Financial Statements of a Company
Meaning, nature, objectives and types of financial statements
After going through this lesson, you shall be able to understand the following concepts.Meaning of Financial Statements Nature of Financial Statements Objectives of Financial Statements Types of Financial Statements
Meaning of Financial Statements
Financial Statements are the end products of the accounting process. These are the annual formal statements that are prepared by various enterprises or organisations for a particular accounting period. The financial statements comprises of Income Statement for the financial year, Balance Sheet at the end of year, Cash Flow Statement for the year, Statement of changes in the Equity and any explanatory note annexed to or forming part of any document mentioned before. These statements reveal the true financial position of a company in terms of their solvency, liquidity, profitability position, etc. It provides the financial information to various accounting users that helps them in decision making and policy designing process. It is also helpful in providing the financial information to the external users (such as creditors, investors, suppliers, government, etc.) who are interested in a company's affairs. In short, financial statements are those statements that express the performance and position of an organisation in financial terms to various users of accounting information.
Quoting the words of the American Institute of Certified Public Accountants (AICPA), "Financial statements are prepared for the purpose of presenting a periodical review or report on progress made by the management and deal with the status of investment in the business and the results achieved during the period under review."
Nature of Financial Statements
The nature of the financial statements depends upon the following aspects.Recorded Facts- Financial statements contains only those facts and data that are recorded in the accounting books and the data that is not recorded in the accounting books is excluded (irrespective of whether such facts are significant or not). The items recorded in the financial statements reflect their original cost (i.e. the cost at which they were acquired). Consequently, financial statements do not reveal the current market price of the items. Further, it fails to capture the inflation effects. Conventions- The preparation of financial statements is based on some accounting conventions such as, Prudence Convention, Materiality Convention, Matching Concept, etc. The adherence to such accounting conventions makes financial statements easy to understand, comparable and to reflect the true and fair financial position of a organisation. Accounting Assumptions- The basic accounting assumptions such as Going Concern Concept, Money Measurement Concept, Realisation Concept, etc. are known as postulates. While preparing the financial statements such postulates are adhered to. Therefore, the nature of these postulates is reflected in the nature of the financial statements. Personal Judgement- Personal value judgement plays an important role in deciding the nature of the financial statements. Different judgements are attached to different practices of recording transactions in the financial statements. For example, method of charging depreciation requires personal value judgement (i.e. it entirely depends on the concerned accountant) Some accountants may use written-down value method of depreciation, while, some may use original cost method. Similarly, provision on various assets, period chosen to write-off intangible assets, etc. depend on personal judgement. Thus, personal judgement determine the nature of the financial statements to a great extent.
Objectives of Financial Statements
The financial statements are basically the accounts that are prepared for providing the true financial information to the internal as well as external users. These statements lay the base for the decision making process and policy designing by different users. The following are the various objectives for preparing financial statements.To Provide Information about Economic Resources- Financial statements provide adequate, accurate, reliable and periodical information about the employment of economic resources. It also specifies the obligation of a business to its external users who do not have the powers or authority to access the information directly. To Ascertain the Financial Position- These statements help to reveal the true financial position of an enterprise. In other words, it discloses the performance and position of an organisation in terms of their profitability, solvency, liquidity, financial viability, etc. To Ascertain the Earning Capacity- These statements are prepared with an objective of providing useful information to compare, predict and evaluate the earning capacity of a business firm. Thus, it helps in ascertaining the earning capacity of firms. To Judge the Effectiveness of Management- Financial statements also reveal the efficiency and effectiveness of management. It can be easily be assessed by the financial statements of a company that whether its management is judiciously using the scarce resources, effectively implementing the planned to meet the organisational goals, taking any cost-effective measures if needed, etc. Helps in Decision Making- These statements help the management to frame policies and decision-making process on various accounting matters.
Types of Financial Statements
Financial Statements as per Section 2 (40) of the Companies Act, 2013 inter-alia includes five things namely, (i) Balance Sheet or Position Statement at the end of financial year, (ii) Statement of Profit and Loss or Income Statement for the financial year, (iii) Cash Flow Statement for the financial year and (iv) Any explanatory notes or Notes to Accounts annexed to or forming part of any of the documents listed above
However, it should be noted that financial statements with respect to One Person Company (OPC), Dormant Company and Small Company, may not include Cash Flow Statements. And Section 129 of the Companies Act, 2013 states that the financial statements of the company be prepared as per Schedule III of the Companies Act, 2013. All the above listed statements are helpful in providing the useful financial information to both internal as well as external users. The internal users (such as owners, management, employees and workers) can use these statements for decision making process and external users (such as creditors, investors, government, etc.) can use this to reach or obtain the information about the financial position.
(I) Balance Sheet
Balance Sheet refers to a statement that reflects the financial position of an organisation. It can be defined as a status report of a company giving information related to various assets and liabilities of an organisation at the closing of an accounting period. The form and format of a Company's Balance Sheet is prescribed in the Schedule III of the Companies Act, 2013.
As per the Schedule III of the Companies Act, 2013, a company can prepare its Balance Sheet in Vertical format only as against the previous schedule which provides the preparation of balance sheet either in horizontal form or in vertical form. The format of New Balance Sheet as prescribed in the Revised Schedule is given in the latter lessons of this chapter.
(II) Statement of Profit and Loss
The basic motive of preparing Statement of Profit and Loss is to express the financial performance of an organisation in terms of profits and losses for a particular period. The Statement of Profit and Loss represent the concise version (summary) of the revenues earned and expenses incurred to earn such revenues. These statements act as inputs for preparing Balance Sheet. The information regarding the various items and adjustments to be included in these statements is given in the Schedule III, Part II of the Companies Act, 2013. This Schedule III of Companies Act, 2013 has prescribed a particular format for preparing Income Statement (Profit and Loss Account). The format of Statement of Profit and Loss as prescribed under Part II of Schedule III of Companies Act, 2013 is given in the latter lessons of this chapter.
(III) Cash Flow Statement
Cash Flow Statement records the inflows and outflows of cash and cash equivalents during a particular period. This statement is prepared to know how the cash and cash equivalents are used in the business. All the listed Companies are compulsorily required to prepare the Cash Flow Statement as per the Revised Accounting Standard- 3 (AS-3) along with their Financial Statements. According to the AS-3, Cash Flow Statement is bifurcated into three main heads.(i) Cash Flow from Operating Activities (ii) Cash Flow from Investing Activities (iii) Cash Flow from Financing Activities We will learn about these in greater details in the coming chapter. However, one thing should be noted that financial statements with respect to One Person Company (OPC), Dormant Company and Small Company, may not include Cash Flow Statements.
(IV) Notes to Accounts These are the supporting accounts that provides with details of the items mentioned in the Balance Sheet and Statement of Profit and Loss. Additional disclosures specified in the Accounting Standards are made by the way of notes to accounts or by the way of additional statement unless required to be disclosed on the face of the Financial Statements. Similarly, all other disclosures as required by the Companies Act are made in the notes to accounts in addition to the requirements set out in this Schedule. It should be noted that neither the Companies Act, 2013 nor any Accounting Standard specifies any fixed format for preparation of notes to accounts.
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