Financial Accounting
Final Accounts of a Business Organisation (Sole Proprietorship)
Part A: Discussion of basic theories in regard to –
1. The mechanics of finalisation of
accounts of a trading concern at the end of the accounting period;
2. The formats of Manufacturing A/c,
Trading A/c, Profit and Loss A/c and Balance Sheet; and
3. The necessary adjustments to be taken
into consideration and made at the time of finalisation of accounts.
Part B: Three Illustrations with Solutions
At the end of each accounting period (which is usually one year) a business enterprise prepares its Final Accounts. For a manufacturing concern final accounts comprise:
1. Manufacturing Account,
2.
Trading Account,
3.
Profit and Loss Account, and
4.
Balance Sheet.
On the other hand, for a trading concern final accounts comprise:
2.
Profit and Loss Account, and
3.
Balance Sheet.
Manufacturing Account
Manufacturing accounts are
prepared by the manufacturing concerns to determine the cost of goods
manufactured during the accounting period. At the end of the accounting period when
accounts are finalised cost of finished goods manufactured is transferred from
the Manufacturing Account to the Trading Account.
Click here for Format of Manufacturing Account
Trading Account
Trading account is prepared
by a business enterprise to know the gross profit it made during the accounting
period.
1. Gross Profit = Sales – Cost of Goods Sold
2. Cost of Goods Sold = Opening stock of finished
goods + Cost of finished goods manufactured during the accounting year /
Purchases of finished goods during the accounting year + All Direct Expenses
incurred during the accounting period – Abnormal loss of finished goods during the
accounting year (if any) – Closing stock of finished goods
3. Direct Expenses = All expenses incurred in
connection with production / manufacture of finished goods or purchase of
finished goods before the finished goods are ready to be sold in the market.
Examples of direct expenses are:
(a)
Carriage inwards,
(b)
Freight inwards,
(c)
Import duty,
(d)
Direct wages,
(e)
Manufacturing expenses,
(f)
Fuel and Power, etc.
Important notes:
1.
In many manufacturing concerns where they have
their full-fledged Cost Accounting Departments a separate Manufacturing Account
is not prepared in the process of period ending finalisation of accounts as a
part of financial accounting system. These concerns usually merge the
Manufacturing Account and the Trading Account and prepare only the Trading
Account to determine the Gross Profit made by them during the accounting period
for which the Trading Account is prepared. In such cases the cost of goods
manufactured during the accounting period is determined by the Cost Accounting
Department.
2.
In examinations, if Manufacturing Account is not
asked to be prepared even in problems involving finalisation of accounts of a
manufacturing concern, the Manufacturing Account and the Trading Account may be
merged and only the Trading Account may be prepared to determine the Gross
Profit made during the accounting period for which the Trading Account is
prepared.
Profit and Loss Account
Profit and loss account is
prepared by a business enterprise to know the net profit it made during the
accounting period.
1.
Net Profit = Gross Profit + Non-Operating
incomes – Non-Operating expenses – Other indirect expenses
2.
Non-Operating incomes = Example of non-operating
incomes: Interest income, dividend income, profit on sale of fixed assets,
discount received, commission received, etc.
3.
Non-Operating expenses = Examples of
non-operating expenses: Goodwill written off, loss on sale of fixed assets,
loss on sale of investments, etc.
4.
Indirect Expenses = All expenses which are not
directly connected with production / manufacture of finished goods or purchase
of finished goods are known as indirect expenses. Examples of indirect expenses
are:
(a)
Carriage outwards,
(b)
Freight outwards,
(c)
Office salaries,
(d)
Rates and taxes,
(e)
Discount allowed,
(f)
Bad debts,
(g)
Travelling expenses,
(h)
Conveyance expenses,
(i)
Delivery expenses,
(j)
Commission on sales paid,
(k)
Depreciation of office building,
(l)
Depreciation of office furniture,
(m) Printing and stationery
expenses,
(n)
Telephone expenses, etc.
Balance Sheet
Balance sheet is prepared
by the business enterprise to know the position of the business in terms of
owners’ equity and assets and liabilities of the business on the date of the
balance sheet. Thus, a balance sheet is a statement of financial position of
the business as on the day it is prepared. A balance sheet is prepared usually at
the end of each accounting period.
Click here for Format of Balance Sheet
Some common adjustments
1. Expenses incurred during the current year, but not yet paid by the end
of the year (Outstanding Expenses):
These expenses, if
appear in the trial balance, will be shown in the liabilities side of
the balance sheet under the head “Current Liabilities”, but if
appear in the adjustments, first will be shown in the profit and loss
account (as an addition to the relevant account head) and then will be shown in
the liabilities side of the balance sheet under the head “Current Liabilities”.
2. Expenses
paid during the current year, but not yet incurred by the end of the year (Prepaid
Expenses):
These expenses, if
appear in the trial balance, will be shown in the assets side of the
balance sheet under the head “Loans and Advances”, but if appear in the adjustments,
first will be shown in the profit and loss account (as a deduction from the
relevant account head) and then will be shown in the assets side of the
balance sheet under the head “Loans and Advances”.
3. Incomes
accrued during the current year, but not yet received by the end of the year
(Accrued Incomes):
These incomes, if
appear in the trial balance, will be shown in the assets side of the
balance sheet under the head “Current Assets”, but if appear in the adjustments,
first will be shown in the profit and loss account (as an addition to the
relevant account head) and then will be shown in the assets side of the balance
sheet under the head “Current Assets”.
4. Incomes
received during the current year, but not yet earned by the end of the year
(Incomes Received in Advance):
These incomes, if
appear in the trial balance, will be shown in the liabilities side of
the balance sheet under the head “Current Liabilities”, but if
appear in the adjustments, first will be shown in the profit and loss
account (as a deduction from the relevant account head) and then will be shown
in the liabilities side of the balance sheet under the head “Current
Liabilities”.
5. Goods
distributed as free samples:
This is one kind of advertisement and usually appears in the adjustments. Therefore, the value of these goods distributed as free samples will be shown in the profit and loss account as “Advertisement Expense” and will be deducted from “Purchase” in the trading account.
6. Income
tax:
For a sole proprietor,
income tax is payable by the owner and not by the business. Therefore, if it appears
in the trial balance, it should be treated as drawings and should be deducted
from capital.
7. Advance
tax:
For a sole proprietor,
advance tax is payable by the owner and not by the business. Therefore, if it appears
in the trial balance, it should be treated as drawings and should be deducted
from capital.
8. Goods
withdrawn from the business by the proprietor:
This is one kind of
drawings by the proprietor from the business and usually appears in the
adjustments. Therefore, the value of these goods withdrawn from the business
will be deducted from “Purchase” in the trading account and from “Capital” in
the balance sheet.
9. Mutual
indebtedness:
When a debtor is also a
creditor for the business, the smaller of the amounts of his debit and credit balances
will be deducted both from “Debtors” and “Creditors” in the balance sheet.
10. Depreciation
on fixed assets:
If appears in trial
balance:
Debit profit and loss
account.
If appears as additional
information:
a) Debit profit and loss account, and
b) (I) add current year’s
depreciation to the opening balance of accumulated depreciation;
(II) Deduct the total
accumulated depreciation from the original cost of the asset in the balance
sheet.
11. Dishonour
of cheque appearing in the adjustments:
The cheque amount will be
added to “Debtors” and deducted from “Cash at Bank” in the balance sheet.
12. Dishonour
of bill appearing in the adjustment:
The bill amount will be
added to “Debtors” and deducted from “Bills Receivable” in the balance sheet.
13. Goods
sent on approval basis appearing in the adjustment:
(a) The
sale price of such goods should be deducted from “Sales” in the trading account
and from “Debtors” in the balance sheet.
(b) The
cost price of such goods should be added to “Closing Stock” both in the trading
account and the balance sheet.
14. Interest on capital:
Profit and loss account (in
case of sole proprietorship business) or profit and loss appropriation account (in
case of partnership business) will be debited for interest on capital and in
the balance sheet interest on capital will be added to “Capital” in the
liabilities asset side.
15. Interest
on drawings:
Profit and loss account (in
case of sole proprietorship business) or profit and loss appropriation account
(in case of partnership business) will be credited for interest on drawings and
in the balance sheet interest on drawings will be deducted from “Capital” in
the liabilities asset side.
16. Closing
stock:
(a) If closing stock is appearing in the trial balance, it will be shown
in the balance sheet only under “Current Assets”.
(b) If closing stock is appearing in the adjustments, it will be shown
in the credit side of trading account and also in the balance sheet under
“Current Assets”.
17. Wages
paid for installation of machinery included in total wages:
Wages paid for installation
of machinery will be added to original cost of machinery in the balance sheet
under “Fixed Assets” and will be deducted from “Wages” in the trading account.
Depreciation on machinery will be calculated on the basis of the original cost
including the wages paid for installation.
18. Provision
for bad and doubtful debts and provision for discount on debtors:
Computation
|
Particulars |
Rs |
|
Sundry debtors as per trial
balance |
××× |
|
LESS: Further bad debt and discount allowed as
per additional adjustments |
××× |
|
(A) |
××× |
|
LESS: Provision for bad
and doubtful debt (new) [A × Given %-age] |
××× |
|
(B) |
××× |
|
LESS: Provision for
discount on debtors (new) [B × Given %-age] |
××× |
|
Amount to be shown in the
balance sheet under current assets as sundry debtors |
××× |
Profit and Loss Account (extract)
[When sum of
bad debt, further bad debt and new P/B/D > old P/B/D]
|
Particulars |
Rs |
Rs |
Particulars |
Rs |
|
To Prov. for B/D/D: |
|
|
|
|
|
Bad Debt (as per TB) |
××× |
|
|
|
|
ADD:
Further bad debt |
××× |
|
|
|
|
ADD:
New Prov. for B/D |
××× |
|
|
|
|
LESS: Old Prov. for B/D (as
per TB) |
××× |
××× |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Profit and Loss Account (extract)
[When sum of
bad debt, further bad debt and new P/B/D < old P/B/D]
|
Particulars |
Rs |
Particulars |
Rs |
Rs |
|
|
|
By Prov. for B/D/D: |
|
|
|
|
|
Old Prov
for B/D (as per TB) |
××× |
|
|
|
|
LESS: Bad
Debt (as per TB) |
××× |
|
|
|
|
LESS:
Further Bad Debt |
××× |
|
|
|
|
LESS: New
Prov. for B/D |
××× |
××× |
|
|
|
|
|
|
|
|
|
|
|
|
19. Manager’s
commission:
Sometimes the manager of a
concern is given a percentage of the net profit as commission. At the time of
finalisation of accounts, this information is, usually, included in “Additional
information” or “Adjustments”. Accordingly, such commission will be debited to
the profit and loss account (just before the net profit) as “Outstanding
manager’s commission” and shown under “Current Liabilities” in the balance
sheet.
Computation of Manager’s
Commission
Case 1: When commission is paid at a fixed percentage
of net profit before charging such commission
Commission = Net profit before such commission × (Rate of
commission ÷ 100)
Case 2: When commission is paid at a fixed percentage
of net profit after charging such commission
Commission = Net profit before such commission × [Rate of
commission ÷ (100 + Rate of commission)]
20. Cash
embezzlement by dishonest employee:
If this adjustment appears
as additional information after the trial balance, the amount embezzled has to
be debited to profit and loss account as “Cash embezzlement” and deducted from
“cash in hand” under “Current Assets” in the balance sheet.
Part B
Financial Accounting
Final Accounts of Sole Proprietor
Selected
Problems and Solutions
Illustration: 1
The
following are the balances of Shri Gupta as on the 30th June, 2015:
|
Debit balances: |
Rs |
|
Cash in hand |
540 |
|
Cash at bank |
2,630 |
|
Purchases |
40,675 |
|
Return inward |
680 |
|
Wages |
8,480 |
|
Fuel and power |
4,730 |
|
Carriage on sales |
3,200 |
|
Carriage on purchases |
2,040 |
|
Stock (1st July, 2014) |
5,760 |
|
Buildings |
22,000 |
|
Freehold land |
10,000 |
|
Machinery |
20,000 |
|
Investments |
10,000 |
|
Patents |
7,500 |
|
Salaries |
15,000 |
|
General expenses |
3,000 |
|
Insurance |
600 |
|
Drawings |
5,245 |
|
Sundry debtors |
14,500 |
|
Credit balances: |
|
|
Sales |
98,780 |
|
Return outward |
500 |
|
Capital |
62,000 |
|
Sundry creditors |
6,300 |
|
Rent |
9,000 |
Taking into account
the following adjustments prepare the Trading and Profit and Loss Account and
Balance Sheet as on 30th June, 2015:
(a) Stock on hand on
30th June, 2015 is Rs 6,800.
(b) Machinery is to be
depreciated at the rate of 10% and patents at the rate of 20%.
(c) Salaries for the
month of June, 2015 amounting to Rs 1,500 were unpaid.
(d) Insurance includes
a premium of Rs 170 on a policy expiring on 31st December 2015.
(e) Bad Debts are Rs
725.
(f)
Rent received in advance Rs 1,000.
(g) Interest on
investment of Rs 2,000 is accrued.
Illustration: 2
Mr. Arvind Kumar has a small business enterprise. He
has given the following trial balance as at 31st March, 2015. You
are required to prepare the final accounts in the books of Mr. Arvind Kumar.
|
Debit balances: |
Rs |
|
Machinery |
36,000 |
|
Depreciation on machinery |
4,000 |
|
Repairs to machinery |
5,200 |
|
Wages |
54,000 |
|
Salaries |
21,000 |
|
Income tax of Mr. Arvind Kumar |
1,000 |
|
Cash in hand |
4,000 |
|
Land and building |
1,49,000 |
|
Depreciation on building |
5,000 |
|
Purchases |
2,50,000 |
|
Accrued income |
3,000 |
|
Bills receivable |
30,000 |
|
Bad debts |
2,000 |
|
Debtors |
70,000 |
|
Opening stock |
74,000 |
|
|
7,08,200 |
|
Credit balances: |
|
|
Mr. Arvind Kumar’s Capital |
1,00,000 |
|
Purchases returns |
3,000 |
|
Sales |
4,98,000 |
|
Citi Bank |
7,600 |
|
Salaries outstanding |
4,000 |
|
Provision for doubtful debts |
10,000 |
|
Bills payable |
16,000 |
|
Discount on purchases |
7,080 |
|
Creditors |
62,520 |
|
|
7,08,200 |
Additional
information:
1.
Stock as on 31st
March 2015 was valued at Rs 60,000;
2. Write off further Rs 6,000
as bad debt and maintain a provision of 5% on doubtful debt;
3. Goods costing Rs 10,000 were
sent on approval basis to a customer for Rs 12,000 on 30th March,
2015. This was recorded as actual sales.
4.
Rs 2,400 paid as rent for
office was debited to Landlord’s Account and was included in debtors.
5. General Manager is to be
given commission at 10% of net profits after charging his commission.
6. Works manager is to be given
a commission at 12% of net profit before charging General Manager’s commission
and his own.
Click here for Solution: 2 in PDF
Illustration: 3
The following Trial Balance has been extracted from
the books of Mr. Agarwal as on 31.03.2013:
|
Debit balances: |
Rs |
|
Purchases |
6,80,000 |
|
Sundry Debtors |
96,000 |
|
Drawings |
36,000 |
|
Bad Debts |
2,000 |
|
Furniture and Fixtures |
81,000 |
|
Office Equipments |
54,000 |
|
Salaries |
24,000 |
|
Advanced Salary |
1,500 |
|
Carriage Inward |
6,500 |
|
Miscellaneous Expenses |
12,000 |
|
Travelling Expenses |
6,500 |
|
Printing and Stationery |
1,500 |
|
Rent |
18,000 |
|
Electricity and Telephone |
6,800 |
|
Cash in hand |
5,900 |
|
Cash at Bank (SBI) |
53,000 |
|
Stock (as on 01.04.2012) |
50,000 |
|
Repairs |
7,500 |
|
Moto car |
56,000 |
|
Depreciation on Furniture |
9,000 |
|
Depreciation on Office Equipments |
6,000 |
|
|
12,13,200 |
|
Credit balances: |
|
|
Sales |
8,38,200 |
|
Capital Account |
1,97,000 |
|
Sundry Creditors |
1,14,000 |
|
Outstanding Salary |
2,500 |
|
Sale of old papers |
1,500 |
|
Bank Overdraft (UBI) |
60,000 |
|
|
12,13,200 |
Additional
Information:
1.
Sales include Rs 60,000
towards goods for cash on account of a joint venture with Mr. Reddy who
incurred Rs 800 as forwarding expenses. The joint venture earned a profit of Rs
15,000 to which Mr. Reddy is entitled to 60%.
2.
The motor car account
represents an old motor car which was replaced on 01.04.2012 by a new motor car
costing Rs 1, 20,000 with an additional cash payment of Rs 40,000 laying
debited to Purchase Account.
3.
UBI has allowed an overdraft
limit against hypothecation of stocks keeping a margin of 20%. The present
balance is the maximum as permitted by the Bank.
4.
Sundry Debtors include Rs
4,000 as due from Mr. Trivedi and Sundry Creditors include Rs 7,000 as payable
to him.
5.
On 31.03.2013 outstanding
rent amounted to Rs 6,000 and you are informed that 50% of the total rent is
attributable towards Agarwal’s
resident.
6.
Depreciation to be provided
on motor car @ 20% (excluding sold item).
Mr.
Agarwal requests you to prepare a Trading and Profit & Loss Account for the
year ended 31.03.2013 and a Balance Sheet as on that date.
Click here for Solution: 3 in PDF
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