing, Enforcement, Ministry of
Corporate Affairs (MCA), Reserve Bank of India (RBI), Securities and
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n o t e s
S
Consolidation of financial statements of foreign MNCs operating
in India and Indian MNCs operating in abroad.
It should be noted that accounting standards have a legal backing.
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The ICAI expects that its members should implement the account-
ing standards issued by it through their independent attest function.
Attest function includes independently reviewing the validity of data
through audits conducted by accountants. The ASB has been entrust-
ed with the responsibility of propagating the accounting standards
and persuading the concerned parties to adopt them in the prepara-
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n o t e s
Activity
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as compare to Ind AS and IGAAP and also the terms used in IFRS are
different from Ind AS and IGAAP. For instance, Ind AS and IGAAP
uses the term ‘Balance Sheet’ while under IFRS it is known as ‘State-
ment of Financial Position’. As a principle based accounting system,
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IFRS represents and includes the economics of a transaction better
than IGAAP and Ind AS. There are several similarities between these
three accounting systems. For example, all three accounting systems
use the same reporting elements; assets, liabilities, equity, income
(revenues and gains) and expenses (losses). Ind AS is mostly inspired
from IFRS, which is a set of global accounting standards that are al-
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n o t e s
S
transferred to profit is transferred to is transferred to
and loss account capital reserves capital reserves
as per IFRS 28. and AS 23 is appli- and AS 28 is
Uniformity in ac- cable. applicable. It is
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counting policies is impracticable to
required for associ- change account-
ates. Retrospective ing policies
costs to be calculat- which are men-
ed as per IFRS 1. tioned under
Ind AS 101 and
book value in
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declined cost to
be calculated as
per Ind AS 1.
Foreign Foreign currency No such definition. Foreign curren-
currency convertible bonds cy convertible
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n o t e s
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(b) 1979
(c) 1983
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(d) 1989
Activity
6.6 SUMMARY
Accounting statements are prepared to communicate the finan-
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n o t e s
S
The requirements for the presentation of financial statements are
set out in Schedule IV of the Companies Act, 1956, Schedule III to
the Banking Regulation Act, 1949, the regulations issued by the
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Insurance Regulatory and Development Authority (IRDA) and the
SEBI guidelines together with the Accounting standards notified
under the Companies (Accounting Standards) Rules, 2006.
Inventory valuation refers to the cost associated with an organi-
sation’s inventory in hand at the end of a reporting period. Inven-
tories owned by a manufacturing company typically include raw
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key words
n o t e s
S
asset is expected to generate net cash inflow for the entity such
as land.
International Financial Reporting Standards (IFRS): IFRS
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Accounting standards developed by the IFRS foundation and
International Accounting Standards Board (IASB). As of now,
there are two types of accounting standards issued by the IFRS,
type one IFRS for large scale companies and IFRS for Small
and Medium Enterprises (SMEs).
Non-current assets: An organisation’s assets such as plant,
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n o t e s
S
hints for Descriptive Questions
1. GAAP provides accounting frameworks to the various companies
that follow these principles. The main characteristics of GAAP are
IM
that it provides simple guidelines, ensures uniformity, relevance,
objectivity and feasibility in maintaining financial data. Refer to
Section 6.2 Generally Accepted Accounting Principles (GAAP).
2. ICAI issues accounting standards in India, recommended
in the initial years. These are applicable to all organisations
whose accounts are audited by qualified auditors as per the
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Suggested Readings
Epstein,
B., Nach, R., & Bragg, S. (2009). Wiley GAAP codification
enhanced (1st ed. pp. 105-110). Hoboken, NJ: John Wiley & Sons.
Kuppapally, J. (2010). Accounting for managers (1st ed. pp. 20-23).
India: PHI Learning.
Everingham, G., Kleynhans, J., & Posthumus, L. (2007). Principles
of Generally Accepted Accounting Practice (3rd ed.,. pp. 1-18). Cape
Town, South Africa: Juta and Co.
n o t e s
E-REFERENCES
My Accounting Course. (2014). GAAP | Accounting Principles and
Objectives. Retrieved from, http://www.myaccountingcourse.com/
accounting-principles/generally-accepted-accounting-principles
Pkobp.pl. (2014). PKO BP Annual Report 2012 - Tangible fixed as-
sets and intangible assets. Retrieved from, http://www.pkobp.pl/
raportroczny2012/en/tangible-fixed-assets-and-intangible-assets.
html
Sage Fixed Assets. (2012). Explaining Tangible and Intangible
Fixed Asset Categorisations - Sage Fixed Assets. Retrieved from,
http://blog.sagefixedassets.com/fixed-asset-management/explain-
ing-tangible-and-intangible-fixed-asset-categorizations/
Usgaap.tripod.com. (2014). US GAAP vs Indian GAAP. Retrieved
S
IMfrom, http://usgaap.tripod.com/id6.html
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Case study
n o t e s
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Shareholders’ funds As AS As IFRS % Diff
Share capital 4,915 4917 0.04%
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Reserves and surplus 2,65,258 281246 6.03%
2,70,173 286163 5.92%
Minority interest 849 -100.00%
Non-current liabilities
Long term borrowings 22,510 22817 1.36%
Deferred tax liabilities 275 353 28.36%
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Case study
n o t e s
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is different from the amount in GAAP. Also, the amounts of short
term loans and advances and that of other current assets are dif-
ferent. The reason behind this is the difference in recognition of
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certain items of loans and trade receivables. Under IFRS loans
and trade receivables are treated quite differently. The total of the
current assets is 1.66% more in the case of IFRS which shows that
AS are more conservative. Similarly short term loans and advanc-
es, prepaid expenses, advance to suppliers are accounted for dif-
ferently in IFRS and GAAP. The total of current liability varies by
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questions
CORPORATE ACCOUNTS
CONTENTS
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7.1 Introduction
7.2 Schedule III of the Companies Act, 2013
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7.2.1 The Companies Act, 2013
7.2.2 Format of Balance Sheet
7.2.3 General Instructions, for the Preparation of a Balance Sheet
7.2.4 General Instructions for the Statement of Profit and Loss
Self Assessment Questions
Activity
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7.3 Summary
7.4 Descriptive Questions
7.5 Answers and Hints
7.6 Solved Numerical Illustrations
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Introductory Caselet
n o t e s
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of the rubber plantation business was whether or not to include
these years in its operating cycles. With respect to this problem,
attention was drawn towards the opinion of the Expert Advisory
Committee who released their statement on this matter in their
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research dated 23-3-2007 ‘Accounting treatments of surplus re-
alised on the sale of rubber trees’. The Committee opined that
rubber plants are fixed assets for rubber planting organisations
and any expenditure incurred on rubber plantations should be
capitalised when the plants are mature for tapping. Consequently,
the cost capitalised in this way required to be amortised during
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the useful life of the rubber plants. The Expert Advisory Commit-
tee stated that the rubber plants are fixed assets and are not pro-
cessed. Apart from this, the plants not kept for sale by the rubber
planting organisations. It was then decided that the time of six to
seven years taken for plantations should be considered as part of
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n o t e s
learning objectives
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7.1 INTRODUCTION
The Ministry of Corporate Affairs (MCA) prescribed Schedule III (ap-
IM
plicable as per accounting standards) of Section 129 of Indian Compa-
nies Act, 2013, which specifies the new format for the preparation and
presentation of financial statements by Indian corporates. The Re-
vised Schedule lays down the new acceptable format and general in-
structions for the preparation of financial statements of corporations;
viz. the balance sheet and the profit and loss statement. A balance
sheet is a summary of financial balances of a corporate body stating
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the position of its assets and liabilities. On the other hand, a profit and
loss statement summarises revenues, costs and expenses incurred by
an organisation during a specific period of time usually a financial
year. This schedule prescribes various mandatory requirements such
as disclosure of addition, substitution or deletion in the head or sub-
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In this chapter, you will study about Schedule III of Companies Act,
2013 and the format and general instructions laid down by the Act for
the preparation of financial statements, in detail.
n o t e s
S
Acquaint corporates with IGAAP/IFRS
Ensure effective presentation, disclosure of financial data to facili-
tate organised data for users of financial statement.
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The Schedule III of the Companies Act lays down general instructions
for the preparation of the Balance Sheet and the statement of the prof-
it and loss of a company in addition to the notes incorporated adjacent
to the heading of the Balance sheet. These are as follows:
1. Where compliance with the requirements of the Act including
accounting standards as applicable to corporations, require
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n o t e s
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Amount below one hundred rounded off to the nearest hundreds,
Crore rupees thousands, rupees Lakhs or Millions,
or decimals thereof
Amount equal to or above
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rounded off to the nearest, Lakhs,
one hundred Crore rupees Millions or Crores, more or decimals
thereof
6. For the purpose of the Revised Schedule VI, the terms used
herein shall be as per the applicable accounting standards.
note
Apart from this, the Revised Schedule also specifies the require-
ment of notes by the corporations. Notes disclosed at the end of the
financial statements set out the minimum requirements for disclo-
sures on the face of the Balance Sheet, and the Statement of Profit
and Loss (hereinafter referred to as “Financial Statements” for the
purpose of this Schedule). Line items, sub-line items and sub-totals
shall be presented as an addition or substitution on the face of the
Financial Statements when such presentation is relevant to an un-
derstanding of the company’s financial position or performance or
to cater to industry/sector-specific disclosure or when required for
compliance with the amendments to the Companies Act or speci-
fied in the accounting standards.
n o t e s
The Companies Act, 2013 is the same as the notified under the existing
Companies Act, 1956. The Act combines and amends the Companies
Act, 1956. The core changes of the new Act as compared to Companies
Act, 1956 are as follows:
Companies Act, 1956 defines the term “financial year” as the peri-
od in respect of which any profit and loss account of the body corpo-
rate laid before it in AGM is made up, whether that period is a year
or not. However, according to Companies Act, 2013, every company
shall follow uniform accounting year starting April 1 – March 31.
According to Companies Act, 2013, every Listed Company /Pub-
lic Company with paid up capital of `100 Crores or more / Public
Company with turnover of `300 Crores or more shall have at least
S
one Woman Director.
The Companies Act, 1956 does not define the term “financial
statements.” The Companies Act, 2013 defines the term “financial
IMstatements” to include:
a. Balance Sheet as at the end of the financial year
b. Profit and Loss account for the financial year
c. Cash flow Statement for the financial year
d. Statement of change in equity, if applicable
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n o t e s
S
Financial
State-
ments
4. Share-
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Maximum limit for no. of Maximum limit for no. of
holding shareholders 50. shareholders 200.
in Pvt.
Company
n o t e s
2 3 4
I. Equity and Liabilities
1. Shareholders’ Funds
a. Share capital
b. Reserves and surplus
c. Money received against share
warrants
2. Share Application money pending
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allotment
3. Non-current liabilities
a. long-term borrowings
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b. Deferred tax liabilities (Net)
c. Other Long term liabilities
d. Long-term provisions
4. Current liabilities
a. Short term borrowings
b. Trade payables
c. Other current liabilities
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n o t e s
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it is the cash or cash equivalent unless it is restricted from be-
ing exchanged or used to settle a liability for at least twelve
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months after the reporting date.
All other assets shall be classified as non-current.
A receivable shall be classified as a ‘trade receivable’ if it is in re-
spect of the amount due on account of goods sold or services ren-
dered in the normal course of business.
An operating cycle refers to the time between the acquisition of an
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n o t e s
Share Capital
Reserves and Surplus
Non-current Liabilities
Long term loans and Short Term Loans
Current Liabilities
Non-Current Assets
Capital Work-in-Progress
Long term Investments & Current Investments
Current Assets
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Other Current Assets
Contingent Liabilities and Commitments
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Figure 7.1: Different Items in a Balance Sheet
SHARE CAPITAL
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For each class of share capital, the following disclosures are required
to be made by the corporations:
the number and amount of shares authorised;
the number of shares issued, subscribed and fully paid, and sub-
N
n o t e s
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Forfeited shares ( amount originally paid up)
Additions and deductions since the last balance sheet need to be re-
vealed under each of the following heads:
A reserve specifically represented by earmarked investments shall
be termed as a ‘fund’.
Debit balance of Statement of Profit and Loss shall be shown as a
negative figure under the head ‘Surplus’.
The balance of ‘Reserves and Surplus’, after adjusting negative
balance of surplus, if any, shall be shown under the head ‘Reserves
and Surplus’ even if the resulting figure is in the negative.
n o t e s
As per the Schedule III of Companies Act, 2013, long-term loans shall
be categorised as:
a. Bonds/debentures
b. Term loans
from banks
from other parties
c. Deferred payment liabilities
d. Deposits
e. Loans and advances from related parties
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f. Long-term maturities of finance lease obligations
g. Other loans and advances
tion thereof shall be made and also the aggregate amount of such
loans under each head shall be disclosed.
Bonds/debentures (along with the rate of interest and particu-
lars of redemption or conversion, as the case may be) stated in
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As per the Schedule III of Companies Act, 2013, short term loans shall
be categorised as:
Loans repayable on demand
from banks
from other parties
n o t e s
NON-CURRENT ASSETS
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Tangible assets
Intangible Assets
Capital work-in-progress
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Intangible assets under development
Non-current investments
Deferred tax assets
Long-term loans and advances
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CAPITAL WORK-IN-PROGRESS
As per Schedule III of the Companies Act 2013, capital work-in-prog-
ress (WIP) is treated as a non-current asset. In the balance sheet, cap-
ital WIP is treated as a different account which is shown after fixed
assets. Provisions for non-current assets shall apply in the same way
on capital work-in-progress.
n o t e s
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Other non –current investments (specify nature)
As per the Schedule III of the Companies Act, 2013, current invest-
ments shall be classified as:
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Investments in equity instruments
Investments in preference shares
Investments in government or trust securities
Investments in units, debentures or bonds
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99 associates
99 joint ventures
99 controlled special purpose entities
ii. It should also include the details of the nature and extent of
the investment so made in each such corporate body.
iii. With respect to investments in the capital of partnership firms,
the names of the firms (with the names of all their partners,
total capital and the shares of each partner) shall be given.
iv. Investments carried at other than at cost should be separately
stated specifying the basis for the valuation thereof.
n o t e s
CURRENT ASSETS
As per the Schedule III of the Companies Act, 2013, current assets,
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loans and advances shall be categorised as follows:
Current investments
Inventories
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Trade receivables
Cash and cash equivalents
Short- term loans and advances
Other current assets
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Doubtful
i. Allowance for bad and doubtful loans and advances shall be
disclosed under the relevant heads separately.
ii. Loans and advances due by directors or other officers of
the corporate body either severally or jointly with any other
persons or amounts due by firms or private companies
respectively in which any director is a partner or a director or
a member should be stated separately.
As per the Schedule III of Companies Act, 2013, current liabilities and
provisions shall be categorised as:
Short term borrowings
Trade payables
Other current liabilities
Short-term provisions
n o t e s
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Claims against the company not acknowledged as debt
Guarantees
Other commitments
for the period and the related amount per share shall be disclosed sep-
arately. Arrears of fixed cumulative dividends shall also be disclosed
separately.
Where in respect of an issue of securities made for a specific purpose,
the whole or part of the amount has not been used for the specific
purpose at the balance sheet date, there shall be indications by way
of notes about how such unused amounts have been used or invested.
If in the opinion of the board, any of the assets other than fixed assets
and non-current assets do not have a value on realisation in the or-
dinary course of business (at least equal to the amount at which they
are stated) the fact that the board is of the opinion, shall be indicated.
Let us understand the preparation of a balance sheet as per Schedule
III of Companies Act, 2013, with the help of an example.
n o t e s
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Particulars Note No. 2011-12
I. Equity and Liabilities
1. Shareholders’ Funds
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a. Share Capital
b. Reserves & Surplus 400
2. Non-current liabilities 90
Long-term borrowings 500
3. Current liabilities
Trade payables 30
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Total 1020
II. Assets
1. Non-Current Assets
a. Fixed Assets
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n o t e s
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Revenue under each of the above heads shall be disclosed
separately by way of notes to accounts to the extent applicable.
3. Finance costs shall be disclosed as:
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i. Interest expense
ii. Other borrowing costs
iii. Applicable net gain/loss on foreign currency transaction and
translation
4. Other Income shall be categorised as:
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a. Interest Income
b. Dividend Income
c. Net gain/loss on sale of investments
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n o t e s
6. The P&L account shall also disclose by way of notes, the following
information:
i. Value of imports during the financial year in respect of the
following:
99 Raw material
99 Components and spare parts
99 Capital goods
ii. Expenditure in foreign currency during the financial year on
account of royalty, know-how, professional and consultation
fees, interest and other matters
iii. Total value if all imported raw materials, spare parts and
components consumed during the financial year and the
total value of all indigenous raw materials, spare parts and
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components similarly consumed and the percentage of each
to the total consumptions
iv. Earnings in foreign exchange classified under the following:
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99 Exports of Goods
99 Royalty, know-how, professional and consultation fees
99 Interest and Dividends
99 Other Income
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Repairs to building
Repairs to machinery
Insurance
Apart from the above the following would also need to be disclosed
separately:
items exceeding the higher of one per cent of revenue from opera-
tions or INR 1,00,000
net loss on sale of investments
provision for diminution in the value of investments/other adjust-
ments to carrying amount of investments
n o t e s
The Revised Schedule VI of the Companies Act, 1956 lays down a new
format for the presentation of Profit and Loss (P&L) account of cor-
porate bodies. It permits the use of the vertical format of presentation
only. The revised format of P&L account is as follows:
Part II – Form of Statement of Profit and Loss
Name of the company………………………
Profit and Loss statement for the year ended ……………………….
(Rupees in……………)
Particulars Note Figures as Figures as
No. at the end of at the end of
the current the previous
reporting reporting
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period period
I. Revenue from operations XXX XXX
II. Other Income XXX XXX
III. Total Revenue (I+II) XXX XXX
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IV. Expenses:
Cost of materials con- XXX XXX
sumed
Purchases of Stock-In-
Trade
XXX XXX
Changes in inventories
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n o t e s
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period
XVI. Earnings per equity
share:
1. Basic XXX XXX XXX
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2. Diluted XXX XXX XXX
n o t e s
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5. Which of these is NOT included in current liabilities?
(a) Short term borrowings
(b) Capital work-in-progress
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(c) Other current liabilities
(d) Short-term provisions
6. As per Schedule III of Companies Act, 2013, which of the
following represents fixed assets?
(a) Capital work-in-progress
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n o t e s
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(d) All of the above
11. Income generated from interest and dividends are categorised
as ____________ in the P&L account of a corporation as per
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the revised schedule.
(a) Interest income
(b) Other income
(c) Opportunity income
(d) Real income
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(b) Summarisation
(c) Notes
(d) All of the above
13. As per Revised Schedule VI, the value of imports is disclosed
in notes with respect to:
(a) Raw material
(b) Components and spare parts
(c) Capital goods
(d) All of the above
14. As per the new P&L format, tax expense of corporations is
classified further into:
(a) Current Tax
(b) Duties and Taxes
n o t e s
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(c) Surplus
(d) Both (a) and (c)
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17. ___________ refers to potential liabilities that occur due to an
unforeseen or uncertain future event such as a court case or
fire.
(a) Non-current liabilities
(b) Contingent liabilities
(c) Current liabilities
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(d) Emergencies
18. As per the Schedule III of Companies Act, 2013, _________
format of the balance sheet is/are permitted to be used by
corporates.
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(a) Horizontal
(b) Vertical
(c) Straight line
(d) Both (a) and (b)
19. ________ amounts due to a business from its customers in
exchange for the goods or services delivered to them in the
ordinary course of business.
(a) Trade receivable
(b) Trade payable
(c) Prepaid expenses
(d) Customer liability
20. Uncalled liability on shares and other investments partly paid
are categorised under the head _______________.
(a) On spot Liability
(b) Promised Liability
n o t e s
(c) Commitments
(d) Current liability
21. As per the Companies Act, 2013, financial year is defined as
the period from __________ to ___________.
(a) 1st April to 31st March
(b) 31st March 1st April
(c) 1st January to 31st December
(d) Both (a) and (c)
Activity
Identify and list down the main points of differences between the
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Old Schedule VI and Revise Schedule VI.
7.3 SUMMARY
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The Ministry of Corporate Affairs (MCA) vide Notification No.
1/19/2013-CL-V dated April 04, 2014, which provides the com-
mencement of provisions under Companies Act 2013 including the
maintaining books of accounts, auditors report board of directors
report, instructions for the preparation of the balance sheet, state-
ment of profit & loss of corporations and consolidated statement,
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etc.
Old Revised Schedule VI to the Companies Act, 1956 has not been
able to keep pace with changes taking place in the international
arena.
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n o t e s
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mation regarding aggregate expenditure and income.
The P&L account shall also disclose by way of notes, the value
of imports, earnings in foreign exchange, expenditure in foreign
IMcurrency, total value if all imported raw materials, spare parts and
components consumed during the financial year, etc.
key words
n o t e s
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6. Is it possible to round off the amount appearing in the financial
statements? Explain the method.
7. Describe the general instruction for preparing a balance sheet.
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8. Name sub-heads under the heads ‘Shareholders Funds’ and
‘Non-current liabilities as per Schedule VI Part 1 of the Balance
Sheet.
9. What were the main reasons for the revision of the old schedule
by the Ministry of Corporate Affairs?
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n o t e s
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20. c. Commitments
21. a. 1st April to 31st March
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hints for Descriptive Questions
1. Schedule III of Companies Act 2013 deals with the form of balance
sheet and profit and loss account and classified disclosure to be
made therein and it applies uniformly to all companies registered
under the Companies Act, 2013, for the preparation of financial
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n o t e s
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8. Sub-heads under ‘Shareholders’ Funds are (i) Share Capital,
(ii) Reserves and Surplus, (iii) Money received against Share
Warrants. The sub-heads under ‘Non-current liabilities’ are (i)
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Long-term Borrowings, (ii) Deferred Tax Liabilities (iii) Other
Long-term Liabilities and (iv) Long-term Provisions. Refer to 7.2
Schedule III of Companies Act 2013.
9. Old Revised Schedule VI to the Companies Act, 1956 has not been
able to keep pace with changes taking place in the international
arena. Refer to Section 7.2 Schedule III of Companies Act 2013.
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n o t e s
Solution:
ZZ Ltd. Balance Sheet as at 31stMarch, 2017
Particulars Note No. Amount (`)
I. EQUITY AND LIABILITIES
Shareholders’ funds
(a) Share capital 600000
(b) Reserves and surplus 90000
Non-current liabilities
(a) Long-term borrowings 240000
Current liabilities
Trade payables 30000
TOTAL 960000
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II. ASSETS
Non-current assets
Fixed assets 720000
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Current assets
Inventories 20000
Trade receivables 100000
Cash and cash equivalents 120000
TOTAL 960000
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n o t e s
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Patents 50000
Capital work-in-progress 100000
Copyrights under development
IM 75000
Total Fixed Assets 10325000
note
n o t e s
Solution:
Total current assets can be calculated as follows:
Particulars Amount (`)
Current investments 1000000
Inventories 100000
Trade receivables 50000
Mutual funds 50000
Cash 200000
Particulars Amount (`)
Foreign exchange reserves 10000
Short term government bonds 20000
Prepaid expenses 30000
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Total Current Assets 1460000
note
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Goodwill, Patents and Trademark are part of fixed assets.
n o t e s
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We know that,
Total Assets = Liabilities + Capital
Or
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Liabilities = Total Assets – Capital
= 900000 – 500000
Therefore, Liabilities = `400000
Other current liabilities = Liabilities – (Long term loan +
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SUGGESTED READINGS
Bhattacharya,
A. (2014). Essentials of Financial Accounting:
BASED ON IFRS (3rd ed., pp. 151-152). Delhi: Prentice Hall India.
Khatri, D. (2011). Financial Accounting (1st ed., pp. 685-696). Delhi:
Tata McGraw Hill.
Kuppapally, J. (2008). Accounting for Managers (1st ed., pp. 19-23).
Delhi: Prentice Hall India.
Ramachandran, N., & Kakani, R. (2011). Financial Accounting for
Management (3rd ed., pp. 710-715). Delhi: Tata McGraw Hill.
n o t e s
E-REFERENCES
Abaobkn.org. (2014). SCHEDULE VI-1203971 Download www.
sebpdf.org. Retrieved from, http://www.abaobkn.org/down-
load/1203971.htm#.U8UdzJSSxb5
Chartered Club. (2011). Changes in Schedule VI – Old vs New (Re-
vised). Retrieved from, http://www.charteredclub.com/changes-in-
schedule-vi-old-vs-new-revised/
Wirc-icai.org. (2014). WIRC. Retrieved from, https://www.wirc-icai.
org
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Case study
n o t e s
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Travelling & conveyance `1.40 crores
Income tax penalty `0.50 lakhs
separately disclosed.
questions
CONTENTS
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8.1 Introduction
8.2 Concept of Cash Flow Statement
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8.2.1 Meaning and Objectives of Cash Flow Statement
8.2.2 Limitations of Cash Flow Statement
Self Assessment Questions
Activity
8.3 Cash Flow Statements (AS-3)
8.3.1 Cash Flows from Operating Activities
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Activity
8.4 Summary
8.5 Descriptive Questions
8.6 Answers and Hints
8.7 Solved Numerical Illustrations
8.7 Suggested Readings & References
Introductory Caselet
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(cash received from financing and cash paid to owners).
The third and last section of cash flow statement is for cash flow
from financing activities. Under this section, any cash inflow or
outflow from financing activities (loans, issue of shares, issue of
debentures, so it is a cash inflow and it should etc.) are recorded
under this head. It also involves recording of various transactions
such as Interest received (Add), Sale of old machinery (Add), Div-
idend received (Add), repurchase of shares (Subtract), etc. In this
case, suppose Shivay Textiles buys a clothing store by borrowing
Introductory Caselet
n o t e s
In the last step the total of all three sections has to be calculated
by using formula, cash inflows minus cash outflow. After calcu-
lating this, suppose Shivay Enterprise shows a change in positive
cash balance with `250000 and the beginning cash balance was
`100000. Then the total cash balance at the end will be calculated
by adding `250000 and ` 100000. Which is equal to ` 350000 and
the ending cash in the balance sheet will be recorded as 350000.
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n o t e s
learning objectives
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8.1 INTRODUCTION
Generally a reference to the financial statements of an organisation
means its balance sheet and profit and loss/income statements. The
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income/profit and loss statement of the organisation gives an account
of its financial performance due to its operations in a given financial
year. However, the income/P&L account does not disclose the cash
flows in the organisations made later (deferred payments to and by
suppliers and customers respectively).
cash expenses are also not included in the cash flow statements. There-
fore, there is a need to maintain a separate record of the cash inflows
and outflows, non-cash expenses and deferred payments made by an
organisation from to its operating, investing and financing activities.
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The Cash Flow Statement allows the investors to assess the perfor-
mance of an organisation based on its sources and outflows of cash
and cash equivalents. As a result, a Cash Flow Statement is now con-
sidered as the third most important financial statement of an organi-
sation. The traditional method of preparation of the Cash Flow State-
ment has been replaced by the format specified as per Accounting
Standard 3 (AS-3).
In this chapter, you will study about how the Cash Flow Statement
is structured, the components of a Cash Flow Statement and the as-
sessment of net cash flows due to operating, investing and financing
activities of an organisation.
n o t e s
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FLOW STATEMENT
Cash Flow
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Statement
A Cash Flow Statement reports the cash flows during the period clas-
sified by operating, investing and financing activities.
n o t e s
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Financing activities: Cash flows from financing activities include
the changes in the size and composition of the share/owner’s cap-
ital and debt of the organisation. Financing activities of an organ-
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isation depict how a firm raises capital and pays back to investors
through the capital markets. For example, cash proceeds from is-
sue of shares and other market instruments, cash proceeds from
issue of loans, debentures, bonds etc., dividend/interest paid by
the organisation to its shareholders, etc. Hence this section of the
cash flow deals with the capital structure and major changes in the
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n o t e s
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The limitations of Cash Flow Statements are as follows:
Cash Flow Statements are based on cash flows and record the
movement of cash. Only cash transactions are recorded. Thus, it
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ignores the accrual concept of accounting.
Cash Flow Statements are not a complete substitute for the In-
come Statement or the Profit & Loss Account. The net cash flow
calculated in the Cash Flow Statement cannot be equal to the net
profit calculated under a profit and loss account. As it considers
only the inflows and outflows of cash, the Net Cash Flow of a cer-
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tain period does not necessarily mean the Net Profit of the busi-
ness, as Net Profit is determined using both cash as well as non-
cash transactions.
It ignores the non-cash transactions. For example, the purchase of
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n o t e s
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(c) Current debtors
(d) None of the above
4. Cash flows from which of these activities include changes in
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cash due to major revenue producing activities?
(a) Operating activities (b) Investing activities
(c) Financing activities (d) Departmental activities
5. ________________ of an organisation depicts how a firm raises
capital and pays back to investors through capital markets.
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Activity
List some examples of non-cash items that affect the cash position
of an organisation.
The Cash Flow Statement as per AS-3 has some fundamental differ-
ences from the Cash Flow Statement as per the traditional method
which is shown in Table 8.1:
n o t e s
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Procedure to Prepare Cash Flow Statement as Per AS-3
(Revised)
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Firstly, all the information relating to the cash flow statement is col-
lected from the Profit & Loss Account and the Balance Sheet. The
following steps are necessary to prepare the Cash Flow Statement:
1. Opening and closing balances of cash and cash equivalents are
determined. These balances are calculated by addition of the
following amounts:
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a. Cash in hand
b. Cash at bank
c. Marketable Securities
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n o t e s
The direct and indirect methods for presentation of Cash Flow State-
ment as per AS-3 are as follows:
Direct Method: As per the direct method, the net cash flows from
operating activities is calculated directly by deducting the cash
outflows from Operating Activities from cash inflows from Oper-
ating Activities.
Indirect Method: As per the indirect method, the net cash flows
from operating activities is calculated indirectly by adding all
non-operational and non-cash items debited to Profit and Loss Ac-
count and later deducting it from non-operational and non-cash
items credited to Profit and Loss Account for a financial year.
The proforma of Cash Flow Statement using direct and indirect meth-
ods are as follows:
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Proforma of Cash Flow Statement using direct method:
n o t e s
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Particulars ` ` `
Interest earned
Dividend earned
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Profit on sale of fixed assets and investments
Operating Profit before Working Capital changes
Add: Increase in operating current liabilities
Decrease in operating current assets
Less: Increase in operating current assets
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n o t e s
Cash flows from operating activities constitute the first part of a Cash
Flow Statement. Operating activities provide details about how much
cash an organisation has generated from its core business, as opposed
to peripheral activities such as investing or financing. These cash flows
are directly associated with production and sale of a firm’s products or
services. This is a key indicator of the extent to which the firm’s oper-
ation has generated adequate cash flows to maintain the operational
efficiency without having recourse to external sources of funds. Cash
flows from operating activities can be calculated using either of the
two methods as follows:
Direct method: In this method, gross cash receipts and gross cash
payments for the major items are disclosed such as cash receipts
from customers and cash payments to suppliers and employees.
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Under the direct method, information can be obtained from either
accounting records of the organisation or by adjusting the sales,
cost of sales and other items in the P&L statement of the organisa-
IMtion. These items are as follows:
Changes during the period in inventories and operating receiv-
ables and payables
Other non-cash items
Other items for which cash effects are shown either in invest-
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n o t e s
note
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rect and indirect methods with the help of the following illustrations.
Purchases 80000
Direct Expenses 20000
Rent 8000
Salary 20000
Depreciation 15000
Provision for Bad Debts 5000
Lawsuit settlement expenses 11500
Taxes 2500
Total Expenses 162000
n o t e s
Farid Enterprises
Cash flow from operating activities for the year ending March 31, 2017
Particulars Amount (`) as on March 31,
2017
Cash Flow from Operating Activities:
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Less: Non-operational income
Profit from sale of old machinery (13000)
Total Cash inflow from Operating Activities 44500
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Illustration 2: Analyse the profit and loss statement of Rahul Enter-
prises given below and prepare its cash flow statement from operating
activities by using the indirect method.
Rahul Enterprises
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Profit and loss account for the year ending March 31, 2017
Particulars Note No. Amount (`)
as on March
31, 2017
Revenue from operation 4 3100000
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Purchases 1600000
Direct Expenses 200000
Rent 80000
Salary 200000
Depreciation Expenses 100000
Amortisation Expenses 125000
Utilities 25000
Legal Fees 15000
Provision for Bad Debts 32000
Proposed Dividends 160000
Preliminary expenses written off 17000
Taxes (@25%) 230250
Total Expenses 2784250
n o t e s
Rahul Enterprises
Cash flow from operating activities for the year ending March 31, 2017
Particulars Amount (`) as on March
31, 2017
Cash Flow from Operating Activities:
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100000
Depreciation Expenses
125000
Amortisation Expenses
160000
Proposed Dividends
IM 17000
Preliminary expenses written off
434000
Total Non-Cash transactions
n o t e s
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and infrastructure. It has sold off its stake of `50 lakhs on EFG Ltd.,
a subsidiary engaged in food processing. In addition ABCD Ltd. has
received `10 lakhs on account of repayment of principal. It received
dividends of `5 lakhs during the year. Calculate the net cash flows of
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ABCD Ltd. from investing activities.
45, 00,000
note
Cash flows from financing activities constitute the third and last part
of a Cash Flow Statement. Financing activities of an organisation re-
sult in changes in the size and composition of the owner’s capital (in-
cluding preference share capital). It also results in changes in the bor-
rowings of the organisation. In other words, financing activities of an
organisation include total capital employed (equity shares, preference
n o t e s
shares and long-term loans). Any inflow or outflows of cash from these
activities are treated as cash flows from financing activities.
Illustration 4: The following information for XYZ Ltd. has been given:
1. Proceeds from the issue of equity shares = `5, 00,000
2. Proceeds from issue of preference shares = `3, 00,000
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3. Proceeds from long-term loans = `2, 50,000
4. Redemption of preference shares =`1, 50,000
5. Redemption of debentures = `1, 00,000
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6. Payment of dividend = `30,000
7. Payment of interest = `40,000
Calculate the net cash flows from financing activities of XYZ Ltd.
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n o t e s
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Format of Cash Flow Statement based on AS-3: The Cash Flow
Statement of an organisation as per AS-3 is prepared by combining
the cash flows from the three different activities in the following order:
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a. Operating activities
b. Investing activities
c. Financing activities
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While most of the items in the Cash Flow Statement are self-explan-
atory, there are a few transactions/items that need more explanation.
In this section, you will study about these items (shown in Figure 8.2)
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as per AS-3.
Extraordinary Items
Taxes on Income
Non-cash Transactions
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Let us discuss these items and their treatment in Cash Flow State-
ment in the following section:
Extraordinary Items: Cash flows from extraordinary items are
classified as items arising out of operating, financing or investing
activities as applicable and disclosed separately. A few examples
of extraordinary items in the Cash Flow Statement are claim for
loss of stock (operating activity), claims for loss of assets (investing
activity), lottery (investing activity), etc.
Taxes on Income: Cash flows from taxes on income are disclosed
separately and classified as arising out of operating activities un-
less otherwise specified. A few examples of taxes on income are
provision for taxation for the current year (non-cash charge due to
operating activity), tax paid (cash outflow due to operating activi-
ty), tax refund (cash inflow due to operating activity), etc.
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Foreign Currency Cash Flows: These should be converted at the
prevailing exchange rate. The gain or loss on cash and cash equiv-
alents are reported as part of reconciliation of change in cash and
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cash equivalents for the current period and therefore not reported
in the Cash Flow Statement.
Non-cash Transactions: Such transactions do not require the use
of cash or cash equivalents. Non-cash transactions such as depre-
ciation, amortisation, purchase of building by issuing shares, etc.
are not disclosed in cash flow statements because these transac-
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n o t e s
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10. Cash paid in mergers and acquisitions and purchase of
marketable securities are examples of ___________.
(a) Cash outflow from investing activities
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(b) Cash inflow from investing activities
(c) Cash outflow from operating activities
(d) Cash inflow from investing activities
11. Depreciation and interest paid are treated as which of the
following in a cash flow statement?
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Table 1 Table 2
I. Claim for loss of stock A. Financing activity
II. Tax refund B. Extraordinary items
III. Issue of shares and deben- C. Taxes on income
tures
IV. Acquisition of interest in a D. Investments in subsidiaries
subsidiary
(a) I(A), II(B), III(C), IV(D)
(b) I(C), II(D), III(A), IV(B)
(c) I(B), II(C), III(A), IV(D)
(d) I(D), 2(C), 3(D), 4(A)
n o t e s
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Activity
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Using the Internet, download the cash flow of an automobile cor-
poration for the financial year 2012 and 2013 and compare the net
increase/decrease in its cash position.
8.4 SUMMARY
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The Cash Flow Statement records the amount of cash and cash
equivalents entering and leaving an organisation in a given time
period.
A Cash Flow Statement consists of details about cash flows of an
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n o t e s
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Non-cash transactions do not require the use of cash or cash equiv-
alents and are not disclosed in the Cash Flow Statement.
Acquisition of interest in a subsidiary, associate or a joint venture
IMis treated as ‘investing activity’ in the Cash Flow Statement.
Sale or disposal of such interest and receipt of interest or divi-
dends on such investments is included as ‘investing activity’ in the
Cash Flow Statement.
key words
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n o t e s
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b. indirect methods
4. Explain the treatment of the following items in the Cash Flow
Statement as per AS-3:
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a. Extraordinary items
b. Investments in subsidiaries
c. Non-cash transaction
d. Taxes on income
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n o t e s
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14. c. Current
3. In the direct format, gross cash receipts and gross cash payments
for the major items are disclosed such as cash receipts from
customers and cash payments to suppliers and employees. In
this method, P&L account is adjusted for the following heads,
effects of transactions of a non-cash nature such as depreciation,
amortisation, deferred taxes, loss on sale of fixed assets and
unrealised foreign exchange gains and losses. Refer to Section
8.3 Cash Flow Statement (AS-3).
4. Cash flows from extraordinary items are classified as arising
out of operating, financing or investing activities as applicable
and disclosed separately. Cash flows from taxes on income are
disclosed separately and classified as arising out of operating
activities unless otherwise specified. Refer to Section 8.3 Cash
Flow Statement (AS-3).
5. Consider the necessary steps to prepare the cash flow statement
as per AS 3. Refer to Section 8.3 Cash Flow Statements (AS-3).
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6. There are three basic activities under the head of cash flow
statements namely, cash flow from operating activities, cash flow
from investing activities and cash flow from financing activities.
Operating activities provide details about how much cash an
organisation has generated from production and selling of its
products. Investing activities provide details of cash flows related
to the acquisition and disposal of an organisation’s long-term
investments such as property, plant and equipment. Financing
activities provides the structure of share capital and debt capital
employed within the entity. Refer to Section 8.3 Cash Flow
Statements (AS-3).
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Cash from bonds issued =`25,00,000
Cash from new stock issued = `30,00,000
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Repayment on existing loans = `1,00,000
Dividends paid =`8,00,000
Repurchase of existing stock = `2, 00,000.
Calculate the net cash flow from financing activities.
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Solution:
Non-cash transactions do not require the use of cash or cash
equivalents and are not disclosed in the Cash Flow Statement.
Acquisition of interest in a subsidiary, associate or a joint venture
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n o t e s
Profit and Loss Account for year ended 31st March, 2012
Particulars Amount Particulars Amount
(`) (`)
To opening stock 1,60,000 By sale 42,50,000
To purchases (cash) 31,00,000 By commission 40,000
To wages 4,40,000 accrued
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To selling expenses 1,20,000
To depreciation 1,10,000 8,20,000
To income tax paid 20,000 48,10,000
To goodwill written off 44,000
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To preliminary expenses
written off 20,000
To office rent 4,26,000
To Net Profit
48,10,000 48,10,000
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Solution:
The net cash flows of XYZ from operating activities using the
direct method would be calculated as follows:
Particulars `
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n o t e s
S
Sale of shares 325000
Interest received 18000
Sale of old machinery 60000
Dividend received
IM 22000
Less: Outflow for Machinery purchased 200000
n o t e s
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Cash Flow Statement from Financing Activities
Particulars Amount (`)
IM Cash flow from financing activities
Long term borrowings 1500000
Dividend Received 40000
Issue of debenture 450000
Proceeds from forward contract 150000
Issue of equity share capital 200000
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Suggested Readings
Debarshi, B. (2011). Management Accounting (1st ed., pp. 203-208).
Delhi: Dorling Kindersley India.
Goyal, V., & Goyal, R. (2013). Corporate Accounting (1st ed., pp.
460-528). Delhi: Prentice Hall India.
Ramachandran, N., & Kakani, R. (2010). How to Read a Cash Flow
Statement (1st ed., pp. 51-57). Delhi: Tata McGraw Hill.
Sinha, G. (2009). Financial Statement Analysis (1st ed., pp. 346-
445). Delhi: Prentice Hall India.
n o t e s
E-references
A,P., & A, P. (2013). Limitations of Cash Flow Analysis. BMS.co.in:
Bachelor of Management Studies. Retrieved from, http://www.
bms.co.in/limitations-of-cash-flow-analysis/
CA Results. (2014). Download All Accounting Standards for CA,
CWA/CMA, CS Exams -CA Results. Retrieved from, http://caulti-
mates.in/download-accounting-standards-cacwacmacs-exams/
Letslearnfinance.com. (2014). Advantages and Disadvantages
of Cash Flow Statement | LetsLearnFinance. Retrieved from,
http://www.letslearnfinance.com/advantages-and-disadvantag-
es-of-cash-flow-statement.html
Studytesttime.com. (2014). Classification of Cash Flows as per Ac-
counting Standard-3 (Revised). Retrieved from, http://studytest-
S
time.com/all-topics/22-analysis-of-financial-statements/56-classifi-
cation-of-cash-flows-as-per-accounting-standard-3-revised
IM
M
N
Case study
n o t e s
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2. Purchase modern machinery
3. Train employees
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4. Advertise and promote business
5. Obtain license for advanced technology from foreign
collaborators
To achieve this, the management decided to obtain a loan of
`5000000 from the State Bank of India. The SBI visited Pal and
Bose (PB) Ltd. to assess the organisation’s credit worthiness. The
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Particulars Amount
(` in 000)
Cash flows from operating activities
Net income 2500
Add: Non Cash transactions
Depreciation and amortization 125
Provision for Bad Debts 20
Less: Non-operational income
Gain on sale of facility (65)
Total Cash inflow from Operating Activities 2580
Case study
n o t e s
Particulars Amount
(` in 000)
Cash flows from financing activities
Proceeds from issue of common stock 150
Proceeds from issuance of long-term debt 175
Less: Dividends paid 45
Net cash used in financing activities (280)
The net cash flows from operating activities of Pal and Bose Ltd.
are `71, 35,000 which imply that the organisation can support div-
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idend payments to shareholders. However, outflows from financ-
ing activities are `5, 54,000 which signify that the proceeds from
shares are less than the payments for interest and dividends. The
organisation is not strong enough to repay the loan and thus, the
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SBI declines the loan application made by Pal and Bose Ltd.
questions
CONTENTS
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9.1 Introduction
9.2 Financial Statements
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9.2.1 Meaning of Financial Statement
9.2.2 Characteristics of Financial Statement
9.2.3 Scope of Financial Statements
Self Assessment Questions
Activity
9.3 Profit and Loss Account
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9.4.1 Relationship between Profit and Loss Account and Balance Sheet
Self Assessment Questions
Activity
9.5 Financial statement analysis
9.5.1 Types of financial statement analysis
9.5.2 Techniques of financial statements analysis
9.5.3 Process of Financial Statement Analysis
9.6 Summary
9.7 Descriptive Questions
9.8 Answers and Hints
9.9 Suggested Readings & References
Introductory Caselet
n o t e s
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The management of the company hired a financial consultant to
evaluate the past performance and current situation in the com-
pany. The consultant recommended a financial statement analysis
in the company. According to the consultant, financial statement
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analysis would help in assessing the past performance and the cur-
rent position of the company. Past financial performance is a good
indicator of the future performance potential of a company. The
trend of past sales, expenses, net income and cash flow, and return
to investment reflects the future trends of these variables.
banks.
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learning objectives
9.1 Introduction
In the previous chapter, you studied cash flow statements. The chapter
included the concept of cash flow statement along with its objectives
and limitations. Now, let us move forward and discuss financial state-
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ments, such as the Profit and Loss accounts and the Balance Sheet.
The Profit and Loss account or the Income Statement refers to one of
the financial statements of a company that shows the revenues and
expenses during a particular period. The account indicates how reve-
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nues are transferred into net income. The main objective of the Prof-
it and Loss statement is to show managers and investors, whether a
company has made or lost money during a reported period.
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In this chapter, you will study the meaning, characteristics and scope
of financial statements. Next, you will study the Profit and Loss state-
ment along with its components.
Towards the end, you will study about the meaning, need, importance,
types, techniques, procedures of financial statement analysis.
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In a business, the sole purpose of investing money is earning profits.
The financial position of an organisation is determined by evaluating
the profit earned or loss suffered by an organisation. In addition, dif-
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ferent users of accounting information need other accounting infor-
mation. Financial statements are created to fulfil these requirements.
Financial statements provide information regarding total profit earned
or loss suffered the net income and the distribution of income. Prepara-
tion of the financial statement is the final step in the accounting cycle.
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n o t e s
Understandability
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information and ambiguity in the information itself. An organisation
cannot do anything about the understanding level of the users. How-
ever, an organisation can present the financial information in such a
way that it helps in understanding the underlying information. There-
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fore adequate measures need to be taken on behalf of the organisa-
tion to follow standard guidelines so that the financial statements are
comprehensible. However, it does not mean that complex information
should be excluded from the financial statements just because these
are creating problems in overall understanding of the statements.
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Relevance
Reliability
Comparability
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the financial position of the organisation at a particular point in
time. This is like a snapshot of the company.
Providing information about the financial performance: It refers
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to the reporting of the expenses incurred and profits earned by the
organisation during an accounting period. It represents the organ-
isation’s ability to use the available economic resources in a profit-
able manner. This is like a video of the operations of the company.
Providing information about changes in the financial position:
It refers to the reporting of the effect of business activities on the
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tion. In addition, it notices the item that has not been mentioned
in the balance sheet of an organisation.
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Activity
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words, the profit and loss account is a statement that shows the expen-
ditures, revenues and net income of an organisation.
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The general pro forma of the profit and loss account is shown as follows:
Profit & Loss Account for the year ended 31st March _________
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Particulars Amount (`) Particulars Amount (`)
To Trading A/c By Trading A/c
(Gross Loss) (Gross Profit)
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To Salaries By Commission
To Rent & Taxes earned
To Stationeries By Rent received
To Postage expenses By Interest received
To Insurance By Discounts received
To Repairs By Net Loss
To Trading expenses (Capital A/c)
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To office expenses
To Interest
To Bank charges
To Establishment expenses
To Sunder expenses
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To Commission
To Discount
To Advertisement
To Carriage outwards
To Traveling expenses
To Distribution expenses
To Bad Debt provision
To Net Profit
(transferred to Capital A/c)
The profit and loss account plays an important role in the accounting
process as it helps in determining the net results of the business activ-
ities. The main objectives of the profit and loss account are as follows:
Determining the net gain or loss of an organisation
Controlling unnecessary expenses by providing information about
the effect of individual expense on the net profit or loss of the or-
ganisation
Assisting in analysing the progress of an organisation by compar-
ing the current and previous year’s net profit
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Office Salaries
Postage & Telephone
Traveling & Conveyance
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Legal Charges
Office Rent
Depreciation
Audit Fees
Insurance
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n o t e s
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tions within an organization that are not directly involved in the
production and supply of goods and services offered by the entity.
Examples of administrative expenses include:
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Salary cost of executive management
Legal and professional charges
Depreciation of head office building
Rent expense of offices used for administration and manage-
ment purposes
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n o t e s
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vi. Advertising 6,000
vii. Commission paid 2,500
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v
iii. Bad debts 1,500
ix. Depreciation 1,000
x. Legal charges 3,000
xi. Interest Received 4,000
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Solution:
Profit and Loss Account for the year ending on March 31, 2011
Particulars Amount (`) Particulars Amount (`)
To Salary 30,000 By Gross profit 75,000
To Rent 15,000 By Interest received 4,000
To Interest paid on loan 5,000
To Postage and telegram 2,000
To Advertising 6,000
To Commission paid 2,500
To Bad debts 1,500
To Depreciation 1,000
To Legal Charges 3,000
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Activity
Depreciation
Audit Fees
Bad Debts written off
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n o t e s
grouped as assets and liabilities and are arranged in a proper way. The
resultant statement obtained is called the balance sheet.
In the balance sheet, assets are represented on the right side and liabili-
ties are shown on the left side. It is also known as the statement of sources
of funds and application of funds. The financial position of the organisa-
tion includes its economic resources (assets), economic obligations (lia-
bilities), and owner’s equity. As discussed in previous chapters, a balance
sheet is the detailed summary of the basic accounting equation:
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The pro forma of the balance sheet:
fund
Loans (Cr.) Loan (Dr.)
Mortgage Closing stock
Reserves or reserve Loose tools
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funds
Capital Investment
Add: Interest on capital Furniture and fitting
Add: Net profit Plant and machinery
Less: Drawing Land and building
Less: Income tax Leasehold land
Less: Interest on Business premises
drawing
Less: Net loss Patent and trade mark
Goodwill
Total Total
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Let us take the following trial balance and prepare a balance sheet:
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Debit Balances Amount (`) Credit Balances Amount (`)
Opening Stock 2,00,000 Sundry Creditors 1,50,000
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Purchase 7,50,000 Purchase Returns 30,000
Sales Return 80,000 Sales 25,00,000
Freight and Carriage 75,000 Commission 33,000
Wages 3,65,000 Capital 17,00,000
Salaries 1,20,000 Interest on Bank Deposit 20,000
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n o t e s
Any profit that is not paid as dividend is shown in the retained profit
column of the Balance Sheet. The amount that will be shown as cash
or at the bank under current assets on the balance sheets will be de-
termined in part by the incomes and expenses recorded in the P&L.
For instance, if sales income exceeds spending in the immediately pre-
ceding period of the publication of the accounts; then, all other things
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remaining equal, current assets will be higher in case expenses ex-
ceeded income in the same period.
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In case of short-term loans taken by a business, the loan will be shown
in the Balance Sheet under current liabilities but the loan will not be
recorded in the P&L account. However, the P&L account will include
interest payments on the loan in its expenditure column. These fig-
ures will affect the bottom line (net profit) of the company.
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Activity
n o t e s
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very essential to measure financial soundness and future prospects of
the business organisation.
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Need for Financial Statements Analysis
n o t e s
the organisation and the analyst do not rely only on the past per-
formance. Current performance reflects that whether the business
is doing well or not in the current scenario. So, in order to predict
future performance more accurately an analyst must have to con-
sider both past performance as well as the current performance
and there must be a trade-off between the two.
Estimation of current position: As we know that performance
and position of an organisation are two different issues because
performance is related to earning capacity of the organisation
while position reflects the organisation’s ability to meet debt ob-
ligations. So the financial statement analyses helps to estimates
current position of the organisation with regard to, the type of as-
sets held with the organisation and its obligation to meet current
liabilities. In other words, it predicts bankruptcy related issues of
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the organisations before their occurrence.
Growth forecast: The growth rate of an organisation depends on
several components such as, earnings, sales, market price of share,
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etc. Financial statements analysis provides a pathway to forecast
future growth of the organisation. The decision makers of an or-
ganisation are futuristic and they can make future growth fore-
cast by scanning out the trend of the growth rate in past years. It
enables finance managers or investors in the process of efficient
decision making to minimise the risk and uncertainty factor.
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n o t e s
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II. On the basis of Modus Operand (methods used and time period
of study)
n o t e s
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figures for every year is compared with that of the base year.
Horizontal analysis is most applicable when an organisation
examines the direction of trend for a period of several years
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several years. Comparative statements and trend analysis are
two main techniques under horizontal analysis.
(ii) Vertical analysis of financial analysis is also known as ‘Static
Analysis’ and it is that type of analysis in which study is conducted
only for one particular period. Under this analysis each item of
financial statement is expressed in terms of percentage of the
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same item in the base year. Common size statements and ratio
analysis are two important tools to perform vertical analysis.
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Common size statements: Under this method figures of finan-
cial statements are shown in analytical percentage. The figures
of all items are shown as the percentage of their relevant head
(i.e. total assets and total liabilities in the balance sheet, total
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sales/revenue in the profit and loss account). The total percent-
age of each head is taken as 100. You will study common size
statement in detailed manner in chapter 11.
Fund Flow Analysis: It involves the analysis of funds flow
statement which acts as additional statement to the profit and
loss account and balance sheet. It shows the changes in finan-
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n o t e s
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budgeted resources
for completion.
2. Data collection Financial statements, Organized financial
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other financial data, ques- statements and data
tionnaires, and industry tables.
data.
Discussions with manage-
ment, suppliers, custom-
ers, and competitors,
Company site visits (e.g.,
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to production facilities or
retails stores).
3. Data process- Data of collection stage. Adjusted financial
ing statements, com-
mon-size state-
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ments, comparative
statements, ratios
and graphs.
4. Analysis and Processed data Analytical results
interpretation with interpretation.
of data
5. Presentation of Data from stage 5 Financial analysis
report (con- report along with
clusions and answers of purpose
recommenda- established in stage
tions) 1 and recommen-
dation regarding
purpose.
6. Follow-up Information gathered by Final updated report
action periodically repeating and recommenda-
above steps as necessary tions.
to determine whether
changes to holdings or
recommendations are
necessary.
n o t e s
9.6 SUMMARY
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In a business, the sole purpose of investing money is earning prof-
its. The financial position of an organisation is determined by eval-
uating the profit earned or loss suffered by an organisation.
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Financial statements act as an important source of information as
they provide a structured and easy to understand information re-
garding the business activities of an organisation.
The objective of financial statements is to provide information that
would convey the performance details, financial position, and the
changes in the financial position of the organisation. These help
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n o t e s
The profit and loss account is prepared to ascertain the net profit
earned or the net loss suffered by the business over an accounting
period, depicting the financial performance of the organisation.
The profit and loss account plays an important role in the account-
ing process as it helps in determining the net results of the busi-
ness activities.
The main components of a profit and loss account are expenses
and incomes. The expenses are shown on the debit side and the
incomes are shown on the credit side of the P&L account.
A balance sheet is the statement that summarises, and presents
the financial position of an organisation as on a particular date, by
showing the assets and liabilities of the organisation.
In the balance sheet, assets are represented on the right side and
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liabilities are shown on the left side.
A balance sheet plays a vital role in taking important financial de-
cisions by management and investors of the organisation.
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Trading transactions of a company, such as income, sales and
expenditure and the resulting profit or loss for a given period is
summarised in the profit and loss (P&L) account. In comparison,
the balance sheet provides a financial snapshot of a company at a
given moment.
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key words
n o t e s
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4. c. Horizontal Analysis
Balance Sheet 5. a. Gross profit
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Financial statement anal- 6. d. All of the above
ysis
7. d. All of the above
Suggested Readings
n o t e s
E-references
S
ing Basics. Expertsmind.com. Retrieved from, http://www.ex-
pertsmind.com/questions/components-of-profit-and-loss-ac-
count-30117983.aspx
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My Accounting Course. (2014). Balance Sheet | Example | Tem-
plate | Format. Retrieved from, http://www.myaccountingcourse.
com/financial-statements/balance-sheet
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Case study
n o t e s
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end of the month (By April 30, 2016).
Other transactions during the year:
(II) Rohit took an interest free loan of `150 crore from one of his
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relative’s company which is in size equal to twice the capital
of his firm.
(III) The firm makes a credit sales of `70 crore during the year.
At the end of the year, total trade receivables were `15 crore
and it is expected that out of this 10% to be turned out as bad
debt.
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(IV) Market and distribution expenses for the year were `1 crore.
Salaries for the year stood at `50 lakh and Electricity charges
for the year at `1 crore. All these expenses have been paid
and there are no dues at the end of year (March 31, 2017).
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(V) The firm also made a cash purchase of raw material of worth
`15 crore and the firm made credit purchase of `15 crore. At
the end of year (March 31, 2017) balance remained in the
books was `4.5 crore.
(VI) At the end of the year (March 31, 2017) the firm had raw
materials of `10 lakh and no other inventory remained.
(VII) The machinery was to be depreciated @20 per cent per
annum. The applicable corporate income tax was 25%.
Fringe tax benefits were to be estimated as `3 lakh. However,
taxes had not been paid by the firm and provision had been
made for the same.
Now, you are required to prepare a balance sheet and a profit
and loss account at the end of the year and answer the following
questions:
Case study
n o t e s
questions
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in order to match balance sheet but make sure that each
item is recorded under the correct head. Also consider
accounting year for the case is from April 1, 2016 to March
31, 2017 and you can assume dates of other transactions
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on your behalf.)
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CONTENTS
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10.1 Introduction
10.2 Ratio Analysis
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10.2.1 Significance of Ratio and Ratio Analysis
10.2.2 Advantages and Limitations of Ratio Analysis
Self Assessment Questions
Activity
10.3 Types of Ratios
10.3.1 Liquidity Ratios
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Activity
10.4 The DuPont Equation
Self Assessment Questions
Activity
10.5 Summary
10.6 Descriptive Questions
10.7 Answers and Hints
10.8 Numerical Ability Questions
10.9 Suggested Readings & References
Introductory Caselet
n o t e s
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balance sheet for the last five years was presented to the bank for
providing details about the financial position of the bank. However,
the government required finer details to assess the different finan-
cial aspects of the bank such as its liquidity, solvency, profitability,
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etc. To meet the government’s requirement, the District Central
Cooperative Bank Ltd. the bank decided to conduct a ratio anal-
ysis to depict its state of profitability, solvency, liquidity, indebted-
ness, etc. The financial position of this bank proved that the posi-
tion of solvency, liquidity and profitability are satisfactory. When
presented with the details, the Government of Chhattisgarh not
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only sanctioned funds for opening more branches but also award-
ed the bank for excellent service and contribution in cooperative
development for the year 2011. DCC bank obtained 79 Marks out
of 100 Marks and achieved grade “A” in Audit Report of Financial
Year 2010-2011.
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n o t e s
learning objectives
10.1 Introduction
In the past for an organisation to obtain loans and advances from fi-
nancial institutions, security from banks was a considered to be a suf-
ficient guarantee. However, in the present scenario the entire business
of lending is based on a thorough analysis and financial viability of a
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business proposal and not on a mere security by a bank. In addition,
all business decisions related to credit have an element of risk. Various
quantitative methods help in the analysis and assessment of this risk.
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One of the commonly used techniques to assess this element of risk
and the financial health of organisations is ratio analysis.
In this chapter, you will study about the concept and significance of
ratio analysis and the advantages and limitations of ratio analysis. You
will also study the commonly used ratios, their interpretation and dis-
cuss the DuPont equation.
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Let us discuss the meaning of ratio and ratio analysis in the subse-
quent sections.
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tio depicts the relationship between two or more accounting data
expressed in mathematical terms. Accounting or financial ratio are
based on information obtained from financial statements (Balance
Sheet and Profit and Loss Statement) and expressed in terms of ratio
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(for example, 2:1), in terms of number (for example 2 or 2 times) or
in terms of percentage (for example 50 per cent). A single accounting
data by itself does not communicate much information about an or-
ganisation’s position.
Assume that an organisation’s sales figures for the given year are ` 80,
00,000 and its net profit is ` 5, 00,000. The ratio of profit to sales will be
calculated as follows:
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5, 00, 000
= 1:16 or 6.25 %
80, 00, 000
Ratio analysis is a tool for determining and interpreting the relation-
ships between different items of financial statements for providing
understanding of the performance and financial position of an organi-
sation. Ratio analysis is an accounting tool to present accounting vari-
ables in a simple, concise and meaningful form.
DEFINITION
n o t e s
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Ratio analysis helps in simplifying accounting figures: Ratio
analysis simplifies and organises a wide array of accounting fig-
ures to make them meaningful for the concerned parties. Finan-
cial ratios are used to summarise the results of the detailed and
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complicated computation which can lead to diagnosing the finan-
cial health of a firm.
Ratio analysis is used to evaluate the operating efficiency of a
business: Ratio analysis helps in the diagnosis of an organisation’s
financial health by evaluating its state of liquidity, solvency, prof-
itability etc. This enables the management to assess and compare
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n o t e s
However, ratio analysis has certain drawbacks that limit its use for
financial analysis. These limitations are as follows:
Incorrect or unauthenticated data may lead to wrong interpre-
tations: Ratio analysis depends on the data in the financial state-
ments, which if not accurate or authenticated may lead to incor-
rect interpretation of results.
Dependence on historical data may not help in proper forecasts:
Ratio analysis depends on the past data and thus, does not incor-
porate the current trends financial analysis. Forecasts based on
historical data may not always lead to accurate trend prediction.
A single ratio does not provide sufficient information: A single
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ratio computed for a specific area is insufficient to interpret a sig-
nificant conclusion thus, a series of ratios need to be calculated to
ascertain the situation of a particular business area.
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Different firms follow different accounting principles: Organi-
sations may follow different accounting principles, which limit the
use of inter-firm comparisons. Inter-firm comparisons are possible
only when the organisations being compared follow uniform ac-
counting principles and policies.
Price level changes may affect the forecasting: Changes in price
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level often distort the trend analysis process, which is carried out
by computing a series of ratios for making forecasts.
Qualitative factors may get ignored: Financial Ratios are based
on quantitative analysis of financial statements. Often qualitative
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n o t e s
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Activity
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With the help of an organisation’s financial statements, assess how
window dressing (manipulation of figures) can affect the computa-
tion of various ratios. Present your assessment in a short note.
Types of Ratios
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10.3.1 LIQUIDITY RATIOS
CURRENT RATIO
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The current ratio (CR) is equal to total current assets divided by total
current liabilities. It indicates the extent to which current assets can
be used to pay off current liabilities. Mathematically, it is expressed as
follows:
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Current Assets
Current Ratio =
Current Liabilities
Let us understand this with the help of the following illustrations:
Solution:
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pay off its liabilities if the major part of its assets is composed of slow
moving or obsolete inventories. Similarly, an organisation with a low
current ratio may be strong enough to pay its current liabilities if the
major part of its current assets is composed of highly liquid assets i.e.,
cash, bank balance, marketable securities and fast moving invento-
ries. Let us understand this with the help of the following illustration:
Illustration 2: Calculate the current ratio from the data given below:
Particulars Amount (`)
Cash in hand 170000
Bank balance 65000
Goodwill 130000
Trademarks 172000
Inventory 90000
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Accounts Receivable 185000
Accounts payables 135000
Income tax payables 35000
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Capital Work in progress 42000
Long term loan 250000
Deferred tax payable 32000
Solution:
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Current Assets
Current Ratio =
Current Liabilities
Where,
counts Receivable
= 510000
= 135000 + 35000
= 170000
Therefore,
Current Assets
Current Ratio =
Current Liabilities
510000
=
170000
= 3:1
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QUICK RATIO
One of the limitations of the current ratio is that it assumes that all
current assets of an organisation can be easily converted to cash in
order to meet its current liabilities. This assumption may not always
be true. There are current assets such as inventory and pre-paid ex-
penses which cannot be readily converted into cash. To overcome this
limitation, there is another ratio called the quick ratio, which removes
from current assets, the less liquid current assets such as inventory
and pre-paid expenses. The quick ratio is also referred to as the acid
test ratio. Quick ratio is equal to liquid current assets divided by cur-
rent liabilities. Mathematically, it can be expressed as follows:
Cash in hand + Cash at Bank + Receivables + Marketable Securities
Quick Ratio =
Current Liabilities
Alternatively, quick ratio can also be calculated as follows:
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Current Assets − Inventory − Advances − Prepayments
Quick Ratio =
Current Liabilities
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It indicates the extent to which an organisation’s current liabilities
can be paid off using its liquid current assets including cash, market-
able securities, and accounts receivables. Ideally, a quick ratio of 1:1 is
considered financially viable.
Non-current Assets
Goodwill 75
Fixed Assets 75 150
Current Assets
Cash in hand 25
Cash in bank 50
Short term investments 75
Inventory 25
Receivable 100 275
Current Liabilities
Trade payables 100
Income tax payables 60 160
Non-current Liabilities
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note
Solution:
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Current Liabilities
25 + 50 + 45
= = 120/160 = 0.75
160
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CASH RATIO
10.3.2 SOLVENCY RATIOS
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DEBT-EQUITY RATIO
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ratio Debt-Equity ratio measures the ratio of long-term or total debt to
shareholders’ equity. Mathematically, it can be expressed as follows:
Total Liabilities
Debt-Equity Ratio =
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Shareholder 's Equity
In the above formula, two variables debt and equity are discussed and
their meaning is as follows:
Debt is a borrowed capital and includes those funds which are owed
by the firm from external sources of finance. These funds are obligato-
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new shares or equity. These funds are ownership based in nature and
belong to shareholders, proprietors or the owner of the entity.
Total debt
Debt-Equity Ratio =
Shareholders 'equity
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Therefore, the D/E ratio is the ratio of total external liabilities to own-
ers’ total funds. In other words, it is the ratio of the amount invested
by outsiders (shareholders) to the amount invested by the owners of
an organisation. For example, a D/E ratio of 1:2 implies that for every
rupee of shareholders’ liability, the organisation two rupees of internal
capital. Conversely, a ratio of 2:1 would imply that the safety margin is
one-third for the investors.
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Common equity 50000
Preferred equity 25000
Additional paid in capital 600000
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Retained earnings 325000
Solution:
Total Liabilities
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Debt-Equity Ratio =
Shareholder 's Equity
Where,
= 500000 + 1000000
= 1500000
= 1000000
Total Liabilities
Therefore D/E ratio of XYZ Ltd. = =
Shareholder 's Equity
1500000
=
1000000
= 1.5 times or 150%
This implies that for every `1 of XYZ Ltd. owned by the shareholders,
XYZ Ltd. owes ` 1.50 to creditors.
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Solution:
Total Liabilities
Debt-Equity Ratio =
Shareholder 's Equity
Or
= 1.5 800000
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DEBT TO TOTAL ASSETS RATIOS
This ratio also represents an organisation’s ability to meet all its finan-
cial obligations. It is a measure of the organisation’s financial position
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as it represents the percentage of an organisation’s assets financed
through loans and other financial liabilities (total debt). A ratio great-
er than 1 implies that a significant proportion of assets are being fi-
nanced using debt whereas a ratio below 1 implies that most of the
assets are financed through equity. Debt to Total Assets Ratio can be
calculated as follows:
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is calculated as follows:
This implies that the organisation has `0.44 in long term debt for every
`1 it has in assets.
PROPRIETARY RATIO
Suppose, a firm has total assets worth `40, 00,000 and proprietary
funds worth `30, 00,000, then the Proprietary Ratio of the firm would
be calculated as follows:
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note
Interest Coverage Ratio denotes the relationship between the net profit
before the deduction of interest and tax and the fixed interest charges.
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It is used as a measure for the stakeholders to gain an insight that the
concerned enterprise would be able to pay its interest periodically.
Interest Coverage Ratio = Net profit before Interest & Taxes / Fixed
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Interest Charges
Taxes `50,000
Interest Coverage Ratio= (3, 50,000 +4, 00,000 + 50,000)/4, 00,000 = 2.0
From the viewpoint of investors, the higher the coverage, the greater
would be the ability of the firm to handle fixed charge liabilities and
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SOLVENCY RATIO
/ Total liabilities
A firm which is completely insolvent and unable to pay its debts would
be forced into bankruptcy. Investors need to examine all the financial
statements of a firm to make sure that the firm is solvent as well as
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profitable.
This ratio measures a firm’s ability to generate net sales from fixed as-
sets specially property, plant and equipment less depreciation. Math-
ematically,
Net Sales
Fixed Assets Ratio =
Net Property, Plant and Equipment
A higher Fixed-Asset ratio indicates that the firm has been effectively
using the investment in fixed assets to generate revenues. Lower ra-
tios are indicative of underutilisation of resources and presence of idle
capacity.
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fixed interest and/or fixed dividend bearing and the equity sharehold-
ers’ fund. Mathematically, it can be calculated as follows:
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The capital structure of XYZ Ltd. is as follows:
Bearing Funds
This is a low Capital Gearing Ratio indicating that XYZ Ltd.’s prefer-
ence share capital and other fixed interest bearing loans in the organ-
isation are less than the equity share capital.
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the operational performance of the organisation. It is calculated by
dividing the gross profit figure by the net sales in a given time period.
Mathematically, gross profit ratio can be expressed as follows:
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Gross Profit Ratio = Gross Profit or
Net Sales
Sales – ( Direct materials + Direct Labour + Overhead )
Sales
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Gross Profit
Gross Profit Margin = × 100
Net Sales
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Higher ratios are considered favourable as they imply that the organ-
isation is selling its products at a higher profit percentage. Let us un-
derstand this with the help of an illustration:
Particulars `
Gross sales 10,00,000
Sales returns 90,000
Opening stock 2,00,000
Purchases 5,90,000
Purchases returns 70,000
Closing stock 45,000
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Particulars Amount
Sales 10,00,000
Less sales returns 90,000
Net sales 9,10,000
Less cost of goods sold (COGS):
Opening inventory 2, 00,000
Purchases 5, 90,000
Purchases returns 70,000 5, 20,000
Available for sale 7, 20,000
Less closing inventory 45,000 6, 75,000
Gross profit (Net Sales – COGS) 2, 35,000
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Gross Profit 2, 35, 000
Therefore, Gross Profit Ratio = = = 0.26
Net Sales 9,10, 000
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2, 35, 000
Gross Profit Margin = × 100 = 26%
9,10, 000
This implies that A Ltd. earns a gross profit ` 0.26 on each ` 1 of sales.
by the net sales in a given time period. Net profit is equal to gross
profit minus operating expenses and income tax. Mathematically, net
profit ratio can be expressed as follows:
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Particulars `
Sales 2,10,000
Returns inwards 10,000
Gross profit 80,000
Administrative expenses 15,000
Selling expenses 15,000
Interest on investment 10,000
Loss on account of fire 6,000
Income tax 5,000
Solution:
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a. Computation of net operating profit after tax:
Gross profit 80,000
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Less operating expenses:
Administrative expenses 15,000
Selling expenses 15,000
Net operating profit before tax 50,000
Less income tax 5,000
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Operating Income
Operating Profit Ratio =
Sales Revenue
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Operating Income
Operating Margin = x 100
Sales Revenue
Operating income is also referred to as earnings before income and
taxes or EBIT. EBIT includes the income that remains on the income
statement after all operating and overhead costs are deducted.
Let us understand this with the help of the illustration:
Illustration 8: The financial information for PQR Ltd. is as follows.
Compute the operating profit ratio.
Particulars Amount
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Net Sales `10,00,000
Cost of Goods Sold `5,00,000
Rent `15,000
Wages
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Other Operating Expenses `25,000
This implies that PQR Ltd. earns `0.36 as operating income from ev-
ery `1 of sales revenue. It is important to note that this ratio does not
take into account the organisation’s capital and tax structure.
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Let us assume that XYZ earned `10 lakhs of net income last year.
Shareholders’ equity is `20 lakh. The ROE of XYZ can be calculated
as follows:
This implies that Company XYZ earned `0.50 for every `1 of share-
holders’ equity.
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as a percentage and the formula is as follows:
Net Income
ROA =
Total Assets
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10.3.4 ACTIVITY RATIOS
and the date that receivables are collected from the customer. It is
computed as follows:
365
Average collection period =
Average Receivables Turnover Ratio
Let us discuss the activity ratios in detail:
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Particulars `
Sales 75, 00,000
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Purchases 20, 00,000
Opening inventory 9, 00,000
Closing inventory 7, 00,000
365
Average Selling Period = = 132.7
2.75
This implies that EFG Ltd. will take 132.7 days to sell the average in-
ventory.
This ratio measures the number of times average debtors are turned
over during a financial year. Debtors turnover ratio is also referred to
as accounts receivable turnover ratio. It indicates the frequency with
which the sundry debtors in an organisation are converted into cash.
A higher value of debtors turnover ratio reflects an efficient manage-
ment of debtors by an organisation. On the other hand, lower value of
debtors turnover ratio reflects an inefficient management of debtors
by the organisation. Accounts receivable turnover is calculated by di-
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viding net credit sales by average accounts receivable for that period.
Mathematically, it can be expressed as follows:
Illustration 10: Net credit sales of PQR Ltd. for the year ended March
31, 2013 were worth ` 6, 44,790. It received ` 43,300 on July 1, 2012 and
` 51,730 on January, 2013. Calculate the debtors turnover ratio.
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Debtors collection period: 365/ Debtors Turnover = approximately 27
days
This implies that PQR Ltd. collects its due on credit sales in a financial
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year with a frequency of 13.57 times. The debts are collected every
27th day of the year.
This is the ratio between net credit purchases and the average amount of
creditors outstanding during a financial year. It is computed as follows:
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This implies that the firm repays its credit purchases after every 91.25
days. It signifies healthy credit terms between the firm and its suppliers.
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Particulars `
Net Sales 75, 00,000
Current Assets 20, 00,000
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Current Liabilities 10, 00,000
Solution: Working Capital = Current Assets – Current Liabilities
Therefore WC = 20, 00,000 – 10, 00, 000 = `10, 00, 000
Net Sales
Working Capital Turnover Ratio =
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period ending March 31, 2013. Its closing working capital is `2, 00,000
and opening working capital is worth `4, 50,000. Calculate its working
capital turnover ratio.
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Exhibit
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Price Earnings Market Price Per Share Measures the amount
Ratio (P/E Ratio) Earnings Per Share the investors are
willing to pay for each
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Source: http://www.gulfbase.com/InvestmentTutorial/SubSection?id=61&SectId=107
n o t e s
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(a) Debt-equity ratio
(b) Debt to total assets ratios
(c) Quick ratio
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(d) Debtors turnover ratio
6. __________ measures an organisation’s performance in
generating earnings over related expenses over a specified
time period.
(a) Liquidity ratio (b) Solvency ratio
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Activity
Find out (a) debtors turnover and (b) average collection period of
the organisation whose annual credit sales are `5,00,000, debtors in
the beginning `80, 000, debtors at the end are ` 1,00,000 and debt is
taken for a year (360 days).
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other words, the DuPont equation breaks down the return on equity
ratio to explain how organisations can increase their return for inves-
tors. Return on equity is a relevant measure of how well an organisa-
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tion’s management creates value for its shareholders.
The DuPont model concludes that an organisation can raise its ROE
by maintaining a high profit margin, increasing asset turnover or le-
veraging assets more effectively.
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Balance Sheet:
Particulars ` ’000
Total Assets 250
Shareholders’ equity 50
Income Statement
Particulars ` ’000
Revenue 100
Net income 20
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Revenues Total Assets
Therefore, ROE of XYZ Ltd. is calculated as follows:
to decrease the share capital, ROE can be increased even when the
income remains constant.
Illustration 14: Company P Ltd. and Q Ltd. operate in the same mar-
ket and have the same size. Both companies earn the same return on
equity of 15%. The respective net profit margin, asset turnover and
financial leverage of both organisations are as follows:
Company P Company Q
Net Profit Margin 10% 10%
Asset Turnover 1 1.5
Financial Leverage 1.5 1
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11. The DuPont model breaks down the return on equity ratio
into three components, which are:
(a) Net profit margin, asset turnover and equity multiplier
(b) Net profit margin, sales turnover and equity multiplier
(c) Net profit margin, earning per share and equity multiplier
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(d) Net profit margin, gross profit margin and equity multi-
plier
12. __________ measures the ratio between an organisation’s
IM net income and its stockholders’ equity during a given time
period.
(a) Return on Asset (b) Return on Investment
(c) Return on equity (d) Net profit margin
13. Which of the following indicates the proportion of total assets
financed by the owners of a firm?
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Activity
From the given information, calculate the ROE of Z Ltd. and assess
its profitability:
(` in lakhs)
Year 2011 2012 2013
Net Income 20 22 21
Revenue 100 105 120
Equity 68 70 80
Assets 120 140 200
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The ratios and their interpretation are summarised in the Table 10.1:
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using its cash and cash
equivalents only.
Solvency Ratios
Debt-Equity Ratio
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(Total Liabilities)/ Indicates the extent to
(Shareholders’ equity) which an organisation’s
assets are financed using
debt.
Debt to Total Assets (Long Term Debt )/ Indicates the percentage of
Ratio (Total Assets) an organisation’s assets fi-
nanced through loans and
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(ROI) ment-Cost of Invest- of an investment or to
ment)/(Cost of Invest- compare the competence
ment) of different investments.
Return on Equity Net Income/Sharehold- Indicates an organisa-
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(ROE) er’s Equity tion’s profitability by
revealing how much profit
organisation yields with
the shareholders’ money.
Return on Assets (Net Income)/(Total Indicates how profitable
(ROA) Assets) an organisation is relative
to its total assets.
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Activity Ratios
Inventory Turnover (Cost of Goods Sold)/ Measures the number of
Ratio (Average Inventory) times average inventory is
“turned” or sold during a
given period.
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10.5 SUMMARY
A financial ratio depicts the relationship between two or more ac-
counting data expressed in mathematical terms.
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assets ratios.
Profitability
ratios measure an organisation’s performance in gen-
erating earnings over related expenses over a specified time peri-
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od. For example, gross profit, net profit and operating profit ratios.
Activity ratios also referred to as operating or management ratios
are used to measure an organisation’s efficiency to use its assets
such as inventories, accounts receivable, working capital and fixed
assets. The most commonly used activity ratios are inventory turn-
over, debtors turnover, working capital turnover ratios.
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The DuPont model breaks down the return on equity ratio into
three components; the net profit margin, asset turnover and the
equity multiplier.
In a DuPont analysis, the formula for Return on Equity is:
Net Income Revenues
The formula for ROE is ROE = ×
Revenues Total Assets
Total Assets
×
Shareholders' Equity
key words
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Working capital: The capital used by an organisation to per-
form its day-to-day operations and is obtained by deducting the
current liabilities from the current assets.
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10.6 DESCRIPTIVE QUESTIONS
1. What is a quick ratio? What does it signify?
2. What do you mean by profitability ratios? Explain the following
profitability ratios:
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uses.
4. What are the advantages and limitations of ratio analysis?
Discuss.
5. Discuss the composition of Return on Equity based on the
DuPont Model.
6. What are various types of activity matrices? Explain with relevant
examples.
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8. a. EBIT
9. a. Sale of core products
10. b. Lowers
The DuPont 11. a. Net profit margin, asset turnover
Equation and equity multiplier
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12. c. Return on equity
13. d. Proprietary ratio
14.
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c. DuPont
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5. The DuPont model breaks down the return on equity ratio into
three components; the net profit margin, asset turnover and the
equity multiplier. Refer to Section 10.4 The DuPont Equation.
6. Activity matrices indicates organisations overall ability to
convert various heads of balance sheet into cash and it can
be expressed in number of days. Inventory turnover, debtors
turnover, creditors turnover and working capital turnover ratio
are some important types of activity ratio. Refer to Section 10.4
The Dupont Equation.
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Notes Payable: `10 crore
Long term debt: ` 50 crore
Cash: ` 60 crore
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Accounts receivable: ` 50 crore
Inventory: ` 70 crore
Solution:
Current Ratio = (Current Assets)/(Current Liabilities)
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=180/30
Current Ratio = 6 times
2. Calculate the quick ratio from the data given below:
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n o t e s
Solution :
Debt to equity ratio = (Total Liability)/(Total equity)
= 80/180
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Debt to equity ratio = 0.44 times (approx.)
4. Calculate the inventory turnover ratio from the data given below:
Cost of goods sold: `70 crore
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Administrative expenses: `10 crore
Depreciation: `30 crore
Beginning inventory: `40 crore
Ending inventory: `30 crore
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Solution :
Inventory turnover ratio = (Cost of goods sold)/(Average
Inventory)
Average inventory = (Begining Inventory+Ending Inventory)/2
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=70/2
=35
Therefore,
Inventory turnover ratio = 70/35
= 2
Inventory turnover ratio =2 times
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Suggested Readings
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Debarshi, B. (2011). Management Accounting. (1st ed., pp. 57-79).
Delhi: Dorling Kindersley India.
Bhat, S. (2008). Financial Management. (2nd ed.). New Delhi: Excel
IMBooks, pp.27-52.
Goyal, V. & Goyal, R. (2013). Corporate Accounting (1st ed., pp.
529-626). Delhi: Prentice Hall India.
Sinha, G. (2009). Financial Statement Analysis (1st ed., pp. 97-133).
Delhi: Prentice Hall India.
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E-references
Accounting Coach.com. (2014). Financial Ratios and Analysis |
Explanation | Accounting Coach. Retrieved from, http://www.ac-
countingcoach.com/financial-ratios/explanation
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Case study
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stating that he wishes to introduce a stronger management con-
trol within the company. The director receives a file containing
a summary of Stortford Yachts Ltd. Profit and Loss and Balance
Sheet statements for the past three years which is as follows:
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Profit and Loss Account summary:
Particulars (` in lakhs)
2011 2012 2013
Sales turnover 4.90 5.30 6.60
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Particulars (` in lakhs)
2011 2012 2013
Fixed assets 2.40 2.77 2.88
Current assets
Stocks:
Raw materials 0.09 0.12 0.15
Finished goods 0.40 0.43 0.45
Debtors 1.14 1.32 1.84
Bank 0.03 0.04 0.05
1.66 1.91 2.49
Less Current liabilities 1.35 1.56 1.90
Case study
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Particulars (` in lakhs)
2011 2012 2013
Net current assets 0.31 0.35 0.59
2.71 3.12 3.47
Financial ratios of Stortford Yacht Ltd. for the year 2013 were also
provided to the consultants:
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Ratio 2013
Return on Equity 27.78%
Asset turnover 1.9 times
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Net profit margin 5.3%
Current ratio 1.31 times
Quick ratio 0.995 times
Debtors collection period 28 days
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questions
Case study
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CONTENTS
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11.1 Introduction
11.2 Components of Financial Statement Analysis
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11.2.1 Common Size Analysis
11.2.2 Comparative Statement
Self Assessment Questions
Activity
11.3 Trend Analysis
Self Assessment Questions
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Activity
11.4 Percentage Change Analysis
Self Assessment Questions
Activity
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Introductory Caselet
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AMAZON OR WAL-MART?
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between them.
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learning objectives
11.1 Introduction
In the previous chapter, you studied about the concept and signifi-
cance of ratio analysis using financial statements of an organisation
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for assessing its financial health. In this chapter, you will study about
the other common financial analysis method used by organisations,
the common size analysis.
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Generally speaking analysis of any kind and especially financial anal-
ysis can be broadly categorised into two segments.
1. Time Series Comparison or Trend Analysis: The performance
of the firm is compared with the past performance to analyse
how to improve the productivity and achieve sustainable growth.
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All three of the primary financial statements are analysed using com-
mon size analysis. The amounts included in financial statements of
an organisation can be converted to common size statements, which
could be used to compare organisations belonging to different indus-
tries and having different sizes. The main advantage of common size
analysis is that it allows for a vertical analysis over a single time peri-
n o t e s
In this chapter, you will study about the different kinds of common
size analysis used for comparing organisation’s performance. The
chapter explains vertical and horizontal common size analysis. Later,
the chapter describes the trend analysis and percentage change anal-
ysis of financial statements. Towards the end, the chapter discusses
the significance of Management’s Discussion and Analysis.
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Components of Financial
11.2
Statement Analysis
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You have studied earlier that the financial statements of an organisa-
tion are used for reporting the financial position of the company for
public use. The financial statement analysis are categorised majorly
into two parts:
pany for public use. Whenever an investor intends to compare the fi-
nancial statements of two organisations, there is a need for a common
scale in order to match the two distinct businesses for investment pur-
poses. As organisations are different in size, growth, etc. comparing
the traditional financial statements might lead to misleading interpre-
tations affecting the investors.
For example, A Ltd. has liabilities worth `10, 00,000 while B Ltd. has
liabilities worth `100, 00,000. Does this information from their balance
sheets imply that A Ltd. is less risky than B Ltd.?
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absolute amounts in different currencies into percentages makes
comparisons and financial analysis more meaningful and simpler.
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The most widely used common size analysis methods are as follows:
i. Horizontal Common Size Analysis
ii. Vertical Common Size Analysis
Although both methods are similar considering that the figures in fi-
nancial statements are converted to percentages however, they differ
in the base used to compute the percentages. Let us discuss the two
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n o t e s
Source: http://valueinvestingbasics.com
Assuming 2011 is the base year, 2012 and 2013 revenues will be calcu-
lated as follows, respectively:
note
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(Revenue of 2012/Revenue of 2011) × 100 = 62,071/61,494 × 100 = 101%
(COGS of 2012/ COGS of 2011) × 100 = 56,940/61,494 × 100 = 93%
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Thus, the horizontal analysis of Dell’s Income Statement would be as
follows:
This analysis shows that the percentages of revenue for 2012 and 2013
first increased and later decreased the 100% benchmark of 2011. The
financial statement user would interpret this as an increase and later
decrease in Dell Inc.’s sales performance. Revenue for 2013 may be
misleading at first glance, however, further analysis reveals that the
decrease in 2013 represents only 7% fall compared to the 100% bench-
mark of revenue in 2011. In reality, the COGS in 2013 have come down
by 11% compared to the benchmark COGS in 2011. Thus, the compa-
ny is in a better position in managing its resources.
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Salaries and wages 2,50,000 25%
Office rent 50,000 5%
Supplies 10,000 1%
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Utilities 20,000 2%
Other expenses 90,000 9%
Total expenses 4,20,000 42%
Net profit 1,80,000 18%
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note
Vertical analysis of a balance sheet uses the common base as the total
assets of an organisation. However, for a deeper analysis, users tend
to use the total of all liabilities as the base for calculating line item li-
abilities in a balance sheet and the total of all equity accounts as base
when calculating all equity line item percentages.
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Total current liabilities are 20% of total liabilities and equity
Current assets account for 20% of the total assets
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Exhibit
Interpretation:
The relative investment in fixed assets (currently around 52%
of assets), when compared with current assets, has increased
since 2008.
The proportions of assets that are current assets have decreased
slightly over time.
Source: CFA Institute
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The methods used under the comparative statements are as follows:
2017 is as follows:
MAR’17 MAR’16
Parameter Change %
(` Cr.) (` Cr.)
Operating Income 59,289.00 53,983.00 9.83%
Less: Inter divisional
0.00 0.00 0.00%
transfers
Less: Excise 0.00 0.00 0.00%
Net Sales 59,289.00 53,983.00 9.83%
EXPENDITURE:
Stock Adjustments 0.00 0.00 0.00%
Raw Materials Con-
0.00 0.00 0.00%
sumed
Power & Fuel Cost 180.00 179.00 0.56%
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MAR’17 MAR’16
Parameter Change %
(` Cr.) (` Cr.)
Employee Cost 30,944.00 28,207.00 9.70%
Cost of Software de-
6,044.00 5,466.00 10.57%
velopments
Operating Expenses 399.00 221.00 80.54%
General and Adminis-
3,884.00 3,666.00 5.95%
tration Expenses
Selling and Marketing
276.00 229.00 20.52%
Expenses
Miscellaneous Ex-
355.00 351.00 1.14%
penses
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Expenses Capitalised 0.00 0.00 0.00%
Total Expenditure 42,082.00 38,319.00 9.82%
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PBIDT (Excl OI) 17,207.00 15,664.00 9.85%
Other Income 3,062.00 3,051.00 0.36%
Operating Profit 20,269.00 18,715.00 8.30%
Interest 0.00 0.00 0.00%
PBDT 20,269.00 18,715.00 8.30%
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Exceptional Income /
0.00 0.00 0.00%
Expenses
n o t e s
Comparative Balance Sheet of Infosys for year ended March 31, 2017
is as follows:
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Parameter MAR’17 MAR’16 YoY
(` Cr.) (` Cr.) %Change
Current Liabilities
n o t e s
ASSETS
Less: Accumulated
7,635.00 6,491.00 17.62%
Depreciation
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Net Block 8,605.00 8,248.00 4.33%
Pre-operative Expenses
0.00 0.00 0.00%
pending
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n o t e s
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Total Debt 0.00 0.00 0.00%
n o t e s
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(d) Total Sales
6. Which of the following financial statements can be analysed
using common size statements?
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(a) Balance sheet
(b) Profit and loss account
(c) Consolidated financial statement
(d) All of the above
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Activity
n o t e s
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% 100 129 160 202 250 319 379
note
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Trend analysis percentage = (figure of the concerned year / figure
of the base year) × 100
From the above illustrated trend analysis, it can be observed that sales
in 2012 were 379% of the 2006 sales achieved by the organisation. Using
information from trend analysis makes it much convenient to see how
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Exhibit
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n o t e s
Activity
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11.4 PERCENTAGE CHANGE ANALYSIS
A percentage change analysis illustrates how two items in a financial
statement changed as a percentage from one period to another period.
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For example, percentage change analysis of items in a balance sheet
illustrates how a balance sheet account changes from year- to- year, or
quarter- to- quarter. The balance sheet accounts are assets, liabilities
and stockholders’ equity. Percentage change analysis helps managers
and investors to assess how an organisation is performing over a time
period. Consider the following illustration:
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n o t e s
Step 4: Repeat these steps for other balance sheet items for per-
centage change analysis.
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Taxes 1,00,000 75,000 25,000 33.3
Activity
n o t e s
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obligations and expansion plans, if any.
n o t e s
The MD&A along with the financial statements offers the oppor-
tunity for an organisation to communicate the effectiveness of its
resources and progress towards its defined strategic objectives.
The MD&A is helpful in integrating and accumulating material in-
formation about the organisation that investors are interested in.
Apart from imparting information to investors, many organisa-
tions use the MD&A to help new directors in orienting themselves
to an organisation’s performance and prospects.
The internal processes, systems and control required in the prepa-
ration of an effective MD&A deliver significant advantages to or-
ganisations by improving organisational focus, giving new insights
into key performance indicators, encouraging accountability and
control and enabling performance benchmarking.
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Exhibit
FY 2016-17 and the Tata Motors market share are given in the
following table:
Category Industry Sales Company Sales Market Share
Fiscal 2017 Fiscal 2016 Growth Fiscal 2017 Fiscal 2016 Growth Fiscal 2017 Fiscal 2016
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Units % Units % %
Commercial Vehicles1 7,29,360 7,06,819 3.2% 3,24,175 3,26,755 (0.8)% 44.4% 46.2%
Passenger Vehicles2 30,34,670 27,68,290 9.6% 1,57,020 1,27,118 23.5% 5.2% 4.6%
Total 37,64,030 34,75,109 8.3% 4,81,195 4,53,879 6.0% 12.8% 13.1%
Source:
Society of India Automobile manufacturers report and Company Analysis
1
Commercial vehicles include V2 van sales
2
Passenger vehicles include Flat and Jaguar Land Rover-branded cars.
Units % Units % %
M&HCV 3,02,402 3,02,556 (0.1)% 1,48,774 1,57,120 (5.3)% 49.2% 51.9%
LCVs1 4,26,958 4,04,263 5.6% 1,75,401 1,69,635 3.4% 41.1% 42.2%
Total 7,29,360 7,06,819 3.2% 3,24,175 3,26,755 (0.8)% 44.4% 46.2%
Source:
Society of India Automobile manufacturers report and Company Analysis
1
LCVs include V2 van sales
n o t e s
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Materiality balanced
iii. Strategic Perspective C. Fundamental to use-
ful Management Dis-
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(MD&A) reporting
iv. Usefulness D. Focus on Manage-
ment’s strategy
(a) I(A), II(B), III(D), IV(C) (b) I(C), II(A), III(D), IV(B)
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(c) I(B), II(C), III(D), IV(A) (d) I(C), II(B), III(D), IV(A)
12. _________________________ principle implies that MD&A
should complement as well as supplement financial statements.
(a) Diversification of investments
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n o t e s
Activity
11.6 SUMMARY
Common size analysis is a popular method of financial statement
analysis, which makes use of common size financial statements.
Horizontal common-size analysis uses one type of financial state-
ment at a time over several consecutive years.
Verticalanalysis refers to the proportional analysis of a financial
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statement, where each item on a financial statement is recorded as
a percentage of another item.
Invertical analysis, each item on the income statement of an or-
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ganisation is recorded as a percentage of the gross sales.
Similarly,each item on the balance sheet of an organisation is re-
corded as a percentage of the total assets.
Investorsuse trend analysis to determine the financial position of
an organisation for decision making.
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n o t e s
key words
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report or other documents in a list format.
Performance benchmarking: The process of comparing an or-
ganisation’s processes and performance metrics to best practic-
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es from other industries and organisations.
Stockholders’ equity: The equity currently held on the books
by an organisation’s equity investors.
Timeline analysis: A tool used by analysts to identify changes
that impacted the performance of an organisation over a time
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period.
1. Explain the need for Common Size Analysis. What are its main
uses?
2. What do you understand by comparative analysis and what are
its types?
3. Explain trend analysis and various steps under it.
4. Explain the use of Percentage Change Analysis in comparing
and evaluating an organisation’s financial statements.
5. Explain management discussion and analysis and its main
principles.
6. Explain the principles and advantages of Management Discussion
and Analysis.
n o t e s
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Percentage Change Analysis 9. a. Percentage change analysis
Management Discussion and 10. b. Management Discussion and
Analysis: Thinking Beyond Analysis
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Numbers
11. d. I(C), II(B), III(D), IV(A)
12. b. Integration with Financial
Statements
13. d. All of the above
14. b. Through the Eyes of the Man-
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agement
n o t e s
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and the managerial perspective about the past performance,
challenges and the plans for the future. There are six disclosure
principles that guide the preparation of MD&A in the annual
report of an organisation. Refer to Section 11.5 Management’s
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Discussion and Analysis: Thinking beyond Numbers.
n o t e s
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= 120%
2. The Income Statement of PQR Private Ltd. is as follows:
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Income Statement of PQR Private. Ltd.
Particulars 2017 (Amount in `) 2016 (Amount in `)
Revenue `3000000 `2500000
Cost of goods sold `2200000 `1850000
Depreciation and `350000 `350000
Amortisation
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n o t e s
S
3. Prepare vertical common size analysis on the balance sheet XYZ
Ltd. given below.
Particulars (Amount in `)
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Cash 1000000
Accounts receivable 350000
Inventory 250000
Fixed assets 800000
Total assets 3000000
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n o t e s
S
4. Prepare horizontal common size analysis on the balance sheet
Bharat Enterprises given below.
Particulars 2015 2016 2017
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(Amount (Amount (Amount
in `) in `) in `)
Revenue 15000000 18000000 17400000
Cost of goods sold 11000000 13000000 13200000
Gross profit 4000000 5000000 4200000
Operating expenses 1500000 1800000 1700000
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n o t e s
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paid
Net income 1687500 100% 2250000 133.33% 1725000 102%
Solution:
For conducting percentage change analysis of given data,
we have to take figures of year 2016 as base figure and then
calculate difference between figures of 2016 and 2017 to calculate
percentage change.
We will calculate percentage change analysis for all the items in
the year 2017 by using below formula:
Percentage Change for year n= [(figure of the n year – figure of
base year)/ figure of the base year] × 100
Particulars 2016 2017 Difference Percentage
(Amount (Amount (Amount Change
in `) in `) in `)
n o t e s
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SUGGESTED READINGS
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Norman, H., Alderman, W., & Godwin, C. (2010). Financial ACCT
2010 (1st ed., p. 38). Mason, USA: Cengage Learning.
Peterson Drake, P., & J. Fabozzi, F. (2012). Analysis of Financial
Statements (3rd ed., pp. 127-129). Hoboken, New Jersey: Wiley
Publishers.
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E-REFERENCES
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Introductory Caselet
n o t e s
You are being given the balance sheets of two well-known organ-
isations, namely, XYZ Bank Ltd. and ABC Industries Ltd. While
one is a large state owned bank and other is a large manufactur-
ing company.
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Equity and Liabilities
Capital 9720
Reserves and Surplus 17800
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Deposits 245000
Borrowings 16000
Other Liabilities and Provisions 12000
TOTAL 300520
Assets
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Introductory Caselet
n o t e s
Application of funds
Fixed Assets 12610
Goodwill 523
Patents and Trademarks 565
Capital work in progress 1112
Net deferred tax assets 389
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Investments 9830
Current assets 2561
Inventories 817
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Accounts Receivable 2252
Cash and Bank Balances 828
Short term loans and advances 4719
Other current assets 8153
Loans and Advances 2523
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TOTAL 46882
questions
CASE STUDIES
CONTENTS
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Case Study 1 Assessment of Business Expenses
Case Study 2 Transactional Analysis and Balance Sheet
Case Study 3 Sanjeev’s Delicious Bites
Case Study 4
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Satyam Computers Limited- Business Accounting Fraud
Case Study 5 Reporting the Depreciation of Assets at Abyss Inc.
Case Study 6 Voilation of Accounting Standards by Xerox
Case Study 7 Flymates Reports Accounting Data as per Schedule III of
Companies Act, 2013
Case Study 8 Tata Motors- Cash Flow Analysis
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Case study 1
n o t e s
His only source of income was the fare money collected from cab
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and during the first year, he had all the information on money
spent by him that he had noted in his pocket diary.
At the end of year, he organised a small party for his family. His
wife pointed out that he had put in all his savings in the cab. ‘Did
you make any profit?’ He did some mental calculations and re-
plied, ‘as of now, I made a loss of ` 277510.
Case study 1
n o t e s
questions
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are personal expenses and should not be considered as
business expenses. On the other hand, his uniform and
driver’s badge, food and drinks while driving, diesel and
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oil, etc. should be considered as business expenses.)
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N
S
On May 06, 2016, Arvind purchased a laptop for cash `40 thou-
sand.
On May 07, 2016, full advance payment of `25 thousand, was
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made to the website developer for developing a customized
website for ‘rider.com’.
On May 08, 2016, `20 thousand had been spend for office fur-
niture.
On May 09, 2016, Arvind received rights for fully customized
website of ‘rider.com’.
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bikes for 5 days bike rental and full payment of `7500 had been
received.
On May 15, 2016, paid `2200 for electricity charges.
On May 20, 2017, Arvind purchased 10 more motorcycles for
`25000 each.
On May 22, 2016, got another order for 12 bikes for 6 days and
full payment of `36000 has been received.
On May 27, 2016, salary of `20000 paid to employees.
On May 30, 2016, Arvind withdrew `6000 for personal use.
On May 31, 2016, Additional capital of `1 lakh brought in by
Arvind.
Case study 2
n o t e s
questions
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all the journal entries by applying accounting equation,
i.e. Assets = Liabilities + Share Capital)
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N
This Case Study discusses the preparation of Trial Balance and rec-
tification of errors in the Trial Balance for Sanjeev’s new restau-
rant, ‘Delicious Bites’. It is with respect to Chapter-3 of the book.
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presented to the lending bank. The bank would assess Sanjeev
and his restaurant’s credibility to repay the loan. For this purpose,
Sanjeev hired a book keeper who kept a record of all the trans-
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actions that took place and forwarded them to Sanjeev’s accoun-
tant. The book keeper recorded the following transactions:
Jan 1: Sanjeev started business with cash `8, 00,000 and furni-
ture `2, 00,000.
Jan5: Purchased goods on credit worth `3, 00,000 from Taste-
makers Inc.
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Sanjeev’s Ledger
Cash Account (No.5)
Date References J.F Debit (`) Credit (`) Balance (`)
2013 Dr. Cr.
Jan. 1 Capital A/C 5 8,00,000 8,00,000
Jan 8 Sales A/C 5 4,60,000 12,60,000
Jan 16 Customer’s A/C 5 98,000 13,58,000
Case study 3
n o t e s
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Date References J.F Debit (`) Credit Balance (`)
2013 (`) Dr. Cr.
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Jan 5 Purchases A/C 5 3, 00,000 3, 00,000
Case study 3
n o t e s
Sanjeev asked his accountant to rectify the error; however his ac-
countant was unable to find out the reason for his unbalanced
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entries.
questions
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1. Suppose you are an accountant at Sanjeev’s old restaurant.
He seeks your help in the rectification of his trial balance
entries. Analyse the reason for the mismatched entries.
(Hint: Cash received from customers worth `98, 000,
which means a discount worth `2000, which has not been
M
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tors and analysts, among others to check fraudulent financial re-
porting.
grew considerably and generated USD $467 million from its total
sales. By March 2008, Satyam Computer had grown to USD $2.1
billion. It booked an annual compound growth rate of 35% in that
time period.
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Case study 4
n o t e s
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investors’ confidence in the capital market was shaken consider-
ably. The fraud also had an adverse impact on Satyam’s employ-
ees who lost their jobs and diminished pension fund value. The
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others that were affected were depositors in Satyam Computers,
the company’s underwriters, auditors, attorneys, and insurers
and even trustworthy competitors whose reputations suffered
owing to their association with Satyam.
Case study 4
n o t e s
questions
S
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M
N
Abyss Inc. was incorporated in April, 2008 and deals in the pro-
cessing and distribution of dried fruits. The company also car-
ries out research and development activities related to different
varieties of dry fruits. It follows the Indian Generally Accepted
Accounting principles (i-GAAP) for preparing and reporting its
financial statements. In preparing its financial statements for fi-
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nancial year ending 31st March, 2012, Abyss Inc. used the follow-
ing useful lives for its property, plant and equipment:
The book value of Abyss Inc.’s property, plant and equipment are
as follows:
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Case study 5
n o t e s
questions
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reported in the same way?
(Hint: AS 6 does not apply on intangible assets, patents,
goodwill, research and development, etc.)
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M
N
S
Then in 1959, Carlson introduced ‘Xerox 914’ the first plain pho-
tocopier of that time which became so popular and resulted as a
game changer for Xerox. This product brought substantial chang-
es in company’s revenue and it jumped to over US $ 500 million by
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1965 from US $ 60 million in 1961. During 1960s, Xerox acquired
many companies such as, University Microfilms International,
Electro-Optical Systems, Scientific Data Systems, etc.
which was 100% during early 1970s. Then in 1981, ‘Memory writ-
er’ (an electronic memory typewriter) was launched by Xerox and
good response has been received from market. By the year end
of its launched, around 20 % market share was captured by this
product. In mid 1980s, during the time of computing revolution,
N
most of the market share was loosed to other major players such
as, Apple, IBM, Microsoft, etc. However, from that time to till date
Xerox has achieved many milestones and today it is a well-known
brand in Document solutions and services provider company with
global reach of 180 countries.
Case study 6
n o t e s
During the investigation it was found out that Xerox was engaged
in such practices from past many years. For instance, during the
financial year 1996-1997 the expected return of investment (ROI)
recorded was US $ 2.02 per share while the actual ROI per share
was US $ 1.65 per share. By using Cookie Jar Reserves (or Ac-
counting) false profits were recorded by Xerox and to carry out
such practice it was using past profits of successful years to cover
up losses. In many cases, Xerox was recording future revenue in
order to compensate with current revenue. In this scenario, ‘In-
ternational Financial Reporting Standard (IFRS) 15’ or ‘Interna-
tional Accounting Standard (IAS) 18’ of revenue recognition has
been violated by the company. As per the Indian context, ‘Indian
Accounting Standard (Ind AS) 18’ deals with Revenue Recogni-
tion.
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On the other hand, many times long-term leases have been re-
corded as short term rentals in order to delay the revenue recog-
nition process. While the G.A.A.P states that the revenues for long
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term leases are supposed to be recorded immediately. It also spec-
ifies that the revenues from short-term equipment rentals are to
be spread over the duration of the contract. In spite of this, Xerox
sometimes purposely classifies its long-term leases as short-term
rentals in an effort to postpone revenue recording. In this man-
ner, Xerox was also violating, ‘International Financial Reporting
Standard (IFRS) 16’ or ‘International Accounting Standard (IAS)
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questions
N
This Case Study discusses the Schedule III of Companies Act, 2013,
adopted by Indian corporates w.e.f. April 1, 2016 for preparing and
presenting their financial statements. It explains the way the assets
and liabilities are reported in the balance sheet of Flymates Pvt.
Ltd. as per Schedule III of Companies Act, 2013. It is with respect to
Chapter 7 of the book.
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for its worldwide customers. The organisation has developed a
technical support team to serve airlines that adhere to document-
ed safety standards. Flymates Pvt. Ltd. prepares and presents its
financial statements as per Schedule III of Companies Act, 2013.
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Although the organisation is performing fairly satisfactorily for
the last two decades, there are a few problems in its accounting
procedures owing to the adoption of the Schedule III of Compa-
nies Act, 2013. The following information has been provided by
the Accounts Manager to the consultants of the organisation:
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The time period from the initial purchase of raw materials till the
completion of final production of the spares and their delivery
after quality certification is approximately 10 months on an av-
erage. Once the spares are sold to the buyers, the credit terms
of Flymates provides for payment of the amount due within six
N
Flymates Pvt. Ltd. has acquired a 7 year term loan from a public
sector bank against security of its plant & machinery. The com-
pany has already paid principal and interest amount of the loan
for the first 3 years and the opening balance of the loan as on
1st April, 2016 is `5.50 crore. The principal repayment per year
is nearly `2 crore. However, for the last 2 months Flymates’ loan
instalments are unpaid as at 31st March, 2017. As per the bank’s
terms and conditions, the loan would be liable to be recalled in
case of failure to adhere to loan terms which include submission
of quarterly performance indicators. During 2016-2017, Flymates
Pvt. Ltd. failed to submit any statements. Until now, the bank has
not issued any notice for recalling the loan.
Case study 7
n o t e s
questions
S
IMNon-current Liabilities → Long term borrowings.)
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N
This Case Study discusses the analysis of the Cash Flow Statement
of Tata Motors Limited to assess the financial performance of the
organisation in the FY 2016-17. It is with respect to Chapter 8 of the
book.
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runs a joint venture for manufacturing buses with Marcopolo S.A.
Besides, Tata Motors also runs a joint venture with Hitachi for
manufacturing construction machinery. Fiat-Tata is another India
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based joint venture between Tata and Fiat for manufacturing Fiat
and Tata passenger cars, engines and transmissions.
Motors Limited:
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Case study 8
n o t e s
S
Source: http://profit.ndtv.com/stock/tata-motors-ltd_tatamotors/financials-cash-flow
questions
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1. You are required to prepare the summary of cash flow
statement of Tata motors in less than 400 words.
(Hint: Analyse the cash flow statement and prepare a
summary in a way that it shows comparative summary of
year 2015-16 and 2017-18. For instance, Net cash flow from
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This Case Study discusses the analysis of profit and loss of Tata
Motors Limited on a basis to assess the financial performance of the
organisation in the Financial Year (FY) 2016-17. It is with respect to
Chapter 9 of the book.
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facturer in the world.
Case study 9
n o t e s
Source: http://www.tatamotors.com/investors/financials/72-ar-html/profit-loss.html
questions
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statement analysis of Tata Motors Limited?
(Hint: Analyse the profit and loss account of Tata Motors
and summarise all the significant changes.)
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2. Prepare a comparative profit and loss account of Tata
motors for the year 2016-17.
(Hint: Prepare comparative profit and loss as per the
format and instructions mentioned in chapter 11. Also note
that, in comparative profit and loss account percentage
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This Case Study discusses the ratio analysis of ITC Limited using
its financial statements for the year ending 31st March, 2014. It is
with respect to Chapter-10 of the book.
ITC Limited was incorporated on August 24, 1910 under the name
of ‘Imperial Tobacco Company of India Limited’ in a leased office
on Radha Bazar Lane, Kolkata. ITC Limited’s principal activities
are to manufacture cigarettes and tobacco. The Group operates in
retailing business such as garments, greeting, gift and stationery,
packaged foods and export of agricultural products. ITC provides
a range of branded packaged and convenience food for its cus-
tomers in its operations all over India. Some of the brands under
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ITC are India Kings, Wills, Gold Flake, Checkers, Hi-Val, Wills
Sport, Expressions, etc. The company’s financial statements for
the year 2013-2014 are as follows:
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Balance Sheet of the ITC for year ended 31.03.2014
ASSETS
Non-current assets
Fixed assets 10
Tangible assets 12556.00 11728.45
Case study 10
n o t e s
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Inventories 14 8255.24 7522.09
Trade receivables 15 2439.21 1395.76
Cash and bank balance 16 3490.19 3828.30
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Short-term loans and advances 17 816.20 529.61
Other current assets 18 1094.72 22581.06 622.83 19065.70
Total 40883.93 35353.38
services
Less: Excise Duty 14262.58 12597.31
Net Revenue from sale of products and 34984.70 31323.45
services
Other operating revenue 332.38 304.09
Revenue from operations 20 35317.08 31627.54
Other income 21 970.95 877.60
Total Revenue 36288.03 32505.14
Expenses
Cost of materials consumed 10376.05 9069.82
(Includes share of Joint Ventures
` 108.30 Crores (2013- ` 83.62 Crores))
Purchases of Stock-in- Trade and Interme- 2976.96 3305.23
diates
Changes in inventories of finished goods, 22 (112.74) (256.84)
work-in-progress, Stock-in-Trade and Inter-
mediate
Employee benefits expense 23 2504.24 2145.63
Case study 10
n o t e s
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Profit after tax before share of results of 8990.62 7693.58
associates and minority interests
Less: Minority interests 109.81 96.38
Share of net profit of associates
IM 10.57 10.87
Profit for the year 8891.38 7608.07
Earnings per share (Face Value ` 1.00 each) 28(i)
Basic ` 11.22 ` 9.69
Diluted ` 11.09 ` 9.56
Source: http://www.itcportal.com/about-itc/shareholder-value/annual-reports/itc-annu-
al-report-2014/pdf/ITC-Consolidated-Financials-Statement.pdf
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how it used its resources, its ability to pay its liabilities and gen-
erate profit. These investors used the following financial ratios to
compare ITC Limited across different time periods.
Ratios:
i. Current Ratio = Current Assets/Current Liabilities =
22581.06/11886.06 = 1.9
ii. Quick Ratio = (Current Assets-Inventories-Prepaid
Expenses)/ Current Liabilities = (22581.06 – 8255.24)/
11886.06 = 1.2
iii. Cash Ratio = Cash and Cash equivalents/ Current Liabilities
= 3490.19/11886.06 = 0.3
iv. Debt-Total Assets Ratio = (Long term debt)/(Total Assets)
= 1577.88/40883.93 = 0.03
v. Gross Profit Ratio = (Gross Profit )/(Net Sales) = 50550.61/
34984.70= 1.44
Case study 10
n o t e s
vi. Net Profit Ratio = (Net Profit after Tax )/(Net Sales) =
8990.62/34984.70 = 0.25
vii. Return on Assets = (Net Income)/(Total Assets) =
8891.38/40883.93 = 0.21
viii. Working Capital Turnover Ratio = (Net Sales)/(Average
Working Capital) = 34984.70/10695 = 3.27
(Working capital = Current Assets-Current Liabilities)
questions
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(Hint: assess the liquidity, profitability and activity status
of ITC on the basis of its ratio against the ideal ratios and
give your analysis.)
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2. Has the financial position of ITC Limited improved
compared to its 2013 results?
(Hint: calculate the given ratios for year 2013 using the
data on the balance sheet and P&L account of ITC,
compare against 2014 results to give your analysis.)
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N
This Case Study discusses the common size analysis for interpreting
Notion Graphics Ltd.’s financial position for investment purposes
by a group of venture capitalists. It is with respect to Chapter-11 of
the book.
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March, 2014 is as follows:
Income statement for the year ended 31st March, 2014 (Amount
in lakh of `)
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Particulars 2013 2014
Gross sales 370 480
Less: Returns 20 30
Net Sales 350 450
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Case study 11
n o t e s
Common Size Income statement for the year ended 31st March,
2014 (Percentages)
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Earnings after Taxes (EAT) 16.7 21.0
questions
Marico was found in 1988 and it is one of the leading FMCG brand
in India. It is registered in Mumbai and as of now it is the 7th larg-
est FMCG Company with a customer base of around 130 million.
Marico has very effective distribution channel with over 2.5 mil-
lion outlets in India and overseas. Its PE ratio was 52.15 against
the industry PE ratio of 56.5. With a total debt of `108 crore, it has
a Debt-to-Equity ratio of just 0.1 and this makes a Marico almost a
debt free company. As per the current shareholding pattern of the
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company includes 59.7 % in promoter’s holdings and 7% non-in-
stitutional public holding while Foreign Institutional Investors
(FIIs) and (Direct Institutional Investors) DIIs have 29% holding.
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Analyse the below data regarding Marico’s Standalone perfor-
mance in stock market as of November 2017:
TTTM)
Price To Earn- 50.37 times Put-Call Ratio 45.46 times
ings Ratio (PE
Ratio)
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Case study 12
n o t e s
S
To provide maximum return to shareholders, the company
has increased its dividend pay-out to 350% in 2017 as com-
pared to 337% in 2016.
IM
Total expenses have risen by 4% to 863.9 crore from 829.3 in
the last year.
Group Company’s Debt to Equity, ratio (DE Ratio) was signifi-
cantly decreased from 0.2% in 2016 to 0.13% in 2017.
Case study 12
n o t e s
questions
S
Materiality’ in Management Discussion and Analysis. So
first of all you need to have complete and fair information
about the issue. Then analyse that whether the effect is
positive, negative or no effect).
IM
M
N