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5 CORPORATE FINANCIAL REPORTING notes

CORPORATE FINANCIAL REPORTING

Defined as communication of published financial statement and related
information to interested parties. It contains both qualitative and quantitative
information.

Objectives of financial reporting

The objectives of financial reporting to provide information: 5.1
(1) that is useful to present / potential investors
(2) about the economic resources of an enterprise
(3) about the enterprise’s financial performance
(4) about how management of an enterprise obtains and spends cash
(5) about how management discharged its stewardship
(6) that is useful to management and directors in making decisions

Various requirements of corporate reporting in India:

(1) Balance Sheet
(2) Profit & Loss A/c (Income Statement)
(3) Cash Flow Statement:
(4) Director’s Report
(5) Management Discussion & Analysis Report
(6) Auditor’s Report
(7) Disclosure of Significant Accounting Policies
(8) Disclosure of Notes on Accounts

1. VALUE ADDED STATEMENT

Value added can be defined as the value created by the activities of a firm,
that is, sales less the cost of bought in goods and services and its allocation

Advantages of Value Added Statement:

(1) It helps in the comparison of the performance of the company.
(2) It helps in judging the productivity of the company.
(3) Provides a better alternative by focusing other factors rather than just
profit.
(4) It also helps in devising the incentives schemes for the employees.
(5) It reflects a broader view of the company’s objectives and
responsibilities.

Limitation of Value Added Statement:

(a) The treatments of depreciation resulting in gross and net value added.
(b) The treatment of taxes like pay – as – you –earn, fringe benefits and other
benefits in the employee’s share of value added.
(c) The timing of recognition of value added – production or sales.
(d) The treatment of taxes such as VAT / GST and deferred tax and
(e) The treatment of non – operating items.

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FORMAT FOR VALUE ADDED & ITS APPLICATION:

Particulars Rs.
VALUE ADDED:
Sales less returns XXXX
Less: (Cost of bought out goods & services)
- Audit Fees XXXX
5.2
- Material consumed/Decrease in Stock XXXX
- Administration Cost/Stationery/etc. XXXX
- Selling & Distribution Expenses XXXX
- Interest on short term loan XXXX
- General Expenses (Other Exp.) XXXX
- Hire Charges for Equip./Rent/Rates/Taxes XXXX
- Provision for Doubtful Debt XXXX
- Excise duty XXXX
- Purchase XXXX
- Manufacturing & Other Expenses XXXX
- Depreciation (If NET VALUE ADDED) XXXX (XXX)
Value added from operations XXXX
Add:
- Other Income (Interest/Rent received) XXXX
Add/Less Extra Ordinary Items:
- (-) Loss by theft, etc. (XXX)
- (+) Surplus on sale of Assets XXX XXX
Total Value Added: XXXX

VALUE APPLIED:
Towards employees
- Wages & Salaries XXXX
- Salaries and commission to directors XXXX XXXX
Towards Government
- Local Tax/Cess XXXX
- Provision for tax XXXX XXXX
Towards providers of finance
- Interest on fixed loan/Intt. on Debenture XXXX
- Dividend paid/Proposed Dividend XXXX XXXX
Toward replacement & expansion
- Depreciation (If GROSS VALUE ADDED) XXXX
- Replacement Reserve/Trf. to any Reserve XXXX
- Deferred tax account XXXX
- Retained Profit (CURRENT YEAR ONLY) XXXX XXXX
TOTAL VALUE APPLIED XXXX

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Reconciliation of Value Added with Profit Before Tax (PBT):
Sr. No. Particulars Rs. Rs.
(A) Profit Before Tax (PBT) XXX
(B) Add: Items of Application of Value Added (2nd XXX XXX
Statement) {EXCEPT: FOLLOWING ITEMS,
SINCE THESE ITEMS ARE ALREADY INCLUDED
IN PBT SO NO NEED TO ADD THESE ITEMS
AGAIN} 5.3
Example of items NO NEED TO ADD:
- Provision for Tax
- Proposed Dividend
- Transfer to Reserve
- Retained Earnings
- Dividend Paid
- Surplus transferred to Balance sheet
(C) (=) Value Added XXX

2. ECONOMIC VALUE ADDED

Economic value added measures he excess returns over costs of capital. If a
company’s EVA is negative it is destroying shareholders wealth even though it
may be reporting positive and growing EPS or return on capital employed.
Particulars Rs.
EBIT XXXX
Less: Interest (XXX)
EBT XXXX
Less: Tax (XXX)
Profit After Tax (PAT) XXXX
Add: Interest (1 –t) XXXX
Net Operating Profit After Tax (NOPAT) XXXX
Less: Cost of Capital (XXX)
Economic Value Added XXXX
Expressed as a formula: EVA = NOPAT – (Capital Employed X WACC)

Advantages of EVA analysis are as follows:

(1) In some cases, company pay bonuses to the employees on the basis of
EVA generated. Promotes the employees for working hard
(2) Using EVA, company can evaluate the projects
(3) It helps the company in monitoring the problem areas
(4) EVA presents a better and true picture of the company
(5) It helps the owners to identify the best way to run the company

Disadvantages of EVA
It is difficult to compute and also it does not take into account inflation into
its calculation. Therefore, company should take into account above advantages
and disadvantages before deciding whether to implement EVA or not.

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3. MARKET & SHAREHOLDERS VALUE ADDED

Market value added is the difference between the Company’s market and book
value of shares. According to Stern Stewart, if the total market value of a
company is more than the amount of capital invested, the company has managed
to create shareholder value. If the market value is less than capital invested,
the company has destroyed shareholder value.
5.4 Market Value Added = Company’s Market Value – Capital Invested

Shareholder Value Added (SVA) represents the economic profits generated by

a business above and beyond the minimum return required by all provides of
capital. SVA integrates financial statements of the business (profit and loss,
balance sheet and cash flow) into one meaningful measure.
The SVA methodology is highly flexible approach to assist management in the
decision making process.

PRACTICAL QUESTIONS
Que No. 1: From the following Profit and Loss Account of X Ltd. prepare Gross
Value Added Statement and show the reconciliation between Gross Value Added
and Profit before taxation:
Profit and Loss Account for the year ended 31st March, 2014
Rs. Lakhs Rs.Lakhs
Income:
Sales 800
Other Income 50
Total Income: 850
Expenditure:
Production and Operational Expenses 600
Administrative Expenses 30
Interest and Other charges 30
Depreciation 20 680
Profit before taxes 170
Provision for taxes 30
PAT 140
Balance as per last balance sheet 10
150
Transferred to:
General Reserve 80
Proposed dividend 20
Surplus carried to Balance Sheet 50
150
Break – up of some of the Expenditure is as follows:
Production and operational expenses:
Consumption of raw materials and stores 320
Salaries, wages and bonus 60

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Cess and Local taxes 20

Other Manufacturing expenses 200
600
Administrative Expenses:
Audit fee 6
Salaries and Commission to Directors 8
Provision for Doubtful Debts 6
5.5
Other Expenses 10
30
Interest and work charges:
On working capital loans from bank 10
On fixed loans from ICICI 15
On Debentures 5
30

ECONOMIC VALUE ADDED

Problem no. 1 Following information is given to you by NSX Ltd.:
EBIT Rs.3,50,000
Capital Structure:
Equity Capital Rs.4,25,000
Reserve and surplus Rs.3,25,000
10% Debentures Rs.10,00,000
Dividend at the end of the year (D1) Rs.35 per share
Market value of shares Rs.1,400 per share
Growth rate 15%
Income tax rate 30%
Calculate economic value added (EVA) with the help of above information.
Ans.:
Particulars Calculations Rs.
EBIT 3,50,000
Less: Interest (10,00,000 x 10%) (1,00,000)
EBIT 2,50,000
Less: Tax (2,50,000 x 30%) (75,000)
Profit after tax (PAT) 1,75,000
Add: Interest (1 – t) (1,00,000 (1 – 0.3)) 70,000
Net operating profit after tax (NOPAT) 2,45,000
Less: Cost of Capital (17,50,000 x 11.5%) (2,01,250)
Economic Value Added 43,750
Working note:
Calculation of cost of equity: Calculation of cost of debts
𝐷1
𝐾𝑒 = 𝑀 + 𝑔 𝐾𝑑 = 𝐼(1 − 𝑡)
𝑣
𝐾𝑒 = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 = 10 (1 – 0.3) = 7%
𝐷1 = Dividend at the end of year 1 t = Tax rate
g = Growth Rate
35
𝐾𝑒 = 1,400 + 0.15 = 0.175 i:e 17.5%

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Capital Amount Weight Cost of Product

capital (Weight X Cost
of capital)
Equity Capital & Reserve 7,50,000 7.5 17.5% 131.25
10% Debentures 10,00,000 10 7% 70
17,50,000 17.5 201.25
𝑻𝒐𝒕𝒂𝒍 𝒐𝒇 𝑷𝒓𝒐𝒅𝒖𝒄𝒕
5.6 Weighted Average Cost of Capital (WACC) = = 11.5%
𝑻𝒐𝒕𝒂𝒍 𝒐𝒇 𝑾𝒆𝒊𝒈𝒉𝒕

Problem no. 2 LG Ltd. provides you the following as at 31st March, 2014:
Equities and Liabilities Rs.
Shareholders’ funds:
Equity Share Capital 10,00,000
Reserve and Surplus 20,00,000
Non-current liabilities:
10% Long Term Debts 2,00,000
Current Liabilities:
Sundry Creditors 50,000
32,50,000
Assets Rs.
Non-current assets:
Fixed assets 30,00,000
Investments 1,50,000
Current assets 1,00,000
32,50,000
Additional information:
1. Profit before interest and tax is Rs.10,00,000
2. Tax rate – 35.875%
3. Risk free rate interest – 10%
4. Market rate – 15%
5. Beta Factor (𝛽) – 1.4
Compute Economic Value Added.
Ans.:
Particulars Calculations Rs.
EBIT 10,00,000
Less: Interest (2,00,000 x 10%) (20,000)
EBIT 9,80,000
Less: Tax (9,80,000 x 35.875%) (3,51,575)
Profit after tax (PAT) 6,28,425
Add: Interest (1 – t) (20,000 (1 – 0.35875)) 12,825
Net operating profit after tax (NOPAT) 6,41,250
Less: Cost of Capital (32,00,000 x 16.34%) (5,22,880)
Economic Value Added 1,18,370
Calculation of cost of equity:
𝐾𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅1 ) 𝑅𝑓 = 𝑅𝑖𝑠𝑘 𝐹𝑟𝑒𝑒 𝑅𝑎𝑡𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝐾𝑒 = 10 + 1.4(15 − 10) 𝑅𝑚 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑅𝑎𝑡𝑒
𝐾𝑒 = 17% 𝛽 = 𝐵𝑒𝑡𝑎 𝐹𝑎𝑐𝑡𝑜𝑟

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Calculation of cost of debts:
𝐾𝑑 = 𝐼(1 − 𝑡) I = Interest
𝐾𝑑 = 10(1 − 0.35875)= 6.4125% t = Tax Rate
Capital Rs. Weight Cost of Product
capital (Weight X Cost
of capital)
Equity Capital & Reserve 30,00,000 30 17% 510
10% Long Term Debt 2,00,000 2 6.4125% 12.825 5.7
32,00,000 32 522.825
𝑻𝒐𝒕𝒂𝒍 𝒐𝒇 𝑷𝒓𝒐𝒅𝒖𝒄𝒕 𝒄𝒐𝒍𝒖𝒎𝒏
Weighted Average Cost of Capital (WACC) = =
𝑻𝒐𝒕𝒂𝒍 𝒐𝒇 𝑾𝒆𝒊𝒈𝒉𝒕
522.825/32 = 16.34%

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5.8

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