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7/30/2019 eco unit 5
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UNIT V
FINANCIAL ACCOUNTING
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It is the art of recording,classifying, summarizing, analyzing andreporting of business transactions andinterpreting their effect on the affairs ofthe business concerns.
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Branches of accounting
FINANCIALACCOUNTING
Cost AccountingManagement Accounting
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Financial accounting gathers and summarizes financialdata to prepare financial reports such as balance sheetand income statements for the firm’s management
investors , lenders, suppliers, tax authorities, and other
stakeholders
It involves the recording and summarization of businesstransactions and events. Financial accounting relates to
the preparation of financial statements for externalusers such as creditors, investors, and suppliers. Thefinancial statements include the balance sheet, incomestatement, and statement of changes in financial
position.
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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 ascertaindate and the income statement showing the
results of operations during a certain period”
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Financial Statements
Balance
sheetProfit & Loss
Account
Statement of
changes in
Owner’s equity
Statement of
changes in financial
position
Funds
flow
Cash
flow
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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 chargesTo Dock dues
To Power
To Gross Proft (to be
transferred to P & L A/c)
xxx
xxx
Xxx
Xxx
xxx
Xxx
Xxx
Xxx
Xxx
Xxx
XxxXxx
Xxx
Xxx
By Sales
Less: Returns Inwards
By Closing Stock
By Gross Loss (to
be transferred to
P&L A/c)
Xxx
xxxxxx
Xxx
xxx
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To Trading A/c
(Gross Loss)
To Salaries
To Rent & Taxes
To Stationeries
To Postage expenses
To InsuranceTo Repairs
To Trading expenses
To office expenses
To InterestTo Bank charges
To Establishmentexpenses
To Sundry expenses
To Commission
Xxx
Xxxx
Xxx
Xxx
XxxXxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
By Trading A/c
(Gross Profit)
By Commissionearned
By Rent received
By Interest received
By Discountsreceived
By Net Loss
(Capital A/c)
Xxxxxx
Xxx
Xxx
Xxx
Xxx
xxx
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To Discount
To Advertisement
To Carriage
outwards
To Travelingexpenses
To Distributionexpenses
To Bad debt
provision
To Net Profit
(transferred to
Capital A/c)
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
xxxx xxxx
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Liabilities
Sundry Creditors
Bills Payable
Bank overdraft
LoansMortgage
Reserve Fund
Outstanding exp.
Capital
Add: Net Profit
(or)
Less : Net Loss
Less Drawings
Less: Income tax
Xxx
Xxx
Xxx
xxx
Xxx
Xxx
Xxx
XxxXxx
Xxx
Xxx
xxxx
Assets
Cash in hand
Cash at bank
Bills receivable
Sundry Debtors
Closing Stock
Furniture & Fittings
Investments
Plant & Machinery
Loose toolsLand & Buildings
Business premises
Horses & carts
Prepaid exp.
Patents & Trademarks
Xxx
Xxx
Xxx
XxxXxxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
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Meaning & Concept of Funds:
1.
Cash2. 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
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List of Non Current or Permanent Capital Accounts
Non Current or permanent
Liabilities
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
Non Current or permanent 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
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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
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Differences Between funds Flow & income Statement
Funds Flow
Shows changes in financial position
Complementary to income statement
Both capital and revenue items are
considered
No prescribed format
Income Statement
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
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Differences between Funds flow statement & Balance Sheet
Funds Flow statement
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
Balance Sheet
Statement of financial position on a
particular Date
Depicts the assets & Liabilities at a
particular point of time
Not much of help to Management indecision Making
No such Statement is prepared. Rather
P&L a/c is prepared.
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Statement/Schedule of Changes In Working Capital
Effect in Working capital
Particulars Previous Current Increase Decrease
Year Year
Current
Assets:
Total CA
Current
Liabilities:
Total CL
Net increase
In WC
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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
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Adjusted Profit & Loss Account
To Depreciation, Depletion & Amortizationof fictitious & Intangible assets such asGoodwill, Patents, Trade Marks,Preliminary Expenses etc
To Appropriation of Retained Earnings(Transfers to General Reserve, DividendEqualisation Fund, Sinking Fund….. Etc)
To sale on loss of any non-current assetsTo 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 Non-
Current AssetsBy Funds From Operations (b/f)
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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”
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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 inadvance
Outstanding Expenses
Bad debts provision
Provision for tax Dividend payable
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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
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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
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CLASSIFICATION OF RATIOS
Functional
Classification
Liquidity ratios
Long Term
Solvency
And
Leverage Ratio
Activity ratios Profitability Ratios
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LIQUIDITY RATIO
Current Ratio = Current Assets (ideal ratio is 2:1)
Current Liabilities
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)
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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
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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
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Fixed Asset Net Worth Ratio = Fixed Assets( After Depreciation)
Shareholders’ funds
Solvency Ratio = Total Liabilities to outsiders
Total Assets
Ratio Of Current Assets = Current Assets
to proprietors Funds Share Holders Funds
Debt- Service or = Net Profit ( Before Interest & Tax)Interest coverage Ratio Fixed Interest charges
Total Coverage or = EBIT
Fixed charge Coverage Total Fixed Charges
Preference Dividend Coverage Ratio = Net Profit( Before Interest & Tax)Preference Dividend annual cash flow
(Before Interest & Taxes)
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ANALYSIS OF PROFITABILITY
(I) GENERAL PROFITABILITY
Gross profit ratio = Gross profit x 100
Net sales
Operating Ratio = Operating Cost X 100
Net sales
Net Profit Ratio = Net Profit x 100
Net Sales
Expenses Ratio= Particular expenses x 100Net sales
Operating Profit Ratio = Operating Profit x 100
Net Sales
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(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 100Paid 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
P i i R i M k P i E i Sh
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Price- earning Ratio = Market Price per Equity Share
(P/E ratio) EPS
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