mba 2012 14 presentation ii
TRANSCRIPT
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Curriculum for Financial Accounting
Income statement, Balance Sheet, Assets,
Liabilities, Provisions, Capital, reserve, Cash
flow statement, Consolidated Financial
Statement, Annual Reports, Understanding
and analyzing annual reports.
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Types of Organization
Trading organization
Manufacturing organization
Service organization
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Understanding Business organization
Cash receiptfrom currentsales
Process startswith
Raj Ltd.
Cash paymentfor materials
Administrativeexpenses etc.
Cash left inBank
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Case-2
Cash from
current sales
Advance from
customers
Collection from
debtors
Creditors
for material
and
expenses
Raj Ltd
Receivable
from
customers
Cash
payment for
materials
and
expenses
Cash left in
Bank
account
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Accounting Analysis
AccountingAnalysis
Providinginformation for
Planning andControl
Audience
Internal
Investors
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Financial Accounting
FinancialAccounting
Used forreporting
Audience :outside world
like governmentbodies etc.
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Basics for understanding accounting
Creditors, loan,outstandingexpenses, incomereceived in advance,capital
Building, plant,furniture, cash,bank, stock etc
Salary, rent,purchases,commission,interest,advertisement etc.
Sales, interestreceived,commissionreceived, discountreceived etc.
Income expenses
LiabilitiesAssets
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Accounting Information system
Input
Processing
Users
Output
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Inputs
Business Transactions- purchase, sales, cash
receipts and cash payments
External events- fire, earth quake, change in
tax laws.
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Processing
Accounting principles
Accounting standards
Estimates Laws and regulations etc.
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Outputs
Profit & Loss Account
Balance Sheet
Cash flow statement Analysis
Tax returns etc.
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Users
Share holders
Security analysts
Banks
Rating agencies
Managers
Employees
Suppliers
Customers
government
Researchers etc
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Income
It refers to all the revenue receipts during the
accounting period. It includes sale proceeds,amount received from services, rent received,
interest received , commission received and all
other receipts which will can be considered as
revenue
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Various Incomes
Sales
Income from services
Rent received
discount received
commission received
interest received
bad debts recovered
apprentice premium
income from investment
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Expenses
It includes all the revenue expenses which are
incurred to run the organization. It includes all
the day to day expenses. Like sales expenses,
administrative expenses
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Various expenses
Purchases
Carriage
Carriage inward
Freight Freight inward
Wages
Factory expenses
Stores consumed
Royalty
Motive Power
Coal, coke Water
Oil
Octroi
Dock charges
Custom Duty
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Contd.
salary
rent, rate & taxes
stationary
postage and telegram audit fees
legal charges
telephone charges
insurance premium
entertainment expenses
repairs
depreciation
interest trade expenses
conveyance
charity
bank charges
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Contd.
office expenses
establishment exp
stable expenses
license fees
brokerage
commission
office lighting
advertisement
export duty
discount
packing charges
traveling exp
bad debts
provision for bad debts
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Assets
Assets represent something that the
organization possess, something that it owns,
and which has been obtained by spending the
money raised. In other words, assets tells uswhere the money was spent- the use of
money.
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Various assets
Cash in hand
Cash at bank
Bills receivable
Sundry debtors
Closing stock
Finished goods
Raw materials
Work in progress
Stationary
Goods sent on consignment
Long term investments
Trade mark
Patents
Vehicle
Furniture
Investments
Machinery and plant
Tools
Land and building
Goodwill
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Classification of Assets
Current
Assets
Fixed
Assets
Wasting
Assets
Fictitious
Assets
Contingent
Assets
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Current Assets
Cash, bank, goods
Bills receivable,prepaid expenses,
Raw materials, stock,work in progress etc.
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Fixed Assets
Land, building, plant,furniture, motor vehicleand tools etc.
Tangible fixedassets
Patents, trade mark, copy
rights, goodwill andresearch anddevelopment cost etc.
Intangiblefixed assets
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Wasting assets
Assets diminish invalue when the
assets are taken outof natural resources
Mines, Ores, oil wellsetc.
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Fictitious Assets
Which do not haveany concrete value
Preliminary expenses,Issue expenses of shares
and debentures,formation expenses
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Contingent assets
An asset the existence, value and ownership
of which depend upon the occurrence or non
occurrence of a specified act.
The undecided suits for a property
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Liabilities
Liabilities represent money that organization
owes. This is money that it owes because it
was borrowed by the organization. In other
words, liabilities shows the sources of money,where the organization has received its funds.
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Various liabilities
Bank overdraft
Bills payable
Sundry creditors
Short term loans
Bank loans
Long-term loans
Incomes received in advance
Capital
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Classification of Liabilities
Long-term liabilities-
Current liabilities
Contingent liablities
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Long term liabilities
Which does not fall duefor payment in
relatively short period
( more than 12 months)
Long term loan takenfrom banks, financial
institutions anddebentures.
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Current liability
Which falls due forpayment in a relativelyshort period (less than
12 months)
Bills payable, Tradecreditors, outstanding
expenses, bankoverdraft, income
received in advance etc.
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Contingent Liabilities
Depending upon theoccurrence of certain event
which are uncertain
Arrears of dividend oncumulative preference
shares, Bills of exchangediscounted, suit for damages
against the company.
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Transaction
Any exchange of goods or services for money
or moneys worth by the business with any
other business or person is called transaction.
It is an economic activity of the business thatchanges its financial position.
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Determinants of cash transaction
The transactions, where
the terms on cash or on
cheques, by cash or by
cheques, for cash or forcheques are used are
identified as cash
transactions.
Goods sold for cash
Rs1,000
Rent paid by cash Rs
500 Salary paid by cheque
Rs 2,000
Good are purchased for
cash Rs 6000
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Contd.
The transactions where
in the terms paid,
received, settled,
cleared, deposited,withdrawn etc is used
are identified as cash
transactions.
Charges paid Rs200
Shilpi settled her
account of Rs1,000
Rs2,000 deposited inthe bank
Mr. Anirban cleared his
account or Rs500 by
paying Rs450
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Contd.
The transactions where
both cash and personal
names are mentioned
are termed as cashtransactions
Goods sold to Sravani
for Cash Rs1,000
Goods purchased from
Suman for cash Rs6,000
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Credit transactions
The transactions where
in personal names or
name of a firm is
mentioned areidentified as credit
transactions
Goods sold to Sravani
Rs1,000
Good returned from
Sreemoti Rs5,000 Goods returned to
Sivani Rs1,000
Goods purchased from
Suman Rs6,000
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Account
An account is summarized record of relevant
transactions relating to same activity or
particular head that has taken place during a
given period. Separate individual accounts areopened for every head of expenses, revenue,
asset, liability and capital
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Accounts involved
Transactions
1. Purchased goods for cash
2. Purchased plant
3. Purchased furniture
4. Purchased good on credit5. Sold goods on credit to X
6. Rent received
7. Salary paid
8. Commission received
9. Cash deposited in to bank
10. Started business withcapital
Accounts involved
Cash, goods
Plant ,cash
Furniture, cash
Goods, creditor
Goods, X
Cash, rent
Salary, cash
Commission, cashBank ,cash
Cash, capital
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Accounting equation
Asset= Liabilities + Equity
Asset- Liabilities = Equity
Assets Equity = Liabilities
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Format of Accounting Equation
Transactions Assets Liability + Equity
Cash Goods Furniture
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Impact on Accounting Equation
Decrease in asset
Decrease in ownerscapital
Cash withdrawnfor privatepurpose
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Contd.
Decrease in asset
Decrease inliability
Amount paidto creditors
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Furniture purchased
Increase inone asset
Decrease inother asset
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Contd.
Cash brought in tobusiness
Increase in capital
Increase in asset
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Contd.
Goods purchasedon credit
Increase inLiability
Increase in assets
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Creditors paid by taking a fresh loan
Increase in oneliability
Decrease inanother liability
C di b h h
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Creditor becomes the partner or the
contributor
Increase incapital
Decrease inliability
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Capital transferred to loan
Increase inliability
Decrease incapital
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Contd.
Increase incapital
Decreasein liability
Dischargeof liability
at discount
Decreasein assets
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Contd.
Increase inassets
Decrease inassets
Amountcollected
from debtorsat discount
Decrease incapital
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Tips for Accounting equation
Whether expensespaid or outstandingboth the cases the
capital will bereduced
If expenses paid itwill reduce from
the cash
If outstanding itwill increase the
liability
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Contd.
If incomereceived in
advance
Increasethe liability
Increasethe cash
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Contd.
If any expensespaid in advance
Prepaid expensescolumn will be
opened in assetside
It will reducefrom the cash
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Contd.
For accruedincome ( incomeearned but not
received)
A separate columnwill be opened inthe asset side asaccrued income
Added to theequity / capital
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Balance Sheet
The Balance Sheet presents an enterprises
assets, liabilities and equity at a point in time.
It summarizes the resources, and the claim to
those resources by owners and creditors ofthe enterprise on a certain date
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Balance Sheet
Liabilities +equity
Assets
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Format of Balance Sheet
Items Details Amount
Assets
Office equipments
Stock
Bank
CashBuilding
Total of assets
Liabilities
Creditors
Outstanding expenses
OverdraftEquity
Share capital
Retained earnings
Total equity
Total of liabilities and equity
Income Statement or Profit & Loss
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Income Statement or Profit & Loss
Account
It is a dynamic document which shows the
results of operation of an enterprise for a
particular period of time. In this statement
revenue of a particular period are marchedwith the expenses of that period. The excess
of revenue over expenses is known as net
income and excess of expenses over revenueis known as net loss
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Why Profit is important?
For business profit is like engine of a car. As
the car ends when its engine is separated
from it, similarly identity of business comes to
an end when the word profit is removed fromit. Profit is very important in any business.
Why Profit & Loss Account is
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Why Profit & Loss Account is
prepared?
The answer to this question is simple and
obvious . As the name suggests, this
statement is prepared to find out whether an
organization has made a profit or a loss.
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Profit Cycle
Profit
Expenses
Revenue/Income
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Loss Cycle
Income
Expenses
Loss
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Profit and Loss
Items Amount
Income
Sales
Income from services
Other receipts
Total IncomeExpenses
Cost of sales
Salary
Expenses due
Depreciation
RentTotal of Income
Profit ( Income Expenses) / Loss ( Expenses- Income)
____________
____________
____________
____________
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Statement of retained earnings
Particulars Amount
Opening retained earnings
Add Profit during the year
Les Dividend paid during the yearClosing balance of retained earnings
Stake holders for Revenue generated
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Stake holders for Revenue generated
in business
Stakeholders
the shareholders whoalso expect
reward
government,which
expects tocollect tax
the lendersalso need tobe rewarded.
employees,vendors,printing
stationer etc.This grouprepresentsoperatingexpenses.
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Capital Expenditure
It is the amount spent to acquire the assets
not for resale them, it is for generating the
income of the business unit. The benefit of
this is not for one year, it is for the longerperiod. For example purchase of land and
building, purchase of plant, brokerage or
commission paid for acquiring the long termloan etc. These expenses are recorded in
Balance Sheet.
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Contd.
Capitalexpenditure
Purchase ofland, building,
plant andmachinery,furniture,
vehicle and anyother fixed
asset.
Expenditureincurred for
increasing thesitting
accommodation ina auditorium or
restaurant.
Amount spent forerecting of plant
Cost of replacingpetrol driven
engine to a dieseldriven engine
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Revenue expenditure
It includes purchasing assets required for resale
at a profit or being made into saleable goods,
maintaining fixed assets in good working
conditions, meeting the day to day expensesof carrying business, cost of goods, raw
materials and replacements, renewals, repairs,
depreciation of fixed assets, rent rates, taxes,wages and salaries, carriage, insurance etc.
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Contd.
Revenueexpenses
Rent,rates,salary,
telephoneexpenses
Cost ofgoods sold,
repairs,stationary
Discount ,interest,postage
etc.
Commission paid,
rent paid,advertise
ment
Revenue expenditure becomes capital
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Revenue expenditure becomes capital
expenditure
Repairs to second handmachine
Legal expenses at the timeof purchase of fixed assets
Transport charges for Plantand Machinery
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Contd.
Wages paid to work manfor erecting of PM
Development expenditurefor plantation, Collieries
etc,
Interest paid during
construction of building orplant etc.
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Deferred Revenue Expenditure
It is the expenditure which would be normallytreated as revenue expenditure but it notwritten off in one year as its benefit is not
exhausted in one year but over a period ofyear. The nature of this is non-recurring andspecial nature. It may be spread over anumber of years, a proportionate amount is
charged to profit &loss account every year andthe balance amount is treated as an asset andshown on the balance sheet asset side
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Contd.
Huge advertisementexpenses forbusiness promotion
Heavy Insurancepremium paid the
benefit derived beyondthe accounting period.
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Revenue Profit
Income from
investment
Commission received,
interest received,discount received etc.
Profit from
sale of goods
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Capital receipt
Capital receipts capital invested in thebusiness, loans and the
proceeds of sale ofassets etc
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Revenue receipt
Revenue receipts cash from sales, discountreceived, commission,interest on investment,
transfer fees received etc
l l
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Capital loss
Capital LossLoss while which occurswhile selling fixed assetsor raising share capital
l
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Revenue loss
Revenueloss Loss on sale
of goods
Profit Before Interest and Tax (PBIT)
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Profit Before Interest and Tax (PBIT)
or operating profit or EBIT
This is a measure of gross performance of a
company with reference to its total capital
employed. As the term suggests, interest and
tax are not deducted while computing PBIT.Interest is a reward of borrowed capital and
tax is a compulsory deduction imposed by law.
It is also known as Earnings Before Interestand Tax ( EBIT). Generally it is used to measure
managerial Performance.
P fi B f T (PBT) EBT
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Profit Before Tax (PBT) or EBT
This is a measure of net profit before charging
tax. Since tax is a compulsory and non
discretionary charge on the company, net
profit is first presented before charging tax. Bythis the users can understand profit earning
ability of the company and the tax impact
separately. This also otherwise known asEarnings Before Tax (EBT).
P fi Af T (PAT)
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Profit After Tax (PAT)
This is a measure of net profit. This is used tounderstand the profit earned after tax charge.
It is otherwise known as Earnings After Tax
(EAT).
B i
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Basics
PBIT
PBT
PAT
B i
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Basics
DISTRUBUTABLEPROFIT PAT + Previous
years undistributedprofit.
B i
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Basics
Non- operatingincome Income from
investment, profiton sale of assets etc.
B i
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Basics
Non- operatingexpenses Loss on sale of assets
or loss on sale ofinvestments etc.
O d f P t
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Order of Payment
Operatingexpenses
Interest
Tax
Shareholders
C h Fl A l i
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Cash Flow Analysis
Explains reasons for changes in cash positionof a concern. Transactions which increase the
cash position of the concern are known as
inflow of cash and those decreases the cashposition are known as out flow of cash.
C h fl R ti
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Cash flow Reporting
Cash flow from OPERATION
Cash flow from INVESTMENT
Cash flow from FINANCING
O ti A ti it
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Operation Activity
Receipts from
customers for saleof goods andservices
Cash inflow
Operatingactivities Payments to
suppliers andemployees
Payment to govt. fortaxes and duties
Cash outflow
Investing Activity
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Investing Activity
Sale of fixed assets,
sale of investments,collection of loans,interest and dividendreceived etc.
Cash inflow
Investingactivity Payment for purchase
of fixed assets,Payment for purchasedof investment and formaking loans.
Cash outflow
Financing Activity
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Financing Activity
Issue of share
capital, debenturesand otherborrowings
Cash inflow
Financingactivity Dividend paid,
interest paid,payment of loan,capital .
Debentures paid
Outflow of
cash
Cash from investing activities
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Cash from investing activities
Sale of fixed assets Sale of investment
Purchase of fixed asset (-)
Purchase of investment (-) Interest received
Dividend received
Loans to subsidiaries (-) Net cash from investing activities
Cash flow from financing activity
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Cash flow from financing activity
Issue of shares and debentures Proceeds from long-term borrowings
Repayment of long-term borrowings (-)
Redemption of preference shares anddebentures (-)
Dividend paid (-)
Interest paid (-) Net cash from financing activities
Cash Flow Statement
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Cash Flow Statement
Particulars Details Amount
I. Cash flow from Operating Activities
II. Cash flow from Investing Activities
III. Cash flow from Financing Activities
Net Increase (Decrease) in cash
+ Beginning Balance of Cash
End Balance of Cash
____________
---
----
Trial Balance
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Trial Balance
Trial Balance is a statement, prepared with thedebit and credit balances of ledger accounts
to test the arithmetical accuracy of books of
accounts.
Items shown in the trial balance
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Items shown in the trial balance
Debit side Credit side
Cash in hand
Cash at bank
Bills receivable
Drawings
Land and building
Furniture
Plant and machinery
Investments
Opening stock
Rent ,rates and taxes
WagesFreight
Discount allowed
Export duty
Horse and cart
Goodwill
Sales tax
Capital
Bank overdraft
Creditors
Sales
Bills payable
Loan (credit)
Mortgage (payable)
Purchase return
Discount ,rent, interest (received)
Provisions for bad debts
General reserveDepreciation reserve
Depreciation fund
Provision for depreciation
Apprentice premium
Commission received
Interest received
Provisions
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Provisions
set aside ,before ascertaining thenet profits,
charge against profit for allanticipated losses
reasonably necessary for thepurpose of providing for any
liability or loss, which is likely orcertain to be incurred;
Reserve
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Reserve
Reserve
amount of money that isset aside until that isrequired for other purpose
capital receipts( profit onsale of fixed assets or issue
of shares at a premium)upward revaluation of
assets( bringing the assetsto current value from
historical cost Reserves are the items ofowners' equity which arise
from retention of profits(an appropriation ofprofits, sum of money setaside from distributable
profits
Classification of reserve
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Classification of reserve
Capitalreserve
Generalreserve
Specificreserve
Revenuereserve
Depreciation
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Depreciation
Decrease in value
of an asset
Due to outdate of
technology
Due to wearand tear
Causes of Depreciation
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Causes of Depreciation
Lapse of time
Wear and tear dueto constant use
Depletion
Contd
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Contd.
Exhaustion of assets
Accident
Obsolescence
Ratio Analysis
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Ratio Analysis
In general words, a ratio is an expression ofrelationship of one figure with another. It may
be defined as the relationship, or proportion
that one amount bears to another. It is foundby dividing a figure with another. A ratio may
be expressed in percentage in which the base,
is taken as equal to 100 and the quotient isexpressed as per hundred of the base
Various ratios
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Various ratios
Capital structure or leverage ratio
Liquidity ratios
Activity or turnover ratio
Profitability or profit earning capacity ratios.
Components
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Components
Cash in hand, cash at bank, debtors, prepaidexpenses, short term deposits, billsreceivable, money at call and short notice,stock ,finished goods, work in progress stockof raw materials and sundry supplies
CurrentAssets
Bills payable, income tax payable, creditors.Outstanding expenses, bank overdraft,provision for taxation, interest due on fixed
liabilities, reserve for unbilled expenses,installment payable on long-term loans.
CurrentLiabilities
Short term ratio
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Short term ratio
Primarily short term creditors
interested in liquidity or shortterm solvency of the firm.Since their claims are to bemet in the short term.
It is the ability of the firm to meetshort term obligations. Thismeasures concerns ability to meetshort term obligation
Short term solvency or liquidity ratios
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Short term solvency or liquidity ratios
Current Ratio
Liquid Ratio
Absolute Liquid Ratio
Current ratio or working capital ratio
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Current ratio or working capital ratio
This ratio establishes relationshipbetween current assets and currentliability
Meaning
Current assets / Current liabilitiesRatio
2:1Standardnorm
Liquid Ratio or quick ratio
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Liquid Ratio or quick ratio
This ratio establishes relationship between quick assets andcurrent liability . Quick assets refer to those current assetswhich can be converted into cash immediately or at a shortnotice with out a loss of value.
Meaning
Quick Assets/ Current liability or
Quick assets / Quick liabilityRatio
1:1
Note Quick assets are current assets- stockprepaid expensesand quick liabilities are current liability- bank overdraft.
Standardnorm
Absolute liquid ratio
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Absolute liquid ratio
Establishes the relationship between absolute liquid assetsand absolute liquid liabilities or current liabilities .
Absolute liquid assets = Cash in hand, cash at bank andshort term marketable securities
Meaning
Absolute liquid assets / Absolute liquid liabilities or CLRatio
.5:1Standardnorm
Activity or Turnover ratio
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Activity or Turnover ratio
It measures the effectiveness with which afirm uses its available resources.
Activity or Turnover ratios
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Activity or Turnover ratios
Stock or inventory turnover ratio
Debtors or receivable turnover ratio
Average collection period or debtor velocity
Creditors or payable turnover ratio
Average payment period
Contd.
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Contd.
Total assets turnover ratio
Fixed asset turnover ratio
Current asset turnover ratio
Working capital turnover ratio
Capital or net worth turnover ratio
Total capital turnover ratio
Stock or inventory turnover ratio
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This ratio is an indicator of velocity of flow ofinventory in business. This shows the rate ofconversion of stock in to sales. In fact,inventory policy of management and liquidityof firm both may be tested by this ratio. This isalso a measure of marketing capacity of thefirm. No any standard rate or norm can be
determined for this ratio because it basedmore on nature of industry and sales policy ofthe firm.
Contd.
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Contd.
Cost of goods sold / Average stock
Cost of goods sold = opening stock + purchases+ directexpenses closing stock
Average stock = opening stock + closing stock / 2
Note :1. If cost of goods sold cannot be calculated thensales will be taken as base
2. if opening and closing stock is not given in that caseclosing stock will be treated as average stock
3 Higher the ratio good for the organization. A lowstock turnover ratio indicates that the goods do notsell quickly and efficiently, so the maximum inventoryremains lying in the warehouse.
Debtors Turnover ratio or Receivable TurnoverRatio(DTR)
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( )
This ratio is a qualitative analysis of a firmsmarketing and credit policy and debtors
realizations. It is calculated to know the
uncollected portion of credit sales in the formof debtors by establishing relationship
between trade debtors and net credit sales of
the business.
Contd.
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Contd.
DTR = Net credit sales / Average receivables Net credit sales = Total sales cash sales
sales return
Avg. receivables = opening receivable +closingreceivable / 2
Receivable = Debtors + Bills receivable
A decrease in this ratio each year is anindicator of efficiency of marketing and creditpolicy of the firm.
Average collection period:
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This period indicates the period taken in therealization or collection of debtors. In other
words, it represents the average number of
days for which a firm has to wait before itsreceivables are converted into cash. The
purpose of calculating this period is to find out
the ratio of cash flow from collection of
debtors
Contd.
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Contd.
Average collection period or average age ofreceivables=
Trade receivables/ sales per day
Or
Trade receivables / net credit sales X 365
days
Or
365/ DTR
Contd.
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Contd.
In this respect, the general rule is that averagecollection period should not exceed the stated
credit period on trade terms plus 1/3rd of such
period. If average collection period exceeds4/3 of stated credit period, it will indicate
either liberal credit policy or slackness of
management in realizing debts. A higher
average collection period also implies that
chances of bad debts are larger.
Creditors Turnover Ratio
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The short-term creditors ( i.e, suppliers ofgoods and bankers) are very much interestedin this ratio, as it shows the firms trend ofpayment to its short-term creditors. This ratioshows the relationship of credit purchases andtrade creditors. This ratio indicates thevelocity with which the creditors are turned
over in relation to purchases. Higher thecreditors velocity, better it is. A fall in this ratioshows delay in payment to creditors.
Creditors or payable turnover ratio
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p y
CTR = Net credit purchases / Average payables(creditor +BP)
Net credit purchase = Total purchase cash
purchase purchase return Average payable = opening payable + closing
payable / 2
Note : if opening and closing is not given thenclosing will be considered as average
Average payment period
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g p y p
While analyzing creditors, usually averageperiod is also calculated. This period discloses
the time taken by the firm in making payment
to its trade creditors. Average disbursement period is compared
with credit period allowed by suppliers of
goods to know promptness or delay inpayment
Contd.
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Average payable / net credit purchase X no. ofmonth or weeks or days
Or
No. of month or week or days / CTR
Total assets turnover ratio
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Cost of goods sold or net sales / Total assets Total assets = Fixed assets + current assets
fictitious assets- depreciation on fixed assets
This relationship indicates the efficiency ofthe utilization of assets to attain themaximum turnover on sales. A rise in theratio indicates more intensive utilization of
assets, while fall in the turnover suggestsunder utilization of assets.
Fixed assets turnover ratio
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Cost of goods sold or net sales / net fixedassets
Net fixed assets = Fixed assets depreciation
If there is an increase in this ratio, it willshow that there is better utilization of fixedassets .If there is a fall in this ratio, it willshow that investment in fixed has not been
utilized efficiently. Ideal of this in amanufacturing company is 5:1
Current assets turnover ratio
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Cost of goods sold or net sales / current assets This ratio measures the concerns efficiency in
utilization of its current assets. This ratio also
indicates the over investment or underinvestment position of current assets in a
concern.
Working capital turnover ratio
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g p
Cost of goods sold or net sales / workingcapital
The high ratio indicates efficient use of
working capital in the concern while lowworking capital turnover ratio indicates
under utilization of working capital in the
concern
Capital or net worth turnover ratio
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p
Net sales or cost of goods sold / net worth orshare holders fund
It indicates whether the capital employed by
the shareholders in a business is usedefficiently or not
Total capital turnover ratio
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p
Cost of goods sold or net sales / capitalemployed
Capital employed = long term and short termcapital
By calculating this ratio, efficiency of capitalemployed may be known. This ratio showshow many times capital has been rotated forgenerating the sales. The higher the ratio,
better it is for the business concerns. No idealstandard can be fixed for this ratio.
Capital Structure Ratio or longterm
solvency ratios
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solvency ratios
Debt equity ratio Solvency ratio
Proprietary ratio
Fixed asset ratio
Capital gearing ratio
Debt service ratio or interest coverage ratio
Debt Equity Ratio
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Debt equity ratio = Outsiders fund /shareholders fund Alternative: Debt equity ratio = long-term debt / share
holders fund or net worth Note: in this case current liabilities will be
ignored. Standard norm: 2 : 1, however lending
institutions prefer 1:1
A low ratio signifies a smaller claim of creditors.More precisely, the greater the debt-equityratio, greater the risk to the creditor.
Outsiders fund and share holders fund
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Debt, long-term or short term,whether in the form of mortgage,bills or debentures
Outsidersfund
Preference share capital, equityshare capital, capital reserves,
retained earnings and any otherreserves representing theaccumulated profit
Shareholders fund
Proprietary Ratio
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This is also known as equity ratio, net worth tototal assets ratio.
Proprietary ratio = Share holders fund / Total
assets Higher the ratio better is the financial
position of the firm.
Solvency Ratio or debt to total assets
ratio
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ratio
Solvency ratio = Total outside liabilities / totalassets
If the amount is enough to pay the external
liabilities then the company is said to besolvent.
Fixed Asset Ratio
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Fixed assets ratio = Net fixed assets /(shareholders fund + long term liability)
Or
Fixed asset ratio = Net fixed assets / Shareholders fund
Standard norm: 1 :1. It is well establishedthat fixed assets should be financed only out
of long-term funds. This ratio shows whetherthis is so.
Capital gearing ratio
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CGR = Share holders fund / out siders fund Share holders fund = Equity capital +
reserve +surplus
Outsiders fund = Preference share capital+ Debentures + Other long term loans.
Note : If capital gearing ratio is less than 1,we will call it high gearing of capital and if
gearing ratio is more than 1 then low gearingof capital is assumed
Debt service ratio or interest coverage
ratio
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ratio
Interest coverage ratio = Net profit before interest and tax /Interest on
fixed long term loans or debentures.
Note : This ratio measures the margin ofsafety for the lenders. The higher the number,more secure the lender is in respect of his
periodical interest income. Normally, fixed
interest charges should be covered six toseven times.
Profitability ratios:
Based on sales
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Based on sales
Gross profit ratio Operating ratio
Expenses ratio
Operating profit ratio
Net profit ratio
Gross profit ratio
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Gross profit / net sales X100
Net sales = Sales sales return
Gross profit = net sales cost of goods sold.
The gross profit ratio is primarily a test of theefficiency of purchases and salesmanagement. No ideal standard is fixed forthis ratio, but the gross profit ratio must be
adequate.
Operating ratio
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Cost of sales + operating expenses / net salesX 100
Operating expenses = office and
administrative expenses + selling expenses +discount allowed + bad debts etc.
Other profitability ratios
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Expenses ratio= Particular expenses/ nets sales X100
Operating profit ratio=Operating profit/net sales X100
Net profit ratio= Net profit/ net sales X100
Profitability ratios based on capital
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Return on gross capital employed Return on net capital employed
Return on proprietors net capital
Return on average capital employed
Return on total assets
Return on gross capital employed
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EBIT / Gross capital employed X100
Gross capital = Equity share capital +preference share capital +reserve and surplus+ all long and short term external loans
Or
All net fixed assets + current assets + includinggoodwill of the firm but fictitious assets are
not included
Return on net capital
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EBIT / Net capital employed X100 Net capital employed = Equity share capital +
preference share capital + reserve and surplus
+ long term loans
Return on proprietors capital
employed
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employed
Net profit after interest and tax / proprietorsnet capital employed X100
Proprietors net capital = Equity share capital +
preference share capital + reserves andsurplus accumulated losses, if any
Return on average capital employed
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Net profit / average capital X100
Average capital = Opening capital + closing capital/ 2
Or
Opening capital +1/2 of current years profit
Or
Closing capital of current years profit
Return on capital employed reflects the overallprofitability of the business
Return on total assets
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Net profit / Total net assets X 100 Total net assets = Total assets fictitious
assets
Return on proprietors fund or equity
or return on net worth
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or return on net worth
Net profit / Proprietors fund X100 Proprietors fund =Equity share capital +
preference share capital +reserves and
surplus+ undistributed profit debit balanceof profit & loss if any.
Ratios showing profitability on shares
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Earning per share(EPS) Earning Yield Ratio(EYR)
Dividend Per share (DPS)
Pay-out Ratio (POR)
Dividend Yield Ratio (DYR)
Dividend coverage ratio (DCR)
Price earning ratio (PER)
Earning per share(EPS)
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Net profit after tax,interest and preferencedividend / no of equityshares
EPS
It indicates the amount ofearnings that equity share
commands.Indicator
Earning Yield ratio (EYR)
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= EPS / Market price pershare X 100EYR
This ratio indicates therelationship between
earning per share andmarket price per shareIndicator
Dividend Per Share (DPS)
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Dividend for equity share holders/no. of equity shares
DPS
Higher the ratio, the better is forequity share holders of the concern.This ratio shows the amount ofdividend per share paid by themanagement of the companyIndicator
Pay-out ratio (POR)
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dividend per equity shares/earning per share X100
POR
This ratio helps us to calculate thepercentage of dividend paid out
of earned incomes and thepercentage of earned profitsretained in the business concernIndicator
Dividend Yield Ratio (DYR)
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Dividend per share / Market priceper share X100
DYR
Dividend yield ratio helpsinvestors to ascertain the
effective return on the amountthey invest or intend to invest inthe equity shares of a companyIndicator
Dividend cover ratio (DCR)
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EPS / DPS
DCR
This ratio indicates the relationshipbetween dividend per share andearning per share. This ratiocalculated by dividing earning pershare by dividend per shareindicator
Price Earning Ratio (PER)
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MPS /EPS
PER
This ratio indicates relationshipbetween market price per equity sharesand earning per share. In other words,
this ratio indicates the number of timesthe earning per share is covered by itsmarket price.
Indicator
Analysis and Interpretation of Financial
Statements
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It is the process of identifying the financialstrengths and weakness of the firm by
properly establishing relationship between the
items of the Balance Sheet and Profit & LossAccount and other operating data.
Meaning
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It is used to mean thesimplification of financial data bymethodical classification of thedata given in the financialstatements
Analysis
It is the explaining the meaningand significance of the data so
simplified.Interpretation
Comparative Income Statement
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This statement shows the operational resultsof the business for a number of accounting
periods so that changes in absolute figures
from one period to another period may bestated in terms of money and percentage.
Comparative Balance Sheet
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Comparative Balance Sheet analysis is thestudy of the trend of the same items, group of
items and computed items in two or more
balance sheets of the same businessenterprise on different dates
Common- Size Statements
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Common-size statements cover up theshortcomings of the comparative statements
by expressing each item of the statements as a
percentage of total. In common-sizestatements relative values of items are shown.
Common-Size Balance Sheet
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In common-size balance sheets, various itemsof assets and liabilities of balance sheets of
two or more years are shown at their relative
values. That is ,each item of the assets isshown as percentage of total assets and each
item of liabilities as percentage of total
liabilities and capital fund.
Common-Size Income Statement
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In this statement relationship is establishedbetween items of income statement and
volume of sales in percentage form. In other
words, in a common size income statement,each item of income statement is shown in
percentage based on net sales.
Consolidated Balance sheet
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A Balance Sheet which is prepared bycombining holding companys balance sheet
and subsidiary companys balance sheet is
called consolidated balance sheet. Inpreparing consolidated balance sheet, the
assets and liabilities of both companies are
added together but some adjustments are
made.
Steps for preparing consolidated
balance sheet
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Step-I: Share of holding and subsidiarycompany
Step-II: Capital reserve or goodwill
Step-III: Minority Interest Step-IV: Consolidate profit
Step-V: Consolidated reserve
Step-VI: Consolidated Balance Sheet
Adjustments:
Elimination of investments
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The investment in shares of subsidiary is shown inthe balance sheet of holding company on theassets side and share capital of subsidiarycompany is shown in its balance sheet on the
liability side. If the holding company haspurchased the entire share capital of thesubsidiary company, the investment appearing inthe balance sheet of holding company is adjusted
with share capital appearing in the balance sheetof subsidiary company.
Goodwill or capital reserve
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If the holding company has purchased sharesin subsidiary company at above par value or
below par value and the balance sheet of the
subsidiary company has pre-acquisition profitsand reserves and all the shares in subsidiary
company are held by the holding company,
the cost of investment in shares will be
adjusted to share capital + pre-acquisition
profits and reserves..
Contd.
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If the cost of investment is more, thedifference will be shown as goodwill on asset
side in the balance sheet and if the cost of
investment is less the difference will be shownon the liability side of consolidated balance
sheet as capital reserve.
Minority interest
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Minority interest includes nominal value ofshare held by minority share holders and
proportionate reserves and profits. In the
reserves and profits of the holding company,only. On the liability side of consolidated
balance sheet minority interest is shown as a
separate item.
Elimination of intercompany debts
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Debtors and creditors
Bills receivable and bills payable
Bills discounted with the bank
Mutual loans
Unrealized profit
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Percentage profit on sales :- If percentage ofprofit on sales is known, the unrealized profitwill be
stock X % /100
For example, if stock of B Ltd. includes goodsworth Rs10,000 purchased from A Ltd.charged profit of 20% on sales. Then
unrealized profit will be 10,000 X20% =Rs2,000.
Contd.
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Percentage of profit on cost:- If profit charged byvendor company is a certain percent on cost,then unrealized profit will be
Stock X %/ 100 +%
For example, stock of B Ltd includes goods worthRs8,000 purchased from A Ltd. on which A Ltdearned a profit of 25% on cost. Then unrealized
Profit will be 8,000 X25/125 = Rs1,600, as goodscost Rs100 was sold at Rs125, thus profit of Rs25on goods sold of Rs125
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WISH YOU ALL THE BEST
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