Financial Statements and Reporting

The statement of financial position (balance sheet) shows the assets, liabilities and equity of a business as at a particular date. It is prepared from the adjusted trial balance after the income statement has been prepared.

Steps in preparation

1. Take the balances of real and personal accounts (assets, liabilities, capital) from the adjusted trial balance.
2. Classify assets into non-current (land, building, machinery, furniture) and current (stock, debtors, cash, prepaid expenses).
3. Classify liabilities into current (creditors, outstanding expenses, overdraft) and long-term (loans, debentures).
4. Adjust capital: opening capital + net profit (or − net loss) − drawings + additional capital.
5. Arrange assets in the order of permanence (or liquidity) and liabilities in the order of urgency.
6. Total both sides, which must agree: $\text{Assets} = \text{Liabilities} + \text{Capital}$.

Format

The statement of financial position (balance sheet) shows the assets, liabilities and equity of a business as at a particular date.

Steps in preparation

1. Fix the date, the last day of the accounting period (e.g. Ashadh end).
2. List assets in the order of permanence (fixed assets first) or liquidity.
3. List liabilities in the order of urgency (current liabilities, then long-term loans).
4. Compute adjusted capital = opening capital + net profit − drawings (+ additional capital).
5. Check the accounting equation:

$\text{Assets} = \text{Liabilities} + \text{Equity}$

Format

Example. On Ashadh 31: cash Rs 40,000; debtors Rs 60,000; stock Rs 50,000; machinery Rs 2,00,000; furniture Rs 50,000; creditors Rs 80,000; bank loan Rs 1,00,000; opening capital Rs 2,00,000; net profit Rs 70,000; drawings Rs 50,000.

$\text{Adjusted capital} = 2{,}00{,}000 + 70{,}000 - 50{,}000 = \text{Rs } 2{,}20{,}000$

Statement of Financial Position as at Ashadh 31

Verification: Liabilities Rs 1,80,000 + Equity Rs 2,20,000 = Rs 4,00,000 = Total assets, so the equation holds.

The income statement (statement of profit or loss) shows the net profit or net loss.

It records the revenues and expenses of a period and gives the resulting net profit or loss. The balance sheet shows financial position, not profit.

The balance sheet (statement of financial position) shows the financial position of a business.

It presents the assets, liabilities and owners' equity as on a particular date.

The income statement (statement of profit or loss) is prepared to find the net profit or net loss of a business for an accounting period. It starts from the gross profit (or loss) brought down from the trading account.

Steps in preparation

1. Write gross profit on the credit side (gross loss on the debit side).
2. Write indirect incomes on the credit side: commission, interest, rent and dividend received, discount received, profit on sale of assets.
3. Write indirect expenses on the debit side: salaries, rent, insurance, depreciation, interest paid, discount allowed, bad debts, advertisement, carriage outwards, provision for doubtful debts.
4. Total both sides. If credits exceed debits, the difference is net profit; otherwise it is net loss. Net profit is transferred to the capital account.

Format

Example. Gross profit Rs 80,000; salaries Rs 20,000; rent Rs 8,000; insurance Rs 4,000; depreciation Rs 5,000; commission received Rs 6,000; interest received Rs 2,000.

Total expenses = 20,000 + 8,000 + 4,000 + 5,000 = Rs 37,000, and total incomes = 80,000 + 6,000 + 2,000 = Rs 88,000.

$\text{Net profit} = 88{,}000 - 37{,}000 = \text{Rs } 51{,}000$

This net profit is added to capital in the balance sheet.

Statement of financial position and statement of profit or loss.

An annual report typically includes the financial statements — the statement of financial position (balance sheet) and the statement of profit or loss (income statement) — along with other disclosures such as the auditor's report and notes to accounts.

Statement of Financial Position (Balance Sheet) and Statement of Profit or Loss (Income Statement).

These are the two basic financial statements a company prepares — the statement of financial position shows assets, liabilities and equity at a point in time, while the statement of profit or loss shows revenues and expenses for the period.

Components of a Company Balance Sheet

A company's balance sheet is prepared in the prescribed form (Schedule 6 of the Companies Act, 2063) and shows the financial position on a particular date. It has two sides — Assets and Liabilities — which must always agree.

A. Assets Side

1. Fixed (Tangible) Assets — Land and building, plant and machinery, furniture and fixtures, vehicles, equipment, etc., shown at cost less accumulated depreciation.
2. Intangible Assets — Goodwill, patent, trademark, copyright, and preliminary/pre-operative expenses not yet written off.
3. Investments — Shares, debentures and securities of other companies, government bonds, and long-term deposits held as investment.
4. Current Assets — Cash in hand, cash at bank, bills receivable, sundry debtors (less provision for doubtful debts), stock/inventory, prepaid expenses and accrued income.
5. Loans and Advances — Advances given to employees, suppliers, branches and subsidiary companies.
6. Miscellaneous Expenditure — Discount on issue of shares, underwriting commission, etc., pending write-off.

B. Liabilities Side

1. Share Capital — Authorised, issued, subscribed and paid-up capital, divided into equity share capital and preference share capital.
2. Reserves and Surplus — General reserve, capital reserve, share premium, sinking fund, and credit balance of profit and loss appropriation account.
3. Secured Loans — Debentures, bank loans and mortgage loans that are backed by the charge on company assets.
4. Unsecured Loans — Loans from directors, public deposits and other borrowings without any security.
5. Current Liabilities and Provisions — Sundry creditors, bills payable, bank overdraft, outstanding expenses, provision for taxation, proposed dividend and provision for doubtful debts.

Note: Assets are arranged in order of permanence (least liquid first) and liabilities in order of priority of repayment. The total of both sides must be equal, since every asset is financed either by owners' funds (capital and reserves) or by outsiders' funds (loans and liabilities).

Activities of the cash flow statement (10 marks)

A cash flow statement reports the inflows and outflows of cash and cash equivalents during a period. It classifies all cash flows into three activities, so users can see where cash came from and where it was used.

1. Operating activities

These are the principal revenue-producing activities of the business and other activities that are not investing or financing. They show cash generated from the core business.

• Inflows: cash received from customers for sales, interest and dividends received (where treated as operating).
• Outflows: cash paid to suppliers, employees, for rent, other expenses, interest paid (where treated as operating) and income tax.

Example: A trading firm receives Rs 8,00,000 from customers and pays Rs 5,00,000 to suppliers, Rs 1,00,000 as salaries and Rs 50,000 as tax. Net cash from operating activities is $8{,}00{,}000 - 5{,}00{,}000 - 1{,}00{,}000 - 50{,}000 = \text{Rs } 1{,}50{,}000.$

2. Investing activities

These involve the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

• Inflows: sale of land, building or machinery; sale of shares or bonds of other companies; recovery of loans given to others.
• Outflows: purchase of fixed assets; purchase of investments; loans given to others.

Example: Purchase of machinery for Rs 2,00,000 and sale of old equipment for Rs 40,000 gives net cash used in investing activities of Rs 1,60,000.

3. Financing activities

These change the size and composition of the owners' capital and borrowings of the firm.

• Inflows: issue of shares or debentures; bank loans taken.
• Outflows: repayment of loans; redemption of debentures or preference shares; buy-back of shares; dividend paid.

Example: Issue of shares of Rs 3,00,000 and payment of dividend of Rs 50,000 gives net cash from financing activities of Rs 2,50,000.

Net change in cash

$\text{Net change} = \text{Operating} \pm \text{Investing} \pm \text{Financing}$

Adding this to the opening cash balance gives the closing cash balance. A healthy firm usually shows positive operating cash flow, negative investing cash flow (it is expanding) and financing flows that balance the two.