Financial Statement Analysis And Reporting - Lecture-60- Financial Reporting (Part-2)

Welcome students. So, this is our final lecture and we are discussing the process of financial reporting. After this we will be closing the discussion on this particular subject. So, after this long journey of you can call it as say 59 lectures.

Now, this is the last step. Six years so, we will be having a discussion on it and then for the detailed reference you can refer to the different sources and largely when we talk about the financial reporting, you can use the important say provisions you can refer to the important provisions of Indian companies at 1956 and amendments done in different at different times say in 2000, 2013 and then you can refer to the income tax act also and some important provisions are there given to. And then the other things I will be talking to you that you have to refer to for the detailed reference of the financial reporting. So, we will be talking about the objectives and financial statements in the last lecture on the last part of discussion and then some other things important related to the financial reporting are say characteristics of a coherent financial reporting framework.

So, to make a important reporting interesting and important, the reporting means all the financial statements we are preparing and using for the reporting they should be transparent means that is a one important requirement that they should be transparent enough they should not be any hidden information anything which is concealed from the shareholders or from the lenders or from the say the suppliers or anybody else that should be avoided comprehensive. It should include as much as information so that by reading even the first two pages that is of the balance sheet and income statement you can be clear about to the maximum things and you do not need to look at anything more beyond that and consistent. Consistency is the most important component of the financial reporting because consistency if consistency is not maintained it is not allowed also not to being consistent and sometime if consistency is not maintained then it is very difficult to understand the information given. Say for example, we normally talk about the consistency with regard to the depreciation charging methods.

So, when you charge that depreciation if you talk about the concept of depreciation you could not get the time here otherwise I could have discussed with you the concept of depreciation also. So, if you want to calculate the depreciation to be charged on the fixed assets you have almost 10 methods to charge that depreciation. Though every methods is giving you the same amount of depreciation for that given period of time. Say for example, one machine is depreciating in 10 years then at the end of the 10th year the residual value will also come as same the depreciation amount will also come as the same and depreciate the method the asset will be depreciated finally to the extent we want to depreciate or that is equal to the end of its technical value but the annual values may be different the annual amount of that depreciation may be different.

So, we are using the different method to commonly use methods are like a state line method that is SLM and written down value method is the WDB methods. So, when you use the state line method here depreciation amount remains the same all through the years for example, it is 10,000 10,000 and it is 10,000. But in case of the written down value method it changes first year it will be 10,000 next year it may be 9,000 next year it may be 8,100 like that. So, value of the depreciation changes.

So, it means in the first year if you are using the state line method and fourth year onwards you started suddenly change the method from the say a state line method to the written down value method it means the consistency is broken. That consistency should not be broken and we should remain consistent for some reason if some changes are required then on the same page of where that depreciation figure is given or being given in the profit and loss account they are on the same page by putting a line drawing a line on the as a footnote you should give a note there that there is a change in the depreciation method and detailed discussion about that has been details explanation and calculations have been given in the schedule number this appended to the profit and loss account. So, that disclosure normally method should not be changed but if it is required to be changed then say the disclosure is important. So, consistency is a very important characteristic of the better financial reporting.

Then we talk about the there are some barriers also but because we have the different valuation methods in their case valuation techniques are different. So, some companies use some techniques, some companies use other techniques and even the country wise also the valuation is the different. So, for example, the valuation of inventory. Now, you talk about the valuation of inventory there are different methods like Lyfow, then we have FIFO and then we have average cost method.

So, different methods are there. So, different companies, different use different methods of valuation. So, this is similar information cannot be worked out. So, these are the barriers.

Then standard setting approach means when you talk about the standard setting approach in the different countries because we are not a world we are not in the world accounting system. So, when the standards setting approach you talk about India has a different standards Pakistan has different standards US has different standards UK has different standards and though we are referring and trying to converge with the IFRS International financial reporting standards but that will take time. So, in that case the figures are different the total reporting process is different. Similarly, you talk about the measurement that is means how you to measure the different items and it means the focus should be on the balance sheet or on the income statement.

Means both the statements are equally important. One is reporting the profit or loss situation and another is reporting the financial position. So, they should be looked at with the equally important but sometime we are only looking at the balance sheet lying more in faces on the balance sheet less on the profit and loss account. So, some kind of the barriers are there in the financial reporting which should be recorded and which should be avoided.

I would like to say. So, then we talk about the other important things. When you talk about the other things then the disclosure of their relevant accounting policies that is also very very important while we talk about the financial reporting process. Say, important points that companies are required to disclose their accounting policies and estimates in the notes to the financial statements.

Means we are told that they are the three components. One is the profit and loss account balance sheet and then the schedules. Schedules are notes. So, the notes what are the policies being followed?

How what are the standards being followed? How the calculations have been done? Detailed should be given in the schedules. Then companies also discuss in the management commentary those policies that management team is most important.

What is the say some in a brief manner what is the say strategy of the firm or what is the what are the important policies say for example, the policies with regard to employees policies with regard to payment of dividend policies with regard to transferring of the say part of the profit to reserves. Some brief analysis and discussion also remains. Many of the policies are discussed in both the management commentary and in the notes of the financial statements and finally, companies also disclose information about changes. Naturally as I told you that if you are changing the method of depreciation or the changing the method of inventory valuation in that case you have to disclose it where you are changing that figure you are giving that changed figure.

That has to be given by putting a line after that is that the last part of the page where that figure is given that by drawing a line as a foot you have to give the detailed description why there is a change in the current year's figure as compared to previous year's figure because we have changed the method of depreciation. We have changed the method of inventory valuation and that is the reason why this difference is occurring. Now, we talk about that important role in the better financial reporting is of the two important bodies. One is of the standard setting bodies and second is of the regulatory bodies.

Standard setting bodies and the regulatory bodies. First role in this process comes up of the standard setting bodies and if you talk about the standard setting bodies, every country has a standard setting body and in this case say for example, you talk about the India in India, the standard setting bodies one ICAI. Institute of Saturday Countance of India set the standards for financial reporting in India. How the financial reporting has to be done?

Apart from that, the government center government also has some their own standards. They have also delved some standards under the Indian Companies Act. Under the Indian Companies Act also some standards are delved by the government also. Ministry of Corporate Affairs, but generally the main responsibility of delving the standards for the financial reporting in India are with the ICAI.

For example, you talk about the US. Now, US in US there is a body like US FASB that is United States financial accounting standards board. They make the standards for US and likewise, the different countries have their own say standard setting bodies and to harmonize and to coordinate among these bodies. There is one standard body which is called as IASB and IASB is setting the standards which are called as IFRS and they are the International Financial Reporting Standards.

Now, little background and discussion about the IASB International Accounting Standard Board. Actually, we have called International Accounting Standard Board, but before that it was IASB. International Accounting Standard Committee. It was International Accounting Standard Committee.

This committee came into being in 1973. The firm in 1973, the financial reporting at the International level was quite fragmented. Every country was moving its own direction. But then the leading institutes of US and UK, they came forward in 1973 and they decided that to guide the reporting at the international level especially for the multinational companies offered exporters and others, we should have some kind of the standards and for that we should have some standard setting body.

So, these leading national level bodies, they set up this body which was say two as developed by the International Standards facilitating the international trade by the multinational companies and they set this body in 1973. So, this body was called International Accounting Standard Committee and since 1973 till 2001, this company was in existence and during this period of 1973 to 2001, they gave 41 IAS. They gave 41 IAS International Accounting Standards. And from first April 2000, then this was converted into from 2001 onwards after 2001, this body was reconstituted reorganized and was renamed as IASB International Accounting Standard Board and this started functioning, this came into existence and started functioning from first April, first April 2001.

So, after first April 2001, IAS is called as IASB and the name of their standards is also changed and earlier it was called as International Accounting Standards and this IASC has given 41 standards so far, they are still in practice, they are used and then when it was converted from IASC to IASB, then they also started giving the further standards and so far and whatever the standards are now given by the IASB, they are called under a different name and they are called as International Financial Reporting Standards and so far, IASB has given us the 16 IFRS. So, total standards are 51 plus 16 that is 57 and IASB keep on developing some new standards also as an event the problems come up to say go for say to deal with the different aspects of financial reporting especially at the international level. So, this is the one part that we have the standard setting bodies at the country level and second important role in the financial reporting is of the regulatory authorities and regulatory authorities, say for example in regulatory authorities in the different countries, different regulatory authorities are there. So, if you talk about the regulatory authorities who has an eye and watch upon the reporting process of the corporates in India, so first name comes is a SEBI, security and exchange board of India.

This is the first regulator which is important regulator especially for the joint stock companies who are using the share capital and who are issuing the shares to the general public and using the share capital. So, they are the first regulator SEBI apart from some other regulators are also there but their role is scantry, say RBI also is to some extent acts as a regulator. Then register of companies is another place that also acts as a means register of companies where the company is registered, ROC they also act as a regulator. So, different regulators are there but the main regulator if you talk about that role is played by in case of the company form of organization joint stock companies, SEBI is the most important regulator, every country has their own say regulatory authorities and they play the regulatory role.

So, if you talk about the connecting role between the regulator and the standard setting body is that the standard setting body gives the directions and guidelines and implementation of those guidelines, the regulators power is that he can ensure that whatever the standards are dealt by the standard setting body they are being followed, they are being observed and financial reporting is being done on the basis of the prevalent or extent financial reporting, financial accounting or the financial reporting standards. So, we will say some important developments about the financial reporting standards are all the many countries have adopted IFRS not all the countries have done so far. Means many countries are moving from the national accounting to international accounting but still it is taking time say for example, in India we have say two kinds of the standards. Are there be used to call our standards as AS that is the accounting standards?

We had about 32 standards and now we have changed the name say those AS which are similar to IFRS we have converged with the IFRS and we are using the same standards in India also as they are the IFRS. But those standards which are little different for them now we are calling under different name and they are called as INDAS, IND accounting standards. So, it means there are processes going on a time will come that both the say standards will same in that case everybody will use the IFRS but the time has not come. Financial reporting standards both IFRS and home country gap continue to evolve for various reasons including changes in economic activity, improvement to existing standards and convergence between the international and the home country standards.

So, currently both are in existence but when we are becoming more advanced we are means more narrow to each other in the rest of the world and when the business world boundaries are shrinking or eliminating then may be possible that means we have only one type of standards and everybody has converged with the IFRS but the time has not come so far. An analyst and analyst needs to understand whether in how differences in the financial reporting standards affect comparability in the cross sectional analysis that is the intelligence of the analyst. He has to look at from the country standards point of view also and by using the international standards also and then he has to give his own opinion that how this company is doing and how its position or the performance is. Then if you talk about the global convergence of the accounting standards still there is a difference means as I told you that even you talk about that most of the economies are converging with the or most of the national economies are converging with the IFRS but still those differences are existing.

So, for example you talk about US now if you compare the convergence of the US gap and that say with the IFRS still that differences there though the US has converged to a larger extent with IFRS but still the gap is remaining and complete convergence is not possible means some country level differences will also be there. So, if you talk about the country level differences say in US you talk about there is a method of valuing inventory which is called as LIFO. So, as per IFRS means under IFRS use of the LIFO is not allowed last in first out it is not permissible but in US LIFO is the most important method and they value their inventory on the basis of LIFO because the problem in US is the structural because the companies when they have to value the inventory. So, and if you want to take the income tax advantage they want to reduce their income tax liability in that case they have to use LIFO and miss that income tax liability can be reduced.

Advantage of income tax can be taken by the US companies provided their own reporting processes based upon the LIFO and in their own internal or maybe the external reporting process on the basis of the company's acts they have used the LIFO then they can claim the income tax advantage. So, it means if the US government has to de-recognize LIFO then they have to make the change in the income tax act. So, that they have to make it that you use any method of inventory valuation and you prepare your company's statement by using LIFO or any other method you will be given the income tax advantage but that difference always remains and that change the government is not tied to make in US. So, even you converge but some problems will be there and some differences will be there.

Here are some examples of the regulatory authorities we were talking about in India we have the Sabi that is a security and exchange board of India. So, Australia has it is the Australian Securities and Investment Commission Financial Services and Market Authority in Belgium and Japan is Financial Services Agency similarly Nigeria Security and Exchange Commission of Nigeria. So, it means different regulators are there after that RBI is also a regulator and then the register of companies is also a regulator to some extent. Then these regulators have formed the International Organization which is called as IO-SEO International Organization of Securities Commission and they have created this organization just to remain close to each other.

So, that to share their regulatory process with the other countries means India to share with other countries draw good benefits from their system and they can draw good benefits from our system. So, that the investor protection can be maximized and overall stability can be ensured in the economic system or in the financial system of that country. So, for that they are regularly meeting at the international level and they have formed the association also. So, that financial system improves and the financial system improves reporting will improve and reporting improves then investor is safe, lender is safe, supplier is safe.

So, there is a job of the regulator. Now, we will talk about quickly about the components of the financial reporting in India. Then we talk about the components of financial reporting in India they are divided into five parts. First, there is the legal requirements of financial reporting they are described under the Indian Companies Act and under the Indian Income Tax Act 1956 and Madmatch done in 2000 and then in 2013.

And in income tax act Indian Income Tax Act that is 1961. So, under these two acts the financial reporting processes carried on. And second is the financial reporting the requirement is adhering to the accounting standards and guidance notes of the ICAI. That is again important requirement if you talk about the reporting process.

And third is say ensuring adhering to the IAS and IFRS if you are dealing internationally. If you are a national company only then there is no problem you can be doing a job by following only the local standards, Indian standards. But if you are dealing in any way with the if you are transferring your product from India to other country also multinational companies is subsidiaries working here they are manufacturing the product here and they are selling it to the say even they are holding company back in their home country. So, it means they are indulging into international trade and for them observance of the IAS and IFRS is important.

Requirements of the stock exchanges is the another component which is again the part of the regulatory network. And then some other trends which are really important for us say for example having the say information in the financial statements about corporate governance similarly about the corporate social responsibility, similarly about the environmental protection but the companies are doing. So, having this additional information in the financial statements again is the important requirement. So, these are the five broad components under which the financial reporting process in India can be studied can be understood and can be divided.

Now, we are running short of time but still I would like to go through I like to share with you some important provisions of the Indian Companies Act that is 1956, I am and much done in 2013. And some important provisions or some relevant sections which are useful for Indian reporting process is we will be talking about to the extent we could talk here and that is say books of accounts should be kept on first requirement is under the section 209 subsection 3 and 4. Books of accounts should be kept on a cruel basis. We all know that and according to double entry system of accounting what we learnt in detail about that and companies are required to preserve their financial statements of one year for minimum next eight years.

This is the requirement of this section. Second are the requirements of section 210. Describes this section describes the duty of boards of directors to lay before the annual general meeting. The balance sheet and the profit and loss account of the complete income statement should not predate six months.

It should not be six months old when you are preparing the income statement it should be latest it should be prepared after the last operating day after taking into consideration that total information whether it is a guard expense and income it should not be old information it should be latest information and the provision here it is that is it should not be at least six months old and it may be one way at one point of time you can prepare it not only for one accounting period it can be for the one and half year 18 months it can be prepared. But for us the useful information will be only for say 12 months but we can get to know that what is happening in the past six months or what is going to happen in the what has happened in the past six months means current 12 months and past six months so total is the 18 months information can be gave there. Section 211 deals with the forms and contents of the profit and loss account and balance sheet it means ultimately and this section provides you to do six of the act two provide format for the balance sheet and profit and loss account it means ultimately the objective of financial reporting is what that the company should be reporting true and fair view of their performance. This is the objective of preparing these statements every 12 months this is objective of getting these statements audited from the independent chartered accountants certified chartered accountants means everything for profit and loss account and balance sheet should not be like septium computers balance sheets that rameling a Raju was getting it windowed rest with the help of the auditors who had bought the auditors from the price water scoop or these two guys and they were semi-sappropriating.

In that case the purpose of the financial reporting is defeated. Then section 215 requires that balance sheet and profit and loss account must be signed by the company secretary and at least two directors and if there is no company secretary then apart from two directors must be signed by any designated secretary who may be a manager even and last is the section 2016 of the act requires that profit and loss account should be annexed to the balance sheet. More the things should be put together apart from that the third is now also mandatory that is the cash flow statement. Now there are some additional preparations with regard to section 17217 of the Indian company Zact and these are the important points.

Coquial reader for you that is the state of company affairs it must explain in detail. Amount proposed to be transferred to the reserves how much that should be clearly given. Amount recommended as dividend that should be clearly given. Material changes affecting the financial position of the company between the end of the financial year and at the date of the report and changes that have occurred in the nature of companies business during the financial year that detail should be there.

Names of the employees who have received an aggregate renovation in excess of rupees 12 lakhs per annum under section 17217 subsection to AA which was introduced in that company's Amountment Act 2000. The section was added so that it can be made out to whom the salaries more than one like per month has been paid who are those people and why the Amount has been paid their names and details should be there. A report on conservation of energy technology absorption and for an exchange earnings and the use that should be there are reference to benefits expected from the contracts here to be executed and lastly changes in the types of business carried out by the company. So, these some further information should also be there in the income statement as well as in the balance sheet apart from the profit and loss position financial position and cash flow position some additional information is also required under the financial reporting.

And some other element sections are section 224 it requires that every company shall at each annual general meeting a point and audit a most important thing and auditor or auditors to the hold office from the say conclusion of that meeting to the conclusion of the next meeting. So, for one full year beginning of the year and till the end of the next year may have that accounting period you have to appoint the auditors and section 226 says that those auditors have to be the chartered accountants who are chartered accountants under the chartered accountants at 1949 and who are qualified to be appointed as auditors of the company they are only the qualified chartered accountants they are qualified auditors. And section 227 says power and duties of auditors should be properly means they are defined under section 227 if somebody is appointed as a auditor of the company it means he knows what are his powers and duties. In addition in addition to the above the provision of section 205 to 208 of the Indian companies law 1956 and further amendments dealing with payment of dividends also have a bearing on the financial statements and reporting of the company.

So, some important provisions I am quickly taking up with you then provisions of the Indian income tax act that is two important sections are there section 44 AB requires all the companies in India to have tax audit as mandatory means you have any form of organization it is important mandatory for the company form of organization if it is a joint stock company but if it is a sole proprietor of it is a partnership firm even then for them the mandate it means the tax audit is mandatory the provisions of this section actually require for every one whose waiver is carrying on the business or profession and fulfilling certain condition to get his accounts audited before the specified date. And then last is section 145 deals with methods of accounting provisions of this section requires SSEs to maintain the books of accounts under the cash system of accounting or the mercantile system of accounting but only one system of accounting not hybrid of the two. Say for example in India for the businesses other than banking they are allowed to follow the mercantile system of accounting or the accrual system of accounting but the banking sector banking organization in India they have to compulsively follow the cash system of accounting. So in whichever category you follow whether you follow the cash system of accounting or you follow the mercantile system of accounting but you have to have only one system you cannot have that part of the statements are on cash and part of the statements are on mercantile accrual and you are creating a hybrid kind of a system that is not allowed.

Then financial standard and reporting ICI has dealt 32 accounting standards so far. So they are a relevant for which are means 29 are mandatory and 3 are non mandatory. Apart from that central government under Indian companies act have dealt their own standards and after beyond that we use the 41 IAS and 16 IFR as also for harmonization of the divergent accounting practices they are also in use and companies who are dealing in the international business or who are dealing at the international level they have to observe the IAS and the IFRS also. And then we have the some important points with regard to the say financial reporting requirements of the stock exchanges in India.

So I have discussed these some provisions here and you can refer to the different stock exchanges also the information is given at the stock exchanges level also. So you can easily go through these provisions and you can understand what are the requirements of the stock exchanges provisions and then we have some other requirements. Last is the other requirements that regulatory framework for support or financial reporting has to comprise means regulatory framework for support of financial reporting has to comprise recent trends and emerging issues for instance corporate governance, social disclosures and environmental issues, interim reporting and segment reporting. These are also some additional requirements, recent trends going on and general instructions for the preparation of the balance sheet are given in the schedule 6, part 1 as per the provisions of section 211 of the company is act 1956.

So last the concluding part is for this whole discussion that if you look at these some observations concluding observations you will see and agree with me that objective of 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. Fundamental qualitative characteristics that make financial information useful include relevance whatever the information is given that should be relevant. Faithful representation that whatever the information is there that should be complete prepared in the neutral mind and it should be free from error. Enhancing qualitative characteristics that make financial information useful include comparability, verifiability, timeliness and understandability and benefits of preparing the financial statement should certainly outweigh the cost.

And lastly underlying assumptions of the financial reporting are a cruel accounting means for the businesses other than banking they have to follow the a cruel accounting system and businesses concerned as always a going concern. We do not feel that the business is going to say going to end up its life in the near future is considered as a entity with the perpetual succession with unending life and with that perception in mind we prepared our trading and profit and loss account and balance sheet and cash flow statement and other related statements and complete the process of and complete the process of financial reporting. So this quickly I could discuss with you about the financial reporting and for the detailed reference you can refer to these different means you go to the SEBI website you can go to RBI website you can go to the say concerned ROC's register of companies websites and you can have some important references with the Indian companies act which are easily available on the websites of respective ministries then income tax act and say you can it is a very important source for the information for you will be the website of institute of chartered accountants of India. So you these are the different resources you can use and you can refer and you can learn about the entire subject of this that what we discussed in the last 60 lectures that is the financial statements analysis and reporting where we learned how to prepare the important financial statements that is a profit and loss account balance sheet and cash flow statement how to analyze the important financial statements and what are the important provisions with regard to the financial reporting.

So with this I complete my discussion on this subject I hope that you have learned something after going through all the 60 lectures and you have felt benefited and I am really confident that you will perform very well in the examination tomorrow wherever in any say area of your life in any sector of your life you go and you join you will really you will prove to be an excellent financial analyst and you will be able to justify your position and the knowledge which you have gained by studying this very interesting and important subject. Wish you all the best thank you very much.