Accounting is used by business firms for keeping records of their money invested for financial transaction by which they can know the profit or loss incurred, the position of the assets and liabilities of the firm as well as the comparatively with those of others . The transactions of any business for an accounting period are recorded through these accounting cycles:
Journal - it's a prime entry book where transaction is recorded in a chronological order before posting into further books like ledger. The process is kept in columnar basis of date, particulars, ledger folio, debit amount, credit amount.
Ledger -a set of accounts where similar transactions relating to a particular person or property or revenue or expense are recorded. It helps the firm at the end of the accounting period each account will contain the entire information of all the transaction relating to the summarized form. It helps in finding out the combined effect of entries for each individual account and entire business.
Ledger posting- secondary entry after journal, the term positing means transferring the debit and credit items from the journal to their respective accounts in the ledger.
Trial balance- it's a statement that show the debit and credit balances after its posting in ledger. It proves the mathematical accuracy, both debit and credit entries are posted in a correct manner.
In addition to these recording processes done throughout the year the firm needs a summarized statement at the end of the accounting period through which it can communicate to the internal and external users. It's the last stage of accounting process with a view to determine -
The net profit from the trading activities in terms of profit made or loss incurred at a given period
Financial position in terms of assets and liabilities as on the last date.
Thus, financial statements are prepared.
Financial statements are prepared for the purpose of presenting a periodical review or report on progress made by the management and deal with the status of investment in the business and the result achieved during the period under review. It's prepared following the accounting concepts, principles and the legal environment in which the enterprise operates.
Characteristics and nature of financial statement
Records facts of business transaction - these are facts based on evidences of the accounting books. For e.g. fixed assets are shown at the cost irrespective of their market or replacement price since such price is not recorded in the books.
Financial character of data- The statements expressed in financial or monetary nature are only considered.
Accounting conventions - these are adopted to facilitate accounting techniques. For e.g. the conventions of materiality is followed in dealing with small items like pen, pencils, postage stamps. These items are considered as expenditure in the year in which they are purchased even though they are assets in nature. The use of accounting conventions makes financial statements simpler, comparable and realistic.
Accounting concepts- as we prepare these statements we assume or prerequisites such as going concern, money measurement concepts or the realization concept etc. The realisation concept require that revenue is earned in the year in which the sales was undertaken even though sale price may be received in a number of year.
Personal judgment- these are used in the application of conventions and postulates. For e.g. selection of inventory valuation method also depends on the personal judgment of the accountant.
Historical documents- these statements relate to the past period and thus are historical in nature.
Objectives of financial statement
To provide financial data on economic resources and obligations of an enterprise.
To reveal implication of operating profits on the financial position of an enterprise.
To provide sufficient and reliable data to various parties interested in financial statements.
To serve the future as a basis of operation.
To present a true and fair view of business.
Internal and external users of financial statements
Investors and potential investors- shareholders are generally not involved in day to day business operations; they come to know about the operations and financial position of the company through financial statements only. Potential investors make use of these statements to ascertain earnings, safety of investments and growth prospects.
Customers- an enterprise may be the supplier of raw materials and in case it appears that the enterprise may not continue for a long time, the customer has to develop an alternate solution.
Creditors and lenders- such as debenture holders, suppliers of loan and leases in ascertaining the long and short term solvency of the business and like to know about the capability of the business to repay the debt and interest.
Stock exchange- financial statements provide information about the performance and financial health of the company thus helps the stock exchange members know about the company.
Employee and trade union- they use to ascertain the amount ascertain the bonus payable, negotiating the wages and salary. Also to know whether the due like PF,ESI are deposited with authorities.
Government and agencies- these are used by the government to formulate policies to regulate the activities of business, taxation policies besides compilation of national accounts. Taxation authorities such a IT, sales dept. etc., for their required functioning and also for compilation of national income statistics.
Following three accounts are prepared
Trading or manufacturing account- it ascertains the gross profit and gross loss for an accounting period. The basic contains on debit side
Purchases and purchases return
Direct expense ……. ……….Gross profit
And on the credit side are-
Sales and sales return
Closing stock………………… gross loss
Profit and loss account
Shows all the gains and losses are collected in order to ascertain the excess of gains over the losses and vice versa. Expenses and losses shown on debit side include-
Selling and distribution expenses
Administrative and office management expenses
Profits shown on credit side are:
Income from main business
Financial and other incidental income
If the credit side is more than the debit side it shows net profit and if debt side.
It shows the financial position i.e. the balances of assets liabilities and capital of a business entity for a given date. It's prepared from the trial balance after all nominal accounts and accounts relating to goods have been closed by transferring to trading and profit and loss account. The basic objective:
It shows the nature and value of assets, liabilities and position of capital.
Never prepared for a particular period but only on a certain date.
Generally prepared for the external users such as creditors, government authorities and shareholders.
Following is the solution to the question:
To opn stock
By closing stock
-purch of fur 950
To gross profit
Profit and loss account
To free samples
By gross profit
By disct received
By provn for debts
To carriage outward
To net profit
Balance sheet for the year ended 30December, 2001
- dep 7,800