Definition Of Accounting And Its Users And Uses ✓ Solved

Definition of accounting and discuss users and uses of accou

Definition of accounting and discuss users and uses of accounting information. Discuss the elements of the Balance Sheet of Amul Industries to guide an investor. For each case below: define and identify the type of income/expense; state treatment in the Profit and Loss Account; state impact on the Balance Sheet. (a) You purchased 10 shares of L&T. On 5 March 2019 the company declared a dividend of Rs 50 per share that is earned but not yet collected. (b) On 5 March 2019 Mehta Brothers received 100% advance for goods to be supplied next month; cost of goods Rs 50,000; usual selling markup 10%.

Paper For Above Instructions

Introduction

Accounting is the systematic process of identifying, measuring, recording and communicating economic information to permit informed judgments and decisions by users of those accounts (Kieso et al., 2019). It converts business transactions into financial statements — principally the Balance Sheet, Profit & Loss Account (Statement of Profit or Loss) and cash flow statements — prepared under applicable standards (Ind AS/IFRS or local GAAP) so users can assess past performance, financial position and future prospects (IFRS Foundation, 2018; ICAI, Ind AS guidance).

1. Definition, users and uses of accounting information

Definition: Accounting records, classifies and summarises financial transactions in monetary terms and interprets the results to stakeholders (Horngren et al., 2013).

Primary users and their uses:

  • Investors and potential investors — assess profitability, dividend prospects, solvency and return on equity to inform buy/hold/sell decisions (Khan & Jain, 2015).
  • Creditors and lenders — evaluate liquidity, debt-servicing ability and covenant compliance using ratios and maturity schedules (FASB, 2016).
  • Management — internal planning, control, budgeting and performance evaluation (Grewal, 2016).
  • Regulators and tax authorities — ensure compliance with statutory reporting, tax liabilities and disclosure norms (Companies Act 2013).
  • Employees and trade unions — assess job security, profit-sharing and pension funding (Investopedia, 2020).
  • Suppliers and customers — evaluate creditworthiness and long‑term viability (PwC guidance).

Uses: decision making (investment, lending), stewardship (accountability of management), resource allocation, performance measurement (ratios), legal and tax compliance and supporting strategic planning (Kieso et al., 2019).

2. Elements of the Balance Sheet — Guidance for Mr. Kohli (investor studying Amul Industries)

When Mr. Kohli examines the balance sheet of Amul Industries (or any company), he should focus on structure, quality of assets, level and nature of liabilities, and equity composition. Key elements to identify:

  • Non-current assets: property, plant & equipment (PPE), intangible assets, long-term investments. Check depreciation policy, revaluations and impairments (Ind AS/IAS 16).
  • Current assets: cash & cash equivalents, trade receivables, inventories, short-term investments, and other current assets. Assess receivables ageing, inventory turnover and provisions for obsolete stock (Kieso et al., 2019).
  • Equity: share capital, share premium, reserves and retained earnings. Evaluate retained earnings trend and whether reserves are distributable.
  • Non-current liabilities: long-term borrowings, deferred tax liabilities, provisions. Consider maturity profile and interest rate exposure.
  • Current liabilities: trade payables, short-term borrowings, current maturities of long-term debt, and other payables. Examine working capital cycle and liquidity risk.
  • Contingent liabilities and commitments: note disclosures for guarantees, litigation and guarantees (critical for hidden risks).
  • Related party transactions and accounting policies: review notes to understand one-off items and accounting estimates that affect comparability.

Practical checks and ratios Mr. Kohli should compute:

  • Current ratio = Current assets / Current liabilities (liquidity)
  • Quick ratio = (Current assets - Inventories) / Current liabilities
  • Debt–equity ratio = Total debt / Equity (leverage)
  • Return on equity (ROE) = Net income / Average equity
  • Working capital cycle: days inventory outstanding + days receivable - days payable

Interpretation guidance: Compare year-on-year figures, industry peers and footnote disclosures; isolate one-offs (asset sales, exceptional gains) from recurring operating profit; check cash flow from operations relative to reported profit to assess earnings quality (IFRS Foundation; KPMG guidance).

3. Accounting treatment and impact — Cases (a) and (b)

Case (a): Dividend declared but not collected — 10 L&T shares; dividend Rs 50 per share declared on 5 March 2019

Nature: Dividend receivable is income from investments. Under the accrual basis, income is recognised when the entity’s right to receive payment is established (Ind AS/IFRS principles; IAS 10 guidance on post‑reporting events where applicable). For a dividend declared by the investee prior to the reporting date (and entitlement exists), the investor recognises dividend income even if cash not yet received.

Computation: 10 shares × Rs 50 = Rs 500 dividend receivable.

Treatment in Profit & Loss Account: Recognise Rs 500 under “Other income – Dividend income” for the financial year in which entitlement arose (Kieso et al., 2019).

Impact on Balance Sheet: Record a current asset “Dividend receivable” (or other receivables) of Rs 500 and increase retained earnings/equity via the P&L effect. Ledger entries: Debit Dividend Receivable Rs 500; Credit Dividend Income Rs 500. When cash is received subsequently: Debit Bank Rs 500; Credit Dividend Receivable Rs 500. Thus, at year‑end the Balance Sheet shows higher assets and higher equity from recognised income.

Case (b): Mehta Brothers received 100% advance for goods to be supplied next month; cost Rs 50,000; usual markup 10%

Nature: The advance represents unearned revenue (a liability) until the performance obligation (delivery of goods) is satisfied (IFRS 15 / revenue recognition principles). It is not income at receipt because earnings process is incomplete.

Compute selling price: Cost × (1 + markup) = 50,000 × 1.10 = Rs 55,000. Advance received = Rs 55,000.

Treatment at receipt (5 March 2019): Do not recognise sales revenue or COGS. Journal entry: Debit Bank/Cash Rs 55,000; Credit Contract liability / Unearned revenue Rs 55,000 (current liability). Inventory remains on books at cost Rs 50,000.

Treatment on delivery (next month): Recognise revenue and cost of goods sold. Entries: Debit Unearned revenue Rs 55,000; Credit Sales Rs 55,000. Debit Cost of Goods Sold Rs 50,000; Credit Inventory Rs 50,000. Net profit recognised on delivery = Rs 5,000.

Impact on Balance Sheet: On receipt, assets (cash) increase by Rs 55,000 and liabilities (unearned revenue) increase by Rs 55,000 — no impact on equity or profit until delivery. On delivery, the liability is removed, revenue and COGS are recognised; inventory decreases by Rs 50,000 and retained earnings increase by the net profit of Rs 5,000 (after tax if applicable).

Conclusion

Accounting provides a structured framework for converting business activity into financial information that various users rely on to make decisions. An investor like Mr. Kohli should read the balance sheet with an emphasis on asset quality, liabilities (including off‑balance-sheet items), equity composition and supporting notes; compute core ratios to assess liquidity, solvency and profitability. Specific transactions must follow accrual principles: dividend receivable is recognised as income when entitlement exists and increases receivables and equity, while customer advances are liabilities (deferred revenue) until goods are delivered, at which point revenue and matching cost of goods sold are recorded.

References

  • Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). Intermediate Accounting. Wiley.
  • Horngren, C., Sundem, G., & Elliott, J. (2013). Introduction to Financial Accounting. Pearson.
  • IFRS Foundation. (2018). International Financial Reporting Standards. https://www.ifrs.org
  • Institute of Chartered Accountants of India (ICAI). Ind AS Guidance and Standards. https://www.icai.org
  • Companies Act, 2013 (India) and relevant statutory reporting guidelines.
  • Khan, M. Y., & Jain, P. K. (2015). Management Accounting. McGraw Hill Education.
  • Grewal, T. S. (2016). Double Entry Book Keeping. S. Chand Publishing.
  • Investopedia. (2020). Understanding Financial Statements. https://www.investopedia.com
  • PwC. (Guidance) Financial statement analysis and disclosures (Practical guides).
  • KPMG. (Guidance) Revenue recognition and contract liabilities overview. https://home.kpmg

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