Accounting & Financial

Management
Session - 3

Business

What is the first requirement

of business

Business
MONEY
Who will arrange money for
business and how?

Money for the business

The person who starts the business is

responsible to arrange finance for the
business.

1.
2.
3.

Sources:
All the money provided by the proprietor
All the money Borrowed from bank
Some portion of the required amount provided
by proprietor and the reminder borrowed from
the bank.

Algebraic Form
Case-1: Assets = Capital / Ownership
Case-2: Assets = Liabilities
Case-3: Assets = Capital + Liabilities

(Basic Accounting Equation)

Example
Mr. Khan starts a business for which cash
of Rs.100,000 is required. He invests
Rs.70,000 of his own money and borrows
the balance amount Rs.30,000 from a
bank:
Accounting equation:
Assets(100k)= Capital (70k) +Liabilities(30k)
(Business prop) (Khan rights) (Bank rights)

Analysis of Transaction
(Four Steps)
1. Identify the accounts affected by a
transaction
2. Classify the accounts affected (assets,
liabilities, capital)
3. How these accounts are affected
(increased or decreased)
4. Apply the rule

Debit and Credit Rules

1.
2.

1.
2.
3.

Debit for increases in

Assets
Expense
And for decrease in
Liabilities
Capital
income

1.
2.

1.
2.
3.

credit for decreases in

Assets
Expense
And for increases in
Liabilities
Capital
income

T - Accounts
Assets
Incr
(+)

decr
(-)

Liabilities
decr incr
(-)
(+)

Capital
decr
(-)

incr
(+)

Example
Khan purchases furniture for cash Rs.5000

Cash
Furniture

Furniture 5000

Cash 5000

Example
Khan purchases computer on credit from
XYZ. Co worth Rs.25000

XYZ. CO
Computer 25000

Computer
XYZ.Co 25000

Example
Khan further invest Rs.50000 in his
business.
Capital Khan
Cash 50000

Cash
Capital (Khan) 50000

Example
Khan pays salary to his staff Rs.15000.
salary expense
Cash 15000

Cash
Salary exp 15000

Example
Khan receives interest in cash on his
saving certificates Rs.5000.

Interest income
Cash 5000

Cash
Interest income 5000

Balancing
An account is said to be balance when the
sum of the credit items of that account is
equal to the sum of the debit items.
To balance a ledger account means to
strike out the difference between two side
of account.

Practice problem
On Jan. 1,2000 Mr. Ali started business and invested
therein cash Rs.60,000.
On Jan. 10, a delivery van was purchased for
Rs.15000 cash and on Jan 15, a typewriter was
purchased for Rs. 1500.
On Jan 20, Mr Ali purchased merchandise for
Rs.10000 cash.
On Jan 25, Mr.Ali sold goods for cash Rs.8000
On Jan 26 Mr.Ali purchased goods from N Grocers of
Rs.8000 on credit.
On jan 29, Mr.Ali paid cash Rs.5000 to N Grocers.

Ledger Accounts

Cash

Ali, Propriet

60,000

60,000

Cash

Typewriter

15,000

1,500

Delivery Van
15,000

Cash

1,500

Ledger Accounts
Purchases (goods)

Cash

10,000

Cash
8,000

10,000
Purch (goods)
8,000

Sales Rev
8,000
N Grocers
8,000

Ledger Accounts

Cash
5,000

N Grocers
5,000

Recording of Transactions in Journal

It is a book in which original records for
business transactions and happening are
made in the order in which they take place
A Journal is a chronological record of
transaction
Journal is the book of original entry

Form of Journal
Date

Particulars

Folio Debit

Credit

Recording of Transactions in Journal

(Example)
On Jan. 1,2000 Mr. Ali started business and invested
therein cash Rs.60,000.
On Jan. 10, a delivery van was purchased for
Rs.15000 cash and on Jan 15, a typewriter was
purchased for Rs. 1500.
On Jan 20, Mr Ali purchased merchandise for
Rs.10000 cash.
On Jan 25, Mr.Ali sold goods for cash Rs.8000
On Jan 26 Mr.Ali purchased goods from N Grocers of
Rs.8000 on credit.
On jan 29, Mr.Ali paid cash Rs.5000 to N Grocers.

ALI - JOURNAL
Date

Particulars

2000
Jan. 1

Cash Account .Dr.

To Ali Capital A/C
(Cash invested by.)
Jan. 10 Delivery Van A/C
To Cash A/C
(van purchd for cash)
Jan. 15 Office equipment A/C
To cash A/C
T.writer purchd for )

L.F.

Debit
Rs.

Credit
Rs.

60000
60000
15000
15000
1500
1500

Trial balance
A trial balance is a statement of the
balances of all accounts in the ledger.
The amounts of debit and credit in a
journal entry are always equal. It therefore
follows that debit and credit balances of
the accounts should also be equal.
It is arithmetical accuracy device of the
record in the ledger.

Format of Trial Balance

Khan &Co
Trial Balance
December 30,2007
# of A/C Name of account
Debit
Credit
balance balance

xxxx

xxxx

Income Statement
It is a summary of revenues and expenses
of an enterprise for a given period.
Objective of business is profit and Income
Statement shows whether the objective
has been achieved or not

Profit
Profit = Revenue - Cost
The Profit for the sake of convenient has
been divided into two forms:
Gross Profit = Sales Purchases
(included expenses on purchase)
Net Profit = Gross profit Expenses
(Selling + Office + Maintenance)

Format:
Khan & Co
Income Statement
Year ended Dec 31,..
Revenue
Sales
Interest revenue
Total revenue
Expenses
Cost of goods sold
Selling
Administrative
Other
Total expenses
Income before tax
Taxes for year
Net Profit for year

xxxx
xxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx

Cost of Goods Sold

It represents the net cost of producing the
product marketed by the firm.
The total of cost of goods sold statement is
entered as an expense item on the income
statement.
Cost of goods sold = prime cost + factory exp.
Prime cost = direct materials + direct labour
Factory expenses includes all indirect costs
and overhead charged to a product.

Format:
Khan & Co
Statement of Cost of Goods Sold
Year ended Dec 31, 2007
Materials
Inventory, Jan 1, 2007
xxxx
Purchases during year
xxxx
Total
xxxx
Less; Inventory Dec 31, 2007
xxxx
Cost of material
Direct labour
Prime Cost
Factory expenses ( indirect cost)
Factory cost
Less; Increased in finished goods during year
Cost of goods sold

xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx

Example
From the following figures, prepare income statement
Khan Associate for the year ended 31st December 2007.
Inventory jan 1, 2007 was Rs. 54000
Purchases during year Rs. 174500
Direct labor charges Rs.110000
Factory expenses Rs.7000
Increase finish goods inventory during year Rs.5500
Inventory Dec. 31st 2007 Rs.50000
Selling, administrative and other expenses are
Rs.25000, Rs.45000 and Rs.5000 respectively
Taxes for year 2007 Rs.64575
Interest income in 2007 Rs.3500
Sales 2007 Rs.505000

Khan & Co
Statement of Cost of Goods Sold
Year ended Dec 31, 2007

Materials
Inventory, Jan 1, 2007
Rs.54000
Purchases during year
Rs.174500
Total
Rs.228500
Less; Inventory Dec 31, 2007
Rs.50000
Cost of material
Rs.178500
Direct labour
110000
Prime Cost
288500
Factory expenses ( indirect cost)
7000
Factory cost
295500
Less; Increased in finished goods during year
5500
Cost of goods sold
Rs. 290000

Khan & Co
Income Statement
Year ended Dec 31,2007
Revenue
Sales
Rs.505000
Interest revenue
Rs. 3500
Total revenue
Expenses
Cost of goods sold
Rs.290000
Selling
25000
Administrative
45000
Other
5000
Total expenses
Income before tax
Taxes for year 2007
Net Profit for year 2007

Rs.508500

Rs.365000
Rs.143500
Rs. 64575
Rs. 78925

Balance Sheet
A detailed statement showing the amount
of each asset, the amount of each liability
and the amount of capital is known as
balance sheet.
It is not an account but simply a statement
of assets and equities of an enterprise at
given date.

Functions of B.S
It shows the financial position of an
enterprise on a particular date.
It provides financial information of an
enterprise to interested parties

Format
ABC CORPORATION
Balance Sheet
Dec. 31, ..
Assets
Current
Cash
A/C receivable
Int. accrued rec.
Inventories
Total C.A
Fixed
Land
Building & equipt.
Less: Dep. xxxxx
Total F.A
Total Assets

xxxxx
xxxxx
Xxxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxxx

Liabilities

A/C payable
xxxxx
Dividend payable
xxxxx
Long term note p/a
xxxxx
Bonds payable
xxxxx
Total liabilities
xxxxx
Net Worth
Common stock
Preferred stock
Retained earning
Total net worth
Total liab & net worth

xxxxx
xxxxx
xxxxx
xxxxx
xxxxx

Common Stock vs. Preferred Stock

Both represent a piece of ownership in a
company.
The main difference between the two types of
stock is that holders of common stock typically
have voting privileges, whereas holders of
preferred stock do not.
Preferred stockholders receive a fixed dividend
from the company, while common shareholders
may or may not receive one (depending on the
decisions of the board of directors).
The bottom line is that preferred stock is less
risky than common stock.

Example
From the following information, prepare the Balance Sheet
of ABC corporation for the year ended Dec. 31, 2007.

Inventories stock on Jan. 1, 2008

of $52000
Cash in hand $5000
Cash at bank $5500
Account receivable $18700
Account payable $19700
Interest accrued receivable $500
Bonds payable $20000
Common stock $275000
Retained earning $25000

Dividend

payable $7000

Building and equipt $438000

Long term note payable $16000
Preferred stock $100000
Depreciation allowance $82000
Land $25000

ABC CORPORATION
Balance Sheet
Dec. 31, 2007

Assets

Current
Cash in hand
$5000
Cash at bank
5500
A/C receivable
18700
Int. accrued rec.
500
Inventories
52000
Total C.A
$81700
Fixed
Land
$25000
Building & equipt. 438000
Less: Dep. $82000
356000
Total F.A
381000
Total Assets
$462700

Liabilities

A/C payable
Dividend payable
Long term note p/a
Bonds payable
Total liabilities

$19700
7000
16000
20000
$62700

Net Worth

Common stock
Preferred stock
Retained earning

$275000
100000
25000

Total net worth

400000

Total liab & net worth

$462700

Practice Case
From the following information, prepare the Final accounts of Ali &
Co. for the year ended Dec. 31, 2007.
Stock on 1-1-2007. Rs.11000
Carriage inwards Rs. 2000
Purchases Rs.182000
Freight Rs. 26000
Salaries Rs.12000
Traveling exp. Rs. 6000
Wages Rs.8000
Repair to furniture Rs.500
Machinery Rs. 50000
Discounts Rs.4500
Sales Rs. 240000
Bills receivable Rs.35000
Furniture Rs.9000
Bills payable Rs.15500
Debtors Rs. 95000
Income tax Rs.17000
Creditors Rs.78000
Return outwards Rs.3000
Alis drawing A/C Rs.18000
Return inwards Rs.4000
Alis capital A/C Rs.254000
Cash in hand Rs.4000
General expenses Rs. 32500
Cash at bank Rs.70000
Stock at end Rs.67500
Rents, rates and taxes Rs 13000

Ali & Co
Statement of Cost of Goods Sold
Year ended Dec 31, 2007

Materials
Inventory, Jan 1, 2007
Purchases during yearRs.182000
less: Ret outwards Rs.3000
Total
Less: inventory at end
Total Cost of material

Direct labour (wages)

Prime Cost
Factory expenses ( indirect cost)
Carriage inwards Rs.2000
Freight
26000

Rs.11000

179000
Rs190000
Rs.67500
Rs.122500
8000
Rs.130500

Factory cost

28000
Rs.158500

Cost of goods sold

Rs.158500

Ali & Co
Income Statement
Year ended Dec 31, 2007
Revenue
Sales
Rs.240000
Discounts
4500
Less: Returns O/W Rs. 4000
Total revenue
Expenses
Cost of goods sold Rs.158500
Salaries
12000
Rent, Rates & Taxes
13000
Traveling
6000
Repair to Furn.
500
Gen. expenses
32500
Total expenses
Income before tax
Taxes for year
Net Profit for year

Rs.240500

Rs.222500
Rs.18000
17000
Rs.1000

Ali & Co.

Balance Sheet
Dec. 31, 2007

Current
Cash in hand
Cash at bank
Debtors
Bills rec.
Inventories
Total C.A
Fixed
Furniture
Machinery

Total F.A
Total Assets

Assets

Rs.4000
70000
95000
35000
67500
Rs.271500
Rs.9000
50000

Rs.59000
Rs.330500

Liabilities

Creditors
Bills payable

Rs.78000
Rs.15500

Total liabilities

Rs.93500

Net Worth

Ahmeds capital
Rs.254000
Add: Net profit Rs 1000
Less: Drawing
18000
Total net worth

Rs. 237000

Total liab & net worth

Rs.330500

Business Ratio Analysis

Ratios expressing relationship between
items or group of items of the financial
statements.
It is used to evaluate financial strength of
a company over time in relation to industry
norms.

Classification
Solvency ratios: An ability to meet short
term and long term financial obligations
Efficiency ratios: Measures which reflect
managements ability to use and control
assets
Profitability ratios: Evaluate the ability to
earn a return for the owners of the
corporation

Further Classification
Financial statements may be classified as
Balance Sheet Ratios
1.
2.
3.

Current ratio
Acid test ratio
Equity ratio

Income Statement ratios

1.
2.
3.

Return on sale ratio

Operating ratio
Return on asset ratio

4.

Inventory turnover ratio

Current Ratio
It shows the relationship between the current
assets and the current liabilities of an
enterprise.
This ratio is utilized to analyze the companys
working capital condition
Current ratio= Current assets / current liabilities

Example
Items
Current Assets
Current Liabilities
Working Capital

Company A
$ 200000
$ 160000
$ 40000

Company B
$ 400000
$ 360000
$ 40000

Solution
Financial position of company A is Better
than company B
Current ratio of A = 200000/160000 = 1.25
Current ratio of B = 400000/360000 = 1.11
Company A has $1.25 of current assets for
$ 1 of current liabilities, while B has $1.11
of current assets for $1 of current liabilities.

Acid test Ratio

It is used to evaluate immediate financial
position of a company.
It shows the relationship between quick
assets to current liabilities.
ATR = Quick assets / current liabilities
Quick Assets = current assets Inventories

Equity Ratio
This ratio expresses the relation of the
total net worth to the total assets.
Equity Ratio = Total net worth / Total assets
An equity ratio in the range 0.8 to 1 usually
indicates a sound financial condition.

Return on Sale Ratio

This often quoted ratio indicates the profit
margin for the company.
This ratio measure the rate of return on
net sale.
Return on sale = Net profit / net sale

Operating Ratio
It is good index of operating efficiency.
Operating Ratio = Total operating exp / net sales

Return on Assets
This is the key indicator of profitability.
It evaluates the ability of the corporation to
transfer assets into operating profit.
Return on assets = net profit / total assets
High return means efficient use of assets.

Inventory Turnover Ratio

This ratio indicates the number of times the
average inventory value passes through the
operations of company.
Net sales to inventory = net sales / av. inventory