UNIT-3

Preparation of final account

 Profit making concern:
• After preparation of the trial balance, the businessman gets
interested in knowing that he has earned profit or incurred
losses.
• And to know his business position at the end of the accounting
period.
There are three stages in preparation of financial account:
I. Trading account
II. Profit and loss account
III. Balance sheet
 Cont…
Trading Account:
• This is the first part of financial accounts. This is created to
determine the result of trading i.e. purchasing and selling of
goods.
• Through this we can get to know if the firm has made profits
or losses during the accounting period.
• “Trading account shows the result of buying and selling of
goods. In preparing this account the general establishment
charges are ignored and only the transactions in goods are
included” J.R. Batliboi
 Important items of trading account:
• Open stock: in the beginning of the year the businessmen has
some unsold stock of the previous year. It is called the open
stock.
• Purchases and purchase return: the goods brought for resale is
called purchases. It includes cash sales and credit sales.
It is mentioned as following in trading account:
Net purchase= cash purchase+ credit purchase- purchase return.
• direct expenses: it consists of expenses incurred in acquiring
and manufacturing goods. The most common of them are
carriage, excise duty, import duty clearing charges, wages,
power, manufacturing expenses, factory expenses.
 Cont…
Sales and sales return: sales are shown on credit side of the
trading A/c.
• We should deduct sales return from such sales to find net sales.
Net sales= cash sales+ credit sales – sales return.
• closing stock =the goods remained unsold at the end of the
year is called closing stock.
• Valuation of closing stock: closing stock is valued at cost price
or market price whichever is less.
• This follows on the principle that a gain can not be treated a
gain unless it is actually received
• A loss is treated as a loss when it is visible.
 Cont…
Equation of trading account:
• Gross profit= Net sales – cost of goods sold
• Cost of goods sold = sales – gross profit
• Cost of goods sold = opening stock +purchase +direct
expenses –closing stock

Valuation of closing stock: closing stock is valued at cost price or

market price whichever is less.
it is followed by the principle that a gain cannot be treated a gain
unless it is actually received.
 Cont..
Importance of preparing a trading account:
• It provides information about gross profits and gross loss.
• Gross profit ratio is used to improve business administration.
• The actual performance can be compared with the desired performance.

Profit and loss account:

• This account is prepared after trading account. It is prepared to check on the net
profit and losses of the business concern.
• In P&L A/c all the indirect expenses, losses are shown in Dr. side of P&L while
all the indirect incomes and indirect profits are shown in Cr side of P&L account.
• Expenses and incomes which are not for manufacturing or trading of goods but
are because of business are included in P&L A/c.
• The operating expenses relate to office and administrating setting and distribution
whereas non operating expenses are debited to P&L A/c where all non- operating
incomes such as rent etc are credited to P/L A/c
 Important points regarding profit and loss
accounts:
Salaries:
• Any salary paid or payable to employees for service providing
by them in operation of business is shown in Dr. side of P&L
account.
Interest:
• It is the indirect nature. Interest an be on loan or over draft if it
is paid is mentioned in Dr. side of P&L A/c and if received is
credited in P&L A/c.
Bad debts:
• It denotes the amount loss from debtors to whom the goods
were sold on credit, it is loss.
 Cont..
Depreciation:
• It is decrease in value of fixed assets due to wear and tear
obsolesce. It is debited to P/L A/c.
Interest on capital & drawing:
• Interest in capital is given to the proprietor of the business. It
is an indirect expenses and debit to P/L A/c.
• The interest on drawing is charged from proprietor of business
so it is indirect income &credited to P/L A/c.
Factory expenses:
• All the indirect factory expenses are debited in P/L A/c.
 Balance sheet
• Balance sheet is prepared after preparing the P&L account.
• It is a sheet of balances in which a company mentions assets &
liabilities.
• Balance sheet is a classified summary of the balances remaining
open in the ledger, after all the income and expenditure accounts
have been closed off by a transfer to trading and profit and loss
account.
It has two sides:
• Left hand side is a liability side, while right had side is asset side.
• At the end the balance of both the sides should be equal.
• A balance sheet is the mixed list of the assets, liabilities and
proprietorship of business of an individuals.
 Cont …
Characteristics of a balance sheet:
• It is always prepared on particular date.
• The total of both the sides must be equal.
• Shows the financial position of the business.
• It is not an account but a statement but still it is a part of
the final accounts and is prepared with the help of
accounts.
• It has no debit side and credit side. Neither “to” nor “by”
are used before the names of the account.
 Importance of balance sheet:
• Financial position: balance sheet shows the financial position
of the firm. It is the list of liabilities and assets of the firm on a
specific date.
• Information of liquidity: it shows us the current assets and
liabilities of the firm.
If the current assets are greater that the current liability it is a
symbol of a health and sound liquidity position of the firm.
• Knowledge of proprietary ratio: ratios helps in decision
making. Proprietary ratio shows the relationship between
proprietor funds and total funds.
 Difference between profit and loss account
and balance sheets:
• P/L account is an account but a balance sheet is not an account
but a statement.
• P/L account includes nominal accounts while balance sheet
includes personal and real account.
• P/L account shows the profit and loss while balance sheets
shows the financial position of the firm.
• P/L account Dr. and Cr. is used while in balance sheet assets
and liabilities are used.
Accounting treatment of bad debt:
• An entity may not be able to recover its balances outstanding in respect
of certain money that was to be received.
• In accountancy we refer to such receivables as Irrecoverable Debts or
Bad Debts.
• Bad debts could arise for a number of reasons such as customer going
bankrupt, trade dispute or fraud.
• Every time an entity realizes that it unlikely to recover its debt from a
receivable, it must “write off” the bad debt from its books.
• This ensures that the entity's assets (i.e. receivables) are not stated above
the amount it can reasonably expect to recover which is in line with the
concept of prudence.
• The credit entry reduces the receivable balance to nil as no amount is
expected to be recovered from the receivable.
 Cont..
• Some people fail to pay their dues partially or completely. the
amount that is irrecoverable is loss and considered as bad debt.
The entry will be such:
• Bad debt A/C Dr.
• To debtor’s (name) Cr.
• So in this situation the debtors account is closed and a bad
debt account is opened, which is at the end of the year
transferred to the P/L account.
P/L account Dr.
Bad debt account Cr.
 Cont…
• Items appearing in the trial balance are transferred in the
trading account or P/L account or balance sheet.
• Eg. Bad debts that are appearing in the trial balance will be
transferred to the profit and loss account.
• If amount of bad debt is given outside the trial balance it is
called is future bad debt.
 Reserve for bad and doubtful debts:
• The provision for doubtful debts is the estimated amount of bad debt that
will arise from accounts receivable that have been issued but not yet
collected.
• It is identical to the allowance for doubtful accounts.
• Before doing accounting treatment of provision for doubtful debts , you
must know the complete definition of provision.
• In accounting, it is a reserve that is against loss due to non payment
of debtors .
• In case debtor does not give us our amount , then if we have make provision
or reserve for this,
• We can easily purchase new good but if we have no money due to every
year bad debts then we can become insolvent.
• So with our work experience we should make our provision on our debtors
with some % on debtor.
 Cont…
• Not necessary that provision for doubtful debt account will go
only to the debit side of this account but it may go to the
credit side as well.
• It will decide after making provision for doubtful debt
account ,which is very easy to make.
Provisions for discount on debtors:
• Discount is allowed when our debtors settle their accounts
promptly.
• If the debtors of the current period settle their accounts
promptly in the succeeding period, discount will have to be
allowed by us.
• The amount of discount is an expected loss and a provision
has to be made for it in the final accounts of the current year.
• The accounting procedure for this provision is similar to that
of Provision for doubtful debts discussed above.
• The discount that might be allowed on debts whose debts fall
in the succeeding year is estimated.
 Cont…
• The discount payable on debtors is only a contingent loss
and not a loss already incurred.
• The discount is to be given only to those debtors who
make prompt payment, thus the amount of provision for
discount on debtors is to be calculated on good debts.
• The account provision for discount on debtors is carried
forward next year.
• Profit and loss account and balance Sheet disclose true
financial position.
When discount is allowed, the entry is:
To discount account Dr.
To debtors account
• At the end of accounting year, the firm also estimates the amount
of discount which it may have to give to the debtors outstanding at
the end of the accounting period in the course of next year.
• Discount is allowed to prompt debtors, but not too bad and
doubtful debtors.
• Before making the provision for discount, the amount of bad and
doubtful debtors must first be estimated and deducted from the
amount of debtors as per the ledger on the balance of debtors.
• That is, on the good debtors only, the provision for discount on
debtors must be created.
Cont…
The double effect of Provision for Discount on Debtors is:
1) It is shown on the debit side of Profit and Loss Account.
2) It is shown as deduction from Debtors in Balance Sheet.
But remember the amount of Provision is calculated only after
deducting the amount of additional Bad Debts.
 Provisions for discount on creditors:
• Similar to cash discount allowed to debtors, the firm may have
a chance to receive the cash discount from the creditors for
prompt payment.
• Provision for discount on Creditors is calculated at a certain
percentage on Sundry Creditors.
Preparation of receipt and payment account
• "A receipt and payment account is a summarized cash book (cash and bank) for a
given period".
• This is simply a summary of the cash transactions as in the cash book, analyzed and
classified under suitable headings, including the opening and closing balances.
• Non-profit organizations prepare a receipt and payment account at the end of year.
• With the help of this account and some additional information, an income and
expenditure account is prepared to disclose the true results of non-profit
organizations.
• Receipt and payment account cannot disclose the true result of non-trading concern.
• All the information necessary for the preparation of this account is available
from cash book.
• Various cash receipts and cash payments during the whole year find place in this
account in a classified manner. Its closing balance indicates cash in hand and cash at
bank at the year end.
 Cont…
Features:
• It is a bridged addition of cash book it is, in effect, a summary of cash book.
• All cash receipts during the whole year are recorded on its left hand (i.e.
debit) side. While all the cash payments during the whole year written on its
right hand (i.e., credit) side, arranged in a classified form.
• Cash receipts and cash payments of both capital and revenue nature are
recorded here.
• Only cash transactions are recorded in this account.
• It generally shows a debit balance. In case of bank overdraft balance, its net
balance may be shown as credit.
• It may also show nil balance but such occasion is rare.
• Its closing balance indicates closing cash in hand and closing cash at bank.
• It is not an account within the double entry system it is a statement only.
• It is prepared on the last day of the accounting year.
 Cont….
Advantages of receipt and payment account:
• Total receipts and total payments under various heads
are available at a glance.
• The amount of cash in hand at the year end can be
ascertained.
• The correctness of cash book can be verified through it.
• The total of debit side of cash book will agree with the
total of receipt side of this account.
• On the other hand, the total of credit side of cash book
will agree with that of payment of this account.
 Preparation of income and expenditure
account
• Income and expenditure account is prepared in non profit
organization whose aim is not to earn money for personal
benefits but they distribute the profit for welfare activities.
• So, for showing the organization different from for profit
organization, they prepare income and expenditure account. It
is prepared just like preparing of profit and loss account.
 Cont…
1st Step: Get the Raw Data:
• Income and expenditure account is made on the basis of raw data which we get
from trial balance. All revenue nature expenses and incomes are added in the
income statement.
• If we did not make the trial balance, we can make income and expenditure account
on the basis of receipt and payment account.
• For charging the depreciation, you need opening balance of fixed asset which you
can find from opening balance sheet. Now, we tell you what you have to take from
receipt and payment account.

2nd Step: Show the Expenses and Incomes from Receipt and Payment Account :
We have explaining, how you can convert the payments and receipts of receipt
and payment account into the incomes and expenses of income and expenditure
account.
 Cont….
a) Credit side of receipt and payment will be payment side.
• In this side, you have to leave capital nature expenses and closing
balance.
• All other expenses payments will go to the debit side of income and
expenditure account.
 b) Debit side of receipt and payment will be receipt side.
• In this side, you have to leave capital nature incomes and opening
balance.
• All other income receipt will go to the credit side of income and
expenditure account.
 Cont..
3rd Step: Not Included Items in I/E Account: 
 a) Any donation which we receive for any particular fund,
we will not add in income and expenditure account.
• As per fund based accounting, we will treat it in that
particular fund.
 b) Any legacy amount which will get from the will of any
person will be capital receipt and will not shown in
income and expenditure account.
 Cont….
4th Step : Show Adjustments:
• There are many adjustments which you have to do in the
income and expenditure account whose information, you
can not get from receipt and payment account.
• For example, you have to show depreciation of
fixed assets in the debit side of income and expenditure
account.
• You may show bad debt if there is any in the debit side of
I/E account.
Cont…
5th Step : Find the Balance of I/E Account: 
• Compare debit and credit side of income and expenditure
account.
• If credit side is more than debit side, it will be surplus over
expenses.
• If debit side will more than credit side, it will be deficit.