TEQIP-II 1st Joint Review Mission February 2013

Indian Institute of Management TiruchirappalliCONCEPT OF BALANCE SHEET AND INCOME STATEMENT AND BASIC ACCOUNTING EQUATIONSESSION 2

PGDM 2015-17 BATCHFINANCIAL ACCOUNTING1Account CategoriesGroups of related items.Main categories.BALANCE SHEET ITEMSAssets.Liabilities.Owners (shareholders) equityINCOME STATEMENT ITEMSRevenuesExpenses.2TRANSACTIONTRANSACTION IN FINANCIAL ACCOUNTING IS ANYTHING / ACTIVITY WHICH AFFECTS A BALANCE SHEET.

IT MAY BE PHYSICAL OR NON-PHYSICALEX: PHYSICAL : PURCHASE OF EQUIPMENTEX: NON-PHYSICAL : DEPRECIATION

IT MAY BE DIRECT OR INDIRECTEX: PURCHASE OF EQUIPMENTEX: SALESWhat are liabilities and assets?Liabilities : sources of moneyDifferent sources come with different obligations and returns

Assets: uses of moneyDifferent assets have different life time

Cash is also an assetIncome statementOpen the HUL income statement

What is the name used to describe this statement?

What differences do you find between balance sheet and income statement?Balance SheetStatement of Financial Position. Point in time or status report.More formally, Statement of Financial Position.Contains (and shows equality of amounts of):Assets = Liabilities + Owners equity.Assets = Liabilities + Shareholders equity.

6Balance SheetResources and Claims ViewAssets = Claims on assets (liabilities and owners equity)Owners equity is a residual claim.Shortcomings:Balance Sheet is not at market or liquidating values.Owners equity as a claim is unclear (i.e., residual claim).Claim is a legalistic view (i.e., better suited to liquidation, not to going concern).7Please go through the book How to Read a Balance Sheet.

What do you find there?BASIC ACCOUNTING EQUATIONSubscript denotes end of the periodSuperscript denotes during a period

We will use subscript for balance sheet or stock itemsWe will use superscript for income statement itemsDual AspectFundamental accounting equation: Assets = Liabilities + Owners equity

For a corporation: Assets = Liabilities + Stockholders equity

Assets = Liabilities + Paid-in cap. + Ret. earnings10Dual AspectTransactions are events that affect accounting records.Every transaction has a dual impact on accounting records.Dual impact:Results in maintaining equality of accounting equation.Double-entry accounting system.11Net worthbeg. = Assetsbeg. - liabilitiesbeg.

Contributed capitalbeg. + Retained earningsbeg. = Assetsbeg. - liabilitiesbeg.

Net worthend = Assetsend. - liabilitiesend

Contributed capitalend + Retained earningsend = Assetsend. - liabilitiesendAssetsend =

Assetsbeg. + Assetsadded Assetsdisposed Accumulated depreciation write off - impairmentliabilitiesend =

liabilitiesbeg. + liabilitiesadded liabilitiespaidoffContributed capitalend =

Contributed capitalbeg. + contributed capital added contributed capital bought backNet worthend =

Net worthbeg. + revenuefor the year expensesfor the year dividends for the year

Balance SheetAssets: Resources of entity.Cash.Accounts Receivable.Inventory.Equipment.Investments.etc.1-1717Balance SheetLiabilities: Claims by creditors.Accounts payable.Notes payable.Owners Equity: Claims by investors.Amounts provided directly by equity investors (Paid-in-capital).Amounts retained from earnings, i.e. profits (Retained earnings).

1-1818What are AssetsAn asset must be:Acquired in a transaction.An economic resource (i.e. provide future benefits).Cash or convertible to cash.Goods to be sold for cash.Items to be used to generate cash.Controlled by the entity.An objectively measurable cost at time of acquisition.

19Assets.economic resources of an entity.recorded at cost (i.e., price paid).Book value of assets.recorded value.Fair value of assets.amount for which asset could be currently purchased or sold..20Reporting of Assets on Balance SheetGrouped into categories.Decreasing order of liquidity (i.e., in US).Current assets (almost) always shown separately.

Check with the balance sheet21What do you find in the HUL annual report?Problem 1-1, 1-2 and 1-3 from page 20Current AssetsCash.Funds available for disbursement.Other assets expected to be realized in cash, or sold, or consumed, within one year.Or normal operating cycle, if longer. 24Other AssetsInvestments (not expected to be sold within a year).Intangible assets.Goodwill, patents, trademarks, copyrights.Longer life than prepaid expenses.

25LiabilitiesObligations to transfer assets or provide services to outside parties.Arising from past transactions or events.Claims against entitys assets.But not against specific assets, unless indicated.Reported at amount that would satisfy obligations on Balance Sheet date.Principal + unpaid interest.

26Current LiabilitiesSatisfied or extinguished within one yearor normal operating cycle, if longer.27Current Liabilities:Accounts (and Notes) PayableAccounts Payable:Suppliers (i.e. vendors) claims for goods or services furnished, but not yet paid.Unsecured.Notes payable:Short-term loans.Formal written note.Includes amounts owed to financial institutions.28Current Liabilities:Taxes PayableOwed to government agencies for taxes.Income taxes often shown separately because of size.29Current Liabilities:Accrued ExpensesEarned by outside parties but not yet paid (i.e., unpaid expenses).Usually no invoice.Includes interest payable, wages payable.30Current Liabilities:Deferred RevenuesAlso called unearned revenues or pre-collected revenues.Advance payment received, but company has not yet performed service or delivered product.31Current Liabilities:Current Portion of Long-Term DebtPortion due within upcoming year.Gives complete picture of entitys short-term obligations.32Long-Term LiabilitiesAlso called:Long-term debt.Non-current liabilities.Due beyond upcoming year.33Owners EquityAmount owners have invested in entity.Also know as Net assets (i.e., Assets minus Liabilities).For a corporation: Shareholders or stockholders equity .Shares of stock evidence ownership interest.34Two Categories ofShareholders EquityPaid-in or contributed capital.Retained earnings.35Shareholders Equity:Paid-in CapitalAmount owners have paid in to purchase shares of stock.Classified as:Par value.Additional paid-in capital.

36Shareholders Equity:Retained EarningsReinvested earnings from inception to date less dividends to date. If negative, amount labeled as deficit.Question: Is Retained Earnings the same as Cash?No, does not indicate the form of reinvestment.

37Unincorporated BusinessesProprietorship.Business owned by one person.Partnership.Business owned jointly by two or more persons.Utilize a Capital account for each partner.Capital account decreased by withdrawals by each owner (i.e., drawings).38Exercises for this class and next class from Antony, Hawkins and MerchantProblem 2-2 page 45

Problem 2-3 page 45

Problem 2-4 page 45

Problem 2-5 page 46

Case 2-2 Music mart Inc. page 48Please work these problems

To be done in groups

Not part of evaluation

Thank You