Preparation of Financial

Statements of Limited
Companies
P. GURU PRASAD
FACULTY MEMBER
INC GUNTUR
General requirements of the companies act

 The joint stock companies, are legally required

to prepare a set of financial statements to
periodically assess the profits earned and to
know the financial position of the company as on
a specified date.
 In the case of companies registered under the
companies act the act specified the books of
accounts to be maintained and also prescribes
the format and content of the financial
statements.
General requirements of the companies act

 The legal requirement laid down by the

companies act, there fore assumes a great
importance in the preparation of the financial
statements of a join stock company.
 In addition , the accounts must be statutorily
audited by an external person called the auditor
and it is the duty of the auditor to submit a report
in the prescribed format to the shareholders
 Books of Accounts
 Section 209 of the companies act specifies the
books of accounts to be maintained by a
company
 All sums of money received and expended by
the company and the matters in respect of which
the receipts and expenditure take place
 All sales and purchases of goods by the
company
 The assets and liabilities of the company
 Companies have to compulsorily maintain their
accounts only on the accrual basis . Cash basis
of accounting cannot be followed. Also double
entry system of accounting should be followed.
 Books of Accounts

 The books of accounts for a period of eight

years preceding the current year together with
the vouchers relating to any entry in such books
of accounts should be preserved in good
condition
 The books of accounts and other books and
papers of a company must be open to inspection
during business hours , by the registrar or such
authorized government officer to carry out such
inspections
 Legal requirements regarding
annual accounts
 The annual accounts of the company must be submitted
in an annual general meeting within six months counted
from the last day of the accounting period to which the
accounts relate.
 The period to which the accounts relate is known as the
financial year and it may be less than, equal to or greater
than 12 months but cannot exceed 15 months. Where
special permission has been granted by the registrar the
financial year may extend to eighteen months
 Format of Balance sheet
 The balance sheet should be in the form
set out in part I of schedule VI of the
companies act,1956. However this format
does not apply to banking companies ,
insurance companies and companies
engaged in the generation or supply of
electricity.
Requirement of the companies Act
with Respect to Profit and loss a/c
 Part II of schedule VI of the companies act
1956 does not prescribe any format for the
profit and loss account but only outlines
the information to be included. The various
items of receipts ad expenses should be
arranged under the most convenient
heads
 Revenues
 The following are the revenues which must be disclosed
in the P&L
 The turnover or the aggregate amount of sales effected
by the company
 The gross income derived from services rendered or
supplied.
 Incomes from trade investments and other investments
 Incomes by way of interests
 Profit on investments
 Profits of non recurring nature
 Miscellaneous income
 Dividends from subsidiary companies
 Expenses
 The following are the expenses which must be disclosed in the profit
and loss a/c
 The value of raw material consumes, item wise break up and
quantity consumed.
 Opening & closing stock of raw material
 Opening & closing work-in-progress
 The amount provided for depreciation,
 Consumption of stores and spare parts
 Power and fuel
 Rent
 Repairs to buildings
 Repairs to machinery
 Salaries and wages and bonus
 Miscellaneous expenses
 Expenses
 Contribution to provident fund an other funds
 Staff welfare expenses
 Insurance
 Income tax payable
 Dividend paid
 Provision for losses of subsidiary companies
 Amounts reserved for repayment of share capital
 Amounts set aside for reserves
 Amounts set aside for provisions
 Expenses related to sales, trade discounts
 Notes to profit and loss a/c
 According to part II schedule VI , certain information has to be
provided by way of notes to P&L account.

 payments made to directors

 Managerial remuneration paid or payable under section 198
 Other allowances & commission
 Any other perquisites or benefits in cash or in kind
 Pensions
 Gratuities
 Payment to provident fund
 Compensation for loss of office
 Retirement benefits
 Auditors fees
 Value of imports calculate on C.I.F basis
 Expenditure in foreign currency on account of royalty, etc.,
 Export of goods calculated on F.O.B basis
 Other incomes indicating the nature there of
 Profit and loss appropriation
account
 It shows in detail the appropriations made from
the profits in respect of dividends and transfer to
reserves etc., The balance in the P&L
appropriation account ,if it is a credit balance will
be shown on the liability side of the balance
sheet heading “reserves and surplus”. If there is
a closing debit balance in the profit and loss
appropriation account (that is, a loss), then such
balance will be shown on the asset side under
the heading “miscellaneous expenditure”
Requirements of the companies act
with respect to Balance Sheet
 The assets of the limited company should
be classified into
 Fixed assets and investments,
 Current assets,
 Loans and advances and
 Miscellaneous expenditure
 Goodwill
Fixed assets
 Land
 Buildings
 Lease hold
 Railway sidings
 Plant and machinery
 Furniture and fittings
 Development of property
 Patents, trademarks and designs
 Live stocks
 Vehicles etc.,
 Current assets
 Interest accrued on investment
 Stores and spare parts
 Loose tools
 Stock-in-trade
 Work-in-progress
 Sundry debtors
 Cash balance on hand
 Bank balances
 Sundry debtors
 Broadly classified into
 Debits outstanding for a period exceeding
6 months
 Other debits
 The provision for doubtful debits should be
shown as deduction from the debtors
 Miscellaneous expenditure
 Preliminary expenses
 Expenses including commission or
brokerage on un writing or subscription of
share or debentures
 Discount allowed on the issue of share or
debentures
 Interest paid out of capital during
construction
 Development expenditure (not adjusted)
 Other items
 Liabilities
 Share capital
 Reserves and surplus
 Secured loans
 Unsecured loans
 current liabilities
 provisions
 Share capital
 Authorized capital
 Issued capital
 Subscribed capital
 Called up capital
 Calls in arrears
 Any forfeited shares
 Classes of preferences
 Paid up capital
 Bonus shares have been issued
 Forfeiture

 Definition

 A loss of money, property, or privileges

due to a breach of legal obligation, which
serves as compensation for resulting
losses.
 Preference shares
 Definition

 Capital stock which provides a specific dividend that is

paid before any dividends are paid to common stock
holders, and which takes precedence over common
stock in the event of a liquidation. Like common stock,
preference shares represent partial ownership in a
company, although preferred stock shareholders do not
enjoy any of the voting rights of common stockholders.
The main benefit to owning preference shares are that
the investor has a greater claim on the company's assets
than common stockholders. In the event the company
goes bankrupt, preferred shareholders are paid off
before common stockholders.
 Book building

 Definition

 The process of determining the price at which an

Initial Public Offering will be offered. The book is
filled with the prices that investors indicate they
are willing to pay per share, and when the book
is closed, the issue price is determined by an
underwriter by analyzing these values.
 Reserves and surplus
 Capital reserves
 Capital redemption reserve
 Share premium account
 Other reserves
 Surplus, balance after providing for
dividend, bonus or reserves
 Proposed additions to reserves
 Sinking fund
 Sinking fund
 Definition

 Reserves created by periodically setting

aside certain sums in a custodial account
(as cash or investment in marketable
securities) for future replacement of an
asset or repayment of a liability.
 Secured loans
 Debentures
 Loans and advances from the banks
 Loans and advances from subsidiaries
 Other loans and advances
 Debenture

 Definition 1:-
 Charge, claim, or lien on asset or property, usually as a
result of a loan.
 Definition 2:-
 Promissory note or a corporate bond which (in the US) is
backed generally only by the reputation and integrity of
the borrower and (in the UK) by the borrower's specific
assets. When unsecured, it is called a bare debenture or
naked debenture; when secured by a charge on a
specific property, it is called a mortgage debenture.
 Unsecured loans
 Fixed deposits
 Short term loans from banks
 Loans from others
 Current liabilities
 Bills payable (accounts payable)
 Sundry creditors
 Amount due to subsidiary companies
 Advance payment received
 Unclaimed dividend
 Other’s liabilities
 interest accrued but not due on loans
 Accounts payable (A/P)

 Definition
 Unpaid bills. Accounts that are owed to suppliers
(trade creditors) as distinguished from accrued
interest, rent, salaries, taxes, and other such
accounts. Accounts payable are shown under
current (short-term) liabilities in the balance
sheet. Lenders and investors examine the
relationship of these accounts to the firm's
purchases in order to judge the soundness of its
day to day financial management.
 Accrued interest
 Definition
 Interest earned but not received (realized).
For example, bonds usually pay interest
every six months, therefore interest
accrues between one interest payment
and the next. The buyer of a bond pays its
market value plus the interest earned up
to the settlement date.
 Sundry creditors
 Definition

 Miscellaneous small or infrequent

suppliers that are not assigned individual
ledger accounts but are classified as a
group.
 capital reserve

 Definition
 Resource created by the accumulated capital
surplus (not revenue surplus) of a firm, such as
by an upward revaluation of its assets to reflect
their current market value after appreciation.
Allocating such sums to capital reserve means
they are permanently invested and will not be
paid as dividends.
 Provisions
 Provision for taxation
 Proposed dividends
 Provision for contingencies
 Provision for provident fund and to their
schemes
 Provisions for insurance, pension and
similar staff benefit schemes
 Other provisions
 Provision
 Provision: A present obligation which satisfies
the rest of the definition of a liability, even if the
amount of the obligation has to be estimated.
 In financial accounting, provisions are liabilities
similar to accruals, for which the amount or
probability of occurrence are not known.
 Typical examples are provisions for warranty
costs and provision for taxes, or for the results of
court ruling.
 Sometimes, the term reserve is used instead of
term provision; such a use, however, is
inconsistent with the terminology suggested by
International Accounting Standards Board.
 Reserves
 In financial accounting, the term reserve is most
commonly used to describe any part of
shareholders' equity, except for basic share
capital. Sometimes, the term is used instead of
the term provision; such a use, however, is
inconsistent with the terminology suggested by
International Accounting Standards Board.
Reserve - ACCOUNT used to earmark a portion
of EQUITY or fund balance to indicate that it is
not available for expenditure. An obsolete term
in the United States. More commonly used in
Europe.
 Reserves
 Equity reserves are created from several
possible sources:
 Reserves created from shareholders'
contributions, the most common examples of
which are:
 legal reserve fund - it is required in many

legislations and it must be paid as a

percentage of share capital
 share premium - amount paid by

shareholders for shares in excess of

their nominal value
 Reserves
 Reserves created from profit, especially
retained earnings, i.e. accumulated accounting
profits. However, profits may be distributed also
to other types of reserves, for example:
 legal reserve fund from profit - many
legislations require creation of the fund as a
percentage of profits
 remuneration reserve - will be used later to pay

bonuses to employees or management

 translation reserve - arises during consolidation

of entities with different reporting currencies

 Difference Between Provision &
Reserve
 The Provisions are charged on profit and loss
account, even though there were no profits for
the current financial year. It is mandatory to
create the Provisions according to conservatism
concept.
 Where as the Reserves are apportioned from
the profits only. If there are no profits, then the
management can not create Reserve. They are
not mandatory. It can be used to write off capital
losses. Later they will form the part of owners
net worth.
 Share premium account
 Share Premium account is shown on
liability side of balance sheet under the
head reserves and surplus. Section 78 of
the companies act restricts the use of the
amount collected as premium on
securities for the following purpose
alone.
2. Issuing fully paid bonus shares to the
members
3. Writing off preliminary expenses
 Share premium account
1. Writing off the expenses of issue or the
commission paid of or discount allowed on any
issue of shares or debentures of the company.
2. Providing for the premium payable on the
redemption of any redeemable preference shares
or of any debentures of the company,
3. In purchasing its own shares (buy back) [section
77A]
4. Otherwise called as “Securities Premium Account.
(Shares, Bonds, or debentures)
 Notes to the balance sheet
 Claims against the company not
acknowledged as debts
 Uncalled liability on shares partly paid
 Arrears of fixed cumulative dividends
 Estimated amount of contracts remaining
to be executed on capital account and not
provided for.
 Other money for which the company is
contingently liable.
 Form of balance sheet
 A company may prepare its balance sheet
either in the horizontal form specified in
part I of schedule VI or may prepare it in a
statement form, stating the liabilities as
sources of funds in the first part and listing
the assets as applications of funds in the
second part
 Depreciation
 The companies act requires the provision of
adequate depreciation for the following purpose
 For determination of the profits out of which
dividends can be declared
 for determination of the profits for the purpose
of calculation of managerial remuneration.
 The depreciation to be written off to profit and
loss account is the amount of depreciation
chargeable for the calculation of devisable
profits
 Interest on debentures
 When a company has raised funds by
floating debenture, the profit and loss
account must be charged with interest on
debentures for the financial year or where
the debentures had been floated only in
the current financial year , for the period
for which they have been out standing.
 Interest accrued but not due should be
shown in the balance sheet as a current
liability
 Income tax
 Dividends to both the equity and the preference
share holders can paid only out of profits available
after taking into account the income tax. the profits
on which income tax is payable is termed as
taxable profits and the calculation of taxable profits
is based on the provisions as per the income tax
act.
 Though the actual amount of tax can be calculated
only when the books of accounts are closed for the
accounting period and profits are ascertained, the
income tax act requires a business to pay advance
tax by forecasting the likely profits that would
accrue during the year
 Income tax
 The process of assessment may take quite
some time to be completed and until such
completion, the exact tax liability will not be
known to the company. Thus the accounting
treatment of income tax must take into account
the following three stages.
 Payment of advance income tax
 Determination of the tax liability by the company
from its books of accounts, making a provision
for such liability and payment of difference, if
any, between advance tax and tax now
computed
 Completion of the assessment by the income tax
officer.
 Dividends
 Dividends may be defined as the share of profits
that is payable to each share holder of the
company. The companies act lays down that
dividends can be paid out of profits only and
prohibits the payment of any dividend out of
capital .also , dividends should be paid in cash
only. a company may pay dividends from any or
all of the three sources.
 Profits of the current year
 Undistributed profits of previous year
 Money provided by the central or any state
government for the payment of dividends
 Dividends
 The directors generally recommended the
percentage of dividend payable on the equity
shares . The share holders in the annual general
meeting may pass a resolution adopting the
recommendation or may lower the percentage
recommended. The share holders don’t have the
power to enhance the dividend recommended by
the directors. The percentage adopted must be
applied only on the paid up capital. Calls in
arrears do not qualify for the dividends.
 Dividends
 The dividend recommended by the
directors is termed as proposed dividend
till such time it is adopted by the share
holders in the annual general meeting.
 The proposed dividend will be classified
as a provision and shown on the liability
side of the balance sheet . The dividend
finally decided by the share holders in the
annual general meeting as a payable is
termed as declared dividend.
 Dividends
 Any dividend declared must be paid with
in 42 days from the date of declaration.
Hence a declared dividend must be
classified current liability in the balance
sheet of the company. Though the
dividends can be declared only by a
resolution of the share holders , if the
articles of the company permit , the
directors can declare and interim dividend
between two annual general meetings.
 Dividends
 As per the companies act , no dividend
shall be declared or paid by a company for
any financial year out of the profits of the
company for that year arrived at after
providing for depreciation in accordance
with the provisions of he sec 205 (2),
except after the transfer to the reserves of
the company a percentage for its profits of
that year as specified below
 Dividends
 Where the dividend proposed exceeds
10% but not 12.5% of the paid up capital ,
the amount to be transferred to the
reserves shall not be less than 2.5% of the
current profits
 Where the dividends proposed exceeds
12.5% but does not exceed 15% paid up
capital , the amount to be transferred to
the reserves shall not be less than 5% of
the current profits
 Dividends
 Where the dividend proposed 15% but
does not exceed 20% of the paid up
capital the amount to be transferred to the
reserves shall not be less than 7.5% of the
current profits.
 Where the dividend exceeds 20% of the
paid up capital the amount to be
transferred to reserves shall not be less
than 10% of the current profits.
 Dividends
 Any dividend declared by the company reaming
un paid with in 30 days of declaration , shall be
transfer by the company to a special account
with in 7 days of the expiry of the aforesaid
30days.
 If the dividend is not claimed for a period of 7
years from the date of transfer to the special
bank account , then the unclaimed amount must
be transferred by the company to the fund
established under sec 205C.
 After such transfer , any share holder entitled to
claim such dividend may claim it from the
government.
Profit on revaluation of fixed assets
 When a company revalues its fixed assets and if there is
profit on revaluation it should be transfer to capital
reserve account.
 Capital Reserve- Reserve created by the accumulated
capital surplus( not the revenue surplus) of the firm e.g.
an upward revaluation of assets by a firm to reflect its
assets at the current market values after appreciation.

.
Capital reserve is created from the capital gains
Capital reserve is that reserve which is created out of
profit of capital nature such as: revaluation, business
purchase, forfeiture, etc.
 Interest out of capital

 Though the companies act provides that the

dividends to share holders are payable only out
of profits , in certain circumstances with the
previous sanction of central government interest
may be paid to share holders out of capital . The
circumstances classified by sec 208 of the
companies act are as below:-
 Interest out of capital
 Where any shares in a company are
issued for the purpose of raising money to
defray the expenses of the construction of
any work or building or the provision of
any plant
 Such construction or provision of plant
cannot be made profitable for a lengthy
period. ( notified rate of interest 12%)
 Suspense account
 Some times suspense account is shown in
the trial balance because some items
which cannot be posted to the correct
account for some reason or the other is
shown as suspense account which is
rectified or adjusted while preparing the
final accounts
 Managerial remuneration
 Calculating of managerial remuneration payable
to directors , mangers , managing director is
base on net profit which is calculated as follows.
 The net profit for this purpose is calculate after
making the four adjustment to gross profit
 Credit shall be given for the following sums
 Credit shall not be given for the following sums
 The following sums shall be deducted
 The following sums shall not be deducted
 Credit shall be given for the
following sums
 Bounties and subsidies received fromany
government or any public authority should
be added with the gross profit.

 Bounty:- rewards, generosity

 Subsidies:- gift of supporting funds
 Credit shall not be given for the following
sums
 Profits, by way of premium, on shares or
debentures of the company
 Profits on sales by the company of forfeited
shares
 Profits of capital nature including profits from
sale of undertaking
 Profits from the sale of immovable property
 However, credit shall be given for revenue profit(
difference between original cost and written
down value) on the sale of fixed asset
The following sums shall be deducted
 All the usual working charges
 Directors remuneration
 Bonus or commission paid to any member of the
staff
 Any tax on excess or abnormal profits
 Interest on debentures
 Interest on mortgage
 Expenses on repairs
 Outgoings , inclusive of contributions
 Depreciation toa the extent specified in sec 350
 The following sums shall be
deducted
 The excess of expenditure over income
 Any compensation or damages to be paid
in virtue of any legal liability
 Any sum paid by way of insurance
 Debts considering bad and written-off
 Amount paid as cess u/s441 A
 The following sums shall not be
deducted
 The remuneration payable to the
managing agent (not in force)
 Income tax and super tax payable
 Any compensation, damages or payments
made voluntarily
 Loss of capital nature including loss on
sale of the undertaking. sec 350
 Commission after charging such
commission
 :-as per the provision of the companies
act, commission to managerial staff
should be calculated before charging such
commission . However, a company may
enter into an agreement to pay
commission as a percentage of profit after
charging such commission. In this case,
commission is calculated as follows
commission is calculated as follows

Commission =

rate of commission
profit before commission
* 100+rate of commission
Commission payable to more than
one member of managerial staff
 There may be an agreement that the
whole time directors will get commission at
a fixed rate on net profits after the
commission of the part time directors.
Again the part time directors will get
commission at a fixed rate on net profit
after the commission of the whole time
directors. In this situation, the commission
of each group is calculated with the help of
simultaneous equations.( refer 7.3)
 Thank you
 "When people say to me: "How do you do
so many things?" I often answer them
without meaning to be cruel: "How do you
do so little?" It seems to me that people
have vast potential. Most people can do
extraordinary things if they have the
confidence or take the risks. Yet most
people sit in front of the TV and treat life
as if it goes on forever." -- Phillip Adams