Final Accounts


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Final Accounts

  1. 1. Amit Kumar (Amicus Curiae) JAY MATA DI # 9717841557 FINAL ACCOUNTSWHAT ARE ASSETS-A resource controlled by the enterprise as a result of past events and from which futureeconomic benefits are expected to flow to the enterprise. In other words anything which is….  cash  convertible into cash  future benefitsAn asset is a possession of a business that will bring the business benefits in the future An asset is anything that will add future value to your business. Employees can even be seen as assets. What is the test of whether something is considered an asset for your business? Well, one asks, “Is the _______something I own, and will it brings me benefits in the future?”What about a motor vehicle – is this an asset? Does it have benefits for your business,and if so, what are they? Answer: Yes, there are benefits for your business... You can use the motor vehicle topick up and deliver goods. So yes, this is also an asset.(convertible into cash) What about cash? Is cash an asset? Answer: cash is certainly an asset. What are the benefits of having cash? Simple: you can pay for things! That is certainly useful (and indeed essential) for a business.Test of whether something is an asset is:1. DOES YOUR BUSINESS OWN/CONTROL IT?2. WILL IT BRING YOUR BUSINESS BENEFITS IN THE FUTURE?3. CAN YOU VALUE IT ACCURATELY?The cost of an asset includes all costs necessary to get it to the business premises and intoa condition in which it can be sold. So the cost of an asset can include the following:- Purchase price, Import duties,- Transport costs to get it to your premises,- Installation or set-up costs.LIABILITY-Amount owed by the business to the outsiders and to the proprietors .  A debt of the business.  Obligation of the  Payable By business enterpriseYOU --------------------> OWE --------------------> BANKthe debt will result in assets (usually cash) leaving the business in the future.The most common liability is a loan.Another common liability is called creditors.WHAT IS OWNERS EQUITY-The residual interest in the assets of the enterprise after deducting all its liabilities.The owner’s equity is simply the owner’s share of the assets of a business.Assets can only ‘belong’ to two types of people: the first type is people outside the business you owe money to(liabilities), and the second is the owner himself (owner’s equity).MANUFACTURING.BUSINESSES:Manufacturing means to make a product, whether by hand or by machine orboth. The word manufacture originates from Latin manu faceremeaning "make by hand"; (manus = "hand"andfacere = "to make").Unlike trading businesses, manufacturing businesses do not buy products at a low priceand sell at a higher price. Instead manufacturing businesses make products, which they then sell.The formula above was based on the calculation of the value of closing inventories:
  2. 2. Amit Kumar (Amicus Curiae) JAY MATA DI # 9717841557 Finished goods: Inventories that have been fully manufactured and are ready for sale.In a manufacturing business the closing value of finished goods are calculated asfollows:The cost of finished goods that were sold (cost of sales) is thus calculated by saying: 1. Trading Account: The account which is prepared to determine the gross profit or gross loss of a business concern is called trading account (during a specific period). 2. Profit and loss a/c-The account, through which annual net profit or loss of a business is ascertained, is called profit and loss account. Gross profit or loss of a business is ascertained through trading account and net profit is determined by deducting all indirect expenses (business operating expenses) from the gross profit through profit and loss account. Thus profit and loss account starts with the result provided by trading account. 3. Balance Sheet: Balance sheet is a financial mirror of the company showing financial position (assets, liabilities) at a particular time. It is list of the accounts having debit balance or credit balance in the ledger. On one side it shows the accounts that have a debit balance (assets) and on the other side the accounts that have a credit balance (capital liabilities).Difference between Trial Balance and Balance Sheet: Trial Balance Balance Sheet1- To verify the arithmetical accuracy of books of a/c. 1-Show true financial position of the business.2- Prepared with balances of all the ledger accounts. 2- Prepared with the balances ofAssets/liab. A/c.3-It is not a part of final accounts. 3-It is an important part of final accounts.4-There is no rule for arranging the ledger balances in it. 4- A & L must be according to the rule ofmarshaling.Revenue: Revenue is the monetary expression of the aggregate of products or services transferred by anenterprise to its customers during a period of time. The revenue for a given period is equal to the inflow of cashand receivables (debtors) from sales made in that period. ThusRevenue = Amount received in cash + ReceivableSources of Revenue: 1. Sale proceeds of goods or services (Sales A/C). 2. Interest received on investment (Interest A/C credit balance). 3. Dividend received on share (Dividend A/C). 1. Discount received from creditors (Discount received account credit balance) 2. Operational Sources or Major Sources or Direct Sources of Revenue: The revenue earned out of normal business activities belongs to this source. For example, for a trader, sale proceeds of goods is a major source of revenue; for a property dealer, commission earned is a major source of revenue, for a lawyer, fees earned is a major source of revenue. 3. Financial Sources or Minor Sources or Indirect Sources of Revenue: Any revenue arising from sources other than normal business activities belongs to this category. e.g. interest, dividend, profit on sale of fixed assets etc. Thus for a trader;
  3. 3. Amit Kumar (Amicus Curiae) JAY MATA DI # 9717841557EXPENSES -means the expired costs incurred for earning revenue of a certain accounting period. They are thecost of the goods and services used up in the process of obtaining revenue. Expenses are mainly divided into twocategories: 1. Direct expenses 2. Indirect expensesDirect Expenses: Expenses connected with purchases and manufacturing of goods are known as directexpenses. For example, freight, insurance, of goods in transit, carriage, wages, custom duty, import duty, octroiduty etc. Such expenses are collectively known as direct expenses.Indirect Expenses: All expenses other than direct expenses are assumed as indirect expenses. Such expenseshave no relationship with purchase of goods. Examples of direct expenses include rent of building, salaries toemployees, legal charges, insurance of building, depreciation, printing charges etc. SoTRADING ACCOUNT: The account which is prepared to determine the gross profit or gross loss of a businessconcern is called trading account. Features: 1. First stage of final accounts of a trading concern. 2. Prepared on the last day of an accounting period. 3. Only direct revenue and direct expenses are considered in it. 4. Expenses are recorded on its debit side and revenue on its credit side. 5. Expenses and revenue concerning current year are taken into account.Purpose of Preparing Trading Account: 1. Gross profit (since all business expenses are met out of it). 2. The amount of net sales. 3. Percentage of gross profit on net sales (gross profit ratio).. 4. Inventory or stock turnover ratio. TRADING ACCOUNTS DEBIT SIDE CREDIT SIDE DIRECT EXPANCES DIRECT INCOMES INCOMES RELATED TO ---- EXPANCES RELATED TO---- ☺SALES ☺PURCHASE ☺SERVICE PROVIDED ☺MANUFACTURING ++++ ☺FACTORY ☺CLOSING STOCKPROFIT AND LOSS ACCOUNT: The account through which annual net profit or loss of a business is ascertained, iscalled profit and loss account. Thus profit and loss account starts with the result provided by trading account. Only
  4. 4. Amit Kumar (Amicus Curiae) JAY MATA DI # 9717841557indirect expenses and indirect revenues are considered in it. All indirect expenses are transferred on the debitside of this account and all indirect revenues on credit side. Sequence of Expenses in Profit and Loss Account:There is no hard and fast rule as to the order in which the items of expenses are shown in profit and lossaccount. Generally, the items of expenses are shown in the following sequence:Office and Administration Expenses: These are the expenses with the management of the business e.g. salaries ofmanager, accountant and office clerks, office rent, office stationary, office electric charges, office telephone etc.Selling and Distribution Expenses: These are the expenses which are directly or indirectly connected with the sale ofgoods. These expenses vary with the sales i.e. they increase or decrease with the increase or decrease of sale of goods.Examples are advertisements, carriage outward, salesmens salaries and commission, discount allowed.Financial and Other Expenses: All other expenses excepting those mentioned above are considered under this class.Features of Profit and Loss Account; 1. Prepared on the last day of an account year. 2. Second stage of the final accounts. 3. Only indirect expenses and indirect revenues are shown. 4. It starts with gross profit or gross loss. 5. All items of revenue concerning current year - whether received in cash or not - and all items of expenses - whether paid in cash or not - are considered in this account. PROFIT AND LOSS ACCOUNTS DEBIT SIDE CREDIT SIDE INDIRECT INDIRECT EXPANCES INCOMES EXPANCES RELATED TO---- INCOMES RELATED TO ---- ☺SALES ☺BUSINESS INCOME ☺OFFICE ☺FINANCIAL ☺FINANCIAL ☺INCIDENTAL ☺ABNORMAL ☺ABNORMAL GAIN (OTHER THAN DIRECT EXPANCES) (OTHER THAN DIRECT INCOMES)Difference between Trading Account and Profit and Loss Account: Trading Account Profit and Loss Account First stage of final accounts.  Second stage of the final accounts. Shows the gross profit or loss.  Shows the net profit or loss. All direct expenses (expenses connected with  All expenses connected with sales and administration purchase or production of goods) are (indirect expenses) of business is considered. considered in it.  Starts with (gross profit or gross loss). Does not start with the balance.  Its balance is transferred to capital account. Its balance is transferred to P&L a/c.Gross Profit or Loss:Gross profit is ascertained by deducting cost of goods sold (all direct expenses like purchases, carriage, customduty, sock charges, octroi duty etc.) from sales. Gross profit = Total sales - All direct expenses or cost of goods soldFor example, suppose Mr. X purchased some goods for Rs.10,000 and paid Rs.200 on account of carriage andRs.100 as octroi duty. He sold the goods for Rs.1,4000. Now, the cost of goods sold will be Rs.10,300 (10,000 + 200+ 100) and gross profit will be Rs.3,700.Gross profit = Total sales - Cost of goods sold = 14000 – 10300 =3,700Thus the account which is prepared to determine the gross profit or gross loss of a business concern iscalled trading account.NET PROFIT OR LOSS: It is ascertained by deducting all indirect expenses (the expenses incurred for running thebusiness and selling the goods) from the gross profit.Net profit = Gross profit - All indirect expensesSuppose in the above example, Mr. X paid Rs.1,000 as salaries and Rs.500 as rent. His net profit will be Rs.2,200.Net profit = Gross profit - All indirect expenses = 3,700 - 1,500 = 2,200Thus the account which is prepared to determine the net profit or net loss of a business concern is calledprofit and loss account.Following are the main points of difference between gross profit and net profit:
  5. 5. Amit Kumar (Amicus Curiae) JAY MATA DI # 9717841557Gross Profit Net Profit  It is the excess of net sales over cost of  It is the excess of gross profit over all indirect purchase or manufacture of goods. expenses.  It is not true profit of the business  It is true profit of the business.  It shows credit balance of the trading account  Shows credit balance of the P&L a/c.  The progress of the business can be judged  Profitability of the business can be measured by by the comparison of gross profit with net the comparison of net profit with net sales. salesBalance Sheet - Last Stage in Final Accounts:Balance sheet is a list of the accounts having debit balance or credit balance in the ledger. The purpose of abalance sheet is to show a true and fair financial position of a business at a particular date. Every businessprepares a balance sheet at the end of the account year. A balance sheet may be defined as: 1. "It is a statement of assets, liabilities and owners equity (capital) on a particular date". 2. "It is a statement of what a business concern owns and what it owes on a particular date". What is owns are called assets and what it owes are called liabilities. 3. "It is a statement where all the ledger account balances which remain open after the preparation of trading and profit and loss account, find place".Balance sheet is so called because it is prepared with the closing balance of ledger accounts at the end of the year.It has two sides - assets side or left hand side and liabilities side or right hand side. The accounts have a debitbalance are shown on the asset side and those have a credit balance are shown on the liabilities side and the totalof the two sides will agree.ASSETS MEAN all the things and properties under the ownership of the business i.e. building, plant, Assets alsoinclude anything against which money or service will be received i.e. creditors accrued income, prepaid expensesetc.LIABILITIES MEANS our dues to others or anything against which we are to pay money or render service, i.e.creditors, outstanding expenses, amount payable to the owner of the business (capital) etc.Balance sheet reveals the financial position of the firm on a particular date at a point of time, so it is also called"position statement". Features:  last stage of final accounts  Prepared on the last day of an a/c year.  It is not an account but a statement only.  It has asset side and liabilities side.(it does not have Debit and Credit side as in case of ledger)  The total of both sides are always equal.  No expense accounts and revenue accounts are shown here.  It discloses the financial position and solvency of the business.Classification of Assets:Assets may be classified as follows:Real Assets: Assets which have some market value are called real assets, e.g. building, machinery, stock.Fixed Assets: Assets which have long life and which are bought for use for a long period of time are called "fixedassets". These are not bought for selling purposes, e.g. land, building, plant, machinery, furniture etc. Fixed assetsare again sub-divided into two: 1. Tangible Assets: Assets which have physical existence and which can be seen, touched and felt are called "tangible assets", e.g. building, plant, machinery, furniture etc. 2. Intangible Assets: Assets which have no physical existence and which cannot be seen, touched or felt are called "intangible assets", e.g. goodwill, patent right, trade mark etc.Current Assets: Assets which are short-lived and which can be converted into cash quickly to meet short termliabilities are called "current assets", e.g. stock debtors, cash etc. Such assets change their form repeatedly and so,they are also known as circulating or floating assets.
  6. 6. Amit Kumar (Amicus Curiae) JAY MATA DI # 9717841557Out of current assets those which can be converted into cash very quickly or which are already in the form of cashare called liquid or quick assets e.g. debtors, cash in hand, cash at bank etc. (CA-stock-prepaid exp.).Fictitious Assets: Assets which have no market value are called fictitious assets. Examples of fictitious assetsinclude preliminary expenses, loss on issue of shares etc. They are also known as nominal assets.Besides these, there is another type of assets whose value gradually reduce on account of use and finally exhaustcompletely. This type of assets is called wasting assets e.g. mine, forest etc.Classification of Liabilities:Internal Liabilities: The total amount of debts payable by a business to its owner is called internal liability e.g.Owners equity (capital), reserve etc. From practical view point internal liabilities should not be regarded asliabilities, since there is no question of meeting such liabilities as long as the business continues.External Liabilities: All debts payable by a business to the outsiders (other than the owner) are called externalliabilities e.g. creditors, debentures, bills payable etc. External liabilities are further divided into two.Fixed or Long Term Liabilities: The liabilities which are payable after a long period of time are called fixed orlong term liabilities e.g. debentures, loan on mortgage etc.Current or Short Term Liabilities: The debts which are repayable within a short period of time are calledcurrent or short-term liabilities e.g. creditors, bills payable, bank overdraft etc. Current liabilities may again bedivided into two: 1. Deferred Liabilities: Debts which are repayable in the course of less than one year but more than one month are called deferred liabilities e.g. Short term loan etc. 2. Liquid or Quick Liabilities: Debts are repayable in the course of a month are called liquid or quick liabilities e.g. Bank overdraft, outstanding expenses, creditors etc.Besides the above, there is another type of liability which is known as contingent liability. It is one which is not aliability at present, but which may or may not become a liability in future. It depends upon certain futureevent. For example, suppose, the buyer of goods filed a suit in the court against the seller claiming damage ofRs.10,000 for breach of contract. To the buyer, this is a contingent asset. Both contingent liability and contingentasset are not recorded in the balance sheet. They are generally mentioned in the balance sheet as a note.Grouping and Marshaling -An arrangement is made in which assets and liabilities are shown in thebalance sheet. Such an arrangement is called marshaling of assets and liabilities. There are three methodsof marshaling: 1. Permanency Preference Method 2. Liquidity Preference Method
  7. 7. Amit Kumar (Amicus Curiae) JAY MATA DI # 9717841557(Liquidity preference method is exactly reverse of the first method) BALANCE SHEET LIABILITIES ASSET SIDE SIDE CAPITAL +LIABILITY ASSET+PROPERTIES CAPITAL--- ☺FIXED ASSETS LIABILITY--- LAND & BUILDING ☺INITIAL ☺LONG TERM PLANT & MACHINERY ☺ADDITIONAL DEBENTURE ☺INVESTMENTS (CAPITAL) ........ ☺RESERVE BANK LOAN ☺CURRENT ASSETS +NET PROFIT AND ☺SHORT TERM +INTEREST ON CAP. CASH ☺SURPLUS CREDITOR BANK -WITHDRAWING BILL PAYABLE DEBTOR -INT. ON WITHD. O/S EXPANCES ☺MISC.EXPENDITURES -INCOME TAX -NET LOSS PRELINIMARY EXPANCES LOSS ON ISSUE OF SEC.Capital and Revenue Payments:It may be noted that there is a difference between an expenditure and payment.Expenditure is the full amount spent by a business whether paid or yet to be paid while payment means theamount actually paid. For example, a machinery is purchased for Rs.50,000 from Saleem & Co., Rs.30,000 werepaid to them in cash, agreeing to pay Rs.20,000 after one month. In this case, total amount spent is Rs.50,000 butthe payment is Rs.30,000 only.Capital Payments: This is an amount which is actually paid on account of a CE.Revenue Payments: This is an amount which is actually paid on account of some RE. For example, we purchasegoods of Rs.30,000, this is a RE of Rs.30,000. We paid cash to the supplier only Rs.20,000, this is a revenuepayment. If the whole amount is paid in cash, then both the RE as well as revenue payment will be Rs.30,000.CE (capital expenditures)-An expenditure which results in the acquisition of permanent asset which is intendedto be permanently used in the business for the purpose of earning revenue is known as CE. These expendituresare non-recurring by nature. Moreover, any expenditure which is incurred for the purpose of increasing profitearning capacity or reducing cost of production is a CE. Examples: 1. Purchase of furniture, motor vehicles, electric motors, loose tools and other tangible assets. 2. Cost of acquiring intangible assets like goodwill, patents, copy rights, trade marks, patterns and designs. 3. Addition or extension of assets. RE (Revenue Expenditure)-All the expenditures which are incurred in the day to day conduct andadministration of a business and the effect-of which is completely exhausted within the current accounting yearare known as "REs". These expenditures are recurring by nature . These expenditures is always short-lived. REalso includes the expenditure incurred for the purchase of raw material and stores required for manufacturingsaleable goods and the expenditure incurred to maintain the- fixed assets in proper working conditions i.e. repairof machinery, building, furniture etc. Examples: 1. Wages paid to factory workers. Expenditure incurred in the ordinary conduct and administration of business, i.e. rent, , carriage on saleable goods, salaries, wages manufacturing expenses, commission, legal expenses, insurance, advertisement, free samples, RE CE1. Its effect is temporary. 1. Its effect is long-term.2. Neither an asset is acquired nor is the value of an 2. An asset is acquired or the value of an existing asset is asset increased. increased.3. It has no physical existence. 3. It has physical existence except intangible assets.4. It is recurring and regular and it occurs repeatedly. 4. It does not occur again and again. It is nonrecurring and irregular.5. It does not appear in the balance sheet. 5. It appears in the balance sheet .When REs are not regarded as REs? (Revenue expenditure)
  8. 8. Amit Kumar (Amicus Curiae) JAY MATA DI # 9717841557 There are some items of expenditure which are revenue by nature, yet they are not regarded as RE. Such expenditures may be divided into two groups: 1. Deferred RE 2. Capitalized RE 1. Deferred RE:This is a RE, the benefit of which is not confined to one accounting year - it extends to future accounting year or years also. However, this expenditure does not result in the acquisition of any fixed asset. Ex- heavy advertisement expenditure, RE chargeable in the current a/c year and the remaining portion is temporarily treated as CE and shown on the Asset side of the Balance Sheet. Below are a few examples of such expenditure: (a) Expenditure incurred to the formation of a joint stock company i.e. Preliminary Expenses. (b) Expenditure on research and experiment connected with the introduction of a new product. 2. Capitalized Expenditures: Expenditures connected with fixed assets and spent directly on the acquisition of fixed assets. Such expenditures are added to the cost of assets and are called "Capitalized Expenditures". For example, we buy a second-hand plant for Rs.50,000. A further sum of Rs.5,000 is spent on its repair and overhauling in order to bring the plant into proper working order. Thus, a RE which increases the utility or productive capacity of an asset, is treated as capitalized expenditure. (a) Expenditure on installing an asset. I.e. installation charges. (b) Expenditure on repair to property, if the production capacity or utility of the property is increased. (c) Expenditure incidental to purchase of fixed assets, e.g. freight, clearing charges, customs duty, Example: 1. Preliminary expenses paid in the formation of a company. 2. Heavy advertisement expenses paid to introduce a new product in the market. 3. Wages paid for the installation of a machinery. 4. Carriage paid on the purchase of a machinery.No. Nature of Reason Expenditure1. Deferred RE. At the time of formation of a company certain expenses are incurred which are revenue by nature e.g. cost of preparing documents, registration fee, cost of stamp etc. Such expenditures are large in amount and it will be logical to spread such expenditures over a number of years.2. Deferred RE. It is ordinarily a RE. But if heavy advertisement expenses are paid to introduce a new product, then, the benefit will be received for a number of years, so it is treated as deferred RE.3. Capitalized This expenditure is regarded as a part of the cost of machinery, so it is regarded as a expenditure. capitalized expenditure.4. Capitalized Carriage paid on machinery is also regarded as an additional cost of the machinery, expenditure. therefore, treated as a expenditure. Note: Both deferred RE and capitalized expenditure are shown on the asset side of the Balance Sheet Capital Receipt: Receipts which are non-recurring (not received again and again) by nature and whose benefit is enjoyed over a long period are called "Capital Receipts", e.g. money brought into the business by the owner (capital invested), loan from bank, sale proceeds of fixed assets etc. Capital receipt is shown on the liabilities side of the B/s Revenue Receipt: Receipts which are recurring (received again and again) by nature and which are available for meeting all day to day expenses (RE) of a business concern are known as "Revenue receipts", e.g. sale proceeds of goods, interest received, commission received, rent received, dividend received etc. Distinction between Capital Receipt and Revenue Receipt: Revenue Receipt Capital Receipt 1. Short-term effect. Benefit is within one a/c period. 1. Long-term effect. The benefit is for many years in future. 2. It is recurring and regular 2. It is nonrecurring and irregular. 3. Shown in P & L a/c on the credit side. 3. It is shown in the Balance Sheet on the liability side. 4 not increase or decrease the value of asset or liability 4. Decreases the value of asset or increases the value of liability . Example: 1. Amount realized from sale of old furniture. 2. Money borrowed from a bank to acquire fixed assets. 3. Amount received from a debtor whose account was previously written off as bad. 4. Rs.20,000 received from sale of old machinery which had cost Rs.12,000. 5. A motor car, whose book value is Rs.8,000 was sold for Rs.60,000. Solution:No. Nature of Items Reasons1. Capital Receipt. When furniture was purchased it was a CE. Therefore, the sale of furniture will be a capital receipt now. DAKSH ACADEMY Feel free to mail me: Page 2
  9. 9. Amit Kumar (Amicus Curiae) JAY MATA DI # 97178415572. Capital Receipt. Money is borrowed to acquire fixed assets, that will benefit the business for many years, so it is a capital receipt.3. Revenue Receipt. When debtors account was previously written off, it was treated as a revenue loss (expenditure), now, amount received from him will be treated as a revenue receipt.4. (a) Rs.20,000, Capital Receipt Furniture of Rs.12,000 was sold for Rs.20,000 and there was a profit of (b) Rs.8000, Capital Profit. Rs.8,000. Therefore, Rs.20,000 is a Capital Receipt and the profit of Rs.8,000 is regarded as Capital Profit.5. (a) Capital Receipt Rs.60,000 A motor car of the book value of Rs.80,000 is sold for Rs.60,000 and so there is (b) Capital loss Rs.20,000 a loss of Rs.20,000. The full amount received Rs.60,000 is a capital receipt and loss of Rs.20,000 is a capital loss, because this is not a loss which occurred in the ordinary course of the business. CAPITAL PROFITS: Capital profit is a profit which is earned, on the sale of a fixed asset or profit earned on raising capital for a company (by issuing shares at premium). This is not a regular profit of the business and is not earned in the ordinary trade of the business. REVENUE PROFITS: This is a profit which is earned during the ordinary course of business e.g. profit on sale of goods, rent received, interest received etc. CAPITAL LOSS: This is a Joss suffered by a business on the sale of a fixed asset or it is incurred on raising capital of a joint stock company. This is not a recurring loss and is not made in the ordinary course of the business. Capital loss is sown in the Balance Sheet on the asset side as a fictitious asset. REVENUE LOSS: This loss is made in the ordinary course or day to day operation of a business such as loss on sale of goods etc. Revenue loss appears in the profit and loss account or income statement in the year in which it occurs. DAKSH ACADEMY Feel free to mail me: Page 2