questions financial accouing 1-year 1-sem mba

8/2/2019 Questions Financial Accouing 1-Year 1-Sem Mba

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Profit and Loss Account:

Definition

Aprofit and loss account, also known as anincome statement.Gross profit or loss of a business is ascertained throughtrading accountandnet profit is determined by deducting all indirect expenses (businessoperating expenses) from the gross profit through profit and loss account.Thus profit and loss account starts with the result provided bytradingaccount.

BENEFITS OF PREPARING PROFIT &LOSS ACCOUNT:

The particulars required for thepreparation of profit and loss accountare availablefrom the trial balance. Only indirect expenses and indirect revenues are considered in

it. This account starts from the result of trading account (gross profit or gross loss).Gross profit is shown on the credit side of the profit and loss account and gross loss isshown on the debit side of this account. All indirect expenses are transferred on thedebit side of this account and all indirect revenues on credit side. If the total of thecredit side exceeds the debit side, the result is "net profit" and if the total of the debit

side exceeds the total of the credit side, the result is net loss. As the net profit or netloss of a certain accounting period is determined through profit and loss account, soits heading is:

Name of BusinessProfit and Loss Account for the year ended 31.12.2005

Sequence of Expenses in Profit and Loss Account:

There is no hard and fast rule as to the order in which the items of expenses areshown in profit and loss account. Generally, the items of expenses are shown in thefollowing sequence:

Office and Administration Expenses: These are the expenses with the managementof the business e.g. salaries of manager, accountant and office clerks, office rent,office stationary, office electric charges, office telephone etc.

Selling and Distribution Expenses: These are the expenses which are directly orindirectly connected with the sale of goods. These expenses vary with the sales i.e.they increase or decrease with the increase or decrease of sale of goods. Examplesare advertisements, carriage outward, salesmen's salaries and commission, discountallowed, traveling expenses, bad debts, packaging expenses, warehouse rent etc.

Financial and Other Expenses:All other expenses excepting those mentioned aboveare considered under this class.

The elements of income are generally divided into four categories: revenues,expenses, gains and losses .
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Revenue

The amount of money that a company actually receives during a specific period, including

discounts and deductions for returned merchandise.Revenue is calculated by multiplying the price at which goods or services are sold by thenumber of units or amount sold.

Expenses:

In common usage, an expense or expenditure is an outflow ofmoneyto another person

or group to pay for an item or service, or for a category of costs. For a tenant,rentis an

expense. For students or parents,tuitionis an expense

Gain:

Infinance,gain is aprofitor an increase in value of aninvestmentsuch as astockor

bond. Gain is calculated byfair market valueor the proceeds from the sale of theinvestment minus the sum of the purchase price and allcostsassociated with it. If the

investment is not converted into cash or another asset, the gain is then called an unrealized

gain.

Features of Profit and Loss Account:

1. This account is prepared on the last day of an account year in order todetermine the net result of the business.

2. It is second stage of the final accounts.3. Only indirect expenses and indirect revenues are shown in this account.

4. It starts with the closing balance of the trading account i.e. gross profit orgross loss.

5. All items of revenue concerning current year - whether received in cash or not- and all items of expenses - whether paid in cash or not - are considered inthis account. But no item relating to past or next year is included in it.

If credit side exceeds the debit side = Net profit

If debit side exceeds the credit side = Net loss

(XYZ co.)Profit and Loss Account for the year ended 31.12.2005

$ $Office and AdministrationExpenses: Gross profit (transferred from 312,000

Salaries 96,000Rent, rates, taxes 72,000Selling and DistributionExpenses:

Carriage outwards 10,000Discount allowed 8,000Net profit - transferred to capital A/C 126,000

312,000 312,000
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Balance Sheet Components - Assets

Total AssetsTotal assets on the balance sheet are composed of:

1. Current Assets- These are assets that may be converted into cash, sold or consumed

within a year or less. These usually include: Cash - This is what the company has in cash in the bank. Cash is reported at its

market value at the reporting date in the respective currency in which the financials

are prepared. (Different cash denominations are converted at the market conversion

rate.

Marketable securities (short-term investments) - These can be both equity and/or

debt securities for which a ready market exist. Furthermore, management expects

to sell these investments within one year's time. These short-term investments arereported at their market value.

Accounts receivable - This represents the money that is owed to the company for

the goods and services it has provided to customers on credit. Every business has

customers that will not pay for the products or services the company has provided.

Management must estimate which customers are unlikely to pay and create an

account called allowance for doubtful accounts.Variations in this account will

impact the reported sales on the income statement. Accounts receivable reported

on the balance sheet are net of their realizable value (reduced byallowance for

doubtful accounts).

Notes receivable - This account is similar in nature to accounts receivable but it is

supported by more formal agreements such as a "promissory notes" (usually ashort term-loan that carries interest). Furthermore, the maturity of notes receivable

is generally longer than accounts receivable but less than a year. Notes receivable

is reported at its net realizable value (what will be collected).

Inventory - This represents raw materials and items that are available for sale or are

in the process of being made ready for sale. These items can be valued individually

by several different means - at cost or current market value - and collectively by

FIFO (first in, first out), LIFO (last in, first out) or average-cost method. Inventory is

valued at the lower of the cost or market price to preclude overstating earnings and

assets.

Prepaid expenses - These are payments that have been made for services that the

company expects to receive in the near future. Typical prepaid expenses includerent, insurance premiums and taxes. These expenses are valued at their original

cost (historical cost).

2. Long-term assets - These are assets that may not be converted into cash, sold orconsumed within a year or less. The heading "Long-Term Assets" is usually not displayedon a company's consolidated balance sheet. However, all items that are not included incurrent assets are long-term Assets. These are:

Investments - These are investments that management does not expect to sell

within the year. These investments can include bonds, common stock, long-term

notes, investments in tangible fixed assets not currently used in operations (such

as land held for speculation) and investments set aside in special funds, such assinking funds, pension funds and plan-expansion funds. These long-term
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investments are reported at their historical cost or market value on the balance

sheet.

Fixed assets - These are durable physical properties used in operations that have a

useful life longer than one year. This includes:

Machinery and equipment - This category represents the total machinery,

equipment and furniture used in the company's operations. These assets

are reported at their historical cost less accumulated depreciation.

Buildings (plants) - These are buildings that the company uses for its

operations. These assets are depreciated and are reported at historical cost

less accumulated depreciation.

Land - The land owned by the company on which the company's buildings

or plants are sitting on. Land is valued at historical cost and is not

depreciable under U.S. GAAP

Total Liabilities

Liabilities have the same classifications as assets: current and long-term.

3. Current liabilities - These are debts that are due to be paid within one year or the operating

cycle, whichever is longer; further, such obligations will typically involve the use of current assets,

the creation of another current liability or the providing of some service.

Usually included in this section are:

Bank indebtedness - This amount is owed to the bank in the short term, such as a bank

line of credit.

Accounts payable - This amount is owed to suppliers for products and services that aredelivered but not paid for.

Wages payable (salaries), rent, tax and utilities - This amount is payable to employees,

landlords, government and others.

Accrued liabilities (accrued expenses) - These liabilities arise because an expense

occurs in a period prior to the related cash payment. This accounting term is usually used

as an all-encompassing term that includes customer prepayments, dividends payables

and wages payables, among others.

Notes payable (short-term loans) - This is an amount that the company owes to a

creditor, and it usually carries an interest expense.

Unearned revenues (customer prepayments) - These are payments received by

customers for products and services the company has not delivered or started to incur anycost for its delivery.

Dividends payable - This occurs as a company declares a dividend but has not of yet

paid it out to its owners.

Current portion of long-term debt - The currently maturing portion of the long-term debt

is classified as a current liability. Theoretically, any related premium or discount should

also be reclassified as a current liability.

Current portion of capital-lease obligation - This is the portion of a long-term capital

lease that is due within the next year.
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4. Long-term Liabilities - These are obligations that are reasonably expected to be liquidated at

some date beyond one year or one operating cycle. Long-term obligations are reported as the

present value of all future cash payments. Usually included are:

Notes payables - This is an amount the company owes to a creditor, which usually caries

an interest expense.

Long-term debt (bonds payable) - This is long-term debt net of current portion.

Deferred income tax liability - GAAP allows management to use different accounting

principles and/or methods for reporting purposes than it uses for corporate tax fillings

(IRS). Deferred tax liabilities are taxes due in the future (future cash outflow for taxes

payable) on income that has already been recognized for the books. In effect, although the

company has already recognized the income on its books, the IRS lets it pay the taxes

later (due to the timing difference). If a company's tax expense is greater than its tax

payable, then the company has created a future tax liability (the inverse would beaccounted for as a deferred tax asset).

Pension fund liability - This is a company's obligation to pay its past and current

employees' post-retirement benefits; they are expected to materialize when the employees

take their retirement (defined-benefit plan). Valued by actuaries and represents the

estimated present value of future pension expense, compared to the current value of the

pension fund. The pension fund liability represents the additional amount the company will

have to contribute to the current pension fund to meet future obligations.

Long-term capital-lease obligation - This is a written agreement under which a property

owner allows a tenant to use and rent the property for a specified period of. Long-term

capital-lease obligations are net of current portion.

cash flow statement :

The statement of cash flows tells you how much cash went into and out of a company

during a specific time frame such as a quarter or a year. You may wonder why there's aneed for such a statement because it sounds very similar to the income statement, which

shows how much revenue came in and how many expenses went out.

The difference lies in a complex concept called accrual accounting. Accrual accounting

requires companies to record revenues and expenses when transactions occur, not when

cash is exchanged. While that explanation seems simple enough, it's a big mess in practice,

and the statement of cash flows helps investors sort it out.

The statement of cash flows is very important to investors because it shows how much

actual cash a company has generated. The income statement, on the other hand, oftenincludes noncash revenues or expenses, which the statement of cash flows excludes.


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One of the most important traits you should seek in a potential investment is the firm's

ability to generate cash. Many companies have shown profits on the income statement but

stumbled later because of insufficient cash flows. A good look at the statement of cash

flows for those companies may have warned investors that rocky times were ahead.

The Three Elements of the Statement of Cash Flows

Because companies can generate and use cash in several different ways, the statement of

cash flows is separated into three sections: cash flows from operating activities, from

investing activities, and from financing activities.

The cash flows from operating activities section shows how much cash the company

generated from its core business, as opposed to peripheral activities such as investing or

borrowing. Investors should look closely at how much cash a firm generates from its

operating activities because it paints the best picture of how well the business is producing

cash that will ultimately benefit shareholders.

The cash flows from investing activities section shows the amount of cash firms spent on

investments. Investments are usually classified as either capital expenditures--money spent

on items such as new equipment or anything else needed to keep the business running--or

monetary investments such as the purchase or sale of money market funds.

The cash flows from financing activities section includes any activities involved in

transactions with the company's owners or debtors. For example, cash proceeds from new

debt, or dividends paid to investors would be found in this section.


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