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Final Accounts


Final Accounts mean the financial statements prepared consequent to the drawing of Trial Balance. Financial Statements include:
  1. Trading and Profit and Loss Account or Income Statements
  2. Balance Sheet

Income Statement


An income statement is a summary of accounts that affects the Profit or Loss of an enterprise. Many accounts shown in the trial balance relate to expenditure or income. These accounts either increase or decrease the profit. Accounts that increase the profit are shown on one side while accounts that decrease the profit, ie., losses and expenses are shown on the other side. The statement so prepared is known as “Income Statement”.

An Income Statement has two parts namely,
  1. Trading Account - It reveals gross profit or gross loss and
  2. Profit and Loss Account - It reveals net profit or net loss.
Let us discuss these in detail:

Trading Account


Meaning
Trading Account is the first stage in the process of preparing final accounts. Trading account shows the gross profit or gross loss during an accounting year. Its main components are sales, services rendered in the credit side of such sales or services rendered in the debit side.

Features of Trading Account
  1. It is the first stage in the preparation of final accounts of a trading concern
  2. It records only net sales and direct cost of goods sold
  3. The balance of this account discloses the gross profit or gross loss
  4. The balance of this account is transferred to the Profit and Loss Account
Purpose of the Trading Account
The Trading Account is prepared to know the gross profit or gross loss during the accounting period. The account is based on matching the selling price of goods and services with the cost of goods sold and services rendered.

Contents of a Trading Account
Items shown on the debit side of the Trading Account
  1. Opening Stock - refers to the closing stock of the previous year, which has been entered in the opening stock account through an opening entry. Therefore, it will be found in the Trial Balance. This item is usually put as the first item on the debit side of the Trading Account. Of course, in the first year of a business there will be no opening stock. In case of a trader, the opening stock consists of different types of finished goods. For the manufacturing concern, the opening stock consists of raw materials; work - in - process and finished goods.
  2. Purchases and Purchases returns - The purchases account will show a debit balance, showing the gross amount of purchases made of the materials. This refers to the goods purchased, both cash and credit purchases, for resale. Remember, the purchases of assets which are meant for permanent use in business such as machinery, furniture etc., are not included in the purchases. The purchases returns account will show a credit balance showing the returns of materials to the suppliers. On the debit side of the trading account, the net amount is shown as indicated below (with assumed figures):
To Purchases Rs. 3,00,000
Less: Purchases Returns Rs. 10,000
  Rs. 2,90,000

Besides the Purchases returns, the following entries should also be deducted:
  1. Goods taken by the proprietor for his personal use
  2. Goods given as charity
  3. Goods given by way of samples
  4. Direct Expenses - Direct expenses are those expenses which are incurred on the goods purchased till they are brought to the place of business for sale. Examples of such expenses are freight inward, insurance, customs (import) duty, clearing charges, octroi duty, cartage etc. In a manufacturing business, besides the above, expenses incurred for purposes of production such as wages, power and fuel, factory rent, etc are also direct expenses.
Let us discuss direct expenses separately-
  1. Carraige or Frieght or Cartage inwards - it is the cost of bringing materials to the firm's godown and making them available for use. If any freight or carriage is paid on any asset, like machinery, it is added to the cost of the asset and not debited to the Trading Account.
  2. Manufacturing Wages - wages paid to workers in the factory, including stores are debited to the Trading Account. If any amount is outstanding it must be brought into the books so that the full wages for the period are charged to the trading account. It any amount is spent on the making of an asset, the amount is added to the cost of the asset. And debit to the trading account is reduced to that extent. But the difficulty arises when wages are clubbed with salaries (an indirect expense) and the Trial Balance includes a single amount for “Wages and Salaries”. In such a situation it is assumed that the item includes the salaries of the supervisory staff in the factory itself. Therefore, the amount is shown in the Trading account. But, if the item in the Trial Balance is shown as “Salaries and Wages”, it is shown in the Profit and Loss Account. It is assumed that the item includes the wages of office staff only.
  3. Power and Fuel - the cost of coal used in the boiler or electricity consumed in running the machines is included under this head of accounts. Expenses incurred including not paid, ie., outstanding expenses are debited to the Trading Account.
  4. Factory Lighting - Electricity consumed for providing light for running the factory is debited to the Trading Account. If there is a common meter for the office and the factory, the total bill should be appropriately divided between the two - only the portion relating to the factory is debited to the Trading Account and the other portion will be debited to the Profit and Loss Account.
  5. Factory Rent and Rates - the rent paid for the factory premises as well as the municipal taxes (which are called rates ) or charges for water etc., are debited to the Trading Account. If the office and the factory are in the same premises, the total rent rates have to be suitably apportioned.
  6. Duty on Purchases - Any duty paid in connection with the purchases of goods is debited to the Trading Account.
  7. Royalties are the payments which are made for acquiring the right to the patents. It is treated as direct expenses if it is based on the number of unit produced.
  8. Consumable Stores - These are incurred to keep the machine in right condition and include engine oil, cotton waste, soft soap, oil grease and waste, consumed in a factory.
Stores consumed during the year = Opening Balance in stores + Purchases of Stores during the year - Closing Balance of Stores.

Items shown on the Credit Side of the Trading Account
  1. Sales and Sales Returns - The Sales account always has a credit balance indicating the total sales made during the year. The sales returns account has always a debit balance showing the total of the amount of goods returned by customers. The net of the two amounts is called ' net sales' and is entered on the credit side of the Trading Account.

    It must be understood that the Sales Tax or Value Added Tax (VAT) charged is not a part of the sales revenue. Sales Tax or VAT charged is to be deposited with Government. However, if sales are inclusive of tax, the tax amount must be deducted from the sales amount.
  2. Closing Stock - Closing Stock refers to the stock of unsold goods at the end of the current accounting period. Usually there is no account to show the value of goods lying in the godown at the end of the year. However, to correctly ascertain the grow profit, the closing stock must be taken and valued.
The following entry is recorded to incorporate the closing stock in the books-
Closing Stock A/c                                  Dr
To Trading A/c

 

As a result the closing stock appears both on the credit side of the Trading Account and on the asset side of the Balance Sheet.

 

Note: In this case the closing stock appears outside the trial balance.

 

According to the convention of conservatism, stock is valued at its cost or its market price, ie., net realizable value, whichever is lower.

 

Balancing of Trading Account


Gross Profit or Gross Loss
After recording the above items in the respective sides of the Trading Account, the balance is calculated to ascertain Gross Profit or Gross Loss. If the total of the credit side is more than that of the debit side, the excess is Gross Profit.

If the total of the debit side is more than that of the credit side, the excess is Gross Loss. Gross Profit is transferred to the credit side of the Profit and Loss Account and Gross Loss is transferred to the debit side of the Profit and Loss Account.

Closing Entries for Trading Account
Preparation of a Trading Account requires recording entries to transfer the balance of accounts of all the concerned items to the Trading Account. These entries are called Closing Entries as after recording the entries these accounts are closed. The following closing entries are passed to give effect of such transfer of balances:

 

1

For the items of Debit Side

Trading A/c                        Dr
To Opening Stock A/c
To Purchases A/c
To Direct Expenses A/c

2

For the Items on Credit Side

Sales A/c (Net) A/c             Dr
Closing Stock A/c                Dr
To Trading A/c

3

For Gross Profit

Trading A/c                        Dr.
To Profit and Loss A/c

4

For Gross Loss

Profit and Loss A/c             Dr.
To Trading A/c

 

Format of a Trading Account

A general format of a Trading Account is given below:
Trading Account
For the year ending.....
Dr.     Cr.

Particulars

Rs.

Particulars

Rs.

To Opening Stock

 

By Sales Less Sales Returns

 

To Purchases Less Purchases Returns

 

By Closing Stock

 

To Direct Expenses

 

By Abnormal loss of stock

 

To Wages and Salaries

 

By Gross Loss transferred to P & L A/c

 

To Frieght Inwards

     

To Carraige Inwards

     

To Cartage Inwards

     

To Gross Profit transferred to P & L A/c

     

Total

 

Total

 

Either Gross Profit or Gross Loss will appear

Illustration 1:
Prepare a Trading Account for the year ending March 31, 2008 from the following balances as at March 31, 2008:

 

Details

Rs.

Details

Rs.

Opening Stock

10,000

Wages

5,000

Sales (inclusive of sales Tax)

1,70,000

Returns Outwards

8,000

Freight

500

Purchases

1,00,000

Carriage Inwards

1,000

Returns Inwards

5,000

Sales Tax paid

15,000

Octroi Duty

2,500

Closing Stock is valued at Rs. 20,000 as at March 31, 2008

Solution:
Trading Account
For the year ending March 31, 2008
Dr.     Cr.

Particulars

Rs.

Particulars

Rs.

To Opening Stock

10,000

By Sales A/c          1,70,000
Less: Sales tax         15,000
                          ------------
                           1, 55,000
Less: Returns              5,000

 

 

 

1,50,000

To Purchases A/c       1,00,000
Less: Returns                8,000

 

92,000

By Closing Stock

20,000

To Wages

5,000

   

To Carriage Inwards

1,000

   

To Freight

500

   

To Octroi Duty

2,500

   

To Profit and Loss A/c (Gross Profit)

59,000

   
 

1,70,000

 

1,70,000

Points to remember

  1. Trading Account shows Gross Profit or Gross Loss
  2. Gross Profit can be presented in the form of an equation as follows-
    Gross Profit = Net Sales - Cost of Goods Sold
    Where
    1. Net Sales = Total Sales - Sales Returns
    2. Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses - Closing Stock
    3. Net Purchases = Total Purchases - Purchases Returns
  3. Carraige Inward is debited to the Trading Account and Carraige Outward to the Profit and Loss Account
  4. Return Inwards are deducted from Sales whereas Return outwards are deducted from the Purchases in the Trading Account.
Illustration 2:
Opening Stock, Rs. 30,000; Purchases Rs. 54,600; Expenses on Purchases Rs. 6,000; Sales Rs. 90,000; Expenses on Sales Rs. 3,000; Closing Stock Rs. 36,600. Calculate cost of goods sold and gross profit.


Solution:
Cost of Goods sold = Opening Stock + Purchases + Expenses on Purchases - #9; Closing stock
Cost of Goods sold = Rs. (30,000 + 54,600 + 6,000 - 36,600)
                           = Rs. 54,000

Gross Profit = Net Sales - Cost of goods sold
                  = Rs. 90,000 - Rs. 54,000 = Rs. 36,000

Expenses on sales will not be considered while computing the cost of goods sold.

Illustration 3:
From the following prepare a Trading Account for the year ended 31st March 2008.

Opening Stock Rs. 1,00,000
Purchases Rs. 2,80,000
Closing Stock Rs. 80,000
Wages Rs. 2,000
Freight Rs. 3,600
Carraige Inwards Rs. 1,000

Solution:
In this problem, sales figure has not been given. However, gross profit rate on sales has been given.

Let Sales = Rs. 100, Gross Profit will be Rs. 20.
Therefore, cost of sales will be = Rs. 100 - Rs. 20 = Rs. 80
When cost of sales is Rs. 80, then sales = Rs. 100
When cost of sales is Re. 1, then sales = Rs. 100
When cost of sales is Rs. 3,06,600, then sales = Rs. 100 / Rs. 80*3,06,600

                                                                   = Rs. 3, 83, 250.
 

Trading Account
For the year ended 31st March 2008

Dr.     Cr.

Particulars

Rs.

Particulars

Rs.

To Opening stock

To Purchases

To Wages

To Frieght

To Carraige Inwards

To Gross Profit transferred to Profit and Loss A/c

1,00,000

2,80,000

2,000

3,600

1,000

76,650


4,63,250

By Sales

By Closing Stock

3,83,250

80,000

 

 

 

 

 


4,63,250

Calculation of Cost of Sales

Rs.

Opening Stock

1,00,000

Add: Purchases

2,80,000

Wages

2,000

Freight

3,600

Carraige Inwards

1,000

 

3,86,600

Less: Closing Stock

80,000

Cost of Sales

3,06,600

Profit and Loss Account

Meaning -
The next step after preparing the Trading Account, is preparing the Profit and Loss Account. Profit and Loss Account is prepared to calculate the net profit or net loss of the business for a given accounting period.

“A 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” - Prof. Carter

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 indirect expenses and losses are debited to the Profit and Loss Account. It means all those expenses or incomes which have not been debited or credited to the Trading Account are debited or credited in the Profit and Loss Account. Indirect expenses include all administration, selling and distribution expenses such as salaries, rent and taxes, postage, and stationery, insurance, depreciation, interest paid, office lighting, advertising, packing, carriage outwards, etc. Losses include items like loss by fire, loss by theft, etc. If there is any income and gain besides the gross profit, it will also be transferred to the credit of the Profit and Loss Account. The difference of the two sides of this account is either net profit or net loss. If the total of the credit side exceeds the total of the debit side, the difference represents the net profit. In a reverse situation, the difference will represent net loss. This difference (ie., net profit or net loss) is transferred to the capital account of the proprietors. Net profit increases the capital or net loss decreases the capital.

Features of Profit and Loss Account

  1. It is the second stage in the preparation of the final accounts
  2. It relates to a particular accounting period and is prepared at the end of that period.
  3. Accrual basis of accounting is followed in the preparation of this account.
  4. This account is credited with the gross profit and income from other sources and debited with indirect expenses and losses
  5. The balance of this account is the net profit or net loss
  6. The capital of the owner is increased or decreased by the balance of this account (Net Profit or Net Loss).
Need: The need for preparing a Profit and Loss Account can briefly be summed up as under:
  1. To Ascertain Net Profit
  2. Comparison with the Previous Year's Profit
  3. Control over Expenses
Items of Profit and Loss Account
According to present day thinking, it is desirable that the Profit and Loss Account should be prepared in such a manner as to enable the reader to form a correct view about the profit earned or loss suffered by the firm during the period together with other significant factors.

Expenses and losses shown on the debit side of the Profit and Loss Account can be classified as follows:
  1. Administration and Office Management Expenses - Administration expenses include the following-
    1. Establishment Expenses
    2. Office salaries
    3. Office rent and rates
    4. Lighting
    5. Printing and Stationery
    6. Postage and Telephone Charges
    7. Legal Expenses
    8. Audit Fee
    9. General or Trade Expenses
  2. Selling and Distribution Expenses - These will comprise the following:
    1. Salesmen's salaries and commission
    2. Commission of Agents
    3. Advertising
    4. Warehousing Expenses
    5. Packing Expenses
    6. Freight and Carraige on Sales
    7. Export Duties
    8. Maintenance of Vehicles for distribution of goods and their running expenses
    9. Insurance of Finished Goods, Stock and Goods in Transit and
    10. Bad Debts
  3. Financial Expenses - These are those expenses which are incurred in respect of arranging Finance for business. Financial expenses include the following expenses. a. Interest on Loan b. Interest on Capital and c. Discount Allowed.
  4. Abnormal Losses - Abnormal loss such as stock loss by fire not covered by insurance, loss on sale of fixed assets, loss by theft, cash defalcation, etc., may occur during the accounting period. Abnormal losses are treated as extraordinary expenses and debited and shown separately in the Profit and Loss Account.
Following expenses do not appear in the Profit and Loss Account-
  1. Domestic expenses of the Proprietor or partners as they are personal expenses.
  2. Drawings in the form of cash, goods by the proprietor or partners
  3. Personal income tax and life insurance premium paid by the firm on behalf of the proprietor or partners. If income tax appears in the Trial Balance of a sole proprietorship concern, it is treated as drawings and deducted from capital.
Incomes and items of profit which are shown on the credit side of Profit and Loss Account can be divided into the following groups-
  1. Income from Main Business - These refer to those profits and incomes which are received from the operations of the main business. This includes the following types of profits and incomes :
    1. Gross Profit
    2. Profit on consignment
    3. Profit on Joint Venture and
    4. Commission Receivabl
  2. Financial and other Incidental Income - Income received from other sources except the main function of the business comes under this category. These include -
    1. Interest on Fixed Deposits
    2. Income from Investment
    3. Rent Received
    4. Interest on Drawings and
    5. Discount Received.

Balances of the Profit and Loss Account


Net Profit or Net Loss:
The balance in the Profit and Loss Account represents the net profit or net loss. If the credit side is more than the debit side, it shows net profit. If the debit side is more than the credit side, it shows net loss. Both (Net Profit or Net Loss) are transferred to the Capital Account.




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