Corporate Financial Reporting & Analysis

Session 1: MBA 2020

Introduction and Accounting Equation

Prof. Arpita Ghosh

Indian Institute of Management Calcutta
 Introduction to the Course
• Introduction and Accounting Equation: Users and Principal Uses,
Classification of Business Transactions, Qualitative characteristics, Basic
concepts and assumptions and Accounting Equation Sessions
1 to 5
• Accounting Mechanics: Rules of Debits and Credits, Journalizing, Ledger
Posting, Adjustment & Closing Entries and Preparation of Trial balance

• Preparing and Understanding of Income Statement

Sessions 6 to 10
• Preparing and Understanding of Balance sheet
• Using some tools for Analyzing the Financial statements Sessions 11 to 13a
– Common-Size, Trend, Ratio analysis
• Preparing, Understanding and Analyzing Cash flow statements Sessions 13a to 16

Sessions
• Accounting for Property, Plant & Equipment (PPE), Inventory reporting
17 to 20
BOOKS
• Till FSA: “Financial Accounting – Tools for Business Decision Making “by Kimmel, Weygandt & Kieso, International
Student Version, Wiley Publications, Seventh Edition [KWK]
• From CFS: “Corporate Financial Reporting and Analysis”, Asish K. Bhattacharyya, PHI, Second Edition [AKB] 2
 The Do’s, the Don’ts, & the Grading
• The Do’s
– Go through the problems specified in the course outline and try to solve
them before you come to the class
– Prepare for the case before coming to the class based on case-questions (will
be provided to you)
– Form study-groups : For learning together and for Project submission
• By next weekend, send me the details of the groups in an excel sheet
(Name, Section, Reg number, email-id, group number)
– Student Tutors: Dhruv Gupta (C), Pulkit Sharma (E), Rachil Vijay Malwali (DA)
– TTA: Section C & E - Payel Chatterjee (payel_tta@iimcal.ac.in)
– Contact me when in doubt or have any query :
– Office Hours (by appointment) -Thurs 5 to 6 pm, Email: arpitag@iimcal.ac.in
• The Don’ts
– Don’t be late for the class, Don’t postpone your work
– Don’t violate academic integrity – Heavy Penalties
• Grading: 2 Graded Quizzes (30%), Project (30%), End Term (40%)
3
 Learning Goals - Session 1
• Why should you learn Financial Accounting ?
• What is Accounting ?
• Users and Principal uses of accounting information
• Classification of Business Transactions
• Basic Accounting Equation, Event Vs Transaction
– Effect of transactions on accounting equation
• Elements of Financial Statements : Assets, Liabilities, Owners’
Equity, Dividends, Retained Earnings, Revenues, Expenses
• Financial Statements and Interrelationships
• Richie Advisors Pvt Ltd Case Questions

4
 Why should you learn Financial Accounting ?
Accounting is the Language of Business
– Company uses the language to speak about its financial performance,
position and cash flows
– Analysts, investors and other users understand the language and rely
on the information to make their decisions

A manager needs to understand the business language so that

– He can understand information communicated
• Example: Sales Target
– He can use the language to communicate what he intends to do
• Example: Increase in ROI in southern markets
– He can understand the implications of his actions and the way his
actions are going to be evaluated
• Example: Performance bonus

5
 Language of Business
Hindalco Industries Limited (HIL) intends to sell nearly 65 percent of its aluminium output
in the international market in 2020-2021, as local demand is impacted by the COVID-19
pandemic. Exports will increase to about 65 percent of total output for 2020-2021 as
against 50 percent in 2019-2020, said Satish Pai, Managing Director, HIL. (BS, 20 Jun 2020;Pg 2.)

CRISIL revised rating outlook on long-term debt instruments of Hindalco Industries from
'positive', to 'stable' as it expects an increase in the company's financial leverage after
debt funded $2.8 billion acquisition of Aleris Corporation by its subsidiary Novelis. (BS, 25 Apr
2020;Pg 2)

CRISIL in its study of the top 800 companies (by revenue) from 30 sectors observed that
their revenue could dip by 15-17 percent and EBITDA by 25-30 percent in 2020-2021,
which is the steepest decline in a decade. (BS, 3 Aug 2020;Pg 4)
Media : Asian Paints Limited (APL) has been ranked third among the companies
operating in the fast-moving consumer goods (FMCG) sector in the sectoral ranking of
Fortune India 500 for 2019 (Fortune India, 14 Mar 2020;Pg 121).

Share price of Infosys dropped 16.65 percent at Rs640 on the National Stock Exchange on
22 Oct 2019 following the news of whistleblower complaint. The Whistleblower had
lodged a complaint with the United States Securities and Exchange Commission claiming
wrongdoing in accounting. (23 Oct 2019;Pg 1)

Lupin plunges 6% as June quarter profit tanks 60% YoY to Rs 107 crore (BS, Aug7, 2020)
 What is Accounting
An information system that measures, processes, and communicates financial
information about an economic entity to help users make decisions

Financial
Statements
• Balance
Users/
Business Sheet For
Data
Accounting Decision Makers
Activities: • Income
Statement Internal Users
(Transactions) Measure, Process,
& communicate • Cash Flow
Operating External Users
Statement
Investing
• Retained
Financing Earnings
Statement

Decisions/Actions
Accounting is a link between Business activities & Decision makers
7
 Business Activities
Financing Activities – Includes obtaining funds to begin operations and continue
operating
• Borrowings : Party to whom amounts are owed are Creditors /Lenders -
Amounts owed/ obligations of business are called Liabilities
• Issuing shares: Amounts paid by stockholders to buy shares gives rise to
Common Stock - Payments to stockholders are called Dividends

Investing Activities – Spending funds in productive ways : Purchase of resources a

company needs to operate
• Buying Land,Buildings, Equipment, Furniture etc. – Resources owned by a
business are called Assets

Operating Activities - Once a business has the assets it needs, it can begin its
operations. Includes
• Selling goods and services to customers - Amounts earned from sale of
products are called Revenues
• Employing & paying managers and workers, buying & producing goods and
services, paying taxes - These are Expenses 8
 Users: Who uses accounting information ?
Accounting is a link between Business activities & Decision makers

Decision Makers/ Users

INSIDERS OUTSIDERS

Management Those with Direct Financial Interest

• Human Resources
• Investors
• Marketing
• Creditors/Lenders
• Operations Those with Indirect Financial Interest
• Production • Tax Authorities
• Finance • Regulatory Agencies
• Labour Unions
• Customers
• Economic Planners
9
 Accounting is complex
An information system that measures, processes, and communicates financial
information about an economic entity to help users make decisions
Management
GAAP: Choice
Concepts, Financial
Standards Statements
• Balance Users/
Business Sheet For
Data
Accounting Decision Makers
Activities: • Income
(Transactions) Measure, Process, Statement Internal Users
Operating & communicate • Cash Flow External Users
Investing Statement
Financing •Statement of
Auditors, Board, Retained
Companies Law, Earnings
Market Regulator Analysts, CRA , Media

Decisions/Actions
Accounting is a link between Business activities & Decision makers
10
 Event Vs Transaction
What does accounting measure ? Business transactions

A Business Transaction: An economic event that affects the financial position

of a business
– It can be an exchange of value (like Purchase, Sale, Payment,
Collection, Loan)
– It can be an event that have the same effect as an exchange of value
(non-exchange transaction like Loss from fire, flood, theft, Physical
wear and tear on equipment, Accumulation of interest)

Every transaction affects the BASIC ACCOUNTING EQUATION

11
 Financial Position: Basic Accounting Equation
Economic Resources (OWNED) = Equities (OWED)

Economic Resources = Creditors’ Equities + Stockholders’ (or Owners’) Equity

Assets = Liabilities + Owners’ Equity

Assets = Liabilities + Common stock + Retained Earnings

12
 Whether Transaction ?
Are the following events recorded in the accounting records as transactions?

Event Criterion Record/

don’t Record
1 GM purchases an office building Is the Record
financial
2 GAP announces a new marketing strategy Don’t Record
position
3 Wipro receives a new contract (assets, Don’t Record
4 Customer buys a product liabilities, or Record
stockholders’
5 Infosys pays wages to its workers Record
equity) of the
6 Kundu travels discusses a guided trip with a company Don’t Record
potential customer changed?
7 Cost of Supplies used by ABC Ltd Record

• All transactions are events.

• But all economic events are not transactions.
• Only Transactions are recorded.
13
 Whether Transaction ?
Are the following events recorded in the accounting records as transactions?

Event Criterion Record/

don’t Record
1 GM purchases an office building Is the Record
financial
2 GAP announces a new marketing strategy Don’t Record
position
3 Wipro receives a new contract (assets, Don’t Record
4 Customer buys a product liabilities, or Record
stockholders’
5 Infosys pays wages to its workers Record
equity) of the
6 Kundu travels discusses a guided trip with a company Don’t Record
potential customer changed?
7 Cost of Supplies used by ABC Ltd Record

• All transactions are events.

• But all economic events are not transactions.
• Only Transactions are recorded.
14
 Financial Position: Basic Accounting Equation
Economic Resources (OWNED) = Equities (OWED)

Economic Resources = Creditors’ Equities + Stockholders’ (or Owners’) Equity

Assets = Liabilities + Owners’ Equity

If an asset increases, there must be a corresponding 

• decrease in other asset, increase in a liability, or increase in Owners’ Equity
• Every transaction has dual-effect (double-sided) on Basic Accounting Equation
i.e. it affects at least two items in the accounting equation
• The accounting equation must always balance : the two sides of the equation
must always be equal
• It is important to identify the specific effects of every transaction on the
accounting equation. The process is called Transaction Analysis.
– This is the first step of accounting cycle
15
 Exercise on THE ACCOUNTING EQUATION
Exercise 1
A = L + SE
$125,000 = $75,000 + SE
SE = $50,000
Exercise 2
The liabilities of AC Ltd equal one third of total assets, and stockholders’
equity is $90,000. What is the amount of liabilities ?
Assets = 1/3 Assets + $90,000
2/3 Assets = $90,000
Assets = $135,000
Liabilities = 1/3 × $135,000 = $45,000
Exercise 3
At the beginning of the year, LC’s assets were $6,20,000, and its stockholders’
equity was $300,000. During the year, assets increased $90,000 and liabilities
decreased $45,000. What is stockholders’ equity at the end of the year ?
Beginning: $620,000 = Liabilities + $300,000
Liabilities = $320,000
$620,000 = $320,000 + $300,000
Change: + 90,000 – 45,000
End: $710,000 = $275,000 + Stockholders' Equity
16
End: Stockholders' Equity = $435,000 16
 Accounting is complex
An information system that measures, processes, and communicates financial
information about an economic entity to help users make decisions
Management
GAAP: Choice
Concepts, Financial
Standards Statements
• Balance Users/
Business Sheet For
Data
Accounting Decision Makers
Activities: • Income
(Transactions) Measure, Process, Statement Internal Users
Operating & communicate • Cash Flow External Users
Investing Statement
Financing •Statement of
Auditors, Board, Retained
Companies Law, Earnings
Market Regulator Analysts, CRA , Media

Decisions/Actions
Accounting is a link between Business activities & Decision makers
17
Communicating with Users • Summarizes revenues
Income Statement earned & expenses
incurred over an
Weiss Consultancy, Inc. accounting period
Income Statement
For the Month Ended December 31, 2014 • Shows if the entity has
earned profits
Revenues Date reflects revenues
Commissions and expenses incurred $14,000 • Net income if
earned over a period of time Revenues > Expenses,
Expenses o.w. Net Loss
Equipment rental $2,800
• Flow Report
expense
Wages expense 1,600 • Use : Past net income
Utilities expense 1,200 provides information
Total expenses 5,600 for predicting future
Income before income $8,400 net income –
taxes
investors, lenders
Income taxes expense 1,200
Net income $7,200
Net income figure used to prepare
statement of retained earnings 18
Communicating with Users

Statement of Retained Earnings

Weiss Consultancy, Inc.
Shows
Statement of Retained Earnings changes in
For the Month Ended December 31, 2014 retained
earnings over
Retained earnings, December 1, 2014 $0 an accounting
Net income for the month 7,200 period
Subtotal $7,200
Less dividends 2,400
Retained earnings, December 31, 2014 $4,800

Net income figure comes

Ending balance of retained
from income statement
earnings is needed in
preparing the balance sheet

19
Communicating with Users
Date reflects
Balance Sheet account balances as
Weiss Consultancy, Inc. of a certain date
Balance Sheet
 Reports assets and 31-Dec-2014
claims to assets at a
specific point in time. Assets Liabilities
Cash $61,200 Accounts payable $2,400
 Status or stock
Accounts receivable 4,000
report Supplies 2,000 Stockholders’ Equity
 Use: Evaluate
Land 40,000
Building 100,000 Common stock $200,000
reliance on debt vs.
Retained earnings 4,800
equity in funding its
Total stockholders’ equity 204,800
assets, Cash

Total assets $207,200 Total liabilities and $207,200

stockholders’ equity

Ending balance of Retained Earnings comes

from statement of retained earnings

Assets = Liabilities + Stockholders’ Equity. 20

 Communicating with Users

Statement of Cash Flows

Weiss Consultancy, Inc. Begins with a net
 Where did cash Statement of Cash Flows income figure
come from For the Month Ended December 31, 2012
from income
during the statement
Cash flows from operating activities
period?
Net income $ 7,200
Adjustments to reconcile net income to net
 How was cash cash flows from operating activities
used during the Increase in accounts receivable ($4,000)
period? Increase in supplies (2.000)
Increase in accounts payable 2,400 (3,600)
 What was the Net cash flows from operating activities $ 3,600
Cash flows from investing activities
change in the
Purchase of land ($40,000)
cash balance Purchase of building (100,000)
during the Net cash flows from investing activities (140,000)
Cash Flows from financing activities
period?
Investments by stockholders $200,000
Dividends (2,400)
 Cash effect of
Net cash flows from financing activities 197,600
Operating, Net increase (decrease) in cash $61,200
Financing and Cash at beginning of month 0
Cash at end of month Cash at end of month should be $61,200
Investing
the same as Cash account
balance on balance sheet
21
 Inter-relationships

3.

1.

2.

22
Interrelationships

23
23
 Case Questions: Week 1 - On Richie Advisors Private Ltd.

 Identify the business transactions which took place during the month of February and
March 2020.
 Analyze each of the business transactions during the month of February and March
2020 to explain the impact of transactions on items of Basic Accounting Equation,
namely Assets, Liabilities and Shareholder’s Equity
 Name the accounts which might be involved and classify them as A, L or SE
 Show how each of the transactions affect the accounting equation
 Check whether Accounting Equation is in balance after every transaction and after all
the transactions at the end of each month.
 Compare the accounting equation at the beginning and at the end of the two months
period.
 Segregate the transactions involving Revenues and Expenses.
 Calculate: total revenues – total expenses.
 Prepare single-step Income Statements for the month ended 28th February 2020 and
31st March 2020.
 Prepare Statement of Retained Earnings for the month ended 31st March 2020.
 Prepare Balance Sheets at the end of February and March 2020.

11-08-2020 24
Thank You
Corporate Financial Reporting

Session 2: PGP 2020-21

Introduction and Accounting Equation
 Session- 2: Learning Goals
• Quick Revision: Numericals - Basic Accounting Equation & Expansion
– Formal Definition of Elements of FS: Assets, Liabilities, Income,
Expenses, Stockholders’ Equity
• Basic Accounting Principles, Assumptions and Concepts :
– Assumptions: Money Measurement (Monetary Unit), Separate Entity
(Economic Entity), Going Concern, Cash Versus Accrual Accounting,
Accounting Period (Periodicity), Materiality
– Principles: Historical Cost & Fair value measurement, Full Disclosure,
Conservatism
• Conceptual Framework
– Qualitative characteristics of Accounting Information
• Fundamental and Enhancing Qualities
– Constraints : Materiality, Cost-Benefit
– Ethics : Sarbanes-Oxley (SOX), Preventing Fraudulent Reporting and
Corporate governance
• Assignments
• Case : Richie Advisors Private Ltd.

2
 Elements of Financial Statements (BS)
ASSETS
A (present) economic resource controlled
by an entity as a result of past events and
from which future economic benefits are
expected to flow to the entity
1. Future Economic Benefit is probable to
flow in (direct/indirect cash inflow)
2. Control : Right to use the item to the
exclusion of others
3. Result of a past event
• Is Investment in shares of a company
which vanished after IPO an asset ?
• Is Salary paid to employees an asset ?
• Is intention to purchase an equipment an
asset ?
• Are patents owned by an entity an asset ?
Ex: Building, Plant and Machinery,
Inventories, Accounts receivables, Cash
LIABILITIES
Present obligation of the entity arising from past
events, the settlement of which is expected to
result in an outflow from the enterprise of
resources embodying economic benefits
1. Economic benefit is expected to flow out of the
entity to settle the liability
– Settlement can occur through payment of cash,
transfer of asset, replacement with other liability
2. Test: No realistic alternative but to settle the
obligation
3. Result of past obligating event
Can be
– Contractual (Borrowings, creditors),
– Arising from operation of law (tax payable,
penalty imposed)
Ex: Borrowings, Bonds/ Debentures, Advances
from customers, Accounts Payable, Wages
outstanding, Taxes payable 3
 Elements of Financial Statements (BS): Shareholders’ Equity

SHAREHOLDERS’ EQUITY :
The owner’s funds invested and earned in the business.
– EQUITY is the residual interest (or claims of the owners) in the assets of the entity after
deducting all its liabilities

Contributed Capital (Original + New)

+ Retained Earnings (Profits less Distributions to equity holders)

– Retained Earnings:
• Measure of undistributed profits of a business
• Retained Earnings balance =
(Cumulative sum of profits earned since inception)
– (Cumulative sum of dividend distributed since inception)
• Dividends: Distribution to the owners out of the profits earned by the business
• Revenues increase RE, Expenses and Dividends decrease RE.

• Increase in assets without any change in liabilities -> increases equity

• Decrease in assets without any change in liabilities -> decreases equity

4
 Revenues and Expenses
Revenues:
Economic resources earned by an entity
during a given accounting period
• These result from core operating (earning)
activities or ordinary activities of an entity
• It involves gross inflow or increase in
economic benefits in the form of
– Inflow or enhancement of assets
(A/R) or
– Settlement of liabilities or
– A combination of both
Example: For a manufacturer - Sale of
goods to customers, For insurance
company – Premiums from policy
holders, Banks ? Lawyers ?
• They result in increase in RE, Equity
Can any increase in equity called Revenue ?
Expenses:
Resources consumed in the process of
generating revenue during a given accounting
period
• These are incurred in the process of creating
revenues & involve decrease in economic
benefits in the form of :
– Outflow or consumption of assets or
– Incurrence of liabilities or
– A combination of both
Example: Cost of goods sold, rent expense
• They result in decrease in RE, Equity
Can any decrease in equity called Expense ?
• So, if an entity has Revenues > Expenses,
– It has made a profit and the same goes to
• Increase owners’ equity
• This profit can be called Net income or
Net earnings
• But, if Revenues < Expenses, it has made a
Net Loss 5
 New CF (IASB)
ASSETS
A present economic resource controlled by the
entity as a result of past events
• An economic resource is a right that has the
potential to produce economic benefits
1. Right (to receive cash/ goods & services/
physical or intellectual property)
2. Potential to produce Economic Benefit (to
receive contractual cashflows/ other
economic resource/produce cash ins or avoid
cash outs etc.)
3. Control : Present ability to direct the use of
the economic resource and obtain the
economic benefits that flow from it
– Comes Not necessarily from ownership
4. Result of a Past Event (say, a transaction)
Ex: Building, Plant and Machinery, Inventories,
Investments, Accounts receivables, Cash
LIABILITIES
A present obligation of the entity to transfer an
economic resource as a result of past events
• An obligation is a duty or responsibility that
the entity has no practical ability to avoid
1. the entity has an obligation
• to transfer an economic resource
• present obligation that exists as a result
of past events
2. No realistic alternative but to settle the
obligation
Can be
– Contractual (Borrowings, creditors),
– Arising from operation of law (tax payable,
penalty imposed)
Ex: Borrowings, Bonds/ Debentures, Advances
from customers, Accounts Payable, Wages
outstanding, Taxes payable
6
 New CF (IASB)
ASSETS
A present economic resource controlled by the
entity as a result of past events
• An economic resource is a right that has the
potential to produce economic benefits
1. Right (to receive cash/ goods & services/
physical or intellectual property)
2. Potential to produce Economic Benefit (to
receive contractual cashflows/ other
economic resource/produce cash ins or
avoid cash outs etc.)
3. Control : Present ability to direct the use of
the economic resource and obtain the
economic benefits that flow from it
– Comes Not necessarily from ownership
4. Result of a Past Event (say, a transaction)
Ex: Building, Plant and Machinery,
Inventories, Investments, Accounts
receivables, Cash
LIABILITIES
A present obligation of the entity to transfer
an economic resource as a result of past
events
• An obligation is a duty or responsibility
that the entity has no practical ability to
avoid
1. the entity has an obligation
• to transfer an economic resource
• present obligation that exists as a
result of past events
2. No realistic alternative but to settle the
obligation
Can be
– Contractual (Borrowings, creditors),
– Arising from operation of law (tax payable,
penalty imposed)
Ex: Borrowings, Bonds/ Debentures, Advances
from customers, Accounts Payable, Wages
outstanding, Taxes payable 7
 New CF (IASB)
Income
• Increases in assets, or
• Decreases in liabilities,
that result in increases in equity,
other than those relating to contributions
from holders of equity claims.
Incomes include amounts generated by
transactions and other events, including
changes in the carrying amount of assets
and liabilities
• Income includes gains
Examples:
• Revenue from sale of goods/services;
• Interest and dividend income from
investments in financial assets;
• Rent earned
• Gain from sale of a PPE/ Investment
• Gain on revaluation of a PPE
Expenses:
• Decreases in assets, or
• Increases in liabilities,
that result in decreases in equity,
other than those relating to distributions to
holders of equity claims.
Expenses include amounts generated by
transactions and other events, including
changes in the carrying amount of assets and
liabilities.
• Expenses include losses
Examples:
• Cost of goods sold,
• Operating Expense like rent expense,
electricity expense etc
• Loss on sale of a PPE/ Investment
• Loss on Revaluation of a PPE
• Depreciation & Impairment of PPE
8
EXERCISE 1 : CLASSIFICATION OF FINANCIAL STATEMENT ITEMS

Classify the items :

1. Whether it belongs on the Income statement (IS), Balance Sheet (BS)
2. Whether it is a revenue (R ), expense (E ), asset(A), liability(L) or
stockholders’ equity (SE)
Item Appears on the Classified as
Cash BS A
1 Salaries Expense IS E
2 Equipment BS A
3 Accounts Payable BS L
4 Membership fees earned IS R
5 Capital Stock BS SE
6 Accounts Receivable BS A
7 Buildings BS A
8 Advertising expense IS E
9 Retained Earnings BS SE
9
EXERCISE 1 : CLASSIFICATION OF FINANCIAL STATEMENT ITEMS

Classify the items :

1. Whether it belongs on the Income statement (IS), Balance Sheet (BS)
2. Whether it is a revenue (R ), expense (E ), asset(A), liability(L) or
stockholders’ equity (SE)
Item Appears on the Classified as
Cash BS A
1 Salaries Expense IS E
2 Equipment BS A
3 Accounts Payable BS L
4 Membership fees earned IS R
5 Capital Stock BS SE
6 Accounts Receivable BS A
7 Buildings BS A
8 Advertising expense IS E
9 Retained Earnings BS SE
Assignments: KWK - E1-15, E1-16 10
 Basic Accounting Equation - Extension
Assets = Liabilities + Common Stock + Retained Earnings (RE)

• Change in Retained earnings during the year (∆ RE )

= (Revenues t – Expenses t – Dividends t )
• Retained Earnings at the end of the year (REt)
= Prior Retained Earnings (RE t-1) + ∆ RE
= Prior Retained Earnings (RE t-1) + (Revenues t – Expenses t – Dividends t )
= (Revenues – Expenses – Dividends) accumulated over the life of the entity
Thus,
Assets = Liabilities + Common stock + ⅀ (Revenues - Expenses – Dividends)

Net Income
Or re-arranging we can write:
Assets t + ⅀ Expenses + ⅀ Dividends = Liabilitiest + Common Stock t + ⅀Revenues

Assets = Liabilities + Common Stock + ( Beg. RE + Net Income – Dividend)

11 11
 Basic Accounting Equation

Assets = Liabilities + Common Stock + ( Beg. RE + Net Income – Dividend)

12
 Exercises: THE ACCOUNTING EQUATION
Exercise 2

BC starts the year with $100,000 in assets and $80,000 in liabilities. Net
Income for the year is $25,000 and dividends paid is $5000.
How much is owners’ equity at the end of the year ?
A = L + SE
Beginning of year $100,000 = $80,000 +$20,000
+ Net income +$25,000
– Dividends –5,000
Exercise 3
Stockholders’ equity at end of year $40,000
Revenue increases by $1000 and all other categories remain unchanged except
Assets. What is the change in Assets ?
Assets = Liabilities+ Common Stock + ( Beg. RE + Revenue – Expenses – Dividend)
Exercise 4
Expense increases by $500 and all other categories remain unchanged except
Cash. What is the change in Cash?
Assets = Liabilities + Common Stock + ( Beg. RE + Revenue – Expenses – Dividend)
13
 Exercise 5
Assets = Liabilities + Stockholders' Equity
End: $550,000 = $301,000 + Stockholders' Equity
Beginning: $360,000 = $137,500 + Stockholders' Equity
Net income ?

Ex 5a . The stockholders made no investment in the business, no dividends

were paid during the year
Ans Assets = Liabilities + Stockholders' Equity
End: $550,000 = $301,000 + $249,000
Beginning: $360,000 = $137,500 + 222,500
Net income $ 26,500

Ex 5b. The stockholders made no investment in the business, but dividends

of $55,000 were paid during the year
Ans
Change in Stockholders' Equity $26,500
+ Dividends 55,000
Net income $81,500
14
 Continued from previous slide
Assets = Liabilities + Stockholders' Equity
End: $550,000 = $301,000 + $249,000
Beginning: $360,000 = $137,500 + 222,500
26,500
Ex 5c. The stockholders invested $32,500 in the business, and no dividends
were paid during the year

Ans
Change in Stockholders' Equity $26,500
– Stockholders' investments 32,500
Net loss ($ 6,000)

Ex 5d. The stockholders invested $25,000 in the business, and dividends of

$58,000 were paid during the year

Ans
Change in Stockholders' Equity $26,500
+ Dividends 58,000
$84,500
– Stockholders' investments 25,000
Net income $59,500
Net Income = Change in SE - New Investments by SH +Dividends
15
 EXERCISE CASE 1 CASE 2 CASE 3 CASE 4
Total assets, end of period $ 40,000 34,000 ? $ 75,000 $ 50,000
Total liabilities, end of period 9,000 ? 15,000 25,000 10,000
Capital stock, end of period 10,000 5,000 20,000 15,000
Retained earnings, beginning of period 15,000 8,000 10,000 20,000
Net income for the period 8,000 7,000 23,000 ? 9,000
Dividends for the period 2,000 1,000 3,000 4,000 ?

A = L + CS + (Beg. RE + Net Income – Div.)

Case 1: 40 = L + 10 + (15 + 8 – 2)
Liabilities = 9

Case 2: A = 15 + 5 + (8 + 7 – 1)
Assets = 34
Case 3: 75 = 25 + 20 + (10 + N. Income – 3)
Income = 23
Case 4: 50 = 10 + 15 + (20 + 9 – Div.)
Dividends = 4

16
 Basic Assumptions
Money Measurement (or Monetary Unit) Assumption
• Financial accounting records only those events which can be expressed in
monetary terms
• Money provides a common denominator to all transactions
• FS prepared in currency of the country where incorporated (& where listed if
needed)
• Limitations ? Qualitative information, Inflation

Separate Entity (or Economic Entity) Assumption

• Business: Separate entity, distinct from its owners, creditors, customers
• Accounts are kept for entities as distinguished from the persons associated with
the entities. Its financial records and reports should refer to the financial affairs
of the business only.
• So, capital brought in by the owner to his business is kind of an obligation of the
business entity to its owner
• Holds irrespective of the form of the business even if from legal point of view
separate entity doesn’t hold (Sole Proprietor, Partnership)
• Economic events of every entity can be separately identified and accounted for
17
 Basic Assumptions
Going Concern Assumption
– An entity would continue to operate in foreseeable future, and is not going to be
liquidated
– Will continue operation long enough to carry out its existing objectives and
commitments
– Helps to spread the effect of long term transactions over time
– Measurement of Assets and Liabilities on closing date
– Going Concern Value > Liquidation Value
Accounting Period or Periodicity Assumption
• Measurement of income generated by an entity can not be postponed indefinitely
– since a number of users need to have the information at periodic intervals for
their economic decisions
• Interval of time, at the end of which financial statements of the entity are prepared
is called an Accounting period
– So, economic life of a business can be divided into artificial time periods/
intervals
– The intervals are generally of equal length,
• Usually 1 year which can be calendar year, Can be prepared for the interim
period (Quarterly) 18
 Basic Assumptions: Accrual versus Cash Basis
Limitation of Cash Basis Accounting :
Timing of cash flows can be different from the substance of the transaction
• Selling goods on credit, Receiving money in advance for services to be provided in
the future (magazine subscription)
– time of cash receipts might not be the same as the time of revenue being
earned (Revenues can be earned in a period other than the one in which
cash is received)
– the time of cash payments might not match the time of expense being
incurred
Suppose that FC paints a building in 2015. In 2015, it incurs total expenses
(salaries and paint costs) of $50,000 but pays $40,000 during 2015.
It bills the customer $80,000, but receives payment of $20,000 until 2015.

• This Complexity is addressed by Accrual Basis of Accounting (required by GAAP)

– Transactions (like revenues and expenses) are recorded when they occur (&
not when cash is exchanged) and are reported in FS of the period to which
they relate
– This is more appropriate than cash basis for calculation of profits because it
leads to matching of revenues with expenses
– It informs users of not only past cash transactions but also future venues of
cash receipts (A/R) and payments (A/P, Loan repayment) 19
 Accounting Principles

• Measurement Bases: Historical Cost Principle and Fair value

– Cost or historical cost principle, dictates that companies record assets
at their acquisition cost (price + costs to get the asset ready for use)
– Fair Value: Indicates that assets and liabilities should be reported at
fair value (the price received to sell an asset or settle a liability)

• Full disclosure Principle: Requires that financial statements and their

notes present all information relevant to users
– Explanatory Notes / Notes to FS: Clarify FS & provide additional details
• Explanations to keep FS from being misleading
– Mandatory Disclosure :
• Accounting Policies used in preparing FS like Revenue recognition
policy, Depreciation accounting, Inventory Valuation
– Voluntary Disclosure : Judgment
• Too much disclosure can create clutter and be misleading

20
 Conservatism or Prudence
Conservatism : When dealing with measurement uncertainties, if two
estimates of some future amounts are equally likely,
– there should be preference for the smaller number when measuring
assets and revenues &
– for the larger number for liabilities and expenses
Ex: Valuing closing inventory at cost or market value whichever is lower
Anticipate no profits but provide for all losses
Currently, move towards Prudence :
Exercise of caution in making judgments (when arriving at estimates) under
conditions of uncertainty
• Seeks to prevent Overstatement of Assets & Income, and Understatement
of Liabilities & Expenses and, thus avoid Overstatement of profits
– possibility of such overstated profit being distributed by way of dividend
• However, deliberate overstatement of liabilities/expenses and deliberate
understatement of assets /income is not allowed
– can bias the financial statements with hidden reserves
21
Corporate Financial Reporting
Session 3: IIMC-PGP 2020-21
Accounting Mechanics
 Learning Goals
• The Account – the T Account
• Rules of Debits and Credits, Normal Balance
• Accounting Cycle
– Transaction Analysis (covered)
– Journalising, Ledger Posting: Preparation of Trial Balance
– Adjustment Entries: Adjusted trial balance
– Preparing Financial Statements
– Closing Entries
• Assignments

2
 Account, The T Account
Account: Basic storage units for accounting data.
• Used to accumulate amounts from similar transactions
• Separate accounts used for: Assets, Liabilities, Components of
stockholders’ equity (includes revenues and expenses) Identifies the
asset, liability, or
stockholders’
equity account
The T account Title of Account
Three parts:
Left-side Entry Right-side Entry
• A title that describes the account
• A left side, called the debit side Debit Credit
• A right side, called the credit side (left) side (right) side

Chart of Accounts: List of accounts used by a company to record transactions

• No standard set of accounts applicable to all companies
• Every company specifies its own set of accounts based on its needs and
circumstances
– a small co might need few accounts, an MNC might need thousands
3
 Double-entry system
• Every transaction has two aspects that balance each other:
• Effort & reward, Sacrifice & benefit
• Each transaction must affect at least two accounts - In order to keep the
basic accounting equation in balance
• One or more accounts must be debited & one or more accounts must be
credited, No negative numbers allowed
• DEBITS must equal CREDITS: for each transaction, for whole system
Account Balance : Beginning Balance + Increases - Decreases = Ending Balance

• If Debits are greater than Credits, • If Credits are greater than Debits,
– the account will have a debit – the account will have a credit
balance balance.
Account Name Account Name
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.
$10,000 $3,000
$10,000 $3,000
$8,000
$8,000
$10,000 $11,000
$18,000 $3,000
Bal. $1,000
Bal. $15,000
4
 Rules of Debit and Credit
Basic Acc Equation : Assets = Liabilities + Stockholders’ Equity

Assets + Expenses + Dividends For RHS components

For LHS components = Liabilities + Common Stock +Revenues

Debit Credit
Debit Credit
for for
for for
Decreases Increases
Increases Decreases
(–) (+)
(+) (–)

Effect Assets, Liabilities,

Expenses, Common Stock,
Dividends Revenues,
Stockholders equity
Increase DEBIT CREDIT
Decrease CREDIT DEBIT
5
Example: Borrowed money from Bank; Repaid the loan to Bank  Cash Asset, Loan Liability
 Illustration
If a debit increases assets by Rs100, then a credit must increase stockholders’
equity or liabilities by Rs100 for the accounting equation to stay in balance.
Example: Loan Received from Bank

Assets = Liabilities + Stockholders’ Equity

700 200 500

100 100
800 = 300 + 500

Decide on the debits and credits for the following:

Insurance premium paid in advance, Salary paid, Issue of bonds,
Dividend paid, Dividend Income received, Collection from Accounts Receivable
6
Corporate Financial Reporting
Session 4 & 5 : IIMC-PGP 2020-21
Accounting Mechanics

1
 Learning Goals

– Adjustment Entries
• Deferrals and Accruals
 Preparing an Adjusted Trial Balance
– Preparing Financial Statements
– Closing Entries
 Preparing a Post-Closing Trial Balance
– Assignment Problems

2
Trial Balance
– Each
account is
analyzed to
determine
whether it is
complete and
up-to-date.

3
 Accrual Concept
• Problem:
– Revenues can be earned in a period other than the one in which
cash is received
– Expenses can be incurred in a period other than the one in
which cash is paid

• Solution:
Transactions recorded in the periods in which the events occur
• Recognize revenues in the accounting period in which the
goods are sold or services are rendered (even if cash was not
received
• Recognize expenses in the accounting period in which they
are used to generate revenues (even if cash was not paid)

4
 Revenue Recognition and Expense Recognition
Revenue Recognition Principle:
• Companies recognize revenue in the accounting period in which the
performance obligation is satisfied

Expense Recognition :
• Expenses need to be matched with the revenue in the period when
the company makes efforts to generate those revenues
“Let the expenses follow the revenues”
• Also referred to as Matching Principle

• Accrual basis of accounting helps to apply the matching principle

– The difficulty of assigning revenues and expenses to the
appropriate accounting period is addressed so that net income
is measured accurately

5
 Assumptions and Matching Rule
Going Concern,
Accruals Basis

Matching
Principle
“Let the expenses
follow the revenues.”

Realisation convention:
Amounts reasonably certain
to be realized,
Unrealised gain should not
Some transactions span more than one accounting period be recorded 6
 Adjusting Entries
Adjusting entries needed to ensure that
• Transactions that span more than one period are adjusted at the end of
an accounting period – Applying Accrual Basis
• Revenue recognition & Expense recognition principles are followed

Adjusting entries make it possible to report

• correct amounts on the balance sheet and income statement.

A company must make adjusting entries

• every time it prepares financial statements at the end of a period

Adjustment Entry must:

• Include at least one income statement A/c
• Include at least one balance sheet A/c
• Do not affect cash flows in current period, never affect Cash A/c

Involves Judgment: Potential for abuse (Ethics)

7
 Types of Adjusting Entries
Deferrals: Cash Exchanged in Advance of a future Revenue or Expense
1. Prepaid expenses: Recognition of Expense is Deferred
Expenses already paid in cash and recorded as assets
before they are used or consumed.
Recognition of Revenue is Deferred
3. Unearned revenues: (Pre-received/ Received in advance)
Cash received in advance and reported as liabilities
before revenue is earned.

Accruals: Cash to be Exchanged Later for a current Revenue or Expense

2. Accrued expenses:
Expenses incurred Expenses arisen, not yet recorded
but not yet paid in cash or recorded.
4. Accrued revenues: Revenue arisen, not yet recorded
Revenues earned
but not yet received in cash or recorded
8
 Four Types of Adjustments
Cash exchanged BALANCE SHEET
BEFORE recognition
Assets Liabilities

1. Recorded costs are 2. Expenses are

Expense allocated between incurred but not yet
Note: Each
two or more recorded adjusting entry
INCOME STATEMENT

accounting periods involves one

(Accrued Expenses) balance sheet
(Deferred Expenses) account & one
income statement
4. Revenues are 3. Recorded unearned account
Revenue earned but not yet revenues are
recorded allocated between
two or more
accounting periods
(Accrued Revenues)
(Deferred Revenues)
Cash to be exchanged
AFTER recognition

9
 DEFERRALS
(Type 1 and 3)

10
 Adjustment Entries – Deferrals: Prepaid Expense (Type 1)
Prepaid Expense : Expenses paid in advance that have not yet expired
– Cash Payment Before Expenses are recorded (Supplies, Prepaid Rent, Plant)
– Recorded costs to be allocated between two or more accounting periods
– At the time of Payment : Service or benefit is yet to be received
• Debited to an Asset a/c Recognition of Expense is Deferred
– At the end of Accounting Period: A certain portion Expires (with passage of
time or Use)
• Expired portion to be transferred to an Expense A/c  Adjustment Entry
– Adjusting entry to record the EXPENSE that has been incurred and to the
ASSET that remains. Results in
• an increase to an expense account (Dr.) and
• a decrease to an asset account (Cr.)

11
 Prepaid Expense

– When payment was made

• Recognition of expense was postponed and asset recorded
– If adjustment entry is not passed at the end of the accounting period,
even though the asset has been used/consumed
• Assets will be overstated
• Expenses will be understated
• Net income will be overstated
• Stockholders’ equity will be overstated
12
 Adjustment Entry (Type 1) : Prepaid Insurance

Illustration: On October 4, Sierra Corporation paid $600 for a one-year fire

insurance policy. Coverage began on October 1. Sierra recorded the
payment by increasing (debiting) Prepaid Insurance. This account shows a
balance of $600 in the October 31 trial balance (if not adjusted).
Insurance of $50 ($600 ÷ 12) expires each month.

Oct. 31 Insurance Expense 50

Prepaid Insurance 50

13
 Adjustment Entry (Type 1) : Supplies

Illustration: Sierra Corporation purchased supplies costing $2,500 on

October 5. Sierra recorded the purchase by increasing (debiting) the asset
Supplies. This account shows a balance of $2,500 in the October 31 trial
balance (if not adjusted).
An inventory count at the close of business on October 31 reveals that
$1,000 of supplies are still on hand.

Oct. 31 Supplies Expense 1,500

Supplies 1,500
($2,500 – 1,000 = $1,500)

14
 Plant, Depreciation Expense, Accumulated Depreciation
Purchase of a long term asset is a deferral of an expense
– The cost of the asset must be allocated over its estimated useful life.
• The amount allocated to any one period is called depreciation.

Depreciation expense
– Incurred during an accounting period to produce revenue, must be estimated
– Based on: Cost of the asset, its estimated useful life (number of methods)

• Depreciation expense does not reduce the asset account directly, but is recorded
in a Contra Account, called Accumulated Depreciation
– A separate account, shown as a deduction from the related asset account
• Contra account is used to
– Recognize that depreciation is an estimate, Preserves original cost of the asset
• In combination with the asset account, it shows
– How much of the asset has been allocated as an expense
– The balance left to be depreciated
15
 Adjusting Entry (Type 1): Prepaid Expense (Asset, Depreciation)
Depreciation is the process of allocating cost of an asset to expense over its useful life
- Depreciation doesn’t attempt to report actual change in the value of the asset
For Sierra Corporation, assume that depreciation on the office equipment is $480
a year, or $40 per month.
Oct. 31 Depreciation Expense 40
Accumulated Depreciation - Equipment 40

16
 Prepaid Expense and Unearned Revenue
Mr. A records Mr. B records
Prepaid Rent (A) Cash (A) (Dr.)
Cash (A) (Cr.) Unearned Revenue (L)
Advance payment today

Mr. A (Tenant) Mr. B (Landlord)

Service Tomorrow

Mr. A records: Mr. B records

Rent Expense (E) (Dr.), Unearned Revenue (L) (Dr.),
Prepaid Rent (A) (Cr.) Rent Revenue ( R ) (Cr.)

17
 Adjustment Entries – Deferred or Unearned Revenue (Type 3)
Unearned Revenue (Pre-received/ Received in advance)
— Cash Receipt Before Revenue earned or recognized
(Airline Tickets, Magazine Subscription, Rent, Customer deposits)
— Recorded unearned revenue to be allocated between two or more
accounting periods
— At the time of cash receipt: Service (goods) yet to be rendered (delivered)
— Credited to a Liability A/c Recognition of Revenue is Deferred
— At the end of the accounting period: Service Rendered (or Goods delivered)
— Amount Earned is transferred to a Revenue A/c  Adjustment Entry
— Adjusting entry to record the REVENUE that has been earned and to show
the LIABILITY that remains. Results in :
— a decrease to a liability account (Dr.) and
— an increase to a revenue account (Cr.)

18
 Unearned Revenue

– When payment was received

• Recognition of revenue was postponed and LIABILITY recorded
– If adjustment entry is not passed at the end of the accounting period,
even though the REVENUE has been Earned
• LIABIITIES will be overstated
• REVENUES will be understated
• Net income will be Understated
• Stockholders’ equity will be Understated
19
 Adjustment Entries (Type 3) –Unearned Revenue

Illustration: Sierra Corporation received $1,200 on October 2 from R. Knox

for guide services for multi-day trips expected to be completed by
December 31. Unearned Service Revenue shows a balance of $1,200 in the
October 31 trial balance.
From an evaluation of the service Sierra performed for Knox during
October, the company determines that it has earned $400 in October.

Oct. 31 Unearned Service Revenue 400

Service Revenue 400

20
 ACCRUALS
(Type 2 and 4)

21
 Adjustment Entries – Accrued Expense (Type 2)

Accrued Expenses or Outstanding Expenses

• Expenses Incurred during the period, but not yet recorded – no cash paid yet
(Rent, Interest, Wages, Taxes, Utilities) Expenses arisen, not yet recorded

• At the end of the Accounting Period: Amount that has been incurred is
– Recognized as an Expense, and Adjustment Entry
– Recorded as a Liability.  As the expense accumulates,
it is said to accrue
• Adjustment Entry results in
– Increases an expense account (Dr.) and
– Increases a liability account (Cr.)

22
 Adjustment Entry (Type 2 ): Accrued Wages
Illustration: Sierra Corporation last paid salaries on October 26; the next payment of
salaries will not occur until November 9. The employees receive total salaries of $2,000
for a five-day work week, or $400 per day.
Thus, accrued salaries at October 31 are $1,200 ($400 x 3 days).

Hired : 9th Oct,

Work started :15th Oct,
Wages payable:
Every 2 weeks
First Wage Paid: 26th Oct

Oct. 31 Salaries and Wages Expense 1,200

Salaries and Wages Payable 1,200

23
 Adjustment Entry (Type 2 ): Accrued Interest

Illustration: Sierra Corporation signed a three-month note

payable in the amount of $5,000 on October 1. The note
requires Sierra to pay interest at an annual rate of 12%.

Oct. 31 Interest Expense 50

Interest Payable 50

24
 Adjustment Entries – Accrued Revenue (Type 4)
Accrued Revenue or Receivables
• Revenue earned during the period, but not yet recorded: no cash receipts
yet Revenue arisen, not yet recorded
(Rent, Interest, Service performed, Revenues earned on operations)
• At the end of the Accounting Period: Amount that has been Earned is
– Recognized as an REVENUE, and Adjustment Entry
– Recorded as an ASSET (Accounts Receivable) – amount due to the
company for services performed (or goods delivered)
 As the revenue accumulates,
• Adjustment Entry results in it is said to accrue
– Increases an asset account (debits) and
– Increases a revenue account (credits)

25
 Adjustment Entries – Accrued Revenue (Type 4)

Illustration: In October, Sierra Corporation performed guide services

for $200 that were not billed to clients before October 31.

Oct. 31 Accounts Receivable 200

Service Revenue 200

26
 Adjusting Entries - Accruals

• Without Adjustment for Accrued Expenses - Expenses and Liabilities will

be understated: NI, Shareholders’ Equity will be Overstated
• Without Adjustment for Accrued Revenues – Revenues and Assets will be
understated: NI, Shareholders’ Equity will be Understated
• Balance Sheet and Income Statement would be incorrect
• Mr X’s Accrued Expenses (A/P) would be Mr. Y’s Accrued Revenue (A/R)
27
 Preparing an Adjusted Trial Balance

• After all adjusting entries are recorded (journalized) and posted

– the Ledger Account balances are recalculated

 Some accounts will have the same balance they had on the trial balance
 Others will be different because adjusting entries changed the balances

• After that another Trial balance is prepared from the ledger accounts
(Adjusted Trial Balance)

• The adjusted trial balance’s purpose is

– to prove the equality of debit balances and credit balances in the
ledger.
• The adjusted trial balance is
– the primary basis for the preparation of the financial statements.
28
28
The Adjusted Trial Balance

29
 Preparing Financial Statements : Sequence
Adjusted Trial Balance
Asset accounts
Liability accounts
Common Stock
Retained Earnings
Dividends
Revenue accounts
Expense accounts
1 Income Statement
Revenue accounts
– Expense accounts
Net income
2 Statement of Retained Earnings
Beginning retained earnings
+ Net Income
– Dividends
Ending retained earnings
Balance Sheet
3 Assets
Asset accounts
Liabilities
Liability accounts
Stockholders’ Equity
Common stock
Retained earnings
30
Preparing Financial Statements

31
Preparing Financial Statements

From
Balance Sheet
32
 Closing the Books

Temporary accounts Permanent accounts

(or nominal accounts)
All Revenue accounts,
All Expense accounts,
Dividends accounts
(or real accounts)
All Assets accounts,
All Liabilities accounts,
All Shareholders’ Equity accounts
i.e. all Balance sheet accounts

Are closed at the end of each period Are not closed at the end of each
period

Begin each period with a zero Carry their end-of-period balances to

balance next period

At the end of the accounting period, companies transfer the temporary account
balances to : Retained Earnings (stockholders’ equity account- permanent)
33
 Closing Entries
CLOSING ENTRY: Required at the end of any period for which financial
statements are prepared
• Summarizes a period’s revenues and expenses by transferring balances to
the Income Summary account
– Updates Retained Earnings to its correct ending balance
• Produces a zero balance in each temporary account
– Set the stage for the next period by clearing revenue, expense, and
dividends accounts of their balances

• Does not appear on financial statements Income Summary

• Only used in the closing process
• Balance of account equals the net income or loss reported on the income statement
34
 The Closing Process

Expense Accounts Revenue Accounts

xxx xxx

Step 2: Close Step 1: Close

expense accounts Income Summary revenue accounts
xxx xxx
xx

Step 3: Close
Income Summary

Dividends Retained Earnings

xx Step 4: xx xx
Close
Dividends

35
 Closing the Books

2012

36
 Closing the Books

37 37
 Preparing a Post-Closing Trial Balance

• Trial balance is prepared again after the closing entries

– All temporary accounts will have zero balances.
– It would show balances of ONLY Permanent (Balance Sheet)
accounts

• The purpose of the post-closing trial balance is

– To check that total debits equal total credits in the ledger after
closing entries have been posted
– To prove the equality of the permanent account balances that
the company carries forward into the next accounting period
– Hence prove equality of the two sides of balance sheet

38
Below are the adjusted accounts of Century Realtors, Inc., for the month ended
October 31, 20x7, listed in alphabetical order:
Accounts Payable $ 520 Dividends $ 750
Accounts Receivable 2,400 Income Taxes Expense 80
Accumulated Depreciation– Income Taxes Payable 80
Office Equipment 3,000 Office Equipment 7,500
Cash 1,200 Prepaid Rent 1,100
Commissions Revenue 5,400 Retained Earnings 4,000
Common Stock 2,000 Salaries Expense 1,720
Depreciation Expense– Utilities Expense 100
Office Equipment 150

Prepare a post-closing trial balance

39
 Below are the adjusted accounts of Century Realtors, Inc., for the month ended
October 31, 20x7, listed in alphabetical order:
Accounts Payable $ 520 Dividends $ 750
Accounts Receivable 2,400 Income Taxes Expense 80
Accumulated Depreciation– Income Taxes Payable 80
Office Equipment 3,000 Office Equipment 7,500
Cash 1,200 Prepaid Rent 1,100
Commissions Revenue 5,400 Retained Earnings 4,000
Common Stock 2,000 Salaries Expense 1,720
Depreciation Expense– Utilities Expense 100
Office Equipment 150

Prepare a post-closing trial balance Commissions Revenue 5,400

Century Realtors, Inc. Depreciation Expense 150
Post-Closing Trial Balance Income Taxes Expense 80
October 31, 20x7 Salaries Expense 1,720
Utilities Expense 100 2,050
Cash $ 1,200 Net Income 3,350
Accounts Receivable 2,400
Prepaid Rent 1,100 Which accounts will have a zero
Office Equipment 7,500 balance after closing entries?
Accumulated Depreciation–Office Equipment $ 3,000
• Revenues (Commissions Revenue)
Accounts Payable 520 • Expenses (Depreciation Expense, Income
Income Taxes Payable 80 Taxes Expense, Salaries Expense, Utilities
Expense)
Common Stock 2,000 • Dividends
Retained Earnings 6,600*
$12,200 $12,200
*$4,000 + $3,350 net income – $750 dividends = $6,600.
40
 Summary of the Accounting Cycle

1. Analyze business transactions

9. Prepare a post-closing trial

2. Journalize the transactions
balance

8. Journalize and post closing

3. Post to ledger accounts
entries

7. Prepare financial statements 4. Prepare a trial balance

6. Prepare an adjusted trial 5. Journalize and post

balance adjusting entries:
Deferrals/Accruals

41
 Deferrals Accruals
Prepaid Expense Unearned Accrued Expense Accrued
Revenue Revenue
Examples Insurance, Rent, Customer Interest, Revenue earned
Supplies, Plant deposits Salaries, Tax not collected
Cash exchange Assets ... Dr. Cash ..… Dr.
(in advance) Cash … Cr. Liability … Cr.
Reason for Prepaid Unearned Expenses Revenues
Adjustment expenses Revenue incurred but not earned but not
recorded in recorded in yet paid in cash yet received in
asset have been liability have or recorded cash or recorded
used been earned
Adjustment Expense … Dr. Liability … Dr. Expense … Dr. Asset… Dr.
Entry Assets ….Cr. Revenue … Cr. Liability .Cr. Revenue … Cr.
Without Adjustment Entry:
Overstated Assets, Profit, Liability Profit, Equity
Equity
Understated Expenses Revenue, Profit, Expenses, Revenue, Assets,
Equity Liability Profit, Equity
Cash exchange Liability … Dr. Cash .… Dr.
(later) Cash … Cr. Asset… Cr.
 Summary of Basic Relationship

43
 I.For each of the following oversights, state whether Total assets, Total liabilities, Net income,
Owner’s equity will be understated, overstated, or not affected (NA).
Also, state the amount of increase/decrease in A, L, NI, OE to correct the effect of these oversights
______ a. Failure to record revenue of Rs12,000 earned but not yet received
A, NI, OE: Understated  Increase by 12,000; L: NA
______ b. Failure to record expired rent Rs 4000 (Prepaid Rent 8000)
A, NI, OE: Overstated  Decrease by 4,000; L: NA
______ c. Failure to record accrued interest income of Rs 3000 at the bank
A, NI, OE: Understated  Increase by 3,000; L: NA
______ d. Failure to record depreciation of Rs 2000
A, NI, OE: Overstated  Decrease by 2,000; L: NA
______ e. Failure to record accrued wages of Rs700
L : Understated Increase by 700; NI, OE: Overstated  Decrease by 700; A: NA
______ f. Failure to convert unearned revenue to earned revenue of Rs 200
L : Overstated Decrease by 200; NI, OE: Understated  Increase by 200; A: NA
II. Jamal Company began the year with $84,000 in its Common Stock account and a debit balance in
Retained Earnings of $36,000. During the year, the company earned net income of $18,000 and declared
and paid $6,000 of dividends. In addition, the company sold additional common stock amounting to
$22,000. Based on this information, what should the transaction analysis show for the ending total of all
stockholders' equity accounts?
a. $154,000
b. $166,000
c. $82,000
d. $110,000
Solution: $84,000 + ($36,000) + $18,000  $6,000 + $22,000  $82,000 44
 Determining Cash Flows: Applying the General Rule
Note: The general rule
General Rule Potential cash payments or receipts
does not apply to
– Amount not paid or received
depreciation
Cash flows for expenses or from revenues
Application of the general rule varies with the type of asset or liability account
• For accruals
 Accrued expenses
• Beginning Balance + Expense for the Period – Ending Balance
 Accrued revenues
• Beginning Balance + Revenue for the Period – Ending Balance
Cash Receipts (Payments) for Revenue (or Expense) for - Increase in Accrual
Revenue (Expense) = the period (Receivables / Payables)
• For deferrals
 Prepaid expenses
• Ending Balance + Expense for the Period – Beginning Balance
 Unearned revenues
• Ending Balance + Revenue for the Period – Beginning Balance
Cash Receipts (Payments) Revenue (or Expense) for + Increase in Deferral
for Revenue (Expense) = the period (Prepaid/ Unearned)

Cash Receipts (Payments) for Revenue (or Expense) for + Increase in Deferral - Increase in Accrual
Revenue (Expense) = the period (Prepaid/ Unearned) (Receivables / Payables)
 Cash Payments for Insurance
Cash Prepaid Insurance Insurance Expense
310 May 31 480 120 120
310

Jun 30 670
General Rule:
Ending balance + Expense for period – Beginning Balance = Cash payments

Prepaid Insurance at June 30 $670

Insurance Expense during June 120
Potential cash payments for insurance 790
Less Prepaid Insurance at May 31 480
Cash payments for insurance during June $310
The beginning balance is deducted
because it was paid in a prior period
Practice

47
Journalize: On December 12, Roger Kent, a painter, was paid $1,800 in advance for performing a
service that would extend into the following calendar year.
By December 31, he still had three-fourths of the service remaining to perform.
In the journal provided, prepare the December 12 entry, the December 31 end-of-period adjustment,
as well as the entry on January 29 when the job was completed. Omit explanations.

a. Equipment is purchased for $48,000, to be used for eight years. Assuming zero value at the end of
eight years, what is the equipment's carrying value after two years and three months?
a. $34,500 [$48,000 - ($48,000 ÷ 8 = $6,000 ÷ 12 = $500 * 27 months = $13,500)]

b. Prepaid Insurance has an $800 balance prior to adjustment. By year end, one-fourth has expired. What
will be the balance in Prepaid Insurance after the adjusting entry has been made?
b. $600 [$800 - ($800 ÷ 4)]
c. A company purchased $210 in supplies during the year, recorded $120 in Supplies Expense, and ended
with $350 of supplies. What was the beginning balance of Supplies? 48
c. $260 ($350 + $120 = $470 - $210)
Journalize: On December 12, Roger Kent, a painter, was paid $1,800 in advance for performing a
service that would extend into the following calendar year.
By December 31, he still had three-fourths of the service remaining to perform.
In the journal provided, prepare the December 12 entry, the December 31 end-of-period adjustment,
as well as the entry on January 29 when the job was completed. Omit explanations.

a. Equipment is purchased for $48,000, to be used for eight years. Assuming zero value at the end of
eight years, what is the equipment's carrying value after two years and three months?
a. $34,500 [$48,000 - ($48,000 ÷ 8 = $6,000 ÷ 12 = $500 * 27 months = $13,500)]

b. Prepaid Insurance has an $800 balance prior to adjustment. By year end, one-fourth has expired. What
will be the balance in Prepaid Insurance after the adjusting entry has been made?
b. $600 [$800 - ($800 ÷ 4)]
c. A company purchased $210 in supplies during the year, recorded $120 in Supplies Expense, and ended
with $350 of supplies. What was the beginning balance of Supplies? 49
c. $260 ($350 + $120 = $470 - $210)
In the journal provided, prepare adjusting entries for the following items. Omit explanations.

a. Depreciation on machinery is $940 for the accounting period.

b. Interest incurred on a loan but not paid or recorded is $635.
c. Office supplies of $600 were on hand at the beginning of the period. Purchases of office supplies during
the period totaled $200. At the end of the period, $140 in office supplies remained.
d. Commissions amounting to $540 were earned but not recorded or collected by year end.
e. Prepaid Rent had an $8,000 normal balance prior to adjustment. By year end, 50 percent had expired.
f. Income taxes for the year are estimated to be $3,250.
What is the effect of the adjustment entry on Income statement and Balance Sheet ?
In the journal provided, prepare adjusting entries for the following items. Omit explanations.

a. Depreciation on machinery is $940 for the accounting period.

b. Interest incurred on a loan but not paid or recorded is $635.
c. Office supplies of $600 were on hand at the beginning of the period. Purchases of office supplies during
the period totaled $200. At the end of the period, $140 in office supplies remained.
d. Commissions amounting to $540 were earned but not recorded or collected by year end.
e. Prepaid Rent had an $8,000 normal balance prior to adjustment. By year end, 50 percent had expired.
f. Income taxes for the year are estimated to be $3,250.
What is the effect of the adjustment entry on Income statement and Balance Sheet ?
Indicate with an X in the appropriate column the type of entry to be made to close the
following accounts:

52
Thank You

53
Corporate Financial Reporting & Analysis

Session 6, 7 & 8 : MBA 2020
Preparing and understanding Income Statement
 Learning Goals ‐ Income Statement
• Revenue and Expenses, Gains and Losses
• Product cost and Period Cost
• Income Statement : Single Step and Multi‐Step
• Format  of Income Statement as per Schedule III (Division II) of 
Companies Act 2013
• Flow of costs – perpetual and periodic
• Understanding and computation of :
– Net Sales, Cost of Goods Sold (COGS), Gross Profit, Operating 
Expenses, Operating Profit, Non‐operating Income, EBIT, Finance 
charges, EBT, Tax Expenses ‐ Deferred and Current Tax, Net 
Income (PAT)
• Earning Per Share (EPS) – Basic and Diluted
• Income Statement – Asian Paints, Infosys

2
 Revenues and Expenses
Revenues: Expenses: 
Economic resources earned by an entity  Resources consumed in the process of 
during a given accounting period generating revenue during a given accounting 
period 
• These result from core operating (earning) 
• These are incurred in the process of creating 
activities or ordinary activities of an entity revenues &  involve decrease in economic 
• It involves gross inflow or  increase in  benefits in the form of : 
economic benefits in the form of   – Outflow or consumption of assets or 
– Inflow or enhancement of assets  – Incurrence of liabilities or
(A/R) or  – A combination of both
– Settlement of liabilities or  Example: Cost of goods sold, rent expense

– A combination of both  • They result in decrease in Equity 
• So, if an entity has Revenues > Expenses, 
Example:  For a manufacturer ‐ Sale of 
– It has made a profit and the same goes to
goods to customers 
• Increase owners’ equity
They result in increase in Equity • This profit can be called Net income or 
Net earnings 
• But, if Revenues < Expenses, it has made a 
Net Loss 3
 Gains and Losses
Gains
• Increases in Equity 
• Result from peripheral or incidental transactions (i.e. other than those which 
generate revenue or are new contribution by owners)
– Might be beyond entity’s control (change in Market Value of an investment)
– Described by the source , Measured at Net amounts, Realizability
Example: Gain on sale of equipment 
• Expected to be non‐recurring
• Include Non‐reciprocal transactions like compensation received on winning a case

Losses: 
• Decreases Equity 
• Results from peripheral or incidental transactions  (i.e. other than those generating 
expenses for earning revenue or distribution to owners)
• Opposite of Gains: Source, Net Amount, Recognized when Loss is evident (lost a 
lawsuit and fine is payable) 
• Includes Non‐reciprocal transactions like loss by fire

Net Income = (Revenues + Gains) – (Expenses + Losses)
4
 Income
Income
Is recognised when Increases in economic benefits in the form of 
– Increase in assets or decreases of liabilities has arisen  (that result in increases 
in equity, other than those relating to contributions from holders of equity 
claims)
• that can be measured reliably

Income in statement of profit and loss can be 
• Revenue from Operations: Arises in the course of an entity’s ordinary activities, 
primarily from
– Sale of products ,  Sale of Services
– Other operating income:  Arises from activities incidental to core activities like 
sale of scrap generated during manufacturing activities
• Other income : Incomes that cannot be classified either as revenue or as other 
operating income 
– like Interest and dividend income from investments in financial assets, 
– Gain from sale of a PPE/ Investment 
– Rent income
5
Ind AS 115  ‐Revenue from contracts with customers – 5 steps
Revenues – is the Income resulting from satisfying 
1) Identify the (existence of ) performance obligations arising from contracts with 
contract with the customer  customers, who purchase entity’s output (goods or 
services) from the entity’s ordinary activities. 

2) Identify the separate performance 
obligations in the contract.

3) Determine the transaction price

4) Allocate the transaction price to 
separate performance obligations.

5) Recognize revenue as & when the entity 
satisfies each performance obligation
 Recognition and Measurement Principle
• TIMING: An entity recognizes revenue when  the entity satisfies a performance 
obligation by transferring a promised good/service to the customer (customer obtains 
control of the asset) and expects receiving the promised consideration. Recognition 
can be
– At a point in time:  like in merchandising business
– Over time :  like Monthly magazines subscriptions, construction/service contract 
• AMOUNT: Entity measures revenue at an amount that reflects the consideration 
which the entity expects to be entitled in exchange for goods or services 
– If contract Price = Rs12,000, & Entity expects to receive Rs10,000  ‐ may be discount, may be 
estimates a refund liability & right to return asset Book Revenue at Rs10,000  
Infosys : 
Revenue from licenses where the customer obtains a “right to use” the licenses is recognized at the time the license 
is made available to the customer. 
Revenue from licenses where the customer obtains a “right to access” is recognized over the access period.

ASIAN PAINTS  ‐ Annual Report ‐ Notes to the Financial Statements

Sale of products:
Revenue from sale of products is recognized when the control on the goods have been transferred to the customer. 
The performance obligation in case of sale of product is satisfied at a point in time i.e., when the material is 
shipped to the customer or on delivery to the customer, as may be specified in the contract.
Rendering of services:
Revenue from services is recognized over time by measuring progress towards satisfaction of performance 
obligation for the services rendered. 7
Percentage Completion 
 Expense Recognition
Expense Recognition :
• Fundamental principle: A company recognizes expenses in the period in 
which it consumes (i.e., uses up) the economic benefits associated with 
the expenditure 
• However, Expenses need to be matched with the revenue in the period 
when the company makes efforts to generate those revenues
“Let the expenses follow the revenues”  Matching Principle

Expense 
is recognized when decrease in future economic benefit in the form of 
– Decreases in assets, or Increases in liabilities has arisen 
• that can be measured reliably

8
 Recognition of Expense
A cost is an expense for the year in case of either of the three situations:

• It has cause and effect relationship with revenues for the year
– Direct Matching : Cost of goods sold, commission to sales person

• It relates to the activities for the accounting period which might have no direct cause and 
effect relation with sales volume for the period
– Office Salary, Other Administrative Expenses, Advertising Expense, Training Expense 
– Association with revenue can only be broadly or indirectly determined (like systematic 
and rational allocation of cost of Plant bought during the current or previous periods) 
• Even if can’t be associated with operations of a period, it can be an expense if 
– It can’t be associated with future revenues and therefore is recognised in the 
immediate period (like inventory assessed obsolete, Loss due to fire) 
– There is no future economic benefits from it to meet asset recognition criteria (like, 
outcome of research might be uncertain, difficult to measure reliably)

Expenses are expired costs, or items that were assets but are no longer assets because they 
have no future value. 
9
 Capital and Revenue Expenditure
Expenditure : Cost of all goods and services acquired during the year
 Results in decrease in assets (Cash) or increase in liability (on credit ‐ A/P) associated 
with cost incurrence
 Apply Matching Principle, the associated cost is either an asset or an expense
 If cost benefits future periods   Asset  In BS  (Capital expenditure)
 Otherwise                                     Expense in IS (Revenue expenditure)

Two companies C and E started with cash and equity share capital of Rs 1000
Capitalize Rs 900; SLM Dep, UL=3, RV=0 Expense Rs 900 in year 1
 C E
Year 1 2 3 Year 1 2 3
Revenue 1500 1500 1500 Revenue 1500 1500 1500
Cash Exp 500 500 500 Cash Exp 1400 500 500
Depn 300 300 300 Depn 0 0 0
PBT 700 700 700 PBT 100 1000 1000
Tax @30% 210 210 210 Tax @30% 30 300 300
PAT 490 490 490 PAT 70 700 700

Retained Earnings 490 980 1470 Retained Earnings 70 770 1470

Share Capital 1000 1000 1000 Share Capital 1000 1000 1000
Shareholders' Equity 1490 1980 2470 1070 1770 2470

Asset ‐Net Block 900 600 300 Asset ‐Net Block 0 0 0

10
 Income Statement Presentation 
Income Statement Forms : Single Step and Multi‐Step
Single‐Step Income Statement 
Cruz Corporation
 A condensed income statement Income Statement
For the Year Ended December 31, 2010
that arrives at net income in a
single step Income
All major categories 
Net sales $12,48,624
of income
Interest income 5,600
 Subtract total expenses from Total Income $12,54,224
total income
Costs and expenses
Cost of goods sold $8,15,040
 Two reasons for using the Selling expenses 2,19,120
All major categories 
of expenses 
single-step format: General and administrative 1,38,016
Interest expense 10,524
Total costs and expenses 11,82,700
• No profits until total revenues
exceed total expenses. Income before income taxes $71,524
Income taxes Income Tax listed separately 13,524
• Format is simpler and easier
Net income $58,000
to read.
Earnings per share $2.90
11
 Income Statement: US GAAP and IFRS
• Two ways of grouping  income statement items (particularly operating and other 
expenses)
– by Function
– by Nature 
• Classification by nature identifies costs and expenses in terms of their character, 
leads to descriptions such as salaries and wages, raw materials consumed, 
depreciation expense, utilities expense etc.
• Classification by function presents the expenses in terms of the purpose of the 
expenditure, such as for manufacturing, administration, selling & distribution etc
• Note that finance costs, tax expense must be identified separately regardless of 
which classification is employed.

• Under US GAAP, companies classify income statement items by function
• Under IFRS, companies can classify expenses by either nature or function. 
– However, if a company uses the functional classification on the income 
statement, disclosure by nature is required in notes to financial statements. 

12
 Classification
Functional Classification : Cost of sales is deducted from Revenues to calculate gross profit. 
• So, it can provide more relevant information useful for analysis of Financial Statements
• But allocating costs to functions may require arbitrary allocations based on judgment.

Income Statement Income Statement
For the Year Ended December 31, 2008 For the Year Ended December 31, 
(classification of expense by nature) 2008

(in Rs Crores ) (classification of expense by function)
Revenue 800,000 (in Rs Crores )
Other income 100,000 Revenue 800,000
Changes in inventories of finished goods 
and work in progress 50,000 Cost of sale 500,000
Raw materials and consumables used 110,000 Gross profit 300,000
Utility Expenses 60,000 Other income 100,000
Employee benefits expense 350,000
Selling and distribution expenses 100,000
Depreciation expense 200,000
Administrative expenses 170,000
Other expense 10,000
Finance costs 30,000 Other expenses 10,000

Total expenses 810,000 Finance costs 30,000

Profit before tax 90,000 Profit before tax 90,000
13
 Name of the Company……………………. Revision: As per MCA Notification (6th April 2016)
As per Schedule III, Division II of Companies Act 2013 
Statement of Profit and loss for the year ended ………………………
Particulars Note No. Figures for year ended March 31, 
Current Year  Previous Year 
I. Revenue from operations
II. Other income
III. Total Income (I + II) 
IV. Expenses:
Cost of materials consumed
Purchases of Stock‐in‐Trade
Changes in inventories of finished goods, work‐in‐progress, and Stock‐in‐Trade
Employee benefits expense
Finance costs
Depreciation and amortization expense
Other expenses
Total expenses  (IV)
V. Profit before exceptional items and tax (III‐IV)
VI. Exceptional items
VII. Profit before tax (V‐ VI)
VIII Tax expense:
(1) Current tax
(2) Deferred tax
A disposal of a component of an entity or a group of 
IX Profit/ (Loss) for the period from continuing operations (VII‐VIII) components of an entity shall be reported in 
X Profit/(loss) from discontinuing operations discontinued operations if the disposal represents a 
XI Tax expense of discontinuing operations strategic shift that has (or will have) a major effect on 
an entity’s operations and financial results. 
XII Profit/(loss) from Discontinuing operations (after tax) (X‐XI) Example: Disposal of a major geographical area, a 
XIII Profit (Loss) for the period (IX + XII) major line of business
XIV Other Comprehensive Income (OCI)
A (i) Items that will not be reclassified to profit or loss
(ii) Income tax relating to items that will not be reclassified to profit or loss
B (i) Items that will be reclassified to profit or loss
(ii) Income tax relating to items that will be reclassified to profit or loss
XV Total Comprehensive Income for the period (XIII+XIV)
[ Profit/(loss) + OCI for the period ]
XVI Earnings per equity share (for continuing ops), (for discontinued ops) & (for both)
(1) Basic
(2) Diluted IFRS requires that 2 years of income statement information be presented, whereas GAAP requires 3 years.
Asian Paints Limited 
Statement of Profit and Loss 
for the year ended 31st March 2020

15
INFOSYS Statement of Profit and Loss for the year ended 31st March  (in Rupees Crores)

16
Total Comprehensive Income for the period = Profit or loss for the period (Net Income)  + Other Comprehensive Income (OCI) for the period 
 Income Statement Presentation
Multiple-Step Income Statement
• Presented in a series of
steps, or subtotals, to
arrive at net income

• Highlights the components

of net income
• Separates sources of
operating income from
non-operating sources
• Three important line items:
• Gross profit,
• Income from operations
(Operating Income)
• Net income.

17
Multiple‐Step  IS : Infosys
 Types of companies and their Operations
Merchandising or Trading Companies – Retailer or Wholesaler
• Buy and Sell products in the same form in which acquired
• Merchandise Inventory: Cost of goods acquired but not sold
Manufacturing Companies
• Converts raw material and purchased parts into finished  goods
• Makes and Sells products
• Three types of Inventories – RM, WIP, FG
Service Companies
• Do not sell a physical product
• Furnishes intangible services rather than tangible products
• Example:  Hotels, Legal firms
• Might have some material inventories 
• like service of the plumber, Job in progress, but no FG

19
 Multistep Income Statements : Components
Service Merchandising/ Manufacturing      
Revenues Net Sales
minus
Cost of Goods Sold
minus
Not used in a equals
Service business
Step 1: Gross  Profit
minus
Operating Expenses Operating Expenses
equals equals
Operating 
Step 1: Income from Operations Income Step 2: Income from Operations
plus or minus plus or minus
Other Income and Expenses Non‐Operating Other Income and Expenses
minus minus
Interest Expense Interest Expense
equals equals
Step 2: Inc. Bef. Income Taxes EBT Step 3: Inc. Before Income Taxes
minus minus
Income Taxes Expense Income Taxes Expense
equals equals
Step 3: Net Income PAT Step 4: Net Income 20
 Gross  Sales and Net Sales
• Gross sales equal the total cash sales and total credit sales during a given 
accounting period
– Revenue is recorded when  earned under Revenue recognition rule
– Revenue is recognized even though cash may not be collected until the 
following accounting period
• Net Sales ‐ Amount of sales and trends in net sales over time are used to analyze a 
company’s progress
Payment Terms:  n/15/EOM: Payment due in 15 days from the end of the month
Gross Sales  (Cash and Credit sales) 1,20,000 Sales Returns and Allowances Dr
Less: Sales Returns and Allowances 20,600 Accounts/Trade Receivables      Cr.
Net Sales  99,400
Sales Discount eg. 1/10, n/30:
Buyer gets 1% discount if pays in 10 days, 
o.w. he can pay full amt in 30 days
Sales Discount: ‐ US: Contra‐revenue;   India :  Operating Expense
After Ind AS 115 : Revenue recognised at consideration the entity  Trade Receivables     Dr.  1000
expects to be entitled i.e. net of discount  Sales Revenue         Cr       1000
Cash                   Dr.    990
Sales Discount  Dr.     10 
Asian Paints Limited
Trade Receivables    Cr   1,000
Infosys
22A. Revenue from Operations: 2019‐20 2018‐19
2.17 Revenue from operations 2019‐20 2018‐19
Revenue from Sale of Products 17,025.26 16,196.87
Revenue from Sale of Services 0.35 12.57 Revenue from software services 78,809 72,845
Other Operating Revenues 168.48 182.34 Revenue from software products & Platforms 238 262
Total Revenue from operations 79,047 73,107
17,194.09 16,391.78
 Cost of Goods Purchased : Merchandising company
• Purchase Price * Quantity Purchased
• Exclude:  Purchase Returns & Allowances and Purchase Discounts
=  Net Purchases
• Include:   Freight in, Taxes (like Customs duty, Road Taxes) Transit Insurance, 
Handling Charges (Unloading etc)
=  Cost of Goods Purchased ( or Net Cost of Purchase)

Purchases ( Rs 6 * 10,000) 60,000

Less: Purchase Returns  800
and Purchase Discounts
Add: Freight‐In, Taxes,  If 
any (like Customs Duty), 
Handling Charges, Transit  5,000
Insurance Premium
Cost of goods Purchased 64,200  

22
 Freight Costs – Terms of Sale 

Title passes when shipped
Ownership passes to the buyer 
when the public carrier accepts the 
goods from the seller
• Buyer bears freight‐in
• Goods in transit : Buyer’s 
Inventory
Freight-in costs incurred by the buyer is part of cost of goods purchased.

Title passes at destination
Ownership remains with the seller 
until the goods reach the buyer 
• Seller bears freight‐out
• Goods in transit : Seller’s Inventory

Freight costs incurred by the seller are an operating expense.

23
 Cost of Goods Sold: Merchandising Company

Beginning inventory $ 15,000

Beginning Purchases of 
inventory + merchandise
+ Cost of goods purchased 63,000
= Cost of goods available for sale 78,000
– Ending inventory (18,000)
= = Cost of goods sold $ 60,000
Goods Available for Sale

“Pool” of goods
Less:  Ending inventory available to sell
during the period

Cost  An increase in ending 
of goods inventory means more 
was bought than sold
sold
24
 Merchandising Operations ‐ Flow of Costs and COGS 
Beginning Inventory + Cost of goods Purchased 
= Cost of goods Available for Sale   =  Cost of goods Sold + Ending Inventory

Ins Beginning Inventory Cost of goods Purchased

Cost of Goods 
Available for Sale
Outs Cost of Goods Sold Ending Inventory

Calculation of Cost of goods sold (COGS) - For Merchandising Company

Purchases net of Purchase Returns and Discounts 300000
Add: Freight inwards, Transit Insurance , Others like handling 4000
Charges (related to Purchases)
= Cost of goods Purchased 304000
Add: Opening Inventory 10000
= Cost of goods available for sale 314000
Less: Closing Inventory 4000
= Cost of goods sold 310000

Companies use either a perpetual inventory system or a periodic inventory system to 

account for inventory. 25
 Cost of Goods Sold : Manufacturing Company

Raw Material : Direct Material Cost Total Manufacturing Costs

Opening RM  + Opening WIP
+ RM Purchases (net) + Direct Labour Costs ‐ Closing WIP
+ Freight‐in, if any
‐ Closing RM + Manufacturing Exp
Incl. depreciation on = Cost of goods
= Raw Material 
factory assets manufactured
Consumed in 
production + Opening FG
= Total Manufacturing Costs
=  Goods available for 
Sale
‐ Closing FG
Conversion Costs
= Cost of Goods 
Sold (COGS)
26
Calculation of Cost of goods sold (COGS) ‐ For Manufacturing Company
Opening Raw Material 10000
Add: Raw Material Purchased net of Sales returns and Discounts 200000
Add: Freight in etc. 4000
Less: Closing Stock of Raw Material 7000
= Raw Material Consumed 207000

Add : Direct Labour cost or Direct wages 50000

Add: Manufacturing Expenses Conversion Cost 35000
= Total Manufacturing Costs 292000
Adjustment for WIP :
Add: Opening WIP 20000
Less: Closing WIP 30000
Adjustment for FG :
= Cost of goods manufactured 282000
Add: Opening Finished Goods 8000
= Cost of goods available for sale 290000
Less: Closing Finished Goods 10000
= Cost of goods sold 280000

27
 Self Assessment
Which of the following would not be a line item of a company reporting 
costs by nature?
a) Depreciation expense.
b) Salaries expense.
c) Interest expense.
d) Manufacturing expense.

Which of the following would not be a line item of a company reporting 
costs by function?
a) Administration.
b) Manufacturing.
c) Utilities expense.
d) Distribution.

28
Prepare correct income statement for JULY
The income statement of N for the month of July shows net income of $2,000 based on Service 
Revenue $5,500, Salaries and Wages Expense $2,100, Supplies Expense $900, and Utilities Expense 
$500. Owner’s Equity 15,000
In reviewing the statement, you discover the following:
1 Insurance expired during July of $350 was omitted.
2 Supplies expense includes $200 of supplies that are still on hand at July 31.
3 Depreciation on equipment of $150 was omitted.
4 Unpaid wages at July 31 of $360 were not included.
5 Services performed but unrecorded totaled $700.

Revenues Incorrect Corrections Corrected

Service Revenue 5500 700 6200

Expenses
Salaries and Wages Expense 2100 360 2460
Supplies Expense 900 ‐200 700
Utilities Expense 500 500
Insurance Expense 350 350
Depreciation on Equipment 150 150

Total Expenses 3500 660 4160

Net Income 2000 40 2040

Owner's Equity 15,000 40 15,040 29

Prepare correct income statement for JULY
The income statement of N for the month of July shows net income of $2,000 based on Service 
Revenue $5,500, Salaries and Wages Expense $2,100, Supplies Expense $900, and Utilities Expense 
$500. Owner’s Equity 15,000
In reviewing the statement, you discover the following:
1 Insurance expired during July of $350 was omitted.
2 Supplies expense includes $200 of supplies that are still on hand at July 31.
3 Depreciation on equipment of $150 was omitted.
4 Unpaid wages at July 31 of $360 were not included.
5 Services performed but unrecorded totaled $700.

Revenues Incorrect Corrections Corrected

Service Revenue 5500 700 6200

Expenses
Salaries and Wages Expense 2100 360 2460
Supplies Expense 900 ‐200 700
Utilities Expense 500 500
Insurance Expense 350 350
Depreciation on Equipment 150 150

Total Expenses 3500 660 4160

Net Income 2000 40 2040

Owner's Equity 15,000 40 15,040 30

 Product Cost and Period Cost
Product costs
• Are connected with production of goods  
– Includes Material cost, Labour cost and other costs incurred to convert the RM 
into Finished Goods
– Also called Inventoriable Cost
• Added to Inventory (assets) till the products are sold
• Charged to IS as and when goods are sold (Matching Principle)
– Cause and Effect relation with Sales, Important for ascertaining Gross Profits
– Do not have an impact on income until the product has been sold 
Period Costs
• Are costs associated with a given accounting period which are expenses in the 
period in which they are incurred
• Can not be traced to any revenue transaction during the period, No Cause & Effect 
relationship with Revenues
• General costs of being in the business like General and Administrative Expenses
What if there is difference of opinion in classifying a cost like Production Administration 
as Period cost or Product cost ?
31
 Inventory systems – Merchandising Company ‐ Flow of Costs 

Perpetual System Periodic System
• Maintain detailed records of the cost of  • Do not keep detailed records of the 
each inventory purchase and sale. goods on hand.
• Records continuously show inventory  • No Running account of changes in 
that should be on hand. inventory,  COGS not determined 
after every sale
• Company determines and records cost of 
goods sold each time a sale occurs.
• At the end of the accounting period, 
• Physical inventory count for verification  the ending inventory on hand is 
of accuracy of records
determined by physical count 

• Traditionally used for merchandise with  • and Cost of goods sold is calculated 
high unit values. at that time as follows :
• Provides better control over inventories  Beginning inventory $ 100,000
– identifies Inventory  Loss Add: Cost of goods
purchased 800,000
• Requires additional clerical work and  Goods available for sale 900,000
additional cost to maintain inventory  Less: Ending inventory 125,000
records. Cost of goods sold $ 775,000
32
 Comparison
Transactions related to Purchases

Cost of goods purchased

= 3800-300-70 +150 = 3580

Transactions related to Sales

 Gross Profits
• Cost of Goods Sold (COGS) : 
– Aggregate of cost of purchase or production of units sold and cost 
incurred to bring them to the location and condition of sales
– Matched with Revenues generated during the period, Product Cost

• Gross Profits  
= Net Sales – Cost of Goods Sold

• Comparison with past, Industry
– Gross Profit : Absolute
– Gross Profit/ Net Sales 
• Shows efficiency of 
– Pricing, Purchasing 
& Manufacturing Process
• Can also be improved by Operating Exp
34
Asian Paints Limited 

35
 Operating Expenses and Operating Income 
Expenses other than COGS that are incurred in running a business
General & Administrative Expenses
• Accounting, Personnel (Salaries)
• Credit & Collections
• Office rent, Dep on Office Equipm
•Expenses related to overall 
operations (Stationery, Telephone)
•Training Expenses

Selling Expenses
•Store Rent, Salary, travel expenses 
of Sales staff, Sales Commission,  
Delivery Expense
• Promoting sales, Advertising
• Freight out expense (FOB‐D), 
Depreciation  on store equipment

General Occupancy Expenses: Rent, 
Utilities, Insurance (To be allocated: 
Selling and Gen & Admn Expenses)
Research Expenses
Operating Profit: Gross Profit ‐ Operating Expenses
36
36
 Asian Paints Limited 

Infosys

Depreciation and amortization expense 2020 2019

2.1 Depreciation ‐ Property, Plant and equipment (1775) (1572)
2.2.2.Amortisation ‐ Other intangible assets (26) (27)
2.3 Depreciation‐ Right of use assets (Leases) (343)
2,144  1,599 

37
Asian Paints Limited  Infosys

38
 Earnings Before Interest and Taxes (EBIT) 
=  Operating Profit
+ Other Revenues and Gains 
– Other Expenses and Losses 

Other Income and Expenses: Non‐ operating Activities,  EBIT
Various revenues, expenses, gains and losses unrelated to company’s main line
of operations, Not part of a company’s operating activities
Other income and gains
Interest Income on securities (in case of a company other than a finance company)
Dividend Income (from investment in capital of other companies)
Gain on sale of investments, plant & equipment
Other non‐operating income (net of expenses directly attributable to such income) 
like Rent income
Other expenses and losses
Casualty losses from causes like vandalism, accidents
Loss from sale of investment, plant & equipment
Loss from strikes by employees, suppliers

39
Other Revenues and Expenses: Non‐ operating Activities
2.18 Other income, net INFOSYS
Asian Paints Limited  As at Mar 31,
Particulars
2020 2019
Interest income on financial assets carried at 
amortized cost
Tax‐free bonds and government bonds 138 137
Deposits with banks and others 1080 1276

Interest income on financial assets fair valued through 
other comprehensive income (FVOCI)
Non‐convertible debentures, commercial paper, 
certificates of deposit and government securities 282 581
Income on investments carried  at fair value through 
other
comprehensive income 41
Income on investments carried at fair value through 
profit or loss
Dividend  income on liquid mutual funds 2 2
Gain / (loss) on liquid mutual funds and other 
investments 188 175
Interest income on income tax refund 250 50
Exchange gains / (losses) on foreign currency forward 
and options contracts ‐528 184

Exchange gains / (losses) on translation of other assets 
and liabilities 1056 144
Miscellaneous income, net 191 303
2700 2852

when eBay sold the remainder of its investment in Skype
to Microsoft, it reported a gain in “Other revenues and 
gains” of $1.7 billion. Since eBay’s total income from 
operations was $2.4 billion, it was very important that 
the gain from the Skype sale not be buried in operating 
income.
 EBIT and EBT
Income before income taxes  (EBT)   =      EBIT – Interest Expense/Finance cost 

Asian Paints Limited 

INFOSYS : No Finance Costs

EBITDA  (Earning before interest, tax , depreciation and amortization)   

=      EBIT    +      Depreciation & Amortization
41
 EBT,  Taxes  and Net Income (PAT)
Income before income taxes  Amount a company has earned from all activities: operating and 
(EBT) non‐operating—before taking into account the amount of income 
taxes it incurred

Less   Provision for income taxes, represent the expense for taxes on 
Income taxes expense corporate income

Net income  “Bottom line” is what remains of the gross margin after
• operating expenses are deducted, 
• other revenues and expenses are added or deducted, and
• income taxes expense are deducted
• Represents  earnings that accrue to stockholders
• Amount transferred to Retained Earnings from IS

Asian Paints Limited  2020 2019 INFOSYS

PROFIT BEFORE TAX 3,413.03 3,170.25 2020 2019
Tax Expense 18 Profit before tax 20,477 19,927
(1) Current Tax 871.15 881.64 Tax expense
Current tax 2.16 5,235 5,189
(2) Short/ (Excess) tax provision for earlier years 5.66 ‐2.17
Deferred tax 2.16 ‐301 36
(3) Deferred Tax ‐117.73 158.61 Income tax expense 4,934 5,225
Total tax expense 759.08 1,038.08 Profit for the period 15,543 14,702
PROFIT AFTER TAX 2,653.95 2,132.17

Net income        =  Income before income taxes (EBT)  – Income taxes expense
PAT   =   EBIT    – Interest  Expense              – Income taxes expense 42
 Income 
Statement 
Presentation

• Net Profit Margin

= Net Income
Net Sales

Measures the
extent by which
selling price covers
all expenses

Show 
separately 
as finance 
cost

43
 Income Statement 20XX
Multiple Step Income Statement
• Sales Revenue
Continuation…                                                     20XX
Gross Sales  (Price per unit * Units sold)
Less: Sales Returns
OPERATING PROFIT 
or Profit from Operations
Net Sales ***
Add:   Other Income (Non‐Operating‐ **
Less: Cost of Goods Sold (COGS) : like Gain on sale of equipment)
• Raw Material Consumed (includes Interest Income)
(Opening + Purchases(Net of returns + Freight In)  Less:  **
– Closing) Other Expenses (Non‐Operating)
• Direct Labour Cost EBIT
(Earnings Before Interest and Taxes )
• Manufacturing Expenses (related to Factory) Less:  Interest Expense
• Adjustment for WIP  EBT (Earnings Before Tax)
(Add: Opening WIP Less: closing WIP)
Less: Income Tax
• Adjustment for FG
(Add: Opening FG, Less: closing FG) PAT
(Earnings  or Profits After Tax)
COGS ***
or (Net Income or Net Profits)
GROSS PROFIT
Add: Other Operating Income (if any) **
Less: Operating Expenses (SG&A) **
OPERATING PROFIT  44
 Income Statement 20XX
Multiple Step Income Statement
• Sales Revenue
Continuation…                                                     20XX
Gross Sales  (Price per unit * Units sold)
Less: Sales Returns
OPERATING PROFIT 
or Profit from Operations
Net Sales ***
Add:   Other Income (Non‐Operating‐ **
Less: Cost of Goods Sold (COGS) : like Gain on sale of equipment)
• Raw Material Consumed (includes Interest Income)
(Opening + Purchases(Net of returns + Freight In)  Less:  **
– Closing) Other Expenses (Non‐Operating)
• Direct Labour Cost EBIT
(Earnings Before Interest and Taxes )
• Manufacturing Expenses (related to Factory) Less:  Interest Expense
• Adjustment for WIP  EBT (Earnings Before Tax)
(Add: Opening WIP Less: closing WIP)
Less: Income Tax
• Adjustment for FG
(Add: Opening FG, Less: closing FG) PAT
(Earnings  or Profits After Tax)
COGS ***
or (Net Income or Net Profits)
GROSS PROFIT
Add: Other Operating Income (if any) **
Less: Operating Expenses (SG&A) **
OPERATING PROFIT  45
 Missing Figures
E‐5‐7 (page 221) YANIK  NUNNEZ

Sales 90,000 105,000

Sales returns and allowances (6,000) (5,000)
Net sales 84,000 100,000
Cost of goods sold (58,000) 60,000
Gross profit 26,000 40,000
Operating expenses (14,380) 23,000
Net income 11,620 17,000

Yanik Nunez

$11,620 ÷ $84,000  $17,000 ÷ $100,000 

Profit margin  = 14% = 17%

$26,000 ÷ $84,000  $40,000 ÷ $100,000 

Gross profit rate = 31% = 40%

46
Comprehensive Income  = Net Income  + OCI
The Statement of Profit and Loss shall include (Sch. III of Companies Act 2013) :
(1) Profit or loss for the period (NI);  (2) Other Comprehensive Income (OCI) for the period.
The sum of (1) and (2) above is ‘Total Comprehensive Income’
Asian Paints Limited 

INFOSYS

Comprehensive Income : All changes in the equity (or Net Assets) of the company due to transactions 
with non‐owners: 
 Transactions that affect stockholders’ equity, but are not stock transactions
 (OCI) includes items not allowed to be recognized in the Income Statement 47
 Comprehensive income 

Beginning Equity + or – Change = Ending Equity

Retained earnings + Net income Retained earnings
– Dividends
Accumulated other  + Other comprehensive  Accumulated other 
comprehensive income income comprehensive income
– Other comprehensive loss
Share Capital + Issuances  Share Capital
– Repurchases

48
 Comprehensive income: Example

Assume the following about a company:
-beginning shareholders’ equity is €200 million
-net income for the year is €20 million
-cash dividends for the year are €3 million
-no issuance or repurchase of common stock. 
-actual ending shareholders’ equity is €227 million.

 What amount has bypassed the net income calculation by being 
classified as other comprehensive income?
Answer: €10 million.

 What is the company’s comprehensive income?

Answer: €30 million

49
 Asian Paints Limited : Statement of Profit and Loss for the year ended March 31st

Task: Prepare Multi‐step Income Statement for Asian Paints and check whether you got the net profit correct. 

Make the following Assumptions :
1. 60% of Employees Benefit Expense relates to workers and employees directly engaged with production (in factories)
2. 80% of Depreciation and Amortization are product costs
3. Repairs and maintenance, Rates and taxes, Water Charges fully relates to factory
4. 50% of Rent and amenity charges relates to production
5. 90% of Insurance & 70% of Electricity expenses relates to PP&E in Factory
6. 40% of Security expenses relates to factory
 Assignment Questions for Chemalite Case:

1. Prepare T accounts to record the transactions of Chemalite during its pre‐

operation period as well as for the full year 2003. Compute the closing balances
of each account and prepare the Adjusted Trial Balance.

2. Recording of the some of these transactions would have involved you making
one or more assumptions. Identify such transactions and explain the
assumptions.

3. Prepare Multi‐Step Income Statement, Classified Balance sheet, and Statement

of Retained Earnings for the year ended 31st Dec 2003.

4. Explain the change in cash. How much of the total change in cash is related to
operations? How much is related to financing? How much is related to
investing?

5. Use 3) and 4) above to help perplexed Alexander explain to the stockholders

why Chemalite’s bank account did not support Alexander’s feeling that “things
were going well”.

51
Thanks 
Corporate Financial Reporting & Analysis

Session 10 B: MBA 2020
Preparing and Understanding Balance Sheet
 Learning Goals
• Elements of Balance Sheet – A quick revision
• Describe alternative formats of balance sheet presentation (including format as 
per Schedule III, Division II of Companies Act 2013)
• Preparation and Understanding of Classified Balance Sheet (or Statement of 
Financial Position)
– Total Assets : 
• Distinguish between Current Assets and Non‐Current Assets
– Total Liabilities: 
• Distinguish between Current Liabilities and Non‐Current Liabilities
– Components of shareholders’ equity
• Share Capital: Common (Equity) shares, Preference shares, Other Equity
• Bonus Share, Stock Split, Share Buyback
• Some Important Concepts and their computation: 
– PP&E, Net Working Capital, Net Worth, Total Borrowings, Financial assets, 
Financial Liabilities, Receivables net of Allowance for doubtful debt 
• Standalone Balance Sheets ‐ Asian Paints and Infosys
• Discussion on selected Assignments
• Chemalite Inc. Case 2
NON-CURRENT LIABILITIES
 Long Term Liabilities
• Obligations a company reasonably expects to pay at least after one year in the future 
or beyond the normal operating cycle (typically will be paid out of noncurrent assets)
• Primarily in the nature of long‐term financing like Long term Borrowings,  Notes 
Payables, Debentures or Bonds payable, Term Loans from banks or others 
– Secured Loans : Loans secured by mortgage of assets ‐ Mortgage Payable
• Deferred Tax Liability: Taxes Payable is future arising from Taxable Temporary 
difference  (Always non‐current in nature)
• Lease Liabilities (Lease payments due) and Pension Liabilities (for pension benefits 
payable to employees)

Non‐current liabilities
a Financial liabilities
i Borrowings

ii Trade payables

iii Other financial liabilities

b Provisions
c Deferred tax liabilities (net)
d Other non‐current liabilities
53
2.12 Other financial liabilities 2020 2019 DEFERRED INCOME TAX ASSETS 2020 2019
NON-CURRENT Property, plant and equipment         203         223
Others
 Trade receivables         182         164
Compensated absences 32 38
Accrued compensation to employees 12 - Compensated absences         380         349
Payable for acquisition of business - Contingent consideratio - 41 Post‐sales client support         101           95
Rental deposit 5 - Derivative financial instruments              4             4
TOTAL NON-CURRENT OTHER FINANCIAL LIABILITIES 49 79 Credits related to branch profits         377         340
CURRENT others           93           93
Unpaid dividends 30 29 Deferred Income Tax Assets     1,340     1,268
Others
Intangibles ‐ ‐
Accrued compensation to employees 2264 2006
Accrued expenses (1) 2646 2310 Branch profit tax       ‐541       ‐505
Retention monies 30 60 Derivative financial instruments       ‐106            ‐1
Payable for acquisition of business -Contingent consideratio 151 75 Others          ‐48            ‐7
Capital creditors 254 653 TOTAL DEFERRED INCOME TAX Liabilities       ‐695       ‐513
Financial Liability relating to buyback - 1202
Deferred income tax assets after set off     1,429     1,114
Compensated absences 1,497 1,373
Other payables (2) 603 807
Deferred income tax liabilities after set off         556         541
Foreign currency forward and options contracts 461 13
TOTAL CURRENT OTHER FINANCIAL LIABILITIES 7936 8528
TOTAL FINANCIAL LIABILITIES 7985 8607

2.14 Other liabilities 2020 2019

NON‐CURRENT
Accrued provident fund liability 185
Deferred income 22 29
Deferred rent ‐ 140 Infosys 2020
TOTAL NON‐CURRENT OTHER LIABILITIES 207 169
CURRENT Non‐current liabilities 2020 2019
Accrued provident fund liability 64 Financial liabilities
Unearned revenue 2140 2094 Lease liabilities 2.3 2,775 
Client deposits 9 19
Others Other financial liabilities 2.12 49  79 
Withholding taxes and others 1344 1168 Deferred tax liabilities (net) 2.16 556  541 
Deferred rent ‐ 54
TOTAL CURRENT OTHER LIABILITIES 3557 3335 Other non‐current liabilities 2.14 207  169 
55
TOTAL OTHER LIABILITIES 3764 3504 Total non‐current liabilities 3,587  789 
2020 ASIAN PAINTS

56
ASIAN PAINTS

57
EQUITY
 Equity Financing vs Debt Financing 
Equity Debt
Advantages Advantages
• Less risky than financing with debt • Shareholders’ control is not  affected
• Dividends do not have to be paid unless board  ‐ Bondholders don’t have voting rights – Full 
declares them  control retained by current SH
• Cash generated by profitable operations can be  • Tax Savings ‐ Interest is tax deductible
reinvested back into the company. • Helps to expand 
• Protection to debt‐holders • Often Higher EPS, ROE
Disadvantages
Disadvantages
• Debt requires interest payments
• Dividends paid on stock are not 
‐ Company must pay the fixed charges in
tax‐deductible 
good times as well as in bad times
• Issuance of stock dilutes ownership 
• Debt reduces Solvency  
‐ In periods of low earnings and weak cash
position – may call for bankruptcy
X currently has 100,000 shares of common 
stock o/s issued at $25 per share and no 
debt (SE= $2500,000). 
It is considering two alternatives for raising 
an additional $5 million: 
Plan A: 200,000 shares of common stock at 
$25 per share. 
Plan B: $5 million of 12% bonds at face value.  59
EPS                                                                                     1050/300=   3.5                 630/100= 6.3
 Equity:  Share Capital – Issuance of Shares
Stockholders’ Equity = Contributed Capital + Retained Earnings + Accumulated OCI
Contributed capital (Paid‐in Capital) is generally shown as two amounts: 
• The par value of the issued stock and India: Shareholders' Equity = Equity Share Capital + Other Equity
• The Additional paid‐in capital in excess of par (called Share/securities Premium in India ‐ Reserves)
• Authorised Capital and Face Value
– Maximum amount of capital that the company is authorised to issue to its shareholders during its 
life – part remains unissued
Par value per share : Set when the stock is 
– Mentioned in Memorandum of Association  authorized, establishes a company’s legal 
• Large authorised capital signals ?  Ambition to grow large  capital 
– Face Value or Par value is the value assigned per share 
= Authorized capital amount / Max number of shares that can be issued
• Issued Capital: Part of the ‘Authorized capital’ which has been issued to investors for subscription
• Subscribed & fully paid up: Part of the ‘issued capital’ which has been subscribed by investors, fully paid 
XYZ issued 20,000 shares of $10 par value common stock for cash at $12 per share
Issuance of common stock affects paid‐in capital accounts
New Common Stock, or 
Cash  (20,000 shares x $12)                                                            Dr.      240,000 Equity Share capital  Issue
Common stock (20,000 x $10) (Equity Share Capital)                Cr.                        200,000
Additional Paid‐in capital (Equity Share Premium ‐Reserves)  Cr.                          40,000
Contributed capital US 
Common stock, $10 par value, 20,000 shares authorized, issued, and outstanding                             $200,000          
Additional paid‐in capital 40,000
Total contributed capital $240,000
Retained earnings 153,732 
Total stockholders’ equity 393,732   60
 Shareholders’ Equity:   Equity & Other Equity
1)  Share Capital  (Equity and Preference) Less: Treasury Stock if any
2)  Other Equity
 Reserves & Surplus
– Capital Reserve : Not available for distribution of dividend (capital profits)
– Share (Securities) Premium (Addln paid in capital ‐ US) ‐ Reported as part of Reserves
– Revenue Reserve : Reserve other than capital reserve ( Example: General reserve)
– Other Reserves created for specific purpose like Capital Redemption Reserve
– Retained Earnings ‐ Surplus or deficit in Profit and Loss Account
Opening Balance
Add: Net Profit for the period
Less: Dividends
Less: Transfers to say, General Reserve or Debenture Redemption Reserve
Closing Balance ( Can have a negative balance ?)
 Other Comprehensive Income – Accumulated (AOCI) (Items which bypass Income Statement)

Movement in Shareholders’ Equity
Beginning SH’s Equity + or – Change = Ending SH’s Equity
1) EQUITY + Issuances  EQUITY
Beg Stock / Share Capital – Repurchases End Stock/ Share Capital
2) OTHER EQUITY  + Net income OTHER EQUITY 
Beg Retained earnings and other  – Dividends End Retained earnings and other 
Reserves Reserves
Beg Accumulated other  + Other comprehensive income End Accumulated other 
comprehensive income – Other comprehensive loss comprehensive income
61
 Shareholders’ Equity:   Equity & Other Equity
1)  Share Capital  (Equity and Preference) Less: Treasury Stock if any
2)  Other Equity
 Reserves & Surplus
– Capital Reserve : Not available for distribution of dividend (capital profits)
– Share (Securities) Premium (Addln paid in capital ‐ US) ‐ Reported as part of Reserves
– Revenue Reserve : Reserve other than capital reserve ( Example: General reserve)
– Other Reserves created for specific purpose like Capital Redemption Reserve
– Retained Earnings ‐ Surplus or deficit in Profit and Loss Account
Opening Balance
Add: Net Profit for the period
Less: Dividends
Less: Transfers to say, General Reserve or Debenture Redemption Reserve
Closing Balance ( Can have a negative balance ?)
 Other Comprehensive Income – Accumulated (AOCI) (Items which bypass Income Statement)

Movement in Shareholders’ Equity
Beginning SH’s Equity + or – Change = Ending SH’s Equity
1) EQUITY + Issuances  EQUITY
Beg Stock / Share Capital – Repurchases End Stock/ Share Capital
2) OTHER EQUITY  + Net income OTHER EQUITY 
Beg Retained earnings and other  – Dividends End Retained earnings and other 
Reserves Reserves
Beg Accumulated other  + Other comprehensive income End Accumulated other 
comprehensive income – Other comprehensive loss comprehensive income
62
Infosys 2020

63
Infosys 2020
Statement of Changes in Equity

60,244 ‐139 = 60,105
2129 + 60,105= 62,234

64
ASIAN PAINTS
Statement of Changes in Equity

9186.26 + 171.11 =9357.37

67
 Some Calculations
• Property, Plant & Equipment (net) 
NCV = GCV of PP&E – Accumulated Depreciation
• Capital Work in Progress is not yet PP&E
• Working Capital  (or Net Current Assets) =  Current Assets ‐ Current Liabilities
• Net Worth or Shareholders’ Equity: 
= Contributed Capital (Capital Stock + Additional Paid‐in Capital)  + Retained Earnings         [US]
or   =  Share Capital   +  Other Equity  [=Reserves and Surplus (including Securities Premium, Surplus 
in P/L or Retained earnings, other  reserves like General Reserve) + AOCI] India     
= Total Assets – Total Liabilities = NET ASSETS   
= Non‐Current Assets ‐ Non‐Current Liabilities + Working Capital
Book value per share : The equity a common stockholder has in the net assets of the corporation from 
owning one ordinary/ common share
= [Shareholders Equity‐ Preferred Equity (if any)]/ Number of common shares outstanding
• Capital Employed:  
– Net Worth +  Non‐current liabilities (typically Long‐term, Interest Bearing Debt)
– Total Assets  – Current Liabilities
– Non‐Current Assets + Working Capital
• Borrowings:
– Long Term Borrowings,  Short‐term Borrowings, Current Maturity of Long‐term borrowings 
(OFL) , Redeemable Preference Shares 68
Calculations ‐ Asian Paints 2020 2019 Growth Alternatively 2020 2019 Growth
Property, plant and equipment  Capital Employed
5,734 5,532
Gross Carrying value  3.65% Total Assets  13,587.62 13,682.89  ‐0.7%

Less: Accumulated Depreciation  1,585 1,102 Less:  Current Liabilities 3,195  3,841  ‐16.8%

Net Carrying Amount 4,149 4,431 ‐6.37% 10,393  9,841  5.6%

Net Working Capital or Net Current Assets

Current Assets 5,826 6,053 ‐3.76%

Current Liabilities 3,195 3,841 ‐16.83% Net Assets

CA‐CL 2,631 2,212 18.93% Total Assets 13,588  13,683  ‐0.7%

Less: Total Liabilities  4,134  4,840  ‐14.6%

Net Worth 9,453  8,843  6.9%

Equity Share capital 96 96 0.00%

Other Equity 9,357 8,747 6.98% Inter‐relationship

9,453 8,843 6.90% Non‐current Assets  7,762  7,630  1.7%

Capital Employed Add: Net current Assets 2,631  2,212  18.9%

Net Worth 9,453 8,843 6.90% Capital Employed 10,393  9,841  5.6%

Add: Non‐current Liabilities 939 999 ‐5.93% Less: Non‐current Liabilities 939  999  ‐5.9%

10,393 9,841 5.60% Net Worth  9,453  8,843  6.9%

Calculations ‐ INFOSYS 2020 2019 Growth Alternatively 2020 2019 Growth
Property, plant and equipment  Capital Employed

Gross book value  22,763  20475 11.2% Total Assets  81,041  78,930  2.7%

‐
Less: Accumulated Depreciation  ‐11671 10,081  Less:  Current Liabilities 15,220  15,430  ‐1.4%

11,092  10,394  6.7% 65,821  63,500  3.7%

Net Working Capital or Net Current Assets

Current Assets 43,820  46,223 

Current Liabilities 15,220  15,430  Net Assets

CA‐CL 28,600  30,793  ‐7.1% Total Assets 81,041  78,930  2.7%

Less: Total Liabilities (C+NC) 18,807  16,219  16.0%

Net Worth 62,234  62,711  ‐0.8%

Equity Share capital 2,129  2,178 

Other Equity 60,105  60,533  Inter‐relationship

62,234  62,711  ‐0.8% Non‐current Assets 37,221  32,707  13.8%

Capital Employed Add: Net current Assets 28,600  30,793  ‐7.1%

Net Worth 62,234  62,711  Capital Employed 65,821  63,500  3.7%

Add: Non‐current Liabilities 3587 789  Less: Non‐current Liabilities 3587 789 354.6%

65,821  63,500  3.7% Net Worth  62,234  62,711  ‐0.8%

70
 More on Stockholders’ Equity: 
Cash Dividend, Stock dividend , Treasury Stock and Stock Split

71
Stockholders earn a return on their investment by:
Dividends are not guaranteed
• Receiving dividends, and
• By selling shares for more than they paid for them (capital gains)

Cash Dividends
Distributions to stockholders of a corporation’s assets that are generated by earnings
For a corporation to pay a cash dividend, it must have: Pro‐ rata:  Dividend  paid in 
1. Adequate Retained earnings proportion to the ownership
2. Adequate cash (Need of cash for expansion, handling uncertainties‐lawsuits)
3. Declaration by the Board of Directors (senior managers have influence) and 
approval by SH
Illustration:  On Dec. 1, the directors of Media General declare a 50¢ per share cash dividend on 
100,000 shares of $10 par value common stock. The dividend is payable on Jan. 20 to shareholders of 
record on Dec. 22:
December 1 (Declaration Date) Dr Cr.
(Cash) Dividends  (Reduces Retained Earnings) Dr. 50,000
Dividends payable (Creates Current Liability) 50,000
December 22 (Record Date) No entry
January 20 (Payment Date) Dr Cr.
Registered SHs eligible for dividends
Dividends payable   (CL Reduces) Dr. 50,000
72
Cash                  (CA Reduces)  50,000
 Stock Dividends or Issue of Bonus Shares
Proportional distribution of shares among corporation’s stockholders
Reasons why corporations issue stock dividends:
1. Satisfy stockholders’ dividend expectations without spending cash.
‐ Gives stockholders some evidence of the company’s success without reducing working capital 
2. Increase the marketability of the corporation’s stock. 
– Reduces the stock’s market price by increasing the number of shares outstanding
3. Emphasize that a portion of stockholders’ equity has been permanently reinvested in the 
business – not available for cash dividend 

Bonus Shares (1:10) ‐> 1500 shares Before Effect After Retained Earnings (Reserves and Surplus) Dr  15,000

Share Capital (common Stock) (PV:Rs10)        150,000 15000      165,000 Common stock (Share capital)                  Cr.   15,000
Reserves & Surplus (Retained Earnings)        300,000 ‐15000      285,000
Total SE        450,000      450,000
Shares Outstanding (A)           15,000 1500        16,500 Total stockholders’ equity remains the 
From a single Shareholder's point of view same (before & after a stock dividend) 
Say, Shares owned (B) 500 50 550 Changes the composition of 
Percentage Ownership (B/A) 3.33% 3.33% stockholders’ equity. 
Number of shares owned increases, % of company owned remains the same

– No effect on the par/ face value per share, Total Liabilities or Earnings
– No effect on Total Assets : The assets of a corporation are not reduced as they would have been if a 
cash dividend had been declared and paid

Results in decrease in retained earnings and  increase in contributed capital 
 Stock Split
Subdivision of shares into smaller denomination 
• Increases the number of shares of stock  ‘Issued & outstanding’ and  reduces 
the par value  in the same proportion
• Has the effect of lowering a stock’s market value per share and increasing the 
demand for the stock at this lower price
• No entry recorded for a stock split – No effect on Equity
No effect on : Balance Sheet, Income Statement or Cash flow Statement except
• adjustment in number of shares and par value
Stock split changes par value per share but does not affect any balances in stockholders’ equity accounts

Illustration: Medland splits its 50,000 shares of common stock on a 2‐for‐1 basis.

74
 Stock Split Illustrated
July 15: MUI Corporation’s 15,000 shares of $5 par value common stock issued 
and outstanding were split 2 for 1.
Common Stock Before Stock Split After Stock Split
Shares issued and outstanding 15,000 30,000
Par value per share $5.00 $2.50
Amount of common stock equity $75,000 $75,000
Each stockholder’s proportionate interest in  A stock split does not increase the 
the company remains the same because  authorized capital, nor does it change the 
each share of $5 par value stock was  balances in the  accounts in the 
converted to 2 shares of $2.50 par value  stockholders’ equity section of the balance 
stock. sheet.

No journal entry required, memorandum entry is appropriate.

Stock Spilt‐
Asian Paints 
– 30‐Jul‐2013

75
 Comparison: Stock Dividend and Stock Split

DIFFRENCE :
– A stock dividend changes the makeup of stockholders’ equity in that it 
transfers capital from retained earnings to permanent capital accounts. 
– A stock split does not change the makeup or balances of stockholders’ 
equity
SIMILARITY:
– Stock splits and stock dividends reduce earnings per share because they 
increase the number of shares issued and outstanding. 

Stock Dividend Stock Split
Retained Earnings  Decrease Same
Common Stock Increase Same
Par Value Per Share Same Decrease

76
 Comparison: Stock Dividend and Stock Split

DIFFRENCE :
– A stock dividend changes the makeup of stockholders’ equity in that it 
transfers capital from retained earnings to permanent capital accounts. 
– A stock split does not change the makeup or balances of stockholders’ 
equity
SIMILARITY:
– Stock splits and stock dividends reduce earnings per share because they 
increase the number of shares issued and outstanding. 

Stock Dividend Stock Split
Retained Earnings  Decrease Same
Common Stock Increase Same
Par Value Per Share Same Decrease

77
 Accounting for Treasury Stock or Buy Back
Treasury stock ‐ Corporation’s own stock that it has reacquired from shareholders, but 
not retired. Repurchase of a company’s own 
Why Corporations purchase their outstanding stock ? stock off the open market
1. To have stock available so that they can be reissued to officers and employees 
under bonus and stock compensation plans.
2. To maintain a favourable market for company’s stock  
3. To have additional shares available for use in acquiring other companies.
4. To increase earnings per share by reducing the number of shares O/S.
5. To prevent a  hostile takeover.

• Generally accounted for by 
• Debiting Treasury Stock for the price paid. (credit Cash)
• Treasury stock is a contra stockholders’ equity account, not an asset.
• Purchase of treasury stock reduces stockholders’ equity and assets (cash)
• No voting rights or Dividends 
TCS: The Board of Directors of the Company at its meeting held on February 20, 2017, has approved 
buyback up to 56,140,351 equity shares of Re 1 each, on a proportionate basis, at a price of Rs
2,850 per equity share (AR 2017 – buy back in May 2017)
78
 Accounting for Treasury Stock

Number of 
shares issued  Mead acquires 4,000 shares of its stock at $8 per share.
has not  Treasury stock (4,000 x $8) Dr. 32,000
Cash Cr. 32,000
changed,

Even though 
the number 
of shares 
outstanding 
has 
decreased.

79
 Impact ‐ Summarized

Bonus
Buy Back or Issue or
New Share Treasury Cash Stock
Impact Issue Stock Dividend Dividend Stock Split

Number of Shares
1 Outstanding Increase Decrease Same Increase Increase

2 EPS Decrease Increase Same Decrease Decrease

3 Par Value per Share Same Same Same Same Decreases

Equity Share Capital

4 or Common stock Increase Not shown Same Increase Same

5 Retained Earnings Same Separately Decrease Decrease Same

Net Worth or Share

6 Holders' Equity Increase Decrease Decrease Same Same

80
 Impact ‐ Summarized

Bonus
Buy Back or Issue or
New Share Treasury Cash Stock
Impact Issue Stock Dividend Dividend Stock Split

Number of Shares
1 Outstanding Increase Decrease Same Increase Increase

2 EPS Decrease Increase Same Decrease Decrease

3 Par Value per Share Same Same Same Same Decreases

Equity Share Capital

4 or Common stock Increase Not shown Same Increase Same

5 Retained Earnings Same Separately Decrease Decrease Same

Net Worth or Share

6 Holders' Equity Increase Decrease Decrease Same Same

81
EXTRA – Not part of syllabus

82
 Accounting for Treasury Stock

Number of 
shares issued  Mead acquires 4,000 shares of its stock at $8 per share.
has not  Treasury stock (4,000 x $8) Dr. 32,000
Cash Cr. 32,000
changed,

Even though 
the number 
of shares 
outstanding 
has 
decreased.

In INDIA – for typical Buy Back :  General Reserve  Dr (5*4000 shares)  20,000

Equity Share Capital Dr  (FV:  ₹ 5 * 4,000 shares)        20,000     Capital Redemption Reserve  (FV)          20,000
General Reserve       Dr   ( Excess: ₹ 3 * 4000 shares)  12,000
Bank (8*4000shares)                   32,000 83
17‐09‐2020 IIMC 2015 – Prof. Arpita Ghosh 84
 Corporate Financial Reporting

Session‐ 11A : IIMC‐MBA‐2020
Financial Statement Analysis: 
Horizontal & Trend analysis and Common Size Statements 

1
 Learning Goals for Sessions on FSA
Standards of Comparison
Tools:
1. Horizontal Analysis and Trend Analysis
2. Vertical Analysis and Common size statements
3. Ratio Analysis – Calculation and Interpretation
– Liquidity and Cash Flow Ratios
– Efficiency or Turnover Ratios
– Leverage Ratios
– Profitability and Cost Structure Ratios
• DuPont Analysis of ROE 
– Market Ratios
• Assignments 

2
 Horizontal Analysis
• Purpose - To determine increase or decrease that has taken place.

– Computes changes from the previous year to the current year in both
absolute dollar amounts and percentages (The base year is the first year 
considered) 

• Commonly applied to the balance sheet and income statement.

Amount of Change since base year

= Current Year Amount – Base Year Amount

 Amount of Change 
Percentage Change  100   
 Base Year Amount 

$ % 3
 Horizontal Analysis: Income Statement

Percentage 
change
from one year 
to
the next year

Dollar change 
from 
year to year

Asian Paints Limited
Income Statement ( Multi step ‐ functionwise)    Change 
for the year ended 31st March   (Rs in crores) 2020 2019 2020‐2019 Growth % CS 2020 CS 2019
Net Sales (Work1)    17,025.61    16,209.44 816.2 5.04 100.0 100.0
Less: COGS   (Work2)  ‐11,074.63  ‐10,772.01 302.6 2.81 ‐65.0 ‐66.5
Gross Profit     5,950.98     5,437.43 513.5 9.44 35.0 33.5
   Other Operating Revenues IS          168.48          182.34 ‐13.9 ‐7.60 1.0 1.1
   Operating Expenses  (Work3)     ‐2,952.39    ‐2,655.73 296.7 11.17 ‐17.3 ‐16.4
Operating Profit       3,167.07      2,964.04 203.0 6.85 18.6 18.3
  Non‐Operating items:  Other Income   IS          357.54          284.81 72.7 25.54 2.1 1.8
EBIT      3,524.61      3,248.85 275.8 8.49 20.7 20.0
 Less: Finance Costs   IS           ‐78.38          ‐78.60 ‐0.2 ‐0.28 ‐0.5 ‐0.5
Profit Before Exceptional Items and Tax     3,446.23     3,170.25 276.0 8.71 20.2 19.6
Exceptional Items (Net) IS           ‐33.20                ‐ 33.2 ‐0.2 0.0
 EBT or PBT ( Profit before Tax )      3,413.03      3,170.25 242.8 7.66 20.0 19.6
 Tax Expenses  IS        ‐759.08    ‐1,038.08 ‐279.0 ‐26.88 ‐4.5 ‐6.4
4
PAT      2,653.95      2,132.17 521.8 24.47 15.6 13.2
 Asian Paints Limited HA: Classified BALANCE SHEET
ASSETS 2020 2019 Change % Change CS20 CS19
NON-CURRENT ASSETS
Property, Plant and Equipment 2A 4,148.60 4,430.62 -282.02 -6.37 30.53 32.38
Right of Use Asset 2B 726.63 700.61 26.02 3.71 5.35 5.12
Capital work-in-progress 108.09 179.31 -71.22 -39.72 0.80 1.31
Goodwill 3A 35.36 35.36 0.00 0.00 0.26 0.26
Other Intangible Assets 3B 50.27 54.61 -4.34 -7.95 0.37 0.40
Investments in Subsidiaries and Associates 4 1,176.99 830.35 346.64 41.75 8.66 6.07
Financial Assets
Investments 4 1,048.59 987.02 61.57 6.24 7.72 7.21
Loans 5 64.11 76 -11.89 -15.64 0.47 0.56
Other Financial Assets 6 232.47 220.7 11.77 5.33 1.71 1.61
Current Tax Assets (Net) 7 137.94 81.48 56.46 69.29 1.02 0.60
Other Non-current assets 8 32.87 33.48 -0.61 -1.82 0.24 0.24
Total non-current assets 7,761.92 7,629.54 132.38 1.74 57.12 55.76
CURRENT ASSETS
Inventories 9 2,827.47 2,585.10 242.37 9.38 20.81 18.89
Financial Assets
Investments 4 432.35 1,146.63 -714.28 -62.29 3.18 8.38
Trade Receivables 10 1,109.22 1,244.95 -135.73 -10.90 8.16 9.10
Cash and Cash Equivalents 11A 336.96 98.33 238.63 242.68 2.48 0.72
Other Balances with Banks 11B 39.1 69.19 -30.09 -43.49 0.29 0.51
Loans 5 21.31 13.98 7.33 52.43 0.16 0.10
Other Financial Assets 6 846.96 567.63 279.33 49.21 6.23 4.15
Assets classified as Held for Sale - -
Other Current Assets 8 212.33 327.54 -115.21 -35.17 1.56 2.39
5,825.70 6,053.35 -227.65 -3.76 42.88 44.24
Total Assets 13,587.62 13,682.89 -95.27 -0.70 100.00 100.005
 Asian Paints Limited HA: Classified BALANCE SHEET continued

EQUITY AND LIABILITIES 2020 2019 Change % Change CS20 CS19

EQUITY
Equity Share Capital 12 95.92 95.92 0.00 0.00 0.71 0.70
Other Equity 13 9,357.37 8,747.04 610.33 6.98 68.87 63.93
9,453.29 8,842.96 610.33 6.90 69.57 64.63
LIABILITIES
Non-Current Liabilities
Financial Liabilities
Borrowings 14 18.5 10.89 7.61 69.88 0.14 0.08
Lease Liabilities 15 496.22 473.86 22.36 4.72 3.65 3.46
Other Financial Liabilities 16 0.46 1.38 -0.92 -66.67 0.00 0.01
Provisions 17 136.78 118.48 18.30 15.45 1.01 0.87
Deferred Tax Liabilities (Net) 18C 282.68 392.39 -109.71 -27.96 2.08 2.87
Other Non-current Liabilities 19 4.64 1.52 3.12 205.26 0.03 0.01
939.28 998.52 -59.24 -5.93 6.91 7.30
Current Liabilities
Financial Liabilities
Borrowings 14 - 4.35 0.03
Lease Liabilities 15 142.43 125.22 17.21 13.74 1.05 0.92
Trade Payables
Total Outstanding dues of MSE 20 45.86 42.22 3.64 8.62 0.34 0.31
Total Outstanding dues of creditors other than MSE 20 1,714.22 2,020.07 -305.85 -15.14 12.62 14.76
Other Financial Liabilities 16 1,118.89 1,429.38 -310.49 -21.72 8.23 10.45
Other Current liabilities 19 80.92 119.23 -38.31 -32.13 0.60 0.87
Provisions 17 44.14 52.27 -8.13 -15.55 0.32 0.38
Current Tax Liabilities (Net) 21 48.59 48.67 -0.08 -0.16 0.36 0.36
3,195.05 3,841.41 -646.36 -16.83 23.51 28.07
6
Total Equity and Liabilities 13,587.62 13,682.89 -95.27 -0.70 100.00 100.00
 Trend Analysis
A type of horizontal analysis in which percentage changes are calculated 
for several successive years instead of for just two years
• Important because it may point to basic changes in the nature of a
business
• Uses an index number to show changes in related items over a period of 
time
• Current Results in relation to Base year: 
Index  =   100   *   Current Year Amount
Base Year amount
Asian Paints Limited
 (Rupees  in crores) 2020 2019 2018 2017 2016 2015 2014 2013 2012 2011
Net Revenue from Operations 17,194.10 16,391.80 14,153.70 12,722.80 11,830.30 11,648.80 10,418.80 8,960.10 7,964.20 6,336.10
PBT 3,413.00 3,170.30 2,865.80 2,656.70 2,403.10 1,933.60 1,702.60 1,515.90 1,362.90 1,122.30
TREND ANALYSIS 
Net Revenue from Operations 271% 259% 223% 201% 187% 184% 164% 141% 126% 100%
PBT 304% 282% 255% 237% 214% 172% 152% 135% 121% 100%
XYZ Company

7
 Vertical Analysis
• Shows how the different components of a financial statement relate to a 
total figure in the statement 
• Expresses each financial statement item as a percent of a base amount
• Commonly applied to the balance sheet and the income statement.
– On the balance sheet, set total assets or (TL +SE) to 100 . 
– On the income statement, set net sales to 100 
– The resulting statement, expressed entirely in percentages
• is called a common‐size statement

• The total figure in the statement set to equal to 100 
– Each component’s percentage of that total is computed
• Useful for comparing
– The importance of specific components in the operation of a business
– Changes in the components from one year to the next

8
Comparative Analysis 
‐ Intercompany Comparison by vertical analysis

Vertical analysis 
also enables a 
comparison of 
companies of 
different sizes and 
companies 
reporting in 
different 
currencies.

Although Chicago Cereal’s net sales are less than those of General Mills, vertical 
analysis eliminates the impact of this size difference for our analysis.

9
 Asian Paints Limited
Income Statement ( Multi step ‐  2020 2019 CS 2020 CS 2019
Net Sales    17,025.61   16,209.44 100.0 100.0
Less: COGS    ‐11,074.63  ‐10,772.01 ‐65.0 ‐66.5
Gross Profit      5,950.98      5,437.43 35.0 33.5
   Other Operating Revenues         168.48         182.34 1.0 1.1
   Operating Expenses      ‐2,952.39    ‐2,655.73 ‐17.3 ‐16.4
Operating Profit       3,167.07      2,964.04 18.6 18.3
  Non‐Operating items:  Other Income           357.54         284.81 2.1 1.8
EBIT      3,524.61      3,248.85 20.7 20.0 Statement of Profit and Loss Account 2020 2019 CS2 CS19
 Less: Finance Costs            ‐78.38          ‐78.60 ‐0.5 ‐0.5 REVENUE FROM OPERATIONS
Profit Before Exceptional Items and Tax      3,446.23    3,170.25 20.2 19.6 Revenue from Sale of Products 17,025.26 16,196.87 100.0 100.0
Exceptional Items (Net)          ‐33.20                ‐ ‐0.2 0.0
0.35 12.57 0.0 0.1
Revenue from Sale of Services
 EBT or PBT ( Profit before Tax )      3,413.03      3,170.25 20.0 19.6
Other Operating Revenues 168.48 182.34 1.0 1.1
 Tax Expenses         ‐759.08    ‐1,038.08 ‐4.5 ‐6.4
Other Income 357.54 284.81 2.1 1.8
PAT      2,653.95      2,132.17 15.6 13.2 TOTAL INCOME (I) 17,551.63 16,676.59 103.1 102.9
EXPENSES
EBITDA (EBIT + Depreciation)       4,214.58      3,789.62 24.8 23.4 Cost of Materials Consumed 8,432.51 8,647.82 49.5 53.4
Purchases of Stock‐in‐Trade 1,283.88 1,010.66 7.5 6.2
Changes in inventories of finished goods, Stock‐ ‐210.21 ‐247.86 ‐1.2 ‐1.5
Employee Benefits Expense 985.43 900.14 5.8 5.6
Vertical analysis: Income Statement Other Expenses 2,845.44 2,576.21 16.7 15.9
TOTAL (II) 13,337.05 12,886.97 78.3 79.5
EARNING BEFORE INTEREST, TAX, DEPRECIATION AND 
AMORTISATION (EBITDA) (I‐II) 4,214.58 3,789.62 24.8 23.4
0.0 0.0
Finance Costs 78.38 78.6 0.5 0.5
Depreciation and Amortisation Expense 689.97 540.77 4.1 3.3
PROFIT BEFORE EXCEPTIONAL ITEMS AND TAX 3,446.23 3,170.25 20.2 19.6
Exceptional Items 33.2 ‐ 0.2
PROFIT BEFORE TAX 3,413.03 3,170.25 20.0 19.6
Tax Expense 0.0 0.0
(1) Current Tax 871.15 881.64 5.1 5.4
(2) Short/ (Excess) tax provision for earlier years 5.66 ‐2.17 0.0 0.0
(3) Deferred Tax ‐117.73 158.61 ‐0.7 1.0
Total tax expense 759.08 1,038.08 4.5 6.4
PROFIT AFTER TAX 2,653.95 2,132.17 15.6 13.2
 Asian Paints : Classified BALANCE SHEET
ASSETS 2020 2019 Change % Change CS20 CS19
NON-CURRENT ASSETS
Property, Plant and Equipment 2A 4,148.60 4,430.62 -282.02 -6.37 30.53 32.38
Right of Use Asset 2B 726.63 700.61 26.02 3.71 5.35 5.12
Capital work-in-progress 108.09 179.31 -71.22 -39.72 0.80 1.31
Goodwill 3A 35.36 35.36 0.00 0.00 0.26 0.26
Other Intangible Assets 3B 50.27 54.61 -4.34 -7.95 0.37 0.40
Investments in Subsidiaries and Associates 4 1,176.99 830.35 346.64 41.75 8.66 6.07
Financial Assets
Investments 4 1,048.59 987.02 61.57 6.24 7.72 7.21
Loans 5 64.11 76 -11.89 -15.64 0.47 0.56
Other Financial Assets 6 232.47 220.7 11.77 5.33 1.71 1.61
Current Tax Assets (Net) 7 137.94 81.48 56.46 69.29 1.02 0.60
Other Non-current assets 8 32.87 33.48 -0.61 -1.82 0.24 0.24
Total non-current assets 7,761.92 7,629.54 132.38 1.74 57.12 55.76
CURRENT ASSETS
Inventories 9 2,827.47 2,585.10 242.37 9.38 20.81 18.89
Financial Assets
Investments 4 432.35 1,146.63 -714.28 -62.29 3.18 8.38
Trade Receivables 10 1,109.22 1,244.95 -135.73 -10.90 8.16 9.10
Cash and Cash Equivalents 11A 336.96 98.33 238.63 242.68 2.48 0.72
Other Balances with Banks 11B 39.1 69.19 -30.09 -43.49 0.29 0.51
Loans 5 21.31 13.98 7.33 52.43 0.16 0.10
Other Financial Assets 6 846.96 567.63 279.33 49.21 6.23 4.15
Assets classified as Held for Sale - -
Other Current Assets 8 212.33 327.54 -115.21 -35.17 1.56 2.39
5,825.70 6,053.35 -227.65 -3.76 42.88 44.24
Total Assets 13,587.62 13,682.89 -95.27 -0.70 100.00 100.00
 Asian Paints : Classified BALANCE SHEET

EQUITY AND LIABILITIES 2020 2019 Change % Change CS20 CS19

EQUITY
Equity Share Capital 12 95.92 95.92 0.00 0.00 0.71 0.70
Other Equity 13 9,357.37 8,747.04 610.33 6.98 68.87 63.93
9,453.29 8,842.96 610.33 6.90 69.57 64.63
LIABILITIES
Non-Current Liabilities
Financial Liabilities
Borrowings 14 18.5 10.89 7.61 69.88 0.14 0.08
Lease Liabilities 15 496.22 473.86 22.36 4.72 3.65 3.46
Other Financial Liabilities 16 0.46 1.38 -0.92 -66.67 0.00 0.01
Provisions 17 136.78 118.48 18.30 15.45 1.01 0.87
Deferred Tax Liabilities (Net) 18C 282.68 392.39 -109.71 -27.96 2.08 2.87
Other Non-current Liabilities 19 4.64 1.52 3.12 205.26 0.03 0.01
939.28 998.52 -59.24 -5.93 6.91 7.30
Current Liabilities
Financial Liabilities
Borrowings 14 - 4.35 0.03
Lease Liabilities 15 142.43 125.22 17.21 13.74 1.05 0.92
Trade Payables
Total Outstanding dues of MSE 20 45.86 42.22 3.64 8.62 0.34 0.31
Total Outstanding dues of creditors other than MSE 20 1,714.22 2,020.07 -305.85 -15.14 12.62 14.76
Other Financial Liabilities 16 1,118.89 1,429.38 -310.49 -21.72 8.23 10.45
Other Current liabilities 19 80.92 119.23 -38.31 -32.13 0.60 0.87
Provisions 17 44.14 52.27 -8.13 -15.55 0.32 0.38
Current Tax Liabilities (Net) 21 48.59 48.67 -0.08 -0.16 0.36 0.36
3,195.05 3,841.41 -646.36 -16.83 23.51 28.07
Total Equity and Liabilities 13,587.62 13,682.89 -95.27 -0.70 100.00 100.00
 Comparisons: Asian Paints Vs Infosys
Asian Paints Infosys
2020 2020
Total Assets 13,588 100%               81,041 100%
Non‐current assets 7,762 57%               37,221 46%
Total current assets 5,826 43%               43,820 54%
Total equity 9,453 70%               62,234 77%
Total non‐current liabilities 939 7%                 3,587 4%
Total current liabilities 3,195 24%               15,220 19%
0%
Total Income 17,552 100%               81,747 100%
 Cost of Raw Materials Consumed   8,433 48%                     ‐ 0%
Employee benefit expenses 985 6%               42,434 52%
Depreciation and amortization expense 690 4%                 2,144 3%
Profit for the period 2,654 15%               15,543 19%
13
EXERCISE 13‐6: (page 635)

EUDALEY CORPORATION
Condensed Income Statements
Horizontal Analysis
For the Years Ended December 31
Increase or (Decrease)
During 2014

2014 2013 Amount Percentage

Net sales $598,000 $500,000 $98,000 19.6%
Cost of goods sold 477,000 420,000 57,000 13.6%
Gross profit 121,000 80,000 41,000 51.3%
Operating expenses 80,000 44,000 36,000 81.8%
Net income $ 41,000 $  36,000 $  5,000 13.9%

EUDALEY CORPORATION
Condensed Income Statements Vertical Analysis
For the Years Ended December 31
2014 2013
$ Percent $ Percent
Net sales $598,000 100.0% $500,000 100.0%
Cost of goods sold 477,000 79.8% 420,000 84.0%
Gross profit 121,000 20.2% 80,000 16.0%
Operating expenses 80,000 13.4% 44,000 8.8%
Net income $  41,000 6.8% $  36,000 7.2% 14
 Vertical analysis: Sustainable Income

Whom would you 
grant loan ?

Sustainable Income – Most likely level of income to be obtained in the future

• Net income adjusted for irregular and one time items (like discontinued operations,
extraordinary items)
• Users are interested in Sustainable Income because it helps them derive an estimate of
future earnings without a noise of irregular items 15
Thanks 

16
Corporate Financial Reporting

Session‐ 11B, 12 & 13: MBA 2020
Financial Statement Analysis : 
Based on Ratio Analysis
 Learning Goals
Sources of Information, Standards of Performance
Skimming : Asian Paint’s Annual Report‐ 2019‐20
Guidelines for Financial Statements Analysis Group Project

Tools:
1. Horizontal Analysis and Trend Analysis
2. Vertical Analysis and Common size statements
3. Ratio Analysis – Calculation and Interpretation
– Liquidity and Cash Flow Ratios
– Efficiency or Turnover Ratios
– Leverage Ratios
– Profitability and Cost Structure Ratios
• DuPont Analysis of ROE 
– Market Ratios
• Assignments

2
 Sources of Information
– Reports published by the company
• Annual report, Interim financial statements
• Press Releases from the company, Analysts’ Meets, Investor 
presentations – available on the website of the companies
– Reports filed with the Market Regulator, SEC (SEBI, MCA in India)
– Business periodicals
• Newspapers: The Wall Street Journal, Financial Times, Economic Times, 
Business Line, Business Standard
• Magazines : Forbes, Barron’s , Fortune, Business Today, Business India
– Credit and investment advisory services : Industry averages, history
• Moody's Investors Service, Inc. and Standard & Poor's, 
• ICRA, CRISIL in India
– Internet : finance.yahoo.com, google finance, livemint.com, Reuters

3
 Asian Paint’s Annual Report‐ 2019‐20
1. Chairman’s Letter & letter from MD (Pg 6‐9) (5‐6) : Key focus areas, transitions from past and way ahead

2. Business information (6‐38, 62‐64) (7‐17, 33‐34): Company Profile, Products, BOD, Geographical presence, 
Business divisions, Manufacturing scale, Talent pool, Distribution network, Brand portfolio, KPI, USP, 
Response to change in environment (like COVID 19), CSR initiatives & spend, 10‐year review, Awards

3. Management discussion and analysis (p 39 to 61) (21‐32)
i. Macroeconomic Scenario – Global & Indian Economic Landscape, Industry Synopsis & Overview –
Trend & outlook of various product segments
ii. Performance Review‐ Overall & Business Segment, Key Initiatives, Business Continuity during Covid‐
19 Lockdown, Human Resources, Environment, Health & Safety, Information Technology, Research & 
Development, Enterprise Risk Management, Internal Control Systems & their adequacy

4. Board’s Report (p 82/52) : Summary of FS,  performance overview, dividends, NRC ‐ appointment, 
retirement of directors, Directors Responsibility statement (P87/57), CSR (68‐71), subsidiaries, 
shareholding & changes (74/104), Indebtedness, Remuneration – KMP, Directors  (83/113), Energy 

5. CEO/CFO certification(p147/117), General Shareholder Information (137/107)
6. Report on Corporate Governance (119/89), Business Responsibility Report (BRR) (P149/119)
7. Independent Auditors’ Report (161/131)
8. Financial Statements (P161 ‐ 172) (138‐142)
– Statement of Financial Position (Balance Sheet), Statement of Profit or Loss (Income Statement), 
Statement of Cash flows, Statement of changes in equity, Financial Highlights 
9. Notes to The Financial Statements (P173/143) 
– Significant Accounting Policies – Revenue Recognition, Depreciation, Inventory valuation etc
Page number in violet  is as per the pdf
 Guidelines for Financial Statements Analysis Group Project

• This project gives you an opportunity to demonstrate your skill in understanding, interpreting,
and analyzing the financial information contained in the financial statements of Indian
companies.
• Form a team of up to a maximum of five members. Each team has to choose a lead company
and two of its competitors from the same industry. Your class representative/s must email
your CFR course instructor an excel file containing team-wise details: team members,
• Infosys and Asian Paints cannot be chosen either as a lead company or as a competitor. All
three companies must (1) not belong to electricity, real estate, banking, insurance, or
financial sector; (2) be listed in either the National Stock Exchange or the Bombay Stock
Exchange; and (3) have the 2018 and 2019 annual reports available on their website. You
will get 2018 and 2019 financial statements from the 2019 annual report and 2017 financial
statements from the 2018 annual report.
• Please download all the 6 annual reports, before you finalize the lead company and two of its
competitors. Within a section, no two groups can select the same lead company. If two or
more groups in a section choose the same set of three companies, they all must have a
different lead company. Once the instructor approves your chosen company and its two
competitors, it will be final and cannot be changed. Non-submission of your analysis due to
lack of data will result in zero points in the project component.
• You are required to evaluate these firms for 3 years and ascertain the strength & weakness of
your chosen company vis-à-vis its competitors you have chosen. You must prepare a written
report, with adequate margins and proper formatting (amounts in Rupees Crores and comma
formatted with 0 decimal place).
5
 Your report will have two parts. Part 1 will be a two-page write-up summarizing your key findings
in Part 2.

Part 2 will be a detailed one (up to 10 pages in length) and cover:

1. A brief company background, nature of its operations, and lines of its business, and a brief
discussion of its industry outlook (Not more than one page)
2. Abridged Classified Standalone Balance Sheet, Multi-step Income Statement, and Direct Method
Cash flows for three years for each of the three firms (Not more than one page)
3. Key accounting policies of the firm, which you think are important to highlight (Not more than one
page)
4. Overall interpretation of the latest Balance Sheet, Income Statement and Cash Flow Statement -
broad highlights based on the absolute numbers - without using any financial ratio. Spend equal space
for each of the three financial statements (Not more than one page).
5. Trend and Common size analysis (using three-year data) of key information from financial
statements of the lead company (Not more than one page).
6. Ratio Analyses of the lead company: Discuss your insights about the lead company based on its
financial ratios (Not more than one page).
7. DuPont Analysis of the lead company: Discuss how the lead company’s ROE and its drivers have
changed over the three years (Not more than one page).
8. Comparative Analysis: Compare the financial ratios, growth, and financial performance of the lead
company with its competitors. (Not more than two pages).
9. Your overall assessment of the lead company’s financial strengths and weaknesses relative to its two
competitors (Not more than one page)

DEADLINE FOR PROJECT SUBMISSION: Upload by 9 pm on 11th October (Sunday)
Grade will be awarded based only on part 1 of the report. Part 2 may be read for any clarification. 6
 Ratio Analysis
A technique of evaluation that identifies key relationships between components of the  
financial statements
Useful in
• Evaluating a company’s financial position and operations
• Making comparisons with results in previous years (intra‐company comparison), or 
with other peer companies (inter‐company comparison) in the industry, or with 
industry average
The primary purpose of ratios is to point out areas needing further investigation

1. Liquidity Ratios Ratios may be expressed in several ways:
• Net income is 1/10 of sales
2. Efficiency or Turnover Ratios  • Net income is 10 percent of sales
3. Solvency or Leverage Ratios • The ratio of net income to sales is 1 to 10 (1:10)
4. Profitability and Costs • Sales are 10 times net income
• For every dollar of sales, the company has a net 
– Du pont Analysis of ROE
income of 10 cents
5. Market based Ratios

7
 P13‐2A (p638‐639) Osborne Company
2014 2013 Additional Information : 2014 2013
Direct Material Consumed 
included in COGS  500,000 450,000
Depreciation 100,000 80,000
Price Per Share 8
Net CFO 220,000
Capital Expenditure 136,000
Cash Dividends 70,000

2014 2013
2014 2013

$1026,900 $852,800

8
 Liquidity
• Does the company have enough cash and current assets to pay obligations 
as they come due?  It measures the short‐term ability of a company to pay 
maturing obligations and to meet unexpected needs for cash

Net Working capital = [ Current Assets – Current Liabilities ]

Current Assets
Current Ratio =
Current Liabilities
Cash + M arketable Securities + Receivables
Quick Ratio =
Current Liabilities

Quick Ratio =  (Current Assets – Inventory – Prepaid Expenses)

Current Liabilities
= [Current Investments + Trade Receivables + Cash & bank + Short term loans & 
advances (excluding prepaid expenses)]  ÷ Current Liabilities

Some Additional liquidity ratios : Typically,  Current Ratio  > Quick ratio
Cash Ratio =   Cash and cash equivalent + Marketable Securities
Total Assets
Current Cash Debt Coverage Ratio    =  Net Cash Flow from Operating Activities (CFO)
Average Current Liabilities 9
 ELLIOTT COMPANY 
Balance Sheet (31st December, 20XX)  Ex 13:13 (page 637)
Assets
2014 2013 2014 2013
Current assets
Cash and Cash Equivalents 330 360
Accounts receivable 470 400
Inventory 460 390 Working Capital 570 520
Prepaid Expenses 130 160
Total current assets 1390 1310 Current Ratio 1.70 1.66

Property, plant & Equipment 410 380 Quick Ratio 0.98 0.96

Investments 10 10
Intangible and Other Assets 530 510 Cash Ratio 0.14 0.16
Total assets 2,340 2,210

Liabilities and Stockholders' Equity
Liquidity position of the 
Current Liabilities 820 790
Long term liabilities 480 380
company improved over last year
Stockholders' equity 1040 1040 in terms of current ratio as well 
Total liabilities and stockholders' equity 2,340 2,210 as quick ratio

P 13‐2A (page 638‐639): OSBORNE COMPANY  OSBORNE COMPANY 2014

I) Liquidity Ratios:  2014 2013
Average Current Liabilities 1,95,450 
Working Capital 1,74,400  1,45,100  Current cash debt coverage ratio    1.13
Current Ratio 1.86 1.77
Quick Ratio  1.24  1.16 
10
 Efficiency  or Turnover Ratios
• How efficient are the operations of the company?
Measures how efficiently assets have been used 
‐ Evaluates the speed with which certain accounts are converted into sales or cash 

Total Assets Turnover Ratio    =  Net Sales
Average Total Assets
Measures how efficiently assets are used to produce sales

Ratios ‐2020 Steel & Iron Products Retailing

Asset Turnover 0.80 5.23

a) Fixed Asset Turnover ratio (Capital Intensity)  =  Net Sales
Average Fixed Assets
b) Current  Assets Turnover ratio              = Net Sales
Average Current Assets
c)  Working Capital Turnover Ratio             =  Net Sales
Average Working Capital
11
 Efficiency or Turnover Ratios
1. Inventory Turnover   =         Cost of Goods Sold 
Average Inventory
‐ Measures relative size of inventory   (use Net sales only if COGS not available for numerator)
• Days’ Inventory on Hand or Days’ Inventory Outstanding  or Days of Inventory               
(Inventory holding period)
 Sale Period =    Average Inventory
Cost of goods sold per day ( = COGS/365)
Average Daily COGS =      Days in a year (= 365) 
Inventory Turnover  Use ‘Net Sales’ assuming all 
‐ Measures average days taken to sell inventory sales to be on credit, if 
information on cash sales is 
not available
2. Accounts Receivables (or Debtors) Turnover  =     Net (Credit) Sales
Average Accounts Receivables
‐ Measures relative size of receivables and effectiveness of credit policies
• Days Sales Uncollected or Days’ Receivables Outstanding  or Days of Accounts Receivable
Average Collection Period 
Average Daily Credit Sales =     Average Accounts Receivables
Net Credit Sales per day (= Annual Sales / 365 
=      Days in a year (= 365)
Accounts Receivables Turnover
‐ Measures average days taken to collect receivables 12
 Efficiency /Turnover Ratios
Purchases (roughly)
3. Accounts Payables Turnover =  (Cost of Goods Sold + Closing Inventory ‐ Opening inventory) 
Average Accounts Payables
=       Net (Credit) Purchases
Average Accounts Payables Assumption: 
All purchases are on 
• Days’ Payables Outstanding  or Days of Accounts Payable Payment period credit unless 
otherwise indicated
=   Average Accounts Payables
Net Credit Purchases per day ( =Annual Net Cr. Purchases/365)

=    365  (= Days in a year)  Average Daily Net Purchases

Accounts Payables Turnover

 Can also be called Suppliers credit period

 Operating Cycle (or Gross WC Cycle) = Days’ of Inventory
+ Days’ of Accounts Receivables     

 Cash Conversion Cycle (or Net WC Cycle)  Or Financing Period or Cash Cycle
= Operating Cycle ‐ Days’ of Accounts Payables

13
P13‐2A Osborne Company (page 638‐639)
III) Turnover Ratios 2014
Total Assets Turnover Ratio     Net Sales/ Average TA 2.01 
Fixed Asset Turnover ratio  Net Sales/ Average FA 3.23 
Current  Assets Turnover ratio               Net Sales/ Average CA 5.32 
Inventory Turnover  COGS/ Average Inventory 8.77 
Days’ Inventory Outstanding  365/Inventory Turnover  41.64 
Receivables Turnover Net Sales/ Average Trade Receivables 17.14 
Days’ Receivables Outstanding  365/ Receivables Turnover 21.30 
Payables Turnover Credit Purchases/Average Trade Payables 7.00 
Days’ Payables Outstanding  365/Payables Turnover 52.14 
Credit Purchase = COGS + Closing Inventory ‐ Opening Inventory 10,69,040 
Working Capital Turnover Ratio Net Sales/ Average Working Capital 11.83 
Days’ Inventory Outstanding 
Operating Cycle  + Days’ Receivables Outstanding  62.93 
Cash Conversion Cycle  Operating Cycle ‐ Days’ Payables Outstanding  10.80 

Net Sales 18,90,540 
Average Total Assets 9,39,850 
Average Net Fixed Assets 5,84,650 
Average Current Assets 3,55,200 
Average Inventory 1,20,750 
Average Accounts Receivables 1,10,300 
Average Accounts Payables 1,52,700 
Average Working Capital 1,59,750 
14
P13‐2A Osborne Company (page 638‐639)
III) Turnover Ratios 2014
Total Assets Turnover Ratio     Net Sales/ Average TA 2.01 
Fixed Asset Turnover ratio  Net Sales/ Average FA 3.23 
Current  Assets Turnover ratio               Net Sales/ Average CA 5.32 
Inventory Turnover  COGS/ Average Inventory 8.77 
Days’ Inventory Outstanding  365/Inventory Turnover  41.64 
Receivables Turnover Net Sales/ Average Trade Receivables 17.14 
Days’ Receivables Outstanding  365/ Receivables Turnover 21.30 
Payables Turnover Credit Purchases/Average Trade Payables 7.00 
Days’ Payables Outstanding  365/Payables Turnover 52.14 
Credit Purchase = COGS + Closing Inventory ‐ Opening Inventory 10,69,040 
Working Capital Turnover Ratio Net Sales/ Average Working Capital 11.83 
Days’ Inventory Outstanding 
Operating Cycle  + Days’ Receivables Outstanding  62.93 
Cash Conversion Cycle  Operating Cycle ‐ Days’ Payables Outstanding  10.80 

Net Sales 18,90,540 
Average Total Assets 9,39,850 
Average Net Fixed Assets 5,84,650 
Average Current Assets 3,55,200 
Average Inventory 1,20,750 
Average Accounts Receivables 1,10,300 
Average Accounts Payables 1,52,700 
Average Working Capital 1,59,750 
15
Changes in Liquidity and Efficiency Ratios over the period 

UF

UF

16
 F

2012   2011     
Days Inventory  86.9 91.3
Days Receivable  45.6  56.2 
Days Payable  56.2 52.9

Change
Operating Cycle :  45.6 + 86.9 = 132.5 days            56.2 + 91.3 = 147.5 days        Decline 

Financing Period : 132.5 – 56.2 = 76.3 days          147.5 – 52.9 = 94.6 days          Decline

17
 Solvency 

• Solvency ratios measure the ability of the company to survive over a long 
period of time.
• Solvency is the ability to pay interest as it comes due and to repay the 
balance of a debt due at its maturity.
• What is the extent of indebtedness ?

• The aim of long‐term solvency analysis is to detect early signs that a 
company is headed for financial difficulty
– Declining profitability and liquidity ratios
– Unfavorable debt to equity ratio
– Unfavorable interest coverage ratio

18
 Solvency Ratios
1.   a)  Liabilities to Equity Ratio   = Total Liability ÷ Total Equity 
Capital structure and financial 
= (Total Assets ÷ Total Equity) – 1  leverage: 
b)  Liabilities to Assets Ratio   =     Total Liabilities Amount of a company’s assets 
Total Assets funded by the liability holders in 
relation to that funded by 
c)   Debt Equity Ratio                  =     Total Borrowings
stockholders
Total Equity
Where, Total Borrowings = Non‐Current Borrowings, Current Borrowings, Current maturities/portion of Non‐
Current Borrowings, includes lease obligations, redeemable preference shares)
d)   Financial Leverage Multiplier   =       Total Assets/ Total Equity
 Liabilities to Equity Ratio =     (Total Assets/ Total Equity ) ‐ 1   

2. Interest Coverage Ratio 
or Times Interest Earned = Net Income + Interest Expense +Tax Expense
Interest Expense
= PBT + Interest Expense   =   EBIT
Interest Expense                             Interest Expense
Measure of creditors’ protection from default on interest payments

3. Cash Debt Coverage Ratio    =  Net Cash Flow from Operating Activities (CFO)
Average Total Liabilities
19
P13‐2A Osborne Company (page 638‐639)

II) Solvency Ratios 2014 2013

Total Assets 1,026,900 852,800

Total Liabilities 4,23,500  3,87,400 
Debt Total Borrowings 2,20,000  2,00,000 
Equity Shareholders' funds 6,03,400  4,65,400 
Liabilities to Equity Total Liabilities/Equity 0.70 0.83 F
Debt Equity Ratio                           Total Borrowings / Equity 0.36 0.43 F
Liabilities to Total Assets Ratio     Total Liabilities/TA 0.41 0.45 F
Financial Leverage Multiplier   Total Assets/ Stockholders’ Equity  1.70 1.83 F
More accurate FLM  would be: Avg TA / Avg Eq. =939,850/534,400 1.76
Interest Coverage Ratio  EBIT / Interest Expense 15.1 13.3 F

Note:  Financial Leverage Multiplier – 1 = Liabilities to Equity Ratio
Average Total Liabilities 405,450
Cash debt coverage ratio for 2014 Net CFO / Avg TL (220,000/404,450) 
= .54
20
 Profitability

How profitable is the company 
• In relation to its investments  ?
• In relation to sales ?
• Profitability reflects a company's ability to earn a satisfactory income
• A company's profitability is closely linked to its liquidity because earnings 
ultimately produce cash flow

21
 Profitability:  In relation to Sales

1. Gross Margin (GM) (Gross Profit Rate)  =   Gross Profit  *100
Net Sales
– Gross Profit = Sales ‐ COGS
– If GM is improving, signals strong future performance 
• COGS has fallen down – production efficiency
• Sales has increased, may be the pricing – Quality advantage
– Indicates percentage of Revenue available to cover Operating and other Expenses
Who will have higher GM – Microsoft or Wal‐Mart ?

2. Operating Profit Margin (OPM) =  Operating Profit *  100
Net Sales
– Operating Profit = Gross Profit – Operating Expenses 
– Common Measure of operating performance 
– If ratio deteriorates ‐> indicates deteriorating control over operating costs
• If GM and OPM differ significantly
– reasons could be high operating costs like SG&A

• Margin ratios can be calculated for other profit figures like : 
EBITDA/ Net Sales*100,     EBIT/ Net Sales*100,    PBT/ Net Sales*100
22
 Profitability : In relation to Sales
3. Profit Margin Ratio or Net Profit Margin = Net Profit (or PAT) * 100
Net Sales
– Measures net income produced by each sales dollar
– Common measure of profitability – SHs expect dividends out of it
– Varies widely across industries
– Affected by leverage  – so not comparable across firms
A decline in Net Profit margin might suggest that
• Gross margin might have come down due to higher COGS
• Disproportionate Increase in Operating Expense, Interest & Tax Expense

P13‐2A Osborne Company (page 638‐639)
Profitability Ratio in relation to Sales  2014 (%)  2013 (%)
Gross Margin (GM)  Gross Profit/ Net Sales *100 44.01 42.53
Operating Profit Margin Operating Profit / Net Sales *100 17.56 15.17
Net Profit Margin  Net Profit/ Net Sales *100 11.53 9.85
EBITDA to Sales EBITDA/ Net Sales *100 22.85 19.74
EBITDA=(EBIT+Depreciation & Amortn) $ 4,32,000  $ 3,45,500 
Additional: 2014 2013
Direct Material Consumed 
included in COGS  500,000 450,000
Steel & Iron  Automobiles‐
Depreciation 100,000 80,000
Ratios ‐2020 Products Retailing IT Software Trucks
Price Per Share 8
PAT Margin 6.44 3.59 21.41 ‐10.62 23
 Cost Structure: Costs as percentage of Net Sales
1. Material Cost to Sales: (Material Cost/ Net Sales) × 100
2. Cost of goods sold to Sales: (COGS / Net Sales) × 100
3.    Operating Ratio = (Operating Expense /Net Sales) × 100 
– Ratio for each item of expense calculated to gauge operating efficiency viz. SG&A, 
Advertising, R&D.
4.  Operating leverage  : Extent of fixed costs one has in the cost structure (Depreciation)

Margins are Effected by Strategy: 
A firm adopting low cost strategy (& aggressive pricing) likely to have lower GM than firm 
adopting differentiated product strategy
– 1995‐1997: Dell (Low cost PC provider) had Lower GM but lower Operating expense 
(Selling, R&D ) than Compaq (Brand name PC provider) 
– Net profit margin similar 

P13‐2A (page 638‐639) Osborne Company
Costs  in relation to Sales  2014 (%)  2013 (%)
Material Cost to Sales Material Cost/ Net Sales *100 26.45  25.71 
COGS / Net Sales * 100 COGS/ Net Sales *100 55.99  57.47 

Effective Tax Rate  Income Tax Expense / PBT 0.30 0.30

ETR 2020 2019
Effective Tax Rate (ETR) = Income Tax Expense ÷ PBT Infosys 0.24 0.26
24
Asian Paints 0.22 0.33
 Profitability : In Relation to Investment
Return on Assets (ROA)  =    Net Profit ÷ Average Total Assets
 Measures overall earning power
• Shows Profit generated by a given level of assets i.e. how effectively an entity has utilized sources 
of  funds invested in total assets 
– without regard to how these assets were funded
• Used by top management for measuring divisional performance
– Since divisional managers have little control on how the assets are funded
More perfect : Profit after tax + [Interest Expense × (1 – tax rate)]
Average Total Assets

Return on Equity (ROE) (or RONW) Income available to Common Stockholders, 
assuming there are no preference shares
=           Net Profit (or PAT)
Average Equity
 Measures profitability of stockholders’ investments
• Reflects how profitably a firm has been able to invest SH’s funds for the period
• If ROA > Cost of Debt  Trading on Equity at gain
• Not comparable across firms with different degrees of financial leverage

P13‐2A  (page 638‐639)  (Du Pont) Osborne Company 2014 (%)

Return on Assets (ROA) Net Profit/ Average Total Assets 23.20 
Return on Equity (ROE)  Net Profit / Average Equity 40.79
25
 DuPont analysis: Decomposition of  ROA and ROE
Steel & Iron  Automobiles‐
Ratios ‐2020 Products Retailing IT Software Trucks

• ROA = Net Profit PAT Margin 6.44 3.59 21.41 ‐10.62

Asset Turnover 0.80 5.23 1.24 1.35
Average Total Assets ROA (%) 5.15 18.79 26.55 ‐14.34

= Net Profit × Net Sales

Net Sales Average Total Assets
[ Net Profit Margin × Total Assets Turnover]

• ROE = Net Profit

Average Equity

Or, ROE = Net Profit × Net Sales × Average Total Assets

Net Sales Average Total Assets Average Equity
[ Net Profit Margin × Total Asset Turnover × Financial Leverage Multiplier]
So, ROE = ROA × FLM
Steel & Iron  Automobiles
Ratios ‐2020 Products Retailing IT Software ‐Trucks
ROA (%) 5.15 18.79 26.55 ‐14.34
Financial Leverage 1.73 1.18 1.06 1.63
ROE (%) 8.90 22.22 28.05 ‐23.40

ROE = Net Profit Margin  Total Asset Turnover  Financial Leverage Multiplier 26
Profitability In relation to Investment P13‐2A (DU Pont)  2014
Return on Assets (ROA) Net Profit/ Average TA 23.20 
Return on Equity (ROE)  Net Profit/ Average Equity 40.79
2 Part ‐ ROE
Return on Assets (ROA) Net Profit/ Average TA 23.20
Financial Leverage Multiplier   Average TA / Average Equity 1.76
40.79
3 Part ‐ ROE
Net Profit Margin (ROS) Net Profit/ Net Sales *104 11.53
Total Assets Turnover Ratio     Net Sales/ Average TA 2.01 
Financial Leverage Multiplier   Average TA / Average Equity 1.76
40.79 

27
Selected Financial Data for 2014 P13‐5A  
(page 641)

Compare the 
Liquidity, 
Solvency and 
Profitability of 
the two 
companies

28
Ratio ( P13‐5A, page 641)
(1) Current Ratio
(2) Receivables turnover
(3) Average collection period (in days)
(4) Inventory turnover
(5) Days in inventory
(6) Profit margin
(6) Profit margin (ROS)
(7) Asset turnover
(7) Asset turnover
(8) Return on assets
(8) Return on assets (ROA)
Average TA / Average Equity
Average TA / Average Equity
(9) Return on common  stockholders’ equity 17.1 % ($2,488 ÷
(9) Return on common  stockholders’ equity (ROE)  17.1 %   ($2,488 ÷$14,529.5b)
(10) Debt to total assets
(11) Times interest earned
(12) Current cash debt coverage
(13) Cash debt coverage
(14) Free cash flow
Calculation of Averages
Average of Total Assets
Average of Stockholders' Equity
PBIT (= PAT + Tax + Interest)
Average of current liabilities
Average of total Liabilities
Target
(All Dollars Are in Millions)
1.63:1   ($18,424 ÷ $11,327)
8.7         ($65,357 ÷ $7,525)
42.0       (365 ÷ 8.7)
6.6         ($45,583 ÷ $6,942)
55.3       (365 ÷ 6.6)
3.8 %     ($2,488 ÷
3.8 % ($2,488 ÷ $65,357)
$65,357)
1.5         ($65,357 ÷ $44,319.5a)
1.5 ($65,357 ÷ $44,319.5a)
5.6 %     ($2,488 ÷ $44,319.5a)
5.6 % ($2,488 ÷ $44,319.5a)
3.05
3.05
$14,529.5b)
66 %      ($29,186 ÷ $44,533)
6.5         ($4,579 c ÷ $707)
.20 ($5,881 ÷ $29,790 e)
$3,656 ($5,881 – $1,729 – $496)
a ($44,533 + $44,106) ÷ 2
b ($15,347 + $13,712) ÷ 2
c ($2,488 + $1,384 + $707)
d ($11,327 + $10,512) ÷ 2
e (($11,327 + $17,859) + $30,394) ÷ 2
Wal‐Mart
.87:1     ($48,331 ÷ $55,561)
101.4    ($408,214 ÷ $4,025)
3.6 (365 ÷ 101.4)
9.0         ($304,657 ÷ $33,836)
40.6 (365 ÷ 9.0)
3.5%      ($14,335 ÷ $408,214)
3.5% ($14,335 ÷ $408,214)
2.4         ($408,214 ÷ $167,067.5f)
2.4 ($408,214 ÷ $167,067.5f)
8.6%     ($14,335 ÷ $167,067.5 f)
8.6% ($14,335 ÷ $167,067.5 f)
2.44
2.44
21.0%    ($14,335 ÷ $68,369 g)
21.0% ($14,335 ÷ $68,369 g)
58% ($99,650 ÷ $170,706)
11.4  ($23,539 h ÷ $2,065)
.27 ($26,249 ÷ $98,698.5 j)
$9,848 ($26,249 – $12,184 – $4,217)
f ($170,706 + $163,429) ÷ 2
g ($71,056 + $65,682) ÷ 2
h ($14,335 + $7,139 + $2,065)
i ($55,561 + $55,390) ÷ 2
j (($55,561 + $44,089) + $97,747) ÷ 2
29
 Evaluating Market Strength
Market price:  Price at which a company’s stock is bought and sold
– Provides information about how investors view the potential return and risk 
connected with owning the company's stock
1. Price/Earnings ratio: Measures investors’  assessment of a company’s future earnings and 
their confidence in a company  Market Price per Share
Price/Earnings Ratio 
High if investors think that earnings will  Earnings per Share (basic)
increase substantially in the future. 
2020 EPS P/E P/B Div P/O
Asian Paints 27.67 60.24 16.91 43.37
Berger Paints 7.2 94.87 25.29 30.56

2. Dividends yield :  Measures a stock’s current return to an investor in the form of dividends
Cash Dividends per Share
Dividends Yield
Market Price per Share

where Dividend Per Share (DPS) {or cash dividend declared per share}
=     Cash Dividends declared
Weighted Average Number of equity shares outstanding
• Dividend Payout Ratio = Cash Dividends declared ~  DPS ÷ (Basic)EPS 
Net Profit (or  PAT)
Retention Ratio  = 1 – Dividend Payout Ratio 
= (Net Income – Cash Dividend Declared) ÷ Net Income
30
Changes in Ratios over the period 

P13‐2A  (page 638‐639)  (Du Pont) Osborne Company 2014

EPS (Net Income ‐ Preferred Dividend) / Average Shares OS 3.69 
Average Shares Outstanding 59000
DPS Cash Dividend / Average shares OS 1.19 
P/E Market Price per Share/ EPS 2.17 
Dividend Yield DPS/ Market price per share 0.15 
Dividend Payout Cash Dividend /Net Income 0.32
Sustainable Growth Rate 27.69
31
 Asian Paints Mar 2020 Mar 2019 Mar 2018 Mar 2017 Mar 2016 Mar 2015 Mar 2014 Mar 2013 Mar 2012 Mar 2011
II) Liquidity Ratios
   Current Ratio(x) 1.82 1.58 1.62 1.89 1.85 1.5 1.35 1.29 1.29 1.46
   Quick Ratio(x) 0.94 0.9 0.98 1.13 1.19 0.85 0.77 0.66 0.69 0.82
II) Solvency Ratios
Assets to Shareholders' funds  1.49 1.52 1.47 1.46 1.58 1.79 1.86 1.90 1.94 2.40
   Interest Cover(x) 43.49 40.27 121.31 120.14 90 63.05 59.77 45.68 44.53 69.69
III) Turnover Ratios
   Asset Turnover(x) 1.46 1.49 1.52 1.7 1.87 1.95 1.97 2 2.11 1.71
   Fixed Asset Turnover ratio  3.04 3.82 5.1 5.4 5.02 4.49 4.16 4.63 5.58 5.16
   Receivable days 21.58 23.16 23.38 19.75 18.14 19.27 20.19 19.78 17.13 17.31
   Inventory Days 49.62 46.29 47.92 42.85 41.59 46.33 47.19 47.88 46.75 46.24
   Payable days 51 54.2 59.95 54.29 54.62 54.07 58.31 55.94 54.9 52.93
Operating Cycle  71.2 69.45 71.3 62.6 59.73 65.6 67.38 67.66 63.88 63.55
Cash Conversion Cycle  20.2 15.25 11.35 8.31 5.11 11.53 9.07 11.72 8.98 10.62
IV) Profitability Ratios
   PAT Margin (%) 13.33 11.35 11.38 11.12 10.84 9.72 9.61 10.04 10.51 10.7
   EBIT Margin(%) 17.55 17.31 17.35 16.53 16.23 14.39 14.23 14.81 15.29 15.72
   ROA (%) 19.46 16.87 17.27 18.88 20.29 18.97 18.91 20.11 22.16 18.35
   ROE (%) 29.01 25.63 25.45 27.68 31.96 33.9 35.3 38.11 42.95 43.89
V) Market Strength
   Earnings Per Share (Rs) 27.67 22.23 19.75 18.78 16.92 13.84 12.19 109.47 99.92 80.81
   DPS(Rs) 12 10.5 8.7 10.3 7.5 6.1 5.3 46 40 32
   Dividend Pay Out Ratio(%) 43.37 47.24 44.04 54.84 44.33 44.08 43.49 42.02 40.03 39.6
  P/E Ratio 60.24   67.12   56.73   57.03   51.35   58.44   44.84   4.49   3.24   3.13  
        Growth 
   Net Sales Growth(%) 4.89 15.81 11.25 7.54 1.56 11.81 10.91 12.5 25.7 23.63
   PAT Growth(%) 24.47 12.53 5.17 11.02 22.25 13.54 11.34 9.56 23.64 0.08
32
 Comparisons: With Industry Average and with Peer
Asian  Paints  Asian  Paints  Asian  Paint 
 Company Vs Industry Paints Industry Paints AIndustry Paints Industry
Year  Mar 2020 2020 Mar 2019 2019 Mar 2018 2018
I) Liquidity Ratios
   Quick Ratio(x) 0.94 0.92 0.9 1 0.98 1.09
   Current Ratio(x) 1.82 1.79 1.58 1.73 1.62 1.73
II) Solvency Ratios
  Assets to Shareholders' funds  1.49 1.18 1.52 1.11 1.47 1.08
   Interest Cover(x) 43.49 42.49 40.27 30.21 121.31 46.12
III) Turnover Ratios
   Asset Turnover(x) 1.46 1.75 1.49 1.98 1.52 2.04
   Fixed Asset Turnover ratio  3.04 2.95 3.82 3.72 5.1 4.22
   Receivable days 21.58 30.8 23.16 38 23.38 40.1
   Inventory Days 49.62 56.97 46.29 52.32 47.92 52.13
   Payable days 51 58.74 54.2 60.48 59.95 66.39
Operating Cycle  71.2 87.77 69.45 90.32 71.3 92.23
Cash Conversion Cycle  20.2 29.03 15.25 29.84 11.35 25.84
IV) Profitability Ratios
   PAT Margin (%) 13.33 12.21 11.35 8.89 11.38 9.88
   EBIT Margin(%) 17.55 16.14 17.31 13.84 17.35 14.92
   ROA(%) 19.46 21.37 16.87 17.64 17.27 20.15
   ROE(%) 29.01 25.12 25.63 19.6 25.45 21.73
Growth
   Net Sales Growth(%) 4.89 1.6 15.81 14.36 11.25 11.77
   PAT Growth(%) 24.47 27.11 12.53 0.24 5.17 6.36
No of Companies 5 28 44

202003 Net Sales (Cr) ROE EPS ICR P/E 5Y Rtn% 1Y Rtn%

Asian Paints        17,194.1   29.01   27.67 43.49 60.24   145.14   7.88
Berger Paints           5,691.7   28.10   7.20 28.71 94.87   263.02   30.99
Kansai Nerolac           4,943.2   14.85   9.94 137.72   59.84   96.50   ‐8.71

33
 Comparison across Industries
Cement & 
Construction  Metal ‐ Non  Automobiles‐
Across Industries IT Software Materials Ferrous Trucks/Lcv
Year End 2020 2019 2020 2019 2020 2019 2020 2019
No of Companies 55 497 23 89 5 59 4 8
I) Liquidity Ratios:
   Current Ratio(x) 2.41 2.36 0.95 0.89 0.65 0.64 0.61 0.79
   Quick Ratio(x) 2.41 2.34 0.6 0.61 0.35 0.32 0.43 0.5
II) Solvency Ratios
    Assets to Shareholders' funds  1.06 1.08 1.45 1.57 1.22 1.25 1.63 1.49
   Interest Cover(x) 48.65 49.27 4.12 2.54 0.67 3.95 ‐2.18 3.6
III) Turnover Ratios
   Asset Turnover(x) 1.24 1.23 0.82 0.85 0.47 0.61 1.35 2.25
   Sales/Fixed Asset(x) 3.42 3.54 0.87 0.91 0.54 0.79 1.09 1.97
   Receivable days 72.24 78.43 21.91 21.78 15.48 19.46 26.08 21.99
   Inventory Days 0.36 1.56 40.74 44.7 77.52 66.36 39.14 31.1
   Payable days 40 43.07 37.07 40.49 82.16 71.31 79.21 61.59
Operating Cycle  72.6 79.99 62.65 66.48 93 85.82 65.22 53.09
Cash Conversion Cycle  32.6 36.92 25.58 25.99 10.84 14.51 ‐14 ‐8.5
IV) Profitability Ratios
   ROA(%) 26.58 20.71 8.47 3.71 0.03 7 ‐14.3 8.06
   ROE(%) 28.05 22.44 12.25 5.8 0.04 8.76 ‐23.4 12.03
   PATM(%) 21.41 16.86 10.31 4.35 0.07 11.52 ‐10.6 3.58

34
 Operating ratios
Investment ratios

Pricing conditions Financing ratios

Competition Revenue mngt

Market potential Gross Margin Operating Profit 

margin
Supply conditions Vol Mix
Interest, 
Labour markets Cost management Operating  Income Tax
Expense Ratio
Net Profit margin
Cost requirements

Inventory mngt ROA

Debtors mngt Working Cap TO

Creditors mngt Assets  turnover ROE

Capital budgeting
FA  turnover
Project 
management

Debt policy

Payout Leverage 

Business risk 35
FSA ‐ test
 FSA TEST: Effects of transactions on Ratios
Transaction Ratio Effect
1 Issued common stock for Cash Asset Turnover Ratio Decrease
2 Issued Bonds Payable Asset Turnover Ratio Decrease

3 Purchased Treasury Stock ROA  Increase

4 Paid current portion of long‐term debt ROA Increase
5 Declared Cash dividend ROE Increase
6 Borrowed cash by issuing Notes Payable Liabilities to Equity Ratio Increase

7 Sold Merchandise on Account Quick Ratio Increase

8 Purchased marketable securities for cash Quick Ratio None
9 Collected money from Accounts receivables Quick Ratio None
Assuming current ratio before the transaction was > 1  
10 Declared Cash dividend Current Ratio Decrease
11 Declared stock dividend Current Ratio None
12 Paid to Accounts Payable Current Ratio  Increase
13 Received customer advances Current Ratio  Decrease
14 Purchased raw materials Current Ratio  None
15 Purchased land for cash Current Ratio  Decrease
16 Issued Debentures for cash Current Ratio  Increase
 FSA TEST: Effects of transactions on Ratios
Transaction Ratio Effect
1 Issued common stock for Cash Asset Turnover Ratio Decrease
2 Issued Bonds Payable Asset Turnover Ratio Decrease

3 Purchased Treasury Stock ROA  Increase

4 Paid current portion of long‐term debt ROA Increase
5 Declared Cash dividend ROE Increase
6 Borrowed cash by issuing Notes Payable Liabilities to Equity Ratio Increase

7 Sold Merchandise on Account Quick Ratio Increase

8 Purchased marketable securities for cash Quick Ratio None
9 Collected money from Accounts receivables Quick Ratio None
Assuming current ratio before the transaction was > 1  
10 Declared Cash dividend Current Ratio Decrease
11 Declared stock dividend Current Ratio None
12 Paid to Accounts Payable Current Ratio  Increase
13 Received customer advances Current Ratio  Decrease
14 Purchased raw materials Current Ratio  None
15 Purchased land for cash Current Ratio  Decrease
16 Issued Debentures for cash Current Ratio  Increase
(KWK Page 734)

39
Thanks
Corporate Financial Reporting

Session‐ 14 to 16: 
Cash Flow Statement
IIMC‐MBA 2020: Prof. Arpita Ghosh

1
At the end of a Round

2
 Learning Goals : Cash Flow Statement

• Cash Flow statement – Purpose & Linkages
• Classification of transactions: Operating , Financing, Investing, Non‐cash
• Preparation of Cash Flow Statement
– Computing Cash Flow from Operating Activities (CFO)
• Direct Method and Indirect Method
– Computing Cash Flow from Investing Activities (CFI)
– Computing Cash Flow from Financing Activities (CFF)
• Analysis of Cash Flows to evaluate a company
• Cash Flow Statement of Infosys and Asian Paints
• Assignment Problems

3
 Cash Flow Statement – Purpose & Linkages
Beginning Cash Add: Cash Receipts Closing Cash
Less: Cash Payments

Opening Balance Sheet Cash Flow Statement Closing Balance Sheet

Is it a static report?

• Provides information about cash receipts  & cash payments during an accounting period
• Explains the net increase (or decrease) in cash during an accounting period

• Why is it prepared ? 
• Is Income statement, Balance sheet not good enough ? 
• Isn’t cash account good enough to explain the change in cash during the year ? 

• Shows how a company’s Operating, Investing and Financing Activities have affected cash  
• This along with other statements helps to understand  the activities of an entity
• Helps understand the relation between Net Income and cash flow from operating activities
4
 Format of Cash Flow Statement

Cash here includes  Cash and Cash equivalents (C&CE) (Disclosure required – with restrictions details): 

Cash Equivalents: Short term, highly liquid investments that can be readily converted into cash 
• which are subject to insignificant risk of changes in value, & which have maturity < 3 Months 
(90 days) from date of purchase like Treasury bills, Term deposits & Marketable debt securities<3M
• Cash Credit, Bank Overdraft (which is repayable on demand) is part of C&CE

So if Cash in hand+ Cheques=7, 2mth Bank term deposit=3, Bank Overdraft= 100  C&CE = 10 ‐100  =‐ 90
5
 Classification of Cash Flows
Cash Receipts and Cash Payments are classified into three categories:
• Operating Activities: Principal revenue generating activities or core operations of an 
entity: Income Statement items
• Cash inflows and outflows from activities that determine Net Income like 
acquiring and selling of goods and services

• Investing Activities : Activities relating to changes in size and composition of long‐
term assets and other investments (not included in cash equivalents)
• Cash transactions concerned with Purchase and Sale of 
 long term assets like PP&E, Intangible Assets, Inter‐corporate Investments 
(stocks/bonds of another company)
• Cash lent to borrowers  & collection of Loan repayments, Acquisition of business

• Financing Activities : Activities relating to change in capital structure of the entity  ‐
that cause changes in size and composition of an entity’s borrowings and 
stockholders’ equity  ‐ Transactions with Fund providers
• Borrowings and repayments of loans (or issue and redemption of 
bonds/debentures/ notes/preference shares), Issue (sale) and repurchase of 
shares (treasury stock/ buyback), paying dividends 6
 Cash Inflows Activities Cash Outflows

Cash Received from customers  Cash paid to Suppliers (for Inventory)
(for Sale of Goods  & Services, 
other operating activities like   Cash paid to Employees (Wages ) C
Operating Activities
royalties, fees, commissions) F
Cash paid for other Expenses (eg.Ins.) 
O
Cash paid for Taxes (net of refund if 
Cash Received from Sale of PPE, 
any)
Intangible Assets, Divestment of 
business
Cash paid for purchase of PPE, 
Cash Received from Sale of  Intangible Assets 
Investments (debt, equity), JVs
Cash paid for purchase of 
C
[Both Short‐ & long‐term   Investing Activities
investments (except held for  Investments, acquisition of   F
business
Trading, Cash & Cash Equivalent)] I
Cash Received from Collection of  Cash lent to borrowers 
Loans (Making Loans)

Interest  and Dividend Received
Cash Paid for repurchase of 
shares 
(common or preferred stock)
Cash Received from Issue of  C
Shares (common or preferred  Dividends Paid
stock), Reissue of treasury stock Financing Activities F
Cash paid for repayment/  F
redemption  of borrowings 
Cash Received from borrowings or 
issuance of Debentures,  Bonds etc Cash Paid for Interest Expense

Non‐Cash Investing and Financing Transactions 7
Classification Differences under US GAAP, IFRS and Indian GAAP

Item US GAAP (IGNORE) IFRS (IGNORE) Indian GAAP (Follow this)

Interest Received,       Operating or 
Dividend Received Operating Investing  Investing 
Operating or 
Interest Paid Operating Financing  Financing 
Operating or 
Dividend Paid Financing Financing Financing

Classified as  Considered part of  Considered part of cash 

Bank Overdraft Financing  cash equivalents equivalents
Classification Differences under US GAAP, IFRS and Indian GAAP

Item US GAAP (IGNORE) IFRS (IGNORE) Indian GAAP (Follow this)

Interest Received,       Operating or 
Dividend Received Operating Investing  Investing 
Operating or 
Interest Paid Operating Financing  Financing 
Operating or 
Dividend Paid Financing Financing Financing

Classified as  Considered part of  Considered part of cash 

Bank Overdraft Financing  cash equivalents equivalents
 Disclosure: Significant Non‐Cash Transactions

Significant transactions that involve only long‐term assets, long‐term liabilities, 
or stockholders’ equity
• Simultaneous Investing and Financing Activities
 Exchange of long‐term asset for a long‐term liability or stockholders’ equity
 Issuance of bonds or common stock to purchase Land
 Take out a long‐term mortgage to purchase real estate 
 Exchange of old equipment for a new one
 Settle a debt by issuing capital stock, Conversion of bonds into common stock

• No Cash inflows or Outflows involved
• So, not reflected on either of the three sections in the statement of 
cash flows
• To be disclosed in a separate schedule (bottom of  the statement) (US), or 
as a separate note to the financial statements (IFRS & IndAS)
• since these have potential to impact future cash flows  Full Disclosure
10
 Classify Transactions into Operating, Investing and Financing Activities or CC&E

Activity
Purchase of land Investing activity.
Exchange of land for patent Non‐cash investing activity
Retirement of bonds Financing activity.
Conversion of bonds into common stock Noncash financing activity.
Repurchased Common Stock or purchase of treasury stock Financing activity.
Declared and Issued a stock dividend Non‐Cash financing activity
Purchased a 60‐day treasury bill Cash Equivalent
Issuance of bonds for land Noncash investing and financing activity.
Payment of interest on notes payable Financing activity.
Repaid notes payable Financing activity.

11
 Classify Transactions into Operating, Investing and Financing Activities or CC&E

Activity
Purchase of land Investing activity.
Exchange of land for patent Non‐cash investing activity
Retirement of bonds Financing activity.
Conversion of bonds into common stock Noncash financing activity.
Repurchased Common Stock or purchase of treasury stock Financing activity.
Declared and Issued a stock dividend Non‐Cash financing activity
Purchased a 60‐day treasury bill Cash Equivalent
Issuance of bonds for land Noncash investing and financing activity.
Payment of interest on notes payable Financing activity.
Repaid notes payable Financing activity.

12
 Classify the following activities as  Operating Activities (OA), Investing Activities (IA), 
Financing Activities (FA), or Cash and Cash Equivalent (CCE)

1 Bank overdraft *If overdraft is not repayable on demand, it is treated as financing activity. CCE*

2 Brokerage paid on issue of shares FA
3 Brokerage paid on purchase of investments IA
4 Cash credit CCE
5 Cash sales OA
6 Cash purchase of goods OA
7 Cash paid to suppliers for goods OA
8 Cash receipts from debtors OA
9 Commission and royalty received OA
10 Discount allowed to customers OA
11 Discount received from suppliers OA
12 Dividend paid on shares FA
13 Dividend received on shares IA
14 Income tax paid OA
15 Interest paid on long‐term borrowings FA
16 Interest paid on short‐term borrowings FA
17 Interest received on debentures held as investment IA
18 Interim dividend paid on equity shares FA
19 Issue of equity share capital FA 13
 Classify the following activities as  Operating Activities (OA), Investing Activities (IA), 
Financing Activities (FA), or Cash and Cash Equivalent (CCE)

1 Bank overdraft *If overdraft is not repayable on demand, it is treated as financing activity. CCE*

2 Brokerage paid on issue of shares FA
3 Brokerage paid on purchase of investments IA
4 Cash credit CCE
5 Cash sales OA
6 Cash purchase of goods OA
7 Cash paid to suppliers for goods OA
8 Cash receipts from debtors OA
9 Commission and royalty received OA
10 Discount allowed to customers OA
11 Discount received from suppliers OA
12 Dividend paid on shares FA
13 Dividend received on shares IA
14 Income tax paid OA
15 Interest paid on long‐term borrowings FA
16 Interest paid on short‐term borrowings FA
17 Interest received on debentures held as investment IA
18 Interim dividend paid on equity shares FA
19 Issue of equity share capital FA 14
 Classify the following activities as  Operating Activities (OA), Investing Activities (IA), 
Financing Activities (FA), or Cash and Cash Equivalent (CCE)
20. Manufacturing overhead paid OA

21. Office and administrative expenses paid OA

22. Purchase of current investments IA

23. Purchase of goodwill IA

24. Purchase of machinery IA

25 Purchase of marketable debt securities having maturity of three months CCE

26. Purchase of marketable debt securities having maturity of six months IA

27. Redemption of preference shares FA

28. Rent paid OA

29. Rent received on investment property IA

30. Refund of income tax received OA

31. Sale of investments IA

32. Sale of machinery IA

33 Sale of patents IA

34. Selling and distribution expenses paid OA

35 Short-term bank deposits having maturity of three months CCE

36 Underwriting commission paid FA

37 Wages and salaries paid OA

15
 Classify the following activities as  Operating Activities (OA), Investing Activities (IA), 
Financing Activities (FA), or Cash and Cash Equivalent (CCE)
20. Manufacturing overhead paid OA

21. Office and administrative expenses paid OA

22. Purchase of current investments IA

23. Purchase of goodwill IA

24. Purchase of machinery IA

25 Purchase of marketable debt securities having maturity of three months CCE

26. Purchase of marketable debt securities having maturity of six months IA

27. Redemption of preference shares FA

28. Rent paid OA

29. Rent received on investment property IA

30. Refund of income tax received OA

31. Sale of investments IA

32. Sale of machinery IA

33 Sale of patents IA

34. Selling and distribution expenses paid OA

35 Short-term bank deposits having maturity of three months CCE

36 Underwriting commission paid FA

37 Wages and salaries paid OA

16
 Preparation of CFS

Three sources of information :
• Income Statement to help us find the CFO
• Comparative Balance Sheets showing changes in A,L, SE
• Additional Information on how cash was used or provided 
(Illustration 12‐5, p 634)

17
 Simple 
Problem  

KWK ‐ Illustration 12A‐1, p 564

Investing 

Financing 

(COGS)

18
 CFO : Direct vs Indirect Method
In order to determine CFO, the Income figure in IS must be converted from 
accrual basis to cash basis. CFO: Only section of statement that differs in form between 
direct and indirect method 
• Direct Method 
– Adjusts each item in the income statement (accrual basis) to its cash 
equivalent (cash basis)
– More easily understood by the average reader but costly to prepare
– US GAAP encourages it, Might become more important under IFRS 
because:  Shows Operating Cash Receipts and Cash Payments
• Indirect Method
– Lists necessary adjustments to convert Profit to net CFO 
• Adjusts Profits to adjust the effect of all deferrals, accruals & non‐cash
– Superior from an analyst’s perspective
– Used by most companies because:
• Easier and less costly to prepare. 
• Reconciles Income Figure with CFO
– SEBI requires companies listed in Indian stock exchanges to use this
• Both methods produce same CFO figure 19
 Computing CFO ‐ Direct Method

• Under the direct method, each item in the income statement is adjusted 
from the accrual basis to the cash basis
– Take each item of Revenue and Expense in the income statement
– Adjust it  for its related deferrals/accruals like CA or CL to arrive at the related 
cash flow

Cash Flow Statement  ( Direct Method) :
Cash Flow from Operating Activities:
Cash Receipts from customers (for sale of goods and the rendering of services)
Less: Cash paid to suppliers (for Inventory)
Less: Cash paid to employees (Wages and Salaries)
Less: Cash paid for other Operating Expenses
Less: Income Tax paid (unless otherwise specified)
Net Cash from Operating Activities (CFO) (A)
20
 Calculating Cash Receipts/ Payments 

Cash Receipts  Revenue (or  + Increase in  ‐ Increase  in 

(Payments) for  Expense) for  Deferral (Prepaid/  Accrual (Receivables 
Revenue (Expense) = the period  Unearned) / Payables)

For Deferrals For Accruals
Prepaid Expense Unearned Revenue Accrued Payable Accrued Receivable

Ending Balance  Ending Balance Beg. Balance Beg. Balance

+        Expense for  +      Revenue for the  +   Expense for the  +  Revenue for the 
the Period  Period Period Period
– Beginning  – Beginning  – Ending  – Ending 
Balance Balance Balance Balance
Cash Payments for  Cash Receipts from  Cash Payments for  Cash Receipts from 
Expenses Revenues Expenses Revenues
21
 Calculating Cash Receipts  for Direct Method

Accounts receivable decreased $10,000
 Collections or Cash Receipts from Customers
Credit Sales
Add: Opening Balance of Accounts Receivable
Credit Sales – Increase in A/R
Less: Closing Balance of Accounts Receivable

Accounts Receivable
From Beg. BS Beg. Bal.      30,000 517,000 Gross A/R
Cash Receipts 
from Customers
From IS Sales Revenue 507,000

From End. BS End. Bal.      20,000

A/R balance has declined from 30,000 to 20,000 by $10,000
Collections or Cash Receipts from Customers 
= Credit Sales + Decrease in A/R 
= 507,000 + 10,000  = 517,000

What if there is Advance from Customers ? Credit Sales + Advance from Customers – Increase in A/R 22

 Calculating  Cash Payments for Direct Method
 Cash Payment to suppliers
COGS + Closing Inventory – Opening Inventory = Purchases
Inventory From IS
Beg. Bal.        10,000 150,000 COGS Increase in Inventory
= 15,000 ‐10,000 = 5,000
Purchases 1,55,000
End. Bal.     15,000
Assume all purchases to be on credit : Cash paid to Suppliers  
= Credit Purchases + Opening Accounts Payable – Closing Accounts Payable 
Accounts Payable Increase in Accounts Payable
= 28,000 ‐ 12,000 = 16,000
Cash Paid to  139,000 Beg. Bal.       12,000
Suppliers 155,000 Purchases 

End. Bal.      28,000
So, Cash paid to Suppliers  = COGS + Closing Inventory – Opening Inventory
+ Opening Accounts Payable – Closing Accounts Payable

Cash paid to Suppliers  = COGS + ↑Inventory – ↑ in A/P
23
= 150,000 + 5,000 – 16,000 = 139,000
 Calculating  Cash Payments for Direct Method
 Cash Payment for Operating Expenses
Operating Expenses (say Salaries Expense, Insurance Expense etc.)
+ (Closing Prepaid – Opening Prepaid) 
‐ (Closing Payable – Opening Payable)
=    Cash paid for Operating Expenses

Prepaid Expense Accrued Payable Note: Non‐cash expenses (like Depreciation, 

Provisions etc)  if included in Operating 
Ending Balance  Beg. Balance expenses must be first adjusted before one 
+ Expense for the Period  +  Expense for the Period starts adjusting for prepaid and payables –
– Beginning Balance towards arriving at ‘cash payment for operating 
– Ending Balance
expenses’
Cash Payments for Expenses Cash Payments for Expenses

Cash payment for Operating Expenses Increase in Prepaid = 4,000
= Operating Expenses (excl. Depn.) + ↑ Prepaid  ‐ ↑ Payables
=   111,000  + 4000  = 115,000

24
ANS:  Cash paid= 90,000 ‐7,200 ‐ 4,400 = 78,400
 Calculating Cash Payments for Direct Method
 Income Tax Paid
Current Tax Expense (= Income Tax Expense – ↑DTE if any  +      DTE if any)
↓
+ (Closing Advance Tax – Opening Advance Tax)  Current Tax Assets/ITA
‐ (Closing Tax Payable – Opening Tax Payable) Current Tax Liability/ITL
= Cash paid for Income Tax
Decrease in Tax Payable 
Income Tax Payable = 8000 ‐6000 = 2,000

Cash Paid for Income Tax  49,000 Beg. Bal.      8,000

47,000 Income Tax Expense

End. Bal.      6,000
Income Tax Paid 
= Current Tax Expense + ↑ Advance Tax + ↓Tax Payable
=             47,000             + 0                           + 2,000                  = 49,000 

(Assuming zero DTE)

Current Tax Expense = (Income Tax Expense   – ↑DTE + ↓DTE)  ↑ DTE  ↑ DTL

↓ DTE   ↑ DTA
OR CTE = ( Income Tax Expense – ↑ DTL + ↑ DTA)
 Cash Flow Statement  ( Direct Method) :
Cash Flow from Operating Activities:
Cash Receipts from customers (for sale of goods and the rendering of 
services) 517,000
Less: Cash paid to suppliers (for goods and services) (139,000)
Less: Cash paid to employees (Wages and Salaries) 0
Less: Cash paid for other Operating Expenses (115,000)
Less: Income Tax paid (unless otherwise specified) (49,000)
Net Cash from Operating Activities  (CFO)                    214,000 

Cash Flow from Investing Activities ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐

Cash Flow from Financing Activities ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐

26
 Revision: CFO ‐ Direct Method

Cash Receipts for  Revenue (or  + Increase in 

Revenue  (Cash  Expense) for  Deferral (Prepaid/  ‐ Increase  in Accrual 
Payments for Expense) = the period  Unearned (Receivables / Payables)

+ Increase in Unearned Service Revenue

Or
- Decrease in Unearned Service Revenue

(Assuming zero DTE) + Increase in Advance Taxes

Or
- Decrease in Advance Taxes

i. e. Income Tax Paid   = Current Tax Expense + ↑ Advance Tax (ITA) + ↓Tax Payable (ITL)

CTE = ( Income Tax Expense – ↑ DTL + ↑ DTA) 27

 AKB Book page 255‐256

100             120

28
 Solution 11.6 page 255‐256

Remember: DTL ↓ / DTA ↑ ↓ DTE

DTL decreased by (500‐400) =100  Negative DTE 
Income tax exp (ITE) (11,200) = Current Tax Exp (CTE) + Deferred Tax Exp (DTE) (‐100)
 CTE= 11,200 +100 =11,300. 
Income tax paid = CTE (11,300) ‐ Increase in tax payable (net of advance) (120‐100 =20) = 11,280

29
 Indirect Method : CFO

Income Statement

Conversion 
of accrual 
to cash 
basis

Cash Flows from Operating Activities
30
 Computing CFO ‐ Indirect Method

Adjustments to 
PBT Reconcile Profits to 
CFO

Determine net cash provided/used by operating activities by converting income figure 
from accrual basis to cash basis
Common adjustments to Income figure (PBT) to move towards CFO:
 Non‐cash items ‐ Non‐cash expenses like depreciation, amortization, depletion 
expense, Provisions, unrealized gains (like unrealized foreign exchange gains) etc
 Non‐Operating Items ‐ Gains or Loss on sale of PPE/ Investments, Interest expense , 
Interest income, Dividend Income
 Changes in Working capital items  ‐ Operating assets (like Trade Receivables, 
Inventory, Prepaid Expense, Accrued Income, Unbilled Revenue), Operating liabilities 
(like Trade Payables, Unearned Revenue, Accrued Expenses) 31
 CFO (Indirect Method) : Non‐Cash & Non‐Operating
 NON‐CASH ITEMS 
 Depreciation Expense: 
• Reduces profit, does not reduce cash  Must be added back to PBT.
 Unrealized Gains
• Increases profit, does not increase cash  Must be deducted from PBT.
 NON‐OPEARTING ITEMS
 Loss or Gain on Sale of Equipment:
Full amount of cash received from the sale (including the gain or excluding the loss)
Reported as a source of cash in the investing activities section. So, to avoid double counting: 
• Any loss on sale is to be added  to PBT in the operating section.
• Any gain on sale is to be deducted from PBT in the operating section

 Interest Expense  Add,  Interest Income, Dividend Income  Deduct

Cash flows from operating activities
Profit Before Tax $192,000 
Adjustments to reconcile net income to 
net cash flows from operating activities
Depreciation  $9,000 
From
Income 
Loss on sale of plant assets 3,000
Statement Interest Expense 42,000 54,000
246,000
32
 CFO (Indirect Method) ‐ Decrease in Operating Assets:  Add 
For Computer Services, accounts  Cash↑ + Non‐Cash Assets ↓ = L + SE
receivable decreased $10,000
 Collections or Cash Receipts from Customers
Credit Sales
Add: Opening Balance of Accounts Receivable Or,
Less: Closing Balance of Accounts Receivable Credit Sales + Decrease in A/R

Accounts Receivable
From Beg. BS Beg. Bal.      30,000 Cash Receipts 517,000
from Customers
From IS Sales Revenue 507,000

From End. BS End. Bal.      20,000

A/R balance has declined from 30,000 to 20,000 by $10,000
Collections or Cash Receipts from Customers 
= Credit Sales + Decrease in A/R 
Cash Receipts from Customers > Sales
= 507,000 + 10,000  = 517,000
• Decreases in operating current assets (frees up cash) have a positive effect on cash flows
• To reconcile PBT to cash flows, 
• Decreases in Operating Current Assets is added to PBT
• Decline in A/R of 10,000 needs to be added to PBT
 CFO (Indirect Method) ‐ Increase in Operating Assets:  Deduct 
Inventory Cash ↓ + Non‐Cash Assets ↑ = L + SE
Beg. Bal.     10,000 150,000 COGS From IS
Purchase 155,000 Increase in Inventory
= 15,000 ‐10,000 = 5,000
End. Bal.     15,000

When the Inventory balance increases,  Cost of merchandise purchased >  Cost of goods 
sold (included in IS)  
• Increases in operating current assets (consumes cash) have a negative effect on 
cash flows.
• To reconcile PBT to cash flows, 
– an increase in operating current assets is subtracted from PBT
• Increase in Inventory of 5,000 needs to be deducted from PBT

Cash Paid for Operating Expenses Increase in Prepaid
=  Opera ng Expenses + ↑ in Prepaid Expense = 5,000 ‐1,000 = 4,000

• When the Prepaid Expense Increases, 
Cash paid for expenses >  Expenses reported in IS on an accrual basis
• Increase in Prepaid Expenses of 4000 to be deducted from PBT
34
 CFO (Indirect Method) ‐ Increase in Operating Liabilities  Add
Cash ↑ + Non‐Cash Assets = L ↑ + SE
Accounts Payable
Cash Paid to  139,000 Beg. Bal.      12,000
Suppliers Purchase
155,000
Increase in Accounts Payable
End. Bal.      28,000
= 28,000 ‐ 12,000 = 16,000

Credit Purchases – Increase in Accounts Payable = Cash paid to Suppliers
 Cash paid to Suppliers <  Credit Purchases  16,000 ↑ in A/P to be added to PBT

• Increases in current liabilities represent a postponement of cash payments
– It frees up cash and increases cash flows in the current period
• To reconcile PBT with CFO : Increases in current liabilities are added to PBT

Operating Expenses ‐ Increase in Payables = Cash paid for Operating Expenses
•When the Expense Payable Increases, 
Cash paid for operating expenses <  Op. Expenses reported in IS on an accrual basis
• Increase in Expenses Payable to be added to PBT

35
 CFO (Indirect Method) ‐ Decrease in Operating Liabilities:  Deduct 
– Decreases in operating liabilities represent the use of cash, thereby decreasing cash 
flows 
Cash ↓ + Non‐Cash Assets = L ↓ + SE

• To reconcile PBT with CFO:  Decreases in current liabilities are deducted from PBT

Add to Deduct from

Net Income
PBT NetPBT
Income
Operating Assets:
A/R Decrease Increase
Inventory Decrease Increase
Prepaid expenses Decrease Increase
Operating Liabilities:
A/P Increase Decrease
Accrued Liabilities Increase Decrease
Income Taxes Payable Increase Decrease

Cash↑ + Non‐Cash Assets ↓ = L + SE 36

 Indirect Method: CFO (Computer Services Company)

Cash flows from operating activities
Profit Before Tax $192,000 
Adjustments to reconcile profits to net cash flows 
from operating activities
Depreciation $9,000 
Loss on sale of plant assets 3,000
Interest Expense 42,000 54,000
246,000
Changes in Operating Assets & Operating Liabilities
Decrease in accounts receivable 10,000
Increase in inventory (5,000)
Increase in prepaid expenses (4,000)
Increase in accounts payable 16,000
17,000
263,000
Less: Income taxes paid   (calculated before) (49,000)
Net cash flows from operating activities $214,000 

37
 page 255‐256

100             120

38
 Solution 11.6 page 255‐256

DTL decreased by (500‐400) =100  Negative DTE (DTL Reversal/ DTA) 
Income tax exp (ITE) (11,200) = Current Tax Exp (CTE) + Deferred Tax Exp (DTE) (‐100)
CTE= 11,200 +100 =11,300. 
Income tax paid = CTE (11,300) ‐ Increase in tax payable (net of advance) (120‐100 =20) = 11,280

19, 720 39
 Profit before tax
Adjustment for reconciliation of PBT to CFO:
– Non-cash items like
Add: Depreciation on PPE, Provisions
Add: Amortization of intangible Assets, Impairment Losses
– Non-operating and non-recurring items like
CFO:   Indirect   Method

Add: Loss on sale of assets/investments

Less: Gain on sale of assets/investment 
Gain on sale of asset
Less: Interest Income = Cash Received from sale of the asset
Add: Interest expense Less: (Cost of the asset – Accumulated Depreciation)
- Changes in Operating Assets & Operating Liabilities

Add: Decrease in Accounts Receivable/Inventory/Prepaid Expense/Unbilled revenue

Add: Increase in Accounts Payable/ Salaries Payable/ Rent Payable/ Unearned revenue
Less: Increase in Accounts Receivable/Inventory/Prepaid Expense/Unbilled revenue
Less: Decrease in Accounts Payable/ Salaries Payable/ Rent Payable/Unearned revenue
Cash Flow from Operating Activities
Less : Income Tax Paid
Net Cash Flow from Operating Activities (CFO)

40
 Computing Cash Flow from Investing Activities (CFI)

• Examine individual Cash Receipts and Cash Payments related to Investing 
Activities
– To determine Cash flow from Investing Activity

• Analyze increases and decreases in Long term assets and Investments to 
determine effects on Cash account
• Objective
– Explain the change in each account balance from one year to the next

• Focus 
– Long term assets and Investments (balance sheet) 
– Short‐term investments (current asset section of the balance sheet)
– Investment gains and losses (income statement)
– Interest and dividend Received on Investment (Calculate)

41
 Computing Cash Flow from Investing Activities (CFI): Building

From the additional information:
The company acquired a building for $120,000 cash. 
This is a cash outflow reported in the investing section.

Building

1/1/14 Balance 40,000

Purchase of building 120,000

12/31/14 Balance 160,000

42
 Computing Cash Flow from Investing Activities (CFI) ‐ Equipment
• Purchased Equipment of $25,000.
• Sold Equipment with book value of 7,000 . Its cost was $8,000, accumulated 
depreciation was 1,000 . It was sold for $4,000
• Depreciation expense comprised of $6000 for building and $3000 for equipment

Cost of the Plant Asset 8,000
Cash Dr.   4,000
Less: Accum. Depreciation 1,000 Accumulated Depreciation           Dr.    1,000
Net Block or Book Value  Loss on Disposal of  Equipment   Dr.    3,000
or Carrying Value 7,000
Equipment                           Cr. 8,000
Sale Proceeds 4,000
Loss on sale of Equipment 3,000
Equipment Account Accumulated Depreciation: Equipment
Beg. Bal.        10,000 Cost of  8,000 Sale of PA        1,000 Beg. Bal.      1,000
Purchase of PA 25,000 Equipment  Dep Exp 3,000  
Sold End. Bal.       3,000
End. Bal.      27,000
Investing activities section
• For  Asset sold: Reduce Equipment ( PPE) by cost, 
• Reduce Acc Depn by Depreciation accumulated for the asset Purchase of Equipment ($25,000)
• Loss: If Sales Proceeds < Carrying Value
Sale of plant assets 4,000
43
 Cash flows from Investing activities  (CFI)

 Interest Received (if any) 
Interest Income for the year +  Decrease in Interest Receivable 
= Cash received for Interest Income

Net Cash provided by Operating Activities 214,000
Cash flows from Investing activities (CFI)
Purchase of Building ($120,000)
Purchase of Equipment (25,000)
Sale of Equipment 4,000
Net cash used by investing activities (141,000)

44
 CFI ‐ Summarized

Cash Flow from Investing Activities 

Add: Cash Receipts from Sale of fixed assets like Building, Plant, Equipment & Machinery

Add: Cash Receipts from Sale of investments in equity or debt of other entities (current & non‐current)

Add: Collection of repayments –related to loans/advances made to other parties (current & non‐current)

Less: Cash Payments for Purchase of fixed assets like Building, Equipment, Intangible assets

Less: Cash Payments for Purchase of Investments ‐ equity/debt of other entities (current & non‐current)

Less: Loans and Advances made to other parties (current & non‐current)

Add: Interest Received  (not the Interest Income)

Add: Dividend Received (not the Dividend Income)

Net Cash from Investing Activities  (CFI) (B)

45
 Non‐Cash : Investing & Financing Activities 
• Issued $110,000 of long‐term bonds in direct exchange for land.
• There are no cash inflows or outflows
• But it is a significant noncash investing and financing transaction that merits   
disclosure in a separate schedule.
Disclosure :        Schedule of Noncash Investing and Financing Transactions
Issuance of bonds to purchase Land  $110,000

Land                   Dr.  110,000
Bonds Payable  Cr.                    1,10,000
Land
1/1/14  Balance   20,000
Issued bonds   110,000
12/31/14  Balance   130,000

Bonds Payable
1/1/14  Balance   20,000
For land   110,000
12/31/14  Balance   130,000
 Computing Cash flow from financing activities

• To determine cash flows from financing activities,
– accounts involving cash receipts and cash payments from 
financing activities are examined individually
• Focus
– Short‐term borrowings
– Long‐term liabilities
– Stockholders’ equity accounts

• Must also consider
– Cash dividends from the statement of stockholders’ equity
– Interest paid on borrowings

47
 Computing Cash flow from financing activities (CFF)
Issued common stock for $20,000 cash.
Common Stock
1/1/14  Balance   50,000
Shares Issued   20,000
12/31/14  Balance   70,000

The company declared and paid  $29,000 cash dividends. 
This amount decreased Retained Earnings and caused an $29,000 
decrease in cash flows (cash paid).
Retained Earnings

1/1/14  Balance   48,000

Dividends   29,000 Net income   145,000
12/31/14  Balance   164,000

Financing activities section
Issue of common stock  $20,000
Payment of dividends  ($29,000) 48
 CFF

 Interest Paid
Interest Expense for the year Interest Paid  = Interest Expense +  
+ Opening Balance of Interest Payable  Decrease in Interest Payable 
Interest Paid =  42,000 +  0 = 42,000
– Closing Balance of Interest Payable
= Cash paid for Interest Expense or Interest Paid

Issue of common stock  $20,000 
Payment of dividends  ($29,000)
Interest Paid ($42,000)
Net cash used by Financing activities (51,000) 

49
 CFF Summarized

Cash Flow from Financing Activity:

Add: Cash proceeds from issuing shares (or common or preference stock)
Add: Cash proceeds from issuing debentures, loans, notes, borrowings, bonds,
mortgages (current & non-current)

Less: Cash payments for Shares Repurchase (Buy Back)

Less: Repayment/ Prepayment of borrowings/debt (current & non-current)

Less: Interest Paid (not the Interest Expense)

Less: Dividend Paid (Dividend declared adjusted for dividend payable if any)

Net Cash from Financing Activities (CFF) (C)

50
 Statement of Cash Flows ‐ Summarized
Computer Services Company
Statement of Cash Flows 
For the Year Ended December 31, 2014
Net cash flows from operating activities $214,000 
Net cash flows from investing activities (141,000)
Net cash flows from financing activities (51,000)
Net increase (decrease) in cash $22,000 
Cash at beginning of year $33,000
Cash at end of year $55,000 
Schedule for Non‐Cash Transactions
Issue of bonds payable for plant assets  110,000

51
 Cash flows from operating activities
Profit Before Tax  $192,000 
Adjustments to reconcile PBT to net cash flows from operating activities
Depreciation $9,000 
Cash Flow Statement    :   Indirect   Method 

Loss on sale of equipment  $3,000 
Interest Expense  $42,000 
Changes in Operating  assets and Operating  liabilities
Decrease in accounts receivable 10,000
Increase in inventory (5,000)
Decrease in prepaid expenses (4,000)
Increase in accounts payable 16,000 71,000
cash flows from operating activities 263,000
Less:  Income taxes paid  ($49,000)
Net cash flows from operating activities $214,000 
Cash flows from Investing activities (CFI)
Purchase of Building ($120,000)
Purchase of Equipment (25,000)
Sale of Equipment 4,000
Net cash flows from investing activities ($141,000)
Cash flows from Financing Activities (CFF)
Issue of common stock  $20,000 
Payment of dividends  ($29,000)
Interest Paid ($42,000)
Net cash used by Financing activities (51,000) 
Net  increase in Cash and Cash Equivalents  $22,000
Cash and cash equivalents at the beginning  $33,000
Cash and cash equivalents at the end of the year                $55,000
Schedule of Noncash Investing and Financing Transactions  52
Issuance of bonds to purchase Land  $110,000
 Cash flows from operating activities
Cash Flow Statement    :   Direct   Method 

Cash Receipts from customers (for sale of goods and the rendering of services) 517,000
Less: Cash paid to suppliers (for goods and services) (139,000)
Less: Cash paid for other Operating Expenses (115,000)
263,000
Less:  Income taxes paid  ($49,000)
Net cash flows from operating activities $214,000 
Cash flows from Investing activities (CFI)
Purchase of Building ($120,000)
Purchase of Equipment (25,000)
Sale of Equipment 4,000
Net cash flows from investing activities ($141,000)
Cash flows from Financing Activities (CFF)
Issue of common stock  $20,000 
Payment of dividends  ($29,000)
Interest Paid ($42,000)
Net cash used by Financing activities (51,000) 
Net  increase in Cash and Cash Equivalents  $22,000
Cash and cash equivalents at the beginning  $33,000
Cash and cash equivalents at the end of the year                $55,000

Schedule of Noncash Investing and Financing Transactions 
Issuance of bonds to purchase Land  $110,000
53
 Cash Flow from Operating Activities:
Profit before tax
Adjustment for reconciliation of PBT to CFO:
– Non‐cash items: Add: Depreciation‐PPE, Provisions, Amortization of intangible Assets, Impairment Losses
– Non‐operating items : Add: Loss on sale of assets/investments, Interest expense
Less: Gain on sale of assets/investment, Interest Income
Cash Flow Statement    :  Indirect   Method

‐ Changes in Working capital items
Add: Decrease in  Current Assets ,  Increase in Current Liabilities ;    Less : Increase  in  CA, Decrease in CL
Less: Income Tax paid (unless otherwise specified)
Net Cash from  / (used in) Operating Activities  (CFO)                    (A)
Cash Flow from Investing Activities 
Cash Receipts from Sale of fixed assets or PPE, Intangibles like trademarks 
Add: Cash Receipts from Sale of investments in equity or debt of other entities
Less: Cash advances and loans made to other parties
Less: Cash Payments for Purchase of fixed assets  ( including Capital Advances), Intangibles
Less: Cash Payments for Purchase of Investments in equity or debt of other entities 
Add: Repayment collections related to advances and loans made to other parties
Add: Interest Received (not the Interest Income), Dividend Received  (not the Dividend Income)
Net Cash from / (used in) Investing Activities  (CFI) (B)
Cash Flow from Financing Activity:
Cash proceeds from issuing shares (or common or preference stock)
Add: Cash proceeds from issuing debentures, loans, notes payable, borrowings bonds & mortgages  payable and other short‐
term or long‐term  debt
Less: Cash payments for shares repurchase
Less: Repayment of borrowings
Less: Interest Paid (not the Interest Expense), Dividend Paid ( on preferred or common stock)  (including  dividend tax if any)
Net Cash from / (used in) Financing Activities  (CFF) (C)
Net  increase/ (decrease)  in Cash and Cash Equivalents (CFO +CFI +CFF)   (D)=(A+B+C)
Cash and cash equivalents at the beginning of the year  (Adj: Effect of Exchange Rates on CCE) (E)
Cash and cash equivalents at the end of the year                (E)+ (D)
In order to reconcile the movement in foreign currency CCE  from 
opening to closing balance sheet
 Cash Flow from Operating Activities:
Cash Receipts from customers (for sale of goods and the rendering of services)
Less: Cash paid to suppliers (for goods and services)
Less: Cash paid to employees
Less: Cash paid for other Operating Expenses
Less: Income Tax paid (unless otherwise specified)
Cash Flow Statement    :   Direct Method

Net Cash from  / (used in) Operating Activities  (CFO)                    (A)

Cash Flow from Investing Activities 
Cash Receipts from Sale of fixed assets or PPE, Intangibles like trademarks 
Add: Cash Receipts from Sale of investments in equity or debt of other entities
Less: Cash advances and loans made to other parties
Less: Cash Payments for Purchase of fixed assets  ( including Capital Advances), Intangibles
Less: Cash Payments for Purchase of Investments in equity or debt of other entities 
Add: Repayment collections related to advances and loans made to other parties
Add: Interest Received (not the Interest Income)
Add: Dividend Received  
Net Cash from / (used in) Investing Activities  (CFI) (B)
Cash Flow from Financing Activity:
Cash proceeds from issuing shares (or common or preference stock)
Add: Cash proceeds from issuing debentures, loans, notes payable, borrowings
bonds & mortgages  payable and other short‐term or long‐term  debt
Less: Cash payments for shares repurchase
Less: Repayment of borrowings
Less: Interest Paid (not the Interest Expense)
Less: Dividend Paid ( on preferred or common stock)  (including  dividend tax if any)
Net Cash from / (used in) Financing Activities  (CFF) (C)
Net  increase/ (decrease)  in Cash and Cash Equivalents (CFO +CFI +CFF)   (D)=(A+B+C)
Cash and cash equivalents at the beginning of the year  (Adj: Effect of Exchange Rates on CCE) (E)
Cash and cash equivalents at the end of the year                (E)+ (D)
In order to reconcile the movement in foreign 
currency CCE  from opening to closing balance sheet
 AKB page 258‐259

Additional Information

56
 Solution 11.7 page 258‐259

Please Practice the Self Study Problems : AKB book ‐ Case study 11.5, 11.8 & 11.9
57
Solution continued … 11.7 page 258‐259

58
 59
Please try the rest of the assignment  problems: AKB book ‐ A11.4 , 6 (iii)
4. (Pg 269) Cash Flow Statement of Vasi Ltd.  For The Year ended 31st Dec 2017
Cash flow from operating activities Amount Rs'000
Net profit for the year 120
Add income tax 80
Profit before tax expense 200
Adjust: Non‐cash expenses:
Depreciation 50
Amortisation of goodwill 10 60
Adjust: Non‐Operating Items
Interest paid 50
Income from dividend ‐10
Profit on sale of machinery ‐20 20
280
Adjustment for changes in working capital:
Increase in stock ‐20
Increase in debtors ‐25
Decrease in pre‐paid expenses 10
Increase in trade creditors 50 15
Cash flow after adjustments for change in WC 295
Income tax paid (20+80‐30) 70
Cash flow from operating activities 225
Cash flow from investing activities
Purchase of plant and machinery ‐180
Sale of plant and machinery 50
Sale of investment 20
Income from dividend 10
Cash flow from investing activities ‐100
Cash flow from financing activities
Repayment  of loan from IDBI ‐45
Interest paid ‐50
Cash flow from financing activities ‐95
Net cash flow for the year 30
Opening cash balance:
Cash 10
Cash credit from SBI ‐100 ‐90
Closing cash balance ‐60
Cash 20
Cash credit from SBI ‐80 60
‐60
 A11.4     From the following information, Calculate cash flow from operating activities:

Particulars Rs Rs

1. Net profit before taxation 8,30,000 10. Interest income on non-current investments 8,000

2. Depreciation 1,50,000 11. Interest income on current investments 5,000

3. Loss on sale of machinery 20,000 12. Profit on sale of current investments 4,000

4. Interest paid on debenture 30,000 13. Loss on sale of non-current investments 6,000

5. Interest paid on bank loan 10,000 14. Tax paid during the current year 1,00,000

6. Goodwill amortised 6,000 15. Refund of tax 3,000

7 Preliminary expenses written off 5,000 16. Loss due to earth quake 1,50,000

8. Premium on redemption of preference shares 10,000 17. Insurance proceeds from earth quake disaster settlement 1,20,000

9. Gain from fair value change of investment in equity held for trading 20,000

Position of Current Assets and Current Liabilities
Particulars Closing (Rs) Opening (Rs)

Inventories 1,10,000 1,00,000

Trade Receivables 1,00,000 2,00,000

Trade Payables 80,000 1,00,000

Outstanding expenses 15,000 10,000

Cash and Cash Equivalents 30,000 50,000

61
 Solution    A11.4 Amt. (Rs) Amt. (Rs)
Net  profit before taxation and extraordinary items (8,30,000 + 
8,60,000
1,50,000 ‐ 1,20,000)
Non‐cash & Non‐Operating items:
Depreciation 1,50,000
Goodwill amortised 6,000
Preliminary expenses written off 5,000
Gain from fair value change of investment in equity held for trading ‐20,000
Loss on sale of machinery 20,000
Interest paid on debentures 30,000
Interest paid on bank loans 10,000
Premium on redemption of preference shares 10,000
Interest income on non‐current investments ‐8,000
Interest income on current investments ‐5,000
Profit on sale of current investments ‐4,000
Loss on sale of non‐current investments 6,000 2,00,000
Operating cash flow before working capital changes 10,60,000
Changes in current assets and current liabilities:
Inventories ‐10,000
Trade receivables 1,00,000
Trade payables ‐20,000
Outstanding expenses 5,000 75,000
Operating cash flow before taxes 11,35,000
Income taxes paid net of refund ‐97,000
Operating cash flow before extra‐ordinary items 10,38,000
Loss due to earth quake ‐1,50,000
Insurance proceeds from earth quake disaster settlement 1,20,000 ‐30,000 62
Net operating cash flow 10,08,000
 You are asked to prepare the 
following for the year ended 
March 31, 2017
(iii) Statement of cash flow.

2017‐18 10 0
2016‐17 0 9
2015‐16 0 6
2014‐15 0 5
10 20

63
 6. (Pg 270 ‐271 Cash Flow Statement
– f ‐ iii) Cash flow from operating activities
Net profit for the year 63.00
Increase in other reserves and surplus 60.00 Add: Income tax expense 40.00
Dividend paid 33.00 Profit Before Tax 103.00
93.00
Increase in reserve and surplus due to 
Add:
merger 30.00 Depreciation charged to P/L  (250 – (40‐15) +Dep = 300) 75.00
Net profit for the year 63.00 Interest paid on loan 10.50
Write back of IT provision  (20‐17.5) ‐2.50
Loss on sale of machinery   (15‐5) 5.00
191.00
Adjustment for changes in working capital
Increase in working capital (excluding cash) ‐70.00
Increase in Inventory ‐5
121.00
Increase in customer dues ‐75
Decrease in Advances 30 Income tax paid (Earlier years: 9+4.5+4  + Advance30) 47.50
Decrease in Creditors ‐20 Cash flow from operating activities 73.50
Net Adjustment due to Wcap changes ‐70
Cash flow from investing activities
Purchase of fixed assets  (350+90‐40‐500) ‐100.00
Sale of fixed assets    10.00
Cash flow from Investing activities ‐90.00
Cash flow from financing activities
Issue of equity shares  (40 + share premium 80) 120.00
Redemption of preference shares ‐20.00
Repayment of loan ‐60.00
Interest paid on loan ‐10.50
Payment of dividend   (30+3) ‐33.00
Cash flow from financing activities ‐3.50
Net cash flow ‐20.00
Opening cash balance 64 35.00
Closing cash balance 15.00
Analysis of Cash Flows

65
 Statement of Cash Flows
For the Year Ended December 31, Year 20XX
PBT 90,000
Add (deduct):
Depreciation & amortization expense 40,000
Gain on sale of assets (5,000)
Increase in Accounts receivable (9,000)
Decrease in Inventories 6,000
Decrease in Accounts payable (5,000)
Net cash flow from operating activities 117,000
Purchase of equipment (170,000)
Purchase of investment (40,000)
Sale of equipment 7,000
Net cash flow from investing activities (203,000)
Mortgage payable (50,000)
Preferred stock 175,000
Dividends (51,000)
Net Cash flow from financing activities 74,000
Net increase in cash (12,000)
Beginning cash 51,000
Ending cash 39,000

CFO = -20,000, CFI = 30,000, CFF=40,000, Net cash increase =50,000

A successful company can experience problems in cash flows 
while an unsuccessful one might be loaded with positive cash balance
66
Cash Flow Statements of Indian Companies

2020: Asian Paints and Infosys

67
The Corporate Life Cycle

PHASE CFO CFI CFF

Introductory ‐27 ‐45 72
Growth 12 ‐40 28
Mature 40 ‐25 ‐15
Decline 17 3 ‐20

PHASE CFO CFI CFF

Introductory ‐ve ‐ve +ve Funds needed to support operations
Growth +ve (rises) ‐ve +ve CFO< NI
Mature +ve (high) ‐ve ‐ve CFO > CFI, CFO ~ NI
Decline +ve (falls) +ve ‐ve (high) Selling off assets , retiring debt, buying back 
Identify Phases 
of PLC

(point A) ‐ introductory phase ‐ net CFO and CFI are expected to be negative while CFF would be positive

(point D)‐ growth phase  ‐ a company would continue to show negative net CFO and CFI while positive CFF
(point C)‐ maturity phase ‐ net CFO and net income would be approximately the same. Net CFO activities would exceed 
investing needs. 
(point B) ‐ decline phase‐ net CFO would diminish while CFF would be negative

Asian Paints : Cash Flow Statement for the year ended 31st March  2020   2019

INFOSYS: Cash Flow Statement

69
Asian Paints : Cash Flow Statement for the year ended 31st March  2020   2019

2020   2019

70
Asian Paints  2020   2019
INFOSYS: Cash Flow Statement

2020                       2019
INFOSYS: Cash Flow Statement
SOME MORE PRACTICE

74
 Required: Calculate the cash flow for the year 
Problem 2 Amount
2017 from the sale of the old item of plant and 
1. Cost of the item plant and machinery sold
machinery 
Opening gross book value 600
Add Purchase during the year 450
1,050
Less closing gross book value 1,000
Cost of the item plant and machinery sold 50
2. Accumulated depreciation on the item of plant and machinery sold
Opening accumulated depreciation 200
Add depreciation for the year 100
300
Less Closing accumulated depreciation 290
Accumulated depreciation on the item of plant and machinery sold 10
3. Cash Inflow from the item of plant and machinery sold
Cost of the item plant and machinery sold 50
Problem ‐2  NCV of P&M: Less Accumulated depreciation on the item of plant and machinery sold 10
Net book value (WDV) of the item of plant and machinery sold 40
Opening + Purchase = Depn. + Sold + Closing
Add profit from the sale of the item of plant and machinery 20
(600‐200) + 450       =  100   + Sold +  (1000‐290) Fund flow from the sale of the item of plant and machinery 60
 NCV of Plant Sold = 40
 Cash Inflow from the plant sold 
75
= NCV of 40 + Profit on sale of  20 = 60
 Required: Calculate: (a) the cash flow for the year 2017, from the sale of the 
old item of plant and machinery; (b) the cost of new machinery purchased 
during the year 2017.

Amount
Problem – 3 Problem 3
a) Cash Inflow from the plant sold  (a) Cash Inflow from the sale of machinery (Amount in Rs’000)
Written down value of the amount sold 50
= WDV of plant sold of 50 
Less loss on the sale of machinery 20
‐ Loss on sale of Plant 20 = 30 Fund flow from the sale of machinery 30
b) Opening + Purchase = Depn. + Sold + Closing
700  +  450         =  150   + 50 +  1000 (b) The cost of machinery purchased during the year (Amount
 Purchase  = 500  in Rs’000)
Written down value at the end of the year 1,000
Less written down value at the beginning of the year 700
300
Add depreciation for the year 150
Add written down value of the item sold during the year 50
The cost of machinery purchased during the year 500
76
THANKS

77
 Corporate Financial 
Reporting & Analysis

Session 17 to 19:
Property, Plant & Equipment ‐
Acquisition, Depreciation, Impairment, Sale

1
 Property, Plant and Equipment  or Tangible Fixed Assets
• Determining Cost
• Depreciation and changes
– The Concept, Useful Life, Salvage Value, Choice of Method – SLM, WDV
• Impairment
• Disposal
• Impact on ratios

Applying the Matching Principle

2
 Plant Assets or Tangible Fixed Assets
Property, Plant and Equipment (PP&E) are
 Tangible Assets (have physical substance ‐ a definite size and shape), 
 An entity holds them for use in the production or supply of goods or services, for rental to 
others, or for administrative purposes (are used in the operations of a business), 
 are not intended for resale to customers, 
 are classified as non‐current assets (expected to be used by the company for more than a 
year)
Examples: Land, Land Improvement, Equipment, Building, Furniture, Bearer plants, Vehicles, Ships, 
Aircraft, Office Equipment
• PP&E includes bearer plants (grape vines) but does not include Investment Property, Produce on 
bearer plants (lumber), or livestock  
Critical to a company’s success. So a company should
 Keep assets in good operating condition, Replace worn‐out or outdated assets, Expand its 
productive assets as needed (Capital Budgeting decision & Financing decision)
Recognition Criteria  Cost of an item of PP&E is initially recognised when:
 it is probable that future economic benefits associated with the item will flow to the entity
 the cost of the item can be measured reliably
Asset acquired for safety & environment purposes – PP&E?
Judgment – Major Spare parts, servicing equipment – can qualify as PP&E if  definition met  (usually 
Inventory, recognized in P&L as consumed)
Unit of Measure: Individually insignificant but similar items can be aggregated (moulds, tools, dies)
Component Accounting:  Cost of PP&E is allocated to significant parts (can have different Useful lives, 
Dep method) – Engine and Airframe of an Aircraft (Can be grouped ‐ if similar in UL, method)
Determining the Cost of Plant Assets

4
 Elements of cost
An item of property, plant and equipment that qualifies for recognition as an asset shall be 
measured at its cost  (Historical Cost Principle)
The cost of an item of property, plant and equipment comprises:
• its purchase price, including import duties and non‐refundable purchase taxes, after 
deducting trade discounts and rebates.
• any costs directly attributable to bringing the asset to the location and condition 
necessary for it to be capable of operating in the manner intended by management.
– costs of employee benefits arising directly from the construction or acquisition of 
PP&E
– costs of site preparation;
– initial delivery and handling costs;
– installation and assembly costs;
– costs of testing whether the asset is functioning properly, 
• after deducting the net proceeds from selling any items produced while bringing 
the asset to that location & condition (such as samples produced when testing 
equipment);
– professional fees.
• the initial estimate of the costs of dismantling and removing the item and restoring the 
site on which it is located
Revenue expenditure: Costs which are expensed immediately 
Capital expenditures: Costs which are included in PP&E Asset A/c 5
 Not Recognized in Cost of PP&E
Examples of costs that are not costs of an item of PP&E are:
• costs of opening a new facility (inauguration costs);
• costs of introducing a new product or service (including costs of advertising and promotional 
activities);
• costs of conducting business in a new location or with a new class of customer (including costs 
of staff training); and
• administration and other general overhead costs

Cessation of Accumulating costs : Recognition of costs in the carrying amount of an item of PP&E 
ceases when it is in the location and condition necessary for it to be capable of operating in the 
manner intended by management. 
Costs incurred in using or redeploying an item ‐ not included in the carrying amount
• costs incurred while an item capable of operating in the manner intended by management has 
yet to be brought into use or is operated at less than full capacity;
• initial operating losses, such as those incurred while demand for the item’s output builds up
(CS15.5 – Loss caused by selling sub‐std product after commercial production has commenced,
CS15.6 – Loss in initial years of hotel due to low occupancy)
• costs of relocating or reorganizing part or all of an entity’s operations 
(CS15.4, 15.14 –Cost of relocating factory,  CS15.13‐ Cost of changing plant layout)
CS15.12: Cost of repair of accidental damage not contemplated at the time of purchase: Expensed
6
 Nature of the Cost  (Page 353‐354)                                                  Directly        Not Directly       
Attributable    Attributable    

08‐10‐2020 7
 Cost of Plant Assets – Land & Land improvement 
All necessary costs incurred in making land ready for its intended use : Will increase (Debit) 
Land Account
Costs typically include:
1) cash purchase price, 
2) closing costs such as title and lawyers’ (attorney) fees, 
3) real estate agents’ commissions,
4) accrued property taxes and other liens on the land assumed by the purchaser
5) Cost of preparing the land ready for its intended use 
• If vacant land: clearing, draining, & filling of land, grading; 
• if land has old construction:  Cost of demolition of old building on it (net of 
proceeds from salvaged materials of demolished building)
Land is not depreciated – Unlimited Useful Life
Land Improvements : Includes all expenditures necessary to make the improvements ready 
for their intended use.
• Structural additions made to land like driveways, parking lots, fences, landscaping, 
and underground sprinklers.
• Limited useful lives ‐ Depreciate the cost over their useful lives
Zobrist Company acquires real estate at a cash cost of $80,000. The property contains an old
warehouse that is demolished at a net cost of $6,500 ($8,200 in costs less $1,700 proceeds from
salvaged materials). Additional expenditures before construction of a building began included:
attorney’s fee, $1,900; the real estate broker’s commission, $5,200; architect’s fee $9,100;
$14,000 to put in driveways & parking lot. Determine the amount to be reported as the cost of the
land. Ans. $93,600 8
 Illustrations Directly Attributable Cost
At the beginning of 2018, SK Limited (SKL) purchased equipment to produce a new 
product,  which it believes will complete the portfolio of skin care products and, thus, will 
help achieve the target market share in skin care products. The purchase price of the 
equipment was Rs 1 crore (10 million). 
In addition, it incurred the following expenditure:
(a) Cost for transporting the equipment to the site Rs 50,000
(b) Labour charges for loading and unloading the equipment: Rs 5,000
(c) Transit insurance: Rs 200,000
(d) Cost of preparing the site: Rs 40,000
(e) Expenditures required in assembling, installing, and testing the unit Rs 60,000
(f) Cost to train employees in operating the equipment: Rs 200,000
(g) Cost to promote the new product: Rs 1,000,000
(h) Premium paid for a 3 year accident insurance policy (during use) Rs 20,000
Cost of equipment        Purchase Price                                                                   Rs 10
Directly attributable Costs (.05+.005+.2 +.04 +.06) =  Rs  0.355
Rs 10.355 mn
CS15.9 : Relocating the community ‐ Costs to be incurred for relocating community settled 
on the ground identified for construction of golf course :
• To be included in the cost of the golf  course because they are directly attributable to the 
construction of the same
9
 Allocation of cost between land and building : Land & Building bought together
CS 15.2 BN Limited (BNL) has purchased a building for Rs 20 million. 
It incurred the following additional expenditures to make the building ready for the intended 
use:
(a) Amount paid to an advocate to search the title of the land and building: Rs 20,000
(b) Amount paid towards registration charges & real estate agents’ commission : Rs 2 million
(c) Amount paid to ‘vastu’ expert to suggest modifications in the building: Rs 100,000
(d) Amount paid to an architect to design and supervise modifications: Rs 1,000,000
(e) Cost of demolishing a part of the building for reconstruction: Rs 100,000
(f) Cost of modifications: Rs 4 Million (Contemplated when bought) (Also see CS 15.10)
The fair value (at the date of acquisition) of the land on which the building is 
constructed is estimated at Rs 12 million
Cost of Building  (Rs Mn)
Purchase Price allocated 8
a) Search Costs =  0.4 * Rs 20,000 0.008
b) Registration charges = 0.4* 2 mn 0.8
c) Vastu costs 0.1
L&B bought at  20 1
d) Architect fees 1
FV of Land  12 0.6
e) Demolition for recon 0.1
FV of Building 8 0.4
f) Modification costs 4
14.008
See 15.7, 15.8  & 15.11 :  For examples on Cost of demolishing existing building 10
Q3 (iii)
In 2006, Anuj Limited (AL) had purchased an old building on a free hold land for Rs. 8000,000. 
The fair value of the land was estimated at Rs. 4000,000. 
AL paid Rs. 1000,000 towards registration charges and it incurred Rs. 50,000 towards legal 
expenses for documentation and registration. 
When renovation of the building was in progress, AL received a notice from the local municipal 
corporation for demolition of the building as the building plan was not approved by the 
municipality. AL appointed a lawyer to deal with the issue. A settlement was reached, 
according to which AL had to pay penalty of Rs. 500,000 and it had to demolish a part of the 
building. The cost of demolition was Rs. 100,000. The lawyer was paid Rs. 20,000.
An architect estimated that the part demolished constituted 5 percent of the original building 
in terms of its value. 
The building should be carried (gross block) in the balance sheet as at December 31, 2006 at ?
Purchase Price allocated 4,000.00 
L&B bought at  8,000  1
Registration charges = 1000 *0.5 500.00 
FV of Land  4,000  0.5
Legal expenses   = 50*.5 25.00 
FV of Building 4,000  0.5
COST of Building 4,525.00 
Less: Write down due to demolition
Carrying amount of the building should be written 
(5%*4,525) 226.25 
down by the carrying amount attributable to the 
CV of building at December 31, 2006 (Ans) 4,298.75
portion demolished
To be Expensed : 
The demolition was not contemplated at the time of  Penalty 500
acquisition   Lawyer was paid  20
‐ the cost of demolition to be recognized as an expense 11
Cost of demolition  100
 Subsequent costs
• Repair and Maintenance of PP&E (Ordinary Repairs): 
– Costs of day‐to‐day servicing are primarily the costs of labour and consumables, and 
may include the cost of small parts 
(generally small amounts, incurred frequently – to maintain operating efficiency of the 
asset like oiling of parts )
– Not included in PP&E, expensed in profit or loss as incurred
• Debited to Repair Expense
• Additions to PP&E
– Example: Construction of food court to increase footfall in a mall, Installation of AC in 
delivery van
– Capitalize in cost of the PP&E (mall/ delivery van) if recognition criteria met (flow of 
future economic benefits, cost can be reliably measured)  Debit to Asset A/C (PP&E)
• Part replacement  (cost of replacing interior walls of a building)
– Can be at regular intervals /less frequently recurring replacement / non‐recurring 
replacement (Usually material amount)
– If recognition criteria is met, Cost incurred to replace the item added to carrying 
amount of PP&E (capitalized),  Carrying Amount of parts replaced is De‐recognized
• Major Inspection & Overhaul 
– Example: Major inspection‐regulatory condition for continuing to operate an aircraft
– Is recognized in carrying amount of PP&E as a replacement, if recognition criteria is 
satisfied (Any remaining CA of the cost of previous inspection is derecognized)
12
 Measurement of Cost
Cost is the amount of CC&E paid or the fair value of other consideration given to acquire an asset
The cost of an item of PP&E is the cash price equivalent at the recognition date. 
If payment is deferred beyond normal credit terms
• the difference between the cash price equivalent and  total payment 
 is recognized as interest over the period of credit  (unless such interest is capitalized)
KL purchased equipment on April 1, 2017 for Rs 5 million. The amount is payable over a period of 3 
years.  Rs1 mn were paid on April 1, 2017. The outstanding amount of Rs 4 mn is payable in 2 equal 
yearly installments of Rs 2 mn each payable on March 31, 2018 and March 31, 2019. The cash price of 
the equipment is Rs 4.5 million  IRR= 9.38 %
Total Payment of 5 mn (1+2+2) ‐ Cash price of the equipment of Rs 4.5 ( PVs: 1+1.828+1.672)
= 0.5 mn is recognized as interest expense over the period of credit :  
Interest for the year 2017–18 will be (4.5 – 1) × 0.0938                  or 0.328 million.
Interest for the year 2018–19 will be (4.5 ‐1 ‐2 + 0.328) × 0.0938 or 0.172 million

PP&E acquired in exchange of a non‐monetary asset : measured at fair value unless
• the exchange transaction lacks commercial  substance or
• the fair value of neither the asset received, nor the asset given up is reliably measurable
• If an entity is able to measure reliably the fair value of either the asset received or the asset given 
up, then the fair value of the asset given up is used to measure the cost of the asset received 
unless the fair value of the asset received is more  clearly evident
• If the acquired item is not measured at fair value, its cost is measured at the carrying amount of 
the asset given up   X agrees to exchange its warehouse with Y’s in the same vicinity Lacks Commercial sub:
13
X’s warehouse CV=Rs1L, FV=1.25L,  FV of Y’s warehouse =Rs1.2L New Warehouse  at 1 L
Corporate Financial Reporting & analysis
Property, Plant & Equipment
Session ‐ 18
 Asset Retirement Obligation (ARO)
Asset Retirement Obligation (ARO) : Cost of dismantling and removing the item and restoring the site after
retirement of the asset from use is estimated
– should be included in the acquisition cost of the item of PP&E
– recognized as a liability (provision) in the balance sheet
Estimating ARO: Present value of the estimated amount that will be required to settle the obligation
(Discount rate : Risk‐free rate  YTM of government bond matching the ‘useful life of the asset’)
If the liability arises while operating the equipment,
– Amount of liability is counted in the cost of inventory
– Example: Production site gets damaged on production of goods using the equipment
Change in provision due to unwinding of discount
• The carrying amount of the provision increases in each period due to unwinding of discount rate.
• This increase is recognized as borrowing cost in the statement of profit and loss
Illustration 15.1 (AKB) : The liability as at 31/3/ 2017 was recognized at Rs10,000 = PV of the estimated amount 
that would be required to fulfill the asset retirement obligation. The PV was calculated using the discount rate 
of 8%. The amount was included in the cost of the asset.
• Calculate the carrying amount of liability in the balance sheet as at March 31, 2018 (10,000 ×1.08) or Rs 10,800 
• How will the change be accounted for in the financial statements for the year 2017‐18 ? 
Increase of 800 (increase in Liability due to unwinding of discount) – recognize as borrowing cost in the statement of 
profit and loss for the year 2017–18
Change in provision due to reasons other than unwinding of discount like changes in the estimated timing 
or amount of the outflow of resources required to settle the obligation, or a change in the discount rate  
For Cost Model: Increase (decrease) in the liability should be added to (deducted from) the Cost of the Asset 
15
 Cost of Self Constructed Asset
Cost of self‐constructed asset
• Excludes :  Any internal profits, 
• Excludes :  Cost of abnormal amounts of wasted material, labour, or other resources 
• Includes: Borrowing costs directly attributable  ‐ as part of cost (on fulfilment of certain criteria)
Expenditure during Construction
– Indirect expenditures during the construction of a project (Cannot be assigned directly to items of 
PP&E  but Essential to construction) 
• Allocated to the items of PP&E constructed in the project (in proportion to  their respective costs)
Examples: General admin & office expenditure at the construction site, cost of running of vehicles, in 
connection with temporary structures & service facilities, Depreciation on items of PP&E used
AKB: Page 363
Accumulation of costs to commence from: 
The date on which management authorizes 
& commits fund for the project
Cost of each item of PP&E: 
3.2/32= 10%
‐ Expenditure Directly attributable to the project [50 +(0.5*1.1)] = 

Like Costs of detailed project report, surveys and preliminary 
studies by project team after project approval
‐ Expenditure that could be avoided had it not taken up the new 
project  Capitalize as part of the project cost
‐ If unavoidable eg. Gen OHs, Corporate expenses  – to be expensed
Incidental: Parking fees  Construction and demolition of  
earned from a part of the  temporary quarters ‐ Necessary 
Income during Construction  (CS 15.15, CS15.16 ) construction site – in P&L Net indirect cost = (Cost of Constn & 
If Necessary for construction activities : To be deducted from construction cost  demolition) – ( Rent received)
 to be allocated to items of PP&E16
(Income, Expense of Incidental Operations – Recognize in P&L for the period)
 Borrowing Costs (IndAS‐23)
Borrowing Costs: Interest and other costs that an entity incurs in connection with borrowing 
of funds 
• Borrowing Costs directly attributable to the acquisition, construction or production of 
Qualifying assets, form part of the cost of that asset  (Capitalise as part of the cost of the 
asset i.e. add to Plant Asset account)
• Other Borrowing Costs are recognised as Expense
Qualifying asset :  Asset that necessarily takes a substantial period of time to get ready for its 
intended use or sale (typically more than a year) (Example: self‐constructed mfg plant)
Time period for capitalization of borrowing costs incurred:
• Starts when all the following conditions are met:
– it incurs expenditures for the asset
– it incurs borrowing costs
– it undertakes activities that are necessary to prepare the asset for its intended use/sale
• Ceases when the asset is substantially complete i.e. ready for intended use
• Suspension: Extended period during which it suspends active development of a Qualifying 
asset 
– if abnormal in nature – it is excluded (For example : Labour unrest period )
– if it is normal in nature – it is included (Interruption due to Heavy rain which is normal 
during the period, in the relevant geographical area)
Disclosure
• Amount of borrowing costs capitalized during the period  Ratio effect ?
17
 Borrowing Costs: Illustration
Problem A Ltd started construction of a building on 1/1/2010
It spent Rs15 lakhs on the construction
For funding the same, it took a loan of Rs10 lakhs from a bank on 1/1/2010 @10% p.a.
The construction was completed on 30/10/2011. Loan paid was repaid on 31/12/2011
The construction was suspended from 1/4/2010 to 30/04/2010 due to a directive from court
Calculate the amount of Borrowing Costs to be capitalized.
Solution  Total Interest Costs on the loan for 2 years  = Rs 10 Lakhs  * 10% * 2 years 2,00,000 
Interest Cost to be capitalized to cost of building = Rs 10 Lakhs *(11+10)/12 *0.1 1,75,000 

Interest Cost to be Expensed to Income Statement  in 2 years 25,000 
Year 1 (2010) Interest Cost to be Expensed to Income Statement  = 10 Lakhs *10%* (1 month/12) 8,333 
Year 2  (2011) Interest Cost to be Expensed to Income Statement  = 10 Lakhs *10%* (2 months/12) 16,667 

• What if the loan taken was Rs16 lakhs: 15 lakhs for building,1 lakh for working capital ?
Total Interest Costs on the loan for 2 years  = Rs 16 Lakhs  * 10% * 2 years 3,20,000 
Capitalize Borrowing costs  = Rs 15 Lakhs * 10% * (21/12) 2,62,500 

Interest Cost to be Expensed to Income Statement  in 2 years 57,500 
Year 1 Interest Expense  = (Rs 1 Lakh * 12/12*0.1) + (15 Lakh*1/12*0.1) 22,500
Year 2  Interest Expense  = (Rs 1 Lakh * 12/12*0.1) + (15 Lakh*2/12*0.1) 35,000

• What if there was a loan processing fees of Rs 32,000 for a loan of 16 lakhs
 Capitalize: Proportionate to the extent the loan was used for funding the asset (Rs30,000)
18
Depreciation

19
 Depreciation ‐ Concept
Depreciation is the systematic allocation of the depreciable amount of an asset over its 
useful life
• Process of allocating to expense
• the cost of a plant asset over its useful (service) life in a rational and systematic 
manner (Depletion for Natural Resources, Amortization for Intangible assets)
• Purpose: Match expenses with revenue
• Affects Income Statement – Depreciation expense 
(if used to used to construct another PP&E, Dep. to be included in the Cost of that PP&E)
• Affects Balance sheet – Accumulated depreciation (Contra asset)

• Process of cost allocation, not a process of asset valuation.

• Net Book Value =>  Gross BV – Accumulated Depreciation       its Fair Value
• Unexpired Cost (Carrying Values) = Cost – Accumulated Depreciation
• Doesn’t result in accumulation of cash fund for replacement of asset
• Depreciation is  not a source of fund,  Is Depreciation – a product or period cost ?
• Each significant Part of PP&E to be depreciated separately (can be grouped if similar)
Depreciation  
• Begins when it is available for intended use (immaterial if actually put to use)
• Ceases at the earlier of ‐ Date it is classified as ‘held for sale’ and  Date it is derecognized 
(does not cease when asset becomes idle/retired from active use, unless fully depreciated or usage 
method applied & no production) 
20
 Factors in Computing Depreciation
Basic elements for measuring depreciation:
1. Hist.Cost: All expenditure necessary to purchase or construct the asset &make it ready for use
2. Estimated Useful Life (UL): Period over which an asset is expected to be available for use
– Can be expressed in number of years, units of activity/output expected to be obtained
– Estimate based on judgement : Past Experience, Corporate Strategy, Expected usage, Repair & 
Maintenance plan, Obsolescence, Legal limits 
Useful life is Entity Specific.  Typically, UL < EL < TL 
Technical (physical) life : Period over which an asset is expected to produce the intended result (Asset Specific)
Economic life: Period over which the use of the asset makes economic sense (Asset Specific)
Part C, Schedule II of Companies Act 2013 provides indicative ‘Useful lives’ :  
Managers can use different estimates – but UL not to be longer than prescribed/indicative
 FS to disclose difference, if any, & justification supported by technical advice
3. Estimated Residual Value /Salvage Value (SV): 
– Estimated amount an entity would currently obtain from disposal of the asset (after deducting 
the estimated costs of disposal), if it was already of the age & condition expected at the end of 
its useful life Cos Act 2013 – RV: Max 5% of original cost, Disclose if higher, supported by technical advice

Depreciable amount (Net Cost) : (Cost of depreciable asset)  less its (Residual Value)
Systematic basis: Depreciation Method ‐ Management selects based on the pattern in which the 
entity expects to consume the asset’s future economic benefits (type of asset, nature of use)
• Straight‐line method, Declining‐balance method, Units‐of‐activity method 
Land has unlimited UL ‐ not depreciated (exception quarries), but subject to Impairment test
 Accounting for Plant Assets
Illustration:  Bill’s Pizzas purchased a small delivery truck on January 1, 2012.

Required: Compute depreciation using the following. 
(a) Straight‐Line Time Method (popularly known as Straight‐Line Method –SLM) 
(b) Declining Balance or Accelerated deprecation method (WDV Method)

If FA is bought during the year 
• first year’s depreciation is: annual depreciation pro‐rated for proportion of the year

Straight‐line use method (AKB) : popularly called Units‐of‐activity method 
Depreciable Cost = 12,000; No. of units estimated to be produced over the useful life 120,000 units,  
Production for 2013 was 9,000 units.
Depreciation rate = 12,000/120,000= 0.1 per unit, 
Depreciation for 2013  = 9,000*0.1 =900

22
Straight‐Line Method
• Same expense each year
• Acc Dep increases uniformly
• CV decreases uniformly till RV

Depreciable Annual Dep Accum. Book

Year Cost x Rate = Expense Deprec. Value (CV)
13,000 ‐
2012 $ 12,000 20% $ 2,400 $ 2,400 2,400 $ 10,600
2013 12,000 20 Rate =  2,400 4,800 8,200
2014 12,000 20 100 / UL 2,400 7,200 5,800
2015 12,000 20 2,400 9,600 3,400
2016 12,000 20 2,400 12,000 1,000
Cost - Residual Value
Yearly Depreciation 
Estimated Useful Life
2012 Depreciation expense  2,400
Journal Entry Accumulated depreciation 2,400
UL = Depreciable Cost ÷ Annual Depreciation Age of an asset = Accumulated Depreciation ÷ Annual Depreciation
23
= 12,000/2400 = 5 years  = 9600/2400 = 4 years  Remaining UL = 5‐4 = 1 year
 Accounting for Plant Assets ‐ Declining‐Balance
 Decreasing annual depreciation expense over the asset’s useful life 
 Based on passage of time
 Called Declining balance method because
 Depreciation is calculated by applying a constant rate on Beginning book value
(Beg BV declines every year  Declining balance)
 Called Accelerated method – because results in more depreciation in initial years 
than later years when compared with SLM 
 Suited for assets which are expected to lose their usefulness rapidly because of 
obsolescence
 Assumes many plant assets are more efficient when new‐ Consistent with 
matching rule
 One approach is ‐ Double declining‐balance method
 where the rate is double the straight‐line rate

 Witten Down Value (WDV)  method ( Reducing balance method) – more common

𝒏 𝑹 r = [1 – {(R/C)^(1/n)}], where C = Cost 
Calculation of Depreciation Rate :  r = 𝟏 R = Residual Value,  n = useful life
𝑪
 Calculation of Depreciation Using Other Methods

Illustration:  (Declining‐Balance Method : double the straight line rate)
Beginning Declining Annual
Book value Balance Depreciation Accum. Book
Year (WDV) x Rate = Expense Deprec. Value

2012 13,000 40% $ 5,200 $ 5,200 $ 7,800

2013 7,800 40 3,120 8,320 4,680
2014 4,680 40 1,872 10,192 2,808
2015 2,808 40 1,123 11,315 1,685
2016 1,685 40 685* 12,000 1,000

2012     Depreciation expense  5,200

Journal Entry
Accumulated depreciation 5,200
* Computation of $674 ($1,685 x 40%) is adjusted to $685 
so that the ending book value will equal the salvage value  25
 Accounting for Plant Assets: Comparison of Depreciation Methods

Each method is acceptable because each 
recognizes decline in service potential of the 
asset in a rational and systematic manner.
• Which method will lead to higher reported net 
income in i) 2012 ? ii) over UL of 5 years ?

• Higher RV, Higher UL 
 Leads to lower depreciation rate

Total cost of maintaining an asset is the total of the cost of its acquisition and the maintenance cost
If both depreciation & maintenance costs considered.  With age, 
• Maintenance cost is expected to increase, Depreciation Expense under WDV decreases 
Thus, WDV results in an equal annual charge on P&L over UL of the asset 
So, some accountants prefer WDV over SLM 
Changes in Depreciation

27
Changes in Depreciation – Change in Estimate: Prospective affect
Depreciation Expense  Dr. 2,500 
 Change in estimated residual value 
Accumulated Depreciation Cr. 2,500 
 Change in estimated useful life 
At the beginning of year 1: Revisions at the beginning of year 4
Bought on1st Jan, 2012 Revised on 1st Jan 2015
Original Cost 55,000 Residual Value 10,000
Residual Value 5,000 Total Estimated Useful Life 15
Estimated Useful Life 10
Method SLM Year 1
Original Cost 55,000
Dep =(55000-5000)/10 =5000 Less: Dep 5,000
NBV 50,000
Equipment 55,000 Year 2 Less: Dep 5,000
Less: Acc Depn 15,000 NBV 45,000
40,000 Year 3 Less: Dep 5,000
NBV 40,000
Revised Dep for each of the remaining 12 years = 40000-10000/ (15-3) = 2500
𝒏 𝑹
 Change in depreciation method  r = 𝟏
𝑪
With old estimates of UL and RV With new estimates of UL and RV
Depreciation Rate r = 1‐ [(5,000/ 40,000)]^(1/(10‐3)] =25.7% r = 1‐ [(10,000/ 40,000)]^(1/(15‐3)] =10.91%
Depreciation Expense 40,000 * 25.7% = Rs. 10,280 40,000 * 10.91% =  Rs. 4,364

28
Changes in Depreciation – Change in Estimate: Prospective affect
Depreciation Expense  Dr. 2,500 
 Change in estimated residual value 
Accumulated Depreciation Cr. 2,500 
 Change in estimated useful life 
At the beginning of year 1: Revisions at the beginning of year 4
Bought on1st Jan, 2012 Revised on 1st Jan 2015
Original Cost 55,000 Residual Value 10,000
Residual Value 5,000 Total Estimated Useful Life 15
Estimated Useful Life 10
Method SLM Year 1
Original Cost 55,000
Dep =(55000-5000)/10 =5000 Less: Dep 5,000
NBV 50,000
Equipment 55,000 Year 2 Less: Dep 5,000
Less: Acc Depn 15,000 NBV 45,000
40,000 Year 3 Less: Dep 5,000
NBV 40,000
Revised Dep for each of the remaining 12 years = 40000-10000/ (15-3) = 2500
𝒏 𝑹
 Change in depreciation method  r = 𝟏
𝑪
With old estimates of UL and RV With new estimates of UL and RV
Depreciation Rate r = 1‐ [(5,000/ 40,000)]^(1/(10‐3)] =25.7% r = 1‐ [(10,000/ 40,000)]^(1/(15‐3)] =10.91%
Depreciation Expense 40,000 * 25.7% = Rs. 10,280 40,000 * 10.91% =  Rs. 4,364
Depreciation Expense  Dr. 10,280 Depreciation Expense  Dr. 4,364
Accumulated Depreciation Cr. 10,280 Accumulated Depreciation Cr. 4,364 29
 Impairments
• Permanent decline in the value of an asset
• Carrying Amount > Recoverable amount of an asset  (IFRS, Indian GAAP)
• Purpose: Not to overstate the asset on the books
• Whenever possible, individual assets should be tested for impairment  
• Often tested at group [cash generating unit (CGU)] level
Both under IFRS and Indian GAAP (Ind AS 36):
• Step 1: At the end of each reporting period, entity assesses if there is any indication 
that an asset might be impaired
External Factors – significant decline in asset’s market value; change in technological, 
market, economic, or legal environment –with an adverse effect on the entity; increase
in market interest rates; Carrying amount of Net assets of the entity > its market 
capitalization
Internal Factors – Evidence of obsolescence/physical damage of an asset; Economic 
performance worse than expected; Asset becoming idle or plan to dispose it before 
expected date of disposal
• Step 2: Estimate Recoverable Amount, Conduct Impairment Test, & Review RUL, RV 
and depreciation method   If indication of Impairment present
• Step 3: Recognize impairment loss  If any  event identified as above leads to  
Impairment Loss being identified
A f h fl h ih h i h
 Impairment of Assets: IFRS and Indian GAAP
Cost- Beg Year 1= 50,000; UL=10Y
Y5-End:Carrying Value (CA) 25,000
An asset is said to have impaired if its : Value in Use 24,000
Carrying  Amount (CA) > Recoverable Amount (RA) Fair Value - Cost of Disposal 19,000
Recoverable Amount (RA) 24,000
Impairment Loss = CA - RA =1,000

Carrying 
Impairment  Recoverable 
= Amount  Minus
Loss (IL) Amount (RA)
(CA or NBV)

Charged to Income Statement, 
CA of the asset brought down to its RA

Impairment Loss (Charged to Income Statement) Dr. 1,000 Higher of

Accumulated Impairment (Reduces CA of Asset) Cr. 1,000 

Fair value  less
Value in Use
costs of disposal 

‘Fair Value less Costs of disposal’ = Fair Value (MV) – Cost of Disposal (i.e. cost to sell the asset)

‘Value in Use’ = Present Value of future cash flow expected to be derived from an asset
(from continuing use of the asset and its ultimate disposal at the end of UL)
32
Impairment loss is charged to IS, alternatively to revaluation surplus (if any, from before)
 Plant Asset Disposals – Sale and Retirement

Original Cost of equipment 60000 Original Cost 60000

Accumulated Depreciation 49000
Accumulated Depreciation as on 31/12/2010 41000
NBV on date of disposal 11000
Sales Proceeds obtained on 1/7/2011 16000 No cash received on retireme 0
Depreciation for first 6 months 8000 Loss on sale 11000
Depreciation up to the date of disposal DISCARDED
Depreciation Expense Dr 8000
Accumulated Depreciation Cr 8000 Accumulated Depreciation Dr 49000
Loss on disposal Dr 11000
Equipment Cr 60000
Original Cost 60000
Accumulated Depreciation 49000 Original Cost 60000
NBV on date of disposal 11000 Accumulated Depreciation 49000
Proceeds from sale 16000 NBV on date of disposal 11000
Gain on sale 5000 Proceeds from sale 9000
SOLD for CASH, Proceeds> CV Loss on sale 2000
Cash Dr 16000 SOLD for CASH , Proceeds < CV
Accumulated Depreciation Dr 49000 Cash Dr 9000
Equipment Cr 60000 Accumulated Depreciation Dr 49000
Loss on disposal Dr 2000
Gain on sale Cr 5000
Equipment Cr 60000
FS Effects:    Gain/Loss on Disposal = Net Disposal Proceeds – Carrying Value
• Asset is eliminated from BS,   
• Cash Received from Disposal net of costs associated with disposal  shown as cash inflow in CFI, 
33
• Gain/Loss on sale – Non‐operating Item in Income Statement
 Disposal : (KWK) P9‐3A (page 422) Journalize Transactions for Pine Company for 2014 (Dep: SLM)

Retired Jan. 1, 2014:  Retired a piece of machinery that was purchased on January 1, 2004. On date of 
purchase, the machine cost $71,000 and had a useful life of 10 years with no salvage value.

Sold at a Gain,  June 30, 2014:  Sold a computer that was purchased on January 1, 2011. The computer cost 
middle of the  $30,000 and had a useful life of 5 years with no salvage value. The computer was sold for $12,000
year

Discarded, at  Dec 31, 2014: Discarded a delivery truck that was purchased on January 1, 2009. The truck cost 
the end of the  $33,400 and was depreciated based on an 8‐year useful life with a $3,000 salvage value
year 

34
 Lease  (as per Old Standard) – Before IndAS 115
A contractual agreement in which the owner of an asset (lessor) conveys to a counter party (known as lessee)
the right to use an asset for an agreed period of time in return for a payment or series of payments
Finance Lease :  Transfers substantially all the risks and rewards incidental to ownership of an underlying asset. 
Operating Lease  : A lease other than Finance Lease 
Examples of situations which will normally lead lease being classified as Finance lease 
It is non‐cancellable and any of the following conditions is met :
1. The ownership of the asset is transferred to the lessee by the end of the lease term.
2. The lessee has a Bargain Purchase Option
3. The lease term covers major part of the economic life of the asset  (75% US GAAP)
4. At the inception of the lease,  Present value of the minimum lease payments substantially covers all of the 
fair value of the leased asset (90% US GAAP)
5. Lease assets are of such specialised nature that only lessee can use them without major modifications
Operating  Lease: 
Finance Lease 
• Lease Payments should be recognised as an expense           
 At the inception, the lessee should recognise (as a rental of the asset).
An Asset and a Liability at lower of
• Fair value of leased asset  • If rentals amounts are unequal over the lease term, a 
• Present Value of Minimum Lease Payments  uniform rental cost should be recognised on a straight‐
(MLP) line basis over the lease term (unless more systematic 
 Upon payment of lease Rentals:  basis available)
Lessee should apportion the lease payments  Merely taking asset on rent: 
between the finance charge and the reduction  No Asset ‐> No Depreciation, 
of the outstanding liability  No Liability or debt  –>No Interest Expense
Example: Lease Rent to be paid in Yr1 =Rs. 18K; in Yr 2= Rs 20 K
Annual Straight‐line lease expense = (20+18)/2 = 19 K
 The lessee should charge depreciation on the 
Yr1 Lease Rental Expense       Dr 19 Yr2 Lease Rental Expense         Dr 19
leased asset 
Accrued Lease Rental (L) 1 Accrued Lease Rental (L) Dr 1
Cash                               18 Cash                               20
 Illustration ‐ Before IndAS 115
Expected Useful life of the asset = 3 years. The asset is transferred to the lessee on expiry of lease 
term. Three annual lease rentals due to lessor at the end of each year are @ Rs 20,000. The 
lessee's incremental borrowing rate is 10%. FV of the asset = Rs 55,000. Assume actual Residual 
Value of the asset at the end of year 3 is zero.
Period Lease Rental PV of Re 1 PV of LR
1 20,000 0.909 18182
2 20,000 0.826 16529
3 20,000 0.751 15026
Present value of MLP : 49737

Classification : The lease qualifies as Finance (Capital) Lease since it meets two of the conditions ‐
1. Lease Term = 3 years = 100% of Expected Useful life of the asset
2. PV of MLP ( 49,737) = 90.43% i.e. substantially all of FV of leased asset (Rs 55,000)
Lease Asset & Liability  to be recorded at lower of PV of MLP or FV of leased asset: Rs 49,737
Annual Depreciation Expense = 49,737/3 =  16,579  Year 1
Depreciation Exp    Dr  16,579 Lease Liability       Dr 15,026
Lease asset      Dr  49,737 Interest Expense  Dr   4,974
Lease Liability       49,737 Accum Depreciation      16,579 Cash                           20,000

Amortizations table : Lease payments = finance charge (Interest Expense) +  reduction of  liability (Repayment of Principal) 
A                             B  (= 10%* A)                                C (=D‐ B)  
Amortisation Table for Lease D              E = (A ‐ C) or (A +B‐ D)

 Lease Liability ‐ Finance Charge or  Reduction in  Lease  Lease Liability ‐

Opening Interest Expense Lease Liability Payment Closing  Depreciation
Year 1                 49,737                               4,974                     15,026        20,000               34,711            16,579
Year 2                 34,711                               3,471                     16,529        20,000               18,182            16,579 36
Year 3                 18,182                               1,818                     18,182        20,000                        (0)            16,579
 Financial Statement Implications ‐ Before IndAS 115
Operating Lease Capital Lease
Year Rent Expense Interest  Depreciation  Total 
1          20,000 Year Expense Expense Expense
1 4974 16579        21,553
2          20,000
2 3471 16579        20,050
3          20,000
3 1818 16579        18,397
10263 49737 60,000

Operating Lease Capital Lease
Year 1 2 3 Year 1 2 3
Revenues 50,000 50,000 50,000 Revenues 50,000 50,000 50,000
Lease Rental 20000 20000 20000 Depreciation Expense 16579 16579 16579
Operating Income 30,000 30,000 30,000 Operating Income 33,421 33,421 33,421
Interest Expense 0 0 0 Interest Expense 4974 3471 1818
EBT 30,000 30,000 30,000 EBT 28,447 29,950 31,603
Tax 40% 12000 12000 12000 Tax 40% 11379 11980 12641
PAT 18,000 18,000 18,000 PAT 17,068 17,970 18,962

Over 3 years:   Total Expense same  Operating Lease  20,000 * 3 = Rs 60,000  
Capital Lease  Depreciation (49,737)  + Interest (10,263) =  Rs. 60,000

Year 1 : Expense under Operating Lease = 20,000 < Expense  under Capital lease = 16,579 + 4,974= 21,553

 During initial Years : PAT higher for operating lease

Year 3 : Expense ‐ Under OL= 20,000 > Under FL =Interest Exp lower(1818) + Dep constant(16579) = 18,397

 During Later Years : PAT lower for operating lease
37
 Financial Statement Implications ‐ Before IndAS 115
Lessee – Finance (Capital) Lease
Lessee – Operating Lease
Balance sheet Impact :
Balance sheet Impact :
• Cash Outflow
• Only Cash Outflow , Nothing else
• Lease Asset : Net of Depreciation
Income Statement Impact :
• Lease Liability : Net of principal repaid
• Operating Expense: Lease Rentals 
Income Statement Impact :
Cash Flow Statement Impact : CFO
• Depreciation and Interest Expense
Cash Flow Statement Impact : CFF

Operating Lease Finance (Capital) Lease

Profitability
Operating Expense Lease Rentals  > Depreciation 
Operating Profit  & EBITDA Lower Higher
Total Expenses Lease Rentals only Depreciation + Interest Expense
Initial years  Lease Rentals  < [Depreciation (constant) + Interest expense (declining)] 
PAT  in initial years Higher Lower
Total Assets Lower  Higher
ROA in initial years
( PAT *100/ Avg TA)  Higher (No Asset ) Lower (Leased Asset)
Asset Turnover Ratios Higher (No Asset) Lower  (Leased Asset)
Solvency
Debt/Total Assets Ratio (<1)  Lower (No Debt & Asset) Higher (Debt & Asset recorded)
Interest coverage Ratio  Higher (No Interest Expense) Lower  (Interest Expense recognized)
CFS Lower –CFO Lower CFF :  Interest Paid, Repayments
Lower (since CL includes Current Portion of Lease 
Current Ratio Higher (no lease obligations) Obligations) 38
 Lease  (IndAS 115 ) – Lessee 
Lease is a contract, that conveys the right to control the use of an identified asset for a period of time in 
exchange for consideration
Exemptions: For short‐term leases (lease term <=12 months from commencement date) or leases for which the 
underlying asset is of low value (eg. Laptop, telephone), lessee can opt to not apply these accounting provisions
• IS: the lessee shall recognize the lease payments as an operating expense on either a straight‐line basis over 
the lease term or another systematic basis (if more representative of the pattern of the lessee’s benefit)
For all other leases,  a lessee shall at the LEASE commencement date,  ROU asset             Dr 
• BS: recognize a right‐of‐use (ROU) asset  Lease Liability 
Cost of ROU Asset = Lease liability [PV of future lease payments (discounted at the interest rate 
implicit in the lease or the incremental borrowing rate)] + (lease payments in advance minus lease 
incentives received, if any)    +  Initial direct costs + ARO 
• BS: a Lease liability =  Present value of future lease payments (discounted at the interest rate implicit in the 
lease or the incremental borrowing rate)   Depreciation Expense            Dr 
• IS: Subsequently, lessee should charge depreciation expense for ROU asset Accumulated Depreciation
– Over Useful Life :  if ownership passes to lessee at the end of lease term, or if there is certainty that 
purchase option will exercised by the lessee
Lease Liability        Dr
– Otherwise  over Useful Life or Lease term, whichever is shorter Interest Expense   Dr
Cash (lease payments)
• IS: Subsequently, book Interest expense on lease liability – as part of finance cost (effective interest rate)
– The carrying amount of the lease liability will 
• increase by the amount of interest accrued on the lease liability (unwinding of disc) & 
• reduce on account of the payments made towards the lease liability
– Lessee should apportion the lease payments between the finance charge (interest exp)  and the 
reduction of the outstanding liability (principal)
39
 Some Important Disclosures
Property, Plant and Equipment 
The financial statements shall disclose, for each class of property, plant and equipment:
(a) the measurement bases used for determining the gross carrying amount;
(b) the depreciation methods used; 
(c) the useful lives or the depreciation rates used; 
(d) the gross carrying amount and the accumulated depreciation (aggregated with accumulated 
impairment losses) at the beginning and end of the period; and
(e) a reconciliation of the carrying amount at the beginning and end of the period

Impairment :
An entity shall disclose the following for each class of assets 
(a) Amount of impairment losses recognised in profit or loss during the period and the line item(s) of 
the statement  of profit and loss in which those impairment losses are included.
(b) the amount of reversals of impairment losses recognised in profit or loss during the period and the 
line item(s) of the statement of profit and loss in which those impairment losses are reversed

Disclosure by Lessee :
a)depreciation charge for right‐of‐use assets
b)interest expense on lease liabilities 
c) the expense relating to short‐term leases & leases of low‐value assets 
d)the carrying amount of right‐of‐use assets at the end of reporting period(separately)(non‐current)
e)total cash outflow for leases 
f) lease liabilities separately from other liabilities – with a maturity analysis (current & non‐current)
Disclosures are also required for Revaluations  40
 Disclosures 
Significant accounting policies

Infosys 2019‐20 

41
 2019‐20

2018‐19

15‐10‐2020 42
Infosys : 2020

43
   Category of ROU asset  Total
2.3 Leases ‐ Right of use assets Land Buil di ngs Computers
Balance as at April  1, 2019 – 1,861 – 1,861
Reclassi fied on account of adoption of Ind AS  561 – – 561
Addi ti ons 1 737 49 787
Deletion (3) (58) – (61)
Depreciati on (5) (331) (7) (343)
Balance as at March 31, 2020 554 2,209 42 2,805

44
Assignments

45
Chapter 15 (AKB)
3 (i) : Mallika Limited (ML) purchased a machine for Rs. 20,00,000 for its manufacturing 
operation and paid transportation charge of Rs. 10,000. In addition, ML spent Rs. 50,000 
towards testing and preparing the machine for use. The cost of the machine should be 
recorded at ??
Purchase Price         20,00,000
Trasportation Charge               10,000
Testing and preparing the machine for use              50,000
Cost of the machine should be recorded at        20,60,000
3 (ii) : On December 1, 2006, Shipra Limited (SL) purchased a piece of land for Rs.
40,00,000 for a factory site. SL razed an old structure and sold the material salvaged from
the old structure. The company incurred additional costs and realised salvage proceeds
during December 2006 as follows:
• Demolition of old building Rs. 70,000
• Legal fees Rs. 50,000
• Registration charges Rs. 4,00,000
• Proceeds from sale of salvaged material Rs. 15,000
In its balance sheet on December 31, 2006, SL should carry the land at ??
Purchase Price        40,00,000
Demolition of old building               70,000
3 (iii) – Discussed before   Legal fees              50,000
Registration charges            4,00,000
Less : Proceeds from sale of salvaged material              ‐15,000
46
SL should carry the land at        45,35,000
3 (iv)  Nisha Limited (NL) began constructing a building for its own use in January 2006. 
• During 2006, NL incurred an interest of Rs. 60,000 on the amount specifically borrowed for 
construction of the building, and Rs. 20,000 on other borrowings.
• Interest computed on the weighted average amount of accumulated expenditures for the building 
during the year 2006 was Rs. 35,000. 
Chapter 15 (AKB)
NL should capitalize interest amounting to Rs. 35,000. 
3 (v)  On April 20, 2007, Preeti Limited (PL) exchanges a car for 1,000 equity shares of Indian Oil 
Corporation Limited (IOCL). On that date, the written down value of the car was Rs. 3,50,000 and its fair 
value was Rs. 4,50,000. On that date, the share price of IOCL in the Bombay Stock exchange (BSE) was 
Rs. 395 per share. PL intends to hold the share for long term. PL should record the cost of investment at
PL should record the cost of investment at Rs395,000 (FV of the shares more clearly evident)
3 (vi) Omkara Limited (OL) participated in an auction of a ‘haveli’ (manson) which was put on auction 
by the revenue department of the government. OL purchased the haveli for Rs. 2 crore. The most 
popular and respected business ‘daily’ reported that the government could not realise the fair value 
of the property as Mr. Omkara participated in the auction. The daily estimates the fair value at Rs. 4 
crore. The newspaper daily alleges that the reserve price was set at Rs. 2 crore to facilitate OL’s 
acquisition of the property at a discount.  
OL should record the haveli as an asset at Rs. 2 crore  (not a non‐monetary exchange)
4 (i) A piece of equipment imported from the USA on deferred credit basis during the reporting period 
(calendar year) was recorded at Rs. 4,00,000 ($1 = Rs. 40). On the balance sheet’s date, the exchange rate is 
$1 = Rs. 45. Under Ind AS, the asset should be carried in the balance sheet at :
Rs. 4,00,000  (asset not measured in foreign currency)
4 (iii) GBV & accumulated depreciation of an asset as on 1 Jan 2006 are Rs.1,50,000 and Rs. 90,000
respectively. On June 30, 2006, the asset is sold at Rs 70,000. The profit/(loss) on sale of the asset is  
Gain : Rs.70,000 – (150,000‐90,000) = 10,000  47
 Depreciation AKB BOOK : Chapter 17 (page 418)  
2 (ii) On January 1, 2003, Naina Limited (NL) purchased a machine for Rs 3,00,000 and depreciated it 
by the straight‐line method using an estimated useful life of 10 years with no salvage value. 
On January 1, 2006, NL determined that the machine had a useful life of 6 years from the date of 
acquisition and would have a salvage value of Rs 30,000. 
An accounting change was made in 2006 to reflect the additional data. The accumulated depreciation 
for this machine should have a balance at December 31, 2006, of  ??

Date  Useful Life Salvage Value

acquired
Cost Life expired (years) OLD  Prop Old Prop.
Machine  300,000 Jan1, 2003 3 (2003 to 2005) 10 6 0 30,000

Old Annual Depreciation for 3 years:  Building:  (300,00‐0)/10 = 30,000

As on 31/12/2005
Cost  300,000

Less: Acc. Depreciation  as on 31/12/2005  = 30,000 * 3 = 90,000

Net Book Value  as on 31/12/2005 = 300,000‐90,000 = 210,000

New Depreciation for year ended 31/12/2006 = (210,000 – 30,000)/ (6‐3) = 60,000

Accumulated depreciation as on December 31, 2006 (ANS) = 90,000 + 60,000  = 150,000

48
 Impairment Loss AKB BOOK : Chapter 17 
3 (i) The acquisition cost of equipment, acquired during the reporting period, is Rs 1,20,000. On the 
balance sheet date, the PV of the future cash flow to be generated by the equipment is estimated at Rs
90,000 and the ‘fair value less costs to sell’ is estimated at Rs 1,00,000. 
The impairment loss should be recognized at
Solution: IL = RA – CA = 120,000 – 100,000 = Rs20,000
Problem 1 (page 419)
JL’s factory producing chemicals emits chemical waste to the nearby canal. The company has recognised a liability of
Rs10,00,000 towards the estimated cost of cleaning the canal, as required by a newly enacted environmental law.
The assets of JL, which are subject to impairment test, are carried at Rs100,00,000. The chemical factory is a CGU. The
company can sell the chemical factory as a whole, and the buyer will have to take over the liability for restoration of the
environment.
The net selling price (fair value less costs to sell) of the factory is estimated at Rs89,00,000.
The value in use, considering the present value of expenditure to be incurred for restoration of the environment, is
estimated at Rs85,00,000.
Note: Cash Generating Unit (CGU) is the smallest group of assets that generates cash flows from continuing use largely independent of cash 
flows generated by other assets/CGUs 

Solution:  JL has recognized the environmental liability. So, it must have included the same in the carrying 
amount of the fixed assets included in the CGU.
The buyer of the chemical factory will assume the liability. Therefore, the recoverable amount is the higher of 
the following:
(i) Fair value less net selling expenses + the amount of liability that will be extinguished 
(Rs. 89,00,000 + 10,00,000) = Rs. 99,00,000
(ii)  Value in use  =  Rs. 85,00,000
The recoverable amount is Rs. 99,00,000. The impairment loss is (Rs. 100,00,000 ‐ 99,00,000) = Rs. 100,000 49
Thanks

50
Corporate Financial Reporting & Analysis

Session 20: Inventory Reporting & Analysis
IIMC‐MBA‐2020 ‐ Prof. Arpita Ghosh

1
 Learning Goals: Inventory Accounting 

• Recap – Definition, Classification,  Inventory systems (Perpetual & Periodic)
• Determining Quantity of the Inventory ‐ Ownership
• Analysis of Inventory ‐ Higher/Lower levels, Effect of Errors/Misstatements
• Inventory costing methods‐ Specific Identification, Weighted Average Cost, FIFO, LIFO
– Ascertaining  COGS and Closing Inventory
• Effect costing methods on Financial Statements and Ratios
• Inventory Valuation Method: Lower of Cost or NRV
– Understanding the Cost and NRV
• IFRS Vs US GAAP: Primary differences
• Disclosures – Accounting Policy 
• Assignments

2
 Recapitulation
Definition of Inventory Classification of Inventory ?
Assets that are 
• held for sale in ordinary course of business,
• In the process of production for such sale, or
• in the form of materials/supplies to be consumed in production process/rendering of services 

Beginning Inventory + Cost of goods Purchased  = Cost of goods Available for Sale 
=  Cost of goods Sold + Ending Inventory

Ins Beginning Inventory Cost of goods Purchased

Objective: Matching Cost of Goods 
Available for Sale
Outs Cost of Goods Sold Ending Inventory

• Costs in Inventory gets recognized in I.S. when related sales occur
• Recorded in Balance sheet (Current Assets)  
Inventory Processing Systems:  Perpetual  or Periodic Inventory system
• Which system records COGS each time a sale occurs ?
• Which  system will help identify inventory loss due to wastage / theft? 
• Which  system will help avoid stock‐out ? 3
 Determining ownership of goods
A) Goods/Merchandise in transit ‐
Goods purchased not yet received,
Goods sold and shipped but not yet received by the buyer
Neither the seller nor the buyer has physical possession of merchandise in transit.
– To be included in the inventory of the company that has legal title to the goods. 
– Legal title is determined by the terms of sale (or terms of shipping agreement)
• FOB Shipping Point ‐ Ownership passes to the buyer when the public carrier 
accepts the goods from the seller (Buyer bears freight‐in)
• FOB Destination ‐ Ownership remains with the seller until the goods reach 
the buyer (Seller bears freight‐out)
• Outgoing/ incoming goods shipped FOB 
shipping point are included in the buyer’s 
merchandise inventory

• Outgoing/ Incoming goods shipped FOB 
(free on board) destination are included in 
the seller’s merchandise inventory

4
 Determining ownership of goods
B) Consigned Goods ‐ Goods held for sale by consignee (another company), who acts as 
an agent of the consignor (owner) in selling the goods for a fee 
– Ownership of the goods is retained by the consignor until sold by consignee.
C) Exclude:
– Goods Sold (title transferred) not yet shipped,  
– Damaged/Obsolete goods which cannot be sold

Example: Determine the correct inventory . Ans: 
A Ltd determined its ending inventory at 3 lakhs on 31st Dec. It excluded: 300,000 +20,000 +10,000 +8,000 
= Rs 338,000
1. Inventory costing Rs 20,000 sent on consignment to B Ltd, not yet sold
2. Inventory costing Rs 10,000 sold, in transit with terms ‐ FOB Destination
3. Inventory costing Rs 15,000 sold, in transit with terms ‐ FOB Shipping
4. Inventory costing Rs 12,000 bought, in transit with terms ‐FOB Destination
5. Inventory costing Rs 8,000 bought, in transit with terms ‐FOB Shipping
Determine the correct inventory
A Ltd determined its ending inventory at 3 lakhs on 31st Dec. It included 1‐5 above and 
the following : 
• Inventory costing Rs 5,000 received on consignment from IMX Ltd
Ans: 
300,000 ‐15,000 ‐12,000 ‐ 5,000 = Rs 268,000

5
 Analysis of Inventory
Inventory management is very important
• High Inventory Levels ‐ may incur high carrying costs (e.g. storage costs, interest on 
funds tied up, insurance, obsolescence, shift in fashion, and damage).
• Low Inventory Levels – may lead to stock outs, lost sales, and  disgruntled 
customers.
Ratios: Inventory Turnover Ratio, Days in Inventory

Key: To have Low levels of Inventory and still satisfy customer needs Use: Just‐in‐time 
(JIT) operating environment, Supply‐chain management, Coordinate with suppliers
Dell experienced a record Average Inventory on hand of 5 days
Common causes of Inventory Errors or Misstatements : 
• Failure to count or price inventory correctly 
• Not properly recognizing the transfer of legal title to goods in transit
Deliberate manipulation (Rite Aid, RentWay)
6
Inventory Errors or Misstatements
‐ Income Statement and Balance Sheet Effects   
Affect the computation of Cost of goods sold, Gross Margin and Net income.

The higher the value of ending inventory 
 lower the COGS and higher the GM, NI
PBT and

7
 Inventory Misstatements affect for the current year 
Inventory errors affect the computation of COGS & net income in two periods
An error in ending inventory of the current period will have a reverse effect on net income 
of the next accounting period 2013 2014
2011 2012
Incorrect Correct Incorrect Correct
Sales $ 80,000 $ 80,000 $ 90,000 $ 90,000
Beginning inventory 20,000 20,000 Understated 12,000 15,000
Cost of goods purchased 40,000 40,000 68,000 68,000
Cost of goods available 60,000 60,000 Understated 80,000 83,000
Ending inventory Understated
12,000 15,000 23,000 23,000
Cost of good sold Overstated
48,000 45,000 Understated 57,000 60,000
Gross profit Understated
32,000 35,000 Overstated 33,000 30,000
Operating expenses 10,000 10,000 20,000 20,000
Understated
Overstated
Net income $ 22,000 $ 25,000 $ 13,000 $ 10,000

Combined income for   
2‐year period is correct. ($3,000) $3,000
Net Income Net Income
understated overstated
8
 Inventory Misstatements affect for the current year 
Inventory errors affect the computation of COGS & net income in two periods
An error in ending inventory of the current period will have a reverse effect on net income 
of the next accounting period 2013 2014
2011 2012
Incorrect Correct Incorrect Correct
Sales $ 80,000 $ 80,000 $ 90,000 $ 90,000
Beginning inventory 20,000 20,000 Understated 12,000 15,000
Cost of goods purchased 40,000 40,000 68,000 68,000
Cost of goods available 60,000 60,000 Understated 80,000 83,000
Ending inventory Understated
12,000 15,000 23,000 23,000
Cost of good sold Overstated
48,000 45,000 Understated 57,000 60,000
Gross profit Understated
32,000 35,000 Overstated 33,000 30,000
Operating expenses 10,000 10,000 20,000 20,000
Understated
Overstated
Net income $ 22,000 $ 25,000 $ 13,000 $ 10,000

Combined income for   
2‐year period is correct. ($3,000) $3,000
Net Income Net Income
understated overstated
9
E 6‐15 (p270): Preparing Correct Income Statement 
A Company reported these income 
statement data for a 2‐year period: 

Company uses a periodic inventory system. The inventories 
at January 1, 2013 and December 31, 2014 are correct. 
However, the ending inventory at December 31, 2013, is 
overstated by $8,000
(a) Prepare correct income statement data for the 2 years.
(b) What is the cumulative effect of the inventory error on 
total gross profit for the 2 years?

Corrected Income Statement

Before  Correction (Incorrect)
COGS 165,000 187,000
Gross Profit 45,000 63,000

(2013) (2014)
 Cost Formula ‐ Costing Methods
Applying Unit costs to Quantities on hand gives 
– Total cost of Ending Inventory   helps find out COGS

Application of Unit cost complicated
• Because identical Inventories are bought at different points in time, at different prices
• One needs to make an assumption about the order in which items are sold: 
• Select a cost formula or a costing method
• Cost flow assumptions need not mirror actual physical movement of the goods in 
the operation of the company 

Selection of cost formula should reflect fairest possible approximation of the cost 
incurred in bringing the items of inventory to their present location and condition  

For Items which are not ordinarily interchangeable, or which have been segregated for specific 
projects  Use Specific Identification Method
Otherwise 
• Can use cost flow assumptions like FIFO, Average Cost, LIFO (LIFO not allowed by IFRS, IndAS)

11
 Specific Identification Method 
– Based on Actual physical flow
 Ending inventory is specifically costed by identifying actual individual units left in 
inventory and summing the actual costs of those individual units, Rare
 Used for high unit cost, limited variety, low turnover items like gems, cars

If the company sold the TVs it purchased on February 3 and May 22

Disadvantage:
• Arbitrary – can 
raise income by 
exercising choice
• Impractical
12
 First‐In‐First‐Out (FIFO)

 Goods purchased/produced first are sold first. 
 Often parallels actual physical flow of merchandise.
 Generally good business practice to sell oldest units first.
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

Units Sold: 550, So, Units in Ending Inventory = 1000 - 550 =450

13
Values the ending inventory at the most recent costs, COGS far from current values 
 First‐In‐First‐Out (FIFO)

 Goods purchased/produced first are sold first. 
 Often parallels actual physical flow of merchandise.
 Generally good business practice to sell oldest units first.
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

Units Sold: 550, So, Units in Ending Inventory = 1000 - 550 =450

14
Values the ending inventory at the most recent costs, COGS far from current values 
 Last‐In‐First‐Out (LIFO)

• Goods purchased/produced last are sold first
• Seldom coincides with actual physical flow of goods 
• Exceptions include goods stored in piles
• such as coal or hay.

Units Sold: 550. So, Units in Ending Inventory = 1000 - 550 =450

Values the ending inventory at the earlier costs, include most recent costs in COGS. 15
 Last‐In‐First‐Out (LIFO)

• Goods purchased/produced last are sold first
• Seldom coincides with actual physical flow of goods 
• Exceptions include goods stored in piles
• such as coal or hay.

Units Sold: 550. So, Units in Ending Inventory = 1000 - 550 =450

Values the ending inventory at the earlier costs, include most recent costs in COGS. 16
 Average‐Cost (Weighted Average Method)
– Allocates cost of goods available for sale on the basis of average unit cost
incurred. 
– Assumes goods are similar in nature.
– Applies average unit cost to 
• the units on hand to determine cost of the ending inventory
Average unit cost = Total cost of goods available for sale/ Total units available for sale

Units Sold: 550. So, Units in Ending Inventory = 1000 - 550 =450

Levels out effects of cost increases and decreases. Criticism: Recent costs are more relevant 
17
 Average‐Cost (Weighted Average Method)
– Allocates cost of goods available for sale on the basis of average unit cost
incurred. 
– Assumes goods are similar in nature.
– Applies average unit cost to 
• the units on hand to determine cost of the ending inventory
Average unit cost = Total cost of goods available for sale/ Total units available for sale

Units Sold: 550. So, Units in Ending Inventory = 1000 - 550 =450

Levels out effects of cost increases and decreases. Criticism: Recent costs are more relevant 
18
 Financial Statement and Tax Effects
Comparison In Period of Rising Prices
FIFO Average LIFO
FIFO : Lowest
Sales $9,000 $9,000 $9,000
LIFO: Highest
Cost of goods sold 6,200 6,600 7,000
Gross profit 2,800 2,400 2,000
Admin. & selling expense 330 330 330
Income before taxes 2,470 2,070 1,670
Income tax expense 140 120 110
FIFO: Highest Net income $2,330 $1,950 $1,560
LIFO: Lowest

Inventory balance $5,800 $5,400 $5,000

Which method will show highest 
During periods of consistently rising prices : Inventory Turnover ratio ? 
 FIFO yields the highest inventory(BS), the highest NI and taxes (IS).  
But during periods of consistently falling prices: FIFO reports lowest NI 
FIFO : Magnifies effects of business cycle on NI 19
 Page 267 E 6‐5
Cost of goods available for sale
Date Units Unit Cost Total Cost
1-May Beginning inventory 30 $9.00 $270
Units in 
15-May Purchase 25 $10.00 250
Inventory 
24-May Purchase 38 $11.00 418 668
= 93 ‐74 = 19
Cost of goods available for sale 93 $938
Sales 74
• Calculate the ending inventory at May 31 using the (a) FIFO, (b) LIFO, and (c) average cost methods
• Prove the amount allocated to cost of goods sold under each method
FIFO Method
Ending Inventory 19 $11.00 209

Cost of goods available for Sale 938 LIFO Method

Less: Ending Inventory 209 Ending Inventory 19 $9.00 171
COGS 729
Cost of goods available for Sale 938
Proof of COGS Less: Ending Inventory 171
1-May 30 $9.00 $270 COGS 767
15-May 25 $10.00 $250
24-May 19 $11.00 $209 Proof of COGS
729 24-May 38 $11.00 $418
15-May 25 $10.00 $250
1-May 11 $9.00 $99
767 20
 Page 267 E 6‐5
Cost of goods available for sale
Date Units Unit Cost Total Cost
1-May Beginning inventory 30 $9.00 $270
15-May Purchase 25 $10.00 250
24-May Purchase 38 $11.00 418 668
Cost of goods available for sale 93 $938
Sales 74
Average Cost Method
Ending Inventory 19 $10.086 191.634
938/93 =10.086
Cost of goods available for Sale 938.000
Less: Ending Inventory 191.634 Let us say, 74 units were sold  at $30 
COGS 746.366
per unit. Calculate the gross profit  
Proof of COGS
under each method and compare.
1-May 30 $10.086 $302.581
At the time of rising prices: 
15-May 25 $10.086 $252.151
FIFO shows highest Inventory on BS, 
24-May 19 $10.086 $191.634
Lowest COGS & highest Gross profit 
746.366

FIFO LIFO Avg Prices are increasing Ending Inventory COGS Profit 

Sales(74 *30) 2,220 2,220 2,220 FIFO 209 729 1,491
COGS 729 767 746.4 LIFO 171 767 1,453
Gross Profit 1,491 1,453 1,473.6 Average 191.6 746.4 1,473.6
21
 Inventory Valuation
• Cost Flow Methods should be used consistently :   Enhances comparability
• Although consistency is preferred, a company may change its inventory costing 
method if necessary, like in situations where
– the new method reflects the economic reality better
– the change is made mandatory say by a new accounting standard
Disclose: the change and the effect of change on financial statement items
• If the Net Realizable Value (NRV) of inventory falls below its historical cost because of 
– physical deterioration/obsolescence/decline in price level, 
‐ a loss has occurred. 
– This loss is recognized by writing the inventory down to NRV
• Lower of COST or Net Realizable Value (NRV)  Rule:
– Application of Conservatism principle  [US GAAP: COST‐or‐MARKET (LCM)]
– If Cost = Rs 60,000 & MV declines to Rs 45,000 
• Write down the inventory to its market value of Rs 45000 in the period when 
price decline occurred
– If Cost = Rs 60,000 & MV increases to Rs 70,000
• Continue to value inventory at cost of Rs 60,000

22
 Diagrammatic Representation of Inventory Valuation
Inventory should be valued at  at the lower of Cost and Net realizable value (NRV)
Cost Net Realizable Value (NRV)

Components of Cost
Ascertaining NRV
a. Cost of Purchase
b. Cost of Conversion Expected Selling price 
c. Other costs (attributable to bring the inventories  to  Less: Cost of completion 
current location & condition) Less: Other costs necessary to effect the sale
Exclude: Abnormal waste, Admn, storage, selling costs

a. Cost of Purchase
i. Purchase price
ii. Freight, duties & taxes
iii. Other expenses directly 
attributable to acquisition

b. Cost of Conversion 
i. Direct labour
ii. Variable Production Overhead
iii. Fixed Production Overhead

c. Other costs directly attributable to bring 
items to their location and condition 
(eg: designing products for specific customers)

Select and apply appropriate inventory costing method – FIFO, Average Cost, or 

Specific identification method.

Disclose Inventory valuation policy, changes if any therein as also impact of change.
 Cost ‐ Cost of Purchase, Conversion and Other Costs
Costs of purchase of inventories comprise of
• The purchase price Including 
– Applicable taxes and tariffs [eg. Import duties and non‐refundable taxes]
– Transport (freight‐in, including transit insurance), Handling (unloading etc.) and 
Other costs directly attributable to the acquisition. 
• Deduct : Trade discounts, rebates etc.
(Costs not to be included : 
Demurrage charge, Financing component of purchase on deferred settlement)
Also, Exclude from Cost of Inventories and recognize as expense :
• Cost of abnormal wastage (wasted materials, labour, other production costs)
• Storage costs (unless the costs are necessary in the production process before next
production stage)
• Administrative Overheads, Selling costs (that do not contribute to bringing inventories 
to their present location and condition)
• Interest and Borrowing costs (except for qualifying assets like wine, timber)
Cost of Conversion includes:
• Costs directly related to production like Direct labour
• Production (Manufacturing) Overheads (Fixed & Variable) : Allocated systematically 
Other Costs : Non‐Production Costs, Directly attributable (designing products for specific 
customers) 24
AKB chapter 16 : Page 397
1. PDS started operations on January 1, 2007. It was engaged in the following transactions during 
January. Identify the amount that the company should include in the valuation of the merchandise 
inventory.
(i) Purchases of merchandise on account during January: Rs50,00,000
(ii) Freight cost to transport merchandise to the warehouse of PDS: Rs20,000
(iii) Salary of the purchase manager: Rs50,000
(iv) Depreciation, taxes, insurance and utilities for the warehouse: Rs30,000
(v) Salary of the warehouse manager: Rs20,000
(vi) Cost of merchandise that PDS purchased in part (i) and that was returned to the supplier 
Rs10,000
(vii) Cash discount taken by PDS from purchases on account in part (i) Rs5,000

Ans:  Purchase – Returns – Discount + Freight Costs = Rs 50,05,000 

2. On December 20, 2006, SL purchased goods costing Rs5,00,000. The terms were ‘Free on board’
(FOB) destination. The following costs were incurred in connection with the delivery of goods:
• Packaging and shipment Rs6,000
• Shipping Rs4,000
• Special handling charges Rs2,000
These goods are included in inventory. What cost should be considered for the purpose of
inventory valuation?
Rs 500,000
25
 Net Realizable Value (NRV)
Net Realizable Value (NRV) is
Estimated selling price in the ordinary course of business 
Less:  Estimated costs of completion 
Less:  Estimated costs necessary to make the sale.

• Cost incurred on a job till date 6,00,000
• Further costs estimated to complete it  1,00,000
• Contract Price 9,00,000
• Estimated Selling Costs 10,000

NRV ?  = 900,000 – 100,000 ‐10,000 = 790,000 
Inventory to be carried at ? Lower (Cost=600,000, NRV=790,000) = 600,000 

Comparison of Cost with NRV 
– Should in principle be carried out on Item by item basis 
– If impracticable: Consider by group if items are of similar nature

Under US GAAP – Lower of Cost or Market 
Market Value refers to Current Replacement Cost 
Replacement Cost : amount at which the asset can be purchased

26
 NRV of raw materials, components and other supplies 
Net Realizable Value (NRV) for Raw Materials: 
Raw Materials and other supplies should be valued at cost.
They should be valued at Replacement cost (best measure of NRV) if :
– Price of RM has declined and
– When a decline indicates that the cost of FG will exceed NRV of FG

10000 units of Raw Material P is in stock
One unit of P is required to produce 
one unit of Finished Goods Q
On Balance  For P  For Q  Amount at which P is 
sheet date: (Raw Material) (Finished Goods) to be carried in BS
COST Replacement Cost Cost NRV
Case A 20 25 Irrelevant RM: RC > COST
Case B 20 15 100 120 FG: NRV >Cost 20
Case C 20 15 100 98 FG: NRV < Cost 15
FG: NRV < Cost
Case D 20 15 100 78 (Ignore amt of loss)  15
Inventory Write‐down Expensed Reversal in Inventory Write‐down  Reduction of Inventory Expensed
Say, an item of inventory was written down below its cost to its NRV (as in case C or D above). 
It is still on hand in a subsequent period and its NRV now increases
• Write‐down can be reversed : Reversal  limited to the amount of the original write‐down
• so that the new carrying amount is the lower of the cost and the revised NRV 27
 NRV of raw materials, components and other supplies 
Net Realizable Value (NRV) for Raw Materials: 
Raw Materials and other supplies should be valued at cost.
They should be valued at Replacement cost (best measure of NRV) if :
– Price of RM has declined and
– When a decline indicates that the cost of FG will exceed NRV of FG

10000 units of Raw Material P is in stock
One unit of P is required to produce 
one unit of Finished Goods Q
On Balance  For P  For Q  Amount at which P is 
sheet date: (Raw Material) (Finished Goods) to be carried in BS
COST Replacement Cost Cost NRV
Case A 20 25 Irrelevant RM: RC > COST
Case B 20 15 100 120 FG: NRV >Cost 20
Case C 20 15 100 98 FG: NRV < Cost 15
FG: NRV < Cost
Case D 20 15 100 78 (Ignore amt of loss)  15
Inventory Write‐down Expensed Reversal in Inventory Write‐down  Reduction of Inventory Expensed
Say, an item of inventory was written down below its cost to its NRV (as in case C or D above). 
It is still on hand in a subsequent period and its NRV now increases
• Write‐down can be reversed : Reversal  limited to the amount of the original write‐down
• so that the new carrying amount is the lower of the cost and the revised NRV 28
 AKB chapter 16 : Page 397‐398
6 (iv)  Kaveri Limited (KL) produces machine tools against confirmed orders from customers. The work‐in‐progress inventory 
as at the end of the year includes a job order on which cost accumulated till the end of the year was Rs10,00,000. The 
management estimates that it has to incur Rs 5,00,000 to complete the job. The selling price of the job as per the contract is 
Rs18,00,000. Thus, the estimated gross profit on the job is 20 percent of the total cost of production. The net realisable
value at the balance sheet date was Rs ??

Solution 
Net Realizable Value (NRV) is
Estimated selling price in the ordinary course of business                               =   Rs18,00,000
Less:  Estimated costs of completion & costs necessary to make the sale     =    ‐ Rs 5,00,00
NRV=   Rs 13,00,000

6 (v) Natasha Limited (NL) uses raw material X to produce an electronic safety device that is used by the Railways. One unit 
of the material is used to produce one unit of the finished product. 
With the increase in budget allocation for safety items, a large player in the electronic industry has included in its 
product portfolio a product similar to that is being produced by NL. In order to penetrate the market, it has quoted a price 
lower than the price at which NL secured orders from Railways in the past. 
NL has secured a fresh order after matching its price with that of the new player which quoted the lowest price. NL 
estimates that it will incur a loss of  Rs 5,000 per unit. The cost of production is estimated at Rs160,000 (RM 100, Direct 
Wages 40,OH 20). The book value of the material X is Rs25,000 per unit and its replacement cost is Rs28,000 per unit. The 
year‐end inventory of the material X should be valued at Rs…… per unit. 

Raw Material (X) Finished Product Amount at which X to be carried in BS (Ans)

Cost Replacement cost(RC) Cost  NRV (SP)
V 25,000 28,000 160,000 155,000 Rs 25,000 (RC > Cost)
6 vi 24,000 20,000 150,000 145,000 Rs 20,000 (RC < Cost & FG to be sold below cost 29
 AKB chapter 16 : Page 397‐398
6 (iv)  Kaveri Limited (KL) produces machine tools against confirmed orders from customers. The work‐in‐progress inventory 
as at the end of the year includes a job order on which cost accumulated till the end of the year was Rs10,00,000. The 
management estimates that it has to incur Rs 5,00,000 to complete the job. The selling price of the job as per the contract is 
Rs18,00,000. Thus, the estimated gross profit on the job is 20 percent of the total cost of production. The net realisable
value at the balance sheet date was Rs ??

Solution 
Net Realizable Value (NRV) is
Estimated selling price in the ordinary course of business                               =   Rs18,00,000
Less:  Estimated costs of completion & costs necessary to make the sale     =    ‐ Rs 5,00,00
NRV=   Rs 13,00,000

6 (v) Natasha Limited (NL) uses raw material X to produce an electronic safety device that is used by the Railways. One unit 
of the material is used to produce one unit of the finished product. 
With the increase in budget allocation for safety items, a large player in the electronic industry has included in its 
product portfolio a product similar to that is being produced by NL. In order to penetrate the market, it has quoted a price 
lower than the price at which NL secured orders from Railways in the past. 
NL has secured a fresh order after matching its price with that of the new player which quoted the lowest price. NL 
estimates that it will incur a loss of  Rs 5,000 per unit. The cost of production is estimated at Rs160,000 (RM 100, Direct 
Wages 40,OH 20). The book value of the material X is Rs25,000 per unit and its replacement cost is Rs28,000 per unit. The 
year‐end inventory of the material X should be valued at Rs…… per unit. 

Raw Material (X) Finished Product Amount at which X to be carried in BS (Ans)

Cost Replacement cost(RC) Cost  NRV (SP)
V 25,000 28,000 160,000 155,000 Rs 25,000 (RC > Cost)
6 vi 24,000 20,000 150,000 145,000 Rs 20,000 (RC < Cost & FG to be sold below cost 30
 IFRS Vs US GAAP

MAJOR DIFFERENCES: 

 US GAAP allows LIFO method for inventory valuation. IFRS and Ind AS 2 prohibit 
use of LIFO method
1. Under IFRS, Market value refers to NRV.  Under US GAAP, Market value refers to 
replacement cost 
 Under US GAAP,
– Once written down, the new value becomes the cost of the inventory 
– It can not be written back up to its original cost in a subsequent 
period
• Under IFRS,
– the write‐down may be reversed in a subsequent period up to the 
amount of the previous write‐down (both write‐down and reversal 
reflected in Income Statement)
– But inventory cannot be written up above its original cost

31
 Disclosure  on  Inventory Asian Paints :  2019‐20 

Full Disclosure
Disclosure Requirement as per Ind AS‐2: Inventories  (Indian GAAP)
• Accounting Policies adopted in measuring Inventories, including the cost 
Notes to the Financial Statements
formula used
• Total Carrying amount of inventories, its classification appropriate to the 
entity
• Amount of inventory recognized as expense during the period, write‐
downs, reversals, pledged

The cost of 
inventories 
recognised as an 
expense during the 
year is disclosed in 
Note 24. IS Class
The cost of 
inventories 
recognised as an 
expense includes ₹ 
30.90 crores (Previous 
year ₹ 2.98 crores) in 
respect of write down 
of inventory to net 
realisable value. 
There has been no 
reversal of such write 
down in current and
previous years.
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 Course Recap
1. Introduction & Accounting Equation : Users & Principal Uses of Accounting , Classification of Business 
Transactions,  Qualitative characteristics of Accounting Information, Accounting Cycle, Basic Accounting Principles 
Assumptions and Concepts, Basic Accounting Equation, Elements of Financial Statements
2. Accounting Mechanics : Account, Effect of a transaction on Accounting Equation, The Rules of Debit and Credit, 
Steps in Accounting Cycle – Journalizing, Ledger Posting, Passing Adjustments and Closing entries, Preparing Trial 
Balance, Basics of adjusting entries and closing the books
3. Preparing and Understanding Income Statement :Income statement: Single‐step and Multi‐step, Product 
Cost versus Period Cost, Different line items in multi‐step Income Statement like Net Sales, COGS, Gross Profit, 
Operating Profit, EBIT, Net Profit, Deferred and current tax, Earnings Per Share, Indian format of Income Statement
4. Preparing and Understanding Balance Sheet: Elements of Balance Sheet, Classified Balance Sheet, Assets & 
Liabilities: Current & Non‐current, Financial & non‐financial, Shareholder’s Equity – Equity Share Capital, Other 
Equity (Reserves & Surplus), Bonus Share, Buyback, and Stock Split, Schedule of Property, Plant and Equipment, Net 
working Capital, Indian format of Balance Sheet
5. Financial Statement Analysis ‐ Tools & Application: Comparative Analysis: Horizontal & Vertical, Ratio 
Analysis: Liquidity, Efficiency, Profitability, solvency, market‐based, DuPont Analysis, Assessment of financial 
performance & health of companies – across time, over the periods
6. Preparing, Understanding & Analyzing Cash Flow Statements : Usefulness & Format of Cash Flow 
Statement (Indian format), Cash and Cash Equivalents, Classification cash flows into Operating, Investing or 
Financing flows, Preparing Cash Flow statement – Direct & Indirect Method, Use of CFS to evaluate a company
7. Accounting for Property, Plant, & Equipment (PPE) : Accounting for Acquisition, Depreciation, Impairment, 
and Disposal, Operating Versus Financial Lease, Presentation in financial statements, Impact on Ratios 
8. Inventory Reporting and Analysis: Classification and determining inventory, Perpetual and Periodic Inventory 
system, Inventory Costing under FIFO, LIFO, & Weighted Average Cost methods, Inventory Valuation Methods, 
Presentation in financial statements, Impact on Ratios
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Thank You

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