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PGDM 2015-17 BATCH

FINANCIAL ACCOUNTING
CONCEPT OF BALANCE SHEET AND
INCOME STATEMENT AND BASIC
ACCOUNTING EQUATION
SESSION 2

Indian Institute of
Management
Tiruchirappalli

Account Categories
Groups of related items.
Main categories.

BALANCE SHEET ITEMS


Assets.
Liabilities.
Owners (shareholders) equity
INCOME STATEMENT ITEMS
Revenues
Expenses.

TRANSACTION
TRANSACTION IN FINANCIAL ACCOUNTING IS

ANYTHING / ACTIVITY WHICH AFFECTS A BALANCE


SHEET.
IT MAY BE PHYSICAL OR NON-PHYSICAL
EX: PHYSICAL : PURCHASE OF EQUIPMENT
EX: NON-PHYSICAL : DEPRECIATION
IT MAY BE DIRECT OR INDIRECT
EX: PURCHASE OF EQUIPMENT
EX: SALES

What are liabilities and


assets?
Liabilities : sources of money
Different sources come with different

obligations and returns

Assets: uses of money


Different assets have different life time
Cash is also an asset

Income statement
Open 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 Sheet
Statement 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.

Balance Sheet
Resources and Claims View
Assets = 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).

Please go through the book How to Read a

Balance Sheet.
What do you find there?

BASIC ACCOUNTING
EQUATION
Subscript denotes end of the period
Superscript denotes during a period
We will use subscript for balance

sheet or stock items


We will use superscript for income
statement items

Dual Aspect
Fundamental accounting equation:

Assets = Liabilities + Owners equity


For a corporation:

Assets = Liabilities + Stockholders


equity
Assets = Liabilities + Paid-in cap. +
Ret. earnings

Dual Aspect
Transactions 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.

Net worthbeg. = Assetsbeg. -

liabilitiesbeg.
Contributed capitalbeg. + Retained

earningsbeg. = Assetsbeg. - liabilitiesbeg.


Net worthend = Assetsend. - liabilitiesend
Contributed capitalend + Retained

earningsend = Assetsend. - liabilitiesend

Assetsend =
Assetsbeg. + Assetsadded
Assetsdisposed Accumulated
depreciation write off impairment

liabilitiesend =
liabilitiesbeg. + liabilitiesadded
liabilitiespaidoff

Contributed capitalend =
Contributed capitalbeg. +
contributed capital added
contributed capital bought back

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

Balance Sheet
Assets: Resources of entity.
Cash.
Accounts Receivable.
Inventory.
Equipment.
Investments.
etc.
1-17

Balance Sheet
Liabilities: Claims by creditors.
Accounts payable.
Notes payable.
Owners Equity: Claims by

investors.
Amounts provided directly by
equity investors (Paid-incapital).
Amounts retained from
earnings, i.e. profits (Retained

1-18

What are Assets


An asset must be:
1. Acquired in a transaction.
2. 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.
3. Controlled by the entity.
4. An objectively measurable cost at
time of acquisition.

Assets.
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..

Reporting of Assets on Balance


Sheet
Grouped into categories.
Decreasing order of liquidity

(i.e., in US).
Current assets (almost)
always shown separately.
Check with the balance sheet

What do you find in

the HUL annual


report?

Problem 1-1, 1-2 and 1-3 from page 20

Current Assets
Cash.
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.

Other Assets
Investments (not expected

to be sold within a year).


Intangible assets.
Goodwill, patents,
trademarks, copyrights.
Longer life than prepaid
expenses.

Liabilities
Obligations 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.

Current Liabilities
Satisfied or extinguished

within one year


or normal operating
cycle, if longer.

Current Liabilities:
Accounts (and Notes) Payable
Accounts 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.

Current Liabilities:
Taxes Payable

Owed to government

agencies for taxes.


Income taxes often shown
separately because of size.

Current Liabilities:
Accrued Expenses

Earned by outside parties

but not yet paid (i.e., unpaid


expenses).
Usually no invoice.
Includes interest payable,
wages payable.

Current Liabilities:
Deferred Revenues

Also called unearned

revenues or pre-collected
revenues.
Advance payment received,
but company has not yet
performed service or
delivered product.

Current Liabilities:
Current Portion of Long-Term Debt

Portion due within

upcoming year.
Gives complete picture
of entitys short-term
obligations.

Long-Term Liabilities
Also called:
Long-term debt.
Non-current liabilities.
Due beyond upcoming

year.

Owners Equity
Amount 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.

Two Categories of
Shareholders Equity

Paid-in or contributed

capital.
Retained earnings.

Shareholders Equity:
Paid-in Capital
Amount owners have paid in to

purchase shares of stock.


Classified as:
Par value.
Additional paid-in capital.

Shareholders Equity:
Retained Earnings
Reinvested 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.

Unincorporated Businesses
Proprietorship.
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).

Exercises for this class and next class


from Antony, Hawkins and Merchant
Problem 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 48

Please work these problems


To be done in groups
Not part of evaluation

Thank
You