CHAPTER-15

FINANCIALSTATEMENTS
Meaning
inancial Statements refer to such statements which report the profitability and the financial position of the business at
t e end otaccounting-period. The term financial statements includes atleast two basic statements which are as under:
i) ncome Statement (or Trading and Profit and Loss Account) which shows results of business
operations during an accounting period, and
(i) Statement of Financial Position (or Balance Sheet) which shows financial position of an enterprise at a
specified point of time.
n the words of John N. Mayer, " The financial statements provide a summary of the accounts of a business enterprise.
the balance sheet reflecting the assets, liabilities and capital as on a certain date and the income statement showing the
results of operations
during a certain period."
Objectives of Preparing Financial Statements:
(i) To present a true and fair view of the financial performance (i.e. profi/loss) of the business.
ii) To present a true and fair view of the financial position (i.e. Assets/Liabilities) of the business.

Users of Financial Statements:

. Owners: Owners contributes capital in the business and thus bear maximum risk. They are interested to know the
profit earned or loss incurred by the business, besides safety oftheir capital. The Financial Statements give this
information about the business.
2. Management: The Financial Statements heip the management in assessing the profitability of various activities and
various departments. Management makes extensive use of accounting information to arrive at informed decisions such
as determinationof selling price, cost controls and reduction, investment into new projects, etc.
3. nvestors: They can assess the short-term and long-tem financial soundness and earning capacity of the business
with the help of financial statements. They can also study the trend of sales, trend of profits, shortcomings and the
prospects of future growth of the enterprise.
4. Potential Investors : Potential investors need information to judge prospects of an enterprise and to determine
whether they should buy the shares.
5. Employees : On the basis of financial statements they can judge as to how much bonus and increase in their wages is
possible from the profits of the enterprise. Besides, financial statements also show whether the enterprise has deposited
its dues into the Provident Fund and Employees State Insurance, etc., or not.
6. Long Term Creditors or Lenders: On the basis offinancial statements they may determine (i) whether the
enterprise will be able to pay the interest consistently, and (i) whether the company will be able to pay their debts when
due. On this basis they may also decide to extend, maintain or restrict the loans extended to the
7. Short term Creditors : On the basis of financial statements they assess whether the
enterprise.
enterprise will be able to pay
their debts when they fall due and may decide to extend, maintain or restrict the credit allowed to the
8.
enterprise.
Government and its Authorities : Government makes use of financial statements to compile national income
accounts and other information. The information so available to it enables them to take policy decisions.
Government Levies varied taxes such as Excise Duty, VAT, Service Tax and Income Tax. These government authorities
assess the correct tax dues from the financial statements.
9. Researchers : The information in financial statements helps researchers in studies or
surveys related with a particular
firm or industry.
10. Public : Enterprises affect members of the public in a variety of ways. For example, enterprises may make a
substantial contribution to the local economy in many ways including the number of people, they employ and their
patronage of local suppliers. Financial statements may assist the public by providing information about trends and recent
developments in the prosperity of the enterprise and the range of its activities.

Objective and Importance:

. Knowing profitability of business:- Financial statements are required to ascertain whether the enterprise is
earning adequate profit and to know whether the profits have increased ordecreased as compared to the
previous year(s), so that corrective steps can be taken well in advance.
2. Knowing the solvency of the business:- Financial statements help to analyse the position of the business as
regards to the capacity of the entity to repay its short as well as long term liabilities.

69
 oftwo date or more ycars ofbusiness entity,
of the Through comparison of business.
business:-
3. Judging the growth conclusion as regard
to growth of the
a meaningful
we can draw
business.
4 Judging financial strength of
policy.
and selection of appropriale
5. Making comparison
budgets.
6. Forecasting and preparing
Communicating
with different parties
7.

Statements:-
Limitations of Financial item and when
two

1. Manipulation or Window Dressing

There may be more
than one way of treating a particular
difficult to make a
becomes very
policies, it
Procedures:-
2 Use of Diverse different accounting
dilferent business
enterprises adopt can be expresscd

information which
between such enterprises. incorporate the
monetar
comparison statements converted into
be
lgnored:- The financial which cannot
. Qualitative Aspect fail to assimilate the transactions
lerms. Thus, they
in monetary events and facts. Due On

they record past

based

terms. historical in nature as etc, analysis

are government
statements firm or
Historical:-
Financial
policies of the
demand of the product,
4.
changes in the
continuous serve any useful
purpose.
information does not
past
5. Price Level Changes.
Personal bias.
6. Subjectivity & Data/Information.

7. Lack of Regular
Items: of fixed
Capital on purchase
and normally
Classification of Revenue incurred by an enterprise
resale.
Fixed assets
purchased may

Expenditure
is the amount intended for
not
Expenditure :
Capital earn
income and are
business to expenditure
I. Capital used in the
Fixed a s s e t s are accounting period. Capital
assets. beyond the
intangible. or periods be
or extends to period business.
it should
be tangible benefit expenses
of a smoothly,
expenditure gives the operating
reduces
e s t a b l i s h e d and
run

Capital capacity or business in being

the
increases the earning incurred
which helps
expenditure
is his business.
When an
Aman for setting up
capital
expenditure.
of R 60,00
paid by
treated as
expenses
Preliminary Expenditure: vehicle. etec.
motor
Example:- accounted asCapital furniture,
machinery,
usually building,
are
such as land,
Following types
of expenditures
for acquisition
of fixed assets
installation
ofa f+xed
asset.
incurred or
Expenditure receipt assets.
(i) incurred for purchase, improvement
in fixed
etc.
Expenditure extension
of o r business. trademark, copyright,
(ii) for the to carry on
rights and
Expenditure the right goodwill, patents fined assets.
protecting
(ii)
Expenditure
i n c u r r e d to
acquire
of intangible assets such as acquiring o r defending
suits tor
(iv) incurred for purchase in
connection
with
incurred
Expenditure
(v)
Expenses:
Legal expenses
the Balance
(vi) Legal and is shown in
expenditure.
capital also assets
account
debited to fixed
are
etc.,
rights, Expenditure is
Capital
Expenditure:
i.e., benefit ofsuch
Treatment of Capital incurred on running a business,
is the amount
expenditure which
is not capital
Expenditure
period. In short,
Revenue an
Sheet Expenditure: the accounting period
in
2. Revenue
consumed or
exhausted withinthe accoUnting
ol revenue
is
e x h a u s t e d within
expenditure
benelit
are The
expenses expenditure.
revenue
expenditure is
it is
incurred.
power, fuel, etc.
which
expenses
are:
such as rent, salaries, wages,
Examples of such
incurred in day-l0-day ruining
or
tne Dusiness
maintenance of fixed assets.
)Expenses and
that these are used up
incurred
for repairs
and goOdIs to the extent
(ii) Expenses
on purchase of sloCK Olmateriais
Expenses incurred remaining
amount will bean asset.
the
During the
year; of f+xed assets.
cost
or the expired
Depreciation
(iv)

70
Revenue expenditure is accounted as an
expense and is matched against revenues of the
ofthat period. It also includes that part of capital expenditure which expires or consurnedperiod
to determine
profit or loss
within an accountingyear
(Depreciation).
Treatment of Revenue Expenditure : Revenue
Account
expenditure is shown on the debit side of Trading or Profit and Loss

Distinction betw een Capital Expenditure and Revenue

Basis
Expenditure
Capital Espenditure Revenue Fxpenditure
1. Purpose It is incurred for acquisition of fixed assets t is incurred for running of business.
for use in business.
2. Capacity It increases carning capacity of the business. It is incurred for earning profits.
3. Period lts benefit extends to more than one year. Its benefit is exhausted within the year.
4. Debited It is debited to an Asset
5. Nature of Account
Account. It is debited to an Expense Account
It is an Asset Account and non-recurring in It is an Expense Account and recCurring in
nature. nature.
6. Depiction It is shown in the Balance Sheet. t is shown in the Trading or Profit and Loss

7. Examples Cost of Plant and Machinery, Buildings etc.

Account.
Depreciation on Plant and Machinery. Rent.
Salaries etc.
3. Deferred Revenue Expenditure : Deferred Revenue
Expenditure is a revenue expenditure that is incurred during an
accounting period but its benefit extends beyond that accounting period, i.e., is not exhausted within the
period. Such an expenditure is unusually larger than the normal expenditure under the head. An accounting
example of this is large
expense, say on advertising a new product. The expenditure so incurred will give benefit in the periods beyond the
accounting period in which the expenditure was incurred. It will thus, be
proper to spread the expenditure over a period
and not debit the entire amount to Profit and Loss Account for the
year in which the expense id incurred. Normally such
expenditure should be written off over a period of 3 to 5 years.
It should be noted that Deferred revenue
expenditure and prepaid expenses o different terms. In case of deferred
revenue
expenditure,
benefits available cannot be precisely estimated but in case of
prepaid expenses, like payment of
rent in advance, benefits available can be
precisely estimated.
Treatment of Deferred Revenue Expenditure: Amount not to be written
side of Balance Sheet as fictitious asset. off in the current year is shown on the assets
Deferred Revenue Expenditure is a Fictitious Asset:
Although it appears on the assets side of the
Balance Sheet, it is
not really an asset to the business.

CAPITAL RECEIPTS AND REVENUE RECEIPTS

4. Capital Receipts: Capital receipts are the amounts received in the form of
business, loans received and sale proceeds of the fixed assets. You may observeadditional
capital introduced in the
that when the loan is received, it
increases the business liability. Thus, it is not treated as revenue receipt. Sale of any fiNed asset reduces fixed assets.
thus, the amount received is not revenue earned in the normal course of business. In fact, capital receipts do not atfeet
profit or loss of the business. They either increase liabilities or reduce assets. Hence, these are shown in the Balance
Sheet.
5. Revenue Receipts: These are the amounts received in the normal course
of the business, mainly from sale of
and services. An important feature of revenue receipts is that such receipts are incomes. Hence, these are shown on
goods
credit side of the Trading and Profit and Loss Account.

DISTINCTION BETWEEN CAPITAL RECEIPT AND REVENUE RECEIPT

Capital Receipt RevenueReceipt

1. It isthe amount realised by sale of fixed assets or receipt It is the amount realised by sale of goods or rendering of
as capital or loans taken. seryices.
2.It is shown in Balance Sheet. It is shownin Trading or Prolit and Loss Account.
S.Capital Receipts are normally of non-recurring ature Revenue Reccipts are normally of recuring nature.
4 Capital Receipts are the receipts which are not received Reveue Receipts are received in the course of normal
in course of normal business activities. | Trading Operations.

71
INCOME STATEMENT

gross loss.
It shows the gross profit
or
It is divided into
two parts :
Account. loss.
(1) is called Trading
The first part
Loss Account. It shows the net profit or net

called Profit &

(ii) The second part is
of the trading
TRADING ACCOUNT: oss arising orincurred as a result
ross.profitor gross
calculating the
manufacturing. buying
and selling of goods
Trading a c c o u n t is prepared for words. it is prepared to show the result of with such purchases. the
In other connected
activities ofa business. and the cxpenses directiy
exceeds the amount of purchases excecd the sales. the
sales and direct expenses
Ifthe amount of termed
the contrary. if the purchases,
profit. On
difference is as gross
Batliboi:
loss. According to
J.R. the general
called gross In preparing this account.
difference and selling of goods.
is

The Trading Account shows the results of buying included."

the transactions in goods
are
are ignored and only
establishment charges
ACCOUNT:
FEATURES OF TRADING of final accounts trading of a
concern.

1. the first stage to the preparation

It is
sold.
sales and direct cost of goods
2. It records only net or gross loss.
account shows gross profit
3. The balance ofthis transferred to Profit and Loss Account.
4. Gross Profit or
Gross Loss is
Account
Need and Importance of Trading
Account serves the following objectives:
Preparation of Trading Gross Loss.
1. It providesinformation about Gross Profit and
about the direct expenses.
2. It provides infomation
of closing stock with those of the previous years.
3. Comparison
losses.
4. It provides safety against possible

PROFIT AND LOSS ACCOUNT: However. a

gross profit
earned as a result buying and selling goods.a businessman is m o r e
of of
Trading Account only discloses the not taken to trading
account. Hence,
businessmen has to incur a
number of expenses which are and Loss Account is
loss incurred during the year. As such, a Profit
profít earned or net Carter-
interested in knowing the net
and gains pertaining to the accounting
period. According to Prof.
contains all the items oflosses ascertain the e x c e s s of
and losses are collected, in order to
prepared which
is an account into which allgains
A Profit and Loss Account
vice-versa"
o v e r the losses or
gains

FEATURES OF PROFIT AND LOSS ACCOUNT: accounts.

It is the second stage in the preparation of final
is prepared at the end ofthat period.
.
accounting period and
2. It relates to a particular
is followed in the preparation of this account. and losses.
3. Accrual basis of accounting from other sources and debited with indirect expenses
4. It is credited with
the gross profit and income
is the net profit or net loss.
5. Balance of this account

ACCOUNT:
NEED AND IMPORTANCE
OF PROFIT AND LOSS
Profit Net ILoss.
2. Comparison with previous years' profits.
1. To ascertain the Net
or

3. Control on Expenses.
Sheet.
4. THelpful in the preparation of Balance
ACCOUNT
ACCOUNT AND PROFIT AND LOSS
DIFFERENCE BETWEEN TRADING

Profit and Loss Account

Trading Account
Basis is the main account
Trading Account is a part of Prolit and Loss Account. Protit and Loss Account
I. Relation Protit and Loss Account is prepared
to
Gross Profít or Gross Loss is ascertained trom
2. Nature
ascertain net profít or net loss of the business.
Trading Account. is
3. Transfer of Balance of the 'Trading Account is transferred to Profit Balance of the Profit and Loss Account
and Loss Account. transferredto Capital Account of the proprietor
Balance Items shown in the Trading Account are purchases,
sales,
items like indirect expenses related to
4. Items distribution, administration, finance, etc.,
are
sales, stock, direct expenses etc.
shown in the Profit and Loss Account.

72
 OPERATING PROFIT AND NET PROFIT
Prolit may be
of two types (i) Operating profit
:
and (i) Net profit.
Operating Profit is the profit carned through normal
the opcrat ing activities of the business. It is arrived at by deducting
operating expenses lrom gross profit. FExpenses which arc related to the main or
called operating normal activities of the business are
expenses. They include office and administrative expcses and sclling and distribution
discount bad-debts cte. expenses,
Operating Profit Gross Profit Operating Expenses
Or
Net Profit t
Non-Operating Expenses-Non-Operating
Net Prolit is arrived at by dcducting operating as well as Income
are mcidental or
indirect to the main operations of
non-operating cxpenses from the gross profit. Expen Cs whicn
on loan. charities
the business arc called non-opcrating
cxpenses. They include interest
and donations, loss on sale
of fixed assets. cxtraordinary losses duc to theft. Joss by fire and s0 on
Similarly. non-operating ineomes are added while caleulating the netl
interest. rent and dividend, gain on sale of lixed:assets etc. profit. Non-operating incomes include receipt of

BALANCE SHEET:
Aller ascertaining the net prolit or loss of the business enterprise,
the busincssman would also like to know the eact
inancial position of his business. For this purpose statenment is
prepared which contains all the Assets and Liabilities
a
of the business enterprise. The statement so prepared is called a Balance Sheet because it is a sheet of balances of ledger
accounts which are still open after the transfer of all nominal accounts to the Trading and Profit and Loss Account.
Balances of all the personal and real accounts are grouped as assets and liabilities. Liabilities are shown on the left hand
side of the Balance Sheet and Assets on the right hand side.
According to A. Palmer:
*The Balance Sheet is a statement at a particular date showing on one side the trader' s property and possessions and on
the other hand the liabilities".
According to J.R. Batliboi :
A Balance Sheet is a statement prepared with a view to measure the exact financial position of a business on a certain
fixed date."
Characteristics/Features of Balance Sheet:
The Characteristics of Balance Sheet are:
(i) It is prepared at a particular date and not for a particular period.
(ii) It is prepared after the preparation of Profit and Loss Account.
(iii) It shows financial position of a business as a going concern.
(iv) Balance Sheet is not an account but only a statement of assets and liabilities.
(v) Total of assets side must be equal to the total of liabilities side, i.e., two sides of the Balance Sheet must have
same total.
Need and Importance of Balance Sheet :
The purpose of preparing a Balance Sheet are as follows:
I. The main purpose of preparing a Balance Sheet is to ascertain the true financial position of the business at a particular
point of time.
2. t helps in ascertaining the nature and cost of various assets of the business such as the amount of closing Stock.
amount owing from Debtors, amount of fictitious assets etc.
3. It helps in determining the nature and amount of various liabilities of the business.
4. It gives information about the exact amount of capital at the end of the year and the addition or deduction made into it

in the current year.

5. It helps in finding out whether the firm is solvent or not. The firm is solvent if
the assets exceed the external
liabilities. It would be insolvent if opposite is the case.
Grouping and Marshalling of Assets and Liabilities: in
ASsels and I.iabilities should be shown in a certain order in the
Balance Sheet. Therefore, they should be arranged
certain groups and in a particular order. This is called Grouping and Marshalling of the Balance Sheet.
head. The arrangement of assets and
means putting items of a similar nature under common accounting
a
rouping'
liabilities in a particular order in the Balance Sheet is called Marshalling.
assets and liabilities in a proper
order. Marshalling can be done in any of
arshalling' is the arrangement of various
the following two
ways to this method, an asset which
is most easily convertible into Cash such as
n the Order of Liquidity : According are comparatively less easily
convertible, so that the least
is written first and then follow those assets which
sn n hand
liquid asset such as goodwill, is shown last.

73
 In the same way. those liabilities wh are to be paid at the carliest will be written first. In other words, current
liabilities are written first ofall, then fixed or long-term liabilities and lastly. the proprietor'scapital.
Generally. sole proprietors and partnership firms prepare their Balance Shect in the order ofliquidíty. Proforma ofa
Balance Sheet in the order of Liquidity will be as follows
BALANCE SHEET as at
Liabilities Amount | Assets Amount

Current Liabilities Current Assets:

Bank Overdraft Cash in Hland
Bills Payable Cash at Bank
Sundry Creditors Bills Receivable
Outstanding Expenses Short Term Investments
Unearned Income Sundry Debtors
Long-term Liabilities Stock
Long Termm Loans Prepaid Expenses
Reserves Accrued Income
Capital Long Term Investments
Add : Net Profit
Fixed Assets:
Less Drawings Furniture
Less IncomeTax Loose Tools
Less : Life Insurance Premium Motor Velhicle
Plant and Machinery
Land and Buildings
Patents
Goodwill

2. In the Order of Permanence: This method is

exactly the reverse of the first method discussed above. Assets which
are most difticult to be converted into cash such as
Goodwill are written first and the assets which are most
Cash in hand are written last. Similarly, those liabilities which are to be liquid such as
the proprietor's capital is written first of all, then fixed or
paid last, will be written first. In other words.
long term liabilities and lastly, the current Iliabilities. Joint
stock companies are required under the
Companies Act to prepare their Balance Sheet in the order of pemanence.
It is essential to understand the classification of various Assets and
Liabilities before preparing a Balance Sheet.
Classification of Assets:
Assets are divided as follows:
1. Fixed Assets : Fixed Assets are those assets that are
acquired for continued use and not for resale. They be
tangible assets like land. building. plant and machinery. furniture and fixtures, etc., or intangible assets like may
patents. etc. goodwill.
(1) Tangible Fixed Assets are those fixed assets which can be seen and touched, e.g., Land and
Plant and Machinery. Furniture and Fixtures, etc. Building.
(ii) Intangible Fixed Assets are those fixed assets which are not in a physical form, i.e., they can neither
Be seen nor touched., e.g., goodwill of a firm or the know how which it
Marks, etc.
possesses, patents, Trade-

Distinetion between tangible Assets and lntangible Assets

Basis Tangible Assets Intangible Assets
1. Physical Existence Tangible Assets are assets having a physical Intangible Assets are fixed assets having no
existence.
physical existence.
Example: Land and Building, Plant and
Example:Goodwill. Patents. Trade-marks.
2. Fixed vs. Current
Machinery, etc. etc.
Tangible Assets can be fixed or current, e.g..
Intangible Assets usually fall in the
stock. ategory of fixed assets.
3. Depreciation or Fixed Tangible Assets are depreciated. Intangible Assets are amortised.
Amortisation
4. Risk of
Loss These assets may be lost due to
fire. hese assets cannot be lost
5. Acceptance as Lenders accept such assets as security for due to fire.
enders usually do not accept these assets
Security providing loan. as security for providing loan.
74
2. Investments: Investments are
capital expenditure incurred on purchase olf shares, debentures, bonds, etc., to earn
interest, dividend and other benefits.
*Investment is shown separately in the Balance Sheet.
3. Current Assets: These are those assets of the business which are held for resale or for converting into cash. These
arethe assets which are likely to be realised within a
period of one year or during the period of normal operating cycle.
A business earns profit by sale of these assets but not by keeping them in hand. Examples are unsold goods, debtors,
bills receivable. bank balance., cash in hand, cte.
4. Liquid/Quick Assets : Liquid Assets are those which are either in the form of Cash or can be quickly converted into
cash. such as Cash, Bills Receivable, Short Term Investments, Debtors, Accrued Income etc. In other
words, if Prepaid
Expenses and Closing Stock are excluded from Current Asscts, the balance will be Liquid Assets.
5. Fictitious or Nominal Assets: Theseare the Assets which cannot be realised in Cash or no further benefit can be
derived from these assts. Such assets include Debit balance of Prolit and Loss Account and the expenditure not yet
Written off such as Advertisement Expensces etc. These assets are not really assets but are shown on the Assets side only
tor the purpose of transferring them to the Profit and Loss Account gradually over a period of time.
6. Wasting Asets: These are the Assets which are exhausted or consuned over a period oftime such as mines and oil-
wells. Their value reduces through being worked. These also include Patents and the properties taken on lease for a
definite period of time.

Classification of Lialbilities
According to their nature, the liabilities may be classified as follows
1. Fixed or Long-term Liabilities: Those liabilities which are to be repaid after one year or more are termed as long-

term liabilities. These include Public Deposits, Long-term Loans, Debentures etc.
2. Current or Short-term Liabilities: Those liabilities which are expected to be paid within one year of the date ofthe
Balance Sheet are termed as current or short-term liabilities. These include Bank Overdraft, Creditors, Bills Payable.
Outstanding Expenses etc.
3. Contingent Liabilities : These are the liabilities which will become payable only on the happening of some specific
event, otherwise not. Such as
:
(i) Liabilities for Bill Discounted: In case a bill discounted from the bank is dishonoured by the acceptor on the
due date, the firm will become liable to the bank.
(ii) Liability in respect ofa suit pending in a court of law: This would become an actual liabilityifthe suit is
decided against the firm.
(ii) Liability in respeet of a guarantee given for another person: The firm would become liable to pay the
amount
ifthe person for whom guarantee is given fails to meet his obligation.
Contingent Liabilities are not shown in the Balance Sheet: They are, however, shown as a footnote just betlow the
Balance Sheet so that their existence may be revealed.

DISTINCTION BETWEEN TRIAL BALANCE AND BALANCE SHEET

Basis of Difference Trial Balance Balance Sheet
1. Object It is prepared to check the arithmetical It is prepared to know the true tinancial
accuracy ofthe books of accounts. position ofthefirm.
2. Information about It is not possible to have information about Since net profit or loss is recorded in the
Profit or Loss net profit or net loss from a trial balance. Capital shown in Balance Sheet. It is possible
to have the information about net profit or net
lossfrom a Balance Sheet.
3. Necessity Though desirable, its preparation is not It is necessary to prepare a Balance Sheet.
necessary
4. Headings The headings ofits two columns are debit and The headings of its two sides are assets and
credit. liabilities.
5. Types of Accounts All types of accounts whether personal, real Only persoal and real accounts are included in
or nominal must be written in it. it.
6. Closing Stock Normally, it does not contain the item of It contains the item of Closing Stock.
Closing Stock

75
DISTINGUISH BETWEEN DEFERIRED REVENUE EXPENDrruRE AND PREPAID EXPENDITURE
Basis Deferred Revenue Expenditure Prepaid Expenditure
1. Benefit In the case of prepaid expenditure, benefit
In the case of deferred revenue
is known for the exact known period. For
expenditure, benelit would be
example, salary for two months paidin
available in luture but the precise
advance or insurance premium paid in
time cannot be calculated. For
advance for the next 6 months after the
example, heavy expenditure incurred
on an advertising delinitely would closure of final accounts.

give beneit to raise sales in future

also but *upto which period" cannot
be estimated with certainly.
2. Recovery o n c e paid can be
Deferred revenue expenditure once Prepaid expenditure
incurred cannot be recovered back. recovered. However, in certain cases that
amount is given back after deduction of
some amount. For example, prepaid
insurance.
DISTINCTiON BETWEEN CAPITAL EXPENDITUREAND DEFERRED REVENUE EXPENDITURE
Basis Capital Expenditure Deferred Revenue Expenditure
1. Recovery Capital expenditure once incurred Deferred revenue expenditure once

can be reconverted into cash. For incurred cannot be reconverted into cash.
example selling the fixed assets. For Example heavy expenditure incurred
on launching a new product in the

market.
Depreciation can be charged on Depreciation cannot be charged on
2. Depreciation
capital expenditure. For example, deferred revenue expenditure. This
expenditure once incurred should be
charging depreciation on fixed
shown on the assets side the balance
assets.
sheet. However, a reasonable portion is
chargedtorevenue every year.
DIFFERENCE BETWEEN DIRECT AND INDIRECT EXPENSE
Basis
Direct Expense_ IndirectExpense
Direct expenses are the expenses Indirect expenses are those exp ses
1. Meaning incurred by trading concerns, on which are incurred in connection with
purchase of goods and making selling and distribution of goods and
them to saleable. general administration of the business
enterprise.
Direct expenses are to be shown in Indirect expenses are to be shown in the
2. Presentation
the Trading Account. Prolit and Loss Account.
DIFEERENCE BETWEEN GROSS PROFIT AND OPERATING PROFIT
Gross Profit Operating Profit
Basis excess of
The gross prolit is the Operating protit is the profit earned
. Meaning revenueover directlyrelated cost purely through the normal operating
and also termed as gross margin. activities of the business concern.
estimation is
lowever, if such
it is considered as gross
negative,
loss.
Gross profit is the difference Operating profit is the difference
2. Calculation sales revenue and cost between
between net net sales revenue and all
ofsalcs. operational expenses.

76
 Basis
DIFFERENCE BETWEEN GROSS P'ROFIT AND NET PROFIT
Gross P'rofit Net Profit
1. Meaning The gross prolit is the excess of The net profit is the excess of revenuce
revenue over directly related cost
and also termed
over expenses during an
accounting
as gross margin. year and when the result of this
However, if such estimation is computation is negative then it is known
negative. il is considered as gross as net loSs.
loss.
2. Caleulation
Gross prolit is the dilference The net result of operating profit, non
between net sales revenue and cost operating expense and non-operating
of sales. income is the net profit.

DIFFERENCE BETWEEN OPERATING PROFIT AND NET PROFIT

Basis
1. Meaning Operating Profit Net Profit
Operating profit is the profit The net profit is the excess of revenue
earned purely through the normal over expenses during an
accounting
operating activities of the business year and when the result of this
concern and when the result of this computation is negative then it is known
computation is negative then it is as net loss.

2. Calculation
known as net loss.
Operating profit is the difference The net result of operating profít, non
between net sales revenue and all operating expense and non-operating
operational expenses. income is the net profit.
DIFFERENCE BETWEEN DIRECT AND INDIRECT EXPENSE
Basis Direct Expense
1. Meaning Direct expenses are the Indirect Expense _
expenses Indirect expenses are those expenses
incurred by trading concerns, on which are incurred in connection with
purchase of goods and making selling and distribution of goods and
them to saleable. general administration of the business
2. Presentation Direct expenses
enterprise.
are to be shown in| Indirect expenses are to be shown in the
theTrading Account. Profit and Loss Account.
METHODS OF PRESENTATION OF FINANCIAL STATEMENTS
Trading and Profit and Loss Account and the Balance Sheet can be presented either in the Horizontal Form or in Vertical
Form.
(i) Horizontal Form: Under this form of presentation, the financial statements are presented in T' Form.
(ii) Vertical Form: Under this form of presentation, the financial statements are presented in a Single Column
Statement in a purposeful sequence.

Higher Order Thinking Skils (HOTS) Questions:

Q. I. Can you think of an example where an item may have been treated
wrongly as Revenue Expenditure and charged
in the Trading Account when it should have been treated as Capital Expenditure?
Ans. Wages paid to workers for installing a machinery wrongly debited to Wages Account.
Q. 2. Do you agree that Profit and Loss Account shows the financial position of the enterprise?
Ans. Profit and Loss Account does not show the financial position
of an enterprise. It shows the finaneial perfomance
(Net Profit or Net Loss) of an enterprise for a particular period.
.3. Debit Balance in the Profit and Loss Account is a prolit. Comment.
Ans. Debit balance in the Profit And Loss Account is a loss because expenses are more than revemue.
Q.4. Trial Balance is prepared after preparing the Protit and Loss Account, Comment.
Ans. Trial Balance is prepared before preparing the Prolit and Loss Account.
Q.5. Under the liquidity approach' assets which are most liquid are presented at the bottom od the Balance Sheet.
Comment.
Ans. Under the "liquidity approach' assets which are more liquid are presented first.

77
 statcnment.
Cominent
whercas a Balance Sheet is a periodie
ITOn
and
Loss Account is a point statement
is a point statCc
Prolil and Loss Account is a periodic statenment and a BalanceShcct
AS business in Capital Expenditure or
Revenue Fxpenditurc?

OSt
o1 oblaning licence to carry out a

Ans. I is a Capital Expenditure.

8 . X p l a i n the tem 'Dcferred Revenue Expenditure' with
the hclp of an Cxanmpic.
Or
Give any one example of Deferred Revenue Expenditure. but the benelit of which extends
revenuc in nature
that expenditure that is
AnS.Dclerred Revenue ENpenditure is
beyond the accounting year in which it is incurred to introduce a new product in the
EXanple of Defecrred Revenue Expenditure: Large
expenditure incurred on advertising
market. Balance, will you transter "Closing Stock" to
11 Adjusted Purchases' and 'losing Stock' are piven in the Trial
99.
Trading Account? Give reason. stands credited to Trading
Account because it already
Ans. No. Closing be transfered to Trading
Stock will not
Purchases Closing Stock.
Account as Adjusted Purchascs mean Opening Stock
Q. 10. What are Direct Expenses? to the point of bring1ng them to
are those expenses which are
incurred on purchases of goods up
Ans.
Direct EXpenses incurred to make them ready for sale.
The place of busiess. In the case of manufacturing
business, they are the expenses
of inventory'?
Q. 11. What is the principle of valuation valued at cost or net
realisable value, whichever is
Ans. The principle of val uation inventory is that inventory is
of
lower
understand by Operating Profit? How is it calculated?
Q. 12. What do you over operating expenses.
Ans. Operating Profit is the e x c e s s of gross profit Profit Net Profit =
+ Non-operating Expenses - Non-
Operating Profit Net Sales -Operating Cost or Operating
operating Incomes. from Trading and Protit and Loss
chronological order of ascertainment
of the following profits
Q. 13. Give the correct
Net Profit.
Account:Operating Profit, Gross Profit,
Profit, Net Profit.
Ans. Gross Profit, Operating
a Balance Sheet
serve?
Q. 14. What purpose does financial position of the business as at
a particular date.
of Balance Sheet is to m e a s u r e the
Ans. The purpose Sheet'?
a Balance
Grouping or Marshalling Marshalling of
Q. 15. What is meant by Sheet m e a n s pulting items of similar nalure under a commmon heading. ot
Balance order
Ans. Grouping of
a particular order, i.c., in order
of pemanence or in
the assets and liabilities in
Balance Sheet means arranging
liquidity.
do you understand by Contingent Liability? suit tor
happening of an event. For example.
a
Q. 16. What is that liability which becones payable on the
beeoune
Contingent Liability itnd wil
Ans. the business does noi acknowledge, It is a contingent liability
filed against the business which
claim is
court decides against eanh case
payable il the Revcnue Txpenditne, sMating resons
in

the following into Capilal,

Kevenue
and deleITed
0. 17. Classify neuTed the lollowing Cxpenditue
lo more Sujtable sile and
removed their jactory
. A company
and re-installing the plkant 25,000
i) Cost of dismantling, removing site cost? 10,000
the old factory to new

(ii) Removal of stock from machne which stood in the

b0oks al wa ound otsolete and
?30,0000
oltav i
sile
removal to the new
a

2 Before al he iew sile at a cost ol?50 000

was installed i
ls plice
for 7 8.000. A newmachine il j e w sile wiis in progess, lew luts we i l t lo ite latu g
Duilajig
(3) While the construction ol 1aclory the lactory
demolisied after the compleion of
8,000 which
were
piul wliichCsulcd u adding 1ive yeala it mouhin t
of ? 40,000 was spent
) Overjauling s cliy
4 A Sum
of railway sidings.
5 . 1 0 Lac spent onthe constructjon chen)jCal prouduct which did nol resull in b
a

6. 7 50.000 spent on experinenung uapeises sluld b treatst us delelede

Is r e m o v e d
o a OfC COVejCl
Sile, Ihe
Ans. (ib. When the factory Ihejeore, ?25,00) pls ? 10,000stiul. be pan tr
is g lastiiE
expenditurebecausethebenetit rejnovial
Jroin
deVey yein
Say Chaigel lo Uhe P'iulii mud Iiss Av
oie-tOu,

Scnense Account and only a portioin, hs liatged io 'iiit an

24,y90 }5 a Tevejue cxpu*nditue and stnl|
old n a c D I n i y
Ans. ii). The loss on sale o1 59,909 s capital e s p e n d i c .
machine

Account.
The cost of new
73
 Ans. It is capital expenditure because it is incurred for the
(ii). purpose of constructing the factory. Hence. it should be
debited to Building Account.
Ans. (iv). It is capital expenditure since it has resulted in inerease of the working life of the asset.
Ans. (v). It is capital expenditure since as asset is created which will be used
for a number of years.
Ans.(vi). It should be treated as deferred revenue expenditure so that the entire burden
may not fall on one year.
Q. 18. State with reasons whether the following are capital or revenue
expenditures:
(i) A new machine is purchased for R 60,000, R800 were spent on its carriage andRI.500 were paid as wages for its
installation.
(ii) A sum
of R10,000 was spent on
painting the new lactory.
(ii) 5,000 paid for the erection of a new machine.
(iv) 2.000 were spent on repairs before using a second hand
generator purchased recently.
(v)1500 were spent on the repair on a maclhinery.
(vi)10,000 was paid as brokerage on issue of shares and other expenses of issuc were 25,000.
(Ans. Capital Expenditure (i), (i), (ii), (iv) and (vi); Revenue Expenditure (v).)
Q. 19. State whether the following expenditure are Capital, Revenue or Deferred Revenue. Give reasons:
G) Furniture of the book value of F 10,000 were sold off at R 2,500 and new furniture of the value of 6,000 were
acquired, cartage on purchase? 50.
i Temporary huts were constructed costing 25,000. These were necessary for the construction ofthe new building
and demolished when the building was ready.
were

(iii) Replacement of old machine by a new one.

(iv) Damages paid by a transport company to its passengers injured in an accident.
(v) 40,000 were spent in dismantling and removing the machinery from old site to a more suitable site.
(vi) Removal ofstock from old site to new site cost 20,000. The new site is more favorably located.
(Ans. IN Jem No,) Loss on sale R7,500 will be revenue expenditure and T6,050 is Capital expenditure. ltem
Nos.(i)and-ii) are Capital expenditure. IHem No. (iv) is Revenue expenditure. Item Nos. (v) and (vi) should be
treated as deferred Revenue expenditure).
9.20. Classify the following into Capita, Revenue and Deferred Revenue expenditure. stating reasons in each case:
(a) A sum of? 32,000 has been spent on a machine as follows: () T 20,000 for addition to double the output. (i)
5,000 for repairs necessitated by negligence and (ii) R7,000 for replacement of worn-out parts
(b) Total expenditure on a cinema building during the year was 2,00,000 out of which 20% related to repairs and 80°
represcnted improvenents and additions.
(c) Compensation paid to a retrenched employee for the loss of employment.
(d) Second-hand furniture wortlhR 40,000 was purchased and repairing ofthis furniture cost 15,000. The furniture was
installed by own workmen-wages for this being 5,000.
(e) A person was injured by the motor car ofthe company. 10,000 was paid to him by way of compensation.
(1) Advertisement expenditure in special advertisement drive.
Ans. (a) 20,000 is eapital expenditure and 12,000 is Revenueexpenditure.
(b) 40,000 is Revenue expenditureand 1,60,000 is Capital expenditure
(e) Revenue expenditure; (d) Capital expenditure; (e) Revenue evpenditure and () Deferred Revenue
Fxpenditure.
9.21. State with reasons whether the following receipts would betreated as Capital or Revenue :
(a) 5,000 received from a customer whose account was previously written offas bad.
(b) 20,000 received from sale of old machine.
(c)2,60.000 received from sale ofstock-in-trade
(dy 5,00,000 is contributed by a partner as capital.
(e) Took a loan oft
10 Lac from Punjab National Bamk.

( Received ? 4 Lac as subsidy from State CGovernment.

(g) Received 8 lac as grant from State (Giovernment for the construction ofquarters for the stal.
(Ans, Capital Receipts (b); (d); (e);(g); Revenue Receipts (a); (c); ().

79