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city SNS rn en ee ane
financial Statements of Sole
proprietorship (Final Accounts: Trading
Account, Profit and Loss Account and Balance Sheet)
S
LEARNING OBJECTIVES
this Chapter would enable you to understand: |
Q Meaning of Financial Statements
1 Objectives or Need or Importancé of Financial Statements j
Users of Financial Statements
O Classification of Capital and Revenue Items:
> Capital Expenditure, Revenue Expenditure and Deferred Revenue Expenditure
> Capital Receipts and Revenue Receipts
1 Preparation of Trading Account, Profit and Loss Account and Balance Sheet
Q Difference between:
> Trading Account and Profit and Loss Account {
> Balance Sheet and Trial Balance
> Profit and Loss Account and Balance Sheet
Q Grouping and Marshalling (Arrangement) of Assets and Liabilities
O Caassification of Assets and Liabilities
O Methods of Presentation of Financial Statements:
> Horizontal Form > Vertical Form
Wel eco via see
Meaning
Financial Statements are the statements prepared at the end of the accounting period
Sedetermine the financial performance, ie., profit earned or loss incurred during the
18.5
inancial ‘statements of Sole Proprietorship ...
Fit
i i i _ ssary
i i ‘ed t re the right to do business: Expenses neces pa
9 Beevrinng licence o patent i ture. Only the initial
| for obtaining licence or patents, etc., are capital expendit a
expenditure is capital expenditure, renewal fee is revenue Se
Expenditure incurred for purchase of intangible assets such as goodwill, patents,
trademarks, copyrights, ete.
4p Legal Expenses Incurred for Acquiring a Fixed Asset: Legal expenses incurred for
a acquiring fixed assets, rights, etc., are also capital expenditure.
(i
Treatment of Capital Expenditure: Capital Expenditure is debited to relevant Fixed
Asset Account and is shown in the Balance Sheet.
Revenue Expenditure
Revenue Expenditure is the expenditure benefit of which is consumed or exhausted
‘within the accounting period. Stating differently, an expenditure which is not capital
expenditure is revenue expenditure. Examples of such expenses are:
() Expenses incurred in day-to-day running of the business such as rent, salaries,
wages, power, fuel, etc.
(i) Expenses incurred for repairs and maintenance of fixed assets.
(iii) Expenses incurred on purchase of stock of materials and goods to the extent that
they are used (consumed) during the year; the remaining amount will be an asset.
(jv) Depreciation on fixed assets.
Revenue expenditure is accounted as an expense and is matched against revenues of
the period to determine profit or loss of that period. It also includes that part of capital
expenditure which expires or is consumed within an accounting year. For example,
depreciation on fixed assets.
We have discussed the basis for distinguishing Capital Expenditure-from Revenue
Expenditure. However, the distinction is not simple.
Following expenses appear to be revenue expenses but they are capital expenses:
1. Expenses incurred on the repairs and whitewashing for the first time on the purchase
of an old building, since these expenses are necessary to make the building usable.
2. Wages paid to workers to produce a tool to be used in the factory itself or to fix
@ machine.
a Expenses incurred for purchase of land or building such as fees paid to lawyer or
Tegistration expenses.
Interest on loan raised to acquire an asset up to the point of time it is ready
for use.
Tre
j otha ent of Revenue Expenditure: Revenue expenditure is shown on the debit side
*ading Account or Profit and Loss Account.
a — Oe / |
1 Double Entry Book Kee,
ro Che |
Ditterence between Capital Expenditure and Revenue Expenditure | 4
Capt Excerdtoce Revenue Expendiurg ,
t t 8 reset ty acaueticr of fed axvets fr use | nae font fbi, :
ane |
2 Cagney trea var, seen) Ite Dre, itis incurred for eaming profits,
ihe Tis benef is exhausted within the year
tts debited to related Expense Accouny é
| Wis an Expense Account. ==
itis shown inthe Trading or Profit and Loss jp—~
(@) Degredaton on Plant and Machine, Ke
2 Wed xox. 56g (0) Rent, s
Sete rmre ac Fons. (Q) Repairs and insurance,
lenproper Considerations in the Determination of Capital Expenditure and
Revenue Expenditure
Whether an expenditure is capital or revenue is determined after considering nating
of the expenditure. I revenue expenditure is debited to Asset Account, it will oversiag (
prifis and also value of the asset. On the other hand, if capital expenditure is debite
t0 Profit and Loss Account, it will understate profit and also value of the asset, (
important Points to Categorise an Expenditure as Capital or Revenue Expenditure
G Amuunt of Expenditure: Capital expenditure is normally larger than revenve
expenditure. But it does not mean that if the amount is small, it is a revenue
expenditure and if the amount is large, it is a capital Expenditure.
hy Payment—Perindic or Lump Sum: Capital expenditure is normally not frequent
and is made at a time, in lump sum. For example, purchase of land. On the other |
hand, revenue expenditure is paid periodically such as salary. It should not be
omclsaed that if payment is made frequently, it is revenue expenditure. It i
possible that payment for an asset purchased (which is a capital expenditure),
is made in instalments, |
Gy Source of Payment: Mostly payment of capital expenditure is made out of the |
cyital while revenue expenditure is paid out of revenue receipts. But it should |
nt be omsidered as a general rule that expenses paid out of the capital ar
always capital expenditure and expenses paid out of revenue receipts are alwav®
revenue expenditure.
(9 ls Nature in the Hands of Recipient: Whether any expenditure is a capt
expenditure or revenue expenditure, nature of payment in the hands of recipie"
in rut material. It may be possible that an item, which is of revenue nature £0
the payee, is capital nature for the payer. For example, for a car manufactur
amount received from sale of car is a revenue receipt but for the purchaser, it
4 capital expenditure, >
® ancial Statements of Sole Proprietorship o 18.7
qivstration
uate whether following expenditures are capital or revenue in nature:
a Second-hand car was purchased for a sum of & 1,00,000. A sum of % 10,000 was
spent on its overhauling.
«i 25,000 paid for the installation of a new machine,
(i) Repairs for € 5,000 necessitated by negligence.
{iv) Cost of annual taxes paid and the annual insurance premium paid on the car
mentioned above.
(v) Cost of air-conditioning of the office of the General Manager.
Solution:
() Total expenditure of 1,10,000 is Capital Expenditure. A sum of % 1,00,000 was
spent on a capital asset while another & 10,000 was spent for making the capital
asset ready for use.
(i) Cost of installing the new machine is a Capital Expenditure because the amount
spent is up to the point when the asset is ready for use.
(iii) Repair charges are Revenue Expenditure since they are for maintaining an asset
and not for improving the asset.
(iv) Annual taxes and insurance premium paid on the car are Revenue Expenditure
because they do not add to the value of the car and their benefit will be exhausted
within the year.
() Itis Capital Expenditure because the benefit of this expenditure will be available
for a number of years.
Mlustration 2.
State with reasons whether following are Capital or Revenue Expenditures:
() Custom duty paid on import of a machinery.
(i) Wages paid in connection with the erection of a new machinery.
(ii) © 5,000 spent on repainting the factory.
(iv) Repairs for % 2,000 necessitated by negligence of an operator of machine.
©) % 10,000 paid for electricity bill. (Delhi 2007)
Solution:
Custom duty paid on import of a machinery is a Capital Expenditure because it
is incurred for the acquisition of a new asset.
{t) Wages paid in connection with the erection of a new machinery is Capital
__ Expenditure because it is in connection with the acquisition of new asset.
URIS 000 evantfonisenarntinetteliatinny in) icetenrel corer eel becteet tlle
__ been incurred to maintain the factory building.
(2) Repairs for 2,000 necessitated by negligence of an operator of machine is Revenue
‘penditure since it has not improved the asset (machine) in any way.
© % 10,000 paid for electricity bill is Revenue Expenditure because it is a part of
Operati, Double Entry Book Keepin,
'o~Cn,
%
18.8
Deferred Revenue Expenditure ;
Deferred Revenue Expenditure is a revenue expenditure that is incurreq unin
‘accounting period but it is estimated that its benefit swill er beyond that accoye, %
period. i.e, will not be exhausted within the accounting period. Such an expe, ty
is usually larger than the normal expenditure under the head. An example of thig ot
expense, say on advertising a new product. The expenditure so incurred will giyg yt |
in the periods beyond the accounting period in which the expenditure was incureeg’ |
will thus. be proper to spread the expenditure over a period and not debit the a “lt
amount to Profit and Loss Account for the year in which the expense is incurreg,
It may be noted that the amount which has not been charged to Profit and Loss Acco
is shown in the Balance Sheet as an asset. mt
It should be noted that deferred revenue expenditure and prepaid expenses are ty
different terms. In case of deferred revenue expenditure, benefits available cannot,
precisely estimated but in case of prepaid expenses, like payment of rent in adyae,”
benefits available can be precisely estimated.
Treatment of Deferred Revenue Expenditure: Amount to be written off in the
current year is debited to the Profit and Loss Account and amount not written off in
the current year is shown on the assets side of Balance Sheet as fictitious asset,
Deferred Revenue Expenditure is a Fictitious Asset: Although it appears on the asses |
side of the Balance Sheet, it is not really an asset to the business. |
ECEIPTS AND REVENUE RECEIPTS
CAPITI
Difference between capital receipts and revenue receipts is also necessary as is in the
case of expenditure.
Capital Receipts: Capital Receipts are the amounts received by the enterprise that
are not income. Examples of capital receipts are capital contribution by the
proprietor, loan received and sale proceeds of fixed assets. Capital and loan received
increase the liability of the enterprise thus, is not an income. Sale of fixed asst!
reduces fixed assets, thus, the amount received is not revenue earned in the norm#l
course of business. Stating differently, capital receipts do not affect profit or loss
the business. They either increase liabilities or reduce assets. Hence, these are sho"
in the Balance Sheet.
Revenue Receipts: These are the amounts received in the normal course of noel
mainly from sale of goods and/or services. Cash sales, cash received from debtor
debts recovered are examples of revenue receipts. In other words, revenue re
arise from operating activities in the normal course of business. An important fet
of revenue receipts is that such receipts are incomes. Hence, these are shown 0?
side of the Trading Account or Profit and Loss Account.
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