Financial

Accounting &
Analysis

Bineet Desai
 Introduction
“Accounting is the art of recording, classifying, and summarising in a
significant manner and in terms of money, transactions and events which
are, in part at least, of a financial character, and interpreting the result
thereof.”

Transactions Events

Thus, accounting may be defined as the process of recording, classifying,

summarising, analysing and interpreting the financial transactions and
communicating the results thereof to the persons interested in such
information.
 Steps in the Accounting Process
1. Recording
Documents such as sales bill, pass book, salary slip etc. are recorded in the books of account.
Recording is done in a book called “Journal.”

2. Classifying
Systematic analysis of the recorded data, with a view to group transactions of one nature at one
place so as to put information in compact and usable form.
The book containing classified information is called “Ledger”.
For example, there may be separate account heads for Salaries, Rent, Printing and Stationeries,
Advertisement etc.
All expenses under these heads, after being recorded in the Journal, will be classified under separate
heads in the Ledger.
This will help in finding out the total expenditure incurred under each of the above heads.

3. Summarising
It is concerned with the preparation and presentation of the classified data in a manner useful to the
internal as well as the external users of financial statements.
This process leads to the preparation of the following financial statements:(a) Trial Balance (b) Profit
and Loss Account (c) Balance Sheet (d) Cash-flow Statement.
 Steps in the Accounting Process
4. Analysing
The figures given in the financial statements will not help anyone unless they are in a simplified form.
For example, all items relating to fixed assets are put at one place while all items relating to current
assets are put at another place.
It is concerned with the establishment of relationship between the items of the Profit and Loss
Account and Balance Sheet

5. Interpreting
This is the final function of accounting.
The recorded financial data is analysed and interpreted in a manner that will enable the end-users to
make a meaningful judgement about the financial condition and profitability of the business
operations.
The financial statement should explain not only what had happened but also why it happened and
what is likely to happen under specified conditions.

6. Communicating
Information to the end-users to enable them to make rational decisions.
Besides the usual profit and loss account and the balance sheet, additional information in the form of
accounting ratios, graphs, diagrams, fund flow statements etc.
 Sub-Fields of Accounting
Financial Accounting – It covers the preparation and interpretation of financial statements
and communication to the users of accounts. The final step of financial accounting is the
preparation of Profit and Loss Account and the Balance Sheet. It primarily helps in
determination of the net result for an accounting period and the financial position as on the
given date.

Management Accounting – Internal reporting to the managers of a business unit. To

discharge the functions of planning, control and decision- making, the management needs
variety of information. The different ways of grouping information and preparing reports as
desired by managers for discharging their functions are referred to as management
accounting.

Cost Accounting – Ends with the preparation of periodical statements and reports for
ascertaining and controlling costs.

Social Responsibility Accounting – The demand for social responsibility accounting stems
from increasing social awareness about the undesirable by-products of economic activities.
Accounting for costs incurred by the enterprise and social benefits created.
 Users of Accounting Information
(i) Investors
They need information to assess whether to buy, hold or sell their investment
know the ability of the business to survive, prosper and to pay dividend. In non-corporate sector,
where ownership and management are not essentially separated, the owners still need information
about performance of the business and its financial position to decide whether to continue or shut
down

(ii) Employees: Growth of the employees is directly related to the growth of the organisation and
therefore, they are interested to know the stability, continuity and growth of the enterprise and its
ability to provide remuneration, retirement and other benefits and to enhance employment
opportunities.

(iii) Lenders: They are interested to know whether their loan-principal and interest will be paid when
due.

(iv) Suppliers and Creditors: They are also interested to know the ability of the enterprise to pay their
dues, that helps them to decide the credit policy for the relevant concern, rates to be charged and so
on. Sometimes, they also become interested in long-term continuation of the enterprise if their
existence becomes dependent on the survival of that business. Suppose, small ancillary units supply
their products to a big enterprise, if the big enterprise collapses, the fate of the small units also
becomes sealed.
 Users of Accounting Information
(v) Customers: Customers are also concerned with the stability and profitability of the enterprise because
their functioning is more or less dependent on the supply of goods, suppose, a company produces some
chemicals used by pharmaceutical companies and supplies chemicals on three month’s credit. If all of a
sudden it faces some trouble and is unable to supply the chemical, the customers will also be in trouble.

(vi) Government and their agencies: They regulate the functioning of business enterprises for public
good, allocate scarce resources among competing enterprises, control prices, charge excise duties and
taxes, and so they have continued interest in the business enterprise.

(vii) Public: The public at large is interested in the functioning of the enterprise because it may make a
substantial contribution to the local economy in many ways including the number of people employed
and their patronage to local suppliers.

(viii) Management : Management as whole is also interested in the accounts for various managerial
decisions. On the basis of the accounts, management determines the effects of their various decisions on
the functioning of the organisation. This helps them to make further managerial decisions.
 Limitations of Accounting
▪ The Balance sheet cannot reflect the value of certain factors like loyalty and skill of
the personnel which may be the most valuable asset of an enterprise these days.

▪ Balance Sheet shows the position of the business on the day of its preparation and
not on the future date

▪ Accounting ignores changes in some money factors like inflation

▪ Certain accounting estimates depend on the sheer personal judgement of the

accountant, e.g., provision for doubtful debts, method of depreciation adopted,
recording certain expenditure as revenue expenditure or capital expenditure,
selection of method of valuation of inventories

▪ Though through various laws and Accounting Standards, efforts are made to
reduce manipulations, these cannot be completely eliminated.
 Areas of Service
(i) Maintenance of Books of Accounts:
An accountant is able to maintain a systematic record of financial transactions in
order to establish the net result of the transactions entered into during a period
and to state the financial position of the concern as at a particular date.

(ii) Statutory Audit:

Every limited company is required to appoint a chartered accountant as their
auditor who are statutorily required to report each year whether in their opinion
the balance sheet shows a true and fair view of the state of affairs on the balance
sheet date, and the profit and loss account shows a true and fair view of the profit
or loss for the year.
Law also requires (for example, the Co-operative Societies Act, the Income-tax Act,
etc.)
or because the proprietors wisely decided so (for example, a partnership firm or an
individual trader).
 Areas of Service

(iii) Internal Audit:

It is a management tool whereby an internal auditor thoroughly examines the
accounting transactions and also the system, according to which these have been
recorded with a view to ensure the management that the accounts are being
properly maintained and the system contains adequate safeguards to check any
leakage of revenue or misappropriation of property or assets and the operations
have been carried out in conformity with the plans of management.
Now-a-days internal auditing has developed as a service to management.
The internal auditor constructively contributes in improving the operational
efficiency of the business through an independent review and appraisal of all
business operations.

(iv) Taxation:
An accountant can handle taxation matters of a business or a person and he can
represent that business or person before the tax authorities and settle the tax
liability under the statute prevailing.
 Areas of Service

(v) Management Accounting and Consultancy Services:

Management accountant performs an advisory function.
He is largely responsible for internal reporting to the management for planning and
controlling current operations, decision-making on special matters and for
formulating long-range plans.
His job is to collect, analyse, interpret and present all accounting information which is
useful to the management.
Accountant provides management consultancy services in the areas of management
information system, expenditure control and evaluation of appraisal techniques for
new investments and divestments, working capital management, corporate planning
etc.
 Areas of Service
(vi) Financial Advice:
Many people need help and guidance in planning their personal financial affairs. An
accountant who knows about finances, taxation and family problems is well placed to
give such advice. Some of the areas in which an accountant can render financial
advice are:
(a) Investments: An accountant can explain the significance of the formidable
documents which shareholders receive from companies and help in making decisions
relating to their investments.
(b) Insurance: An accountant can provide information to his clients on various
insurance policies and helps in choosing appropriate policy.
(c) Business Expansion: As businesses grow in size and complexity and mergers
are being considered, accountants are in the forefront in interpreting accounts,
making suggestions as to the form of schemes and the fairness of proposals
considering cost and financial consequences and generally advising their clients. They
also advise on how to set about the problem of borrowing money or whether this is
an appropriate method of finance. Accountants can render extremely useful service
in connection of negotiations with foreign collaborators.
 Areas of Service
(d) Investigations: Financial investigations are required for a variety of purposes.
Examples are:
(i) To ascertain the financial position of a business, for the information of
interested parties in connection with an issue of capital, the purchase or sale of the
business or a reconstruction or amalgamation.
(ii) To help the management to decide whether it is cheaper to manufacture an
article or to buy out.
(iii) To ascertain why profits have fallen.
(iv) To achieve greater efficiency in management.
(v) To ascertain whether fraud has occurred and if so, its nature and extent and to
make suggestions which will help to prevent a recurrence.
(vi) To value businesses and shares in private companies for purposes such as
purchase, sale, estate duty or wealth tax etc.
For such problems requiring financial investigation, you need an accountant. His task
as an independent professional is to establish the facts fairly and clearly for the
benefit of those who have to make decisions and to give advice in many areas in
which he has competence and experience.
 Areas of Service
(e) Pension schemes: Specialist advice from actuaries, insurance agents or
insurance company is needed before launching or amending a provident fund or
pension scheme in a business. But before making a final decision, an accountant has
to be consulted. Later on, his help may be needed for managing the scheme or
obtaining tax relief.

(vii) Other Services

(a) Secretarial Work: Companies, clubs, and associations indeed, virtually all
organisations involve secretarial work. Accountants frequently do this work.
(b) Share Registration Work: Accountants are often used by many companies to
undertake the work involved in registering share transfers and new issues.
(c) Company Formation: In conjunction with legal advisers, accountants help in the
formation of a company or advise against doing so.
(d) Receiverships, Liquidations, etc.: An accountant has to sometimes take on the
onerous duties of liquidator when a company is being wound up or receiver when a
debenture holder exercises a right to recover a loan on which the borrower has
defaulted. Accountant is just the man for the job. He is also just the man to help you
to keep insolvency away if you consult him in time.
 Areas of Service

(e) Arbitrations: At times, accountants are invited by parties to act as

arbitrators in a dispute or settle disputes of various kinds.
(f) As regards the Cost Accounts: A cost accountant’s job is to continuously
report cost data and related information at frequent intervals to the management.
(g) Accountant and Information Services: An accountant will be effective in his
role if he supplies the information promptly and in an unambiguous language. He
should develop a system by which there is a regular flow of information both
horizontally and vertically.
The information system should be such that comparability of financial statement is
possible both business-wise and year-wise so that it benefits both the management
and the investors. Dependence on data from the computerised information system
will put new responsibilities on an accountant but his product will command greater
attention and respect.
Concepts
To achieve uniformity, accounting process
is applied within the conceptual
framework of
Generally Accepted Accounting
Principles (GAAPs)

GAAPs is used to describe rules concepts,

conventions, principles etc.

There are three fundamental accounting

assumptions :
(i) Going Concern
(ii) Consistency
(iii) Accrual
(1) Entity concept
Entity concept states that business enterprise is a separate identity apart from its owner.
Business transactions are recorded in the business books of accounts and owner’s
transactions in his personal books of accounts.
Entity concept means that the enterprise is liable to the owner for capital investment made
by the owner. Since the owner invested capital, which is also called risk capital, he has claim
on the profit of the enterprise.
Example: Mr. X started business investing Rs.7,00,000 with which he purchased machinery
for Rs.5,00,000 and maintained the balance in hand. The financial position of the will be:

Now if Mr. X spends Rs.5,000 to meet his family expenses from the business fund

It should not be taken as business expenses and would be charged to his capital account (i.e., his
investment would be reduced by Rs.5,000).
2. Money Measurement Concept
Only those transactions, which can be measured in terms of money are recorded

Exceptions
For example, a Company has very knowledgeable and skilled employees who have
worked in it for a number of years. Since the Co can't put a value on the
contributions that the employees make because of their skills, it can't record them
in her financial records.

Other examples of items that a Company can't record include its loyal customer
base or the industry-leading customer service the company provides.

Even though the Company can't record all items, some of them will eventually have
a monetary impact. For example, loyal customers continue to buy the Company's
shoes and it can record those sales in the financial records when the sale occurs
and can quantify them.
 Money Measurement Concept

Can Goodwill be measured ?

Concept of Goodwill :
For example, a software company may have net assets (consisting primarily
of miscellaneous equipment, and assuming no debt) valued at Rs.1 million,
but the company's overall value (including brand, customers, intellectual
capital) is valued at Rs.10 million. Anybody buying that company would
book Rs.10 million in total assets acquired, comprising Rs.1 million physical
assets, and Rs.9 million in Goodwill.
3. Periodicity concept
This is also called the concept of definite accounting period. As per ‘going concern’
concept an indefinite life of the entity is assumed.
If a textile mill lasts for 100 years, it is not desirable to measure its performance as
well as financial position only at the end of its life.
So a small but workable fraction of time is chosen out of infinite life cycle of the
business entity for measuring performance and looking at the financial position.
Generally one year period is taken up for performance measurement and appraisal
of financial position. In India it is 1st April – 31st March.

Thus, the periodicity concept facilitates in:

(i) Comparing of financial statements of different periods
(ii) Uniform and consistent accounting treatment for ascertaining the profit and
assets of the business
(iii) Matching periodic revenues with expenses for getting correct results of the
business operations
 4. Accrual concept
Under accrual concept, the effects of transactions and other events are recognised
on mercantile basis i.e., when they occur (and not as cash or a cash equivalent is
received or paid)
Financial statements prepared on the accrual basis inform users not only of past
events involving the payment and receipt of cash but also of obligations to pay cash
in the future and of resources that represent cash to be received in the future.

Accrual means recognition of revenue and costs as they are earned or incurred and
not as money is received or paid. The accrual concept relates to measurement of
income, identifying assets and liabilities.

Example: Mr. Shroff buys clothing of Rs.50,000 paying cash Rs.20,000 and sells at
Rs.60,000 of which customers paid only Rs.50,000.
His revenue is Rs.60,000, not Rs.50,000 cash received.
Expense (i.e., cost incurred for the revenue) is Rs.50,000, not Rs.20,000 cash paid.
So the accrual concept based profit is Rs.10,000 (Revenue – Expenses)
 Accrual concept
Alternative as per Cash basis

Cash received in ordinary course of business – Cash paid in ordinary course of

business = Profit.

Revenue may not be realised in cash. Cash may be received simultaneously or

(i) Before revenue is created (A. 1)
A.1 creates a LIABILITY when cash is received in advance.
(ii) After revenue is created (A. 2)
A.2 creates an ASSET called Trade receivables.
Expenses may not be paid in cash. Cash may be paid simultaneously or
(i) Before expense is made (B. 1)
B.1 creates an ASSET called Trade Advance when cash is paid in advance
(ii) After expense is made (B. 2)
B.2 creates a LIABILITY called payables or Trade payables or outstanding liabilities.
5. Matching concept
In this concept, all expenses matched with the revenue of that period should only
be taken into consideration. In the financial statements of the organization if any
revenue is recognized then expenses related to earn that revenue should also be
recognized.

This concept is based on accrual concept as it considers the occurrence of expenses

and income and do not concentrate on actual inflow or outflow of cash. This leads
to adjustment of certain items like prepaid and outstanding expenses, unearned or
accrued incomes.

It is not necessary that every expense identify every income. Some expenses are
directly related to the revenue and some are time bound. For example:- selling
expenses are directly related to sales but rent, salaries etc are recorded on accrual
basis for a particular accounting period. In other words periodicity concept has also
been followed while applying matching concept.
 Matching concept
Example :
Mr. P K started cloth business. He purchased 10,000 pcs. garments @ Rs.100 per
piece and sold 8,000 pcs @ Rs.150 per piece during the accounting period of 12
months 1st January to 31st December, 2019. He paid shop rent @ Rs.3,000 per
month for 11 months and paid Rs.8,00,000 to the suppliers of garments and
received Rs.10,00,000 from the customers. Show Profit, Assets & Liabilities
6. Going Concern concept

- The financial statements are normally prepared on the assumption that

an enterprise is a going concern and will continue in operation for the

foreseeable future.

- Hence, it is assumed that the enterprise has neither the intention nor the

need to liquidate or curtail materially the scale of its operations

7. Cost Concept

The value of an asset is to be determined on the basis of historical cost, in other

words, acquisition cost.

Distortions :
In an inflationary situation when prices of all commodities go up on an average,
acquisition cost loses its relevance. For example, a piece of land purchased on
1.1.1995 for Rs.2,000 may cost Rs.1,00,000 as on 1.1.2020. So if the accountant
makes valuation of asset at historical cost, the accounts will not reflect the true
position.

In many circumstances, the cost convention is not followed

8. Realisation concept
It closely follows the cost concept. Any change in value of an asset is to be recorded only when the
business realises it. When an asset is recorded at its historical cost of Rs.5 lacs and even if its current
cost is Rs.15 lacs such change is not counted unless there is certainty that such change will materialize.
However, accountants follow a more conservative path. They try to cover all probable losses but do not
count any probable gain.

Example: Mr. X purchased a piece of land on 1.1.1995 paying Rs.2,000. Its current market value is
Rs.1,02,000 on 31.12.2015. Should the accountant show the land at Rs.2,000 following cost concept
and ignoring Rs.1,00,000 value increase since it is not realised?

Revaluation of assets has

become a widely
accepted practice when
the change in value is of
permanent nature.
Accountants adjust such
value change through
creation of revaluation
(capital) reserve.
9. Dual aspect concept
This concept is the core of double entry book-keeping. Every transaction or
event has two aspects:
(1) It increases one Asset and decreases other Asset;
(2) It increases an Asset and simultaneously increases Liability;
(3) It decreases one Asset, increases another Asset;
(4) It decreases one Asset, decreases a Liability.
Alternatively:
(5) It increases one Liability, decreases other Liability;
(6) It increases a Liability, increases an Asset;
(7) It decreases Liability, increases other Liability;
(8) It decreases Liability, decreases an Asset.
 Dual aspect concept

Transactions:
(a) A new machine is purchased paying Rs.50,000 in cash.
(b) A new machine is purchased for Rs. 50,000 on credit, cash is to be paid later on.
(c) Cash paid to repay bank loan to the extent of Rs. 50,000.
(d) Raised bank loan of Rs. 50,000 to pay off other loan.
 Dual aspect concept
(a) A new machine is purchased paying Rs.50,000 in cash.

(b) A new machine is purchased for Rs.50,000 on credit, cash is to be paid later on.
 Dual aspect concept
(c) Cash paid to repay bank loan to the extent of Rs.50,000.

(d) Raised bank loan of Rs.50,000 to pay off other loan.

 Dual aspect concept
So every transaction and event has two aspects. This gives basic accounting equation :
Equity (E) + Liabilities (L) = Assets (A) or
Equity + Long Term Liabilities + Current Liabilities = Fixed Assets + Current Assets
Equity (E)= Assets (A) – Liabilities(L)
Equity + Long Term Liabilities = Fixed Assets + (Current Assets – Current Liabilities)
Equity = Fixed Assets + Net Working Capital – Long Term Liabilities

Required
1) Develop the accounting equation
2) Find the profit for the year & the Balance sheet as on 31/3/2017.
 Dual aspect concept
Solution :
For the year ended April 1, 2016:
1) Equity = Capital 1,00,000
2) Liabilities = Bank Loan + Trade Payables
Liabilities1,00,000 + 75,000 = 1,75,000
3) Assets = Fixed Assets + Trade Receivables + Inventory + Cash & Bank
Assets = 1,25,000 + 75,000 + 70,000 + 5,000 = 2,75,000
4) Equity + Liabilities = Assets
1,00,000 + ` 1,75,000 = 2,75,000

For the year ended April 1, 2017:

Assets = 1,10,000 + 80,000 + 80,000 + 6,000 = 2,76,000
Liabilities = 1,00,000 + 70,000 = 1,70,000
Equity = Assets – Liabilities
= 2,76,000 – 1,70,000
= 1,06,000

Profits = New Equity – Old Equity

= 1,06,000 – 1,00,000
= 6,000
10. Conservatism
Conservatism states that the accountant should not anticipate income and should
provide for all possible losses

The Golden Rule of current assets valuation ‘Cost or Market price whichever is
lower’ originated from this concept.

The Realisation Concept also states that no change should be counted unless it has
materialised.

The Conservatism Concept goes a step further to state that it is not prudent to
count unrealised gain but it is desirable to guard against all possible losses

The principle advocates Prudence, i.e., judgement about the possible future
losses which are to be guarded, as well as gains which are uncertain.
11. Consistency
In order to achieve comparability of the financial statements of an enterprise through time,
the accounting policies are followed consistently from one period to another; a change in
an accounting policy is made only in certain exceptional circumstances.
For example a company may adopt any of several methods of depreciation such as written-
down-value method, straight-line method, etc. Likewise there are many methods for
valuation of inventories.
In case of valuation of Inventories if the company applies the principle ‘at cost or market
price whichever is lower’ and if this principle accordingly results in the valuation of
Inventories in one year at cost price and the market price in the other year, is there an
inconsistency ??? There is no inconsistency here. It is only an application of the principle.

An enterprise should change its accounting policy in any of the following circumstances
only:
a. To bring the books of accounts in accordance with the issued Accounting Standards.
b. To comply with the provision of Law.
c. When under changed circumstances it is felt that new method will reflect more true
and fair picture in the financial statement.
12. Materiality
According to materiality principle, all the items having significant economic effect on the business of the
enterprise should be disclosed in the financial statements and any insignificant item which will only
increase the work of the accountant but will not be relevant to the users’ need should not be disclosed
in the financial statements.

The term materiality is the subjective term. It is on the judgement, common sense and discretion of the
accountant that which item is material and which is not. Moreover an item material to one person may
be immaterial to another person.

For example stationary purchased by the organization though not used fully in the accounting year
purchased still shown as an expense of that year because of the materiality concept. Similarly
depreciation on small items like books, calculators etc. is taken as 100% in the year of purchase though
used by the entity for more than a year. This is because the amount of books or calculator is very small
to be shown in the balance sheet though it is the asset of the company.

The materiality depends on :

- Amount of the item
- Size of the business
- Nature and level of information
- Level of the person making the decision etc.
Accounting vs Economics
 Accounting Profit vs Economic Profit
Sales Rs.500,000 Sales Rs.500,000
Rent Rs.100,000 Rent Rs.100,000
Raw Materials Rs.200,000 Raw Materials Rs.200,000
Labour Rs.100,000 Labour Rs.100,000
Utilities Rs.50,000 Utilities Rs.50,000
Profit Rs. 50,000 Profit Rs. 50,000
Opportunity Rs.150,000
Accounting Profit Cost
Profit / Loss - Rs. 100,000

Economic Profit
 Accounting Values vs Economic Values
Historic Cost Principle – Value represents a historic no & NOT Market Value
Hence Accounting Values may differ from current Economic Value.
Intangible Assets – difficult to objectively value them, but have substantial
Economic Value
Contingent Liabilities
- Recorded as a footnote in Balance Sheet, however can be substantial
Treatment of R&D Expenses / Treatment of Advertisement Expenses
R&D expences increases a firms technical know-how
Advertisement expenditure builds brand image.
Both lead to ultimate increase in Sales.
Creative Accounting
- Change in Method of Stock Valuation
- Change in method of depreciation
- Sale & Leaseback arrangements
Thank you