Unit – 2: Final Accounts and Financial reporting
MEANING OF DIVIDEND AND ITS TYPES
Shareholders expect some return for the money invested by them in the company. They get the return on their investment in the form of dividends given to them from time to time. Thus, dividends are the profits of the company distributed amongst the shareholders. The company may declare dividends in general meeting, but no dividend shall exceed the amount recommended by the Board of Directors. Thus, shareholders in annual general meeting can only reduce the amount of dividends but cannot increase the amount of dividends recommended by the Board of Directors. The directors may no recommend dividend even if there are profits if they think that distribution of dividend will impair the financial position of the company.
Dividends are usually paid on the paid up value shares in the absence of any indication to the contrary in the Articles of Association. For example, if a company has share capital of 1,00,000 equity shares of Rs. 10 each, Rs. 7 per share called up, and paid up and if the rate of dividend is 15%, total dividend paid will be 15% of Rs. 7,00,000 paid up capital (i.e. 1,00,000 shares @ 7 each) i.e. Rs. 1,05,000.
Sources of Declaring Dividend
As per Section 123 of the Companies Act, 2013 dividend may be declared out of the following three sources:
1) Out of Current Profits: Dividend may be declared out of the profits of the company for the current year after providing depreciation. The company must transfer the prescribed percentage of its profits to general reserve before declaring dividends. This percentage depends on the percentage of dividend declared.
2) Out of Past Reserves: Dividend may be declared out of the profits of the company for any previous financial year or years arrived at after providing for depreciation in accordance with the provisions of Schedule II of the Companies Act, 2013 and remaining undistributed. Section 123 of the Act, requires that dividend can be declared out of the reserves only in accordance with the rules framed by the Central Government in this behalf.
3) Out of Money provided by the Government: A company can also declare dividend out of the moneys provided by the Central Government for payment of such dividend in pursuance of guarantee given by the Government.
Dividends may be of the following two types:
1) Interim Dividend.
2) Final Dividend.
Interim Dividend: This dividend is declared between two annual general meetings. Section 123 of the Companies Act, 2013 provides that the Board of Directors of a company may declare interim dividend during any financial year out of the surplus in the profit and loss account and out of profits of the financial year which interim dividend is sought to be declared. It further provides that in case the company has incurred loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, such interim dividend shall no be declared at a rate higher than the average dividends declared by the company during the immediately preceding three financial years. The Board may from time to time pay to the shareholders such interim dividends as appear to it to be justified keeping in view the profits of the company.
Final Dividend: It is a dividend which is declared at the annual general meeting of the shareholders and is declared by the shareholders only on the recommendation of the directors. The dividend proposed by the directors is provided for in the final accounts of the company and is paid only after it has been passed at the annual general meeting of the shareholders.
Distinction between Interim Dividend and Final Dividend
1) Interim dividend is the dividend which is paid in anticipation of profits. It is dividend paid by the directors any time between the two annual general meetings of the company, that is, on the basis of less than a full year’s results. Final dividend is recommended by the directors and declared by the shareholders in the Annual General meeting.
2) The payment of interim dividends depends much more upon estimates and opinions than the declaration of a final dividend which is made upon the information contained in the Final Balance Sheets.
3) Once a final dividend is declared, it is a debt payable to the shareholders and cannot be revoked or reduced by any subsequent action of the company. But declaration of interim dividend does not create a debt against the company and can be rescinded or reduced at any time before payment.
4) For declaration and payment of interim dividend, the directors need to satisfy that there are adequate distributable profits and payment of interim dividend would not result in payment out of capital.
Corporate Dividend Tax: As per the Finance Act, 1997 dividends paid or declared were subject to corporate dividend tax @ 10% with effect from 1st June, 1997. Such corporate dividend tax is deducted from Surplus sub-head in the Balance Sheet and it is also shown under the heading current liabilities as a provision till it is paid. But as per recent Finance Act, the rate of this tax is 15% plus 10% surcharge and cess of 2%. Total percentage of corporate dividend tax with surcharge and education cess comes to 17% approximately.
Divisible Profits and Rules regarding Dividends and Transfer to reserves
The term “Divisible Profit” is a very complicated term because all profits are not divisible profits. Only those profits are divisible profits which are legally available for dividend to shareholders. Dividends cannot be declared except out of profits, i.e. excess of income over expenditure; ordinarily capital profits are not available for distribution amongst shareholders because such profits are not trading profits. Thus, profits arising from revaluation or sale of fixed assets or redemption of fixed liabilities should not be available for distribution as dividend amongst shareholders. The principles of determination of the divisible profit are given below:
1) According to Section 123 of the Companies Act, 2013 no dividends can be declared unless:
Ø Depreciation has been provided for in respect of the current financial years for which dividend is to be declared;
Ø Arrears of depreciation in respect of previous years have been deducted from the profits; and
Ø Losses incurred by the company in the previous years.
2) Section 123 of the Companies Act, 2013 provides that before any dividend is declared or paid a certain percentage of profits for that financial year depending upon the rate of dividend to be paid or declared should be transferred to the reserves of the company.
Provided that nothing in this sub-section shall be deemed to prohibit the voluntary transfer by a company of a higher percentage of its profits to the reserves in accordance with such rules as may be made by the Central Government in this behalf.
3) No dividend shall be payable except in cash;
4) There is no prohibition on the company for the capitalization of profits or reserves of a company for the purpose of issuing fully paid-up bonus shares or paying up any amount for the time unpaid on any shares held by the members of the company.
5) Any dividend payable in cash may be paid by cheque or warrant sent through the post directed to the registered address of the shareholder entitled to the payment of the dividend or in the case of joint shareholder to the registered address of that one of the joint shareholder which is first named on the register of members or to such person and to such address as the shareholder or the joint shareholder may in writing direct.”
Transfer to Reserves: Section 123 of the Companies Act, 2013 provides that
No dividend shall be declared or paid by a company for any financial year out of the profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of Schedule II, except after the transfer to the reserves of the company a certain percentage of its profits for that year as specified:
i. Where the dividend proposed exceeds 10 percent but not 12.5 percent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 2.5 percent of the current profits;
ii. Where the dividend proposed exceeds 12.5 percent but does not exceeds 15 percent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 5 percent of the current profits;
iii. Where the dividend proposed exceeds 15 percent, but does not exceed 20 percent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 7.5 percent of the current profits; and
iv. Where the dividend exceeds 20 percent of the paid-up capital, the amount to the transferred to reserves shall not be less than 10 percent of the current profits.
Books of Accounts to be maintained by a Company
Section 128 of the Companies Act, 2013 requires that every company shall prepare and keep at its registered office books of accounts and other relevant books and papers and financial statements for every financial year which give a true and fair view of the state of affairs of the company, including that of its branch office or offices, if any, and explain the transactions effected both at the registered office and its branches and such book will be kept on accrual basis and according to the double entry system of accounting. All or any of the books of account aforesaid and other relevant papers may be kept at such other place in India as the Board of Directors may decide and where such a decision is taken, the company shall, within seven days thereof, file with the Registrar a notice in writing giving full address of that other place.
The company may keep such books of account or other relevant papers in electronic mode in such manner as may be prescribed. The books of account and other books and papers maintained by the company within India shall be open for inspection at the registered office of the company. The books of account of every company relating to a period of not less than eight financial years immediately preceding a financial year, or where the company had been in existence for a period less than eight years, in respect of all the preceding years together with the vouchers relevant to any entry in such books of account shall be kept in good order.
Section 129 of the Companies Act, 2013 requires that the financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards under Section 133 and shall be in the form or forms as may be provided for different class or classes of companies in Schedule III.
Where a company has one or more subsidiaries, it shall in addition to its financial statements, prepare a consolidated financial statements of the company and of all the subsidiaries in the same form and manner as that of its own which shall also be laid before the annual general meeting of the company along with the laying of its financial statements.
It is further stated that the books of account should be maintained on accrual basis and according to the double entry system of accounting to ensure that these represent true and fair view of the affairs of the company or branch office, as the case may be. The Act requires that proper stock records should form a necessary part of proper books of account and also that the books of account and the relevant vouchers must be preserved for a minimum period of eight years in good order.
Meaning of Financial Reporting, its components and objectives
Basically, financial reporting is the process of preparing, presenting and circulating the financial information in various forms to the users which helps in making vigilant planning and decision making by users. The core objective of financial reporting is to present financial information of the business entity which will help in decision making about the resources provided to the reporting entity and in assessing whether the management and the governing board of that entity have made efficient and effective use of the resources provided. The components of financial reporting are:
a) The financial statements – Balance Sheet, Profit & loss account, Cash flow statement & Statement of changes in stock holder’s equity
b) The notes to financial statements
c) Quarterly & Annual reports (in case of listed companies)
d) Prospectus (In case of companies going for IPOs)
e) Management Discussion & Analysis (In case of public companies)
Objectives of Financial Reporting
The following points sum up the objectives & purposes of financial reporting:
a) Providing information to management of an organization which is used for the purpose of planning, analysis, benchmarking and decision making.
b) Providing information to investors, promoters, debt provider and creditors which is used to enable them to male rational and prudent decisions regarding investment, credit etc.
c) Providing information to shareholders & public at large in case of listed companies about various aspects of an organization.
d) Providing information about the economic resources of an organization, claims to those resources (liabilities & owner’s equity) and how these resources and claims have undergone change over a period of time.
e) Providing information as to how an organization is procuring & using various resources.
f) Providing information to various stakeholders regarding performance of management of an organization as to how diligently & ethically they are discharging their fiduciary duties & responsibilities.
g) Providing information to the statutory auditors which in turn facilitates audit.
h) Enhancing social welfare by looking into the interest of employees, trade union & Government.
Qualitative Characteristics of Financial Reports
The Qualitative characteristics that make financial information useful:
a) Relevance: Information is relevant if it would potentially affect or make a difference in users’ decisions. A related concept is that of materiality i.e. information is considered to be material if omission or misstatement of the information could influence users’ decisions.
b) Faithful Representation: This means that the information is ideally complete, neutral, and free from error. The financial information presented reflects the underlying economic reality.
c) Comparability: This means that the information is presented in a consistent manner over time and across entities which enables users to make comparisons easily.
d) Verifiability: This means that different knowledgeable and independent observers would agree that the information presented faithfully represents the economic phenomena it claims to represent.
e) Timeliness: Timely information is available to decision makers prior to their making a decision.
f) Understandability: This refers to clear and concise presentation of information. The information should be understandable by users who have a reasonable knowledge of business and economic activities and who are willing to study the information with diligence.
International Financial Reporting Standards (IFRS)
IFRS is a set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements. IFRS are generally principles-based standards and seek to avoid a rule-book mentality. Application of IFRS requires exercise of judgment by the preparer and the auditor in applying principles of accounting on the basis of the economic substance of transactions. IFRS are issued by the International Accounting Standards Board (IASB).
IASB issued only thirteen (13) IFRS which are as follows:
IFRS 1 - First-time adoption of International Financial Reporting Standards
IFRS 2 - Share-based payment
IFRS 3 - Business combinations
IFRS 4 - Insurance contracts
IFRS 5 - Non-current assets held for sale and discontinued operations
IFRS 6 - Exploration for and evaluation of mineral resources
IFRS 7 - Financial instruments: disclosures
IFRS 8 - Operating segments
IFRS 9 - Financial instruments
IFRS 10 - Consolidated financial statements
IFRS 11- Joint arrangements
IFRS 12- Disclosure of interests in other entities
IFRS 13- Fair Value measurement
Need and Importance of IFRS
The goal of IFRS is to provide a global framework for how public companies prepare and disclose their financial statements. IFRS provides general guidance for the preparation of financial statements, rather than setting rules for industry-specific reporting. Having an international standard is especially important for large companies that have subsidiaries in different countries. Adopting a single set of world-wide standards will simplify accounting procedures by allowing a company to use one reporting language throughout. A single standard will also provide investors and auditors with a comprehensive view of finances.
Merits of IFRS
1. IFRS brings improvement in comparability of financial information and financial performance with global peers and industry standards. This will result in more transparent financial reporting of a company’s activities which will benefit investors, customers and other key stakeholders in India and overseas.
2. The adoption of IFRS is expected to result in better quality of financial reporting due to consistent application of accounting principles and improvement in reliability of financial statements.
3. IFRS provide better access to the capital raised from global capital markets since IFRS are now accepted as a financial reporting framework for companies seeking to raise funds from most capital markets across the globe.
4. IFRS minimize the obstacles faced by Multi-national Corporations by reducing the risk associated with dual filings of accounts.
5. The impact of globalization causes spectacular changes in the development of Multi-national Corporations in India. This has created the need for uniform accounting practices which are more accurate, transparent and which satisfy the needs of the users.
6. Uniform accounting standards (IFRS) enable investors to understand better the investment opportunities as against multiple sets of national accounting standard.
7. With the help of IFRS, investors can increase the ability to secure cross border listing.
Limitations of IFRS
1. The perceived benefits from IFRS’ adoption are based on the experience of IFRS compliant countries in a period of mild economic conditions. Any decline in market confidence in India and overseas coupled with tougher economic conditions may present significant challenges to Indian companies.
2. IFRS requires application of fair value principles in certain situations and this would result in significant differences in financial information currently presented, especially in relation to financial instruments and business combinations.
3. This situation is worsened by the lack of availability of professionals with adequate valuation skills, to assist Indian corporate in arriving at reliable fair value estimates.
4. Although IFRS are principles-based standards, they offer certain accounting policy choices to preparers of financial statements.
5. IFRS are formulated by the International Accounting Standards Board (IASB) which is an international standard body. However, the responsibility for enforcement and providing guidance on implementation vests with local government and accounting and regulatory bodies, such as the ICAI in India. Consequently, there may be differences in interpretation or practical application of IFRS provisions, which could further reduce consistency in financial reporting and comparability with global peers.
Explanation of Some Important IFRS
IFRS 1 – First-time adoption of International Financial Reporting Standards: The IASB issued the IFRS 1 on June 19, 2003. It applies to all those business concerns which are going to converge their accounting statements with IFRS from the first time. The IFRS1 has come into with effect from 1st January 2004. The main purpose of IFRS1 is to set out the basic rules or regulations for preparing and presenting first IFRS financial statements and interim financial statements by business concerns. The IFRS1 applies to first IFRS complied financial statements and each interim report which is presented under IAS 34 for part of the period is covered by first IFRS financial statements of a business concern
IFRS 2 - Share-based payment: The major objective of this IFRS is to reflect the effect of share based transitions in the financial statements of an entity, including expenses associated with transactions in which share options are granted to employees. It is entailed for an entity to mention all the transactions which are associated with employees or other parties to be settled either in cash or other equity instruments of the business entity.
IFRS 3 - Business combinations: The major objective of this IFRS is to specify all requirements for an entity when it undertakes a business. Business combination means combining two separate entities in to a single economic entity. As a result of this, an enterprise obtains the control over the net assets or operations of other enterprises.
IFRS 4 - Insurance contracts: An insurance contract is that where one party (the insurer) accepts the insurance risk of another party (the policy holder) by agreeing to reimburse the amount of policy to the policy holder if any specified uncertain future events occur and adversely affect the policy holder. The primary objective of this IFRS for an entity is to determine the financial reporting for the issued insurance contracts (described in this IFRS as an insurer) until the Board completes the second phase of its project on insurance contracts.
IFRS 5 - Non-current assets held for sale and discontinued operations: The main purpose of this IFRS is to measure the accounting for the assets held for sale, and the preparation and disclosure of discontinued operations in the financial statements of an entity. Particularly, the IFRS requires those assets which can be categorized as held for sale to be measured at the lower degree of carrying amount and fair value less costs to sell, and the amount of depreciation on such assets to cease.
IFRS 6 - Explorations for and evaluation of mineral resources: The primary objective of this IFRS is to specify the effects of exploration for and evaluation of mineral resources in the financial reporting of an entity. This IFRS state that initially an entity should measure mineral resources assets on cost and subsequently measurement can be at cost or revalued amount. The IFRS demands for an entity to perform an impairment test when there are indications that the carrying amount of exploration and evaluation assets exceeds recoverable amount.
IFRS 7 - Financial instruments disclosures: The main purpose of this IFRS is to compel entities to prescribe disclosures that enable financial statements users to measure the significance of financial instruments for the entity’s financial position and performance; the nature and extent of their risk and how the entity manage these risks. This IFRS applies to all type of entities, either that have few financial instruments or those that have many financial instruments. This IFRS does not apply to those financial instruments which are associated with insurance contracts and financial instruments, contracts and obligations under share based payment transactions.
IFRS 8 - Operating segments: The primary objective of this IFRS is to disclose such information that enables the users of financial statements to evaluate the nature and financial effects of the business activities in which it is engaged and the economic environments in which it operates. This IFRS applies to the separate or individual financial statements of an entity and to the consolidated financial statements of a group with a parent whose debt or equity instruments are traded in a public market. If the parent company presents both separate and consolidated financial statement in a single financial report then segment information should be presented only on the basis of consolidated financial statements.
IFRS 9 - Financial instruments: This IFRS is replacement of IAS 39 and its major objective is to set some principles for the financial reporting of financial assets and financial liabilities of an entity’s financial statements and providing useful information to the users of these financial statements so that they can take rational decisions. This IFRS prescribes general guidelines such as how an entity should classify and determine the financial assets and financial liabilities.
ACCOUNTING STANDARDS – MEANING, OBJECTIVES AND LIMITATIONS
Accounting Standards are the policy documents or written statements issued, from time to time, by an apex expert accounting body in relation to various aspects of measurement, treatment and disclosure of accounting transactions for ensuring uniformity in accounting practices and reporting. These standards are prepared by Accounting Standard Board (ASB).
Every statement of profit and loss and balance sheet of a company shall comply with the accounting standards. Accounting Standards recommended by the Institute of Chartered Accountants of India and prescribed by the Central Government in consultation with National Advisory Committee on accounting Standards are mandatory and applicable to all companies while preparing statement of profit and loss and balance sheet. Where the statement of profit and loss and the balance sheet of a company do not comply with the accounting standards, such a company shall disclose in its statement of profit and loss and balance sheet (a) the deviation from the accounting standards; (b) the reasons for such deviation and (c) the financial effect, if any, arising due to such deviation.
Objectives or Purposes of Accounting Standards:
a. To provide information to the users as to the basis on which the accounts have been prepared and the financial statements have been presented.
b. To harmonize the diverse accounting policies & practices which are in use the preparation & presentation of financial statements.
c. To make the financial statements more meaningful and comparable and to make people place more reliance on financial statements prepared in conformity with the accounting standards.
d. To guide the judgment of professional accountants in dealing with those items, which are to be followed consistently from year to year.
e. To provide a set of standard accounting policies, valuation norms and disclosure requirements.
By setting the accounting standards, the accountant has following benefits:
a. Standards reduce to a reasonable extent or eliminate altogether confusing variations in the accounting treatments used to prepare financial statements.
b. There are certain areas where important information is not statutorily required to be disclosed. standards may call for disclosure beyond that required by law.
c. The application of accounting standards would ,to a limited extent, facilitate comparison of financial statements of companies situated in different parts of the world and also of different companies situated in the same country.
However, there are some limitations of setting of accounting standards:
(i)Alternative solution to certain accounting problems may each have arguments to recommend them. Therefore, the choice between different alternative accounting treatments may become difficult.
(ii)there may be a trend towards rigidity and away from flexibility in applying the accounting standards.
(iii)Accounting standards cannot override the statute. The standards are required to be framed within the ambit of prevailing statutes.
Convergence of Indian accounting standards with International financial reporting standards (IFRS):
MEANING of convergence: The convergence of accounting standards refers to the goal of establishing a single set of accounting standards that will be used internationally, and in particular the effort to reduce the differences between the US generally accepted accounting principles (USGAAP) and the International financial reporting standards (IFRS)
Meaning of convergence with IFRS: Convergence means to achieve harmony with IFRSs; in precise terms convergence can be considered “to design and maintain national accounting standards in a way that financial statements prepared in accordance with national accounting standards draw unreserved statement of compliance with IFRSs”, i.e., when the national accounting standards will comply with all the requirements of IFRS.
But convergence doesn’t mean that IFRS should be adopted word by word, e.g., replacing the term ‘true & fair’ for ‘present fairly’, in IAS 1, ‘Presentation of Financial Statements’. Such changes do not lead to non-convergence with IFRS.
A set of accounting standards notified by the Ministry of Corporate Affairs which are converged with International Financial Reporting Standards (IFRS) which are now termed as IND AS’s.
Need for convergence with IFRS
In the present era of globalization and liberalization, the World has become an economic village. The globalization of the business world and the attendant structures and the regulations, which support it, as well as the development of e-commerce make it imperative to have a single globally accepted financial reporting system. A number of multi-national companies are establishing their businesses in various countries with emerging economies and vice versa. The entities in emerging economies are increasingly accessing the global markets to fulfill their capital needs by getting their securities listed on the stock exchanges outside their country. Capital markets are, thus, becoming integrated consistent with this world-wide trend. More and more Indian companies are also being listed on overseas stock exchanges. Sound financial reporting structure is imperative for economic well-being and effective functioning of capital markets.
The use of different accounting frameworks in different countries, which require inconsistent treatment and presentation of the same underlying economic transactions, creates confusion for users of financial statements. This confusion leads to inefficiency in capital markets across the world. Therefore, increasing complexity of business transactions and globalization of capital markets call for a single set of high quality accounting standards. High standards of financial reporting underpin the trust investors place in financial and non-financial information. Thus, the case for a single set of globally accepted accounting standards has prompted many countries to pursue convergence of national accounting standards with IFRS.
Benefits of achieving convergence with IFRS
There are many beneficiaries of convergence with IFRS such as the economy, investors, industry and accounting professionals.
1) Economy: As the markets expand globally, the need for convergence also increases. The convergence benefits the economy by increasing growth of its international business. It facilitates maintenance of orderly and efficient capital markets and also helps to increase the capital formation and thereby economic growth.
2) Investors: A strong case for convergence can be made from the viewpoint of the investors who wish to invest outside their own country. Investors want the information that is more relevant, reliable, timely and comparable across the jurisdictions. Financial statements prepared using a common set of accounting standards help investors better understand investment opportunities as opposed to financial statements prepared using a different set of national accounting standards.
3) Industry: A major force in the movement towards convergence has been the interest of the industry. The industry is able to raise capital from foreign markets at lower cost if it can create confidence in the minds of foreign investors that their financial statements comply with globally accepted accounting standards.
4) Accounting professionals: Convergence with IFRS also benefits the accounting professionals in a way that they are able to sell their services as experts in different parts of the world. It offers them more opportunities in any part of the world if same accounting practices prevail throughout the world.
Relevance/Applicability of Ind AS (Converged IFRS)
The Ministry of Corporate Affairs (MCA) notified the Companies (Indian Accounting Standards) Rules, 2015 (the ‘Rules’) on 16th February, 2015. The Rules specify the Indian Accounting Standards (Ind AS) applicable to certain class of companies and set out the dates of applicability as follows:
1) Voluntary adoption: Companies may voluntarily adopt Ind AS for financial statements for accounting periods beginning on or after 1 April, 2015, with the comparatives for the periods ending 31 March, 2015 or thereafter. Once a company opts to follow the Ind AS, it will be required to follow the same for all the subsequent financial statements.
2) Mandatory adoption: The following companies will have to adopt Ind AS for financial statements from the accounting periods beginning on or after 1 April, 2016:
a) Companies whose equity and/or debt securities are listed or are in the process of listing on any stock exchange in India or outside India (listed companies) and having net worth of Rs. 500 crores or more.
b) Unlisted companies having a net worth of Rs. 500 crores or more.
c) Holding, subsidiary, joint venture or associate companies of the listed and unlisted companies covered above.
Comparatives for these financial statements will be periods ending 31 March, 2016 or thereafter.
3) The following companies will have to adopt Ind AS for financial statements from the accounting periods beginning on or after 1 April, 2017:
a) Listed companies having net worth of less than Rs. 500 crore.
b) Unlisted companies having net worth of Rs. 250 crore or more but less than Rs. 500 crore.
c) Holding, subsidiary, joint venture or associate companies of the listed and unlisted companies covered above.
Comparatives for these financial statements will be periods ending 31 March, 2017 or thereafter.
4) The above mentioned roadmap for adoption will not be applicable to:
a) Companies whose securities are listed or in the process of listing on SME exchanges (Exchanges meant for small and medium-sized enterprises).
b) Companies not covered by the roadmap in the ‘Mandatory adoption’ categories mentioned above.
c) Insurance companies, banking companies and non-banking finance companies.
Challenges envisaged in convergence:
a) Change to regulatory environment: For the success of convergence in India, certain regulatory amendment is required.
b) Lack of Preparedness: Corporate India and accounting professionals need to be trained for effective migration to IFRS. Additionally auditors would need to train their staff to audit under IFRS environment
c) Significant cost: Significant one-time costs of converting to IFRS (including costs of adapting IT systems, training personnel and educating investors)
d) Impact on financial performance: Due to the significant differences between Indian GAAP and IFRS, adoption of IFRS is likely to have a significant impact on the financial position and financial performance of most Indian companies
e) Communication of Impact of IFRS to investors: Companies also need to communicate the impact of IFRS convergence to their investors to ensure they understand the shift from Indian GAAP to IFRS.
Important Short Notes
1) Preliminary Expenses: Preliminary expenses are those expenses which are incurred on the formation of the company. Such expenses include stamp duty and fees payable on registration of the company, legal and printing charges for preparing the Prospectus, Memorandum and Articles of Association, Accountants’ and Valuers’ fees for reports, certificates, etc. Cost of printing the stamping letters of allotment and share certificates, cost of company seal, books of account, statutory books and statistical books, etc. Such expenses are written off from the Statement of Profit and Loss in the year in the year of their incurrence as per AS-26.
2) Pre-operative Expenses: Such expenses are incurred by a company after the stage of incorporation till the time it is in a position to start its operations. These expenses are charged to the Statement of Profit and Loss.
3) Capital Profits: Capital profits are not earned during the normal course of the business and arise in the following special circumstances:
a) Profit on sale of fixed assets.
b) Profits on purchase of business, such profit arises when the value of assets taken over minus the liabilities taken over is more then the amount paid for the purchase of the business.
c) Profit prior to incorporation.
d) Premium received on issue of shares or debentures.
e) Balance left in Forfeited Shares Account after the reissue of forfeited shares.
f) Profit made on redemption of debentures.
g) Profit set aside for redemption of preference shares.
Ordinarily capital profits are not available for the distribution of dividend. Such profits can be utilized for writing off capital losses and fictitious assets like preliminary expenses, goodwill, discount or commission on issue of shares or debentures etc. or for issuing bonus shares.
Capital profits can be distributed as dividend only if (a) The Articles of a company permit; (b) they are realized in cash; (c) surplus remains after a revaluation of all assets; and (d) capital losses have been written off. It may be noted that securities premium account, Capital redemption reserve account, profit prior to incorporation and profit on reissue of forfeited shares cannot be distributed as dividend under the Companies Act.
4) Political Contribution: According to Section 182 of the Companies Act, 2013 Government companies and companies which have been in existence for less than three financial years are not allowed to make any political contribution. However, other companies may make political contributions in a financial year not exceeding 7.5% of their average net profits determined on the basis of three immediately preceding financial year’s profits if a resolution authorizing such contribution is passed at a meeting of the Board of Directors. Such political contributions along with the name of the parties or persons to which or to whom such amount has been contributed should be disclosed in the Statement of Profit and Loss.
5) Profits of Subsidiary Companies: Profits of subsidiary companies are not to be included in divisible profits of the holding company. Only share of dividend declared by the subsidiary company belonging to the holding company should be treated as divisible profit. Dividend received out of profits existing on the date of acquiring shares of the subsidiary company mush be treated as a capital receipt and is not to be included in divisible profits of the holding company.
6) Provision for Taxation: Statement of Profit and Loss of a company must set out the amount of charge for Indian income-tax and other Indian taxation on profits, including where practicable, with Indian Income-tax, any taxation imposed elsewhere to the extent of the relief, if any, from Indian income-tax and distinguishing, where practicable, between income-tax and other taxation.
A company is liable to pay income-tax or tax on profits under the Income-tax Act, 1961 and such tax is treated as charge against the profits of the accounting year, although the profits are assessed and actual liability for tax is determined in the following year. Moreover, the assessable profits (taxable profits) are seldom the same as accounting profits. As such it is not possible to determine the actual amount of tax payable at the time the financial statements are prepared. Therefore, liability for tax is estimated and provided for while preparing the final statements. Such provision is change against profit in the profit and loss statement and credited to provision for taxation account.
While making the estimate of provision for taxation, due consideration should be given to the following points:
a) Whether the net profit has been determined after deducting depreciation according to Income-tax Act and managerial remuneration.
b) Whether income-tax has been computed at the rates prescribed.
c) Whether profit sur-tax is payable or not.
d) Whether capital gains tax is payable or not.
e) Whether penalty is payable under any tax laws.
f) Whether rebate is available for double taxation.
g) Whether investment allowance, extra shift allowance, etc., if any, have been duly deducted or not in estimating the tax liability.
h) Whether adjustment has made for the last year’s actual tax liability or not.
7) Advance Payment of Tax and Provision for Taxation
Under Income Tax Act 1961, companies are required to pay advance tax on their expected profits. When advance payment of tax is made, the entry is:
Advance Income Tax Account ………………………………………………………………….. Dr.
To Bank Account
(Being payment of tax in advance)
Since the actual amount payable as income tax will be known long after the preparation of the Profit and Loss Account (i.e. when the assessment is made by the Income Tax Department), the liability for taxes has to be estimated while preparing the Profit and Loss Account so that dividend to shareholders may be made from revenue profits and not from capital profits. So, liability for taxes is estimated and provided for in the books. The entry is:
Profit and Loss Account……………………………………………………………..…………... Dr.
To Provision for Income Tax Account
(Being provision for income tax for the year)