Understanding of Financial Statements

Introduction
• Financial statements are written records that illustrates the business activities and the financial
performance of a company

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 Balance Sheet
The Balance Sheet has three main categories:

• Assets: An asset is a resource with economic value that a business

owns with the expectation that it will provide future benefit to the
business
• Liabilities: A business’s liabilities are obligations the business owes
• Equity: Sometimes referred to as Net Worth, it refers to value of
ownership

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 Balance Sheet
• Current vs Non Current

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 Balance Sheet
• Statement of Changes in Shareholders Equity
The statement of changes in equity is a reconciliation of the beginning and ending balances in a
company’s equity during a reporting period. The statement starts with the beginning equity
balance, and then adds or subtracts such items as profits and dividend payments to arrive at the
ending balance. Below is a general format of such statement:

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 Balance Sheet
• Statement of Changes in Shareholders Equity
Other Equity

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 Balance Sheet
Other Comprehensive Income: Other comprehensive income is those revenues, expenses, gains,
and losses that are excluded from net income on the income statement. This means that they are
instead listed after net income on the income statement.
Revenues, expenses, gains and losses appear in other comprehensive income when they have not yet
been realized. Something has been realized when the underlying transaction has been completed,
such as when an investment is sold. Thus, if your company has invested in bonds, and the value of
those bonds changes, you recognize the difference as a gain or loss in other comprehensive income.
Examples of OCI include unrealized holding gains or losses on investments that are classified as
available for sale, foreign currency translation gains or losses, etc.

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 Balance Sheet
Brief Overview of Reclassification to Profit or Loss:
It is the process where gains or losses are reclassified from equity to Statement of Profit & Loss as an
accounting adjustment. In other words gains or losses are first recognised in the Other
Comprehensive Income and then in a later accounting period also recognised in the Statement of
Profit & Loss. It is down to individual accounting standards to direct when gains and losses are to be
reclassified from equity to Statement of Profit & Loss as a reclassification adjustment. So rather than
have a clear principles based approach on recycling what we currently have is a rules based approach
to this issue.
Let’s look at an example to understand the concept:
Suppose as per the concerned standard, reclassification is permissible on a particular type of asset.
Let’s assume the cost of that asset is Rs. 10 mn and it is subsequently revalued to Rs. 12 mn. Then a
gain of Rs. 2 mn is recognized directly in Equity. When in later period, the asset is sold for say Rs. 13
mn, the profit on disposal recognized in the Profit & Loss Statement is Rs. 1 mn (Rs.13 mn – Rs.12 mn)
i.e. difference between the sale proceeds of Rs.13 mn and the carrying amount of Rs. 12 mn
However the Rs. 2 mn balance in the Equity is now redundant as the asset has been sold and the
profit is realised. As per the reclassification principle, we can reclassify Rs. 2 mn from equity to Profit
& Loss Statement and profit on disposal recognized in Profit & Loss Statement will be Rs. 3 mn
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 Income Statement
• The Income Statement has three main sections:
Revenue: These are the amounts of the business earned by selling its products or providing
services to customers, called sales revenue. Other items of revenue common to many businesses
are: commission, interest, dividends, rent received, etc. Revenue is also called income
Expenses: Costs incurred by a business in the process of earning revenue are known as expenses.
Generally, expenses are measured by the cost of assets consumed or services used during an
accounting period. The usual items of expenses are: depreciation, rent, wages, salaries, interest,
cost of heater, light and water, telephone, etc.
Profit or Loss: The excess of revenues of a period over its related expenses during an accounting
year is profit. Profit increases the investment of the owners.
How is profit different from gain?: Discussed in Class

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 Income Statement
Cost of Sales or Cost of Goods Sold: This can be shown as a summarised line item or may be
broken down to its expense items such as Direct Materials, Direct Labour and Direct Expenses.
Sometime we also see the below line items in Profit & Loss Statement:

What exactly the above line items mean?: Discussed in Class

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 Cash Flow Statement

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 Cash Flow Statement
Let’s look at few items:
Treatment of Interest Expense??
In case of Indian companies, you will find that the Interest Expense is added back while
calculating Cash Flow from Operations because it is an expense which is considered of Financial
Nature. Hence, it is subtracted at the time of calculating Cash Flow from Financing Activity

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 Cash Flow Statement
Let’s look at few items:
Treatment of Interest & Dividend Income??

In case of Indian Companies, you will find that the Interest Income and Dividend Income is
subtracted while calculating Cash Flow from Operations because it is an income which is
considered of Investment Nature. Hence, it is added at the time of calculating Cash Flow from
Investing Activity

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 Cash Flow Statement
Let’s look at few items:
Treatment of Dividend Paid??

In case of Indian Companies, Dividend paid is considered Financial in Nature.

So what should be the adjustments in this scenario in Cash Flow Statement?

No adjustments in CFO as Dividends have not been deducted from Profit before tax from where
we are starting the CFO. Only adjustment will be in Cash Flow from Financing, where Dividend
Paid will be subtracted.

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Thank You