d accounting and ratio analysis

________________________________ R & D ACCOUNTING AND REPORTING and RATIO ANALYSIS

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A

REPORT

ON

R & D ACCOUNTING AND REPORTING

and

RATIO ANALYSIS

For

DR.REDDY S LABORATORIES LTD.

Submitted to University of Pune

In partial fulfillment of two year full time Course

MASTER OF BUSINESS ADMINISTRATION

Submitted by

Ms. Shweta Subhedar M.B.A. Finance

Vishwakarma Institute of Management Pune - 48.

2005-2006


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ACKNOWLEDGEMENT

In appreciation, I wish to sincerely place on record my indebtedness and

gratitude for this work. If this project study has seen the light of day. It is

due to the concerted effort of many persons. As the whole work is outcome

of integrated efforts of all those concerned with it, through whose

cooperation and effective guidance I could achieve its completion.

I take this opportunity to express my deep sense of obligation in

particular, I am thankful to Prof. Mrs. Smita Sovani, my guide who made

it possible for me to present this project after her approval and consent. I

am very much thankful to Mr. Sampath Anand, Manager Finance, Dr.

Reddy s Laboratories Ltd. Discovery unit., who has given me the

opportunity to undergo training at their organization. I would like to

express my deep indebtedness for Mr. Subhash, Manager, account payable

for his kind cooperation and help in getting the all necessary information

that was very useful for the preparation of this report.

I am thankful to the entire staff of, Dr. Reddy s Laboratories Ltd.,

whose, constructive criticisms helped me in successful completion of this

project. Mrs.Manga, Mr. Ravi, Mr. Ashok.

I would acknowledge the gratitude to Dr. Sharad Joshi, director

V.I.M. for his keen interest and valuable suggestions that went all the way

in successful completion of this work.

This study has indeed helped me to explore more knowledgeable

avenues related to my topic and I am sure it will help me in my future.

Shweta Subhedar.


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CERTIFICATE

This is to certify that the project report titled

R & D

accounting and reporting and Ratio Analysis at Dr. Reddy s

Laboratories Ltd., Hyderabad is a bonafied work carried out by

Shweta Subhedar, a student of Vishwakarma Institute of

management in partial fulfillment of the degree of MBA from

university of Pune. She has worked under our direction and

control.

Dr. Sharad Joshi Mrs. Smita

Sovani.

Signature of Director Signature of Guide.

Date:


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TABLE OF CONTENTS

Sr.No. TOPIC PAGE No.

1 EXECUTIVE SUMMERY 1

2 OBJECTIVE AND SCOPE OF PROJECT 4 3 COMPANY PROFILE 6 4 FINANCIAL HIGHLIGHTS 14 5 THEROTICAL BACKGROUND 18 6 RESEARCH METHODOLOGY 62 7 FINDINGS 64 8 LIMITATIONS 65 9 RECOMMENDATIONS 67 8 CONCLUSION 68

9 BIBLIOGRAPHY 51

Sr.No. TOPIC PAGE No.

1 Revenue break-up chart 12

2 Revenue growth chart. 15

3 R & D investments chart 29 4 Comparison table of AS-26 with IAS & USGAAP. 30

5 Liquidity ratios table 60 6 Leverage ratios table 60

7 Profitability Ratios 61


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EXECUTIVE SUMMARY

INTRODUCTION OF THE PROJECT.

This project was carried out in Dr. Reddy s Laboratories Ltd. The project

was done in Discovery Unit of the Company. The area of project was R &

D accounting and Reporting and evaluation of financial position of the

company by using ratio analysis.

R & D, especially in any pharmaceutical company constitute major

area of investment. Huge investments are required to carry out the R & D

process. There are different costs involved at each level of R & D process.

The company s main focus will be on R & D to reduce their costs on it.

Thus, there are critical costs involved in this the presentation of the same is

very important. Hence, it s accounting and reporting is done with utmost

care and according to accounting standards regarding R & D.

Ratio Analysis is the process of determining and interpreting

numerical relationship based on financial statement. It is defined as the

systematic use of ratio to interpret the financial statement so that the

strength and weakness of a firm as well as its historical performance and

current financial conditions can be determined.

PROJECT TITLE

R & D ACCOUNTING AND REPORTING AND RATIO ANALYSIS

OF DR.REDDY S LABORATORIES LTD.


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REASONS FOR CHOOSING THIS COMPANY AND THIS

PROJECT.

Dr. Reddy s laboratories Ltd. is the second largest

Pharmaceutical Company. The company mainly focuses on

R & D division for reducing its costs and to effectively

present its financial information relating to it. Thus it must

be done in an effective way.

And most importantly I was getting the rarest opportunity of

actually acquire knowledge about accounting and reporting

of R & D expenditures.

The project constituted not only understanding of company s

R & D accounting and reporting but also of other few top

pharmaceutical companies for making a comparative study.

Project provided the understanding of evaluating company s

financial position by using Ratio Analysis.


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COURSE OF ACTION TAKEN IN COMPLETING THE PROJECT.

Visiting the company s Discovery unit and corporate office

for 50 days.

Collecting the primary data with the help of personal

interaction with the finance head and other persons of

finance department.

Study of Accounting Standards with regard to IGAAP

(Indian generally accepted accounting principles) and

USGAAP (United States generally accepted accounting

principles) related to R & D.

Studying the data collected for proper understanding of the

concepts.

Study about the process of R & D carried out and costs

involved at each level of the process of the company.

Collecting the data related to R & D accounting and

reporting of few top pharmaceutical companies with the help

of surfing their websites.

Arranging the data collected in to a logical form by

considering few relevant factors.

Collecting the data required to analyze the financial position

of the company by using Ratio Analysis.

Analyzing the Ratios helpful in giving out the financial

position of the company.

Concluding the work done on R & D accounting and

reporting and Ratio Analysis.


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OBJECTIVE AND SCOPE OF THE PROJECT

TITLE:

R & D ACCOUNTING AND REPORTING AND RATIO ANALYSIS

OF DR.REDDY S LABORATORIES LTD.

Every project report is carried out with some specific OBJECTIVE in the

mind. Objective is basically the purpose behind conducting a project and

unless the objective is certain or specifically defined it is not understood

what data has to be collected. Objectives of the project are nothing but what

is to be learned out of this project report.

PRIMARY OBJECTIVE:

To understand the process of R & D in pharmaceutical companies.

To understand the accounting standards related to R & D.

To study the IGAAP and USGAAP related to R & D.

To understand the process of R & D accounting and reporting.

Do a comparative study by analyzing annual accounts and other

financial information of R & D presented by Big Pharmaceutical

Companies in the world.

To understand the financial aspects of R & D.

To understand the evaluation of the financial position of the

company on the basis of ratio analysis.

Interpreting the financial statements with the help of ratio analysis

in order to find the weaknesses and strengths of the company.


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SCOPE OF THE PROJECT.

As R & D process involves huge expenditure and major percentage of

company s turnover is invested in it. Thus, understanding the financial

aspects of R & D ensures the proper usage of funds invested in it. Not only

knowing the aspects is necessary but also the presentation of those is

equally important. Hence, reporting and accounting of R & D expenses id

significant. Study of this gives a broader idea of representing the expenses

in effective way. Comparing the procedure of presenting this information of

the company and other companies helps in finding the better way of

showing those expenses.

Generally, an absolute figure conveys no meaning. A figure may

become meaningful if it is compared with some other information. The

absolute figures appearing on the financial statements is not the qualitative

indication regarding the financial position or performance of the company.

It is possible if the accounting figures can be compared with each other.

The technique of Ratio Analysis as a technique for interpretation

of financial statements deals with computation of various ratios, with the

intention to draw the fruitful conclusions there from.


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COMPANY PROFILE

Dr. Reddy's Laboratories Limited.

Type: Public

Founded: 1984

Headquarters: Hyderabad

Key people: Anji Reddy (Chairman)

Industry: Pharmaceuticals

Revenue: $502 million (JUL2006)

Employees: 7,525

VISIONS AND VALUES OF THE COMPANY.

CORE PURPOSE

To help people live healthier lives

VISION

To become a discovery led global pharmaceutical company.

VALUES

We strive for excellence in everything we think, say and do.

Quality: We are dedicated to achieving the highest levels of quality in everything we do to delight customers, internal & external, every time

Respect for the Individual: We uphold the self esteem and dignity of each other by creating an open culture conducive for expression of views and ideas irrespective of hierarchy

Innovation & Continuous Learning: We create an environment of innovation and learning that fosters, in each one of us, a desire to excel and willingness to experiment

Collaboration & Teamwork: We seek opportunities to build relationships and leverage knowledge, expertise and resources to create greater value across functions, businesses and locations

Harmony & Social Responsibility: We take utmost care to protect our natural environment and serve the communities in which we live and work


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Our business practices are guided by the highest ethical standards of truth, integrity and transparency.

LOGO OF THE COMPANY.

Key people as on March 31, 2006

Dr. K Anji Reddy

- chairman

Mr. G V Prasad

- vice chairman & CEO

Mr. Satish Reddy

- managing director & COO

Mr. Anupam Puri

- independent director

Dr. Krishna G Palepu


Dr. Omkar Goswami


Mr. P N Devarajan


Mr. Ravi Bhoothalingam


Dr. V Mohan


Top-10 brands of the Company.

Nise

Omez

Stalmo

Stalmo Beta

Enam

Atocor

Razo

Reclimet

Clamp

Mintop


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Dr. Reddy's Laboratories Ltd. is a medium sized multinational

pharmaceutical

company based in Hyderabad, India. The company was

founded by Dr Anji Reddy

in 1984. Dr Reddy's main business is

manufacturing and marketing generic drugs, though it is also researching

some new drugs. These are initially sold in India and other developing

nations; once the original patents expire, they are also imported into the

U.S., Europe, and other industrialized nations.

The DNA of the company is drawn from its founder and his vision to

establish India s first discovery led global pharmaceutical company. In fact,

it is this spirit of entrepreneurship that has shaped the company to become

what it is today.

Dr Anji Reddy, having moved out of Standard Organics Limited, a

company he had successfully co-founded, started Dr. Reddy s Laboratories

with $ 40,000 in cash and $120,000 in bank loan! Today, the company with

revenues of Rs.1947 crore (US $446 million), as of fiscal year 2005, is

India s second largest pharmaceutical company and the youngest among its

peer group.

The company has several distinctions to its credit. Being the first

pharmaceutical company from Asia Pacific (outside Japan) to be listed on

the New York Stock Exchange (on April 11, 2001) is only one among

them. And as always, Dr. Reddy s chose to do it in the most difficult of

circumstances against widespread skepticism. Dr. Reddy s came up trumps

not only having its stock oversubscribed but also becoming the best

performing IPO that year.

Dr. Anji Reddy is well known for his passion for research and drug

discovery. Dr. Reddy s started its drug discovery programme in 1993 and

within three years it achieved its first breakthrough by out licensing an

anti-diabetes molecule to Novo Nordisk in March 1997. With this very

small but significant step, the Indian industry went through a paradigm shift


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in its image from being known as just copycats to innovators ! Through

its success, Dr. Reddy s pioneered drug discovery in India.

There are several such inflection points in the company s evolution from a

bulk drug (API) manufacturer into a vertically integrated global

pharmaceutical company today.

Today, the company manufactures and markets API (Bulk Actives),

Finished Dosages and Biologics in over 100 countries worldwide, in

addition to having a very promising Drug Discovery Pipeline. When Dr.

Reddy s started its first big move in 1986 from manufacturing and

marketing bulk actives to the domestic (Indian) market to manufacturing

and exporting difficult-to-manufacture bulk actives such as Methyldopa to

highly regulated overseas markets, it had to not only overcome regulatory

and legal hurdles but also battle deeply entrenched mind-set issues of

Indian Pharma being seen as producers of 'cheap' and therefore low

quality pharmaceuticals. Today, the Indian pharma industry, in stark

contrast, is known globally for its proven high quality-low cost advantage

in delivering safe and effective pharmaceuticals. This transition, a tough

and often-perilous one, was made possible thanks to the pioneering efforts

of companies such as Dr. Reddy s.

Technology Development Center Hyderabad, India


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Dr. Reddy s continues its journey. Leveraging on its Low Cost, High

Intellect advantage. Foraying into new markets and new businesses.

Taking on new challenges and growing stronger and more capable. Each

failure and each success renewing the sense of purpose and helping the

company evolve.

With over 950 scientists working across the globe, around the clock, the

company continues its relentless march forward to discover and deliver a

breakthrough medicine to address an unmet medical need and make a

difference to people s lives worldwide. And when it does that, it would

only be the beginning and yet it would be the most important step. As Lao

Tzu wrote a long time ago, Even a 1000 mile journey starts with a single

step.

Effective governance consists of competent management; implementation

of standard policies and processes; maintenance of an appropriate audit

program and internal control environment and effective risk monitoring and

management information systems.

The company is an attractive proxy for prevailing and prospective growth

of the Indian and global pharmaceutical industry.

Dr. Reddy's is presently licensed by Merck & Co.

to sell an authorized

generic version of the popular drug simvastatin

(Zocor) in the U.S. Since

Dr. Reddy's has a license from Merck, it is not subject to the exclusivity

period on generic simvastatin of 180 days from June 23, 2006, which is

split between Ranbaxy Laboratories and Teva Pharmaceutical Industries.

BUSINESSES

Dr. Reddy's is a vertically integrated, global pharmaceutical company with

proven research capabilities and presence across the pharmaceutical value

chain. We manufacture Active Pharmaceutical Ingredients and Finished


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Dosage forms and market them globally, with a focus on United States,

Europe, India and Russia. In addition, the drug discovery arm of the

company conducts basic research in the areas of diabetes, cardiovascular,

inflammation and bacterial infection.

Company s core areas

Our core businesses of Active Pharmaceutical Ingredients (API) and

Branded Formulations are well established with an impressive track record

of growth and profitability. Our Generics business started operations in

2001 and focuses primarily on the North America and EU markets.

We have built a robust pipeline of generic products, which will help

us drive growth in the medium and long term. In addition, the company is

investing in creating businesses of the future - the innovation led businesses

- of Specialty and Drug Discovery.

Active Pharmaceutical Ingredients - Unit - III Bollaram, Hyderabad, India

Our revenues for fiscal 2006 were U.S. $546 million.


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The following charts show the break-up of our revenues, for the fiscal

2006, by business and by geography.


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DISCOVERY RESEARCH UNIT.

This pioneering spirit drives the research efforts for drug discovery and

development at Discovery Research, a Strategic Business Unit (SBU) of Dr

Reddy's Laboratories Limited. All Research and Development (R & D) at

Discovery Research is focused on the goal of developing breakthrough

treatments that will make a real difference in patients' lives.

At Dr. Reddy s, this quest for pioneering has been well supported by

investments. In the decade leading to 2004-2005, the company invested

close to U.S.$ 79 million in R & D, one of the highest among

pharmaceutical companies. Over the last decade, the company has made a

significant progress in drug discovery in the following respects: expanding

its horizon in terms of uderstanding the human biology and disease states.

With this perspective, the company invested in world-class R & D

infrastructure and intellectual capital with the objective to create a drug-

discovery led organization with sustainable growth and momentum. Today,

the company possesses research labs in India and Atlanta(U.S.A) as well as

of 320 dedicated scientists comprising 62 Ph.Ds.

One if the most important initiatives embarked upon by the company in

2004-05 was a responsible risk sharing of its growing investments in

research. It has entered into a partnership with ICICI venture to strengthen

its long term commitment to generics product development.

The impact of the partnership is as follows:

Enter into funding partnerships to migrate the assets into clinical

development,


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Leverage its existing R & D infrastructure to create new assets and

generate resources,

Get more molecules from pre-clinical to the clinical stage,

Unlock value of assets of the speciality business in similar way.

Discovery Research Centre Hyderabad, India

FINANCIAL HIGHLIGHTS

Decline in revenue by 3% to Rs. 19,472 miilion

Revenue increase of 25% from Russia and CIS drives growth in the

company s international branded finished dosages segment.

Revenue growth of 18% to Rs. 2,170 million in Russia, one of the

most successful international markets.

Revenue increase in the key products of omerprazole and amlodipine

maleate drives a growth of 44% in Europe Generics to Rs. 1,340

million.

Increase in revenue in the emerging high margin Custom

Pharmeceutical Services business from Rs. 113 million in 2003-04 to

Rs.312 in 2004-05.

Nearly 7% of the total revenue derived from new product launches

across businesses.

o In India, new product launches in the finished dosages

segment contributes Rs. 252 million to the company s total

revenue. The Company improved its industry ranking from the


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24th position in 2003-04 to the 4th in 2004-05 in terms of value

of the new product launches.

o In the U.S, new product launches of citalopram and

ciprofloxacin accounted for Rs. 319 million of the total

revenue, capturing a significant market share in the range of

15% to 17% despite stiff competition.

R & D investments increased by 41% to Rs. 2,803 million.

Net profit declined from Rs. 2,474 million in 2003-04 to Rs. 211

million as a result of an overall decline in revenue and higher R & D

investments.

YEAR

REVENUE

2001 252

2002 381

2003 414

2004 460

2005 446


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R & D INVESTMENTS.

An increase in R & investments to 14% of the company s total

revenue at Rs. 2,803 million.

An allocation of 48% of the total R & D investment in the

innovation led business of drug discovery and speciality.

Commencements of the first-ever clinical trials outside India on

Two NCE assets, a significant milestone.

Completion of the phase-I trials for DRF 10945 in Canada.

Prioritizing the developments ot two key assets in the

dermetology spciality segment; assets likely to move into

clinical development in 2005-06.

The R & D investments trend of last five years.


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AWARDS AND RECOGNITIONS

Leveraging Global Opportunity 2005-2006

Pharma Excellence Award

Business Development Deal 2005-2006

Operational Excellence 2005-2006

Pharma Excellence Award

Best Management Award 2005 - May Day 2005

Labour Department, Govt. of Andhra Pradesh

IBLA Indian Corporate Citizen of the Year 2005

India's Best Managed Company - 2004-05 - Business Today

Presented by Microsoft

Most Respected Company Awards 2004

Business world

Best Employers in India 2004 Hewitt - CNBC TV 18

Sodex ho PASS Award for HR Excellence

Organization with Innovative HR Practice - 2004

Presented by Asia Pacific Congress

Pharmabio Awards 2004 chemtech foundation


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WORLDSTAR Award for Packaging Excellence - 2003

Omez Capsules Pack with Anti-Counterfeiting Features

Best Employer Award 2002 - Hewitt

Business Today

INDIASTAR 2002 - Indian Institute of Packaging

Entrepreneur of the Year - 2001 - Ernst & Young

Healthcare and Life Sciences 2001 India

CHEMTECH CEW Award - Achiever of the Year 2000

Chemtech Foundation

DH Avenue Awards for HR Excellence

Centre for Change Management

Third Express Pharma Award - Best Bulk Drug Company

Express Pharma Pulse Awards

Pharma Excellence Awards

THEORETICAL BACKGROUND.

Accounting Standards.

Financial statements summarize the end-result business activates of an

enterprise during an accounting period in monetary terms. Business

activates are varied. It is a strenuous task to present the facts intelligibly, in

a summarized form, and yet with minimum loss of information. In order

that the methods and the principles adopted by various reporting enterprises

are coherent, not misleading

and to the extent possible are uniform and

comparable- standards are evolved.

The term standards denotes a discipline, which provides both guidelines

and yardsticks for evaluation. As yardsticks, standards are used in

comparative analysis involving more than one subject matter.


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Accounting standard is an authoritative pronouncement of code of practice

of the regulatory accountancy body to be observed and applied in the

preparation and presentation of financial statements. The standards are

intended to apply only to material items. The standards may also

provide a framework for an accounting policy to be adopted by an

enterprise or a group of enterprises such that financial information

presented to the users is in compliance with the prescribed codes. Utility of

such information is greatly enhanced for all users, including present and

potential investors, employees, lenders, suppliers and other trade creditors,

customer, governments and their agencies and the public. The aim of such

code is to eliminate confusing variations in the treatment of several

accounting aspects and to bring about, to the extent feasible, uniformity in

presentation.

Accounting bodies.

Accounting statements and standards constitute vital documents, the basic

principles and essential procedures laid down in which are to be adhered to

in the preparation of financial statements, by entities engaged either in

business or non-business activities. These documents generally cover

various aspects of measurement, treatment, disclosure of accounting

transactions and events.

World over, professional bodies of accountants have the authority and the

obligation to prescribe accounting standards . International accounting

standards (IASs) are pronounced by the International Accounting

Standards committee (IASC). The IASC was set up in 1973, with

headquarters in London with the following objectives:


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a) to formulate and publish in the pubic interest, accounting standards

to be observed in the presentation of financial statements and to

promote their world wide acceptance and observance; and

b) To work generally for the improvement and harmonization of

regulations, accounting standards and procedures relating to the

presentation of financial statements.

In India, the Institute of Chartered Accountants of India (ICAI) had

established in 1977 the Accounting Standards Board (ASB). The

composition of ASB includes

i. Elected

ii. Ex-officio and

iii. Co-opted members of the Institute, Nominees of RBI, FICCI,

Assocham, ICSI, ICWAI, and special invitees from UGC, SEBI,

IDBI, and IIM.

ASB is entrusted with the responsibility of formulating standards on

significant accounting matters, keeping in view

a) International developments as also,

b) Legal requirements in India.

According t the preface to the statement on Accounting Standards issued by

the ICAI, accounting Standards issued by the ASB constituted for the

purpose of harmonizing the different and diverse accounting policies and

practices in use in India and propagating the accounting standards and

persuading the concerned enterprises to adopt them in the preparation and

presentation of financial statements.

Due process.

The procedure adopted by ASB in formulating accounting standards is as

under:

1. ASB shall determine the broad areas in which AS need to be

formulated and the priority in regard to selection thereof.


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2. ASB will be assisted in the preparation of AS, by study groups with

wide participation by members of ICAI and others constituted for

specific subjects.

3. ASB will hold dialogue with the representatives of the

governments, PSUs, industry and other organizations, for

ascertaining their views.

4. Based on the work of the study group and information elicited from

outside sources, an exposure draft of the proposed standard is

prepared and is issued, for comments by members of the institute

and by public.

5. The draft of the proposed standard will include the following

critical elements:

A statement of concepts and fundamental accounting

principles relating to the Standard.

Definition of the terms used.

The manner in which the accounting principles have been

applied for formulating the Standard.

Presentation and disclosure requirements

Class of enterprises to which the Standard will apply

Date from which the standard will be effective.

6. While finalizing every Accounting Standard, the following factors

will be considered:

Evaluation of comments received on the exposure draft

All associated accounting issues


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ICAI s framework document

Accounting requirements at national level

Legal requirements

7. Based on these, ASB will submit its recommendations to the

Central Council of ICAI, who will accord approval for the Standard

with such modifications as considered essential. ICAI will also

make recommendations to the central government, who in

consultation with the National Advisory Committee on Accounting

Standards { in terms of the provisions of sections 210A(1) and

211(3C)}, will prescribe the Standards for adoption of the

companies.

ASB has constituted a sub-committee, i.e., Accounting Standards

interpretations sub-committee (ASISC). The objective of ASISC is to

provide interpretations and clarification on Accounting Standards.

Explanatory notes on applicability of accounting standards

(relating to R & D).

As a rule, accounting standards are applicable to all reporting enterprises,

and are made operative from a date specified in the standard. Also,

effective date bears a linkage to the date of commencement of an

accounting period, on or after the 1st April of relevant financial year.

However, for convenience of adoption and implementation, certain

exceptions have been provided for. A summary of the position follows.

Two stage applicability.

Accounting standards 1, 8, 9 and 10 were made applicable in two stages, in

the first stage, effective from 1st April 1991, the standards were made


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applicable to companies governed by Companies Act, 1956 and to

enterprises other than

i. Sole proprietary concerns and individuals,

ii. Partnership firms,

iii. Societies registered under Societies registration Act, 1860,

iv. Trusts,

v. Hindu Undivided Families, and

vi. Association of persons.

In the second stage, effective from 1st April 1993, the Standards were made

applicable to all enterprises including the above-noted six categories.

Similarly AS 26( Intangible assets), has been made applicable in two

stages, i.e., April 2003 and 2004.

AS-8 : Accounting for R & D.

On AS-26: Intangible assets coming into force, AS-8 will be withdrawn.

Accounting for R & D

A. Applicability

1. Has it been ensured that the entity has not applied this standard for the

following activities.

a. R & D activities conducted for others under a contract.

b. Exploration for oil, gas & mineral deposits.

c. R & D activities at the construction stage.


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B. Identification of costs.

1. Has it been ensured that R & D include the following:

a. Salaries, wages & other related costs of personnel engaged in

R & D.

b. Costs of material & services consumed in R & D.

c. Depreciation of building, equipment & facilities, which have

alternate economic use, to the extent that they are used for

R&D.

d. An appropriate amortization of the cost of building equipment &

facilities which have no alternative economic use, to the extent

that they are used for R & D.

e. Overhead costs related to R & D.

f. Payments to outside bodies for R & D projects related to the

enterprise.

g. Other costs related to R & D such as amortization of patents &

licenses.

2. Has it been ensured that costs relating to production or promotion of

sales of existing products are excluded from R & D?

C. Accounting treatment.

1. Have R & D costs been expensed in the period in which they have

been incurred?

2. Have R & D costs been deferred?

3. Have the following criteria satisfied before deferral for each R&D

project?

a. A product or process is clearly defined & the costs

attributable to the product or process can be separately

identified.

b. The technical feasibility of the products or process has been

demonstrated.

c. The management of the enterprise has indicated its intention

to produce & market or use the product or process.


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d. There is a reasonable indication that current and future R &

D costs to be incurred on the project, together with expected

production, selling & administration costs are likely to be

more than covered by related future revenues, benefits.

e. Adequate resources exists, or are reasonably expected to be

available to complete the project & market the product and

process.

4. Have appropriate legal requirement been fulfilled before opting for

deferral.

Note: Depreciation on assets in R & D cannot be deferred & has to

be provided for arriving at divisible profit.

5. Are the deferred costs of R & D allocated to the future accounting

periods?

6. Is allocation of expenditure to various years on a systematic,

defined basis?

7. Is a constant review of deferred R & D costs being done in order to

ensure that the criterion for deferred continuous on the basis of

evidence.

D. Disclosure.

1. Has the total of R & D costs been changed off and disclosed in the P

& L account.?

2. Have deferred R & D costs been disclosed under miscellaneous

expenditure in the balance sheet.

In P & L,

- Aggregate amount of R & D expenses, Recorded as expense.

Note: All expenditure in research phase have to be expensed.

- Other internally generated IA: research expenses.

What are these?

Generally these are related to & arising from R & D.


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These should first be a classification of expenses under research phase

& development phase.

IA:- arising from research phase of a project.

- Should not be recognized but should be charged as expense as and when

incurred

Inclusion of R & D expenses or AS-8 in AS-26:

Intangible asset

Intangible assets are defined as assets that are not physical in nature. The

most common types of intangible assets are trade secrets (e.g., customer

lists and know-how), copyrights, patents, trademarks, and goodwill.

The Uniform Commercial Code (Section 9-102(a)(42)) defines "general

intangibles" as


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"any personal property...other than accounts, chattel paper, commercial tort

claims, deposit accounts, documents, goods, instruments, investment

property, letter of credit rights, letters of credit, money, and oil, gas, or

other minerals before extraction. The term includes payment intangibles

and software .

Research & Development

Millions are spent each year by corporatios to research and develop new

intangible assets. To protect their research and development (R&D) efforts,

corporatios generally rely on intellectual property laws and unfair

competition laws.

Financial accounting

General standards

The Financial Accounting Standards Board (FASB) offers some guidance

as to how intangible assets should be accounted for in financial statements.

In general, intangibles that are developed internally are not recognized and

intangibles that are purchased from third-parties are recognized.


- 32 -

Expense recognition

Intangible assets are typically expensed according to their respective life

expectancy. Intangible assets have either an identifiable or indefinite useful

life. Intangible assets with identifiable useful lives are amortized on a

straight-line basis over their economic or legal life, whichever is shorter.

Examples of intangible assets with identifiable useful lives include

copyrights and patents. Intangible assets with indefinite useful lives are

reassessed each year for impairment. If an impairment has occurred, then a

loss must be recognized. An impairment loss is determined by subtracting

the asset's fair value from the asset's book/carrying value. This impairment

loss may only be reversed under certain circumstances. Trademarks and

goodwill are examples of intangible assets with indefinite useful lives.

Research expenses are other internally generated intangible assets.

Intangible asset- Development stage

Expenditure for development activities comprise, costs for designing proto-

types and models, jigs/tools, pilot plants, and costs for designing,

constructing and testing methods, processes, etc

Cost of internally generated IA- expenditure for development stage.

IA emerging for development phase of a project can be recognized if and

only if all the following six conditions are met:

1. Technical feasibility of completing the intangible asset, so that it is

available for use;

2. Intention to complete IA and use it.


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3. Ability to use it.

4. It is probable that IA will generate future economic benefits.

5. Availability of technical and financial resources to complete it.

6. The expenses incurred can be measured reliably.

Development of cost

Cost for recognizing an internally generated IA (R&D related) represents

direct, and allocate indirect expenditure incurred for making the IA ready

for intended use- such as

- Materials and services.

- Salaries and wages of personnel directly associated with the

creation of IA

- Reasonable, and rational allocation of attributable overheads

based on canons in AS 2

- Borrowing costs, if criteria under AS 16 are met

Selling, general and administration, inefficiencies(waste, scrap) training of

staff etc., do not form part of cost for measurement.

Take cognizance of the principles for assessing impairment loses; review

and test the validity of business plans; examine cost records.

Disclosure requirements

(i) In P & L

a. Amortization recognized during the period.

b. Aggregate amount of R & D expenses, recognized as expense .

c. All expenditure in research phase have to be expensed.

d. Adjustments if any made to NP for eliminating an IA under

transitional provisions.


- 34 -

e. Gains or losses consequent on retirement and disposal, and

impairment losses on IA recognized, if any, may also be

disclosed.

Item of expenditure Accounting treatment.

a. Preliminary project phase Expensed in the period in which

expenditure. incurred.

b. Development phase

expenditure:

i) Up to the stage the Expensed

recognition criteria

are not met..

ii) When recognition criteria. Capitalized.

are met.

Comparison of AS-26 with IAS & USGAAP.

AS 26 IAS 38 US GAAP

Research expenses are

to be charged off as

expense.



expense.



expense.

Development expenses Development expenses Development expenses


- 35 -

can be capitalized

subject to conditions

laid down being fully

met.

can be capitalized

subject to conditions

laid down being fully

met.

should also be written

off, subject to few

exceptions.

Revaluation of

intangibles not

permitted

Revaluation of

intangibles is a

permitted method.

In lie with AS 26

Subsequent expenses

cannot be capitalized

unless the test of cost-

benefit proves

incremental advantage

relative to cost

incurred.

In line with AS 26 This aspect is not dealt

with in US GAAP.

Generally Accepted Accounting Principles (USA)

Basic objectives

Financial reporting should provide information that is:

useful to present and potential investors and creditors and other

users in making ratioal investment, credit, and other financial

decisions.


- 36 -

helpful to present and potential investors and creditors and other

users in assessing the amounts, timing, and uncertainty of

prospective cash receipts.

about economic resources, the claims to those resources, and the

changes in them.

Fundamental qualities

To be useful and helpful to users, financial statements must be:

Relevant: relevant information makes a difference in a decision. It

also helps users make predictions about past, present and future

events (it has predictive value). Relevant information helps users

confirm or correct prior expectations (it has feedback value). It must

also be available on time, that is before decisions are made.

Reliable: reliable information is verifiable (when independent

auditors using the same methods get similar results), neutral (free

from bias), and demonstrate representational faithfulness (what

really happened or existed).

Comparable: information must be measured and reported in a

similar manner for different enterprises (allows financial statements

to be compared between different companies).

Consistent: the same accounting methods should be applied from

period to period and all changes in methods should be well

explained and justified (allows financial statements of the same

company to be compared between different periods).

Basic concepts

To achieve basic objectives and implement fundamental qualities GAAP

has four basic assumptions, four basic principles, and four basic constraints.


- 37 -

Assumptions

Economic Entity Assumption assumes that the business is separate

from its owners or other businesses. Revenues and expenses should

be kept separate from personal expenses. This applies even for

partnerships and sole proprietorships. The entity concept does not

necessarily refer to a legal entity.

Going Concern Assumption assumes that the business will be in

operatio for a long time. This validates the methods of asset

capitalization, depreciation, and amortization. Only when

liquidation is certain is this assumption not applicable.

Monetary Unit Assumption assumes a stable currency is going to

be the unit of record. The FASB accepts the nominal value of the

US Dollar as the monetary unit of record (unadjusted for inflation).

Periodic Reporting Assumption assumes that the business

operatios can be recorded and separated into different periods (most

common periods are months, quarters and years). This is required

for comparison between present and past performance.

Principles

The historical cost principle requires companies to account and

report based on acquisition costs rather than fair market value for

most assets and liabilities. This principle provides information that

is reliable (removing opportunity to provide subjective and

potentially biased market values), but not very relevant. Thus there

is a trend to use fair values. Most debts and securities are now

reported at market values.

The revenue recognition principle requires companies to record

when revenue is (1) realized or realizable and (2) earned, not when

cash is received. This way of accounting is called accrual basis

accounting.

The matching principle. Expenses have to be matched with

revenues as long as it is reasonable to do so. Expenses are

recognized not when the work is performed, or when a product is


- 38 -

produced, but when the work or the product actually makes its

contribution to revenue. Only if no connection with revenue can be

established, cost can be charged as expenses to the current period

(e.g. office salaries and other administrative expenses). This

principle allows greater evaluation of actual profitability and

performance (shows how much was spent to earn revenue).

Depreciation and Cost of Goods Sold are good examples of

application of this principle.

The full disclosure principle. Amount and kinds of information

disclosed should be decided based on trade-off analysis as a larger

amount of information costs more to prepare and use. Information

disclosed should be enough to make a judgment while keeping costs

reasonable. Information is presented in the main body of financial

statements, in the notes or as supplementary information.

Constraints

Cost-benefit relationship states that the benefit of providing the

financial information should also be weighed against the cost of

providing it.

Materiality states that the significance of an item should be

considered when it is reported. An item is considered significant

when it would affect the decision of a reasonable individual.

Industry practices states that accounting procedures should follow

industry practices.

Conservatism states that when choosing between two solutions, the

one that will be least likely to overstate assets and income should be

picked.

Setting GAAP

These organizations influence the development of GAAP in the United

States.

U.S. Securities and Exchange Commission (SEC)


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The SEC was created as a result of the Great Depression. At that time there

was no structure setting accounting standards. The SEC encouraged the

establishment of private standard-setting bodies through the AICPA and

later the FASB, believing that the private sector had the proper knowledge,

resources, and talents. The SEC works closely with various private

organizations setting GAAP, but does not set GAAP itself.

American Institute of Certified Public Accountants (AICPA)

In 1939, urged by the SEC, the AICPA appointed the Committee on

Accounting Procedure (CAP). During the years 1939 to 1959 CAP issued

51 Accounting Research Bulletins that dealt with a variety of timely

accounting problems. However, this problem-by-problem approach failed

to develop the much needed structured body of accounting principles. Thus,

in 1959, the AICPA created the Accounting Principles Board (APB),

whose mission it was to develop an overall conceptual framework. It issued

31 opinions and was dissolved in 1973 for lack of productivity and failure

to act promptly. After the creation of the FASB, the AICPA established the

Accounting Standards Executive Committee (AcSEC). It publishes:

1. Audit and Accounting Guidelines, which summarizes the

accounting practices of specific industries (e.g. casinos, colleges,

airlines, etc.) and provides specific guidance on matters not

addressed by FASB or GASB.

2. Statements of Position, which provides guidance on financial

reporting topics until the FASB or GASB sets standards on the

issue.

3. Practice Bulletins, which indicate the AcSEC's views on narrow

financial reporting issues not considered by the FASB or the GASB.

Financial Accounting Standards Board (FASB)

Realizing the need to reform the APB, leaders in the accounting profession

appointed a Study Group on the Establishment of Accounting Principles

(commonly known as the Wheat Committee for its chair Francis Wheat).

This group determined that the APB must be dissolved and a new standard-


- 40 -

setting structure be created. This structure is composed of three

organizations: the Financial Accounting Foundation (FAF, it selects

members of the FASB, funds and oversees their activities), the Financial

Accounting Standards Advisory Council (FASAC), and the major operating

organization in this structure the Financial Accounting Standards Board

(FASB). FASB has 4 major types of publications:

1.Statements of Financial Accounting Standards - the most

authoritative GAAP setting publications. More than 150 have

been issued to date.

2. Statements of Financial Accounting Concepts - first issued in

1978. They are part of the FASB's conceptual framework project

and set forth fundamental objectives and concepts that the FASB

use in developing future standards. However, they are not a part

of GAAP. There have been 7 concepts published to date.

3. Interpretations - modify or extend existing standards. There have

been around 50 interpretations published to date.

4. Technical Bulletins - guidelines on applying standards,

interpretations, and opinions. Usually solves some very specific

accounting issue that will not have a significant, lasting effect.

In 1984 the FASB created the Emerging Issues Task Force (EITF) which

deals with new and unusual financial transactions that have the potential to

become common (e.g. accounting for Internet based companies). It acts

more like a problem filter for the FASB - the EITF deals with short-term,

quickly resolvable issues, leaving long-term, more pervasive problems for

the FASB.

Governmental Accounting Standards Board (GASB)

Created in 1984, the GASB addresses state and local government reporting

issues. Its structure is similar to that of the FASB's.


- 41 -

Other influential organizations (e.g. American Accounting

Association, Institute of Management Accountants, Financial

Executives Institute)

Pharmaceutical company

A pharmaceutical company, or drug company, is a company licensed to

discover, develop, market and distribute drugs.


- 42 -

History

Most major pharmaceutical companies were founded in the late 19th and

early 20th centuries, although it is only since the 1950's the industry got

underway in earnest. The discovery of penicillin is widely regarded as the

birth of modern pharmaceuticals - this was the moment where systematic

scientific approaches, understanding of human biology and sophisticated

manufacturing techniques all made the development of medicines possible.

The industry remained relatively small scale until a long period of scientific

advancements through the 1970s to present day elevated some companies

to become among the most profitable and productive in the world.

The industry has delivered significantly improved treatment for patients

and morbidity/ mortality rates across developing countries continue to fall

due in no small part to the innovation of research-based pharmaceutical

companies.

There are currently more than 200 major pharmaceutical companies. As in

some other industries, economic pressures are forcing pharmaceutical

companies toward greater efficiency. The costs of research and

manufacture of ever more sophisticated medicines grows every year and

the tension between the affordability of new medicines and their benefits

look certain to be a continuing major debating point.

Drug discovery

Drug discovery is the process by which drugs are discovered and/or

designed. In the past most drugs have been discovered either by identifying

the active ingredient from traditional remedies or by serendipitous

discovery. The new approach has been to understand how disease and

infection are controlled at the molecular and physiology level and to target


- 43 -

specific entities based on this knowledge. New technologies and Data

Management/Informatics systems are now employed to speed up this

process.

New drugs begin in the laboratory with chemists, scientists and

pharmacologists who identify cellular and genetic factors that play a role in

specific diseases. "They search for chemical and biological substances that

target these biological markers and are likely to have drug-like effects. Out

of every 5,000 new compounds identified during the discovery process,

only five are considered safe for testing in human volunteers after

preclinical evaluations. After three to six years of further clinical testing in

patients, only one of these compounds is ultimately approved as a marketed

drug for treatment. The following sequence of research activities begins the

process that results in development of new medicines:"

Drug discovery includes the following.

Target identification

Target prioritization/validation

Lead identification

Lead optimization

DRUG DEVELOPMENT

Drug development is considered a costly and intensive process. Of all

compounds investigated for use in humans only a small fraction is

eventually approved, and only after heavy investment in pre-clinical

development, clinical trials, and safety monitoring to determine the safety

and efficacy of a compound. Most clinical trials are randomized and

controlled. The cost for a new drug (new chemical entity) is estimated to be


- 44 -

about 1 billion USD. Half of this amount are opportunity costs, others are

costs for the development of all unsuccessful drugs.

Clinical testing is usually described as consisting of Phase I, Phase II and

Phase III clinical studies. In each successive phase, increasing numbers of

patients are tested. There are a large number of firms worldwide that

support clinical trials and perform clinical trials services for pharmaceutical

firms.

Phase I Clinical Studies

"Phase I studies are designed to verify safety and tolerability of the

candidate drug in humans and typically take six to nine months. These are

the first studies conducted in humans. A small number of subjects, usually

from 20 to 100 healthy volunteers, take the investigational drug for short

periods of time. Testing includes observation and careful documentation of

the pharmacodynamics and the pharmacokinetics of the drug - how the

drug acts in the body, how it is absorbed, distributed, metabolized,

excreted, its half-life etc."

Phase II Clinical Studies

"Phase II studies are designed to determine effectiveness and further study

the safety of the candidate drug in humans. Depending upon the type of

investigational drug and the condition it treats, this phase of development

generally takes from six months up to three years. Testing is conducted

with up to several hundred patients suffering from the condition the

investigational drug is designed to treat. This testing determines safety and

effectiveness of the drug in treating the condition and establishes the

minimum and maximum effective dose. Most Phase II clinical trials are

randomized, or randomly divided into groups, one of which receives the

investigational drug, one of which gets a placebo containing no medication

and sometimes a third that receives a current standard treatment to which

the new investigational drug will be compared. In addition, most Phase II

studies are double-blinded, meaning that neither patients nor researchers


- 45 -

evaluating the compound know who is receiving the investigational drug or

placebo."

Phase III Clinical Studies

"Phase III studies provide expanded testing of effectiveness and safety of

an investigational drug, usually in randomized, and blinded clinical trials.

Depending upon the type of drug candidate and the condition it treats, this

phase usually requires one to four years of testing. In Phase III, safety and

efficacy testing is conducted with several hundred to thousands of

volunteer patients suffering from the condition the investigational drug

treats."

New Drug Application

"(NDA)/Marketing Authorization Application (MAA) NDAs (in the U.S.)

and MAAs (in the U.K.) are examples of applications to market a new

drug. Such applications document safety and efficacy of the investigational

drug and contain all the information collected during the drug development

process. At the conclusion of successful preclinical and clinical testing, this

series of documents is submitted to the FDA in the U.S. or to the applicable

regulatory authorities in other countries. The application must present

substantial evidence that the drug will have the effect it is represented to

have when people use it or under the conditions for which it is prescribed,

recommended or suggested in the labeling. Obtaining approval to market a

new drug frequently takes between six months and two years.

Orphan drug

There are special rules for certain rare diseases ("orphan diseases")

involving fewer than 200,000 people in the United States. Because medical

research and development of drugs to treat such diseases is financially

disadvantageous, companies that do so are rewarded with tax reductions

and a monopoly on that orphan drug for a limited time (seven years).


- 46 -

Post-approval surveillance

Some medications only show to have safety issues after they are marketed,

as clinical trials are of a limited size, such as the 3,000 test subjects

required by the FDA. Post-marketing surveillance ensures that after

marketing the safety of a drug is monitored closely. In certain instances, its

indication may need to be limited to particular patient groups, and in others

the substance is withdrawn from the market completely."Late-stage drug

development studies of approved, marketed drugs may continue for several

months to several years."

Phase IIIb/IV Studies

"Phase IIIb trials, which often begin before approval, may supplement or

complete earlier trials by providing additional safety data or they may test

the approved drug for additional conditions for which it may prove useful.

Phase IV studies expand testing of a proven drug to broader patient

populations and compare the long-term effectiveness and/or cost of the

drug to other marketed drugs available to treat the same condition.

Post-Market Studies

"Post-market studies test a marketed drug in new age groups or patient

types. Some studies focus on previously unknown side effects or related

risk factors. As with all stages of drug development testing, the purpose is

to ensure the safety and effectiveness of marketed drugs."

Patents

A land grant is also called a patent.

A patent is a set of exclusive rights granted by a state to a patentee (the

inventor or assignee) for a fixed period of time in exchange for the

regulated, public disclosure of certain details of a device, method, process

or composition of matter (substance) (known as an invention) which is

new, inventive, and useful or industrially applicable.


- 47 -

The exclusive right granted to a patentee in most countries is the right to

prevent or exclude others from making, using, selling, offering to sell or

importing the claimed invention. The rights given to the patentee do not

include the right to make, use, or sell the invention themselves. The

patentee may have to comply with other laws and regulations to make use

of the claimed invention. So, for example, a pharmaceutical company may

obtain a patent on a new drug but will be unable to market the drug without

regulatory approval, or an inventor may patent an improvement to a

particular type of laser, but be unable to make or sell the new design

without a license from the owner of an earlier broader patent covering

lasers of that type.

The term "patent" originates from the Latin word patere which means "to

lay open" (i.e. make available for public inspection) and the term letters

patent, which originally denoted royal decrees granting exclusive rights to

certain individuals or businesses.

Obtaining a patent

A patent is obtained by filing a written application at the relevant patent

office. That application will contain a specification detailing the invention

and the protection claimed, together with forms relating to the procedural

aspects of obtaining a patent. In most countries, including the United

States, there is no requirement that the inventor actually build a prototype

or otherwise reduce his or her invention to practice in order to obtain a

patent.


- 48 -

Once a patent application has been filed, a patent office examines that

application for compliance with the requirements of the relevant patent law.

If the application does not comply with all of the requirements, the

objections are communicated to the Applicant (or his representative), who

can then respond to those objections to attempt to overcome them to obtain

the grant of a patent. Once granted the patent is subject in most countries to

renewal fees, generally due each year, to keep the patent in force.

Evaluating Financial position by using ratio Analysis.

Introduction

Importance of financial statement analysis in an organization.

In our money-oriented economy, Finance may be defined as provision of

money at the time it is needed. To every one responsible for provision of

funds, it is problem of securing importance to so adjust his resources as to


- 49 -

provide for a regular outflow of expenditure in face of an irregular inflow

of income.

1. The profit and loss account (Income Statement).

2. The balance sheet

In companies, these are the two statements that have been prescribed and

there contents have been also been laid down by law in most countries

including India.

There has been increasing emphasis on

(a) Giving information to the shareholder in such a manner as to enable

them to grasp it easily.

(b) Giving much more information e.g. funds flow statement, again

with a view to facilitating easy understanding and to place a year

results in perspective through comparison with post year results.

(c) The directors report being quite comprehensive to cover the factors

that have been operating and are likely to operate in the near future

as regards to the various functions of production, marketing,

finance, labour, government policies, environment in general.

Financial statements are being made use of increasingly by parties like

Governments, Institutions, and Financial Analysis etc.

The statement should be sufficiently informative so as to serve as wide a

curia as possible.

The financial statement is prepared by accounts based on the activities that

take in production and non-production wings in a factory. The accounts

convert activities in monetary terms to the help know the position uses of

Financial Statement Analysis.

The main uses of accounting statements for; -

Executives : - To formulate policies.

Bankers : - To establish basis for Granting Loans.

Institutions \ Auditors : - To extend Credit facility to business.

Investors : - To assess the prospects of the business and to know

whether they can get a good return on their investment.

Accountants : - To study the statement for comparative purposes.

Government Agencies: - To study from an angle of tax collection

duty levee etc.


- 50 -

Financial Ratio Analysis The Tool Kit

Ratio Analysis: -

Ratio Analysis is the process of determining and interpreting numerical

relationship based on financial statement. It is defined as the systematic use

of ratio to interpret the financial statement so that the strength and

weakness of a firm as well as its historical performance and current

financial conditions can be determined. A ratio is a statically yard stick that


- 51 -

provides a measure of the relationship between variables and figures. The

relationship between variables or figures can be expressed in fractions.

These alternative methods establish a relationship among variables

for the purposes of financial analysis referred to as Ratio Analysis. Ratio

are simple to calculate and easy to understand, Financial analysis employee

these fools to explain financial statements and performance of a company.

Objectives of Ratio Analysis: -

The main objective of Ratio Analysis technique is to reveal the relationship

in more meaningful way so as to enable us to draw conclusion from them.

The ratio analysis thus as a quantitative tool helps the Analyst to draw

answers to questions such as

Are the Net Profits Adequate

Are the assets being use efficiently is the firm solvent

Can the firm meet its current obligation and so on

Thus the Ratio Analysis help the

Owner or Investors: For estimating earning capacity.

Creditors: Concerned primarily with liquidity and ability to pay

interest and redeem loan within specified period.

Financial Executive: - Interested in evaluating analytical tool that

will measure costs efficiency ,liquidity and profitability, with a view

to making intelligent decisions.

Basis of comparison ;-

Ratio are relative figures reflecting the relationship between variables. This

enables the analysis to draw conclusion regarding financial operations The

use of ratio as a tool of financial analysis involves their comparison, for a

single ratio, like absolute figures, fails to reveal the true position. For ex,

P /E ratio (price/earning ratio for a particular script) should be compared

over a period of time to get a true picture of company performance.


- 52 -

Thus comparisons with related facts is the basis of ratio analysis s

In ratio analysis, four types of comparisons are involved.

Trend Ratio

Inter firm comparisons

Comparisons of items within a single year s financial statement of a

firm.

Comparisons with standard or plans

Types of Ratio

Types of Ratios: -

1. Liquidity ratios

2. Leverage Ratios

3. Turnover Ratios

4. Profitability Ratios


- 53 -

5. Valuation Ratios.

Liquidity Ratio: -

Liquidity refers of the ability of a firm to meet its obligation in the short

run, usually one year or when the become duration for payment.

A proper balance between liquidly and profitability is required for efficient

Financial Management. Liquidity ratios are based on the relationship

between current assets the sources for meeting short-term obligation and

current liabilities. The ratios, which indicate the liquidity of a firm, are: -

1. Current Ratio.

2. Acid test Ratio.

3. Fund-Flow Ratio.

4. Net working capital.

Current Ratio

The current Ratio is the ratio of current liabilities it is calculated as: - Current assets Current ratio = - - - - - - - - - - - - - - - - - - Current Liabilities

The current assets include cash and Bank Balance, Marketable

securities, Bills Receivable, Inventories, Loan sand advances, Advances

Payment and prepaid expenses.

The current liabilities include creditors, bills payable bank overdraft

short-term loans, outstanding expense & income tax payable, unclaimed

divided and proposed dividend.

The current ratio measures the ability of the firm to meet its current

liabilities. The current assets get converted into cash into the operational

cycle of the firm and provide the fund needed to pay current liabilities. The

higher the ratio, to ward off.

Acid Test Ratio: -

The acid test ratio is the ratio between quick current assets and current

liabilities.

It is calculated as Quick assets Acid Test Ratio = - - - - - - - - - - - - - - - - - Current liabilities


- 54 -

The term quick asset refers to current assets that can be converted into cash

immediately.

Quick assets current assets (inventories + prepaid expenses)

It is based on current asset, which are highly liquid. This also called quick

ratio.

Generally, an acid test ratio of 1:1 considered satisfactory as a firm

can easily meet all current claims.

Bank to working capital Gap Ratio: -

This ratio establishes a relationship between short-term bank borrowing and

working capital gap

It is calculated as Short term bank Borrowing Bank Finance to working Gap Ratio = - - - - - - - - - - - - - - - - - Working capital gap

Working capital equal to current assets less current liabilities other than

bank borrowing. The tondon committee report suggest that this ratio should

not exceed 0.75 even under most liberal scheme of financing.

Fund flow ratio : -

A dynamic analysis of liquidity call for examination of cash inflow and

cash outflow in addition to the size of the liquid asset balances at a given

point of time.

The current ratio and acid test ratio are static in nature.

Quick assets Internal measure = - - - - - - - - - - - - - - - - - Average daily flow of operational cash expenditure

Leverage of capital structure ratios: -

These ratios refer to the use of debt finance long term solvency of the firm

can be examined by using leverage or capital ratios.


- 55 -

The leverage ratio or capital structure ratio can be defined as the

financial ratios which throw light on the long term solvency of a firm

reflected in its ability to assure the long term creditors with regards to.

1. Periodic payment of interest during the period of loan.

2. Repayment of Principe on maturity or in predetermined installments at

due dates.

Leverage ratio help in assessing the risk arising from the use debt capital.

Two types of ratio that are commonly used to analyze financial ratio are.

1. Structural ratios.

2. Coverage ratios

Structural ratios: -

Structural ratios are based on the proportion of debt and equality in the

financial structure of the firm, two important coverage ratios are interest

converge ratios and fixed charge coverage ratio 5:3:1 Structural ratios.

Debt equity ratio

This ratio reflects the relative claims of creditors and share holders against

the assets of the firm, debt equity ratios establishment relation ship between

borrowed funds and owner capital to measure the long term financial

solvency of the firm. The ratio indicates the relative proportions of debt and

equity in financing the assets of the firm.

It is calculated as follows

Debt Debt equity ratio = ------------------------------- Equity

The debts side consist of all liabilities ( that include short term and long

term liabilities) of the firm. The equity side consists of new worth (plus)

preference capital. The lower the debt equity ratio the higher in the degree

of protection enjoyed by the creditors.


- 56 -

The debt equity ratio defined by the controller of capital issue, debt is

defined as long term debt plus preference capital which is redeemable

before 12 years and equity is defined as paid up equity capital plus

preference capital which is redeemable after 12 years.

The general norm for this ratio is 2:1. on case of capital intensive

industries as norms of 4:1 is used for fertilizer and cement industry and a

norms of 6:1 is used for shipping units.

Debt asset ratio:

The debit asset ratio establishes a relationship between borrowed funds

and the assets of firm.

It is calculated as: Debt Debt Asset Ratio = ------------------------------- Asset

Debt includes all liabilities. short term as well as long term and the assets

include the total of all the assets (the balance sheet total )

This ratio is related to the debt equity as follows . Debt ---------- Equity Debt asset ratio = -- ------------------------------------------ 1+ Debt ---------- Equity

Coverage Ratios.

These ratios are computed from the information available in the profit and

loss account. The coverage ratios measure the relation ship between what is

normally available from operations of the firm and the claims of the

outsider.

The various coverage ratios are

1) Interest coverage ratio


- 57 -

2) Fixed charges average ratio

3) Dividend coverage ratio

Interest coverage Ratio

This ratio is also know as Time interested Earned ratio This ratio measures

the debt servicing of capacity of a firm in so far as fixed interest on long

term loan is concerned. Interest coverage ratio determined by dividing the

operating profits or earning before interest and taxes by fixed interest

charges on loans

It is calculated as

Earning Before Interest &Taxes (EBIT) Interest coverage Ratio = ---------------------------- Debt Interest

The EBIT is used in the numerator of this ratio because the ability of a firm

to pay interest is not affected by tax payment as interest on debt fund in a

tax deductible expenses.

The ratio apparently measure the margin of safety the firm enjoys

with the respect to its interest burden.

A high interest coverage ratio implies that the firm can easily meet

its interest burden even if EBIT decline.

A low interest coverage ratio results in financial embarrassment

when EBIT declines.

This ratio is not appropriate measures of interest coverage because

the source of interest payment is cash flow before interest and taxes, not

EBIT.

In this view, we may use the modified interest coverage ratio.

EBIT +depreciation coverage ratio Modified Interest Coverage Ratio = ----------------------------- Debt Interest

Fixed charges coverage Ratio:


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This ratio help in measuring the debt servicing ability adequately because it

considers both interest and the principal repayment obligations.

It is calculated as :

EBIT +depreciation Fixed charges coverage Ratio : - --------------------------------------- Repayment of Loan Debt Interest + 1 - Tax Ratio

If the denominator of this ratio only the repayment of loan is adjusted

upwards for the tax factor because the loan repayment amount un like

interest, is not tax deductible.

This ratio may be amplified to include other fixed charges like lease

payment and preference dividend.

Thus, Earning After Tax (EST) Dividend Coverage Ratio = ------------------------------------------------- Preference Dividend

This ratio like the interest coverage ratio, reveals the safety margin

available to the preference share holder . The higher the coverage the better

it is from their point of view.

Profitability Ratios

Profitability is measured of efficiency and the search for its provides an

incentive to achieve efficiency. Profitability the final results of business

operations mainly the owners and management are in the financial

soundness of the firm. The management of the firm, is eager to measure its

acting efficient. Similarly the owners invest their funds with the expectation

of reasonable return. Thus it all depends on the profit for the ensure


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operating efficiency to the management and ensure reasonable return to the

owners.

1. Profit margin ratio (gross and net)

2. Expenses ratio or operating ratio profitability ratios in relation to

investment are.

3. Return on investment

4. Return on assets

5. Return on equity

6. Return on capital employed.

7. Net income to total assets ratio.

Profit margin ratio

Profit margin ratio measures the relationship between profit and sales, there

are two profit margin ratios

1. Gross margin ratio

2. Net margin ratio

Gross profit margin ratio: -

Gross profit can be defined as the difference between net sales and cost of

goods sold. Gross margin profit ratio is also known as gross margin gross

profit margin ratio is calculated by dividing gross profit by sales.

Gross profit

Gross profit margin ratio = ------------------

Net sales

The gross profit margin ratio shows the margin left after meeting

manufacturing cost. The ratio also measures. The efficiency of production

as well as pricing. The Gross profit to sales is a sign of good management s

as it implies that the cost of production of the firm is relatively low. A high

ratio may also imply of a higher sales rise without a corresponding increase

in the cost of goods sold.

Whereas a low gross profit margin in a danger signals, warranting a

careful and detailed analysis of the factors responsible for the same. The

main contributing factors responsible for low ratio maybe high cost of

production as will as inefficient utilization of fixed as well as current assets


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a low selling price resulting from severe competition, inferior quality. Lock

of demand etc .

Net Profit Margin Ratio:

The Net Profit Margin Ratio determines the between Net profit and sales of

business firm. This relationship is also known as net margin. This ratio

shows the earning left for shareholder (both equity and preference) as

percentage of Net sales.

Net Margin Ratio measures the over all efficiency of production,

Administration selling,

Financing, pricing and Tase Management.

Thus,

Net Profit

Net profit Margin Ratio: - -------------------

Net Sales

A high Net profit Margin indicates adequate return to the owners as will as

enable a firm to withstand adverse economic conditions when selling price

is decanting, cost of production is rising and demand for product is falling.

A low Net Profit Margin has opposite implications. A firm with low net

profit margin can earn a high rate of return on investment it has a higher

inventory turnover. Jointly considering gross and net profit margin provides

a valuable understanding of the cost and profit structure of the firm and

enables the analyst to identity the source of business efficiency of

inefficiency.

Profitable Ratios in regard to Investment

The profitable ratios can also be computed by relating the profits of a firm

to its investments. These ratios are popularly termed return on investment

(ROI).


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There are three different concept of investment in vogue assets. Capital

employed and Shareholders Equity.

Based on each of the above there are three board categories of ROI s

They are

Return on Assets

Return on Capital Employed

Return on Shareholders Equity.

Return on Assets: -

Return on Assets ratio measure the profitability ratio in terms of

relationship between Net Profit and Assets. There are various approaches

possible to define net profit and Assets.

The concept of Net profit may be

Net Profit after Taxes.

Net Profit after Taxes plus Interest

Net Profit after Taxes plus Interest minus Tax Saving.

Assets may be variants of return on assets are

Net Profit after Taxes

Return on Assets = ---------------------------------

Average Total Assets

The Return on Assets based ratio would be an under estimate as the interest

paid to the creditor is excluded from the Net Profit.

Net Profit after Taxes +Interest

Return on Assets = ---------------------------------

Average Fixed Assets

Net Profit after Taxes +Interest

Return on Assets = ---------------------------------

Average Tangible Assets


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The above may not provide correct results for inter firm comparison. As a

measure of operating performance, the above equations should be

substituted by the following: -

Net Profit after Taxes +Interest Tax Advantage on

Interest

Return on Assets = -------------------------------------------------------------------

- Average Total \ Fixed Tangible Assets

This equation correctly reports about the operating efficiency of firms if

they all are equity financed. The main purpose of return on assets is to

measure the profitability of the total funds Investment of a firm.

Return on Capital Employed (ROCE) :-

Return on capital employed is same as return on assets except for the

difference that the profit are related to the capital employed. In this ratio the

term capital employed refers to the long term funds supplied by the

creditors and owners of the firms.

The return on capital employed can be computed\calculated in two ways

firstly it is equal to non-current liabilities (Long Term Liabilities) plus

owner s equity. secondly it is equivalent to net working capital plus fixed

assets.

Net profit After Taxes +Interest

ROCE = -----------------------------------------------------

Average Total Capital Employed

Net profit After Taxes +Interest Tax Advantage on Interest

ROCE = -----------------------------------------------------

Average Total Capital Employed

Net profit After Taxes +Interest

ROCE = -----------------------------------------------------

Average Total Capital Employed-Average Intangible Assets

In the ratio is compared with similar firms, with industry average and over

time would provide sufficient insight into how efficiently the long term

funds of owners and creditors are being used. The higher the ratio, the more

efficient in used of the capital employed.


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Return on Equity :-

The return on equity the profitability of equity funds invested in the firm.

Return on equity is regarded as very important measures because it reflects

the productivity of the ownership (or risk capital employed in the firm)

Thus,

Equity Earning

Return on Equity = -------------------

Net Worth

Equity earning of this ratio is equal to profit after tax less preference

divided Net worth includes all contribution made by equity shareholder

( paid up capital + reserve & surplus) This ratio is called as return on net

worth.

This ratio is influenced by several factors return on investment, debt equity

ratio average cost of Debt. Funds and tax rate.

Return on investment

The return on investment is a measure of business performance, which is

not affected by interest charges and tax payments.

Thus,

EBIT

Return on investment = -------------

Total assets

Numerator represent pre-earning belonging to all sources of finance, total

assets represent total financing.

This ratio focuses on operation performance and obstructs away the effect

of financial structure and tax rate. It is eminently suited for inter firm

comparisons. This ratio is internally consistent.

Net income to total assets ratio: -

The main purpose of net income to total assets ratio is measure how

efficiency the is employed.

net income profit


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Net income of total assets ratio = -----------------------

Earning per share

The market price per share may be the price prevailing on a certain day or

preferably average price over a period of time. The earning per share (EPS)

is simply profit after tax divided by number of outstanding equity shares.

The PE ratio is a summary measures & which primarily reflects following

factors growth, prospects, risk characteristics, share holders, orientation,

corporate image and degree of liquidity.

Yield: -

Divided + price change

Yield = --------------------------

Initial price

Generally companies with low growth prospects after a high divided yield

and low capital gains yield, companies with superior growth prospects after

a low divided yield and high capital gains yield.

Market value to book value ratio: -

Market value per share

Market value to book value ratio = ----------------------------

Book value per share

This ratio reflects the contribution of a firm to the net wealth of the society.

If the market value to book value ratio is equal to 1. All the three ratios

return on equity, earnings per share (which is inverse to PE ratio) and total

yield are equal. If the ratio is say 2 the firm has created a net wealth of one

rupee for every rupees invested in it. If the ratio is equal to 1 it implies that

the firm has neither contribution nor detracted from the net wealth of the

society.

Application on ratio analysis technique

Liquidity ratios


- 65 -

Leverage ratios

Profitability Ratios


- 66 -

Research Methodology


- 67 -

Research Methodology is a systematic method of discovering new facts or

verifying old facts, their sequence, inter-relationship, casual explanation

and the natural laws which governs them.

Research Methodology explained by Redman and Mory are as follows

systematized effort to gain new knowledge Research Methodology is

original contribution to the existing stock of knowledge making for its

advancement. It is the purist of truth with the help of study. Observation,

comparison and experiment. In short also covers the systematic method of

finding solution to a problem is research. It also covers the systematic

approach concerning generalization and the formulation of the theory.

Different stages involved in research consists of enacting the problem,

formulating a hypothesis, collecting the facts or data, analyzing the facts

and reaching certain conclusion either in the form of solution towards the

concerned problem or in generalization for some theoretical formulation.

In Research Methodology mainly Data plays an important role.

The Data is divided in two parts:

a) Primary Data.

b) Secondary Data.

Primary Data is the data, which is collected directly by personal

interaction with the persons concerned. This is of good use in

understanding the process.

This can be done through observation of some quantitative measurements,

or the data, with the help of personal interview, telephone interviews,

mailing of questionnaires, schedules, etc.

Secondary Data is the data, which is collected from the various books,

magazine and material, reports, etc. The data which is stored in the


- 68 -

organization and provide by the HR people are also secondary data. The

various information is taken out regarding that subject as well other subject

from various sources and stored. The last years data stored can also be

secondary data. This data is kept for the internal use of the organization.

The HR manual is for the internal use of the organization they are

secondary data which help people to gain information. In this report the

data plays a very crucial role. For this report the data was provided to me

by HR department and other departmental head in the organization.

In execution of this project the above specified data was collected

by the way of personal interactions and indirect information available in the

form of reports, books, etc.

There are few more important steps in carrying out the Project, these are

specified below.

Execution of the project.

Analysis of data.

Hypothesis-testing.

Generalization and interpretation.

Preparation of the report.

Findings

Findings in respect of R & D accounting and reporting.


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Dr. Reddy s laboratories Ltd. s R & D accounting and reporting is

found considerably good in comparison with other companies.

The ideal expenditure to be made on R & D is 10-20% as a

percentage of total turnover and the company is satisfying this.

The findings R & D accounting and reporting of other

Pharmaceutical companies are given in the excel sheet attached.

There are regular partnerships and mergers in relation with R & D

by many companies.

R & D expenditure constitutes major part of the turnover.

R & D expenses are treated as intangible assets.

Efforts have been put to cut down the expenses of R & D without

compromising with the effectiveness of the research.

Findings in respect of Ratio Analysis.


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The return on assets, return on capital employed and return on

shareholder s equity has been considerably increased from 1995-96

to 2004-05.

Return on assets (ROA) return on total capital employed and return

on shareholders equity how increased by about 35% from 1995-96

to 2004-05 indicating an excellent overall performance by the

management.

The current ratio (approx. 1.5) and quick ratio (approx. 1.3)

indicates an effective liquidity management by Company. A high

current and quick ratio indicates that the company can meet its

current obligation liabilities.

The high liquidity ratios reflect a very strong short term financial

structure. The company should maintain current assets in the form

of receivables and cash rather than in inventory so as to meet its

current obligation efficiency.

Gross profit Margin ratio and the net profit margin ratio on an

average of is about 35% and 10% respectively. These figures and

during the last three financial years are truly remarkable. The gross

profit margin ratio and the net profit margin ratio have increased

during 1995-96 to 2004-05 in spite to low profit suffered by the

company during 1995-96.

It may by noted as Net profit Margin has been around 15% in the

last three financial years reflecting a better earning for the

shareholders.

The high Debt equity, debt assets and debt to total capital ratio

indicates a moderate existence of equity and capital employed these

ratio indicate that the company has a low geared capital structure

and it is able to maintain an average interest coverage ratio

indicating that the firm enjoys the margins of safety with the respect

to this interest burden.

The company maintains a modest interest coverage ratio so that it

can easily meet its interest burden even if EBIT suffers a decline.

Limitations


- 71 -

R & D process is carried out for more than 10 years, thus in this long

period of time the expenses at every stage are variable. Even the

changes in value of the money create a hurdle in planning the

expenditure of R & D.

The budgeting of R & D is difficult due to regular technical

innovations. The company has to acquire these at times compromising

with the expenditure involved in it.

The financial aspects of R & D are so critical that its accounting and

reporting is a challenging process.

The collection of the data for ratio analysis is difficult.

Ratio Analysis is the process to carry out the financial position of the

company but only use of this is limited as there are few other factors

which can present the financial position of the company.

The data required to do the comparative study with other

pharmaceutical companies was difficult to trace.

Recommendations.


- 72 -

The company can further cut down its expenditure on R & D by

applying more effective costing and budgeting techniques.

The method of R & D accounting and reporting of the company is

satisfactory and can be continued unless there are future changes

in principles of accounting.

The company can get into partnerships and acquisitions for

financing the R & D expenditure.

The accounting and reporting of R & D related costs are treated as

the intangible assets as the reap of this is huge in the future. Thus,

the company can invest till 20 % of their total turnover.


structure. The company should maintain current assets in the form

of receivables and cash rather than in inventory so as to meet its

current obligation efficiency.

The debt ratio of the company is good but it still needs to focus on

capital structure of the company.

Conclusion.


- 73 -

Dr. Reddy s laboratories Ltd. is the 2nd largest pharmaceutical company in

terms of its R & D. As, the R & D process continues to the number of years

its investment costs are significant because those will be segregated over

the profits. Instead of adopting short term reaction of drastically cutting R

& D expenditure, the company decided to continue with the present R & D

investments to secure a sustainable and profitable future for the company.

In fact, with the outlay of Rs. 2, 803 million, company invested 41% more

in R & D than in 2003-04, R & D accounted for 14 per cent of total revenue

in 2004-04, versus 10 per cent in the previous year.

The company views R & D as the key to sustainable long term

growth of the company, and therefore, has not compromised on research

and development efforts despite 2004-05 being a difficult year financially.

The above said expenditure on R & D indicates increase in investments.

This was on account of various segments of the R & D process.


structure. The company should maintain current assets in the form of

receivables and cash rather than in inventory so as to meet its current

obligation efficiency.

The process of R & D accounting and reporting is satisfactory and

is according to set norms of the IGAAP and USGAAP.

R & D is the main focus of the company thus the investments

required were fulfilled with the help of some partnerships and

acquisitions.

The method of R & D investments and its accounting process is

better compared to other pharmaceutical companies.

It may by noted as Net profit Margin has been around 15% in the

last three financial years reflecting a better earning for the

shareholders.

The company maintains a modest interest coverage ratio so that it

can easily meet its interest burden even if EBIT suffers a decline.

BIBLIOGRAPHY

Books


- 74 -

Principles of Financial Management.

- Satish Inamdar

Lessons in Accounting Standards.

- M.P. Vijay kumar.

FCA, AICWA, FCS.

Websites.

www.drreddys.com

www.wikipedia.com

http://www.drreddys.com

http://www.wikipedia.com

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