UNIT V

FINANCIAL ACCOUNTING

ACCOUNTING MEANING:

It is the art of recording, classifying, summarizing, analyzing and reporting of business transactions and interpreting their effect on the affairs of the business concerns.

Branches of accounting

FINANCIAL ACCOUNTING

Cost Accounting

Management Accounting

Financial accounting gathers and summarizes financial data to prepare financial reports such as balance sheet and income statements for the firms management investors , lenders, suppliers, tax authorities, and other stakeholders It involves the recording and summarization of business transactions and events. Financial accounting relates to the preparation of financial statements for external users such as creditors, investors, and suppliers. The financial statements include the balance sheet, income statement, and statement of changes in financial position.

FINANCIAL STATEMENTS
The financial statements provide a summary of the accounts of a business enterprise, the balance sheet reflecting the assets, liabilities and capital as on ascertain date and the income statement showing the results of operations during a certain period

Financial Statements

Balance sheet

Profit & Loss Account

Statement of changes in Owners equity

Statement of changes in financial position

Funds flow

Cash flow

Trading, Profit & Loss A/c of . For the year ended.

To Opening Stock To Purchase Less: Returns Outwards To Wages To Freight To Carriage Inwards To Clearing Charges To Packing charges To Dock dues To Power To Gross Proft (to be transferred to P & L A/c) Xxx

xxx xxx

By Sales Less: Returns Inwards By Closing Stock By Gross Loss (to be transferred to P&L A/c)

Xxx xxx

Xxx xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx

xxx Xxx xxx

To Trading A/c (Gross Loss) To Salaries To Rent & Taxes To Stationeries To Postage expenses To Insurance To Repairs To Trading expenses To office expenses To Interest To Bank charges To Establishment expenses To Sundry expenses To Commission

Xxx By Trading A/c (Gross Profit) Xxx By Commission x earned Xxx By Rent received Xxx By Interest received Xxx By Discounts Xxx received Xxx By Net Loss Xxx (Capital A/c) Xxx Xxx Xxx Xxx Xxx Xxx

Xxx xxx Xxx Xxx Xxx Xxx xxx

To Discount To Advertisement To Carriage outwards To Traveling expenses To Distribution expenses To Bad debt provision To Net Profit (transferred to Capital A/c)

Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx

xxx x

xxxx

Balance Sheet of ___________ As on _____________

Liabilities Sundry Creditors Bills Payable Bank overdraft Loans Mortgage Reserve Fund Outstanding exp. Capital Add: Net Profit (or) Less : Net Loss Less Drawings Less: Income tax
Assets Xxx Cash in hand Xxx Cash at bank Bills receivable Xxx Sundry Debtors Xxx Closing Stock Xxx Furniture & Fittings Xxx Investments Xxx Plant & Machinery Loose tools Land & Buildings Business premises Horses & carts Prepaid exp. Patents & Trade xxxx marks

Xxx Xxx Xxx xxx

Xxx Xxx Xxx Xxx Xxxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx

Funds Flow Statement

Meaning & Concept of Funds: 1. Cash 2. Money Values 3. Working Capital Funds flow Statement - meaning: Statement which shows movement of funds Indicates various means by which funds were obtained during a particular period and the ways in which these funds were employed

List of Non Current or Permanent Capital Accounts

Non Current or permanent Liabilities

Non Current or permanent Assets

Equity Share Capital Preference Share Capital Redeemable Preference Share Capital Debentures Long Term Loans Share Premium Account Shares Forfeited Account Profit & Loss Account Capital Reserve Capital Redemption Reserve Provision for Depreciation Against Fixed Assets

Goodwill Land Buildings Plant & Machinery Furniture & Fittings Trade Marks Patent Rights Long- Term Investments Profit & Loss Account Discount on issue of Shares Discount on issue of Debentures Preliminary Expenses Other Deferred Expenses

Appropriation of Profits (a) General Reserve (b) Dividend Equalization Fund (c) Insurance Fund (d) Compensation Fund (e) Sinking Fund (f) Investment fluctuation Fund (g) Provision for Taxation (h) Proposed Dividend

Differences Between funds Flow & income Statement

Funds Flow

Income Statement

Shows changes in financial position Complementary to income statement Both capital and revenue items are considered No prescribed format

It depicts the items of expenses & income and arrive at profit or loss Not prepared from funds flow statement Only revenue items are considered Prepared in prescribed format

Differences between Funds flow statement & Balance Sheet

Funds Flow statement

Balance Sheet

Statement of financial changes Shows sources of funds & uses of funds Tool of Management for financial analysis and helps in making decisions Usually Schedule of changes in working Capital has to be Prepared before preparing fund flow statement

Statement of financial position on a particular Date Depicts the assets & Liabilities at a particular point of time Not much of help to Management in decision Making No such Statement is prepared. Rather P&L a/c is prepared.

Statement/Schedule of Changes In Working Capital

Particulars Current Assets:

Previous Year

Current Year

Effect in Working capital Increase Decrease

Total CA Current Liabilities:

Total CL Net increase In WC

Funds Flow Statement

Sources Funds From Operations Issue of Share of Capital Issue Of Debentures Raising of Long- term Loans Receipts From Partly Paid Capitals Sale Of non-current assets Non-Trading receipts like dividend Sale of Long term Investments Net decrease in Working Capital

Application Funds lost in Operations Redemption of Preference Share Capital Redemption of Debentures Repayment of Long term Loans Purchases of Long Term investments Non-Trading Investments Payment of Dividends* Payment Of Tax* Net Increasein Working Capital

Adjusted Profit & Loss Account

To Depreciation, Depletion & Amortization of fictitious & Intangible assets such as Goodwill, Patents, Trade Marks, Preliminary Expenses etc To Appropriation of Retained Earnings (Transfers to General Reserve, Dividend Equalisation Fund, Sinking Fund.. Etc) To sale on loss of any non-current assets To Dividends (including interim dividends) To Discount on Issue of Shares To Proposed dividend* To Provision For taxation* To Closing Balance of (P&LA/c) To Funds Lost in operations (b/f) By Opening Balance of P&L A/c By Transfer from excess Provisions By appreciation in the value of Fixed Assets By Dividends received By Profit on Sale of Fixed Assets or NonCurrent Assets By Funds From Operations (b/f)

RATIO ANALYSIS

Ratio- one number expressed in terms of another. It describes in Mathematical terms the quantitative relationship between two numbers J.Batty Defines Accounting ratio is used to describe significant relationship between figures shown on balance sheet, in a profit & loss account, in a budgetary control system or in any other part of the accounting organisation

CURRENT ASSETS

CURRENT LIABILITIES

Cash in Hand Cash at bank Stock Sundry debtors Bills receivables Short term Investments Marketable securities Accrued Income Prepaid Expenses

Bank Overdraft Sundry creditors Bills Payable Income Received in advance Outstanding Expenses Bad debts provision Provision for tax Dividend payable

ADVANTAGES OF RATIO ANALYSIS

Simplifies Financial Statements Facilitates Intra-firm Comparison Planning & Forecasting

Aids to inter-firm Comparison

Facilitates Decision Making Helps in Corrective action Aids to Co-ordination

LIMITATIONS OF RATIO ANALYSIS

Limitations of Financial statements No fixed standards Qualitative factors Ignored Lack of Standard Formulae It is not substitute for personal judgment Problems of price level changes Ratios alone are not adequate

CLASSIFICATION OF RATIOS

Functional Classification

Liquidity ratios

Long Term Solvency And Leverage Ratio

Activity ratios

Profitability Ratios

LIQUIDITY RATIO

Current Ratio = Current Assets Current Liabilities

(ideal ratio is 2:1)

Quick/ Acid Test =Liquid/quick Assets (ideal ratio is 1:1) /liquid ratios Current Liabilities (Liquid Assets =Current Assets-(inventories + prepaid expenses)

Absolute Liquid Ratio = Absolute Liquid Assets (ideal Ratio is 0.5 : 1) Current Liabilities (Cash in hand, cash at bank and Marketable Securities)

ACTIVITY BASED RATIOS

Inventory Turnover Ratio= Cost of Goods sold Average Inventory at Cost Inventory Conversion Period = Days in a Year Inventory Turnover Ratio Debtors (Receivables) Turnover Ratio = Net Credit Annual Sales Average Trade Debtors [ Average Trade Debtors = (Opening Drs + Closing Drs)/2] Average Collection Period = No.of working Days Debtors Turnover Ratios Creditors (payables) Turnover Ratio = Net Credit Annual Purchases Average Trade Creditors Average Payment Period = No.Of Working Days Creditors Turnover Ratio Working Capital Turnover Ratio = Cost Of sales Average Working Capital

LONG TERM SOLVENCY RATIO

Debt- Equity ratio = Outsiders Funds Share holders funds

Funded debt to total Capitalisation = Funded Debt x 100 Total Capitalisation Ratio of long term debt to Shareholders funds

= Long Term Debt Shareholders funds

Proprietary or Equity Ratio

= Shareholders funds Total assets

Fixed Assets Ratio = Fixed Assets( After Dep) Total Long- Term Funds

Fixed Asset Net Worth Ratio = Fixed Assets( After Depreciation) Shareholders funds Solvency Ratio = Total Liabilities to outsiders Total Assets

Ratio Of Current Assets = to proprietors Funds Debt- Service or Interest coverage Ratio Total Coverage or Fixed charge Coverage

Current Assets Share Holders Funds

= Net Profit ( Before Interest & Tax) Fixed Interest charges = EBIT Total Fixed Charges

Preference Dividend Coverage Ratio = Net Profit( Before Interest & Tax) Preference Dividend annual cash flow (Before Interest & Taxes)

ANALYSIS OF PROFITABILITY
(I) GENERAL PROFITABILITY Gross profit ratio = Gross profit Net sales

x 100

Operating Ratio = Operating Cost X 100 Net sales Net Profit Ratio = Net Profit x 100 Net Sales Expenses Ratio= Particular expenses x 100 Net sales Operating Profit Ratio = Operating Profit x 100 Net Sales

(II) OVERALL PROFITABILITY RATIOS

Return on Shareholders Investments = Net Profit (After interest & tax) x 100 (or) Net worth (R.O.I) Shareholders Funds Return on Equity Capital = Net profit after Tax Preference Dividend x 100 Paid up equity capital Earnings per Share = Net Profit after tax and Preference dividend (E.P.S) Number of Equity share Return on Gross Capital Employed = Adjusted Net profit x 100 Gross Capital Employed Return on Net Capital Employed = Adjusted Net profit x 100 Net Capital Employed Capital Turnover Ratio = Sales or cost of sales Capital Employed Dividend Yield Ratio = Dividend per Share Market Value per share Dividend Pay out ratio = Dividend per equity share or pay out ratio EPS

Price- earning Ratio = Market Price per Equity Share (P/E ratio) EPS