TOPIC:FINANCIAL

STATEMENTS OF
SOLE
PROPRIETORSHIP

FINANCIAL
STATEMENTS

Financial statements are those statements

prepared at the end of the accounting
period to show financial performance and
financial position of the business. These
financial statements are communicated to
the users of the accounting information. A
complete set of financial statements
includes :i. Balance sheet
ii. Profit & loss account
iii. Schedules and notes forming part of

Why are Financial

statements
prepared?

The profit earned

or loss incurred
from the business
operations during
an accounting
period. It is
known from the
profit and loss

The financial
position, by
preparing
the Balance
Sheet

OBJECTIVES
AND
IMPORTANCE
Profit & Loss
Account
Ascertain
Gross
Profit &
Loss

Compariso
n with the
Previous
Years
Profit
Preparing
Balance
Sheet

Ascertain
Net Profit
or Net
Loss
Details of
Indirect
Expenses

Maintaining
Provisions
and
Reserves
Calculatio
n of

Balance
Sheet
Ascertaini
ng
Financial
Position

Analysis of
Industrial
Items

Compariso
n with
Previous
Year

Calculating
Ratios

PROFIT AND LOSS ACCOUNT

Ascertain gross profit or gross loss:-Trading Account provides information
about the gross profit earned or gross loss incurred by the business during
the accounting period.
Ascertain Net Profit or Loss:-The profit and loss account provides
information about the net profit or the net loss earned or suffered by the
business during the accounting period.
Comparison with the Previous Years Profit :-the profit amount ascertained
by the profit and loss account for the accounting period can be compared
with that of the previous years profit.
Details of Indirect Expenses:-All the indirect expenses are shown in the
Profit & Loss Account. These expenses can be compared over the period
and suitable steps may be taken for controlling these expenses.
Preparing Balance Sheet:-It discloses capital at the end of the year.
Maintaining Provisions and Reserves:-to meet future uncertainties and to
strengthen financial position Provisions & Reserves are made.
Calculation of Ratios:-For financial analysis, several ratios are calculated
with the help of information/data provided in the Profit & Loss account. For
example:-Net Profit Ratio, Operating Ratio, Return on Capital Employed,
etc..

BALANCE
SHEET

Ascertaining Financial Position:-Balance sheet is a part of the financial

statements that shows the financial position of the business at a
particular point of time under various heads. If the assets are more
than the outside liabilities, the business is considered to be in sound
financial position.
Comparison with Previous Year:-The amounts under various heads of
Balance Sheet can be compared with that of previous year &
ascertained whether the financial position has improved or worsened
as compared to previous year.
Analysis of Industrial Items:-An analysis of individual items of Balance
Sheet can be carried out to ascertain whether long-terms funds have
been invested in long-term assets, whether the current assets are
realised as stipulated, whether the business has sufficient working
capital, whether appropriate credit period is enjoyed or not etc. .
Calculating Ratios:-The Balance Sheet enables calculation of financial
position ratios such as Debt-equity; current ratio etc.. Ratio analysis
helps analysing over or under investment in fixed assets, working
capital, etc., and in process helps in taking appropriate decisions.

WHO ARE THE USERS

OF FINANCIAL
STATEMENTS?
Internal Users

Owners

Manageme
nt

Employees
and
Workers

External Users

Banks & Financial

Institutions,
Investors & Potential
Investors,
Creditors,
Government & Its
Authorities,
Researchers,
Consumers and,
Public

INTERNAL
USERS

Owners:-They contribute capital in the business and thus are

exposed to maximum risk. Naturally, they are interested in
knowing the profit earned or loss incurred by the business,
besides the safety of their capital. The Financial Statements
give the information about the profits or loss and financial
position.
Management:-The management makes extensive decisions
use of the accounting information to arrive at informed
decisions such as determination of the selling price, cost
controls and reduction, investment into new projects, etc.
Employees and Workers:-They are entitled to bonus at the
year end, which is linked to the profit earned by an
enterprise. Therefore, the employees and workers are
interested in the Financial Statements. Besides, the Financial
Statements also reflect whether the enterprise has
deposited its dues into the Provident Fund and Employees
State Insurance, etc., or not.

EXTERNAL
USERS

Banks & Financial Institutions:-They provide loans to the

businesses.
Investors & Potential Investors:-Investment involves risk & also the
investors do not have direct control over the business affairs.
Creditors:-They are the parties who supply goods and services to
the firm on credit.
Government & Its Authorities:-They make use of the Financial
Statements to compile national income accounts and other
information.
Researchers:-They use accounting information in their research
work.
Consumers:-They need the information for establishing good
accounting control so that the cost of production gets reduced
with the resultant reduction of the prices of the products they buy.
Public:-They want to see the business running since it makes
substantial contribution to the economy in many ways, e.g.,
employment of people, patronage to suppliers, etc.

HOW ARE CAPITAL AND

REVENUE ITEMS
CLASSIFIED?

Capital
expendi
ture

Revenue
expendit
ure

basis

Capital
expenditure

Revenue
expenditure

Purpose

Incurred for acquisition of Incurred for conduct of

fixed assets for use in
business.
business.

Capacity

Increases the earning

capacity of the business.

Incurred for earning

profits.

Period

Its benefit extends to

more than one year.

Its benefit extends to only

one year.

Debited

It is debited to an Asset
Account.

It is debited to an
Expense Account.

Nature Of
Account
Depiction

It is a real account.

It is a nominal account.

Examples

a) Cost of Plant &

Machinery.
b) Cost of Land &
Building.
c) Cost of Furniture &

It is shown in the balance It is a part of the Trading

sheet.
Account.
a) Depreciation on Plant
& Machinery.
b) Rent.
c) Repairs, Insurance.

CONSIDERATION IN
THE DETERMINATION
OF CAPITAL AND
REVENUE
An amount
of payment.
EXPENDITURE
Payment-Periodic or Lump-Sum.
Source of Payment.
Its Nature in the Hands of Recipient

DEFFERED REVENUE
EXPENDITURE
It is that
class of Revenue Expenditure

which is incurred during an accounting

period but the benefit arising out of it
extends beyond that accounting period.
Such an expenditure is unusually large
than the normal expenditure under the
head.
A Deferred Revenue expenditure is a
fictitious asset:- Although it appears on
the assets side of a balance sheet, it is
not an asset.

CAPITAL
RECEIPT

REVENUE
RECEIPT

1. It is the amount realised by sale of

fixed assets or by issue of shares or
debentures or by secured or
unsecured loans taken.

1. It is the amount realised by the

sale of goods or rendering of services.

2. It is an item of Balance Sheet.

2. It is an item of Trading and Profit

and Loss account.

3. Capital Receipts are normally of

non-recurring nature.

3. Revenue Receipts are normally of

recurring nature.

4. Capital Receipts are the receipts

which are not obtained in course of
normal business.

4. Revenue Receipts are obtained in

the course of normal trading
operations.

5. Capital Receipts are normally not

available for payment as profit to the
owner of the business.

5. Revenue Receipts net of revenue

expenses and expired portion of
Capital Expenditure/ Deferred
Revenue Expenditure are available for
distribution to the owner of the
business.

INCOME
STATEMENT

An Income Statement is a summary of the accounts that

affects the profit and loss account of an enterprise. Many
accounts shown in the Trial Balance relate to expenditure
or income. These accounts either increase or decrease the
profit. Accounts that increase the profit are shown on one
side while accounts that decreases the profit, i.e., losses
and expenses are shown on the other side. The statement
so prepared is known as an Income Statement.

An income statement has two

parts, namely,
1.TRADING ACCOUNT:-It reveals gross profit and
gross loss .
2.PROFIT AND LOSS ACCOUNT:-It reveals net
profit or net loss.

TRADING
ACCOUNT
MEANING:Trading Account

is the first stage in the process

of preparing the final accounts.
Trading Account shows the
gross profit or gross loss during
an accounting year. Its main
components are sales, services
rendered on the credit side and
cost of such sales or services

FEATURES OF TRADING
ACCOUNT
It is the first
stage in the
preparation of final accounts
of a trading concern.
It records only net sales and
direct cost of goods sold.
The balance of this account
discloses the gross profit or
gross loss.
The balance of this account is

PURPOSE OF THE
TRADING
The Trading
Account is
ACCOUNT
prepared to know gross
profit or gross loss during
the accounting period. This
account is based on
matching the sales of goods

CONTENTS OF A
TRADING ACCOUNT

ITEMS SHOWN ON THE DEBIT SIDE

OF THE TRADING ACCOUNT ARE AS
FOLLOWS:1. Opening Stock.
2. Purchases Return & Purchases.
3. Direct Expenses.
.

ITEMS SHOWN ON THE CREDIT

SIDE OF THE TRADING ACCOUNT:-

1) Sales &Sales Return Book.

2) Closing Stock.

FORMAT OF A TRADING ACCOUNT

Dr.

Cr.

PARTICUL AM PARTICUL AMT

T.
.
ARS
ARS
To Opening Stock
To Purchases
Less: Return
Outwards
To Wages & Salaries
To Direct Expenses
To Carriage Inwards
To Freight, Octroi
and Cartage A/C
To Gross Profit

By sales
.
Less: Return
Inwards

..

By Scrap Sales

..

By Closing Stock

..

By Gross Loss
transferred to P & L

..

Some
examples:-

Prepare a Trading Account for the year ended 31 st

March,2011. Also show the Closing Entries :Stock(1st April,2010)
10,000
Wages
5,000
Sales (Inclusive of all taxes)
1,70,000
Return Outwards
8,000
Freight
500
Purchases
1,00,000
Carriage Inwards
1,000
Return Inwards
5,000
Sales Tax Paid
15,000
Octroi Duty
2,500

TRADING ACCOUNT
for the year ended 31st march, 2011

Dr.

Cr.
PARTICULA
RS
To Opening Stock
To Purchases A/c
1,00,000
Less: Return Outwards
8,000
To Wages
To Carriage Inwards
To Freight
To Octroi Duty
To Profit & Loss A/c (Gross
Profit)

PARTICULA
RS
10,000
92,000
5,000
1,000
500
2,500
59,000

By Sales A/c
1,70,000
Less: Sales Tax
15,000
1,55,000
Less: Return Inwards
5,000
By Closing Stock

1,50,00
0
20,000

DAT
E
PARTICULARS

L. Dr.
F.

Cr.

2011
March
31

Trading A/c
....Dr.
To Opening Stock A/c
To Purchases A/c
To Return Inwards A/c
To Wages A/c
To Carriage Inwards A/c
To Freight A/c
To Octroi Duty A/c

March
31

Sales A/c
..Dr.
To Sales Tax

March
31

Sales A/c
.....Dr.
Return Outwards A/c
To Trading A/c

March
31

Closing Stock A/c

.....Dr.

1,24,000
10,000
1,00,000
5,000
5,000
1,000
500
2,500
15,000
15,000
1,55,000
8,000
1,63,000
20,000
20,000

SOME POINTS TO
Trading Account
REMEMBER
shows Gross Profit or Gross Loss.
Gross Profit can be presented in the form of an
equation as follows:GROSS PROFIT=Net Sales Cost of Goods Sold
where, (i) Net Sales = Total Sales Sales Return
(ii) Cost of Goods Sold=Opening Stock + Net
Purchases + Direct Expenses Closing Stock
(iii) Net Purchases = Total Purchases
Purchase Return
Gross Profit is usually ascertained by preparing the
trading account.
Carriage Inwards is debited to the Trading Account
and Carriage Outwards to the Profit And Loss
Account.

PROFIT AND LOSS

A Profit and Loss
Account is an account into which
ACCOUNT
all the gains and losses are collected in order to
ascertain the excess of gains and losses or viceversa.

-Prof. Carter
The Profit And Loss Account starts with the credit
from the Trading Account in respect of Gross Profit(or
debit side in case of Gross Loss). Therefore, all
indirect Expenses and Losses are transferred to the
debit side of the Profit And Loss Account. It means all
those Expenses or Losses which have not been
debited or credited to the Trading Account are
debited or credited in the Profit And Loss Account.

FEATURES OF PROFIT AND

LOSS ACCOUNT
1. It is the second stage in the preparation of Final
Accounts.
2. It relates to a particular accounting period and is
prepared at the end of that period.
3. Accrual basis of accounting is followed in the
preparation of this account.
4. This account is credited with the gross profit and
income from other sources and debited with
indirect expenses and losses.
5. The capital of the owner is increased or decreased
by the balance of this A/c (Net Profit and Net Loss).
6. The balance of this account is always net profit or
net loss.

Format of Profit and Loss Account

PARTICULARS
To Gross Loss transferred
from
Trading account
To Salaries
To Rent, Rates & Taxes
To Stationery & Printing
To Postage and Telegrams
To Audit Fees
To Legal Charges
To Telephone Expenses
To Insurance Premium
To Business Promotion
Expenses
To Repairs And Renewals
To Depreciation
To Interest
To Sundry Trade Expense
To Conveyance
To Charity
To Bank Charges

PARTICULARS

...

By Gross Profit Transferred

From
Trading A/C
By Rent
By Discount Received
By Commission Earned
By Interest
By Bad Debts Recovered
By Income From Investment
By Dividends On Shares
By Miscellaneous Revenue
Gains
By Income From Any Other
Source
By Net Loss Transferred To
Capital
A/C

PARTICULAR
S

PARTICULARS
To Office Expense
To Establishment Expense
To General Expense
To Loss In Exchange
To License Fee
To Brokerage
To Car Running In
Maintenance
To Office Lighting
To Loss By Fire, Theft
To Commission
To Advertisement
To Freight And Carriage
Outwards
To Discount Allowed
To Packaging Expenses
To Travelling Expenses
To Distribution Expenses
To Bad Debts
To Net Profit Transferred to

...

...

ITEMS OF PROFIT AND LOSS ACCOUNT

Administration and office management:These include-(i)Establishment Expenses

Or Charges, (ii)Office Salaries, (iii)Office
Rent And Rates, (iv)Lighting, (v)Printing
And Stationery, (vi)postage and
Telephone, (vii)Legal Expenses, (viii)Audit
Fee, And (ix)General Or Trade Expenses.
Selling and Distribution Expenses,
Financial Expenses,
Abnormal Expenses,
Income From Main Business,

BAS
IS

TRADING
ACCOUNT

PROFIT /
LOSS
ACCOUNT

1.Relati
on

Trading Account is a
part of profit and loss
account.

Profit And Loss Account is

the main account.

2.Natur
e

The gross profit or

gross loss is
ascertained from the
trading account.

The Profit And Loss

Account is prepared to
ascertain the Net Profit or
Net Loss of the business.

3.Transf

The balance of the

trading account is
transferred to the profit
and loss account.

The balance of the Profit

And Loss Account is
transferred to the Capital
Account of the proprietor.

er of
balance

Difference B/W Gross Profit

And Net Profit

Gross profit

Gross Profit = Sales Cost

of Goods Sold.
It is ascertained from the
Trading Account.
Gross Profit is transferred
to the Profit and Loss
Account.
It does include any income
from other sources.
It does not depend on the
amount of Net Profit.
Amount of Gross Profit
depends on the valuation
of stock.

Net Profit

Net Profit = Gross Profit +

All other incomes indirect
Expenses & Losses.
It is ascertained from the
Profit and Loss Account.
Net Profit is transferred to
the Capital Account.
It includes income from
other sources.
It depend on the amount of
Gross Profit.
Amount of Net Profit
depends on the valuation
of assets, stock.

Difference B/w Balance Sheet and Trial Balance

BASIS

BALANCE TRIAL
SHEET
BALANCE

1. Purpose

The purpose is to
portray financial
position.

The purpose is to
establish the
arithmetical accuracy
of the book of
accounts.

2.
Information
About Profits

It provides
information as to the
profitability and
financial position of
the firm.

No such information is
possible form the trial
balance.

3. Necessity

It is essential to
prepare a Balance
Sheet to complete the
accounting process.

Though desirable, it
may be possible to
dispense with its
preparation.

4. Headings

The two sides are

headed as assets and

The two columns are

headed as debit and

METHODS OF PRESENTATION OF
FINANCIAL STATEMENTS
Trading Account,
Profit and Loss
Account,
Balance Sheet.

POINT
S TO

 Financial Statements :are organised

summaries of detailed information about the
financial position and performance of an
enterprise. The term Financial statements is
used to denote only two basic statements:
Trading and Profit and Loss account(Income
Statement),
Balance Sheet(Position Statement)
Users of Financial Statements: The
information conveyed through Financial
Statements is used by the management,
present and potential investors, lenders,
short-term creditors, employees, customers,
govt. and its agencies to satisfy their info.
need.

Capital Expenditure: Is the amount spent by an

enterprise on purchase of fixed assets that are
used in the business to earn income and are not
intended for resale. The benefit of Capital
Expenditure extends beyond the financial year.
Revenue Expenditure: Is the amount spent on
running the business. The benefit of Revenue
Expenditure expires within the financial year.
Deferred Revenue Expenditure: Is a revenue
expenditure, the benefit of which extends beyond
an accounting period. Unduly large expenditure on
advertisement, say, to introduce a new product.
Final Accounts: Include (i) Trading, Profit and Loss
Account and (ii) Balance Sheet. Final accounts are
prepared on the basis of a Trial Balance.

Trading Account: Is the account, which shows

the gross profit or gross loss. Its contents are
Revenue Receipts on the credit side and
Revenue Expenditure on the debit side.
Profit and Loss Account: Is the account,
which shows the net profit or the net loss of the
business for an accounting period. It is credited
with gross profit and non-business revenue
income and debited with indirect revenue
expenses.
Balance Sheet: Is a statement, which sets out
the assets and liabilities of a firm or an
institution at a certain date. It is true on that
particular date as every transaction has an
impact on the balance sheet.

Grouping:- It refers to putting items of similar

nature under a common accounting head.
Marshalling:- It refers to arrangement of
assets and liabilities in a particular order in the
balance sheet. Assets may be arranged in the
form of liquidity of permanence.
Contingent Liabilities are the liabilities that
may or may not take place. The liability
becomes payable on happening of a certain
event.
Presentation of Financial Statements:The Trading and Profit and Loss Account and
the Balance Sheet can be presented either in
vertical form or in horizontal form.

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