Management Accounting – Sessions 4/5 – MAC

Attendees : 191

Date:- 31-May-2008

Summary :- Ram Trader’s Balance Sheet (Solved with Roll # 58), Deferred Revenue Expenditure, P&L Account, Income Statement, Difference between BS and PL Statement, Components of a P&L Statement, Various types of Profit, Adjustments for P&L Account, Basis of Accounting (Accrual Vs Cash), Formats, Warranties/Bad Debts, Depreciation, Methods of calculation of Depreciation, Sample P&L Statement

Ram Trader’s Balance sheet was solved in the class using the sample roll # 58. Pretty much done in the line of how I did my assignment. The only difference being I accounted for the rent for 1 month while the prof. did it for 29 days.

On the question of Ram traders spending a 1000 rupees being a Deferred Revenue expenditure, the Prof. addressed that the question was subjective and we will have to evaluate whether the expense took care of the business for years to come or applicable only for the year.

 On a lighter note, the prof indicated that he had caught sight (on the video) of Rajesh Ramani on a mobile, vehemently denied by Rajesh, and effectively getting 5 marks for his question.

Profit and Loss Statement

Statement of Revenue and Expenses of a company. It is also referred as the Income statement. Apart from the revenues and expenses accomodated in this statement, it also needs to accomodate items like Depreciation, Accrued Interest, Tax Provisions etc. P&L statement is also a summary of the companies operations and helps us analyze the company’s performance in greater detail.

Wikipedia states “An Income Statement, also called a Profit and Loss Statement (P&L), is a financial statement for companies that indicates how Revenue (money received from the sale of products and services before expenses are taken out, also known as the “top line”) is transformed into net income (the result after all revenues and expenses have been accounted for, also known as the “bottom line”). The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported.”

As this deals with the Profit/Loss Statement, we come across various types of profits like Gross Profit, Operating Profit, Net Profit etc.

Gross Profit : Sales – Cost of Goods (Direct Costs)

Operating Profit : Gross Profit – Operating Expenses

Net Profit : Operating Profit – (Interest Amt to be Paid + Taxes)

Withdrawals and Dividends are supposed to be done on the Net Profit numbers.

 In Services Industry such as IT/ITeS (Gross Profit will be pretty much same as Net Profit numbers)

Past Earnings – Profits carried on in the companies books, from previous years.

Difference Between Balance Sheet and P&L Statement of Accounts

1. Balance Sheet is a Position Statement, while P&L is a Performance Statement

2. Balance Sheet is a statement of Assets, Liabilities and OE, while P&L Statement is a statement of revenue/expenses/profit.

3. Balance Sheet states the matter of fact with respect to the companie’s performance (OE) , while P&L Statement can be used to analyze the performance of the company and provides answers to questions around company’s performance, expenses incurred etc

 Types of Accounting

Cash Basis – Governments (Road Tax collected now for 15 yrs will come under the current reporting period), also allowed for professionals (Lawyers, Doctors). Cash-basis accounting is not considered to provide a true and fair view of the financial performance and hence not used by companies.

Accrual Basis – Followed by companies, Complies GAAP Standard.  It is based on Realization. A Sale is made when the goods are delivered. Under accrual accounting, revenue is recorded when it is earned and realized, regardless of when actual payment is received. Similarly, expenses are “matched” (a process known as matching or expense matching) revenue regardless of when they are actually paid.

 P&L accounts are reported in 2 formats (Horizontal and Vertical). Not sure which is the standard?

Bad debts/warranties needs to be shown in P&L Statements, and reported accordingly. These are also shown under respective sections in the balance sheet. Bad Debts Losses (To be deducted in Current Assets), while Warranties are liabilities arrived at based on experience in the industry.

Concept of Depreciation 

Depreciation is a concept of reflecting the decrease the future economic utility of an Asset. It is applicable for Tangible assets of a business. It is done to account the normal wear and tear of an asset. Depreciation does not figure in the cash flow statement as it is notional.

Various Methods of Calculating Depreciation

Straight Line Method :- The reduction in cost of the asset is linear year on year. The formula to calculate Depreciation under this method

Depreciation = (Initial Cost – Salvage Cost)/Life of the Asset. This is applicable for items with the same usage during all the time of its use. E.g Furniture

Book Value – Beginning of Year	Depreciation Expense	Accumulated Depreciation	Book Value – End of Year
$17,000 (Original Cost)	$3,000	$3,000	$14,000
$14,000	$3,000	$6,000	$11,000
$11,000	$3,000	$9,000	$8,000
$8,000	$3,000	$12,000	$5,000
$5,000	$3,000	$15,000	$2,000 (Scrap Value)

WDV Method : The decrease in the value is based on a guidance percentage. e.g Computers in IT Industry (60 % YoY). Hence the decrease is more during initial years.

M.A.R.C.S Method : Modified Accelerated Cash Recovery System. US Concept. Decrease is more during the middle years. E.g Industrial Boilers, Pumps as it takes some time for such equipments to reach some optimal levels and then depreciates more from then on.

Companies may have 2 different P&L Accounts for a FY. i.e one for Investors and one for Tax authorites. (Different ways of Depreciation accounted for Assets in both cases)

P&L Statement also include schedule numbers, which provide details of the expense/sales and provides further break up of details.

Class work : – Preparing the P&L Statement for Ram Traders and Tallying the Retained Earnings in the BS problem with the Profit.

Some good read

http://ohioline.osu.edu/cd-fact/1153.html

http://en.allexperts.com/q/Managing-Business-1088/2008/3/balance-sheet-1.htm