CA Final Paper1 Financial Reporting Chapter 10 Unit 1

CA Susheel Bhandari

Survival or growth of enterprise depends on capacity to generate wealth.

Existence is possible without making profits, but survival is impossible without adding value.

Value added is basic and important measurement to judge the performance of an enterprise.

It is more meaningful measure of corporate performance than conventional based traditional accounting.

“How” we measure income rather than “whose” income we measure.

The common belief of the traditional accountants is that the net income or profit is the reward of the proprietors (share holders in the case of company). It has been considered as a very narrow definition of income.

Proprietary Theory vs. Enterprise Theory

• If investment does not create wealth (i.e. value added), it means waste of public funds.

• Concept of value added has a direct linkage with the concept of ‘Social Responsibility’.

Value Added is the wealth of reporting entity created through the effective effort of capital, management and employees.

In economic terms value added is market price of the output of enterprise less the price of the goods and services acquired by transfer from other firms.

It is also defined as increase in market value resulting from an alteration in the form, location, or availability of products or service excluded the cost of goods and services purchased from outside.

Value added is described as ‘the wealth created by the reporting entity by its own and its employees efforts and comprises salaries and wages fringe benefits, interest, dividend, tax, depreciation and net profit (retained)’.

The value added is an excess of turnover plus income from services over the cost of bought in material and services.

The term ‘turnover means the sale value of goods plus duties and tax minus the amount of rebates, returns, discount, commission, etc. The term income from services represents dividend from subsidiaries, rent, royalty compensation and other income.

The word ‘cost of bought in material’ includes cost of material consumed. This figure is to adjusted with change in stock work in progress and finished goods. The term ‘cost of services’ represents cost of services availed from external agencies. The employees costs, excise duty and depreciation have not been included in the cost of bought in material and services.

The value added is shared by three contributing members viz.

• Employee • Government • Providers of capital. (Lenders and Shareholders)

The remainder of the value added is reinvested in business in the form of depreciation and retained earnings.

Employees

Wages, Salaries, Gratuity

Provident Fund

Contribution, Bonus

Managerial Remuneration, Staff Welfare

Expenses

Government

Custom Duty, Excise Duty,

Sales Tax

VAT, Income Tax

Wealth Tax, Rates & Taxes

Providers of Capital

Interest to Lenders & Debentureholders

Dividend to Shareholders

Value added statements recognise Enterprise Theory.

Improvement of attitude of employees towards their employer company.

Easier for the company to introduce productivity linked bonus scheme, to its employees.

VA based ratios are useful for diagnostic and productivity tools for SWOT analysis.

VA indicates company’s contribution to the national income.

VA statement is based on well accepted financial accounting base.

When Company is in trouble, the entire risk associated therein is borne only by shareholders. Therefore, concept of VA as applied to several interest groups is being questioned by academicians.

VA is a non-standardised statement, especially in the area of treatment of depreciation and indirect taxes.

VA statement does not substitute traditional income statement.

VALUE ADDED STATEMENT

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Gross Value Added is arrived at by deducting from sales revenue, the cost of all bought in all materials and services acquired or transferred from other firm.

Conventional Formula : R = S – B – Dep. – W – I – T – Div. GVA Formula : S – B = R + Dep. + W + I + T + Div. GVA Refined Formula : (S + Di) – B + Inv. + Ei = R + Dep. + W + I + T + Div. Where, R = Retained Profits, S = Sales Revenue, B = Bought out items & services, Dep. = Depreciation, W = Wages, I = Interest, T = Taxes, Div = Dividend, Di = Direct Income, Inv. = Investment Income, Ei = Extraordinary Items

GVA can be derived more objectively than NVA because depreciation is more prone to subjective judgement than are bought-in-costs.

GVA formula presents depreciation along with retained profit and, therefore, resultant subtotal shows the portion of the profitability of the year available for reinvestment.

GVA leads to closer correspondence to national income theory. because economists prefer gross measure of income compared to net.

VALUE ADDED STATEMENT

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Net Value Added can be defined as GVA - Depreciation.

NVA Formula : S – B – Dep. = R + W + I + T + Div. NVA Refined Formula : (S + Di) – B + Inv. + Ei – Dep. = R + W + I + T +Div.

Where, R = Retained Profits S = Sales Revenue B = Bought out items & services Dep. = Depreciation W = Wages I = Interest T = Taxes Div = Dividend Di = Direct Income Inv. = Investment Income Ei = Extraordinary Items

Wealth creation is overstated if no allowance for depreciation is provided on fixed assets.

NVA as a base is better for calculation of productivity bonus than GVA.

Format

Particulars Rs. Rs. Creation of Value Added (a) Sales (Including excise duty & sales tax)

Less: Rebates Commissions Returns Discounts Goods used for self consumption

(b) Income from Services

Royalty Dividend & Interest Rent Received Other miscellaneous Income Add: Scrap realised

(c) Increase in stock of finished goods & WIP

Particulars Rs. Rs. (d) Cost of bought in material

Raw Material Consumed Consumables Packing Material Stationery Fuel & Oil Electricity Repairs to plant & building

(e) Cost of bought in services Audit Fees Insurance Rent, rates etc Travelling Expenses Advertisement Postage & Telegram Printing Subscription Carriage Outward Other Expenses

GROSS VALUE ADDED = (a) + (b) + (c) – (d) – (e)

Particulars Rs. Rs. Distribution of Value Added

(A)To Employees

a. Wages & Salaries b. MD’s Remuneration c. Director’s Sitting Fees etc. d. Contribution to PF, ESI and other benefits e. Staff Welfare etc.

(B) To Government

a. Custom Duty b. Excise Duty c. Income Tax d. Wealth Tax e. Rates & Taxes etc.

Particulars Rs. Rs. (C) To Providers of Finance

a. Interest b. Dividend

(D) Towards Replacement and Expansion

a. Depreciation b. Retained Profits

Gross Value Applied (A + B + C + D)

From the following profit and loss account of Amartya Ltd. prepare GVA statement and show how GVA and profit before tax can be reconciled.

Profit and loss account for the year ended 31st March, 2013

Particulars Note Ref. (Rs. in lakhs)

Rs. Rs. Sales Other income

Total Expenditure

Production and operational expenses Administration expenses Interest and other charges Depreciation

Profit before tax Provision for tax

Profit after tax Investment allowance written back Balance as per last balance sheet

Total Transfer to general reserve Proposed dividend Surplus carried to balance sheet

Total

1 2 3

166.57

6.12 8.00 5.69

24.30 3.00

206.42 10.20

216.62

186.38 30.24 3.00

27.24 0.46 1.35

29.05

27.30 1.75

29.05

Notes : 1. Production and operating expenses

2. Administrative expenses include inter alia audit fees of Rs. 1 lakh salaries and commission to directors of Rs. 2.20 lakhs, Reserves for doubtful debt of Rs. 2.50 lakhs.

Rs. in lakhs Decrease in stock Consumption of raw materials Consumption of stores Salaries, wages, bonus and other benefits Cess and local taxes Other manufacturing expenses

Total

30.50 80.57

5.30 12.80

3.20 34.20

166.57

Notes : 3. Interest and other charges

Rs. in lakhs

On fixed loans from financial institutions On debentures On working capital loan from bank

Total

3.90 1.80 2.30 8.00

VALUE ADDED STATEMENT OF AMARTYA LTD. For the year ended 31.03.2013

(Rs. in lakhs) Particulars Rs. Rs.

Sales 206.42

Decrease in stock (30.50)

Adjusted Sales 175.92 Less: Bought in material and services cost

Consumption of raw material 80.57

Consumption of stores 5.30

Other manufacturing expenses 34.20

Audit Fees 1.00

Reserve for doubtful debts 2.50

Other administration expenses 0.42

Interest on working capital loan from bank 2.30 126.29

Gross Value Added from manufacturing activities 49.63

Other Income 10.20

GROSS VALUE ADDED 59.83

Statement showing Application of GVA: (Rs. in lakhs)

Sr. No. Particulars Rs. Rs. % to GVA I Payment to employees Salaries, wages, bonus & other benefits 12.80 Salaries and commission to directors 2.20 15.00 25.07% II Payment to Providers of Capital Interest on fixed loans from financial institutions 3.90 Interest on debentures 1.80 Dividend 3.00 8.70 14.54%

III Payment to Government Cess and local taxes 3.20 Provision for tax 3.00 6.20 10.36%

Statement showing Application of GVA: (Rs. in lakhs)

Sr. No. Particulars Rs. Rs. % to GVA IV Retained Earnings

Depreciation 5.69

Transfer to General Reserve 24.30

Investment Allowance Reserve written back (0.46)

Retained Profits 0.40

(1.75 lakhs - 1.35 lakhs) 29.93 50.03%

Total GVA applied 59.83 100.00%

Reconciliation of GVA with Profit before Tax

Rs. in lakhs

Gross Value Added 59.83

Less: Expenditure charged in Profit & Loss A/c, but considered

as Appropriation of GVA 1. Wages, Salaries, Bonus and other benefits 12.80 2. Cess and local taxes 3.20 3. Salaries & Commission to directors 2.20 4. Depreciation 5.69 5. Interest on fixed loans 3.90

6. Interest on debentures 1.80 29.59

Profit before tax 30.24

Which of the following are the contributories of Value added?

(a) Employees (b) Government (c) Owners (d) All of the above

Which of the following is incorrect? (a) Depreciation is deducted in calculation of NVA (b) Bonus paid to employees is an appropriation of

value added (c) VA Statement is a substitute of Profit & Loss A/c (d) VA Statement recognises Enterprise Theory

Which of the following is not an advantage of Value Added Statement?

(a) It recognises Enterprise Theory (b) It improves the attitude of employees (c) It is based on well accepted financial

accounting base (d) It is a non standardized statement

VA Statement emphasizes that the performance of enterprise represents collective efforts of employees, management and providers of capital

GVA vs. NVA

Even though a logical concept, can not substitute traditional Profit and Loss Statement.