Financial Statements 3

FINANCIAL STATEMENTS Balance sheet Profit and loss account Cash flow statement

BALANCE SHEET Horizontal Form Liabilities + Equity

Assets

• Share capital

• Fixed assets

• Reserves and surplus

• Investments

• Secured loans

• Current assets, loans and

• Unsecured loans • Current liabilities and provisions

advances • Miscellaneous expenditures and losses

BALANCE SHEET Vertical (or Report) Form I.

Sources of Funds (1) Shareholders’ funds: (a) Capital (b) Reserves and Surplus (2) Loan funds: (a) Secured loans (b) Unsecured loans

II. Application of funds (1) Fixed assets (2) Investments (3) Current assets, loans and advances Less: Current liabilities and provisions: Net current assets (4) Miscellaneous expenditures and losses

BALANCE SHEET OF HORIZON LIMITED AS ON MARCH 31, 20 X 1 A. Account Form Liabilities

Rs.in crore

20 x 1

20 x 0

Assets

20 x 1

20 x 0

Share capital

15.00

15.00

Fixed assets

33.00

32.20

Equity

15.00

15.00

Investments

1.00

1.00

– 11.20 14.30 6.90

– 10.60 13.10 2.50

Current assets, loans and advances 23.40 Miscellaneous expenditures and losses

10.50 57.90

8.10 49.30

57.90

Preference Reserve & surplus Secured loans Unsecured loans 0.50 Current liabilities and provisions

15.60 0.50

49.30

BALANCE SHEET OF HORIZON LIMITED AS ON MARCH 31, 20 X 1 Rs.in million

I.

Sources of Funds (1) Shareholders’ funds: (a) Capital (b) Reserves and surplus (2) Loan funds: (a) Secured loans (b) Unsecured loans

20 x 1

20 x 0

26.20

25.60

21.20

15.60

47.40

41.20

33.00 1.00 23.40 57.40 10.50 12.90 0.50 47.40

32.20 1.00 15.60 48.80 8.10 40.70 0.50 41.20

15.00 11.20 14.30 6.90

II. Application of Funds (1) Fixed assets (2) Investments (3) Current assets, loans and advances Less: Current liabilities and provisions: Net current assets (4) Miscellaneous expenditures and losses

LIABILITIES • Share Capital

• Reserves & Surplus • Secured Loans • Unsecured Loans • Current Liabilities and Provisions

ASSETS • Fixed Assets • Investments • Current Assets, Loans, & Advances • Miscellaneous Expenditure & Losses

PROFIT & LOSS ACCOUNT OF HORIZON LTD, FOR THE YEAR ENDING ON MARCH 31, 20 X 1 (Rs.in crore) Income Sales Other income (loss)

70.1

– 70.1

Expenditure Material and other expenditure Interest Depreciation Profit before tax Provision for tax Profit after tax

58.2 2.1 3.0 6.8 3.4 3.4

Prior period adjustments 0.8 Profit available for appropriations Appropriations Balance carried forward

4.2 3.5 0.7

`PROFIT & LOSS ACCOUNT OF HORIZON LTD, FOR THE YEAR ENDING ON MARCH 31, 20 X 1 (Rs. in crore) Net sales Cost of goods sold Stocks Wages and salaries Other manufacturing expenses Gross profit Operating expenses Depreciation General administration Selling Operating profit Non-operating surplus/deficit Profit before interest and tax Interest Profit before tax Provision for tax Current tax Deferred tax Profit after tax Prior period adjustments Amount available for appropriation Appropriations Balance carried forward

42.1 6.8 6.3 3.0 1.2 1.8

20 x 1 70.1 55.2

20 x 0 62.3 47.5

14.9 6.0

14.8 4.9

8.9 – 8.9 2.1 6.8 3.4 2.1 1.3 3.4 0.8 4.2 3.5 0.7

9.9 0.6 10.5 2.2 8.3 4.1 2.9 1.2 4.2 0.7 4.9 4.0 0.9

PROFIT AND LOSS ACCOUNT ITEMS • Net Sales • Cost of Goods Sold • Gross Profit • Operating Expenses • Operating Profit • Non-operating Gains and Losses • Profit Before Interest and Taxes • Interest • Profit before Tax • Income Tax Provision • Profit After Tax • Prior Period Adjustments • Amount Available for Appropriation • Appropriations • Balance Carried Forward

DEPRECIATION Depreciation is the allocation of the cost of a tangible fixed asset to various accounting periods that benefit from its use. Amortisation is the allocation of the cost of an intangible fixed asset to various accounting periods that benefit from its use. Depreciation Schedule 1. Determine the depreciable base. 2. Estimate the useful life of the asset. 3. Choose the depreciation method.

METHODS OF DEPRECIATION 1. Straight line method 2. Decreasing-charge (accelerated) methods • Sum-of-the-years-digits method • Declining-balance (or written down value) method

DECLINING BALANCE (WRITTEN DOWN VALUE) METHOD The declining-balance depreciation methods provide decreasing charges by applying a constant percentage rate to a declining asset book value. In India, the rates are specified by the Companies Act (for reporting purposes) and the Income Tax Act (for tax purposes). In the U.S. the most popular rates are 1.5 times the straight-line rate, often referred to as ‘150% declining balance’ and 2 times the straight-line rate, often referred to as ‘double-decliningbalance’ depreciation.

DEFERRED TAX • Deferred tax is caused by timing difference between when an amount is recognised for ACCOUNTING INCOME purposes and when it is recognised for TAXABLE INCOME. • For example, suppose that DEPRECIATION for tax purposes is more rapid than for accounting purposes. This means that in the early years of an assets’ life tax depreciation will be larger than accounting depreciation (and vice versa later). • In order to account fully for deferred tax, an additional deferred tax charge would be recorded to represent tax at current rates and the excess of the tax depreciation over the accounting depreciation. A deferred tax liability would also be recorded for this amount.

STATEMENT OF CASH FLOWS Operating

Cash inflows from operations

–

Cash outflows from operations

=

Cash flow from operations + –

Investing

Cash inflows from investing activities

–

Cash outflows from investing activities

=

Cash flow from investing activities + –

Financing

Cash inflows from financing activities

–

Cash outflows from financing activities

=

Cash flow from financing activities = Net cash flow for the period

CASH FLOW STATEMENT LIABILITIES CAPITAL

ASSETS FIXED ASSETS

RESERVES & SURPLUS INVESTMENTS LOANS INVENTORIES CURRENT LIABILITIES

DEBTORS

AND PROVISIONS CASH

SOURCES

USES

• FINANCING

CAPITAL

CAPITAL

• OPERATING

RES. & SURPLUS

RES. & SURPLUS

• FINANCING

LOANS

LOANS

• OPERATING

CURRENT LIABILITIES & PROVISIONS

CURRENT LIABILITIES & PROVISIONS

• INVESTMENT

FIXED ASSETS

FIXED ASSETS

• INVESTMENT

INVESTMENTS

INVESTMENTS

• OPERATING

INVENTORIES

INVENTORIES

• OPERATING

DEBTORS

DEBTORS

CASH FLOW STATEMENT FOR HORIZON LTD, FOR THE PERIOD 1.4.20X0 TO 31.3.20X1 (Rs. in crore) (A) Cash Flow from Operating Activities Net profit before tax and extraordinary items Adjustments for Interest paid Depreciation Operating profit before working capital changes Adjustments Debtors Inventories Advances Trade credit Advances Provisions Cash generated from operations Income tax paid Cash flow before extraordinary items Extraordinary item Net cash flow from operating activities

6.8 2.1 3.0 11.9 (4.6) (3.3) 0.5 1.5 0.7 0.2 6.9 (3.4) 3.5 – 3.5 (Contd.)

(Contd.) (Rs.in crore) (B) Cash Flow from Investing Activities Purchase of fixed assets

(3.8)

Net cash flow from investing activities

(3.8)

(C) Cash Flow from Financing Activities Proceeds from term loans

1.2

Proceeds from inter-corporate deposits

4.4

Interest paid

(2.1)

Dividend paid

(2.8)

Net cash flow from financing activities

0.7

(D) Net Increase in Cash and Cash Equivalents

0.4

Cash and cash equivalents as on 1.04.20x0

0.6

Cash and cash equivalents as on 31.03.20x1

1.0

OTHER ITEMS IN ANNUAL REPORTS • Supporting Schedules & Notes • Report of Auditors • Report on Corporate Governance • Management Discussion & Analysis

MANIPULATION OF THE BOTTOM LINE 1. INFLATE THE SALES FOR THE CURRENT YEAR BY ADVANCING THE SALES FROM THE FOLLOWING YEAR 2. ALTER THE ‘OTHER INCOME’ FIGURE BY PLAYING WITH NON-OPERATIONAL ITEMS 3. FIDDLE WITH THE METHOD & RATE OF DEPR’N 4. DEFER CERTAIN DISCRETIONARY EXPENSES TO THE FOLLOWING YEAR. 5. MAKE INADEQUATE PROVISIONS . . LIABILITIES 6. MAKE EXTRA PROVISIONS . . PROSPEROUS PERIODS . . WRITE THEM BACK . . LEAN PERIODS 7. USE TOTALLY UNACCEPTABLE ACCOUNTING PRACTICES. 8.LENGTHEN … ACCOUNTING YEAR . . ATTEMPT COVER POOR PERFORMANCE.

WHY ?

PROJECT IMAGE OF LOW RISK PROMOTE PERCEP’N . . COMPETENT MGT INCREASE MGRL COMPEN’N

SOME COMMONLY ASKED QUESTION •WHY IS IT THAT THE BALANCE SHEET ALWAYS BALANCES ? •WHY IS IT THAT SHARE CAPITAL IS SHOWN AS A LIABILITY ? •WHAT IS THE NATURE OF DEPRECIATION ? •WHAT IS THE SIGNIFICANCE OF THE AUDITOR’S REPORT ? • WHAT IS THE LINK BETWEEN BALANCE SHEET & THE PROFIT & LOSS ACCOUNT ?

• HOW IS THE CASH FLOW STATEMENT DERIVED FROM THE BALANCE SHEET & THE PROFIT & LOSS ACCOUNT ? •WHAT DOES A BONUS ISSUE OR STOCK SPLIT IMPLY ? •WHAT IS CREATIVE ACCOUNTING ? •WHAT IS GAAP

?

SUMMING UP • THERE ARE THREE FINANCIAL STATEMENTS • BALANCE SHEET • P & L ACCOUNT • CASH FLOW STATEMENT • THE KEY CONCEPTS UNDERLYING FINANCIAL ACCOUNTING ARE: • ENTITY CONCEPT • DUAL ASPECT CONCEPT • HISTORICAL COST CONCEPT • REALISATION CONCEPT • MATCHING CONCEPT • FINANCIAL STATEMENTS REFLECT REVENUES, EXPENSES, ASSETS AND LIABILITIES. CORPORATE MANAGEMENTS HAVE SOME DISCRETION IN INFLUENCING THE OCCURRENCE, MEASUREMENT AND REPORTING OF THESE ITEMS.