SYDENHAM COLLEGE OF COMMERCE & ECONOMICS

2015-16

Program under faculty of commerce

MASTER OF COMMERCE (EVENING)

Project Title:

FINANCIAL ACCOUNTING

IN PARTIAL FULLFILMENT OF THE REQUIRNMENT UNDER SEMESTER

BASED ON

CREDIT & GRADING SYSTEM FOR POST GRADJUATION SEMESTER – I

SUBMITTED BY:

CHINTAN CHIMANBHAI KANABAR

Roll no. 27 (Div – A)

PROJECT GUIDE:

Dr. Paras Jain

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DECLARATION

I, CHINTAN CHIMANBHAI KANABAR of Sydenham College of

commerce & economics ‘B’ Road, Church gate, Mumbai – 400020 currently

studying in M.com –I (Evening), Hereby declare that I have completed this

project on FINANCIAL ACCOUNTING for semester –I of the academic

year 2015-16. The information given under the project is true and fair to the

best of my knowledge.

Signature of Student:

.

CHINTAN C KANABAR

Roll No. 27 (DIV-A)

2

CERTIFICATE

This is to certify that MR. CHINTAN CHIMANBHAI KANABAR of the M.COM – I

(Evening) Semester-I has successfully completed project on FINANCIAL

ACCOUNTING under the Guidance of Dr. Paras Jain

1. Project Guide. : Dr. Paras Jain

2. Internal Examiner :

3. External Examiner :

Date :

Time :

3

INDEX

CHAPTER I CORPORATE FINANCIAL ACCOUNTING

CHAPTER II CONSOLIDATION OF FINANCIAL

STATEMENTS

CHAPTER III ACCOUNTING OF BANKING COMPANIES

CHAPTER IV FOREIGN BRANCH

REFERENCE & BIBLIOGRAPHY

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AKNOWLEDGMENT

I would firstly like to thank “UNIVECITY OF MUMBAI” For giving us the liberty to select the

topic which will benefit to us in the future. I would like to thanks to the principle of Sydenham

College of commerce & economics Dr. Annasaheb Khemnar for giving me an opportunity to study

in the esteemed college and doing the course of accounting. I would like to express my sincere

gratitude and thanks to professor Dr. Paras Jain who is my project guide , as he has been

guiding light on this project and also provided me with the best of his knowledge, advice and

encouragement which helps in the successful completion of my project.

My colleague and specially my parent who has also supported and encourages me the success of

this project to the large extant is also dedicated to them.

I would like to thanks all those who helped me but I forgotten to mention in this space.

Signature of Student:

.

CHINTAN C KANABAR

Roll No. 27 (DIV-A)

5

CHAPTER I

What is   Corporate   Finance?

Every decision made in a business has financial implications, and any decision that involves the use

of money is a corporate financial decision. Defined broadly, everything that a business does fits

under the rubric of corporate finance. It is, in fact, unfortunate that we even call the subject

corporate finance, because it suggests to many observers a focus on how large corporations make

financial decisions and seems to exclude small and private businesses from its purview.

A more appropriate title for this discipline would be Business Finance, because the basic principles

remain the same, whether one looks at large, publicly traded company or small, privately run

businesses. All businesses have to invest their resources wisely, find the right kind and mix of

financing to fund these investments, and return cash to the owners if there are not enough good

investments.

In this introduction, we will lay the foundation for this discussion by listing the three fundamental

principles that underlie corporate finance - the investment, financing, and dividend principles - and

the objective of company value maximization that is at the heart of corporate financial theory.

The Company: Structural Set-Up :

In corporate finance, we will use company generically to refer to any business, large or small,

manufacturing or service, private or public. Thus, a corner grocery store and Microsoft are both

company. The company investments are generically termed assets.

Although assets are often categorized by accountants into fixed assets, which are long-lived, and

current assets, which are short-term, we prefer a different categorization. The assets that the

company has already invested in are called assets in place, whereas those assets that the company is

expected to invest in the future are called growth assets.

To finance these assets, the company can raise money from two sources. It can raise funds from

investors or financial institutions by promising investors a fixed claim on the cash flows generated 6

by the assets, with a limited or no role in the day-to-day running of the business. We categorize this

type of financing to be debt.

Alternatively, it can offer a residual claim on the cash flows and a much greater role in the operation

of the business. We call this equity. Note that these definitions are general enough to cover both

private company, where debt may take the form of bank loans and equity is the owner’s own

money, as well as publicly traded companies, where the company may issue bonds and common

stock.

Thus, at this stage, we can lay out the financial balance sheet of a company as follows:

Note the contrast between this balance sheet and a conventional accounting balance sheet.

An accounting balance sheet is primarily a listing of assets in place, though there are some

circumstances where growth assets may find their place in it; in an acquisition, what gets recorded

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as goodwill is a conglomeration of growth assets in the target Company, synergies and

overpayment.

First Principle :

Every discipline has first principles that govern and guide everything that gets done within it. All of

corporate finance is built on three principles, which we will call, rather unimaginatively, the

investment principle, the financing principle, and the dividend principle. The investment principle

determines where businesses invest their resources, the financing principle governs the mix of

funding used to fund these investments, and the dividend principle answers the question of how

much earnings should be reinvested back into the business and how much returned to the owners of

the business. These core corporate finance principles can be stated as follows:

The Investment Principle:

Invest in assets and projects that yield a return greater than the minimum acceptable hurdle rate. The

hurdle rate should be higher for riskier projects and should reflect the financing mix used - owner’s

funds (equity) or borrowed money (debt). Returns on projects should be measured based on cash

flows generated and the timing of these cash flows; they should also consider both positive and

negative side effects of these projects.

The Financing Principle:

Choose a financing mix (debt and equity) that maximizes the value of the investments made

and match the financing to nature of the assets being financed.

The Dividend Principle:

If there are not enough investments that earn the hurdle rate, return the cash to the owners of the

business. In the case of a publicly traded company, the form of the return - dividends or stock

buybacks - will depend on what stockholders prefer.

When making investment, financing and dividend decisions, corporate finance is single-minded

about the ultimate objective, which is assumed to be maximizing the value of the business. These

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first principles provide the basis from which we will extract the numerous models and theories that

comprise modern corporate finance, but they are also commonsense principles.

It is incredible conceit on our part to assume that until corporate finance was developed as a

coherent discipline starting just a few decades ago, people who ran businesses made decisions

randomly with no principles to govern their thinking. Good businesspeople through the ages have

always recognized the importance of these first principles and adhered to them, albeit in intuitive

ways.

In fact, one of the ironies of recent times is that many managers at large and presumably

sophisticated company with access to the latest corporate finance technology have lost sight of these

basic principles.

The Objective of the Company:

No discipline can develop cohesively over time without a unifying objective. The growth of

corporate financial theory can be traced to its choice of a single objective and the development of

models built around this objective. The objective in conventional corporate financial theory when

making decisions is to maximize the value of the business or company.

Consequently, any decision (investment, financial, or dividend) that increases the value of a

business is considered a good one, whereas one that reduces company value is considered a poor

one. Although the choice of a singular objective has provided corporate finance with a unifying

theme and internal consistency, it comes at a cost.

To the degree that one buys into this objective, much of what corporate financial theory suggests

makes sense. To the degree that this objective is flawed, however, it can be argued that the theory

built on it is flawed as well.

Many of the disagreements between corporate financial theorists and others (academics as well as

practitioners) can be traced to fundamentally different views about the correct objective for a

business.

For instance, there are some critics of corporate finance who argue that company should have

multiple objectives where a variety of interests (stockholders, labor, customers) are met, and there

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are others who would have company focus on what they view as simpler and more direct objectives,

such as market share or profitability.

Given the significance of this objective for both the development and the applicability of corporate

financial theory, it is important that we examine it much more carefully and address some of the

very real concerns and criticisms it has garnered: It assumes that what stockholders do in their own

self-interest is also in the best interests of the company, it is sometimes dependent on the existence

of efficient markets, and it is often blind to the social costs associated with value maximization.

Corporate Financial Decisions, Company Value, and Equity Value:

If the objective function in corporate finance is to maximize company value, it follows that

company value must be linked to the three corporate finance decisions outlined investment,

financing, and dividend decisions. The link between these decisions and company value can be

made by recognizing that the value of a company is the present value of its expected cash flows,

discounted back at a rate that reflects both the riskiness of the projects of the company and the

financing mix used to finance them.

Investors form expectations about future cash flows based on observed current cash flows and

expected future growth, which in turn depend on the quality of the company projects (its investment

decisions) and the amount reinvested back into the business (its dividend decisions). The financing

decisions affect the value of a company through both the discount rate and potentially through the

expected cash flows.

Chapter - II

Consolidated Financial Statements

Meaning

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Financial Information presentation in which the assets, equity, liabilities, and operating accounts of

a firm and its subsidiaries are combined (after the eliminating all inter-firm transactions) and shown

as belonging to a single reporting entity. Also called combined financial statement or consolidated

accounts.

How it works/Example:

Let's assume Company XYZ is a holding company that owns four other companies: Company A,

Company B, Company C, and Company D. Each of the four companies pays royalties and other

fees to Company XYZ.  

At the end of the year, Company XYZ's income statement reflects a large amount of royalties and

fees with very few expenses -- because they are recorded on the subsidiary income statements. An

investor looking solely at Company XYZ's holding company financial statements could easily get a

misleading view of the entity's performance. 

However, if Company XYZ consolidates its financial statements -- "adding" the income statements,

balance sheets, and cash flow statements of XYZ and the four subsidiaries together -- the results

give a more complete picture of the whole Company XYZ enterprise.

In Figure 1 below, Company XYZ's assets are only $1 million, but the consolidated number shows

that the entity as a whole controls $213 million in assets.

In the real world, generally accepted accounting principles (GAAP) require companies to eliminate

intercompany transactions from their consolidated statements. This means they must exclude

movements of cash, revenue, assets, or liabilities from one entity to another in order to avoid double

counting them. Some examples include interest one subsidiary earns from a loan made to another

subsidiary, "management fees" that a subsidiary pays the parent company, and sales and purchases

among subsidiaries.11

Applicable Accounting Standard

Ordinarily, following accounting standards are applicable for the preparation of consolidated

financial statement.

As-21 – Consolidated Financial Statements.

AS-23 – Accounting for Investment in Associates in Consolidated financial Statement

As-24 – Financial reporting of Interests in Joint venture

Meanings of Holding Company

Subsidiaries

Subsidiary is one which is “controlled” by a parent – (Need not be a company an Subsidiary can be

any type of organization)

Control – Ownership, directly or indirectly through one or more subsidiaries, of more than half of

voting power of an enterprise more than half of voting power of an enterprise,

OR

Controlling composition of board of directors in case of a company or governing council so as to

obtain economic benefits from the enterprise

Analysis of definition of control

Deliberately set so as to avoid conflict with Companies Act definition

• Subsidiaries under Companies Act –

These are the examples of subsidiaries.

• A controls B

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• A controls B, B controls C

• A controls B and C. B and C together controls D

Principles for consolidation

Exceptions to consolidation

There are two exceptions –

1. Where control is temporary Where control is temporary –

2. Subsidiary operates under long term restrictions which significantly impair

its ability to transfer funds to parent

What if activities of the subsidiary are totally different from the parent? Different from the

parent? Not a valid ground for not doing consolidation

Consolidation procedures:

Line by line consolidation of assets/liabilities/incomes and expenses of the subsidiary.

Investment of the parent in the capital of the subsidiary (A), and parent’s potion of the equity of the

subsidiary (B) should be eliminated

If is A is more than B, A-B is goodwill

If B is more than A, B-A is capital reserve

This determination is done on the date of investment in the subsidiary –

Minority interest in the net income of the subsidiary should be adjusted against group income

– Minority interest in the net assets should be identified and reflected separately from the

liabilities and equity of the parent.

Intra-group balances and intra group transactions, and any unrealized profits should be

eliminated completely.

Unrealized losses are also eliminated, but may reflect impairment - Financial statements are

drawn unto the same date.

However, if it is not practical to prepare on the same date, a gap of not more than 6 months is

permissible.

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Uniform accounting Policy.

De-Subscription

From the date on which the holding and subsidiary relationship ceases, the difference between the

proceeds of investment, and the carrying amount of net asset on the balance sheet of the parent, is

recognized as profit / loss.

Example:

How to Consolidate ?

Let’s be more practical today and learn some advanced accounting techniques. After summaries of

standards related to consolidation and group accounts, I’d like to show you how to prepare

consolidated financial statements step by step. I’ll do it on a case study, with explaining what I do

and why. If you don’t like reading, you can skip to the end of this article and watch my video. If

you’d like to revise a theory first, then please read my summary AS-21 Consolidated Financial

Statements,

What’s the situation?

Here’s the question: Mommy Corp has owned 80% shares of Baby Ltd since Baby’s incorporation.

Below there are statements of financial positions of both Mommy and Baby at 31 December 2014.

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Prepare consolidated statement of financial position of Mommy Group as at 31 December 20X4.

Measure NCI at its proportionate share of Baby’s net assets.

Please note here that in the above statements of financial position, all assets are with “+” and all

liabilities are with “-“. I use it this way because for me it’s easier to verify and identify mistakes, but

it’s up to you.

Step 1: Combine

After you make sure that all subsidiary’s assets and liabilities are stated at fair values and all the

other conditions are met, you can combine, or add up like items.

It’s very easy when a parent (Mommy) and a subsidiary (Baby) use the same format of the

statement of financial position – you just add Mommy’s PPE and Baby’s PPE, Mommy’s cash and

Baby’s cash balance, etc. In reality, companies use their own format for presenting their financial

position and therefore it can be difficult to combine. That’s exactly WHY so many groups use their

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“consolidation packages” and subsidiaries’ accountants must fill them up along with preparing own

financial statements.

Therefore, when a group controller calls you every five minutes to remind you the consolidation

package, you’ll know why!

In our case study, combined numbers looks as follows:

Of course, there are some strange and redundant numbers, for example both Mommy’s and Baby’s

share capital, but we haven’t finished yet!

Step 2: Eliminate

After combining like items, we need to offset (eliminate):

the carrying amount of the parent’s investment in each subsidiary; and

the parent’s portion of equity of each subsidiary;

and of course, recognize any non-controlling interest and goodwill.

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So let’s proceed. The first two items are easy – just remove Mommy’s investment into Baby (CU –

70 000), and remove Baby’s share capital in full (CU + 80 000).

As there is some non-controlling interest of 20% (please see below), you need to remove its share in

Baby’s post-acquisition retained earnings of CU 9 000 (20%*CU 45 000).

Wait a second – how do we know that all Baby’s reserves (retained earnings) of CU 45 000 are

post-acquisition?

Well, the question says that Mommy has owned Baby’s shares since its incorporation; therefore full

Baby’s retained earnings are post-acquisition.

Be careful here, because you absolutely need to differentiate pre-acquisition retained earnings from

post-acquisition retained earnings, but here, we’re not going to complicate the things.

Then we need to recognize any non-controlling interest and goodwill.

Non-controlling interest at 31 December 20X4

Mommy has owned 80% of Baby’s share and therefore, non-controlling interest owns remaining

20% of Baby’s net assets.

The question asks to measure non-controlling interest at proportionate share on Baby’s net assets, so

here’s how it looks like at the end of the reporting period:

Baby’s net assets are CU 125 000 as at 31 December 20X4, including Baby’s share capital of CU

80 000 and Baby’s post-acquisition reserves of CU 45 000.

Non-controlling interest at 31 December 20X4 is 20% of Baby’s net assets of CU 125 000, which is

CU 25 000. Recognize it with minus, as we are crediting equity with non-controlling interest.

Initial recognition of goodwill

There might be some goodwill arisen on initial recognition. If you’d like to learn more about

goodwill, please refer to the article about.

Let’s calculate it. Please don’t forget that we calculate goodwill based on numbers on acquisition,

not on 31 December 20X4.

The goodwill is calculated as:

Fair value of consideration transferred: in this case, we simply take Mommy’s investment in

Baby of CU 70 000;

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Add any non-controlling interest at acquisition: here, we’re not adding the non-controlling

interest calculated above, as it’s the measurement on 31 December 20X4. At acquisition, the

value of non-controlling interest is 20% of Baby’s net assets on its incorporation of CU 80 000

(share capital only). It equals CU 16 000.

When a business combination was achieved in stages, you would need to add the acquisition-

date fair value of the acquirer’s previously-held equity interest in the acquiree, but in this

example, it’s not applicable,

Deduct Baby’s net assets at acquisition: CU – 80 000.

Goodwill acquired in a business combination comes to CU 6 000 (70 000 + 16 000 – 80 000).

The elimination entry looks as follows (sign “+” indicates a debit entry; sign “-“ indicates a credit

entry):

Description Amount Debit Credit

Remove Mommy’s investment in Baby -70 000

FP – Investment in Baby

Remove Baby’s share capital in full +80 000

FP – Baby’s share capital

Remove 20% (NCI) of Baby’s post-acquisition retained earnings +9 000

FP – Retained earnings

Recognize non-controlling interest on 31 December 20X4 -25 000

FP - Non-controlling interest

Recognize goodwill acquired in a business combination +6 000

FP – Intangible assets (goodwill)

Check 0

I have transferred this journal entry into our consolidation worksheet and it looks as follows:

18

Eliminate Intragroup Transactions

Parents and subsidiaries trade with each other very often. However, when you look at both parent

and subsidiary as at 1 company, which is the purpose of consolidation, then you find out that there’s

no transaction at all. In other words, group has not performed any transaction from the view of some

external user.

Therefore you need to eliminate all transactions happening within the group, between a parent and

its subsidiaries. Looking to above individual statements of financial position of Mommy and Baby

you see that Mommy has a receivable to Baby of CU 8 000 and Baby has a payable to Mommy of

CU 8 000. Perhaps these 2 items relate to the same transaction between them and we need to

eliminate them, by debiting payables and crediting receivables:

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Final steps

After we have completed all steps or consolidation procedures, we can add up all the combined

numbers with our adjustments and thus we arrive at consolidated statement of financial position.

You can revise all the steps and formulas in Excel file that you can download at the end of this

article.

Here’s how it looks like:

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Please note the following facts:

Consolidated numbers are simply sum of Mommy’s balance, Baby’s balance and all

adjustments or entries (Steps 1-3).

Mommy’s investment in Baby’s shares is 0 as we eliminated it in the step 2. The same applies

for Baby’s share capital and consolidated statement of financial position shows only a share

capital of Mommy (parent)

Consolidated retained earnings are CU 98 000 and they consist of:

Mommy’s retained earnings of CU 62 000 in full, and

Mommy’s share (80%) on Baby’s post-acquisition retained earnings of CU 45 000, that is CU

36 000.

 

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Chapter - III

Accounts of Bank

Just like a nonfinancial service company, a bank has to manage the trade-off between its profits and

risks. However, two distinct characteristics for banks pose challenges in analyzing their financial

statements. The first relates to defining debt and reinvestment needs for banks, making it difficult to

calculate cash flows for investment analysis. The second difficulty has to do with regulation, which

became especially burdensome after the 2009 financial crisis.

In the financial statement analysis for a typical nonfinancial service company, capital is calculated

as the sum of debt and equity. The company borrows funds and issues equity to invest in property,

plant and equipment.

With banks, the capital definition becomes blurrier. For banks, debt is like a raw material that is

turned into other more profitable financial products. For example, a bank raises funds from

bondholders and invests these proceeds into foreign bonds with a yield above its borrowing rate.

For this reason, the definition of banks' capital used by regulatory and investment professionals

focuses on banks' equity.

The problem of defining debt for banks is especially evident when considering

customers' deposits in checking and savings accounts. Since banks pay interest on savings accounts,

such deposits should be considered debt and all interest expenses must be excluded in

Calculating free cash flow to the firm. However, this poses a problem since interest expense is one

of the largest components on banks' financial statements. In some sense, interest expense to banks is

similar to a cost of goods sold to nonfinancial service companies.

Another problem that financial institutions' business nature poses is how to measure banks'

reinvestment needs. For a manufacturing company such as Boeing, the reinvestment need can be

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easily calculated by taking capital expenditures, subtracting depreciation and adding back changes

in working capital.

Consider one of the largest U.S. commercial banks, Wells Fargo. Other than leasing buildings,

Wells Fargo does not have to invest in property and its fixed assets are a very small fraction of its

total assets.

A quick look at the cash flow statement for Wells Fargo shows very small capital expenditures and

depreciation that bear very little relation to its profitability. On the other hand, Wells Fargo heavily

invests in its brand name and its employees, who are one of its most valuable assets.

Consider changes in working capital for Wells Fargo. Working capital is ordinarily defined as the

difference between current assets and current liabilities. Looking at Wells Fargo's recent balance

sheet reveals it does not break down its assets and liabilities by their maturity or expected use.

If an investment analyst still categorizes Wells Fargo's assets and liabilities, most of them fall into

one or the other category, and calculated changes in working capital have little relationship with

reinvestment needs.

Finally, consider the regulatory burden. Regulatory requirements have a profound effect on banks'

financial statements in the form of higher capital requirements, smaller payouts, additional expenses

and other constraints.

For example, due to the inability to pass stress tests conducted by the Federal Reserve, banks such

as Citibank and Deutsche Bank were constrained in their ability to pay out dividends and repurchase

their stocks. Regulation also imposes high compliance costs for the banks, reducing their

profitability.

Format of Financial Statement

It has two part A- Balance sheet and Part B Profit and loss account. Format of both is as under :

Form of Balance Sheet

Balance Sheet of __(here enter name of the Banking Company)

Balance Sheet as on 31st March (Year)                                                          

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ScheduleAs on 31.3__

(current year)

As on 31.3__

(previous year)

Capital & Liabilities

Capital 1

Reserves & Surplus 2

Deposits 3

Borrowings 4

Other liabilities and provisions 5

            Total

Assets

Cash and Balances with Reserve Bank

of India

6

Balances with banks and money at call

and short notice

7

Investments 8

Advances 9

Fixed Assets 10

Other Assets 11

            Total

Contingent Liabilities  Bills for

Collection

12

 

Schedule I

Capital

As on 31.3__

(current year)

As on 31.3__

(previous year)

I. For Nationalised Banks

Capital (Fully owned by Central Government)

II. For Banks Incorporated Outside India

Capital (The amount brought in by banks by way

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of start-up capital as prescribed by RBI should be

shown under this head.)

Amount of deposit kept with RBI under section

11(2) of the Banking Regulation Act, 1949

            Total

III. For Other Banks

Authorised Capital

(@@@. shares of Rs@ each)

Issued Capital

(@@@. shares of Rs@ each)

Subscribed Capital

(@@@. shares of Rs@ each)

Called-up Capital

(@@@. shares of Rs@ each)

Less: Calls unpaid

Add: Forfeited shares

            Total

 

Schedule 2

Reserves & Surplus

As on 31.3__

(current year)

As on 31.3__

(previous year)

I. Statutory Reserves Opening Balances

Additions during the year Deductions

during the year

II. Capital Reserves Opening Balances

Additions during the year Deductions

during the year

III. Share Premium Opening Balances

Additions during the year Deductions

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during the year

IV. Revenue and Other Reserves Opening

Balance Additions during the year

Deductions during the year

V. Balance in Profit and Loss Account

            Total (I, II, III, IV and V)

Schedule 3

Deposits

(current year) (previous year)

A. I. Demand Deposits

(i)         From banks

(ii)        From others

II. Savings Bank Deposits

III. Term Deposits

(i)         From banks

(ii)        From others

Case study

Balance Sheet of Yes Bank ------------------- in Rs. Cr. -------------------

Mar '15 Mar '14 Mar '13 Mar '12 Mar '11

Capital and Liabilities:

Total Share Capital 417.74 360.63 358.62 352.99 347.15

Equity Share Capital 417.74 360.63 358.62 352.99 347.15

Share Application Money 0.00 0.00 0.00 0.00 0.00

Preference Share Capital 0.00 0.00 0.00 0.00 0.00

Reserves 11,262.25 6,761.11 5,449.05 4,323.65 3,446.93

Net Worth 11,679.99 7,121.74 5,807.67 4,676.64 3,794.08

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Deposits 91,175.85 74,192.02 66,955.59 49,151.71 45,938.93

Borrowings 26,220.40 21,314.29 20,922.15 14,156.49 6,690.91

Total Debt 117,396.25 95,506.31 87,877.74 63,308.20 52,629.84

Other Liabilities & Provisions 7,094.18 6,387.75 5,418.72 5,677.28 2,583.07

Total Liabilities 136,170.42 109,015.80 99,104.13 73,662.12 59,006.99

Assets Mar '15 Mar '14 Mar '13 Mar '12 Mar '11

Cash & Balances with RBI 5,240.65 4,541.57 3,338.76 2,332.54 3,076.02

Balance with Banks, Money at

Call2,316.50 1,350.10 727.00 1,253.00 419.96

Advances 75,549.82 55,632.96 46,999.57 37,988.64 34,363.64

Investments 46,605.24 40,950.36 42,976.04 27,757.35 18,828.84

Gross Block 318.97 273.29 218.45 169.06 129.52

Revaluation Reserves 0.00 0.00 0.00 0.00 0.00

Accumulated Depreciation 0.00 0.00 0.00 0.00 0.00

Net Block 318.97 273.29 218.45 169.06 129.52

Capital Work In Progress 0.00 20.18 11.09 8.04 2.91

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Other Assets 6,139.24 6,247.33 4,833.21 4,153.48 2,186.11

Total Assets 136,170.42 109,015.79 99,104.12 73,662.11 59,007.00

Contingent Liabilities 338,673.20 202,013.89 481,023.19 161,829.13 136,395.52

Bills for collection 0.00 0.00 0.00 0.00 0.00

Book Value (Rs) 279.60 197.48 161.94 132.49 109.29

CHAPTER IV

ACCOUNTING FOREIGN BRANCHES

Foreign Branches:-

Whenever any entity has operation outside country, such operations are called  foreign operation. It

can be in the form of Branch, Subsidiary, Associate and Joint Venture.

The foreign operation should be classified as-

(i) Integral Foreign Operation (IFO)

(ii) Non- Integral foreign Operation (NIFO)

Item Exchange Rate

Revenue Items Date of transaction rate / Average rate

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Opening Stock Opening Rate

Closing Rate Closing Rate

Fixed Assets Translated at the original rate. If there is a change in the

value of the Foreign Currency Liabilities, adjustment

should be made to cost of fixed assets in rupees.

Depreciation Rate Used for translation of value of fixed assets

Current Assets & Current

Liab.

Closing Rate

Long Term Liabilities Closing Rate

Items related to HO Balances in the books of head Office

Integral Foreign Operation (IFO)

It is a foreign operation, the activities of which are an integral part of those of the reporting

enterprise. The business of IFO is carried on as if it were an extension of the reporting enterprise’s

operations. Generally, IFO carries on business in a single foreign currency, i.e. of the country where

it is located. For example- sale of goods imported from the reporting enterprise and remittance of

proceesa to the reporting enterprise. NIFO is other than IFO.

Non-Integral Foreign Operation (NIFO):-

It is a foreign operation that is not an Integral Foreign Operation. The business of a NFO is carried

on in a substantially independent way by accumulating cash and other monetary items, incurring

expenses generating income and arranging borrowing in its local currency. An NFO may also enter

into transactions in foreign currencies, including transactions in the reporting currency. An example

of NFO may be production in a foreign currency out of the resources available in such country

independent of the reporting enterprise.

Applicable exchange rates- IFO

Imp. Note: Any difference in converted TB is transferred to P&L29

Applicable exchange rates-NIFO

Item Exchange

All Assets / All Liabilities Closing Rate

Pre acquisition Profit Rate when such profit were earned

Items related to HO Balance in the books of Head Office

Share Capital Earliest Rate given

 

Accounting in respect of Foreign Branches:

Accounting in respect of foreign branches is done in the books of the branch as well as in the books

of the Head Office.

Accounting at Branch:

As the foreign branch is an independent branch, it keeps a complete set of books on the double entry

system, prepares all the necessary accounts including the account of the Head Office, prepares its

own trial balance, Trading and Profit and Loss Account and Balance Sheet. In short, the accounting

procedure adopted at a foreign branch is exactly the same as that adopted at an independent

domestic branch.

Accounting at the Head Office:

The trial balance received by the Head Office from the foreign branch is in foreign currency.

Therefore, before incorporating the items in the trial balance of the foreign branch, the Head Office

is required to convert the various items in the trial balance into the currency of the Head Office.

Thereafter, it has to incorporate the items in the Converted Branch Trial Balance in its books,

prepare the Branch Trading and Profit and Loss account and Balance Sheet and Branch Account.

30

Rates at which the items in the trial balance of a foreign branch should be converted:

It is true that the items in the trial balance of a foreign branch should be converted into the currency

of th e Head Office. But the question is at what rates the various items in the trial balance of a

foreign branch should be converted.

The following points should be borne in mind while converting the items in the Trial Balance of a

foreign branch :

1. If the rate of exchange is not subject to wide and frequent fluctuations, all the items in the trial

balance (other than remittances and Head Office Account) can be converted at a fixed rate of

exchange.

2. If the rate of exchange is subject to wide and frequent fluctuations, then, different rates should

be adopted for different items. They are :

Opening stock should be converted at the opening rate of exchange (i.e, the rate of exchange

prevailing at the beginning of the accounting year).

Closing stock should be converted at the closing rate of exchange (i.e., the rate of exchange

prevailing on the last day of the accounting year).

All the other revenue items (i.e., expenses and incomes, except depreciation on fixed assets

and reserve for bad debts, should be converted at the average rate for the year. (In this

context, it may be noted that according to the recommendation of the Institute of Chartered

Accountants, in the year in which the local currency is devalued, the revenue items should

be converted at the closing rate, and not at the average rate.)

Depreciation on fixed assets should be converted at the same rate at which

the converted fixed asset is converted. Fixed assets should be taken at the same figure at

which they (i.e., branch fixed asset) appear in the books of Head Office. If that figure is not

given, the fixed assets should be converted at the rate of exchange prevailing on the date on

31

which the fixed assets were acquired. If that rate is not given, then, the fixed assets should

be converted at the opening rate of exchange.

If additions to fixed assets are made on various dates, average date of exchange for the

period should be adopted. Fixed liabilities should be converted at the rate of exchange

prevailing on the date on which they were contracted. If that rate is not given, then, they

should be converted at the opening rate of exchange.

All current assets and current liabilities should be converted at the closing rate of exchange.

Remittances appearing in the branch trial balance are converted at the actual rates at which

they were affected. If they are not given, they should be converted, i.e., taken, at the samme

figure at which they appear in the Head Office books.i. Head Office account is converted,

i.e., taken at the same figure at which Branch Account appears in the Head Office books,

Goods received from Head Office should be converted, i.e., taken, at the same figure at

which goods sent to branch appear in the head office books. If that figure is not given, then,

the goods received from Head Office should be converted at the average rate of exchange,

as it is a revenue item.

However, it should be noted that the converted Trial Balance, generally, does not tally. This is

because the different items in the branch trial balance are converted at different rates. The

difference in tial balance is taken as Difference in Exchange and is entered in the Profit and Loss

Account, either on the debit side or on the credit side.depending upon its nature, if the difference is

small. On the other hand, if the difference is fairly large, it is taken as Exchange Fluctuations

Account or Exchange Suspense Account and is shown in the Balance Sheet either as an asset or as a

liability, depending upon the nature, and is carried forward to be set off against future differences.

After having converted the Branch Trial Balance into head office currency, the Head Office will

incorporte the items in the branch trial balance in its books and prepare the Branch Trading and

Profit and Loss Account and Balance Sheet and the Combined Trading and Profit and Loss Account

and the Balance Sheet, as required.

EXAMPLES WE HAVE TAKEN FOR BETTER UNDERSTANDING OF ACCOUNTING

TREATMENT OF THE BRANCH/H.O ACCOUNT SITUATED AT OUTSIDE INDIA

32

IF H.O SITUATED OUTSIDE INDIA

M/s Carlin has head office at New York (U.S.A.) and branch at Mumbai (India). Mumbai branch is

an integral foreign operation of Carlin & Co.

Mumbai branch furnishes you with its trial balance as on 31st March, 2013 and the additional

information given thereafter:

Dr. Cr.

Rupees in thousands

Stock on 1st April, 2012 300 –

Purchases and sales 800 1,200

Sundry Debtors and creditors 400 300

Bills of exchange 120 240

Wages and salaries 560 –

Rent, rates and taxes 360 –

Sundry charges 160 –

Computers 240

Bank balance 420 –

New York office a/c – 1,620

TOTAL 3,360 3,360

Additional information:

Computers were acquired from a remittance of US $ 6,000 received from New York head

office and paid to the suppliers. Depreciate computers at 60% for the year.

Unsold stock of Mumbai branch was worth ` 4,20,000 on 31st March, 2013.

The rates of exchange may be taken as follows: on 1.4.2012 @ ` 40 per US $

on 31.3.2013 @ ` 42 per US $

average exchange rate for the year @ ` 41 per US $

33

conversion in $ shall be made upto two decimal accuracy.

You are asked to prepare in US dollars the revenue statement for the year ended 31st March, 2013

and the balance sheet as on that date of Mumbai branch as would appear in the books of New York

head office of Carlin & Co. You are informed that Mumbai branch account showed a debit balance

of US $ 39609.18 on 31.3.2013 in New York books and there were no items pending reconciliation.

Solution :

M/s Carlin

Mumbai Branch Trial Balance in (US $)

as on 31st March, 2013

Conversion Dr. Cr.

US $ US $

Stock on 1.4.12 40 7,500.00 –

Purchases and sales 41 19,512.20 29,268.29

Sundry debtors and creditors 42 9,523.81 7,142.86

Bills of exchange 42 2,857.14 5,714.29

Wages and salaries 41 13,658.54 –

Rent, rates and taxes 41 8,780.49 –

Sundry charges 41 3,902.44 –

Computers – 6,000.00 –

Bank balance 42 10,000.00 –

New York office A/c – – 39,609.18

TOTAL 81,734.62 81,734.62

Trading and Profit & Loss Account

for the year ended 31st March, 2013

34

US $ US $

To Opening Stock 7,500.00 29,268.29

To Purchases 19,512.20 By Closing stock 10,000.00

To Wages and salaries 13,658.54 By Gross Loss c/d 1,402.45

40,670.74 40,670.74

To Gross Loss b/d 1,402.45 17,685.38

To Rent, rates and taxes 8,780.49

To Sundry charges 3,902.44

To Depreciation on

computers 3,600.00

(US $ 6,000 × 0.6)

17,685.38 17,685.38

35

Balance Sheet of Mumbai Branch

as on 31st March, 2013

Liabilities US $ US $ Assets US $ US $

New York Office 39,609.18 Computers 6,000

A/c

Less : Net Loss (17,685.38) 21,923.80 Less:

Depreciation (3,600) 2,400

Sundry creditors 7,142.86 Closing stock 10,000

Bills payable 5,714.29 Sundry debtors 9,523.81

Bank balance 10,000

Bills receivable 2,857.14

34,780.95 34,780.95

(II) IF BRANCH SITUATED OUTSIDE INDIA

S & M Ltd., Bombay, have a branch in Sydney, Australia. Sydney branch is an integral

foreign operation of S & M Ltd.

At the end of 31st March, 2013, the following ledger balances have been extracted from

the books of the Bombay Office and the Sydney Office:

36 FINANCIAL ACCOUNTING

Bombay . Sydney

(Rs. in ‘000) (Austr dollars in ‘000)

Debit Credit Debit Credit

Share Capital – 2,000 – –

Reserves & Surplus – 1,000 – –

Land 500 – – –

Buildings (Cost) 1,000 – – –

Buildings Dep. Reserve – 200 – –

Plant & Machinery (Cost) 2,500 – 200 –

Plant & Machinery Dep.

Reserve – 600 – 130

Debtors / Creditors 280 200 60 30

Stock (1.4.2012) 100 – 20 –

Branch Stock Reserve – 4 – –

Cash & Bank Balances 10 – 10 –

Purchases / Sales 240 520 20 123

Goods sent to Branch – 100 5 –

Managing Director’s salary 30 – – –

Wages & Salaries 75 – 45 –

Rent – – 12 –

Office Expenses 25 – 18 –

Commission Receipts – 256 – 100

Branch / H.O. Current A/c 120 – – 7

4,880 4,880 390 390

37 FINANCIAL ACCOUNTING

The following information is also available:

(1) Stock as at 31.3.2013:

Bombay ` 1,50,000

Sydney A $ 3,125

You are required to convert the Sydney Branch Trial Balance into rupees;

(use the following rates of exchange :

Opening rate A $ = 20

Closing rate A $ = 24

Average rate A $ = 22

For Fixed Assets A $ = 18.

Solution :

Sydney Branch Trial Balance (in Rupees)

As on 31st March, 2013

Conversion rate per A$ Dr. Cr.

Plant & Machinery (cost) 18 36,00

Plant & Machinery Dep. Reserve 18 23,40

Debtors / Creditors 24 14,40 7,20

Stock (1.4.2012) 20 4,00

Cash & Bank Balances 24 2,40

Purchase / Sales 22 4,40 27,06

Goods received from H.O. – 1,00

Wages & Salaries 22 9,90

Rent 22 2,64

Office expenses 22 3,96

Commission Receipts 22 22,00

H.O. Current A/c 1,20

78,70 80,86

Exchange loss (balancing figure) 2,16

TOTAL 80,86 80,86

38 FINANCIAL ACCOUNTING

Reference & Bibliography

- The ICAI study material

- www.wikipidia.com

- www.caclubindia.com

- www.topfirms.com

- www.accountingexplained.com

- Dion Global Solutions Limited

39 FINANCIAL ACCOUNTING