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As businesses become larger and more complex, the role of financial managers changes considerably transcending from their traditional role of raising external funds only to a total involvement in the overall financial problems and decisions related to capital employed by the firm, allocation of funds to differing projects and activities, and measurement of results of each allocation. These technical finance functions therefore call for the utilization of various kinds of financial statements, as the balance sheet, the funds flow statement, the cash flow, and the income statement, as the case may be, in order to improve liquidity and profitability in such a firm.

These financial statements, when used together, generally will offer a valuable insight into the present historical record of the firms financial development., Secondly it will also be used to forecast a future course of action for the firm, and also exposing financial factors that must have influenced the growth/failure, and current status of such a firm. Nevertheless, these financial statements vary in their usage, serves some specific functions, and suffer some peculiar demerits.

Financial Statement Analysis : Approach

The theory or finance, both on the corporate and on the individual investor level, also largely ignores financial statement analysis. For example, the extensive portfolio theory literature is practically devoid of studies integrating financial statement information with the input requirements of the portfolio model. One of the major contributors to portfolio theory, Sharpe (1) provides in his book. Portfolio Theory and Capital Markets, a bibliographical list of over 150 related books and articles. None of which deals with financial analysis. It is also interesting to note that reading collection on the theory of finance usually do not include studies related to financial statement analysis : Financial statement analysis still remains in the initial state of development of the science of financial management.

Recent research in the area signifies the beginning of a new approach which is mainly characterized by the emphasis on development of financial analysis techniques within the context of formal decision models. Financial statement analysis is thus viewed as an information - processing system designed to provide data for decision-making models, such as the portfolio selection model, bank lending decision models and corporate financial management models. The purpose of financial statement analysis is to provide the data required by the model (e.g., predictions of future returns) in the most efficient (less costly) way.

As to the new approach formulated by the eminent financial management expert Baruch Lev (2) financial statement tools and techniques are developed and tested within the well defined frame-work or decision theory. The information users (i.e., decision makers) thus direct the development of financial analysis. The strong orientation of modem financial analysis towards decision making is reflected in the following characteristics :

Financial statement analysis is no longer detached from economic theories and models. The production of information (financial analysis) is now an integral part of the information use (economic and finance models). The construction and verification of financial analysis system requires considerable analytical sophistication. The informational demands of modern decision models, such as those derived from portfolio theory cannot be satisfied by simple financial ratios, Accordingly, advanced statistical techniques such as regression analysis, are used to develop and verify the financial statement information system. Modern financial analysis is no longer restricted to the accounting data conventionally reported in financial statements. Use is made of unreported data, such as market value of assets and management's forecasts of future earnings. The analysis also encompasses non-accounting data such as security prices, swaps, bond ratings and political risks.

Trained accountants are available everywhere but the unchallenged ability to interpret the balance sheet, income statement figures, realigning to dynamic and macro economic variables, intelligently and accurately is essential to an understanding of the operations of business enterprises in a highly competitive public or private enterprise. The new approach to financial statement analysis is still in the embryonic stage. The imperfect knowledge of decision makers behaviour and informational needs obviously hinders the progress of financial statement analysis.

Accontancy System in Hungary Tuned to the New Approach to Financial Statement Analysis (3):

The uniquely developed accountancy system in Hungary will serve to act as a guide to other countries to aid judicious financial decision making (3). According to the Act on Public Finances (1988), the order of book keeping of enterprises is regulated by a decree issued by the Ministry of Finance. In the General Compulsory Scheme of Accounts, published in accordance with the 1988 Decree, balance sheet accounts and result accounts are distinctly separated, permitting the drawing up of the balance sheet and of a profit and loss account equivalent to it, which are supplemented by cost accounts. The basis of the profit and loss account is the accounts concerning the cost of rates, sales receipts and other costs and incomes; The balance sheet is drawn up from assets and liabilities accounts. The types of costs schedule can be drawn up from the respective cost accounts.

Within the General Scheme of Accounts, classes 1 to 4 contain balance sheet accounts and within this, classes 1 to 3 contain the accounts for fixed assets, stocks and cash receivables, while class 4 includes funds and liabilities, (own and other resources).

* In class 1, accounts for fixed assets and investments are shown - According to the principle of gross clearance the gross value of fixed assets and depreciations are shown in separate groups of accounts.

* In class 2, all stocks, either bought or produced, are included. Raw materials, semi-fixed assets, purchased non-material goods, means of production, packing materials, livestock, finished and semi-finished products, social-purpose stocks and goods for sale are included in this class.

* In class 3, receivables are listed, cash and deposit accounts, financial settlements, clearings with buyers, debtors, employees and members, claims from the State budget and other organizations (associations, affiliates etc.) and other assets invested elsewhere are included. Deferred assets are also shown in this class.

* Assets are financed from own funds (owner's property fund and reserve property) and liabilities. Liabilities are accounts payable to suppliers, creditors, financial institutions, permanent liabilities and other credits that are recorded in class 4. Deferred liabilities, aftertax profit accounts, as well as the annual balance sheet and profit and loss accounts, are also included in class 4.

* Classes 5 to 7 are designated to classify costs, group them by type of costs, places of costs and according to cost bearers (functions). Homogeneous cost elements are listed for each type of cost and give an answer to the content of expenditures (use of raw materials, labour, fixed assets etc.) Basically, accounting by type of costs satisfies the information requirements of the national economy.

* From among the result accounts, the direct costs of sales and various other costs; nor represented in direct costs, are shown in class, 8, and the incomes from sales are shown in class 9. The result of the company's activity (profit or loss) equalling the result shown in the balance sheet is the difference between total receipts and total costs.

Enterprises draw up their own system of accounts on the basis of the General Compulsory Scheme of Accounts and the Branch Account Schemes, taking due consideration of these regulations. Within this framework; the enterprise determines the scheme of accounts most suitable to its characteristics and internal information requirements, taking into account the features of its production (activity), its organizational structure, as well as specific of the branch and the technology employed. This is especially valid for class 6, which is regulated in the General Compulsory Scheme of Accounts only within a broad framework.

Preparation and Analysis of Financial Statement: Hungary (3)

The obligation of economic organizations to take inventories and draw up financial statements is regulated by Order No. 60/1987 (XII. 7) of the Ministry of Finance. The Order establishes the method and frequency of stock-taking of assets and liabilities, their valuation and the obligation to draw up the balance sheet. All economic organizations, including share companies and limited liabilities companies established in accordance with the national law, come under the ruling of this Order.

The enterprise draws up a balance sheet on its financial status as at the end of the year and a profit and loss statement on the result of its economy activity. The balance sheet contains, on the one hand, the property of the company and, on the other hand, the value of all sources of assets. The balance sheet is prepared on the basis of audited, accounting records corrected by the figures of a properly conducted inventory and documents and on the basis of a trial balance. Balance sheets of consecutive years are interlinked so that the closing balance of one year is the opening, balance of the next. In the updated balance sheet, assets are listed according to their order of mobility, and the sources of assets according to the owner's equity and liabilities. This grouping makes solvency, creditability and indebtedness of the enterprise apparent to the interested parties. The profit and loss statement contains the total revenue of the enterprise (i.e., receipt from sales and other incomes), as well as the total costs (costs of sale, overhead costs not distributed to products, other expenses). From this, the net income of the accounting period is obtained, which equals the profit (or loss) slated in the balance sheet. Thus the enterprise can ensure that accounting serves as a means for effective corporate / public management, for increasing the net worth and for effecting cost reduction.

Disclosure of Information through Notes to Financial Statements : UNCTC Guidelines (4)

In addition, bank managers are as aware as corporate accountants of the problems of a company trying to manage on too high a proportion of borrowed capital. In this regard, it would be meaningful to look not just at the audited balance sheet of a customer, but at the notes attached to the accounts to see what reliance the company has on off-balance sheet finance by way of leasing or other financial facilities. The balance sheet may need to be restated to allow for such sources of finance, to get a true gearing ratio.

Disclosure of accounting policies is essential for understanding the content of financial statements. Notes to the financial statements should disclose all significant accounting policies which have been used, including overall valuation policies (for example, historical cost, application of a general purchasing power index, replacement value or any other basis). These disclosures should include in particular a description of the accounting policies concerning:

Inclusion and exclusion of group enterprises in consolidation; investments in groups and associated enterprises; intra-group transactions; translation of accounts denominated in foreign currency; transactions of group' enterprises with associated : enterprises; criteria for the selection of geographical areas or countries reported separately; and criteria for segmentation by line of business reported separately. The following information items should be disclosed by (a) the enterprise as a whole; and (b) the individual members enterprise unless otherwise stated:

Property, plant and equipment

(a) Accounting treatment including depreciation accounting : It is appropriate to regard property, plant and equipment as economic resources representing expected future benefits to be used up in the production of goods and/or provision of services on a continuing basis. Accordingly, it is appropriate to capitalize expenditures on property, plant and equipment.' Such expenditures should include the initial cost of acquisition and post-acquisition expenditures which would extend the useful life, increase the capacity or improve the efficiency of property, plant and equipment. The amount to be capitalized should comprise the purchase price or production cost and all other expenditures necessary to put the asset in operating condition and location for use. Interest on debt could be capitalized as part of the cost of property, plant and equipment up to the time when the asset is ready for use.

The predominant practice in accounting is to account for property, plant and equipment on the basis of their historical cost. However, there could be instances where it would be appropriate to reflect property, plant and equipment at values different from historical cost. Those instances could be indicated by considerations such as inflation rates, specific price changes, currency revaluation and fluctuations in foreign exchange rates. In cases of permanent impairment and technological obsolescence, a write-down should be made.

Property, plant and equipment with limited useful lives should be depreciated. The aim of the depreciation method used should be to provide a reasonable consistent matching of revenue and expense by systematically allocating the cost of depreciable asset over its estimated useful life. The basis and method used in computing depreciation should be those that must reflect the underlying physical, technical and economic facts, and should be such that they could be reliably and consistently applied. Depreciation rates should be reviewed periodically and, if necessary, adjusted so that they reflect the most recent estimates of the useful lives of the respective assets, having regard to such factors as asset usage and the rate of technical and economic obsolescence, and also the most recent assessment of the net amounts expected to be recovered on their disposal.

(b) Disclosure of property, plant and equipment

Financial statements should disclose property, plant and equipment providing information in regard to both owned and non-owned properties shown in the accounts. Leaseholds and improvements thereto should be included under this item where they are treated as assets.

Disclosure concerning property, plant and equipment should be required in financial statements or the notes thereto. Disclosure should include (a) the gross carrying amounts of land and buildings, plant and equipment; (b) acquisitions, disposals, transfers, write-offs and revaluations during the year; (c) exceptional profit or loss from sales, disposals and transfers, if material; (d) depreciation for the year and accumulated depreciation; (e) the bases used in determining the gross carrying amounts or revalued amounts; (f) the depreciation methods and rates used; and (g) the extent to which property, plant and equipment have been pledged as security. Where land and buildings, plant and equipment are material in relation to total assets, an appropriate breakdown should be provided.


The enterprise as a whole should disclose separately investments in group enterprises not consolidated, investments in associated enterprises' and other long-term investment. The individual member enterprise should disclose separately investments in group enterprises, investments in associated enterprises and other long-term investments. Regarding direct investment in associated enterprises, long-term investment in marketable securities and investment in joint ventures, the enterprise as a whole should disclose:
The amount invested during the year; the carrying value of the
investment at the end of the year; the income derived from the
investment; changes in the value of the investment; and an exceptional
gain or losses arising from sales of the investment, if material.

Significant new direct investment should be disclosed by geographical area. The investing enterprise should disclose the name and host country of each of (a) the investees under its control or significant influence; and (b) its joint ventures, showing the proportion of the capitalheld, the amount of capital, retained earnings and reserves, and the profit or loss for the latest financial year of the undertaking concerned for which accounts had been adopted.

Short-term loans and overdrafts

The individual member enterprise should separately disclose loans and debentures from group and associated enterprises.


Deferred taxes, provisions for pensions and other provisions should each be indicated separately. Appropriate explanations and descriptions should be given of other provisions. Deferred taxes are amounts provided for taxes in respect of the current and previous years' results which are expected to become payable in future periods. The amount reflects the fact that the periods in which some items of revenue and expense are recognized for tax purposes do not coincide with the periods in which they are included in accounting income.

Owners's interest

A description and quantification of each component element should be provided, such as, if any, different classes of shares and other forms of owners' interest, capital paid in excess of par, revaluation surplus, reserves and retained earnings. Movements during the accounting period should be indicated.

Restricted assets and secured liabilities

Where assets are restricted or pledge, or liabilities secured, an indication in summary form should be provided.


Leases not reflected in fixed assets and other long-term commitments should be appropriately described and quantified.

Contingent liabilities and assets

Accounting and reporting of contingent liabilities and assets should be based on the concept of prudence in respect of a contingent asset, and on the degree of the probability of payment in respect of a contingent liability.

(a) Contingent liability : A condition or situation existing at the balance-sheet date that mayor may not result in loss or expenditure depending on the outcome of one or more uncertain future events. A contingent liability is disclosed in the notes to the extent that it has not been accrued by a charge in the income statement, unless the possibility of a loss is remote. Contingent liabilities resulting from specific legal obligations undertaken by the enterprise, such as guarantees or discounted bills of exchange, are disclosed in the notes to the financial statements, even though it is unlikely that a loss to the enterprise will occur.

(b) Contingent asset : A condition or situation existing at the balance-sheet date that mayor may not result in a gain expenditure depending on the outcome of one or more uncertain future events. A contingent asset is disclosed in the notes to the extent that it has not bee accrued by a charge in the income statement, unless the possibility of a loss is remote. Contingent liabilities resulting from specific legal obligations undertaken by the enterprise, such as guarantees or discounted bills of exchange, are disclosed in the notes to the financial statements, even though it is unlikely that a loss to the enterprise will occur.

Contracts for future capital expenditure

Contracts for future capital expenditure should be quantified and disclosed.

Events after balance sheet date

Material events that have occurred after the balance-sheet date should be quantified and disclosed.

Movements in certain assets

There is a need for disclosure of information concerning movements in certain assets, namely, (a) land and buildings; (b) plant and equipment; (c) assets under construction; (d) long-term investments; (e) long-term receivables; (f) purchased goodwill; (g) patents, trade marks and similar intangibles; (h) deferred charges of a long-term nature. Concerning e,f,g and h information should disclosed in respect of opening balance (gross amounts before depreciation) acquisitions, disposals, transfers, write-offs, revaluations /adjustments and closing balance.

Reserve accounting, including hidden reserves (excluding banks and insurance companies)

The term "reserves" is not applied universally: sometimes the term is used to describe or refer to valuation accounts, such as accumulated depreciation and allowances for uncollectible receivables, or to estimated liabilities, such as the amounts set aside by way of provisions for product warranties. Such usages should be avoided and consideration of reserve accounting should be confined to items which would normally be considered to be components of equity. Hidden reserves are created when there is a material understatement of assets : or an overstatement of liabilities. The creation of such reserves adversely affects the ability to show a true and fair view of the financial position as at the end of the accounting period, and results of operations for the period. Reserves should not be used to avoid charges to operations. For example, it is inappropriate to charge to a reserve a probable loss which could be reasonably estimated. Such amounts should be charged to the profit and loss account of the current period. That would apply whether the reserve was created voluntarily or pursuant to legal requirements, and irrespective of whether it was established, inter alia, from accumulated earnings (revenue reserves) or from contributed capital.

The amounts arising from balance sheet recognition of unrealized increases in values are sometimes included in equity. Such amounts might occur, for example, upon the revaluation of fixed assets. Likewise, translation differences arising upon translation of a consolidated subsidiary's financial statements denominated in a foreign currency might be included in equity. Normally, the inclusion of those amounts in equity is appropriate before accounting recognition and measurement takes place based on transactions and events external to the enterprise, such as the disposal of a fixed asset.

Disclosure of information on reserves, as well as movements in each reserve, is necessary for the meaningful interpretation of an enterprise's financial statements. In that regard, the information provided should include the opening balance, changes during the period, the closing balance and the sources of changes. Long-term investments in marketable securities are sometimes accounted for in financial statements at their historical cost and sometimes at their market value. Marketable debt securities are currently accounted for at their historical cost, their present value or their market value.

Receivables and payables

a) Long-term receivables:

Receivables from group enterprises not consolidated, or in the case of individual member enterprises receivables from group enterprises, receivables from associated enterprises and other long-term receivables should each appear separately.

b) Receivables:

Accounts and notes receivable (trade), receivables from members of the board of directors, and other receivables should each be indicated. Individual member enterprises should indicate receivables from group and associated enterprises separately. Appropriate explanations and descriptions should be given of other receivables.

c) Payables:

Accounts and notes payable (trade), payables to members of the board of directors, taxes on income, dividends payable, as well as other accounts payable and accrued expenses should each be shown. Individual member enterprises should show payables to group and associated enterprises separately. Appropriate explanations and descriptions should be given of other accounts payable and accrued expenses.

d) Deferred charges

This item generally includes expenditures not recognized as a cost of operations in the period in which they are incurred but which are carried forward to be written off over a period of years. Where treated as assets, the following would each appear separately: formation expenditure, research and development and other deferred charges. Appropriate explanations and descriptions should be given of other deferred charges This item excludes prepaid expenses reported elsewhere. When used as "other" long-term assets, an appropriate descriptive caption should be used in place of deferred charges if a material balance is carried"

e) Cash

The item should show cash on hand and in banks, including time deposits due within a short period.


The term "inventory" denotes the aggregate -of items of tangible property held

a) for sale in the ordinary course of business;

b) in the process of production for such sale, or

c) for consumption in the production of goods or services for sale, including maintenance supplies and consumables.

a) Valuation of inventory cost: selection of an appropriate method:

Different practices exist as regards the composition of inventory cost, the methods of costing inventory measurement. Thus, there is a need for harmonization in those instances where the application of different practices would limit the comparability of the financial statements. Inventory cost should normally comprise the applicable expenditures and charges directly and indirectly incurred in bringing an inventory item to its existing condition and location. In some countries it is an accepted practice to include only direct expenditure and charges in inventory cost.

Considering that various accounting methods exist and that they are based on different assumptions about inventory movements and cost flows, in selecting a method the major objective should be to choose the one that, under the circumstances, most clearly reflects the economic reality of the situation. The overriding consideration should be that the method selected permits a true and fair view of the results of operations and the financial position of the enterprise. The method adopted should be consistently applied from period to period and adequately disclosed in the financial statements.

b) Disclosure of inventories and of valuation policy:

Inventories should be disclosed in the balance sheet. Where inventories are a material item, an appropriate breakdown-such as raw materials, work-in-process, finished goods, in transit, spare parts and supplies, and long-term contracts in progress-should be provided, and the amount for each category shown. However, where special circumstances would entail undue expense, inventories could be combined in the consolidated accounts. Information should be disclosed in respect of :

(a) the accounting policies adopted for the purpose of inventory valuation,

(b) change in inventory valuation policy that had a material effect in the current period or might have a material effect in subsequent periods; and

(c) the effect of the change in inventory valuation policy.

Where book value of inventories determined on the basis of the weighted average price, first-in, first-out (FIFO), last-in, first-out (LIFO), or other similar methods differs materially from the market value at the balance-sheet date, the amount of the difference should be disclosed in the notes to the accounts. The amount of inventories pledged as collateral for repayment of loans should be disclosed. The amount of any exceptional value adjustment(s) should be disclosed.

Long-term loans and debentures

A summary 'of maturity patterns, the basis of currency conversion and exchange rates used should be disclosed. The individual member enterprise should separately disclose loans and debentures from group and associated enterprises.

Transnational corporations should, within reasonable time-limits and on a regular basis, but at least annually, provide to the public in the countries in which they operate clear and comprehensible information designed to improve understanding of the structure, activities and policies of the transnational corporations as a whole. Such information should supplement information required by national laws, regulations and administrative practices and be provided in a consolidated form. In providing information, transnational corporations should have particular regard to the significance of their operations for the countries concerned, irrespective of the relative importance of such operation for the transnational corporation as a whole.


Although the basic principles of accounting may be quite similar in all nations, the accounting systems among nations often vary, as they do among different industries. Such diversity of accounting systems can be attributed to the differences in the level(s) of economic development, social climate, and, to a great extent, the degree of accounting sophistication of financial information users in the various countries and industries. Furthermore, and equally significant, analyses of accounting systems among nations indicate that no two accounting and business environments are quite the same. Each national accounting and business environment is different and may require an accounting system with a difference approach from that used in other countries (5).

Given this view point and approach to analyzing the accounting systems of different countries and different business environments, an ideal goal for the accounting bodies of emerging nations would be to adopt those aspects of generally accepted accounting principles and techniques applicable to their particular environment. Ironically, most developing nations have chosen to engage in the erroneous and often regrettable practice of "importing" accounting systems from developed nations." Such imported accounting systems have been indiscriminately adopted in some developing nations, without proper modification to the needs of the nation's specific accounting and business environment, a practice which has sometimes led to rather chaotic practices.


(1.) Sharpe, Portfolio Theory and Capital Market (New York, 1970)

(2.) Lev, B. Financial Statement Analysis : A New Approach (New Jersey, 1974)

(3.) Deak, D., Consolidated Tax System Induces Foreign Investment in Hungary : Journey Towards A Market-Oriented Economy, Journal of Financial Management and Analysis (January-June 1993)

(4.) United Nations Centre on Transnational Corporations,

i) Conclusions on Accounting and Reporting on Transnational Corporations (New York, September 1988)

ii) International Accounting and Reporting Issues (New York, June 1988)

(5.) Jagetia, L. and Nwadike, E.C., Accounting Systems in Developing Countries : Center for International Education and Research in Accounting (University of Illinois at Urbana-Champaign)

Professor M. R. KUMARA SWAMY, MA, Ph.D.


Om Sai Ram Centre for Financial Management Research

Mumbai, INDIA

e-mail: jfmaosr@gmail. com

Assets                                Liabilities

01      Cash at bank and in hand      15   Short-term credits
02      Accounts receivable (debtors  16   Accounts payable (credits)
03      Other claims                  17   Permanent liabilities
04      Stocks                        18   Balance of tax settlements
05      Current working assets        19   Instalment payable in the
                                           following year on long-term
06      Financial investments         20   Other short-term liabilities
                                           due within one year
07      Current (working) assets      21   Total current liabilities
        (from 01 to 06)                    (from 15 to 20)
08      Fixed assets at gross value   22   Non-current liabilities
09      Accumulated depreciation      23   Long-term credits (loans)
10      Fixed assets at net value     24   Homogeneous property fund
11      Investments                   25   Reserve property
12      Fixed assets invested         26   Other funds
13      Total assets (07+13)          27   After-tax profit (or loss) of
                                           the curent year
                                      28   Own funds (from 23 to 27)
                                      29   Total liabilities : Sources


Reserves from basic activity  Prime costs of basic activiity
Revenues from activities      Prime costs accounted
outside basic activity        on activities outside basic activity
Consumption tax               Undivided (overhead) costs
Miscellaneous revenues        Miscellaneous expenses:
Revenues from sales and       Costs of goods sold and
other revenues (R)            other expenses
LOSS                          PROFIT
if R[less than or equal to]C  if R [less than or equal to] C
COPYRIGHT 2018 Reprinted with permission from JFMA. Copyright reserved with JFMA.
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Article Details
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Author:Swamy, M.R. Kumara
Publication:Journal of Financial Management & Analysis
Article Type:Report
Geographic Code:4EXHU
Date:Jan 1, 2018
Next Article:Financial Management Digest.

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