FINANCIAL REPORTING

Financial reporting is concerned with providing useful information to the user group of financial statements i.e. shareholders, creditors, potential investors etc. Financial reporting thus includes, “not only the financial statements but also other means of communicating information that relates directly or indirectly to the information provided by the accounting system i.e. information about enterprises resources, obligations earnings etc. The corporate annual reports form one of the most common means of financial reporting. Such reports incorporate not only income statement, balance sheet and statement of retained earnings but also important accounting ratios, graphs, diagrams, etc. all meant for providing useful information to the interested parties. OBJECTIVES OF FINANCIAL REPORTING The basic objective of financial reporting is to provide information useful for making economic decisions. According to SFAC-1, financial reporting should provide the following information: Information for investment and credit decisions. Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence. Information for assessing cash flow prospects. reporting should provide information to help present and potential investors and creditors and other users in assessing the amounts, timing and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption and maturity of securities or loans. The prospects for those cash receipts are affected by an enterprises ability to generate enough cash to meet its obligations when due and its other cash operating needs, to reinvest in operations and to pay cash dividends and may also be affected by perceptions of investors and creditors generally about the ability, which affect market prices of the enterprises securities. Thus financial reporting should provide information to help investors, creditors and others to assess the amount, timing and uncertainty of prospective net cash inflows to the related enterprise. Economic resources and claims Information about the nature and amounts of a reporting entity’s economic resources and claims assists users to assess that entity’s financial strengths and weaknesses; to assess liquidity and solvency, and its need and ability to obtain financing. Information about the claims and payment requirements assists users to predict how future cash flows will be distributed among those with a claim on the reporting entity. A reporting entity’s economic resources and claims are reported in the statement of financial position. Changes in economic resources and claims Changes in a reporting entity’s economic resources and claims result from that entity’s performance and from other events or transactions such as issuing debt or equity instruments. Users need to be able to distinguish between both of these changes.

" Advantages and Uses of Ratio Analysis There are various groups of people who are interested in analysis of financial position of a company. including information about its borrowing and repayment of debt. Changes in economic resources and claims not resulting from financial performance Information about changes in an entity’s economic resources and claims resulting from events and transactions other than financial performance. In this way profitability ratios show the actual performance of the business. is useful in assessing the entity’s past and future ability to generate net cash inflows.Information about a reporting entity’s financial performance during a period. The changes in an entity’s economic resources and claims are presented in the statement of comprehensive income. These ratios show the relationship between the liabilities and assets. ratio means the comparison of one figure to other relevant figure or figures. such as the issue of equity instruments or distributions of cash or other assets to shareholders is necessary to complete the picture of the total change in the entity’s economic resources and claims. It helps the management to know about the earning capacity of the business concern. They use the ratio analysis to workout a particular financial characteristic of the company in which they are interested. " Ratio analysis of financial statements is a study of relationship among various financial factors in a business as disclosed by a single set of statements and a study of trend of these factors as shown in a series of statements. The changes in an entity’s economic resources and claims not resulting from financial performance is presented in the statement of changes in equity Ratio Analysis Ratio analysis is one of the techniques of financial analysis to evaluate the financial condition and performance of a business concern. Helpful in analysis of financial statement: Ratio analysis help the outsiders just like creditors. shareholders. etc. The changes in the entity’s cash flows are presented in the statement of cash flows. Financial performance reflected by past cash flows Information about a reporting entity’s cash flows during the reporting period also assists users to assess the entity’s ability to generate future net cash inflows. In this case the business has to make it possible to repay its loans. . Ratio analysis helps the various groups in the following manner: To workout the profitability: Accounting ratio help to measure the profitability of the business by calculating the various profitability ratios. According to Myers. To workout the solvency: With the help of solvency ratios. debenture-holders. Simply. solvency of the company can be measured. This information indicates how the entity obtains and spends cash. representing changes in economic resources and claims other than those obtained directly from investors and creditors. In case external liabilities are more than that of the assets of the company. it shows the unsound position of the business. cash dividends to shareholders. bankers to know about the profitability and ability of the company to pay them interest and dividend etc. Such information may also indicate the extent to which general economic events have changed the entity’s ability to generate future cash inflows.

Some firms may value the closing stock on LIFO basis while some other firms may value on FIFO basis. there are certain limitations of the ratio analysis techniques and they should be kept in mind while using them in interpreting financial statements. Helpful for forecasting purposes: Accounting ratios indicate the trend of the business. then only the ratios will be correct. Therefore the ratio of one firm can not always be compared with the ratio of other firm. For example. In this way company comes to know about its weak point and be able to improve them. False Results: Accounting ratios are based on data drawn from accounting records. They may record the accounting data according to the convenience to show the financial position of the company in a better way. average collection period may be equal to standard credit period. In case that data is correct. In this way these ratios provide the basis for preparing budgets and also determine future line of action. For example. The data therefore must be absolutely correct. The following are the main limitations of accounting ratios: Limited Comparability: Different firms apply different accounting policies. The trend is useful for estimating future. To simplify the accounting information: Accounting ratios are very useful as they briefly summarise the result of detailed and complicated computations. valuation of stock is based on very high price. estimates for future can be made. Similarly there may be difference in providing depreciation of fixed assets or certain of provision for doubtful debts etc. Effect of window-dressing: In order to cover up their bad financial position some companies resort to window dressing.Helpful in comparative analysis of the performance: With the help of ratio analysis a company may have comparative study of its performance to the previous years. which may be important in decision making. Qualitative factors are ignored: analysis is a technique of quantitative analysis and thus. With the help of previous years’ ratios. Changes in price affects the cost of production. Therefore. the profits of the concern will be inflated and it will indicate a wrong financial position. To workout short-term financial position: Ratio analysis helps to workout the short-term financial position of the company with the help of liquidity ratios. In case short-term financial position is not healthy efforts are made to improve it. Effect of Price Level Changes: Price level changes often make the comparison of figures difficult over a period of time. which is not disclosed by ratio analysis. ignores qualitative factors. Limitations of Ratio Analysis In spite of many advantages. All turnover ratios are worked out to evaluate the performance of the business in utilising the resources. sales and also the value of assets. To workout the operating efficiency: Ratio analysis helps to workout the operating efficiency of the company with the help of various turnover ratios. it is necessary to make proper adjustment for price-level changes before any comparison. Costly Technique: . but some debtors may be in the list of doubtful debts.

Dividend on Equity shares depend on the balance of profit left after the payment of dividend to preference shares.000. the amount Voting Right Redemption of Share Capital .000 and sales are Rs. They can vote only in special circumstances. in case the company is going to wind up.000 and profit earned by the other one is Rs. 10. the result may be misleading. 40. An equity share does not carry any preferential right. Corporate Accounting Equity Share: According to Indian Companies Act 1956 " an equity share is share which is not preference share". the gross profit of two firms is 25%.000 and sales are Rs.00. Whereas the profit earned by one is just Rs. Difference between Preference Share and Equity Share Basis of Difference Preference Share Equity Share Equity shares are paid dividend out of the balance of profit after the dividend paid to preference shareholders. Rate of Dividend Preference shares are given dividend at a fixed rate. before the capital of equity shareholders is returned. Small business units are not able to afford it. 5.Ratio analysis is a costly technique and can be used by big business houses. In case the preference shares are redeemable. Equity shareholders carry the right to vote in all circumstances. Equity shares capital is refundable only at the time of Right of Dividend Preference shares are paid dividend before the Equity shares. 20. Equity shares are entitled to dividend and repayment of capital after the claims of preference shares are satisfied.00. For example. Preference Share: A share that carries the following two preferential rights is called ‘Preference Share’: Preference shares have a right to receive dividend at a fixed rate before any dividend given to equity shares. Equity shareholders carry the right to interfere in management of the company due to investigating risk of capital in the company. Equity shareholders control the affairs of the company and have right to all the profits after the preference dividend has been paid. Management Preference shareholders do not carry the right to participate in the management of the company. Misleading Results: In the absence of absolute data. Preference shareholders do not carry the voting right. Preference shares have a right to get their capital returned. Even the profitability of the two firms is same but the magnitude of their business is quite different.

The amount of the subscribed capital. is known as uncalled capital. The capital of a joint stock company is divided into shares and called ‘Share Capital’. issued capital is that part of the nominal capital. but while preparing funds flow statement all the current assets and current liabilities are taken into consideration. which not paid by the shareho0lders. which is not called. Refund of Capital At the time of dissolution of the company. unsubscribe capital. which is applied for by the public. preference share capital is paid before the payment of Equity share capital.of capital will be refunded to shareholders after a certain period. Cash Flow Statement A Cash Flow Statement is similar to the Funds Flow Statement. The balance of the nominal capital. The amount of the called-up capital. which is not offered to the public for subscription. Subscribed Capital: This is the nominal amount of the shares taken up by the public. which is not subscribed for by the public is called. is called unissued capital. subscribed capital is that part of the issued capital. In other words. Equity shareholders are paid their capital if there is some balance left after the payment of preference shareholders. which is actually received by the company. Paid up Capital: This represents that part of the called up capital. which is offered to the public for subscription. is called as unpaid capital or calls in arrears. In other words. winding up of the company. The nominal amount of the shares is usually collected from the shareholders in installments and it is possible that the entire amount of the subscribed capital may not have been called. Called up Capital: This is the amount of the capital that the shareholders have been called to pay on the shares subscribed for by them. The balance of the issued capital. . But in a cash flow statement only those sources of funds are taken which provide cash and only the uses of cash are taken into consideration. Issued Capital: This is the nominal amount of shares actually issued to the public. The share capital may be classified as below: Types of capital Nominal/Authorised/Registered Capital: This is the amount of the capital which is stated in Memorandum of Association and with which the company is registered. even liquid asset like Debtors and Bills Receivables are ignored. Nominal capital is the maximum amount which the company is authorised to raise from the public.

is a source of cash and any transaction. Difference between Funds Flow Statement and Cash Flow Statement Basis of Difference 1. which summarises the resources of cash available to finance the activities of a business enterprise and the uses for which such resources have been used during a particular period of time. which is working capital. A Cash Flow Statement provides very useful help to financial management of a business enterprise. Cash Flow Statement helps to know about the sources where from the cash will be available to pay off the liabilities. which increases the amount of cash. Cash Flow Statement provides help to the management to prepare Cash Budget. cash. which decreases the amount of cash. A Cash Flow Statement has the following uses: Helpful in short-term financial planning: Cash Flow Statement provides useful information to a business enterprise to make decision for its short-term financial planning. Funds flow statement tells about the various sources from where the funds generated with various uses to which they are put. It helps to predict this type of sickness. Basis of Analysis Funds Flow Statement Cash Flow Statement Funds flow statement is based Cash flow statement is based on on broader concept i. only one of the elements of working capital. phenomena affecting the liquidity of the business.e. A comparison of cash budget and cash flow statement reveals the extent to which the sources of the business were generated and used as per the plans of the business. Prediction of sickness: With the help of preparing cash from operation a business enterprise may come to know about cash losses in operation. It summarises the sources from where the cash may be obtained and the specific uses to which the cash may be applied during a particular period of time. Usefulness Funds flow statement is more Cash flow statement is useful in useful in assessing the longunderstanding the short-term range financial strategy. 2. Any transaction. when company declares it. narrow concept i. Dividend decisions: Dividend is paid within 42 days. . Cash Flow Statement helps the management to know about the sources of cash to pay off dividend. Cash flow statement stars with the opening balance of cash and reaches to the closing balance of cash by proceeding through sources and uses. is an application of cash.e. Helpful in preparing Cash Budget: A Cash Budget is an estimate of cash receipts and disbursement for a future period of time. Helps to understand liquidity: Liquidity means ability of a business enterprise to pay off its liabilities when due.A Cash Flow Statement is a statement. Source 3.

. In cash flow statement changes in current assets and current liabilities are shown in the cash flow statement itself.4. its profit or loss during the year. To study the increasing or decreasing tendency of ‘Cost of Goods Sold’. Financial statements of different enterprises for the same accounting year. Causes 6. Cash flow statement shows the causes the changes in cash. It shows the absolute change from one period to another. To analyse the various items of incomes. Comparative Statements The Profit & Loss Account reveals the trading results of a concern i. Funds flow statement shows the causes of changes in net working capital. 5. Net Profit and Operating Profits.e. Principal of Accounting Comparison of Financial Statements is primarily an analytical study of the different items shown in the Income Statement and Position Statement (Balance Sheet) over a period of time. Funds flow statement is consonant with the accrual basis of accounting. In cash flow statement data obtained on accrual basis are converted into cash basis. Schedule of Changes in Working Capital In funds flow statement changes in current assets and current liabilities are shown through the schedule of changes in working capital. But the Comparative Income Statement presents a review of two or more years. It may refer to: Financial statements of an enterprise for two or more accounting years. Comparative Income Statement is prepared: To study increase or decrease in ‘Sales’. To study the increase or decrease in Gross Profit.