CHAPTER -7

Income Statements
Learning Objectives
• To understand the meaning of profit and loss account
• To understand the method of preparing the profit and loss account

Introduction
After the agreement of trial balance, a trader closes ledger accounts with a view to ascertain the
following aspects:
• Gross profit
• Net profit
• Financial position of the firm

The gross profit on purchase and sale of goods is ascertained from the goods account. This is
because the goods account has stock of goods at commencement and purchases during the period
on the debit side and total sales and stock of goods at the end on the credit side. The difference
between the total of the two sides represents either gross profit or gross loss of the trader during a
given period.
In practice, however, an account under the heading of goods account is not opened. For detailed
information, the trader sub-divides the transactions relating to the movements of goods and
maintains separate accounts of the following:
• Cash and credit purchases under the heading “purchase account”
• Cash and credit sales under the heading “sales account”
• A separate stock account

The format of trading account is as follows:

Specimen

Dr. Trading A/c Cr.

Rs. Rs.
 To (Opening) Stock By Sales
To Purchases Less—
Less-- Returns outward Returns inward
To Carriage/Freight inward By (Closing) Stock
To Clearing Charges
To Octroi charges
To Wages
To Direct Expenses
* To Gross Profit
(Balancing Figure)
Total Total

In order to find out the gross profit or gross loss of a business, a trading account is prepared. This
account gives the overall profit of the business relating to an accounting period which is subject
to deduction of general administrative, selling and other expenses. Gross profit is the difference
between sale proceeds of a particular period and the cost of the goods actually sold during that
period.

Profit and Loss Account

Profit and loss account is prepared with a view to ascertain the profit or loss on account of
business activity during an accounting period. Profit and loss account is also an account like
other accounts in the ledger which discloses the net effect in the form of profit or loss resulting
from settling off the expenses incurred against the revenue earned during the accounting period.
The profit and loss account measures net income by matching revenues and expenses as per the
accepted accounting principles. The difference between total revenue and total expenses
represents net income or net loss according to whether the difference is positive or negative. In
this regard, it is pertinent to note that all the expenses incurred for the period are to be debited to
this account, whether paid or not. Likewise, all revenue earned, whether received or not, are to
be credited to this account.

The net result of the profit and loss account is ascertained by balancing it. If the credit side is
more than the debit side, it indicates net profit for the period. Conversely, if the debit side is
more than the credit side, it indicates net loss for the period.

Profit and Loss Account

Dr. For the year ended on .... . Cr.
 To Gross Loss By Gross Profit
To Salaries By Interest Received
To Office Rent By Discount
To Office Received
Expenses/General By Commission
Expenses/Admini Received
strative By Bad Debts
Expenses/Sundry Recovered
Expenses * By Net Loss
To Telephone transferred to
Charges/Rent Capital A/c
To Rates and
Taxes
To Insurance
To Printing and
Stationery
To Audit Fees
To Postage and
Telegram
To Interest Paid
To Bank Charges
To Commission
Paid
To Discount
Allowed
To Advertisement
To Bad Debts
To Carriage
outward
To Depreciation
on
Building
Furniture
Equipment
* To Net Profit
transferred to
Capital A/c

CHAPTER -8
Balance Sheet
Learning Objectives
• To understand the meaning of balance sheet
• To know the method of preparing a balance sheet
• To know the difference between profit and loss account and balance sheet
• To know the relationship between profit and loss account and balance sheet
Balance Sheet
The American Institute of Certified Public Accountants defines balance sheet as “a tabular
statement of summary of balances (debits and credits) carried forward after an actual and
constructive closing of books of account and kept according to the principles of accounting.” The
purpose of balance sheet is to show the resources that the company has, i.e. its assets, and from
where those resources come from, i.e. its liabilities and investments by owners and outsiders.
The balance sheet is one of the important statements depicting the financial strength of the
company. On one hand, it shows the properties which were utilized and on the other, the sources
of those properties. The balance sheet shows all the assets owned by the company and all the
liabilities and claims it owes to owners and outsiders. The balance sheet is prepared on a
particular date. The right hand side shows properties and assets. Usually, there is no particular
sequence for showing various assets and liabilities.

Form and Contents of Balance Sheet

There is no specific way to prepare balance sheet in the case of proprietary concerns and
partnership firms. The balance sheet is generally divided into parts, i.e. assets, liabilities and
capital. It is usually prepared in the horizontal form. The assets are shown on the right hand side
and capital and liabilities on the left hand side. The order of assets and liabilities is either on
liquidity basis or on permanency basis. When balance sheet is prepared on liquidity basis, large
liquid assets like cash in hand, cast at bank, investments etc. are shown first and small liquid
assets later. On liabilities side, the liabilities to be paid in the short period are shown first, long-
term liabilities next and capital in the last.
The liquidity form is suitable for banking and other financial companies. When balance sheet
prepared on permanency basis, on assets side, fixed assets are shown first and liquid assets later.
On liabilities side, the capital is shown first, long-term liabilities next, and short-term and current
liabilities in the last.

Schedules
The details of various items are shown separately in schedules. It incorporates all the information
required under Part I A of Schedule VI. The schedules, accounting policies and other explanatory
notes will form part of the balance sheet.
A number of schedules are prepared to supplement the information supplied in the balance sheet.
The schedules of investments, fixed assets, debtors etc. are prepared to give details about these
transactions. A banking company may prepare a detailed schedule of advances so as to
supplement the balance sheet information. All these schedules are used as part of financial
statements.

Explanation of Balance Sheet Items

1. Share Capital
Share capital is the first item on the liabilities side of a balance sheet. Authorized and issued
capital is shown giving the number of shares and their amount. The number of shares for which
public has applied (subscribed capital) are mentioned along with the type of capital, i.e.
preference share capital and equity share capital. If the capital is issued for other than cash, the
amount of such capital is mentioned. The fact of issue of bonus share is also mentioned. Any
unpaid calls are deducted from the called up capital. If forfeited shares are reissued, this amount
is added to the paid-up capital.

2. Reserves and Surplus

Under this heading, all those reserves which have been created out of undistributed profits are
shown. Reserves are classified as capital reserves and revenue reserves. Capital reserves are the
reserves which are not free for distribution as profits whereas revenue reserves are created out of
appropriations of profits. Following items are included here:
• Capital reserves
• Capital redemption reserve
• Share premium account
• Other reserves
• Surplus, i.e. profit and loss account
• Proposed additions to reserves
• Sinking fund

3. Secured Loans
All those loans against which securities are given are shown under this category. Debentures are
shown under this heading. Loans and advances from bank, subsidiary companies etc. should be
shown separately and the nature of securities should also be mentioned.

4. Unsecured Loans
These are the loans and advances against which the company has not given any security. The
items included here are deposits, loans and advances from subsidiary companies and loans and
advances from other sources. Short-term loans from banks and other sources are also shown in
this category. Short-term loans include those which are due for not more than one year on the
balance sheet. Loans from directors, managers etc. should be shown separately under different
sub-headings. This is done to show regard to them.

5. Current Liabilities and Provisions

These are divided into current liabilities and provisions. In this category, following items are
included:
(a) Current liabilities include the following:
• Acceptances
• Sundry creditors
• Subsidiary companies
• Advance payments and unexpired discounts
• Unclaimed dividends
• Other liabilities, if any
• Interest accrued but not paid on loans
(b) Following items are included under provisions:
• Provision for taxation
• Proposed dividends
• Provision for contingencies
• Provision for provident fund scheme
• Provision for insurance, pension and similar staff benefits schemes
• Other provisions

Assets Side
The assets are given under the following heads:
1. Fixed Assets
Fixed assets are shown distinctly from each other, e.g., goodwill, land building, leaseholds, plant
and machinery, furniture, railways sidings, patents, live stock, vehicles etc. These assets are
shown at their original cost. Any additions and deductions during the year are shown separately.
The amount of depreciation upto the previous year and during the current year is separately
deducted from the assets.
2. Investments
Investments are shown by giving their nature and mode of valuation. Investments under various
sub-heads such as investments in government or trust securities, in shares, debentures and bonds,
and in immovable properties are given separately in the inner column of the balance sheet.
3. Current Assets
According to Alexander Wall, “Current assets are such assets as in the ordinary and natural
course of business move onward through the various processes of production, distribution and
payment of goods, until they become cash or its equivalent by which debts may be readily and
immediately paid.” Current assets are either cash in hand and at bank or shortly convertible into
cash. The assets like debtors and bills receivables are one step away from cash. The stocks-in-
trade is considered to be two steps away from sales, which when made the collections will be
undertaken. The commonly used method of valuation, i.e. cost price, is not strictly used while
valuing stock. The stock is used either at cost or market price, whichever is low. This is done to
avoid anticipating profits during inflationary conditions and taking into account losses if there is
a fall in prices of stock. The debtors are shown after making a provision for bad and doubtful
debts. The debtors, if more than six months old, are given separately. The amounts owned by
directors etc., if included in debtors, are also separately mentioned.
4. Miscellaneous Expenditure
Deferred expenditure is shown under this heading. Miscellaneous expenditure are the expenses
which are not debited fully to the profit and loss account of the year in which they have been
incurred. These expenses are spread over a number of years and unwritten balance is shown in
the balance sheet. The items under this heading are preliminary expenses, discount allowed on
issue of shares or debentures, interest paid out of capital during construction etc.
 Balance Sheet of ….(name of the company)
as on ….(date on which balance sheet is prepared)
Liabilities Rs.
Share Capital
Authorized--
Shares of Rs.…each
Issued--
Preference shares of Rs…
each
Equity shares of Rs…each
Less calls unpaid
Reserves and Surplus
Capital Reserve
Capital Redemption
Reserve
Share Premium
Other reserves
Profit and Loss Account
Secured Loans
Debentures
Loan and advances from
banks
Loans and advances from
subsidiary
Other loans and advances
Unsecured loans
Fixed deposits
Short term loans and
advances
Other loans and advances
Current Liabilities and
Provisions
A. Current Liabilities
Acceptances
Sundry Creditors
Outstanding Expenses
B. Provisions
Provision for Taxation
Proposed Dividends
For Contingencies
For Provident Funds
Scheme
For Insurance, Pension
and other benefits
Assets Rs.
Fixed Assets
Goodwill
Land
Building
Households
Railway Sidings
Plant and Machinery
Furniture
Patents and Trade Marks
Livestock
Vehicles
Investments
Government or trust
Securities
Shares, Debentures, Bonds
A. Current Assets
Loans and Advances
Interest accrued
Stores and Spare parts
Loose tools
Stock in Trade
Work in progress
Sundry debtors
Cash and Bank Balances
B. Loans and Advances
Advances and loans to
subsidiary
Bills receivables
Advance Payments
Miscellaneous Expenditure
Preliminary Expenses
Discount on issue of
Shares and Debentures
Other Deferred Expenses
Profit and Loss Account
(Debit Balance)
Distinction between Profit and Loss Account and Balance Sheet
Profit and Loss Account Balance Sheet
1. Profit and loss account is an account. 1. Balance sheet is a
statement of assets
and liabilities.
2. Profit and loss account shows the 2 The balance sheet
profit or losses during the accounting shows the financial
period. position of the
business.
3. It is prepared for the accounting period 3. It is prepared as on
which has ended. the last date of the
accounting period.
4. Accounts appearing in profit and loss 4. Accounts appearing
account are completely closed. in the balance sheet
carry forward balance
which become the
opening balances for
the next period.

Summary

1. The profit and loss account and the balance sheet are together known as final accounts. These
are the final steps in the accounting process.

2. The profit and loss account is prepared to show the financial results of an enterprise.

3. Balance sheet shows the position of assets and liabilities of a business entity as on a particular
date.

CHAPTER -9
Final Accounts
Learning Objective
• To know how to make various adjustments in trial balance

Adjustments
All the transactions which pertain to the period of final accounts but are not considered while
preparing the trial balance are called adjustments. These transactions have been recorded and
appear in trial balance but do not pertain to the period of final accounts.
Adjustments given outside the trial balance represent entries yet to be made in the journal and the
ledger, with the result that the effects of each of the adjustments have to be recorded. Therefore,
the effect of nominal account appears in the trading or profit and loss account. At the same time,
the effect concerning an asset or liability appears in the balance sheet.
In short, all the adjustments given outside the trial balance will appear in both the trading or
profit and loss account and the balance sheet. The exception will be in the cases where an
adjustment is such that it affects two nominal accounts only and when both the effects of the
adjustment will have to be dealt with in the trading and profit and loss account.
Problem 1
Prepare a trading account, profit and loss account and balance sheet from the following trial
balance of Mr. Kumar.
PARTICULARS Amount (Dr.) Amount (Cr.)
Stock at Commencement 60,000
Kumar’s Drawings 22,000
Trade Expenses 1,350
Salaries 11,200
Advertising 840
Discount 600
Bad Debts 800
Business Premises 12,000
Furniture and Fixtures 10,000
Cash in Hand 2,060
Kumar’s Capital 70,000
Purchase Returns 2,600
Purchases 1,50,000
Sales Returns 5,400
Wages 7,000
Conveyance Charges 1,320
Rent, Rates, Taxes and Insurance 5,600
Interest 430
Plant and Machinery 20,000
Sundry Debtors 92,000
Sales 2,50,000
Sundry Creditors 60,000
Bank Overdraft 20,000
Total 4,02,600 4,02,600

Adjustments
1. Stock at end was Rs. 90,000
2. Outstanding rent was Rs. 500
3. Outstanding wages Rs. 400
4. Prepaid insurance was Rs. 300 and prepaid salaries were Rs. 700
5. Write off Rs. 800 as further bad debts
6. Provide for doubtful debts at 5% on sundry debtors
7. Provide depreciation on premises at 2½%, plant and machinery at 7½% and
furniture at 10%.

Profit and Loss A/c for the year ended on March 31, 1999
 Particulars Amount Particulars Amount
To Trade Expenses 1,350 By Gross Profit 1,19,800
To Salaries 11,200
Less-- Prepaid 700 10,500
To Conveyance Charges 1,320
To Advertising 840
To Rent, Rates, Taxes and
Insurance 5,600
Add-- Rent Outstanding 500
6,100
Less-- Prepaid Insurance 300 5,800
To Discount 600
To Interest 430
To Bad Debts 800
Add-- Further 800
Add-- New Bad Debts
Reserve 4,560 6,160
To Depreciation
Premises 300
Plant and Machinery 1,500
Furniture and Fixtures 1,000 2,800
To Net Profit 90,000
119800 119800

Note
The bad debts reserve (new) is calculated at 5% on sundry debtors, i.e. Rs. 92,000, after
deducting the bad debts of Rs. 800 written off this year (the adjustments), i.e. 5% of Rs. 92,000 –
800 = Rs. 91,200 (i.e. Rs. 4,560).

Balance Sheet of Mr. Kumar as on March 31, 1999

Liabilities Rs. Assets Rs.
Capital 70,000 Plant and Machinery 20,000
Less--Drawings 22,000 Less--Depreciation 1,500 18,500
48,000 Business Premises 12,000
Add Net Profit 90,000 1,38,000 Less--Depreciation 300 11,700
Outstanding-- Furniture and Fixtures 10,000
Rent 500 Less--Depreciation 1,000 9,000
Wages 400 900 Sundry Debtors 92,000
Bank Overdraft 20,000 Less--Bad Debts 800
Sundry Creditors 60,000 91,200
Less--Bad Debts R. 4,560 86,840
Cash in hand 2,000
Stock at end 90,000
Prepaid--
Insurance 300
 Salaries 700 1,000
334600 334600

Problem 2
From the following trial balance of Shri Wani, prepare final accounts for the year ended on
March 31, 1999.
Trial Balance
Debit (Rs.) Credit (Rs.)
Stock on 1.4.1999 30,000 35,000
Purchases 75,000 1,25,000
Investments 11,000 1,300
Returns Inward 2,700
Trade Expenses 675
Wages 3,500
Salaries 5,600
Office Expenses 660
Advertisement 420
Rent, Rates and Insurance 2,800
Bad Debts 400
Discount 300
Interest and Commission 215
Premises 6,000
Plant and Machinery 10,000
Fixtures and Fittings 5,000
Sundry Debtors 46,000
Cash in hand 1,030
Capital
Sales
Returns Outwards
Creditors 30,000
Bank Overdraft 10,000
201300 201300
Total

Adjustments
1. Stock on March 31, 1999 was Rs. 45,000.
2. There were outstanding liabilities in respect of rent of Rs. 550 and wages of Rs. 200.
3. Insurance paid in advance amounted to Rs. 150. Salaries were unpaid to the extent of Rs. 350.
4. Write off Rs. 400 as further bad debts and maintain doubtful debts at 5% on debtors.
5. Depreciate premises by 2½%, machinery at 7½% and fixture and fitting at 10%.
6. Accrued interest on investments is Rs. 275.

Solution
Trading and Profit and Loss Account of Shri Wani
 Dr. for the year ended on March 31, 1999 Cr.

To (Opening) Stock 30,000 By Sales 1,25,000

To Purchases 75,000 Less--
Less-- Return outwards _1,300 73,700 Returns 2,700 1,22,300
To Trade Expenses 675 Inwards
To Wages 3,500
Add-- Outstanding __200 3,700 By (Closing)
To Gross Profit c/d 59,225 Stock 45,000
1,67,300 1,67,300
To Salaries 5,600
Add-- Outstanding __350 5,950 By Gross 59,225
To Rent, Rates and 2,800 Profit
Insurance __250 By Accrued 275
Add-- Outstanding Rent 3,050 Interest on
Less-- Prepaid Insurance __150 2,900 Investments
To Office Expenses 660
To Interest and Comm. 215
To Discount 300
To Bad Debts 400
Additional 400 800
To Reserve for Doubtful
Debts 2,280
To Advertisement 420
To Depreciation-- 150
Premises 750
Machinery 500 1,400
Fittings
To Net Profit
transferred to capital 44,575
59500 59500

Balance Sheet as on March 31, 1999

 Bank Overdraft 10,000 Cash in Hand 1,030
Creditors 30,000 Stock 45,000
Outstanding Expenses Sundry Debtors 46,000
Wages 200 Less-- Bad Debts ___400
Rent 250 Written off 45,600
Salaries 350 800 Less-- R.D.D. _2,280 43,320
Capital 35,000 Investments 11,000
Add-- Net Profit 44,575 79,575 Accrued Interest 275
Prepaid Insurance 150
Fixtures & Fittings 5,000
Less-- Depreciation __500 4,500
Plant & Machinery 10,000
Less-- Depreciation __750 9,250
Premises 6,000
Less-- Depreciation 150 5,850

334600 334600

Questions
1. What are the final accounts of a company? State their importance.
2. What is the relationship between profit and loss account and balance sheet?
3. What do you understand by adjustment entries?
4. From the following trial balance, prepare the trading and profit and loss account for the year
ended on March 31, 1996. Also prepare the balance sheet as on date after taking into account the
adjustments given below:
 Rs. Rs.
Salaries and Wages 40,600
Fright and Clearing Charges 6,725
Commission 12,750
Printing and Stationery 6,400
Furniture and Fixtures 12,000
Rent, Rates and Taxes 35,250
Telephone Charge 3,715
Postage and Telegrams 6,280
Office Expenses 9,655
Shah’s Capital Account 3,08,860
Shah’s Drawings Account 28,000
Insurance Charges 1,200
Purchases 7,92,000
Sales 6,40,000
Returns Inwards 3,400
Returns Outwards 12,000
Stock on April 1995 45,000
Sundry Debtors 1,00,000
Sundry Creditors 1,80,000
Bad Debts 6,000
Doubtful Debts Reserve (April 1995) 12,000
Cash at Bank 16,935
Cash in hand 1,275
Motor Car Expenses 7,675
Motor Car 18,000

1152860 1152860

Adjustments

(a) Depreciation to be provided on furniture and fixtures @ 10% and on motor car @ 20%.

(b) Insurance is paid for the year ended on 30th June 1996.

(c) Rent outstanding was Rs. 750.

(d) Commission due to salesman was Rs. 3,250.

(e) Closing stock was valued at Rs. 3,08,400.

(f) It was decided to bring doubtful debts reserve to Rs. 5,000.

(Answers: Gross Profit-- Rs. 1,13,275, Net Loss-- Rs. 17,000, Balance Sheet total-- Rs.
4,47,110)