MODULE - 3

Financial Statement

16
FINANCIAL STATEMENTS : AN
Notes
INTRODUCTION

In the previous lessons you have learnt to record the business transactions in various
books of accounts and their posting into ledger. You have also learnt about balancing
the account and preparing the trial balance. One of the most important purposes of
accounting is to ascertain financial results, i.e., profit or loss of the business operations
of a business enterprise after a certain period and financial position on a particular date.
For this certain financial statements are prepared which are termed as income statement
(i.e. Trading and Profit & Loss Account) to know what the business has earned during
a particular period and the Position Statement (i.e. Balance Sheet) to know the financial
position of the business enterprise on a particular date.
In this lesson you will learn about the financial statements that are prepared by a profit
organisations.

OBJECTIVES
After studying this lesson you will be able to :
z explain the meaning and the objectives of preparing financial statements;
z classify the financial statements into Trading and Profit & Loss Account and Balance
Sheet;
z distinguish between capital expenditure and revenue expenditure, capital receipts
and revenue receipts;
z explain the purpose of preparing Trading Account and Profit and Loss Account;
z draw the format of Trading Account and Profit and Loss Account and
z prepare the Balance Sheet.

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16.1 FINANCIAL STATEMENTS : MEANING AND
OBJECTIVES
When a student has studied for a year, he/she wants to know how much he/she has
learnt during that period. Similarly, every business enterprise wants to know the result
of its activities of a particular period which is generally one year and what is its financial
position on a particular date which is at the end of this period. For this, it prepares
various statements which are called the financial statements.
Notes
Financial statements are the statements that are prepared at the end of the
accounting period, which is generally one year. These include Income Statement
i.e. Trading and Profit & Loss Account and Position statement i.e. Balance
Sheet.
Objectives of preparing Financial Statements
Financial statements are prepared to ascertain the profits earned or losses incurred by
a business concern during a specified period and also to ascertain its financial position
at the end of that specified period.
Financial statements are generally of two types (a) Income Statement which comprises
of Trading Account and Profit & Loss Account, and (b) Position Statement i.e., the
Balance Sheet.
Following are the objectives of preparing financial statements: -
1. Ascertaining the results of business operations : Every businessman wants
to know the results of the business operations of his enterprise during a particular
period in terms of profits earned or losses incurred. Income statement serves this
purpose.
2. Ascertaining the financial position : Financial statements show the financial
position of the business concern on a particular date which is generally the last
date of the accounting period. Position statement i.e. Balance Sheet is prepared
for this purpose.
3. Source of information : Financial statements constitute an important source of
information regarding finance of a business unit which helps the finance manager
to plan the financial activities of the business and making proper utilisation of the
funds.
4. Helps in managerial decision making : The Manager can make comparative
study of the profitability of the concern by comparing the results of the current
year with the results of the previous years and make his/her managerial decisions
accordingly.

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Financial Statement
5. An index of solvency of the concern : Financial statements also show the short
term as well as long term solvency of the concern. This helps the business enterprise
in borrowing money from bank and other financial institutions and/or buying goods
on credit.
Importance of Financial Statements
i. Pertaining to Finance : The term “financial statement” doesn’t make sense at
first. Numbers are for counting while statements need words, so how could these
Notes
two mix together? But when seen as “money statements,” then suddenly it’s a
crucially important matter.
ii. Facilitate in Decision Making : Not only is it important for you, but for the
management and stockholders as well. It’s important for the management because
financial statements speak of the company’s success and competence, whereas
stockholders refer to financial statements to know whether or not to invest in a
company. In other words, financial statements tell whether the company made or
lost money.
iii. Showing the Operational Performance : Financial statement hold the secrets
of a company. Aside from stating whether the company earns or loses money,
they also provide clues on where the mangement might find more resources to
boost its revenue. In addition, financial statements reveal a company’s past
performance and potential.
Capital Expenditure and Revenue Expenditure, Capital Receipts and Revenue
Receipts
The preparation of Trading Account and Profit and Loss Account requires the knowledge
of revenue expenditure, revenue receipts and capital expenditure and capital receipts.
The knowledge shall facilitate the classification of revenue items and put them in the
Trading account and Profit and Loss Account on one hand and prepare Balance Sheet
based on capital items (expenditure as well as receipts) on the other hand.
Capital Expenditure refers to the expenditure incurred for acquiring fixed assets or
assets which increase the earning capacity of the business. The benefits of capital
expenditure to the firm extend to number of years. Examples of capital expenditure are
expenditure incurred for acquiring a fixed asset such as building, plant and machinery
etc.
Revenue expenditure, on the other hand, is an expenditure incurred in the course of
normal business transactions of a concern and its benefits are availed of during the
same accounting year. Salaries, carriage etc. are examples of revenue expenditure.

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There is another category of expenditure called deferred revenue expenditure. These
are the expenses incurred during one accounting year but benefits from the same are
available wholly or in part in future periods also. These expenditures are otherwise of a
revenue nature. Example of deferred revenue expenditure are heavy expenditure on
advertisement say for introducing a new product in the market, expenditure incurred
on research and development, etc.

Notes Difference between Capital Expenditure and

Revenue Expenditure

Basis of Capital Revenue

Difference Expenditure Expenditure

1. Purpose It is incurred for It is incurred for the

acquiring fixed assets. maintenance of fixed assets.

2. Earning It increases the earning It helps in maintaining

capacity capacity of the business. the earning capacity
of the business intact.

3. Periodicity Its benefits are spread Its benefits accrue only in

of benefit over a number of years. one accounting year.

4. Placement in It is an item of Balance It is an item of Trading

financial Sheet and is shown as and Profit and Loss
statements an item of asset. Account and is shown
on the debit side of
either of the two.

5. Occurrence of It is non-recurring It is usually a recurring

expenditure in nature. expenditure.

Capital and Revenue Receipts

Capital receipts are receipts which do not arise out of normal course of business.
Examples of such receipts are sale of fixed assets, and raising of loans etc. Such receipts
are not treated as income of the enterprise.

Revenue receipts are receipts which arise during the normal course of business, Sale of
goods, rent from tenants, dividend received, etc. are some of the examples of revenue
receipts. They are the items of incomes of the business entity.

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Distinction between Capital Receipts and Revenue Receipts
Basis of Capital Receipt Revenue Receipt
Difference

Source Receipts that do not arise during Receipts that arise during the
the normal course of business. normal course of business.

Nature These are of capital nature and These are of revenue nature and
hence are not treated as items hence are treated as items of Notes
of income of the business. income of the business.

Occurrence These are of non-recurring These are recurring in nature.

in nature.

INTEXT QUESTIONS 16.1

I. Classify the following items of expenditure into capital expenditure revenue
expenditure and deferred revenue expenditure

(i) Amount spent on purchase of machine.

(ii) Expenditure incurred on repairs of building.

(iii) Heavy expenditure on advertisement to introduce a new product in the market.

(iv) Purchase of motor vehicle for business use.

II. One important objective of financial statements is to ascertain the results

of business operations. List the other objectives of the financial statements:
(a) ...........................................................................................................

(b) ...........................................................................................................

(c) ...........................................................................................................

(d) ...........................................................................................................

16.2 TRADING ACCOUNT

Income statement consists of Trading and Profit and Loss Account. Let us, first study
the Trading Account. A business firm either purchases goods from others and sells
them or manufactures and sells them to earn profit. These are known as trading activities.
A statement is prepared to know the results in terms of profit or loss of these activities.
This statement is called Trading Account.

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Trading Account is prepared to ascertain the results of the trading activities of the
business enterprise. It shows whether the selling of goods purchased or manufactured
has earned profit or incurred loss for the business unit. Cost of goods sold is subtracted
from the net sales of the business of that accounting year. In case the total sales value
exceeds the cost of goods sold, the difference is called Gross Profit. On the other
hand, if the cost of goods sold exceeds the total net sales, the difference is Gross Loss.
All accounts related to cost of goods sold such as opening stock, net purchases i.e.
purchase less returns outward, direct expenses such as wages, carriage inward etc.
Notes and closing stock with net sales (i.e. Sales minus Sales returns) are posted to the
Trading Account. Then this account is balanced. Credit balance shows the gross profit
and debit balance shows the gross loss.
It is necessary to understand the meaning of cost of goods sold before preparing Trading
Account.
Cost of goods sold and gross profit
A business enterprise either purchases goods or manufactures goods to sell in the
market. Cost of goods sold is computed to know the profit earned (Gross Profit) or
loss incurred (Gross Loss) from the trading activities of a business unit for a particular
period.
Cost of goods sold = the amount of goods purchased + expenses incurred in bringing
the goods to the place of sale or expenses incurred on manufacturing the goods (called
direct expenses).
In case there is a stock of goods to be sold in the beginning of the year or at the end of
the year, the cost of goods is calculated as follows :
Cost of goods sold = Opening stock + Net purchases + All direct expenses – Closing
stock
Gross Profit = Net sales – Cost of goods sold
Illustration 1
Calculate the cost of goods sold from the following information :
`
Opening stock 10000
Closing stock 8000
Purchases 80000
Carriage on purchases 2000
Wages 6600

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Financial Statement
Solution :
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses
(Carriage on Purchases + Wages) – Closing Stock
= ` [10,000 + 80,000 + 86,00
(i.e. 2,000 + 6,600) – 8,000]
= ` 90600
Illustration 2 Notes

Calculate cost of goods sold and gross profit from the following information.
Sales ` 62500
Sales Returns ` 500
Opening Stock ` 6400
Purchases ` 32000
Direct Expenses ` 4200
Closing Stock ` 7200
Solution :
`
Net sales
(Sales-Sales Returns i.e. 62500 – 500) 62000
Less : Cost of goods sold
Opening Stock 6400
Add Purchases 32000
Add Direct Expenses 4200
Less : Closing Stock (7200) 35400
Gross Profit 26600
Or Gross profit = Net sales – cost of goods sold
= 62000 – 35400 = 26600
Illustration 3
From the following information for the year ending 31st March, 2014 furnished by Mr.
Vikram, a trader, calculate cost of goods sold and also calculate Gross Profit/Gross
Loss of business.

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Financial Statement
`
Sales 1,20,000
Purchases 80,000
Octroi 1,600
Carriage on purchases 4,500

Notes Purchase Returns 2,400

Opening Stock 27,600
Closing Stock 32,400
Solution :
`
Cost of goods sold :
Opening stock 27,600
Add Net Purchases
(` 80,000 – ` 2,400) 77,600
Add carriage on Purchases 4,500
Add Octroi 1,600
Cost of goods available for sale 1,11,300
Less closing stock 32,400
Cost of goods sold 78,900
Gross Profit : `
Sales 1,20,000
Less : Cost of goods Sold 78,900
Gross Profit 41,100
Need of Trading Account
Trading Account serves the following purposes :
1. Knowledge of Gross Profit : Trading Account gives information about Gross
Profit. It is the profit earned by a business enterprise from its trading activities.
The percentage of gross profit on sales reflects the degree of success of business.

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2. Knowledge of All Direct Expenses : All direct expenses are debited to trading
Account. Direct expenses are the expenses that can be directly attributed to
purchase or manufacturing of goods for sale. Percentage of Direct expenses on
sales of current year when compared with the same of previous years, helps the
manager to exercise control over direct expenses.
3. Precaution against Future Losses : Trading Account, if shows gross loss,
reasons for this loss can be found out and necessary corrective steps can be
taken. Notes
FORMAT OF TRADING ACCOUNT
Trading Account of ..............................
for the year ending …………..
Dr. Cr.
Particulars Amount Particulars Amount
` `
Opening Stock Sales
Purchases Less: Sales Returns
Less Purchase Returns Closing stock
Direct Expenses : Gross loss transferred to
Carriage Inward Profit & Loss Account
Freight
Wages
Fuel & Power
Excise Duty
Factory Rent
Heating & Lighting
Factory Rent & Insurance
Work Managers Salary
Gross Profit transferred
to Profit & Loss Account
Important Items of Trading Account
Important items of Trading account are :

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1. Stock : Stock refers to the goods lying unsold on a particular date. It can be
of two types : (a) Opening stock and (b) Closing stock
(a) Opening Stock : Opening stock refers to the value of goods lying unsold at
the beginning of the accounting year. It is shown on the debit side of the
Trading Account. In the first year of business there is no opening stock.
(b) Closing Stock : It is the value of goods lying unsold at the end of the
accounting year. It is valued at the cost price or market price whichever is
Notes less. It is shown on the credit side of the Trading Account.
2. Purchases : Purchases mean total items purchased for resale during the year.
It can be both in cash and on credit. Purchases are shown on the debit side
of the Trading Account. These are always shown as net purchases i.e. amount
of purchases returned (Purchase returns or return outwards) is deducted from
the total amount of purchases made. Goods received on consignment basis are
never treated as purchases. Similarly, goods received on ‘sale or return’ basis
are never treated as purchases.
3. Sales : Sales refer to the total revenue from sale of goods of the business
enterprise for which the Trading Account is being prepared. It includes both cash
sales and credit sales. These are recorded on the credit side of the Trading
Account. Sales are shown at their net value i.e. sales return or returns inward
is deducted from the total sales. Cash sales plus credit sales minus sales returns
constitute net sales. Goods sent on ‘sale or approval’ are not part of sales until
approval is received.
4. Direct Expenses : Direct expenses are the expenses that can be attributed
directly to the purchase of goods or goods manufactured. These are shown on
the debit side of the Trading Account. These are shown at the amount as shown
in the Trial Balance. For example, wages are recorded on the debit side of
Trading Account at the amount shown in the Trial Balance.
Important Items of Direct Expenses
1. Wages i.e. wages relate to production. If amount under this head includes
wages paid for construction of building or manufacturing of furniture for office
it will be subtracted from the amount of wages.
2. Carriage, Cartage and Freight i.e. amount paid for carriage of goods
purchased for sale or raw material purchased for manufacturing.
3. Other such direct expenses are customs and import duty, packing materials,
gas, electricity water, fuel, oil, gas greese, heating and lighting, factory rent
and insurance and many more such items.

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5. Gross Profit/Gross Loss : It is the excess of net sales revenue over cost of goods
sold. Gross Profit is equal to net sales minus cost of goods sold. If total of the credit
side exceeds the total of debit side, the excess amount is termed as ‘gross profit’
and is shown on the debit side of Trading Account. On the other hand if debit
side is more than the credit side, the difference in amount is called gross loss
and is shown on the credit side of the Trading Account.
Gross Profit = Net Sales – Cost of Goods Sold
Gross Loss = Cost of Goods Sold – Net Sales Notes

INTEXT QUESTIONS 16.1

I. Fill in the blanks with suitable word/words :
1. Financial statements are generally of .......……. Types.
2. Income statement comprises of .......….. A/c and ......……. A/c.
3. Trading Account is prepared to ascertain the .......……. profit of the business.
4. The percentage of gross profit on sales reflects the degree of .......……. of
business.
II. Show the result in the following cases
(a) Sales – sales return = ..............................
(b) Purchases – purchases return = ..............................
(c) Total of the credit column of trading account – total of the debit column of
trading account = ..............................
(d) Cost of goods sold – total sales = ..............................
(e) Total of the debt column of trading account - Total of the credit column of
trading account = ..............................

16.3 TRANSFER ENTRIES

Before preparing Trading Account, closing or transfer journal entries are made in the
journal proper of the business enterprise. These journal entries are:
(a) For transferring debit balances
Trading A/c Dr.
To Opening stock
To Purchases

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Financial Statement
To Direct expenses
To Sales returns
(Transfer of balances of opening Stock,
Purchases, direct expenses & Sales Returns)
(b) For transferring credit balances
Sales A/c Dr.
Notes Closing stock A/c Dr.
Purchase Returns A/c Dr.
To Trading A/c
(Transfer of credit balances of Sales,
Closing Stock, Purchase return)
(c) For transferring gross profit
Trading A/c Dr
To Profit & Loss A/c
(Transferring of gross profit)
(d) For transferring gross loss
Profit & Loss A/c Dr.
To Trading A/c
(Transferring of gross loss)
Illustration 4
The ledger balances extracted at the close of a trading year on 31st March, 2014 are
given as follows
Name of the Account Amount (` )
Opening stock 12,000
Purchases 52,000
Sales 74,000
Purchase Returns 2,000
Carriage Inward 800
Wages 4,200
Closing stock 13,500
Pass necessary journal entries in the journal proper.

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Financial Statement
Solution :
Journal
Date Particulars LF Dr Cr
2014 Amount Amount
` `
March 31 Trading A/c Dr 69,000
To Opening stock A/c 12,000 Notes
To Purchases A/c 52,000
To Wages A/c 4,200
To Carriage Inward A/c 800
(Transfer of debit balances
to trading Account)
March 31 Sales A/c Dr 74,000
Purchase Returns A/c Dr 2,000
Closing stock A/c Dr 13,500
To Trading A/c 89,500
(Transfer of credit items to
trading account)
March 31 Trading A/c Dr 20,500
To Profit & Loss A/c 20,500
(Transfer of gross profit to
Profit & Loss Account)
Illustration 5
Following balances have been extracted from the ledger of Rohit & Sons at the close
of the year 2014.
`
Stock (1.1.2014) 21,000
Purchases 1,40,000
Sales 2,24,000
Purchases Returns 8,000

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Financial Statement
Sales Returns 12,000

Wages 15,000

Factory Power 12,000

Stock (31.12.2014) 26,500

Make closing journal entries in the journal proper.

Notes
Solution :

Journal

Date Particulars LF Dr Cr
2014 Amount Amount

Dec. 31 Trading A/c Dr 2,00,000

To Opening stock A/c 21,000

To Purchases A/c 1,40,000

To Sales Returns A/c 12,000

To wages A/c 15,000

To Factory power A/c 12,000

(Closing entry of debit items

transferred to Trading A/c)

Sales A/c Dr 2,24,000

Closing stock A/c Dr 26,500

Purchase Returns A/c Dr 8,000

To Trading A/c 2,58,500

(Transfer of credit balances

to Trading A/c)

Trading A/c Dr 58,500

To Profit & Loss A/c 5,8500

(Transfer of Gross Profit)

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INTEXT QUESTIONS 16.3

Write the “debit” if the items given below are to be placed in debit side of the
Trading A/c and “Credit” if they are placed in the credit side of the Trading
Account.
(i) Closing stock
(ii) Carriage inward Notes

(iii) Sales
(iv) Custom duty

16.4 PROFIT & LOSS ACCOUNT

As stated earlier, income statement consists of two accounts : Trading Account and
Profit & Loss Account. You have seen that Trading account is prepared to ascertain
the gross profit or gross loss of the trading activities of the business. But these are not
the final results of business operations of an enterprise. Apart from direct expenses,
there are indirect expenses also. These may be conveniently divided into office and
administrative expenses, selling and distribution expenses, financial expenses,
depreciation and maintenance charges etc.
Similarly, there can be income from sources other than sales revenue. These may be
interest on investments, discount received from creditors, commission received, etc.
Another account is prepared in which all indirect expenses and revenues from sources
other than sales are presented. This account when balanced shows net profit (or net
loss). This account is termed as Profit and Loss Account. The profit shown by this
account is called ‘net profit’ and if it shows loss it is known as ‘net loss’.
FORMAT OF PROFIT AND LOSS ACCOUNT
Profit and Loss A/c of M/s ................…..
for the year ended ...............
Dr. Cr.
Particulars Amount Particulars Amount
` `
Gross loss b/d; if any — Gross Profit b/d —
Salaries — Discount Received —
Rent, Rates & taxes — Commission Received —
Insurance Premium — Dividend Received —

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Advertising — Interest on Investment —
Commission paid — Rent Received —
Discount Allowed — Net Loss transferred
Repairs & Renewals — to capital account; if any —
Bad Debts —

Notes Establishment charges —

Travelling Expenses —
Bank Charges —
Sales Tax/Value added Tax —
Depreciation on fixed assets —
Net Profit transferred to
Capital Account —
Some important items of Profit and Loss Account
As stated earlier indirect expense are shown on the debit side of Profit and Loss A/c.
These can be classified under the following heads :
Debit Items
1. Selling and Distribution Expenses : To materialise sales, the expenses incurred
are called selling and distribution expenses. Examples are :
Carriage on sales/carriage outwards, advertisement, selling expenses, travelling
expenses and salesman commission, depreciation of delivery van, salary of driver
of the delivery van, etc.
2. Office and Administration Expenses : These are the expenses incurred on
establishment and maintenance of office. Some of the expenses that may be under
this head are: rent, rates and taxes, postage, printing and stationery, insurance,
legal charges, audit fees, office salaries, etc.
3. Financial Expenses : Finances are to be arranged for carrying on business.
Expenses that are incurred in this connection are called financial expenses. Some
of the financial expenses are: interest on loan, interest on capital, discount on bills,
etc.
4. Depreciation and Maintenance Charges : The total value of a fixed asset like
machinery, building, furniture, etc. is not charged to profit and loss account in the
year in which it is purchased. Such assets help running business for a number of

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Financial Statement
years to come. Therefore, only a part of the value of such assets is treated as an
expense and is charged to Profit and Loss A/c as depreciation. Depreciation
means decline in the value of fixed asset due to wear and tear, lapse of time,
obsolescence, etc. Expense incurred on repairs and renewals and maintenance of
assets are expenses other than depreciation under this category.
5. Other Expenses : These are the expenses which are not included under the
above mentioned heads of expenses for example, losses and expenses due to fire,
theft etc. Notes
Credit Items
On the credit side of Profit and Loss Account, items of revenue and incomes are
written. The first item on this side of Profit and Loss Account is the gross profit transferred
from trading account. Other items of the credit side are : Interest on investment, interest
on fixed deposits etc. rent received, commission received, discount received, dividend
on shares received etc.
Need of preparing Profit and Loss Account
Need of preparing profit and loss account by a business concern may be stated as
follows :
(i) To know the net profit or net loss of a business for an accounting year.
(ii) Net profit of one year can be compared with net profits of previous year or years.
It helps in ascertaining whether the business is being conducted efficiently or not.
(iii) Different expenses which are taken to Profit & Loss A/c in one year can be
compared with the amounts incurred in previous year or years. This helps in
ascertaining the need of applying control over such expenses.

INTEXT QUESTIONS 16.4

I. Following are the items of expenditure and income to be taken to Profit
and Loss Account. Write ‘E’ for expenses and ‘I’ for income against each
item.
(i) Interest on Fixed Deposit
(ii) Advertisement
(iii) Insurance Premium
(iv) Discount allowed by creditors
(v) Carriage on sales

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II. State whether the following statements are ‘true or false’. Write true for
true statements and ‘false’ for false statements.
(i) Profit and Loss Account is prepared to ascertain the Gross Profit of a business
unit.
(ii) Items of income are written on the credit side of Profit and Loss Account.
(iii) Net Profit calculated by preparing Profit and Loss Account is transferred to
Notes Trading Account.
(iv) Profit and Loss Account is prepared for an accounting year.

16.5 TRANSFERRING ENTRIES OF PROFIT AND LOSS ACCOUNT

Before preparing Profit and Loss Account as per the format given in the previous
section, closing entries are made in the journal proper of the enterprise. Following
journal entries are made :
(i) For transferring the indirect expense accounts :
Profit & Loss A/c Dr.
To Salaries A/c
To Insurance Premium A/c
To Bad Debts A/c
To Discount Allowed A/c
(Transfer of indirect expenses)
(ii) For transfer of items of incomes and gain
Interest on investment A/c Dr.
Rent Received A/c Dr.
Discount Received A/c Dr
To Profit & Loss A/c
(Transfer of items of income)
(iii) For transferring Net Profit :
Profit & Loss A/c Dr.
To Capital A/c
(Transferring of Net Profit to Capital A/c)

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(iv) For transferring Net Loss
Capital A/c Dr.
To Profit & Loss A/c
(Transfer of Net Loss to Capital Account)
Illustration 6
The following balances were extracted from the books of Maya Gupta & Sons at the Notes
end of March 31, 2014. Make necessary closing entries as on that date:
Items Dr. Cr.
Balance Balance
(` ) (` )
Gross Profit 65,000
Salaries 11,500
Audit fees 400
Insurance Premium 800
Interest received 1,600
Discount (Cr) 460
Advertisement 1,200
Bad Debts 150
Discount Allowed 340
Depreciation 460
Rent from tenants — 1,800
Solution :
Journal Entries
(i) Trading A/c Dr. 65,000
To P&L A/c 65,000
(Gross profit transfered to P&L A/c)
(ii) Profit & Loss A/c Dr. 14850
To Salaries A/c 11500
To Audit Fees A/c 400

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To Insurance Premium A/c 800
To Advertisement A/c 1200
To Bad Debts A/c 150
To Discount Allowed A/c 340
To Depreciation A/c 460
(Transfer of items of expenses to profit & Loss A/c)
Notes
(iii) Interest A/c Dr. 1600
Discount Received A/c Dr. 460
Rent A/c Dr. 1800
To Profit & Loss A/c 3860
(Transfer of items of income to Profit & Loss A/c)
(iv) Profit & Loss A/c Dr. 54010
To Capital A/c 54010
(Transfer of Net Profit to Capital Account)
Illustration 7
The following ledger balances were extracted from the books of Rabina & Brothers at
the end of accounting year 31st March, 2014. Make journal entries to transfer these
balances to prepare Profit & Loss A/c for the year ending 31st March, 2014.
`
Gross Profit 65800
Salaries 8400
Rent paid 2400
Discount allowed 500
Interest on investments 3100
Advertisement 1800
Trading expenses 1600
Bad Debts 500
Depreciation 600
Insurance Premium 800
Commission received 2700

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Solution :
Trading A/c Dr. 65,800
To P & L A/c 65,800
(Gross profit transferring to P&L A/c)

Journal
Date Particulars LF Dr Cr
2014 Amount Amount Notes

March 31 Profit & Loss A/c Dr 16600

To Salaries A/c 8400
To Rent A/c 2400
To Discount allowed A/c 500
To Advertisement A/c 1800
To Trading expenses A/c 1600
To Bad Debts A/c 500
To Depreciation A/c 600
To Insurance Premium A/c 800
(Transfer of indirect expenses
to profit & Loss A/c)
March 31 Commision A/c Dr 2700
Interest A/c Dr 3100
To Profit & Loss A/c 5800
(Transfer of incomes other than
sales to Profit & Loss A/c)
March 31 Profit & Loss A/c Dr 55000
To Capital A/c 55000
(Transfer of net profit to capital A/c)
Operating Profit
Operating profit is the excess of gross profit over operating expenses. Gross Profit is
the excess of net sales revenue over cost of goods sold. Operating expenses includes
office and administration expenses, selling and distribution expenses, cash discount
allowed, interest on bills payable and other short term debt, bad debts and so on. Net
sales means cash sales + credit sales - sales returns.

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 MODULE - 3 Financial Statements : An Introduction
Financial Statement
Operating Profit = Net Sales - Operating Cost
= Net Sales - (Cost of goods sold + administration and
office exp. + Selling and Distribution expenses)
Operating Profit = Net Profit + Non-operating exp. - Non-Operating Income
Illustration 8
Compute Operating profit from the following particular.
Notes
` `
Gross Profit 44,000 Interest on loan 2200
Carriage outward 480 Interest on investment 280
Advertising 1200 Printing and Stationery 360
Salaries 17,800 Loss on Sale of furniture 3,500
Rent & Taxes 6,200 General expenses 140
Lighting 1,500 Donation 510
Insurance charge 240 Rent Received 600
Bad Debts 150 Loss by fire 2,000
Audit fees 200 Gain on sale of machine 5,000
Solution
Computation of Operating Profit
` `
Gross Profit 44,000
Less : Selling and Distribution expenses :
Carriage outward 480
Advertising 1,200
Bad Debts 150 1,830
Less : Office and Administrative Expenses
Salaries 17,800
Rent & Taxes 6,200
Lighting 1,500
Insurance 240
Audit fees 200
Printing & Stationery 360
General expense 140 26,440 (28,270)
Operating Profit 15,730

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 Financial Statements : An Introduction MODULE - 3
Financial Statement
Position Statement/Balance Sheet
Position Statement or Balance Sheet is another financial statement that a business
enterprise prepares. Balance Sheet is a statement prepared on a particular date, generally
at the end of accounting year to ascertain the financial position of the business entity. It
consists of assets on the one hand and liabilities on the other.
In the words of Francis R Steal, “Balance Sheet is a screen picture of the
financial position of a going business at a certain moment.” In the words of
Freeman, “A Balance Sheet is an item wise list of assets, liabilities and Notes
proprietorship of a business at a certain date.”
Financial position of a business is the list of assets owned by the business and the
claims of various parties against these assets. The statement prepared to show the
financial position is termed as Balance Sheet.
In the next lesson we shall discuss Balance Sheet in detail.

INTEXT QUESTIONS 16.5

I. Write ‘debit’ if Profit and Loss Account is to be debited and ‘credit’ if
profit and loss account is to be credited of the following items :
(a) Legal charges (b) Net Loss (c) Rent Received
(d) Discount Allowed (e) Salaries
II. (a) Name the financial statement which is prepared in addition to income statement.
(b) Why it is prepared?
(c) When it is prepared?
(d) Name its two elements.
III. (a) Operating Profit = Net Sales - _______________
(b) Operating Profit = Net Profit + Non-Operating Expenses - __________
(c) If Net Sales = ` 2,00,000 and Operating cost = ` 1,50,000 than calculate
Operating profit.

WHAT YOU HAVE LEARNT

z Financial statements are of two types :
(a) Income Statement i.e. Trading Account and Profit and Loss Account.

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Financial Statement
(b) Position Statement i.e. Balance Sheet.
z Trading Account is prepared to ascertain the results of the trading activities of the
business.
z Trading Account may show profit (i.e. the excess of sales to cost of goods sold or
excess of credit side over debit side), which is termed as Gross Profit.
Trading Account may show loss (i.e. Cost of goods sold exceeds sales or total of
Notes debit side exceeds total of credit side). This is called Gross Loss.
z Profit and Loss Account is prepared to find out Net Profit/Net Loss.
Net Profit = Gross Profit + other incomes – Indirect expenses.
It may also show a net loss.
All indirect expenses are shown on the debit side of Profit & Loss Account.
All incomes and gains are shown on the credit side of Profit & Loss Account.
z Balance Sheet is prepared to ascertain the financial position of a firm on a particular
date.

TERMINAL EXERCISE
1. State the meaning of financial statements.
2. Explain in brief the various objectives of finanacial statements.
3. Explain in brief the following terms with two examples of each :
(a) Revenue expenditure.
(b) Revenue Receipts
(c) Capital expenditure
(d) Capital Receipts
4. Distinguish between capital expenditure and Revenue expenditure on the basis of:
(a) Earning capacity
(b) Placement in financial statements
(c) Occurrence of expenditure
5. Distinguish between capital receipts and revenue receipts.
6. How is cost of goods sold calculated?

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Financial Statement
7. What is Trading Account? Why is it prepared?
8. How is Gross Profit calculated?
9. What is meant by Profit and Loss Account? Why is it prepared?
10. When does Profit and Loss Account show Net Profit?
11. What are direct expenses? Give two examples of such expenses.
12. State the meaning of Balance Sheet.
Notes
13. From the following balances of Sabana calculate Gross Profit or Gross Loss by
subtracting cost of goods sold from sales for the year ended 31st December,
2014
`
Stock (1.1.2014) 26500
Purchases 64600
Sales 86800
Purchases Returns 2600
Sales Returns 1800
Freight inward 750
Wages 1850
Closing Stock 31100
14. From the following balances extracted from the books of Seth Brothers. Pass
journal entries to prepare a Trading Account and Profit and Loss Account for the
year ended 31st March, 2014.
` `
Stock (1.4.2013) 20000 Electric Power 5000
Purchases 95000 Wages 14000
Return Inwards 2000 Selling Commission 5500
Carriage Inwards 1850 Repair & Renewals 2000
Carriage Outwards 1200 General Expenses 8000
Custom duty 3000 Insurance 2200
Return outwards 5000 Stock (31.3.2014) 45000
Sales 165000
Discount Received 1500

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Financial Statement
15. The balances from the books of Parimal Ghosh are given below. Pass journal
entries to prepare Trading and Profit & Loss Account for the year ended 31st
March, 2014
` `
Stock as on 1.4.2013 9480 Purchase Returns 1800
Purchases 50800 Advertising 1500

Notes Wages 1200 Commission (Cr.) 3200

Salaries 3400 Rent from tenant 2800
Octroi 1320 Sales 72000
Rent & Taxes 850 Stock (31.3.2014) 10700
Bad Debts 250
Discount (Dr.) 360
Interest on capital 760
16. From the following information calculate cost of goods sold for the year ending
31st March, 2014
` `
Opening Stock 14800 Factory expenses 7200
Purchases 65700 Closing stock 28400
Returns outward 1700
Wages 12500
Carriage Inward 2400
Custom Duty 3200
Rent paid 4500
Establishment expenses 650
17. From the following balances extracted from the books of Jai Bhagwan & Sons as
on 31st March, 2014. Pass journal entries to prepare Trading A/c and Profits &
Loss A/c
` `
Opening Stock 16000 Rent 3600
Purchases 76000 Office expenses 1600
Machinery 28000 Carriage Inward 1200

70 Accountancy
 Financial Statements : An Introduction MODULE - 3
Financial Statement
Debtors 21600 Sales Returns 5400
Drawings 7200 Credit Balance
Wages 1500 Capital 70000
Bank 12000 Creditors 14000
Depreciaiton 2800 Sales 108000
Closing stock 24000 Purchase Returns 2600
Notes

ANSWERS TO INTEXT QUESTIONS

16.1 I. (i) Capital (ii) Revenue
(iii) Deferred Revenue (iv) Capital
II. (a) Ascertaining the financial position
(b) Source of information
(c) Helps in managerial decision making
(d) An index of the solvency of the concern.
16.2 I. 1. Two 2. Trading and Profit & Loss
3. Gross Profit 4. Success
II. (a) Net sales (b) Net purchases (c) Gross profit
(d) Gross Loss (e) Gross Loss
16.3 (i) Credit (ii) Debit (iii) Credit (iv) Debit
16.4 I. (i) I (ii) E (iii) E (iv) I (v) E
II. (i) F (ii) T (iii) F (iv) T
16.5 I. (a) debit (b) debit (c) Credit (d) debit (e) debit
II. (a) Balance sheet
(b) to show the financial position of the concern
(c) At the end of an accounting year
(d) assets; liabilities
III. (a) Operating Cost (b) Non-operating income
(c) ` 50,000

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Financial Statement

ANSWERS TO TERMINAL EXERCISE

13. Gross Profit : ` 25000
14. Gross Profit : ` 74150 Net Profit : ` 56750
15. Gross Profit : ` 21700 Net Profit : ` 20580
Notes 16. Cost of goods sold : ` 75700
17. Gross Profit : ` 21000 Net Profit : ` 13000

ACTIVITY
Procure trial balance of at least four business concerns and classify the items into :
(a) Revenue expenditure (b) Revenue receipts
(c) Capital expenditure (d) Capital Receipts
Name of Item of Revenue Revenue Capital Capital
organisation expenditure expenditure receipts expenditure Receipts

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 MODULE - 3
Financial Statement

17
FINANCIAL STATEMENTS : I
Notes

You have learnt the meaning of the financial statements and the need to prepare these
statements for the business organisations. You have also learnt the format of these
statements and the important items that are recorded in these statements. You would
now like to learn how to prepare these statements. You know Trial Balance is the basis
of preparation of these statements. Every business organisation prepares two financial
statements i.e. Trading and Profit and Loss A/c and the Balance sheet.
In this lesson you will learn the prepration of these statements.

OBJECTIVES
After studying this lesson you will be able to :
z prepare Trading Account and Profit and Loss Account;
z explain the Balance Sheet as per format;
z appreciate the marshalling of Balance Sheet;
z classify the assets and liabilities and
z prepare Balance Sheet.
17.1 PREPARATION OF TRADING ACCOUNT AND
PROFIT AND LOSS ACCOUNT
You have already learnt the meaning and format of Trading Account and Profit and
Loss Account. You have also learnt how to make journal entries to transfer relevant
ledger balances to Trading Account and Profit and Loss Account. Now, you will learn
the various steps to be followed in preparing these statements.

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Financial Statement
Steps to be followed while preparing Trading Account
A. Debit side
(i) We post the amount of opening stock (In case of a new firm there will not be any
opening stock).
(ii) We post the amount of purchases Out of this, purchases returns or returns outward
is deducted. Purchases may be cash or credit or both.
(iii) Then we post the direct expenses such as carriage inward, wages, power, etc.
Notes
B. Credit side
(i) We post sales. Sales return or returns inward is deducted from the sales to get the
net sales figure. Sales may be cash or credit or both.
(ii) Closing stock is the next item.
C. Ascertaining Gross Profit/Gross Loss
Finally, Trading Account is closed by calculating the difference of the two sides. If
credit side exceeds the debit side, the difference is written as Gross Profit on the debit
side of the Trading A/c. In case debit side is more than the credit side, the difference
amount is termed as ‘Gross Loss’ and is shown on the credit side of the Trading A/c.
Total of Debit column < Total of credit column
⇒ Gross profit
Total of credit column < Total of debit column
⇒ Gross loss
Steps to be followed while preparing Profit and Loss Account
A. Debit side
(i) Gross Loss, if any, transferred from Trading A/c is written as the first item.
(ii) Next all items of revenue expenses and losses are written. These items may be
salaries, rent paid, depreciation, etc.
B. Credit side
1. Gross Profit transferred from Trading A/c is the first item.
2. Next all items of revenue incomes and gains are written. These may be interest on
investments, discount received, commission received, etc.
C. Ascertaining Net Profit/Net Loss
The next step is to get the balance. If credit side is more than the debit side the difference
in amount is shown as Net Profit. If debit side exceeds the credit side, the difference is
Net Loss. This amount is transferred to Capital Account.

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 Financial Statements : I MODULE - 3
Financial Statement
Total of Debit side < Total of credit side
⇒ Net profit
Total of credit side < Total of debit side
⇒ Net loss
Illustration 1
From the following information of M/s Nand Lal & Bros. for the year ending 31st
Notes
March, 2014 prepare Trading A/c and Profit and Loss A/c for the year ended 31st
March, 2014.
` `
Stock 1.4.2013 5,800 Sales 72,000
Purchases - cash 42,000 Return Inward 2,000
Purchases - credit 18,000 Interest on Investment 1,500
Freight Inward 1,800 Discount Received 1,200
Wages 4,500 Closing stock (31.3.2014) 7,200
Carriage on Sales 800
Telephone Charges 1,600
Electricity Expenses 1,200
Office Rent Paid 6,000
Salaries 8,000
Depreciation 1,400
Solution :
Books of M/s Nand Lal & Bros.
Trading A/c
for the year ended 31st March, 2014
Dr. Cr.
Particulars Amount Particulars Amount
` `
Stock (1.4.2013) 5,800 Sales 72,000
Purchases Less: Return Inward 2,000 70,000
Cash 42,000 Closing stock (31.3.2014) 7,200
Credit 18,000 60,000

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 MODULE - 3 Financial Statements : I
Financial Statement
Freight Inward 1,800
Wages 4,500
Gross profit transferred to
Profit and Loss A/c 5,100
77,200 77,200

Profit and Loss A/c

Notes for the year ending 31st March, 2014
Particulars Amount Particulars Amount
(` ) (` )

Carriage on sale 800 Gross Profit transferred

Telephone charges 1,600 from Trading A/c 5,100

Electricity Expenses 1,200 Interest on Investment 1,500

Office Rent 6,000 Discount Received 1,200

Salaries 8,000 Net Loss transferred

Depreciation 1,400 to capital A/c 11,200

19,000 19,000

Illustration 2
Prepare Trading A/c and Profit and Loss A/c of Raman Irani from the following balances
for the year ending 31st March, 2014.
` `

Opening Stock (1.4.2013) 14,600 Trading Expenses 1,450

Purchases 68,700 Discount allowed 1,250

Sales 85,300 Discount Received 800

Return outward 2,200 Bill Receivables 4,500

Carriage Inward 2,100 Debtors 16,800

Capital 50,000 Closing stock (31.3.2014) 28,700

Drawings 12,000

Insurance 1,600

Advertisement 2,400

Salesmen’s Salaries 5,200

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 Financial Statements : I MODULE - 3
Financial Statement
Solution :
Books of Raman Irani
Trading A/c
for the year ending 31st March, 2014
Dr. Cr.
Particulars Amount Particulars Amount
` `
Opening Stock 14,600 Sales 85,300 Notes
Purchases 68,700 Closing stock 28,700
Less Return outward 2,200 66,500
Carriage Inward 2,100
Gross profit transferred to
Profit and Loss A/c 30,800
1,14,000 1,14,000

Profit and Loss A/c

for the year ended 31st March, 2014
Dr. Cr.

Particulars Amount Particulars Amount

(` ) (` )
Insurance 1,600 Gross Profit transferred
Advertisement 2,400 from Trading A/c 30,800
Salesmen’s salaries 5,200 Discount Received 800
Trading Expenses 1,450
Discount allowed 1,250
Net Profit transferred to
capital A/c 19,700
31,600 31,600

INTEXT QUESTIONS 17.1

Write the name of the Account (Trading A/c, Profit & Loss A/c) and the side
(debit/credit) against the items given below to which these are posted:
(i) Closing stock ................ ................
(ii) Carriage outward ................ ................

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 MODULE - 3 Financial Statements : I
Financial Statement
(iii) Interest on Investment ................ ................
(iv) Custom duty . ............... ................
(v) Fuel & Power ................ ................
(vi) Sales ................ ................
(vii) Salaries ................ ................
(viii) Rent from tenant ................ ................
Notes
17.2 BALANCE SHEET
Apart from Trading Account and Profit and Loss Account, Balance Sheet is another
financial statement that is prepared by every business firm. Balance sheet is a statement
which shows the financial position of a business organisation on a particular date which
is generally the last date of the accounting period. Financial position of a business unit
is the amount of claims against the resources of business. These resources are cash,
stock of goods, furniture, machinery, etc. The claims include the claims of the owner
capital and the claims of outsiders such as creditors, bankers, etc. Therefore, it can be
stated that Balance Sheet is the statement which shows assets owned by the business
and liabilities owed by it on a particular date. Balance Sheet is not an account. It has
two sides. (i) Assets side and (ii) the Liabilities side. The Asset side has a list of fixed as
well current assets. The liabilities side has a list of items of capital, long term as well as
short term liabilities.
Need
1. Balance Sheet is prepared to measure the true financial position of a business
entity at a particular point of time.
2. It is a systematic presentation of what a business unit owns and what it owes.
3. Balance Sheet shows the financial position of the concern at a glance.
4. Creditors, financiers are particularly interested in the Balance Sheet of a concern
so that they can decide whether to deal with the concern or not.
Grouping of Assets and Liabilities
All the assets can be categorised in following groups :
1. Current Assets
2. Liquid Assets
3. Non-current Assets
4. Tangible Assets
5. Intangible Assets

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Financial Statement
All the liabilities can be catagorised in two groups :
1. Current Liabilities
2. Non-current Liabilities
Marshalling of Assets and Liabilities
As stated above Balance sheet has two sides i.e. Assets side, which has various items
of assets of the concern and liabilities side which has the liability or claim of the owner
as well as of the outside parties. Notes
Assets refer to the financial resources of the business and can broadly be divided into
Current Assets and Fixed Assets, Liabilities denote claims against the assets of the
business. Liabilities can be of two types owners liability or capital and outsiders liabilities
such as creditors, bills payable, Bank Loan etc.
There is no prescribed form in which a Balance Sheet should be prepared by a sole
proprietary business or a partnership firm. However, an order is generally maintained
in which assets and liabilities are written. This is to maintain uniformity/consistency
which facilitates comparative analysis for decision making. Balance sheet may be
prepared in any of the following orders :
(a) Liquidity order (b) Permanency order
(a) Liquidity Order
Liquidity means convertibility of assets into cash. Every asset cannot be converted into
cash at the same degree of ease and convenience. Assets are written in the order of
their liquidity, Assets of highest liquidity is written first and next highest follows and so
on. Similarly, liabilities are also written in this very order. Short term liabilities are written
first and then long term liabilities and lastly the capital.
A specimen of the balance sheet prepared in order of liquidity is given below:

Balance Sheet of M/s ............

as at .................
Liabilities Amount Assets Amount
` `
Bank overdraft xxxx Cash in hand xxxx
Outstanding Expenses xxxx Cash at bank xxxx
Bill payables xxxx Prepaid expenses xxxx
Sundry creditors xxxx Investments (short term) xxxx
Loans xxxx Bill Receivables xxxx
Capital xxxx Sundry Debtors xxxx
Add Net Profit xxxx Closing stock xxxx

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 MODULE - 3 Financial Statements : I
Financial Statement
Less drawings xxxx Investments xxxx
Furniture xxxx
Plant & Machinery xxxx
Land & Building xxxx
Goodwill xxxx
xxxx xxxx

Notes (Investments on short term basis are marketable securities; they form part of current
assets.)
(b) Permanency order
While following the order of permanency, assets, which are to be used permanently i.e.
for a long time and not meant for resale are presented first. For example, Land and
Building, Plant and Machinery, furniture etc. are written first. Assets which are most
liquid such as cash in hand is written in the last. Order of liabilities is similarly changed.
Capital is written first, then the long term liabilities and lastly the short term liabilities and
provisions. Specimen of a Balance Sheet that can be prepared in the order of permanency
is as follows :
Balance sheet of M/s ..............
as at ................
Liabilities Amount Asset Amount
` `

Capital xxxx Goodwill xxxx

Add : Net profit xxxx Land & Building xxxx

Less : Drawings xxxx xxxx Plant & Machinery xxxx

Loans xxxx Furniture xxxx

Sundry creditors xxxx Investments xxxx

Bills payable xxxx Closing stock xxxx

Outstanding expenses xxxx Sundry Debtors xxxx

Bank overdraft xxxx Bills Receivables xxxx

Investments (short term) xxxx

Prepaid expenses xxxx

Cash at bank xxxx

Cash in hand xxxx

xxxx xxxx

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 Financial Statements : I MODULE - 3
Financial Statement
[In case of joint stock companies balance sheet is prepared as per schedule VI of the
Companies Act 1956]
Illustration 3
From the balances given below prepare Balance sheet of M/s Bharat & Bros as on
31st December, 2014. In (a) liquidity order and, (b) in permanency order.
Particulars Amount Particulars Amount
` `
Notes
Capital 50,000 Sundry Debtors 24,000
Loan from Bank 20,000 Bills Payable 8,000
Cash in hand 2,500 Drawings 6,000
Cash at Bank 12,800 Building 25,000
Closing stock 24,700 Furniture 4,500
Sundry creditor 15,000 Investments 15,000
Net Profit 21,500
Solution :
A. Liquidity order
Balance sheet of M/s Bharat & Bros
as on 31st Dec., 2014
Liabilities Amount Assets Amount
` `
Bills Payable 8,000 Cash in hand 2,500
Sundry creditors 15,000 Cash at Bank 12,800
Loan from Bank 20,000 Sundry Debtors 24,000
Capital 50,000 Closing stock 24,700
Add : Net Profit 21,500 Investments 15,000
71,500 Furniture 45,00
Less : drawings 6,000 65,500 Building 25,000
1,08,500 1,08,500

B. In permanency Order
Balance sheet of M/s Bharat & Bros
as on 31st Dec., 2014
Liabilities Amount Assets Amount
` `
Capital 50,000 Building 25,000
Add Net Profit 21,500 Furniture 4,500
Less drawings 6,000 65,500 Investments 15,000

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 MODULE - 3 Financial Statements : I
Financial Statement
Loan from Bank 20,000 Closing stock 24,700
Sundry creditors 15,000 Sundry Debtors 240,00
Bills payable 8,000 Cash at Bank 12,800
Cash in hand 2,500
1,08,500 1,08,500

Notes INTEXT QUESTIONS 17.2

I. Arrange the following Assets in (i) Liquidity order (ii) Permanency order.
(i) Closing stock (ii) Furniture
(iii) Cash in hand (iv) Investments
(v) Bills Receivable (vi) Goodwill
(vii) Building (viii) Debtors
II. Arrange the following items of liabilities in (i) Liquidity order and (ii) in
permanency order
(i) Bills Payable (ii) Sundry Creditors
(iii) Loan on Mortgage (iv) Outstanding Expenses
(v) Capital

17.3 CLASSIFICATION OF ASSETS AND LIABILITIES

Assets and Liabilities are of various types. These can be classified as under:
Assets
Assets can be classified as follows :
(a) Fixed Assets : These are the assets that are purchased on permanent basis i.e.
for long term use and help the business to earn revenue. Examples of such assets
are Building, Machinery, Motor Vehicle, etc. These assets are not for sale in
ordinary course of business but can be disposed off, if no more needed for
business use.
(b) Current Assets : These are the assets which are acquired by the business either
for resale or for converting them into cash. These are normally realised within
a period of one year. Examples of such assets are : cash in hand, cash at bank,
bill receivable, debtors, stock etc.
(c) Tangible Assets : These are the assets that can be seen, touched and have
certain volume. Building, Machinery, goods etc. are tangible assets.

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 Financial Statements : I MODULE - 3
Financial Statement
(d) Intangible Assets : Assets which can neither be seen nor touched and have no
volume are called intangible assets. Patents, trademark, goodwill etc are the
examples of such assets.
(e) Liquid Assets : These are the assets which are either in cash or can be easily
converted into cash. For example cash, stock, marketable securities etc.
(f) Wasting Assets : These are the assets which exhaust or reduce in value by
their use. Mines, quarries etc come under this category.
Notes
(g) Fictitious Assets : These are not the real assets. These are the items of such
expenses and losses which have not been written off in full. For example,
preliminary expenses, underwriting commission, etc.
Liabilities
Liabilities can be classified as follows :
(a) Long term Liabilities : These are the liabilities which are not payable during
the current accounting year. Generally, the funds raised through such means are
used for purchase of fixed assets. Examples of such liabilities are loan on
mortgage, loan from financial institutions.
(b) Current Liabilities : These are the liabilities which are payable during the
current year. These include Bank overdraft, trade creditors, bill payable etc.
(c) Owners’ Funds : The amount owing to the proprietor or proprietors is called
owners’ funds. As per business entity concept this is a liability of the business.
Apart from capital it also includes undistributed profits and reserves. Amount
of drawings by the proprietor is deducted from it.

INTEXT QUESTIONS 17.3

I. Write the type of assets against the items given below :
(i) Goodwill (ii) Bills Receivable
(iii) Preliminary Expenses (iv) Mines
(v) Furniture
II. Write the type of liabilities against the items given below :
(i) Loan on mortgage (ii) Creditors
(iii) Outstanding expenses (iv) Capital

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Financial Statement
17.4 PREPARATION OF BALANCE SHEET
Balance sheet has two sides : Assets and Liabilities. On the assets side we present all
types of assets such as Cash, Bills Receivable, Stock, Building etc.
On the liabilities side all liabilities, both long term liabilities and current liabilities are
presented, such as Bills Payable, trade creditors, bank loan etc. Next we write owners’
capital. Net profit is added to it. If there is net loss it is deducted from the capital.
Amount of drawings is also deducted from the capital. Finally the two sides are totalled
Notes
and the totals should agree.
Illustration 4
From the following Trial Balance of M/s Vikram Brothers prepare Trading and Profit
and Loss Account for the year ended 31st March 2014 and Balance Sheet as on that
date.
Dr. Cr.
Particulars Balances Particulars Balance
` `
Cash in hand 500 Capital 70,000
Motor car 25,000 Discount Received 2,000
Drawings 48,000 Sales 2,30,000
Legal charges 1,500 Creditors 46,000
Plant & Machinery 60,000 Interest on investment 5,200
Investments 40,000 Purchases Return 3,800
Opening stock 35,000 Bills payable 34,000
Sales Returns 2,500
Salaries 12,000
Discount allowed 600
Carriage Inward 1,800
Wages 21,000
Postage 400
Debtors 60,000
Interest 1,500
Insurance Premium 1,200
Purchases 80,000
3,91,000 3,91,000

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 Financial Statements : I MODULE - 3
Financial Statement
Closing stock as on 31.3.2014 `28,000
Solution :
Trading A/c
for the year ended 31st March, 2014
Dr. Cr.

Particulars Amount Particulars Amount

` `
Notes
Opening stock 35,000 Sales 2,30,000
Purchases 80,000 Less sales Returns 2,500 2,275,00
Less purchase return 3,800 76,200 Closing stock 28,000
Wages 21,000
Carriage Inward 1,800
Gross Profit transferred
to Profit & Loss A/c 1,21,500
2,55,500 2,55,500

Profit & Loss A/c

for the year ended 31st March, 2014
Particulars Amount Particulars Amount
` `
Salaries 12,000 Gross Profit transferred
Insurance Premium 1,200 from Trading A/c 1,21,500
Discount allowed 600 Discount Received 2,000
Postage 400 Interest on Investments 5,200
Interest 1,500
Legal charges 1,500
Net Profit Transferred
to Capital A/c 1,11,500
1,28,700 1,28,700

Balance Sheet
As on 31st March, 2014
Liabilities Amount Assets Amount
` `
Bills Payable 34,000 Cash in hand 500
Creditors 46,000 Debtors 60,000

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Financial Statement
Capital 70,000 Closing stock 28,000
Add : Net Profit 1,11,500 Investments 40,000
1,81,500 Motor car 25,000
Less : Drawings 48,000 1,33,500 Plant & Machinery 60,000
2,13,500 2,13,500

Illustration 5
Notes Following is the Trial Balance extracted from the books of Jasmine Enterprises as on
31st March, 2014. Prepare Trading and Profit & Loss A/c from the information given
in Trial Balance for the year ending 31st March, 2014. Also prepare the Balance Sheet
as on that date.
Dr. Cr.
Particulars Amount Amount
(` ) (` )
Stock (1.4.2013) 18,500
Purchases & Sales 78,500 1,54,200
Return Inwards & Return Outwards 2,200 2,500
Debtors & Creditors 16,500 18,000
Bills Receivable & Bills Payable 14,000 21,000
Commission paid 2,000
Audit fees 1,800
Building 65,000
Furniture 12,000
Salaries 14,000
Telephone charges 4,200
Insurance 2,100
Discount allowed 1,000
Octroi 1,200
Wages 16,000
Freight Inward 2,400
Bad debts 600
Depreciation 4,200
Bank loan 32,000
Cash in hand and at Bank 25,000

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Financial Statement
Capital 1,00,000
Drawing 16,500
Machinery 30,000
3,277,00 3,27,700
Stock as on 31.3.2014 ` 19,600
Solution :
Trading A/c Notes
For the year ended 31st March, 2014
Dr. Cr.

Particulars Amount Particulars Amount

` `
Stock (1.4.2013) 18,500 Sales 1,54,200
Purchases 78,500 Less Return Inward 2,200 152000
Less return outward 2,500 76,000 Closing stock 19,600
Wages 16,000
Freight Inward 2,400
Octroi 1,200
Gross Profit transferred
to Profit & Loss A/c 57,500
1,71,600 1,71,600

Profit & Loss A/c

for the year ended 31st March, 2014
Particulars Amount Particulars Amount
` `
Salaries 14,000 Gross Profit transferred
Telephone Charge 4,200 from Trading A/c 57,500
Insurance Premium 2,100
Bad debts 600
Depreciation 4,200
Audit fees 1,800
Discount allowed 1,000
Commission paid 2,000
Net Profit Transferred
to Capital A/c 27,600
57,500 57,500

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 MODULE - 3 Financial Statements : I
Financial Statement
Balance Sheet
as at 31st March, 2014
Liabilities Amount Assets Amount
` `
Bills Payable 21,000 Cash in hand & at Bank 25,000
Sundry creditors 18,000 Bill receivable 14,000
Bank Loan 32,000 Sundry Debtors 16,500
Capital 1,00,000 Closing stock 19,600
Notes
Add : Net Profit 27,600 Furniture 12,000
1,27,600 Machinery 30,000
Less : Drawings 16,500 1,11,100 Building 65,000
1,82,100 1,82,100

Illustration : 6
From the following balances extracted from the books of Hari on 31st March, 2014,
prepare his Trading and Profit and Loss Accounts and Balance Sheet :

Trial Balance
` `
Opening Stock 9,600 Repairs to Plant 160
Wages and Salaries 3,200 Cash in Hand and at Bank 200
Commission on Purchases 200 Debtors 4,000
Freight 300 Income-Tax 550
Purchases less Returns 11,850 Drawings 650
Sales less Returns 24,900 Capital 5,000
Trade Expenses 20 Bills Payable 500
Bills Receivable 600 Loan 900
Rent 200 Discount on Purchases 400
Plant 2,000 Creditors 2,330
Bad Debts 500
Information : Stock at the end was ` 3,500
Solution :
Trading and Profit & Loss Account
Dr. for the year ending 31st March, 2014 Cr.

Particulars ` Particulars `
To Opening Stock 9,600 By Sales less Returns 24,900
To Purchases less Returns 11,850 By Closing Stock 3,500

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Financial Statement
To Wages and Salaries 3,200
To Commission on Purchases 200
To Freight 300
To Gross Profit c/d 3,250
28,400 28,400
To Trade Expenses 20 By Gross Profit b/d 3,250
To Rent 200 By Discount on Purchases 400
To Bad Debts 500 Notes
To Repairs to Plant 160
To Net Profit transferred to
Capital A/c 2,770
3,650 3,650
Balance Sheet of Hari
as at March 31, 2014
Liabilities ` Assets `
Capital Plant 2,000
Opening Balance 5,000 Stock at the end 3,500
Add : Net Profit 2,770 Debtors 4,000
7,770 Bills Receivable 600
Less: Income Tax 550 Cash-in-Hand and at Bank 200
Drawing 650 1,200 6,570
Loan 900
Bills Payable 500
Creditors 2,330
10,300 10,300

INTEXT QUESTIONS 17.4

Fill in the blanks with appropriate word/words :

(i) The amount by which credit side of Trading A/c exceeds the debit side is known
as ......................

(ii) The amount by which debit side exceeds the credit side of Profit & Loss A/c is
shown as ......................

(iii) The totals of the two sides of the Balance sheet should always be ......................

(iv) Bank loan is shown on the ...................... side of the Balance sheet.

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WHAT YOU HAVE LEARNT

z To prepare Trading Account, on the debit side we present opening stock, net
purchases and direct expenses on the credit we present net sales and closing
stock. The difference of the two sides is found out which may be Gross Profit or
Gross Loss. The same is transferred to Profit & Loss Account.
Notes z All items of revenue expenditure and losses are shown on the debit side of Profit
and Loss Account and on the credit are shown items of revenue receipts and
gains. The difference of the two sides is calculated which may be either Net Profit
or Net Loss.
z Balance sheet is a statement showing the financial position of a business unit on
the last date of the accounting year.
z Balance sheet is a systematic presentation of what a business unit owns and what
it owes.
z Balance sheet has two sides Assets and Liabilities.
z Assets and Liabilities may be written in (i) Liquidity order or (ii) Permanency
order.
z Assets may be classified as : fixed assets, current assets, tangible assets, intangible
assets, liquid assets, wasting assets and fictitious assets.
z Liabilities can be long term liabilities, current liabilities and owners funds.

TERMINAL EXERCISE
1. State the steps for preparing Trading Account.
2. Explain the term Balance Sheet. Also explain the objectives of preparing a Balance
sheet.
3. List assets in ‘liquidity order’ and ‘permanency order’ in a Balance Sheet.
4. Explain the following types of assets with two examples each :
(a)Intangible Assets (b) Fictitious Assets
(c)Fixed Assets (d) Current Assets
5. What are owners’ funds ?
6. From the following information extracted from the books of P. Mukherjee, prepare
Trading Account for the year ending 31st March, 2014.

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Financial Statement
` `
Opening stock 6,500 Cash 4,500
Purchases 45,000 Office expenses 3,200
Sales 72,000 Office Rent 6,800
Return Inward 1,500
Return Outward 500
Notes
Carriage on Purchases 1,200
Wages 4,800
Fuel & Power 3,200
Closing stock on 31st March, 2014 was ` 8,600
7. From the following information of Rashmi prepare Profit & Loss Account for the
year ending 31st March, 2014.
` `
Gross Profit 64,800 Discount Received 600
Bad debts 1,500 Commission Received 2,100
Depreciation 2,500 Freight outward 1,600
Office rent 4,800 Prepaid Insurance 600
Insurance 3,200 Salary 6,400
Telephone charges 1,700 Stationery 700
Interest on loan 2,400 Furniture 6,000
Building 50,000
Closing stock as on 31st March, 2014 ` 20,000
8. From the following Trial Balance of M/s Krishna Murthi Garments as on 31st
March, 2014, you are required to prepare Trading Account, Profit and Loss A/c
for the year ended 31st March, 2014 and a Balance sheet as on that date.
Trial Balance of M/s Krishna Murthi Garments
as at 31st March, 2014
Dr. Cr.
Particulars Balances Balances
` `
Cash in hand 2,000
Bank overdraft 35,000

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 MODULE - 3 Financial Statements : I
Financial Statement
Stock (1.4.2013) 32,000
Purchases 80,000
Freight Inward 4,000
Custom duty 5,500
Power 6,500
Machines 40,000
Notes
Furniture 20,000
Sales 1,65,000
Bills Payable 18,000
Sundry Debtors 28,000
Sundry creditors 22,000
Salaries 6,500
Salesmen’s commission 7,800
Rent of Godown 7,200
Insurance 2,400
Land & Building 75,000
Carriage on sales 3,600
Advertisement 4,500
Capital 1,00,000
Drawings 15,000
3,40,000 3,40,000
Closing stock as on 31st March, 2014 ` 38,000
9. Rakesh carries on business as a furniture manufacturer. Prepare his Trading and
Profit & Loss Acount and Balance Sheet from the following balances as on 31st
March, 2014 :
` `
Capital 6,000 Polishing 500
Withdrawals (Drawings) 1,000 Rates and Taxes 40
Sales 10,000 Bills Receivable 300
Raw material (Purchased) 2,000 Insurance 150

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Financial Statement
Loan or Mortgage (Cr.) 1,000 Carriage 10
Machinery 1,500 Incidental Expenses 200
Land and Building 2,000 Stock, 1st April, 2013 2,000
Creditors 500 Cash at Bank 1,250
Wages 5,000 Cash in Hand 50
Debtors 1,500
Notes
Stock on 31st March, 2014, ` 1,500.
10. The following balances were extracted from the books of Harish Jalal on 31st
March, 2014 :
` `
Capital 24,500 Loan 7,880
Drawings 2,000 Sales 65,360
General Expenses 2,500 Purchases 47,000
Buildings 11,000 Motor Car 2,000
Machinery 9,340 Reserve Fund (Cr.) 900
Stock 16,200 Commission (Cr.) 1,320
Power 2,240 Car Expenses 1,800
Taxes and Insurance 1,315 Bills Payable 3,850
Wages 7,200 Cash 80
Debtors 6,280 Bank Overdraft 3,300
Creditors 2,500 Charity 105
Bad Debts 550
Stock on 31st March, 2014 was valued at ` 23,500.

ANSWERS TO INTEXT QUESTIONS

17.1 (i) Trading A/c credit
(ii) Profit & Loss A/c debit
(iii) Profit & Loss A/c credit
(iv) Trading A/c debit

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Financial Statement
(v) Trading A/c debit
(vi) Trading A/c credit
(vii) Profit & Loss A/c debit
(viii) Profit & Loss A/c credit
17.2 I. Liquidity order Permanency order
Cash in hand Goodwill
Notes
Bills Receivable Furniture
Sundry Debtors Building
Closing stocks Investments
Investments Closing stock
Furniture Sundry Debtors
Building Bills Receivable
Goodwill Cash in hand
II. Liquidity order Permanency order
Outstanding expenses Capital
Bills payable Loan on Mortgage
Sundry Creditors Sundry Creditors
Loan on Mortgage Bill payable
Capital Outstanding expenses
17.3 I. (i) Intangible Asset (ii) Current Asset (iii) Fictitious Asset
(iv) Wasting Asset (v) Fixed Asset
II. (i) Long term liability (ii) Current liability
(iii) Current liability (iv) Owner fund
17.4 (i) Gross Profit (ii) Net Loss (iii) Equal (iv) Liabilities

ANSWERS TO TERMINAL EXERCISE

6. Gross profit ` 10,300
7. Net Profit ` 42,700
8. Gross Profit ` 75,000

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Financial Statement
Net Profit ` 44,000
Total of Balance Sheet ` 2,03,000
9. Gross Profit ` 1,790
Net Profit ` 1,600
Total of Balance Sheet ` 8,100
10. Gross Profit ` 16,220
Notes
Net Profit ` 11,270
Total of Balance Sheet ` 52,200

ACTIVITIES
1. Visit some business firms of your locality, parents of your friends and of your
relatives and collect the information about assets which are not common because
of the nature of their business and classify them into relevant categories.
Name of the Nature of Name of the Category of the
firm business asset asset
1.
2.
3.
4.
5.

2. Analyse the Balance Sheet of a business enterprise being run by your father/father
of your friend or by a relative and check the marshalling of Assets and Liabilities.
If these are not in order place them in liquidity order or permanency order. If these
are already in liquidity order place them in permanency order and vice-versa.

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Financial Statement

18
FINANCIAL STATEMENTS - II
Notes

You have learnt that Income Statement i.e. Trading & Profit and Loss Account and
Position Statement i.e., Balance Sheet are two financial statements, which are prepared
by every business concern at the end of a period. Income statement shows the Net
Profit or Net loss as the case may be for that period and Position Statement presents
the financial position of the business on the specific date. These statements are prepared
on the basis of Trial Balance and other information. It is possible that there are certain
items of income or expenses which do not pertain to the accounting period for which
Trial Balance is prepared or other such items which have accrued but have not been
accounted for and hence are not reflected in Trial Balance. Both these types of incomes
and expenses are to be fully accounted for, only then the above stated two statements
will show the true and fair position of the business. These are called ‘adjustments’. In
this lesson we shall learn about accounting treatment of some of the adjustments and
incorporation of these adjustments in financial statements.

OBJECTIVES
After studying this lesson you will be able to:
z recognise the need for accounting adjustments;
z explain the adjustments as to closing stock, outstanding and pre-paid expenses,
accrued income and income received in advance;
z interest on capital and drawings, depreciation, provision for bad and doubtful
debts; and
z incorporate the adjustments in Trading Account, Profit & Loss Account and Balance
Sheet.

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Financial Statement
18.1 NEED FOR ACCOUNTING ADJUSTMENTS
You have already learnt that every business entity prepares Trading and Profit & Loss
Account and Balance Sheet, the two financial statements, at the end of an accounting
period which is generally one year. It needs to be ensured that such items of income
and expenditure which do not pertain to the said accounting period, should not to be
included. If some of these items have been included in the trial balance these must be
excluded by making necessary adjusting entry. Similarly, there can be items which are
left out and are needed to be accounted for. Adjustment entry will also be made for Notes
them. This is necessary in order to calculate the correct profit or loss and to show true
and fair financial position of the business. For example, a firm closes its books on March
31, every year, Suppose it has not paid rent of the shop for the month of March. This
will not be reflected in Trial Balance and hence it needs to be accounted for as it relates
to the year for which accounts are being prepared. Similarly, suppose annual insurance
premium has been paid up to June, 30. It means premium for three months has been
paid in advance. This is included in the item of insurance appearing in the Trial Balance.
This amount paid in advance needs to be excluded. This process of exclusion or inclusion
of items into books of accounts at the time of preparing finanacial statements is called
adjustments. These are to be incorporated to arrive at the true and fair position of the
business.

INTEXT QUESTIONS 18.1

Fill in the blanks with suitable word/words :
(i) Trading and Profit & Loss Account shows the ............... or ...............
(ii) Adjustments are necessary to show the correct ............... and ............... of a
business concern.
(iii) Items of income and expenditure which do not pertain to the accounting period
should be ...............
(iv) Items of income & expenditure which relate to the accounting period but are left
out should be ...............

18.2 ADJUSTMENTS AND THEIR INCORPORATION

The number and nature of adjustments differ from organisation to organisation. It depends
upon the volume and nature of activities in the organisation, However, certain adjustments
are common in all types of organisations. Moreover, while making adjustments you will
have to follow the general principle of double entry i.e. the amount is to be debited to
one account and credited to another account. Thus in the finanacial statements the item
to be adjusted should appear at two places one representing the debit and the other
representing the credit.

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Financial Statement
Let us, now discuss some of the items of adjustment and their accounting treatment in
financial statements. These are as under :
1. Closing Stock
2. Outstanding Expenses.
3. Prepaid Expenses
4. Accrued Income.
5. Income received in advance
Notes 6. Interest on Capital
7. Interests on Drawings
8. Depreciation.
9. Further Bad Debts.
10. Provision for Bad and Doubtful Debts.
11. Provision for discount on debtors.
12. Managers Commission
13. Abnormal losses.
14. Drawing of Goods by the Proprietor.
15. Goods Distributed as free Sample.
Let us take up these adjustments one by one:
1. Closing Stock
Closing Stock is the stock of goods remaining unsold at the end of the accounting year.
Ordinarily this does not appear in the Trial Balance. Hence, this needs to be incorporated
in financial statements. This appears on the credit side of the Trading Account as well
as Assets side of the Balance Sheet.
The adjustment entry will be:
Closing Stock A/c Dr
To Trading A/c
(Closing stock transferred to trading A/c)
The effect of the adjustment entry on financial statements is as under :
Trading A/c
Dr Cr
Particulars Amount Particulars Amount
` `
Closing stock ......

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 Financial Statements : II MODULE - 3
Financial Statement
Balance Sheet
Liabilities Amount Assets Amount
` `
Closing stock ........
In case closing stock has already been accounted for it will form part of the Trial
Balance and hence there is no need of making any adjustments in the Trading A/c. Then
the adjusted closing stock will be on the asset side of the Balance Sheet only. Notes
2. Outstanding Expenses
Expense which is related to the current accounting period but not yet paid is known as
Outstanding Expense. Suppose the accounts are closed on 31st December every year.
Salary for the month of December is due but not paid. It is an example of salary
outstanding. Similarly, there are some other items like Rent outstanding, Wages
outstanding etc. In case of Salaries Outstanding following adjustment entry will be
made :
Salary A/c Dr.
To Salary Outstanding A/c
(Salary outstanding for the month of December)
In financial statements it will be recorded as :
Profit & Loss A/c
Dr. Cr.
Particulars Amount Particulars Amount
` `
Salaries
Add : Salary outstanding

Balance Sheet
Liabilities Amount Assets Amount
` `
Salary Outstanding
Amount of expense outstanding will be added to its paid amount which is shown in the
Trading A/c or Profit & Loss A/c as the case may be. It is also shown on the liabilities
side of the Balance Sheet because it is an item of liabilities.

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Financial Statement
3. Prepaid Expenses
Sometimes a part of a certain expense paid may relate to the next accounting period.
Such expenses is called prepaid expense or expenses paid in advance. For example,
insurance premium paid in the current year may be for the year ending, the date of
which falls in the next year. The part of insurance premium which relates to next accounting
year is the insurance premium paid in advance. It is deducted from the amount paid and
is shown as an item of asset. Similarly, such items may be rent prepaid, tax prepaid etc.
Notes
Adjustment entry for prepaid Insurance Premium
Prepaid Insurance Premium A/c Dr.
To Insurance Premium A/c
(Insurance premium paid in advance)
In financial statements, it is recorded as :
Profit & Loss A/c
Dr. Cr.
Particulars Amount Particulars Amount
` `
Insurance Premium
Less : Prepaid Insurance
premium
Balance Sheet
Liabilities Amount Assets Amount
` `
Prepaid insurance
4. Accrued income (Due but not received)
Accrued income means income earned but not received till the end of the accounting
year. For example, interest on securities or dividends on shares, which has become
due but may be received on a date falling in the next year. Such income does not
appear in the trial balance but should be duly accounted for in the year, because such
income has accrued.
Adjustment entry for the transaction : suppose Rent receivable as it has become due
but is not yet received

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Financial Statement
Rent Receivable (accrued) A/c Dr.
To Rent Received A/c
(Amount of rent due but not received)
In financial statements, it will be recorded as;
Profit & Loss A/c
Dr. Cr.
Notes
Particulars Amount Particulars Amount
` `
Rent Received
Add : Rent Accrued
Balance Sheet
Liabilities Amount Assets Amount
` `
Rent Accrued

5. Unearned income/income Received in Advance

Sometimes income is received before it becomes actually due. Such income is called
“unearned income” or “income received in advance”. Since this income does not relate
to the accounting year, it should be deducted from the relevant head of income in the
Profit & Loss A/c. It is a liability and hence is shown in the liability side of the Balance
Sheet. Example of such income is rent that has been received for the months of January
and February of the coming accounting year.
Adjustment entry for the same is
Rent Received A/c Dr
To Rent Received in Advance A/c
(Rent received in advance)
In financial statements
Profit and Loss A/c
Dr. Cr.
Particulars Amount Particulars Amount
` `
Rent Received
Less : Rent received
in advance

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 MODULE - 3 Financial Statements : II
Financial Statement
Balance Sheet
Liabilities Amount Assets Amount
` `
Rent received in advance

INTEXT QUESTIONS 18.2

Notes
Fill in the blanks with suitable terms :
(i) Expenses related to the current accounting period but have not been paid are
known as ...………
(ii) Part of expenses paid if relates to the next accounting year, it is called ...………
(iii) Income earned but not received till the end of the accounting year is termed as
...………
(iv) Income if received before it becomes due is called ...………

18.3 OTHER ADJUSTMENTS

6. Interest on Capital
As per business entity concept capital of the proprietor is a liability for the business.
Like other loans, interest can be allowed on capital also. In case it is decided to allow
interest on capital, adjustment entry will be as follows :
Interest on Capital A/c Dr
To Capital A/c
(Interest allowed on capital)
In financial statements it is shown as under:
Profit & Loss A/c
Dr. Cr.
Particulars Amount Particulars Amount
` `
Interest on capital
Balance Sheet
Liabilities Amount Assets Amount
` `
Capital
Add : Interest on Capital

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Financial Statement
7. Interest on Drawings
Interest may also be charged on money withdrawn by the proprietor for personal use.
Following journal entry is made.
Capital A/c Dr.
To Interest on Drawings A/c
(Interest on Drawings charged)
Notes
In financial statements, it will be shown as :
Profit & Loss A/c
Dr. Cr.
Particulars Amount Particulars Amount
` `
Interest on Drawings
Balance Sheet
Liabilities Amount Assets Amount
` `
Capital
Less : Interest on drawings
8. Depreciation
The value of fixed assets such as Plant and Machinery, Furniture and Fixtures, Land &
Building, Motor Vehicles etc. goes on reducing year after year due to wear and tear,
obsolescence or for any other reason.
As the fixed assets are used for earning revenue the amount by which the value of a
fixed asset decreases is an item of expense, similar to other expenses. This is called
depreciation. It should be charged to the Profit and loss Account. The value of such
assets should also be shown in the Balance Sheet at the reduced value by the amount
of depreciation:
The adjustment entry for depreciation will be
Depreciation A/c Dr
To Asset ( by name ) Account
It will be shown in the Profit and Loss A/c and Balance sheet as under :

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 MODULE - 3 Financial Statements : II
Financial Statement
Profit & Loss A/c

Dr. Cr.

Particulars Amount Particulars Amount

` `

Depreciation on

Notes Plant & Machinery

Motor Vehicle (etc)

Balance Sheet

Liabilities Amount Assets Amount

` `

Plant & Machinery ........

Less : Depreciation ........ ........

Motor Vehicle ........

Less: Depreciation ........ ........

Note : In case amount of depreciation has been calculated before closing of accounts,
it will appear in the debit column of the Trial Balance. It will be shown only on the debit
of profit & Loss A/c and further adjustment is not required in the Balance Sheet.

9. Further Bad Debts

When the goods are sold on credit basis some of the debtors partly pay the due amount
or do not pay at all. If this amount cannot be recovered it is called bad debts and is a
loss to the firm. This is entered on the debit side of the Profit & loss A/c. But then there
may be amount of bad debt which was not recorded in the books of accounts and
hence did not appear in the Trial Balance. But the same was discovered before preparing
the financial statements. It is called further bad-debts. Following adjustment entry is
made for the same :

Bad Debts A/c Dr.

To Debtors A/c

(Further bad debts recorded)

In Profit and Loss A/c and Balance sheet it is shown as under :

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Financial Statement
Profit & Loss A/c
Dr Cr
Particulars Amount Particulars Amount
` `
Bad Debts
Add Further
Bad debts Notes
Balance Sheet
Liabilities Amount Assets Amount
` `
Sundry Debtors
Less: Further
Bad debts
10. Provision for Bad and Doubtful debts
Some Debts of a particular year may become bad debts in the next year. It means the
loss due to bad debts will be written off in the year it takes place instead of the year it
belongs to. It will be a sound accounting practice that a suitable amount is kept aside in
the current year to meet the possible loss of bad debts in the next year. Decision
regarding maintenance for provision for Bad and Doubtful Debts is taken at the end of
the year so it is an item of adjustment. It is called a provision for Bad and Doubtful
Debt.
The adjustment entry will be as under :
Profit & loss A/c Dr.
To Provision for Doubtful Debts A/c
(Provision for doubtful debts created)
In the Profit and Loss A/c and Balance sheet it will be shown as under:
Profit & Loss A/c
Dr Cr
Particulars Amount Particulars Amount
` `
Bad Debts
Add : Provision for Doubtful
debts

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 MODULE - 3 Financial Statements : II
Financial Statement
Balance Sheet
Liabilities Amount Assets Amount
` `
Debtors
Less : Provision for bad
Debts

Notes Such Provision is created on Debtors at a given rate say 5%. In case there is further
bad debts, provision for bad and doubtful Debts will be calculated on the amount of
debtors after deducting from it the amount of further Bad Debts.
Over the years businessman might have experienced that a certain percentage of the
debts created due to credit sales go bad every year. So a provision for bad and doubtful
debt is made on the debtors of a year at a fixed percentage say 5%. This percentage
may change if the circumstances have changed. For example, it may be reduced if the
businessman has become selective in selling goods on credit.
Provision for bad and doubtful debt is maintained at every year at a fixed percentage of
the debtors. Last year balance is carried forward in the current year. This may be
called old provision for bad and doubtful debts. Current years bad debts or/and further
bad debts is adjusted towards this provision and more provision is created, which may
be called new provision for bad debts.
Arithmatically it is shown in the Profit and Loss A/c as follows :
Profit and Loss A/c
Dr Cr
Particulars Amount Particulars Amount
` `
Bad Debts
Add : Further Bad Debts
Add new provision for Bad
and Doubtful Debts
Less : Old provision for Bad
and Doubtful Debts
In case the balance amount of provision for bad and doubtful debts carried forward
from last year is more than the amount of bad debts, amount of further Bad Debts and
the amount of new provision for bad debts combined together, the excess balance will
be credited to Profit and Loss A/c.

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The amount of provision for Bad and Doubtful Debts is an item of liability. But usual
practice is to show it as deducted from the amount of book debts/sundry debtors on
the assets side of the Balance Sheet.
The above can best be explained by the following example :
Items appearing in the Trial Balance of a sole trader on 31st Dec, 2013.
Dr Cr
Particulars Balance Balance
` ` Notes
Sundry Debtors 24600
Provision for Bad and Doubtful Debts 1000
Bad Debts 700
Additional Information
Further bad debts amounted to ` 600. Make a provision for Bad and Doubtful debts
on Debtors @ 5%.
Show the above items and related adjustments in the financial statements as on that
date.
Proft and Loss A/c
for the year ended 31st Dec., 2013
Dr. Cr.
Particulars Amount Particulars Amount
` `
Bad Debts 700
Further Bad Debts 600
Add : New Provision for bad
and Doubtful Debts 1200
2500
Less : Old provision for bad
and Doubtful Debts (1000) 1500

Balance Sheet
as on 31st Dec., 2013
Liabilities Amount Assets Amount
` `
Sundry Debtors 24600
Less : Further Bad Debts 600
24000
Less : Provision for bad
Debts @ 5% 1200 22800

Accountancy 107
 MODULE - 3 Financial Statements : II
Financial Statement
18.4 ADJUSTMENTS IN PREPRATIONS OF FINANCIAL
STATEMENTS
11. Provision for Discount on Debtors
Debtors outstanding at the end of year make payment in the next year and they may
be entitled to cash discount if they make the payment by the due date. Because, the
debt has arisen during the year, the discount is to be taken as expense for the year.
Notes Thus a Provision for Discount on Debtors is made.
The process is same as for the provision for doubtful debt. The likely amount of the
discount to be allowed is debited to the Profit and Loss Account and credited to
the Provision for Discount Account. This amount is deducted from book debts
(debtors) in the balance sheet and is carried forward to the next year. Discount allowed
to the existing debtors in the next year are debited to the Provision for Discount
Account and not to the Profit and Loss Account. The debit reduces the balance in
the provision account, it is made up to the required figure by a debit to the Profit
& Loss Account and credit to the provisions account just like the Provision for
Doubtful Debts Account.
An important point to note is that discount is not allowed on debts that became bad.
Therefore, the provision for discount is made for good debts only. In other words,
the amount of the Provision for Discount is calculated after deducting bad debts and
the provision for doubtful debts from sundry debtros. Suppose, sundry debtors total
` 1,00,000; provision for doubtful debts is required at 5% and provision for discounts
at 2.5%. So first we have to calculate provision for doubtful debts i.e. ` 1,00,000
x 5% = ` 5,000; the remaining amount is ` 95,000. Now we calculate Provision
for Discount on Debtors i.e. ` 95,000 x 2.5% it will be ` 2,375.
Accounting Treatment
(i) For Discount Allowed :
Discount Allowed A/c Dr.
To Debtors A/c
(Being discount allowed to debtors)
(ii) For transferring the amount of discount to profit & loss Account.
Profit & Loss A/c Dr.
To Discount Allowed
(Being discount allowed transferred to Profit & Loss A/c)

108 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
(iii) If the existing provision appears in the books, then the discount allowed would
be transferred to the Provision and Discount on Debtors Account instead of the
Profit Loss Account. The entry would be :-
Provision for Discount on Debtors A/c Dr.
To Discount Allowed
(Being discount transferred to Provision for Discount on Debtors A/c)
(iv) For creating Provision for Discount on Debtors : Notes
Profit and Loss A/c Dr.
To Provision for Discount on Debtors A/c
(Being balance of provision for discount account
being charged to Profit & Loss A/c)
Illustration : 1
The Sundry Debts of a firm on 31st December, 2012 were ` 4,00,000. On that date,
it was decided to create a Provision for Discount at 2% on Sundry Debtors. During
2013 the actual amount of discount allowed was ` 4000. The debtors on 31st
December, 2013 were ` 3,00,000 and it was again decided to create a Provision for
Discount over Debtors at 2%. Pass the Journal entries and prepare Discount Account
and Provision for Discount Account for both the years.
Solution :
Journal
Date Particulars L.F. Dr. (`) Cr. (`)
2012
Dec. 31 Profit and Loss A/c ...Dr. 8,000
To Provision for Discount on Debtors A/c 8,000
(Being provision for discount on debtor credited)
2013
Dec. 31 Discount Allowed A/c ...Dr. 4,000
To Sundry Debtors A/c 4,000
(Being discount allowed on payment received)
Dec. 31 Provision for Discount on Debtors A/c ...Dr. 4,000
To Discount Allowed A/c 4,000
(Being discount transferred to Provision Account)
Dec. 31 Profit and Loss A/c ...Dr. 2,000
To Provision for Discount on Debtors A/c 2,000
(Being provision created)

Accountancy 109
 MODULE - 3 Financial Statements : II
Financial Statement
Provision for Discount on Debtors Account
Date Particulars J.F. ` Date Particulars J.F. `

2012 2012

Dec. 31 To Balance c/d 8,000 Dec. 31 By Profit and Loss A/c 8,000

2013 2013

Dec. 31 To Discount Allowed A/c 4,000 Jan. 1 By Balance b/d 8,000

Dec. 31 To Balance c/d 6,000 Dec. 31 By Profit and Loss A/c 2,000
Notes
10,000 10,000

2014

Jan. 1 By Balance c/d 6,000

Discount Allowed Account

Date Particulars J.F. ` Date Particulars J.F. `

2013 2013

Dec. 31 To Sundry Debtors A/c 4000 Dec. 31 By Provision for

Discount A/c 4000

12. Manager’s Commission

Sometimes, the manager is entitled to a commission on profits which is usually calculated
as a fixed percentage of the profits. Suppose, the profit earned by the firm is ` 80,000
without considering the commission which is at 5%. The commission will be then
` 4,000. The profit will be reduced to ` 76,000. As the amount of commission ` 4,000
is still to be paid, it should be treated as an outstanding expense. Accordingly, the entry
is:
Profit and Loss A/c ...Dr.
To Commission Payable or Outstanding Commission A/c
Commission Payable is a current liability and is shown in the Balance Sheet.
Sometimes, however, the commission is calculated on profits remaining finally after the
commission. If the rate of the commission is 5%, and the profit remaining after the
commission is ` 100; then the profit before the commission will be ` 105. That is in this
case the commission of ` 5 should be out of every ` 105 of profit before the commission.
The formula to calculate the commission in such a case is :

Percentage of the commission

x Net Profit before charging the Commission
100 + Percentage of the commission

110 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
If the profit before commission is ` 8,00,000 and the manager is entitled to a commission
of 5% after deducting the commission, the amount will be ` 38,095, ` 8,00,000 of
5/105. This comission amount can be verified too. The profit after the commission is
` 7,61,905 and ` 38,095 is 5% of this figure. One can see that if we calculate it at 5%
of ` 8,00,000 will be wrong since ` 40,000 is not 5% of ` 7,60,000.
Illustration : 2
The net profit of a firm amount to ` 1,05,000 before charging commission. The manager Notes
of the firm is entitled to a commission of Rs. 5% on the net profit. Calculate the comission
payable to the manager under the following alternative cases :-
I. If the manager is allowed commission on the net profit before charging such
commission, and
II. If the manager is allowed commission on the net profit after charging such
commission. Also show the treatment in the final account ending on 31st March
2013.
Solution :
I Case
[Commission allowed on the net profit before charging such commission]

Commission = Net Profit before charging the Commission x % of Commission

100
5 =
= ` 1,05,000 x ` 5,250
100

Profit & Loss Account

for the year ended 31st March 2013
Particulars ` Particulars `
To Managers Commision 5,250
Balance Sheet
as at 31st March 2013
Liabilities ` Assets `
Current Liabilities
Manager’s Com. Outstanding 5,250
II Case
[Commission allowed on the net profit after charging such commission]
5
Commission = Net Profit before charging the Commission x
105

Accountancy 111
 MODULE - 3 Financial Statements : II
Financial Statement
5 =
= ` 1,05,000 x ` 5,000
105

Profit & Loss Account

for the year ended 31st March 2013
Particulars ` Particulars `
To Managers Commision 5,000
Notes Balance Sheet
as at 31st March 2013
Liabilities ` Assets `
Current Liabilities
Manager’s Com. Outstanding 5,000

INTEXT QUESTIONS 18.3

I. Give exact term for the following:
(i) Provision against amount due from debtors.
(ii) Fall in the value of fixed assets due to wear and tear.
(iii) Debts which can not be recovered.
(iv) Stock of goods remaining unsold at the end of year.
II. Complete the journal entries for the following adjustments
(i) Interest on capital allowed
Interest on capital A/c Dr
To ……………..
(ii) Wages Outstanding
Wages A/c
To ………..
(iii) Insurance Premium paid for six months in advance
Unexpired Insurance A/c
To …………
(iv) Commission received but not yet earned
Commission A/c
To ………………..

112 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
III. State whether the following statements are True or False :
(i) Provision for discount on debtors is shown on the credit side of Profit &
Loss A/c.
(ii) The Amount of Provision for discount on debtors is deducted from debtors.
(iii) Provision for discount on debtors is a income for a business.
(iv) Provision for discount on debtors is an asset for a company.
(v) If sundry debtors are of ` 10,000 and company creates provision for discount Notes
on debtors @ 10%. Then total provision is ` 1,000.
IV. Fill in the blanks with appropriate words :
(i) Manager’s commission is shown in the ________ side of Profit & Loss A/c
(ii) Manager’s commission is shown in the ___________ of Balance Sheet.
Illustration : 3
From the following Trial Balance of M.B. Garments as on 31st December, 2013, prepare
Trading A/c and Profit & Loss A/c for the year ended 31st December, 2013 and Balance
Sheet as on that date :
Name of the Account Dr. Amount Cr. Amount
` `
Capital 80,000
Cash in hand 570
Cash at bank 5,600
Purchases 43,200
Sales 78,000
Wages 10,400
Power 4,730
Carriage inward 2,040
Carriage outward 3,200
Stock (1.1.2006) 5,660
Land & Building 40,000
Machinery 20,000
Salaries 4,000

Accountancy 113
 MODULE - 3 Financial Statements : II
Financial Statement
Insurance 600
Sundry Debtors 28,000
Sundry Creditors 10,000
1,68,000 1,68,000
Following adjustments are to be accounted for:

Notes (i) Stock on 31.12.2013 ` 10000.

(ii) Machinery to be depreciated @10% p.a. and Building to be depreciated @ 2%
p.a.
(iii) Salaries for the month of December outstanding were ` 1200.
(iv) Insurance Premium was paid for one year ending 30th June, 2014.

Make journal entries for the adjustments and prepare Trading and Profit & loss A/c
and the Balance Sheet.

Solution

Dr. Cr.
Date Particulars Amount Amount
` `

2013

Dec 31 Closing stock A/c ...Dr 10,000

To Trading A/c 10,000
(Closing stock taken to Trading A/c)

Dec 31 Depreciation A/c ...Dr. 2,800

To Machinery A/c 2,000
To Land & Building A/c 800
(Depreciation on machinery @ 10% p.a. and on
land & Building @ 2% p.a.charged)

Dec 31 Salaries A/c ...Dr. 1,200

To Salary Outstanding A/c 1,200
(Salary due but not paid for December 2013)

Dec 31 Prepaid Insurance A/c ...Dr. 300

To Insurance A/c 300
(Insurance paid in advance accounted for)

114 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
Trading A/c
for the year ended 31st Dec, 2013
Dr. Cr.
Particulars Amount Particulars Amount
` `
Stock 5,660 Sales 78,000
Purchases 43,200 Closing stock 10,000
Wages 10,400 Notes
Power 4,730
Carriage Inward 2,040
Gross Profit transferred to
Profit & Loss A/c 21,970

88,000 88,000

Profit & Loss A/c

for the year ended 31st Dec. 2013
Dr. Cr.

Particulars Amount Particulars Amount

` `
Carriage outward 3,200 Gross Profit transferred from
Salaries 4,000 Trading A/c 21,970
Add : Salary Outstanding 1,200 5,200
Insurance 600
Less : Prepaid insurance
Depreciation on 300 300
Machinery 2000
Land & building 800 2,800
Net Profit transferred
to capital A/c 10,470

21,970 21,970

Balance Sheet
as at 31st Dec. 2013
Liabilities Amount Assets Amount
` `
Salary Outstanding 1,200 Cash in hand 570
Sundry Creditors 10,000 Cash at Bank 5,600

Accountancy 115
 MODULE - 3 Financial Statements : II
Financial Statement
Capital 80,000 Sundry debtors 28,000
Add: net profit 10,470 90,470 Closing stock 10,000
Prepaid Insurance 300
Land & Building 40,000
Less depreciation 800 39,200
Machinery 20,000
Less depreciation 2,000 18,000
Notes
1,01,670 1,01,670

Illustration : 4
From the following Trial Balance of Mustafa & Co., prepare Trading and Profit and
loss A/c for the year ending on 31st Dec. 2013 and Balance Sheet as on that date after
making necessary journal entries for adjustments.
Dr. Cr.
Balance Balance
(`) (` )
Land and Building 60,000 Capital 1,50,000
Plant and Machinery 40,000 Sundry Creditors 30,000
Bill Receivables 8,000 Sales 1,20,000
Stock on 1.1.2013 40,000 Reserve for Bad 4,500
Purchases 51,000 and Doubtful Debts
Wages 20,000 Loan (12% p.a.) 10,000
Coal, Gas & Coke 5,800 Commission Received 2,000
Salaries 5,000
Rent 2,800
Cash at bank 25,000
Sundry Debtors 45,000
Repairs 1,800
Bad Debts 5,500
Sales Returns 2,000
Furniture and Fixture 4,000
Interest on Loan 600
3,16,500 3,16,500

116 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
Adjustments
1. Closing stock was valued at ` 30000.
2. Depreciate Plant & Machinery @ 5% and Furniture & Fixture @ 10%.
3. Provide for Bad and Doubtful Debts @ 5%.
4. Outstanding Wages ` 1000, Rent ` 500 and interest on loan outstandin ` 600.
5. Commission accrued ` 1000.
Solution. Notes
Adjustment Entries
Date Particulars Amount Amount
` `
2013
Dec 31 Closing Stock A/c Dr. 30,000
To Trading A/c 30,000
(Closing stock taken into account)
Depreciation A/c Dr. 2400
To Plant & Machinery 2000
To Furniture & Fixture 400
(Depreciation charged @ 5% on Plant
& Machinery & @10% on Furniture)
Profit & loss A/c Dr. 2250
To Reserve for Doubtful Debts 2250
(Reserve for Doubtful Debts created)
Wages A/c Dr 1000
Rent A/c Dr 500
To Outstanding Expenses A/c 1500
(Outstanding expenses provided for)
Commission Accrued A/c Dr. 1000
To commission received 1000
(Commission accrued taken into
consideration)
Interest on loan A/c Dr 600
To Interest on loan Outstanding A/c 600
(Interest on loan due but not paid)

Accountancy 117
 MODULE - 3 Financial Statements : II
Financial Statement
Trading and Profit & Loss A/c of M/s Mustafa & Co.
for the year ended on 31.12.2013
Dr. Cr.
Particulars ` Particulars `
Opening Stock 40,000 Sales 1,20,000
Purchases 51,000 Less : Sales Returns 2,000 1,18,000
Wages 20,000 Closing Stock 30,000
Notes Add : Outstanding 1,000 21,000
Coal, Gas & Coke 5,800
Gross Profit c/d 30,200
1,48,000 1,48,000

Salaries 5,000 Gross Profit b/d 30,200

Rent 2,800 Commission Received
Add : Outstanding 500 3,300 Received 2,000
Repairs 1,800 Add : Accrued
Bad Debts 5,500 Commission 1,000 3,000
Add : New Reserve 2,250
7,750
Less : Old Reserve 4,500 3,250
Interest on Loan 600
Add : Interest Outstanding 600 1,200
Depreciation
Plant & Machinery 2,000
Furniture & Fixture 400 2,400
Net Profit Transferred to
Capital A/c 16,250

33,200 33,200

Balance sheet of M/s Mustafa & Co.

as at 31.12. 2013
Liabilities ` Assets `
Sundry creditors 30,000 Cash in Bank 25,000
Loan 10,000 Bill Receivables 8,000
Interest outstanding 600 Sundry Debtors 45,000
Outstanding Expenses : Less : Reserve for
Wages 1,000 Doubtful Debts 2,250 42,750
Rent 500 1,500 Closing Stock 30,000

118 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
Capital 1,50,000 Furniture & Fixture 4,000
Add : Net Profit 16,250 1,66,250 Less : Dep. 400 3,600
Plant & Machinery 40,000
Less : Dep. 2,000 38,000
Land & Building 60,000
Commission Accrued 1,000
2,08,350 2,08,350
Notes
Illustration : 5
From the following balances of the year ending 31st December, 2013 and additional
information prepare the Trading and Profit and Loss Account and the Balance Sheet of
M/s Kanohal and Sons.
` `
Capital 80,000 Insurance 600
Purchases 82,000 Salaries 12,500
Sales 1,10,000 Bad Debts 200
Return Outwards 1,000 Carriage on Purchase 200
Buildings 45,000 Commission (Cr.) 1,500
Opening Stock 15,000 Cash in Hand 5,000
Debtors 20,100 Cash at Bank 25,000
Creditors 28,000 Sales Tax Paid 5,000
Furniture 7,000 Sales Tax Collected 3,500
Wages 1,800 Interest on Investments 500
Rent 5,100
Additional Information:
(a) Closing Stock was valued at ` 20,000.
(b) Provide Depreciation on building @5% and on furniture @10%.
(c) Outstanding salaries ` 1,000.
(d) Unexpired insurance ` 50.
(e) Accrued commission ` 300
(f) Provide for Manager’s Commission at 5% on net profit after charging such
commision.

Accountancy 119
 MODULE - 3 Financial Statements : II
Financial Statement
Solution :
Trading and Profit & Loss Account
for the ended 31st December, 2013
Dr. Cr.
Particulars ` Particulars `
To Opening Stock 15,000 By Sales 1,10,000
To Purchases 82,000 By Closing Stock 20,000
Notes
Less : Return Outward 1,000 81,000
To Wages 1,800
To Carriage on Purchases 200
To Gross Profit c/d 32,000
1,30,000 1,30,000
To Rent 5,100 By Gross Profit b/d 32,000
To Insurance 600 By Interest on Investment 500
Less : Unexpired Insurance 50 550 By Commission 1,500
To Salaries 12,500 Add : Accrued
Add : Outstanding Commission 300 1,800
Salaries 1,000 13,500
To Bad Debts 200
To Depreciation on :
Building 2,250
Furniture 700 2,950
To Net Profit before
Manager’s Commission 12,000
34,300 34,300
To Manager’s Commission By Net Profit before
(5/105 x 12,000) 571 Manager’s Commission 12,000
To Net Profit after Manager
Commission 11,429
12,000 12,000

Balance Sheet
as at 31st December, 2013
Liabilities ` Assets `
Creditors 28,000 Cash in Hand 5,000
Outstanding Salary 1,000 Cash at Bank 25,000
Manager’s Commission 571 Closing Stock 20,000

120 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
Capital 80,000 Debtors 20,100
Add : Net Profit 11,429 91,429 Advance Sales Tax Paid
(Sales Tax Paid - Sales Tax Collected) 1,500
Accrued Commission 300
Prepaid Insurance 50
Building 45,000
Less : Depreciation 2,250 42,750
Furniture 7,000 Notes
Less : Depreciation 700 6,300

1,21,000 1,21,000

13. Abnormal Losses

Such losses occur because of fire, earthquakes or accidents. These may destroy some
fixed assets of the firm. In such case an Asset Account is credited and the Profit and
Loss Account is debited. The debit may be spread over two or three years.
Stock of goods may also be destroyed or damaged by fire, or other causes. It is
obvious that because of this, the value of the stock will be lower than otherwise. This
will reduce the amount of gross and net profit. It is, however, better to ascertain the
gross profit which would have been earned without the loss since this enables the firm
to judge its trading operations properly. To nullify the effect of loss of stock, the Trading
Account is credited with the cost of the goods destroyed. If the goods destroyed are
not insured then the cost price of the goods destroyed is debited to Profit and Loss
Account. If the goods are insured, then the claim admitted by the insurance company is
deducted and the claim not admitted is debited to the Profit and Loss Account. The
adjusting entries are as follows :
(i) Accidental Loss of Stock A/c
or Loss by Fire ...Dr. [Total Value of Abnormal Loss]
To Trading A/c
(ii) Insurance Claim or Insurance Co. ...Dr. [Amount of Insurance Claim]
Profit and Loss A/c ...Dr. [Value of Irrecovered Loss]
To Accidental Loss of Stock A/c [Total Value of Abnormal Loss]
Insurance Company’s Account will be shown as an asset in Balance Sheet
Note : If stock is not insured, following entry will be passed.
Profit and Loss A/c ...Dr. [Total Value of Abnormal Loss]
To Trading A/c

Accountancy 121
 MODULE - 3 Financial Statements : II
Financial Statement
Illustration : 6
On 31st Dec. 2013, stocks worth ` 4,00,000 were destroyed by fire. The stock was
insured and the insurance company admitted the claim of ` 3,00,000 only. Give the
necessary journal entries and show how it will be treated in the Final Accounts.
Solution :
Journal

Notes Date Particulars LF. Dr. (`) Cr. (`)

2013
Dec. 31 Loss by Fire A/c Dr. 4,00,000
To Trading A/c 4,00,000
(Being loss of stock by fire)
Mar. 31 Insurance Co. Dr. 3,00,000
P & L A/c Dr. 1,00,000
To Loss by fire A/c 4,00,000
(Being insurance co. admitted
a partial claim only)
Trading Account
for the year ended 31st Dec. 2013
Dr. Cr.
Particulars ` Particulars `

By Loss by Fire A/c 4,00,000

Profit and Loss Account

for the year ended 31st Dec. 2013
Dr. Cr.
Particulars ` Particulars `

To Loss by fire 4,00,000

Less : Ins. Claim 3,00,000 1,00,000

Balance Sheet
as at 31st Dec. 2013
Liabilities ` Asset `
Current Assets

Claim due from Insurance Co. 3,00,000

122 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
Illustration : 7
From the following Ledger balances of Mr. Ghanshyam, prepare the Trading and Profit
and Loss Account for the year ended 31st March 2013 and the Balance Sheet as on
that date after making the necessary adjustments.
Particulars ` Particulars `
Trade Expenses 8,000 Purchases 8,20,000
Freight and Duty 20,000 Stock on (1.4.2012) 1,50,000
Carriage Outwards 5,000 Plant and Machinery (1.4.2012) 2,00,000
Notes
Sundry Debtors 2,06,000 Pland and Machinery (additions
Furniture and Fixtures 50,000 on 1.10.2012) 50,000
Return Inwards 20,000 Drawings 60,000
Printing and Stationery 4,000 Capital 8,00,000
Rent, Rates and Taxes 46,000 Reserve for Doubtful Debts 8,000
Sundry Creditors 1,00,000 Rent for Premises Sublet 16,000
Sales 12,00,000 Insurance Charges 7,000
Return Outwards 10,000 Salaries and wages 2,13,000
Postage and Telegraphs 8,000 Cash in Hand 62,000
Cash at Bank 2,05,000

Adjustments :
(i) Stock on 31st March 2013 was ` 1,40,000.
(ii) Write off ` 6,000 as Bad Debts.
(iii) Provision for Doubtful Debts is to be maintained @5%.
(iv) Provide Depreciation on furniture and fixtures at 5% p.a. and on plant and
machinery at 20% p.a.
(v) Insurance prepaid was ` 1,000.
(vi) A fire occurred in the godown and stock of the value of ` 50,000 was destroyed.
It was insured and the insurance company admitted full claim.
Solution :
Trading and Profit and Loss Account
for the year ended 31st March, 2013
Dr. Cr.
Particulars ` Particulars `
To Opening Stock 1,50,000 By Sales 12,00,000
To Purchases 8,20,000 Less : Return Inwards 20,000 11,80,000
Less : Return Outwards 10,000 8,10,000 By Loss of Stock by Fire A/c 50,000
To Freight and Duty 20,000 By Closing Stock 1,40,000
To Gross Profit c/d 3,90,000
13,70,000 13,70,000

Accountancy 123
 MODULE - 3 Financial Statements : II
Financial Statement
To Trade Expenses 8,000 By Gross Profit b/d 3,90,000
To Carriage Outwards 5,000 By Rent for Premises 16,000
To Depreciation on Furniture
and Fixtures 2,500
To Dep. on Plant and Machinery
2,00,000 x 20/100 40,000
5,000 x 20/100 x 6/12 5,000 45,000
To Printing & Stationery 4,000
Notes To Rent, Rates and Taxes 46,000
To Insurance 7,000
Less : Prepaid 1,000 6,000
To Salaries and Wages 2,13,000
To Postage and Telegraphs 8,000
To Provision for Doubtful
Debts (Closing)
(` 2,00,000 x 5/100) 10,000
Add : Bad Debts 6,000
16,000
Less: Provison for Doubtful
Debts (Opening) 8,000 8,000
To Net Profit transferred
to Capital A/c 60,500
4,06,000 4,06,000

Balance Sheet
as at 31st March, 2013
Libilities ` Assets `
Current Liabilities Current Assets
Sundry Creditors 1,00,000 Cash in Hand 62,000
Capital Cash at Bank 2,05,000
Opening Balance 8,00,000 Sundry Debtors 2,06,000
Add: Net Profit 60,500 Less: Further Bad Debts 6,000
8,60,500 2,00,000
Less: Drawings 60,000 8,00,500 Less: Provision for
Doubtful Debts 10,000 1,90,000
Closing Stock 1,40,000
Insurance Claim 50,000
Prepaid Insurance 1,000
Fixed Assets
Furniture and Fixture 50,000
Less: Depreciation 2,500 47,500

124 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
Plant and Machinery 2,50,000
Less: Depreciation 45,000 2,05,000
9,00,500 9,00,500

14. Drawings of Goods by the Proprietor

When the proprietor draws some goods or cash from the business for his/her personal
use, it is a drawing.
Now, if you find that this has not been recorded in the books, you have to make the
Notes
necessary adjustments to take it into the Final Accounts. Then the treatment of such
drawings of goods by the proprietor in the Final Account is as follows:
i. Deduct it from purchases on the debit side of Trading A/c.
ii. Deduct it either from the capital or add to drawings on the liability side of the
Balance Sheet.
Accounting Treatment of Drawings
I. Drawing made in cash
(i) Drawings A/c Dr.
To Cash/Bank A/c
(Being cash withdrawn for personal use)
(ii) Capital A/c Dr.
To Drawings A/c
(Being drawings transferred)
II. Withdrawal of Goods by the Proprietor
(i) Drawings A/c Dr.
To Purchases A/c
(Being goods withdrawn for personal use)
(ii) Capital A/c Dr.
To Drawings A/c
(Being drawings transferred)
III. Income Tax Paid by sole proprietor out of the entity’s (business) cash
(i) Income Tax A/c Dr.
To Cash/Bank A/c
(Being Income Tax Paid)

Accountancy 125
 MODULE - 3 Financial Statements : II
Financial Statement
(ii) Drawings A/c Dr.
To Income Tax
(Being Income Tax Transferred)
(iii) Capital A/c Dr.
To Drawings
(Being drawings transferred)
Notes
15. Goods Distributed as Free Samples
For sales promotion, some of the goods may be distributed as free samples. For example,
if goods worth ` 10,000 are distributed as free samples then it will be an advertisement
for the concern but on the other hand the stocks will be less by goods of such value. In
order to bring this into the books of accounts the following entry is passed :
Advertisement A/c Dr.
To Purchases A/c
(Being goods distributed as free samples)
The two-hold effect of this entry will be :
i. It is shown on the credit side of Trading A/c, or deducted from the purchases.
ii. It is shown on the debit side of the profit and loss A/c as advertisement expenses.
Illustration : 8
From the following Trail Balance, Prepare the Trading and Profit & Loss A/c for the
year ended March 31, 2014 and the balance sheet as on that date :
Debit Balance ` Credit Balance `
Salaries 10,600 Sales 66,420
Bills Receivable 6,000 Capital 50,000
Investments 40,000 Pro. for Doubtful Debts. 2,500
Furniture 12,000 10% Loan (1.10.2013) 10,000
Opening Stock 4,500 Discount Received 400
Purchases 30,000 Sundry Creditors 9,300
Sundry Debtors 20,000 Bills Payable 5,000
Interest on Loan 400 Outstanding Salaries 500
Insurance Premium 900 Bad Debts Recovered 200
Wages 4,600 Interest on Investments 2,000

126 Accountancy
 Financial Statements : II MODULE - 3
Financial Statement
Rent 1,520 Trading Commission 7,000
Bad Debts 1,200
Carriage Outwards 600
Cash at Bank 10,000
Depreciation on Furniture 2,500
Accrued Commission 1,000
Notes
Advertisement 7,500
1,53,320 1,53,320
Adjustments :
i. Closing Stock - ` 6,000.
ii. Goods costing ` 1,000 were distributed as free samples while goods costing
` 500 were taken by the proprietor for personal use.
iii. A credit sale of ` 2,000 was not recorded in the sales book.
iv. Closing Stock included goods costing ` 1,000 which were sold and recorded as
sales but not delivered to the customer.
v. Maintain provision for Doubtful Debts @5%.
vi. Only one-third advertising expenses are to be written off.
Solution
Trading and Profit & Loss Account
for the year ending 31st March, 2014
Dr. Cr.
Particulars ` Particulars `
To Opening Stock 4,500 By Sales 66,420
To Purchases 30,000 Add : Credit Sales 2,000 68,420
Less: Free Samples 1,000 By Closing Stock 6,000
29,000 Less: Cost of Goods sold
Less : Drawing of Goods 500 28,500 but not delivered 1,000 5,000
To Wages 4,600
To Gross Profit c/d 35,820
73,420 73,420
To Salaries 10,600 By Gross Profit b/d 35,820
To Interest on Loan 400 By Old Pro. for Bad Debts 2,500
Add: Outstanding Interest Less: Bad Debts 1,200
on Loan 100 500 1,300
To Insurance Premium 900 Less : New Provision 1,100 200

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 MODULE - 3 Financial Statements : II
Financial Statement
To Rent 1,520 By Discount Received 400
To Carriage Outwards 600 By Bad Debts Recovered 200
To Depreciation of Furniture 2,500 By Interest on Investment 2,000
To Advertisement 2,500 By Trading Commission 7,000
To Free Samples 1,000
To Net Profit transferred to
Capital A/c 25,500
45,620 45,620
Notes
Balance Sheet
as at 31st March, 2013
Liabilities ` Assets `
Capital 50,000 Bill Receivable 6,000
Add: Net Profit 25,500 Investments 40,000
75,500 Furniture 12,000
Less: Drawings 500 75,000 Debtors 20,000
10% Loan 10,000 Add: Credit Sales Not
Outstanding Interest on Loan 100 Recorded 2,000
Creditors 9,300 22,000
Bills Payable 5,000 Less: New Provision 1,100 20,900
Outstanding Salaries 500 Accrued Commission 1,000
Closing Stock 5,000
Bank 10,000
Unexpired Advertisement Exp. 5,000
99,900 99,900

Summarised view of Adjustment Entries

Adjustment Adjustment entry Treatment in Trading Treatment in
and Profit & Balance Sheet
Loss A/c
1. Closing stock Closing stock A/c Dr Shown on the credit Shown on the
To Trading A/c side of Trading A/c Assets side

2. Outstanding Expenses A/c Dr Added to respective Shown on the

expenses To Outstanding expenses on the liabilities side
expenses A/c debit side

3. Prepaid Prepaid expenses A/c Dr Deducted from the Shown on the

expenses To Expenses A/c respective expenses Assets side
on the debit side

4. Accrued Accrued income A/c Dr Added to the Shown on the

income To Income A/c respective income Assets side
on the credit side

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 Financial Statements : II MODULE - 3
Financial Statement
5. Income Income A/c Dr Deducted from the Shownn on the
received in To income received respective income liabilities side
advance in advance A/c on the credit side

6. Interest on Interest on capital A/c Dr Shown on the debit Shown as

capital To capital A/c side of P&L A/c addition to
capital on
liabilities side

7. Interest Capital A/c Dr Shown on the Shown as

on drawings To interest on credit side P&L A/c deduction to Notes
drawing A/c capital on
liabilities side

8. Depreciation Depreciation A/c Dr Shown on the Deducted from

To Assets A/c debit side P&L A/c the value of
Assets

9. Further Bad Debts A/c Dr Shown on the Deducted from

bad debts To Debtors A/c debit side P&L A/c debtors, shown
on Assets side

10. Provision for Profit & Loss A/c Dr Shown on the Shown as
bad and To Provision for bad debit side P&L A/c deduction from
doubtful debts and doubtful debts debtors on
Assets side.

11. Provision for Profit & Loss A/c Dr. Shown on the debit Shown as
Discount on To Provision for side P&L A/c deduction from
Debtors Discount debtors on
Assets side.

12. Commission to Profit & Loss A/c Dr. Shown on the debit Shown in
Manager To Manager’s side P&L A/c liability side
Commission

13. Extra Ordinary Profit & Loss A/c Dr. Shown on the debit Shown as
Loss To Extra Ordinary side P&L A/c deduction from
Loss concerned
Asset on
Assets side.

14. Drawings of Drawings A/c Dr. To be deducted from Shown as

goods by the To Purchases A/c purchases. deduction from
Owner Capital on
Liabilities side.

15. Distribution of Advertisement A/c Dr. To be deducted from Shown on

goods as free To Purchases A/c purchases. debit side of
samples P & L A/c

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Financial Statement

INTEXT QUESTIONS 18.4

State whether the following statements are True or False :
i. Proprietor draws some goods or cash from the business is a drawing.
ii. If proprietor draws goods then it will be deducted from purchases.
iii. Drawing is an asset.
Notes iv. Good distributed as free samples is advertisement for the business.
v. Goods distributed as free sample is shown on the debit side of trading A/c.

WHAT YOU HAVE LEARNT

z Adjustments are needed to be accounted for so that Income Statement and Position
Statement show the correct profit or loss and financial position.
z There can be items of income and expenditure which do not pertain to the
accounting year for which financial statements are being prepared. These are to
be excluded. These are called prepaid items.
z There can be items of expenses and income which are left out and are to be
accounted, which are called outstanding expenses or accrued incomes.
z Other important adjustments to be carried out are Closing Stock, Depreciation
on fixed assets, interest on capital and interest on Drawings.
z There may be further bad debts and provision for bad and doubtful debts need to
be made on debtors.
z Further bad debts are irrecoverable debts in addition to what has been shown in
the Trial Balance as bad debts
z Provision for bad and doubtful debts is created for future payments due from
debtors but seems to be irrecoverable. It is created on the basis of past experiences.
z The Process of creating provision for discount on debtors is same as provision for
doubtful debts. The likely amount of the discount to be allowed is debited to the
P&L A/c and the same will be deducted from debtors in the balance sheet.
z If the manager is allowed commission on the net profit before charging such
commission then the following formula should be used :
% of commission
Net Profit x
100
and if the manager is entitled for commission. On the net profit after charging such
commission then the following formula should be used :

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 Financial Statements : II MODULE - 3
Financial Statement
Net Profit x % of commission
(100 + % of commission)
z Abnormal losses occur because of fire, earthquakes or accidents. These may
destroy some fixed assets of the firm. In such case an Asset Account is credited to
trading A/c and debited to profit and loss A/c debited.
z Drawings of goods by the propriter is deducted from purchases on the debit side
of Trading A/c., and deducted from capital in Balance Shet.
z Goods distributed as free sample is duducted from purchases and shown in the Notes
debit side of P&L A/c as advertisement.

TERMINAL EXERCISE
1. Answer the following questions in brief.
(a) Why are adjustments needed?
(b) Why are outstanding expenses treated as liabilities?
(c) What is the difference between accrued income and unearned income?
2. Pass necessary journal entries for following adjustments :
i. Wages outstanding
ii. Depreciation on Furniture
iii. Interest on Investment accrued but not received
iv. Insurance Premium paid in advance
3. Why reserve is created for doubtful debts?
4. From the following trial balance of M/s V.B. Fertilizers prepare Trading & Profit
and Loss Account for the year ending 31st December, 2013 and Balance Sheet as
on that date. Also pass Journal entries for the adjustments:
Particulars Dr. (`) Particulars Cr (`)
Stock (1.1.2013) 13,800 Capital 65,000
Purchases 52,000 Bills payable 18,000
Wages 4,000 Sales 74,400
Return inward 2,400 Return outward 1,500
Land & Building 40,000 Discount 450
Plant & machinery 24,500 Creditors 6,500
Bills receivable 12,000 Interest 600
Debtors 5,500 Bad debts Reserve 250

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 MODULE - 3 Financial Statements : II
Financial Statement
Cash in hand & at Bank 8,750 Loan 8,000
Rent (office) 2,200 Commission 700
Bad Debts 400
Insurance 1,500
Freight inward 1,400
Fuel & Power 2,450
Furniture 4,500
Notes
1,75,400 1,75,400
Adjustments
i. Stock on 31.12.2013 ` 25,000.
ii. Write off depreciation on furniture 10% and on plant & machinery 20%.
iii. Provide for wages outstanding `650 and rent outstanding
` 200. Prepaid insurance amounted to ` 300.
iv. Further bad debts amounted to ` 100. Make a provision for bad & doubtful
debts @ 5% on debtors.
v. Interest on capital to be allowed @ 6%.
5. On 1st April, 2013 reserve for Bad Debts shows a balance of ` 3,200 Bad debts
during the year as per ledger were ` 2,100. Debtors amounted to `7,000. After
closing of the ledger, it was found that there were bad debts of ` 800. It was
decided to create a reserve for doubtful debts on creditors @6%.
Pass necessary journal entries and show the items in Profit & Loss account and
Balance Sheet.
6. From the following trial balance of Pranaya as at 31st December, 2014, prepare
Trading and Profit & loss account for the year ended 31st December, 2014 and a
Balance Sheet as on that date after making necessary adjustments. Also Give
journal entries for these adjustments
Trial Balance
as at 31-12-2014
Name of Account Dr. Balances Dr. Balances
(`) (`)
Pranaya’s Capital Account 1,00,000
Drawings 24,000 –
Plant and Machinery 45,000 –
Stock (1st Jan, 2014) 15,000 –
Purchases 85,000 –
Return inwards 5,000 –
Sundry Debtors 24,600 –

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 Financial Statements : II MODULE - 3
Financial Statement
Freight and duty 2,000 –
Carriage outwards 1,600 –
Rent Rates & Taxes 3,800 –
Sundry Creditors – 22,000
Postage & Courier Expenses 1,800
Sales – 1,35,000
Provision for Bad Debts – 600
Discount – 800
Insurance Premium 900 – Notes
Wages 23,000 –
Cash in Hand 6,200 –
Cash at Bank 20,500 –
2,58,400 2,58,400
Adjustments
i. Stock on 31st December, 2014 was valued at ` 24,000.
ii. Write off ` 600 as bad debts.
iii. Provision for doubtful debts is to be maintained at 5% on sundry debtors.
iv. Provide depreciation on plant and machinery at 20%. A machine costing `
1,500 was purchased on 1st July, 2014.
v. Wages outstanding amounted to ` 1,500, and Insurance Prepaid was ` 250.
7. The following are the balances extracted from the books of Chinmay Aggarwal
on 31st March 2014.
` `
Chinmay’s Capital 60,000 Stock (1.4.2013) 44,200
Furniture & Fixtures 5,000 Debtors 36,000
Bank Overdraft 8,400 Rent received 2,000
Creditors 27,600 Purchases 2,20,000
Business Premises 50,000 Sales 3,00,000
Discount (Dr) 3,200 Sales Returns 4,000
Tax & Insurance 4,000 Bills Payable 10,000
Salaries 20,000
Commission (Cr.) 2,000
Carriage inward 3,600
Bad Debts 1,600
Motor Vehicle 14,400
Investments 4,000
Following adjustments are to be made :
(i) Stock on 31 March, 2014 ` 35,000.

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 MODULE - 3 Financial Statements : II
Financial Statement
(ii) Write off depreciation on :
Business Premises ` 800
Furniture & Fixture ` 500
Motor Vehicle 10% p.a.
(iii) Interest on bank overdraft ` 150.
(iv) Interest on capital was to be allowed @ 6% p.a.
Notes
(v) Make a provision of 5% on debtors for doubtful debts.
(vi) Carry forward ` 500 for unexpired insurance.
Prepare Trading and Profit & loss A/c for the year ended 31st March, 2014 and
Balance Sheet as on that date.
8. Pass necessary journal entries for the following adjustments :
i. 1/3 rd of the total commission received during the year of
`12000 relates to the next year
ii. Insurance premium of Rs.8000 is paid for the year ending 30st June. Accounts
are closed on 31st March every year.
iii. Interest on drawing is charged for the year amounting to ` 450.
9. Explain the following adjustments with examples :
i. Provision for discount on debtors.
ii. Manager’s Commission
10. What do you mean by Abnormal loss? Also explain its accounting treatment with
the help of an example.
11. Explain the accounting treatment of drawing of goods by the proprietor and goods
distributed as free samples.

ANSWERS TO INTEXT QUESTIONS

18.1 (i) profit, loss (ii) profit or loss, financial position
(iii) excluded (iv) accounted for
18.2 (i) Outstanding expenses (ii) Prepaid expenses
(iii) Accrued income (iv) Income received in advance
18.3 I. (i) provision for bad & doubtful debts
(ii) depreciation (iii) bad debts (iv) closing stock

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 Financial Statements : II MODULE - 3
Financial Statement
II. (i) To capital account (ii) To wages outstanding A/c
(iii) To insurance premium A/c
(iv) To commission received in advance A/c
III. (i) False (ii) True(iii) False (iv) False (v) True
IV. (i) Debit (ii) Liability
18.4 (i) True (ii) True (iii) False (iv) True (v) False
Notes

ANSWERS TO TERMINAL EXERCISE

4. (G.P. ` 24200; N.P. ` 12580
Total of Balance Sheet ` 114830
6. G.P. ` 27500; N.P. ` 10400
Total Balance Sheet ` 109900
7. G.P. ` 63200; N.P. ` 30610
Total balance Sheet : ` 140360

ACTIVITY
Analyse the financial statements of at least four business concerns and record the rate
at which depreciaiton is charged on various fixed assets and provision is made for
doubtful debts and find out the reasons of variation.
S.No. Name of Business Rate of Reasons of
concern Depreciation variation

Accountancy 135