Financial Accounting - I (I B.Com)

1. SAIVA BHANU KSHATRIYA COLLEGE, ARUPPUKOTTAI.
Department of Commerce,
Dr. K. SUDHAGARAN M.Com., M.Phil., Ph.D., AssociateProfessor,
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FINANCIALACCOUNTING –FINALACCOUNTS
STUDY NOTES
FINALACCOUNTS
Businessman is interested in knowing whether his business is running on Profit or Loss and
also the true financial position of his business. The main aim of Bookkeeping is to inform the
Proprietor, about the business progress and the financial position at the right time and in the
right way. Preparation of Final accounts is possible only after the preparation of Trial
Balance.
The term ‘Final Accounts’is a broader term. The following financial statements are prepared
for the preparation of final accounts:
(i) Trading account: It shows gross profit/loss of the business.
(ii) Profit & loss account: It shows the net profit/loss of the business.
(iii) Balance sheet: It shows the financial position of the business.
Out of the above three statements, trading, profit & loss accounts are prepared, together, and
balance sheet is prepared, independently.
Trading, profit & loss account and balance sheet, all these three together,are called as
final accounts. Final result of trading is known through Profit and Loss Account.
Financial position is reflected by Balance Sheet. These are, usually, prepared at the
close of the year hence known as final accounts.
TRADING ACCOUNT
Trading refers buying and selling of goods. Trading A/c shows the result of buying and
selling of goods. This account is prepared to find out the difference between the Selling
prices and Cost price. If the selling price exceeds the cost price, it will bring Gross Profit.
The difference between the two sides of the Trading Account indicates either Gross Profit or
Gross Loss.
The total on the credit side is more, the difference represents Gross Profit.
On the other hand, if the total of the debit side is high, the difference represents Gross Loss.
The Gross Profit or Gross Loss is transferred to Profit and Loss A/c.
The account which is prepared to determine the gross profit or gross loss of a business
concern is called trading account.

2. SPECIMEN OF TRADING ACCOUNTS
Trading account for the year ended ……………
Particulars Rs Rs Particulars Rs Rs
To Opening stock
To Purchases
Less returns
To Direct expenses:
To Carriage inward
To Wages
To Insurance in transit
To Custom duty
To Clearing charges
To Freight inward
To Transportation
inward
To Excise duty on
goods
To Royalty on
production
To Dock charges
To Coal, Gas, fuel
To Motive power
To Oil, water
To Import duty
To Consumable stores
To Factory expenses
To Gross profit
(Transferred to P&l
A/C)
*****
****
******
******
*******
*******
*******
By Sales
Less returns
By Closing stock
By Gross loss
(Transferred to P&l
A/C)
******
***** ******
******
******
*******
The trading accounting has the following features:
It is the first stage of final accounts of a trading concern.
It is prepared on the last day of an accounting period.

3. Only direct revenue and direct expenses are considered in it.
Direct expenses are recorded on its debit side and direct revenue on its credit side.
All items of direct expenses and direct revenue concerning current year are taken into account
but no item relating to past or next year is considered in it.
If its credit side exceeds it represents gross profit and if debit side exceeds it shows gross
loss.
Advantages of Trading Account
1. The result of Purchases and Sales can be clearly ascertained
2. Gross Profit ratio to Sales could also be easily ascertained. It helps to determine Price.
3.Gross Profit ratio to direct Expenses could also be easily ascertained. And so, unnecessary
expenses could be eliminated.
4. Comparison of trading account details with previous years details help to draw better
administrative policies.
PROFITAND LOSS ACCOUNT
Trading account reveals Gross Profit or Gross Loss. Gross Profit is transferred to credit side
of Profit and Loss A/c. Gross Loss is transferred to debit side of the Profit Loss Account.
Thus Profit and Loss A/c is commenced. This Profit & Loss A/c reveals Net Profit or Net loss
at a given time of accounting year.

4. THE SPECIMEN OF PROFIT AND LOSS ACCOUNT
Profit and Loss Account of ………. For the year ended ………..
Particulars Rs Rs Particulars Rs Rs
To Gross loss b/d
To Administration
expenses
Salaries
Rent rates & taxes
Printing & Stationery
Postage and Telegrams
Telephone expenses
Legal charges
Insurance
Audit fees
Directors fees
General expenses
To Selling &
Distribution Expenses
Showroom expenses
Advertising
Commission paid to
salesmen
Bad debts
Provision for doubtful
debts
Godown rent
Carriage outward
Upkeep of delivery vans
To Depreciation and
maintenance
Depreciation
Repairs &Maintenance
To Financial expenses
Interest on borrowings
Discount allowed
Loss on sale of assets
To Net profit
Transferred to capital A/c
(bal.fig)
Total
………..
………..
By Gross profit b/d
By Dividends received
By Interest received
By Discount received
By commission received
By Rent received
By Profit on sale of asset
By Sundry revenue
receipts
By Net loss
Transferred to Capital A/c
(bal.fig)
Total
………
………

5. BALANCE SHEET
Trading A/c and Profit & Loss A/c reveals G.P. or G.L and N.P or N.L respectively,
Besides the Proprietor wants
i. To know the total Assets invested in business
ii. To know the Position of owner’s equity
iii. To know the liabilities of business.
Definition
The Word ‘Balance Sheet’ is defined as “a Statement which sets out the Assets and
Liabilities of a business firm and which serves to ascertain the financial position of the same
on
any particular date.”
On the left hand side of this statement, the liabilities and capital are shown. On the right
hand side, all the assets are shown. Therefore the two sides of the Balance sheet must always
be
equal. Capital arrives Assets exceeds the liabilities.
Objectives :
1. It shows accurate financial position of a firm.
2. It is a gist of various transactions at a given period.
3. It clearly indicates, whether the firm has sufficient assents to repay its liabilities.
4. The accuracy of final accounts is verified by this statement
5. It shows the profit or Loss arrived through Profit & Loss A/c.
SPECIMEN OF BALANCE SHEET
Balance Sheet of As on
Liabilities Amount Amount Assests Amount Amount
Capital
Add: Net Profit
Interest on capital
Less : Net Loss ……
Drawings ……
Interest on Drawing...
Income tax …..
SundryCreditors
Bills Payable
Bank overdraft
Loans
Mortgage
Reserve Fund
Outstanding expenses
Income received in
advance
Total
xxxxx
xxxx
xxxx
………..
xxxxxx
xxxxx
………..
xxxxxxxx
xxxxx
xxxxx
xxxxxx
xxxxxx
xxxxx
xxxxxx
xxxxxx
xxxxxx
……………
xxxxxxxx
Cash in hand
Cash at bank
Closing Stock
Bills receivable
SundryDebtors
Investments
Furniture & Fittings
Plant & Machinery
Less depriciation
Loose tools
Land & Buildings
Business premises
Patents &Trade marks
Good will
Prepaid expenses
Outstanding income
Total
xxxxxx
xxxxx
xxxxx
xxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
………….
xxxxxxxx

6. The Balance sheet contains two parts
1.Left hand side- the Liabilities 2. Right hand side -the Assets
ASSETS:
Assets represent everything which a business owns and has money value. Assets are always
shown as debit balance inthe ledger. Assets are classified as follows.
1. Tangible Assets:
Assets which can be seen and felt by touch are called Tangible Assets. Tangible Assets are
A.Fixed Assets: Assets which are durable in nature and used in business over and again are
known as Fixed Assets.e.g. land and Building, Machinery, Trucks, etc.
B. Floating Assets or Current Assets: Current Assets are i. Meant to be converted into cash,
ii. Meant for resale, iii. Likely to undergo change e.g. Cash balance, Stock, Sundry Debtors.
2. Intangible Assets: Assets which cannot be seen and has no fixed shape -goodwill, Patent.
3.Fictitious assets: Assets which have no real value and will appear on the Assets side of
Balance sheet are known as Fictitious assets: E.g. Preliminary expenses, Discount on
creditors.
LIABILITIES:
All that the business owes to others are called Liabilities. It also includes Proprietor’s Capital.
They are known as credit balances in ledger.
Classification of Liabilities:
1. Long Term Liabilities: Liabilities will be redeemed after a long period of time 10 to 15
years
E.g. Capital, Long Term Loans.
2.Current Liabilities: Liabilities, which are redeemed within a year, are called Current
Liabilities or Short-term liabilities E.g. Trade creditors, B/P, Bank Loan.
3.Contingent Liabilities: Liabilities, which have the following features, are called
contingent
liabilities. They are: a. Not actual liability at present b. Might become a liability in future on
condition that the contemplated event occurs. E.g. Liability in respect of pending suit
Difference between Trial Balance & Balance Sheet
S.No. Trial Balance Balance Sheet
1
2
3
4
5
6
It shows the balances of all ledger
accounts.
It is prepared after the completion
of the ledger accounts or arrival of
the balances.
Its object is to check the arithmetical
accuracy.
Items shown in the Trial balance are
not in order.
It shows the opening stock
It has the headings, debit and
credit.
It shows the balances of personal and real
accounts only.
It is prepared after the completion of Trading
and P&L A/c.
Its object is to reveal the financial position
of the business.
But in the B/S, the items shown must be in
order.
It shows the closing stock.
It has the heading of Assets and Liabilities.

7. Difference between Profit and Loss Account and Balance Sheet
Profit and Loss Account Balance Sheet
1
It is prepared with the debit or credit
balance of Nominal Account.
It shows the assets and liabilities on a
particular date.
2
It reveals the Net Profit or Net Loss of
a concern during the particular period.
It is a statement of financial position on a
particular date.
3
The difference between the two sides
of Trading Account will be gross profit
or gross loss transferred to Profit and
Loss Account.
The difference between the two sides of
profit and loss account will be Net Profit or
Net Loss transferred to liability side of
Balance Sheet.
4
The debit or credit balances of nominal
accounts are closed by transferring
Profit and Loss Account
It is the statement of static in nature thus,
accounts do not require to close them.
ADJUSTMENTS IN FINAL ACCOUNTS
Transactions omitted relate to the current year must be entered in books. If a
transaction entered is not related to the current year, fully or partly, that portion of
income or expense must be excluded. This process is made through adjustment entries
in the books of accounts.
1 Closing Stock
Closing Stock appears below the Trial Balance as an adjustment entry:
Closing Stock A/c … Dr
To Trading Account
(i)Stock will have a debit balance. Being a real account, it will be shown on the assets side of
the Balance Sheet.
(ii) Closing stock will be shown on the credit side of the Trading Account.
2 Outstanding Expenses
There are certain expenses, which have been incurred but not paid. These expenses are called
outstanding expenses.
Salary Account …..Dr.
To Outstanding Salary A/c.
(i)Outstanding salary will be added to salary, if any, on the debit side of Profit & Loss
Account.
(ii) Outstanding Salary Account, being personal and having credit balance, will be shown on
the liabilities side of the Balance Sheet.

8. 3 Prepaid or Unexpired Expenses
Those expenses which have been paid, in full, but their utility or benefit has not expired
during the accounting period are called prepaid or unexpired expenses. In other words,
amount has been paid even for the period next to the balance sheet date.
Prepaid Insurance Premium Account…..Dr.
To Insurance Premium
(i)Prepaid insurance will be deducted from the insurance premium on the debit side of the
Profit & Loss Account.
(ii) Prepaid insurance, being personal account and having debit balance, will be shown on the
assets side of the Balance Sheet.
4 Accrued Income
Income earned but not received during the accounting period is called accrued Income.
Accrued Interest on Investments Account …..Dr.
To Interest on Investment Account
(i)Interest on Investment account (accrued interest) will be added to the interest account on
the credit side of the profit & loss account.
(ii)Accrued interest, being personal account and having debit balance, will be shown on the
debit side of the Balance Sheet.
5 Unearned Income or Income Received in Advance
The amount received in respect of an income during the year pertains, partially, to the next
year.
Rent Account ….Dr.
To Rent Received in Advance Account
(i)Rent Received in Advance Account will be deducted from the Rent Account on the credit
side ofthe Profit & Loss Account.
(ii) Rent Received in Advance Account being personal account and having debit balance,
will be shown on the debit side of the Balance Sheet.
6 Depreciation
The value of fixed assets goes on reducing year by year because of wear, tear and efflux of
time. This fall in the value should be treated as a loss or expense, to be considered before
profit or loss is ascertained. The value to be shown in the Balance Sheet must also be,
suitably, reduced.
Depreciation Account …Dr.
To Machinery Account
(i) Depreciation Account will be added on the debit side of Profit & Loss Account.
(ii)Depreciation Account will be deducted from the asset shown on the asset side of the
Balance Sheet.
7 Interest on Capital
The proprietor may wish to ascertain his profit, after considering the interest for the amount
invested in the firm. It will be treated like other expenses and debited to the Profit and Loss
Account; the amount will also be credited to the Capital Account. The entry is:
Interest on Capital Account …Dr.

9. To Capital Account
8 Interest on Drawings
The proprietor may also realize that when he draws money for private use, the firm loses
interest
as funds for business are reduced. Therefore, the proprietor’s capital may be debited with the
interest on the money drawn by him.
Interest on Drawings ...Dr
To Profit & Loss Account
9 Interest on Loan
Interest must be paid on loans, whether there is profit or loss. It is calculated by reference to
the rate of interest agreed to be paid by the firm.
Interest on Loan Account ….Dr.
To Outstanding Interest
(i) Interest on Loan Account will be added on the debit side of Profit & Loss Account.
(ii) Interest on Loan Account will be shown on the liabilities side of the Balance Sheet.
10 Bad Debts
Credit sales have become a must these days and bad debts occur, when there are credit
sales.Bad Debt is a loss to the business and a gain to the debtor.
Bad Debts A/c Dr.
To Debtor’s PersonalA/c
Note: Bad debts, appearing in Trial Balance, have already seen provided for. Now, the
adjustment relates to
additional bad debts for the amount appearing in sundry debtors.
11 Provision for Bad and Doubtful Debts
The following journal entry is passed for creating a provision for bad debts.
Profit & Loss A/c Dr.
To Provision for Bad and Doubtful Debts
The provision for bad debts is charged to the Profit & Loss Account and is deducted from
debtors in the Balance Sheet.
Calculation of Provision for Bad and Doubtful Debts:
From debtors, first deduct total bad debts from debtors. Bad debts are that amount,
appearing in the trial balance and any further provision that may be required in the
adjustment for bad debts.
On the balance amount of debtors only, Provision for Bad and Doubtful Debts is to be
calculated.
Provision for Bad and Doubtful Debts is to be calculated on that amount of debtors,
after deducting bad debts. Provision is not to be calculated on the total amount of
debtors.

10. IMPORTANT QUESTIONS
What are ‘Final Accounts’? Why they are so called?
Trading and Profit and Loss Account and Balance Sheet, all together, are called as ‘Final
Accounts’. These are called as final accounts because they are the last accounts prepared at
the end of the year. The final accounts convey the final position of the firm, in terms of final
profit and final financial position of the organization.
What is the purpose of Trading, Profit and Loss Account and Balance Sheet?
Every businessman is interested to know the operating results and ascertain the financial
position of the firm he runs for monitoring, from time to time. Trading Account shows the
gross profit, while Profit and Loss Account shows the net profit. Final results of business,
profit or loss, are known through Profit and Loss Account. Balance sheet exhibits the final
financial position of the organization.
What is the meaning of ‘Marshalling of Assets and Liabilities’?
‘Marshalling of Assets and Liabilities’ means arranging the assets and liabilities of the firm in
a specific sequence. Assets may be recorded on the basis of liquidity, speed of conversion of
assets into cash. Liquid assets first and non-liquid assets, later, are shown on the assets side of
the balance sheet. In a similar manner, capital is recorded first and other liabilities later.
There is no standard format of the balance sheet for a proprietary concern and partnership
firm, unlike a limited company.
What is the need of ‘Adjustment Entries’?
‘Adjustment Entries’ are required to be made, before preparing the financial statements such
as Trading, Profit and Loss Account and Balance Sheet. Financial statements are made on the
basis of trial balance. However, certain accounting adjustments do not find a place in the trial
balance. All expenses and incomes related to the year are to be fully accounted for, before
drawing the financial statements. There may be certain outstanding expenses, payments made
in advance, accrued income but not accounted for and income received in advance etc. All
these adjustments are to be made in the financial statements. Then only, profit and loss
account shows the factual operating results and balance sheet shows the financial position in
a proper way.
Why ‘Closing Entries’are required to be made?
‘Closing Entries’ are essential to ascertain the correct operating results. Accounts relating to
expenses and incomes are to be closed to find out the operating profit. So, balances in the
expenses and income accounts have to be transferred to Trading and Profit and Loss
Accounts. Process of transferring expenses and income accounts to Trading and Profit and
Loss Accounts is done through closing entries.
What is the need of ‘Opening Entries’?
Assets, liabilities, capital appearing in the previous year’s balance sheet are to be brought into
the ledger of the current year. Balances of these accounts are brought forward into the ledger
for continuation in the current year. The process of bringing them into the current year’s
ledger is done through ‘Opening Entries’.
What is the difference between outstanding expenses and prepaid expenses?
Outstanding expenses are the expenses, which have been incurred, but not paid. Prepaid

11. expenses are the amounts paid for which benefit has not been received during the year in
which the payment has been made.
What is depreciation? What adjustment entry is made for it?
Depreciation is a reduction in the value of the asset for use, wear and tear etc. Depreciation
account is debited and the concerned asset account is credited with the amount of
depreciation.
What is the need for providing depreciation, when there is no cash outgo?
Depreciation is an expense as asset has been used in conducting the business. Adjustment for
depreciation is to be made before drawing the financial statements to show proper operating
results and financial position.
What is a contingent liability?
Contingent liability is a liability that may occur depending on the happening of a future event.
Contingent liability is a liability that may occur or may not occur. There is no certainty of its
happening. Occurrence of the liability is uncertain as it depends on the happening of an
external event, in future, on which the company has no control.
On which side of the balance sheet does contingent liability appear? Explain with an
example?
Contingent liability does not appear on any side of the balance sheet. Contingent liability is
not shown in the main body of the balance sheet. Contingent liability is always shown in
‘Notes to Accounts’, beneath the balance sheet. Example for contingent liability is ‘liability
for bills discounted, not matured’. As the bill is already discounted, say with a bank, bill
amount does not appear on the assets side in the balance sheet. Due date has not yet arrived,
so the position of liability is not known. Liability may occur only if the drawee (person who
has accepted the bill and liable to make payment on the due date) fails to make the payment
to the bank on the due date, which is subsequent to the balance sheet date.
Balance Sheet is a ‘Snap Shot’. Why it is so called?
When you are photographed, your photo shows the dress you wear for the photo. It does not
show the dress that has been changed, ten minutes back. In a similar manner, balance sheet
shows the financial position in respect of assets and liabilities on a particular date. Balance
sheet does not show the changes that have occurred, earlier.