Understanding

Financial
Statement
Dr. Krishnendu Ghosh
Learning outcomes
• Introduction
• Nature and objectives of Financial Statements
• Uses of Financial Statements
• Form and Content of Financial Statements
• Users of Financial Statements
Financial Statements
 Financial statements are compilation of financial data, collected and
classified in a systematic manner according to the accounting principles,
to assess the financial position of an enterprise as regards to its
profitability, operational efficiency, long and short-term solvency and
growth potential
 Financial statements are structured financial representation of the
financial position, performance and cash flows of an enterprise
 Financial statements are the report card of business
 A company's financial statements are a window into its financial health
Financial Statements (contd….)
 Companies Bill 2013 got its assent in the Lok Sabha on 18th December 2012 and in the
Rajya Sabha on 8th August 2013. After having obtained the assent of the President of
India on 29 August 2013, it has now become the much awaited Companies Act, 2013
(2013 Act)
 The Companies Act, 2013 comprises of 470 sections, 7 Schedules and 29 Chapters. Out
of 470 sections, 99 sections were notified on 12.09.2013 and 183 sections of the
Companies Act, 2013 were notified w.e.f. 01.04.2014 which include the sections
regarding the financial statements of the Companies. The remaining Sections are
expected to be notified in due course of time
 Companies to follow uniform accounting period i.e. from 1st April to 31st March of next
year, with exception of subsidiaries who with approval of Tribunal may opt for different
accounting period
 National Advisory Committee on Accounting Standards (NACAS) is to be replaced by
National Financial Reporting Authority (NFRA) with enlarged power of setting audit
standards and investigating professional misconduct
Financial Statements (contd…)
Nature of Financial Statements
 The American Institute of Certified Public Accountants (AICPA) stated: “they
(financial statements) reflect a combination of recorded facts, accounting
conventions and personal judgment, and the judgments and conventions
applied affect them materially.”
 Therefore the nature of financial statements are:
 Recorded facts: Financial statements are prepared on the basis of facts
in the form of cost data recorded in accounting books
 Accounting Conventions: Certain accounting conventions are followed
while preparing financial statements
 Postulates: Financial statements are prepared on certain basic
assumptions (pre-requisites) known as postulates such as going concern
postulate, money measurement postulate, realisation postulate, etc.
Nature of Financial Statements (contd…)
 Legal implications:
 Personal judgment: Under more than one circumstance, facts and
figures presented through financial statements are based on personal
opinion, estimates and judgements
Purpose of Financial Statements
The Framework of Financial Statements
The Framework of Financial Statements (contd…)
 Presentation of True & Fair View and Compliance with Ind AS
 True & Fair view assumed through application of Ind AS
 Explicit & Unreserved Statement of Compliance of all Ind AS needs to be
disclosed
 Departure from Compliance of Ind AS
 In extremely rare circumstances, where compliance with a Standard
would be misleading so it would conflict with objective set out in the
framework
 Departure is permissible, if regulatory framework requires or does not
prohibit
 Specified disclosure required
The Framework of Financial Statements (contd…)
 Going concern
 When preparing financial statements, management shall make an
assessment of an entity’s ability to continue as a going concern :
An entity shall prepare financial statements on a going concern basis
unless
• there is intention to liquidate or to cease trading or
• no other alternative except to do so
Disclose in case of material uncertainty
If FS are not prepared on Going Concern basis – Disclose fact, basis
and reason for that
The Framework of Financial Statements (contd…)
The Framework of Financial Statements (contd…)
The Framework of Financial Statements (contd…)
The Framework of Financial Statements (contd…)
Qualitative Characteristics of the Financial Statements
Qualitative Characteristics of the Financial Statements
(contd…)
Other Important Accounting Concepts
Elements of the Financial Statements
 The financial statements must summarise five key elements in order to
reflect the financial position and performance
Definition
 An asset is ‘a resource owned or controlled by an entity as a result of past
events and from which future economic benefits are expected to flow to the
entity’
 A liability is ‘a present obligation arising from past events, the settlement of
which is expected to result in an outflow from the entity of resources
embodying economic benefits’
 Capital/equity is a special kind of liability due to the owner(s) and is ‘the
residual interest in the assets of the entity after deducting all its liabilities’
 Income ‘increases in economic benefits during the accounting period in the
form of inflows or enhancements of assets or decreases of liabilities that result
in an increase in equity’
 Expense ‘decreases in economic benefits during the accounting period in the
form of outflows or diminutions of assets or increases of liabilities that result
in a decrease in equity’
Categorisation of Assets and Liabilities
 Assetsand liabilities need to be classified according to the length of time
they are employed in the business

A tangible asset has physical substance. A non-tangible asset has no

physical substance
Categorisation of Assets and Liabilities (contd…)
Categorisation of Assets and Liabilities (contd…)
Categorisation of Assets and Liabilities (contd…)
Objectives of Financial Statements
 The primary objectives of financial statements is to present the true and
fair value of the state of affairs of the firm with the help of its various
statements
 To supply necessary information to the users and analysts for taking
decisions which will be formulated in future
 To provide information about economic resources and obligations of a
business
 To provide information about the earning capacity of the business
 To provide information about cash flows
 To judge effectiveness of management
 To provide information about activities of business affecting the society
 Disclosing accounting policies
Uses of Financial Statements
 They provides necessary information about the financial activities to the
interested parties
 They reveal the right and proper position of a business
 They provides necessary information about the efficiency or otherwise of
the management, regarding the proper utilization of the scarce resources
 They provide necessary information for predictions (financial forecasting)
 They help to evaluate the earning capacity of the firm by supplying a
statement of financial position, a statement of periodical earnings together
with a statement of financial activities to the various interested persons
 They facilitate decisions regarding the changes in the manner of
acquisition, utilization, preservation and distribution of the scarce
resources
Uses of Financial Statements (contd…)
 They facilitate decisions regarding replacement of fixed assets and expansion of
the firm
 They provide necessary data to the government for taking proper decisions
relating to duties, taxes and price control, etc. and for some legal and control
purposes
 Theydevice remedial measures for the deviations between the actual and
budgeted performances
 Theyalso provide necessary data and information to the managers for internal
reporting and formulation of overall policies
 They also help to safeguard the interest of shareholders who are not allowed to
go through the day-to-day affairs of the firm
 They help the credit rating agencies to determine the rating of the Company
Users of Financial Statements
Users of Financial Statements (contd…)
 What do internal users use it for?

 Planning, evaluating and controlling company operations

 What do external users use it for?

 Assessing past performance and current financial position and

making predictions about the future profitability and solvency of
the company as well as evaluating the effectiveness of
management
Users of Financial Statements (contd…)
Form and Content of Financial Statements
 As per Section 2(40) of Companies Act, 2013, Financial Statement in
relation to a company, includes-
(i) a balance sheet as at the end of the financial year;
(ii) a statement of profit and loss account, or in case of company carrying
out activity not for profit, an income and expenditure account for the
financial year;
(iii) cash flow statement for the financial year;
(iv) statement of changes in equity, if applicable; and
(v) any explanatory note annexed to, or forming part of, any document
referred to sub-clause (iv) stated above
 Provided that the financial statement, with respect to One Person Company,
small company and dormant company, may not include the cash flow
statement
Form and Content of Financial Statements (contd…)
 Schedule III to the Companies Act, 2013 provides the manner in which
every company registered under the Act shall prepare its Balance Sheet,
Statement of Profit and Loss and notes thereto
 The requirements of the Schedule III however, do not apply to companies
as referred to in the proviso to Section 129(1) of the Act, i.e., any insurance
or banking company, or any company engaged in the generation or supply
of electricity or to any other class of company for which a form of Balance
Sheet and Statement of Profit and Loss has been specified in or under any
other Act governing such class of company
 Presentation of the financial statements of a non-banking finance
companies (NBFCs) would be governed by Schedule III
 The Schedule III (and earlier, the Revised Schedule VI) prescribes only the
vertical format for presentation of Financial Statements
Form and Content of Financial Statements (contd..)
 Current and non-current classification has been introduced for
presentation of assets and liabilities in the Balance Sheet
 Unlike the Old Schedule VI, the Schedule III (and earlier Revised Schedule
VI) lays down a format for the presentation of Statement of Profit and
Loss
 The Structure of Schedule III is as under:
I. General Instructions
II. Part I – Form of Balance Sheet
III. General Instructions for Preparation of Balance Sheet
IV. Part II – Form of Statement of Profit and Loss
V. General Instructions for Preparation of Statement of Profit and Loss
VI. General Instructions for the Preparation of Consolidated Financial
Statements
Form and Content of Financial Statements (contd..)
 The Schedule III (and earlier, the Revised Schedule VI) has specifically
introduced a new requirement of using the same unit of measurement
uniformly across the Financial Statements
 The Schedule III (and earlier, the Revised Schedule VI) has also
introduced new rounding off requirements as compared to the Old
Schedule VI
 The new requirement does not prescribe the option to present figures in
terms of hundreds and thousands if the turnover equals or exceeds Rs.
100 crores. Rather, they allow rounding off in crores, which was earlier
permitted only when the turnover equalled or exceeded 500 crores
rupees. Similarly, where turnover is below Rs. 100 crore, the Schedule III
(and earlier, the Revised Schedule VI) gives an option to present figures in
lakhs and millions as well, which did not exist earlier
Form and Content of Financial Statements (contd..)
 It is not compulsory to apply rounding off and a company can
continue to disclose full figures. But, if the same is applied, the rounding
off requirement should be complied with
 The General Instructions for the preparation of the Consolidated
Financial Statements were not included in Revised Schedule VI and is
now a part of the Schedule III
Components of Financial Statements
Income Statement
 The Income Statement, also known as profit and loss statement, statement
of comprehensive income or statement of income, is a financial statement
which tallies revenues, cost of goods sold, and operating expenses
 Income Statement provides information on the revenues and expenses of
the firm, and the resulting income made by the firm, during a period. The
period can be a quarter (if it is a quarterly income statement) or a year (if
it is an annual report)
 Income Statement is composed of the following two elements:
Income: What the business has earned over a period (e.g. sales
revenue, dividend income, etc.)
Expense: The cost incurred by the business over a period (e.g.
salaries and wages, depreciation, rental charges, etc.)
Income Statement (contd…)
 The main point of emphasis on the income statement is the relationship between
revenues and expenses. https://youtu.be/5L0wwsNFads
 Revenue is defined as what an organization earns for delivering services or selling goods.
Expenses are the are the cost of doing business
 Cost of goods sold: the total cost of the goods that you’ve sold
 Operating expenses: the costs of operating your business except for the costs of things
that you’ve sold
 The positive difference between sales and cost of goods sold is your gross profit or gross
margin
 The positive difference between gross profit and operating expenses is your net income
or profit, which is the “bottom line.” (If this difference is negative, you took a loss instead
of making a profit.)
 To break even (have no profit or loss), your total sales revenue must exactly equal all
your expenses (both variable and fixed)
Income Statement (contd…)
 Statement of Profit and Loss includes Profit or loss and Other
Comprehensive Income (OCI)
 Profit or loss is defined as "the total of income less expenses, excluding
the components of other comprehensive income"
 An income statement is developed by listing all revenues (sales) within
a specific time frame, listing all cost of goods sold and operating
expenses within the same time frame
 Then you subtract all the costs and expenses from the revenues to
arrive at Earnings Before Taxes (EBT) for that time frame
 Earnings before taxes is also referred to as net income before taxes
(NIBT) as well as Operating Income
Income Statement (contd…)
 Income taxes are then calculated and subtracted from earnings before
taxes to arrive at the Net Income After Taxes or what many people refer
to as – THE BOTTOM LINE
 Other comprehensive income (OCI) is defined as comprising "items of
income and expense (including reclassification adjustments) that are not
recognised in profit or loss as required or permitted by other Ind ASs”
 Total comprehensive income is defined as the sum of regular income
and other comprehensive income
 Comprehensive income includes realized and unrealized income, such as
unrealized gains and losses from the other comprehensive income
statement, and therefore is a more detailed view of a company's net
income, which is not fully captured on the income statement
Income Statement (contd…)
Income Statement (contd…)
Income Statement (contd…)
Balance Sheet
 The balance sheet is called so because it always balances according to this
relation: Assets = Liabilities + Owners' equity
 The balance sheet or statement of financial position shows the assets
that a business owns, the liabilities that it owes and the funds
contributed by its shareholders
 A Balance Sheet is a statement of assets and liabilities of an entity at any
particular date
 At the end of each accounting period, every business organization
prepares a balance sheet to have a clear understanding of its asset and
liabilities which indicate the financial position
 Balance Sheet shows the cumulative position of resources (assets) and
sources of funds (liabilities ) at the end of the year
Balance Sheet (contd…)
Balance Sheet (contd..)
Balance Sheet (contd..)
Balance Sheet (contd…)
Balance Sheet (contd…)
Statement of Changes in Equity
 Statement of Changes in Equity/Owners’ Equity are amount payable to
owners
 Format of Statement of Changes in Equity is not available in Schedule III
and is also not mandated in the existing accounting standards
 Itis considered as liability due to Entity Concept of Accounting which
assumes business as separate from its owner and hence amount
contributed by the owner is considered as liability for the business
Owners Equity = Net Worth = Proprietor's Equity = Equity

Owner’s Fund = Capital + Reserves

Owner’s Fund = Capital + Accumulated Profits

Statement of Changes in Equity (contd…)
 Separate component of financial statements

 On the face for each component of equity a reconciliation between

carrying amount at beginning and at end of period
 Profit or loss for the period
 Other comprehensive income
 Effect of retrospective application or restatement
 Also in statement or in the notes

 Capital transactions with owners

 Movements in accumulated profit
 Movements in capital and reserves
Cash Flow Statement
 Cash Flow Statement is defined as a statement:
 Reflecting the cash inflows (cash receipts) and cash outflows (cash
payments) from business/non-business operations
 With a purpose to analyze the adequate generation and systematic
utilization of cash in the business during an accounting period and
 To effect reconciliation between opening and closing cash balance
 While businesses can misstate their profits through accounting jugglery,
they can't fudge the movement of hard cash
 Hence, a cash-flow statement provides a true picture of a company's
financial health
 The statement also mentions the current cash holding of the business
Cash Flow Statement (contd..)
 CashFlow Statement provides an analysis of changes in cash and cash
equivalents:
Cash comprises of cash in hand and demand deposits

Cash equivalents includes short-term, highly liquid investments

(equity investments are excluded)
Bank overdrafts : Excess of withdrawal over the bank balance
Cash Flow Statement (contd..)
 Cash Flow Statement, presents the movement in cash and bank
balances over a period
 The movement in cash flows is classified into the following segments:
Operating Activities: Represents the cash flow from primary
activities of a business
Investing Activities: Represents cash flow from the purchase
and sale of assets other than inventories (e.g. purchase of a
factory plant)
Financing Activities: Represents cash flow generated or spent
on raising and repaying share capital and debt together with the
payments of interest and dividends
Form of Cash Flow Statement
Form of Cash Flow Statement (contd..)
Form of Cash Flow Statement (contd..)
• Notes:
(1) Figures of cash sales may be directly available from cash book. Then
cash collection can be derived taking
Credit sales + Opening balance of debtors - closing balance of debtors
(2) Similarly figures of cash purchases can also be obtained from cash
book
(3) Interest and dividend are investment cash inflow and, therefore, to be
excluded
(4) Interest expense is financing cash outflow
(5) Tax provision is not cash expense, advance tax paid should be treated
as tax cash outflow
• https://youtu.be/EA-3bAHrMxE
Form of Cash Flow Statement (contd….)
Form of Cash Flow Statement (contd..)
Schedule III - Companies Act, 2013
• http://mca.gov.in/XBRL/pdf/Guidance_Note_Rev_ScheduleVI.pdf
• http://www.mca.gov.in/SearchableActs/Schedule3.htm
• http://ebook.mca.gov.in/Actpagedisplay.aspx?PAGENAME=17919
• https://taxguru.in/company-law/financial-statementsscheduleiii-
companies-act-2013.html
Notes to the Financial Statements
Notes to the Financial Statements (contd…)
Notes to the Financial Statements (contd…)
 Critical Management Judgments
A special purpose vehicle, also called a special
 Examples purpose entity (SPE), is a subsidiary created
by a parent company to isolate financial risk.
 Substance over form issues Its legal status as a separate company makes
its obligations secure even if the parent
 Sale of goods/financing arrangements company goes bankrupt

 Existence of control over SPEs (Special Purpose Entity)

 Critical Estimates
 Examples
 Recoverability of internally generated intangible assets
 Impairment of goodwill
 Useful lives of property, plant and equipment etc.
 Capital Management policies
Financial Statements - Interrelation

Source: https://accounting-simplified.com/financial/statements/types.html
The Relationship Between Financial Statements
• The financial statements are comprised of the income statement, balance sheet,
and statement of cash flows. These three statements are interrelated in several
ways, as noted in the following bullet points:
The net income figure in the income statement is added to the retained
earnings line item in the balance sheet, which alters the amount of equity
listed on the balance sheet
The net income figure also appears as a line item in the cash flows from
operating activities section of the statement of cash flows
Changes in various line items in the balance sheet roll forward into the cash
flow line items listed on the statement of cash flows. For example, an increase
in the outstanding amount of a loan appears in both the liabilities section of
the balance sheet (as an ongoing balance) and in the cash flows from
financing activities section of the statement of cash flows (in the amount of
the incremental change)
The Relationship Between Financial Statements (contd…)
The ending cash balance in the balance sheet also appears in the
statement of cash flows
The purchase, sale, or other disposition of assets appears on both the
balance sheet (as an asset reduction) and the income statement (as a
gain or loss, if any)
• In short, the financial statements are highly interrelated. Consequently,
when reviewing the financial statements of an organization, one should
examine all of the financial statements in order to obtain a complete
picture of its financial situation
Consolidated Financial Statement
 There are two types of statements known as a consolidated statement
and a standalone statement
 Section 129 (Clause 3) of the Companies Act, 2013 mandated the
companies having one or more subsidiaries, to prepare Consolidated
Financial Statements
 Consolidated financial statements present the financial position and
results of operations for a parent (controlling entity) and one or more
subsidiaries (controlled entities) as if the individual entities actually were
a single company or entity
 Consolidated financial statements are the financial statements of a ‘group’
presented as those of a single enterprise, where a ‘group’ refers to a
parent and all its subsidiaries
Consolidated Financial Statement (contd…)
 When preparing consolidated financial statements, the individual
balances of the parent and its subsidiaries are combined or consolidated
on a line-by-line basis, and then certain consolidation adjustments are
made
 The consolidated financial statements are presented to the extent
possible in the same format as that adopted by the parent for its separate
financial statements
 Accounting Standard 21, ‘Consolidated Financial Statements’ should be
applied in the preparation and presentation of consolidated financial
statements for a group of enterprises under the control of a parent
 Consolidated Financial Statement of TATA Steel Ltd. –
https://www.tatasteel.com/investors/integrated-reportannual-report/
Consolidated Financial Statement (contd…)
A parent company can claim exemption for preparation and filing of
consolidated financial statements with ROC if it meets the following
conditions:
 (i) it is a wholly-owned subsidiary, or is a partially-owned subsidiary of
another company and all its other members, including those not
otherwise entitled to vote, having been intimated in writing and for
which the proof of delivery of such intimation is available with the
company, do not object to the company not presenting consolidated
financial statements;
 (ii) it is a company whose securities are not listed or are not in the
process of listing on any stock exchange, whether in India or outside
India; and
Consolidated Financial Statement (contd…)
 (iii) Its ultimate or any intermediate holding company files
consolidated financial statements with the Registrar which are in
compliance with the applicable Accounting Standards
 As per AS 21, a subsidiary should be excluded from consolidation when:
 (a) control is intended to be temporary because the subsidiary is
acquired and held exclusively with a view to its subsequent disposal
in the near future; or
 (b) it operates under severe long-term restrictions which significantly
impair its ability to transfer funds to the parent
 Schedule III to the Companies Act, 2013 contains the ‘General
Instructions for Preparation of Consolidated Financial Statements’
Consolidated Financial Statement (contd…)
 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
Components of Consolidated Financial Statements
Measurement of the Elements of Financial Statements
Measurement of the Elements of Financial
Statements (contd…)
 Historical Cost – means the transaction value that has been given or received
at the time of recognising such element in the financial statements together
with all attributable costs incurred or expected to be incurred
 Current Cost – means the value of an element which has been recognised at its
recent paid / received price
 Settlement Value – means the value of an element which are required to be
recognised at the value which is to be received / paid by selling or for
immediate settlement
 Present Value - Present value means present discounted value of the future
net cash inflows / outflows that the item is expected to generate / settle in the
normal course of business. The calculated value will represent its current value
 Fair Value – means an amount at which asset / liability could be exchanged /
settled, between knowledgeable, willing parties in an arm’s length transaction
Limitations of Financial Statements

Source: https://www.wallstreetmojo.com/financial-statement-limitations/
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