Q.

1 BREIFLY EXPLAIN:
1) Realization Concept
"Revenues are recognized when goods and services are delivered and in an amount that is
reasonably certain to be realized"

There are two important dimensions to this principle, i.e. when revenue is
recognized, and whether it is certain that all revenue will eventually be
collected.

If the accountant believes that based on past experience only 90% of

revenues will be collected, then the accountant will create an "allowance for
doubtful accounts".

2) Money measurement concept

The money measurement concept underlines the fact that in accounting, every recorded event
or transaction is measured in terms of money. Using this principle, a fact or a happening which
cannot be expressed in terms of money is not recorded in the accounting books.

One of the basic principles in accounting is "The Measuring Unit principle: The unit of
measure in accounting shall be the base money unit of the most relevant currency.

This principle also assumes the unit of measure is stable; that is, changes in its general
purchasing power are not considered sufficiently important to require adjustments to the basic
financial statements."[1]

3) Personal Account, Nominal Account, Real Account with their rules

and proper examples:
Rules:
REAL ACCOUNTS DEBIT WHAT COMES IN
CREDIT WHAT GOES OUT

NOMINAL ACCOUNTS DEBIT ALL EXPENSES AND LOSSES

CREDIT ALL INCOMES AND REVENUES

PERSONAL ACCOUNTS DEBIT THE RECEIVER

CREDIT THE GIVER

Definition:
Nominal Account
 Definition

Revenue or expense account that is a subdivision of the owners' equity account, and which is
closed to a zero balance at the end of each accounting period. It starts with a zero balance at
the beginning of a new accounting period, accumulates balances during the period, and returns
to zero at the yearend by means of closing entries. Nominal accounts are income statement
accounts and are also called 'temporary accounts' in contrast to balance sheet (asset, liability,
and owners' equity) accounts which are called 'permanent accounts' or 'real accounts.'

4) ACCRUALS CONCEPT
The effects of transactions and other events are recognized when they occur (and not as cash or
its equivalent is received or paid) and they are recorded in the accounting records and
reported in the financial statements of the periods to which they relate.

5) FUNDAMENTAL CONCEPTS OF ACCOUNTING

Accounting is the language of business and it is used to communicate financial information.

In order for that information to make sense, accounting is based on 12 fundamental
concepts. These fundamental concepts then form the basis for all of the Generally Accepted
Accounting Principles (GAAP). By using these concepts as the foundation, readers of
financial statements and other accounting information do not need to make assumptions
about what the numbers mean.

For instance, the difference between reading that a truck has a value of $9000 on the
balance sheet and understanding what that $9000 represents is huge. Can you turn around
and sell the truck for $9000? If you had to buy the truck today, would you pay $9000? Or,
perhaps the original purchase price of the truck was $9000. All of these assumptions lead
to very different evaluations of the worth of that asset and how it contributes to the
company’s financial situation.

For this reason it is imperative to know and understand the eleven key concepts.
 ELEVEN KEY ACCOUNTING CONCEPTS
Entity
Accounts are kept for entities and not the people who own or run the company. Even in
proprietorships and partnerships, the accounts for the business must be kept separate
from those of the owner(s).

Money-Measurement

For an accounting record to be made it must be able to be expressed in monetary terms.

For this reason, financial statements show only a limited picture of the business. Consider
a situation where there is a labor strike pending or the business owner’s health is failing;
these situations have a huge impact on the operations and financial security of the
company but this information is not reflected in the financial statements.

Going Concern
Accounting assumes that an entity will continue to operate indefinitely. This concept
implies that financial statements do not represent a company’s worth if its assets were to be
liquidated, but rather that the assets will be used in future operations. This concept also
allows businesses to spread (amortize) the cost of an asset over its expected useful life.

Cost
An asset (something that is owned by the company) is entered into the accounting records
at the price paid to acquire it. Because the “worth” of an asset changes over time it would
be impossible to accurately record the market value for the assets of a company. The cost
concept does recognize that assets generally depreciate in value and so accounting practice
removes the depreciation amount from the original cost, shows the value as a net amount,
and records the difference as a cost of operations (depreciation expense.) Look at the
following example:

Truck $10,000 purchase price of the truck

Less depreciation $ 1,000 amount deducted as a depreciation expense
Net Truck: $ 9,000 net book-value of the truck

The $9000 simply represents the book value of the truck after depreciation has been
accounted for. This figure says nothing about other aspects that affect the value of an item
and is not considered a market price.

Dual Aspect
This concept is the basis of the fundamental accounting equation:

Assets = Liabilities + Equity

1. Assets are what the company owns.

2. Liabilities are what the company owes to creditors against those assets
3. Equity is the difference between the two and represents what the company owes to
its investors/owners.

All accounting transactions must keep this equation balanced so when there is an increase
on one side there must be an equal increase on the other side or an equal decrease on the
same side.

Objectivity
6) Trading a/c, profit and loss a/c and balance sheet with proper
format.
Trading Account:
An account similar to a traditional bank account, holding cash and securities, and is
administered by an investment dealer.

An account held at a financial institution and administered by an investment dealer that the
account holder uses to employ a trading strategy rather than a buy-and-hold investment
strategy.

Profit And Loss A/c

An income statement, also called a profit and loss statement, shows the revenues from business
operations, expenses of operating the business, and the resulting net profit or loss of a company
over a specific period of time.

In assessing the overall financial condition of a company, you'll want to look at the income
statement and the balance sheet together, as the income statement captures the company's
operating performance and the balance sheet shows its net worth.

Balance Sheet

A balance sheet is a statement of the total assets and liabilities of an organization at a

particular date - usually the last date of an accounting period.

The balance sheet is split into two parts:

(1) A statement of fixed assets, current assets and the liabilities (sometimes referred to as "Net
Assets")

(2) A statement showing how the Net Assets have been financed, for example through share
capital and retained profits.

The Companies Act requires the balance sheet to be included in the published financial
accounts of all limited companies. In reality, all other organizations that need to prepare
accounting information for external users (e.g. charities, clubs, and partnerships) will also
product a balance sheet since it is an important statement of the financial affairs of the
organization.

A balance sheet does not necessary "value" a company, since assets and liabilities are shown at
"historical cost" and some intangible assets (e.g. brands, quality of management, market
leadership) are not included.
7) Memorandum of association

Document that regulates a firm's external activities and must be drawn up on the formation of
a registered or incorporated firm. As the firm's charter it (together with the firm's articles of
association) forms the firm's constitution. Also called 'memorandum,' it gives the firm's name,
names of its members (shareholders) and number of shares held by them, and location of its
registered office. It also states the firm's (1) objectives, (2) amount of authorized share capital,
(3) whether liability of its members is limited by shares or by guaranty, and (4) what type of
contracts the firm is allowed to enter into. Almost all of its provisions (except those mandated
by corporate legislation) can be altered by the firm's members by following the prescribed
procedures. The memorandum is a public document and may be inspected (normally on
payment of a fee) by anyone, usually at the public office where it is lodged (such as the
registrar of companies office). Called articles of incorporation in the US

8) Articles of association

The internal 'rule book' that, according to corporate legislation, every incorporated firm must
have and work by. And which, along with memorandum of association, forms the constitution
of a firm. Also called articles, it is a contract (1) between the members (stockholders,
subscribers) and the firm and (2) among the members themselves. It sets out the rights and
duties of directors and stockholders individually and in meetings. Certain statutory
(obligatory) clauses (such as those dealing with allotment, transfer, and forfeiture of shares)
must be included; the other (non-obligatory) clauses are chosen by the stockholders to make up
the bylaws of the firm. A court, however, may declare a clause ultra virus if it is deemed
unfair, unlawful, or unreasonable. A copy of the articles is lodged with the appropriate
authority such as the registrar of companies. Articles are public documents and may be
inspected by anyone (usually on payment of a fee) either at the premises of the firm and/or at
the registrar's office. Lenders to the firm take special interest in its provisions that impose a
ceiling on the borrowings beyond which the firm's management must get stockholders'
approval before taking on more debt.

9) Types of companies

In India, the following types of business entities are available:

• Private Limited Company

• Public Limited Company
• Unlimited Company
• Limited Liability Partnership (LLP)
• Partnership
• Sole Proprietorship
• Liaison Office/Representative Office
• Project Office
• Branch Office
• Joint Venture Company
 • Subsidiary Company

10) Preliminary expanses

Professional and other expenses involved in establishing a business. Also called formation
expenses.

11) Share capital & types of share capital

Types of shares: Shares in the company may be similar i.e. they may carry the same rights and
liabilities and confer on their holders the same rights, liabilities and duties. There are two types
of shares under Indian Company Law:-

1. Equity shares means that part of the share capital of the company which are not preference
shares.

2. Preference Shares means shares which fulfill the following 2 conditions. Therefore, a share
which is does not fulfill both these conditions is an equity share.

a. It carries Preferential rights in respect of Dividend at fixed amount or at fixed rate i.e.
dividend payable is payable on fixed figure or percent and this dividend must paid before the
holders of the equity shares can be paid dividend.

b. It also carries preferential right in regard to payment of capital on winding up or otherwise.

It means the amount paid on preference share must be paid back to preference shareholders
before anything in paid to the equity shareholders. In other words, preference share capital
has priority both in repayment of dividend as well as capital.

Types of Preference Shares

1.Cumulative or Non-cumulative: A non-cumulative or simple preference shares gives right to
fixed percentage dividend of profit of each year. In case no dividend thereon is declared in any
year because of absence of profit, the holders of preference shares get nothing nor can they
claim unpaid dividend in the subsequent year or years in respect of that year. Cumulative
preference shares however give the right to the preference shareholders to demand the unpaid
dividend in any year during the subsequent year or years when the profits are available for
distribution. In this case dividends which are not paid in any year are accumulated and are
paid out when the profits are available.

2. Redeemable and Non- Redeemable: Redeemable Preference shares are preference shares
which have to be repaid by the company after the term of which for which the preference
shares have been issued. Irredeemable Preference shares means preference shares need not
repaid by the company except on winding up of the company. However, under the Indian
Companies Act, a company cannot issue irredeemable preference shares. In fact, a company
limited by shares cannot issue preference shares which are redeemable after more than 10
years from the date of issue. In other words the maximum tenure of preference shares is 10
years. If a company is unable to redeem any preference shares within the specified period, it
may, with consent of the Company Law Board, issue further redeemable preference shares
equal to redeem the old preference shares including dividend thereon. A company can issue the
preference shares which from the very beginning are redeemable on a fixed date or after
certain period of time not exceeding 10 years provided it comprises of following conditions :-

1. It must be authorized by the articles of association to make such an issue.

2. The shares will be only redeemable if they are fully paid up.

3. The shares may be redeemed out of profits of the company which otherwise would be
available for dividends or out of proceeds of new issue of shares made for the purpose of
redeem shares.

4. If there is premium payable on redemption it must have provided out of profits or out of
shares premium account before the shares are redeemed.

5. When shares are redeemed out of profits a sum equal to nominal amount of shares redeemed
is to be transferred out of profits to the capital redemption reserve account. This amount
should then be utilized for the purpose of redemption of redeemable preference shares. This
reserve can be used to issue of fully paid bonus shares to the members of the company.

3. Participating Preference Share or non-participating preference shares: Participating

Preference shares are entitled to a preferential dividend at a fixed rate with the right to
participate further in the profits either along with or after payment of certain rate of dividend
on equity shares. A non-participating share is one which does not such right to participate in
the profits of the company after the dividend and capital has been paid to the preference
shareholders.

12) Qualitative characteristic of financial statement

UNDERSTANDABLE & USEFUL

• Accounting information should be readily understandable to the intended users of the

information.

• This is a function of both the intended users and the intended uses of the information.
Accounting systems that define either the users or uses narrowly may justify more
complex information requirements and standards. Accounting systems that envision a
broad body of users and/or uses would tend towards less complexity in published
information and standards.

• Typically the belief that, for information to be understandable, information contained

in the various financial disclosures and reporting must be transparent (i.e., clearly
disclosed and readily discernable).

RELEVANT
The information should be relevant to the decision-making users of the information. It should
make a difference in their decisions. Typically, this means the information must

Be:

• Timely
• Have predictive value
• Provide useful feedback on past decisions

RELIABLE

The information should be reliable and dependable. This usually includes the concepts of:

• Representational faithfulness – the information represents what it claims to represent.

For example, if the reported value of a common stock holding purports to be the
current market value, that value should be approximately what the stock could be sold
for by the company holding it.

• Verifiability - another person or entity should be able to recreate the reported value
using the same information that the reporting entity had.

• Completeness - the reported information should not be missing a material fact or

consideration that would make the reported information misleading.

• The concept of neutrality is sometimes incorporated into the concept of reliability.

COMPARABLE AND CONSISTENT

• For accounting information to be usable, it must allow for comparisons across time and
across competing interests (such as competing companies or industries).

• This leads to a need for some consistency, wherever such comparisons are to be
expected. For example, comparisons of two companies would be very difficult and
potentially misleading if one discounts all its liabilities while the other discounts none of
its liabilities.

UNBIASED

• Information that is biased can be misleading.

• Biased information is not useful unless the users understand the bias, any bias is
consistently applied across years/firms/industries, and the users can adjust the reported
results to reflect their own desired bias.

• When faced with uncertainty, there is a need to either require reporting of unbiased
values accompanied with sufficient disclosure, or require the reporting of biased
 (prudent or conservative) values with the bias determined in a predictable, consistent
fashion.

COST-BENEFIT EFFECTIVE

• General understanding that the development of accounting information consumes

resources.

• As such, the cost of producing such information should be reasonable in relation to the
expected benefit.

• Use the materiality accounting rule – may not have to be fully followed for immaterial
items if full compliance would result in unwarranted higher costs.

13) GAAP (Generally Accepted Accounting Principal)

What Does Generally Accepted Accounting Principles - GAAP Mean?

The common set of accounting principles, standards and procedures that companies use to
compile their financial statements. GAAP are a combination of authoritative standards (set by
policy boards) and simply the commonly accepted ways of recording and reporting accounting
information.

Investopedia explains generally Accepted Accounting Principles - GAAP

GAAP are imposed on companies so that investors have a minimum level of consistency in the
financial statements they use when analyzing companies for investment purposes. GAAP cover
such things as revenue recognition, balance sheet item classification and outstanding share
measurements. Companies are expected to follow GAAP rules when reporting their financial
data via financial statements. If a financial statement is not prepared using GAAP principles,
be very wary!

That said, keep in mind that GAAP is only a set of standards. There is plenty of room within
GAAP for unscrupulous accountants to distort figures. So, even when a company uses GAAP,
you still need to scrutinize its financial statements.

15) CBDT (Central Board of Direct Taxes)

Since 1 January 1964 the Central Board of Direct Taxes (CBDT) has been charged with all
matters relating to various direct taxes in India and it derives its authority from Central Board
of Revenue Act 1963. The CBDT is a part of Department of Revenue in the Ministry of
Finance. On one hand, CBDT provides essential inputs for policy and planning of direct taxes
in India, at same time it is also responsible for administration of direct tax laws through
Income Tax Department.

The Chairman, who is also an ex-officio Special Secretary to Government of India, heads the
CBDT. In addition, CBDT has six Members, who are ex-officio Additional Secretaries to
Government of India. The Chairman and Members of CBDT are selected from Indian
Revenue Service (IRS), a premier civil service of India, whose members constitute the top
management of Income Tax Department. The support staff for CBDT is drawn from IRS as
well as other premier civil services of the country and is assisted by several attached offices.

16) ASB (Accounting Standard Board)

UK organization (similar to the US Financial Accounting Standards Board) responsible for

drafting and establishing accounting standards. ASB is a subsidiary of Financial Reporting
Council; one of its committees publishes the International Accounting Standards.

17) Auditors’ Report: -

A section of an annual report that includes the auditor's opinion about the veracity of the
financial statements.

18) Directors’ Report

In the UK and commonwealth countries, the part of a large firm's annual report package that
(among other items of information) states (1) names of directors that served during the
reporting year, (2) summary of the firm's trading activities and its future prospects, (3)
principal activities of the firm and its subsidiaries, and any changes therein, (4) recommended
dividend for the reporting year, (5) post-balance sheet date events that may materially affect
the firm's finances, and (6) significant changes in the value of fixed assets. Called Form 10-k in
the US, a director’s report must be independently audited like the accompanying financial
statements.

19) Corporate Governance Report

The system of checks and balances designed to ensure that corporate managers are just as
vigilant on behalf of long-term shareholder value as they would be if it was their own money at
risk. It is also the process whereby shareholders-the actual owners of any publicly traded firm-
assert their ownership rights, through an elected board of directors and the CEO and other
officers and managers they appoint and oversee. In the heels of corporate scandals including
the Enron debacle in 2002, a series of sweeping changes are being sought, such as forcing
boards to have a majority of independent directors, granting audit committees power to hire
and fire accountants, banning sweetheart loans to officers and directors, and requiring
shareholder's approval for stock option plans. More specifically, the following principles
constitute good governance:
1. To avoid conflicts of interest, a company's board of directors should include a substantial
majority of independent directors-independent meaning that directors don't have financial or
close personal ties to the company or its executives.

2. a company's audit, nominating, and compensation committees should consist entirely of

independent directors.

3. a board should obtain shareholder approval for any actions that could significantly affect
the relationship between the board and shareholders, including the adoption of anti-takeover
measures such as "poison pills."

4. Companies should base executive compensation plans on pay for performance and should
provide full disclosure of these plans.

5. To avoid abuse in the use of stock options (and executive perquisites), all employee stock
option plans should be submitted to shareholders for approval.

20) Quality of earning

A condition describing how earnings are recognized. Earnings of high quality are attributable
to conservative accounting standards and/or strong cash flows. Low quality earnings come
from artificial sources, such as inflation or aggressive accounting. For example, in the early
2000s, Krispy Kreme doughnuts had strong earnings and consequently a high stock price.
However, the company had low cash flow from operations and the strong earnings came
mainly from the accounting structures it used. Therefore, its stock was overvalued. Quality of
earnings ratings is subjective, but they take into account matters such as corporate
governance, inventory-to-sales ratios, and other factors.

21) Window Dressing

The deceptive practice of some mutual funds, in which recently weak stocks are sold and
recently strong stocks are bought just before the fund's holdings are made public, in order to
give the appearance that they've been holding good stocks all along.

25) Foreign Currency Accounting

Paper (unrealized) gain or loss (as on a balance sheet date) resulting from an appreciation or
devaluation of the non-local currency in which the assets and/or liabilities of a firm are
denominated in its account books.

26) Inflation Accounting,

Adjusting financial statements to show a firm's real financial position in inflationary times. It
aims to indicate how rising prices and lower purchasing power of the currency affect a firm's
cost of refinancing its productive assets, and of its ability to maintain an adequate level of
profit on the capital employed. One method is to adjust every figure in the balance sheet on the
basis of a price index (such as consumer price index) which reflects the current purchasing
power of the currency. Another method suggests revaluing tangible assets at their replacement
cost. In valuation of an inventory, inflation accounting treatment can affect the firm's taxable
income, cash position, and reported earnings, depending on whether the firm uses FIFO or
LIFO methods. FIFO method, shows a higher profit, therefore higher tax burden and a
decrease in net cash flow. LIFO method lowers the profit and tax burden and increases the net
cash flow.

27) Human Resource Accounting

Method that recognizes a variety of human resources and shows them on a company's balance
sheet. Under human resource accounting, a value is placed on people based on such factors as
experience, education, and psychological traits, and, most importantly, future earning power
(benefit) to the company. The idea has been well received by human-resource-oriented firms,
such as those engaged in accounting, law, and consulting. Practical application is limited,
however, primarily because of difficulty and the lack of uniform, consistent methods of
quantifying the values of human resources.

28) Environment accounting

He practices of including the indirect costs and benefits of a product or activity, for example,
its environmental effects on health and the economy, along with its direct costs when making
business decisions.

29) Responsibility Accounting

Collection, summarization, and reporting of financial information about various decision

centers (responsibility centers) throughout an organization; also called activity accounting or
profitability accounting. It traces costs, revenues, or profits to the individual managers who are
primarily responsible for making decisions about the costs, revenues, or profits in question and
taking action about them. Responsibility accounting is appropriate where top management has
delegated authority to make decisions. The idea behind responsibility accounting is that each
manager's performance should be judged by how well he or she manages those items under his
or her control.
Q. 2 Which are the financial statement & reports presented in
the annual report? What are the objectives of financial
statements & who are the users of financial information?

Financial statements (or financial reports) are formal records of the financial activities of a
business, person, or other entity. In British English, including United Kingdom company law,
financial statements are often referred to as accounts, although the term financial statements is
also used, particularly by accountants.

Financial statements provide an overview of a business or person's financial condition in both

short and long term. All the relevant financial information of a business enterprise presented
in a structured manner and in a form easy to understand, is called the financial statements.
There are four basic financial statements: [1]

1. Balance sheet: also referred to as statement of financial position or condition, reports on

a company's assets, liabilities, and Ownership equity at a given point in time.
2. Income statement: also referred to as Profit and Loss statement (or a "P&L"), reports
on a company's income, expenses, and profits over a period of time. Profit & Loss
account provide information on the operation of the enterprise. These include sale and
the various expenses incurred during the processing state.
3. Statement of retained earnings: explains the changes in a company's retained earnings
over the reporting period.
4. Statement of cash flows: reports on a company's cash flow activities, particularly its
operating, investing and financing activities.

For large corporations, these statements are often complex and may include an extensive set of
notes to the financial statements and management discussion and analysis. The notes typically
describe each item on the balance sheet, income statement and cash flow statement in further
detail. Notes to financial statements are considered an integral part of the financial statements.
Contents
[hide]

• 1 Purpose of financial statements

• 2 Government financial statements
• 3 Audit and legal implications
• 4 Standards and regulations
• 5 Inclusion in annual reports
• 6 References
• 7 See also

• 8 External links

Purpose of financial statements

"The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an enterprise that is useful to a wide range of
users in making economic decisions."[2] Financial statements should be understandable,
relevant, reliable and comparable. Reported assets, liabilities and equity are directly related to
an organization's financial position. Reported income and expenses are directly related to an
organization's financial performance.

Financial statements are intended to be understandable by readers who have "a reasonable
knowledge of business and economic activities and accounting and who are willing to study the
information diligently."[2] Financial statements may be used by users for different purposes:

• Owners and managers require financial statements to make important business

decisions that affect its continued operations. Financial analysis is then performed on
these statements to provide management with a more detailed understanding of the
figures. These statements are also used as part of management's annual report to the
stockholders.

• Employees also need these reports in making collective bargaining agreements (CBA)
with the management, in the case of labor unions or for individuals in discussing their
compensation, promotion and rankings.

• Prospective investors make use of financial statements to assess the viability of investing
in a business. Financial analyses are often used by investors and are prepared by
professionals (financial analysts), thus providing them with the basis for making
investment decisions.

• Financial institutions (banks and other lending companies) use them to decide whether
to grant a company with fresh working capital or extend debt securities (such as a long-
term bank loan or debentures) to finance expansion and other significant expenditures.

• Government entities (tax authorities) need financial statements to ascertain the

propriety and accuracy of taxes and other duties declared and paid by a company.
 • Vendors who extend credit to a business require financial statements to assess the
creditworthiness of the business.

• Media and the general public are also interested in financial statements for a variety of
reasons.

Government financial statements

See also: Fund accounting

The rules for the recording, measurement and presentation of government financial statements
may be different from those required for business and even for non-profit organizations. They
may use either of two accounting methods: accrual accounting, or cash accounting, or a
combination of the two (OCBOA). A complete set of chart of accounts is also used that is
substantially different from the chart of a profit-oriented business

Audit and legal implications

Although laws differ from country to country, an audit of the financial statements of a public
company is usually required for investment, financing, and tax purposes. These are usually
performed by independent accountants or auditing firms. Results of the audit are summarized
in an audit report that either provides an unqualified opinion on the financial statements or
qualifications as to its fairness and accuracy. The audit opinion on the financial statements is
usually included in the annual report.

There has been much legal debate over who an auditor is liable to. Since audit reports tend to
be addressed to the current shareholders, it is commonly thought that they owe a legal duty of
care to them. But this may not be the case as determined by common law precedent. In
Canada, auditors are liable only to investors using a prospectus to buy shares in the primary
market. In the United Kingdom, they have been held liable to potential investors when the
auditor was aware of the potential investor and how they would use the information in the
financial statements. Nowadays auditors tend to include in their report liability restricting
language, discouraging anyone other than the addressees of their report from relying on it.
Liability is an important issue: in the UK, for example, auditors have unlimited liability.

In the United States, especially in the post-Enron era there has been substantial concern about
the accuracy of financial statements. Corporate officers (the chief executive officer (CEO) and
chief financial officer (CFO)) are personally liable for attesting that financial statements "do
not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by the[e] report." Making or
certifying misleading financial statements exposes the people involved to substantial civil and
criminal liability. For example Bernie Embers (former CEO of WorldCom) was sentenced to
25 years in federal prison for allowing WorldCom's revenues to be overstated by $11 billion
over five years.

Standards and regulations

Different countries have developed their own accounting principles over time, making
international comparisons of companies difficult. To ensure uniformity and comparability
between financial statements prepared by different companies, a set of guidelines and rules are
used. Commonly referred to as Generally Accepted Accounting Principles (GAAP), these set of
guidelines provide the basis in the preparation of financial statements.

Recently there has been a push towards standardizing accounting rules made by the
International Accounting Standards Board ("IASB"). IASB develops International Financial
Reporting Standards that have been adopted by Australia, Canada and the European Union
(for publicly quoted companies only), are under consideration in South Africa and other
countries. The United States Financial Accounting Standards Board has made a commitment
to converge the U.S. GAAP and IFRS over time.

Inclusion in annual reports

To entice new investors, most public companies assemble their financial statements on fine
paper with pleasing graphics and photos in an annual report to shareholders, attempting to
capture the excitement and culture of the organization in a "marketing brochure" of sorts.
Usually the company's chief executive will write a letter to shareholders, describing
management's performance and the company's financial highlights.

In the United States, prior to the advent of the internet, the annual report was considered the
most effective way for corporations to communicate with individual shareholders. Blue chip
companies went to great expense to produce and mail out attractive annual reports to every
shareholder. The annual report was often prepared in the style of a coffee table book.

Q.3 Prepare the vertical format of balance sheet and income

statement.
SAMPLE STATEMENT

Happy Travel Court

Income Statement
For the Month Ended March 31, 2005

Revenues
Rental Revenue $65,000
Operating
Expenses
Advertising $5,310
Wages $30,500
Utilities $1,080
Depreciation $800
Repairs $4,260
Insurance $600
Interest $100
Supplies $3,900
Total Operating
Expenses: $46,550
Net Income: $18,450
Q. 4 what is cash-flow statement? Explain the three
different activities of cash flow statement and non cash
items. Prepare the format of cash flow statement.

Definition

Summary of the actual or anticipated incomings and outgoings of cash in a firm over an
accounting period (month, quarter, year). It answers the questions Where the money came
(will come) from? And where it went (will go)? cash flow statements assess the amount, timing,
and predictability of cash-inflows and cash-outflows, and are used as the basis for budgeting
and business-planning. The accounting data is presented usually in three main sections: (1)
Operating-activities (sales of goods or services), (2) Investing-activities (sale or purchase of an
asset, for example), and (3) Financing-activities (borrowings, or sale of common stock, for
example). Together, these sections show the overall (net) change in the firm's cash-flow for the
period the statement is prepared. Lenders and potential investors closely examine the cash flow
resulting from the operating activities. This section represents after-tax net income plus
depreciation and amortization and, therefore, the ability of the firm to service its debt and pay
dividends. With balance sheet and income statement (profit and loss account), cash flow
statement constitutes the critical set of financial information required to manage a business.

A cash flow statement is a financial report that describes the source of a company's cash and
how it was spent over a specified time period. Because of the varied accrual accounting
methods companies may employ, it is possible for a company to show profits while not having
enough cash to sustain operations. A cash flow statement neutralizes the impact of the accrual
entries on the other financial statements. It also categorizes the sources and uses of cash to
provide the reader with an understanding of the amount of cash a company generates and uses
in its operations, as opposed to the amount of cash provided by sources outside the company,
such as borrowed funds or funds from stockholders. The cash flow statement also tells the
reader how much money was spent for items that do not appear on the income statement, such
as loan repayments, long-term asset purchases, and payment of cash dividends.

Cash flow statements classify cash receipts and payments according to whether they stem from
operating, investing, or financing activities. It also provides that the statement of cash flows
may be prepared under either the direct or indirect method, and provides illustrative examples
for the preparation of statements of cash flows under both the direct and the indirect methods.

CLASSIFICATIONS OF CASH RECEIPTS AND PAYMENTS. At the beginning of a

company's life cycle, a person or group of people comes up with an idea for a new company.
The initial money comes from the owners, or could be borrowed. This is how the new company
is "financed." The money owners put into the company, or money the company borrows, is
classified as a financing activity. Generally, any item that would be classified on the balance
sheet as either a long-term liability or equity would be a candidate for classification as a
financing activity.

The owners or managers of the business use the initial funds to buy equipment or other assets
they need to run the business. In other words, they invest it. The purchase of property, plant,
equipment, and other productive assets is classified as an investing activity. Sometimes a
company has enough cash of its own that it can lend money to another enterprise. This, too,
would be classified as an investing activity. Generally, any item that would be classified on the
balance sheet as a long-term asset would be a candidate for classification as an investing
activity.

Now the company can start doing business. It has procured the funds and purchased the
equipment and other assets it needs to operate. It starts to sell merchandise or services and
make payments for rent, supplies, taxes, and all of the other costs of doing business. All of the
cash inflows and outflows associated with doing the work for which the company was
established would be classified as an operating activity. In general, if an activity appears on the
company's income statement, it is a candidate for the operating section of the cash flow
statement.

ACCRUAL AND ITS EFFECT ON FINANCIAL STATEMENTS. Generally accepted

accounting principles (GAAP) require that financial statements are prepared on the accrual
basis. For example, revenues that were earned during an accounting period may not have been
collected during that period, and appear on the balance sheet as accounts receivable. Similarly,
some of the collections of that period may have been from sales made in prior periods. Cash
may have been collected in a period prior to the services rendered or goods delivered, resulting
in deferred recognition of the revenue. This would appear on the balance sheet as unearned
revenue.

Sometimes goods or services are paid for prior to the period in which the benefit is matched to
revenue (recognized). This results in a deferred expense, or a prepaid expense. Items such as
insurance premiums that are paid in advance of the coverage period are classified as prepaid.
Sometimes goods or services are received and used by the company before they are paid for,
such as telephone service or merchandise inventory. These items are called accrued expenses,
or payables, and are recognized on the income statement as an expense before the cash flow
occurs. When buildings or equipment are purchased for cash, the cash flow precedes the
recognition of the expense by many years. The expense is recognized over the life of the asset as
depreciation. One of the main benefits of the cash flow statement is that it removes the effect of
any such accruals or deferrals.

METHODS OF PREPARING THE CASH FLOW STATEMENT. Small business owners

preparing a cash flow statement Chan choose either the direct or the indirect method of cash
flow statement presentation. The operating section of a cash flow statement prepared using
either method converts the income statement from the accrual to the cash basis, and
reclassifies any activity not directly associated with the basic business activity of the firm. The
difference lies in the presentation of the information.

Companies that use the direct method are required, at a minimum, to report separately the
following classes of operating cash receipts and payments:

RECEIPTS. Companies are encouraged to provide further breakdown of operating cash

receipts and payments that they consider meaningful.

Companies using either method to prepare the cash flow statement are also required to
separately disclose changes in inventory, receivables, and payables to reconcile net income (the
result of the income statement) to net cash flow from operating activities. In addition, interest
paid (net of amount capitalized) and income taxes paid must be disclosed elsewhere in the
financial statements or accompanying notes. An acceptable alternative presentation of the
indirect method is to report net cash flow from operating activities as a single line item in the
statement of cash flows and to present the reconciliation details elsewhere in the financial
statements.

The reconciliation of the operating section of a cash flow statement using the indirect method
always begins with net income or loss, and is followed by an "adjustments" section to reconcile
net income to net cash provided by operating activities.

Regardless of whether the direct or the indirect method is used, the operating section of the
cash flow statement ends with net cash provided (used) by operating activities. This is the most
important line item on the cash flow statement. A company has to generate enough cash from
operations to sustain its business activity. If a company continually needs to borrow or obtain
additional investor capitalization to survive, the company's long-term existence is in jeopardy.

The presentation of the investing and financing sections is the same regardless of whether the
statement is prepared using the direct or indirect method. The final section of the cash flow
statement is always a reconciliation of the net increase or decrease in cash for the period for
which the statement is prepared, with the beginning and ending balances in cash for the
period.

Analyzing and Classifying Common Transactions

Transactions on the balance sheet also must be analyzed and converted from the accrual to the
cash basis in preparation of the cash flow statement. Every balance sheet account reflects
specific activity. There are only a few distinctive transactions that affect each account.
Following are examples of some of the common transactions affecting balance sheet items:

Accounts receivable increases when the company sells merchandise or does a service on credit,
and decreases when the customer pays its bill. Accounts receivable is associated with the
income statement account Sales or Revenue. The change in accounts receivable or the cash
collected from customers is classified as an operating activity.

Inventory increases when the company buys merchandise for resale or use in its
manufacturing process, and decreases when the merchandise is sold. Inventory is associated
with the income statement account Cost of Goods Sold. The change in inventory or the cash
paid for inventory purchases is classified as an operating activity.

Prepaid insurance increases when the company pays insurance premiums covering future
periods and decreases when the time period of coverage expires. Prepaid insurance is
associated with the income statement account Insurance Expense. The change in prepaid or the
amount paid for insurance is classified as an operating activity.

The Land, Building, and Equipment accounts increase when the company purchases additional
assets. They also undergo a corresponding decrease when the assets are sold. The only time the
income statement is affected is when the asset is sold at a price higher or lower than book
value, at which time a gain or loss on sale of assets appears on the income statement. The
amount of cash used or received from the purchase or sale of such assets is classified as an
investing activity. The gain or loss is classified as an adjustment in the operating section on a
cash flow statement prepared using the indirect method.
Accumulated depreciation increases as the building and equipment depreciates and decreases
when building and equipment is sold. Accumulated depreciation is associated with
depreciation expense on the income statement. Depreciation expense does not appear on a cash
flow statement presented using the direct method. Depreciation expense is added back to net
income on a cash flow statement presented using the indirect method, since the depreciation
caused net income to decrease during the period but did not affect cash.

Goodwill increases when the parent company acquires a subsidiary for more than the fair
market value of its net assets. Goodwill amortizes over a time period not to exceed 40 years.
Goodwill is associated with amortization expense on the income statement. Amortization
expense appears in the operating section of a cash flow statement prepared using the indirect
method. Amortization expense does not appear on a cash flow statement prepared using the
direct method.

Notes payable increases when the company borrows money, and decreases when the company
repays the funds borrowed. Since only the principal appears on the balance sheet, there is no
impact on the income statement for repaying the principal component of the note. Notes
payable appear in the financing section of a cash flow section.

Premiums and discounts on bonds are amortized through bond interest expense. There is no
cash flow associated with the amortization of bond discounts or premiums. Therefore, there
will always be an adjustment in the operating section of the cash flow statement prepared using
the indirect method for premium or discount amortization. Premium or discount amortization
will not appear on a cash flow statement prepared using the direct method.

Common stock and preferred stock with their associated paid in capital accounts increase
when additional stock is sold to investors and decrease when stock is retired. There is no
income statement impact for stock transactions. The cash flow associated with stock sales and
repurchases appears in the financing section.

Retained earnings increases when the company earns profits and decreases when the company
suffers a loss or declares dividends. The profit or loss appears as the first line of the operating
section of the cash flow statement. The dividends appear in the financing section when they are
paid.

CASH INFLOWS OR RECEIPTS. When preparing the cash flow statement using the direct
method, the cash collected from customers may be found by analyzing accounts receivable, as
follows: Beginning balance of accounts receivable, plus sales for the period (from the income
statement), less ending balance of accounts receivable, equals cash received from customers.
This is an extremely simplified formula, and does not take into account written off receivables
or other noncash adjustments to customer accounts. If there is no accounts receivable on the
balance sheet, the company does cash business and cash collected from customers will equal
sales or revenue on the income statement.

If the cash flow statement is prepared using the indirect method, the adjustment to net income
may be found in a similar manner. If the cash received from customers is more than the sales
shown on the income statement, causing accounts receivable to decrease, the difference is
added to net income. If cash received from customers is less than the sales shown on the income
statement, causing accounts receivable to increase, the difference is subtracted from net
income.
The amounts borrowed during the period may be found by analyzing the Liability Accounts.
The amounts received from investors during the period may be found by doing a similar
analysis on the Equity Accounts. Both of these types of transactions will be classified as
financing activities.

If any land, buildings, or equipment were sold during the period, the information will be found
in the Land, Building, and Equipment Accounts and their associated accumulated
depreciation. One simple way to properly categorize the transaction is to reconstruct the
journal entry. For example, assume that equipment that had cost $8,000 and had accumulated
depreciation of $6,000 was sold during the period for $2,500. The journal entry for this
transaction should indicate:

Cash $2,500
Accumulated depreciation $6,000
Equipment $8,000
Gain on sale of equipment $500

The cash received from the sale of the equipment is classified as an investing activity. If the
statement is prepared using the direct method, no other part of the journal entry is used. If the
statement is prepared using the indirect method, the gain on sale of equipment is subtracted
from net income. When the gain was recorded, net income increased. However, since the
company is not in the business of buying and selling equipment, the gain needs to be subtracted
from net income to arrive at the adjusted total related only to the proceeds from the company's
direct business activities. If the sale had resulted in a loss, the loss is added back to net income.

CASH PAYMENTS. Cash payments are found using similar methods to those used for
determining cash received. Cash payments for the purchase of inventory are found by
analyzing accounts payable. The following formula can be used to find the cash paid for
inventory purchases: beginning balance of accounts payable, plus inventory purchases during
the period, less ending balance of accounts payable equals payments made for inventory
during the period. This is a simplified formula and does not take into account any noncash
adjustments.

If the cash paid for inventory is greater than the inventory purchased during the period, the
difference between the amount purchased and the amount paid is deducted from net income if
preparing the cash flow statement using the indirect method. If cash paid for inventory is less
than the inventory purchased during the period, the difference between the amount purchased
and the amount paid is added to net income if preparing the cash flow statement using the
indirect method. Cash payments for land, building, and equipment purchases, repayments of
loans, purchases of treasury stock, and payment of dividends may be found by performing
similar analysis on the appropriate accounts.

SIGNIFICANT NONCASH TRANSACTIONS. Noncash transactions are not to be

incorporated in the statement of cash flows. Examples of these types of transactions include
conversion of bonds to stock and the acquisition of assets by assuming liabilities. If there are
only a few such transactions, it may be convenient to include them on the same page as the
statement of cash flows, in a separate schedule at the bottom of the statement. Otherwise, the
transactions may be reported elsewhere in the financial statements, clearly referenced to the
statement of cash flows.
Other events that are generally not reported in conjunction with the statement of cash flows
include stock dividends, stock splits, and appropriation of retained earnings. These items are
generally reported in conjunction with the statement of retained earnings or schedules and
notes pertaining to changes in capital accounts.

Statement of Cash Flows

Cash Flow from Operating Activities
Net Income XXX,XXX
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization XX,XXX
Changes in other accounts affecting operations:
(Increase)/decrease in accounts receivable X,XXX
(Increase)/decrease in inventories X,XXX
(Increase)/decrease in prepaid expenses X,XXX
Increase/(decrease) in accounts payable X,XXX
Increase/(decrease) in taxes payable X,XXX
Net cash provided by operating activities XXX,XXX
Cash Flow from Investing Activities
Capital expenditures (XXX,XXX)
Proceeds from sales of equipment XX,XXX
Proceeds from sales of investments XX,XXX
Investments in subsidiary (XXX,XXX)
Net cash provided by investing activities (XXX,XXX)
Cash Flow from Financing Activities
Payments of long-term debt (XX,XXX)
Proceeds from issuance of long-term debt XX,XXX
Proceeds from issuance of common stock XXX,XXX
Dividends paid (XX,XXX)
Purchase of treasury stock (XX,XXX)
Net cash provided by financing activities (XX,XXX)
Increase (Decrease) in Cash XX,XXX

Q. 5 what are the main objectives of accounting

standards in global context?

An in-depth knowledge of global accounting regulations is becoming ever more critical, as

many countries, including all 25 members of the European Union, will require the adoption of
International Financial Reporting Standards (IFRS) for the first time in 2005. For example,
approximately 2,000 companies in the United Kingdom alone will need to convert from U.K.
GAAP to IFRS this year using special transition rules covering past transactions and opening
balances.

Adding to this challenge, approximately 10 percent of the companies listed on the NYSE and
NASDAQ are non-U.S. companies, and the U.S. Securities and Exchange Commission requires
these companies to submit either financial statements that conform to U.S. GAAP or financial
statements prepared using other GAAP, like IFRS, accompanied by a reconciliation of
earnings and net assets to U.S. GAAP figures.

As more and more companies are becoming global rather than just national entities, cross-
border accounting compliance will remain a key element of doing business. American
subsidiaries of foreign entities must follow the same accounting standards as their corporate
parents, and for many, that means IFRS. Likewise, U.S. multinational entities seeking to enter
new markets or to expand operations abroad may need to provide IFRS financial statements in
order to obtain an operating permit or to raise capital.

In 2002, the FASB and the International Accounting Standards Board (IASB) reached
agreement on a project to eliminate major differences between IFRS and U.S. GAAP.
Although considerable progress has been made thus far, convergence of IFRS and U.S. GAAP
is far from complete. Some of the differences still under review include accounting policies,
construction contracts, investments in joint ventures, interim financial reporting, and research
and development costs.

Beginning in 2005, all 7,000 EU publicly traded companies are required to apply IFRS in the
preparation of their consolidated financial statements. In preparation for this sweeping
change, the IASB completed its “stable platform” of standards in March 2004. New and
revised standards included five new IFRSs and 17 amended IASs, resulting from the IASB’s
Improvements Project and Phase I of its Business Combinations Project.

Since completion of the stable platform, the IASB has issued IFRS 6, Exploration for and
Evaluation of Mineral Resources, and several interpretations of IFRS and amendments to
current standards, including regulations on insurance contracts, financial reporting by small
and medium-sized entities, disclosures for financial instruments, and financial guarantees and
credit insurance, among others.