Basic Account Unit 2 Final Accounts

 

Final Accounts

1. Meaning of Final Accounts

Final Accounts are prepared at the end of an accounting year to determine the financial performance and financial position of a business.

They help to find out:

• Whether the business has earned a profit or suffered a loss.

• What assets the business owns.

• What liabilities the business owes.

• The overall financial position of the business.

Final Accounts are generally prepared on the basis of the Trial Balance and other adjustments.

Definition: Final Accounts are the financial statements prepared at the end of an accounting period to ascertain the net profit or net loss and the financial position of a business.

2. Objectives of Final Accounts

The main objectives are:

1. To calculate the gross profit or gross loss.

2. To calculate the net profit or net loss.

3. To determine the financial position of the business.

4. To know the assets and liabilities of the business.

5. To provide financial information to owners and management.

6. To help in making business decisions.

7. To compare the performance of different accounting years.

8. To provide information to creditors, investors and other interested parties.

3. Components of Final Accounts

Final Accounts generally consist of three main parts:

Components of Final Accounts

Final Accounts

1. Trading Account

To calculate Gross Profit or Gross Loss

2. Profit and Loss Account

To calculate Net Profit or Net Loss

3. Balance Sheet

To show financial position

4. Trading Account

Meaning

Trading Account is the first part of Final Accounts. It is prepared to calculate the gross profit or gross loss of a business during an accounting period.

It records direct expenses and direct incomes related to the purchase and sale of goods.

Objectives of Trading Account

1. To calculate gross profit or gross loss.

2. To know the cost of goods sold.

3. To determine the efficiency of buying and selling activities.

4. To compare sales and cost of goods sold.

Items Recorded in Trading Account

Debit Side (Expenses and Costs)

• Opening Stock

• Purchases

• Less: Purchase Returns

• Wages

• Carriage Inward

• Freight Inward

• Octroi and Import Duty

• Factory Fuel

• Direct Manufacturing Expenses

Credit Side (Income and Stock)

• Sales

• Less: Sales Returns

• Closing Stock

Format of Trading Account

Trading Account for the year ended 31 March 20XX

Dr. Particulars	Amount (₹)	Cr. Particulars	Amount (₹)
To Opening Stock	20,000	By Sales	1,00,000
To Purchases	50,000	Less: Returns	5,000
Less: Returns	2,000	Net Sales	95,000
Net Purchases	48,000	By Closing Stock	15,000
To Wages	10,000
To Carriage Inward	2,000
To Gross Profit c/d	30,000
Total	1,10,000	Total	1,10,000

Gross Profit = ₹30,000

Formula of Gross Profit

$$\text{Gross Profit}=\text{Net Sales}-\text{Cost of Goods Sold}$$

Where:

$$\text{COGS}=\text{Opening Stock}+\text{Net Purchases}+\text{Direct Expenses}-\text{Closing Stock}$$

If the debit side of the Trading Account is greater than the credit side, the result is Gross Loss.

5. Profit and Loss Account

Meaning

Profit and Loss Account is the second part of Final Accounts. It is prepared to calculate the net profit or net loss of a business.

It records all indirect expenses and indirect incomes.

Objectives of Profit and Loss Account

1. To calculate net profit or net loss.

2. To record indirect expenses.

3. To record indirect incomes.

4. To determine the overall profitability of the business.

5. To help management in decision-making.

Items Recorded in Profit and Loss Account

Debit Side (Indirect Expenses and Losses)

• Salaries

• Rent

• Insurance

• Advertisement

• Office Expenses

• Printing and Stationery

• Depreciation

• Bad Debts

• Discount Allowed

• Interest on Loan

• Carriage Outward

• Repairs and Maintenance

• Commission Paid

Credit Side (Indirect Incomes and Gains)

• Gross Profit b/d

• Commission Received

• Discount Received

• Interest Received

• Rent Received

• Dividend Received

• Profit on Sale of Assets

Format of Profit and Loss Account

Formula of Net Profit

$$\text{Net Profit}=\text{Gross Profit}+\text{Indirect Income}-\text{Indirect Expenses}$$

If indirect expenses are greater than gross profit and other incomes, the business suffers a Net Loss.

From the following information, prepare profit and loss account for the year ended 31st March, 2018.

From the following particulars, prepare profit and loss account for the year ended 31st December, 2017.

Solution

 

6. Balance Sheet

Meaning

A Balance Sheet is a statement prepared at the end of an accounting year to show the financial position of a business.

It shows the assets, liabilities and capital of a business on a particular date.

Definition: A Balance Sheet is a statement showing the financial position of a business by presenting its assets, liabilities and capital on a specific date.

Objectives of Balance Sheet

1. To know the financial position of the business.

2. To determine total assets and liabilities.

3. To know the capital of the owner.

4. To assess the financial stability of the business.

5. To provide information to creditors and investors.

6. To help in financial planning.

Main Components of Balance Sheet

A. Assets

Assets are the properties and resources owned or controlled by a business.

Types of Assets:

1. Fixed Assets: Land, Building, Machinery, Furniture.

2. Current Assets: Cash, Bank Balance, Debtors, Closing Stock.

3. Tangible Assets: Assets that can be physically touched.

4. Intangible Assets: Goodwill, Patents, Copyrights.

5. Fictitious Assets: Certain deferred expenses shown in traditional textbook formats; these are not actual assets under modern accounting standards.

B. Liabilities

Liabilities are the amounts payable by a business to outsiders.

Types of Liabilities:

1. Fixed or Non-current Liabilities: Long-term loans, Debentures.

2. Current Liabilities: Creditors, Bills Payable, Outstanding Expenses.

3. Contingent Liabilities: Possible obligations depending on future events, generally disclosed rather than recognised as liabilities.

C. Capital

Capital is the amount invested by the owner in the business.

$$\text{Closing Capital}=\text{Opening Capital}+\text{Additional Capital}+\text{Net Profit}-\text{Drawings}$$

Format of Balance Sheet

Methods of drafting a balance sheet

The balance sheet of business concern can be presented in the following two forms.

a.               Horizontal form

b.               Vertical form

a) Horizontal form of balance sheet

In the horizontal form, assets are shown on right hand side of the balance sheet and the liabilities are shown on the left hand side of the balance sheet.

b) Vertical form of balance sheet

The balance sheet of a sole proprietor can be presented in a vertical statement form as given below:

Accounting Equation

$$\text{Assets}=\text{Capital}+\text{Liabilities}$$

This equation is the basic principle of the Balance Sheet.

From the following balances of Niruban, prepare balance sheet as on 31st December, 2017.

Solution:

From the following information, prepare trading and profit and loss of Abdul Rahuman for the year ending 31st December, 2016 and balance sheet as on that date. The closing stock on 31st December, 2016 was valued at Rs.  2,000.

Solution:

Q. From the following trial balance of Sharan, prepare trading and profit and loss account for the year ending 31st December, 2017 and balance sheet as on that date. The closing stock on 31st December, 2017 was valued at Rs.  2,50,000.

Solution:

Q From the following particulars presented by Thilak for the year ended 31st March, 2017, prepare profit and loss account

Adjustments:

i.               Outstanding salaries amounted to Rs.  4,000

 

ii.               Rent paid for 11 months

 

iii.               Interest due but not received amounted to Rs.  2,000

 

iv.               Prepaid insurance amounted to Rs.  2,000

 

v.               Depreciate buildings by 10%

 

vi.               Further bad debts amounted to Rs.  3,000 and make a provision for bad debts @ 5% on sundry debtors 

vii.               Commission received in advance amounted to Rs.  2,000

 

Solution:

Debtors : 40,000

Less: Further bad debts : 2,000          : 38,000

Provision for bad and doubtful debts at 5% : 38,000 x 5% = Rs. 1,900

7. Difference Between Trading Account, Profit and Loss Account and Balance Sheet

Basis	Trading Account	Profit & Loss A/c	Balance Sheet
Purpose	Finds gross profit/loss	Finds net profit/loss	Shows financial position
Nature	Nominal account	Nominal account	Statement
Items	Direct expenses and sales	Indirect expenses and incomes	Assets, liabilities and capital
Period	For an accounting period	For an accounting period	On a particular date
Result	Gross Profit/Loss	Net Profit/Loss	Financial position

8. Important Adjustments in Final Accounts

Adjustments are necessary to prepare correct and accurate Final Accounts.

1. Closing Stock

Closing stock means unsold goods remaining at the end of the accounting year.

Treatment:

• Credit side of Trading Account.

• Asset side of Balance Sheet.

2. Outstanding Expenses

Expenses that have become due but have not yet been paid.

Example: Outstanding salary.

Treatment:

• Add to the related expense in Profit and Loss Account.

• Show as a current liability in Balance Sheet.

3. Prepaid Expenses

Expenses paid in advance for the next accounting period.

Example: Prepaid insurance.

Treatment:

• Deduct from the related expense in Profit and Loss Account.

• Show as a current asset in Balance Sheet.

4. Accrued Income

Income earned but not yet received.

Treatment:

• Add to the related income in Profit and Loss Account.

• Show as a current asset in Balance Sheet.

5. Income Received in Advance

Income received but not yet earned.

Treatment:

• Deduct from the related income in Profit and Loss Account.

• Show as a current liability in Balance Sheet.

6. Depreciation

Depreciation means the reduction in the value of fixed assets due to use, passage of time or obsolescence.

Treatment:

• Debit side of Profit and Loss Account.

• Deduct from the related asset in Balance Sheet.

7. Bad Debts

Bad debts are amounts that cannot be recovered from debtors.

Treatment:

• Debit side of Profit and Loss Account.

• Deduct from debtors in Balance Sheet.

8. Provision for Doubtful Debts

It is an estimated amount set aside to cover possible losses from debtors who may not pay.

Treatment:

• Charge the appropriate amount to Profit and Loss Account.

• Deduct the provision from debtors in Balance Sheet.

9. Interest on Capital

Interest allowed by the business to the owner on capital invested.

Treatment:

• Debit side of Profit and Loss Account.

• Add to capital in Balance Sheet.

10. Interest on Drawings

Interest charged by the business on money or goods withdrawn by the owner.

Treatment:

• Credit side of Profit and Loss Account.

• Deduct from capital in Balance Sheet.

9. Difference Between Gross Profit and Net Profit

Gross Profit	Net Profit
Calculated through Trading Account	Calculated through Profit and Loss Account
It is the difference between net sales and cost of goods sold	It is the profit after deducting indirect expenses and adding indirect incomes
It does not consider indirect expenses	It considers indirect expenses
It is transferred to P&L Account	It is added to capital

10. Importance of Final Accounts

• Helps in knowing business profitability.

• Shows financial position.

• Helps in controlling expenses.

• Helps in business planning.

• Provides information to investors.

• Helps creditors assess repayment capacity.

• Helps in comparing business performance.

• Provides a basis for tax and statutory reporting.

Differences between trial balance and balance sheet

11. Important Examination Questions

Short Answer Questions (2–3 Marks)

1. What are Final Accounts?

2. Define Trading Account.

3. What is a Profit and Loss Account?

4. Define Balance Sheet.

5. What is Gross Profit?

6. What is Net Profit?

7. What are outstanding expenses?

8. What are prepaid expenses?

9. What is depreciation?

10. What is closing stock?

11. What are current assets?

12. What are current liabilities?

Long Answer Questions (5–10 Marks)

1. Explain the meaning and objectives of Final Accounts.

2. Explain the components of Final Accounts.

3. Describe the preparation of Trading Account with its format.

4. Explain the Profit and Loss Account with its format.

5. Explain the Balance Sheet and its objectives.

6. Differentiate between Trading Account and Profit and Loss Account.

7. Explain the various adjustments made while preparing Final Accounts.

8. Explain the difference between Gross Profit and Net Profit.

12. Quick Revision Notes

Remember these important formulas:

1. Net Sales

$$Sales-SalesReturns$$

2. Net Purchases

$$Purchases-PurchaseReturns$$

3. Cost of Goods Sold

$$OpeningStock+NetPurchases$$

$$+DirectExpenses-ClosingStock$$

4. Gross Profit

$$NetSales-COGS$$

5. Net Profit

$$GrossProfit+IndirectIncome$$

$$-IndirectExpenses$$

6. Accounting Equation

$$Assets=Capital+Liabilities$$