Financial Accounting & Analysis

Semester 1
September 2022 Examination

Q1. In the year 2021, the company sell off the Land at 70 Lakhs and to dispose of the Machinery at 30 Lakhs.
Also, the company acquired certain Investments for Rs 50 Lakhs from the sales proceed, Pay off certain Current
liabilities for Rs 5 Lakhs, Interest on long term Loan Rs 7 Lakhs

Discuss the type and amount of cash flows in the year 2021, as per the Accounting Standard 3 and P&L on sale
of the machinery, if any.

Introduction
In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that
shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis
down to operating, investing and financing activities., The cash flow statement is concerned with the flow of cash
in and out of the business. 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

The cash flow statement differs from the balance sheet and income statement in that it excludes non-cash
transactions required by accrual basis accounting, such as depreciation, deferred income taxes, write-offs on
bad debts and sales on credit where receivables have not yet been collected.

Cash flow activities

Operating activities: Operating activities include the production, sales and delivery of the company's product as
well as collecting payment from its customers. This could include purchasing raw materials, building inventory,
advertising, and shipping the product.

 Receipts for the sale of loans, debt or equity instruments in a trading portfolio
 Interest received on loans
 Payments to suppliers for goods and services
 Payments to employees or on behalf of employees
 Interest payments (alternatively, this can be reported under financing activities in IAS 7)
 Purchases of merchandise

Investing activities: The second section on the cash flow statement records the gains and losses caused due to
investment in assets like property, plant, or equipment (PPE) thus reflecting overall change in the cash position for a
company Examples of investing activities are:

 Purchase or sale of an asset

 Loans made to suppliers
 Payments related to mergers and acquisitions

Financing activities: Financing activities include inflows and outflows of cash between investors and the company

 Dividends paid
 Sale or repurchase of the company's stock
 Net borrowings
 Repayment of debt principal, including capital leases
 Other activities which impact the company's long-term liabilities and equity
 Direct Cash Flow Method: The direct method adds
up all of the cash payments and receipts, including
cash paid to suppliers, cash receipts from customers,
Investing and cash paid out in salaries. This method of CFS is
Operating
Activities easier for very small businesses that use the cash basis
Activities accounting method.

Indirect Cash Flow Method: With the indirect

Financing method, cash flow is calculated by adjusting net
Activities
income by adding or subtracting differences resulting
from non-cash transactions. Non-cash items show up
in the changes to a company’s assets and liabilities on
the balance sheet from one period to the next.
Therefore, the accountant will identify any increases
and decreases to asset and liability accounts that need
Cash Inflow to be added back to or removed from the net income
figure, in order to identify an accurate cash inflow or
outflow.

Net Cash Flow for the Year 2021

Serial No Particulars Amount
A Cash flow from Investing Activities
1 Sale of Land 70,00,000
2 Sale of Machinery 30,00,000
3 Investment from Sales Proceeds 50,00,000
Net Cash flow from Investing 1,50,00,000
B Cash flow from Financing Activities
4 Payment of Liabilities 5,00,000
5 Payment of Loan Interest 7,00,000
Net Cash flow from Investing 12,00,000

C Net Cash flow for FY 2021 1,38,00,000

Conclusion
The cash flow statement measures the performance of a company over a period of time. But it is not as easily
manipulated by the timing of non-cash transactions. As noted above, the CFS can be derived from the income
statement and the balance sheet. Net earnings from the income statement are the figure from which the
information on the CFS is deduced. But they only factor into determining the operating activities section of
the CFS. As such, net earnings have nothing to do with the investing or financial activities sections of the
CFS.

The income statement includes depreciation expense, which doesn't actually have an associated cash outflow.
It is simply an allocation of the cost of an asset over its useful life.

As for the balance sheet, the net cash flow reported on the CFS should equal the net change in the various
line items reported on the balance sheet. This excludes cash and cash equivalents and non-cash accounts, such
as accumulated depreciation and accumulated amortization.

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Q2. Mr. Somil is working as an accounts executive for Tarak Shah & Company. He has to record certain accounting
transactions as on 30th March2021, so that he can move ahead to close the books of accounts as on 31st March.

He is confused between Realization concept of accounting and Matching concept of Accounting. As an accounts
manager, kindly help him in understanding these two, by

 Defining the Meaning and purpose of both the concepts.

 Suitable example for each concept highlighting the difference between these concepts

Introduction
Accounting is both a science and an art. And just like all other streams of science, even in accounting certain rules
are followed. Also, accounting is based on certain assumptions as well. We call these accounting concepts or
accounting concepts and principles. Let us study accounting concepts and applications in brief.

Definition: Realization Concept

Realization concept in accounting, also known as revenue recognition principle, refers to the application of
accruals concept towards the recognition of revenue (income). Under this principle, revenue is recognized by
the seller when it is earned irrespective of whether cash from the transaction has been received or not.

This principle entails the time when a business should record revenue in the books of accounting records. This
concept is applied in determining cut-off for the income, it helps in calculating profit/loss for a period under a
specific accounting period.

The realization principle is most often violated when a company wants to accelerate the recognition of
revenue, and so books revenues in advance of all related earning activities being completed

The best way to understand the realization principle is through the following examples:

1. For goods sold on advance payment: If the buyer has made the payment for corresponding goods before
the delivery is made, then according to the realization concept, the revenue is not going to be recognized
until and unless the goods are transferred to the buyer, even though the cash has been received. This is
known as the transfer of ‘risk and rewards’ because the risk of damage or loss of goods is eliminated and
delivery has been accomplished.

E.g.: Payment of an Online Order is made in full on 5th March 2022 but the car is delivered on 15th March
2022. The revenue will be recorded on the 15th March

2. For goods sold on credit: Payment for corresponding goods is made after the goods have been delivered.
Again, the accountant is not going to wait for receiving cash to recognize revenue. Instead, according to the
recognition principle, a receivables account will be created and the revenue is going to be realized the
moment it is earned i.e. at the time delivery of goods has been made.

E.g.: The business has delivered goods to the customers on March 20th. However, payment is to be received
in April. So, the revenue needs to be recorded on 20th March because risk and rewards have been
transferred on this date.
 3. For services rendered: If services are to be rendered at a point in time the revenue is recognized as soon
as the services have been performed. But if the services are to be provided continuously for more than one
accounting period under consideration, then the ‘percentage completion method’, is followed.

For E.g.: A business agrees to provide Annual maintenance services to manufacturing for 3 years, for Rs.
8,00,000 From the service provider perspective, if this payment is received in advance, then it will be
recorded as deferred income during 3 years.
Conclusion
 It ensures a true and fair view of the accounts as profit is to be realized and recognized only when the seller
transfers risk and rewards.
 The risk can be minimized through the realization principle.
 True revenue earned during the year is given importance and recognition instead of revenue collection.
 It ensures recognition consistently.
 In the case of continuous services percentage of completion, the method can be used to recognize revenue.
Hence it provides a solution for all types of revenue recognition based on the type of revenue.
 It gives importance to legal ownership, which is acceptable and enforceable by law.

Definition: Matching Concept

The “Matching Principle of Accounting” guides the accounting. It means that the expenses entered into the debit
side of the accounts should have a corresponding credit entry (as required by the double-entry bookkeeping system
of accounting) in the same period, irrespective of when the actual transaction is made. All the expenses should be
recorded in the period’s income statement in which the revenue related to that expense is earned.

Prior to the application of the matching principle, Expenses were charged to the income statement in the
accounting period in which they were paid irrespective of whether they relate to the revenue earned during
that period. This resulted in non-recognition of expenses incurred but not paid for during an accounting
period (i.e. accrued expenses) and the charge to income statement of expenses paid in respect of future
periods (i.e. prepaid expenses).

Let us study the following transactions of a business during the month of August 2022

 Sale: Cash Rs.2, 00,000 and credit Rs.1, 00,000

 Salaries Paid Rs.35, 000
 Commission Paid Rs.1500
 Interest Received Rs.50, 000
 Rent received Rs.14, 000 out of which Rs.4000 received for the year 2023
 Carriage paid Rs.2000
 Postage Rs.300
 Rent paid Rs.20, 000, out of which Rs.5000 belong to the year 2021
 Goods purchased Rs.15, 000 cash and on credit Rs.5, 000 in the year 2022
 Depreciation of Rs.20,000 on machine
 In the above example expenses have been matched
Expenses Amount Revenue Amount
with revenue i.e.
Salaries Sales
35,000.00 (Revenue Rs.3, 60,000 - Expenses Rs.93,800)
Commission Cash
This comparison has resulted in profit of
1,500.00 2,00,000.00
Rs.2,66, 000/- This is what exactly has been done by
Carriage Credit
applying the matching concept.
2,000.00 1,00,000.00
Postage Interest
Therefore, the matching concept implies that all
300.00 Received 50,000.00
revenues earned during an accounting year, whether
Rent Paid Rent
received/not received during that year and all cost
Received
incurred, whether paid/not paid during the year
Less for 2021 Less for should be taken into account while ascertaining
15,000.00 2023 10,000.00 profit or loss for that year.
Good Purchased
Cash Significance
15,000.00
 It guides how the expenses should be
Credit matched with revenue for determining exact
5,000.00 profit or loss for a particular period.
Depreciation on  It is very helpful for the
Machine 20,000.00 investors/shareholders to know the exact amount
Total Total of profit or loss of the business.
93,800.00 3,60,000.00
Conclusion
The matching principle of the accounting system is, which follows a dual-entry bookkeeping system. Using
this principle, the accounting system gives a very clear picture of mainly the company’s current assets and
current liabilities, which helps investors and other financial analysts understand the worth of the company
and how well it is being operated

Conclusion

Difference between Realization & Matching Concept

The Realization principle is a standard according to which the revenue is put into books only when it is earned.
This happens when a product has been sold or a service has been provided.

Contrary to this, Matching Principle states that while mentioning the net income of a period in the books, it is
necessary to match the expenses as well as the revenues in the same period. The revenues and the cost incurred
during the production etc. are to be compared against each other.

These principles are not used in cash accounting because the sale of a product or service or the earning of
Revenues may not necessarily be through a Cash transaction.

While the realization principle determines when to record revenue during the selling and earning process, the
matching principle considers the cost it took to make a sale and deducts this from the revenue made from the
sale.

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Q3. You entered into the following transactions

1. Introduced Rs 7,00,000 in the business by taking loan from bank of Baroda

2. Purchased machineries for Rs 50,000 and payment done by cheque

a. In order to record the accounting transaction in the books of accounts briefly define the
Steps to record, classify and summaries business transactions, that is accounting cycle

Introduction

An enterprise must have a proper accounting system for recording the effect of economic events such as purchase of
raw materials, sale of goods, acquisition and disposal of assets, etc. The final step in the accounting process is the
preparation of financial statements. Financial statements, however, are not prepared after every transaction.

A continuous sequence of steps (called accounting cycle) is followed to record, classify and summarize
business transactions in accounting records. The data in these accounting records is then used to prepare
financial statements. Accounting records are also used for several other purposes.

Concept & Application

The accounting cycle is a collective process of Identifying, Analysing, and Recording the accounting events of a
company. It is a standard 8-step process that begins when a transaction occurs and ends with its inclusion in the
financial statements
1) Identify and analyse transactions during the accounting
Identify period: A business starts its accounting cycle by identifying
Transactions
and gathering details about the transactions during the
Closong the
Record the accounting period. When identifying a transaction, you’ll
Book of
Transactions
Accounts need to determine its impact. Transactions include
expenses, asset acquisition, borrowing, debt payments,
debts acquired and sales revenues.

Create Post Important info to identify includes: Transaction dates,

Financial Transactions Product prices & Amounts paid
Statments to Ledger

2) Record transactions in a journal: Next come

recording of transactions using journal entries. The entries
are based on the receipt of an invoice, recognition of a
Adjust the Create the sale, or completion of other economic events.
Journal Trial
Enteries Balance
Double-entry accounting suggests recording every transaction
Analyse the
Worksheet as a credit or debit in separate journals to maintain a proper
balance sheet, cash flow statement and income statement.

On the other hand, Single-entry accounting is more like

managing a check book. It doesn’t require multiple entries but
instead gives a balance report.

3) Post transactions to the general ledger: A general ledger is a critical aspect of accounting, serving as a master
record of all financial transactions. The general ledger breaks down the financial activities of different accounts so
you can keep track of various company account finances. A cash account is by far the most crucial account in a
general ledger, as it gives an idea of the cash available at any time. Think of the general ledger as a summary
sheet where all of the transactions live and are categorized.
4) Create the trial balance: After the company posts journal entries to individual general ledger accounts, An
unadjusted trial balance is prepared. The trial balance ensures that total debits equal the total credits in the
financial records. Creating an unadjusted trial balance is crucial for a business, as it helps ensure that total debits
equal total credits in your financial records. If they don’t, something is either missing or misaligned. This step
generally identifies anomalies, such as payments you may have thought were collected and invoices you thought
were cleared but actually weren’t, The accounting period can vary (monthly, quarterly, annually) depending on
the company.

5) Analyze the worksheet: Analysing a worksheet and identifying adjusting entries make up the fifth step in the
cycle. A worksheet is created and used to ensure that debits and credits are equal. If there are discrepancies then
adjustments will need to be made.

6) Adjusting Journal Entries: At the end of the period, adjusting entries are made. These are the result of
corrections made on the worksheet and the results from the passage of time. For example, an adjusting entry may
accrue interest revenue that has been earned based on the passage of time and one should double-check
everything with the help of a new adjusted trial balance.

7) Create and produce financial statements: Once the company has made all the adjusting entries, it creates
financial statements. Most companies create Balance sheets (Assets – Liabilities = Equity) , Income statements
(Revenue – Expenses = Net Income) and Cash flow statement (The ending balance in the cash flow statement
must equal the company’s cash balance on the balance sheet)

8) Close the books for the accounting period: The last step in the accounting cycle is to make closing entries by
finalizing expenses, revenues and temporary accounts at the end of the accounting period. This involves closing out
temporary accounts, such as Expenses and Revenue, and transferring the net income to permanent accounts like
retained earnings.

After you close the books, the financial statements produced provide a comprehensive performance analysis
for the time frame. Then the accounting cycle starts again for the new reporting period i.e Financial Year
April 01 to March 31

b. Define the concept of accounting equation and record the above transactions following the accounting
equation rule.

Definition of Accounting: Accounting is a set of concepts and techniques that are used to Identify, Measure,
Record, Classify, Summarize and Report financial information of an economic unit to the users of the
accounting information.

Concept & Application: Accounting Equation

The accounting equation states that a company's total assets are equal to the sum of its liabilities and its
shareholders' equity. This straightforward relationship between assets, liabilities, and equity is considered to be the
foundation of the double-entry accounting system. The accounting equation ensures that the balance sheet remains
balanced. That is, each entry made on the debit side has a corresponding entry (or coverage) on the credit side.

Assets = Equities (Total Claims) Liabilities = Assets – Capital

Assets = Liabilities + Capital Capital = Assets – Liabilities

Traditional Approach of Recording Transactions

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 & Losses and Credit all Incomes & Gains

Balance Sheet Approach of Recording Transactions

Rules of Debit Credit

- Assets Account : Debit increase in Assets and Credit decrease in Assets

- Capital Account: Credit increase in Capital and Debit decrease in Capital
- Liabilities Account: Credit increase in Liabilities and Debit decrease in Liabilities

1) Bank Loan Received Journal Entry

Debit: Bank Account (Asset account) Credit: Loan (Liability account)

Bank A/c Dr 7, 00,000

Loan A/c Cr 7,00,000

2) Machinery Purchased Journal Entry

Debit: Machine (Asset account) Credit: Payment by Cheque (Expenses account)

Machinery A/c Dr 50,000

Bank A/c Cr 50,000

PARTICULARS
Investment in Business with
Bank Loan
Purchased machinery of
100000 for cash.
ACCOUNTNG EQUATION
ASSETS = LIABILITIES + EQUITY
LIABILITIES EQUITY ASSETS
700000 (Increase) 700000 Cash (Increase)
Machinery 50000 (Increase)
Cash 50000 (Decrease)

Conclusion: It is understood that the double-entry book-entry accounting system is followed globally and adheres to
the rules of debit and credit entries. These entries should tally to each other at the end of a particular period, and if
there is a gap in total balances, it needs to be investigated.

This system makes accounting a lot easier by creating a relationship between the expense/liability and cause of
expense/liability (or income/asset and source of income/asset).

We need to understand the underlying concept and thumb rule of accounting which relates to debit and credit entries
at the root level. Thus, although the accounting equation formula seems like a one-liner, it contains a lot of meaning
and can be explored deeper with complex expense entries.

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