Professor Vipin 2014
Unit 8
Financial Statements
Meaning
Financial statements are the statements that are prepared at the end of the accounting period, which is
generally one year. These include income statement i.e. Trading and Profit & Loss Account and Position
statement i.e. Balance Sheet.
Uses
1. Ascertaining the results of business operations: Every businessman wants to know the results of
the business operations of his enterprise during a particular period in terms of profits earned or
losses incurred. Income statement serves this purpose.
2. Ascertaining the financial position: Financial statements show the financial position of the
business concern on a particular date which is generally the last date of the accounting period.
Position statement i.e. Balance Sheet is prepared for this purpose.
3. Source of information: Financial statements constitute an important source of information
regarding finance of a business unit which helps the finance manager to plan the financial
activities of the business and making proper utilization of the funds.
4. Helps in managerial decision making: The Manager can make comparative study of the
profitability of the concern by comparing the results of the current year with the results of the
previous years and make his/her managerial decisions accordingly.
5. An index of solvency of the concern: Financial statements also show the short term as well as
long term solvency of the concern. This helps the business enterprise in borrowing money from
bank and other financial institutions and/or buying goods on credit.
Revenue and Capital Items
The preparation of Trading Account and Profit and Loss Account requires the knowledge of revenue
expenditure, revenue receipts and capital expenditure and capital receipts. The knowledge shall
facilitate the classification of revenue items and put them in the
Trading account and Profit and Loss Account on one hand and prepare Balance Sheet based on capital
items (expenditure as well as receipts) on the other hand. Capital Expenditure refers to the expenditure
incurred for acquiring fixed assets or assets which increase the earning capacity of the business. The
benefits of capital expenditure to the firm extend to number of years. Examples of capital expenditure
are expenditure incurred for acquiring a fixed asset such as building, plant and machinery etc.
Revenue expenditure, on the other hand, is an expenditure incurred in the course of normal business
transactions of a concern and its benefits are availed of during the same accounting year. Salaries,
carriage etc. are examples of revenue expenditure.
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Difference Between Revenue and Capital Items
Basis
Purpose
Placement in financial
statements
Capital Expenditure
It is incurred for acquiring fixed
assets
Increases the earning capacity of
the business
Benefits spread over several
years
It is an item of balance sheet and
is shown as an asset
Occurrence of expenditure
Non recurring
Earning Capacity
Periodicity of benefit
Revenue expenditure
It is incurred for maintenance of
fixed asset
Helps maintain the earning
capacity of the business
Benefits accrue only in one year
Part of Trading and Profit & Loss
account and is shown on the
debit side of the two
Recurring expense
Preparation of Trading Account
Stock
Stock refers to the goods lying unsold on a particular date. It can be of two types:
a) Opening stock: Opening stock refers to the value of goods lying unsold at the beginning of the
accounting year. It is shown on the debit side of the Trading Account. In the first year of
business there is no opening stock
b) Closing stock: It is the value of goods lying unsold at the end of the accounting year. It is valued
at the cost price or market price whichever is less. It is shown on the credit side of the Trading
Account.
Purchases
Purchases mean total items purchased for resale during the year. It can be both in cash and on credit.
Purchases are shown on the debit side of the Trading account. These are always shown as net purchases
i.e. amount of purchases returned (Purchase returns or return outwards) is deducted from the total
amount of purchases made. Goods received on consignment basis are never treated as purchases.
Similarly, goods received on ‘sale or return’ basis are never treated as purchases.
Sales
Sales refer to the total revenue from sale of goods of the business enterprise for which the
Trading account is being prepared. It includes both cash sales and credit sales.
These are recorded on the credit side of the Trading Account. Sales are shown at their net value i.e.
sales return or returns inward is deducted from the total sales. Cash sales plus credit sales minus sales
returns constitute net sales. Goods sent on ‘sale or approval’ are not part of sales until approval is
received.
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Direct Expenses
Direct expenses are the expenses that can be attributed directly to the purchase of goods or goods
manufactured. These are shown on the debit side of the Trading Account. These are shown at the
amount as shown in the Trial balance. For example, wages are recorded on the debit side of Trading
Account at the amount shown in the Trial balance. Important items of direct expenses
a) Wages i.e. wages relate to production. If amount under this head includes wages paid for
construction of building or manufacturing of furniture for office it will be subtracted from the
amount of wages.
b) Carriage Cartage Freight i.e. amount paid for carriage of goods purchased for sale or raw
material purchased for manufacturing.
c) Other such direct expenses are customs and import duty, packing, materials, gas, electricity
water, fuel, oil, gas, grease, heating and lighting, factory rent and insurance and many more
such items.
Gross Profit/Gross Loss
It is the excess of net sales revenue over cost of goods sold. Gross Profit is equal to net sales minus cost
of goods sold. If total of the credit side exceeds the total of debit side, the excess amount is termed as
‘gross profit’ and is shown on the debit side of Trading Account. On the other hand if debit side is more
than the credit side, the difference in amount is called gross loss and is shown on the credit side of the
Trading Account.
Gross profit = Net sales – Cost of goods sold
Gross loss = Cost of goods sold – Net sales
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Trading Account
Particulars
Opening Stock
Purchases
(Less) Returns
Direct Expenses
Carriage Inward
Freight
Wages
Fuel and Power
Excise Duty
Factory Rent
Heating and Lighting
Insurance
Work Manager's Salary
Gross Profit transferred to P&L
A/c
Amount
Particulars
Sales
(Less) Returns
Amount
Closing Stock
Gross Loss transferred to P&L
A/C
Preparation of P&L Account
Gross Profit / Gross Loss
The value of gross profit or gross loss brought down from Trading A/C. There will be only value, either
gross loss or gross profit
Salaries / Salaries after Taxes / Salaries after Deductions
Salaries are the payable to employees. In some cases it is required to deduct taxes and other charges
such as provident fund deductions.
Interest
Interest on loans, either short or long term is an indirect expense and will be credited to the P&L
account in case the firm has given loans to third parties.
Commission
Commission is both an income and an expense. If the firm has given commissions to its employees its an
expense, however if the firm has received commission it becomes an income.
Trade Expenses
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These are small expenses and are debited to P&L account.
Printing and Stationery
This includes printing of bills, invoices, and other items of stationery. It is an indirect expense.
Advertisements
Advertisement expenses incurred for the purchasing of goods should be charged to the trading account,
while advertisement expenses incurred for the purchase of capital asset should be considered as a
capital expense and be charged to the concerned asset account.
Advertisement expense expenditure incurred for the sale of a capital asset must be deducted out of the
sale proceeds of the asset concerned.
Bad Debts
It is a loss due to debtors whom the goods were sold on credit. It is a loss and hence must be debited to
the P&L account.
Depreciation
It is an expense which denotes the value of an asset due to wear and tear, lapse of time and
obsolescence.
Profit and Loss Account
Particulars
To Gross Loss b/d
To Admin Expenses
Salaries
Rent
Taxes
Printing and stationery
Postage and Telegram
Telephone Expenses
Legal Charges
Insurance
Audit Fees
Directors Fees
General Expenses
To Selling and Distribution Expenses
Showroom Expenses
Advertising
Commission Paid
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Rs
Particulars
By Gross Profit b/d
By Dividends Received
By Interest Received
By Discount Received
By Commission Received
By Rent Received
By Profit on Sale of Assets
By Sundry revenue receipts
By Net Loss Transferred to capital A/C (Bal fig)
Rs
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Bad Debts
Provision for Doubtful Debts
Godown Rent
Carriage Outward
Upkeep of Delivery Vans
To Depreciation and Maintenance
Depreciation
Repairs
To Financial Expenses
Interest on Borrowings
Discount Allowed
To Abnormal Losses
Loss on Sale of Assets
To Net Profit Transferred to Capital A/C
Adjustment Entries
Adjustment
Journal Entry
Closing Stock A/C
to Trading A/C
Closing Stock
Outstanding Expenses
Expenses A/C
To Outstanding Expenses
A/C
Prepaid Expenses A/C
To Expenses A/C
Treatment in Trading
and P&L A/C
Credit Side of Trading
A/C
Added to respective
expenses on debit
side
Treatment in Bal
Sheet
Assets Side
Liabilities Side
Deducted from
respective expenses
on debit side
Assets Side
Income earned but
not received
Accrued Income A/C
To Income A/C
Added to respective
income on credit side
Assets Side
Income received in
advance
Income A/C
To Income Received in
Advance A/C
Dedicted from
respective income on
the credit side
Liabilities Side
Prepaid / Unexpired
Expenses
Depreciation A/C
To Assets A/C
Debit Side of P&L
Deducted from the
value of asset on
assets side
Appreciation
Assets A/C
To Appreciation A/C
Credit side of P&L
Added to the value of
asset on assets side
Further bad debts
Bad Debts A/C
To Sundry Debtors A/C
Debit Side of P&L
Deducted from
debtors on assets side
Depreciation
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Provision for doubtful
debts
P&L A/C
To Provision for Doubtful
Debts A/C
Provision for discount
on debtors
P&L A/C
To Provision for discount
on Debtors a/c
Provision for discount
on creditors
Provision for discount on
Creditors A/C
To P&L A/C
Debit Side of P&L
Shown as deduction
from debtors on asset
side
Debit Side of P&L
Shown as deduction
from debtors on asset
side
Credit side of P&L
Shown as deduction
from creditors on
liabilites side
Example 1
From the following trial balance of Vijay, prepare the trading & profit and loss account for the year
ending 30-12-11 and balance sheet as on that date.
Name of the Account
Vijay Capital
Vijay Drawings
Purchases and Sales
Stock (1/11/11)
Returns Inwards
Returns Outward
Wages
Salaries
Rent and Insurance
General Expenses
Debtors
Creditors
Bills Receivable
Bills Payable
Provision for Doubtful Debts
Provision for Discount on Debtors
Bad Debts
Discount Allowed
Plant and Machinery
Furniture and Fixtures
Cash and Bank Balance
Debit
Credit
40000
10000
74000 112500
18000
2500
1500
6000
5500
1400
4600
20000
27000
8000
12000
2400
900
1200
320
30000
5000
9780
Adjustments:
1. Wages and Salaries unpaid Rs. 500 each
2. Insurance prepaid Rs. 200
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3. General expenses include prepaid amount of Rs. 400
4. A provision for doubtful debts is to be maintained at 5% on debtor and provision for discount on
debtor at 2%
5. Depreciation at 5% on Machinery and 10% on furniture.
6. Stock on 31/12/11 was Rs. 15000
Solution 1
Particulars
To Opening Stock
To Purchase Returns
Less: Returns
To Wages
Add: Outstanding
To P&L A/C (Gross Profit
c/d)
Amount Amount
18000 By Sales
74000
Less: Returns
1500
72500 By Closing Stock
6000
500
6500
28000
125000
To Salaries
5500
Add: Outstanding
TO Rent & Insurance
Less: Prepaid
To General Expenses
500
1400
200
4600
Less: Prepaid
To Depreciation
Add: Machinery
Add: Furniture
To Net Profit
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Amount Amount
112500
2500 110000
15000
400
1500
500
By Gross Profit b/d
By Prov for Doubtful Debts (old
6000 Prov)
Less: Bad Debts
1200
Less: New Prov
By Prov for discount on debtors (old
4200 prov)
Less: Discount
2000 Less: New Prov
15000
28400
125000
28000
2400
1200
1200
1000
200
900
320
580
380
200
28400
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Balance Sheet as on 31/12/11
Liabilities
Capital
Add: Net Profit
Less: Drawings
Sundry Creditors
Bills Payable
Outstanding
Expens
Wages
Salaries
Amount Amount
40000
15000
55000
10000
45000
27000
12000
500
500
Assets
Plant and Machinery
Less: Depreciation
Furniture and Fixture
Less: Depreciation
Closing Stock
Sundry Debtors
Less: Prov for Doubtful
debts
1000 Less: Prov for discount
Bills Receivable
Prepaid Insurance
Prepaid Expenses
Cash and Bank Balances
85000
Amount Amount
30000
1500
28500
5000
500
4500
15000
20000
1000
19000
380
18620
8000
200
400
9780
85000
Example 2
The following is the trial balance of Shri Om as on 31/03/99. You are requested to prepare Trading &
Profit and Loss A/c for the year 31/03/99 and Balance Sheet as on the date after making necessary
adjustments
Particulars
Sundry Debtors
Sundry Creditors
Outstanding Liability for Expenses
Wages
Carriage Outwards
Carriage Inwards
General Expenses
Cash Discount
Bad Debts
Motor Car
Printing and Stationery
Furniture
Advertisements
Insurance
Salesman Commission
Postage and Telephone
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Debit
Credit
500000
200000
55000
100000
110000
50000
70000
20000
10000
240000
15000
110000
85000
45000
87500
57500
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Salaries
Rates and Taxes
Drawings
Capital Account
Purchases
Sales
Stock on 1/4/90
Cash at Bank
Cash at Hand
160000
25000
20000
1443000
1550000
1987500
250000
60000
10500
3630500
3630500
The following adjustments are to be made:
1. Stock 31/03/99 was valued at Rs. 725000
2. A provision for bad and doubtful debts is to be created to the extent of 5% on Sundry Debtors
3. Depreciate:
a) Furniture – 10%
b) Motor Car – 20%
4. Shri Om had withdrawn goods worth Rs. 25000 during the year
5. Sales made include Rs. 75000 sent to Shanti & Co on approval and remaining unsold as on
31/03/99. The cost of goods was Rs. 50000
6. Salesman is entitled to a commission of 5% on total sales.
7. Debtors include Rs. 25000 bad debts
8. Printing and stationery expenses of Rs. 55000 relating to 1997-98 had not been provided in that
year but was paid in this year by debiting outstanding liabilities.
9. Purchases include purchase of furniture worth Rs. 50000
Shri Om
Trading & Profit and Loss A/C as on 31/09/99
Particulars
To Opening Stock
To Purchases
Less: Drawings
Less: Furniture
To Wages
To Carriage Inwards
To Gross Profit
To Salaries
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Amount
Amount Particulars
250000 By Sales
Less: Goods Sent on
1550000
Approval
25000
By Closing Stock
50000 1475000 Add: Stock at Approval
100000
50000
812500
2687500
160000 To Gross Profit
Amount Amount
1987500
75000
725000
50000
1912500
775000
2687500
812500
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To Rates and taxes
To Postage and Telephone
To Insurance
To Printing and Stationery
To General Expenses
To Depreciation
Furniture
Motor Car
To Sales Commission (5%)
To Advertisement
To Carriage Outwards
To Bad Debts
Add: Addl Bad Debts
Add: Prov for Bad Debts
(5%)
To Cash Discount
To Net Profit
25000
57500
45000
15000
70000
16000
48000
64000
95625
85000
110000
10000
25000
20000
55000
20000
10375
812500
812500
Shri Om
Balance Sheet as on 31/09/99
Liabilities
Capital
Add: Net Profit
Less: Drawings
(20000+25000)
Less: Printing and Stationery
Sundry Creditors
Salesman's Commission
Outstanding
(95625-87530)
Amount Amount
144300
10375
1453375
Assets
Furniture
Add: Additions during the yr
45000
Less: Depreciation
55000 1353375 Motor Car
200000 Less: Depreciation
8125 Closing Stock (725000+50000)
Sundry Debtors
Less: Goods sent on approval
Less: Addl Bad Debts
Less: Prov for doubtful debts
(5% of 400000)
Cash at Bank
Cash at Hand
1561500
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Amount Amount
110000
50000
160000
16000
240000
48000
144000
192000
775000
500000
75000
400000
20000
380000
60000
10500
1561500
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Working Note:
1. Both sales and sundry debtors have been reduced by Rs. 75000 representing invoice value of
goods sent on approval. Rs. 50000 have been added to the closing stock being the cost of goods
sent on approval.
2. Last year’s short provision for printing and stationery has not been charged to the current year’s
profit and loss A/C. It is preferable to charge it directly to the capital account.
3. Sundry Debtors = Rs. 500000 [Rs. 75000 (goods on approval) + Rs. 25000 (Bad debts)] = Rs.
400000
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