accounting standards and ratio analysis

1For internal circulation of BSNLonly

E1-E2

Accounting Standards

And Ratio analysis

2

WELCOME

• This is a presentation for the E1-E2 (Finance)

• Module for the Topic: Accounting standards and Ratio

analysis

• Eligibility: Those who have got the Upgradation from E1

to E2.

• This presentation is last updated on 15-3-2011.

• You can also visit the Digital library of BSNL to see this

topic.

For internal circulation of BSNL only

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What are Accounting Standards

• Guidelines to direct as to how the items which go to

make up the financial statements should be dealt with in

Accounts and presented in the Annual Accounts

• Norms of Accounting Policies and practices by way of

codes i.e., codification of Generally accepted

Accounting principles


Introduction

• If Accounts is the language of business, Accounting

Standards may be stated to be the grammar of that

language.

• These standards are mandatory to be complied with to

ensure that financial statements are prepared in

accordance with the generally accepted accounting

practices

• Accounting Standards provide for disclosure norms to add

value to the preparation of accounting statements.


Objectives of Accounting Standards

• Provides a structural framework within which credible

financial statements can be produced

• Brings about uniformity in financial reporting

• Ensures consistency & comparability in the data published

by the enterprises

• Enhances the Quality and the degree of dependability of the

financial statements


Significance of Accounting Standards

• Accounting standards address the core issue of

information needs of the stakeholders.

– Useful to investors assessing the yield and risk of

alternative investments

• Will raise the standards of the audit in its task or

reporting on the financial statements

• Meaningfulness of the numbers in the accounting reports

for the purpose of economic planning, market analysis

etc,

• Confidence that user groups have in the fairness and

reliability of the financial statements


Significance of Accounting Standards

• Accounting standards directly and indirectly influence,

command and control many important aspects of

company’s operations, administration, revenue etc., as

the final operational results of all operations get reflected

in the financial statements.

• Accounting standards are also an effective way of

ensuring managements compliance to ethics,

consistency and business transparency.


Scope of Accounting Standards

• These are supplementary to the laws of the land and do

not substitute their provisions in any manner.

• i.e., Accounting Standards will be prepared in conformity

with the provisions of the applicable laws, customs

usages and business environment in India – However if

a particular Accounting Standard is found to be not in

conformity with law, the provisions of the law will prevail.


Accounting Standards Board

• ICAI recognizing the need to harmonize the diverse

accounting policies and practices prevalent in India

constituted an ASB in April 1977


Accounting Standards Board

• Objectives and functions of ASB

– To conceive of and suggest areas in which AS needs

to be developed

– To formulate Accounting Standards

– To examine how far the relevant International

Accounting Standard / International financial reporting

standard can be adopted in India

– To review at regular intervals and if necessary revise

the existing AS

– To provide from time to time, interpretations and

guidance notes on AS

For internal circulation of BSNL only28 April 201111

Procedure for issuing AS

• ASB will determine the broad areas in which AS need to

be formulated and their priority

• Study groups are constituted to assist ASB

• ASB will hold dialogue with the representatives of Govt,

PSUs, Industry and other organizations

• On the basis of work of study group and dialogue an

exposure draft of the proposed AS will be issued for

comments.

• After taking into consideration the comments received

the proposed AS will be finalized by the ASB. AS on the

relevant subject will be issued by the ICAI after

modification, if found necessary.


Procedure for issuing AS

• The draft of the proposed standard will normally

include:

a) Objective of the standard

b) Scope of the standard

c) Definitions of the terms used in the standard

d) Recognition and measurement principles, wherever

applicable

e) Presentation and disclosure requirements


Compliance

• Compliance with the Accounting Standards has been

made mandatory. Sub section 3(A) to section 211 of

Companies Act requires that every profit and loss

account and Balance Sheet shall comply with the

Accounting Standards.


Compliance

Sub Section 3(B) prescribes that in case the profit

and loss account and balance sheet of a

company does not comply with the requirements

of the AS, disclosures should be made stating

I. Deviations from the AS

II. The Reasons for such deviation and

III. The financial effect, if any, arising due to

such deviation


Compliance

• Sub Section 3(C) Provides that the standard of

accounting specified by the Institute of Chartered

Accountants of India shall be deemed to be the

Accounting Standards until the accounting standards are

prescribed by the Central Government


Compliance

• Sub Section (3) of Section 227 of Companies Act

requires the auditors to report whether in his opinion the

profit and loss account and balance sheet comply with

the accounting standards

• The statutory auditors are required to make qualification

in his report in case any item is treated differently from

the prescribed treatment in the relevant Accounting

standard.


Accounting Standards

• As on date 32 Accounting Standards are issued


List of Accounting Standards

• Disclosure of Accounting Policies (AS-1)

• Valuation of Inventories (AS-2)

• Cash Flow Statements (AS-3)

• Contingencies and Events occurring after the Balance

Sheet Date (AS 4)

• Net Profit or Loss for the Period, Prior Period Items and

Changes in the Accounting Policies (AS-5)

• Depreciation Accounting (AS-6)



• Construction Contacts (AS-7) Revised

• Accounting for Research and Development

(AS-8) ----Since withdrawn

• Revenue Recognition (AS-9)

• Accounting for Fixed Assets (AS-10)

• Accounting for the effect of changes in foreign exchange

rates (AS-11)

• Accounting for Government Grants (AS-12)



• Accounting for Investments (AS-13)

• Accounting for Amalgamations (AS-14)

• Accounting for Employee Benefits (AS-15)

• Borrowing Costs (AS-16)

• Segment Reporting (AS-17)

• Related Party Disclosures (AS-18)



• Leases (AS-19)

• Earning Per Share (AS-20)

• Consolidated Financial Statements (AS-21)

• Accounting for Taxes on Income (AS-22)

• Accounting for Investments in Associates in Consolidated

Financial Statements (AS-23)

• Discontinuing Operations (AS-24)



• Interim Financial Reporting (AS-25)

• Intangible Assets (AS-26)

• Financial Reporting of Interest in Joint Ventures (AS-27)

• Impairment of Assets (AS-28)

• Provisions Contingent Liabilities and Contingent Assets

(AS-29)



• New standards effective from 01-04-2009 and

mandatory from 01-04-2011

– Financial instruments – recognition and measurement

(AS 30)

– Financial instruments – presentation (AS 31)

– Financial instruments – Disclosure (AS 32)


RATIO ANALYSIS

• FINANCIAL ANALYSIS : Is the process of identifying the

financial strengths and weakness of the firm by properly

establishing relationships between the items of Balance

Sheet and Profit and Loss Account

• RATIO ANALYSIS : is a tool of financial analysis.


RATIO ANALYSIS

• Ratio analysis is the analysis of the relationship between

items of financial data, or between financial and non

financial data.

• Ratios sometimes prove themselves to be more

meaningful than the absolute figures


Advantages of Ratio Analysis

I. Simplifies, Summarizes and Systematizes

accounting figures for easy understanding;

II. Ratios helps the management in measuring

things like Long-term Solvency, Operational

Efficiency, etc. of the firm

III. It can be used to compare the risk and return

relationships of firms of different sizes.


Advantages of Ratio Analysis

IV. Facilitates inter-firm comparison showing

relative performance of enterprise in the

industry;

V. Facilitates intra-firm comparison showing the

improvement/degradation in the performance

of the enterprise;

VI. It provides a profile of a firm, its economic

characteristics and competitive strategies, and

its unique operating, financial and investment

characteristics.


Standards of comparison:

• A single ratio does not indicate any condition. It should

be compared with some standard. Standards of

comparison may consist of:

1) Ratios calculated from the past financial statements

of the same firm.

2) Ratios developed using the projected, or pro forma,

financial statements of the same firm.

3) Ratios of some selected firms, ( most progressive &

successful,)

4) Ratios of the industry to which the firm belongs.


Limitations of Ratio Analysis

They are arithmetical expressions. Qualitative aspects

cannot be presented directly.

They are calculated from accounting records which

have their own limitations.

Ratios are indicators only and must be supplemented by

a detailed analysis to discover the reality.

Strongly affected by manipulations of financial

statements & this fact is not revealed by Ratio Analysis.

Factors like Inflation also distort the Ratio Analysis.


Precautions

• Points to be borne in mind while using ratio analysis

technique

– Only figures that have a mutual cause and effect

relationship should be considered

– Particular characteristics of the industry should

always be kept in mind while a firm is being studied.

– Ratios are only symptoms and not the real disease in

itself

– Good profits rather than good ratios is the objective of

the firm


RATIO ANALYSIS

• Classification of Ratios:

Structural Classification

Functional Classification



of Ratios

• This is the Conventional mode of classifying ratios where

the ratios are classified on the basis of information given

in the financial statements.



of RatiosS.N Type What it is Examples

1 Balance Sheet

Ratios

Ratios for which the components for

computation are drawn from the

Balance Sheet. (Financial Ratios.)

* Current Ratio * Liquid Ratio

* Debt Equity Ratio

* Proprietary Ratio

* Capital Gearing Ratio

* Fixed Assets Ratio

2 P&L A/c Ratios Ratios for which the components are

drawn from the P&L Account.

(Income Statement Ratios or Operating

Ratios )

* Gross Profit Ratio

* Net Profit Ratio

* Operating Ratio

* Stock Turnover Ratio

* Expenses Ratio

3 Inter-statement

Ratios or

Combined Ratios

Ratios for which the components are

drawn both from the Balance Sheet

and P&L Account.

( Financial Ratios. )

* Return on Capital Employed [ROCE]

* Return on Investments [ROI]

* Debtors Turnover Ratio

* Creditors Turnover Ratio

* Fixed Assets Turnover Ratio

* Working Capital Turnover Ratio


Functional Classification Of Ratios:

• Financial ratios are broadly categorized in four broad

heads

• Activity analysis

• Liquidity analysis

• Long term debt and solvency analysis

• Profitability analysis


Activity analysis

• Activity ratios describe the relationship between the firm’s

level of operations and the assets needed to sustain

operating activities.

• Short term (operating) activity ratios

– Inventory turnover

– Receivables turnover

– Payable turnover

– Working capital turnover

• Long term (investment) activity ratios

– Fixed assets turnover

– Total asset turnover


Liquidity analysis

• Liquidity ratios helps in assessing the ability of a firm to

meet its current obligations.

• This ability depends on the cash resources available as

on the balance sheet date.

– Current ratio

– Quick ratio

– Cash ratio


Long term debt and solvency analysis

• Analysis of a firm’s capital structure is essential to

evaluate its long term risk and return prospects.

– Debt ratio

• Debt to total capital

• Debt to equity

– Interest coverage ratio


Profitability analysis

• Investors are concerned with the firm’s ability to

generate, sustain and increase profits

• Return on sales

– Gross margin

– Operating margin

– Profit margin

• Return on investments

– Return on assets

– Return on equity


EPS and P/E ratios

• EPS is the most widely available and commonly used

performance statistics for publicly traded firms

• Calculation of EPS is governed and mandated by the

financial reporting standards

– Earnings per share

– Price earning ratio

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accounting standards and ratio analysis

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