Chapter 9: Financial Statements – I

1. Meaning of Financial Statements

Financial Statements are summary documents prepared at the end of the accounting period to show the financial performance and financial position of a business. For a trading firm, they consist of:

• Trading Account: Shows Gross Profit or Gross Loss.
• Profit & Loss Account: Shows Net Profit or Net Loss.
• Balance Sheet: Shows Financial Position (Assets, Liabilities, Capital) as on a specific date.

2. Trading Account

The Trading Account is prepared to ascertain the Gross Profit or Gross Loss from trading activities (buying and selling of goods).

Dr. Side (Debit — Expenses/Costs)

• Opening Stock
• Net Purchases (= Total Purchases – Purchase Returns)
• Direct Expenses (Carriage inwards, Wages, Factory Rent, Octroi, Custom Duty, Gas & Fuel, Packing charges for production)
• Gross Profit c/d (if Sales > COGS — transferred to Cr. side to balance)

Cr. Side (Credit — Revenue)

• Net Sales (= Total Sales – Sales Returns)
• Closing Stock
• Gross Loss c/d (if COGS > Sales — placed on Cr. side to balance)

3. Profit & Loss Account

Prepared after the Trading Account to determine the Net Profit or Net Loss of the business.

Dr. Side (Indirect Expenses)

• Selling & Distribution: Advertisement, Carriage outwards, Bad debts, Commission paid, Sales salaries, Packing (delivery)
• Administrative: Office rent, Salaries, Stationery, Postage, Audit fees, Legal charges
• Financial: Discount allowed, Interest on loan, Bank charges
• Other: Depreciation, Provision for Bad Debts

Cr. Side (Other Incomes)

• Discount received, Commission received, Interest received, Rent received, Profit on sale of assets
• Gross Profit b/d (from Trading Account)

4. Important Adjustments

Closing Stock

Closing stock is shown on the Credit side of Trading Account AND as a Current Asset in the Balance Sheet. It is valued at Cost or Net Realisable Value (NRV), whichever is lower (Conservatism concept).

Outstanding Expenses (Accrued Expenses)

Expenses incurred but NOT yet paid. Adjustment: Add to the expense amount (on Dr. side of P&L) AND show as a Current Liability in Balance Sheet.

Prepaid Expenses (Expenses Paid in Advance)

Expenses paid but NOT yet due/consumed. Adjustment: Deduct from the expense amount (Dr. side) AND show as a Current Asset in Balance Sheet.

Accrued Income (Outstanding Income)

Income earned but NOT yet received. Add to the income (Cr. side of P&L) and show as Current Asset in Balance Sheet.

Income Received in Advance (Deferred Income)

Income received but NOT yet earned. Deduct from income (Cr. side of P&L) and show as Current Liability in Balance Sheet.

Depreciation

Charge to P&L Account (Dr. side) and deduct from the asset in the Balance Sheet.

Bad Debts and Provision for Bad Debts

• Bad Debts: Debts that cannot be recovered — charged as an expense in P&L (Dr. side).
• New Provision for Bad Debts: Charged to P&L as an expense. Old provision is first transferred to P&L Cr. side, then new provision is calculated on remaining debtors.

Interest on Capital

Interest allowed to the proprietor on their capital — Dr. to P&L, Cr. to Capital Account (increases capital).

Interest on Drawings

Charged from the proprietor for withdrawals — Credit to P&L, Debit to Capital Account (reduces capital).

5. Direct vs Indirect Expenses