 Good morning class. It is good to see you again. Last class, we covered the basics about what a business organization is and what this course business analysis for engineers is going to actually offer you. So, it was kind of an introductory framework to this entire course in which I said in addition to defining what a business is, I had provided the 3 C's that actually is used to analyze the business. A quick recap of those 3 C's namely the code, the conduct and the climate and we concluded last class with code and I said that I would be beginning this session today with some introduction to accounting and that is what we are going to do this class. Now, I told you last class that in any business organization whether it is for profit or not for profit, there is a lot of activity that happens in a business organization. Activities or rather lot of work happens in a business organization and this work is done using resources, resources being men, material and other productive resources and when such resources are being used, we need to know some information on those resources. What type of information? We need to know what are the resources at the first place, to what extent are they available with us and when it was acquired what were the sources of finance to acquire these resources and how these resources were spent and as a result of utilizing these resources, what is the benefit to the business organization. So, we need to understand that all this information in different forms is required, could be the means of financing these resources, the extent to which these resources were used and the results achieved by using these resources. So, the information hence is critical not only for those who are inside the business organization, but also outside the business organization. So, in essence this information gathering is a big exercise by itself and now this information is about resources that are being consumed and who is going to use this information it could be the stakeholders, by stakeholders it means both parties inside as well as outside to the business organization. So, when we are going to capture this information we need a system that provides this information. In the absence of any system think about capturing this information there is one business organization x, there is one business organization y and for the sake of comparison let us assume that these are the only two organizations, but however in reality you have thousands and millions of organizations outside. So, information gathering has to be in a uniform has to be in a manner that is done at least to ensure that there is some consistency across various organizations in gathering this information. Now, a system that provides this consistency between two organizations x or y or for that matter a system that provides consistency to all the organizations when it comes to gathering this information is actually accounting. So, accounting in a very very broad perspective you are going to get into the finer definitions of what accounting is, but at a very broad general level it is a system that provides this information. So, this system provides the info that stakeholders inside and outside the business organization need and this info is about the resources that are being utilized in contact of business whether it is for profit or not for profit. So, the central piece to the accounting system is the information that is required. So, information is the key in this system. Now, when I am going to say that information is required I cannot just let it allow to hang loosely, because information by itself is a generic statement generic word it covers everything the fact that today is a holiday for my company is information, but accounting need not capture that. So, we need to know what type of information is actually essential for the purpose of accounting for which let us say information can further be categorized into two forms non quantitative and then quantitative. I am more interested in quantitative information, I am not interested in non quantitative information what could be non quantitative information it could be that the CEOs interview appeared in a newspaper or the visual advertisements of the organization is available press releases. This is also information about a business organization, but it is more qualitative or rather it is non quantitative and hence an accounting system need not really capture these types of non quantitative information. So, I am going to ignore for the purpose of accounting not that non quantitative information is not necessary, but for the purpose of accounting I am going to spend more time in collecting only quantitative information, because that is actually the required information. Now, again in quantitative information still it is a very broad terminology, still I need to segregate certain type of information that I need and then ignore other quantitative information that I do not need. In a very broad perspective I can say there is some non accounting quantitative information and then accounting quantitative information. Non accounting suppose the average work experience of the employees in a business organization is 45 years, it is quantitative, but then whether it is required from an accounting perspective no. So, as long as there is quantitative information that is non monetary put it this way then I can say that it is non accounting information. So, I am not interested in information that is non accounting though it is quantitative. So, I am interested in getting information which is quantitative, but at the same time is accounting in nature. What do I mean by accounting in nature? In that case I have to express this information in monetary terms. Now, what type of information would they be? Again last class I was mentioning that there are three two types of accounting, the financial accounting, the management accounting, the third accounting related quantitative information is the operational information. Now, operational information is accounting to a certain extent and quantitative as well, number of units of a product in the business organization sells. It is a definitely accounting information and quantitative payroll. So, this is again quantitative as well as relevant from an accounting perspective, but from a reporting perspective I would say that I am not really concerned though it is relevant information for accounting and quantitative. For the purpose of reporting I would restrict the information that I need broadly into these two categories namely financial and management accounting. Now, financial accounting as I said in last class it is actually more for the purpose of internal managers to understand to capture this information that we have been talking about as well as external stakeholders. So, this financial accounting is one form of accounting that captures information reports it in a particular form which is used by not only those internal to the organization but also other stakeholders in making judgments or making investment decisions or for whatever purpose they think they could use this best. And the other hand you also have management accounting which by enlarge is an internal control system where it is used more to plan effective usage of resources to implement certain optimization mechanisms to control the budgets. So, we need to capture some information that is required to plan, implement or control the internal business system. And remember last class I was talking about how management accounting hence would be dealing with various issues like fixed cost, variable cost, budgeting, variance analysis and all this is internally consumed because it is more to be used for the purpose of improving mechanisms internal to the organization. To provide a textbook definition of accounting hence looking at all of these terminologies I would say that accounting is the process of identifying, measuring because after you identify you need to measure and also communicate it in a proper format. So, identifying, measuring and communicating communicating what communicating I am using this word economic information this is synonymous with the quantitative accounting information that I explained before. And after doing this why are we doing this? This is after you identify you measure and communicate this economic information then the users of this information can take informed decisions or make judgments. So, hence this permits informed judgment and decisions who the users of this information. So, in a sense accounting identifies measures and communicates economic information to a specific set of user group who based on this information can take decisions or make an informed judgment. This in a sense is the broad principle or the definition of accounting. And those who practice the profession of accounting are called the charted accountants in our country regulated through the institute the ICAI or also called as CPAs elsewhere outside India. So, CPAs are charted accountants are the ones who are professionally engaged in the practice of accounting as a profession. I mean they are empowered to sign on financial statements on behalf of business organizations they do the auditing. So, they endorse that this information that we have identified measured and communicated is correct. And satisfies the various stipulations the norms and benchmarks and very much within the allowable framework of accounting standards about which we will be discussing later. But this profession of accounting is practiced by those certified professionals called charted accountants or CPAs. I told you last class that my endeavor is not to give you an orientation towards accounting. So, that you can appear for a charted accountants examination and clear that no. I am just going to give you some inputs. So, that you can appreciate and understand by the very look of a balance sheet or an income statement you can make some sense from the these statements you can make some sense from the annual reports of various companies. And it is only to that limited extent that I will be giving you some inputs on accounting. Now, having said that let me just give you some history to accounting. Now, accounting is not a new concept even in 5000 BC you know we had some symbols that recorded transactions symbols used by those tribals recording transactions. So, the idea was to record transactions that were significant. And then as ages went by various civilizations be the Indian civilization of the Egyptian of the Mesopotamian whatever they are every civilization had its own ways of recording information that could convey that such a transaction has happened. But the most telling form of accounting namely the double entry book keeping trace traces its origin to the European zone probably somewhere during the 1300s. And then predominantly used by government enterprises because you know government was the was the agency that was engaged in business in those days. But after the industrial revolution took place even private organizations were part of the big enterprise as a result of which the users or the creators of this accounting statements or the financial statements were not just government agencies, but also private enterprises. So, post the industrial revolution we could see that there was a great need for accounting professionals because all these transactions which till one point of time was restricted with government agencies now were undertaken by private enterprises. And then proliferated over a period of time. So, today you can imagine how many government agencies how many private enterprises all of them doing business for profit not for profit and all of them engaged in utilizing some resources in their day to day activities which needs to be captured. And then you can understand the need for accounting professionals as well. So, accounting is hence in my opinion I told you last class is become the language of business any type of business any type of business it could be a government a private or whoever it is just become the language of business it could be a not for profit entity it could be a temple it could be a church it could be a university whatever they are all of them need to capture information using a particular language that provides some common understanding across all stakeholders who use this information in taking judgements or making decisions. But, that does not mean that accounting is a foreign language it is foreign to the limited extent that you know consider an American trying to talk English in the British way, wheat in America is corn in UK and corn in UK is maize for Americans. Football in India is football if you say football in the US they think it is the NFL or the American football it is soccer in US. So, accounting is a language which is foreign to the limited extent that a few words could convey a different meaning. But, majority of what happens within this accounting framework understands the language in a uniform manner except for these minor exceptions because different countries will have different reporting standards as a result of which certain terminologies will connote different meanings in certain geography. But, by enlarge accounting as a subject of study is governed by some generally accepted accounting principles. Now, let us understand what these generally accounting generally accepted accounting principles are. Now, before I tell you what those principles are let me clarify that these accounting principles are general rules and conventions these are rules and conventions which means it is a settled it is a it is a settled form that actually that actually provides the basis on which business practice or accounting as a profession is conducted. It is kind of a general law a guide to action and these principles are settled as I told you before. But, across organizations within the generally accepted principles different organizations might record the same transactions in different way that I will give you some examples later for you to understand what I mean by this. But, at least at this point of time you must understand that though these are generally accepted principles there might be different interpretations as a result of which you find different organizations recording the same type of transaction in different ways. And these principles are not rigid it is not that they will never change these are man made principles because we make these accounting principles man made these are not principles that you see in physics or chemistry or other natural sign subjects. Hence, these principles may change but, when they change everybody will resort to these new changes and ensure that these principles are followed as and when changes are being made and these principles as I told you called the generally accepted accounting principles. And this is generally accepted universally accepted and the pillar the foundation to these accounting principles is the fact that these principles actually meet three very important criteria which actually in my opinion forms the very foundation on which accounting as a subject of study survives. Gap meets three criteria one relevance by relevance to the extent that the information that is captured is meaningful and useful to the user. What is the point if the price of if the if the market price of the building that I am going to acquire now is one million dollars. And in 1950 it was ten thousand dollars the fact that it costed ten thousand dollars in 1950 is no longer relevant for me the information that is relevant is that today if I buy this building it is going to cost one million dollars it can it the fact that it costed ten thousand dollars in 1950 is relevant in a different context but, in an accounting context it is irrelevant the second criteria that needs to be satisfied is that there should be some objectivity while we capture this information. To the extent that the information that we capture is measured and reported with no inherent bias in it. So, it should be an unbiased way of reporting the transaction measuring the transaction and communicating the transaction. And not only should it be unbiased it should also stand on its own merit which means that it should be it could be verifiable at a later stage. So, to that extent the principle must ensure that it is objective you cannot allow the rules of subjectivity to intrude these principles. The third one is feasibility to the extent that the entire exercise of identifying measuring and communicating information is implementable no undue complexities when we are going to do this. So, to that extent the accounting principles must ensure that there is relevance that there is objectivity and there is feasibility when we are trying to identify measure and communicate this information this economic information. So, the generally accepted accounting principles ensures that these three foundational pillars is not overlooked at any point of time. I will just give you a small example for you to understand this better. Apple as a company the book value of Apple shares let us say is 10 dollars today 10 dollars book value of Apple shares. So, today it is trading in the market for let us say 200 dollars, but when you look at the balance sheet of Apple you would find the stocks value that it is book value. Now, are you going to tell me that it is an error in accounting because the market value is 200 dollars and that the balance sheet is not captured the market value. No it is not an error in accounting, but a principle of accounting that says that when you capture such stock values and reflected in the balance sheet it has to be at its book value and not at its market value. We are going to see a lot of examples when I going to talk about this, but please have in mind that relevance objectivity and feasibility of the three corner stones that actually guides practicing professionals to ensure that the information that they capture is done in a proper manner. Now, why are we capturing this information? We are capturing this information so that we are able to come out with some financial statements and the three most commonly used financial statements balance sheet, the income statement or the profit and loss statement, the cash flow statement. These are the three main financial statements that we would be trying to construct based on the information that we have captured and I am going to spend a lot of time in understanding what these individual statements are, but for the purpose of today's class it is enough for you to understand that balance sheet is kind of a status report, kind of a stock report that actually highlights the financial strength of an organization. The income statement and cash flow statements are flow reports, this kind of a status report while these are flow reports. What do you mean by this? Water in a reservoir at one point of time, the stock or status, the amount of water that flows through the reservoir over a period of time, let us say a day is a flow. You can understand that there is a difference between status and flow. The status or the stock report is kind of a snapshot, you take a photo, the snapshot while the flow report is like a motion picture, you take a video. So, balance sheet is kind of a stock report that immediately says, this is the financial strength of the entity while the income statement and cash flow statement are flow reports that analyzes transactions over a period of time and provides information on the performance of the entity, how profitable they are, how did cash come in and how did cash go out. So, there is this level of difference between these three statements and when we try to create them ourselves after we actually understand the accounting principles, then you will begin to appreciate the essence of these three statements. Now, why do we actually create or why do we construct these financial statements? Financial statement objectives, why do we need such financial statements? Any answers? These statements are useful for present or potential investors or creditors so that they can take investment decisions or take credit decisions based on what this balance sheet or income statement provides as signals. So, it is useful for financial present as well as potential investors or creditors, creditors meaning the banks that give you loans and all that. So, you need to create a financial statement because these people need to understand what this financial statement is as a result of which they can take proper decisions. And also for the purpose of understanding economic decisions with reasonable diligence. So, if you actually try to understand the rationale, the thought process behind certain economic decision making with reasonable amount of diligence, you can look at the financial statements. And then as an investor or a creditor or some manager also, you would say yes this decision was taken because we felt that at this profitability or at this capital structure or at this current asset management strategy we would be able to achieve target x, target y, target z. Now, I told you that every business has an economic resource and every economic resource has a claim against it. So, you create a resource, you create the resource because somebody gave you money or you put your money which means that resource can be claimed by the owner or the person who gave money to create that resource. And that claim will also change over a period of time as well, you can repay your loans. So, the economic resources that are created and the claims against those resources also need to be understood and also we need to understand that the claims against those resources also keep changing as a result of which we need to understand what is the level of claim for the various claim holders. In addition, we also need to understand the business, the businesses financial performance. By financial performance I mean the financial profitability of the business whether it is the gross margin is high, we understand the operational margin, the net margin of the business. So, how profitable is this business return on investment? Of course, for return on investment you also need to use the balance sheet as well. And also we need information on the amount, the timing and probably even the uncertainty of cash flows. You need to know when I am going to get cash, you need to know how much cash I am going to get and whether I will be able to get it at the first place. So, when cash comes in, how much of cash comes in, whether it will come in, how it goes out, I get cash either by an income that I generate, I meaning the business organization, the business gets cash because it invested in some instruments outside and it is getting an investment income or it disposed of its own assets as a result of which I got in cash. So, cash from the proceeds of disposing of some assets or cash can also leave a business enterprise, I pay dividends to my shareholders, so the cash goes, I pay interest on my loans cash goes out, I pay a portion of my loan cash goes out. So, broadly these 5 objectives namely useful information for present and potential investors and for them also to understand the rational behind these economic decision making. And for these two types of objectives, these two objectives actually we need some level of sophistication, not everybody can exercise due diligence in understanding the rational behind the economic decision making. You need some level of sophistication in accounting as a subject, so that you use an income statement balance sheet, I mean any financial statement for that matter for these two purposes. The third purpose is the economic resources that are being created in a business, every economic resource there is a claim against the resource that is created. So, you need to know what these claims are, these claims might change also over a period of time and you will also understand how these claims keeps changing over a period of time. And fourthly you need to understand the business performance, the financial performance of the business. So, you will understand the claims against these economic resources if you look at the balance sheet, you will understand the financial performance of the business if you look at the income statement or the profit and loss statement. And the fifth objective that provides you input on the timing, the amount or the uncertainty in your cash flow, you will be able to understand if you are able to create a cash flow statement. So, in essence these financial statements try to satisfy these five broad objectives for which these financial statements are being created. Now, we can construct these financial statements by following certain syntax, last class I was mentioning about the code, which means to this language of business there is a syntax. And you follow that syntax and since the user of this information is not only somebody inside the organization, it is also somebody who is outside the organization, outside even the country in which the organization is existing, which means at all levels at all geographies people need to understand and interpret this information in a uniform manner. I cannot say that looking at the financial statement in India I am making profit and the same financial statement if reported elsewhere it is reporting loss, it could be for different reasons, but all things being equal it is very unlikely that the situation of this type will arise. And for investors, for creditors, for government agencies, for any end user of this information it is always better that there is some consistency in identifying, in measuring and communicating this information. So, that as an end user I can also interpret from this information in the same way that any other sensible end user would do that is the fundamental premise for which we need to have a common syntax. So, that this language of accounting is spoken and understood in a manner that is universally acceptable, while reporting could be different. See in some countries financial statements for the purpose of reporting to income tax authorities could be a little different from financial statements for the purpose of reporting to shareholders, not that they are doing something wrong, but then within the allowed framework some entries can be reported in a different way when we file our income tax returns. Some entries can be reported in a different way remember it can be reported in a different way I am not saying that it can be reported in a wrong way it is a different way, but very much within the accepted framework as a result of which you can still have an income statement balance sheet for the purpose of income tax, a different income statement and balance sheet for the purpose of reporting to a shareholder. So, this difference may occur, but that does not mean that there is something wrong in it as long as it follows the accepted principles the broadly allowed framework it is an accepted practice. So, quick recap accounting is hence a system that provides a framework which captures information which by enlarge is quantitative and can be expressed in monetary terms for the purpose of use by both internal as well as external users. And in the process of identifying measuring and communicating this information we create three important financial statements namely the balance sheet the income statement and the cash flow statement which predominantly satisfies five main objectives of a financial statement which are basically to provide good level of information based on which we can take good decisions understand the economic resources and claims against these resources understand the financial performance of business and also get to know the movements of cash within a business entity. So, this is an introduction to accounting as a concept accounting as a system. Now, what we will be doing further is to understand what are the various principles that actually governs this practice of accounting. And I told you that these principles the foundation to these principles are the relevance the objectivity and the feasibility. So, you should have these three in mind when we are actually trying to identify measure and communicate this economic information. And it is only on these three foundational pillars the eleven principles have been formulated which is been followed. Now, what I will be doing is I will be explaining to you each of these principles and as and when possible I will try to give some examples for you to understand what these principles actually mean. But, have in mind that these are the broad principles which will give you some sense of direction in the absence of which you would just record or report transaction in an arbitrary way questionable practices how to avoid this arbitrariness or questionable practices. We need some guiding principles these principles may change, but what is applicable now is those set of guiding principles which is well settled and this forms the basis of the contact of accounting as a profession or contact of business in general. And when you understand these principles then when you actually try to capture these transactions in a business entity you will relate a particular transaction to one or more of these principles. And then decide whether this is the right way to do or is there a better way of reporting this transaction. So, you will be revisiting these principles as and when you have doubts when you are going to capture these transactions. And when you start capturing these transactions for a longer period of time it then becomes a usual practice for you that you will report transactions in a perfect manner knowingly or unknowingly you will be following these principles. Till such time this principles not till such time every time these principles form the foundation of bed, but till the time you get comfortable till the time you are convenient in reporting transactions. You will definitely revisit these principles and then convince yourself yes this is the right way to record this transaction why because the principle of entity as a going concern tells me this the principle of money measurement tells me this. We are going to talk in detail about what these principles are, but have in mind that these principles will be forming the very foundations on which you will be interpreting these day to day transactions. You will be capturing this information which when aggregated all of the transactions in a business entity when aggregated together by way of proper reporting is your balance sheet is your income statement is your cash flow. Now, this aggregation is possible only if there is some structure to this reporting only if there is some structure whose foundation is based on some principles that is universally accepted. Because remember this structure is the one that is going to give you the balance sheet or your income statement or your cash flow and this is the one that everybody will be using as a result of which I again reiterate that it has to follow a set of generally accepted accounting principles about which I will be talking in next class. So, we will be next class where I will be starting with some of those principles and I will try to finish all of them in next class. So, I will meet you next class. Thank you.