MBA604_Financial Reporting and Analysis (1)

MASTER OF COMMERCE FINANCIAL REPORTING AND ANALYSIS 21MCM619

MASTER OF BUSINESS ADMINISTRATION FINANCIAL REPORTING AND ANALYSIS 21MCM619 Prof. Jawahar Lal Dr. Sucheta Gauba

CHANDIGARH UNIVERSITY Institute of Distance and Online Learning Course Development Committee Chairman Prof. (Dr.) R.S. Bawa Vice Chancellor, Chandigarh University, Punjab Advisors Prof. (Dr.) Bharat Bhushan, Director, IGNOU Prof. (Dr.) Manjulika Srivastava, Director, CIQA, IGNOU Programme Coordinators & Editing Team Master of Business Administration (MBA) Bachelor of Business Administration (BBA) Co-ordinator - Prof. Pragya Sharma Co-ordinator - Dr. Rupali Arora Master of Computer Applications (MCA) Bachelor of Computer Applications (BCA) Co-ordinator - Dr. Deepti Rani Sindhu Co-ordinator - Dr. Raju Kumar Master of Commerce (M.Com.) Bachelor of Commerce (B.Com.) Co-ordinator - Dr. Shashi Singhal Co-ordinator - Dr. Minakshi Garg Master of Arts (Psychology) Bachelor of Science (Travel & Tourism Management) Co-ordinator - Ms. Nitya Mahajan Co-ordinator - Dr. Shikha Sharma Master of Arts (English) Bachelor of Arts (General) Co-ordinator - Dr. Ashita Chadha Co-ordinator - Ms. Neeraj Gohlan Master of Arts (Mass Communication and Bachelor of Arts (Mass Communication and Journalism) Journalism) Co-ordinator - Dr. Chanchal Sachdeva Suri Co-ordinator - Dr. Kamaljit Kaur Academic and Administrative Management Prof. (Dr.) Pranveer Singh Satvat Prof. (Dr.) S.S. Sehgal Pro VC (Academic) Registrar Prof. (Dr.) H. Nagaraja Udupa Prof. (Dr.) Shiv Kumar Tripathi Director (IDOL) Executive Director (USB) © No part of this publication should be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the author and the publisher. SLM SPECIALLY PREPARED FOR CU IDOL STUDENTS Printed and Published by: Himalaya Publishing House Pvt. Ltd., E-mail: [email protected], Website: www.himpub.com For: CHANDIGARH UNIVERSITY Institute of Distance and Online Learning CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Reporting and Analysis Course Code: 21MCM619 Credits: 3 Course Objectives:  To impart understanding of the application of accounting fundamentals in business organisations.  To explain the significance of accounting information from the perspective of different users of accounting information.  To apply accounting principles to record business transactions culminating into a statement of profit and loss, balance sheet and statement of cash flows. Syllabus Unit 1 – Understanding Financial Statement: Nature and Objectives of Financial Statements, Uses of Financial Statements. Unit 2 – Understanding Financial Statement: Form and Content of Financial Statements, Users of Financial Statements. Unit 3 – Financial Statements: The Balance Sheet – As Per Companies Act, 1956, Fixed Assets, Methods of Depreciation, Investments and Current Assets. Unit 4 – Financial Statements: The Balance Sheet: Loans and Advances, Methods of Inventory Valuation, Liabilities. Unit 5 – The Income Statement – Requirements as Per Companies Act, Revenue Recognition, Notes on Accounts and Additional Information to Investors. Unit 6 – Financial Statement Analysis: Introduction, Common Size Statements, Comparative Statement Analysis, Significance of Financial Analysis to Different Parties. Unit 7 – Financial Statement Analysis: Vertical vs. Horizontal Analysis, Internal vs. External Analysis. Unit 8 – Financial Statement Analysis: Accounting Ratio Analysis, Cash Flow Analysis, Cash Flow Statement Preparation. Unit 9 – Window Dressing: Problems in Financial Statements, Window Dressing. CU IDOL SELF LEARNING MATERIAL (SLM)

Text Books: 1. Hanif, M. and Mukherjee, A. (2015), Modern Accountancy, New Delhi: Tata McGraw Hill. 2. Maheshwari, S.N. (2012), Accounting for Management, New Delhi: Vikas Publishing House. Reference Books: 1. Horngren, Sundem (2012), Introduction to Management, New Delhi: Prentice Hall India. 2. Kishor Ravi, M. (2014), Cost Accounting and Financial Management, New Delhi: Taxman Publishers. CU IDOL SELF LEARNING MATERIAL (SLM)

CONTENTS 1-7 8 - 38 Unit 1: Understanding Financial Statement I 39 - 101 Unit 2: Understanding Financial Statement II 102 - 169 Unit 3: Financial Statements: The Balance Sheet I 170 - 185 Unit 4: Financial Statements: The Balance Sheet II 186 - 201 Unit 5: The Income Statement 202 - 206 Unit 6: Financial Statement Analysis I 207 - 304 Unit 7: Financial Statement Analysis II 305 - 312 Unit 8: Financial Statement Analysis III Unit 9: Window Dressing CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement I 1 UNIT 1 UNDERSTANDING FINANCIAL STATEMENT I Structure: 1.0 Learning Objectives 1.1 Introduction 1.2 FinancialStatements — Nature 1.3 Objectives ofFinancial Statements 1.4 Uses of FinancialStatements 1.5 Summary 1.6 KeyWords/Abbreviations 1.7 LearningActivity 1.8 Unit End Questions (MCQ and Descriptive) 1.9 References 1.0 Learning Objectives After studying this unit, you will be able to:  Explain the nature of items within financial statements  Explain the purpose for which financial statements are being prepared  Describe the uses of financial statements 1.1 Introduction Accounting process involves recording, classifying and summarising of various business transactions. In the process of summarising, efforts are made to clarify the profitability and financial position of the enterprise. Financial statements are the outcome of this process which provides various informations related to profitability and financial position of the business. CU IDOL SELF LEARNING MATERIAL (SLM)

2 Financial Reporting and Analysis “Financial Statements essentially are interim reports presented annually and reflect a division of the life of an enterprise into more or less arbitrary accounting period more frequently a year.” — Anthony Meaning of Financial Statements As per Section 2(40) of the Companies Act, 2013, ‘Financial Statements’ in relation to a Company include the following: (i) A balance sheet at the end of the financial year (ii) A statement of the profit and loss for the financial year (iii) Cash flow statement for the financial year (iv) A statement of changes in equity, if applicable (v) Explanatory notes Features of Financial Statements 1. As the financial statements are related to past period of time hence, are historical documents. 2. They are expressed in monetary terms. 3. Financial statements show profitability through Statement of Profit and Loss and financial position through Balance Sheet. Features of Balance Sheet 1. It shows the financial position of a company at a specific point of time. 2. It shows the financial position as per the going concern concept. 3. It establishes a relationship between Equity, and Liabilities and Assets. It shows that the total of Equity and Liabilities side is always equal to the Assets side. Features of Statement of Profit and Loss 1. It is a historical document, prepared for the past period. 2. It is prepared for a particular period and not on a particular date. 3. It shows the financial performance of a company (revenues, expenses and profits or loss for the period). CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement I 3 1.2 Financial Statements — Nature Financial statements are the set of documents representing the state of affairs of a company to the external users. Different components of the statements are interrelated and should be interpreted in totality to understand financial performance of an enterprise. According to the Conceptual Framework developed by ASB India, “Information about financial position is primarily provided in a balance sheet. Information about performance is primarily provided in a statement of profit and loss. Information about cash flows is provided in the financial statements by means of a cash flow statement. The component parts of the financial statements are interrelated because they reflect different aspects of the same transactions or other events. Although each statement provides information that is different from the others, none is likely to serve only a single purpose nor to provide all the information necessary for particular needs of users.” Notes and Supplementary Schedules The financial statements also contain notes and supplementary schedules and other information For example they may contain additional information that is relevant to the needs of users about the items in the balance sheet and statement of profit and loss. They may include disclosures about the risks and uncertainties affecting the enterprise and any resources and obligations not recognised in the balance sheet (such as mineral reserves). Information about business and geographical segments and the effect of changing prices on the enterprise may also be provided in the form of supplementary information. Data presented in the financial statements are not absolute facts because they are affected by: 1. Recorded facts: The term ‘recorded facts’ implies that the data used for preparing financial statements are drawn from accounting records, e.g., amounts of cash in hand, cash at bank, debtors, etc. 2. Accounting concepts and conventions: Financial statements are prepared by following the accounting concepts and conventions. Now, for example, due to the ‘Convention of Conservatism’ provision is made for expected losses but expected gains and profits are ignored. It signifies that the real financial performance and financial position of the business may be better than what is shown by the financial statements. When we talk about accounting concepts, fixed assets are shown in the balance sheet at their historical value rather than their market value. 3. Personal judgement: For example, the choice of making depreciation rests with the management (whether to apply straight line method or diminishing balance method). Here, the management applies the method on the basis of their personal judgement. CU IDOL SELF LEARNING MATERIAL (SLM)

4 Financial Reporting and Analysis 1.3 Objectives of Financial Statements The main objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to wide range of users in making economic decisions. Various objectives of financial statements are:  It provides significant information about the financial activities to the interested parties.  It helps in financial forecasting.  It helps in evaluating the earning capacity of the firm by supplying a statement of financial position to interested parties.  It facilitates decisions regarding the changes in the manner of acquisition, utilisation, preservation and distribution of the scarce resources.  It facilitates decisions regarding replacement of fixed assets and expansion of the firm.  It safeguards the interest of the shareholders who are not aware of the day to day affairs of the firm.  It helps in advising the remedial measure for the deviations between the actual and budgeted performances.  It helps the credit rating agencies to determine the rating of the company.  It helps in providing the managers with necessary data and information for internal reporting and formulation of overall policies. 1.4 Uses of Financial Statements Decision making requires critical analysis and careful interpretation of the published financial statements. In general, the common tools used by the management to facilitate analysis are Ratio analysis, Fund flow statement, Cash flow statement, Comparative Statements and Common size statements.  Make decisions about the future of the business, whether to continue or stop it.  Decide whether to lease some equipment in the goods production.  Perform financial analysis, a key component in investment decision making in the case of prospective investors.  Examine the financial strength of a person or company so as to arrive at a decision as to whether to lend to the company or person. CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement I 5  The government uses the financial statements to ascertain the accuracy to taxes paid by the organisation.  Those who may want to extend credit to the business will use these statements to ascertain the creditworthiness of the company.  Financial statements are used by employees of the business to make collective bargaining agreements. 1.5 Summary Accounting process involves recording, classifying and summarising of various business transactions. In the process of summarising, efforts are made to clarify the profitability and financial position of the enterprise. The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to wide range of users in making economic decisions. Decision making requires critical analysis and careful interpretation of the published financial statements. Financial statements present a mass of complex data in simple and understandable form. Financial statements are prepared for the purpose of disclosing the financial position and performance and cash flows of the business concern at a point of time which is further useful to a wide range of users in making economic decisions. In general, the common tools used by the management to facilitate analysis are Ratio analysis, Fund flow statement, Cash flow statement, Comparative statements and Common size statements. Various objectives of financial statements are: (1) to provide significant information about the financial activities to the interested parties, (2) to help in financial forecasting, (3) to help in evaluating the earning capacity of the firm by supplying a statement of financial position to interested parties, (4) to facilitate decisions regarding the changes in the manner of acquisition, utilisation, preservation and distribution of the scarce resources, (5) to facilitate decisions regarding replacement of fixed assets and expansion of the firm, (6) to safeguard the interest of the shareholders who are not aware of the day to day affairs of the firm, (7) to help in advising the remedial measure for the deviations between the actual and budgeted performance, (8) to help the credit rating agencies to determine the rating of the company and (9) to help in providing the managers with necessary data and information for internal reporting and formulation of overall policies. Uses of Financial statements: (1) it makes decisions about the future of the business, whether to continue or stop it, (2) to decide whether to lease some equipment in the goods production, (3) to perform financial analysis, a key component in investment decision making in the case of prospective investors, (4) to examine the financial strength of a person or company so as to arrive at a decision as to whether to lend to the company or person, (5) government uses the financial statements to CU IDOL SELF LEARNING MATERIAL (SLM)

6 Financial Reporting and Analysis ascertain the accuracy to taxes paid by the organisation, (6) to ascertain the credit worthiness of the company and (7) is used by employees of the business to make collective bargaining agreements. 1.6 Key Words/Abbreviations  ASB: Accounting Standard Board.  Financial Forecasting: It refers to the processing, estimating or predicting how business will perform in the future.  Critical Analysis: It is a careful examination and evaluation of the text, image, or other work performance. 1.7 Learning Activity 1. One of the objectives of ‘Financial Statement’ is to identify the reasons for change in the financial position of the enterprise. State two more objectives of this analysis. _________________________________________________________________ _________________________________________________________________ 1.8 Unit End Questions (MCQ and Descriptive) A. Descriptive Type Questions 1. What are the objectives of preparing financial statement? 2. List any two uses of analysing financial statement. 3. Describe the nature of Financial Statement. B. Multiple Choice/Objective Type Questions 1. Which among the following is the objective of ‘Financial statement’? (a) It provides significant information about the financial activities to the interested parties. (b) It helps in financial forecasting. (c) It helps in evaluating the earning capacity of the firm (d) It helps in safeguarding the interest of the shareholders (e) All the above CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement I 7 2. Which among the following are the common tools used by the management to facilitate analysis of financial statement: (a) Ratio analysis (b) Fund flow statement (c) Cash flow statement (d) Comparative statements and Common size statements (e) All the above 3. Which among the following are the uses of financial statements? (a) To make decisions about the future of the business, whether to continue or stop it (b) To decide whether to lease some equipment in the goods production. (c) To perform financial analysis (d) To examine the financial strength of a person or company (e) All the above 4. Information about the financial position of the company is provided in . (a) Balance sheet (b) Income statement (c) Both (a) and (b) (d) None of the above 5. Information about the performance of the company is provided in . (a) Balance sheet (b) Income statement (c) Both (a) and (b) (d) None of the above Answers 1. (e), 2. (e), 3. (e), 4. (a), 5. (b) 1.9 References 1. C. Horngren, “Uses of a Conceptual Framework,” Journal of Accountancy (April 1981), p. 90. 2. Hampton J.J., ‘Financial Decision Making’ (Edition 1977), p. 62/ CU IDOL SELF LEARNING MATERIAL (SLM)

8 Financial Reporting and Analysis UNIT 2 UNDERSTANDING FINANCIAL STATEMENT II Structure: 2.0 Learning Objectives 2.1 Introduction 2.2 FinancialYear 2.3 Formand Content of FinancialStatement 2.4 Users ofFinancial Statement 2.5 Summary 2.6 Key Words/Abbreviations 2.7 LearningActivity 2.8 Unit End Questions (MCQ and Descriptive) 2.9 References 2.0 Learning Objectives After studying this unit, you will be able to:  Understand the structure and contents of published financial statements  Prepare the main statements comprising published financial statements  Comment critically on the information included in financial statements  Understand the users of financial statements CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 9 2.1 Introduction Financial statements are the end products of accounting process. They provide information about the profitability and the financial position of a business. As per section 2 (40) of the Companies Act, 2013, financial statement of a company includes: (i) a balance sheet as at the end of the financial year; (ii) a profit and loss account, or in case of a company carrying on any activity not for profit, an income and expenditure account for the financial year; (iii) cash flow statement for the financial year; (iv) a statement of changes in equality, if applicable and (v) any explanatory note annexed to, or forming part of any document referred to in subclause (i) to subclause (iv). However, cash flow statement may not be included in the financial statement with respect to one person company, small company and dormant company as per section 455. 2.2 Financial Year As per Section 2(41) of the Companies Act, 2013, all companies are required to have a uniform financial year which shall be a period from 1st April to 31st March every year. Only companies which are a holding or subsidiary of a foreign company required to follow different financial year for the purpose of consolidation of its accounts outside India may apply to the Tribunal for a different financial year. Values that a Company Should Observe While Preparing Financial Statements Section 129(1) of the Companies Act, 2013 requires that the financial statements of a Company: (i) shall give a true and fair view of the state of affairs of the Company, (ii) shall comply with the accounting standards notified under section 133 and (iii) shall be in the prescribed form given in Schedule III. The prescribed form for the preparation of balance sheet has been given in Part I of Schedule III and prescribed form for the preparation of Statement of Profit and Loss has been given in Part II of Schedule III. CU IDOL SELF LEARNING MATERIAL (SLM)

10 Financial Reporting and Analysis 2.3 Form and Content of Financial Statement Legal Requirements under Companies Act, 2013 The following are the provisions under the Companies Act, 2013: 1. Section 129(1) states that the financial statement of a company shall: (i) give a true and fair view of affairs of the company; (ii) comply with accounting standards notified by the Central Government, in consultation with National Financial Reporting Authority; and (iii) be in the form or forms provided in Schedule III. This section excludes any insurance or banking company or company engaged in the generation or supply of electricity, or to any other class of company for which form of financial statement has been specified in or under the Act of governing such class of a company. 2. The books of accounts must be: (i) prepared on accrual basis [Sec. 128(1)]; (ii) follow double entry system of accounting [Sec. 128(1)]; (iii) may be maintained in electronic mode [Sec. 128(1)]; (iv) maintained in good order for a period of at least 8 financial years immediately preceding a financial year, or for all years where company’s age is less than 8 years [Sec. 128(5)]; (v) open for inspection at the registered office of the company or such other place in India by any director during business hours and for information maintained outside India, if any, copies of such financial information shall be maintained or produced for inspection by any director subject to such conditions as may be prescribed [Sec. 128(3)]. 3. Financial statements must be laid down by Board of Directors of every general meeting of the company [Sec. 129(2)]. 4. The company must prepare Consolidated Financial Statement in case it has one or more subsidiaries and place before general meeting. The Central Government may provide for the consolidation of accounts of companies in such manner as may be prescribed [Sec. 129(3)]. 5. Provisions of the Act applicable to preparation and audit of holding company, shall mutatis mutandis, apply to consolidated financial statements [Sec. 129(4)]. CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 11 6. The financial statements of a company do not comply with the accounting standards referred to in Sec. 129(1), the company shall disclose in its financial statements, the deviation from the accounting standards, the reasons for such deviation and the financial effects, if any, arising out of such deviation [Sec. 129(5)]. 7. Central Government may exempt any class or classes of companies from complying with any of the requirements of Sec. 129 or rules made thereunder, if it is considered necessary to grant such exemption in the public interest [Sec. 129(6)]. 8. The Central Government may, by notification, constitute a National Financial Reporting Authority to provide for matters relating to accounting and auditing standards under the Companies Act, 2013 [Sec. 132]. 9. The Central Government may prescribe the standards of accounting or any addendum thereto, as recommended by the Institute of Chartered Accountants of India, in consultation with and after examination of the recommendations made by the National Financial Reporting Authority [Sec. 133]. Schedule III of Companies Act, 2013 Schedule III of Companies Act, 2013 is applicable for financial year commencing on or after 1st April, 2014. [Earlier, Revised Schedule IV was applicable w.e.f. 1st April, 2011 as per notification dated 30th March 2011 and it was same as Schedule III]. All companies whether private or public, whether listed or unlisted, and irrespective of their size in terms of turnover, assets, etc. (other than those mentioned above) will have to adhere to the new format of financial statements from 2011-12 onwards. Salient Features of Schedule III General instructions for preparation of Balance Sheet and statement of Profit and Loss of a company: (i) Schedule III gives a priority status to other requirements of Companies Act, 2013 and Accounting standards over the Schedule itself. (ii) Disclosure requirements of the schedule are in addition to and not in substitution of disclosure requirements of Accounting Standards. (iii) Additional information/narrative descriptions about various items of Balance Sheet and statement of Profit and Loss shall be provided in cross referenced Notes to Accounts. (iv) New norms of rounding off have been introduced. CU IDOL SELF LEARNING MATERIAL (SLM)

12 Financial Reporting and Analysis (v) Figures of immediately preceding year are to be provided except for companies preparing first set of financial statementss. (vi) Terms used in the schedule shall be as per Accounting Standards. Format of Balance Sheet Name of the Company ................. Balance Sheet as at ................. (` in....... ) Particulars Note Figures as Figures as No. at the end at the end of the of the current previous reporting reporting period period 1 23 4 I. EQUITY AND LIABILITIES 1. Shareholders’ funds (a) Share capital (b) Reserves and surplus (c) Money received against share warrants 2. Share application money pending allotment 3. Non-current liabilities (a) Long-term borrowings (b) Deferred tax liabilities (Net) (c) Other long-term liabilities (d) Long-term provisions 4. Current liabilities (a) Short-term borrowings (b) Trade payables (c) Other current liabilities (d) Short-term provisions TOTAL II. ASSETS 1. Non-current assets (a) Fixed assets (i) Tangible assets (ii) Intangible assets (iii) Capital work-in-progress (iv) Intangible assets under development CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 13 (b) Non-current investments (c) Deferred tax assets (Net) (d) Long-term loans and advances (e) Other non-current assets 2. Current assets (a) Current investments (b) Inventories (c) Trade receivables (d) Cash and cash equivalents (e) Short-term loans and advances (f) Other current assets TOTAL See accompanying notes to Financial Statements Notes GENERALINSTRUCTIONS FOR PREPARATION OF BALANCE SHEET 1. An asset shall be classified as current when it satisfies any of the following criteria: (a) it is expected to be realised in or is intended for sale or consumption in, the company’s normal operating cycle; (b) it is held primarily for the purpose of being traded; (c) it is expected to be realised within twelve months after the reporting date; or (d) it is cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting date. All other assets shall be classified as non-current 2. An operating cycle is the time between the acquisition of assets for processing and then realisation in cash or cash equivalents. Where the normal operating cycle cannot be identified, it is assumed to have a duration of 12 months. 3. A liability shall be classified as current when it satisfies any of the following criteria: (a) it is expected to be settled in the company’s normal operating cycle; (b) it is held primarily for the purpose of being traded; (c) it is due to be settled within twelve months after the reporting date; or (d) the company does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date. Terms of a liability that could, at the CU IDOL SELF LEARNING MATERIAL (SLM)

14 Financial Reporting and Analysis option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification. All other liabilities shall be classified as non-current. 4. A receivable shall be classified as a trade receivable if it is in respect of the amount due on account of goods sold or services rendered in the normal course of business. 5. A payable shall be classified as a trade payable if it is in respect of the amount due on account of goods purchased or services received in the normal course of business. 6. A company shall disclose the following in the notes to accounts: A. Share Capital For each class of share capital (different classes of preference shares to be treated separately): (a) the number and amount of shares authorised; (b) the number of shares issued, subscribed and fully paid and subscribed but not fully paid; (c) par value per share; (d) a reconciliation of the number of shares outstanding at the beginning and at the end of the reporting period; (e) the rights, preferences and restrictions attaching to each class of shares including restrictions on the distribution of dividends and the repayment of capital; (f) shares in respect of each class in the company held by its holding company or its ultimate holding company including shares held by or by subsidiaries or associates of the holding company or the ultimate holding company in aggregate; (g) shares in the company held by each shareholder holding more than five per cent shares specifying the number of shares held; (h) shares reserved for issue under options and contracts/commitments for the sale of shares/ disinvestment, including the terms and amounts; (i) for the period of five years immediately preceding the date as at which the Balance Sheet is prepared: (a) Aggregate number and class of shares allotted as fully paid-up pursuant to contract(s) without payment being received in cash (b) Aggregate number and class of shares allotted as fully paid-up by way of bonus shares (c) Aggregate number and class of shares bought back CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 15 (j) terms of any securities convertible into equity/preference shares issued along with the earliest date of conversion in descending order starting from the farthest such date; (k) calls unpaid (showing aggregate value of calls unpaid by directors and officers); (l) forfeited shares (amount originally paid up). B. Reserves and Surplus (i) Reserves and Surplus shall be classified as: (a) Capital Reserve; (b) Capital Redemption Reserve (c) Securities Premium Reserve (d) Debenture Redemption Reserve (e) Revaluation Reserve (f) Share Options Outstanding Account (g) Other Reserves (specify the nature and purpose of each reserve and the amount in respect thereof) (h) Surplus, i.e., balance in Statement of Profit and Loss disclosing allocations and appropriations such as dividend bonus shares and transfer to/from reserves, etc. (Additions and deductions since last balance sheet to be shown under each of the specified heads.) (ii) A reserve specifically represented by earmarked investments shall be termed as a ‘fund’. (iii) Debit balance of statement of profit and loss shall be shown as a negative figure under the head ‘Surplus’. Similarly, the balance of ‘Reserves and Surplus’, after adjusting negative balance of surplus if any, shall be shown under the head ‘Reserves and Surplus’ even if the resulting figure is in the negative. C. Long-term Borrowings (i) Long term borrowings shall be classified as: (a) Bonds/Debentures (b) Term loans (A) From banks (B) From other parties CU IDOL SELF LEARNING MATERIAL (SLM)

16 Financial Reporting and Analysis (c) Deferred payment liabilities (d) Deposits (e) Loans and advances from related parties (f) Long-term maturities of finance lease obligations (g) Other loans and advances (specify nature) (ii) Borrowings shall further be subclassified as secured and unsecured. Nature of security shall be specified separately in each case. (iii) Where loans have been guaranteed by directors or others, the aggregate amount of such loans under each head shall be disclosed. (iv) Bonds/Debentures (along with the rate of interest and particulars of redemption or conversion, as the case may be) shall be stated in descending order of maturity or conversion, starting from farthest redemption or conversion date as the case may be. Where bonds/debentures are redeemable by instalments, the date of maturity for this purpose must be reckoned as the date on which the first instalment becomes due. (v) Particulars of any redeemed bonds/debentures which the company has power to re-issue shall be disclosed. (vi) Terms of repayment of term loans and other loans shall be stated. (vii) Period and amount of continuing default as on the balance sheet date in repayment of loans and interest shall be specified separately in each case. D. Other Long-term Liabilities Other long-term liabilities shall be classified as: (a) Trade payables (b) Others E. Long-term Provisions The amounts shall be classified as: (a) Provision for employee benefits (b) Others (specify nature) CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 17 F. Short-term Borrowings (i) Short-term borrowings shall be classified as: (a) Loans repayable on demand (A) from banks (B) from other parties (b) Loans and advances from related parties (c) Deposits (d) Other loans and advances (specify nature). (ii) Borrowings shall farther be subclassified as secured and unsecured. Nature of security shall be specified separately in each case. (iii) Where loans have been guaranteed by directors or others, the aggregate amount of such loans under each head shall be disclosed. (iv) Period and amount of default as on the balance sheet date in repayment of loans and interest shall be specified separately in each case. G. Other Current Liabilities The amounts shall be classified as: (a) Current maturities of long-term debt. (b) Current maturities of finance lease obligations. (c) Interest accrued but not due on borrowings. (d) Interest accrued and due on borrowings. (e) Income received in advance. (f) Unpaid dividends. (g) Application money received for allotment of securities and due for refund and interest accrued thereon. Share application money includes advances towards allotment of share capital. The terms and conditions including the number of shares proposed to be issued, the amount of premium, if any, and the period before which shares shall be allotted shall be disclosed. It shall also be disclosed whether the company has sufficient authorised capital to cover the share capital amount resulting from allotment of shares out of such share application money. Further, the period for which the share application money has been pending beyond the period for allotment as mentioned in the document inviting application for shares along with the reason for such share application money being pending shall be CU IDOL SELF LEARNING MATERIAL (SLM)

18 Financial Reporting and Analysis disclosed. Share application money not exceeding the issued capital and to the extent not refundable shall be shown under the head equity and share application money to the extent refundable, i.e., the amount in excess of subscription or in case the requirements of minimum subscription are not met, shall be separately shown under ‘Other Current Liabilities’. (h) Unpaid matured deposits and interest accrued thereon. (i) Unpaid matured debentures and interest accrued thereon. (j) Other payables (specify nature). H. Short-term Provisions The amounts shall be classified as: (a) Provision for employee benefits (b) Others (specify nature) I. Tangible Assets (i) Classification shall be given as: (a) Land (b) Buildings (c) Plant and equipment (d) Furniture and fixtures (e) Vehicles (f) Office equipment. (g) Others (specify nature). (ii) Assets under lease shall be separately specified under each class of asset. (iii) A reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting period showing additions, disposals, acquisitions through business combinations and other adjustments and the related depreciation and impairment losses/reversals shall be disclosed separately. (iv) Where sums have been written off on a reduction of capital or revaluation of assets or where sums have been added on revaluation of assets, every balance sheet subsequent to date of such write-off, or addition shall show the reduced or increased figures as applicable and shall by way of a note also show the amount of the reduction or increase as applicable together with the date thereof for the first five years subsequent to the date or such reduction or increase. CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 19 J. Intangible Assets (i) Classification shall be given as: (a) Goodwill (b) Brands trademarks (c) Computer software (d) Mastheads and publishing titles (e) Mining rights (f) Copyrights, and patents and other intellectual property rights, services and operating rights (g) Recipes, formulae, models, designs and prototypes (h) Licenses and franchise (i) Others (specify nature). (ii) A reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting period showing additions, disposals, acquisitions through business combinations and other adjustments and the related amortisation and impairment losses/reversals shall be disclosed separately. (iii) Where sums have been written off on a reduction of capital or revaluation of assets or where sums have been added on revaluation of assets, every balance sheet subsequent to date of such write-off or addition shall show the reduced or increased figures as applicable and shall by way of a note also show the amount of the reduction or increase as applicable together with the date thereof for the first five years subsequent to the date of such reduction or increase. K. Non-current Investments (i) Non-current investments shall be classified as trade investments and other investments and further classified as: (a) Investment property (b) Investments in equity instruments (c) Investments in preference shares (d) Investments in Government or trust securities (e) Investments in debentures or bonds CU IDOL SELF LEARNING MATERIAL (SLM)

20 Financial Reporting and Analysis (f) Investments in mutual funds (g) Investments in partnership firms (h) Other non-current investments (specify nature). Under each classification, details shall be given of names of the bodies corporate [indicating separately whether such bodies are: (i) subsidiaries, (ii) associates, (iii) joint ventures, or (iv) controlled special purpose entities] in whom investments have been made and the nature and extent of the investment so made in each such body corporate (showing separately investments which are partly paid). In regard to investments in the capital of partnership firms, the names or the firms (with the names of all their partners, total capital and the shares of each partner) shall be given. (ii) Investments carried at other than at cost should be separately stated specifying the basis for valuation thereof. (ii) The following shall also be disclosed: (a) Aggregate amount of quoted investments and market value thereof (b) Aggregate amount of unquoted investments (c) Aggregate provision for diminution in value of investments. L. Long-term Loans and Advances (i) Long-term loans and advances shall be classified as: (a) Capital advances (b) Security deposits (c) Loans and advances to related parties (giving details thereof) (d) Other loans and advances (specify nature). (ii) The above shall also be separately subclassified as: (a) Secured, considered good (b) Unsecured considered good (c) Doubtful. (iii) Allowance for bad and doubtful loans and advances shall be disclosed under the relevant heads separately. CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 21 (iv) Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other persons or amounts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated. M. Other Non-current Assets Other non-current assets shall be classified as: (i) Long-term Trade Receivables (including trade receivables on deferred credit terms); (ii) Others (specify nature). (iii) Long-term Trade Receivables, shall be subclassified as: (a) (A) Secured, considered good, (B) Unsecured considered good, (C) Doubtful. (b) Allowance for bad and doubtful debts shall be disclosed under the relevant heads separately. (c) Debts due by directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated. N. Current Investments (i) Current investments shall be classified as: (a) Investments in equity instruments (b) Investment in preference shares (c) Investments in government or trust securities (d) Investments in debentures or bonds (e) Investments in mutual funds (f) Investments in partnership firms (g) Other investments (specify nature). Under each classification, details shall be given of names of the bodies corporate [indicating separately whether such bodies are: (i) subsidiaries, (ii) associates, (iii) joint ventures or (iv) controlled special purpose entities] in whom investments have been made and the CU IDOL SELF LEARNING MATERIAL (SLM)

22 Financial Reporting and Analysis nature and extent of the investment so made in each such body corporate (showing separately investments which are partly paid). In regard to investments in the capital of partnership firms, the names of the firms (with the names of all their partners, total capital and the shares of each partner) shall be given. (ii) The following shall also be disclosed: (a) The basis of valuation of individual investments (b) Aggregate amount of quoted investments and market value thereof (c) Aggregate amount of unquoted investments (d) Aggregate provision made for diminution in value of investments. O. Inventories (i) Inventories shall be classified as: (a) Raw materials (b) Work-in-progress (c) Finished goods (d) Stock-in-trade (in respect of goods acquired for trading) (e) Stores and spares (f) Loose tools (g) Others (specify nature). (ii) Goods-in-transit shall be disclosed under the relevant subhead of inventories. (iii) Mode of valuation shall be stated. P. Trade Receivables (i) Aggregate amount of Trade Receivables outstanding for a period exceeding six months from the date they are due for payment should be separately stated. (ii) Trade receivables shall be subclassified as: (a) Secured, considered good (b) Unsecured, considered good (c) Doubtful. (iii) Allowance for bad and doubtful debts shall be disclosed under the relevant heads separately. CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 23 (iv) Debts due by directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated. Q. Cash and Cash Equivalents (i) Cash and cash equivalents shall be classified as: (a) Balances with banks (b) Cheques, drafts on hand (c) Cash on hand (d) Others (specify nature). (ii) Earmarked balances with banks (e.g., for unpaid dividend) shall be separately stated. (iii) Balances with banks to the extent held as margin money or security against the borrowings, guarantees other commitments shall be disclosed separately. (iv) Repatriation restrictions, if any, in respect ot cash and bank balances shall be separately stated. (V) Bank deposits with more than twelve months maturity shall be disclosed separately. R. Short-term Loans and Advances (i) Short-term loans and advances shall be classified as: (a) Loans and advances to related parties (giving details thereof) (b) Others (specify nature). (ii) The above shall also be subclassified as: (a) Secured, considered good (b) Unsecured, considered good (c) Doubtful. (iii) Allowance for bad and doubtful loans and advances shall be disclosed under the relevant heads separately. (iv) Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other person or amounts due by firms or private companies respectively in which any director is a partner or a director or a member shall be separately stated. CU IDOL SELF LEARNING MATERIAL (SLM)

24 Financial Reporting and Analysis S. Other Current Assets (Specify Nature) This is an all-inclusive heading, which incorporates current assets that do not fit into any other asset categories. T. Contingent liabilities and commitments (to the extent not provided for) (i) Contingent liabilities shall be classified as: (a) Claims against the company not acknowledged as debt (b) Guarantees (c) Other money for which the company is contingently liable. (ii) Commitments shall be classified as: (a) Estimated amount of contracts remaining to be executed on capital account and not provided for; (b) Uncalled liability on shares and other investments partly paid; (c) Other commitments (specify nature). U. The amount of dividends proposed to be distributed to equity and preference shareholders for the period and the related amount per share shall be disclosed separately. Arrears of fixed cumulative dividends on preference shares shall also be disclosed separately. V. Where in respect of an issue of securities made for a specific purpose, the whole or part of the amount has not been used for the specific purpose at the balance sheet date, they shall be indicated by way of note how such unutilised amounts have been used or invested. W. If, in the opinion of the board, any of the assets other than fixed assets and non-current investments do not have a value on realisation in the ordinary course of business at least equal to the amount at which they are stated, the fact that the Board is of that opinion, shall be stated. CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 25 PART II - STATEMENT OF PROFIT AND LOSS (` in .......) Figures Name of the Company ................. for the Profit and loss statements for the year ended ................. previous reporting Particulars Note Figures period No. for the current 4 1 2 reporting xxx period xxx I. Revenue from operations xxx II. Other income 3 xxx III. Total Revenue (I + II) xxx xxx IV. Expenses: xxx xxx xxx Cost of materials consumed xxx xxx Purchases of stock-in-trade xxx xxx Changes in inventories of finished goods xxx xxx Work-in-progress xxx xxx Stock-in-trade xxx Employee benefits expense xxx xxx Finance costs xxx xxx Depreciation and amortisation expense xxx xxx Other expenses xxx Total expenses xxx xxx V. Profit before exceptional and extraordinary items and xxx xxx tax (III – IV) xxx xxx VI. Exceptional items xxx VII. Profit before extraordinary items and tax (V – VI) xxx VIII. Extraordinary items xxx xxx IX. Profit before tax (VII – VIII) xxx xxx X. Tax expense xxx xxx (1) Current tax (2) Deferred tax xxx xxx XI. Profit (Loss) for the period from continuing operations xxx (VII – VIII) xxx CU IDOL SELF LEARNING MATERIAL (SLM)

26 Financial Reporting and Analysis XII. Profit/(Loss) from discontinuing operations xxx xxx XIII. Tax expense of discontinuing operations xxx xxx XIV. Profit (Loss) from discontinuing operations (after tax) xxx xxx (XII – XIII) xxx xxx XV. Profit (Loss) for the period (XI + XIV) XVI. Earnings per equity share xxx xxx xxx xxx (1) Basic (2) Diluted See accompanying notes to the financial statements GENERALINSTRUCTIONS FOR PREPARATION OF STATEMENT OF PROFITAND LOSS 1. The provisions of this Part shall apply to the income and expenditure account referred to in sub-clause (ii) of Clause (40) of Section 2 in like manner as they apply to a statement of profit and loss. 2. (A) In respect of a company other than a finance company revenue from operations shall disclose separately in the notes revenue from: (a) Sale of products; (b) Sale of services; (c) Other operating revenues; Less: (d) Excise duty. (B) In respect of a finance company, revenue from operations shall include revenue from: (a) Interest, and (b) Other financial services. Revenue under each of the above heads shall be disclosed separately by way of notes to accounts to the extent applicable. 3. Finance costs shall be classified as: (a) Interest expense; (b) Other borrowing costs; (c) Applicable net gain/loss on foreign currency transactions and translation. CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 27 4. Other income shall be classified as: (a) Interest Income (in case of a company other than a finance company); (b) Dividend Income; (c) Not gain/loss on sale of investments; (d) Other non-operating income (net of expenses directly attributable to such income). 5. Additional Information A Company shall disclose by way of notes additional information regarding aggregate expenditure and income on the following items: (i) (a) Employee Benefits Expense [showing separately (i) salaries and wages, (ii) contribution to provident and other funds, (iii) expense on Employee Stock Option Scheme (ESOP) and Employee Stock Purchase Plan (ESPP), (iv) staff welfare expenses]; (b) Depreciation and amortisation expense; (c) Any item of income or expenditure which exceeds one per cent of the revenue from operations or ` 1,00,000, whichever is higher, (d) Interest income; (e) Interest expense; (f) Dividend income; (g) Net gain/loss on sale of investments; (h) Adjustments to the carrying amount of investments; (i) Net gain or loss on foreign currency transaction and translation (other than considered as finance cost.); (j) Payments to the auditor as: 1. auditor, 2. for taxation matters, 3. for company law matters, 4. for management services, 5. for other services, 6. for reimbursement of expenses: CU IDOL SELF LEARNING MATERIAL (SLM)

28 Financial Reporting and Analysis (k) In case of companies covered u/s 135, amount of expenditure incurred on corporate social responsibility activities; (l) Details of items of exceptional and extraordinary nature; (m) Prior period items; (ii) (a) In the case of manufacturing companies: 1. Raw materials under broad heads, 2. Goods purchased under broad heads. (b) In the case of trading companies, purchases in respect of goods traded in by the company under broad heads. (c) In the case of companies rendering or supplying services, gross income derived from services rendered or supplied under broad heads. (d) In the case of a company which falls under more than one of the categories mentioned in (a), (b) and (c) above, it shall be sufficient compliance with the requirements herein if purchases, sales and consumption of raw material and the gross income from services rendered is shown under broad heads. (e) In the case of other companies, gross income derived under broad heads. (iii) In the case of all concerns having work-in-progress, work in-progress under broad heads. (iv) (a) The aggregate, if material, of any amounts set aside or proposed to be set aside, to reserve but not including provisions made to meet any specific liability, contingency or commitment, known to exist at the date as to which the balance sheet is made up. (b) The aggregate, if material, of any amounts withdrawn from such, reserves. (v) (a) The aggregate, if material, of the amount set aside to provisions made for meeting specific liabilities, contingency or commitments. (b) The aggregate if material of the amounts withdrawn from such provisions as no longer required. (vi) Expenditure incurred on each of the following items, separately for each item: (a) Consumption of stores and spare parts (b) Power and fuel (c) Rent (d) Repairs to buildings CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 29 (e) Repairs to machinery (f) Insurance (g) Rates and taxes, excluding, taxes on income (h) Miscellaneous expenses. (vii) (a) Dividends from subsidiary companies. (b) Provisions for losses of subsidiary companies. (viii) The profit and loss account shall also contain by way of a note the following information, namely: (a) Value of imports calculated on C.I.F. basis by the company during the financial year in respect of— I. Raw materials; II. Components and spare parts; III. Capital goods; (b) Expenditure in foreign currency during the financial year on account of royalty, know- how, professional and consultation fees, interest, and other matters; (c) Total value if all imported raw materials, spare parts and components consumed during the financial year and the total value of all indigenous raw materials, spare parts and components similarly consumed and the percentage of each to the total consumption; (d) the amount remitted during the year in foreign currencies on account of dividends with a specific mention of the total number of non-resident shareholders, the total number of shares held by them on which the dividends were due and the year to which the dividends related; (e) Earnings in foreign exchange classified under the following heads, namely; I. Export of goods calculated on F.O.B. basis. II. Royalty, know-how, professional and consultation fees. III. Interest and dividend. IV. Other income, indicating the nature thereof. Note: Broad heads shall be decided taking into account the concept of materiality and presentation of true and fair view of financial statements. CU IDOL SELF LEARNING MATERIAL (SLM)

30 Financial Reporting and Analysis GENERALINSTRUCTIONS FOR THE PREPARATION OF CONSOLIDATED FINANCIALSTATEMENTS 1. Where a company is required to prepare Consolidated Financial Statements, i.e., consolidated balance sheet and consolidated statement of profit and loss, the company shall mutatis mutandis follow the requirements of this Schedule as applicable to a company in the preparation of balance sheet and statement of profit and loss. In addition, the consolidated financial statements shall disclose the information as per the requirements specified in the applicable Accounting Standards including the following: (i) Profit or loss attributable to “minority interest” and to owners of the parent in the statement of profit and loss shall be presented as allocation for the period. (ii) “Minority interests” in the balance sheet within equity shall be presented separately from the equity of the owners of the parent. 2. In Consolidated Financial Statements, the following shall be disclosed by way of additional information: Name of the entity in the Net Assets, i.e., total assets Share in profit or loss minus total liabilities As % Amount As % of Amount consolidated consolidated of net assets profit or loss 1 2 34 5 Parent Subsidiaries Indian 1 2 3 Foreign 1 2 3 Minority Interests in all Subsidiaries Associates (Investment as per the equity method) Indian 1 2 3 CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 31 Foreign 1 2 3 Joint Ventures (as per proportionate consolidation/investment as per the equity method) Indian 1 2 3 Foreign 1 2 3 Total 3. All subsidiaries, associates and joint ventures (whether Indian or foreign) will be covered under consolidated financial statements. 4. An entity shall disclose the list of subsidiaries or associates or joint ventures which have not been consolidated in the consolidated financial statements along with the reasons of not consolidating. Note: Schedule III has been amended by Ministry of Corporate Affairs in April 2016 to include general instructions for preparation of financial statements of a company whose financial statements of a company are required to comply with Ind AS. The amendment has divided the schedule into two parts, i.e., Division I and II. • Division I is applicable to a company whose financial statements are required to comply with the current accounting standards. • Division II is applicable to a company whose financial statements are drawn up in compliance with Ind AS. “Division I” Financial Statements for a company whose financial statements are required to comply with the Companies (Accounting Standards) Rules, 2006. General Instructions for Preparation of Balance Sheet and Statement of Profit and Loss of a Company In the principal Act, in Schedule III, at the end, the following shall be inserted, namely: Balance Sheet and Statement of Profit and Loss of a Company. CU IDOL SELF LEARNING MATERIAL (SLM)

32 Financial Reporting and Analysis “Division II” Financial Statements for a company whose financial statements are drawn up in compliance of the Companies (Indian Accounting Standards) Rules, 2015. General Instructions for Preparation of Financial Statements of a Company Required to Comply with Ind AS 1. Every company to which Indian Accounting Standards apply, shall prepare its financial statements in accordance with this Schedule or with such modification as may be required under certain circumstances. 2. Where compliance with the requirements of the Act including Indian Accounting Standards (except the option of presenting assets and liabilities in the order of liquidity as provided by the relevant Ind AS) as applicable to the companies require any) change in treatment or disclosure including addition, amendment, substitution or deletion in the head or subhead or any changes inter se. in the financial statements or statements forming part thereof, the same shall he made and the requirements under this Schedule shall stand modified accordingly. 3. The disclosure requirements specified in this Schedule are in addition to and not in substitution of the disclosure requirements specified in the Indian Accounting Standards. Additional disclosures specified in the Indian Accounting Standards shall be made in the Notes or by way of additional statement or statements unless required to be disclosed on the face of the Financial Statements. Similarly, all other disclosures as required by the Companies Act, 2013 shall be made in the Notes in addition to the requirements set out in this Schedule. 4. (i) Notes shall contain information in addition to that presented in the Financial Statements and shall provide where required— (a) narrative descriptions or disaggregations of items recognised in those statements; and (b) information about items that do not qualify for recognition in those statements. (ii) Each item on the face of the Balance Sheet, Statement of Changes in Equity and Statement of Profit and Loss shall be cross-referenced to any related information in the Notes. In preparing the Financial Statements including the Notes, a balance shall be maintained between providing excessive detail that may not assist users of Financial Statements and not providing important information as a result of too much aggregation. 5. Depending upon the turnover of the company, the figures appearing in the Financial Statements shall be rounded off as below: CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 33 Turnover Rounding Off (i) Less than one hundred crore rupees To the nearest hundreds, thousands, lakhs, millions, (ii) One hundred crore rupees or more or decimals thereof. To the nearest, lakhs, millions or crores, or decimals thereof. Once a unit of measurement is used, it should he used uniformly in the Financial Statements. 6. Financial Statements shall contain the corresponding amounts (comparatives) for the immediately preceding reporting period for all items shown in the Financial Statements including Notes except in the case of first Financial Statements laid before the company after incorporation. 7. Financial Statements shall disclose all ‘material’ items, i.e., the items if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements. Materiality depends on the size or nature of the item or a combination of both, to be judged in the particular circumstances. 8. For the purpose of this Schedule, the terms used herein shall have the same meanings assigned to them in Indian Accounting Standards. 9. Where any Act or Regulation requires specific disclosures to he made in the stand-alone financial statements of a company, the said disclosures shall be made in addition to those required under this Schedule. 2.4 Users of Financial Statement The users of financial statements include present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies, and the public. They use financial statements in order to satisfy some of their information needs. These needs include the following: (a) Investors. The providers of risk capital are concerned with the risk inherent in, and return provided by, their investments. They need information to help them determine whether they should buy, hold or sell. They are also interested in information that enables them to assess the ability of the enterprise to pay dividends. (b) Employees. Employees and their representative groups are interested in information about the stability and profitability of their employers. They are also interested in information that enables them to assess the ability of the enterprise to provide remuneration, retirement benefits and employment opportunities. (c) Lenders. Lenders are interested in information that enables them to determine whether their loans, and the interest attaching to them, will be paid when due. CU IDOL SELF LEARNING MATERIAL (SLM)

34 Financial Reporting and Analysis (d) Suppliers and other trade creditors. Suppliers and other creditors are interested in information that enables them to determine whether amounts owing to them will be paid when due. Trade creditors are likely to be interested in an enterprise over a shorter period than lenders unless they are dependent upon the continuance of the enterprise as a major customer. (e) Customers. Customers have an interest in information about the continuance of an enterprise, especially when they have a long-term involvement with, or are dependent on, the enterprise. (f) Governments and their agencies. Governments and their agencies are interested in the allocation of resources and, therefore, the activities of enterprises. They also require information in order to regulate the activities of enterprises and determine taxation policies, and to serve as the basis for determination of national income and similar statistics. (g) Public. Enterprises affect members of the public in a variety of ways, e.g., enterprises may make a substantial contribution to the local economy in many ways including the number of people they employ and their patronage of local suppliers. Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the enterprise and the range of its activities. While financial statements cannot meet all of the information needs of these users, there are needs that are common to all users. As providers of risk capital to the enterprise, investors need more comprehensive information than other users. The provision of financial statements that meet their needs will also meet most of the needs of other users that financial statements can satisfy. The management of an enterprise has the responsibility for the preparation and presentation of the financial statements of the enterprise. Management is also interested in the information contained in the financial statements even though it has additional access to additional information to perform planning, decision making and control responsibilities. 2.5 Summary Financial statements are the end products of accounting process. They provide information about the profitability and the financial position of a business. As per Section 2(41) of the Companies Act, 2013, all companies are required to have a uniform financial year which shall be a period from 1st April to 31st March every year. Only companies which are a holding or subsidiary of a foreign company required to follow different financial year for the purpose of consolidation of its accounts outside India may apply to the Tribunal for a different financial year. CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 35 Values that a Company should observe while preparing financial statements: Section 129(1) of the Companies Act 2013, requires that the financial statements of a Company (i) Shall give a true and fair view of the state of affairs of the Company; (ii) Shall comply with the accounting standards notified under section 133; and (iii) Shall be in the prescribed form given in Schedule III. Schedule III of Companies Act, 2013, is applicable for financial year commencing on or after1st April, 2014. [Earlier, Revised Schedule IV was applicable w.e.f. 1st April. 2011 as per notification dated 30th March 2011 and it was same as Schedule III.] All companies whether private or public, whether listed or unlisted, and irrespective of their size in terms of turnover, assets, etc. (other than those mentioned above) will have to adhere to the new format of financial statements from 2011-12 onwards. The primary means of providing financial information to investors, creditors and other external users is through financial statements. Users of financial statement are: (a) Investors are providers of risk capital, they need information to help them determine whether they should buy, hold or sell. (b) Employees and their representative groups are interested in information that enables them to assess the ability of the enterprise to provide remuneration, retirement benefits and employment opportunities. (c) Lenders are interested in information that enables them to determine whether their loans, and the interest attaching to them, will be paid when due. (d) Suppliers and other trade creditors are interested in information that enables them to determine whether amounts owing to them will be paid when due. (e) Customers have an interest in information about the continuance of an enterprise, especially when they have a long-term involvement with, or are dependent on, the enterprise. (f) Governments and their agencies require information in order to regulate the activities of enterprises and determine taxation policies. (g) Financial statements may assist the public by providing information about the trends. In this chapter, we learnt the steps in creating financial statements, the various users of financial statement, form and content of financial statements and the various concepts underlying the measurement of elements constituting the financial statements. It is critical that the investors should be able to compare financial information among companies. 2.6 Key Words/Abbreviations  C.I.F.: Customer Information File.  F.O.B.: Free on Board.  Mutatis mutandis: Used when comparing two or more cases or situations  AS: Accounting Standard. CU IDOL SELF LEARNING MATERIAL (SLM)

36 Financial Reporting and Analysis 2.7 Learning Activity 1. Jatin Ltd. was registered with an authorised capital of ` 50,00,000 divided in 5,00,000 equity shares of ` 10 each. Company invited applications for 3,00,000 equity shares at a premium of ` 3 per share, payable as follows: ` 4 on application, ` 5 on allotment (including premium, balance as and when required. Applications were received for 2,75,000 shares and allotment was made to all applicants. All money due on allotment was duly received except from one applicant. All money due on allotment was duly received except from one shareholder holding 1,000 shares. Show the Balance Sheet of the Company. 2. Operating cycle and the period when payment is made is given below. How will you classify liability? Particulars (i) (ii) (iii) (iv) (v) (vi) (vii) Operating cycle (month) 9 10 10 15 15 15 16 Expected period of payment of Trade payable (months) 10 12 14 12 13 18 15 2.8 Unit End Questions (MCQ and Descriptive) A. Descriptive Type Questions 1. What is the interest of shareholders or investors in the analysis of financial statements? 2. State who may be interested in the analysis of financial statement and why? 3. What is the interest of lenders or bankers in the analysis of financial statements? 4. Give two areas of interest for management while analysing the financial statements. 5. Explain the general instructions for preparation of financial statements in the Schedule III. 6. Give the format of Balance Sheet and Statement of Profit and Loss as per Schedule III. 7. State how will you deal with ‘Miscellaneous Expenditure’ in the Balance Sheet of a Company as per Schedule III Part I of the Companies Act 2013. Short AnswerType Questions: 1. Name any two financial statements of the company. 2. What is deferred tax asset and deferred tax liability? CU IDOL SELF LEARNING MATERIAL (SLM)

Understanding Financial Statement II 37 3. Name any two items which can be disclosed under ‘Reserve and Surplus’. 4. Name any two items which can be disclosed under ‘Intangible Assets’. 5. Name any two items which can be disclosed under ‘Long-term Borrowings’. 6. Under what heads and subheads, the items ‘Proposed Dividend’ and ‘Unclaimed Dividend’ will be presented in the Balance Sheet? 7. Under what heads and subheads, the items ‘Preliminary Expenses’ and ‘Acceptance’ will be presented in the Balance Sheet? 8. How would you disclose the following items in the Financial Statements of a Limited Company? (i) Outstanding Salary (ii) Bank Balance (iii) Unpaid Matured Deposits (iv) Preliminary expenses (v) Bills Payable (vi) Sale of Services (vii) Goodwill written off 9. State under which major headings and subheadings the following items will be presented in the Balance Sheet of a company as per Schedule III of the Companies Act, 2013? (i) Capital Reserve (ii) Calls-in-Advance (iii) Loose Tools (iv) Bank Overdraft (v) Provision for Warranties B. Multiple Choice/Objective Type Questions 1. The form of Balance Sheet is . (a) Horizontal (b) Vertical (c) Horizontal or Vertical (d) None of the above 2. Financial statements are _. (a) Estimated facts (b) Recorded facts (c) Anticipated facts (d) All the above 3. Statement of Profit and Loss is also known as . (a) Statement of earnings (b) Statement of operations (c) Statement of income (d) All the above CU IDOL SELF LEARNING MATERIAL (SLM)

38 Financial Reporting and Analysis 4. Which among the following is correct? (a) A deferred tax liability arise when accounting income is more than taxable income. (b) Operating cycle is the time between the acquisition of assets for processing and their realisation in cash and cash equivalents. (c) Financial year of a Company is from 1st April to 31st March (d) All the above 5. What is the number of major heads of the Equity and Liabilities side of a Company’s Balance Sheet? (a) Three (b) Four (c) Two (d) Five Answers 1. (c), 2. (b), 3. (d), 4. (d), 5. (b) 2.9 References 1. “Presentation of Financial Statement”, Standard IAS 1, International Accounting Standards Board, Accessed on 24 June 2007. 2. “The Framework for the Preparation and Presentation of Financial Statements”, International Accounting Standards Board, Accessed on 24 June 2007. 3. Alexander, D., Britton, A. and Jorissen, A., “International Financial Reporting andAnalysis”, Second Edition, 2005. CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statements: The Balance Sheet I 39 UNIT 3 FINANCIALSTATEMENTS: THE BALANCE SHEET I Structure: 3.0 Learning Objectives 3.1 Definition 3.2 Characteristics of Assets 3.3 Objectives of Asset Valuation 3.4 Types of Assets 3.5 Lease 3.6 Accounting Problems in Long-termAssets 3.7 Nature of Depreciation 3.8 Depreciation Methods 3.9 Degree of Acceleration in Depreciation Methods 3.10 Disposal of Fixed Assets 3.11 Evaluation of Accelerated Methods 3.12 Factors Influencing the Selection of Depreciation Method 3.13 Summary 3.14 Key Words/Abbreviations 3.15 Learning Activity 3.16 Unit End Questions (MCQ and Descriptive) 3.17 References CU IDOL SELF LEARNING MATERIAL (SLM)

40 Financial Reporting and Analysis 3.0 Learning Objectives After studying this unit, you will be able to:  Understand the requirement for preparing financial statements  Explain the meaning of assets and classify different types of assets  Understand the salient features of new AS-10 and Ind AS-16 with respect to property, plant and equipment  Calculate depreciation expense using different methods 3.1 Definition Financial accounting has basic elements like assets, liabilities, owners’ equity, revenue, expenses and net income (or net loss) which are related to the economic resources, economic obligations, residual interest and changes in them. Similarly, balance sheet which displays financial position of a business enterprise has basic elements like assets, liabilities and owners’ equity. Assets denote economic resources of an enterprise that are recognised and measured in conformity with generally accepted accounting principles. Assets also include certain deferred charges that are not resources but that are recognised and measured in conformity with generally accepted accounting principles.1 The Institute of Chartered Accountants of India defines assets as “tangible objects or intangible rights owned by an enterprise and carrying probable future benefits”.2 3.2 Characteristics of Assets Assets have the following main characteristics: 1. Future Economic Benefits: ‘Future economic benefit’ or ‘service potential’ is the essence of an asset. This means that the asset has capacity to provide services or benefits to the enterprises that use them. In a business enterprise, that service potential or future economic benefit eventually results in net cash inflows to the enterprise. Money (cash, including deposit in banks) is valuable because of what it can buy. It can be exchanged for virtually any goods services that are available or it can be saved and exchanged for them in the future. Money’s command over resources—its purchasing power—is the basis of its value and future economic benefits. Assets other than cash provide benefits to a business enterprise by being exchanged for cash or other goods or services, by being used to produce or otherwise increase the value of other assets, or by being used to settle liabilities. Services provided by other entities, including personal services, cannot be stored and are received and used simultaneously. They can be assets of a business enterprise only momentarily—as the enterprise receives and uses them—although their use may CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statements: The Balance Sheet I 41 create or add value to other assets of the enterprise. Rights to receive services of other entities for specified or determinable future periods can be assets of particular business enterprises. 2. Control by a Particular Enterprise: To have an asset, a business enterprise must control future economic benefit to the extent that it can benefit from the asset and generally can deny or regulate access to that benefit by others, e.g., by permitting access only at a price. Although the ability of an enterprise to obtain the future economic benefit of an asset and to deny or control access to it by others rests generally on foundation of legal rights, legal enforceability of a right is not an indispensable prerequisite for an enterprise to have an asset if the enterprise otherwise will probably obtain the future economic benefit involved. For example, exclusive access to future economic benefit may be maintained by keeping secret a formula or process. Some future economic benefits cannot meet the test of control. For example, public highways and stations and equipment of municipal fire and police departments may qualify as assets of governmental units but they cannot qualify as assets of individual business enterprises. Similarly, general access to things such as clean air or water resulting from environmental laws or requirements cannot qualify as assets of individual business enterprises, even if the enterprises have incurred costs to help clean up the environment. These examples should be distinguished from similar future economic benefits that an individual enterprise can control and thus are its assets. For example, an enterprise can control benefits from a private road on its own property, clean air it provides in a laboratory or water it provides in a storage tank, or a private fire department or private security force, and the related equipment probably qualifies as an asset even if it has no other use to the enterprise and cannot be sold except as scrap. 3. Occurrence of a Past Transaction or Event: Assets imply the future economic benefits of present assets only and not the future assets of an enterprise. Only present abilities to obtain future economic benefits are assets and these assets are the result of transactions or other events or circumstances affecting the enterprise. For example, the future economic benefits of a particular building can be an asset of a particular entity only after a transaction or other event—such as a purchase or a lease agreement—has occurred that gives it access to and control of those benefits. Similarly, although an oil deposit may have existed in a certain place for millions of years, it can be an asset of a particular enterprise only after the enterprise has discovered it in circumstances that permit the enterprise to exploit it or has acquired the rights to exploit it from whoever had them. This characteristic of assets excludes from assets items that may in the future become an enterprise’s assets but have not yet become its assets. An enterprise has no asset for a particular future economic benefit if the transactions or events that give it access to and control of the benefit are yet in the future. For example, an enterprise does not acquire an asset merely by budgeting the purchase of a machine, and does not lose an asset from fire until a fire destroys or damages some assets. CU IDOL SELF LEARNING MATERIAL (SLM)

42 Financial Reporting and Analysis Once acquired, an asset continues as an asset of the enterprise until the enterprise collects it, transfers it to another entity, or uses it, or some other event or circumstance destroys the future benefit or removes the enterprises ability to obtain it. In addition to the above, assets commonly have other features that help identify them—for example, assets may be acquired at a cost and they may be tangible, exchangeable or legally enforceable. However, those features are not essential characteristics of assets. Their absence, by itself, is not sufficient to preclude an item’s qualifying as an asset. That is, assets may be acquired without cost, they may be intangible, and although not exchangeable they may be usable by the enterprise in producing or distributing other goods or services. 3.3 Objectives of Asset Valuation Financial accounting requires quantification of assets in terms of monetary units which is known as valuation. In other accounting such as managerial accounting, other measures, e.g., physical units may be useful for the managerial purposes. The questions of asset valuation, it is argued, should be decided in terms of user of the information, and the purpose for which the information is to be used. In financial accounting, the following are the objectives of asset valuation: 1. Income determination: In accounting, valuation is a prerequisite in the income measurement. In the capital maintenance concept, valuation of assets is needed to compute income from the increase in these valuations over time. In behavioural accounting theory, valuations should help the decision makers in making proper predictions and decisions. Two basic approaches to valuation for income determination purposes are: (a) the emphasis may he placed on the valuation of the inputs as they expire. For example, the cost of goods sold may be valued on a current basis, by the use of LIFO or current replacement costs, while the ending inventories are left in terms of residuals, (b) the non-monetary assets may be restated at the balance sheet date or periodically during the year, permitting assumed matching as these asset expire. 2. Determination of financial position: A basic purpose of financial accounting is to determine the financial position of a business enterprise, and balance sheet determines the financial position. Balance sheet uses valuations for meaningful preparation of statement of financial position. Investors are generally interested in predicting the future cash flows to shareholders in the form of dividends and other distributions, in order to make proper decision—about purchase and sale of shares. Income statements, cash flow statements and funds flow statements are relevant for this purpose, and a position statement should also provide relevant information for the making of these predictions. In order for a statement of financial position to provide information relevant to a prediction of future cash flows, it should include quantitative measurements of resources and commitments for comparisons with other periods or with other firms. Valuations of assets held by the firm can provide relevant information only if the investor can detect some relationship between such measurements and expected cash flows.3 CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statements: The Balance Sheet I 43 3. Managerial Decisions: Valuation figures are also useful to management in making operating decisions. However, the informational requirements of management are quite different from the informational requirements of the investors and creditors. Investors and creditors are interested primarily in predicting the future course of the business from an evaluation of the past and from other information; but management must continually make decisions that determine the future course of action. Therefore, management has greater need for information, regarding valuations arising from different courses of action. For example, opportunity costs, marginal or differential costs, and present values from expected differential cash flows are relevant for many types of managerial decisions. But just because they are relevant to managerial decisions does not necessarily mean that they are also relevant to the decision of investors and creditors. Therefore, these valuations do not need to be reported in the position statement; they can be made readily available to management in supplementary reports. Asset Valuation Concepts Generally, the following four valuation concepts are popularly used: 1. Historical Cost — It measures historical cost of units of money. 2. Current entry price (e.g., replacement cost) — It measures current entry price, i.e., replacement cost in units of money. 3. Current exit price (e.g., net realisable value) — It measures net realisable value (i.e., current exit price) in units of money. 4. Present value of expected cash flows — It measures present value in units of money. Each of these valuation models yields a different financial statement, with different meaning and relevance to its users. The above valuation models can be classified in different ways. First, they may be classified with respect to whether they focus on the past, present or future. Hence, historical cost focuses on the past, replacement cost and net realisable value focuses on the present, and present value focuses to the future. Second, we may classify these measures with respect to the kind of transactions from which they are derived. Hence, historical cost and replacement cost concern the acquisition of assets or the incurrence of liabilities, while net realisable value and present value concern the disposition of assets or the redemption of liabilities. Thirdly, classification may be done with respect to the nature of event originating the measure. Hence, historical cost is based on an actual event, present value on an expected event, and replacement cost and net realisable value on hypothetical event. 1. Historical Cost Cost has been the most common valuation concept in the traditional accounting structure. Assets are generally recorded initially on the basis of the exchange prices at which the acquisition transactions take place. They are then presented in financial statements at this acquisition cost or CU IDOL SELF LEARNING MATERIAL (SLM)

44 Financial Reporting and Analysis some unamortised portion of it. Therefore, cost is the exchange price of goods and services at the time they are acquired. When the consideration given in the exchange consists of non-monetary assets, the exchange price is determined by the current fair value of assets given up in the exchange. Cost is thus the economic sacrifice expressed in monetary terms required to obtain a specific asset or a group of assets. Very often, cost is not represented by a single exchange price, but it includes many sacrifices of economic resources necessary to obtain the asset in the form, location, and time in which it can be useful to the operations of the firm. Thus, all of these sacrifices should be included in the concept of cost valuation. But it should be recognised that the term cost is used in many senses and for various purposes. In many cases, it includes only a part of the total sacrifices and in other cases, it includes too much. One of the main disadvantages of historical cost valuation is that the value of the assets to the firm may change over time; after long periods of time, it may have no significance whatever as a measure of the quantity of resources available to the enterprise. Historical cost valuation is also disadvantageous because it fails to permit the recognition of gains and losses in the periods in which they may actually occur. Also, because of changes over time, costs of assets acquired in different time periods cannot be added together in the balance sheet to provide interpretable sums. The historical cost valuation concept has the added practical disadvantage of blocking out other possibly more useful valuation concepts. Historical cost accounting has the following advantages relative to other alternative methods of asset valuation. 1. It automatically requires the recording of all actual transactions in the past. The market value of finished goods can be ascertained without knowing how the goods were actually produced. But there is no way to determine the historical cost of the goods without a record of how the goods were actually produced and how the materials and labour that contributed to the production of the goods were actually obtained. Thus, implicit in financial statements under historical cost is a supporting record of all actual transactions in the past. 2. Historical cost is essential for the proper functioning of accountability, the concept upon which our modern economic society is built. Without historical cost data, a manager will have a difficult time demonstrating that he has properly utilised the resources entrusted to him by the shareholders. For example, if a manager purchases merchandise for ` 1,00,000 when he could have purchased it for ` 90,000, the manager may be held accountable for the opportunity loss. The manager may, however, be able to demonstrate that without his special care and talent in bargaining, the firm would have bought the merchandise for ` 1,20,000. Many speculations and hypothesis may be offered concerning what the firm could have done but the evaluation of accountability must always depend on what has actually happened. CU IDOL SELF LEARNING MATERIAL (SLM)