FINANCIAL STATEMENTS OF A COMPANY

FINANCIAL STATEMENTS OF A COMPANY

Meaning of financial statements:

Final accounts are the final product of accounting work done during the accounting
period i.e. quarterly, half yearly or annually. By this the accounting information is
communicated to the external users. It includes two basic financial statements namely:
(i) Profit and Loss Account
(ii) Balance Sheet.
Although the general principles of preparing the final accounts of joint stock companies
are the same as in the case of the sole proprietorship or partnership firms, but in
addition to these principles, a joint stock company must confirm to certain legal
provisions as given in the Indian Companies Act 1956.
Every company must prepare final accounts every year. At every annual general
meeting of a company, the Board of Directors of the company shall lay before the
company (a) a Balance Sheet as at the end of period (b) a Profit and Loss Account for
that period. In case, a company is not carrying on business for profit, an Income and
Expenditure Account shall be laid before the company at its annual general meeting
instead Profit and Loss Account. The report of Auditor and Board of Directors should be
attached to every Profit and Loss Account and Balance Sheet. Enterprises having a
turnover in excess of Rs. 50 crores have to attach Cash Flow Statement and Segment
Report with the annual accounts.
A Balance Sheet is a statement of assets and liabilities indication the financial position
of an enterprise at a given date.
A Profit and Loss Account shows the net result of business operations during an
accounting period.
A Profit and Loss Appropriation Account shows how the profit for the year has been
distributed or appropriated.
Schedules have the details of amounts in the Balance Sheet and Profit and Loss
Account, while the notes are the statements of accounting polices adopted and
explanation of material information.

Application of Schedule VI of the Companies Act:

The form and contents of Balance Sheet and Profit and Loss Account are governed by
Section 211 of the Companies Act, 1956.
Section 211 (1): According to this section every Balance Sheet must give true and fair
view of the state of affairs of the company as at the end of the financial year and to be
in the form set out in Part I of Schedule VI or as near thereto as circumstances permit or
in such form as may be approved by the Central Government.

Section 211 (2): According to this section every Profit and Loss Account must give
true and fair view of the profit or loss of the company for the financial year and shall
comply to with the requirement of Part II of Schedule VI, so far they are applicable.

Note: It must be noted here that Schedule VI has prescribed a form in which Balance
Sheet is to be prepared; it has not prescribed any form for Profit and Loss Account.
The Companies Act, 1956 has not recognised Trading Account and Profit and Loss
Appropriation Account, yet there is no bar to prepare these accounts. It is so because
Schedule VI has not prescribed any form for Profit and Loss Account. But, it must be
remembered that the Trading Account, Profit and Loss Account and Profit and Loss
Appropriation Account must comply with the requirements of Part II of Schedule VI of
Companies Act, 1956.

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FINANCIAL STATEMENTS OF A COMPANY

Balance Sheet:
In the simplest form, a Balance Sheet may be defined to be a statement of company’s
assets and liabilities as on a particular date. The assets of the company, fixed assets
and current assets, are represented by the liabilities, long-term liabilities and short-
term liabilities, and the share holders equity, i.e., paid up share capital and reserves.

Name of the Company

Balance Sheet as at _________

Liabilities Rs. Rs. Assets

Share Capital Fixed Assets

Authorised Capital Investments

____ shares of Rs. ____ xx
each Current Assets and
Loans & Advances
Issued Capital xx (a) Current Assets
____ shares of Rs. ____ (b) Loans & Advances xx
each
Miscellaneous xx
Subscribed Capital Expenditure
____ shares of Rs. ____ xx
each Profit and Loss
(Rs. ____called up ( Account xx
/ fully called up) xx) (Debit balance) xx
xx
Less: Calls unpaid (
(a) By Directors xx)
xx
(b) By Others
xx
Forfeited Shares xx
xx
Calls-in-advance
xx
Reserves and Surplus
xx
Secured Loans

Unsecured Loans
xx
xx
Current Liabilities &
Provisions
(a) Current Liabilities
(b) Provision

Total xx Total xx

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FINANCIAL STATEMENTS OF A COMPANY

Items appearing in the Liability side:

Share Capital:
The word capital in connection with a company may mean any of the following divisions
of capital:
1) Authorised capital: An authorised capital refers to that amount which is stated in the
‘Capital Clause’ of the Memorandum of Association as the share capital of the
company. This is the maximum limit of the company which it is authorised to raise
and beyond which company cannot raise unless the capital clause in the
Memorandum is altered in accordance with the provisions of Sec. 94 of the
Companies Act, 1956.
2) Issued capital: An issued capital refers to the nominal value of that part of
authorised capital, which has been (1) subscribed for by the signatories to the
Memorandum of Association, (2) allotted for cash or for consideration other than
cash and (3) allotted as Bonus shares.
3) Subscribed capital: Subscribed capital refers to the paid-up value of the issued
capital i.e. the total amount called by the company less calls-in-arrear. It is only
the actual liability for the company hence it will be only be added while totalling
the liability side.

Reserves and Surplus:

(i) Capital Reserve: It includes amount which are not earned during normal operation
of business, therefore the amount of such reserve is not available for distribution
as dividend, e.g., profit prior to incorporation of a company, profit on acquisition of
business, profit on sale of fixed assets, profit remaining on re-issue of forfeited
shares, profit on redemption of shares and debentures, profit on revaluation of
fixed assets and liabilities, premium of issue of shares and debentures.

(ii) Capital Redemption Reserve.

(iii) Securities Premium Account.

(iv) Other Reserves: Nature and amount if each reserve should be explained
separately. If there is any debit balance in profit and loss account, it should be
deducted from the General Reserve.

(v) Surplus: It refers to the credit balance of Profit and Loss Appropriation.

(vi) Proposed additions to Reserves.

(vii) Sinking Fund.

Secured Loans: If the company borrows loans secured by or mortgage or charge on

all or any of its assets, the loan is termed as ‘Secured Loan’. Interest accrued and due
on such loan is also termed as secured hence shown under this heading. Short term
and long term loans should be shown separately.

Unsecured Loans: If the company borrows loans without giving any security, the loan
is termed as ‘Unsecured Loan’. Under this head ‘Unsecured Loan’ as well as the part of
secured loan which is not covered by the value of security provided are included. Short
term and long term loans should be shown separately.

Current Liabilities: These are those liabilities which are payable within the period of
12 months from the closure of last accounts.

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FINANCIAL STATEMENTS OF A COMPANY

Provision: The term ‘Provision’ refers to any of the following amounts:

(i) The amount written off or retained by way of providing depreciation, renewals or
diminution in the value of assets; or
(ii) The amount retained by way of providing for any known liability of which the
amount cannot be determined with substantial accuracy.

Contingent Liabilities: These are such liabilities which are not liability for the
business on close of accounts, but may or may not become liability in future on
happening of certain event. It will never be shown in the liabilities side. These are
always stated as foot-note on the liabilities side. Following are the exampled of
contingent liabilities:
(i) Claims against the company not acknowledged as debts.
(ii) Uncalled liability on partly paid shares.
(iii) Arrears of dividends on cumulative preference shares.
(iv) Other money for which the company is contingently liable.
(v) Bills discounted but not matured.
(vi) Liabilities under a guarantee.

Items appearing in the assets side:

The various assets shown under different headings in the Balance Sheet of a company
include:
Fixed assets: Relevant information to be given regarding such assets are:
(i) As far as possible, different assets should be shown separately.
(ii) Regarding every fixed asset, it is necessary to show its original cost and additions
(purchase) thereto and deductions (sale) there from during the year and the total
depreciation written off or provided in it up to the end of the year.

Investments: Investments by nature are fixed. Schedule VI of Companies Act, 1956

requires following details to be given with respect to investments:
1) Investments are categorised into:
(a) Investment in Government and trust securities;
(b) Investment in shares, debentures and bonds of various companies;
(c) Investment in shares, debentures and bonds of subsidiary companies; and
(d) Investment in fixed assets.

2) It is necessary to disclose the nature (long term or current) and mode of valuation
of every investment.
3) It is necessary to disclose the total amount of company’s quoted and unquoted
investments and market value of quoted investments in the Balance Sheet.

Current assets and Loans & Advances: These should be divided into two parts:
1) Current Assets
2) Loans and Advances

Miscellaneous Expenditure: It includes those items which are not really assets but
are recorded in the assets side because it shows debit balance, hence are called
fictitious assets. The amount of miscellaneous expenditure which is written off this year
is shown on the debit side of Profit and Loss Account and the unwritten off portion is
shown in the Balance Sheet under this head.
This includes the followings:
(i) Preliminary expenses.
(ii) Expenses including commission or brokerage on underwriting or subscription of
share or debentures.
(iii) Discount allowed on issue of shares or debentures.
(iv) Interest paid out of capital during construction.

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FINANCIAL STATEMENTS OF A COMPANY

(v) Development expenditure not adjusted.

(vi) Other sums, specifying the nature.

Profit and Loss Account (Debit balance): If there is net loss in a company and
other reserves is given, then first of all such loss will be deducted from such reserves
and if such reserve is not given or the amount of reserve is not sufficient to cover the
total amount of loss then the balance amount of net loss will be shown under this head.

Explanation of some specific terms:

Provision: The term ‘Provision’ refers to any of the following amounts:

(iii) The amount written off or retained by way of providing depreciation, renewals or
diminution in the value of assets; or
(iv) The amount retained by way of providing for any known liability of which the
amount cannot be determined with substantial accuracy.
If the amount of liability can be ascertained with substantial accuracy, or is set aside
out of profit for any known liability, it is termed as liability.
Following are the examples of provisions:
(i) Provision for Bad and Doubtful (v) Provision for Fluctuation in
Debts. Investments.
(ii) Provision for Discount on Debtors. (vi) Proposed Dividend.
(iii) Provision for Taxation.
(iv) Provision for Repairs and Renewals.

Reserves: Reserve means amount set aside out of profit, to meet out either an
expected or an unexpected future liability or loss. I other words any amount set aside
out of profit and other surpluses, which are not earmarked (assign) in any way to meet
any particular liability, known to exist on date of the Balance Sheet. It is provided for
meeting prospective losses or liabilities, creation of reserves to increase the working
capital in the business and strengthen its financial position. Provision in excess of the
amount considered necessary for the purpose for which it was created is treated as
reserve. Examples of reserves are General Reserves, Capital Reserve, Dividend
Equalisation Reserves, and Contingency Reserves etc.

Characteristics of Reserves: Reserves have got the following special features:

(i) They are appropriated out of profits. When there is no profit, no reserve may be
created.
(ii) Reserves are created to strengthen the financial position of the concern.
(iii) Reserves are not earmarked in any way to meet any liability or diminution in the
value of assets.
(iv) If the amount of reserves is invested outside the business in securities, it is called
the (Name of reserve) Fund.
(v) Since a reserve is a part of profit, hence the proprietor has claim over it. He may
use it in any manner he likes.

Importance or Purpose of Reserves:

The purpose, for which the amount is so set aside, may be any one of the following:
(i) To strengthening the financial position: Improvement of the financial position
of the business by keeping back a portion of profits and thus conserving the
resources which would have otherwise been distributed to the owners.

(ii) Meeting future unanticipated loss: Arrangement for meeting unforeseen

abnormal losses irrespective of their nature.

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FINANCIAL STATEMENTS OF A COMPANY

(iii) Normal rate of dividend: Equalisation of dividend by allowing its balance to be

drawn upon during periods of inadequate profits.

(iv) Fulfilling some specific purpose: Sometimes, a reserve is created for a specific
purpose such as ‘Debenture Sinking Fund’ for redemption of debentures.

Types of Reserves: Basically there are two types of reserves, viz., Open Reserves and
Secret Reserves.

Open Reserves: These are the reserves which are shown in the Balance Sheet under
the heading ‘Reserve and Surplus’. These are of following two types:

 Revenue Reserves: The reserve which is created setting aside the amount out
of the net profit of the business (profit which is earned in normal course of the
business) is known as revenue reserve. Therefore, the revenue reserves
represent the undistributed profits and as such are available for the distribution
as dividend.
• General reserves: A general reserve is that reserve which is created out of
profits to meet any unforeseen contingency and not for any specific purpose.
Such reserve is also called ‘Contingencies Reserve’ or ‘Free Reserve’ because
it is not created for specific purpose and can be freely used for any purpose. It
serves the following purposes:
(i) To be distributed as dividend among the shareholders.
(ii) Strengthening the general financial position of a business.
(iii)Maintaining equal rate of dividend every year.
(iv)Aid to expansion of a business.
(v) Meeting a future liability or loss.
Creation of reserve is not compulsory; it depends on the willingness of the
owner of the business or its directors. It is always shown on the liabilities side
of the balance sheet because it is created out of the profit.

• Specific Reserve: Such reserves are created out of the profit of the business
but are created for a specific purposes and the amount of such reserves

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FINANCIAL STATEMENTS OF A COMPANY

cannot be utilised for any other purpose. If there is amount left in such
reserve after the purpose has been completed then that amount will be
transferred back to the profits. Examples of such reserves are Dividend
equalisation reserve, Reserve for replacement of assets, Debenture
redemption reserve.

• Funds: The word ‘Fund’ in relation to any reserve should be used if such
reserve is specifically represented by earmarked (assign) investment for a
particular purpose. In other words, if the amount of reserve, which is created
for any specific purpose is invested outside business in securities, it is called
reserve fund otherwise it will be known as reserve.

 Capital Reserves: It includes amount which are not earned during normal
operation of business, therefore the amount of such reserve is not available for
distribution as dividend, e.g., profit prior to incorporation of a company, profit on
acquisition of business, profit on sale of fixed assets, profit remaining on re-issue
of forfeited shares, profit on redemption of shares and debentures, profit on
revaluation of fixed assets and liabilities, premium of issue of shares and
debentures.

Difference between Reserves and Provisions:

Basis of
Provisions Reserves
difference
Meaning Provision is created for some Reserve may be created for a
specific object for which it is specific purpose and it may not
created. be created for a specific purpose.
Charge Vs. A provision is a charge against A reserve is an appropriation of
Appropriation profit i.e. it will be created even profit i.e. it will not be created or
though there is no profit. the amount will not be
transferred to any reserve if
there is no profits.
Time of A provision is created before A reserve is created after
creation ascertaining the profit or los of a ascertaining the profit.
business.
Object The object of creating provision is to A reserve is created to
make arrangement for any known strengthen the financial position
liability. of the business and to increase in
the working capital.
Utilisation Provision can be utilised only for the Reserve can be used in the
purpose for which it is meant. payment of any liability or loss.
Distribution Provision cannot be utilised for Reserves can be used for
declaration of dividends. declaration of dividends.
Disclosure in It is shown as deduction form the Reserves are always shown as a
Balance value of assets concerned on the separate item under the head
Sheet assets side of the Balance Sheet. ‘Reserve and Surplus’ on the
However, it may be shown on the liabilities side of the Balance
liabilities side also. Sheet.
Investment Amount of provision cannot be Reserve can be invested outside
outside invested outside. It always remains the business but in that cased it
business in the business. is called fund.

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FINANCIAL STATEMENTS OF A COMPANY

Distinction between a ‘Reserve’ and ‘Reserve Fund’:

The term reserve will indicate that the amount represented by the reserve is being
utilised in the business itself. However, if the amount of reserve is invested in outside
securities and such securities are earmarked for the particular purpose indicated by the
reserve, and then reserve will be named as ‘Reserve Fund’.

Quoted and Unquoted Investments:

Investments in shares and debentures which are listed on any recognised stock
exchange are called quoted investments. A company, after fulfilment of certain
conditions and payment of requisite fees, gets its shares and debentures listed on a
stock exchange. Only listed securities can be freely purchased or sold through the stock
exchange.
Investments in shares and debentures which are not listed on any recognised stock
exchange are called unquoted investments.
Schedule VI requires that the aggregate amount of the company’s quoted investment
and the market value thereof and the aggregate amount of its unquoted investments
be separately disclosed in the balance sheet.

Profit and loss account:

Part II of the Schedule VI of the Companies Act, 1956 deals with the Profit and Loss
Account. It has not prescribed the form in which the profit and loss account is to be
prepared but, has instead prescribed the particulars and information to be given in the
Profit and Loss Account. As a result, in practice, it is prepared in different forms based
on the needs of the business and type of industry. What ever may be the form of Profit
and Loss Account but it must exhibit a true and fair view of the profit or loss of the
company during the year under reference.
In case of a company, it is not necessary to split the Profit and Loss Account into three
sections i.e., Trading Account, Profit and Loss Account and Profit and Loss Appropriation
Account. Only Profit and Loss Account may be prepared which may cover items
appearing in Trading Account and Profit and Loss Appropriation Account. However, the
splitting of Profit and Loss Account into three sections is not forbidden (prohibited) by
the Act. It is desirable to split the Profit and Loss Account into three sections so that
gross profit, net profit and surplus carried to the balance sheet may be ascertained
separately.
However, in case of in case of a company, instead of the heading of Trading Account
and Profit & Loss Account, the heading is only Profit & Loss Account. Items relating to
Trading Account are shown in its first part and the items relating to Profit and Loss
Account appear in its second part.

Profit and Loss Appropriation Account:

After calculation and ascertainment of profit, question of its distribution or
appropriation arises. Generally the Articles of Association of the Company empower the
directors to decide the amount of profit to be transferred to reserves and the quantum
of dividends. The directors may decide to retain a certain amount of profit to
strengthen the financial position of the company, which is done by transferring the
amount to various reserves, or even by keeping as balance. A part of the profits may
also be distributed as dividend. The account showing the disposal of profit is called
‘Profit and Loss Appropriation Account ‘

Name of the Company

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FINANCIAL STATEMENTS OF A COMPANY

Profit and Loss Account

for the year ended ________

R R
Particulars Particulars
s. s.
To Opening stock By Sales
Raw material xx xx xx
Work-in- xx Less: Return xx
progress xx By Closing stock xx
Finished goods Raw material xx
To purchase xx xx Work-in- xx
Less: Returns xx xx progress
To Expenses on xx Finished
purchase xx goods
To Manufacturing
xx xx
expenses
xx xx
To Gross Profit
xx xx
By Indirect expenses xx By Gross Profit xx
By Net Profit By Indirect incomes

Profit and Loss Appropriation Account

for the year ending __________

R R
Particulars Particulars
s. s.
To Transfer to Reserves xx By Balance b/d xx
To Preference dividend By net Profit xx
Interim xx By Transfer form xx
Proposed xx Reserves xx
Final xx By Transfer from
Additional xx Provisions
To Equity dividend
Interim xx
Proposed xx
Final xx
Additional xx
To Provision for Dividend xx
Tax
To Balance of Profit xx
transferred xx xx
to Balance Sheet

Important term related to Profit and Loss Appropriation Account:

Interim Dividend: Dividend paid by the company before the ascertainment of the
profit is called ‘Interim Dividend’. This dividend is declared by the directors at any time
during the year if they think that company will earn more profit than what is expected.
It is paid before the final dividend and in between the two annual general meetings,
without the sanction from the shareholders. However, if an interim dividend is paid and
it is found subsequently that the company’s profits are inadequate to cover the interim
dividend, it amounts to payment of dividend out of capital and hence the directors will
be liable to make good the amount.

Proposed Dividend: After ascertainment of profit directors fix the rate of dividend
which is to be paid to the shareholders. This is a type of proposal by the directors on

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FINANCIAL STATEMENTS OF A COMPANY

which the consent of the shareholders is required. Hence it can be defined as the
dividend which fixed by the shareholders on which consent of shareholders is not
received.

Final Dividend: Dividend proposed by the directors is declared by shareholders at the

annual general meetings. After the declaration the proposed dividend is termed as final
dividend. Shareholders cannot increase the rate of dividend fixed by the directors but
they can decrease it if they think fit.

Additional dividend: If after the normal dividend any extra dividend is paid to the
shareholders, such a dividend is termed as additional dividend. This dividend is paid
when any surplus profit is left out of the profit set aside for distribution of the normal
dividend.

Divisible profits:
All profits are not divisible profits. Only those profits which are legally available to
shareholders for dividend are known as divisible profits. In normal course, divisible
profits are the profits left after meeting all expenses, losses, depreciation on fixed
assets, fall in the price of current assets, taxation, writing off past losses and after
transferring a reasonable amount to reserves. Divisible profits should not include
capital profits. Dividends cannot be declared except out of divisible profits.

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