(a) Highlight various limitations of financial statements. How can these be minimized or resolved ? (10 marks) (b) Highlight the…

(a) Limitations of financial statements and remedies

Limitations:

• Historical cost ignores current values and changes in purchasing power, so inflation overstates profits.
• Window dressing can flatter liquidity or hide liabilities at the reporting date.
• Non-monetary assets such as human capital, brands and culture are left out.
• Estimates of depreciation, bad debts and inventory bring in judgement and bias.
• They are backward-looking and say little about qualitative factors.

Remedies: inflation-adjusted methods (current purchasing power and current cost accounting), cash flow statements (Ind AS 7) and segment reporting (Ind AS 108), detailed notes and Management Discussion and Analysis, ratio and trend analysis, independent audit, and integrated or sustainability reporting such as SEBI’s BRSR to capture non-financial capitals.

(b) Capital market and money market

• Maturity and purpose: the capital market raises funds for more than a year for capital formation, while the money market meets liquidity needs from overnight up to a year.
• Instruments: equity, preference shares, debentures and bonds, against Treasury Bills, Commercial Paper, Certificates of Deposit, call money and repo.
• Regulator and venue: SEBI and exchanges such as NSE and BSE, against the RBI with trading largely over-the-counter and settled through CCIL.
• Participants: retail investors, mutual funds and foreign portfolio investors, against banks, primary dealers and corporate treasuries.
• Risk and return: higher price and default risk with higher long-term returns, against high liquidity, low risk and large wholesale deals.

(c) Futures contract and mark-to-market

A futures contract is a standardised exchange-traded agreement to buy or sell a set quantity of an asset (an index, commodity or currency) at a fixed price on a future date. Unlike a customised forward, it has standard size and expiry, and the clearing corporation is the central counterparty.

Exchanges mark futures to market daily to remove counterparty risk. Each day, open positions are revalued at the settlement price, and gains are credited and losses debited to margin accounts. If margin falls below the maintenance level, a margin call follows, and positions are closed out if it is not met. Losses therefore cannot pile up over the life of the contract, and one default cannot cascade through the clearing system. Example: a long position in 100 units bought at Rs 500 that settles at Rs 490 is debited Rs 1,000 that day.

(d) Customer lifetime value, CRM and IT

CLV is the present value of the net profit expected from a customer over the whole relationship, estimated from average purchase value, purchase frequency, margin and retention rate, discounted at the cost of capital.

In CRM, CLV is used to:

• segment customers into value tiers, often with RFM (recency, frequency, monetary) analysis,
• cap acquisition cost below expected lifetime value, and
• direct loyalty and retention spending to high-value segments, as telecom firms do with premium plans.

IT and retention: CRM platforms such as Salesforce, analytics and machine learning predict churn and trigger personalised offers. E-commerce firms use churn models and cart-recovery messages, and super-apps such as Tata Neu link data across businesses for unified loyalty, raising retention and lifetime value.

(e) Transfer pricing in India

Transfer pricing is the price set for goods, services, intangibles or loans between associated enterprises, often across borders. Groups can shift profit to low-tax countries through it. Example: an Indian subsidiary providing IT services to its US parent must charge an arm’s length price, not an artificially low one that cuts Indian taxable income.

Methods for the arm’s length price are comparable uncontrolled price, resale price, cost plus, transactional net margin and profit split.

The rules are now in the Income-tax Act, 2025 (from 1 April 2026), carried over from ss.92-92F of the Income-tax Act, 1961. They cover international and specified domestic transactions, require documentation and an accountant’s report (Form 3CEB), and follow OECD BEPS Action 13 with a Master File and Country-by-Country reporting. Transfer Pricing Officers under the CBDT examine cases. Advance Pricing Agreements and Safe Harbour Rules reduce disputes.