Framework for Preparation of Financial Statements
by Financial Statements are a structured representation of an entity’s financial position, financial performance, and cash flows, prepared to provide information useful to a wide range of users—investors, lenders, employees, regulators, and the public for making economic decisions. Under Ind AS 1, they present the results of management’s stewardship of resources entrusted to it. A complete set comprises the Balance Sheet, Statement of Profit and Loss, Statement of Changes in Equity, Cash Flow Statement, and Notes, including significant accounting policies. Ind AS 1 lays down overall requirements for presentation, structure, and minimum content, ensuring comparability both across periods and across entities globally.
Framework for Preparation of Financial Statements:
1. Objective of the Framework
The Framework for Preparation and Presentation of Financial Statements sets out the concepts underlying the preparation of general-purpose financial statements for external users. It assists standard-setters in developing consistent accounting standards, helps preparers apply standards and deal with topics not yet covered by a specific standard, and aids auditors in forming opinions on compliance. It also helps users interpret financial information and provides those interested in ICAI’s work with insight into its approach to formulating standards. The Framework itself is not an accounting standard and does not override any specific Ind AS in case of conflict between the two.
2. Scope of the Framework
The Framework deals with the objective of financial statements, qualitative characteristics determining usefulness of information, definitions and recognition criteria for the elements of financial statements (assets, liabilities, equity, income, expenses), and concepts of capital and capital maintenance. It applies to financial statements of all commercial, industrial, and business entities, whether in the public or private sector, and covers general-purpose statements including consolidated statements. It does not specifically address special purpose reports, such as prospectuses or computations for tax purposes, though many principles may still apply usefully to such reports where relevant.
3. Objective of Financial Statements
The objective of financial statements is to provide information about the financial position, performance, and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. Financial statements prepared for this purpose meet the common needs of most users, since almost all users are making economic decisions such as whether to buy, hold, or sell an investment, assess management’s accountability, or evaluate the entity’s ability to pay employees and meet obligations. They do not, however, provide all information users may need, as most reflect financial effects of past events only.
4. Underlying Assumptions – Accrual Basis
Financial statements are prepared on the accrual basis of accounting, under which transactions and events are recognised when they occur, not merely when cash is received or paid. They are recorded in the accounting records and reported in financial statements of the periods to which they relate. This basis provides information not only about past transactions involving payment or receipt of cash but also about obligations to pay cash in future and resources representing cash to be received in future, thereby offering the most useful information to users for evaluating past performance and predicting future economic outcomes.
5. Underlying Assumptions – Going Concern
Financial statements are normally prepared on the assumption that an entity will continue in operation for the foreseeable future, without any intention or necessity of liquidation, ceasing trade, or curtailing materially the scale of operations. Where such intention or necessity exists, financial statements may need to be prepared on a different basis, and if so, the basis used must be disclosed. The going concern assumption underlies the classification of assets and liabilities as current or non-current and justifies carrying assets at cost rather than liquidation value, reflecting continuity of business operations in the ordinary course.
6. Qualitative Characteristics – Understandability and Relevance
Understandability requires that information in financial statements be readily comprehensible to users with reasonable business, economic, and accounting knowledge, and a willingness to study the information diligently; complex matters should not be excluded merely because they may be too difficult for some users. Relevance requires that information influence the economic decisions of users by helping them evaluate past, present, or future events, or confirm/correct past evaluations. The relevance of information is affected by its nature and materiality, with materiality depending on the size of the item or error judged in the surrounding circumstances.
7. Qualitative Characteristics – Reliability
Information is reliable when it is free from material error and bias and can be depended upon by users to represent faithfully what it purports to represent. Reliability encompasses faithful representation of transactions, substance over legal form, neutrality (freedom from bias), prudence (exercise of caution in conditions of uncertainty without creating hidden reserves or excessive provisions), and completeness within the bounds of materiality and cost. An omission can cause information to be false or misleading, and thus unreliable and deficient in relevance, making completeness within reasonable cost-benefit limits essential to reliable financial reporting.
8. Qualitative Characteristics – Comparability
Comparability requires that financial statements be prepared and presented consistently over time within the same entity, and consistently across different entities, enabling users to identify trends in financial position and performance and to compare entities’ relative performance. This implies users must be informed of accounting policies used, any changes in those policies, and the effects of such changes, along with corresponding information for preceding periods. Comparability should not, however, be allowed to become an obstacle to the introduction of improved accounting standards, since static consistency should never override genuinely more relevant or reliable financial reporting practices.
9. Elements of Financial Statements
Financial statements portray the financial effects of transactions and events by grouping them into broad classes called elements. Elements directly related to financial position are assets, liabilities, and equity, while elements directly related to performance are income and expenses. Assets are resources controlled by the entity from past events, expected to yield future economic benefits; liabilities are present obligations from past events, expected to result in outflow of resources; equity is the residual interest in assets after deducting liabilities. Income increases economic benefits, while expenses represent decreases, each affecting equity other than owner contributions or distributions.
10. Recognition of Elements
Recognition is the process of incorporating an item in the balance sheet or statement of profit and loss that meets the definition of an element and satisfies two criteria: it is probable that any future economic benefit associated with the item will flow to or from the entity, and the item has a cost or value that can be measured with reliability. An item that fails to meet recognition criteria at one point may qualify later due to subsequent circumstances or events. Items not meeting recognition criteria may still warrant disclosure in notes or explanatory material accompanying financial statements.
Preparation of Financial Statements:
| Particular | Description |
|---|---|
| 1. Statement of Financial Position | Shows assets, liabilities and equity of the entity at the reporting date. |
| 2. Statement of Profit and Loss | Shows income, expenses and profit or loss for the reporting period. |
| 3. Other Comprehensive Income | Presents items of income and expense recognised outside profit or loss, as required by Ind AS. |
| 4. Statement of Changes in Equity | Shows changes in equity, reserves and retained earnings during the reporting period. |
| 5. Statement of Cash Flows | Shows cash inflows and outflows from operating, investing and financing activities. |
| 6. Notes to Financial Statements | Provides accounting policies, explanations, supporting details and additional disclosures. |
| 7. Comparative Information | Comparative figures for the previous period are generally presented to help users understand changes in financial position and performance. |
| 8. Going Concern | Financial statements are normally prepared assuming that the entity will continue its operations for the foreseeable future. |
| 9. Accrual Basis | Financial statements are generally prepared using the accrual basis of accounting, except for cash flow information. |
| 10. Consistency | Presentation and classification of items should be consistent from one period to another unless a change is required or provides more reliable and relevant information. |
Financial Statements: Journal entries:
The preparation of financial statements involves transferring balances and recording necessary adjustments. The following are common journal entries relevant to the preparation of financial statements:
| Transaction / Adjustment | Journal Entry |
|---|---|
| Closing revenue accounts | Revenue A/c Dr.
→ To Statement of Profit and Loss A/c |
| Closing expense accounts | Statement of Profit and Loss A/c Dr.
→ To Expense A/c |
| Profit for the year | Statement of Profit and Loss A/c Dr.
→ To Retained Earnings A/c |
| Loss for the year | Retained Earnings A/c Dr.
→ To Statement of Profit and Loss A/c |
| Depreciation | Depreciation Expense A/c Dr.
→ To Accumulated Depreciation A/c |
| Outstanding expenses | Expense A/c Dr.
→ To Outstanding Expense A/c |
| Prepaid expenses | Prepaid Expense A/c Dr.
→ To Expense A/c |
| Accrued income | Accrued Income A/c Dr.
→ To Income A/c |
| Income received in advance | Income A/c Dr.
→ To Income Received in Advance A/c |
| Provision for expense | Expense A/c Dr.
→ To Provision A/c |
| Current tax provision | Current Tax Expense A/c Dr.
→ To Current Tax Liability A/c |
| Deferred tax liability | Income Tax Expense A/c Dr.
→ To Deferred Tax Liability A/c |
| Deferred tax asset | Deferred Tax Asset A/c Dr.
→ To Income Tax Expense A/c |
| Transfer to general reserve | Retained Earnings A/c Dr.
→ To General Reserve A/c |
| Dividend declared |
Retained Earnings A/c Dr. → To Dividend Payable A/c |