Notes - Final Accounts

20. Final Accounts

20.1 Final Accounts of Sole Proprietor    

Financial statements are the final or end product of an accounting process. Financial statements are prepared by following the accounting concepts and conventions. These are the statements prepared at the end of accounting period and give information about the financial position and performance of an enterprise. A complete set of financial statements include balance sheet (or position statement) trading and profit and loss account (or income statement) schedules and notes to accounts forming part of balance sheet and profit and loss account.     

20.1.1 Trading Account   

Trading account is the first stage in the preparation of the final accounts. The trading account ascertains the result from basic operational activities of the business. Trading account is prepared to know the gross profit earned or gross loss incurred during the accounting period. Entries or items of debit side are opening stock, purchases and other direct expenses and on credit side, sales and closing stock are recorded. 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 follows    

\[Gross\text{ }Profit=Net\text{ }Sales-Cost\text{ }of\text{ }Goods\text{ }Sold\]where,

\[Net\text{ }Sales=Total\text{ }Sales-Sales\text{ }Return\text{ }Cost\text{ }of\text{ }Goods\text{ }Sold=Opening\text{ }Stock+Net\text{ }Purchases+Direct\text{ }Expenses-Closing\text{ }Stock\]\[Net\text{ }Purchases=Total\text{ }Purchases-Purchase\text{ }Return\]

20.1.2 Profit and Loss Account

Profit and loss account is prepared after the preparation of trading account. It shows the financial performance of a business during an accounting period. It is prepared to ascertain the net profit earned or net loss incurred by the business entity during an accounting period. Balance of trading account (gross profit or gross loss) is transferred to profit and loss account. The indirect expenses are transferred to the debit side of the profit and loss account. All revenues/gains other than sales are transferred to the credit side of the profit and loss account. If the total of the credit side of the profit and loss account is more than the total of the debit side, the difference is the net profit for the period, of which it is being prepared.

On the other hand, if the total of the debit side is more than the total of the credit side, the difference is the net loss incurred by the business firm. In an equation form, it is shown as follows

\[Net\text{ }Profit=Gross\text{ }Profit+Other\text{ }Incomes-Indirect\text{ }Expenses\]

20.1.3 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. It is prepared at the end of the accounting period after the trading and profit and loss account have been prepared. The assets reflect debit balances and liabilities (including capital) reflect credit balances. It is called balance sheet because it is a statement of balances of ledger account, which have not been closed till the preparation of the trading and profit and loss account.

Grouping and Marshalling of Assets and Liabilities

(i)   Grouping of Assets and Liabilities The term grouping means putting together items of similar nature under a common heading. The various items appearing in the balance sheet can also be properly grouped, e.g. die balance of accounts of cash, bank, debtors etc. can be grouped and shown under the heading of ‘current assets’.

(ii)  Marshalling of Assets and Liabilities Marshaling refers to the arrangement of assets and liabilities in a particular order. In a balance sheet, the assets and liabilities are arranged either in the order of liquidity or permanence

(a)  Order of Permanence In case of permanence, the most permanent assets or liabilities are put on the top in a balance sheet and thereafter they are arranged in their reducing level of permanence. In other words in case of assets, the ones which are to be used permanently in the business and are not meant to be sold are written first, e.g. goodwill and the ones which are most liquid are written last, e.g. cash in hand. In case of liabilities the payments to be made which are least urgent are written first, e.g. capital and the payments to be made which most urgent are written last, eg. short-term liabilities say short-term creditors (i.e. firstly capital then long-term liabilities and at last short-term liabilities).

(b)  Order of Liquidity Liquidity means the facility with which the assets may be converted into cash. In case of liquidity, the order is reversed. In case of assets, the most liquid assets are written first, e.g. cash in hand and the least liquid assets are written last, e.g. goodwill. In ruse of liabilities, the most urgent payments to be made are written first short-term creditors and the least urgent payments to be made are written last, e.g. capital (i.e. firstly short-term liabilities, then long- term liabilities and in last capital). It can be better understood with the general format of balance sheet in order of liquidity.

20.2 Final Accounts of Not-for-Profit Organisations

Not-for-profit organisations or non-profit organisations are set up to render service to its members and to the society at large and not with the aim of earning profit. Examples of such organisations are schools, hospitals, clubs etc.

Accounting Records Maintained by Not-for-Profit Organisations

The final accounts of not-for-profit organisations include

1. Receipt and Payment Account

It is a summary of cash and bank transactions during an accounting period. It begins with cash and bank balances in the beginning and ends with cash and bank balances at the end. Receipts are shown on the debit side and payments are shown on the credit side. Receipts and payments of every nature, i.e., whether it is capital or revenue in nature or whether it relates to the current year, previous year or next year are shown in this account. This account gives a fair idea about the cash position of an organisation. Format of Receipts and Payments Account

2. Income and Expenditure Account

It is just like the profit and loss account of a business firm. Incomes are shown on the credit side and expenses on the debit side. The difference between the two sides is either surplus (total of credit side is more than the total of the debit side) or deficit (total of credit side is less than the total of debit side). The balance is transferred to capital fund. The following points related to this account should be kept in mind.

• It is prepared according to the accrual basis of accounting.
• Only revenue incomes and revenue expenditures, whether received or paid or not are considered while preparing this account.
• Non-cash expenses such as depreciation are accounted.
• Capital expenditures and capital receipts are not recorded in this account.

3. Balance Sheet

Balance sheet is prepared by not-for-profit organisations to ascertain the financial position of the organisation. It is prepared on the same pattern as that of the business entities. Balance sheet is prepared at the end of the accounting period after preparing income and expenditure account. Sometimes, balance sheet needs to be prepared at the beginning of the year in order to find out the opening balance of the capital/general fund. The balance sheet shows assets on the right hand side and liabilities are shown on the left hand side along with capital fund or general fund. The capital fund or general fund is in place of the capital arid the surplus or deficit as per income and expenditure account shall be added to/deducted from this fund. Capital Fund = Total Assets - Total Liabilities

Format of Balance Sheet