Asok Nadhani-Accountancy-Final Accounts

Final Accounts

By Asok Nadhani

16.1 Final Accounts

i)      The term “Final Accounts” means Accounts statements which are finally prepared showing the profit earned or loss suffered (called Profit & Loss A/c) by the firm and the financial state of affairs of the firm at the end of the concerned period (called as Balance Sheet).

ii)     Financial Statements are the systematically organized summary of all the ledger account heads presented in such a manner that it gives detailed information about the financial position and the performance of the enterprise. Performance of the enterprise is judged on the basis of the income earned or accrued during the year in the form of profit after the adjustments of expenses related to the enterprise and to the income earned or accrued.

iii)    In Financial Accounting, profit is measured at two levels:

a)     Gross Profit.

b)    Net Profit.

16.2 Preparation of Final Accounts

The principal function of final statement of accounts (i.e. Trading Account, Profit and Loss Account and the Balance Sheet) are to exhibit truly and fairly the profitability and the financial position of the business to which they relate. While preparing these statements the basic principles are followed:

i)      A distinction be made between capital and revenue, both income and expenditure;

ii)     Income and expenses relating to a period of account should be separated from those of another period. Different items of income and expenditure should be accumulated under significant heads so as to disclose the sources from which capital has been procured and the nature of liabilities, which are outstanding for payment.

16.3 Trading Account

Trading Account is prepared to ascertain the Gross Profit. Gross Profit is the difference between sales and cost of goods sold. Sometimes it is possible to first determine the gross profit (arising out of trading operations) and then deduct all administrative and selling expenses from gross profit, to determine the net profit.

At the end of the year, every business must ascertain its net profit (or loss). This is done in two stages: (1) Finding out the gross profit (or gross loss) and then

(2) Finding out the net profit (or net loss).

Gross Profit is the excess of net sales (that is, gross sales minus returns from customers) over the cost of goods sold. Cost of goods sold involves an adjustment for stocks on hand. Thus, if in the first year of its existence, a business purchases goods (net, that is after deducting returns to suppliers) to the extent of Rs.1,00,000 and if, at the end of the year, goods worth rs.15,000 are still unsold, the cost of goods sold will be Rs.85,000.

 

16.3.1 Format of Trading Accounts

Dr.							Cr.
Date	Particulars		Amount (Rs.)	Date	Particulars		Amount (Rs.)
	To Opening Stock	xxx			By Sales	xxx
	Add: Purchases	xx			Less: Return	xx	xxx
		xxx			By Closing Stock		xxx
	Less: Returns	xx	xxx
	To Wages		xxx
	To Carriage Inward		xxx
	To Gas, water, fuel etc.		xxx
	To Packaging Charges		xxx
	To Other factory expenses		xxx
	To Gross Profit. (Bal. fig.)		xxx
			xxx				xxx

16.4 Profit and Loss Accounts

Profit and Loss Account is prepared to ascertain net profit. Net profit is calculated by deducting other expenses (like general, administrative or selling and distribution expenses) from gross profit.

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The Profit and Loss Account starts with the credit from the Trading Account in respect of Gross Profit (or debit if there is Gross Loss). Thereafter, all those expenses or losses which have not been debited to the Trading Account are debited to the Profit and Loss Account. If there is any income besides the Gross Profit, it will also be transferred to the credit of the Profit and Loss Account.

 

The Net Profit/Loss is completed as follows:

Gross Profit (or Loss)	xxx
Add: All indirect expenses (non-trading and non-manufacturing incomes)	xxx
	xxx
Less: All indirect expenses (non-trading and non-manufacturing expenses)	xxx
Net Profit (or Loss)	xxx

16.5 Balance Sheet

A Balance Sheet is a list of assets and claims of a business at some specific point of time and is prepared from the adjusted Trial Balance. It shows the financial position of a business by detailing the assets and liabilities, grouped, properly classified and arranged in a specific manner.

16.5.1 Limitations of the Balance Sheet

Though the Balance Sheet discloses financial position of an organisation, yet it suffers from the following limitations:

1.     Fixed assets are shown at historical cost depreciated up-to-date. It does not reflect the true value of these assets. Intangible assets are shown in the Balance Sheet at book values which may bear no relationship to market values.

2.     Sometimes, Balance Sheet contains some assets which do not reflect any value, such as preliminary expenses, debenture discount, etc. The inclusion of these assets unduly inflates the total value of assets.

3.     The Balance Sheet does not reflect the value of factors like managerial skill.

4.     Value of many current assets are based on some estimates, so it cannot reflect the true financial position of the business.

16.5.2 Relationship between Balance Sheet and Profit and Loss Account

The primary relationship between a Profit and Loss Account and a Balance Sheet is that a Profit and Loss Account is a link between the Balance Sheet at the beginning of a period and the Balance Sheet at the end of that period. The Profit and Loss Account and the Balance Sheet are the two technical instruments used in reporting the division of costs incurred between the present and future accounting periods. In one word, the Profit and Loss Account shows the division of costs assigned to current period, whereas the Balance Sheet exhibits the costs incurred which are reasonably applicable to future years. The Balance Sheet thus serves as a means of carrying forward unexpired acquisition costs of assets.

So, we can infer that a Balance Sheet can be described as a summary of residual transactions that results from the Profit and loss Account transactions.

16.5.3 Distinction between Profit and Loss Account and Balance Sheet

Profit and Loss Account provides a ‘historical’ review of the accounts of the past transactions while the Balance Sheet gives a ‘static’ picture of the financial position as on the last day of the accounting period.

1.     Profit and Loss Account itself is an account whereas a Balance Sheet is a statement of Assets and Liabilities.

2.     Profit and Loss Account shows the profit earned or losses incurred for the accounting period whereas the Balance Sheet shows the financial position of the business.

3.     Profit and Loss Account is prepared for the accounting period ended whereas a Balance Sheet is prepared as at the last day of the accounting period.

4.     The accounts that are transferred to the Profit and Loss Account are closed and no balance is carried to next accounting period. But the accounts that are transferred to the Balance Sheet carry the balances as opening balances for the next period.

16.6 Formats of Balance Sheet

A Balance Sheet may be prepared in one of two forms:

(i)     Horizontal (Traditional) format

(ii)    Vertical format.

16.6.1 Horizontal Format

In this format, the left hand side lists liabilities of the business as on the last day of the accounting period as well as details of its capital position and on the right hand side are listed various assets of the enterprise.

Balance Sheet

As on ….

Liabilities	Rs.	Assets	Rs.
Capital	xxx	Land and Building	xxx
Reserve and Surplus	xxx	Plant and Machinery	xxx
Outstanding Expenses	xxx	Furniture and Fixtures	xxx
Loans	xxx	Stock	xxx
Trade Creditors	xxx	Sundry Debtors	xxx
Bills Payable	xxx	Bills Receivables	xxx
		Other Investments	xxx
		Government Securities	xxx
		Cash at Bank	xxx
		Cash in Hand	xxx
	xxx		xxx

16.6.2 Vertical Format

The vertical format clearly displays the net worth of the business to the owner – i.e. the capital. This format also displays the amount of investment in the fixed assets and in working capital.

 Balance Sheet

As on ….

Particulars	Rs.	Rs.	Rs.
Fixed Assets:
Land -		2,00,000
Building -		4,00,000
Plant and Machinery -		3,00,000
Furniture -		1,00,000
Delivery Van -		2,00,000	12,00,00
Current Assets:
Stock -	1,50,000
Debtors -	2,50,000
Bills Receivable -	50,000
Cash at Bank -	30,000
Cash in Hand -	20,000	5,00,000
Current Liabilities:
Creditors -	1,00,000
Bills Payable -	50,000
Outstanding Expenses	50,000	2,00,000
Working Capital:			3,00,000
NET ASSETS EMPLOYED			15,00,000
FINANCED BY:
Capital		13,70,000
Add: Net Profit		1,30,000	15,00,000

[Hanif, Pg- 17.14 – 17.16]