Thursday, March 26, 2015

INTRODUCTION TO FINAL ACCOUNT




INTRODUCTION

All business transactions are first recorded in Journal or Subsidiary Books. They are transferred to Ledger and balanced it. The main object of keeping the books of accounts is to ascertain the profit or loss of business and to assess the financial position of the business at the end of the year. The object is better served if the businessman first satisfies himself that the accounts written up during the year are correct or al least arithmetically accurate.

When the transactions are recorded under double entry system, there is a credit for every debit, when on a/c is debited; another a/c is credited with equal amount.

If a Statement is prepared with debit balances on one side and credit balances on the other side, the totals of the two sides will be equal. Such a Statement is called Trial Balance.

DEFINITION

Trial Balance can be defined as “a list of all balances standing in the Ledger Accounts and Cash Book of a concern at any given time.

Advantages:

  1. It is the shortest method of verifying the arithmetical accuracy of entries made in the Ledger. If the Trial balances agree, it is an indication that the Accounts are correctly written up; but it is not a conclusive proof. 
  2. It helps to prepare the Trading A/c, Profit & Loss a/c and Balance Sheet. 
  3. It presents to the businessman consolidated lists of all Ledger Balances. 


Preparation:

There are two methods for preparing the Trial Balance

  • First Method: In this method, Ledger Accounts are not balanced.They are totaled.The debit side totals and the credit side totals are entered in a separate sheet. equal to the grand total of the Credit Column. They are totaled. The debit side totals The grand total of Debit Column will be
  • Second Method: This method is more widely used. In this method, Ledger accounts are balanced. 

Assets, Sundry Debtors, Losses, Expenses and Drawings and debit balances; Capital, abilities,Sundry Creditors, Gains, Incomes and Capital, Revenues are credit balances

SUNDRY DEBTORS

When a trader sells on credit basis, The Buyer’s Account in the Ledger is debited. For each buyer, here is one Ledger a/c. Some of the buyer accounts may be automatically balanced. But it is quite natural that many of these Customer’s Accounts have a debit balances.

When we bring these balances to the Trial Balance, if we are going to write all individual names of customers, then the Trial balance will be too lengthy. Therefore, first a list of Debtors with their individual debit balances are prepared and totaled. Instead of writing the individual names of Debtors, the total is written under the heading “Sundry Debtors” which appears in the Trial Balance.

SUNDRY CREDITORS

There are a number of parties from whom the Trader buys goods on credit basis. For each one of them, an Account is opened in the Ledger. As in the case of Debtors, a List of Creditors with the balances due to them is prepared. In the Trial Balance, instead of writing the individual names of Creditors, the total of the balances of the creditors is written under the heading “Sundry Creditors”

If the Trial Balance agrees, it is an indication that the accounts are correctly written up; but it is not a conclusive proof. If the trial balance disagrees, then the difference amount is generally placed in ‘Suspense Account’

The total amount of debit balances should be equal to the total amount of credit balances. This method is uniformly followed by all

FINAL ACCOUNTS

So far, we have discussed that how the business transactions are recorded in Journal and ledger and how to detect and rectify the errors and how to prepare Trial Balance.

Is quire natural that the businessman is interested in knowing whether his business is running on profit or Loss and also the true financial position of his business. The main aim of Bookkeeping is to inform the Proprietor, about the business progress and the financial position at the right time and in the right way. Preparation of Final accounts is highly possible only after the preparation of Trial Balance.

Trading & Profit and Loss A/c
Balance sheet


  1. Trading and Profit and Loss A/c is prepared to find out Profit or Loss.
  2. Balance Sheet is prepared to find out financial position a if concern.

Trading and P&L A/c and Balance sheet are prepared at the end of the year or at end of the part. So it is called Final Account.

Revenue account of trading concern is divided into two-part i.e.

  1. Trading Account and
  2. Profit and Loss Account.

TRADING ACCOUNT

Trading refers buying and selling of goods. Trading A/c shows the result of buying and selling of goods. This account is prepared to find out the difference between the Selling prices and cost price. If the selling price exceeds the cost price, it will bring Gross Profit. For Example, If the cost price Rs.50,000 worth of goods are sold for Rs.60,000 that will bring in Gross Profit Rs.10,000

If the cost price exceeds the selling price , the result will be Gross loss. For example, if the cost price Rs. 60,000 worth of goods are sold for Rs. 50,000 that will result in Gross Loss of Rs.10,000

Thus the Gross Profit or Gross Loss is indicated in Trading Account.

Items appearing in the Debit side of Trading Account.

  1. Opening Stock: Stock on hand at the commencement of the year or peiod is termed as the opening stock.
  2. Purchases: It indicates total purchases both cash and credit made during the year.
  3. Purchases Returns or Returns out words: Purchases Returns must be subtracted from the total purchases to get the net purchases. Net purchases will be shown in the trading account.
  4. Direct Expenses on Purchases: Some of the Direct Expenses are.


  • Wages: It is also known as Productive wages or Manufactur
  • Carriage or Carriage Inwards
  • Octroi Duty: Duty paid on goods for bringing them within municipal limits.
  • Customs duty, dock dues, Clearing charges, Import duty etc.
  • Fuel, Power, Lighting charges related to production
  • Oil, Grease and Waste.
  • Packing charges: Such expenses are incurred with a view to put the goods in the Saleable Condition.

Items appearing on the credit side of Trading Account.

  1. Sales: Total Sales (Including both cash and credit) made during the year.
  2. Sales Returns or Return Inwards: Sales Returns must be subtracted from the Total Sales to get Net sales. Net Sales will be shown
  3. Closing stock: Generally, Closing stock does not apperar in the Trial Balance. It appears outside the Trial balance. It epresents the value of goods at the end of the trading period.


BALANCING OF TRADING ACCOUNT

The difference between the two sides of the Trading Account indicates either Gross Profit or Gross Loss. If the total on the credit side is more, the difference represents Gross Profit. On the other hand, if the total of the debit side is high, the difference represents Gross Loss. The Gross Profit or Gross Loss is transferred to Profit and Loss A/c.

Closing Entries of Trading A/c:
Trading A/c is a ledger account. Hence, no direct entries should be made in the trading account. Several items such as Purchases, Sales are first recorded in the journal and then posted to the ledger. The same accounts are closed by the transferring them to the trading account. Hence it is called as closing entries.

Advantages of Trading Account

  1. The result of Purchases and Sales can be clearly ascertained
  2. Gross Profit ratio to Sales could also be easily ascertained. It helps to determine Price.
  3. Gross Profit ratio to direct Expenses could also be easily ascertained. And so, unnecessary expenses could be eliminated.
  4. Comparison of trading account details with previous years details help to draw better administrative policies

PROFIT AND LOSS ACCOUNT

Trading account reveals Gross Profit or Gross Loss. Gross Profit is transferred to credit side of Profit and Loss A/c. Gross Loss is transferred to debit side of the Profit Loss Account. Thus Profit and Loss A/c is commenced. This Profit & Loss A/c reveals Net Profit or Net loss at a given time of accounting year

Items appearing on Debit side of the Profit & Loss A/c
The Expenses incurred in a business is divided in too parts. i.e. one is Direct expenses are recorded in trading A/c., and another one is Indirect expenses, which are recorded on the debit side of Profit & Loss A/c. Indirect Expenses are grouped under four heads:

  1. Selling Expenses: All expenses relating to sales such as Carriage outwards, Travelling Expenses, Advertising etc.,
  2. Office Expenses: Expenses incurred on running an office such as Office Salaries, Rent, Tax, Postage, Stationery etc.,
  3. Maintenance Expenses: Maintenance expenses of assets. It includes Repairs and Renewals, Depreciation etc.
  4. Financial Expenses: Interest Paid on loan , Discount allowed etc., are few examples for Financial Expenses.

Item appearing on Credit side of Profit and Loss A/c.
Gross Profit is appeared on the credit side of P & L. A/c. Also other gains and incomes of the business are shown on the credit side. Typical of such gains are items such as interest received,Rent received, Discounts earned, Commission earned. 


BALANCE SHEET

Trading A/c and Profit & Loss A/c reveals G.P. or G.L and N.P or N.L respectively, Besides the Proprietor wants

  • To know the total Assets invested in business
  • To know the Position of owner’s equity
  • To know the liabilities of business.

DEFINITION
The Word ‘Balance Sheet’ is defined as “a Statement which sets out the Assets and Liabilities of a business firm and which serves to ascertain the financial position of the same on any particular date.”

On the left hand side of this statement, the liabilities and capital are shown. On the right hand side, all the assets are shown. Therefore the two sides of the Balance sheet must always be equal. Capital arrives Assets exceeds the liabilities

OBJECTIVES OF BALANCE SHEET

  1. It shows accurate financial position of a firm.
  2. It is a gist of various transactions at a given period.
  3. It clearly indicates, whether the firm has sufficient assents to repay its liabilities.
  4. The accuracy of final accounts is verified by this statement
  5. It shows the profit or Loss arrived through Profit & Loss A/c.

The Balance sheet contains two parts i.e.

  1. Left hand side i.e. the Liabilities
  2. Right hand side i.e. the Assets

ASSETS:
Assets represent everything which a business owns and has money value. Assets are always shown as debit balance in the ledger. Assets are classified as follows.

1. Tangible Assets:
Assets which can be seen and felt by touch are called Tangible Assets. Tangible Assets are classified into two:

  • Fixed Assets: Assets which are durable in nature and used in business over and again are known as Fixed Assets. e.g. land and Building, Machinery, Trucks, etc.
  • Floating Assets or Current Assets: Current Assets are i. Meant to be converted into cash, ii. Meant for resale, iii. Likely to undergo change e.g. Cash, Balance, stock,Sundry Debtors.

2. Intangible Assets: Assets which cannot be seen and has no fixed shape. E.g., goodwill,Patent.
3. Fictitious assets: Assets which have no real value and will appear on the Assets side of B/S. are known as Fictitious assets:
E.g. Preliminary expenses, Discount or creditors.

LIABILITIES:
All that the business owes to others are called Liabilities. It also includes Proprietor’s Capital. They are known as credit balances in ledger.

Classification of Liabilities:

  1. Long Term Liabilities: Liabilities will be redeemed after a long period of time 10 to 15 years E.g. Capital, Long Term Loans.
  2. Current Liabilities: Liabilities, which are redeemed within a year, are called Current Liabilities or short-term liabilities E.g. Trade creditors, B/P, Bank Loan.
  3. Contingent Liabilities: Liabilities, which have the following features, are called contingent liabilities. They are:


  • Not actual liability at present
  • Might become a liability in future on condition that the contemplated event occurs. E.g. Liability in respect of pending suit.

Equation of Balance Sheet:

  • Capital = Assets – Liabilities
  • Liabilities = Assets – Capital
  • Assets = Liabilities + Capital


DIFFERENCE BETWEEN A TRIAL BALANCE AND A BALANCE SHEET

Trial Balance
1. It shows the balances of all ledger accounts.
2. It is prepared after the completion of the ledger accounts or arrival of the balances
3. Its object is to check the arithmetical accuracy
4. Items shown in the Trial balance are not in order
5. It shows the opening stock.
6. It has the headings, debit and credit.

Balance Sheet
1. It shows the balances of personal and real accounts only.
2. It is prepared after the completion of Trading and P&L A/c.
3. Its object is to reveal the financial position of the business.
4. But in the B/S, the items shown must be in order.
5. It shows the closing stock
6. It has the heading of Assets and Liabilities.


Check your Progress - I

1. _________ account enables the trader to find out Gross Profit or Loss
2. _________ account enables the trader to find out the Net Profit or Loss.
3. Direct Expenses appears on ______ side of _________ account.
4. Indirect Expenses appears on _________ side of _____ account.
5. Wages and Salaries appear on __________ account
6. Salaries and wages appear on ________ account.
7. Trade Expenses will appear on __________ side of P & L A/c.
8. If the Trail Balance contains both Trade Expenses and Office Expenses, The Trade Expenses
Posted to _____________ account and office Expenses posted to _______ account.
9. __________ shows the Financial Position of a Trader.
10. Assets – Liabilities = _________
11. Assets – Capital = _____________
12. Capital + Liabilities = _____________

Answers
1. Trading
2. Profit & Loss
3. Debit, Trading
4. Debit, Profit & Loss
5. Trading
6. Profit & Loss
7. Debit
8. Trading, P & L A/c
9. Balance Sheet
10. Capital
11. Liabilities
12. Assets

Check your Progress - II

State whether the following are true or false:
1. Balance Sheet is a ledger A/c
2. Land is an intangible asset
3. Patent is a tangible asset
4. Stock is a floating asset.
5. Bills payable is a long term liabilities

Answers
1. False,
2. False,
3. False,
4. True,
5. False

2 comments:

  1. This is really wonderful and easy to understand introduction buddy. You can also take help from the financial and accounting journals of Dr. Aloke Ghosh. He is really great and above all that he has published articles which are worth reading.

    ReplyDelete
    Replies
    1. Dear Mr.Derine Smith,

      Thank for ur comment and ur valuable advise.

      Regards
      G.S.VASU

      Delete

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