Financial Statements Analysis Solved Question Paper May' 2015
COMMERCE (Speciality)
Course: 602 (Financial Statement Analysis)
Full Marks: 80
Pass Marks: 32
Time: 3 hours
The figures in the margin indicate full marks for the
questions.
1. (a) Fill in the blanks with appropriate words: 1x5=5
(i)
Financial statement analysis helps to measure ________ (Operating efficiency/Management efficiency/Employee’s
efficiency)
(ii)
GAAP stands for Generally Accepted Accounting Principles
(iii)
Reporting to corporate governance reflects __________. (Company
Management/Earning status/Socio economic status).
(iv)
The institute of chartered accountants if India (ICAI) has decided to adopt
IFRS in India from ____. (2011/2012/2013)
(v)
According to IFRS, banking companies are to adopt _______ (Fair value
accounting/Historical value accounting).
(b) State whether the following statements are
true or false:
1x3=3
(i)
Financial statement analysis is an important means of assessing past
performance and planning future performance. True
(ii)
The new name of standards issued the ISAB is international financial reporting
standards (IFRS). True
(iii)
Higher the price earnings ratio, better it is, as it indicates growth of the
company. False
2. Write short notes on any four of the
following: 4x4=16
(a) Comparative statements
Ans: Comparative Statements: These are the statements showing the
profitability and financial position of a firm for different periods of time in
a comparative form to give an idea about the position of two or more periods.
It usually applies to the two important financial statements, namely, balance
sheet and statement of profit and loss prepared in a comparative form. The
financial data will be comparative only when same accounting principles are
used in preparing these statements. If this is not the case, the deviation in
the use of accounting principles should be mentioned as a footnote. Comparative
figures indicate the trend and direction of financial position and operating
results. This analysis is also known as ‘horizontal analysis’.
Merits of
Comparative Financial Statements:
a)
Comparison of financial statements
helps to identify the size and direction of changes in financial position of an
enterprise.
b)
These statements help to ascertain
the weakness and soundness about liquidity, profitability and solvency of an
enterprise.
c)
These statements help the
management in making forecasts for the future.
Demerits
of Comparative Financial Statements:
a)
Inter-firm comparison may be
misleading if the firms are not of the same age and size, follow different
accounting policies.
b)
Inter-period comparison will also
be misleading if there are frequent changes in accounting policies.
(b) Significance of solvency ratio
Ans:
Solvency Ratio/Debt to Total Funds Ratio: This
ratio gives same indication as the debt-equity ratio as this is a variation of
debt-equity ratio. This ratio is also known as solvency ratio. This is a ratio
between long-term debt and total long-term funds.
Debt to
Total Funds Ratio = Debt/Total Funds
Where Debt
(long term loans) include Debentures, Mortgage Loan, Bank Loan, Public
Deposits, Loan from financial institution etc.
Total
Funds = Equity + Debt = Capital Employed
Equity
(Shareholders’ Funds) = Share Capital (Equity + Preference) + Reserves and
Surplus – Fictitious Assets
Objective
and Significance: Debt to Total Funds Ratios shows the proportion of long-term
funds, which have been raised by way of loans. This ratio measures the
long-term financial position and soundness of long-term financial policies. A
higher proportion is not considered good and treated an indicator of risky
long-term financial position of the business.
(c) Reporting of corporate governance
Ans: Report on Corporate Governance: There
shall be a separate section on Corporate Governance in the Annual Reports of
company, with a detailed compliance report on Corporate Governance.
Non-compliance of any mandatory requirement of this clause with reasons thereof
and the extent to which the non-mandatory requirements have been adopted should
be specifically highlighted.
The companies shall submit a quarterly
compliance report to the stock exchanges within 15 days from the close of
quarter as per the format given latter. The report shall be signed either by
the Compliance Officer or the Chief Executive Officer of the company.
Compliance:
The company shall obtain a certificate from either the auditors or
practicing company secretaries regarding compliance of conditions of corporate
governance as stipulated in this clause and annex the certificate with the
directors’ report, which is sent annually to all the shareholders of the
company. The same certificate shall also be sent to the Stock Exchanges along
with the annual report field by the company.
The non-mandatory requirements may be
implemented as per the discretion of the company. However, the disclosures of
the compliance with mandatory requirements and adoption (and compliance) /
non-adoption of the non-mandatory requirements shall be made in the section on
corporate governance of the Annual Report.
Information
to be placed before Board of Directors
1.
Annual operating plans and budgets
and any updates.
2.
Capital budgets and any updates.
3.
Quarterly results for the company
and its operating divisions or business segments.
4.
Minutes of meetings of audit
committee and other committees of the board.
5.
The information on recruitment and
remuneration of senior officers just below the board level, including
appointment or removal of Chief Financial Officer and the Company Secretary.
6.
Show cause, demand, prosecution
notices and penalty notices which are materially important.
7.
Fatal or serious accidents,
dangerous occurrences, any material effluent or pollution problems.
8.
Any material default in financial
obligations to and by the company, or substantial nonpayment for goods sold by
the company.
9.
Any issue, which involves possible
public or product liability claims of substantial nature, including any judgement
or order which, may have passed strictures on the conduct of the company or
taken an adverse view regarding another enterprise that can have negative
implications on the company.
10.
Details of any joint venture or
collaboration agreement.
11.
Transactions that involve
substantial payment towards goodwill, brand equity, or intellectual property.
12.
Significant labour problems and
their proposed solutions. Any significant development in Human Resources /
Industrial Relations from like signing of wage agreement, implementation of
Voluntary Retirement Scheme etc.
13.
Sale of material nature, of
investments, subsidiaries, assets, which is not in normal course of business.
14.
Quarterly details of foreign
exchange exposures and the steps taken by management to limit the risks of
adverse exchange rate movement, if material.
15.
Non-compliance of any regulatory,
statutory or listing requirements and shareholders service such as non-payment
of dividend, delay in share transfer etc.
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Financial Statements Analysis Solved Question Paper 2014
Financial Statements Analysis Solved Question Paper 2015
(d) RBI guidelines regarding financial reporting
of banks
Ans: DISCLOSURE OF ACCOUNTS AND BALANCE SHEETS
OF BANKS (RBI Guidelines)
There are
various types of users of the financial statements of banks who need
information about the financial position and performance of the banks. The
financial statements are required to provide the information about the
financial position and performance of the bank in making economic decisions by
the users. The important information sought by these users are, about bank’s
Liquidity and solvency and the risks related to the assets and liabilities
recognized on its balance sheet and to its off balance sheet items. This useful
information can be provided by way of ‘Notes’ to the financial statements,
hence notes become an integral part of the financial statements of banks. The
users can make use of these notes and supplementary information to arrive at a
meaningful decision. Some of the specific disclosure requirements in Bank’s
financial statement are given below:
a)
Presentation: Summary of Significant Accounting Policies’ and ‘Notes to
Accounts’ may be shown under Schedule 17 and Schedule 18 respectively, to
maintain uniformity.
b) Minimum
Disclosures: While complying with the requirements of Minimum disclosures,
banks should ensure to furnish all the required information in ‘Notes to
Accounts’. In addition to the minimum disclosures, banks are also encouraged to
make more comprehensive disclosures to assist in understanding of the financial
position and performance of the bank.
c) Summary
of Significant Accounting Policies: Banks should disclose the accounting
policies regarding key areas of operations at one place (under Schedule 17)
along with Notes to Accounts in their financial statements. The list includes –
Basis of Accounting, Transactions involving Foreign Exchange, Investments –
Classification, Valuation etc., Advances and Provisions thereon, Fixed Assets
and Depreciation, Revenue Recognition, Employee Benefits, Provision for
Taxation, Net Profit, etc.
d)
Disclosure Requirements: In order to encourage market discipline, Reserve Bank
has over the years developed a set of disclosure requirements which allow the
market participants to assess key pieces of information on capital adequacy,
risk exposures, risk assessment processes and key business parameters which
provide a consistent and understandable disclosure framework that enhances
comparability. Banks are also required to comply with the Accounting Standard 1
(AS 1) on Disclosure of Accounting Policies issued by the Institute of
Chartered Accountants of India (ICAI). The enhanced disclosures have been
achieved through revision of Balance Sheet and Profit & Loss Account of
banks and enlarging the scope of disclosures to be made in “Notes to Accounts”.
e)
Additional/Supplementary Information: In addition to the 16 detailed prescribed
schedules to the balance sheet, banks are required to furnish the following
information in the “Notes to Accounts”. Such furnished (information should
cover the current year and the previous year). “Notes to Accounts” may contain
the supplementary information such as:
1.
Capital (Current & Previous
Year) with breakup including CRAR – Tier I/II capital (%), % of shareholding of
GOI, amount of subordinated debt raised as Tier II capital. Also it should show
the total amount of subordinated debt through borrowings from Head Office for
inclusion in Tier II capital etc.
2.
Investments: Total amount should
be mentioned in crores, with the total amount of investments, showing the gross
value and net value of investments in India and Abroad. The details should also
cover the movement of provisions held towards depreciation on investments.
3.
Derivatives: Forward Rate
Agreement/Interest Rates Swap: Important aspects of the disclosures would include
the details relating to:
a.
The notional principal of swap
agreements;
b.
Losses which would be incurred if
counterparties failed to fulfill their obligations under the agreements;
c.
Collateral required by the bank
upon entering into swaps;
d.
Nature and terms of the swaps
including information on credit and market risk and the accounting policies
adopted for recording the swaps etc.
4.
Exchange Traded Interest Rate
Derivatives: As regards Exchange Traded Interest Rate Derivatives, details
would include the notional principal amount undertaken:
a.
During the year (instrument-wise),
b.
Outstanding as on 31st
March (instrument-wise),
c.
Outstanding and not “highly
effective” (instrument-wise),
d.
Mark-to-market value of exchange
traded interest rate derivatives outstanding and not “highly effective”
(instrument-wise).
f)
Qualitative Disclosure: Banks should discuss their risk management policies
pertaining to derivatives with a specific reference to the extent to which
derivatives are used, the associated risks and business purposes served. This
also includes:
a.
The structure and organization for
management of risk in derivatives trading,
b.
The scope and nature of risk
measurement, risk reporting and risk monitoring systems,
c.
Policies for hedging and/or
mitigating risk and strategies and processes for monitoring the continuing
effectiveness of hedges/mitigates, and accounting policy for recording hedge
and non-hedge transactions; recognition of income, premiums and discounts;
valuation of outstanding contracts; provisioning, collateral and credit risk
mitigation.
g)
Quantitative Disclosures: Apart from qualitative disclosures, banks should also
include the quantitative disclosures. The details are both Currency Derivatives
and Interest rate derivatives.
h) Asset
Quality: Banks’ performances are considered good based on the quality of assets
held by banks. With the changing scenario and due to number of risks associated
with banks like Credit, Market and Operational risks, banks are concentrating
to ensure better quality assets are held by them. Hence, the disclosure needs
to cover various aspects of asset quality consisting of:
a.
Non-Performing Assets, covering
various details like Net NPAs, movement of NPAs (Gross)/(Net) and relevant
details provisioning to different types of NPAs including Write off/write-back
of excess provisions, etc., Details of Non-Performing financial assets
purchased, sold, are also required to be furnished.
b.
Particulars of Accounts
Restructured: The details under different types of assets such as (i) Standard
advances (ii) Sub-standard advances restructured (iii) Doubtful advances
restructured (iv) TOTAL with details number of borrowers, amount outstanding,
sacrifice.
c.
Banks disclose the total amount
outstanding in all the accounts/facilities of borrowers whose accounts have
been restructured along with the restructured part or facility. This means even
if only one of the facilities/accounts of a borrower has been restructured, the
bank should also disclose the entire outstanding amount pertaining to all the
facilities/accounts of that particular borrower.
d.
Details of financial assets sold
to Securitization/Reconstruction Company for Assets Reconstruction.
e.
Provisions on Standard Assets:
Provisions towards Standard Assets need not be netted from gross advances but
shown separately as ‘Provisions against Standard Assets’, under ‘Other
Liabilities and Provisions – Others’ in Schedule No. 5 of the balance sheet.
f.
Other Details: Business Ratios:
(i) Interest Income as a percentage to Working Funds (ii) Non-interest income
as a percentage to Working Funds (iii) Operating Profit as a percentage to
Working Funds (iv) Return on Assets (v) Business (Deposits plus advances) per
employee (vi) Profit per employee.
i) Assets
Liability Management: As part of Assets Liability Management, the maturity
pattern of certain items of assets and liabilities such as deposits, advances,
investments, borrowings, foreign current assets, and foreign currency
liabilities. Banks are required to disclose the information based on the maturity
patterns covering daily, monthly and yearly basis.
j) Break
up Exposures: Banks should also furnish details of exposures to certain sectors
like Real Estate Sector.
Exposure
to Capital Market: Capital Market exposure details should be disclosed for the
current and previous year in crores. The details would include direct
investment in equity shares, convertible bonds, convertible debentures and
units of equity-oriented mutual funds the corpus of which is not exclusively
invested in corporate debt and also loan raised against such securities. A bank
must also disclose the risk associated with such investments. The risks are to
be categorized as Insignificant, Low, Moderate, High, Very high, Restricted and
Off-credit.
Apart from
the above category of exposures, banks are required to disclose details
relating to Single Borrower Limit (SGL)/Group Borrower Limit (GBL) exceeded by
the bank, and Unsecured Advances are to be furnished. Miscellaneous items would
include Amount of Provisions made for Income Tax during the year, and
Disclosure of Penalties imposed by RBI, etc.
(e) Activity ratio
Ans: Activity Ratio: This ratio
is also known as turnover ratio or productivity ratio or efficiency and
performance ratio. These ratios show relationship between the sales and the
assets. These are designed to indicate the effectiveness of the firm in using
funds, degree of efficiency, and its standard of performance of the
organization. Example: Stock
Turnover Ratio, Debtors' Turnover Ratio, Turnover Assets Ratio, Stock working
capital Ratio, working capital Turnover Ratio, Fixed Assets Turnover Ratio.
(f) Value-added statement
Ans:
Value Added Statement is a financial statement that depicts wealth created by
an organization and how is that wealth distributed among various stakeholders.
The various stakeholders comprise of the employees, shareholders, government,
creditors and the wealth that is retained in the business. As per the concept of Enterprise
Theory, profit is calculated for various stakeholders by an organization. Value
Added is this profit generated by the collective efforts of management,
employees, capital and the utilization of its capacity that is distributed
amongst its various stakeholders. Consider
a manufacturing firm. A typical firm would buy raw materials from the market.
Process the raw materials and assemble them to produce the finished goods. The
finished goods are then sold in the market. The additional work that the firm
does to the raw materials in order for it to be sold in the market is the value
added by that firm. Value added can also be defined as the difference between
the value that the customers are willing to pay for the finished goods and the
cost of materials.
3. (a) What is meant by analysis of financial
statement? How and in what way prospective investors are benefited through such
analysis? 4+7=11
Ans:
Financial Statement Analysis
We know
business is mainly concerned with the financial activities. In order to
ascertain the financial status of the business every enterprise prepares
certain statements, known as financial statements. Financial statements are
mainly prepared for decision making purposes. But the information as is
provided in the financial statements is not adequately helpful in drawing a
meaningful conclusion. Thus, an effective analysis and interpretation of
financial statements is required.
Financial
Statement Analysis is the process of identifying the financial strength and
weakness of a firm from the available accounting and financial statements. The
analysis is done by properly establishing the relationship between the items of
balance sheet and profit and loss account.
In the
words of Myer “Financial Statement analysis is largely a study of relationship
among the various financial factors in a business, as disclosed by a single set
of statements, and a study of trends of these factors, as shown in a series of
statements.”
In simple
words, analysis of financial statement is a process of division, establishing
relationship between various items of financial statements and interpreting the
result thereof to understand the working and financial position of a business.
Objectives
(Purposes) and significance of Financial Statement analysis:
Financial
analysis serves the following purposes and that brings out the significance of
such analysis:
a)
To judge the financial health of
the company: The main objective of the financial analysis is to determine the
financial health of the company. It is done by properly establishing the
relationship between the items of balance sheet and profit and loss account.
b)
To judge the earnings performance
of the company: Potential investors are primarily interested in earning
efficiency of the company and its dividend paying capacity. The analysis and
interpretation is done with a view to ascertain the company’s position in this
regard.
c)
To judge the Managerial
efficiency: The financial analysis helps to pinpoint the areas wherein the
managers have shown better efficiency and the areas of inefficiency. Any
favourable and unfavourable variations can be identified and reasons thereof
can be ascertained to pinpoint weak areas.
d)
To judge the Short-term and Long-term
solvency of the undertaking: On the
basis of financial analysis, Long-term as well as short-term solvency of the
concern can be judged. Trade creditors or suppliers are mainly interested in
assessing the liquidity position for which they look into the following:
Ø Whether
the current assets are sufficient to pay off the current liabilities.
Ø The
proportion of liquid assets to current assets.
e)
Indicating
the trend of Achievements: Financial statements of the
previous years can be compared and the trend regarding various expenses,
purchases, sales, gross profits and net profit etc. can be ascertained. Value
of assets and liabilities can be compared and the future prospects of the
business can be envisaged.
f)
Inter-firm Comparison: Inter-firm
comparison becomes easy with the help of financial analysis. It helps in
assessing own performance as well as that of others.
g)
Understandable: Financial analysis helps the users of the
financial statement to understand the complicated matter in simplified manner.
h) Assessing the growth potential of the business: The
trend and other analysis of the business provide sufficient information
indicating the growth potential of the business.
Or
(b) Discuss different types of financial
statement. 11
Ans: Types of Financial statements
A set of
financial statements includes (Types):
a)
Profit and loss account or Income
statements
b)
Balance sheet or Position
statements
c)
Cash flow statements
d)
Funds flow statements or
e)
Schedules and notes to accounts.
a) Profit
and loss account or income statement: Income statement is one of the
financial statements of business enterprises which shows the revenues,
expenses, and profits or losses of business enterprises for a particular period
of time. Its main aim to show the operating efficiency of the enterprises.
Income Statement is sometime called the statement of financial performance
because this statement let the users to assess and measure the financial
performance of entity from period to period of the same entity or with
competitors.
b) Balance
sheet or Position statement: Balance Sheet is sometime called
statement of financial position. It shows the balance of assets, liabilities
and equity at the end of the period of time. Balance sheet is sometime called
statement of financial position since it shows the values of net worth of
entity. The net worth of the entity can be obtained by deducting liabilities
from total assets. It is different from income statement since balance sheet
report account’s balance as on a particular date while income statement report
that the account’s transactions during a particular period of time.
c) Cash
flow statement: A Cash Flow Statement is similar to the Funds
Flow Statement, but while preparing funds flow statement all the current assets
and current liabilities are taken into consideration. But in a cash flow
statement only sources and applications of cash are taken into consideration,
even liquid asset like Debtors and Bills Receivables are ignored. A Cash Flow
Statement is a statement, 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. Any transaction,
which increases the amount of cash, is a source of cash and any transaction,
which decreases the amount of cash, is an application of cash. Simply, Cash Flow is a statement which
analyses the reasons for changes in balance of cash in hand and at bank between
two accounting period. It shows the inflows and outflows of cash.
d) Funds flow statement: The financial
statement of the business indicates assets, liabilities and capital on
a particular date and also the profit or loss during a period. But it is
possible that there is enough profit in the business and the financial position
is also good and still there may be deficiency of cash or of working capital in
business. Financial statements are not helpful in analysing such situation.
Therefore, a statement of the sources and applications of funds is prepared
which indicates the utilisation of working capital during an accounting period.
This statement is called Funds Flow statement.
According to
R.N. Anthony, “Fund Flow is a
statement prepared to indicate the increase in cash resources and the
utilization of such resources of a business during the accounting period.”
According to
Smith Brown, “Fund Flow is
prepared in summary form to indicate changes occurring in items of financial
condition between two different balance sheet dates.”
From the above discussion, it is clear
that the fund flow statement is statement summarising the significant financial
change which have occurred between the beginning and the end of a company’s
accounting period.
e) Schedule and
notes to account: The notes to the
financial statements are integral part of a company's external financial
statements. They are necessary because not all relevant financial information
can be communicated through the amounts shown (or not shown) on the face of the
financial statements. Generally, the notes are the main method for complying
with the full disclosure principle and are also referred
to footnote disclosures. The first note to the financial statements is
usually a summary of the company's significant accounting policies for the use
of estimates, revenue recognition, inventories, property and equipment,
goodwill and other intangible assets, fair value measurement, discontinued
operations, foreign currency translation, recently issued accounting
pronouncements, and others.
The first note is followed by many
additional notes that contain the details (including schedules of amounts) for
items such as inventories, accrued liabilities, income taxes, employee
benefit plans, leases, business segment information, fair value measurements,
derivative instruments and hedging, stock options, commitments and
contingencies, and more. Each external financial statement should also include
a reference (usually as footer) which states that the accompanying notes are an
integral part of the financial statements.
4. (a) From the following balance sheet of Assam
Co. Ltd as on 30th June, 2014, calculate the
following: 3x4=12
(i) Debt to equity ratio
(ii) Current ratio
(iii) Quick ratio
(iv) Working capital turnover ratio
Balance Sheet of Assam Co. Ltd
AS on 30th June, 2014
|
Liabilities |
Amount |
Assets |
Amount |
|
Equity Share capital Capital Reserve 12% loan Creditors Bank overdraft Provision for taxation Profit and loss account |
28,000 5,600 22,400 11,200 2,800 5,600 8,400 |
Goodwill Fixed Assets Stock Debtors Short-term investment Cash in hand Underwriting commission |
13,600 39,200 8,400 8,400 4,800 4,800 4,800 |
|
84,000 |
84,000 |
Additional Information: Sales Rs. 25,200
Or
(b) What are the categories under which
various ratios are grouped? What purposes are served by profitability
ratios? 6+6=12
Ans: CLASSIFICATION OF RATIOS
The ratios are used for different purposes, for different users
and for different analysis. The ratios can be classified as under:
a)
Traditional classification
b)
Functional classification
c)
Classification from user ‘s point
of view
1) Traditional classification: As per this classification, the ratios
readily suggest through their names, their respective resources. From this
point of view, the ratios are classified as follows.
a) Balance Sheet Ratio: This
ratio is also known as financial ratios. The ratios which express relationships
between two items or group of items mentioned in the balance sheet at the end
of the year. Example: Current
ratio, Liquid ratio, Stock to Working Capital ratio, Capital Gearing ratio,
Proprietary ratio, etc.
b) Revenue Statement Ratio: This
ratio is also known as income statement ratio which expresses the relationship
between two items or two groups of items which are found in the income
statement of the year. Example: Gross
Profit ratio, operating ratio, Expenses Ratio, Net Profit ratio, Stock Turnover
ratio, Operating Profit ratio.
c) Combined Ratio: These
ratios show the relationship between two items or two groups of items, of which
one is from balance sheet and another from income statement (Trading A/c and
Profit & Loss A/c and Balance Sheet). Example: Return on Capital Employed, return on Proprietors' Fund
ratio, return on Equity Capital ratio, Earning per Share ratio, Debtors'
Turnover ratio, Creditors Turnover ratio.
2) Functional Classification of Ratios: The accounting ratios can also be
classified according their functions as follows:
a) Liquidity Ratios: These
ratios show relationship between current assets and current liabilities of the
business enterprise. Example: Current
Ratio, Liquid Ratio.
b) Leverage Ratios: These
ratios show relationship between proprietor's fund and debts used in financing
the assets of the business organization. Example: Capital gearing ratio, debt-equity ratio, and proprietary
ratio. This ratio measures the relationship between proprietor’s fund and
borrowed funds.
c) Activity Ratio: This
ratio is also known as turnover ratio or productivity ratio or efficiency and
performance ratio. These ratios show relationship between the sales and the
assets. These are designed to indicate the effectiveness of the firm in using
funds, degree of efficiency, and its standard of performance of the
organization. Example: Stock
Turnover Ratio, Debtors' Turnover Ratio, Turnover Assets Ratio, Stock working
capital Ratio, working capital Turnover Ratio, Fixed Assets Turnover Ratio.
d) Profitability Ratio: These
ratios show relationship between profits and sales and profit &
investments. It reflects overall efficiency of the organizations, its ability
to earn reasonable return on capital employed and effectiveness of investment
policies. Example: i) Profits and
Sales: Operating Ratio, Gross Profit Ratio, Operating Net Profit Ratio,
Expenses Ratio etc. ii) Profits and Investments: Return on Investments, Return
on Equity Capital etc.
e) Coverage Ratios: These
ratios show relationship between profit in hand and claims of outsiders to be
paid out of profits. Example: Dividend
Payout Ratio, Debt Service Ratio and Debt Service Coverage Ratio.
3) Classification from the view point of user: Ratio
from the users' point of view is classified as follows:
a) Shareholders' point of view: These
ratios serve the purposes of shareholders. Shareholders, generally expect the
reasonable return on their capital. They are interested in the safety of shareholder’s
investments and interest on it. Example:
Return on proprietor's funds, return on capital, Earning per share.
b) Long term creditors: Normally
leverage ratios provide useful information to the long term creditors which
include debenture holders, vendors of fixed assets, etc. The creditors
interested to know the ability of repayment of principal sum and periodical
interest payments as and when they become due. Example: Debt equity ratio, return on capital employed,
proprietary ratio.
c) Short term creditors: The
short-term creditors of the company are basically interested to know the
ability of repayment of short-term liabilities as and when they become due.
Therefore, the creditors have important place on the liquidity aspects of the
company's assets. Example: a)
Liquidity Ratios - Current Ratio, Liquid Ratio. b) Debtors Turnover Ratio. c)
Stock working capital Ratio.
d) Management: Management
is interested to use borrowed funds to improve the earnings. Example: Return on capital employed,
Turnover Ratio, Operating Ratio, Expenses Ratio.
Purpose of Profitability
Ratios
There are various groups of people who are interested
in analysis profitability of a company. Ratio analysis helps the various groups
in the following manner:
a) To work out the profitability: Profitability ratios
help to measure the profitability of the business by calculating the various
profitability ratios. It helps the management to know about the earning
capacity of the business concern.
b) Helpful in analysis of financial statement: Profitability
ratios help the outsiders just like creditors, shareholders, debenture-holders,
bankers to know about the profitability and ability of the company to pay them
interest and dividend etc.
c) Helpful in comparative analysis of the performance:
With the help of Profitability ratios a company may have comparative study of
its performance to the previous years. In this way company comes to know about
its weak point and be able to improve them.
d) To simplify the accounting information: Profitability
ratios are very useful as they briefly summaries the result of detailed and
complicated computations.
e) Helpful for forecasting purposes: Profitability
ratios indicate the trend of the business. The trend is useful for estimating
future. With the help of previous years’ ratios, estimates for future can be
made.
5. (a) Define financial reporting. Discuss the
qualitative characteristics which make financial reporting more useful for its
users.
4+7=11
Ans:
Basically, financial reporting is the process of preparing, presenting and
circulating the financial information in various forms to the users which helps
in making vigilant planning and decision making by users. The core objective of
financial reporting is to present financial information of the business entity
which will help in decision making about the resources provided to the
reporting entity and in assessing whether the management and the governing
board of that entity have made efficient and effective use of the resources
provided. Financial reporting is of two types – Internal reporting and external
reporting. The financial report made to the management is generally known as
internal reporting and the financial report made to the shareholders and
creditors is generally known as external reporting. The internal reporting is a
part of management information system and they use MIS reporting for the
purpose of analysis and as an aid in decision making process.
The components of financial reporting are:
a)
The financial statements – Balance Sheet, Profit &
loss account, Cash flow
statement & Statement of changes in stock holder’s equity
b)
The notes to financial statements
c)
Quarterly &
Annual
reports (in case
of listed companies)
d)
Prospectus (In
case of companies going for IPOs)
e)
Management Discussion &
Analysis (In
case of public companies)
Qualitative Characteristics of Financial Reports
The objective of general purpose financial reporting is to provide
financial information about the reporting entity that is useful to existing and
potential investors, lenders and other creditors in making decisions about
providing resources to the entity. The Qualitative characteristics of useful
financial reporting identify the types of information which are likely to be
most useful to users in making decision about the reporting authority on the
basis of information in its financial report. Financial information is useful
when it is relevant and presented faithfully. Some of the qualitative
characteristics which makes the financial reports useful to its users are given
below:
a)
Relevance: Information is relevant
if it would potentially affect or make a difference in users’ decisions. A
related concept is that of materiality i.e. information is considered to be
material if omission or misstatement of the information could influence users’
decisions.
b)
Faithful Representation: This
means that the information is ideally complete, neutral, and free from error.
The financial information presented reflects the underlying economic reality.
c)
Comparability: This means that the
information is presented in a consistent manner over time and across entities
which enables users to make comparisons easily.
d)
Materiality: Materiality is an
entity-specific aspect of relevance based on the nature or magnitude (or both)
of the items to which the information relates in the context of an individual
entity's financial report.
e)
Verifiability: This means that
different knowledgeable and independent observers would agree that the
information presented faithfully represents the economic phenomena it claims to
represent.
f)
Timeliness: Timely information is
available to decision makers prior to their making a decision.
g)
Understandability: This refers to
clear and concise presentation of information. The information should be
understandable by users who have a reasonable knowledge of business and
economic activities and who are willing to study the information with
diligence.
h)
Transparency: This means that
users should be able to see the underlying economics of a business reflected
clearly in the company’s financial statements.
i)
Comprehensiveness: A framework
should encompass the full spectrum of transactions that have financial
consequences.
j) Consistency:
Similar transactions should be measured and presented in a similar manner
across companies and time periods regardless of industry, company size,
geography or other characteristics.
Or
(b) What do you mean by ‘social benefits’ and
‘social costs’? What suggestions would you give to improve the disclosure
practices in reporting of corporate social
responsibility? 4+4+3=11
6. (a) Discuss the purpose underlying the issue of
an accounting standard. How has global accounting standards (IFRS) affected
Indian
GAAP?
7+4=11
Or
(b) What do you mean by international financial
reporting standard (IFRS)? Discuss the role played by the ICAI in convergence
of Indian GAAP with
IFRS.
5+6=11
7. (a) Discuss the suggestions made by RBI’s
advisory group on accounting and auditing in financial reporting of banks and
FIs. 11
Ans: DISCLOSURE OF ACCOUNTS AND BALANCE SHEETS
OF BANKS (RBI Guidelines)
There are various types of users of the financial statements of
banks who need information about the financial position and performance of the
banks. The financial statements are required to provide the information about
the financial position and performance of the bank in making economic decisions
by the users. The important information sought by these users are, about bank’s
Liquidity and solvency and the risks related to the assets and liabilities
recognized on its balance sheet and to its off balance sheet items. This useful
information can be provided by way of ‘Notes’ to the financial statements,
hence notes become an integral part of the financial statements of banks. The
users can make use of these notes and supplementary information to arrive at a
meaningful decision. Some of the specific disclosure requirements in Bank’s
financial statement are given below:
a) Presentation: Summary of Significant Accounting Policies’ and
‘Notes to Accounts’ may be shown under Schedule 17 and Schedule 18
respectively, to maintain uniformity.
b) Minimum Disclosures: While complying with the requirements of
Minimum disclosures, banks should ensure to furnish all the required
information in ‘Notes to Accounts’. In addition to the minimum disclosures,
banks are also encouraged to make more comprehensive disclosures to assist in
understanding of the financial position and performance of the bank.
c) Summary of Significant Accounting Policies: Banks should
disclose the accounting policies regarding key areas of operations at one place
(under Schedule 17) along with Notes to Accounts in their financial statements.
The list includes – Basis of Accounting, Transactions involving Foreign
Exchange, Investments – Classification, Valuation etc., Advances and Provisions
thereon, Fixed Assets and Depreciation, Revenue Recognition, Employee Benefits,
Provision for Taxation, Net Profit, etc.
d) Disclosure Requirements: In order to encourage market
discipline, Reserve Bank has over the years developed a set of disclosure
requirements which allow the market participants to assess key pieces of
information on capital adequacy, risk exposures, risk assessment processes and
key business parameters which provide a consistent and understandable
disclosure framework that enhances comparability. Banks are also required to
comply with the Accounting Standard 1 (AS 1) on Disclosure of Accounting
Policies issued by the Institute of Chartered Accountants of India (ICAI). The
enhanced disclosures have been achieved through revision of Balance Sheet and
Profit & Loss Account of banks and enlarging the scope of disclosures to be
made in “Notes to Accounts”.
e) Additional/Supplementary Information: In addition to the 16
detailed prescribed schedules to the balance sheet, banks are required to
furnish the following information in the “Notes to Accounts”. Such furnished
(information should cover the current year and the previous year). “Notes to
Accounts” may contain the supplementary information such as:
5.
Capital (Current & Previous
Year) with breakup including CRAR – Tier I/II capital (%), % of shareholding of
GOI, amount of subordinated debt raised as Tier II capital. Also it should show
the total amount of subordinated debt through borrowings from Head Office for
inclusion in Tier II capital etc.
6.
Investments: Total amount should
be mentioned in crores, with the total amount of investments, showing the gross
value and net value of investments in India and Abroad. The details should also
cover the movement of provisions held towards depreciation on investments.
7.
Derivatives: Forward Rate
Agreement/Interest Rates Swap: Important aspects of the disclosures would
include the details relating to:
e.
The notional principal of swap
agreements;
f.
Losses which would be incurred if
counterparties failed to fulfill their obligations under the agreements;
g.
Collateral required by the bank
upon entering into swaps;
h.
Nature and terms of the swaps
including information on credit and market risk and the accounting policies
adopted for recording the swaps etc.
8.
Exchange Traded Interest Rate
Derivatives: As regards Exchange Traded Interest Rate Derivatives, details
would include the notional principal amount undertaken:
e.
During the year (instrument-wise),
f.
Outstanding as on 31st
March (instrument-wise),
g.
Outstanding and not “highly
effective” (instrument-wise),
h.
Mark-to-market value of exchange
traded interest rate derivatives outstanding and not “highly effective”
(instrument-wise).
f) Qualitative Disclosure: Banks should discuss their risk
management policies pertaining to derivatives with a specific reference to the
extent to which derivatives are used, the associated risks and business
purposes served. This also includes:
d.
The structure and organization for
management of risk in derivatives trading,
e.
The scope and nature of risk
measurement, risk reporting and risk monitoring systems,
f.
Policies for hedging and/or
mitigating risk and strategies and processes for monitoring the continuing
effectiveness of hedges/mitigates, and accounting policy for recording hedge
and non-hedge transactions; recognition of income, premiums and discounts;
valuation of outstanding contracts; provisioning, collateral and credit risk
mitigation.
g) Quantitative Disclosures: Apart from qualitative disclosures,
banks should also include the quantitative disclosures. The details are both
Currency Derivatives and Interest rate derivatives.
h) Asset Quality: Banks’ performances are considered good based on
the quality of assets held by banks. With the changing scenario and due to number
of risks associated with banks like Credit, Market and Operational risks, banks
are concentrating to ensure better quality assets are held by them. Hence, the
disclosure needs to cover various aspects of asset quality consisting of:
g.
Non-Performing Assets, covering
various details like Net NPAs, movement of NPAs (Gross)/(Net) and relevant
details provisioning to different types of NPAs including Write off/write-back
of excess provisions, etc., Details of Non-Performing financial assets
purchased, sold, are also required to be furnished.
h.
Particulars of Accounts
Restructured: The details under different types of assets such as (i) Standard
advances (ii) Sub-standard advances restructured (iii) Doubtful advances
restructured (iv) TOTAL with details number of borrowers, amount outstanding,
sacrifice.
i.
Banks disclose the total amount
outstanding in all the accounts/facilities of borrowers whose accounts have
been restructured along with the restructured part or facility. This means even
if only one of the facilities/accounts of a borrower has been restructured, the
bank should also disclose the entire outstanding amount pertaining to all the
facilities/accounts of that particular borrower.
j.
Details of financial assets sold
to Securitization/Reconstruction Company for Assets Reconstruction.
k.
Provisions on Standard Assets:
Provisions towards Standard Assets need not be netted from gross advances but
shown separately as ‘Provisions against Standard Assets’, under ‘Other
Liabilities and Provisions – Others’ in Schedule No. 5 of the balance sheet.
l.
Other Details: Business Ratios:
(i) Interest Income as a percentage to Working Funds (ii) Non-interest income
as a percentage to Working Funds (iii) Operating Profit as a percentage to
Working Funds (iv) Return on Assets (v) Business (Deposits plus advances) per
employee (vi) Profit per employee.
i) Assets Liability Management: As part of Assets Liability
Management, the maturity pattern of certain items of assets and liabilities
such as deposits, advances, investments, borrowings, foreign current assets,
and foreign currency liabilities. Banks are required to disclose the
information based on the maturity patterns covering daily, monthly and yearly
basis.
j) Break up Exposures: Banks should also furnish details of exposures
to certain sectors like Real Estate Sector.
Exposure to Capital Market: Capital Market exposure details should
be disclosed for the current and previous year in crores. The details would
include direct investment in equity shares, convertible bonds, convertible
debentures and units of equity-oriented mutual funds the corpus of which is not
exclusively invested in corporate debt and also loan raised against such
securities. A bank must also disclose the risk associated with such
investments. The risks are to be categorized as Insignificant, Low, Moderate,
High, Very high, Restricted and Off-credit.
Apart from the above category of exposures, banks are required to
disclose details relating to Single Borrower Limit (SGL)/Group Borrower Limit
(GBL) exceeded by the bank, and Unsecured Advances are to be furnished.
Miscellaneous items would include Amount of Provisions made for Income Tax
during the year, and Disclosure of Penalties imposed by RBI, etc.
Or
(b) Explain the
following:
6+5=11
(i) IFRS – 4
Ans: IFRS 4 - Insurance contracts: An
insurance contract is that where one party (the insurer) accepts the insurance
risk of another party (the
policy holder) by agreeing to reimburse the amount of policy to the policy holder if any specified uncertain
future events occur and adversely affect the policy holder. The primary objective of this IFRS
for an entity is to determine the financial reporting for the issued insurance contracts (described
in this IFRS as an insurer) until the Board completes the second phase of its project on
insurance contracts.
(ii) Financial reporting of NBFC as per RBI’s
Guidelines
Ans: RBI – GUIDELINES REGARDING FINANCIAL
STATEMENTS OF NBFC’S
The issues related to accounting include Income Recognition
criteria, Accounting of Investments, asset classification and provisioning
requirements. These have been provided in details in the RBI Directions, namely
“Non-Systemically Important Non-Banking Financial (Non-Deposit Accepting or
Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015” and
“Systemically Important Non-Banking Financial (Non-Deposit Accepting or
Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015”.
RBI has prescribed that Income recognition should be based on
recognised accounting principles, however
Accounting Standards and Guidance Notes issued by the Institute of Chartered
Accountants of India (referred to in
these Directions as “ICAI” shall be followed in so far as they are not
inconsistent with any of these Directions.
Income Recognition
1. The
income recognition of NBFCs, irrespective of their categorisation, shall be
based on recognised accounting principles.
2. Income
including interest/ discount/ hire charges/ lease rentals or any other charges
on NPA shall be recognised only when
it is actually realised. Any such income recognised before the asset became
non-performing and remaining
unrealised shall be reversed.
3. Income
like interest /discount /any other charges on NPAs shall be recognised only
when actually realised, RBI also
requires that income recognised before asset becoming NPA should be reversed in
the financial year in which such
asset becomes NPA.
4. The
NBFCs are required to recognise income from dividends on shares of corporate
bodies and units of mutual funds on
cash basis, unless the company has declared the dividend in AGM and right of
the company to receive the same has
been established, in such cases, it can be recognized on accrual basis.
5. Income
from bonds and debentures of corporate bodies and from government
securities/bonds may be taken into
account on accrual basis provided it is paid regularly and is not in arrears.
6. Income
on securities of corporate bodies or public sector undertakings may be taken
into account on accrual basis
provided the payment of interest and repayment of the security has been
guaranteed by Central Government.
Principles for accounting of Investments
Investing is one of the core activities of NBFCs, hence RBI
requires the Board of Directors to Frame investment policy of the
company and implement the same. The investments in securities shall be
classified into current and long term, at the time of making each investment.
The Board of the company should include in the investment policy the criteria
for classification of investments into current and long-term. The
investments need to be classified into current or long term at the time of
making each investment. There can be no inter-class transfer of
investments on ad hoc basis later on. Inter class transfer, if warranted, should
be done at the beginning of half year, on April 1 or October 1, and with the
approval of the Board. The investments shall be transferred scrip-wise,
from current to long-term or vice-versa, at book value or market value,
whichever is lower;
The depreciation, if any, in each scrip shall be fully provided
for and appreciation, if any, shall be ignored.
Moreover, the depreciation in one scrip shall not be set off
against appreciation in another scrip, at the time of such inter-class
transfer, even in respect of the scrips of the same category.
Valuation of Investments
A) The directions also specifies various
valuation guidelines in respect of Quoted and Unquoted current investments
leaving the Long Term Investments to be valued as per ICAI Accounting
Standards. It requires Quoted current investments to be grouped into
specified categories, viz. (i) equity shares, (ii) preference shares, (iii)
debentures and bonds, (iv) Government securities including treasury bills, (v)
units of mutual fund, and (vi) others.
The valuation of each specified category is to be done at
aggregate cost or aggregate market value whichever is lower. For this purpose,
the investments in each category shall be considered scrip-wise and the cost
and market value aggregated for all investments in each category. If the
aggregate market value for the category is less than the aggregate cost for
that category, the net depreciation shall be provided for or charged to the
profit and loss account. If the aggregate market value for the category exceeds
the aggregate cost for the category, the net appreciation shall be ignored.
Depreciation in one category of investments shall not be set off against
appreciation in another category.
B) Unquoted equity shares in the nature of current investments shall
be valued at cost or break-up value, whichever is lower. However, the RBI
Directions has prescribed that fair value for the break-up value of the shares
may be replaced, if considered necessary.
C) Unquoted preference shares in the nature of current
investments shall be valued at cost or face value, whichever is lower.
D) Investments in unquoted Government securities or Government
guaranteed bonds shall be valued at carrying cost.
E) Unquoted investments in the units of mutual funds in the
nature of current investments shall be valued at the net asset value
declared by the mutual fund in respect of each particular scheme.
F) Commercial papers shall be valued at carrying cost.
G) A long term investment shall be
valued in accordance with the Accounting Standard issued by ICAI.
Preparation of Balance Sheet and Profit and Loss Account
1.
Every non-banking financial
company shall prepare its balance sheet and profit and loss account as on March
31 every year. Whenever a non-banking financial company intends to extend
the date of its balance sheet as per provisions of the Companies Act, it
should take prior approval of the Reserve Bank of India before approaching
the Registrar of Companies for this purpose.
2.
Further, even in cases where the
Bank and the Registrar of Companies grant extension of time, the nonbanking financial
company shall furnish to the Bank a proforma balance sheet (unaudited) as on
March 31 of the year and the statutory returns due on the said date.
Every non-banking financial company shall finalise its balance sheet
within a period of 3 months from the date to which it pertains.
3.
Every non-banking financial
company shall append to its balance sheet prescribed under the Companies Act,
2013, the particulars in the schedule as set out in Annex I.
Disclosures in the Balance Sheet
1.
The directions specify certain
disclosure requirements in the balance sheet.
2.
Disclosure of provisions created
without netting them from the income or against the value of assets. The
provisions shall be distinctly indicated under separate heads of account as (i)
Provisions for bad and doubtful debts; and (ii) Provisions for depreciation in
investments.
3.
Provisions shall not be
appropriated from the general provisions and loss reserves held. Provisions
shall be debited to the profit and loss account.
4.
The excess of provisions, if any,
held under the heads general provisions and loss reserves may be written back
without making adjustment against the provisions.
5.
Every non-banking financial
company shall append to its balance sheet prescribed under the Companies Act,
2013, the particulars in the schedule as set out in Annex I.
6.
The following disclosure
requirements are applicable only to systemically important (Asset Size more
than Rs. 500 crores) non-deposit taking non-banking financial company:
a)
Capital to Risk Assets Ratio
(CRAR);
b)
Exposure to real estate sector,
both direct and indirect; and
c)
Maturity pattern of assets and
liabilities.”
7. The formats for the above disclosures are also specified by RBI.
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