Question Bank for Practice

1. Financial Statements
Meaning : The ‘Framework for Preparation and Presentation of Financial Statements’
issued by the Institute of Charted Accountant of India deals with the various aspects of
financial statements. A complete set of financial statements normally includes a balance
sheet, a statement of profit and loss (also known as income statement’), å cash flow
statement and those notes and other statements and explanatory material that are an integral
part of the financial statements.
Financial statements do not, however, include such items as reports by directors, statements
by the chairman, discussion and analysis by management and similar items that may be
included in a financial or annual report.

2. Objectives of Financial Statement
(a) Basic Objectives : The objective of financial statements is to provide
information about the financial position, performance and cash flows of an
enterprise that is useful to a wide range of users in making economic decisions.
Users need to know the capacity of an enterprise to pay its employees and
suppliers, meet interest payments, repay loans, and make distributions to its
owners.

3. (b) Financial Position: The financial position of an enterprise
depends on…
(i) the economic resources it controls,
(ii) its financial structure, and
(iii) its liquidity and its solvency.

4. (b) Financial Position: The financial position of an enterprise
depends on…
(i) the economic resources it controls: Information about the
economic resources controlled by the enterprise (i.e. its
assets) is useful in predicting the future cash inflows.
(ii) its financial structure, and
(iii) its liquidity and its solvency.

5. (b) Financial Position: The financial position of an enterprise
depends on…
(i) the economic resources it controls,
(ii) its financial structure: Information about financial
structure is useful in predicting future liabilities and cash
outflows.
(iii) its liquidity and its solvency.

6. (b) Financial Position: The financial position of an
enterprise depends on…
(i) the economic resources it controls,
(ii) its financial structure, and
(iii) its liquidity and its solvency: Information about liquid
in and solvency is useful in predicting the ability of the
enterprise to meet its financial commitments as they fall
due, in the short as well as the long term.

7. (c) Performance: Information about the performance of an enterprise, in
particular its profitability, is required in order to assess future cash flows.
Information about variability of performance is important in this respect.
Information about performance is useful in predicting the capacity of the
enterprise is generate cash flows from its existing resources. It is also useful in
forming judgements about the effectiveness with which the enterprise might
employ additional resources.

8. (d) Cash Flows: Information concerning cash flows of
an enterprise is useful in order to evaluate its investing,
financing and operating activities during the reporting
period. This information helps to assess the ability of
the enterprise to generate and utilize cash flows.

9. (e) Stewardship and Accountability
Financial statements also show the results of the stewardship
of management, or the accountability of management for the
resources entrusted to it. This helps the users to make
economic decisions e.g., whether to hold or self their
investment in the enterprise or whether to reappoint or
replace the management.

10. (3) Components
(a) Balance Sheet: Information about financial position is primarily provided in a balance sheet.
(b) P&L Statement: Information about performance is primarily provided in a statement of profit and loss.
(c) Cash Flow Statement: Information about cash flows is provided in the financial statements by means of a cash
flow statement.
(d) Notes and Schedules: The financial statements also contain notes and supplementary schedules and other
information. For example, they may contain additional information that is relevant to the needs of users about the
items in the balance sheet and statement of profit and loss. They may include disclosures about the risks and
uncertainties affecting the enterprise and may resources and obligations not disclosed in the balance sheet (such as
mineral reserves).
Information about business and geographical segments and the effect of changing prices on the enterprise
(Inflation -adjusted Accounts) may also be provided in the form of supplementary information.

11. Qualitative characteristics of Financial Statements
Qualitative characteristics are the features that make the information provided in the financial
statements useful to the users. The four principles qualitative characteristics are:
(1) Understandability, (2) Relevance, (3) Reliability and (4) Comparability.
(l)Understandability: Users must be able to understand financial statements. They are
assumed to have the necessary knowledge and skill to study the should not be information
properly. Complex matters left out of financial statements if it is relevant information.
(2) Relevance: Information must be relevant to the decision making needs of all the users.
Information should help the users to evaluate past, present or future events or confirm or
correct their past evaluations. Relevance of an information depends on its nature and
materiality.

12. Qualitative characteristics of Financial Statements
Qualitative characteristics are the features that make the information provided in the financial
statements useful to the users. The four principles qualitative characteristics are:
(1) Understandability, (2) Relevance, (3) Reliability and (4) Comparability.
(3) Reliability: Information must also be reliable. Reliability of the faithful information
depends on (i) representation, (ii) substance over form, (iii) neutrality, (iv) prudence and (v)
completeness.
(4) Comparability: Users must be able to compare the financial statements of an enterprise
through time in order to identify trends in its financial position and performance. Users should
be of the accounting policies informed employed in the preparation of the financial
statements, any changes in those policies and the effects of such changes.

13. Analysis and Interpretation
(1) Need for Analysis and Interpretation: A typical Financial Statement of a
company may run into several pages. It normally contains a huge mass of data
and figures. A common user would be at a loss to understand which figures are
important and what is the exact significance of all the figures shown in the
Financial Statements. The Financial Statements are basically prepared for the
owners or managers and outsiders such as Creditors, Lenders or researchers have
re-organise the figures appearing in the Financial Statements for the purpose of
their study.

14. (2) Meaning of Analysis: Analysis means to resolve something into its
elements or components. For an outside user. the details in the Financial
Statements signify only raw data or ‘raw material’.
This ‘raw material’ needs to be re-organised, processed and converted
into an easy to understand form. The process of breaking up a large
mass of raw data into manageable form is called ‘analysis’ of the
Financial Statements.

15. Financial statement analysis is a process of evaluating the relationship between
the component parts of a financial statement to obtain a better understanding of a
firm’s financial position and performance.
(3) Financial Statement Analysis

16. To Conclude….
Analysis of Profit and Loss Account, therefore, means breaking down the Profit and Loss
Account into its various components or segments i.e., Gross Sales, Net Sales, Cost of Goods
Sold, Operating Profit and so on.
This is done by converting the T-Form and statutory form of Profit and Loss Account into a
Vertical Income Statement.
Analysis of Balance Sheet means breaking down or ‘analyzing’ the Funds into Total Funds
Available and Total Funds Employed.
The Total Funds Available are further broken down into Owners’ Funds and Loan Funds.
The Total Funds employed are broken down into Fixed Assets, Investments and Working
Capital. This is done by converting the T-Form Balance Sheet into a Vertical Balance Sheet.

17. (4) Types of Financial Analysis
A distinction may be drawn between various types
of financial analysis either on the basis of ‘who
does it’ or according to ‘how it is done’.

18. (a) According to Who Does It…
It is done by the owners or managers of the concern itself. Owners are the main users of
Financial Statements.
In case of a Limited Company the managers who are different from the owners
(shareholders) also rely on the study of the Financial Statements to analyse the income, the
expenses, the assets and the liabilities of the company. The owners or the managers study the
Financial Statements to make inter-firm and inter-period comparisons, to study the trends
in sales, expenses etc., to study the relationship among various items of the Financial
Statements by means of Ratio Analysis and to know the movement of Funds (from where
funds have come and where funds have gone) through Cash Flow and Fund Flow Analysis.
1. Internal analysis

19. 2. External Analysis
(i) Investors: Potential investors have to study the Financial Statements before deciding upon whether to buy or
not a business or shares. If they decide to buy, then the purchase price of the business or the shares is also fixed
on the basis of a detailed study of the Financial Statements.
(ii) Creditors and Lenders: Creditors and Lenders study the Financial Statements of the borrower before
advancing credit or loan. Thereafter also, the creditors and Lenders study the Financial Statements to find out
whether the business is solvent (in a position to repay the loan).
(iii)Government: The amounts payable by a concern by way of taxes levied by Government such as Income Tax,
Sales Tax, Excise, etc. are determined on the basis of the data in the Financial Statements.
(iv)Misc. Users: Employees study the Financial Statements before joining a concern and during the period of their
employment. Researchers in the field of Economics or Accountancy and Journalists also use the Financial
Statements for research and interpretation.

20. According to How It is Done?
(a) Conversion of Financial Statement: For an outside user, the details in the
Financial Statement indicates only raw data or raw material.
This ‘raw material’ needs to be re-organised, processed and converted into an easy
and understandable form. The process of breaking up a large mass of raw data into
manageable form is called ‘analysis’ of the Financial Statements.

21. According to How It is Done? (Continued…)
Analysis of Profit and Loss Account, therefore, means breaking down the Profit and Loss
Account into its various components or segments i.e., Gross Sales, Net Sales, Cost of Goods
Sold, Operating Profit and so on.
This is done by converting the T-Form and statutory form of Profit and Loss Account into a
Vertical Income Statement. Analysis of Balance Sheet means breaking down or ‘analyzing’ the
Funds into Total Funds Available and Total Funds Employed. The Total Funds Available are
further broken down into Owners’ Funds and Loan Funds. The Total Funds employed are
broken down into Fixed Assets, Investments and Working Capital. This is done by converting
the T-Form Balance Sheet into a Vertical Balance Sheet.

22. (b) Comparison of Financial Statements
The Analysis of Financial Statements may be of two types-Horizontal Analysis and Vertical
Analysis.
Horizontal analysis involves comparison of two concerns or two years in respect of the same
item. Since horizontal analysis moves over a number of years or across many concerns, it is
called ‘Dynamic Analysis’.
Comparative statements and Trend Percentages are the examples of ‘Horizontal Analysis’.
Vertical analysis, on the other hand involves finding out the relationship between two items in
respect of the same concern and in the same year. Vertical analysis is, therefore, called ‘Static
Analysis’.
‘Common Size Statements’ and ‘Ratio Analysis’ are the examples of ‘Vertical Analysis’.

23. On the Basis of Method of Operation
Horizontal/Dynamic
Analysis
Comparative
Statement
Comparative
Balance Sheet
Statement
Comparative
Income
Statement
Trend Analysis
Trend Balance
Sheet
Trend Income
Statement
Vertical /Static Analysis
Common Size
Statement
Common Size
Balance Sheet
Common Size
Income
Statement
Ratio
Analysis
Balance Sheet
Ratios
Income
Statement Ratios
Composite
Ratios

24. Meaning of Interpretations
The user of the Financial Statements may, by means of the tools of analysis, obtain certain
figures such as Trend Percentage or the Net Profit Ratio. Such figures (Trend Percentages or
Ratios) have to be then interpreted. For example, the figures of sales for several years may be
interpreted with the help of Trend Percentages to warn the owner (user) that the sales are
showing a decreasing trend. Or, if the Net Profit ratio (i.e. Net Profits/Sales X 100) is 20, this
figure of 20% by itself does not indicate anything; it has to be interpreted to ascertain its
significance. The user can interpret the Ratio in Several ways.
Has the Ratio increased or decreased as compared to earlier years?
How does it compare with the average Net Profits Ratio of the Industry? and so on.
In short, the Ratio obtained by analysis has to be interpreted.

25. To Conclude….
Interpretation, means to bring out the meaning for the benefit
of a person. Interpretation is an art. It is a skill developed by
experience and practice over a number years. Interpretation
brings the significance hidden within the data or figures to the
attention of the user. Interpretation means coming to a
conclusion or forming an opinion about the significance of item.

26. Back to the Past for a Moment
You learned Conventional or T-Form of Balance Sheet
Which Appears like

27. Balance Sheet

28. Whereas, Trading and Profit & Loss Account appeared like

29. Trading Account Trading Account
for the year ended ….

31. Whereas as per Statutory Compliance as per Schedule III of Part I
of Companies Act 2013, Balance Sheet should be prepared as….

32. Whereas as per Statutory Compliance as per Schedule III of Part I
of Companies Act 2013, Balance Sheet should be prepared as….

33. and Statement of Profit & Loss Account

34. Whereas as per Statutory Compliance as per Schedule
III of Part I of Companies Act 2013, Statement of
Profit & Loss Account should be prepared as….
Atlas Skill Tech University
Atlas Skill Tech
University

35. But for Analysis and Interpretation we have to
follow
For Balance Sheet – Vertical Analytical Balance Sheet
Format
For Profit & Loss Account – Vertical Analytical Profit
& Loss Account Format

36. That is

37. Check Google Sheet for the Specimen
https://docs.google.com/spreadsheets/d/1kQrqetzE2xtQIeiJ9uRb6Z
saieExduWC/edit?usp=sharing&ouid=106144611718743032509&r
tpof=true&sd=true