Meaning and Components

Financial Statements are popularly known as Final Accounts. Trial Balance is generally prepared at the end of every month and at the end of the accounting year to know the balances of all the accounts & to test the arithmetic accuracy of accounts.

The basic objective of accounting is to know about the profit or loss during the previous year & present financial position at the end of the accounting year. This can be known only if Trading account and Profit & Loss account and Balance Sheet are prepared at the end of year. These are also known as FINANCIAL STATEMENTS.

It is only from Trial Balance that the Final Accounts i.e.

1) Trading and Profit & Loss account and

2) Balance Sheet

can be prepared.

As these two statements are prepared to give the final results of the business, both of these are collectively called as final accounts. Accounting cycle finally ends with these statements.

Trading account is prepared by trading concerns i.e., concerns which purchase and sell finished goods, to know the gross profit or gross loss incurred by them from buying and selling of goods during a particular period of time. Gross profit or gross loss is the difference between the cost of goods sold and the proceeds of their sale. If the sale proceeds exceed the cost of goods sold, gross profit is made and vice-versa in case of gross loss.

For non-corporate business organization Profit & Loss account is second part of income statement. It is prepared to know the net profit or net loss of business during a particular period. Every businessman has to spend on expenses other than on manufacture or purchase of goods which are called indirect expenses. There can be other incomes except sales. So, gross profit or loss is adjusted keeping in view these indirect expenses and other incomes to find out net profit or net loss.

Balance Sheet is a component of financial statements which shows balances of capital, liabilities & assets. All nominal accounts are closed by transferring these to Trading & Profit & Loss Account. Only personal & real accounts are left to be entered in Balance sheet.

Balance Sheet is the final step in accounting cycle. It shows the true position of the business in terms of assets, liabilities and capital on a particular date.

Precautions while preparing Financial Statements:

• All items given in the Trial balance will move to one place only, out of Trading / Profit and Loss Account and Balance Sheet.
• If the item moves to the Trading and Profit and Loss Account, it moves to the same side.
• If it moves to the Balance Sheet, it moves to the opposite side.
• All adjustments given outside the Trial Balance will be taken to two of these three places.
• Write down TD, TC; PD; PC; BL and BA in the Trial Balance items, to simplify the transfer process. (TD means Trading A/c Debit side; TC means Trading A/c Credit side, PD means P&L A/c Debit side, PC means P&L A/c Credit side, BL means Balance Sheet Liabilities side, BA means Balance Sheet Assets side.)
• Heading for the Trading and Profit and Loss Account is …for the year ended / ending but for the Balance Sheet, write … as at ….

Accounting Synonyms

Where to Transfer These Items in Final Accounts?

Do this activity.

Test Your Understanding

Final Accounts Formats

Final Accounts with Adjustments 1

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Trading Account:

This account is used to determine the gross profit or loss of a business over a specific period of time. It includes the direct costs associated with producing goods or services, such as raw materials, labor, and manufacturing expenses.

The formula is: Gross Profit/Loss = Sales - (Opening Stock + Purchases + Direct Expenses - Closing Stock)

      Dr.                                                        Trading Account                                                       Cr.  

Profit and Loss Account:

This account is used to determine the net profit or loss of a business over a specific period of time. It includes all indirect expenses and incomes. The net profit or loss is calculated by deducting the total expenses from the total revenues. The formula is:

Net Profit/Loss = Gross Profit - Operating Expenses + Other Revenues

       Dr.                                         Profit and Loss Account                                                          Cr.

Final Accounts Formats

Balance Sheet:

This is a financial statement that provides a snapshot of a company's financial position at a specific point in time. It includes assets, liabilities, and shareholders' equity. The balance sheet follows the accounting equation:

Assets = Liabilities + Shareholders' Equity

                                                            Balance Sheet

Identify Capital and Revenue Items

Activity 2

Final Accounts with Adjustments 1

Final Accounts with Adjustments 2

Final Accounts with Adjustments 3

Final Accounts with Adjustments 4

Final Accounts with Adjustments 5

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Any information given outside the Trial Balance is called adjustment or additional information. It is important to note that every item appearing outside the trial balance should be treated at two places out of the three: Trading Account, Profit and Loss account and Balance Sheet.

1. CLOSING STOCK

Meaning:   Closing stock means the unsold goods lying in store at the end of accounting year.

Treatment:

Closing Stock a/c          Dr.

        To Trading a/c

Two-fold effect of this adjustment will be:

1. Show on Credit side of the Trading account.

2. Shown on the asset side of Balance Sheet.

2. OUTSTANDING EXPENSES

Meaning: Outstanding expenses are the expenses which have been incurred & but not yet paid.

Treatment: 

Expenses a/c             Dr.

       To outstanding expenses

Two-fold effect:

1. Shown on debit side of trading or profit & loss a/c (as the case may be, depending on the type of expense), by way of addition to particular expense.

2. Shown on liabilities side of Balance Sheet.

3. PREPAID EXPENSES

Meaning: Those expenses which have been paid in advance i.e., whose benefit will be available in future is called prepaid expenses.

Treatment:

Prepaid Expenses a/c    Dr.

         To Expenses a/c

Two-fold effect:

1. Shown in trading account or Profit & Loss a/c by way deduction from particular expense.

2. Shown on asset side of Balance Sheet.

4. ACCRUED INCOME

Meaning: That income which has been earned but not received during the accounting year is called accrued income.

Treatment:

Accrued Income a/c       Dr.

         To Income a/c

Two-fold effect:

1. Shown on credit side of P & L a/c.

2. Shown on asset side of Balance Sheet.

Final Accounts with Adjustments 1

5. INCOME RECEIVED IN ADVANCE

Meaning: Income received but not earned during accounting year is called income received in advance.

Treatment:

Income a/c                 Dr.

          To Income Received in advance

Two-fold effect:

1. Shown on credit side of P & L a/c by the way of deduction from particular income.

2. Shown on liabilities side of Balance Sheet.

6. DEPRECIATION

Meaning: Depreciation is the reduction in the value of fixed asset due to its use, wear & tear.

Treatment:

Depreciation a/c            Dr.

        To Asset a/c

Two-fold effect:

1. Shown on debit side of P & L a/c.

2. Shown on the Asset side of the Balance Sheet by way of deduction from value of concerned asset.

(Appreciation means increase in the value of an asset and the treatment is exactly opposite to that of Depreciation i.e. credited in the Profit and Loss account and added to asset in the balance sheet.)

Final Accounts with Adjustments 2

Final Accounts with Adjustments 3

Final Accounts with Adjustments 4

Final Accounts with Adjustments 5

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7. BAD DEBTS

Meaning: Out of total debts, Debts which are definitely irrecoverable are called Bad Debts.

Treatment:

Bad Debts A/c           Dr.

        To Sundry Debtors a/c

Two fold effect:

1. Shown on debit side of P & L a/c.

2. Shown on assets side of Balance Sheet by way of deduction from Sundry Debtors.

8. PROVISION FOR DOUBTFUL DEBTS

Meaning: It is a provision created to cover any possible loss on account of bad debts likely to occur in future.

Treatment:

Profit and Loss A/c         Dr.

        To Provision for Doubtful Debts A/c

Two fold effect:

1. On debit side of Profit and Loss A/c or by way of addition to Bad Debts. (Old provision for doubtful debts at the beginning of the year will be deducted).

2. Shown on assets side of Balance Sheet by way of deduction from Sundry Debtors (deducting further bad debts if any).

9. PROVISION FOR DISCOUNT ON DEBTORS

Meaning: If sales are made by the merchant on condition that if the amount of sales is paid within a certain period, he will allow a certain percentage of discount.

Treatment:

Profit and Loss A/c              Dr.

        To Provision for Discount on Debtors A/c

Two-fold effect:

1. Shown on debit side of Profit and Loss A/c

2. Shown by way of deduction from Sundry Debtors (after deduction of further bad debts and provision for doubtful debts) on assets side of Balance Sheet.

10. RESERVE FOR DISCOUNT ON CREDITORS

Meaning: Firm may have chance to receive discount on last date of accounting year, if the payment is made within the scheduled period .These are anticipated profit and therefore this account is made.

Treatment:

Reserve for Discount on Creditors A/c           Dr.

        To Profit & Loss A/c

Two fold effect:

1. Shown on the credit side of Profit &Loss A/c.

2. Shown on liabilities side of Balance Sheet by way of deduction from sundry creditors.

Final Accounts with Adjustments 2

All the above cases can be easily understood from the following:

Final Accounts of Sole Proprietor

Final Accounts Formats

Final Accounts with Adjustments 1

Final Accounts with Adjustments 3

Final Accounts with Adjustments 4

Final Accounts with Adjustments 5

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11. INTEREST ON CAPITAL

Meaning: To see whether the business is really earning profit or not, interest on capital at a certain rate is provided. However, some experts are against the recording of interest on capital.

Treatment:

Interest on capital A/c                Dr.

         To Capital A/c

Two-fold effect:

1. Shown on debit side of Profit and Loss A/c.

2. Shown on liabilities side of Balance Sheet by way of addition to the capital.

(Interest on loan has the similar treatment with the only difference that the amount paid appearing in the trial balance will be deducted to be shown in the balance sheet.)

Final Accounts with Adjustments 3

12. INTEREST ON DRAWINGS

Meaning: Interest on drawings is charged from proprietor, as drawings reduce capital. However some experts are against the recording of interest on drawings.

Treatment:

Drawings A/c                Dr.

          To Interest on Drawings A/c

Two-fold effect:

1. Shown on credit side of Profit and Loss Account.

2. On liabilities side of Balance Sheet by way of addition to the drawings which are ultimately deducted from the capital.

Final Accounts with Adjustments 3

13. DEFERRED REVENUE EXPENDITURE

The expenditure done in initial stage but the benefit of which will also be available in subsequent years is called deferred revenue expenditure.

Treatment:

Profit &loss A/c            Dr.

          To advertisement A/c

Two-fold effect:

1. Shown on the debit side of Profit &loss A/c

2. Shown on assets side by way of deduction from capitalised expenditure.

Final Accounts with Adjustments 3

14. LOSS OF STOCK BY FIRE

There can be three cases:

1. All the stock is fully insured.

2. The stock is partly insured.

3. The stock is not insured at all.

1. If the stock is fully insured:

The whole loss will be claimed from the insurance company.

Treatment:

Insurance Co. A/c              Dr.

        To Trading A/c

Two fold effect:-

1. Shown on credit side of Trading A/c.

2. Shown on Assets Side of Balance Sheet.

2. If the stock is partially insured:

The loss of stock covered by insurance policy will be claimed from the insurance company and the rest of amount will be loss for the business.

Treatment:

Insurance Co. A/c           Dr.

Profit & Loss A/c            Dr.

          To Trading A/c

Two fold effect:-

1. Shown on credit side of Trading A/c with the value of stock & shown on debit side of P& L A/c for that part of the stock which is not insured.

2. Loss of stock Fire is shown on asset side of the Balance sheet which amount is to be realized from the insurance company.

3. If the stock is not insured:

Whole loss will be borne by the firm.

Treatment:

Profit & Loss A/c            Dr.

          To Trading A/c

Two fold effect:-

1. Shown on the credit side of Trading A/c.

2. Shown on the debit side of P&L A/c.

Final Accounts of Sole Proprietor

Final Accounts Formats

Final Accounts with Adjustments 1

Final Accounts with Adjustments 2

Final Accounts with Adjustments 4

Final Accounts with Adjustments 5

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15. RESERVE FUND

Reserve is created out of profit & Loss A/c and thus is an appropriation of net profit for strengthening the financial position of the business.

Treatment:

Profit & Loss A/c            Dr.

           To Reserve Fund A/c

Two-fold effect:

1. Shown on debit side of P&L A/c.

2. Shown on the liabilities side of Balance Sheet.

Final Accounts with Adjustments 4

16. GOODS DISTRIBUTED AS FREE SAMPLES/ CHARITY

To promote the sale of goods, some of the produced goods are distributed as free samples.

Treatment:

Advertisement (charity) A/c            Dr.

           To Purchase A/c

Two-fold effect:

1. Deducted from purchases.

2. Shown on debit side of P&L A/c.

17. GOODS TAKEN BY PROPRIETOR FOR PERSONAL USE

Goods taken by the proprietor for his personal use will be considered as drawings.

Treatment:

Drawings A/c             Dr.

           To Purchases A/c

Two-fold effect:

1. Deducted from purchases.

2. Deducted from Drawings.

Final Accounts with Adjustments 4

18. MANAGER'S COMMISSION

To increase the profit, manager is given some percentage of commission on profits. can be given at a certain percentage on the net profits before charging such commission or after charging such commission.

Treatment:

Profit & Loss A/c         Dr.

         To Commission Payable

Two-fold effect:

1. Shown on debit side of P&L A/c.

2. Shown on the liabilities side of Balance Sheet.

Calculation:

1. Before charging such commission:

Commission= Net Profit *(rate/100)

2. After charging such commission:

Commission= Net Profit *(rate/100+rate)

Final Accounts with Adjustments 4

19. GOODS ON SALE OR APPROVAL BASIS

Sometimes goods are sold to customers on approval basis. If they approve, it will become sale. If such goods are lying with customers on last day of the accounting year and these can be returned, it should be treated as stock lying with customers.

Treatment:

1. Sales A/c          Dr.

            To debtor's A/c (with sales price)

2. Stock A/c         Dr.

             To trading A/c (at cost Price of goods)

Two-fold effect:

1. Credit side of trading account: (1) Sales minus stock at sales price (2) Closing stock plus stock at cost price.

2. Shown on assets side: (1) deduction from sundry debtors at sale price (2) add stock at cost to stock on the assets side of balance sheet.

Final Accounts of Sole Proprietor

Final Accounts Formats

Final Accounts with Adjustments 1

Final Accounts with Adjustments 2

Final Accounts with Adjustments 3

Final Accounts with Adjustments 5

Learning Games and Activities in Accountancy – Class 11

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(20) GOODS PURCHASED BUT IN TRANSIT

Sometimes the goods are purchased but in transit, such goods should be considered as Goods-in-transit and added to creditors in the balance sheet also.

Treatment:

Goods-in-transit A/c                Dr.

           To Creditors A/c

Two fold effect:

(1) Shown as Goods-in-transit on the asset side, in the Balance sheet.

(2) Shown on liabilities side of the Balance Sheet by adding to the Creditors.

Final Accounts with Adjustments 5

Special Notes for preparing Final Accounts

(1) Contingent liabilities are not to be taken in final accounts but shown as a footnote below the balance sheet.

(2) Apprenticeship premium if any should be considered as an income and credited to profit and Loss account.

(3) Goods sold but not recorded, should be added to sales and to debtors.

(4) Goods purchased but not recorded should be added to purchases and to creditors.

(5) Income Tax and LIC premium should be considered as drawings.

Distinction between Capital and Revenue ITEMS

Items that have important implications for preparing Final Accounts:

The revenue items form part of the trading and profit and loss account.

the capital items help in the preparation of a balance sheet.

If the benefit of expenditure extends up to one accounting period, it is termed as Revenue expenditure.

If the benefit of expenditure extends to more than one accounting period, it is termed Capital expenditure.

Distinction between Capital Expenditure and Revenue Expenditure:

(a) Capital expenditure increases earning capacity of business whereas

Revenue expenditure is incurred to maintain the earning capacity.

(b) Capital expenditure is incurred to acquire fixed assets for operation of business whereas

Revenue expenditure is incurred on day-to-day conduct of business.

(c) Capital expenditure is non-recurring by nature whereas

Revenue expenditure is generally recurring expenditure.

(d) Capital expenditure benefits more than one accounting year whereas

Revenue expenditure normally benefits one accounting year.

(e) Capital expenditure (subject to depreciation) is recorded in balance sheet whereas

Revenue expenditure (subject to adjustment for outstanding and prepaid amount) is transferred to trading and profit and loss account.

Final Accounts of Sole Proprietor

Final Accounts Formats

Final Accounts with Adjustments 1

Final Accounts with Adjustments 2

Final Accounts with Adjustments 3

Final Accounts with Adjustments 4

Check Your Understanding 

Identify Capital and Revenue Expenditure

Single Entry System

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