FINANCIAL STATEMENTS 1

SEEMA SAXENA

PGT COM

JNV SIRSA

• “Financial statements are reports that show how income and expenses have affected the company as a whole. They provide a snapshot of the current financial standing of the business.”

Objectives/Need/Importance of Financial Statements

• To determine true and fair view of financial performance by reflecting profit or loss.
• To determine true and fair view of financial position by reflecting accurate values of assets and liabilities.
• To determine efficiency in conducting business operations through comparison with previous years.
• To determine the ability of a business to generate cash, and the sources and uses of that cash.
• To determine how expenses can be controlled and sources of income can be enhanced.
• To determine whether a business has the capability to pay back its debts.
• To derive accounting ratios from the financial statements that are helpful in financial analysis and can indicate the condition of the business.
• To investigate the details of certain business transactions, as outlined in the disclosures that accompany the financial statements.

Important Terms

• Capital Expenditure
• Revenue Expenditure
• Deferred Revenue Expenditure
• Capital Receipts
• Revenue Receipts

REVENUE / CAPITAL EXPENDITURE

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(i) Expenditure incurred on repairs and whitewashing at the time of purchase of an old building in order to make it usable.

(ii) Expenditure incurred to provide one more exit in a cinema hall in compliance with a government order.

(iii) Registration fees paid at the time of purchase of a building.

(iv) Expenditure incurred for the maintenance of a tea garden which will produce tea after four years.

(v) Depreciation charged on a plant.

(vi) The expenditure incurred in erecting a platform on which a machine will be fixed.

(vii) Advertisement expenditure, the benefits of which will last for four years.

(viii) Legal expenses incurred for acquiring a plot of land to set-up a factory building.

Solution

(i) Capital expenditure

(ii) Revenue expenditure

(iii) Capital expenditure

(iv) Capital expenditure

(v) Revenue expenditure

(vi) Capital expenditure

(vii) Deferred revenue expenditure

(viii) Capital Expenditure

Parts of Financial Statements

Final Accounts

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Trading and Balance Sheet

Profit and Loss Account

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TRADING ACCOUNT

• Trading means buying and selling. The trading account shows the result of buying and selling

of goods, i.e., it shows the gross profit earned or the gross loss incurred through purchases and sales of the goods.

• Gross Profit = Sales – Cost of Goods Sold
• Gross Loss = Cost of Goods sold – Sales

Features of Trading Account

1. It serves as the first step in preparation of financial statements.

2. It exhibits value of direct sales and direct cost of goods sold.

3. It ascertains gross profit or gross loss.

4. It provides the opening balance for profit and loss account, i.e., the balance of this account

gets transferred to profit and loss account.

Purpose or Need or Importance of Trading Account

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• To determine the gross profit and gross loss of the business which is the difference between net sales and cost of goods sold
• To provide information about the direct expenses that are incurred on the purchase and manufacturing of goods
• To compare closing stock with previous years’ closing stock and draw out various analysis, especially if it exhibits an increasing trend
• To study ratio of gross profit and if it shows a decreasing trend, then take steps to safeguard against it.

Closing Entries in the Trading Account

(a) Transfer of Opening Stock to Trading A/c

Trading A/c Dr.

To Opening Stock A/c

(Being transfer of opening stock)

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(b) Transfer of Closing Stock to Trading A/c

Stock (Closing) A/c Dr.

To Trading A/c

(Being transfer of closing stock)

(c) Transfer of Purchases and Direct Expenses

Trading A/c Dr.

To Purchases A/c

To Freight and Carriage A/c

To Wages A/c

To Manufacturing Expenses A/c

To Coal, Gas and Power A/c

(Being transfer of purchases and other direct expenses)

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(d) Transfer of Sales to Trading A/c�

Sales A/c Dr.

To Trading A/c

(Being transfer of sales)

(e) For transferring gross profit to Profit and Loss Account:�

Trading A/c Dr.

To Profit and Loss A/c (Profit)

(Being transfer of gross profit to profit and loss account)

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�For transferring gross loss to Profit and Loss Account:�

Profit and Loss A/c (Loss) Dr.

To Trading A/c

(Being transfer of gross loss to profit and loss account)

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Prepare a Trading Account for the year ended 31st March,2020:�

1st April, 2019 Opening Stock Rs.15,000

31st March, 2020 Purchases Rs. 16,500

Sales Rs.30,600

Closing Stock Rs.13,500

CALCULATE COST OF GOODS SOLD AND GROSS PROFIT

Total purchases during the year are Rs. 8,00,000

Returns outward Rs.20,000

Direct expenses Rs.60,000

2/3 of the goods are sold for Rs.6,10,000

Solution

Cost of Goods Sold = Total Purchases – Return Outwards + Direct Expenses

= Rs. 8,00,000 – Rs.20,000 + Rs. 60,000

= Rs. 8,40,000

2/3 of the goods are sold for Rs. 6,10,000.

Cost of 2/3 of the goods sold = Rs. 8,40,000 × 2/3

= Rs 5,60,000

Gross Profit = Sales – Cost of Goods Sold

= ™ 6,10,000 – ™ 5,60,000 = ™ 50,000

PROFIT & LOSS A/C

Prof. Carter, “Profit and Loss Account is an account into which all gains and losses are collected in order to ascertain the excess of gains over the losses or vice versa.”

Need or Objectives or Importance of Profit and Loss Account�

• To ascertain the net profit earned or net loss suffered during a particular period.
• To facilitate comparison with previous years’ and assess efficiency of operations.
• To assist in studying various expense ratios for present and previous years and thus control wasteful expenditure.
• To help in the preparation of Balance Sheet by presenting net profit or net loss for the period

Principles of Preparing Profit and Loss Account

1. Revenue Receipts: Only revenue receipts should be entered on the credit side.

2. Revenue Expenses: Only revenue expenses together with losses should be entered on the debit side.

3. Period of Accounting: Expenses and incomes relating only to the period for which the accounts are being prepared should be considered.

4. Accrual Basis: All expenses and incomes related to the period concerned should be considered even if the expense has not yet been paid in cash or the income has not yet been received in cash.

5. Personal Expenses and Incomes: All personal expenses of the proprietor must be subtracted as drawings from the capital accounts and must not be debited to the profit and loss account. Similarly, if any income has been earned from the private assets of the proprietor which is received by firm, it must be added to the capital.

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Transfer of Expenses to the Debit side of Profit and Loss A/c

Profit and Loss A/c Dr.

To Rent A/c

To Salaries A/c

To Advertisement A/c

To Printing and Stationery A/c

To Interest (paid) A/c

To Bank Interest A/c

To Depreciation A/c

To Bank Charges A/c

To General Expenses A/c

To Miscellaneous Expenses A/c

(Being transfer of various expenses account to Profit and Loss A/c)

Transfer of Incomes to the Credit side of Profit and Loss Account

Interest (received) A/c Dr.

Discount (received) A/c Dr.

Dividend A/c Dr.

Bad Debts Recovered A/c Dr.

Miscellaneous Income A/c Dr.

To Profit and Loss A/c

(Being transfer of various income accounts to Profit and Loss A/c)

Transfer of Net Profit to Capital Account

Profit and Loss A/c Dr.

To Capital A/c

(Being the transfer of net profit to Capital A/c)

Transfer of Net Loss to Capital Account

Capital A/c Dr.

To Profit and Loss A/c

(Being the transfer of net loss to Capital A/c)

Operating Profit and Net Profit

“Operating profit refers to the profit earned from a firm’s normal course of business operations.”

Operating Profit = Net Sales – Operating Cost

Or

Operating Profit = Net Sales – Cost of Goods Sold – Operating Expenses

Or

Operating Profit = Gross Profit – Operating Expenses

(Operating Expenses includes Administration and office expenses, Selling and Distribution Expenses, etc.)

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Operating Profit = Net Profit + Non-operating Expenses – Non-operating Incomes

Calculate the amount of gross profit and operating profit on the�basis of the following balances extracted for the year ended March 31, 2018�

Rs.

Opening Stock 50,000

Net Sales 11,00,000

Net Purchases 6,00,000

Direct expenses 60,000

Administration expenses 45,000

Selling and distribution expenses 65,000

Loss due to fire 20,000

Closing stock 70,000

Operating Profit = Sales – (Opening Stock + Net Purchases + Direct Expenses – Closing Stock + Administration Expenses + Selling and Distribution

Expenses)

= 11,00,000 – (50,000 + 6,00,000 + 60,000 – 70,000+ 45,000 + 65,000)

= Rs.3,50,000.

or

Operating Profit = Gross Profit – Operating Expenses

= 4,60,000 – 45,000 – 65,000

= Rs. 3,50,000

BALANCE SHEET

• As per Francis R. Stead, “Balance Sheet is a screen picture of the financial position of a going business at a certain moment.”

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• J. R. Batliboi, “A Balance Sheet is a statement prepared with a view to measure the exact financial position of a business on a certain fixed date.”

Features of Balance Sheet

1. Part of Financial Statements

2. A Statement

3. Summary of Accounts

4. Equality of Both Sides:

5. Reflects Financial Position at a Specific Time

6. Follows Going Concern Postulate

OBJECTIVES/NEED/IMPORTANCE

To determine the true financial position of business at a particular point of time.

To ascertain nature, value and costs of various assets involved in the business.

To ascertain nature, value and costs of various liabilities involved in the business.

To calculate the claims of proprietor to provide accurate information about the capital invested into the business at the end of the year and any additions or deductions made into it in the current year.

To establish the solvency of the firm at the end of the year or an accounting period.

To assist in preparing the opening entries in the beginning of the next period.

GROUPING AND MARSHALLING OF ASSETS AND LIABILITIES

• Grouping implies classifying those of a similar nature into a particular unit while marshalling means arranging such groups properly in a well-defined order.
• Order of Liquidity
• Order of Permanence

1. Order of Liquidity

2. Order of Permanence

Distinction between Trial Balance and Balance Sheet

Distinction between Trial Balance and Balance Sheet

HAPPY LEARNING

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THANKS