Analysis of Financial

Statement Class 1
 Accounting
• Accounting is the systematic process of identifying,
measuring, recording, classifying summarizing, interpreting
and communicating financial information.
• Accounting is defined as the process of identifying,
measuring, recording and communicating the required
information relating to the economic events of an
organisation to the interested users of such information.
• A company must record in its accounting records
any economic event that impacts the company's
finances.
• An economic event is known as a happening of
consequence to a business organisation which
consists of transactions and which are measurable in
monetary terms.
• Identification : It means determining what
transactions to record, i.e., to identity events which
are to be recorded.
• Measurement : It means quantification of business
transactions into financial terms by using monetary unit.
• Recording : Once the economic events are identified and
measured in financial terms, these are recorded in books
of account in monetary terms and in a chronological order.
• Communication : The economic events are identified,
measured and recorded in order that the pertinent
information is generated and communicated in a certain
form to management and other internal and external
users.
Basic Accounting Concepts
• Business entity – This concept assumes that business has
distinct and separate entity from its owners. Thus, for the
purpose of accounting, business and its owners are to be
treated as two separate entities.
• Money measurement – The concept of money
measurement states that only those transactions and
happenings in an organisation, which can be expressed in
terms of money are to be recorded in the book of accounts.
Basic Accounting Concepts
• Going concern - The concept of going concern assumes that
a business firm would continue to carry out its operations
indefinitely (for a fairly long period of time) and would not
be liquidated in the near future.

• Accounting period – It refers to the span of time at the end

of which the financial statements of an enterprise are
prepared to know whether it has earned profits or incurred
losses
 Accounting Principles

Cost Principle Matching

The cost concept requires that The concept requires that expenses
all assets are recorded in the incurred in an accounting period should
book of accounts at their cost be matched with revenues during that
price. period.

Full Disclosure Revenue recognition

This concept requires that all material
and relevant facts concerning financial
performance of an enterprise must be
fully & completely disclosed in the
financial statements.
The concept of revenue recognition
requires that the revenue for a
business transaction should be
considered realised when a legal
right to receive it arises.
 Basic Accounting Concepts
• Cost - The cost concept requires that all assets are
recorded in the book of accounts at their cost price, which
includes cost of acquisition, transportation, installation and
making the asset ready for the use.
• Full disclosure - This concept requires that all material and
relevant facts concerning financial performance of an
enterprise must be fully and completely disclosed in the
financial statements.
 Basic Accounting Concepts
• Revenue recognition - The concept of revenue recognition
requires that the revenue for a business transaction should be
considered realised when a legal right to receive it arises.

• Matching –The concept of matching emphasises that

expenses incurred in an accounting period should be matched
with revenues during that period.
Basic Accounting Concepts
• Consistency - This concepts states that accounting
policies and practices followed by enterprises should
be uniform and consistent one the period of time.

• Conservatism (Prudence) - This concept requires that

business transactions should be recorded in such a
manner that profits are not overstated.
 Basic Accounting Concepts
• Materiality - This concept states that accounting should
focus on material facts. If the item is likely to influence
the decision of a reasonably prudent investor or creditor,
it should be regarded as material, and shown in the
financial statements.
• Objectivity - According to this concept, accounting
transactions should be recorded in the manner so that it
is free from the bias of accountants and others.
 Basic Accounting Concepts

Dual aspect - This concept states that every

transaction has a dual or two-fold effect on
various accounts and should therefore be
recorded at two places. Assets = Liabilities +
Capital.
 Qualitative Characteristics of
Accounting Information
• Reliability - Reliability means the users must be able to depend on
the information. The reliability of accounting information is
determined by the degree of correspondence between what the
information conveys about the transactions or events that have
occurred, measured and displayed.
• Relevance - To be relevant, information must be available in time,
must help in prediction and feedback, and must influence the
decisions of users by helping them form prediction about the
outcomes of past, present or future events.
 Qualitative Characteristics of
Accounting Information
• Understandability - Understandability means decision-makers must
interpret accounting information in the same sense as it is prepared and
conveyed to them.
• Comparability – It is important that the users of the financial reports are
able to compare various aspects of an entity over different time period
and with other entities. To be comparable, accounting reports must
belong to a common period and use common unit of measurement and
format of reporting.
Accounting Equation
 Basis of Accounting

a) Cash Basis

b) Accrual / Mercantile Basis

Cash Basis:- Under this basis, actual cash receipts & actual cash
payments are recorded. Credit transactions are not recorded
until the cash is actually received or paid.

Example :- Revenue will be recognized when it is received.

Mercantile or Accrual Basis:-

In the accrual basis of accounting, the income, whether

received or not, but has been earned or accrued during the
period forms part of the total income of that period.

• Credit Sale will be recognized as sale irrespective of the fact whether

amount has been received or not.
• Rent for the month of March will be recorded irrespective of the fact
when it is paid.
 Capital Drawings
• It means the amount which the
It is the amount of money or the
proprietor has invested in the firm
value of goods which the
or can claim from the firm.
proprietor takes for his domestic
• For the firm Capital is a liability
or personal use.
towards the owner.
• It is so because the owner is
treated to be separate from the
business.
 Liabilities:-
If an amount is due to be paid to any other person or institution other
than the owner it is called as a liability. Liabilities can be classified into
following:
i) Long-term liabilities: These are those liabilities which are payable after
a long term, (generally more than one year).
Example; Long-term loans, debentures etc.
ii) Current liabilities: These are those liabilities which are payable in near
future (generally within one year).
Example; creditors, bank overdrafts, bills payable, short-term loans, etc.
 Assets:-
Any physical thing or right owned that has a money value is an asset. In
other words, an asset is that expenditure which results in acquiring
of some property or benefit of a lasting nature. Assets can be
classified as:
i) Fixed Assets: Fixed assets are those assets which are purchased for
the purpose of operating the business and not for resale. E.g. land,
building, machinery, furniture, etc.
ii) Current Asset: Current assets are those assets of the business which
are kept for short term for converting into cash. E.g. debtors, bills
receivables, bank balance, etc.
 Fixed Assets:-
i) Tangible Assets: Assets which have physical existence
are called Tangible Assets i.e. can be seen and
touched. Land, Building, Furniture etc.
ii) Intangible Asset: Assets which do not have physical
existence are called Intangible Assets i.e. cannot
be seen and touched. Computer Software,
Goodwill, Trademarks, Patents etc. .
 Debtors:- Receivables:-
• A person who owes money to the
The term receivables is used for the
firm, generally on account of credit
amount that is receivable by the
sale of goods is called a debtor.
firm, other than the amount due
• For e.g. When goods are sold to a
from the debtors.
person on credit that person pays
It is also called as Bills Receivable.
the price in future.
• He is called a debtor because he
owes the amount to the firm.
 Creditors:- Payables

A person to whom the firm owes money The term payables is used for the

is called a creditor. For e.g. Mr. M is amount payable by the firm, other
creditor of the firm when goods are than the amount due to creditors.
purchased on credit from him. It is also called as Bills Payable.
 Revenue:-
It means the amount which is received or is
receivable in the normal course of the business.
Example –
• Sales of goods or
• Rendering of services
 Expense:-
It is the amount spent in order to produce and
sell the goods and services which produce the
revenue. “Expenses is the cost of the use of
things or services for the purpose of generating
revenue”.
E.g. payment of salary, wages, rent, etc.
• Prepaid Expenses
• Outstanding Expenses
 Income:-

It is the profit earned during a period of time.

In other words, the difference between
revenue and expense is called income.
It is broader term than Profit.
 Profit
Profit means income earned by the business from its
operating activity or business activity.

• Gross Profit:- Gross profit is the difference between sales

revenue or the proceeds of goods sold and services rendered
over its direct cost.
• Net Profit:- Net Profit is the profit made after allowing for all
expenses. In case, expenses are more than revenue, it is Net
Loss.
 Transactions

Cash Transaction:- Transactions involving

immediate receipt or payment of cash.

Credit Transaction:- Transactions in which the

receipt/payment of cash is postponed to a
future date is called as a credit transaction.
 Purchases
The term purchases is used to record
purchase of Goods or Raw materials
for resale or for producing products
which are to be sold. It includes Cash
and Credit Purchases.
Purchases Return
• Goods purchased may be returned
to the seller for any reason like
defective etc. it is called Purchase
Return.
• It is also called as return Outward.
 Sales
The term sales is associated with or
used for sale of goods. It includes both
Cash Sales and Credit Sales.
Sales Return
• The goods that we have sold are
when returned by the buyer is
termed as sales return.
• It is also called as Return Inward.
 Inventory:-
Stock or Inventory is a tangible asset held by an enterprise
for the purpose of sale in the ordinary course of business as
on the end of Accounting Year. They are of two types:-
1. Opening Stock – It is the inventory in the beginning of
the accounting year.
2. Closing Stock - It is the inventory at the end of the
accounting year.
 Voucher:-

Any written document in support of a

business transaction is called a voucher. It is
an objective evidence in support of a
transaction.
 Discount:-
When customers are allowed any type of reduction
in the prices of goods by the businessman, that is
called discount. It is of two types:-
1. Trade Discount – offered at the time of purchase
of goods due to quantity or value.
2. Cash Discount – allowed for timely payment of
due amount.
 The Double-Entry System
The double-entry book-keeping system is based on the
principle that for every business transaction that takes
place two entries must be made in the accounts: a
debit entry, showing goods or value coming into the
business, & a corresponding credit entry, showing
goods or value going out of the business.
Modern Approach
 Debit
1. Increase in asset accounts
2. Increase in expense accounts
3. Decrease in liability accounts
4. Decrease in equity accounts
5. Decrease in revenue accounts

Credit
1. Decrease in asset accounts
2. Decrease in expense accounts
3. Increase in liability accounts
4. Increase in equity accounts
5. Increase in revenue accounts
Accounting Cycle
The accounting process starts with:-
1. Recording the economic event in a business
2. Once the entry is Journalized in Journal Entry then it is posted to a individual account
which is referred as to Ledger.
3. With the help of ledger final balances are calculated.
4. These balances are then forwarded to Trial Balance to identify any error done in the
previous steps.
5. Once the trial balance is equated then the balances are moved to either Trading &
P/L or Balance Sheet which is even called as Financial Statements.
 Financial Statements
The financial statements generally include two
statements:
• Balance sheet
• Statement of profit and loss
They are required for external reporting and also
for internal needs of the management like
planning, decision-making and control.
Balance sheet of a company is prepared
and presented in the form prescribed in
(Revised) Schedule VI of the Companies
Act, 2013. The form prescribed is vertical
It does not apply to (i) Insurance or
Banking Company, (ii) Company for
which a form of balance sheet or
income statement is specified under
any other Act.
 Trading and Profit and Loss account
• Trading and Profit and Loss account is prepared to determine the profit
earned or loss sustained by the business enterprise during the accounting
period.
• It is basically a summary of revenues and expenses of the business and
calculates the net figure termed as profit or loss. Profit is revenue less
expenses.
• If expenses are more than revenues, the figure is termed as loss. Trading and
Profit and Loss account summarises the performance for an accounting
period.
• It is achieved by transferring the balances of revenues and expenses to the
trading and profit and loss account from the trial balance.
• Trading and Profit and Loss account is also an account with Debit and
Credit sides.
• It can be observed that debit balances (representing expenses) and losses
are transferred to the debit side of the Trading and a Profit and Loss
account and credit balance (representing revenues/gains) are transferred
to its credit side.
Balance Sheet
• A Balance sheet is a precise representation of the assets,
equity and liabilities of the entity.
• Balance Sheet is a statement
• Accounts added in balance sheet maintain their identity and
are carried forward for the next accounting period.
• It represents the financial state of the business concern at a
particular date.
• It is now prepared in Vertical format.
Vertical format of balance
sheet followed now.
Which of the following is included in the final accounts of a
business entity?
(i) Balance Sheet
(ii) Manufacturing ad trading Accounts
(iii) Profit and Loss Accounts
(iv) Fund flow and cash flow
1. All of the above
2. (i) Only
3. (i) to (iii) only
4. None of these
 Financial Statements:-
• Position Statement - showing the financial position of an
enterprise as on a particular date.
• Income Statement - showing the result of the operational
activities of an enterprise over a particular period.
• Cash flow statement - shows inflows and outflows of the cash and
cash equivalents.
Companies Act, 2013

Financial Statements are defined in Companies

Act, 2013 (Section 2 (40)] and includes Cash Flow
Statement prepared in accordance with
Accounting Standard- 3 (AS-3)- Cash Flow
Statement.
Cash Flow Statement
• A cash flow statement provides information about the historical changes in
cash and cash equivalents of an enterprise by classifying cash flows into
operating, investing and financing activities.
• ‘Cash’ comprises cash in hand and demand deposits with banks, and ‘Cash
equivalents’ means short-term highly liquid investments that are readily
convertible into known amounts of cash and which are subject to an
insignificant risk of changes in value.
• An investment normally qualifies as cash equivalents only when it has a short
maturity.
Activities under Cash Flow Statement
Cash from Operating Activities
• Operating activities are the activities that constitute the
primary or main activities of an enterprise.
• These are the principal revenue generating activities or the
main activities of the enterprise.
Cash from investing Activities
• Investing activities are the acquisition and disposal of long-
term assets and other investments not included in cash
equivalents.
• Transactions related to long-term investment are also investing
activities.
Cash from Financing Activities
• Financing activities relate to long-term funds or capital of an
enterprise.
• Financing activities are activities that result in changes in the
size and composition of the owners’ capital (including
preference share capital in case of a company) and borrowings
of the enterprise
FORMAT OF CASH FLOW STATEMENT