Chapter 3 — Financial Statements of a Company

Chapter 3 covers Financial Statements of a Company, explaining the meaning, nature, and objectives of financial statements, the prescribed formats for the Balance Sheet and Statement of Profit and Loss under Schedule III of the Companies Act 2013, the current and non-current classification of assets and liabilities, and the uses and limitations of financial statements.

Financial statements are the basic and formal annual reports through which corporate management communicates financial information to its owners and various external parties such as investors, tax authorities, government, and employees. They refer to the balance sheet, the statement of profit and loss, and the cash flow statement.

The nature of financial statements rests on four elements: recorded facts based on historical cost, accounting conventions such as valuing inventory at cost or market price whichever is lower, postulates such as going concern, money measurement, and realisation, and personal judgements on matters like depreciation rates and provisions for doubtful debts.

The six objectives include providing information about economic resources and obligations of the business, the earning capacity of the business, cash flows in terms of amount and timing, the effectiveness of management in utilising resources, the activities of the business affecting society, and the significant accounting policies and changes adopted during the year.

The Balance Sheet follows a vertical format with two major sections. The first, Equity and Liabilities, covers shareholders' funds (share capital, reserves and surplus, money received against share warrants), share application money pending allotment, non-current liabilities (long-term borrowings, deferred tax liabilities, other long-term liabilities, long-term provisions), and current liabilities. The second section, Assets, covers non-current assets (fixed assets, non-current investments, deferred tax assets, long-term loans and advances) and current assets.

An item is classified as current if it is involved in the entity's operating cycle, is expected to be realised or settled within twelve months, is held primarily for trading, or is cash and cash equivalents. All inventories are always treated as current, fixed assets are always non-current even if their useful life is less than twelve months, and deferred tax assets or liabilities are always non-current.

Reserves and Surplus are classified into capital reserve, capital redemption reserve, securities premium reserve, debenture redemption reserve, revaluation reserve, share options outstanding account, other reserves specifying nature and purpose, and surplus representing the balance in the statement of profit and loss. A debit balance in the statement of profit and loss is disclosed as a negative figure under the surplus head.

The statement shows revenue from operations (sale of products, sale of services, other operating revenues) and other income, followed by expense heads including cost of materials consumed, purchases of stock-in-trade, changes in inventories of finished goods and work-in-progress, employee benefits expense, finance costs, depreciation and amortisation, and other expenses. The statement proceeds from profit before extraordinary items and tax down to profit or loss for the period and earnings per equity share.

Rounding off is mandatory. Companies with a turnover below Rs. 100 crore must round figures to the nearest hundreds, thousands, lakhs, or millions or decimal thereof. Companies with a turnover above Rs. 100 crore must round figures to the nearest lakhs or millions or decimal thereof.

Financial statements serve multiple users: they report the stewardship function to shareholders, provide input for government fiscal and taxation policies, form the basis for credit granting decisions by banks and financial institutions, help prospective investors assess solvency and profitability, guide existing shareholders on the value of their investment, assist trade associations in developing standard ratios, and help stock exchanges ensure transparency in financial reporting.

Financial statements are prepared on historical cost and therefore do not reflect current market conditions. They may show asset values that cannot be realised in a forced liquidation. Personal judgements and conventions introduce bias. They present only aggregate information and lack qualitative data such as labour relations and quality of work. The balance sheet reflects the financial position only at a point in time, and the statement of profit and loss covers only a specified period, making both interim in nature.

Proposed dividend is proposed by the Board of Directors and declared by the shareholders in their Annual General Meeting. Since declaration is contingent upon shareholders' approval, proposed dividend is shown as a contingent liability in the notes to accounts as prescribed by AS-4, Contingencies and Events Occurring after the Balance Sheet Date.

Under the revised Schedule III of the Companies Act 2013, 'Sundry Debtors' has been replaced by the term 'Trade Receivables' and 'Sundry Creditors' has been replaced by the term 'Trade Payables'.

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