FRCC MODULE 1

FINANCIAL REPORTING AND
COST CONTROL
COMPANIES FINAL ACCOUNTS
Module 1
ALLIANCE UNIVERSITY ABS MBA
LAKSHMI NARASIMHAN
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CHAPTER CONTENTS
 Introduction
 Meaning of companies
 Types of companies
 Characteristics of companies
 Understanding Annual Reports
 Profit and loss statement and balance sheet
 Off Balance sheet items
 Treatment of events occurring after Balance sheet
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LEARNING OUTCOMES
 Obtaining a basic understanding about company form of business
organization
 Understanding the contents and format of P&L and Balance sheet
of companies.
 Understanding Annual reports.
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INTRODUCTION

INTRODUCTION
 Industrial revolution has led to the emergence of large scale business
organizations. These organization require big investments and the risk involved is
very high.
 Joint Stock Company form of business organization has become extremely
popular as it provides a solution to overcome the limitations of partnership
business.
 The giant Indian Companies may include the names like Reliance, Talco
Bajaj Auto, Infosys Technologies, Hindustan Lever Ltd., Ranbaxy Laboratories Ltd.,
and Larsen and Tubro etc.
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DEFINITION/MEANING OF
COMPANY
 A comprehensive and clear definition of a company is given by Lord
Justice Lindley, “A company is meant an association of many persons who contribute
money or money’s worth to a common stock and employ it in some trade or business,
and who share the profit and loss (as the case may be) arising there from. The common
stock contributed is denoted in money and is the capital of the company. The persons
who contribute it, or to whom it belongs, are members. The proportion of capital to
which each member is entitled is his share. Shares are always transferable although the
right to transfer them is often more or less restricted”.
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TYPES OF COMPANIES
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TYPES OF COMPANIES-BY
INCORPORATION
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Incorporation
Chartered Statutory
Registered or
Incorporated

TYPES OF INCORPORATED
COMPANIES
Registered or
incorporated
Limited by
Shares
Limited by
Guarantee
Unlimted
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BY NO. OF MEMBERS
Pvt. Ltd
Company
Public
Limited
Company
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BY OWNERSHIP
Government
Companies
Non-
Government
Companies
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BY COUNTRY OF ORIGIN OR
NATIONALITY
Indian
Companies
Foreign
Companies
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CHARACTERISTICS OF
COMPANIES
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CHARACTERISTICS OF COMPANY
 Separate Legal Entity:
Under Incorporation law, a company becomes a separate legal entity as
compared to its members. The company is distinct and different from its
members in law. It has its own seal and its own name, its assets and
liabilities are separate and distinct from those of its members. It is capable
of owning property, incurring debt, and borrowing money, employing
people, having a bank account, entering into contracts and suing and
being sued separately.
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 Limited Liability:
The liability of the members of the company is limited to contribution to the assets
of the company upto the face value of shares held by him. A member is liable to
pay only the uncalled money due on shares held by him. If the assets of the firm
are not sufficient to pay the liabilities of the firm, the creditors can force the
partners to make good the deficit from their personal assets. This cannot be done in
the case of a company once the members have paid all their dues towards the shares
held by them in the company.
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 Perpetual Succession:
A company does not cease to exist unless it is specifically wound up
or the task for which it was formed has been completed. Membership
of a company may keep on changing from time to time but that does
not affect life of the company. Insolvency or Death of member does
not affect the existence of the company.
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 Separate Property:
A company is a distinct legal entity. The company's property is its own. A member cannot
claim to be owner of the company's property during the existence of the company.
 Transferability of Shares:
Shares in a company are freely transferable, subject to certain conditions, such that no
share-holder is permanently or necessarily wedded to a company. When a member
transfers his shares to another person, the transferee steps into the shoes of the transferor
and acquires all the rights of the transferor in respect of those shares.
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 Common Seal:
A company is an artificial person and does not have a physical presence.
Thus, it acts through its Board of Directors for carrying out its activities
and entering into various agreements. Such contracts must be under the
seal of the company. The common seal is the official signature of the
company. The name of the company must be engraved on the common
seal. Any document not bearing the seal of the company may not be
accepted as authentic and may not have any legal force.
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 Capacity to sue and being sued:
A company can sue or be sued in its own name as distinct from its
members.
 Separate Management:
A company is administered and managed by its managerial personnel i.e.
the Board of Directors. The shareholders are simply the holders of the
shares in the company and need not be necessarily the managers of the
company.
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 One Share-One Vote:
The principle of voting in a company is one share-one vote i.e. if a
person has 10 shares, he has 10 votes in the company. This is in direct
distinction to the voting principle of a co-operative society where the
"One Member - One Vote" principle applies i.e. irrespective of the
number of shares held, one member has only one vote.
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UNDERSTANDING A
COMPANY’S ANNUAL REPORT
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ABOUT ANNUAL REPORTS
 An annual report is intended to provide a snapshot of a business' performance with
investors, potential investors and other stakeholders.
 It should provide enough information so that a potential investor understands the
nature and scope of the business, its recent developments and future outlook.
 The main sections of an annual report typically include the financial statements and
the "Management Discussion and Analysis."
 The former gives a summary of the financial results over the past year. For publicly
traded companies, all financial results must be reported for public consumption. Privately
held companies are under no such obligation, but most will share key financial
information with investors.
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ABOUT ANNUAL REPORTS
 The information contained in an annual report should give investors
and other stakeholders a clear idea of how the company is performing
and how it plans to grow and improve its business in coming years.
 Publicly traded companies mail reports to shareholders or provide a
copy of the annual report on their websites.
 Investors who want the straight financial data can also download
copies of the company's 10-K it files with the Securities & Exchange
Commission.
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CHAIRMAN’S LETTER
 It is customary for the annual report to contain a letter from the chairman of
the board of directors to shareholders.
 A small business might not have a separate board of directors, but a letter from
the chairman and CEO/president is appropriate to give to investors and other
stakeholders and should provide an overview of the past year's key developments.
 The chairman's letter should provide details about the successes as well as the
challenges of the past year. It should also include the future outlook for the
company, including insights about the market and growth opportunities.
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MANAGEMENT DISCUSSION &
ANALYSIS
 The Management Discussion and Analysis is a section of the annual report that
discusses different aspects of the business.
 Topics of discussion typically include new hires or appointments, new product
introductions, updates on the progress of business acquisitions, product launches
and other information management believes to be important to investors.
 It is an overview of the previous year's developments and how the company
performed over that period. It should be a good starting point for a new investor
who wants to understand a business' fundamentals.
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AUDITOR’S REPORT/LETTER
 Annual reports include a letter form the party reviewing and
externally verifying the financial data, typically in the form of an
auditors report or Certified Public Accountant letter.
 This letter provides proof of independent verification of the data
presented.
 It is typically presented on the official letterhead of the auditing
firm or individual CPA.
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FINANCIAL STATEMENTS
 The financial statements comprise the meat of the annual report. This is where the company
provides the numbers that investors use to determine how well the company performed
financially.
 The financial statements consist of the income or profit and loss statement, balance sheet
and cash flow statement for the current year previous year and prior years so investors can
compare the performance from one year to the next.
 Publicly traded companies are required to provide three years worth of financial statements
in their annual reports. A privately held company is not bound by the same regulations.
 However, investors will always welcome greater transparency. A privately held business that
goes above and beyond to publish prior-year financial results in its annual report increases its
chances of attracting new money.
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NOTES TO STATEMENTS
 An annual report’s financial statements are followed by notes that clarify various
points.
 This may include an introductory summary of the nature of the organization
and its business.
 This may be followed by a summary of the accounting policies applied,
information regarding capital contributions, investments and stock redemptions,
and other items depending on the business and events of the prior year.
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ADDITIONAL INFORMATION
 If the company has partners or subsidiary companies, partner
profiles and company data sheets may be included in the report to
provide a more complete picture of the year’s activities.
 Contact information is always included and generally closes the
report.
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PROFIT & LOSS STATEMENTS
& BALANCE SHEET

SCHEDULE VI OF COMPANIES
ACT(2013 AMENDMENT)
Schedule VI to Indian Companies Act 1956
specifies the format of Profit & Loss account &
Balance Sheet.
The latest format as per 2013 amendment is
attached for perusal & understanding
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FORMAT OF P & L ACCOUNT &
BALANCE SHEET
 BALANCE SHEET AND PROFIT AND LOSS FORMAT.xlsx
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MAJOR CHANGES IN REVISED
SCHEDULE VI
 The major changes that have been made in schedule Vi can be
better understood by categorizing the changes into 3 broad headings
 Major changes in balance sheet
 Additional disclosures that are required in balance sheet
 Major changes in P & L account
 Disclosures that are not required
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MAJOR CHANGES RELATED TO
THE BALANCE SHEET
 The Revised Schedule VI prescribes only the vertical format for
presentation of Financial Statements. Thus, a company will now not have an option
to use horizontal format for the presentation of Financial Statements as prescribed
in Old Schedule VI.
 Current and non-current classification has been introduced for
presentation of assets and liabilities in the Balance Sheet. The application of
this classification will require assets and liabilities to be segregated into their
current and non-current portions. For instance, current maturities of a long term
borrowing will have to be classified under the head “Other current liabilities.”
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THE BALANCE SHEET
 The Number of shares held by each shareholder holding more than 5
percent shares in the company now needs to be disclosed. In the absence
of any specific indication of the date of holding, such information should
be based on shares held as on the Balance Sheet date.
 Details pertaining to aggregate number and class of shares allotted for
consideration other than cash, bonus shares and shares bought back will
need to be disclosed only for a period of five years immediately preceding
the Balance Sheet date including the current year.
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THE BALANCE SHEET
 Any debit balance in the Statement of Profit and Loss will be disclosed under
the head “Reserves and surplus.” Earlier, any debit balance in Profit and Loss
Account carried forward after deduction from uncommitted reserves was required
to be shown as the last item on the Assets side of the Balance Sheet.
 Specific disclosures are prescribed for Share Application money. The application
money not exceeding the capital offered for issuance and to the extent not
refundable will be shown separately on the face of the Balance Sheet. The amount
in excess of subscription or if the requirements of minimum subscription are not
met will be shown under “Other current liabilities.”
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THE BALANCE SHEET
 The term “sundry debtors” has been replaced with the term “trade receivables.”
‘Trade receivables’ are defined as dues arising only from goods sold or services rendered
in the normal course of business. Hence, amounts due on account of other contractual
obligations can no longer be included in the trade receivables.
 The Old Schedule VI required separate presentation of debtors outstanding for a
period exceeding six months based on date on which the Guidance Note on the Revised
Schedule VI to the Companies Act, 1956 bill/invoice was raised whereas, the Revised
Schedule VI requires separate disclosure of trade receivables outstanding for a period
exceeding six months from the date the bill/invoice is due for payment.
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THE BALANCE SHEET
 “Capital advances” are specifically required to be presented separately
under the head “Loans & advances” rather than including elsewhere.
 Tangible assets under lease are required to be separately specified
under each class of asset. In the absence of any further clarification, the
term “under lease” should be taken to mean assets given on operating
lease in the case of lessor and assets held under finance lease in the case
of lessee.
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THE BALANCE SHEET
 In the Old Schedule VI, details of only capital commitments were required to be
disclosed. Under the Revised Schedule VI, other commitments also need to be
disclosed.
 The Revised Schedule VI requires disclosure of all defaults in repayment of
loans and interest to be specified in each case. Earlier, no such disclosure was
required in the Financial Statements. However, disclosures pertaining to defaults in
repayment of dues to a financial institution, bank and debenture holders continue to
be required in the report under Companies (Auditor’s Report) Order, 2003 (CARO).
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ADDITIONAL DISCLOSURES
 (a) Rights, preferences and restrictions attaching to each class of shares,
including restrictions on the distribution of dividends and the repayment of capital;
 (b) Terms of repayment of long-term loans;
 (c) In each class of investment, details regarding names of the bodies corporate
in whom investments have been made, indicating separately whether such bodies are
(i) subsidiaries, (ii) associates, (iii) joint ventures, or (iv) controlled special purpose
entities, and the nature and extent of the investment made in each such body
corporate (showing separately partly-paid investments);
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ADDITIONAL DISCLOSURES-
CONTD.
 (d) Aggregate provision for diminution in value
of investments separately for current and long-term
investments;
(e) Stock-in-trade held for trading purposes,
separately from other finished goods.
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THE P & L ACCOUNT
 The name has been changed to “Statement of Profit and Loss” as
against ‘Profit and Loss Account’ as contained in the Old Schedule
VI.
 Unlike the Old Schedule VI, the Revised Schedule VI lays down a
format for the presentation of Statement of Profit and Loss. This
format of Statement of Profit and Loss does not mention any
appropriation item on its face.
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THE P & L ACCOUNT
 In addition to specific disclosures prescribed in the Statement of Profit and
Loss, any item of income or expense which exceeds one percent of the revenue
from operations or Rs. 100,000 (earlier 1 % of total revenue or Rs. 5,000),
whichever is higher, needs to be disclosed separately.
 The Old Schedule VI required the parent company to recognize
dividends declared by subsidiary companies even after the date of the
Balance Sheet if they were pertaining to the period ending on or before the
Balance Sheet date. Such requirement no longer exists in the Revised
Schedule VI.
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THE P & L ACCOUNT
 In respect of companies other than finance companies, revenue from
operations need to be disclosed separately as revenue from (a) sale of
products, (b) sale of services and (c) other operating revenues.
 Net exchange gain/loss on foreign currency borrowings to the extent
considered as an adjustment to interest cost needs to be disclosed
separately as finance cost.
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THE P & L ACCOUNT
 Break-up in terms of quantitative disclosures for significant items of
Statement of Profit and Loss, such as raw material consumption, stocks,
purchases and sales have been simplified and replaced with the disclosure
of “broad heads” only.
The broad heads need to be decided based on considerations of
materiality and presentation of true and fair view of the Financial
Statements.
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DISCLOSURES THAT ARE NOT
REQUIRED
 Disclosures relating to managerial remuneration and computation of net profits for
calculation of commission;
 Information relating to licensed capacity, installed capacity and actual production;
 Information on investments purchased and sold during the year;
 Investments, sundry debtors and loans & advances pertaining to companies under
the same management;
 Maximum amounts due on account of loans and advances from directors or officers
of the company;
 Commission, brokerage and non-trade discounts
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OFF BALANCE SHEET
ITEMS
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OFF BALANCE SHEET ITEMS
Off-balance sheet financing means a company
does not include a liability on its balance sheet.
It is an accounting term and impacts a company’s
level of debt and liability.
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EXAMPLE OF OFF BALANCE SHEET
ITEMS
 Common forms of off-balance sheet financing include operating
leases and partnerships. Operating leases have been widely used over the
years, although the accounting rules have been tightened to lessen the use.
 For example, a company can rent or lease a piece of equipment and
then buy the equipment at the end of the lease period for a minimal
amount of money, or it can buy the equipment outright. In both cases, a
company will eventually own the equipment or building.
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ANALYSIS OF EXAMPLE-CONTD
 The difference is in how a company accounts for the purchase. In an
operating lease, the company records only the rental expense for the
equipment rather than the full cost of buying it outright.
 When a company buys it outright, it records the asset (the equipment)
and the liability (the purchase price). So by using the operating lease, the
company is recording only rental expense, which is significantly lower
than booking the entire purchase price, resulting in a cleaner balance
sheet.
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ANOTHER EXAMPLE
 Partnerships are another common OBS financing item
 When a company engages in a partnership, even if the company
has a controlling interest, it does not have to show the partnership’s
liabilities on its balance sheet, again resulting in a cleaner balance
sheet.
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OBS & INVESTORS
 These two examples of OBS financing arrangements depict the reason their use is
attractive to many companies.
 The problem investors encounter when analyzing a company’s financial statements is
that many of these OBS financing agreements are not required to be disclosed at all, or
they have partial disclosures, which are very minimal and do not provide adequate data
required to fully understand a company’s total debt.
 Even more perplexing is that these financing arrangements are allowable under
current accounting rules, although some rules govern how each can be used. Because of
the lack of full disclosure, investors need to determine the worthiness of the reported
statements prior to investing by understanding any OBS arrangements.
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WHY OBS FINANCING IS SO
ATTRACTIVE
 OBS financing is very attractive to all companies, but especially to those that are
already highly levered. For a company that has high debt to equity, increasing its
debt may be problematic for several reasons.
 First, for companies that already have high debt levels, borrowing more money
is usually exceedingly more expensive than for companies that have little debt
because the interest charged by the lender is high.
 Second, borrowing more may increase a company’s leverage ratios, causing
agreements (called covenants) between the borrower and lender to be violated.
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WHY OBS FINANCING IS SO
ATTRACTIVE
 Third, partnerships, such as in research and development, are attractive to companies
because R&D is expensive and may have a long-time horizon before completion. The accounting
benefits of partnerships are many-fold.
 For example, accounting for an R&D partnership allows the company to add very minimal
liability to its balance sheet while conducting the research. This is beneficial because during the
research process, there is no high-value asset to help offset the large liability. This is particularly
true in the pharmaceutical industry where R&D for new drugs takes many years to complete.
 Last, OBS financing can often create liquidity for a company. For example, if a company
uses an operating lease, capital is not tied up in buying the equipment since only rental expense is
paid out.
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HOW OBS FINANCING AFFECTS
INVESTORS
 Financial ratios are used to analyze a company’s financial standing. OBS
financing affects the leverage ratios, like the debt ratio, a common ratio used to
determine if the debt level is too high when compared to a company's assets.
 Debt-to-equity, another leverage ratio, is perhaps the most common because it
looks at a company's ability to finance its operations long term using shareholder
equity instead of debt.
 The debt-to-equity ratio does not include short-term debt used in a company's
day-to-day operations to more accurately depict a company’s financial strength.
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HOW OBS FINANCING AFFECTS
INVESTORS
 In addition to the debt ratios, other OBS financing situations include operating leases
and sale-lease back impact liquidity ratios. Sale-lease back is a situation where a company
sells a large asset, usually a fixed asset like a building or large capital equipment, and then
leases it back from the purchaser.
 Sale-lease back arrangements increase liquidity because they show a large cash inflow
after the sale and a small nominal cash outflow for booking a rental expense instead of a
capital purchase. This reduces the cash outflow level tremendously, so the liquidity ratios
are also affected.
 Current assets to current liabilities is a common liquidity ratio used to assess a
company’s ability to meet its short-term obligations. The higher the ratio, the better the
ability to cover current liabilities. The cash inflow from the sale increases the current
assets, making the liquidity ratio more favorable.
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EVENTS AFTER
BALANCE SHEET DATE
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EVENTS AFTER BALANCE SHEET
DATE
 Events after the balance sheet date are significant financial events that occur after the
date of the balance sheet, but prior to the date that the financial statements are issued.
 For example, a company's balance sheet that has the heading of December 31, 2012
might not be finalized and distributed until February 1, 2013.
 During January new information may arise that has financial significance. Perhaps
there is an event that provides more information about the conditions actually existing on
December 31.
 The second type of event would be a new January event that does not change the
December 31 amounts, but needs to be disclosed to the readers of the December 31
financial statements.
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AN EXAMPLE…..
 An example of the first situation might be that a customer owes Jay Company
$200,000 on December 31 and Jay Company assumed that the customer was financially
sound.
 As a result Jay Company did not provide any allowance for the customer's account
being uncollectible.
 Then on January 28, the customer filed for bankruptcy and Jay Company learns that
none of the $200,000 receivable will be collected.
 If the customer's financial condition on December 31 was already in bankruptcy
condition, Jay Company will need to adjust its December 31 balance sheet and its income
statement for the year 2012 for this $200,000 of bad debts expense.
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ANOTHER EXAMPLE….
 An example of the second situation might be a loss arising from a catastrophe
occurring on January 16, 2013. The amounts reported as of December 31, 2012 will
not be adjusted since those amounts were correct as of December 31.
 However, the readers of the December 31 balance sheet and the 2012 income
statement should be informed through a disclosure that something significant has
occurred to the company's financial position since December 31.
 The events after the balance sheet date are often referred to as subsequent
events or post balance sheet events.
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