Conceptual Framework of Accounting

Session One
Understanding Financial Statements

SESSION PLAN

12

Britannia Industries
The companys consolidated net sales for the
year ended March 2008 increased by 23% to
Rs 2776.9 crore. OPM of the company
increased to 8.41%. The increased in
operating profit margin is due to decline in
raw material cost, purchased of finished
goods and conversion & other charges. As a
result, the PBT before extra ordinary items
increased by 85% to Rs 229.30 crore.

13

NIIT net profit rises 163.08% in the March 2008

quarter- Sales rise 33.85% to Rs 143.96 crore
In spite of dip of 18% in revenues from
corporate business contributing 49% of the
consolidated net income, NIIT reported 6%
growth in consolidated top line at Rs 272.40
crore. The operating margins improved at
11.2% on the back of improvement in margins
of individual business and school learning
business and new businesses turning
marginally profitable. The resultant bottom
line grew 47% at Rs 25.20 crore.

14

Engineers India (EIL)

The company reported an earnings growth of
33% (to Rs 56.68 crore) for the quarter ended
Mar 08. Strong sales growth of 49% to Rs
242.82 crore was well backed by expansion in
operating margin thus taking operating profit
up by 57% to Rs 75.19 crore. However the
growth at PBT level was limited to 27%
strained by lower other income (down 3%) and
higher depreciation (up 31%). With EO
expenses being lower by 12% to Rs 30 crore,
the PBT after EO grew by 50%. The growth at
net profit level was 33% to Rs 56.68 crore
bogged down by higher taxation.
15

Role of Accounting
Accounting is a system that provides
information on:
Amounts of resources.
How resources were financed.
How were the resources invested.
Results achieved by using those resources.

Through Internal & External Reporting

For:
Parties inside and outside the organization.

16

The
Accounting
process
Monetary activities
(Money Measurement Concept)

Economic
activities
(Monetary &
Non-monetary)

Actions
(decisions)

Accounting connects
decision makers with
economic activities
and the cycle
continues with the
results of their
decisions

Accounting
Information
(Financial &
Management
Accounting)

Decision
makers
17

Financial Accounting
Accounting

Financial
Accounting

Used for Financial reporting

Audience: External users
(Investors, Creditors,
Govt. Bodies, society, etc.)

Management
Accounting

Providing information for

planning and control
Audience: Internal users
(Managers, BOD & employees)

18

Process of Accounting
Creating Accounting heads
Asset, Liability, Equity, Income & Expense

Double Entry system

Accounting Equation
Assets = Owners Equity + Liabilities
Resources financed by = business creditors
+ lenders + capital provided by owners.
Resources Invested in = Fixed Asset +
Investment + Current Assets
LHS = RHS

Yields Financial Statements

19

Financial Statements: Elements

Elements measuring financial position:
Assets
Liabilities
Equity

Elements measuring performance

Revenue / Income (includes gains)
Expenses (includes losses)

110

111

Financial Elements - Definition

Assets are Probable Future economic

benefits obtained or controlled by a particular
entity as a result of past transaction or
events.
Liabilities are probable Future Sacrifices of
economic benefits, arising from present
obligations of a particular entity to transfer
assets in the future, as a result of past
transaction or events.
Equity is the residual interest in the assets of an
entity that remains after deducting its liabilities.
In business enterprises, the equity is the
ownership interest.
112

Financial Elements

113

Accounting Equation
Travel
Assets
Liabilities
++ Agency
Owners
Assets ==Vagabond
Liabilities
OwnersEquity
Equity

Balance Sheet
December 31, 2007
$300,000
$220,000
$300,000
= $80,000
$80,000 +Liabilities
+
$220,000
Assets=
& Owners' Equity
Cash
$ 22,500 Liabilities:
Notes receivable
10,000
Notes payable
$ 41,000
Accounts receivable
60,500
Accounts payable
36,000
Supplies
2,000
Salaries payable
3,000
Land
100,000
Total liabilities
$ 80,000
Building
90,000 Owners' Equity
Office equipment
15,000
Capital stock
150,000
Retained earnings
70,000
Total
$ 300,000 Total
$ 300,000
114

Financial Elements - Definition

Revenues / Incomes represent actual or expected
cash inflows that result from an entitys central
operation or core activities or principal business.
Examples: Sales for Manufacturing & Trading Companies,
Interest & Investment Income for Banks.
Increase Owners Equity
May not be realized in cash immediately

Expenses represent actual or expected cash outflows

that result from an entitys central operations.
Examples: Raw Material Expenses, Personnel Expenses,
Manufacturing Expenses, Selling Expenses, etc.
Decreases Owners Equity
May not be paid in cash immediately
115

Accounting Equation

Assets = Owners Equity + Liabilities

Owners Equity = Total Assets Total External

Liability

In B/S as per Indian GAAP

In B/S as per US GAAP

Owners Equity = FA + Investments + CA

CL(NWC) Secured Debt Unsecured Debt

Owners Equity = Non CA + NWC Non CL

(NWC = CA CL)

Retained Earnings or (Revenue Expenses)

are added to Owners Equity
116

Accounting equation in balance- an

illustration

Few of us jointly promote a trading

Co. on 1-1-06 to buy & sell few
consumer durable items,
contributing 5 lakhs each (6 of us)
to the share capital.
Assets = Liabilities + Owners Equity
Cash (30 lakhs) = 0 + Equity share capital (30
lakhs)

Business Entity Concept

117

Contd
Took a bank loan Rs 20 lakhs.
Assets = Liabilities + Owners Equity
Cash (20) = Bank Loan (20)

Cumulative Impact
Cash (50) = Loan (20) + Equity share capital (30)
Monetary Unit Concept

118

Contd

Rented a showroom, paid 5 lakhs as

refundable advance to be returned on vacating
the premises. Rent is agreed at 1 lakh p.m.
Assets = Liabilities + Owners Equity

Advance rent (5) + Cash (-5) = 0

Cumulative Impact
Advance (5) + Cash (45) = Loan (20) + Equity
share capital (30)
119

Contd
Bought furniture for the showroom for 5
lakhs.
Assets = Liabilities + Owners Equity
Furniture (5) + Cash (-5) = 0

Cumulative Impact
Furniture (5) + Advance (5) + Cash (40) = Loan
(20) + Equity share capital (30)
Historical Cost Assumption
120

Contd
Purchased inventory for 60 lakhs. Paid
50% in cash and agreed to pay the
balance in 60 days time.
Assets = Liabilities + Owners Equity
Inventory (60) + Cash (-30) = Creditors (30)

Cumulative Impact
Furniture (5) + Inventory (60)+ Advance (5) +
Cash (10) = Creditors (30) + Loan (20) + Equity
share capital (30)
121

Contd
Sold 40 lakhs worth of inventory for 50
lakhs;

cash sales 30 lakhs, & balance on credit.

Assets = Liabilities + Owners Equity

Inventory (-40) + Debtors (20) + Cash (30) = Sales
(50) Cost of goods sold (40)

Cumulative Impact
Furniture (5) + Stock (20)+ Debtors (20) +
Advance (5) + Cash (40) = Creditors (30) +
Loan (20) + Equity share capital (30) + { Sales
(50) Cost of goods sold (40) }
122

Contd

Manager informs about the following dues staff salary 2 lakhs, advertisement
expenses 2 lakhs, interest 20,000 & rent 1
lakh.
Assets = Liabilities + Owners Equity
0 = Expenses payable (5.2) + OE (-5.2)

Cumulative Impact
Furniture (5) + Stock (20)+ Debtors (20) + Advance
(5) + Cash (40) = Creditors (30) + Expenses
payable (5.2) + Loan (20) + Equity share capital
(30) + {Sales (50) Cost of goods sold (40)
Expenses (5.2)}
123

Contd
Dividend paid to investors 1 lakh
Assets = Liabilities + Owners Equity
Cash (-1) = OE (-1)

Cumulative Impact
Furniture (5) + Stock (20)+ Debtors (20) +
Advance (5) + Cash (39) = Creditors (30) +
Expenses payable (5.2) + Loan (20) + Equity
share capital (30) + {Sales (50) Cost of
goods sold (40) Expenses (5.2)} Dividend
(1)
124

Balance Sheet as at 31-01-08

Liabilities
Share capital

Assets
30

Fixed Assets
Furniture

Reserves & Surplus

Owner's Equity
Loan from Bank

3.8
33.8
20

Current Assets Loans & Advances

Inventory

20

Debtors

20

Rent Advance
Current Liabilities & Provisions
Creditors

30

Expenses payable

5.2
89

Cash

5
39

84

89
125

Income Statement for the month ending 31-01-08

Income
Sales

50

Other Income

Total Income

50

Expenditure
Cost of goods sold

40

Salary

Advertisement

rent

1
45

PBDIT

Depreciation

Interest

0.2

PBT

4.8

Tax
PAT/Disposable profit
Dividend

0
4.8
1

126

Cash Flow Summary for the period 07-08

Receipts
cash from fresh equity

30

Bank loan

20

cash received from customers

30
80

Payments
cash paid to supplier

-30

cash paid for advance rent

-5

purchase of furniture

-5

paid dividend

-1
-41

Balance of cash closing

39
127

Relationship among Financial

Statements

Date at
beginning
of period

Time

Balance
Sheet

Date at
end of
period
Balance
Sheet

Income Statement
Statement of Cash Flows
128

Financial Statements Articulate

Income Statement for the
month ending 31-01-08
Cash Flow Summary
for the period 07-08

Income
Sales

Receipts

Other Income

0
50

cash from fresh equity

30

Total Income

Bank loan

20

Expenditure

cash received from

customers

Cost of goods sold

cash paid for advance

rent

40

Salary

Liabilities

80

Advertisement

Share capital

rent

1
45

-30
-5

purchase of
furniture

-5

paid dividend

-1
-41

Balance of cash closing

Balance Sheet as at 3101-08

30

Payments
cash paid to
supplier

50

39

PBDIT

Depreciation

Interest

0.2

PBT

4.8

Tax
PAT/Disposable profit
Dividend
Balance profit carried to B/S

Assets
30

Furniture
Reserves &
Surplus
Owner's
Equity

Loan from
Bank

3.8

3.8
33.8

20

Current Assets Loans &

Advances
Inventory

20

Debtors

20

Rent Advance

4.8
1

Fixed Assets

Current Liabilities &

Provisions
Credit
ors

30

Expenses
payable

5.2
89

Cash

5
39

129

84

89

Purpose of Financial Accounting

To provide financial information about an organization, its

current financial position as well as its ability to generate
earnings & cash flows, to various interested parties.

Such parties include

Investors
Creditors
& Others including the Regulators, Industry Associations,
Researchers including Academicians & (Wall) Street Analysts,
General Public, etc.

It should be noted that all these interested parties are external

to the organization.

Thus Accounting Information used for decision making

meets certain qualitative characteristics.
130

Qualitative Characteristics of
Accounting Information
1. Understandability
2. Usefulness
1. Relevance
1. Be timely,
2. Provide feedback, and
3. Help predict future conditions

2. Reliability
1. Faithful Representation
2. Credible & Verifiable
3. Neutral

3. Comparability (including Consistency)

131

Basic Accounting Assumptions

An understanding of basic accounting
assumptions is vital to understand the
process of accounting.
Accounting concepts underlying the
recording of transactions:
Separate Entity Concept
Money Measurement Concept
Going Concern Concept
Accounting Period Concept
132

Thank You