Notable Terms

Intangible Assets
Assets that are not physical in nature. Eg: Goodwill, brand recognition, and intellectual property, such as patents, trademarks, and copyrights, are all intangible assets.

Cash Equivalents
Short-term highly liquid investments are readily convertible to known amounts of cash. (without risk of change in value)

Book-keeping
Book-keeping is the recording of financial transactions and is part of the process of accounting in business.

Gross vs Net
Gross describes the total before expenses, taxes, and deductions. Net describes the total after all expenses, taxes, and deductions have been taken into account.

Liquidity
The ability of a firm to meet its current liabilities.

GAAP
Generally accepted accounting principles or its acronym ‘GAAP’ is a collection of commonly-followed accounting rules and standards for financial reporting. Its’ specifications include definitions of concepts and principles, as well as industry-specific rules.

Cash Fund
Cash in hand, demand deposits, cash equivalents.

Cash Budget
A cash budget is an estimation of the cash flows for a business over a specific period of time. This budget is used to assess whether the entity has sufficient cash to operate.

Capital Expenditure
Expenditure incurred for acquiring a fixed asset. (Eg: Purchasing a mobile, car)

Revenue Expenditure
Expenditure for which the benefit is received for one accounting period, less than 12 months. (Eg: Recharging internet for the mobile, purchasing petrol for the car)

Accounting Basics

Accounting principles
The rules of conduct or procedure that are adopted by the accountants universally for recording and reporting of financial data.

Financial Accounting
Art of recording and classifying business transactions and summaries of the same for determining year-end profit or loss and the financial position of the concerned.
Functions: Recording information, classification of data, making summaries, dealing with transactions, interpreting financial information, etc.

Financial Statements and its components
Financial statements provides a summary of the books of accounts of a business enterprise, the balance sheet reflecting the assets, liabilities, and capital as of a certain date, and the income statement showing the results of operation during a certain period. Income statement
Shows the result of a business operation during an accounting period. It is divided into two parts - The trading account (which shares the gross profit/loss) and the profit and loss account (which shows the net profit/loss). Balance sheet
It shows the assets and liabilities of an entity on a particular date.

Double-Entry system
It states that every transaction has a two-fold aspect and that the effects of these two-fold aspects are opposite in nature. If one aspect/account receives a benefit then there must be another aspect/account to impart the same benefit or to have incurred a loss providing the benefit on their behalf. The system in which both the aspects of every transaction are recorded in the books of accounts is called Double Entry System.
Advantages: Scientific system, provides a complete record, checks arithmetical accuracy, ascertains financial position, etc.
Disadvantages: Requires expert knowledge, expensive, unsuitable for small organizations.

Trial Balance
A list of debit and credit balances is taken out from the ledger. It also includes the balances of cash and bank taken from the cash book. Tests arithmetical accuracy of ledger. If debit and credit totals are equal, it may be presumed that the postings are correct and the books of account are arithmetically correct. Note that it is not a part of the double-entry system, nor a conclusive proof of accuracy.
Advantages: Check accuracy of ledger accounts, helpful in detecting errors, provide a summary of each account, helps in preparing final account, etc.
Disadvantages: Not conclusive proof, error in books of original entry carries error here, non-disclosure of operational results and compensating error, etc.

Fund Flow analysis
Reconciliation or maintaining consistency between opening and closing balance sheets for a given accounting period through an explanation of the changes. This explanation is in the form of an analysis of the sources of additional funds available to the firm during the accounting period and the analysis in which they have been utilized. ‘Fund Flow’ means a change in the working capital, wherein a transaction resulting in an increase of working capital is termed as a source of fund and one which results in a decrease of the same is termed as an application of fund. Effects of the flow of funds include Inflow of funds (source), outflow of funds (application) or no flow of funds.

Fund Flow statement
It is a summary of transactions indicating sources and applications of funds. It is also known as the ‘statement of sources and uses of funds’.

Cash Flow analysis
Investigate the movement of cash during a given period.

Cash Flow statment
It is a statement of change in cash position between the beginning and the end of a given period. It is a statement that summarizes the sources from which cash payments are made during a particular period of time, say one accounting year. It explains the reasons for the inflow/outflow of cash.

Cash Flow Statement vs Fund Flow Statement

Ratio Analysis
Process of identifying the strengths and weaknesses of a firm by properly establishing the relationship between items on the balance sheet and P/L account. It is used to describe significant relationships which exist between figures in the balance sheet and P/L account in a budgetary system.
Advantages: Helpful in the analysis of Financial statements, comaprative study, etc. Disadvantages: False accounting data gives false ratios, and a comparison is not possible if different firms adopt different policies, window dressing, etc.

Parties involved in financial statements

Internal Users
Owners/partners, board of directors, workers, managers etc. External Users
Financing group - investors, creditors, lenders, suppliers, etc.
Public group - Tax authorities, employees’ union, stock exchange authorities, research/academic institutions, financial analysts, consumers, etc.

Marginal cost
Incremental or decremental cost due to an increase or decrease in the number of units produced. It consists of variable costs only and relates to changes in output in a particular circumstance. The ascertainment of marginal cost and of the effect on profit of changes in volume is called marginal costing.
Features of marginal costing: costs are classified into fixed and variable costs, a technique of cost ascertainment, selling price is based on marginal cost plus contribution, etc.
Advantages: Gives better results (with standard costing), flexible to use with other techniques, better presentations, provides data for decision making, etc.
Limitations: Understatement of profit, Ineffective tool of control, misleading selling price, etc.

Break-even chart and point
A Break-even chart is the graphical representation of marginal costing, showing the interrelationship between cost, volume, and profit. It shows the break-even point (no profit no loss point of sale) and indicates estimated profit/loss at varying volumes of activity. Hence the break-even point is the level of activity at which there is neither profit nor loss.

Break even analysis
Study of cost-volume analysis. It is used in two senses:
Narrow sense: technique of determining the level of operations where total revenues equal total expenses i.e. no profit no loss.
Broad sense: a study of the relationship between cost, volume, and profit.
It is a method of presenting to the management the effect of alternative decisions on cost, volume, and profit.

Margin of Safety
The difference between actual sales and break-even sales at the break-even point - i.e., it is the excess of production over the break-even point of output. If the margin of safety is large, it indicates the strength of the business to have a bit of profit at least.

Budgetary control
Budgetary control is a system of procedures used to ensure that an organization’s actual revenues and expenditures adhere closely to its financial plan.

Basis of Accounting
Criterion based on which a transaction is recorded in the books of account and the method followed for ascertaining the income/profit earned during a particular accounting period.

• Cash basis
  Only the cash transactions are recorded in the books of account. Only transactions giving rise to receipts or payment of cash are recorded. No record is made for any amount which is accrual. Profit is the difference between cash receipts and payments relating to revenue items during a period. It is generally used by professionals. (Lawyers, doctors, clerks, etc)

• Accrual Basis
  Basis of accounting under which incomes are recorded or credited to the period in which they are earned irrespective of, whether the same has actually been received or not. Similarly, expenses are charged to the period in which they relate, irrespective of whether they have been actually been paid or not. (Eg: used by Shopkeepers)

• Mixed/Hybrid Basis
  Kind of like the best of two worlds. Eg: Revenues are accounted on a cash basis + expenses are accounted on an accrual basis.

Financial Accounting Art of recording and classifying transactions and summaries of the same for determining year-end profit or loss and the financial position of the concerned.

Working Captial Funds are needed for short-term purposes such as purchasing raw materials, payment of wages, and other day-to-day expenses (day-to-day working requirements). It is the part of the capital that is required for financing short-term or current assets. (including the operating cost of the enterprise)
Importance of working capital:
Solvency of business, goodwill, can avail loans easily, cash discounts, regular supply of raw materials, etc.
Factors determining working capital requirements:
Nature of business (public utilities - small wc, manufacturers - large wc), size of business (greater the size, greater the wc), Production policy (demand is subject to fluctuations in the policy), Manufacturing process, seasonal variations, price level change, etc.

Cost-Accounting
The technique and process of ascertaining costs. It identifies measures and analyses and reports the various elements of direct and indirect costs associated with the manufacturing of goods or providing costs of services.

Primary functions of cost accounts
Cost ascertainment, analysis of costs, cost reporting, management control, cost book-keeping, etc.
Advantages: Disclosure of profitable and unprofitable activities, cost control, aid in decision making, basis for fixing selling price, etc.
Disadvantages: Lack of uniform procedure, Expensive system, Unhelpful in inflatory situations.

Costing types
Uniform costing: Use of standard principles, practices, and methods of cost accounting within a class of industry.
Marginal costing: Cost ascertainment using variable costs only. Applied to ascertain the effect of change in volume on profit.
Direct costing: All direct costs consisting of all variable costs and some fixed costs are included, excluding indirect costs.
Absorption costing: Charges all costs (fixed and variable) to operations, processes, and products.
Historical costing: Costs are ascertained as they are incurred.
Standard costing: Predetermined costs.

Cost sheet
It is a statement prepared at a given interval of time showing the various elements of cost of a product or a service or a job in total as well per unit of output produced during the period. costs are shown in an analytical and detailed form. Advantages include cost disclosure, cost contribution of each element, the break-up of costs, price fixation, price regulation, cost estimate/quotation, etc.
Elements of costs
Material, labor, expenses, and overheads.

Master Budget
When the functional budgets have been prepared, the summary of all these budgets that are made is known as Master Budget. It shows the overall plan of the business for the next period.

Zero Budget
Zero is taken as a base and a budget is prepared based on likely activities for the future period.

Basic accounting concepts

• Business Entity
  Here the business and the owner are treated as two separate entities, with each of them having a completely separate set of books. For example, the business transactions are recorded from the point of view of the firm (not the proprietor/owner) and assets such as the owner’s house, car, etc are personal investments and not a part of the business.

• Money Measurement
  Only those events which are capable of being expressed in terms of money are recorded in the books of accounts. (Accounting system uses money as its basic unit of measurement) The concept operates on the assumption that the value of money is constant throughout the accounting period. (Effect of inflation/deflation is ignored)

• Going Concern Concept
  It simply states that in the future the business will not be liquidated or closed down. While recording business transactions into the books of accounts, it is assumed that the business will be carried on for a long time to carry out its objectives. (not that business is immortal, but it implies that it will be carried out and has no intentions to close down) The assets and liabilities are carried on for the next Financial year or Accounting year. If it is assumed that the business is to be closed soon, then the assets will be shown at a saleable price, not the cost price.

• Accounting period
  At the end of each accounting period, an income statement and balance sheet are prepared. It must be there since if income is not measured periodically then there isn’t any significance here. Note that the Income statement discloses P/L made by the business during an accounting period, whereas the Balance sheet depicts the financial position as on a date. Because of the application of this concept, while preparing these statements, a proper distinction is made between capital and revenue expenditure. (usually on the last day of the accounting period)

• Cost concept
  An asset is recorded in the books at the price paid to acquire it and cost is the basis for all subsequent accounting for the asset. There are alternatives to cost like market value, current value, replacement value, etc, But in accounting, cost is used for keeping records and making financial statements consistent.
  Applications: Gives fair financial results, maintains consistency, switching over to other values defeats the purpose of accounting. The limitation would be the unrealistic value of assets during inflation.
  

• Dual Aspect concept
  Every business transaction has a double effect - at any point in time, the total assets of a business are equal to the total liabilities. The liability of an entity to outsiders is a liability but for the proprietor/owner, it is termed as capital. (Follows the accounting equation Assets = Liabilities + Captial) For example (x) Cash in hand of 50,000 comes to business with investment on (y) captial of 25,000 and a (z) loan of 25,000. (x=y+z)

• Consistency concept
  The accounting policies should be consistent and not changed from period to period. It is assumed that the entity is a ‘Going concern’ one. (discussed above) The accounting principles, methods, etc. must be consistently followed while recording and preparing financial statements. If accounting techniques or policy methods differ for the current year with respect to the previous year, then financial statements will be inconsistent. However, note that any policy is not rigid and if required policies may change.

• Conservatism (Prudence) concept
  (Also known as the modifying concept) ‘Conservatism’ here implies that all probable and anticipated losses should be provided and all anticipated unrealized gains should be ignored and the profit should not be overstated (or state things exactly the way they are). It is not applicable to all cases and must be used carefully. It restricts the concept of full disclosure and objectivity. Examples where it is applicable - Maintaining provision for bad and doubtful debts, not taking appreciated values of fixed assets and investment at cost/market price whichever is lower. It makes financial statements more prudent, users’ decisions more sound, and provides future possible losses.

Formulae:

Contribution = Selling price (per unit) - variable cost (per unit) = fix cost + profit = P/V ratio x sales

Current Ratio Current assets / Current liabilities

Acid Test / Liquid / Quick Ratio = Liquid assets / Current liabilities

Liquid Assets = Current assets - inventory

Shareholders Fund = Equity share capital + preference share capital + reserves and surplus - preliminary expenses

Long Term Debt = Deventures + long term debts + other liabilities

Debt Equity Ratio = Shareholders fund / Long term debt

Propreitary Ratio = Total assets / shareholders fund

Break Even point (units) = fix cost / contribution per unit

Break Even point (sales) = fix cost / P/V ratio

Profit/Volume or P/V Ratio = contribution / sales x 100 (%) or simply contribution / sales = change in profit / change in sales

Margin of Safety = (Actual) Sales - Break even sales = Profit / P/V Ratio

Desired sales (units) = (fix cost + desired profit) / contribution per unit

Desired sales (currency) = (fix cost + desired profit) / P/V Ratio

Material cost variance = SQ.SR - AQ.AR

Material price variance = AQ.(SR-AR)

Material usage variance = SR.(SQ-AQ)

MCV = MPV + MUV (follow S-A for above formulas)

(Current) Assets = (Current) Liabilities + (Working) Capital

Anirban

12/20/2019