Financial Statements

Shajedul Alam
Senior Lecturer
ULAB School of Business

All businesses prepare financial statements at the end of their financial year to summarize the year’s
transactions and to determine the profit/loss.

There are 4 major financial statements:

1. Trading profit and loss account/Income Statement: Presents the revenues/incomes and
expenses and calculates the resulting profit/loss for the accounting period or year ended.
2. Balance sheet/Statement of Financial Position: Presents the assets, liabilities and capital of the
business on the last day of the year or accounting period.
3. Owner’s equity statement/ Statement of changes in equity: Presents the changes in equity
(capital) during the accounting period or year.
4. Cash flow statement: Presents the cash inflows and outflows during the year or accounting
period and finally presents the closing balance at the end of the year.

Trading profit and loss account/Income Statement

The main purpose of income statement is to present the revenues (Incomes) and expenses in a
predetermined format and to calculate the gross profit and net profit.

What is gross profit?

This is the excess of sales over cost of goods sold

Gross profit= Sales/Revenues – Cost of goods sold

What is cost of goods sold (COGS)?

COGS are the actual cost of the goods that have been sold during the year.

Cost of goods sold and closing inventory/stock

Usually some of the goods purchased (with the intension to sell) may not have been sold by the
end of the accounting period.
So, what we have purchased in this period -------------------------------------- Purchases
Less: Goods bought but not sold------------------------------------------------------(Closing inventory)
= Cost of goods sold

Cost of goods sold= Opening inventory/stock + purchases – purchase returns/ returns outwards –Stock
drawings + carriage inwards/ transport cost – closing inventory

Stock drawings= If the owner takes any goods from the business for personal use.
 Carriage inwards = the transport cost to bring in the goods to the business.

So, gross profit is the profit earned by selling the goods or providing services.
From the beginning up to gross profit, this part of the income statement is also called “Trading
Account”.
Example:
Sales Cost of goods sold Gross profit/(Gross loss)
Tk. 10,500 Tk. 9,300 Tk. 1,200
Tk. 15,430 Tk. 12,200 Tk. 3,230
Tk. 9,200 Tk. 9,620 (Tk. 420)
Other income
There can be some other sources of income/revenue which will be written under the heading of other
income.

What are the other incomes?

i. Discount received: If the business receives any discount from suppliers.

ii. Bad debt recovery: If past years defaulter customers’ payments are recovered. It is treated
as revenue. (What is meant by bad debt? When customers or accounts receivables fail to
pay it is called bad debt. Bad debt is treated as an expense)
iii. Reduction in provision for doubtful debt: If the estimate of future possible bad debt
reduces. (Logically if the estimate increases it will be an expense).
iv. Profit on disposal of non-current assets: If the business makes some profit by selling an
non-current asset
v. Interest/Rent/commission received

Adjusted gross profit= gross profit + other incomes

Example:

Gross profit/(Gross loss) Other revenues Adjusted Gross profit/(Gross loss)

Tk. 1,200 - Tk. 1,200
Tk. 3,230 Tk. 1,200 Tk. 4,430
(Tk. 420) Tk. 620 Tk. 200

Notes on Financial Statements – Shajedul Alam Page 2

Operating expenses

These are the expenses to run the business. It can range from salaries and wages, rent, utility bills,
delivery charges/carriage outwards, trade license fees, interest on loan or the tax paid for the business.

The final profit is called net profit. This is what if left of the gross profit after all other expenses have
been deducted.

Net profit= Adjusted gross profit – operating expenses

Example:
Adjusted Gross profit/(Gross loss) Operating Expenses Net profit/(Net loss)
Tk. 1,200 Tk. 900 Tk. 300
Tk. 4,430 Tk. 3,200 Tk. 1,230
Tk. 200 Tk. 900 (Tk. 700)
Example:
This is the first year of business for A Arif
A Arif
Trial balance as at December 31 2019
Details Dr. Tk. Cr. Tk.
Sales 40,000
Purchases 29,000
Rent 2,400
Utility 1,800
Office expenses 1,000
Office machinery 5,000
Accounts receivables 6,000
Accounts payables 9,000
Bank 16,000
Cash 2,500
Drawings 8,000
Capital 22,700
71,700 71,700
Note: On December 31 2019 the closing inventory was Tk. 3000

First the cost of goods sold figure needs to be calculated

Purchases 29,000
Less: Closing inventory (3,000)
Cost of goods sold 26,000

Notes on Financial Statements – Shajedul Alam Page 3

 The gross profit will be:
Sales 40,000
Less: Cost of goods sold (26,000)
Gross profit 14,000
The net profit will be:
Gross profit 14,000
Less: Expenses
Rent 2,400
Utility 1,800
Office expenses 1,000
Total expenses (5,200)
Net profit 8,800

Notes on Financial Statements – Shajedul Alam Page 4

 Name of the Owner/Organization
Income Statement for the year ended 31 December 2019
Tk Tk Tk
Sales/Revenue/Turnover #####
Less: Return Inwards/Sales returns (###)
Net Sales/Net Turnover #####
Less: Cost of Goods Sold
Opening Stock/Inventory #####
Add: Purchases ######
Less: Return Outward/Purchase returns (###)
Less: Stock drawings/Stock damaged (#)
Net Purchase #####
Add: Carriage Inward ###
Goods available for sale #####
Less: Closing Stock/Inventory (####)
Cost of Sales (####)
Gross Profit ######
Add: Other Income
Reduction in provision for bad debt/doubtful debt ###
Income/gain on disposal of asset ##
Discount received ##
Bad debt recovered #
Interest/Rent/Commission received #
Any other income ##
Total other income ###
Adjusted Gross Profit ######
Less Operating Expenses:
Salaries and wages ###
Rent and rates ###
Carriage Outward/Delivery expenses ###
Bad Debt ###
Increase in Allowance/Provision for doubtful debt #
Depreciation expenses:
Equipment ###
Motor vehicles ###
Fixture, fittings, furniture ###
Building ###
####
Discount Allowed ###
Insurance ###
Motor Expenses ###
Office Expenses ###
Lighting and Heating ###
General Expenses ###
Sundry/Misc. Expenses ###
Total Expenses (####)
Net Profit/Profit for the year (or Net Loss/Loss for the year) ####
Note: All the prepaid expenses will be subtracted from the original accounts and any accrued
or due payment will be added with the account. (Why? Discussed later)

Notes on Financial Statements – Shajedul Alam Page 5

Balance sheet/ Statement of financial position

Balance sheet is now called statement of financial position. It presents the assets, liabilities and
capital/owner’s equity on a specific day of the year, usually the last day of the year. Balance sheet
follows the basic accounting equitation:

C= A - L A= C + L
or
So, the totals of the two sections of the statement of financial position will agree.

Statement of financial position will start with the Non-current Assets section. Here all the non-current
assets will be presented according the life span of the assets. That means land/premises will be at the
top and it will end with motor vehicles. (See the format for detailed presentation).

Non-current Assets are

- Are not bought primarily to be sold

- Are to be used in the business for a long time

The non-current assets will lose their value (except land). The reduction of value of non-current asset is
called Depreciation. Depreciation is subtracted from the non-current assets in the balance sheet.

Current assets are assets that are likely to change in the short term and certainly within twelve months.
These include items held for resale at a profit (Inventory), accounts receivables/ debtors, any prepaid
expense, cash at bank, cash in hand. The current asset’s section will be written in the order of liquidity
from bottom to top. (See the format for detailed presentation)

The liabilities will be divided as Long-term liabilities/Non-current liabilities. This section will present the
liabilities which will be repaid over long period of time which is more than one year. Example: Bank loan,
loan from other businesses, mortgage etc. (See the format for detailed presentation)

The current liability section will present only those liabilities which will be repaid within one year.
Example: Accounts payable/creditor, accrued/due expenses, bank overdraft etc. (See the format for
detailed presentation)

In the Financed by section of the statement of financial position we will present the opening capital of
the year. The current year’s net profit will be added or net loss will be subtracted. Finally the drawings
will be subtracted. This section presents the changes in the capital or equity. (See the format for
detailed presentation)

Notes on Financial Statements – Shajedul Alam Page 6

 Name of the owner/Organization
Statement of Financial Position as at 31 December 2019
Details Tk Tk Tk
Non-Current Assets
Premises/Land ###
Building ###
Less: Accumulated Depreciation (#)
##
Machineries/Equipment ###
Less: Accumulated Depreciation (#)
##
Furniture/Fixtures & Fittings ###
Less: Accumulated Depreciation (#)
##
Motor Vehicles ###
Less: Accumulated Depreciation (#)
##
Total Non-Current Assets ###
Current Assets
Closing Inventory/Stock ##
Accounts/Trade Receivables ###
Less: Allowance for doubtful debt (#)
##
Other receivables: Prepaids #
Bank #
Cash #
Total Current Assets ##
Total Assets ###
Liabilities and Capital
Current Liabilities
Accounts/ Trade Payables #
Other Payables: Accrued expenses #
Bank overdraft #
Total Current Liabilities ##
Non-current Liabilities
Bank Loan #
Notes Payable/ Loan Note #
Total non-current liabilities ##
Total Liabilities ###
Financed by:
Capital ###
Add: Net Profit (or less: Net loss) ##
Less: Drawings (Cash drawings + Goods drawings) (#)
Owner's Capital ##
Total Liabilities and Capital ###

Notes on Financial Statements – Shajedul Alam Page 7

Example (Continued)

A. Arif
Statement of Financial Position as at December 31 2019
Details Tk. Tk. Tk.
Non-current Assets
Office machinery 5,000
Total Non-Current Assets 5,000
Current Assets
Inventory 3,000
Accounts receivable 6,000
Bank 16,000
Cash 2500
Total Current Assets 27,500
Total Assets 32,500
Liabilities and Owner's Equity
Current Liabilities
Accounts payable 9,000
Financed by:
Capital 22,700
Add: Net profit 8,800
Less: Drawings (8,000)
Owner's Capital 23,500
Total Liabilities and Capital 32,500

The highlighted values will be equal in the balance sheet i.e. Total assets= total liabilities + capital.

Why? (A very common interview question)

Because the balance sheet follows the accounting equation. The basic form of the equation is: Assets =
Liabilities + Capital + Owner’s Equity

Notes on Financial Statements – Shajedul Alam Page 8

Exercise 1
From the following trial balance of Shakil Sultan, you are asked to draw up an income statement for the
year ended 31 March 2012 and a balance sheet as at that date.

Details Dr. Cr.

Tk. Tk.
Sales 168,000
Purchases 99,995
Inventory as at 1 April 2011 4,330
Premises 75,000
Equipment 18,500
Carriage inwards 230
Carriage outwards 195
Returns inwards 375
Bank 5,995
Cash in hand 877
Wages 9,500
Insurance 750
Advertising 205
Motor repairs 590
Capital 76,850
Drawings 11,540
Returns outwards 560
Vehicles 12,000
Accounts receivable 8,950
Accounts payable 11,560
Sundries 328
Rent 3,260
Rates 4,350
256,970 256,970

Inventory as at 31 March 2012 was valued at Tk. 11,855

[Net profit= Tk. 56,307, Total Assets= Tk. 133,177]

Notes on Financial Statements – Shajedul Alam Page 9

Adjustments
Supporting accounting concepts

1. Accruals Concept/ Matching Principle

All transactions of the accounting period should be recorded in the ledgers during
that accounting period whenever they take place whether the money is
paid/received or not. In the accounting system the expenses should be matched
with the revenues.
2. Going Concern Concept
It is assumed that a business will continue its operations till the unforeseeable
future i.e. for a very long time. So we have to consider the reduction of value of
non-current assets from one year to another; bad debts etc.

Types of adjusting entries

1. Accrued income/revenue (Asset)

2. Prepaid income or Income received in advance or unearned revenue
(Liability)
3. Prepaid expense or expenses paid in advance (Asset)
4. Accrued/due/unpaid/arrear Expenses: (Liability)
5. Depreciation: Reduction of value of Non-current/fixed assets. Depreciation is non-
cash expenditure.

Reasons of depreciation:

1. Physical factors: Wear &tear; erosion, rot, rust, decay etc.

2. Time factor:
3. Economic factor:
a. Inadequacy
b. Technological Obsolescence

Methods of Depreciation:

1. Straight Line method/ Equal Installment method

2. Reducing balance method/ Diminishing balance method

Notes on Financial Statements – Shajedul Alam Page 10

4 terms related to depreciation:

1. Cost, C= the original price of the asset.

2. Useful economic life, n= the estimated no. of years that the asset will be in use.
3. Scrap value/Disposal value/Residual value/Salvage value, S= the estimated selling price
of the asset at the end of its estimated life.
4. Net Book Value= Cost- Accumulated (total) Depreciation

Calculation in Straight Line Method/Equal Installment method

Per year Depreciation= =

The depreciation of all the years will be same.

Rate= (Per year depreciation/ Cost) x 100

Reducing Balance Method

Rate, r= √

Data for an example:

Cost of a Guitar, C= Tk. 20,000

Estimated useful Life, n= 4 years
Scrap value, S= Tk. 4000
Example of Calculation of Depreciation in both methods:

Details Straight Line Reducing Balance @

@ of 20% of Cost 33% of Net Book Value
Cost Tk. 20000 Tk. 20000
Less: Year 1 Depreciation (4000) (6600)
Book Value at the beginning of year 2 16000 13400
Less: Year 2 Depreciation (4000) (4422)
Book Value at the beginning of year 3 12000 8978
Less: Year 3 Depreciation (4000) (2963)
Book Value at the beginning of year 4 8000 6015
Less: Year 4 Depreciation (4000) (1985)
Net Book Value 4000 4030

Notes on Financial Statements – Shajedul Alam Page 11

Bad debt
When debtors or account receivables do not pay the organization it is called bad debt. Bad debt is
treated as an expense (non-cash expense). The value of the accounts receivables will reduce because of
the bad debt.

Bad debt recovery

When a past bad debt’s money is recovered from the customer or accounts receivable. It is treated as
revenue and the money recovered will be added to cash or bank.

What are provision/allowances for doubtful debt?

This is an anticipated value for future possible bad debts. It is calculated in advance to give a forecast
about the next accounting period’s possible bad debt. It is treated as a contra asset i.e. it is subtracted
from the accounts receivables in the balance sheet to show a true and fair value of assets.

Why do organizations calculate depreciation and bad debts and provision for
doubtful debt?
It is because of the Prudence Concept/Principle of Conservatism. According to this concept all
accounting statement must be based on facts. We should never overstate or understate the value of profit
or assets. The losses incurred or expected to be incurred are to be taken in to account but not all
anticipated profits to be taken into consideration while finding the profit. Similarly while finding the
value of closing stock; least of the two values i.e. market price or cost price is to be taken into account-
“Lower of the cost or net realizable value”.

Interest Calculation:

Simple Interest, I= Prt

Where,
P= principal
R= rate
T= time (in year)

Example: If Tk. 80,000 is borrowed for 9 months @12% per annum then the

Interest= Tk. 80,000 x 12% x 9/12= Tk. 7,200

Notes on Financial Statements – Shajedul Alam Page 12