Essentials of FA_Chapter 8a

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Essen t i a l s o f F inanc ia l Accoun t ing , Second Ed i t ion ASISH K. BHATTACHARYYA

E SSENTIALS OF F INANCIAL ACCOUNTING

B Y ASISH K B HATTACHARYYA Second Edition

Chapter 8


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Balance Sheet and Profit and Loss Account: General Requirements

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

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

Every profit and loss account of a company shouldgive a true and fair view of the profit or loss of thecompany for the financial year.

It should comply with the requirements of Part II ofSchedule VI to the Companies Act, 1956.No format has been prescribed for a profit and lossaccount.

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Balance Sheet and Profit and Loss Account:General Requirements (cont.)

Insurance companies, banking companies andcompanies engaged in the generation or supply ofelectricity are required to draw their financialstatements in accordance with provisions in therelevant statute.

Requirements of the Companies Act, 1956 are notapplicable to these companies.

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Compliance with Accounting Standards

Every profit and loss account and balance sheetshould comply with the accounting standardsissued by the Institute of Chartered Accountants ofIndia (ICAI) and notified by the government.Where the profit and loss account and the balancesheet of the company do not comply with theaccounting standards, such companies are requiredto disclose in their profit and loss accounts andbalance sheets:

The deviation from the accounting standards and thereason for such deviation, andThe financial effect, if any, arising due to such deviation.

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Group Accounts

The Companies Act, 1956, does not require that aholding company present consolidated financialstatements.Section 212 of the Act, inter alia , requires that thefollowing documents should be attached with thebalance sheet of a holding company:a. A copy of the balance sheet of the subsidiaryb. A copy of its profit and loss accountc. A copy of the report of its Board of Directorsd. A copy of the report of its auditorse. A statement of the holding companys interest in the

subsidiary

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Group Accounts (cont.)

SEBI requires a holding company, which is listed ina recognised stock exchange, to issue consolidatedfinancial statements.

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Board of Directors Report (cont.)

e. The conservation of energy, technology absorption andforeign exchange earnings and outgo

f. In addition, the report should deal with any changesthat have occurred during the financial year:i. In the nature of the companys business ii. In the companys subsidiaries or in the nature of business

carried out by themiii. Generally in the classes of business in which the company

has an interest

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Board of Directors Report (cont.)

The Board is also bound to give in its report thefullest information and explanations on everyreservation, qualification, or adverse remarkcontained in the auditors report.

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Directors Responsibility Statement

The Boards report shall include a DirectorsResponsibility Statement, indicating therein:a) That in the preparation of the annual accounts, the

applicable accounting standards had been followedalong with proper explanation relating to materialdepartures.

b) That the directors had selected such accountingpolicies and applied them consistently and made

judgements and estimates that are reasonable andprudent so as to give a true and fair view of the state ofaffairs of the company at the end of the financial year,and of the profit or loss of the company for that period.

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Directors Responsibility Statement (cont.)

c. That the directors have taken proper and sufficient carefor the maintenance of adequate accounting records inaccordance with the provisions of this Act forsafeguarding 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 .

Directors Responsibility Statement is aninstrument to enforce accountability of directorstowards shareholders and investors.

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CEO/CFO Certification

SEBI requires that the CEO (either the ManagingDirector or Manager appointed under theCompanies Act) and the CFO (whole-time FinanceDirector or other person discharging this function)of the company shall certify to board that:a. They have reviewed the financial statements and the

cash flow statements and to the best of their knowledgeand belief these statements are true.

b. There were no fraudulent or illegal transactions ortransactions violative of the Companys code ofconduct .

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CEO/CFO Certification (cont.)

c. They accept the responsibility of internal control.d. They have indicated to the auditors and audit

committee significant changes in internal control duringthe year.

e. They have indicated to the auditors and auditcommittee significant changes in accounting policiesduring the year.

f. They have indicated to the auditors and auditcommittee instances of fraud of which they had becomeaware.

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Divisible Profit

Section 205 of the Companies Act, 1956, dealswith dividend.It provides that no dividend should be paid exceptin cash.The section further provides that dividend can bedeclared or paid only out of:1. The profit of the company for the financial year after

providing for depreciation in accordance with theprovision of this section.

2. The profit of the company for any previous financialyear or years arrived at after providing for depreciationin accordance with this section and remainingundistributed.

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Divisible Profit (cont.)

3. Money provided by the Central Government or a stategovernment for the payment of dividend in pursuance ofa 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.

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Minimum Depreciation

In calculating the divisible profit, a company shouldprovide, at the minimum, depreciation specified inthe Companies Act (schedule IX).

A company may provide higher depreciation.

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Dividend: Mandatory Transfer to Reserve A company is required to transfer the followingamount to the reserve:1. 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.

2. Where the proposed dividend exceeds 12.5% but doesnot exceed 15% of the paid-up capital: not less than 5%of the current profits.

3. Where the proposed dividend exceeds 15% but does not

exceed 20% of the paid-up capital: not less than 7.5% ofthe current profits.4. Where the proposed dividend exceeds 20% of the paid-

up capital: not less than 10% of the current profits.

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Reserve

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

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

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Revenue Reserve and Capital Reserve

Capital reserve should not include any amountregarded as free for distribution through the profitand loss account, and the expression revenuereserve should mean any reserve other than capitalreserve.

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Capital Reserve

Only profit or loss of a capital nature should beincluded in the capital reserve.The following are the examples of capital profits:1. Profit prior to incorporation2. Unrealised profit on sale or revaluation of fixed assets3. The excess of the amount realized on sale of an asset

over the price paid for the acquisition of the asset4. The excess of the value of net assets over the price

paid for the acquisition of a business5. Profits on reissue of forfeited shares

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Reserve and Reserve Fund

A reserve should be distinguished from a reservefund .

A reserve fund is only such reserves that areinvested outside the business .

If the retained profit is used in the business, it is areserve and not a reserve fund.For example, a sinking fund is a reserve fund, becausethe amount allocated to the reserve is set aside and

invested outside the business.Capital redemption reserves, general reserves ordividend equalisation reserves are not reserve funds,because the amounts allocated to these reserves arenot invested outside the business.

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Essen t i a l so fFinanc ia lAccoun t ing Second Edi t ion ASISH K BHATTACHARYYA

END

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Essentials of FA_Chapter 8a

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