Unit – 7: Financial Statements of a Company
Q.1. Explain the term “Financial Statements”. What are its objectives and Ideal Characteristics? 2012, 2016
Ans: Introduction: Financial statements are the summarized statements of accounting data produced at the end of accounting process by an enterprise through which accounting information are communicated to the internal and external users.
A set of financial statements includes (Types): 2016
a) Balance sheet
b) Profit and loss account
c) Statement of retained earnings
d) Funds flow statement and Cash flow Statement
e) Schedules and notes to accounts.
In the words of Myer,” The financial statements provide a summary of accounts of a business enterprise, the balance sheet reflecting the assets, liabilities and capital as on a certain date and income statement showing the result of operations during a certain period”.
Objectives of Financial Statements:
a) To provide information about economic resources and obligations of a business.
b) To provide information about earning capacity of the business.
c) To provide information about cash Flows.
d) To judge effectiveness of management.
Characteristics of Ideal financial Statements are:
a) Understandability: The information must be readily understandable to users of the financial statements.
b) Relevance: The information must be relevant to the needs of the users, which is the case when the information influences the economic decisions of users.
c) Reliability: The information must be free of material error and bias, and not misleading.
d) Comparability: The information must be comparable to the financial information presented for other accounting periods.
Q.2. Draft a Format of Revised Balance Sheet of a Company. Distinguish between a company’s balance sheet and a balance sheet of a partnership firm. (MOST IMPORTANT PART) 2012
Proforma of Balance Sheet
Name of the Company …………………………………….
Balance Sheet as at……………………………………..
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
(1) Non-Current Assets
(a) Fixed assets
(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
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short term loans and advances
(f) Other current assets
Q.3. Who are the users of Financial Statement? What types of information provided by it? Explain its importance and limitations. 2012, 2013, 2015, 2016
Ans: Users of Financial Statements: Users of accounting information may be categorised into
(1) Internal Users: Owners, Management, Employees and Workers.
(2) External Users: Banks and Financial Institutions, Investors and Potential Investors, Creditors, Government authorities, Consumers.
Information provided by the financial statements
a) A balance sheet (or statement of financial position) summarizes the financial position of an accounting entity at a particular point in time.
b) An income statement summarizes the results of operations for a given period of time.
c) A statement of cash flows summarizes the impact of an enterprise's cash flows on its operating, financing, and investing activities over a given period of time.
d) A statement of retained earnings shows the increases and decreases in earnings retained by the company over a given period of time.
Uses and Importance of Financial Statements to its various users
a) To Management: Management is interested in knowing the existing profits, earnings per share, chances of survival, possibility of growth and diversification etc. from the financial statements so that is can frame suitable strategy for its entity.
b) Potential investors: Potential investors are keen to know the earning potential of the business. They want to know how safe the investment already made is and how safe the proposed investment will be.
c) Bankers and financial institutions: These institutions are interested in the security of the loan advanced, entity’s capacity to repay the principal interest as per terms. Financial statements help these institutions to check the operating efficiency and financial position.
d) Shareholders: Shareholders of the business are interested to know the earning capacity of the business and its prospects of future growth.
e) Taxation authorities: Income tax authorities are interested in knowing the profits of the business so that income tax can be imposed thereon. Financial statements help them a great deal in determining the taxes payable.
Limitations of financial statements:
Financial Statements suffers from various limitations which are given below:
(i) Historical Records: The information given in these statements is historic in nature and does not reflect the future.
(ii) It Ignores Price Level Changes.
(iii) Qualitative aspect Ignored: Financial statements considered only those items which can be expressed in terms of money. Financial Statements ignores the qualitative aspect.
(iv) Not free from Bias: Financial statements are largely affected by the personal judgments of the accountant.
(v) Variation is accounting practices: Different firms follow different accounting practices. Therefore, a meaningful comparison of their financial statements is not possible.
Q.4. Mention three items shown under the Reserves and Surplus of Company’s Balance Sheet. 2016
Ans: Reserves and Surplus: Under this head the following items are shown:
a) Capital Reserve
b) Securities Premium (Reserve)
c) Capital Redemption Reserve.
d) Debenture Redemption Reserve
e) Revaluation Reserve
Q.5. What are contingent liabilities? Mention two items included under this head? 2013
Ans: Contingent Liabilities: Those liabilities which may or may not arise because they are dependent on a happening in future. It is not recorded in the books of accounts but is disclosed in the Notes to Accounts for the information of the users. Examples:
a) Claims against the company not acknowledged as debts.
c) Other money for which the company is contingently liable.