Introduction of Accounting

to MBA

By Narain
Accounting : Information needs
of the users
• The process of identifying,
measuring and communicating
economic information to permit
informed judgements and
decisions by the users of
accounts.
• Is the language of the business
 Goals of Accounting
 Financial Accounting
 To satisfy information needs of the
external users i.e. investors, creditors,
employees, customers
 For attracting capital for the company
 Management Accounting
 To satisfy information needs of the
internal users i.e. management
 For informed decision making
 Tax Accounting
 To satisfy information needs of the tax
Assignment Problem
1. A company issues 50K shares of Rs. 10
face value equity stock at par value for
cash.
2. Acquires Land & Building costing Rs.
225K with the payment of 50K cash
and balance settled through 8%
Mortgage for 20 years.
3. Purchases a used JCB for Rs. 13200
cash.
4. Acquires raw material costing Rs. 8600
on account.
5. Returns defective raw material
 Assignment cont……..
6. Pays the supplier in (4) and (5) the
amount due, less a 2% discount for the
prompt payment. The firm treats cash
discount as a reduction in the
purchasing cost of raw material.
7. Obtains a fire insurance policy
providing Rs. 500K coverage beginning
next month. It pays the one year
premium of Rs. 4950.
8. Issues a cheque for Rs. 1800 for 3
 Assignment cont………
9. Purchases a Patent on a machine
process for Rs. 90K cash.
10. Purchases office equipment for Rs.
2700, making a down payment of Rs.
250 and agreeing to pay the balance in
30 days.
11. Pays Rs. 825 to Express
Transportations Co. for delivering the
equipment purchased in (10)
12. The company makes sale of Rs. 16K.
 Solution to Exercise 1
Balance Sheet of …..
as on …….
Liabilities Assets

2,25,0
Creditors 2,450 Land & Building
00
1,75,0
8% Mortgage Equipments 16,725
00
5,00,0
Equity Shares Patent 90,000
00
-14,29 3,31,4
Profit & Loss A/C Cash
6 29
6,63,1 6,63,1
54 54
 Solution to Exercise 1
Income Statement
for the period ending ….

Revenue 0
Purchase of Raw Material 8,600
less: Returns (900)
less: Cash Discount (154) 7,546
Insurance 4,950
Rent 1,800

Profit/Loss 14,296
 Solution to Exercise 1
Cash Flow Statement
for the period ending …
Cash generated from operations
payment to creditors 7,546
payment to insurer 4,950
payment for rent 1,800
Net cash outflow from operations 14,296
Cash generated from investments
Land & Building bought 2,25,0
JCB bought with transportation 00
14,025
Patent bought 90,000
Office Equipment bought 250
Net cash outflow from investments 3,29,275
 Solution to Exercise 1
Continued …….
Cash generated from financing activities
Issue of Equity Shares 5,00,0
Raising 8% Mortgage Loan 00
1,75,0
Net cash inflow from financing 00 6,75,000
Increase in cash balance 3,31,429
Cash balance at the beginning of the period 0
Cash balance at the end of the period 3,31,429
 Initial Problem
Accounting Equation Approach

ASSETS = LIABILITI + EQUITY

Cash Equipment Debtor ES
Bank Capital Earnings
1. +10,000 s Loan +10,000
2. +3,000 +3,000
3. -5,000 +5,000
4. +8,000 +4,00 +12,000
5. -9,000 0 -9,000
6. -1,000 -1,000
6,000 5,000 4,000 3,000 10,000 +2,000
 Illustration
1. A company issues 50,000 shares of
Rs. 10 face value Equity Shares at
par value for cash.
2. The company acquires Land &
Building costing Rs. 2,25,000 with
the payment of Rs. 50,000
in cash and the balance is settled by
raising 8% Mortgage for 20 years.
3. Purchases a used JCB for Rs. 13,200
cash.
 Illustration
5. Returns defective Raw Material
purchased above and costing Rs. 900
to the supplier . The
account has not yet been paid.
6. Pays the supplier in (4) and (5) the
amount due, less a 2% discount for
the prompt payment. The firm treats
this cash discount as a reduction in
the purchasing cost of Raw Material.
 Illustration
7. Obtains a fire insurance policy
providing Rs. 5,00,000 coverage
beginning next month. It pays the
Insurance Premium of Rs. 4,950 for
the current year.
8. Pays Rs. 1,800 for 3 month Rent in
advance for office space.
9. Purchases a Patent on a machine
process for Rs. 90,000 cash .
 Illustration
10. Purchases Office Equipment from
Mr. R for Rs. 2,700 making a down
payment of Rs. 250 and agreeing to
pay the balance in 30 days.
11. Pays Rs. 825 to Express
Transportation Co. for delivering the
equipment purchased in (10).
12. The company makes sales of Rs.
16,000 out of which only Rs. 12,000
could be Realised from Mr. Y
 Cash Flow Statement

• Profit ≠ Cash
– As P & L a/c is prepared on Accrual basis
• The term cash mean & include –
1.Cash in Hand
2.Demand deposit with banks
3.Cash Equivalents
 Cash Flow Statement
• Cash Flow Statement reflects the
movement of cash from three
Activities of the firm
– Operating Activities
– Investing Activities
– Financing Activities
 Preparation of CFS
• Direct Method
– Comparatively more useful
– Disclose gross receipts & gross
payments

• Indirect Method
– Profit & Loss a/c is adjusted for the
effects of transaction of non – cash
nature
 CFS: Indirect
Performa
• Classify the extraordinary items
based on the Activities
• Tax flow also to be classified based
on the Activities
• Do not disclose the non – cash
transactions
– Like acquisition of fixed assets by
issuing shares
– Conversion of debt into equity
 Steps to Prepare CFS
• Information needed for its
preparation –
1. Comparative Balance Sheet
2. Income Statement
3. Additional information
• Steps to prepare CFS
– Analyse the Non – Current Accounts
– Analyse the profit & loss figure
– Chart the cash flow statement
 Financial Analysis
Financial analysis is the process of identifying
the financial strengths and weaknesses of the
firm by property establishing relationships
between the item of the balance sheet and the
profit and loss account.
Users of Financial Analysis
• Trade creditors
• Lenders
• Investors
• Management
Nature of Ratio Analysis
A financial ratio is a relationship
between two accounting numbers.
Ratios help to make a qualitative
judgement about the firm’s
financial performance.
 Standard of Comparison
• Time series analysis
• Inter-firm analysis
• Industry analysis
• Proforma financial statement
analysis
Types of Financial Ratios
• Liquidity ratios
• Solvency ratios
• Turnover ratios
• Profitability ratios
• Equity-related ratios
 Liquidity Ratios
• Liquidity ratios measure a firm’s
ability to meet its current
obligations.
Current ratio =
Current assets
Current liabilities
Current assets – Inventories
Quick ratio =
Current liabilities
Cash + Marketable securities
Cash ratio =
Current liabilities
Currentassets- Inventory
IntervalMeasure=
Averagedaily operatingexpenses
Net workingcapital
NetWorkingCapitalRatio =
Net assets
 Solvency Ratios
• Solvency ratios measure the
dependence of a firm on borrowed
funds.
Debt-equity ratio 
Debt
Equity (Net Worth)
Debt Debt
Debt ratio  
Debt  Equity Capital employed
Earnings before interest and tax
Interest coverage 
Interest

• Treatment of –
– Preference Shares
 Turnover Ratios
• Turnover or activity ratios
measure the firm’s efficiency in
utilising itsCost
assets.
of goods sold or net sales
Inventory Turnover =
Average (or closing) inventory
Number of days in the year (say, 360)
Days of inventory holding =
Inventory turnover
Credit sales or net sales
Debtors Turnover =
Average (or closing) debtors
Number of days in the year (say, 360)
Collection period =
Debtors turnover
 Turnover Ratios
Net sales
Current assets turnover 
Current assets
Net sales
Net current assets turnover 
Net current assets
Net sales
Fixed assets turnover 
Net fixed assets
Net sales
Net assets turnover 
Net assets or capital employed
 Profitability Ratios
• Profitability ratios measure a firm’s
overall efficiency and effectiveness
in generating profit.
Profit before interest and tax (PBIT)
Margin 
Net sales
Profit after tax (PAT)
Net margin 
Net sales
PBIT
Before tax return on investment 
Net assets
Profit after tax
Return on equity 
Equity (net worth)
 Equity-related Ratios
• Equity-related ratios measure the
shareholders’ return and value.
Profit after tax
EPS 
Number of ordinary shares
Dividends
DPS 
Number of ordinary shares
DPS Dividends
Payout ratio  
EPS Pr ofit after tax
DPS
Dividend yield 
Market value per share
 Equity-related Ratios
EPS
Earnings yield 
Market value per share
Market value per share
P / E ratio =
EPS
Net worth
Book value per share 
Number of ordinary shares
Market value per share
M B value 
Book value per share
Market value of assets
Tobin ' s q 
Economic value of assets
 DuPont Analysis
DuPont Analysis
integrates the important ratios to analyse a firm's profitability.
PBIT Sales PBIT
RONA=  
Net Assets Net Assets Sales
PAT Sales PBIT  PAT Net Assets 
ROE     
Net Worth Net Assets Sales  PBIT Net Worth 
ROE  Assets turnover × Margin × Leverage
 ISPAT INDUSTRIES LIMITED
RATIO ANALYSIS
Liquidity ratios
Current ratio 1.47 1.24
Quick ratio 0.05 0.06
Activity ratios
Sales/TA 0.30 0.22

Sales/FA 0.81 1.25

Sales/Debtors 5.75 5.69
Sales/Inventory 8.70 5.49
Leverage ratios
Debt/Equity 2.85 2.50
Debt/TA 0.74 0.71
PBIT/Interest 1.90 1.04
Profitability ratios
PBIT/Sales 29.41% 7.30%
Net profit/Sales 13.96% 0.26%
PBIT/TA 8.68% 1.59%
Net profit/NW 15.87% 0.21%
INFOSYS
Balance Sheeet as at March 31
in Rs.
2,001 2,000
SOURCES OF FUNDS
SHAREHOLDERS FUNDS
Share capital 330,792,085 330,755,000
Reserves and surplus 13,565,599,903 8,002,273,248
Capital Employed 13,896,391,988 8,333,028,248
APPLICATION OF FUNDS
FIXED ASSETS
Original cost 6,311,444,025 2,840,305,143
Less: Depreciation 2,441,315,982 1,336,520,594
Net book value 3,870,128,043 1,503,784,549
Add: Capital work-in-progress 1,706,504,250 569,603,505
5,576,632,293 2,073,388,054
INVESTMENTS 341,154,821 138,348,469
CURRENT ASSETS, LOANS AND ADVANCES
Sundry debtors 3,023,702,417 1,361,781,253
Cash and bank balances 3,850,610,285 4,317,935,730
Loans and advances 4,302,793,623 2,101,277,161
11,177,106,325 7,780,994,144
Less: Current liabilities 1,349,181,176 671,506,459
Provisions 1,849,320,275 988,195,960
NET CURRENT ASSETS 7,978,604,874 6,121,291,725
Net Assets 13,896,391,988 8,333,028,248
INFOSYS
Profit and Loss Account for the year ended March 31
in Rs.
2001 2000
INCOME
Software development services and products
Overseas 18,740,266,421.00 8,696,980,931.00
Domestic 265,392,386.00 126,256,042.00
Other income 593,714,915.00 391,411,095.00
19,599,373,722.00 9,214,648,068.00
EXPENDITURE
Software development expenses 9,581,766,650.00 4,662,684,578.00
Administrative and other expenses 1,775,470,971.00 694,850,282.00
Provision for investments 152,898,608.00
Provision for contingencies 33,300,000.00
Provision for e-inventing the company 35,000,000.00
11,510,136,229.00 5,425,834,860.00
Operating profit (PBIDT) 8,089,237,493.00 3,788,813,208.00
Interest
Depreciation 1,128,945,152.00 532,327,389.00
Profit before tax and extraordinary item 6,960,292,341.00 3,256,485,819.00
Provision for tax
earlier years 14,000,000.00 2,400,000.00
current year 713,100,000.00 394,600,000.00
Profit after tax before extraordinary item 6,233,192,341.00 2,859,485,819.00
Extraordinary item -- transfer of intellectual property right (net of tax) 54,944,000.00
-- provision no longer required 75,670,846.00
Net profit after tax and extraordinary item 6,288,136,341.00 2,935,156,665.00
AMOUNT AVAILABLE FOR APPROPRIATION 6,288,136,341.00 2,935,156,665.00
INFOSYS
Financial Ratios
2001 2000
Activity Ratios
Income/Assets 1.41 1.11
Income/Debtors 6.48 6.77

Current Ratios
CA/CL 3.49 4.69
CA/Assets 0.80 0.93
NCA/Assets 0.57 0.73

Profitability Ratios
Margin
PBDIT/Income 41.27% 41.12%
PBIT/Income 35.51% 35.34%
PAT/Income 31.80% 31.03%
Return on Investment
PBDIT/Assets 58.21% 45.47%
PBIT/Assets 50.09% 39.08%
PAT/NW 44.85% 34.32%
 SBU PROFIT & LOSS ACCOUNT, YTD 2002
USD in '000
% of
YTD Re v.

Tota l Re ve nue 14850 100.0%

Onsite re ve nue 12600 84.8%
Offshore re ve nue 2250 15.2%
Se rvice Cre dit
- Onsite Re ve nue % 85%
CONTROLLABLE COSTS
CGS A
Sa la rie s & Re la te d Costs:
Onsite Sa la rie s 6375 42.9%
Offshore Sa la rie s
GRP Alloca te d 0 0.0%
Offshore Sa la rie s 840 5.7%
Othe r Sa la ry Ove rhe a ds 34 0.2%
Subcontra ctor Costs
Sa la rie s-Onsite 0 0.0%
Sa la rie s-Offshore 0 0.0%
Fore ign Tra ve l 250 1.7%
Ince ntive s
Proje ct Ince ntive s 0 0.0%
SBU Spe cia l Ince ntive s 0 0.0%
Da ta Communica tion Cha rge s 0 0.0%
Le ga l Immigra tion Fe e s 333 2.2%
Othe r Profe ssiona l Fe e s 0 0.0%
Tota l CGS A Cost 7832 52.7%
CGS B
Da ta Communica tion Cha rge s 90 0.6%
Me dica l Insura nce 300 2.0%
De pre cia tion: CGS 223 1.5%
Othe rs CGS 0 0.0%
Tota l CGS B Cost 613 4.1%
TOTAL CGS A + CGS B Costs 8445 56.9%
Gross Ma rgin 6405 43.1%
 Utility of Ratio Analysis
• Assessment of the firm’s financial
conditions and capabilities.
• Diagnosis of the firm’s problems,
weaknesses and strengths.
• Credit analysis
• Security analysis
• Comparative analysis
• Time series analysis
 Cautions in Using Ratio
Analysis
• Standards of comparisons
• Company differences
• Price level
• Different definition
• Changing situations
• Past data
ThankQ