acc - fin material

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FINANCE, ACCOUNTS AND FINANCIALMARKETS

Accounting:Accounting is an art of identifying, recording, classifying, summarizing, analyzing

and interpreting the financial transactions and communicating the results thereofto the persons interested in such information.

Branches of Accounting: Financial Accounting

Cost Accounting

Management Accounting

Inflation Accounting

HR Accounting

Financial Accounting:Financial Accounting is to ascertain the financial results of an organization duringa specific period. It is concerned with record keeping directed towards thepreparation of Trail Balance and Financial Statements (Final Accounts).

Cost Accounting:It is to analyze the expenditure to ascertain the cost of various productsmanufactured by the firm and for the future decision making. It is systematicprocedure for determining the unit cost of output produced (or) services renderedby the organization.

Management Accounting:It concerned with the internal reporting of information to management for:

A. planning & controlling operationsB. decision makingC. formulating long term plans

Inflation Accounting:It is concerned with adjustment in the value of assets and profit in the light ofPrice level changes.

HR Accounting:It is concerned with the process of identifying and measuring data about humanresources.

Functions of Accounting:1) Classifying work2) Recording work3) Summarizing work4) Interpretation/Analysis of Work5) Reporting the Work

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6) Preparation of Budget7) Taxation work8) Auditing

Basis of Accounting:1) Cash basis:In this system entries are made only when cash is received or paid.

2) Mercantile or Accrual Basis:Irrespective of cash receipt or payment, transactions are recorded when they arerealised i.e. a transaction is recorded as it is earned or incurred regardless ofwhen actual payments are received or made.3) Mixed Basis:Incomes are recoded on cash basis and expenses are recorded on accrual basis.

Accounting Concepts:1. Business Entity Concept: In Accounting the business and the proprietors

are regarded as two separate entities. All the transactions of business are

recorded from the point of view of business is a separate entity.

2. Dual Aspect / Accounting / Balance sheet Concept : According to thisconcept each transaction has two folded affect, the receiving of the benefitand the giving of the benefit. The receiving aspect is called Debit and thegiving aspect is called Credit. Therefore for every Debit (Dr) there will be acorresponding Credit (Cr).

Accounting Equation Assets =Liabilities + Capital

3. Going Concern Concept : It is assumed that the business will continue for

a fairly long time until it is dissolved. This is called the going concernconcept.

4. Cost Concept : All the transactions should be recorded at cost in the booksof accounts and this cost will be the basis for all subsequent accounting forthe asset.

(OR)An asset is ordinarily entered in the accounting records at the price paid toacquire it and this cost is the basis for all subsequent accounting for theasset.

5. Money Measurement Concept : In accounting, a record is made only ofthose transactions, which can be expressed in terms of money. It helps to

express heterogeneous (various kinds of) items such as Bank BalanceMachinery and stock etc.

6. Accounting Period Concept : According to this concept, the life of thebusiness is divided into appropriate segments for studying the resultsshown by the business after each segment. Accounting period is the periodfollowed by a business concern for studying the results shown by thebusiness after each period. Usually one year will be Accounting Period

7. Matching Concept : According to this principle the expenses incurred inan accounting period should be matched with the revenue recognized inthat period.

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8. Realisation Concept: According to this concept all thetransactions are recorded when they are realised but not on the base ofcash paid or cash received.

9. Accrual Concept: This concept implies that the income should bemeasured as a difference between revenue and expenditure rather thanthe difference between cash received and cash disbursements.

Accounting Conventions:a) Convention of Full Disclosure :

According to this convention accounting reports should be disclosed fullyand fairly the information they intend to represent. They should discloseinformation which is of material interest to proprietors, present andpotential creditors and investors. (Companies Act 1956)

b) Convention of Materiality :

According to this convention the accountant should attach importantmaterial details and ignore insignificant details. This is because otherwiseaccounting will be unnecessarily overburdened with minute details.

c) Convention of Consistency :The methods or principles followed in the preparation of various accountsshould be consistent (same) from one accounting year to another.

d) Convention of Conservatism : This convention warns the trader not to take unrealised income intoaccount. This is the policy of playing safe. It takes into consideration alpossible losses or expected losses, but leaves all unearned or unrealisedprofits.

Accounting systems: Single entry system: Which doesnt follow the principles of double entry

system iscalled the single entry system. Transactions are recorded only in Cash Bookand Personal A/cs.

Double entry system: This method of writing every transaction in twoaccounts is known as Double entry system. Every transaction is divided intotwo aspects viz. Dr and Cr.

Classification of Accounts:1) Personal AccountsDebit the receiver and Credit the giver

2) Impersonal Accountsa) Real Account:

Debit what comes in and Credit what goes out

b) Nominal Account:Debit all expenses and losses and Credit all incomes and gains

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The golden rules of Accounting: The following are treated as thegolden rules of accounting.

Debits ALWAYS EQUAL credits

Increases DO NOT NECESSARILY EQUAL Decreases.

Assets Liabilities = Owners Equity (The Accounting Equation)

In some of the parts of the world the principles of types of accounts are alsocalled to be the Golden rules of accounting. They are:

Personal Account: Debit the receiver and Credit the giver

Real Account: Debit what comes in and Credit what goes out

Nominal Account: Debit all expenses and losses and Credit all Incomesand Gains

ACCOUTING TERMINOLOGY

Accounting Standards: Accounting Standards are definitive statements for

the purpose of preparing Financial Statements. They provide the norms on thebasis of which Financial Statements should be prepared. They help auditors in theaudit of accounts.

Capital: It is the amount invested by the proprietor in the business. It is alwaysequal to assets minus liabilities. It is also called Owners Fund. It is a liability tothe firm.

Asset: An asset is a thing which has certain economic value and which is usedfor the production and administration of a business unit.

Fixed Assets: These assets are acquired for long term use in the business.Liquid Assets: Which can be converted into cash without losing much of itsvalue is called Liquid Asset.

Fictitious Assets: Which do not have physical form and real value. Ex: P&LDr Balance, deferred revenue expenditure and preliminary expenses.

Intangible Assets: Which do not have physical existence, yet very useful tothe smooth running of the business is called an intangible asset. Ex: goodwillpatents and trademarks.

Wasting Assets: Which are concerned through being worked or used.Liabilities: Obligations or Debts payable by the enterprise in future in the formof money.

Current Liabilities: The liabilities which are payable within a year calledcurrent liabilities. Ex: outstanding expenses, creditors and bills payable.

Contingent Liabilities: It is not real liability. Future event only decidewhether it is really a liability or not. A good example of a contingent liabilitywould be an outstanding lawsuit.

Business: It is an activity which involves exchange of goods and / services withthe intention of earning income and profit.

Account: A summarized statement of transactions relating to a particularperson, thing, expense or income.

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Transaction: Any sale or purchase of goods or services is called thetransaction. They are 3 types.

1) Cash 2) Credit 3) Non cash transaction

Debtor: Debtor means a person who owes money to the trader or to theorganization.

Creditor: A person to whom something is owed by the business.

Insolvent: The inability of a person to pay his debts when they become dueThe condition in which the liability exceed assets.Goods: All those things which a firm purchases for resale are called goods.Purchases: It means purchase of goods, unless it is stated otherwise. It alsorepresents the goods purchased.

Sales: It means sale of goods. It is also represents the goods sold.Revenue: It refers to the earnings of a business. It includes the sale proceedsof goods, receipts for services rendered and commission.

Expenses: It is the amount spent in conducting business activities. It is theexpenditure in return for some benefit. Ex: salary, rent etc

Entry: The record of a transaction in a journal is called entry.

Journal: It is an A/c book where business transactions are first recorded. It is abook of original entry.

Ledger: It is a book in which various accounts are opened.Voucher: Accounting transactions must be supported by documents. Thesedocumentary proofs in support of the transaction called voucher.

Brought down (B/D): This term is written in the ledger to show the openingbalance in any account.

Carried down (C/D): This is written in the ledger account at the time o

closing the account.Gross Profit: The difference between the selling price and the cost price ofgoods before the deduction of any expenses incurred in selling goods.

Net Profit: deducting all the expenses from Gross Profit called Net Profit. Itrepresents the real gain of the business.

Provision: Provision is a charge against profit and is created to meet a knownloss / expected contingency / outstanding liability.

Reserve: Reserve is an amount set aside out of profits to provide additionalworking capital or to equalize dividends. It is an appropriation of profit.

Reserve fund: If an amount equal to reserve is invested in readily realisable

securities then the reserve is called reserve fund.Profit: The sum of amount earned by a business unit during an accountingperiod is said to be profit.

Loss: Excess of expenditure over income is said to be loss.Balance Sheet: A balance sheet is an item wise list of all assets, liabilities andproprietorship of a business at a certain date.

Trail Balance: It is a statement containing all ledger accounts at any date,arranged in the form of Dr and Cr columns side by side. The use of trail balance isto check the arithmetical accuracy of ledger posting.

Bad Debts: Debts which are irrecoverable are called Bad debts.

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Unexpired / Prepaid Expenses: Expenses which have been paid inadvance i.e. whose benefit will be available in future are called unexpired /prepaid expenses. It will be shown assets side of the Balance Sheet.

Outstanding / Accrued Income: The income which is earned but notreceived during the accounting year is called Accrued Income. It will be shown onasset side of B/S.

Income Received in advance: Income received but not earned during theaccounting period is called income received n advance. It will be shown onliabilities side of B/S.

Capital Expenditure: If an expenditure is useful for more than one year thatis called capital expenditure. Ex: Expenses for acquiring fixed assets.

Revenue Expenditure: If the use of expenditure is limited to the accountingperiod that is called revenue expenditure. Ex: purchase of raw material, repairsand salaries etc

Deferred Revenue Expenditure: A heavy expenditure of revenue natureincurred for getting benefits over a period of years called deferred revenue

expenditure. Ex: preliminary expenditure, heavy advertisements etc.

Every year a part of such expenditure is charged to P&L A/c and theunwritten-off portion is shown in B/S till it is completely written off. Deferredrevenue is important because it's the money a company collects before itactually delivers a product.

Capital Receipts: Amounts received from selling of Fixed Assets are calledcapital receipts.

Revenue Receipts: Amount received from sale of goods and receivedinterest all these are called revenue receipts. It will be shown on P&L A/c.

Working Capital: The part of the capital available with the firm for day to dayworking of the business is called working capital. Working capital is furtherdivided into two ways.

1. From the point of view of concept:a. Gross working capitalb. Net working capital

2. from the point of view of time:a. Permanent working capitalb. Temporary working capital

Gross Working Capital: The gross working capital refers to the investmentin all the current assets taken together. The total of investments in all currentassets is known as gross working capital.

Net Working Capital: Excess of current assets over current liabilities is saidto be net working capital.

Net Working capital Current Assets -Current Liabilities

Permanent Working Capital: It is the minimum level of investment in thecurrent assets that is carried by the business at all times.

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Temporary Working Capital: It refers to the part of workingcapital which is required by a business over and above permanent workingcapital. It is also called as variable working capital.

Working capital cycle

Goodwill: Goodwill is known as the name and fame of a company.Goodwill Market value of the firm Bookvalue of the firm

Bank Reconciliation Statement (BRS): A Bank ReconciliationStatement is a statement reconciling the balance as shown by the Banks PassBook and the balance as shown by the Cash Book. The objective of preparingsuch a statement is to know the causes of difference between the two balancesand pass necessary adjusting entries in the books of the firm.

Causes of difference:

Cheques issued but not presented for payment

Cheques sent for collection but not yet collected

Cheques issued but paid after the due date Cheques sent for collection but collected after the due date

Bank charges not entered into Cash Book

Direct collections on behalf-of customers

Bank made payments on behalf-of client/organization, but notentered into Cash Book

Errors in Cash Books / Pass Books

Dishonour of Bills / Cheques

Amalgamation: The term amalgamation is used when two (or) morecompanies carrying on similar business go into liquidation and a new company isformed to take over their business.

Absorption: The term absorption is used when an existing company takesover the business of one (or) more other existing companies.

Reconstruction: It means reconstruction of companys financial structure. Itmay take place either with (or) without the liquidation of the company.

External Reconstruction: When a new company is formed with the samename in order to take over the business of an existing company, then it is calledexternal reconstruction. In this process one company will go into liquidation andjoins another company.

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Internal Reconstruction: This is generally resorted to by acompany which is being reorganised internally. Internal reconstruction means thereduction of capital to cancel any paid up share capital which is lost (or)unrepresented by available assets. This is generally resorted to write-off the pastaccumulated losses of the company. Thus internal reconstruction and reductionof capital mean the same.

Transferor Company: The company which is amalgamated into anothecompany.

Transferee Company: Means the company into which a transfer companyis amalgamated.

Purchase consideration: It is the amount which is paid by the transfereecompany for the purchase of the business of the transferor company.

Holding Company: A holding company is one that holds either the whole ormore than 50% shares of one (or) companies so to have a controlling power oversuch companies.

Subsidiary Company: The Company which is being hold by other companyis said to be subsidiary company.

Merger: The term merger includes consolidation, amalgamation anabsorption. It refers to a situation when two or more existing firms combinetogether and form a new entity. Either a new company may be incorporated forthis purpose or one existing company (generally a bigger one) survives andanother existing company (which is smaller) is merged into it.

Acquisition: In general, acquisition refers to the acquiring of ownership rightin the property and assets. It denotes a situation when one company acquiresownership in the assets, and to control monies of another company. The othercompany, of which the control is so acquired, remains a separate company and is

not liquidated, but there is a change in control.Depreciation: A permanent and gradual declining in value of an asset due toany cause is called depreciation.Types of Depreciation:

1. Straight Line Method2. Written Down Value method3. Annuity Method4. Sinking Fund Method5. Depletion Method6. Revaluation Method7. Insurance Policy Method

8. Machine Hour Rate Method9. Mileage Method

Depletion: Depletion is the decrease in the value of natural resources likemineral deposits, coal mines and oil wells etc.

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Obsolescence: Obsolescence means loss in the value of an asset dueto external reasons like new inventions or changed fashions.

Amortization: Amortization means the reduction in the value of a long terminvestment in intangible assets such as copyrights and patents.

Fluctuations: It is the temporary change in the market value of a floating

asset.Dilapidation: It is the loss / reduction in the value of a leased property. Thisterm refers to damage done to a building or other property during tenancy.

COSTINGStandard Cost: Standard cost is a predetermined cost. It is a technique ofreducing the cost.

Marginal Cost: It is nothing but additional product cost.Absorption costing: A method for calculating the total cost (variable cost,fixed cost and product cost). It is a technique that takes into account the total

cost of running an enterprise. It is also called as Total Costing or Full Costing.Economic Ordering Quantities: It refers to the size of the order whichgives maximum economy in purchasing any material.

Where C = Annual consumption of the material in units

O = Cost of placing one order including the cost of receiving the goodsI = Interest payments including cost of storage per unit per year

FIFO (First In First Out): Material received first is issued firstLIFO (Last in First Out): The cost of materials last received is used inpricing the materials first issued.

Simple Average Price Method: Adding up the prices and dividing thesum by number of prices involved.

Weighted Average Price Method: Multiplying the price by the quantitiespurchased and then dividing the total value by the total of quantities.

Base Stock Method: Every concern will maintain a minimum quantity ofstock. This quantity is termed as base stock. It is always kept in store, where it isused in emergency arises.

Break Even Point: It is a point of No Profit, No Loss, where total sales areequal to its total costs. It is also called as Balancing Point.

Where SPU = Selling Price per Unit VCU = Variable Cost per Unit

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Fixed Costs: It also referred to non-variable costs, stand by costs.These costs, which not vary with changes in volume of output over given periodof time.

Variable Costs: Variable Costs are those costs which fluctuate in directproportion to the volume of output. Such costs increase in aggregate as theoutput increase and decrease in the same proportion when the output falls.

Semi-variable Costs: Semi-variable Costs are a combination of fixed andvariable costs and are also known as Mixed Costs.

SHARE CAPITAL

Kinds of share capital:1. Authorized / Nominal / Registered Capital: It refers to that amount

which is stated in Memorandum of Association to raise from the public iscalled Authorized capital of the Company.

2. Issued Capital: It is part of Authorized share which is offered to the publicfor subscription.

3. Subscribed Capital: It is part of Issued Capital for which applications arereceived from public.

4. Called-up Capital:The amount on the shares which is actually demandedby the Company to be paid is known as called-up Capital.

5. Paid-up Capital: It is the part of the Called up Capital which is actuallypaid by the shareholders.

6. Over Subscribed Capital: If the subscribed Capital is more than theissued capital the issue is said to be oversubscribed.

Types of Shares:1) Equity shares: Equity share holders are supposed to be the owners of the

company, who therefore, have right to get dividend, as declared, and aright to vote in the Annual General Meeting for passing any resolution.There will be no fixed rate of dividend to be paid to the equity shareholdersand this rate may vary from year to year.

2) Preference Shares: shares which enjoy Preferential Rights as to dividendand repayment of capital in the event of winding up of the company overthe equity shares are called preference shares. The holders of preferenceshares will get a fixed rate of dividend.Preference shares are again classified into the following:

a. Convertible Preference Shares: The shares which can be convertedinto equity shares after a stipulated period are called ConvertiblePreference shares

b. Non-convertible Preference Shares: If the Articles of Association issilent about the convertibility feature, these preference shares aredeemed to be Non-convertible thought the life of the company.

c. Cumulative Preference Shares: When the dividend on the preferenceshares is of accumulative in nature, in the event, the company fails topay the dividend then the shares are called Cumulative preferenceshares.

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d. Non-cumulative Preference Shares: If in any financial year, thecompany does not pay dividends on the shares and the dividend onthese shares will not get accumulated then the shares are called Non-cumulative preference shares.

e. Redeemable Preference Shares: Generally whatever capital is raisedby issuing either equity or preference shares, is not to be repaid tothe shareholders but capital raised through the issue of redeemable

preference shares is to be paid back by the company to suchshareholders after the expiry of a stipulated period, whether thecompany is wound up or not.

f. Irredeemable Preference Shares: The principle on these shares is notpaid back to the shareholders. It can be paid only on the event ofliquidation of the company.

g. Participating Preference Shares: The preference shares which are

entitled to a share in the surplus profit of the company in addition tothe fixed rate of preference dividend are known as the Participatingpreference shares.

h. Non-participating Preference Shares: Those preference shares whichdo not carry the right of share in excess profits are known as Non-participating Preference Shares.

Debentures: It defined as a document issued by the company as an evidenceof debt. It is the acknowledgement of the companys indebt ness to its holders.Types of debentures:

a. Secured Debenturesb. Unsecured Debenturesc. Registered Debenturesd. Bearer Debenturese. Redeemable Debenturesf. Irredeemable Debentures

Call in arrears: If a share holder fails to pay money for the call, is called callin arrears.

Call in advance: If a share holder sends more money for the remainingunpaid calls along with the required money, then the excess money is called callin advance.

Forfeiture of shares: It means compulsory determination of membership ofthe shares by the way of penalty for non payment of any call, installment orpremium on shares. When it is reissued it should be less than the amount due onsuch shares.

Shares: The capital of the company can be divided into equal denominatedunits and each unit is called share.

Rights issue: The issue of new securities to its existing share holders is calledrights issue. It may be noted that a right is an option and not an obligation to buya specified number of shares at a specified price per share over a fixed timeinterval.

Bonus shares: Whenever a company pays extra dividend in the form ofshares out of surplus profits then the shares are called bonus shares.

Buy back of shares: If a company purchases its own shares from otherinvestors in the market to invest in itself. Usually these shares will be purchased

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at a price more than the market price. It is useful to shareholders toincrease the share price, NPV, EPS.

Underwriting: A process in which both the purchase price and offering pricefor a new issue are negotiated between the issuer and a single underwriter.

Underwriter: The process by which investment bankers raise investmentcapital from investors on behalf of corporations and governments that are issuingsecurities both equity and debt.

Stock Split: The dividing of companys existing stock into multiple shares. In a2-for-1 stock split, each stockholder receives an additional share for each sharehe or she holds.

A stock split is often prompted by a desire to reduce the market priceper share in order to stimulate investor buying. Assume XYZ Company has 1000shares of Rs.20 par value common stock. The total par value is thus Rs.20,000. Atwo-for-one stock split is issued. There will now be 2000 shares at Rs.10 parvalue. The total par value remains at Rs.20,000. Typically, the market price pershare of the stock should also drop to one-half of what it was before the split.

Primary Market: The market in which investors have the first opportunity tobuy a newly issued security

Secondary Market: A market on which an investor purchases an asset fromanother investor rather than an issuing corporation

Bankruptcy:The state of a person or firm unable to repay debts.

Pooling: Pooling is the grouping together of assets. Debt instruments withsimilar characteristics, such as mortgages, can be pooled into a new security.

Hedge:Making an investment to reduce the risk of adverse price movements

in an asset. Normally, a hedge consists of taking an offsetting position in arelated security, such as a futures contract.An example of a hedge would be if you owned a stock, then sold a futures

contract stating that you will sell your stock at a set price, therefore avoidingmarket fluctuations. Process of protecting oneself against unfavorable changes inprices. Thus one may enter into an offsetting purchase or sale agreement for theexpress purpose of balancing out any unfavorable changes in an alreadyconsummated agreement due to price fluctuations. Hedge transactions arecommonly used to protect positions in (1) foreign currency, (2) commodities, and(3) securities.

Money Market: The securities market dealing in short-term debt andmonetary instruments. Money market instruments are forms of debt that maturein less than one year and are very liquid. Treasury bills make up the bulk of themoney market instruments. Securities in the money market are relatively risk-free.

Money market is a financial market for short-term borrowing and lendingtypically up to thirteen months. This contrasts with the capital market for longer-term funds. In the money markets, banks lend to and borrow from each other,short-term financial instruments such as certificates of deposits (CDs) or enterinto agreements such as repurchase agreements (repos). It provides short to

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medium term liquidity in the global financial system. Money marketderivatives include forward rate agreements (FRAs) and short-term interest ratefutures.

Budget: Quantitative plan of activities and programs expressed in terms ofassets, liabilities, revenues, and expenses. It is an estimation of the revenue andexpenses over a specified future period of time.

Leverage:The amount of debt used to finance a firm's assets. A firm withsignificantly more debt than equity is considered to be highly leveraged. The useof various financial instrumentsor borrowed capital, such as margin, to increase the potential return of aninvestment.

Return: Profit on a securities or capital investment, usually expressed as anannual percentage rate.Portfolio Management:The art and science of making decisions aboutinvestment mix and policy, matching investments to objectives, asset allocationfor individuals and institutions, and balancing risk vs. performance.

Book Value: By being compared to the company's market value, the book

value can indicate whether a stock is under- or overpriced. It is the total value ofthe company's assets that shareholders would theoretically receive if a companywere liquidated. In personal finance, the book value of an investment is the pricepaid for a security or debt investment. When a stock is sold, the selling price lessthe book value is the capital gain (or loss) from the investment.

Market Value:The current quoted price at which investors buy or sell a shareof common stock or a bond at a given time.

Bond: In finance, a bond is a debt security, in which the issuer owes the holdersa debt and is obliged to repay the principal and interest (the coupon) at a laterdate, termed maturity. Other stipulations may also be attached to the bond issue,

such as the obligation for the issuer to provide certain information to the bondholder, or limitations on the behavior of the issuer. Bonds are generally issued fora fixed term (the maturity) longer than one year. Bonds are called "fixed-income"securities because they pay a fixed interest rateso long as the company issolvent.

Sweat Equity Share: Sweat equity is a term used to describe thecontribution made to a project by people who contribute their time and effort. Itcan be contrasted with financial equity which is the money contributed towardsthe project. It is used to refer to a form of compensation by businesses to theirowners or employees.

Term Loan: A loan from a bank for a specific amount that has a specifiedrepayment schedule and a floating interest rate. Term loans almost alwaysmature between one and 10 years.

Financial Instrument: A real or virtual document representing a legaagreement involving some sort of monetary value. In today's financiamarketplace, financial instruments can be classified generally as equity based,representing ownership of the asset, or debt based, representing a loan made byan investor to the owner of the asset.

MOA, AOA and Prospectus: A Memorandum of Association should statethe name ofthe company (a company incorporated under the Companies Acts),

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whether the company is to be a public limited company or a privatelimited company, or other legal status, the objectives of the company, theauthorised share capital and the subscribers (the first promoters of thecompany).

The main purpose of the Articles of Association are to state the rules andregulations of how the directors should run the company and will cover suchthings as the issue of shares (also called stock), whether different shares carry

different voting and dividend rights, any restrictions on transfer of shares, howoften the directors are supposed to meet, period of notice required for notice ofmeetings, including Annual General Meetings (when the appointment andremoval of directors and approval of accounts are voted on), the calling ofextraordinary and special meetings, in other words basic and fundamental detailsof the company; i.e. name, purpose, directors and allocation of stock.

Rights Issue:An offering of common stock to existing shareholders who holdsubscription rights or pre-emptive rights that entitle them to buy newly issuedshares at a discount from the price at which they will be offered to the public

later.Proxy: An agent legally authorized to act on behalf of another party.Shareholders not attending a company's annual meeting may choose to votetheir shares by proxy by allowing someone else to cast votes on their behalf.

Seed Capital: Seed money, or seed capital, is the financing an entrepreneurneeds in the very early stages of launching a new business.

Share Premium:The difference between the higher price paid for a fixed-income security and the security's face amount at issue. Usually found on thebalance sheet, this is the account to which the amount of money paid (orpromised to be paid) by a shareholder for a share is credited to, only if theshareholder paid more than the cost of the share.

The share premium account may be used to issue bonus shares, write-offequity related expenses like underwriting costs, etc.

Operating Profit: An indicator of a company's profitability, calculated asrevenue minus expenses, excluding tax and interest. EBIT is also referred to as"operating earnings", "operating profit" and "operating income".

Operating Expense:The expense of maintaining property (e.g., payingproperty taxes and utilities and insurance); it does not include depreciation or thecost of financing or income taxes.

Margin Of Safety: Difference between the actual level of sales and Break-Even Sales. It is the amount by which sales revenue may drop before losses

begin and is often expressed as a percentage of budgeted sales.Margin of safety = Budgeted Sales - Breakeven Sales /Budgeted Sales

Mutual Funds:A mutual fund is a form of collective investment that poolsmoney from many investors and invests the money in stocks, bonds, short-termmoney market instruments, and/or other securities. Types of mutual funds are:

Open Ended

Closed Ended

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Derivative: Derivative is a security or a financial asset which derivesits value from some specified underlying asset. The main purpose of usingderivatives in the financial markets is to manage risks attached to theorganization.

Types of derivatives: The following are the types of derivatives classified intwo parts.

1. Commodity and Financial derivatives

2. Basic and Complex derivatives

Futures: A futures contract is a contract to buy or sell a stated quantity of acommodity or a financial claim at a specified price at a future specified date.

Forward Contracts: A forward contract is an agreement to buy or sell anasset at a certain time in the future for a certain price (the delivery price). It canbe contrasted with a spot contract, which is an agreement to buy or selimmediately. The typical usage of a forward would be to hedge the value offoreign currency denominated assets and liabilities. However, forwards can alsobe used for speculation.

Options: Options are contracts which provide the holder, the right to sell orbuy a specified quantity of an underlying asset, but not the obligation to buy orsell i.e., the holder of the option can exercise the option at his discretion or mayallow the option to lapse.Types of options:

Call Option- A call option provides to the holder a right to buy a specified asset ata specified price on or before a specified date.Put Option- Aput option provides to the holder a right to sell specified assets atspecified price on or before a specified date.

Strike Price: A specified price at which the option can be exercised is knownas the strike price.

Call option holder (exercises) if actual price > Strike price.Put option holder (exercises) if actual price < Strike price.

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If actual price > strike price In the moneyIf actual price < strike price - Out of moneyIf actual price = strike price - At the money

Swaps: It is another important type of derivative.A swap is a transaction inwhich two or more parties swap (exchanges) one set of pre-determined paymentfor another. Swaps are of two types.

1) Interest rate swap: It is an agreement between two parties to exchangeinterest obligations or receipts for an agreed period of time. Interest rateswaps are generally used when two parties are able to borrow at differentinterest rate system i.e., fixed rate of interest and floating rate of interest.

2) Currency Swap: It is an agreement between two parties to exchange (swap)payments or receipts in one currency for payment or receipts in anothercurrency.

Swaption: A Swaption is an option on a swap. The option provides the holderwith the right to enter in to a swap at a specified future date at specified terms.

This derivative has characteristics of an option and a swap. These types ofderivatives are also called multiple derivatives.

: ACCOUNTING STANDARDS:

In order to bring uniformity in terminology, approach and presentation ofaccounting results, the Institute of Chartered Accountants of India hasestablished an Accounting Standards Board (ASB) through which it has givensome Standards of Accounting, which every business has to follow. They aregiven below.

AS 1 Disclosure of Accounting PoliciesAS 2 Valuation of InventoriesAS 3 Cash Flow StatementsAS 4 Contingencies and Events Occurring after the Balance SheetDateAS 5 Net Profit or Loss for the period, Prior Period and Extraordinary Items and

Changes in Accounting PoliciesAS 6 Depreciation AccountingAS 7 Accounting for Construction contractsAS 8 -----AS 9 Revenue RecognitionAS 10 Accounting for Fixed AssetsAS 11 Accounting for the Effects of Changes in ForeignExchange RatesAS 12 Accounting for Government GrantsAS 13 Accounting for InvestmentsAS 14 Accounting for AmalgamationsAS 15 Accounting for Retirement Benefits in the Financial Statement

of EmployersAS16 Borrowing CostsAS 17 Segment Reporting

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AS 18 Related Party DisclosuresAS 19 LeasesAS 20 Earnings per ShareAS 21 Consolidated Financial StatementsAS 22 Accounting For Taxes on IncomeAS 23 Accounting for Investments in Associates in Consolidated

Financial Statements

AS 24 Discontinuing Operations

AS 25 Interim Financial ReportingAS 26 Intangible Assets and Accounting for Research andDevelopment

AS 27 Financial Reporting of Interests in Joint VenturesAS 28 Impairment of Fixed Assets (new) Deal with the valuation of

fixed assets, scrapping, valuation of old assets, valuation andchanging the value of fixed assets after valuation at the yearend. This also deals with the adding of new machinery to

plant.

: RATIO ANALYSIS:Ratio: Ratio is the numerical or an arithmetical relationship between twofigures. It is expressed when one figure is divided by another.

Ratio Analysis: It is the process of determining and presenting therelationship between two financial variables/values.Classification of Ratios:

1) Traditional Classification 2) Functional Classification

a. P&L a/c ratios a. Profitability Ratiosb. Balance sheet ratios b. Financial / Liquidity Ratiosc. Composite ratios c. Leverage / Capital Structure ratios

[P&L A/c + B/S] d. Solvency Ratiose. Turnover/Performance/Activity Ratios

A. Profitability Ratios: The profitability ratios measure thoperational efficiency of the firm. Generally they are calculated either inrelation to Sales or in relation to Investments. The profitability ratios arebroadly classified in three categories.

I. Profitability ratios required for analysis from owners point of

view:a) Return on Equity: Return on equity measures the profitability o

the equity funds invested in the firm. This ratio reveals howprofitably the owners funds has been utilized by the firm.

ROE = Profit after Tax Preference dividendEquity shareholders funds

b) Earnings per Share: It measures the profit available to the equityshareholders per share, that is, the amount that they can get on

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every share held. It indicates the value of equity in themarket.

EPS = Net profit available to the equity share holdersNumber of Equity shares

c) Dividend per share: The amount of profits distributed toshareholdersPer share is known as Dividend per Share. Sometimes the equity

shareholders may not be interested in the EPS, but in the returnwhich they are actually receiving from the firm in the form ofdividend.

DPS = Total profits distributed to the equity shareholdersNumber of equity shares

d) Price earning Ratio : This ratio which establishes the relationshipbetween the EPS and the market price of a share.

P/E Ratio = Market price per shareEarning per share

e) Dividend payout / Yield Ratio: The DP ratio is the ratio betweenthe Dividend per Share and the Earning per Share of the firm i.e. it

refers to the proportion of the EPS which has been distributed bythe company as dividends.

DP Ratio = Dividend Per Share * 100EPS

f) Yield: The yield is defined as the rate of return on the amouninvested.

Earnings Yield = EPSMPS

Dividend Yield = DPSMPS

Earnings yield and Dividend yield evaluate the profitability ofthe firm in terms of the MPS of the share and hence are usefulmeasures from the point of view of a prospective investor whois evaluating a share worth to take a buy or not to buy decision.

II. Profitability ratios based on Investments or Assets:

a) Return on Capital Employed / Return on Investment Ratio: Thisratio is an indicator of the earning capacity of the CapitaEmployed in the business.Return on Capital Employed = Net profit before Interest andTax

Capital EmployedThis ratio is a true measure of the firms ability to generate returnfor its shareholders. The higher the ROCE the better it is.

b) Return on Net worth / Shareholders Funds Ratio: The ratio, alsocalled Return on Proprietors Funds, is a measure of thepercentage of Net profit to shareholders funds.Return on Net worth = Net profit after Tax, Interest andPreference Dividend

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Equity Shareholders Fundsc) Return on Assets ratio: This ratio is calculated to measure the

profit after tax against the amount invested in total assets toascertain whether assets are being utilized properly or not.Return on Assets = Net profit after Interest and Tax * 100

Total AssetsThe higher the ratio, the better it is to the firm.

III. Profitability ratios based on Sales of the firm:a) Gross profit ratio: The gross profit ratio is called as the Average

Mark up ratio. This ratio is used to compare the departmentalprofitability or product profitability. Higher the ratio the better it is.A low ratio indicates unfavourable trends in the form of reductionsin selling prices not accompanies by proportionate decrease incost of goods or increase in cost of production.Gross profit Ratio = Gross profit * 100

Net Salesb) Operating profit ratio: This ratio establishes the relationship

between operating profit and sales.

Operating profit = Net profit before interest and tax.

Operating profit ratio = Operating profit * 100Net sales

c) Net profit ratio: This ratio is very useful to the proprietors andprospective investors because it reveals the overall profitability ofthe concern.

Net profit ratio = Net profit after interest and taxNet sales

d) Operating ratio: This ratio indicates the proportion that the cost ofsales bearsto sales.

Operating ratio = cost of goods sold + operating expenses *100

Net salesCost of goods sold = Opening stock + purchases + direct

expenses +Manufacturing expenses closing stock (or)Sales - Gross profit

Operating expenses = administrative expenses + selling anddistribution

Expenses

B. Financial / Liquidity / Short term solvency ratios: Theseratios indicate the short-term financial solvency and the ability to pay offliabilities of the firm.

1) Current Ratio: The current ratio gives the margin by which thevalue of the current assets may go down without creating anypayment problem for the firm. Generally 2:1 is considered ideal fora concern.

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Current assets = Cash in hand and at bank + billsreceivables + sundry

debtors + inventories + prepaid expenses +outstanding

incomes, accrued incomes + short terminvestments

Current liabilities = bills payable + sundry creditors + bankoverdraft +

outstanding expenses + incomesreceived in advance

proposed dividends + provision for taxation +unclaimed dividends + short term loans andadvancesrepayable within one year

2) Quick ratio: This ratio establishes the relationship betweenquick/liquid current assets and the current liabilities. The quickratio looks for the ready availability or convertibility into cashGenerally 1:1 is considered ideal ratio for a concern. Because it iswise to keep the liquid assets at least equal to the liquid liabilitiesat all times.

Quick Assets = Current Assets Inventories

Quick Liabilities = Current Liabilities Bank Overdraft Cash Credit

3) Absolute Liquidity Ratio / Super Quick Ratio / Cash Ratio: This ratioconsiders only the absolute liquidity available with the firm. Thecash and bank balance are no doubt, the most liquid assets and

the marketable securities are also considered as highly liquidassets. Generally 1:2 is considered as the ideal ratio to a concern.

Marketable securities = short term investments

4) Inventory Working capital ratio: In order to ascertain that there isno overstocking, the ration of inventory to working capital should

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be calculated. Increase in volume of sales requiresincrease in size of inventory, but from a sound financial point ofview inventory should not exceed amount of working capital. Thedesirable ratio is 1:1.

5) Fixed Assets Ratio: This ratio gives an idea as to what part of the

capital employed has been used in purchasing the fixed assets forthe concern. If the ratio is less than one (1) it is good for theconcern. This ratio is calculated as under:

Capital Employed = Equity share capital + Preferenceshare

Capital + Reserves & Surplus + Long-term

Liabilities Fictitious Assets6) Ratio of Current Assets to Fixed Assets: This ratio is differ from

industry to industry and, therefore, no standard can be laid down.A decrease in the ratio may mean that trading is slack or moremechanization has been put through. An increase in the ratio mayreveal that inventories and debtors have unduly increased or fixedassets have been intensively used. An increase in the ratioaccompanied by increase in profit, indicates that business isexpanding.

7) Debt to Equity Ratio: This ratio is calculated to measure therelative proportions of outsiders funds and shareholders fundsinvested in the company. This ratio is also known as external-internal equity ratio and is calculated as follows. Generally 2:1 isconsidered as the ideal ratio to a concern.

Long term debts = Debentures + Loans from

financialInstitutions + Public deposits

Shareholders Funds = Preference share capital + Equityshare

Capital + P&L A/c Cr Balance + Capital& Revenue reserves Fictitious Assets

8) Proprietary Ratio: A variant of debt to equity ratio is theProprietary ratio which shows the relationship betweenshareholders funds and total assets. This ratio should be 1:3 i.e.

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one-third of the assets minus current liabilities should beacquired by shareholders funds and the other two-thirds of theassets should be financed by outsiders funds.

9) Capital Gearing Ratio: This ratio establishes the relationship

between the fixed interest-bearing securities and equity shares ofa company. If this ratio is less than one, it is said to be low geared.If it is exactly one, it is evenly geared. This ratio must be carefullyplanned as it affects the companys capacity to maintain a uniformdividend policy during trading periods that may occur. Too muchcapital should not be realised by way of debentures, becausedebentures do not share in business losses.

C. Turnover / Performance / Activity Ratios: These ratios are

employed toevaluate the efficiency with which the firm manages and utilises itsassets. These

ratios usually indicates the frequently of sales with reference to itsassets.

These ratios are generally calculated on the basis of sales or costof salesand are expressed in integers rather than as a percentage. Such ratiosshould be calculated separately for each type of asset. Higher theturnover ratio, the better the profitability and use of capital or resourceswill be.

A. Capital Turnover Ratio (Sales to Capital Employed): This ratioindicates the firms ability of generating sales per rupee of longterm investment. The higher the ratio, the more efficient theuitilsation of owners and long-term creditors funds. The higherthe ratio, the greater are the profits. A low capital turnover ratioshould be taken to mean that sufficient sales are not being madeand profits are lower.

B. Fixed Assets Ratio (Sales to Fixed Assets): This ratio shows howwell the fixed assets are being utilised in the business. The ratio isimportant in case of manufacturing concerns because sales areproduced not only by use of current assets but also by amountinvested in fixed assets. The higher is the ratio, the better is theperformance. On the other hand, a low ratio indicates that fixedassets are not being efficiently utilised.

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C. Working Capital Turnover Ratio (Sales to Working Capital):This ratio shows the number of times working capital is turned-over in a stated period. The higher the ratio, the lower theinvestment in working capital and the greater are profitsHowever, a very high turnover of working capital is a sign ofovertrading and may put the concern into financial difficulties. Onthe other hand a low working capital turnover ratio indicates that

working capital is not efficiently utilised.

D. Total Assets Turnover Ratio: This ratio measures the per rupeesales generated by per rupee of tangible assets being maintainedby the firm. A high ratio is an indicator of overtrading of totaassets while a low ratio reveals idle capacity. The traditionastandard for the ratio is two times.

E. Stock Turnover Ratio / Inventory Turnover Ratio: This ratioestablishes a relationship between cost of goods of sold during agiven period and the average amount of inventory held during thatperiod. Higher the ratio, the better it is because it shows thatfinished stock is rapidly turned over. On the other hand a low ratiois not desirable because it reveals the accumulation of obsoletestock, or the carrying of too much stock.

Cost of goods sold = Opening stock + Purchases +Manufacturing

Expenses Closing Stock or sales GrossProfit

F. Debtors Turnover Ratio (Receivables Turnover Ratio): This ratio

measures the accounts receivables (trade debtors and billsreceivables) in terms of number of days of credit sales during aparticular period. This ratio also tells us about the collectibility ofaccounts receivables and tells about how the credit policy of thecompany is being enforced.

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G. Creditors Turnover Ratio: This ratio gives the average creditenjoyed from the creditors by the company. This ratio shows thevelocity of debt payment by the firm. A high ratio indicates thatcreditors are not paid in time while a low ratio gives an idea thatthe business is not taking full advantage of credit period allowedby the creditors.

ANALYSIS OF FINANCIAL STATEMENTS

Funds Flow Statement (FFS): It shows the sources and uses of workingcapital between two balance sheet dates. The Funds Flow Statement attempts toexplain the change in financial position from one Balance sheet date to thesubsequent Balance sheet in terms of the change in the funds (or) the workingcapital position of the firm. So, the FFS is a historical record, a postmortem ofwhere the funds cane from and how these were utilized during the year.

SOURCES OF FUNDS APPLICATION OF FUNDS

Increase in Liabilities Decrease in Liabilities Increase in Capital Decrease in Capital

Decrease in Assets and Investments Increase in Fixed Assetsand Investments

Pro forma of Funds Flow Statement (Vertical Form):

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I SOURCES OF FUNDS Amount Amount

1. Funds from Operations *******2. Issue of Share Capital *******3. Issue of Debentures *******4. Long Term Borrowings *******5. Sale of Assets/Investments *******

6. Non Operating Incomes *******7. Any other Source *******

Total Sources (A) ******* ********

II APPLICATION OF FUNDS

1. Loss from Operations *******2. Redemption of Share Capital *******3. Redemption of Debentures *******4. Repayment of Loans *******5. Purchase of Assets/Investment *******

6. Payments of Dividends *******7. Any other Use *******

Total Application (B) ******* *********

Increase/Decrease in WC (Bal. Fig.) (A B)

Cash Flow Statement: It shows the movements of cash between twoBalance sheet dates.The Cash Flow Statement attempts to analyze the transactions of the firm interms of cash i.e. the transactions generating cash and using the cash. The focus

in the CFS is on cash rather than on Working Capital.

Pro forma of cash flow statement:I. CASH FLOWS FROM OPERATING ACTIVITIES:

Cash receipts from customers ******Cash paid to suppliers and employees ******Cash generated from operations ******Income tax paid ******Cash flow before extraordinary item ******

Extra-ordinary items ******Net cash from operating activities*******

II. CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of fixed assets ******Proceeds from sale of equipment ******Interest received ******Dividend received ******Net cash from investing activities*******

III. CASH FLOWS FROM FINANCING ACTIVITIES:

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Proceeds form issuance of share capital ******Proceeds form long term borrowings ******Repayments of long term borrowings ******Interest paid ******Dividend paid ******Net cash from financing activities*******

Net increase in cash and cash equivalents*******Cash and cash equivalents at beginning of period*******Cash and cash equivalents at the end of the period*******

Differences between FFS and CFS:1. FFS is based on the concept of Working capital whereas CFS is based on

cash which is only one of the elements of Working capital.2. CFS considers only the actual movements of cash whereas FFS considers

the movement of funds as defined in terms of net working capital.

CAPITAL BUDGETING AND COST OF CAPITAL

Cost of Capital: The rate of return the firm requires from investment in orderto increase the value of the firm in the market value is cost of capital.

Venture Capital: Venture capital is a form of equity financing designedspecially for funding high risk and high reward projects.

Venture funds are provided by Industrial Financing Corporation of India

(IFCI), IDBI, Small Industries Development Bank of India (SIDBI) and ICICI.

Capital Budgeting: Capital budgeting refers to long term planning forproposed capital outlays and financing. Any decision that requires the use ofresources is a capital budgeting decision.The capital budgeting decision denotes a decision situation where the lump sumfunds are invested in the initial stages of a project and the returns are expectedover a long period.Techniques involved in Capital Budgeting: Traditional/non-discounting Time adjusted/discounted cashflows

Payback period

Net Present Value (NPV)

Accounting/average Rate of Return (ARR) Profitability Index

Internal Rate of Return (IRR)

Terminal value

Payback period: The payback period is the length of time required torecover the initial cost of the project. The payback period therefore, can belooked upon as the length of time required to Break Even on its net investmenta) When annual inflows are equal: When the cash inflows being generated by aproposal are

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equal per time period i.e. the cash flows are in the form of an annuity,the payback period can

be computed by dividing the cash outflow by the amount of annuity. Cashinflows means

profit after tax but before depreciation.

b) When the annual cash inflows are unequal: In case the cash inflows from the

proposal are not in annuity form then the cumulative cash inflows are used tocompute the payback period.

Payback period = Cost of projectTotal cash inflows

The project with lower payback period will bepreferred always.

Payback period reciprocal = (1/ payback period) *100

The higher the payback period reciprocal (and hence lower the paybackperiod), the more worth is the proposal is.

Accounting Rate of Return or Average Rate of Return: The ARRis based on the accounting concept of return on investment or rate of return. TheARR may be defined as the annualized net income earned on the average fundsinvested in a project. In other words, the annual returns of a project areexpressed as a percentage of the net investment in the project.

ARR = Average Annual profit (after tax)Average investment in the project

OrInitial investment

Average Investment = (Initial Cost + Installation Expenses salvagevalue) + salvagevalue

Net Present Value (NPV) Method: The NPV of an investment proposa

may be defined as the sum of the present values of all the cash inflows less thesum of the present value of all cash outflows associated with the proposal. Thus,the NPV is the sum of the discounted values of the cash flows of a proposal. Aproject can be accepted if NPV is positive i.e. NPV>0 and rejected when isnegative i.e. NPV


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Where NPV = Net Present ValueCFi = Cash flows at the end of the year 0,

1, 2..n,k = The discount rate, andn = Life of the project in years

Profitability Index (PI): The PI is also based upon the basic concept ofdiscounting the future cash flows and is ascertained by comparing the presentvalue of the future cash inflows with the present value of the future cashoutflows. The PI technique is a formal way of expressing the relationship betweencost and benefit.

PI = Total present value of cashinflows

Total present value of cashoutflows

Internal Rate of Return: The IRR of a proposal is defined as the discountrate which produces a zero NPV i.e. the IRR is the discount rate which will equate

the present value of cash inflows with the present value of cash outflows. The IRRis also known as Marginal Rate of Return or Time Adjusted Rate of Return.

Where CO0 = Cash outflow at time 0,CFi = Cash inflow at different point of time

n = Life of the project, andr = Rate of discount (yet to be calculated)

SV&WC = Salvage value and working capital at the endof the n years

Terminal value: In the Terminal Value technique, the future cash flows arefirst compounded at the expected rate of interest for the period from theiroccurrence till the end of the economic life of the project. The compoundedvalues are then discounted at an appropriate discount rate to find out the presentvalue. This present value is compared with the initial outflow to find out thesuitability of the proposal.

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V = S +D

Where V = Value of the firmS = Market value of equityD = Market value of Debt

WhereNI = Earnings available for equity shareholdersKe = Equity Capitalisation rate

The overall cost of capital under this approach is ascertained by:

B. Net Operating Income Approach (NOI approach) : This approach isalso suggested by Mr. Durand. According to this approach, the marketvalue of the firm is not affected by the capital structure changes. Themarket value of the firm is ascertained by capitalising the net operatingincome at the overall cost of capital which is constant. The market value ofthe firm is determined as follows:

The value of equity can be determined by the following equation:

Value of equity (S) = V (market value of firm D (Marketvalue of debt)

The Net Income Operating Income Approach is based on the followingassumptions:

i. The overall cost of capital remains constant for all degrees of equitymixii. The market capitalises the value of firm as a whole. Thus the split

between debt and equity is not important.iii. The use of less costly debt funds increases the risk of shareholders.iv. There are no corporate taxes.v. The cost of debt is constant.

Overall cost of capital is calculated under this method is:

Market value of equity (S) =NI

Ke

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Where Ko = Cost of capitalKd = Cost of debentures

Ke = Cost of equityD = Market value of debt

S = Market value of equityC. Traditional Approach: The traditional approach is also called a

Intermediate approach as it takes a midway between NI approach (that thevalue of the firm can be increased by increasing financial leverage) and NOapproach (that the value of firm is constant irrespective of the degree offinancial leverage). According to this approach the firm should strive toreach the optimal capital structure and its total valuation through ajudicious use of the both debt and equity in capital structure.

D. Modigliani and Miller Approach (MM approach): According to thisapproach the total cost of capital of particular firm is independent of itsmethods and level of financing. Modigliani and Miller argued that the

weighted average cost of capital of a firm is completely independent of itscapital structure. In other words, a change in the debt equity mix does notaffect the cost of capital. But mostly Modigliani and Miller supported NOI(Net Operating Income) approach. According to the MM approach theoverall cost of capital is constant and the cost of equity increases linearly(same direction) with debt. The equity capitalisation rate is given by:

MEASUREMENT OF COST OF CAPITAL: The cost of capital is asignificant factor in designing the capital structure of an undertaking. The basicreason behind running a business undertaking is to earn a return at least equal toits cost of capital. The following are the various measures of cost of capital.

1) Cost of Debt:The explicit cost of debt is the interest rate as per contractadjusted for tax and the cost of raising the debt.Cost of irredeemable debentures: Cost of the debentures not redeemableduring the life time of the company.

Where Kd = Cost of debt after taxI = Annual interest rate

NP = Net proceeds of debenturesT = Tax rate

Cost of redeemable debentures: If the debentures are redeemable afterthe expiry of a fixed period the cost of debentures would be:

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WhereI = Annual interest payment

NP = Net proceeds of debenturesRV = Redemption value of debentures

t = Tax rate

2) Cost of preference shares: In the case of preference shares, thedividend rate can be taken as its cost since it is this amount which thecompany intends to pay against preference shares.

Cost of irredeemable preference shares:PDPO

Where PD = Annual preference dividendPO = Net proceeds in issue of preference shares

Cost of redeemable preference shares:

Where PD = Annual preference dividendRV = Redemption value of preference sharesNP = Net proceeds in issue of preference sharesN = Life of preference shares

3) Cost of Ordinary (or) Equity shares: Calculation of cost of ordinaryshares involves a complex procedure. This is because unlike debt andpreference shares there is no fixed rate of interest or dividend againstordinary shares.

i. The dividend price approach:

Where Ke = Cost of Equityd1 = Annual dividendPo = Market value of equity

ii. Extending the above model to incorporate for growth g:

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Where g = Growth rate

4) Weighted Average Cost of Capital (WACC): The composite oroverall cost of capital

of a form is the weighted average of the costs of various sources of fundsWeights are

taken to be the proportion of each source of funds in the capital structure.

The weighted average cost of capital (WACC) is calculated by:

i. Calculating the cost of sources of funds, for e.g. - cost of debt, equity etcii. Multiplying the cost of each source by its proportion in capital structureiii. Adding the weighted component costs to get the firms WACC.

Thus WACC is:

Ko = K1 W1 + K2 W2 +..

Where K1, K2 are component costs andW1, W2 are weights.

WACC after Tax = Kd (1-t)

: METHODS FOR CALCULATING DEPRECIATION:

The Standard which is laid down by the ICAI (Institute of CharteredAccountants of India) in September 1994 about Depreciation is, AccountingStandard No: 6. This has become mandatory from the year April 1st, 1995.

A) Fixed Installment Method (or) Straight Line Method (SLM): Depreciation is

charged evenly every year throughout the effective life of the asset.

Depreciation = Cost of the Asset (C) Scrap value (S)

Life of the Asset (N)(OR)

D = C - SN

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B) Diminishing Balances Method: Depreciation is charged on the bookvalue of the asset each year.

C) Machine Hour Rate Method (Service Hour Method): This method takes intoaccount the running time of the asset for the purpose of calculating thedepreciation.

Depreciation = Original Cost of the Asset Scrap Value

Life of the Asset in Hours

JOURNAL ENTRIES FOR DEPRECIATION ACCOUNTING

1. When a Provision for Depreciation Account is maintained:

A) Depreciation A/c DrTo Provision for Depreciation A/c

B) For transferring depreciation to Profit and Loss A/c:Profit and Loss A/c Dr

To Depreciation A/cC) On sale of Asset:

Provision for Depreciation A/cDrTo Asset A/c

For Profit on sale of Asset:Asset A/c Dr

To Profit and Loss A/c

For Loss on sale of Asset:Profit and Loss A/c

To Asset A/c

2. When a Provision for Depreciation account is not maintained:

A) For providing Depreciation:Depreciation A/c Dr

To Asset A/c

B) For transferring of Depreciation to the P&L A/c:Profit and Loss A/c Dr

To Depreciation A/c

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: ACCRUALS AND OUTSTANDINGS:(Which are also comes under the adjustment entries in Final Accounts)

EXPENSES:

1) Outstanding expenses: Outstanding expenses refer to those expenses, which

have become due during the accounting period for which the Final Accounts havebeen prepared but have not yet been paid.

The journal entry for an outstanding expense is:Expenses A/c Dr

To Outstanding Expenses A/c

It should be noted that any item given outside the Trail Balance will berecorded at two

places on account of Dual Aspect Concept.

2) Prepaid expenses: Prepaid expenses are expenses which have been paid inadvance. In otherwords, these are the expenses which have been paid during the accountingperiod for which the Final Accounts are being prepared but they relate to thenext period.

The journal entry is:

Prepaid Expenses A/c DrTo Expenses A/c

INCOMES:

1) Outstanding Income: The income which has become due during theaccounting year but which has not so far been received by the firm.

The journal entry is:Outstanding Income A/c Dr

To Income A/c

2) Accrued Income: The income which has been earned by the businessduring the accountingyear but which has not yet become due and, therefore, has not received.

The journal entry is:Accrued Income A/c DrTo Income A/c

3) Income received in Advance: Income received in advance means incomewhich has been received by the business before it being earned by thebusiness. This includes certain pre-payments which the business mayreceive during the course of the accounting year. In order to ascertain thetrue Profit or Loss, it is necessary that such income is not taken intoaccount while preparing the Profit and Loss Account for the year.

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The journal entry is:Income A/c Dr

To Income received in Advance A/c

Bad debts: Credit Sales have become a must these days and bad debts occurwhen thereare credit sales. Bad Debt is a loss to the business and a gain to the debtor.

Bad Debts A/c DrTo Debtors personal A/c

Provision for Bad Debts: A firm makes provision at the end of theaccounting year forlikely bad debts which may happen during the course of the next year. This is forthe simplereason that if out of credit sales made during a particular year, some sales like to

become badin the course of the next year, the proper course would be to charge the sameaccounting yearwith such likely bad debts in which the sales have been made, since, the profit onsuch saleshas been considered in the year in which the sales have been made.

The journal entry is:Profit & Loss A/c Dr

To Provision for Bad Debts A/c

Provision for discount on Debtors: Discount may have to be allowed tothe debtors on account of their prompt payments.

The entry is:Discount A/c Dr

To Debtors personal A/c

At the end of the accounting year, the firm also estimates the amount ofdiscount which it may have to give to the debtors outstanding at the end of theaccounting year in the course of the next year. This is done by creating aprovision for discount on debtors. The following journal entry is passed in thatcase:

Profit and Loss A/c DrTo Provision for Discount on debtors A/c

It should be noted that provision for discount will be created only on gooddebtors. In other words, provision for discount should be made after deductingbad debts and provision for bad debts from the debtors balances.

Reserve for discount on creditors: A firm may like to crate a reservefor discount on its creditors on a similar pattern on which a provision for discount

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on debtors is made. However, creating of such a reserve is against thefundamental convention of conservatism. However, if this is done the accountingentries are passed on the same pattern on which the accounting entries arepassed for provision for discount on debtors.

i. For discount received form creditors:Sundry Creditors A/c Dr

To Discount A/cii. For creating a reserve for discount creditors:

Reserve for discount on creditors A/c DrTo Profit and loss A/c

Interest on Capital: Interest on capital is allowed on the balance in theCapital Account in the beginning of the accounting year.

Interest on capital A/c DrTo Capital A/c

Interest on drawings: Drawings denote the money withdrawn by theproprietor from the business for his personal use. It is usual to charge interest ondrawings in case interest is allowed to the proprietor on his capital.

Capital A/c DrTo Interest on drawings A/c

Closing stock: The stock at the end appears in the Balance Sheet and itsbalance at the end of the accounting year is carried forward to the next year.

Closing stock A/c DrTo Trading A/c

BRANCH AND HEAD OFFICE ACCOUNTS

The various divisions of the business located in different places in the same town(or) in different towns in the state or country are known as Branches.

Branches can be broadly classified into two categories for the purpose ofrecording transactions in the books of accounts.

I. Dependent BranchesII. Independent Branches

I. Dependent Branches: A branch which does not maintain its own set ofbooks and all of the records have to be maintained by the office is said to be aDependent Branch.

It maintains only two ledgers. They are:

a. Debtors ledger To find out money due from debtors

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b. Stock ledger To provide information regardingthe stock received

from Head Office and Balance in hand

II. Independent Branches: A branch which maintains its own set of booksSuch branch can either be a Home Branch or a Foreign Branch. The method ofaccounting is the same in both the cases except that in case of a foreign branch,

the trail balance sent by the foreign branch is to be converted into the currencyof the country of the Head Office.

Systems of Accounting:

1. Debtors System: This system is followed in case of branches of small size. The head office maintains a Branch Account, in its books. The BranchAccount is of the nature of Nominal Account.

2. Stock and Debtors System: In this system of accounting, the Head Officemaintains a number of accounts for keeping a record of Branchtransactions in place of one branch account.

3. Final Accounts System: The balance in the Branch Account (prepared withthis method) at the end of a particular period represents the net assets atthe Branch (i.e., Assets Liabilities at the Branch).

4. Wholesale Branch System: In this method of accounting the Head office wilCrate a Stock Reserve for any unrealised profit in respect of goods lyingunsold at the Branch which are appearing there at invoice price. Such asystem of finding out the profit and loss at the Branch is known asWholesale Branch System.

Journal Entries:

1. For goods supplied by the Head Office to Branch Office:

Branch A/c DrTo Goods sent to Branch A/c

2. For goods returned by the Branch Office to Head Office:

Goods sent to Branch A/c DrTo Branch A/c

3. For goods sent by Branch to another Branch on Head Office instructions:

Goods sent to Branch A/c DrTo Branch A/c

4. For remittances received from Branch:

Bank A/c Dr

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Opening Balance + Purchases of Fixed Assets Amount realised on accountof Sale of Fixed

assets

RECTIFICATION OF ERRORS

The preparation of Trail Balance is a method of verifying the arithmeticaaccuracy of entries made in the ledger. But it may not be noted that anagreement in the Trail Balance does not prove that.

(I) All transactions have been correctly analyzed and recorded in theproper accounts;

(II) All transactions have been recorded in the books of original entry.

Hence we can say that a trail balance should not be regarded as a conclusiveproof of the correctness of the books of accounts, that if the trail balance doesnot agree, there are errors or mistakes and if the trail balance does agree, theremay be errors in the accounts.

Classification of Errors:

(A critical evaluation of classification of Errors)

Classification of Errors:

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(A simple view of Errors Classification)

Errors of Omission: These errors are incurred in those cases when atransaction is completely omitted from the books of accounts. It happens when atransaction is not recorded in the books of the original entry (i.e. variousjournals). These errors cannot be traced easily.

Errors of commission: Such errors include errors on account of wrongbalancing of an account, wrong posting, wrong carry forwards, wrong totaling,and etc. Errors of commission affect the agreement of the Trail Balance and,therefore, their location is easier.

Errors of Principle: Errors of principle are committed in those cases where aproper distinction is not made between Revenue and Capital items such asdistinction between Revenue Receipt and Capital Receipt and RevenueExpenditure and that of Capital Expenditure. Such errors by themselves do notaffect the agreement of Trail Balance. Therefore, they are also difficult to locate.

Errors of Compensating: As the name indicates, compensating errors arethose errors which compensate the agreement each other. These are group oferrors, the total of which are not reflected in the trail balance. These errors alsodo not affect the agreement of trail balance and, therefore, their location is alsodifficult.

SUSPENSE ACCOUNT The Accountant should take various steps one after the other to locate thedifference in the totals of the Trail Balance. In case, he is not in a position tolocate the difference and he is in a hurry to close the books of accounts, he maytransfer the difference to an account known as Suspense Account. ThusSuspense Account is an account to which the difference in the Trail Balance hasbeen put temporarily. On locating the errors in the beginning (or) during thecourse of the next year, suitable accounting entries are passed and the SuspenseAccount is closed. However, it should be noted that Suspense Account should beopened by the accountant only when he has failed to locate the errors in spite ofhis best efforts. It should be opened by the way of a normal practice, because thevery existence of Suspense Account creates doubt about the authenticity of thebooks of accounts.

RECTIFYING ACCOUNTING ERRORS

The errors committed in the books of accounts when located out, have to becorrected. However, corrections in the books of accounts should be done, by

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passing proper rectifying entries and not by cutting or erasing figures.Such entries are passed in the General Journal or Journal Proper.

(Please go through any of the Author Books to practice RectifyingEntries)

ACCOUNTING OF BANKING COMPANIES

According to Banking Regulations Act Banking is the accepting of deposits ofmoney from public for the purpose of lending or investment of money, repayableon demand or otherwise and withdrawable by cheque, draft, and order orotherwise.

A banking company is required to prepare its Profit and Loss Accountaccording to Form B in the Third Schedule of the Banking Regulations act, 1949.Form B is in a summary form and the details of the various items are given in theSchedules.

In the Profit and Loss Account of a Banking company the following schedules canbe seen:

They are:

SCHEDULE -13 INTEREST EARNED

SCHEDULE -14 OTHER INCOME

SCHEDULE -15 INTEREST EXPENDED

SCHEDULE -16 OPEARTING EXPENSES

In the same way as like P&L Account we will find some schedules in the Balance

Sheet of Banking Company.They are:

SCHEDULE -1 CAPITAL

SCHEDULE -2 RESERVES & SURPLUS

SCHEDULE -3 DEPOSITS

SCHEDULE -4 BORROWINGS

SCHEDULE -5 OTHER LIABILITIES & PROVISIONS

SCHEDULE -6 CASH AND BALANCES WITH RESERVE BANK OF INDIA

SCHEDULE -7 BALANCES WITH BANKS & MONEY AT CALL & SHORT NOTICE

SCHEDULE -8 INVESTMENTS

SCHEDULE -9 ADVANCESSCHEDULE -10 FIXED ASSETS

SCHEDULE -11 OTHER ASSETS

SCHEDULE -12 CONTINGENT LIABILITIES: SOME OF THE OTHER TERMS MAILNT USED IN BANKING COMPANIES:

Money at call and short notice

Cash credit

Overdraft

Loan

Discounting of Bills

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Purchasing and Discounting of Bills

Clean bills

Documentary bills

Bills for collection

Acceptances, Endorsements and other Obligations

Bills payable

Inter office adjustments Non-banking Assets

Rebate on Bills discounted or unexpired discounts

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acc - fin material

Documents