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Financial Statements of a Company

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Chapter Notes

Overview
This chapter explains the nature, objectives, types, and contents of financial statements of a company as per the Companies Act, 2013 and Schedule III. It covers the meaning of financial statements, their nature (recorded facts, accounting conventions, postulates, personal judgements), objectives, and the detailed format and content of the Balance Sheet and Statement of Profit and Loss. The one big idea a student must walk away with is that financial statements are the end products of the accounting process, prepared in a prescribed vertical format under Schedule III, which communicate the financial position and performance of a company to its stakeholders, and they have both uses and limitations.
Key Concepts (25)
Financial Statements
Financial statements are the basic and formal annual reports through which the corporate management communicates financial information to its owners and various other external parties which include investors, tax authorities, government, employees, etc. These refer to: the balance sheet (position statement) as at the end of accounting period, the statement of profit and loss of a company and the cash flow statement.
e.g. A company like Reliance Industries Ltd. publishes its Balance Sheet and Statement of Profit and Loss every year for shareholders and the public to see its financial health.
Nature of Financial Statements
Financial statements reflect a combination of recorded facts, accounting principles and personal judgements. They are prepared on the basis of facts in the form of cost data recorded in accounting books, following accounting conventions and postulates, and involve personal judgements and estimates.
e.g. Depreciation is provided based on the estimated useful life of an asset, which involves personal judgement.
Recorded Facts
Financial statements are prepared on the basis of facts in the form of cost data recorded in accounting books. The original cost or historical cost is the basis of recording transactions.
e.g. A machine purchased for Rs. 5,00,000 in 2010 is still shown at Rs. 5,00,000 (less depreciation) even if its market value is now Rs. 8,00,000.
Accounting Conventions
Certain accounting conventions are followed while preparing financial statements, such as valuing inventory at cost or market price, whichever is lower, and valuing assets at cost less depreciation.
e.g. Stationery items like pens and pencils are treated as expenditure in the year of purchase even though they are assets in nature, following the convention of materiality.
Postulates
Financial statements are prepared on certain basic assumptions known as postulates such as going concern postulate, money measurement postulate, and realisation postulate.
e.g. The going concern postulate assumes the enterprise will continue for a longer period, so assets are shown at historical cost rather than liquidation value.
Personal Judgements
Facts and figures presented through financial statements are based on personal opinion, estimates and judgements, such as provisions for doubtful debts and depreciation.
e.g. The provision for doubtful debts is made based on an estimate of how many debtors may not pay, which involves personal judgement.
Objectives of Financial Statements
The primary objective of financial statements is to assist the users in their decision-making. Specific objectives include providing information about economic resources and obligations, earning capacity, cash flows, effectiveness of management, activities affecting society, and disclosing accounting policies.
e.g. A bank uses a company's financial statements to decide whether to grant a loan.
Balance Sheet
A balance sheet is a financial statement that shows all the assets owned by the concern, all the obligations or liabilities payable to outsiders or creditors, and claims of the owners on a particular date. It is prepared as per the format prescribed in Schedule III of the Companies Act, 2013.
e.g. The Balance Sheet of TCS Ltd. as on March 31, 2023 shows its assets like cash, buildings, and liabilities like loans and share capital.
Statement of Profit and Loss
The Statement of Profit and Loss is prepared for a specific period to determine the operational results of an undertaking. It is a statement of revenue earned and the expenses incurred for earning the revenue, showing the profit or loss for the period.
e.g. The Statement of Profit and Loss of Hindustan Unilever Ltd. for the year ended March 31, 2023 shows its sales revenue, costs, and net profit.
Shareholders' Funds
Shareholders' funds are sub-classified on the face of the balance sheet into (a) Share Capital, (b) Reserves and Surplus, and (c) Money received against Share Warrants.
e.g. If a company has issued equity shares of Rs. 10,00,000 and has reserves of Rs. 5,00,000, the shareholders' funds total Rs. 15,00,000.
Share Capital
Share capital includes disclosures for each class of shares such as authorised, issued, subscribed, and paid-up capital, along with rights, preferences, and restrictions. It also includes details of shares held by holding company, shareholders holding more than 5% shares, and shares allotted as bonus or bought back in the last 5 years.
e.g. A company may have 1,00,000 equity shares of Rs. 10 each, fully paid up, shown under share capital.
Reserves and Surplus
Reserves and Surplus are classified into Capital Reserve, Capital Redemption Reserve, Securities Premium Reserve, Debenture Redemption Reserve, Revaluation Reserve, Share Options Outstanding Account, Other Reserves, and Surplus (balance in statement of profit and loss). A debit balance in statement of profit and loss is shown as a negative figure under Surplus.
e.g. Securities Premium Reserve of Rs. 2,00,000 is shown under Reserves and Surplus.
Money Received against Share Warrants
It is the amount received by the company which are converted into shares at a specified date on a specified rate. The instrument issued against the amount so received as share warrants.
e.g. If a company receives Rs. 5,00,000 against share warrants, it is shown as a separate line item under Shareholders' Funds.
Current and Non-current Classification
An item is classified as current if it is involved in the entity's operating cycle, expected to be realised/settled within twelve months, held primarily for trading, is cash or cash equivalent, or if the entity does not have an unconditional right to defer settlement for at least 12 months. Other assets and liabilities are non-current.
e.g. Trade receivables expected to be received within 12 months are current assets; a building is a non-current asset.
Trade Payables
Sundry creditors have been replaced with the term Trade payables and are classified as current and non-current. Trade payables to be settled beyond 12 months from the date of balance sheet or beyond the operating cycle are classified under 'other long-term liabilities'.
e.g. Amounts owed to suppliers for goods purchased on credit are shown as trade payables.
Trade Receivables
Trade receivables realised beyond twelve months from reporting date/operating cycle are classified as 'Other non-current assets' under the head non-current assets. Others are classified as current assets.
e.g. Amounts due from customers for goods sold on credit are shown as trade receivables.
Proposed Dividend
Proposed dividend is proposed by the Board of Directors and declared (approved) by the shareholders in their Annual General Meeting. Since declaration of proposed (final) dividend is contingent upon shareholders' approval, Proposed dividend is shown as contingent liability. AS-4 prescribes that proposed dividend will be shown in the Notes to Accounts.
e.g. If the Board proposes a dividend of Rs. 2 per share, it is shown as a contingent liability until approved by shareholders.
Revenue from Operations
This includes sale of products, sale of services, and other operating revenues. For a finance company, it includes revenue from interest, dividend and income from other financial services.
e.g. A manufacturing company's revenue from operations includes sales of goods manufactured.
Other Income
Other income includes interest income (for non-finance companies), dividend income, net gain/loss on sale of investments, and other non-operating income (net of expenses directly attributable to such income).
e.g. Interest earned on bank deposits is shown as other income.
Finance Cost
Finance cost is the expenses towards interest charges during the year on the borrowings. Only the interest cost is to be shown under this head. Other financial expenses such as bank charges are shown under 'Other Expenses'.
e.g. Interest paid on a bank loan of Rs. 10,00,000 at 10% per annum is Rs. 1,00,000, shown as finance cost.
Depreciation and Amortisation Expense
Depreciation is the diminution in the value of fixed assets whereas amortisation is writing off the amount relating to intangible assets.
e.g. Depreciation on a machine costing Rs. 1,00,000 with a life of 10 years is Rs. 10,000 per year.
Limitations of Financial Statements
Financial statements do not reflect current situation (historical cost), assets may not realise stated values, bias may be present, they show aggregate information, vital information may be missing, no qualitative information, and they are only interim reports.
e.g. A building purchased in 2000 for Rs. 20 lakhs is shown at cost less depreciation, even if its market value is now Rs. 1 crore.
Uses and Importance of Financial Statements
Financial statements report on stewardship function, form basis for fiscal policies, granting of credit, prospective investors, guide to value of investment already made, aid trade associations, and help stock exchanges.
e.g. A bank uses financial statements to assess a company's creditworthiness before granting a loan.
Rounding-off Rule
Rounding off of figures to be reported in the financial statements is based on the size of turnover: if turnover is less than Rs. 100 crore, round to nearest hundreds, thousands, lakhs or millions or decimal thereof; if turnover is more than Rs. 100 crore, round to nearest lakhs or millions or decimal thereof.
e.g. A company with turnover of Rs. 50 crore can show figures in lakhs, e.g., Rs. 1,23,45,678 as Rs. 123.46 lakhs.
Deferred Tax Assets/Liabilities
Deferred tax assets/liabilities are always non-current. This is in accordance with Schedule III of the Companies Act.
e.g. Deferred tax liability arising from timing differences is shown under non-current liabilities.
Formulas & Equations (4)
Total Revenue = Revenue from Operations + Other Income
Reads as: Total Revenue equals Revenue from Operations plus Other Income
Variables: Revenue from Operations: income from main business activities (e.g., sales); Other Income: income from non-core activities (e.g., interest, dividend)
Use when: Calculating total income in the Statement of Profit and Loss before deducting expenses
⚠ Students often forget to include Other Income or double-count items already in Revenue from Operations.
Profit before tax = Total Revenue - Total Expenses
Reads as: Profit before tax equals Total Revenue minus Total Expenses
Variables: Total Revenue: sum of Revenue from Operations and Other Income; Total Expenses: sum of all expenses including cost of materials, employee benefits, finance cost, depreciation, and other expenses
Use when: Calculating profit before tax in the Statement of Profit and Loss
⚠ Students sometimes forget to include all expense heads like finance cost or depreciation, leading to an incorrect profit figure.
Profit/(Loss) for the period = Profit/(Loss) from continuing operations + Profit/(Loss) from discontinuing operations (after tax)
Reads as: Profit or Loss for the period equals Profit or Loss from continuing operations plus Profit or Loss from discontinuing operations after tax
Variables: Profit/(Loss) from continuing operations: profit after tax from ongoing business activities; Profit/(Loss) from discontinuing operations: profit or loss from operations that are being discontinued, net of tax
Use when: Calculating the final net profit or loss for the period in the Statement of Profit and Loss
⚠ Students often forget to include the tax expense on discontinuing operations or add the profit before tax instead of after tax.
Earnings per Equity Share (Basic) = Profit/(Loss) for the period attributable to equity shareholders / Weighted average number of equity shares outstanding
Reads as: Earnings per equity share equals profit or loss for the period attributable to equity shareholders divided by weighted average number of equity shares outstanding
Variables: Profit/(Loss) for the period attributable to equity shareholders: net profit after tax and preference dividend; Weighted average number of equity shares: average number of shares outstanding during the period
Use when: Calculating basic earnings per share as required in the Statement of Profit and Loss
⚠ Students often forget to deduct preference dividend from net profit before calculating EPS.
How It Works
Preparation of Balance Sheet as per Schedule III
  1. Step 1: Identify all items of equity and liabilities and classify them into Shareholders' Funds (Share Capital, Reserves and Surplus, Money received against share warrants), Share Application money pending allotment, Non-current Liabilities, and Current Liabilities.
  2. Step 2: Identify all items of assets and classify them into Non-current Assets (Fixed assets, Non-current investments, Deferred tax assets, Long-term loans and advances, Other non-current assets) and Current Assets (Current investments, Inventories, Trade receivables, Cash and cash equivalents, Short term loans and advances, Other current assets).
  3. Step 3: Arrange the items under the correct major heads and sub-heads as per the prescribed vertical format.
  4. Step 4: Provide Note numbers for each item that requires detailed disclosure, and prepare Notes to Accounts with the necessary breakdowns (e.g., share capital details, reserves and surplus classification, borrowings classification).
  5. Step 5: Ensure current/non-current classification is correctly applied based on the operating cycle or 12-month rule.
  6. Step 6: Apply rounding-off rules based on turnover size.
💡 Students often misclassify items like preliminary expenses (shown under other non-current assets) or loose tools (shown under inventories). Also, remember that proposed dividend is shown as a contingent liability in notes, not as a current liability on the face of the balance sheet.
Preparation of Statement of Profit and Loss as per Schedule III
  1. Step 1: Calculate Revenue from Operations (sales of products/services, other operating revenues).
  2. Step 2: Calculate Other Income (interest, dividend, gain on sale of investments, etc.).
  3. Step 3: Compute Total Revenue by adding Revenue from Operations and Other Income.
  4. Step 4: List all expenses: Cost of materials consumed, Purchases of stock-in-trade, Changes in inventories, Employee benefits expense, Finance costs, Depreciation and amortisation expense, and Other expenses.
  5. Step 5: Calculate Total Expenses.
  6. Step 6: Compute Profit before extraordinary items and tax by subtracting Total Expenses from Total Revenue.
  7. Step 7: Deduct Exceptional items (if any) to get Profit before extraordinary items and tax.
  8. Step 8: Deduct Extraordinary items (if any) to get Profit before tax.
  9. Step 9: Deduct Tax expense (current and deferred) to get Profit/(Loss) for the period from continuing operations.
  10. Step 10: Add or subtract Profit/(Loss) from discontinuing operations (after tax) to get Profit/(Loss) for the period.
  11. Step 11: Disclose Earnings per share (basic and diluted).
💡 Students often confuse 'Exceptional items' and 'Extraordinary items'. Exceptional items are material items that are part of ordinary activities but are unusual in size or nature, while extraordinary items are events clearly distinct from ordinary activities. Also, finance cost includes only interest on borrowings, not bank charges.
Disclosure of Share Capital in Notes to Accounts
  1. Step 1: For each class of shares, disclose authorised, issued, subscribed and fully paid, and subscribed but not fully paid capital with par value.
  2. Step 2: Provide a reconciliation of the number of shares outstanding at the beginning and end of the accounting period.
  3. Step 3: Disclose rights, preferences, and restrictions attached to each class of shares.
  4. Step 4: Disclose shares held by holding company, ultimate holding company, and subsidiaries/associates.
  5. Step 5: Disclose shares held by each shareholder holding more than 5% shares.
  6. Step 6: For the last 5 years, disclose shares allotted as fully paid up without cash, bonus shares, and shares bought back.
  7. Step 7: Disclose shares reserved for issue under options and contracts, calls unpaid, and forfeited shares (amount originally paid up).
💡 Students often forget to include the disclosure of shares held by the holding company and shareholders holding more than 5% shares. Also, the reconciliation of shares outstanding is a common exam question.
Treatment of Proposed Dividend
  1. Step 1: At the end of the financial year, the Board of Directors proposes a dividend (proposed dividend).
  2. Step 2: Since the proposed dividend is contingent upon shareholders' approval at the Annual General Meeting (held in the next financial year), it is shown as a contingent liability in the Notes to Accounts as per AS-4.
  3. Step 3: In the next financial year, after the shareholders declare (approve) the proposed dividend, it becomes a liability and is accounted in the books.
  4. Step 4: The proposed dividend of the previous year, once declared, is recorded as a current liability and paid.
  5. Step 5: The proposed dividend for the current year is again shown as a contingent liability in the notes.
💡 Students often mistakenly show proposed dividend as a current liability on the face of the balance sheet. It is shown as a contingent liability in notes until declared by shareholders.
Classification of Borrowings
  1. Step 1: Identify loans that are repayable in more than twelve months or the operating cycle — classify as long-term borrowings under non-current liabilities.
  2. Step 2: Identify loans repayable on demand or whose original tenure is not more than twelve months or the operating cycle — classify as short-term borrowings under current liabilities.
  3. Step 3: Identify the portion of long-term loans that is repayable within twelve months or the operating cycle — classify as 'current maturities of long-term debt' under other current liabilities with a note to account.
💡 Students often forget to split long-term borrowings into current and non-current portions. The portion due within 12 months must be shown as a current liability.
Exam Traps — Don't Make These Mistakes
⚠ Misclassifying Preliminary Expenses
✗ Students often write preliminary expenses under 'Current Assets' or 'Miscellaneous Expenditure'.
→ As per Schedule III, preliminary expenses are not a separate head. They are written off completely in the year incurred, first from Securities Premium and then from Statement of Profit and Loss. Any unamortised balance is shown under 'Other non-current assets'.
✓ Show preliminary expenses under 'Other non-current assets' in the balance sheet, and in Notes to Accounts, show that they have been written off against Securities Premium and/or Statement of Profit and Loss.
⚠ Showing Proposed Dividend as a Current Liability
✗ Students often show proposed dividend as a current liability on the face of the balance sheet.
→ Proposed dividend is proposed by the Board but not yet declared (approved) by shareholders. It is contingent upon approval, so as per AS-4, it is shown as a contingent liability in Notes to Accounts, not as a liability on the face of the balance sheet.
✓ Show proposed dividend as a contingent liability in Notes to Accounts. Only after declaration by shareholders does it become a current liability.
⚠ Confusing 'Trade Receivables' with 'Bills Receivable' or 'Sundry Debtors'
✗ Students write 'Sundry Debtors' or 'Bills Receivable' as separate items on the face of the balance sheet.
→ Schedule III has replaced 'Sundry Debtors' with 'Trade Receivables'. Bills Receivable is a sub-component of Trade Receivables and should be disclosed in Notes to Accounts, not on the face of the balance sheet.
✓ Show 'Trade Receivables' on the face of the balance sheet under Current Assets, and in Notes to Accounts, provide the breakdown (e.g., Bills Receivable, Debtors).
⚠ Incorrect Treatment of Debit Balance in Statement of Profit and Loss
✗ Students show a debit balance in Statement of Profit and Loss as a separate asset or as a negative figure under a different head.
→ A debit balance in Statement of Profit and Loss (i.e., accumulated losses) is shown as a negative figure under 'Surplus' within 'Reserves and Surplus' under Shareholders' Funds. It reduces the total of Reserves and Surplus.
✓ Show the debit balance as a negative figure under 'Surplus' in Notes to Accounts for Reserves and Surplus. For example, if General Reserve is Rs. 5,00,000 and Statement of Profit and Loss (Dr.) is Rs. 3,00,000, show Reserves and Surplus as Rs. 2,00,000.
⚠ Misclassifying Loose Tools
✗ Students often show loose tools under 'Fixed Assets' or 'Current Assets' as a separate item.
→ Loose tools are classified as 'Inventories' under Current Assets, not as fixed assets. They are part of stores and spares.
✓ Show loose tools under 'Inventories' in the balance sheet, and in Notes to Accounts, include them in the breakdown of inventories.
⚠ Forgetting to Disclose Share Capital Details in Notes
✗ Students only show the total share capital figure on the face of the balance sheet and omit the detailed notes.
→ Schedule III requires extensive disclosures for share capital in Notes to Accounts, including authorised, issued, subscribed, paid-up capital, reconciliation of shares, rights, shares held by holding company, shareholders holding >5%, and details of shares allotted without cash, bonus shares, and buyback in the last 5 years.
✓ Always prepare a detailed Note to Accounts for Share Capital covering all required disclosures as per the chapter.
Compare & Contrast
Classification based on realisation period
Current Assets
Non-current Assets
Current assets are expected to be realised within twelve months or the operating cycle (e.g., cash, trade receivables, inventories), while non-current assets are held for longer than twelve months (e.g., fixed assets, long-term investments, deferred tax assets).
Classification based on settlement period
Current Liabilities
Non-current Liabilities
Current liabilities are expected to be settled within twelve months or the operating cycle (e.g., trade payables, short-term borrowings, short-term provisions), while non-current liabilities are settled after more than twelve months (e.g., long-term borrowings, deferred tax liabilities, long-term provisions).
Nature of funds
Reserves and Surplus
Share Capital
Share Capital represents the amount contributed by shareholders as capital, while Reserves and Surplus are accumulated profits retained in the business (e.g., General Reserve, Securities Premium, Surplus from Statement of Profit and Loss). Both are part of Shareholders' Funds.
Source of income
Revenue from Operations
Other Income
Revenue from Operations is income from the main business activities (e.g., sale of goods or services), while Other Income is income from non-core activities (e.g., interest, dividend, gain on sale of investments).
Exam Focus
Marks pattern: This chapter typically appears in board exams with 2-3 MCQs (1 mark each), 1-2 short answer questions (3 marks each) on classification or disclosure, and 1 long answer question (5-6 marks) requiring preparation of Balance Sheet or Statement of Profit and Loss from given data.
Most asked: Format of Balance Sheet as per Schedule III with classification of items into current/non-current · Format of Statement of Profit and Loss up to profit before tax · Disclosure of Share Capital and Reserves and Surplus in Notes to Accounts · Treatment of Proposed Dividend · Treatment of Preliminary Expenses and Discount on Issue of Shares/Debentures · Classification of items like Loose Tools, Trade Receivables, Trade Payables, Borrowings
Don't skip: Prepare a complete Balance Sheet as per Schedule III from a given list of items (including Notes to Accounts) — carries 5-6 marks.; Prepare a Statement of Profit and Loss from given data showing profit before tax — carries 5-6 marks.; Questions on disclosure of Share Capital and Reserves and Surplus in Notes to Accounts — carries 3-4 marks.
One-Line Revision (read aloud before the exam)
  1. Financial statements are the end products of accounting process, including Balance Sheet, Statement of Profit and Loss, and Cash Flow Statement.
  2. The nature of financial statements includes recorded facts, accounting conventions, postulates, and personal judgements.
  3. The primary objective of financial statements is to assist users in decision-making.
  4. Balance Sheet as per Schedule III is prepared in vertical format with Equity and Liabilities on one side and Assets on the other, classified into current and non-current.
  5. Shareholders' Funds include Share Capital, Reserves and Surplus, and Money received against share warrants.
  6. Reserves and Surplus include Capital Reserve, Capital Redemption Reserve, Securities Premium Reserve, Debenture Redemption Reserve, Revaluation Reserve, Share Options Outstanding Account, Other Reserves, and Surplus.
  7. A debit balance in Statement of Profit and Loss is shown as a negative figure under Surplus in Reserves and Surplus.
  8. Proposed dividend is shown as a contingent liability in Notes to Accounts until declared by shareholders.
  9. Current assets are expected to be realised within 12 months or operating cycle; non-current assets are held longer.
  10. Trade Receivables replace Sundry Debtors; Trade Payables replace Sundry Creditors.
  11. Preliminary expenses are written off completely in the year incurred, first from Securities Premium, then from Statement of Profit and Loss; any balance is shown under Other non-current assets.
  12. Loose tools are classified as Inventories under Current Assets.
  13. Revenue from Operations includes sale of products, services, and other operating revenues.
  14. Finance cost includes only interest on borrowings, not bank charges.
  15. Depreciation is diminution in value of fixed assets; amortisation is writing off intangible assets.
  16. Limitations of financial statements include historical cost basis, bias, aggregate information, and lack of qualitative information.
  17. Financial statements are useful to shareholders, investors, creditors, government, stock exchanges, and trade associations.
  18. Rounding off of figures depends on turnover: below Rs. 100 crore to nearest hundreds/thousands/lakhs/millions; above to nearest lakhs/millions.
  19. Deferred tax assets/liabilities are always non-current.
  20. Current maturities of long-term debt are shown under other current liabilities.

MCQs — 10 Questions with Answers

Q1. Financial statements are prepared primarily on the basis of which principle?

  • A. Historical cost principle ✓
  • B. Current market value principle
  • C. Liquidation value principle
  • D. Replacement cost principle

Answer: A — Financial statements follow the historical cost principle, recording transactions at original cost paid, not market prices; this is the foundation of the recorded facts basis.

Q2. Which postulate assumes that a business will continue to operate indefinitely?

  • A. Money measurement postulate
  • B. Going concern postulate ✓
  • C. Realisation postulate
  • D. Materiality postulate

Answer: B — The going concern postulate assumes the business will operate long-term, so fixed assets are valued at cost rather than liquidation value.

Q3. Why are small items like pens and pencils expensed immediately rather than capitalised as assets?

  • A. Consistency convention
  • B. Materiality convention ✓
  • C. Conservatism convention
  • D. Matching convention

Answer: B — The materiality convention treats insignificant items as expenses in the year purchased to avoid the complexity of tracking minor assets.

Q4. Which of the following is NOT a primary objective of financial statements?

  • A. To provide information about earning capacity
  • B. To establish market prices of company shares ✓
  • C. To judge management effectiveness in using resources
  • D. To provide information about potential cash flows

Answer: B — Financial statements provide historical financial data and performance metrics; they do not establish market share prices—that is determined by stock market forces.

Q5. The realisation postulate in accounting means that revenue should be recorded when:

  • A. Cash is physically received from the customer
  • B. The sale transaction is completed, regardless of payment timing ✓
  • C. The goods are manufactured or produced
  • D. The customer places the order

Answer: B — The realisation postulate records revenue in the period the sale occurs (delivery/transfer of goods), not when cash is received or ordered.

Q6. A fundamental limitation of financial statements prepared under the historical cost principle is that:

  • A. Assets are overstated in value
  • B. Liabilities are understated
  • C. Asset values do not reflect current market prices due to inflation ✓
  • D. Revenue cannot be accurately measured

Answer: C — Historical cost basis means assets are shown at purchase price, not adjusted for inflation or market changes, so balance sheet values may not reflect economic reality.

Q7. Which of the following best illustrates the use of personal judgement in preparing financial statements?

  • A. Recording cash received in the bank account
  • B. Estimating the useful life of machinery to calculate depreciation ✓
  • C. Listing all fixed assets purchased during the year
  • D. Totalling all cash payments made for expenses

Answer: B — Estimating useful life for depreciation requires personal judgment and professional estimates; recording cash or listing assets are factual data, not judgements.

Q8. According to the money measurement postulate, the primary advantage it provides to financial statements is: (A) Assets are always adjusted for inflation (B) Non-monetary assets like brand reputation are included (C) All economic data can be expressed in a common unit—money (D) Future cash flows are predicted with certainty

  • A. Assets are always adjusted for inflation
  • B. Non-monetary assets like brand reputation are included
  • C. All economic data can be expressed in a common unit—money ✓
  • D. Future cash flows are predicted with certainty

Answer: C — The money measurement postulate allows diverse transactions and resources to be expressed in a single monetary unit, enabling comparison and aggregation in financial statements.

Q9. Which two of the following statements about financial statements are correct? (I) They are based solely on recorded facts without personal estimates. (II) They follow accounting conventions to ensure comparability and consistency. (III) They show the current market value of all company assets. (IV) They reflect management's ability to utilise resources effectively.

  • A. Statements (I) and (II) are correct
  • B. Statements (II) and (IV) are correct ✓
  • C. Statements (I) and (III) are correct
  • D. Statements (III) and (IV) are correct

Answer: B — Financial statements include personal estimates (depreciation, provisions); they show historical cost, not market value; but they do follow conventions for comparability and reveal management effectiveness.

Q10. A company purchased machinery for ₹10,00,000 on 1 April 2023. On 31 March 2024, the market value of the machinery is ₹12,00,000. In the Balance Sheet as on 31 March 2024, at what value should the machinery be shown (assuming 10% depreciation)?

  • A. ₹12,00,000
  • B. ₹10,00,000
  • C. ₹9,00,000 ✓
  • D. ₹11,00,000

Answer: C — Under historical cost principle, machinery is shown at cost less depreciation: ₹10,00,000 − (10% × ₹10,00,000) = ₹9,00,000; market value of ₹12,00,000 is ignored.

Flashcards

What is the primary objective of financial statements?

To assist users (shareholders, investors, creditors) in making informed economic decisions about a company's profitability, financial position and cash flows.

Define the 'going concern' postulate in financial statement preparation.

The assumption that a business will continue to operate indefinitely, so fixed assets are recorded at historical cost rather than liquidation value.

Why are inventory and fixed assets shown at historical cost rather than current market value?

Because financial statements follow the cost principle and historical cost basis; current market values would change every period and violate the money measurement postulate.

What is the 'realisation postulate' in accounting?

Revenue is recorded in the period when the sale occurs, not when payment is received, ensuring profit is matched to the correct accounting period.

Name three external users of a company's financial statements.

Investors, tax authorities, creditors (or government, employees, banks, stock exchange regulators).

Which accounting convention is applied when pencils and pens are expensed immediately instead of capitalised as assets?

The convention of materiality — insignificant items are treated as revenue expenses in the year purchased to avoid complex asset tracking.

What is the fundamental limitation of using historical cost in financial statements?

Historical cost does not reflect current market prices or the impact of inflation, so balance sheet asset values may not show a company's true economic position.

State the role of personal judgement in preparing financial statements with one example.

Personal judgement is used to estimate depreciation of fixed assets based on useful life, provision for doubtful debts, and inventory valuation methods.

How do accounting conventions ensure financial statements are useful?

Conventions like consistency, materiality, and conservatism make statements comparable across periods, simple to understand, and realistic for decision-making.

Which three financial statements form the complete financial reporting package of a company?

Balance Sheet (position statement), Statement of Profit and Loss (performance), and Cash Flow Statement (cash movements).

Important Board Questions

Define financial statements and state the three main statements that form a company's complete financial reporting package. [2 marks]

Define as 'formal annual reports communicating financial information.' Name: Balance Sheet (position), Statement of Profit & Loss (performance), Cash Flow Statement (liquidity).

Explain with examples how four accounting postulates (going concern, money measurement, realisation, materiality) influence the preparation of financial statements. Why is each postulate important? [5 marks]

Going concern: assets at cost not liquidation value. Money measurement: diverse items in one unit. Realisation: revenue when earned. Materiality: small items expensed. Link each to practical impact on reported figures.

A company's Balance Sheet shows machinery at ₹5,00,000 (cost ₹10,00,000 less ₹5,00,000 accumulated depreciation). The current market value is ₹8,00,000. Critically analyse: (a) Why is machinery not shown at ₹8,00,000? (b) What is the limitation this creates for financial statement users? (c) How does the 'going concern' postulate justify this treatment? [6 marks]

Apply historical cost principle, explain market value vs recorded value gap. Discuss limitation: users don't see current position. Justify going concern: assets for long-term use, not immediate sale. Link conservatism and objectivity reasons.

Assertion-Reason Questions for Financial Statements of a Company

Q1. Assertion (A):

Financial statements are prepared based on recorded facts in monetary terms using historical cost basis.

Reason (R):

Historical cost basis ensures that financial statements reflect the current market values of all assets and liabilities of the business.

Answer: C — A is true but R is false — The assertion is correct - financial statements ARE prepared on recorded facts using historical cost. However, the reason is false. Historical cost does NOT ensure current market values; in fact, it explicitly does NOT reflect current market values. The reason contradicts a fundamental limitation of financial statements mentioned in the study material. A student choosing 'B' (both true but reason not the correct explanation) would miss this critical distinction.

Q2. Assertion (A):

The Going Concern Postulate assumes that a business enterprise will continue to operate indefinitely.

Reason (R):

Under this postulate, assets are shown at historical cost rather than their current market value or liquidation value.

Answer: A — Both A and R are true, and R is the correct explanation of A — Both the assertion and reason are correct, and the reason correctly explains why the assertion matters. If a business is assumed to be a going concern (continuing indefinitely), then historical cost is appropriate because we don't need immediate market values (as would be needed for liquidation). The study material confirms both parts: 'Going concern postulate assumes that the enterprise is treated as a going concern and exists for a longer period of time. So the assets are shown on historical cost basis.'

Q3. Assertion (A):

Personal judgements and estimates are completely eliminated from financial statements by using accounting conventions and principles.

Reason (R):

Accounting conventions like materiality and conservatism require personal judgements to be made about depreciation, doubtful debts, and inventory valuation.

Answer: D — A is false but R is true — The assertion is false - the study material clearly states that personal judgements CANNOT be completely eliminated and are actually necessary. The reason is correct - conventions do require personal judgements. Since the assertion is false, the answer is 'D'. A student might choose 'B' thinking that conventions help reduce judgements, but the study material indicates conventions actually structure how judgements are made, not eliminate them.

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Case-Based Questions (CBQ) for Financial Statements of a Company

Case Study:

Apex Ltd., a manufacturing company, had a net profit of ₹15,00,000 for the year ended 31st March 2026. It proposed a dividend of ₹3,00,000 and transferred ₹1,50,000 to General Reserve. The company also had a balance of ₹2,00,000 in the Securities Premium Reserve account, which it used to issue fully paid bonus shares of ₹1,00,000 to its shareholders.

Q1. What is the total amount that will be shown under 'Reserves and Surplus' in the Balance Sheet of Apex Ltd. after the above appropriations, assuming the opening balance of Reserves and Surplus was ₹5,00,000?

  • A. ₹17,50,000
  • B. ₹18,50,000 ✓
  • C. ₹16,50,000
  • D. ₹19,00,000

Answer: B

Q2. The transfer of ₹1,50,000 to General Reserve will be shown in the Statement of Profit and Loss under which heading?

  • A. Other Expenses
  • B. Appropriations ✓
  • C. Finance Costs
  • D. Exceptional Items

Answer: B

Q3. The issue of bonus shares of ₹1,00,000 using Securities Premium Reserve will:

  • A. Increase the Share Capital and decrease the Securities Premium Reserve ✓
  • B. Decrease the Share Capital and increase the Securities Premium Reserve
  • C. Increase both Share Capital and Securities Premium Reserve
  • D. Decrease both Share Capital and Securities Premium Reserve

Answer: A

Q4. If the proposed dividend of ₹3,00,000 is not yet paid by the year-end, how will it be classified in the Balance Sheet?

  • A. As a Current Liability under 'Other Current Liabilities' ✓
  • B. As a Non-Current Liability under 'Long-Term Provisions'
  • C. As a deduction from Reserves and Surplus
  • D. It is not recorded in the Balance Sheet until paid

Answer: A

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Previous Year Questions (PYQ) for Financial Statements of a Company

Real CBSE board exam questions from past papers — free to attempt.

CBSE 2026 · Set 67/3/1 · 1 mark

Which of the following is a financial statement of a company?

  • Common Size Statement of Profit and Loss
  • Statement of Profit and Loss
  • Comparative Balance Sheet
  • Comparative Statement of Profit and Loss

CBSE 2026 · Set 67/3/1 · 3 marks

Classify the following items under major heads and sub-heads (if any) in the Balance Sheet of a company as per Schedule-III, Part-I of the Companies Act, 2013: (i) Prepaid insurance (ii) Securities Premium (iii) Design

CBSE 2026 · Set 67/3/2 · 3 marks

Classify the following items under major heads and sub-heads (if any) in the Balance Sheet of a company as per Schedule-III, Part-I of the Companies Act, 2013: (i) Outstanding Salary (ii) Capital work-in-progress (iii) Stores and Spare parts

CBSE 2026 · Set 67/3/2 · 3 marks

From the following information of GV Ltd., prepare a Comparative Statement of Profit and Loss for the years ended 31st March, 2024 and 2025: Particulars Note No. 2024-25 2023-24 Revenue from operations 30,00,000 20,00,000 Cost of revenue from operations 50% of revenue from operations 50% of revenue from operations Other Expenses 7,50,000 5,00,000 Tax Rate 50% 50%

CBSE 2026 · Set 67/3/2 · 4 marks

(b) From the following information, prepare a Statement of Profit and Loss for the year ended 31st March, 2025: Revenue from operations 15,00,000 Opening inventory 2,00,000 Gross profit is 25% of cost of revenue from operations. Closing inventory was 2 times the opening inventory.

CBSE 2026 · Set 67/3/3 · 3 marks

Classify the following items under major heads and sub-heads (if any) in the Balance Sheet of a company as per Schedule-III, Part-I of the Companies Act, 2013: (i) Unclaimed dividend (ii) Trademarks (iii) Vehicles

CBSE 2026 · Set 67/4/1 · 3 marks

Classify the following items under major heads and subheads (if any) in the Balance Sheet of the company as per Schedule III, Part I of the Companies Act, 2013: (a) Interest Accrued on Investments (b) Calls-in-Advance (c) Mortgage Loans

CBSE 2026 · Set 67/4/2 · 3 marks

Classify the following items under major heads and sub-heads (if any) in the Balance Sheet of the company as per Schedule III, Part I of the Companies Act, 2013: (a) Bills Payable (b) Public Deposits (c) Accrued Income

CBSE 2026 · Set 67/4/3 · 3 marks

Classify the following items under major heads and sub-heads (if any) in the Balance Sheet of the company as per Schedule III, Part I of the Companies Act, 2013: (a) Licenses and Franchise (b) Capital Advance (c) Stores and Spares

CBSE 2026 · Set 67/4/3 · 3 marks

From the following information, prepare a Comparative Statement of Profit and Loss of YX Ltd. for the year ended 31st March, 2025: Particulars 2024-25 () 2023-24 () Revenue from Operations 30,00,000 20,00,000 Other Income (% of Revenue from Operations) 60% 50% Employee Benefit Expenses 12,00,000 6,00,000 Tax Rate 40%

CBSE 2026 · Set 67/5/1 · 3 marks

The following information was extracted from the Statement of Profit and Loss of Chaman Ltd. for the year ended 31st March, 2025: Particulars (31.3.2025 / 31.3.2024): Revenue from operations (40,00,000 / 32,00,000); Employee Benefit Expenses (20,00,000 / 16,00,000); Other Expenses (2,00,000 / 4,00,000); Tax Rate 50%. Prepare a Comparative Statement of Profit and Loss.

CBSE 2026 · Set 67/5/1 · 3 marks

Under which major head and sub-heads (if any) will the following items be presented in the Balance Sheet of a company as per Schedule III, Part I of the Companies Act, 2013? (i) Demand deposits with banks (ii) Long-term loans (iii) Livestock

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Class 12 Accountancy Previous Year Questions, Chapter-wise

All 1230 CBSE board questions from 2022–2026, sorted by chapter and question type. Free PDF download.

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