Back to Main Page

Web Notes

Financial Statements of a Proprietorship

General Accounting Principles Accounting cycles

FINANCIAL STATEMENTS

Stakeholder’s requirement for information-

A stakeholder is any person associated with the business. The stakes of various stakeholders can be monetary or non-monetary. The stakes can be active or passive; or can be direct or indirect. The owner and persons advancing loan to the business would have monetary stake.

The stakeholders are also called users who are normally classified as internal and external depending upon whether they are inside the business or outside the business.

Financial Statement –

In order to give information regarding the business to it users financial statements are prepared -

The basic objectives of preparing financial statements are :

(a) To present a true and fair view of the financial performance of the business;

(b) To present a true and fair view of the financial position of the business; and

For this purpose, the firm usually prepares the following financial statements:

1. Trading and Profit and Loss Account

Trading and Profit and Loss account, also known as Income statement, shows the financial performance in the form of profit earned or loss sustained by the business.

2. Balance Sheet

Balance Sheet shows financial position in the form of assets, liabilities and capital. These are prepared on the basis of trial balance and additional information, if any

Note –

The balance sheet and profit and loss account are now called position statement and statement of profit and loss in the company’s financial statements.

Trading Account

The trading account ascertains the result from basic operational activities of the business. The basic operational activity involves the manufacturing, purchasing and selling of goods.
It is prepared to ascertain whether the selling of goods and/or rendering of services to customers have proved profitable for the business or not.
It records the purchases made , direct expenses incurred on production and the sales made by the proprietorship in one year.

Format of Trading Account

Particular

Amount

Particular

Amount

To Opening stock

To Net Purchases

To direct expenses

To Gross profit*

By Net sales

By closing stock

By Gross Loss*

Total

* There would be either gross profit or gross loss

Relevant Items in Trading and Profit and Loss Account

The different items appearing in the trading and profit and loss account are explained hereunder:

Items on the debit side

(i) Opening stock :

It is the stock of goods in hand at the beginning of the accounting year. This is the stock of goods which has been carried forward from the previous year and remains unchanged during the year and appears in the trial balance. In the trading account it appears on the debit side because it forms the part of cost of goods sold for the current accounting year

(ii) Purchases less returns :

Goods, which have been bought for resale appears as purchases on the debit side of the trading account. They include both cash as well as credit purchases. Goods which are returned to suppliers are termed as purchases return. It is shown by way of deduction from purchases and the computed amount is known as Net purchases.

(iii) Wages :

Wages refer to remuneration paid to workers who are directly engaged in factory for loading, unloading and production of goods and are debited to trading account.

(iv) Carriage inwards/Freight inwards: These expenses are the items of transport expenses, which are incurred on bringing materials/goods purchased to the place of business. These items are paid in respect of purchases made during the year and are debited to the trading account.

(v) Fuel/Water/Power/Gas : These items are used in the production process and hence are part of expenses.

(vi) Duty on purchases:

Any duty ( custom duty on goods imported ) paid on the purchase of goods is a part of purchase cost

(vii) Packaging material and Packing charges Cost of packaging material used in the product are direct expenses as it refers to small containers which form part of goods sold. However, the packing refers to the big containers that are used for transporting the goods and is regarded as an indirect expense debited to profit and loss account.

(vii) Royalties

The payments which are made for acquiring the right to use patents. It s treated as direct expenses

Items on the credit side

(i) Sales less returns :

Sales account in trial balance shows gross total sales(cash as well as credit) made during the year. It is shown on the credit side of the trading account. Goods returned by customers are called return inwards and are shown as deduction from total sales and the computed amount is known as net sales.

(ii) Closing stock :

The inventory that is left at the end of the year as it could not be sold during the year is termed as closing stock

GROSS PROFIT OR GROSS LOSS

The excess of sales over purchases and direct expenses is called gross profit.
If the amount of purchases including direct expenses is more than the sales revenue, the resultant figure is gross loss.
The computation of gross profit can be shown in the form of equation as : Gross Profit = Sales – (Purchases + Direct Expenses) The gross profit or the gross loss is transferred to profit and loss account.
Cost of Goods Sold –
Opening stock+ (purchase-purchase return)+ direct expenses – closing stock
Gross Profit = Sales - COGS

Example-

1. Consider the following information:

Rate of gross profit-25% on cost of goods sold , Sales – Rs 20,00,000, what is the gross profit

Explanation

Sales – cost of goods sold = Gross Profit

Let COGS be x

20,00,000 - 25% of x = x

20,00,000 = x+25%of x

20,00,000 = 1.25x

X = Rs. 16,00,000

Gp = 16,00,000* 25% = Rs. 4,00,000

2. Compute cost of goods sold for the year 2020 with the help of the following information and prepare trading account