Financial Statements of a Company

This page contains the CBSE accountancy class 12 chapter Financial Statements of a Company. You can find the questions/answers/solutions for the chapter 8 of CBSE class 12 accountancy in this page. So is the case if you are looking for CBSE class 12 Commerce related topic Financial Statements of a Company. This page contains theretical questions, Test Your Understanding, Do It Yourself, Short Answers and Long Answers. If you’re looking for Numerical Questions Solutions, you can find them at Numerical Questions Solutions

Do it yourself
Classify the following items in the balance sheet of a company under Major heads and Sub-heads
S.No.
Items
Major Head
Sub-head (if any)
1.
Goodwill
Non-current Assets
Fixed Assets (Intangible Assets)
2.
Forfeited shares
Shareholders’ Funds
Share Capital (Subscribed Capital)
3.
Acceptances
Current Liabilities
Trade Payables
4.
Preliminary expenses
Current Assets
Other Current Assets
5.
Capital reserve
Shareholders’ Funds
Reserves and Surplus
6.
Loans from banks
Non-Current Liabilities
Long-term Borrowings
7.
Investment in shares and debentures
Non-current Assets
Non-current Investments
8.
Interest accrued and due on debentures
Current Liabilities
Other Current Liabilities
9.
Interest accrued but not due on Secured Loans
Current Liabilities
Other Current Liabilities
10.
Interest accrued but not due on Unsecured Loans
Current Liabilities
Other Current Liabilities
11.
Interest accrued on Investments
Current Assets
Other Current Assets
12.
Surplus
Shareholders’ Funds
Reserves and Surplus
13.
Securities Premium Reserve
Shareholders’ Funds
Reserves and Surplus
14.
Loose Tools
Current Assets
Inventories
15.
Provision for Taxation
Current Liabilities
Short-term Provisions
16.
Under writing Commission
Current Assets
Other Current Assets
17.
Bills of Exchange
Current Liabilities (for Bills Payable)/ Current Assets (for Bills Receivable)
Trade Payables (for Bills Payable)/Trade Receivables (for Bills Receivable)
18.
Unclaimed dividend
Current Liabilities
Other Current Liabilities
19.
Short term loans & advances
Current Assets
Short-term Loans and Advances
20.
Live stock
Non-Current Assets
Fixed Assets -> Tangible Assets
21.
Calls unpaid/calls in arrears
Shareholders’ Funds
Share Capital
This is shown as a deduction from Subscribed Capital shown as “Subscribed but not fully paid”.
22.
Uncalled liability on shares partly paid
Commitments in Notes to Accounts
Commitments in Notes to Accounts
23.
Pre-paid Insurance
Current Assets
Other Current Assets
24.
Stores and spare parts
Current Assets
Inventories
25.
Advances from customers
Current Liabilities
Other Current Liabilities
26.
Debentures redemption reserve
Shareholders’ Funds
Reserves and Surplus
27.
Premium on redemption of debentures
Non-current Liabilities
Long-term Borrowings
28.
Loss on issue of debentures
Current Assets (if written-off within 12 months) / Non-Current Assets (if written-off after 12 months)
Other Current Assets (if written-off within 12 months) / Other Non-Current Assets (if written-off after 12 months)
29.
Debentures redemption fund
Shareholders’ Fund
Reserves and Surplus
30.
Debentures redemption fund investment
Current Assets
Current Investments
31.
Vehicles
Non-Current Assets
Fixed Assets (Tangible Assets)
32.
Advances to suppliers
Current Assets
Short-term loans and advances
33.
Patents, trademarks, design
Non-current Assets
Fixed Assets (Intangible Assets)
34.
Calls in advance
Current Liabilities
Other-current Liabilities
35.
Deposits with custom authorities
Current Assets
Short-term Loans and Advances
36.
Arrears of fixed cumulative dividend
Contingent Liabilities and Commitments
It is shown as Contingent Liabilities and Commitments in Notes to Accounts
37.
Furniture and fittings
Non-current Assets
Fixed Assets (Tangible Assets)
38.
Brokerage on issues of shares
Non-Current Assets
Other Non-Current Assets
39.
Statement of profit & loss (Dr.)
Shareholders’ Funds
Reserves and Surplus as negative item.
40.
Capital work-in-progress
Non-Current Assets
Fixed Assets (Capital Work-in-Progress)
41.
Provision for doubtful debts
Current Liabilities
Short-term provisions
42.
Statement of profit & loss (Cr.)
Shareholders’ Funds
Reserves and Surplus
43.
Uncalled liability on partly paid shares held as investments
Commitments in Notes to Accounts
Commitments in Notes to Accounts
44.
Claims against the company not acknowledged as debt
Contingent Liability and hence disclosed in Notes to Accounts
Contingent Liability and hence disclosed in Notes to Accounts
45.
Capital redemption reserve
Shareholders’ Funds
Reserves and Surplus
46.
Public deposits
Non-Current Liabilities
Long-term Borrowings
47.
Authorised Capital
Shareholders’ Funds
Share Capital

Short Answer Questions
1. State the meaning of financial statements?
The financial statements are the basic and formal annual reports used by the corporate management to communicate the financial information to its owners and various other external parties which includes
investors
tax authorities
government
employees etc
The financial statements basically refer to the
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
As statement by AICPA, the financial statements are the statements prepared for the purpose of presenting a periodical review of report on progress by the managemnet and deal with the status of investement in the businesss and results achived during the period under review.

2. What are limitations of financial statements?
The following are the limitations of the financial statements:
1.
Do not reflect current situation: The costs are historical and do not take the changes in the purchasing power of money. Hence they don’t reflect the current market situation.
2.
Assets may not realise: If liquidation is forced on the company, the assets mentioned in the balance sheet might reflect unexpired or unamartised cost. This might happen as the accounting is done on the basis of certain conventions.
3.
Bias: Financial statements are prepared based on the recoded facts, accounting concepts and conventions used and personal judgements. This implies that there will be bias in the preparation of financial statements. So, the financial position projected by the financial statements may not be realistic.
4.
Aggregate Information: As the financial statements reflect aggregate information but not detailed information, they may not help the users much in decision-making.
5.
Vital information missing: Balance sheet does not disclose information relating to loss of markets, and cessation of agreements, which are critical for the enterprise.
5.
No qualitative information: The financial statements reflect only monetary information but not qualitative information like
industrial relations
industrial climate
labour relations
quality of work etc.
6.
They are only interim reports: Statement of profit and loss discloses the profit/loss for a specified period. It doesn’t reflect the earning capacity over time. Similarly, the balance sheets reflect the financial position which is true only at that point of time. However, it does not take into consideration the changes that are likely to occur on a future date.

3. List any three objectives of financial statements?
The primary object of the financial statements is to help the users in their decision-making. The specific objectives include the following:
1.
To provide information about economic resources and obligations of a business: They reflect
adequate
reliable
and periodic
information about economic resources and oblgations of a firm to the investors and other expernal parties who have limited
authority
ability
or resources
to obtain information.
2.
To Provide information about the earning capacity of the business: They provide useful financial information which can be used to
predict
compare
and evaluate
the business firm’s earning capacity.
3.
To provide information about cash flows: They provide useful information to investors and creditors that helps them to
predict
compare
and evaluate
potential cash flows in terms of
amount
timing
and related uncertainities.
4.
To judge effectiveness of management: The provide useful information to judge whether the managment is able to utilise the resources of a business effectively or not.
5.
Information about activities of business affecting the society: They have to report the activities of the business organisation that can affect the society. From this information these activities can be determined and described or measured. This will help to decide which of these activities are thse activities are important in its social environment.
6.
Disclosing accounting policies: These reports should provide the details of the significant policies, concepts followed in the process of accounting, the changes taken up in these policies and concepts during the year/accounting period as compared to previous year/accounting period. This will help to understand these statements in a better way.

4. State the importance of financial statements to :
(i)
shareholders
(ii)
creditors
(iii)
government
(iv)
investors
(i) Importance of financial statements to shareholders: The financial statements report the performance of the management to the shareholders. This will help the shareholders to understand the gap between the management performance and ownership expectation. Based on the financial performance as reported the by the financial statements, the shareholders decide whether to hold or sell or increase their stake in the business.
(ii) Importance of financial statements to creditors: Crediors take decisions regarding the issuing of the loans/purchase of debentures of the business based on the performance of the business. They get the details about the performance of the business from the financial statements.
(iii) Importance of financial statements to the government: Financial statements will be useful for the government as they provide details of the fiscal policies, especially taxation policies adopted by the business and whether the business is complying with these policies or not.
(iv) Importance of financial statements to the investors: The investors get the details about the security and liquidity of their investments and whether the investment is giving them reasonable profitability or not.

5. How will you disclose the following items in the Balance Sheet of a company;
(i)
Current assets, inventory
(ii)
Contigent liabilities in notes to accounts
(iii)
Shareholders Funds, Reserve and Surplus
(iv)
Fixed Assets, Intangible Assets
(v)
Proposed Dividend for the current year
(vi)
Non Current Liabilities
(vii)
Arrears of Dividend on Cumulative Preference Shares.
Items
Main Head
Sub-Head
(i)
Current assets, inventory
Current Assets
Inventory
(ii)
Contingent Liabilities in notes to accounts
Contingent Liabilties
(iii)
Shareholders Funds, Reserve and Surplus
Shareholders’ Funds
Reserves and Surplus
(iv)
Fixed Assets, Intangible Assets
Non-Current Assets
Fixed Assets (Intangible Assets)
(v)
Proposed Dividend for the current year
Current Liabilities
Short-term Provisions
(vi)
Non Current Liabilities
Non-Current Liabilities
(vii)
Arrears of Dividend on Cumulative Preference Shares
Current Liabilities
Other Current Liabilities

Long Answer Questions
1. Explain the nature of the financial statements.
The basis for the preparation of the financial is the facts recorded in chronological order, about the events which are expressed in monetary terms, for a specific defined period of time. The financial statements reveal the financial position as on a date and also reveals the financial results obtained during that perod. The nature of financial statements as stated by AICPA is the statements prepared for the purpose of presenting a periodical review of report on progress by the management and deal with the status of investment in the business and the results acheived during the period under review. They reflect a combination of recorded facts, accounting principles and personal judgements.
The following are the details regarding the nature of financial statements:
1.
Recorded Facts: The financial statements are prepared on the basis of facts. These facts are presented in the form of cost data recorded in accounting books. The basis for recording the transactions is the original cost or historical cost. The figures of various accounts such as
cash in hand
cash at bank
trade receivables
fixed assets etc.,
are taken as per the figures recorded in the accounting books. For instance, the assets purchased at different times and at different prices are put together and shown at costs. As these costs are not based on market prices, the financial statements do no reflect the current financial condition of the business.
2.
Accounting Conventions: When preparing the financial statements certain accounting principles are followed. One such conventions followed is to value the inventory at cost or market price, whichever is lower. For the sake of balance sheet, the convention followed is to value the assets at cost less depreciation. When dealing with small items like
pencils
pens
postage stamps etc.,
the convention of materiality is followed. So, these items are considered as expenses incurred in the year in which they are purchased even though they should be treated as assets in nature. Thus this stationery is valued at cost and is not valued based on the principle of cost or market price, whichever is less. Thus the use of accounting conventions makes the financial statements
comparable
simple
and realistic.
3.
Postulates: When preparing the financial statements, certain basic assumption (pre-requisites) known as postulates such as
going concern postulate
money measurement postulate
realisation postulate etc.,
are followed. Going concern postulate assumes that the enterprise is treated as a going concern and exists for a longer period of time or exists forever. So, the assets are shown on historical cost basis. Money measurement postulate assumes that the value of money will remain the same in different periods. Thus, even though there is a big change in the purchasing power of money from one period to the other, the assets purchased at different times will be shown at the amount paid for them. While preparing the profit and loss statement, the revenue is included for the year in which the sales is done even though the sales price may be recovered over a number of years. This assumption is known as realisation postulate.
4.
Personal Judgements: Under more than one circumstance, the facts and figures presented through the financial statements are based on personal
opinions
estimates
judgements.
For instance, the depreciation is provided taking the useful economic life of the fixed assets into consideration. Provision for doubtful debts are made on the estimates and personal judgements. When the inventory is valued, the cost or market value, whichever is less is followed. When it is required to decide the cost of inventory or market value of inventory, many personal judgements have to be made based on certain considerations. Personal opinion, judgements and estimates are made while preparing the financial statemetns to avoid any posiibility of over statement of assets and liabilities, income and expenditure, keeping in mind the convention of conservatism.

2. Explain in detail about the significance of the financial statements.
The financial statements are used largely by
management
investors
shareholders
creditors
government
bankers
employees
and public etc.
The financial statemnts provide important information about the performance of the management to these parties who are interested in the organisation and they help in taking the necessary economic decisions.
The following are the various details about the significance of the financial statements
1.
Report on stewardship function: The performance of the management is reflected from the financial statemnets. This will help to understand the gap between the owners’ expectations and the management’s performance.
2.
Basis for fiscal policies: The fiscal policies, especially the taxation policies of the governement, are related to the financial performance of the business. The financial statements contain basic information about the
industrial
taxation
and other economic policies
of the governemnt
3.
Basis for granting of credit: Corporate undertakings have to borrow funds from banks and other financial institutions for different purposes. The financial statements provide important information to the credit granting institutions regarding the financial performance of the business and based on this information they take decisions regarding the granting of credit.
4.
Basis for prospective investors: The primary consideration for both short-term and long-term investors regarding their investments is the security and liquidity of their investment with considerable profits. Financial statements provide important information to the investors that will help them to assess the long-term and short-term solvency as well as the profitability of the business.
5.
Guide to the value of the investment already made: Shareholders are keen to know the information regarding
the status
safety
and return
on their investment. They also need information which will help them to decide about whether they should continue their investments in the business or not. The finaincial statements provide important information to the shareholders which will help them to make these decisions.
6.
Aids trade associations in helping their members: Trade associations will analyse the financial statements in order to provide service and protection to their members. From the information available in the financial statements they may develop standard ratios and design uniform system of accounts.
7.
Helps stock exchanges: Financial statements provide important information to the stock exchanges that will help them to understand the extent of transparency in reporting on financial performance of the business. This will help them to call for required information to protect the interest of the investors. The financial statements also provide important information to the stock brokers and help them to judge the financial position of the different concerns and take decisions about the prices to be quoted.

3. Explain the limitations of financial statements.
The following are the limiations of the financial statements
1.
Do not reflect current situation: The financial statements are prepared on the basis of historical cost. As the purchasing power of money will be changing over time, the values of the assets and liabilities shown in the financial statements do not reflect the current market situation.
2.
Assets may not realise: Accounting is done on the basis of certain conventions. Some of the assets may not realise the stated values, if the liquidation is forced on the company. Assets shown in the balance sheet reflect the unexpired or unamortised cost.
3.
Bias: Financial statements are the outcome of
recorded facts
accounting concepts
conventions used
personal judgements
taken in different situations by the accountants. Due this, there might be bias in the results. So, the financial position as projected by the financial statements might deviate from the real financial position.
4.
Aggregate information: Financial statements show only aggregate information but not the detailed information. So, this aggregate information may not be of much help to the users in making certain decisions.
5.
Vital information missing: Balance sheets do no disclose information related to loss of markets and cessassion of agreements etc. These details will have significant impact on the business. But this vital information will be missing from the financial statements.
6.
No qualitative information: Financial statements contain only monetary information but not qualitative information like
industrial relations
industrial climate
labour relations
quality of work etc.
7.
They are only interim reports: Statement of profit and loss project the profit/loss for a specified period of time. It does not give an idea about the earning capacity over time. Similarly, the financial position reflected in the balance sheet is true only at that point of time. The change in the financial statement that is likely to occur on a future date is not depicted.

4. Prepare the format of statement of profit and loss and explain its items upto the ascertainment of profit before tax.
The following is the format of statement of profit and loss.
Statement of Profit and loss for the year ended ……..
S.No
Particulars
Note
No.
Figure as at the end of current reporting period
Figure as at the end of Previous reporting period
I
Revenue from operations
II
Other income
III
Total Revenue (I + II)
IV
Expenses
Cost of Material consumed
Purchases of stock-in-trade
Changes in inventories of finished goods
Work-in-progress and stock-in-trade
Employee benefits expense
Finance costs
Depreciation and amortisation expenses
Other expenses
Total Expenses
V
Profit before exceptional and extraordinary items and tax (V – IV)
VI
Exceptional items
VII
Profit before extraordinary items and tax (V – VI)
VIII
Extraordinary items
IX
Profit before tax (VII – VIII)
X
Tax expense:
(1)
Current tax
(2)
Deferred tax
XI
Profit/(Loss) for the period from continuing operations (IX – X)
XII
Profit/(Loss) from discontinuing operations
XIII
Tax expense of discontinuing operations
XIV
Profit/(Loss) from Discontinuing operations (after tax) (XII – XIII)
XV
Profit/(Loss) for the period (XI + XIV)
XVI
Earnings per equity share:
(1)
Basic
(2)
Diluted
The explanation of the terms upto the ascertainment of profit before tax are as follows:
1.
Revenue from operations:
This includes the revenue earned from basic operations of the business through
(i)
Sale of products
(ii)
Sale of services
(iii)
Other operating revenues.
In addition to this, in case of a finance company the revenue operations includes the revenue from
(i)
interest
(ii)
dividends
(iii)
and other financial services
2.
Other income:
This includes the income from sources other than the basic operations of the business such as
(i)
Interest income (for a non-finance company)
(ii)
Dividend income (for a non-finance company)
(iii)
Net gain/loss on sale of investments.
(iv)
Other non-operating income (This should be net of expenses. In otherwords, the income after deducing the expenses directly related to this income)
3.
Expenses
This includes the expenses incurred to earn income shown under various heads as mentioned below:
Expense
(a) Cost of materials
This applies to manufacturing companies. It comprises of raw materials and other materials consumed in the manufacturing of goods.
(b) Purchase of Stock-in-trade
It means purchase of goods for the purpose of trading.
(c) Changes in inventories of finished goods WIP and stock-in-trade
It is the difference between the operning inventory (stock) of finished goods, WIP and stock-in-trade and closing inventory.
(d) Employees benefit expenses
Expenses are incurred on employees towards
salary
wages
leave encashment
staff welfare etc.,
are shown under this head. Employees benefit expenses may be further categorized into direct and indirect expenses.
(e) Finance cost
It is the expense towards interrest charges during the year on the borrowings. Only the interest cost is to be shown under this head. Other financial expense such as bank charges are shown under “Other Expenses”.
(f) Depreciation
Depreciation is the diminition in the value of fixed assets whereas amortisation is writing off the amount relating to intangible assets.
(g) Other expenses
All other expenses which do not fall in the above categories are shown under other expenses. Other expenses may further be categorised into
direct expenses
indirect expenses
non-operating expenses

5. Prepare the format of balance sheet and explain the various elements of balance sheet.
The following is the format of balance sheet.
Balance sheet as at ……….
Particulars
Note
No.
Figure as at the end of Current reporting period
Figure as at the end of the Previous reporting period.
I. EQUITY AND LIABILITIES
1) Shareholders’ Funds
(a) Share Capital
(b) Reserves and Surplus
(c) Money received against share warrants
2) Share Application Money Pending Allotment
3) Non-current Liabilities
(a) Long term borrowings
(b) Deferred tax liabilities (net)
(c) Other long term liabilities
(d) Long term provisions
4) Current Liabilities
(a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions
Total
 
II. ASSETS
1) Non-Current Assets
(a) Share Capital
(i) Tangible Assets
(ii) Intangible Assets
(iii) Capital work-in-progress
(iv) Intangible assets under development
(b) Non-Current Investments
(c) Deferred tax assets (net)
(d) Long-term loans and advances
(e) Other non-current assets
2) Current Assets
(a) Current investments
(b) inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and advances
(e) Other current assets
Total
 
The following is the explanation of the various elements of the balance sheet:
I. 1) Share holders’ Funds The share holders funds consists of the following:
a.
Share Capital: It includes the following items
i.
Authorised capital
ii.
Issued share capital
iii.
Subscribed share capital
iv.
Called-up share capital
v.
Paid-up share capital
vi.
Share forfeiture money
b.
Reserves and Surplus: It includes the following items.
i.
Capital Reserve
ii.
Capital Redemption Reserve
iii.
Securities Premium Reserve
iv.
Debenture Redemption Reserve
v.
Revaluation Reserve
vi.
Share Options Outstanding account
vii.
Other Reserves (Specifying nature and purpose)
viii.
Surplus: Balance in statement of profit and loss account. It should disclose allocations and appropriation such as dividend, bonus shares transfer to/from reserve, etc.
c.
Money received against warrants: This is the money received by the company when the holders of a specifc instrument (for example debentures) convert their holdings into equity shares. This is disclosed as a separate line item under shareholders’ fund.
I 2) Share Application Money Pending Allotment: This is the application money received on shares. However, these shares are not yet alloted to shareholders at the time the financial statements are prepared. In other words, they are scheduled to be alloted at a later date. This is share application money pending allotment.
I 3) Non-Current Liabilities: They include the items satisfying the following criteria:
a.
They last beyond the entity’s operating cycle.
b.
Expected to be realised/settled beyond twelve months
c.
the primary purpose of holding them is not trading
d.
the entity have the unconditional rights to defer settlement of liability beyond 12 months after the reporting period.
e.
Other liabilities that are not current.
I 4) Current Liabilities: They include the items satisfying the following criteria:
a.
They are involved in the entity’s operating cycle.
b.
Expected to be realised/settled within twelve months
c.
the primary purpose of holding them is trading
d.
the entity does not have the unconditional rights to defer settlement of liability beyond 12 months after the reporting period.
e.
Other liabilities that are not non-current.
II 1) Non-Current Assets: They include the items satisfying the following criteria:
a.
They last beyond the entity’s operating cycle.
b.
Expected to be realised/settled beyond twelve months
c.
the primary purpose of holding them is not trading
d.
Other assets that are not current.
II 2) Current Assets: They include the items satisfying the following criteria:
a.
They are involved in the entity’s operating cycle.
b.
Expected to be realised/settled within twelve months
c.
the primary purpose of holding them is trading
d.
cash and cash equivalent
e.
Other assets that are not non-current.
6. Explain how financial statements are useful to the various parties who are interested in the affairs of an undertaking?
The financial statements are useful to the various parties who are interested in the affairs of an undertaking as follows. The usefulness for various parties is depicted by classifying the parties into the major and minor criteria as follows:
Various Parties Interested in financial Statements
 
 
Internal Parties
External Parties
 
 
Owners
Management
Employees and Workers
Government
Tax Authorities
Investors
Bank and Other Financial Institutions
Creditors
Trade Associations
Stock Exchanges
Consumers
General Public
1. Internal Parties: The following are the details of the usefulness of the various internal parties who are interested in the affairs of an undertaking.
1.
Owners: The owner(s) are interested in the profitability of the concern as well as assessing the concern’s short and long term solvency as well as the gap between the owners’ expectations and the management’s performance. Their main concern is regarding whether the resources of the firm are used most efficiently and also whether the firm’s financial condition is sound. The financial statements also help them to measure the success of the company’s operations.
2.
Management: The management is interested in gauging their performance, identify the gap between their performance and owner’s expectations. The financial statements also help the managment in
drafting different policies and implement them
planning and decision making
implement cost controlling measures
improve the operations/process efficiencies
They use the financial statements to measure the success of operations, appraising the individual’s performance and evaluating the system of internal control.
3.
Employees and Workers/ Labour Unions: The financial statements provide the employees and workers with the information to help them to know about
Whether the concern is capable of paying their salaries and wages in the coming days
issue of bonus and hikes
possibility of promotions
possibility of any other additional employee benefits etc.
They mainly look for whether the business can absorb an increase in the pay through increased productivity or by raising the prices of the products or services.
II. External Parties: The following are the details of the usefulness of the various external parties who are interested in the affairs of an undertaking.
1.
Government: The financial statements provide the government about the information required for determination of GDP, industrial growth and national income etc. They also get an idea about compliance of the concern with the various fiscal and economic policies and taxation policies. This will further help the government to take important decisions and bring about new policies to control various economic issues like unemployment, poverty etc.
2.
Tax Authorities: The tax authorities are interested to know about the compliance with the taxation policies. They would also be interested in the sales, revenues, profits and the taxable income and the amount of tax paid/deferred.
3.
Investors: The investors would like to know about the profitability of the concern and also information related to the short and long term solvency. They will be looking for security and liquidity of thier investment with reasonable profitability.
4.
Banks and Other Financial Institutions: Corporate undertakings borrow funds from banks and other financial institutions. These finance institutions will depend on the information in the financial statements to take decisions about granting credit to the concern based on the financial performace of the undertakings. So, they look for
Liquidity
Solvency
Creditworthiness
and Profitability
Their major concern will be to know about the ability of the firm to be profitable and generate cash and its ability to pay the interest and repay the principal.
5.
Creditors: These are the vendors from whom the business purchases goods/services on credit. They look for the credit worthiness of the business to repay their credit in the shortest possible time and also the liquidity of the business. This will help them to take decisions regarding continuing the business with the firm on credit in future.
6.
Trade Associations: Trade assiciations analyze the financial statements so as to provide service and protection to their members. They may develop standard ratios and design uniform system of accounts.
7.
Stock Exchanges: Stock exchanges look for the extent of transparancy in reporting and financial performance. This enables them to call for required information to protect the interest of investors. Stock borkers use this information to judge the financial position of different concerns and take decisions about the prices to be quoted.
8.
Consumers: Consumers look for future sustainability of the business to provide after sales-service at reasonable and at affordable price. The financial statements help the consumers to gauge the transparency in the cost and help them in making decisions about the purchase of the products/services from the business.
9.
General Public: The general public is interested in the allocation of funds by the business for various environmental protection and welfare projects undertaken by the business.
7. ‘Financial statements reflect a combination of recorded facts, accounting conventions and personal judgements’. Discuss.
The basis for the preparation of financial statements is the events expressed in monetary terms in chronological order for a defined period of time. They reveal the financial position on a specific date and project the financial results obtained during a period. They reflect a combination of recorded facts, accounting principles and personal judgements as explained below:
1.
Recorded Facts: The financial statements are prepared on the basis of facts that exist in the form of cost data recorded in accounting books. The original cost or historical cost is the basis of recording transactions. The entries or summaries of various accounts such as
Cash in Hand
Cash at Bank
Trade Receivables
Fixed Assets etc.,
are taken as per the figures recorded in the accounting books. The various assets purchased at different times and at different prices are put together and shown at costs. As these are not based on current market prices, the financial statements do not show current financial condition of the concern.
2.
Accounting Conventions: The financial statements are prepared based on certain accounting conventions. The convention of valuing inventory at cost or makrket price, whichever is lower, is followed. The valuing of assets at cost less depreciation principle for balance sheet purposes is followed. The convention of materiality is followed in dealing with small items like pencils, pens, postage stamps etc. These items are treated as expenditure in the year in which they are purchased even though they are assets in nature. The stationary is valued at cost and not on the principle of cost or makrket price whichever is less. The use of accounting conventions makes financial statements
comparable
simple
realistic
3.
Postulates: Financial statements are prepared on certain basic assumption (pre-requisites) known as postulates. Few of the postulates are
going concern postulate
money measurement postulate
realisation postulate etc.,
Going concern postulate assumes that the enterprise is treated as a going conern and exists forever. So, the assets are shown on historical cost basis. Money measurement postulate assumes that the value of money will remain the same in different periods. However, there is a huge difference in the purchasing power of money over a period of time. But the assets purchased at differnt times will be shown at the amount paid for them. While preparing the statement of profit and loss, the revenue is included in the sales of the year in which the sales was undertaken even though the sale price may be received over a number of years. This assumption is known as realisation postulate.
4.
Personal Judgements: In more than one occurence, facts and figures represented through financial statements are based on
personal opinion
estimates
and judgements
The depreciation is provided taking into consideration the useful economic life of fixed assets. Provisions for doubtful debts are made on estimates and personal judgements. In valuing inventory, cost or market value, whichever is less is being followed. While deciding either cost of inventory or market value of inventory, many personal judgements are to be made based on certain considerations. Personal opinion, judgements and estimates are made while preparing the financial statements to avoid any possibility of over statement of assets and liabilities, income and expenditure, keeping in mind the convention of conservatism.
Through this discussion we can come to the conclusion that the Financial statements reflect a combination of recorded facts, accounting conventions and personal judgements
8. Explain the process of preparing income statement and balance sheet.
The following steps are followed in the process of preparing income statement
1.
Gather the balances from various ledger accounts and prepare a trial balance.
2.
Calculate the revenue from operations. This can be calculated as
Revenue from operations
= Sales – Sales Returns
3.
To the revenue from operations calculated above add other incomes like profit on sale of assets, commission received etc.
4.
From the total revenues, subtract the expenses such as cost of goods consumed, depreciation, finance cost etc. This will give profit before tax.
5.
The profit or loss for the accounting period is calculated by subtracting the tax from the profit before tax.
The following steps are followed in the process of preparing balance sheet in the vertical format.
I.
Record the following items under the head Equity and Liabilities.
1
Shareholders Funds
2
Share Application Money Pending Allotment
3
Non-Current Liabilities
4
Current Liabilities
II.
Record the following items under the Assets.
1.
Non-Current Assets. This includes
a.
Fixed Assets
b.
Non-Current Investments
c.
Deferred tax assets (net)
d.
Long-term loans and advances
e.
Other non-current assets
2.
Current Assets. This includes
a.
Current Investments
b.
Inventories
c.
Trade receivables
d.
Cash and cash equivalents
e.
Short term loans and advances
f.
Other current assets
III.
At the end the heads Equity and Liabilities and Assets are totalled. The total of both the heads should be equal.