MEFA UNIT-v.docx
- 1. 1 UNIT-5 INTRODUCTION TO FINANCIAL ACCOUNTING Double entry book keeping Journals Ledger Trail Balance Final accounts Ratios Introduction:- Every business organization wants to know whether it has made profit or not at the end of a given period. For this purpose, it has to prepare a statement containing profit or loss. If also wants to know what it owns (Assets) and how much it owns (liabilities) to its suppliers and others. For this purpose it prepares a statement showing its assets and liabilities. In order to prepare these statements, the business organization has to maintain a set of accounts. Definition:- American institute of certified public accountants(AICPA) defines “accounting as an art of recording, classifinf, and summarizing the financial transaction in a significant manner, and in terms of money and events which are in part at least of a financial character and interpreting the result theory. SIGNIFICANCE OF ACCOUNTING:- 1. Maintaining its records of business 2. Monitor the business activities 3. Calculate profit or loss for a given period 4. Fulfill legal obligations 5. Show financial position for a given period 6. Communicate the information to the interested parties.
- 2. 2 TERMS OF ACCOUNTING 1 Capital credit Loan 2 Openig stock debit Asset 3 Purchasers debit Expense 4 Sales credit Income Revenue 5 Return in wards debit Loss 6 Return out wards credit Gain 7 Wages debit Expense 8 Freight debit Expense 9 Transport expenses debit Expense 10 Royalties on production debit Expense 11 Gas , fuel debit Expense 12 Discount received credit Loss 13 Discount allowed debit Loss 14 Bad debts debit Gain 15 Bad debts provision credit Revenue 16 Commision received credit Expense 17 Repairs debit Expense 18 Rent debit Expense 19 Salaries debit Loan 20 Loan taken credit Revenue 21 Interest Received credit Expense 22 Interest paid debit Expense 23 Insurance debit Expense 24 Carrage outwards debit Expense 25 Advertisements debit Expense 26 Petty Expenses debit Expense 27 Trade Expenses debit Expense 28 Petty receipts credit Revenue 29 Income tax debit expenditure 30 Office expenses debit Expense 31 Customs Duty debit Expense 32 Sales tax debit Expense 33 Debtors debit asset 34 Creditors credit LIABILITY 35 Goodwill debit Asset 36 Plant, machinery debit Asset 37 Land , buildings debit Asset
- 3. 3 38 Furniture, fittings debit Asset 39 Investments debit Asset 40 Cash in hand debit Asset 41 Cash at Bank debit Asset 42 Reserve Fund credit LIABILITY 43 Advances debit Asset 44 Vehicles debit Asset 45 Excise duty debit Expense 46 General Reserve credit LIABILITY 47 Provision for Depreciation credit LIABILITY 48 Bills Receivable debit Asset 49 Bills payable credit LIABILITY 50 Depreciation debit Loss 51 Bank over Draft credit LIABILITY 52 Out standing salaries credit LIABILITY 53 Prepaid insurance debit Asset 54 Patents and trade marks debit Asset 55 Motor vehicle debit Asset 56 out standing rent credit Liability USE OF ACCOUNTING INFORMATION 1. Owners:- Owners want to know about the profit . They want to know how their business going on. 2.Creditors or financial institution:- Creditors or financial institutions are those who lend finances to the business firm. They want to know whether their funds ar safe or not. They use accounting information to judge the credit worthiness of a business firm. They wish to know whether the firm is capable of paying interest from time to time or not. 3.Managers:- Managers use accounting information to report t the owners or shareholders. From accounting information, they can know whether their decisions are effective or not. 4. Government or tax authorities:-Government is interested in taxes. From accounting information it assesses the tax liability of a firm, based on the net profit earned for a particular period.
- 4. 4 5. Employees:- Employees are personally interested in the accounting information to know if they can put forth their claims for better wages or better facilities. 6. Investors:- Both present and potential investors need the information to judge the prospects of present and potential investment in the business. Present investors need the information to decide whether they should continue in the present investment or not. Prospective investors need the information to decide whether to invest in the business or not. 7. Public:- The public as consumers is interested in accounting statements in order to know whether the control is exercised on controlling the expenses of the business and the price fixed is reasonable. FUNCTIONS OF ACCOUNTING 1. Recording 2. Classifying 3. Summarizing 4. Analyzing 5. Interpretation 6. Communication BRANCHES OF ACCOUNTING:- 1. Financial Accounting:- It is a process of recording , classifying, summarizing, analyzing, interpreting and communicating financial transactions and events. The purpose of this branch of accounting is to keep systematic records to ascertain financial performance (profit and loss account) and financial position (balance sheet) and communicate the accounting information to the interested parties. 2. Cost Accounting:- It is process of accounting and controlling the cost of a product. The purpose of this branch of accounting is to: a) Ascertain the cost of various product and services. b) Controlling the cost c) Communicate cost related information for decision making 3. Management Accounting:- It is the application of accounting techniques for providing information to assist the management in the formulation of policies and in planning and controlling the activities of the business enterprises.
- 5. 5 ADVANTAGES OF ACCOUNTING:- 1.It helps in ascertaining profit/loss for the financial year 2. It facilitates to ascertain financial position of the business 3. It facilitates to replace human memory by maintaining complete record of financial transactions. 4. It facilitates to comply with legal requirements which require an enterprise maintain books of accounts. 5. It facilities the users to take decisions. 6. It helps in determining cost of product/services 7. It helps the management in planning and controlling business activities and in taking decision. 8. It helps in comparing performance of business also its own performance in the past. 9. It helps in determining income tax liability, sales tax, commercial tax etc. 10. Facilitates in raising loans and also in ascertainment of value business. DISADVANTAGES OF ACCOUNTING:- 1. It ignores qualitative elements, like quality of its manpower, managerial skills of its administrators, public relations etc. 2. The financial statements are prepared on historical cost basis. It ignores the price on changes i.e time value and purchasing power of money. 3. It is also not free from personal bias when exercise the choice out of alternatives available. ACCOUNTING CONCEPTS 1. Business entity concept:- Which recording the transactions in the books of accounts, should be noted that business and owners are separate distinct entities in the eyes of accounting. All the books of accounts from the point of view of the business. 2. Money measurement concept:- According to this concept, only those monetary transaction which are capable of being expressed in terms of money are included in the accounting records.
- 6. 6 3. Cost concept:- According to this concept the transactions are recorded “at cost” in the books of accounts. For example, if building is purchased for Rs 80,000/- but its market value is Rs 1,00,000/- it is to be recorded at Rs 80,000/- only because the actual expenditure incurred is Rs 80,000/- not to be recorded at the market value of Rs 1,00,000/- 4. Going concern concept:- This concept assumes that business will continue to exist for a fairly long period of time. 5. Accounting period concept:-The life of the business is considered to be indefinite, but the measurement of income cannot be postponed for a very long period of time. Therefore, it is necessary to have a period for which the operational results are assessed for external reporting. April 1st to march 31st 6. Dual aspect concept:- This is one of the most fundamental concept of accounting. It may be stated that for every debit there is a corresponding credit. Every business transaction has a dual effect. One is receiving aspect and the other is giving aspect. Therefore for every debit there is an equal corresponding credit. 7. Accrual concept:- This concept implies that revenue is recognized in the period in which it is earned irrespective of the fact whether it is received or not during that period For example, commission Rs. 2,000 earned in the year 2008, but received in cash in the year2009, then the commission is to be taken as income for the year 2003 only, no as income of the year 2009. 8. Realization concept:- According to this concept, the revenue should be considered only when it is realized. 9. Matching concept:-This concept is based on accounting period concept which requires that here should be a periodic matching of cost incurred and revenues earned during the accounting period. Accounting conventions 1.FULL DISCLOSURE: According to this convention accounting reports should disclose fully and fairly the information. They purport to represent. They should be prepared honestly and sufficiently disclose information which is if material interest to proprietors, present and potential creditors and investors. The companies ACT, 1956 makes it compulsory to provide all the information in the prescribed form. 2. MATERIALITY: Under this convention the trader records important factor about the commercial activities. In the form of financial statements if any unimportant information is to be given for the sake of clarity it will be given as footnotes.
- 7. 7 3. CONSISTENCY: It means that accounting method adopted should not be changed from year to year. It means that there should be consistent in the methods or principles followed. Or else the results of a year cannot be conveniently compared with that of another. 4. CONSERVATISM: This convention warns the trader not to take unrealized income in to account. That is why the practice of valuing stock at cost or market price, whichever is lower is in vague. This is the policy of “playing safe”; it takes in to consideration all prospective losses but leaves all prospective profits. BOOK-KEEPING In financial accounting there are two systems of book-keeping a. Single entry book-keeping b. Double entry book-keeping (a) Single entry book-keeping system:- Single entry system is an unscientific sector maintain their books of account under single entry system of book-keeping. (b) Double entry book-keeping system:- Double entry book-keeping is a scientific way of recording transactions based on the fact for every debit, there is a corresponding credit. Under double entry system, both debit and credit aspects of the transactions are being recorded. This chapter deals with only double entry system of book-keeping. ADVANTAGES OF DOUBLE ENTRY BOOK-KEEPING:- 1. Information about every account:- under double entry system, both aspects of transactions are being recorded in the books of accounts. Hence information about every account is available in this books of account as all accounts are to be found in the ledger under double entry system. Under single entry system, only a few accounts such as cash account, debtor’s accounts and creditor’s accounts are maintained. 2. Help to know the receivables and payables: It helps to know how much is owed to the creditors and how much is due from debtors. Also it focuses on the bills payable and receivables. 3. Arithmetic accuracy: It can be ascertained by preparing a statement of debits and credits called trail balance and this is possible because both aspects of every transactions are recorded. 4. Helps to local errors: trail balance can reveal the errors that creep in accounts while recording the business information.
- 8. 8 5. Helps to ascertain profit/loss: the profit and loss statement can be prepared without much difficulty under double –entry system unlike in single-entry system. 6. Helps to know the financial business: double entry system helps to prepare balance sheet that reveals the financial position of business as on a particular date. DIFFERENCE BETWEEN SINGLE ENTRY AND DOUBLE ENTRY TYPES OF ACCOUNTS &RULES GOVERNING EACH ACCOUNT 1. Personal account: these are accounts opened in the name of persons ,firms and companies with whom the firm deals. Rule: debit the receiver and credit the giver. Ex: suppose x buys good worth Rs.5000 from us. This is not a cash transaction. This is credit transaction .so x is our debtor as he is receiving the goods. So debit x accounts in our books. 2. Real account: these are accounts opened in the named of assets such as land, buildings, plant and machinery, furniture, and fixtures etc…. Rule: debit what comes in and credit what goes out. 3. Nominal account: this is also called factious account .it exists only for namesake. nominal accounts cannot be seen. nominal accounts are those which are opened in the name of expense, losses, profits ,incomes and gain . these cannot be physically seen. Rule: debit- all expenses and losses
- 9. 9 Credit-all incomes and gains. ACCOUNTING CYCLE JOURNAL It is called a book of prime entry, because of the transaction are entered first in a book. Journalizing: the process of recording transactions in journal is called ‘journalizing’. The entry made in the journal is called journal entry. The format of a journal: Date Particulars L.F Debit Amount R.s Credit Amount R.s Explanation:
- 10. 10 Date column: in this column the table the date on which the transaction took place is entered. The transactions must be recorded in chronological order ,i.e transactions are to be entered date wise. the year and month is written once, till they change. Particular column: in this column the names of accounts to be debited is written in the first line and then the name of account to be credited is recorded in the second line. They are followed by narration given in bracket. narration is a brief explanation of the transaction entered. L.F. column: this is called ledger folio column. In this column the page number of the ledger will be entered when it is posted into its relevant account in the ledger. This helps in verification of books of accounts in case of any error. Debit account column: in this column the amount to be debited is written. Credit account column: in this column amount to be credited is written. Ex: journal the following transaction. Furniture is purchased to Rs.1000 jan-5 Date Particulars Amount Dr Rs Amount Cr. Rs 5-Jan Furniture A/C Dr 1000 To cash A/C 1000 ADVANTAGES OF JOURNAL ENTRIES: Chronological order: transactions are recorded in a choronological (date wise) order in journal. hence, when any information is required the information can be traced out quickly and easily. Explanation of transaction: each journal entry entered in the journal gives brief narration or explanation. Record of both aspects (debit &credit): both debit and credit aspects of a transaction are recorded in journal. since the amount recorded in debit amount
- 11. 11 column and credit amount column must be equal. Therefore the possibility of committing errors in reduced and the detection of errors, if any, committed becomes easy. LEDGER ledger is a book of many accounts .the process of preparation of accounts from the journal into ledger is called posting in the ledger. Ex: it may includes sales account, purchase account, sales returns account, purchase returns account, bills payable account, bills receivable account, cash account, debtors account, creditors account, and so on…. The format of ledger account: It is of two parts: Left-hand side called debit side. Right-hand side called credit side. (Or) Debit starts with ‘to’. Credit starts with ‘by’. Account Debit side (Dr) Credit side (Cr) Date particulars L.F Amount Date Particulars L.F Amount HOW TO BALANCE AN ACCOUNT? There may be any number of entries on the debit or credit side or both sides of the given account. Among the various accounts in business, if both sides tally on both the debit and credit side, the amount is settled. If the account shows more entries on one side it is necessary to balance the account to find out whether the account shows debit balance or credit balance. Calculate the totals on each side of the account. Check up on which side the total is higher. Put the total on the higher side of the account first. Then see by how much the other side is lesser. Put the difference on the lesser side writing clearly balance carried down or balance C/D . This is the closing balance for the end of the given period. The same difference becomes the opening balance for the next period.
- 12. 12 The opening balance will be written in the beginning of the next period on the higher side of the account. It should be noted that the closing balance will be put on the lesser side where as the opening balance will come on the higher side of the account. TRIAL BALANCE Trial balance is a statement containing debit and credit balances of various accounts taken out from ledger books as on a particular date. A trial balance must agree as on that date. Significance:- The trial balance must agree as on a given date i.e the total of debit balances must be equal to the total of credit balances. If it does not agree, that means there are certain arithmetical errors in the books of accounts. Preparation of trial balances Accounts showing the debit balance Debit accounts Asset accounts such a plant, furniture, etc… Expense accounts such a rent paid etc… Losses accounts such as goods destroyed in fire Purchaser accounts Sales returns accounts Drawing account Accounts showing credit balance Creditors account Liabilities account Incomes account Gain account Profit account Loan account Bank over draft account Sales account Purchase returns account Provisions account Reserves account TRIAL BALANCE
- 13. 13 PARTICULARS Debit balances Credit balances FINAL ACCOUNTS INTRODUCTION: Final accounts are prepared at the end of the year to find out results of the business during the year of profit or loss and financial position of the position of the business at the year end in terms of assets and liabilities. To find out profit or loss trading and profit and loss accounts is prepared where as to find out assets and liabilities. To find out profit or loss trading and profit and loss accounts is prepared where a to find out assets and liabilities balance sheet I prepared. In preparing the final accounts the accounting priniciple of showing all the revenue expenditure and receipts in the trading or profit and loss account where as the capital expenditure and receipts in balance sheets are followed. Before preparation of final accounts it is necessary to know that something about Revenue and capital expenditure and receipts: Revenue expenditure: any amount spent in earning revenue /profit is called as revenue expenditure and includes the expenses like salaries, rent ,wages, repairs, maintenance , stores, depreciation, materials etc…… All the items of revenue expenditure are to be debited to trading or profit or loss amount. Capital expenditure: any amount spent in increasing the earning capacity of business like purchase, installation, improvement of fixed assets and repayment of loans. all the items of capital expenditure are to be shown as an asset or to be devoted from the liability in the balance sheet. Revenue receipts: any amount received in this normal course of business is called revenue receipts and includes sale of goods, interest, discount, commission, rent received. All of the items of revenue receipt are to be credited to trading or profit and loss account. Capital receipts: any amount received as investment by the owners, raised by the way of loans and ale proceeds of fixed assets is called as capital receipt. All of the item of capital receipts are as to be shown as liability or to be deducted from the assets in the balance sheet.
- 14. 14 DEFERRED REVENUE AND EXPENDITURE any amount of revenue expenditure nature spent in huge sum and its benefits will be spread over more than one year is called deferred revenue expenditure and includes the expenses like preliminary expenses, discount on issue of shares and debentures, heavy advertisement and shifting of business promises etc…….. All the items of differed revenue expenditure are to be shown as an asset in the balance sheet where as a part of expenditure should be debited to profit and loss account. MEANING OF FINAL ACCOUNTS: any business is started with an objective of earning profit. As such the business concerns are interested to know. Results of business is profit earned or loss incurred during the year will be calculated by preparing trading and profit and loss account which I also called as income statement. Financial position of business is assets and liabilities at the yearend will be calculated by preparing balance sheet. The above two cases are called financial statements they show financial results in financial position of business. ADVANTAGES OF FINAL ACCOUNTS: Reveals financial results of business either profit or loss. Reveals financial results of business either assets or liabilities. Liquidity and solvency of business can be understood. Helps in tax calculation. LIMITATIONS OF FINAL ACCOUNTS: The final accounts are suffering from Profit or loss true picture cannot be calculated. Assets and liabilities values also not accurate. Window dressing is possible in preparing final accounts. Personal opinion of accountants/owners will influence final accounts to some extent. PARTS OF FINAL ACCOUNTS OR ELEMENTS: Trading account Profit and loss account Balance sheet TRADING ACCOUNT: It is the account prepared to find out trading profit or loss of the business is gross profit or loss during the period. This is the nominal account in its nature hence all the trading expenses should be debited where as all the trading incomes should be credited to trading account. The
- 15. 15 balance of trading account will be considered as gross profit (credit balance) or gross loss (debit balance) and will be transferred to profit and loss account. We preparing the trading account the following equation also can be used Gross profit/loss =sales less returns-cost of goods sold Sales=total (cash + credit) sales Cost of the goods sold = opening stock of goods +purchasers (cash + credit) less returns +direct expense +closing stock of goods. Advantages of trading account: It reveals trading profit or loss business. Gross profit ratio is percentage of gross profit to net sales can be neglected. Gross profit and related items like purchasers, sales, direct expenses , opening ,and closing stock , of the current year can be compared with that of previous period. Trading account proforma particulars Dr. Amount Rs. Particulars Cr Amount Rs. PROFIT AND LOSS ACCOUNT Meaning: It is the account prepared to find out net profit or loss of the business during the period. This is the nominal account in its nature hence all the other expenses should be debited where as all the other incomes and gains should be credited to profit account. The balance of profit account will be considered as net profit (credit balance) or net loss (debit balance) and will be transferred to capital account. We preparing the profit account the following equation also can be used: Gross profit +other incomes /gain –indirect expenses/loses =net profit or net loss. IMPORTANCE OF PROFIT AND LOSS ACCOUNT: It reveals net profit or net loss business. Net profit ratio is percentage of net profit to net sales can be calculated.
- 16. 16 Net profit and related items like operating expenses, non operating expenses, operating and non operating incomes of the current year can be compared with that of previous period. It helps in the preparation of balance sheet. PROFIT AND LOSS ACCOUNT PROFORMA particulars Dr. Amount Rs. Particulars Cr Amount Rs. BALANCE SHEET It is the statement prepared to find out financial position i.e. assets and liabilities of a concern of a given date. It is a statement (not an account) prepared by taking all the real accounts of personal account. In preferring the balance sheet liabilities are shown on the left hand side where as the assets are shown on right side. Importance of balance sheet: Financial position of the business can be known. Financial solvency of the business can be known. BALANCE SHEET PROFORMA: liabilities Amount Rs. Assets Amount Rs.
- 17. 17 JOURNAL PROBLEMS 1. PREPARE JOURNAL ENTRIES FOR THE GIVEN FINANCIAL TRANSCATIONS January 1- 2011-ganesh commenced business with cash Rs.20, 000 January 2- 2011-purchased furniture for Rs.1000 January 3- 2011 -Borrowed from Mr. raju Rs.2000 January 4- 2011 -Purchase of goods on credit from mr.mohan for Rs.800 January 5- 2011 -Sold goods to mr.rajesh on credit Rs.2500 January 6- 2011 -Purchase of goods for cash Rs.900 January 7- 2011 -Sold goods for cash Rs.5000 January 8- 2011 -Cash deposited into bank Rs.1000 January 9 -2011 -Rent paid Rs.400 January 10 -2011 -Withdraw cash for personal use Rs.500 January 11-2011 -Received commission Rs.200 January 12- 2011 -Received cash from mr.santhosh Rs.2100 January 13 -2011 -Interest paid on loan January 14 -2011 -Outstanding salary Rs.100 January 15- 2011 -Paid to mr.sudeep Rs.600 January 16-2011 -Goods withdrawn for personal use Rs.700 January 19- 2011 -Received a cheque from mr.rao Rs.1000 January 25- 2011 -Issued a cheque to mr.manoj,a supplier Rs.1200 January 28- 2011 -Interest received by bank Rs.200 January 31- 2011 -With draw from bank for office use Rs.300 3. PREPARE JOURNAL ENTRY FOR THE GIVEN FINANCIAL TRANSCATIONS GIVEN BELOW IN THE BOOKS OF SHANKAR 2012 MONTH OF APRIL.
- 18. 18 April 1-Shankar commenced the business with a cash Rs.30, 000 April 3-Cash sales Rs.5000 April 4-Bought machinery Rs.10, 000 April 7-Sold goods to Ravi Rs.10, 000 April 9-Purchased goods from kamala Rs.8, 000 April 10-Sold goods to Kiran Rs.6, 000 April 12-Paid for stationary Rs.1000 April 14-Carriage expenses Rs.500 April 15-Bought furniture for proprietor (personal) residence and paid cash Rs.3000 April 17-Sold goods for santhosh for cash Rs.3000 April 22-Received discount Rs.800 April 24-Paid for wages Rs.1200 April 26-Sales Rs.15000 April 27-Deposited cash into bank Rs.6000 April 28-Received cash from Mahesh Rs.1500 April 29-Received interest on loan from mr.suresh Rs.600 3. PREPARE JOURNAL ENTRY FOR THE GIVEN FINANCIAL TRANSCATIONS GIVEN BELOW IN THE BOOKS OF KRISHNA 2012 MONTH OF AUGUST. August 1-Krishna commenced business with cash Rs.50, 000 August 2-Deposited with bank 10, 000 August 3-Sold goods to Kiran is the customer Rs.20, 000 August 4- goods Sold for cash 5, 000 August 5-purchasers Rs.2, 000 August 8-bought goods from rajiv he is the supplier for Rs.4, 000 August 12-returned goods by kiran Rs.1000 August 15-paid telephone bill Rs.500 August 16-bought furniture &paid by cheque Rs.12, 000 August 17-goods return to rajiv Rs.300 August 18-paid for advertisements Rs.1500 August 19-commission received Rs.450 August 22-goods sold to ramesh Rs.5, 000 August 25-interest received from nagesh Rs.2000 August 27-cash received from lal Rs.2 ,000 August 28-received cash from kiran Rs.4,000 August 29-purchased goods from ramu for cash Rs.1200 August 29-3,650 Rs. Cash paid to rajiv in full settlement of his a/c for Rs.3700(discount received Rs.50)
- 19. 19 August 30-Received cash from kiran Rs.14600 in full settlement of his a/c for Rs.15000(discount allowed Rs.400) LEDGER PROBLEMS Example-1: journalize the following transactions post them into ledger and balance the accounts. SNO MONTH DATE PARTICULARS AMOUNT 1 March 1 Ramu commenced business 1,00,000 2 March 2 Purchased goods from rani 10,000 3 March 4 sold goods to govind 20,000 4 March 5 Cash purchase 20,000 5 March 7 paid for salaries 5000 6 March 8 Sold for cash 15,000 7 March 9 Bought furniture paid by cheque 2,000 8 March 9 Bought goods from sobhan 10,000 9 March 14 Cash paid to rani(discount received 200) 9,800 10 March 17 Received cash from govind(discount allowed 500) 19,500 11 March 18 Deposited in bank 10,000 12 March 20 paid for advertisements by cheque 700 13 March 22 stationary expenses 800 14 March 24 Sold old furniture 1,700 15 March 25 paid cash to sobhan 4,000 16 March 26 Received interest through cheque 500 17 March 31 cash withdraw for personal use 1,000 Example-2: journalize the following transactions post them into ledger and in the books of madhu and prepare necessary accounts 2009 january. SL/NO MONTH DATE PARTICULARS AMOUNT 1 JANUARY 1 Madhu commenced business 15000 2 JANUARY 2 paid in to bank 10000 3 JANUARY 3 Purchased goods from bhargav 2000
- 20. 20 4 JANUARY 4 Returned goods to Bhargav 200 5 JANUARY 5 Paid to Bhargav in full settlement 1700 6 JANUARY 6 Received interest from the bank 750 7 JANUARY 9 SOLD GOODS FOR CASH 7000 8 JANUARY 12 sold goods to don 4000 9 JANUARY 15 received goods from don with a complaint about damage 100 10 JANUARY 16 paid salaries 400 11 JANUARY 17 Entertainment 50 12 JANUARY 20 received a cheue from don 500 13 JANUARY 25 issue a cheque toward rent to land lord 100 FINAL ACCOUNTS PROBLEMS 1. From the following trial balance of vikram foundary works ,prepare trading account profit and loss account for the year march 31,2003. Prepare a balance sheet on that date. Trial balance as on march 31,2003 Trial Balance as on March 31,2003 Debit balance (Dr) Rs Credit Balance(Cr) Rs Electricity 14,000 Interest 16,000 Land 1,40,000 Discount 6,000 Interest 16,000 Sales 8,00,000 Wages 50,000 Returns 10,000 Opening Stock 20,000 Sundry creditors 60,000 Rent 24,000 Capital 3,02,000 Purchases 3,00,000 Bills payable 15,000 Office expenses 30,000 Building 4,00,000 Salaries 90,000 Power gas and water 30,000 Returns 20,000 Furniture 15,000
- 21. 21 Sundry debtors 60,000 12,09,000 12,09,000 ADJUSTMENTS: 1. Outstanding salaries Rs.10, 000 2. Closing stock Rs.80, 000 3. Deprecate buildings @10 percent per annum 4. Interested received in advance Rs.2, 000 5. Write off bad debts Rs.10, 000 2. From the following trial balance of vikram foundary works ,prepare trading account profit and loss account for the year ending 30.6.2002. Prepare a balance sheet on that date. Trial balance: Rs Rs Sundry debtors 64,000 Stock (1.1.2001) 44,000 Cash in hand 70,000 plant and Machinery 35,000 Sundry creditors 21,300 Trade Expenses 2,150 Sales 2,69,000 Salaries 4,450 Carriage out wards 800 Rent 18,00 Bills payable 15,000 Purchasers 2,37,740 Discount 2,200 Business premises 69,000 Capital 1,59,000
- 22. 22 Cash at bank 3,090 4,64,300 4,64,300 Adjustments: 1. The stock as on December 31, 2001 was R.24,900 2. Rent was unpaid to the extent Rs.170 3. Outstanding trade expense were Rs.300 4. Write off for bad debt R.800 5. Provide 5% doubtful debts 6. Depreciate plant and machinery @10%per annum 7. Business premises are to be depreciated by 2% per annum 3. From the following trial balance of vikram foundary works ,prepare trading account profit and loss account for the year ended December 31,2001. Prepare a balance sheet on that date. Trial Balance Debit balance (Dr) Rs Credit Blance(Cr) Rs Opening stock 5,000 Capital 20,000 purchasers 29,200 Sales 62,500 Sundry debtors 25,000 Sundry creditors 13,400 Bills receivable 2,800 Bills payable 5,000 Plant 10,000 Loan and Mortgage 18,000 Interest on Loan 300 Bank over Draft 2,400 Wages 15,000 Buildings 24,000 Loose Tools 600 Cash on hand 600 Stationery 500 Salaries 8,200 Discount 100 1,21,300 1,21,300 Adjustments:
- 23. 23 1. Closing stock Rs .5, 600 2. Write off loose tools Rs.540 3. Interest on mortgage @15% per annum 4. Provide interest on capital @5% per annum 5. Provide 5%reserve for doubtful debts. ILLUSTRATION 4: From the following trial balance of suresh a at december 31,2002,prepare trading, profit and loss account for the year ended December 31,2002 and a balance sheet as on that SL.NO PARTICULARS DEBIT DR(RS) CREDIT CR(RS) 1 purchase of materials 32000 2 productive wages 13000 3 Sales 60000 4 Salaries 4000 5 travelling expences 1000 6 carriage inwards 550 7 Insurance 300 8 Commission 650 9 rent and rates 1000 10 cash in hand 350 11 cash at bank 5550 12 Repairs 600 13 sundry expenses 110 14 Mortgage 6100 15 Buildings 8000 16 Machinery 3000 17 Furniture 1000 18 stock on hand(1.12002) 11500
- 24. 24 19 Capital 21310 20 sundry debtors 9000 21 sundry creditors 4200 91610 91610 Adjustments: a. Prepaid rent Rs.100 b. Depreciate the following. Building @10%per annum Machinery@20% per annum furniture@15%per annum c. provide for bad debts Rs.100 d. out standing insurance Rs.50 e. closing stock Rs.12000 5. From the following trial balance of patel on june 30,2002, prepare trading account profit and loss account for the year ended june 30,2002. Prepare a balance sheet on that date. SL NO PARTICULARS DEBTORS DR(RS) PARTICULARS CREDITORS CR (RS) 1 OPENING STOCK 48000 2 SALARIES 2000 3 WAGES 14000 4 FRIEGHT 2500 5 PURCHASES 60000 6 INTEREST ON BANK LOAN 100 7 BILLS RECIVEABLE 3000 8 RENT 1000 9 SALES 125000 10 RESERVE FOR BAD AND DOUBTFUL DEBTS 2500 11 SUNDRY CREDITORS 13650 12 RETURNS OUTWARDS 750 13 PLANT AND MACHINERY 10000 14 TRAVELLING EXPENSES 2500 15 PLANT REPAIRS 800 16 CASH IN HAND 100
- 25. 25 17 CASH AT BANK 900 18 BUILDINGS 2500 19 RETURNS INWARDS 500 20 SUNDRY DEBTORS 17500 21 OFFICE EXPENSES 2500 22 INCOME TAX 250 23 DRAWINGS 3250 24 PATELS CAPITAL 25000 25 BILLS PAYABLE 2500 26 LOAN FROM ANDHRA BANK 2000 171400 171400 Adjustments: a. Closing stock Rs.17500 b. Depreciate plant and machinery @10%per annum c. Allow interest on capital Rs.1000 per annum d. Outstanding wages Rs.700 e. Salaries yet to be paid Rs.225 f. Rent yet to be paid Rs.400 g. Maintain reserve for bad and doubtful debts of Rs.2000 FINANCIAL ANLYIS THROUGH RATIO Ratio analysis: - Ratio analysis is the process of determining and interpreting numerical relationship based on financial statements by computing ration it is easy to understand the financial position of the firm What Is ratio: - Ratio is simply a number expressed in terms of another. It refers to the numerical or quantitative relationship b/w two variables which are comparable. TYPES OF RATIOS Liquidity ratios Activity ratios Capital structure (or) leverage ratios Profitability ratios I. LIQUIDITY RATIOS
- 26. 26 Liquidity ratios express the ability of the firm to meet its short-term commitments as and when they become due. Creditors are the interested to know whether the firm will be in a position to meet its commitments on time or not. If the firm is not in a position to meet its short-term commitments such as payments of taxes wages and salaries and so on then it cannot continue in business for long despite its strong capital base Liquidity ratios can be classified in to two types 1. Current ratio 2. Quick ratio Current ratio:- current ratio is the ratio b/w current asset and current liabilities the firm is said to be comfortable in its liquidity position if the current ratio is 2:1 it is almost considered as a yardstick to as short-term liquidity however, it may vary from one industry sector to the other Current ratio = current asset/current liabilities Quick ratio:- Quick ratio is also called acid test ratio it measure the firm’s ability to convert its current assets quickly into cash in order to meet its current liabilities it is the ratio b/w liquid assets and liquid liabilities QUICK RATIO = QUICK AESTS / CURRENT LIABILITIES Quick assets = current-(stock +prepaid expenses) II. ACTIVITY RATIOS: 1. Inventory turnover ratio 2. Debtor’s turnover ratio 3. Creditors turnover ratio I 1. NVENTORY TURNOVER RATIO:- it is also called stock turnover ratio it indicates the number of items the average stock is being sold during a given accounting period it establishes the relationship b/w the cost of goods sold during a given period and the average amount of inventory outstanding during that period. The higher the inventory turnover ratio the better is the performance of the firm in selling its stocks. It helps in determining the liquidity of the firm by giving the rate at which inventory are converted into sales and then to cash it also helps the financial manager to design an appropriate inventory policy so as to avoid pilling of inventories. Inventory turnover ratio= cost of goods sold/average inventory Cost of the goods sold =sales –cross profit Average stock=opening stock + closing stock/2
- 27. 27 Inventory holding period = 365 days/ inventory turnover ratio 2. DEBTORS TURNOVER RATIO:- debtors turnover ratio reveals the number of times the average debtors are collected during a given accountant period in other words it shows how quickly the firm is in a position to collect it debts it is necessary to keep close monitoring of realization of debits because it directly affects the working capital position. In case the firm is not in a Position to collect its debits o meets the working capitals requirements it has to borrow paying interest Debtors turnover ratio=credit sales/average debtors Average debtors=(opening+closing) of debtors/2 Debt collection period = 365 days/ debtors turnover ratio 4. CREDITORS TURNOVER RATIO:- Creditors turnover reveals the number of times of the creditors are paid during a given accounting period in other words it shares how promptly the firm is in a position to pay its creditors its necessary to keep close. III. CAPITAL STRUCTURE RATIOES 1. Debt-Equity Ratio 2. Interest coverage ratio 3. Ratio of proprietors funds to total Asset 1. DEBT-EQUITY RATIO:- Debt equity ratio is the ratio between outsiders funds and insiders funds i.e, debt and equity. This is used to measure the firms obligations to creditors in relation to the owners funds. It is a measure of solvency. The yardstick for this ratio is 1:1 in other words, for every rupee of debt; there should be one rupee worth internal fund. Debt-Equity Ratio = Debt/Equity (or) Outsider’s funds/insiders funds or shareholders funds 2. INTEREST COVERAGE RATIO:- Interest coverage ratio is calculated to judge the firm’s capacity to pay the interest on debt it borrows. It give an idea of the extent the firm’s earning may contract before it is unable to pay interest payments out of current earning. It is a very important ratio for the financial institutions to judge the ability of the borrower to service the loan from the current year’s profits. The higher ratio, better it is in other words , a higher ratio implies that the company has no problems in paying interest.
- 28. 28 Interest coverage ratio= net profit before interest and taxes/fixed interest charges. 3. RATIO OF PROPRIETORS FUNDS TO TOTAL ASSETS:- This establishes the relationship between proprietor’s funds and the total assets. Here the total assets include the tangible fixed assets plus current assets. As a guideline a ratio of around 0.5:1 or 50% is considered as the minimum desirable. IV. PROFITABILITY RATIOS:- 1. Gross profit ratio 2. Net profit ratio 3. Operating ratio 4. Return on investment (ROI) 5. Earnings per share (EPS) 6. Dividend yield 7. price /Earning ratio(P/E Ratio) 1. GROSS PROFIT RATIO:- Gross profit ratio is the ratio between gross profit to sales during a given period. It is expressed in terms of percentage. Gross profit is the difference between the net sales and the cost of goods sold. Gross profit ratio = (Gross profit/sales)*100 2. Net profit ratio:- Net profit ratio is the ratio between net profits after taxes and net sales. It indicates what portion of sales is left to the owners after operating expenses. Non operating income such as interest on investment, gain on sale of fixed assets and so on are added to the operating profit and non operating expenses such as laws on sale of fixed assets and so on are deducted from such profit. This is the net profit after adjusting non operating income and non operating expenses. Net profit ratio=(Net profit after taxes/net sales)*100 3. OPERATING RATIO:- Operating ratio is the ratio between costs of goods sold plus operating expenses and the net sales. This is expressed as a percentage to net sales. The higher the operating ratio, the lower is the profitability and vice versa. Operating ratio=(operating expenses/net sales)*100 4. Earnings per share (EPS):- EPS is the relationship between net profit and the number of shares outstanding at the end of the given period. This can be compared with previous years to provide a basis for assessing the company’s performance EPS= (Net profit after taxes/Number of shares outstanding)
- 29. 29 5. DIVIDEND YIELD RATIO:- Yield refers to the amount of total return the investor will receive for a given period of time for the amount of his investment. Dividend yield refers to the percentage return on the price paid for shares. Dividend yield =(Nominal (or) face value of the share/cost or market price of the share)* (%dividend per annum) 6. price/earning ratio:- This is the share price divided by earnings per share. EXAMPLE PROBLEMS 1.From the following balance sheet of ABC co.Ltd, Calculate Liquidity ratios and debt equity ratio? RS in Thousand Labilities Rs Assets Rs preference share capital 100 Land and buildings 225 Equity share captial 150 Plant and machinery 250 General reserve 250 Furniture and fixtures 100 Debentury 400 Stock 250 Creditors 200 Debtors 125 Bills payable 50 Cash at bank 250 Out standing expenses 50 Cash in hand 125 Profit & Loss account 100 Prepaid expense 50 Bank loan 200 Marketable securities 125 1500 1500 2. A Firm sold goods worth Rs 5, 00,000 and its gross profit is 20 percent of sales value. The inventory at the beginning of the year was Rs 16,000 and at end of the year were 14,000.compute inventory turnover ratio and also the inventory holding period? 3. A Firm sales during the year was Rs 4,00,000 of which 60 percent were on credit basis. The balance of debtors at the beginning and end of the year were 25,000 and 15,000 respectively. Calculate debtor’s turnover ratio of the firm. Also find out debt collection period?
- 30. 30 4. Calculate Debt-Equity ratio from the data given in example 1? Liabilities Rs Assets Rs preference share capital 100 Land and buildings 225 Equity share capital 150 Plant and machinery 250 General reserve 250 Furniture and fixtures 100 Debenture 400 Stock 250 Creditors 200 Debtors 125 Bills payable 50 Cash at bank 250 Outstanding expenses 50 Cash in hand 125 Profit & Loss account 100 Prepaid expenses 50 Bank loan 200 Marketable securities 125 1500 1500 5. The earnings before interest and taxes (EBIT) its fixed commitments include payment at 10% on 7000 debentures of Rs 100 each. It is subject to tax of 30 percent per annum. Calculate interest coverage ratio? 6. Compute ratio of proprietor’s funds to total assets from the data given in example 1? Liabilities Rs Assets Rs preference share capital 100 Land and buildings 225 Equity share capital 150 Plant and machinery 250 General reserve 250 Furniture and fixtures 100 Debenture 400 Stock 250 Creditors 200 Debtors 125 Bills payable 50 Cash at bank 250 Outstanding expenses 50 Cash in hand 125 Profit & Loss account 100 Prepaid expenses 50 Bank loan 200 Marketable securities 125 1500 1500 7. The net sales are 50,000 for a firm and cost of goods sold is Rs 20,000. Calculate the gross profit ratio?
- 31. 31 8. Given that the number of shares is 10,000 and the net profit after taxes for a given accounting period is Rs 4, 50,000 Calculate EPS? 9. Given that current market price of a share RS 300; face value of the share is Rs 100, percentage of dividend declared is 20% calculate dividend yield? 10. Given that market price of a share is Rs 340 and EPS of Rs 10 calculate P/E ratio?