# Financial Statement Analysis Solved Papers May' 2019, Dibrugarh University B.Com 6th Sem

## Financial Statements Analysis Solved Question Paper May' 2019COMMERCE (Speciality)Course: 602 (Financial Statement Analysis)Full Marks: 80Pass Marks: 24Time: 3 hours

1. (a) State whether the following statements are True or False:              1x4=4
1)         Valuation of unsold stock depends on the personal judgement of the accountant.                 False
2)         Earning yield ratio is the relationship between earning per share and the market value of per share.  True
3)         Clause 49 of the Listing Agreement consists of mandatory provisions only.                 False
4)         CRR stands for Cash Reserve Ratio.                True
(b) Fill in the blanks with appropriate word(s):                                                 1x4=4

1)         Creditors are always interested in knowing the _______ (financial soundness / earning capacity / solvency position) of the business.
2)         Liquid asset is computed by deducting _______ (cash / debtors / stock and prepaid expenses).
3)         Reporting of corporate governance reflects _______ (socio-economic status / company management / economic status).
4)         Cash certificates are _______ (time liabilities / demand liabilities / time and demand liabilities).
2. Write short notes on any four of the following:                           4x4=16
a) Common-size income statement: These are the statements which indicate the relationship of different items of a income statement with a common item by expressing each item as a percentage of that common item. The percentage thus calculated can be easily compared with the results of corresponding percentages of the previous year or of some other firms, as the numbers are brought to common base. Such statements also allow an analyst to compare the operating efficiency of two companies of different sizes in the same industry. Thus, common size income statements are useful, both, in intra-firm comparisons over different years and also in making inter-firm comparisons for the same year or for several years. This analysis is also known as ‘Vertical analysis’.
Merits of Common Size income statement Statements:
a)      A common size income statement facilitates both types of analysis, horizontal as well as vertical. It allows both comparisons across the years and also each individual item as shown in income statement.
b)      Comparison of the performance and financial condition in respect of different units of the same industry can also be done.
c)      These statements help the management in making forecasts for the future.
Demerits of Common Size income Statements:
a)      If there is no identical head of accounts, then inter-firm comparison will be difficult.
b)      Inter-firm comparison may be misleading if the firms are not of the same age and size, follow different accounting policies.
c)       Inter-period comparison will also be misleading if there is frequent changes in accounting policies.
b) Statement of changes in financial position: 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 or statement of changes in financial position.
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.
c) Activity ratios: 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) Corporate social responsibility reporting:  Corporate social responsibility (CSR) is a business approach that contributes to sustainable development by delivering economic, social and environmental benefits for all stakeholders. CSR is a concept with many definitions and practices. Corporate social responsibility (CSR) promotes a vision of business accountability to a wide range of stakeholders, besides shareholders and investors. Key areas of concern are environmental protection and the wellbeing of employees, the community and civil society in general, both now and in the future.
The concept of CSR is underpinned by the idea that corporations can no longer act as isolated economic entities operating in detachment from broader society. Traditional views about competitiveness, survival and profitability are being swept away.
e) Statutory liquidity ratio (SLR): Statutory liquidity ratio refers to the amount that the commercial banks require to maintain in the form of gold or government approved securities before providing credit to the customers.  Statutory Liquidity Ratio is determined and maintained by the Reserve Bank of India in order to control the expansion of bank credit. It is determined as % of total demand and time liabilities. Time Liabilities refer to the liabilities, which the commercial banks are liable to pay to the customers after a certain period mutually agreed upon and demand liabilities are such deposits of the customers which are payable on demand. The maximum limit of SLR is 40% and minimum limit of SLR is 23% In India.
If any Indian bank fails to maintain the required level of Statutory Liquidity Ratio, then it becomes liable to pay penalty to Reserve Bank of India. The defaulter bank pays penal interest at the rate of 3% per annum above the Bank Rate, on the shortfall amount for that particular day. But, according to the circular, released by the Department of Banking Operations and Development, Reserve Bank of India; if the defaulter bank continues to default on the next working day, then the rate of penal interest can be increased to 5% per annum above the Bank Rate.
f) Non-banking financial company (NBFC): A Non-Banking Financial Company (NBFC) is a company engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issue by Government or local authority or other marketable securities of a like nature, leasing, hire purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner, is also a non-banking financial company (Residuary non-banking company).
As per Sec. 45I(f) of RBI Act, 1934, a non-banking financial company’’ means:
(i) a financial institution which is a company;
(ii) a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner;
(iii) such other non-banking institution or class of such institutions, as the Bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify.
A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 2013 which is engaged in the business of:
a)      loans and advances,
b)      acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature,
c)       leasing,
d)      hire-purchase,
e)      insurance business,
f)       chit business.

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3. (a) What is financial statement analysis? State the significance of analysis of financial statements in respect to stakeholders of the company.   4+10=14
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:
Ã˜  Whether the current assets are sufficient to pay off the current liabilities.
Ã˜  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) Following are the two Ledger Balances A Ltd. and B Ltd. as on 31st March, 2017:
 Cr. Balances A Ltd. B Ltd. Dr. Balances A Ltd. B Ltd. Sundry Creditors Other Current Liabilities Fixed Liabilities Capital 42,00078,0002,25,0006,58,000 1,54,00062,0003,18,0004,93,000 Cash Sundry Debtors Stock Prepaid Expenses Other Current Assets Fixed Assets (net) 27,0002,20,0001,00,00011,00010,0006,35,000 72,0002,26,0001,74,00021,00021,0005,13,000 10,03,000 10,27,000 10,03,000 10,27,000
From the above data, prepare a common-size statement and make comments.                7+7=14
Ans: For Solution follow our YouTube Channel
4. (a) “Ratio analysis is a tool of financial statement analysis for identifying financial strength, weakness and growth of an enterprise in a simple and understandable form to the interested parties.” Discuss.                     14
Ans: Meaning of Ratio Analysis: A ratio is one figure expressed in terms of another figure. It is mathematical yardstick of measuring relationship of two figures or items or group of items, which are related, is each other and mutually inter-dependent. It is simply the quotient of two numbers. It can be expressed in fraction or in decimal point or in pure number. Accounting ratio is an expression relating to two figures or two accounts or two set accounting heads or group of items stated in financial statement.
Ratio analysis is the method or process of expressing relationship between items or group of items in the financial statement are computed, determined and presented. It is an attempt to draw quantitative measures or guides concerning the financial health and profitability of an enterprise. It can be used in trend and static analysis. It is the process of comparison of one figure or item or group of items with another, which make a ratio, and the appraisal of the ratios to make proper analysis of the strengths and weakness of the operations of an enterprise.
According to Myers, “Ratio analysis of financial statements is a study of relationship among various financial factors in a business as disclosed by a single set of statements and a study of trend of these factors as shown in a series of statements."
Objectives of Ratio analysis
a)      To know the area of the business which need more attention.
b)      To know about the potential areas which can be improved with the effort in the desired direction.
c)       To provide a deeper analysis of the profitability, liquidity, solvency and efficiency levels in the business.
d)      To provide information for decision making.
e)      To Judge Operational efficiency
f)       Structural analysis of the company
g)      Proper Utilization of resources and
h)      Leverage or external financing
Advantages and Uses of Ratio Analysis for various users
There are various groups of people who are interested in analysis of financial position of a company used the ratio analysis to workout a particular financial characteristic of the company in which they are interested. Ratio analysis helps the various groups in the following manner:
a)      To workout the profitability: Accounting ratio 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: Ratio analysis 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 ratio analysis 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: Accounting ratios are very useful as they briefly summaries the result of detailed and complicated computations.
e)      To workout the operating efficiency: Ratio analysis helps to workout the operating efficiency of the company with the help of various turnover ratios. All turnover ratios are worked out to evaluate the performance of the business in utilising the resources.
f)       To workout short-term financial position: Ratio analysis helps to workout the short-term financial position of the company with the help of liquidity ratios. In case short-term financial position is not healthy efforts are made to improve it.
g)      Helpful for forecasting purposes: Accounting 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.
From the above discussion we can say that, Ratio analysis is a tool of financial statement analysis for identifying financial strength, weakness and growth of an enterprise in a simple and understandable form to the interested parties
Or
(b) Describe with illustration of the following:                  3.5*4=14
1)         Debt to equity ratio.
2)         Current ratio.
3)         Operating ratio.
4)         Inventory turnover ratio.
Ans: 1) Debt-Equity Ratio: Debt equity ratio shows the relationship between long-term debts and shareholders funds’. It is also known as ‘External-Internal’ equity ratio.
Debt Equity Ratio = Debt/Equity
Where Debt (long term loans) include Debentures, Mortgage Loan, Bank Loan, Public Deposits, Loan from financial institution etc.
Equity (Shareholders’ Funds) = Share Capital (Equity + Preference) + Reserves and Surplus – Fictitious Assets
Objective and Significance: This ratio is a measure of owner’s stock in the business. Proprietors are always keen to have more funds from borrowings because:
(i) Their stake in the business is reduced and subsequently their risk too
(ii) Interest on loans or borrowings is a deductible expenditure while computing taxable profits. Dividend on shares is not so allowed by Income Tax Authorities.
The normally acceptable debt-equity ratio is 2:1.
2) Current Ratio: Current ratio is calculated in order to work out firm’s ability to pay off its short-term liabilities. This ratio is also called working capital ratio. This ratio explains the relationship between current assets and current liabilities of a business. It is calculated by applying the following formula:
Current Ratio = Current Assets/Current Liabilities
Current Assets includes Cash in hand, Cash at Bank, Sundry Debtors, Bills Receivable, Stock of Goods, Short-term Investments, Prepaid Expenses, Accrued Incomes etc.
Current Liabilities includes Sundry Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses etc.
Objective and Significance: Current ratio shows the short-term financial position of the business. This ratio measures the ability of the business to pay its current liabilities. The ideal current ratio is supposed to be 2:1. In case, if this ratio is less than 2:1, the short-term financial position is not supposed to be very sound and in case, if it is more than 2:1, it indicates idleness of working capital.
3) Operating Ratio: Operating Ratio matches the operating cost to the net sales of the business. Operating Cost means Cost of goods sold plus Operating Expenses.
Operating Ratio = Operating Cost/Net Sales x 100
Where Operating Cost = Cost of goods sold + Operating Expenses
(Operating Expenses = Selling and Distribution Expenses, Office and Administration Expenses, Repair and Maintenance.)
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses – Closing Stock
Or Cost of Goods Sold = Net sales – Gross Profit
Objective and Significance: Operating Ratio is calculated in order to calculate the operating efficiency of the concern. As this ratio indicates about the percentage of operating cost to the net sales, so it is better for a concern to have this ratio in less percentage. The less percentage of cost means higher margin to earn profit.
4) Stock Turnover Ratio: Stock turnover ratio is a ratio between cost of goods sold and average stock. This ratio is also known as stock velocity or inventory turnover ratio.
Stock Turnover Ratio = Cost of Goods Sold/Average Stock
Where Average Stock = [Opening Stock + Closing Stock]/2
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses – Closing Stock
Objective and Significance: Stock is a most important component of working capital. This ratio provides guidelines to the management while framing stock policy. It measures how fast the stock is moving through the firm and generating sales. It helps to maintain a proper amount of stock to fulfill the requirements of the concern. A proper inventory turnover makes the business to earn a reasonable margin of profit.
5. (a) What do you mean by financial reporting? Discuss its main qualitative characteristics which make financial reporting more reliable to its users.           4+10=14
Ans: Financial Reporting: 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 uses 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) Discuss the new standards of Corporate Governance under the Companies Act, 2013.     14
Ans: Companies Act 2013 – Current status of corporate governance in India
Despite of all the mandatory and non-mandatory requirements as per Clause 49, India was still not in a position to project itself having highest standards of corporate governance. Taking forward, the Companies Law 2013 also came up with a dedicated chapter on Corporate Governance. Under this law, various provisions were made under at least 11 heads viz. Composition of the Board, Woman Director, Independent Directors, Directors Training and Evaluation, Audit Committee, Nomination and Remuneration Committee, Subsidiary Companies, Internal Audit, SFIO, Risk Management Committee and Compliance to provide a rock-solid framework around Corporate Governance. The key provisions in Clause 49 and 2013 act are summarized as follows:
a) Aligning Listing Agreement with the Companies Act 2013: Companies Act requirements on issuing a formal letter of appointment, performance evaluation and conducting at least one separate meeting of the independent directors each year and providing suitable training to them are now included in the revised norms of SEBI. Independent directors are not entitled to any stock option, and companies must establish a whistle-blower mechanism and disclose them on their websites.
b) Restricting Number of Independent Directorships: Per Clause 49, the maximum number of boards a person can serve as independent director is seven and three in case of individuals also serving as a full-time director in any listed company. The Companies Act sets the maximum number of directorships at 20, of which not more than 10 can be public companies. There are no specific limits prescribed for independent directors in the Companies Act.
c) Maximum Tenure of Independent Directors: Based on the Companies Act as well as the new Equity Listing Agreement, an independent director can serve a maximum of two consecutive terms of five years each (aggregate tenure of 10 years). These directors are eligible for reappointment after a cooling-off period of three years.
d) Board-Mix Criteria Redefined: Per Clause 49 of the Equity Listing Agreement, 50% of the board should be made up of independent directors if the board chair is an executive director. Otherwise, one-third of the board should consist of independent directors. Additionally, the board of directors of a listed company should have at least one female director.
e) Role of Audit Committee Enhanced: The SEBI reforms call for two-thirds of the members of audit committee to be independent directors, with an independent director serving as the committee’s chairman. While the Companies Act requires the audit committee to be formed with a majority of independent directors, SEBI has gone a step further to improve the independence of the audit committee.
f) More Stringent Rules for Related-Party Transactions: The scope of the definitions of RPTs has been broadened to include elements of the Companies Act and accounting standards:
1.       All RPTs require prior approval of the audit committee.
2.       All material RPTs must require shareholder approval through special resolution, with related parties abstaining from voting.
3.       The threshold for determining materiality has been defined as any transaction with a related party that exceeds 5% of the annual turnover or 20% of the net worth of the company based on the last audited financial statement of the company, whichever is higher.
g) Improved Disclosure Norms: In certain areas, SEBI resorts to disclosures as an enforcement tool. Listed companies are now required to disclose in their annual report granular details on director compensation (including stock options), directors’ performance evaluation metrics, and directors’ training. Independent directors’ formal letter of appointment / resignation, with their detailed profiles and the code of conduct of all board members, must now be disclosed in companies’ websites and to stock exchanges.
h) E-voting Mandatory for All Listed Companies: Until now, resolutions at shareholder meetings in listed Indian companies were usually passed by a show of hands (except for those that required postal ballot). This means votes were counted based on the physical presence of shareholders. SEBI also has changed Clause 35B of the Equity Listing Agreement to provide e-voting facility for all shareholder resolutions.
i) Enforcement: SEBI is setting up the infrastructure to assess compliance with Clause 49 to ensure effective enforcement. Companies need to buckle up and assess the impact of these reforms and step up compliance.
6. (a) Discuss the provisions of Banking Regulation Act, 1949 relating to Financial Statement of banking company.    14
Ans: MEANING OF A BANKING COMPANY
A banking company is defined as a company which transacts the business of banking in India. Section 5 (b) of The Banking Regulation Act, 1949 defines the term banking as “accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdraw able by cheque, draft, order or otherwise.
Section – 7 of this Act makes it essential for every company carrying on the business of banking in India to use as part of its name at least one of the words – bank, banker, banking or banking company. Section 49A of the Act prohibits any institution other than banking companies to accept deposit money from public withdraw able by cheque. The essence of banking business is the function of accepting deposits from public with the facility of withdrawal of money by cheque. In other words, the combination of the functions of acceptance of public deposits and withdrawal of the money by cheque by any institution cannot be performed without the approval of Reserve Bank.
DISCLOSURE OF ACCOUNTS AND BALANCE SHEETS OF BANKS
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/mitigants, 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 included 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.
AUDIT AND INSPECTION OF BANKING COMPANY
Audit: The balance sheet and the profit and loss account of a banking company have to be audited as stipulated under Section 30 of the Banking Regulation Act. Every banking company’s account needs to be verified and certified by the Statutory Auditors as per the provisions of legal frame work. The powers, functions and duties of the auditors and other terms and conditions as applicable to auditors under the provisions of the Companies Act are applicable to auditors of the banking companies as well. The audit of banking companies books of accounts calls for additional details and certificates to be provided by the auditors.
Apart from the balance sheet audit, Reserve Bank of India is empowered by the provisions of the Banking Regulation Act to conduct/order a special audit of the accounts of any banking company. The special audit may be conducted or ordered to be conducted, in the opinion of the Reserve Bank of India that the special audit is necessary;
a.       In the public interest and/or
b.      In the interest of the banking company and/or
c.       In the interest of the depositors.
The Reserve Bank of India’s directions can order the bank to appoint the same auditor or another auditor to conduct the special audit. The special audit report should be submitted to the Reserve Bank of India with a copy to the banking company. The cost of the audit is to be borne by the banking company.
Or
(b) What is non-banking financial company? Discuss the RBI guidelines on regulatory framework of NBFC.       4+10=14
Ans: Non-Banking Financial Company
A Non-Banking Financial Company (NBFC) is a company engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issue by Government or local authority or other marketable securities of a like nature, leasing, hire purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner, is also a non-banking financial company (Residuary non-banking company).
As per Sec. 45I(f) of RBI Act, 1934, a non-banking financial company’’ means:
(i) a financial institution which is a company;
(ii) a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner;
(iii) such other non-banking institution or class of such institutions, as the Bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify.
A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 2013 which is engaged in the business of:
g)      loans and advances,
h)      acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature,
i)        leasing,
j)        hire-purchase,
k)      insurance business,
l)        chit business.
However, such a company but does not include any institution whose principal business is that of:
a)      agriculture activity,
b)      industrial activity,
c)      purchase or sale of any goods (other than securities), or providing any services, and
d)      sale/ purchase/ construction of immovable property.
Moreover, a non-banking institution which is a company and has principal business of receiving deposits, under any scheme or arrangement, in one lump sum or in installments, by way of contributions or in any other manner, is also a non-banking financial company (called a Residuary non-banking company).
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 hav 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.
(OLD COURSE)
Full Marks: 80
Pass Marks: 32
1. (a) Fill in the blanks with appropriate word(s):                                               1x4=4
1)         Financial statements are _______ (recorded facts / estimated facts / anticipated facts).
2)         Static analysis takes the data for _______ (one year / two years / three years).
3)         Net capital employed _______ [all assets – current liabilities / all assets (excluding fictitious assets) – current liabilities / current assets – current liabilities].
4)         International Accounting Standard-2 associated with _______ (cash flow statement / inventories / revenues).
(b) State whether the following statements are True or False:                                1x4=4
1)         Cash flow statement is a part of financial statement.
2)         Economic value added helps to measure the performance of business.
3)         CSR policy does not include the activities relating to promotion of gender equality and empowering women.
4)         Section 24 of Banking Regulation Act, 1949 specifies the requirement of maintenance of cash reserve ratio.
2. Write short notes on any four of the following:                             4x4=16
a)         Indian accounting standard.
b)         Balance Sheet ratios.
c)          Sustainability reporting.
d)         NBFC.
e)         Demand and time liabilities.
f)          Insurance contracts.
3. (a) “Analysis of financial statements is the best way to judge the overall financial health of a company.” Explain the statement with your justification.                                            12
Or
(b) What is common-size income statement? State the steps for preparation of common-size income statement.   4+8=12
4. (a) Describe the principle ratios which you consider significant while interpreting the financial statement of a company and explain the inferences which may be drawn from them.       11
Or
(b) The following information is given about PD Ltd. for the year ended 31st March, 2017:
 Current ratioAcid-test ratio Current liabilities 2.5 : 11.5 : 1Rs. 50,000
Find out:
1)         Current assets;
2)         Liquid assets;
3)         Inventory.                        4+3+4=11
5. (a) Define financial reporting. What are the benefits derived from financial reporting?     4+7=11
Or
(b) What is corporate social responsibility reporting? Explain the present legal provisions of corporate social responsibility and its reporting practices in India.                           4+7=11
6. (a) What are Accounting Standards? Why is it necessary to convergence the Indian GAAP with IFRS in Indian accounting practices?                            3+8=11
Or
(b) What is international financial reporting standard (IFRS)? What are the differences between IFRS and AS? 3+8=11
7. (a) Discuss all the important provisions of Banking Regulation Act, 1949 for Banking Companies.      11
Or
(b) Write brief note on IRDA. Discuss the impacts of IFRS on insurance industry in India.      3+8=11

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