Final Accounts:: Definition and Explanation
Final Accounts:: Definition and Explanation
Final Accounts:: Definition and Explanation
The basis of these statements is trial balance. The trial balance includes all the
accounts from the ledger. the nature of which may be either, personal, real, or
nominal. It should be noted that from the trial balance only nominal accounts are
transferred to the profit and loss account. The real or personal accounts go to the
balance sheet.
Trading Account:
A trading account is an account which contains, " in summarized form, all the
transactions, occurring, throughout the trading period, in commodities in which he
deals" and which gives the gross trading result. In short, trading account is the
account which is prepared to determine the gross profit or the gross loss of a trader.
1. The value of opening stocks of goods (i.e., the stock of goods with which the
business was started).
2. Net purchase made during the year (i.e., purchases less returns).
3. Direct expenses, if any.
Credit Side Items:
1. Total sales made during the period less the value of returns, i.e., net sales.
2. The value of closing stock of goods.
The difference between the two sides of the trading account represents either gross
profit or gross loss. Thus if the credit side is heavier that would mean that the trader
has earned gross profit i.e., the excess of selling price of the goods sold over their
purchase price. If the debit side is heavier it would mean that the trader has suffered
gross loss i.e., purchase price of goods exceeds the selling price.
The balance of trading account which represents either gross profit or gross loss is
transferred to profit and loss account.
Dr. Cr.
To Opening stock ........ By Sales .........
To purchases ......... Less returns ......... .........
Less Returns ......... ........ By Closing stock .........
To Carriage inwards ......... By Gross loss
To Cartage ......... transferred to profit
and loss account .........
To dock charges .........
To Wages .........
To Duty .........
To Freight .........
To Clearing charges .........
To Etc. Etc., .........
To Gross profit
(Transferred to profit
and loss account) .........
In case of trading concerns it will consist of only finished goods or goods to be sold
without alteration. In manufacturing concerns, the opening stock will consist of three
parts
(a). Stock of raw materials.
(b). Stock of partly completed goods or work-in-progress.
(c). Stock of finished goods.
Purchases:
This item includes both cash and credit purchases of goods bought with the object of
sales.
Discount on Purchases:
Sales:
This item includes total of both cash and credit sales of goods in which businessman
deals in. It is credited to trading account.
It means goods returned to a trader by his customers from out of goods sold to
them. It is shown by way of deduction from sales on the credit side, of the trading
account.
Discount on Sales:
This account has always a debit balance and is shown by deduction from sales in the
trading account.
Direct Expenses:
Direct expenses are those expenses which are incurred to convert raw-materials
into finished goods or which may be regarded as a part of the cost of purchasing the
goods. e.g., wages paid by a manufacturer to construct furniture out of raw wood,
the expenses incurred to bring goods from the place of purchase to the business
place of the trader etc. All the direct expenses are charged to the trading account.
The items usually included in the direct expenses are:
Closing stock represents the value of goods lying unsold in the hands of a trader at
the end of a trading period. The value of closing stock is ascertained by means of
compilation of list of materials, stores and goods actually in possession at the close
of the trading period. This work is known as taking the inventory. The inventory or
lists of physical stock are then faired and valued. The total of the lists will be closing
stock. The closing stock is valued at cost or market price whichever is lower. As this
item materially affects the gross profit (or gross loss), it is essential that all possible
care should be taken to calculate the closing stock at a proper value.
The value of closing stock is taken into consideration only at the time of preparing
the trading account and not before. The trial balance is prepared before the
preparation of the trading account. Hence the closing stock does not appear in a trial
balance. It is brought into account by means of a journal entry debiting stock
account and crediting the trading account.
1. Trading Account
To Purchases Account
To Returns Inwards Account
To Direct Expenses Account (wages, carriage etc.)
(Being the transfer of the latter accounts to the former.)
2. Sales Account
Returns Outward Account
To Trading Account
(Sales etc., transferred to trading account)
1. A trader can find out the gross profit and thereby can ascertain the
percentage of profit he has earned on the cost of goods sold. This percentage
of gross profit may serve as his ready guide for the adjustment of future sale
price.
2. A trading account help a trader to compare his stock at open with that at the
close. He can further find out whether the purchases he has made during the
period of account have been judicious.
3. Once can compare the figure of sales with similar figure of the previous year
and can find out whether business is improving or declining.
4. If the gross profit disclosed by the trading account is less than expected, an
enquiry can be made into the cause responsible for the decline. And if the
gross profit is more than was expected, steps can be taken to maintain it.
Profit and loss account is the account whereby a trader determines the net result
of his business transactions. It is the account which reveals the net profit (or net
loss) of the trader.
The profit and loss account is opened with gross profit transferred from the trading
account (or with gross loss which will be debited to profit and loss account). After
this all expenses and losses (which have not been dealt in the trading account) are
transferred to the debit side of the profit and loss account. If there are any incomes
or gains, these will be credited to the profit and loss account. The excess of the gain
over the losses is called the net profit and that of the loss over the gain is called the
net loss. The account is closed by transferring the net profit or loss to capital account
of the trader.
Operating Expenses:
Selling Expenses:
Sales salaries ------
Advertising expenses ------
Insurance expense - selling ------
Store supplies expenses ------
Sundry selling expenses ------
Total selling expenses
------
General Expenses:
Office salaries ------
Taxes ------
Insurance expenses general ------
Office supplies expenses ------
Sundry general expenses ------
Other Income:
Rent income ------
Other Expenses:
Interest expenses ------
------
Income from sales: The total of all charges to customers for goods sold, both for
cash and on credit, is reported in this section. Sales returns and allowances and sales
discounts are deducted from the gross amount to yield net sales.
Cost of Goods Sold: Cost of goods sold refers to the cost price of goods which have
been sold during a given period of time. In order to calculate the cost of goods sold
we should deduct from the total cost of goods purchased the cost of goods at the
end of the year. This can be explained with the help of following formula/equation:
(Opening stock + Cost of goods purchased) - Closing stock = Cost of goods sold
Gross Profit: The excess of the net income from sales over the cost of goods sold is
also called gross profit on sales, trading profit or gross margin. It is as gross because
all other expenses for the period must be deducted from it to obtain the net profit or
net income of the business.
Net Profit from Operations: The excess of gross profit on sales over total
operating expenses is called net profit or net profit from operations. If operating
expenses should exceed gross profit, the excess is designated as net loss or net loss
from operations.
Other Income: Minor sources of income are classified as other income or non-
operating income. In a merchandising business this category often include income
from interest, rent, dividends and gains from the sale of fixed assets.
Other Expenses: Expenses that cannot be associated definitely with the operations
are identified as other expenses or non-operating expenses. Interest expense that
results from financing activities and losses incurred in the disposal of fixed assets are
examples of items reported in this section.
The two categories of non-operating items, other income and other expenses, are
offset against each other on the profit and loss account. If the total of other income
exceeds the total other expenses, the excess is added to net profit from operations;
if the reverse is true, the difference is subtracted from net profit from operations.
Net Profit: The final figure on the profit and loss account is labeled as net profit (or
net loss) or net profit carried to balance sheet. It is the net increase in capital from
profit making activities.
The main difference between trading account and profit and loss account is
that the gross profit or loss which is derived from the trading account shows the
trend of the business and the profit and loss account reflects on the management of
the business the final outcomes of the concern.
The main difference between trading account and profit and loss account is
that the gross profit or loss which is derived from the trading account shows the
trend of the business and the profit and loss account reflects on the management of
the business the final outcomes of the concern. Trading account deals with the cost
price of the goods. All the expenses directly connected with the buying of goods are
entered in it. It is credited with the sale proceeds of the goods. Profit and loss
account deals with the expenses indirectly connected with the goods (expenses with
the selling of the goods.)
Balance Sheet:
A balance sheet is a statement drawn up at the end of each trading period stating
therein all the assets and liabilities of a business arranged in the customary order to
exhibit the true and correct state of affairs of the concern as on a given date.
Definition and Explanation:
A balance sheet is a statement drawn up at the end of each trading period stating
therein all the assets and liabilities of a business arranged in the customary order to
exhibit the true and correct state of affairs of the concern as on a given date.
A balance sheet is prepared from a trial balance after the balances of nominal
accounts are transferred to the trading account or to the profit and loss account. The
remaining balances of personal or real accounts represent either assets or liabilities
at the closing date. These assets ant liabilities are shown in the balance sheet in a
classified form - the assets being shown on the right side and the liabilities on the
left hand side.
The term marshalling means the order in which assets and liabilities are stated on
the balance sheet as the balance sheet exhibits the financial position of a concern
even to a non technical observer. It is of great importance that the different assets
and liabilities should be arranged in the balance sheet on certain principles. The
balance sheet is generally marshaled in three ways:
According to this method assets are entered up in the balance sheet following the
order in which they can be converted into cash and the liabilities in the order in
which they can be paid off. The following is a format of a balance sheet based on this
order:
This method is the reverse of the first method. Under this method the assets are
stated according to their permanency i.e., permanent assets are shown first and less
permanent are shown one after another. Similarly the fixed liabilities are stated first
and the floating liabilities follow. The following is a specimen of a balance sheet
based on this order:
This method is the combination of the first two methods. Under this method the
assets are arranged in order of realisability and liabilities are arranged in order of
permanence.
The first method is adopted by sol proprietors, firms and partnership concerns. The
second method is adopted by companies and the third method is adopted by banking
concerns.
Classification of Assets:
The properties and possessions of a business are called assets and they are classified
into the following classes:
Fixed assets:
Fixed assets are assets which are acquired not for sale but for permanent use in
the business e.g., land and buildings, plant and machinery, furniture etc. These
assets help the business to be carried on.
Current assets denote those assets which are held for sale or to be converted into
cash after some time e.g., sundry debtors. bills receivables, stock of goods etc.
Liquid Assets:
Liquid assets are those assets which are with us in cash or easily converted into
cash e.g., cash in hand, cash at bank, investments etc.
Wasting Assets:
The assets that depreciate through "wear and tear", whose values expire with lapse
of time or that become exhausted through working are known as wasting assets.
This is a sub-class of fixed assets e.g., plant machinery, mines etc.
There are assets which have no physical existence. Which can neither be seen with
eyes not touched with hands. These are called intangible assets or fictitious
assets. They do not represent any thing valuable. They include debit balance of
profit and loss account, goodwill etc.
Contingent Assets:
A contingent asset is one which comes into existence upon the happening of a
certain event. If that event happens the asset becomes available, otherwise not. For
example uncalled capital of a limited company.
Outstanding Assets:
Expenses paid in advance i.e., prepaid expenses, and income earned but not
received are known as outstanding assets.
Classification of Liabilities:
The liabilities of a business are classified as follows:
Fixed Liabilities:
These are the liabilities which are payable immediately or in the near future. These
liabilities are payable after a long period. Long term loans, capital of the proprietor
are the examples of such kind of liabilities.
Current Liabilities:
These are the liabilities which are payable immediately or in the near future, such as
creditors, bank loans etc.
Contingent Liabilities:
Contingent liabilities are those liabilities which arise only on the happening of some
event. The event may or may not happen. Thus a contingent liability may or may not
involve the payment of money. Examples of contingent liabilities are:
Contingent liabilities are not recorded in the books not they are included in the
balance sheet. They are simply referred to by way of foot notes on the balance
sheet.
Fixed Assets:
Fixed assets are valued on the method "going concern." Valuation of the fixed
assets must be ascertained from their capacity to earn revenue and that is shy they
should be valued for the purpose of the balance sheet at cost price less depreciation
which is an estimated loss arising out of the use of the fixed assets in course of the
business.
Floating Assets:
Floating assets are valued on the principle of the "cost or market price
whichever is less." They are valued at a figure which they are likely to realize when
converted into cash and as such they are valued at cost price or market price if the
same is below the cost price at the date of valuation. It is never valued at a price
exceeding the cost even if the market price is in excess of the cost price at the date
of such valuation.
Fixed Assets:
Furniture and fittings ---------
Buildings ---------
Plant and machinery ---------
Land ---------
Liabilities:
Current Liabilities:
Creditors (Accounts payable) ---------
Bills payable (Notes payable) ---------
Bank overdraft ---------
Fixed Liabilities:
Fixed Liabilities:
Long terms loans ---------
Owner's capital ---------
Add net income for the year ---------
---------
The following are the points of distinction/difference between trial balance and
balance sheet:
Trial Balance Balance Sheet
► It is a list of balance extracted from the ► It is a statement of assets and liabilities
ledger accounts
► It contains the balance of all accounts - ► It contains the balance of only those
real, nominal and personal. accounts which represents assets and
liabilities.
► It does not contain the value of the ► It contains the value of closing stock,
closing stock of goods. which appears on the assets side.
► Expenses due but not paid and incomes ► Expenses due but not paid appear on
due but not received do not appear in the liability side and income due but not
the trial balance received appear on the asset side of the
balance sheet.
Examples of Trading and Profit and Loss Account and Balance Sheet:
There are two examples of trading and profit and loss account and balance sheet.
Example 1:
From the following balances extracted from the books of X & Co., prepare a trading
and profit and loss account and balance sheet on 31st December, 1991.
$ $
Stock on 1st January 11,000 Returns outwards 500
Bills receivables 4,500 Trade expenses 200
Purchases 39,000 Office fixtures 1,000
Wages 2,800 Cash in hand 500
Insurance 700 Cash at bank 4,750
Sundry debtors 30,000 Tent and taxes 1,100
Carriage inwards 800 Carriage outwards 1,450
Commission (Dr.) 800 Sales 60,000
Interest on capital 700 Bills payable 3,000
Stationary 450 Creditors 19,650
Returns inwards 1,300 Capital 17,900
Solution:
X & Co.
Trading and Profit and Loss Account
For the year ended 31st December, 1991
To Opening
11,000 |By Sales 60,000
stock
To Purchases 39,000 | Less 1,300
returns
i/w
Less returns
500 | 58,700
o/w
By Closing
38,500 | 25,000
stock
To Carriage
800 |
inwards
To Wages 2,800 |
To Gross profit
30,600 |
c/d
|
83,700 | 83,700
|
By Gross
To Stationary 450 | 30,600
profit b/d
To Rent and
1,100 |
rates
To Carriage
1,450 |
outwards
To Insurance 700 |
To Trade
200 |
expenses
To Commission 800 |
To Interest on
700 |
capital
To Net profit
transferred to 25,200 |
capital a/c
|
|
30,600 | 30,600
|
X & Co.
Balance Sheet
As at 31st December, 1991
Liabilities $ | Assets $
|
Creditors 19,650 Cash in hand 500
|
Bills payable 3,000 Cash at bank 4,750
|
Capital 17,900 Sundry debtors 30,000
|
Add Net profit 25,200 Bill receivable 4,500
|
43,100 Stock 25,000
|
Office equipment 1,000
|
|
65,750 65,750
|
Example 2:
The following trial balance was taken from the books of Habib-ur-Rehman on
December 31, 19 ....
Cash 13,000
Sundry debtors 10,000
Bill receivable 8,500
Opening stock 45,000
Building 50,000
Furniture and fittings 10,000
Investment (Temporary) 5,000
Plant and Machinery 15,500
Bills payable 9,000
Sundry creditors 20,000
Habib's capital 78,200
Habib's drawings 1,000
Sales 100,000
Sales discount 400
Purchases 30,000
Freight in 1,000
Purchase discount 500
Sales salary expenses 5,000
Advertising expenses 4,000
Miscellaneous sales expenses 500
Office salary expenses 8,000
Misc. general expenses 1,000
Interest income 1,000
Interest expenses 800
2,08,700 2,08,700
Solution:
Habib-ur-Rehman
Income Statement/Profit and Loss Account
For the year ended December 31, 19.....
31,000
Less purchase discount 500
Operating Expenses:
Selling Expenses:
Sales salary expenses 5,000
Advertising expenses 4,000
Misc. selling expenses 500
9,500
General Expense:
Office salaries expenses 8,000
Misc. general expenses 1,000
9,000
Habib-ur-Rehman
Balance Sheet
As at December 31, 19.....
ASSETS
Current Assets:
Cash 13,000
Sundry debtors 10,000
Bills receivable 8,500
Stock on Dec. 31, 19 .. 10,000
Investment 5,000
LIABILITIES:
Current Liabilities:
Sundry creditors 20,000
Bills payable 9,000
94,000
Less: Drawings 1,000
93,000