Preparation of Financial Statements

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1 Business Accounting & Analysis Session Two Preparation of Financial Statements Manju Jaiswall IIM Calcutta

2 Exercise Do you agree or disagree with the following: Machinery is a asset Creditors represent a long term liability Investment in a 5 year Govt. bond is a current asset Salary payable to employees is an expense Interest on debt taken is an income Capital stock invested by owners is an asset Interest earned on mutual funds is an expense Inventory is a Non current asset 1 2

3 Balance Sheet - Concept X wants to purchase a car for Rs. 5 lakhs. X Needs to borrow. A bank agrees to finance him if he can invest Rs. 1 lakh on his own Two relevant questions: What are the things of value he owns? How much does he owe, and to whom? 1 3

4 Illustration Things of value owned by X Rs. Amounts owed by X Rs. Savings bank Account Loan from a friend Fixed deposit in bank 1 Owner equity or net worth 200,000 Other personal possessions Total 2 Total 2, Say, the bank grants X the loan of Rs. 4 lakhs and he buys the car for Rs. 5 lakhs. After purchase of the car his statement of financial position will change as follows: 1 4

5 Illustration continued Things of value owned by X Rs. Amounts owed by X Rs. Savings bank Account Loan from a friend Fixed deposit in bank Own claim or net worth 200,000 Car 500,000 Bank Loan 400,000 Other personal possessions Total 6 Total 6 As a result of this transaction X s worth has increased from Rs. 2 to Rs. 6. But, his Net Worth remains the same. Why? 1 5

6 Lets compare Assets I II Liabilities & Net Worth I II Bank Savings Deposit Loan from a friend Term deposit in bank 1 Own claim / Net worth 200, ,000 Car - 500,000 Bank Loan - 400,000 Personal Possessions Total 2 6 Total

7 Balance Sheet Format: Sources of Funds Shareholders Funds Loan Funds Application of Funds Net Block (Gross Block Accumulated Depn.) Capital Work in Progress Investments Net Current Assets (Current Assets, Loans and Advances Current Liabilities & Provisions) Misc. Expenditure (to the extent not yet written off) Profit and Loss Account (losses) 1 7

8 Hitech Ltd. Balance Sheet as at 31 December 2006 (all figures are in Rs. 000) % Assets Rs. Liabilities & Shareholders Equity Current Assets Current Liabilities & Provisions Cash 500 Notes payable Marketable Securities 200 Accounts payable / Creditors Notes/Bills receivable 300 Accrued Liabilities / expenses Accounts receivable / Debtors 1,000 Income Tax payable Less: estimated loss on collection Bank overdraft Prepaid / Expenses paid in advance 500 Unearned Revenue/Advance receipt of Income Inventory 1,100 Current Liabilities Total Rs , ,000 Current Assets Total 3,500 Long term Liabilities Fixed Assets Debentures 1,000 Land 2,000 Long term loans 2,000 Buildings, plant and machinery: 2000 Long term Liabilities 3,000 Less: Accumulated depreciation 1,000 1,000 Shareholder s Equity Property Plant and Equipment Total 3,000 Ordinary share capital 2,000 Intangible Assets Capital Reserves 500 Goodwill 1,500 Reserves & Surplus 1,500 Investments 1000 Share holders equity 4,000 Deferred Expenditure / Misc Expenditure 1,000 Total Assets 10,000 Total Liabilities & Shareholders Equity ,000

9 Hitech Ltd. Balance Sheet as at 31 December 2006 (all figures are in Rs. 000) % Liabilities & Shareholders Equity Rs. Assets Shareholder s Equity Fixed Assets Ordinary share capital 2,000 Land Capital Reserves 500 Buildings, plant and machinery: 2000 Reserves & Surplus 1,500 Less: Accumulated depreciation 1,000 Share holders equity 4,000 Property Plant and Equipment Total Long term Liabilities Intangible Assets Debentures 1,000 Goodwill Long term loans 2,000 Investments Rs. 2,000 1,000 3,000 1, Long term Liabilities 3,000 Current Assets Current Liabilities & Provisions Cash 500 Notes payable 600 Marketable Securities 200 Accounts payable / Creditors 1,000 Notes/Bills receivable 300 Accrued Liabilities / expenses 600 Accounts receivable / Debtors 1,000 Income Tax payable 400 Less: estimated loss on collection Bank overdraft 200 Prepaid / Expenses paid in advance 500 Unearned Revenue/Advance receipt of Income 200 Inventory 1,100 Current Liabilities Total 3,000 Deferred Expenditure/ Misc Expenditure 1,000 Total Liabilities & Shareholders Equity 10,000 Total Assets ,000

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11 Questions asked by owners/managers Was it a good year or bad year? What was the volume of operations? What was the margin available on sales realization? The answer Profit and Loss Account 1 11

12 Net Income Net Income is the change in equity that results from the Operations of an entity during an accounting period. net effect of Revenue, Expenses, Gains and Losses for the period Net Income Net Income is Positive when (Revenue + Gains) is greater than (Expenses + Losses This Increases the Equity of the Owners Net Income is Negative when (Revenue + Gains) is less than (Expenses + Losses) This Decreases the Equity of the Owners 1 12

13 Revenue vs. Receipt Retailer gives 30 days to pay to the customer in December. An attorney requires client to prepay Rs 10,000 before researching the case. A manufacturer sells a products & gets cash immediately on sale in December. 1 13

14 Net Income / Profit Profit = Sales - Purchases OR Profit = Sales - Cost of Goods Sold Sales 1000kgs Open 100 kgs 900 Closing stock 325 kgs 2600 Purchase 1225 kgs 9800 Profit? 1 14

15 Disclosure in Income Statement 1st Alternative INCOME Sales EXPENSES Opening stock 900 Add: Purchase 9800 Less: Closing 2600 COGS 8100 Profit nd Alternative INCOME Sales Increase in stock 1700 EXPENSES Purchase 9800 Profit

16 Illustration We purchase merchandise worth Rs. 1,000 during the period; sell 40% of this during the period for Rs Rental for the facilities during the period was Rs st alternative Sales 750 less: COGS 400 Less: Operating expens 200 Profit nd alternative Sales 750 Change in stock 600 Less: Purchases 1000 Less: Operating expens 200 Profit

17 Discussion Item Cost of inventory Rs 1000 Increase in owners equity i.e., Revenue Rs 750 Expenses i.e., expiration of inventoriable cost Rs 400 Expenses i.e. expiration of non-inventoriable cost Rs 200 Ending Inventory Rs 600 Remarks The purchase price of the merchandise. The sale proceeds realized in exchange of one half of the merchandise. The cost of the merchandise parted with in exchange for the revenue. The cost with respect to the revenue earned and hence expired cost. The cost of rent for the facility is a cost incurred during the period and expiring during the period i.e., a period cost. The unexpired cost. An asset merchandise inventory, as a convention valued at cost. 1 17

18 Common Items in Income Statement = Above the Line Items Revenue or Sales = TOP LINE ITEM Cost Of Goods Sold: The cost the company incurred to purchase and convert material into the finished products sold to customers. Gross Margin: The difference between revenues and cost of goods sold. Otherwise referred to as gross profit. Operating Expenses: Expenses of an operating nature, such as general, marketing, administrative expenses, incurred in the generation of revenues. Operating Income: gross margin less operating expenses EBIT: Operating income plus other income & Gains minus other expense & Losses. Interest expenses: Debt servicing charges Income Taxes: tax as per books of accounts EAT / PAT: = On the Line Item 1 18

19 Profit & Loss Account: No specific format 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) 1 19

20 Profit & Loss A/c Horizontal Format Sales net Gross profit Salaries Depreciation Other expenses Other Income EBIT / PBIT Interest EBT / PBT Income tax Tools India Ltd. Profit & Loss Account For the year ended December 31, 2006 Less: Cost of goods sold Operating expenses: Operating profit EAT / PAT (Net Profit) Amount Amount

21 Profit & Loss A/c Vertical Format Cost of goods sold Gross profit Salaries Depreciation Other expenses Operating profit Tools India Ltd. Profit & Loss Account for the year ended December 31, 2006 Amount Sales net Gross profit Amount Interest 12 Operating income 37 Profit before taxes/ EBT 30 Other income Income tax 12 Profit before taxes 30 Net profit after tax/pat

22 Infosys Technologies 1 22

23 Preparation of Balance Sheet and P&L Statement Identify the items of income and expenses from the Trial Balance and prepare a Profit and Loss Account with those items. Identify assets, liabilities and equity items from the Trial Balance and prepare a Balance Sheet. There is a linkage between Profit and Loss Account and Balance Sheet Items in the Trial Balance will appear only once in the Profit and Loss Account/Balance Sheet. Items taken from outside the Trail Balance (called adjustment entries) will find their place twice. 1 23

24 Problem 2. Could you find out the profit/loss of ABC Ltd. for the year ended 30 June 2006 (figs in Rs. Million)? Balance Sheet as on 31 March Paid up capital Reserves and surplus Loan Funds Total Fixed Assets (net block) Investment Net Current Assets Total During : 1. Company paid interim dividend of Rs. 25 million and proposed dividend of Rs. 25 million 2. Fixed assets worth Rs. 100 million were sold at a profit of Rs.25 million and the profit was taken to reserves 3. Bonus 1:5 were issued by capitalizing reserves. 1 24

25 Depreciation Definition: The systematic allocation of the original cost of an asset to the periods in which the asset provides benefit to the entity Judgement required: Service life of asset. Residual value at the end of its service life. Net cost = original cost - residual value. Method of depreciation used to allocate cost over useful life of asset 1 25

26 Depreciation methods: Two popular methods: Straight line method (SLM) Written down value method (WDV) While Companies Act, 1956 (Schedule XIV) recognises both the methods, Income Tax Act, 1961 generally recognises only one method (WDV) Straight Line Method Depreciation = Original book value * depreciation rate, or (original cost- residual value)/n Declining Balance Method Depreciation = Net book value * depreciation rate Depreciation Rate = 1- n residual value/original cost 1 26

27 Thank You

INTER CA NOVEMBER 2018

INTER CA NOVEMBER 2018 Sub: FINANCIAL MANAGEMENT Topics Estimation of Working Capital, Receivables Management, Accounting Ratio, Leverages, Capital Structure. Test Code N16 Branch: Multiple Date: (50 Marks)