Financial Accounting and Analysis

September 2021 Examination

1. This pandemic situations has drawn the attention of a lot of individuals to actively watch
and participant in the Indian financial market. As a life-long learner, you also decide to
understand the fundamentals of certain companies listed on the stock exchanges in India.
One of your friends advised you to look in to the various techniques of financial analysis, as
one of the way of evaluating the financials of business entities. You are done with getting an
understanding about various techniques of financial analysis. Elaborate any five of the said
techniques for financial analysis. (10 Marks)

Ans 1.

Introduction:

When determining a company's financial health to determine its stock market valuation, analysts
employ various methodologies. One of these is the examination of financial statements. The
economic numbers presented in the report are at the heart of the information and help investors
to forecast long-term business success. The financial statement review is a decision-making
process that involves examining the financial status and making financial decisions. Moreover, it
enables external stakeholders to evaluate the financial performance and value for money of the
organization. The balance sheet, income statement, and cash flow statement are all three critical
financial statements that must be included in every financial statement. Analysts employ various
ways to gain a practical understanding of a company's financial performance over an extended
period. Horizontal analysis, vertical analysis, ratio, and trend analysis are the three primary
economic analytical approaches employed in the financial industry.

Concept and Application:

Contents of financial statement:

A company's valuation about its book value is shown on a report card issued after a given year. It
comprises three essential components: assets, liabilities (debt), and the equity of the company's
shareholders. The quickest and most straightforward strategy to increase book value or stock of
shareholders is to eliminate debt from assets. The book value is a critical performance indicator
since it indicates whether its finance operations are increasing or decreasing.

Cash Flow Statement: The Cash Flow Statement is a financial statement that shows how much
the company circulates cash or cash equivalents. This card demonstrates an organization's ability
to manage its cash position. To evaluate a company's financial health, the cash flow statement is
a crucial document.

Revenue Statement: In the Revenue Statement, the company's net income is described in great
detail. This statement, also known as a profit and loss statement, provides the foundation for
determining whether or not an organization is profitable.

The following are the five methodologies that were employed in the financial analysis:

1. Horizontal Analysis: The performance of two or more periods contrasts with the firm's
progression overtime in the first step of the horizontal analysis. Every component of a ledger is
compared to the previous period to understand the trends. For example, if the cost of finished
commodities grows by 20% each year without being reflected in the revenue, some components
may end up costing the business more money.

2. Vertical Analysis: Vertical analysis aids in creating a link in a ledger between the various line
items. It provides analysts with Insights into the actual income and spending performance are
provided to analysts through this report. The findings are compared to one another in a ratio. The
total assets or liabilities and total sales are taken into consideration, and a percentage is used to
compare the balance sheets to the total assets, liabilities, or sales in each category. As a result,
the connection between each portion and the whole is demonstrated in a single-size declaration.
It is generated for the profit and loss accounts the Common Size Revenue Statement and the
Common Size Balance Sheet in Common Size.

3. Ratio Analysis: Ratio analysis ratio methods compare one financial component to another and
reveal a general upward or downward trend in the market. Once the ratio has been computed, it
may be used to identify whether or not the firm's performance meets or exceeds expectations. It
may then be compared to the previous period to be studied—management assists in identifying
and correcting departures from particular expectations and implementing corrective measures.

4. Trend Investigation: It is used to aid in analyzing patterns over three or more years. It
considers progressive ways of development, with the earliest year considered to be a significant
era. A change in the financial statements will reveal either positive or negative tendencies in the
economy.

5. Average Analysis: The trend ratios of a business corporation are determined and compared to
the average percentages of the industry. These two patterns are likewise depicted on graph paper
in the shape of curvy lines. The use of images to show data helps to improve the quality of the
analysis and comparison.

6. Fund Flow Analysis: The fund flow analysis examines the sources of the enterprise's money
and the implementation over a specified period. During the review phase, it demonstrates where
and how money is spent. It draws attention to the fact that the company's financial structure has
changed.

7. Cash Flow Analysis: Cash and bank balance changes are used to determine the cash flow for
a particular period. In other words, cash movements would be considered during the cash flow
analysis rather than work capital transfers. There are two different types of cash flows available.
There are two types of cash flows: actual cash flows and nominal cash flows.

8. Cost Volume Profit Analysis: The research indicates the most crucial link between sales,
costs, and profits. The prices are divided into two categories. The costs are fixed, and the fees are
variable. The relationship between sales and variable costs is always present. Profit planning can
be improved by cost analysis, which is performed by management.

Conclusion:

In this way, we can infer that financial statement analysis is a decision-making process carried
out to analyze the financial position. Moreover, it enables external stakeholders to evaluate the
financial performance and value for money of the organization. It is used by third parties to
analyze the general health of a company and its financial performance and commercial worth. It
is used internally as a financial management monitoring tool by many components of the
organization.

2. Mahesh wants to start his business and for that he decides that he will take loan for
Rupees 7 Lakhs from the Bank of Baroda. He also decides to use his saving worth 3 lakhs
in the bank account to start the business. Discuss how these two transactions will be
recorded in the books of accounts by passing the relevant journal entries? How these
transactions will be reflected in the Books of accounts (that' is in the financial statements)?
Lastly, conclude your answer by stating the applicability of which accounting
assumption/s you did the above mentioned accounting treatment/ recognition and
presentation in the books of accounts. (10 Marks)

Ans 2.

Introduction:

Books or account books include ledgers, daybooks, cash books, account books, and other books,
regardless of whether they are preserved in writing or printed from data stored on a floppy disc,
tape, or other electric data storage devices. Ledgers, daybooks, cash books, account books, and
other books are examples of books or account books. The journal is the first stage of the
accounting cycle, and it is responsible for examining and recording all accounting transactions as
journal entries in the ledger. The Ledger is an extension of the Journal to the company's general
leader account, which includes journal entries based on which the company's financial statements
are generated. The Ledger is also known as the available ledger account. Both of these principles
are pretty significant when it comes to the preparation of financial statements. Journal is the first
transaction to be performed. The accountant enters the transaction in the account books using the
dual-entry approach for the first time, debiting and crediting the correct accounts and debiting
and crediting the proper arrangements. The ledger is formatted in the "T" format, and the Journal
is then placed in the correct sequence according to the design. We can determine that the ledger
is a newspaper extension because of the font style. However, it is also necessary to construct a
test balance, income statement, and balance sheet by only looking at the booklet.
Concept and Application:

When faced with the situation presented, Mahesh decides to borrow Rs. 7 lakhs from the Bank of
Baroda to establish his business. Banks and non-bank financial companies (NBFCs) contribute to
the economy by providing additional monetary leverage in loans to businesses in need of help. A
loan of this nature is recorded as a liability in the company's financial statements. Bank loans
may be paid back in the short or long term, depending on the terms and circumstances
established by the financial institution that provided the loan. The loan must be repaid according
to the schedule that has been agreed upon. Unlike the short-term loan, which has a primary duty,
the long-term loan has a task that will last for an extended period.

The journal entry would be:

Cash Account ---------- Dr 7, 00,000

To Bank of Baroda Account 7, 00,000

(Being loan taken from Bank of Baroda for starting the business.)

Mahesh also decides to invest Rs. 3, 00,000 of his resources into the company as working
capital. The following would be the journal entry for the introduction of money into the business:

Cash Account ---------- Dr 3, 00,000

To Capital Account. 3, 00,000

(Being Capital worth Rs. 3, 00,000 introduced by the owner into the business)

As a liability in the books of accounts, the loan from the Bank of Baroda will be recorded on the
liability side of the balance sheet, and it will be represented on the assets side of the balance
sheet as well. The short-term loans are to be recorded in the balance sheet under the current
obligation section of the account. The loan accepted will raise the cash account on the balance
sheet's asset side, bringing the balance sheet into better balance. Cash must be recorded as a
current asset on the asset side of the balance sheet and not as a fixed asset. Only the interest
portion of a loan payment is considered an expense, not the total loan amount. The principal paid
by a company is a reduction in the amount of "loans paid" by the company, and it is recorded as
a cash outflow on the Cash Flow Statement by the administration.

In the firm's eyes, Mahesh's capital contribution will be viewed as a liability, and it will be
recorded under the heading "Owner's Capital" on the liability side of the balance sheet. This
entry is to be created by the accounting concept known as the "Business Entity Concept." This
concept suggests that transactions about a firm must be documented separately from those about
its owners or other businesses. This entails maintaining separate accounting records that are
entirely divorced from the assets and liabilities of any other firm or proprietorship. Without this
concept, the data from multiple companies would be muddled together, and the outcomes from a
single firm would be difficult to distinguish. The idea of a business entity serves various
functions, among which are Each corporation is subject to its taxation. It is necessary to calculate
the financial performance and financial status of a corporation. When a company is liquidated, it
is required to calculate the number of payments made to the various owners. In the event of a
judicial judgment against a business entity, evaluating the available assets from a liability
standpoint is necessary. If the records of a company have been amalgamated with other firms and
individuals' data, the firm's diaries cannot be checked.

Conclusion:

As a result, we can assume that loan accounts are responsible. At any point in the company's
existence, the company can owe money to the bank or another company. The "Loan's
receivables" section shows you the exact amount of money that your debtors owe you on their
loans. Consider the following scenario: you are the company that lends the money. This does not
indicate the payment of money but rather the identification of the amounts to be paid. A capital
accounts debit shows that a firm owes less cash to its shareholders (i.e., its capital has
decreased). When a capital account is credited, it shows that a firm owes more to its shareholders
(increasing the business's capital).

3. Take Britannia Industries Ltd as a case. In the context of its financial statements and
annual report answer the following
a. It's a largely acceptable practice among the corporate entities to pay dividend to its
shareholders. Take Britannia Industries Ltd as a case. Discuss and differentiate the types
of dividend the company paid for the financial year 2020-2021. Also, mention your
understanding about what could be the accounting treatment of dividend in the books of
Britannia Industries Ltd. (5 Marks)

Ans 3a.

Introduction:

A dividend can be thought of as a reward given to shareholders by publicly traded companies,

with the money coming from the company's net profit as the source. These incentives might be in
the form of cash, cash equivalents, stock options, or other forms of compensation, and they are
often paid out of the remaining profits after all high costs have been met. The dividend rate is
determined by the board of directors of a company, including approval by the majority of its
shareholders, and is published annually.

Concept and Application:

Types of Dividends:

1. Special dividends: The common stock is used to pay for the payout in question. It is often
supplied in a specific context when a company has generated considerable profits over several
years. According to the law, most of those earnings are regarded as surplus cash, and they should
not be spent at that time or in the foreseeable future.

2. Preferred Dividends: A preferred dividend is a dividend paid to preferred shareholders and is

usually in the form of a preset quarterly payment. This form of compensation is also paid out on
shares that are more closely related to bonds.

3. Cash Dividends: The vast majority of firms elect to distribute their dividends in cash to their
shareholders. Typically, such revenue is sent electronically or extended through the use of a
check.

4. Interim Dividends: An interim dividend is a payout to shareholders that have been declared
and paid out before the company's full-year results have been determined. Dividends on ordinary
stock are typically paid out quarterly or semi-annually to shareholders of a corporation's common
shares.

Dividends are treated as follows:

The declaration date, that is, the day on which the board of directors of your company officially
approves the payment of dividends, is the starting point for recording your rewards in the first
step of the process. According to GAAP, once a firm has declared a bonus, it is recognized as a
liability for the company and must be recorded on the liability side of the balance sheet until the
dividend is paid to the shareholders is received. The company must debit the retained income
account, which contains gains that the corporation has not distributed over a long period. The
amount debited from the report is reduced by the amount paid in other forms of payment, which
is referred to as retained profit.

Conclusion:

As a result, we may conclude that the due dividends account reflects the amount of money owed
to shareholders by your company. This is the individual's obligation. It is typically grouped with
the existing commitments in the larger organizational hierarchy. On the day of declaration, credit
the payable dividend account with the amount due.

b. Discuss and share your understanding on any three profitability ratios which you feel
relevant to assess the profitability of the company. (5 Marks)

Ans 3b.

Introduction:

Profitability ratios are indicators of a company's financial health that can be used to make
decisions about its future. This is done by calculating the performance of a given variable, such
as the company's income, over a specified period. The data demonstrate how effective a
company is in creating profits from its assets, giving value to its shareholders, and making cash
to pay down its debts.
Concept and Application:

The following are three profitability ratios that are important in determining the profitability of a
business:

1. Net Profit Margin: Net profit margin equals net profit divided by revenue multiplied by 100.
The net income or profit measures the proportion of payment generated in net profit or just net
margin, depending on the definition. It is the relationship between net profits and revenues for a
company or business sector. Ordinarily, the net profit margin is reported as a percentage,
although it can also be expressed as a decimal number. The profit margin measures how much of
each dollar of revenue a company generates is converted into profit. The net profit margin of a
firm is one of the most important indicators of its financial health. A company can determine if
its existing processes effectively predict revenue-based profits by tracking increases and
decreases in its net profit margin. Because net profit is expressed as a percentage rather than as a
monetary number, it is possible to compare the profitability of two or more businesses,
regardless of their size.

2. Cash Flow Margin: The cash flow margin indicates the relationship between cash flows from
operations and cash flows from company sales. It measures the ability of a corporation to convert
revenues into cash consistently. As the share of cash flow increases, more money is available for
the sale, payment, and purchase of goods and services and the acquisition of capital assets for
providers, dividends, utilities, and the servicing of outstanding debt. On the other hand, negative
cash flow indicates that the organization may still lose money even if it makes sales or revenues.
It may be necessary for the company to borrow funds or seek money from investors to continue
operations if cash flow are inadequate.

3. Return on Equity (ROE): The rate of return on the amount of money invested by equity
investors, also known as the rate of return on equity, refers to the proportion of net income that is
distributed to shareholders in the form of equity. The return on equity (ROE) ratio is one that
stock analysts and investors pay close attention to. A favorable and high return on equity (ROE)
ratio is frequently cited as a motivator for purchasing goods from a company. Companies that
achieve a high return on equity produce cash internally and are therefore less reliant on debt
financing to fund their operations.
Conclusion:

As a result, we may infer that the three profitability measures listed above are the most important
to consider when evaluating a company's profitability.