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Financial Statements of a Company – Class 12 Accountancy notes, important questions and MCQs

NCERT Class 12 Accountancy, chapter 7. Notes, key terms, important questions with answers and MCQs.

Chapter overview

A company prepares its financial statements, the balance sheet and the statement of profit and loss, in the format given in Schedule III of the Companies Act, 2013, along with notes to accounts. These statements show the company's financial position and performance and are used by shareholders, lenders, government and others. They have limitations because they are based on historical cost and some judgement.

Balance sheet (Schedule III)

Equity and liabilities: shareholders' funds (share capital, reserves and surplus), non-current liabilities (long-term borrowings, long-term provisions) and current liabilities (short-term borrowings, trade payables, short-term provisions).
Assets: non-current assets (property, plant and equipment, intangible assets, non-current investments, long-term loans and advances) and current assets (current investments, inventories, trade receivables, cash and cash equivalents, short-term loans and advances).
Items are classified as current if they are expected to be realised or settled within the operating cycle or twelve months.

Statement of profit and loss

Revenue from operations and other income make up total income.
Expenses include cost of materials consumed, purchases of stock-in-trade, changes in inventories, employee benefits expense, finance costs, depreciation and amortisation, and other expenses.
Profit before tax minus tax expense gives profit for the period.

Nature, uses and limitations

Financial statements are prepared under the going concern, accrual and other accounting concepts and contain recorded facts, conventions and personal judgements.
They are useful for assessing profitability, solvency and liquidity and for decisions by investors, lenders and government.
Limitations: historical cost ignores inflation, qualitative factors are not shown, and estimates such as depreciation involve judgement.

Key terms

Schedule III: the part of the Companies Act, 2013 that prescribes the format of company financial statements
Shareholders' funds: share capital plus reserves and surplus
Non-current liabilities: obligations not due for settlement within twelve months or the operating cycle
Trade receivables: amounts due from customers for goods sold or services provided on credit
Operating cycle: the time between acquiring materials and realising cash from sales

Important questions with answers

Name the main headings of the equity and liabilities side of a company's balance sheet.2 marks

The main headings are shareholders' funds, which include share capital and reserves and surplus; share application money pending allotment; non-current liabilities, such as long-term borrowings and long-term provisions; and current liabilities, such as short-term borrowings, trade payables, other current liabilities and short-term provisions.

What are the limitations of financial statements?3 marks

Financial statements are based on historical cost, so they do not reflect changes in price levels. They ignore qualitative factors such as management quality and employee relations. They include estimates and personal judgement, such as depreciation and provisions. They show the position on one date only and may be affected by window dressing.

Explain the format of the balance sheet of a company as per Schedule III of the Companies Act, 2013.5 marks

Schedule III prescribes a vertical format for the balance sheet with two parts. The first part is equity and liabilities. Under shareholders' funds, it shows share capital, reserves and surplus (such as capital reserve, securities premium, general reserve and surplus in the statement of profit and loss) and money received against share warrants. Next comes share application money pending allotment. Non-current liabilities include long-term borrowings such as debentures and term loans, deferred tax liabilities, other long-term liabilities and long-term provisions. Current liabilities include short-term borrowings, trade payables, other current liabilities such as current maturities of long-term debt and interest accrued, and short-term provisions. The second part is assets. Non-current assets include property, plant and equipment, intangible assets, capital work-in-progress, non-current investments, deferred tax assets and long-term loans and advances. Current assets include current investments, inventories, trade receivables, cash and cash equivalents, short-term loans and advances and other current assets. Items are classified as current or non-current on the basis of the operating cycle or twelve months. Figures for the current and previous years are shown, and details are given in notes to accounts.

Quick revision

Schedule III format.
Equity and liabilities: shareholders' funds, non-current, current.
Assets: non-current and current.
Statement of P&L: income, expenses, profit before and after tax.

Exam tips

Learn the main headings and sub-headings of the Schedule III balance sheet in order.
Practise classifying items as current or non-current using the twelve-month rule.

Practice MCQs

The format of company financial statements is given in
1. Schedule I
2. Section 135
3. Section 52
4. Schedule III
Show answer
Answer: (d) Schedule III. It is part of the Companies Act, 2013.
Share capital and reserves and surplus together form
1. shareholders' funds
2. current liabilities
3. non-current assets
4. provisions
Show answer
Answer: (a) shareholders' funds. They belong to owners.
Trade payables are shown under
1. non-current liabilities
2. current assets
3. shareholders' funds
4. current liabilities
Show answer
Answer: (d) current liabilities. They are due within a year.
Long-term borrowings are shown under
1. current liabilities
2. current assets
3. non-current liabilities
4. shareholders' funds
Show answer
Answer: (c) non-current liabilities. They are due after twelve months.
Inventories are shown under
1. non-current assets
2. reserves
3. current liabilities
4. current assets
Show answer
Answer: (d) current assets. They are expected to be sold within the operating cycle.
Interest on borrowings is shown in the statement of profit and loss as
1. other income
2. finance costs
3. employee benefits expense
4. depreciation
Show answer
Answer: (b) finance costs. It is the cost of borrowing.
Securities premium is shown under
1. share capital
2. current liabilities
3. reserves and surplus
4. other income
Show answer
Answer: (c) reserves and surplus. It is a part of shareholders' funds.
Which is a limitation of financial statements
1. they show legal form
2. they follow Schedule III
3. they are audited
4. they are based on historical cost and ignore price changes
Show answer
Answer: (d) they are based on historical cost and ignore price changes. Values may not reflect current worth.

All chapters of Class 12 Accountancy

Written by Kundali IQ from standard, well-established facts to help with revision. This is not an official NCERT publication; always read your textbook too.