4

Financial Statements of Companies

4.1 INTRODUCTION

The accounting cycle, leading to the preparation of financial statements as discussed in Chapter 3, is followed by all accounting entities. However, companies are subject to much higher requirements of disclosure. Obviously, they use vast societal resources, and therefore, many stakeholders are interested in their financial performance and health. Disclosures in financial statements of companies are guided by the requirements of the Companies Act, 2013 and the relevant accounting standards. To ensure standardized presentation for easy comparability, the format of the balance sheet and the statement of profit and loss has been prescribed in the Schedule III of the Companies Act, 2013. Additionally, Ind AS 1 lays down the basic requirements for the presentation of financial statements to ensure comparability, both with the entity’s financial statements of previous periods and with the financial statements of other entities.

4.1.1 Purpose of Financial Statements

Financial statements provide information about the financial position, financial performance and cash flows of an entity which is useful to users in making economic decisions. In particular, financial statements provide information about an entity:

1. assets;
2. liabilities;
3. equity;
4. income and expenses, including gains and losses;
5. contributions by and distributions to owners in their capacity as owners; and
6. cash flows.

This information is useful for forecasting the entity’s future cash flows especially, their timing and certainty.

4.1.2 Key Requirements for Presentation

Ind AS 1 also lays down some of the key requirements to be followed for presenting information in financial statements.

(i) Going Concern—Financial statements are prepared on a going concern basis. Management has to assess the entity’s ability to continue as a going concern. If financial statements are not based upon going concern basis, the reasons are to be disclosed.

(ii) Accrual Basis of Accounting—Financial statements, except cash flow statement, are required to be prepared using accrual basis of accounting.

(iii) Materiality—Each material class of similar items must be presented separately and same has to be followed for the items of dissimilar nature or function. If a line item is not individually material, it is aggregated with other items either in those statements or in the notes. An item, that is not sufficiently material to warrant separate presentation in those statements, may warrant separate presentation in the notes.

(iv) Offsetting—Assets and liabilities or income and expenses are required to be shown on gross basis without offsetting against each other, unless required or permitted by an Ind AS.

(v) Frequency of Reporting—Financial statements must be presented annually. If the entity changes, its accounting period and financial statements are prepared for a period longer or shorter than one year. The reason for using a longer or shorter period shall be disclosed with a statement that financial statements are not entirely comparable.

(vi) Comparative Information—Comparative information in respect of the preceding accounting period for all amounts presented in the currents year’s financial statements shall be given for better analysis.

(vii) Consistency—Presentation and classification of items in the financial statements from period to period shall be consistently followed. However, if an Ind AS requires a change in presentation or another presentation or classification is considered to be more appropriate, the classification and presentation may be changed.

(viii) True and Fair—Financial statements shall present information which is relevant, reliable, comparable and understandable. It is presumed that financial statements that are compliant with the Ind AS present a true and fair view of the financial position, performance and cash flow of the entity. Any deviation from compliance with Ind AS shall be explicitly disclosed.

4.2 FINANCIAL STATEMENTS

As per Ind AS 1, a complete set of financial statements comprises:

1. A statement of profit and loss for the period.
2. A balance sheet at the end of the period.
3. Statement of changes in equity for the period.
4. A statement of cash flows for the period.
5. Notes—comprising a summary of significant accounting policies and other explanatory information.

To ensure uniformity in the presentation of financial statements, the formats for the statement of profit and loss and the balance sheet have been prescribed in the Schedule III of the Companies Act, 2013. The Schedule III also includes general instructions for the preparation of financial statements.

Accordingly, it is mandatory to present current year figures and the comparative figures of the previous year. The figures in financial statements may be rounded off depending upon the turnover of the company. If the turnover is less than ₹ 100 crore, the figures may be rounded off to the nearest hundreds, thousands, lakh or millions. If, however, it is ₹ 100 crore or more, rounding off is permitted in the nearest lakh, millions or crore.

Each entry in the balance sheet, statement of changes in equity and statement of profit and loss is required to be cross-referenced with the related information in the notes.

All material items—information that individually or collectively could be relevant for decision making by users—shall be disclosed. At the same time, excessive disclosures shall be avoided. Materiality of an item should be judged in the particular circumstances considering the size or nature of the item or a combination of both. In addition, disclosures required by any law or regulation shall also be made.

4.3 STATEMENT OF PROFIT AND LOSS

The statement of profit and loss (also called profit and loss account) is the primary financial statement to understand the financial performance of an enterprise during a given period. It summarizes incomes earned and expenses incurred by an enterprise during a given period. If the aggregate income earned exceeds the expenses incurred, the difference is called net income or simply net profit. If, however, the income fails to cover the expenses, the enterprise is said to have incurred a loss. The purpose of the statement of profit and loss is to provide information about different sources of income and gains and also expenses and losses incurred during an accounting period.

Incomes and expenses may be arranged one after the other and such a presentation is called vertical format. The same information may also be presented in a T-shaped format wherein incomes are presented on the right-hand side and expenses are on the left-hand side, such a presentation is called horizontal format. The Schedule III prescribes the vertical format to be followed showing income first followed by expenses.

The statement of profit and loss is presented in two sections:

1. Profit or loss for the period.
2. Other comprehensive income (OCI) for the period.

The sum of (i) and (ii) above is called total comprehensive income.

It may be noted that these are not two different statements rather two sections of the same statement. Profit or loss is defined as ‘the total of income less expenses, excluding the components of other comprehensive income’. Other comprehensive income is defined as ‘comprising items of income and expense (including reclassification adjustments) that are not recognized in profit or loss as required or permitted by other Ind ASs. It may be noted that the classification of income and expense between profit or loss and OCI is not principle-based but is rule-based. Whether an item of income or expense is to be presented in profit or loss or in OCI is based upon the requirements of the relevant Ind AS. The format and contents of the statement of profit and loss have been discussed in detail in Chapter 5.

Income represents increase in economic benefits during the accounting period. The increase in economic benefits may be in the form of inflows or enhancement of assets or decrease in liabilities. An entity may earn income by sale of goods, provision of services, or by letting others use its assets, e.g., rent, interest, royalty, etc. Income earned from its main revenue generating activities (from core operations) is called revenue from operations. Income from incidental activities is presented as other income. The sum total of revenue from operations and other income is called total income for the period.

Expenses represent decrease in economic benefits during the accounting period. The decrease is evidenced by outflow or depletion of assets or increase in liabilities. Expenses are presented under various heads depending upon their nature. For example, material consumed, employee benefits, finance cost, depreciation, etc.

Income and expense are recorded using accrual basis of accounting. Income is recognized if it is probable that the future benefits will flow to the enterprise and that same can be measured reliably. Expense is recognized if it is probable that the future benefits will flow from the entity and that the cost can be measured reliably.

4.4 BALANCE SHEET

The balance sheet in simple terms is a statement of assets and liabilities of a business enterprise on a particular day. It is prepared on the last day of the accounting period. Unlike the statement of profit and loss which summarizes the incomes earned and expenses incurred during an accounting period, balance sheet depicts what the business own (assets) and what is owes (liabilities) on a particular day, i.e., at the end of the accounting period. Accordingly, statement of profit and loss is a flow statement, whereas balance sheet is a position statement. The format of the balance sheet has been prescribed in the Schedule III of the Companies Act, 2013.

The balance sheet represents the basic accounting equation, i.e., Assets = Equity + Liabilities. The information may be presented one after the other in a vertical format. The same information may also be given in a T-shaped format. Assets are presented on the right-hand side and equity and liabilities are shown on the left-hand side. Such a presentation is called horizontal format. The Schedule III prescribes the vertical format to be followed in which details of assets are followed by equity and liabilities.

An asset is a resource controlled by an entity as a result of past events from which future economic benefits are expected to flow to the entity. The future benefits may be in the form of increase in cash flow or reduction in the cash outflow. Assets are classified as current assets and non-current assets. Current assets include cash and cash equivalents and those assets that are expected to be consumed or converted into cash within 12 months or in the normal operating cycle of the business. For example cash, bank balance, inventories, trade receivables, short-term loans and advances, short-term investments, etc. Assets other than current assets, for example, land, building, plant, equipment, vehicles, long-term investments, long-term loans and advances are classified as non-current assets or fixed assets. As per the format prescribed in the Schedule III, non-current assets are presented first, followed by current assets.

A liability is a present obligation of an enterprise arising from past events. The settlement of the obligation would require outflow of resources in future. Equity represents the contribution of the owner to the enterprise. It is the residual interest in the assets of the enterprise after deducting all liabilities. Liabilities are further classified as current and non-current or fixed liabilities. Current liabilities are expected to be settled within 12 months or in the normal operating cycle of the business. For example, short-term loans, trade payables for goods and services, outstanding expenses, advances from customers, short-term provisions, etc. All other liabilities are classified as non-current liabilities. Non-current liabilities are expected to be settled after 12 months or beyond the normal operating cycle of the enterprise. For example, term loans from banks, long-term provisions, etc. As per the format prescribed in the Schedule III, non-current liabilities are presented first, followed by current liabilities.

4.5 STATEMENT OF CHANGE IN EQUITY

Schedule III requires a separate ‘statement of change in equity’ to be presented comprising equity share capital and other equity. Other equity includes all items other than equity shares that are attributable to the holders of equity instruments of an entity. The statement of change in equity represents a reconciliation of equity, shows balances in the beginning of the year, changes occurred during the year, and balances at the end of the year. Ind AS 1 requires such reconciliation for each component of equity showing separately changes resulting from:

1. profit or loss;
2. other comprehensive income;
3. transactions with owners in their capacity as owners, showing separately contributions by, and distributions to owners and changes in the ownership interests in subsidiaries that do not result in a loss of control; and
4. any item recognized directly in equity.

The balance sheet depicts the equity balance at the end of the accounting period. The statement of change in equity identifies the reasons for change in the various components of equity during the year. The primary reasons for change in equity are profit or loss for the year, other comprehensive income for the year, distribution of dividend to the shareholders, issue of fresh shares, buy-back of shares and any direct adjustment in the equity balances.

4.6 CASH FLOW STATEMENT

Cash flow statement provides detail about the sources and uses of cash during an accounting period. The balance sheet shows the cash balance on a particular date but it does not explain the change in the cash position since the last balance sheet date. The cash flow statement aims to explain the variation in cash position between two balance sheets by showing the sources and uses of cash. The cash flows are broken under three heads:

(i) Cash Flow from Operating Activities—sources and uses of cash arising directly from the main revenue generating activities of the organization.

(ii) Cash Flow from Investing Activities—sources and uses of cash related to investing in long-term assets including long-term investments. This also includes the income generated from these long-term investments.

(iii) Cash Flow from Financing Activities—sources and uses of cash related to funds raising activities including repayment of loans, payment of interest on borrowed funds and payments of dividends on shares.

Cash flow statement helps the users in understanding the cash generating ability of the business organization and the needs of the entity to utilize these cash flows. Ind AS 7 deals with the presentation and disclosure of cash flow statement.

4.7 NOTES TO ACCOUNTS

Notes to accounts are used to present information about the basis of preparation of the financial statements and the specific accounting policies used. It also provides information as may be required by various Ind ASs those are not presented elsewhere in the financial statements. Additional information, relevant for understanding the financial statements, is also provided in the notes to accounts.

Notes to accounts shall be presented in a systematic manner. Each item in the balance sheet, the statement of profit and loss, the statements of changes in equity and cash flows statement is cross-referenced to any related information in the notes to accounts. The notes to accounts also include a statement that the relevant accounting standards have been complied with.

The purpose and inter-relationship between various financial statements is depicted in Figure 4.1.

Figure 4.1 Financial Statements of a Company

Assignment Questions

1. Financial statements of companies are much more detailed and structured. Why?
2. Explain the key requirements as laid down by Ind AS 1 relating to the presentation of financial statements.
3. Write a short note on various financial statements which are required to be prepared by a company.
4. The statement of profit and loss is a flow-based statement whereas the balance sheet is a static statement. Explain.
5. For better understanding of financial statements, it is important to go through the notes to accounts. Do you agree?

Problems

1. Ramesh, a fresh graduate, has recently joined his first job in a bank. His supervisor has asked him to find certain information from financial statements of a company. Please help him by suggesting which financial statement will contain the following information:
   1. Inventory in hand at the end of the year
   2. Employee cost during the year
   3. Cash and bank balance
   4. Cash outflow on account of purchase of investments
   5. Operating income during the year
   6. Accounting policies
   7. Reasons for change in equity during the year
   8. Intangible assets
   9. Material consumed during the year
   10. Details regarding non-current investments

Solution to Problem

1. 1. Balance sheet
   2. Statement of profit and loss
   3. Balance sheet
   4. Cash flow statement
   5. Statement of profit and loss
   6. Notes to accounts
   7. Statement of change in equity
   8. Balance sheet
   9. Statement of profit and loss
   10. Notes to accounts

Try It Yourself

1. Identify financial statements which include the following information:
   1. Shares issued during the year
   2. Other income earned during the year
   3. Trade receivables at the end of the year
   4. Depreciation on assets charged during the year
   5. Accumulated depreciation on assets
   6. Dividend received during the year
   7. Interest earned during the year
   8. Loan outstanding
   9. Loan repaid during the year
   10. Interest expenses during the year