Chapter: Final Accounts (Financial Statements)
**Overview**:
Final accounts are prepared at the end of an accounting period to determine the financial
performance (profit or loss) and financial position (assets and liabilities) of a business. For
a sole proprietorship, final accounts include the Trading Account, Profit and Loss Account,
and Balance Sheet, which summarize business transactions and provide insights for
stakeholders.
#### Key Points:
1. **Objectives of Final Accounts**:
- To ascertain the **gross profit or loss** through the Trading Account.
- To determine the **net profit or loss** through the Profit and Loss Account.
- To present the **financial position** (assets, liabilities, and capital) through the Balance
Sheet.
- To provide information for decision-making, tax computation, and assessing business
performance.
2. **Components of Final Accounts**:
- **Trading Account**:
- Prepared to calculate **gross profit** (or gross loss) by comparing sales and the cost of
goods sold.
- **Format**:
```
Trading Account for the year ended ...
Dr. Cr.
Particulars Amount | Particulars Amount
To Opening Stock XXX | By Sales XXX
To Purchases XXX | Less: Returns Inward (XXX)
To Direct Expenses: | By Closing Stock XXX
- Wages XXX | By Gross Loss c/d (if any) XXX
- Carriage Inward XXX |
To Gross Profit c/d XXX |
Total XXX | Total XXX
```
- **Key Points**:
- **Debit Side**: Opening stock, purchases (less returns outward), and direct expenses
(e.g., wages, freight, customs duty).
- **Credit Side**: Sales (less returns inward) and closing stock.
- Gross Profit = Sales – Cost of Goods Sold (Opening Stock + Purchases + Direct
Expenses – Closing Stock).
- Gross profit/loss is transferred to the Profit and Loss Account.
- **Profit and Loss Account**:
- Prepared to calculate **net profit** (or net loss) by deducting indirect expenses from
gross profit and adding other incomes.
- **Format**:
```
Profit and Loss Account for the year ended ...
Dr. Cr.
Particulars Amount | Particulars Amount
To Gross Loss b/d (if any) XXX | By Gross Profit b/d XXX
To Indirect Expenses: | By Other Incomes:
- Rent XXX | - Interest Received XXX
- Salaries XXX | - Discount Received XXX
- Depreciation XXX | By Net Loss (if any) XXX
To Net Profit XXX |
Total XXX | Total XXX
```
- **Key Points**:
- **Debit Side**: Indirect expenses (e.g., rent, salaries, advertising, depreciation, bad
debts).
- **Credit Side**: Gross profit and other incomes (e.g., commission, interest, discount
received).
- Net profit/loss is transferred to the Capital Account in the Balance Sheet.
- **Balance Sheet**:
- A statement showing the financial position of the business (assets and liabilities) as on
a specific date.
- **Format**:
```
Balance Sheet as on ...
Liabilities Amount | Assets Amount
Capital: | Fixed Assets:
Opening Balance XXX | - Machinery XXX
Add: Net Profit XXX | - Furniture XXX
Less: Drawings (XXX) | Current Assets:
Long-term Liabilities: | - Cash XXX
- Bank Loan XXX | - Debtors XXX
Current Liabilities: | - Closing Stock XXX
- Creditors XXX |
- Outstanding Expenses XXX |
Total XXX | Total XXX
```
- **Key Points**:
- **Liabilities Side**: Capital (adjusted for profit/loss and drawings), long-term liabilities
(e.g., loans), and current liabilities (e.g., creditors, bills payable).
- **Assets Side**: Fixed assets (e.g., machinery, land) and current assets (e.g., cash,
debtors, closing stock).
- Total Assets = Total Liabilities (based on the accounting equation: Assets = Liabilities +
Capital).
3. **Adjustments in Final Accounts**:
- Adjustments are entries made to account for transactions or events not yet recorded by
the end of the accounting period.
- Common adjustments and their treatment:
- **Closing Stock**:
- Appears on the credit side of the Trading Account and as a current asset in the Balance
Sheet.
- **Outstanding Expenses**:
- Added to the respective expense in the Profit and Loss Account and shown as a
current liability in the Balance Sheet.
- Entry: Dr. Expense A/c, Cr. Outstanding Expense A/c.
- **Prepaid Expenses**:
- Deducted from the respective expense in the Profit and Loss Account and shown as a
current asset in the Balance Sheet.
- Entry: Dr. Prepaid Expense A/c, Cr. Expense A/c.
- **Accrued Income**:
- Added to the respective income in the Profit and Loss Account and shown as a current
asset in the Balance Sheet.
- Entry: Dr. Accrued Income A/c, Cr. Income A/c.
- **Income Received in Advance**:
- Deducted from the respective income in the Profit and Loss Account and shown as a
current liability in the Balance Sheet.
- Entry: Dr. Income A/c, Cr. Income Received in Advance A/c.
- **Depreciation**:
- Debited to the Profit and Loss Account and deducted from the respective asset in the
Balance Sheet.
- Entry: Dr. Depreciation A/c, Cr. Asset A/c.
- **Bad Debts**:
- Debited to the Profit and Loss Account and deducted from debtors in the Balance
Sheet.
- Entry: Dr. Bad Debts A/c, Cr. Debtors A/c.
- **Provision for Bad Debts**:
- Debited to the Profit and Loss Account and deducted from debtors in the Balance
Sheet.
- Entry: Dr. Profit and Loss A/c, Cr. Provision for Bad Debts A/c.
4. **Steps to Prepare Final Accounts**:
1. Start with the **Trial Balance** to gather balances of all accounts.
2. Prepare the **Trading Account**:
- Include opening stock, purchases, direct expenses, sales, and closing stock.
- Calculate gross profit/loss.
3. Prepare the **Profit and Loss Account**:
- Transfer gross profit/loss.
- Include indirect expenses and other incomes.
- Calculate net profit/loss.
4. Prepare the **Balance Sheet**:
- Adjust capital for net profit/loss and drawings.
- List liabilities (capital, long-term, current) and assets (fixed, current).
- Ensure total assets equal total liabilities.
5. Incorporate **adjustments** (e.g., closing stock, depreciation) in both the Profit and
Loss Account and Balance Sheet as required.
5. **Importance of Final Accounts**:
- Provide a clear picture of profitability and financial health.
- Help in decision-making, tax assessment, and obtaining loans.
- Enable comparison with past performance or industry standards.
- Ensure compliance with accounting standards.
6. **Limitations**:
- Based on historical data, not future projections.
- May not reflect qualitative factors (e.g., management efficiency).
- Subject to estimates (e.g., depreciation, provisions), which may affect accuracy.
#### Key Terms:
- **Gross Profit**: Excess of sales and closing stock over the cost of goods sold.
- **Net Profit**: Gross profit plus other incomes minus indirect expenses.
- **Direct Expenses**: Costs directly related to production (e.g., wages, carriage inward).
- **Indirect Expenses**: Costs not directly tied to production (e.g., rent, salaries).
- **Adjustments**: Entries to account for accrued, prepaid, or outstanding items.
---
### Example:
**Question**:
From the following Trial Balance of M/s Ravi Traders as on 31st March 2023, prepare Trading
Account, Profit and Loss Account, and Balance Sheet:
- Opening Stock: ₹20,000
- Purchases: ₹80,000
- Sales: ₹1,20,000
- Wages: ₹10,000
- Salaries: ₹15,000
- Rent: ₹5,000
- Cash: ₹12,000
- Debtors: ₹25,000
- Creditors: ₹15,000
- Capital: ₹52,000
- Machinery: ₹40,000
**Adjustments**:
- Closing Stock: ₹30,000
- Depreciation on Machinery: 10%
- Outstanding Rent: ₹1,000
**Solution**:
1. **Trading Account**:
```
Trading Account for the year ended 31st March 2023
Dr. Cr.
Particulars Amount | Particulars Amount
To Opening Stock 20,000 | By Sales 1,20,000
To Purchases 80,000 | By Closing Stock 30,000
To Wages 10,000 |
To Gross Profit c/d 40,000 |
Total 1,50,000 | Total 1,50,000
```
2. **Profit and Loss Account**:
```
Profit and Loss Account for the year ended 31st March 2023
Dr. Cr.
Particulars Amount | Particulars Amount
To Salaries 15,000 | By Gross Profit b/d 40,000
To Rent 5,000 |
To Outstanding Rent 1,000 |
To Depreciation (10% of 40,000) 4,000 |
To Net Profit 15,000 |
Total 40,000 | Total 40,000
```
3. **Balance Sheet**:
```
Balance Sheet as on 31st March 2023
Liabilities Amount | Assets Amount
Capital: | Machinery 40,000
Opening Balance 52,000 | Less: Depreciation (4,000)
Add: Net Profit 15,000 | 36,000
67,000 | Closing Stock 30,000
Creditors 15,000 | Debtors 25,000
Outstanding Rent 1,000 | Cash 12,000
Total 83,000 | Total 83,000
```
**Calculations**:
- Gross Profit = Sales + Closing Stock – (Opening Stock + Purchases + Wages) = ₹1,20,000 +
₹30,000 – (₹20,000 + ₹80,000 + ₹10,000) = ₹40,000.
- Net Profit = Gross Profit – (Salaries + Rent + Outstanding Rent + Depreciation) = ₹40,000 –
(₹15,000 + ₹5,000 + ₹1,000 + ₹4,000) = ₹15,000.
