BBA110 CU - Sem 2 -Bcom-BBA- Advance Accounting-converted

Format of a Comparative Expenses Statement: Illustration 3: From the following information prepare a comparative Expenses statement showing Increase, Decrease and Percentage Change: 51 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustration 4: From the following information, prepare a Comparative Balance Sheet of X. Ltd.: 52 CU IDOL SELF LEARNING MATERIAL (SLM)

Comments: From the above table it becomes quite clear that percentage of fixed assets was increased by 20% but, in case of current assets, the same was 30% and total assets were increased by 3% as a whole. Similarly, percentage of current liabilities was increased by 10% without making any change of long- term loan. At the same time, percentage of Reserve and Surplus was increased by 20% corresponding to a total increase in shareholders’ equity by 31/3 % without making any change in Equity share capital. Illustration 5: Prepare a comparative Balance Sheet from the summarised Balance Sheet of Y Ltd.: 53 CU IDOL SELF LEARNING MATERIAL (SLM)

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Illustration 1: From the following information, prepare a comparative Balance Sheet of Deepti Ltd.: 56 CU IDOL SELF LEARNING MATERIAL (SLM)

57 CU IDOL SELF LEARNING MATERIAL (SLM)

58 CU IDOL SELF LEARNING MATERIAL (SLM)

Interpretation: (1) The comparative balance sheet of the company reveals that during 2007 there has been an increase in fixed assets of 1,10,000 i.e. 13.49% while long-term liabilities to outsiders have relatively increased by Rs 1,50,000 and equity share capital has increased by Rs 2 lakhs. This fact depicts that the policy of the company is to purchase fixed assets from the long-term sources of finance thereby not affecting the working capital. (2) The current assets have increased by Rs 1, 52,000 i.e. 24.52% and cash has increased by Rs 60,000. On the other hand, there has been an increase in inventories amounting to Rs 1 lakh. The current liabilities have increased only by Rs 20,000 i.e. 12.9%. This further confirms that the company has raised long-term finances even for the current assets resulting into an improvement in the liquidity position of the company. (3) Reserves and surpluses have decreased from Rs 3,30,000 to Rs 2,22,000 i.e., 32 73% which shows that the company has utilized reserves and surpluses for the payment of dividends to shareholders either in cash or by the issue of bonus shares. (4) The overall financial position of the company is satisfactory, (ii) Comparative Income Statement: The Income statement gives the results of the operations of a business. The comparative income statement gives an idea of the progress of a business over a period of time. The changes in absolute data in money values and percentages can be determined to analyse the profitability of the business. Like comparative balance sheet, income statement also has four columns. First two columns give 59 CU IDOL SELF LEARNING MATERIAL (SLM)

figures of various items for two years. Third and fourth columns are used to show increase or decrease in figures in absolute amounts and percentages respectively. Guidelines for Interpretation of Income Statements: The analysis and interpretation of income statement will involve the following steps: (1) The increase or decrease in sales should be compared with the increase or decrease in cost of goods sold. An increase in sales will not always mean an increase in profit. The profitability will improve if increase in sales is more than the increase in cost of goods sold. The amount of gross profit should be studied in the first step. (2) The second step of analysis should be the study of operational profits. The operating expenses such as office and administrative expenses, selling and distribution expenses should be deducted from gross profit to find out operating profits. An increase in operating profit will result from the increase in sales position and control of operating expenses. A decrease in operating profit may be due to an increase in operating expenses or decrease in sales. The change in individual expenses should also be studied. Some expenses may increase due to the expansion of business activities while others may go up due to managerial inefficiency. (3) The increase or decrease in net profit will give an idea about the overall profitability of the concern. Non-operating expenses such as interest paid, losses from sale of assets, writing off of deferred expenses, payment of tax, etc. decrease the figure of operating profit. When all non- operating expenses are deducted from operational profit, we get a figure of net profit. Some non- operating incomes may also be there which will increase net profit. An increase in net profit will gave us an idea about the progress of the concern. (4) An opinion should be formed about profitability of the concern and it should be given at theend. It should be mentioned whether the overall profitability is good or not. Illustration 2: From the following information, prepare a comparative income statement of Java Ltd. 60 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustration 3: The income statements of a concern are given for the year ending on 31st Dec., 2010 and 2011. Re-arrange the figures in a comparative form and study the profitability position of the concern. 61 CU IDOL SELF LEARNING MATERIAL (SLM)

Interpretation: The comparative income statement given above reveals that there has been an increase in net sales of 14.65% while the cost of goods sold has increased nearly by 11% thereby resulting in an increase in the gross profit of 19.4%. Although the operating expenses have increased by 8% the increase in gross profit is sufficient to compensate for the increase in operating expenses and hence there has been an overall increase in operational profits amounting to Rs 53,000 i.e. 28.65% in spite of an increase in financial expenses of Rs5,000 for interest and Rs10,000 for income -tax. There in an increase in net profits after tax amounting to Rs 38,000 i.e. 42.22%. It may be concluded that there is a sufficient progress in the company and the overall profitability of the company is good. Illustration 4: Prepare comparative statements from the following data: 62 CU IDOL SELF LEARNING MATERIAL (SLM)

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Interpretation: (a) The comparative income statement reveals that there has been increase in net sales of 25% while the cost of goods sold has increased disproportionately by 50% thereby resulting in a decrease of gross profit of 25%. Although the operating expenses have remained constant, there has been decrease in net profit of 29.41%. The company needs to look into the causes of increase in cost of goods sold and control the same. (b) The comparative balance sheet of the company reveals that during 2008 there has been decrease in fixed assets of Rs 20 lakhs, i.e. 2.5% while long-term liabilities to outsiders have increased by Rs 64 CU IDOL SELF LEARNING MATERIAL (SLM)

50 lakhs, i.e. 50%. There has also been increase of Rs 45 lakhs, i.e. 22.5% in reserves of the company. Thus, the company has used long-term resources to finance additional workingcapital. The current assets have increased by Rs 240 lakhs in 2011, i.e. 48%. There has been sufficient increase in balance of cash as well as stock. On the other hand current liabilities have increased by only Rs 125 lakhs, i.e. 41.67%. This further confirms that the company has raised long-term finances even for the current assets resulting into an improvement in the liquidity position of the company. Illustration 5: The Income Statements of Sanyasi Ltd are given for the years 2010 and 2011. Convert them into Common-size Income Statement and interpret the changes. 65 CU IDOL SELF LEARNING MATERIAL (SLM)

Interpretation: (1) The gross profit ratio has improved in 2011 because the company has been able to reduce cost of sales. The cost of sales which was 85% of sales in 2010 was brought down to 76.87% in 2011. (2) The concern has been able to reduce operational expenses too, this has helped the companyto increase operating profit from 9.9% to 18.56% (3) Net profit ratio has almost doubled from 9.82% to 19.32% in just one year period. (4) Profitability of the company has improved a lot in 2011. This has beenpossible for two reasons, one is that the company has increased sales by Rs 1,00,000 in 2011 from 2010, the second reason is that the company has not only controlled but reduced its operating cost. The profitability of the company is very good. Illustration 6: Following is the statement of cost of goods manufactured by Nirmala Private Ltd. Present the data in a suitable form for analysis: 66 CU IDOL SELF LEARNING MATERIAL (SLM)

Meaning of Common-Size Statement: The common-size statements, balance sheet and income statement are shown in analytical percentages. The figures are shown as percentages of total assets, total liabilities and total sales. The total assets are taken as 100 and different assets are expressed as a percentage of the total. Similarly, various liabilities are taken as a part of total liabilities. These statements are also known as component percentage or 100 per cent statements because every individual item is stated as a percentage of the total 100. The short-comings in comparative statements and trend percentages where changes in items could not be compared with the totals have been covered up. The analyst is able to assess the figures in relation to total values. The common-size statements may be prepared in the following way: (1) The totals of assets or liabilities are taken as 100. (2) The individual assets are expressed as a percentage of total assets, i.e., 100 and different liabilities are calculated in relation to total liabilities. For example, if total assets are Rs 5 lakhs and inventory value is Rs 50,000, then it will be 10% of total assets (50,000×100/5,00,000) Common Size Statement Format 67 CU IDOL SELF LEARNING MATERIAL (SLM)

The common size statement format is as follows: Types of Common-Size Statements: (i) Common-Size Balance Sheet: A statement in which balance sheet items are expressed as the ratio of each asset to total assets and the ratio of each liability is expressed as a ratio of total liabilities is called common-size balance sheet. For example, following assets are shown in a common-size balance sheet: 68 CU IDOL SELF LEARNING MATERIAL (SLM)

The total figure of assets Rs 2,00,000, is taken as 100 and all other assets are expressed as a percentage of total assets. The relation of each asset to total assets is expressed in the statement. The relation of each liability to total liabilities is similarly expressed. The common-size balance sheet can be used to compare companies of differing size. The comparison of figures in different periods is not useful because total figures may be affected by a number of factors. It is not possible to establish standard norms for various assets. The trends of figures from year to year may not be studied and even they may not give proper results. Illustration 1: The Balance Sheets of S & Co. and K& Co. are given as follows: 69 CU IDOL SELF LEARNING MATERIAL (SLM)

Comments: (1) An analysis of pattern of financing of both the companies shows that K &Co. is moretraditionally financed as compared to S&Co. The former company has depended more on its own funds as is shown by balance sheet. Out of total investments, 71.53% of the funds are proprietor’s funds and outsiders’ funds account only for 28.47%. In S & Co. proprietors’ funds are 64.83% while outsiders’ share is 35.17% which shows that this company has depended more upon outsiders funds. In the present day economic world, generally, 70 CU IDOL SELF LEARNING MATERIAL (SLM)

companies depend more on outsiders’ funds. In this context both the companies have good financial planning but K& Co. is more financed on traditional lines. (2) Both the companies are suffering from inadequacy of working capital. The percentage of current liabilities is more than the percentage of current assets in both the companies. The first company is suffering more fromworking capital position than the second company because current liabilities are more than current assets by 3.44% and this percentage is 1.86% in the case of second company. (3) A close look at the balance sheets shows that investments in fixed assets have been financed from working capital in both the companies. In S & Co. fixed assets account for 94.52% of total assets while long- term funds account for 91.08% of total funds. In K& Co. fixed assets account for 89.48% whereas long term funds account for 87.62% of total funds Instead of using long-term funds for working capital purposes the companies have used working capital for purchasing fixed assets. (4) Both the companies face working capital problem and immediate steps should be taken to issue more capital or raise long-term loans to raise working capital position. (ii) Common Size Income Statement: The items in income statement can be shown as percentages of sales to show the relation of each item to sales. A significant relationship can be established between items of income statement and volume of sales. The increase in sales will certainly increase selling expenses and not administrative or financial expenses. In case the volume of sales increases to a considerable extent, administrative and financial expenses may go up. In case the sales are declining, the selling expenses should be reduced at once. So, a relationship is established between sales and other items in income statement and this relationship is helpful in evaluating operational activities of the enterprise. Illustration 2: Following are the Income Statements of a company for the years ending Dec., 31, 2010 and 2011: 71 CU IDOL SELF LEARNING MATERIAL (SLM)

Interpretation: (1) The sales and gross profit has increased in absolute figures in 2011 as compared to 2010 but the percentage of gross profit to sales has gone down in 2011. (2) The increase in cost of sales as a percentage of sales has brought the profitability from 35 to 27.14%. (3) Operating expenses have remained the same in both the years but non-operating expenses have decreased as a percentage in 2011. A slight decrease in non-operating expenses in the latter year could not help to improve profits. (4) Net profits have decreased both in absolute figures and as a percentage in 2011 as compared to 2010. 72 CU IDOL SELF LEARNING MATERIAL (SLM)

(5) The overall profitability has decreased in 2011 and the reason is a rise in cost of sales. The company should take immediate steps to control its cost of sales, otherwise the company will be in trouble. Illustration 3: The following are the Balance Sheets of X Ltd. and Y Ltd. for the year ending 31st of December, 2011: 73 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustration 4: Following are the two Balance Sheets of A Ltd and B Ltd on 31-3-2011: 74 CU IDOL SELF LEARNING MATERIAL (SLM)

Comments: A Ltd. is more traditionally financed as compared to B Ltd. In A Ltd. Share capital consists of 65.6% total investments while the percentage is 48 in B Ltd. Company A Ltd. has relied more on shareholders’ funds. Generally, if shareholders investments are 50% of total investments even then it is considered to be a safe financial planning B Ltd has 48% investments from shareholders and have relied on outsiders for other funds. So financial structure of A Ltd is safer as compare to B. Ltd. Both the companies have followed the policy of financing fixed assets from long-term funds. In A Ltd investment in fixed assets are 63.32% while long term funds are 88.03%, these figures in B Ltd are 49.95% and 78.97. This shows that both the companies have financed working capital from long- term fund also. In comparison B Ltd has spared more fund for working capital (29.7%) than A Ltd (24.7%). The working capital position of both the companies is good. A Ltd has 36.68% of current assets while current liabilities are 11.97% of total investments. In B Ltd current assets are 50.05% While current liabilities are 21.03. % Looking at the difference of percentages of current assets and current liabilities, the position of B. Ltd looks better but in fact working capital of A Ltd (Current ratio 3.06) is much better than that of B Ltd (2.4) The analysis of various figures shows that both the companies have satisfactory long term and short term financial position. In comparison, company A Ltd has better financial position than that of B Ltd. Illustration 5: Develop proforma income statement for the months of July, August and September for a company from the following information: (a) Sales are projected at Rs 2,25, 000, Rs 2,40,000 and Rs 2,15,000 for July, August and September respectively. (b) Cost of Goods is Rs 50,000 plus 30% of selling price per month. (c) Selling expenses are 3% of sales. (d) Rent is 7,500 per month administrative expenses for July are expected to be Rs 60,000 but are expected to rise 1% per month over the previous month’s expenses. 75 CU IDOL SELF LEARNING MATERIAL (SLM)

(e) The company has Rs 3,00,000 of 8% loan, interest payable monthly. (J) Corporate tax rate is 70%. SUMMARY Financial statements are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to understand. Stakeholders use financial statements to gather information about an organization and perform financial analysis. Common-size financial statements present all items in percentage terms. Balance sheet items are presented as percentages of assets, while income statement items are presented as percentages of sales. Comparative financial statements present financial data for several years side by side. Data may be presented in the form of absolute values, percentages or both. 76 CU IDOL SELF LEARNING MATERIAL (SLM)

KEY WORDS • Income statement: A financial statement that summarizes the revenues, expenses, and results of operations for a specified period of time • Intangible asset: Lack physical existence, and include items like purchased patents and copyrights • Liabilities:Amounts owed by an entity to others • Net income:The excess of revenues over expenses for a designated period of time • Owners' equity:The residual ofassets minus liabilities, representing the collective interest or position of the entity's owners LEARNING ACTIVITY 1. Prepare a comparative statement of profit and loss from the following information 2. The following data is related to Cambridge Ltd.(₹ in lakhs) Particulars 31.03.2019 31.03.2018 ₹ ₹ 16 2 Equity Share Capital 16 4 Preference Share Capital 2 Reserves and Surplus 5.4 77 CU IDOL SELF LEARNING MATERIAL (SLM)

Non-Current Liabilities 14.4 14 Current Liabilities 7.2 4 Non-Current Assets 30.60 28 Current Assets 14.4 12 Now, you are required to prepare a Common Size Balance Sheet. UNIT END QUESTIONS A. Descriptive Type Questions Short Questions 1. What are common size statements? State any two uses of common size statements 2. What are the types of common size statements? 3. Explain comparative statement Long Questions 1. From the following balance sheet and income statement of day dreaming Co.Ltd., For the Year Ending 2002 And 2003, Prepare the Comparative Statements. 78 CU IDOL SELF LEARNING MATERIAL (SLM)

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2. From The Following Income Statement, Prepare A Common Size Statement Of Profit And Loss Jayant Ltd For The Year Ended 31st March, 2011 3. From The Following Information Provided, Prepare A Comparative Statement Of Profit And Loss For The Period 2008 And 2009. 4. Followings Is The Statement Of Profit And Loss Of Raj Ltd For The Year Ended 31st March, 2011 80 CU IDOL SELF LEARNING MATERIAL (SLM)

Prepare A Common Size Statement Of Profit And Loss Of Raj Ltd For The Year Ended 31st March, 2011 B. Multiple Choice Questions 1. The most commonly used tools for financial analysis are : a) Comparative Statements b) Common Size Statements c) Accounting Ratios d) All of these 2. This item is not used as a tool for Analysis of Financial Statements : a) Cash Flow Statement b) Fund Flow Statement c) Ratio Analysis d) No. of Employees Statement 3. Which one of the following items is not a tool used for financial analysis? a) Comparative Statements b) Ratio Analysis c) Common Size Statements d) Statement of Dividend Distribution 4. Comparative Balance Sheet: a) Provides a summarized view of the operations of the firm b) Presents the financial position of the firm c) Presents the change in various items of balance sheet d) None of these 5. Comparative Statement of Profit & Loss provides information about: a) Rate of increase or decrease in revenue from operations b) Rate of increase or decrease in cost of revenue from operations c) Rate of increase or decrease in net profit d) All of these 6. Main objective of Common Size statement is : 81 a) To present the changes in various items b) To provide for a common base for comparison c) To establish relationship between various items d) All of the Above CU IDOL SELF LEARNING MATERIAL (SLM)

7. Common Size Statements are prepared a) In the form of Ratios b) In the form of Percentages c) In both of the Above d) None of these 8. The objective of common size Statement of Profit & Loss is not to a) Present Changes in Various items of incomes and expenses b) Judge the cost items c) Establish relationship between revenue from operations and other items of statement of profit & loss d) Judge the relative financial soundness for different enterprises 9. In the Balance Sheet of a Common Size Statement: a) Figure of share capital is assumed to be 100 b) Figure of current liabilities is assumed to be 100 c) Figure of fixed assets is assumed to be 100 d) Figure of total assets is assumed to be 100 10. Main objective of Common Size Statement of Profit & Loss is: a) To present changes in assets and liabilities b) To judge the financial soundness c) To establish relationship between revenue from operations and other items of statement of Profit & Loss d) All of these Answers 1. d 2. d 3. d 4. c 5. d 6. d 7. b 8. d 9. d 10. c REFERENCES • Monga, J.R. (2005). Financial Accounting: Concepts and Applications. New Delhi: Mayor Paper Backs. 82 CU IDOL SELF LEARNING MATERIAL (SLM)

• Maheshwari, S.N., and Maheshwari, S. K. (2002). Financial Accounting. New Delhi: Vikas Publishing House. • Tulsian, P.C. (2014). Corporate Accounting. New Delhi: Tata McGraw-Hill Education. • Batra G.C., Modern trends in Accounting Research –New Horizons in Auditing and Contemporary Accounting, Deep and Deep Publication, New Delhi, 2007 Edition. • Prof.Jawahar Lal., Corporate Financial Reporting Theory and Practices, Taxman’s, 2003 Edition • Accounting made simple: accounting explained in 100 pages or less: by mike piper • Accounting game: basic accounting fresh from the lemonade stand: by DarrellMullis and Judith ori off 83 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-4 BANKING ACCOUNTS I Structure Learning Objective Introduction Preparation of Financial Statements. Steps For Preparing Financial Statement Summary Key words Learning Activity Unit -End Questions References LEARNING OBJECTIVES After studying this unit, you will be able to: • Explain financial statement • State highlights of bank’s financial statement • Explain steps in preparing balance sheet for banking company INTRODUCTION The reported financial statements for banks are somewhat different from most companies that investors analyze. For example, there are no accounts receivables or inventory to gauge whether sales are rising or falling. On top of that, there are several unique characteristics of bank financial statements that include how the balance sheet and income statement are laid out. However, once investors have a solid understanding of how banks earn revenue and how to analyze what's driving that revenue, bank financial statements are relatively easy to grasp. PREPARATION OF FINANCIAL STATEMENTS Bankers are familiar with Profit & Loss Account and Balance Sheet of Corporates as they day in and day out read, analyze, disseminate information for processing the credit requirements of the borrowers. They calculate various ratios including Current Ratio, Interest Coverage Ratio, Debt Equity Ratio, Debt Service Coverage Ratio to assess whether the Bank will be assured of return of its funds. They flip through hard bound books of Reports submitted by them in order to be doubly sure that they are financing the right borrower with eligible financial limits. But, we hardly come across any banker reading the financial statements of his own Bank. 84 CU IDOL SELF LEARNING MATERIAL (SLM)

While preparing financial statements, banks have to follow various guidelines / directions given by RBI/Government of India governing the Financial Statements. It is important to go through the Director’s Report, Management Discussion and Analysis Report, Corporate Governance Certificate which normally precede the Financial Statements. All together all these are incorporated in Annual Report of the Bank HIGH LIGHTS OF BANKS’ BALANCE SHEETS: The following are the highlights of Banks’ Balance Sheets: 1. Balance Sheet is prepared in conformity with Form A of the Third Schedule to the Banking Regulation Act, 1949 and Profit and Loss Account in conformity with Form B ibid. They are prepared in accordance with provisions of Section 29 of the Banking Regulation Act read with Section 211 (10), (2), and 3 © of the Companies Act 1956. 2. They are always prepared as on 31st March of every year. Listed Banks are required to publish Review financial results every quarter. But full-fledged Profit and Loss Account and Balance Sheet are prepared as on 31st March every year by all the Banks. 3. They contain 18 schedules as under: Schedules forming part of Form A – Balance Sheet Schedule - 1 - Capital Schedule - 2 - Reserves& Surplus Schedule - 3 - Deposits Schedule - 4 - Borrowings Schedule - 5 - Other Liabilities and Provisions Schedule - 6 - Cash and balances with RBI Schedule - 7 - Balances with Banks and money at call and short notice. Schedule - 8 - Investments Schedule - 9 - Advances. Schedule - 10 - Fixed Assets. Schedule - 11 - Other Assets. Schedule - 12 - Contingent Liabilities / Bills for Collection. Schedules forming Part of Form B – Profit and Loss Account Schedule - 13 - Interest Earned. Schedule - 14 - Other Income. 85 CU IDOL SELF LEARNING MATERIAL (SLM)

Schedule - 15 - Interest Expended. Schedule - 16 - Operating Expenses. Schedules forming Part of Annual Report Schedule - 17 - Significant Accounting Policies. Schedule -18 - Notes forming part of accounts. Some of these Schedules viz., 1,2,4,8,17 and 18 are not required to be prepared by Bank’s branches. They are consolidated at Head office level. Schedule 1 to 5 form Liability Side of the Banks Balance Sheet and Schedule 6 to 12 on the Asset side of the Balance Sheet. The Assets side of the Balance Sheet has been arranged in such a manner that liquid assets such as Cash, Balances with Banks and Investments are shown in that order. This enables the investor to quickly identify how much the Bank is liquid enough to meet its commitment towards its customers. This arrangement of Assets is from liquid to fixed assets in contrast to corporate balance sheets where the arrangement is from fixed to liquid. 1. RBI mandated all banks to disclose the accounting policies regarding key areas of operation in Schedule 17 along with Note to Accounts in their financial statements. They include basis of Accounting, Transactions involving Foreign Exchange, Investments etc. 2. RBI has also directed Banks to make 53 disclosures to enable the market participants to assess the key areas of performance of the Banks. In addition to 53 disclosures mandated by RBI, Banks are also required to comply with the Accounting Standard 1 (AS 1) on Disclosure of Accounting Policies issued by Institute of Chartered Accountants of India. 3. The performance of Bank is assessed through calculation of various ratios such as CRAR, Gross NPA, Net NPA, NIM, Interest income as percentage to average working funds, Non-interest income as percentage to average working funds, Operating profit as percentage to average working funds, Return on Assets, Business / Profit per employee, Provision Coverage Ratio, etc. whereas a Company’s strength is assessed through Current Ratio, ISCR, DER, DSCR etc. 4. Banks prepare two sets of financial statements (includes Balance Sheet and Profit and Loss Account), one containing the performance of the Bank through its Banking operations, bothdomestic and international and the other called consolidated Financial Statements containing the performance of the Bank of its Banking operations and subsidiary units, joint ventures and associates in accordance with AS 21, issued by ICAI on a line-by-line basis by adding together the like items of assets, liabilities, income and expenditure of the Bank. Sometimes, a standalone balance sheet may give a better picture of performance of the Bank than when consolidated business of the subsidiaries, joint ventures and associates are combined, if they have less profit making subsidiaries. Investor is interested in consolidated financial statements as it is the position of the “Group”. Some banks 86 CU IDOL SELF LEARNING MATERIAL (SLM)

having international branches may prepare financial statements in dollar terms also to meet the requirements of their overseas centres. 5. They are prepared onthe basis of “going concern approach” adhering to various accounting, disclosures prescribed by agencies like ICAI (Accounting Standards – GAAP), RBI (Banking Regulation Act, RBI Act), and Government of India. Banks are also required to prepare their financial statements based on International Financial Reporting Standards w.e.f. 1.4.2013. Now look at the Schedules forming part of Financial Statements: SCHEDULE 1: CAPITAL &LIABILITIES: The Schedule gives details of Authorised, Issued, Subscribed and Paid up Capital of the Bank. Special mention should be made of capital held by Central Government. If calculated in percentage terms, it will give an idea of Central Government’s contribution to the Capital of the bank. For example, as on 31.3.2012, Oriental Bank of Commerce’s paid up capital was Rs.291.76 Cr out of which Central Government holding was Rs. 169.22 Cr representing 57.99 %. In the case of Bank of India, the paid up capital was Rs. 574.51 Cr out of which Central Government holding was Rs.359.88 Cr. representing 62.72 %. Investor can get an idea which bank’s share has velocity in the market and better traded. SCHEDULE 2 – RESERVES & SURPLUS: This schedule consists of Statutory Reserves, Capital Reserves (revaluation reserve), Share Premium, Revenue & Other Reserves. Statutory Reserve is created by transferring 25 % of net profit earned by the Bank every year. Capital Reserve consists of revaluation reserve created out of (1) revaluation of property of the Bank, (2) Profit on sale of investments, which are “Held to Maturity” (3) Foreign Currency Translation Reserve and (4) Special Reserve for Currency Swaps. These items of capital reserve are appropriated from Net Profit of the Bank. Share Premium is created from the premium collected by the Bank while issuing shares to the public. Revenue & other reserves are recreated by transferring balance of Net profit after making appropriations for Statutory, Capital Reserves, Dividend payment and Special Reserves. SCHEDULE -3 - DEPOSITS: Deposits are mainly bifurcated into Demand Deposits (which includes Current Account Deposits, Sundry Deposits and Overdue Term / Time deposits), Savings Bank Deposits and Term Deposits. Sub-bifurcation in all these segments is Deposits from Banks and Others. It is now established that a bank should have higher percentage of Demand Deposits and Savings Bank Deposits (CASA Deposits) for better NIM (net interest margin). In the computerized environment, Branches should not have major chunk of Overdue Term Deposits in the Demand Deposits portfolio. It will also have 87 CU IDOL SELF LEARNING MATERIAL (SLM)

an impact on the Assets and Liabilities Management of the Bank (ALM). As per the recent guidelines of Government of India, bulk deposits should not be more than 10 % of the total deposits. SCHEDULE – 4 – BORROWINGS: This schedule which is managed at Head Office level, consists of borrowing from RBI and other Banks. Borrowings from other Banks/other Institutions are mainly funds raised under various instruments (Innovative Perpetual Debt Instruments, Subordinated debts, Unsecured non-convertible redeemable bonds etc) which qualify for Tier I and II capital of the Bank. Schedules 1 (Capital), Schedule 2 (Reserves & Surplus) and Schedule 4 (Borrowings) are relevant for calculation of Capital to Risk Weighted Asset Ratio (CRAR) as some balances under these schedules are considered for Calculation of CRAR. Some important points to be noted here for calculation of Capital Adequacy under Basel I and II guidelines are given below: (Basel III guidelines are still in discussion stage and hence are not considered here) 1. Banks are required to maintain minimum capital of 9% on on-going basis for Credit Risk, Market Risk and Operational Risk. 2. The capital so calculated consists of Tier I and Tier II capital. 3. Minimum Tier I capital should be 6% 4. 80% of minimum capital to be maintained under Basel I frame work. 5. Banks are required to declare the CRAR under Basel I and II frame works in their financial statements. 6. Method of computing risk weights is different under Basel I and Basel II frame works. SCHEDULE 5 – OTHER LIABILITIES AND PROVISIONS: The schedule mainly consists of Bills Payable (both inward and outward Bills for collection sent to upcountry banks/branches), Interest accrued, Contingent provisions against standard assets (banks are required to maintain provisions on Standard Assets @ 0.25 % to 0.40% and in some cases 1%), Proposed Dividend and any other liabilities that have to be provided for. The above schedules 1 to 5 form Liabilities side of the Balance Sheet. The following schedules form part of Assets side of the Balance Sheet. SCHEDULE 6 – CASH AND BALANCES WITH RBI: Cash in Hand represents the cash held by branches of the Bank. All Branches are required to maintain cash within retention limit prescribed by the bank (normally 0.25% of deposits). Any amount beyond the limit should be transferred to RBI accounts so that the balances in RBI accounts qualify for CRR (Cash Reserve Ratio) calculations. Keeping excess cash is fraught with security 88 CU IDOL SELF LEARNING MATERIAL (SLM)

issues, and the Bank will be losing interest / other benefits on idle component of the Cash held at branches. Balances with RBI qualify for CRR calculations. Excess amount over required CRR will qualify for SLR (Statutory Liquidity Ratio). Branches should therefore maintain minimum cash with them. SCHEDULE – 7 – BALANCES WITH BANKS AND MONEY AT CALL AND SHORT NOTICE: Balances with Banks represent the balances maintained by branches with other Banks (such as SBI) for clearing purposes, etc. Any excess balance should be transferred to RBI account. Balances with banks do not earn any interest and also under Basel I frame work, Banks are required to calculate Risk weights @ 20% of such balances. Money at Call and Short Notice are entries created by Treasury of the Bank and hence should not reflect in individual branch balance sheets unless parked for any reason by the Bank. SCHEDULE – 8 – INVESTMENTS: Investments are bifurcated into six segments in Balance sheets, viz. i) Government Securities, ii) Other approved Securities, iii) Shares, iv) Debentures and Bonds, v) Subsidiaries / joint ventures, vi) Others The Investments under Government Securities and Other Approved Securities qualify for SLR (Statutory Liquidity Ratio) calculations. Investments under Others include CDs/CPs etc. All investments are to be classified into Held to Maturity, Held for Trading and Available for Sale. Depending upon the classification of the investments into these categories valuation of investments has to be made as per RBI guidelines. The valuations will have a great bearing on the profit of the bank. SCHEDULE 9 – ADVANCES: There are three classifications under Advances, viz. first classification into Bills purchased and discounted, Cash Credit, Overdrafts and Loans repayable on demand (normally loans withrepayment period less than 36 months) and Term Loans. This classification will enable the investor to know the liquidity of funds for the Bank and also how the interest streams are ensured. For example, if the balances under Cash Credit, Overdraft etc are more than Term Loans, the Bank’s liquidity position is good where as more balances in Term Loans show steady profit by way of interest earnings. Second classification is based on the security available in the loan portfolio. The classification is i) secured by tangible assets, ii) covered by Bank/Government Guarantee and iii) unsecured. Large amount of unsecured advances and / or increase over last may indicate the Bank’s vulnerability for credit risk. 89 CU IDOL SELF LEARNING MATERIAL (SLM)

Third classification is, Advances under i) Priority Sector ii) Public Sector iii) Banks iv) Others. This classification is required as all banks are required to lend 40 % of their Advances under Priority Sector. As of now, capital requirement for Credit Risk is higher than Capital requirement for Market Risk and Operational Risk. It is therefore necessary that while undertaking Credit Risk availability and costs of additional Capital requirement need to be looked into. A realignment of portfolios and/ or securing assets with collaterals will enable reduce risk weights. For example, under Basel I frame work, all outstanding advances carry a risk weight of 100%, whereas under Basel II frame work, the risk weights vary from 20 % to 150% depending upon corporate borrowers external rating, unsecured portfolios and similar activities. Under Basel I frame work, cash margins and deposits are eligible financial collaterals. For example, a borrower has been financed Rs.100 lakhs and there is a deposit of Rs. 10 lakhs as cash collateral, for the purpose of calculation of risk weights, the amount is Rs. 90 lakhs. Under Basel II frame work, not only cash collaterals, bonds, gold, debt mutual funds etc. are also considered as collateral for calculation of risk weights. Under Basel II frame work, risk weight for restructured advances is 125 % whereas under Basel I, it is 100%. If branches are able to understand the concept of risk weights for credit risk, they can ensure and properly account for all eligible securities as collaterals for calculation of risk weights, thus reducing the higher requirement of Capital. Further, the advances shown under this schedule are net of provisions. In other words, they only include performing portion of advances. SCHEDULE 10 – FIXED ASSETS AND SCHEDULE – 11 OTHER ASSETS: These schedules do not need much explanation. However, Branches are to be careful while calculating depreciation of these assets as it will have a direct bearing on the profit of the Bank. Many branches continue to hold unserviceable, irreparable furniture and redundant computer hardware items on their books. They should ensure to dispose of the same and properly account for only serviceable items. SCHEDULE – 12 CONTINGENT LIABILITIES: They mainly consists of Claims against the bank not acknowledge as debts, Liability on account of outstanding Forward Exchange Contracts, Derivative Contracts, Guarantees Issued etc. Notes to accounts should be referred to for any disputed liabilities that are hampering the profit of the bank in case the contingent liabilities turn out to be funded liabilities. 90 CU IDOL SELF LEARNING MATERIAL (SLM)

At branches, bifurcation of guarantees into Financial and Performance should be done correctly as they carry different risk weights for CRAR calculation. Any cash collaterals available in the guarantees should be properly reduced from the outstanding amounts for CRAR calculations. The liability in respect of expired guarantees should be reversed immediately following the guidelines of their Banks. SCHEDULE 13 – INTEREST EARNED, SCHEDULE – 14 – OTHER INCOME, SCHEDULE 15 – INTEREST EXPENDED AND SCHEDULE 16 – OPERATING EXPENSES: These schedules form FORM-B of Financial Statements. They are profit and loss statements of the Bank. SCHEDULE – 17 SIGNIFICANT ACCOUNTING POLICIES: This schedule discusses various accounting policies adopted by the Bank in preparing the financial statements. The schedule mainly should be looked into to check whether Bank has made any changes in the accounting procedures which may have bearing on the profit and loss of the Bank. SCHEDULE 18 – NOTES FORMING PART OF THE FINANCIAL STATEMENTS: RBI mandated all banks to make 53 specific disclosures in respect of preparation of financial statements. One must go through these disclosures to really understand the SWOT (STRENGTH, WEAKNESS, OPPORTUNITY, THREATS) of the Bank. Depending upon the market analysis and requirements, RBI advises the Banks to make more disclosures in their Financial Statements. This schedule forms crux of the strength of the Financial statements. Financial Statements reflect outstanding balances in the books of the Bank on a given date. This schedule disseminates important information about the balances reflected in each schedule. STEPS FOR PREPARING FINANCIAL STATEMENT Here we detail about the three basic steps taken for preparing financial statement. Step-1: To Understand The Meaning of Debit and Credit Balances: 91 CU IDOL SELF LEARNING MATERIAL (SLM)

The first step in preparation of financial statements is to understand the meaning of debit and credit balances appearing in the trial balance. (i) Debit Balances in the Trial Balance: The debit balances appearing in the trial balance either represents balances of (a) Assets and Deferred Revenue Expenditure or (b) Losses and Expenses. (ii) Credit Balances in the Trial Balance: The credit balances appearing in the trial balance either represents balances of (a) Capital, Liabilities, Provision and Reserves or (b) Revenue and Gains. Step-2: Analyse the Debit and Credit Balances: The next step is to examine and arrive at a conclusion as to which debit balance is an asset and which balance is an expenditure or loss? Similarly, which credit balance is liability and which balance is a gain or income? (i) Analysis of Debit Balances: If the business enterprise can recover any amount of debit balance, it should be treated as an asset and when business cannot recover anything of debit balance; it should be treated as losses and expenses. (ii) Analysis of Credit Balances: If the business has to pay any amount of credit balance to either owner or outsider, it should be treated as liability (internal or external) and when the business is not liable to pay any amount of credit balance to either owner or outsider, it should be treated as gain or income. Step-3: Treatment of Debit and Credit Balances: The next step in preparing financial statements is to treat the debit and credit balances appearing in the trial balance. (i) Treatment of Debit Balances: The balances of assets and deferred revenue expenditure are directly shown on the assets side of the balance sheet. The balances of losses and expenses, depending upon their nature, being direct or 92 CU IDOL SELF LEARNING MATERIAL (SLM)

indirect, are transferred to the debit side of either Trading Account or Profit & Loss Account as the case may be. (ii) Treatment of Credit Balances: The balances of capital, liabilities, provisions and reserves are directly shown on the liabilities side of the balance sheet. The balances of revenue and gains, depending upon their nature, being direct or indirect, are transferred to the credit side of either Trading Account or Profit & Loss Account as the case may be. Form A is given as follows: 93 CU IDOL SELF LEARNING MATERIAL (SLM)

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