CHAPTER
1
INTRODUCTION
Financial
statements are key indicators of the heath of your business .In the preparation
of final account of a firm, the financial statements displays the net results
for the given year. They play a vital role in allowing a user of a financial
statement, to understand the result of a firm for a given year.
You have learnt the
procedure for recording and posting various business transactions in the
appropriate books of accounts and testing the arithmetic accuracy of these
records with the help of a trail balance. These are preliminaries to accounting
which is in fact called book keeping. A trader is anxious to know the operating
results in terms of profit or loss during a specified period of time and his
financial position on a particular date. The financial statement prepare at the
end of the accounting year. Normally the accounting year consider in 1ST
APRIL to 31ST MARCH. The summary is prepared in the form of a
trading account and Profit and Loss Accounting and Balance Sheet.
Hence the trail balance
forms the major source document for preparing the final statements. Since the
traders prepare his final account on the basis of ledger account balances, he
should make sure that the accounts are correct. Therefore, he should verify the
corrections of ledger accounts before the preparation for trading and profit
and loss accounts and balance sheet. The trail balance is the tool by which the
arithmetical accuracy of ledger accounts is tested. A trail balance is a
statement of all ledger accounts, prepared at the end of a period, to check the
arithmetical accuracy of the books kept under double entry principles.
The financial statements
that reflect a company’s profitability is the income statement (Trading and
profit and loss accounts) and position statements (Balance sheet).
Meaning
of Financial Statements
A
financial
statement is a formal record of the financial activities, and position of a
business, person, or other entity .It is presented in a structured manner and
in a form easy to understand. Financial statements of a company reflect true
pictures of its financial performance. It prepared a trading and profit and
loss account and balance sheet.
Financial statements are
the end products of the accounting process, which reveals the financial result
of the specified period and financial position as on a particular date. It is
the basic and formal annual report through which a business communities
financial information to its various user groups.
Definition
of Financial Statement
The American Institute of
Certified Public Accountants (AICPA) defines Financial Statements are prepared
for the purpose of presenting a periodical review of report on progress by the
management and deal with the status of investment in the business and the
result achieved during the period under review. They reflect a combination of
recorded facts, accounting principles and personal judgments”.
Financial
statements are defined as” a structured representation of the financial
position (Balance sheet), financial performance (Income statements) of an
entity and inflow and outflow of cash (Cash flow statement)”.
Nature
of Financial Statements
1. Recorded
facts
2. Accounting
conventions
3. Assumptions
4. Personal
judgments
5. Legal
implications
1. Recorded
facts
In accounting, only financial transactions are
recorded chronologically day to day transactions that are expressed and
measured in terms of money or money’s worth
2. Accounting convention
It refers to the general agreement on the
usage and practices in social or economic life, i.e., it is a customary
practice or rule, method, a usage. In other words, it is an accounting
procedure followed for the accounting community on the basis of long-standing
customs.
3. Assumptions
It is principle which is taken to be
self-evident or axiomatic
4.
Personal judgments
Financial Statements must be prepared as
per the accounting principles and the legal framework along with the
consultation of Accounting Standards.
4. Legal
implications
While
preparing the financial statements, legal formalities of the country must be
observed or followed, i.e., law of the land, for example Indian Companies must
prepare their financial statements as per the requirements of Indian Companies
Act,1956. In short, the Profit and Loss Account and Balance Sheet must be
prepared as per the Schedule V1 of the Companies Act, 1999.
Objectives of Financial Statements
· To
assess the earning capacity or profitability of the firm.
· To
assess the operational efficiency and managerial effectiveness.
· To
assess the short term as well long term solvency position of the firm.
· To
identify the reason for change in the profitability and financial position of
the firm.
· To
make inter-firm comparison.
· To
make forecasts about future prospect of the firm.
· To
assess the progress of the firm over a period of time.
· To
help in decision making and control.
· To
guide or determine the dividend action.
· To
provide important information for granting credit.
Characteristics of Financial
Statements
·
Relevance
·
Reliability
·
Understandability
·
Comparability
·
Consistency
·
Objectivity
·
Liquidity
·
Foresight
·
Simplicity
·
Timeliness
Importance of Financial Statements
·
Importance to management
·
Importance to creditors
·
Importance of bankers
·
Importance to investors
·
Importance to government
·
Importance to the shareholders
·
Importance of labor
·
Importance of public
Components
of Financial Statements
1. Income
statements
v Trading Account
v Profit
and Loss Account
2. Statement
of Financial Position
v Balance
Sheet
Limitations
of Financial Statements
·
Provide only interim reports
·
Aggregative information
·
No qualitative information
·
Personal biasness
·
Historical cost
·
Financial Statements are based on accounting
concepts and conventions
·
Inflationary effects
·
Intangible assets not recorded
·
Based on specific time period
EXCERCISES
1. Short
answer type question
1. What
is financial statements
2. Define
financial statements
3. What
are the components of financial statements
4. What
are the objectives of financial statements
II.
Long
answer type question
1. What
are the needs and importance of financial statements
2. Define
financial statements and explain its characteristics and limitations
CHAPTER 2
TRADING
ACCOUNT
A
trading account can be any investment accounts containing securities, cash or other holdings. Most
commonly, trading account refers to a day trader’s primary account. These
inventors tend to buy and sell assets frequently, often within the same trading
session, and their accounts are subject to special regulation as a result. The
assets held in a trading account are separated from others that may be part of
a long-term buy and hold strategy.
The action or activity of
buying and selling goods and service is known as trade. Trade is a basic
economic concept involving the buying and selling of goods and services, with
compensation paid by a buyer to a seller, or the exchange of goods or services
between parties is known as trading. Trading account is the first step of final
accounts. It is prepared with a view to determine the amount of gross profit or
gross loss made by the business during he given period of time. This note has
information about trading account.
Meaning
of Trading Account
Trading Account is the
account prepared to ascertain the trading profit or gross profit, which is the
difference between sales and cost of goods sold or cost of services rendered by
an enterprise. It is the first statements to be prepared in Final Account. It
is prepared to find out the result of buying and selling of goods or services.
It is a Nominal Account. Trading accounts consists of two sides debit and
credit. All direct expenses are debited and all direct incomes are credit in
trading account.
The trading accounts
include mainly four items. They are as follows
1.
Opening and closing stock
2.
Net purchase and sale of goods
3.
All expenses relating to purchase of
goods, and
4.
All expenses relating to day-to - day
operations like wages, factory rent, factory insurance etc.
5.
Objectives of Trading Account
The
trading account is prepared to achieve certain objectives, which are as follows
1. To
know the gross profit or gross loss
2. To
provide information about stock
3. To
provide information about net purchases and net sales
4. To
know about the factory expenses
5. To
make comparison
6. To
provide information about direct expenses
7. To
measures efficiency
Features of Trading Accounts
1.
It is a nominal account
2.
It is prepared on the last day of an
accounting year
3.
Only revenue transactions are included in
it. No capital items is taken into
account.
4.
It is the first stage in the preparation
of financial accounting statement of a trading concern
5.
It is records only the net sales and
direct cost of goods sold
6.
The balance of this account discloses the
gross profit and gross loss
7.
We transfer the balance of the trading
account to the profit and loss account
Purpose
of Trading Account
·
Ascertain the gross profit or gross loss
·
Enabling the management to make a comparison
of gross profit or gross loss of the current year with that of the previous
year.
·
Ascertaining different ratios such as
gross profit ratio, ratio of cost of goods sold to sale etc
Gross
profit/ Gross Loss
Profit arising out of
trading alone is called gross profit. Gross profit is the excess of net sales
over the cost of goods sold. If value of net sales is below the cost of goods
sold, the result will be a Gross loss. This can be presented in the form of an
equation.
Gross Profit =
Net Sales – Cost of goods sold
Where, 1. Net sales = Total Sales – Sales Return
2. Cost of
goods sold = Opening stock + Net purchase + Direct expenses - Closing stock
3. Net purchase = Total purchase-Purchase return
Gross profit may be calculated with the help of the
following statement.
Statement
of Trading Account
|
Particulars |
Amount(Rs) |
Amount(Rs) |
|
|
Net sales Less: Opening stock +Net purchase +Direct expense Cost of goods available for sale Less: Closing stock Cost of goods sold Gross profit/Gross loss |
xxx
xxx
xxx |
xxx xxx |
|
|
xxx
xxx |
|||
|
|
|||
|
xxx |
Illustration
1.
From the
following figures calculate the amount of Gross Profit earned by ABC, company
for the year ended 31st March 2019
Credit
sales Rs.125000, Cash Rs.85000, Sales return Rs.10000, Cost of goods sold
during the year Rs.112000.
Solution
Gross
Profit = Net Sales-Cost of goods
sold
Net
Sales = Total cash-Sales
return
Total
cash = Cash sales+ credit sales
Net
sales = Rs.85000+
Rs.125000-Rs.10000
= Rs.200000
Gross
Profit = Rs.200000-Rs.112000
= Rs.88000
Illustration
2.
The following relate to a
concern for the year 2019.Calulate Gross Profit.
Opening stock Rs. 15000
Purchase Rs. 35000
Direct expenses
Rs. 4000
Sales Rs.
8000
Closing stock Rs. 12000
Solution
Gross profit = Sales – Cost of goods sol
Cost of goods sold = Opening stock+ Purchase+
Direct expenses- Closing
stock
=
Rs15000+35000+4000+-12000
= Rs.42000
Sales = Rs. 80000
Gross Profit = Rs.80000- Rs.42000
= Rs.38000
Illustration
3.
Given below the balances
extracted from the books of XYZ Books stall for the year ending 31st
March 2019.
Opening stock Rs. 15000, Net
purchases Rs. 110000, Direct expenses, Rs.10000,Net sales Rs.200000,Closing
stock 15000.
Solution
Statement
of Gross Profit of XYX Book stall
for
the year ending 31st March 2019
|
Particulars |
Amount (Rs.) |
Amount (Rs.) |
|
|
Net Sales Less : Opening stock Net Purchase Direct Expenses Cost of goods available
for sale Less.: Closing
stock Cost of goods
sold Gross Profit |
15000 110000 10000 |
200000 |
|
|
120000 |
|||
|
135000 15000 |
|||
|
|
|||
|
80000 |
Illustration
4
Calculate Gross profit
and Gross loss from the following details from lechu’s textiles for the year
ending 31st March 2019
Purchase
= 36000
Sales
= 92000
Purchase return = 3000
Sales return = 2000
Direct expenses =2000
Closing stock =15000
Solution
Statement of Gross Profit of Lechu’s Textiles
for
the year ending 31st March 2019
|
Particulars |
Amount (Rs.) |
Amount (Rs.) |
|
|
|
|
|
|
|
Net Sales
Sales = 92000 Less:Return 2000 Less :
Opening stock Net Purchase
Purchase = 36000 Less: return 3000 Direct Expenses Cost of goods available for sale Less.: Closing stock Cost of goods sold Gross Profit |
14000 33000 2000 |
90000 34000 |
|
|
49000 15000 |
|||
|
|
|||
|
56000 |
Preparation
of Trading account
Trading account is prepared by debiting the account
with opining stock, purchase and expenses directly connected with purchase and
production and by crediting he same with sales and closing stock. The
differences between the total of the debit side and credit side of the account
gives the gross profit or gross loss. If the credit side total is more, the
differences is gross profit and if debit side total is more, the differences is
gross loss
Proforma of Trading Account
|
Particulars |
Amount (Rs.) |
Particulars |
Amount (Rs.) |
|
|
Opening stock Purchase xxx Less: Return xxx Direct expenses
Carriage
Wages
Fuel Royalty
Consumable stores
Manufacturing expenses
Import duty
Excise duty
Clearing charges
Dock duties
packing materials
Octroi Profit or Loss a/c |
xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxxx |
Sales xxx Less: Return
xxx Closing stock Profit and loss a/c |
Xxx Xxx
xxx |
Relevant
terms in Trading Account
1.
Opening Stock
Opening
stock is the balance of stock forward from the previous year. It is the first item
on the debit side of the Trading Account.
2.
Purchase
The
term purchase refers to goods purchased for resale in business. It is the major
expenses, which will be debited to trading account. Goods which are returned,
called Purchase Return.
3.
Direct Expenses
All expenses incurred for
purchasing or manufacturing the goods and making them ready for sale are called
direct expenses. These are as follows.
v Wages
These
expenses include wages paid to workers who are directly engaged in the production,
wages paid to workers for loading and unloading of goods for production purpose
v Carriage/Cartage/Freight
These expenses are incurred for bringing the goods
to the place of production or to the place where goods are sold
v Fuel/Power/Gas/Water
These expenses are incurred for production
and hence it falls under the category of direct expenses.
· Royalty
It is the amount paid to the owner for
using his right. Such expenses are directly related to production.
v Consumable
stores
It includes lubricating oil, grease, cotton
waste etc which are used in the process
of manufacture and hence it comes under direct expenses.
v Customs
duty/Excise duty/Octroi
These expense are related to purchase of goods
and is debited to trading account.
v Primary
packaging materials
Packing materials and
charges necessary to make the goods in saleable conditions have to be treated
as direct expenses
v Dock
dues and clearing charges
These expenses are incurred in connection
with purchase of goods and form part of direct expenses
v Sales
Sales less return (Net
Sales) is direct income for any business and is credited to trading account
v Closing
stock
It is the value of goods remaining unsold at
the end of the accounting year
Closing Entries
The preparation of trading requires
that the
balances of accounts of all
concerned items are transferred to it for its
compilation.
• Opening stock account, Purchases
account, Wages account, Carriage
inwards account and direct expenses
account are closed by transferring
to the debit side of the trading
and profit and loss account.
This is done by recording the
following entry :
Trading A/c Dr.
To Opening
stock A/c
To
Purchases A/c
To
Wages A/c
To Carriage inwards A/c
To All other direct expenses A/c
• The purchases returns or return
outwards are closed by transferring its
balance to the purchases account.
The following entry is recorded for this purpose :
Purchases return
A/c Dr
To
Purchases A/c
Similarly, the sales returns or
returns inwards account is closed by
transferring its balance to the
sales account as :
Sales A/c Dr.
To Sales return
A/c
• The sales account is closed by
transferring its balance to the credit side of the trading and profit and loss
account by recording the following entry:
Sales
A/c Dr.
To Trading A/c
E.g.: The posting for closing the accounts of
expenses and revenues as they appear in the trial balance are given below:
1.Trading A/c Dr. 83,000
To Purchases A/c 75,000
ToWages A/c 8,000
2.Sales A/c Dr. 1,25,000
To Trading A/c 1,25,000
Purchases
Account
|
Date |
Particulars |
J/F |
Amount |
Date |
Particulars |
J/F |
Amount |
|
|
Balance b/d |
|
75000 |
|
Trading a/c |
|
75000 |
|
75000 |
75000 |
Wages Account
|
Date |
Particulars |
J/F |
Amount |
Date |
Particulars |
J/F |
Amount |
|
|
Balance b/d |
|
8000 |
|
Trading a/c |
|
8000 |
|
8000 |
8000 |
Sales Account
|
Date |
Particulars |
J/F |
Amount |
Date |
Particulars |
J/F |
Amount |
|
|
Trading a/c |
|
125000 |
|
Balance b/d |
|
125000 |
|
125000 |
125000 |
Illustration
5
Preparing Trading account
from the following
Stock
as on 1st January 2019 30000 Wages 5000
Carriage
inwards 3000
Purchase 45000
Sales
80000
Purchase
return and Sales Return 2000 and 3000
Stock on 31st December
2019
25000
Solution
|
Particulars |
Amount (Rs.) |
Particulars |
Amount (Rs.) |
|
|
Opening stock Purchase
45000 Less: Return 2000 |
30000 43000 5000 3000 21000 |
Sales
80000 Less: Return 3000 Closing stock |
77000 25000 |
|
|
Wages Carriage inwards Gross profit c/d |
||||
|
102000 |
102000 |
|
Operating
profit
Trading account shows
only the trading result of a business. A trader, having prepared the trading
account, is interested in knowing the operating profit. It is the profit he has
earned during a particular period which has resulted from his routine business activities. It is the excess of
operating revenue over operating expenses. Operating expenses are those
expenses which affect the normal course of business operations. These expenses
are meant for administration, and selling and distribution activities. Any
expenses other than one as stated above will not form part of operating
expenses.
Operating profit = Gross
profit – Operating expenses
Or
Operating profit = Gross
profit – ( Administration expenses + Selling and distribution expenses)
Illustration
6
Calculate the amount of
Operating profit from the following figures.
Sales=RS.200000, Cost of goods sold rs ., Administration
expenses Rs. 10000, Loss on furniture Rs.12000,Selling and distribution
expensed Rs.20000.
Operating profit = Gross
profit - Operating expenses
= Rs.80000-Rs.30000
=Rs.50000
Solution
1.Gross profit = Net sales – Cost of goods sold
= Rs.200000-Rs.120000
=Rs.80000
2.Operating expenses = Administration expenses-+selling and distribution expenses
= Rs.10000+Rs.20000 = Rs.30000
3.Operating profit
=
Gross profit - Operating expenses
= Rs.80000-Rs.30000
=Rs.50000
EXERCISES
I.
Fill
in the blanks
1.
2.
3.
4.
II.
Short
answer type question
1.
What is trading account
2.
What are the main items mainly involved in
trading account
3.
Write any three objectives of trading
account
III.
Long
answer type question
1. Explain
trading account and advantages of
trading account
2. What
are the relevant terms involved in trading account .Explain
IV.
Problems
1 . Compute cost of
goods sold for the year 2017 with the help of the following information and
prepare trading account
Particulars
Amount
(Rs)
Sales 20, 00,000
Purchases 15,
00,000
Wages 1, 00,000
Stock (Apr. 01, 2016)
3, 00,000
Stock (March 31, 2017) 4,00,000
Freight inwards 1,00,000
Answer
: cost of goods sold = 1600000
2. From the following balances obtained from
the few accounts of Mr. HIMAN . Prepare the
Trading and Profit and Loss Account.
articulars Amount Rs.
Stock on Apr. 01, 2016 8,000
Purchases for the year
22,000
Rent 1,200
Sales for the year
42,000
Discount allowed 600
Purchase expenses 2,500
Commission paid 1,100
wages 3,500
Sales expenses
600
Closing stock
4500
Answer
: G/P = 14000
3. Prepare a trading account of M/s Anjali
from the following information related to March 31, 2017.
Particulars
Amount( Rs.)
Opening stock
60,000
Purchases 3,
00,000
Sales 7,
50,000
Purchases return 18,000
Sales return 30,000
Carriage on purchases
12,000
Carriage on sales 15,000
Factory rent 18,000
Office rent 18,000
Dock and Clearing charges
48,000
Freight and Octroi 6
500
Coal, Gas and Water 10,000
Answer : G/P = 283500