Question

NCERT Solutions Class 12, Accountancy Part-II, Chapter- 3, Financial Statements of a Company

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Concepts covered in Class 12 Accountancy Part-II Chapter- 3 Financial Statements of a Company, are-

• Meaning of financial statements
• Nature of financial statements
• Objectives of financial statements
• Types of financial statements
• Limitations of financial statements

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Answer 1

NCERT Solutions Class 12, Accountancy Part-II, Chapter- 3, Financial Statements of a Company

Short Answers

1. State the meaning of financial statements.

Solution:

Financial statements are the end products of an accounting process It provides a true picture of the performance of the company over a time period, and such a statement is used by different users of accounting information. These statements are prepared annually.

2. What are the limitations of financial statements?

Solution:

The limitations are

1. Financial statements reflect historical data, i.e., it reflects the original price of the items or the price at which items were acquired. It fails to highlight the current price of items as per market and also inflated prices due to rising inflation in the market. Hence, data and information are historical in nature.

2. Financial statements do not portray the qualitative aspects of any transaction, the aspects such as size, colour, quality and capabilities. Only quantitative data, which can be expressed in monetary value, are considered

3. Financial statements are biased in nature, as they are dependent on human interference.

4. It becomes difficult to assess the performance of another company.

5. It will be difficult to forecast, as the statement is prepared based on historical data.

3. List any three objectives of financial statements.

Solution:

The objectives of preparing financial statements are

1. A financial statement provides timely and reliable information on the economic status of a company on a periodical basis. It also makes information available to external users or stakeholders who do not have direct access to the information.

2. A financial statement helps in revealing the true financial position of a company. It contains information related to liquidity, profitability, financial viability and solvency of an organisation.

3. A financial statement is helpful in evaluating the earning capacity of a firm.

4. State the importance of financial statements to

(i) shareholders
(ii) creditors
(iii) government
(iv) investors

Solution:

The following are the importance of financial statements for

1. Shareholders: For a shareholder, a financial statement is helpful in determining the viability and profit-making capacity of a business. It provides businesses with sufficient data to analyse the financial health and performance of the business.

2. Creditors: A financial statement is essential for a creditor to understand the creditworthiness of the business along with liquidity. It helps them to decide whether further investments can be done in this business.

3. Government: A financial statement helps the government in determining GDP, national income, industrial growth etc., which leads to the formulation of various policies and addressing problems like poverty, unemployment, etc.

4. Investors: For Investors who have invested or those planning to invest, a financial statement is necessary. The financial statement helps determine the prospects and viability of new investments.

5. How will you disclose the following items in the Balance Sheet of a company;

(i) Current assets, inventory

(ii) Contigent liabilities in notes to accounts

(iii) Shareholders Funds, Reserve and Surplus

(iv) Fixed Assets, Intangible Assets

(v) Proposed Dividend for the current year

(vi) Non Current Liabilities

(vii) Arrears of Dividend on Commulative Preference Shares.

Solution:

The following items will be disclosed in the balance sheet as-

(i) Inventories- Sub-head,

Current Assets- Main Head.

(ii) Contingent Liability- Main Head in Notes to Accounts.

(iii) Shareholders Fund- Main Head,

Reserves and Surplus- Sub head.

(iv) Fixed Assets- Sub-head,

Intangible Assets- A part of Sub-head.

(v) Proposed Dividend for the current year- Under the head Current Liabilities and Sub-head Short term Provision.

(vi) Non-Current Liabilities- Main Head.

(vii) Arrears of Dividend on Cumulative Preference Shares- Under the head Current Liabilities and Sub-head Other Current Liabilities.

Long Answers

1. Explain the nature of the financial statements.

Solution:

The nature of financial statements are

1. A financial statement records facts about the items at the original price at which they were purchased. It does not take into account the prevailing market price and also does not include price fluctuations due to inflation.

2. The financial statements are created based on various accounting conventions such as the Prudence convention, matching concept, etc. and adhering to such conventions results in the statements being easy to understand, compare and reflect the fair and true financial situation of the organisation.

3. A financial statement is based on many concepts, such as the going concern concept, realisation concept, and money measurement concept. A financial statement adheres to all these concepts when financial statements are prepared.

4. In preparing financial statements, personal judgements play an important role. For example, when determining which method to charge depreciation and recording of stock at market value or cost price. All these are based on personal judgement.

2. Explain in detail the significance of the financial statements.

Solution:

Importance of financial statements

1. They provide information to various users of accounting information which can be both internal and external. Users derive information as per their needs from such statements. For example, they provide shareholders with an idea about the viability of the business while the same statement can be used by tax authorities to determine the tax payable by an organisation.

2. They help management in comparing performance which can be on both inter and intra-firm basis, it helps in determining the viability of the business and also is helpful in the framing of policies for business. It enhances the decision-making capabilities of the management.

3. Financial statements help creditors and investors determine the state of solvency of a business which influences the decision to offer loans and credit.

4. Financial statements help provide information on different policies, methods, best practices and accounting processes. Disclosing accounting policies simplifies financial statements and gives users of accounting information.

5. The government uses accounting information to determine various parameters of national growth like GDP, National Income, Industrial growth, etc.

6. Investors need information on business solvency and profitability to offer further loans and invest in the business, and such information is obtained from financial statements.

3. Explain the limitations of financial statements.

Solution:

The limitations are

1. Financial statements reflect historical data, i.e., they reflect the original price of the items or the price at which items were acquired. It fails to highlight the current price of items as per market and also inflated prices due to rising inflation in the market. Hence, data and information are historical in nature.

2. Financial statements do not portray the qualitative aspects of any transaction, the aspects such as size, colour, quality and capabilities. Only quantitative data which can be expressed in monetary value are considered.

3. Financial statements are biased in nature, as they are dependent on personal judgement regarding the way transactions are recorded

4. It becomes difficult to assess the financial performance of one company with another due to differences in practices and methods adopted by each company.

5. It will be difficult to forecast, as the statement is prepared based on historical data, as it fails to capture inflation rates.

6. The company can manipulate the data to show a better liquidity position, which can give a false impression to the investors leading to project cancellation.

Answer 2

4. Prepare the format of statement of profit and loss and explain its items upto the as certainment of profit before tax.

Solution:

Format of Statement of Profit and Loss- As per the REVISED SCHEDULE VI

I. Revenue from Operations- It refers to the revenue earned from the basic operating business activities of an organization. For Non-financing companies, it consists of the following.

• Sale of Products
• Sale of Services
• Other Operating Revenues

For financing companies, revenue from operations includes the following.

• Interest
• Dividends
• Other Financial Services

II. Other Incomes- This income includes the income earned other than from the operating activities of a business. It comprised of the following incomes.

• Interest Income (in case of Non-Financing Company)
• Dividend Income (in case of Non-Financing Company)
• Net Gain or Loss on Sale of Investments
• Other Non-Operating Incomes (i.e. after deducting expenses directly related to such income)

III. Expenses- These can be bifurcated in the following given below types.

• Cost of Materials Consumed- It includes all the materials consumed during the process of manufacturing. It can also be calculated with the help of the given below formula.

Material Consumed = Opening Stock of Raw Material + Purchase of Raw Material – Closing Stock of Raw Material

• Purchase of Stock-in-Trade - It includes all the goods purchased by a trading concern with an intention of resell.
• Change in Inventories, Work-in-Progress and Stock-in-Trade - It is difference of  opening and closing balance of inventories (stock), work-in-progress and stock-in-trade.

5. Prepare the format of balance sheet and explain the various elements of balance sheet.

Solution:

COMPANY'S BALANCE SHEET- As per REVISED SCHEDULE VI

Items under the head Equity and Liabilities

I. Shareholders’ Funds

i. Share Capital:

• Authorised Capital
• Issued Share Capital
• Subscribed Share Capital
• Called-up Share Capital
• Paid-up Share Capital
• Share Forfeiture Amount

ii. Reserves and Surplus: It consists of the following items to be shown separately.

• Capital Reserve
• Capital Redemption Reserve
• Securities Premium
• Debenture Redemption Reserve
• Revaluation Reserve
• Other Reserves (such as General Reserve, Tax reserve, etc.)
• Proposed Additions to Reserves
• Sinking Fund
• Share Option Outstanding Amount
• Surplus i.e. credit balance in Statement of Profit and Loss. However, in case of debit balance in Statement of Profit and Loss, it is deducted from the total of reserves.

iii. Money received against warrants: A financial instrument that allows its holder to acquire equity shares is known as Share Warrant. Any amount received by the company on such share warrants is required to be disclosed under this head.

II. Share Application Money Pending Allotment

Amount received by the company on application of shares issued and the allotment on which is to be received after the date of balance sheet is shown under this head separately.

III. Non-Current Liabilities

These are comprised of the following items.

i. Long-Term Borrowings- It is further consists of the given below items.

• Debentures
• Bonds
• Term Loans from bank as well as from other parties
• Deposits
• Other Loans and Advances

ii. Deferred Tax Liabilities (Net)
iii. Other Long-Term Liabilities
iv. Long-Term Provisions

IV. Current Liabilities

Under this head the following items are disclosed.

i. Short-term Liabilities- It is further comprised of the given below items.

• Loan repayable on demands from bank as well as from other parties
• Deposits
• Other Loans and Advances

ii. Trade Payables

iii. Other Current Liabilities- It includes all those liabilities that are not covered in any of the mentioned above heads. Some examples are-

• Income received in advance
• Interest accrued but not due on borrowings
• Interest accrued and due on borrowings
• Unpaid Dividends
• Calls-in-Advance and interest thereon
• Other Payables etc.

iv. Short-term Provisions- These are categorised as follows.

• Provision for Doubtful Debts
• Proposed Dividend
• Provision for Tax
• Provision for Employees Benefits
• Others

Items under the head Assets

Non-Current Assets and Current Assets are two titles that come under the heading of Assets.

I. Non-Current Assets

i. Fixed Assets- These are further classified s follows.

• Tangible Assets (such as, Building, Machinery, Furniture, etc.)
• Intangible Assets (such as Goodwill, Trademark, Copyrights, Mining Rights, etc.)
• Capital Work-in-Progress
• Intangible Assets under development

ii. Non-current Investments- These are the investments that are not held for the purpose of resale.
iii. Deferred Tax Assets
iv. Long-term Loans and Advances
v. Other Non-Current Assets

II. Current Assets

Under this head the following items are shown.

i. Current Investments- Investments that are held for conversion into cash within a period of 12 months. These are further classified as follows.

• Investment in Equity Shares
• Investment in Preference Shares
• Investment in Government or Trust Securities
• Investment in Debentures or Bonds
• Investment in Mutual Funds
• Investment in Partnership Firms
• Other Investments

ii. Inventories- It comprised of the given items.

• Raw Materials
• Work-in-Progress
• Finished Goods
• Stock-in-Trade (goods acquired for trading)
• Stores and Spares
• Loose Tools

iii. Trade Receivables

iv. Cash and Cash Equivalents- These are classified as follows.

• Cash on Hand
• Balances with Banks
• Cheques, Drafts on Hand
• Others

v. Short-term Loans and Advances

vi. Other Current Assets (such as prepaid expenses, advance taxes, etc.)

Answer 3

6. Explain how financial statements are useful to the various parties who are interested in the affairs of an undertaking?

Solution:

The various parties interested in the financial statements of a company can be broadly classified as Internal and External.

Internal Users-

1. Owners: The interest of an owner is towards knowing whether profit is earned or loss is incurred by the business. They are more interested in knowing about the viability of the capital that is invested in the business.

2. Management: Financial statements help management in devising new policies for the growth of business and also provide management with the insights required for implementing various cost-cutting measures.

3. Employees: They are interested in timely payments, bonuses and appraisals at the decided time. Financial statements help employees to learn about the financial position of the organisation so that appropriate salaries can be demanded.

External Users-

1. Banks and Financial Institutions: Such institutions provide credit, so it is necessary to understand the liquidity, solvency and creditworthiness of the organisation for loan requirements in future.

2. Creditors: Businesses owe money to creditors, and hence, it is important for them to have information about the creditworthiness of the business.

3. Investors or potential investors: These are people who will provide funds by means of investment in the business. Hence, the viability and solvency of an organisation will help in making investment decisions.

4. Tax Authorities: Information is required by them for determining the types of taxes that can be charged to the organisation.

5. Government: Government needs information to determine National Income, GDP and industrial growth. Financial statements help the government formulate various policies and address issues like poverty and unemployment.

6. Consumers: An organisation publishing a financial statement makes consumers aware of the profits they are earning and the relative expenses that go into providing services at affordable prices, thus helping to gain a good name among consumers.

7. Public: Public knowledge of financial statements is about how the business is spending money for social welfare.

8. Researchers: Researchers use financial statements to predict market trends and undertake research projects.

7. `Financial statements reflect a combination of recorded facts, accounting conventions and personal judgments.’ Discuss.

Solution:

Financial statements reveal the true financial position of a company and help in formulating various decisions and policy making. The nature of financial statements is dependent on these aspects:

1. Financial statement records facts about the items at the original price at which they were purchased. It does not take into account the prevailing market price and also does not include price fluctuations due to inflation.

2. The financial statements are created based on various accounting conventions such as the Prudence convention, matching concept etc., and adhering to such conventions results in the statements being easy to understand, compare and reflect the fair and true financial situation of the organisation.

3. A financial statement is based on many concepts, such as the going concern concept, realisation concept, and money measurement concept. A financial statement adheres to all these concepts when financial statements are prepared.

4. In preparing financial statements, personal judgements play an important role. For example, when determining which method to charge depreciation and recording of stock at market value or cost price. All these are based on personal judgement.

8. Explain the process of preparing the income statement and a balance sheet.

Solution:

The process of preparing the income statement and balance sheet is as follows:

Income Statement-

1. Prepare a trial balance as per the balance of different accounts in the ledger.

2. Determine revenue received from the business operation, which is achieved by subtracting sales return from sales conducted.

3. Add incomes received other than revenue (such as cash discount and profit earned from the sale of assets.)

4. Deduct expenses from total revenue to determine profit before tax.

5. Deduct tax paid by the company from the amount determined as profit before tax to arrive at Net Profit or Loss.

Balance Sheet-

The balance sheet consists of two parts: Equity and Liabilities and Assets.

1. The equity and liabilities contain shareholder funds, non-current liabilities, current liabilities and share application money pending allotment are recorded.

2. Assets are recorded next, and they contain all non-current and current assets

3. Tally the total of both sides. It must be equal for the total to tally.

Numerical Questions

1. Show the following items in the balance sheet as per the provisions of the Companies Act, 2013 in Schedule III:

Particulars	Rs.	Particulars	Rs.
Preliminary Expenses	2,40,000	Good will	30,000
Discount on issue of shares	20,000	Loose tools	12,000
10% Debentures	2,00,000	Motor Vehicles	4,75,000
Stock in Trade	1,40,000	Provision for tax	16,000
Cash at bank	1,35,000
Bills receivable	1,20,000

Solution:

Notes to Accounts

2. On 1^st Aril, 2017, Jumbo Ltd. issued 10,000; 12% debentures of Rs. 100 each a discount of 20%, redeemable after 5 years. The company decided to write-off discount on issue of such debentures over the life time of the Debentures. Show the items in the balance sheet of the company immediately after the issue of these debentures.

Solution:

Notes to Accounts

3. From the following information prepare the balance sheet of Gitanjali Ltd., as per the (Revised) Schedule VI:

Inventories Rs. 14,00,000; Equity Share Capital Rs. 20,00,000; Plant and Machinery Rs. 10,00,000; Preference Share Capital Rs. 12,00,000; Debenture Redemption Reserve Rs. 6,00,000; Outstanding Expenses Rs. 3,00,000; Proposed Dividend Rs. 5,00,000; Land and Building Rs. 20,00,000; Current Investments Rs. 8,00,000; Cash Equivalent Rs. 10,00,000; Short term loan from Zaveri Ltd. (A Subsidiary Company of Twilight Ltd.) Rs. 4,00,000; Public Deposits Rs. 12,00,000.

Solution:

Notes to Accounts

Answer 4

4. From the following information prepare the balance sheet of Jam Ltd. as per the (revised) Schedule VI:

Inventories Rs. 7,00,000; Equity Share Capital Rs. 16,00,000; Plant and Machinery Rs. 8,00,000; Preference Share Capital Rs. 6,00,000; General Reserves Rs. 6,00,000; Bills payable Rs. 1,50,000; Provision for taxation Rs. 2,50,000; Land and Building Rs. 16,00,000; Noncurrent Investments Rs. 10,00,000; Cash at Bank Rs. 5,00,000;Creditors Rs. 2,00,000; 12% Debentures Rs. 12,00,000.

Solution:

Notes to Accounts

5. Prepare the balance sheet of Jyoti Ltd. as at March 31, 2017 from the following information:

Building Rs. 10,00,000; Investments in the shares of Metro Tyers Rs. 3,00,000; Stores & Spares Rs. 1,00,000; Discount on issue of 10% debentures Rs. 10,000; Statement of Profit and Loss (Dr.) Rs. 90,000; 5,00,000 Equity Shares of Rs. 20 each fully paid-up; Capital Redemption Reserve Rs. 1,00,000; 10% Debentures Rs. 3,00,000; Unpaid dividends Rs. 90,000; Share options outstanding account Rs. 10,000.

Solution:

Notes to Accounts

Note: There is a misprint in the book. The number of equity shares issued must be 50,000 so that both the sides of the Balance Sheet stand equal.

6. Brinda Ltd. has furnished the following information:

(a) 25,000, 10% debentures of Rs. 100 each;

(b) Bank Loan of Rs. 10,00,000 repayable after 5 years;

(c) Interest on debentures is yet to be paid.

Show the above items in the balance sheet of the company as at March 31, 2017.

Solution:

Notes to Accounts

7. Prepare a balance sheet of Black Swan Ltd., as at March 31, 2017 form the following information:

General Reserve	:	3,000
10% Debentures	:	3,000
Statement of Profit & Loss	:	1,200
Depreciation on fixed assets	:	700
Gross Block	:	9,000
Current Liabilities	:	2,500
Preliminary Expenses	:	300
6% Preference Share Capital	:	5,000
Cash & Cash Equivalents	:	6,100

Solution:

Notes to Accounts