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Understanding Financial Statements

This document provides an overview of key accounting concepts and financial statements. It discusses the accounting equation, double-entry bookkeeping, types of accounts, ledgers, trial balances, profit and loss statements, and balance sheets. It explains fundamentals like the entity, going concern, historical cost, and accrual concepts. Standard formats are shown for profit and loss statements and balance sheets. The document also discusses the qualities of well-presented financial statements and why developing a proper accounting system is important.

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Abhay
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178 views

Understanding Financial Statements

This document provides an overview of key accounting concepts and financial statements. It discusses the accounting equation, double-entry bookkeeping, types of accounts, ledgers, trial balances, profit and loss statements, and balance sheets. It explains fundamentals like the entity, going concern, historical cost, and accrual concepts. Standard formats are shown for profit and loss statements and balance sheets. The document also discusses the qualities of well-presented financial statements and why developing a proper accounting system is important.

Uploaded by

Abhay
Copyright
© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Understanding Financial

Statements
Prof. (Dr.) Gourav Vallabh
XLRI, Jamshedpur

Business Transaction

Inflow of Funds

Revenues (I)

Outflow of Funds

External Sources L (Capital and Loans)

Direct Income

Indirect Income

Accounting Equation:
Assets + Expenses = Liabilities + Income
A+E=L+I

Purchase of Assets (A)

Revenue Expenses (E)

Concept of Double Entry


Every Transaction has two
aspects and according to this
system both the aspects are
recorded.
If

Then (Either / Or)

Relation

A is created

Another A reduces
L Increases
E Decreases
I Increases

Vice Versa

L is created

Another L reduces
A increases
E Increases
I decreases

Vice Versa

E is incurred

A reduces
L increases

Vice Versa

I is generated

A Increases
L reduces

Vice Versa

Classification of Accounts
1. Assets: Indicates the resources which
the firm enjoys.
2. Liabilities: Indicates the amounts
which the firm owes to the outsiders.
3. Expenses: Amount which has been
spent or even lost in carrying on
operations.
4. Income: Amounts earned by the firm

Ledger
On the basis of entries made in the
journal, accounts are prepared in T
form (as discussed earlier)
The book which contains the accounts
is called ledger.
Ledger is also called the principal
books of account.

Trial Balance
After passing the accounts in ledger, a
statement is prepared showing the debit and
credit balances in two separate columns.
These two columns agrees automatically.
T B helps to establish arithmetical accuracy
of the books of accounts.
Financial statements are normally prepared
on the basis of agreed T B.
T B serves as a summary of what is
contained in the ledger.

Profit and Loss Account


Expenses

Income

E
P

TOTAL = I

TOTAL = I

Balance Sheet
Liabilities

Assets

L
P

TOTAL = L + P

TOTAL = A

Proof of the Accounting Equation


LHS = L + P = L + (I E)
=L+IE
=A
= RHS (applying the
accounting
equation)

Profit and Loss Account


This is prepared for a certain period.
The revenue incomes and revenue
expenses pertaining to that year for which
the Profit and Loss Account is being
prepared are considered and the profit or
loss is computed.
All revenue expenses chargeable to that
year is taken into consideration irrespective
of the fact, whether it is actually paid or not.
Similarly all revenue incomes are also
considered irrespective of the fact whether it
is actually received or not.

Balance Sheet
This is prepared at a particular date.
Balance Sheet reflects the financial
position of the organization at that
particular date.
Balance Sheet depicts the assets and
liabilities position of the organization
at that particular date.

Fundamentals Concepts of
Accounts
1. Entity Concept: The business of the
owner and the owner himself are
considered as two separate entities. It is
due to this reason, that the owners fund
(Capital plus accumulated Surplus is
regarded as a liability of the business
entity)
2. Going Concern Concept: The business
entity to have perpetual existence.
3. Historical Cost Concept: Value of an
asset is to be determined on the basis of
the cost of acquisition.

Fundamentals Concepts of
Accounts Contd.
4.
5.
6.
7.

Accrual Concept: Recognition of revenue and


costs as they are earned or incurred rather than
money actually received or paid.
Consistency: Whatever may be the accounting
policies adopted, these are to be followed
consistently promoting comparability.
Conservatism: It is not prudent to account or
provide for unrealised gain but it is desirable to
guard or provide against all possible losses.
Matching Principle: If any income is recognised
in the books of accounts then the simultaneous
expenditure should also be booked.

A Standard Profit and Loss Account (In


vertical form)
Income
Sales
Other Income
Expenses
Cost of Goods Sold
Manufacturing Expenses
Establishment Expenses
Depreciation
Interest
Profit before Tax
Taxation
Profit after Tax
Distribution of Profits
Transfer to Reserves
Dividend
Retained Earnings

Notes

Rs.

A Standard Balance Sheet (In vertical form)


Employment of Capital
Fixed Assets
Investments
Preliminary Expenses
Deferred Revenue Expenses
Current Assets
Inventories
Receivables
Loans and Advances
Cash and Bank Balances
Current Liabilities
Trade Creditors
Provisions
Bank Overdraft
Net Current Assets
Capital Employed
Capital
Reserves and Surplus
Long Term Loans

Notes

Rs.

Qualities of well presented accounts


Readability
Transparency
Comparability
Reflecting a true and fair view of the state
of affairs of the business.
Informative
Compliance with the fundamental
principles and assumptions
Supplemented with adequate disclosures
for inconsistencies, non compliance with
reasons thereof.

Why it is necessary to develop a


good accounting system
Proper reflection of the actual financial
performance/results/position.
Aids in evaluating the strengths and
weaknesses of the organisation.
The first word in MIS
Information base for decision making
by the management
Compliance with various legal
formalities and statutory regulations

Users of Accounting Information


Internal User
Management

External Users
Investors
Employees
Lenders
Suppliers
Customers
Government
Tax Authorities and
other statutory
bodies.
General Public

Accounting as MIS
A large portion of accounting information is
prepared for management decision
making.
Accounting data is used as basic source
document for MIS
Management also depends on other data
source for information.
Accounting system can be moulded to
serve requirements of management
Accounting is an essential service function
to management.

Transactions of Photocopywala
1)Started business with cash Rs. 60,000,
deposited Rs. 20,000 at bank, brought paper
worth Rs. 10,000 from home
2) Bought furniture for Rs. 10,000 and paid cash.
3) Bought machines worth Rs. 60,000 and paid
Rs. 40,000 cash and balance to be paid after 2
months.
4) Paid Office Rent Rs. 3,000 by cheque.
5) Took a bank loan of Rs. 80,000.
6) Received cash for services Rs. 20,000.

.Contd
7) Paid interest on bank loan Rs. 4500.
8) Repaid 10% of the bank loan.
9) Withdrew cash of Rs. 10,000 from
the bank for personal use.
10) Provided services to Mr. ABC and
billed him for Rs. 5000, amount yet to
be received.
11) Collected Rs. 3000 from Mr. ABC

Solution

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