Fa&a All Unit (KMBN 103)

FINANCIAL ACCOUNTING AND ANALYSIS
KMBN 103
Unit-I
Meaning and scope of Accounting-
Accounting is a systematic recorded presentation of the financial activities of the
business. There must be documentary evidence of every business transaction.
Accounting records all the transactions of financial nature.
The transaction can be financial or non-financial. Transaction which are financial in
nature and are business transactions are recorded in accounting.
Accounting is proper recording of financial and business transactions.
Accounting communicates the results of business operations to various parties who
have some stake in the business viz., the proprietor, creditors, investors,
Government and other agencies.
The main purpose of accounting is to ascertain profit or loss during a specified period, to
show financial condition of the business on a particular date and to have control over the
firm's property.
Definition of Accounting:-
1) According to American Institute of Certified Public
Accounting-“Accounting is the art of recording, classifying and
summarizing in a significant manner and In terms of money, transactions
and events, which are, in part at least ,of a financial character and
interpreting the results thereof ’’
2) According to Accounting Association- “Accounting is the process of
identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of the information.’
Elements of Accounting:-
1) Recording: It is concerned with the recording of financial transactions in an orderly
manner, soon after their occurrence In the proper books of accounts.
2) Classifying: It Is concerned with the systematic analysis of the recorded data so as

to accumulate the transactions of similar type at one place. This function is
performed by maintaining the ledger in which different accounts are opened to
which related transactions are posted.
3) Summarizing: It is concerned with the preparation and presentation of the classified

data in a manner useful to the users. This function involves the preparation of
financial statements such as Income Statement, Balance Sheet, Statement of Cash
Flow.
4) Money measurement: It refers only those elements are to be recorded which are
evaluated in terms of money like assets, plants, furniture etc. Those elements are not
recorded which cannot be evaluated in terms of money. Like feelings, relationship
etc.
5) Interpreting: The accountants should interpret the statements in a manner useful to

action. The accountant should explain not only what has happened but also (a) why
it happened, and (b) what is likely to happen under specified conditions.
6) Communication: After the analysis and Interpretation of record it must be maintain properly so that to
communicate the books of account to the end- users like , management, creditors ,investors, bankers
government etc.
Users of Accounting
1) Owners: The owners provide funds or capital for the organization. A business is done with the
objective of making profit. Its profitability and financial soundness are therefore, matters of prime
importance to the owner.
2) Management: The management is interested in financial accounting to find whether the business
carried on is profitable or not. The financial accounting is the eyes and ears of management.
3) Employees: Payment of bonus depends upon the size of profit earned by the firm. The more important
point is that the workers expect regular income for the bread. The demand for wage rise, bonus, better
working conditions etc. For these reasons, this group is interested in accounting.
4) Creditors: Creditors are the persons who supply goods on credit, or bankers or lenders of money. It is
usual that these groups are interested to know the financial soundness before granting credit..
5) Investors: The prospective investors, who want to invest their money in a firm, of course wish to
see the progress and prosperity of the firm, before investing their amount, by going through the
financial statements of the firm. This is to safeguard the investment.
6) Government: Government keeps a close watch on the firms which yield good amount of profits. The
state and central Governments are interested in the financial statements to know the earnings for the
purpose of taxation.
7) Consumers: These groups are interested in getting the goods at reduced price. Therefore, they wish to
know the establishment of a proper accounting control, which in turn will reduce to cost of production,
in turn less-price to be paid by the consumers.
8) Research Scholars: Accounting information, being a mirror of the financial performance of a business
organization the researcher use the financial information for analysis and interpreting the financial
statement of the concern.
Scope of Accounting
Accounting has got a very wide scope and area of application. Its use is not confined to the business
world alone, but spread over in all the spheres of the society and in all professions. Now-a-days, in any
social institution or professional activity, whether that is profit earning or not, financial transactions
must take place. So there arises the need for recording and summarizing these transactions when they
occur and the necessity of finding out the net result of the same after the expiry of a certain fixed
period. Besides, the is also the need for interpretation and communication of those information to the
appropriate persons. Only accounting use can help overcome these problems.
In the modern world, accounting system is practiced no only in all the business institutions but also in
many non-trading institutions like Schools, Colleges, Hospitals, Charitable Trust Clubs, Co-operative
Society etc. and also Government and Local Self-Government in the form of Municipality, Panchayat.
The professional persons like Medical practitioners, practicing Lawyers, Chartered Accountants etc.
also adopt some suitable types of accounting methods. As a matter of fact, accounting methods are
used by all who are involved in a series of financial transactions. The scope of accounting as it was in
earlier days has undergone lots of changes in recent times. As accounting is a dynamic subject, its
scope and area of operation have been always increasing keeping pace with the changes in socio-
economic changes. As a result of continuous research in this field the new areas of application of
accounting principles and policies are emerged. National accounting, human resources accounting and
social Accounting are examples of the new areas of application of accounting systems.
Objective of Accounting
1) To keeping systematic record: It is very difficult to remember all the business transactions that take
place. Accounting serves this purpose of record keeping by promptly recording all the business
transactions in the books of account.
2) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit earned
or loss suffered in business during a particular period. For this purpose, a business entity prepares
either a Trading and Profit and Loss account or an Income and Expenditure account.
3) To ascertain the financial position of the business: In addition to profit, a businessman must know
his financial position i.e., availability of cash, position of assets and liabilities etc. This helps the
businessman to know his financial strength.
4) To protect business properties: Accounting provides up-to date information about the various assets
that the firm possesses and the liabilities the firm owes, so that nobody can claim a payment which is
not due to him.
5) To facilitate rational decision – making: Accounting records and financial statements provide
financial information which help the business in making rational decisions about the steps to be taken
in respect of various aspects of business.
6) To satisfy the requirements of law: Entities such as companies, societies, public trusts are
compulsorily required to maintain accounts as per the law governing their operations such as the
Companies Act, Public Trust Act, Sales Tax Act and Income Tax Act.
Advantages of Accounting
1) It helps in having complete record of business transactions.

2) It gives information about the profit or loss made by the business.
3) It provides useful information for making economic decisions,
4) It facilitates comparative study of current year’s profit, sales, expenses etc., with those of the previous
years.
5) It supplies information useful in judging the management’s ability to utilise enterprise resources
effectively in achieving primary enterprise goals.
6) It helps in complying with certain legal formalities like filing of income-tax and sales-tax returns. If
the accounts are properly maintained, the assessment of taxes is greatly facilitated.
Limitation of Accounting
1) Accounting is historical in nature: It does not reflect the current financial position or worth of a
business.
2) Transactions of non-monetary nature do not find place in accounting. Accounting is limited to
monetary transactions only. It excludes qualitative elements like management, reputation, employee
morale, Labour strike etc.
3) Cost concept is found in accounting. Price changes are not considered. Money value is bound to
change often from time to time. This is a strong limitation of accounting.
4) Accounting statements do not show the impact of inflation.
5) The accounting statements do not reflect those increase in net asset values that are not considered
realized.
Some basic terms used in Accounting
1) Debtor - A person who owes money to the firm mostly on account of credit sales of goods is called a
debtor. For example, when goods are sold to a person on credit that person pays the price in future, he
is called a debtor because he owes the amount to the firm.
2) Creditor - A person to whom money are owing by the firm is called creditor. For example, Madan is a
creditor of the firm when goods are purchased on credit from him.
3) Capital - It means the amount (in terms of money or assets having money value) which the proprietor
has invested in the firm or can claim from the firm. It is also known as owner’s equity or net worth.
Owner’s equity means owner’s claim against the assets. It will always be equal to assets less liabilities,
say: Capital = Assets - Liabilities.
4) Liability - It means the amount which the firm owes to outsiders that is, excepting the proprietors. In
the words of Finny and Miller, “Liabilities are debts; they are amounts owed to creditors; thus the
claims of those who ate not owners are called liabilities”. In simple terms, debts repayable to outsiders
by the business are known as liabilities.
5) Asset - Any physical thing or right owned that has a money value is an asset. In other words, an asset
is that expenditure which results in acquiring of some property or benefits of a lasting nature.
6) Goods - It is a general term used for the articles in which the business deals; that is, only those
articles which are bought for resale for profit are known as Goods.
7) Revenue - It means the amount which, as a result of operations, is added to the capital. It is defined as
the inflow of assets which result in an increase in the owner’s equity. It includes all incomes like sales
receipts, interest, commission, brokerage etc., However, receipts of capital nature like additional
capital, sale of assets etc., are not a pant of revenue.
8) Expense - The terms ‘expense’ refers to the amount incurred in the process of earning revenue. If the
benefit of an expenditure is limited to one year, it is treated as an expense (also know is as revenue
expenditure) such as payment of salaries and rent.
9) Expenditure - Expenditure takes place when an asset or service is acquired. The purchase of goods is
expenditure, where as cost of goods sold is an expense. Similarly, if an asset is acquired during the
year, it is expenditure, if it is consumed during the same year, it is also an expense of the year.
10) Purchases - Buying of goods by the trader for selling them to his customers is known as purchases. As
the trade is buying and selling of commodities purchase is the main function of a trade. Purchases can
be of two types. viz, cash purchases and credit purchases. If cash is paid immediately for the
purchase, it is cash purchases, If the payment is postponed, it is credit purchases.
11) Sales - When the goods purchased are sold out, it is known as sales. Here, the possession and the
ownership right over the goods are transferred to the buyer. It is known as. 'Business Turnover’ or
sales proceeds. It can be of two types, viz.,, cash sales and credit sales. If the sale is for immediate cash
payment, it is cash sales. If payment for sales is postponed, it is credit sales.
12) Stock - The goods purchased are for selling, if the goods are not sold out fully, a part of the total goods
purchased is kept with the trader unlit it is sold out, it is said to be a stock. If there is stock at the end of
the accounting year, it is said to be a closing stock. This closing stock at the year-end will be the
opening stock for the subsequent year.
13) Drawings - It is the amount of money or the value of goods which the proprietor takes for his
domestic or personal use. It is usually subtracted from capital
14) Losses - Loss really means something against which the firm receives no benefit. It represents money
given up without any return. It may be noted that expense leads to revenue but losses do not. (e.g.) loss
due to fire, theft and damages payable to others,
15) Invoice - While making a sale, the seller prepares a statement giving the particulars such as the
quantity, price per unit, the total amount payable, any deductions made and shows the net amount
payable by the buyer. Such a statement is called an invoice.
16) Voucher - A voucher is a written document in support of a transaction. It is a proof that a particular
transaction has taken place for the value stated in the voucher. Voucher is necessary to audit the
accounts.
17) Proprietor - The person who makes the investment and bears all the risks connected with the business
is known as proprietor.
18) Solvent - A person who has assets with realizable values which exceeds his liabilities is insolvent.
19) Insolvent - A person whose liabilities are more than the realizable values of his assets is called an
insolvent.
Accounting Concepts And Conventions
Accounting Concepts-
1) Business Entity Concept: Business entity concept implies that the business unit is separate and
distinct from the persons who provide the required capital to it. This concept can be expressed through
an accounting equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the
business itself owns the assets and in turn owes to various claim
2) Money Measurement Concept: In accounting all events and transactions are recode in terms of
money. Money is considered as a common denominator, by means of which various facts, events and
transactions about a business can be expressed in terms of numbers.
3) Going Concern Concept: Under this concept, the transactions are recorded assuming that the business
will exist for a longer period of time, i.e., a business unit is considered to be a going concern and not a
liquidated one. Keeping this in view, the suppliers and other companies enter into business transactions
with the business unit.
4) Dual Aspect Concept: According to this basic concept of accounting, every transaction has a two-fold
aspect, Viz., 1.giving certain benefits and 2. Receiving certain benefits. The basic principle of double
entry system is that every debit has a corresponding and equal amount of credit.
5) Periodicity Concept: Every businessman wants to know the profit or loss of a business so that as per
the requirement of its own and end-users so that account may be prepare for three month, six month,
one year or two year and also it can be prepare as per the nature of account like, construction work,
sugar mills, woolen industries etc
6) Historical Cost Concept: It means that the asset is recorded at cost at the time of purchase but it may
be methodically reduced in its value by way of charging depreciation
7) Matching Concept: The essence of the matching concept lies in the view that all costs which are
associated to a particular period should be compared with the revenues associated to the same period to
obtain the net income of the business.
8) Realization Concept: This concept assumes or recognizes revenue when a sale is made. Sale is
considered to be complete when the ownership and property are transferred from the seller to the buyer
and the consideration is paid in full.
9) Accrual Concept: Accrual concept ensure that the profit or loss shown is on the basis of full facts
relating to all the expenses and income. Accrual refers to those expenses and income which have not
been derived in terms of cash. The income-pay in advance, the out-standing expenses these terms are
not entered into cash book because there is no flow of cash.
10) Objective Evidence Concept: This concept ensures that all accounting must be based on objective
evidence, i.e., every transaction recorded in the books of account must have a verifiable document in
support of its, existence like cash receipts, cash memo, invoice bills etc.
Accounting Conventions
1) Consistency: The accounting practice and method should remain consistent from one accounting
period to another. Whatever accounting practice is followed by the business enterprise, should be
followed on a consistent basis from year to year.
2) Full Disclosure of Accounts: The convention of disclosure stresses the importance of providing
accurate, full and reliable information and data in the financial statements which is of material interest
to the user’s and readers of such statements.
3) Conservatism: This convention follows the policy of caution or playing safe. It takes into account all
possible losses but not the possible profits or gains. Accountant should always be on side of safety.
4) Convention of Materiality:- Only those transaction, important facts and items are shown which are
useful and material for the business. The firm need not record immaterial and insignificant items.
Accounting Equation
The accounting equation is a basic principle of accounting and a fundamental element of the balance
sheet.
Assets = Liabilities + Capital (Shareholder’s Equity)

Assets – Liabilities = Capital (Shareholder’s Equity)
This equation sets the foundation of double-entry accounting and highlights the structure of the
balance sheet. Double-entry accounting is a system where every transaction affects both sides of the
accounting equation. For every change to an asset account, there must be an equal change to a related
liability or shareholder’s equity account. It is important to keep the accounting equation in mind when
performing journal entries.
The balance sheet is broken down into three major sections and its various underlying items are
Assets, Liabilities, and Shareholder’s Equity. Below are some examples of items that fall under each
section:
Assets: Cash, Accounts Receivable, Inventory, Machinery etc.

Liabilities: Accounts Payable, Short-term borrowings, Long-term Debt
Shareholder’s Equity: Share Capital, Reserve & Surplus of profit.
Depreciation
The assets gradually loss their value due to constant use.
Depreciation is the systematic reduction of the recorded cost of a fixed asset. Examples of fixed assets
that can be depreciated are buildings, furniture, and office equipment. The only exception is land,
which is not depreciated. The reason for using depreciation is to match a portion of the cost of a fixed
asset to the revenue that it generates; this is mandated under the matching principle.
Definition of Depreciation:-
1) R.N. Carter- ‘Depreciation is gradual and permanent decrease in the value of an asset from
any cause.’
2) “Small wear and tear of a machinery during processing time in a given financial year is
known as depreciation “
Reasons of depreciation-
i) By constant use
ii) By expiry of time
iii) By obsolescence
iv) Permanent fall in prices
v) By Accident
Methods of Depreciation-
1) Straight Line Method: under this method, total depreciable amount is spread equally over the useful
life of the asset. It result into equal amount of depreciation in each of the year.
1. Depreciation is calculated on original cost of the asset.
2. Amount of depreciation remains same during the useful life of the asset.
3. Book value of the asset can be reduced to zero or to its scrap value.
4. Not applicable for income tax purposes.
2) Written Down Value Method: under this method , depreciation is charged on the opening
net value of the asset in each of the year; therefore, it result into reducing amount of depreciation year
after year, till the end of useful life of the asset . This is also called as reducing balance method of
charging depreciation
1. Depreciation is calculated on written down value of the asset.
2. Amount of depreciation keeps on reducing every year.
3. Book value never gets reduced to zero.
4. Applicable for income tax purposes.
5. This method is suitable for assets which give higher utility in the initial years like Machinery etc.
NUMERICAL:-
Q-1) On January 1, 2020 M/s. Ram & Sons purchased Machinery for Rs.200000. They spent Rs. 12000 on its
freight and Rs. 8000 for its installation. The expected life of the machine is 10 years. It is expected that the
machine will be sold for Rs. 20000 after its useful life. Prepare Machinery Account and Depreciation account
for 3 years by Straight line method. Books of accounts are closed on December 31, every year.
Solution-1) Machinery Account
Dr. Cr.
Amoun J.F
Date Particulars J.F. t Date Particulars . Amount
1990 1990
Jan.1 To Bank A/c 220000 Dec. 31 By Dep. A/c 20000
Dec. 31 By Balance c/d 200000
220000 220000
1991 1991
Jan.1 To Balance b/d 200000 Dec. 31 By Dep. A/c 20000
200000 200000
1992 1992
180000 180000
Depreciation A/c
Dr. Cr.
J.F
Date Particulars . Amount Date Particulars J.F. Amount
1990 1990
Jan.1 To Machine A/c 20000 Dec. 31 By P/L A/c 20000
1991 1991
1992 1992
Q-2) A company whose accounting year is calendar year purchased on 1 April, 2010 machinery costing Rs.
30000. It further purchased machinery on 1 October, 2010 costing Rs. 20000 and on 1st July, 2011 costing Rs.
10000. On 1st Jan, 2012 one third of machinery which was installed on 1st April, 2010 became obsolete and was
sold for Rs. 3000. Show how the machinery account would appear in the books of company. The depreciation
is to be charged at 10% p.a. on Written down value method.
Solution- Written Down Method

Machinery Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 2010
April.
1 To Bank A/c 30000 Dec. 31 By Dep. A/c 2750
Oct. 1 To Bank A/c 20000 Dec. 31 By Balance c/d 47250
50000 50000
2011 2011
Jul-01 To Bank A/c 10000 Dec. 31 By Balance c/d 52025
57250 57250
2012 2012
By Bank A/c
Jan.1 To Balance b/d 52025 Jan. 1 (Sale) 3000
By P/L A/c
Jan. 1 (Loss) 5325
Dec. 31 By Dep. A/c 4370
52025 52025
2013
Jan. 1 To Balance b/d 39330
Depreciation A/c
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
2010 2010
2011 2011
2012 2012
Unit II
INDIAN ACCOUNTING STANDARD (IND AS)

Accounting Standard- An accounting standard is a set of accounting policies or board guideline regarding the
principles and method to be chosen out of several alternatives.
The accounting standard seeks to describe the accounting principles, the valuation techniques and the methods
of applying the accounting principles in the preparation and presentation of financial statements so that they
may give a true and fair view.
The term ‘accounting standard’ is defined as written statements issued from time to time by institutions of
the accounting profession or institutions in which there is sufficient involvement and which are established
expressly for this purpose. Such accounting institutions or bodies are currently found in many countries of
the world, e.g. Accounting Standards Board (India), Financial Accounting Standards Board (US),
Accounting Standards Committee (UK), Accounting Standards Committee (Canada), etc.
ACCOUNTING STANDARDS ISSUED BY ASB

The Institute of Chartered Accountants of India Accounting Standards Board of the (as on 1 st July,2017 and
onwards), Has in line with the International Standards, issued thirty two standards to be followed by its
members while auditing the accounts of the companies. These are-
SN. AS Related to
1 AS 1 Disclosures of Accounting Policies
2 AS 2 Valuation of Inventories
3 AS 3 Cash flow statements
4 AS 4 Contingencies and Events Occuring After the Balance sheet Date
5 AS 5 Net Profit or Loss for the period, Prior period Items and Changes
in Accounting Policies
6 AS 6 Depreciation Accounting
7 AS 7 Accounting for Construction Contract
8 AS 8 Accounting for Research and Development
9 AS 9 Revenue Recognition
10 AS 10 Accounting for Fixed Assets
11 AS 11 Effects of Changes in Foreign Exchange Rates
12 AS 12 Accounting for Government Grants
13 AS 13 Accounting for Investment
14 AS 14 Accounting for Amalgamation
15 AS 15 Accounting For Retirement Benefits of Employers
16 AS 16 Borrowing Cost
17 AS 17 Segment Reporting
18 AS 18 Related Party Disclosures
19 AS 19 Leases
20 AS 20 Earnings Per Share
21 AS 21 Consolidated Financial Statements
22 AS 22 Accounting for taxes on income
23 AS 23 Accounting for Investments in Associates
24 AS 24 Discounting Operations
25 AS 25 Interim Financial Reporting
26 AS 26 Intangible Assets
27 AS 27 Financial Reporting of Interest in Joint venture
28 AS 28 Impairment of Assets
29 AS 29 Provisions, Contigent Liabilities
30 AS 30 Recognition and Measurement
31 AS 31 Presentation
32 AS 32 Disclosures
In short Accounting Standards can be thought of as a system of measurements and disclosure.
International Accounting Principles and Standards

The foundation of accounting consists of a set of accounting principles known as Generally Accepted
Accounting principles or GAAP. The US GAAP is established by the financial Accounting Standard Board
(FASB) and American Institute of Certified Public Accountants (AICPA). To develop standards, committees
are formed, exposure drafts are prepared which are circulated to the accounting financial and business
communities and if approved these drafts become standards.
International Accounting Standards (IAS) are older accounting standards that were replaced in 2001 by
International Financial reporting Standards (IFRS), Issue by the International Accounting Standards
Boards Board (IASB), an independent International standard setting body based in LONDON. Understanding
International Accounting Standards (IAS)
In India, the institute of Chartered Accountants of India (ICAI) has worked towards convergence by
considering the application of IFRS in Indian corporate environment of Indian Accounting Standard with
IFRS, ICAI constituted a task force to examine various issues involved.
Indian Accounting Standards (Ind AS) are IFRS converged standard issued by the Central Government of
Indian under the supervision and control of Accounting Standards Board (ASB) of ICAI and in
consultation with National Advisory Committee on Accounting Standards (NACAS).
Moving Toward New Global Accounting Standards

There has been significant progress towards developing a single set of high-quality global accounting
standards since the IASC was replaced by the IASB. IFRS have been adopted by the European Union leaving
the U.S., Japan and China as the only major capital markets without an IFRS mandate. As of 2018, 144
jurisdictions require the use of IFRS for all or most publicly listed companies and a future 12 jurisdictions
permit its use.
Global comparable accounting standards promote transparency, accountability, and efficiency in financial
markets around the world.
Matching of Indian Accounting Standards with International Accounting Standards

S. Basis for
n o. Comparison IFRS INDIAN GAAP
between
IFRS Vs
INDIAN
GAAP
1 Meaning of International Financial The Indian version of Generally
the Reporting Standard Accepted
abbreviatio Accounting Principles
n
2 Developed by International Accounting Ministry of Corporate Affairs
Standards Board (IASB) (MCA)
3 Disclosure A company that is complying When a company is said to
with IFRS needs to disclose follow the Indian GAAP, It’s
as a note that their financial presumed that It’s complying
statements with it and showing a true &
comply with the IFRS fair view of its financial affairs
4 Adopted by Companies in 110+ countries Indian GAAP is only adopted
have adopted IFRS. More and by Indian companies.
more countries are making
the shift as well
5 How to adopt it IFRS provides clear Indian GAAP doesn’t give any
for the first instruction on how to adopt type Instruction on the first time
time? IFRS for the first time adoption
6 Usage of When the financial statement There’s no question of using
currency in the are not presented in the exchange rat e since Indian
presentation function currency, then the GAAP is only used in the
assets and liabilities of the Indian context.
balance sheet are
transmuted by the exchange
rate
7 Consolida If the companies don’t come As per the Indian GAAP the
ted under the exemption criteria companies should prepare
Financial mention under IAS individual financial
Statemen 27 (Para 10) the companies statements. There’s no
ts need to prepare consolidated requirement of preparing
financial statements. consolidated statements.
8 What financial The companies following Indian companies following
statements need IFRS needs to prepare the Indian GAAP needs to prepare
to be prepared? balance sheet and the income the balance sheet, profit & loss
statement account, and cash flow
statements.
9 How is A per IFRS, the revenue is The money charged for the
revenue shown at the fair value of the product/ services to the
shown? money received or receivable customers and the rewards
received by using the resource
come under revenue as per
Indian GAAP.
Double Entry: In this system every business transaction is having a two-fold effect of benefits giving and
benefit receiving aspects. The recording is made on the basis of both these aspects. Double Entry is an
accounting system that records the effects of transactions and other events in at least two accounts with equal
debits and credits.
Steps involved in Double entry system

(a) Preparation of Journal: Journal is called the book of original entry. It records the effect of all
transactions for the first time. Here the job of recording takes place.
(b) Preparation of Ledger: Ledger is the collection of all accounts used by a business. Here the grouping
of accounts is performed. Journal is posted to ledger.
(c) Trial Balance preparation: Summarizing. It is a summary of ledge balances prepared in the form of
a list.
(d) Preparation of Final Account: At the end of the accounting period to know the achievements
of the organization and its financial state of affairs, the final accounts are prepared.
Advantages of Double Entry System

i) Scientific system: This system is the only scientific system of recording business transactions in a set of
accounting records. It helps to attain the objectives of accounting.
ii) Complete record of transactions: This system maintains a complete record of all business
transactions.
iii) A check on the accuracy of accounts: By use of this system the accuracy of accounting book can be
established through the device called a Trail balance.
iv) Ascertainment of profit or loss: The profit earned or loss suffered during a period can be ascertained
together with details by the preparation of Profit and Loss Account.
v) Knowledge of the financial position of the business: The financial position of the firm can be
ascertained at the end of each period, through the preparation of balance sheet.
vi) Full details for purposes of control: This system permits accounts to be prepared or kept in as much
detail as necessary and, therefore, affords significant information for purposes of control etc.
vii) Comparative study is possible: Results of one year may be compared with those of the precious year
and reasons for the change may be ascertained.
viii) Helps management in decision making: The management may be also to obtain good information
for its work, especially for making decisions.
ix) No scope for fraud: The firm is saved from frauds and misappropriations since full information about
all assets and liabilities will be available
Journal is a historical record of business transactions or events. The word journal comes from the French
word "Jour" meaning "day". It is a book of original or prime entry written up from the various source
documents. Journal is a primary book for recording the day to day transactions in a chronological order i.e.
in the order in which they occur. The journal is a form of diary for business transactions. This is also called
the book of first entry since every transaction is recorded firstly in the journal. The format of a journal is
shown as follows :
Date Particulars J.F Debit Credit

Rules of Debit and Credit (For recording and journal entry purpose)
The rules of debit and credit are framed on the basis of types of account-
1) Real Account: For real account- Debit what comes in, Credit what goes out
2) Personal Account: For Personal account- Debit the receiver, Credit the giver
3) Nominal Account: For nominal account- Debit all expenses and losses, Credit all income and losses
Illustration 1
From the following transactions, pass journal entries prepare ledger accounts
1. Anil started business with Rs8,000
2. Purchased furniture Rs 1,000
3. Sold goods Rs 7,000
4. Purchased from Raja Rs 4,000
Journal of Anil Business
Date Particulars J.F Debit Credit
Cash A/c 8000
1 To Capital 8000
2 1000
Furniture A/c
To Cash 1000
3 7000
Cash A/c
To Sales 7000
4 4000
Purchase goods
To Raja 4000
Ledger
The mechanics of collecting, assembling and summarizing all transactions of similar nature at one place can
better be served by a book known as 'ledger' i.e. a classified head of accounts.
Ledger is a principal book of accounts of the enterprise. It is rightly called as the 'King of Books'.
Ledger is a set of accounts. Ledger contains the various personal, real and nominal accounts in which all
business transactions of the entity are recorded. The main function of the ledger is to classify and summarise
all the items appearing in Journal and other books of original entry under appropriate head/set of accounts so
that at the end of the accounting period, each account contains the complete information of all transaction
relating to it. A ledger therefore is a collection of accounts and may be defined as a summary statement of all
the transactions relating to a person, asset, expense or income which have taken place during a given period
of time and shows their net effect.
Format of Ledger
Date Particular J.F Amou Date Particular J.F Amou
nt nt
(Dr) (Cr)
Cash Account (Illustration 1)

Date Particular Amount Date Particular Amount
(Dr) (Cr)
To Capital A/c 8000 By Furniture 1000
To Sales A/c 7000 By Purchase A/c 4000
By Balance c/d 10000
15000 15000
To balance b/d 8000
Distinguish between Journal and Ledger

Journal and Ledger are the most useful books kept by a business entity. The points of distinction between the
two are given below:
1. The journal is a book of original entry where as the ledger is the main book of account.
2. In the journal business transactions are recorded as and when they occur i.e. date-wise. However
posting from the journal is done periodically, may be weekly, fortnightly as per the convenience of the
business.
3. The journal does not disclose the complete position of an account. On the other hand, the ledger
indicates the position of each account debit wise or credit wise, as the case may be. In this way, the net
position of each account is known immediately.
4. The record of transactions in the journal is in the form of journal entries whereas the record in the
ledger is in the form of an account.
Trial Balance
When all accounts of the ledger are in balance, A trial Balance is prepared. A Trial Balance is a listing of all the
accounts and their respective balances. Trial balance is a statement of debit balances and credit balance
extracted from ledger accounts on a particular date.
Definition
According to M.S. Gosav “Trail balance is a statement containing the balances of all ledger accounts, as at
any given date, arranged in the form of debit and credit columns placed side by side and prepared with the
object of checking the arithmetical accuracy of ledger postings”.
OBJECTIVES OF PREPARING A TRAIL BALANCE
(i) It gives the balances of all the accounts of the ledger.
(ii) It is a check on the accuracy of posting. If the trail balance agrees, it proves:
(a) That both the aspects of each transaction are recorded and
(b) That the books are arithmetically accurate.
(iii) It facilitates the preparation of profit and loss account and the balance sheet.
(iv) It provide the summarized information of ledger account.
Trial Balance of Illustration -1
Trial Balance
Particulars L.F. Amount
Dr. (Rs.) Cr. (Rs.)
cash 10000
capital 8000
Furniture 1000
Sales 7000
Purchase 4000
Total 15000 15000
UNIT- III
Trading account is prepared for an accounting period to find the trading results or gross margin of the
business i.e., the amount of gross profit the concern has made from buying and selling during the
accounting period. The difference between the sales and cost of sales is gross profit.
Definition of Profit and Loss Account

In the words of Prof. Carter “Profit and loss account is an account into which all gains and losses are
collected in order to ascertain the excess of gains over the losses or vice versa.”
UNIT- III
Preparation of Final Account
There are three steps or stages of preparing final accounts-
1) Trading account (2) Profit and loss account (3) Balance sheet
1) Trading account is prepared for an accounting period to find the overall result of trading i.e.
purchasing and selling of goods. It ascertains the gross profit or gross loss. The difference
between the sales and cost of sales is gross profit.
Gross profit = Net Sales - Cost of goods sold
Net Sales = Sales - Sales return
Cost of goods sold = Opening stock + Net purchase + Direct Expenses – Closing stock
2) Profit and Loss Account

The trading account tells about the gross profit or gross loss made by a businessman on purchasing and
selling of goods. It does not take in to account the other operating expenses incurred by him during the
course of running the business. A businessman is more interested in knowing the net profit earned or net
loss incurred during the years. As such, a Profit & loss account is prepared which contains all the items of
losses and gains pertaining to the accounting period.
In the words of Prof. Carter “Profit and loss account is an account into which all gains and losses are
collected in order to ascertain the excess of gains over the losses or vice versa.”
At the time of preparation of profit & loss account, the following points may be kept in mind-
i) All expenses are debited to Profit and loss account
ii) All incomes are credited to Profit and loss account
Preparation of profit and loss account
Profit and loss account starts with gross profit brought down from trading account on the credit side. (If
gross loss, on the debit side). All the indirect expenses are debited and all the revenue incomes are credited
to the profit and loss account and then net profit or loss is calculated. If incomes or credit is more, than the
expenses or debit, the difference is net profit. On the other hand if the expenses or debit side is more, the
difference is net loss.
The account showing the disposal of profits is known as Profit and Loss Appropriation Account. The
balance on Profit and Loss Account is transferred to this Profit and Loss Appropriation Account. Profits
available for dividend to shareholders are known as divisible profits.
Balance Sheet- Balance sheet reflects the true position of assets and liabilities on a particular date. The
firm makes certain capital expenditure and gets capital receipt. It owns certain assets and also certain
liabilities. These assets and liabilities show the financial position of the firm. The total of assets side should
be equal to total of liabilities side.
Trading Account
Particular Amount Particular Amount
To Opening stock By Sales
To Purchases Less : Return inwards
Less : purchase return Or
To Wages Sales Returns
To Fuel & Power
To Carriage inwards By Closing stock of
To Royalty on production raw material, work-
To Power in-progress finished
To Coal water, Gas goods
To Import duty By Gross loss c/d
To Direct Expenses transferred to profit
To Consumable stores and loss A/c
To Factory expenses (if credit side exceeds
To Gross profit c/d the debit side)
transferred to profit and
loss A/c
(if credit side exceeds the
debit side)
Profit and Loss Account
To Gross Loss b/d * By Gross Profit b/d *
(transferred from profit and (transferred from profit and
loss A/c loss A/c)
To Salaries By Dividends received
To Rent rates & taxes By Interest received
To Printing & Stationery By Discount received
To Postage and Telegrams By commission received
To Telephone expenses By Rent received
To Legal charges By Profit on sale of assets
To Insurance By Sundry revenue receipts
To Audit fees By Net loss (bal.fig)*
To Directors fees
To General expenses
To Showroom expenses
To Advertising
To Commission paid to
salesmen
To Bad-debts
To Provision for doubtful debts
To Go-down rent
To Carriage outward
To Upkeep of delivery vans
To Depreciation
To Interest on borrowings
To Discount allowed
To Loss on sale of assets
To Net profit (bal.fig)
Balance Sheet
Liabilities Amount Assets Amount
Capital Fixed assets

Add: Net profit Goodwill
Add: Interest on capital Land & Buildings
Loose tools
Less: Drawing Furniture & fixtures
Less: Int. on drawings Vehicles
Less: Loss if any Patents Trade
marks
Loan on mortgage Long term loans
Bank loan (advances ) Closing
Sundry creditors stock Sundry
Bills payable debtors Bills
Bank overdraft receivable Prepaid
Creditors for outstanding expenses Accrued
expenses incomes Cash at
Income received in advance bank Cash in hand
Preliminary expenses
Advertisement expenses
Underwriting commission
ILLUSTRATION 1
The following are the balances extracted from the books of Ganesha as on 31-12-1999. Prepare Trading
and Profit and Loss account for the year ending 31-12-1999 and a Balance Sheet as on that date.
Particular Amount
Drawing 4,000
Cash in hand 1,700
Cash at bank 6,500
Capital 20,000
Sales 16,000
Sundry creditors 4,500
Wages 1,000
Purchase 2,000
Stock 1.1.99 6,000
Building 10,000
Sundry debtors 4,400
Bills receivable 2,900
Rent 450
Commission 250
General expenses 800
Furniture 500
The following adjustments are to be made:

(a) Stock on 31-12-99 was Rs 4,000
(b) Interest on Capital at 6% to be provided
(c) Interest on Drawing at 5%to be Charged
(d) Wages yet to be paid Rs 100
(e) Rent prepaid Rs.50
Solution:-
Trading Account
To Opening stock 6,000 By Sales 16,000
To Purchases 2,000 By Closing stock 4,000
To Wages 1,000
Add : Out-standing wages 100 1,100
To Gross profit c/d * 10,900
(transferred to profit and
loss A/c
20,000 20,000
Profit and Loss Account
To Rent rates & taxes 450 By Gross Profit b/d * 10,900
Less : prepaid rent 50 400 (transferred from profit and
To General expenses 800 loss A/c)
To Commission 250 By Interest on Drawing 200
To Interest on capital 1,200 4000*5/100
(20,000*6/100)
To Net profit transferred to capital 8,450
A/c (bal.fig)
11,100 11,100
Balance Sheet
Liabilities Amount Assets Amount
Buildings 10,000
Capital 20,000 Furniture 500
Add: Net profit 8,450 Closing stock 4,000
Add: Interest on Drawing 1,200 Sundry debtors 4,400
29,650 Bills receivable 2,900
Less: Drawing 4,000 Prepaid Rent 50
Less: Int. on drawings 200 Cash at bank 1,700
25,450 Cash in hand 6,500
Sundry creditors 4,500
Outstanding Wages 100
30,050 30,050
Difference between Trading and Profit and Loss Account Trading
Account Profit and Loss Account
1) Trading accounts is prepared of find out the 1) Profit and loss account or income statement
gross profit of the business for the is prepared to find out the net profit/loss of
particular accounting period. the particular accounting period.
2) Trading Account is prepared before the 2) Profit/ Loss Account is prepared after
P&L account the Trading account
3) Under it there is Opening and Closing 3) Under it there is no Opening and Closing
Stock Stock
4) All the Direct Expenses comes under it 4) All the Indirect Expenses comes under it
from Debit side from Debit side
5) All the Direct Income Comes under it 5) All the Indirect Income comes under it
from Credit side from Credit side
6) To get know Gross Profit or Gross Loss of 6) To get know Net profit or Loss of the
the business. business
7) It is a Primary function 7) It is a Secondary function
8) The balance of Trading account will be 8) The balance of profit and loss account
transferred to Profit and loss account will be transferred to Balance Sheet.
Cash Flow Statement
Meaning:- Cash flow statements are statement of changes in financial position of the business due to
inflow and outflow of cash. In other words cash flow statement is inflow and outflow of cash and cash
equivalent. Cash equivalents are short term, highly liquid investments that are convertible into known
amounts of cash and which are subject to an insignificant risk of changes in value.
A cash flow statement discloses net increase or decrease in cash during an accounting period. The change
in the cash position from one period to another is computed by taking in account ‘Sources’ and
‘Applications’ of cash.
It covered by the following activities i.e.
a) Net cash flow from Operating Activities

b) Net cash flow from Investing Activities
c) Net cash flow from Financing Activities
d) Net change in cash and cash equivalents
Operating Activities:- Operating Activities are the principal revenue activities of the enterprise. Cash flow
from these activities result from transactions and other events that enter into the determination of net profit
and loss e.g. Receipts from sale of goods and services, fees, commission, royalty, etc.
Investing Activities:- Under it Purchase and Sale of long-term assets (such as plant, machinery, furniture,
land and building) and other investments not included in cash equivalents.
Financing Activities:- These are the activities that result in changes in the size and composition of the
owner’s capital and borrowings of the enterprise. e.g. cash flow rise due to loan or financing
activities.
Objective of Cash flow Statement
1. To know the specific sources from which cash and cash equivalents were generated by an
organization.
2. To know the specific use for which cash and cash equivalents were used by an
organization.
3. To know the net change in cash and cash equivalents indicating the difference between total
source and total uses between the dates of two balance sheet.
Limitations of cash flow statement
1) Ignores the non-fund transaction:- it means, it does not take into consideration those transaction
which do not affect the cash e.g., issue of share against the purchase of fixed assets
2) Secondary Data Based Statement:- It is a secondary data based statement. It merely rearranges the
primary data already appearing in other statement e.g., Income and Statement and Balance Sheet.
3) Historical Statement:- It is basically historical in nature unless projected cash flow statements are
prepared to plan for the future.
Difference between Fund Flow Statement and Cash Flow
Statement
Basis of Distinction Fund Flow Statement Cash Flow Statement

Disclosure It discloses
It discloses the magnitude, direction the magnitude,
direction and the causes of
and the causes of changes in working
capital changes in cash and cash
equivalents
Components of It include all the components of It includes the cash and cash
working capital working capital equivalents only. Which is just
one of the components of
working capital
Basis of Accounting Funds From Operation work on Cash From Operation work on
accrual accounting cash accounting
Usefulness It is useful for the long-range It is useful for short-range
financial planning financial planning
Scope of The management may The management cannot
Manipulation ( manipulate the net change in working manipulate the cash flows so easily
changes) capital and the figure of funds from
operations by applying the method of
inventory valuation which is most
suitable to it.
Use of Cash Flow Statement
1) As a tool of historical analysis, it provides an answer to some of the

important financial questions
2) As a tool of planning, the projected cash flow statement enables the
management to plan its future investments
3) It enables the management to identify the directions of changes in cash
4) It enables the users to evaluate the changes in net assets of an organization
5) It provides information about cash flow from investing and financing transactions
6) It is useful in checking the accuracy of post assessment of future cash flows.
Numerical of Cash Flow Statement
Balance Sheet
Liabilities 2020 2019 Assets 2020 2019
Equity Share Capital 1000,000 800000 Plant & Machinery 700000 500000
Land & Building
Reserve 20,0000 15,0000 600000 400000
Profit & Loss A/c 100000 60000 Investment 100000 -
Debentures 200000 - Debtors 500000 700000
Creditors 700000 820000 Stock 400000 200000
Provision for tax 100000 70000 Cash on hand 200000 200000
Proposed Dividend 200000 100000
2500000 2000000 2500000 2000000

(i) Depreciation @ 25% was charged on the opening value of Plant & Machinery.
(ii) During the year one old machine costing 50000(WDV 20000) was sold for Rs. 35000.
(iii) Rs. 50000 was paid towards income tax during the year.
(iv) Building under construction was not subject to any depreciation.
Prepare Cash Flow Statetment.

Cash Flow Statement for the year ended 31st December 2020
Particular Rs. Rs.
(A) Cash flow from operating Activities
Net Profit before Tax and Extra ordinary items 320000
Adjustment for:
Add: Transfer to General Reserve 50000
Add: Depreciation 125000
Less: Profit on sale of Plant and Machinery -15000
Operating Profit before working capital change 480000
Less: Increase in stock 200000
Add: Decrease in Debtors 200000
Less: Decrease in Creditors 120000
Cash Generated from Operations 360000
Less:- Income tax paid 50000
310000
Net cash provided by Operating Activities
(B) Cash Flow from Investing Activities-
Less: Purchase of Fixed Assts 345000
Less: Expenses on Building 200000
Less: Increase in Investment 100000
Add: Sale of old machine 35000
Net Cash used in Investing Activities (Less) 610000
(C) Cash Flow from Financial Activities-
Add: Proceeds from Issue of Shares 200000
Add: Proceeds from Issue of debentures 200000
Less: Dividend Paid 100000
Net Cash provided by Financial Activities 300000
Net increase in cash and cash equivalents (A+B+C) NIL
Cash and cash equivalents at the beginning of the year 200000
Cash and cash equivalents at the end of the year 200000
Working note:-
Provision for Taxation Accounts
Rs. Rs.
Bank (paid) 50000 Balance b/d 70000
Balance c/d 100000 P&L A/C (B.F.) 80000
150000 150000
Plant & Machinery Accounts

Rs. Rs.
Balance b/d 500000 Depreciation 125000
Bank (B.F.) 345000 Bank (Sale) 80000
Balance c/d 700000
845000 845000
Unit-IV
Ratio Analysis
Ratio Analysis: -Ratio Analysis is a very important tool of financing analysis. It

is the process of identifying the financial strengths and weakness of the
organization by logically establishing relationship between the items of balance
sheet or income statement or both interpreting the results there of in order to
derive meaningful conclusions.
It describes the significant relationship which exists between various items of
a balance sheet and a statement of profit and loss of a firm. As a technique of
financial analysis, accounting ratios measure the comparative significance of the
individual items of the income and position statements. It is possible to assess the
profitability, solvency and efficiency of an enterprise through the technique of ratio
analysis.
Definition-
1) R.N. Anthony- Relationship between two figures expressed in arithmetical
terms is called ratio.
It is a simply one number expressed in terms of another. It is found by dividing one
number in to other.
Objective of Ratio Analysis

1. To know the areas of the business which need more attention
2. To know about the potential areas which can be improved with the effort in the
desired direction?
3. To provide a deeper analysis of the profitability, liquidity, solvency and efficiency
levels in the business;
4. To provide information for making cross section a analysis by comparing the
performance with the best industry standards.
5. To provide information derived from financial statements useful for making
projections and estimates for the future.
Advantages of Ratio Analysis

1. Helps to understand efficacy of decisions
2. Simplify complex figures and establish relationships
3. Helpful in comparative analysis
4. Identification of problem areas
5. Enables SWOT analysis
6. Various comparisons
Limitations of Ratio Analysis

1. Limitations of Accounting Data
2. Ignores Price-level Changes
3. Ignore Qualitative or Non-monetary Aspects
4. Variations in Accounting Practices
5. Forecasting
Classification of Ratios
Ratio may be classified in to the four categories as follows:
i) Liquidity Ratio
ii) Solvency Ratio
iii) Profitability Ratio or Income Ratio
iv) Activity or Turnover Ratio
(1) Liquidity Ratios- A firm has assets and liabilities to its name. Some are fixed in nature
and then there are current assets and current liabilities. These are short-term in nature and
easily convertible into cash. The liquidity ratios deal with the relationship between such
current assets and current liabilities.
Liquidity ratios evaluate the firm’s ability to pay its short-term liabilities, i.e. current
liabilities. It shows the liquidity levels, i.e. how many of their assets can be quickly converted
to cash to pay off their obligations when they become due.
(i) Current Ratio - The current ratio is also known as the working capital ratio. It will
measure the relationship between current assets and current liabilities. It measures the firm’s
ability to pay for all its current liabilities, due within the next one year by selling off all their
current assets. The formula for is as follows
Current Ratio = Current Assets/Current Liabilities
Current Assets include,
 Stock
 Debtors
 Cash and Bank Balances
 Bills receivable
 Accruals
 Short term loans that are given
 Short term Securities
Current Liabilities include
 Creditors
 Outstanding Expenses
 Short Term Loans that are taken
 Bank Overdrafts
 Provision for taxation
 Proposed Dividend
The ideal current ratio, according to the industry standard is 2:1.
(ii) Quick Ratio–It is also known as a liquid ratio or acid test ratio. This ratio will measure a
firm’s ability to pay off its current liabilities (minus a few) with only selling off their quick
assets.
Now Quick assets are those which can be easily converted to cash with only 90 days’ notice.
Not all current assets are quick assets.
Quick assets generally include cash, cash equivalents, and marketable securities. The
formula is
Quick Ratio = Quick Assets / (Current Liabilities/Quick Liabilities)
Quick Assets = All Current Assets – Stock – Prepaid Expenses
Quick Liabilities = All Current Liabilities – Bank Overdraft – Cash Credit
The ideal quick ratio is considered to be 1:1,
(2) Solvency Ratios- Solvency Ratios also known as leverage ratios determine an entity’s
ability to service its debt. So these ratios calculate if the company can meet its long-term
debt. It is important since the investors would like to know about the solvency of the firm to
meet their interest payments and to ensure that their investments are safe. Hence solvency
ratios compare the levels of debt with equity, fixed assets, earnings of the company etc.
Liquidity ratios compare current assets with current liabilities, i.e. short-term debt. Whereas
solvency ratios analyze the ability to pay long-term debt.
i) Debt to Equity Ratio

The debt to equity ratio measures the relationship between long-term debt of a firm and its
total equity. Since both these figures are obtained from the balance sheet itself, this is a
balance sheet ratio. Let us take a look at the formula:
Debt to Equity Ratio = Long term Debt / Shareholders Fund
Long term Debt = Debentures + Long term loans
Shareholders Fund = Equity Share Capital + Preference Share Capital + Reserves –
Fictitious Assets
The debt-equity ratio holds a lot of significance. Firstly it is a great way for the company to
measure its leverage or indebtedness. A low ratio means the firm is more financially secure,
but it also means that the equity is diluted.
The maximum a company should maintain is the ratio of 2:1, i.e. twice the amount of debt to
equity.
ii) Debt Ratio- This ratio measures the long-term debt of a firm in comparison to its total
capital employed. Alternatively, instead of capital employed, we can use net fixed assets. So
the debt ratio will measure the liabilities (long-term) of a firm as a percent of its long-term
assets. The formula is as follows:
Debt Ratio = Long Term Debt / Capital Employed

OR
Debt Ratio = Long term Debt / Net Assets
Capital Employed = Long Term Debt + Shareholders Fund
Net Assets = Non Fictitious Assets – Current Liabilities
This is one of the more important solvency ratios. It indicates the financial leverage of the
firm. A low ratio points to a more financially stable business, better for the creditors. A
higher ratio points to doubts about the firm’s long-term financial stability. But a higher ratio
helps the management with trading on equity, i.e. earn more income for the shareholders.
Again there is no industry standard for this ratio.
iii) Proprietary Ratio - The third of the solvency ratios is the proprietary ratio or equity
ratio. It expresses the relationship between the proprietor’s funds, i.e. the funds of all the
shareholders and the capital employed or the net assets. Like the debt ratio shows us the
comparison between debt and capital, this ratio shows the comparison between owner’s funds
and total capital or net assets. The ratio is as follows:
Shareholders Fund Equity
Proprietary Ratio = Total tangible assets OR Total Asets
A high ratio is a good indication of the financial health of the firm. It means that a larger
portion of the total capital comes from equity. Or that a larger portion of net assets is financed
by equity rather than debt. One point to note, that when both ratios are calculated with the
same denominator, the sum of debt ratio and the proprietary ratio will be 1.
iv) Interest Coverage Ratio - All debt has a cost, which we normally term as an interest.
Debentures, loans, deposits etc. all have an interest cost. This ratio will measure the security
of this interest payable on long-term debt. It is the ratio between the profits of a firm available
and the interest payable on debt instruments. The formula is:
3) Profitability Ratios
Profitability ratios are both revenue statement ratios and balance sheet ratios. They
compare the revenue of a firm to different types of expense accounts within the Profit and
Loss Statement. And then some profitability ratios also compare revenue to aspects of the
balance sheet such as assets and equity.
There are a variety of profitability ratios calculated with the help of the Income Statement
and the Balance Sheet.
i) Gross Profit Ratio- This ratio simply compares the gross profit of a company to its net
sales. Both of these figures are obtained from the Income Statement. The ratio is also known
as Margin ratio or the Rate of Gross Profit. The ratio is represented as a percentage of
sales.
This ratio basically signifies the basic profitability of the firm. The formula is
Gross Profit Ratio = (Gross Profits/Net Revenue from Operations or Net Sales) × 100
Gross Profit = Revenue from Operations – Cost of Revenue from Operations
Cost of Revenue from Operations = opening stock + Net Purchases + Direct Expenses
+ Closing stock
Net Sales = Sales – Sale Returns
Gross Profit = Sales – Cost of Sales
ii) Operating Ratio

This ratio measures the equation between the cost of operating activities and the net sales, or
revenue from operations. This ratio expresses the cost of goods sold as a percentage of the net
sales.
Operating ratio also takes into account operating expenses such as administration and office
expenses, selling and distribution costs, salaries paid, depreciation expenses etc. Also, it
ignores the non-operating incomes such as interests, commissions, dividends etc.
Operating Ratio = (COGS + Operating Expenses/Net Revenue from Operations) × 100
COGS = opening stock + Net Purchases + Direct Expenses + Closing stock
There is no standard ratio, but a trend analysis must be done on year on year basis to check
the progress of the firm.
iii) Net Profit Ratio - Unlike the operating ratio, the net profit ratio includes the total
revenue of the firm. It takes into account both the operating income as well as the non-
operating income. Then it compares net profit to these incomes. This ratio too is represented
as a percentage. The formula for Net Profit ratio is,
Net Profit Ratio = (Net Profit/Net Revenue) × 100
Net Profit = Net Profit after Tax (NPAT)
This ratio helps measure the overall profitability of the firm. It indicates the portion of the net
revenue that is available to the proprietors. It also reflects on the efficiency of the business
and is a very important ratio for investors and financiers.
iv) Return on Capital Employed (Return on Investment (ROI)-

This ratio is one of the important ones of the profitability ratios. It measures the overall
efficiency of the utilization of the firm’s funds. The ratio explores the relationship between
the total income/profit earned by a firm and the total capital employed by the firm, or the total
investment made. The formula is as follows,
Return on Capital Employed = (PBIT/Capital Employed) × 100
Capital Employed = Shareholder’s Fund + Non Current Liabilities
Capital employed = Non Current Assets + Working Capital (Assets Approach)
Working Capital = Current Assets – Current Liabilities
PBIT = Profit Before Income and Tax
This ratio measures the efficiency with which the capital is being utilized and it indicates the
productivity of the capital employed. It is a good tool to measure the overall profitability of
the firm as well.
v) Return on Equity (ROI)- This ratio indicates how well the firm has used the resources of
owner’s. The ratio is calculated to see the profitability of owners’ investment.
ROI = Profit after taxes / Net worth
vi) Earnings Per Share
This ratio represents the profit or the earnings of a company in the context of one share. It
represents the earnings of a firm whether or not dividends were actually declared on such
shares. The formula for this ratio is
Earnings Per Share (EPS) = (Profit available to Equity Shareholders/Number of equity
Shareholders) × 100
Profit available to Equity Shareholders = NPAT – Preference Dividend
This is an important ratio for the shareholders, it helps them decide whether to hold onto the
shares or sell them. It also is a good indicator of the dividends to be declared and/or bonus
issues.
4) Activity Ratios
These ratios basically measure the efficiency with which assets are being utilized or
managed. This is why they are also known as productivity ratio, efficiency ratio or more
famously as turnover ratios.
These ratios show the relationship between sales and any given asset. It will indicate the ratio
between how much a company has invested in one particular type of group of assets and the
revenue such asset is producing for the company.
The following are the different kinds of activity ratios that measure the effectiveness of the
funds invested and the efficiency of their performance
 Stock Turnover Ratio
 Debtors Turnover Ratio
 Creditors Turnover Ratio
 Stock to Working Capital Ratio
i) Stock Turnover Ratio
One of the most important of the activity ratios is the stock turnover ratio. This ratio focuses
on the relationship between the cost of goods sold and average stock. So it is also known as
Inventory Turnover Ratio or Stock Velocity Ratio.
It basically counts the number of times a stock rotates (completes a cycle) in one given
accounting period and the sales it effects in the same period. So it calculates the speed with
which the company converts stock (lying about) to sales, i.e. revenue. The formula for the
ratio is as follows,
Quick Ratio = COGS / Average Stock
COGS = Sales – Gross Profit
Average Stock = (Opening Stock + Closing Stock)/2
ii) Debtors Turnover Ratio

This ratio measures the efficiency with which Accounts Receivable are being managed,
hence it is also known as ‘Accounts Receivable Turnover ratio’. The ratio shows the equation
between credit sales (cash sales are not taken into consideration) and the average debtors of a
firm. The formula is as below
Debtors Turnover ratio = Credit Sales/Average Debtors OR
Debtors Turnover ratio = Credit Sales/Debtors + Bills Receivable
And with a slight modification, we also derive the average collection period. This will
indicate the average number of days/weeks/months in which the payment from the debtor is
collected by a firm. The formula for this formula is as below,
Average Collection Period = (Number of days/weeks/months)/Debtors T/O Ratio
Both of these ratios are significant in managing the debtors and bills receivables of a
company. Not only do they calculate the velocity with which debtors pay up, they help shape
the credit policy of the firm as well.
iii) Creditors Turnover Ratio

This ratio shows the relation between credit purchases (cash purchases are ignored in this
context) and the average creditors of a company at any given time of the accounting year.
This ratio is also the ‘accounts payable turnover ratio’. While calculating the net purchases
we will minus any purchase return. The formula is as below,
Creditors Turnover ratio = Credit Purchases/Average Creditors OR
Creditors Turnover ratio = Credit Purchases / (Creditors+ Bills Payable)
Average Creditors = (Opening Creditors + Closing Creditors)/2
Average Payment Period = (Number of days/weeks/months)/ (Creditors T/O Ratio)
Again creditor’s turnover ratio has great importance. It calculates the velocity with which
creditors are paid off during the year. It helps the management judge how efficiently the
accounts payables are being handled.
iv) Working Capital Turnover Ratio

This one of the activity ratios will measure the efficiency with which the firm is using their
Working Capital to support their sale volumes. So any excess of current assets over the
current liabilities of a firm is their working capital. The formula for the ratio is
Working Capital Turnover ratio = Total Sales / Working Capital
Working Capital = Current Assets – Current Liabilities
A high Working Capital Turnover ratio means that the working capital is being very
efficiently utilized. But sometimes it could mean that the creditors of the company are
excessive (bringing down the working capital) and this could be a problem in the future.
Conversely, a low ratio could mean that there are too many debtors or a very big inventory
which is not an efficient use of resources.
CONCEPT AND TYPES OF LEVERAGES

The dictionary meaning of the term leverage refers to: an increased means for
accomplishing some purpose”. It helps us in lifting heavy objects by the
magnification of force when a lever is applied to a function.
James Horne has defined leverage as the employment of an asset or funds for
which the firm pays a fixed cost or fixed return.
Christy and Roder defines leverage as the tendency for profits to change a faster
rate than sales.
A few essential characteristics of leverage are as follows:
A) Leverage is applied to the employment of an asset or funds.
B) Profits tend to change at a faster rate than sales.
C) There is risk return relationship which is basically found in the same
direction.
D) If higher is the leverage, higher will be the risk and higher will be the
expected returns.
A brief review of various types of leverage is as follows:

1) Operating Leverage is related to fixed cost. It indicates the impact of changes in
sales on operating income. It is calculated as follows:
Operating leverage=Contribution/ EBIT
Degree of Operating Leverage = Percentage change in EBIT/Percentage
change in Sales
Operating Leverage takes place when a change in revenue produces a greater

change in EBIT. It is related to fixed costs. A firm with relatively high fixed
costs uses much of its marginal contribution to cover fixed costs.
2) Financial Leverage depends upon the ratio of debt and preferred stock together
to common shares. It is calculated with the help of EBIT and EBT as below:
Financial Leverage=EBIT /EBT
Degree of Financial Leverage = Percentage change in EBT/Percentage
change in EBIT
Alternative formula:-
Degree of Financial Leverage = Percentage change in
EPS/Percentage change in EBT
Financial Leverage refers to usage of debt in capital structure. It is the use of
fixed cost capital (debt) in the total capitalization of the firm. Fixed cost capital
includes loans, debentures and preferences share capital.
3) Combined Leverage is the multiplication of operating leverage and financial

leverage. Both operating and financial leverage magnify the returns. There is combined
effect of these leverages on income. Both the leverages are closely concerned with the
firm's capacity to meet its fixed costs (both operating and financial). In case both the
leverages are combined, the result obtained will disclose the effect of change in sales
over change taxable profit.
Composite Leverage = Operating Leverage * Financial
Leverage Contribution It may be expressed as
=Contribution/EBT
The degree of combined leverage is computed in the following manner:
Degree of Combined leverage = Percentage change in

EPS /Percentage change in Sales Volume
Market Capitalization Ratios
Capitalization ratio describes to investors the extent to which a company is using debt to
fund its business and expansion plans. Generally, debt is considered riskier than equity (from
company’s point of view). Hence the higher the ratio, the riskier the company is. Companies
with higher capitalization ratio run higher risk of insolvency or bankruptcy in case they are
not able to repay the debt as per the predetermined schedule. However, higher debt on the
books could also be earnings accretive if the business is growing in a profitable manner
(more on this in the analysis section).
Formula
The capitalization ratio formula is calculated by dividing total debt into total debt plus
shareholders’ equity. Here’s an example:
Total Debt to Capitalization = Total Debt / (Total Debt + Shareholders’ Equity)

You can also calculate the capitalization ratio equation by dividing the total debt by the
shareholders’ equity.
Debt-Equity ratio = Total Debt / Shareholders’ Equity

Total debt refers to both long-term and short-term debts of a company
Shareholder’s equity refers to the book value of equity investment made by the investors
The debt-to-equity investment is calculated by simply dividing the two values. For total
debt to cap ratio, we simply divide total debt with the sum or equity and debt (i.e. the total
capital of a company)
UNIT-5
Financial Statement Analysis and Recent Type of Accounting
There are two main types of presenting information of financial statements,
which are:
Comparative Financial Statement
Common size Financial Statement
Comparative financial statement is a document that represents the financial
performance of the business by comparing them at different time periods. It is
helpful for investors to analyse the trends of the business and make proper
investment decisions.
Common size statements are financial statements that are expressed in the form
of percentage. The assets, liabilities and sales all are presented in the form of
percentages. This method analyses financial statements by taking into
consideration each of the line items as a percentage of the base amount, for that
particular accounting period.
Difference between the comparative and common size financial statements
Comparative Financial Statement Common size Financial Statement
Definition
Comparative financial statement is a Common size financial statement is a

kind of document that presents the way of presenting financial
financial performance of the information of a business by
organizations side by side with the expressing the components of financial
previous year performances, in order to statements as percentages.
compare the growth of business over a
period of time
Type of analysis
Comparative statements are also Common size statements are also

known as horizontal analysis as known as vertical analysis as data is
financial statements are compared side analyzed vertically.
by side.
Purpose
Comparative statements are used for Common size statements are prepared
comparingfinancialperformanceforinte for the reference of stakeholders.
rnalpurposesandforinter-
firmcomparison
Types of comparison made
Comparative statements make use of Common size statements use

both absolute figures and percentages. only percentage form.
Trend Analysis
The financial statements may be analyzed by computing trends of series of information.
Trend analysis determines the direction upwards or downwards and involves the
computation of the percentage relationship that each item bears to the same item in the
base year. In case of comparative statement, an item is compared with itself in the
previous year to know whether it has increased or decreased or remained constant.
Common size analysis is to ascertain whether the proportion of an item (say cost of
revenue from operations) is increasing or decreasing in the common base (say revenue
from operations). But in case of trend analysis, we learn about the behavior of the same
item over a given period, say, during the last 5 years. Take for example, administrative
expenses, whether they are exhibiting increasing tendency or decreasing tendency or
remaining constant over the period of comparison. Generally trend analysis is done for a
reasonably long period. Many companies present their financial data for a period of 5 or
10 years in various forms in their annual reports.
Calculation of Trend Percentage

Trend Percentage = (Present year value / Base year value) * 100
Meaning of Human Resources Accounting

Human resources are considered as important assets and are different from the
physical assets. Physical assets do not have feelings and emotions, whereas
human assets are subjected to various types of feelings and emotions. In the same
way, unlike physical assets human assets never get depreciated.
Therefore, the valuations of human resources along with other assets are also
required in order to find out the total cost of an organization. In 1960s, Rensis
Likert along with other social researchers made an attempt to define the concept
of human resource accounting (HRA).
Definition:
The American Association of Accountants (AAA) defines HRA as follows:
‘HRA is
aprocessofidentifyingandmeasuringdataabouthumanresourcesandcommunicating
this information to interested parties’.
Objectives of HRA:
1) Providing cost value information about acquiring, developing, allocating

and maintaining human resources.
2) Enabling management to monitor the use of human resources.
3) Finding depreciation or appreciation among human resources.
4) Assistingindevelopingeffectivemanagementpractices.
5) Increasingmanagerialawarenessofthevalueofhumanresources.
6) For better human resource planning.
7) For better decisions about people, based on improved information system.
8) Assisting in effective utilization of manpower.
Benefits of HRA:
1) The system of HRA discloses the value of human resources, which helps
in proper interpretation of return on capital employed.
2) Managerial decision-making can be improved with the help of HRA.
3) The implementation of human resource accounting clearly identifies
human resources as valuable assets, which helps in preventing misuse of
human resources by the superiors as well as the management.
4) It helps in efficient utilization of human resources and understanding the
evil effects of labour unrest on the quality of human resources.
5) This system can increase productivity because the human talent, devotion,
and skills are considered valuable assets, which can boost the morale of
the employees.
6) It can assist the management for implementing best methods of wages and
salary administration.
Limitations of HRA:
1) The valuation methods have certain disadvantages as well as advantages;
therefore, there is always a bone of contention among the firms that which
method is an idea lone.
2) There are no standardized procedures developed so far. So, firms are
providing only as additional information.
3) Under conventional accounting, certain standards are accepted commonly,
which is not possible under this method.
4) All the methods of accounting for human assets are based on certain
assumptions, which can go wrong at any time. For example, it is assumed
that all workers continue to work with the same organization till
retirement, which is far from possible.
5) It is believed that human resources do not suffer depreciation, and in fact
they always appreciate which can also prove otherwise in certain firms.
6) The lifespan of human resource s cannot be estimated. So, the valuation
seems to be unrealistic.
Forensic Accounting
A Forensic Accountant is often retained to analyze, interpret, summarize and

present complex financial and business related issues in a manner which is both
understandable and properly supported. Forensic Accountants can be engaged in
public practice or employed by insurance companies, banks, police forces,
government agencies and other organizations.
A Forensic Accountant is often involved in the following:
i) Investigating and analyzing financial evidence;
ii) Developing computerized applications to assist in the
analysis and presentation of financial evidence;
iii) Communicating their findings in the form of reports, exhibits and
collections of documents; and
iv) Assisting in legal proceedings, including testifying in court as an expert
witness and preparing visual aids to support trial evidence.
In order to properly perform these services a Forensic Accountant must be
familiar with legal concepts and procedures. In addition, a Forensic Accountant
must be able to identify substance over form when dealing with an issue.
Forensic accounting utilizes accounting, auditing and investigative skills to

conduct an examination into a company's financial statements. Thus, forensic
accounting provides an accounting analysis suitable for court. Forensic
accountants are trained to look beyond the numbers and deal with the business
reality of a situation. They are frequently used in fraud cases.
A forensic accountant may be asked to quantify the economic damages arising

fromavehicleaccidentoracaseofmedicalmalpractice.Theaccountantmustbeknowle
dgeableaboutthelegislativeprocessrelatingtothesecases.Forensicaccounting
encompasses the review of insurance policies to determine coverage issues and
methods of calculating potential losses. Forensic accounting may be utilized for
either the insured or insurer’s case.
What do you mean by Corporate Social Responsibility?
Corporate Social Responsibility means various social activities carried out by

medium to big sized corporate houses, businesses and MNCs for the benefit of
under-privileged sections of society.
As per the Companies Act 2013, Corporate Social Responsibility is a set of
mandatory guidelines, which a company must follow.
Which company need to constitute a Corporate Social Responsibility
Committee
If a company satisfied any of the following condition during any financial year
shall constitute a Corporate Social Responsibility Committee of the Board
consisting of three or more directors, out of which at least one director shall be
an independent director.
The conditions are as follows:
i) Net worth of Rs500 crore or more,
ii) Turnover of Rs1000 crore or more
iii) Net profit of Rs5 crore or more
Minimum amount of expenditure on Corporate Social Responsibility
The board shall ensure that the company spends, in every financial year at least
2% of the average net profits of the company made during the three immediately
preceding financial years, in pursuance of its corporate social responsibility
policy.
What activities should be included by companies in their Corporate Social

Responsibility?
i) Encouraging education under poor sections of society.
ii) Promoting gender equality.
iii) Promoting women empowerment.
iv) Eradicating extreme hunger and poverty.
v) Reducing child mortality and improving maternal health.
vi) Combating human immunodeficiency virus, acquired immune
deficiency syndrome, malaria and other diseases.
vii) Ensuring environmental sustainability.
viii) Employment enhancing vocational skills.
ix) Social business projects.
x) Contribution to Prime Minister’s National Relief Fund
Accounting treatment of Corporate Social Responsibility expenditure

Schedule VII to the company’s bill, 2013 specifies a list of CSR activities. The
accounting of CSR activities will be done asunder:
i) In case a contribution is made to a fund specified in Schedule VII to the
Act, the same would be treated as an expense for they earned charged
to the statement of profit and loss.
ii) In case the company incurs any expenditure on any of the activities as
per schedule VII on its own, the company needs to analysis the nature
of the expenditure keeping in mind the “Framework for Preparation and
Presentation of Financial Statements issued by ICAI.
iii) In case the company incurs any expenditure on any of the activities as
per schedule VII is of revenue nature, the same should be charged as an
expense to the statement of profit or loss.
iv) In case the company incurs any expenditure which gives rise to an
asset, the company need to analysis whether the expenditure qualifies
the definition of the term asset as per the Framework i.e. whether it has
control over the asset and derives future economic benefits from it.
Tool of Financial Analysis

i) Comparative Financial and operating statements
ii) Trend Analysis
iii) Common Size Statements
iv) Average Analysis
v) Ratio Analysis
vi) Statements of change in working capital
vii) Fund-flow and Cash flow analysis
What Is the Financial Services Sector?
The financial services sector provides financial services to people and corporations. This
segment of the economy is made up of a variety of financial firms including banks,
investment houses, lenders, finance companies, real estate brokers, and insurance companies.
As noted above, the financial services industry is probably the most important sector of the
economy, leading the world in terms of earnings and equity market capitalization.
According to the finance and development department of the International Monetary Fund
(IMF), financial services are the processes by which consumers or businesses acquire
financial goods. For example, a payment system provider offers a financial service when it
accepts and transfers funds between payers and recipients. This includes accounts settled
through credit and debit cards, checks, and electronic funds transfers.
A strong financial services sector can lead to economic growth while a failing
system can drag down nation's economy.
Banking Services
The banking industry is the foundation of the financial services group. It is most concerned
with direct saving and lending, while the financial services sector incorporates investments,
insurance, there distribution of risk, and other financial activities. Banking services are
provided by large commercial banks, community banks, credit unions, and other entities.
Banking Segments
Banking is made up of several segments—retail banking, commercial banking, and
investment banking. Also known as consumer or personal banking, retail banking serves
consumers rather than corporations. These banks offer financial services tailored to
individuals including checking and savings accounts, mortgages, loans and credit cards, as
well as certain investment services.
Q1 From the following information, prepare a comparative statement of profit
and loss for the year
Other Information
1) Income tax is calculated @ 50%.
2) Manufacturing expenses are 50% of the total of that category.

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FINANCIAL ACCOUNTING AND ANALYSIS

2) Classifying: It Is concerned with the systematic analysis of the recorded data so as

3) Summarizing: It is concerned with the preparation and presentation of the classified

5) Interpreting: The accountants should interpret the statements in a manner useful to

1) It helps in having complete record of business transactions.

Accounting Concepts And Conventions

Assets = Liabilities + Capital (Shareholder’s Equity)

Assets: Cash, Accounts Receivable, Inventory, Machinery etc.

Solution-1) Machinery Account

Solution- Written Down Method

INDIAN ACCOUNTING STANDARD (IND AS)

ACCOUNTING STANDARDS ISSUED BY ASB

In short Accounting Standards can be thought of as a system of measurements and disclosure.

International Accounting Principles and Standards

Moving Toward New Global Accounting Standards

Matching of Indian Accounting Standards with International Accounting Standards

Steps involved in Double entry system

Advantages of Double Entry System

Date Particulars J.F Debit Credit

Cash Account (Illustration 1)

Distinguish between Journal and Ledger

Definition of Profit and Loss Account

2) Profit and Loss Account

Capital Fixed assets

The following adjustments are to be made:

Difference between Trading and Profit and Loss Account Trading

Account Profit and Loss Account

a) Net cash flow from Operating Activities

Limitations of cash flow statement

Basis of Distinction Fund Flow Statement Cash Flow Statement

Use of Cash Flow Statement

1) As a tool of historical analysis, it provides an answer to some of the

Numerical of Cash Flow Statement

2500000 2000000 2500000 2000000

Prepare Cash Flow Statetment.

Plant & Machinery Accounts

Ratio Analysis: -Ratio Analysis is a very important tool of financing analysis. It

Objective of Ratio Analysis

Advantages of Ratio Analysis

Limitations of Ratio Analysis

i) Debt to Equity Ratio

Debt Ratio = Long Term Debt / Capital Employed

ii) Operating Ratio

iv) Return on Capital Employed (Return on Investment (ROI)-

ii) Debtors Turnover Ratio

iii) Creditors Turnover Ratio

iv) Working Capital Turnover Ratio

CONCEPT AND TYPES OF LEVERAGES

A brief review of various types of leverage is as follows:

Operating Leverage takes place when a change in revenue produces a greater

3) Combined Leverage is the multiplication of operating leverage and financial

Degree of Combined leverage = Percentage change in

Total Debt to Capitalization = Total Debt / (Total Debt + Shareholders’ Equity)

Debt-Equity ratio = Total Debt / Shareholders’ Equity

Comparative financial statement is a Common size financial statement is a

Comparative statements are also Common size statements are also

Types of comparison made

Comparative statements make use of Common size statements use

Calculation of Trend Percentage

Meaning of Human Resources Accounting

1) Providing cost value information about acquiring, developing, allocating

A Forensic Accountant is often retained to analyze, interpret, summarize and

Forensic accounting utilizes accounting, auditing and investigative skills to