What is the primary objective of a financial statement?
A financial statement is the language of a business through which it communicates. It is a summary of the business performance for a defined period. A summary always requires a clear presentation. The very purpose of a financial statement is that it should present a true and fair view of the business. The users of the financial statement should be able to understand the view of the preparers of the statements. In order to ensure all the above criteria, there must be a format in which the financial statements are prepared, to communicate what it is intended to do. We have a general format of preparation. But unlike others, corporate form of organization, which is governed by an act and involvement of public, should have a format for presenting its financial statement , that must be common in order to ensure transparency, understandability and comparability. Thus, the Companies act, 1956, in schedule VI, prescribes a sketch in which the financial statements of Corporate entities must be prepared.
Need for Revised Schedule VI:-
1. Even though the act had prescribed a format for the financial statements, it was continued to be used without much changes, for the past five decades, even after the changes and complications that the financial statement preparers, regulators and the users have undergone.
2. As Globalization had opened up our economy, our business started to expand beyond our territorial borders. The accounting practices and understandability of users’ abroad depends upon their accounting practices. Hence it becomes necessary for our financial statements to be compliant not only within our country but abroad too. The International accounting standards, comprising IAS and IFRS, was formed with a view to bring cross border understandability. Even though a set of standards is available, which will be accepted worldwide, there are numerous intricacies to change our standards wholly to IFRS. In order to trade across the world, our corporates had to prepare a separate set of globally accepted financial statements, other than the regular statements. This process of preparing two different sets of financial statements is really cumbersome.
3. The process of attracting investments and gearing our business with borrowings from abroad , also gets tougher. An investor or a lender has to understand and should be able to analyze the business. Only then the investor will be ready to deploy funds. A lender has to ensure the credibility of the borrower to lend. For this reason also corporates were preparing two sets of financial statements.
4. Many Indian Companies operate abroad integrally. They tend to list in those stock exchanges. There are cross border acquisitions, mergers, sale outs and many developments that are taking place in more than one country. For all these, clearances of laws and regulations of those countries becomes mandatory. For these purposes too, we require separate set of financial statements.
5. Preparing Globally accepted financial statements being a cause, but not the only cause. The pre revised schedule VI, was not sufficient for the disclosures that the accounting standards required, especially after the introduction of accounting for taxes, Impairment of assets, discontinuing operations etc..
6. Further, there was no industry specific format in the old schedule VI. As every industry cannot prepare in the same format, it became difficult for industries.
7. Another issue to be noted is that, the old schedule VI did not mention any format for presentation of profit & loss account. Eventhough the requirements for preparation of Profit & Loss account were laid down, it requires a specific format , to have clear view for the preparers.
8. Convergence towards IFRS, one of the main goals of the last decade, also requires elaborate disclosures which has to be complied. This required change of the old schedule VI.
9. In the old schedule VI, there were disclosures that were no longer required and there were suggestions for revising the same.
In order to address these issues, it became necessary to revise the existing Schedule VI and to introduce a new format, for removing difficulties. And hence the revised schedule VI has come into picture.
Revising Schedule VI:
The intentions to revise schedule VI as listed out in the explanatory statement released on November,2008 are:-
1. To have ‘readable, useful, transparent and user friendly’ form of schedule VI.
2. To set out minimum disclosure requirements which are considered essential to ensure true and fair presentation of financial position and financial performance of the company and comparability, both with the company’s previous periods and with other companies.
3. The balance sheet and statement of profit & loss account should not be burdened with too many disclosure requirements.
4. To remove disclosure requirements which were meant only for statistical purpose.
5. To have inherent flexibility for amendments and industry specific improvements from time to time and to cater industry specific disclosure requirements.
6. To harmonize and synchronize the general disclosure requirements with those prescribed in the Accounting Standards by removing the existing inherent anomalies.
7. The specific disclosure requirements prescribed in the Accounting Standards are not incorporated here so that amendment in the Accounting Standard does not necessitate an amendment in the form of Schedule VI.
8. To attain compatibility and convergence with the International Accounting Standards and practices.
Thus, the revised schedule VI was intended to remove the anomalies that existed.
Revised Schedule VI:
The Ministry of Company Affairs had comprehensively revised the Schedule VI of The Companies act,1956 on 28th of February, 2011 pertaining to preparation of balance sheet and profit & loss account. It has been framed as per the existing non converged accounting standards. The revised schedule VI will come into force for Balance sheet and Profit & Loss account to be prepared for financial year commencing on or after 01, April 2011.
The salient features to be noted in the Revised Schedule VI are listed below:
Balance Sheet(Part I):
1. The nomenclatures of the headings of the balance sheet has been changed from ‘Source of Funds’ and ‘Application of funds’ to ‘Equities & Liabilities’ and ‘Assets’, respectively.
2. Schedules are replaced by notes. Wherever required, details has to be presented in the form of notes.
3. More details pertaining to Share capital is required. Details regarding preferences, rights and restrictions thereon has to be disclosed. The terms for conversion of any class of shares and the earliest date of conversion has to be disclosed. In order to analyze the holding pattern of share capital, revised schedule VI requires disclosure of shares held by holding company, including ultimate holding company, subsidiaries, associates and any person holding more than five percent of the share capital of the company.
4. Amount received against share warrants to be disclosed in the face of the balance sheet.
5. Aggregate number and class of shares issued and fully paid up, pursuant to contracts without payment received in cash to be disclosed. Details of shares issued by way of bonus and shares bought back to be disclosed.
6. Reserves & Surplus :- Nature, purpose and amount of each item of reserves to be presented. Additions and deductions to reserves to be mentioned. Reserves against earmarked investments to be termed as ‘fund’. Debit balance of profit & loss account to be shown under surplus. Even after reducing reserves by negative profit & loss account, if the surplus shows a negative balance, it has to be shown as such. This way of presentation shows negative figure in shareholders’ funds and reduces equities. Earlier as it was shown under ‘miscellaneous expenditure’ and didn’t reduce the shareholders’ funds.
7. Share application money received for allotment :- Terms and conditions of proposed share issue to be disclosed. The period for which share application money is pending beyond the period of allotment. Share application money not exceeding issued capital to the extent not refundable can be shown under equity. Share application money refundable to be shown under the head ‘Other Current Liabilities’.
8. Assets and liabilities has to classified into current and non-current. The basis of classification is the company’s normal operating cycle. Operating cycle is the time taken for acquisition of assets to realization of cash and its equivalents.
9. The concept of net working capital is dispensed with. Current liabilities which were earlier shown as a reduction from current assets to arrive at the net working capital is changed. Current liabilities will be shown in the ‘equity & liability’ side.
10. Term loan repayable within one year has to be classified as current liabilities. Loans and advances, given and taken will be classified into current and non-current.
11. Loans which were earlier classified into ‘Secured’ and ‘unsecured’ will now be broadly classified into ‘Long term’ and ‘Short term’ and further classified into ‘Secured’ and ‘Unsecured’.
12. If in pursuance of a default, a term loan becomes callable, the loan will be shown under current liabilities.
13. Period and amount of continuing default as on the balance sheet date in repayment of loans and interest to be disclosed separately.
14. Fixed assets have to be sub-divided into tangible and intangible assets. Capital WIP and Intangible assets under development has to be separately identified. Leasehold assets to be disclosed. Revaluation of assets to be separately shown. Any changes in fixed assets, tangible and intangible, to identified.
15. Every addition, disposal, adjustments through business combinations and depreciation/amortization pertaining to tangible and intangible assets to be shown. If any tangible or intangible asset is revalued, increased or decreased, such revalued figure should be shown. Such increase or decrease to be shown by way of a note, for a period of five years from such change.
16. Investments, which was earlier presented under single head, will be classified into current and non-current investments. This is also an area, where current and non-current demarcation has been brought in.
17. Any other asset, that is not current asset in nature, to be shown under other non-current assets. It includes long term trade receivables, long term advances and any other asset that falls under its ambit.
18. Current assets are those assets that are expected to realize within the company’s normal operating cycle. The term ‘Sundry debtors’ and ‘Sundry Creditors’ has been replaced by ‘Trade Receivables’ and ‘Trade Payables’, respectively, in order to include other receivables and other payables.
19. Trade receivables to be classified into ‘secured, considered good’, ‘unsecured, considered good’ and ‘doubtful’. Further to be classified into outstanding for ‘more than six months’ and ‘less than six months’, from the date it became due. Earlier it was from invoice date.
20. ‘Cash and Bank Balances’ to be termed as, ‘Cash and Cash equivalents’, to be bifurcated into cash on hand, cheques on hand, drafts and balances with banks.
21. ‘Deferred tax asset’ or ‘Deferred Tax liability’, net amount, should be disclosed in the face of the balance sheet , as a separate line item, under ‘Non-current assets’ or ‘Non-current liabilities’, respectively.
22. Every loan taken or given to related parties, whether current or non-current, to be disclosed.
23. Separate disclosure of Contingent liabilities and commitments to be disclosed by way of notes.
Statement of Profit & Loss Account (Part II):
1. Step by step methodology to be carried out to bring out a clearer picture.
2. The revised schedule VI has come up with a format of Profit & Loss account, while the earlier schedule VI didn’t prescribe a format for the same.
3. Expenses incurred on employees, finance cost, depreciation and amortization expenses, other material heads to be disclosed by way of notes.
4. Profit from continuing and discontinuing operations to be shown separately.
5. Expenses are to be classified function wise rather than nature wise.
6. Classification of expenses to arrive at EBITDA.
7. Items exceeding 1% of the total revenue or ` 1,00,000, whichever is higher has to be disclosed separately. Earlier it was 1% of the total revenue or ` 5,000, whichever is higher.
8. Any appropriation has to be disclosed in notes pertaining to ‘Reserves & Surplus’ and not in the profit & loss account.
Items no longer to be disclosed:
The disclosure of following items are dispensed with :-
1. Separate disclosure of managerial remuneration.
2. Information pertaining to licensed capacity, installed capacity and actual production
3. Investments purchased and sold during the year.
4. Amounts outstanding and maximum balances outstanding, pertaining to companies under same management , directors and officers of the company.
Implications of Changes:
1. Increasing disclosure in Share capital, better understanding to controlling interests, holding pattern, rights and preferences are brought out.
2. Reserve classifications, showing debit balance of surplus in reserves, making appropriations in notes will give a better picture of shareholders funds.
3. Disclosure of deferred tax assets/liabilities and profit from discontinuing operations are efforts towards disclosure requirements of accounting standards.
4. Demarcation of current and non-current assets and liabilities gives an understanding about company’s liquidity at a glance, and also a move towards IFRS based financial statements, which follows such presentation.
5. Function wise classification of expenses to bring more emphasis in presenting clearer expense classification.
Hence the Ministry of Company Affairs had come up with the revised schedule VI, as a step to move towards IFRS convergence and a better presentability and compliance.