Advanced Accounting: Financial Statements Of Companies | CA Inter Jan 2025 Udesh Fastrack Batch

Key Concepts

• Financial Statements of a Company: Balance Sheet, Statement of Profit and Loss (P&L), Cash Flow Statement, Statement of Changes in Equity (SoCI), and Notes to Accounts.
• Companies Act 2013: Governs how companies maintain books of accounts and prepare financial statements.
• Section 128: Mandates companies to prepare books of accounts on an accrual basis and according to the double-entry system.
• Section 129: Requires financial statements to present a true and fair view of the company's state of affairs and comply with Accounting Standards (AS) or Indian Accounting Standards (Ind AS).
• Schedule III: Provides the format for Balance Sheet (Part 1) and Statement of P&L (Part 2) for companies.
• Divisions (Division 1, Division 2, Division 3): Schedule III is divided into three divisions based on the applicability of AS, Ind AS, and for NBFCs.
• Users of Financial Statements: Investors, shareholders, employees, creditors, customers, government, lenders, and the public at large.
• Revenue from Operations: Revenue generated from the company's principal and ancillary activities.
• Other Income: Income earned from activities other than the company's core operations (e.g., interest, dividends, rental income).
• Cost of Material Consumed: Primarily related to manufacturers, calculated as Opening Stock + Purchases - Closing Stock of raw materials.
• Change in Inventory: Difference between opening and closing stock of finished goods, work-in-progress, and stock-in-trade.
• Employee Benefit Expense: Expenses related to employee compensation, including salaries, wages, and contributions to provident and other funds.
• Finance Costs: Expenses related to borrowing funds, such as interest on loans and debentures.
• Depreciation & Amortization: Allocation of the cost of tangible (depreciation) and intangible (amortization) assets over their useful lives.
• Contingent Liabilities: Potential liabilities that may arise depending on the outcome of uncertain future events.
• Commitments: Contractual obligations for future expenditures.
• Operating Cycle: The time between acquiring raw materials and realizing cash from sales.
• Current vs. Non-Current: Assets and liabilities are classified as current if they are expected to be realized or settled within the operating cycle or 12 months, whichever is longer.
• Aging Schedule: Categorization of trade receivables and payables based on the length of time they have been outstanding.
• Accrued Income: Income that has been earned but not yet received.
• Prepaid Expenses: Expenses that have been paid in advance but not yet incurred.
• Share Forfeiture: The process of canceling shares due to non-payment of calls.
• Reissue of Forfeited Shares: Selling forfeited shares to new investors.
• Capital Reserve: A reserve created from capital profits, such as the profit on the reissue of forfeited shares.
• Dividend: A distribution of a company's profits to its shareholders.
• Interim Dividend: A dividend declared and paid during the financial year.
• Final Dividend: A dividend declared and paid after the end of the financial year.
• Free Reserves: Reserves that are available for distribution as dividends.
• DRR (Debenture Redemption Reserve): A reserve created to protect debenture holders.
• Earning Per Share (EPS): A financial metric that indicates a company's profitability on a per-share basis.
• AS (Accounting Standards): A set of accounting principles and guidelines that companies must follow when preparing their financial statements.
• Ind AS (Indian Accounting Standards): A set of accounting standards that are based on International Financial Reporting Standards (IFRS).

Financial Statement of Companies: A Detailed Summary

1. Introduction to Company Accounts and Regulatory Framework

• The lecture introduces the chapter on Financial Statements of Companies, emphasizing its importance due to the frequent need to prepare company-related balance sheets and P&L accounts in various syllabus topics.
• Company accounts are governed by the Companies Act 2013, which dictates how companies should maintain books and follow specific formats.
• Section 128 of the Act mandates that companies must maintain books of accounts on an accrual basis and according to the double-entry system.
• The financial statements must present a true and fair view of the company's state of affairs, ensuring reliability and accuracy.
• Section 129 requires compliance with Accounting Standards (AS) or Indian Accounting Standards (Ind AS).
• The Board of Directors must present the financial statements at the Annual General Meeting (AGM).
• Financial statements include the Balance Sheet, Statement of P&L, Cash Flow Statement, Statement of Changes in Equity (SoCI), and Notes to Accounts.
• Section 8 companies (charitable organizations) prepare an Income and Expenditure Account instead of a P&L account.
• One-person companies, small companies, dormant companies, and private companies (startups) are exempt from preparing a Cash Flow Statement.
• The format for the Balance Sheet and P&L is provided in Schedule III of the Companies Act.
• Banks and insurance companies are governed by separate acts (Banking Regulation Act and Insurance Act) and follow formats prescribed in those acts, not Schedule III.
• Schedule III is divided into three divisions:
  • Division I: For companies applying Accounting Standards (AS).
  • Division II: For companies applying Indian Accounting Standards (Ind AS).
  • Division III: For Non-Banking Financial Companies (NBFCs).
• The lecture primarily focuses on Division I, which is relevant for the intermediate level.

2. Understanding the Statement of Profit and Loss (P&L)

• The traditional Trading Account and P&L Account format is replaced by a Statement of P&L in a statement form.
• The statement form is designed to be more understandable for a wider range of users, including those without a commerce background.
• The Statement of P&L is prepared for the year and provides a comprehensive view of the company's profitability or loss.
• The format includes:
  • Revenue from Operations: Income from the company's core business activities (e.g., sales of goods or services).
  • Other Income: Income from activities outside the core business (e.g., interest, dividends, rental income).
  • Total Income: Sum of Revenue from Operations and Other Income.
  • Expenses:
    • Cost of Material Consumed: Raw material consumption for manufacturers (Opening Stock + Purchases - Closing Stock).
    • Purchases of Stock-in-Trade: Purchases made by traders.
    • Change in Inventory: Difference between opening and closing stock of finished goods, work-in-progress, and stock-in-trade.
    • Employee Benefit Expense: Salaries, wages, and other employee-related costs.
    • Finance Costs: Interest on loans, debentures, and other borrowing costs.
    • Depreciation and Amortization: Allocation of the cost of tangible and intangible assets.
    • Other Expenses: All other expenses not included in the above categories (e.g., traveling, printing, rent, audit fees).
  • Total Expenses: Sum of all expenses.
  • Profit Before Tax (PBT): Total Income - Total Expenses.
  • Provision for Tax: Estimated tax liability for the year.
  • Profit After Tax (PAT): Profit Before Tax - Provision for Tax.
• Revenue from Operations includes both principal and ancillary activities. For example, for a coaching center, it includes fees from students and income from books and test series.
• Cost of Material Consumed is primarily for manufacturers and includes raw materials. For example, a sugar factory consumes sugarcane.
• Change in Inventory is calculated as Opening Stock - Closing Stock. A negative figure indicates that closing stock is higher than opening stock.
• Employee Benefit Expenses include salaries, wages, contributions to provident funds, and staff welfare expenses.
• Finance Costs include interest on loans and debentures.
• Depreciation is used for tangible assets (Property, Plant, and Equipment - PPE), while Amortization is used for intangible assets (patents, copyrights, goodwill).
• Other Expenses include a wide range of costs, such as traveling, printing, rent, audit fees, and advertising.
• Exceptional Items and Extraordinary Items are discussed in Accounting Standard 5 and are shown separately to highlight their impact on profitability.
• Current Tax and Deferred Tax are discussed in Accounting Standard 22.
• Discontinuing Operations are discussed in Accounting Standard 24.
• Earnings Per Share (EPS) is discussed in Accounting Standard 20.
• Companies covered under Section 135 (Corporate Social Responsibility - CSR) must disclose details of their CSR spending.
• Companies must also disclose details related to cryptocurrency and virtual currency transactions.
• Auditor's fees must be separately disclosed, including fees for audit, taxation matters, company law matters, and management services.

3. Understanding the Balance Sheet

• The Balance Sheet presents a company's financial position as of a specific date and time.
• It includes two main sections: Equity and Liabilities and Assets.
• Equity and Liabilities includes:
  • Shareholder Funds:
    • Share Capital: The amount of capital raised from the issuance of shares.
    • Reserves and Surplus: Accumulated profits and other reserves.
    • Money Received Against Share Warrants: Money received for share warrants that have not yet been converted into shares.
  • Share Application Money Pending Allotment: Money received for share applications that have not yet been allotted.
  • Non-Current Liabilities: Liabilities due after one year or the operating cycle.
    • Long-Term Borrowings: Loans, debentures, and other borrowings due after one year.
    • Deferred Tax Liabilities: Tax liabilities that will be paid in the future.
    • Other Long-Term Liabilities: Other liabilities due after one year.
    • Long-Term Provisions: Provisions for liabilities that will be settled after one year (e.g., provision for gratuity).
  • Current Liabilities: Liabilities due within one year or the operating cycle.
    • Short-Term Borrowings: Loans and other borrowings due within one year.
    • Trade Payables: Amounts owed to suppliers for goods and services.
    • Other Current Liabilities: Other liabilities due within one year (e.g., outstanding expenses, dividend payable).
    • Short-Term Provisions: Provisions for liabilities that will be settled within one year (e.g., provision for tax).
• Assets includes:
  • Non-Current Assets:
    • Property, Plant, and Equipment (PPE): Tangible assets used in the business (e.g., buildings, machinery, furniture).
    • Intangible Assets: Non-physical assets (e.g., patents, copyrights, goodwill).
    • Capital Work-in-Progress (CWIP): Assets under construction.
    • Intangible Assets Under Development: Intangible assets under development.
    • Non-Current Investments: Investments held for more than one year.
    • Deferred Tax Assets: Tax assets that will be realized in the future.
    • Long-Term Loans and Advances: Loans and advances due after one year.
    • Other Non-Current Assets: Other assets held for more than one year.
  • Current Assets:
    • Inventories: Stock of raw materials, work-in-progress, and finished goods.
    • Trade Receivables: Amounts owed by customers for goods and services.
    • Cash and Cash Equivalents: Cash on hand, bank balances, and short-term investments.
    • Short-Term Loans and Advances: Loans and advances due within one year.
    • Other Current Assets: Other assets held for less than one year.
• Share Capital includes authorized, issued, subscribed, called-up, and paid-up capital.
• Reserves and Surplus includes various reserves, such as the P&L account balance, security premium, general reserve, and capital reserve.
• Long-Term Borrowings include debentures, loans, and public deposits due after one year.
• Short-Term Borrowings include loans payable within one year, bank overdrafts, and current maturities of long-term borrowings.
• Trade Payables include creditors and bills payable.
• Other Current Liabilities include share application money pending refund, outstanding interest, and outstanding expenses.
• Short-Term Provisions include provisions for tax.
• Property, Plant, and Equipment (PPE) includes buildings, machinery, furniture, and land.
• Intangible Assets include patents, copyrights, software, and trademarks.
• Inventories include raw materials, work-in-progress, finished goods, and stock-in-trade.
• Trade Receivables include debtors and bills receivable, net of provision for doubtful debts.
• Cash and Cash Equivalents include cash on hand and bank balances.
• Contingent Liabilities are disclosed in the notes to accounts and include claims against the company, guarantees, and arrears of cumulative dividends on preference shares.
• Commitments are also disclosed in the notes to accounts and include estimated amounts of contracts remaining to be executed on capital account.
• Aging Schedule is used to categorize trade receivables and payables based on the length of time they have been outstanding.
• Share Application Money Pending Refund is shown under Other Current Liabilities.
• Calls-in-Advance is shown under Other Current Liabilities.
• Losses are shown as a negative item under Reserves and Surplus.
• Current Maturities of Long-Term Borrowings are shown under Short-Term Borrowings.
• Security Deposits are shown under Other Non-Current Assets.
• Loose Tools and Spare Parts are shown under Inventories unless they meet the definition of PPE.
• Non-Scheduled Bank Balances are disclosed separately under Cash and Cash Equivalents.
• Cost and Accumulated Depreciation are disclosed separately for PPE in the notes to accounts.

4. Contingent Liabilities and Commitments

• Contingent Liabilities are potential liabilities that may arise depending on the outcome of uncertain future events.
• Commitments are contractual obligations for future expenditures.
• These items are disclosed in the notes to accounts below the balance sheet.
• Examples of contingent liabilities include:
  • Claims against the company not acknowledged as debts.
  • Guarantees given by the company.
  • Arrears of fixed cumulative dividends on preference shares.
  • Uncalled liability on partly paid shares and investments.
  • Bills discounted but not yet matured.
• Examples of commitments include:
  • Estimated amount of contracts remaining to be executed on capital account.

5. Accounting for Dividends

• Dividend is an appropriation of profits distributed to shareholders.
• Dividends can be interim (declared during the year) or final (declared after the year-end).
• The power to declare the final dividend lies with the shareholders at the Annual General Meeting (AGM).
• The Board of Directors proposes the dividend, but the actual liability arises only when the dividend is declared.
• The entry for dividend declaration is:
  • P&L Account Debit
  • To Dividend Payable
• The entry for dividend payment is:
  • Dividend Payable Debit
  • To Bank
• All appropriations, including dividends and transfers to reserves, are shown in the notes to accounts under Reserves and Surplus.
• The percentage for dividend is calculated on the capital, while the percentage for transfer to reserves is calculated on the current year's profits.
• If there is a loss, it is shown as a negative item under Reserves and Surplus.
• If the dividend is declared after the year-end, it is disclosed in the notes to accounts but not recorded as a liability in the current year's financial statements.

6. Basic Adjustments

• Outstanding Expenses: Add to the expense in the P&L and show as a liability in the balance sheet.
• Prepaid Expenses: Deduct from the expense in the P&L and show as an asset in the balance sheet.
• Depreciation: Charge to the P&L and deduct from the asset in the balance sheet.
• Accumulated Depreciation: Shown as a deduction from the asset in the balance sheet.
• Opening Stock, Purchases, and Closing Stock:
  • For manufacturers, use the formula: Cost of Material Consumed = Opening Stock + Purchases - Closing Stock.
  • For traders, show Purchases separately and Change in Inventory as Opening Stock - Closing Stock.
• Adjusted Purchases: If closing stock is in the trial balance, use adjusted purchases, which already includes the effect of opening and closing stock.

7. Share Forfeiture and Reissue

• Share Forfeiture: The process of canceling shares due to non-payment of calls.
• Reissue of Forfeited Shares: Selling forfeited shares to new investors.
• The accounting treatment depends on whether the shares are forfeited but not reissued or forfeited and reissued.
• If forfeited but not reissued, the forfeited amount is shown as an addition to share capital in the balance sheet.
• If forfeited and reissued, the profit on reissue is transferred to capital reserve.

8. Conditions for Withdrawing from General Reserve for Dividend

• If the company wants to use the general reserve to pay dividends due to insufficient profits, it must meet the following conditions:
  • The rate of dividend cannot exceed the average of the previous three years.
  • The maximum amount to be withdrawn cannot exceed 10% of the paid-up capital plus free reserves.
  • The amount left in the reserves after withdrawal must be at least 15% of the paid-up capital.

9. Materiality and Rounding Off

• Materiality: Any item of income or expense that exceeds 1% of revenue from operations or ₹1 lakh, whichever is higher, must be disclosed separately.
• Rounding Off: Depending on the total income of the company, figures in the financial statements must be rounded off to the nearest hundred, thousand, lakh, million, or crore.

10. Conclusion

The lecture provides a comprehensive overview of the preparation of financial statements for companies, covering the regulatory framework, key concepts, accounting treatment of various items, and practical examples. It emphasizes the importance of understanding the underlying principles and applying them correctly to ensure accurate and reliable financial reporting.