Page 271 - DMGT104_FINANCIAL_ACCOUNTING

Unit 12: Corporate Financial Statements

Section 209 of the Companies Act, 1956 states that proper books of accounts shall be maintained Notes
at the company’s registered office unless the Board of Directors decides to keep them at another
place in India. A company gets its funds partly from its owners and partly from lenders. Owners’
contribution is called equity share capital. In fact, there are traditionally two types of shares
recognised in the Companies Act—Equity Share and Preference Share. Of late, a new class of
share is allowed to be issued—Non-voting Share. Preference shareholders enjoy privilege or
preference over equity shareholders on two counts:
(i) in respect of dividend (distribution of profits) and
(ii) in respect of repayment of principal in case of liquidation of a company.
Thus, equity shareholders are real risk takers and hence they are the true owners of a company.

The external borrowings by the company may be in the form debentures, term loans from
financial institutions or commercial banks, public deposits, etc. The external borrowings have a
definite cost in the sense that they are to be serviced at a fixed rate of interest periodically. Even
preference shareholders are paid a predetermined rate of dividend. But since equity shareholders
have a ‘residual’ interest in profits, they are not paid a fixed rate of dividend. Dividend on equity
shares is a function of profit.
Companies earn profits as they carry on business. No company expects a loss to be incurred—
loss is only an accident or an unwelcome feature. The entire profits are not distributed as
dividend—a part of the profit is kept as ‘reserves’ to meet any future contingencies or to plough
back in the business. A company also creates provision to meet any specific future happening.
The only difference between a reserve and a provision is that reserve is created for some
unforeseen event whereas provision is created for a known liability of which the amount cannot
be determined with substantial accuracy.

The funds thus generated from internal and external sources are applied to acquire fixed assets
and also to acquire current assets, like inventories.
It can be mentioned here that companies registered in India will have to follow Indian GAAP
(Generally Accepted Accounting Principles) while preparing and presenting their financial
statements. Indian GAAP generally comprise of three regulatory frameworks: (a) the Companies
Act, 1956; (b) the Accounting Standards of ICAI; and (c) the SEBI disclosure norms. The third
framework (c) is applicable only in case of listed companies. Consider the following paragraph
which clearly articulates the basis of preparation of financial statements:
“…… The financial statements are prepared in accordance with Indian Generally Accepted
Accounting Principles (“GAAP”) under the historical cost convention on the accruals basis.
GAAP comprises mandatory accounting standards issued by the Institute of Chartered
Accountants of India (“ICAI”), the provisions of the Companies Act, I956, and guidelines issued
by the Securities and Exchange Board of India……..
The preparation of the financial statements in conformity with GAAP requires management …
to make estimates and assumptions that affect the reported balances of assets and liabilities and
disclosures relating to contingent assets and liabilities as at the date of the financial statements
and reported amounts of income and expenses during the period……. Actual results could differ
from those estimates.” (Source: Annual Report, Infosys Technologies Ltd.)

The above statement highlights another feature of financial statements. The preparers of financial
statements are required to make estimates and apply judgments while reporting the financial
elements. The readers of financial statements are, therefore, forewarned that actual results could
vary from the estimates.
The resultant impact of the performance of a company is measured periodically through the
preparation of financial statements. Thus, financial statements are external reports. At the end of

LOVELY PROFESSIONAL UNIVERSITY 265