Financial statements are plain statements based on historical records, facts and figures. They are uncompromising in their objectives, nature and truthfulness. They reflect a judicious combination of recorded facts, accounting principles, concepts and conventions, personal judgements and sometimes estimates. Financial statements consist of ‘Revenue Account’ and ‘Balance Sheet’. 1. Revenue Account / Income Statement: Revenue Account refers to ‘Profit and Loss Account’ or ‘Income and Expenditure Account’ or simply ‘Income Statement’. Revenue Account may be split up or divided into ‘Manufacturing Account’, "Trading Account, Profit and Loss Account’ and ‘Profit and Loss Appropriation Account’, Revenue Account is prepared for a period, covering one year. This statement shows the expenses incurred on production and distribution of the product and sales and other business incomes. The final result of this statement may be profit of loss for a particular period. 2. Balance Sheet: Balance sheet shows the financial position of a business as on a particular date. It represents the assets owned by the business and the claims of the owners and creditors against the assets in the form of liabilities as on the date of the statement. 3. Funds Flow Statement — It describes the sources from which the additional funds were derived and the use of these funds. Funds flow statement helps to understand the changes in the distribution of resources between two balance sheet periods. The statement reveals the sources of funds and their application for different purposes. 4. Cash flow Statement: ‘A cash flow statement shows the changes in cash position from one period to another. It shows the inflow and outflow of cash and helps the management in making plans for immediate future. An estimated cash flow statement enables the management to ascertain the availability of cash to meet business obligations. This statement is useful for short term planning by the management.5. Schedules: Schedule explains the items given in income statement and balance sheet. Schedules are a part of financial statements which give detailed information about the financial position of a business organization. 7.4 PARTIES INTERESTED IN FINANCIAL, STATEMENTS In recent years, the ownership of capital of many public ‘companies has become truly broad based due to dispersal of ‘shareholding. Therefore, one may say that the public in general has become interested in financial statements. However, in addition to the share holders there are other persons and bodies who are also interested in te nancial resutts disclosed by the annual reports of ‘companies. Such persons and bodies include: 1. Creditors, potential suppliers or others doing business with the ‘company; Debenture-holéers; Crecit institutions like banks Potential Investors; [Employees and trade unions; Important customers who wish to make a long standing contract, ‘wth the company, 7. Economists and investment analyst, 8 Members of Pariament, the Public Accounts Committee and the Estimates Committee in respect of Government Companies: 9. Taxation authorities; 10.0ther departments dealing with the industry in which the ‘company is engaged: and 111-The Company Law Board Financial Statement analysis, therefore, has become of ‘general interest7.5 OBJECTIVES OF FINANCIAL STATEMENTS ‘The main object of financial statements is to provide Information about the financial position, performance and changes taken place in an enterprise. Financial statements are prepared to ‘meet the common needs of most users. The important objectives of Financial stalements are given below. Providing information for taking Economic decisions: “The economic decisions that are taken by users of financial Statements require an evaluation of the ability of an enterprise to generate cash and cash equivalents and of the ming and certainty Of theie generation. This ablity ulimately determines the capacity of fan enterprise to pay i's employees and suppliers meet interest payments, repay loans and make distributions to its owners. 4 2. Providing information about financial position: ‘The financial position of an enterprise is effected by the economic resources it controls, iis financial structures its liquidity and solvency and its capacity to adapt to changes in the environment in hich it operates. Information about financial structure Is useful in predicting future borrowing needs and how future profits and cash flows wil bee distributed among those with an interest in the enterprise. This Information is useful in predicting how successful the enterprise is likely to be in raising further finance. Information about liquidity and solvency is useful to predicting the ability of the enterprise to meet the financial commitments as fall due3. Providing information about performance(working results) of an enterprise: ‘Another Important objective of the financial statements is that it provides information about the performance and in particular ite profitably, which requires in order assessing potential changes: In the economic resources that are Ikely to control in future. Information about performance is useful in predicting the capacity of the enterprise to generate cash inflows from its existing resource ‘base as well in forming judgment about the effectiveness wath hich the enterprises might employ addtional resources. 4. Providing Information about changes in financial position: The financial stalements provide infomation concerning changes in the financial position of an enterprise, which is useful in order 10 assess its investing, financing and operating activities during the reporting periods. This information is useful in providing the user with a basis to assess the abilty of the enterprise 10 generate cash and cash equipments and the needs of te enterprise to utlize those cash flows, 7.6 BASICS OF INCOME STATEMENT AND BALANCE SHEET Each business fim has to prepare two main financial statements viz. Income Statement and Balance sheet. The income Statement reveals the profit of loss during a particular period generated from the activiias of a business. Balance sheet shows: the financial position of a business on 2 particular date. + Income statement Income statement summaries the incomes /gains and expenses /osses of a Business for 2 particular financial period. The format of Income statement explains in detail the items to be included in the statement. I is presented in the traditonal T Format {and also in the vertically statement form,4. Horizontal Form T form ‘Manufacturing Trading and Profit and Loss Account For the yoar ‘nding De ce. Particulars fe Paricular Re. To Opening stock By Chasing sock ‘Rew raters Raw Materia Workin prowess, Wiorkin roses, To Purenase of raw By Com ot Triana rateraie peeds elt To Manufactuing wages By Sales To Carnage’ — Freght By _cesag soak oF Evards ished Goods Te custom aay By Gross Losec To Other facry Expenses By Gross pot To Opening stock By _Sueiness insomse ae Gane Finished Goods By Net Loss a Te Cost of rished By Balance 5d fom Previous year ‘Goods bis By Nel Profit To Gress ott oe TT Gross ons bie To Ofee and Scmnicraton Expenses: To Interest and franca’ Exoonsas To Provan for Income te Toke bomea To Net oss be Te Transier to General To Divcend Te balance oFParticulars ‘Gross Sales Less : Sales returns Sales tax / Excise duty Net Sales k Loss : Cost of goods cord (Materials consumed + Direct Labour + Manufacturing Expenses) ‘Add / Less : Adjustment for change in stock RIERE Grose Profit EE Less : Operating expenses '2. Office and administration Expenses , Selling and distribution Expenses LEIS ‘Add = Operating Income RIB (Operating Profit g ‘Add : Non Operating Income Less : Non Operating expenses (including interest) EE Profit before interest and tax Lass : Interest Profit before tax Less : Appropriations ‘a, Transfer to reserves 2x. b. Dividends declared / paid ‘Surplus carried to Balance Sheet EIELETEIE ELE+ Balance sheet: Itis one of the major financial statements which presents a company's financial postion atthe end of 2 specified date. Balance sheet has been described as a "snapshot" of the companys finarciel position at a moment for e.g. the amounts reported on a balance sheet dated March 31%, 2016 reflects that all the transactions throughout December 31% have been recorded. The balance sheet provides information related to the asses, liablities and the shareholders’ equity of the company 2s on a specific date. Total Assets = Total Liabilities + Share holders’ equity 7 ‘The companies Act, 1856 stipulates thet the balance sheet of a joint stock company’ should be prepared as per Part | of Schedule VI of the Act. However, the statement form has been emphasized upon by accountants for the purpose of analysis and Interpretation.Understanding Corporate Balanco Shoot: A. Assets side: 1. Fixed Assets : Fiked Assets are called long-term assets. These assets are Used over several periods. They are major sources of revenue to the business. They a‘e intended for long term use in the business. ‘They are called “uncle of future services” or “Sunk Costs”. The group of fixed assets is explained in the proforma. Generally the Fixed assets are classifies as: 2} Tanai moti soe ) Tangible immovable assets; and 3) Inotgble sects a) Tangible movable assets are the assets which can be seen, ‘touched and moved from one place to another place. Plant anc Machinery, furniture and fixtures, transportation equipments ‘etc, are tangible movable assets. b) Tangible immovable assets are the assets which can be ‘seen and touched but cannot be moved from one place to another place. Such assets include land, buildings, mines, oil wells, etc. ) Intangible assets are the assets which cannot be seen and touched. However, their existence can only be imagined such ‘2s patents, trademarks, copyrights, goodwill, ete. ‘The Fixed Assets are presented as: Gross Block - Provision for Doprociation = Not Blocks 2. Investments : Investments may be shortterm or long term. Short-term investments are marketable securities and they represent temporary investments of idle funds. These investments can be disposed off by the company at any time. Investments are shown at ‘ops. Cost includes brokerage. fees and all other expenses incurred (on acquisition of investments. However, the market value is shown by way of a note. Long-term investments are held for a long time. They are required to be held by the business by the very nature and conditions of the business. For example, @ company engaged in generating electricity may be required to hold the bonds of the Electricity Board. These bonds ere retained by the company so long as the company uses electric power.‘As per Schedule VI of the Indian Companies Act 1966, Investmmen's are shown separately, showing the nature of investments and the mode of valuation of various classes of ‘securities. Long term Investments are grouped under fixed assets and ‘short term investments under current assets. 3. Curront Assots, Loans and Advances: The item, “Current Assets, Loans and Advances” is divided into two parts: a. Current Assets, and . Loans and Advances, a. Current Assets and Quick assets: “Current Assets include cash and the other assets that are likely to be converted into cash and tne cash thus generated is avalable to pay current liabilities. Current assets are not intendes for longterm use in business. Current assets represent ‘employment of money by the company on a short-ierm basis. They circulate within the group. For example, cash becomes raw ‘material when material is purchased, material becomes finished ‘goods, finished goods become cash or debors when sold and so on. Current Assets = Stock + Debtors + Cash 8 Bank + Loans & Advances + Marketable Securities + Other Current Assets in fact, total current assets are known as “Gross Working Capital’. Current assets less current liabilties are known as ‘net working capital’ Quick Assets are known as ‘near cash’ assets. In other words, quick assets are those which can be converted into cash ‘quickly. Therefore, they are also known as liquid assets. Cash and bank balances are the most liquid assets. Debtors and cash advances can be converted into cash at a short notice. Therefore, they are also regarded as quick assets. Marketable investments ‘can be converted into cash, fall into the category of quick assets. Inventory does not fall in this category of quick assets. since it ‘cannot be converted Into cash quickly, 2s material is to be ‘converted into finished goods and then they should be sold. Expenses paid in advance do not catisty tne criteria of quick assets. ‘They cannot be converted into cash. They can be received in the form of services. ‘Therefore Quick Assets Prepayments Current Assets — Inventory — b. Loans and Advances ‘Loans and advances given are current assets. It includes different types of advances such as advances against salary,‘advances against machinery, advances to subsidiary, prepaid ‘expenses on account of rent, taxes, insurance, etc. 4, Miscellaneous Expenditures and losses : This heading covers Ficlitious Assets and other expenses which are made for future on a mass basis. These expenses are really not assets but the whole balance on the account of these items is not charged to current year's Profit and Loss A/c therefore: the amount to. the extent not written off or adjusted Is shown on the Assets side as Miscellaneous expenditures. ‘The examples of fcitious assets are: a. Preliminary expenses. 'b. Brokerage on issue of shares and debentures. c. Discount on issue of shares and debentures. 4d. Share or debenture issue expenses. fe. Heavy Advertisement and Publicity expenditure. f. Profit and Loss Alc debit balance. Liquidity means easy convertibility into cash. Though ulimately all assets are converted into cash. the term liquidity refers not only to the nature of assets but also to the purposes of holding the assets. Assets are normally arranged in order of permanency Le., from least liquid to most liquid. B. Liabilities Side ‘The term ‘liability’ when used in accounting, means a debt. A. debt is something that a person or an organization owes to another ‘person or organization. In other words, Licbilities are the claims of ‘outsiders against the business. Technically speaking, all liabilities ‘shown in 2 balance sheet are claims against all assets shown in it. But there may be certain cases where a liability has a claim against a specific asset. Even under such circumstances, the liabilities are shown seperately, not as a deduction from the specific assets. Classification of Liabilities : ‘The labilities of an enterprise may be classified into three cat “1 Betmanent Funds o: Proprietors’ Funds. 2 Semi-pernanent Funds or Long term Borrowings, 3. Curent labilies and Provisions. 1. Propriotor’s Funds : ‘These are the funds provided by the proprietors (owners) oF the shareholders. Proprietors’ fund represents the interest of the proprietors in the business. This is the amount belonging to the ‘proprietors. Proprietors’ fund is also called as ‘Proprietors’ Equity’, ‘Owners’ Func’, or ‘Shareholders’ Funds”. This is also known asthe ‘Net Worth’ of the business. Owners’ Equity refers to the claim of the owners it includes ‘Owners’ Equity = Capital (May be Equity Share Caoitel only or Equity and Preference Share Capital) + Reserves + Profit and Loss Ae credit balance — Accumulated losses and Ficttious assets. ‘Owners’ equity increase either through fresh investments by the owners or by way of incressing the eamings retained i.e., profits not distributed. (Retained eamings are that part of the total ‘earnings which have been retained for use in the business) a. SHARE CAPITAL : ‘Share capital iG the amount that is raised by a company from the public at large, through the issue of shares. There are different concepts of share capital from the legal and accounting points of view. ‘The following chart detalls te different concepts of capital : Company's Share Capital Authorised Capital (Registered or Nominal Capital) a 1 Issued Captal + 2 Unissued Captal = 1. Supeorbed Capital | + | 2. Unsubscribed Capzal es | 1.Catedup Canta | + [2 Uncatea capita | + | 3, Reserve Capital ee 4 Paidup Captal_ | + [Cateen-arrears or Cale Unpaid |. Authorised Capital : Authorised Capital is the maximum ccapitel a company can raise as mentioned in the Memorandum of Association under its Capital Clause.lasued Capital : A company usually does not need the entire registered capital. Issued capital is that part of the Authorised ‘capital: which is actually offered to the prospective investors for ‘subscription, The balance of the Authorised capital which is not isaued is caled the ‘unissued capital.’ lil, Subseribed Capital : Subscribed capital is that part of the Issued capital which has deen subscribed or taken up by the public. Therefore, the subscribed capital may be equal to oF less than the ‘ssued capital. Called up Capital Uncalled Capital: The company, therefore, may collect the capital in several instalments as per its need. The callec- Up capital is that portion of the subscribed cepital which has been ‘called or demanded by the company to bo paid. The capital that is ‘not demanded from the shareholders is callad uncalled capital iv. Paid up Capital: Paid up capital ‘s that part of the called up ‘capital which has been actually peid by the members. The paid- up capital is the called-up amount less calls not paid. (Calls unpaid or calls-in-arrears) v. Reserve Capital : Its thal part of the uncalled capital which may only be demanded on winding up or liquidation, but not ‘when the company is a going on. A company may determine this amount by a Special Resolution, b, RESERVES AND SURPLUS ‘A business may have to meet certain compulsory or voluntary, foreseen or unforeseen, recurring or non-recurring ‘obligatons in future. It is advantageous to for the organization to ‘make provision In acvance to meet them. If not sudden payment may adversely affect the financial beaith of the company. In order to avoid auch sitvations some part of profit are retained in each year which is termed as ‘Retained Eamings’ or ‘Plough Back of Drofts. It means the reserves represent amounts set aside out oF ivisible profits. They are appropriations of profts. Indian Companies Act requires every company to transfer @ speciic ppereentage (upto 10%) of the profits to "Reserve" accounts. Reserve oreated for a specific purpose is called as a “Specific Reserve” and a reserve created for a general purpose is called as a “General Reserve.” General reserves are free and can 'bo utlizad for Payment of Dividends, Development and expansion purpose or for any cther purpose the company thinks proper. According to Companies Act “Reserve shall not include any ‘amount written off by Way of providing for depreciation, renewals oF iminution in value of assels or retained by way of providing for ‘any known liability.”I Is compulsory for the business organization to disclose ‘each indivicual head of the reserves in the balance sheet with its ‘opening balance as por last balance sheet, additions theroto and ‘deductions there from in the current yare, 2. LONG-TERM LIABILITIES : ‘A company raises finance either from owners or through extemal borrowings. Extemal borrowngs of a company which constitute its “owed funds” are important sources. of long-term finance. These borrowings are termed es ‘ixed liabilities’ or term liabiities’ or ‘ong term-ioans’. They may take various forms such ‘a5 debentures, public deposits, bank loans, deterted payments, ‘ec. They may be fully secured or partly secured or unsecured, 3. CURRENT LIABILITIES AND PROVISIONS: ‘a. Current Liabilities Current labiliies are those short-term obligations of an enterprse which mature within one year or within the operating cycle. They corsiitule short-term sources of finance. It includes ‘Sundry Creditors, Bills Payable, Intorest accrued but not duo, ‘outstanding expensas, Unclaimed dividends and Bank Qvardra ‘These liabilites are not normally secured and no interest is payable on them with the exception of bank ovardrafis. Thase liaplities, are generally paid of by utlizing current assets or by ‘creating a current liability. Actually all current abilities are payable within a short period of time However, Bank Overdraft IS the current labilty which is not paid immediately or in a very short-time, in practice. ‘Thorefore, Bank Overdraft is not considered as a quick liability. Itis a permanent arrangement with the banker. Hence ‘Quick Liabilities = Current Liabilities ~ Bank Overdraft, b. Provisions : “Provision’ means any amount retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy. Provisions have to be made for ‘maintaining the integrity of assets or for known liabiltias. Although the amount of liabilty is not certain organization has to made provision on best estimaies. The exemples of provisions are Provision for depreciation on assets, Provision for doubtful dabis, Provision for proposed cividends, Provision for taxation 4, CONTINGENT LIABILITIES : ‘According to ICAI, Contingent liabilty refers to an obligation relating to an existing condition or situation which may arise in future depending on the occurrence or non-ocourrence of one or ‘more uncertain future events. These liabillies may or may not beconverted into actual lables at some future date. It Is a liabilty which may or may not occur. But on the date of the Balance Sheet, itis not known definitely whethar the liability would arise or not. But 8 a matter of caution, itis indicated in the balance sheet for the ‘sake of information and disclosure, under the head “Contingent Liabilities. Some of the examples of Contingent Liabilties are Discounted Bills of Exchange, Disputed liability on account of Income-tax, eic.. about which’ appeal nas been fled, Uncalled amount on partly paid-up shares and debentures held by the ‘company as investments, Cumulative preference dividend. in arrears, Mattars referred to arbitration, Claims not acknowledged 2s debis, Estimated amount of contracts remaining to be executed on ‘capital account and not provided for, Guarantees given by the ‘company, Bonds executed. and debentures held by the company as investments, Cumulative preference dividend in arrears, Matters relerted to arbitration, Cleims not acknowledged as debts, Estimated amount of contracts remaining to be executed on carital ‘account and rt provided for, Guarantees given by the company, Bonds executed. Following are the proforma of the Balance sheet 4) Horizontal Form Tanase Tsai Fe share capita Fired Assets iit at prt o 1 Gocc Strona uae, 2. tan ane Buiing ‘subscribed and Called up (3. Lease hold Property canta) 4 Pontond Motney tess: ‘Calls in J cher 5. Furniture and fixture orfeited shares, 6. Patents and trade marks: 4 Vanes Resorve and Surplus lavestments, PCgpntneseve c . 2. Capital Redempton Gurrent assets, Loans and ‘3. Share premium = 4 Ofer Resoves 1 meres ecard on Lese:PaLate pettbatnce | | 2 Leote 08 5 Protend Loss 4 Sinaydobore ss Less Provision for Bad debts. 6. Sinking tana Ave ‘8. Cashin Hand &. Cash at BankUnclaimed Dividends Other liabitias b. Provisions: 4. Provieion fo taxation 2. Proposed dividends 5. Provident fund ane Pension fund Contingent Liab B, Loans and Advances 1 2 3 Miscolaneous expenature 2 3. Pa ‘Advances ‘subsidaries Bile receivables Prepaid expenses Preiminary expenses Disccunt cn iste of shares and Debentures Underwriting commission Profit and Loss afc (debit balance) Income Statement of .. 2 Vertical Form {for the year ending Previou: Particulars [Schedule [Current Year] T. Sources of Funds 1.Shareholders’ Funds a. Cepital b. Reserves and surplus 2.Loan funds ‘2. Secured loan b.Unseoured loans TOTAL 1. Application of Funds 1. Fred Assets a.Gross Block Less DepreciationNet Block 2. Investments 3. Current Assots, Loans and “Agvances: fess, Curent bios and Not Current Assets 4.Mscallaneous expenditure to] the extent not writton off or ‘adjusted Profit and Loss ale} ‘debit balance Torat| ‘+ Statement of Retained Earnings: The Statement of Retained Eamings is prepared to show how the balance in Profit and Loss accounts is appropriated for various purposes like provision for dividend, transfer to reserves ‘lc. The balance on this account is finally shown on the Balance ‘sheet Uncer the heading Reserve and Surplus. 1.6L "ATION OF FINANCIAL STATEMENT Following are the imitations of financial staternents: 1. The information being of historical nature does not reflect the future, 2. Itis the outcome of accounting concept, convention combined with personal jucgement. ‘3. The statement portrays the position in monetary term. The profit, (Floss position excludes from their purview things which cannot bbe exoressed or recorded in term of money. To overcome from the limitations it becomes necessary to analyse the financial statements. 7 EXERCISE 1. Discuss the meaning, nature and limitatons of Financial Statement. 2. Explain the several parties interested in Financial statements. 43 Discuss the horizontal and vertical analysis of Balance sheet.