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CHAPTER
7
PREPARATION OF FINAL
ACCOUNTS OF SOLE
PROPRIETORS
UNIT – 1 FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
LEARNING OUTCOMES
After studying this unit, you would be able to:
 Draw final Accounts of Non- manufacturing entities.
 Learn the relationship between Profit and Loss Account and Balance Sheet.
 Understand the Trading Account items. This will help you to learn which of the transactions and events
should be shown in the Trading Account.
 Understand the items shown in the Profit and Loss Account. By that you will learn the technique of
preparing Profit and Loss Account and deriving the Profit and Loss balance.
 Learn how to adjust outstanding and pre-paid expenses, accrued income and income received in
advance.
 Understand the items to be shown in the balance sheet. Also learn the classification of assets and
liabilities and the order by which they are put in the Balance Sheet.
UNIT OVERVIEW
NON-MANUFACTURING BUSINESS ENTITIES
Final Accounts
Profit & Loss

Trading Account Balance Sheet
Account
© The Institute of Chartered Accountants of India

7.2 PRINCIPLES AND PRACTICE OF ACCOUNTING
1.1 INTRODUCTION
Non-manufacturing entities are the trading entities, which are engaged in the purchase and sale of goods at profit
without changing the form of the goods. In other words, non-manufacturing entities do not process the goods
purchased and sell them in its original form. Meanwhile it indulges in some liabilities, makes some assets and
also incurs some expenses like salaries, stationery expenses, advertisement, rent etc. to run the business. At
the end of the accounting year, the entity must be interested in knowing the results of the business. To ascertain
the final outcome of the business i.e., the income and financial position, they prepare financial statements at the
end of the year.
Financial Statements
Income Statement Positions Statement
Trading Account Profit & Loss Account Balance Sheet
Gross Profit or Gross Position of Assets &

Net Profit or Net Loss
Loss Liabilities
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.
As seen above, through categorization of Financial Statements into Income & Position Statement, the profit or
loss is measured at two levels:
(a) Gross Profit or Gross Loss
(b) Net Profit or Net Loss
The profit or loss of the enterprise is obtained through the preparation of Income Statement i.e Trading and
Profit & Loss A/c
The financial position of the business enterprise is judged by measuring the assets, liabilities and capital of the
enterprise and the same is communicated to the users of financial statements. Financial position of the enterprise
can be known through the preparation of the Position Statement i.e Balance Sheet.
Comparison between Income Statement and Position Statement
Income Statement Position statement
Profit or loss is disclosed in the Income Statement It exhibits assets and liabilities of the business as at
prepared at the close of the financial year the close of the financial year.
Income Statement is sub-divided into following two Apart from balance sheet, to judge financial position
parts for a non-manufacturing concern: of the business, sometimes additional statements are
(i) Trading account; and also prepared like cash flow statement, value added
(ii) Profit and Loss account statement etc. which is not mandatory for non-

3 PREPARATION OF FINAL ACCOUNTS OF SOLE PROPRIETOR 7.3
corporate entities. These additional statements are

prepared for the better understanding of the financial
position of the business.
Income Statement discloses net profit or net loss of Position statement discloses the assets and liabilities
the business after adjusting from the income earned position as on a particular date.
during the year, all the expenditures of the business
incurred in that year.
1.2 PREPARATION OF FINAL ACCOUNTS

The principal function of final accounts (Trading Account, Profit and Loss Account and the Balance Sheet) is to
exhibit truly and fairly the profitability and the financial position of the business to which they relate. In order that
these may be properly drawn up, it is essential that a proper record of transactions entered into by the business
during a particular accounting period should be maintained. The BASIC PRINCIPLES in regard to accumulation
of accounting period data are:
(i) a distinction should be made between capital and revenue receipts and payments;
(ii) also income and expenses relating to a period of account should be separated from those of another
period.
(iii) 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.
Having regard to these basic principles, the various matters to which attention should be paid for determining the
different aspects of transactions, a record of which should be kept, and the different heads of account under
which various items of income and expenditure should be accumulated, are stated below:
(a) Distinction between personal and business income:- Since the final statements of account are
intended to show the profitability of the business and not that of its proprietors, it is essential that all
personal income and expenditure should be separated from business income and expenditure.
(b) Distinction between capital and revenue expenditure:- A distinction should be made between capital
and revenue, both receipts and expenditure. Different types of income and expenditure should be
classified under separate heads. Assets should be included in the Balance Sheet by following accounting
principles and accounting standards. Likewise, a provision for income and expenses which have accrued
but not paid, should be made by estimation or otherwise on the same basis as in the previous year.
(c) All material information to be disclosed:- Every information, considered material for judging the
profitability of the business or its financial position, should be disclosed. For example, when the labour
charges have increased on account of bonus having been paid to workmen, the amount of bonus paid
should be disclosed. Similarly, if some of the items of inventory are not readily saleable, these should
be valued at their approximate net realisable value and the basis of valuation and value of such inventory
should be shown separately.
(d) Record only current period transactions:- Though the record of transactions should be maintained
continuously, at the end of each accounting period, the transactions of the closing accounting period
should be cut off from those of the succeeding period.

(e) Only transactions completed before close of accounts should be given effect:- It should be seen
that only the effect of transactions, which were concluded before the close of period of account, has
been adjusted in the accounts of the year. For example, when a sale of goods is to take place only after
the goods have been inspected by the purchaser and the inspection had not been made before the close
of the year, it would be incorrect to treat the goods as a sale in the accounts of the year.
Inter-relationship of the two statements

One of the points to be remembered is that of total expenditure incurred some type of expenditure appears in the
Profit and Loss Account and some in the Balance Sheet. Consider few examples,
1. Salaries paid is shown on the Dr. side of Profit and Loss Account but outstanding salaries is shown on
liabilities side of Balance Sheet and is added to Salaries.
Profit & Loss A/c
Particulars Amount Particulars Amount
` `
To Salaries 25,000
Add: Outstanding 1,500 26,500
Salaries
Balance Sheet
Liabilities Amount Assets Amount
` `
Outstanding Salaries 1,500
2. When a machine is purchased, that part of it which is attributable to the year considered as depreciation
is debited to the Profit and Loss Account and the balance is shown in the Balance Sheet as an asset.
Profit & Loss A/c
` `
To Depreciation 50,000
Balance Sheet
` `
Fixed Assets 5,00,000
Less:- Depreciation (50,000) 4,50,000
These illustrations show that the two statements, the Profit and Loss Account and the Balance Sheet, are
thoroughly inter-related. The assets shown in the Balance Sheet are mostly only the remainder of the expenditure
incurred after a suitable amount has been charged to the Profit and Loss Account or the Trading Account. For
preparing the two statements properly, it is of the greatest importance that the amounts to be charged to the
Profit and Loss Account should be properly determined as otherwise both statements will show an incorrect
position. The principle that governs this is called the Matching Principle.

Matching Principle
This principle demands that expenses incurred to earn the revenue should be properly matched. This means the
following:
(a) If a certain revenue and income is entered in the Trading / Profit and Loss Account all the expenses
relating to it, whether or not payment has been actually made, should be debited to the Trading / Profit
and Loss Account. This is why at the end of the year an entry is passed to bring into account the
outstanding expenses. That is also the reason why the opening inventory of goods is debited to the
Trading Account since the relevant sale is credited in the same account.
(b) If some expense has been incurred but against it sale will take place in the next year or income will be
received next year, the expense should not be debited to the current year’s Profit and Loss Account but
should be carried forward as an asset and shown in the Balance Sheet. It will be debited to the Profit
and Loss Account only when the relevant income will also be credited. The same reason applies to
depreciation of assets also. The part of the cost which is used to earn current year revenue is debited in
same year.
(c) If an income or revenue is received in the current year but the work against it has to be done and the
cost in respect of it has to be incurred next year, i.e. income received in advance the income or the
revenue is considered to be of next year. It should be shown in the Balance Sheet on the liabilities side
as “income received in advance” and should be credited to the Profit and Loss Account of the next year.
E.g. Newspapers or magazines usually receive subscriptions in advance for a year. The part of
subscription that covers copies to be supplied in the next year is treated as income received in advance.
An exception
There appears to be one exception to the rule that only such costs as have yielded or is expected to yield revenue
should only be debited to Profit and Loss Account. For example, if a fire has occurred and has damaged the
firm’s property the loss must be debited to the Profit and Loss Account to the extent it is not covered by insurance.
A loss, resulting from the fall of selling price below the cost or from some debts turning bad, must similarly be
debited to the Profit and Loss Account. If this is not done the profit will be over-stated.
(NOTE: - The relevant entries and adjustments regarding the above three items are discussed in detail later in
this unit.)
1.3 TRADING ACCOUNT

At the end of the year, as has been seen above, it is necessary to ascertain the net profit or the net loss. For this
purpose, it is first necessary to know the gross profit or gross loss. Gross Profit is the difference between the
selling price and the cost of the goods sold. For a trading firm, the cost of goods sold can be ascertained by
adjusting the cost of goods still on hand at the end of the year against the purchases. It is done as follow:-
Opening Stock ***
Add:- Purchases (Net) **
Add:- Direct Expenses **
***
Less:- Cost of Goods Sold (**)
Closing Stock ***

Suppose, in the first year, the net purchases (that is after deducting returns) total `1,00,000 and that `15,000
worth of goods (at cost) were not sold at the end of the year. The cost of the goods sold will then be ` 85,000. If
in the next year purchases are `1,50,000 and the cost of goods sold is ` 1,45,000 the closing stock will be
` 20,000 calculated as follows:
`
Cost of unsold goods at the beginning of the year 15,000
Purchases during the year 1,50,000
1,65,000
Less: Cost of sold goods during the year 1,45,000
Closing Stock (20,000)
Gross profit is usually ascertained by preparing a Trading account. The format of Trading Account can be shown
as below:-
Trading Account of…..for the year ended…..
` `
To Opening Stock XXX By Sales XXX XXX
To Purchases XXX Less: Returns Inwards XXX XXX
Less: Returns outwards XXX XXX By Closing Stock
To Direct expenses: XXX By Gross Loss c/d*
Freight & Carriage XXX
Customs & Insurance XXX
Wages XXX
Gas, Water & Fuel XXX
Factory Expenses XXX
Royalty on production XXX XXX
XXX XXX
To Gross Profit c/d*
*Only one will appear
If in the above example net sales, i.e., after adjustment for sales returns, is ` 2,00,000 then the gross profit will
be ` 55,000, i.e., `2,00,000 – ` 1,45,000. This profit is called gross profit since from it indirect expenses have
still to be deducted for knowing the net profit. Now, for the same example Trading account will appear as follows:-
Trading Account for the year ending
` `
To Opening Inventory 15,000 By Sales Account 2,00,000
To Purchase Account 1,50,000 By Closing Inventory 20,000
To Gross Profit carried to P & L A/c 55,000
2,20,000 2,20,000

Point to Remember:-
♦ The opening inventory and purchases are written on the debt side.
♦ Sales and the closing inventory are entered on the credit side.
♦ If there are any direct expenses then they should also be written on the debit side of the Trading account.
♦ If the balances of credit side is more, the difference is written on the debit side as gross profit. This
amount will also be carried forward to the Profit and Loss Account on the credit side.
♦ In case of gross loss, i.e., when the debit side of the Trading Account exceeds the credit side, the amount
will be written on the credit side of the Trading Account and transferred to the debit side of the Profit
and Loss Account.
Trading Account Items

In a trading firm like a wholesaler, the main business consists of buying and selling the same goods. In addition
to the amount of the opening inventory, the trading account will also be debited with all expenses incurred in
bringing the goods to the godown of the firm and in making them ready for sale.
For example, freight paid on purchases, cartage, octroi, etc. will all be debited to the Trading Account. The rule
is that this account will be debited with all expenses incurred in bringing the goods to their present location and
condition.
We shall now consider individual items:
(1) Opening Inventory: Since this was closing inventory of the last year, it must have been entered in the
opening inventory account, through the 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 inventory.
Trading A/c Dr.
To Opening Stock A/c
(2) Purchases and Purchase Returns: The purchases account will have debit balance, showing the gross
amount of purchases made of the materials. The purchase returns account will have credit balance
showing the return of materials to the supplier. On the debit side of the trading account the net amount
is shown as indicated (with assumed figures) :
`
To Purchases 3,00,000
Less : Purchase Returns (10,000)
2,90,000
Closing entry for this purpose is follows:
Purchases Return A/c Dr.
To Purchases A/c
(This Net Purchases is transferred to Trading account)

Trading a/c Dr.

To Purchase a/c
It happens sometimes that goods are received but the relevant invoice is not received from the supplier.
On the date of the closing of the account, an entry must be passed to debit the purchases account and
credit the supplier with the cost of goods.
(3) Carriage or Freight Inwards/Freight: This item should also be debited to the Trading Account, as it is
incurred to bring the materials to the firm’s godown and make them available for use. However, if any
freight or cartage is paid on any asset, like machinery, it should be added to the cost of the asset and
not debited to the Trading Account.
Trading a/c Dr.
To Carriage or Freight Inwards
(4) Wages: Wages paid to workers in the godown/stores, should be debited to the Trading Account. If any
amount is outstanding, it must be brought into books so that full wages for the period concerned are
charged to the Trading Account. However, if wages are paid for installation of a fixed asset, it should be
added to the cost of the asset.
Trading a/c Dr.
To Wages
(5) Sales and Sales Returns: The sales account will have a credit balance indicating the total sales made
during the year. The sales return account will have a debit balance, showing the total amount of goods
returned by customer The net of the two amounts is entered on the credit side of the Trading Account.
Sales A/c Dr.
To Sales return
To Trading A/c
Sometimes, goods are sold on approval basis that is when the the customer has the right to return the
goods with in stipulated period in that case the sale entry should be reversed. It is discussed later in
detail..
(6) Closing Inventory and its valuation: 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 gross profit, the closing Inventories
must be properly taken and valued.
The entry is
Closing Inventory Account Dr.
To Trading Account
Alternatively, Closing Inventory can be adjusted with purchases :
To Purchases Account

The effect of this entry is to reduce the debit in the Purchases Account. The closing inventory is also shown in
balance sheet on Assets side.
If Closing Stock appears in the Trial balance:-
The closing inventory is then not entered in the trading account, it is shown only in the balance sheet.
This is because it has already been adjusted to arrive at Cost of Goods Sold.
To ascertain value of the closing inventory, it is necessary to make a complete inventory or list of all the items in
the godown together with quantities. Of course, damaged or obsolete items are separately listed. To the list of
finished goods, one should also add the goods lying with agents sent to them on consignment basis and also the
goods sent on approval to customer.
The valuation principle is cost or net realisable value whichever is lower.
Taking inventory is quite a lengthy process. Strictly, immediately at the end of the year the taking of inventory
should be completed. Sometimes, however this is done either a few weeks before or a few weeks after the
closing. In such a case the value of the inventory thus taken must be adjusted to relate it to the closing date. The
adjustment will be necessary because, in the meantime, purchases and sales must have been made. The main
point to remember is that in respect of sales their cost has been established. Cost will be sales less gross profit.
Except entries mentioned in (ii) above, the other entries are usually summarised as follows:
(1) Trading Account Dr.
To Opening Inventory Account
To Purchases Account
To Wages Account
To Freight on Purchases Account, etc.
(2) Sales Account Dr.
To Trading Account
At this stage Trading Account will reveal the gross profit, if the credit side is more, or gross loss if the credit side
is less. The gross profit will be transferred to the Profit and Loss Account by the entry:
Trading Account Dr.
To Profit and Loss Account
The entry for gross loss, if there be any is :
Profit and Loss Account Dr.
To Trading Account

ILLUSTRATION 1
Trial Balance for the financial year (FY) ended 31st March 2020 of M/s Deepakshi shows following details:
Particulars Debit (`) Credit (`)

Purchase & Sales 10,00,000 12,00,000
Debtors & Creditors 5,00,000 4,00,000
Opening Stock 2,00,000
Closing Stock 3,00,000
Other Expenses & Incomes 7,00,000 9,00,000
Fixed Assets & Long Term Liabilities 25,00,000 6,00,000
Capital 21,00,000
52,00,000 52,00,000
Additional Information: Creditors balance as on 1st April, 2019 is ` 3,00,000.

You are required to calculate cost of goods sold and amount paid to creditors during the year.
SOLUTION
i) Calculation of Cost of Goods sold:
Particulars `
Opening Stock 2,00,000
Add: Purchases (Closing stock already adjusted)* 10,00,000
Cost of Goods Sold 12,00,000
*Since, closing stock appears in Trial Balance, it means following entry has already been passed in
books:
Closing Stock A/c Dr. 3,00,000
To Purchases A/c 3,00,000
So, we can see purchases have already been reduced by the amount of unsold stock, therefore no more
adjustment needs to be made on account of closing stock for computing Cost of goods sold (COGS).
ii) Calculation of amount paid to creditors:
Date Particulars ` Date Particulars `

31.3.20 To Bank A/c (Balancing Figure) 12,00,000 1.4.20 By Balance b/d 3,00,000
To Balance c/d 4,00,000 By Purchases A/c 13,00,000
(Note:1)
16,00,000 16,00,000
Note: 1) Purchases made during the year can be computed as:

Particulars `
Purchases as per Trial Balance 10,00,000
Add: Closing Stock already adjusted 3,00,000
Purchases made during the year 13,00,000
Students may note that in case Closing Stock is not mentioned in Trial Balance, then it means Opening
Stock and Purchases appearing in Trial Balance include the value of unsold stock. Since, we prepare
our financial statements using matching concept such unsold stock should not form part of cost and
therefore is deducted. Therefore, in this case to compute Cost of goods sold (COGS) we will have to
use:
COGS = Opening Stock +Purchases – Closing Stock – Purchase Returns
ILLUSTRATION 2
`
Opening Inventory 1,00,000
Purchases 6,72,000
Carriage Inwards 30,000
Wages 50,000
Sales 11,00,000
Returns inward 1,00,000
Returns outward 72,000
Closing Inventory 2,00,000
Required
From the above information, prepare a Trading Account of M/s. ABC Traders for the year ended 31st March,
2020 and Pass necessary closing entries in the journal proper of M/s. ABC Traders
SOLUTION
In the books of M/s. ABC Traders
Trading Account for the year ended 31st March, 2020
` ` ` `
To Opening Inventory 1,00,000 By Sales 11,00,000
To Purchases 6,72,000 Less : Returns Inward (1,00,000) 10,00,000
Less : Returns outward (72,000) 6,00,000 By Closing Inventory 2,00,000
To Carriage Inwards 30,000
To Wages 50,000
To Gross profit 4,20,000
12,00,000 12,00,000

Journal Proper in the Books of M/s. ABC Traders

Date Particulars Amount Amount
2020 ` `
Mar. 31 Returns outward A/c Dr. 72,000
To Purchases A/c 72,000
(Being the transfer of returns to purchases account)
Sales A/c Dr. 1,00,000
To Returns Inward A/c 1,00,000
(Being the transfer of returns to sales account)
Sales A/c Dr. 10,00,000
To Trading A/c 10,00,000
(Being the transfer of balance of sales account to trading
account)
Trading A/c Dr. 7,80,000
To Opening Inventory A/c 1,00,000
To Purchases A/c 6,00,000
To Wages A/c 50,000
To Carriage Inwards A/c 30,000
(Being the transfer of balances of opening Inventory, purchases
and wages accounts)
Closing Inventory A/c Dr. 2,00,000
(Being the incorporation of value of closing Inventory)
Trading A/c Dr. 4,20,000
To Gross Profit 4,20,000
(Being the amount of gross profit)
Gross profit Dr. 4,20,000
To Profit and Loss A/c 4,20,000
(Being the transfer of gross profit to Profit and Loss Account)

1.4 PROFIT AND LOSS ACCOUNT

The Profit and Loss Account starts with gross profit on the credit side. If there is gross loss, it will be written on
the debit side. After that all those expenses and losses, which have not been entered in the Trading Account, will
be written on the debit side of Profit and Loss Account. Incomes and gains, other than sales, will be written on
the credit side.
If we understand word ‘expenses’ properly, there should be no difficulty in distinguishing between items that will
be debited to the Profit and Loss Account and those that will be shown as Assets in the balance sheet. Further,
it may be noted that the expenses which are personal in nature will not be charged to Profit and Loss A/c. Only
those revenue expenses and losses which are related to the current year, are debited to Profit and Loss Account.
It is desirable, according to modern thinking that the Profit and Loss Account should be prepared in such a manner
as will enable the reader to form a correct idea about the profit earned or loss suffered by the firm during the
period together with the significant factor. Too many details will prevent a person from knowing properly the
factors leading to the profit earned. Therefore, items should be according to the various functions, such as
administrations, selling and financing. The profit/loss A/c appears as follows:-
Dr. Profit and Loss Account for the year ended Cr.
Particulars ` Particulars `
To Gross Loss b/d By Gross Profit b/d
Management expenses Other Income
To Salaries (administrative) By Discount Received
To Office rent, rates and taxes By Commission Received
To Printing and stationery Non-trading Income
To Telephone charges By Bank Interest
To Postage and telegrams By Rent of property let-out
To Insurance By Dividend from shares
To Audit Fees Abnormal Gains
To Legal Charges By Profit on sale of machinery
To Electricity Charges By Profit on sale of investment
Maintenance expenses
To Repairs & renewals By Net Loss (transferred to capital A/c)
To Depreciation on:
Office Equipment
Office Furniture
Office Buildings
Selling and Distribution expenses
To Salaries (selling staff)
To Advertisement

To Godown rent
To Carriage Outward
To Bad Debts
To Provision for bad debts
To Selling commission
Financial expenses
To Bank charges
To Interest on loans
To Discount on bills
To discount allowed to customers
Abnormal Losses
To Loss on sale of machinery
To Loss on sale of investment
To loss by fire
To Net Profit (transferred to Capital A/c)
Note:
(i) Gross loss appears in the debit side of the Profit and Loss Account at the top; while Gross Profit on the
credit side.
(ii) Net loss appears in the credit side of the Profit and Loss Account; while Net profit on debit side as
balancing figures.
It will be good idea to either show these expenses in a separate schedule or to indicate the total of these
prominently in the Profit and Loss Account. This rule should be followed wherever the number of items is rather
large.
On the income side of the Profit and Loss Account, besides the gross profit, there may be interest received,
discount received, rent from subletting of premises, miscellaneous incomes such as from sale of junk material
etc., It would be desirable to show the totals only under each of the main categories of income. However, interest
on fixed deposits, interests or income from investments and other interest should be shown separately. Similarly,
items which have to be debited/credited to the proprietor should be segregated from other items. Examples would
be interest charged on drawings, interest allowed on capital and charges for services rendered by the firm to the
proprietor personally.
We shall now consider a few items individually:
(i) Drawings: Drawings are not expenses for the firm but reduction of capital and therefore should not be
debited to the Profit and Loss Account but to Capital account of the proprietor.
Capital A/c Dr.
To Drawings

If the proprietor has enjoyed some benefit personally, like use of the firm’s car, a suitable amount
should be treated as drawing and to that extent the charge to the Profit and Loss Account will be reduced,
Drawings are debited to the proprietor’s capital account.
(ii) Income Tax: In case of companies, the income tax payable is treated like other expenses. But in the
case of sole proprietorship, income tax is treated as a personal expense. It is debited to the Capital
Account and not to the Profit and Loss Account.
Capital A/c Dr.
To Income Tax A/c
This is because the amount of the tax will depend on the total income of the partners or proprietor besides
the profit of the firm. In case of partnership business, firm’s tax liability is to be debited to profit and loss
account of the firm but partners’ tax liability are not to be borne by the firm. Therefore if the firm pays
income tax on behalf of partners, such payment of personal income tax should be treated as drawings.
(iii) Discount received and allowed: We have already seen that discount is of two types. Trade discount
and Cash discount. Trade discount is allowed when the order for goods is not below a certain figure. It
is deducted from the invoice. Only the net amount of invoice is entered in books. There is no further
treatment of the trade discount. Cash discount is allowed to a customer if he makes the payment before
a certain date. It is allowance made to him for prompt payment and is recorded in the books. Therefore,
Trade discount is not debited to P/L account, but cash discount is.
Discount received is really in the nature of interest received and similarly, discount allowed really means
interest paid. Discount received is a gain and is credited to the Profit and Loss Account while discount
allowed is debited.
Profit/Loss A/c Dr.
To Discount Allowed A/c
Discount Received A/c Dr.
To Profit/Loss A/c
(iv) Rebate: It is the allowance given to a customer when his purchases during a period, say one year, total
upto a certain figure. Suppose a firm allows a rebate of 4% to those customers whose purchases during
the year are at least ` 5,000. One Customer’s purchases are ` 4,500, he will not get any rebate. Another
customer’s purchases total ` 5,100, he will get a rebate of ` 204. The entry for rebate is made only at
the end of the year. The Rebate Account is debited and is later written in the profit and Loss Account on
the debit side. Various customers who have earned the rebate are credited.
Initially when Rebate is given
Rebate A/c Dr.
To Customer A/c
In the year end
Profit/Loss A/c Dr.
To Rebate A/c

(iv) Bad Debts: When a customer does not pay the amount due from him and all hopes of recovering the
amount are lost, it is said to be a bad debt. It is a loss to the firm. Therefore, the bad debts account is
debited, which is later on written in the Profit and Loss Account on the debit side. Since it is no use
showing the amount due still as an asset, the account of the customer concerned is closed by being
credited. The entry
Bad Debts Account Dr.
To Debtor’s / Customer (by name) Account
Profit/Loss Account Dr.
To Bad Debts A/c
In case of Provision for Bad debts has already been prepared then bad debts should be written off first
from it. Entry for it will be:
Provision for Bad Dents A/c Dr.
To Bad Debts A/c
If later on, the amount is recovered, it should be treated as a gain. It should not be credited to the party
paying it. It should be credited to Bad Debts Recovered Account. It will be entered in the Profit and Loss
Account on the credit side.
Bad Debts Recovered Account Dr.
To Profit/Loss Account
CLOSING ENTRIES
The entries that have to be made in the journal for preparing the Trading and the Profit and Loss Account that is
for transferring the various accounts to these two accounts are known as closing entries. We have already seen
the entries required for preparing the Trading Account and for transferring the gross profit to the profit and Loss
Account. Now to complete the Profit and Loss Account, the under mentioned three entries will be necessary.
(a) For items to be debited to the Profit and Loss Account this account will be debited and the various
accounts concerned will be credited. For example,
To Salaries Account
To Rent Account
To Interest Account
To Other Expenses Account
(b) Items of income or gain such as interest received or miscellaneous income will be credited to Profit and
Loss Account.
Discount Received Account Dr.
Bad debts Recovered Account Dr.

(c) At this stage, the Profit and Loss Account will show net profit or net loss. Both have to be transferred to
the Capital Account. In case of net profit, i.e., when the credit side is bigger than the debit side, the entry
is:
To Capital Account
In the case of net loss, the entry will be
Capital Account Dr.
ILLUSTRATION 3
Revenue, Expenses and Gross Profit Balances of M/s ABC Traders for the year ended on 31st March 2020 were
as follows:
Gross Profit ` 4,20,000, Salaries ` 1,10,000, Discount (Cr.), ` 18,000, Discount (Dr.) ` 19,000, Bad Debts
` 17,000, Depreciation ` 65,000, Legal Charges ` 25,000, Consultancy Fees ` 32,000, Audit Fees ` 1,000,
Electricity Charges `17,000, Telephone, Postage and Telegrams ` 12,000, Stationery ` 27,000, Interest paid
on Loans ` 70,000.
Required
Prepare Profit and Loss Account of M/s ABC Traders for the year ended on 31st March, 2020. Show necessary
closing entries in the Journal Proper of M/s. ABC Traders also.
SOLUTION
In the Books of M/s. ABC Traders
Profit and Loss Account for the year ended 31st March, 2020
` `
To Salaries 1,10,000 By Gross Profit 4,20,000
To Legal Charges 25,000 By Discount received 18,000
To Consultancy Fees 32,000
To Audit Fees 1,000
To Electricity Charges 17,000
To Telephone, Postage &Telegrams 12,000
To Stationery 27,000
To Depreciation 65,000
To Discount Allowed 19,000
To Bad Debts 17,000
To Interest 70,000
To Net Profit 43,000
4,38,000 4,38,000

Journal Proper in the Books of M/s. ABC Traders

Date Particulars Amount Amount
2020 ` `
March 31 Profit & Loss Account Dr. 3,95,000
To Salaries A/c 1,10,000
To Legal Charges A/c 25,000
To Consultancy Fees A/c 32,000
To Audit Fees A/c 1,000
To Electricity Charges A/c 17,000
To Telephone, Postage & Telegrams A/c 12,000
To Stationery A/c 27,000
To Depreciation A/c 65,000
To Discount Allowed A/c 19,000
To Bad Debts A/c 17,000
To Interest A/c 70,000
(Being the transfer of balances of various expenses accounts)
Discount Received A/c Dr. 18,000
To Profit & Loss A/c 18,000
(Being the transfer of discount received account balance)
Gross Profit A/c Dr. 4,20,000
To Profit & Loss A/c 4,20,000
(Being the transfer of gross profit from Trading Account)
Profit & Loss A/c Dr. 43,000
To Net Profit A/c 43,000
(Being the ascertainment of net profit)
Net Profit A/c Dr. 43,000
To Capital A/c 43,000
(Being the transfer of net profit to Capital A/c)
Adjustments
The fundamental principle of accounting is that the period to which various items of income and expenditure
pertain should be co-extensive with the period of account. As such before Final Accounts are drawn up. It must
be ensured that the accounts, which require adjustment on this consideration, have been adjusted, both by
providing for expense accrued and including income outstanding and excluding expenses the benefit of which
extends beyond the year of account as well as the income received in advance. The entries that must be passed
for adjusting various accounts of income and expenditure are shown below:

(1) Expenses accrued and accruing, e.g., Rent, Interest, Local Taxes, Wages etc.
Appropriate Expense Account Dr.
To Expenses Accrued/outstanding Account
For Example, if Rent Paid is ` 50,000 for a year and Outstanding Rent is ` 14,000. It will be treated as
follows:-
Profit/Loss Account
` `
To Rent 50,000
Add: Outstanding Rent 14,000 64,000
Balance Sheet
Liabilities Amount Assets Amount `
`
Outstanding Rent 14,000
(2) Income accrued and accruing, e.g., Interest on Government Loans, Discounts on Bill, Professional fees,
Rents and Premiums on leases, etc.
Interest/Fees etc. Accruing Account Dr.
To Appropriate Income Account
Suppose interest received is ` 1,50,000 and accrued interest for the same period is ` 45,000. It will be
treated as follows:-
Profit/Loss Account
` `
By interest 1,50,000
Add: Accrued Interest 45,000 1,95,000
Balance Sheet
` `
Accrued Interest 45,000
Notes:
(1) The term “accrued” signifies that an amount has been incurred as expense or earned as income,
the due date of payment of which falls in the next accounting period. If the due date of payment occurs
in the current accounting period the term used should be outstanding” or accrued and due”.

(2) The expression accrued and accruing’ signifies items which though not due for payment but pertain
to the period of account, a provision for which has been made. Converse is the position so far as items
of income are concerned.
(3) Carrying forward income received in advance e.g., Subscription in the case of a club or fees in case
of professional person.
Appropriate Income Account Dr.
To Income Received in Advance Account
For Example Subscription Received in advance is ` 70,000 and total subscription received is ` 1,75,000.
Profit/Loss Account
` `
By subscription 1,75,000
Less: Advance (70,000) 1,05,000
Balance Sheet
` `
Advance Subscription 70,000
(4) Carrying forward of payments made in advance e.g., Telephone, Rent, Insurance etc.,
Expenses Prepaid Account Dr.
To Appropriate Expenses Account
Suppose out of the total Rent of ` 50,000, ` 14,000 pertains to the next year.
Profit/Loss Account
` `
To Rent 50,000
Less: Prepaid Rent (14,000) 36,000
Balance Sheet
` `
Prepaid Rent 14,000
(5) Adjustment of Inventory of materials in hand, e.g., Stationery, Advertisement, Material,

Manufacturing Stores, etc., the cost whereof already has been debited to expense account.
Inventory of Materials Dr.
To Appropriate Expenses Account

For Example, if opening stock of stationery is ` 15,000 and direct expenses on it is ` 1,700. It is also
given outside the Trial Balance. Closing stock of stationery is ` 5,000. The treatment is as follow:-
Profit/Loss Account
` `
To Stationery:
Opening stock 15,000
Add: Expenses 1,700
Less: Closing Stock (5,000) 11,700
Balance Sheet
` `
Closing Stock 5,000
Note: Next year in the beginning entries No. (1) to (5) should be reversed.
(6) Provision for Bad and doubtful Debts: When it is feared that some of the amount due from customers
will not be collected it is prudent to recognise the expected loss by reducing the current year’s profit and
placing the amount to the credit of a special account called “Provision for Bad and Doubtful Debts
Account”. The entry is;
To Provision for Bad and doubtful Debts Account
Note: The accounts of the customers concerned are not affected until the amount is actually written off
for which the entry is,
Bad Debts Account Dr.
To Customer’s A/c
Bad Debts when written off are debited to the provision in this respect where such a provision exists or
directly to the Profit and Loss Account the corresponding credit being given (ultimately) to the trade
receivable’s account. If, on the other hand, a provision is required to be created, the amount of provision
is also debited to the Profit and Loss Account. Where an examination problem requires that certain bad
debts should be written off and a provision for doubtful debts made, the amount of bad debts to be written
off should be first debited against the existing balance of the provision and the resulting balance in the
account afterwards should be raised to the required figure. The method is illustrated below:
ILLUSTRATION 4
On 1st April 2020 provision for Doubtful Debts existed at ` 40,000. Trade receivables on 31.03.2020
were ` 15,00,000; bad debts totalled ` 1,00,000. It is required to write off the bad debts and create a
provision equal to 5% of the Trade receivables’ balances.
Show how you would compute the amount debited to the Profit and Loss Account.

SOLUTION
PARTICULARS `
Opening Provision (Cr.) 40,000
Bad Debts written off (Dr.) 1,00,000
Short Provision 60,000
Provision required (Dr.) (5% of `14,00,000) 70,000
Additional amount required for debit to the Profit and Loss Account (Dr.) 1,30,000
The account will appear as follows:

Provision for Doubtful Debts Account
` `
March 31, To Bad Debts Account 1,00,000 April 1, By Balance b/d 40,000
2020 2019
To Balance c/d (required) 70,000 March 31, By Profit and Loss A/c 1,30,000
2020 (Balancing Figure)
1,70,000 1,70,000
April 1, By Balance b/d 70,000
2020
(7) Provision for Discount: This provision is created in the same manner, discussed above but the amount
of provision is required to be calculated after deducting the Provision for Bad Debts from the total trade
receivables. This is because Provision for discount is created only on good debtors.
For Example, if Trade Receivables is ` 5,20,000 and provision for doubtful debt is ` 1,20,000. You are
required to create a 10% provision for discount on debtors.
Profit/Loss Account
` `
To Provision for Discount 40,000
(10% of 4,00,000)
Balance Sheet

` `
Debtors 5,20,000
Less:- Provision for (1,20,000)
Doubtful debts
Less:- Provision for (40,000) 3,60,000
Discount

(8) Provision for Depreciation: It is made either by debiting Depreciation Account and crediting the
Provision for depreciation account concerned and afterwards closing of the Depreciation Account by
transfer to the Profit and Loss Account or by directly debiting the profit and loss Account and crediting
provision for depreciation account and explaining the nature of adjustment by recording a detailed
narration in the Journal.
Profit/Loss account Dr.
To Depreciation/Provision for depreciation.
The amount of depreciation is deducted from the concerned asset and is then shown in the Balance
sheet.
For Example if machinery Cost ` 15,00,000 and 10% depreciation is to be provided. The treatment is as
follow:-
Depreciation a/c Dr. ` 1,50,000
To Provision for Depreciation a/c ` 1,50,000
Depreciation is now charged to P&L a/c as:
Profit/Loss Account
` `
To Depreciation 1,50,000
Balance Sheet
` `
Machinery 15,00,000
Less: Provision
for Depreciation (1,50,000) 13,50,000
(9) Other Provisions: Whenever it is expected that a loss, the amount of which is not certain will occur, the
proper course is to create a provision for meeting the loss if and when it occur. This would be the case,
for example, if compensation has to be paid for the late delivery of goods. The entry is to debit the Profit
and Loss Account and credit an account suitably named.
All accounts showing provisions may appear in the Balance Sheet on the liability side but it should be
noted that:
(i) The provision for Bad and Doubtful Debts and the Provision for Discount on Trade receivables
are deducted from the total book debts; and
(ii) The provision for Depreciation is deducted from the cost of the assets concerned.
(10) Transfers, involving correction of errors, are made by debit or credit to the accounts affected, the
corresponding effect being recorded either in a Suspense Account of some other account.

Transfers in respect of special charges to the Profit and Loss Account e.g., partner’s salaries, interest,
etc., and in respect of appropriation of profits are recorded by debit to the Profit and Loss Account and
credit to the parties concerned.
While making adjustments, it is important to remember that every entry has a two-fold aspect, debit and
credit. For example, if an adjustment is required to be made on account of prepaid insurance charges,
the Insurance Charges Account would be credited, and, to complete the double entry, Prepaid Expenses
Account is debited with the same amount. The last mentioned balance would be included on the debit
side of the Trial Balance.
Students should, as a matter of course, record on the rough working sheets, adjustments in respect of
various items stated in a question and then give their effect in the Trial Balance, before proceeding to
draw up the Final Accounts.
1.5 CERTAIN ADJUSTMENTS AND THEIR TREATMENTS

1. Abnormal loss of Inventory by accident or fire: Sometimes loss of goods occurs due to fire, theft,
etc. If due to accident or fire, a portion of Inventory is damaged, the value of loss is first to be ascertained.
Thereafter, Abnormal Loss Account is to be debited and Purchase Account or Trading Account is to be
credited.
Abnormal Loss Account is to be transferred to Profit & Loss Account. If amount of loss is recoverable
from insurance company, then insurance company is to be debited instead of Profit & Loss Account. Till
the money is not received from the insurance company, Insurance Company’s Account will be shown in
the Assets side of the Balance Sheet. If any part of the loss is recoverable from the insurance company,
then the portion not compensated by the insurance company should be debited to Profit & Loss Account.
For example, if goods worth ` 6,000 are destroyed by fire and the insurance company admits the claim
for ` 4,500, the Journal entries will be:-
(i) Loss by Fire Account Dr. 6,000
To Purchases/Trading Account 6,000

(ii) Insurance Company’s A/c (Insurance Claim) Dr. 4,500
Profit & Loss A/c Dr. 1,500
To Loss by Fire A/c 6,000
Profit/Loss Account
` `
To Loss by Fire 1,500
(The amount not compensated by
insurance company)

Balance Sheet
` `
Insurance Claim 4,500
In the Trading Account, Purchases will be reduced by 6,000.
2. Goods sent on Approval basis: Sometimes goods are sold to customers on sale or return basis or on
approval basis. It should not be treated as actual sale till the time it is not approved by the customer.
When goods were sold we have passed the entry for actual sales. Therefore, at the year end, if the
goods are still lying with the customers for approval, following entries are to be passed:
For example -
Goods costing `10,000 sent to a customer on sale or return basis for `12,000. The entry for such
unapproved sale shall be-
(i) Sales A/c Dr. 12,000
To Trade receivables A/c 12,000
(ii) Stock on approval A/c Dr. 10,000
To Trading A/c 10,000
These goods should now be included in the amount of Closing Stock at their cost price.
3. Goods used other than for sale: Sometimes goods are used for some other purposes, such as
distributed as free samples, used in construction of any assets or used by proprietor for personal use.
In such cases the amount used for other purposes is subtracted from Purchases A/c and depending
upon the specific use done, the suitable account head is debited.
For example:-
When goods are given away as donation-
Donation A/c Dr.
To Purchases A/c
When goods are used by the proprietor for his personal use-
Drawings A/c Dr.
To Purchases A/c
When goods are distributed as free samples :-
Free Samples / Advertisement A/c Dr.
To Purchases A/c
When goods are used in business for construction of Building or the Machinery :-
Building A/c / Plant & Machinery A/c Dr.
To Purchases A/c

When goods are used for maintenance of business premises/ Machinery: -

Repair & Maintenance A/c Dr.
To Purchases A/c
4. Commission based on profit: Sometimes commission is payable to manager based on net profit; in
such a case calculation is done as follows:
(i) Commission on net profit before charging such commission =
Rate of commission
Profit before commission x
100
(ii) Commission on net profit after charging such commission =
Rate of commission
Profit before commission x
100 + Rate of commission
Commission is recorded by following journal entry
Commission A/c Dr.
To Commission Payable A/c
(Being commission payable to Mr ….. @ …..% on net profit after charging such commission, net
profit before charging commission being `……..)
Commission will be debited in the Profit & Loss Account and Commission Payable Account will be shown
in the Balance Sheet on liability side.
Profit/Loss Account Dr.
To Commission A/c
For Example if Net profit before Commission is ` 1,00,000 and Manager is entitled to a Commission of
10% of Net Profit before charging such commission. The amount of Commission is = ` 10,000 (10% of
` 1,00,000). It will be shown as follow:-
Profit/Loss Account
` `
To Commission 10,000
To Net Profit transferred to Capital A/c 90,000
Balance Sheet
` `
Commission Payable 10,000
Now, let us assume that 10% commission is payable on Net Profit after charging such commission. The
amount of commission now is = 9,090.90 or 9091 (approx) (` 1,00,000 x 10/110)

ILLUSTRATION 5
The following is the Trial Balance of C. Wanchoo on 31st Dec. 2020.
Trial Balance on 31st December, 2020
Particulars ` `
Capital Account 10,00,000
Inventory Account 2,00,000
Cash in hand 1,44,000
Machinery Account 7,36,000
Purchases Account 18,20,000
Wages Account 10,00,000
Salaries Account 10,00,000
Discount Allowed A/c 50,000
Discount Received A/c 30,000
Sundry Office Expenses Account 6,00,000
Sales Account 50,00,000
Sums owing by customer (Trade receivables) 8,50,000
Trade payables (sums owing to suppliers) 3,70,000
Total 64,00,000 64,00,000
Value of Closing Inventory on 31st March, 2020 was ` 2,70,000
Prepare closing entries for the above items and Prepare Trading and Profit and Loss Account.
SOLUTION
Date Particulars L.F. ` `
2020
March 31 Trading Account Dr. 30,20,000
To Inventory Account 2,00,000
To Purchase A/c 18,20,000
To Wages A/c 10,00,000
(Being the accounts in the Trial Balance which have
to be transferred to the Trading Account debit side)
March 31 Sales Account Dr. 50,00,000
(Being the amount of Sales transferred to the credit
of Trading Account)
March 31 Inventory (Closing) A/c Dr. 2,70,000
(Being the value of Inventory on hand on 31st
Dec. 2016)

March 31 Trading A/c Dr. 22,50,000

To Profit and Loss A/c 22,50,000
(Being the transfer of gross profit.)
March 31 Profit and Loss A/c Dr. 16,50,000
To Discount Allowed Account 50,000
To Salaries A/c 10,00,000
To Sundry Office Expenses A/c 6,00,000
(Being the various expense accounts transferred to
the P & L Account)
March 31 Discount Received A/c Dr. 30,000
To P & L Account 30,000
(Being the credit balance of discount received
transferred to Profit and Loss A/c)
March 31 Profit and Loss A/c Dr. 6,30,000
To Capital A/c 6,30,000
(Being the transfer to Net Profit to the Capital
Account)
1,28,50,000 1,28,50,000
C. WANCHOO
Trading Account of the year ended March 31, 2020
To Inventory A/c 2,00,000 By Sales A/c 50,00,000
To Purchases 18,20,000 By Inventory (Closing) 2,70,000
To Wages 10,00,000
To Gross profit trfd. to P & L A/c 22,50,000
52,70,000 52,70,000
Profit and Loss Account for the year ended March 31, 2020
To Salaries 10,00,000 By Gross profit trfd. From
To Discount Allowed 50,000 the Trading Account 22,50,000
To Sundry Office Expenses 6,00,000 By Discount Received 30,000
To Net Profit transferred to
Capital A/c 6,30,000
22,80,000 22,80,000

1.6 BALANCE SHEET

The balance sheet may be defined as “a statement which sets out the assets and liabilities of a firm or an
institution as at a certain date.” Since even a single transaction will make a difference to some of the assets or
liabilities, the balance sheet is true only at a particular point of time. That is the significance of the word “as at.”
The assets are shown on the right hand side and liabilities and capital on the left hand side.
CHARACTERISTICS
The balance sheet has certain characteristics, which should be noted. These are the following:
(i) It is prepared at a particular date, rather the close of a day and not for a period. It is true only on that
date and not later. Suppose, in the example given above, a part of the goods were sold on 1st April,
2019. This will mean that the value of the Inventory will be reduced, the cash in hand will increase and
the capital account will be reduced or increased depending upon loss or profit on sale.
(ii) The balance sheet is prepared only after the preparation of the Profit and Loss Account. This is the
reason why the Profit and Loss Account (including the Trading Account) and the Balance Sheet are
together called Final Accounts (of course, the Balance Sheet is not an account, the two sides are not
the debit and the credit sides.) Without being accompanied by the Profit and Loss Account, the Balance
Sheet will not be able to throw adequate light on the financial position of the firm. For that purpose an
appreciation of the profits of the firm is necessary.
(iii) Since capital always equals the difference between assets and liabilities and since the capital account
will independently arrive at this figure, the two sides of the Balance Sheet must have the same totals. If
it is not so, there is certainly an error somewhere.
In the illustration no. 5 worked out above it will be seen that the under mentioned accounts have not been closed
even after preparation of the Profit and Loss Account and the transfer of the net profit to the capital account.
`
Cash in Hand 1,44,000 Debit balance
Capital Accounts (`10,00,000+ `6,30,000) 16,30,000 Credit balance
Machinery Account 7,36,000 Debit balance
Trade receivables 8,50,000 Debit balance
Trade payables 3,70,000 Credit balance
Inventory Account 2,70,000 Debit balance
Looking at these accounts, one would know that various assets: Cash balance in hand, cash at bank, machinery,
furniture etc. that the firm possesses and the amounts that are owing as liability to trade payables and to the
proprietor as capital. The capital, of course, will be the difference between the total of assets and of liabilities.
The assets, liabilities and capital are usually presented in a statement called the Balance Sheet. This is given
below for the accounts mentioned above.

C. WANCHOO
Balance Sheet as at March 31, 2020
` `
Trade payables 3,70,000 Cash in Hand 1,44,000
Capital 16,30,000 Trade receivables 8,50,000
Inventories 2,70,000
Machinery 7,36,000
20,00,000 20,00,000
ARRANGEMENTS OF ASSETS AND LIABILITIES

(1) Assets: Assets may be grouped in one of the following two ways:
(i) Liquidity: Under this approach, the asset, which can be converted into cash first, is presented
first. Those assets, which are most difficult in this respect, are presented at the bottom. As per
Liquidity the balance sheet can be prepared as follow:-
Balance Sheet as at…
` `
Bills Payable Cash in Hand
Trade Creditors Cash at Bank
Loans Government Securities
Outstanding Expenses Other Investments
Reserves & Surplus Bills Receivable
Capital Sundry Debtors
Stock
Furniture & Fixtures
Plant & Machinery
Land and Building
(ii) Permanence: Assets, which are to be used, for long term in the business and are not meant to
be sold are presented first. Assets, which are most liquid, such as cash in hand, are presented
at the bottom.
Balance Sheet as at…
` `
Capital Land and Building
Reserves & Surplus Plant & Machinery
Outstanding Expenses Furniture & Fixtures
Loans Stock

Trade Creditors Sundry Debtors

Bills Payable Bills Receivable
Other Investments
Government Securities
Cash at Bank
Cash in Hand
Note:- Some of the assets may be capable of being sold easily like investment in government
securities or shares of some companies. They should be treated as liquid or permanent
according to the intention of the firm.
(2) Liabilities: Liabilities may also be shown according to the urgency with which payment has to be made.
One way is to first show the capital, then long-term liabilities and last of all short term liabilities like
amounts due to suppliers of goods or bills payable. The other way is to start with short-term liabilities
and then show long term liabilities and last of all capital.
CLASSIFICATION OF ASSETS AND LIABILITIES
Assets are basically of two types:
Current Assets: - these assets are meant to be converted into cash as quickly as possible. Generally within one
year. For Example:- Cash in hand, Cash at Bank, Trade receivables, Inventories.
Long Term Assets: - Those that are meant to be used by the firm over a long period and not sold the former
type of assets is also called fixed assets. For Example Machinery, Building, Long term Investment.
Intangible Assets: - the assets which have no physical existence and cannot be seen or touched are called as
Intangible Assets. For example Patents, Copyrights etc.
It is desirable that in the balance sheet the two types of assets should be shown separately and prominently. This
would give meaningful and logical information.
Liabilities to outsider will be of two types:
Current Liabilities: - this liability must be settled in one year or less. It is also called as short term liability. For
Example:- Creditors, Bills Payable etc.
Long Term Liability: - those liabilities which exists for more than one year are Long term liabilities. For example
long term loans from banks. Of course, it will include undistributed profits also.
Sole proprietors generally present Balance Sheet in a horizontal form with “Capital and Liabilities” on the left
hand side and ‘Assets’ on the right-hand side. In the Balance Sheet the various items should be grouped suitably
as indicated below:

Balance Sheet as on…………..

` `
Capital A/c: Tangible Fixed Assets :
Balance Land and Building
Add : Net Profit/Less: Net Loss Plant and Machinery
Less : Drawings Furniture and Fixture
Long Term Loans : Vehicles
Term Loans Intangibles :
Other Loans Goodwill
Short Term Loans : Patent Rights
Cash Credit Designs and Brand Names
Overdrafts Investments :
Other Loans Long term investments
Current Liabilities : Current Assets :
Trade payables Inventory in Trade
Outstanding Expenses Trade receivables
Advances Taken Short term investments
Provision : Prepayments
Provision for Bad debts Advances
Provision for Retirement Benefits Bank Balances
Provision for Taxation Cash In Hand
In course, there is no hard and fast rule regarding presentation of assets, liabilities and equities in the Balance
sheet. However, the model presentation shown above has been designed considering the nature of Balance
Sheet elements and categorizing them appropriately.
Proper presentation of Balance Sheet items improves understandability of the information desired to be
communicated to the users of account.
ILLUSTRATION 6
Given below Trial Balance of M/s Dayal Bros. as on 31st March, 2020 :
Particulars Debit Balances Credit Balances
` `
Land and Building 3,00,000
14% Term Loan 4,00,000
Loan from M/s. D & Co. 4,60,000
Trade receivables 4,20,000

Cash in hand 20,000

Inventories in Trade 6,00,000
Furniture 2,00,000
Trade payables 40,000
Advances to Suppliers 1,00,000
Net Profit 1,00,000
Drawings 60,000
17,00,000 17,00,000
Required
Prepare Balance Sheet as on 31st March, 2020.
SOLUTION
In the Books of M/s Dayal Bros.
Balance Sheet as on 31st March, 2020
` ` `
Capital: Balances 7,00,000 Land & Building 3,00,000
Add: Net Profit 1,00,000 Furniture 2,00,000
8,00,000 Inventories in Trade 6,00,000
Less: Drawings (60,000) 7,40,000 Trade receivables 4,20,000
14% Term Loan 4,00,000 Advances to Suppliers 1,00,000
Loan from M/s D & Co. 4,60,000 Cash in Hand 20,000
Trade payables 40,000
16,40,000 16,40,000
ILLUSTRATION 7
The balance sheet of Thapar on 1st April, 2019 was as follows:
` `
Trade payables 15,00,000 Plant & Machinery 30,00,000
Expenses Payable 1,50,000 Furniture & Fixture 3,00,000
Capital 50,00,000 Trade receivables 14,00,000
Cash at Bank 6,50,000
66,50,000 66,50,000
During 2019-20, his Profit and Loss Account revealed a net profit of ` 18,30,000. This was after allowing for the
following :

(a) Rent received from property let out ` 3,00,000.

(b) Depreciation on Plant and Machinery @ 10% and on Furniture and Fixtures @ 5%.
(c) A provision for Doubtful Debts @ 5% of the trade receivables as at 31st March, 2020.
But while preparing the Profit and Loss Account he had forgotten to provide for (1) outstanding expenses totaling
` 1,80,000 and (2) prepaid insurance to the extent of ` 20,000.
His current assets and liabilities on 31st March, 2020 were: Inventories ` 14,50,000; Trade receivables
` 20,00,000; Cash at Bank ` 10,35,000 and Trade payables ` 11,40,000.
During the year he withdrew ` 6,00,000 for domestic use.
Required
Draw up his Balance Sheet at the end of the year.
SOLUTION
Profit and Loss Account (Revised)
To Outstanding expenses 1,80,000 By Balance b/d 18,30,000
To Net profit 16,70,000 By Prepaid insurance 20,000
18,50,000 18,50,000
Balance Sheet of Thapar as on 31st March, 2020

Liabilities ` Assets ` `
Capital 50,00,000 Cash at Bank 10,35,000
Add: Net Profit 16,70,000 Trade receivables 20,00,000
66,70,000 Less: Provision for
doubtful debts (1,00,000) 19,00,000
Less : Drawings (6,00,000) 60,70,000 Plant and Machinery 30,00,000
Outstanding expenses 1,80,000 Less: Depreciation (3,00,000) 27,00,000
Trade payables 11,40,000 Furniture & Fixtures 3,00,000
Less: Depreciation (15,000) 2,85,000
Prepaid insurance 20,000
73,90 000 73,90,000
1.7 SEQUENCE OF ACCOUNTING PROCEDURE OR THE

ACCOUNTING CYCLE
What has been done so far shows that the accounting process in the following order :
(i) recording the transactions in the journal or journalising;

(ii) preparing ledger accounts on the basis of the journal or posting into the ledger;
(iii) taking out the trial balance to check arithmetical accuracy;
(iv) preparing the trading and profit and loss account or the income statement for the period concerned; and
(v) preparing the balance sheet to show the financial position at the end of the period.
1.8 OPENING ENTRY

We have seen that on commencing a new business one debits the cash account and credits the capital account
with the amount introduced. A firm closes the books of account at the end of each year and starts new books in
the beginning of each year. The first entry in the journal is to record the closing balances of various assets and
liabilities at the end of the previous year as the opening balances in the beginning of the new year. The balance
sheet prepared at the end of the year records these balances and is the basis for this first entry. It is called the
opening entry.
The assets shown in the balance sheet are debited and the liabilities and the capital account credited.
ILLUSTRATION 8
Balance Sheet as at 31st March, 2020
Liabilities ` Assets `
Mahendra & Sons 5,60,000 Cash in hand 43,000
Capital 20,00,000 Cash at Bank 2,67,500
Closing Inventory 9,00,000
Machinery and Equipment 6,00,000
25,60,000 25,60,000
From the above given balance sheet prepare the relevant opening entry.
SOLUTION
The Opening Entry :01-04-2020
Dr. Cr.
` `
Cash A/c Dr. 43,000
Bank A/c Dr. 2,67,500
Trade receivables Dr. 7,49,500
Inventory A/c Dr. 9,00,000
Machinery and Equipment A/c Dr. 6,00,000
To Mahendra & Sons A/c 5,60,000
(Being the balances brought forward) 25,60,000 25,60,000

Posting the Opening Entry

All the assets show debit balance. Such accounts are opened and the relevant amounts written on the debit side
as “To Balance b/d”. Following is the cash account arising from the entry given above.
Cash Account
Date Particulars Amount Date Particulars Amount

2020 ` `
April 1 To Balance b/d 43,000
Similarly account should be opened for all other assets and relevant amount should be posted on the Dr. side.
The accounts of liabilities show credit balances. An account for each liability is opened and the relevant account
is written on the credit side as “By Balance b/d”. This is shown below by opening the accounts of Mahendra &
Sons mentioned in the entry given above.
Mahendra & Sons
Date Particulars Amount Date Particulars Amount

` 2020 `
April 1 To Balance b/d 5,60,000
By posting the opening entry completely all the accounts of assets and liabilities in the beginning are opened.
We illustrate below a complete cycle of journalising, posting and trial balance.
Students should work through the following illustration given by way of practice on the method of making
adjustments in some of the accounts contained in a Trial Balance and afterwards preparing the final Account.
ILLUSTRATION 9
Shri Mittal gives you the following Trial Balance and some other information:
Trial Balances as on 31st March, 2020
Particulars Dr. Cr.
` `
Capital 8,70,000
Purchases and Sales 6,05,000 12,10,000
Opening Inventory 72,000
Trade receivables and Trade payables 90,000 1,70,000
14% Bank Loan (loan taken at year end) 2,00,000
Overdrafts (overdraft taken at year end) 1,12,000
Salaries 2,70,000
Advertisements 1,10,000
Other expenses 60,000
Returns 40,000 30,000

Furniture 4,50,000
Building 8,90,000
Cash in Hand 5,000
25,92,000 25,92,000
Closing Inventory on 31st March, 2020 was valued at ` 1,00,000.

Required
Prepare final accounts of Shri Mittal for the year ended 31st March, 2020.
SOLUTION
In the books of Shri Mittal
` `
To Opening inventory 72,000 By Sales 12,10,000
To Purchases 6,05,000 Less: Returns (40,000) 11,70,000
Less: Returns (30,000) 5,75,000 By Closing inventory 1,00,000
12,70,000 12,70,000
` `
To Salaries 2,70,000 By Gross profit 6,23,000
To Advertisement 1,10,000
To Other expenses 60,000
To Net profit 1,83,000
6,23,000 6,23,000

` ` `
Capital 8,70,000 Building 8,90,000
Add: Net profit 1,83,000 10,53,000 Furniture 4,50,000
14% Bank Loan 2,00,000 Trade receivables 90,000
Trade payables 1,70,000 Closing inventory 1,00,000

Overdrafts 1,12,000 Cash in hand 5,000

15,35,000 15,35,000
Note: As loan and overdraft taken at year end so no interest shown.
ILLUSTRATION 10
Mr. Mohan gives you the following trial balance and some other information:
Trial Balance as on 31st March, 2020Particulars ` `
Capital 6,50,000
Sales 9,70,000
Purchases 4,30,000
Opening Inventory 1,10,000
Freights Inward 40,000
Salaries 2,10,000
Other Administration Expenses 1,50,000
Furniture 3,50,000
Trade receivables and Trade payables 2,10,000 1,90,000
Returns 20,000 12,000
Discounts 19,000 9,000
Bad Debts 5,000
Investments in Government Securities 1,00,000
Cash in Hand and Cash at Bank 1,87,000
18,31,000 18,31,000
Other Information:
(i) Closing Inventory was ` 1,80,000;
(ii) Depreciate Furniture @ 10% p.a.
Required
Prepare Trading and Profit and Loss Account for the year ended on 31.3.2020 and Balance Sheet of
Mr. Mohan as on that date.
SOLUTION
In the books of Mr. Mohan
` `

Less: Returns (12,000) 4,18,000 By Closing Inventory 1,80,000

To Freight Inwards 40,000
To Gross profit 5,62,000
11,30,000 11,30,000
To Depreciation 35,000 By Gross profit 5,62,000
To Salaries 2,10,000 By Discount received 9,000
To Administration expenses 1,50,000
To Discount allowed 19,000
To Bad debts 5,000
To Net profit 1,52,000
5,71,000 5,71,000

` `
Capital 6,50,000 Furniture 3,50,000
Add: Net profit 1,52,000 8,02,000 Less: Depreciation (35,000) 3,15,000
Trade payables 1,90,000 Closing Inventory 1,80,000
Investment in Govt
Securities 1,00,000
Cash in Hand and
Cash at Bank 1,87,000
9,92,000 9,92,000
ILLUSTRATION 11
The Balance Sheet of Mr. Popatlal, a merchant on 31st March, 2020 stood as below:
` `
Capital 2,40,000 Fixed Assets 1,25,600
Trade payables 1,64,000 Inventories 2,06,400
Bank Overdraft 1,46,000 Trade receivables 1,88,000
Less: Provision (6,200) 1,81,800
Cash 36,200
5,50,000 5,50,000

Required
Show opening journal entry on 1st April, 2020 in the books of Mr. Popatlal.
SOLUTION
Opening entry
(Dr.) ` (Cr.) `
1.4.2020 Fixed Assets A/c Dr. 1,25,600
Inventories A/c Dr. 2,06,400
Trade receivables A/c Dr. 1,88,000
Cash A/c Dr. 36,200
To Trade payables A/c 1,64,000
To Bank Overdraft A/c 1,46,000
To Provision for Doubtful Debts A/c 6,200
ILLUSTRATION 12
The following is the schedule of balances as on 31.3.20 extracted from the books of Shri Gavaskar, who carries
on business under the same name and style of Messrs Gavaskar Viswanath & Co., at Bombay:
Particulars Dr. Cr.

` `
Cash in hand 14,000
Cash at bank 26,000
Sundry Debtors 8,60,000
Stock on 1.4.2019 6,20,000
Furniture & fixtures 2,14,000
Office equipment 1,60,000
Buildings 6,00,000
Motor Car 2,00,000
Sundry Creditors 4,30,000
Loan from Viswanath 3,00,000
Provision for bad debts 30,000
Purchases 14,00,000
Purchase Returns 26,000
Sales 23,00,000
Sales Returns 42,000

Salaries 1,10,000
Rent for Godown 55,000
Interest on loan from Viswanath 27,000
Rates & Taxes 21,000
Discount allowed to Debtors 24,000
Discount received from Creditors 16,000
Freight on purchases 12,000
Carriage Outwards 20,000
Drawings 1,20,000
Printing and Stationery 18,000
Electricity Charges 22,000
Insurance Premium 55,000
General office expenses 30,000
Bad Debts 20,000
Bank charges 16,000
Motor car expenses 36,000
TOTAL 47,22,000 47,22,000
Prepare Trading and Profit and Loss Account for the year ended 31st March, 2020 and the Balance Sheet as at
that date after making provision for the following:
1. Depreciate: (a) Building used for business by 5 percent; (b) Furniture and fixtures by 10 percent; One
steel table purchased during the year for ` 14,000 was sold for same price but the sale proceeds were
wrongly credited to Sales Account; (c) Office equipment by 15 percent; Purchase of a typewriter during
the year for ` 40,000 has been wrongly debited to purchase; and (d) Motor car by 20%.
2. Value of stock at the close of the year was ` 4,40,000.
3. Two month’s rent for godown is outstanding.
4. Interest on loan from Viswanath is payable at 12 percent per annum, this loan was taken on 1.5.2019.
5. Provision for bad debts is to be maintained at 5 percent of Sundry Debtors.

6. Insurance premium includes ` 40,000 paid towards proprietor’s life insurance policy and the balance of
the insurance charges cover the period from 1.4.2019 to 30.6.2020.

SOLUTION
M/s Gavaskar Viswanath & Co.
Trading for the year ended 31st March, 2020
Particulars Details Amount Particulars Details Amount

` `
To opening Stock 6,20,000 By Sales 23,00,000
To Purchases 14,00,000 Less: Sale of furniture 14,000
included in sale
Less: Typewriter included in 40,000 Less: Sales Returns 42,000 22,44,000
purchases
Less: Purchase Returns 26,000 13,34,000 By Closing Stock 4,40,000
To Freight on purchase 12,000
To Gross Profit c/d 7,18,000

26,84,000 26,84,000
M/s Gavaskar Viswanath & Co.
Profit/Loss Account for the year ended 31st March, 2020
Particular Details Amount Particular Details Amount
` `
To Salaries 1,10,000 By Gross profit b/d 7,18,000
To Rent for Godown 55,000
Add: Outstanding 11,000 66,000 By Discount received 16,000
To provision for doubtful debts(4) 33,000
To Rent and Taxes 21,000
To Discount Allowed 24,000
To Carriage outwards 20,000
To printing and stationery 18,000
To Electricity charges 22,000
To Insurance premium (1) 12,000
To Depreciation (2) 1,20,000
To general office expenses 30,000
To Bank Charges 16,000
To interest on loan 27,000
Add: Outstanding (3) 6,000 33,000
To Motor car expenses 36,000
To Net Profit transferred to Capital a/c 1,73,000
7,34,000 7,34,000

Balance Sheet of M/s Gavaskar Vishwanath & Co.

as at 31st March, 2020
Liabilities Details Amount Assets Details Amount
` `
Capital 16,20,000 Building 6,00,000
Add: Net Profit 1,73,000 Less: Dep. (30,000) 5,70,000
Less: Drawings (1,20,000)
Less: Insurance Premium (40,000) 16,33,000 Motor Car 2,00,000
Less: Dep. (40,000) 1,60,000
Loan from Vishwanath 3,00,000
Add: Outstanding 6,000 3,06,000 Office equipment 2,00,000
Less: Dep. (30,000) 1,70,000
Sundry Creditors 4,30,000
Outstanding rent 11,000 Furniture & Fixture 2,00,000
Less: Dep. (20,000) 1,80,000
Stock in Trade 4,40,000

Sundry Debtors 8,60,000
Less: Provision for doubtful (43,000) 8,17,000
debts
Cash at hand 26,000
Cash in bank 14,000
Prepaid insurance (1) 3,000
23,80,000 23,80,000
Working Notes :
(1). Insurance premium
`
Insurance premium as given in trial balance 55,000
Less: Personal premium (40,000)
 15,000  (3,000)
Less: Prepaid for 3 months  ×3
 15 
Transfer to Profit & Loss a/c 12,000
(2). Depreciation
Building @ 5% on 6,00,000 30,000
Motor Car @ 20% on 2,00,000 40,000
Furniture & Fittings @ 10% on 2,00,000(2,14,000-14,000) 20,000
Office Equipment @ 15% on 2,00,000 (1,60,000 + 40,000) 30,000
Total 1,20,000

(3) Interest on Loan

Interest on Loan (3,00,000 x 12% x 11/12) = 33,000
Less : interest as per Trial Balance (27,000)
Profit &Loss account (Outstanding ) 6,000
(4) Provision for bad debts a/c

` `
To bad debts a/c 20,000 By balance b/d 30,000
To balance c/d 43,000 By P&L a/c 33,000
63,000 63,000
1.9 PROVISIONS AND RESERVES

Provision means “any amount written off or retained by way of providing for depreciation, renewal or diminution
in the value of assets or retained by way of providing for any known liability of which the amount cannot be
determined with substantial accuracy”. A provision is a liability which can be measured only by using a substantial
degree of estimation.
Thus, a provision may be either in respect of loss in the value of an asset provided or written off on the basis of
an estimate or the one in respect of a liability for expenses incurred in respect of a claim which is disputed i.e.
when it is a contingent liability. On the occurrence of a diminution in asset values due to some of them having
become irrecoverable or Inventory items are lost as a result of some natural calamity, amounts contributed or
transferred from profit to make good the diminution also are described as provision.
The following are instances of amount retained in the business out of earning for different purposes that are
described as provisions.
(1) Amount provided for meeting claims which are admissible in principle but the amount whereof has not
been ascertained.
(2) An appropriation made for payment of taxes still to be assessed.

(3) Amount set aside for writing off bad debts or payment of discounts.
The portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by
the management for a general or a specific purpose other than a provision for depreciation or diminution in the
value of assets or for a known liability is known as reserves. The reserves are primarily of two types: capital
reserves and revenue reserves. Also provisions in excess of the amount considered necessary for the purposes
these were originally made, are to be considered as reserves. It is thus evident that provisions are a charge
against profits, while reserve is an appropriation of profits. Also provisions that ultimately prove to be in
excess of amounts required or have been made too liberally are reserves. Such a distinction is essential for
disclosing truly in the Balance Sheet the amount by which the equity of shareholders has increased with the
accumulation of undistributed profits.

Reserve Fund: It signifies the amount standing to the credit of the reserve that is invested outside the business
in securities which are readily realisable e.g., when the amounts set apart for replacement of an asset are
invested periodically, in government securities or shares. The account to which these amounts are annually
credited is described as the Reserve Fund.
ILLUSTRATION 13
Crimpson Ltd.’s profit and loss account for the year ended 31st March, 2020 includes the following information:
`
(i) Depreciation 57,500
(ii) Bad debts written off 21,000
(iii) Increase in provision for doubtful debts 18,000
(iv) Proposed dividend 15,000
(v) Retained profit for the year 20,000
(vi) Liability for tax 4,000
Required
State which one of the items (i) to (vi) above are – (a) transfer to provisions; (b) transfer to reserves; and (c)
neither related to provisions nor reserves.
SOLUTION
(a) Transfer to provisions - (i), (iii) (vi)
(b) Transfer to reserves - (v)
(c) Neither related to provisions nor reserves - (ii), (iv).
A summary of all adjustments are as follows:
Adjustment If Given in Trial Balance If Not Given in Trial Balance
1. Closing stock Balance Sheet – Asset Side (a) Trading A/c – Credit Side
(b) Balance Sheet – Asset Side
2. Outstanding Expenses Balance Sheet – Liability Side (a) Trading/Profit & Loss A/c Debit Side.
Add to the concerned expenses.
(b) Balance Sheet – Liability Side
3. Prepaid Expenses Balance Sheet – Asset Side (a) Trading/Profit & Loss A/c Debit Side.
Deduct from the concerned expense.
(b) Balance Sheet - Asset
4. Income Outstanding Balance Sheet – Asset Side (a) Profit & Loss A/c – Credit Side. Add to
the concerned income.
(b) Balance Sheet – Asset Side.
5. Incomes Received in Balance Sheet – Liability Side (a) Profit & Loss A/c – Credit Side. Deduct
Advance from concerned income.
(b) Balance Sheet – Liability Side

6. Bad Debts Profit & Loss A/c – Debit Side (a) Profit & Loss A/c – Debit Side.
(b) Balance Sheet – Asset Side. Deduct
from debtors.
7. Provision for Bad or Profit & Loss A/c – Debit Side (a) Profit & Loss A/c – Debit Side.
Doubtful debts (b) Balance Sheet – Asset Side. Deduct
from Debtors after additional bad debts,
if any.
8. Provision for Discount Balance Sheet – Asset Side (a) Profit & Loss A/c – Debit Side.
on Debtors Deduct from Debtors. (b) Balance Sheet – Asset Side. Deduct
from debtors after providing for
provision for bad debts
9. Depreciation Profit & Loss A/c – Debit Side (a) Profit & Loss A/c – Debit Side.
(b) Balance Sheet – Asset Side.
Deduct from Respective Asset.
10. Interest on Capital Profit & Loss A/c – Debit Side (a) Profit & Loss A/c – Debit Side.
(b) Balance Sheet – Liability Side.
Add to Capital.
11. Interest on Drawings Profit & Loss A/c – Credit Side (a) Profit & Loss A/c – Credit Side.
(b) Balance Sheet – Liability Side. Deduct
from Capital.
12. Loss by Fire Profit & Loss A/c – Debit Side (a) Trading A/c – Credit Side (with full
amount of loss)
(b) Profit & Loss A/c – Debit Side (Actual
loss, if any)
(c) Balance Sheet – Asset Side (with
insurance claim admitted by Insurance
Co.)
13. Goods withdrawn for Trading A/c - Credit Side (a) Trading A/c – Credit Side or Deduct
personal use from Purchases.
(b) Balance Sheet – Liability Side (Deduct
from Capital as Drawings)
14. Goods Distributed as Profit & Loss A/c – Debit Side (a) Trading A/c – Credit Side or Deduct
free Samples from Purchases
(b) Profit & Loss A/c – Debit Side
15. Sale of Goods on Usually it is not given in Trial (a) Trading A/c – Credit Side. Deduct from
Approval Basis, Balance Sales the selling price of goods sold
approval not yet and add to stock at cost price.
received (b) Balance Sheet – Asset Side. Deduct
from Debtors the selling price of such
sales and show the cost price of such
sales along with closing stock.

1.10 LIMITATIONS OF FINANCIAL STATEMENTS

Financial statements suffer from a number of limitations. These must, therefore, be studied with care, in order
that correct inferences may be drawn. The limitations are less serious if the objective is only to appraise the
performance of a single company over a period of year Where, however, a comparison of the working of different
companies for the same period is to be made. It can be misleading unless the companies concerned have
followed the same system and basis of accounting. On the account, a comparison of the profitability of different
industries on the basis of financial statements, should be undertaken only if it is not practicable to make such a
comparison on any other basis.
The principal limitations affecting financial statements are the following:
(a) Historical Cost: Accounting records and, on that account, the financial statements are prepared only
on the basis of the money value prevailing at the time the transaction were entered into. Thus, the effect
of subsequent changes in the value of money is not taken into account. At times this has the effect of
making the statements of account quite misleading. Take the obvious example of a house built in 1980,
say at the cost of `15,000, in 2020 the benefit receivable from its occupation will be as much as that of
a house created in 2020, say at a cost of `30,00,000. If the house were included in the financial
statements at its original cost, as normally it would not convey a true picture except to a knowledgeable
person.
The limitations can be serious in the case of other fixed assets that have been working over a long period
over which prices have changed radically. It is, however, not easy to get over this difficulty, since
revaluation of fixed assets, apart from being costly is not practicable when the value of money is
continuously falling. On this account, historical cost continues to be the accepted basis for the
preparation of financial statements. Though it may not be possible to do much to remove the limitation
mentioned above, one must always remember to read the balance sheet and the profit and loss account
in the light of what they cannot reveal as well as what they do.
(b) Intangible strengths and weaknesses: A company may have a number of strengths and weaknesses
which cannot be shown in the balance sheet e.g., the loyalty and calibre of its staff. These must be kept
in mind while judging the financial position of the company.
(c) Perpetual continuity and periodical account: Financial statements ordinarily are drawn up at the end
of each year but the accounting record is maintained on the assumption that the business undertaking
shall continue to exist forever on the basis of going concern assumption. In consequence, much of the
expenditure other than revenue expenditure has to be distributed arbitrarily over a number of years
during which benefit of the expenditure is expected to arise. As a result, financial statements of account
are not absolutely correct.
(d) Different accounting policies: It is permissible for a company within certain limits to adopt different
policies for the preparation of accounts, valuation of various assets and distribution of expenditure over
different periods of account. For example, a company may decide to provide annually for payment of
pensions and gratuities to staff and thus build up a ‘fund’ out of which payments will be made ultimately
whereas another company may deal with these only when actual payments are made. Similarly, a

company may decide whether or not to include intangible assets amongst its assets or manner in which
the amounts thereof should be written off.
(e) Management policies: Management can have different accounting policies for welfare of the staff and
public at large.
SUMMARY
♦ Non-manufacturing entities are the trading entities, which are engaged in the purchase and sale of goods
at profit without changing the form of the goods.
♦ For accounting, profit is measured at two levels:
(a) Gross Profit
(b) Net Profit
♦ The principal function of final statements of account (Trading Account, Profit and Loss Account and the
Balance Sheet) is to exhibit truly and fairly the profitability and the financial position of the business to
which they relate. In order that these may be properly drawn up, it is essential that a proper record of
transactions entered into by the business during a particular accounting period should be maintained.
♦ At the end of the year, it is necessary to ascertain the net profit or the net loss. For this purpose, it is
first necessary to know the gross profit or gross loss. Gross Profit is the difference between the selling
price and the cost of the goods sold. For a trading firm, the cost of goods sold can be ascertained by
adjusting the cost of goods still on hand at the end of the year against the purchases.
TEST YOUR KNOWLEDGE

True and False
1. The income statement shows either net profit or net loss for a particular period.
2. Gains from the sale or exchange of assets are not considered as the revenue of the business.
3. The salary paid in advance is not an expense because it neither reduces assets or nor increase liabilities.
4. A loss is an expenditure which does not bring any benefit to the concern.
5. All liabilities which become due for payment within the year are classified as long-term liabilities.
6. The term current asset is used to designate cash and other assets or resources which are reasonably
expected to be realized or sold or consumed within one year.
7. An asset gives rise to expenditure when it is acquired and to an expense when it is consumed.
8. If the balance of an account on the debit side of the trial balance where the benefit has already expired
then it is treated as an expense.
9. Sales less cost of goods sold = gross profit.
10. If the debit side of the trading account exceeds its credit side then the balance is termed as gross profit.
11. The provision for bad debts is debited to Sundry Debtors Account.

12. The provision for discount on creditors is often not provided in keeping with the principle of conservatism.
13. The debts written off as bad, if recovered subsequently are credited to Debtors Account.
14. The adjustment entry in respect of income received in advance is debit Income received in advance
account and credit income account.
15. Premium paid on the life policy of a proprietor is debited to profit and loss account.
16. Depreciation account appear in the trial balance is taken only to profit and loss account.
17. Personal purchases included in the purchases day book are added to the sales account in the Trading
account.
18. Medicines given to the office staff by a manufacturer of medicines will be debited to salaries account.
19. Goods worth ` 600 taken by the proprietor for personal use should be credited to Capital Account.
20. If Closing Stock appears in the Trial Balance, the Closing inventory is then not entered in Trading
Account. It is only shown in the Balance Sheet.
Multiple Choice Questions

(1) A debit to an account may
(a) increase expense (b) decrease an asset.
(c) increase a liability. (d) increase income.
(2) Prepayment of insurance premium will appear in the Balance Sheet and in the Insurance Account
respectively as:
(a) a liability and a debit balance. (b) an asset and a debit balance.
(c) an asset and a credit balance. (d) a liability and a credit balance.
(3) Gross profit is the difference between:
(a) sales and purchases (b) sales and cost of sales.
(c) sales and total expenses. (d) Sales and total liabilities.
(4) Payment made to a creditor subject to cash discount will :
(a) reduce a liability, reduce an asset and add to expenses.
(b) reduce a liability, add to an asset, and add to revenue.
(c) reduce an asset, reduce a liability, and add to revenue.
(d) reduce a liability, reduce an asset and decrease expenses.
(5) A customer returns goods already charged to him. We should:
(a) debit his account. (b) credit his account.
(c) make no entry on his account. (d) None of the above.

(6) Capital is the difference between

(a) Income and expenses (b) Sales and Cost of goods sold
(c) Assets and liabilities (d) None of the above.
(7) The capital of a sole trader would change as a result of:
(a) A creditor being paid his account by cheque.
(b) Raw materials being purchased on credit.
(c) Fixed assets being purchased on credit.
(d) Wages being paid in cash.
(8) A decrease in the provision for doubtful debts would result in:
(a) An increase in liabilities. (b) A decrease in working capital.
(c) An increase in net profit. (d) None of the three.
(9) A Company wishes to earn a 20% profit margin on selling price. Which of the following is the profit mark
up on cost, which will achieve the required profit margin?
(a) 33% (b) 25% (c) 20% (d) 30%
(10) If sales is ` 2,000 and the rate of gross profit on cost of goods sold is 25%, then the cost of goods sold
will be
(a) ` 2,000. (b) ` 1,500. (c) ` 1,600. (d) ` 1,000.
(11) Sales for the year ended 31st March, 2020 amounted to ` 10,00,000. Sales included goods sold to
Mr. A for ` 50,000 at a profit of 20% on cost. Such goods are still lying in the godown at the buyer’s
risk. Therefore, such goods should be treated as part of
(a) Sales. (b) Closing Inventory.
(c) Goods in transit. (d) None of the above.
(12) If sales revenues are `4,00,000; cost of goods sold is ` 3,10,000 and expenses are `60,000, the gross
profit is
(a) ` 30,000. (b) ` 90,000.
(c) ` 3,40,000. (d) ` 4,00,000.
Theory questions
1. Write shorts notes on:
(a) Balance sheet.
(b) Trading account
(c) Closing entries
2. Distinguish between Provision and reserve fund.

Practical questions
1. From the following particulars extracted from the books of Ganguli, prepare trading and profit and loss
account and balance sheet as at 31st March, 2020 after making the necessary adjustments:
` `
Ganguli’s capital account (Cr.) 5,40,500 Interest received 7,250
Stock on 1.4.2019 2,34,000 Cash with Traders Bank Ltd. 40,000
Sales 14,48,000 Discounts received 14,950
Sales return 43,000 Investments (at 5%) as on 1.4.2019 25,000
Purchases 12,15,500 Furniture as on 1-4-2019 9,000
Purchases return 29,000 Discounts allowed 37,700
Carriage inwards 93,000 General expenses 19,600
Rent 28,500 Audit fees 3,500
Salaries 46,500 Fire insurance premium 3,000
Sundry debtors 1,20,000 Travelling expenses 11,650
Sundry creditors 74,000 Postage and telegrams 4,350
Loan from Dena Bank Ltd. (at 12%) 1,00,000 Cash in hand 1,900
Interest paid 4,500 Deposits at 10% as on 1-4-2019 (Dr.) 1,50,000
Printing and stationery 17,000 Drawings 50,000
Advertisement 56,000
Adjustments:
(1) Value of stock as on 31st March, 2020 is ` 3,93,000. This includes goods returned by customers
on 31st March, 2020 to the value of ` 15,000 for which no entry has been passed in the books.
(2) Purchases include furniture purchased on 1st January, 2020 for `10,000.
(3) Depreciation should be provided on furniture at 10% per annum.
(4) The loan account from Dena bank in the books of Ganguli appears as follows:
` `
31.3.2020 To Balance c/d 1,00,000 1.4.2019 By Balance b/d 50,000
31.3.2020 By Bank 50,000
1,00,000 1,00,000
(5) Sundry debtors include ` 20,000 due from Robert and sundry creditors include ` 10,000 due to
him.
(6) Interest paid include ` 3,000 paid to Dena bank.
(7) Interest received represents ` 1,000 from the sundry debtors (due to delay on their part) and
the balance on investments and deposits.

(8) Provide for interest payable to Dena bank and for interest receivable on investments and
deposits.
(9) Make provision for doubtful debts at 5% on the balance under sundry debtors. No such provision
need to be made for the deposits.
2. Sengupta & Co. employs a team of eight workers who were paid `30,000 per month each in the year
ending 31st March, 2019. At the start of financial year 2019-2020, the company raised salaries by 10%
to `33,000 per month each.
On October 1, 2019 the company hired two trainees at salary of `21,000 per month each. The work force
are paid salary on the first working day of every month, one month in arrears, so that the employees
receive their salary for January on the first working day of February etc.
You are required to calculate:
(i) Amount of salaries which would be charged to the profit and loss for the year ended 31st March, 2020.
(ii) Amount actually paid as salaries during 2019-20
(iii) Outstanding Salaries as on 31st March, 2020.
3. You are required, prepare a Trading and Profit and Loss Account for the year ending 31st March, 2020
and a Balance Sheet as on that date from the Trial Balance given below:
Debit Balance:
Trade receivables 3,50,000 Salaries 2,20,000
Inventory 1st April, 2019 5,00,000 Purchases 12,50,00
Cash in Hand 5,60,000 Plant and Machinery 15,70,000
Wages 3,00,000 Credit Balance:
Bad Debts 50,000 Capital 25,00,000
Furniture and Fixtures 1,50,000 Trade payables 9,00,000
Depreciation 1,50,000 Sales 17,00,000
On 31st March, 2020 the Inventory was valued at `10,00,000.

4. Mr. Kotriwal is engaged in business of selling magazines. Several of his customers pay money in
advance for subscribing his magazines. Information related to year ended 31st March 2020 has been
given below:
On 1.4.2019 he had a balance of ` 2,00,000 advance from customers of which ` 1,50,000 is related to
year 2019-20 while remaining pertains to year 2020-21. During the year 2019-20 he made cash sales of
` 5,00,000. You are required to compute:
(i) Total income for the year 2019-20.
(ii) Total money received during the year if the closing balance in advance from customers account
is ` 1,70,000.

5. Mr. Birla is a proprietor engaged in business of trading electronics. An excerpt from his Trading & P&L
account is as follows:
Trading and P&L A/c for the year ended 31st March, 2020
To Cost of Goods Sold 45,00,000 By Sales C
To Gross Profit c/d D
F F
To Rent A/c 26,00,000 By Gross Profit b/d D
To Office Expenses 13,00,000 By Miscellaneous Income E
To Selling Expenses B
To Commission to Manager (on Net Profit 2,00,000
before charging such commission)
To Net Profit A
G 60,00,000
Commission is charged at the rate of 10%.

Selling Expenses amount to 1% of total sales.
You are required to compute the missing figures.
ANSWERS/HINTS
True and False
1. True: Profit and loss account shows either net profit or net loss for a particular period.
2. False: Gains from the sale or exchange of assets are considered as the revenue of the business. But
this revenue not in the ordinary course of business so it is capital receipts.
3. True: The salary paid in advance is an asset it is not an expense because it neither reduces assets or
nor increase liabilities.
4. True: A loss is an expenditure of the business which does not bring any gain to the business.
5. False: All liabilities which become due for payment within one year are classified as current liabilities.
6. True: Current assets are all the assets which are expected to be realized or sold or consumed within
one year.
7. True: When an asset is purchase capital expenditure is incurred and when the asset is put to use
expenses are incurred in consumption.
8. True: Debit balance of accounts are treated as expenses whose benefit is already received or expired.
9. True: Gross profit is obtained by deducting cost of goods sold from sales.
10. False: If the debit side of the trading account exceeds its credit side then the balance is termed as gross
loss.

11. False: The provision for bad debts is debited to debited to Profit and loss Account, in Balance Sheet it
is shown either on liability side or deducted from the head Debtors.
12. True: According to the provision of conservatism provision is maintained for the losses to be incurred in
future. Discount on creditors is an income so provision in not maintained.
13. False: The debts written off as bad, if recovered subsequently are credited to Bad Debts Recovered
Account and becomes an income.
14. False: Income received in advance is reduces it from the concerned income in profit and loss account.
And, it is shows it as a liability in the current balance sheet under the head Current Liabilities.
15. False: Premium paid on the life policy of a proprietor is to be debited to capital account, as it is personal
expense.
16. True: Depreciation is charge on each of the asset on a certain percentage. Depreciation is a charge to
profit and loss account and should be debited to profit & loss account by crediting the respective assets.
If it appears in trial balance then it is taken only to profit and loss account.
17. False: Personal purchases included in the purchases day book are deducted from the purchases account
in the Trading account.
18. True: Any benefit given to the staff is debited to the salary account.
19. False: Goods taken by the proprietor for personal use should be credited to Purchase Account as less
goods are left in the business for sale.
20. True: The closing Stock appears in the trial balance only when it is adjusted against purchases by
passing the entry. In this case, closing stock is not entered in Trading Account and is shown only in
Balance Sheet.
Multiple Choice Questions

1. (a) 2. (c) 3. (b) 4. (c) 5. (b) 6. (c)
7. (d) 8. (c) 9. (b) 10. (c) 11. (a) 12. (b)
Theoretical Questions
1. (a) The balance sheet may be defined as “a statement which sets out the assets and liabilities of a
firm or an institution as at a certain date.” Since even a single transaction will make a difference
to some of the assets or liabilities, the balance sheet is true only at a particular point of time.
That is the significance of the word “as at.”
(b) At the end of the year, it is necessary to ascertain the net profit or the net loss. For this purpose,
it is first necessary to know the gross profit or gross loss with the helps to Trading A/c. Gross
Profit is the difference between the selling price and the cost of the goods sold.
(c) Closing entries: The entries that have to be made in the journal for preparing the Trading and
the Profit and Loss Account that is for transferring the various accounts to these two accounts
are known as closing entries.

2. Provision means “any amount written off or retained by way of providing for depreciation, renewal or
diminution in the value of assets or retained by way of providing for any known liability of which the
amount cannot be determined with substantial accuracy”.
Reserve Fund: It signifies the amount standing to the credit of the reserve that is invested outside the
business in securities which are readily realisable e.g., when the amounts set apart for replacement of
an asset are invested periodically, in government securities or shares. The account to which these
amounts are annually credited is described as the Reserve Fund.
Practical Questions
Answer 1
In the books of Ganguli
Trading and Profit & Loss Account for the year ended 31st March,2020
` ` ` `
To Opening stock 2,34,000 By Sales 14,48,000
Less: Transfer to furniture A/c (10,000) By Closing stock 3,93,000
12,05,500
Less: Returns (29,000) 11,76,500
To Carriage inwards 93,000
To Gross profit c/d 2,79,500
17,83,000 17,83,000
To Salaries 46,500 By Gross profit b/d 2,79,500
To Rent 28,500 By Interest 17,250
To Advertisement 56,000 By Discount received 14,950
To Printing & stationery 17,000
To Interest 7,500
To Discount allowed 37,700
To General expenses 19,600
To Travelling expenses 11,650
To Fire insurance premium 3,000
To Postage & telegrams 4,350
To Provision for doubtful debts 4,750
(W.N.I)
To Depreciation on furniture 1,150
To Audit fees 3,500

To Capital A/c (Net profit 70,500

transferred)
3,11,700 3,11,700
Balance Sheet as on 31st March,2020

Liabilities ` ` Assets ` `
Capital account: Furniture 9,000
Balance on 1st April,2019 5,40,500 Additions during the year 10,000
Add: Net profit 70,500 19,000
6,11,000 Less: Depreciation (1,150) 17,850
Less: Drawings (50,000) 5,61,000 Investments 25,000
Loan from Dena Bank Ltd. 1,00,000 Deposits 1,50,000
Insurance accrued on bank 3,000 Interest accrued on 10,000
loan (W.N.2) investment & deposits
(W.N.3)
Sundry creditors 64,000 Stock in trade 3,93,000
Sundry debtors 95,000
Less: Provision (4,750) 90,250
Cash with Traders Bank Ltd. 40,000
Cash in hand 1,900
7,28,000 7,28,000
Working Notes:
1. Calculation of provision for doubtful debts: `
Sundry debtors as per trial balance 1,20,000
Less: Sales returns not recorded (15,000)
1,05,000
Less: Cancellation against sundry creditors (10,000)
Adjusted balance of sundry debtors 95,000
Provision for doubtful debts @ 5% 4,750
2. Accrued interest on bank loan:
Annual interest @12% 6,000
Less: Interest paid to Dena bank (3,000)
Accrued interest 3,000
3. Interest accrued on investments and deposits:
Annual interest on investments @ 5% 1,250
Annual interest on deposits @ 10% 15,000
16,250
Less: Interest received on investments and deposits (6,250)
Accrued interest 10,000

Answer 2
`
(i) Salaries to be charged to profit and loss account for the year
ended 31st March, 2020:
Salaries of 8 employees for full year @ `33,000 per month each 31,68,000
Salaries of 2 trainees for 6 months @ `21,000 p.m. 2,52,000
34,20,000
(ii) Salaries actually paid in 2019-20
March, 2019 salaries paid in April, 2019 (8 x 30,000) 2,40,000
Salaries of 8 employees for April 2019 to March, 2020 paid in
May 2019 to March 2020 @ `33,000 for 11 months 29,04,000
Salaries of 2 trainees for October 2019 to February 2020 paid in
November 2019 to March 2020 @ `21,000 for 5 months 2,10,000
33,54,000
(iii) Outstanding salaries as at 31st March, 2020
8 employees @ `33,000 each for 1 month 2,64,000
2 trainees @ `21,000 each for 1 month 42,000
3,06,000
Answer 3
Trading and Profit and Loss Account for the year ending 31st March, 2020
To Purchases 12,50,000 By Closing Inventory 10,00,000
To Wages 3,00,000
27,00,000 27,00,000
To Bad Debts 50,000 By Gross Profit 6,50,000
To Depreciation 1,50,000
To Salaries 2,20,000
To Net Profit transferred. to Capital A/c 2,30,000
6,50,000 6,50,000
Balance Sheet as at 31st March, 2020
Liabilities ` ` Assets ` `
Trade payables 9,00,000 Cash in Hand 5,60,000
Capital: Trade receivables 3,50,000
Previous Balance 25,00,000 Closing Inventory 10,00,000 19,10,000
Add : Net Profit 2,30,000 27,30,000

Furniture & Fixtures 1,50,000

Plant & Machinery 15,70,000 17,20,000
36,30,000 36,30,000
Answer 4
(i) Computation of Income for the year 2019-20:
`
Money received during the year related to 2019-20 5,00,000
Add: Money received in advance during previous years 1,50,000
Total income of the year 2019-20 6,50,000
(ii) Advance from Customers A/c

Date Particulars ` Date Particulars `
To Sales A/c 1,50,000 1.4.2019 By Balance b/d 2,00,000
(Advance related to current By Bank A/c 1,20,000
year transferred to sales) (Balancing Figure)
31.3.20 To Balance c/d 1,70,000
3,20,000 3,20,000
So, total money received during the year is:

`
Cash Sales during the year 5,00,000
Add: Advance received during the year 1,20,000
Total money received during the year 6,20,000
Answer 5
A) Computation of Net Profit:
Commission Manager = Rate of Commission X Net Profit before charging such commission
So, Commission to manager = 10/100 X Net Profit before charging such commission
=> ` 2,00,000 = 10/100 X Net Profit before charging such commission
=> Net Profit before charging such commission = ` 20,00,000
=> Net Profit (A) = ` (20,00,000 - 2,00,000) = `18,00,000
B) Computation of Selling Expenses:
Total income appearing in P&L A/c = ` 60,00,000
Total expenses other than selling expenses = `(26,00,000 + 13,00,000 + 2,00,000)= ` 41,00,000
So, Selling Expenses + Remaining Expenses + Net Profit = Total Income
=> Selling Expenses = ` 60,00,000 -` 41,00,000 - ` 18,00,000
=> Selling Expenses = ` 1,00,000

C) Computation of Sales:
We have been given selling expenses amount to 1% of Sales
Selling Expenses 1,00,000
So, Sales = × 100 = × 100 = ` 100,00,000
1 1
D) Computation of Gross Profit:
In Trading A/c
To COGS 45,00,000 By Sales (from C above) 100,00,000
To Gross Profit (Balancing Figure) 55,00,000
Total (F) 100,00,000 Total (F) 100,00,000
So, Gross Profit (D) = ` 55,00,000
E) Miscellaneous Income = Total Income in P&L - Gross Profit
= ` (60,00,000 - 55,00,000) = ` 5,00,000
F) = ` 100,00,000 (As computed in D above)
G) = ` 60,00,000 (Total of both sides of P&L is equal after balancing has been done)

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CHAPTER

Profit & Loss

© The Institute of Chartered Accountants of India

Income Statement Positions Statement

Trading Account Profit & Loss Account Balance Sheet

Gross Profit or Gross Position of Assets &

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corporate entities. These additional statements are

1.2 PREPARATION OF FINAL ACCOUNTS

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Inter-relationship of the two statements

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1.3 TRADING ACCOUNT

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© The Institute of Chartered Accountants of India

Trading Account Items

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Trading a/c Dr.

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Particulars Debit (`) Credit (`)

Additional Information: Creditors balance as on 1st April, 2019 is ` 3,00,000.

ii) Calculation of amount paid to creditors:

Date Particulars ` Date Particulars `

Note: 1) Purchases made during the year can be computed as:

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Journal Proper in the Books of M/s. ABC Traders

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1.4 PROFIT AND LOSS ACCOUNT

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© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Journal Proper in the Books of M/s. ABC Traders

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© The Institute of Chartered Accountants of India

(5) Adjustment of Inventory of materials in hand, e.g., Stationery, Advertisement, Material,

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© The Institute of Chartered Accountants of India

The account will appear as follows:

Liabilities Amount Assets Amount

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© The Institute of Chartered Accountants of India

1.5 CERTAIN ADJUSTMENTS AND THEIR TREATMENTS

To Purchases/Trading Account 6,000

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© The Institute of Chartered Accountants of India

When goods are used for maintenance of business premises/ Machinery: -

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© The Institute of Chartered Accountants of India

March 31 Trading A/c Dr. 22,50,000

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1.6 BALANCE SHEET

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ARRANGEMENTS OF ASSETS AND LIABILITIES

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