UNIT 1: Meaning And Scope of Accounting

Businesses engage in activities that concentrate on financial worth, such as money, spending, expenses and costs etc.

Accounting is the process of - recording, analyzing, and interpreting the - financial or economic activities of a business.

Financial activities in business are recorded as transactions: Bookkeeping is the recording of all transactions for a business in a specific format.

Double-Entry Book keepingThe principle that each transaction involves two changes is known as double-entry bookkeeping: one increase results in one decrease, two increases results in two decreases, and so on.

Assets :Assets are things of value that a business or person owns.

LiabilitiesLiabilities are debts or amounts of money that are owed to others by an individual or a business.

Equity or Net WorthAn assets, after all liabilities are deducted, is known as equity or net worth.

Accounting and Businesses:A businesses’ assets and liabilities are used to calculate the net worth—the owner’s equity.

Owner’s Equity :

Owner’s equity is the owner’s investment in the business or the financial portion of the business that belongs to the owners or shareholders.

Assets – Liabilities = Owner’s Equity

Balance Sheet EquationsThe balance sheet equation can be expressed in two ways:

1. To determine owner’s equity:

Assets – Liabilities = Owner’s Equity

2. To determine total assets:

Assets = Liabilities + Owner’s Equity

► PROCEDURAL ASPECTS OF ACCOUNTING:-

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On the basis of the above definitions, procedure of accounting can be basically divided into two parts:

(i) Generating financial information and

(ii) Using the financial information.

► 1 :- Generating Financial Information Recording – All business transactions of a financial character, as evidenced by some documents such as sales

bill, pass book, salary slip etc. are recorded in the books of account. Recording is done in a book called “Journal.” Journal may further be divided into several subsidiary books according to the nature and size of

the business.

Classifying – Classification is concerned with the systematic analysis of the recorded data, with a view to

group transactions or entries of one nature at one place . Classification helps to put information in a compact and usable form. The book containing classified information is called “Ledger”. This book contains on different pages, individual account heads under which, all financial

transactions of similar nature are collected. For example, there may be separate account heads for Salaries, Rent, Printing and Stationeries,

Advertisement etc.

Summarising – It is concerned with the preparation and presentation of the classified data in a manner useful

to the internal as well as the external users of financial statements. This process leads to the preparation of the following financial statements:

(a) Trial Balance (b) Profit and Loss Account (c) Balance Sheet (d) Cash-flow Statement.

Analysing :– The term ‘Analysis’ means methodical classification of the data given in the financial

statements. The figures given in the financial statements will not help anyone unless they are in a simplified

form. For ex:- all items relating to fixed assets are put at one place while all items relating to current

assets are put at another place. It is concerned with the establishment of relationship between the items of the Profit and Loss

Account and Balance Sheet i.e. it provides the basis for interpretation.

Interpreting : – This is the final function of accounting. It is concerned with explaining the meaning and significance of the relationship as established by

the analysis of accounting data.

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The recorded financial data is analysed and interpreted in a manner that will enable the end-users to make a meaningful judgement about the financial condition and profitability of the business operations.

The financial statement should explain not only what had happened but also why it happened and what is likely to happen under specified conditions

Communicating :– It is concerned with the transmission of summarised, analysed and interpreted information to

the end-users to enable them to make rational decisions. This is done through preparation and distribution of accounting reports, which include besides

the :- profit and loss account and the balance sheet, additional information

in the form of:- accounting ratios, graphs, diagrams, fund flow statements etc.

► 2 :- Using the Financial Information There are certain users of accounts. Proprietor or owner of the business, Investors, Employees, Lenders, Suppliers, Customers, Government and Other agencies and the public at large. Information is useless and meaningless unless it is relevant and material to a user’s decision. The information should also be free of any biases.

► OBJECTIVES OF ACCOUNTING : Systematic recording of transactions Ascertainment of results of above recorded transactions Ascertainment of the financial position of the business Providing information to the users for rational decision-making To know the solvency position

► FUNCTIONS OF ACCOUNTING:- Measurement:

Measures past performance of the business entity and depicts its current financial position. Forecasting:

helps in forecasting future performance and financial position Decision-making:

relevant information to the users to rational decision-making Comparison & Evaluation:

play an important role in predicting, comparing and evaluating the financial results. Control:

identifies weaknesses of the operational system Government Regulation and Taxation:

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BOOK-KEEPING

► Book-keeping is an activity concerned with the recording of financial data relating to business operation in a significant and orderly manner.

At CPT level, the major concern of the curriculum is with book-keeping and preparation of financial statements.

‘Financial Statements’ means Profit and Loss Account and Balance Sheet including Schedules and Notes Forming part of Accounts.

OBJECTIVES OF BOOK-KEEPING :

1. Complete Recording of Transactions – It is concerned with complete and permanent record of all transactions in a systematic and logical manner to show its financial effect on the business.

2. Ascertainment of Financial Effect on the Business – It is concerned with the combined effect of all the transactions made during the accounting period upon the financial position of the business as a whole.

SUB-FIELDS OF ACCOUNTING :

► Financial Accounting – It covers the preparation and interpretation of financial statements and communication to the

users of accounts. It is historical in nature as it records transactions which had already been occurred. It primarily helps in determination of the net result for an accounting period and the financial

position as on a given date.

► (2) Management Accounting – It is concerned with internal reporting to the managers of a business unit. To discharge the functions of planning, control and decision making, the management needs

variety of information. The different ways of grouping information and preparing reports as desired by managers for

discharging their functions is called Management Accounting.► (3) Cost Accounting – the Institute of Cost and Management Accountants of England defines cost accounting as:

“the process of accounting for cost which begins with the recording of income and expenditure or the bases on which they are calculated and ends with the preparation of periodical statements and reports for ascertaining and controlling costs.”

Cost Accounting will be covered at Professional Competence level and Final level

► (4) Social Responsibility Accounting – Social responsibility accounting is concerned with accounting for social costs incurred by the

enterprise and social benefits created.

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► (5) Human Resource Accounting – Human resource accounting is an attempt to identify,quantify and report investments made in

human resources of an organisation.

LIMITATIONS OF ACCOUNTING

The factors which may be relevant in assessing the worth of the enterprise don’t find place in the accounts as they cannot be measured in terms of money.

Balance Sheet shows the position of the business on the day of its preparation and not on the future date also in long run and not for the past date.

Accounting ignores changes in some money factors like inflation etc. There are occasions when accounting principles conflict with each other. There is no generally accepted formula for the valuation of human resources in money terms. So

it can not shown in the balance sheet. Different accounting policies for the treatment of same item adds to the probability of

manipulations.

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UNIT 2 : ACCOUNTING PRINCIPLES

ACCOUNTING CONCEPTS : The assumptions on the basis of which financial statements of a business

entity are prepared.

Concept means idea or notion, which has universal application.

Concepts are those basic assumptions and conditions, which form the basis upon which the accountancy has been laid.

These accounting concepts lay the foundation on the basis of which the accounting principles

are formulated.

ACCOUNTING PRINCIPLES : “Accounting principles are a body of doctrines commonly

associated with the theory and procedures of accounting.

Serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternatives exits.

Accounting principles must satisfy the following conditions:

1. They should be based on real assumptions;

2. They must be simple, understandable and explanatory;

3. They must be followed consistently;

4. They should be able to reflect future predictions;

5. They should be informational for the users.

ACCOUNTING CONVENTIONS : Accounting conventions emerge out of accounting practices,

commonly known as accounting principles, adopted by various organizations over a period of time.

These conventions are derived by usage and practice.

The accountancy bodies may change any of the convention to improve the quality of accounting information.

In the study material, the terms ‘accounting concepts’, ‘accounting principles’ and ‘accounting conventions’ have been used interchangeably.

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CONCEPTS, PRINCIPLES AND CONVENTIONS :(a)Entity concept :

Entity concept states that business enterprise is a separate identity apart from its owner.

Entity concept means that the enterprise is liable to the owner for capital investment made by the owner.

Since the owner invested capital, which is also called risk capital he has claim on the profit of the enterprise.

(b) Money measurement concept : Only those transactions, which can be measured in terms of money

are recorded.

Transactions, even if, they affect the results of the business materially, are not recorded if they are not convertible in monetary terms.

(c) Periodicity concept : This is also called the concept of definite accounting period.

According to this concept accounts should be prepared after every period & not at the end of the life of the entity.

Usually this period is one calendar year. In India we follow from 1st April of a year to 31st March of the immediately following year.

Accrued expenses or accrued revenue is only with reference to a finite time-frame which is called accounting period.

(d) Accrual concept : Under accrual concept, the effects of transactions and other events

are recognised on mercantile basis. i.e., when they occur not on received or paid.

Accrual means recognition of revenue and costs as they are earned or incurred and not as money is received or paid.

The accrual concept relates to measurement of income, identifying assets and liabilities0.

(e) Matching concept :

In this concept, all expenses matched with the revenue of that period should only be taken into consideration.

This concept is based on accrual concept as it considers the occurrence of expenses and income and do not concentrate on actual inflow or outflow of cash.

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Thus, accrual, matching and periodicity concepts work together for income measurement and recognition of assets and liabilities.

(f) Going Concern concept :

The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future.

It is assumed that the enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its operations;

The valuation of assets of a business entity is dependent on this assumption.

The concept indicates that assets are kept for generating benefit in future, not for immediate sale.

Current change in the asset value is not realisable and so it should not be counted.

(g) Cost concept :

By this concept, the value of an asset is to be determined on the basis of historical cost i.e. acquisition cost.

Current cost of an asset is not easily determinable.

It is highly objective and free from all bias.

If the asset is purchased on 1.1.91 and such model is not available in the market, it becomes difficult to determine which model is the appropriate equivalent to the existing one.

Similarly, unless the machine is actually sold, realisable value will give only a hypothetical figure

(h) Realisation concept :

It closely follows the cost concept

Any change in value of an asset is to be recorded only when the business realises it.

If accountants anticipate decrease in value they count it, but if there is increase in value they ignore it until it is realised.

Now-a-days the revaluation of assets has become a widely accepted practice when the change in value is of permanent nature.

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Thus the going concern, cost concept and realization concept gives the valuation criteria.

(i) Dual aspect concept :

This concept is the core of double entry book-keeping.

Every transaction or event has two aspects.

(j) Conservatism : Conservatism states that the accountant should not anticipate income

and should provide for all possible losses.

The golden rule of current assets valuation - ‘cost or market price’ whichever is lower originated from this concept.

For this concept there should be at least three qualitative characteristics of financial statements :

(i) Prudence, i.e., judgement about the possible future losses which are to be guarded, as well as gains which are uncertain.

(ii) Neutrality, i.e., unbiased outlook is required to identify and record such possible losses, as well as to exclude uncertain gains

(iii) Faithful representation of alternative values.

(k) Consistency : The accounting policies are followed consistently from one period to

another

A change in an accounting policy is made only in certain exceptional circumstances.

Consistency is applied particularly when alternative methods of accounting are equally acceptable.

For example a company may adopt any of several methods of depreciation such as written-down-value method, straight-line method, etc. Likewise there are many methods for valuation of stocks-in-hand.

An enterprise should change its accounting policy in any of the following circumstances only:

To bring the books of accounts in accordance with the issued Accounting Standards.

To compliance with the provision of law.

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When under changed circumstances it is felt that new method will reflect more true and fair picture in the financial statement.

(l) Materiality:

According to materiality principle, all the items having significant economic effect on the business of the enterprise should be disclosed in the financial statements

Materiality principle permits other concepts to be ignored, if the effect is not considered material.

This principle is an exception of full disclosure principle.

The materiality depends not only upon the amount of the item but also upon the size of the business, nature and level of information, level of the person making the decision etc.

For example stationary purchased by the organization though not used fully in the accounting year purchased still shown as an expense of that year because of the materiality concept. Similarly depreciation on small items like books, calculators etc. is taken as 100% in the year of purchase though used by the company for more than a year.

FUNDAMENTAL ACCOUNTING ASSUMPTION

If nothing has been written about the fundamental accounting assumption it is assumed that they have already been followed in their preparation of financial statements.

If any of the mentioned fundamental accounting assumption is not followed then this fact should be specifically disclosed.

There are three fundamental accounting assumptions :

(i) Going Concern

(ii) Consistency

(iii) Accrual

FINANCIAL STATEMENTS

Financial position of an entity and to communicate the relevant financial information to the interested user groups.

QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

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Qualitative characteristics make the information useful to users.

The following are the important qualitative characteristics of the financial statements:

Understandability : Information must be readily understandable by users.

For this purpose, it is assumed that users have a reasonable knowledge of business and economic activities and accounting and study the information with reasonable diligence.

Relevance : Information must be relevant to the decision-making needs of

users.

Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations.

Reliability : To be useful, information must also be reliable.

Information has the quality of reliability when it is free from material error and bias.

Comparability :

Users must be able to compare the financial statements of an enterprise

through time in order to identify trends in its financial position, performance and cash flows.

The four principal qualitative characteristics are understandability, relevance, reliability and comparability.

Materiality : The relevance of information is affected by its materiality.

Information is material if its misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information.

Faithful Representation :

To be reliable, information must represent faithfully the transactions and other events it either purports to represent or could reasonably be expected to represent.

Substance Over Form :

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It is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form.

Neutrality : Financial statements must be neutral, that is, free from bias.

Prudence : The preparers of financial statements have to contend with the

uncertainties that inevitably surround many events and circumstances, such as the collectability of receivables, the probable useful life of plant and machinery, and the warranty claims that may occur.

Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated.

Full, fair and adequate disclosure : The financial statement must disclose all the reliable and relevant

information about the business enterprise.

The principle of full disclosure implies that nothing should be omitted.

All the transactions recorded should be accounted in a manner that financial statement purports true and fair view of the results of the business.

Completeness : To be reliable, the information in financial statements must be

complete within the bounds of materiality and cost.

SYSTEM OF BOOK KEEPING SINGLE ENTRY SYSTEM : An incomplete double entry system can be termed as a single

entry system . DOUBLE ENTRY SYSTEM : Every transaction has two-fold aspects–debit and credit. In the system of book-keeping,transactions are recorded in the books of accounts. A transaction is a type of event, which is generally external in nature and can be

determined in terms of money. Transactions supported by proper documents are recorded in the books of accounts

under double entry system.

Accounting Equation Approach:

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Relationship of assets with that of liabilities and owners' equity in the equation form is known as 'Accounting Equation'.

Due to Double Entry concept each transaction affects changes in assets, liabilities or capital in such a way that an accounting equation is completed and equated.

The contribution by the owner is termed as capital; the borrowings are termed as loans or liabilities. LIABILITIES

Whenever the loan is repayable in the short-run it is called short-term loan or liability If the loan is repayable within 4 or 5 years or more, it would be termed as long term loan or

liability. Liabilities relating to credit purchase of merchandise are called trade creditors, and for other

purchases and services received on credit as expense creditors.(These are also termed as current liabilities.) ASSETS

Two types of assets– Fixed Assets and Current Assets

Owner's claim (Equity ) implies :- Capital invested + Profit - Loss.

Equation: Equity + Liabilities = Assets OR Equity + Long-Term Liabilities = Fixed Assets + Current Assets - Current Liabilities

Compliance with Accounting Standards : BENEFITS AND LIMITATIONS :Accounting standards seek to describe the

accounting principles, the valuation techniques and the methods of applying the accounting principles in the preparation and presentation of financial statements so that they may give a true and fair view. By setting the accounting standards, the accountant has following benefits:

(i) Standards reduce to a reasonable extent or eliminate altogether confusing variations in the accounting treatments used to prepare financial statements.

(ii) There are certain areas where important information are not statutorily required to be disclosed. Standards may call for disclosure beyond that required by law. (iii) The application of accounting standards would, to a limited extent, facilitate comparison of financial statements of companies situated in different parts of the world and also of different companies situated in the same country. However, it should be noted in this respect that differences in the institutions, traditions and legal systems from one country to another give rise

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to differences in accounting standards adopted in different countries.

However, there are some limitations of setting of accounting standards: (i) Alternative solutions to certain accounting problems may each have arguments to recommend them. Therefore, the choice between different alternative accounting treatments may become difficult. (ii) There may be a trend towards rigidity and away from flexibility in applying the accounting standards. (iii) Accounting standards cannot override the statute. The standards are required to be framed within the ambit of prevailing statutes

Sl. Number of the TITLE OF THE ACCOUNTING STANDARDNo. AccountingStandard (AS)1. AS 1 Disclosure of Accounting Policies2. AS 2 (Revised) Valuation of Inventories3. AS 3 (Revised) Cash Flow Statements4. AS 4 (Revised) Contingencies and Events Occurring after the Balance Sheet Date 5. AS 5 (Revised) Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies6. AS 6 (Revised) Depreciation Accounting7. AS 7 (Revised) Accounting for Construction Contracts8. AS 8 (withdrawn Accounting for Research and Development pursuant to AS 26 becoming mandatory)9. AS 9 Revenue Recognition10. AS 10 Accounting for Fixed Assets11. AS 11 (Revised) The Effects of Changes in Foreign Exchange Rates12. AS 12 Accounting for Government Grants13. AS 13 Accounting for Investments14. AS 14 Accounting for Amalgamations15. AS 15 (Revised) Employee Benefits

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16. AS 16 Borrowing Costs17. AS 17 Segment Reporting18 . AS 18 Related Party Disclosures19. AS 19 Leases20. AS 20 Earnings Per Share21. AS 21 Consolidated Financial Statements22. AS 22 Accounting for Taxes on Income23. AS 23 Accounting for Investments in Associates in Consolidated Financial Statements24. AS 24 Discontinuing Operations25. AS 25 Interim Financial Reporting26. AS 26 Intangible Assets27. AS 27 Financial Reporting of Interests in Joint Ventures28. AS 28 Impairment of Assets29 AS 29 Provisions, Contingent Liabilities & 30. AS 30 Financial Instruments: Recognition & Measurement31. AS 31 Financial Instruments: Presentation Contingent Assets

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UNIT 3 : JOURNALIZING TRANSACTIONS AND LEDGER POSTING

Transactions in the journal are recorded on the basis of the rules of debit and credit only. Transactions are classified in three groups:

(i) Personal transactions. (Personal Accounts) (ii) Transactions related to assets and properties. (Real Accounts) (iii) Transactions related to expenses, losses, income and gains. (Nominal Accounts)

CLASSIFICATION OF ACCOUNTS (i) Personal Accounts

Natural personal accounts: It relates to transactions of human beings like Ram, Rita, etc.

Artificial (legal) personal account:

For business purpose, business entities are treated to have separate entity. They are recognised as persons in the eye of law for dealing with other persons. For example:Government, Companies (private or limited), Clubs,Co-operative societies etc.

Representative personal accounts: These are not in the name of any person or organisation but are represented

as personal accounts. For example: outstanding liability or prepaid account, capital account, drawings account.

(ii) Impersonal Accounts Accounts which are not personal:

Real Accounts :

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Accounts which relate to assets of the firm but not debt. For example, accounts regarding land, building, investment, fixed deposits etc., are real accounts.

Nominal Accounts Accounts which relate to expenses, losses, gains, revenue, etc. like

salary account, interest paid account, commission received account. The net result of all the nominal accounts is reflected as profit or loss which is transferred to the capital account.

Nominal accounts are, therefore, temporary.

GOLDEN RULES OF ACCOUNTING :

Personal account is governed by : Debit the receiver Credit the giver

Real account is governed by : Debit what comes in Credit what goes out

Nominal account is governed by : Debit all expenses and losses Credit all incomes and gains

Nature of Account Title of Account Traditional Approach Accounting Equation (a) Building Real Asset(b) Purchases Real Asset(c) Sales Nominal(R) Temporary Capital (R)(d) Bank Deposit Personal Asset(e) Rent Nominal (E) Temporary Capital (E)(f) Rent Outstanding Personal Liability(g) Cash Real Asset(h) Adjusted Purchases Nominal (E) Temporary Capital (E)(i) Closing Stock Real Asset(j) Investment Real Asset(k) Debtors Personal Asset l) Sales Tax Payable Personal Liability(m) Discount Allowed Nominal (E) Temporary Capital (E)(n) Bad Debts Nominal (E) Temporary Capital (E)(o) Capital Personal Capital(p) Drawings Personal Temporary Capital (D)(q) Provision for dep. Real Asset(r) Interest receivable Personal Asset(s) Rent received in adv. Personal Liability(t) Prepaid salary Personal Asset(u) Provision for bad and

doubtful debts Personal Asset(v) Bad debts recovered Nominal (Gain) Temporary Capital (w) Depreciation Nominal (E) Temporary Capital

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(x) Personal Tax Personal (Dra.) Temporary Capital (Dra.) (y) Stock reserve Real Asset (z) Provision for discount on creditors Personal Liability

JOURNAL

Journal is also called subsidiary book. Recording of transactions in journal is termed as journalizing the entries. All transactions are first recorded in the journal as and when they occur. The record is chronological; otherwise it would be difficult to maintain the records in an orderly

manner. IMPORTANT POINTS :

The following points should be noted When making journal : Journal entries can be single entry (i.e. one debit and one credit) or compound entry

(i.e. one debit and two or more credits or two or more debits and one credit or two or more debits and credits). It is important to check that

The total of both debits and credits are equal. If journal entries are recorded in several pages then both the amount column of each

page should be totalled and the balance should be written at the end of that page and also that the same total should be carried forward at the beginning of the next page.

As transactions are recorded on chronological order, We can get complete information about the business transactions on time basis.

Entries recorded in the journal are supported by a note termed as narration, which is a precise explanation of the transaction for the proper understanding of the entry. We can know the correctness of the entry through these narrations.

Journal forms the basis for posting the entries in the ledger. This eases the accountant in their work and reduces the chances of error.

Ledgers

Recorded entries are classified and grouped into by preparation of accounts and the book, is known as Ledger.

It is known as principal books of account in which account-wise balance of each account is determined. POSTING

The process of transferring the debit and credit items from journal to classified accounts in the ledger is known as posting.

Separate account is opened in ledger book for each account and entries from ledger posted to respective account accordingly.

BALANCING AN ACCOUNT

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At the end of the each month or year or any particular day it may be necessary to ascertain the balance in an account.

Nominal accounts are not balanced; the balance in the end are transferred to the profit and loss account.

Only personal and real accounts show balances. The capital account will have to be adjusted for profit or loss.

UNIT 4 : SUBDIVISIONS OF JOURNAL AND TRIAL BALANCE

Subsidiary Books (Subdivision of journal) :

Subsidiary books are books of original or prime entry. Ledger accounts are prepared on the basis of Subsidiary books. Trial balance is prepared on the basis of Ledger. Financial Statements are prepared on the Basis of Trial balance.

Advantages of Subsidiary Books : Division of work Specialisation and efficiency Saving of the time Availability of informations Facility in checking:

DISTINCTION BETWEEN SUBSIDIARY BOOKS AND PRIMARY BOOKS : The books in which transactions are first recorded to enable processing are called

subsidiary books. The ledger and the cash book are the principle books since they furnish information

for preparation of the trial balance and financial statements.► Subsidiary journal (Books ) Are :• Purchase journal ( Book) : Record All Credit Purchases of goods(not cash).• Sales journal ( Book) : Record All Credit Sale of goods(not cash).• Purchase Return journal ( Book) or Return Outward • Sales Return journal ( Book) or Return Inward Book • Bills Receivable journal ( Book) Bills Payable Book

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• Journal Proper transactions

► SALES BOOK WITH SALES TAX COLUMN : Sales Tax is levied at the point of sales. Sales tax is collected by the seller from the customers and deposited the same with the

state government. Sales tax is charged at a fixed percentage on the net price of the goods. It is calculated after giving trade discount, if any. It is better to open a separate column in the Sales Book for sales tax. At the end of a certain period, generally quarterly or monthly, the total of sales tax

column is credited to the Sales Tax Account. When sales tax is deposited the Sales Tax Account is debited and Cash/Bank Account is

credited. If there is any credit balance in Sales Tax Account be shown in the Balance Sheet as a

liability.

► IMPORTANT POINTS: Goods being received and accepted back (Sales Return) from the customers, a credit

note is issued to the customers concerned. (Credit The Customer A/c). When goods are returned to suppliers (Purchase Return) we will issue the necessary

Debit Note to supplier. If someone who accepted a promissory note (or bill) and is not able to pay in on the due

date,a journal entry will be necessary to record the non-payment or dishonour.

TRIAL BALANCE Trial balance is the third phase in the accounting process. After posting the accounts in the ledger, a statement is prepared to show separately the debit

and credit balances, known as the trial balance The totals of the debit sides must be equal to the totals of the credit sides. Trial balance can be prepared any time but it is preferable to prepare it at the end of the

accounting year to ensure the arithmetic accuracy of all the accounts. Trial balance is a statement and not an account.

OBJECTIVES OF PREPARING THE TRIAL BALANCE :

The trial balance helps to establish arithmetical accuracy of the books. Financial statements are normally prepared on the basic of agreed trial balance. The trial balance serves as a summary of Accounts is contained in the ledger.

LIMITATIONS OF TRIAL BALANCE :

`The agreement of Trial Balance is not proof of accuracy. There may some Errors even Trial Balance Agree:

Transaction has not been entered in the journal.

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A wrong amount has been written in both columns of the journal. A wrong account has been mentioned in the journal. An entry has not at all been posted in the ledger. Entry is posted twice in the ledger.

METHODS OF PREPARATION OF TRIAL BALANCE :

► TOTAL METHOD : Under this method, every ledger account is totaled and that total amount (both of debit

side and credit side) is transferred to trial balance. In this method, trial balance can be prepared as soon as ledger account is totaled. Time taken to balance the ledger accounts is saved. The difference of totals of each ledger account is the balance of that particular account. This method is not commonly used as it cannot help in the preparation of the financial

statements.► BALANCE METHOD : Under this method, every ledger account is balanced and those balances only are carry forward

to the trial balance. Financial statements are prepared on the basis of the balances of the ledger accounts.► TOTAL AND BALANCE METHOD : Under this method, the above two explained methods are combined. Under this method statement of trial balance contains seven columns instead of five columns.

Sl. No. Heads of Account L.F. Debit Credit Debit Credit Balance Balance Total Total (Rs.) (Rs.) (Rs.) (Rs.)

► ADJUSTED TRIAL BALANCE (THROUGH SUSPENSE ACCOUNT) : If the trial balance do not agree after transferring the balance of all ledger accounts. The difference is adjusted by opening an account known as suspence account.

This is a temporary account opened to proceed further and to prepare the financial statements timely.

Cash Book

Cash Book is a type of subsidiary book but treated as a principal book. On the basis of Cash Book , ledger accounts are prepared. Therefore, the Cash Book is a

subsidiary book. The Cash Book is part of the ledger also because the balance of cash book are entered in the

trial balance directly. So it also to be treated as the principal book. So The Cash Book is both subsidiary book and a principal book.

KINDS OF CASH BOOK

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The main Cash Book may be of the three types:

(i) Simple Cash Book: In the simple cash book only the cash receipts and cash payment are recorded. (ii) The debit side is always bigger than the credit side since the payment cannot exceed

the available cash. (ii) Two-column Cash Book:

There are two columns one to record cash receipts and cash payments , Another column is added on each side to record the cash discount allowed or the

discount received, or a column the discount columns in the cash book are not accounts; Discount Columns are not balanced; and Totals of discount columns are entered in the discount account in the ledger.

(iii) Three-column Cash Book: Three- column cash book is similar to two column cash book but there is one more column i.e.

Bank column. In case of maintaining more than one Bank Account, separate column can be add for each Bank

Account. In case any Cash deposited to Bank or Cash withdrawal from Bank, the letter "C" (Contra

Entries) should be written in the LF. If initially cheques received are entered in the cash column and then sent to the bank, the entry

is as if cash has been sent to the bank i.e. Contra Entry.

PETTY CASH BOOK Number of small payments, such as for telegrams, taxi fare, cartage, etc., have to be made. If all

these payments are recorded in the cash book, it will become unnecessarily heavy. For petty cash to appoint a person as 'Petty Cashier' and to entrust the task of making small

payments. 'Petty Cashier' will be reimbursed for the payments made. There are mainly three advantages:

(i) Saving of time of the chief cashier; (ii) Saving in labour in writing up the cash book and posting into the ledger; and (iii) Control over small payments.

IMPREST SYSTEM OF PETTY CASH

Under imprest system of petty cash: A definite sum of money to the petty cashier in the beginning of a period and to

reimburse him for payments made at the end of the period. He will have again the fixed amount in the beginning of the new period.

ENTRIES FOR SALE THROUGH CREDIT/DEBIT CARDS

From the seller's point of view, this type of sale is equivalent to a cash sale. Commission charged by the bank will be treated as selling expenses.\ The following general entries will be made in the seller's books of accounts:

1. Bank A/c Dr. To Sales Account

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(Sales made through Credit/Debit Card) 2. Commission Account Dr. To Bank Account (Commission charged by bank)

UNIT 5 : PREPARATION OF FINANCIAL STATEMENTS The primary function of accounting is to accumulate accounting data in a

manner that the amount of profit made or loss suffered during a period can be determined along with the status of the business in financial terms. Statements prepared for this purpose are called final accounts. Final accounts are also termed as financial statements.

This chapter has been divided into two units : (i) Final accounts of Non-manufacturing entities and (ii) Final accounts of Manufacturing entities

In Financial Accounting, profit is measured at two levels : (a) Gross Profit (b) Net Profit The profit of the enterprise is obtained through the preparation of Income Statement. PREPARATION OF FINAL ACCOUNTS

(1) TRADING ACCOUNT : At the end of the year, as has been seen above, it is necessary to

ascertain the net profit or the net loss. For this purpose, it is first necessary to know the gross profit or gross loss.

Gross Profit is the difference between the selling price and the cost of the goods sold.

TRADING ACCOUNT ITEMS (a) In a trading firm like a wholesaler, the main business consists of buying and selling the same goods.

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(1) Opening Stock :. This item is usually put as the first item on the debit side of the Trading Account.

(2) Purchases and Purchase Returns : The purchases account will be debit balance, showing the gross amount of purchases made of the materials. The purchase returns account will be credit balance showing the return of materials to the suppliers. On the debit side of the trading account the net amount is shown as indicated (with assumed figures) :

Rs. To Purchases 5,00,000 Less : Purchase Returns 10,000 4,90,000

(3) Carriage or Freight Inwards : This item should also be debited to the Trading Account, as it is incurred to bring the materials to the firm’s godown and make them available for use. However, if any freight or cartage it paid on any asset, like machinery, it should be added to the cost of the asset and not debited to the Trading Account.

(4) Wages : Wages paid to workers in the godown/stores, should be debited to the Trading Account. If any amount is outstanding, it must be brought into books so that full wages for the period concerned are charged to the Trading Account. However, if wages are paid for installation of an asset, it should be added to the cost of the asset.

(5) Sales and Sales Returns : The sales account will be a credit balance indicating the total sales made during the year. The sales return account will be a debit balance, showing the total of the amount of goods returned by customers. The net of the two amounts is entered on the credit side of the Trading Account.

(6) Closing Stock and its valuation : Usually there is no account to show the value of goods lying in the godown at the end of the year. However, to correctly ascertain the gross profit, the closing stock must be properly taken and valued.

The entry is Closing Stock Account Dr. To Trading Account Alternatively, Closing stock can be adjusted with purchases : Closing Stock Account Dr. To Purchases Account The effect of this entry is to reduce the debit in the Purchases Account. It will then appear in the trial balance. The Stock Account is then not entered in the Trading Account and will be shown only in the Balance sheet.

(7) Sales Tax : Sales Tax is an indirect tax in the sense that it is collected by the seller from the customers and deposited in Government’s Account as per requirements of the Sales Tax Act. Sales tax is generally deducted from gross sales figures and sales tax liability (net of payments) is shown as current liability in the balance sheet.

CLOSING ENTRIES IN RESPECT OF TRADING ACCOUNT The following entries will be required :

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(i) For opening stock : Debit Trading Account and Credit Stock Account.(ii) For purchases returns : Debit Returns Outward Account and Credit

Purchases Account. For returns inward : Debit Sales Account and Credit Returns Inwards Account. (In the trading account information is usually given both in respect of gross sales; and purchases and the respective returns).

(iii) For purchases account : Debit Trading Account and Credit Purchases Account, the amount being the net amount after return.

(iv) For expenses to be debited to the Trading Account, for example wages etc; Debit Trading Account and credit the concerned expenses accounts individually.

(v) For sales : Debit Sales Account with the net amount after returns, and Credit Trading Account.

(vi) For closing stock : Debit Stock Account and Credit Trading Account. The Stock Account will be carried forward to the next year.After making the entries mentioned in (ii) above, the other entries are usually summarised as follows :

(1) Trading Account Dr. To Opening Stock Account To Purchases Account To Wages Account To Freight on Purchases Account, etc. (2) Sales Account Dr. Closing Stock Account Dr. To Trading Account At this stage Trading Account will reveal the gross profit, it the credit side is bigger, or Gross loss it the credit side is short. The gross profit will be transferred to the Profit and Loss Account by the entry: Trading Account Dr. To Profit and Loss Account The entry for gross loss, if there be any is : Profit and Loss Account Dr. To Trading Account

(2) PROFIT AND LOSS ACCOUNT Profit and loss A/C debited with expenses and credited with incomes:(1) Administrative expenses include the following :(i) Salaries paid to the people working in the general office; salaries of executive officersshould be shown separately.(ii) Rent and rates for the office premises.(iii) Lighting in the office.(iv) Printing and stationery.(v) Postage, telegrams and telephone charges.(vi) Legal expenses.(vii) Audit fees, etc.

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(2) The selling and distribution expenses will comprise the following :(i) Salesmen’s salaries and commission.(ii) Commission to agents.(iii) Advertising.(iv) Warehousing expenses.(v) Packing expenses.(vi) Freight and carriage on sales.(vii) Export duties.(viii)Sales tax to the extent it cannot be recovered from the customers.(ix) Maintenance of vehicles for distribution of goods and their runSning expenses.(x) Insurance of finished goods stock and goods in transit.(xi) Bad debts.

BALANCE SHEETThe balance sheet may be defined as “a statement which sets out the assets and liabilities of a firmor an institution as at a certain date.” Since even a single transaction will make a difference tosome of the assets or liabilities, the balance sheet is true only at a particular point of time. Thatis the significance of the word “as at.”In the illustration worked out above it will be seen that the under mentioned accounts havenot been closed even after preparation of the Profit and Loss Account and the transfer of thenet profit to the capital account.

Capital and Liabilities Amount Assets Amount Rs. Rs. Capital A/c: Tangible Fixed Assets : Balance Land and Building Add : Net Profit/Less: Net Loss Plant and Machinery Less : Drawings Furniture and Fixture Long Term Loans : Vehicles Term Loans Intangibles : Other Loans Goodwill Short Term Loans : Patent Rights Cash Credit Designs and Brand Names Overdrafts Deferred Advertisement Other Loans Investments : Current Liabilities : Long term investments Sundry Creditors

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Bills Payable Current Assets : Outstanding Expenses Stock In Trade Advances Taken Sundry Debtors Provision : Bills Receivable Provision for Bad debts Prepayments Provision for Retirement Benefits Advances Provisions for Taxation Bank Balances Cash In Hand

The manufacturing entities generally prepare a separate Manufacturing Account as a part of

Final accounts in addition to Trading Account, Profit and Loss Account and Balance Sheet.The objective of preparing Manufacturing Account is to determine manufacturing costs offinished goods for assessing the cost effectiveness of manufacturing activities.

Manufacturing Account Dr. Cr.Particulars Units Amount Particulars Units Amount Rs. Rs.To Raw Material By By-products atConsumed: net realisable valueOpening Stock … . “ Closing Work-in- ProcessAdd: Purchases ….. “ Trading A/c -Less: Closing Stock ….. …… Cost of production“ Direct Wages ……“ Direct expenses: ……Prime cost ……To Factory overheads:Royalty .….Hire charges …..“ Indirect expenses: …..Repairs & Maintenance .….Depreciation .…. …….

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Factory cost …….To Opening Work-inprocess .……

UNIT 6: BANKING TRANSACTION 1. BILLS OF EXCHANGE

A Bill of Exchange has been defined as an "instrument in writing containing an unconditional order signed by the maker directing a certain person to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instrument".

When such an order is accepted in writing on the face of the order itself, it becomes a valid bill of exchange.

The party which makes the order is known as the drawer.

The party which accepts the order is known as the acceptor.

The party to whom the amount has to be paid is known as the payee.

The drawer and the payee can be the same.

Foreign bill of exchange: Section 12 of the Negotiable Instruments Act provides that all instruments

which are not inland instrument are foreign. The following are examples of foreign bills.

1. A bill drawn in India on a person resident outside India and made payable outside India.

2. A bill drawn outside India on a person resident outside India.

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3. A bill drawn outside India and made payable in India.

4. A bill drawn outside India and made payable outside India. A foreign bill of exchange is generally drawn up in triplicate. Each copy is sent by separate post so that at least one copy

reaches the intented party.

2. PROMISSORY NOTE A promissory note is an instrument in writing, not being a bank note

or currency note containing an unconditional undertaking signed by the maker to pay a certain sum of money only to or to the order of a certain person.

A promissory note has the following characteristics.

1. It must be in writing.

2. It must contain a clear promise to pay. Mere acknowledgement of a debt is not a promissory note.

3. The promise to pay must be unconditional "I promise to pay Rs. 500 as soon as I can” is not an

unconditional promise.

4. The promiser or maker must sign the promissory note.

5. The maker must be a certain person.

6. The payee (the person to whom the payment is promised) must also be certain.

7. The sum payable must be certain. "I promise to pay Rs. 500 plus all fine" is not certain.

8. Payment must be in legal currency of the country.

9. It should not be made payable to the bearer.

10. It should be properly stamped.

3. TERM OF A BILL The term of bill of exchange may be of any duration. Usually the term

does not exceed 90 days from the date of the bill.

When a bill is drawn after sight, the term of the bill begins to run from the date of ‘sighting’, i.e., when the bill is accepted.

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When a bill is drawn ‘after date’, the term of the bill begins to run from the date of drawing the bill.

4. DUE DATE OF A BILL The date on which the term of the bill expires is called as ‘Due Date of

the bill’.

5. DAYS OF GRACE Every instrument payable otherwise than on demand is entitled to

three days of grace.

6. DATE OF MATURITY OF BILL The date which comes after adding three days to the due date of a

bill, is called the date of maturity.

7. BILL AT SIGHT

Bill at Sight means the instruments in which no time for payment is mentioned. A cheque is always payable on demand. A promissory note or bill of exchange is payable on demand-

(a)when no time for payment is specified, or

(b)when it is expressed to be payable on demand, or at sight or on presentment.

‘At sight’ and presentment means on demand.

An instrument payable on demand may be presented for payment at anytime.

Days of grace is not to added to calculate maturity for such types of bill.

8. BILL AFTER DATE Bill after date means the instrument in which time for payment is mentioned.

A promissory note or bill of exchange is a time instrument when it is expressed to be payable-

(a) after a specified period.

(b) on a specific day

(c) after sight

(d) on the happening of event which is certain to happen

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A cheque cannot be a time instrument because the cheque is always payable on demand.

9. HOW TO CALCULATE DUE DATE OF A BIL

When the due date is a public holiday.

The preceding business day will be the due date.

When the due date is an emergency

The next following day will be the due date unforeseen holiday.

10. HOW TO CALCULATE DATE OF MATURITY IN CASE OF TIMEBILLS

In case of time or tenor bills, three days (called days of grace) are added to the due date to arrive at the date of maturity.

11. NOTING CHARGES

If there is dishonour, or fear of dishonour, the bill will be given to a public official known as "Notary Public".

These officials present the bill for payment and if them money is received, they will hand over the money to the original party.

But if the bill is dishonoured they will note the fact of dishonuour, and the reasons given and give the bill back to their client.

For this service they charge a small fee. This fee is known as noting charges.

The amount of noting charges is recoverable from the party which is responsible for dishounour

BANK RECONCILATION STATEMENT

Strictly speaking, there should be no difference between the balance shown by the pass-bookand the cash-book. This is so, if all the entries are recorded in both. However, on a particular date it is possible that balances on both the books do not tally i.e., some entries may have beenrecorded in the cash-book but not in the pass-book and vice versa. After finding the reasons for

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non-agreement of the bank balances of pass-book and cash-book, efforts are made for theirreconciliation. This reconciliation is prepared and presented in the form of a statement commonlyknown as Bank Reconciliation Statement.

IMPORTANCE OF BANK RECONCILIATION STATEMENT Bank reconciliation statement is a very important tool for internal control of

cash flows. Ithelps in detecting errors, frauds and irregularities occurred, if any, at the time of passing entriesin the cash-book or in the pass-book, whether intentionally or unintentionally. Since fraudscan be detected on the preparation of bank reconciliation statement therefore accountants arecareful while preparing and maintaining the records of the business enterprise. Hence it worksas an important mechanism of internal control. Following are the salient features of bankreconciliation statement :

(i)The reconciliation will bring out any errors that may have been committed either in the cash-book or in the pass-book;

(ii) Any undue delay in the clearance of cheques will be shown up by the reconciliation;

(iii) A regular reconciliation discourages the staff of the customer or even that of the bank from embezzlement. There have been many cases when the cashiers merely made entries in the cash-book but never deposited the cash in the bank; they were able to get away with it only because of lack of reconciliation.

(iv) It helps in finding out the actual position of the bank balance.

ASCERTAINING THE CAUSES OF DIFFERENCE OF BANK BALANCE IN BANK COLUMN OF THE CASH-BOOK AND IN PASS-BOOK

The difference in the balances of both the books can be because of the following two reasons :

1. Timing differences, 2. Differences arising due to errors in recording the entries.

TIMING DIFFERENCESWhen the same entry is recorded in either of the book earlier and in the other book later, it istermed as timing difference. The timing difference may arise on account of the following :

(i) Cheques issued but not yet presented for payment :

(ii) Cheques paid into the bank but not yet cleared :

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(iii) Interest allowed by bank :

(iv) Interest and expenses charged by the bank :

(v) Interest and dividends collected by the bank :

(vi) Direct payments by the bank :

(vii) Direct payment into the bank by a customer :

(viii) Dishonour of a bill discounted with the bank :

(ix) Bills collected by the bank on behalf of the customer :

DIFFERENCES ARISING DUE TO ERRORS IN RECORDING THE ENTRIES While recording the entries, errors can occur both in the cash-book and

in the pass-book. A bank rarely commits an error but, if it does, the balance shown in pass-book will naturally differ from that shown in the cash-book. Similarly, if any error is committed in the cash-book then too the balance shown in it will differ from that of the pass-book. Errors include omission of entry, wrong recording of amount, recording of entry on wrong side of the book, wrong totaling of account or wrong balancing of the book, recording of transactions of other party.

BANK RECONCILIATION STATEMENT WITHOUT PREPARATION OF ADJUSTED CASH-BOOK

For reconciliation purposes students can take any of the four balances as the starting point and can proceed further with the causes of differences. Given the causes of disagreement,

the balance of the other book can be either more or less on account of the said causes.

If the balance of the other book is more on account of the said causes then add the amount.

If the balance of the other book is less on account of the said causes then subtract the amount.

Case Studies in Finance and Accounting

Introduction

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As he read his newspaper on the morning of March 29, 2007, Michael J. Sabia, CEO of BCE Inc. (Bell Canada) (NYSE/Toronto: BCE), could not help but feel the pressure being raised a notch. Rumours had been rife for several weeks that a private investment company would attempt to acquire control of his corporation. Now, in a financial paper, he was reading more details confirming that talks between Bell Canada and the New York firm Kohlberg Kravis Roberts & Co. regarding the private buy-out were at an advanced stage. The past weeks’ rumors had been enough that Bell Canada shares were trading at $29.15; two days before they had hit a 52-week high of $ 30.02. Mr. Sabia well knew that another official denial would have absolutely no impact and in fact would do nothing but add plausibility to the rumors. Only two days before, a Bell Canada spokesperson had denied the existence of the buy-out talks, but that had merely put a momentary brake on the steady rise in the price of BCE shares. Some decisions had to be made very quickly. The offer that was the subject of so much speculation did in fact exist. It was in the neighborhood of $30 billion, 20% more than the market capitalization of Bell Canada, which was valued at $24 billion. But there were multiple questions to which Michael Sabia had to find an answer. Was the value of the offer really as good as it looked given Bell’s current financial situation and its future outlook? How would the money be paid? Should the offer be approved and recommended, first to the members of Bell’s board of directors and then to its shareholders? Would it be better to wait until the other organizations that had indicated an interest actually came out with their offers? And what position would the Canadian communications regulatory authorities take, given that Canadian law prohibited foreign companies from owning a majority of Bell Canada shares? So many questions whose answers had to be part of Mr. Sabia’s eagerly awaited final official report. BCE Inc. and the Canadian Telecommunications Market BCE Inc. is Canada’s oldest and largest communications company with over $17 billion in revenues in 2006. BCE offers a wide variety of wire line, voice and wireless communications services to both residential, business and wholesale customers. In 2006, BCE derived 30% of its total revenues from “local and access” products and services, 24% from “data”, 20% from “wireless”, 10% from “long distance”, 9% from “terminal sales and other” and 7% from the “video” segment. Between 2005 and 2006, BCE’s “local and access” and “long distance” as well as “terminal sales and other” segments were losing revenue share to competition, showing declines in revenues of the order of 4.6%, 12.5%, and 3.7% respectively. The “video” and “wireless” segments were adding revenues at 17.8% and 13.2%, respectively. The “data” segment showed slower revenue growth with only 2.6%. 40% of BCE Inc.’s operating revenue came from its “residential” segment, 33% from its “business” segment, 17% from its “Bell Aliant” segment, 8% from its “other Bell Canada” segment and 2% from “other BCE” segment(BCE Inc. Annual Report 2006). As such BCE was a well-diversified large telecommunications company unlike many of its Canadian and even US counterparts. Following rapid and breathless changes in technology, competitive and regulatory landscapes and increasing consumer demands, the telecom giant reorganized its business holding structure in the spring of 1983 with BCE Inc. becoming the parent company of Bell Canada, Bell Aliant and other Bell Canada segments, notably the wholesale business providing access and network services to other providers of local, long distance, wireless, internet, data and other telecommunications services (e.g., Northwestel).

The product and service line of BCE Inc. includes local and wire line access and long distance services, data and high-speed internet subscriptions, wireless and video subscriptions (see product line analysis chart p.27 AR2006). In 2006 and early 2007, the Canadian telecom market was changing rapidly, following other parts of the world and the extensive internet and wireless penetration rates worldwide. The traditional wire line telephone service was undergoing one of the

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sharpest drops in subscriptions and a phenomenal growth in wireless subscriptions continued to characterize the industry as a whole. The wireless and interactive data, video and other internet-based services were contributing more profit margin enhancement power to the major telecom firms. While the telecom industry in Canada is dominated by few major players, such as Telus Corp., Rogers Communications Inc., Shaw Communications Inc. and Manitoba Telecommunications Services Inc., it is quite heavily regulated by federal government agencies, namely the CRTC (Canadian Radio-television and Telecommunications Commission) The CRTC regulates prices and tariffs and access to facilities such as telecom networks. It attempts to balance competition requests for increased access to network infrastructure with the rights of the leading companies such as BCE and Telus to compete effectively and freely with market entrants and rivals by deciding how much to charge for access to those facilities and networks. Telus and Rogers are among the closest and fiercest competitors to Bell Canada and Bell Aliant (BCE subsidiaries). Although Rogers is mainly a wireless and cable player, it is well positioned to capture market share from both BCE and Telus, which it did as consumers fled wire line to wireless and internet services, and is further encouraged by the CRTC decision to let consumers keep their wire line numbers should they decide to switch to wireless instead. By fall of 2006, the telecommunications industry in Canada was restructuring itself to provide more shareholder returns and respond more efficiently to competitive foreign and regulatory pressures. Telus Corp. for example announced a plan to restructure its business by proposing to move to an income trust with an estimated market capitalization of C$20 billion. Telus intended to consolidate its shares into one single class of units following this income trust proposal and needed two thirds of its shareholder approval to proceed. It was “inspired” by BCE Inc.’s Bell Aliant Regional Communications Income Fund created earlier in that year and figured a similar move would make its shareholders “happy,” since it had been highly profitable particularly in its wireless high-growth business and would pass some of those gains in a tax-efficient way to its shareholders. Income trusts allow the companies to pay out regular distributions to unit holders before corporate taxes are considered and taxes on such distributions are paid by the unit holders rather than the company. Telus’s plans to convert to an income trust were abandoned following the statement by the minister of finance that income trusts would be taxable at the company level in November of that year.

Bell Canada’s Principal Competitors BCE Inc. faces increased competition from its traditional competitors (i.e., telephone companies) but also from non-traditional players such as cable and broadcasting companies. The rapid and transformative evolution of the telecommunications sector in North-America and worldwide, following the rapid penetration of personal computers, the internet, VoIP, IPTV, and other information and communication services, had blurred the frontiers between telecommunications, wireless and phone manufacturers, broadcasting companies and telephone giants. With its legacy wire-line networks and systems at risk of quickly becoming obsolete and its heavy reliance on capital to keep operating its networks and equipment, BCE was becoming less competitive in its own market space. The CRTC decision to uphold its May 2005 ruling that allows it to regulate VoIP services pricing did not help BCE or Telus (its main competitor) to use their pricing power over the new rivals in setting their product and service offerings. Later on and in spring 2007, the deregulation of the local telephone industry in Canada was well underway. The industry minister amended changes to the CRTC final proposals to speed up the deregulation of pricing and competition structure in Canada, citing consumer benefits from increased competition and more reliance on market forces and innovation incentives in the telecom industryBell Canada’s Financial Situation

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With 55,000 employees and a market capitalization of $20 billion, Bell is the colossus of the Canadian telecom industry. It is also one of the few widely held Canadian corporations. The Ontario Teachers’ Pension Plan (OTPP), with only 6.3% of its shares, is Bell’s largest shareholder. Over the previous year, OTPP had not disguised its dissatisfaction with the market performance of Bell’s shares, which it attributed in large part to the quality of the corporation’s management. In fact, since its high of $45 in 2001, the price of Bell shares had dropped in 2002, and continued to fluctuate between $25 and $35 over the next five years without ever really showing any signs of picking up. However, Bell shares have often been categorized as a ‘Strong Buy’ by brokers and investment dealers. With a beta between 0.3 and 0.5, its shares have always been regarded as a safe long-term investment with good revenue stability for investors. Appendix 1 shows Bell Canada’s main financial and accounting indicators to December 31 for the years for 2004, 2005 and 2006, as well as some projections for the first two quarters of 2007.

Bell Canada’s Future Outlook Because of its place in the Canadian economy in general and the stock market in particular, Bell Canada has always been followed by financial analysts and investment advisers and consultants. But several surveys conducted over the previous two years indicated that the company did not enjoy the same reputation with its customers as it did with its shareholders. For this reason, Lemay-Yates Associates Inc. (LYA), a management consulting firm specializing in the telecommunications sector, had recommended to Bell that it improve its customers’ perception by emphasizing a more aggressive innovation strategy. LYA told Bell that it would have to take action if it was to remain the major player in its sector over the next 5 to 10 years, whatever the outcome of the takeover process. Action would inevitably have to be along two main lines: ‐ Specialization in the most promising future niches, which would entail disposing of some of its assets. Bell could no longer be satisfied with its residential telephone and cable television service. The future of communications was moving rapidly to wireless and fibre optics, and therefore IP telephone and television. ‐ Geographic diversification through a carefully planned internationalization strategy. “It’s a shame,” said LYA, that this Canadian telecom giant had almost no international operations. It should not be satisfied with the regulatory regime in Canada, which had for so long protected it from foreign takeovers, but should be much more aggressive in taking over foreign companies. Moreover, LYA said, there was very little potential for Bell to grow significantly in Canada.

Features of the Offer The first offer to buy came from the New York firm Kohlberg Kravis Roberts & Co. Aware of the regulatory barriers that prohibit foreign companies from holding more than 47% of a Canadian telecom company, the US firm had formed an alliance with the Canada Pension Plan Fund (CPPF) to make an offer of almost $30 billion in cash. Several other companies and pension funds were also showing interest. Another private New York investment company, Ceberus Capital Management (CCM), with different Canadian partners, made a partial offer with a more complex payment scheme. There were rumors as well of interest on the part of Telus. But a month later, the most promising offer so far seemed to be that of the OTPP in partnership with the New York Equity multinational Providence Equity Partners (PEP), one of the biggest private investment companies specializing in communications in the world. The offer’s net value was $34.8 billion, plus a $16.9 billion buy-back of the company’s debts, making its total value $51.7 billion. If the offer was accepted as it stood, OTPP and PEP would pay $42.75 per share in cash, which represented an average capital gain of almost 40% over the price of Bell shares before all the rumours of talks started. If successful, this would be the biggest takeover ever seen in Canada. The

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result would be that OTPP’s stake in Bell would go from 6.3% to 52%, while that of its US partner would be 32%. The remaining shares would be held by a few private investors. Just because the OTPP-PEP offer was the best so far did not necessarily mean that it was a good one. Michael Sabia was well aware that Bell’s shareholders could vote against the offer for one reason or another. They might consider it undervalued, given the corporation’s current financial situation and its future outlook, or deem the method of payment disadvantageous to them. They might also simply refuse to give up what had always been considered one of the few sure long-term bets and sources of stable dividends for individual Canadian investors. Mr. Sabia had the difficult task of recommending to his shareholders whether the offer should be accepted or not, in a report that would have to respond to all their misgivings..

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