Prepare trading and profit and loss account for the year ended 30 september 2001 and a balance sheet on that date after taking into account the following adjustments:
- Closing stock was valued at Rs, 34,220.
- Provision for doubtful debts is to be kept at Rs. 500.
- Depreciate plant and machinery @ 10% p.a.
- The proprietor has taken goods worth Rs. 5,000 for personal use and additionally distributed goods worth Rs. 1,000 as samples.
- Purchase of furniture Rs. 920 has been passed through purchases book.
Answer: MEANING OF FINAL ACCOUNTS
The final phase of the accounting process involves the preparation of final accounts from a trial balance with a view to ascertain:
- Net profit or net loss for a given period
- The financial position of the business enterprise on the last date of that given period.
The term final accounts are used to include a package of accounts such as:
- Trading account
- Profit and loss account
- A balance sheet.
Although balance sheet is not an account but only a statement, it is treated as a part of final accounts for all practical purposes.
TRADING ACCOUNT
Trading account gives the overall result of trading, i.e., purchasing and selling of goods. In other words, it explains whether purchasing of goods and selling them has proved to be profitable for the business or not. It takes in to account, on the one hand, the cost of goods sold and on the other the value for which they have been sold away. In case the sales value is higher than the cost of goods sold, there will be a profit, while in a reverse case, there will be a loss. The profit disclosed by the Trading Account is termed as GROSS PROFIT. The loss disclosed by the Trading Account is termed as GROSS LOSS.
IMPORTANCE OF THE TRADING ACCOUNT
Trading account provides the following information to a businessman regarding his business:
Gross profit disclosed by the trading account tells him the upper limit with in which he should keep the operating expenses of the business besides saving something for himself. The cost of purchasing and the price at which he can sell the goods are governed largely by market factors over which he has no control. He can control only his operating expenses.
He can calculate his gross profit ratio and compare his performance year after year. A fall in the gross profit ratio means increase in the cost of purchasing the goods or decrease in the selling price of the goods or both. In order to maintain at least same figure of gross profit in absolute terms, he will have to push up the or make all out efforts to obtain goods at cheaper prices. Thus, he can prevent at least fall in the figure of his gross profit if he cannot bring any increase in it.
Comparison of stock figures of one period from another will help in preventing unnecessary lock-up of funds in inventories.
In case of new products, the businessman can easily fix up the selling price of the products by adding to the cost of purchases, the percentage gross profit that he would like to maintain.
PROFIT AND LOSS ACCOUNT
The trading account simply tells about the gross profit or loss made by a businessman on purchasing and selling of goods. It does not take into account the other operating expenses incurred by him during the course of running the business. For example, he has to maintain an office for getting orders and executing them, taking policy decisions and implementing them. All such expenses are charged to the profit and loss account. Besides this, a businessman may have other sources of income. For example, he may receive rent from some of his business properties. He may have invested surplus funds of the business in some securities. He might be getting interest or dividends from such investments.
IMPORTANCE OF PROFIT AND LOSS ACCOUNT
The profit and loss account provides information regarding the following matters:
It provides information about the net profit or net loss earned or suffered by the business during a particular period. Thus, it is an index of the profitability or otherwise of the business.
The profit figure disclosed by the profit and loss account for a particular period can be compared with that of the other period. Thus, it helps in ascertaining whether the business being run efficiently or not.
An analysis of the various expenses included profit and loss account and their comparison with the expenses of the previous period or periods helps in taking steps for effective control of the various expenses.
Allocation of profit among the different periods or setting aside a part of the profit for future contingencies can be done. Moreover, on the basis of profit figures of the current and the previous period estimates about the profit in the year to come can be made.
BALANCE SHEET
Having prepared the trading and profit and loss account, a businessman will like to know the financial position of his business. For this purpose, he prepares a statement of his assets and liabilities as on a particular date. Such a statement is termed as "balance sheet". Thus, balance sheet is not an account but only a statement containing the assets and liabilities of a business on a particular date. It is as a matter of fact a classified summary of the various remaining accounts after accounts relating to incomes and expenses have been closed by transfer to trading and profit and loss account.
Balance sheet has two sides, on the left hand side; the "liabilities" of the business are shown while on the right hand side the assets of the business appear.
The Balance sheet is a statement at a given date showing on one side the trader's property and possessions and on the other side his liabilities.
How the balance sheet works
The balance sheet is divided into two parts that, based on the following equation, must equal (or balance out) each other. The main formula behind balance sheets is:
Assets = liabilities + shareholders' equity
This means that assets, or the means used to operate the company, are balanced by a company's financial obligations along with the equity investment brought into the company and its retained earnings.
Assets are what a company uses to operate its business, while its liabilities and equity are two sources that support these assets. Owners' equity, referred to as shareholders' equity in a publicly traded company, is the amount of money initially invested into the company plus any retained earnings, and it represents a source of funding for the business.
The types of assets
Current assets
Current assets have a life span of one year or less, meaning they can be converted easily into cash. Such assets classes are: cash and cash equivalents, accounts receivable and inventory. Cash, the most fundamental of current assets, also includes non-restricted bank accounts and checks.
Cash equivalents are very safe assets that can be are readily converted into cash such as US Treasuries. Accounts receivable consists of the short-term obligations owed to the company by its clients. Companies often sell products or services to customers on credit, which then are held in this account until they are paid off by the clients.
Lastly, inventory represents the raw materials, work-in-progress goods and the company's finished goods. Depending on the company, the exact makeup of the inventory account will differ. For example, a manufacturing firm will carry a large amount of raw materials, while a retail firm caries none. The makeup of a retailers inventory typically consists of goods purchased from manufacturers and wholesalers.
Non-current assets
Non-current assets are those assets that are not turned into cash easily, expected to be turned into cash within a year and/or have a life-span of over a year. They can refer to tangible assets such as machinery, computers, buildings and land.
Non-current assets also can be intangible assets, such as goodwill, patents or copyright. While these assets are not physical in nature, they are often the resources that can make or break a company - the value of a brand name, for instance, should not be underestimated.
Depreciation is calculated and deducted from most of these assets, which represents the economic cost of the asset over its useful life.
The different liabilities
On the other side of the balance sheet are the liabilities. These are the financial obligations a company owes to outside parties. Like assets, they can be both current and long-term. Long-term liabilities are debts and other non-debt financial obligations, which are due after a period of at least one year from the date of the balance sheet.
Current liabilities are the company's liabilities which will come due, or must be paid, within one year. This is comprised of both shorter term borrowings, such as accounts payables, along with the current portion of longer term borrowing, such as the latest interest payment on a 10-year loan.
Trading account
For the year ending 30.09.2011:
| PARTICULARS | AMOUNT(Rs) | PARTICULARS | AMOUNT(Rs) |
| Opening stock | 30000 | Sales | 1,27,000 |
| Wages | 10000 | Sales return | -1,000 |
| Purchases | 60,000 | 1,26,000 | |
| Purchases return | -750 | Closing stock | 34220 |
| Goods withdraw | -5,000 | Advertisement | -1,000 |
| Furniture | -920 | 52330 | |
| Gross Profit | 67890 | ||
| 1,60,220 | 1,60,220 |
Profit and loss account
| PARTICULAR | AMOUNT(Rs) | PARTICULAR | AMOUNT(Rs) |
| Discount | 425 | Discount | 800 |
| Salaries | 7550 | Provisional for doubtful debts | 25 |
| Carriage outward | 1200 | Gross profit | 67890 |
| Rent, rate and taxes | 10000 | Advertisement | 2000 |
| Depreciation | 7800 | Free samples | 1000 |
| Net profit | 38740 | ||
| 68715 | 68715 |
Balance sheet account
As on 30.09.2011
| PARTICULARS | AMOUNT(Rs) | PARTICULARS | AMOUNT(Rs) |
| Capital A/C | 1,00,000 | Furniture | 2,000 |
| Drawings | -5,000 | Furniture passed | +920 |
| 95000 | 2920 | ||
| Creditors | 25000 | Plant and machinery | 78,000 |
| Net profit | 38740 | Depreciation | -7800 |
| 70200 | |||
| Debtors | 45,000 | Cash | 6900 |
| Provision for doubtful debts | -500 | Closing stock | 34220 |
| 44500 | |||
| 158740 | 158740 |
Points regarding Trading Account AND PROFIT AND LOSS ACCOUNT
Opening stock: The term 'opening stock' means goods lying unsold with the businessman in the beginning of the accounting year. This is shown on the debit side of the Trading Account.
Closing stock: The term 'closing stock' includes goods lying unsold with the businessman at the end of the accounting year. The stock at the end of the accounting year is taken after the books of accounts have been closed. The amount of closing account is shown on the credit side of the trading account and as an asset in the balance sheet. The closing stock at the end of the accounting period will become the opening stock for the next year.
Purchases: The term "purchases'' includes both cash and credit purchases of goods. The term "goods" means items purchased for resale. Assets purchased for permanent use in the business such as purchase of plant, furniture, etc., are not included in the purchase of goods. Similarly, purchase of articles such as stationary meant for using in the business will also not be included in the item of purchases. In case, a proprietor has himself used certain goods for his personal purposes, the value of such goods at cost will be deducted from the purchases and included in the drawing of the proprietor. The amount of purchases will be the net purchases made by the proprietor.
Sales: The term "sales" includes both cash and credit sales. Gross sales will be shown in the inner column of the Trading Account out of which "sales return'' will be deducted. The net sales will then be shown in the outer column of the Trading Account.
Wages: The amount of wages is taken as direct expense and, therefore, is debited to the Trading Account. Difficulty arises in those cases when the trial balance includes a single amount for "wages and salaries". In such a case, the amount is taken to the trading account. However, if the trial balance shows "salaries and wages", the amount is taken to the profit and loss account. In actual practice such difficulties do not arise because the businessman knows for which purpose he has incurred the expenditure by way of wages or salaries.
Wages and Salaries: The item 'Wages' usually represents the remuneration paid to Workers who are directly engaged in the production of goods. It is; therefore, shown on the debit side of the Trading Account (or Manufacturing Account, if prepared) as it is a Direct expense. The item 'Salaries' usually represents the remuneration paid to Employees working in the office. It is an indirect expense and is, therefore, shown in the Profit and Loss Account. The difficulty arises when wages are clubbed with salaries and The Trial Balance includes a single amount for 'Wages and Salaries'. In such a situation The amount may be shown in the Trading Account. It is based on the assumption that the Item includes the salaries of the supervisory staff in the factory itself. But, if the item in The Trial Balance reads 'Salaries and Wages' it will be taken to the Profit and Loss Account on the assumption that the item includes wages of office staff such as Messengers, watchmen, etc. Wages paid to workers engaged for the construction of building or for Installation of machinery are a capital expenditure and should therefore be added to the Cost of the asset concerned. These are not to be shown in the Trading Account.
Carriage: Normally, carriage is the amount paid for bringing the goods purchased to the place of business. It is called Carriage Inwards and shown in the Trading Account. But, when it relates to the goods sold it is called Carriage Outwards. This is treated as a Distribution expense and charged to Profit and Loss Account. However, if it is not indicated whether the expenditure on carriage relates to purchases or sales, it is to be treated as carriage inwards and so charged to Trading Account.
Trade Expenses: This item represents various small and miscellaneous expenses incurred in the business. It is transferred to the debit side of Profit and Loss Account. They are also called Sundry Expenses or Miscellaneous Expenses.
Packing: The cost of packing materials such as polythene bags, wrapping materials, etc. used for packing the items for delivery is a distribution expense and hence charged to Profit and Loss Account. Where, however, packing is essential to make the products fit. For sale in the market as in the case of cigarettes, biscuits, medicines, oil etc., it is called 'packaging' and such expenditure is charged to the Trading Account.
Samples: Generally, samples of goods are distributed free of charge to increase sales. The cost of such samples should be treated as a selling expense and so debited to Profit and Loss Account.
Insurance: Generally, assets are insured to cover the risk of loss, say, by fire. Premium Paid to the insurance company should be treated as a business expense. When assets Such as factory building, factory machinery etc. are insured, the insurance premium Should be debited to Trading Account. If, on the other hand, the premium is paid for Insurance of assets in the office, such as office building, office furniture, etc., it should Be charged to Profit and Loss Account. Sometimes, it is not indicated whether the premium paid relates to factory assets, the same should be shown in the Profit and Loss Account.
Rent, Rates and Taxes: These are charges levied by the municipal bodies on the house Property. It is a common item of indirect expenses debited to the Profit and Loss Account.
Royalties: Royalties refer to the payments made for the use of a copyright or a patent. The amount of royalty is generally based on the quantity produced. It is, therefore, Treated as a direct expense and charged to Trading Account. But, if it is calculated on the basis of quantity sold as in the case of books, it is shown in the Profit and Loss Account. Royalties are also paid to the Government for extraction of minerals such as coal, diamonds, gold, etc. These are charged to the Profit and Loss Account of the mining companies.
Income Tax: It is the tax payable by a person on his income. In the case of a sole Trading concern, the tax paid by the proprietor on the profits of the business is treated as a personal expense. Hence, it should be added to drawings or directly deducted from capital.
Commission: commission may be both an item of income as well as an item of expense. Commission on business by agents is an item of expense while commission earned by the business for giving business to others is an item of income. Commission to agents, therefore, debited to the profit and loss account while commission received is credited to the Profit and Loss account.
DEPRECIATION: Depreciation denotes decrease in the value of an asset due to wear and tear, lapse of time obsolescence, exhaustion and accident. For example, a motor can purchased gets depreciated on account of its constant use.
IMPORTANT POINTS REGARDING BALANCE SHEET
LIABILITIES: The term "Liabilities" denotes claims against the assets of a firm whether those of owners of the business or of the creditors. As a matter of fact, the term "equity" is more appropriate than the term "liabilities".
Liabilities can be classified into two categories:
Current liabilities: the term "current liabilities" is used for such liabilities which are payable within a year from the date of the balance sheet either out of existing current assets or by creation of new current liabilities. The broad categories of current liabilities are as follows:
- Accounts payable
- Outstanding expenses
- Bank overdraft
- Short-term loans
- Advance payments.
Fixed liabilities: all liabilities other than current liabilities come within this category.
ASSETS: the term "assets" denotes the resources acquired by the business from the funds made available either by the owners of the business or others. It thus includes all rights or properties which a business owns. Cash, investments, bills receivable, debtors, stock of raw materials, work in progress and finished goods, land ,building, etc., are some examples.
Assets may be classified into the following categories:
Current assets: current assets are those assets which are acquired with the intention of converting them into cash during the normal business operations of the enterprise. it includes cash and bank balances, stocks of raw materials, work in progress, debtors bills receivable, short term investments, etc.
Liquid assets: liquid assets are those assets which are immediately convertible into cash without much loss. Liquid assets are a part of fixed assets.
Fixed assets: fixed assets are those assets which are acquired for relatively long periods for carrying on the business of the enterprise. They are not meant for resale. Land and building, machinery, furniture are some examples of it.
Intangible assets: these are those assets which cannot be seen and touched. Goodwill, patents, trademark, etc.
Fictitious assets: these assets are not represented by tangible possession or property.
