CBSE Class 11 Accountancy

Revision Notes
Chapter-8 Financial Statements of Sole Proprietorship

Learning Objectives

After studying this lesson you should be able to;

State the nature of the financial statements;

Distinguish between the capital and revenue expenditure and receipts;
Explain the concept of trading and profit and loss account and its preparation;
State the nature of gross profit, net profit and operating profit;
Describe the concept of balance sheet and its preparation;
Explain grouping and marshalling of assets and liabilities;
Prepare profit and loss account and balance sheet of a sole proprietor firm.

Teaching methodology
For teaching this topic the teacher should use discussion method, explanation method,
illustration method etc.

Financial Statements
Financial statements are written records that convey the financial activities and conditions
of a business or entity and consist of four major components. Financial statements are meant
to present the financial information of the entity in question as clearly and concisely as
possible for both the entity and for readers. Financial statements for businesses usually
include income statements, balance sheets, statements of retained earnings and cash flows
but may also require additional detailed disclosures depending on the relevant accounting
framework. Financial statements are often audited by government agencies, accountants,
firms, etc. to ensure accuracy and for tax, financing or investing purposes.Financial
statements serve as a means of communicating information about the profitability (income
statement) and the financial position (Balance Sheet) of the business in a concise and
understandable manner at the end of accounting period.

Financial statements include the following statements:

 i. Income statement (Trading and Profit and Loss Account)—prepared to ascertain gross
profit/loss and net profit/loss during an accounting period.
ii. Statement of Financial Position (Balance Sheet)—prepared to ascertain position (assets,
liabilities and capital) of an enterprise at a particular point of time.
iii. Schedules and notes forming part of Balance sheet and Income statement —to give details
of various items shown in both the statements.

Capital Expenditure
The non-recurring expenditure whose benefit is derived by the business for more than a
year is called Capital Expenditure.
It includes the amount spent or liabilities incurred to acquire or improve any fixed asset or
acquiring any legal rights or first-time expenses incurred to make fixed assets workable e.g.
purchase of machinery/building/furniture etc., expenses incurred to acquire Patents, Trade-
marks etc. and expenditure incurred for making an asset ready to use (like installation exp.,
carriage, first time expenses incurred on second hand fixed asset for making it ready to use).
Capital expenditures are recorded on the assets side of the Balance sheet.

Revenue Expenditure
The recurring and routine nature expenditures which are incurred for operating the
business smoothly and which help to maintain business’s earning capacity, are called
Revenue expenditures e.g. expenses incurred for producing finished goods such as direct
expenses, purchase of raw material and other expenses as rent, salary, repairs etc.
The benefit of these expenses last upto one year (give benefit up to one year). These expenses
are shown on Debit side of the income statement (trading and profit and loss account).

Deferred Revenue Expenditure

The expenditure which is revenue in nature, but the amount spent is large and the benefits
are likely to be derived over a number of years is called deferred revenue expenditure, e.g.
heavy expenses on advertising on launching of a new product. Hence, this expenditure is
capitalized like any fixed asset.

Accounting treatment of Deferred Revenue Expenditure

As per matching principle, expenses incurred in an accounting period are matched with the
revenue recognized in that accounting period. So the whole deferred revenue expenditure
should be spread over the number of years over which the benefit is likely to be derived.
During the current accounting year: (a) Only that portion of the expenditure should be
charged to the profit and loss account which has facilitated the enterprise to earn revenue
during current year (b) Remaining amount of expenditure should be carried forward to the
next year and shown on the assets side of the balance sheet.

Capital Receipt
Capital receipts are those irregular receipts that don’t affect profit or loss of the business; it
either increases the liabilities (raising of loans) or reduces the fixed assets (sale of fixed
assets), so they will be shown in the balance sheet.
Capital receipts are not made available for distribution as profit to the owner.

Revenue Receipt
Revenue receipts are received in the normal and regular course of business like Receipts
from sale of goods and rendering services to customers. Income from non-operating business
activities like income from investment i.e. interest and dividend received and rent received,
Commission and other fees received for non-operating business etc. These receipts increases
profit and are shown on the credit side of the Trading and Profit and Loss account.

Types of Expenses

Direct Expenses: Those expenses which are incurred on purchasing of goods and for
converting the raw materials into the finished goods e.g. Manufacturing wages, Expenses on
purchases (including all duties and taxes paid on purchases), Carriage/Freight/Cartage
inwards, Production expenses (such as power and fuel, water etc.), factory expenses (e.g.
lighting, rent and rates), Royalty based on Production etc.
Note: All direct expenses are debited to Trading account.

Indirect Expenses: Those expenses which are not directly related to production or purchase
of the goods are called indirect expenses. It includes those expenses which are related to
office and administration, selling and distribution of goods and financial expenses etc.
These expenses are shown on the debit side of the Profit and Loss A/c.
Calculation of Gross Profit
Gross Profit = Net Sales - Cost of Goods Sold
Cost of goods sold = Opening Stock + Net Purchases + Direct Expenses - Closing Stock.
Calculation of Operating Profit
Operating profit = Net sales - Operating cost

OR

= Gross Profit - (Office and Administrative Expenses + selling and distribution exp.)
Operating Cost = Cost of Goods Sold + Office and Administrative Expenses + Selling and
distribution exp.
Net Profit = Operating Profit + Non-operating Income - Non-operating expenses.

Operating expenses: The expenses which are related to the main or normal activities of the
business e.g. office and Administrative expenses, selling and distribution expenses.
Operating profit is also called EBIT (Earnings before interest and taxes).

Format of Trading Account

Trading Account
For the year ended.........

Particulars Rs. Particulars Rs.

To Opening Stock
To Purchases
Less: Purchases Returns/ Returns outwards
To Wages/Wages and Salaries
By Sales
To Carriage Inwards
Less: Returns Inward/Sales
To Freight Inwards
Returns
To Gas & Fuel
By Closing Stock
To Power & Water
By Gross Loss
To Factory Rent & Rates
(Transferred to Profit & Loss
To manufacturing Expenses
Account)
To Import and Customs Duty
To Royalties on Production
To Gross Profit (Transferred to Profit & Loss
Account)

Formal of Profit & Loss Account

Profit & Loss Account
 for the Year Ended......

Particulars Rs. Particulars Rs.

To Gross Loss
By Gross Profit
(Transferred from Trading A/c)
(Transferred from Trading A/c)
To Office & Admin. Expenses
By Rent Received
To Salaries
By Discount Received
To Rent Rates Taxes
By Rebates
To Printing and Stationery
By Commission Received
To Salaries & Wages
By Interest Received
To Postages and Telephones
By Dividend Received
To Office Lighting
By Bad Debts Recovered
To Insurance Premium
By Apprentice fees or premium
To Legal Expenses
By Gain on Sale of Fixed Asset
To Audit Fees
By Miscellaneous Receipts
To Travelling Expenses
By Net Loss (Transferred to capital
To Selling & Distribution Exp.
Account)
To Carriage and Freight Outwards

Particulars Rs. Particulars Rs.

To Commission
To Brokerage
To Advertisement
To Publicity
To Bad Debts
To Export Duty
To Packing Expenses
To Salaries of Salesman
To Delivery Van Expenses
To Financial Exp.
To Interest paid on loans
To Discounts Allowed
To Rebate Allowed
To Bank Charges
To Miscellaneous Exp.
To Repairs
To Depreciation on Fixed Assets
To Entertainment Expenses
To Donations & Charity
To Loss on Sale of Fixed Assets
To Stable Expenses
To Loss by Fire
To Loss by theft
To Unproductive Expenses
To Net Profit Transferred to Capital Account
(If Cr. side > Dr, side)

In the Books of Mr. Ranjeet

Trading and Profit & Loss Account for the year ended on March 31, 2013

Particulars Rs. Particulars Rs.

Opening stock 8,000

Purchases 22,000 Sales 42,000
Wages 2,500 Closing stock 4,500
Gross profit 14000

46,500 46,500

Particulars Rs. Particulars Rs.

Salaries and Wages 3,500

Rent 1,200
Advertisement 1,000
Commission
 Discount 1,100
Gross Profit b/d 14,000
Bad debts 600
Sales Expenses 1,200
Repairs 600
Net Profit 600
(transferred to capital) 4,200

14,000 14,000

Grouping and Marshalling of Assets and Liabilities

Grouping: The term ‘Grouping’ means putting together items of a similar nature under a
common heading. For example, under the heading ‘trade Creditors’ the balances of the
ledger accounts of all the suppliers from whom goods have been purchased on credit, will be
shown.

Marshalling: It refers to the order in which the various assets and liabilities are shown in
the Balance Sheet. The assets and liabilities can be shown either in the order of liquidity or in
the order of permanence.

Order of Liquidity

1. The assets are arranged in the order of their liquidity i.e., the most liquid asset (e.g., cash-
in-hand), is shown first. The least liquid asset (e.g., goodwill) is shown last.
2. The liabilities are arranged in the order of timing i.e., the liabilities which are to be
paid immediately {e.g., Creditors) are shown first and which are to be paid later are
shown at last (long-term loans).
A general format of a Balance Sheet in order of liquidity is shown below:

Balance Sheet of ..........

As at.............

Liabilities Rs. Assets Rs.

Current Liabilities: Current Assets:

Bank Overdraft Cash-in hand

Bills Payable Cash at Bank

 Outstanding Bills Receivable
Expenses Sundry Debtors
Sundry Creditors Prepaid Expenses
Income received-in-advance Accrued Income
Closing Stock
Long-term Liabilities:
Loan Investment:
Capital: Fixed Assets:
Opening balance xxxx Furniture and Fixtures
Add: Net Profit xxxx Plant & Machinery
(Less: Net Loss) Building
Less: Drawing (xxxx) Land
Goodwill

Order of Permanence: This order is exactly reverse of the liquidity order

1. The assets are arranged in the order of their permanence i.e., the least liquid asset (e.g.,
goodwill) is shown first and the most liquid asset (e.g., Cash-in-hand) is shown last.
2. The least urgent payment to be made (e.g. long term loans) is shown first and the most
urgent payment to be made (e.g., short-term creditors) is shown last.
3. A company is required to prepare the balance sheet in the order of permanence.

A general format of a Balance Sheet in the order of performance is shown below:

Balance Sheet of …………

As at.............

Liabilities Rs. Assets Rs.

Fixed Assets:
Capital: Good will
Opening Balance xxxx Land
Add: Net Profit xxxx Building
(Less: Net Loss) Plant & Machinery
Less: Drawings xxxx Furniture & Fixtures
Long-term Liabilities:
 Loan Investment:
Current Assets:
Current liabilities: Closing stock
Income received-in-advance Accrued income
Sundry Creditors Prepaid expenses
Outstanding Expenses Sundry Debtors
Bills Payable Bills Receivable
Bank Overdraft Cash at Bank
Cash in Hand

Adjustment in preparation of financial statements of Sole-proprietor

Meaning of Adjustment entries: Those entries which need to be passed at the end of the
accounting year to show the accurate profit or loss and fair financial position of the business.

Need of Adjustment: There are number of transactions that may not find the place in the
Trial Balance due to any reason such as Closing Stock (because it is valued at the end of the
year), Manager’s Commission based on Net profits (because its calculation requires
preparation of Income Statement first). These transactions can only be taken into account by
passing Adjustment entries so that their impact on the profitability and financial position can
be shown.

Closing Stock: the closing stock represents the cost of unsold goods lying in the stores at the
end of the accounting period.

Outstanding Expenses: When expenses of an accounting period remain unpaid at the end of
an accounting period, they are termed as outstanding expenses.
As they relate to the earning of revenue during the current accounting year, it is logical that
they should be duly charged against the revenue for computation of the correct amount of
profit or loss.

Prepaid Expenses: At the end of the accounting year, it is found that the benefits of some
expenses have not yet been fully received; a portion of its benefit would be received in the
next accounting year. This portion of expenses, is carried forward to the next year and is
termed as prepaid expenses.
Accrued Income: It may sometime happen that certain items of income such as a interest on
loan, commission, rent, etc. are earned during the current ac- counting year but have not
been actually received by the end of the same year. Such incomes are known as accrued
income. .

Income Received in Advance: Sometimes, a certain income is received but the whole
amount of it does not belong to the current period. The portion of the income which belongs
to the next accounting period is termed as income received in advance or an Unearned
Income.

Depreciation: It is the decline in the value of assets on account of wear and tear and passage
of time. It is treated as a business expense and is debited to profit and loss account.
This, in effect, amounts to writing-off a portion of the cost of an asset which has been used in
the business for the purpose of earning profits.

(i) Credit side of Trading A/c.

Closing Stock A/c
Closing Stock Dr. (ii) Show on the assets side of
To Trading A/c
BALANCE SHEET.

(i) Add to die concerned item on die

Expenses A/c
Outstanding/Unpaid Debit side of Trading/Profit & Loss A/c.
Outstanding Dr.
Expenses (ii) Shown on the liabilities side of
Expenses
BALANCE SHEET.

(i) Deduct from the concerned

Prepaid Expenses expenses on the debit side of Profit &
Prepaid expenses/
A/c Dr. Loss A/c
Unexpired expenses
To Expenses A/c (ii) Show on the assets side of
BALANCE SHEET.

(i) Add to the concerned income on

Accrued Income
Accrued income/ Income Credit side of Profit and Loss A/c
A/c Dr.
due but not received (ii) Show on the assets side of
To Income A/c
BALANCE SHEET.

(i) Deduct from the concerned income

Unearned income/ Income A/c
on the credit side of Profit & Loss A/c
Income received in To Unearned Dr.
 Advance Income A/c (ii) Show on the liabilities side of
Balance Sheet.

(i) Show on the debit side of Profit

Depreciation A/c Loss A/c
Depreciation Dr.
To Asset A/c & (ii) Deduct from the concerned asset
in the Balance Sheet.

Note: Sometimes the opening and closing stocks are adjusted through purchases account. In
that case, the entry recorded is as follows:

Closing stock A/c Dr.

To Purchase A/c

This entry reduces the amount in the purchases account and is also known as adjusted
purchases which is shown on the debit side of the trading and profit and loss account.

When the opening and closing stocks are adjusted through purchases, the trial balance does
not show any opening stock. Instead, the closing stock shall appear in the trial balance (not
as additional information or as an adjustment item) and so also the adjusted purchases.

(i) Debit side of P&L A/c.

To write off bad Bad Debts A/c
Dr. (ii) Deduct from debtors on the
debts To Debtors
as- sets side of Balance Sheet.

(i) Debit side of P & L A/c.

Provision for bad P & L A/c
Dr. (ii) Deduct from debtors on the
and doubtful debts To Debtors A/c
assets side of Balance Sheet.

P & L A/c (i) Debit side of P & L A/c.

Provision for
To Provision for Discount Dr. (ii) Deduct from debtors on the
discount on debtors
on Debtors Debtors A/c assets side of Balance Sheet.

Further Bad Debts: These Bad debts is a loss that is occurred after preparation of Trial
Balance. Further bad debts be added in the bad debts already appearing in the Profit and
Loss A/c and Debtors would be reduced with the same amount.

Provision for Bad Debts: In the balance sheet, debtors appear on the assets side of the
Balance Sheet, which is their estimated realisable value during next year. It is quite possible
that the whole of the amount may not be realized in future. However, it is not possible to
accurately know the amount of such bad debts.

Hence, a reasonable estimate of such loss is provided in the book. Such provi- sion is called
provision for bad debts. Provision for doubtful debts is shown as a deduction from the
debtors on the asset side of the balance sheet.

Note: The provision for doubtful debts brought forward from the previous year is called the
opening provision or old provision. When such a provision already exists, the loss due to bad
debts during the current year are adjusted against the same and while making provision for
doubtful debts required at the end of the current year is called new provision. The balance of
old provision as given in trial balance should also be taken into account.

Provision for discount on Debtors: Discount is allowed to customers to en- courage them to
make prompt payment. The discount likely to be allowed to customers in an accounting year
can be estimated and provided for by creating a provision for Discount on debtors.

Provision for discount on debtors is made on good debtors which are arrived at by deducting
further bad debts and provision for bad debts out of Debtors shown in the Balance sheet.

Manager’s Commission
The manager of the business is sometimes given the commission on the net profit of the
company. The percentage of the commission is applied on the profit either before charging
such commission or after charging such commission. In the absence of any such information,
it is assumed that commission is allowed as a percentage of the net profit before charging
such commission.

1. Commission on net profits before charging such commission

Commission

2. Commission on net profits after charging such commission

Commission
 Interest on (i) Debit side of P & L A/c.
Interest on Capital Dr.
Capital A/c (ii) Add to capital on the liabilities
To Capital A/c side of Balance Sheet.

Capital/Drawings
(i) Credit side of P & L A/c.
A/c
Interest on drawings Dr. (ii) Deduct from capital on the
To Interest on
liabilities side of Balance Sheet.
Drawings A/c

Interest on Loan (i) Debit side of P & L A/c.

Interest payable on
A/c Dr. (ii) Add to loan on the liabilities side of
loan (borrowed)
To Loan A/c Balance Sheet.

P&L A/c (i) Debit side of P & L A/c.

Commission payable to
To Comm. Dr. (ii) Show on the liabilities side of
manager
Payable to Balance Sheet.

Abnormal loss of goods by fire, theft, accident, etc.

Loss by ...... A/c

To Trading A/c (i) Gross Loss: Deduct from
For gross loss (Total
(or) Dr. Purchases or show on the credit side
loss)
To Purchases of Trading A/c.
A/c

For insurance claim Insurance Claim

accepted, if any To For Loss by .......... Dr. (ii) Net Loss: Debit side of P & L A/c.
net loss A/c

(Total loss-Claim ‘P & L A/c to (iii) Insurance claim: Assets side of

Dr.
accepted by Ins.Co.) Loss by .... A/c Balance Sheet

(i) Deduct the amount of goods from

Goods taken by the Drawings A/c
the purchases in Trading A/c.
proprietor for his To Purchases
Dr. (ii) Deduct the amount from the capital
personal use A/c
on the liabilities side of Balance Sheet.
 (i) Deduct the amount from the
Charity A/c
Goods given as charity Dr. purchases on the debit side of Trading
To Purchases a/c
A/c.
(ii) Show on the debit side of P & L A/c.

Advertising A/c (i) Deduct the amount of goods from

Goods distributed as
To Purchases Dr. the purchases in Trading A/c.
free samples
A/c (ii) Show on the debit side of P & L A/c.

Note:

1. If closing stock is shown in Trial Balance then it will be shown in balance sheet only. It is
assumed that purchases amount already gets adjusted in trial balance.
2. Salary and wages will be shown in profit and loss A/c debit side (assuming that salary is
prominent) while wages and salary will be shown in trading A/c debit side, (wages are
prominent).
3. Freight, carriage, cartage will be shown in Dr. side of trading A/c. if inward word
attached with these then it also debited to trading A/c, if outward word attached with
these item then it will be debited to profit and loss account.
4. Any expenses related to factory are debited to trading account like factory lighting,
factory rent if factory word is not given then lighting and rent will be debited to profit
and loss account.
5. Trade expenses always debited to profit and loss A/c not as name indicate trading A/c.
6. Packaging material: cost of packaging material used in product are direct expenses as it
refers to small containers which form part sold, it will debited to trading A/c.
7. Packing: the packing refers to the big containers that are used for transporting the goods
and regarded as indirect expenses and debited to profit and loss account.
8. Adjusted purchases mean the amount of purchases is adjusted by way of adding opening
stock and reduced by the amount of closing stock, e.g., purchases Rs. 1,00,000; opening
stock Rs. 12,000, closing stock Rs. 8,000. Calculate adjusted purchases.
Adjusted purchases = purchases + opening stock - closing stock = Rs. 1,00,000 + Rs. 12,000 -
Rs. 8,000 = Rs. 1,04,000
When adjusted purchases is given in trail balance, then there is no need of debiting
opening stock and crediting closing stock in trading A/c.
In this case closing stock will be shown in balance sheet only.
Remember
While preparing Final Accounts the items which are given inside the Trial Balance are
written only once either in Income Statement or in the Balance Sheet. (Assuming that they
have been already adjusted in the respective account). On the other hand, the items which
are given outside the Trial Balance (known as adjustment) are to be written twice because
the double entry in respect of all adjustments is to be completed in the final accounts itself.