Acconting Notes
-
Upload
parinkhona -
Category
Documents
-
view
217 -
download
0
Transcript of Acconting Notes
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 1/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 1
Financial Statements: Introduction
Learning Objectives
After studying this chapter, you should be able to understand
Balance sheet
Income Statement
Cash Flow Statement
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 2/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 2
Introduction:The end product of the financial accounting is a set of financial statements. Some of these
statements are statutory and some are not. These financial statements relate to a specific date or
covers a specific period viz. month, quarter, annual. In the Indian context, he balance sheet, the
profit& loss account, and cash flow statement are considered to be the statutory statements,
though many companies have started including other statements in their annual reports.
In this chapter we will concentrate on the two basis statutory statements viz. balance sheet and the
profit & loss account. To examine the content of these financial statements and how to read
them, let’s look at the financial statements of Wipro Limited for the year ending 31st
march 2000
and 2001.
At this point, we will focus our attention on the larger picture and not get into the nitty-gritty of
the financial statements. Our goal is an overall understanding of the basic financial statements.
At this stage we will ignore the details on each statement. However, as we progress through the
text, we will examine these details to enable you to undertake an in-depth analysis of the financial
statements.
Balance sheetLet us begin with the balance sheet of Wipro Limited. The exhibit 2.1 displays the condensed
balance sheet for two years.
The balance sheet represents the financial picture of an organisation as it stood on a particular
date. It can be prepared every day, on the last day of the week, last day of the month, last day of
the year, or any other day. The balance sheet for the previous year is also presented along with the
current one to facilitate comparison. Balance sheet is prepared on the basis of certain basic
concepts and conventions of accounting (which will be discussed in the next chapter) and
presented in the format prescribed by the Companies Act 1956.
Balance Sheet, also known as the statement of financial position, reports a company's financial
status at a set date noted on the statement. The statement is like a snapshot because it shows what
the company is worth as on a particular date . The statement shows:
• what the company owns (Assets)?
• what the company owes (Liabilities)?
• what belongs to the owners (Shareholders’ fund)?
In the standard accounting model, the balance sheet can be represented by using the accounting
equation i.e. Assets = Shareholders’ Funds + Liabilities (More about the accounting equation inthe subsequent chapters). As such, both sides of the balance sheet should be same. They are in
balance because, each rupee of asset acquired will have a corresponding source i.e. eithercollected from the share holders or the creditors
Assets
A thing that is valuable to the business is an asset. The value may be defined in terms of its
capacity to be instrumental in production of goods or services. For example, plant and
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 3/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 3
machinery, equipment, buildings, inventories, etc., or, things that have immediate purchasingpower, like, cash and short-term marketable securities; or claims that can be converted into cash
such as accounts receivable; inventory of finished goods etc., are of value to the enterprise. If an
item is valuable to the enterprise, the acid test of whether a particular item is an asset of an
enterprise or not is the ownership of the item. If an enterprise does not hold title of a particular
item though it may have physical possession (e.g., rental building), it is not represented among
the list of assets. The various categories of assets are discussed as follows:
Fixed Assets
Fixed assets are tangible valuable things owned by the enterprise with the intention of carrying onbusiness operations over a long time horizon. Thus, fixed assets are of a tangible nature and are
durable. The usefulness of an asset to an enterprise is always either on grounds of technology or
economic benefits. When the term “fixed asset” is used without qualification, the reference is
generally to tangible assets and specifically to plant and machinery, buildings and land.
Generally, all the fixed assets are grouped together at the original cost value to represent the gross
block, from this accumulated depreciation on all the assets till the date is subtracted to arrive at
the net block. Usually, this information is substantiated by a schedule containing details on
original cost, accumulated depreciation till the date of previous balance sheet, and depreciationfor the current accounting period for each fixed assets component.
Current Assets, Loans and Advances
Current assets include cash and all “cash-like” items which can be converted into cash in the near
future (i.e., in a year) or during a normal operating cycle. The operating cycle, here, is defined as
the time span between the cash injected into operating processes through purchase of raw
materials and the cash received from the sale of goods. So, current assets are cash and bank
balance, stock of raw materials, work-in-process, finished goods and account receivables. The
current assets are as could be observed from the above explanati9on, asset items of current nature.
Here the word current means that the assets change from (say raw materials into work-in-process,
or work-in-process into finished goods, or finished goods into accounts receivables or receivableinto cash) frequently during the operating period. On the other hand, fixed assets are more
permanent in nature. The various components of current assets are discussed as follows:
i. Cash and bank balance: Cash consists of funds that are immediately available for
disbursement. Usually, most of the organisations do not keep a lot of cash on hand as
most dealings are done through banks.
ii. Stocks: Stocks, also known as inventories, consist of raw materials goods, half-the-way
through the process (work-in-process) and finished goods awaiting sales. The
conservatism concept of accounting is followed in valuing the inventory and is done
either at cost or market value, whichever is lower.
iii. Debtors: Debtors represent the amount owed to an enterprise by the customers. This
shows the claims of the company for the goods and services rendered with an agreement
to receive payment for it at a later date. The amount shown under this head is the netamount which means that out of the total debtors, the amount not likely to be collected
(called, doubtful debts or bad debts), is deducted to get a clear picture of the amount
receivable. Debtors are also termed as accounts receivables. Most of enterprises, in their
schedule of debtors in the balance sheet, segregate the item into two categories: one
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 4/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 4
representing the amount outstanding for more than six months but considered doubtful.Sometimes under the head of debtors, certain amounts arising out of non-regular
operational transactions e.g., amount yet to be received from sale of an asset, are also
included.
iv. Marketable securities: These are the firm’s investment in shares and debentures of
corporations, and other securities for a relatively short period of time. The wordmarketable indicates that these securities can be sold and bought on a stock exchange.
v. Prepaid expenses: These are expenses that have been paid in advance for example
advance income tax or insurance premium paid in advance. If insurance premium is paidon 25th December for the next accounting year, then it will be indicated as prepaid
insurance, because it has been paid for future coverage. Similarly rent paid in advance
for future use of equipment or buildings will be indicated as prepaid rent.
vi. Interest receivable: If interest has been earned but not received in cash as on the date of
balance sheet, it is represented as interest receivable. For example if an enterprise has
deposits in a bank and the bank pays interest half-yearly, then on 31st December it has
earned interest but has not received it. We will represent this information on the balancesheet as interest receivable.
Investments
An enterprise may decide to invest in long-term securities of other institutions. For example a
firm may periodically set aside certain cash and invest this cash in long-term securities, so as to
ensure availability of cash for any repayment at a future date. An enterprise may also buy shares
of another firm with a view to diversify its operations.
Intangible Assets
These are the assets that do not have physical existence, therefore, we cannot see or touch them,
for example goodwill is an intangible asset. Such assets may have a fixed term of existence by
law, regulation or agreement, for example patents, copyrights and leases. Difficulties may arise
in ascertaining the existence and quantum of future benefits from such assets. Therefore, it is
usually recommended that expenditures made by the enterprise in developing these assets should
not be recognized as asset. Only if an intangible asset is acquired through purchase from other
entities, should it be recognized as an asset.
LIABILITIES
Liabilities
On the statement of financial position, debts are called liabilities. Liabilities represent what a
business as a distinct entity owes to various parties either against some specific securities or
otherwise either for relatively a longer period of time or for a short duration.. Examples of liabilities include:
• Money owed to banks and other lenders
• Money owed to suppliers of goods and services (sundry creditors/accounts payable)
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 5/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 5
• Taxes owed to government authorities
• Rent owed to owners of land and buildings
• Money owed to the shareholders
Liabilities represent what a business as a distinct entity owes to various parties namely to
shareholders, for share capital and retained earnings, and to other parties, for loans to the businessentity either against some specific securities or otherwise either for relatively a longer period of
time or for a short duration.
Although liabilities are a necessary part of doing business, companies must manage their
liabilities carefully. If a company cannot make interest payments on time and repay the principal
when due, the company can be forced to declare bankruptcy and either reorganize or disband.
So it is necessary to understand the liabilities in details. Generally liabilities can be differentiated
on the basis of the following:
Insider and outsider
Term (period)
Secured or unsecured
Mode of repayment
Rate of interest
Broadly the total liabilities can be studied under three heads viz. owners’ equity, long-term
liabilities, and current liabilities, which are discussed as follows:
Shareholders’(Owners’) Equity
Stockholders' equity is the amount owners invested in new stock plus the earnings the company
retained since it started. (Retained earnings is the amount of profit kept after dividends are paid).
On the statement of financial position the amount of stockholders' equity always equals the value
of all the assets minus all the liabilities.
This section is subdivided into the following subsections.
i. Share capital: This category of owners’ equity shows the stated value of share
certificates issued (Issued share capital) and the value contributed by the shareholders to
the share pool of the company (paid-up share capital).
ii. Reserve funds and other funds: This section of owners’ equity represents the earnings
foregone by the shareholders in the previous year(s) and retained with the business or
ploughed back into the business. The net profit is apportioned to various reserves. Some
of these are: investment allowance reserve rehabilitation reserve and dividendequalization reserve. Sometimes, provision for certain reserves have to be made in
compliance with various regulatory requirements. The “other funds” represent funds
received from other agencies such as World Food Programmes, and International
Development Agency etc. this item can be seen in the balance sheet of development-
oriented institutions.
Long-Term Liabilities
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 6/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 6
Current liabilities represent the obligations maturing within a relatively short period notexceeding one year or the normal operating cycle of the business. Current liabilities include
sundry creditors, tax liability, unpaid dividend, outstanding expenses and advances from
customers. These dues are honored using current assets. The explanation for these terms is given
below:
i. Sundry creditors: Sundry creditors show the amount due to suppliers, by the enterprise.
These claims are generally not secured against any asset.
ii. Liability for taxation: The amount of taxes as shown in the balance sheet represent the
provisions made on the basis of estimates. Since the actual tax liability is assessed based
on the taxable income of the year, payment is adjusted against the provisions made.
iii. Outstanding expenses: The expenses that relate to the current accounting period and,
therefore, have accrued but have not been paid at the end of the accounting period, are
referred to as accrued expenses. For example, wages for the month of March will remain
unpaid on 31st
March and, therefore, it will be represented as wages payable on the
balance sheet as on 31st March.
In general, long-term liabilities are theenterprise’s obligations for moneyobtained for a relatively long period,generally more than year. Theseliabilities are incurred to finance the
operations of the business. This,therefore, represents claim againstassets. These liabilities are more oftenagainst the securities by hypothecationor pledge of the assets.
Concept of Time
In accounting, time is divided onthe basis of the accounting year i.e.
twelve months. So we have the
long and short-term liabilities.
Where as in economics, time is
divided on the basis of the time
taken for supply to change.
Current Liabilities (Short-Term)
Distinguish between ‘Expenses Accrued’ and
‘Expenses Due’
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 7/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 7
iv. Rent received in advance: if an enterprise owns a building and rents it to a tenant and thetenant has paid the rental charges in advance, then this amount will be indicated as rent
received in advance, on the liability side of the balance sheet.
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 8/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 8
Now let us see the balance sheet of Wipro limited and understand the terms.
Exhibit 4.1
WIPRO LIMITED
BALANCE SHEET AS AT MARCH 31 2001
(All figures in rupees million)
SOURCES OF FUNDS As on March 31 APPLICATION OF FUNDS As on March 31
2001 2000 2001 2000
Share capital 466 708 Gross block 9020 6757
Less Depreciation -3793 -2928
Reserves and surplus 19184 6994Net Block 5227 3829
Shareholders' Funds 19650 7702Capital Work in progress 797 708
Fixed Assets 6024 4537Secured Loans 400 492
Unsecured Loans 47 86 Investments 1636 462
Loan Funds 447 578 Inventories 1152 1340
Sundry creditors 4813 4057Sundry Debtors 6176 4469
Provisions 532 428 Cash and Bank balances 4463 747
Current Liabilities 5345 4485Loans and advances 5992 1210
Current Assets 17783 7766
Total 25442 12765 Total 25443 12765
Some observations:
The balance sheet is true as on the 31st
March 2001 and 2000. The shareholders’ fund has increased by two and half times.
A large component of the shareholders’ fund is reserves and surplus.
The share capital has decreased.
Loans have decreased during this period
Current liabilities have increased marginally.
Fixed assets have increased by one and half times
The company has huge cash and bank balance and has given huge money in the form
of loans and advances to various parties.
Simplified Version of Balance Sheet
To do: Take the balance sheet of any company of your choice and compare it with the
above and write a note on your observations.
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 9/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 9
Let us now further demystify the balance sheet by further reducing the number of items and themunderstand the interrelationship. In the process you will get introduced to some more accounting
terms which will be taken up for further discussion in the subsequent chapters.
Exhibit 4.2
WIPRO LIMITEDBALANCE SHEET AS AT MARCH 31 2001
(All figures in rupees million)
Liabilities As on March 31 Assets As on March 31
2001 2001
Shareholders' Funds 19650 Fixed Assets 7660
Long Term Loan 447
Current Assets 17783
Current Liabilities 5345
Total 25442 Total 25443
So five important items of the balance sheet are as follows:
Shareholders Funds (SF or OF)
Long Term Loans (LTF)
Current Liabilities (CL)
Fixed Assets (FA)
Current Assets (CA)
Some interesting relationships
SF+ LTF = Capital Employed CA-CL = Working Capital (WC) SF = (FA +CA)-(LTF+CL) Capital Employed = FA+WC Total Assets = Capital Employed + CL Total Liabilities = FA+CA
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 10/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 10
Preparing Balance sheet: Common Sense Approach
Even without understanding the technicalities of accounting, one can prepare a balance sheet. The
assumption on which the balance sheet is prepared is quite basic and commonsensical: Every
application (i.e. purchase of asset, or increase in asset) should have a corresponding source. So
based on this assumption the total applications at any point of time will be equal to the source.Let us try to understand this with the following transactions of an hypothetical company.
1. A ltd. is company formed on 1st
April 2001 to buy and sell computers. The promoters
collected Rs. 1000 as share capital from their friends and relatives. The balance sheet will beas follows:
Compusales Ltd.
BALANCE SHEET AS on 2001
(All figures in rupees 000)
SOURCES OF FUNDS APPLICATION OF FUNDS
Capital 1000 Cash 1000
Total 1000 Total 1000
2. Purchased furniture Rs. 100 for cash. This transaction will reduce cash and increase another
form of asset i.e. furniture. The balance sheet will be as follows:
Compusales Ltd.
BALANCE SHEET AS on 2001
(All figures in rupees 000)
SOURCES OF FUNDS As on March 31
APPLICATION OF
FUNDS As on March 31
2001 2001
Capital 1000 Cash 900Furniture 100
Total 1000 Total 1000
n.b. No change in capital and on the sources side.
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 11/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 11
3. Took 12% loan from IDBI: Rs.1500. Deposited the same with UTI bank. In this case the
sources increase and since they have not used that money for acquiring any asset it will be
shown as cash at bank.
Compusales Ltd.
BALANCE SHEET AS on 2001
(All figures in rupees 000)
SOURCES OF FUNDS As on March 31
APPLICATION OF
FUNDS As on March 31
2001 2001
Capital 1000 Cash 900
IDBI Loan 1500 Bank 1500
Furniture 100
Total2500
Total2500
4. Purchased air conditioner and paid by cheque: Rs.25000. This transaction will reduce the
bank balance and increase another form of asset i.e. AC. No change in the sources.
Comp sales Ltd.
BALANCE SHEET AS on 2001
(All figures in rupees 000)
SOURCES OF FUNDS As on March 31
APPLICATION OFFUNDS As on March 31
2001 2001Capital 1000 Cash 900
IDBI Loan 1500 Bank 1475
Furniture 100
AC 25
Total 2500 Total 2500
5. Entered into agreement to buy 1000 computers from a local manufacturers XY Ltd. This
transaction will not affect the balance sheet.
6. Received 100 computers at the rate of Rs. 20,000. Money to be payable on a later date. So
this a credit transaction.
Comp sales Ltd.
BALANCE SHEET AS on 2001
(All figures in rupees 000)
SOURCES OF FUNDS As on March 31
APPLICATION OF
FUNDS As on March 31
2001 2001
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 12/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 12
Capital 1000 Cash 900
IDBI Loan 1500 Bank 1500
XY Ltd. (Creditors) 2000 Stock of Computers 2000
Furniture 100
Total 4500 Total 4500
You can see from the balance sheet that the increase in the assets is being funded by the increasein sources i.e. a new liability has been created.
7. Issued one lakh shares of Rs. 10 to the public and collected money through bank and also
raised further loan of Rs. 50000 from SBI to meet the short term expenses.
Comp sales Ltd.
BALANCE SHEET AS on 2001
(All figures in rupees 000)
SOURCES OF FUNDS As on March 31
APPLICATION OF
FUNDS As on March 31
2001 2001
Capital 2000 Cash 1400
IDBI Loan 1500 Bank 2500
SBI Loan 500
XY Ltd. (Creditors) 2000 Stock of Computers 2000
Furniture 100
Total 7000 Total 6000
8. 2 computers were sold @ Rs. 25000 for cash over the counter. You may aware that the
computers were purchased for Rs.20000. Let us see the impact on the balance sheet. Cash increases by Rs. 50,000
Computers decrease by Rs. 40,000
The balance is treated as Profit: Rs. 10,000
Comp sales Ltd.
BALANCE SHEET AS on 2001
(All figures in rupees 000)
SOURCES OF FUNDS As on March 31
APPLICATION OF
FUNDS As on March 31
2001 2001Capital 2000 Cash 1450
IDBI Loan 1500 Bank 2500
SBI Loan 500
XY Ltd. (Creditors) 2000 Stock of Computers 1960
Profit 10 Furniture 100
Total 6010 Total 6010
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 13/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 13
9. Suppose the company sold 3 computers @ Rs. 18000 to a local school. In this case it has
incurred a loss of Rs. 6000.
Cash increases by Rs. 54,000
Stock decreases by Rs. 60,000 Balance is treated as loss: Rs. 6,000
Comp sales Ltd.
BALANCE SHEET AS on 2001
(All figures in rupees 000)
SOURCES OF FUNDS As on March 31
APPLICATION OF
FUNDS As on March 31
2001 2001
Capital 2000 Cash 1504
IDBI Loan 1500 Bank 2500
SBI Loan 500
XY Ltd. (Creditors) 2000 Stock of Computers 1900
Profit 10 Furniture 100
Loss 6
Total 6010 Total 6010
Now let us summarise the Learnings from the above transactions:
Some interesting relationships
a) Increase in asset will have the following effects Increase in liabilities, or Decrease in cash/other asset
b) Increase in liability will have the following effect
Increase in cash, or Increase in other asset Decrease in any other liability
c) If Source side is greater than application, the difference is treatedas ‘Profit’.
d) If Source side is lesser than the application side, the difference istreated as ‘Loss’
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 14/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 14
10. The company sold another 20 computers @ of Rs. 25000 to a local organisation (ABC ltd.).
10% of the sales collected immediately and the balance to be collected in twelve equal
installments.
Cash increases by Rs. 50,000
Debtors (Receivables) increases by 450,000 Stock decreases by Rs. 400,000
Difference is treated as profit: Rs. 100,000
Comp sales Ltd.
BALANCE SHEET AS on
(All figures in rupees 000)
SOURCES OF FUNDS As on
APPLICATION OF
FUNDS As on
2001 2001
Capital 2000 Cash 1554
IDBI Loan 1500 Bank 2500
SBI Loan 500 Debtors 450
XY Ltd. (Creditors) 2000 Stock of Computers 1500
Profit 10 Furniture 100
Profit 100 Loss 6
Total 6010 Total 6110
Instead of showing the profits and losses separately, they can be netted off as follows:
Comp sales Ltd.
BALANCE SHEET AS on
(All figures in rupees 000)
SOURCES OF FUNDS As on
APPLICATION OFFUNDS As on
2001 2001
Capital 2000 Cash 1554
IDBI Loan 1500 Bank 2500
SBI Loan 500 Debtors 450
XY Ltd. (Creditors) 2000 Stock of Computers 1500
Profit 104 Furniture 100
Total 6104 Total 6104
Profit = 100 + 10 – 6 = 104
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 15/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 15
Now let us present the above balance sheet in the format shown in exhibit 2.2
Comp sales Ltd.
BALANCE SHEET AS on
(All figures in rupees 000)
Liabilities As on March 31 Assets As on March 31
2001 2001
Shareholders' Funds 2104 Fixed Assets 100
Long Term Loan 1500
Current Assets 6004
Current Liabilities 2500
Total 6104 Total 6104
Shareholders’ Fund = Capital + Profit – Loss
Current Liabilities = Creditors + SBI Loan
Current Assets = Cash + Debtors + Stock
So profit or loss of an organisation can be determined by preparing the balance. However, if the
expenses and incomes are many and the net result has to be determined at the end of a particularperiod of time then it is better to prepare the Income Statement or Profit & Loss Account.
To do: Compare the balance sheet of a manufacturing company with that of a service
company and a banking company.
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 16/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 16
Income Statement
Learning Objectives
After studying this chapter, you should be able to understand
Income Statement Relationship between Income Statement and Balance Sheet
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 17/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 17
Profit and Loss Account/Income Statement
The income statement of an organisation shows the net operating result of the activities
undertaken during a particular period of time. The income statement is also known as the Profit
and Loss Account (P/L Account). It tells us the financial results of business activity –howsuccessful the operation of the business is. If income exceeds expenses during the period, it is
profit and if the expenses exceeds the income it will be treated as loss. It is important to note that
the transactions recorded in the profit and loss account flow through to the balance sheet. For
example in the previous section we have sent that the balance sheet shows the profit or loss. Thisprofit or loss can also be determined by preparing the profit and loss account. We discuss the
interrelationship in some details in the later part of the chapter.
Some of the important items that find place in the income statement are as follows:
Income Side
SalesThe sale of products and services is the main source of income for companies. These are usually
recorded at gross value, including excise duty if any. The excise duty is then separately recorded
on the expenditure side.
However, for the purpose of financial analysis, it is better to arrive at the net sales figure (net of
excise duty) because the rates of excise duty may change from year to year depending upon the
policy of the government. The sales figure is also net of discounts and returns. In other words, if
an item’s price is Rs. 50, but is sold at a discount of 10%, the sales shown in the income
statement will be Rs. 45. The net sales values provide a more dependable basis for calculating the
profitability ratios.
Other IncomesThe income received by a company from sources other than sales of its main products and
services is mentioned separately. In many companies the other income constitutes a significant
portion of the profit before tax.
Why is it necessary to show sales and other
incomes as separate items?
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 18/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 18
Expenditure Side
The expenditure side of a P & L account gives the details of all the revenue expenses whether
accrued or paid for during a year.
Cost of goods Consumed
The cost of goods consumed is arrived at after making suitable adjustments for opening andclosing stocks as shown below: (Rs in Lakhs).
Opening Stock 250
Add: Purchases 12001450
Less: Closing Stock 400
Goods Consumed 1050
It is important to note that the cost of goods consumed depends of the principles of valuation of
inventory. Inventory valuation in detail will be discussed in chapter: However, we will see a very
simple example to show the impact of the inventory valuation. There are different methods of valuing inventory. However, we see the impact of only two of them LIFO and FIFO.
LIFO: Last-in-first-out. Under this method the goods purchased last will be used first. So the
unsold stock is generally from the past purchases.
FIFO: First-in-first-out. Under this method, the oldest purchase is used first. So the unsold stock
is from the latest purchases.
Some interesting relationships
OpeningStock/Purchase Rate (Rs.)
1.5.2001 3000 4.5
2.5.2001 1000 5
4.5.2001 2000 6
10.5.2001 2500 units are sold at 10 per unit
COGS Sales G.Profit
FIFO Cost of Goods Sold 11250 25000 13750
(2500*4.5)
LIFO Cost of Goods Sold
2000*6 14500 25000 10500
500*5
Change in profit 31%
Profit changesbecause of thechange in themethod ofvaluation
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 19/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 19
It is important to note that the profit changes by 31% not because of the change in the operatingefficiency, but just because of the change in the valuation method.
FIFO results in higher profits because of lower cost of goods sold and a higher, whereas LIFO
results in lower profits because of higher cost of goods sold.
Manufacturing ExpensesThese include all expenses related to plant and manufacturing operations like power and fuel,
repairs and maintenance, stores consumed, water treatment, pollution treatment, etc.
Excise Duty
This is the amount paid to the government as a tax, before the goods are dispatched from thefactory.
Salaries and WagesSalaries and wages and all other employee benefits and amenities are included in this
expenditure. They include provident fund, ESI (Employees State Insurance) contributions,
medical benefits, leave travel benefits, bonus, gratuity, pension, other super-annuation benefits
etc.
Administrative ExpensesAdministrative expenses include head office expenditure, secretarial costs, postage and
telephones, directors’ remuneration and other administrative expenses.
Selling ExpensesSelling expenses include freight, advertising and sales promotion, commissions and discounts and
other selling and distribution costs.
InterestThe interest cost consists of interest on long-term loans, debentures, bank loans for working
capital, interest on public deposits and other loans.
DepreciationDepreciation is the charge for using the assets. It can be described as the cost of the assets used
during the year. This amount need not be paid to any outside party. Refer to chapter: XX for
details
Other ExpensesThe other expenses include auditors’ remuneration, petty expenses, small donations, if any etc.
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 20/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 20
Presentation of Income Statement:
At this juncture we will see the general format of presenting the incomes and expenses. Generally
the income statement is known as ‘Trading and Profit and Loss Account’ and consists of three
sections as illustrated in the following exhibit
Trading Account Sales
Less Cost of Goods Sold
GROSS PROFIT
Profit and Loss Account GROSS PROFIT
Add Other Incomes
Less All other Expenses
Repairs
Depreciation
Interest
OthersNET PROFIT
Appropriation Account NET PROFIT
Less Income Tax
Transfer to Dividend
Transfer to SpecificReserves
RETAINED PROFIT
Gross Profit: shows the ability of the business to generate profitNet Profit: Money available for distribution among the various stakeholders
Retained Profit: Profit available for re-investing in the business.
Though, the income statement is an important statement, it has the limitation of no being able to
show the cash position. This limitation can be attributed to one of the important concepts of
accounting i.e. Accrual Concept.
The Income statement does not tell us how much cash has been received and how cash has been
paid during the period. All it does is to summarise the incomes and expenses. While preparing the
balance sheet we have seen that when the company has sold 20 computers @ Rs.25000, of which
only 10% was received immediately. For the purpose of determining the profit or loss, the entire
Distinguish between
Profit Before Interest and Tax(PBIT), and
Profit After Tax (PAT)
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 21/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 21
sale value i.e. Rs. 500,000 was shown as the income. Similarly, when an item bought on credit, itis recognized as an expense immediately, though the cash is yet to flow out of the business.
Now let us see the profit and loss account of Wipro Ltd.
WIPRO LIMITEDProfit and Loss Account for the year ending Mar 31
(All figures in rupees million)
2001 2000
IncomeSales and Services 30539 22735
Other Income 692 257
31231 22992Expenditure
Cost of goods sold 18103 15203
Selling, general and administrative expenses interest 5404 3995
Interest 68 286
23575 19484
Profit before taxation and non
Recurring / extraordinary items 7656 3508
Provision for taxation 992 501
Profit after tax before non-recurring/ 6664 3007
Extraordinary items
Non recurring / extraordinary items 16 -523
Profit for the period 6648 2484
AppropriationsInterim Dividend on Preference Shares 18 26
Interim Dividend on Equity Shares 69
Proposed Dividend on Equity Shares 116
Corporate tax on dividend 13 10
Transfer to Capital Redemption Reserve 250
Transfer to general reserve 6251 2379
To do: Study the change in the income statements over the two years and explain how
profit for the period has increased by 168% .
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 22/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 22
Important financial items and financial statements
• Sources (liabilities)
• Uses (assets)
• Expenses
• Incomes
Balance sheet
Owner's Fund Fixed Assets
Long Term Funds Investments
Short Term Funds Current Assets
Income Statement
Sales
Less
Cost of goods consumed
ExpensesDepreciation
Profit before Interest (PBIT)
Interest
Profit after Interest
Tax
Profit after Tax (PAT)
Balance Sheet
Income Statement
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 23/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 23
Financial Statements: Cash Flow Statement
Learning Objectives
After studying this chapter, you should be able to understand
Cash Flow Statement Inter-relationship between BS, IS, and CFS
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 24/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 24
Cash Flow Reporting
The basic objective of a cash flow statement is to provide relevant information as regards cash
receipts and cash payments of an enterprise during the accounting period. CFS shows the
movement of cash of an enterprise. It records all cash flows occurred during a particular period.
It is believed that cash flow information together with other traditional accrual basis financialstatements help investors creditors and others to –
• Assess the enterprise’s ability to generate positive cash flow from operations
in future;
• Assess the enterprise’s ability to meet its obligations, its need for external
financing and ability to pay dividend;
• Assess the reasons for difference between net profit and net cash flow from
operations;
• Assess the effects on an enterprise’s financial position of both its cash and
non-cash investing and financing transactions during the period.
• Shows the balance in hand or at bank,
• Helps in understanding the composition of cash flows, and
• It facilitates financing, investment and dividend decisions.
Cash and Cash Equivalents: However, the term cash and cash flow are not uniquely defined.
Thus cash equivalents are risk-free short term investments, either in reporting currency or in
foreign currency, having a maturity period of not exceeding three months, net of short termadvances. Other definitions may mislead the users by understating the investment cash flows.
What it records?It captures all the cash transactions undertaken during a particular period. In other words it
records the following:
• It records both revenue and capital items: Profit and loss account shows only the revenue
incomes and revenue expenses, balance sheet shows the capital receipts and expenditures,
whereas the cash flow statement shows all types of cash flows. The distinction between
capital and revenue is not relevant while preparing CFS. For example: Salary paid
(revenue expense), Purchased Plant (capital expense), Advertisement for launching a
new product (deferred revenue expense)
• It records all cash flows even if it previous years, or future years. For example: Advance
premium paid (relating to the next year), Arrear salary paid (relating to the previous year)
Components of CFSCash flow statement explains the reasons for changes in cash and cash equivalents detailing out
cash flow on various heads. Important among these heads are:
• Cash flow from operating activities;
• Cash flow from investing activities;
• Cash flow from financing activities.
Operating activities are principal revenue producing activities of the enterprise and other
activities that are not investing or financing activities. Some example of cash flow from
operating activities:
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 25/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 25
• Cash receipts from the sale of goods and the rendering of services;
• Cash receipts from royalties, fees, commissions and other revenue;
• Cash receipts and payments from contracts held for dealing or trading
purposes;
• Cash payments to suppliers for goods and services;
• Cash payment to and on behalf of employees;
• Cash payments for income tax and refunds of income tax unless
specifically identified with financing or investment activities.
Direct approach – Under direct approach operating cash flow information is obtained from
the cash book- cash receipts and payments can be classified and aggregated under the usual
heads of accounts.
Indirect Approach – Under indirect cash approach cash flow form operating activities can
be derived as follows:
Net profit or loss
Add : Non-cash charge such as depreciation, provisions, deferred taxes, unrealized
foreign exchange losses;
Add: Charges which are classified as part of investment or financing activities;
Less : Non-cash income such as depreciation and other write backs;
Less : Income which are classified as part of investment or financing activities.
Add/Less : Changes in inventories, operating receivables and payables.
Direct method is most appropriate for deriving operating cash flow because major heads of
cash receipts and payments are disclosed. However, the SEBI has recently notified to follow
indirect method only.
Investing activities relate to the acquisition and disposal of long term assets and other
investments not included in cash equivalents. As per Para 21 of IAS 7 and Para 21 of AS-3
separate disclosure of cash flows from investing activities is necessary.
Cash inflows from investing activities include –
• Receipts from collections of loans made by the enterprise and sale of debt
instruments of other entities (other than cash equivalents) that were purchased by the
enterprise;
• Receipts from sale of equity instruments of other enter prises and from return of
investment of those enterprises;
• Receipts from sale of property, plant equipment and other productive assets;
• Receipts from derivative transactions
Cash outflows from investing activities include –
• Disbursement of loan made by the enterprise and payments to acquire debt
instruments of other entities (other than cash equivalents);
• Payments to acquire equity instruments of other enterprises;
• Payments for acquisition of property, plant and equipment.
• Payments for derivative transactions.
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 26/27
Veer Consultancy Serviceswww.veerconsultancy.com
Jeet R.Shah 26
Financing activities are activities that result in changes in the size and composition of the
equity capital and borrowing of the enterprise.
Cash inflows from financing activities include –
• Proceeds from issuing equity instruments;
• Proceeds from issuing bonds, mortgages, notes and from other short or long termborrowing.
Cash outflows from financing activities include –
• Repayment of amount borrowed;
• Capital element of finance lease payments;
• Buyback of shares;
• Payment of expenses or commissions on any issue of shares, debentures, loans, notes,
bonds and other financing.
Situation 1
Situation
2
Situation
3
Situation
4
Situation
5
Cash from Operation Negative Positive Negative Positive Negative
Cash from Financing Positive Negative Positive Positive Negative
Cash from Investing Positive Positive Positive Positive Negative
Which is the best combination and why?
Cash Flows of some Indian companies:
India Cements ACC Madras Cements
Cash from Operation 85.74 84.22 66.77
Cash from Financing 419.17 -83.04 -64.54
Cash from Investing -584.13 -15.61 -44.09
Give your comments.
7/30/2019 Acconting Notes
http://slidepdf.com/reader/full/acconting-notes 27/27
Veer Consultancy Serviceswww.veerconsultancy.com
Cash Flow Statement
Opening cash in hand
Add: Cash Receipts
Cash Sales
Collection from customers
Issue of share
Issue of Debentures
Loan Raised
Sale of Assets
Sale of Investments
Dividend Received
Intererets Received
Less: Cash Payments
Cash Purchases
Payment to the suppliers
loan repaid
buy back of shares
purchase of fixed assets
Interest paid
Divident distributed
Closing Cash in hand
Cash Flow Statement
Opening Cash in hand
Add Cash from Operations
Add Cash from Investments
Add Cash from Financing
Closing Cash in hand