NMIMS Global Access School for Continuing Education (NGA-SCE)

Course: Financial Accounting and Analysis

A1. Each of the above transactions can be analysed in the following manner:

Transaction 1: The business received cheque of Rs. 500000; it is an asset to the business.
The business owes this amount to the owner and therefore it also represents the capital of the
business. Capital/Equity of Rs. 500000 is equal to assets of Rs. 500000.

Transaction 2: Purchase of goods on credit increases the goods but is considered as an

expense in the business which increases creditors (Ritu) by 40000 and increases the asset by
Rs. 40000. The sum of liabilities and equity is Rs. 540000 and is matched by assets Rs.
540000.

Transaction 3: The business is paying salary to its employees which reduces the cash/bank
balance (asset) by Rs.10000 and simultaneously decreases the capital of the company by Rs.
10000. After this transaction, the liabilities are Rs. 40000, the capital is Rs. 490000 and the
assets are Rs. 530000.

Transaction 4: Investment in an FD A/c increases the assets by Rs. 200000 which reduces
the bank balance (asset) by Rs. 200000. Hence, the accounting equation remains the same as
transaction 3.

Transaction 5: Withdrawal of Rs. 25000 from business’s bank account for meeting private
expenses are called drawings and decreases bank balance (asset) and also reduces capital by
Rs. 25000. After this transaction, the liabilities are Rs. 40000, the capital is Rs. 465000 and
the assets are Rs. 505000.

Accounting Equation: Accounting Equation are the basic principle of accounting and the
basic element of the balance sheet. This equation shows how the assets, liabilities and equity
are related. The accounting equation is as follows:

Assets = Liabilities + Equity

 Sl. Assets = Liabilities + Equity Transaction
No. Elements
500000 500000 Bank
1 Equity
40000 40000 Purchases, Trade
2 payables/Creditors
10000 10000 Cash/Bank
3 Salaries
200000 Bank
4 Investment
25000 25000 Drawings
5 Bank
Total 505000 40000 465000

Hence, as per the Accounting Equation:

Assets = Liabilities + Equity

505000= 40000 + 465000

Journal Entries: Journal Entries is the most important topic in Accounts. Incorrect journal
entries could lead to incorrect financial statements which can also create legal trouble for the
companies. Whenever a business transacts, there are two accounts that usually affected in two
opposite ways.

Basically, Journals are detailed accounts that record all financial transactions for a company
and are used to reconcile future accounts and transfer information to other official accounting
records such as the general ledger.

Date Particulars L/F Debit Credit

Bank A/c Dr 500000
1 To Equity Capital A/c 500000
(Being money introduced in the business)
Purchases A/c Dr 40000
2 To Ritu A/c 40000
(Being goods purchased on credit from Ms.
Ritu)
Salaries A/c Dr 10000
3 To Cash/Bank A/c 10000
(Being salaries paid to employees)
 Investment A/c Dr 200000
4 To Bank A/c 200000
(Being money invested in FD a/c)
Drawings A/c Dr 25000
5 To Bank A/c 25000
(Being money used for personal use)

A2. Accounting is the process of recording financial transactions that affect a company. The
accounting process involves aggregating, analysing, and reporting these transactions to
supervisors, regulatory agencies, and tax collectors. The financial statements used in
accounting are a brief summary of financial transactions over a period of time, summarizing a
company's business, financial position, and cash flows. The financial statements include
Income statement, Balance sheet and Cash flow statement. Financial statements need to be
crystal clear, accurate and reliable as it helps the users make many crucial decisions.
Accounting has been defined by the American Accounting Association as: “Accounting is the
process of identifying, measuring and communicating economic information to permit
informed judgements and decisions by the users of the accounts.”
According to the American Institute of Certified Public Accountants [AICPA]; “Accounting
is the art of recording, classifying and summarizing in a significant manner and terms of
money, transactions and events, which are, in part at least, of a financial character and
interpreting the result thereof”.
There are several terms used in accounting, some of which are as follows:
1. Assets: According to IFRS,
"An asset is a present economic resource controlled by the entity as a result of past
events. An economic resource is a right that has the potential to produce economic
benefits."
In other words, Assets are economically valuable resources that individuals,
businesses, or countries own or manage in the hope that they will bring future
benefits. Assets, whether manufacturing equipment or patents, can be thought of as
being able to generate cash flow, reduce costs, and increase sales in the future. The
various types of assets include, non-current, current, liquid and prepaid expenses.
Non-current assets include long-term resources such as buildings and equipment.
Current assets include all assets that a company plans to use or sell within a year.
Liquid assets can be easily converted to cash in a short period of time. Prepaid
expenses include prepaid for goods or services that the company will use in the future.
Assets are reported on the left side of a company's balance sheet.
2. Liabilities: According to IASB.
“A present obligation of the entity to transfer an economic resource as a result of past
events.”
Basically, Liabilities are legally binding obligations paid that must be paid to other
individuals or groups. Liabilities can be settled by transferring money, goods, or
services. Liabilities increases when credited and decreases when debited. Liabilities
can be considered a source of funding because the amount payable to a third party is
essentially cash and can be used to support a company's asset base. The various types
of Liabilities include, non-current, current and contingent liabilities. Non-current
liabilities include that are due after a year and not any time before that, like, bonds
payable, long-term debt. Current liabilities are those that are due within a year, like,
accounts payables, interest payables. Contingent liabilities are those that may or may
not arise in the due course of the business as they depend on unforeseen
circumstances. Liabilities are reported on the right side of a company's balance sheet.

3. Expense: According to IFRS,

“Decreases in economic benefits during the accounting period in the form of outflows
or depletions of assets or incurrences of liabilities that result in decreases in equity,
other than those relating to distributions to equity participants.”
Basically, Expenses are the operational costs that a company bears to generate
revenue. There is a big difference between “costs” and “expenses”. Cash is a
monetary means to purchase an asset for the business. Expenses are costs that have
expired or have been used up by activities that help generate revenue. Therefore, all
expenses are costs, but not all costs are expenses. The various types of expenses are
operating, non-operating. Expenditures related to the company's main activities such
as cost of goods sold, administration costs and rent are operating costs. Expenses that
are not directly related to the company's core business. Common examples are interest
and other expenses associated with borrowing are non-operating expenses. Expenses
are reported in the income statement and is deducted from revenue to arrive at net
income.

4. Revenue: According to IAS,

“Revenue is the gross inflow of economic benefits during the period arising from the
course of the ordinary activities of an entity when those inflows result in increases in
equity, other than increases relating to contributions from equity participants.”
In simple words, Revenue is the revenue you earn from normal business operations
and is calculated as the average selling price multiplied by the number of units sold,
services rendered. This is the top line (or total income) from which costs are deducted
to determine net income. There are various ways to calculate revenue in a business,
which depends on the accounting method employed. The different types of revenues
are operating revenue, non-operating revenue. Money generated from the sales of a
company’s core business are operational revenue. Money generated from secondary
sources, which are usually unpredictable or non-recurring, one-time gains are called
non-operational revenue. Revenue is reported as Sales in the income statement.
 5. Debit and Credit: Debit and Credit are two accounting tools used in accounting. A
transaction is an event that has a financial impact on an organization's financial
statements. Accounting records are maintained using double-entry accounting system.
When closing these transactions, the numbers are recorded in two columns, the debit
column on the left and the credit column on the right. Entering transactions on the left
is called debiting the account, entering transactions on the right is called crediting the
account. These records are accurate only when the sum on both the sides are equal.
The terms debit (DR) and credit (CR) have Latin: debit comes from the word
debitum, meaning "what is due," and credit comes from creditum, meaning
"something entrusted to another or a loan."
Debits are accounting entries that increase an asset or expense account or decrease a
liability or capital account. It is placed to the left side of the accounting entry.
Credits are accounting entries that increase liability or equity account or decrease an
asset or expense account. It is placed to the right side of the accounting entry.

A3a. Total Purchases: It includes all the services and goods purchased by an organisation
during an accounting period for consumption or resale. Consumption here refers to the goods
and services being used in the process of production or manufacturing. It excludes capital
goods.
Total purchases = (Closing stock – Opening Stock) + Cost of goods sold
Here,
Closing stock = Rs. 70,00,000
Opening stock = Rs. 40,00,000
COGS = Rs. 5,80,00,000
Hence, as per the formula:
= (70,00,000 – 40,00,000) + 5,80,00,000
= 30,00,000 + 5,80,00,000 = 6,10,00,000
Therefore, total purchases are Rs. 6,10,00,000

Credit Purchase: Purchasing goods or service “on credit”, or credit purchase refers to
utilising the goods or enjoying the benefits of a service today but paying for it on a later date.
It’s also called as purchasing something on account. From the point of view of the business
it’s “Accounts Payable” while from the point of view of seller it’s “Accounts Receivables”.
Credit Purchase = Total Purchase – Cash Purchase
Here,
Total Purchase = Rs. 6,10,00,000
Cash Purchase = Rs. 45,00,000
Hence, as per the formula:
= 6,10,00,000 – 45,00,000
= 5,65,00,000
Therefore, credit purchases are Rs. 5,65,00,000

Payment to Creditors: When a business buys a good or service from someone on credit and
pays to them on a later date it is called “Payment to creditors”.
Payment to Creditors:
Credit Purchase + Creditors at the beginning of the year – Creditors at the ending of the year
Here,
Credit Purchase = Rs. 5,65,00,000
Creditors at the beginning of the year = Rs. 60,00,000
Creditors at the ending of the year = Rs. 1,00,00,000
Hence, as per the formula;
= 5,65,00,000 + 60,00,000 - 1,00,00,000
= 5,25,00,000
Therefore, payment to creditors are Rs. 5,25,00,000.

A3b. Net Book Value: Net book value (NAV) refers to the historical value of a company's
assets, or how the assets are recorded by the auditor. NAV is calculated using the original
cost of an asset – cost to acquire the asset – amortization, depreciation, etc. Net book value is
one of the most common financial metrics. It helps in adding value to a company, maybe for
its accounting records, or when a company is considering taking over a business or
liquidation.
Formula;
Net Book Value = Original cost of asset – Accumulated Depreciation
Accumulated Depreciation: Accumulated depreciation is the total depreciation expense
assigned to a particular asset since the asset was brought in. When the accumulated
depreciation amount is higher it indicates that the company has owned that fixed asset for a
very long period of time. When an asset is sold, the accumulated depreciation amount of that
particular fixed asset is taken off from the balance sheet.

Calculation of Net Book Value and Cash proceeds from sale:

Here, Original cost of asset = Rs. 4,00,00,000
Gain on Equipment sold = Rs. 50,00,000
Accumulated Depreciation = Rs. 80,00,000
As per the formula;
Net Book Value = Original cost of asset – Accumulated Depreciation
= NBV = 4,00,00,000 – 80,00,000
= NBV = 3,20,00,000

Cash proceeds = Net book value + Gain on sale of equipment

= 3,20,00,000 + 50,00,000
= 3,70,00,000
Cash proceeds from the sale of investment are Rs. 3,70,00,000.