Unit I: Basics of Financial Reporting

Financial Reporting - Definition, Types and Importance

Financial reporting is a crucial process for companies and investors, as it provides key
information that shows financial performance over time. Government and private regulatory
institutions also monitor financial reporting to ensure fair trade, compensation and financial
activities. Typically, you record financial activities on several key statements, which others
can use for review. In this article, we discuss what financial reporting is, why it's important,
what financial statements are common and who uses and monitors these documents.
What is financial reporting?
Financial reporting is the process of documenting and communicating financial activities and
performance over specific time periods, typically on a quarterly or yearly basis. Companies
use financial reports to organize accounting data and report on current financial status.
Financial reports are also essential in the projections of future profitability, industry position
and growth, and many financial reports are available for public review. There are several
primary statements to use when reporting financial data, and the information you include in
these documents fulfills several key objectives of financial reporting:
 Tracking cash flow
 Evaluating assets and liabilities
 Analyzing shareholder equity
 Measuring profitability
Importance of financial reporting
Financial reporting is a critical practice that's important because it:
Monitors income and expenses
Tracking income and expenses is another important process that financial reporting
supports. Monitoring financial documentation is necessary for effective debt management
and budget allocation and provides insight into key areas of spending. Monitoring income
and expenses ensures companies track debts regularly to remain transparent in competitive
markets. Therefore, financial reporting gives you documentation methods to track current
liabilities and assets. Accurate financial documentation is also necessary to measure
important metrics, including debt-to-asset ratios, which investors use to evaluate how
effectively companies pay down debt and generate revenue.
Ensures compliance
Financial reporting encompasses specific processes that companies follow to comply with
mandatory accounting regulations. Each document you use to evaluate financial activities
comes under the review of several financial regulatory institutions. This makes accurate
documentation crucial to ensure all financial reports comply with tax regulations and
financial reporting criteria. Accurate financial reporting also simplifies tax, valuation and
auditing processes, reducing the time to complete necessary financial obligations and further
validating financial compliance.
Communicates essential data
Key shareholders, executives, investors and professionals all rely on current financial data
to make decisions, plan budgets and monitor performance. The importance of open
communication and transparency is necessary to support funding, investment opportunities
and financial review. Many investors and creditors rely on the information companies
communicate in financial documentation to assess profitability, risk and future returns.
Supports financial analysis and decision-making
Financial reporting is crucial for performing analysis to support business decisions. Using
financial statements improves accountability and supports the analysis of critical financial
data. Documents like the income statement and balance sheet provide real-time information
that you can use to track historical performance, identify key areas of spending and create
forecasts more accurately. With better-developed data models and detailed financial
analysis, reporting helps businesses evaluate current activities and make decisions for future
growth.

Purposes of financial reporting

1. Statutory purposes
The government is always around to collect taxes and keeps changing tax regimes to make
the process simpler. To adhere to tax reforms and laws, financial management must plan to
pay its taxes on a timely basis. Financial management is an important skill of every small
business owner or manager. Every decision that an owner makes has a financial impact on
the company, and he has to make these decisions within the total context of the company's
operations.
2. Financial management in normal operations
Usually, a company provides a product or service, sells to its customer, collects the money
and the process is repeated again. Financial management is moving cash efficiently through
this cycle. This means that managing the turnover ratios of raw materials and finished goods
inventories, selling to customers and collecting the receivables on a timely basis and starting
over by purchasing more raw materials. While this is happening, the business must also
ensure that it pays suppliers and employees, regularly. All of this must be done with cash,
and it takes astute financial management to make sure that these funds flow efficiently. Even
though economies have a long-term history of going up, occasionally they will also
experience sharp declines. Businesses must plan to have enough liquidity to weather these
economic downturns, otherwise they may need to close their doors for lack of cash.
3. Operation evaluation
When a business starts its operations, it comes with an upfront cost. And as the business
grows, these costs go up for obvious reasons. Setting up a sound structure for financial
management helps business owners evaluate the operational changes that impacted the
overall financial health of the business. Financial reporting which is done on an income
statement generates results about sales, expenses and profit or losses. Using the
4. Decision-making, planning and forecasting
When key decisions are to be taken by a business owner, careful analysis of financial
statements is imperative. One simple look at the value of the assets that a business currently
holds and managers can instantly decide, if they can afford to purchase more or not.
Conversely, when the value of assets is severely depreciated, managers can decide if they
need to be sold off. Financial management also help is creating various strategies for
optimum use of stock-at-hand and resources that will ultimately result in better cash flow.
5. Mitigate errors
Accurate financial reporting can help businesses catch grave mistakes and inter errors early
in the process that could cost the business a hefty amount. There is no better way to detect
illegal financial activities than catch discrepancies in financial statements. Through a
reconciliation process, errors that have been made can be found. Companies spend a lot of
time reconciling their books of accounts and verifying each journal entry, so they can find if
an accounting error has occurred or if anyone has tampered with any part of the business.

Users of Financial Reports

Read this article to learn about the following thirteen users of financial statements, i.e., (1)
Shareholders, (2) Debenture Holders, (3) Creditors, (4) Financial Institutions and
Commercial Banks, (5) Prospective Investors, (6) Employees and Trade Unions, (7)
Important Customers, (8) Tax Authorities, (9) Government Departments, and Others.
1. Shareholders:
Divorce between ownership and management and broad-based ownership of capital due to
dispersal of shareholdings have made shareholders take more interest in the financial
statements with a view to ascertaining the profitability and financial strength of the
company.
2. Debenture Holders:
The debenture holders are interested in the short-term as well as the long-term solvency
position of the company. They have to get their interest payments periodically and at the end
the return of the principal amount.
3. Creditors:
Potential suppliers of goods and materials and others doing business with the company are
interested in the liquidity position of the company.
4. Financial Institutions and Commercial Banks:
These financial institutions are interested in the solvency – short-term as well as long-term
– and profitability position of the company.
5. Prospective Investors:
Prospective Investors are interested in the future prospects and financial strength of the
company.
6. Employees and Trade Unions:
Employees and Trade Unions are interested in the profitability position of the company.
7. Important Customers:
 Important Customers who want to make long-standing contract with the company are
interested in its financial strength.
8. Tax Authorities:
Tax Authorities are interested in the profits earned by the company.
9. Government Departments:
Government Departments dealing with the industry in which the company is engaged are
interested in the financial information relating to the company.
10. Economists and Investments Analysts:
Economists and Investments Analysts are interested in the financial and other information
of the company.
11. Members of Parliament:
Members of Parliament the Public Accounts Committee and Estimates Committee – are
interested in the financial information of the government companies
12. SEBI and Stock Exchanges:
SEBI and Stock Exchanges are interested in the prospects and performance of listed
companies with a view to protecting the interests of investors.
13. Managers:
Managers are interested in knowing through the financial statements the present position
and future prospects of the company. This is mainly to review the company’s progress and
position and take decisions for the future.

Objectives of Financial Reporting

According to International Accounting Standard Board (IASB), the objective of financial
reporting is “to provide information about the financial position, performance and changes
in financial position of an enterprise that is useful to a wide range of users in making
economic decisions.”
The following points sum up the objectives & purposes of financial reporting
1. Providing information to the management of an organization which is used for the purpose
of planning, analysis, benchmarking and decision making.
2. Providing information to investors, promoters, debt provider and creditors which is used to
enable them to male rational and prudent decisions regarding investment, credit etc.
3. Providing information to shareholders & public at large in case of listed companies about
various aspects of an organization.
4. Providing information about the economic resources of an organization, claims to those
resources (liabilities & owner’s equity) and how these resources and claims have undergone
change over a period of time.
5. Providing information as to how an organization is procuring & using various resources.
6. Providing information to various stakeholders regarding performance management of an
organization as to how diligently & ethically they are discharging their fiduciary duties &
responsibilities.
7. Providing information to the statutory auditors which in turn facilitates audit.
8. Enhancing social welfare by looking into the interest of employees, trade union &
Government.

Qualitative Characteristics of Financial Reports

The two fundamental qualitative characteristics of financial reports are relevance and
faithful representation. The four enhancing qualitative characteristics are comparability,
verifiability, timeliness and understandability.
Fundamental qualitative characteristics:
1. Relevance
The characteristic of relevance implies that the information should have predictive
and confirmatory value for users in making and evaluating economic decisions. The
 relevance of information is affected by its nature and materiality. Information is
material if omitting it or misstating it could influence decision making. A financial
report should include all information which is material to a particular entity.
2. Faithful representation
The characteristic of faithful representation implies that financial information
faithfully represents the phenomena it purports to represent. This depiction implies
that the financial information is complete, neutral and free from error.
Enhancing qualitative characteristics:
1. Comparability
The characteristic of comparability implies that users of financial statements must
be able to compare aspects of an entity at one time and over time, and between
entities at one time and over time. Therefore, the measurement and display of
transactions and events should be carried out in a consistent manner throughout
an entity, or fully explained if they are measured or displayed differently.
2. Verifiability
The characteristic of verifiability provides assurance that the information faithfully
represents what it purports to be representing.
3. Timeliness
The characteristic of timeliness means that the accounting information is available
to all stakeholders in time for decision-making purposes.
4. Understandability
The characteristic of understandability implies that preparers of information have
classified, characterized and presented the information clearly and concisely. The
financial reports are prepared with the assumption that its users have a ‘reasonable
knowledge’ of the business and its economic activities.

Standards of financial reporting

 The objective of financial reporting is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders, and other
creditors in making decisions about providing resources to the entity.
 Financial reporting requires policy choices and estimates. These choices and estimates
require judgment, which can vary from one preparer to the next. Accordingly, standards
are needed to ensure increased consistency in these judgments.
 Private sector standard setting bodies and regulatory authorities play significant but
different roles in the standard setting process. In general, standard setting bodies make
the rules, and regulatory authorities enforce the rules. However, regulators typically
retain legal authority to establish financial reporting standards in their jurisdiction.
 The IFRS framework sets forth the concepts that underlie the preparation and
presentation of financial statements for external users.
 The objective of fair presentation of useful information is the center of the
IASB’s Conceptual Framework. The qualitative characteristics of useful information
include fundamental and enhancing characteristics. Information must exhibit the
fundamental characteristics of relevance and faithful representation to be useful. The
enhancing characteristics identified are comparability, verifiability, timeliness, and
understandability.
 IFRS Financial Statements: IAS No. 1 prescribes that a complete set of financial
statements includes a statement of financial position (balance sheet), a statement of
comprehensive income (either two statements—one for net income and one for
comprehensive income—or a single statement combining both net income and
comprehensive income), a statement of changes in equity, a cash flow statement, and
notes. The notes include a summary of significant accounting policies and other
explanatory information.
 Financial statements need to reflect certain basic features: fair presentation, going
concern, accrual basis, materiality and aggregation, and no offsetting.
 Financial statements must be prepared at least annually, must include comparative
information from the previous period, and must be consistent.
 Financial statements must follow certain presentation requirements including a
classified statement of financial position (balance sheet) and minimum information on
both the face of the financial statements and in the notes.
 A significant number of the world’s listed companies report under either IFRS or US
GAAP.
  In many cases, a user of financial statements will lack the information necessary to make
specific adjustments required to achieve comparability between companies that use
IFRS and companies that use US GAAP. Instead, an analyst must maintain general
caution in interpreting comparative financial measures produced under different
accounting standards and monitor significant developments in financial reporting
standards.
 Analysts can remain aware of ongoing developments in financial reporting by
monitoring new products or types of transactions; actions of standard setters,
regulators, and other groups; and company disclosures regarding critical accounting
policies and estimates.

Unit II: Understanding Financial Statements

UNDERSTANDING FINANCIAL STATEMENTS

To understand a company’s financial position—both on its own and within its industry—you
need to review and analyze several financial statements: balance sheets, income statements,
cash flow statements, and annual reports. The value of these documents lies in the story they
tell when reviewed together.
1. How to Read a Balance Sheet
A balance sheet conveys the “book value” of a company. It allows you to see what resources
it has available and how they were financed as of a specific date. It shows its assets, liabilities,
and owners’ equity (essentially, what it owes, owns, and the amount invested by
shareholders).
The balance sheet also provides information that can be leveraged to compute rates of return
and evaluate capital structure, using the accounting equation: Assets = Liabilities + Owners’
Equity.

Assets are anything a company owns with quantifiable value.

 Liabilities refer to money a company owes to a debtor, such as outstanding payroll expenses,
debt payments, rent and utility, bonds payable, and taxes.
Owners’ equity refers to the net worth of a company. It’s the amount of money that would be
left if all assets were sold and all liabilities paid. This money belongs to the shareholders,
who may be private owners or public investors.
Alone, the balance sheet doesn’t provide information on trends, which is why you need to
examine other financial statements, including income and cash flow statements, to fully
comprehend a company’s financial position.
2. How to Read an Income Statement
An income statement, also known as a profit and loss (P&L) statement, summarizes the
cumulative impact of revenue, gain, expense, and loss transactions for a given period. The
document is often shared as part of quarterly and annual reports, and shows financial trends,
business activities (revenue and expenses), and comparisons over set periods.
Income statements typically include the following information:
 Revenue: The amount of money a business takes in
 Expenses: The amount of money a business spends
 Costs of goods sold (COGS): The cost of component parts of what it takes to make
whatever a business sells
 Gross profit: Total revenue less COGS
 Operating income: Gross profit less operating expenses
 Income before taxes: Operating income less non-operating expenses
 Net income: Income before taxes less taxes
 Earnings per share (EPS): Division of net income by the total number of outstanding
shares
 Depreciation: The extent to which assets (for example, aging equipment) have lost value
over time
 EBITDA: Earnings before interest, taxes, depreciation, and amortization
Accountants, investors, and other business professionals regularly review income
statements:
 To understand how well their company is doing: Is it profitable? How much money is
spent to produce a product? Is there cash to invest back into the business?
 To determine financial trends: When are costs highest? When are they lowest?
3. How to Read a Cash Flow Statement
The purpose of a cash flow statement is to provide a detailed picture of what happened to a
business’s cash during a specified duration of time, known as the accounting period. It
demonstrates an organization’s ability to operate in the short and long term, based on how
much cash is flowing into and out of it.
Cash flow statements are broken into three sections: Cash flow from operating activities,
cash flow from investing activities, and cash flow from financing activities.
Operating activities detail cash flow that’s generated once the company delivers its regular
goods or services, and includes both revenue and expenses. Investing activity is cash flow
from purchasing or selling assets—usually in the form of physical property, such as real
estate or vehicles, and non-physical property, like patents—using free cash, not debt.
Financing activities detail cash flow from both debt and equity financing.
It’s important to note there’s a difference between cash flow and profit. While cash flow
refers to the cash that's flowing into and out of a company, profit refers to what remains after
all of a company’s expenses have been deducted from its revenues. Both are important
numbers to know.
With a cash flow statement, you can see the types of activities that generate cash and use that
information to make financial decisions.
Ideally, cash from operating income should routinely exceed net income, because a positive
cash flow speaks to a company’s financial stability and ability to grow its operations.
However, having positive cash flow doesn’t necessarily mean a company is profitable, which
is why you also need to analyze balance sheets and income statements.
4. How to Read an Annual Report
An annual report is a publication that public corporations are required to publish annually
to shareholders to describe their operational and financial conditions.
Annual reports often incorporate editorial and storytelling in the form of images,
infographics, and a letter from the CEO to describe corporate activities, benchmarks, and
achievements. They provide investors, shareholders, and employees with greater insight
into a company’s mission and goals, compared to individual financial statements.
Beyond the editorial, an annual report summarizes financial data and includes a company's
income statement, balance sheet, and cash flow statement. It also provides industry insights,
management’s discussion and analysis (MD&A), accounting policies, and additional investor
information.
In addition to an annual report, the US Securities and Exchange Commission (SEC) requires
public companies to produce a longer, more detailed 10-K report, which informs investors
of a business’s financial status before they buy or sell shares.
10-K reports are organized per SEC guidelines and include full descriptions of a company’s
fiscal activity, corporate agreements, risks, opportunities, current operations, executive
compensation, and market activity. You can also find detailed discussions of operations for
the year, and a full analysis of the industry and marketplace.
Both an annual and 10-K report can help you understand the financial health, status, and
goals of a company. While the annual report offers something of a narrative element,
including management’s vision for the company, the 10-K report reinforces and expands
upon that narrative with more detail.
A CRITICAL SKILL
Reviewing and understanding these financial documents can provide you with valuable
insights about a company, including:
 Its debts and ability to repay them
 Profits and/or losses for a given quarter or year
 Whether profit has increased or decreased compared to similar past accounting periods
 The level of investment required to maintain or grow the business
 Operational expenses, especially compared to the revenue generated from those expenses
Accountants, investors, shareholders, and company leadership need to be keenly aware of
the financial health of an organization, but employees can also benefit from understanding
balance sheets, income statements, cash flow statements, and annual reports.
Financial Statement
Structure of Financial Statements
If you can read a nutrition label or a baseball box score, you can learn to read basic financial
statements. If you can follow a recipe or apply for a loan, you can learn basic accounting. The
basics aren’t difficult and they aren’t rocket science.
This brochure is designed to help you gain a basic understanding of how to read financial
statements. Just as a CPR class teaches you how to perform the basics of cardiac pulmonary
resuscitation, this brochure will explain how to read the basic parts of a financial statement.
It will not train you to be an accountant (just as a CPR course will not make you a cardiac
doctor), but it should give you the confidence to be able to look at a set of financial statements
and make sense of them.
Let’s begin by looking at what financial statements do.
“Show me the money!”
We all remember Cuba Gooding Jr.’s immortal line from the movie Jerry Maguire, “Show me
the money!” Well, that’s what financial statements do. They show you the money. They show
you where a company’s money came from, where it went, and where it is now.
There are four main financial statements. They are: (1) balance sheets; (2) income
statements; (3) cash flow statements; and (4) statements of shareholders’ equity. Balance
sheets show what a company owns and what it owes at a fixed point in time. Income
statements show how much money a company made and spent over a period of time. Cash
flow statements show the exchange of money between a company and the outside world also
over a period of time. The fourth financial statement, called a “statement of shareholders’
equity,” shows changes in the interests of the company’s shareholders over time.
Let’s look at each of the first three financial statements in more detail.
Balance Sheet
A balance sheet provides detailed information about a
company’s assets, liabilities and shareholders’ equity.

Assets are things that a company owns that have value. This typically means they can either
be sold or used by the company to make products or provide services that can be sold. Assets
include physical property, such as plants, trucks, equipment and inventory. It also includes
things that can’t be touched but nevertheless exist and have value, such as trademarks and
patents. And cash itself is an asset. So are investments a company makes.
Liabilities are amounts of money that a company owes to others. This can include all kinds
of obligations, like money borrowed from a bank to launch a new product, rent for use of a
building, money owed to suppliers for materials, payroll a company owes to its employees,
environmental cleanup costs, or taxes owed to the government. Liabilities also include
obligations to provide goods or services to customers in the future.
Shareholders’ equity is sometimes called capital or net worth. It’s the money that would be
left if a company sold all of its assets and paid off all of its liabilities. This leftover money
belongs to the shareholders, or the owners, of the company.

The following formula summarizes what a balance sheet shows:

ASSETS = LIABILITIES + SHAREHOLDERS' EQUITY
A company's assets have to equal, or "balance," the sum of its liabilities
and shareholders' equity.

A company’s balance sheet is set up like the basic accounting equation shown above. On the
left side of the balance sheet, companies list their assets. On the right side, they list their
liabilities and shareholders’ equity. Sometimes balance sheets show assets at the top,
followed by liabilities, with shareholders’ equity at the bottom.
Assets are generally listed based on how quickly they will be converted into
cash. Current assets are things a company expects to convert to cash within one year. A good
example is inventory. Most companies expect to sell their inventory for cash within one
year. Noncurrent assets are things a company does not expect to convert to cash within one
year or that would take longer than one year to sell. Noncurrent assets
include fixed assets. Fixed assets are those assets used to operate the business but that are
not available for sale, such as trucks, office furniture and other property.
Liabilities are generally listed based on their due dates. Liabilities are said to be
either current or long-term. Current liabilities are obligations a company expects to pay off
within the year. Long-term liabilities are obligations due more than one year away.
Shareholders’ equity is the amount owners invested in the company’s stock plus or minus
the company’s earnings or losses since inception. Sometimes companies distribute earnings,
instead of retaining them. These distributions are called dividends.
A balance sheet shows a snapshot of a company’s assets, liabilities and shareholders’ equity
at the end of the reporting period. It does not show the flows into and out of the accounts
during the period.
Income Statements
An income statement is a report that shows how much revenue a company earned over a
specific time period (usually for a year or some portion of a year). An income statement also
shows the costs and expenses associated with earning that revenue. The literal “bottom line”
of the statement usually shows the company’s net earnings or losses. This tells you how
much the company earned or lost over the period.
Income statements also report earnings per share (or “EPS”). This calculation tells you how
much money shareholders would receive if the company decided to distribute all of the net
earnings for the period. (Companies almost never distribute all of their earnings. Usually
they reinvest them in the business.)
To understand how income statements are set up, think of them as a set of stairs. You start
at the top with the total amount of sales made during the accounting period. Then you go
down, one step at a time. At each step, you make a deduction for certain costs or other
operating expenses associated with earning the revenue. At the bottom of the stairs, after
deducting all of the expenses, you learn how much the company actually earned or lost
during the accounting period. People often call this “the bottom line.”
At the top of the income statement is the total amount of money brought in from sales of
products or services. This top line is often referred to as gross revenues or sales. It’s called
“gross” because expenses have not been deducted from it yet. So the number is “gross” or
unrefined.
The next line is money the company doesn’t expect to collect on certain sales. This could be
due, for example, to sales discounts or merchandise returns.
When you subtract the returns and allowances from the gross revenues, you arrive at the
company’s net revenues. It’s called “net” because, if you can imagine a net, these revenues
are left in the net after the deductions for returns and allowances have come out.
Moving down the stairs from the net revenue line, there are several lines that represent
various kinds of operating expenses. Although these lines can be reported in various orders,
the next line after net revenues typically shows the costs of the sales. This number tells you
the amount of money the company spent to produce the goods or services it sold during the
accounting period.
The next line subtracts the costs of sales from the net revenues to arrive at a subtotal called
“gross profit” or sometimes “gross margin.” It’s considered “gross” because there are certain
expenses that haven’t been deducted from it yet.
The next section deals with operating expenses. These are expenses that go toward
supporting a company’s operations for a given period – for example, salaries of
administrative personnel and costs of researching new products. Marketing expenses are
another example. Operating expenses are different from “costs of sales,” which were
deducted above, because operating expenses cannot be linked directly to the production of
the products or services being sold.
Depreciation is also deducted from gross profit. Depreciation takes into account the wear
and tear on some assets, such as machinery, tools and furniture, which are used over the long
term. Companies spread the cost of these assets over the periods they are used. This process
of spreading these costs is called depreciation or amortization. The “charge” for using these
assets during the period is a fraction of the original cost of the assets.
After all operating expenses are deducted from gross profit, you arrive at operating profit
before interest and income tax expenses. This is often called “income from operations.”
Next companies must account for interest income and interest expense. Interest income is
the money companies make from keeping their cash in interest-bearing savings accounts,
money market funds and the like. On the other hand, interest expense is the money
companies paid in interest for money they borrow. Some income statements show interest
income and interest expense separately. Some income statements combine the two numbers.
The interest income and expense are then added or subtracted from the operating profits to
arrive at operating profit before income tax.
Finally, income tax is deducted and you arrive at the bottom line: net profit or net losses.
(Net profit is also called net income or net earnings.) This tells you how much the company
actually earned or lost during the accounting period. Did the company make a profit or did it
lose money?
Earnings per Share or EPS
Most income statements include a calculation of earnings per share or EPS. This calculation
tells you how much money shareholders would receive for each share of stock they own if
the company distributed all of its net income for the period.
To calculate EPS, you take the total net income and divide it by the number of outstanding
shares of the company.
Cash Flow Statements
Cash flow statements report a company’s inflows and outflows of cash. This is important
because a company needs to have enough cash on hand to pay its expenses and purchase
assets. While an income statement can tell you whether a company made a profit, a cash flow
statement can tell you whether the company generated cash.
A cash flow statement shows changes over time rather than absolute dollar amounts at a
point in time. It uses and reorders the information from a company’s balance sheet and
income statement.
The bottom line of the cash flow statement shows the net increase or decrease in cash for
the period. Generally, cash flow statements are divided into three main parts. Each part
reviews the cash flow from one of three types of activities: (1) operating activities;
(2) investing activities; and (3) financing activities.
Operating Activities
The first part of a cash flow statement analyzes a company’s cash flow from net income or
losses. For most companies, this section of the cash flow statement reconciles the net income
(as shown on the income statement) to the actual cash the company received from or used
in its operating activities. To do this, it adjusts net income for any non-cash items (such as
adding back depreciation expenses) and adjusts for any cash that was used or provided by
other operating assets and liabilities.
Investing Activities
The second part of a cash flow statement shows the cash flow from all investing activities,
which generally include purchases or sales of long-term assets, such as property, plant and
equipment, as well as investment securities. If a company buys a piece of machinery, the cash
flow statement would reflect this activity as a cash outflow from investing activities because
it used cash. If the company decided to sell off some investments from an investment
portfolio, the proceeds from the sales would show up as a cash inflow from investing
activities because it provided cash.
Financing Activities
The third part of a cash flow statement shows the cash flow from all financing activities.
Typical sources of cash flow include cash raised by selling stocks and bonds or borrowing
from banks. Likewise, paying back a bank loan would show up as a use of cash flow.
Read the Footnotes
A horse called “Read The Footnotes” ran in the 2004 Kentucky Derby. He finished seventh,
but if he had won, it would have been a victory for financial literacy proponents everywhere.
It’s so important to read the footnotes. The footnotes to financial statements are packed with
information. Here are some of the highlights:
 Significant accounting policies and practices – Companies are required to disclose the
accounting policies that are most important to the portrayal of the company’s financial
condition and results. These often require management’s most difficult, subjective or
complex judgments.
 Income taxes – The footnotes provide detailed information about the company’s current
and deferred income taxes. The information is broken down by level – federal, state, local
and/or foreign, and the main items that affect the company’s effective tax rate are
described.
 Pension plans and other retirement programs – The footnotes discuss the company’s
pension plans and other retirement or post-employment benefit programs. The notes
contain specific information about the assets and costs of these programs, and indicate
whether and by how much the plans are over- or under-funded.
 Stock options – The notes also contain information about stock options granted to officers
and employees, including the method of accounting for stock-based compensation and
the effect of the method on reported results.
Read the MD&A
You can find a narrative explanation of a company’s financial performance in a section of the
quarterly or annual report entitled, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations.” MD&A is management’s opportunity to provide
investors with its view of the financial performance and condition of the company. It’s
management’s opportunity to tell investors what the financial statements show and do not
show, as well as important trends and risks that have shaped the past or are reasonably likely
to shape the company’s future.
The SEC’s rules governing MD&A require disclosure about trends, events or uncertainties
known to management that would have a material impact on reported financial information.
The purpose of MD&A is to provide investors with information that the company’s
management believes to be necessary to an understanding of its financial condition, changes
in financial condition and results of operations. It is intended to help investors to see the
company through the eyes of management. It is also intended to provide context for the
financial statements and information about the company’s earnings and cash flows.
Financial Statement Ratios and Calculations
You’ve probably heard people banter around phrases like “P/E ratio,” “current ratio” and
“operating margin.” But what do these terms mean and why don’t they show up on financial
statements? Listed below are just some of the many ratios that investors calculate from
information on financial statements and then use to evaluate a company. As a general rule,
desirable ratios vary by industry.
If a company has a debt-to-equity ratio of 2 to 1, it means that the company has two dollars
of debt to every one dollar shareholders invest in the company. In other words, the company
is taking on debt at twice the rate that its owners are investing in the company.
Inventory Turnover Ratio = Cost of Sales / Average Inventory for the Period
If a company has an inventory turnover ratio of 2 to 1, it means that the company’s inventory
turned over twice in the reporting period.
Operating Margin = Income from Operations / Net Revenues
Operating margin is usually expressed as a percentage. It shows, for each dollar of sales, what
percentage was profit.
P/E Ratio = Price per share / Earnings per share
If a company’s stock is selling at $20 per share and the company is earning $2 per share, then
the company’s P/E Ratio is 10 to 1. The company’s stock is selling at 10 times its earnings.
Working Capital = Current Assets – Current Liabilities
 Debt-to-equity ratio compares a company’s total debt to shareholders’ equity. Both of
these numbers can be found on a company’s balance sheet. To calculate debt-to-equity
ratio, you divide a company’s total liabilities by its shareholder equity, or
 Inventory turnover ratio compares a company’s cost of sales on its income statement with
its average inventory balance for the period. To calculate the average inventory balance
for the period, look at the inventory numbers listed on the balance sheet. Take the balance
listed for the period of the report and add it to the balance listed for the previous
comparable period, and then divide by two. (Remember that balance sheets are snapshots
in time. So the inventory balance for the previous period is the beginning balance for the
current period, and the inventory balance for the current period is the ending balance.)
To calculate the inventory turnover ratio, you divide a company’s cost of sales (just below
the net revenues on the income statement) by the average inventory for the period, or
 Operating margin compares a company’s operating income to net revenues. Both of these
numbers can be found on a company’s income statement. To calculate operating margin,
you divide a company’s income from operations (before interest and income tax
expenses) by its net revenues, or
 P/E ratio compares a company’s common stock price with its earnings per share. To
calculate a company’s P/E ratio, you divide a company’s stock price by its earnings per
share, or
 Working capital is the money leftover if a company paid its current liabilities (that is, its
debts due within one-year of the date of the balance sheet) from its current assets.
Bringing It All Together
Although this brochure discusses each financial statement separately, keep in mind that they
are all related. The changes in assets and liabilities that you see on the balance sheet are also
reflected in the revenues and expenses that you see on the income statement, which result
in the company’s gains or losses. Cash flows provide more information about cash assets
listed on a balance sheet and are related, but not equivalent, to net income shown on the
income statement. And so on. No one financial statement tells the complete story. But
combined, they provide very powerful information for investors. And information is the
investor’s best tool when it comes to investing wisely.
Additional Disclosure Statements
With a view to promote Transparency and accountability in Company Financial Statement,
the Ministry of Corporate Affairs (MCA) has amended the Schedule III to the Companies Act,
2013 vide notification dated 24.03.2020, wherein the certain disclosure requirements as
well as the principles as stated in respect of the preparation of the financial statements has
been amended.
These additional disclosures will definitely improve the qualities of financial Statement of
the companies but at the same time it will increase the Compliance cost of the company. It
will create friction in the easy of doing especially for smaller companies….. Additional
Disclosure introduced by MCA Vide Notification dated 24.03.2021, which need to be taken
care of by the companies.
1. Every company which uses accounting software for maintaining its books of account,
shall use only such accounting software which has a feature of recording audit trail of each
and every transaction, creating an edit log of each change made in books of account along
with the date when such changes were made and ensuring that the audit trail cannot be
disabled. it will also enhance accountability among company personnel and enable audit of
pervasive controls
2. A company shall disclose Shareholding of Promoters at the end of the Year with regards
to No of Share, %of total shares and % Change during the year
3. This disclosure will mandate the company to disclose the ageing payment cycle for MSMEs
and Non-MSME Trade Payable in the format mentioned below Particulars Outstanding for
following periods from due date of payment# Less than 1 year 1-2 years 2-3 years More than
3 years Total (i) MSME (ii) Others (iii) Disputed dues – MSME (iv) Disputed dues – Others
And the disclosure for trade receivable needs to provide in the format mentioned below
Particulars Outstanding for following periods from due date of payment# Less than 6
months 6 months – 1 year 1-2 years 2-3 years More than 3 years Total (i) Undisputed Trade
receivables – considered good (ii) Undisputed Trade Receivables – considered doubtful
(iii) Disputed Trade Receivables considered good (iv) Disputed Trade Receivables
considered doubtful
4. The company shall provide the details of all the immovable property (other than
properties where the Company is the lessee and the lease agreements are duly executed in
favour of the lessee) whose title deeds are not held in the name of the company in format
given below and where such immovable property is jointly held with others, details are
required to be given to the extent of the company’s share. Relevant line item in the Balance
sheet Description of item of property Gross carrying value Title deeds held in the name of
Whether title deed holder is a promoter, director or relative# of promoter*/director or
employee of promoter/director Property held since which date Reason for not being held in
the name of the company** PPE- Investment property- PPE retired from active use and held
for disposal – others Land Building Land Building Land Building – – – – **also indicate if in
dispute
5. Following disclosures shall be made where Loans or Advances in the nature of loans are
granted to promoters, directors, KMPs and the related parties (as defined under
Companies Act, 2013,) either severally or jointly with any other person, that are: a. repayable
on demand or b. without specifying any terms or period of repayment Type of Borrower
Amount of loan or advance in the nature of loan outstanding Percentage to the total
Loans and Advances in the nature of loans Promoters Directors KMPs Related Parties
6. Capital-Work-in Progress (CWIP): For Capital-work-in progress, following ageing
schedule shall be given: CWIP aging schedule (Amount in Rs.) CWIP Amount in CWIP for a
period of Total* Less than 1 year 1-2 years 2-3 years More than 3 years Projects in progress
Projects temporarily suspended *Total shall tally with CWIP amount in the balance sheet. (a)
For capital-work-in progress, whose completion is overdue or has exceeded its cost
compared to its original plan, following CWIP completion schedule shall be given**: (Amount
in Rs.) CWIP To be completed in Less than1 year 1-2 years 2-3 years More than 3 years
Project 1 Project 2” **Details of projects where activity has been suspended shall be given
separately.
7. For Intangible assets under development, following ageing schedule shall be given:
Intangible assets under development aging schedule (Amount in Rs.) Intangible assets under
development Amount in CWIP for a period of Total* Less than 1 year 1-2 years 2-3 years
More than 3 years Projects in progress Projects temporarily suspended * Total shall tally
with the amount of Intangible assets under development in the balance sheet. a. For
Intangible assets under development, whose completion is overdue or has exceeded its cost
compared to its original plan, following Intangible assets under development completion
schedule shall be given**: (Amount in Rs.) Intangible assets under development To be
completed in Less than 1 year 1-2 years 2-3 years More than 3 years Project 1 Project 2
**Details of projects where activity has been suspended shall be given separately.
8. Details of Benami Property held Where any proceedings have been initiated or pending
against the company for holding any benami property under the Benami Transactions
(Prohibition) Act, 1988 (45 of 1988) and the rules made thereunder, the company shall
disclose the following:- a. Details of such property, including year of acquisition, b. Amount
thereof, c. Details of Beneficiaries, d. If property is in the books, then reference to the item in
the Balance Sheet, e. If property is not in the books, then the fact shall be stated with reasons,
f. Where there are proceedings against the company under this law as an abetter of the
transaction or as the g. Nature of proceedings, status of same and company’s view on
9. Where the Company has borrowings from banks or financial institutions on the basis
of security of current assets, it shall disclose the following:- a. whether quarterly returns
or statements of current assets filed by the Company with banks or financial institutions are
in agreement with the books of b. if not, summary of reconciliation and reasons of material
discrepancies, if any to be adequately
10. Wilful Defaulter* Where a company is a declared wilful defaulter by any bank or
financial Institution or other lender, following details shall be given: a. Date of declaration as
wilful defaulter, b. Details of defaults (amount and nature of defaults), * “wilful defaulter”
here means a person or an issuer who or which is categorized as a wilful defaulter by any
bank or financial institution (as defined under the Act) or consortium thereof, in accordance
with the guidelines on wilful defaulters issued by the Reserve Bank of India.
11. Relationship with Struck off Companies Where the company has any transactions with
companies struck off under section 248 of the Companies Act, 2013 or section 560 of
Companies Act, 1956, the Company shall disclose the following details:- Name of struck off
Company Nature of transactions with struck-off Company Balance outstanding Relationship
with the Struck off company, if any, to be disclosed Investments in securities Receivables
Payables Shares held by stuck off company Other outstanding balances (to be specified)
12. Registration of charges or satisfaction with Registrar of Companies Where any charges
or satisfaction yet to be registered with Registrar of Companies beyond the statutory period,
details and reasons thereof shall be disclosed.
13. Compliance with number of layers of companies Where the company has not
complied with the number of layers prescribed under clause (87) of section 2 of the Act read
with Companies (Restriction on number of Layers) Rules, 2017, the name and CIN of the
companies beyond the specified layers and the relationship/extent of holding of the
company in such downstream companies shall be disclosed.
14. Following Ratios to be disclosed:-
a. Current Ratio,
b. Debt-Equity Ratio,
c. Debt Service Coverage Ratio,
d. Return on Equity Ratio,
e. Inventory turnover ratio,
f. Trade Receivables turnover ratio,
g. Trade payables turnover ratio,
h. Net capital turnover ratio,
i. Net profit ratio,
j. Return on Capital employed,
k. Return on The company shall explain the items included in numerator and denominator
for computing the above ratios. Further explanation shall be provided for any change in the
ratio by more than 25% as compared to the preceding year.
15. Corporate Social Responsibility (CSR) Where the company covered under section 135
of the companies act, the following shall be disclosed with regard to CSR activities:-
a. amount required to be spent by the company during the year,
b. amount of expenditure incurred,
c. shortfall at the end of the year,
d. total of previous years shortfall,
e. reason for shortfall,
f. nature of CSR activities,
g. details of related party transactions, e.g., contribution to a trust controlled by the company
in relation to CSR expenditure as per relevant Accounting Standard,
h. where a provision is made with respect to a liability incurred by entering into a contractual
obligation, the movements in the provision during the year should be shown separately
16. Details of Crypto Currency or Virtual Currency Where the Company has traded or
invested in Crypto currency or Virtual Currency during the financial year, the following shall
be disclosed:-
a. profit or loss on transactions involving Crypto currency or Virtual Currency
b. amount of currency held as at the reporting date,
c. deposits or advances from any person for the purpose of trading or investing in Crypto
Currency/ virtual currency.”;

Need for Additional Financial Statement Disclosure

The required disclosures at the end of a financial statement vary based on the nation where
the statement is being released, as well as the specific type of statement. Generally speaking,
here is some of what might be on your financial statement disclosure checklist. However,
consult with a legal expert about the specific requirements for your business.
Environmental Reporting and Social Disclosures
Businesses in the US, Canada, and the EU are all required to disclose environmental risks and
impacts caused by their operations, though each nation has its own unique specifications. In
the EU specifically, companies with more than 500 employees are also required to disclose
their diversity efforts, treatment of employees, and related information. In North America,
by contrast, it may be that organizations are only required to disclose risks to profitability.
Operations Insights
Events like bankruptcy or loss of contract, which occur between financial statements, are
often required to be disclosed in a narrative. Major changes to the company structure or
operations processes may also be necessary to mention.
Conflicts of Interest
Especially in cases where a brokerage firm has prepared a financial statement, the
relationship between the brokerage and the company in question must be clearly disclosed.
If the broker has done banking for the company or if analysts/other firm members own
company stock, that isn’t necessarily a red flag. However, other parties like outside investors
deserve to be aware so they can make their own analysis of the financial statements with full
context.
Legal Disclaimers
Every financial statement will likely be accompanied by other disclaimers. These include
mentions of whether the report contains forward-looking forecasts that may differ from
future outcomes in reality. It should also be stated whether or not the information in the
report has been checked for complete accuracy, and even whether or not it is fully intended
to guide investment decisions.
As a final rule, if you are reviewing a financial statement that is not accompanied by any
disclosures whatsoever, this report cannot likely be trusted. For the issuing business, this is
why including disclosures in a financial statement is so important. It is a matter of
compliance from a legal perspective and completeness from a public perspective.

Auditor’s report – as an Additional Disclosure of Financial Statements

Introduction
1. This standard sets forth the auditor's responsibilities when the auditor of the company's
financial statements is engaged to perform audit procedures and report on supplemental
information1/ that accompanies financial statements2/ audited pursuant to Public Company
Accounting Oversight Board ("PCAOB") standards.
Objective
2. The objective of the auditor of the financial statements, when engaged to perform audit
procedures and report on supplemental information that accompanies audited financial
statements, is to obtain sufficient appropriate audit evidence to express an opinion on
whether the supplemental information is fairly stated, in all material respects, in relation to
the financial statements as a whole.
Performing Audit Procedures on Supplemental Information Accompanying Audited
Financial Statements
3. The auditor should perform audit procedures to obtain appropriate audit evidence that
is sufficient to support the auditor's opinion regarding whether the supplemental
information is fairly stated, in all material respects, in relation to the financial statements as
a whole. The nature, timing, and extent of audit procedures necessary to obtain sufficient
appropriate audit evidence and to report on the supplemental information depends on,
among other things:
a. The risk of material misstatement of the supplemental information;
b. The materiality considerations relevant to the information presented;
Note: When planning and performing the audit procedures to report on supplemental
information, the auditor generally should use the same materiality considerations as
those used in planning and performing the audit of the financial
statements.3/ However, if applicable regulatory requirements specify a lower
 materiality level to be applied to certain supplemental information, the auditor
should use those prescribed threshold requirements in planning and performing
audit procedures for the supplemental information.
c. The evidence obtained from the audit of financial statements and, if applicable, other
engagements by the auditor or affiliates or affiliates of the firm, 4/ for the period
presented; and
Note: The procedures performed regarding the supplemental information should be
planned and performed in conjunction with the audit of the financial statements. For
audits of brokers and dealers, the procedures should be coordinated with the
attestation engagements related to compliance or exemption reports required by the
U.S. Securities and Exchange Commission ("SEC")5/ The auditor should take into
account relevant evidence from the audit of the financial statements and, for audits of
brokers or dealers, the attestation engagements, in planning and performing audit
procedures related to the supplemental information and in evaluating the results of
the audit procedures to form the opinion on the supplemental information.
d. Whether a qualified opinion, an adverse opinion, or a disclaimer of opinion was
issued on the financial statements.
4. In performing the audit procedures on supplemental information, the auditor should:
a. Obtain an understanding of the purpose of the supplemental information and the
criteria management used to prepare the supplemental information, including
relevant regulatory requirements;
b. Obtain an understanding of the methods of preparing the supplemental information,
evaluate the appropriateness of those methods, and determine whether those
methods have changed from the methods used in the prior period and, if the methods
have changed, determine the reasons for and evaluate the appropriateness of such
changes;
c. Inquire of management about any significant assumptions or interpretations
underlying the measurement or presentation of the supplemental information;
d. Determine that the supplemental information reconciles to the underlying
accounting and other records or to the financial statements, as applicable;
e. Perform procedures to test the completeness and accuracy of the information
presented in the supplemental information to the extent that it was not tested as part
of the audit of financial statements; and
f. Evaluate whether the supplemental information, including its form and content,
complies with relevant regulatory requirements or other applicable criteria, if any.
Management Representations
5. The auditor should obtain written representations from management, including:
a. A statement that management acknowledges its responsibility for the fair
presentation of the supplemental information and, if applicable, the form and content
 of that supplemental information, in conformity with relevant regulatory
requirements or other applicable criteria;
b. A statement that management believes the supplemental information, including its
form and content, is fairly stated, in all material respects;
c. A statement that the methods of measurement or presentation have not changed from
those used in the prior period or, if the methods of measurement or presentation have
changed, the reasons for such changes and why those changes are appropriate;
d. If the form and content of the supplemental information is prescribed by regulatory
requirements or other applicable criteria, a statement that the supplemental
information complies, in all material respects, with the regulatory requirements or
other applicable criteria, and identification of those requirements or other applicable
criteria; and
e. A description of any significant assumptions or interpretations underlying the
measurement or presentation of the supplemental information, and a statement that
management believes that such assumptions or interpretations are appropriate.
Evaluation of Audit Results
6. To form an opinion on the supplemental information, the auditor should evaluate
whether the supplemental information, including its form and content, is fairly stated, in all
material respects, in relation to the financial statements as a whole, including whether the
supplemental information is presented in conformity, in all material respects, with the
relevant regulatory requirements or other applicable criteria.
7. The auditor should accumulate misstatements regarding the supplemental information
identified during performance of audit procedures on the supplemental information and in
the audit of the financial statements.6/ The auditor should communicate accumulated
misstatements regarding the supplemental information to management on a timely basis to
provide management with an opportunity to correct them.
8. The auditor should evaluate whether uncorrected misstatements related to the
supplemental information are material, either individually or in combination with other
misstatements, taking into account relevant quantitative and qualitative factors.
Note: The auditor should evaluate the effect of uncorrected misstatements related to the
supplemental information in evaluating the results of the financial statement audit. 7/
9. The auditor should evaluate the effect of any modifications to the audit report on the
financial statements when forming an opinion on the supplemental information:
a. When the auditor expresses a qualified opinion on the financial statements and the
basis for the qualification also applies to the supplemental information, the auditor
should describe the effects of the qualification on the supplemental information in the
report on supplemental information and should express a qualified opinion on the
supplemental information.
 b. When the auditor expresses an adverse opinion, or disclaims an opinion on the
financial statements, the auditor should express an adverse opinion, or disclaim an
opinion, on the supplemental information, whichever is appropriate.
Reporting
10. The auditor's report on supplemental information accompanying audited financial
statements should include the following:
a. Identification of the supplemental information.
Note: Identification may be by descriptive title of the supplemental information or
reference to the page number and document where the supplemental information is
located.
b. A statement that the supplemental information is the responsibility of management.
c. A statement that the supplemental information has been subjected to audit
procedures performed in conjunction with the audit of the financial statements.
Note: If the financial statements are presented in a separate document from the
supplemental information or otherwise are not readily identifiable to the user of the
supplemental information, the auditor's report on supplemental information should
identify the document containing the company's financial statements.
d. A statement that the audit procedures performed included determining whether the
supplemental information reconciles to the financial statements or the underlying
accounting and other records, as applicable, and performing procedures to test the
completeness and accuracy of the information presented in the supplemental
information.
e. A statement that in forming the auditor's opinion, the auditor evaluated whether
supplemental information, including its form and content, complies, in all material
respects, with the specified regulatory requirements or other criteria, if applicable.
f. A statement, if applicable, that the supplemental information is presented on a basis
that differs from the financial statements and is not prescribed by regulatory
requirements. When such a statement is made, the report should describe the basis
for the supplemental information presentation.
g. An opinion on whether the supplemental information is fairly stated, in all material
respects, in relation to the financial statements as a whole, or a disclaimer of opinion.
11. Unless prescribed by regulatory requirements, the auditor may either include the
auditor's report on the supplemental information in the auditor's report on the financial
statements or issue a separate report on the supplemental information. If the auditor issues
a separate report on the supplemental information, that report should identify the auditor's
report on the financial statements.
12. The date of the auditor's report on the supplemental information in relation to the
financial statements as a whole should not be earlier than:
a. The date of the auditor's report on the financial statements from which the
supplemental information was derived, and
 b. The date on which the auditor obtained sufficient appropriate audit evidence to
support the auditor's opinion on the supplemental information in relation to the
financial statements as a whole.8/
13. The following is an example of an auditor's report on supplemental information when
included in the auditor's report on the financial statements:
The [identify supplemental information] has been subjected to audit procedures performed
in conjunction with the audit of [Company's] financial statements. The [supplemental
information] is the responsibility of the Company's management. Our audit procedures
included determining whether the [supplemental information] reconciles to the financial
statements or the underlying accounting and other records, as applicable, and performing
procedures to test the completeness and accuracy of the information presented in the
[supplemental information]. In forming our opinion on the [supplemental information], we
evaluated whether the [supplemental information], including its form and content, is
presented in conformity with [specify the relevant regulatory requirement or other criteria,
if any]. In our opinion, the [identify supplemental information] is fairly stated, in all material
respects, in relation to the financial statements as a whole.
14. If the auditor determines that the supplemental information is materially misstated in
relation to the financial statements as a whole, the auditor should describe the material
misstatement in the auditor's report on the supplemental information and express a
qualified or adverse opinion on the supplemental information.
15. If the auditor is unable to obtain sufficient appropriate audit evidence to support an
opinion on the supplemental information, the auditor should disclaim an opinion on the
supplemental information. In those situations, the auditor's report on the supplemental
information should describe the reason for the disclaimer and state that the auditor is unable
to and does not express an opinion on the supplemental information.
Note: If the supplemental information consists of two or more schedules, and the auditor is
able to obtain sufficient appropriate audit evidence to support an opinion on some but not
all schedules, the auditor may express an opinion on only those schedules for which he or
she obtained sufficient appropriate evidence but should disclaim an opinion on the other
schedules.
1/Terms defined in Appendix A, Definitions, are set in boldface type the first time they

appear.
2/For purposes of this standard, supplemental information "accompanies financial

statements" when it is (1) presented in the same document as the audited financial
statements, (2) presented in a document in which the audited financial statements are
incorporated by reference, or (3) incorporated by reference in a document containing the
audited financial statements.
3/Auditing Standard No. 11, Consideration of Materiality in Planning and Performing an Audit,

establishes requirements regarding the auditor's consideration of materiality in planning

and performing an audit.
4/The term "affiliates of the firm" as used in this standard has the same meaning as the term
"affiliates of the accounting firm" as defined in PCAOB Rule 3501.
5/See Attestation Standard No. 1, Examination Engagements Regarding Compliance Reports of

Brokers and Dealers, and Attestation Standard No. 2, Review Engagements Regarding
Exemption Reports of Brokers and Dealers.
6/ See paragraph 10 of Auditing Standard No. 14, Evaluating Audit Results, which discusses

the auditor's responsibilities regarding the accumulation of misstatements in an audit of

financial statements.
7/See paragraph 17 of Auditing Standard No. 14, which discusses evaluation of uncorrected

misstatements in the financial statement audit.

8/AU sec. 561, Subsequent Discovery of Facts Existing at the Date of the Auditor's Report, sets

forth procedures to be followed by the auditor who, subsequent to the date of the report
upon audited financial statements becomes aware that facts may have existed at that date
that might have affected the report had he or she then been aware of such facts. AU sec. 561
applies to situations in which the auditor identifies a material misstatement of the financial
statements while performing audit procedures on supplemental information after the date
of the auditor's report on the financial statements.

What is Director’s Report? Contents, Purpose & Benefits

The directors of a company are responsible for its management and are accountable to the
shareholders. The director's report is prepared by the board of directors and presented to
the shareholders at the annual general meeting. It provides an overview of the company’s
performance and activities during the year. The director’s report must include a statement
of the directors’ responsibilities regarding the financial statements and the report of the
auditors. It must also contain a statement of the directors’ opinion on the current concern
basis of the company. The director's report is prepared under the Companies Act and its
regulations. It must be signed by at least two directors, including the chairman or the
managing director.
Did you know?
According to the Companies Act, 2013 every board of directors of a company has to
attach the reports to its financial statements to be given before the members of the
company at the annual meeting.
What is the Director's Report of the Company?
A directors' report is a report written by the directors of a company that outlines the
company's activities over a period, typically one year. It is a requirement for companies to
include a directors' report as part of their annual reports and accounts. The directors' report
usually contains several sections, including a review of the year, a discussion of the
company's financial performance, and an overview of the company's future. The director's
report is a document that is required to be filed with the annual report of a company. The
report includes information on the company's activities during the year, as well as the names
of the directors and officers of the company.
Contents of Director’s Report
The contents of the director's report are as follows: ·

 A statement about the directors’ responsibilities regarding the financial statements

and the report of the auditors
 A statement of the directors’ opinion on the current concern basis of the company
 An overview of the company’s performance and activities during the year
 A description of the principal risks and uncertainties faced by the company
 A review of the company’s financial position and prospects
 A statement of the amount of any remuneration and benefits paid or accrued to the
directors during the year
 The names of the directors who served on the board during the year
 Change in share capital
 Particulars of related party transactions in Form AOC-2
 Comments by the board for remarks given by the auditors in audit reports.
The directors’ report must be approved by the board of directors before it is included in the
company’s annual report. The directors’ report is addressed to the shareholders of the
company. It should be noted that the directors’ report is a public document and is available
to any person who requests it from the company.
Responsibility of the Director of the Company
The director of the company is responsible for the overall management and operations of
the company. This includes the development and implementation of the company's business
strategy, as well as the day-to-day running of the business. The director is also responsible
for ensuring that the company complies with all relevant laws and regulations. The
company's director ensures that the company complies with all applicable laws and
regulations, and the financial statements are accurate and complete. The director carries out
the company's operations safely and efficiently and looks for employees to be treated fairly
and with respect.
Purpose of the Directors' Report
The directors' report is a report prepared by the directors of a company and presented to
the shareholders at the annual general meeting. It is a requirement under the Companies Act,
2013. This statement of affairs gives an overview of the company's financial position and
performance for the year. The director's report includes information on the company's
business activities and results, and the corporate governance report provides information
on the company's compliance with the corporate governance code of conduct.
It is one of the most important parts of a company's annual report that provides shareholders
with information about the company's performance and prospects and allows directors to
explain the company's strategy and future.
The report is also a chance for directors to communicate with shareholders on a more
personal level, and to address any concerns they may have. The director's report must
include a fair review of the company's business and affairs and must disclose any material
information that would be relevant to shareholders' decision-making. It should also explain
the company's dividend policy and provide an update on any significant changes to the
business in the last annual report.
Benefits of a Director's Report
The benefits of a director's report are many and varied but can be broadly summarised as
follows:

 It provides a clear and concise overview of the company's activities and performance
over a given period.
 It helps to improve communication between the board of directors and
shareholders.
 It can help to identify any potential problems or areas of concern within the
company.
 It can help to build shareholder confidence in the company and its management.
 It can be used to highlight any potential risks to the company's future success.
 It can help to improve communication between the board and shareholders.
 It can provide an opportunity for the board to explain its strategy and plans.
 It can give shareholders and other interested parties an insight into the company's
performance and progress.
 It can help to build confidence in the company and its management.
 It can help to identify any potential risks or problems that the company may be
facing.
 It can provide a record of the board's decisions and actions.
The Director's Report and the Company's Future
The Director's Report is an annual report compiled by the Board of Directors of a company.
It is a public report that outlines the company's financial situation and performance over the
past year, as well as the company's plans for the future. A report is a valuable tool for
investors, as it provides insight into the company's strategy and how well it is executing its
plans. It also helps to assess the risks of investing in the company.
The future of the company depends on its ability to execute its plans and generate profits.
The company's plans for the future should be outlined in the director's report. Investors will
want to see that the company has a solid plan in place to continue to grow and be profitable.
If the company does not have a strong plan for the future, it may not be able to attract the
investments it needs to stay afloat.
Preparation of the Director's Report
The Director's Report is typically prepared on an annual basis but may be prepared more
frequently if deemed necessary by the Board of Directors. The report should include a
summary of the company's financial position, a discussion of any significant changes or
trends in the business, and an overview of the company's operations and prospects for the
future.
Conclusion
The director's report contains information about the company’s management and
performance and is required to be submitted to shareholders annually. The report should
provide an overview of the company’s business activities, its financial performance and
position, and any material changes in corporate governance. It should also explain how the
company’s affairs are being managed and identify any potential risks that could affect the
company’s future performance.
Responsibilities & disclosure requirements. Ensuring transparency,
integrity, reputation, accountability for a sustainable businesses
INTRODUCTION
Every company wants to observe basic principles of good corporate governance for
performing efficiently and to increase their valuation in the market. A good corporate can
easily attract capital, foreign investment, investors’ trust and confidence and also takes
advantages somewhere in vibrant stock market. Corporate governance are code of
business conduct and ethics which would greatly benefit the companies enabling them to
thrive and prosper.
NEED FOR CORPORATE GOVERNANCE
Separation of Management from Owners: In most of the companies, promoters who are
holding major shares are holding key positions in the management of the company. They
have effective control of the management. Management should be separated from owners,
so it can be impartial, independent and focus on creating stakeholders friendly policies and
aims to protect their rights.
1. Bridge the gap by and between Producer and Consumers: Management should
identify that society is giving resources for production of end product of the company
and they have to sell that end product again to that society. It is pertinent to understand
that any kind of anonymity between the producer and ultimate consumer should not be
ignored.
2. Responsibility towards Stakeholders: It is most important that companies should
work in the best interest of the stakeholders at every time and maximize the value of
every resource invested by the stakeholders in the company. Stakeholders are broadly
defined as:
INTERNAL: Shareholders, Employees
EXTERNAL: Consumer, Supplier, Government, Community
RESPONSIBILITIES TOWARDS STAKEHOLDERS
SHAREHOLDERS
 Shareholders are the real owners of the company as they contribute towards creating and
growing it with their money against number of shares.
Management’s responsibilities towards them
 Maximize Return on Investment
 Appropriate representation of shareholders in board
 Redressal of grievances of investors
EMPLOYEES
Most important assets of any organization. They led to a successful enterprise from
average.
Management’s responsibilities towards them
 Payment of Wages
 Participation in Profits
 Participation in decision-making
 Participation in Equity shares via ESOPs, Sweat Equity shares, bonus shares
 Safety, Hygiene & working condition
 Opportunity of growth

CONSUMERS
 Offering Right product at right time at right place at right price
 Offering quality & value for the money
 Maximum Information of Product & service, enabling them to make right buying
decision
 After sale Service / Grievance Redressal
COMMUNITY
 Payback for what you take; Clean and Green practices for controlling the pollution
 Payment to creditors, suppliers within time
 Following Fair trade practices
 Corporate Social Responsibility
 Investment towards sustainable business
GOVERNMENT
 Payment of taxes on time, fairly and honestly
 Following Anti-Corruption practices while liaisoning with public servants
 Participate in Government sponsored industry forums; provide policy & industry related
feedbacks
ROLES AND RESPONSIBILITIES OF BOARD OF DIRECTORS
Board of directors are appointed as trustees, to act in best interest on behalf of
stakeholders and to run day to day operations of the company. Good governance requires
that performance of board shall be evaluated at least once in a year. The evaluation process
is constructive mechanism for improving board’s effectiveness, maximizing strengths and
tackling weakness.
1. To act within the scope of powers conferred by the Companies Act and Memorandum
and Articles of Association.
2. In the best conduct and management of the business
3. Formulation and Execution of Corporate Strategy, Business plan, Budget, major Capital
Expenditures, mergers and acquisitions, etc.
4. Formulation of Succession planning
5. Monitoring managerial performance, conflict of interest of management, board
members.
6. Assuring Return on Investment
7. Corporate Social Responsibilities
8. Compliance with Laws and regulations
9. Adequate financial reporting and ensure adequate internal financial controls
10. To develop policies and procedures
CORPORATE GOVERNANCE THROUGH DISCLOSURES
Financial Reporting & disclosures
These are generally influenced by the regulatory requirements prescribed by various
statues.
1. Companies Act, 2013
 The format of Balance sheet, P&L must be in accordance to Schedule III of the act
 The financial statement must be approved by BoDs & signed by at least two directors
 The financial statements shall be filed to the concerned Registrar of Companies.
2. Reserve Bank of India (RBI)
 The financial statement of banking companies shall be conformity with Banking
Regulations
 The format of Balance sheet and Profit & Loss Statement to be followed by the
banking companies has been prescribed by the Banking Regulations
3. Insurance Regulatory and Development Authority (IRDA)
 The financial statement of Insurance companies must be in conformity with IRDA
Regulations
 A Receipts and Payments Account is also required to be prepared.
4. Securities and Exchange Board of India (SEBI) for listed companies
 Prepare consolidated statements in addition to Individual financial statements
 Disclose their quarterly results in format prescribed by SEBI
 The quarterly statement shall be audited one or may limited review by the auditors
OTHER DISCLOSURES
ANNUAL REPORT UNDER COMPANIES ACT, 2013
 Chairman’s Statement
 Key Financial and non-financial indicators
 Management discussion and Analysis report
 Directors' Report
 Secretarial Audit Report
 Corporate Governance Audit Report
 Business Responsibility Report
 Segment Reporting
 Human Resource Disclosure
 Auditors' Report
 Financial Statements
 Related Party Disclosures
 Joint Ventures Details
 Contingent Liability Disclosure
DISCLOSURES UNDER SEBI REGULATIONS
 BoD of listed entity shall authorize one or more KMPs to determine materiality of an
event or information and for the purpose of making disclosures to stock exchange(s)
 Disclosure of Shareholding Pattern
 Corporate Governance Disclosure
 Financial Statement Disclosure
 Fair Disclosure of Unpublished Price Sensitive Information
 Trading by Promoters
 Encumbrance of Shares by Promoters
 Share re- reconciliation audit report
 Transfer & Transmission of Shares Certificate
 Fraud/Default Reporting and Disclosure
 Other disclosures

Audit Committees
The Financial Reporting Council’s Guidance on Audit Committees (‘Guidance’) is designed to
assist company boards in making suitable arrangements for their audit committees, and to
assist directors serving on audit committees in carrying out their role. It is intended to assist
Boards when implementing the relevant provisions of the UK Corporate Governance Code.
Premium listed companies are required by the Listing Rules to state the extent to which they
comply with the Code whilst unlisted companies may voluntarily do so and by extension
follow the Guidance. The most recent version of the Guidance on Audit Committees was pub-
lished in June 2016.
The Guidance provides recommendations on the audit committee’s establishment and ef-
fectiveness, relationship with the board, role and responsibilities and communications with
shareholders.
In May 2023 the Financial Reporting Council (FRC) issued a minimum standard for audit
committees in relation to their oversight responsibilities for the external audit. The FRC has
also issued a consultation on revisions to the UK Corporate Governance Code. The Guidance
on Audit Committees will be updated so that it can be aligned with the revised Code and
Audit Committee Standard.
Establishment and Effectiveness of the audit committee
There should be at least two independent non-executive directors if below the FTSE 350
index or at least three members if above. The chairman should not be a member of FTSE 350
audit committees. At least one member should have recent and relevant financial experience.
The UK Corporate Governance Code states that the audit committee as a whole should have
competence relevant to the sector in which the company operates. The role and responsibil-
ities should be set out in written terms of reference. Meetings should be held as often as
required but there should be no fewer than three for each financial year. The audit commit-
tee and board should review annually the effectiveness of the audit committee. The audit
committee should report on the number of audit committee meetings in the audit committee
report.
The size, skills, experience and balance of the audit committee should be adequate to deal
with the complexity and risk of the business and its industry. The management of the
company should provide all necessary information, training and support to enable the audit
committee to play its role successfully. The remuneration package should be consistent with
the level of work and expertise required from the audit committee.
Relationship with the Board
As a sub-committee of the board, the role of the audit committee is defined by the board. The
audit committee performs its work on behalf of and should report how it has performed its
role and its findings to the board. If any risk management and internal control responsibilit-
ies are delegated to different committees the board should consider the impact of splitting
those responsibilities.
Role and Responsibilities
The audit committee will have oversight of financial reporting matters, the workings of both
internal and external auditors, and procedures for whistleblowing, internal controls and risk
management systems. The board has ultimate responsibility for organisation’s risk manage-
ment and internal control systems, but the board may delegate to the audit committee some
functions to assist the board in meeting this responsibility.
Any financial report that requires board approval should be reviewed by the audit commit-
tee. Except to the extent that this is expressly dealt with by the board or risk committee, the
audit committee should review and recommend to the board the disclosures included in the
annual report in relation to internal control, risk management and the viability statement.
If delegated this responsibility by the board, the audit committee should review the annual
report to determine whether, taken as a whole, it is fair, balanced and understandable and
 provides the information necessary for shareholders to assess the company’s position and
performance, business model and strategy.
Communications with Shareholders
The Guidance recommends that the audit committee should report in a separate section,
signed by its chairman, about its work. This is both to highlight its role and to confer author-
ity without usurping the role of the board.
When following the Guidance, the audit committee must always be mindful that, through
open dialogue and fostering excellent working relationships with stakeholders, its role can
be performed effectively. The chairman of the audit committee should be present at the AGM
to answer questions on the separate section of the annual report describing the audit com-
mittee’s activities and matters within the scope of the audit committee’s responsibilities.
Disclosure
Additional disclosure recommendations in the audit committee report include:
o how the audit committee composition requirements have been addressed;
o how the performance evaluation of the audit committee has been conducted;
o the current external audit partner's name and for how long the partner has held the role;
o advance notice of any plans for retendering of the external audit;
o the committee's policy for approval of non-audit services;
o the audit fees for the statutory audit of the company's consolidated financial statements
and the fees paid to the auditor and its network firms for audit related services and other
non-audit services, including the ratio of audit to non-audit work;
o for each significant engagement, or category of engagements, an explanation of the services
provided and why the audit committee concluded that it was in the interests of the
company to purchase them from the external auditor;
o an explanation of how the committee has assessed the effectiveness of internal audit and
satisfied itself that the quality, experience and expertise of the function is appropriate for
the business;
o the nature and extent of interaction (if any) with the FRC's Corporate Reporting Review
team; and
o When a company's audit has been reviewed by the FRC's Audit Quality Review team, dis-
closures about significant findings and the resulting actions they and the auditors plan to
take. This disclosure should not include the audit quality category awarded.
Remuneration Committees
The key objectives of establishing a remuneration committee are to assist the Board of
Directors to maintain a formal and transparent procedure for setting policy on directors'
remuneration and to determine an appropriate remuneration packages for all directors. The
Remuneration Committee should ensure that remuneration arrangements support the
strategic aims of the business and enable the recruitment, motivation and retention of senior
executives while complying with all rules and regulations.
Remuneration Committee Structure
In Hong Kong, all listed companies must establish a remuneration committee chaired by an
independent non-executive director and comprising a majority of independent non-
executive directors.
The work of the Remuneration Committee
The Stock Exchange of Hong Kong has set out principles and recommendations for effective
remuneration committee practices in Section B of the Corporate Governance Code and
Corporate Governance Report. Listed companies should develop a written terms of reference
to properly document the roles and responsibilities of remuneration committees and the
authority delegated to them by the Board of Directors.
Determination of Directors' and Senior Management's Remuneration
The remuneration committee of a listed company is responsible for making
recommendations to the board on policy and structure for all remuneration of directors and
senior management and on the establishment of a formal and transparent procedure for
developing this policy. It is also responsible for determining specific remuneration packages
for executive directors and senior management, including compensation payments and
benefits in kind. It should also make recommendations to the board of directors for the
remuneration of non-executive directors as well. When considering remuneration structure
and policy, it should consider salaries paid by comparable companies and responsibilities of
directors and it should have access to professional advice, if necessary. It is important to
ensure that no director or any of his associates is involved in deciding his own remuneration.
In addition, Remuneration Committee should be delegated with the authority to review and
approve the following:
 Management’s remuneration proposals with reference to the board’s corporate goals
and objectives;
 Compensation payable to Executive Directors and senior management in connection
with any loss or termination of office or appointment; and
 Compensation arrangements relating to dismissal or removal of directors for
misconduct.
Directors' Remuneration Disclosure
Disclosure requirements for director remuneration are stipulated in the Hong Kong listing
rules. Listed companies are required to disclose in their annual reports all details of current
and past directors’ pay, including:
 Director fees for the financial year;
 Director basic salaries, housing allowance, other allowance and benefits in kind;
 Contributions to pension schemes for directors;
 Bonuses paid or receivable by directors;
 Amounts paid or receivable as an inducement to join or upon joining the listed company;
and
 Compensation paid or receivable for loss of office.
Directors' Remuneration Disclosure - Committee Practices
In addition to the above requirements, Section L of Corporate Governance Code and
Corporate Governance Report also stipulates the disclosure requirements for remuneration
committee practices in the Corporate Governance Report. Such disclosure includes
information relating to directors' remuneration policy:
 Role and function of the remuneration committee;
 Composition of the remuneration committee;
 Number of meetings of the remuneration committee and record of attendance of its
members; and
 Summary of work performed by the remuneration committee, including determining
the remuneration policy, assessing performance, and approving the terms of service
contracts for executive directors.
CONTENTS AND PROCEDURE OF AGM
https://www.aviva.com/investors/shareholder-meetings-and-archive/

Unit III: Elements of Financial Statements

AS-2: Valuation of Inventories
This accounting standard is applicable to all companies irrespective of their level (Level I, II
and III). This standard prescribes the accounting treatment for inventories and sets the
guidelines to determine the value at which the inventories are carried in the financial
statements.
It explains the different methods of accounting the inventory or closing stock which has a
huge impact on the business revenue and the assets. Topics discussed in this article: In this
article, we cover the following topics:
Valuation of Inventories
This Standard should be applied in accounting for all inventories except the following: (a)
work in progress in the construction business, including directly related service contracts
(b) work in progress of service business (consulting, banking etc) (c) shares, debentures and
other financial instruments held as stock in trade (d) Inventories like livestock, agricultural
and forest products, mineral oils etc. These inventories are valued at net realizable value
Definition
I. Definition of the Inventory includes the following:
A. Held for sale in the normal course of business i.e finished goods
B. Goods which are in the production process i.e work in progress
C. Raw materials which are consumed during production process or rendering of services
(including consumable stores item)
II. Net Realizable Value (NRV):
“Net realizable value is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale”
Valuation of Inventories
 Inventories should be valued at lower cost and net realizable value. Following are the steps
for valuation of inventories: A. Determine the cost of inventories B. Determine the net
realizable value of inventories C. On Comparison between the cost and net realizable value,
the lower of the two is considered as the value of inventory.
A comparison can be made the item by item or by the group of items. (Refer Case studies
given at the end of the article)
Let’s discuss the important items of Inventory valuation in detail:
A. Cost of Inventories the cost of inventories includes the following
 Purchase cost
 Conversion cost
 Other costs which are incurred in bringing the inventories to their present location and
condition.
B. Cost of Purchase While determining the purchase cost, the following should be
considered:
 Purchase cost of the inventory includes duties and taxes (except those which are
subsequently recoverable from the taxing authorities)
 Freight inwards
 Other expenditure which is directly attributable to the purchase
 Trade discounts, rebates, duty drawbacks and other similar items are deducted in
determining the costs of purchase
C. Cost of Conversion Cost of conversion includes all cost incurred during the production
process to complete the raw materials into finished goods. Cost of conversion also includes
a systematic allocation of fixed and variable overheads incurred by the enterprise during the
production process.
Following are the categories of conversion cost:
I. Direct Cost
All the cost directly related to the unit of production such as direct labor
II. Fixed Overhead Cost
Fixed overheads are those indirect costs which are incurred by the enterprise irrespective
of production volume. These are the cost that remains relatively constant regardless of the
volume of production, such as depreciation, building maintenance cost, administration cost
etc.
The allocation of fixed production overheads is based on the normal capacity of the
production facilities. In case of low production or idle plant allocation of these fixed
overheads are not increased consequently.
III. Variable Overhead Cost
Variable overheads are those indirect costs of production that vary directly with the volume
of production. These are the cost that will be incurred based on the actual production volume
such as packing materials and indirect labor.
 D. Other Cost
All the other cost which are incurred in bringing the inventories to the current location and
condition. For (eg) design cost which is incurred for the specific customer order. If there are
by-products during the production of main products, their cost has to be separately
identified. If they are not separately identifiable, then allocation can be made on the relative
sale value of the main product and the by-product. Some of the cost which should not be
included are:
a. Cost of any abnormal waste materials cost
b. Selling and distribution cost unless those costs are necessary for the production process
c. A normal loss which occurs during the production process is apportioned over the
remaining no of units and abnormal loss is treated as an expense
(Refer Case studies given at the end of the article)
Methods of Inventory Valuation
The cost of inventories of items which can be segregated for specific projects should be
assigned by specific identification of their individual costs (Specific identification method).
All other items cost should be assigned by using the first-in, first-out (FIFO), or weighted
average cost (WAC) formula. The formula used should reflect the fairest possible
approximation to the cost incurred in bringing the items of inventory to their present
location and condition.
However, when it is difficult to calculate the cost using above methods, Standard cost and
Retail cost can be used if the results approximate the actual cost.
Accounting Disclosure
The following should be disclosed in the financial statements:
 Accounting policy adopted in inventory measurement
 Cost formula used
 Classification of the inventory such as finished goods, raw material & WIP and stores
and spares etc.
 Carrying amount of inventories carried at fair value less sale cost
 Amount of inventories recognized as expense during the period
 Amount of any write-down of inventories recognized as an expense and its subsequent
reversal if any.
Comparison between AS 2 and ICDS

Sl.
Particulars AS 2 ICDS
No

Standard Cost and Standard Cost method is not

1 Methods of Valuation
Retail cost methods allowed to be used
 are allowed if it’s close
to actual cost

Allowed if it provides
Change in method of Not allowed unless there is a
2 more appropriate
valuation reasonable cause
presentation

Shall be the cost of inventory

Opening Inventory of Value of opening
3 available on the day of
New Business inventory should be “Nil”
commencement of business

Given below are some of the key differences between As 2 and Income Computation and
Disclosure Standards (ICDS):
Some of the Major Differences between Ind AS (IAS) and AS 2
 Scope of AS 2 does not deal with the inventory treatment related to Service Providers
whereas IAS 2 details the treatment related to the cost of inventories of Service
Providers
 AS 2 requires lesser disclosure in the financial statements when compared to IAS 2
 Cost of Inventories does not include “selling and distribution costs” under AS 2 and it
is expensed in the period in which they are incurred whereas IAS 2 specifically
excludes only “Selling Costs” and not “Distribution Costs”.
 AS 2 requires the inventory value of goods which cannot be segregated for specific
projects should be assigned using FIFO or WAC whereas IAS requires the same
formula to be used for all the inventories with similar nature.
AS 9 Revenue Recognition
As per the AS 9 Revenue Recognition issued by ICAI “Revenue is the gross inflow of cash,
receivables or other consideration arising in the course of the ordinary activities of an
enterprise from the sale of goods, rendering of services & from various other sources like
interest, royalties & dividends”.

Introduction of AS 9 Revenue Recognition

Revenue has to be measured by the amount charged to the clients for the sale of goods and
services. However, in the case of the agency relationship, the revenue has to be measured by
the amount charged for commission and not on the gross inflow of the cash, receivables or
other consideration. There are few exceptions to the above-mentioned statement where the
special consideration applies: –
 Revenue arising from Construction Contracts

 Revenue arising from hire-purchase, lease agreements

 Revenue arising from government grants and other similar subsidies
 Revenue of Insurance companies arising from insurance contracts

Applicability of AS 9 Revenue Recognition

This standard was issued by ICAI in the year 1985 and in the initial years, it was re-
commendatory for only Level I enterprises and but was made mandatory for all other
enterprises from April 01, 1993.
As per ICAI, “Enterprise means a company as defined in section 3 of the Companies Act,
1956”.
Level I enterprises are those enterprises whose turnover for the immediately preceding
accounting year exceeds 50 crores. The turnover here does not include other income and is
applicable for holding as well as subsidiary companies.
Explanation
 Revenue recognition emphasizes on the timing of recognition of revenue in the
statement of profit and loss of an enterprise
 The amount of revenue arising from a transaction is usually determined by an
agreement between the parties involved in the transaction
 When uncertainties arise regarding the determination of the amount or its associated
costs, these uncertainties may influence the timing of the revenue

Sale of Goods
One key element for determining the recognition of revenue of a transaction involving the
sale of goods is that the seller has transferred the property in the goods to the buyer for a
consideration. In most cases, the transfer of property in the goods results in the transfer of
the significant risks and rewards in ownership of the goods.
However, there are situations where the transfer of significant risks doesn’t coincide with
the transfer of goods to the buyer, in such cases revenue has to be recognized at the time of
transfer of significant risks and rewards to the buyer.
Example: Goods sent to the consignee on approval basis. There are certain cases in the
specific industry where the performance may be substantially complete prior to the
execution of the transaction generating revenue. In such cases, when the sale is assured
under government guarantee or a forward contract or where the market exists and there is
a negligible risk of failure to sell, the goods involved are often valued at the net realizable
value (NRV).
Such amounts are not defined in the definition of the revenue but are still sometimes
recognized in the statement of profit and loss. Example: Harvesting of Agricultural Crops or
extraction of mineral ores.

Rendering of Services
Revenue recognition of services depends as the service is performed. This is further divided
into two ways:
 Proportionate Completion Method: This method of accounting recognizes revenue
in the statement of profit & loss proportionately with the degree of completion of each
service. Here the service completion consists of the execution of more than one act.
Revenue is recognized with the completion of each such act.
 Completed Service Contract Method: This method of accounting recognizes revenue
in the statement of profit & loss only when the rendering of services under a contract
is completed or substantially completed.
Interest, royalties & dividends
The use by others of such enterprise resources gives rise to:
 Interest: Revenue is recognized on the time proportion basis after taking into account
the amount outstanding and the rate applicable. For Example: If the interest on FD is
due on 30th June and 31st Dec. On 31st March when the books will be closed, though
the interest for the period of Jan-March will be received in June, still we have to
recognize the revenue in March itself.

 Royalties: Royalty includes the charge for the use of patents, know-how, trademarks,
and copyrights. Revenue has to be recognized on the basis of accrual basis and in
accordance with the relevant agreement. For Example: If the royalty is payable based
on the number of copies of the book, then it has to be recognized on that basis only.
 Dividends: Revenue has to be recognized when the owner’s right to receive payment
is established. It is only certain when the company declare the dividends on the shares
and the directors actually decide to pay the dividends to their shareholders.

Difference between IND AS -18 & AS -9

AS 9 Revenue Recognition IND AS 18

It is recognized at nominal value It is recognized at fair value

IND AS – 18 also includes the exchange of goods

and services with goods and services of similar
This aspect is not covered in AS-9
and dissimilar nature (Barter Transactions are
included in Ind AS-18)

Interest Income is recognized on Interest Income is recognized using effective

time proportion basis interest rate method
 It recognizes revenue as per
It only recognizes revenue as per percentage of
completed service method or
completion method
percentage completion method

AS-10: Accounting for Fixed Assets

AS 10 Property, Plant, and Equipment prescribes the accounting treatment for properties,
P&E (Plant and Equipment) so that financial statement consumers can recognize and
appreciate information about any enterprise’s property, P&E investment, as well as
understanding changes in such investments. It’s also worth noting that AS 6 – Accounting
for Depreciation has been withdrawn, and all depreciation-related issues are now covered
under AS 10.
Applicability of AS 10 Property, Plant, and Equipment
AS 10 is used to account for property, P&E (Plant and Equipment), and this standard
does not apply to the following items:
(a) Biological assets associated with agricultural activities, with the exception of bearer
plants. The Standard applies to bearer plants, but not to the products produced by bearer
plants; and
(b) Mineral rights, expenses associated to the exploration for and extraction of oil, minerals,
natural gas, and other non-regenerative resources are examples of wasting assets.
Recognized Assets under AS 10 Property, Plant, and Equipment.
The cost of property and P& E shall only be recognized if:
(i) It is clear that future economic advantages connected to such assets will flow to the firm;
and
(ii) The cost of such asset can be reliably determined could the cost of such asset be
recognized as an asset.
Measurement of cost of the asset
An organization’s accounting policy can be either the revaluation model or the cost model,
and it can be applied to the complete class of its properties and P&E. After recognizing the
asset as a piece of property or plant and equipment, it should be carried at cost less
accumulated depreciation and accumulated impairment losses, according to the cost model
(if any).
According to the revaluation model, once an asset is identified and its fair value can be
reliably established, it must be carried at the revalued amount, which is the fair value of the
asset at the revaluation date less any cumulative depreciation and accumulated impairment
losses (if any). Revaluations must be performed at regular intervals to ensure that the
carrying amount does not fluctuate significantly from the fair value at the balance sheet date.
Depreciation under AS 10 Property, Plant, and Equipment
 Depreciation charges must be recorded in the P/L Statement for each period unless
they are included in the carrying amount of another asset, according to the
standard. Any asset’s depreciable value should be distributed in a systematic
manner over the asset’s useful life.
 Every piece of property or P&E (Plant and Equipment) whose cost is significant in
comparison to the item’s overall cost must be depreciated separately.
The standard also states that at the end of each financial year, the residual value and useful
life of an asset must be reviewed, and if the expectations differ from previous estimates, the
differences must be accounted for as changes in accounting estimates under Accounting
Standard 5 – Net Profit or Loss for the Period, Prior Period Items, and Changes in Accounting
Policies. The method of depreciation used must be consistent with the pattern of future
economic benefits of the asset consumed by the business. For allocating the depreciable
amount of an asset on a systematic basis over the asset’s useful life, various depreciation
procedures could be utilised.

AS 22 Accounting for Taxes on Income

Profits as per your financial statements rarely match with your taxable profits. And it would
be incorrect to ignore to account for the difference between these two profits. To govern the
accounting for such differences, we cover the following topics in this article w.r.t. AS 22
Accounting for Taxes on Income:
Introduction – Accounting Standard
Accounting Standard 22 has been prescribed by ICAI to be applied in accounting for taxes on
income. This AS is applied to match the differences between accounting income and taxable
income. 1. Accounting income is the net profit before tax for a period, as reported in the profit
and loss statement. 2. Taxable income is the income on which income tax is payable,
computed by applying provisions of the Income Tax Act, 1961 & Rules.
Types of differences and why they appear
The differences can be of two types:
Timing difference
Timing differences are those differences between accounting income and taxable income
which can be reversed in one or more subsequent periods. For example, Depreciation
allowed as per WDV method for computing taxable income and as per SLM method for
computing accounting income.
Permanent difference
Permanent differences are those differences between accounting income and taxable income
which cannot be reversed any subsequent period. For example, Donation paid in cash is
disallowed in computing taxable income whereas it is allowed as expenditure while
computing accounting income. There can be differences between accounting income and
taxable income because of the following reasons:
1. Expenses debited in profit and loss statement, but disallowed as per Income Tax Act 1961,
while computing taxable income
2. Provision for Bad/doubtful debts allowed while computing accounting income, but
disallowed while computing taxable income
3. Charging depreciation using different rates as per Companies Act 2013 and Income Tax
Act 1961
4. Any income recognized on an accrual basis in profit and loss statement but recognized on
receipt basis in subsequent period for computing taxable income. In order to account for
these kinds of differences, AS 22 needs to be applied.
When to apply AS 22 Accounting for Taxes on Income
AS 22 needs to be applied when there are differences between taxable income and
accounting income. If taxable income is greater than accounting income, then it will result in
deferred tax asset. And if accounting income is greater than taxable income, then it will result
in deferred tax liability.
When the difference is resulting in deferred tax asset, then it should be recognized only when
there is a reasonable certainty of its realization. The recognition of deferred tax asset should
be to the extent of the reasonable certainty of the expected realization. The reasonable
certainty can be determined by making the realistic estimates of future profits based on the
examination of profits and loss statement of earlier periods.
Say, an entity has unabsorbed depreciation or carry forward of losses. In such a case,
deferred tax asset should be recognized to the extent there is a virtual certainty supported
by convincing evidence. Virtual certainty is a matter of judgment of convincing evidence,
which should be available in a concrete form at a particular date.
How to apply AS 22 Accounting for Taxes on Income
The application of AS 22 can be explained with the help of examples:
Example of timing difference:

Particulars Year 1 Year 2 Year 3

Profit before tax (A) 100,000 200,000 180,000

Depreciation as per Companies Act (B) 25,000 25,000 25,000

Accounting income (A-B) 75,000 175,000 125,000

 Depreciation as per Income tax Act (C) 50,000 0 10,000

Taxable income (A-C) 50,000 200,000 170,000

Timing difference (D) 25,000 -25,000 -15,000

Current tax @ 30% 15,000 60,000 51,000

Deferred tax (D * 30%) 7,500 -7,500 -4,500

Total tax expense 22,500 52,500 46,500

Profit after tax 52,500 122,500 78,500

Deferred tax computation

Particulars Year 1 Year 2 Year 3

Opening balance of timing

0 25,000 0
difference

Addition 25,000 0 15,000

Deletion 0 25,000 0

Closing balance of timing

25,000 0 15,000
difference
 Deferred tax @ 30% 7,500 7,500 4,500

DTA/DTL Creation of Reversal of DTL Creation

DTL of DTA

P&L A/c Dr. DTL Dr. To P&L DTA Dr.

Journal Entry To P&L
To DTL A/c
A/c

Comparison between AS 22 and IND AS 12

AS 22 Accounting for Taxes on IND AS 12 (Income

Basis
Income taxes)

IND AS 12 recognized
AS 22 recognized tax effect of tax effect of differences
Recognition differences between taxable between assets and/or
income and accounting income. liabilities and their tax
base.

AS 22 is based on profit or loss IND AS 12 is based on

Approach
statement approach. balance sheet approach.

The types of differences

on which IND AS 12 is
applied are taxable
The types of differences on which
temporary differences
AS 22 is applied are timing
Differences and deductible
differences and permanent
temporary differences.
differences.
Permanent differences
are not dealt in by this
standard.

Recognition of
DTA is recognized only when and to
Deferred tax
the extent there is a reasonable
asset/deductible
certainty of its realization
temporary differences
AS 22 deals with the disclosure of
Disclosure
DTA/DTL in the balance sheet.
AS 22 does not cover the difference
arising between taxable incomes
Revaluation of assets
and accounting income due to the
revaluation of assets.
AS 22 does not cover the difference
Goodwill arising due to goodwill arising a
business combination.
Deductible temporary
differences are
recognized to the extent
of the probability of
taxable profits in future
periods.
IND AS 12 deals with the
recognition of current or
deferred tax as income
or expense in profit and
loss statement. It also
deals with the disclosure
of out of profit and loss
transaction in the
balance sheet as current
or non-current
assets/liability.
IND AS 12 deals with the
difference between
carrying the amount of
revalued asset and its tax
base.
As per IND AS 12, the
difference between
carrying the amount of
goodwill and its tax base
(which will be NIL) is the
taxable temporary
difference. It does not
allow the recognition of
such difference because
goodwill is measured as
a residual and its
recognition would
increase the carrying
amount of goodwill.

The concept of virtual
certainty
When an entity has unabsorbed
depreciation or carry forward of
losses then in such a case deferred
tax asset should be to the extent
there is a virtual certainty
supported by convincing evidence.
There is no concept of
virtual certainty in IND
AS 12. Deductible
temporary differences
are recognized to the
extent of the probability
of taxable profits in
future periods.

AS 22 specifically provides
IND AS 12 does not
guidance regarding recognition of
specifically deal with the
Tax holiday deferred tax in the situations of Tax
situations of the tax
Holiday under Sections 80-IA, 80-
holiday.
IB, 10A and 10B of Income-tax Act.

AS 22 provides guidance regarding IND AS 12 does not

Capital Loss recognition of DTA in case of loss specifically provide for
under the head of ‘capital gains’. the same.

Intangible Assets - AS-26

MEANING
An Intangible Asset is an identifiable asset which is non-monetary in nature that has no
physical substance held for use in production or supply of goods or services. They exist in
opposition to tangible assets like plant, machinery, etc and Financial Assets like government
securities, etc.
Some Examples of Intangible Asset are patents, copyright, franchises, goodwill, trademarks,
and trade names, as well as software.
APPLICABILITY OF AS 26
AS 26 comes into effect on or after 01-04-2003. It is mandatory from that date for the
following –
• Enterprises whose equity or debt securities are listed on a recognized stock exchange in
India
• Enterprises that are in the process of issuing equity or debt securities that will be listed on
a recognized stock exchange in India as evidenced by the board of directors' resolution in
this regard.
• All other commercial, industrial and business reporting enterprises, whose turnover for
the accounting period exceeds Rs. 50 crores. In respect of all other enterprises, the
Accounting Standard will come into effect in respect of expenditure incurred on intangible
items during accounting periods commencing on or after 1-4-2004 and will be mandatory in
nature from that date.
EXCLUSIONS FROM AS-26
AS-26 should be applied in accounting to all Intangible assets except- Intangible assets
covered by another Accounting Standard Financial Assets Mineral Rights Expenditure on the
exploration for, or development and extraction of minerals, oil, natural gas and similar non-
regenerative resources and Intangible assets arising in insurance enterprises from contracts
with policyholders.
Recognition and Initial Measurement of Intangible Asset
An intangible asset should be recognized only if: It is probable to expect future economic
benefits from the assets. The cost can be measured reliably.
Measurement Criteria
An Intangible Asset should be recognized initially at cost. The cost of separately acquired
intangible comprises its purchase price paid including duties paid, taxes paid and any other
expenses incurred directly to bring it into usable condition. If acquired in exchange for an
asset, recognize that asset as a fair value of the asset given up.
Internally Generated Intangible Asset
To assess whether an internally generated intangible asset meets the criteria for recognition,
an enterprise classifies the generation of the asset into two phases: a research phase; and a
development phase. Expenditure of the Research Phase Such expenditure is to be charged
off in the statement of profit and loss as an expense as and when incurred. Examples of
research activities are – activities aimed at obtaining new knowledge, the formulation,
design, evaluation and final selection of possible alternatives for new or improved materials,
devices, products, processes, systems or services.
Expenditure on the Development Phase
An intangible asset arising from development phase can be recognized if and only if the
following conditions can be satisfied: The technical feasibility. Intention to complete it.
Ability to sale or use it. Capability to generate economic benefit like the existence of a market
for it or for products generated from it. Availability of technical, financial & other resources
to complete the development. Ability to reliably measure the expenditure during
development. It is important to note that all of the above conditions should be met to permit
recognition of intangible asset in the development phase.
Cost of an internally generated intangible asset includes Expenditure on materials and
services Salaries, wages & other employment-related costs any expenditure that is directly
attributable to the generation of intangible asset Overheads necessary for the generation of
the asset and that can be allocated on a reasonable basis.
Amortization Period
The depreciable amount of an intangible asset should be allocated on a systematic basis over
the best estimate of its useful life. A presumption is taken that the useful life of an intangible
asset will not exceed ten years. In some cases, it may exceed 10 years. As there are frequent
changes in technology, computer software and many others, it is likely that the life of
intangible assets will be short.
Amortization Method
The amortization method used should reflect the pattern in which the asset's economic
benefits are consumed by the enterprise, or else the straight-line method should be used.
The amortization charge for each period should be recognized as an expense unless another
Accounting Standard permits or requires it to be included in the carrying amount of another
asset. For Example, the amortization of intangible assets used in a production process is
included in the carrying amount of inventories.
Residual Value
The residual value of an intangible asset should be assumed to be zero unless: There is a
commitment by a third party or there is an active market for the asset.
Retirements and Disposals
• An intangible asset should be derecognized (eliminated from the balance sheet) on disposal
or when no future economic benefits are expected from its use
• Any gain and loss (the difference between the net disposal proceeds and the carrying
amount of the asset) arising should be recognized as income or expenses in the statement of
P & L.
• An Intangible asset that is retired from active use and held for disposal is carried at its
carrying amount at the date when the asset is retired from active use. At least at each
financial year end, an enterprise tests the asset for impairment under AS-28 on Impairment
of Assets and recognizes any impairment loss accordingly.

AS 19 – Leases
AS-19 deals with the accounting policies applicable for all types of leases except certain listed
below. A lease is an arrangement between the lessor and the lessee that grants the lessee the
right to use an asset in exchange for a payment or series of payments over a predetermined
period of time.
What types of leases are excluded from this standard?
The following items are not covered by this Standard:
(a) Leases for the exploration or use of natural resources. for example Oil, gas, wood, metals,
and other mineral rights
(a) Licensing agreements for example: Films, video recordings, plays, writings, patents, and
copyrights are examples.
c) Leases for the use of land
There are two types of leases:
1. Finance a lease
2. Operating Lease
Finance Lease
All risks and rewards are transferred to the asset owner in a lease. The title may or may not
be transmitted in the future.
The following are some examples of finance leases:
1. A lease in which the lessee receives the assets at the conclusion of the lease period.
2. Lease term during which the lessee has the option to purchase the assets from the
lessor at a price that is less than fair value on the date the option is exercised.
3. Even if the title is not transferred, the lease term covers the asset’s whole economic
life.
4. A lease period in which the present value of the minimum lease payments equals or
significantly covers the leased asset’s fair value.
5. The leased asset is of a unique kind. Ex-ambulance driver (the lessee can use it
without major modifications being made)
Operating Lease
An Operating Lease is any type of lease that is not a finance lease.
In the case of a finance lease, accounting in the books of the lessee is required.
1. At the start of the lease, the lessee will record the lease as an asset or a liability equal
to the fair value of the leased assets.
2. Divide lease payments between finance charges and the reduction of the
outstanding amount.
3. Distribute the loan fee throughout the lease duration.
4. Make a depreciation journal entry.
Disclosure in the case of a finance lease
1. Leased assets should be reported separately.
2. At the balance sheet date, show the net carrying amount for each leased asset.
3. Provide a reconciliation between the balance sheet date’s Minimum Lease Payment
and their current value.
4. Show the total of minimum lease payments and their current value at the
balance sheet date for:
 One year is the deadline.
 After a year, but not more than five years
 More than five years later
5. At the balance sheet date, the minimum sublease payment is scheduled to be
received.
6. A description of the lessee’s major lease arrangements in general
In the case of an Operating Lease, the payment is recorded as an expense in the profit and
loss account in the Lessee’s books.
  In the case of an Operating Lease, the following information is provided:
1. Future lease payments for the next period
 One year is the deadline.
 After a year, but not more than five years
 More than five years later
2. Total Lease Payments Expected in the Future
3. Lease payment is shown in the period’s profit and loss statement
4. Lessee Significant Leasing Arrangements: A General Description
In the case of a finance lease, accounting in the Lessor’s accounts is required.
1. The lessor must record assets in his or her records in an amount equivalent to the
net investment in the lease.
2. Keep track of financial revenue using a pattern that reflects a consistent periodic
rate of return.
3. Calculate the lessor gross investment in leasing by estimating the unguaranteed
residual value.
4. If the expected unguaranteed residual value decreases, modify the income allocation
for the remainder of the lease term. Reduction in the amount to be recognized
immediately in comparison to the amount already recognized. The upward
adjustment will be overlooked.
5. The initial direct cost of the lease might be reflected in the profit and loss account
right once or spread out over the lease term.
Disclosure required in the case of a finance lease
1. Reconcile the total lease investment at the balance sheet date with the present value of the
minimum lease payment. Also, reveal the same as
 One year is the deadline.
 After a year, but not more than five years
 More than five years later
2. Finance income that was not earned
3. Residual value that isn’t guaranteed
4. Provision for uncollectible minimum lease payments receivable has accumulated.
5. In the profit and loss account, a contingent rent is recorded.
6. A general description of the tenancy agreement
7. The initial direct cost accounting policy was adopted.
In the case of an Operating Lease, accounting in the Lessor’s books is required.
1. Assets should be recorded in the balance sheet under fixed assets by the lessor.
2. Lease income should be recorded in the profit and loss account.
3. Costs incurred, including depreciation, must be recorded in the income statement.
 4. Examine for impairment and account for it in the books in accordance with GAAP.
In the case of an Operating Lease, disclosure is required.
1. At the balance sheet date, accumulated depreciation, accumulated impairment, and
carrying amount for each asset class.
2. Depreciation is accounted for in the profit and loss account.
3. Impairment losses are accounted for in the profit and loss account.
4. In the profit and loss account, the impairment loss has been reversed.
5. For each of the following periods, the future minimum lease payment is:
 One year is the deadline.
 After a year, but not more than five years
 More than five years later
6. The whole contingency is recorded in the profit and loss account.
7. A general description of the tenancy agreement
Transaction of Sale and Leaseback
1. If the sale and leaseback transaction results in a financing lease, any excess or
shortfall over the carrying amount should be delayed and amortized throughout the
lease period in proportion to the leased assets’ depreciation.
2. If a sale and leaseback transaction results in an operating lease, any surplus or deficit
over the carrying value should be reported in the book of account as soon as
possible:
3. If the sale price is less than fair value, the loss is offset by future lease payments at
a lower price; it should be deferred and amortized in proportion to the lease
payments over the estimated life of the asset.
AS19 vs. IAS17: What’s the Difference?

Basis As 19 IAS 17

Lands for lease -AS 19 does not apply to land -IAS17 has special requirements
leases. for land and building leases.

Residual
-In AS 19, the phrase “Residual -The term “Residual Value” is not
worth
Value” is defined defined in IAS 17.

the beginning -Although both terms are used -IAS 17 distinguishes between
and the start in AS 19 at times, they are not lease initiation and lease
defined and distinguished. commencement.
Recognize the -According to IAS 17, at the start
lease -According to AS 19, such of the lease period, the lessee
recognition occurs at the start must recognize financing leases
of the lease as assets and liabilities in the
balance sheet.

-IAS 17 is concerned with the

Modifications
adjustment of lease payments
to lease
-Not Dealt by AS 19 made between the start of the
payments
lease and the start of the lease
term.

-In the case of operating leases,

IAS 17 gives guidance on
accounting for: incentives and
Guidance determining whether a
-There is no guidance
transaction with the legal form
of a lease contains a lease
element, and evaluating the
substance of such a transaction

-During the lease term, IAS 17

Upward -During the lease period, AS 19
allows for an upward
revision precludes upward revision of
modification of unguaranteed
unguaranteed residual value.
residual value.

-In the case of a sale and

-IAS 17 also requires the excess
leaseback transaction (in the
of sale proceeds above the
case of a finance lease), AS 19
carrying price of the asset to be
requires the seller (lessee) to
Amortization delayed and amortized by the
defer and amortize the excess
Method seller (lessee) in the case of a
of sale proceeds over the
sale and leaseback transaction
carrying price of the asset over
(in the case of a finance lease),
the lease term, in proportion to
but it does not specify the
the depreciation of the leased
method of amortization.
asset.
 -If other liabilities are classified
Leasing
-The existing standard does as current or non-current, IAS 17
classification
not address these issues. requires a current/non-current
classification of lease liabilities.

-IAS 17 stipulates that in the

event of an operating lease if the
escalation of lease rates is due to
Lease rental
predicted general inflation to
attribution -AS 19 does not allow for this.
compensate the lessor for
expected inflationary
expenditures, the lease should
not be straight-lined.

-AS 19 requires that the -According to IAS 17, the lessor’s

lessor’s initial direct initial direct expenditures (in the
Direct costs at expenditures (in the event of event of an operating lease)
the start an operating lease) be charged must be included in the carrying
off at the time of incurrence or amount of the leased asset and
amortized over the lease amortized as an expense over
duration. the lease period.

The following are the differences between IAS 17 and IFRS 16:
If payment to the lessor is not made on a straight-line basis, IAS 17 requires all lease rentals
to be charged to the statement of profit and loss account on a straight-line basis unless
another systematic approach is more appropriate.
IFRS 16: Unless the payments to the lessor are structured to increase in step with expected
general inflation to compensate for the lessor’s expected inflationary cost associated with
the lease, all lease rentals shall be charged to the statement of profit and loss as per the lease
agreement.
This requirement is not met if payments to the lessor vary due to factors other than ordinary
inflation.
Conclusion:
If there is an inflation component in the lease rentals, we must compute all expected rentals
and charge them equally in the statement of profit and loss over the lease term, and we must
transfer the excess/deficit to the lease equalisation account under IAS17.
 Unit IV
Analysis & Interpretation of Financial Statements
Analysis and Interpretation of Financial Statements
Introduction
Analysis and interpretation of financial statements are an attempt to determine the
significance and meaning of the financial statement data so that a forecast may be made
of the prospects for future earnings, ability to pay interest, debt maturities, both current
as well as long term, and profitability of sound dividend policy.
The main function of financial analysis is the pinpointing of the strength and weaknesses
of a business undertaking by regrouping and analysis of figures contained in financial
statements, by making comparisons of various components and by examining their
content. The analysis and interpretation of financial statements represent the last of the
four major steps of accounting.
The first three steps involving the work of the accountant in the accumulation and
summarization of financial and operating data as well as in the construction of
financial statements are:
(i) Analysis of each transaction to determine the accounts to be debited and credited and
the measurement and variation of each transaction to determine the amounts involved.
(ii) Recording of the information in the journals, summarization in ledgers and
preparation of a worksheet.
(iii) Preparation of financial statements.
The fourth step of accounting, the analysis and interpretation of financial statements,
results in the presentation of information that aids the business managers, investors and
creditors.
Interpretation of financial statements involves many processes like arrangement,
analysis, establishing relationship between available facts and drawing conclusions on
that basis.
Types of Financial Analysis:
The process of analysis may partake the varying types. Normally, it is classified into
different categories on the basis of information used and on the basis of modus operandi.
(a) On the basis of Information Used:
(i) External analysis.
(ii) Internal analysis.
External analysis is an analysis based on information easily available to outsiders
(externals) for the business. Outsiders include creditors, suppliers, investors, and
government agencies regulating the business in a normal way.
These parties do not have access to the internal records (information) of the concern
and generally obtain data for analysis from the published financial statements. Thus an
analysis done by outsiders is known as external analysis.
Internal analysis is an analysis done on the basis of information obtained from the
internal and unpublished records and books. While conducting this analysis, the analyst
is a part of the enterprise he is analyzing. Analysis for managerial purposes is the
internal type of analysis and is conducted by executives and employees of the enterprise
as well as governmental and court agencies which may have major regulatory and other
jurisdiction over the business.
(b) On the basis of Modus Operandi:
(i) Horizontal analysis.
(ii) Vertical analysis.
Horizontal analysis is also known as ‘dynamic analysis’ or ‘trend analysis’. This analysis
is done by analyzing the statements over a period of time. Under this analysis, we try to
examine as to what has been the periodical trend of various items shown in the
statement. The horizontal analysis consists of a study of the behavior of each of the
entities in the statement.
Vertical analysis is also known as ‘static analysis’ or ‘structural analysis’. It is made by
analyzing a single set of financial statement prepared at a particular date. Under such a
type of analysis, quantitative relationship is established between the different items
shown in a particular statement. Common size statements are the form of vertical
analysis. Thus vertical analysis is the study of quantitative relationship existing among
the items of a particular data.
Preliminaries Required for Analysis and Interpretation of Financial Statements:
The following procedures are required to be completed for making an analysis and
interpretation of financial statements:
(i) Data should be presented in some logical way.
(ii) Data should be analyzed for preparing comparative statements.
(iii) All data shown in financial statements should be studied just to understand their
significance.
(iv) The objective and extent of analysis and interpretation should be determined.
(v) Facts disclosed by the analysis should be interpreted taking into account economic
facts.
(vi) Interpreted data and information should be in a report form.
Objectives of Analysis and Interpretation of Financial Statements:
The following are the some of the common objects of interpretation:
(i) To investigate the future potential of the concern.
(ii) To determine the profitability and future prospects of the concern.
(iii) To make comparative study of operational efficiency of similar concerns.
(iv) To examine the earning capacity and efficiency of various business activities with
the help of income statements.
(v) To estimate about the performance efficiency and managerial ability.
(vi) To determine short term and long term solvency of the business concerns.
(vii) To enquire about the financial position and ability to pay of the concerns.
Importance of Analysis and Interpretation of Financial Statements:
The following factors have increased the importance of the analysis and
interpretation of financial statements:
(i) Decision taken on the basis of intuition may be wrong and defective on the other
hand. Analysis and interpretation are based on some logical and scientific methods and
hence decisions taken on that basis seldom prove to be misleading and wrong.
(ii) The user as individual has a very limited personal experience. He can only
understand the complexities of business and mutual relationship by observation and
external experience. Thus it becomes necessary that financial statements in an implicit
form should be analysed in an intelligible way.
(iii) Decision or conclusions based on scientific analysis and interpretation are relative
and easily to be read and understood by other people.
(iv) Even to verify and examine the correctness and accuracy of the decisions already
taken on the basis of intuition, analysis and interpretation are essential.
Techniques of Analysis and Interpretation:
The most important techniques of analysis and interpretation are:
1. Ratio Analysis
2. Fund Flow Analysis
3. Cash Flow Analysis.
1. Ratio Analysis:
Two individual items on the statements can be compared with one another and the
relationship is expressed as a ratio. Ratios are computed for items on the same financial
statement or on different statements. These ratios are compared with those of prior
years and with those of other companies to make them more meaningful.
A ratio is a simple mathematical expression. Ratio may be expressed by a number of
ways. It is a number expressed in terms of another number. It i s a statistical yard stick
that provides a measure of relationship between two figures.
2. Fund Flow Analysis:
Funds Flow Analysis has been the salient feature of the evolution of accounting theory
and practice. The financial statement of a business provides only some information
about financial activities of a business in a limited manner. The income statement deals
solely with operations and the balance sheet shows the changes in the assets and
liabilities.
In fact, these statements are substantially an analysis of static aspects of financial
statements. Under this context, it is imperative to study and to analyse the fund
movements in the business concern. Such a study or analysis may be und ertaken by
using another tool of financial analysis, which is called ‘Statement of Sources, and Uses
of Funds’ or simply ‘Fund Statement’ or Fund Flow Analysis.
This statement is also called by other several names and they are:
(a) Application of Funds Statement.
(b) Statement of Sources and Applications of Funds.
(c) Statement of Funds Supplied and Applied.
(d) Where Got and Where Gone Statement.
(e) Statement of Resources Provided and Applied.
(f) Fund Movement Statement.
(g) Inflow-Outflow of Fund Statement.
Fund statement is a new contribution of science of accounting but has become the doyen
of tools of Financial Analysis.
3. Cash Flow Analysis:
Fund Flow Statement fails to convey the quantum of inflow of cash and outflow of cash.
When we say cash, we refer to the cash as well as the bank balances of the company at
the end of the accounting period as reflected in the Balance Sheet of the company. Cash
is a current asset like inventory and Accounts Receivables. Cash reflects its liquidity
position.
The term cash can be viewed in two senses. In a narrow sense, it includes actual cash in
the form of notes and coins and bank drafts held by a firm and the deposits withdrawable
on demand the company has held in commercial banks. But in a broader sense, it a lso
includes what are called ‘marketable securities’ which are those securities which can be
immediately sold or converted into cash if required.
Cash flow statement is a statement of cash flow and cash flow signifies the movements
of cash in and out of a business concern. Inflow of cash is known as sources of cash and
outflow of cash is called uses of cash. This statement also depicts factors for such inflow
and outflow of cash.
Thus cash flow statement is a statement designed to highlight upon the causes which
bring changes in cash position between two Balance Sheets dates. It virtually takes the
nature and character of cash receipts and cash payments though the basic information
used in the preparation of this statement differs from that which is used in recording
cash receipts and cash payments.
This is particularly useful to the management, credit grantors, investors and others. As
regards the management, it is helpful in budgeting cash requirements.

Ratio Analysis
Ratio analysis is referred to as the study or analysis of the line items present in the financial
statements of the company. It can be used to check various factors of a business such as
profitability, liquidity, solvency and efficiency of the company or the business.
Ratio analysis is mainly performed by external analysts as financial statements are the
primary source of information for external analysts.
The analysts very much rely on the current and past financial statements in order to obtain
important data for analysing financial performance of the company. The data or information
thus obtained during the analysis is helpful in determining whether the financial position of
a company is improving or deteriorating.

Categories of Ratio Analysis

There are a lot of financial ratios which are used for ratio analysis, for the scope of Class 12
Accountancy students. The following groups of ratios are considered in this article, which
are as follows:
1. Liquidity Ratios: Liquidity ratios are helpful in determining the ability of the company to
meet its debt obligations by using the current assets. At times of financial crisis, the company
can utilise the assets and sell them for obtaining cash, which can be used for paying off the
debts.
Some of the most commonly used liquidity ratios are quick ratio, current ratio, cash ratio,
etc. The liquidity ratios are used mostly by creditors, suppliers and any kind of financial
institutions such as banks, money lending firms, etc for determining the capacity of the
company to pay off its obligations as and when they become due in the current accounting
period.
2. Solvency Ratios: Solvency ratios are used for determining the viability of a company in
the long term or in other words, it is used to determine the long term viability of an
organisation.
Solvency ratios calculate the debt levels of a company in relation to its assets, annual
earnings and equity. Some of the important solvency ratios that are used in accounting are
debt ratio, debt to capital ratio, interest coverage ratio, etc.
Solvency ratios are used by government agencies, institutional investors, banks, etc to
determine the solvency of a company.
3. Activity Ratio: Activity ratios are used to measure the efficiency of the business activities.
It determines how the business is using its available resources to generate maximum
possible revenue.
These ratios are also known as efficiency ratios. These ratios hold special significance for
business in a way that whenever there is an improvement in these ratios, the company is
able to generate revenue and profits much efficiently.
Some of the examples of activity or efficiency ratios are asset turnover ratio, inventory
turnover ratio, etc.
4. Profitability ratios: The purpose of profitability ratios is to determine the ability of a
company to earn profits when compared to their expenses. A better profitability ratio shown
by a business as compared to its previous accounting period shows that business is
performing well.
The profitability ratio can also be used to compare the financial performance of a similar
firm, i.e it can be used for analysing competitor performance.
 Some of the most used profitability ratios are return on capital employed, gross profit ratio,
net profit ratio, etc.

Use of Ratio Analysis

Ratio analysis is useful in the following ways:
1. Comparing Financial Performance: One of the most important things about ratio
analysis is that it helps in comparing the financial performance of two companies.
2. Trend Line: Companies tend to use the activity ratio in order to find any kind of trend in
the performance. Companies use data from financial statements that is collected from
financial statements over many accounting periods. The trend that is obtained can be used
for predicting the future financial performance.
3. Operational Efficiency: Financial ratio analysis can also be used to determine the
efficiency of managing the asset and liabilities. It helps in understanding and determining
whether the resources of the business is over utilized or underutilized.
There are four main types of accounting ratios: –

1. Liquidity Ratio
2. Profitability Ratio
3. Leverage Ratio
4. Activity Ratios

Let us discuss each of these in detail –

Types of Accounting Ratios with Formulas

There are four types of accounting ratios with formulas: –

#1 – Liquidity Ratios
This first accounting ratio formula is used to ascertain the company’s liquidity position. It is
used to determine its paying capacity towards its short-term liabilities. A high liquidity ratio
indicates that the company’s cash position is good. A liquidity ratio of two or more is
acceptable.
Current Ratio
The current ratio compares the current assets to the current liabilities of the business.
This ratio indicates whether the company can settle its short-term liabilities.
Current Ratio = Current Assets / Current Liabilities

Current assets include cash, inventory, trade receivables, other current assets, etc. Current
liabilities include trade payables and other current liabilities.
Example
ABC Corp. has the following assets and liabilities on its balance sheet.

Current Assets = Short-term Capital + Debtors + Stock + Cash and Bank = $10,000 + $95,000
+ $50,000 + $15,000 =$170,000.

Current Liabilities = Debentures + Trade Payables + Bank Overdraft = $50,000 + $40,000

+$40,000 = $130,000.

Current Ratio = $170,000/ $130,000 = 1.3

Quick Ratio
The quick ratio is the same as the current ratio, except it considers only quick assets that
are easy to liquidate. It is also called an acid test ratio.
Quick Ratio = Quick Assets / Current Liabilities

Quick assets exclude inventory and prepaid expenses.

Cash Ratio
The cash ratio considers only those current assets immediately available for liquidity.
Therefore, the cash ratio is ideal if it is one or more.
Cash Ratio = (Cash + Marketable Securities) / Current Liabilities
#2 – Profitability Ratios

This accounting ratio formula indicates the company’s efficiency in generating profits. It
shows the earning capacity of the business in correspondence to the capital employed.

Gross Profit Ratio

The gross profit ratio compares the gross profit to the company’s net sales. It indicates the
margin earned by the business before its operational expenses. It is represented as a
percentage of sales. The higher the gross profit ratio, the more profitable the company is.
Gross Profit Ratio = (Gross Profits/ Net revenue from Operations) X 100
Net Revenue from Operations = Net Sales (i.e.) Sales (-) Sales Returns

Gross Profit = Net Sales – Cost of Goods Sold

The cost of goods sold includes raw materials, labor cost, and other direct expenses.
Example

Zinc Trading Corp. has gross sales of $100,000, sales return of $10,000, and the cost of goods
sold of $80,000.

Net sales = $100,000 – $10,000 = $90, 00

Gross Profit = $90,000 – $80,000 = $10,000

Gross Profit Ratio = $10,000/ $90,000 = 11.11%

Operating Ratio
The operating ratio expresses the relationship between operating costs and net sales. It is
used to check the efficiency of the business and its profitability.
Operating Ratio = ((Cost of Goods Sold + Operating Expenses)/ Net Revenue from
Operations) X 100

Operating expenses include administrative expenses, selling, and distribution expenses,

salary costs, etc.

Net Profit Ratio

The net profit ratio shows the overall profitability available for the owners as it considers
both the operating and non-operating income and expenses. Higher the ratio, the more
returns for the owners. It is an important ratio for investors and financiers.
Net Profit Ratio = (Net Profits after Tax / Net Revenue) X 100

Return on Capital Employed (ROCE)

ROCE shows the company’s efficiency concerning generating profits compared to the funds
invested in the business. It indicates whether the funds are utilized efficiently.
Return on capital employed = (Profits before Interest and Taxes / Capital Employed)
X 100
Example

R&M Inc. had profits before interest and taxes of $10,000, total assets of $1,000,000, and
liabilities of $600,000.

Capital employed = $1,000,000 – $600,000 = $400,000.

Return On Capital Employed = $10,000/ $400,000 = 2.5%.

Earnings per Share

Earnings per Share show the company’s revenues concerning one share. It is helpful to
investors for decision-making about the purchasing/ sale of shares as it determines
the return on investment. It also acts as an indicator of dividend declaration or bonus
issues shares. If earnings per share are high, the company’s stock price will be increased.
Earnings per Share = Profit Available to Equity Shareholders / Weighted Average
Outstanding Shares

#3 – Leverage Ratios
These accounting ratios are known as solvency ratios. That is because it determines its
ability to pay for its debts. Investors are interested in this ratio as it helps determine how
solvent the company is to meet its dues.
Debt-to-Equity Ratio

It shows the relationship between total debts and the company’s total equity. It is useful to
measure the leverage of the company. A low ratio indicates that the company is financially
secure; a high ratio suggests it is at risk as it is more dependent on debts for its operations.
It is also known as the gearing ratio. The ratio should be a maximum of 2:1.

Debt-to-Equity Ratio = Total Debts / Total Equity

Example
INC Corp. has total debts of $10,000, and its total equity is $7,000.

Debt-to-Equity ratio = $10,000/ $7,000 = 1.4:1

Debt Ratio
The Debt Ratio measures the liabilities in comparison to the assets of the company. A high
ratio indicates that the company may face solvency issues.
Debt Ratio = Total Liabilities/ Total Assets

Proprietary Ratio
It shows the relationship between total assets and shareholders’ funds. It indicates how
much of shareholders’ funds are invested in the assets.
Proprietary Ratio = Shareholders Funds / Total Assets

Interest Coverage Ratio

The Interest Coverage Ratio measures its ability to meet its interest payment obligation. A
higher ratio indicates that the company earns enough to cover its interest expense.
Interest Coverage Ratio = Earnings before Interest and Taxes / Interest Expense

Example

Duo Inc. has earnings before interest and taxes of $1,000, and it has issued debentures worth
$10,000 @ 6%.

Interest expense = $10,000*6% = $600

Interest Coverage Ratio = Earnings before Interest and Taxes / Interest Expense =
$1,000/$600 = 1.7:1.

So, the current earnings before interest and taxes can cover the interest expense 1.7 times.

#4 – Activity/Efficiency Ratios

Working Capital Turnover Ratio

It establishes the relationship of sales to net working capital. A higher ratio indicates that
the company’s funds are efficiently used.
Working Capital Turnover Ratio = Net Sales/ Net Working Capital

Inventory Turnover Ratio

The Inventory Turnover Ratio indicates the pace at which the stock is converted into sales.
Therefore, it is useful for inventory reordering and understanding the conversion cycle.
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

Asset Turnover Ratio

The Asset Turnover Ratio indicates the revenue as a percentage of the investment. A high
ratio suggests that its assets are managed better, yielding good income.
Asset Turnover Ratio = Net Revenue / Assets

Debtors Turnover Ratio

The debtors’ turnover ratio indicates how efficiently debtors’ credit sales value is collected.
In addition, it shows the relationship between credit sales and the corresponding
receivables.
Debtors Turnover Ratio = Credit Sales / Average Debtors

X Corp. makes a total sale of $6,000 in the current year, of which 20% is cash sales. Debtors
at the beginning are $800 and at the year-end are $1,600.

Credit sales = 80% of the total sales = $6,000 * 80% = $4,800

Average debtors = ($800+$1,600)/2 = $1,200.

Debtors Turnover Ratio = Credit Sales/Average Debtors = $4,800 / $1,200 = 4 times.

COMMONSIZE STATEMENT ANALYSIS PROBLEMS AND SOLUTIONS

https://dkgoelsolutions.com/class-12/chapter-4-common-size-statements/
https://www.studiestoday.com/dk-goel-accountancy-dk-goel-solutions-class-12-
accountancy-chapter-4-common-size-statements-316426

Expanded Analysis: Financial ratios used in Annual Reports

https://www.wallstreetmojo.com/financial-ratios/

Unit V
Accounting Standards in India and IFRS
Accounting Standards
An accounting standard is a common set of principles, standards, and procedures that define
the basis of financial accounting policies and practices.
Accounting Standards: Concept, Meaning, Nature and Objectives

Concept of Accounting Standards:

We know that Generally Accepted Accounting Principles (GAAP) aims at bringing
uniformity and comparability in the financial statements. It can be seen that at many
places, GAAP permits a variety of alternative accounting treatments for the same item.
For example, different methods for valuation of stock give different results in financial
statements.
Such practices sometimes can misguide intended users in taking decision relating to
their field. Keeping in view the problems faced by many users of accounting, a need for
the development of common accounting standards was aroused.
For this purpose, the Institute of Chartered Accountants of India (ICAI), which is also a
member of International Accounting Standards Committee (IASC), had constituted
Accounting Standard Board (ASB) in the year 1977. ASB identified the areas in which
uniformity in accounting was required. After detailed research and discussions, it
prepared and submitted a draft to the ICAI. After proper examination, ICAI finalized
them and notified for its use in financial statements.

Meaning of Accounting Standards:

Accounting standards are the written statements consisting of rules and guidelines,
issued by the accounting institutions, for the preparation of uniform and consistent
financial statements and also for other disclosures affecting the different users of
accounting information.
Accounting standards lay down the terms and conditions of accounting policies and
practices by way of codes, guidelines and adjustments for making the interpretation of
the items appearing in the financial statements easy and even their treatment in the
books of account.

Nature of Accounting Standards:

On the basis of forgoing discussion we can say that accounting standards are guide,
dictator, service provider and harmonizer in the field of accounting process.
(i) Serve as a guide to the accountants:
Accounting standards serve the accountants as a guide in the accounting process. They
provide basis on which accounts are prepared. For example, they provide the method of
valuation of inventories.
(ii) Act as a dictator:
Accounting standards act as a dictator in the field of accounting. Like a dictator, in some
areas accountants have no choice of their own but to opt for practices other than those
stated in the accounting standards. For example, Cash Flow Statement should be
prepared in the format prescribed by accounting standard.
(iii) Serve as a service provider:
Accounting standards comprise the scope of accounting by defining certain terms,
presenting the accounting issues, specifying standards, explaining numerous disclosures
and implementation date. Thus, accounting standards are descriptive in nature and
serve as a service provider.
(iv) Act as a harmonizer:
Accounting standards are not biased and bring uniformity in accou nting methods. They
remove the effect of diverse accounting practices and policies. On many occasions,
accounting standards develop and provide solutions to specific accounting issues. It is
thus clear that whenever there is any conflict on accounting issues, accounting standards
act as harmonizer and facilitate solutions for accountants.

Objectives of Accounting Standards:

In earlier days, accounting was just used for recording business transactions of financial
nature. Its main emphasis now lies on providing accounting information in the process
of decision making.
For the following purposes, accounting standards are needed:
(i) For bringing uniformity in accounting methods:
Accounting standards are required to bring uniformity in accounting methods by
proposing standard treatments to the accounting issue. For example, AS -6(Revised)
states the methods for depreciation accounting.
(ii) For improving the reliability of the financial statements:
Accounting is a language of business. There are many users of the information provided
by accountants who take various decisions relating to their field just on the basis of
information contained in financial statements. In this connection, it is necessary that the
financial statements should show true and fair view of the business concern. Accounting
standards when used give a sense of faith and reliability to various users.
They also help the potential users of the information contained in the financial
statements by disclosure norms which make it easy even for a layman to interpret the
data. Accounting standards provide a concrete theory base to the process of accounting.
They provide uniformity in accounting which makes the financial statements of different
business units, for different years comparable and again facilitate decision making.
(iii) Simplify the accounting information:
Accounting standards prevent the users from reaching any misleading conclusions and
make the financial data simpler for everyone. For example, AS-3 (Revised) clearly
classifies the flows of cash in terms of ‘operating activities’, ‘investing activities’ and
‘financing activities’.
(iv) Prevents frauds and manipulations:
Accounting standards prevent manipulation of data by the management and others. By
codifying the accounting methods, frauds and manipulations can be minimized.
(v) Helps auditors:
Accounting standards lay down the terms and conditions for accounting policies and
practices by way of codes, guidelines and adjustments for making and interpreting the
items appearing in the financial statements. Thus, these terms, policies and guidelines
etc. become the basis for auditing the books of accounts.

Advantages of Accounting Standards

1. Comparison between Two Organizations
The reports of the businesses follow the same format, so after reviewing the financial
statements of each business, the users of the financial statements can make judgments based
on the comparison. It won't be easy to compare the two firms if they employ distinct
accounting procedures. As a result, the accounting standard allows for comparison
whenever necessary. The standards are helpful in both intra-firm and inter-firm
comparisons of operations and positions based on the accounting reports presented.
2. Uniformity in Accounting
Accounting standards provide rules and regulations that must be followed at all costs by the
company while documenting a transaction. They use a common format for financial
statements and separate values for each organization to ensure consistency throughout the
accounting process. It becomes easier for stakeholders to analyze the reports as they are
based on accounting standards that follow the presentation format without confusion. Also,
these reduce the number of alternative practices adopted in for accounting process.
3. Increased Financial Statement Dependability
There is a standard structure for valuing financial statements, the user, external or internal,
completely depends on this financial statement to make any choice. The notes to account
also detail a firm's many contingencies and the working notes of the headings, making the
system more visible and, as a result, adopting the trait of reliability.
4. Protect Fraud and Manipulation
As previously said, there is a fixed structure for the financial statement that no one can
change or conduct fraud throughout the entire accounting process. As a result, the
accounting standard has already decreased the possibility of manipulation and fraud while
making the accounting system more effective and dependable.
5. Assist Auditors
The auditor's job is to determine whether or not the financial statements prepared by
corporations adhere to the principles and norms established by accounting standards,
because the accounting standard has already laid down the rules, procedures, and structure,
it makes it easier for auditors to assess the financial statements. The quality of financial
records improves as they become easily understandable.
6. Assessing Management Accountability
Accounting standards help determine managerial accountability by measuring the
managerial component of the organization. It also assesses management performance and
the capacity to increase profitability, preserve an entity's solvency, and fulfill other
management obligations. Good management will be consistent in their procedures and rules
to avoid confusing the user's thoughts.
7. Helps Resolve Conflicts
These standards cater to the facility to reduce conflict among various users of financial
statements or information based on their interests. With this, these standards help in the
assessment of management. In the absence of these, a proper analysis of the performance of
the business cannot be done, and so of the management.
Disadvantages of Accounting Standards
1. Rigid and Inflexible
Policies have already been established and must be followed by the entity at all costs; hence,
making the financial statement rigid means that no one may modify it to their liking. The
format has already been established, and it must be followed. As a result, it lacks adaptability.
2. Compromise the Standard
Sometimes, the accounting standard is compromised even in the presence of many
regulations due to lobbying or government pressure on accountable institutions. This is
because the government or a high authority only wants to grant benefits to large, powerful
corporations or if they have some personal interest. As a result, standards are undermined
and cannot be depended on fully, which is a very important disadvantage.
3. Selecting an Alternative is Difficult
There are several techniques for recording transactions in the books of account, it might be
difficult to decide which method to use and which not to, which further makes it difficult to
access when it comes to qualitative analysis. Furthermore, due to limitations in the method
of choice, the entity may be forced to abandon its most convenient way, losing quality and
efficiency, in favor of a secondary method of documenting transactions.
4. Time Consumption is high
The entire process of adhering to accounting standards takes time since each note and
schedule must be prepared by the user and go through a lengthy, time-consuming process.
Many a time, it increases the chances of mistakes. The examination becomes a necessity
which also becomes an obligation and time-consuming, with repetition of the same task. The
work has to be done twice, once the execution and the second that is its examination for
correctness.
5. Scope is Limited
Accounting standards must be established following the rules in place in the country at the
time keeping in the interest of local functionaries. They are unable to override the law. As a
result, the scope for creating policies is limited, which becomes a hurdle to improvement.

Accounting Standards Board (ASB)

Accounting Standards
OBJECTIVES AND FUNCTIONS OF THE ACCOUNTING STANDARDS BOARD
1.The following are the objectives of the Accounting Standards Board:
(i) To conceive of and suggest areas in which Accounting Standards need to be
developed.
(ii) To formulate Accounting Standards with a view to assisting the Council of the ICAI
in evolving and establishing Accounting Standards in India.
(iii) To examine how far the relevant International Accounting Standard/International
Financial Reporting Standard (see paragraph 3 below) can be adapted while
formulating the Accounting Standard and to adapt the same.
(iv) To review, at regular intervals, the Accounting Standards from the point of view of
acceptance or changed conditions, and, if necessary, revise the same.
(v) To provide, from time to time, interpretations and guidance on Accounting
 Standards.
(vi) To carry out such other functions relating to Accounting Standards.
2.The main function of the ASB is to formulate Accounting Standards so that such
standards may be established by the ICAI in India. While formulating the Accounting
Standards, the ASB will take into consideration the applicable laws, customs, usages
and business environment prevailing in India.
3.The ICAI, being a full-fledged member of the International Federation of Accountants
(IFAC), is expected, inter alia, to actively promote the International Accounting
Standards Board’s (IASB) pronouncements in the country with a view to facilitate
global harmonization of accounting standards. Accordingly, while formulating the
Accounting Standards, the ASB will give due consideration to International Accounting
Standards (IASs) issued by the International Accounting Standards Committee
(predecessor body to IASB) or International Financial Reporting Standards (IFRSs)
issued by the IASB, as the case may be, and try to integrate them, to the extent possible,
in the light of the conditions and practices prevailing in India.
4.The Accounting Standards are issued under the authority of the Council of the ICAI. The
ASB has also been entrusted with the responsibility of propagating the Accounting
Standards and of persuading the concerned parties to adopt them in the preparation
and presentation of financial statements. The ASB will provide interpretations and
guidance on issues arising from Accounting Standards. The ASB will also review the
Accounting Standards at periodical intervals and, if necessary, revise the same.
Composition of the Accounting Standards Board
The composition of the ASB is fairly broad-based and ensures participation of all interest-
groups in the standard setting process. Apart from the elected members of the Council of the
ICAI nominated on the ASB, the following are represented on the ASB:
(i) Nominee of the Central Government representing the Department of Company Affairs on
the Council of the ICAI
(ii) Nominee of the Central Government representing the Office of the Comptroller and
Auditor General of India on the Council of the ICAI
(iii) Nominee of the Central Government representing the Central Board of Direct Taxes on
the Council of the ICAI
(iv) Representative of the Institute of Cost and Works Accountants of India
(v) Representative of the Institute of Company Secretaries of India
(vi) Representatives of Industry Associations (1 from Associated Preface to the Statements
of Accounting Standards 3 Chambers of Commerce and Industry (ASSOCHAM), 1 from
Confederation of Indian Industry (CII) and 1 from Federation of Indian Chambers of
Commerce and Industry (FICCI)
(vii) Representative of Reserve Bank of India
(viii) Representative of Securities and Exchange Board of India
(ix) Representative of Controller General of Accounts
(x) Representative of Central Board of Excise and Customs
(xi) Representatives of Academic Institutions (1 from Universities and 1 from Indian
Institutes of Management)
(xii) Representative of Financial Institutions
(xiii) Eminent professionals co-opted by the ICAI (they may be in practice or in industry,
government, education, etc.)
(xiv) Chairman of the Research Committee and the Chairman of the Expert Advisory
Committee of the ICAI, if they are not otherwise members of the Accounting Standards Board
(xv) Representative(s) of any other body, as considered appropriate by the ICAI

International Financial Reporting Standards (IFRS)

Investopedia / Paige McLaughlin

What Are International Financial Reporting Standards (IFRS)?

International Financial Reporting Standards (IFRS) are a set of accounting rules for the
financial statements of public companies that are intended to make them consistent,
transparent, and easily comparable around the world.

IFRS currently has complete profiles for 167 jurisdictions, including those in the European
Union. The United States uses a different system, the generally accepted accounting
principles (GAAP).1

The IFRS is issued by the International Accounting Standards Board (IASB).

The IFRS system is sometimes confused with International Accounting Standards (IAS),
which are the older standards that IFRS replaced in 2001.

KEY TAKEAWAYS
 International Financial Reporting Standards (IFRS) were created to bring
consistency and integrity to accounting standards and practices, regardless of the
company or the country.
 They were issued by the London-based Accounting Standards Board (IASB) and
address record keeping, account reporting, and other aspects of financial reporting.
 The IFRS system replaced the International Accounting Standards (IAS) in 2001.
 IFRS fosters greater corporate transparency.
 IFRS is not used by all countries; for example, the U.S. uses generally accepted
accounting principles (GAAP).
International Financial Reporting Standards (IFRS)
Understanding International Financial Reporting Standards (IFRS)

IFRS specify in detail how companies must maintain their records and report their expenses
and income. They were established to create a common accounting language that could be
understood globally by investors, auditors, government regulators, and other interested
parties.

The standards are designed to bring consistency to accounting language, practices, and
statements, and to help businesses and investors make educated financial analyses and
decisions.

They were developed by the International Accounting Standards Board, which is part of the
not-for-profit, London-based IFRS Foundation. The Foundation says it sets the standards to
“bring transparency, accountability, and efficiency to financial markets around the world."2

IFRS vs. GAAP

Public companies in the U.S. are required to use a rival system, the generally accepted
accounting principles (GAAP). The GAAP standards were developed by the Financial
Standards Accounting Board (FSAB) and the Governmental Accounting Standards Board
(GASB).

The Securities and Exchange Commission (SEC) has said it won't switch to International
Financial Reporting Standards but will continue reviewing a proposal to allow IFRS
information to supplement U.S. financial filings.3

There are differences between IFRS and GAAP reporting. For example, IFRS is not as strict
in defining revenue and allows companies to report revenue sooner. A balance sheet using
this system might show a higher stream of revenue than a GAAP version of the same balance
sheet.

IFRS also has different requirements for reporting expenses. For example, if a company is
spending money on development or on investment for the future, it doesn't necessarily have
to be reported as an expense. It can be capitalized instead.

Standard IFRS Requirements

IFRS covers a wide range of accounting activities. There are certain aspects of business
practice for which IFRS set mandatory rules.
  Statement of Financial Position: This is the balance sheet. IFRS influences the ways
in which the components of a balance sheet are reported.
 Statement of Comprehensive Income: This can take the form of one statement or
be separated into a profit and loss statement and a statement of other income,
including property and equipment.
 Statement of Changes in Equity: Also known as a statement of retained earnings,
this documents the company's change in earnings or profit for the given financial
period.
 Statement of Cash Flows: This report summarizes the company's financial
transactions in the given period, separating cash flow into operations, investing, and
financing.

In addition to these basic reports, a company must give a summary of its accounting policies.
The full report is often seen side by side with the previous report to show the changes in
profit and loss.

A parent company must create separate account reports for each of its subsidiary
companies.

History of IFRS

IFRS originated in the European Union with the intention of making business affairs and
accounts accessible across the continent. It was quickly adopted as a common accounting
language.

Although the U.S. and some other countries don't use IFRS, currently 167 jurisdictions do,
making IFRS the most-used set of standards globally.1

Who Uses IFRS?

IFRS is required to be used by public companies based in 167 jurisdictions, including all of
the nations in the European Union as well as Canada, India, Russia, South Korea, South
Africa, and Chile. The U.S. and China each have their own systems.1

How Does IFRS Differ From GAAP?

The two systems have the same goal: clarity and honesty in financial reporting by publicly-
traded companies.

IFRS was designed as a standards-based approach that could be used internationally. GAAP
is a rules-based system used primarily in the U.S.
Although most of the world uses IFRS standards, it is still not part of the U.S. financial
accounting world. The SEC continues to review switching to the IFRS but has yet to do so.

Several methodological differences exist between the two systems. For instance, GAAP
allows a company to use either of two inventory cost methods: First in, First out (FIFO) or
Last in, First out (LIFO). LIFO, however, is banned under IFRS.

Why Is IFRS Important?

IFRS fosters transparency and trust in the global financial markets and the companies that
list their shares on them. If such standards did not exist, investors would be more reluctant
to believe the financial statements and other information presented to them by companies.
Without that trust, we might see fewer transactions and a less robust economy.

IFRS also helps investors analyze companies by making it easier to perform “apples to
apples” comparisons between one company and another and for fundamental analysis of a
company's performance.

The Bottom Line

The International Financial Reporting Standards (IFRS) are a set of accounting rules for
public companies with the goal of making company financial statements consistent,
transparent, and easily comparable around the world. This helps for auditing, tax purposes,
and investing.

Comparison between Indian Accounting Standards and IFRS

IFRS stands for International Financial Reporting Standards, it is prepared by the IASB
(International Accounting Standards Board). It is used in around 144 countries and is regarded as
one of the most popular accounting standards.
IND AS is also known as Indian Accounting Standards or Indian version of IFRS. Indian AS or
IND AS is used in the context of Indian companies.
Let us look at some of the points of difference between the IFRS and IND AS.
IFRS IND AS

Definition
IFRS stands for International Financial Reporting IND AS stands for Indian Accounting Standards, it is also
Standards, it is an internationally recognised accounting known as India specific version of IFRS
standard

Developed by

IASB (International Accounting Standards Board) MCA (Ministry of Corporate Affairs)

Followed by

144 countries across the world Followed only in India

Disclosure

Companies complying with IFRS have to disclose as a Such a disclosure is not mandatory for companies
note that the financial statements comply with IFRS complying with Indian Accounting Standards or IND AS

Financial Statement Components

It includes the following It includes the following:

1. Balance Sheet
1. Statement of financial position
2. Profit and loss account
2. Statement of profit and loss
3. Cash flow statement
3. Statement of changes in equity for the period
4. Statement of changes in equity
4. Statement of cash flows for the period
5. Notes to financial statements

6. Disclosure of accounting policies

Balance Sheet Format

Companies complying with IFRS need have specific Companies complying with IND AS need have no such
guidelines for preparing balance sheet with assets and requirements for balance sheet format, but the guidelines
liabilities to be classified as current and non-current are defined for presenting balance sheet