MODULE - 3

Financial Statement

16
FINANCIAL STATEMENTS : AN
Notes
INTRODUCTION

In the previous lessons you have learnt to record the business transactions in various
books of accounts and their posting into ledger. You have also learnt about balancing
the account and preparing the trial balance. One of the most important purposes of
accounting is to ascertain financial results, i.e., profit or loss of the business operations
of a business enterprise after a certain period and financial position on a particular date.
For this certain financial statements are prepared which are termed as income statement
(i.e. Trading and Profit & Loss Account) to know what the business has earned during
a particular period and the Position Statement (i.e. Balance Sheet) to know the financial
position of the business enterprise on a particular date.
In this lesson you will learn about the financial statements that are prepared by a profit
organisations.

OBJECTIVES
After studying this lesson you will be able to :
z explain the meaning and the objectives of preparing financial statements;
z classify the financial statements into Trading and Profit & Loss Account and Balance
Sheet;
z distinguish between capital expenditure and revenue expenditure, capital receipts
and revenue receipts;
z explain the purpose of preparing Trading Account and Profit and Loss Account;
z draw the format of Trading Account and Profit and Loss Account and
z prepare the Balance Sheet.

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16.1 FINANCIAL STATEMENTS : MEANING AND
OBJECTIVES
When a student has studied for a year, he/she wants to know how much he/she has
learnt during that period. Similarly, every business enterprise wants to know the result
of its activities of a particular period which is generally one year and what is its financial
position on a particular date which is at the end of this period. For this, it prepares
various statements which are called the financial statements.
Notes
Financial statements are the statements that are prepared at the end of the
accounting period, which is generally one year. These include Income Statement
i.e. Trading and Profit & Loss Account and Position statement i.e. Balance
Sheet.
Objectives of preparing Financial Statements
Financial statements are prepared to ascertain the profits earned or losses incurred by
a business concern during a specified period and also to ascertain its financial position
at the end of that specified period.
Financial statements are generally of two types (a) Income Statement which comprises
of Trading Account and Profit & Loss Account, and (b) Position Statement i.e., the
Balance Sheet.
Following are the objectives of preparing financial statements: -
1. Ascertaining the results of business operations : Every businessman wants
to know the results of the business operations of his enterprise during a particular
period in terms of profits earned or losses incurred. Income statement serves this
purpose.
2. Ascertaining the financial position : Financial statements show the financial
position of the business concern on a particular date which is generally the last
date of the accounting period. Position statement i.e. Balance Sheet is prepared
for this purpose.
3. Source of information : Financial statements constitute an important source of
information regarding finance of a business unit which helps the finance manager
to plan the financial activities of the business and making proper utilisation of the
funds.
4. Helps in managerial decision making : The Manager can make comparative
study of the profitability of the concern by comparing the results of the current
year with the results of the previous years and make his/her managerial decisions
accordingly.

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Financial Statement
5. An index of solvency of the concern : Financial statements also show the short
term as well as long term solvency of the concern. This helps the business enterprise
in borrowing money from bank and other financial institutions and/or buying goods
on credit.
Importance of Financial Statements
i. Pertaining to Finance : The term “financial statement” doesn’t make sense at
first. Numbers are for counting while statements need words, so how could these
Notes
two mix together? But when seen as “money statements,” then suddenly it’s a
crucially important matter.
ii. Facilitate in Decision Making : Not only is it important for you, but for the
management and stockholders as well. It’s important for the management because
financial statements speak of the company’s success and competence, whereas
stockholders refer to financial statements to know whether or not to invest in a
company. In other words, financial statements tell whether the company made or
lost money.
iii. Showing the Operational Performance : Financial statement hold the secrets
of a company. Aside from stating whether the company earns or loses money,
they also provide clues on where the mangement might find more resources to
boost its revenue. In addition, financial statements reveal a company’s past
performance and potential.
Capital Expenditure and Revenue Expenditure, Capital Receipts and Revenue
Receipts
The preparation of Trading Account and Profit and Loss Account requires the knowledge
of revenue expenditure, revenue receipts and capital expenditure and capital receipts.
The knowledge shall facilitate the classification of revenue items and put them in the
Trading account and Profit and Loss Account on one hand and prepare Balance Sheet
based on capital items (expenditure as well as receipts) on the other hand.
Capital Expenditure refers to the expenditure incurred for acquiring fixed assets or
assets which increase the earning capacity of the business. The benefits of capital
expenditure to the firm extend to number of years. Examples of capital expenditure are
expenditure incurred for acquiring a fixed asset such as building, plant and machinery
etc.
Revenue expenditure, on the other hand, is an expenditure incurred in the course of
normal business transactions of a concern and its benefits are availed of during the
same accounting year. Salaries, carriage etc. are examples of revenue expenditure.

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There is another category of expenditure called deferred revenue expenditure. These
are the expenses incurred during one accounting year but benefits from the same are
available wholly or in part in future periods also. These expenditures are otherwise of a
revenue nature. Example of deferred revenue expenditure are heavy expenditure on
advertisement say for introducing a new product in the market, expenditure incurred
on research and development, etc.

Notes Difference between Capital Expenditure and

Revenue Expenditure

Basis of Capital Revenue

Difference Expenditure Expenditure

1. Purpose It is incurred for It is incurred for the

acquiring fixed assets. maintenance of fixed assets.

2. Earning It increases the earning It helps in maintaining

capacity capacity of the business. the earning capacity
of the business intact.

3. Periodicity Its benefits are spread Its benefits accrue only in

of benefit over a number of years. one accounting year.

4. Placement in It is an item of Balance It is an item of Trading

financial Sheet and is shown as and Profit and Loss
statements an item of asset. Account and is shown
on the debit side of
either of the two.

5. Occurrence of It is non-recurring It is usually a recurring

expenditure in nature. expenditure.

Capital and Revenue Receipts

Capital receipts are receipts which do not arise out of normal course of business.
Examples of such receipts are sale of fixed assets, and raising of loans etc. Such receipts
are not treated as income of the enterprise.

Revenue receipts are receipts which arise during the normal course of business, Sale of
goods, rent from tenants, dividend received, etc. are some of the examples of revenue
receipts. They are the items of incomes of the business entity.

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Distinction between Capital Receipts and Revenue Receipts
Basis of Capital Receipt Revenue Receipt
Difference

Source Receipts that do not arise during Receipts that arise during the
the normal course of business. normal course of business.

Nature These are of capital nature and These are of revenue nature and
hence are not treated as items hence are treated as items of Notes
of income of the business. income of the business.

Occurrence These are of non-recurring These are recurring in nature.

in nature.

INTEXT QUESTIONS 16.1

I. Classify the following items of expenditure into capital expenditure revenue
expenditure and deferred revenue expenditure

(i) Amount spent on purchase of machine.

(ii) Expenditure incurred on repairs of building.

(iii) Heavy expenditure on advertisement to introduce a new product in the market.

(iv) Purchase of motor vehicle for business use.

II. One important objective of financial statements is to ascertain the results

of business operations. List the other objectives of the financial statements:
(a) ...........................................................................................................

(b) ...........................................................................................................

(c) ...........................................................................................................

(d) ...........................................................................................................

16.2 TRADING ACCOUNT

Income statement consists of Trading and Profit and Loss Account. Let us, first study
the Trading Account. A business firm either purchases goods from others and sells
them or manufactures and sells them to earn profit. These are known as trading activities.
A statement is prepared to know the results in terms of profit or loss of these activities.
This statement is called Trading Account.

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Trading Account is prepared to ascertain the results of the trading activities of the
business enterprise. It shows whether the selling of goods purchased or manufactured
has earned profit or incurred loss for the business unit. Cost of goods sold is subtracted
from the net sales of the business of that accounting year. In case the total sales value
exceeds the cost of goods sold, the difference is called Gross Profit. On the other
hand, if the cost of goods sold exceeds the total net sales, the difference is Gross Loss.
All accounts related to cost of goods sold such as opening stock, net purchases i.e.
purchase less returns outward, direct expenses such as wages, carriage inward etc.
Notes and closing stock with net sales (i.e. Sales minus Sales returns) are posted to the
Trading Account. Then this account is balanced. Credit balance shows the gross profit
and debit balance shows the gross loss.
It is necessary to understand the meaning of cost of goods sold before preparing Trading
Account.
Cost of goods sold and gross profit
A business enterprise either purchases goods or manufactures goods to sell in the
market. Cost of goods sold is computed to know the profit earned (Gross Profit) or
loss incurred (Gross Loss) from the trading activities of a business unit for a particular
period.
Cost of goods sold = the amount of goods purchased + expenses incurred in bringing
the goods to the place of sale or expenses incurred on manufacturing the goods (called
direct expenses).
In case there is a stock of goods to be sold in the beginning of the year or at the end of
the year, the cost of goods is calculated as follows :
Cost of goods sold = Opening stock + Net purchases + All direct expenses – Closing
stock
Gross Profit = Net sales – Cost of goods sold
Illustration 1
Calculate the cost of goods sold from the following information :
`
Opening stock 10000
Closing stock 8000
Purchases 80000
Carriage on purchases 2000
Wages 6600

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Financial Statement
Solution :
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses
(Carriage on Purchases + Wages) – Closing Stock
= ` [10,000 + 80,000 + 86,00
(i.e. 2,000 + 6,600) – 8,000]
= ` 90600
Illustration 2 Notes

Calculate cost of goods sold and gross profit from the following information.
Sales ` 62500
Sales Returns ` 500
Opening Stock ` 6400
Purchases ` 32000
Direct Expenses ` 4200
Closing Stock ` 7200
Solution :
`
Net sales
(Sales-Sales Returns i.e. 62500 – 500) 62000
Less : Cost of goods sold
Opening Stock 6400
Add Purchases 32000
Add Direct Expenses 4200
Less : Closing Stock (7200) 35400
Gross Profit 26600
Or Gross profit = Net sales – cost of goods sold
= 62000 – 35400 = 26600
Illustration 3
From the following information for the year ending 31st March, 2014 furnished by Mr.
Vikram, a trader, calculate cost of goods sold and also calculate Gross Profit/Gross
Loss of business.

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Financial Statement
`
Sales 1,20,000
Purchases 80,000
Octroi 1,600
Carriage on purchases 4,500

Notes Purchase Returns 2,400

Opening Stock 27,600
Closing Stock 32,400
Solution :
`
Cost of goods sold :
Opening stock 27,600
Add Net Purchases
(` 80,000 – ` 2,400) 77,600
Add carriage on Purchases 4,500
Add Octroi 1,600
Cost of goods available for sale 1,11,300
Less closing stock 32,400
Cost of goods sold 78,900
Gross Profit : `
Sales 1,20,000
Less : Cost of goods Sold 78,900
Gross Profit 41,100
Need of Trading Account
Trading Account serves the following purposes :
1. Knowledge of Gross Profit : Trading Account gives information about Gross
Profit. It is the profit earned by a business enterprise from its trading activities.
The percentage of gross profit on sales reflects the degree of success of business.

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2. Knowledge of All Direct Expenses : All direct expenses are debited to trading
Account. Direct expenses are the expenses that can be directly attributed to
purchase or manufacturing of goods for sale. Percentage of Direct expenses on
sales of current year when compared with the same of previous years, helps the
manager to exercise control over direct expenses.
3. Precaution against Future Losses : Trading Account, if shows gross loss,
reasons for this loss can be found out and necessary corrective steps can be
taken. Notes
FORMAT OF TRADING ACCOUNT
Trading Account of ..............................
for the year ending …………..
Dr. Cr.
Particulars Amount Particulars Amount
` `
Opening Stock Sales
Purchases Less: Sales Returns
Less Purchase Returns Closing stock
Direct Expenses : Gross loss transferred to
Carriage Inward Profit & Loss Account
Freight
Wages
Fuel & Power
Excise Duty
Factory Rent
Heating & Lighting
Factory Rent & Insurance
Work Managers Salary
Gross Profit transferred
to Profit & Loss Account
Important Items of Trading Account
Important items of Trading account are :

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1. Stock : Stock refers to the goods lying unsold on a particular date. It can be
of two types : (a) Opening stock and (b) Closing stock
(a) Opening Stock : Opening stock refers to the value of goods lying unsold at
the beginning of the accounting year. It is shown on the debit side of the
Trading Account. In the first year of business there is no opening stock.
(b) Closing Stock : It is the value of goods lying unsold at the end of the
accounting year. It is valued at the cost price or market price whichever is
Notes less. It is shown on the credit side of the Trading Account.
2. Purchases : Purchases mean total items purchased for resale during the year.
It can be both in cash and on credit. Purchases are shown on the debit side
of the Trading Account. These are always shown as net purchases i.e. amount
of purchases returned (Purchase returns or return outwards) is deducted from
the total amount of purchases made. Goods received on consignment basis are
never treated as purchases. Similarly, goods received on ‘sale or return’ basis
are never treated as purchases.
3. Sales : Sales refer to the total revenue from sale of goods of the business
enterprise for which the Trading Account is being prepared. It includes both cash
sales and credit sales. These are recorded on the credit side of the Trading
Account. Sales are shown at their net value i.e. sales return or returns inward
is deducted from the total sales. Cash sales plus credit sales minus sales returns
constitute net sales. Goods sent on ‘sale or approval’ are not part of sales until
approval is received.
4. Direct Expenses : Direct expenses are the expenses that can be attributed
directly to the purchase of goods or goods manufactured. These are shown on
the debit side of the Trading Account. These are shown at the amount as shown
in the Trial Balance. For example, wages are recorded on the debit side of
Trading Account at the amount shown in the Trial Balance.
Important Items of Direct Expenses
1. Wages i.e. wages relate to production. If amount under this head includes
wages paid for construction of building or manufacturing of furniture for office
it will be subtracted from the amount of wages.
2. Carriage, Cartage and Freight i.e. amount paid for carriage of goods
purchased for sale or raw material purchased for manufacturing.
3. Other such direct expenses are customs and import duty, packing materials,
gas, electricity water, fuel, oil, gas greese, heating and lighting, factory rent
and insurance and many more such items.

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5. Gross Profit/Gross Loss : It is the excess of net sales revenue over cost of goods
sold. Gross Profit is equal to net sales minus cost of goods sold. If total of the credit
side exceeds the total of debit side, the excess amount is termed as ‘gross profit’
and is shown on the debit side of Trading Account. On the other hand if debit
side is more than the credit side, the difference in amount is called gross loss
and is shown on the credit side of the Trading Account.
Gross Profit = Net Sales – Cost of Goods Sold
Gross Loss = Cost of Goods Sold – Net Sales Notes

INTEXT QUESTIONS 16.1

I. Fill in the blanks with suitable word/words :
1. Financial statements are generally of .......……. Types.
2. Income statement comprises of .......….. A/c and ......……. A/c.
3. Trading Account is prepared to ascertain the .......……. profit of the business.
4. The percentage of gross profit on sales reflects the degree of .......……. of
business.
II. Show the result in the following cases
(a) Sales – sales return = ..............................
(b) Purchases – purchases return = ..............................
(c) Total of the credit column of trading account – total of the debit column of
trading account = ..............................
(d) Cost of goods sold – total sales = ..............................
(e) Total of the debt column of trading account - Total of the credit column of
trading account = ..............................

16.3 TRANSFER ENTRIES

Before preparing Trading Account, closing or transfer journal entries are made in the
journal proper of the business enterprise. These journal entries are:
(a) For transferring debit balances
Trading A/c Dr.
To Opening stock
To Purchases

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Financial Statement
To Direct expenses
To Sales returns
(Transfer of balances of opening Stock,
Purchases, direct expenses & Sales Returns)
(b) For transferring credit balances
Sales A/c Dr.
Notes Closing stock A/c Dr.
Purchase Returns A/c Dr.
To Trading A/c
(Transfer of credit balances of Sales,
Closing Stock, Purchase return)
(c) For transferring gross profit
Trading A/c Dr
To Profit & Loss A/c
(Transferring of gross profit)
(d) For transferring gross loss
Profit & Loss A/c Dr.
To Trading A/c
(Transferring of gross loss)
Illustration 4
The ledger balances extracted at the close of a trading year on 31st March, 2014 are
given as follows
Name of the Account Amount (` )
Opening stock 12,000
Purchases 52,000
Sales 74,000
Purchase Returns 2,000
Carriage Inward 800
Wages 4,200
Closing stock 13,500
Pass necessary journal entries in the journal proper.

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Financial Statement
Solution :
Journal
Date Particulars LF Dr Cr
2014 Amount Amount
` `
March 31 Trading A/c Dr 69,000
To Opening stock A/c 12,000 Notes
To Purchases A/c 52,000
To Wages A/c 4,200
To Carriage Inward A/c 800
(Transfer of debit balances
to trading Account)
March 31 Sales A/c Dr 74,000
Purchase Returns A/c Dr 2,000
Closing stock A/c Dr 13,500
To Trading A/c 89,500
(Transfer of credit items to
trading account)
March 31 Trading A/c Dr 20,500
To Profit & Loss A/c 20,500
(Transfer of gross profit to
Profit & Loss Account)
Illustration 5
Following balances have been extracted from the ledger of Rohit & Sons at the close
of the year 2014.
`
Stock (1.1.2014) 21,000
Purchases 1,40,000
Sales 2,24,000
Purchases Returns 8,000

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Financial Statement
Sales Returns 12,000

Wages 15,000

Factory Power 12,000

Stock (31.12.2014) 26,500

Make closing journal entries in the journal proper.

Notes
Solution :

Journal

Date Particulars LF Dr Cr
2014 Amount Amount

Dec. 31 Trading A/c Dr 2,00,000

To Opening stock A/c 21,000

To Purchases A/c 1,40,000

To Sales Returns A/c 12,000

To wages A/c 15,000

To Factory power A/c 12,000

(Closing entry of debit items

transferred to Trading A/c)

Sales A/c Dr 2,24,000

Closing stock A/c Dr 26,500

Purchase Returns A/c Dr 8,000

To Trading A/c 2,58,500

(Transfer of credit balances

to Trading A/c)

Trading A/c Dr 58,500

To Profit & Loss A/c 5,8500

(Transfer of Gross Profit)

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INTEXT QUESTIONS 16.3

Write the “debit” if the items given below are to be placed in debit side of the
Trading A/c and “Credit” if they are placed in the credit side of the Trading
Account.
(i) Closing stock
(ii) Carriage inward Notes

(iii) Sales
(iv) Custom duty

16.4 PROFIT & LOSS ACCOUNT

As stated earlier, income statement consists of two accounts : Trading Account and
Profit & Loss Account. You have seen that Trading account is prepared to ascertain
the gross profit or gross loss of the trading activities of the business. But these are not
the final results of business operations of an enterprise. Apart from direct expenses,
there are indirect expenses also. These may be conveniently divided into office and
administrative expenses, selling and distribution expenses, financial expenses,
depreciation and maintenance charges etc.
Similarly, there can be income from sources other than sales revenue. These may be
interest on investments, discount received from creditors, commission received, etc.
Another account is prepared in which all indirect expenses and revenues from sources
other than sales are presented. This account when balanced shows net profit (or net
loss). This account is termed as Profit and Loss Account. The profit shown by this
account is called ‘net profit’ and if it shows loss it is known as ‘net loss’.
FORMAT OF PROFIT AND LOSS ACCOUNT
Profit and Loss A/c of M/s ................…..
for the year ended ...............
Dr. Cr.
Particulars Amount Particulars Amount
` `
Gross loss b/d; if any — Gross Profit b/d —
Salaries — Discount Received —
Rent, Rates & taxes — Commission Received —
Insurance Premium — Dividend Received —

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Advertising — Interest on Investment —
Commission paid — Rent Received —
Discount Allowed — Net Loss transferred
Repairs & Renewals — to capital account; if any —
Bad Debts —

Notes Establishment charges —

Travelling Expenses —
Bank Charges —
Sales Tax/Value added Tax —
Depreciation on fixed assets —
Net Profit transferred to
Capital Account —
Some important items of Profit and Loss Account
As stated earlier indirect expense are shown on the debit side of Profit and Loss A/c.
These can be classified under the following heads :
Debit Items
1. Selling and Distribution Expenses : To materialise sales, the expenses incurred
are called selling and distribution expenses. Examples are :
Carriage on sales/carriage outwards, advertisement, selling expenses, travelling
expenses and salesman commission, depreciation of delivery van, salary of driver
of the delivery van, etc.
2. Office and Administration Expenses : These are the expenses incurred on
establishment and maintenance of office. Some of the expenses that may be under
this head are: rent, rates and taxes, postage, printing and stationery, insurance,
legal charges, audit fees, office salaries, etc.
3. Financial Expenses : Finances are to be arranged for carrying on business.
Expenses that are incurred in this connection are called financial expenses. Some
of the financial expenses are: interest on loan, interest on capital, discount on bills,
etc.
4. Depreciation and Maintenance Charges : The total value of a fixed asset like
machinery, building, furniture, etc. is not charged to profit and loss account in the
year in which it is purchased. Such assets help running business for a number of

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Financial Statement
years to come. Therefore, only a part of the value of such assets is treated as an
expense and is charged to Profit and Loss A/c as depreciation. Depreciation
means decline in the value of fixed asset due to wear and tear, lapse of time,
obsolescence, etc. Expense incurred on repairs and renewals and maintenance of
assets are expenses other than depreciation under this category.
5. Other Expenses : These are the expenses which are not included under the
above mentioned heads of expenses for example, losses and expenses due to fire,
theft etc. Notes
Credit Items
On the credit side of Profit and Loss Account, items of revenue and incomes are
written. The first item on this side of Profit and Loss Account is the gross profit transferred
from trading account. Other items of the credit side are : Interest on investment, interest
on fixed deposits etc. rent received, commission received, discount received, dividend
on shares received etc.
Need of preparing Profit and Loss Account
Need of preparing profit and loss account by a business concern may be stated as
follows :
(i) To know the net profit or net loss of a business for an accounting year.
(ii) Net profit of one year can be compared with net profits of previous year or years.
It helps in ascertaining whether the business is being conducted efficiently or not.
(iii) Different expenses which are taken to Profit & Loss A/c in one year can be
compared with the amounts incurred in previous year or years. This helps in
ascertaining the need of applying control over such expenses.

INTEXT QUESTIONS 16.4

I. Following are the items of expenditure and income to be taken to Profit
and Loss Account. Write ‘E’ for expenses and ‘I’ for income against each
item.
(i) Interest on Fixed Deposit
(ii) Advertisement
(iii) Insurance Premium
(iv) Discount allowed by creditors
(v) Carriage on sales

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II. State whether the following statements are ‘true or false’. Write true for
true statements and ‘false’ for false statements.
(i) Profit and Loss Account is prepared to ascertain the Gross Profit of a business
unit.
(ii) Items of income are written on the credit side of Profit and Loss Account.
(iii) Net Profit calculated by preparing Profit and Loss Account is transferred to
Notes Trading Account.
(iv) Profit and Loss Account is prepared for an accounting year.

16.5 TRANSFERRING ENTRIES OF PROFIT AND LOSS ACCOUNT

Before preparing Profit and Loss Account as per the format given in the previous
section, closing entries are made in the journal proper of the enterprise. Following
journal entries are made :
(i) For transferring the indirect expense accounts :
Profit & Loss A/c Dr.
To Salaries A/c
To Insurance Premium A/c
To Bad Debts A/c
To Discount Allowed A/c
(Transfer of indirect expenses)
(ii) For transfer of items of incomes and gain
Interest on investment A/c Dr.
Rent Received A/c Dr.
Discount Received A/c Dr
To Profit & Loss A/c
(Transfer of items of income)
(iii) For transferring Net Profit :
Profit & Loss A/c Dr.
To Capital A/c
(Transferring of Net Profit to Capital A/c)

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(iv) For transferring Net Loss
Capital A/c Dr.
To Profit & Loss A/c
(Transfer of Net Loss to Capital Account)
Illustration 6
The following balances were extracted from the books of Maya Gupta & Sons at the Notes
end of March 31, 2014. Make necessary closing entries as on that date:
Items Dr. Cr.
Balance Balance
(` ) (` )
Gross Profit 65,000
Salaries 11,500
Audit fees 400
Insurance Premium 800
Interest received 1,600
Discount (Cr) 460
Advertisement 1,200
Bad Debts 150
Discount Allowed 340
Depreciation 460
Rent from tenants — 1,800
Solution :
Journal Entries
(i) Trading A/c Dr. 65,000
To P&L A/c 65,000
(Gross profit transfered to P&L A/c)
(ii) Profit & Loss A/c Dr. 14850
To Salaries A/c 11500
To Audit Fees A/c 400

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To Insurance Premium A/c 800
To Advertisement A/c 1200
To Bad Debts A/c 150
To Discount Allowed A/c 340
To Depreciation A/c 460
(Transfer of items of expenses to profit & Loss A/c)
Notes
(iii) Interest A/c Dr. 1600
Discount Received A/c Dr. 460
Rent A/c Dr. 1800
To Profit & Loss A/c 3860
(Transfer of items of income to Profit & Loss A/c)
(iv) Profit & Loss A/c Dr. 54010
To Capital A/c 54010
(Transfer of Net Profit to Capital Account)
Illustration 7
The following ledger balances were extracted from the books of Rabina & Brothers at
the end of accounting year 31st March, 2014. Make journal entries to transfer these
balances to prepare Profit & Loss A/c for the year ending 31st March, 2014.
`
Gross Profit 65800
Salaries 8400
Rent paid 2400
Discount allowed 500
Interest on investments 3100
Advertisement 1800
Trading expenses 1600
Bad Debts 500
Depreciation 600
Insurance Premium 800
Commission received 2700

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Solution :
Trading A/c Dr. 65,800
To P & L A/c 65,800
(Gross profit transferring to P&L A/c)

Journal
Date Particulars LF Dr Cr
2014 Amount Amount Notes

March 31 Profit & Loss A/c Dr 16600

To Salaries A/c 8400
To Rent A/c 2400
To Discount allowed A/c 500
To Advertisement A/c 1800
To Trading expenses A/c 1600
To Bad Debts A/c 500
To Depreciation A/c 600
To Insurance Premium A/c 800
(Transfer of indirect expenses
to profit & Loss A/c)
March 31 Commision A/c Dr 2700
Interest A/c Dr 3100
To Profit & Loss A/c 5800
(Transfer of incomes other than
sales to Profit & Loss A/c)
March 31 Profit & Loss A/c Dr 55000
To Capital A/c 55000
(Transfer of net profit to capital A/c)
Operating Profit
Operating profit is the excess of gross profit over operating expenses. Gross Profit is
the excess of net sales revenue over cost of goods sold. Operating expenses includes
office and administration expenses, selling and distribution expenses, cash discount
allowed, interest on bills payable and other short term debt, bad debts and so on. Net
sales means cash sales + credit sales - sales returns.

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 MODULE - 3 Financial Statements : An Introduction
Financial Statement
Operating Profit = Net Sales - Operating Cost
= Net Sales - (Cost of goods sold + administration and
office exp. + Selling and Distribution expenses)
Operating Profit = Net Profit + Non-operating exp. - Non-Operating Income
Illustration 8
Compute Operating profit from the following particular.
Notes
` `
Gross Profit 44,000 Interest on loan 2200
Carriage outward 480 Interest on investment 280
Advertising 1200 Printing and Stationery 360
Salaries 17,800 Loss on Sale of furniture 3,500
Rent & Taxes 6,200 General expenses 140
Lighting 1,500 Donation 510
Insurance charge 240 Rent Received 600
Bad Debts 150 Loss by fire 2,000
Audit fees 200 Gain on sale of machine 5,000
Solution
Computation of Operating Profit
` `
Gross Profit 44,000
Less : Selling and Distribution expenses :
Carriage outward 480
Advertising 1,200
Bad Debts 150 1,830
Less : Office and Administrative Expenses
Salaries 17,800
Rent & Taxes 6,200
Lighting 1,500
Insurance 240
Audit fees 200
Printing & Stationery 360
General expense 140 26,440 (28,270)
Operating Profit 15,730

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 Financial Statements : An Introduction MODULE - 3
Financial Statement
Position Statement/Balance Sheet
Position Statement or Balance Sheet is another financial statement that a business
enterprise prepares. Balance Sheet is a statement prepared on a particular date, generally
at the end of accounting year to ascertain the financial position of the business entity. It
consists of assets on the one hand and liabilities on the other.
In the words of Francis R Steal, “Balance Sheet is a screen picture of the
financial position of a going business at a certain moment.” In the words of
Freeman, “A Balance Sheet is an item wise list of assets, liabilities and Notes
proprietorship of a business at a certain date.”
Financial position of a business is the list of assets owned by the business and the
claims of various parties against these assets. The statement prepared to show the
financial position is termed as Balance Sheet.
In the next lesson we shall discuss Balance Sheet in detail.

INTEXT QUESTIONS 16.5

I. Write ‘debit’ if Profit and Loss Account is to be debited and ‘credit’ if
profit and loss account is to be credited of the following items :
(a) Legal charges (b) Net Loss (c) Rent Received
(d) Discount Allowed (e) Salaries
II. (a) Name the financial statement which is prepared in addition to income statement.
(b) Why it is prepared?
(c) When it is prepared?
(d) Name its two elements.
III. (a) Operating Profit = Net Sales - _______________
(b) Operating Profit = Net Profit + Non-Operating Expenses - __________
(c) If Net Sales = ` 2,00,000 and Operating cost = ` 1,50,000 than calculate
Operating profit.

WHAT YOU HAVE LEARNT

z Financial statements are of two types :
(a) Income Statement i.e. Trading Account and Profit and Loss Account.

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 MODULE - 3 Financial Statements : An Introduction
Financial Statement
(b) Position Statement i.e. Balance Sheet.
z Trading Account is prepared to ascertain the results of the trading activities of the
business.
z Trading Account may show profit (i.e. the excess of sales to cost of goods sold or
excess of credit side over debit side), which is termed as Gross Profit.
Trading Account may show loss (i.e. Cost of goods sold exceeds sales or total of
Notes debit side exceeds total of credit side). This is called Gross Loss.
z Profit and Loss Account is prepared to find out Net Profit/Net Loss.
Net Profit = Gross Profit + other incomes – Indirect expenses.
It may also show a net loss.
All indirect expenses are shown on the debit side of Profit & Loss Account.
All incomes and gains are shown on the credit side of Profit & Loss Account.
z Balance Sheet is prepared to ascertain the financial position of a firm on a particular
date.

TERMINAL EXERCISE
1. State the meaning of financial statements.
2. Explain in brief the various objectives of finanacial statements.
3. Explain in brief the following terms with two examples of each :
(a) Revenue expenditure.
(b) Revenue Receipts
(c) Capital expenditure
(d) Capital Receipts
4. Distinguish between capital expenditure and Revenue expenditure on the basis of:
(a) Earning capacity
(b) Placement in financial statements
(c) Occurrence of expenditure
5. Distinguish between capital receipts and revenue receipts.
6. How is cost of goods sold calculated?

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 Financial Statements : An Introduction MODULE - 3
Financial Statement
7. What is Trading Account? Why is it prepared?
8. How is Gross Profit calculated?
9. What is meant by Profit and Loss Account? Why is it prepared?
10. When does Profit and Loss Account show Net Profit?
11. What are direct expenses? Give two examples of such expenses.
12. State the meaning of Balance Sheet.
Notes
13. From the following balances of Sabana calculate Gross Profit or Gross Loss by
subtracting cost of goods sold from sales for the year ended 31st December,
2014
`
Stock (1.1.2014) 26500
Purchases 64600
Sales 86800
Purchases Returns 2600
Sales Returns 1800
Freight inward 750
Wages 1850
Closing Stock 31100
14. From the following balances extracted from the books of Seth Brothers. Pass
journal entries to prepare a Trading Account and Profit and Loss Account for the
year ended 31st March, 2014.
` `
Stock (1.4.2013) 20000 Electric Power 5000
Purchases 95000 Wages 14000
Return Inwards 2000 Selling Commission 5500
Carriage Inwards 1850 Repair & Renewals 2000
Carriage Outwards 1200 General Expenses 8000
Custom duty 3000 Insurance 2200
Return outwards 5000 Stock (31.3.2014) 45000
Sales 165000
Discount Received 1500

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 MODULE - 3 Financial Statements : An Introduction
Financial Statement
15. The balances from the books of Parimal Ghosh are given below. Pass journal
entries to prepare Trading and Profit & Loss Account for the year ended 31st
March, 2014
` `
Stock as on 1.4.2013 9480 Purchase Returns 1800
Purchases 50800 Advertising 1500

Notes Wages 1200 Commission (Cr.) 3200

Salaries 3400 Rent from tenant 2800
Octroi 1320 Sales 72000
Rent & Taxes 850 Stock (31.3.2014) 10700
Bad Debts 250
Discount (Dr.) 360
Interest on capital 760
16. From the following information calculate cost of goods sold for the year ending
31st March, 2014
` `
Opening Stock 14800 Factory expenses 7200
Purchases 65700 Closing stock 28400
Returns outward 1700
Wages 12500
Carriage Inward 2400
Custom Duty 3200
Rent paid 4500
Establishment expenses 650
17. From the following balances extracted from the books of Jai Bhagwan & Sons as
on 31st March, 2014. Pass journal entries to prepare Trading A/c and Profits &
Loss A/c
` `
Opening Stock 16000 Rent 3600
Purchases 76000 Office expenses 1600
Machinery 28000 Carriage Inward 1200

70 Accountancy
 Financial Statements : An Introduction MODULE - 3
Financial Statement
Debtors 21600 Sales Returns 5400
Drawings 7200 Credit Balance
Wages 1500 Capital 70000
Bank 12000 Creditors 14000
Depreciaiton 2800 Sales 108000
Closing stock 24000 Purchase Returns 2600
Notes

ANSWERS TO INTEXT QUESTIONS

16.1 I. (i) Capital (ii) Revenue
(iii) Deferred Revenue (iv) Capital
II. (a) Ascertaining the financial position
(b) Source of information
(c) Helps in managerial decision making
(d) An index of the solvency of the concern.
16.2 I. 1. Two 2. Trading and Profit & Loss
3. Gross Profit 4. Success
II. (a) Net sales (b) Net purchases (c) Gross profit
(d) Gross Loss (e) Gross Loss
16.3 (i) Credit (ii) Debit (iii) Credit (iv) Debit
16.4 I. (i) I (ii) E (iii) E (iv) I (v) E
II. (i) F (ii) T (iii) F (iv) T
16.5 I. (a) debit (b) debit (c) Credit (d) debit (e) debit
II. (a) Balance sheet
(b) to show the financial position of the concern
(c) At the end of an accounting year
(d) assets; liabilities
III. (a) Operating Cost (b) Non-operating income
(c) ` 50,000

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 MODULE - 3 Financial Statements : An Introduction
Financial Statement

ANSWERS TO TERMINAL EXERCISE

13. Gross Profit : ` 25000
14. Gross Profit : ` 74150 Net Profit : ` 56750
15. Gross Profit : ` 21700 Net Profit : ` 20580
Notes 16. Cost of goods sold : ` 75700
17. Gross Profit : ` 21000 Net Profit : ` 13000

ACTIVITY
Procure trial balance of at least four business concerns and classify the items into :
(a) Revenue expenditure (b) Revenue receipts
(c) Capital expenditure (d) Capital Receipts
Name of Item of Revenue Revenue Capital Capital
organisation expenditure expenditure receipts expenditure Receipts

72 Accountancy