Note oI Discussion

1
Corporate Accounting: Some Issues

Organisations: Subject Matter of Accounting
What is the subject matter oI accounting? It is useIul to be clear what exactly you will be studying about?
For doctors, the subject matter is the human body; For a computer engineering student, the subject matter is
the computers; Ior a space scientist, the subject matter is the space. What about you: management students

Accounting is the branch oI knowledge which helps in understanding organisations better. Accounting
deals with the Iinancial matters oI organisations.

Role of Accounting in Organisations
You will agree that whenever you think oI accounting some Iorm oI business organisation comes to your
mind. You, in Iact every reader oI this book, interact on a day to-day basis with several organisations: as
customer, employee, reporter, analyst, member oI a club, Iriend oI an employee, employer, potential
employee or potential employer.



















Take Iew minutes oII and make a list oI organisations that you interact with on day-to-day basis.


You
Club
Bank
Railway
s
College
Library
Companies
Why is it necessary to know the financial health of these organisations? Who is more interested in the financial
position: Managers or Shareholders?
Note oI Discussion
2



Since you interact with several organisations on day to day basis you need inIormation to understand them
and improve your interactions with them. Such inIormation needs is generally IulIilled by the accounting
inIormation provided by the organisation. Organisations use accounting as the means to communicate with
world outside. Organisations depend on accounting to deIend their actions. Organisations take the help oI
accounting to provide inIormation to the government and diIIerent regulators. In this book we will be
Iocusing our attention on one such inIormation i.e. the Iinancial health oI these organisations.

Accounting provides the necessary inIormation about the Iinancial position oI these organisations.
Organisations can take diIIerent Iorms: Ior example, sole proprietorship, partnership, and joint stock
company. However, we will be Iocusing our attention on the joint stock company Iorm oI organisation.

Let us have look at the vision statements oI some oI the important companies oI India to get Ieel oI the
importance oI the Iinancial numbers.
Mind Tree
Our Vision for the Year 2007-08,
O To achieve $ 231 million in revenue
O To be among the top 10 in our business in terms
O of profit after tax (PAT) and return on investment (ROI)
O To be one of the top 20 globally admired companies in our industry
O To give a significant portion of our PAT to support primary education



Tata Steel
Vision 2007:
To sei:e the opportunities of tomorrow and create a future that will make us an EJA positive company: To
be on the lookout for and shape the opportunities to get the first-mover advantage and remain ahead of
competition. The opportunities could exist in emerging technologies, new business models, value creation,
customer service, new products, services or businesses, financing options etc. To mobili:e all resources
and efforts through value based management that will help us earn returns better than the cost of capital.

Note oI Discussion
3
Infosys
The primary purpose of corporate leadership is to create wealth legally and ethically. This translates to
bringing a high level of satisfaction to five constituencies -- customers, employees, investors, vendors and
the society-at-large. The raison dtre of every corporate body is to ensure predictability, sustainability and
profitability of revenues year after year.
N R Narayana Murthy, Chairman & Chief Mentor

This is not just an Indian phenomenon. Most oI the companies worldwide do give such importance to the
Iinancial returns and Iinancial objectives. Even the regulators do not ignore the Iinancial returns. See the
comments oI a regulator.
Securities Exchange Commission
appy companies have robust growth in revenues, strong balance sheets, and healthy profits that reflect
genuine business success, not phony bookkeeping.

And they share other important traits as well.
They abide by high ethical standards, which is a key to their solid success.

They dont obstruct the flow of information to shareholders, but rather view the shareholder as the ultimate
owner and the ultimate boss.
They choose directors on the strength of their abilities, character, and capacity for independent fudgment.
And their internal controls work well, so that the companys executives can take immediate corrective
action when something goes wrong. Chairman Christopher Cox
U.S. Securities and Exchange Commission, Washington, DC, March 21, 2006
Remarks before the Committee for Economic Development
Where are these leading us to? At this juncture, we will not be wrong iI we say that every company would
like to keep Iinancial statements strong and clean. Every company would like to talk about its Iinancial
strength. Every company would like the world at large to know its Iinancial perIormance.

Coverage of this note
This note describes the Iollowing issues:
a) Accounting and Iorms oI organisation
b) Conceptual Understanding oI GAAP
c) Regulatory Iramework oI accounting in India

Note oI Discussion
4

orms of Organisations:
As mentioned earlier the organisations take diIIerent Iorms. Some oI the popular Iorms oI organisations are
as Iollows:
O Sole Proprietorship
O Partnership
O oint Stock Company
O Society
O Trust

The Iorm oI organisation depends on several Iactors: nature oI the activity, size oI the activity, legal
requirements etc. We will Iocus our attention on the joint stock companies only.

inancial Accounting and 1oint Stock Companies



1oint Stock Companies (1SC):
The Companies Act 1956 has not deIined the SC. The Act says 'a company means a company Iormed
and registered under the Act. However, one can identiIy a company on the basis oI the Iollowing Ieatures:

Following are the some oI the salient Ieatures oI the joint stock companies.
a) Registered Body: The company must be registered under the Companies Act. For the purpose oI
registration minimum oI members required are seven ( Ior public limited company) and two ( Ior
private limited company).

b) Separate legal entity: A company is a separate legal entity. It is distinct Irom its owners. When we
see the balance sheet oI InIosys, it does not reIlect the Iinancial position oI Mr. Narayana Murthy.
MicrosoIt is not Mr. Bill Gates. Even where a single shareholder virtually holds the entire share
capital, a company is to be diIIerentiated Irom the shareholders (Saloman vs Saloman
1
& Co. Ltd.
1895-99). The property oI the company is not the property oI the shareholders, it is the property oI the
company. See the Iollowing table giving some inIormation about the owners oI Satyam Computer
Services ltd.



1
Salomon v. Salomon & Co. (1896), |1897| A.C. 22 (H.L.) is a Ioundational decision oI the House oI
Lords in the area oI company law. The eIIect oI the Lords' unanimous ruling was to Iirmly uphold the
concept oI a corporation as an independent legal entity, as set out in the 1862 Companies Act.
Make a list of organisations that you know and comment on their form?
Note oI Discussion
5


Shareholders of Satyam

No. oI
shareholders
No oI
shares
(mn)
Total 95,356 324
holding less than 500 shares 81,707 86 7.1 2
more than 10000 shares 562 1 233 72
Source: Annual Report 2005-06



c) imited iability: The owners oI the company are not personally liable Ior the debts oI the company.
The liability oI the shareholders is limited to the extent oI the money contributed by them. See the
Iollowing balance sheet oI Paradeep Phosphates ltd.

Balance Sheet of Paradeep Phosphates as on 31st March 2004
Sources Rs. n lakhs Assets Rs. n lakhs
Share Capital 57,545.00 Fixed Assets 27,280.20
Loan 69,407.73 Current Assets 56,905.55
Current Liabilities 34,513.40 Losses 77,280.38
161,466.13 161,466.13
Source: http://www.paradeepphosphates.com/pplnew/Iinancial/balance.htm

The liability oI the shareholders oI the above company is limited to 57545 lakhs even iI, the total liability
oI the company is more than 100 000 lakhs.

d) Separation of ownership from management: The company is owned by the shareholders but its
management is vested in the hands oI the board oI directors (BoD). The Companies Act provides Ior
the management oI the companies through the elected representatives oI the members. Such
representatives are known as the directors. The board oI directors generally consists oI executive (Irom
the company) and non-executive directors (outside the company).

e) Perpetual Succession: Shareholders may come and shareholders may go, the company continues to
exist with the same privileges. A company can continue to exist indeIinitely till it is wound-up in
accordance with the provisions oI the Companies Act..
Note oI Discussion
6

For example:
O Tata steel was envisioned by amshetji Tata and established in 1907, Tata Steel (Iormerly
TISCO - Tata Iron and Steel Company Limited) is Asia's Iirst and India's largest integrated private
sector steel company. Today the shareholders and the management oI the company may be
diIIerent but the companies continues to exist.
O Reliance Energy: Few years back it was owned by Iinancial institutions and today Reliance group
holds majority oI shares.
O arsen and Toubro (T) is a civil engineering company in India. It is one oI the largest
companies in indian and bags many government contracts. The company has also branched out
into electrical and mechanical engineering solutions. The name is derived Irom its two Iounders,
Danish born citizens who settled down in India.

I) Transferability of shares: The Act provides that the shares oI a company (public limited) shall be
moveable property, transIerable. Such transIer encourages investment oI Iunds in shares oI the
companies. For such transIer is, however, Ieasible only when with an active stock exchange.
g) Types of Companies: Companies can be Iurther classiIied into private and public limited companies.
The Companies Act deIine these companies as Iollows:
O private company
O public company
O Government Company//Public Sector Company
O Holding Company
O Subsidiary Company
By virtue of section 3 (1)iii, " private company " means a company which has a minimum paid-up
capital oI one lakh rupees or such higher paid-up capital as may be prescribed, and by its articles,
a) restricts the right to transIer its shares, iI any :
b) limits the number oI its members to IiIty not including
(i) persons who are in the employment oI the company ; and
(ii) persons who, having been Iormerly in the employment oI the
company, were members oI the company while in that employment and
have continued to be members aIter the employment ceased ;
Note oI Discussion
7
c) prohibits any invitation to the public to subscribe Ior any shares in, or debentures oI, the
company ;
d) prohibits any invitation or acceptance oI deposits Irom persons other than its members,
directors or their relatives
By virtue of section 3 (1) iv, public company " means a company which -
a) is not a private company;
b) has a minimum paid-up capital oI Iive lakh rupees or such higher paid-up capital, as may
be prescribed ;
c) is a private company which is a subsidiary oI a company which is not a private company


!ublic imited Company !rivate imited Company
Minimum number oI members: 2 Minimum number oI members: 7
Maximum number oI members: no restriction Maximum number oI members: 50
TransIerability oI shares: Shares are Ireely
transIerable
TransIerability oI shares: Shares are not
transIerable
Minimum number oI directors: 2 Minimum number oI directors: 3
Must hold Statutory meetings and Iile the
reports with the Registrar oI companies
Not required
Retirement oI directors: At 2/3
rd
oI the
directors must retire by rotation at each annual
general meeting.
Not required to retire by rotation
Increase in the number oI directors:
Permission oI the Central Government is
required Ior more than 12 directors
No such permission required
Quorum Ior general meetings: 5 Quorum Ior general meetings: 2
Managerial remuneration: No restriction Managerial remuneration: cannot exceed 11 oI the
net proIits.
Public Deposits: Can accept deposits public. Cannot accept deposits Irom the public other than
the shareholders, directors, and their relatives.


Government Company or !ublic Sector Company
Section 617 oI the Act deIines Government company as any company in which not less than IiIty-one per
cent oI the paid-up share capital is held by the Central Government, or by any State Government or
Note oI Discussion
8
Governments, or partly by the Central Government and partly by one or more State Governments, and
includes a company which is a subsidiary oI a Government company as thus deIined. A subsidiary oI a
Government company shall also be treated as a government company. A statutory corporation Iormed
under a statute oI the legislature is not a company` under the Companies Act 1956.

Government Companies: !ublic limited or private limited companies
A government company may be registered as private limited or public limited company. Most oI the
government companies were established as private limited companies.
Statutory Corporations: Organisations which are established on the basis oI a special Act passed in the
parliament. For example: State Financial Corporations ( under SFC Act), LiIe Insurance Corporation (LIC
Act). IFCI was also set up under IFCI Act, later on it became a company under the Companies Act 1956.
State Electricity Boards were set up under the Electricity (Supply) Act and Indian Electricity Act. AIter the
power sector reIorms many SEBs were dissolved and converted into companies under the Companies Act
1956.

Note oI Discussion
9
















Need for Accounting in Companies
As mentioned earlier, companies are jointly owned by the shareholders. The management oI the company
is vested in the Board oI Directors. The Board oI Directors or the management is the agent oI the
shareholders ( who can be called the principal). The principal-agent relationship is the genesis oI
proIessional management. The principal-agent relationship throws up several issues Ior discussion.

One such issue is the Asymmetry of information. The agent (i.e. the management) will have more
inIormation that the principal. This is more so in case oI the joint stock companies as the owners are widely
dispersed. It is not possible Ior these shareholders( Owners or Principal) to have access to the inIormation
that the managers have access to. In such a situation the principal (owners) will depend on the agents
(management) to get the necessary Iinancial and other inIormation. Financial statements IulIill such
requirements. Financial statements, thereIore, are prepared by the management to keep the owners
inIormed about the status oI the business. However, one should not come to conclusion at this juncture that
Iinancial statements can address the problem oI asymmetry oI inIormation totally.

Another issue is the rent seeking behavior. Rent seeking is the process by which an individual or Iirm
seeks to gain through manipulation oI the economic environment rather than through trade and the
production oI added wealth. Rent seeking generally implies the extraction oI uncompensated value Irom
others.



Public
Private
Private Public
S
e
c
t
o
r
Nalco, SBI, BHE,
ICI, NT!C

!epsico

Infosys, H, Tata
Steel, Reliance

Gridco,
imited
Note oI Discussion
10
Accounting for 1oint Stock Companies Under Different Act
Because oI the above reasons the companies are bound to maintain certain books oI accounts and also
prepare Iinancial statements periodically.
Sec 209 (of the Companies Act 1956) - Books of account to be kept by company.
(1) Every company shall keep at its registered oIIice proper books oI account with respect to:
(a) all sums oI money received and expended by the company and the matters in respect
oI which the receipt and expenditure take place ;
(b) all sales and purchases oI goods by the company ;
(c) the assets and liabilities oI the company ; and
(d) in the case oI a company pertaining to any class oI companies engaged in production,
processing, manuIacturing or mining activities, such particulars relating to utilisation oI
material or labour or to other items oI cost as may be prescribed, iI such class oI
companies is required by the Central Government to include such particulars in the books
oI account :
Provided that all or any oI the books oI account aIoresaid may be kept at such other place
in India as the Board oI directors may decide and when the Board oI directors so decides,
the company shall, within seven days oI the decision, Iile with the Registrar a notice in
writing giving the Iull address oI that other place.
(2) Where a company has a branch oIIice, whether in or outside India, the company shall be
deemed to have complied with the provisions oI sub-section (1), iI proper books oI account
relating to the transactions eIIected at the branch oIIice are kept at that oIIice and proper
summarised returns, made up to dates at intervals oI not more than three months, are sent by the
branch oIIice to the company at its registered oIIice or the other place reIerred to in sub-section
(1).
(3) For the purposes oI sub-sections (1) and (2), proper books oI account shall not be deemed to be
kept with respect to the matters speciIied therein,
(a) iI there are not kept such books as are necessary to give a true and Iair view oI the
state oI the aIIairs oI the company or branch oIIice, as the case may be, and to explain its
transactions ; and
Note oI Discussion
11
(b) iI such books are not kept on accrual basis and according to the double entry system
oI accounting.
(4) The books oI account and other books and papers shall be open to inspection by any director
during business hours.
(4A) The books oI account oI every company relating to a period oI not less than eight years
immediately preceding the current year together with the vouchers relevant to any entry in such
books oI account shall be preserved in good order :
Provided that in the case oI a company incorporated less than eight years beIore the
current year, the books oI account Ior the entire period preceding the current year
together with the vouchers relevant to any entry in such books oI account shall be so
preserved.
(5) II any oI the persons reIerred to in sub-section (6) Iails to take all reasonable steps to secure
compliance by the company with the requirements oI this section, or has by his own willIul act
been the cause oI any deIault by the company thereunder, he shall, in respect oI each oIIence, be
punishable with imprisonment Ior a term which may extend to six months, or with Iine which may
extend to ten thousand rupees, or with both :
Provided that in any proceedings against a person in respect oI an oIIence under this
section consisting oI a Iailure to take reasonable steps to secure compliance by the
company with the requirements oI this section, it shall be a deIense to prove that a
competent and reliable person was charged with the duty oI seeing that those
requirements were complied with and was in a position to discharge that duty:
Provided further that no person shall be sentenced to imprisonment Ior any such oIIence
unless it was committed willIully.
Sec 210 (of the Companies Act 1956) - Annual accounts and balance sheet.
(1) At every annual general meeting oI a company held in pursuance oI section 166, the Board oI
directors oI the company shall lay beIore the company :
(a) a balance sheet as at the end oI the period speciIied in sub-section (3); and
(b) a proIit and loss account Ior that period.
Note oI Discussion
12
(2) In the case oI a company not carrying on business Ior proIit, an income and expenditure
account shall be laid beIore the company at its annual general meeting instead oI a proIit and loss
account, and all reIerences to " proIit and loss account ", " proIit " and " loss " in this section and
elsewhere in this Act, shall be construed, in relation to such a company, as reIerences respectively
to the " income and expenditure account ", " the excess oI income over expenditure ", and " the
excess oI expenditure over income ".
(3) The proIit and loss account shall relate:
(a) in the case oI the Iirst annual general meeting oI the company, to the period beginning
with the incorporation oI the company and ending with a day which shall not precede the
day oI the meeting by more than nine months; and
(b) in the case oI any subsequent annual general meeting oI the company, to the period
beginning with the day immediately aIter the period Ior which the account was last
submitted and ending with a day which shall not precede the day oI the meeting by more
than six months, or in cases where an extension oI time has been granted Ior holding the
meeting under the second proviso to sub-section (1) oI section 166, by more than six
months and the extension so granted.
(4) The period to which the account aIoresaid relates is reIerred to in this Act as a " Iinancial year
" and it may be less or more than a calendar year, but it shall not exceed IiIteen months :
Provided that it may extend to eighteen months where special permission has been
granted in that behalI by the Registrar.
(5) II any person, being a director oI a company, Iails to take all reasonable steps to comply with
the provisions oI this section, he shall, in respect oI each oIIence, be punishable with
imprisonment Ior a term which may extend to six months, or with Iine which may extend to ten
thousand rupees, or with both :
Provided that in any proceedings against a person in respect oI an oIIence under this
section, it shall be a deIense to prove that a competent and reliable person was charged
with the duty oI seeing that the provisions oI this section were complied with and was in
a position to discharge that duty :
Provided Iurther that no person shall be sentenced to imprisonment Ior any such oIIence
unless it was committed willIully.
Note oI Discussion
13
(6) II any person, not being a director oI the company, having been charged by the Board oI
directors with the duty oI seeing that the provisions oI this section are complied with, makes
deIault in doing so, he shall, in respect oI each oIIence, be punishable with imprisonment Ior a
term which may extend to six months, or with Iine which may extend to ten thousand rupees, or
with both:
Provided that no person shall be sentenced to imprisonment Ior any such oIIence unless it
was committed willIully.
Sec 219 (of the Companies Act 1956) - Right of members to copies of Balance Sheet and Auditors'
Report.
(1) A copy oI every Balance Sheet (including the ProIit and Loss Account, the Auditors' Report
and every other document required by law to be annexed or attached, as the case may be, to the
balance sheet) which is to be laid beIore a company in general meeting shall, not less than twenty-
one days beIore the date oI the meeting, be sent to every member oI the company, to every trustee
Ior the holders oI any debentures issued by the company, whether such member or trustee is or is
not entitled to have notices oI general meetings oI the company sent to him, and to all persons
other than such members or trustees, being persons so entitled
Sec 220(of the Companies Act 1956) - Three copies of Balance Sheet, etc., to be filed with
Registrar.
(1) AIter the balance sheet and the proIit and loss account have been laid beIore a company at an
annual general meeting as aIoresaid, there shall be Iiled with the Registrar within thirty days Irom
the date on which the balance sheet and the proIit and loss account were so laid, or where the
annual general meeting oI a company Ior any year has not been held, there shall be Iiled with the
Registrar within thirty days Irom the latest day on or beIore which that meeting should have been
held in accordance with the provisions oI this Act,
(a) three copies oI the balance sheet and the proIit and loss account, signed by the
managing director, manager, or secretary oI the company, or iI there be none oI these, by
a director oI the company, together with three copies oI all documents which are required
by this Act to be annexed or attached to such balance sheet or proIit and loss account:
Provided that in the case oI a private company, copies oI the balance sheet and
copies oI the proIit and loss account shall be Iiled with the Registrar separately
The Users of inancial Statements
Note oI Discussion
14
The users oI Iinancial statements may be classiIied into two broad categories oI internal and external users.
Exhibit 1-1 shows diIIerent users oI the Iinancial statements and other related accounting inIormation.

Exhibit 1-1

Stock Exchange
Shareholders General Public


Creditors Tax Authorities

inancial Statements
Bankers Government


Customers Employees competitors








Accounting and inancial Statements

Financial statements help the owners in understanding the business decisions taken by the mangers. Every
company is under obligation to prepare the Iollowing Iinancial statements;
O Balance Sheet
O Income Sheet
O Cash Flow Sheet

We will make an eIIort to understand the ability oI the Iinancial statements to capture the business
decisions.


inancial Accounting and Business Decisions
To do. Take the annual report of any company and make a list of its stakeholders and
show how the financial statements can be used to provide the relevant information to them.
Note oI Discussion
15
Every business organisation takes number oI decisions in their day-to-day activities. The business
decisions taken by an organisation can be broadly classiIied into Iollowing categories:
a) inancing activities: As per the Accounting Standard- 3
2
, the Iinancing activities are
activities that result in changes in the size and composition oI the owners' capital (including
preIerence share capital in the case oI a company) and borrowings oI the enterprise. Every
business require Iinance to start its activities. InIosys requires money to buy a soItware unit in
Australia; Tata Steel requires money to set up a new unit in the state oI Orissa, Stayam
computers requires money Ior distributing dividend. Such money can be raised by selling
shares or selling bonds and debentures, or borrowing Irom the Iinancial institutions.
A company can raise money through capital, loans, bonds, debentures etc they have diIIerent
Ieatures and accounting treat them in diIIerent ways. These sources are broadly divided into two
categories: Stockholders Money and Liabilities.
Stockholders money is the money contributed by the shareholders by purchasing the shares oI the
company. It also includes the proIit retained in the business. ProIit belongs to the shareholders. II
the proIit is not distributed among the shareholders it tantamount to the contribution oI money by
the shareholders to the business.
Stockholders money Capital Retained ProIit
Outsiders Money: is known as the liability oI the company. Liabilities can take the shape oI bonds,
debentures, loans, public deposits, and trade credit.
b) Investing activities are the acquisition and disposal oI long-term assets and other investments
not included in cash equivalents.
Once a company collects money (Irom stockholders/liabilities)it makes plans to invest to earn
proIits. The investment in operating activities are called the operating activities. The investment
activities include the Iollowing:
O Purchase and sale oI Iixed assets
O Purchase and sale oI shares/bonds/debentures/other securities oI other
companies
O Dividend and interest received on the investments.


2
Details oI AS-3 will be discussed in the chapter relating to the Cash Flow Statement
Note oI Discussion
16
The outcome oI the investment activities may be an acquisition oI an asset or disposal oI an asset
or receiving regular incomes Irom such investments. When a company acquires an asset it is said
to be acquiring the Iuture cash Ilows. ThereIore, one can say that the assets are the present value oI
the Iuture cash Ilow. The value oI the assets that is shown in the books oI accounts can be one oI
the Iollowing:
O Accounting`s Perspective: Money paid Ior aquiring the asset less the decrease in
the value till that date. or
O Finance Perspective: Money that is expected Irom the income generating ability
oI the asset. Accounting to this concept, asset is present value oI Iuture cash
Ilows.
One can see the relationship between the Iinancing and investment activities. some oI the
preliminary observations are as Iollows:
O Investment activities shows how the money collected or raised has been used.
O Financing activities shows how the investment has been Iinanced.
O Investment activities shows the Iuture income generating capacity oI the
business.
O Investment activities shows the ability oI the business to return the borrowings
and capital at the time oI the maturity oI the borrowings and closure oI the
business respectively.
O The liability side and the assets side oI the balance sheet show the Iinancing and
investment activities oI a company.
c) Operating activities are the principal revenue-producing activities oI the enterprise and
other activities that are not investing or Iinancing activities. AIter raising the money (Ior
stockholders and loan givers) and investing the same in the productive assets, the business is
ready to start its operations. The operating activities depend on the core competence oI the
company. For example: Tata Steel is in the business oI making and selling oI steel. Dr.
Reddy`s Lab is in the business oI making and selling drugs. NALCO is in the business oI
aluminium. InIosys has been set up to provide IT solutions to various industries. All the
activities directly aIIecting the main operations are called the operating activities oI the
company. The net operating result oI a company shows the proIit generating ability oI the
businees. Revenue is considered to the result oI the operating activities and iI all expenses
required to generate the revenue are deducted Irom the revenue it will show the proIit or loss
oI the business. Such proIit is called the operating proIit.
O Total activities oI a company Financing Activities Investment Activities
Operating Activities
Note oI Discussion
17
O Total proIit oI a company ProIit Irom Financing Activities ProIit Irom
Investment Activities ProIit Irom Operating
Activities

O Cash in hand Cash Irom Financing Activities Cash Irom Investment
Activities Cash Irom Operating Activities





Conceptual Understanding of GAA!
Financial accounting is governed by a set oI principles called Generally Accepted Accounting Principles.
Neither the Companies Act nor the Institute oI Chartered Accountants oI India deIined GAAP. GAAP has
been deIined by the Auditing Standard Board (ASB, AU-411) as Iollows;
The phrase 'generally accepted accounting principles` is a technical accounting term that encompasses
the conventions, rules, and procedures necessary to define accepted accounting practice at a particular
time. It includes not only broad guidelines of general application, but also detailed practices and
procedures. Those conventions, rules, and procedures provide a standard by which to measure financial
presentations.

For the purpose oI this note we will use the Iollowing as a part oI the Indian GAAP:
O Accounting Standards issued by the Institute oI Chartered Accountants oI India
O Relevant provisions oI the Companies Act
O Relevant regulations oI the SEBI/IREDA
O Relevant provisions oI the Income Tax Act
O Relevant Provisions oI other Acts: The Electricity Act, The Banking Regulations Act, etc.

Accounting Standards in India
Accounting Standards are Iormulated with a view to harmonise diIIerent accounting policies and practices
in use in a country. the Accounting Standards Board (ASB) oI the Institute oI Chartered Accountants oI
India (ICAI) is responsible Ior setting the standards in India. Although the Accounting Standards Board is
a body constituted by the Council oI the Institute oI Chartered Accountants oI India, it is independent in the
Iormulation oI accounting standards. ASB draws resource persons Irom diIIerent interest-groups such
industry, representatives oI various departments oI government and regulatory authorities, Iinancial
institutions and academic and proIessional bodies. So Iar, 29 Indian Accounting Standards on the
Iollowing subjects have been issued by the Institute:
Take a business organisation that you are interacting with and make a list of important decisions taken
by it and classify them on the basis of financing, investment, and operating activities.
Note oI Discussion
18
AS 1 Disclosure oI Accounting Policies
AS 2 Valuation oI Inventories
AS 3 Cash Flow Statements
AS 4 Contingencies and Events Occurring aIter the Balance Sheet Date
AS 5 Net ProIit or Loss Ior the Period, Prior Period Items and Changes in Accounting
Policies
AS 6 Depreciation Accounting
AS 7 Accounting Ior Construction Contracts (recently revised and titled as Construction
Contracts)
AS 8 Accounting Ior Research and Development
AS 9 Revenue Recognition
AS 10 Accounting Ior Fixed Assets
AS 11 Accounting Ior the EIIects oI Changes in Foreign Exchange Rates (recently revised
and titled as The EIIects oI Changes in Foreign Exchange Rates)
AS 12 Accounting Ior Government Grants
AS 13 Accounting Ior Investments
AS 14 Accounting Ior Amalgamations
AS 15 Accounting Ior Retirement BeneIits in the Financial Statements oI Employers
AS 16 Borrowing Costs
AS 17 Segment Reporting
AS 18 Related Party Disclosures
AS 19 Leases
AS 20 Earnings Per Share
AS 21 Consolidated Financial Statements
AS 22 Accounting Ior Taxes on Income
AS 23 Accounting Ior Investments in Associates in Consolidated Financial Statements
AS 24 Discontinuing Operations
AS 25 Interim Financial Reporting
AS 26 Intangible Assets
AS 27 Financial Reporting oI Interests in oint Ventures
AS 28 Impairment oI Assets
AS 29 Provisions, Contingent Liabilities and Contingent Assets

Who are required to comply with the Accounting Standards?

Note oI Discussion
19
O Every company is required to comply with the Accounting Standards and the statutory auditors oI
every company are required to report whether the Accounting Standards have been complied with
or not.
O Even non-corporate entities such as partnership Iirms, sole-proprietary concerns/individuals,
societies registered under the Societies Registration Act, trusts, associations oI persons, and Hindu
Undivided Families, where Iinancial statements oI such entities are statutorily required to be
audited, Ior example, under Section 44AB oI the Income-tax, 1961.
O The Securities and Exchange Board oI India (SEBI) has added a new clause in the listing
agreement to provide that listing companies shall mandatorily comply with all the Accounting
Standards issued by ICAI Irom time to time.
O The Insurance Regulatory and Development Authority (IRDA) requires insurance companies to
Iollow the Accounting Standards issued by the ICAI.


It is the responsibility oI the members (acting as the auditors) to examine compliance with the Accounting
Standards in the Iinancial statements covered by their audit in the event oI any deviations there Irom, to
make adequate disclosures in their audit reports so that the users oI the Iinancial statements may be aware
oI such deviations.

Enough Gaps in GAA!:
Though the Iinancial statement that one get to see Irom the annual report oI a company are required to
comply with the above mentioned accounting standards, one has to keep in mind that there are several areas
where the companies have the Ireedom to Iollow diIIerent accounting policies. Following are some oI the
Iinancial items which requires special attention while understanding and analysing the Iinancial statements:
Methods oI depreciation, depletion and amortisation
O Treatment oI expenditure during construction
O Conversion or translation oI Ioreign currency items
O Valuation oI inventories
O Treatment oI goodwill
O Valuation oI investments
O Treatment oI retirement beneIits
O Recognition oI proIit on long-term contracts
O Valuation oI Iixed assets
Note oI Discussion
20
O Treatment oI contingent liabilities.
More details oI AS- 1 at http://www.icai.org/icairoot/resources/as1.html


What you will not see in the financial statements?
One cannot Iind the Iollowing inIormation even though they are important Ior diIIerent stakeholders
O EVA
O Share price
O Market value oI the assets
O Future cash Ilows
O Replacement cost oI the asset
O Cost oI capital
O Ability oI a company to pay pension in Iuture
O Price oI the product
O Sensitivity oI the product price to the various socio-economic Iactors
O Gap in the salaries between the CEO and accountant (or any other employee)
O Number and nature oI employees unioms

Work To Do
Select a listed company and Iind the Iollowing right oI the Iirst issue oI share
Book value oI share (networth/ Number oI shares) as on the balance sheet date . networth
Capital Reserves Accumulated Losses Misc. Expenses
Market value oI share (price)
Find Market Value to Book Value Ratio
Compare the ratio with industry norm
Comment on the ratio
Examine the limitations oI the Iinancial statements in explaining the very high or low
market to book ratio.




Comments on the note are invited

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