Accounting: An Introduction

Accounting: An introduction

• Accounting is the language of business• Used to communicate matters

relating to various aspects of business operations• To different interested parties

Accounting: An introduction cont..

External Users

External Users• Entities having Economic

transactions with business –Suppliers of goods or services

(creditors)–Providers of funds (banks, FIs

/lenders)–Interested in debt paying capacity of

the company

External users cont…Entities regulating business

enterprise–SEBI, RBI, IRDA, CCI, Income Tax

Dept•Protecting the interest of investors, lenders, creditors, customers etc

External users cont…Entities acting as representatives

– Business analysts, stock brokers, labor unions, economists/financial press, environmental activists, political parties, public affairs groups

–Serving the cause of their clients, employees, readers, general public

External users cont…

Prospective investors

Internal users

Internal users

• Owners –Interested in dividends and

capital appreciation (growth) • Management

–Review of past performance, planning and decision making for future

Internal users cont..

•Employees–Salaries, bonuses, career

growth

Accounting: An introduction cont…

Financial accounting defined..

Accounting is the art of recording, classifying, summarizing, in a significant manner and in terms of money, transactions and events which are, in part at least of financial character and interpreting the results thereof.

Recording of transaction

• There is purchase of furniture for cash on January 1, 2011 from Modern Furniture for Rs. 1000

Journal Entries in the books of M/s…

Date Explanation LF Debit Amount

CreditAmount

Jan. 1, 2011

Furniture account (Debit) Cash Account (Credit)(Being purchase of furniture for cash from Modern Furniture)

10 1,000 1,000

Classification into appropriate heads

Dr. Cash Account Cr.

Date Explanation Amount Date Explanation Amount

Jan 1 Capital 1,000 Jan 8 Merchandize inventory

800

Jan 30 Accounts receivable

500 Jan 31 By Balance c/d 700

1500 1500

Feb 1 To balance b/f 700

CashCash

Accounts Accounts PayablePayable

Common Common StockStock

Many individual assetaccounts

Many individual liabilityaccounts

Many individual stockholders’ equity accounts

All individual accounts combined make up the company’s ledger

LedgerLedger

SummarizationFinancial statements

• Profit and Loss Account/Income Statement

• Balance sheet/position statement

• Cash flow statement

Profit and Loss Account of X Ltd. for the Year Ended 31st March, 2011

To Opening Stock 40,000 By Sales 5,50,000

To Purchases 2,80,000 By Closing Stock 50,000

To Direct Expenses 45,000

To Gross Profit c/d 2,35,000

6,00,000 6,00,000

To Administrative Expenses

20,000 By Gross Profit b/d 2,35,000

To Selling Expenses 15,000 By Other Incomes 18,000

To Distribution expenses

18,000

To financial Expenses

15,000

To Net Profits c/d 1,85,0002,53,000 2,53,000

Balance Sheet of X Ltd. as on 31st March, 2011

Liabilities Amount in Rs.

Assets Amount in Rs.

Shareholders’ funds

5,00,000 Fixed assets 4,50,000

Long term liabilities

2,00,000 Investment 1,50,000

Current liabilities

1,00,000 Current assets 2,00,000

8,00,000 8,00,000

Preparing a Cash Flow StatementCASH FLOW STATEMENT

Cash from operating activities 1

Add: cash from investing activities 2

Add: cash from financing activities 3

Cash generated during the year 1+2+3

Add: Cash at the beginning of the year 4 (From BS)

Cash at the end of the year 1+2+3+4

Interpretation

Presentation of summarized data to enable end users build opinion about the financial condition and profitability of the company and take decision accordingly

Financial highlights: ITC

Financial highlights: ITC

Financial highlights: ITC

Financial highlights: ITC

Financial highlights: ITC

Financial highlights: ITC

Financial accounting defined..

Accounting is the art of recording, classifying, summarizing, in a significant manner and in terms of money, transactions and events which are, in part at least of financial character and interpreting the results thereof.

Transactions versus EventsTransaction: An act that a company

performs on regular basis

Event: A happening, which is a consequence of number of transactions or

An occurrence/happening that takes place occasionally.

Transactions versus EventsSales 6,00,000

Cost of goods sold 4,80,000

Rent Paid 25,000

Salaries paid 40,000

Telephone bill paid 15,000

Net profits 40,000

Transactions

Event

Events are the occurrences that effects the firm

• Vodafone sued by Income Tax Department for unpaid taxes on its cross border deal with Hutchison Essar (Tax liability = $2bn on $11bn deal).

• National air career, Indian’s pilots have gone on strike for wage discrepancies between Air India and Indian Airline pilots.

• Tata Motors Limited has floated the world’s cheapest car Nano in Auto Expo show, 2008

• Ranbaxy Laboratories has been acquired by Japanese company- Diachii Sankyo.

• Bharti Airtel has acquired Zain telecom’s operations in South Africa.

Financial accounting defined..

Accounting is the art of recording, classifying, summarizing, in a significant manner and in terms of money, transactions and events which are, in part at least of financial character and interpreting the results thereof.

Management accounting defined..

“Management accounting is the presentation of accounting information in such a way so as to assist management in creation of policy and in day to day operations of an undertaking”

(by Management Accounting team of Anglo-American Council of Productivity)

36

Illustration on using Accounting Information

A firm sells three products P1, P2, P3. Profit of the firm is declining

Year 1 Year 2

Sales Rs 1000 Rs 1000

Less: cost of goods sold 400 500

Gross margin 600 500

Less: Depreciation 200 200

Other operating expenses 100 100

Profit Rs 300 Rs 200

37

Illustration…

The Problem:• Decrease in profits during the period - as a result of overall

increase in the cost of goods sold• Now, which product is losing money?

Year 1 Year 2

P1 P2 P3 P1 P2 P3

Sales 300 300 400 400 400 200

Less: COGS 150 150 100 200 200 100

Gross margin 150 150 300 200 200 100

Sales of P3 have decreased. Cost of sales to sales of P3 has doubled

Financial accounting versus management accounting

• Financial accounting deals with record keeping and presenting the recorded results in form of financial statements.

• Management deals with rearrangement of accounting information in such a way so as to assist management in decision making.

Tax accounting

Modifying the information provided by financial accounting to compute income chargeable to tax by taxation authorities

Overall framework of accounting

• Accounting concepts

• Generally accepted accounting principle

Accounting concepts

Basic assumptions or postulates on which the science of accounting is based.

In totality, 11 concepts; out of which 5 concepts relates to the balance sheet and 6 concepts relates to profit and loss account.

Balance sheet Concepts

• Business Entity Concept• Going Concern Concept• Cost Concept• Dual Aspect Concept• Money Measurement Concept

Profit and Loss Account Concepts

• Accounting Period Concept• Conservation Concept• Realization Concept• Matching Concept• Consistency Concept• Materiality Concept

Generally Accepted Accounting Principles (GAAP)

Generally Accepted Accounting Principles (GAAP)

• Accounting Standards(strict rules)

• Accounting Policies(accepted ways of doing things where alternatives exist)

GAAP Cont…..• GAAP is thus a combination of

authoritative standards and accepted ways of doing things within the ambit of prescribed rules.

• Different professional bodies in different countries determine GAAP.

47

Accounting Standards Setting Organization in Selected Countries

Country Policy Setting Board

Australia Australian Accounting Standards Board (AASB) of Australian Financial Reporting Council sets GAAP

Canada Canadian Accounting Standards Board (CASB) of the Canada Institute of Chartered Accountants (CICA) sets GAAP

India Accounting Standards Board (ASB) of the Institute of

Chartered Accountants of India (ICAI) is the body entrusted with the work of preparing the standards.

U.K. Accounting Standards Board (ASB) of Financial Reporting Council, UK, prepares the standards.

U.S.A. Financial Accounting Standards Board (FASB) is the body solely in charge of issuing standards.

Indian GAAP cont..• Each standard issued by ICAI deals with

specific topic. Collectively, these standards are set to cover all major issues of accounting. • If an authoritative pronouncement is not

made on a given topic, accountants can treat that topic in the way they believe most fairly presents the situation.

Indian GAAP

In India, besides the AS issued by ICAI,Financial reporting and disclosure rules and

practices prescribed by sectoral regulators such as RBI Act, 1939 (for banking industry); IRDA Act, 2000 (for insurance industry) and those of Securities exchange Board of India (for listed companies), Provisions of companies Act, 1956 regarding presentation of annual accounts, also constitute Indian GAAP.

Indian GAAP cont..

• Each AS is formulated on the basis IAS/IFRS, however, these remain sensitive to local conditions, including legal and economic environment. • IAS29: Financial reporting by

hyperinflation economies (Inflation rate > 26%)

Indian GAAP cont..• ASB along with National Advisory Committee

on Accounting Standards (NACAS) has come up with 35 new AS called Ind AS in consonance with the provisions of IFRS.

• Indian companies were expected to converge to IFRS by Ist April, 2011. however, due to the pending amendments to be made in Income tax Act, 1961 and Companies Act, 1956, its adoption was postponed.

Indian GAAP cont..

Implementability of Accounting Standards:

Initially, enforced by ICAI

With effect from 1999, conferred legal status

53

Three Types of Business Entities

Sole Proprietorship Partnership Company

Examples M/s Ladduram & Sons S S Billimoria & Co. Reliance Industries Limited

No. of Shareholders One PersonMinimum: 2 Minimum: 7

Maximum: 20 Maximum: No Limit

Management Control Proprietor Partners Board of Directors

Liability Unlimited Unlimited Limited

Legal Registration No ProvisionVoluntary under

Partnership Act, 1932

Compulsory under Companies Act,

1956

Flexibility Maximum Depends on Partners Comparatively Less

Limited Liabilities Partnership Firms as per Partnership Act,

2009

LLPs in India An alternative corporate business

form that gives benefits of limited liability of a company and the flexibility of a partnership firm.

First LLP registered in India on 02.04.2009

Total LLPs registered in India till 16th

March, 2011 = 4827