MBA-Financial and Management Accounting

Unit 2
Unit 3
Unit 9
Unit 14
Prof. Nandagopal V. B.
Board of Studies
Professor, Manipal Universal Learning
Prof. K. V. Varambally
Ms. Vimala Parthasarathy
Health, Medical and Technological studies.
Mr. Shankar Jagannathan
Former Group Treasurer
Mr. Abraham Mathews
Chief Financial Officer
Infosys BPO, Bangalore
Mr. Pankaj Khanna
Content Preparation Team Peer Review By
1. Dr. Y. Rajaram Dr. Nagesh Malavalli
Adjunct Faculty, Manipal Universal Learning Principal & Professor of Finance & Accounting
M.P. Birla Institute of Management, Bangalore
2. Mr. S. N. Dorai Raj
Retd Principal & Professor of commerce,
Seshadripuram College, Bangalore.
Edition: Fall 2008
This book is a distance education module comprising of collection of learning material for our students.
All rights reserved. No part of this work may be reproduced in any form by any means without permission in
writing from Sikkim Manipal University of Health, Medical and Technological Sciences, Gangtok, Sikkim.
Printed and Published on behalf of Sikkim Manipal University of Health, Medical and Technological Sciences,
Gangtok, Sikkim by Mr. Rajkumar Mascreen, GM, Manipal Universal Learning Pvt. Ltd., Manipal – 576 104.
Printed at Manipal Press Limited, Manipal.

Accounting is a systematic effect of collecting. Classifying and analyzing financial information for
effective use in decision making activities. There are two facts of accounting namely Financial
Accounting and Management Accounting. While financial accounting is concerned with recording and
preparation of financial statements, management accounting focuses on using the information for
planning, decision making and controlling the financial activities of business enterprise. In view of the
fast changing scenario world over, MBA students should acquaint themselves with rudiments of the
subject. This book contains 15 Units.
Unit 1: Financial Accounting – An Introduction
Presents an overview of meaning, purpose and evolution of accounting and introduces
basic terminology.
Briefly describes the accounting concepts and assumption in financial accounting.
Unit 3: Double Entry Accounting
Deals with basic accounting principles of Double – entry system.
Unit 4: Primary Books
Contains details of primary books- General journal and subsidiary books.
Unit 5: Secondary Books
Covers the process of posting from primary books to ledger, which is called secondary
book.
Unit 6: Trial Balance
Deals with the process of preparing trial balance, errors and rectification.
Unit 7: Final Accounts

Presents the meaning and scope of Management Accounting.
Unit 9: Financial Statement Analysis
Deals with ratio analysis as a part of analysis of financial statements.
Unit 10: Funds Flow Analysis
Focuses on fund flow analysis.
Unit 11: Cash Flow Analysis
Gives a brief sketch of cash analysis.
Unit 12: Understanding Cost
Unit 13: Marginal Costing and Break Even Analysis
Introduces the tool of marginal costing and its usage.
Unit 14: Budgetary Control
Provides an insight of budgets – as a means of control.
Unit 15: Standard Costing

Reference Books:
1. Accounting for managers by Jawahara Lal. 2. Financial Accounting by S.N.Maheswari.
3. Financial Accounting for Managers by R.Narayana Swamy. 4. Introduction to Management by Anthony Reece.

Sikkim Manipal University 1
Structure:
Self Assessment Questions 3
1.1 Introduction
Accounting is a branch of knowledge, concerned with recording classifying, analyzing and
reporting financial information to owners, bankers, creditors, government and host of
stakeholders regarding the financial performance of organizations - business or bon-business
entities. Over a period of time, accounting has assumed a status of a science and an art. In order
to achieve uniformity globally, international standards have also emerged in accounting. In this
Unit, the historical perspective of Accounting, its meaning, functions and basic terms used in the
subject are discussed.
Learning Objectives:
After studying this unit, you should be able to understand the following
1. To expose the students with meaning, need and purpose of accounting.
2. To know the functions Accounting.
3. To understand the difference between Financial Accounting and Management Accounting.
4. To acquaint with the basic terminology used in the subject.
1.2 Evolution of Financial Accounting
Any branch of knowledge does not emerge all of a sudden. Knowledge is a product of continuous
intellectual exercise and the changes in the environmental and social demands. Accounting is an
ancient art. Michael Russel in his article ‘Evolution of Accounting’ points out that as early as 8500
B.C, accounting was existing. Archeologists have found clay tokens as old as 8500 BC in
Mesopotamia which were usually cones, disks, spheres and pellets. These tokens correspond to
such commodities like sheep, clothing or bread. They were used in the Middle West in keeping
records. Similarly in ancient civilizations like China, Babylonia, Greece and Egypt, record keeping
was in practice in the same manner as stated above. During 3600 BC in Babylonia payment of
salaries was recorded in clay tablets. The rulers of these civilizations kept track of labour and
material costs by using accounting methods.
In an article published by John R. Alexander on ‘History of Accounting’, he stated that an
improved system of book keeping known as double entry book keeping was introduced in 14 th
century and the following seven key ingredients were responsible for the creation of double entry
book keeping.
• Private property: The power to change ownership, because book keeping is concerned with
recording the facts about property and property rights
• Capital: Wealth productively employed, because otherwise commerce would be trivial and
credit would not exist
• Commerce: The interchange of goods on a widespread level, because purely local trading in
small volume would not create the sort of press of business needed to spur the creation of an
organized system to replace the existing hodgepodge of record keeping
• Credit: The present use of future goods, because there would have been little impetus to
record transactions completed on the spot.

• Writing: A mechanism for making a permanent record in a common language given the limits
of human memory.
• Money: The common denominator for exchange, since there is no need for book keeping
except as it reduces transactions to a set of monetary values.
• Arithmetic: A means of computing the monetary details of the deal.
Double entry records first came out during 1340 A.D. in Genoa. In 1494, the first systematic
record keeping was formulated by Fra Luca Pacioli a Franciscan monk and one of the most
celebrated mathematicians to this day. Pacioli is considered as the father of accounting.
Michael Russel, in his article states that industrial revolution, which brought paradigm changes in
the working and business transactions paved way to the specialized field of accounting called
‘cost accounting’ in order to meet the need for the analysis of various costs. Mean while,
corporate form of organisation came into being which made it necessary to report financial
information to the owners (shareholders) by the management. Virtually management and
ownership got separated and to instill confidence of the shareholders, managers had to submit
reports, as prepared on the basis of accounting information.
Welsch and Anthony, in their book’ Fundamentals of Financial Accounting’, comment that the
growth of business organizations in size, particularly publicly held corporations, has brought
pressure from stock holders, potential investors, creditors, government agencies, and the public
at large, for increased financial disclosure. The public’s right to know more about organizations
that directly or indirectly affect them (whether or not they are shareholders) is being increasingly,
recognized as essential. An open society is one that has a high degree of freedom at the
individual level and typically evidences an effective commitment to measuring the quality of life
attained. These characteristics make it essential that the members of the society be provided
adequate, understandable, and dependable financial information from the major institutions that
comprise it. So accountants have a greater responsibility of not only being accurate but also
transparent to the possible extent.
At present, there have been tremendous advancements in accounting to meet the needs brought
about by information technology. Work is done faster, more accurate, and more dependable by
using computers. Business can be transacted without even facing one another and accounting
has become so customer friendly that records and reports are generated instantaneously to all
parties concerned.
2. A new accounting system called _______ emerged during industrial revolution.
3. Double Entry book keeping was introduced during ___________ century.
1.3 Need
Economic activities are carried on by trading and non-trading organizations, the former with profit
motive and the latter with a focus on service. Business is prominently carried on under different
forms of organizations, namely sole trading, partnership, Hindu undivided family firms (HUF),
cooperative societies and companies. Having invested capital in the business, one has to find out
at the end of a particular period whether the business has yielded any profit or loss; any assets
are created; the liabilities payable; total expenses incurred; total revenues generated and so on
and so forth. Innumerable business transactions might have taken place during the period and
remembering all transactions is humanly impossible, let alone finding the results of the
transactions. Even to put them in a computer, it requires a systematic approach to record,
classify, analyse and report the financial data to the stake holders of a business enterprise.
Precisely for this purpose, financial accounting is needed.
Proprietor/s in case of sole trading and partnership firms, members in case of cooperative
institutions, shareholders in case of companies, suppliers, customers, tax authorities, banking
institutions, lenders, borrowers, employees, government agencies and general public are the
various parties interested in the financial information of a business enterprise and each one them
is interested in different aspects of the business. Accounting information has to be supplied in a
prescribed manner to these parties and this information is contained in the form of different
statements such as trading account, profit and loss account, balance sheet, cash flow statement,
fund flow statement, statement of investments and so on. While a proprietor/
partner/member/shareholder is interested in profit and loss account and balance sheet, bankers
are interested in cash and fund flow statements in addition to P&L account and balance sheet,
government is interested in the amount of tax collections, employees are interested in P&L
account, customers, in total sales, suppliers in cash statements, security analysts in the ratio
analysis of various financial parameters of the business organization. Financial accounting fulfills
the aspirations of the above parties regarding the enterprise. Thus Accounting has emerged for
two purposes, namely to record all business transactions since one can not remember them and

Self Assessment Questions 2:
1. What are the two purposes of accounting?
2. Shareholders of a company are interested in ______ and _______ of a business.
3. Bankers are interested in _________ and _______ besides P&L A/C and balance sheet.
1.4 Meaning of Accountancy, Book-keeping and Accounting
Book-keeping, accounting and accountancy are the terms used in the science of financial
accounting. Book-keeping means recording of business transactions in the books of accounts in
accordance with the principles of accounting. Book keeping is an adjunct for accounting. Day to
day transactions are entered in a systematic manner to facilitate the preparation of profit and loss
account, balance sheet and other statements containing information about debtors, creditors, tax
payment etc., For the purpose of recording the financial data, debit and credit principles are
adopted so that cross checking is made possible, summary of each account is known at the end
of an accounting period.
Accounting on the other hand is the discipline of measuring, communicating and interpreting
financial activities and it is widely referred to as language of business.
Way back in 1941, the definition for the word Accounting was given by the Committee on
Terminology of the American Institute of Chartered Public Accountants, (AICPA)thus, ‘accounting
is an art of recording, classifying and summarizing in a significant manner and terms of money
transactions and events which are, in part at least, of a financial character, and interpreting the
results thereof.’
The American Accounting Association (AAA) in 1966 provided the following definition:
“Accounting is the process of identifying, measuring and communicating economic information to
permit informed judgements and decisions by users of the information”
In 1970, the AICPA emphasized accounting with reference to the concept of information..
Accounting is treated as a service activity. The function of accounting is to provide quantitative
information, primarily financial in nature, and about economic activities, that is intended to be
useful in making economic decisions.
Accountancy is the profession and the practitioners of accountancy are called accountants.
Therefore book keeping is the basic activity of recording, accounting is the analysis and reporting
function and accountancy is the profession of carrying the above activities.
2. Define Accounting.
3. Accountancy is a __________ and the practitioners of accountancy are __________ .
1.5 Characteristics of Accounting
From the above definitions of Accounting, one can list out the characteristics of accounting:
1. Accounting is an art and science: Recording and maintenance of accounts of various
transactions needs special skill and knowledge. Reading and interpreting the results, obtained
by the accounting system requires experience. From this angle, accounting is an art.
Accountants are endowed with this special skill and aptitude and it is difficult to acquire
proficiency in this art. It is like a doctor who diagnoses and prescribes medicines just by
looking to the medical reports, an accountant on a gaze of the financial reports can find out
the financial health of an enterprise and suggests measures to improve the financial position.
Accounting is also a science, not like physics or chemistry, but it is an exacting science.
Accounting is governed by definite principles, rules, concepts, conventions and policies. A
systematic and scientific approach is adopted to classify, record, analyse and interpret the
accounting information.
2. Accounting involves a process of identifying, classifying and recording financial information,
expressed in terms of money. All financial transactions are expressed in terms of money.
Incomes, expenses, acquisition of assets, payment of liabilities, capital of shareholders etc.,
are stated in money terms and all transactions are broadly classified as related to definite
heads of account, namely – personal, real and nominal. After classification, they are recorded
in the books of original entry as per the accounting principles. The book of original entry is
called Journal. From Journal, the transactions are summarized under each head of relevant
account and posting takes place to a book called ledger. At the end of a particular accounting
period, the gist or the net balance of all ledger accounts is aggregated to prepare a trail
balance. From trial balance, it is possible to prepare trading, profit and loss accounts and
balance sheet.
3. Events of non financial nature can not be recorded, even though such events may have an
impact on the operational results of the enterprise. For instance financial manager and
production manager of a concern do not have good relationship and owing to this the
production process is affected and subsequently the profitability. This event of non financial
nature can not be reflected in accounts.

4. Accounting is an information system. The results of analysis and interpretation are
communicated to the management and other interested parties. Internal control is effectively
exercised and accountability is ensured through accounting information.
5. It helps in taking managerial decisions.
1. The book of original entry is called __________ .
2. Profitability of an enterprise is affected if the finance manager and production manager do not
agree each other. Does this picture in accounts?
1.6 Functions and Objectives of Accounting
From the above paragraphs, it can be concluded that accounting involves the following functions
and objectives.
a) Systematic recording of all business events or transactions and subsequent posting to ledger
to finally prepare financial statements – profit and loss account and balance sheet.
b) Reporting the results to management, shareholders, creditors, bankers, investors, stock
brokers, stock exchanges, employees, governments etc.,
c) Satisfying the statutory requirements, especially of Registrar of Companies, SEBI (Securities
Exchange Board of India) in case the company is listed, tax authorities (sales tax, excise,
customs, income tax) and government in order to protect the interest of general public.
d) Protecting the properties of business by recording them on the date of acquisition and
showing their accounts in the balance sheet.
e) It helps for internal control by holding the concerned persons responsible for any errors,
lapses or under performance. Equally it helps to identify the strong areas of excellent
performance and subsequently pin point the individuals or departments to be rewarded or
appreciated.
f) Accounting is a tool for effective planning. Current year’s financial performance becomes the
basis for future predictions and estimations. Since it is tool for planning, it also acts as tool for
controlling. Preparation of budgets, cost analysis, tax planning, auditing are some of the
functions of accounting.
1. State any two functions of accounting.

1.7 Differences between Book Keeping and Accounting
As already said, book keeping is a system of recording the day to day transactions in the books of
enterprise. Accounting enjoys wider scope and includes not only book keeping but also analysis,
interpretation and reporting of financial information. The later part of accounting is the core
function of accounting. Now - a-days, owing to information technology, ready made packages like
Tally are available, which facilitate entry of transactions and preparation of ledger accounts are
made easy. In case of large industrial enterprises and multi national corporations, regular journal
entries are not recorded owing to very large number of transactions taking place day in and day
out. On the other hand subsidiary books such as cash book, sales book, purchases book, bills
receivable book are prepared and ledger accounts are drawn from them. The differences
between book keeping and accounting are as under:
Book keeping Accounting
transactions in books of accounts
• It includes recording, analyzing and
communicating
recording
knowledge and experience
accounting
end of accounting period
reasons for financial results and
communicate the results to all stakeholders
in a manner they understand.
2. State two differences between book keeping and accounting.
1.8 Financial Accounting and Management Accounting
Financial accounting is the preparation and communication of financial information to outsiders
such as creditors, bankers, government, customers and so on. Another objective of financial
accounting is to give complete picture of the enterprise to shareholders. Management accounting
on the other hand aims at preparing and reporting the financial data to the management on
regular basis. Management is entrusted with the responsibility of taking appropriate decisions,
planning, performance evaluation, control, management of costs, cost determination etc., For

both financial accounting and management accounting the financial data is the same and the
reports prepared in financial accounting are also used in management accounting But the
following are major differences between Financial accounting and Management accounting.
Financial accounting Management accounting
accounting information are
shareholders, creditors, government
authorities, employees etc.,
the information for planning and decision
making
measurement unit like labour hours, machine
hours or product units for the purpose of
analysis
definite period, say one year or a
quarter
• Financial accounting focuses on
future
policies and conventions
disciplines like economics, management,
2. State any two differences between Financial accounting and Management accounting.
1.9 Basic Terms
To understand the subject, proper understanding of the following terms is essential.
1. Transaction: It is transfer of money or goods or service from one person or account to
another person or account. For example, purchase of goods, sale of goods, payment of cash
towards rent, receipt of cash towards interest on loans given, cash brought in as capital
dividend paid to share holders etc are all transactions. There are cash transactions, credit
transactions and paper transactions. In all cash transactions, cash is paid or received
immediately. Ex: Rama paid cash Rs.10000 for purchase of goods. Krishna sells goods for
cash Rs1000.Credit transaction is one where there is a promise to pay/receive cash at a

adjustment is made in the records only. Bad debts of previous year are written off;
depreciation provided on fixed assets etc.,
2. Capital: Funds brought in to start business, by the owner/s. In the case of a company,
capital is collected by issue of shares. Capital used to purchase fixed assets is called fixed
capital and that capital used for day to day affairs of business is known as working capital.
From business point of view, Capital is a liability.
3. Assets: Every enterprise has assets. Land and buildings, plant and machinery, furniture and
fixtures, cash in hand and at bank, debtors and stock etc., are regarded as assets, by the
use of which business is carried on. Assets may be fixed, current, liquid or fictitious. Fixed
assets are those which are held for use in the production or supply of goods and services.
Ex: plant and machinery, which is used fairly for long period. Current assets are those which
are held or receivable within a year or within the operating cycle of the business. They are
intended to be converted into cash within a short period of time. Ex: Stock in trade, debtors,
bills receivable, cash at bank etc., Liquid assets are those which can be easily converted
into cash and for instance, cash in hand, cash at bank, marketable investments etc.,
Fictitious assets are in the form of such expenses which could not be written off during the
period of their incidence. For example, promotional expenses of a company which could not
be treated as expenditure in the year of incidence are shown as fictitious asset.
4. Liability: Obligation to be fulfilled in future with respect to payment towards acquisition of an
asset or performance of a service. Current liability is that obligation which has to be satisfied
within a year. For example, payment to be made sundry creditors for the goods supplied by
them on credit; bills payable accepted by the businessman; overdraft raised by the
businessman in a bank etc.
5. Goods: Commodities or articles purchased for resale are called goods. Furniture items
dealt by a furniture dealer constitute goods for that business. If rice dealer purchases
furniture, not for resale but for use, it is called purchase of asset and the same furniture
becomes asset. Rice for rice dealer is goods, because he purchases only for resale.
6. Trade: Purchase and sale of goods is called trade.
7. Purchases: It refers to goods bought in exchange for cash or credit. In case of credit
purchase, goods are received against a promise to pay the price for the same at a future
date.
8. Sales: Goods sold to customers either for cash or for credit are regarded as sales. In case
of cash sales, cash is received immediately and in case of credit sales, cash will be received
at a future date.
9. Sole trader: A single individual carrying on business with or without the help of his kith and
kin is called sole trader.
10. Partnership: It is a relationship between partners to contribute capital to start business,
agree to distribute profits and losses in an agreed proportion and the business being carried
on by all or any one acting for all. Partnership firm refers to business where as the
partnership refers to relationship caused by agreement.
11. Joint Stock Company: It is an organization, for which the capital is contributed by
shareholders to carry on business and it is registered under Companies Act and it has a
legal entity, having perpetual existence and a common seal.
12. Debtor: Debtor is a person who owes some thing to business. A person to whom goods are
sold on credit becomes a trade debtor to the business.
13. Creditor: A creditor is a person to whom the business owes some thing. For example, a
person from whom goods are purchased on credit and amount is yet to be paid is called a
trade creditor.
14. Stock: Total goods kept on hand by a trader or industrial enterprise on a given date. It
represents unsold part of goods.
1. A company is registered under ___________ .
2. A partnership is ___________ among partners.
3. Rama & Co., owned by Govind. Is it a firm or sole trader?
4. If A purchases goods from B, A is ___________ to B and B is _________ to A.
5. X co Ltd., sold goods to Y Co Ltd and Y Co gave a cheque payable after one month. Is it a
cash sale or credit sale?
6. Mr. P brings furniture worth Rs.10000 and goods worth Rs.200000 into his business. Is it
capital?
1. Briefly describe the meaning of accountancy, book-keeping and accounting.
2. Write the differences between accounting and book-keeping.

4. State the meaning of the folling terms
a. Transaction
b. Assets
1. Fra Luca Pacioli
1. Record all business transactions and communicate the results to interested parties.
2. Profit and loss and balance sheet
3. Cash flow and fund flow statements
2. Accounting is the discipline of measuring, communicating and interpreting financial
activities.
internal control, tool for effective planning (Any two).
2. Shareholders, creditors, bankers, brokers, debtors, customers, suppliers, Government etc.
2. Book keeping is a process of recording but accounting is not only recording but also analyzing
and communicating; book keeping requires the knowledge of accounting principles but
accounting requires not only knowledge but also skill and experience.
1. Taking decisions, planning, evaluating and controlling
2. FA considers historical data and MA focuses on future; FA is a discipline by itself but
MA makes use of other disciplines like economics, information system etc.
Answer for Terminal Questions:

Structure:

10.1 Introduction
The usefulness of developing certain financial statements as an aid to evaluate past and / or
present performance of a business concern is unquestionable and beyond any dispute. The
Income Statement reports the revenues earned and expenses incurred or outstanding. The
Balance Sheet conveys about the deployment of funds in various assets and equities The Fund
Flow analysis is a modern technique of analyzing the movement of “funds” of a concern. The
Fund Flow statement shows the movement of funds between two balance sheet dates. As per
Robert N. Anthony “the Funds Flow statement describes the sources from which additional funds
were derived and the use to which these funds were put”. Such a statement is becoming more
and more popular and is being increasingly published as part of the annual accounts. Para 20 of
International Accounting Standards 7 reads as follows :
“A statement of changes in financial position should be included as an integral part of financial
statements. The statement of changes in financial position should be presented for each period
for which the income statement is prepared”.
The inclusion of such a statement, therefore, is very helpful to improve the understanding of the
operations and activities of an enterprise for the reporting period.
1. Understand the meaning and the concepts of funds flow statement.
2. Familiar with techniques of fund flow statement.
3. Preparation of fund flow statement.

10.2 Meaning of Fund Flow Statement
Statement of Sources and Uses of Funds is a statement which depicts the sources from which
funds are obtained and the uses to which they are being put. It is essentially derived from the
analysis of changes which have occurred in assets and equities between two Balance Sheets
periods. It is not the end-product of accounting records. The statement speaks about the
changes in financial items of Balance Sheets prepared at two different dates. Therefore, the
funds flow indicates the inflows and outflows of funds during a particular accounting period
generally a year. The flow exhibits the movements of funds in both the directions – inside and
outside the business. As such, the term ‘flow’ in the context of funds indicates the transfer of
cash or cash equivalent from asset to equity or one equity to another equity or from one asset to
another asset.
2. FFS speaks about changes in _______________________ Balance Sheets.
3. Flow exhibits the flows _______________ And ________________ business.
4. Flow refers to transfer of ___________________ And __________________.
10.3 Concept of Fund
The term “funds” has been defined in a number of ways in financial circles. The three common
usages of the term are cash , working capita and total financial resources..
Cash: Under this concept, the term “funds” is used only in the sense of cash. Here, only the
changes in cash are considered. Hence, the statement is called “Cash Flow statement. This
statement aims at listing the various items which bring about changes in the cash balance
between two balance sheet dates. Cash planning becomes useful for control purposes.
Using this method has certain disadvantages. Since cash is considered as short term assets,
they are subjected to short term fluctuations. A delay in making payment to suppliers and a
provision of one month’s credit for making a payment of land purchases may show sufficient cash
flow . They may reflect a satisfactory position. But it is not a reality. Therefore, cash equivalent
concept of fund is useful only for short term financial planning and not for long term or
general financial position assessment.

or decrease working capital are included in this statement. It excludes all such items which do
not affect the working capital. The working capital concept of funds is in conformity with normal
accounting procedures. Hence, a funds flow statement based on this concept fits well with the
other statements. Moreover, working capital is also a measure of short term liquidity of the firm.
Therefore, an analysis of factors bringing about a change in the amount of net working capital is
useful for decision making by shareholders, creditors and management. Due to these reasons,
the working capital approach to funds is more useful than the cash approach.
Total Financial Resources : The term “funds” is very often used in the sense of useful financial
resources also. Cash approach and working capital approach both are incomplete and
inadequate to the extent that they omit a few major financial and investment transactions. Such
items do not affect net working capital. But, if they are included, they would certainly provide
qualitative information for the decision making.,
For example issuing equity shares and debentures for purchase of buildings or assets shall not
have any effect on the working capital. But it is a significant financial transaction that should be
disclosed. Therefore, this concept seems to be the best approach to disclose the changes in the
financial position as compared to other concepts. It is in conformity with the statutory regulations
and legal requirements.
4. Working capital is __________________________________.
6. Working capital means ______________________________.
Objectives:
The main objectives of the funds flow statement is normally based on the purpose its going to be
served. These are :
a) to help in understanding the changes that are likely to take place in the assets and liabilities

b) To inform the stakeholders as to how a firm can use the funds which are available at its
disposal.
c) To bring out the financial strengths and weaknesses of the business.
1. The objectives of FFS is to identify ______________ in ______. and ____.
2. FFS is to bring out _______________________.
10.4 Techniques Of Preparing A Funds Flow Statement
Like other accounting statements, the structure of Fund Flow Statement is based on the equality
of financial assets and liabilities including capital. The basic understanding is that the funds are
obtained through profit, external borrowings or by issue of shares. If funds are not available
readily from these sources, the other alternative available is to sell the fixed assets and
investments. . The preparation of Funds Flow Statement is normally based on the following to
bring to scientific method of preparation.
a) Schedule of working capital changes
b) Statement of Sources and Uses of Fund.
Schedule of Working Capital Changes : It is also known as “Comparative change in Working
Capital Statement” or “Working Capital Variation Statement”. The net change in working capital
is projected here in the place of individual changes in all the current assets and current liabilities
in the Funds Flow Statement. The statement indicates the amount of working capital at the end of
two years. It shows the increase or decrease in the individual items of current assets and current
liabilities. The effect of the changes in the individual items of the current assets and current
liabilities on working capital is also presented clearly and precisely. The difference in the amount
of working capital at the end of two years will depict either the increase or decease in working
capital. While ascertaining the increase or decrease in individual items of current assets and
current liabilities and its impact on working capital, the following Rules should be taken into
account.

It is, therefore, noted that the changes in the items of current assets are positively correlated to
the changes in the working capital. On the other hand, changes in current liabilities are inversely
related to the changes in the working capital.
2. FFS is prepared based on ___________________.
3. Working capital schedule indicates the ______________________.
4. Increase in current assets ___________________ the Working capital.
5. Decrease in CA _____________________________________ the WC.
6. Increase in CL ______________________________________ the WC.
7. Decrease in CL ______________________________________ the WC.
8. Changes in CA ________________________________ changes in WC.
9. Changes in CL ________________________________ changes in WC.
10.5 Sources of Funds
The transactions that increase the working capital are sources of funds. Following may the
sources of funds in a concern.
Funds from operations : Profit earned by the concern during the current year is deemed to be
the source of funds. It is very important source of funds inflow. Net profit is arrived at by
deducting cost of goods sold and other expenses from total sales revenue. However, the profit so
calculated is seldom equal to the funds from operations because there are many items which are
debited or credited in the Profit and Loss Account which do not affect working capital. Therefore,
in calculating the funds from operations, the following adjustments must be kept in mind:
Items to be added back to net profit :
a. Non-fund revenue deductions: These are items which are debited to Profit and Loss
account. These do not cause outflow of funds such as depreciation and depletion on non-
current assets, amortization of fictitious and intangible assets, preliminary expenses,
redemption of preference shares or debentures, deferred charges, advertising suspense
account written off. If non fund expenditures does not affect the current assets such as
unexpired insurance, do not add back. So also, all allowances for income tax payable in
future years are excluded.
b. Non-trading charges or losses : These items which were debited to Profit and Loss account
reduce the profits but they do not cause any outflow of funds. Hence, profit should be
corrected by adding back all such charges and losses. These include appropriation of
retained earnings such as general reserve, dividend equalization fund, reserve for
contingencies, sinking fund. In addition the dividend on shares must be added back since it
is an appropriation and not trading charge. The losses arising out of sale of land, buildings,
machinery, long term investments which were written off to the profit and loss account must
be added back. Do not add the loss arising out of sale of a current asset such short term
investments. It is a trading loss and hence it will not require any adjustment. The amount set
aside as provision for current taxation will also be added back. This will be considered only
when the provision for taxation is treated as a charge on profits.
Items to be deducted from Net Profit.
The non fund and non trading revenue receipts or incomes must be deducted
Net profit in order to compute funds from operations. The items are:
(a) Dividend received or receivable: Although this transaction increases the current assets
such as cash and debtors, it is not a trading income. Hence, it should be deducted from the
net profits to determine the funds from operations.
(b) Retransfer of excess provisions: Where the provisions made for taxation, depreciation,
doubtful debts exceed the genuine requirements, the excess amount is transferred back to
the Profit and loss account. It does not create any inflow of funds since it is an accounting
entry. Hence, deduct it.
(c) Profit on sale of non current assets: It is a non trading income. Hence it must be
eliminated from the amount of profit.
(d) Appreciation in fixed assets: The amount of appreciation on revaluation of fixed assets is
normally credited to the profit and loss account. If it is so, deduct it from the profit to compute
the funds from operations.
2. Decrease in WC _____________________________.
3. Net profit is ________________________________.
4. Items to be added back to net profit are __________.
5. Some of non-fund revenue items _______________.

10.6 Increse in Funds
In a nutshell, the sources of funds can be observed as follows :
a) increase of fresh shares derived from increase in share capital.
b) Issue of debentures derived from increase in debentures.
c) Raising of new loan derived from increase in long term loans
d) Sale of fixed assets for cash or for other current assets derived from decrease in fixed assets
and additional information.
e) Non trading income
f) Profit from operations before deducting non cash items of expenses and losses and before
additional non cash, non trading incomes.
g) Decrease in working capital derived from the Schedule of Working capital changes.
2. Increase in debentures _______________________________ of cash.
3. Increase in raising loans ______________________________.
4. sale of fixed assets __________________________________.
5. Non trading income is _______________________________.
6. Profit f rom operations is _____________________________.
7. Decrease in working capital is ________________________.
10.7 Decrease in Assets
Decrease in assets is always a source of funds for the business. Decrease may be in many
ways: such as cash received from debtors, sale of goods for cash, Bills realized, sale of assets,
fixed assets through provision for depreciation or amortization of fictitious assets. Decrease in an
item of assets results in either a parallel decrease in some other liabilities or a parallel increase in
some other item of assets example repayment of bank loan.. It should be remembered at the
very outset that the decrease is ascertained by comparing the cost of fixed assets and not by
comparing the written down value i.e cost less depreciation. If fixed assets have been shown not
at cost but at written down value, then cost may be ascertained by adding total depreciation
written off to-date (generally known as accumulated depreciation) to the written down value The

the problem about this. The decrease in fixed assets not on account of depreciation or writing off
is known as sale of fixed assets. It must be noticed that the total sale proceeds and not the cost
of fixed assets sold are shown as source of fund. If the information in respect of sale of fixed
assets is not clearly given, the following steps should be taken to find out the value of sale
proceeds.
Less: Cost of Fixed Assets of Current year ( ………………)
Cost of Fixed Assets x x x x x x x x
ADD : Profit or DEDUCT loss on sale ………………………
Sale Proceeds to be treated as source XXXXXXXXXXXXXX
The amount of profit or loss on sale of fixed assets for the above purpose derived from profit and
loss account or from capital reserve or from any specific reserve. This is based on the fact that
such profit or loss are credited or debited or transferred to these accounts in accordance with the
accounting principles. It must be remembered that profit or loss on sale of fixed assets are not
included in profit from operation for the purpose of this Fund Flow Statement.
If such profit or loss has been included in Profit and Loss Account , adjustment has to be made.
If there is profit on sale of assets, the net profit disclosed by Profit and Loss Account is reduced
by the amount of profit earned on the sale of fixed assets. On the other hand, the net profit
shown by Profit and Loss Account is increased by the amount of loss incurred on the sale of fixed
assets.
Example:
The land and buildings account had a balance of Rs.5,00,000on Jan 2007. A piece of land has
been sold . There is no purchase. Rs.30,000 depreciation has been charged in 2007. The profit
on sale has been credited to Capital Reserve Account . The balance stood on January 1, 2007
was Rs.20,000 and Rs.50,000 on December 31. The balance of land and building account as on
December 31 is Rs.4,50,000. Find the sale proceeds.
Solution
Balance of land and building on Jan 1, 2007 5,00,000
LESS : Depreciation charged (30,000)
LESS: Balance of Land and Building on Dec 31 ( 4,50,000)
Cost of Land sold 20,000
ADD : Profit on sale (derived from capital reserve) 30,000
(closing minus opening balance
2. Profit or loss on sale of fixed assets ____________________.
10.8 Increase In Liabilities
The increase in liabilities is always a source of funds for the business. It may occur as a result of
many transactions such as equity share capital or / and debentures to the public., purchase of
goods on credit. Outstanding expenses are also considered as source of funds since payments
are postponed and cash saved is parked in the business. A comparison of the amount of the
items of long term liabilities i.e debentures and mortgage and other loans for the current year and
previous year will disclose the increase or decrease in the long term liabilities. Additional
information should also be taken into account for determining the correct amount of increase or
decrease for the purpose of this statement.
Any increase on account of the issue of debentures for consideration other than cash or current
assets for the purchase of fixed assets or redeeming other debentures or preference shares
would not at all be shown in the statement because in such a case there is no flow of fund.
2. Outstanding expenses is __________________ .
10.9 Increase In Net-Worth
There can be only two main channels of increase in net-worth or equity :
a) procurement of more funds by issue of additional shares
b) through accumulation of retained earnings or profits in business
As the increased in owned funds is concerned, it happens only when the business has plans for
expansion, diversification, modernization. The increase in paid-up equity

Share capital is not a regular feature. Its occurrence is only sporadic. But profit generated from
operations is a normal feature and is virtually a continuous process from year to year. Profit
earned during an operating period increases the new worth of the business and hence it is
always considered as a source of funds. Sometimes, the premium received on sale of equity
shares and credited to share premium account is also a source of funds as it adds to the size of
net worth .
Share capital consists of equity share capital and preference share capital. The change in equity
share capital is always in the form of increase it can never be in the form of decrease. The
increase in equity share capital as per Balance Sheet values must be adjusted in terms of
additional information. If the increase has taken place on account of the issue of fresh shares,
only that portion of increase should be treated as sources which is due to the issue of fresh
shares for cash and other current assets. Increase on account of share issues for consideration
involving the purchase of fixed assets or redemption of preference shares or debentures shall
not partake the character of inflow of funds and hence should not be shown in the statement. If
fresh shares have been issued at premium, the amount of premium must be added to the
increase in share capital for the purpose of showing it as source of fund. If the fresh shares
have been issued at discount, the amount of discount must be deducted from the increase in
share capital because it does not involve inflow of fund.
Example:
The opening and closing balance of Share capital are Rs.6,00,000 and Rs.9,50,000 respectively.
The Preference Share capital included in opening balance is Rs.1,00,000. During the year,
Rs.75,000 worth of Preference shares were redeemed at 8 % premium. Bonus shares at Re.1
for every five equity shares held . In addition, a business was purchased by issue of Rs.90,000
shares at a premium of 10 %. The opening and closing balance in the Premium Account is
Rs.8,00,000 and Rs.14,000 respectively. Calculate the further fresh issue.
Solution:
Less: Redemption of Preference

(1/5 of 6,00,000)
8,000 minus 9,000) 3,000
2. Increase in net worth is needed for ________________________.
3. Profit earned _________________________________ net worth.
4. Premium on shares is __________________________.
5. Change in equity shares is always ________________.
6. Decrease in preference share capital is ____________.
10.10 Sources Of Funds
The use of funds results in cash outflows. The outflows are known as :application” of funds. The
uses of funds are mainly concerned with.
a) Redemption of Preference shares in cash derived from decrease in share capital.
b) Redemption of debentures in cash derived from decrease in debentures
c) Repayment of loan derived from decrease in long term loans
d) Purchase of fixed assets for consideration other than shares, debentures or long term debt
derived from increase in fixed assets and additional information.
e) Loss from operations
3. Redemption of debentures is __________________.
4. Redemption of long term loan is _______________.
5. Purchase of fixed asset is _____________________.
6. Loss from operations is ______________________.

7. Payment of dividend is ______________________.
10. 11 Increase In Assets
The increase in fixed assets is known in the accounting language as “Purchase of fixed assets”.
In order to find out the increase in fixed assets, cost of fixed assets of previous year as reduced
by the cost of fixed assets sold during the current year is deducted from the cost of fixed assets of
the current year. In other words, the increase in fixed assets is calculated as under :
Cost of Current year fixed assets ………………
DEDUCT Cost of previous fixed assets ………..
LESS: Cost of fixed assets sold or
Written off during the
Current year (……….) (………………..)
INCREASE in fixed assets x x x x x x x
Example: The opening and closing written down balances of an asset are Rs.5,00,000 and
Rs.5,50,000. The accumulated depreciation has been Rs.1,50,000 at the beginning and
Rs.1,90,000 at the close. A machine costing Rs.30,000 (accumulated depreciation Rs.18,000)
was sold during the year for Rs.9,500. Calculate the purchase price of the fixed assets.
Solution
Depreciation : 5,50,000 + 1,90,000 7,40,000
Value + opening accumulated Depreciation
(6,20,000)
1,20,000
Sometimes, it may happen that the cost figures cannot be ascertained on the basis of information
available. Increase in fixed assets, in this case, has to be found out with reference to the written
down value along with annual depreciation. If no purchase of fixed assets were made during

should be equal to the values of the previous year minus annual depreciation for current year.
The excess of current year’s value over previous year’s value minus annual depreciation will be
treated as increase. This will represent the purchase of fixed assets.
Current year written down value of Asset ……………..
DEDUCT Previous year WDV
_______________
Increase in Fixed Asset being Purchases x x x x x x
Example: The written down value of a Machinery at the beginning and at close were Rs.2,00,000
and 1,75,000. An old machine whose written down value was Rs.12,000 was sold for Rs.6,500.
Rs.32,000 depreciation was charged during the current year. Calculate the purchase price.
Solution:
DEDUCT : Previous year written down
Value of Machinery 2,00,000
1,68,000
(1,56,000)
2. Purchase is _______________________________________.
________________.
10.12 Decrease In Liabilities
It implies application which is the flow of funds out of business. Decrease in liability may be done
due increase in one or more liability items or due to decrease in one or more asset items. It may
also be partly due to increase in liability and partly due to decrease in assets. . Any amount of

account of redemption of debentures through the issue of another debentures or preference
shares should also not be shown in the statement.
Example:
On January 1, 2007, the balance of 8 % Debentures Account stood at Rs.5,00,000. Rs.60,000
debentures were repaid at 5 percent premium. Rs.75,000 debentures were purchased at Rs.95
from the market and cancelled. The closing balance of debentures was Rs. 2,00,000. Calculate
the outflow of funds.
LESS: Closing balance of Debenture Account ( 2,00,000)
Decrease 3,00,000
Value of Rs.100 each or 750 debentures x
Rs.5 each (Rs.100 minus Rs.95) ( 1,250)
2,98,750
Outflow of funds 3,01,750
2. Premium on redemption of debentures is _____________ .
10.13 Net Worth
It may be used due to (a) loss from operations (b) payment of cash dividend out of accumulated
reserves and (c) return of a part of paid up share capital to shareholders implying reduction of
share capital – a rare occurrence. If there is decrease in preference share capital and this
decrease is on account of redemption of these shares in cash or other current assets, such
decrease should be shown as use of fund. But the decrease on account of redemption by the
issue of another preference shares or equity shares or debentures, shall never be shown in the
statement because it will not involve outflow of fund. If the preference shares have been
redeemed at a premium, necessary adjustments should be made

3. Net worth can be ________________________.
10.14 Flow of Funds
It refers to change in fund. Increase of funds of any transaction is a source and decrease of
funds in any transaction is application or uses of funds. But the transactions which do not result
in any change in the funds is called “Non-fund”. Flow of fund takes place when a business
transaction brings a change in the working capital. Such change may be increase or decrease.
The increase is a positive change and the decrease being the negative. These directions in
change are known as fund elements or fund factors. They are commonly known as “inflows” and
“outflows”. The basic rule is :
Flow of fund if a transaction involves :
a) Current assets and fixed assets that is machine sold for cash
b) Current assets and fixed liabilities that is issue of debentures to the public
c) Current assets and owner equity that is issue of shares for cash
d) Current liabilities and fixed assets that is transfer of assets to discharge a claim
e) Current liabilities and fixed liabilities that is conversion of creditors due by issue of
debentures.
f) Current liabilities and capital that is conversion of creditors into owner’s equity by issue of
equity shares.
5. Flow takes place due to __________________ working capital.
6. The increase in fund is a __________________ change.
7. The decrease in fund is a __________________ change.
10.15 Transactions that do not affect the flow of Funds
a) Current assets and current liabilities creditors paid
b) Fixed assets and fixed liabilities purchase of assets for debentures

10.16 Steps In Preparation Of Funds Flow Statement
There are three steps involved in the preparation of a Fund Flow Statement (FFS). They are as
follows:
a) Preparation of Statement of changes in working capital or Schedule of changes in working
capital.
b) Preparation of Adjusted Profit and Loss Account (APL)
c) Statement of changes in Financial position as per AS – 7
2. Second step in the preparation of FFS is _____________.
3. Third step in the preparation of FFS is _______________.
10. 17 Computation of Changes in Working Capital and Funds f rom Operations
It is a customary practice that only the net changes in working capital should be shown in the
Fund Flow Statement instead of individual changes. Here, the current assets and current
liabilities are considered. For this purpose, a separate statement or schedule is being prepared.
Individual items are entered here. The opening and closing balances are entered one after the
other. The corresponding increase or decrease are entered based on the following rules :
a) Increase in a current asset item increases working capital.
b) Decrease in a current asset item decreases working capital.
c) Increase in a current liability item decreases working capital.
d) Decrease in a current liability item increases working capital .
Insert the total of current asset and current liabilities of both opening and closing periods. Say,
the total of current assets as A and that of total of current liabilities as B. Deduct A minus B. The
answer is known as net Working capital. If the working capital at the end of the current year is
more than the working capital at the end of previous year, the excess is called as “increase in
working capital”. Otherwise, if previous year’s working capital is more than the current year’s
working capital, the difference is called as “Decrease in working capital”. Increase in working
capital is shown as application of funds and decrease in working capital as source of funds in the
Funds Flow Statement.
The funds from operation can be found with the help of preparing an Adjusted Profit and Loss
Account.
2. Working capital equation is _______________________.
3. A is total _____________________________________.
4. B is total ____________________________________.
5. Working capital is _____________________________.
10.18 Layout
The layout for schedule of changes in Working Capital is as follows
Balances as on Effect on
Details Last Current Increase Decrease
Year Year
CURRENT ASSETS
CURRENT LIABILITIES
Sundry Creditors
Bills Payable
Bank Overdraft
Outstanding expenses
NET WORKING CAPITAL
A minus B

Jan 1 Dec 31
Bills Receivable 16,000 30,000
Prepare a schedule of changes in working capital

Details Jan 1 Dec 31 Increase Decrease
Current Assets
Sundry Debtors 65,000 1,05,000 40,000
Bills Receivable 16,000 30,000 14,000
Inventory 90,000 84,000 – 6,000
Current Liabilities
Short term loans 32,000 36,000 – 4,000
Total Current Liabilities, B 1,10,000 1,49,000
Working Capital A minus B 89,000 1,10,000
Net Increase in working capital
(balancing figure) 21,000 21,000

Example :
Prepare a statement of changes in working capital from the following information.
Jan 1 Dec 31
Provision for Depreciation on Fixed Assets 22,000 27,000
Investments in shares of subsidiaries 15,000 15,000
8% Debentures (redeemable in 5 equal
annual instalment of Rs.20,000 each,
from the current year) 20,000 –
Prepaid expenses 21,000 14,000
Outstanding expenses 5,000 12,000
Solution
Details Balances as on Effect on WC
Jan 1 Dec 31 Increase Decrease
Current Assets
59,000 39,000 3,000
Dr. Cr.
To By
Depreciation Provision last year from Balance
Preliminary expenses written Sheet
Goodwill written off Profit on sale of Fixed assets
Discount on issue of shares and Dividend and interest received
Debentures written off from trade investments
Fixed assets discarded or
Loss on sale of trade investments TRADING OPERATIONS
Transfer to General Reserve, (balancing figure) transferred
to Funds Flow Statement as
Sinking Funds, Reserve Funds application of funds
Transfer to other Reserves
Premium on redemption of
Year Profit and Loss Account
TOTAL
NOTE : If debit total of APL is more than the credit total, the difference is Funds generated from
Operation : Record on the credit side of Adjusted Profit and Loss Account.
If credit total of APL is more than the debit total, the difference is funds lost in operations. Record
on the debit side of Adjusted Profit and Loss Account
The balancing figures should be transferred in opposite direction to Funds Flow statement..
Example 3: Calculate funds from operations from the following Profit and Loss Account
To By
Outstanding
Loss on sale of machine 4,000
Discount 200
Goodwill 20,000
To Rs. By Rs.
Discount written off 200 (balancing figure)
Loss on sale of machines 4,000
Net Profit 1,15,800
2,10,000 2,10,000
Example 4: Following are the extracts from the Balance sheets of DR Lt.
31-3-2007 31-3-2008
Rs. Rs.
General Reserve 7,400 9,250
Preliminary expenses 2,200 1,500
During the year, the company sold land whose book value was Rs.50,000 for Rs.54,000 and paid
an interim dividend of Rs.2,000
Calculate funds from operations.
To Rs By Rs.
(9,250 minus 7,400) 1,850 being opening balance
Goodwill written off Profit on sale of land 4,000
(3,700 minus 1.850) 1,850
Depreciation written operations (balancing
Off 700 figure) 6,800
Interim dividend paid 2,000
Closing balance of Profit
And Loss account 14,800
NOTES:
1. There is an increase in the balance in General Reserve. It implies that some amount has
been transferred to the account from the Profit and Loss account. This is an appropriation of
profit which does not result in any outflow of funds.
2. The balance in Goodwill Account and preliminary expenses account has come down which
indicates tht the difference has been written. This also does not result in an outflow of funds.
3. The increase in provision for depreciation is on account of current year’s depreciation which
does not result in any outflow of funds.
4. Profit on sale of land and interim dividend being non-operating items are to be separately

Opening balance of Plant Rs.1,32,500. Closing balance of Plant Rs.1,97,500. Provision for
Depreciation in Plant at the beginning 45,000 and at close Rs.61,000. During the year
Rs.65,000 worth of Plant was purchased in exchange for fully paid debentures and old Plant
costing Rs.40,000 was sold for Rs.34,000. Depreciation provided Rs.18,000. Calculate the flow
of funds.
Debenture Account 65,000 Provision for Depreciation
(Plant purchased) Account : Depreciation on
sold 18,000
Bank Account : Plant
Calculation of Profit on sale : 34,000 minus (40,000 – 18,000) = 12,000
Provision for Depreciation on Plant Account
To By
Plant Account
Closing Balance 61,000 Depreciation (bal.figure 34,000
79,000 79,000
Note: For all Asset Account, record the opening balance on the debit side and closing balance on
the credit side of the concerned Asset Account. For all liabilities , record the opening balance on

10.19 TREATMENT OF CERTAIN ITEMS
There are certain items whose treatment is not uniform. Different authors differ differently. But,
in this study material, an uniformity is maintained. The likely arguments have been provided for
treating items on a particular principle. The items are :
Provision for Bad Debts
Sometimes, it is shown as reserve for bad / doubtful debts. Actually, this item is shown as
deduction from total book debts to the asset side of the Balance Sheet. Therefore, this item
should be deducted from the amount of debtors shown in the schedule of working capital
changes. Since such treatment may complicate the calculation work, it is suggested that it should
be shown along with current liabilities, although, it does not belong to that category.
Provision for Tax:
DO not treat this item as a current liability. The Provision has to be made to meet the tax liability
of current year. If there is a Provision for last year, it has to be paid this year. Hence, the last
year Provision actually becomes the current year cash outflow. Hence record it in the Funds flow
statement.
Proposed Dividend
Normally, the proposed dividends are given as Balance Sheet item on the liability side. The
Directors propose the final dividend which needs to be approved by the General Meeting. Hence,
it is fair to assume that the proposed dividend is not a current liability. Do not show in the
schedule of working capital changes. The last year proposed dividend should be paid during the
current year, hence a cash outflow
Investments
It poses problems in its treatment. The Rule is :
a) if the investments are in the form of Government or other marketable securities, treat it as
current assets.
b) If it is mentioned as trade investments, that is investments in shares and debentures of
another companies, treat it as fixed assets.
c) If nothing is mentioned specifically, the treatment is :
: if investments have been sold simultaneously, treat it as current assets
: in other cases, treat it as Fixed Assets.

Depreciation
Normally, the value of deprecation will be provided in the problem as an adjustment items.
Depreciation is a non cash item. It is, therefore, charged to Profit and Loss and recorded in the
concerned Fixed Assets Account. If the depreciation is given as a percentage, calculate the
value on the opening balance of the concerned account.. If the value of depreciation is not
given, it has to be found out as follows :
Opening balance of Fixed Assets ……..
ADD: Purchases …….
Depreciation charges x x x
If a concern intends to show its fixed assets at its cost price, the periodic annual depreciation is
shown under “liabilities” side as Provision for Depreciation commonly known as Accumulated
Depreciation Fund Account. If there were to be an Accumulated Depreciation Fund Account in
already in operation, the current year depreciation is charged against this Provision for
accumulated Depreciation Account and not recorded directly into Adjusted Profit and Loss
Account . In other words, the current year depreciation is routed through the Provision Account.
Increase / Decrease in Fixed Assets
The increase or decrease by means of cash is recorded in the FFS. Increase or decrease due to
purchase consideration through shares and debentures are not recorded.
Increase / Decrease in long-term liabilities
Compare debentures and mortgages as per the Balance Sheet figures. Only consider if cash is
the main striker to cause the increase or decrease. If the changes were to be due to
consideration other than cash or current assets, do not record it in the FFS..
Hidden Items
Prepare the necessary ledger accounts concerned in the fixed assets, fixed liabilities and share
capital and carry out all the necessary adjustments. The balancing figure, if any, would be the
cash transactions. For all non, cash transactions, concentrate on the Adjusted Profit and Loss
Account.
2. Provision for doubtful debts is _______________ from gross debtors
3. Provision is shown in _______________________
4. Provision for tax may be _____________________
5. If Provision for Tax is maintained , treat it in _________________
6. Proposed dividend is shown on ________________ of Balance sheet
7. Proposed dividends are to be approved by _____________________
8. Proposed divided. Is not considered as ________________________
9. Last year proposed dividend is cash __________________________
10. Government investments are _______________________________
12. Depreciation is _____________________
14. If Depreciation is given as a percentage, calculate on _____________
15. If Provision for depreciation account is maintained, charge the current depreciation to
_____________ and not to _______________________
Problem 6: The Balance Sheets are given below :
Year (Rs.in lakhs)
Debentures 10 -

2006 2007
Working Capital : CA minus CL 80 110
Net Increase in working capital transferred to 30 -
FFS (application)
110 110
To By
Closing Balance 30 Funds from Operations 6
36 36
Issue of Equity shares 60 Purchase of Fixed Assets 16
Funds from operation 6 Purchase of investment 10
Redemption of debenture 10
66 66
Problem 7 : From the following extracts, calculate funds from operations
Year
Proposed dividends 5,000 10,000
Additional information: Tax paid Rs.2,500. Dividends paid Rs.1,000.. Calculate funds from
operation taking provision for tax and provision for tax and proposed dividend as (a) non current
liabilities and (b) current liabilities.
Solution:
Provision for tax and proposed dividend are taken as non-current liabilities
To By
Closing balance 15,000 provision made (balance
Figure)
Dividend paid during the Profit and loss account
Year 1,000 proposed dividend 6,000
Closing balance 10,000
To By
Proposed Dividend 6,000 Funds from operations
Closing balance 80,000 (balancing figure) 43,500
93,500 93,500
c) If Provision of tax and proposed dividend are taken as a current liability, funds from
operations will be the difference in Profit and Loss account at the beginning and the end of
the year.
NOTES
1. In case a) Income tax paid Rs.2,500 and Dividend paid Rs.1,000 are shown as application of
funds in the FFS.
2. In case (b), there is no need to prepare proposed dividend account and provision for tax
account,. However, the opening and closing balances of the two accounts are shown as
current liabilities in the statement of changes in working capital
Problem 8: The book value of trade investments of DR Ltd as on March 1, 2006 and March 31,
2007 was Rs.50,000 and Rs.70,000 respectively. During the year, Rs.5,000 was received as
dividends, of which Rs.2,000 pertained to pre-acquisition profits which have been credited to
Investments Account. Investments costing Rs.10,000 have been sold during the year for
Rs.10,000. Find the flow of funds on account of investments.
Solution:
Of investments (balance 32,000 Bank : sale of investments 10,000
Notes:
1) The investments purchased were valued cum-dividend. Hence, on receipt of dividends, they
were rightly credited to Investments. Hence there is no need for any further adjustment.
2) The investments sold has been at the book value. There is no profit or loss on account of the
transactions. If the transaction had resulted in profit, it will have to be deducted from net profit
to calculate funds from operations. In case of loss, it would be added to net profit to calculate
funds from operations.
Problem 9: Prepare a fun d flow statement of DR Ltd.
Year
11 % debentures 8,00,000 6,00,000
Share Premium Account 1,00,000 95,000
Additional information (a) 10 % Preference shares have been redeemed at a premium of 10%,
the premium amount was charged to the share premium account (b) There has been a profit of
Rs.1,000 on the redemption of debentures.
Solution:
Bank (Fresh issue) 5,00,000
Premium on redemption 30,000
Profit on redemption 1,000
capital
1,25,000 1,25,000
Equity share capital 5,00,000 Redemption of Preference shares 3,30,000
Share Premium 25,000 Redemption of Debentures 1,99,000
Decrease in working capital 4,000
5,29,000 5,29,000
Problem 10: The following are the summarized Balance Sheets of DR Ltd.
Liabilities 2006 2007
Debentures 3,00,000 2,50,000
Provision for Income tax 60,000 80,000
12,20,000 12,20,000

2006 2007 Increase Decrease
Cash 1,00,000 75,000 - 25,000 .
Current Liabilities
Provision for income tax 60,000 80,000 - 20,000
Total CL, say B 2,30,000 2,40,000
Working Capital, A – B 3,60,000 4,35,000
Increase in Working capital 75,000 - - 75,000
Total 4,35,000 4,35,000 1,40,000 1,40,000
Adjusted Profit and Loss Account
To By
Depreciation 90,000 Funds from Operation 1.45,000
Closing balance 65,000 transferred to source
1,85,000 1,85,000
Sources Application
Increase in working capital 75,000
2,45,000 2,45,000
Notes:
1) The increase in General Reserve is due to transfer a part of profit of the current year and
hence the difference is transferred to APL since it’s a non-cash item
2) The difference in depreciation is charged to APL, since it’s a non-cash item.
3) Increase in Equity Share capital is assumed to be the fresh issue which is a cash item. It is
recoreded in FFS.
4) The difference is debentures is the redemption. It’s a cash item. Hence taken to FFS
5) Purchase of fixed asset is difference between the opening and closing balance of fixed
assets. It’s a cash item. Hence taken to FFS .
Problem 11
Balance Sheets
Profit & Loss 14,750 17,000 Debtors 25,000 27,000
Trade Creditors 31,000 29,000 Investment 5,000 -
Mortgage 10,000 15,000 Fixed Assets 70,000 80,000
Short term loans 16,500 15,000 Less: Depreciation (25,250) (7,000)
Accrued expenses 7,500 8,000 Goodwill 5,000 -
1,29,750 1,49,000 1,29,750 1,49,000

Balances as on
Current Liabilities
Accrued expenses 8,000 7,500
Working capital, A – B 20,000 24,000
Net increase in Working capital 4,000 -
Total 24,000 24,000
To By
Dividend 3,500 operations 12,500
Issue of fresh equity 15,000 Purchase of fixed assets 30,000
Sale of investment 5,000 Payments of dividends 3,500
Loan on mortgage 5,000 Increase in working capital 4,000
Funds from operations 12,500
Rupees in 000s
Debenture - 25 Plant 18 96
Profit and Loss 15 25 Stock 40 35
Proposed Dividend 5 6 Debtors 15 32.5
Creditors 20 30 Cash 8 9
Liabilities for expenses 5 3.5 Preliminary exp 4 2.5
100 200 100 200
A business was purchased during the year by the issue of 25,000 shares and 25,000 debentures.
Depreciation Rs.6,000 has been provided in the year. A machine has been sold for Rs.1,50,000,
the written down value being Rs.1,000. The business purchased had the following assets and
liabilities : Machine Rs.20,000, Stock Rs.5,000, Debtors Rs.15,000, Creditors Rs.5,000. Prepare
the Funds Flow Statement.
Solution
In this problem, another business concern was purchased whereby the assets and liabilities come
into business. For this purchase, the payment is through the issue of shares and debentures. If
the payment were to be in excess of assets and liabilities taken over, the excess payment is
known as “Goodwill”.
Stock 5,000
Debtors 15,000
Total payments made : Share capital + Debentures 50,000
Excess payment being treated as Goodwill (50,000-35,000) 15,000
Statement showing changes in working capital:
Balances as on
Current Liabilities
Overdraft 5,000 10,500
Working capital A – B 33,000 32,500
Decrease in working capital (source) - 500
33,000 33,000
To By
Preliminary expenses 1,500 Profit on sale of Plant 500
Depreciation 6,000 Funds from operations 28,000
Proposed dividend 6,000
cash for current assets
Funds from operations 28,000
Capital 500
70,000 70,000
Terminal Question
Problem 1: The balance in the Provision for taxation : opening Rs.30,000 and closing
Rs.40,000. Taxes paid during the year was Rs.25,000. Calculate Funds from operation. (b) What
is the provision made during the year?

2006 2007
General Reserve 20,000 25,000
Calculate funds from operation
Profit and Loss Account
Depreciation 70,000 Gain on sale of land 60,000
Loss on sale of plant 4,000
Discount on Debenture 200
Plant (gross) 1,00,000 1,25,000
b) Depreciation charged - 14,000

Capital 25,000 20,000 Cash 4,700 3,000
Profit and Loss 2,300 1,000 Debtors 11,500 12,000
Bills Payable 4,500 7,000 Land 6,600 5,000
Stock 9,000 8,000
Answer Self Assessment Questions
2. Two
2. Control
4. Current assets minus current liabilities
5. Excluded
8. Qualitative information
1. Financial assets and liabilities including capital

4. Increases
5. Decreases
6. Decreases
7. Increases
4. Non fund revenue, non trading changes or losses
5. intangible assets and revenue items
6. Appropriation of retained earnings.
1. Source of funds
2. Source of funds
2. Expansion, diversification and modernization

6. Redemption
3. Increase in fixed assets
1. Change of fund
2. Adjusted Profit and Loss account
3. Funds flow statement
3. (c) Current assets
5. In Provision account
15. Provision account and not to Profit and Loss account
16. Fixed assets
1: 35,000, (b) Taxes paid is an application of funds.
2. Rs.24,000
3. Rs.1,50,000

Structure:
11.1 Introduction
The funds flow analysis deal with the flow of funds within and outside the organization. The main
focus of funds flow statement is to explain the changes which have taken place in net working
capital during the period under consideration. Funds flow statement normally fails to explain the
changes in cash balance. The movement of cash is of vital importance to the management. The
organization may become directionless if the cash inflows are not sufficient to meet the cash
outflows. Many a time, a management is posed with the paradox of huge profits and yet
impossible to pay dividends or even taxes. This is due to the ground realities that cash is either
not received or the cash received is drained out in other items. Hence, it has become a
necessity to have a cash flow analysis on a day to day basis. The statement shows the items
resulting in cash inflows and cash outflows.

1. Understand the meaning of cash flow statement.
2. Appreciate the uses of cash flow statement.
3. Acquaint with steps in preparation of CFS.
4. Distinguish between FFS and CFS.
5. Compute the CFS.
11.2 Meaning of Cash Flow Statement
Cash flow statement, also known as “Statement Accounting for variations in cash” shows the
movement of cash and their causes during the period under consideration. The statement is
mainly prepared to show the impact of financial policies and procedures on the cash position. It
takes into account all the transactions that have a direct impact upon cash.
11.3 Objectives
The main objective of cash flow analysis is to show the causes of changes in cash balances
during the period under consideration. The necessary information required to keep the
management of the real cash position, this statement is comes handy. It bring in the liquidity
position of the firm. It is of particular importance in short range planning. It enables a
management to take a strong short term financial decision relating to liquidity and ways and
means to achieve it.
2. CFS brings in ___________________ position.
3. CFS is ________________ of importance in ________ planning.
11.4 Uses of Cash Flow Statement
The cash flow statement, being one of the important financial documents a firm has to possess ,

It also shows the major sources and uses of cash. By effectively maintaining the cash and
controlling the outflow of cash, it is possible to set in motion the smooth functioning of the
organization. It helps the financial decisions more effectively with regard to short term liquidity
position of an organization. Projections of cash inflows and outflows can be regulated based on
the records available in the past. Proper projections can be made once the reasons are
analyzed. Based on this, it is possible to liquidate the short term obligations without much fun-
fare. Short term obligations need to be serviced so that the credit worthiness of an organization
can be carried on unabated.
2. CFS shows _________ flows.
11.5 Steps In Preparation Of Cash Fl

MBA-Financial and Management Accounting

Documents

Transcript of MBA-Financial and Management Accounting