Brief Summary
This video introduces the "Financial Statements of a Company" chapter from the third book of accounts, which carries 20 marks in the board examination. It explains what financial statements are, their objectives, and the formats of the balance sheet and income statement as per the Companies Act 2013. The video also covers the components of equity and liabilities, assets, and the statement of profit and loss, including key terms and concepts.
- Financial statements are summaries of a company's accounts, including the balance sheet, income statement, cash flow statement, and notes to accounts.
- The objective of financial statements is to provide reliable financial information to various interested parties, including management, creditors, and the government.
- The balance sheet format follows Part One of Schedule III of the Companies Act 2013, presenting equity and liabilities, and assets in a vertical format.
Introduction to Financial Statements
The video introduces the third book of accounts, focusing on "Financial Statements of a Company," which is worth 20 marks in the board examination. The chapter aims to explain the format of a company's balance sheet, including headings and subheadings. The content will be covered in two parts, with the second part focusing on headings and subheadings.
What are Financial Statements?
Financial statements are summaries of a business enterprise's accounts, detailing earnings, costs, assets, and liabilities. Key financial statements include the balance sheet, income statement (Statement of Profit and Loss), cash flow statement, and notes to accounts. These statements provide financial information to the public, verified by a Chartered Accountant, and are essential for understanding a company's financial condition.
Objectives of Preparing Financial Statements
The objectives of preparing financial statements include providing financial information about a company's assets, liabilities, and profitability. They aim to disclose the financial position, provide reliable information to interested parties such as management, creditors, debtors, banks, and the government, and present a true and fair view of the business. Financial statements also help managers make decisions and forecast future activities, ensuring policies are transparent and compliant with accounting standards.
Format of the Balance Sheet
The video transitions to discussing the format of the balance sheet as prescribed in Part One of Schedule III of the Companies Act 2013. Unlike the T format used previously and still used by partnerships, the current format is vertical. The balance sheet includes equity and liabilities, with main heads such as shareholders' funds, share application money pending allotment, non-current liabilities, and current liabilities, followed by assets.
Equity and Liabilities Side of the Balance Sheet
The equity and liabilities side of the balance sheet includes shareholders' funds, which consist of share capital (equity and preference shares), reserves and surplus (including various reserves like general reserve, securities premium reserve, and capital redemption reserve), and money received against share warrants. Share application money pending allotment refers to funds collected from the public before March 31 for allotments to be done later. Non-current liabilities are payable after 12 months and include long-term borrowings, deferred tax liability, other long-term liabilities, and long-term provisions. Current liabilities are debts payable within 12 months, including short-term borrowings, trade payables (creditors and bills payable), other current liabilities (outstanding expenses, advance income), and short-term provisions (provision for tax).
Deferred Tax Liability Explained
Deferred tax liability arises from the difference between accounting income and taxable income. Accounting income is calculated following accounting concepts, while taxable income is determined by the Income Tax Act 1961. If accounting income is more than taxable income, a deferred tax liability is created. Conversely, if accounting income is less than taxable income, a deferred tax asset is created, which appears under non-current assets.
Asset Side of the Balance Sheet
The asset side of the balance sheet includes non-current assets and current assets as the two main heads. Non-current assets include property, plant, and equipment (PPE) and intangible assets. PPE includes land, building, plant, machinery, computers, and furniture, while intangible assets include goodwill, patents, trademarks, and copyrights. Capital work in progress refers to assets under construction, and intangibles under development are intangible assets being created. Non-current investments are long-term investments, and long-term loans and advances are loans given for the long term. Current assets include current investments (marketable securities), inventories (stock of finished goods, raw material, work in progress, loose tools, spare parts), trade receivables (debtors and bills receivable), cash and cash equivalents (cash or bank balance), short-term loans and advances, and other current assets like prepaid expenses and accrued income.
Statement of Profit and Loss (Income Statement)
The statement of profit and loss, or income statement, is presented in a specific format with particulars, notes to accounts, and figures for the current and previous years. It starts with revenue from operations (net sales) and adds other income to get total revenue. Expenses are then listed, including the cost of materials consumed, changes in inventory (opening inventory minus closing inventory), employee benefit expenses, finance costs, and depreciation and amortization. Subtracting total expenses from total revenue gives profit before tax, and further deducting income tax results in profit after tax.
Operating Cycle Explained
The operating cycle is the time from purchasing raw materials to converting them into finished goods, selling them, and receiving cash. It includes raw materials, work in progress, finished goods inventory, debtors, and bills receivable. If the operating cycle is not given, it is assumed to be 12 months. Items within the operating cycle are considered current.
Classifying Liabilities Based on Operating Cycle
Liabilities are classified as current or non-current based on the operating cycle. If a liability is payable within the operating cycle, it is current. If the operating cycle is not specified, the standard 12-month period is used. If a payment is due outside the operating cycle but within 12 months, it is still considered current. Only when a payment is due beyond both the operating cycle and 12 months is it classified as non-current.
Limitations of Financial Statements
Financial statements have several limitations. They rely on historical records, which may not reflect current values or future performance. They are affected by estimates, such as the estimated life of assets and inventory valuation methods, which can introduce inaccuracies. Financial statements can be subject to window dressing, where negative aspects are hidden. They often ignore qualitative elements, focusing only on quantifiable monetary values, and may not reflect price level changes over time.
Provisions vs. Reserves
Provisions are liabilities or estimated losses recognized in advance, such as provision for depreciation or doubtful debts. Reserves, on the other hand, are amounts set aside from profits, representing shareholders' money. Provisions are made for specific purposes and are considered expenses, reducing profit, while reserves are created from profit after it is earned and are considered an appropriation of profit. Provisions appear in the statement of profit and loss, while reserves are shown under shareholders' funds in the balance sheet. Reserve money can be invested, creating a reserve fund, while provision money cannot be invested elsewhere.
Users of Accounting Information
There are two types of users of a company's accounting information: internal and external. Internal users include management and owners, who use financial statements to make managerial decisions and understand the company's financial position. External users include shareholders, employees, tax authorities, creditors, bankers, investors, potential investors, researchers, and the public, all of whom have different interests in the company's financial performance and stability.
