Course: Financial Accounting & Analysis

Question: 1

Introduction: Anmol has started a retail outlet of food corner “Anmol Foods” and is doing well in
his business. He is earning good money that is why he doesn’t think that there is any need for
keeping accounting. In this section we will explain him the importance of financial accounting, its
advantages and need to maintain the transaction records to meet the legal requirements. Also, we
will discuss few important accounting terms.
What is Accounting:
Accounting is referred to as “The Language Of Business” because it communicates the financial
condition and performance of a business to interested users. We can define accounting as “A
systematic process of identifying, measuring, recording, classifying, summarizing interpreting and
communicating financial information”.
Accounting is the systematic recording of the financial transactions of a business. The accounting
process includes setting up a system of record keeping, tracking transactions within that system,
and aggregating the resulting information into a set of financial reports. These three aspects of
accounting are explained in detailed below:
Record keeping system: The system of record keeping for accounting requires the use of a
standard set of accounting policies and procedures, as well as standardized forms. The procedures
should incorporate controls designed to ensure that assets are used as intended. Off-the-shelf
accounting software packages (example: Tally) are available for this purpose. The overall system
will likely need to be designed around the software, to ensure that all features of the software are
fully utilized.
Transaction tracking: A separate process is needed to collect information about each type of
business transaction. For example, separate systems are needed to process customer orders, bill
customers, and c cash receipts from customers. Transaction tracking takes most of the the time in
accounting process.
Financial reporting: Several accounting frameworks, most notably GAAP and IFRS, specify the
manner in which business transactions must be recorded and aggregated into the financial
statements. The financial reports include Income statement, Balance sheet, statement of cash
flows, along with supporting disclosures describe the financial status of the company for reporting
period (typically April-March in India) at the end of that period.

These financial statements describe the five major financial data namely “income, expenditures,
assets, liabilities, and equity”. Balance sheet reports assets and claims to those assets at a specific
point in time. Cash flow statement provides detail about the sources and uses of cash during an
accounting period. Revenue and expense are listed on the income statement.

Users of Accounting Information: Financial statements users include present and potential
investors, employees, lenders, suppliers and other trade creditors, customers, governments and their
agencies and the public. These users look forward to financial statements to satisfy some of their
information needs.
Uses of Accounting information: Following are some of the uses of accounting information.

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 Providing information to the management of an organization which is used for the purpose
of planning, analysis, benchmarking and decision making.
 Providing information to investors, promoters, debt provider and creditors which is used to
enable them to male rational and prudent decisions regarding investment, credit etc.
 Providing information to shareholders & public at large in case of listed companies about
various aspects of an organization.
 Providing information about the economic resources of an organization, claims to those
resources (liabilities & owner’s equity) and how these resources and claims have undergone
change over a period of time.
 Providing information as to how an organization is procuring & using various resources.
 Providing information to various stakeholders regarding performance management of an
organization as to how diligently & ethically they are discharging their fiduciary duties &
responsibilities.
 Providing information to the statutory auditors which in turn facilitates audit.
 Enhancing social welfare by looking into the interest of employees, trade union &
Government.
Accounting terms: There is a widely
accepted set of rules, concepts and
principles that governs the application of
the accounting called as the Generally
Accepted Accounting Principles (GAAP).
Here we discuss few important principles
which we apply during the accounting
process.

Accounting Period: This principle entails

a business to complete the whole
accounting process over a specific operating time period. One year is the usual accounting year.
organization may follow a Calendar or Fiscal Year. Additionally, interim reports are prepared to
meet the requirement of users. When an organization want too switch between calendar to fiscal or
fiscal to calendar year they should adjust the period and declare the same. For example, Anmol was
keeping books of accounts on a calendar year basis till year 2018 and decided to change accounting
period to financial year basis, The accounts for 2019-20 will be for 15 months (Jan 2019 to March
2020) thereafter, regular financial year will be followed.

Business Entity: A business is considered a separate entity from the owner(s) and should be treated
separately. Any personal transactions of its owner should not be recorded in the business
accounting book unless the owner’s personal transaction involves adding and/or withdrawing
resources from the business. For example, if Anmol purchases a chair for his home it should no be
included in business accounts. If he purchases a refrigerator for his shop it should be recorded.

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Going Concern: It assumes that business is a continuing enterprise or going concern. will
continue to operate indefinitely (reasonable period in future). While preparing financial statements
management should disclose the risks, uncertainties, that may cast significant doubt on the
continuation of the business.

Monetary Measurement: The business financial transactions recorded and reported should be in
monetary unit, such as Rupee, US Dollar etc. Employee skills, Management Quality, R&D, though
are very critical for business success cannot be recorded, but instead, a memorandum will be used.
For example, Anmol shop is in a busy street and in convenient location hence attracting more
people, but this fact cannot be entered in accounting books as it cannot be measured in monitory
terms.

Historical Cost: All business resources acquired should be valued and recorded based on the actual
cash equivalent or original cost of acquisition, not the prevailing market value or future value.
Exception to the rule is when the business is in the process of closure and liquidation.
Matching Concept: When a given event affects revenues and expenses, the effect on each should
be recognised in the same accounting period. For correct ascertainment of profits, expenses
incurred to earn revenue are matched against the revenue earned. Both revenue and related
expenses must be accounted for in the same accounting period. Some of the places we use matching
principle are Wages, Bonus, Sales commission, depreciation, etc. For example, if a business pays a
5% commission to sales representatives at the end of each month. If the company has $10,000 in
sales in the month of December, the company will pay the commission of $5,00 next January. The
matching statement requires that the commission expense is reported in the December income
statement.
Dual Aspect (Double entry system): A transaction impacts at least two accounts. An account is a
record for an item. Debit and credit. Every transaction affect at least 2 accounts in such a way that
Assets = Liabilities + Owners Capital
Accounting Period: This principle entails a business to complete the whole accounting process
over a specific operating time period. One year is the usual accounting year. organization may
follow a Calendar or Fiscal Year. Additionally, interim reports are prepared to meet the requirement
of users. When an organization want too switch between calendar to fiscal or fiscal to calendar year
they should adjust the period and declare the same. For example, Anmol was keeping books of
accounts on a calendar year basis till year 2018 and decided to change accounting period to
financial year basis, The accounts for 2019-20 will be for 15 months (Jan 2019 to March 2020)
thereafter, regular financial year will be followed.
Conservatism: This principle states that given two options in the amount of business transactions,
the amount recorded should be the lower rather than the higher value.

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Consistency: This principle ensures similar and consistent accounting procedures is used by the

business, year after year, unless change is necessary.Consistency allows reliable comparison of the
financial information between two accounting periods.
Materiality : Business transactions that will affect the decision of a user are considered important
or material, thus, must be reported properly. This principle states that errors or mistakes
in accounting procedures, that which involves immaterial or small amount, may not need attention
or correction.
Objectivity: This principle states that the recorded amount should have some form of impartial
supporting evidence or documentation. It also states that recording should be performed with
independence, that’s free from bias and prejudice.
Accrual : This principle requires that revenue should be recorded in the period it is earned,
regardless of the time the cash is received. The same is true for expense. Expense should be
recognized and recorded at the time it is incurred, regardless of the time that cash is paid. This is to
show the true picture of the business financial performance.

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Question No. 2
Introduction:

Management discussion and analysis (MD&A): MD&A is a section, sometimes labelled

“Financial Review” of a public company's annual report or quarterly filing. The MD&A addresses
the company’s performance. In this section, the company’s management and executives, present an
analysis of the company’s performance with qualitative and quantitative measures. The section can
also include a discussion of compliance, risks, and future plans, such as goals and new projects. It
provides useful clues to financial performance of the organization. and any future favourable and
unfavourable trends, liquidity, capital resources and results of operations. The MD&A section is
not audited and represents the thoughts and opinions of management. In this section we review and
analyze what should be included in MD&A.
Topics to be covered in MD &A:
Sources of liquidity: In this section the sources of funding Sales of products or services
(internal source) or through borrowing and sales of stock (external sources) will be
presented.
Material deficiencies in liquidity: If the firm does not have enough cash to continue to
operate in the long term, what is it doing to obtain cash and prevent bankruptcy and how
they will be remedied.
Commitments for capital expenditures: In this section firm will discuss about its
investment plans in property, plant, and equipment or acquisitions and how it is planning to
acquire funds.
Anticipated changes in the mix and cost of financing resources: Here the firm discusses
what are the expected changes in debt and equity change in the future relative to prior years
—i.e., will the company borrow more or less, sell more stock, or generate significant profits
or losses?
Unusual or infrequent transactions: Will revenues or expenses be affected in the future
by events not expected in the normal course of business operations that affect income from
continuing operations.
Material changes in the relationship between costs and revenues: Will significant
changes occur that cause revenues (or expenses) to increase or decrease without a
corresponding change in expenses (or revenues)?
Breakdown of sales increases into price and volume components: Analyze the reason
behind the sales increase. Is it due to increase in sales volume or due to price increases (with
even a possible decrease in volume)
Best Practices in preparing the MD&A
Layered Disclosure. Drafting layered disclosure, whereby the MD&A, with the more
important themes or highlights at the beginning of the disclosure, with additional detail to
follow, facilitated by the inclusion of an executive summary.

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Readability: The usage of headings, bullet points, and a plain English drafting  Cross-
referencing (rather than repeating) discussions elsewhere in the periodic report will will
improve the readability.
Disclose Material Trends: As per SEC disclosure requirements MD&A is to provide an
analysis of known material trends, uncertainties and other events impacting a registrant’s
results of operations, liquidity or capital resources.
Quantification of Factors Impacting Performance: When providing a narrative
description of factors impacting the results of operations for a registrant in the MD&A,
disclosure counsel should give consideration not only as to whether particular drivers of
results materially impacted performance, but also whether it is helpful or necessary to
quantify the impact of such trends during the applicable period in order to provide a clearer
picture of performance.
Non-GAAP Financial Measures: Companies may provide less extensive disclosures of
non-GAAP financial measures in periodic reports than in earnings release disclosures, given
the lesser analyst and investor focus on periodic reports in comparison to earnings release
materials.
Post-Period Events. Companies need to disclose events arising following the end of a
quarter, even if such events do not impact results of operations for the quarter.
Review Peer Company Disclosure. There may be benefit in periodically reviewing the
MD&A disclosure of peer companies of the registrant, as well as SEC comment letters
received by such peer companies to keep track of the SEC requirement trends
Critical Accounting Policies and Estimates. Firms need to mention critical accounting
policies and estimates. in the MD&A, and should provide an analysis as to why the impact
of these critical accounting policies could be material.
Observations from HUL 2018-2019 annual report: (From Pages 13-40)
Hindustan Unilever Limited (HUL) is the largest Fast-Moving Consumer Goods (FMCG)
company with a historical presence in India of over 80 years based out of Mumbai. Its
portfolio includes 40 brands across 12 distinct categories including Fabric Wash, Household
Care, Purifiers, Personal Wash, Skin Care, Hair Care, Colour Cosmetics, Oral Care, Deodorants,
Beverages, Ice Cream & Frozen Desserts and Foods. The company has 18000 employees working
in 28 factories across India. HUL sup More than 1,000 suppliers work with the Company’s supply
chain spanning own factories and several others that manufacture on the Company’s behalf. The
products are stocked in warehouses dotted across the country and delivered to over 3,500
distributors. HUL suply chain included more than 1,000 suppliers and 3,500 distributors. I
considered 2018-2019 HUL annual report for analysis of MD&A
MD&A of HUL is prepared as per the regulatory requirements mandated by the Companies Act,
2013, Listing Regulations and the Secretarial Standards.
MD&A of HUL has started with analysis of its portfolio of products across 3 segments namely
“Beauty & Personal Care (BPC)”, “Foods & Refreshment” and “Home Care”. they believe “to

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make sustainable living commonplace” is the best way to deliver long-term sustainable growth.
Their MD&A they extensively covered how they are going to achieve this.
Market place they are operating, the strengths and opportunities for improvements (SWOT)
analysis using SOCIETAL framework are discussed in detail. The risks, mitigations and their
impact on the business are clearly mentioned. Performance of subsidiaries (Lakme, ponds, HUL
Nepal…), are also discussed.
Few observations from MD&A of HUL
 There is no significant change (i.e. change of 25% or more as compared to the immediately
previous financial year) in the key financial ratios.
 There were no material changes and commitments affecting the financial position of the
Company which occurred between the end of the financial year to which this financial
statement relates on the date of this report.
 During the year, the Company did not accept any public deposits under Chapter V of
Companies Act, 2013. Company manages cash and cash flow processes assiduously,
involving all parts of the business.
 The Company’s low debt equity ratio provides ample scope for gearing the Balance Sheet,
should the need arise.
 There are no materially significant uncovered exchange rate risks in the context of
Company’s imports and exports.
Conclusion: We have discussed what is to be covered in MD&A, its importance, and How to
prepare MD&A. Also, we have briefly reviewed HUL MD&A. From the above discussion, it can
be concluded that information provided by the management in this section of their annual report is
very important for the Outside stakeholders because they have to take their capital investment
decisions on such discussions.

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Question No. 3 A:

Introduction: A cash flow statement tells you how much cash is entering and leaving your
business. Along with balance sheets and income statements, it’s one of the three most important
financial statements for managing business and making sure business have enough cash to keep
operating.
Cashflow statement Helps in answering below queries:
• Where did cash come from during the period?
• How was cash used during the period?
• What was the change in the cash balance during the period?
The cash flows are broken under three heads:
• Cash flow from operating activities—sources and uses of cash arising directly from the main
revenue generating activities of the organization.
• Cash flow from investing activities—sources and uses of cash related to investing in long-
term assets including long-term investments. This also includes the income generated from
these long term investments.
• Cash flow from financing activities—sources and uses of cash related to funds raising
activities including repayment of loans, payment of interest on borrowed funds and payments of
dividends on shares.
Given Problem: information available in respect of A Ltd

Particulars As on 31.3.2019 (Rupees. In As on 31.3.2020 (Rupees.

Investment in Financial Assets Lacs)
- In
100Lacs)
Equity Share Capital 150 160
Long term Loans taken 100 200
Dividend paid - 26
Dividend received - 10
Interest received - 15

Cash flow Statement of A Ltd from financing activities as on 1/3/2020

Particulars Amount (Rs. in Lacs)

Investment in Financial Investments -100
Increase in equity share capital 10
Increase in long term loan 100
Dividend paid -26
Dividend received 10
Interest received 10
Total 4

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 Investment in Financial Investments: Cash flow from investment activities shows the flow of
cash from activity in financial markets, operating subsidiaries, and capital assets. A negative
overall cash flow is not necessarily a bad thing because the company may be investing in
capital assets for future gains. Here,100 lacs are expended for investment purposes.
 Increase in equity share Capital: It is a financial activity because receipt of 10 lacs has been
due to increase in equity share capital.
 Increase in Long term Loan: It is a financial activity because receipt of 100 lacs has been due
to increase in long term loan by the company.
 Dividend Paid Dividends are considered a liability, rather than an asset, they won’t influence
your business’s cash flow until the dividends are issued. So it is a financial activity of 26 lacs.
 Dividend received: It is a financial activity because receipt of 10 lacs has been due to dividend
received which is not operational activity of the company.

 Interest received: Interest received in cash from loans and advances is recorded under
investing activities. Interest paid on loans, debentures and advances is recorded under financing
activities.

Conclusion: Cash management is very critical for longevity of a firm and is actually the
culmination of the results of several processes that have to be continuously monitored in a
company.  Cash Flow Statement, in combination with other financial metrics derived from both the
Balance Sheet and the Income Statement, can provide some idea of how well the management team
is generating and using cash or in other words, running the company. 

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Question No. 3 B:

Introduction: The debt-equity ratio is a measure of the relative contribution of the creditors and
shareholders or owners in the capital employed in business. The ratio is used to evaluate a
Company’s financial leverage. It is a measure of the degree to which a Company is financing its
operations through debt versus wholly owned funds. It is calculated by dividing a Company’s total
liabilities by its shareholder’s equity.
A high debt/equity ratio is often associated with high risk; it means that the company is
aggressively financing its growth with debt. If leverage increases earnings by a greater amount than
the debt’s cost (interest), then shareholders should expect to benefit. However, if the cost of debt
financing outweighs the increased income generated, share values may decline.
Given Problem: information available in respect of A Ltd

Particulars As on 31.3.2019 (Rupees. In As on 31.3.2020 (Rupees.

Investment in Financial Assets Lacs)
- In
100Lacs)
Equity Share Capital 150 160
Long term Loans taken 100 200
Dividend paid - 26
Dividend received - 10
Interest received - 15

Debt Equity Ratio:

Total Liabilities
Debt Equity Raito=
Total Shareholder s' equity

Year 2019 Year 2020

 Particulars Amount (Rs. in Lacs) Amount (Rs. in Lacs)
Equity 150 160
Debt 100 200
Debt Equity Ratio 0.67 1.25

For Company A, debt equity ratio as on 31/3/19 was 0.67:1 which is excellent for the company
because debt equity ratio less than 1 is treated excellent for any company.
But debt equity ratio as on 31/3/20 increased to 1.25 :1 which is not good for the company because
debt equity ratio more than 1 is not treated good for any company. The reason seems company has
invested using Long term Debt. This could be company’s growth strategy.

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Conclusion: Debt equity ratio of the company is good as on 31/3/19 as it is less than 1 however it
increased to greater than 1 by 31/3/20.

However, we may not be able to decisively conclude that the situation is worsening for the
company. In general Debt equity ratio gives us a flag to check. We may have to consider other
financial ratios to conclude the company’s real financial situation.

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Financial statements are reports prepared by a company’s management to present the financial performance
and position at a point in time. The very basic objective of financial statements is to provide information
about the financial position, performance and cash flows of an enterprise that is useful to a wide range of
users in making economic decisions.

The Financial Statement are prepared to meet the common needs of most users. However, financial
statements do not provide all the information that users may need to make economic decisions because

 They basically portray the financial effects of past events.

 Do not necessarily provide non-financial information

The statement of financial accounts also shows the results of the stewardship of management or the
accountability of management for the resources entrusted to it. Financial Statements helps the stakeholders,
both internal as well as external take various decisions.

The financial effects of transactions and other events are grouped into broad categories according to their
economic characteristics to give us a true picture of the company as mentioned in the below table.

Elements of Financial Statements Measures

 Assets and Liabilities Financial Position
 Equity = Capital + Reserves

 Incomes and Expenses Statement of Profit and Loss

Users of Financial Statement

Financial statements users include present and potential investors, employees, lenders, suppliers and other
trade creditors, customers, governments and their agencies and the public. These users look forward to
financial statements to satisfy some of their information needs. The below table explains the different types
of users and the specific information they seek form financial statements.

Users of Financial What information they need

Statement
Investors Investors being the providers of capital are concerned with the risk and return provided
by their investments.
Employees They are the internal users who look for this information for making decisions
Lenders Lenders are interested in information which enables them to determine
creditworthiness of the company
Trade creditors Trade creditors are interested in information which enables them to determine whether
amounts owing to them will be paid when due.
Customers These outsiders have an interest in information about the continuance of an enterprise,
especially when they have a long-term involvement with or dependent on the
enterprise.
Government and Governments and their agencies look at these financial statements to determine the
other agencies compliance adherence of the company.

According to International Accounting Standard Board (IASB),

the objective of financial reporting is “to provide information about the
financial position, performance and changes in financial position of an

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enterprise that is useful to a wide range of users in making economic

decisions.”
The following points sum up the objectives & purposes of financial
reporting –
1. Providing information to the management of an organization which
is used for the purpose of planning, analysis, benchmarking and
decision making.
2. Providing information to investors, promoters, debt provider and
creditors which is used to enable them to male rational and prudent
decisions regarding investment, credit etc.
3. Providing information to shareholders & public at large in case of
listed companies about various aspects of an organization.
4. Providing information about the economic resources of an
organization, claims to those resources (liabilities & owner’s equity)
and how these resources and claims have undergone change over a
period of time.
5. Providing information as to how an organization is procuring &
using various resources.
6. Providing information to various stakeholders regarding performance
management of an organization as to how diligently & ethically they
are discharging their fiduciary duties & responsibilities.
7. Providing information to the statutory auditors which in turn
facilitates audit.
8. Enhancing social welfare by looking into the interest of employees,
trade union & Government.
Now let’s discuss few aspects about importance of financial reporting.

Importance of Financial Reporting

The importance of financial reporting cannot be over emphasized. It is
required by each and every stakeholder for multiple reasons & purposes.
The following points highlights why financial reporting framework is
important –
1. In help and organization to comply with various statues and
regulatory requirements. The organizations are required to file
financial statements to ROC, Government Agencies. In case of listed

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companies, quarterly as well as annual results are required to be filed

to stock exchanges and published.
2. It facilitates statutory audit. The Statutory auditors are required to
audit the financial statements of an organization to express their
opinion.
3. Financial Reports forms the backbone for financial planning,
analysis, benchmarking and decision making. These are used for
above purposes by various stakeholders.
4. Financial reporting helps organizations to raise capital both domestic
as well as overseas.
5. On the basis of financials, the public in large can analyze the
performance of the organization as well as of its management.
6. For the purpose of bidding, labor contract, government supplies etc.,
organizations are required to furnish their financial reports &
statements.

Conclusion
So we can conclude from the above points that financial reporting is very
important from various stakeholders point of view. At times for large
organizations, it becomes very complex but the benefits are far more than
such complexities. We can say that financial reporting contains reliable
and relevant information which are used by multiple stakeholders for
various purposes. A sound & robust financial reporting system across
industries promotes good competition and also facilitates capital inflows.
This, in turn, helps in economic development.

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40. Management Discussion and Analysis (MD&A) • Sometimes labeled “Financial Review” •
Contains information that cannot be found in the financial data (C) 2007 Prentice Hall, Inc.
41. MD&A (cont.) Includes discussion of: 1. Internal/external sources of liquidity 2. Any material
deficiencies in liquidity and how they will be remedied 3. Commitments for capital
expenditures/sources of funding (C) 2007 Prentice Hall, Inc.
42. MD&A (cont.) 4. Anticipated changes in mix and cost of financing resources 5.
Unusual/infrequent transactions that affect income from continuing operations (C) 2007 Prentice
Hall, Inc.
43. MD&A (cont.) 6. Events causing material changes in cost/revenue relationships (e.g. future price
increase) 7. Breakdown of sales increases into price & volume components (C) 2007 Prentice
Hall, Inc.
44. MD&A (cont.) Alas, there are problems as well with the usefulness of the MD&A section
Companies do a good job of describing historical events but. . . Very few provide accurate
forecasts (C) 2007 Prentice Hall, Inc.
45. MD&A (cont.) More helpful has been the addition to the MD&A of explanations about why
changes have occurred in profitability and liquidity (C) 2007 Prentice Hall, Inc.

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