ESSENTIALS OF FINANCIAL ACCOUNTING BY ASISH K BHATTACHARYYA

Second Edition Chapter 8

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Balance Sheet and Profit and Loss Account: General Requirements

1/8/2014

Every balance sheet of a company should give a true and fair view of the state of affairs of the company as at the end of the financial year.

It should be set out in the form as in Part I of Schedule VI to the Companies Act, 1956.

Every profit and loss account of a company should give a true and fair view of the profit or loss of the company for the financial year.
It should comply with the requirements of Part II of Schedule VI to the Companies Act, 1956. No format has been prescribed for a profit and loss account.

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

405

Balance Sheet and Profit and Loss Account: General Requirements (cont.)
1/8/2014

Insurance companies, banking companies and companies engaged in the generation or supply of electricity are required to draw their financial statements in accordance with provisions in the relevant statute.

Requirements of the Companies Act, 1956 are not applicable to these companies.

406

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Compliance with Accounting Standards

1/8/2014

Every profit and loss account and balance sheet should comply with the accounting standards issued by the Institute of Chartered Accountants of India (ICAI) and notified by the government. Where the profit and loss account and the balance sheet of the company do not comply with the accounting standards, such companies are required to disclose in their profit and loss accounts and balance sheets:

The deviation from the accounting standards and the reason for such deviation, and The financial effect, if any, arising due to such deviation.
Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

407

Group Accounts
1/8/2014

The Companies Act, 1956, does not require that a holding company present consolidated financial statements. Section 212 of the Act, inter alia, requires that the following documents should be attached with the balance sheet of a holding company:
a. b. c. d. e.

A copy of the balance sheet of the subsidiary A copy of its profit and loss account A copy of the report of its Board of Directors A copy of the report of its auditors A statement of the holding companys interest in the subsidiary
Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

408

Group Accounts (cont.)

1/8/2014

SEBI requires a holding company, which is listed in a recognised stock exchange, to issue consolidated financial statements.

409

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Board of Directors Report

1/8/2014

A report by the Board of Directors of the company be attached to the balance sheet. The report should deal with the following:
The state of the companys affairs b. The amounts, if any, which it proposes to carry to any reserves in the balance sheet c. The amount, if any, which it recommends should be paid by way of dividend d. Material changes and commitments, if any, affecting the financial position of the company and which have occurred between the end of the financial year of the company to which the balance sheet relates and the date of the report
a.
Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

410

Board of Directors Report (cont.)

1/8/2014

The conservation of energy, technology absorption and foreign exchange earnings and outgo f. In addition, the report should deal with any changes that have occurred during the financial year:
e.
i. ii.

iii.

In the nature of the companys business In the companys subsidiaries or in the nature of business carried out by them Generally in the classes of business in which the company has an interest

411

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Board of Directors Report (cont.)

1/8/2014

The Board is also bound to give in its report the fullest information and explanations on every reservation, qualification, or adverse remark contained in the auditors report.

412

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Directors Responsibility Statement

1/8/2014

The Boards report shall include a Directors Responsibility Statement, indicating therein:
That in the preparation of the annual accounts, the applicable accounting standards had been followed along with proper explanation relating to material departures. b) That the directors had selected such accounting policies and applied them consistently and made judgements and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company at the end of the financial year, and of the profit or loss of the company for that period.
a)

413

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Directors Responsibility Statement (cont.)

1/8/2014

That the directors have taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of this Act for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities. d. That the directors had prepared the annual accounts on a going concern basis.
c.

Directors Responsibility Statement is an instrument to enforce accountability of directors towards shareholders and investors.

414

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

CEO/CFO Certification
1/8/2014

SEBI requires that the CEO (either the Managing Director or Manager appointed under the Companies Act) and the CFO (whole-time Finance Director or other person discharging this function) of the company shall certify to board that:
a.

b.

They have reviewed the financial statements and the cash flow statements and to the best of their knowledge and belief these statements are true. There were no fraudulent or illegal transactions or transactions violative of the Companys code of conduct.
415

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

CEO/CFO Certification (cont.)

1/8/2014

They accept the responsibility of internal control. d. They have indicated to the auditors and audit committee significant changes in internal control during the year. e. They have indicated to the auditors and audit committee significant changes in accounting policies during the year. f. They have indicated to the auditors and audit committee instances of fraud of which they had become aware.
c.

416

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Divisible Profit
1/8/2014

Section 205 of the Companies Act, 1956, deals with dividend. It provides that no dividend should be paid except in cash. The section further provides that dividend can be declared or paid only out of:
The profit of the company for the financial year after providing for depreciation in accordance with the provision of this section. 2. The profit of the company for any previous financial year or years arrived at after providing for depreciation in accordance with this section and remaining undistributed.
1.
Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

417

Divisible Profit (cont.)

1/8/2014

3.

Money provided by the Central Government or a state government for the payment of dividend in pursuance of a guarantee given by that government.

However, available profit should first be utilised to:

(a) provide for depreciation not provided for any previous financial year or years and (b) set off the loss incurred in any previous year or the amount provided for depreciation in that year, whichever is less.

418

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Minimum Depreciation
1/8/2014

In calculating the divisible profit, a company should provide, at the minimum, depreciation specified in the Companies Act (schedule IX). A company may provide higher depreciation.

419

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Dividend: Mandatory Transfer to Reserve

A company is required to transfer the following amount to the reserve:

1.

1/8/2014

2.

3.

4.

Where the proposed dividend exceeds 10% but does not exceed 12.5% of the paid-up capital: not less than 2.5% of the current profits. Where the proposed dividend exceeds 12.5% but does not exceed 15% of the paid-up capital: not less than 5% of the current profits. Where the proposed dividend exceeds 15% but does not exceed 20% of the paid-up capital: not less than 7.5% of the current profits. Where the proposed dividend exceeds 20% of the paidup capital: not less than 10% of the current profits.
420
Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Interest on Paid-up Capital

1/8/2014

Subject to certain conditions, the Companies Act, 1956, permits a company to pay interest on the paid-up capital. A company can pay interest for the period of construction and also for a short period after the completion of the construction.

421

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Reserve
1/8/2014

Reserves represent retained profit. They may be created for different purposes.

For example, a reserve may be created for maintaining a steady rate of dividend (dividend equalisation reserve) or for redemption of debentures (sinking fund or debenture redemption fund).

422

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Revenue Reserve and Capital Reserve

1/8/2014

Capital reserve should not include any amount regarded as free for distribution through the profit and loss account, and the expression revenue reserve should mean any reserve other than capital reserve.

423

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Capital Reserve
1/8/2014

Only profit or loss of a capital nature should be included in the capital reserve. The following are the examples of capital profits:

1. Profit prior to incorporation 2. Unrealised profit on sale or revaluation of fixed assets 3. The excess of the amount realized on sale of an asset over the price paid for the acquisition of the asset 4. The excess of the value of net assets over the price paid for the acquisition of a business 5. Profits on reissue of forfeited shares
424

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Capital Reserve (cont.)

1/8/2014

6. Premiums received on issue of debentures or profits on redemption of debentures where distribution of such profits is not permitted by the Articles 7. The credit balance in the capital reduction account, where there has been a reduction of capital with the consent of the court

The share premium account and capital redemption reserve account should not be included in capital reserve.

These should be shown separately because the Companies Act, 1956, restricts utilisation of these two reserves.
425

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

Reserve and Reserve Fund

1/8/2014

A reserve should be distinguished from a reserve fund. A reserve fund is only such reserves that are invested outside the business.

If the retained profit is used in the business, it is a reserve and not a reserve fund. For example, a sinking fund is a reserve fund, because the amount allocated to the reserve is set aside and invested outside the business. Capital redemption reserves, general reserves or dividend equalisation reserves are not reserve funds, because the amounts allocated to these reserves are not invested outside the business.

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA

426

1/8/2014

END

427

Essentials of Financial Accounting, Second Edition ASISH K. BHATTACHARYYA