Preparation of Financial Statements

After reading this article you will learn about the preparation of financial statements.

Financial Statements:

As per IFRSs financial statements comprise of Statement of Comprehensive Income, Statement of Financial Position, Statement of Changes in Equity, Statement of Cash Flows and related notes to accounts. Statement of Comprehensive Income has two sub-components – Statement of Income and Statement of Other Comprehensive Income. Statement of Financial Position is also termed as Balance Sheet.

Statement of Comprehensive Income reflects financial performance of the reporting entity for the accounting period, Statement of Financial Position reflects its assets, liabilities and equity as on the reporting date, Statement of Changes in equity explains changes that have taken place in the shareholders’ equity during the accounting period, and Statement of Cash Flows reflects cash flows of the entity during the accounting period in a classified manner.

In contrast, financial statements as per Indian Company law comprise of Profit and Loss Account, Balance Sheet, Statement of Cash Flows (applicable to listed companies only) and related notes. There are some contrasting difference in the style of presentation of Statement of Financial Position (or Balance Sheet) as per Indian company law and IFRSs. IFRSs based balance sheet is classified balance sheet.

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As per IFRSs assets and liabilities are classified into current and non-current categories:

Statement of Comprehensive Income:

IAS 1 Presentation of Financial Statements offers two alternatives for presenting comprehensive income – (1) presenting components of profit or loss (income statement) and other items of comprehensive income in a single statements or (2) two statements: first one presents just profit or loss (Income Statement) and the second begins with profit or loss and displays other comprehensive income.

What is comprehensive income?

IAS 1 has defined the term total comprehensive income as the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners. Total comprehensive income comprises of all components of profit or loss’ and of other comprehensive income.

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Profit or Loss = Income minus expenses recognized in accordance with the Framework or a specific IFRS.

Profit or loss is the total of income less expenses, excluding the components of other comprehensive income.

Presented below in Table 7.1 structure of the Statement of Income (as per IAS 1 Presentation of Financial Statements).

It is to be mentioned that Schedule VI to the Companies Act, 1956 provides legal framework for the preparation and presentation of financial statements which is supported by the Indian Accounting Standards and listing agreements (applicable to the companies listed in a recognised stock exchange). There is no specified structure of Profit and Loss Account under the Companies Act, 1956.

Statement of Financial Position:

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IFRSs based Statement of Financial Position (Balance Sheet) is a classified presentation of assets and liabilities. Assets and liabilities are classified into current and non-current categories. As an exception assets and liabilities can be presented in order of liquidity if that alternative makes a more reliable and relevant presentation.

Presented below in Table 7.2 is an illustrative structure of Statement of Financial Position:

In India, Part I of the Schedule VI to the Companies Act, 1956 provides a structure of Balance Sheet. Unlike IFRSs, Indian balance sheet is not a classified balance sheet.

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The vertical format of the Balance Sheet is presented in Table 7.3 below:

Statement of Changes in Equity:

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This statement is meant for depicting the movement in equity during the accounting period.

This statement reflects:

i. Various components of the equity with separate presentation of non-controlling interest;

ii Distribution of total comprehensive income during the year to various equity components and non-controlling interest;

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iii. Distribution to owners by way of dividend and other transaction with owners like issue of shares.

Statement of Cash Flows:

It presents the information about the cash flows of an entity which is useful in providing users of financial statements with a basis to assess the ability of the entity to generate cash and cash equivalents, and the need of the entity to utilise those cash flows. Primarily, the statement of cash flows captures the difference between accrual basis income and cash income. It also provides structured information about cash flows resulting from operating activities, investment activities and financing activities. By this users can understand how far internally generated cash flows propels the growth of the entity.

Example 1:

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Huda Trading Co. was registered as a limited company on 1.1.2008 and issued 10lacs shares of Rs.10 each issued at par. It raised 10% Bank loans of Rs. repayable after 5 years. 200 lacs. The company purchased furniture and equipment for Rs.50 lacs.

It purchased goods for Rs.400 lacs (of which Rs.200 lacs were in cash and another Rs.200 lacs were on credit). The company sold goods for Rs.700 lacs (of which Rs.300 lacs in cash and balance on credit). The company collected Rs.350 lacs from the debtors and paid Rs.190 lacs to the creditors. It has incurred Rs. 80 lacs on account of wages and salaries, and Rs.60 lacs on account of general expenses. It paid tax in advance in accordance with the Indian Income Tax Act amounting to Rs. 50 and it wished to provide the same amount as provision for tax. It paid interest for the year and charged depreciation on furniture and equipment @ 20% p.a. Unsold goods at the year end were Rs.50 lacs.

You are required to prepare – (i) Statement of Cash Flows, (ii) Statement of Income and (iii) Balance Sheet in the IFRSs format. Present the same balance sheet in the format given in Schedule VI to the Companies Act as well.

Solution:

1. Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the entity.

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2. Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash and cash equivalents.

3. Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

Cash and cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

1. In the Statement of Income both cash sales and credit sales are recognised under accrual principles. Similarly, both cash and credit purchases are recognised.

2. There is no opening stock. So the change in inventory is the amount of closing stock.

1. Credit sales minus cash collection

2. Credit purchases minus cash payment

Given below the Balance Sheet in accordance with Indian Format:

Example 2:

Gulf Trading Co. was registered as a limited company on 1.1.2008 and issued 10 lacs shares of Rs.10 each at a premium of Rs.10. It raised 10% Bank loans of Rs. repayable after 5 years 300 lacs. The company purchased furniture and equipment for Rs.100 lacs and paid Rs.50 lacs for obtaining Franchising Right from a leading company. The company spent Rs.20 lacs on advertising which it wishes to recognise as Brand (an intangible asset).

It purchased goods for Rs.450 lacs (of which Rs.250 lacs were in cash and another Rs.200 lacs were on credit). The company sold goods for Rs.800 lacs (of which Rs.300 lacs in cash and balance on credit). The company collected Rs.450 lacs from the debtors and paid Rs.180 lacs to the creditors. It has incurred Rs. 90 lacs on account of wages and salaries, and Rs.60 lacs on account of general expenses.

It paid tax in advance in accordance with the Indian Income Tax Act amounting to Rs.10 lacs and it wished to provide the same amount as provision for tax. It paid interest for the year and charged depreciation on furniture and equipment @ 20% p.a. The company amortises Franchise Right over a period of 5 years. Unsold goods at the year end were Rs.40 lacs. It was checked at the year end that 5 bills amounting to Rs.20 lacs of general expense incurred for 2008 are due for payment.

The company invested Rs.300 lacs in held for trading investments (a classification which means those investments are short term). They are measured at fair value which is market price at the reporting date. Market value of these investments are Rs.290 lacs.

Solution:

1. Held for trading investments are classified as current asset and re-measured at market value. The fair value loss/gain is charged to profit or loss.