Financial Accounting & Analysis
Ans 1.
INTRODUCTION
The accounting equation is considered to be the foundation of the double-entry accounting
system. On a company's balance sheet, it shows that a company's total assets are equal to the sum
of the company's liabilities and shareholders' equity. Based on this double-entry system, the
accounting equation ensures that the balance sheet remains “balanced,” and each entry made on
the debit side should have a corresponding entry (or coverage) on the credit side. The financial
position of any business, large or small, is assessed based on two key components of the balance
sheet: assets and liabilities. Owners’ equity, or shareholders' equity, is the third section of the
balance sheet. The accounting equation is a representation of how these three important
components are associated with each other. The accounting equation is also called the basic
accounting equation or the balance sheet equation.
CONCEPT AND APPLICATION
The equation of accounting states that the addition of a company's assets, liabilities, and equity.
To put it another way, a company's equity is proportional to the number of its assets minus its
liabilities. This definition is the analytical basis for double-entry, and it is a way to view and
evaluate financial statements. The formula is:
Asset = Liabilities + Owner’s Equity
1. Asset: Assets include cash and cash equivalents or liquid assets, which may include
Treasury bills and certificates of deposit. Accounts receivables are the amount of money
owed to the company by its customers for the sale of its product and service. Inventory is
also considered an asset.
2. Liability: Liabilities are what a company typically owes or needs to pay to keep the
company running. Debt, including long-term debt, is a liability, as are rent, taxes,
utilities, salaries, wages, and dividends payable.
3. Owner's Equity: Owner's equity applies to a business owner's stake of the firm, as well as
the valuation of the company's properties. The amount of capital the owner has put into
the firm minus the money the owner has taken out.
Let us calculate analyze the equation of the accounts for X Ltd.:
Particulars Assets = Liability + Owner’s Equity Total
1. Purchased Furniture for Furniture: Creditors: 6,75,000
Rs 6,75,000
6,75,000 6,75,000
2. Capital Introduced by the Furniture: Creditors: Capital: 18,75,000
business Owner by
6,75,000 6,75,000 12,00,000
depositing 12 Lakhs in the
bank account. Bank:
12,00,000
3. Goods purchased on credit Furniture: Creditors: Capital: 19,80,000
from Aman Enterprises
6,75,000 6,75,000 12,00,000
for Rs105000
Bank: Creditors(Aman
Enterprises):
12,00,000
1,05,000
Inventory:
1,05,000
4. Purchased goods from Furniture: Creditors: Capital: 19,80,000
Sneha Enterprises for Rs
6,75,000 6,75,000 12,00,000
600000 and payment
made from the business's Bank: Creditors(Aman
bank account Enterprises):
12,00,000 – 6,00,000
1,05,000
Inventory:
1,05,000 + 6,00,000
5. On credit the goods were Furniture: Creditors: Capital: 20,80,000
sold for Rs 400000. The
6,75,000 6,75,000 12,00,000 + 1,00,000
cost of the goods sold was
Rs 300000 Bank: Creditors(Aman
Enterprises):
12,00,000 – 6,00,000
1,05,000
Inventory:
1,05,000 + 6,00,000 –
3,00,000
Debtor:
4,00,000
Total Asset = 20,80,000
Total Liability = 7,80,000
Owner’s Equity = 13,00,000
Explanation of accounting of equation:
1. Furniture has been purchased for Rs. 6,75,000 as nothing is mentioned if it was bought on
cash or credit, so we have assumed that it has been purchased on credit. Therefore, we
have increased the liability section of the equation by adding creditors worth Rs 6,75,000.
2. In the second equation, capital introduces by the owner of the business is worth Rs.
12,00,000, the amount has been deposited into the bank, which is why Asset side has
been increased by introducing the Bank column, also the Owner's Capital has been
increased by Rs. 12,00,000 on the other section.
3. In the third equation, Goods has been purchased worth Rs. 1,05,000 from Aman
Enterprises on credit, which affects both side of the equation. The asset side has been
affected by the introduction of inventors worth Rs. 1,05,000, and for the Liability side, it
has been affected by creditors worth 1,05,000.
4. In the fourth equation, Goods has been purchased from Sneha Enterprises for Rs
6,00,000 and Payment made from the bank. This will affect only the Asset section. As the
payment has been made through the bank, the bank amount will be decreased by Rs.
6,00,000. Also, the inventory will increase by Rs. 6,00,000.
5. In the fifth equation, Goods has been sold on credit worth Rs. 3,00,000 for Rs. 4,00,000.
This will affect the Asset side as well as the Owner's Equity of the accounting equation.
As the goods have been sold on credit, it will increase the debtor by 4,00,000, and the
inventory will decrease by Rs. 3,00,000 as the cost of goods sold is only worth Rs.
3,00,000. As we can see that the goods have been sold on the profit of Rs. 1,00,000, this
will get added to the owner's capital.
CONCLUSION
Hence, the above accounting equation shows that one transaction always affects more than one
account as per the double-entry system.
Ans 2.
INTRODUCTION
Operating income and revenue are important metrics that both show the money made by a
company. However, the two numbers are different ways of expressing a company's earnings, and
they have different deductions and credits involved in their calculations, Nevertheless, both
revenue and operating income are essential in analyzing whether a company is performing well.
Where Revenue is the total amount of income generated by a company for the sale of its goods
or services before any expenses are deducted and Operating income is the sum total of a
company's profit after subtracting its regular, recurring costs and expenses. The disparity
between these two figures can be an important barometer of a company's financial health.
CONCEPT AND APPLICATION
Revenue is the total amount of income generated by a company for the sale of its goods or
services. It refers to the sum generated before any expenses—such as those involved in running
the business—are taken out. Revenue is often called the "top line" because it's located at the top
of the income statement. So, when a company is said to have "top-line growth," it means the
company's revenue—the money it's taking in—is growing
Revenue is of two types:
1. Operating Revenue
2. Non-Operating Revenue
Revenue from Operation:
Revenue from operations or operating revenue can be defined as the income generated by an
entity from its daily core business operations. If the entity is able to generate a steady flow of
income from its operations, it is said to have been running successfully. It is also called operating
revenue.
Example – ABC Automobile Co. makes and sells automobiles as their daily core business, so
their revenue from operations is said to be generated by the selling of automobiles only. let’s say
in a financial year ABC Automobile Co. earns a significant amount of money by selling one of
its manufacturing plant (building), this will NOT be considered as revenue from operations
instead this will be termed as a capital receipt.
As per given case, as Love Doddle is a gifting enterprise of Ms. Dorati and they have their main
operation of business as gifting. That’s why the income that has been generated from the sale of
gift hampers worth Rs. 5,05,000 shall be treated as the income from operating activities and
hence termed as the "Revenue." This is called Revenue from Operation.
Other Income:
Other income is income that does not come from a company's main business, such as interest.
Examples of other income include income from interest, rent, and gains resulting from the sale of
fixed assets. Companies present other income in a separate section, before income from
operations. Other income is income that does not come from a company's main business, such as
interest.
For example, the company runs its business by selling auto cars to local people, and recently, the
company just charge the interest to customers who make late payment longer than the due date.
This kind of income is not from the main operation of the company, therefore, we should records
it to other’s income in the income statement.
In the given case, as Love Doddle is a gifting enterprise of Ms. Dorati, their main activity of
operation for the business is gifting, the income of Rs. Four thousand two hundred which has
come from the bank interest, dividend receipt shall be treated as the other income.
The recording of the above income should be done in the following manner by Ms. Dorati for recording
the profit and loss statement of the enterprise:
Particulars Note Amount in Rs.
1. Revenues from the Operations (a) 5,05,000
2. Other Income (b) 4,200
Total Income: 5,05,000 + 4,200 = 5,09,200
Notes to Accounts:
(a) Revenues from the Operations:
The inflow of cash from selling the gift hampers = 5,05,000
(b) Other Income:
Income from Interest received from bank and dividend received = 4,200
CONCLUSION
Stakeholder should be aware of the income made by the company and it can be only done by
disclosure made of the income information by the company in the notes to accounts. Ms. Dorati
should write the information about the Revenue from Operation and Other Income in the above
manner by disclosing all the important information for their interested parties.
Ans 3a.
INTRODUCTION
The current ratio measures a company's ability to pay current, or short-term, liabilities (debt and
payables) with its current, or short-term, assets (cash, inventory, and receivables). The quick
ratio measures the liquidity of a company by measuring how well its current assets could cover
its current liabilities.
CONCEPT AND APPLICATION
The quick ratio is a more conservative measure of liquidity because it doesn't include all of the
items used in the current ratio. The quick ratio, often referred to as the acid-test ratio, includes
only assets that can be converted to cash within 90 days or less.
Interpretation:
The current ratio compares all of a company’s current assets to its current liabilities. A company
with a current ratio less than 1.0 does not, in many cases, have the capital on hand to meet its
short-term obligations if they were all due at once, while a current ratio greater than one
indicates the company has the financial resources to remain solvent in the short term. However,
because the current ratio at any one time is just a snapshot, it is usually not a complete
representation of a company’s short-term liquidity or longer-term solvency.
So in the given case Current Ratio - Aman Ltd. has a current ratio of 2:01, which is nothing but
2. This indicates that Aman Ltd.’s capacity to settle his short-term debts is very good if they
were due altogether. A current ratio of 2 indicates that for every 1 rupee Aman Ltd. has 2 rupees
in hands to pay. This is a positive sign for the company as well as for the stakeholders. When we
look at Roger Ltd., the current ratio of Roger Ltd. is 1.60:1, which indicates that for every 1
rupee to be paid, Roger Ltd. has 1.60 rupees to settle.
So in the given case Quick Ratio - Aman Ltd., the quick ratio is 1.35:1. This indicates that their
liquid assets are in a good position to settle their debt. This indicates that for every 1 rupee of
debt, it has 1.35 rupees to settle. For Roger Ltd., the quick ratio is 1:1. This indicates that for
every 1 rupee of debt, it has 1 rupee to settle.
CONCLUSION
Hence, we can conclude that Aman Ltd. is performing much better than Roger Ltd. from the
Current Ratio and Quick Ratio point of view as Aman Ltd. has higher rates when compared with
Roger Ltd.
Ans 3b.
INTRODUCTION
Return on investment (ROI) is a performance measure used to evaluate the efficiency or
profitability of an investment or compare the efficiency of a number of different investments.
ROI tries to directly measure the amount of return on a particular investment, relative to the
investment’s cost.
CONCEPT AND APPLICATION
Return on investment (ROI) is an approximate measure of an investment's profitability. ROI has
a wide range of applications; it can be used to measure the profitability of a stock investment,
when deciding whether or not to invest in the purchase of a business, or evaluate the results of a
real estate transaction. ROI is calculated by subtracting the initial value of the investment from
the final value of the investment (which equals the net return), then dividing this new number
(the net return) by the cost of the investment, and, finally, multiplying it by 100. ROI is relatively
easy to calculate and understand, and its simplicity means that it is a standardized, universal
measure of profitability. One disadvantage of ROI is that it doesn't account for how long an
investment is held; so, a profitability measure that incorporates the holding period may be more
useful for an investor that wants to compare potential investments.
Interpretation:
Return on Investment (ROI) is used by the investors and other stakeholders to decide if they
want to invest in any company or not. The Debt to Equity ratio shows the number of debts used
for the funding when compared to the fully owned equity
Return on Investment (ROI) - For Aman Ltd., the Return on investment is 15%, a good ROI is
considered to be 7% and above, so for Aman Ltd, the returns on the investments are very
positive. For Roger Ltd., the ROI is 13%, which is again good for the investors of Roger Ltd.
The Debt to Equity - For Aman Ltd., the Debt to Equity ratio is 2.5:1. This indicates that it has
2.5 rupees debt for every 1 rupee. Generally, a DE ratio of 1 is considered safe, and a ratio
greater than two can be risky for the company. For Roger Ltd. 1.01, this shows that for every 1
rupee of equity, it has 1 rupee of debt. This is considered to be a safe ratio.
CONCLUSION:
Hence, we can conclude that from the ROI point of view, Aman Ltd is performing better than
Roger Ltd, but when it comes to DE ratio, Roger Ltd. is safer than Aman Ltd.
