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 - independent director
Dr. Omkar Goswami - independent director
Mr. P N Devarajan - independent director
Mr. Ravi Bhoothalingam - independent director
Dr. V Mohan - independent director
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.

- 33 -
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)

- 39 -
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:

- 58 -
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

- 59 -
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

- 60 -
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).

- 61 -
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

- 62 -
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 computedcalculated 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.

- 63 -
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

- 64 -
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.

- 69 -
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.

- 70 -
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

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