Finesse Presents

FinGyaa
n
Financial Accounting
October 01, 2024
Accountin
g
Conventio
1. Conservatism or Prudence
● According to the convention of conservatism organisations should err on the side of
caution when recording estimates and assumptions in financial statements.
● The operating rule is that firms should recognise all estimated losses immediately and
should not recognise gains until realised.
● It is preferable to understate profits and assets rather than overstating them.
● The convention does not allow intentional overstatement of liabilities or
understatement of assets.
● Eg. If the cost of Stock-in-trade is Rs. 10,000/- and the firm expects to realise Rs.
12,000/- by selling the goods in the subsequent year, the stock is measured at Rs.
10,000/- and the expected gain is not recognised in the current fiscal year.
2. Consistency
● A firm should apply the same accounting principles across different accounting cycles.
● Once a method is chosen, it is recommended that the firm continue to apply the
method unless, there is a good reason to make a change.
● Without the convention of consistency, the ability of stakeholders to compare and
assess how an organization is performing from on period to the next is hampered.
3. Full Disclosure
● Full-disclosure focuses on the transparency that the company provides in their financial
statements so that they do not mislead the users.
● Full-disclosure convention requires the company to disclose all the information that is
relevant to the users’ understanding of the financial statements.
● That’s why there is a note to financial statements, in which it discloses a lot of
important information including accounting procedures used in preparing the financial
statements, change in accounting procedures, pending lawsuits, etc.
4. Materiality
● Information is said to be material if its omission or misstatement could influence the
decisions of the users of the financial statements.
● According to the materiality convention, a firm must report all such events and items
that might influence the decisions of the various users of financial statements, such as
investors, analysts, regulatory bodies, etc.
● Items that do not meet the threshold of materiality need not be disclosed with the
financial statements.
● E.g., Low-cost assets like stationery and cleaning supplies are charged under the
expense account instead of regular depreciating assets.
Accountin
g
Principles
1. Separate Entity Concept
● According to the entity concept the firm is a separate legal entity and thus, the owners
and the business are separate and distinct.
● The transactions related to a business must be recorded separately from those of its
owners and any other business entities.
● Stand-alone financial statements present the aggregated results of the activities
performed by one organisation, while consolidated financial statements consider the
group (parent company and subsidiaries) as one economic entity.
2. Going Concern Concept
● According to the going concern concept, it is assumed that the business will go on for a
long period of time and will not be wound up in the foreseeable future.
● Foreseeable future is usually considered to be one year after the balance sheet date.
● Certain expenses and assets may be deferred in financial reports if a company is
assumed to be a going concern.
3. Dual Aspect Concept
● The dual aspect concept states that since every transaction has a dual effect, the
accounting records must reflect the same to show the accurate movement of funds.
● Every transaction will have a debit and credit effect.
● The dual aspect concept is the building block for double-entry bookkeeping. Double-
entry is based on the principle that an organization’s assets are equal to its liabilities
and owner’s equity.
● Balance sheet calculation should reflect the following accounting equation:
Capital + Liabilities = Assets
4. Accounting Period
Concept
● The concept of an accounting period is used to segment the life of a business into
equal pieces. Accounting periods must conform to the principle of consistency.
● Accounting periods are used to estimate the profit, loss, and financial position of a
business for a specific time window.
● Generally, an accounting period lasts one year. Hence, an income statement shows the
company’s financial performance over one year, while a balance sheet shows the
financial position at the end of a year.
● Eg. Financial Year 2022-23 is from April 1st, 2022 to March 31st, 2023.
5. Money Measurement
Concept
● A company should record only those events or transactions in its financial statement
which can be measured in terms of money and where assigning the monetary value to
the transactions is not possible, it will not be recorded in the financial statement.
● Presenting the value of business in monetary terms helps in ease of communication
between management and the stakeholders.
6. Revenue Recognition
Concept
● The income generated from the core business activities of an organisation is
considered as the Revenue from Operations.
● Income that is generated from the non-core activities, such as interest on loans
received, interest on deposits received, dividend received on investments, is
categorized as ‘Other Income’.
● Recording revenue before time leads to over-reporting of profits and recording after
time leads to under-reporting profits.
● Firms follow the guidelines given under IND-AS to decide when to record revenue.
7. Matching Concept
● According to the matching concept, in order to present a true and fair view of the
operating result, income and expenses should be matched, to the extent possible.
● The expenditure incurred during an accounting cycle should match revenue collected
during that time frame.
● Expense = Cost incurred to generate Revenue
● As a result of the matching concept accounting, the organization's income statement
will reflect the associated cost of revenues and income for that time and avoid
misstated earnings
8. Accrual Concept
● Accrual accounting is a financial accounting method that allows a company to record
revenue before receiving payment for goods or services sold and record expenses as
they are incurred.
● Record revenues when earned, irrespective of the receipt
● Record expenses when incurred, irrespective of the payment
● The cash system of accounting contrasts with the accrual system
● Accrual accounting follows the matching concept, which states that revenues and
expenses should be recorded in the same period
● Eg. Credit Sales are recorded in the books of accounts when the goods are transferred
not when the payment is received.
9. Cost Concept
● The cost concept of accounting states that all assets are recorded at cost in the books
of account.
● Assets are recorded at the cost that is paid to acquire them rather than their market
value. The acquisition cost includes the cost of transporting and installing the asset, if
any.
● This acquisition cost then becomes the basis for all subsequent accounting for the
assets.
● Eg. the depreciation to be charged year on year is calculated on the cost of the asset
Journal,
Ledger
and Trial
Balance
 JOURNAL
• A journal is a detailed account that records all the financial
transactions of a business, to be used for the future reconciling
of accounts and the transfer of information to other official
accounting records
 TYPES OF ACCOUNTS
• Personal Account– These accounts types are related to
persons or firms with whom the business enters in to dealings.

– Natural Person – Human Beings (Raj’s account, Rajesh’s account)

– Artificial Person – Firms/Institutions (Partnership firms, Companies)
– Representative A/c – Capital or Drawing

• Real Account- These account types are related to assets or

properties under the control of business. E.g., Machinery,
Furniture, Cash etc.
• Nominal Account- These accounts types are related to
income or gains and expenses or losses. E.g., Rent a/c, Salary
a/c, etc
RULES OF DEBIT AND CREDIT
TYPE OF DEBIT CREDIT
ACCOUNT
PERSONAL RECEIVER GIVER

REAL WHAT COMES IN WHAT GOES OUT

NOMINAL EXPENSES AND INCOMES AND GAINS

LOSSES
As per double entry accounting system, Accounting Equation is
Assets= Liabilities + Owner’s Equity
Some Examples
• Salary Paid – Nominal – Debit
• Furniture Purchased – Real – Debit
• Building Sold – Real – Debit
• Commission Received – Nominal – Credit

• Goods Sold – Real – Credit

• Capital Introduced – Personal – Credit
• Loan taken from bank – Personal – Credit
• Sales – Real – Credit
• Purchases – Real – Debit
Let’s take some examples
• Mr. Rajesh started business with cash Rs. 2,00,000

The accounts involved are:

1) Cash a/c (Real)
2) Owner’s equity (Personal)

Entry for the same would be:

Cash a/c Dr 2,00,000
To Capital a/c 2,00,000
Let’s take some examples
• Mr. Rajesh purchased goods worth Rs. 50,000 for cash

The accounts involved are:

1) Cash a/c (Real)
2) Purchases a/c (Real)
Entry for the same would be:
Purchases a/c Dr 50,000
To Cash a/c 50,000
Let’s take some
examples
•Mr. Rajesh purchased machinery worth Rs. 5,00,000 on which
depreciation was charged at 10% pa

Depreciation on asset would be 50,000.

Journal entry for the same would be:

Depreciation a/c Dr. 50,000
To machinery a/c 50,000
Let’s take some
examples
•Mr. Rajesh has paid salaries worth Rs. 1,00,000 in cash

Salary a/c Dr. 1,00,000

To Cash a/c 1,00,000
 General Ledger
• The general ledger is the principal book of accounts.

• After recording transactions in journals, the next phase in the

accounting process is to post entries in appropriate account
heads in the general ledger.

• Periodically, accounts in the general ledger are balanced.

Debit &Credit: What are
these?
Debit: T-Account
• The left side of any T-Account. Debit Credit

• A number entered on the left side of any account is said to be

debited to an account.

Credit:
• The right side of any T- Account.
• A number entered on the right side of any account is said to be
credited to an account.

28
 Balancing General Ledger
• For example, if in a particular account the total of the debit side comes to Rs
10,000 and the total of the credit side comes to Rs 8,000, the account shows a
debit balance of Rs 2,000.

• Financial statements are prepared on the basis of balances in ledger accounts at

the end of the accounting period.
 Accounting
Approaches
Accounting Equation Approach

Increases
Decreases
Assets Debit Credit
Liabilities Credit Debit
Owners’ equity Credit Debit

Asset A/c Liability A/c Owners’

+Equity A/c
- - + - +
Accounting Equation Approach (Cont…)

Increases Decreases
Expense Debit Credit
Drawings Debit Credit
Revenue Credit Debit

Revenue A/c Expense A/c Drawings

A/c
─ + + ─ + ─
Adjustment Entries
1. Outstanding Expenses
Expenses which have fallen due to be paid but which have not been paid during the accounting
year.

Outstanding salaries are an expense that has been incurred but not yet paid, and are treated as a
liability in the balance sheet and added to the profit and loss account

For instance, Trial Balance shows Salary of Rs 15,000 but salary of Rs 1,000 for the month of
December 2004 has not been paid till 31.12.2004.
 2. Prepaid Expense

Prepaid expenses refer to those expenses which are paid in advance by the firm but the benefit of
which are availed in the next accounting period. So, these expenses have to be adjusted, which
have not been incurred in the current accounting period to know the true figure of Profit/ Loss.
• Will be deducted from the related Expenses A/c in the Dr. side of the Profit & Loss A/c
• Will be shown in the Assets side of the Balance Sheet

For instance, Trial Balance shows Insurance Expense of Rs 24,000 but out of this of Rs 10,000 is
prepaid for the next year.

Profit and Loss Account Amount Balance Sheet (Asset Side) Amount

Insurance Expense 24000

- Prepaid Expense 10000 Prepaid Expense 10000

Total Insurance Expense for the Year 14000

 3. Outstanding or Accrual Income

Income earned but not received is called accrued income. It's an accounting concept that recognizes
revenue that has been earned but Cash is not yet received

– Will be added to the other income in Profit & Loss A/c

– Will be shown in the Assets side of the Balance Sheet as Accrued Income

Eg. Interest of Rs.10000 is due from borrower. Rs.9000 received on due date, Rs.1000 is accrued.

Profit and Loss Account Amount Balance Sheet (Asset Side) Amount

Interest Income Received 9000

+ Accrued Interest 1000 Accrued Income 1000

Total Interest Income for the Year 10000

 4. Income received in advance

Income received in advance is revenue that a business receives before it has been earned, and is
also known as unearned revenue or deferred income. It's a liability because the business has an
obligation to deliver goods or services in the future.

– Will be subtracted from other income in Profit & Loss A/c

– Will be shown on the Liabilities side of the Balance Sheet as Income in Advance

Eg. Rent of Rs.10000 is due from Tenant. Rs.12000 received on due date, Rs.2000 is received in
advance.

Profit and Loss Account Amount Balance Sheet (Liabilities Side) Amount

Rent Income Received 12000

- Income in Advance (2000) Rental Income in Advance 2000

Total Rental Income for the Year 10000

 5. Bad Debts

Bad debt refers to loans or outstanding balances owed that are no longer deemed recoverable and
must be written off.
A provision for bad debts, also known as a bad debt allowance or bad debt reserve, is an accounting
method for estimating the amount of uncollectible loans and outstanding balances.
– Will be recorded as in expense in Profit & Loss A/c
– Will be deducted from Debtors in Assets Side of the Balance Sheet.

Eg. Current Debtors = Rs.50000; I anticipate Rs.5000 worth debtors to turn bad. Hence updated
value to good debtors = Rs.45000

Balance Sheet (Assets Side) Amount Profit and Loss A/c Amount

Debtors 50000 Bad Debts 5000

- Bad Debt (5000)

Total Debtors value 45000

TRIAL BALANCE
Trial Balance is the summary of all the closing balances of
ledger accounts .

All the assets expenses losses will carry a debit balance

All liabilities incomes gains provisions and reserves will
carry a credit balance
EXAMPLE QUESTION
Particulars Amount Particulars Amount
Capital 268,800 Wages 81,940
Rent Paid 21,100 Sales 710,800
Creditors 110,060 Return Inward 5,560
15% Term Loan 40,000 Salaries 279,840
Building 205,200 Return Outward 2,060
Cash at Bank 44,000 Discount Allowed 8,200
Debtors 143,000 Administrative Expenses 21,740

Bills Payable 155,500 Insurance Premium 1,200

Prov. For doubtful Debts 1,200 Bad Debts 7,240

Furniture 75,540 Commission Received 11,280

Discount Received 9,200 Outstanding Salaries 3,000
Machinery 109,360
Purchases 307,980
SOLUTION
Particulars Amount Dr Amount Cr
Capital 268,800
Rent Paid 21,100
Creditors 110,060
15% Term Loan 40,000
Building 205,200
Cash at Bank 44,000
Wages 81,940
Sales 710,800
Return Inward 5,560
Salaries 279,840
Return Outward 2,060
Discount Allowed 8,200
Administrative Expenses 21,740
Insurance Premium 1,200
Bad Debts 7,240
SOLUTION
Particulars Amount Dr Amount Cr
Commission Received 11,280
Outstanding Salaries 3,000
Debtors 143,000

Bills Payable 155,500

Prov. For doubtful Debts 1,200
Furniture 75,540

Discount Received 9,200

Machinery 109,360
Purchases 307,980
TOTAL 13,11,900 13,11,900
Financial
Stateme
nts
Financial Statements
Expense For a 12
Income Size &
Revenue months
Statement period
Profitability
Profits

Liabilities
Assets As of last
Financial
(Non Current + Current)
(Non-current + Position &
Balance Sheet date FY
Net Worth
Current) Equity

CF from Operation
For FY 12
Cash
Cash Flow Total Cash Flows CF from Investing
months
Movement
Statement period
CF from Financing
 Standard Income Statement
PARTICULARS

Revenue from Operations

Income
Other Income Dividend, Interest Received, Profit on Sale of Assets

Total Income

Raw Materials Expenses

Power & Fuel Expenses

Operating
Operating
Expenses
Expenses Employee Cost

Other Expenses Spares & Consumables, Rent, Admin, Mktg, Commission, etc.
Total Expenses
Operating Earning Before Interest, Tax, Depreciation & Amortization
EBITDA
Profit
Standard Income Statement
PARTICULARS
EBITDA
Depreciation & Amortization Depreciation on Tangible Fixed Assets
Amortization on Intangibles
EBIT
Finance Expenses Interest on Long Term as well as Short Term Borrowings
Profit Before Tax (PBT)
Tax
Profit After Tax (PAT)
 Standard Balance Sheet
LIABILTIIES
Share Capital
Net Worth/
Total Equity Reserves & Surplus

Bonds/Debentures, Bank loans raised generally for

Non-Current
Long Term Borrowings building fixed assets
Liabilities Deferred Tax, Deposits from Contractors, Employee
Other Non-Current Liabilities
Benefits like Gratuity

Short Term Borrowings

Current Trade Payables
Liabilities
Other Current Liabilities Current Maturities of Long Term Borrowings, Deposits
from Contractors, Tax Outstanding
 Standard Balance Sheet
ASSETS
Plant, Property, Equipment (PPE)
Capital Work in Progress (CWIP)
Non-
Non
Current
Current Intangible Assets
Asset
Assets Investments which cannot be readily sold. Typically
Non-Current Investments Investment in Subsidiaries, Joint Ventures, etc Types
Other Non-Current Assets – oans to related parties, Advanced to
contactor/suppliers, Security Deposits

Investments which
Investments which can
can be
be readily
readily sold.
sold. Typically
Typically those
those
Current Investments which are
which are listed
listed like
like Traded
Traded Equities,
Equities, Mutual
Mutual Funds
Funds etc
etc
Trade Receivables Money to be received from clients for credit sales
Curren
Current
t Assets
Asset Inventory Value of Raw materials, Finished goods lying as
inventory
Cash & Cash Equivalents
Other Current Assets Types
Types – Loans
– Loans toto related
related parties,
parties, Advanced
Advanced toto
contractors/suppliers,
contractors/suppliers, Security
Security Deposits
Deposits
Cash Flow
Statement
 Cash Flow Statement
A cash flow statement is a financial report detailing how cash
entered and left a business during a reporting period.
There are three components of the Cash flow Statement:
1. Cash flow from Operating Activities
2. Cash flow from Investing Activities
3. Cash flow from Financing Activities
 Purpose
Users of financial statements evaluate the ability of an entity
to generate cash and cash equivalents and the timing and
certainty of their generation.

Information about the cash flows of an entity is useful in

providing users with a basis to assess the ability of an entity
to generate cash and cash equivalents and the needs of the
entity to utilize those cash flows.
 1. Cash flow from
Operating Activities
Principal revenue producing activities of an entity.
They generally include the transactions and other
events that enter into determination of net
income.

In other words, cash flow from operating activities

measures the amount of cash generated or used
by the firm in producing and selling goods and
services.
 2. Cash flow from
Investing Activities
Investing activities are the acquisition and disposal of
long-term assets and other investments not included in
cash equivalents.

Cash flow from investing activities represent the extent

to which expenditures have been made for resources
intended to generate future income and cash flows.
 3. Cash flow from
Financing Activities
Financing activities are the activities that result in
changes in the size and composition of the
contributed equity and borrowings of the firm.

These refer to activities like obtaining funds from

debentures and shares and making interest and
dividend payments.
 Cash and cash equivalents
• Cash includes currency and demand deposits with banks and
financial institutions.
• Cash equivalents are short term highly liquid investments that
are both : (A) Readily convertible to known amounts of cash
and (B) Near their maturity that they possess an insignificant
risk of changes in value.
• Money market deposits, certificates of deposits, etc. are
examples of cash equivalents.
Depreciati
on
Depreciation
● Depreciation is the systematic allocation of the cost of a tangible asset over its
useful life. It reflects the decrease in value of the asset over time due to wear
and tear, obsolescence, or other factors.
● Cost of Asset = Cost price of Asset + Cost incurred until the asset is put to use
● Scrap Value / Residual value
● Estimated working life
● TYPES:
 Straight Line Method
 Written Down Value Method
 Sum of years Digits Method
 Units of Production Method
Straight Line Method
When % Dep. Is NOT Given When % Dep. Is Given

Dep.= Cost – Scrap Value / Working Dep.= Cost * %

Life
Written Down Value Method
● Higher depreciation charges in the early years of an asset's life and lower
charges in the later years.
● Dep. = % * Written down value at the beginning of the year
● Example:

● Normal Vs. Accumulated Depreciation

Financial
Statement
Analysis
 Basis Of
•
Comparison
Trend Analysis involves comparison of a firm over a period,
that is, present ratios are compared with past ratios for the
same firm. It indicates the direction of change in the
performance– improvement, deterioration or constancy – over
the years..
• Interfirm Comparison or Cross-Sectional Analysis
involves comparing the ratios of a firm with those of others in
the same lines of business or for the industry. It reflects the
firm’s performance in relation to its competitors.
• Comparison with standards or industry average
• 3) Comparison with standards or industry average.
 Vertical or Common
Size Analysis
1. For a balance sheet, each line item is expressed as a percentage of
total amounts of assets, which is equal to the total amounts of liabilities
plus equity.

2. For the statement of profit and loss, each line item is expressed as a
percentage of the total income.

Common-size financial statements provide an insight into the changes in the

capital structure of an entity, and the changes into relative size of the
components of assets, income and expenses.

Most important weakness is that it does not disclose the size of the firm.
 Horizontal Analysis
• Horizontal analysis expresses financial statement items as
an index relative to the base year. Increase or Decrease in
each item of Balance Sheet and Statement of P/L over the
last year is worked out and expresses as a percentage.

• It facilitates a quick review of the current year’s

performance and for the financial position over the
previous year

• 3) Comparison with standards or industry average.

Ratio
Analysis
Financial To meet its commitments, business needs liquid

Statement funds and the ratios calculated to measure it

are known as ‘Liquidity Ratios’. These are
essentially short-term in nature
Analysis Liquidity Ratios
Solvency of business is determined by its ability
to meet its contractual obligations towards
external stakeholders and the ratios calculated
Solvency Ratios to measure solvency position are known as
‘Solvency Ratios’. These are long-term in
Ratio Analysis nature.
This refers to the ratios that are calculated for
Activity or measuring the efficiency of operations of
Turnover Ratios business based on effective utilization of
resources. Hence, these are also known as
‘Efficiency Ratios’
Profitability Ratios
It refers to the analysis of profits in relation to
revenue from operations or funds (or assets)
employed in the business and the ratios
calculated to meet this objective are known as
‘Profitability Ratios’.
Liquidity
Ratios

• Current Ratio

• Quick Ratio or Acid Test Ratio

Solvenc
y Ratios

• Debt-Equity Ratio
• Interest Coverage Ratio
Debt to Equity Ratio (D/E) helps us in analyzing the financing strategy of a company. The ratio
helps us to know if the company is using equity financing or debt financing to run its operations.

A high ratio indicates significant debt financing, which can impact profitability and future
dividend payouts, thereby posing a greater risk of default if the company struggles financially.
A low ratio reveals that a company relies more on equity financing than debt indicating a lower
level of financial risk which is viewed favorably by investors.

Total Debt = Short term debt + Long term debt + Fixed payment obligations
The Interest Coverage Ratio (ICR) measures a company's ability to handle its outstanding
debt. The "coverage" represents the number of times a company can successfully pay its
obligations with its earnings.

A high ratio indicates there are enough profits available to service the debt, whereas an ICR
below one indicates a company cannot meet its current interest payment obligations and,
therefore, is not in good financial health. Most investors will not want to put their money into
a company that isn't financially sound.
Activity
or
Turnover
Ratio • Inventory Turnover Ratio

• Inventory Holding Period

• Trade Receivable Turnover Ratio

• Average Collection Period

• Trade Payable Turnover Ratio

• Payables Payment Period

• Asset Turnover Ratio

Inventory Holding Period (in no. of days)= 365 5

Inventory Turnover Ratio

4. Asset Turnover Ratio: This ratio measures the efficiency with which firm uses its assets to generate revenue.

Asset Turnover Ratio = Revenue from Operations 5

Average Total Assets

Significance: A high asset turnover ratio indicates better asset utilization and operational efficiency to generate
revenues. A low asset turnover ratio indicates that a company is not efficiently using its assets to generate sales. This
could suggest underutilization of resources, poor operational efficiency, or excess assets relative to sales. It may signal
the need for better asset management or process improvements.
 • Gross Profit Ratio

Profitabili • Net Profit Ratio

ty Ratios • Operating Profit Ratio

• Return on Invested Capital

• Return on Equity

• Return on Capital Employed

• Return on Invested Capital

• Return on Assets

• EPS

• Dividend Payout Ratio

• P/E Ratio
Operating Profit Before Tax = Profit Before Tax – Other Income + Finance Cost (Interest expense)
• Return on Invested Capital = Net Operating Profit After Tax x

Average Invested Capital

NOPAT = Profit After Tax – Other Income (net of tax) + Finance Cost (net of tax)

Assumption of tax rate 30%

Average Invested Capital =

Total Equity + Long-Term Borrowing + Short Long-Term Term Borrowing – Investment Property – Non-
Current Investments – Current Investments

• Dividend Payout Ratio = Dividend Per Share (DPS)

Earning Per Share (EPS)

• EBITDA Ratio = EBITDA/Revenue from Operations X 100