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Understanding Financial Accounting
Ashok Kumar Malhotra, FCA
Professor of Finance & Chairperson of Center forBusiness Management
June 2013
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Basics of Financial Accounting
Introduction
Types of business/Structure of business
Accounting equation GAAP
Conventions
Sample Transactions Trial Balance
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Situation - 1
Infotech was incorporated long back with help of
four friends of Mr. Sahil Gandotra. Infotech has
bank balance of Rs. 200 crores as of 18thJune
2010.
1. Is Infotech a wealthy company?
2. What is the net-worth of an organisation at a
point of time?
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Situation - 2
Infotech has a plant & machinery worth of Rs.
50 lakhs. Infotech is unable to make payment
of electricity bills for the last so many months.
What is the main problem?
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Situation - 3
Infotech is managed by five softwareprofessionals including Mr. Sahil Gandotra
and able to generate revenue of Rs. 45000
every month consistently for the so manyyears but without significant bank balance.
Is it a good company to work with?
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Situation - 4
Infotech has sales of $25/- lakhs and
expenses of Rs. 10/- lakhs and Capital of
50 lakhs, liabilities 25 lakhs and assets
150 lakhs. The data is for the period 2011-
12.
What do understand by about profitability of
Infotech for the period?
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Situation5
Infotech is a consistently profitable
company. 100% of each years profit is
withdrawn in the form of profit by owner
including Mr. Sahil Gandotra.
Can the company achieve sustainable
growth in future?
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Situation - 7
Car purchased by Infotech should be
recorded in accounts at:
Market Price
Value
Cost
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While analyzing a fin. St. one must
consider
i. Cash versus Credit
ii. Cost, Price, Value
iii. Capital Expenditure versus
Revenue Expenditure
iv. Tangible & Intangible Assets
v. Real accounts, Personal accounts
& Nominal accounts
Take now &
pay later
Pay now &
take later
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Financial Statements
vi. Accrual vs. Cash Basis
vii. Long-term vs. short term
viii. Current versus non-current
ix. Debt and owners capital
x. Debit meansExpense, Assets or Recoverable
xi. Credit meansRevenue/Gain, Liabilities or
Reserve
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Manufacturing Business
Product
Maruti Suzuki Cars, trucks, vans
HCL Infosys Computer chips
Bata Athletic shoes and apparel
Coca-Cola BeveragesPhilips Stereos and television
Types of Businesses
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Merchandising Business
Product
Big Bazar General merchandise
Land Mark Toys books etc.
Reliance Digital Consumer electronics
Amazon.com Internet books, music, videoretailer
Types of Businesses
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Service Business
Product
Appu Ghar Entertainment
Jaipur Golden Transportation
Taj Hotels Hospitality and lodging
PVR EntertainmentKarvy Consultants Financial advice
Bharti Airtel Telecommunication
Types of Businesses
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There are three types ofbusiness organizations
Proprietorship
Partnership
Company
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A partnershipis
owned by two or
more individuals.
Advantages
More financialresources than a
proprietorship.
Additional
management skills.
Disadvantage
Unlimited liability.
JM & Co
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A companyis
organized under state
or federal statutes as a
separate legal entity.
Advantage
The ability to obtain
large amounts of
resources by issuing
stocks.
Disadvantage
Double taxation.
JM & Co
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Cash cycle of a firm
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Revenue Expenses = Profit
The Accounting Equation
Sales Material Consumption
+ Expenses incurred
R>E
Profit
elselossWho has to enjoy profit?Who has to bear loss?
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The Accounting Equation
Assets = Liabilities + Owners Capital
The resources
owned by a
business
The rights of
the creditors,
whichrepresent
debts of the
business
The rights of
the owners
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Stock Equation (Quantity & Cost)
Opening Stock + Purchases = Consumption + Closing Stock
Inventory at
the beginning
InventoryPurchased
during the
period
Consumption,
Wastages etc.
of inventory
Closing based onphysical inventory
at the end of
period
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Verification/ approval
Vouchers & Supporting Documents
Enter the Primary Books Filed in Voucher file
Enter into Secondary Books
Compile Trial Balance
Final Accounts
Audited Statements of Account
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Chart of Accounts
Income accounts
Expense accounts
Asset accounts Liability accounts
Capital accounts
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Generally Accepted Accounting
Principles
Matching principle
Period Cost
Entity
There are four more GAAPs, we cover aswe progress
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Economic Transaction -
Vouchers1. Date2. Amount
3. Nature
Capital (Exp. Or gain)
Revenue (Exp. Or gain)
4. Head of accountNominal, personal, real
5. Cash / bank / otherwise6. Increase / decrease
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