Final CA&FM Book 16-2-2024.pdf

STUDY MATERIAL EXECUTIVE PROGRAMME CORPORATE ACCOUNTING & FINANCIAL MANAGEMENT GROUP 1 PAPER 4 (i)  © THE INSTITUTE OF COMPANY SECRETARIES OF INDIA Timing of Headquarters :...

STUDY MATERIAL EXECUTIVE PROGRAMME CORPORATE ACCOUNTING & FINANCIAL MANAGEMENT GROUP 1 PAPER 4 (i)  © THE INSTITUTE OF COMPANY SECRETARIES OF INDIA Timing of Headquarters : Monday to Friday Office Timings : 9.00 A.M. to 5.30 P.M. Public Dealing Timings : Without financial transactions – 9.30 A.M. to 5.00 P.M. With financial transactions – 9.30 A.M. to 4.00 P.M. Phones : 011-45341000 / 0120-4522000 Website : www.icsi.edu E-mail : [email protected] / [email protected] For Academic Updates please visit : https://www.icsi.edu/students/academic-portal/ For any suggestions/clarifications students may write to [email protected] Disclaimer Although due care and diligence have been taken in preparation of this Study Material, the Institute shall not be responsible for any loss or damage, resulting from any action taken on the basis of the contents of this Study Material. Anyone wishing to act on the basis of the material contained herein should do so after cross checking with the original source. Laser Typesetting by : AArushi Graphics, Prashant Vihar, New Delhi (ii)  EXECUTIVE PROGRAMME CORPORATE ACCOUNTING & FINANCIAL MANAGEMENT In today’s business world accounting is considered as ‘the universal language of all business’, because it is the medium for reporting financial information about a business entity to users, such as shareholders, banks and managers. A proper accounting system is essential to any business, whether big or small, in order to manage its daily functions and run it successfully. The main obligation of any business is to maximize profits, minimize losses and at the same time maintain its position as a responsible entity within the society. So, in the current business world, everybody should have the knowledge of accounting discipline irrespective of the job one is doing. Due to the rapid advancement in business activities due to industrialization and globalization, the need for people having knowledge of accounts have increased manifold. It is impossible to survive in today’s advanced business environment without adequate knowledge of basic accountancy. Especially all business students should have some background in accounting to understand, interpret and present the results of business. Keeping this objective in alignment, this study material is prepared to augment the basic as well as advanced understanding of students in the related aspects of Corporate Accounting and Financial Management. The Study Material which is divided in two parts covers in the details the concepts of Corporate Accounting in Part – I and discusses Financial Management in detail under Part-II. The legislative changes made upto November 30, 2023 have been incorporated in the study material. The students are advised to refer to the updations at the Regulator’s website, Supplements relevant for the subject issued by ICSI and ICSI Journal Chartered Secretary and Other publications. Specifically, students are advised to read “Student Company Secretary” e-Journal which covers regulatory and other relevant developments relating to the subject. In the event of any doubt, students may contact the Directorate of Academics at [email protected]. Although due care has been taken in publishing this study material, the possibility of errors, omissions and /or discrepancies cannot be rules out. This publication is released with an understanding that the Institute shall not be responsible for any errors, omissions and/or discrepancies or any action taken in that behalf. (iii)  EXECUTIVE PROGRAMME Group 1 Paper 4 CORPORATE ACCOUNTING & FINANCIAL MANAGEMENT SYLLABUS OBJECTIVES: Part I: To provide knowledge and understanding of the concepts, principles and practices in Company Accounts, Interpretation of Financial Statements. Part II: To provide conceptual clarity and practical aspects of financial management so as to develop skills in taking financial and investment decisions and in business strategies. Level of Knowledge: Working Knowledge PART I – CORPORATE ACCOUNTING (60 MARKS) 1. Introduction to Accounting: Book Keeping l Accounting Cycle l Single / Double entry system l Accounting Principles l Accounting Concept & Convention l Types of Account l Journal l Ledger l Trial Balance l Final Accounts 2. Introduction to Corporate Accounting: Records of accounts to be maintained by a company l Preparation and Presentation of Financial Statements l Schedule III of the Companies Act, 2013 l Disclosure Requirement l True and Fair View of Financial Statements l XBRL 3. Accounting Standards (AS): Applicability l Interpretation l Scope and Compliance l International Financial Reporting Standards l Overview of AS l AS vs. Ind AS vs. IFRS 4. Accounting for Share Capital : Issue of Shares l Forfeiture and Reissue of Shares l Accounting Treatment of Premium l Buy-back of Shares l Redemption and Conversion l Capital Redemption Reserve lBonus Shares l Rights Issue l ESOPs l ESPS l Sweat Equity Shares and Underwriting l Book Building 5. Accounting for Debentures: Accounting Treatment l Debenture Redemption Reserve l Redemption of Debentures and Conversion of Debentures into Shares 6. Related Aspects of Company Accounts: Accounting for ESOP l Buy-back l Equity Shares with differential rights l Underwriting and Debentures 7. Consolidation of Accounts: Standalone and Consolidated Financial Statements l Holding Company l Subsidiary Company l Associate Companies and Joint Venture l Accounting Treatment and disclosures 8. Financial Statement Analysis: Introduction l Characteristics of good financial statements and its relevancy for better reporting l Requirements of Financial Reporting and Recent trends l Best Practices (iv)  applicable to all companies l Usage and features of ratios analysis l liquidity ratios l turnover ratio l leverage ratios l Insolvency ratio and profitability ratio l DuPont Analysis l Reading and Interpretation of Financial Statements 9. Cash Flows: Understanding the Statement of Cash Flows l Identify the purpose of the statement of Cash Flows l structure and interpretation of operating l investing and financing activities in Cash Flow statement l Analyze information in the statement of Cash Flows to determine whether the firm is in its life cycle l Examine additional uses of Cash Flow information 10. Forecasting Financial Statements: Build forecasts of future Balance Sheets l Income Statements and Statements of Cash Flows. PART II – FINANCIAL MANAGEMENT (40 MARKS) 11. Introduction : Nature l Scope & Objectives of Financial Management l Profit Maximization vs. Wealth Maximization 12. Time Value of Money: Introduction l Concept of Time Value of Money – The power of compounding l Significance and application of Time Value of money l Concept of Annuity l Understanding and application of Table used in Time value of money 13. Capital Budgeting: Compounding and Discounting techniques - Capital Budgeting Process l Techniques of Capital Budgeting - Discounted and Non- Discounted Cash Flow Methods l NPV l Payback l Profitability Index l IRR l Economic Value Added (EVA) l Capital Rationing l Risk Evaluation and Sensitivity Analysis 14. Cost of Capital: Sources l Meaning l Factors Affecting Cost of Capital l Methods for Calculating Cost of Capital l Weighted Average Cost of Capital (WACC) l Marginal Cost of Capital 15. Capital Structure: Introduction l Significance of Capital Structure l Determinants of Capital Structure l Capital structure planning and designing of optimum capital structure l Capital Structure Theories l EBIT- EPS Analysis l Breakeven - EBIT Analysis l Under / Over Capitalisation 16. Dividend Decisions: Factors determining dividend policy l Dividend Models- Relevant/ Irrelevant Theories - Walter’s Model, Gordon’s Model, M-M Model l Forms of Dividend – Cash Dividend, Stock Dividend, Stock Splits, Share repurchase 17. Working Capital Management: Meaning l Types l Determinants and Assessment of Working Capital Requirements l Negative Working Capital l Operating Cycle Concept and Applications of Quantitative Techniques l Management of Working Capital – Cash Receivables Inventories l Financing of Working Capital l Banking Norms and Macro Aspects l Factoring and Forfaiting 18. Security Analysis: Measuring of Systematic and Unsystematic Risk l Fundamental Analysis (Economic, Industry and Company) l Technical Analysis and Efficient Market Hypothesis 19. Operational Approach to Financial Decision: An Overview of Costing l Key Concepts l Basics Principles of Costing l Marginal Costing – Breakeven Point, Margin of Safety (v)  ARRANGEMENT OF STUDY LESSONS CORPORATE ACCOUNTING & FINANCIAL MANAGEMENT GROUP 1 l PAPER 4 PART I : CORPORATE ACCOUNTING (60 MARKS) Sl. No. Lesson Title 1. Introduction to Accounting 2. Introduction to Corporate Accounting 3. Accounting Standards (AS) 4. Accounting for Share Capital 5. Accounting for Debentures 6. Related Aspects of Company Accounts 7. Consolidation of Accounts 8. Financial Statement Analysis 9. Cash Flows 10. Forecasting Financial Statements PART II : FINANCIAL MANAGEMENT (40 MARKS) 11. Introduction 12. Time Value of Money 13. Capital Budgeting 14. Cost of Capital 15. Capital Structure 16. Dividend Decisions 17. Working Capital Management 18. Security Analysis 19. Operational Approach to Financial Decision (vi)  LESSON WISE SUMMARY CORPORATE ACCOUNTING & FINANCIAL MANAGEMENT PART I : CORPORATE ACCOUNTING (60 MARKS) Lesson 1 – Introduction to Accounting Accounting is a very old concept – as old as money. A description of proper keeping of accounts is also found in ‘Arthashastra” written by Kautilya. However, it has developed with the passage of time to meet the requirements and challenges of ever – growing society. The modern-day accounting concept based on double entry system was originated by Luco Pacioli in Italy. Though the act of accounting is very old, in recent times it has acquired special significance because of rapidly growing economy, cut-throat competition, expanding markets and increasing production and changes in technology. In this lesson, we will throw light on the basic concepts of accounting, types of accounts, accounting principles, conventions, accounting concepts, meaning of double entry system and the rules of debit & credit on which the entire concept of accounting is based. Accounting process involves identification and analysis of financial transactions. These transactions are recorded, classified and summarised in a systematic manner to give useful information. Thus, accounting process starts with the recording of business transactions in monetary terms, in the primary books of accounts. For recording business transactions, it is necessary that these transactions are evidenced by proper source documents like cash memoes, purchase bills, sales bills, counterfoils of cheques issued, salary slips etc. From these source documents, transactions are recorded in the books of accounts which are the first and major step in accounting. It is the basis of accounting as entire future process would depend upon this recording of transactions. In this lesson, we will know about recording transactions in primary books like Journal and other subsidiary books, posting in ledger and then preparation of trial balance. Lesson 2 – Introduction to Corporate Accounting There is no legal obligation for sole proprietorship and partnership firm to prepare final accounts, but companies have statutory obligations to keep proper books of account and to prepare its final accounts every year in the manner as prescribed in the Companies Act. Chapter IX, Sections 128 to 138 of the Companies Act, 2013 deals with the legal provisions relating to the Accounts of Companies. Final accounts of a company consist of balance sheet as at the end of the accounting period and profit and loss account for that period. Section 129 of the Companies Act, 2013 prescribes the form and contents of balance sheet and profit and loss account of a company. Balance sheet of a company shall be prepared according to Schedule III of the Companies Act, 2013. The Schedule III sets out the minimum requirements for disclosure on the face of the Balance Sheet, and the Statement of Profit and Loss (hereinafter referred to as “Financial Statements”) and Notes. Statement of Profit & Loss of a company shall be prepared according to Part II of Schedule III of the Companies Act, 2013. Section 129(1) of the Companies Act 2013, states that the financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards notified under section 133 and shall be in the form provided for different class or classes of companies in Schedule III. Lesson 3 – Accounting Standards (AS) Accounting Standards (AS) are written policy documents by expert accounting body or by government or other regulatory body covering the aspects of recognition, measurement, presentation and disclosure of accounting (vii) transactions in the financial statements. The ostensible purpose of the standard setting bodies is to promote the dissemination of timely and useful financial information to investors and certain other parties having an interest in the company’s economic performance. Accounting standards reduce the accounting alternatives in the presentation of financial statements within the bounds of rationality, thereby ensuing comparability of financial statements of different enterprises. This lesson covers the brief about the Accounting Standard, the International Financial Reporting Standard and also list out the difference between Accounting Standard and IFRS. Lesson 4 – Accounting for Share Capital The most striking feature of a company is its ownership structure. The capital in a company is divided into small shares of fixed value. The shares of a company may be equity shares or preference shares. The objective of this lesson is to make students aware about accounting of different aspects of share capital. After studying this lesson, students will be able to: l Understand the share capital structure in the balance sheet of a company. l Understand the methods and accounting procedure of issue of shares. l Specify the accounting treatment when shares are issued at par, premium and at discount. l Explain the meaning and accounting treatment of forfeiture of shares and reissue thereof. l Understand the accounting procedure of buy-back of shares. l Enumerate the steps for redemption of preference shares. l Appreciate the purpose of issuing Right shares & Bonus shares. l Understand the accounting treatment for ESOPs, ESPS, Sweat Equity Shares. l Understand the meaning of underwriting. l Familiarize with various types of underwriting. l Distinguish between marked application and unmarked applications. l Determine the liability of underwriters. Lesson 5 – Accounting for Debentures Equity sources of financing are however not always sufficient to meet the ever growing needs of the corporate expansion and growth. Hence, corporates turn to debt financing through financial institutions, commercial banks or by issuing debt instruments either through the route of private placement or by offering the same for public subscription. Owing tax shield provided by debt instruments, the debt financing not only helps in reducing the cost of capital but also helps in designing appropriate capital structure of the company. This lesson deals with the accounting treatment of different aspects of debenture and bond especially with issue, redemption including conversion of debenture. Lesson 6 – Related Aspects of Company Accounts The objective of this lesson is to make students aware about accounting of different aspects of share capital and deals with the accounting treatment of different aspects of debenture and bond especially with issue, redemption including conversion of debenture. Understand the share capital structure in the balance sheet of a company. Discuss the methods and accounting procedure of issue of shares. Understand the accounting procedure of buy- back of shares. Understand the accounting treatment for ESOPs and ESPS. Understand the meaning of underwriting Familiarize with various types of underwriting. Distinguish between marked application (viii) and unmarked applications. Determine the liability of underwriters. State the meaning of debenture and bonds; Describe the methods for the issue of debenture for cash and for consideration other than cash; Explain the issue of debenture as a collateral security; Explain the sources and record transaction relating to redemption of debenture; Discuss the methods of redemption of debenture; Record the Sinking Fund Investment transactions; Deal with cum-interest and ex-interest, open market operations. Lesson 7 – Consolidation of Accounts A holding company is one which acquires all or a majority of the equity shares of any other company called subsidiary company in order to have control over the subsidiary company. In order to understand the financial position of holding company, consolidations of accounts become very vital. After studying this lesson, students will be able to: l Understand the concept of holding company and subsidiary company. l Familiarize the legal requirements for preparation of final accounts of holding company. l Prepare consolidated balance sheet and statement of profit and loss. l Make appropriate accounting adjustments required for the preparation of consolidated balance sheet. l Understand the concept of minority interest in consolidation of accounts. l Appreciate the treatment of pre-acquisition profits and losses of the subsidiary company. Make adjustment regarding profit and loss on revaluation of assets of subsidiary company. l Understand the calculation of goodwill or cost of control. l Make adjustment for inter-company unrealized profits and inter-company transactions. l Understand the treatment of bonus issue on consolidation of accounts. l Make adjustment on dividend received from subsidiary company. Lesson 8 – Financial Statement Analysis Financial statements are compilation of financial data, collected and classified in a systematic manner according to the accounting principles, to assess the financial position of an enterprise as regards to its profitability, operational efficiency, long and short – term solvency and growth potential. Financial statements are basic and formal means through which management of an enterprise make public communication of financial information along with select quantitative details. They are structured financial representation of the financial position, performance and cash flows of an enterprise. Many users rely on the general purpose financial statements as the major source of financial information and therefore, financial statements should be prepared and presented in accordance with their requirement. That does not undermine the dependence of the general users on the information contents of the financial statements. Lesson 9 – Cash Flows Cash flow statement is additional information to user of financial statement. This statement exhibits the flow of incoming and outgoing cash and cash equivalent. It assesses the ability of the enterprise to generate cash and utilize cash. Cash Flow Statement is one of the tools for assessing the liquidity and solvency of the enterprise. Cash Flow Statement is considered to be a summarized statement showing sources of Cash Inflows and application of cash outflows of an enterprise during a particular period of time. It is prepared on the basis of the published data as disclosed by the Financial Statement of two different financial periods. It is an essential tool for managerial decision-making. Cash Flow reports the management Net Cash Flow (i.e. cash inflow less cash (ix) outflow or vice versa) from each activity of the enterprise as well as of the overall business of the enterprise. The management of the enterprise gets a picture of movement of cash resources from the Cash Flow Statement and can assess the stronger and weaker area of movement of cash for different activities of the business for drawing up the future planning. Lesson 10 – Forecasting Financial Statements According to section 2(40) of Companies Act, 2013 defines “financial statement” in relation to a company, includes l Balance Sheet as at the end of the financial year, l Profit and Loss account, or (In the case of a company carrying on any activity not for profit, an income and expenditure account for the financial year), l Cash Flow Statement for the financial year, l Statement of Changes in Equity, if applicable, and l Any explanatory note annexed to, or forming part of, any document. Financial Statements shall be considered as horoscope if one knows how to read and analyze it then probably by addressing the various early warning signal available in statements would have helped to great extent. Financial Forecasting is a process of estimating or predicting a company’s financial future by examining historical performance of data like revenue, cash flow, expenses, or sales. It is at the heart of driving business performance and stakeholder’s confidence. This lesson covers the Forecasting of Balance Sheet, Profit and Loss A/c , Cash Flows. PART II : FINANCIAL MANAGEMENT (40 MARKS) Lesson 11 – Introduction This lesson covers the nature, scope and objectives of financial management, risk-return and value of the firm, objective of the firm: profit maximisation vs. wealth maximisation and emerging role of finance managers. Financial Management deals with procurement of funds and its effective utilizations in the business. It is concerned with investment, financing and dividend decisions in relation to objectives of the company. Financial management is very important for an organisation as it brings economic growth and development through investment, financing, dividend and risk management decision which help companies to undertake better projects. Lack of financial management in business will lead to losses and closure of business. Lesson 12 – Time Value of Money Time value of money is the quintessence in the formulation of financial decisions, especially in case of capital expenditure and long-term investments related decisions. Compounding and discounting are two pillars of time value of money. Now, depending upon the scenarios, cash inflows and outflows may take different forms, such as cash outflow in lump-sum at present and inflow in lump-sum in future, cash outflow and inflow in the form of annuities in the future etc. In view of the mentioned facts, this lesson elucidated the concepts of time value of money, the power of compounding, concept of annuity, application of the various tables, i.e., Present Value Interest Factor, Future Value Interest Factor, Present Value Interest Factor of Annuity, Future Value of an Annuity and other pertinent concepts. (x)  Lesson 13 – Capital Budgeting This lesson covers capital budgeting process, its need and importance, kinds of capital budgeting decisions, capital expenditure control, capital rationing, various methods of capital budgeting- non discounted and discounted cash flow techniques, risk evaluation and sensitivity analysis, simulation for risk evaluation and some case studies on capital budgeting. Capital budgeting refers to long-term planning for proposed capital outlays and their financing. Thus, it includes both raising of long-term funds as well as their utilisation. It may, thus, be defined as the firm’s formal process for acquisition and investment of capital. Capital budgeting requires use of various methods including statistical techniques which have been discussed in the chapter. Lesson 14 – Cost of Capital A business requires funds to purchase fixed assets like land and building, plant and machinery, furniture etc. These assets may be regarded as the foundation of a business. The cost of capital is the required rate of return that a firm must achieve in order to cover the cost of generating funds in the marketplace. It is used as a discount rate in determining the present value of future cash flows associated with capital projects. In this lesson we will study Sources of Long Term Finance, cost of capital, factors affecting the cost of capital, calculation of cost of capital of for different sources of finance, calculation of weighted cost of capital and marginal cost of capital. Lesson 15 – Capital Structure Capital Structure of a firm is a reflection of the overall investment and financing strategy of the firm. It shows how much reliance is being placed by the firm on external sources of finance and how much internal accruals are being used to finance expansions. Optimal capital structure means arrangement of various components of the structure in tune with both the long-term and short term objectives of the firm. This lesson comprises of nature, scope and significance of capital structure, factors affecting capital structure, capital structure vis a vis financial structure, planning and designing of capital structure, optimal capital structure, capital structure & valuation, theories of capital structure, types of leverage – operating leverage, financial leverage, combined leverage, EBIT-EPS analysis and effect of leverages on return on equity. Lesson 16 – Dividend Decisions Dividend policy determines what portion of earnings will be paid out to stock holders and what portion will be retained in the business to finance long-term growth. Dividend decision is one of the crucial parts of the financial manager, as it determines the amount available for financing the organization long term growth and it plays very important part in the financial management. This lesson includes types of dividend policies, determinants and constraints of dividend policy, type/ forms of dividend, different dividend theories – Walter’s Model, Gordon’s Model, Modigliani-Miller Hypothesis of Dividend Irrelevance Policy etc. Lesson 17 – Working Capital Management The capital which is required to finance current assets is called working capital. It is the capital of a business which is used to carry out day-to-day business operations of a firm. Working capital is vital for the proper and smooth functioning of an organisation. Therefore, it is very necessary for a corporate professional to know about management of different constituents of working capital. In this lesson we will study the meaning, types, determinants and assessment of working capital requirements, concept of negative working capital, operating cycle concept and applications of quantitative techniques, financing of working capital etc. Lesson 18 - Security Analysis Investment may be defined as a conscious act on the part of a person that involves deployment of money in securities issued by firms with a view to obtain a target rate of return over a specified period of time. Securities (xi) are the instruments issued by seekers of funds in the investment market to the providers of funds in lieu of funds. Security analysis is about valuing the securities using publicly available information. In this lesson we will cover the concept of investment and security analysis, investment vs. speculation, risks and its types, approaches to valuation of a security, fundamental analysis, technical analysis and efficient market theory. Lesson 19 – Operational Approach to Financial Decision Financial decisions are largely influenced by the scale of operations of a business organization, which in turn are influenced by various forms of costs incurred on operations, like cost incurred on procurement of raw materials, employment of human capital, manufacturing process, sales and distribution etc., and in this regard different costing techniques plays a pivotal role in formulation of robust financial decisions. This lesson makes an endeavour to throw light on the pertinent cost dimensions that affects the operations of an enterprise, such as an overview of costing, key concepts, basics principles of costing, marginal costing etc. (xii)  CONTENTS PART I : CORPORATE ACCOUNTING LESSON 1 INTRODUCTION TO ACCOUNTING Introduction 2 Attributes of Accounting 3 Objectives of Accounting 4 Book-Keeping 4 Accounting Cycle 5 Basic Accounting Terms 6 Single Entry System 9 Double Entry System 9 Features of Double Entry System 10 Advantages of Double Entry System 10 Limitations of Double Entry System 10 Accounting Concept 10 Types of Accounts 11 Golden Rules of Accounting 12 Journal 13 Advantages of Journal 13 Sub-division of Journals 14 Subsidiary Books 14 Cash Book 15 Purchase Day Book 17 Sales Day Book 17 Other Subsidiary Books – Returns Inward, Return Outward, Bills Receivable, Bills Payable 17 Journal Proper 18 Ledger Accounts 18 Ledger Posting 18 Posting to Ledger Accounts from Subsidiary Books 19 (xiii) Closing Balance and Opening Balance 19 Sub-divisions of Ledger 20 Trial Balance 21 Features of a Trial Balance 21 Preparation of Trial Balance 21 Purpose of a Trial Balance 22 Method of Preparation 22 Final Accounts 23 Trading Account 24 Profit and Loss Account 24 Balance Sheet 24 Lesson Round-Up 24 List of Further Readings 27 LESSON 2 INTRODUCTION TO CORPORATE ACCOUNTING Regulatory Framework 30 Introduction 30 Records of Accounts to be Maintained by a Company 30 Financial Statements 32 Preparation and Presentation of Financial Statements 32 Schedule III of the Companies Act, 2013 34 General Instructions for the Preparation of Balance Sheet and Profit and Loss Account 35 Presentation of Balance Sheet 36 Part I – Form of Balance Sheet 38 Disclosure Requirement: Schedules Forming Part of Financial Statements 39 Part II-Form of Statement of Profit and Loss 60 General Instructions for Preparation of Statement of Profit and Loss 61 True and Fair View of Financial Statements 65 XBRL (Extensible Business Reporting Language) 66 How Does XBRL work? 66 How do companies create statements in XBRL? 66 XBRL filing under the Companies Act, 2013 66 (xiv) Benefits of XBRL 67 Lesson Round-Up 68 Glossary 68 Test Yourself 68 LESSON 3 ACCOUNTING STANDARDS (AS) Introduction - Accounting Standards 74 Need of Accounting Standard 75 List of Accounting Standards Issued by ICAI 75 Applicability of Accounting Standards 77 Need for Convergence with Global Standards 89 International Financial Reporting Standards (IFRS) as Global Standards 90 Convergence of Accounting Standard with IFRS in India 91 List of IFRS 92 Applicability of Indian Accounting Standards [Ind AS] 93 Overview of Ind AS 95 IFRS VS IGAAP 110 Comparison of Indian GAAP and Ind AS 112 Comparison of Ind AS 1 with Existing Indian GAAP 1 112 Comparison of Ind AS 2 with Existing Indian GAAP 2 113 Comparison of Ind AS 7 with Existing Indian GAAP 3 113 Comparison of Ind AS 8 with existing Indian GAAP 5 115 Comparison of Ind AS 12 with existing Indian GAAP 22 116 Comparison of Ind AS 16 with existing Indian GAAP 10 116 Comparison of Ind AS 116 with existing Indian GAAP 19 116 Comparison of Ind AS 115 with existing Indian GAAP AS 7 and AS 9 117 Comparison of Ind AS 19 with existing Indian GAAP 15 119 Comparison of Ind AS 20 with existing Indian GAAP 12 119 Comparison of Ind AS 21 with existing Indian GAAP 11 120 Comparison of Ind AS 23 with existing Indian GAAP 16 120 Comparison of Ind AS 24 with existing Indian GAAP 18 121 Comparison of Ind AS 27 with existing Indian GAAP 21 121 (xv) Comparison of Ind AS 28 with existing Indian GAAP 23 122 Comparison of Ind AS 33 with existing Indian GAAP 20 123 Comparison of Ind AS 34 with existing Indian GAAP 25 123 Comparison of Ind AS 36 with existing Indian GAAP 28 124 Comparison of Ind AS 37 with existing Indian GAAP 29 124 Comparison of Ind AS 38 with existing Indian GAAP 26 125 Comparison of Ind AS 103 with existing Indian GAAP 14 125 Comparison of Ind AS 105 with existing Indian GAAP 24 126 Comparison of Ind AS 108 with existing Indian GAAP 17 127 Lesson Round-Up 128 Glossary 128 Test Yourself 129 List of Further Readings 129 LESSON 4 ACCOUNTING FOR SHARE CAPITAL Meaning of Shares 132 Meaning of Share Capital 132 Kinds of Share Capital 132 Types/Classes of Preference Shares 134 Disclosure of Share Capital 134 Terms of Issue of Share 136 A. Issue of Shares at Par 136 B. Issue of Shares at Premium 141 C. Issue of Shares at Discount 143 Subscription 143 Calls-in-Advance 145 Calls-in-Arrear 146 Issue of Shares for Consideration other than Cash 146 Forfeiture of Shares 147 Accounting Treatment for Forfeiture of Share 149 Reissue of Forfeited Shares 153 Buy-Back of Shares 158 (xvi) Relevant extracts for Sections 68, 69 and 70 of Companies Act, 2013 for Buy-Back of Shares 159 Companies (Share Capital and Debentures) Rules, 2014 for Buy-Back 162 Issue of Bonus Shares [Section 63] 167 Issue of Sweat Equity Shares [Section 54] 168 Quantum of Sweat Equity Share 169 Pricing of Sweat Equity Share 170 Disclosure in the Directors’ report in respect of Sweat Equity Share 170 Accounting Treatment of Sweat Equity Share 170 Issue of Right Shares 171 Redemption of Preference Shares 172 Capital Redemption Reserve Account 172 Premium on redemption of Preference Shares 172 Lesson Round-Up 178 List of Further Readings 180 LESSON 5 ACCOUNTING FOR DEBENTURES Debentures 182 Kinds of Debentures 182 Difference between Shares and Debentures 183 Issue of Debentures 183 Conditions for issue of Debentures as per Companies Act, 2013 184 Issue of Debentures for Cash 184 Issue of Debentures at Par 184 Issue of Debentures at Premium 186 Issue of Debentures at Discount 188 Over Subscription 190 Issue of Debentures for Consideration other than Cash 190 Debentures Issued as a Collateral Security 192 Debenture Interest 195 Terms of Issue of Debentures 197 Accounting Treatment of Discount/Loss on the Issue of Debentures 200 Redemption of Debentures 201 (xvii) Creation of Debenture Redemption Reserve 201 Adequacy of Debenture Redemption Reserve (DRR) 201 Investment of Debenture Redemption Reserve (DRR) 202 Purchase of Debentures before the Specified Date of Payment of Interest [Cum-Interest and Ex-Interest Quotations] 209 Lesson Round-Up 213 Glossary 213 List of Further Readings 216 LESSON 6 RELATED ASPECTS OF COMPANY ACCOUNTS Employee Stock Option Plan (ESOP) 218 Accounting for ESOP 219 Equity-settled Employee Share-based Payment Plans 220 Cash-settled Employee Share-based Payment Plans 220 Employee Share-based Payment Plans with Cash Alternatives 220 Buy-Back of Shares 226 Transfer of certain sums to Capital Redemption Reserves Account [Section 69] 229 Prohibition on buy-back in following circumstances [Section 70] 229 Modes of Buy-Back 230 Disclosures, filing requirements and timelines for public announcement and draft letter of offer 230 Escrow account 231 Accounting for Buy-Back 231 Equity Shares with Differential Rights 232 Explanatory Statement Annexed to Notice 233 Underwriting of Shares / Debentures 235 Full and Partial Underwriting 237 Accounting Entries 237 Determination of Liability in respect of Underwriting Contract 237 Firm Underwriting 240 Lesson Round-Up 250 Test Yourself 251 List of Further Readings 252 (xviii)  LESSON 7 CONSOLIDATION OF ACCOUNTS Introduction 254 Holding Company 254 Subsidiary Company 254 Associate company 255 Wholly Owned Subsidiary Company 255 Partly Owned Subsidiary Company 255 Minority Shareholder 255 Legal Requirements for a Holding Company 256 Advantages of Consolidation of Financial Statements 259 Consolidation Procedures 259 Contents and Format of Consolidated Balance Sheet 260 Calculation of Goodwill/Capital Reserve (Cost of Control) 263 Minority Interest 267 Contents and Format of Consolidated Profit and Loss Account 269 Pre-acquisition and post-acquisition Profits/Reserves 272 Elimination of Inter-Company Balances and Amounts 276 Revaluation of Fixed Assets of Subsidiary and Treatment 279 Bonus Shares Issued by Subsidiary Company 284 Treatment of Dividend 286 Treatment of Goodwill appearing in the Balance Sheet of Subsidiary Company 289 Summarized Steps for preparation of Consolidated Financial Statement 293 Glossary 318 Test Yourself 318 List of Further Readings 320 LESSON 8 FINANCIAL STATEMENT ANALYSIS Introduction 322 Characteristics of Good Financial Statement and Its Relevancy for Better Reporting 322 Relevancy of Better Reporting in Financial Statement 323 (xix) Usage and Features of Ratio Analysis 325 Financial Ratios 325 A. Liquidity Ratios 326 B. Leverage / Solvency Ratios 328 C. Turnover Ratios 332 D. Profitability Ratios 335 Comparison with Industry Averages 338 Du Pont Analysis 340 Reading and Interpretation of Financial Statement 342 Problems in Financial Statement Analysis 344 Guidelines for Financial Statement Analysis 345 Going Beyond the Numbers 346 Lesson Round-Up 347 Test Yourself 347 List of Further Readings 349 LESSON 9 CASH FLOWS Introduction 352 Utility of Cash Flow Analysis 352 Meaning of certain terms used in the Context of Cash Flow Statement 354 Classification of Cash Flow Statement 354 Treatment of Some Peculiar Items 356 Preparation of a Cash Flow Statement 358 A. Cash Flows from Operating Activities 358 Direct Method 358 Indirect Method 361 B & C - Cash Flows from Investing and Financing Activities 363 Format of Cash Flow Statement 363 Limitations of Cash Flow Analysis 377 How to Interpret a Cash Flow Statement 377 Lesson Round-Up 379 (xx) Test Yourself 380 List of Further Readings 385 LESSON 10 FORECASTING FINANCIAL STATEMENTS Introduction 388 Financial Statements 388 Financial Forecasting: Meaning and Introduction 389 Importance of Financial Forecasting 389 Financial Forecasting vs. Budgeting 390 Financial Forecasting vs Financial Projection 390 Financial Forecasting Components and Factors 391 Financial Statement Forecasting 391 Forecasting of Profit & Loss (Profitability Projections) 393 Forecasting of Cash Flow Statement 395 Forecasting of Balance Sheet 398 Lesson Round-Up 407 Test Yourself 407 PART II : FINANCIAL MANAGEMENT LESSON 11 INTRODUCTION (FINANCIAL MANAGEMENT) Financial Framework 410 Introduction 410 Meaning of Finance 411 Definition of Financial Management 412 Nature, Scope and Objectives of Financial Management 413 Types of Financial Decisions 414 Investment Decisions 414 Things to check from Cash Flow from Investing Activities 417 Understanding Cash Flow from Investing Activities 418 Financing Decisions 419 (xxi) Factors affecting Financing Decision 420 Understanding Cash Flow from Financing Activities 420 Dividend Decisions 421 Stable Dividend Policy: A Policy of Dividend Smoothing 422 Rationale for stable dividend policy 423 Decision Criteria 423 Capital Structure 429 Value of Firm-Risk And Return 430 Liquidity 431 Profitability 433 Costing and Risk 435 Objectives of a Firm 438 (a) Profit Maximisation 439 (b) Shareholder Wealth Maximisation 439 Ethics of Shareholder Wealth Maximization 443 Profit Maximisation Versus Shareholder Wealth Maximisation 443 Advantages of Profit Maximisation Hypothesis 444 Disadvantages of Profit Maximisation 444 Advantages of Wealth Maximisation 446 Disadvantages of Wealth Maximisation 446 Economic Value-Added (EVA) – A Criterion to Gauge Shareholder’s Value 447 Advantages of the Economic Value Added (EVA) 449 Disadvantages of the Economic Value Added (EVA) 449 Interpreting the calculated EVA 449 Market Value Added (MVA) – Another Criterion to Gauge Wealth Maximization 450 Financial Distress and Insolvency 451 Financial Management is a Science or an Art 451 Emerging Roles of Financial Manager 452 Relation of Finance to Economics and Accounting 453 Lesson Round-Up 455 Glossary 455 Test Yourself 456 List of Further Readings 457 (xxii)  LESSON 12 TIME VALUE OF MONEY Introduction 460 Concepts of Time Value of Money 460 Compound and Simple Interest 460 Present Value of an Uneven Series 464 Present Value of an Annuity 465 Applications of Present Value of an Annuity 466 Present Value of Perpetuity 471 Future Value of a Single Amount 472 Future Value of an Annuity 476 Annuity Due vs. Ordinary Annuity 478 Doubling Period 478 Lesson Round-Up 480 Glossary 481 Test Yourself 482 List of Further Readings 483 Other References 484 LESSON 13 CAPITAL BUDGETING Importance of Capital Budgeting 486 Capital Budgeting Process 486 Scope of Capital Budgeting Decisions 487 Cost and Benefits of Project (Capital Budgeting Decision) 488 Initial Investment / Outlay 488 Net Annual Cash Inflows 489 Terminal Cash Inflows 489 Capital Budgeting Techniques 490 Payback Period Method 490 Post Payback Profitability (P.P.B. Profit) 493 (xxiii) Discounted Payback Period 495 Accounting Rate of Return Method (Arr Method) 495 Present Value Method 498 Present Value Methods 498 (C) Time Adjusted Rate of Return Method (Tar Method) or Internal Rate of Return Method (IRR Method) 503 Unequal lives of the Projects or Life Disparity 509 Capital Rationing 510 Types of capital rationing 511 Consideration other than Profitability in Managerial Decisions 512 Risk and Uncertainty in Capital Budgeting 513 1. Risk Adjusted Discount Rate (RADR) 514 2. Certainty Equivalent Technique 515 3. PROBABILITY TECHNIQUE 516 4. STANDARD DEVIATION 517 5. Co-Efficient of Variation 519 6. Sensitivity Technique 521 7. Decision Tree Technique 522 Case Studies 524 Lesson Round-Up 532 Glossary 532 Test Yourself 533 List of Further Readings 539 LESSON 14 COST OF CAPITAL Introduction 542 Importance of the Concept of Cost of Capital 542 Factors Determining the Firm’s Cost of Capital 543 Measurement of Cost of Capital or Components of Cost of Capital 544 Assumption of Cost of Capital 544 1. Cost of Debt Capital 544 2. Cost of Preference Share Capital 548 (xxiv) 3. Cost of Equity Share Capital 550 4. Cost of Retained Earnings 554 Overall Cost of Capital 556 Marginal Cost of Capital (MCC) 562 Case Studies 562 Lesson Round-Up 566 Glossary 567 Test Yourself 567 List of Further Readings 572 LESSON 15 CAPITAL STRUCTURE Introduction, Definition and Significance of Capital Structure 574 Introduction 574 Definition of Capital Structure 574 Type of Capital Structure 574 Significance of Capital Structure 575 Capital Structure vis-a-vis Financial Structure 575 Planning and Designing of Capital Structure 577 Attributes of a Well Planned Capital Structure 577 Designing a Capital Structure 577 Optimal Capital Structure 578 Factors Influencing Capital Structure 578 Capital Structure and Valuation 581 Capital Structure Theories 581 1. Net Income Approach 581 2. Net Operating Income Approach 585 3. Traditional Approach 590 4. Modigliani - Miller Theory 591 CRITICISM OF MM HYPOTHESIS 594 MM Hypothesis with Corporate Taxes 594 Empirical evidence against MM Hypothesis 594 (xxv) Pecking Order Theory 595 EBIT - EPS Analysis 595 EBITDA Analysis (Earnings Before Interest, Tax, Depreciation and Amortization), 598 Analysis with EBITDA 598 Limitations of EBITDA 598 Measures of Operating and Financial Leverage 599 Definition of Leverage 599 Types of Leverage 599 Degree of Operating Leverage 599 Uses of Operating Leverage 600 Financial Leverage 601 Degree of Financial Leverage 601 Alternative Definition of Financial Leverage 601 Uses of Financial Leverage 602 Difference between Operating Leverage and Financial Leverage 603 Financial Break Even Point 604 Indifference Point 605 Combined Leverage 606 Degree of Combined Leverage 606 Working Capital Leverage 607 Effects of Leverage on Shareholders’ Returns 608 1. Operating Leverage Effect: % Change in EBIT is more than % Change in Sale 608 2. Effect of Financial Leverage on ROE 609 3. Effect of High Operating leverage and High Financial Leverage 609 4. Effect of Low Operating leverage and High Financial Leverage 609 Risk and Leverage 609 Relationship between Financial Risk and Financial Leverage 613 Some Case Studies 613 Hamada Equation 616 Lesson Round-Up 617 Glossary 618 Test Yourself 618 List of Further Readings 618 (xxvi)  LESSON 16 DIVIDEND DECISIONS Introduction 620 Meaning of Dividend 620 Dividend policy 620 Kinds (Forms) of Dividend 620 Stock Splits 622 Stock Split Example 622 Reason Behind Stocks Split 623 Share Repurchase 623 Impact of a Share Repurchase 623 Determinants of Dividend Policy 624 Types of Dividend Policy 626 Essentials of a Sound Dividend Policy 628 Dividend Theories / dividend models 629 Modigliani and Miller’s Approach (M-M Model) 629 Walter’s Approach 635 Gordon’s Approach 639 Gordon’s Revised Model 641 Lesson Round-Up 643 Glossary 643 Test Yourself 644 List of Further Readings 647 LESSON 17 WORKING CAPITAL MANAGEMENT Introduction 650 Types of Working Capital 650 Importance or Advantages of Working Capital 652 Factors Determining the Working Capital 653 The Concept of Negative Working Capital 655 Management of Working Capital 655 (xxvii) Estimation of Working Capital Requirement 656 Percentage (%) on Sales Method 656 Regression Analysis Method 657 Forecasting Net Current Assets Method 658 Projected Balance Sheet Method 661 The Operational Cycle Method Concept and Application of Quantitative Techniques 663 Management of Cash 666 Nature of Cash 666 Motives for holding Cash 666 Factors Determining Level of Cash 667 Advantages of Ample Cash 668 Cash Management Models 668 Managing Cash Flows 672 Management of Inventory 676 Objectives of inventory management 677 Risk associated with inventory 677 Tools and Techniques of Inventory Management 678 Determination of Stock Levels, Safety Stocks & EOQ 678 Ordering Systems of Inventory 680 Economic Order Quantity (EOQ) 680 Just-in-Time (JIT) System 683 ABC Inventory Control System 683 VED Analysis 684 Inventory Turnover Ratio 684 Ageing of Inventories 685 Perpetual Inventory System 685 Management of Receivables 685 Costs of maintaining receivables 685 Scope of receivables management 685 Factors Affecting the Size of Receivables 686 Working Capital Financing 690 Financing of Permanent/Fixed or Long-Term Working Capital 690 Financing of Temporary, Variable or Short-term Working Capital 691 (xxviii) Policies for Financing Current Assets 693 Matching Approach 693 Conservative Approach 694 Aggressive Approach 695 Banking Norms and Macro Aspect 695 Factoring 697 Definition and functions 697 Factoring vs. Accounts Receivable Loans 698 Factoring vs. Bill Discounting 698 Mechanics of Factoring 698 Forfaiting 699 Forfaiting vs. Export Factoring 700 Case Studies 700 Lesson Round-Up 713 Glossary 714 Test Yourself 714 List of Further Readings 720 Other References 721 LESSON 18 SECURITY ANALYSIS Introduction 724 What are Securities 724 Investment 724 Investment vs. Speculation 725 Investment vs. Gambling 726 Security Analysis 727 Fundamental Analysis can be segregated into economic analysis, industry analysis and company analysis 727 Analysis of the economy 727 Industry Level Analysis 728 Company Analysis 728 A. Ratio Analysis 729 B. Comparative Financial Statements 735 (xxix) C. Trend Analysis 737 D. Common size statement 737 E. Fund Flow Analysis 738 F. Cash Flow Statement 743 Technical Analysis 746 Dow Jones Theory 746 Primary Trends 746 Graph of Bullish Phase 747 Graph of a Bearish Phase 747 Secondary Trends 748 Minor Trend 748 Tools of Technical Analysis 748 1. Technical Charts 748 Line Chart 748 Bar Chart 749 Candlestick Charts 750 Point and Figure Charts 750 Patterns created by charts 751 Limitations of charts 753 2. Technical Indicators 753 (a) Advance-Decline Ratio 754 (b) Market Breadth Index 754 (c) Moving Averages 754 (d) Relative Strength Index 754 (e) Aroon Indicator 755 (f) Price Rate of Change 756 Risk and its Types 756 A. Systematic Risk 757 B. Unsystematic Risk 758 Return of the Security 759 Measuring Return 759 Approaches to Valuation of Security 761 Case Study 763 (xxx) Fundamental Approach to Valuation 765 Alternative Approaches to Valuation 767 1. Random walk theory 767 2. Efficient – Market Theory 767 3. Capital Asset Pricing Mode (CAPM) 769 Lesson Round up 770 Test Yourself 773 List of Further Readings 773 Other References 773 LESSON 19 OPERATIONAL APPROACH TO FINANCIAL DECISION Introduction 776 An overview of Costing 776 Nature and Scope of Costing 776 Nature of Costing 777 Objectives of Costing 778 Types of Costing 778 Advantages of Costing 779 Limitation of Costing 781 Basic Principles of Costing 781 Relationship of Cost Accounting, Management Accounting, Financial Accounting and Financial 782 Management Classification of Costs 782 Marginal Costing 783 Need for Marginal Costing 787 Features of Marginal Costing 787 Ascertainment of Profit under Marginal Cost 788 Advantages of Marginal Costing 791 Breakeven Point 792 Steps in Construction of Break-even Chart 792 Assumption and Limitation of Breakeven Analysis 796 Profit Volume Ratio 796 (xxxi) Limitation 796 Margin of Safety 799 How to improve margin of Safety 800 Angle of Incidence 801 Lesson Round-up 801 List of Further Readings 807 Other References 807 TEST PAPER 810 (xxxii) Introduction to Accounting Lesson LESSON 1 Introduction to Accounting 1 KEY CONCEPTS n Accounting n Book-Keeping n Debit n Credit n Personal Account n Real Account n Nominal Account nSingle Entry System n Double Entry System n Journal n Subsidiary Books n Ledger n Trial Balance n Final Accounts Learning Objectives To understand:  Basic Concepts of Accounting  Attributes and Objectives of Accounting  Book-Keeping & Accounting Cycle  Accounting Concept  Golden Rules of Accounting  Types of Accounts i.e. Personal , Real , Nominal  Single and Double Entry System  Journal, Subsidiary Books, Ledger, Trail Balance  Final Accounts (Trading , Profit and Loss & Balance Sheet) Lesson Outline  Introduction  Book-Keeping  Accounting Cycle  Single Entry System  Double Entry System  Accounting Concept  Types of Accounts  Journal  Ledger  Trial Balance  Final Accounts  Lesson Round-Up  Glossary  Test Yourself  List of Further Readings 1 EP-CA&FM Introduction to Accounting INTRODUCTION Business is the activity of making one’s living or making money by producing or buying and selling products (such as goods and services). It is also “any activity or enterprise entered into with the motive of earning profits and maximization of the wealth for owners. No business can run in isolation. Largely, the business activity is carried out by people coming together with a purpose to serve a common cause. This term is often referred to as an organization, which could be in different forms such as sole proprietorship, partnership, corporate body, etc. l Sole proprietorship: A sole proprietorship, also known as a sole trader, is owned by one person and operates for their benefit. All assets of the business belong to a sole proprietor, including, for example, a computer infrastructure, any inventory, manufacturing equipment, or retail fixtures, as well as any real property owned by the sole proprietor. l Partnership: A partnership is a business owned by two or more people. In most forms of partnerships, each partner has unlimited liability for the debts incurred by the business. The three most prevalent types of for-profit partnerships are general partnerships, limited partnerships, and limited liability partnerships. l Corporation: The owners of a corporation have limited liability and the business has a separate legal personality from its owners. Corporations can be either government-owned or privately owned, and they can organize either for profit or as nonprofit organizations. l Co-operative: Often referred to as a “co-op”, a co-operative is a limited-liability business that can organize as for-profit or not-for-profit. A cooperative differs from a corporation in that it has members, not shareholders, and they share decision-making authority. l Franchises: A franchise is a system in which entrepreneurs purchase the rights to open and run a business from a larger corporation. Franchising in the United States is widespread and is a major economic powerhouse. l A company limited by guarantee: Commonly used where companies are formed for non-commercial purposes, such as clubs or charities. The members guarantee the payment of certain (usually nominal) amounts if the company goes into insolvent liquidation, but otherwise, they have no economic rights in relation to the company. A company limited by guarantee may be with or without having share capital. l A company limited by shares: The most common form of the company used for business ventures. Specifically, a limited company is a “company in which the liability of each shareholder is limited to the amount individually invested” with corporations being “the most common example of a limited company.” l A company limited by guarantee with a share capital: A hybrid entity, usually used where the company is formed for non-commercial purposes, but the activities of the company are partly funded by investors who expect a return. l An unlimited company with or without a share capital: A hybrid entity, a company where the liability of members or shareholders for the debts (if any) of the company are not limited. In this case, the doctrine of a veil of incorporation does not apply. The business activities require resources (which are limited and have multiple uses) primarily in terms of material, labour, technology etc. The success of a business depends on how efficiently and effectively these resources are managed. Therefore, there is a need to ensure that the businessman tracks the use of these resources. The resources are not free, and thus one must be careful to keep an eye on the cost of acquiring them as well. As the basic purpose of business is to make profit, one must keep an ongoing track of the activities undertaken in the course of business. Two basic questions would have to be answered: 2 Introduction to Accounting LESSON 1 (a) What is the result of any business operations? i.e. whether it has made profit or loss? (b) What is the position of the resources acquired and used for business purposes? How are these resources financed and where do the funds come from? The answers to these questions can be found through recording all the business activities / transaction / event. Recording of business activities has to be done in a scientific manner so that they reveal the correct outcome. Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the “language of business”, measures the results of an organization’s economic activities and conveys this information to a variety of stakeholders, including investors, creditors, management, and regulators. Practitioners of accounting are known as accountants. The terms “accounting” and “financial reporting” are often used as synonyms. “Accounting is “the art of recording, classifying and summarizing 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 results thereof”. - American Institute of Certified Public Accountants (‘AICPA’) Attributes of Accounting (i) Accounting is an Art - Accounting is classified as an art, as it helps us in attaining our aim of ascertaining the financial results, that is, operating profit and financial position through analysis and interpretation of financial data which requires special knowledge, experience and judgment. (ii) It involves recording, classifying and summarizing - Recording means systematically writing down the transactions and events in account books soon after their occurrence. Classifying is the process of grouping transactions or entries of the same type at one place. This is done by opening accounts in a book called ledger. Summarizing involves the preparation of reports and statements from the classified data (ledger), understandable and useful to management and other interested parties. This involves preparation of final accounts namely profit and loss account and balance sheet. (iii) It records transactions in terms of money - All transactions are recorded in terms of common measure, i.e., money which increases the understanding of the state of affairs of the business. (iv) It records only those transactions and events which are of financial character - If an event has no financial character then it will not be capable of being measured in terms of money; it will not be, therefore, recorded. 3 EP-CA&FM Introduction to Accounting (v) It is the art of interpreting the results of operations - to determine the financial position of the enterprise, the progress it has made and how well it is getting along. Objectives of Accounting Providing Accounting provides useful information for decision-making to stakeholders such as Information owners, management, creditors and investors and other stake holders. Various outcomes to the Users of business activities such as costs, prices, sales volume, value under ownership and for Rational return on investment are measured in the accounting process. All these accounting Decision measurements areused by stakeholders in decision making process. Hence, accounting making is identified as the language of a business. Systematic To ensure reliabity and precision for the accounting measurements, it is necessary to keep a Recording of systematic record of all financial transactions of a business enterprise which is ensured by Transactions book-keeping. These financial records are classified, summarized and reposted in the form of accounting measurements to the users of accounting information i.e., stakeholders. Ascertainment Profit/Loss is a core accounting measurement done and measured by preparing a Profit the results and Loss Account for a particular period. Difference between these revenue incomes and of above revenue expenses is known as the result of business transactions identified as profit/loss. Transactions As this measure is used very frequently by stake-holders for rational decision making, it has become the objective of accounting. For example, Income TaxAct requires that every business should have an accounting systemthat can measure taxable income of the business and also explain nature and source of every item reported in Income Tax Return. Ascertain Financial position is identified by preparing a statement of ownership meaning Assets, the Financial and owing meaning Liabilities of the business as on a certain date. This statement is Position of popularly known asBalance Sheet. This statement may be used by various stakeholders for taking financing and investment decisions. Business To Know the Balance Sheet and Profit and Loss Account provide useful information to stockholders Solvency regarding potential of the entity to meet their obligations in the short as well as in the Position long run. BOOK-KEEPING As defined by Carter, “Book-Keeping is a science as well as art of correctly recording in books of accounts all those business transactions that result in transfer of money or money‘s worth”. Book-keeping is an activity concerned with recording and classifying financial data related to business operations in order of occurrence. Book-keeping involves: l Collection of basic financial information l Identification of events and transactions with financial character, i.e., economic transactions l Measurement of economic transactions in terms of money l Recording of financial effects of economic transactions in order of its occurrence l Classifying effects of economic transactions l Preparing organized statement known as Trial Balance 4 Introduction to Accounting LESSON 1 Distinction between Book-Keeping and Accounting Book-Keeping Accounting Output of book-keeping is an input for accounting. Output of accounting permits informed judgments and decisions by the user (stakeholders) of accounting information. Purpose of book-keeping is to keep systematic Purpose of accounting is to find results of operating record of transactions and events of financial activity of a business and to report its financial strength. character in order of occurrence. Book-keeping is the foundation of accounting. Accounting is considered as a language of business. Book-keeping is carried out by the junior staff. Accounting is done by the senior staff who haveskills of analysis and interpretation. Objective of book-keeping is to summarize the Object of accounting is not only book-keeping but cumulative effect of all economic transactions of also analyzing and interpreting reported financial business for a given period by maintaining permanent information for informed decisions by the stake-holders record of each business transaction with its evidence or user of financial statement. and financial effects on accountingvariable. ACCOUNTING CYCLE 5 EP-CA&FM Introduction to Accounting The accounting cycle is a basic, eight-step process for completing a company’s book-keeping tasks. It provides a clear guide for the recording, analysis, and final reporting of a business’s financial activities. The steps or phases of accounting cycle can be developed as under: Basic Accounting Terms In order to understand the Accounting clearly, one must grasp the following common expressions used in business accounting. The aim here is to enable the student to understand these often used concepts before we embark on accounting procedures and rules. l Transaction: It means an event or a business activity which involves exchange of money or money‘s worth between parties. The event can be measured in terms of money and changes the financial position of a entity e.g., purchase of goods would involve receiving material and making payment or creating an obligation to pay to the supplier at a future date. Transaction could be a cash transaction or credit transaction. When the parties settle the transaction immediately by making payment in cash or by cheque, it is called a cash transaction. On the other hand, in credit transactions, the payment is settled at a future date as per agreement between the parties. l Event: An event may be described as any incidence that occurs as a result of something. In an accounting sense, an event can be understood as the final outcome of a business activity that can affect the account balances of the company if it is financial in nature. Whenever there is an increase or decrease in the company’s assets or liabilities, an accounting event takes place. Therefore, it can change the fundamental accounting equation and can be expressed monetarily. l Goods/Services: These are tangible article or commodities in which a business deals. These articles or commodities are either bought and sold or produced and sold. At times, what may be classified as goods to one business firm may not be goods to the other firm, e.g., for a machine manufacturing company, the machines are goods as they are frequently made and sold. But for the buying firm, it is not goods as the intention is to use it as a long-term resource and not sell it. The services are intangible in nature and are rendered with or without the object of earning profits. l Capital Expenditure: This represents expenditure incurred for the purpose of acquiring a fixed asset which is intended to be used over long term for earning profits there from, e.g., amount paid to buy a computer for office use is a capital expenditure. At times expenditure may be incurred for enhancing the production capacity of the machine. This will also be a capital expenditure. Capital expenditure forms a part of the Balance Sheet. l Revenue Expenditure: This represents expenditure incurred to earn revenue of the current period. The benefits of revenue expenses get exhausted in the year of the incurrence. For example repairs, insurance, salary and wages to employees, travel, etc. The revenue expenditure results in the reduction in profit or surplus. It becomes part of the Income statement. l Profit and Loss Account or Income Statement: This account shows the revenue earned by the business and the expenses incurred by it to earn that revenue. This is prepared usually for a particular accounting period, which could be a month, quarter, half a year or a year. The net result of the Profit and Loss Account shows profit earned or loss suffered by t