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UnderstandingCorporate FinancialStatements
Ashok Banerjee
Indian Institute of Management Calcutta
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Why Accounting?
Every business entity is exposed to three
types of risks of varying degree: Market Risk
Credit Risk
Operational Risk
Accounting help reduce operational risks.
Accountants ideally should not be toocreative!
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Functions of Accounting
System Internal routine reporting to managers for costplanning and cost control of operations, andperformance evaluation of people andactivities.
Internal routine reporting to managers on theprofitability of products, brand categories,customers etc.
Internal non-routine reporting to managers for
strategic and tactical decisions. External reporting through financial
statements.
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Corporate Reporting SupplyChain Management: responsibility to be honest, direct, and
transparent.
Board: responsibility of oversight.
Auditors: responsibility to investigate and provideassurance.
Analysts: responsibility to be independent.
Media: responsibility to report fairly. Investor: responsibility to do his/her homework. Regulator:responsibility to frame accounting guidelines
and reporting practices.
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Basic Accounting Concepts
An understanding of accounting concepts is
vital to understand the process of accounting.
Accounting concepts underlying the
recording of transactions: Entity Concept
Money Measurement Concept
Accrual Concept Matching Concept
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Accruals
What is an accrual?
It is the recognition of an expense or revenue
that has arisen but has not yet been
recorded.
Expenses or revenues are recorded before
the cash settlement.
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Distinguish accrual-basisaccounting from cash-basis accounting.
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The Two Bases of Accounting:
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Accrual Versus Cash Example
In January 2003, Prism Insurance sells a
three-year health insurance policy to a
business client.
The contract specifies that the client had topay Rs.150,000 in advance.
Yearly expenses amount to Rs. 20,000.
What is the income or loss?
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Accrual Basis of Accounting
(000 omitted) 2003 2004 2005
Income Rs. 50 Rs. 50 Rs. 50
Expenses Rs. 20 Rs. 20 Rs. 20
Net Income (Loss) Rs. 30 Rs. 30 Rs. 30
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Cash Basis of Accounting
(000 omitted) 2003 2004 2005
Income Rs. 150 0 0
Expenses Rs. 20 Rs. 20 Rs. 20
Net Income (Loss) Rs. 130 (Rs. 20) (Rs. 20)
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Cash basis Vs. Accrual basis
XYZ Ltd. sold goods for cash worth Rs. 20 million during theyear and collected cash of Rs. 100 million from its wholesalers(whom XYZ Ltd sells on credit) during the same period. Thewholesalers owed the company Rs. 10 million at the beginning ofthe year and still owes Rs.15 million at the end of the year. How
much is the revenue of XYZ Ltd. during the year? ABC Ltd. invested its surplus fund of Rs. 30 million in a three-
year fixed deposit at an interest rate of 7% p.a. calculated on ahalf yearly basis and paid within next fifteen days. Investmentwas made at the beginning of the year. How much is the interest
income of ABC Ltd. during the year?
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Financial Statements:Objective To provide information about the financial
position, performance and cash flows of an
enterprise that is useful to a wide range of
users in making economic decisions. Financial statements do not necessarily
provide non-financial information.
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Financial Statements:Elements Elements measuring financial position:
Assets
Liabilities
Equity
Elements measuring performance Income (includes gains)
Expenses (includes losses)
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Corporate FinancialStatements What are the corporate financial statements?
Balance Sheet Shows the financial position (position of assets, liabilities
and equity) as on the reporting date. Profit & Loss Account
Shows the financial results (profit or loss) for an
accounting period.
Cash Flow Statement Shows the net increase /decrease in cash and cash
equivalents during the accounting period.
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Balance Sheet Format:
Sources of Funds Shareholders Funds Loan Funds
Application of Funds Net Block (Gross Block Accumulated Depn.) Investments Net Current Assets (Current Assets, Loans and
Advances Current Liabilities & Provisions) Misc. Expenditure (to the extent not yet written off) Profit & Loss Account (losses)
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Balance Sheet as at 31 March 2010(contd.)
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Profit & Loss Account: No specificformat Sample format:
INCOME Operating income Non-operating income
EXPENDITURE Manufacturing expenses Administration expenses Selling & distribution expenses Depreciation Interest expenses
Profit before tax (INCOME- EXPENDITURE) Provision for tax
Profit after tax (Profit before tax Provision for tax)
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P&L (contd.)
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Additional FinancialStatements Segment Reporting.
Earning per share statement.
Consolidated Financial Statements.
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Segment Report
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Operating Segments