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The primary function of accounting is to accumulate
accounting data in a manner that the amount of
profit made or loss suffered during a period can be
determined along with the status of the business in
financial terms. Statements prepared for this purpose
are called final accounts. Final accounts are also
termed as financial statements.
Preparation of final accounts is the last phase of the
accounting process. The process of accounting
starting from recording of source documents in books
of accounts to preparation of trial balance has
already been discussed in units 1 to 5 of chapter 2.
This chapter deals with preparation of final accounts
of sole proprietors headed by one person only. For
the purpose of final accounts, the sole proprietors
can be classified into non-manufacturing and
manufacturing business entities. Final accounts of
non-manufacturing entities include Trading
account, Profit and Loss Account and Balance Sheet
while final accounts of manufacturing entities
include Manufacturing account, Trading account,
Profit and Loss account and Balance Sheet.
This chapter has been divided into two units :
(i) Final accounts of Non-manufacturing entities
and
(ii) Final accounts of Manufacturing entities for the
purpose of convenience in understanding of
students.
Copyright -The Institute of Chartered Accountants of India
Sole Proprietors
Non-Manufacturing
Business Entities
Manufacturing
Business Entities
Final Accounts Final Accounts
Trading Accounts Profit & Loss
Accounts
Balance Sheet
Trading Accounts Profit & Loss
Accounts
Balance Sheet Manufacturing
Accounts
An overview of the final accounts of sole proprietors can be explained with the help of the
following chart :
Copyright -The Institute of Chartered Accountants of India
CHAPTER - -- -- 6
PREPARATION
OF FINAL
ACCOUNTS OF
SOLE
PROPRIETORS
Unit 1
Final Accounts of
Non-Manufacturing
Entities
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.4
COMMON PROFICIENCY TEST
Learning Objectives
After studying this unit you will be able to :
Make out the various accounts, which are the parts of Final Accounts.
Learn the relationship between Profit and Loss Account and Balance Sheet.
Understand the Trading Account items. This will help you to learn which of the
transactions and events should be shown in the Trading Account.
Understand the items shown in the Profit and Loss Account. By that you will learn the
technique of preparing Profit and Loss Account and deriving the Profit and Loss balance.
Learn how to adjust outstanding and pre-paid expenses, accrued income and income
received in advance.
Understand the items to be shown in the balance sheet. Also learn the classifications of
assets and liabilities and the order by which they are put in the Balance Sheet.
1. INTRODUCTION
Non-manufacturing entities are the trading entities, which are engaged in the purchase and
sale of goods at profit without changing the form of the goods. In other words, non-
manufacturing entities do not process the goods purchased and sell them in its original form.
Meanwhile it indulges in some liabilities, makes some assets and also incurs some expenses like
salaries, stationary expenses, advertisement, rent etc to run the business. At the end of the
accounting year, the entity must be interested in knowing the results of the business. To ascertain
the final outcome of the business i.e., the income and financial position, they prepare financial
statements at the end of the year.
Financial Statements are the systematically organized summary of all the ledger account heads
presented in such a manner that it gives detailed information about the financial position and
the performance of the enterprise. Performance of the enterprise is judged on the basis of the
income earned/accrued during the year in the form of profit after the adjustments of expenses
related to the enterprise and to the income earned or accrued. In Financial Accounting, profit
is measured at two levels :
(a) Gross Profit
(b) Net Profit
The profit of the enterprise is obtained through the preparation of Income Statement.
The financial position of the business enterprise is judged by measuring the assets, liabilities
and capital of the enterprise and the same is communicated to the users of financial statements.
Financial position of the enterprise can be known through the preparation of the Position
Statement.
From the above explanation, one can conclude that final accounts is the next step after the
preparation of trial balance which is mainly divided into following two parts :
A. Income Statement
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.5
B. Position Statement
A. Income Statement
The manner in which amount of profit or loss is arrived at is disclosed in the Income
Statement, prepared at the close of the year. The Income Statement discloses net profit of
the business after adjusting from the income earned during the year, all the expenditures
of the business incurred in that year. The various items of income and expenditure, which
arouse during the accounting period, are detailed out therein, and grouped under significant
heads. The primary objective of the Income Statement is to present the details of various
items of income or expenditure which have contributed to the making of the profit or loss.
Income Statement is sub-divided into following two parts for a non-manufacturing concern:
(i) Trading account; and
(ii) Profit and Loss account
Procedure for the preparation of these accounts has been explained separately in this
chapter.
B. Position Statement
Position statement mainly comprises of Balance Sheet, which exhibits assets and liabilities
of the business as at the close of the period. For proper knowledge of the financial position
of the business, sometimes additional statements are also prepared like cash flow statement,
statement showing earnings per share, value added statement etc. which is not mandatory
for non-corporate entities. These additional statements are prepared for the better
understanding of the financial position of the business. You will learn the preparation of
these additional statements in Integrated Professional Competence Course and Final.
Here, we will restrict our discussion to Trading account, Profit and Loss account and
Balance Sheet only.
2. PREPARATION OF FINAL ACCOUNTS
The principal function of final statements of account (Trading Account, Profit and Loss Account
and the Balance Sheet) is to exhibit truly and fairly the profitability and the financial position
of the business to which they relate. In order that these may be properly drawn up, it is essential
that a proper record of transactions entered into by the business during a particular accounting
period should be maintained. The basic principles in regard to accumulation of accounting
period data are:
(i) a distinction should be made between capital and revenue receipts and payments;
(ii) also income and expenses relating to a period of account should be separated from those
of another period. What is more important is, different items of income and expenditure
should be accumulated under significant heads so as to disclose the sources from which
capital has been procured and the nature of liabilities, which are outstanding for payment.
Having regard to these basic principles, the various matters to which attention should be paid
for determining the different aspects of transactions, a record of which should be kept, and the
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.6
COMMON PROFICIENCY TEST
different heads of account under which various items of income and expenditure should be
accumulated, are stated below:
(a) Since the final statements of account are intended to show the profitability of the
business and not that of its proprietors, it is essential that all personal income and
expenditure should be separated from business income and expenditure.
(b) A distinction should be made between capital and revenue, both receipts and
expenditure. Different types of income and expenditure should be classified under
separate heads. Assets should be included in the Balance Sheet at a valuation arrived
at on the basis at which these are valued in the preceding year. Likewise, a provision
for income and expenses which have accrued but not paid, should be made by
estimation or otherwise on the same basis as in the previous year.
(c) Every information, considered material for judging the profitability of the business or
its financial position, should be disclosed. For example, when the labour charges have
increased on account of bonus having been paid to workmen, the amount of bonus
paid should be disclosed. Similarly, if some of the items of stock are not readily saleable,
these should be valued at their approximate sale price and the basis of valuation and
value of such stocks should be shown separately.
(d) Though the record of transactions should be maintained continuously, at the end of
each accounting period, the transactions of the closing accounting period should be
cut off from those of the succeeding period.
(e) It should be seen that only the effect of transactions, which were concluded before
the close of period of account, has been adjusted in the accounts of the year. For
example, when a sale of goods is to take place only after the goods have been inspected
by the purchaser and the inspection had not been made before the close of the year, it
would be incorrect to treat the goods as a sale in the accounts of the year.
2.1 INTER-RELATIONSHIP OF THE TWO STATEMENTS
One of the points to be remembered is that of total expenditure incurred. Some appears in the
Profit and Loss Account and some in the Balance Sheet. Consider few examples, of the total
amount spent on manufacturing goods. That part which is attributable to finished goods in
stock is shown in the Balance Sheet as closing stock and the amount debited to the Income
Statement is thereby ultimately reduced. When a machine is purchased, that part of it which is
attributable to the year considered as depreciation is debited to the Profit and Loss Account
and the balance is shown in the Balance Sheet as an asset. Next year again, part of the cost of
asset will be debited to the Profit and Loss Account and the remaining cost will be shown as an
asset in the Balance Sheet. These illustrations show that the two statements, the Profit and
Loss Account and the Balance Sheet, are thoroughly inter-related. The assets shown in the
Balance Sheet are mostly only the remainder of the expenditure incurred after a suitable amount
has been charged to the Profit and Loss Account or the Trading Account. For preparing the
two statements properly, it is of the greatest importance that the amounts to be charged to the
Profit and Loss Account should be properly determined as otherwise both statements will
show an incorrect position. The principle that governs this is called the Matching Principle.
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.7
2.2 MATCHING PRINCIPLE
This principle demands that expenses incurred to earn the revenue should be properly matched.
This means the following :
(a) If a certain revenue and income is entered in the Trading / Profit and Loss Account all the
expenses relating to it, whether or not payment has been actually made, should be debited
to the Trading / Profit and Loss Account. This is why at the end of the year an entry is
passed to bring into account the outstanding expenses. That is also the reason why the
opening stock of goods is debited to the Trading Account since the relevant sale is credited
in the same account.
(b) If some expense has been incurred but against it sale will take place in the next year or
income will be received next year, the expense should not be debited to the current years
Profit and Loss Account but should be carried forward as an asset and shown in the
Balance Sheet. It will be debited to the Profit and Loss Account only when the relevant
income will also be credited. It is because of this principle that :
(i) at the end of the year inventory of all the stocks in hand is prepared and is valued at
cost. The credit to the Trading Account has the effect of reducing the debit in the
Trading Account to the extent goods remain unsold or unutilised, these will be sold
or used up next year and the cost will therefore, be properly debited to the next years
Trading Account. If the selling or the replacement value is lower than the cost, stock
will be valued at the realisable value and not at cost. This has the effect of raising the
net debit in the Trading Account higher than the cost of goods sold or utilised in the
year, but that is proper. The fall of the selling price below cost means that the loss has
occurred in the year and therefore, the debit properly is to current years Trading and
Profit and Loss Account;
(ii) at the end of the year prepaid expenses are brought into the books by debiting prepaid
expenses account and crediting the expenses concerned. The effect of this is also to
transfer the debit in respect of prepaid expenses to the year in which the benefit from
such expenses will accrue; and
(iii) at the end of the year, appropriate depreciation of fixed assets is charged to the profit
and loss account (and credited to the assets concerned ). In this manner, that part of
the cost of the assets which has been used up for earning current years revenue is
debited to the Profit and Loss Account.
(c) If an income or revenue is received in the current year but the work against it has to be
done and the cost in respect of it has to be incurred next year, the income or the revenue
is considered to be of next year. It should be shown in the Balance Sheet on the liabilities
side as income received in advance and should be credited to the Profit and Loss Account
of the next year. Firms, except those, which follow the cash system (and such firms are
usually of specialised personal service nature), do not credit to the Profit and Loss Account
that income or revenue against which service is to be rendered in future. Newspapers or
magazines usually receive subscriptions in advance for a year. The part of subscription
that covers copies to be supplied in the next year is treated as income received in advance.
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.8
COMMON PROFICIENCY TEST
2.3 AN EXCEPTION
There appears to be one exception to the rule that only such costs as have yielded or is expected
to yield revenue should only be debited to Profit and Loss Account. For example, if a fire has
occurred and has damaged the firms property the loss must be debited to the Profit and Loss
Account to the extent it is not covered by insurance. A loss, resulting from the fall of selling
price below the cost or from some debts turning bad, must similarly be debited to the Profit and
Loss Account. If this is not done the profit will be over-stated.
3. TRADING ACCOUNT
At the end of the year, as has been seen above, it is necessary to ascertain the net profit or the
net loss. For this purpose, it is first necessary to know the gross profit or gross loss. Gross Profit
is the difference between the selling price and the cost of the goods sold. For a trading firm, the
cost of goods sold can be ascertained by adjusting the cost of goods still on hand at the end of
the year against the purchases. Suppose, in the first year, the net purchases (that is after
deducting returns) total Rs. 1,00,000 and that Rs. 15,000 worth of goods (at cost) were not sold
at the end of the year. The cost of the goods sold will then be Rs. 85,000. If in the next year
purchases are Rs. 1,50,000 and the cost of goods on hand at the end of the year is Rs. 20,000
the cost of goods sold will be Rs. 1,45,000, calculated as follows:
Rs.
Cost of unsold goods at the beginning of the year 15,000
Purchases during the year 1,50,000
1,65,000
Less: Cost of unsold goods at the end of the year 20,000
Cost of goods sold 1,45,000
If net sales, i.e., after adjustment for sales returns, total Rs. 2,00,000 the gross profit will be
Rs. 55,000, i.e., Rs. 2,00,000 1,45,000. This profit is called gross profit since from it expenses
have still to be deducted for knowing the net profit.
Gross profit is usually ascertained by preparing a Trading account. For the figures given above,
the Trading Account will appear as shown below :
Trading Account for the year ending
Dr. Cr.
Rs. Rs.
To Opening Stock 15,000 By Sales Account 2,00,000
To Purchase Account 1,50,000 By Closing Stock 20,000
To Gross Profit carried to P & L A/c 55,000
2,20,000 2,20,000
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.9
The opening stock and purchases are written on the debit side. Sales and the closing stocks are
entered on the credit side. If there are any direct expenses then they should also be written on
the debit side of the Trading account. If the balance of credit side is more, the difference is
written on the debit side as gross profit. This amount will also be carried forward to the Profit
and Loss Account on the credit side. In case of gross loss, i.e., when the debit side of the
Trading Account exceeds the credit side, the amount will be written on the credit side of the
Trading Account and transferred to the debit side of the Profit and Loss Account.
3.1 TRADING ACCOUNT ITEMS
(a) In a trading firm like a wholesaler, the main business consists of buying and selling the
same goods. In addition to the amount of the opening stock, the trading account will also
be debited with all expenses incurred in bringing the goods to the godown of the firm and
in making them ready for sale. For example, freight paid on purchases, cartage, octroi,
etc. will all be debited to the Trading Account. The rule is that this account will be debited
with all expenses incurred in bringing the goods to their present location and condition.
We shall now consider individual items :
(1) Opening Stock : Since this was closing stock of the last year, it must have been entered
in the opening stock account, through the opening entry. Therefore, it will be found
in the trial balance. This item is usually put as the first item on the debit side of the
Trading Account. Of course, in the first year of a business there will be no opening
stock.
(2) Purchases and Purchase Returns : The purchases account will have debit balance,
showing the gross amount of purchases made of the materials. The purchase returns
account will have credit balance showing the return of materials to the suppliers. On
the debit side of the trading account the net amount is shown as indicated (with
assumed figures) :
Rs.
To Purchases 3,00,000
Less : Purchase Returns 10,000
2,90,000
It happens sometimes that goods are received but the relevant invoice is not received
from the supplier. On the date of the closing of the account, an entry must be passed
to debit the purchases account and credit the supplier with the cost of goods. One
may also exclude such goods from the closing stock and not pass any entry, but this
course is not recommended.
(3) Carriage or Freight Inwards : This item should also be debited to the Trading Account,
as it is incurred to bring the materials to the firms godown and make them available
for use. However, if any freight or cartage is paid on any asset, like machinery, it
should be added to the cost of the asset and not debited to the Trading Account.
(4) Wages : Wages paid to workers in the godown/stores, should be debited to the Trading
Account. If any amount is outstanding, it must be brought into books so that full
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.10
COMMON PROFICIENCY TEST
wages for the period concerned are charged to the Trading Account. However, if
wages are paid for installation of an asset, it should be added to the cost of the asset.
(5) Sales and Sales Returns : The sales account will have a credit balance indicating the
total sales made during the year. The sales return account will have a debit balance,
showing the total amount of goods returned by customers. The net of the two amounts
is entered on the credit side of the Trading Account.
Sometimes, goods which have been sold and for which invoice has been prepared
may not have been dispatched. If the sale is complete, that is if the customer is liable
to pay the amount, such goods should be kept aside and not included in the closing
stock. If however, the sale is not yet complete say, when sent to customers on approval
basis, that is when the customer has the right to return the goods within the stipulated
period, the cost of the goods should be included in the closing stock and, if any entry
was passed to record the sale, it should be reversed.
(6) Closing Stock and its valuation : Usually there is no account to show the value of
goods lying in the godown at the end of the year. However, to correctly ascertain the
gross profit, the closing stock must be properly taken and valued.
The entry is
Closing Stock Account Dr.
To Trading Account
Alternatively, Closing stock can be adjusted with purchases :
Closing Stock Account Dr.
To Purchases Account
The effect of this entry is to reduce the debit in the Purchases Account. It will then
appear in the trial balance. The Closing Stock Account is then not entered in the
Trading Account and will be shown only in the Balance sheet.
To ascertain value of the closing stock, it is necessary to make a complete inventory or
list of all the items in the godown together with quantities. Of course, damaged or
obsolete items are separately listed. To the list of finished goods, one should also add
the goods lying with agents sent to them on consignment basis and also the goods
sent on approval to customers.
The valuation principle is cost or net realisable value whichever is lower.
Taking stock is quite a lengthy process. Strictly, immediately at the end of the year the
taking of stock should be completed. Sometimes, however this is done either a few
weeks before or a few weeks after the closing. In such a case the value of the stock
thus taken must be adjusted to relate it to the closing date. The adjustment will be
necessary because, in the meantime, purchases and sales must have been made. The
main point to remember is that in respect of sales their cost has been established. Cost
will be sales less gross profit.
(7) Sales Tax : Sales Tax is an indirect tax in the sense that it is collected by the seller
from the customers and deposited in Governments Account as per requirements of
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.11
the Sales Tax Act. Sales tax is generally deducted from gross sales figures and sales
tax liability (net of payments) is shown as current liability in the balance sheet.
The Trading Account is very useful; with its help the firm can see the relationship between the
costs incurred and the revenues earned and also the level of efficiency with which operations
have been conducted. The ratio of gross profit to sales is very significant. It is arrived as
Gross Profit
100
Sale
In the illustration given under para 3 of the unit, the rate of gross profit is 27.5%.
3.2 CLOSING ENTRIES IN RESPECT OF TRADING ACCOUNT
The following entries will be required :
(i) For opening stock : Debit Trading Account and Credit Stock Account.
(ii) For purchases returns : Debit Returns Outward Account and Credit Purchases Account.
For returns inward : Debit Sales Account and Credit Returns Inwards Account. (In the
trading account information is usually given both in respect of gross sales; and purchases
and the respective returns).
(iii) For purchases account : Debit Trading Account and Credit Purchases Account, the amount
being the net amount after return.
(iv) For expenses to be debited to the Trading Account, for example wages etc; Debit Trading
Account and credit the concerned expenses accounts individually.
(v) For sales : Debit Sales Account with the net amount after returns, and Credit Trading
Account.
The student will see that all the accounts mentioned above will be closed with the exception
of the Trading Account.
(vi) For closing stock : Debit Stock Account and Credit Trading Account. The Stock Account
will be carried forward to the next year.
Except entries mentioned in (ii) above, the other entries are usually summarised as follows :
(1) Trading Account Dr.
To Opening Stock Account
To Purchases Account
To Wages Account
To Freight on Purchases Account, etc.
(2) Sales Account Dr.
Closing Stock Account Dr.
To Trading Account
At this stage Trading Account will reveal the gross profit, if the credit side is more, or gross loss
if the credit side is less. The gross profit will be transferred to the Profit and Loss Account by
the entry:
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.12
COMMON PROFICIENCY TEST
Trading Account Dr.
To Profit and Loss Account
The entry for gross loss, if there be any is :
Profit and Loss Account Dr.
To Trading Account
Illustration 1
From the following information, prepare a Trading Account of M/s. ABC Traders for the year
ended 31st March, 2009 :
Rs.
Opening Stock 1,00,000
Purchases 6,72,000
Carriage Inwards 30,000
Wages 50,000
Sales 11,00,000
Returns inward 1,00,000
Returns outward 72,000
Closing stock 2,00,000
Solution
In the books of M/s. ABC Traders
Trading Account for the year ended 31st March, 2009
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs. Rs. Rs.
To Opening stock 1,00,000 By Sales 11,00,000
To Purchases 6,72,000 Less : Returns
Inward 1,00,000 10,00,000
Less : Returns
outward 72,000 6,00,000 ByClosing stock 2,00,000
To Carriage Inwards 30,000
To Wages 50,000
To Gross profit 4,20,000
12,00,000 12,00,000
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.13
Illustration 2
From the information given in illustration 1, pass necessary closing entries in the journal proper
of M/s. ABC Traders.
Solution
In the Books of M/s. ABC Traders
Journal Proper
Dr. Cr.
Date Particulars Amount Amount
2009 Rs. Rs.
Mar. 31 Returns outward A/c Dr. 72,000
To Purchases A/c 72,000
(Being the transfer of returns to purchases
account)
Sales A/c Dr. 1,00,000
To Returns Inward A/c 1,00,000
(Being the transfer of returns to sales
account)
Sales A/c Dr. 10,00,000
To Trading A/c 10,00,000
(Being the transfer of balance of sales
account to trading account)
Trading A/c Dr. 7,80,000
To Opening Stock A/c 1,00,000
To Purchases A/c 6,00,000
To Wages A/c 50,000
To Carriage Inwards A/c 30,000
(Being the transfer of balances of opening
stock, purchases and wages accounts)
Closing stock A/c Dr. 2,00,000
To Trading A/c 2,00,000
(Being the incorporation of value of closing stock)
Trading A/c Dr. 4,20,000
To Gross Profit 4,20,000
(Being the amount of gross profit)
Gross profit Dr. 4,20,000
To Profit and Loss A/c 4,20,000
(Being the transfer of gross profit to Profit
and Loss Account)
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.14
COMMON PROFICIENCY TEST
4. PROFIT AND LOSS ACCOUNT
The Profit and Loss Account starts with gross profit on the credit side. If there is gross loss, it
will be written on the debit side. After that all those expenses and losses, which have not been
entered in the Trading Account, will be written on the debit side of Profit and Loss Account.
Incomes and gains, other than sales, will be written on the credit side.
If we understand word expenses properly, there should be no difficulty in distinguishing
between items that will be debited to the Profit and Loss Account and those that will be shown
as Assets in the balance sheet. Further, it may be noted that the expenses which are personal in
nature will not be charged to Profit and Loss A/c. Only those revenue expenses and losses
which are related to the current year, are debited to Profit and Loss Account.
It is desirable, according to modern thinking that the Profit and Loss Account should be prepared
in such a manner as will enable the reader to form a correct idea about the profit earned or loss
suffered by the firm during the period together with the significant factors. Too many details
will prevent a person from knowing properly the factors leading to the profit earned. Therefore,
items should be according to the various functions, such as administrations, selling and
financing:
(1) Administrative expenses include the following :
(i) Salaries paid to the people working in the general office;
(ii) Rent and rates for the office premises.
(iii) Lighting in the office.
(iv) Printing and stationery.
(v) Postage, telegrams and telephone charges.
(vi) Legal expenses.
(vii) Audit fees, etc.
(2) The selling and distribution expenses will comprise the following :
(i) Salesmens salaries and commission.
(ii) Commission to agents.
(iii) Advertising.
(iv) Warehousing expenses.
(v) Packing expenses.
(vi) Freight and carriage on sales.
(vii) Export duties.
(viii)Sales tax to the extent it cannot be recovered from the customers.
(ix) Maintenance of vehicles for distribution of goods and their running expenses.
(x) Insurance of finished goods in stock and goods in transit.
(xi) Bad debts.
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.15
It will be good idea to either show these expenses in a separate schedule or to indicate the total
of these prominently in the Profit and Loss Account. This rule should be followed wherever
the number of items is rather large.
Financing expenses normally include interest paid on loan, discount on bills discounted and
the discount allowed to customers. It is possible to show only the net amount of interest if it has
been both received and paid. It is however; better to show the two figures separately.
On the income side of the Profit and Loss Account, besides the gross profit, there may be
interest received, discount received, rent from subletting of premises, miscellaneous incomes
such as from sale of junk material etc., It would be desirable to show the totals only under each
of the main categories of income. However, interest on fixed deposits, interests or income from
investments and other interest should be shown separately. Similarly, items which have to be
debited/credited to the proprietor should be segregated from other items. Examples would be
interest charged on drawings, interest allowed on capital and charges for services rendered by
the firm to the proprietor personally.
We shall now consider a few items individually :
(i) Drawings : Drawings are not expenses for the firm and therefore should not be debited to
the Profit and Loss Account. If the proprietor has enjoyed some benefit personally, like
use of the firms car, a suitable amount should be treated as drawing and to that extent
the charge to the Profit and Loss Account will be reduced, Drawings are debited to the
proprietors capital account.
(ii) Income Tax : In case of companies, the income tax payable is treated like other expenses.
But in the case of sole proprietorship, income tax is treated as a personal expense. It is
debited to the Capital Account and not to the Profit and Loss Account. This is because the
amount of the tax will depend on the total income of the partners or proprietor besides the
profit of the firm. In case of partnership business, firms tax liability is to be debited to
profit and loss account of the firm but partners tax liability are not to be borne by the firm.
Therefore if the firm pays income tax on behalf of partners, such payment of personal
income tax should be treated as drawings.
(iii) Discount received and allowed : We have already seen that discount is of two types.
Trade discount and Cash discount. Trade discount is allowed when the order for goods is
not below a certain figure. It is deducted from the invoice. Only the net amount of invoice
is entered in books. There is no further treatment of the trade discount. Cash discount is
allowed to a customer if he makes the payment before a certain date. It is allowance made
to him for prompt payment. Discount received is really in the nature of interest received
and similarly, discount allowed really means interest paid. Discount received is a gain
and is credited to the Profit and Loss Account while discount allowed is debited.
There is another term - Rebate. It is the allowance given to a customer when his purchases
during a period, say one year, total upto a certain figure. Suppose a firm allows a rebate of
4% to those customers whose purchases during the year are at least Rs. 5,000. One
Customers purchases are Rs. 4,500, he will not get any rebate. Another customers
purchases total Rs. 5,100, he will get a rebate of Rs. 204. The entry for rebate is made only
at the end of the year. The Rebate Account is debited and is later written in the profit and
Loss Account on the debit side. Various customers who have earned the rebate are credited.
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.16
COMMON PROFICIENCY TEST
(iv) Bad Debts: When a customer does not pay the amount due from him and all hopes of
recovering the amount are lost, it is said to be a bad debt. It is a loss to the firm. Therefore,
the bad debts account is debited, which is later on written in the Profit and Loss Account
on the debit side. Since it is no use showing the amount due still as an asset, the account of
the customer concerned is closed by being credited. The entry
Bad Debts Account Dr.
To Debtors (by name) Account
If later on, the amount is recovered, it should be treated as a gain. It should not be credited to
the party paying it. It should be credited to Bad Debts Recovered Account. It will be entered in
the Profit and Loss Account on the credit side.
4.1 CLOSING ENTRIES
The entries that have to be made in the journal for preparing the Trading and the Profit and
Loss Account that is for transferring the various accounts to these two accounts are known as
closing entries. We have already seen the entries required for preparing the Trading Account
and for transferring the gross profit to the profit and Loss Account. Now to complete the Profit
and Loss Account, the under mentioned three entries will be necessary.
(a) For items to be debited to the Profit and Loss Account this account will be debited and the
various accounts concerned will be credited. For example,
Profit and Loss Account Dr.
To Salaries Account
To Rent Account
To Interest Account
To Other Expenses Account
(b) Items of income or gain such as interest received or miscellaneous income will be debited
and credited to Profit and Loss Account.
Discount Received Account Dr.
Bad debts Recovered Account Dr.
To Profit and Loss Account
(c) At this stage, the Profit and Loss Account will show net profit or net loss. Both have to be
transferred to the Capital Account. In case of net profit, i.e., when the credit side is bigger
than the debit side, the entry is :
Profit and Loss Account Dr.
To Capital Account
In the case of net loss, the entry will be
Capital Account Dr.
To Profit and Loss Account
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.17
Illustration 3
Revenue, Expenses and Gross Profit Balances of M/s ABC Traders for the year ended on 31
st
March 2006 were as follows:
Gross Profit Rs. 4,20,000, Salaries Rs. 1,10,000, Discount (Cr.), Rs. 18,000, Discount (Dr.)
Rs. 19,000, Bad Debts Rs. 17,000, Depreciation Rs. 65,000, Legal Charges Rs. 25,000,
Consultancy Fees Rs. 32,000, Audit Fees Rs. 1,000, Electricity Charges Rs. 17,000, Telephone,
Postage and Telegrams Rs. 12,000, Stationery Rs. 27,000, Interest paid on Loans Rs. 70,000.
Prepare Profit and Loss Account of M/s ABC Traders for the year ended on 31st March,
2006.
Solution
In the Books of M/s. ABC Traders
Profit and Loss Account
For the year ended 31st March, 2006
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
To Salaries 1,10,000 By Gross Profit 4,20,000
Legal Charges 25,000 By Discount received 18,000
Consultancy Fees 32,000
Audit Fees 1,000
Electricity Charges 17,000
Telephone, Postage &
Telegrams 12,000
Stationery 27,000
Depreciation 65,000
Discount Allowed 19,000
Bad Debts 17,000
Interest 70,000
Net Profit 43,000
4,38,000 4,38,000
Illustration 4
From the information given in illustration 3, show necessary closing entries in the Journal
Proper of M/s. ABC Traders.
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.18
COMMON PROFICIENCY TEST
Solution: In the Books of M/s. ABC Traders
Journal Proper
Date Particulars Dr. Cr.
2006 Amount Amount
Rs. Rs.
March 31 Profit & Loss Account Dr. 3,95,000
To Salaries A/c 1,10,000
To Legal Charges A/c 25,000
To Consultancy Fees A/c 32,000
To Audit Fees A/c 1,000
To Electricity Charges A/c 17,000
To Telephone, Postage & Telegrams A/c 12,000
To Stationery A/c 27,000
To Depreciation A/c 65,000
To Discount Allowed A/c 19,000
To Bad Debts A/c 17,000
To Interest A/c 70,000
(Being the transfer of balances of various
expenses accounts)
Discount Received A/c Dr. 18,000
To Profit & Loss A/c 18,000
(Being the transfer of discount received
account balance)
Gross Profit A/c Dr. 4,20,000
To Profit & Loss A/c 4,20,000
(Being the transfer of gross profit from
Trading Account)
Profit & Loss A/c Dr. 43,000
To Net Profit A/c 43,000
(Being the ascertainment of net profit)
Net Profit A/c Dr. 43,000
To Capital A/c 43,000
(Being the transfer of net profit to Capital A/c)
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.19
4.2 ADJUSTMENTS
The fundamental principle of accounting is that the period to which various items of income
and expenditure pertain should be co-extensive with the period of account. As such before
Final Accounts are drawn up. It must be ensured that the accounts, which require adjustment
on this consideration, have been adjusted, both by providing for expense accrued and including
income outstanding and excluding expenses the benefit of which extends beyond the year of
account as well as the income received in advance. The entries that will have to be passed for
adjusting various accounts of income and expenditure are shown below:
(1) Expenses accrued and accruing, e.g., Rent, Interest, Local Taxes, Wages etc.
Appropriate Expense Account Dr.
To Expenses Accrued Account
(2) Income accrued and accruing, e.g., Interest on Government Loans, Discounts on Bill,
Professional fees, Rents and Premiums on leases, etc.
Interest/Fees etc. Accruing Account Dr.
To Appropriate Income Account
Notes :
(1) The term accrued signifies that an amount has been incurred as expense or earned as
income, the due date of payment of which falls in the next trading period. If the due date
of payment occurs in the accounting period the term used should be Outstanding or
accrued and due.
(2) The expression accrued and accruing signifies items which though not due for payment
but pertain to the period of account, a provision for which has been made. Converse is the
position so far as items of income are concerned.
(3) Carrying forward income received in advance e.g., Subscription in the case of a club or
fees in case of professional person.
Appropriate Income Account Dr.
To Income Received in Advance Account
(4) Carrying forward of payments made in advance e.g., Telephone, Rent, Insurance etc.,
amounts where of stand debited to an expense account.
Expenses Prepaid Account Dr.
To Appropriate Expenses Account
(5) Adjustment of stock of materials in hand, e.g., Stationery, Advertisement, Material,
Manufacturing Stores, etc., the cost whereof already has been debited to expense account.
Stock of Materials Dr.
To Appropriate Expenses Account
Note : Next year in the beginning entries No. (1) to (5) should be reversed.
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.20
COMMON PROFICIENCY TEST
(6) Provision for Bad and doubtful Debts : When it is feared that some of the amount due
from customers will not be collected it is prudent to recognise the expected loss by reducing
the current years profit and placing the amount to the credit of a special account called
Provision for Bad and Doubtful Debts Account. The entry is;
Profit and Loss Account Dr.
To Provision for Bad and doubtful Debts Account
Note : The accounts of the customers concerned are not affected until the amount is actually
written off for which the entry is,
Bad Debts Account Dr.
To Customers A/c
Bad Debts when written off are debited to the provision in this respect where such a
provision exists or directly to the Profit and Loss Account the corresponding credit being
given (ultimately) to the debtors account. If, on the other hand, a provision is required to
be created, the amount of provision is also debited to the Profit and Loss Account. Where
an examination problem requires that certain bad debts should be written off and a
provision for doubtful debts made, the amount of bad debts to be written off should be
first debited against the existing balance of the provision and the resulting balance in the
account afterwards should be raised to the required figure. The method is illustrated below :
Illustration 5
On 1st Jan. 2006 provision for Doubtful Debts existed at Rs. 400. Debtors on 31.12.2006 were
Rs. 15,000; bad debts totalled Rs. 1,000. It is required to write off the bad debts and create a
provision equal to 5% of the debtors balances. Show how you would compute the amount
debited to the Profit and Loss Account.
Opening Provision (Cr.) 400
Bad Debts written off (Dr.) 1,000
600
Provision required (Dr.) (5% of Rs. 14,000) 700
Additional amount required for debit to the Profit and Loss Account (Dr.) 1,300
Solution
The account will appear as follows:
Provision for Doubtful Debts Account
2006 Rs. 2006 Rs.
Dec. 31 To Bad Debts Account 1,000 Jan. 1 By Balance b/d 400
To Balance c/d (required) 700 Dec. 31. By Profit and Loss A/c
(Balancing Figure) 1,300
1,700 1,700
2007
Jan 1. By Balance b/d 700
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.21
(7) Provision for Discount : This provision is created in the same manner, as discussed above
but the amount of provision is required to be calculated after deducting the Provision for
Bad Debts from the total debtors.
(8) Provision for Depreciation : It is made either by debiting Depreciation Account and
crediting the asset account concerned and afterwards closing of the Depreciation Account
by transfer to the Profit and Loss Account or by directly debiting the profit and loss Account
and crediting the asset account and explaining the nature of adjustment by recording a
detailed narration in the Journal. More appropriately, the Profit and Loss Account or first
the Depreciation Account may be debited and Provision Account credited by the amount
of annual depreciation.
(9) Other Provisions : Whenever it is expected that a loss, the amount of which is not certain
will occur, the proper course is to create a provision for meeting the loss if and when it
occurs. This would be the case, for example, if compensation has to be paid for the late
delivery of goods. The entry is to debit the Profit and Loss Account and credit an account
suitably named.
All accounts showing provisions may appear in the Balance Sheet but it should be noted
that:
(i) The provision for Bad and Doubtful Debts and the Provision for Discount on Debtors
are deducted from the total book debts; and
(ii) The provision for Depreciation is deducted from the cost of the assets concerned.
(10) Transfers, involving correction of errors, are made by debit or credit to the accounts affected,
the corresponding effect being recorded either in a Suspense Account of some other account.
Transfers in respect of special charges to the Profit and Loss Account e.g., partners salaries,
interest, etc., and in respect of appropriation of profits are recorded by debit to the Profit and
Loss Account and credit to the parties concerned.
While making adjustments, it is important to remember that every entry has a two-fold aspect,
debit and credit. For example, if an adjustment is required to be made on account of prepaid
insurance charges, the Insurance Charges Account would be credited, and, to complete the
double entry, Prepaid Expenses Account is debited with the same amount. The last mentioned
balance would be included on the debit side of the Trial Balance.
Students should, as a matter of course, record on the rough working sheets adjustments in
respect of various items stated in a question and then appropriate their effect in the Trial
Balance, before proceeding to draw up the Final Accounts.
5. CERTAIN ADJUSTMENTS AND THEIR TREATMENTS
1. Abnormal loss of stock by accident or fire : Sometimes loss of goods occurs due to fire,
theft, etc. If due to accident or fire, a portion of stock is damaged, the value of loss is first
to be ascertained. Thereafter, Abnormal Loss Account is to be debited and Purchase
Account is to be credited.
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.22
COMMON PROFICIENCY TEST
Abnormal Loss Account is to be transferred to Profit & Loss Account. If amount of loss is
recoverable from insurance company, then insurance company is to be debited instead of
Profit & Loss Account. Till the money not received from the insurance company, Insurance
Companys Account will be shown in the Assets side of the Balance Sheet. If any part of
the loss is recoverable from the insurance company, then the portion not compensated by
the insurance company should be debited to Profit & Loss Account. For example, if goods
worth Rs. 6,000 are destroyed by fire and the insurance company admits the claim for
Rs. 4,500, the Journal entries will be:-
(i) Loss by Fire Account Dr. 6,000
To Purchases Account 6,000
(ii) Insurance Companys A/c (Insurance Claim) Dr. 4,500
Profit & Loss A/c Dr. 1,500
To Loss by Fire A/c 6,000
2. Goods sent on Approval basis : Sometimes goods are sold to customers on sale or return
basis or on approval basis. It should not be treated as actual sale till the time it is not
approved by the customer. When goods were sold we have passed the entry for actual
sales. Therefore, at the year end, if the goods are still lying with the customers for approval,
following entries are to be passed:
For example -
Goods costing Rs.10,000 sent to a customer on sale or return basis for Rs.12,000. The entry
for such unapproved sale shall be-
(i) Sales A/c Dr. 12,000
To Sundry Debtors A/c 12,000
(ii) Stock with Customers A/c Dr. 10,000
To Trading A/c 10,000
3. Goods used other than for sale : Sometimes goods are used for some other purposes,
such as distributed as free samples, used in construction of any assets or used by
proprietor for personal use. In such cases the amount used for other purposes is subtracted
from Purchases A/c and depending upon the specific use done, the suitable account head
is debited.
For example :-
When goods are given away as donation-
Donation A/c Dr.
To Purchases A/c
When goods are used by the proprietor for his personal use-
Drawings A/c Dr.
To Purchases A/c
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.23
When goods are distributed as free samples :-
Free Samples / Advertisement A/c Dr.
To Purchases A/c
When goods are used in business for construction of Building or the Machinery :-
Building A/c / Plant & Machinery A/c Dr
To Purchases A/c
When goods are used for maintenance of business premises/ Machinery : -
Repair & Maintenance A/c Dr.
To Purchases A/c
4. Sales Tax : If Sales Tax is charged from the customers, along with the price of the goods
sold, amount of sales tax should be shown separately in the sales day book. Periodically
this sales tax is to be deposited with the Sales Tax Department of the Government. The
following entries are passed-
(i) At the time of sale-
Cash/Debtors A/c Dr.
To Sales A/c
To Sales Tax Payable A/c
(ii) On payment of sales-
Sales Tax Payable A/c Dr.
To Bank A/c
If any balance remains in the Sales Tax Payable Account, it should be shown in the Balance
Sheet as liability.
5. Commission based on profit : Sometimes commission is payable to manager based on net
profit; in such a case calculation is done as follows:
(i) Commission on net profit before charging such commission =
Rate of commission
Profit before commission
100
(ii) Commission on net profit after charging such commission =
Rate of commission
Profit before commission
100+ Rate of commission
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.24
COMMON PROFICIENCY TEST
Commission is recorded by following journal entry-
Commission A/c Dr.
To Commission Payable A/c
(Being commission payable to Mr .. @ ..% on net profit after
charging such commission, net profit before charging commission being Rs ..)
Commission will be debited in the Profit & Loss Account and Commission Payable Account
will be shown in the Balance Sheet on liability side.
Illustration 6
The following is the Trial Balance of C. Wanchoo on 31st Dec. 2009.
Trial Balance on 31st December, 2009
Dr. Cr.
Rs. Rs.
Capital Account 10,000
Stock Account 2,000
Cash in hand 1,440
Machinery Account 7,360
Purchases Account 18,200
Wages Account 10,000
Salaries Account 10,000
Discount Allowed A/c 500
Discount Received A/c 300
Sundry Office Expenses Account 6,000
Sales Account 50,000
Sums owing by customer (Sundry Debtors) 8,500
Sundry Creditors (sums owing to suppliers) 3,700
Total 64,000 64,000
Value of Closing Stock on 31st Dec. 2009 was Rs. 2,700
Prepare closing entries for the above items.
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.25
Solution
Journal
Date Particulars L.F. Dr. Cr.
2009 Rs. Rs.
Dec. 31 Trading Account Dr. 30,200
To Stock Account 2,000
To Purchase A/c 18,200
To Wages A/c 10,000
(Being the accounts in the Trial Balance
which have to be transferred to the Trading
Account debit side)
Dec. 31 Sales Account Dr. 50,000
To Trading A/c 50,000
(Being the amount of Sales transferred
to the credit of Trading Account)
Dec. 31 Stock (Closing) A/c Dr. 2,700
To Trading A/c 2,700
(Being the value of Stock on hand on
31st Dec. 2009)
Dec. 31 Trading A/c Dr. 22,500
To Profit and Loss A/c 22,500
(Being the transfer of gross profit.)
Dec. 31 Profit and Loss A/c Dr. 16,500
To Discount Allowed Account 500
To Salaries A/c 10,000
To Sundry Office Expenses A/c 6,000
(Being the various expense accounts
transferred to the P & L Account)
Dec. 31 Discount Received A/c Dr. 300
To P & L Account 300
(Being the credit balance of discount received
transferred to Profit and Loss A/c)
Dec. 31 Profit and Loss A/c Dr. 6,300
To Capital A/c 6,300
(Being the transfer to Net Profit to the
Capital Account)
1,28,500 1,28,500
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.26
COMMON PROFICIENCY TEST
Illustration 7
From the data given in illustration 6, prepare Trading and Profit and Loss Account.
Solution
C. WANCHOO
Trading Account of the year ended December 31, 2009
Rs. Rs.
To Stock A/c 2,000 By Sales A/c 50,000
To Purchases 18,200 By Stock (Closing) 2,700
To Wages 10,000
To Gross profit trfd. to P & L A/c 22,500
52,700 52,700
Profit and Loss Account for the year ended December 31, 2009
Rs. Rs.
To Salaries 10,000 By Gross profit trfd. from
To Discount Allowed 500 the Trading Account 22,500
To Sundry Office Expenses 6,000 By Discount Received 300
To Net Profit transferred to
Capital A/c 6,300
22,800 22,800
6. BALANCE SHEET
The balance sheet may be defined as a statement which sets out the assets and liabilities of a firm
or an institution as at a certain date. Since even a single transaction will make a difference to
some of the assets or liabilities, the balance sheet is true only at a particular point of time. That
is the significance of the word as at.
In the illustration worked out above it will be seen that the under mentioned accounts have
not been closed even after preparation of the Profit and Loss Account and the transfer of the
net profit to the capital account.
Rs.
Cash in Hand 1,440 Debit balance
Capital Accounts (Rs.10,000+ Rs.6,300) 16,300 Credit balance
Machinery Account 7,360 Debit balance
Sundry Debtors 8,500 Debit balance
Sundry Creditors 3,700 Credit balance
Stock Account 2,700 Debit balance
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.27
Looking at these accounts, one would know that various assets : Cash balance in hand, cash at
bank, machinery, furniture etc. that the firm possesses and the amounts that are owing as
liability to Sundry Creditors and to the proprietor as capital. The capital, of course, will be the
difference between the total of assets and of liabilities. The assets, liabilities and capital are
usually presented in a statement called the Balance Sheet. This is given below for the accounts
mentioned above.
C. WANCHOO
Balance Sheet as at December 31, 2009
Liabilities Rs. Assets Rs.
Sundry Creditors 3,700 Cash in Hand 1,440
Capital 16,300 Sundry Debtors 8,500
Stock 2,700
Machinery 7,360
20,000 20,000
The assets are shown on the right hand side and liabilities and capital on the left hand side.
6.1 CHARACTERISTICS
The balance sheet has certain characteristics, which should be noted. These are the following:
(i) It is prepared at a particular date, rather the close of a day and not for a period. It is true
only on that date and not later. Suppose, in the example given above, a part of the goods
were sold on 1st January, 2010. This will mean that the value of the stock will be reduced,
the cash in hand will increase and the capital account will be reduced.
(ii) The balance sheet is prepared only after the preparation of the Profit and Loss Account.
This is the reason why the Profit and Loss Account (including the Trading Account) and
the Balance Sheet are together called Final Accounts (Of course, the Balance Sheet is not
an account, the two sides are not the debit and the credit sides.) Without being accompanied
by the Profit and Loss Account, the Balance Sheet will not be able to throw adequate light
on the financial position of the firm. For that purpose an appreciation of the profits of the
firm is necessary.
(iii) Since capital always equals the difference between assets and liabilities and since the capital
account will independently arrive at this figure, the two sides of the Balance Sheet must
have the same totals. If it is not so, there is certainly an error somewhere.
6.2 ARRANGEMENTS OF ASSETS AND LIABILITIES
(1) Assets : Assets may be grouped in one of the following two ways :
(i) Liquidity : Under this approach, the asset, which can be converted into cash first, is
presented first. Those assets, which are most difficult in this respect, are presented at
the bottom.
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.28
COMMON PROFICIENCY TEST
(ii) Permanence: Assets, which are to be used, for long term in the business and are not
meant to be sold are presented first. Assets, which are most liquid, such as cash in
hand, are presented at the bottom.
The various assets in two order will be as follows:
In the order of Liquidity In the order of Permanence
Cash in Hand Goodwill
Cash at Bank Patents
Investments Furniture
Sundry Debtors Machinery
Stock of Finished Goods Stock of Partly Finished goods
Stock of Raw Materials Stock of Raw Materials
Partly Finished goods Stock of Finished goods
Machinery Sundry Debtors
Furniture Investments
Patents Cash at Bank
Goodwill Cash in Hand
Some of the assets may be capable of being sold easily like investment in government
securities or shares of some companies. They should be treated as liquid or permanent
according to the intention of the firm. One should also note that the order in which the
assets of a company are to be shown is described by the Companies Act.
(2) Liabilities : Liabilities may also be shown according to the urgency with which payment
has to be made. One way is to first show the capital, then long-term liabilities and last of
all short term liabilities like amounts due to suppliers of goods or bills payable. The other
way is to start with short-term liabilities and then show long term liabilities and last of all
capital.
6.3 CLASSIFICATION OF ASSETS AND LIABILITIES
Assets are basically of two types. Those that are meant to be used by the firm over a long
period and not sold and those that are meant to be converted into cash as quickly as possible.
Examples of the latter are book debts, stocks of finished goods and materials, etc. The later
types of assets are called current assets. These include cash also. The former type of assets is
called fixed assets. It is desirable that in the balance sheet the two types of assets should be
shown separately and prominently. This would give meaningful and logical information.
The liabilities to outsider will be of two types. Those that must be settled within one year and
those that will be paid after one year. The former type of liability is called current or short-term
liability. The latter type is long term liability. Of course, it will include undistributed profits
also.
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.29
Sole proprietors generally present Balance Sheet in a horizontal form with Capital and
Liabilities on the left hand side and Assets on the right-hand side. In the Balance Sheet the
various items should be grouped suitably as indicated below:
Balance Sheet as on..
Capital and Liabilities Amount Assets Amount
Rs. Rs.
Capital A/c: Tangible Fixed Assets :
Balance Land and Building
Add : Net Profit/Less: Net Loss Plant and Machinery
Less : Drawings Furniture and Fixture
Long Term Loans : Vehicles
Term Loans Intangibles :
Other Loans Goodwill
Short Term Loans : Patent Rights
Cash Credit Designs and Brand Names
Overdrafts Deferred Advertisement
Other Loans Investments :
Current Liabilities : Long term investments
Sundry Creditors
Bills Payable Current Assets :
Outstanding Expenses Stock In Trade
Advances Taken Sundry Debtors
Provision : Bills Receivable
Provision for Bad debts Prepayments
Provision for Retirement Benefits Advances
Provision for Taxation Bank Balances
Cash In Hand
Of course, there is no hard and fast rule regarding presentation of assets, liabilities and equities
in the Balance sheet. However, the model presentation shown above has been designed
considering the nature of Balance Sheet elements and categorizing them appropriately.
Proper presentation of Balance Sheet items improves understandability of the information
desired to be communicated to the users of account.
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.30
COMMON PROFICIENCY TEST
Illustration 8
Given below Trial Balance of M/s Dayal Bros. as on 31st March, 2009 :
Debit Balances Credit Balances
Rs. Rs.
Capital A/c 7,00,000
Land and Building 3,00,000
14% Term Loan 4,00,000
Loan from M/s. D & Co. 4,60,000
Sundry Debtors 4,20,000
Cash in hand 20,000
Stock In Trade 6,00,000
Furniture 2,00,000
Sundry Creditors 40,000
Advances to Suppliers 1,00,000
Net Profit 1,00,000
Drawings 60,000
17,00,000 17,00,000
Prepare Balance Sheet as on 31st March, 2009.
Solution
In the Books of M/s Dayal Bros.
Balance Sheet
as on 31st March, 2009
Capital and Liabilities Amount Amount
Rs. Rs. Assets Rs.
Capital: Balances 7,00,000 Land & Building 3,00,000
Add: Net Profit 1,00,000 Furniture 2,00,000
8,00,000 Stock in Trade 6,00,000
Less: Drawings 60,000 7,40,000 Sundry Debtors 4,20,000
14% Term Loan 4,00,000 Advances to Suppliers 1,00,000
Loan from M/s D & Co. 4,60,000 Cash in Hand 20,000
Sundry Creditors 40,000
16,40,000 16,40,000
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.31
Illustration 9
The balance sheet of Thapar on 1st January, 2009 was as follows :
Particulars Rs. Particulars Rs.
Sundry Creditors 15,000 Plant & Machinery 30,000
Expenses Payable 1,500 Furniture & Fixture 3,000
Capital 50,000 Stock 13,000
Sundry Debtors 14,000
Cash at Bank 6,500
66,500 66,500
During 2009, his Profit and Loss Account revealed a net profit of Rs. 15,300. This was
after allowing for the following :
(a) Interest on capital @ 6% p.a.
(b) Depreciation on Plant and Machinery @ 10% and on Furniture and Fixtures @ 5%.
(c) A provision for Doubtful Debts @ 5% of the debtors as at 31st December, 2009.
But while preparing the Profit and Loss Account he had forgotten to provide for (1) outstanding
expenses totaling Rs. 1,800 and (2) prepaid insurance to the extent of Rs. 200.
His current assets and liabilities on 31st December, 2009 were : Stock Rs. 14,500; Debtors,
Rs. 20,000; Cash at Bank, Rs. 10,350 and Sundry Creditors Rs. 11,400.
During the year he withdrew Rs. 6,000 for domestic use. Draw up his Balance Sheet at the
end of the year.
Solution
Profit and Loss Account (Revised)
Particulars Rs. Particulars Rs.
To Outstanding expenses 1,800 By Balance b/d 15,300
To Net profit 13,700 By Prepaid insurance 200
15,500 15,500
Balance Sheet of Thapar
as on 31st December, 2005
Liabilities Rs. Assets Rs. Rs.
Capital 50,000 Cash at Bank 10,350
Add: Net Profit 13,700 Debtors 20,000
63,700 Less: Provision for
doubtful debts 1,000 19,000
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.32
COMMON PROFICIENCY TEST
Less : Drawings 6,000 Plant and Machinery 30,000
57,700 Less: Depreciation 3,000 27,000
Add: Interest on capital 3,000 60,700 Furniture & Fixtures 3,000
Outstanding expenses 1,800 Less: Depreciation 150 2,850
Creditors 11,400 Stock 14,500
Prepaid insurance 200
73,900 73,900
7. SEQUENCE OF ACCOUNTING PROCEDURE OR THE
ACCOUNTING CYCLE
What has been done so far shows that the accounting process in the following order :
(i) recording the transactions in the journal or journalising;
(ii) preparing ledger accounts on the basis of the journal or posting into the ledger;
(iii) taking out the trial balance to check arithmetical accuracy;
(iv) preparing the profit and loss account or the income statement for the period concerned;
and
(v) preparing the balance sheet to show the financial position at the end of the period.
8. OPENING ENTRY
We have seen that on commencing a new business one debits the cash account and credits the
capital account with the amount introduced. A firm closes the books of account at the end of
each year and starts new books in the beginning of each year. The first entry in the journal is to
record the closing balances of various assets and liablities at the end of the previous year as the
opening balances in the beginning of the new year. The balance sheet prepared at the end of
the year records these balances and is the basis for this first entry. It is called the opening entry.
The assets shown in the balance sheet are debited and the liabilities and the capital account
credited.
Illustration 10
From the given below balance sheet prepare the relevant opening entry.
BALANCE SHEET
As at 31st December, 2009
Liabilities Rs. Assets Rs.
Mahendra & Sons 5,600 Cash in hand 430
Capital 20,000 Cash at Bank 2,675
Debtors 7,495
Closing Stock 9,000
Machinery and Equipment 6,000
25,600 25,600
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.33
Solution
The Opening Entry :
Dr. Cr.
Rs. Rs.
Cash A/c Dr. 430
Bank A/c Dr. 2,675
Sundry Debtors Dr. 7,495
Stock A/c Dr. 9,000
Machinery and Equipment A/c Dr. 6,000
To Mahendra & Sons A/c 5,600
To Capital A/c 20,000
(Being the balances brought forward) 25,600 25,600
8.1 POSTING THE OPENING ENTRY
All the assets show debit balance. Such accounts are opened and the relevant amounts written
on the debit side as To Balance b/d. Following is the cash account arising from the entry
given above.
CASH ACCOUNT
Dr. Cr.
Date Particulars Amount Date Particulars Amount
2010 Rs. P.
Jan. 1 To Balance b/d 430
The accounts of liabilities show credit balances. An account for each liability is opened and the
relevant account is written on the credit side as By Balance b/d. This is shown below by
opening the accounts of Mahendra & Sons mentioned in the entry given above.
MAHENDRA & SONS
Dr. Cr.
Date Particulars Amount Date Particulars Amount
Rs. P. 2010 Rs. P.
Jan. 1 By Balance b/d 5,600
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.34
COMMON PROFICIENCY TEST
By posting the opening entry completely all the accounts of assets and liabilities in the beginning
are opened. We illustrate below a complete cycle of journalising, posting and trial balance.
Students should work through the following illustration given by way of practice on the method
of making adjustments in some of the accounts contained in a Trial Balance and afterwards
preparing the final Account.
Illustration 11
Shri Mittal gives you the following Trial Balance and some other information :
Trial Balances as on 31st March, 2009
Dr. Cr.
Rs. Rs.
Capital 8,70,000
Purchases and Sales 6,05,000 12,10,000
Opening Stock 72,000
Debtors and Creditors 90,000 1,70,000
14% Bank Loan 2,00,000
Overdrafts 1,12,000
Salaries 2,70,000
Advertisements 1,10,000
Other expenses 60,000
Returns 40,000 30,000
Furniture 4,50,000
Building 8,90,000
Cash in Hand 5,000
25,92,000 25,92,000
Closing stock on 31st March, 2009 was valued at Rs. 1,00,000.
Prepare his final accounts.
Solution
In the books of Shri Mittal
Trading Account
for the year ended 31st March, 2009
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
To Opening Stock 72,000 By Sales 12,10,000
To Purchases 6,05,000 Less: Returns 40,000 11,70,000
Less: Returns 30,000 5,75,000 By Closing stock 1,00,000
To Gross Profit 6,23,000
12,70,000 12,70,000
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.35
Profit and Loss Account
For the year ended 31st March, 2009
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
To Salaries 2,70,000 By Gross profit 6,23,000
To Advertisement 1,10,000
To Other expenses 60,000
To Net profit 1,83,000
6,23,000 6,23,000
Balance Sheet as on 31st March, 2009
Liabilities Amount Assets Amount
Rs. Rs. Rs.
Capital 8,70,000 Building 8,90,000
Add: Net profit 1,83,000 10,53,000 Furniture 4,50,000
14% Bank Loan 2,00,000 Debtors 90,000
Creditors 1,70,000 Closing stock 1,00,000
Overdrafts 1,12,000 Cash in hand 5,000
15,35,000 15,35,000
Illustration 12
Mr. Mohan gives you the following trial balance and some other information:
Trial Balance as on 31st March, 2009
Dr. Cr.
Rs. Rs.
Capital 6,50,000
Sales 9,70,000
Purchases 4,30,000
Opening Stock 1,10,000
Freights Inward 40,000
Salaries 2,10,000
Other Administration Expenses 1,50,000
Furniture 3,50,000
Debtors and Creditors 2,10,000 1,90,000
Returns 20,000 12,000
Discounts 19,000 9,000
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.36
COMMON PROFICIENCY TEST
Bad Debts 5,000
Investments in Government Securities 1,00,000
Cash in Hand and Cash at Bank 1,87,000
18,31,000 18,31,000
Other Information :
(i) Closing stock was Rs. 1,80,000;
(ii) Depreciate Furniture @ 10% p.a.
You are required to prepare Trading and Profit and Loss Account for the year ended on
31.3.2009 and Balance Sheet of Mr. Mohan as on that date.
Solution
In the books of Mr. Mohan
Trading Account
for the year ended 31st March, 2009
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
To Opening stock 1,10,000 By Sales 9,70,000
To Purchases 4,30,000 Less: Returns 20,000 9,50,000
Less: Returns 12,000 4,18,000 By Closing stock 1,80,000
To Freight Inwards 40,000
To Net profit 5,62,000
11,30,000 11,30,000
Profit and Loss Account
for the year ended 31st March, 2009
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
To Depreciation 35,000 By Gross profit 5,62,000
To Salaries 2,10,000 By Discount received 9,000
To Administration expenses 1,50,000
To Discount allowed 19,000
To Bad debts 5,000
To Net profit 1,52,000
5,71,000 5,71,000
Copyright -The Institute of Chartered Accountants of India
FUNDAMENTALS OF ACCOUNTING
6.37
Balance Sheet
as on 31st March, 2009
Liabilities Amount Assets Amount
Rs. Rs.
Capital 6,50,000 Furniture 3,50,000
Add: Net profit 1,52,000 8,02,000 Less: Depreciation 35,000 3,15,000
Creditors 1,90,000 Closing stock 1,80,000
Debtors 2,10,000
Investment in Govt
securities 1,00,000
Cash in Hand and
Cash at Bank 1,87,000
9,92,000 9,92,000
Illustration 13
From the following Trial Balance prepare a Trading and Profit and Loss Account for the year
ending 31st December, 2009 and a Balance Sheet as on that date:
Rs. Rs.
Debit Balance :
Sundry Debtors 3,500 Salaries 2,200
Stock 1st January, 2009 5,000 Purchases 12,500
Cash in Hand 5,600 Plant and Machinery 15,700
Wages 3,000 Credit Balance:
Bad Debts 500 Capital 25,000
Furniture and Fixtures 1,500 Sundry Creditors 9,000
Depreciation 1,500 Sales 17,000
On 31st December, 2009 the stock was valued at Rs. 10,000.
Solution
Trading and Profit and Loss Account for the year ending 31st Dec., 2009
Rs. Rs.
To Opening Stock 5,000 By Sales 17,000
To Purchases 12,500 By Closing Stock 10,000
To Wages 3,000
To Gross Profit c/d 6,500
27,000 27,000
To Bad Debts 500 By Gross Profit b/d 6,500
To Depreciation 1,500
To Salaries 2,200
To Net Profit trfd. to Capital A/c 2,300
6,500 6,500
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.38
COMMON PROFICIENCY TEST
Balance Sheet as at 31st Dec., 2009
Liabilities Rs. Rs. Assets Rs. Rs.
Current Liabilities: Current Assets :
Sundry Creditors 9,000 Cash in Hand 5,600
Capital: Sundry Debtors 3,500
Previous Balance 25,000 Closing Stock 10,000 19,100
Add : Net Profit 2,300 27,300 Fixed Assets :
Furniture & Fixtures 1,500
Plant & Machinery 15,700 17,200
36,300 36,300
Illustration 14
Sengupta & Co. employs a team of eight workers who were paid Rs. 3,000 per month each in
the year ending 31st December, 2008. At the start of 2009, the company raised salaries by 10%
to Rs. 3,300 per month each.
On July 1, 2009 the company hired two trainees at salary of Rs. 2,100 per month each. The
work force are paid salary on the first working day of every month, one month in arrears, so
that the employees receive their salary for January on the first working day of February etc.
Calculate:
(i) Amount of salaries which would be charged to the profit and loss for the year ended
31st December, 2009.
(ii) Amount actually paid as salaries during 2009.
(iii) Outstanding Salaries as on 31st December, 2009.
Solution
Rs.
(i) Salaries to be charged to profit and loss account for the year
ended 31st December, 2009:
Salaries of 8 employees for full year @ Rs. 3,300 per month each 3,16,800
Salaries of 2 trainees for 6 months @ Rs. 2,100 p.m. 25,200
3,42,000
(ii) Salaries actually paid in 2009
December, 2008 salaries paid in January, 2009 (8 x 3,000) 24,000
Salaries of 8 employees for January to November, 2009 paid in
February-December, 2009 @ Rs. 3,300 for 11 months 2,90,400
Salaries of 2 trainees for July to November paid in August-
December @ Rs. 2,100 for 5 months 21,000
3,35,400
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FUNDAMENTALS OF ACCOUNTING
6.39
(iii) Outstanding salaries as at 31st December, 2009
8 employees @ Rs. 3,300 each for 1 month 26,400
2 trainees @ Rs. 2,100 each for 2 months 4,200
30,600
Illustration 15
Mr. James submits you the following information for the year ended 31.3.2006:
Rs.
Stock as on 1.4.2008 1,50,500
Purchases 4,37,000
Manufacturing expenses 85,000
Expenses on sale 33,000
Expenses on administration 18,000
Financial charges 6,000
Sales 6,25,000
Gross profit is 20% of sales.
Compute the net profit of Mr. James for the year ended 31.3.2009.
Solution
Statement showing Computation of Net Profit of
Mr. James for the year ended 31.3.2009
Rs. Rs.
Gross profit on sales (Rs.6,25,000x 20/100) 1,25,000
Less: Overhead expenses:
Administration expenses 18,000
Selling expenses 33,000
Financial charges 6,000 57,000
Net profit 68,000
Alternatively, trading and profit and loss account for the year ended 31st March, 2009 can be
prepared to compute the amount of net profit.
Trading and Profit & Loss Account of Mr. James
for the year ended 31st March, 2009
Rs. Rs.
To Opening stock 1,50,500 By Sales 6,25,000
To Purchases 4,37,000 By Closing stock 1,72,500
To Manufacturing expenses 85,000 (balancing figure)
To Gross profit c/d 1,25,000
7,97,500 7,97,500
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.40
COMMON PROFICIENCY TEST
To Administration expenses 18,000 By Gross profit b/d 1,25,000
To Selling expenses 33,000
To Financial charges 6,000
To Net profit 68,000
1,25,000 1,25,000
Illustration 16
The Balance Sheet of Mr. Popatlal, a merchant on 31st December, 2009 stood as below:
Liabilities Amount Assets Amount
Rs. Rs.
Capital 24,000 Fixed Assets 12,560
Creditors 16,400 Stock 20,640
Bank Overdraft 14,600 Debtors 18,800
Less: Provision 620 18,180
Cash 3,620
55,000 55,000
Show opening journal entry on 1st January, 2010 in the books of Mr. Popatlal.
Solution
Opening entry
(Dr.) Rs. (Cr.) Rs.
1.1.2010 Fixed Assets A/c Dr. 12,560
Stock A/c Dr. 20,640
Debtors A/c Dr. 18,800
Cash A/c Dr. 3,620
To Creditors A/c 16,400
To Bank Overdraft A/c 14,600
To Provision for Doubtful Debts A/c 620
To Capital A/c 24,000
9. PROVISIONS AND RESERVES
Provision means any amount written off or retained by way of providing for depreciation,
renewal or diminution in the value of assets or retained by way of providing for any known
liability of which the amount cannot be determined with substantial accuracy.
Thus, a provision may be either in respect of loss in the value of an asset provided or written off
on the basis of an estimate or the one in respect of a liability for expenses incurred in respect of
a claim which is disputed i.e. when it is a contingent liability. On the occurrence of a diminution
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FUNDAMENTALS OF ACCOUNTING
6.41
in asset values due to some of them having become irrecoverable or stock items are lost as a
result of some natural calamity, amounts contributed or transferred from profit to make good
the diminution also are described as provision.
The following are instances of amount retained in the business out of earning for different
purposes that are described as provisions.
(1) Amount provided for meeting claims which are admissible in principle but the amount
whereof has not been ascertained.
(2) An appropriation made for payment of taxes still to be assessed.
(3) Amount set aside for writing off bad debts or payment of discounts.
The term reserve is not defined in Part III of Schedule VI except negatively in the sense that
profit retained in the business not having any of the attribute of a provision is to be treated as
a reserve. Also provisions in excess of the amount considered necessary for the purposes these
were originally made, are to be considered as reserves. It is thus evident that provisions are a
charge against profits, while reserve is an appropriation of profits. Also provisions that ultimately
prove to be in excess of amounts required or have been made too liberally are reserves. Such a
distinction is essential for disclosing truly in the Balance Sheet the amount by which the equity
of shareholders has increased with the accumulation of undistributed profits.
Reserve Fund : It signifies the amount standing to the credit of the reserve that is invested
outside the business in securities which are readily realisable e.g., when the amounts set apart
for replacement of an asset are invested periodically, in government securities or shares. The
account to which these amounts are annually credited is described as the Reserve Fund.
Illustration 17
Crimpson Ltd.s profit and loss account for the year ended 31st December, 2009 includes the
following information:
Rs.
(i) Depreciation 57,500
(ii) Bad debts written off 21,000
(iii) Increase in provision for doubtful debts 18,000
(iv) Proposed dividend 15,000
(v) Retained profit for the year 20,000
(vi) Liability for tax 4,000
State which one of the items (i) to (vi) above are (a) transfer to provisions; (b) transfer to
reserves; and (c) neither related to provisions nor reserves.
Solution
(a) Transfer to provisions - (i), (iii) (vi)
(b) Transfer to reserves - (v)
(c) Neither related to provisions nor reserves - (ii), (iv).
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES
6.42
COMMON PROFICIENCY TEST
10. LIMITATIONS OF FINANCIAL STATEMENTS
Financial statements suffer from a number of limitations. These must, therefore be studied
with care, in order that correct inferences may be drawn. The limitations are less serious if the
objective is only to appraise the performance of a single company over a period of years. Where,
however, a comparison of the working of different companies for the same period is to be
made. It can be misleading unless the companies concerned have followed the same system
and basis of accounting. On the account, a comparison of the profitability of different industries
on the basis of financial statements, should be undertaken only if it is not practicable to make
such a comparison on any other basis.
The principal limitations affecting financial statements are the following:
(a) Historical Cost : Accounting records and, on that account, the financial statements are
prepared only on the basis of the money value prevailing at the time the transaction were
entered into. Thus, the effect of subsequent changes in the value of money is not taken into
account. At times this has the effect of making the statements of account quite misleading.
Take the obvious example of a house built in 1945, say at the cost of Rs. 15,000, in 2009 the
benefit receivable from its occupation will be as much as that of a house created in 2009,
say at a cost of Rs. 14,50,000. If the house were included in the financial statements at its
original cost, as normally it would not convey a true picture except to a knowledgeable
person.
The limitations can be serious in the case of other fixed assets that have been working over
a long period over which prices have changed radically. It is, however, not easy to get
over this difficulty, since revaluation of fixed assets, apart from being costly is not practicable
when the value of money is continuously falling. On this account, historical cost continues
to be the accepted basis for the preparation of financial statements. Though it may not be
possible to do much to remove the limitation mentioned above, one must always remember
to read the balance sheet and the profit and loss account in the light of what they cannot
reveal as well as what they do.
(b) Intangible strengths and weaknesses : A company may have a number of strengths and
weaknesses which cannot be shown in the balance sheet e.g., the loyalty and calibre of its
staff. These must be kept in mind while judging the financial position of the company.
(c) Perpetual continuity and periodical account : Financial statements ordinarily are drawn
up at the end of each year but the accounting record is maintained on the assumption that
the business undertaking shall continue to exist forever. In consequence, much of the
expenditure other than revenue expenditure has to be distributed arbitrarily over a number
of years during which benefit of the expenditure is expected to arise. As a result, financial
statements of account are not absolutely correct.
The management of a business entity is left with discretion as regard valuation and treatment
of a number of assets, some of which are mentioned below:
(i) Goodwill and other intangible assets;
(ii) Wasting assets like mines, quarries etc.;
(iii) Deferred revenue expenditure; and
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FUNDAMENTALS OF ACCOUNTING
6.43
(iv) Fictitious assets like Preliminary Expenses, Discount on Debentures, etc.
As a result, if one company follows one method as regards valuation of one or more of
these assets and the second follows another, the financial results shown by the two
companies are not comparable.
(d) Different accounting policies : It is permissible for a company within certain limits to
adopt different policies for the preparation of accounts, valuation of various assets and
distribution of expenditure over different periods of account. For example, a company
may decide to provide annually for payment of pensions and gratuities to staff and thus
build up a fund out of which payments will be made ultimately whereas another company
may deal with these only when actual payments are made. Similarly, a company may
decide whether or not to include intangible assets amongst its assets or manner in which
the amounts thereof should be written off.
Whatever basis of accounting is decided upon the same must be followed consistently,
from year to year. Whenever it is departed from, the effect of it would be the effect of
obscuring the profit of the year in which the change in the basis of accounting is made.
(e) Management policies : There is general impression that each undertaking endeavours to
earn as much profit as it can. This is not wholly correct. The management often attempts
not to allow its profit to rise above a level that it consider appropriate, in the circumstances
it is functioning, due to a variety of reasons. This may be:
(i) Disinclination to undertake new risks and responsibilities on account of high rates of
taxation;
(ii) Fear of the odium of profiteering a bad reputation that prices charged by the concern
for its goods are not reasonable :
(iii) Fear that larger profits may give rise to demand for higher wages which may throw
the costs and prices relationship out of gear or impression may gain ground that
there has been an increased workload on the workers which may lead to
discontentment amongst them :
(iv) Fear that the concern may be considered to have developed monopolistic tendencies;
(v) Consideration to maintain efficiency; and
(vi) Unwillingness to expand, unduly on account of uncertainty of the future.
To conclude, on these considerations. Financial statements need to be studied with great
care. The information disclosed by them has to be judged in the light of the economic
change, such as inflationary condition over the short period, as well as, over the long
period (like one witnessed in India after 1971) and the nature of management and its
basic motives. Despite the limitations, the financial statements, verified by independent
auditors, often are the only tangible evidence available as regards the profitability and the
financial position of the company. Their importance, therefore, cannot be under-estimated.
If properly analysed, they are capable of yielding a flood of information.
Copyright -The Institute of Chartered Accountants of India
CHAPTER - -- -- 6
Unit 2
Final Accounts of
Manufacturing
Entities
PREPARATION
OF FINAL
ACCOUNTS OF
SOLE
PROPRIETORS
Copyright -The Institute of Chartered Accountants of India
Learning Objectives :
After studying this unit you will be able to :
Understand the purpose of preparing Manufacturing Account.
Learn the items to be included in the Manufacturing Account.
1. INTRODUCTION
The manufacturing entities generally prepare a separate Manufacturing Account as a part of
Final accounts in addition to Trading Account, Profit and Loss Account and Balance Sheet.
The objective of preparing Manufacturing Account is to determine manufacturing costs of
finished goods for assessing the cost effectiveness of manufacturing activities. Manufacturing
costs of finished goods are then transferred from the Manufacturing Account to Trading
Account.
2. PURPOSE
A manufacturing account serves the following functions:
(1) It shows the total cost of manufacturing the finished products and sets out in detail, with
appropriate classifications, the constituent elements of such cost. It is, therefore, debited
with the cost of materials, manufacturing wages and expenses incurred directly or indirectly
on manufacture.
(2) It provides details of factory cost and facilitates reconciliation of financial books with cost records
and also serves as a basis of comparison of manufacturing operations from year to year.
(3) The Manufacturing Account may also be used for various other purposes. For example, if
the output is carried to the Trading Account at market prices, it discloses the profit or loss
on manufacture. Similarly, it may also be used to fix the amount of production of profit
sharing bonus when such schemes are in force.
3. MANUFACTURING COSTS
Manufacturing costs are classified into :
Raw Material Consumed ....
Direct Manufacturing Wages
Direct Manufacturing Expenses
Prime Cost
Indirect Manufacturing expenses or
Manufacturing Overhead
Total Manufacturing Cost ______
Raw Material consumed is arrived at after adjustment of opening and closing stock of raw
materials:
Raw Material Consumed = Opening Stock of Raw Materials
+ Purchases
- Closing Stock of Raw Materials
6.45
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF MANUFACTURING ENTITIES
6.46
COMMON PROFICIENCY TEST
If there remain unfinished goods at the beginning and at the end of the accounting period, cost
of such unfinished goods (also termed as Work-In-Process) is shown in the Manufacturing
Account opening stock of Work-in-Process is posted to the debit of the Manufacturing Account
and closing stock of Work-in-Process is posted to the credit of the Manufacturing Account.
3.1 DIRECT MANUFACTURING EXPENSES
Direct manufacturing expenses are costs, other than material or wages, which are incurred for
a specific product or saleable service.
Examples of direct manufacturing expenses are (i) Royalties for using license or technology if
based on units produced, (ii) Hire charge of the plant and machinery used on hire, if based on
units produced, etc.
When royalty or hire charges are based on units produced, these expenses directly vary with
production.
Illustration 1
10,000 units were produced in a factory. Per unit material cost was Rs. 10 and per unit labour
cost was Rs. 5. That apart it was agreed to pay royalty @Rs. 3 per unit to the Japanese collaborator
who supplied technology.
Solution
In this case Prime Cost comprises of
Raw Material consumed (10,000 Rs. 10) Rs. 1,00,000
Direct Wages (10,000 Rs. 5) Rs. 50,000
Direct Expenses (10,000 Rs. 3) Rs. 30,000
Rs. 1,80,000
3.2 INDIRECT MANUFACTURING EXPENSES
These are also called Manufacturing overhead, Production overhead, Works overhead, etc.
Overhead is defined as total cost of indirect material, indirect wages and indirect expenses.
Indirect material means materials which cannot be linked directly with the units produced, for
example, stores consumed for repair and maintenance work, small tools, fuel and lubricating
oil, etc. Indirect wages are those which cannot be directly linked to the units produced, for
example, wages for maintenance works, holding pay, etc. Indirect expenses are those which
cannot be directly linked to the units produced, for example, training expenses, depreciation
of plant and machinery, depreciation of factory shed, insurance premium for plant and
machinery, factory shed, etc.
Accordingly, indirect manufacturing expenses comprise indirect material, indirect wages and
indirect expenses of the manufacturing division.
3.3 BY-PRODUCTS
In most manufacturing operations, the production of the main product is accompanied by the
production of a subsidiary product which has a value on sale. For example, the production of
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FUNDAMENTALS OF ACCOUNTING
6.47
hydrogenated vegetable oil is accompanied by the production of oxygen gas and the production
of steel yields scrap. The subsidiary product is termed as a by-product because its production is
not consciously undertaken but results out of the production of the main product. It is usually
very difficult to ascertain the cost of the product. Moreover, its value usually forms a very
small percentage of the main product.
By-product is a secondary product. This is produced from the same raw materials, which are
used for producing the main product and without incurring any additional expenses from the
same production process in which the main product is produced. Some examples of by-product
are given below:
(i) Molasses is the by-product in sugar manufacturing;
(ii) Butter milk is the by-product of a dairy which produces butter and cheese, etc.
By-products generally have insignificant value as compared to the value of main product.
They are generally valued at net realisable value, if their costs cannot be separately identified.
It is often treated, as Miscellaneous income but the correct treatment would be to credit the
sale value of the by-product to Manufacturing Account so as to reduce to that extent, the cost
of manufacture of main product.
4. DESIGN OF A MANUFACTURING ACCOUNT
There is no standardized design for the presentation of a Manufacturing Account. Given below
is a format covering various elements:
Manufacturing Account
Dr. Cr.
Particulars Units Amount Particulars Units Amount
Rs. Rs.
To Raw Material By By-products at
Consumed: net realisable value
Opening Stock . Closing Work-in-
Process
Add: Purchases .. Trading A/c -
Less: Closing Stock .. Cost of production
Direct Wages
Direct expenses:
Prime cost
To Factory overheads:
Royalty ..
Hire charges ..
Indirect expenses: ..
Repairs & Maintenance ..
Depreciation .. .
Factory cost .
To Opening Work-in-
process .
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FINAL ACCOUNTS OF MANUFACTURING ENTITIES
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COMMON PROFICIENCY TEST
Tutorial Note : Frequently, problems are set, in which all the ledger balances are not given.
Instead, details are given regarding the number of items in stocks, quantity manufactured etc.
the figures for stocks, sales etc., would therefore have to be worked out independently from
the data given.
The following general rules may be observed.
(a) The Manufacturing Account should have columns showing the quantities and values.
Frequently, all the quantities are not given and the quantities applicable to one or more of
the items would have to be worked out. For example, if the question does not state the
total number of items sold, the quantity can be worked out by adding opening stock and
units manufactured and deducting closing stock. It is, therefore, useful to have quantity
columns in the account so that it can be seen that both sides balance.
(b) The Manufacturing Account will show the quantity of raw materials in stock at the
beginning and at the end of the year and the purchases during the year. As regards finished
goods, it will only show the quantity manufactured and, as regards work-in-progress, the
opening and closing amounts.
(c) The Trading Account will show the quantities of finished goods manufactured and sold
and the opening and closing stocks. It will not show the quantity of raw materials or
work-in-progress.
(d) For determining the value of closing stock, in the absence of specific instruction to the
contrary, it must be assumed that sales have been on first in-first out basis, that is, the
closing stock consists as far as possible of goods produced during the year, the opening
stock being sold out.
It may be mentioned here that nowadays no manufacturing business entity prepares
manufacturing account as part of its final set of accounts. Even the items of manufacturing
account are shown either in trading account (in case of non-corporate entities) or in profit and
loss account (in case of corporate entities).
The procedure of preparation of Trading Account, Profit and Loss Account and Balance Sheet
have already been explained in Unit 1 of this chapter. Students should refer the earlier unit for
attempting the problems based on the preparation of complete set of final accounts of a sole
proprietor.
Illustration 2
Mr. Vimal runs a factory which produces toilet soaps. Following details were available in
respect of his manufacturing activities for the year ended on 31.3.2009:
Opening Work-in-Process (10,000 units) 16,000
Closing Work-in-Process (12,000 units) 20,000
Opening Stock of Raw Materials 1,70,000
Closing Stock of Raw Materials 1,90,000
Purchases 8,20,000
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FUNDAMENTALS OF ACCOUNTING
6.49
Hire charges of machine @ Re. 0.60 per unit manufactured
Hire charges of factory 2,20,000
Direct wages-Contracted @ Re. 0.80 per unit manufactured and
@ Re. 0.40 per unit of Closing W.I.P.
Repairs and Maintenance 1,80,000
Units produced 5,00,000 units
You are required to prepare a Manufacturing Account of Mr. Vimal for the year ended 31.3.2009.
Solution
In the Books of Mr. Vimal
Manufacturing Account for the Year ended 30.6.2009
Dr. Cr.
Particulars Units Amount Particulars Units Amount
Rs. Rs.
To Opening Work- 10,000 16,000 By Closing Work- 12,000 20,000
in-Process in-Process
To Raw Materials Trading A/c 5,00,000 19,00,800
Consumed: transfer of
manufacturing
Opening 1,70,000 cost @ Rs. 4.00
Stock per unit
Add:
Purchases 8,20,000
9,90,000
Less: Closing
Stock 1,90,000 8,00,000
To Direct Wages
W.N.(1) 4,04,800
To Direct
expenses:
Hire charges
on Machinery
W.N. (3) 3,00,000
To Indirect
expenses:
Hire charges
of Factory
Shed 2,20,000
Repairs &
Maintenance 1,80,000
19,20,800 19,20,800
Copyright -The Institute of Chartered Accountants of India
FINAL ACCOUNTS OF MANUFACTURING ENTITIES
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COMMON PROFICIENCY TEST
Working Notes :
(1) Direct Wages 5,00,000 units @ Rs. 0.80 = Rs. 4,00,000
12,000 units @ Rs. 0.40 = Rs. 4,800
Rs. 4,04,800
(3) Hire charges on Machinery 5,00,000 units @ Re. 0.60 = Rs. 3,00,000
Illustration 3
Mr. Pankaj runs a factory which produces motor spares of export quality. The following details
were obtained about his manufacturing expenses for the year ended on 31.3.2009.
Rs.
W.I.P. - Opening 3,90,000
- Closing 5,07,000
Raw Materials - Purchases 12,10,000
- Opening 3,02,000
- Closing 3,10,000
- Returned 18,000
- Indirect material 16,000
Wages - direct 2,10,000
- indirect 48,000
Direct expenses - Royalty on production 1,30,000
- Repairs and maintenance 2,30,000
- Depreciation on factory shed 40,000
- Depreciation on plant & machinery 60,000
By-product at
selling price 20,000
You are required to prepare Manufacturing Account of Mr. Pankaj for the year ended on
31.3.2009.
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FUNDAMENTALS OF ACCOUNTING
6.51
Solution
In the Books of Mr. Pankaj
Manufacturing Account
for the year ended on 31.3.2009
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs. Rs.
To Opening W.I.P. 3,90,000 By Closing W-I-P 5,07,000
To Raw Material Consumed: By By - products 20,000
Opening Stock 3,02,000 By Trading A/c- 17,81,000
Purchases 12,10,000 Cost of
finished goods
15,12,000 transferred
Less: Return 18,000
14,94,000
Less: Closing Stock 3,10,000 11,84,000
To Direct Wages 2,10,000
To Direct expenses:
Royalty 1,30,000
To Manufacturing Overhead:
Indirect Material 16,000
Indirect Wages 48,000
Repairs & Maintenance 2,30,000
Depreciation on
Factory Shed 40,000
Depreciation on Plant &
Machinery 60,000 3,94,000
23,08,000 23,08,000
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FINAL ACCOUNTS OF MANUFACTURING ENTITIES
6.52
COMMON PROFICIENCY TEST
SELF EXAMINATION QUESTIONS
Pick up the correct answer from the given choices:
1. The balance of the petty cash is
(a) an expense (b) an income (c) an asset (d) a liability
2. Fixed assets are
(a) kept in the business for use over a long time for earning income
(b) meant for resale
(c) meant for conversion into cash as quickly as possible
(d) All of the above
3. Goodwill is
(a) a current asset (b) an intangible fixed asset
(c) a tangible fixed asset (d) an investment.
4. Stock is
(a) included in the category of fixed assets
(b) an investment.
(c) a part of current assets
(d) an intangible fixed asset.
5. The manufacturing account is prepared:
(a) to ascertain the profit or loss on the goods produced
(b) to ascertain the cost of the manufactured goods
(c) to show the sale proceeds from the goods produced during the year
(d) both (b) and (c).
6. A new firm commenced business on 1st January, 2009 and purchased goods costing
Rs. 90,000 during the year. A sum of Rs. 6,000 was spent on freight inwards. At the
end of the year the cost of goods still unsold was Rs. 12,000. Sales during the year
Rs. 1,20,000. What is the gross profit earned by the firm?
(a) Rs. 36,000 (b) Rs. 30,000 (c) Rs. 42,000 (d) Rs. 38,000
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FUNDAMENTALS OF ACCOUNTING
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7. From the following figures ascertain the gross profit:
Rs.
Opening stock (1.1.2009) 25,000
Goods purchased during 2009 1,30,000
Freight and packing on above 5,000
Closing Stock (31.12.2009) 15,000
Sales 1,90,000
Selling expenses on sales 9,000
(a) Rs.36,000 (b) Rs. 45,000 (c) Rs. 50,000 (d) Rs.59,000
8. A prepayment of insurance premium will appear in the Balance Sheet and in the Insurance
Account respectively as:
(a) a liability and a debit balance. (b) an asset and a debit balance.
(c) an asset and a credit balance. (d) None of the above
9. Under-statement of closing work in progress in the period will
(a) Understate cost of goods manufactured in that period.
(b) Overstate current assets.
(c) Overstate gross profit from sales in that period.
(d) Understate net income in that period.
10. If sales revenues are Rs. 4,00,000; cost of goods sold is Rs. 3,10,000 and operating expenses
are Rs.60,000, the gross profit is
(a) Rs. 30,000. (b) Rs. 90,000. (c) Rs. 3,40,000. (d) Rs. 60,000
11. Sales is equal to
(a) Cost of goods sold Gross profit. (b) Cost of goods sold + Gross profit.
(c) Gross profit Cost of goods sold. (d) Cost of goods sold + Net profit.
12. A Company wishes to earn a 20% profit margin on selling price. Which of the following is
the profit mark up on cost, which will achieve the required profit margin?
(a) 33% (b) 25% (c) 20% (d) None of the above
13. If sales is Rs. 2,000 and the rate of gross profit on cost of goods sold is 25%, then the cost of
goods sold will be
(a) Rs. 2,000. (b) Rs. 1,500. (c) Rs. 1,600. (d) None of the above.
14. Sales for the year ended 31st March, 2009 amounted to Rs. 10,00,000. Sales included
goods sold to Mr. A for Rs. 50,000 at a profit of 20% on cost. Such goods are still lying in
the godown at the buyers risk. Therefore, such goods should be treated as part of
(a) Sales. (b) Closing stock. (c) Goods in transit. (d) Sales return.
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FINAL ACCOUNTS OF MANUFACTURING ENTITIES
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COMMON PROFICIENCY TEST
15. The capital of a sole trader would change as a result of:
(a) a creditor being paid his account by cheque.
(b) raw materials being purchased on credit.
(c) fixed assets being purchased on credit.
(d) wages being paid in cash.
16. Rent paid on 1
st
October, 2008 for the year to 30 September, 2009 was Rs. 1,200 and
rent paid on 1
st
October, 2009 for the year to 30 September, 2010 was Rs. 1,600. Rent
payable, as shown in the profit and loss account for the year ended 31 December 2009,
would be:
(a) Rs. 1,200. (b) Rs. 1,600. (c) Rs. 1,300. (d) Rs. 1,500.
17. A decrease in the provision for doubtful debts would result in:
(a) an increase in liabilities. (b) a decrease in working capital.
(c) a decrease in net profit. (d) an increase in net profit.
From the given information, choose the most appropriate answer for Questions 18, 19 & 20:
Sales Opening Purchases Closing Cost of Gross Selling Net
Stock Stock goods sold Profit Expenses Profit
Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs.
15,000 6,000 10,000 ? 9,000 ? 4,000 ?
18. The value of closing stock is
(a) Rs. 9,000 (b) Rs.4,000 (c) Rs.8,000 (d) Rs. 7,000
19. Gross profit will be
(a) Rs. 6,000 (b) Rs. 5,000 (c) Rs.8,000 (d) Rs. 7,000
20. Net profit will be
(a) Rs. 6,000 (b) Rs. 5,000 (c) Rs. 2,000 (d) Rs. 7,000
From the given information, choose the most appropriate answer for Questions 21 and 22:
Opening Investment Capital at the Net Profit
Capital By Proprietor Drawings end of the year (Loss)
Rs. Rs. Rs. Rs. Rs.
16,000 Nil 3,000 13,500 ?
21. The net profit will be
(a) Rs. 600 (b) Rs. 500 (c) Rs. 550 (d) Rs. 700
22. If in the given information, Net Loss is Rs. 1,000, then the investment made by the proprietor
during the year will be
(a) Rs.1,500 (b) Rs. 2,000 (c) Rs. 1,200 (d) Rs. 1,700
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FUNDAMENTALS OF ACCOUNTING
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From the given information, choose the most appropriate answer for Questions 23 and 24:
Rs. Rs.
Opening Stock 20,000 Carriage on sales 3,000
Closing Stock 18,000 Rent of Office 5,000
Purchases 85,800 Sales 1,40,700
Carriage on purchases 2,300
23. Gross profit will be
(a) Rs. 50,000 (b) Rs. 47,600 (c) Rs. 42,600 (d) Rs. 50,600
24. Net profit will be
(a) Rs. 42,600 (b) Rs. 50,600 (c) Rs. 45,600 (d) Rs. 47,600
From the given information, choose the most appropriate answer for Questions 25 and 26:
The Zed Company, a whole seller estimates the following sales for the indicated months:
June July August
2009 2009 2009
Rs. Rs. Rs.
Opening stock 4,08,000 4,34,400 4,60,800
Credit Sales 15,00,000 16,00,000 17,00,000
Cash Sales 2,00,000 2,10,000 2,20,000
Total Sales 17,00,000 18,10,000 19,20,000
Selling price is 125% of the purchase price.
25. The cost of goods sold for the month of June, 2009 is:
(a) Rs. 15,20,000 (b) Rs. 14,02,500 (c) Rs. 12,75,000 (d) Rs. 13,60,000
26. Stock purchased in July, 2006 is :
(a) Rs. 16,05,000 (b) Rs. 14,74,400 (c) Rs. 14,40,000 (d) Rs. 13,82,500
Considering the following information answer the Questions 27, 28 and 29 given below:
1st January 31st December
Rs. Rs.
Stock of raw materials 17,400 18,100
Work-in-progress 11,200 11,400
Stock of finished goods 41,500 40,700
During the year manufacturing overhead expenses amounted Rs. 61,100, manufacturing
wages Rs. 40,400 and purchase of raw materials Rs. 91,900. There were no other direct
expenses.
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FINAL ACCOUNTS OF MANUFACTURING ENTITIES
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COMMON PROFICIENCY TEST
27. The cost of raw materials consumed, issued and used were:
(a) Rs. 1,09,300 (b) Rs. 91,200 (c) Rs. 91,900 (d) Rs. 92,600.
28. The manufacturing cost of finished goods produced were:
(a) Rs. 1,31,600 (b) Rs. 1,93,300 (c) Rs. 1,91,900 (d) Rs. 1,92,500.
29. The manufacturing cost of finished goods sold was:
(a) Rs. 1,91,700 (b) Rs. 1,92,500 (c) Rs. 1,94,000 (d) Rs. 1,93,300.
30. Capital is the difference between
(a) Income and expenses
(b) Sales and Cost of goods sold
(c) Assets and liabilities
(d) None of the above
ANSWERS
1. (c) 2. (a) 3. (b) 4. (c) 5. (b) 6. (a) 7. (b)
8. (c) 9. (d) 10. (b) 11. (b) 12. (b) 13. (c) 14. (a)
15. (d) 16. (c) 17. (d) 18. (d) 19. (a) 20. (c) 21. (b)
22. (a) 23. (d) 24. (a) 25. (d) 26. (b) 27. (b) 28. (d)
29. (d) 30. (c)
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