FINANCIAL STATEMENTS ‘The significance of financial statements is given below: 1. Balance Sheet or Position Statement: Balance sheet is a statement showing the nature and amount of a company’s assets on one side and liabilities and capital on the other. In other words, the balance sheet shows the financial position on a particular date usually at the end of one year period. Balance sheet shows how the money has been made available to the business of the company and how the money is employed in the business. 2. Profit and Loss Account or Income Statement: Earning profit isthe principal objective of all business enterprises and Profit and Loss Account or Income Statement is the document which indicates the extent of success achieved by a business in meeting this objective. Profits are of primary importance to the board of directors in evaluating the management of a company, to sharcholders or potential shareholders in making investment decisions and to banks and other creditors in judging the loan repayment capacities and abilities of the company. It is because of this that the profit and loss or income statement is regarded as the primary statement and commands a careful scrutiny by all interested parties. It is prepared for a particular period which is mentioned along with the tile of these statements, which includes the name of the business firm also. 3. Statement of Retained Earnings: This statement is also known as Profit and Loss Appropriation Account and is generally a part of the Profit and Loss Account. This statement shows how the profits of the business for the accounting period have been utilised or appropriated towards reserves and dividend and how much of the same is carried forward to the next period. The term ‘retained earnings’ means the accumulated excess of earnings over losses and dividends. The balance shown by Profit and Loss Account is to be transferred to the Balance Sheet through this statement after making necessary appropriations. 4. Cash Flow Statement: This is a statement which summarises for the period, the cash available to finance the activities of an organisation and the uses to which such cash have been put. A statement of cash flow reports cash receipts and payments classified according to the organisation's major activities i.e. operating activities, investing activities and financing activities. This statement reports the net cash inflow or outflow for each activity and for the overall business. ‘The cash flow statement is to be prepared according to the Accounting Standard-3 (Revised) “Cash Flow Statement’, The details of this statement have been discussed in a separate study. Nature of Financial Statements Financial statements are prepared for the purpose of presenting a periodical review or report on the Progress by the management and deal with the (a) status of the investments in the business and (b) results achieved during the period under review. The data exhibited in these financial statements are the result of the combined effect of (i) recorded facts; (ii) accounting conventions; (iii) postulates oFChapter 5 Fanci Statements: Abst and nerpretaton a 5S sumptions made co implement conventional procedures i ; applications of conventions and postulates; and © — “a ea Judgements used = furors are explained below: g standards and guidance notes. 1, Recorded Facts: The term ‘recorded facts means ooks, such as cash i = Le ene hhand, cash at bank, bills receivables, bills payable, debtors, creditors, fixed sry » Mages, capital and so forth. These items are listed on the basis of historical records of the ‘ansactions and valued at the price at which such transactions took place. Facts ich have not b P i oe em ae eae — accounting books are not depicted in the financial statements, facts which have been recorded in the accounting 2 Accounting ceed Accounting conventions have reference to certain fundamental accounting, principle, ch appietions of which has been sanctified by long usage. For example, on account of the eon conservation, provision is made for expected losses but expected profits are ignored. 3. Postulates: This assumption is referred to as the permanency postulate, and the assets of the business are valued under this assumption at cost less depreciation. In absence of this assumption, the assets may have to be valued at realisable value which may be negligible if the business is not a going concern. Another postulate which accountants make is the monetary postulate. It is the tacit assumption that the value of money, that is its purchasing power, remains constant over different periods. The accountants does not take into consideration the price-level changes while valuing various assets in different periods. Of late, however, accountants in the west have shown growing consciousness for incorporating price-level changes while preparing financial statements. A third postulate is the realisation postulate which takes cognizance of the time lag beween production and sales affected. Under this postulate entire revenue is considered to be earned at the moment the sales take place and not at the time when the production took place. This postulates forms the basis for the convention of matching costs with revenues, where under, the costs incurred in the past period are brought forward to be accounted for against the revenues earned at a later period. 4. Personal Judgements: It may be noted that the application of conventions, assumptions or postulates depends on the personal judgements of the accountant. For example, the choice of selecting methods of depreciation, the mode of amortisation of fictitious assets, the method of valuation of stock, calculation of provision for doubtful debts, etc. depend on the personal judgements of the accountant, However, the existence of consistency principle serves as a check on the power of the accountant to use his personal judgement. Since the accountant is guided by the past practices, the area of application of his personal judgement is reduced. Objectives of Financial Statements . ‘According to author every one both internal stake cents are necessary for shareholders and potential ‘The number and types of people interested in Who is interested in financial statement analysis? holder and external stake holder. Financial statem shareholders, in addition to management and creditors. financial statements have changed radically in recent times. it rect i i Jal statements of companies: suppliers and The following groups have a direct interest in the financial starements potential suppliers of fends, i.e. shareholders, debenturcholdess, employees, customers, suppliers of ods a eee eee ae ariicdent one Envadididon, (hcrejare rope, whens pave so) adie ies ca smears accel Vamslpeis ond advisors, mach exclaees, aesteuiaaaes oe Taee egulatory authorities, trade associations and labour unions.| 156 m Management Accounting, ‘The Accounting Principles Board of America mentions the objectives of financial statemens follows: a 1. To provide reliable financial information about economic resources and obligations of bung enterprise, 2. To provide reliable information about the net resources (resources less obligations) of an enterprise that results from its activities. 3. To provide financial information that assists in estimating the earning potentials of a busines, 4. To provide other needed information about changes in economic resources or obligation, 5 Th disclose, to the extent possible, other information related to the financial statements that relevant to the needs of the users of these statements |n order to meet the above objectives and to suit the needs of the varied users, entrusted with the task of compiling and presenting financial statements must follow a set of guidelines {0 ensure consistency, completeness, and fairness of the statements, These guidelines are called “generally accepted accounting principles’. In absence of these ‘generally accepted accounting princi ples’ statements Prepared may be un-understandable and misleading forthe various groups of users. In elds the accountant Importance of Financial Statements ‘The most important objective of financial statements is to present information for the use of different categories of persons as mentioned below: in understanding the progress, statements, by helping the m: business vis-a-vis the industry. Financial enable them to formulate ap With the causes of the business result, of action for the future the society, though not directly connected id prospects of a business enterprise. These wanagement to be acquainted propriate policies and courses entity: Various groups of are interested in the the public in case of ji Bartnerships, and other form of ownership the public. The Shareholders and the Lenders: and probable shareholder, through a critical examin, about the eficeney and effectiveness of thy the company. For this Purpose, it is nec complete and systematic facts and fig ‘eparding the present position and far The financi the suppliers, essary that the financial starements should contain sor Mone op chat these people can gee a full and accurate Het ure of the company. Since published financial statem™(Chapter 5 Financial Statements: Analysis and Interpretation ™ 157 i in bases availabl a a ene eee of people to judge the affairs of the company, it has been these statements, £0 project a “becter” on cores aie dressing’ in the presentation of at is” the position of the company. id Trade Unions: In Indi See eee Unions: In India, workers are ented to bonus under the Payment of Paar ‘orokt and + pp ae of the profit as disclosed by audited Profit and Loss Account. ae comes greatly is 5 an also, the size of profits and the profitability opines In wage negotiations 5. The pate cpt nneaee oe of country is to a great extent, associated with the rise and growe iF J 7 companies. The divergence between ownership and management of such eee Ses led an opportunity for unscrupulous and fraudulent persons to cheat and defraud the public. Such unscrupulous acts affect the industry and people in the region in which che company operates, to a significant extent. Such fraudulent actvitics impair the confidence of the general public in joint stock companies as forerunner of economic progress and thus retard economic growth of the country. The solution lies in raising the level of business and financial morality of the promoters and managements and in imparting knowledge about financial seae-noO to the public so that they can examine and assess the real worth of the company and avoid being cheated by unscrupulous persons. The law endeavours to raise the level of business morality by compelling the companies to draw up financial statements it a clear systematic form and disclose cervia rainimum information. Such provisions increase the confidence of the public in joint stock companies, thus enabling faster economic progress of the country. This has a the more grestlt significance in under developed and developing countries, In such countries, capital is not only sace but also shy. Malpractices on the part of promoters and managements, only help to increase the scarcity and shyness of capital, thus blocking economic progress. Published financial statements fan opportunity for the critical assessment of the worth of company and thus prosect provid and help faster economic progress innocent public, increase their confidence, Limitations of Financial Statements The financial statements are based on certain accounting concepts and conventions which can not be said to be foolproof. ‘The following are the limitations of the financial erim reports the termination of the business. 2. Financial statements take into consideration only the financial factors. They fail to bring out the significance of non-financial factors which may have considerable bearing on the operating results ae fancial conditions of an enterprise. For example, public image of the enterprise, the calibre of its management, efficiency and loyalty of its workers, ete | starements: 1. Financial statements are essentially int and therefore, cannot be final because the final gain or loss can be computed only at 3. It is not always possible to discover false figures in financial statements. Unscrupulous managements such starements. gencally resort wo window dressing’ in the preparation of lect the progress and position of che busines at frequent intervals er ofthese statements is a matter of personal judgement dirures over various periods. 4. Financial statements only rel during its life. The decision regarding the Ps and it gives rise to the problem of allocating expen Financial starements though expressed in exact monetary terms af¢ 208 absolutely final and accurate. ‘As the balance sheet is prepared on the basis of a going coneo™ asset valuation represents neither the realisable value nor replacement costs. They depend on the judgement of the management in respect of various accounting policies.Section ies Act, 1956. Keeping in view the complicacies of statutory forms in the Companies Act, now-a-days it is common practice to add the profit and lass account and balance sheet drawn in statutory forms, some voluntary supplementary information in a simple manner as would be easily understood by a layman. This voluntary information may include the following: 1, Summarised profit and lass account and balance sheet: Now-a-days, companies are discarding the Preparation of traditional two sided balance sheet and profit and loss account and are following columnar forms of balance sheet and profit and loss account which are simple way of presentation of information, 2 2.: Provision of important accounting ratios: Accounting ratios show the inter-relationship which exists among various accounting data. Balance sheet is substantiated by the important ratios of the current year and of the last two years. 3. Disclosure of accounting policies: Presently, progressive companies disclose accounting policies in their published accounts on the basis of which they have prepared their financial statements. This is done with a view co giving better understanding of the financial statements to the public. 4, Impact of price level changes: Since prices go on changing every day financial statements based on historical costs do not reflect the effect of price level changes on the financial position and profitability of the company. In order to accommodate the effect of price level changes in the financial starements now-a-days many companies have started showing this effects on financial statements in a supplementary statement in addition to the conventional statements prepared on historical basis. 5. Rounding-off of figures: The Sachhar Committee has recommended’ the companies should be given the option to round off the figures of financial statements to the nearest thousand and/or hundred or ten rupees. This recommendation has been accepted and companies are now-a-days making the use of rounding-off of figures. 6. Use of charts, graphs and diagrams: Many companies incorporate charts, graphs and diagrams in their published accounts. It is known as graphic method of presentation of information. It attracts the attention of the users more quickly and forcibly. Recently, graphs and diagrams have been becoming very popular, because they are considered to be the most effective media for disclosing + trends and making comparisons over fairly long periods within a short space. The method of presenting information can effectively depict production costs, fluctuations in ouput and sales, components of cost of production and income, use of divisible profits as taxes, dividends, other "appropriations and retained profits, etc. prescribed7. Use of schedules: In order to make the balance sheet and profit and loss account as compact as / possible, separate schedules for different heads (e.g., share capital, reserves and surplus, secured xs loans, unsecured loans, current liabilities and provisions, fixed assets, investments, current assets, Joans and advances, miscellaneous expenditure, etc.) are prepared and details regarding these heads as prescribed in the Companies Act are given in these schedules. This is done to make the balance sheet and profit and loss account manageable within limited space. These schedules are properly numbered and reference of these is given in the balance sheet and profit and loss account. © Highlights: Highlights are usually shown at che beginning of the annual report so that the users _ ‘may come across the important facts of the company immediately as he opens the report. It may “usually cover information about sales, production, profit before and after tax, capital projects, working capital, fixed assets, share capital, important landmarks of the year, etc. 9. Cash flow statements: The preparation of cash flow statement has become mandatory now a days. ‘A statement of cash flow, reports the cash receipts, cash payments and net changes in cash resulting from operating, investing and financing activities of an enterprise during a period in a format that reconciles the beginning and ending cash balances. It reports a net cash inflow or outflow for each activity and for the overall business.