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Liability of investors in equity is limited to their commitment to contribute to the capital. A company can sue or be sued in its own name.
Existence of a company is not affected by change in shareholders Signature of the company
Classification of Limited Liability Companies
Private limited company
Prohibition on inviting public to contribute to equity capital Prohibition on having more than 50 members (equity share holders) Low compliance cost
Public limited company Listed company
Significant disclosure requirements High compliance cost
Governance of Public Limited Company
As per law
Shareholders use their voting rights to elect directors. The board of directors appoints the CEO. The board of directors provides direction to the company and monitors the CEO. The incumbent management elects its nominees to the board.
Capital represents the amount invested in the business. Capital provided to the company belongs to the company. Capital providers provide capital in exchange of their claim on the assets (economic resources).
Types of Capital
Debt capital (Loan Fund)
The company has an obligation to repay the capital and to pay return on capital as per agreed terms. If, the company fails to meet its commitment, debt holders have the right to take legal recourse for winding up the company. Assets of the company are sold on winding up of the company and the debt and outstanding return on capital is settles to the extent possible. Investment in debt capital is exposed to credit risk
It is the residual interest in the assets of the company after deducting all its liabilities. 3/10/2013 6 .Types of Capital (Contd. Equity is the total of contributed capital and retained profit.) Equity Capital Equity capital represents owners capital.
Types of Capital (Contd.) Net profit. that is profit after deduction of interest and tax expense belongs to shareholders There is prohibition on distribution of contributed capital. This is to protect the interest of creditors. 3/10/2013 7 . Investment in equity is exposed to business risks. The company has unconditional discretion to distribute the profit to shareholders.
Balance sheet Sources of Funds (Claims on economic resources) Equity (Contributed capital + Retained profit): Residual claim Rs. 100.000 Rs.000 3/10/2013 8 .000 Application of Fund Economic resources (Assets) Figures are hypothetical Rs. 200. 200.000 Debt (Loan Fund) Rs. 100.
Shareholders can sell shares to others in the capital market.Equity: Return of Capital and Return on Capital Distribution of dividend is at the discretion of the company. Return to shareholders = [D1+(P1 – P0)] ÷ P0 P1 depends on investors‟ expectation about the future performance of the company 9 3/10/2013 . Contributed capital cannot be returned.
After a year market price Rs. 120. Dividend received Rs.Equity: Return of Capital and Return on Capital Assume share purchased at Rs. 100.5 Return to shareholders = [5+(120 – 100)] ÷ 100 = 25% 3/10/2013 10 .
The secondary objective is to provide information to evaluate management in its stewardship responsibilities. lenders and other creditors in making decisions in their capacity as capital providers. 3/10/2013 11 .Purpose of Financial Statements The primary purpose is to provide financial information that is useful to present and potential equity investors.
12 Profit and loss account Statement of changes in equity 3/10/2013 .Complete Set of Financial Statements Balance sheet It provides information on the financial position of the company at the end of the accounting period It provides information on the performance of the company during the accounting period It reconciles the equity as at the beginning of the period and the same as at the end of the period.
Notes to accounts 3/10/2013 13 .Complete Set of Financial Statements (Contd.) Statement of cash flows It provides information on cash inflows and outflows during the accounting period It summarise accounting policies and provide explanatory information.
owners). an entity records the amount due to owners as claims (equity capital) on assets it controls. Therefore.g.Entity Convention According to the entity convention all transactions are recorded from the point of view of the entity itself and not from the perspective of other stake holders (e. 3/10/2013 14 .
Current accounting rules require companies to measure transactions and events at nominal amount. 3/10/2013 15 .Money Measurement Convention According to the money measurement convention all transactions and events should be measured in terms of money. without any adjustment for inflation.
Going Concern Convention Assets and liabilities at the balance sheet date are measured with the assumption that the entity is a going concern. in the foreseeable future. An entity is a going concern if. intentionally or otherwise. it is not expected to close down or curtail the scale of operation. 3/10/2013 16 . unless there is evidence to suggest otherwise.
Going Concern (Contd. 3/10/2013 17 . A different measurement base may be used if the company ceases to be a going concern.) This convention is important because entities hold assets that are valuable to the entity only and have relatively significantly low value to others. If the company ceases to exist or curtails its activity level materially. the value is lost.
g. Under historical cost system. historical cost and fair value) to measure assets and liabilities.Cost Convention Traditionally. assets are recorded at acquisition cost and liabilities are recorded at the amount of proceeds received in exchange for an obligation. The current accounting practice is to use mixed attributes (e. financial statements are prepared and presented based on historical cost. 18 3/10/2013 .
Realisation Convention The realisation convention is closely related to the cost convention. 3/10/2013 19 . An unrealised gain should not be recognised. According to this convention. an asset should be recorded at historical cost and any change in value should be recognised at the time the firm realises or disposes of the asset.
income is recognised as it is earned and expenditure is recognised. In other words income is recognised when the right to receive cash arises and expenditure is recognised when the obligation to pay cash arises without waiting for actual receipt or payment of cash.Accrual Convention According to the accrual convention. when it is incurred. 20 3/10/2013 . either as an asset or as an expense.
focus was on the profit and loss account. income and expenses should be matched. with shift of focus from the profit and loss account to balance sheet.Matching Convention According to the matching convention. to the extent possible. matching principle is no more the overriding principle. and matching principle was the overriding principle. 21 3/10/2013 . However. In past.
Periodicity Convention The indefinite life of a firm is subdivided into smaller time unit to measure and understand its performance and financial position. publicly traded companies are required to publish abridged financial statements on quarterly basis. The convention is to issue complete set of financial statements at an interval of 12 months. 22 3/10/2013 .
Conservatism Convention According to the conservatism convention. and Face with the choice between two methods of valuing an asset. the accountant should choose a method that leads to the lesser value. in a situation of uncertainty. The operating rules are: An entity should not anticipate income and should provide for all estimated losses. it is preferable to understate profit and assets rather than overstating the same. 23 3/10/2013 .
Fundamental Qualitative Characteristics Relevance Faithful representation 3/10/2013 24 .
Relevance Information is relevant when it influences economic decisions of users by helping them to evaluate past. 3/10/2013 25 . present or future events or confirming or correcting their past evaluations.
Relevance: Materiality The relevance of a financial statement gets enhanced if material items are shown separately. Information is material if its misstatement or omission could influence the economic decisions of users taken on the basis of the financial statements. Materiality is assessed taking into account both quantitative and qualitative factors. 26 3/10/2013 .
27 3/10/2013 . event or circumstances. which is not always the same as its legal form.Faithful Representation Faithful representation is attained when the depiction of an economic phenomenon is complete. Financial information that faithfully represents an economic phenomenon depicts the economic substance of the underlying transaction. and free from material error. neutral.
timeliness and understandability.Enhancing Qualitative Characteristics Enhancing qualitative characteristics are complementary to the fundamental qualitative characteristics. 28 3/10/2013 . The enhancing qualitative characteristics are comparability. Enhancing qualitative characteristics distinguish more useful information from less useful information. verifiability.
Understandability is enhanced when information is classified. 3/10/2013 29 . Comparability also enhances understandability. characterised and presented clearly and concisely.Understandability Understandability implies that information is presented in a manner that a user can comprehend the meaning easily.
In making decisions.) It is assumed to that users have a reasonable knowledge of business and economic activities and have financial and accounting literacy. It is incorrect to assume that financial statements are aimed at retail investors. users are expected to review and analyse the information with reasonable diligence. 30 3/10/2013 .Understandability (Contd.
Constraints in Financial Reporting Materiality Cost 3/10/2013 31 .
3/10/2013 32 .Materiality Information is material if its omission or misstatement could influence the decisions that users make on the basis of an entity‟s financial information. The materiality of an item should be assessed in terms of its nature and amount.
Assessing whether the benefits of providing information justify the related costs will usually be more qualitative than quantitative.Cost Financial reporting imposes costs. the benefits of financial reporting should justify those costs. 3/10/2013 33 .
When making this assessment.Cost (Contd. 34 3/10/2013 . they consider whether one or more qualitative characteristics might be sacrificed to some degree to reduce cost.) In applying the cost constraint standard setters assess whether the benefits of reporting information are likely to justify the costs incurred to provide and use that information.
and It is prepared in the format prescribed by the regulator or in absence of a prescribed format it is prepared in a manner that facilitates analyses of the financial position and the performance of the reporting enterprise. 35 3/10/2013 . It is prepared using the appropriate accounting policy and applicable accounting standards.True and Fair View Generally financial statements provide a true and fair view if It is free from any material error and bias.
Internal Control Internal control is a process designed to provide reasonable assurance regarding achievement of objectives in the following categories: Effectiveness and efficiency of operations Reliability of financial reporting Compliance with applicable rules and regulations 3/10/2013 36 .
but are beyond the control of the management. which affect the performance of the enterprise. However. 37 3/10/2013 . because it cannot change inherently poor managers into good managers and cannot change variables (in the business environment).Internal Control Internal control is a process. it cannot ensure success or even survival. which helps an enterprise to achieve its objectives and avoid pitfalls and surprises in its operation.
and organizes and develops people. 38 3/10/2013 . management‟s philosophy and operating style. and the attention and direction provided by board of directors.Internal Control: Control environment Control environment provides the discipline and structure and it is the foundation of other components of internal control. the way management assigns authority and responsibility. ethical values and competence of people. Control environment factors include integrity.
Risk Assessment Risk assessment is the identification and analysis of relevant risks to achievement of enterprise‟s objectives. Internal control provides mechanisms to identify and deal with special risks that arise from a change in the business environment including technological environment and socio-political environment. It forms the basis for determining how the risks should be managed. 39 3/10/2013 .
Control activities occur throughout the organisation. reviewing of operating performance. authorisations. They include approvals. verifications. and reconciliations. security of assets and segregation of duties.Internal Control: Control Activities Control activities are the policies and procedures that ensure that management activities are carried out efficiently and effectively. 40 3/10/2013 . at all levels and in all functions.
and conditions relevant to the business. captured and communicated in a form and timeframe that enable people to carry out their responsibilities. Information and communication should flow seamlessly across. 3/10/2013 41 . down and up the organisation. events.Internal Control: Information and Communication Pertinent information should be identified. The information and communication system should deal with internal data and external activities.
3/10/2013 42 .Internal Control: Monitoring Regular monitoring is essential to ensure that the internal control system is adequate and operating effectively.
and governance process”.Internal Audit “Independent. It helps an organisation accomplish its objectives by bringing a systematic. objective assurance and consulting activity designed to add value and improve an organisation‟s operations. control. 3/10/2013 43 . disciplined approach to evaluate and improve the effectiveness of risk management.
Auditor‟s unqualified opinion should not be viewed as an assurance as to the future viability of the enterprise or the efficiency or effectiveness with which the management has conducted the affairs of the enterprise. 44 3/10/2013 .External Audit The auditor of financial statements provides a reasonable assurance (and not absolute assurance) that financial statements provide true and fair view of the financial position and operating results of the enterprise.
Selection of the accounting policy is not left to the individual firms.Accounting Policy Accounting policy refers to the specific accounting principles and the methods of applying those principles adopted by an entity in the preparation and presentation of financial statements. 45 3/10/2013 . A firm selects accounting principles and methods from the alternatives provided in accounting standards.
3/10/2013 46 .Accounting Standards Accounting standards are regulations that govern accounting policy of companies. In India. the Institute of Chartered Accountants of India (ICAI) issue accounting standards and the government makes it mandatory for limited liability companies through notification.
2011 European Union (EU) has adopted IFRS from the year 2005. USA has prepared a road map for adoption of IFRS from the year 2014. 47 3/10/2013 .International Financial Reporting Standards IFRSs are issued by the International Accounting Standards Board (IASB). India has decided to adopt IFRS from April 1. More than 100 countries have adopted IFRS.
3/10/2013 48 .Events Occurring After the Balance Sheet Date To a significant extent. judgements and models of the financial effects on an entity of transactions and other events and circumstances that have happened or that exist. rather than on exact depictions of those effects. financial reporting information is based on estimates.
Events Occurring After the Balance Sheet Date Management develop its perception about the economic consequences of transactions and other events based on information collected by it using reasonable efforts. 3/10/2013 49 . Information gathered by it is likely to be incomplete.
3/10/2013 50 . management takes into consideration additional evidence (about the conditions at the balance sheet date) provided by events unfolded after the balance sheet date but before approval by the board of directors for issuance.Events Occurring After the Balance Sheet Date Therefore. Events that provide the additional evidence are called „adjusting events‟.
Assets and liabilities should not be adjusted for non-adjusting events. in the financial report. if material.Non-adjusting Events Events that are indicative of conditions that arose after the balance sheet date are nonadjusting events. The disclosure provides information about the nature of the event and estimate of its financial effect. usually in the board of director‟s report. 51 3/10/2013 . Companies disclose non-adjusting events.
Announcing a plan to discontinue an operation. and 52 3/10/2013 . Issuance of significant guarantees on behalf of third parties.Non-adjusting Events:Examples Major business combination after the balance sheet date. or acquisition of major assets by the government. Commencement of a major restructuring. Major change in tax rates. Major change in exchange rates. Major purchase or disposal of assets.
END 3/10/2013 53 .