E1-E2

Accounting Standards And Ratio analysis

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WELCOME
This is a presentation for the E1-E2 (Finance) Module for the Topic: Accounting standards and Ratio analysis Eligibility: Those who have got the Upgradation from E1 to E2. This presentation is last updated on 15-3-2011. You can also visit the Digital library of BSNL to see this topic.

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What are Accounting Standards

Guidelines to direct as to how the items which go to make up the financial statements should be dealt with in Accounts and presented in the Annual Accounts Norms of Accounting Policies and practices by way of codes i.e., codification of Generally accepted Accounting principles

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Introduction
If Accounts is the language of business, Accounting Standards may be stated to be the grammar of that language. These standards are mandatory to be complied with to ensure that financial statements are prepared in accordance with the generally accepted accounting practices Accounting Standards provide for disclosure norms to add value to the preparation of accounting statements.

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Objectives of Accounting Standards

Provides a structural framework within which credible financial statements can be produced Brings about uniformity in financial reporting Ensures consistency & comparability in the data published by the enterprises Enhances the Quality and the degree of dependability of the financial statements

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Significance of Accounting Standards

Accounting standards address the core issue of information needs of the stakeholders. Useful to investors assessing the yield and risk of alternative investments Will raise the standards of the audit in its task or reporting on the financial statements Meaningfulness of the numbers in the accounting reports for the purpose of economic planning, market analysis etc, Confidence that user groups have in the fairness and reliability of the financial statements
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Significance of Accounting Standards

Accounting standards directly and indirectly influence, command and control many important aspects of companys operations, administration, revenue etc., as the final operational results of all operations get reflected in the financial statements. Accounting standards are also an effective way of ensuring managements compliance to ethics, consistency and business transparency.

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Scope of Accounting Standards

These are supplementary to the laws of the land and do not substitute their provisions in any manner. i.e., Accounting Standards will be prepared in conformity with the provisions of the applicable laws, customs usages and business environment in India However if a particular Accounting Standard is found to be not in conformity with law, the provisions of the law will prevail.

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Accounting Standards Board

ICAI recognizing the need to harmonize the diverse accounting policies and practices prevalent in India constituted an ASB in April 1977

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Accounting Standards Board

Objectives and functions of ASB To conceive of and suggest areas in which AS needs to be developed To formulate Accounting Standards To examine how far the relevant International Accounting Standard / International financial reporting standard can be adopted in India To review at regular intervals and if necessary revise the existing AS To provide from time to time, interpretations and guidance notes on AS
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Procedure for issuing AS

ASB will determine the broad areas in which AS need to be formulated and their priority Study groups are constituted to assist ASB ASB will hold dialogue with the representatives of Govt, PSUs, Industry and other organizations On the basis of work of study group and dialogue an exposure draft of the proposed AS will be issued for comments. After taking into consideration the comments received the proposed AS will be finalized by the ASB. AS on the relevant subject will be issued by the ICAI after modification, if found necessary.
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Procedure for issuing AS

The draft of the proposed standard will normally include: a) Objective of the standard b) Scope of the standard c) Definitions of the terms used in the standard d) Recognition and measurement principles, wherever applicable e) Presentation and disclosure requirements

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Compliance
Compliance with the Accounting Standards has been made mandatory. Sub section 3(A) to section 211 of Companies Act requires that every profit and loss account and Balance Sheet shall comply with the Accounting Standards.

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Compliance
Sub Section 3(B) prescribes that in case the profit and loss account and balance sheet of a company does not comply with the requirements of the AS, disclosures should be made stating

I. Deviations from the AS II. The Reasons for such deviation and III. The financial effect, if any, arising due to such deviation

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Compliance
Sub Section 3(C) Provides that the standard of accounting specified by the Institute of Chartered Accountants of India shall be deemed to be the Accounting Standards until the accounting standards are prescribed by the Central Government

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Compliance
Sub Section (3) of Section 227 of Companies Act requires the auditors to report whether in his opinion the profit and loss account and balance sheet comply with the accounting standards The statutory auditors are required to make qualification in his report in case any item is treated differently from the prescribed treatment in the relevant Accounting standard.

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Accounting Standards

As on date 32 Accounting Standards are issued

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List of Accounting Standards

Disclosure of Accounting Policies (AS-1) Valuation of Inventories (AS-2) Cash Flow Statements (AS-3) Contingencies and Events occurring after the Balance Sheet Date (AS 4) Net Profit or Loss for the Period, Prior Period Items and Changes in the Accounting Policies (AS-5) Depreciation Accounting (AS-6)

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List of Accounting Standards

Construction Contacts (AS-7) Revised Accounting for Research and Development (AS-8) ----Since withdrawn Revenue Recognition (AS-9) Accounting for Fixed Assets (AS-10) Accounting for the effect of changes in foreign exchange rates (AS-11) Accounting for Government Grants (AS-12)

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List of Accounting Standards

Accounting for Investments (AS-13) Accounting for Amalgamations (AS-14) Accounting for Employee Benefits (AS-15) Borrowing Costs (AS-16) Segment Reporting (AS-17) Related Party Disclosures (AS-18)

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List of Accounting Standards

Leases (AS-19) Earning Per Share (AS-20) Consolidated Financial Statements (AS-21) Accounting for Taxes on Income (AS-22) Accounting for Investments in Associates in Consolidated Financial Statements (AS-23) Discontinuing Operations (AS-24)

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List of Accounting Standards

Interim Financial Reporting (AS-25) Intangible Assets (AS-26) Financial Reporting of Interest in Joint Ventures (AS-27) Impairment of Assets (AS-28) Provisions Contingent Liabilities and Contingent Assets (AS-29)

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List of Accounting Standards

New standards effective from 01-04-2009 and mandatory from 01-04-2011 Financial instruments recognition and measurement (AS 30) Financial instruments presentation (AS 31) Financial instruments Disclosure (AS 32)

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RATIO ANALYSIS

FINANCIAL ANALYSIS : Is the process of identifying the financial strengths and weakness of the firm by properly establishing relationships between the items of Balance Sheet and Profit and Loss Account RATIO ANALYSIS : is a tool of financial analysis.

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RATIO ANALYSIS
Ratio analysis is the analysis of the relationship between items of financial data, or between financial and non financial data. Ratios sometimes prove themselves to be more meaningful than the absolute figures

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Advantages of Ratio Analysis

I. Simplifies, Summarizes and Systematizes accounting figures for easy understanding; II. Ratios helps the management in measuring things like Long-term Solvency, Operational Efficiency, etc. of the firm III. It can be used to compare the risk and return relationships of firms of different sizes.

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Advantages of Ratio Analysis

IV. Facilitates inter-firm comparison showing relative performance of enterprise in the industry; Facilitates intra-firm comparison showing the improvement/degradation in the performance of the enterprise; It provides a profile of a firm, its economic characteristics and competitive strategies, and its unique operating, financial and investment characteristics.

V.

VI.

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Standards of comparison:
A single ratio does not indicate any condition. It should be compared with some standard. Standards of comparison may consist of: 1) Ratios calculated from the past financial statements of the same firm. 2) Ratios developed using the projected, or pro forma, financial statements of the same firm. 3) Ratios of some selected firms, ( most progressive & successful,) 4) Ratios of the industry to which the firm belongs.
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Limitations of Ratio Analysis

They are arithmetical expressions. Qualitative aspects cannot be presented directly. They are calculated from accounting records which have their own limitations. Ratios are indicators only and must be supplemented by a detailed analysis to discover the reality. Strongly affected by manipulations of financial statements & this fact is not revealed by Ratio Analysis. Factors like Inflation also distort the Ratio Analysis.

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Precautions
Points to be borne in mind while using ratio analysis technique Only figures that have a mutual cause and effect relationship should be considered Particular characteristics of the industry should always be kept in mind while a firm is being studied. Ratios are only symptoms and not the real disease in itself Good profits rather than good ratios is the objective of the firm
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RATIO ANALYSIS
Classification of Ratios:
Structural Classification Functional Classification

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Structural Classification of Ratios

This is the Conventional mode of classifying ratios where the ratios are classified on the basis of information given in the financial statements.

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S.N
1

Type
Balance Sheet Ratios

Structural Classification of Ratios

What it is Examples
Ratios for which the components for computation are drawn from the Balance Sheet. (Financial Ratios.) * Current Ratio * Liquid Ratio * Debt Equity Ratio * Proprietary Ratio * Capital Gearing Ratio * Fixed Assets Ratio

P&L A/c Ratios

Ratios for which the components are drawn from the P&L Account. (Income Statement Ratios or Operating Ratios )

* Gross Profit Ratio * Net Profit Ratio * Operating Ratio * Stock Turnover Ratio * Expenses Ratio

Inter-statement Ratios or Combined Ratios

Ratios for which the components are drawn both from the Balance Sheet and P&L Account. ( Financial Ratios. )

* Return on Capital Employed * Return on Investments [ROI] * Debtors Turnover Ratio * Creditors Turnover Ratio * Fixed Assets Turnover Ratio

[ROCE]

* Working Capital Turnover Ratio

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Functional Classification Of Ratios:

Financial ratios are broadly categorized in four broad heads Activity analysis Liquidity analysis Long term debt and solvency analysis Profitability analysis

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Activity analysis
Activity ratios describe the relationship between the firms level of operations and the assets needed to sustain operating activities. Short term (operating) activity ratios Inventory turnover Receivables turnover Payable turnover Working capital turnover Long term (investment) activity ratios Fixed assets turnover Total asset turnover
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Liquidity analysis
Liquidity ratios helps in assessing the ability of a firm to meet its current obligations. This ability depends on the cash resources available as on the balance sheet date. Current ratio Quick ratio Cash ratio

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Long term debt and solvency analysis

Analysis of a firms capital structure is essential to evaluate its long term risk and return prospects. Debt ratio Debt to total capital Debt to equity Interest coverage ratio

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Profitability analysis
Investors are concerned with the firms ability to generate, sustain and increase profits Return on sales Gross margin Operating margin Profit margin Return on investments Return on assets Return on equity

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EPS and P/E ratios

EPS is the most widely available and commonly used performance statistics for publicly traded firms Calculation of EPS is governed and mandated by the financial reporting standards Earnings per share Price earning ratio

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