Important topic

2. ACCOUNTING
Accounting is the process of recording financial transactions pertaining to a business.
The accounting process includes summarizing, analyzing, and reporting these
transactions to oversight agencies, regulators, and tax collection entities.

3. Functions of accounting
Keeping financial records: Accounting helps businesses maintain an accurate and up-
to-date record of the day-to-day financial transactions of the company, such as supply
purchases, product sales, receipts and payments.
Keeping digital records: Accounting may involve creating, maintaining and updating
digital accounting systems to store and calculate the company's financial data.
Making bill payments: Accounting involves checking invoices to ensure the legitimacy
of the charges, setting payment dates and paying the bills that the company owes to
various vendors and suppliers.
Making financial projections: Accounting involves analysing the company's available
financial resources, expected revenues and business goals and using this information
to predict future business expansion and growth.
Paying employee salaries: Companies can use accounting to make payroll payments
from company funds, manage employee benefits and issue employee work-related
bonuses.

4. Preparing budgets: The accounts department may reference the company's financial data
to prepare the overall company budget, the department budgets and the project budgets.
Achieving business goals: An accountant can analyse financial data to formulate and
implement comprehensive financial policies and strategies to advance the company's
business goals.
Reviewing performances: Accounting involves performing regular financial reviews of the
company's departments to assess their performance and make changes to reduce waste,
increase productivity and streamline expenses.
Complying with legal requirements: Accountants make sure the company complies with
industry and government rules, regulations and policies related to taxation, financial
reporting and employee wages.
Preventing mismanagement: The accounting department can keep accurate track of the
company's financial transactions to ensure no mismanagement or wastage of money
occurs in the company.

5. JOURNAL
A journal is a detailed record of all transactions done by a business. The information
recorded in a journal is used to reconcile accounts. Entries are usually recorded using a
double-entry method. The double-entry method records a transaction in two (or more)
entries.
LEDGER
An accounting ledger is an account or record used to store bookkeeping entries for
balance-sheet and income-statement transactions. Accounting ledger journal entries
can include accounts like cash, accounts receivable, investments, inventory, accounts
payable, accrued expenses, and customer deposits.
TRAIL BALANCE
A trial balance is a bookkeeping worksheet in which the balances of all ledgers are
compiled into debit and credit account column totals that are equal. A company
prepares a trial balance periodically, usually at the end of every reporting period.

6. FINANCIAL STATEMENT
A financial statement is a report that shows the financial activities and performance of a
business. It is used by lenders and investors to check a business's financial health and
earnings potential. The three main types of financial statements are the balance sheet,
the income statement, and the cash flow statement.

7. CASH FLOW STATEMENT
A cash flow statement is a financial statement that shows how cash entered and exited a
company during an accounting period. Cash coming in and out of a business is referred
to as cash flows, and accountants use these statements to record, track, and report
these transactions
FUND FLOW STATEMENT
The fund flow statement is a financial statement that records the inward and outward
flow of business funds or assets. It identifies the reason for a change in the financial
position of a company by comparing two years' balance sheets.

8. BALANCE SHEET
A balance sheet is a financial statement that reports a company's assets, liabilities, and
shareholder equity. The balance sheet is one of the three core financial statements
that are used to evaluate a business. It provides a snapshot of a company's finances
(what it owns and owes) as of the date of publication.

9. RATIO ANALYSIS
Ratio analysis is a quantitative method of gaining insight into a company's liquidity,
operational efficiency, and profitability by studying its financial statements such as the
balance sheet and income statement.

11. Top 5 Types of Ratio Analysis
1. Type #1 – Profitability Ratios
These ratios convey how well a company can generate profits from its operations.
• Gross Profit Ratio
It represents the company’s operating profit after adjusting the cost of the goods
that are sold. The higher the gross profit ratio, the lower the cost of goods sold, and
the greater satisfaction for the management.
Gross Profit Ratio = Gross Profit/Net Sales*100.
• Net Profit Ratio
It represents the company’s overall profitability after deducting all the cash & no cash
expenses: the higher the net profit ratio, the higher the net worth, and the stronger
the balance sheet.
Net Profit Ratio Formula = Net Profit/Net Sales*100

12. • Operating Profit Ratio
It represents the soundness of the company and the ability to pay off its debt obligations.
Operating Profit Ratio Formula = Ebit/Net sales*100
• Return on Capital Employed
ROCE represents the company’s profitability with the capital invested in the business.
Return on Capital Employed Formula = Ebit/Capital Employed
Type #2 – Solvency Ratios
These ratio analysis types suggest whether the company is solvent & can pay off the
lenders’ debts or not.
• Debt-Equity Ratio
This ratio represents the leverage of the company. A low d/e ratio means that the
company has a lesser amount of debt on its books and is more equity diluted. A 2:1 is an
ideal debt-equity ratio to be maintained by any company.
Debt Equity Ratio Formula = Total Debt/Shareholders Fund.
Where, total debt = long term + short term + other fixed payments
shareholder funds = equity share capital + reserves + preference share capital – fictitious
assets.

13. • Interest Coverage Ratio
It represents how many times the company’s profits can cover its interest expense . It also
signifies the company’s solvency shortly since the higher the ratio, the more comfort to the
shareholders & lenders regarding servicing of the debt obligations and smooth functioning
of the business operations of the company.
Interest Coverage Ratio Formula = Ebit/Interest Expense
Type #3 – Liquidity Ratios
These ratios represent whether the company has enough liquidity to meet its short-term
obligations or not. Higher liquidity ratios are more cash-rich for the company.
• Current Ratio
It represents the company’s liquidity to meet its obligations in the next 12 months. Higher
the current ratio, the stronger the company to pay its current liabilities. However, a very
high current ratio signifies that a lot of money is stuck in receivables that might not be
realized in the future.
Formula = Current Assets / Current Liablities

14. • Quick Ratio
It represents how cash-rich the company is to pay off its immediate liabilities in the short
term.
Quick Ratio Formula = Cash & Cash Equivalents+Marketable Securities+Accounts
Receivables/Current Liabilities
Type #4 – Turnover Ratios
These ratios signify how efficiently the assets and liabilities of the company are used to
generate revenue.
• Fixed Assets Turnover Ratio
It brepresents the efficiency of the company to generate revenue from its assets. In
simple terms, it is a return on the investment in fixed assets.
Net Sales = Gross Sales – Returns.
Net Fixed Assets = Gross Fixed Assets –Accumulated Depreciation.
Average Net Fixed Assets = (Opening Balance of Net Fixed Assets + Closing Balance of
Net Fixed Assets)/2.
Fixed Assets Turnover Ratio Formula = Net Sales / Average Fixed Assets

15. • Inventory Turnover Ratio
The Inventory Turnover Ratio represents how fast the company can convert its
inventory into sales. It is calculated in days signifying the time required to sell the stock
on an average. The average inventory is considered in this formula since the company’s
inventory keeps on fluctuating throughout the year.
Inventory Turnover Ratio Formula = Cost of Goods Sold/Average Inventories
• Receivable Turnover Ratio
It reflects the efficiency of the company to collect its receivables. It signifies how many
times the receivables are converted to cash. A higher receivable turnover ratio also
indicates that the company is collecting money in cash.
Receivables Turnover Ratio Formula = Net Credit Sales/Average Receivables

16. #5 – Earning Ratios
This ratio analysis type speaks about the company’s returns for its shareholders or
investors.
• P/E Ratio
It represents the company’s earnings multiple and the market value of the shares
based on the PE multiple. A high P/E Ratio is a positive sign for the company since it
gets a high valuation in the market for m&a opportunities.
P/E Ratio Formula = Market Price per Share/Earnings Per Share
• Earnings Per Share
Earnings Per Share represents the monetary value of the earnings of each shareholder.
It is one of the major components looked at by the analyst while investing in equity
markets.
Earnings Per Share Formula = (Net Income – Preferred Dividends ) / (Weighted
Average of Shares Outstanding)

17. • Return on Net Worth
It represents how much profit the company generated with the invested capital from
equity & preference shareholders both.
Return on Net Worth Formula = Net Profit/Equity Shareholder Funds. Equity Funds =
Equity+Preference+Reserves -Fictitious Assets.

18. Types of Ratio Analysis
1. Liquidity Ratios
Liquidity ratios measure a company's ability to pay off its short-term debts as they
become due, using the company's current or quick assets. Liquidity ratios include the
current ratio, quick ratio, and working capital ratio.
2. Solvency Ratios
Also called financial leverage ratios, A solvency ratio is a vital metric used to see a
business's ability to fulfil long-term debt requirements. It shows whether a company's
cash flow is good enough to meet its long-term liabilities. It is, therefore, considered to a
measure of its financial health.Examples of solvency ratios include: debt-equity ratios,
debt-assets ratios, and interest coverage ratios.
3. Profitability Ratios
These ratios convey how well a company can generate profits from its operations. Profit
margin, return on assets, return on equity, return on capital employed, and gross margin
ratios are all examples of profitability ratios.

19. 4. Efficiency Ratios
Also called activity ratios, efficiency ratios evaluate how efficiently a company uses its assets
and liabilities to generate sales and maximize profits. Key efficiency ratios include: turnover
ratio, inventory turnover, and days' sales in inventory.
5. Coverage Ratios
Coverage ratios measure a company's ability to make the interest payments and other
obligations associated with its debts. Examples include the times interest earned ratio and
the debt-service coverage ratio.
6. Market Prospect Ratios
These are the most commonly used ratios in fundamental analysis. They include dividend
yield, P/E ratio, earnings per share (EPS), and dividend payout ratio. Investors use these
metrics to predict earnings and future performance.

20. USES OR IMPORTANCE OR UTILITIES OF EVERYTHING
• Liquidity
Assessment of Liquidity. Liquidity ratios are a class of financial metrics that helps to
determine the ability of a company to meet its immediate short-term needs
. Operational effeciency
to determine financial health and operational efficiency of a company. Top
management utilizes it to gauge the performance.
.profitability
The management is always concerned with the overall profitability of the firm. They
want to know whether the firm has the ability to meet its short-term as well long
term needs

21. Forecasting and planning
Forecasting is the process of predicting future events based on historical data and
trends, while planning involves creating a set of actions or strategies to achieve
specific goals or outcomes. In simple terms, forecasting informs planning by providing
data to make informed decisions about the future.
. Solvency
assess a company's long-term financial sustainability by evaluating its ability to meet
its long-term debt obligations.
. effeciency
From assessing profitability and liquidity to gauging efficiency and solvency, it
supports precise decision-making which increases effeciency
. To Compare the Performance of the Firms
Helps in comparing a firm with another so that company can implement strategies
accordingly to gain competitive advantage
. Helps in identifying risk
Helps to know whether the firm is in risk by analysing its ability to pay debt

22. limitations of everything
Historical Information: Information used in the analysis is based on real past results that
are released by the company. Therefore, ratio analysis metrics do not necessarily
represent future company performance.
Inflationary effects: Financial statements are released periodically and, therefore, there
are time differences between each release. If inflation has occurred in between periods,
then real prices are not reflected in the financial statements. Thus, the numbers across
different periods are not comparable until they are adjusted for inflation.
Changes in accounting policies: If the company has changed its accounting policies and
procedures, this may significantly affect financial reporting. In this case, the key financial
metrics utilized in ratio analysis are altered, and the financial results recorded after the
change are not comparable to the results recorded before the change. It is up to the
analyst to be up to date with changes to accounting policies. Changes made are
generally found in the notes to the financial statements section.
Bias: Financial statements are the outcome of recorded facts, accounting concepts and
conventions used and personal judgments, made in different situations by the
accountants. Hence, bias may be observed in the results, and the financial position
depicted in financial statements may not be realistic.

23. Operational changes: A company may significantly change its operational structure,
anything from their supply chain strategy to the product that they are selling. When
significant operational changes occur, the comparison of financial metrics before and
after the operational change may lead to misleading conclusions about the company’s
performance and future prospects.
Manipulation of financial statements: . The information may be manipulated by the
company’s management to report a better result than its actual performance. Hence,
ratio analysis may not accurately reflect the true nature of the business, as the
misrepresentation of information is not detected by simple analysis. It is important that
an analyst is aware of these possible manipulations and always complete extensive due
diligence before reaching any conclusions.
Aggregate Information: Financial statements show aggregate information but not
detailed information. Hence, they may not be help the users in decision-making much.
No Qualitative Information: Financial statements contain only monetary information
but not qualitative information like industrial relations, industrial climate, labour
relations, quality of work, etc.

24. WINDOW DRESSING
The term 'window dressing' means manipulation of accounts so as to present the
financial statements in a way to show better position than the actual.
DEFERRED REVENUE EXPENDITURE
This term refers to money spent during one accounting period with the intention of
creating revenue in a future accounting period. You pay the initial expense upfront
to see benefits earned in the future.
AMORTIZATION
Amortization is an accounting technique used to periodically lower the book value
of a loan or an intangible asset over a set period of time.
Depreciation and amortization are ways to calculate asset value over a period of
time. Depreciation is the amount of asset value lost over time. Amortization is a
method for decreasing an asset cost over a period of time.

25. DEPRECIATION
The monetary value of an asset decreases over time due to use, wear and tear
or obsolescence. This decrease is measured as depreciation. Description:
Depreciation, i.e. a decrease in an asset's value, may be caused by a number of
other factors as well such as unfavorable market conditions, etc.
Advantages
Asset value can be written off completely
It helps in tax reduction
It helps in valuation of the asset
Disadvantage
The actual use of assets is not considered

26. METHODS OF DEPRECIATION
1. Straight-Line Depreciation Method
Straight-line depreciation is a very common, and the simplest,
method of calculating depreciation expense. The Straight Line
Method (SLM) of Depreciation reduces the value of an asset
consistently till it reaches its scrap value. A fixed amount of
depreciation gets deducted from the value of the asset on an
annual basis.
2.Declining Balance Depreciation
In accounting, the declining balance method is an accelerated
depreciation system of recording larger depreciation expenses
during the earlier years of an asset's useful life while recording
smaller depreciation during its later years. It minimize tax
exposure.

27. 3.Double Declining Balance Method
Also known as the reducing balance method, double declining is another accelerated
depreciation method that, as the name implies, depreciates assets twice as fast as the
declining balance method. It is another method that is commonly used by businesses.
4.Units of Production Depreciation
The units of production method assigns an equal expense rate to each unit produced. It's
most useful where an asset's value lies in the number of units it produces or in how much
it's used, rather than in its lifespan. The formula determines the expense for the accounting
period multiplied by the number of units produced.
5. Sum-of-the-Years-Digits Depreciation Method
The sum-of-the-years-digits method is one of the accelerated depreciation methods. A
higher expense is incurred in the early years and a lower expense in the latter years of the
asset’s useful life.
In the sum-of-the-years digits depreciation method, the remaining life of an asset is
divided by the sum of the years and then multiplied by the depreciating base to determine
the depreciation expense.

28. ACCOUNTING CONCEPT
Accounting concept refers to the basic assumptions and rules and principles which work as
the basis of recording of business transactions and preparing accounts.

29. Different types of accounting concepts
1. Going concern concept
According to the going concern concept, a firm will continue to operate indefinitely.
This assumption has an impact on financial statement preparation, allowing
accountants to portray long-term assets at their historical cost and giving stakeholders a
more realistic picture of a company's financial health in the long run.
2. Business entity concept
In terms of the business entity concept, a business is a distinct economic entity from its
owners. This notion guarantees that personal and corporate money are kept separate,
allowing for transparent financial reporting. It facilitates measuring the success of the
firm independent of its owners' financial actions, fostering openness and accountability.
3. Accrual concept
The accrual concept mandates that revenues and costs be recognised as they are
received or spent, regardless of financial movements. This idea improves financial
statement accuracy by matching them with the economic content of transactions and
giving stakeholders a more complete knowledge of a company's financial status.
4. Historical cost concept
The historical cost concept assesses assets at their original cost, giving financial
reporting a solid and objective foundation. This notion improves dependability by
minimising subjective values and guaranteeing that financial statements accurately
represent asset purchase costs.

30. 5. Money measurement concept
According to the money measurement concept, only monetary transactions should be
documented in accounting. This approach makes quantification and comparison easier,
ensuring that financial statements contain relevant and comparable information for
decision-making.
6. Accounting period concept
The accounting period concept separates a company's economic existence into discrete
periods, often a fiscal year, for financial reporting. This approach enables timely and
consistent reporting, assisting stakeholders to evaluate a company's performance and
make educated decisions at precise intervals.
7. Dual aspect concept
According to the dual aspect concept, every financial transaction includes two
components: a debit and a credit. This double-entry technique keeps the accounting
equation (Assets = Liabilities + Equity) balanced, allowing for a systematic approach to
documenting and assessing financial transactions.
8. Revenue realisation concept
As to the income realisation concept, income should be recognised when it is earned,
regardless of when payment is received. This notion prevents revenue from being
recognised prematurely, aligning financial statements with the actual delivery of products
or services and improving the trustworthiness of reported revenues.

31. What Is an Accounting Convention?
Accounting conventions are guidelines used to help companies determine how to record
certain business transactions that have not yet been fully addressed by accounting
standards. These procedures and principles are not legally binding but are generally
accepted by accounting bodies. Basically, they are designed to promote consistency and
help accountants overcome practical problems that can arise when preparing financial
statements.

32. Accounting Convention Methods
Conservatism : Playing it safe is both an accounting principle and convention. It tells
accountants to err on the side of caution when providing estimates for assets and
liabilities. That means that when two values of a transaction are available, the lower one
should be favored. The general concept is to factor in the worst-case scenario of a firm’s
financial future.
Consistency: A company should apply the same accounting principles across
different accounting cycles. Once it chooses a method it is urged to stick with it in the
future, unless it has a good reason to do otherwise. Without this convention, investors'
ability to compare and assess how the company performs from one period to the next is
made much more challenging.
Full disclosure: Information considered potentially important and relevant must be
revealed, regardless of whether it is detrimental to the company.
Materiality: Like full disclosure, this convention urges companies to lay all their cards on
the table. If an item or event is material, in other words important, it should be
disclosed. The idea here is that any information that could influence the decision of a
person looking at the financial statement must be included.

33. ACCOUNTING STANDARDS

34. Benefits of Accounting convention , Accounting Standards &
Accounting concepts
1. Reduces Confusion: If certain standards are followed during the creation of
financial reports, then it can reduce confusion due to multiple people creating the
reports in their own way.
2. Comparability: Accounting Standards ensure that the reports of any organisation
can be compared with that of others across the globe.
3. Uniformity: Each transaction can be easily identified with the use of Accounting
standards, as a particular type of transaction will follow certain rules and standards to
record it in the reports and statements.
4. Reliability: Financial Statements and Reports that follow accounting standards allow
stakeholders to take important decisions regarding investment easily, as the
company’s financial reports are a major source to make decisions for them.
Accounting standards ensure that the financial reports and statements of an
organisation are fair and transparent.
5. Better understanding of the financial statements

35. Cash Flow Fund Flow
Definition
Cash flow is based on the concept of outflow and
inflow of cash and cash equivalents during a
particular period
Fund flow is based on the concept of changes in
working capital over a period of time
What is calculated?
Cash from the operations is calculated Fund from the operation is calculated.
What it shows
It shows the short term position of the business It shows the position of the business in the long
term
Purpose
To show the movement of cash during the
beginning and end of an accounting period
To show the changes in the financial position of
business between previous and current
accounting periods
Discloses
Inflows and Outflows of cash Source and application of the available funds
Accounting Basis
Cash Basis of accounting Accrual basis of accounting
Part of Financial Statement
Yes No
Used for
Cash Budgeting Capital Budgeting

36. Balance Sheet Profit & Loss Account
Definition
A Balance sheet is a precise representation of the
assets, equity and liabilities of the entity. This is
outlined by every enterprise, a partnership enterprise
or sole proprietorship firm. It reveals the financial
security of the enterprise.
P&L a/c which also called a statement of revenue and
expenses or an income statement. The account
depicts the financial production of the enterprise in a
specific time.
What exactly is it?
Balance Sheet is a statement P & L Account is an account
State of accounts
Accounts added in balance sheet maintain their
identity and are carried forward for the next
accounting period
Accounts that get transferred to P & L account are
closed and do not retain their identity
What does it represent?
It represents the financial state of the business
concern at a particular date
It represents the profit earned or the loss incurred by
a business concern during an accounting period
What does it disclose?
Capital of shareholders and the various assets and
liabilities of the business
The gains and losses along with various incomes and
indirect expenses taking place in the business during
the accounting period
Order of creation
Balance sheet is prepared after creating the P & L
Account
P & L Account is prepared before creating the balance
sheet

37. Journal Ledger
Definition
Journal is a subsidiary book of account that records
transactions.
Ledger is a principal book of account that classifies
transactions recorded in a journal.
Order
The journal transactions get recorded in chronological
order on the day of their occurrence.
The ledger classifies the transactions from the journal
under the respective accounts to which they are related.
Explanation
Each journal entry has a detailed narration of the
transaction.
The ledger accounts do not have a detailed narration of
each transaction.
Result
The journal does not reveal the total results of a
transaction.
The Ledger accounts help reveal the result of transactions
for a particular account.
Trial Balance
The journal cannot help prepare the Trial Balance directly. The ledger helps to prepare the Trial Balance.
Financial Statements
The journal does not have a direct role in the preparation
of financial statements like Profit and Loss Account or
Balance Sheet.
The balances from different ledger accounts help to
prepare financial statements like Profit and Loss Account
or Balance Sheet.
Opening Balance
A journal does not have an opening balance, and it is only
concerned with the current transactions that occur on a
Some ledger accounts have an opening balance, which is
the closing balance from the previous year.

38. Capital Expenditure Revenue Expenditure
Definition
Expenditure incurred for acquiring assets, to enhance the
capacity of an existing asset that results in increasing its
lifespan
Expense incurred for maintaining the day to day activities
of a business
Tenure
Long Term Short term
Value Addition
Enhances the value of an existing asset Does not enhance the value of an existing asset
Physical Presence
Has a physical presence except for intangible assets Does not have a physical presence
Occurrence
Non-recurring in nature Recurring in nature
Availability of Capitalisation
Yes No
Impact on Revenue
Do not reduce business revenue Reduce business revenue
Potential Benefits
Long-term benefits for business Short-term benefits for business
Appearance
Appears as assets in the balance sheet and some portion
in the income statement
Always appears in the income statement

39. Common size statement
Common size statement is a form of analysis and interpretation of the financial
statement. It is also known as vertical analysis. This method analyses financial
statements by taking into consideration each of the line items as a percentage of
the base amount for that particular accounting period.
Types of Common Size Statements
There are two types of common size statements:
Common size income statement
Common size balance sheet
1. Common Size Income Statement
This is one type of common size statement where the sales is taken as the base
for all calculations. Therefore, the calculation of each line item will take into
account the sales as a base, and each item will be expressed as a percentage of
the sales.

40. Use of Common Size Income Statement
It helps the business owner in understanding the following points
Whether profits are showing an increase or decrease in relation to the sales obtained.
Percentage change in cost of goods that were sold during the accounting period.
Variation that might have occurred in expense.
If the increase in retained earnings is in proportion to the increase in profit of the
business.
Helps to compare income statements of two or more periods.
Recognises the changes happening in the financial statements of the organisation, which
will help investors in making decisions about investing in the business.
2. Common Size Balance Sheet:
A common size balance sheet is a statement in which balance sheet items are being
calculated as the ratio of each asset in relation to the total assets. For the liabilities, each
liability is being calculated as a ratio of the total liabilities.
Common size balance sheets can be used for comparing companies that differ in size.
The comparison of such figures for the different periods is not found to be that useful
because the total figures seem to be affected by a number of factors.
Standard values for various assets cannot be established by this method as the trends of
the figures cannot be studied and may not give proper results.