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Understanding Financial Accounting

Ashok Kumar Malhotra, FCA

Professor of Finance & Chairperson of Center forBusiness Management

June 2013

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Basics of Financial Accounting

Introduction

Types of business/Structure of business

Accounting equation GAAP

Conventions

Sample Transactions Trial Balance

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Situation - 1

Infotech was incorporated long back with help of

four friends of Mr. Sahil Gandotra. Infotech has

bank balance of Rs. 200 crores as of 18thJune

2010.

1. Is Infotech a wealthy company?

2. What is the net-worth of an organisation at a

point of time?

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Situation - 2

Infotech has a plant & machinery worth of Rs.

50 lakhs. Infotech is unable to make payment

of electricity bills for the last so many months.

What is the main problem?

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Situation - 3

Infotech is managed by five softwareprofessionals including Mr. Sahil Gandotra

and able to generate revenue of Rs. 45000

every month consistently for the so manyyears but without significant bank balance.

Is it a good company to work with?

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Situation - 4

Infotech has sales of $25/- lakhs and

expenses of Rs. 10/- lakhs and Capital of

50 lakhs, liabilities 25 lakhs and assets

150 lakhs. The data is for the period 2011-

12.

What do understand by about profitability of

Infotech for the period?

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Situation5

Infotech is a consistently profitable

company. 100% of each years profit is

withdrawn in the form of profit by owner

including Mr. Sahil Gandotra.

Can the company achieve sustainable

growth in future?

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Situation - 7

Car purchased by Infotech should be

recorded in accounts at:

Market Price

Value

Cost

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While analyzing a fin. St. one must

consider

i. Cash versus Credit

ii. Cost, Price, Value

iii. Capital Expenditure versus

Revenue Expenditure

iv. Tangible & Intangible Assets

v. Real accounts, Personal accounts

& Nominal accounts

Take now &

pay later

Pay now &

take later

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Financial Statements

vi. Accrual vs. Cash Basis

vii. Long-term vs. short term

viii. Current versus non-current

ix. Debt and owners capital

x. Debit meansExpense, Assets or Recoverable

xi. Credit meansRevenue/Gain, Liabilities or

Reserve

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Manufacturing Business

Product

Maruti Suzuki Cars, trucks, vans

HCL Infosys Computer chips

Bata Athletic shoes and apparel

Coca-Cola BeveragesPhilips Stereos and television

Types of Businesses

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Merchandising Business

Product

Big Bazar General merchandise

Land Mark Toys books etc.

Reliance Digital Consumer electronics

Amazon.com Internet books, music, videoretailer

Types of Businesses

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Service Business

Product

Appu Ghar Entertainment

Jaipur Golden Transportation

Taj Hotels Hospitality and lodging

PVR EntertainmentKarvy Consultants Financial advice

Bharti Airtel Telecommunication

Types of Businesses

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There are three types ofbusiness organizations

Proprietorship

Partnership

Company

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A partnershipis

owned by two or

more individuals.

Advantages

More financialresources than a

proprietorship.

Additional

management skills.

Disadvantage

Unlimited liability.

JM & Co

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A companyis

organized under state

or federal statutes as a

separate legal entity.

Advantage

The ability to obtain

large amounts of

resources by issuing

stocks.

Disadvantage

Double taxation.

JM & Co

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Cash cycle of a firm

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Revenue Expenses = Profit

The Accounting Equation

Sales Material Consumption

+ Expenses incurred

R>E

Profit

elselossWho has to enjoy profit?Who has to bear loss?

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The Accounting Equation

Assets = Liabilities + Owners Capital

The resources

owned by a

business

The rights of

the creditors,

whichrepresent

debts of the

business

The rights of

the owners

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Stock Equation (Quantity & Cost)

Opening Stock + Purchases = Consumption + Closing Stock

Inventory at

the beginning

InventoryPurchased

during the

period

Consumption,

Wastages etc.

of inventory

Closing based onphysical inventory

at the end of

period

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Verification/ approval

Vouchers & Supporting Documents

Enter the Primary Books Filed in Voucher file

Enter into Secondary Books

Compile Trial Balance

Final Accounts

Audited Statements of Account

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Chart of Accounts

Income accounts

Expense accounts

Asset accounts Liability accounts

Capital accounts

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Generally Accepted Accounting

Principles

Matching principle

Period Cost

Entity

There are four more GAAPs, we cover aswe progress

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Economic Transaction -

Vouchers1. Date2. Amount

3. Nature

Capital (Exp. Or gain)

Revenue (Exp. Or gain)

4. Head of accountNominal, personal, real

5. Cash / bank / otherwise6. Increase / decrease