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Understanding Corporate Financial Statements

Ashok Banerjee Indian Institute of Management Calcutta

Why Accounting?

Every business entity is exposed to three types of risks of varying degree:
  

Market Risk Credit Risk Operational Risk

 

Accounting help reduce operational risks. Accountants ideally should not be too “creative”!
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Functions of Accounting System  Internal routine reporting to managers for cost

planning and cost control of operations, and performance evaluation of people and activities. Internal routine reporting to managers on the profitability of products, brand categories, customers etc. Internal non-routine reporting to managers for strategic and tactical decisions. External reporting through financial statements.
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in 4 . 04/30/12 ashok@iimcal.  Investor: responsibility to do his/her homework. direct.  Auditors: responsibility to investigate and provide  assurance. Board: responsibility of oversight.  Media: responsibility to report fairly.  Regulator: responsibility to frame accounting guidelines  and reporting practices. Analysts: responsibility to be independent. and Chain transparent.Corporate Reporting Supply  Management: responsibility to be honest.ac.

in 5 .Basic Accounting Concepts   An understanding of accounting concepts is vital to understand the process of accounting. Accounting concepts underlying the recording of transactions:     Entity Concept Money Measurement Concept Accrual Concept Matching Concept 04/30/12 ashok@iimcal.ac.

in 6 . 04/30/12 ashok@iimcal. Expenses or revenues are recorded before the cash settlement.ac.Accruals    What is an accrual? It is the recognition of an expense or revenue that has arisen but has not yet been recorded.

Distinguish accrual-basis accounting from cashbasis accounting.in 7 . 04/30/12 ashok@iimcal.ac.

in 8 .ac.The Two Bases of Accounting: 04/30/12 ashok@iimcal.

20. The contract specifies that the client had to pay Rs.150.in 9 .Accrual Versus Cash Example     In January 2003.000 in advance.ac. What is the income or loss? 04/30/12 ashok@iimcal. Prism Insurance sells a three-year health insurance policy to a business client.000. Yearly expenses amount to Rs.

ac. 30 04/30/12 ashok@iimcal. 30 2004 Rs.in 10 . 20 Rs. 20 Rs.Accrual Basis of Accounting (000 omitted) Income Expenses Net Income (Loss) 2003 Rs. 30 2005 Rs. 50 Rs. 20 Rs. 50 Rs. 50 Rs.

20 (Rs. 130 2004 0 Rs. 20 (Rs. 20) 2005 0 Rs. 20 Rs.ac.Cash Basis of Accounting (000 omitted) Income Expenses Net Income (Loss) 2003 Rs. 20) 04/30/12 ashok@iimcal. 150 Rs.in 11 .

ac. Investment was made at the beginning of the year.a. calculated on a half yearly basis and paid within next fifteen days. 20 million during the year and collected cash of Rs. invested its surplus fund of Rs. The wholesalers owed the company Rs. 10 million at the beginning of the year and still owes Rs. 100 million from its wholesalers (whom XYZ Ltd sells on credit) during the same period.in 12 . sold goods for cash worth Rs. 30 million in a threeyear fixed deposit at an interest rate of 7% p. during the year? ABC Ltd.15 million at the end of the year. How much is the revenue of XYZ Ltd. Accrual basis   XYZ Ltd. during the year? 04/30/12 ashok@iimcal.Cash basis Vs. How much is the interest income of ABC Ltd.

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04/30/12 ashok@iimcal.Financial Statements: Objective   To provide information about the financial position.ac. performance and cash flows of an enterprise that is useful to a wide range of users in making economic decisions. Financial statements do not necessarily provide non-financial information.in 14 .

ac.in 15 .Financial Statements: Elements  Elements measuring financial position:    Assets Liabilities Equity Income (includes gains) Expenses (includes losses)  Elements measuring performance   04/30/12 ashok@iimcal.

Shows the financial results (profit or loss) for an accounting period.  Profit & Loss Account   Cash Flow Statement  04/30/12 ashok@iimcal. liabilities and equity) as on the reporting date.in 16 . Shows the net increase /decrease in cash and cash equivalents during the accounting period.ac.Corporate Financial Statements  What are the corporate financial statements?  Balance Sheet  Shows the financial position (position of assets.

) Investments Net Current Assets (Current Assets.in 17 . Loans and Advances – Current Liabilities & Provisions) Misc.Balance Sheet Format:  Sources of Funds   Shareholders Funds Loan Funds Net Block (Gross Block – Accumulated Depn.ac. Expenditure (to the extent not yet written off) Profit & Loss Account (losses)  Application of Funds      04/30/12 ashok@iimcal.

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Balance Sheet as at 31 March 2010 (contd.in 19 .) 04/30/12 ashok@iimcal.ac.

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Profit & Loss Account: No specific format  Sample format:  INCOME   Operating income Non-operating income Manufacturing expenses Administration expenses Selling & distribution expenses Depreciation Interest expenses Provision for tax  EXPENDITURE       Profit before tax (INCOME.in 24 04/30/12 .EXPENDITURE)   Profit after tax (Profit before tax – Provision for tax) ashok@iimcal.ac.

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P&L (contd.) 04/30/12 ashok@iimcal.in 26 .ac.

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Earning per share statement. Consolidated Financial Statements.Additional Financial Statements    Segment Reporting.ac.in 30 . 04/30/12 ashok@iimcal.

ac.Segment Report 04/30/12 ashok@iimcal.in 31 .

in 32 .Operating Segments 04/30/12 ashok@iimcal.ac.

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