Fundamentals of Accounting

Preparation and Analysis of Final Accounts

(Module – III)
Meaning of Financial Statements

Financial statements basically reports the financial and accounting

information relating to businesses. A company’s management uses
financial statements to communicate with external stakeholders. These
include shareholders, tax authorities, regulatory bodies, investors,
creditors, etc
 Objectives of Financial Statements
 These statements show an accurate state of a company’s economic assets and liabilities. External
stakeholders like investors and authorities generally do not possess this information otherwise.
 They help in predicting the extent of a company’s capacity to earn profits. Shareholders and
investors can use this data to make their financial decisions.
 These statements depict the effectiveness of a company’s management. How well a company is
performing depends on its profitability, which these statements show.
 They even help readers of these statements know the accounting policies used in them. This
helps in understanding statements more comprehensively.
 These statements also provide information relating to the company’s cash flows. Investors and
creditors can use this data to predict the company’s liquidity and cash requirements.
 Finally, they explain the social impact of businesses. This is because it shows how the company’s
external factors affect its functioning.
Profitability

Liquidity

Solvency
Users of Financial Statements

Internal Users • Management

• Lenders, Government, Creditors,

External Users
Customers, Suppliers etc.
Meaning of Trading Accounts

A trading account is used to record the sale and purchase of

goods/services. This temporary account closes at the end of each
accounting period. The purpose of the trading account is to show the
gross profit or gross loss made in a particular time period.
Need of Trading Accounts

The purpose of creating a trading account in accounting is to:

 Maintain a record of goods sold and purchased.
 Establish whether the sale of goods resulted in a gross profit or gross loss.
 Provide a basis for the calculation of net profit or loss.
 Provide information that is useful for management accounting.
 Comply with accounting standards and regulations.
 Prepare the basis of the income statement for the accounting period.
Meaning of Profit & Loss Accounts

Profit and Loss Account is a type of financial statement which reflects

the outcome of business activities during an accounting period (i.e.
Profit or loss). Reported income and expenses are directly related to an
organization’s are considered to measure the performance in terms of
profit & loss.
Profit & loss a/c is popularly known as P&L A/c.
Need of Profit & Loss Accounts

• Tracks the Net Profit or Net Loss

• Tracks Indirect Expenses
• Helps in Ascertaining the Net Profit Ratios
• Helps in Decision Making
Meaning of Balance Sheet

The term balance sheet refers to a financial statement that reports a

company's assets, liabilities, and shareholder equity at a specific point in
time. Balance sheets provide the basis for computing rates of return for
investors and evaluating a company's capital structure.
In short, the balance sheet is a financial statement that provides a
snapshot of what a company owns and owes, as well as the amount
invested by shareholders. Balance sheets can be used with other
important financial statements to conduct fundamental analysis or
calculate financial ratios.
 Distinction between Trial Balance and Balance Sheet
Trial Balance Balance Sheet
Definition
Trial balance is a statement that is created with the intention of Balance sheet is the financial statement which shows the position of
recording balances from all the ledger accounts the assets and liabilities of an organisation at a given point of time

Applied in
The main application of trial balance is to check whether debit balance The main application of balance sheet is to determine the accuracy of
and credit balance tally with each other or not the financial position of the company

Component of Financial Statement

Not a component of financial statement Is a part of financial statement
Purpose of Creation
It is used for internal users of information It is used for external users of information
Frequency of Recording
Trial balance is recorded monthly, quarterly, half-yearly and yearly Balance sheet is prepared yearly

Source of data
Data collected from General ledger Data collected from trial balance
Meaning of Financial Statements-With Adjustments

Every company prepares Profit & Loss Account and Trading account (also
known as an income statement) and Balance Sheet statement(position statement)
every financial year. The income statement indicates the net profit and loss
status of a company, whereas, the balance sheet indicates the financial position
of the business.
All these statements are provided according to the trial balance record. While
preparing these accounts, it can be noticed that few accounts or transactions are
(i) Omitted from the record book (ii) Sometimes have been recorded wrongly in
the book or (iii) Sometimes entered only one part of the transactions. Entries
passed for such financial transactions are known as adjustment entries.
Objectives and Needs of Adjustments

• To get information about actual Profit or Loss

• To know about the real financial position of the business
• To rectify the errors found in the books of accounts
• To complete the incomplete transactions
• To make provision for depreciation and other such provisions
• To include all incomes, whether received or about to be received
• To include all the expenses, whether paid or about to be paid
• To record all such incomes, which have been received in advance
• To record all such expenses, which have been paid in advance
Meaning of Incomplete Records

Accounting records, which are not strictly kept according to double entry system
are known as incomplete records. Many authors describe it as single entry system.
However, single entry system is a misnomer because there is no such system of
maintaining accounting records. It is also not a ‘short cut’ method as an alternative
to double entry system. It is rather a mechanism of maintaining records whereby
some transactions are recorded with proper debits and credits while in case of
others, either one sided or no entry is made. Normally, under this system records
of cash and personal accounts of debtors and creditors are properly maintained,
while the information relating to assets, liabilities, expenses and revenues is
partially recorded. Hence, these are usually referred as incomplete records.
Limitations of incomplete records
a) As double entry system is not followed, a trial balance cannot be prepared and
(

accuracy of accounts cannot be ensured.

(b) Correct ascertainment and evaluation of financial result of business operations
can not be made.
(c) Analysis of profitability, liquidity and solvency of the business cannot be done.
This may cause a problem in raising funds from outsiders and planning future
business activities.
(d) The owners face great difficulty in filing an insurance claim with an insurance
company in case of loss of inventory by fire or theft.
(e) It becomes difficult to convince the income tax authorities about the reliability
of the computed income.
 Difference between Double Entry System and Incomplete Records

INCOMPLETE RECORDS DOUBLE-ENTRY SYSTEM

Trading, profit and loss account, and the balance sheet Trading, profit and loss accounts, and balance sheets can be
cannot be prepared. prepared.

This method is suitable for small-scale business units where This method is suitable for large-scale business units where
the owners can directly control the affairs of the business. the owners cannot directly control the affairs of the business.

Personal transactions of the owner get mixed up with Personal transactions of the owner are kept separate from
business transactions business transactions.

Both aspects of each transaction are not recorded. Both aspects of each transaction are recorded.

Only personal accounts are kept and in some cases, a cash

Personal, real, and nominal accounts are kept fully.
account is maintained.
 Difference between Balance Sheet and Statement of Affairs
Statement of Affairs Balance Sheet

1. Shows the financial position of a company at a specific point in time 1. Shows the financial position of a company at a specific point in time

2. Includes both assets and liabilities 2. Includes both assets and liabilities

3. Emphasizes current assets and current liabilities 3. Emphasizes long-term assets and liabilities

4. Provides information on cash flow 4. Provides information on the liquidity of the company

5. May include a statement of income and expenses 5. Does not include a statement of income and expenses

6. May provide information on the company's operations and performance 6. Provides information on the company's assets and liabilities

7. May be more comprehensive than a balance sheet 7. Focuses more on the company's net worth

8. May be prepared for a specific purpose such as a loan application 8. Is a standard financial statement that is prepared on a regular basis
Meaning of Accounts for Not-For-Profit Organizations

• Not-for-Profit Organisations are the establishments that are utilised for the welfare of the
community and are set up as charitable associations which operate without any motive for profit.
Their primary objective is to provide service to a specific class or the public. Usually, they do not
produce, buy or sell commodities and may not have credit transactions.

• Therefore, they need not manage many books of account (as the trading entities do) and Trading
and Profit & Loss Account. The funds raised by such establishments are credited to the general
fund or capital fund. The major sources of their income usually are subscriptions from their
member’s donations, income from investments, grants-in-aid etc.
• The main aim of maintaining records in such establishments is to meet the statutory necessities
and assist them in exercising control over the consumption of their funds. They also have to
prepare the financial statements during the closure of each accounting period (usually a financial
year) and determine their income and expenditure and the financial condition and submit them to
the statutory authority known as Registrar of Societies
Difference between Profit Seeking Organization and
Not-For-Profit Organization
BASIS FOR COMPARISON PROFIT ORGANIZATION NON-PROFIT ORGANIZATION

Meaning A legal entity, which operates for earning profit for the A non-profit organization is a legal entity, which
owner, is known as For-profit or Profit organization. operates for serving the society as a whole.

Motive Profit motive Service Motive

Form of organization Sole proprietorship, Partnership firm or company Club, Trust, Public hospitals, society, etc.

Management Sole proprietor, partners or directors, as the case may Trustees, committees or governing bodies.
be.

Source of revenue Sale of goods and services. Donation, subscription, membership fee etc.

Commenced through Capital contributed by the owners. Funds from donation, subscription, government grant
and so on.

Financial Statement Income statement, Balance Sheet and Cash flow Receipt & Payment A/c, Income & Expenditure A/c
statement and Balance Sheet.

Money earned over and above Profit, is transferred to capital account. Surplus is transferred to capital fund.
Meaning of Financial Statement Analysis

Financial statement analysis is the process of analysing a

company’s financial statements for decision-making purposes. External
stakeholders use it to understand the overall health of an organization
and to evaluate financial performance and business value. Internal
constituents use it as a monitoring tool for managing the finances.
Importance of Financial Statement Analysis
(i) To assess the earning capacity or profitability of the firm.
(ii) To assess the operational efficiency and managerial effectiveness.
(iii) To assess the short term as well as long term solvency position of the firm.
(iv) To identify the reasons for change in profitability and financial position of the firm
(v) To make inter-firm comparison.
(vi) To make forecasts about future prospects of the firm.
(vii) To assess the progress of the firm over a period of time.
(viii) To help in decision making and control.
(ix) To guide or determine the dividend action.
(x) To provide important information for granting credit.
Techniques of Financial Statement Analysis

Ratio Analysis
Ratio analysis refers to the analysis of various pieces of financial
information in the financial statements of a business. They are mainly used
by external analysts to determine various aspects of a business, such as its
profitability, liquidity, and solvency.
Analysts rely on current and past financial statements to obtain data to
evaluate the financial performance of a company. They use the data to
determine if a company’s financial health is on an upward or downward
trend and to draw comparisons to other competing firms.
Comparative Analysis
• Comparative financial statements present the same company’s
financial statements for one or two successive periods in side-by-side
columns. The calculation of dollar changes or percentage changes in
the statement items or totals is horizontal analysis. This analysis
detects changes in a company’s performance and highlights trends.
• Horizontal analysis is called horizontal because it consider one
account at a time across time. We can perform this type of analysis on
the balance sheet or the income statement.
Thankyou