FINAL ACCOUNTS vis-à-vis Financial Statements. Samir K Mahajan

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1 FINAL ACCOUNTS vis-à-vis Financial Statements Samir K Mahajan

2 CLASSIFICATION OF FINAL ACCOUNT Trial balance proves the arithmetical accuracy of the business transactions, but it is not the end. The businessman is interested in knowing whether the business has resulted in profit or loss and what the financial position of the business is at a given period. In short, he wants to know the profitability and the financial soundness of the business. The trader can ascertain these by preparing the final accounts. The final accounts are prepared at the end of the year from the trial balance. Hence the trial balance is said to be the connecting link between the ledger accounts and the final accounts.

3 CLASSIFICATION OF FINAL ACCOUNT contd. The basic objectives of preparing financial statements are : (a) To present a true and fair view of the financial performance of the business; (b) To present a true and fair view of the financial position of the business; and For this purpose, the firm usually prepares the following financial statements: 1. Trading and Profit and Loss Account 2. Balance Sheet Trading and Profit and Loss account, also known as Income statement, shows the financial performance in the form of profit earned or loss sustained by the business. Balance Sheet shows financial position in the form of assets, liabilities and capital. These are prepared onthe basis of trial balance and additional information, if any.

4 It is achieved by transferring the balances of revenues and expenses to the trading and profit and loss account from the trial balance. TRADING AND PROFIT AND LOSS ACCOUNT Trading and Profit and Loss account is prepared to determine the profit earned or loss sustained by the business enterprise during the accounting period. It is basically a summary of revenues and expenses of the business and calculates the net figure termed as profit or loss. Profit is revenue less expenses. If expenses are more than revenues, the figure is termed as loss. Trading and Profit and Loss account summarises the performance for an accounting period.

5 Concept of Gross Profit and Net Profit Trading and Profit and Loss account is also an account with Debit and Credit sides. It can be observed that debit balances (representing expenses) and losses are transferred to the debit side of the Trading and a Profit and Loss account and credit balance (representing revenues/gains) are transferred to its credit side. The trading and profit and loss can be seen as combination of two accounts, viz. Trading account and Profit and Loss account. The trading account or the first part ascertains the gross profit and

6 TRADING ACCOUNT The trading account ascertains the result from basic operational activities of the business. The basic operational activity involves the manufacturing, purchasing and selling of goods. It is prepared to ascertain whether the selling of goods and/or rendering of services to customers have proved profitable for the business or not. Trading account ascertain gross profit or gross loss. Gross Profit = Sales (Purchases + Direct Expenses) The gross profit or the gross loss is transferred to profit and loss account.

7 Trading Account contd. ITEMS APPEARING IN THE DEBIT SIDE OF TRADING ACCOUNT o Opening stock: Stock on hand at the beginning of the year is termed as opening stock. The closing stock of the previous accounting year is brought forward as opening stock of the current accounting year. In the case of new business, there will not be any opening stock. o Purchases less returns : Purchases made during the year, includes both cash and credit purchases of goods. Purchase returns must be deducted from the total purchases to get net purchases.

8 ITEMS APPEARING IN THE DEBIT SIDE OF TRADING ACCOUNT contd. Trading Account contd. Direct Expenses: Direct expenses means all expenses directly connected with the manufacture, purchase of goods and bringing them to the point of sale. Some of the direct expenses are: i. Wages: It means remuneration paid to workers. ii. Carriage (Freight or cartage) or carriage inwards: It means the transportation charges paid to bring the goods from the place of purchase to the place of business. iii. Octroi Duty: Amount paid to bring the goods within the municipal limits. iv. Customs duty, dock dues, clearing charges, import duty etc. These expenses are paid to the Government on the goods imported. v. Factory rent paid vi. Other expenses :, Fuel, power, lighting charges, oil, grease, waste related to production and packing expenses

9 ITEMS APPEARING IN THE CREDIT SIDE OF TRADING ACCOUNT Trading Account contd. o Sales less returns: This includes both cash and credit sale made during the year. Net sales is derived by deducting sales return from the total sales. o Closing stock: Closing stock is the value of goods which remain in the hands of the trader at the end of the year. It does not appear in the trial balance. It appears outside the trial balance. o (As it appears outside the trial balance, first it will be recorded in the credit side of the trading account and then shown in the assets side of the balance sheet).

10 ITEMS APPEARING IN THE CREDIT SIDE OF TRADING ACCOUNT contd. Trading Account contd. BALANCING OF TRADING ACCOUNT The difference between the two sides of the Trading Account, indicates either Gross Profit or Gross Loss. If the credit side total is more, the difference represents Gross Profit. On the other hand, if the total of the debit side is more, the difference represents Gross Loss. o The Gross Profit or Gross Loss is transferred to Profit & Loss Account.

11 Format of Trading Account Dr Trading Account for the year ending 31st March. Cr Particulars (expenses /loss) Rs Rs Particulars (revenue/gains) Rs Rs To Opening Stock To Stock: Raw materials Work in progress Semi-finished goods Finished goods To Purchases Less: Returns outward or purchase return Less: goods taken away by proprietor Less: goods given as free samples Less goods: given as charity To direct wages or manufacturing wages To Freight or carriage inwards or purchase carriage To octroi duty or local taxes To import duties, customs, To Clearing charge, landing charges, Dock duties To power (factory) To fuels To coal, gas, water To heating, lighting To manufacturing expenses To packing expenses to assembling expenses To royalty To gross profit c/d (Transferred to P&L A/C) By Sales Less: Returns inwards By Closing stock By Gross Loss c/d (Transferred to P&L A/C)

12 CLOSING ENTRIES OF TRADING ACCOUNT Like ledger accounts, trading account will be closed by transferring the gross profit or gross loss to the profit and loss account. If gross profit Date Particular L.F. Debit Amount (Rs) 2013 Trading A/c Dr January 1 To profit and loss account (Gross Profit transferred to Profit and loss A/c) If gross loss Credit Amount (Rs) Date Particular L.F. Debit Amount (Rs) 2013 Profit and loss A/c Dr January 1 To Trading A/C (Gross Loss transferred to Profit and loss A/c) Credit Amount (Rs)

13 PROFIT AND LOSS ACCOUNT After calculating the gross profit or gross loss the next step is to prepare the profit and loss account. To earn net profit a trader has to incur many expenses apart from those spent for purchases and manufacturing of goods. If such expenses are less than gross profit, the result will be net profit. When total of all these expenses are more than gross profit the result will be net loss. The aim of profit and loss account is to ascertain the net profit earned or net loss suffered during a particular period. Net Profit = Gross profit + Other incomes Indirect Expenses

14 PROFIT AND LOSS ACCOUNT contd. ITEMS APPEARING IN THE DEBIT SIDE 0F PROFIT AND LOSS ACCOUNT Those expenses which are chargeable to the normal activities of the business are recorded in the debit side of profit and loss account. They are termed as indirect expenses which include: Office and Administrative Expenses :Expenses incurred for the functioning of an office such as office salaries, office rent, godown rent, municipal rates and taxes office lighting, printing and stationery, postages, telephone charges office. Repairs and Maintenance Expenses :Expenses relates to the maintenance of assets such deprecation, repairs and small renewals/ replacements relating to plant and machinery, furniture, fixtures, fittings, etc

15 PROFIT AND LOSS ACCOUNT contd. ITEMS APPEARING IN THE DEBIT SIDE 0F PROFIT AND LOSS ACCOUNT contd. Financial Expenses :Expenses incurred on borrowings interest paid on loan, Bad debts, o Selling and Distribution Expenses :All expenses relating to sales and distribution of goods such as: advertising, travelling expenses, salesmen salary, commission paid to salesmen, discount allowed, repacking charges etc.

16 PROFIT AND LOSS ACCOUNT contd. ITEMS APPEARING IN THE CREDIT SIDE 0F PROFIT AND LOSS ACCOUNT contd. Besides the gross profit, other gains and incomes of the business are shown on the credit side. The following are some of the incomes and gains. o Dividend received on investment o Interest received on fixed deposits. o Discount earned. o Commission earned. o Rent Received

17 PROFIT AND LOSS ACCOUNT contd. ITEMS APPEARING IN THE CREDIT SIDE 0F PROFIT AND LOSS ACCOUNT contd. BALANCING 0F PROFIT AND LOSS ACCOUNT The difference between the two sides of profit and loss account indicates either net profit or net loss. If the total on the credit side is more the difference is called net profit. On the other hand if the total of debit side is more the difference represents net loss. The net profit or net loss is transferred to capital account.

18 Dr Profit and Loss Account for the year ended 31 March,. Cr Particulars (expenses /loss) Rs Particulars (revenue/gains) Rs To Trading A/c (Gross loss) By Trading A/c (Gross profit) To Salaries By Commission earned To rents and rates By Rent received To stationaries By Interest received To postage expenses By Discount received To insurance By Net Loss(Transferred to Capital A/c) To repairs To trading expenses To office dues To interest paid To bank charges To sundry expenses To Commission paid To Discount allowed To Advertisement To Carriage outwards To Travelling expenses To Distribution expenses To Repacking charges Bad debts Depreciation To Net Profit (transferred capital A/C)

19 PROFIT AND LOSS ACCOUNT contd. It is the profit earned through the normal operations and activities of the business. Operating profit is the excess of operating revenue over operating expenses. While calculating operating profit, the incomes and expenses of a purely financial nature are not taken into account. Thus, operating profit is profit before interest and tax (EBIT). Similarly, abnormal items such as loss by fire, etc. are also not taken into account. It is calculated as follows : Operating profit = Net Profit + Non-Operating Expenses Non Operating Incomes

20 PROFIT AND LOSS ACCOUNT contd. It is the profit earned through the normal operations and activities of the business. Operating profit is the excess of operating revenue over operating expenses. While calculating operating profit, the incomes and expenses of a purely financial nature are not taken into account. Thus, operating profit is profit before interest and tax (EBIT). Similarly, abnormal items such as loss by fire, etc. are also not taken into account. It is calculated as follows : Operating profit = Net Profit + Non-Operating Expenses Non Operating Incomes

21 If net profit CLOSING ENTRIES OF 0F PROFIT AND LOSS ACCOUNT Like ledger accounts, trading account will be closed by transferring the gross profit or gross loss to the profit and loss account. Date Particular L.F. Debit Amount (Rs) 2013 Profit and Loss A/c Dr January 1 To Capital A/C (Net Profit transferred to Capital A/C ) Credit Amount (Rs) If net loss Date Particular L.F. Debit Amount (Rs) 2013 Capital A/c Dr January 1 To Profit and Loss A/C (Net loss transferred to capital A/C) Credit Amount (Rs)

22 If net profit CLOSING ENTRIES OF 0F PROFIT AND LOSS ACCOUNT Like ledger accounts, trading account will be closed by transferring the gross profit or gross loss to the profit and loss account. Date Particular L.F. Debit Amount (Rs) 2013 Profit and Loss A/c Dr January 1 To Capital A/C (Net Profit transferred to Capital A/C ) Credit Amount (Rs) If net loss Date Particular L.F. Debit Amount (Rs) 2013 Capital A/c Dr January 1 To Profit and Loss A/C (Net loss transferred to capital A/C) Credit Amount (Rs)

23 Dr Rs Cr Rs Illustration1: Prepare a trading account from the following trial balance of Tuli Hotel as on 31 march, 2013 Purchase Sales Returns inward Opening stock Freight outward Carriage inward Salaries and wages Rents and taxes Ravelling expenses Discount Commission Bank A/C Trade creditors Sundry debtors Capital A/C Drawing A/C Closing stock was estimated at Rs. 12,

24 Illustration1: Trading Account of Tuli Hotel for the year ended 31 st March, 2014 Dr Cr Expenses/Losses Amount Rs Revenue/Gain Amount Rs To Opening stock To Purchase To carriage Inward To Gross Profit transferred to P/L A/C By Sales Less: Returns 600 By Closing stock

25 Illustration2: Prepare a profit and loss account from the following information Particulars Rs Particulars Rs Carriage on purchases Carriage on sales Duty on export Water and electricity advertisement Salaries factory s manager Office manger Gross profit Rent received Rent paid Commission (CR)

26 Illustration2: Profit and Loss Account Dr Cr Expenses/Losses Amount Rs Revenue/Gain Amount Rs To carriage on sales To duty on export To lighting To water and electricity To advertisement To salaries office To Rent paid To Net Profit transferred to P/L A/C By gross profit By rent received By Commission

27 Illustration3: Prepare a Trading Account and Profit & Loss account from the following trial balance of Tali and Sons as on 31 March, 2002 Name Account Tali s capital Tali s drawings Purchase and sale Sales and purchase return Stock ( ) Wages Building Freight and carriage Trade expenses Advertisement Interest Taxes and insurance Debtors and creditors Bills receivables and bills payables Cash at bank Cash in hand Salaries Dr Rs Cr Rs Adjustment: Stock on 31 st March, 2002 was valued at Rs

28 Illustration3: Trading and Profit and Loss Account of Tali and Sons for the year ended 31 st March, 2002 Dr Expenses/Losses To Stock ( ) To Purchase 8900 Less: Return 450 To wage To freight and carriage To Gross profit c/d To trade expenses To Advertisement To taxes and insurance To salaries To Net profit transferred to Capital A/C Amount Rs By Sales Less: Return 280 By Closing stock Revenue/Gain Cr Amount Rs By Goss profit b/d By Interest

29 Illustration 4 : Prepare a Trading Account and Profit & Loss account from the following trial balance of Mr Ram on 31 March, and balance sheet on that date. Adjustment: Closing Stock valued at Rs was Name Account Drawings and capital Plant and machineries Debtor and creditors Purchase and sales Returns Wages Cash in hand Cash at bank Salaries Repairs Stock Rent Manufacturing expenses Bills receivables Bills payables Bad debts Carriage Furniture's Income tax Dr Rs Cr Rs

30 Illustration 4: Dr Expenses/Losses To Opening Stock To Purchase Less: Return 7000 To Manufacturing Expenses To carriage To wage To Gross profit c/d To salaries To Repairs To Rent To bad debts To Net Profit transferred to Capital A/C Trading and Profit and Loss Account of Mr Ram for the year ended 31 st March, 2002 Amount Rs By Sales Less: Return By Closing stock Revenue/Gain Cr Amount Rs By Goss profit b/d

31 Illustration4: Balance Sheet of Mr Mr Ram as on 31 st March, 2002 Liabilities Amount Rs Assets Amount Rs Capital Add: Net Profit Less: Drawings Less : Income tax Sundry creditors Bills Payables Plant and machineries Furniture Bills receivables Sundry Debtors Closing Stock Cash at bank Cash in hand

32 BALANCE SHEET contd. Balance Sheet Liabilities and Capital Amount(Rs) Assets Amount(Rs) Fixed Liabilities Loans Debentures Fixed Assets Lands Building Mortgages Plants & machines Fixtures & filings Capital / Owner s Equity Reserves and Surpluses Current Liabilities Short term loans sundry creditors Bills payable Outstanding expenses Investments Current Assets Cash inhand & bank Stock of inventories Sundry debtors Receivables Prepaid expenses Accrued income

33 BALANCE SHEET Balance sheet is defined as a statement which sets out the assets and liabilities of a business firm and which serves to ascertain the financial position of the same on any particular date. This forms the second part of the final accounts. It is a statement showing the financial position of a business. Balance sheet is prepared by taking up all personal accounts and real accounts (assets and properties) together with the net result obtained from profit and loss account. On the left hand side of the statement, the liabilities and capital are shown. On the right hand side, all the assets are shown. Balance sheet is not an account but it is a statement prepared from the ledger balances. So we should not prefix the accounts with the words To and By.

34 The need for preparing a Balance sheet is as follows: i. To know the nature and value of assets of the business ii. To ascertain the total liabilities of the business. iii. To know the position of owner s equity. BALANCE SHEET

35 FORMAT OF BALANCE SHEET The Balance sheet of a business concern can be presented in the following two forms i. Horizontal form or the Account form ii. Vertical form or Report form Horizontal form of Balance Sheet: The right hand side of the balance sheet is asset side and the left hand side is liabilities side. All accounts having debit balance will appear in the asset side and all those having credit balance will appear in the liability side.

36 BALANCE SHEET contd. Liabilities The amount which a business owes to others is liabilities. Credit balance of personal and real accounts together with the capital account are liabilities. Long Term Liabilities: Liabilities which are repayable after a long period of time are known as Long Term Liabilities. For example, capital, long term loans etc. Drawings : Amount withdrawn by the proprietor is termed as drawings and has the effect of reducing the balance on his capital account. Therefore, the drawings account is closed by transferring its balance to his capital account. However it is shown by way of deduction from capital in the balance Current Liabilities: Current liabilities are those which are repayable within a year. For example, creditors for goods purchased, short term loans etc. Contingent liabilities: It is an anticipated liability which may or may not arise in future. For example, liability arising for bills discounted. Contingent liabilities will not appear in the balance sheet. But shown as foot note

37 BALANCE SHEET contd. Assets The properties and assets owned the business are assets. Debit balance of personal and real accounts together with the capital account are assets. Fixed Assets :Fixed assets are acquired for long term use in business. They are not meant for business transaction rather are used to produce goods or service. Fixed assets includes, Lands, buildings, Machines and plants, Furniture's, fixtures, fittings, Livestock Current Assets : Currents assets / floating assets/circulating assets includes cash and other resources or assets which are reasonably expected to be realised in cash, sold or consumed during normal operation of business. Investments: Investments represent the funds invested in government securities, shares of a company, etc. They are shown at cost price. If, on the date of preparation the balance sheet, the market price of investments is lower than the cost price, a footnote to that effect may be appended to the balance sheet. Intangible Assets : These are such assets which cannot be seen or touched. sgoodwill, Patents, Trademarks are some of the examples of intangible assets.

38 Assets contd. Current assets are most liquid assets meaning that they are either in cash or going to be converted into cash. Current assets change their value constantly. Current assets include Cash in hand and bank, Stock of inventories of raw materials, finished and semi-finished goods, Sundry debtors/book debt/buyers of goods on credit that have not paid yet to the firm, account/ Bill receivables (bills drawn by the firm to buyers on credit and buyers have accepted.), prepaid expenses, Accrued income Investments: Investment includes purchase of in shares and debentures of other firms. BALANCE SHEET contd.

FINANCIAL STATEMENTS OF SOLE PROPRIETORSHIP

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