FINANCIAL STATEMENTS
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.
In order to give information regarding the business to it users financial statements are prepared -
The basic objectives of preparing financial statements are :
- To present a true and fair view of the financial performance of the business;
- 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:
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.
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
|
|
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.
(viii) 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
PROFIT & LOSS ACCOUNT
Steps to be followed while preparing Profit and Loss Account
Debit side
- In case there is a Gross Loss, it is transferred from Trading A/c is written as the firstitem.
- then all items of revenue expenses and losses are written. These items may be stationery expenses, salaries, interest on loan,etc.
Creditside
- In case there is a Gross Profit, it is transferred from Trading A/c is written as the firstitem.
- Next all items of revenue incomes and gains are recorded. These may be interest oninvestments, discount received, commission received,etc.
Ascertaining Net Profit/NetLoss
The next step is to get the balancing figure as debit and credit will not match generally. If credit side is more than the debit side the difference in amount is written as Net Profit. If debit side exceeds the credit side, the difference is Net Loss. This amount is transferred to Capital Account.
Total of Debit side > Total of credit side ⇒ Net profit Total of creditside > Total of debit side ⇒ Net loss
Net Profit = Gross Profit + Other Incomes – Indirect Expenses
Relevant items in Profit & Loss account
- Salaries : These include salaries paid to the administration, godown and warehouse staff for the services rendered by them for running the business. If salaries are paid in kind by providing certain facilities (called perks) to the employees such as rent free accommodation, meals, uniform, medical facilities should also be regarded as salaries and debited to the profit and loss account.
- Rent paid : These include office and godown rent, municipal rates and taxes, factory rent, rates and taxes. The amount of rent paid is shown on the debit side of the profit and loss account.
- Commission paid: Commission paid or payable on business transactions undertaken through the agents is an item of expense and is debited to profit and loss account.
- Repairs :Repairs and small renewals/ replacements relating to plant and machinery, furniture, fixtures, fittings, etc. for keeping them in working condition are included under this head. Such expenditure is debited to profit and loss account.
- Selling & distribution expenses:These expenses are done in order to sell the goods in the market and to boost the sales as well as providing it to maximum sellers to cover a greater area. It is an indirect expense that is recorded in the debit side of profit & loss account.
- Provide Free delivery to Customer- Freight outward, Carriageoutward
- Godown rent
- After-saleservices
- Advertisement andPublicity
- Commission to the employee to promotesales
- Salary of the Marketingteam
- Travelling Expenses of the MarketingTeam
- Brokerage to an agent to promotesales
- Sales PromotionalExpenses
- Depreciation expenses: The expenses which occur due to reduction in the value of asset because of wear and tear of assets, technological obsolescence , usage of assets etc. It is a non cash expense.
- Interest paid : Interest paid on loans, bank overdraft, renewal of bills of exchange, etc. is an expense and is debited to profit and loss account.
- Miscellaneous expenses :Though expenses are classified and booked under different heads, but certain expenses being ofsmall amount clubbed together and are called miscellaneous expenses. In normal usage these expenses are called Sundry expenses or Tradeexpenses.
Credit side items
Other incomes :Besides salaries and other gains and incomes are also recorded in the profit and loss account. Examples of such incomes are rent received, dividend received, interest received, discount received, commission received, etc.
PROFIT & LOSS ACCOUNT OF ……. FOR THE YEAR ENDED 31ST MARCH 20XX
|
Particular
|
Amount
|
Particular
|
Amount
|
|
To Gross loss To Salaries
To commission paid To rent paid
To discount allowed To freight outwards To carriage outwards To bank charges paid To interest on loan
To printing &stationery To Travelling expenses To legal charges
To advertisement expenses To depreciation
To loss on sale of asset To profit
( Transferred to capital account)
|
|
By Gross Profit
By commission received By rent received
By discount received By gain on sale of asset By loss
( transferred to capital account)
|
|
|
Total
|
|
Total
|
|
Operating Profit
Operating profit is the excess of operating revenue over operating expenses. While calculating operating profit, the incomes and expenses of a purely financial nature are not taken into account. Thus, operating profit is profit before interest and tax (EBIT). Similarly, abnormal items such as loss by fire, etc. are also not taken into account. It is calculated as follows:
Operating profit = Net Profit +Non Operating Expenses – Non Operating Incomes
Non operating expenses includes expenses that are incurred for other than the core business of the entity. e.g. interest on loan
Non operating income includes income that is earned from other than the core business of the entity.
e.g. dividend income, profits or incomes earned from outside the business
Balance sheet
The balance sheet is a statement prepared for showing the financial position of the business summarising its assets and liabilities at a given date. The assets reflect debit balances and liabilities (including capital) reflect credit balances. It is prepared at the end of the accounting period after the trading and profit and loss account have been prepared. It is called balance sheet because it is a statement of balances of ledger accounts that have not been transferred to trading and profit and loss account and are to be carried forward to the next year with the help of an opening entry made in the journal at the beginning of the next year.
Preparing Balance sheet
All the account of assets, liabilities and capital are shown in the balance sheet. Accounts of capital and liabilities are shown on the left hand side, known as Liabilities. Assets and other debit balances are shown on the right hand side, known as Assets. There is no prescribed form of Balance sheet, for a proprietary and partnership firms.
BALANCESHEET OF …… AS AT 31ST MARCH, 20XX
|
Liabilities
|
Amount
|
Assets
|
Amount
|
|
Capital –
|
|
Fixed Assets-
|
|
|
+Profit for the year
|
Furniture& fixtures
|
|
– loss for the year
|
Land & Building
|
|
+ Drawings
+ additionalcapital
|
Goodwill.
Current Assets
|
|
= closing capital
|
Cash balance
|
|
Long term liabilities-
|
Bills receivable
|
|
Long term loans
|
Debtors
|
|
Current liabilities-
|
Bank balance
|
|
Bills payable
|
Closing stock
|
|
Bank overdraft
|
|
|
Creditors
|
|
|
Total
|
|
Total
|
|
Relevant Items in the Balance Sheet Items which are generally included in a balance sheet are explained below :
- CurrentAssets: Current assets are those which are either in the form of cash or a can be converted into cash within a year. The examples of such assets are cash in hand/bank, bills receivable, stock of raw materials, semi-finished goods and finished goods, sundry debtors, short term investments, prepaid expenses, etc.
- CurrentLiabilities: Current liabilities are those liabilities which are expected to be paid within a year and whichare usually tobe paid out of current assets. The examples of such liabilities are bank overdraft, bills payable, sundry creditors, short-term loans, outstanding expenses,etc.
- FixedAssets: Fixed assets are those assets, which are held on a long-term basis in the business. Such assets are not acquired for the purpose of resale, e.g. land, building, plant and machinery, furniture and fixtures, etc. Sometimes the term ‘Fixed Block’ or ‘Block Capital’ is also used for them.
- Intangible Assets: These are such assets which cannot be seen or touched. Goodwill, Patents, Trademarks are some of the examples of intangible assets.
- Investments: Investments represent the funds invested in government securities, shares of a company, etc. They are shown at cost price. If, on the date of preparation the balance sheet, the market price of investments is lower than the cost price, a footnote to that effect may be appended to the balance sheet.
- Long-term Liabilities: All liabilities other than the current liabilities are known as long-term liabilities. Such liabilitiesare usually payable after one year of the date of the balance sheet. The important items of long-term liabilities are long-term loans from bank and other financialinstitutions.
- Capital: It is the excess of assets over liabilities due to outsiders. It represents the amount originally contributed by the proprietor/ partners as increased by profits and interest on capital and decreased by losses drawings and interest on drawings.
- Drawings: Amount withdrawn by the proprietor is termed as drawings and has the effect of reducing the balance on his capital account. Therefore, the drawings account is closed by transferring its balance to his capital account. However it is shown by way of deduction from capital in the balance sheet.
Marshalling of Assets and Liabilities
- In a balance sheet, the assets and liabilities are arranged either in the order of liquidity or permanence. Arrangement of assets and liabilities in a particular order is known as Marshalling.
- In case of permanence, the most permanent asset or liability is put on the top in the balance sheet and thereafter the assets are arranged in their reducing level of permanence.