FINANCIAL ACCOUNTING II
LECTURE-05
PRESENTATION OF FINANCIAL STATEMENTS
Profit & Loss Account
Standard format of profit & loss account is shown as follows:
Particulars
Sales
Less: Cost of Goods Sold
Gross Profit
Less: Administrative Expenses
Selling Expenses
Amount
Rs.
X
X
Operating Profit
Less: Financial Expenses
Add : Other income
Profit Before Tax
Less: Tax
Net Profit After Tax for the Year
Other income
Amount
Rs.
X
(x)
X
(x)
X
(x)
X
(x)
X
Sales
Sales as we know are the revenue against the sale of the product in which the organization
deals. In case of a service organization, there will be Income against Services Rendered
instead of Sales and there will be no Cost of Sales or Gross Profit.
Cost of Goods Sold/Gross Profit
Cost of goods sold is the cost incurred in purchasing or manufacturing the product, which an
organization is selling plus any other expense incurred in bringing the product in salable
condition. Cost of goods sold contains the following heads of accounts:
o Purchase of raw material/goods
o Wages paid to employees for manufacturing of
goods o Any tax/freight is paid on purchases
o Any expense incurred on carriage/transportation of purchased items.
Gross Profit = Sales – Cost of goods sold
Other Income
Other income includes revenue from indirect source of income, such as return on investment,
profit on PLS account etc.
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FINANCIAL ACCOUNTING II
Administrative Expenses
Administrative expenses are the expenses incurred in running a business effectively. Main
components of this group are:
o Payment of utility
bills o Payment of rent
o Salaries of employees
o General office
expenses
o Repair & maintenance of office equipment & vehicles.
It is important to distribute expenses properly among the three classifications i.e. Cost of
Goods Sold, Administrative Expenses and Selling Expenses to present the financial
statements fairly. Take the example of following costs:
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o
Salaries and Wages
ƒ
Although both these terms mean remuneration paid to labor and
employee against services.
ƒ
Wages usually denotes remuneration paid to daily wages labor.
Whereas salary denotes payments to permanent employees.
Salaries can be classified in any of the classifications mentioned below.
• Salaries / wages paid to labor and supervisors/officers working
for the manufacturing of goods become a part of Cost of Goods
Sold.
ƒ
•
•
Salaries and benefits of general administrative staff becomes
part of Administrative Expenses
Salaries and benefits of sales and marketing staff become part
of selling expenses.
Other expenses like Depreciation, Utilities and Maintenance can also be classified in all
three, depending upon the exact nature of the expenditure.
Selling Expenses
Selling expenses are the expenses incurred directly in connection with the sale of goods. This
head contains:
o Transportation/carriage of goods
sold o Tax/freight paid on sale
If the expense head ‘salaries’ includes salaries of sales staff, it will be excluded from salaries
& appear under the heading of ‘selling expenses’.
Financial Expenses
Financial expenses are the interest paid on bank loan & charges deducted by bank on entity’s
bank accounts. These are shown separately in the Profit and Loss Account. These include:
o Interest on loan
o Bank charges
There is, however, one exception and that is the interest paid on loan taken to build an asset
is capitalized as cost of the asset up to the time that asset is completed.
Income Tax
Different types of entities have to pay income tax at different rates. At the time of preparing
annual financial statements, an estimate of expected tax liability is made. A provision is then,
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created equal to that estimate.
You should remember the treatment of Provision for Doubtful debts. Same is the case with
income tax i.e. provision is made at the time of preparing accounts which is then adjusted
accordingly at the time when actual tax expense is known.
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FINANCIAL ACCOUNTING II
Balance Sheet (Asset Side)
Standard format of the balance sheet is given as
follows:
Particulars
Amount Rs. Amount Rs.
Assets
Non Current Assets
Fixed Assets
Capital Work In Progress
Deferred Costs
Long Term Investments
X
X
X
X
Current Assets
Stocks
Trade debtors and Other Receivables
Prepayments
Short Term Investments
Cash and Bank
X
X
X
X
X
Total
X
X
Fixed Assets
•
Fixed assets are the assets of permanent nature that a business acquires, such as plant,
machinery, building, furniture, vehicles etc.
•
Fixed assets are presented at cost less accumulated depreciation OR revalued amount.
Capital Work In Progress
If an asset is not completed at that time when balance sheet is prepared, all costs incurred on
that asset up to the balance sheet date are transferred to an account called Capital Work in
Progress Account. This account is shown separately in the balance sheet below the fixed
assets. Capital work in progress account contains all expenses incurred on the asset until it is
converted into working condition. All these expenses will become part of the cost of that
asset. When an asset is completed and it is ready to work, all costs will transfer to the
relevant asset account.
Deferred Costs
An expense that has a future benefit in excess of one year and recorded in a capital asset
account
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FINANCIAL ACCOUNTING II
Long Term and Short Term Investments
Where a business has surplus funds, it is better to invest those funds where these can generate
a return greater than PLS accounts. These investments can be of different types e.g. shares of
other companies, fixed deposits with banks, government securities, national savings etc. or
presentation purposes, these Investments are classified in two categories, long term and short
term investments. Investments made with the intention that they will be held for a period
longer than twelve months are classified as long term and those made for a period equal to or
shorter than 12 months are classified as short term.
Following things are important to note here:
•
Classification is to be made every time a balance sheet is prepared and the
period is to be calculated from the date of balance sheet.
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•
•
•
This means that an investment made for 2 years on May 2000 will be classified as
long term investment in accounts prepared on Jun 30, 2000 and the same investment
will be classified as current investment in the accounts prepared on June 30, 2001.
An investment may initially be made as current investment. Subsequently, if it is
decided to hold it for a longer period, then its classification will have to be changed
accordingly and vice versa.
Therefore, investments are checked for classification every time a balance sheet is
prepared and presented accordingly.
Current Assets
Current Assets are the receivables that are expected to be received within one year of the
balance sheet date. Debtors, closing stock & all accrued incomes are the examples of Current
Assets because these are expected to be received within one accounting period from the
balance sheet date.
It is important to note that assets and liabilities are presented in the balance sheet in the order
of their maturity i.e. assets / liabilities having longer life are presented first and assets /
liabilities having shorter life are presented later.
PRESENTATION OF FINANCIAL STATEMENTS (Continued)
Standard Format of Balance Sheet (Liability Side)
Particulars
Amount
Rs.
Amount
Rs.
Liabilities
Capital and Reserves
Capital
Reserves
Profit and Loss Account
X
X
X
X
Non Current / Long Term Liabilities
Long term loans
Other long term liabilities
X
X
X
Current Liabilities
Trade creditors and other payables
Short term borrowings
Current portion of long term
X
X
X
X
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FINANCIAL ACCOUNTING II
borrowings
Total
X
Capital
Capital is the first item shown on the liability side of the balance sheet of an organization.
Capita l is the Money invested in the business by the owners. Capital is a liability for the
business as the business has to pay return against this money and in case the business is
closed, then it has to return the amount. Capital is also termed as “Share Capital”.
Recording of Capital
Recording of Capital is
Simple.
• At the time of receipt
Debit
Cash / Bank
Credit
Capital
• If the owner contributes an asset instead of cash,
then
Debit
Asset Account
Credit
Capital
• When the capital is repaid (this does not happen in normal course of business, but just in
case)
Debit
Capital
Credit
Cash / Bank
Reserves
The portion of profit which is not paid to proprietor, but is kept apart for meeting some
known or unknown losses is called Reserve, e.g. Reserve fund, contingencies reserve etc.
.
There are two major types of reserves:
Revenue Reserves
From the view point of its creation revenue reserve may again be classified into:
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a. General reserve
Reserve which is not created for any specific purpose, but for strengthening the financial
position of the business is known as General Reserve, e.g. Reserve fund, contingencies
reserve etc.
b. Specific Reserve
Reserve created for any special purpose is known as Specific Reserve. e.g., Dividend
Equalization fund, Debenture sinking fund etc.
Capital Reserves
Capital reserves, in most of the cases, are created due to legal requirements. Profit may arise
from sources, other than normal business activity. For example, profit on sale of fixed assets
or profit on revaluation of fixed assets. When a reserve is created out of these profits, it is
termed as capitalreserve. One capital reserve about which we already know is “Fixed Assets
Revaluation Reserve”. Capital reserves can be used for specific purposes only.
Difference between Reserve And Provision
Both reserves and provisions are created out of revenues of the business, but they differ from
each other.
•
Creating a provision is necessary to show a true profit for the period, whereas
the reserve is created on the discretion of the owner, out of profits.
•
•
Provision is to be made, even, if there is a loss; Reserves are created out of profits only.
Reserve is shown as liability in the balance sheet, Provision is shown as a
reduction from the asset against which it is created.
Provision is used specifically for the purpose for which it is made, Reserves are
usually general and can be used for any purpose.
•
Profit And Loss Account
Profit and Loss Account or Accumulated Profit and Loss Account shows the balance of undistributed profit accumulated over the periods. In the first year of business, this account
shows following figure:
Profits for the year
Less: Transferred to Reserve
Less: Profit distributed
Balance carried to Balance Sheet
X
(X)
(X)
X
In Subsequent years, balance brought forward from previous years and profit for the year is
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added and distributed as above and the balance is carried to next year. This is why; it is
termed as Accumulated Profit and Loss Account.
Long Term Loans
The owners of the business may feel that their business can flourish, if there are more funds.
These funds can be arranged from their own resources, if possible, or they can ask a bank or
financial institution for funds. This loan, if extended by bank for a period of more than one
year is termed as a long term loan. There can be other sources of long term loans as well, e.g.
Term Finance Certificates and Debentures, where money is borrowed from general public
under certain legal restrictions.
Other Long Term Liabilities
These include all other liabilities that are payable after a period of one year of balance sheet
date. For example, staff gratuity and other benefits, taxes and liabilities that become payable
after a period of one year.
Current Liabilities
Current Liabilities are the obligations of the business that are payable within twelve months
of the balance sheet date. Creditors, all accrued expenses are the examples of current
liabilities of the business because business is expected to pay these back within one
accounting period.
Current Portion of Long Term Liabilities
Long term loans are usually payable in installments. Therefore, at the end of every year,
some portion of the loan becomes payable within one year of the balance sheet date. The
portion that becomes payable within the next accounting period is transferred to current
liabilities and classified under current portion of long term liabilities.
Format of current liabilities shown in the balance sheet is as follows:
Current Liabilities
Trade Creditors
Short Term Borrowings
Other Short Term Liabilities
•
•
•
•
Salaries Payable
Accrued Expenses
Bills payable
Advances from Customers
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