M007 – LEVEL 01 ACCOUNTING PRINCIPLES AND PROCEDURES

1. BALANCE SHEET
A balance sheet is a financial statement that indicates the assets, liabilities and equity of a company or individual at a specific
time or date.
Equity = Assets – Liabilities.

2. CONSOLIDATED FINANCIAL STATEMENT:

 Director’s Report
 Auditor’s Report
 Consolidated balance sheet statement
 Consolidated income sheet statement
 Consolidated cash flow statement
 Change in equity statement
 Notes to financial statement

3. DOUBLE ENTRY BOOK KEEPING: In double-entry bookkeeping every entry to an account requires a corresponding and
opposite entry to a different account. The double entry has two equal and corresponding sides known as debit and credit. The
left-hand side is debit and right-hand side is credit.

4. INCOME STATEMENT (PROFIT & LOSS STATEMENT):

An income statement or profit & loss statement is a financial statement that indicates the revenues, expenses and net income of
a company or individual over a period of time.
Revenue – Expenses = Net Income.
Revenue = Money received from sale of goods or services before expenses are taken out

5. CAPITAL EXPENDITURE: A capital expenditure is an amount spent to acquire or improve long term assets such as
equipment or land. Capital expenditure is on item that will help generate profit over longer period of time and the depreciation
amount is charged against the profits in the income sheet.

6. REVENUE EXPENDITURE: A revenue expenditure is an amount that is related to expenses in daily repair and
maintenance works. Revenue expenditure is normally charged against profit in the income statement.

7. CASH FLOW: Cash flow refers to the movement of cash in or out of a business during a specified time. Measurement of
cash flow can help in:
 Project’s rate of return or value
 Determine liquidity. Being profitable doesn’t mean being liquid. A company can fail because of shortage of liquid
cash, even while profitable.
 Cash flow can be used to evaluate the quality of income generated. When net income consists of non-cash items, it
is referred to as low quality of income.
 To evaluate the risks within a financial product. E.g. matching cash requirements, evaluating default risks, re-
investment requirements etc.

8. CASH FLOW STATEMENT: Cash flow statement shows how changes in balance sheet and income accounts affect cash
and cash equivalent and breaks the analysis down to operating, investing and financing activities. As an analytical tool, the
statement of cash flows is useful in determining the short term viability of a company, particularly its ability to pay bills.

9. AUDITS: Audit is an evaluation of an organization or company or system to ascertain the validity and reliability of
information; an assessment of internal control. Audits are associated with gaining information about financial systems and
records of a business. It is performed by auditors and an auditor’s reports is based on the audit report.

1|Page
 M007 – LEVEL 01 ACCOUNTING PRINCIPLES AND PROCEDURES
10. FINANCIAL RATIOS ANALYSIS: Financial ratio analyses enables to spot the trends in a business and to
compare its performance and conditions with the average performance of similar business in the similar industry. Ratio
analysis also provide early warning indication that allow you to solve your business problems. They include the following
ratios:
 GEARING RATIOS: (Long Term Liabilities) / (Equity Share Holder’s Fund)

11.BALANCE SHEET RATIO ANALYSIS: Balance sheet ratio measures liquidity and solvency and leverage. They include
LIQUIDITY RATIO (Ease of Turning Assets to Cash):
 CURRENT RATIOS (Measure of Financial Strength): (Total Current Assets) / (Total Current Liability)

 QUICK RATIOS (Measure of Liquidity): (Cash + Government Securities + Receivables) / (Total Current Liability)

 WORKING CAPITAL: (Measure of a cash flow) = Total Current Assets – Total Current Liabilities.
The bankers look at working capital to determine the company’s ability to weather financial crisis and loans are often tied to minimum
working capital requirements.
Higher the liquidity ratio, they are better, especially if you are relying to any significant extent on creditor money to finance assets. If you
decide your business's current ratio is too low, you may be able to raise it by:
 Paying some debts.
 Increasing your current assets from loans or other borrowings with a maturity of more than one year.
 Converting non-current assets into current assets.
 Increasing your current assets from new equity contributions.

12. LEVERAGE RATIO: This Debt / Worth or Leverage Ratio indicates the extent to which the business is reliant on
debt financing (creditor money versus owner's equity):
 Debt Ratio or Leverage Ratio: (Total Liabilities) / Net Worth

13. INCOME STATEMENT RATIO ANALYSIS – It is an analysis of measurement of profitability.

 Gross Margin Ratio = (Gross Sales) / Net Sales

 Net Profit Margin Ratio = (Net Profit before Tax)/ Net Sales

14. INVENTORY TURN OVER RATIO - This ratio reveals how well inventory is being managed.
Inventory Turn Over Ratio = (Net Sales) / (Average Inventory at Cost)

15. ACCOUNT RECIEVABLE RATIO - his ratio indicates how well accounts receivable are being collected
Account Receivable Turn Over Ratio = (Accounts Receivable) / (Daily Credit Sales)

16. RETURN ON ASSET RATIO - This measure how efficiently profits are being generated from the assets
employed in the business
Return on Asset = (Net Profit before Tax) / (Total Asset)
RETURN ON INVESTMENT - This ratio reveals how well inventory is being managed.
Return on Investment = (Net Profit before Tax) / (Net Worth)

17. CREDIT CONTROL: Credit control policies are aimed at serving the dual purpose:
a) increasing sales revenue by extending credit to customers who are deemed a good credit risk,
b) minimizing risk of loss from bad debts by restricting or denying credit to customers who are not a good credit risk

18. INSOLVENCY: Insolvency means the inability to pay one's debts as they fall due. Usually used in
business terms, insolvency refers to the inability for a 'limited liability ' company to pay off debts.

2|Page
 M007 – LEVEL 01 ACCOUNTING PRINCIPLES AND PROCEDURES
19. BANKRUPTCY: It is a legally declared inability or impairment of ability of an individual or organization to pay its
creditors.

20. LIMITED LIABILITY: Is a concept whereby a person's financial liability is limited to a fixed sum, most
commonly the value of a person's investment in a company or partnership with limited liability.

3|Page