Financial Accounting & Analysis

December 2020 Examination

1. Karagiri is a Pune based startup that works with 800 families across India. The startup is
in the business of handloom saris. They converted the pandemic period in to an opportunity.
The business owners realized that accounting is essential to permit informed judgements and
decisions by the user of accounts. In the light of given definition of accounting, discuss about
users and uses of accounting information (10 Marks)

Solution:

Introduction:

Accounting is a systematic record of business and business transactions. It is the basis on which
accounting summary is prepared for analyzing accounting information and business performance.

According to Kohler, Accountancy refers to the entire body of the theory and process of
accounting.

According to Prof. Robert N. Anthony, nearly every business enterprise has an accounting system.
It means collecting, summarizing, analyzing, and reporting in monetary terms information about
business information.

Concept:

There are three methods for recording accounting information in the accounting system. They are
as under:

(i) Cash system of accounting

Under this accounting system method, expenses and incomes are recorded when spent and earned
in cash. Professionals usually follow this method of accounting.

(ii) Accrual system of accounting

Under this method, incomes and expenses are recognized when they are accrued. When the income
is earned, it is recognized in the books even though it is not received. Expenses are recognized
when they are incurred irrespective of the actual outflow of cash.

Most of the companies and firms follow this method of accounting in their accounting system.

(iii) Hybrid or Mix system of accounting

It is a combination of both the systems discussed above. Generally, the incomes and assets are
recognized on a cash basis, and liabilities and expenses are recorded on an accrual basis.

In India, it is not permitted to follow this form of an accounting system.

Users of Accounting Information:

The accounting information is useful to one and all. That is to say that the internal and external
users find the accounting information useful for their various reasons and help them in making
informed business decisions. Let us comprehend the users of accounting information in detail:

(i) Internal Users – Owners:

They use accounting information for various decisions related to income earned and expenses
incurred. The information helps them in understanding the profitability of their business. 
They are also provided with segmentation performance since accounting information can be
prepared according to the business segments. 
It also helps them to understand the stability of their business and business operations.

(ii) Internal Users – Employees:

Employees are also one of the users of accounting information. Usually, the finance team
employees use this information to prepare the organization's financial forecast. It will help the
employees understand the organization's financial stability and help them inculcate a sense of job
security. They can also use this information to expect a salary hike and bonus for the year.

(iii) External Users – Lenders:

The lenders are significant external users of accounting information. They make use of this
information to analyze the financial stability and financial growth of the organization. Based on
this information, they can decide the amount to be lent to the organization and assure their
finances.

(iv) External Users – Investors:

Investors are essential for any business organization. They are the ones who invest their money in
the business pf the organization. As a result, they are interested in assessing the performance of the
business organization. They can use this information to assess if their investment is to be increased
or to be reduced.

(v) External Users – Suppliers:

Suppliers are the ones who supply goods and render services to the business organization for
selling goods and services to customers. They use this information to assess the creditworthiness of
the organization. Based on this, credit terms can be decided.

(vi) External Users – Tax Authorities:

Tax authorities use this accounting information to know the estimated tax collection from the
organization. They can also know if the organization is complying with the taxation laws.

Uses of Accounting Information:

The Accounting Information has various users, as discussed above. Therefore, it is very evident
that the accounting information has many uses. Let us discuss the uses of accounting information.

(i) Financial Statements:

The accounting information is processed and analyzed to prepare the financial statements of the
organization. These help the investors and stakeholders in making business decisions. They reflect
the true and fair view of the operations of the business organization.
The financial statements show the business organization's profitability and help them perform
variance analysis and trend analysis. They also show the cash flow movement of the organization.
(ii) Useful for preparing budgets:

When analyzed with historical data, the accounting information can be used for preparing a future
forecast and budget of the organization. It helps the organization in various ways as they have a
detailed explanation of the expenses and incomes and its quantum.

(iii) Business Decisions:

The information helps the management and stakeholders in making various business decisions.
Various decisions can be taken with the help of this accounting information. They can be related to
expenditure or investment or expanding business operations.

Conclusion:

Thus, it is evident that the accounting and accounting information is a critical aspect of the
organization. It helps those interested in undertaking various strategic business decisions.

2. Mr. Kohli is planning to invest in the share market. He wants to study the Balance Sheet of
Amul Industries. He wants your guidance in finding the various elements of the Balance
Sheet of Amul Industries. Kindly discuss the same

Solution:

Introduction:

The Balance sheet is a part of company financial statements. It gives details about the company’s
assets and liabilities. It helps the stakeholders and management to understand the net worth of the
company. It is a part of a company’s financial reporting statements and is an important aspect to
analyze while making strategic business decisions.

Concept:

The Balance sheet is divided broadly into two parts. i.e., Assets and Liabilities. Liabilities are
further divided into Owners Equity and Other Liabilities.

Let us discuss the components of the Balance sheet in detail.

(I) Assets
Assets are those that provide future economic benefits to the company. To qualify as an asset, it
has to satisfy all the below-mentioned conditions:

● The company must own them

● They must be as a result of the past event of the company
● They must be expected to generate future economic benefits to the company.
For an asset to classify as a current asset, it has to satisfy any of the criteria mentioned below:

● It should be held for the trading and operations of the company

 ● It should realize its value within twelve months from the company’s reporting date.
● It is owned and expected to be sold or consumed in the company’s standard operating
cycle.

(i) Fixed Assets

Fixed assets are those purchased by the company for its long-term use and can be depreciated over
their period of life. Land, Building, Machinery, Equipment, etc. are examples of Fixed Assets.

(ii) Non-Current Investments

Investments held for more than one year classify as non-current investments. These are created to
earn profits and receive dividends in the future. Investments in mutual funds, shares of other
companies with a holding period of more than one year are examples of non-current investments.

(iii) Long term loans and advances

Long term loans and advances are those advances that are recoverable in cash or kind but are not
expected to be recovered within 12 months from the reporting date or in the company’s standard
operating cycle. These also include capital advances given and security deposits are given.

(iv) Other non–current assets

Those assets that are not covered by any of the above specific head and are not current assets are
covered here.

(v) Current Investments

Investments held for trading are covered under this head in the balance sheet.

(vi) Inventories
Inventories are the stock of goods that a company deals in. They are valued at cost or market value,
whichever is lower. They are generally classified as a current asset of the company.

(vii) Trade receivables

They are the debtors of the company. They arise on account of goods sold to them but not collected
from them against the goods sold.

(viii) Cash and Cash equivalents

It represents the cash in hand and at the bank of the company. It also means the amount kept in
fixed deposit and available for immediate use by the company.

(ix) Short Term Loans and advances

Those advances that are recoverable in cash or kind and are expected to be recovered or realized
within 12 months from the reporting date or normal operating cycle are covered here.

(x) Other current assets

It is a residual head and includes items like prepaid expenditure, miscellaneous expenditure, etc.

(II) Liabilities
Liabilities are the obligations of the company. They can be towards the shareholders or outsiders.

For liability to be classified as a non – current liability, it has to satisfy any of the criteria
mentioned below:

● It should be held primarily for the trading and operations of the company.
● It is expected to be settled within twelve months from the company’s reporting date.
● It is expected to be paid in the company’s standard operating cycle.
Liabilities that do not fall in any of the criteria mentioned above are classified as non- current
liabilities.

(i) Share Capital

This represents the owners’ funds in the company. It includes Equity Share Capital and Preference
Share Capital of the company.

(ii) Reserves and Surplus

It represents the amount available for appropriation to the shareholders. They include profit arising
out of business operations, securities premiums, capital reserves, etc.

(iii) Long term borrowings

These include secured and unsecured borrowings for which repayment is to be done after 12
months from the reporting date. They are expected to be settled after the company’s standard
operating cycle.

(iv) Other long-term liabilities

Those liabilities which are not covered under long-term borrowings but are long term in nature are
classified under this head. These include the amount payable in respect of lease rentals, the amount
owed to employees in the form of pension, etc.

(v) Long Term Provisions

Provisions are those monies that are set aside to meet future expenses. Long term provisions imply
that the expenditure will be incurred after 12 months from the reporting period. Some examples are
provision for gratuity and leave encashment, provision for interest payable on borrowings after 12
months.

(vi) Short Term Borrowings

These include secured and unsecured borrowings for which repayment is to be done within 12
months from the reporting date. They are expected to be settled in the company’s standard
operating cycle.

(vii) Trade Payables

They are the payables of the company. These are the amount payable against the goods and
services purchased to resell.

(viii) Other Current liabilities

It is a residual head where those liabilities which are not covered under any other head are covered
here. Statutory dues and penalities, interest payable within the next 12 months, etc. are covered
here.

(ix) Short Term Provisions

Provisions created for meeting expenditure to be incurred in the next 12 months are reported here.
Employee benefits expected to be settled in the next 12 months are reported here.

Conclusion:

Mr. Kohli can understand these terminologies and decide upon his decision to invest in Amul
Industries. He can also perform specific ratio analysis based on these elements.

3. Discuss for question (a) and (b)

Define and identify the type of Income / Expenses

Treatment of the Income / Expenses in the Profit and Loss account, Impact of the Income /
Expenses in the Balance Sheet

a. You purchased 10 shares of L& T Company last year. On 5th March 2019, the company
has declared a dividend Rs 50 per share. The income is earned but not yet collected in your
account during this financial year. (5 Marks)

Solution:

Introduction

Income is generally the amount received against the rendering of services and selling of goods.
Companies usually name it as revenue from operations. The profit and loss statement shows the
income earned by the company in a particular year. Gains are recorded on the credit side of the
profit and loss statement.

Concept:

In India, the accrual system of accounting is followed mostly. As a result of this, basic accounting
conventions need to be tracked in the accounting system. These accounting conventions are
conservatism, materiality, consistency, and full disclosure.

Incomes are usually the amounts that are collected against the sale of goods and services. However,
specific payments may not be collected but are a part of income. They are known as income
accrued but not due or income accrued but not received. These amounts are still considered one's
income and are reported and recorded on the profit and loss account statement's credit side.
Examples of Income accrued but not due include those amounts that one has earned but not yet
entitled to receive. A classic example to understand this concept is of Fixed Deposit Interest
amount receivable on maturity. The interest on fixed deposit accrues every year, but the claim is
received only on maturity. Since the accrual accounting system is followed, one must record the
interest accrued on fixed deposits every year in accounts.

Accounting treatment of income accrued but not received.

Since it is an income, it must be recorded on the profit and loss account's credit side. And its
second impact must be recorded on the balance sheet's asset side under other current assets or non-
current assets as the case may be.

The accounting entry for the same will be as follows:

Accrued Income on Fixed Deposit A/c Dr. xxx

To Income A/c xxx

In the given question, L&T has declared a dividend. That means that the income has been earned,
but it is not yet received in the bank account. On the base of the accrual accounting system, one
must record the income earned in the form of a dividend in the profit and loss account. The second
effect must be recorded in the balance sheet asset side.

The amount that must be recorded as income accrued but not received will be Rs.500/-.

Entry for the same will be as under:

Dividend receivable A/c Dr. 500

To Dividend A/c 500

(Being dividend receivable on L&T Shares)

Conclusion:

Incomes, whether received or not, must be recorded in the financial year they are earned. Hence,
we must account for the dividend receivable of L&T in our books of accounts.

b. On 5th March 2019, Mehta Brothers received 100% advance for goods, to be supplied in
the next month. The Cost of the goods was Rs50000. They usually sells the goods at 10%
mark up. (5 Marks)

Introduction

The accounting system's accrual method advocates that the incomes and expenses must be recorded
in the accounting system when accrued and earned. That means the payment, even if not received
in cash, must be accounted for. The expense must be recorded when due irrespective of the amount
spent.

Concept:
Advances collected against the rendering of services or sale of goods must be accounted for. The
same must be reflected in the balance sheet's liability side under the head of other current liabilities
as advances against service rendered. The second impact of the same is in the bank account on the
balance sheet's asset side as the same is collected. Therefore, the entry on the collection of the
advance will be as under:

Bank A/c Dr. xxx

To Trade Advances Received A/c xxx

In the given question, Mehta Brothers have received an advance of 100% for goods to be supplied
in the next month. The accounting entry on 05th March 2019, for the same, will be as under:

Bank A/c Dr. 55000/-

To Trade advance received a/c 55000/-

(Being trade advance received against the goods to be supplied in the next month)

The Selling Price of Rs.55000/- is calculated as Cost + Markup

= 50000 + 5000 (10% * 50000)

= 55000/-

Revenue of Rs.55000/- and cost of goods of Rs.50000/- must be accounted for in the next month
i.e., April 2019. It is so because the sale has not taken place. Revenue must be recognized only
when the transfer of title and ownership occurs according to the accounting standards.

Since revenue is not recognized, the corresponding expense of Rs.50000/- of the cost of goods sold
must also not be recognized in the current financial year according to the accounting conventions'
matching concept.

Hence, Mehta Brothers must only account for trade advance received in the FY 2018-2019. In the
financial year 2019-2020, they can account for the income of Rs.55000/- on the credit side of Profit
& Loss Account Statement and Expense of Rs.50000/- on the debit side of the Profit & Loss
Account Statement.

Conclusion:

It is essential to follow the accounting conventions and accounting standards by a person. Hence,
one must take the utmost care that the same are adhered to while preparing the company's financial
statements. One must follow these conventions and standards as they will provide an accurate and
fair view of the business's affairs and operations to the users of this accounting information.