Financial Statement
Analysis Solved Question Paper 2023 (May / June)
COMMERCE (Discipline
Specific Elective)
(For Honours and
Non-Honours)
Paper: DSE-602 (GR-I)
(Financial Statement
Analysis)
Full
Marks: 80
Pass Marks: 32
Time: 3 hours
The figures in the margin
indicate full marks for the questions
1. Write True or False: 1x4=4
(a) Financial statements disclose only monetary facts.
Ans: True
(b) Current ratio is calculated to compute current assets and fixed
liabilities.
Ans: False
(c) IFRS 4 is associated with insurance contract.
Ans: True
(d) The Corporate Governance Rules were notified on 25th
March, 2014 under the Companies Act, 2013.
Ans: False
2. Fill in the blanks: 1x4=4
(a) Profit & Loss A/c is also known as ______.
Ans: Income Statement
(b) CRR stands for ______.
Ans: Cash Reserve Ratio
(c) Common-size statement analysis is also known as ______.
Ans: Vertical
Analysis
(d) Reporting of corporate governance reflects ______.
Ans: Socio-economic status
3. Write short notes on
(any four): 4x4=16
(a) Comparative Income
Statement.
Ans: Comparative Statements: These are the statements showing the profitability
and financial position of a firm for different periods of time in a comparative
form to give an idea about the position of two or more periods. It usually
applies to the two important financial statements, namely, balance sheet and
statement of profit and loss prepared in a comparative form. The financial data
will be comparative only when same accounting principles are used in preparing
these statements. If this is not the case, the deviation in the use of
accounting principles should be mentioned as a footnote. Comparative figures
indicate the trend and direction of financial position and operating results.
This analysis is also known as ‘horizontal analysis’.
Comparative Income statement is a type
of Comparative statement in which profit and loss account of two or more period
of a firm is compared to get an idea about the operative efficiency of the
firm.
Merits of
Comparative Financial Statements:
a)
Comparison of financial statements
helps to identify the size and direction of changes in financial position of an
enterprise.
b)
These statements help to ascertain
the weakness and soundness about liquidity, profitability and solvency of an
enterprise.
c)
These statements help the
management in making forecasts for the future.
Demerits
of Comparative Financial Statements:
a)
Inter-firm comparison may be
misleading if the firms are not of the same age and size, follow different
accounting policies.
b)
Inter-period comparison will also
be misleading if there are frequent changes in accounting policies.
(b) Value-added Statement.
Ans:
Value Added Statement is a financial statement that depicts wealth created by
an organization and how is that wealth distributed among various stakeholders.
The various stakeholders comprise of the employees, shareholders, government,
creditors and the wealth that is retained in the business. As per the concept of Enterprise
Theory, profit is calculated for various stakeholders by an organization. Value
Added is this profit generated by the collective efforts of management,
employees, capital and the utilization of its capacity that is distributed
amongst its various stakeholders. Consider
a manufacturing firm. A typical firm would buy raw materials from the market.
Process the raw materials and assemble them to produce the finished goods. The
finished goods are then sold in the market. The additional work that the firm
does to the raw materials in order for it to be sold in the market is the value
added by that firm. Value added can also be defined as the difference between
the value that the customers are willing to pay for the finished goods and the
cost of materials.
Advantages of a
Value Added Statement
a)
It is easy to calculate.
b)
Helps a company to apportion the
value to various stakeholders. The company can use this to analyze what
proportion of value added is allocated to which stakeholder.
c)
Useful for doing a direct
comparison with your competitors.
d) Useful for internal comparison purposes and to devise
employee incentive schemes.
(c) Balance Sheet Ratio.
Ans: Balance Sheet Ratio: This ratio
is also known as financial ratios. The ratios which express relationships
between two items or group of items mentioned in the balance sheet at the end
of the year. Example: Current
ratio, Liquid ratio, Stock to Working Capital ratio, Capital Gearing ratio,
Proprietary ratio, etc.
(d) Non-Banking Financial
Company.
Ans: 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.
(e) Corporate Governance.
Ans: Corporate
governance is the system of
rules, practices and processes by which a company is directed and controlled. Corporate governance essentially involves balancing the
interests of a company's many stakeholders, such as shareholders, management,
customers, suppliers, financiers, government and the community.
Corporate
governance is concerned with holding the balance between economic and social
goals and between individual and communal goals. The corporate governance
framework is there to encourage the efficient use of resources and equally to
require accountability for the stewardship of those resources. This article
outlines the relationship between corporate governance and corporate social
responsibility (CSR). It begins by examining the role of corporate governance
in creating value for shareholders. It focuses on the actions of the
corporation and the board toward its shareholders and other stakeholders, i.e.,
how corporate governance serves or fails to serve their interests. It covers
the assumptions that underlie theories of corporate governance and the expected
outcomes of various board structures and compositions. It then examines the
state of corporate democracy, the issue of accountability, and key legislation
relative to corporate governance.
James D. Wolfensohn
"Corporate Governance is about promoting corporate fairness, transparency
and accountability".
In the
words of Robert Ian (Bob) Tricker, "Corporate Governance is concerned with
the way corporate entities are governed, as distinct from the way business
within those companies is managed. Corporate governance addresses the issues
facing Board of Directors, such as the interaction with top management and
relationships with the owners and others interested in the affairs of the
company"
👉Also Read:
Financial Statements Analysis Solved Question Paper 2014
Financial Statements Analysis Solved Question Paper 2015
4. (a) What constitutes
financial statements? Explain the limitations of financial statements. 7+7=14
Ans: Meaning of Financial Statements
Financial
statements are the summarized statements of accounting data produced at the end
of accounting process by an enterprise through which accounting information are
communicated to the internal and external users.
The
American Institute of Certified Public Accountants states the nature of
financial statements as “Financial Statements are prepared for the purpose of
presenting a periodical review of report on progress by the management and deal
with the status of investment in the business and the results achieved during
the period under review. They reflect a combination of recorded facts,
accounting principles and personal judgments.”
In the words of Myer,” The financial statements provide a
summary of accounts of a business enterprise, the balance sheet reflecting the assets,
liabilities and capital as on a certain date and income statement showing the
result of operations during a certain period”.
Types
of Financial statements
A set of
financial statements includes (Types):
a)
Profit and loss account or Income
statements
b)
Balance sheet or Position
statements
c)
Cash flow statements
d)
Funds flow statements or
e)
Schedules and notes to accounts.
a) Profit
and loss account or income statement: Income statement is one of the
financial statements of business enterprises which shows the revenues,
expenses, and profits or losses of business enterprises for a particular period
of time. Its main aim to show the operating efficiency of the enterprises.
Income Statement is sometime called the statement of financial performance
because this statement let the users to assess and measure the financial
performance of entity from period to period of the same entity or with
competitors.
b) Balance
sheet or Position statement: Balance Sheet is sometime called
statement of financial position. It shows the balance of assets, liabilities
and equity at the end of the period of time. Balance sheet is sometime called
statement of financial position since it shows the values of net worth of
entity. The net worth of the entity can be obtained by deducting liabilities
from total assets. It is different from income statement since balance sheet
report account’s balance as on a particular date while income statement report
that the account’s transactions during a particular period of time.
c) Cash
flow statement: A Cash Flow Statement is similar to the Funds
Flow Statement, but while preparing funds flow statement all the current assets
and current liabilities are taken into consideration. But in a cash flow
statement only sources and applications of cash are taken into consideration,
even liquid asset like Debtors and Bills Receivables are ignored. A Cash Flow
Statement is a statement, which summarises the resources of cash available to
finance the activities of a business enterprise and the uses for which such resources
have been used during a particular period of time. Any transaction, which
increases the amount of cash, is a source of cash and any transaction, which
decreases the amount of cash, is an application of cash. Simply, Cash Flow is a statement which analyses the reasons for
changes in balance of cash in hand and at bank between two accounting period.
It shows the inflows and outflows of cash.
d) Funds flow statement: The financial
statement of the business indicates assets, liabilities and capital on a particular
date and also the profit or loss during a period. But it is possible that there
is enough profit in the business and the financial position is also good and
still there may be deficiency of cash or of working capital in business.
Financial statements are not helpful in analysing such situation. Therefore, a
statement of the sources and applications of funds is prepared which indicates
the utilisation of working capital during an accounting period. This statement
is called Funds Flow statement.
e) Schedule and
notes to account: The notes to the
financial statements are integral part of a company's external financial
statements. They are necessary because not all relevant financial information
can be communicated through the amounts shown (or not shown) on the face of the
financial statements. Generally, the notes are the main method for complying
with the full disclosure principle and are also referred
to footnote disclosures. The first note to the financial statements is
usually a summary of the company's significant accounting policies for the use
of estimates, revenue recognition, inventories, property and equipment,
goodwill and other intangible assets, fair value measurement, discontinued
operations, foreign currency translation, recently issued accounting
pronouncements, and others.
Limitations of financial statements
Financial Statements suffers from various limitations which are given
below:
(i) Historical Records: Persons like shareholders, investors etc., are
mainly interested in knowing the likely position in future. The financial
statements are not of much help as the information given in these statements is
historic in nature and does not reflect the future.
(ii) Ignores Price Level Changes: Price level change and purchasing power
of money are inversely related. Different assets are shown at the historical
cost in financial statements. It, therefore, ignore the price level change or
present value of the assets.
(iii) Qualitative aspect Ignored: Financial statements considered only
those items which can be expressed in terms of money. Financial Statements
ignores the qualitative aspect such as quality of management, quality of labour
force, Public relations.
(iv) Suffers from the Limitations of financial statements: Since analysis
of financial statements is based on the information given in the financial
statements, it suffers from all such limitations from which the financial
statements suffer.
(v) Not free from Bias: Financial statements are largely affected by the
personal judgement of the accountant in selecting accounting policies.
Therefore, financial are not free from bias.
(vi) Variation is accounting practices: Different firms follow different
accounting practices. For example, depreciation can be provided either on SLM
basis or WDV basis. Profits earned or loss suffered will be different when
different practices are followed. Therefore, a meaningful comparison of their
financial statements is not possible.
Or
(b) What is financial
statement analysis? Explain the various techniques of financial statement
analysis. 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.
Tools
of Analysis of Financial Statements
The most
commonly used techniques of financial analysis are as follows:
1. Comparative
Statements: These
are the statements showing the profitability and financial position of a firm
for different periods of time in a comparative form to give an idea about the
position of two or more periods. It usually applies to the two important
financial statements, namely, balance sheet and statement of profit and loss
prepared in a comparative form. The financial data will be comparative only
when same accounting principles are used in preparing these statements. If this
is not the case, the deviation in the use of accounting principles should be
mentioned as a footnote. Comparative figures indicate the trend and direction
of financial position and operating results. This analysis is also known as
‘horizontal analysis’.
Merits of
Comparative Financial Statements:
d)
Comparison of financial statements
helps to identify the size and direction of changes in financial position of an
enterprise.
e)
These statements help to ascertain
the weakness and soundness about liquidity, profitability and solvency of an
enterprise.
f)
These statements help the
management in making forecasts for the future.
Demerits
of Comparative Financial Statements:
c)
Inter-firm comparison may be
misleading if the firms are not of the same age and size, follow different
accounting policies.
d)
Inter-period comparison will also
be misleading if there are frequent changes in accounting policies.
2. Common Size
Statements: These
are the statements which indicate the relationship of different items of a
financial 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 and financing characteristics of two companies
of different sizes in the same industry. Thus, common size 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 Statements:
a)
A common size 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
financial statements.
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 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 are frequent changes in accounting policies.
3. Trend Analysis: It is a technique of studying the
operational results and financial position over a series of years. Using the
previous years’ data of a business enterprise, trend analysis can be done to
observe the percentage changes over time in the selected data. The trend
percentage is the percentage relationship, in which each item of different
years bears to the same item in the base year. Trend analysis is important
because, with its long run view, it may point to basic changes in the nature of
the business. By looking at a trend in a particular ratio, one may find whether
the ratio is falling, rising or remaining relatively constant. From this
observation, a problem is detected or the sign of good or poor management is
detected.
Merits of
Trend analysis:
a)
Trend percentages can be presented
in the form of Index Numbers showing relative change in the financial
statements during a certain period.
b)
Trend analysis will exhibit the
direction to which the concern is proceeding.
c)
The trend ratio may be compared
with the industry, in order to know the strong or weak points of a concern.
Demerits
of Common Size Statements:
a) These
are calculated only for major items instead of calculating for all items in the
financial statements.
b)
Trend values will also be
misleading if there are frequent changes in accounting policies.
4. Ratio Analysis: It describes the significant
relationship which exists between various items of a balance sheet and a
statement of profit and loss of a firm. As a technique of financial analysis,
accounting ratios measure the comparative significance of the individual items
of the income and position statements. It is possible to assess the
profitability, solvency and efficiency of an enterprise through the technique
of ratio analysis.
5. Funds
flow statement: The financial
statement of the business indicates assets, liabilities and capital on
a particular date and also the profit or loss during a period. But it is
possible that there is enough profit in the business and the financial position
is also good and still there may be deficiency of cash or of working capital in
business. Financial statements are not helpful in analysing such situation.
Therefore, a statement of the sources and applications of funds is prepared
which indicates the utilisation of working capital during an accounting period.
This statement is called Funds Flow statement.
6. Cash Flow Analysis: A Cash Flow Statement is similar to
the Funds Flow Statement, but while preparing funds flow statement all the
current assets and current liabilities are taken into consideration. But in a
cash flow statement only sources and applications of cash are taken into
consideration, even liquid asset like Debtors and Bills Receivables are
ignored. A Cash Flow Statement is a statement, which summarises the resources
of cash available to finance the activities of a business enterprise and the
uses for which such resources have been used during a particular period of
time. Any transaction, which increases the amount of cash, is a source of cash
and any transaction, which decreases the amount of cash, is an application of
cash. Simply, Cash Flow is a
statement which analyses the reasons for changes in balance of cash in hand and
at bank between two accounting period. It shows the inflows and outflows of
cash.
5. (a) A company has owner’s equity of Rs. 1,00,000 and following
accounting ratios:
Short-term debt to total debt = 0.40
Total debt to owner’s equity = 0.60
Fixed assets to owner’s equity = 0.60
Total assets turnover = 2 times.
Inventory turnover = 8 times.
On the basis of the above data prepare the Balance Sheet:
|
Capital & Liabilities |
Rs. |
Assets |
Rs. |
|
Short-term Debts Long-term Debts Owner’s Equity |
-- -- -- |
Cash Inventories Total Current Assets Fixed Assets |
-- -- -- |
Or
(b) Explain the following
(any four): 3½ x 4 =
14
(1) Ratio Analysis.
Ans: 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."
(2) Liquidity ratio.
Liquidity
is the ability of the firm to meet its current liabilities as they fall due.
Since the liquidity is basic to continuous operations of the firm, it is
necessary to determine the degree of liquidity of the firm. These are important
because liquidity is close to the heart of the firm. A firm may have a high
level of long term assets and substantial net income, but if they do not have
enough cash on hand or assets that can be turned into cash fairly quickly, they
will not be able to operate day to day.
The
liquidity ratios examine the current portion of the balance sheet: current
assets and current liabilities. The implicit assumption is that current assets
will be used to pay off current liabilities. This makes sense due to the
matching principle (match the maturity of the debt with the duration of the
need) e.g. one would not take a five-year bank loan to pay off an account
payable due in thirty days. There are two ratios that determine how liquid a
firm is: the current ratio and quick ratio
(3) Return on investment.
Ans: Return
on Investment or Return on Capital Employed: This
ratio shows the relationship between the profit earned before interest and tax
and the capital employed to earn such profit.
Return on
Capital Employed = Net Profit before Interest, Tax and Dividend/Capital
Employed x 100
Where Capital
Employed = Share Capital (Equity + Preference) + Reserves and Surplus +
Long-term Loans – Fictitious Assets
Or
Capital
Employed = Fixed Assets + Current Assets – Current Liabilities
Objective
and Significance: Return on capital employed measures the profit, which a firm
earns on investing a unit of capital. The profit being the net result of all
operations, the return on capital expresses all efficiencies and inefficiencies
of a business. This ratio has a great importance to the shareholders and investors
and also to management. To shareholders it indicates how much their capital is
earning and to the management as to how efficiently it has been working. This
ratio influences the market price of the shares. The higher the ratio, the
better it is.
(4) Operating profit
ratio.
Ans: Operating
Profit Ratio: Operating Profit Ratio shows the relationship
between Operating Profit and Net Sales. Operating Profit Ratio can be
calculated in the following manner:
Operating
Profit Ratio = (Operating Profit/Net Sales) x 100
Where
Operating Profit = Gross Profit – Operating Expenses
Or
Operating Profit = Net Profit + Non-Operating Expenses – Non Operating Incomes
And Net
Sales = Total Sales – Sales Return
Objective
and Significance: Operating Profit Ratio indicates the earning capacity of the
concern on the basis of its business operations and not from earning from the
other sources. It shows whether the business is able to stand in the market or
not.
(5) Debtors turnover
ratio.
Ans: Debtors turnover ratio indicates
the relation between net credit sales and average accounts receivables of the
year. This ratio is also known as Debtors’ Velocity.
Debtors
Turnover Ratio = Net Credit Sales/Average Accounts Receivables
Where
Average Accounts Receivables = [Opening Debtors and B/R + Closing Debtors and
B/R]/2
Credit
Sales = Total Sales – Cash Sales-Return Inward
Objective
and Significance: This ratio indicates the efficiency of the concern to collect
the amount due from debtors. It determines the efficiency with which the trade
debtors are managed. Higher the ratio, better it is as it proves that the debts
are being collected very quickly.
6. (a) Define financial
reporting. What are the benefits derived from financial reporting? 4+10=14
Ans: Basically, financial reporting is
the process of preparing, presenting and circulating the financial information
in various forms to the users which helps in making vigilant planning and
decision making by users. The core objective of financial reporting is to
present financial information of the business entity which will help in
decision making about the resources provided to the reporting entity and in
assessing whether the management and the governing board of that entity have
made efficient and effective use of the resources provided. Financial reporting
is of two types – Internal reporting and external reporting. The financial
report made to the management is generally known as internal reporting and the
financial report made to the shareholders and creditors is generally known as
external reporting. The internal reporting is a part of management information
system and they use MIS reporting for the purpose of analysis and as an aid in
decision making process.
The components of financial reporting are:
a)
The financial statements – Balance Sheet, Profit &
loss account, Cash flow
statement & Statement of changes in stock holder’s equity
b)
The notes to financial statements
c)
Quarterly &
Annual
reports (in case
of listed companies)
d)
Prospectus (In
case of companies going for IPOs)
e)
Management Discussion &
Analysis (In
case of public companies)
Objectives
(Purposes) and significance of Financial reporting:
Financial reporting
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 reporting 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 reporting 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 reporting, Long-term as well as short-term
solvency of the concern can be judged. Trade creditors or suppliers are mainly
interested in assessing the liquidity position for which they look into the
following:
Ø Whether
the current assets are sufficient to pay off the current liabilities.
Ø The
proportion of liquid assets to current assets.
e)
Indicating
the trend of Achievements: Financial statements of the
previous years can be compared and the trend regarding various expenses,
purchases, sales, gross profits and net profit etc. can be ascertained. Value
of assets and liabilities can be compared and the future prospects of the
business can be envisaged.
f)
Inter-firm Comparison: Inter-firm
comparison becomes easy with the help of financial analysis. It helps in
assessing own performance as well as that of others.
g)
Understandable: Financial reporting 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) What is a corporate
social responsibility reporting? Explain the present legal provisions of
corporate social responsibility and its reporting practice in India. 4+10=14
Ans:
Meaning of Corporate Social Responsibility (CSR)
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.
RECENT
DEVELOPMENTS IN CORPORATE SOCIAL RESPONSIBILITY: UNDER NEW COMPANIS ACT, 2013
Corporate Social Responsibility (CSR)
is a continuous commitment by the business houses and the corporate to
contribute towards inclusive growth in the society. CSR is the process by which
an organization thinks about and evolves its relationships with stakeholders
for the common good, and demonstrates its commitment in this regard by adoption
of appropriate business processes and strategies. Thus CSR is not charity or
mere donations. CSR is a way of conducting business, by which corporate
entities visibly contribute to the social good. Socially responsible companies
do not limit themselves to using resources to engage in activities that
increase only their profits. They use CSR to integrate economic, environmental
and social objectives with the company’s operations and growth. CSR is often
called the triple bottom-line approach – Sustainability in Environment, Social
Community & Business.
Changing nearly six decades (57 Years)
old regulations for corporate reporting, the new Companies Act 2013 makes it
mandatory for certain class of profitable enterprises to spend profits on
social welfare activities. Under Section 135 (5) of the new Companies Act, 2013,
passed by Parliament in August 2013, profitable companies must spend every year
at least 2 per cent of their average net profit over the preceding three years
on CSR works and shall not include profits arising from branches outside India.
This mandatory CSR-spend rule will apply from fiscal 2014-15 onwards. The
Ministry of Corporate Affairs, vide its Notification dated 11 October 2018, has
reconstituted the High Level Committee on Corporate Social Responsibility. The
Scope of the said committee is to review existing framework under the Companies
Act, 2013, regarding CSR, recommend guidelines for enforcement of CSR
provisions, suggest measures for adequate monitoring and evaluation of CSR by
companies and examine and recommend audit (financial, performance, social) for CSR, as well as
analyse outcomes of CSR activities/programmes/projects.
Present
Corporate Social Responsibility Norms in India
Applicability: As
per Section 135 of the Act and rules issued there under, CSR norms are
applicable on companies which have (a) net worth of Rs 500 Crore or more; (b)
turnover of Rs 1000 Crore or more; or (c) net profit of Rs 5 Crore or more.
Compliance: The
companies, crossing the prescribed threshold, are required to spend at least 2%
of their average net profit for the immediately preceding 3 financial years on
CSR activities. Such expenditure incurred on the CSR activities cannot be taken
as an expenditure incurred by the company being an assessee for the purposes of
the business or profession. Further, no specific tax exemptions have been
extended to CSR expenditure per se.
Other key requirements include constitution of
a committee of the Board of Directors consisting of 3 or more directors,
formulation of the Corporate Social Responsibility Policy by the Board of
Directors on the recommendation of the CSR Committee, undertaking the CSR
activities and spending the prescribed amount of expenditure on CSR activities
as per CSR Policy and recommendations of CSR Committee and monitoring effective
implementation of CSR Policy.
Board's Responsibility: The
Board of Directors are required to disclose in their report the composition of
the CSR Committee and other compliance undertaken by the company and place it
on company's website. If the company fails to spend the prescribed amount on
CSR activities, the Board is also required to specify the reasons for not
spending the amount in their report.
Penal provisions: At
present, there is no penal provision for non-compliance under CSR norms.
However, penalties can be levied of the Act for not making the required
disclosures in Board's report on an annual basis besides prosecution of the
officers of the company in default.
Activities which may be included by companies in their Corporate
Social Responsibility Policies relating to:
a)
Eradicating extreme hunger and
poverty;
b)
Promotion of education;
c)
Promoting gender equality and
empowering women;
d)
Reducing child morality and
improving maternal health;
e)
Combating human immunodeficiency
virus (HIV), acquired immune deficiency syndrome, (AIDS), malaria and other
diseases;
f)
Ensuring environmental
sustainability;
g)
Employment enhancing vocational
skills;
h)
Social business projects;
i)
Contribution to the Prime
Minister’s National Relief Fund or any other fund set up by the Central
Government or the State Governments for socio-economic development and relief
and funds for the welfare of the Scheduled Castes, the Scheduled Tribes, other
backward classes, minorities and women; and
j)
Such other matters as may be
prescribed.
Current Status of CSR in India
Today,
the basic objective of CSR is to maximize the company’s overall impact on the
society as well as on the stakeholders. An increasing number of companies are
comprehensively integrating CSR policies, practices and programs throughout
their business operations and processes. CSR is perceived not just another form
of indirect expense but an important tool for protecting and enhancing the
goodwill, defending attacks and increasing competitiveness.
Companies
have stated having specialized CSR teams that formulate strategies, policies
and goals for their CSR programs and include in their budgets to fund them.
These programs are determined by social philosophy and have clear objectives.
Also, they are aligned with the mainstream business. These CSR programs are
implemented by the employees crucial to the process. CSR programs range from
community development to development in environment, education and healthcare
etc.
For
instance, corporations such as Bharat Petroleum Corporation Limited, Hindustan
Unilever Limited and Maruti Suzuki India Limited have adopted a more
comprehensive method of development. Building schools and houses and empowering
the villagers, provision of improved medical and sanitation facilities, making
them self-reliant by providing vocational training and knowledge of business
operations are the facilities focused on by these corporations.
On
the other hand, corporations like GlaxoSmithKline Pharmaceuticals’ focus on
health related aspects of the community through their CSR programs. They set up
health camps in remote tribal villages offering medical check-ups and treatment
and also undertake health awareness programs.
Nowadays,
corporates are joining hands with various NGOs and use their expertise in
devising effective CSR programs to address wider societal problems. In India,
the CSR multi-stakeholder approach is fragmented. Interaction between business
and civil societies, especially trade unions, is still rare, usually taking
place on an ad-hoc basis. The understanding of CSR in India is still not
directly linked to the multi-stakeholder approach. A few companies in India
that have successfully integrated sustainability into their business processes
are discussed below.
7. (a) Write a brief note
on IRDA. Discuss the impacts of IFRS on Insurance Industry in India. 14
Financial
Reporting Requirements of Insurance Companies in India
To protect
the interests of policyholders and to increase transparency and credibility of
insurance companies there is a need to have an effective regulatory system for
financial reporting of insurance companies. Reporting requirements of insurance
companies are different from that of other companies, because of the concept of
policyholders and shareholders’ fund, segment reporting in respect of all the
funds maintained by the company, complexity of insurance contracts and
insurance itself is an intangible product.
Earlier
the accounts of insurance companies were governed by Insurance Act 1938, but
passing of Insurance Regulatory Development Authority Act (IRDA Act) in 1999
opened a new chapter for disclosure norms of insurance companies. In the year
2002, the IRDA came up with regulations for the preparation of the financial
statements of insurance companies. According to the Insurance (Amendment) Act,
2002, the first, second and third schedules prescribed for balance sheet,
profit and loss account and revenue account respectively as given in Insurance
Act, 1938 have been omitted. Now revenue account, profit and loss account and
balance sheet are to be prepared as per the formats prescribed by IRDA.
However, the statutes governing financial reporting practices of insurance
companies in India are: Insurance Act 1938, IRDA Act, 1999 (including IRDA Regulations),
Companies Act and Institute of Chartered Accountants of India (ICAI).
IRDA Act 1999 (Including IRDA Regulations)
Insurance
Regulatory Development Authority (IRDA) has prescribed various regulations from
time to time. Preparation of Financial Statements and Auditor’s Report of
Insurance Companies Regulations, 2002 are one of them. These regulations are
related to the financial reporting practices of insurance companies. These
regulations are important constituents of the Indian regulatory regime.
According to the regulations made by the authority in consultation with the
Insurance Advisory Committee, accounts of insurance companies are prepared
according to the prescribed formats given by the authority. Details are given
as under:
a)
Preparation of Financial Statements: After the commencement of Insurance
Regulatory Development Authority, Regulations, 2002, all the life insurance
companies shall comply with the requirements of Schedule A and general
insurance companies with Schedule B of these regulations while preparing their
financial statements. The auditor’s report on the financial statements of all
insurance companies shall be in conformity with the requirements of Schedule C.
IRDA given the list of items to be disclosed in the financial statements of
insurance companies under Part II of Schedule A (for life insurance companies)
and Schedule B (for general insurance companies) of the (Preparation of
Financial Statements and auditor’s report of Insurance Companies) Regulations,
2002. According to these regulations, following disclosure will form part of
financial statements of insurance companies:
1.
Every insurance company will
disclose all significant accounting policies and accounting standards followed
by them in the manner required under Accounting Standard I issued by the
Institute of Chartered Accountants of India. (ICAI).
2.
All companies will separately
disclose if there is any departure from the accounting policies with reasons
for such departure.
3.
Disclosure of investments made in
accordance with statutory requirements separately together with its amount,
nature, security and any special rights in and outside India.
4.
Disclosure of performing and
non-performing investments separately.
5.
Disclosure of assets to the extent
required to be deposited under local laws for otherwise encumbered in or
outside India.
6.
All the companies are required to
show sector-wise percentage of their business.
7.
To include a summary of financial
statements for the last five years in their annual report to be prepared as
prescribed by the IRDA.
8.
Disclose the basis of allocation
of investments and income thereon between policyholders’ account and
shareholders’ account.
9.
To disclose accounting ratios as
prescribed by the Insurance Regulatory and Development Authority.
Disclosure
of following items is made by way of notes to balance sheet:
1.
Contingent Liabilities.
2.
Actuarial assumptions for
valuation of liabilities for life policies in force.
3.
Encumbrance’s to assets of the
company in and outside India.
4.
Commitments made and outstanding
for loans, investments and fixed assets.
5.
Basis of amortization of debt
securities.
6.
Claims settled and remaining
unpaid for a period of more than six months as on the balance sheet date.
7.
Value of contracts in relation to investments,
for purchases where deliveries are pending and sales where payments are
overdue.
8.
Operating expenses relating to
insurance business and basis of allocation of expenditure to various segments
of business.
9.
Computation of managerial
remuneration.
10.
Historical costs of those
investments valued on fair value basis.
11.
Basis of revaluation of investment
property.
b)
Management Report: According to the IRDA Regulations 2002, all the insurance
companies are required to attach a management report to their financial
statements. The contents of the management report are given under PART IV
(Schedule A and Schedule B) of these regulations and reproduced below:
1.
Confirmation regarding the
continued validity of the registration granted by the IRDA.
2.
Certification that all the dues
payable to the statutory authorities has been duly paid.
3.
Confirmation to the effect that
the shareholding patterns and the transfer of shares during the year are in
accordance with the statutory or regulatory requirements.
4.
Declaration that the management
has not directly or indirectly invested outside India the funds of the
policyholders.
5.
Confirmation regarding required
solvency margins.
6.
Certification to the effect that
no part of the life insurance fund has been directly or indirectly applied in
contravention of the provisions of the Insurance Act, 1938 (4 of 1938) relating
to the application and investment of the life insurance funds.
7.
Disclosure with regard to the
overall risk exposure and strategy adopted to mitigate the same.
8.
Operations in other countries, if
any, with a separate statement giving the management’s estimate of country risk
and exposure risk and the hedging strategy adopted.
9.
Ageing of claims indicating the
trends in average claim settlement time during the preceding five years.
10.
Certification to the effect as to
how the values, as shown in the balance sheet, of the investments and stocks
and shares have been arrived at, and how the market value thereof has been
ascertained for the purpose of comparison with the values so shown.
11.
Review of assets quality and
performance of investment in terms of portfolio, i.e. separately in terms of
real estate, loans, investments. Etc.
12.
A schedule payment, which have
been made to individuals, firms, companies and organizations in which directors
of the insurance company are interested.
13)
A responsibility statement indicating therein that:
Ø In
the preparation of financial statements, the applicable amounting standards,
principles and policies have been followed along with proper explanations
relating to material departures, if any;
Ø The
management has adopted accounting policies and applied them consistently and
made judgements and estimates that are reasonable and prudent so as to give a
true and fair view of the state of affairs of the company at the end of the
financial year and of the operating profit or loss and of the profit or loss of
the company for the year;
Ø The
management has taken proper and sufficient care for the maintenance of adequate
accounting records in accordance with the applicable provisions of the
Insurance Act, 1938 and Companies Act 1956 for safeguarding the assets of the
company and for preventing and detecting fraud and other irregularities;
Ø The
management has prepared the financial statements on a going concern basis;
Ø The
management has ensured that an internal audit system commensurate with the size
and nature of the business exists and is operating effectively.
Or
(b) Discuss the important
provisions need to be taken into consideration for financial reporting of
NBFCs. 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:
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.
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 have
been provided in details in the RBI Directions, namely “Non-Systemically
Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies
Prudential Norms (Reserve Bank) Directions, 2015” and “Systemically Important
Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential
Norms (Reserve Bank) Directions, 2015”.
RBI
has prescribed that Income recognition should be based on recognised accounting
principles, however Accounting
Standards and Guidance Notes issued by the Institute of Chartered Accountants
of India (referred to in these
Directions as “ICAI” shall be followed in so far as they are not inconsistent
with any of these Directions.
Income
Recognition
1. The
income recognition of NBFCs, irrespective of their categorisation, shall be
based on recognised accounting principles.
2. Income
including interest/ discount/ hire charges/ lease rentals or any other charges
on NPA shall be recognised only when
it is actually realised. Any such income recognised before the asset became
non-performing and remaining
unrealised shall be reversed.
3. Income
like interest /discount /any other charges on NPAs shall be recognised only
when actually realised, RBI also
requires that income recognised before asset becoming NPA should be reversed in
the financial year in which such
asset becomes NPA.
4. The
NBFCs are required to recognise income from dividends on shares of corporate
bodies and units of mutual funds on
cash basis, unless the company has declared the dividend in AGM and right of
the company to receive the same has
been established, in such cases, it can be recognized on accrual basis.
5. Income
from bonds and debentures of corporate bodies and from government securities/bonds
may be taken into account on accrual
basis provided it is paid regularly and is not in arrears.
6. Income
on securities of corporate bodies or public sector undertakings may be taken
into account on accrual basis
provided the payment of interest and repayment of the security has been
guaranteed by Central Government.
Principles for accounting of
Investments
Investing is one of the core activities of
NBFCs, hence RBI requires the Board of Directors to Frame investment policy
of the company and implement the same. The investments in securities
shall be classified into current and long term, at the time of making each investment.
The Board of the company should include in the investment policy the criteria
for classification of investments into current and long-term. The
investments need to be classified into current or long term at the time of
making each investment. There can be no inter-class transfer of
investments on ad hoc basis later on. Inter class transfer, if warranted, should
be done at the beginning of half year, on April 1 or October 1, and with the
approval of the Board. The investments shall be transferred scrip-wise,
from current to long-term or vice-versa, at book value or market value,
whichever is lower;
The depreciation, if any, in each scrip shall
be fully provided for and appreciation, if any, shall be ignored.
Moreover, the depreciation in one scrip shall
not be set off against appreciation in another scrip, at the time of such
inter-class transfer, even in respect of the scrips of the same category.
Valuation of Investments
A) The
directions also specifies various valuation guidelines in respect of Quoted and
Unquoted current investments leaving the Long Term Investments to be valued as
per ICAI Accounting Standards. It requires Quoted current investments to
be grouped into specified categories, viz. (i) equity shares, (ii) preference
shares, (iii) debentures and bonds, (iv) Government securities including
treasury bills, (v) units of mutual fund, and (vi) others.
The valuation of each specified category is to
be done at aggregate cost or aggregate market value whichever is lower. For
this purpose, the investments in each category shall be considered scrip-wise
and the cost and market value aggregated for all investments in each category.
If the aggregate market value for the category is less than the aggregate cost
for that category, the net depreciation shall be provided for or charged to the
profit and loss account. If the aggregate market value for the category exceeds
the aggregate cost for the category, the net appreciation shall be ignored.
Depreciation in one category of investments shall not be set off against
appreciation in another category.
B) Unquoted equity shares in the nature of
current investments shall be valued at cost or break-up value, whichever is
lower. However, the RBI Directions has prescribed that fair value for the
break-up value of the shares may be replaced, if considered necessary.
C) Unquoted preference shares in the nature
of current investments shall be valued at cost or face value, whichever is
lower.
D) Investments in unquoted Government
securities or Government guaranteed bonds shall be valued at carrying cost.
E) Unquoted investments in the units of
mutual funds in the nature of current investments shall be valued at the
net asset value declared by the mutual fund in respect of each particular
scheme.
F) Commercial papers shall
be valued at carrying cost.
G) A long term investment shall
be valued in accordance with the Accounting Standard issued by ICAI.
Preparation of Balance Sheet and
Profit and Loss Account
1.
Every non-banking financial
company shall prepare its balance sheet and profit and loss account as on March
31 every year. Whenever a non-banking financial company intends to extend
the date of its balance sheet as per provisions of the Companies Act, it
should take prior approval of the Reserve Bank of India before approaching
the Registrar of Companies for this purpose.
2.
Further, even in cases where the
Bank and the Registrar of Companies grant extension of time, the nonbanking financial
company shall furnish to the Bank a proforma balance sheet (unaudited) as on
March 31 of the year and the statutory returns due on the said date.
Every non-banking financial company shall finalise its balance sheet
within a period of 3 months from the date to which it pertains.
3.
Every non-banking financial
company shall append to its balance sheet prescribed under the Companies Act,
2013, the particulars in the schedule as set out in Annex I.
Disclosures in the Balance Sheet
1.
The directions specify certain
disclosure requirements in the balance sheet.
2.
Disclosure of provisions created
without netting them from the income or against the value of assets. The
provisions shall be distinctly indicated under separate heads of account as (i)
Provisions for bad and doubtful debts; and (ii) Provisions for depreciation in
investments.
3.
Provisions shall not be
appropriated from the general provisions and loss reserves held. Provisions
shall be debited to the profit and loss account.
4.
The excess of provisions, if any,
held under the heads general provisions and loss reserves may be written back
without making adjustment against the provisions.
5.
Every non-banking financial
company shall append to its balance sheet prescribed under the Companies Act,
2013, the particulars in the schedule as set out in Annex I.
6.
The following disclosure
requirements are applicable only to systemically important (Asset Size more
than Rs. 500 crores) non-deposit taking non-banking financial company:
a)
Capital to Risk Assets Ratio
(CRAR);
b)
Exposure to real estate sector,
both direct and indirect; and
c)
Maturity pattern of assets and
liabilities.”
7. The formats for the above disclosures are
also specified by RBI.
***
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