Financial Statements:

Basic Concepts: I
 What is the Importance of
Accounting for us
• Accounting is the Language of Business
• Used to measure the performance of an
organization
• Provides useful information for decision
making.
• Useful tool of management control
 Branches of Accounting
• External Accounting:
– FINANCIAL ACCOUNTING

• Internal Accounting
– COST ACCOUNTING
 Financial Statements
• Balance Sheet
• Profit and Loss Account/ Income Statement
• Cash-flow Statement
• Statement of Changes in Equity
 My Balance Sheet
• Money Measurement Concept:
– All the assets and liabilities are measured in terms
of Money.
– Only those assets and liabilities are included in the
balance sheet which are measurable in monetary
terms.
I want to purchase a new car and I approach to my bank for a car
loan; most probably, the bank will be interested to know about
my financial standing – what I own and what I owe. Bank asks
me to submit a statement of my assets and liabilities. I sit to
prepare the statement. My assets are:
•A house at my home town. I bought this house five years back
taking a loan of Rs. 20 lakh from the bank. The construction cost
of the house was Rs. 25 lakh.
•Gold Jewellery worth of Rs. 500000.
•Bank Saving Account Rs. 25,280
•Bank FD Rs. 80,000
•PF Account Rs. 2,40,320
•Some household appliances worth Rs. 150000.
 My Balance Sheet
My assets and Liabilities on 1st July 20XX
Liabilities Amount (Rs) Assets Amount (Rs)

Loan 2000000 House 2500000

Net worth 1495600 Gold 500000
Bank Savings A/c 25280
Bank FD 80000
PF 240320
Household appliances 150000

Total Liabilities 3495600 Total Assets 3495600

 I had
purchased it
My Balance Sheet for Rs. 25
lakh
My assets and Liabilities on 1st July 20XX
Liabilities Amount Assets Amount
(Rs) (Rs)
House 25,00,000?
 One of my friend
says the value of
similar house in this
My Balance Sheet locality is Rs. 30Lakh

My assets and Liabilities on 1st July 20XX

Liabilities Amount Assets Amount
(Rs) (Rs)
House 30,00,000?
 My another friend
says it can fetch Rs.
35Lakh
My Balance Sheet
My assets and Liabilities on 1st July 20XX
Liabilities Amount Assets Amount
(Rs) (Rs)
House 35,00,000?
 Historical Cost Concept

• Why do we go for historical cost:

– Concept of “Going Concern”
– Objectivity
 My Balance Sheet

My assets and Liabilities on 1st July 20XX

Liabilities Amount Assets Amount

(Rs) (Rs)
House 25,00,000
I want to purchase a new car and I approach to my bank for a car
loan; most probably, the bank will be interested to know about
my financial standing – what I own and what I owe. Bank asks
me to submit a statement of my assets and liabilities. I sit to
prepare the statement. My assets are:
•A house at my home town. I bought this house five years back
taking a loan of Rs. 20 lakh from the bank. The construction cost
of the house was Rs. 25 lakh.
•Gold Jewellery worth of Rs. 500000.
•Bank Saving Account Rs. 25,280
•Bank FD Rs. 80,000
•PF Account Rs. 2,40,320
•Some household appliances worth Rs. 150000.
 My Balance Sheet
My assets and Liabilities 1st July 20XX

Liabilities Amount Assets Amount

(Rs) (Rs)
House 25,00,000
Jewellery 5,00,000
PF Account 2,40,320
Bank FD 80,000
Saving Account 25,280
Household Appliances 1,50,000

34,95,600
Now I think about my liabilities. I have no dues
regarding the loans I had ever taken from my friends.
Yes, the monthly installments of the loan I had taken to
purchase the house are directly deducted from my salary
account in the bank. The statement that I got from the
bank a few days back shows a balance of Rs. 9,50,630 in
my loan account. I get the goods of my daily needs from
a nearby grocer and I clear his dues on monthly basis in
the first week of the next month, when I get my salary.
This month dues of Rs. 5,640 are still to be paid. I have
received an electricity bill of Rs. 1,287 just yesterday
which I have still to pay
 My Balance Sheet
My assets and Liabilities 1st July 20XX

Liabilities Amount Assets Amount

(Rs) (Rs)
Housing Loan 9,50,630 House 25,00,000
Grocer’s Dues 5,640 Jewellery 5,00,000
Electricity Bill 1,287 PF Account 2,40,320
Bank FD 80,000
Saving Account 25,280
Household Appliances 1,50,000

9,57,557 34,95,600
 My Balance Sheet

My assets and Liabilities 1st July 20XX

Liabilities Amount Assets Amount

(Rs)
Net Worth= Assets-Liabilities (Rs)
It is also called ‘equity’.
Housing Loan 9,50,630 House 25,00,000
Grocer’s Dues 5,640 Jewellery 5,00,000
Electricity Bill 1,287 PF Account 2,40,320
Bank FD 80,000
Net Worth 25,38,043 Saving Account 25,280
Household Appliances 1,50,000

34,95,600 34,95,600
 Review
• What is an Asset?
– Something which gives you right to receive future
cash-flow of economic benefits which can be
measure with certainty.
• What is liability?
– Contractual obligation to pay cash or to deliver
other economic benefits in the future resulted out
of a historical event.
 Is this an asset for an accountant?
• A car owned by my firm
• Salary paid in advance
• Electricity bill to be paid
• Employees of the Organisation
• Good reputation of the business
• My intelligent son
• A new product developed by my firm
Is this a liability for an accountant?
• Salary to be paid
• Commission to be received
• Rent received in advance
• Bank overdraft
• I have to spent money for future education of
my son.
• I have to spent money for marriage of my
daughter
 Concepts for Discussion
• Money Measurement Concept
• Historical Cost Concept
• Net Worth

• Accounting Equation

Assets = Liabilities + Equity (net worth).

Ramu’s Vegetable Business
 Ramu was working in a factory but unfortunately that closed
down during recent recession. Now he was unemployed. On
June 30, 20XX, he discussed with his wife and they decided that
Ramu should start selling vegetables. They have a total saving of
Rs. 3800 in a bank account and Rs. 1500 at hand; but they want
to keep some money safe to meet out their daily and contingency
needs. So they decide to withdraw Rs. 2000 from the bank
account to start the business and Ramu’s close friend Vinod
provides a loan to his business Rs. 1000 for one month without
any interest. Next day, on July 1, Ramu starts his business. He
hires a Rickshaw trolley at a rent of Rs. 500 p.m., first two
months rent is in paid advance. He purchases Vegetables costing
Rs. 1200 at the morning on this date.
How will we present the financial position of Ramu’s
Vegetable Business on July 1, 20XX at the morning, when he
started the business?
 Which Assets
Balance Sheet of Ramu’s Vegetable Business
On July 1, 20 at the Morning (Opening Balance
and Liabilities
Sheet) to include?

Liabilities Amount Assets Amount

Cash ???????

3000 3000
 Entity Concept
• The entity of business is treated separate from
the entity of its owners
 Balance Sheet of Ramu’s Vegetable Business
On July 1, 20XX at the Morning (Opening Balance
Sheet)

Liabilities Amount Assets Amount

Vinod Loan 1000 Stock 1200

Equity 2000 Advance Rent 1000

Paid
Cash in Hand 800

3000 3000
 We revisit Ramu’s mobile shop after 15 days on July 15. 20XX.
Ramu has not maintained any record of the goods he purchased and
sold. Can we still know whether Ramu’s business is generating a profit
or a loss? We get the information about his present assets and
liabilities. He has opened a bank account where he deposits the surplus
money of his business. Today the balance in his bank account is Rs.
5200. He has a cash balance of Rs. 1525. He has also some surplus
vegetables in his trolley which remained unsold today. We can divide
them into two categories - durable vegetables, like potato and onion,
costing Rs. 530 which can be sold at normal price of Rs. 850;
perishable vegetables, such as tomato, green vegetables of costing Rs.
220, which can be sold tomorrow at reduced price only and Ramu
expects to realise Rs. 180 from it. Ramu has returned half of the loan
that he had taken from his friend. Out of the rent paid in advance for
rickshaw trolley, rent of 15 days (Rs. 250) has been expensed and
remaining one and half month’s advance rent is still there. Ramu tells
us that he has to pay Rs. 500 to vegetable dealer for the vegetables he
purchased today morning.
 Balance Sheet of Ramu’s Vegetable Business
Conservatism
On July 15, 20XX

Liabilities Amount Assets Amount

Stock ??????
 Balance Sheet of Ramu’s Vegetable Business
On July 15, 20XX

Liabilities Amount Assets Amount

Vinod’s Loan 500 Stock 710

Accounts Payable 500 Advance Rent Paid 750

Equity 7185 Cash in Hand 1525

Cash at Bank 5200

8185 8185
 Concepts for Discussion
• Entity Concept
• Conservatism
• Equity at the end of the period= Equity at the
beginning of the period + Profit
 But Ramu forgot to tell us one thing. He has taken some
vegetables for household consumption from the shop every day.
If the cost of this vegetable was Rs. 15 per day; how will we
revise his estimated profit?
Any withdrawn will reduce his claim on the business,
or his equity. Ramu had invested Rs. 2000 and
withdrawn Rs. 225 (15×15). So his equity reduces to
Rs. 1775. Now at the end of the month, the equity has
increased to Rs. 7185. Therefore, he had earned a
profit of Rs. 5410.
How much profit did Ramu earn?

His Equity at the beginning = Rs. 2000 - 225

His Equity at the End = Rs. 7185

Did he make additional investment?

Did he withdraw money from the business?

So, how much profit did he earn?

 Flow and Stock
Revenue

Profit = Change in Equity

EQUITY

Profit = Revenue-Expenses

Expenses
 A Quick Revision
• Ravi started his business on January 1. He hired a shop at a
rent of Rs. 5000 p.m. and paid three month’s rent in advance.
He purchased furniture for Rs. 45000 and stock for Rs. 80, 000.
He took a loan of Rs. 75000 from the bank and contributed
rest of the money from his own savings.
• On December 31, he had a balance of Rs. 52000 in his loan
account; cash in hand Rs. 2500, stock Rs. 72000, amount to be
paid to suppliers Rs. 48000; amount to be received from
customers Rs. 87000, rent to be paid for one month.
• He withdrawn Rs. 3000 pm from his business for his household
consumption.
• Prepare the balance sheets of Ravi’s business on January 1 and
December 31 (avoiding depreciation on furniture)
• and also compute the profit earned by him during the year.
 Balance Sheet on January 1
Liabilities Amount Assets Amount
(Rs) (Rs)
Loan 75,000 Advance Rent 15,000

Equity 65,000 Furniture 45,000

Stock 80,000

1,40,000 1,40,000
 Balance Sheet on December 31
Liabilities Amount Assets Amount
(Rs) (Rs)
Loan 52,000 Cash 2,500

Creditors 48,000 Stock 72,000

Unpaid Rent 5,000 Debtors 87,000

Equity 1,01,500 Furniture 45,000

2,06,500 2,06,500
 Computation of Profit earned
during the year
Particulars Amount

Equity at the end of the year 1,01,500

Equity at the beginning 65,000
Change in Equity 36,500

Amount withdrawn during the year 36,000

Total Profit earned during the year 72,500