Financial Statements of a Company — Study Notes

1. Introduction

The financial statements of a company are the formal records that present the financial performance and financial position of the enterprise. Under the Companies Act, 2013, a company is required to prepare its financial statements in accordance with the Schedule III of the Act, which prescribes the format and the minimum disclosures. The two main financial statements are the Statement of Profit and Loss and the Balance Sheet.

The Statement of Profit and Loss shows the results of the operations of the company for an accounting period, presenting revenue, expenses, and the profit or loss for the year. The Balance Sheet presents the financial position of the company at a particular date, showing its assets, liabilities, and shareholders' funds. In addition, companies prepare notes to accounts, which contain significant accounting policies and detailed breakdowns of the items in the main statements.

The Schedule III format emphasizes transparency and the fair presentation of the company's affairs. It requires that items be classified into current and non-current categories, with comparative figures and prior period adjustments disclosed. The financial statements must be approved by the board of directors and signed before they are presented to the shareholders.

2. Balance Sheet as per Schedule III

The Balance Sheet is presented in vertical format with the following major headings:

Equity and Liabilities

1. Shareholders' Funds: Share capital, Reserves and Surplus, Money received against share warrants.
2. Share Application Money Pending Allotment.
3. Non-Current Liabilities: Long-term borrowings, Deferred tax liabilities, Other long-term liabilities, Long-term provisions.
4. Current Liabilities: Short-term borrowings, Trade payables, Other current liabilities, Short-term provisions.

Assets

1. Non-Current Assets: Fixed assets (tangible, intangible, capital work-in-progress), Non-current investments, Deferred tax assets, Long-term loans and advances, Other non-current assets.
2. Current Assets: Current investments, Inventories, Trade receivables, Cash and cash equivalents, Short-term loans and advances, Other current assets.

$$\text{Total Assets} = \text{Total Equity and Liabilities}$$

3. Statement of Profit and Loss

The Statement of Profit and Loss shows the profit or loss for the year. It presents revenue from operations, other income, total revenue, expenses (cost of materials consumed, changes in inventories, employee benefits expense, finance costs, depreciation, other expenses), and the resultant profit before tax, tax expense, and profit after tax.

$$\text{Profit Before Tax} = \text{Total Revenue} - \text{Total Expenses}$$

$$\text{Profit After Tax} = \text{Profit Before Tax} - \text{Tax Expense}$$

4. Key Items in the Financial Statements

4.1 Reserves and Surplus

Reserves and surplus include the Capital Reserve, Capital Redemption Reserve, Securities Premium Reserve, General Reserve, Debenture Redemption Reserve, and the balance in the Statement of Profit and Loss.

4.2 Tangible and Intangible Assets

Tangible assets include plant, machinery, land, buildings, and furniture. Intangible assets include goodwill, patents, trademarks, and computer software. The gross value and accumulated depreciation of each asset are disclosed.

4.3 Trade Receivables and Trade Payables

Trade receivables are amounts due from customers for goods and services sold. Trade payables are amounts due to suppliers for goods and services purchased.

4.4 Cash and Cash Equivalents

Cash in hand, cash at bank, cheques in hand, and short-term highly liquid investments form cash and cash equivalents.

5. Notes to Accounts

Notes to accounts are an integral part of the financial statements. They disclose the significant accounting policies, the break-up of items such as share capital and reserves, the details of borrowings, the maturity profile of liabilities, contingent liabilities, and commitments. The notes ensure that the financial statements present a true and fair view.

6. Distinction Between Current and Non-Current Items

An asset is classified as current if it is expected to be realised within the operating cycle or within 12 months. A liability is current if it is expected to be settled within the operating cycle or within 12 months. All other assets and liabilities are non-current.

Quick Revision Tables

Table 1: Headings of the Balance Sheet

Table 2: Components of Reserves and Surplus

Table 3: Current vs Non-Current Classification

Mind Map

Important Diagrams (SVG)

Diagram 1: Structure of the Balance Sheet (Schedule III)

Diagram 2: Structure of the Statement of Profit and Loss

Common Mistakes

1. Using the old horizontal format of the Balance Sheet instead of the vertical format prescribed by Schedule III.
2. Classifying items as current or non-current incorrectly; the 12-month and operating cycle test must be applied.
3. Including proposed dividends as a current liability; under the Companies Act, dividend is recognised only when declared.
4. Mixing up reserves and provisions; reserves are appropriations of profit while provisions are charges.
5. Forgetting to present comparative figures for the previous year.
6. Showing the gross value of fixed assets without accumulated depreciation and net block disclosure.
7. Not preparing the notes to accounts which form an integral part of the financial statements.

Exam Tips

1. Memorise the major headings of the Balance Sheet as per Schedule III in the correct order.
2. Prepare a working note for reserves and surplus and fixed assets since they are the most common examination items.
3. When computing profit before tax, subtract all operating and non-operating expenses including finance costs.
4. Distinguish clearly between trade receivables, cash and cash equivalents, and current investments.
5. Practise classifying each given item as current or non-current.
6. Remember that total assets must always equal total equity and liabilities.
7. Read the additional information in the question carefully; it usually contains depreciation and interim dividend adjustments.

Conclusion

The financial statements of a company, prepared as per Schedule III of the Companies Act, 2013, provide a standardized and transparent presentation of the company's performance and position. The Balance Sheet and the Statement of Profit and Loss, supported by the notes to accounts, enable stakeholders to evaluate the enterprise. The proper classification of items into current and non-current categories and the accurate calculation of profit are the key skills in this chapter. These financial statements form the foundation for the analysis of financial statements, ratio analysis, and the cash flow statement, which are covered in the following chapters.