Financial AccountingTerm Paper

- Sanmeet Dhokay

(2015PGPMX 025)

Day 1:-

Accounting is art of recording, classifying, summarizing and interpretation of business

Journal is the first book of the company

Ledger - is for classification and sorting of transactions under various heads . Payment made over the month to maid .

Trial Balance - Summary of ledger

Accounting Mechanics - Journal is for recording, Ledger and Trial Balance are for classification, Income Statement and Balance Sheet are for Summary

Balance Sheet /Income statement is the summary of whole year operation

Owes to Pay

Owns to Get

Liabilities - Sources of fund

Assets – Uses of Funds

Industry trend -The past 10 years growth trend is used to forecast the future

Interpretation - Trend Identification

Planning Controlling Decision making Valuation

Recording Classifying Summarizing Interpreting

Accounting

Financial Accounting

JournalLedgerTrial

Income statementBalance sheet

Real

Cost Accounting

Estimated dataProjected financial statementsBusiness plan, Strategic Planning

(10 year,20 year plan)Vision DefinitionEstimation

Refundable Liability

Non – Refundable Asset

If you get back ,then it’s called Asset

If you don’t get back , then it’s called Expense

Expenses(Non-Refundable)

Assets(Refundable)

Debit

Incomes(Non-Refundable)

Liabilities(Refundable)

Credit

LiabilitiesAssets

Balance Sheet

IncomesExpenses

Profit/Loss/Income Statement

OutflowInflow

Cash Flow Statement

Trial Balance :-

Building Asset DebitLand Asset DebitLoan Taken Liability CreditSalary Income CreditDiscount Given Expense Debit

Direct Ledger:-

All Entries are done by double entry system

Credit Debit

Debit Credit

(Gupta Umbrella) (Mandar Umbrella)

Assets Expenses Liabilities Income

Day 2:-

Questions to ask in accounting:-

Are you doing things right?

Are you doing the right things?

Debt – Equity Ratio – Financer Money

Operation Return

SEBI Rules - Data is required for 2 years(previous and current) for analysis

In India we work on Conservatism principle which is general concept of recognizing expenses and liabilities as soon as possible when there is uncertainty about the outcome, but to only recognize revenues and assets when they are assured of being received.

SMART

S - Specific

M – Measurable

A – Achievable

R – Relevant

T – Time Bound

Two Managerial Approaches in Accounting :-

1)Think Present , Forward Typical Managerial Approach

2)Think Future , Backward

Language and Accounting Software is used for creating Balance Sheets and Income Statements

Resulted in

Ledger

Trial Balance

Financial Statements

Balance SheetIncome Statement

Journal

Assets Liabilities Expenses Income

Dr Cr

Dr Cr

Dr Cr

Accounting is always done from Business Point of View

Examples of different transactions :-

Cash Dr – 100000 Cash Asset

Capital Cr – 100000 Liability

T accounts are used .Every transaction has two parts – credit and debit which are divided in 2 columns which look like a T

Cash a/c

Cash 100000

Capital a/c

Capital – 100000

Trial Balance:-

Name of Accounts Dr CrCashCapital

100000100000

100000 100000

Profit/Loss

Balance Statements

AssetsCash 100000

100000

LiabilitiesCapital 100000

100000

Expenses Income

Furniture Purchases – 20000

Furniture Account and Cash Account

Cash a/c

Furniture 20000

Furniture a/c

Cash 20000

Commission Received - 50000

Commission Account and Cash Account

Cash a/c

Commission 50000

Commission a/c

Cash 50000

Profit ,Commission is shown as Liabilities as Business owes it to Businessman.

Unclosed Accounts are reflected in Balance Sheet.

Day 3:-

Inventory

Manufacturing process:-

Input Process Output

Raw Material Consumed also called as Cost of Raw Material Consumed

Opening Stock+Purchase of Raw Material+Expenses incurred-Closing Stock of Raw Material-Scrap

Input Opening WIP Opening Finished Goods

Closing Finished Goods

PAT (Profit After Tax)

Raw Material Consumed

Labour

Expenses

Processing

Cost

Closing WIP

Finished Goods

or

Cost of Production

Cost of Goods SoldCompare with SalesGross Margin/Profit

Deduct TaxProfit Before TaxDeduct Expenses

Profit before tax = Tax – Profit after tax

Finance Expenses

Operating Expenses

Other Expenses

For Company

Profit Part goes into reserves due to limited liability

For Individual and Partnership Liability is limitless (Personal Asset and Belonging)

Retained Earning - is allowed for the time period of 1 year only, It is time bound and cannot be extended

Dividend Distribution is not an expense. It is shown as Distribution of Profit

Book Value = Share Capital + Reserve Surplus

Shareholder Fund

Market Value Added How much value have you added for my shares in the market

- Tax = Profit

ExternalInternal

Finance

Accounting communication – How are you communicating the inputs to your accounting to the shareholders

Routine or Regular Income is part of Profit & Loss Account

Non Routine Income Market Value – Book Value

Non Operational Income – Capital Income

Retention of Shareholders Supply will be less

Retained Earning of last year – Dividend = Retained Earning of Current Year

Accounting Standard Z

FIFO and Weighted Average

As per IS2 Standard

FIFO , LIFO and Weighted Average

Valuation of the inventory is done at cost price or net realized value

Conservatism principle If there is a loss then book the loss but not the profit

10* 2 = 20 10 * 3 = 30 This value should be considered

Inventory Costs = 6,7,8,9,10

Price Increased

To determine price of raw material use of inventory valuation

Quality of earning latest term used

Weighted average

Perpetual Continuous

If FIFO is used then inventory is LIFO

If LIFO is used then Inventory is FIFO

If Ledger is created then it is perpetual

Depreciation:-

Associated with Wear & Tear

Tangible Asset :- Physical

Intangible Asset :- Patent , Copyright

Obsolete :– When Depreciation is too high

For Eg 100000 10000

Accumulated Depreciation It is used when asset value is shown at original/procurement value

It is shown as Liability

Depreciation is shown as Expense

Capital Expense – Initial

Revenue Expense – After Operations

Deferred Expenses :-

Depreciation is used to replace the asset

Acts as Internal Source of Financing

Depreciable value spread over useful life

Purchase/Cost Repair at time of install Salvage Value

100 crore + 10 crore - 20 crore (value after 5 years)

= 90 crore

Straight Line Depreciation/Fixed Method/Cost Method :-

Written down value Method / Diminishing Balance / Diminishing Value:-

In this method, the Cost of the asset in the second year is calculated after subtracting the depreciation of the first year.

Unit Method:- Based on utilization

Eg – Usage of car in kms driven

Sum of digits method :- – digits of useful life

5 4 3 2 1

15 15 15 15 15

Salvage value would be represented at the end of useful life as sale

20

0 1 2 3 4 5

International Financial reporting standard (IFRS) – Assets are shown at Market Value

Capital Employed :-

Inflation accounting is not shown in India due to conservatism principle

In India, Valuation is done only at the time of acquisition of business

Cash Flow Statement:-

Cash flow from operations should be positive

C2C – Cash to Cash Cycle( Should always be positive)

Process Re-engineering :- Change the process to make C2C cycle positive

++ -+

+- --

Profit is negative, but the Cash Flow is positive (Green section) there is a need to diversify Funds because the Business is giving negative returns

Cash

Profit

Profit is positive but the cash flow is negative(Yellow section) we can infuse finance in to the company after checking the cost of Funds

Profit and Cash are negative(Orange section) the business is sick and requires complete process re-engineering

Profit is purely based on accrual( Due,Payable)

Cash means only when we have received the amount

Funds requirement includes Cash and Non Cash Both

Cash Requirement includes only cash(liquid)

Own – Shareholder fund/Equity/Owner’s Fund/Net Worth/Capital Fund

Loan – Secured/Unsecured,Inside/Outside,Current/Non Current

Non Current Assets – Fixed Investments

Debt Equity Ratio – Relationship between own and loan ,Internal and External

Interest Coverage Ratio :- Indicates how much profit is available to pay Interest

Earning Before Interest and Tax(EBIT)

Liquidity Current Ratio Assets(Current)

Liabilities (Current)

High value shows that it is Easy to convert

Current Assets Inventory

Cash in Hand

Cash at Bank

Account Receivables

Cash in Hand

Super Quick Liquidity

Cash at Bank

Dividend___ = DPS

No. of Shares

200 % Dividend Dividend is always given on face value

Eg:- Face Value of share is Rs 10 , then 200% dividend will give return Rs 20

PE Ratio :- is the price earnings ratio i.e. the earning on the Market value of shares i.e. the Earning per share (the Book value) vs the Market price per share.

Book Value

10 Rs - EPS - Earning per share

6 Rs - DPS – Dividend per share

How much is the company distributing the profit - 60% (6/10 * 100)

Common Size Income Statement - both value and the percentage of each entry is displayed

Cost Control - Benchmark, competitor comparison and controlling the cost

Operating cost is cost of goods sold + operating expenses

Value Engineering – When you spend 1 Rs , are you getting the money worth

Cost cutting department / Cost Creation program :- is basically a Cost reduction program – it means using Creativity and Innovation to create Better value

Harvard Term

Return on Equity Shareholder fund – Retention Strategy of the company

Capital Employed – Funds deployed into the organization

ROI – Return on Investment

ROA – Return on Assets Same

ROI – Return on Cash

How much return = EBIT (Earnings Before Interest and Tax)

Working capital invested EBIT

Projected Cashflow :- can help you evaluate your personal income and expenses to check profitability

Hedging :- The aim of hedge accounting is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account. For a fair value hedge this is achieved either by marking-to-market an asset or a liability which offsets the P&L movement of the derivative.

ROI

I - 1% 4%

II - 2% If fund(cost) is at 5% then loss is 3% So no value

III - 4.5% 0.5%

Conclusion :- There is profit and growth but no value

Economic Value Added (EVA)

ROI – Weighted Avg Cost of Capital

Growth

Business Buyability

Business Feasibility

IRR(Internal Rate) > Check Cost of Fund (For eg – 5%) then accept proposal

Proposed Return

on Investment

Market Efficiency/Activity Ratio/Operation Effectiveness :- It is linked with turnover

Profit Turnover :- Cost of Inventory vs Cost of Goods

Asset Turnover :- Assets vs Sales

Inventory Turnover :- is a measure of the number of times inventory is sold or used in a time period such as a year

Account Payable Turnover :- Payables vs. Credit Purchases

Account Receivable Turnover :- measuring how efficiently a firm uses its assets.

Turnover Sales + Purchase

Central Sales Tax Act :-

Sales :-

Credit Cash Cost of goods sold

Asset turnover Average

Day 4:-

Operating income :- earnings before interest and taxes (EBIT)

Non-Operating income :- is gains or losses from sources not related to the typical activities of the business or organization

Department expenses :- Expenses on a particular department in the company

Net profit PBT Profit before tax

Profit After Tax PAT

Completion certificate – real estate value should booked when it is issued

Building under constructing is capital in progress

Copyright- only after it is registered, it can be shown as an asset

Till it is filed – intangible in progress

Fixed /Current Assets :-

Fixed assets are long-term, tangible assets such as land, equipment, buildings, furniture and vehicles.

Current assets are the general inventory of a company, including cash, accounts receivable, insurance claims, investments, and intangible or non-physical items

Tangible/ Intangible :- Goodwill,copyright, patent

Cash inflow /Cash outflow :-

Cash Inflow :- Money received by an organization as a result of its operating activities, investment activities, and financing activities.

Cash Outflow :- is the net amount of cash and cash-equivalents moving into and out of a business.

Balance sheet

Cash flow statement is created in 3 categories

Cash from operating activity Cash from investing activity Cash from financing activity

Shareholder Fund

Loan Fund

Fixed Assets

Investments

Net Current Assets

CA – Current Assets

CL – Current Liabilities

Investing Activities

Operating Activities

Financing Activities

Opening and closing balance of cash

As a successful manager, you have to ensure surplus of cash from operating is also known as economic value added (EVA)

Wealth Creation, shareholder value management

Profit:- A financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity.

Growth:- An increase in the capacity of an economy to produce goods and services, compared from one period of time to another.

Value:- The monetary, material or assessed worth of an asset, good or service. In accounting,value describes what something is worth in terms of something else.

Excess cash from operation, discounted by weighted average cost of capital

Weighted avg cost - is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted.

Cash flow :- the total amount of money being transferred into and out of a business, especially as affecting liquidity.

Direct/Indirect method :-

Two activities will be common:-

1. cash flow from financing activities

2. cash flow from investing activities

Only difference is if we are calculating cash flow from operating activity

Direct method – consider all the items for which we get cash receipt

Profit and loss is created on Accrual Basis whether received or not received, for that particular period

Converting accrual into cash :- is used to record revenues and expenses in the period in which they are earned, irrespective of the timing of the associated cash flows

Indirect Method – non cash and non income

Direct method – used in software

Indirect method – used by companies (eg. HUL)

Day 5:-

Economic Value Added (EVA) = ROI – cost of funds

= NOPAT – cost of funds

Profit sharing :- A plan that gives employees a share in the profits of the company. Each employee receives a percentage of those profits based on the company's earnings.

Customer based management

Business excellence model

Trend line – A line that is drawn over pivot highs or under pivot lows to show the prevailing direction of price.

Self-Assessment - comparing past and present data

Competitor analysis – cause – effect – analysis (gap analysis)

Controllable / Non Controllable

Dupont chart :- used to break apart ROE and get a much better understanding about where movements in ROE are coming from.

ROI = PBT

Capital employed

Capital employed

Equity Fixed Assets

Debt Investment Current Assets

Net Current Assets

Trial and error method :- A method of estimating an unknown price or yield of a security

Optimal capital structuring :- Can you get Rs 1

Book value/Market value :-  If Company XYZ has total assets of $100 million and total liabilities of $80 million, the book value of the company is $20 million. In a very broad sense, this means that if the company sold off its assets and paid down its liabilities, the equity value or net worth of the business, would be $20 million.

Market value added :- A calculation that shows the difference between the market value of a company and the capital contributed by investors (both bondholders and shareholders).

Accounting Standards

Principles

Universal TruthsDouble EntryConservatism

PeriodMatching

Policies

Norms adopted by management

Norms which are accepted universally are called accounting principles

Accounting standards :- norms released by statutory body

National International

India has adopted /developed from 41 standards

Accounting policy manual:- A manual that contains pertinent accounting rules and other information for a business or organization. Accounting manuals can contain guidelines for various policies and procedures.

Mandatory standards ->

Auditor appointment is done by board of directors .He has to represent the government for the customers/stakeholders

Ethics in accounting/Accounting in ethics

Auditor’s report

Clean report Qualified report

If there is no observation If there is observation (para)

Disclosure of significant accounting policies

Window dressing -> dirty profit

Director’s report :- Contains Result of operations ,future plan, management discussion

Shareholders are owners

Directors are servants

Corporate governance report:- To show Transparency and accountability

Secretarial standards report :- Secretary related – meeting minutes documentation,etc

CAO - Chief Administration Officer Newly introduced position in companies

Undertaking for information given to CA

Equivalent -> CFO or CEO

Book value = Share capital + Reserve and Surplus

No of outstanding equity shares

DPS = Total dividend to equity shareholders

No of outstanding equity shares

EPS (Earning per share) = PAT

No of outstanding equity share

Payout ratio = DPS

EPS

PES ( Price Earnings Ratio) = Market price of share

EPS