Financial Statements of a Company

Meaning of Financial Statements

**Financial statements** are the basic and formal annual reports through which corporate management communicates financial information to owners and external parties including investors, tax authorities, government, and employees. They comprise three primary documents:

**Balance Sheet** — position statement showing financial position at the end of accounting period

**Statement of Profit and Loss** — revenue statement showing results during the period

**Cash Flow Statement** — showing movement of funds and changes in financial position

These statements are end products of the accounting process and serve as sources of information for drawing conclusions about profitability and financial position. They are arranged in proper form with suitable contents so that shareholders and other users can understand and use them meaningfully for economic decision-making.

Nature of Financial Statements

**Financial statements** reflect a combination of recorded facts, accounting principles, and personal judgements. They reveal the financial position as on a specific date and financial results obtained during a period.

Recorded Facts

Financial statements are prepared on the basis of facts expressed in monetary terms from accounting books using **original cost or historical cost** as the basis of recording transactions. Figures for cash, trade receivables, fixed assets, and similar items are taken from recorded accounting books at amounts actually paid at different times and different prices.

**Key limitation:** Assets are shown at historical costs, not market prices, so financial statements do not show the current financial condition of the enterprise.

Accounting Conventions

Certain established conventions are followed while preparing financial statements:

**Valuation of Inventory:** Cost or market price, whichever is lower

**Asset Valuation:** Assets shown at cost less depreciation in balance sheet

**Materiality Convention:** Small items like pencils, pens, postage stamps are treated as expenditure in the year purchased, not capitalized as assets

**Stationery Valuation:** Valued at cost, not on cost-or-market-price-whichever-is-less principle

These conventions make financial statements **comparable, simple, and realistic**.

Postulates

Financial statements are prepared on basic assumptions known as **postulates**:

**Going Concern Postulate:** Enterprise is treated as a going concern existing for a longer period; assets shown at historical cost basis

**Money Measurement Postulate:** Assumes value of money remains constant in different periods; assets purchased at different times shown at amounts actually paid despite changes in purchasing power

**Realisation Postulate:** Revenue is included in statement of profit and loss of the year in which sale was undertaken, even if payment is received over multiple years

Personal Judgements

Financial statements incorporate personal opinions, estimates, and judgements in multiple circumstances:

**Depreciation:** Based on estimated useful economic life of fixed assets

**Provisions for Doubtful Debts:** Made on estimates and personal judgement

**Inventory Valuation:** Deciding between cost or market value involves personal judgements based on various considerations

Personal opinions and estimates are made following the **convention of conservatism** to avoid overstatement of assets, liabilities, income, and expenditure.

Objectives of Financial Statements

The primary objective of financial statements is to **assist users in their decision-making** by providing relevant, reliable, and timely information. Specific objectives include:

Information about Economic Resources and Obligations

Financial statements provide adequate, reliable, and periodical information about economic resources and obligations of a business firm to investors and external parties who have limited authority, ability, or resources to obtain information independently.

Information about Earning Capacity

Financial statements provide useful information that can be gainfully utilized to **predict, compare, and evaluate** the business firm's earning capacity, allowing stakeholders to assess future profitability and performance.

Information about Cash Flows

Statements provide information useful to investors and creditors for **predicting, comparing, and evaluating** potential cash flows in terms of amount, timing, and related uncertainties.

Judge Effectiveness of Management

Financial statements supply information useful for judging **management's ability to utilise the resources** of a business effectively, enabling shareholders to assess management performance.

Information about Activities Affecting Society

Financial statements report the activities of the business organisation affecting society that can be measured and determined, which are important in its social environment.

Disclosing Accounting Policies

Financial statements must provide significant **policies, concepts followed** in the accounting process and changes undertaken during the year to enable better understanding of the statements.

Types of Financial Statements

Every company registered under **The Companies Act 2013** must prepare its balance sheet, statement of profit and loss, and notes to accounts in accordance with the manner prescribed in the revised **Schedule III to the Companies Act, 2013** to harmonise disclosure requirements with accounting standards and converge with new reforms.

Balance Sheet Format (Schedule III)

The balance sheet is presented in **vertical format** with two main sections:

**I. EQUITY AND LIABILITIES:**

1. **Shareholder's Funds**

Share Capital

Reserves and Surplus

Money received against share warrants

2. **Share Application Money Pending Allotment**

3. **Non-current Liabilities**

Long-term borrowings

Deferred tax liabilities (net)

Other long-term liabilities

Long-term provisions

4. **Current Liabilities**

Short-term borrowings

Trade payables

Other current liabilities

Short-term provisions

**II. ASSETS:**

1. **Non-Current Assets**

Fixed assets (Tangible, Intangible, Capital work-in-progress, Intangible assets under development)

Non-current investments

Deferred tax assets (net)

Long-term loans and advances

Other non-current assets

2. **Current Assets**

Current investments

Inventories

Trade receivables

Cash and cash equivalents

Short-term loans and advances

Other current assets

Important Features of Schedule III Presentation

**Applicability:** Applies to all Indian companies preparing financial statements as per Schedule III; **does not apply** to Banking, Insurance Companies, or companies with forms specified under other Acts

**Accounting Standards Prevail:** Accounting standards supersede Schedule III of Companies Act 2013

**Mandatory Disclosures:** Disclosure on face of financial statements or in notes is essential and mandatory

**Definition Alignment:** Terms in Schedule III carry meanings as defined by applicable accounting standards

**Balance in Details:** Balance maintained between excessive details and provision of important information

**Current and Non-current Bifurcation:** Mandatory classification of assets and liabilities into current and non-current

**Rounding-off Rules:**

Turnover < Rs. 100 crore: Nearest hundreds, thousands, lakhs, millions or decimals thereof

Turnover ≥ Rs. 100 crore: Nearest lakhs, millions or decimals thereof

**Vertical Format Mandatory:** Only vertical format prescribed for presentation

**Debit Balance Treatment:** Debit balance in statement of profit and loss disclosed as **negative figure** under "Surplus"

**Terminology Changes:** 'Sundry Debtors' and 'Sundry Creditors' replaced by **'Trade Receivables'** and **'Trade Payables'**

Shareholders' Funds

Shareholders' funds are sub-classified on the face of balance sheet into three components: Share Capital, Reserves and Surplus, and Money received against Share Warrants.

Share Capital

Share capital disclosures in notes to accounts must include:

**Outstanding Shares:** Number of shares outstanding at beginning and end of reporting period for each class

**Rights and Restrictions:** Rights, preferences, and restrictions attached to each class of shares including restrictions on distribution of dividends and capital repayment

**Ownership Transparency:**

Shares held by holding company, ultimate holding company, or their subsidiaries/associates in aggregate

Shares held by each shareholder holding more than 5% shares specifying number held

5-year disclosure of aggregate shares allotted as fully paid (without cash), bonus shares, and bought-back shares

For each class of share capital, notes must disclose:

Number and amount of shares authorised

Number of shares issued, subscribed, fully paid, and subscribed but not fully paid

Par value per share

Reconciliation of shares outstanding at beginning and end of period

Rights, preferences, restrictions for each class

Shares held by holding company and ultimate holding company

Shares reserved for issue under options and contracts

5-year history of shares allotted (non-cash), bonus shares, and bought-back shares

Terms of convertible securities with earliest conversion date

Calls unpaid (aggregate amount)

Forfeited shares (amount originally paid up)

Reserves and Surplus

Reserves and Surplus are classified into:

**Capital Reserve** — created from capital transactions

**Capital Redemption Reserve** — created on redemption of preference shares or debentures

**Securities Premium Reserve** — created from issue of shares/debentures at premium

**Debenture Redemption Reserve** — created for redemption of debentures

**Revaluation Reserve** — created on revaluation of assets

**Share Options Outstanding Account** — recognized as separate item under shareholders' funds

**Other Reserves** — specifying nature and purpose

**Surplus** — balance in statement of profit and loss, disclosing allocations and appropriations such as dividend, bonus shares, transfers to/from reserves

**Significant modifications:**

Reserves specifically represented by **earmarked investments termed as "Fund"**

**Debit balance of statement of profit and loss shown as negative figure** under 'Surplus'

Balance of Reserves and Surplus after adjusting negative Surplus balance shown as stated, even if resulting figure is negative

Money Received against Share Warrants

**Share warrants** are instruments where amount received is converted into shares at a specified date on a specified rate. This amount must be disclosed as a **separate line item** under shareholders' funds.

Current and Non-current Classification

The classified balance sheet bifurcates assets and liabilities into **current and non-current** based on clear criteria:

An item is classified as **current** if:

It is involved in entity's operating cycle, OR

Expected to be realised/settled within twelve months, OR

Held primarily for trading, OR

Is cash and cash equivalent, OR

Entity does not have unconditional right to defer settlement of liability for at least 12 months after reporting period

All **other assets and liabilities are non-current** (classified as residual items).

**Practical Example:** Inventory used in operations is current even if realization takes >12 months. Trade receivables expected to be collected within 12 months are current. Debentures repayable after >12 months are non-current liabilities.

Illustration: Share Capital Presentation

**Dinkar Ltd. has authorised capital of Rs. 50,00,000 divided into equity shares of Rs. 100 each. Company invited applications for 40,000 shares; applications for 36,000 received. All calls made and received except 500 shares on which final call of Rs. 20 not received. Company forfeited 200 shares on which final call not received.**

**Balance Sheet Extract:**

Shareholders' funds — Share capital (Note 1): Rs. 35,90,000

**Notes to Accounts:**

| Particulars | Rs. |

|---|---|

| **Authorised:** 50,000 equity shares @ Rs. 100 | 50,00,000 |

| **Issued:** 40,000 equity shares @ Rs. 100 | 40,00,000 |

| **Subscribed and fully paid:** 35,500 shares @ Rs. 100 | 35,50,000 |

| **Subscribed not fully paid:** 300 shares @ Rs. 100, called up | 30,000 |

| Less: Calls-in-arrears (300 × Rs. 20) | (6,000) |

| | 24,000 |

| Add: Share forfeiture A/c (200 shares × Rs. 80) | 16,000 |

| **Total Share Capital** | **35,90,000** |

**Key Points:** Calls-in-arrears shown as deduction; forfeited shares shown at amount paid up (not fully called amount). Numbers reconciled: 36,000 applied + 200 forfeited = 36,200; of these, 35,500 fully paid + 300 partly paid + 200 forfeited = 36,000 accounted for.

Illustration: Balance Sheet with Current/Non-current Classification

**Amba Ltd. Balance Sheet items as on March 31, 2017:**

8% Debentures Rs. 10,00,000; Equity share capital Rs. 50,00,000; Securities premium Rs. 20,000; Preliminary expenses Rs. 40,000; Statement of P&L (Cr.) Rs. 1,50,000; Loose tools Rs. 20,000; Bank balance Rs. 60,000; Cash in hand Rs. 38,000.

**Balance Sheet:**

| **I. EQUITY AND LIABILITIES** | **Note** | **Rs.** |

|---|---|---|

| 1. Shareholders' Funds | | |

| a) Share capital | | 50,00,000 |

| b) Reserves and surplus | 1 | 1,30,000 |

| 2. Non-current Liabilities | | |

| a) Long-term borrowings | 2 | 10,00,000 |

| **II. ASSETS** | | |

| Current Assets | | |

| a) Inventories | 3 | 20,000 |

| b) Cash and cash equivalents | 4 | 98,000 |

| c) Other current assets | 5 | 10,000 |

**Notes to Accounts:**

**1. Reserve and Surplus:** Securities premium Rs. 20,000; Less: Preliminary expenses (Rs. 40,000) = (Rs. 20,000); Add: Statement of P&L Rs. 1,50,000 = **Rs. 1,30,000**

**2. Long-term Borrowings:** 8% Debentures = **Rs. 10,00,000**

**3. Inventories:** Loose tools = **Rs. 20,000**

**4. Cash and Cash Equivalents:** Bank balance Rs. 60,000 + Cash in hand Rs. 38,000 = **Rs. 98,000**

**5. Other Current Assets:** Preliminary expenses = **Rs. 10,000** (written down from Rs. 40,000 by adjustment against Reserves and Surplus)

**Key Points:** Preliminary expenses (capital item) shown as adjustment to Reserves and Surplus in notes; loose tools (inventory) classified as current; debentures repayable after 12 months as non-current; cash items combined under single head.