Duration: 60

mins
Slides: 21

LMT SCHOOL OF MANAGEMENT, THAPAR

UNIVERSITY
Masters of Business Administration

Course: Financial Reporting and Analysis

Faculty: Dr. Sonia Garg (Email:
sonia.garg@thapar.edu)

Session 1: Overview and Scope of Financial

Accounting

Companies today are increasingly

recognizing human capital as a form of
wealth. Our core corporate assets
walk out every evening, mentally and
physically tired. So said one of the
most sought-after CEOs of India Inc. to
a graduating class of Wharton. Name
the CEO.
NR Narayan Murthy
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Overview and Scope of Financial

Accounting

Purpose of any business:

PROFIT

How does one ascertain what is the profit ?

PROFIT & LOSS STATEMENT

Is the business earning a reasonable rate of return? This will

depend on the amount of resources deployed, how do we
know that?
BALANCE SHEET STATEMENT
Does the firm have the ability to generate cash to run its
operations?
CASH FLOW STATEMENT
Together these statements are called FINANCIAL STATEMENTS
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Overview and Scope of Financial

Accounting

Financial Statements
Growing complexities in the modern day business like
Separation of ownership and management
Large scale public participation
Dependence on lending institutions
Legal interventions of laws like Companies Act and
Income Tax Act
Global fund raising
Increased general public awareness
Increased role of SEBI, IRDA, RBI, etc.

Have led to heavy demand on the enterprises in the

preparation and presentation of Financial Statements
which need to follow a FRAMEWORK
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Overview and Scope of Financial

Accounting

Purpose of the FRAMEWORK

The conceptual framework creates a base for financial
statements which assist the:
Preparers in applying accounting standards and dealing with
topics that are yet not a subject of any accounting standard
Auditors in forming an opinion as to whether financial
statements conform to accounting standards or not
Users in analysing and interpreting the information contained
in financial statements
The Accounting Standards Board of the ICAI in the
development of future accounting standards and in the review
of the existing ones
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Overview and Scope of Financial

Accounting

Components of Financial
Statements
Financial Statements are the most important part
of Financial Reporting. A complete set of financial
statements consist of:
Balance Sheet (stock reports)
Profit & Loss Statement (flow reports)
Cash flow Statement (flow reports)
Other items included in the Annual Reports like
Directors report, Chairmans statement although
an integral part of Annual Report are not financial
statements
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Overview and Scope of Financial

Accounting

Contents
of the
Annual
Report
2005-06
of Tata
Motors
Ltd

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Overview and Scope of Financial

Accounting

Why do we need other

reports ?
Financial Statements do not provide all
the information that the users may
need as
They largely portray the financial
effects of past events
Throw little light on the future
direction of growth
Do not necessarily provide nonfinancial information
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Overview and Scope of Financial Accounting

Objective of Financial
Statements
Financial Position
Economic Resources: that are controlled by the enterprise are
useful in predicting its ability to generate cash in future
Financial Structure: predicts present and future borrowing
needs and how profits will be distributed
Liquidity and Solvency: predicts the availability of cash to meet
short-term and long-term financial commitments respectively

Performance: or profitability predicts capacity to

generate internal cash flows and effectiveness of
employing resources
Cash flows: evaluate investing, financing and operating
cash flows
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Overview and Scope of Financial

Accounting

Users and Their Information

Needs

Investors: return on investment, they should hold or sell, dividend paying

ability
Employees: ability to provide remuneration, retirement benefits and
opportunities of unhindered employment and growth
Lenders: ability to service loans and interest thereon, long-term solvency
Suppliers: short-term liquidity
Customers: product quality, credit policy and continuance of the enterprise
Government and its agencies: information to regulate and formulate policies
Public: ability to impart corporate social responsibility
Management: evaluate their own performance
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Overview and Scope of Financial

Accounting

10

Example:
Reliance
Industries
Ltd

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Overview and Scope of Financial Accounting

11

Assumptions underlying preparation

of Financial Statements
Accrual Basis: the effect of transactions is
recognized when they occur not when cash is
received or paid
Going Concern: it is normally assumed that the
enterprise will continue its operations for the
foreseeable future
Consistency: to achieve comparability, accounting
policies are followed consistently from one period
to another
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Overview and Scope of Financial

Accounting

12

Qualitative Characteristics of
Financial Statements
Understandability: Information included in the financial
statements should be understandable assuming the user
has a reasonable knowledge of business, economic
activity and accounting
Relevance: Information must be relevant to the decision
making needs of users
Materiality: Information is material if its misstatement
could influence the decision of users
Reliability: Information is reliable if it is free from material
error and bias
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Overview and Scope of Financial

Accounting

13

Implications of Reliability
Faithful representation: if valid amounts are
unknown do not recognize
Substance over form: economic reality over legal
form
Neutrality: free from bias
Prudence: in making estimates required under
uncertain conditions
Completeness: within the bounds of materiality
and cost
Comparability: explain if any changes in
accounting policy and effect of such change
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Overview and Scope of Financial

Accounting

14

Constraints on Qualitative
Characteristics
Balance between timeliness and
reliability
Balance between benefit and cost
Balance between qualitative
characteristics like completeness and
materiality
Overriding consideration is how best to
satisfy the information needs of users
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Overview and Scope of Financial

Accounting

15

Generally Accepted Accounting

Principles (GAAPs)
Financial Statements are prepared and presented
on the basis of GAAPs, which includes
Conceptual framework
Accounting concepts
Requirements of Companies Act and rules made
thereunder
Accounting Standards formulated by the ICAI
Directives of regulatory bodies like SEBI, RBI,
IRDA, etc.
Requirements of Income Tax Act and rules made
thereunder
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Overview and Scope of Financial Accounting

16

Requirement of the
Companies Act
Maintenance of proper books of
accounts
Recommend Accounting Standards of
ICAI to be followed
Its Schedule VI sets out the form of
balance sheet, requirements as to
the profit and loss account, some
interpretations and balance sheet
abstract
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Overview and Scope of Financial

Accounting

17

Accounting Standards (ASs)

of ICAI
They apply to all enterprises engaged in commercial,
industrial or business activity weather profit
There are 31 ASs covering various aspects of
financial accounting
Company Law has attached greater authority to
these Ass
Statutory Auditors are responsible for any noncompliance or deviation from the ASs
ICAI has come up with IFRS converged Indian ASs for
more uniform financial reporting globally although
their implementation is deferred for now

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Overview and Scope of Financial

Accounting

18

Requirements of SEBI
Clause 32 of the Listing Agreement: A copy of accounts to
each shareholder, cash flow statement, consolidated
financial statements, etc.
Clause 41 of the Listing Agreement: quarterly unaudited
financial results, segment results, accounting for taxes on
income, etc.
Clause 49 of the Listing Agreement: Corporate
Governance
Clause 50 of the Listing Agreement: Comply with the ASs
of ICAI
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Overview and Scope of Financial

Accounting

19

Requirement of Income Tax

Act
Section 145 of Income Tax Act
Deals with the method of accounting to be
followed by the income tax payer in respect
of his business income
It allows both cash and accrual system
(Company law allows only accrual system)
Issues two accounting standards related to
disclosure of accounting policies and
disclosure of change in accounting policies.
These correspond to AS-1 and AS-5 of ICAI
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Overview and Scope of Financial

Accounting

20

Why did Steve Jobs sell all his Apple

stocks except one after disagreement
with John Sculley ?
To receive annual reports

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Overview and Scope of Financial

Accounting

21