Business Economics and Financial Analysis Unit-IV

FINANCIAL ACCOUNTING
Accounting:
“Accounting is a means of measuring and reporting the results of economic activities.” – Smith
Accounting system is a means of collecting summarizing, analyzing and reporting in monetary terms, the
information about the business. - Anthony
The art of recording, classifying and summarizing in a significant manner and in terms of money
transactions and events, which are in part at least, of a financial character and interpreting the results thereof.
-American Institute of Certified Public Accountants
Accounting is an art of identifying, recording, summarizing and interpreting business transactions of
financial nature. Hence, accounting is the Language of Business.
Users of Accounting Information:
Managers: These are the persons who manage the business, i.e. management at the top, middle and lower
levels. Their requirements of information are different because they make different types of decisions.
Accounting reports are important to managers for evaluating the results of their decisions. In additions to
external financial statements, managers need detailed internal reports either branch division or department or
product-wise. Accounting reports for managers are prepared much more frequently than external reports.
Accounting information also helps the managers in appraising the performance of subordinates.
Investors: Those who are interested in buying the shares of company are naturally interested in the financial
statements to know how safe the investment already made is and how safe the proposed investments will be.
Creditors: Lenders are interested to know whether their load, principal and interest, will be paid when due.
Suppliers and other creditors are also interested to know the ability of the firm to pay their dues in time.
Workers: In our country, workers are entitled to payment of bonus which depends on the size of profit earned.
Hence, they would like to be satisfied that he bonus being paid to them is correct. This knowledge also helps
them in conducting negotiations for wages.
Customers: They are also concerned with the stability and profitability of the enterprise. They may be
interested in knowing the financial strength of the company to rent it for further decisions relating to purchase
of goods.
Government: Governments all over the world are using financial statements for compiling statistics concerning
business which, in turn, helps in compiling national accounts. The financial statements are useful for tax
authorities for calculating taxes.
Public : The public at large interested in the functioning of the enterprises because it may make a substantial
contribution to the local economy in many ways including the number of people employed and their patronage
to local suppliers.
Researchers: The financial statements, being a mirror of business conditions, are of great interest to scholars
undertaking research in accounting theory as well as business affairs and practices.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

ADVANTAGES OF ACCOUNTING
The role of accounting has changed from that of a mere record keeping during the 1 st decade of 20th
century of the present stage, which it is accepted as information system and decision making activity. The
following are the advantages of accounting.
1. Provides for systematic records: Since all the financial transactions are recorded in the books, one need not
rely on memory. Any information required is readily available from these records.
2. Facilitates the preparation of financial statements: Profit and loss accountant and balance sheet can be
easily prepared with the help of the information in the records. This enables the trader to know the net result of
business operations (i.e. profit / loss) during the accounting period and the financial position of the business at
the end of the accounting period.
3. Provides control over assets: Book-keeping provides information regarding cash in hand, cash at bank, stock
of goods, accounts receivables from various parties and the amounts invested in various other assets. As the
trader knows the values of the assets he will have control over them.
4. Provides the required information: Interested parties such as owners, lenders, creditors etc. get necessary
information at frequent intervals.
5. Comparative study: One can compare the present performance of the organization with that of its past. This
enables the managers to draw useful conclusion and make proper decisions.
6. Less Scope for fraud or theft: It is difficult to conceal fraud or theft etc., because of the balancing of the
books of accounts periodically. As the work is divided among many persons, there will be check and counter
check.
7. Tax matters: Properly maintained book-keeping records will help in the settlement of all tax matters with the
tax authorities.
8. Ascertaining Value of Business: The accounting records will help in ascertaining the correct value of the
business. This helps in the event of sale or purchase of a business.
9. Documentary evidence: Accounting records can also be used as evidence in the court to substantiate the
claim of the business. These records are based on documentary proof. Every entry is supported by authentic
vouchers. As such, Courts accept these records as evidence.
10. Helpful to management: Accounting is useful to the management in various ways. It enables the
management to assess the achievement of its performance. The weakness of the business can be identified and
corrective measures can be applied to remove them with the helps accounting.
LIMITATIONS OF ACCOUNTING
The following are the limitations of accounting.
1. Does not record all events: Only the transactions of a financial character will be recorded under book-
keeping. So it does not reveal a complete picture about the quality of human resources, vocational advantage,
and business contacts etc.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

2. Does not reflect current values: The data available under book-keeping is historical in nature. So they do not
reflect current values. For instance, we record the value of stock at cost price or market price, whichever is less.
In case of, building, machinery etc., we adopt historical cost as the basis. In fact the current values of buildings,
plant and machinery may be much more than what is recorded in the balance sheet.
3. Estimates based on Personal Judgment: The estimate used for determining the values of various items may
not be correct. For example, debtor is estimated in terms of collectability, inventories are based on
marketability, and fixed assets are based on useful working life. These estimates are based on personal
judgment and hence sometimes may not be correct.
4. Inadequate information on costs and Profits: Book-keeping only provides information about the overall
profitability of the business. No information is given about the cost and profitability of different activities of
products or divisions.
BASIC ACCOUNTING CONCEPTS
Accounting is a system evolved to achieve a set of objectives. In order to achieve the goals, we need a
set of rules or guidelines. These guidelines are termed here as “basic accounting concepts”. The term concept
means an idea or thought. Basic accounting concepts are the fundamental ideas or basic assumptions underlying
the theory and profit of financial accounting. These concepts help in bringing about uniformity in the practice of
accounting. In accountancy following concepts are quite popular.
1.Business Entity Concept: In this concept “Business is treated as separate from the proprietor”. All the
transactions recorded in the book of Business and not in the books of proprietor. The proprietor is also treated as
a creditor for the Business.
2.Going Concern Concept: This concept relates with the long life of Business. The assumption is that business
will continue to exist for unlimited period unless it is dissolved due to some reasons or the other.
3.Money Measurement Concept: In this concept “Only those transactions are recorded in accounting which can
be expressed in terms of money, those transactions which cannot be expressed in terms of money are not
recorded in the books of accounting”.
4.Cost Concept: Accounting to this concept, can asset is recorded at its cost in the books of account. i.e., the
price, which is paid at the time of acquiring it. In balance sheet, these assets appear not at cost price every year,
but depreciation is deducted and they appear at the amount, which is cost, less classification.
5.Accounting Period Concept: Every Businessman wants to know the result of his investment and efforts after
a certain period. Usually one-year period is regarded as an ideal for this purpose. This period is called
Accounting Period. It depends on the nature of the business and object of the proprietor of business.
6.Dual Aspect Concept: According to this concept “Every business transactions has two aspects”, one is the
receiving benefit aspect another one is giving benefit aspect. The receiving benefit aspect is termed as “DEBIT”,
where as the giving benefit aspect is termed as “CREDIT”. Therefore, for every debit, there will be
corresponding credit.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

7.Matching Cost Concept: According to this concept “The expenses incurred during an accounting period,
e.g., if revenue is recognized on all goods sold during a period, cost of those good sole should also be charged
to that period.
8.Realisation Concept: According to this concept revenue is recognized when a sale is made. Sale is
considered to be made at the point when the property in goods posses to the buyer and he becomes legally
liable to pay.
ACCOUNTING CONVENTIONS
Accounting is based on some customs or usages. Naturally accountants here to adopt that usage or
custom. They are termed as convert conventions in accounting. The following are some of the important
accounting conventions.
1. Full Disclosure: According to this convention accounting reports should disclose fully and fairly the
information. They purport to represent. They should be prepared honestly and sufficiently disclose information
which is if material interest to proprietors, present and potential creditors and investors. The companies ACT,
1956 makes it compulsory to provide all the information in the prescribed form.
2. Materiality: Under this convention the trader records important factor about the commercial activities. In the
form of financial statements if any unimportant information is to be given for the sake of clarity it will be given
as footnotes.
3. Consistency: It means that accounting method adopted should not be changed from year to year. It means that
there should be consistent in the methods or principles followed. Or else the results of a year cannot be
conveniently compared with that of another.
4. Conservatism: This convention warns the trader not to take unrealized income in to account. That is why the
practice of valuing stock at cost or market price, whichever is lower is in vague. This is the policy of “playing
safe”; it takes in to consideration all prospective losses but leaves all prospective profits.
DOUBLE ENTRY ACCOUNTING SYSTEM
The double entry system of accounting or bookkeeping means that every business transaction will
involve two accounts (or more).
Ex: When a company borrows money from its bank, the company’s Cash account will increase and its liability
account Loans Payable will increase.
Double entry also allows for the accounting equation (Assets = Liabilities + Owner’s Equity) to always be in
balance. A third aspect of double entry is that the amounts entered into the general ledger accounts as debits
must be equal to the amounts entered as credits. Debits and credits are numbers recorded as follows:
• Debits are recorded on the left side of a “T” account in a ledger. Debits increase balances in asset accounts
and expense accounts and decrease balances in liability accounts, revenue accounts, and capital accounts.
• Credits are recorded on the right side of a “T” account in a ledger. Credits increase balances in liability
accounts, revenue accounts, and capital accounts, and decrease balances in asset accounts and expense

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

accounts.
• Debit accounts are asset and expense accounts that usually have debit balances, i.e. the total debits usually
exceed the total credits in each debit account.
• Credit accounts are revenue (income, gains) accounts and liability accounts that usually have credit balances.
Advantages of Double Entry Accounting System
1. Scientific: The double-entry book-keeping system is a scientific system of book-keeping. Double-entry
system has its own set of principles and rules. Under those principles and rules, two aspects of every financial
transaction are recorded.
2. Systematic: A systematic technique is followed in recording financial transaction in double- entry book-
keeping system. It records financial transactions in a systematic and chronological order with suitable narration
of the financial transaction.
3. Complete: Double-entry system is a complete system of book-keeping. It records not only each and every
financial transaction, but also each aspect of the transaction.
4. Accuracy: Double-entry book-keeping system is based on the double-entry principle which means ' for every
debit amount there is a corresponding credit amount'. Such a method of debit and credit can help ensure
arithmetical accuracy of the recordings of financial transactions.
5. Profit or Loss: Double-entry book-keeping system helps to ascertain the true profit or loss of a business by
preparing the profit and loss account for a given period.
6. Financial Position: Double-entry book-keeping system also helps to reveal information about the financial
position of the business by preparing a statement called balance sheet.
7. Control: Double-entry book-keeping system keeps a detailed record of financial transactions. Therefore, the
recording of financial transactions in books provides necessary information for the purpose of costs control.
8. Decision Making: Double-entry book-keeping system communicates financial information that is necessary
for taking decisions by a business. Double-entry book-keeping system also provides necessary information to
different users such as owners, managers and creditors for their decision making purposes.
KEY WORDS IN BOOK-KEEPING
Transactions: Any sale or purchase of goods of services is called the transaction. Transactions are two types.
Cash transaction: cash transaction is one where cash receipt or payment is involved in the exchange.
Credit transaction: Credit transaction will not have cash, either received or paid, for something given or
received respectively.
Goods: Fill those things which a firm purchases for resale are called goods.
Purchases: Purchases means purchase of goods, unless it is stated otherwise it also represents the Goods
purchased.
Sales: Sales means sale of goods, unless it is stated otherwise it also represents these goods sold.
Expenses: Payments for the purchase of goods as services are known as expenses.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

Revenue: Revenue is the amount realized or receivable from the sale of goods or services. Assets: The
valuable things owned by the business are known as assets. These are the properties owned by the business.
Liabilities: Liabilities are the obligations or debts payable by the enterprise in future in the terms of money or
goods.
Debtors: Debtors means a person who owes money to the trader.
Creditors: A creditor is a person to whom something is owned by the business.
Drawings: Cash or goods withdrawn by the proprietor from the Business for his personal or household is
termed to as “drawing”.
Reserve: An amount set aside out of profits or other surplus and designed to meet contingencies. Account: A
summarized statements of transactions relating to a particular person, thing, expense or income.
CLASSIFICATION OF BUSINESS TRANSACTIONS
All business transactions are classified into three categories:
1.Those relating to persons
2.Those relating to property (Assets)
3.Those relating to income & expenses
Thus, three classes of accounts are maintained for recording all business transactions.
They are:
1. Personal accounts 2. Real accounts 3.Nominal accounts
1. Personal Accounts: Accounts which are transactions with persons or artificial persons (names of the
companies) are called “Personal Accounts”. A separate account is kept on the name of each person for
recording the benefits received from or given to the person in the course of dealings withhim.
E.g.: Krishna’s A/C, Gopal’s A/C, SBI A/C, Nagarjuna Finanace Ltd.A/C, HMT Ltd. A/C, Capital A/C,
Drawings A/C etc.
2. Real Accounts: The accounts relating to properties or assets are known as “Real Accounts”. Every business
needs assets such as machinery, furniture etc, for running its activities .A separate account is maintained for
each asset owned by the business.
E.g.: Cash A/C, furniture A/C, building A/C, machinery A/C etc.
3. Nominal Accounts: Accounts relating to expenses, losses, incomes and gains are known as “Nominal
Accounts”. A separate account is maintained for each item of expenses, losses, income or gain.
E.g.: Salaries A/C, stationery A/C, wages A/C, postage A/C, commission A/C, interest A/C, purchases A/C,
rent A/C, discount A/C, commission received A/C, interest received A/C, rent received A/C, discount received
A/C.
Before recording a transaction, it is necessary to find out which of the accounts is to be debited and which is to
be credited. The following three different rules have been laid down for the three classes of accounts.
RULES OF ACCOUNTS

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

Personal Accounts: The account of the person receiving benefit (receiver) is to be debited and the account of
the person giving the benefit (given) is to be credited.

Rule: “Debit ---- The Receiver

Credit--8 --- The Giver”

Real Accounts: When an asset is coming into the business, account of that asset is to be debited. When an
asset is going out of the business, the account of that asset is to be credited.

Rule: “Debit ---- What comes in

Credit ----What goes out”

Nominal Accounts: When an expense is incurred or loss encountered, the account representing the expense or
loss is to be debited. When any income is earned or gain made, the account representing the income of gain is
to be credited.

Rule: “Debit -----All expenses and losses

Credit -----All incomes and gains”

ACCOUNTING CYCLE

Journal

Balance sheet Accounting cycle Ledger

Trial balance

JOURNAL
The first step in accounting is the record of all the transactions in the books of original entry i.e Journal.
Journal: The word Journal is derived from the Latin word ‘journ’ which means a day. Therefore, journal
means a ‘day Book’ in day-to-day business transactions are recorded in chronological order.
Journal is treated as the book of original entry or first entry or prime entry. All the business transactions
are recorded in this book before they are posted in the ledger. The journal is a complete and chronological (in
order of dates) record of business transactions.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

It is recorded in a systematic manner. The process of recording a transaction in the journal is called
“Journalising”. The entries made in the book are called “Journal Entries”.
Format of journal
The proforma of Journal is given below.
Journal entries in the books of (name of the company) for the year ended (month & year)
Date Particulars L.F. Debit (RS.) Credit (RS.)
1998 Jan 1 Purchases a/c Dr. 10,000/-
To cash a/c 10,000/-
(being goods purchased for
cash)

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV
LEDGER
All the transactions in a journal are recorded in a chronological order. After a certain period, if we
want to know whether a particular account is showing a debit or credit balance it becomes very difficult. So,
the ledger is designed to accommodate the various accounts maintained the trader. It contains the final or
permanent record of all the transactions in duly classified form.
“A ledger is a book which contains various accounts.” The process of transferring entries from
journal to ledger is called “POSTING”.
Posting is the process of entering in the ledger the entries given in the journal. Posting into ledger is
done periodically, may be weekly or fortnightly as per the convenience of the business. The following are
the guidelines for posting transactions in the ledger.
 After the completion of Journal entries only posting is to be made in the ledger.
 For each item in the Journal a separate account is to be opened. Further, for each new item a new
account is to be opened.
 Depending upon the number of transactions space for each account is to be determined in the ledger.
 For each account there must be a name. This should be written in the top of the table. At the end of the
name, theword “Account” is to be added.
 The debit side of the Journal entry is to be posted on the debit side of the account, by starting with “TO”.
The credit side of the Journal entry is to be posted on the debit side of the account, by starting with “BY”.
PROFORMA FOR LEDGER

LEDGER BOOK

Dr. Name of the account Cr.

Date Particulars J.f Amount Date Particulars J.f Amount

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV
TRAIL BALANCE
The first step in the preparation of final accounts is the preparation of trail balance. In the double
entry system of book keeping, there will be credit for every debit and there will not be any debit without
credit. When this principle is followed in writing journal entries, the total amount of all debits is equal to the
total amount allcredits.
A trail balance is a statement of debit and credit balances. It is prepared on a particular date with the
object of checking the accuracy of the books of accounts. It indicates that all the transactions for a particular
period have been duly entered in the book, properly posted and balanced. The trail balance doesn’t include
stock in hand at the end of the period. All adjustments required to be done at the end of the period including
closing stock are generally given under the trail balance.
DEFINITIONS:
Spicer And Poglar: A trail balance is a list of all the balances standing on the ledger accounts and cash
book of a concern at any given date.
J.R.Batliboi: A trail balance is a statement of debit and credit balances extracted from the ledger with a
view to test the arithmetical accuracy of the books.
Thus a trail balance is a list of balances of the ledger accounts’ and cash book of a business concern at any
given date.
PROFORMA FOR TRAIL BALANCE:

Trail balance for (name of the company) as on (date, month & year)
Name of Account (Particulars) Debit (Rs.) Credit (Rs.)

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV
Trail Balance
Specimen of trial balance

1 Capital Credit Loan

2 Opening stock Debit Asset
3 Purchases Debit Expense
4 Sales Credit Gain
5 Returns inwards Debit Loss
6 Returns outwards Debit Gain
7 Wages Debit Expense
8 Freight Debit Expense
9 Transport expenses Debit Expense
10 Royalities on production Debit Expense
11 Gas, fuel Debit Expense
12 Discount received Credit Revenue
13 Discount allowed Debit Loss
14 Bad debts Debit Loss
15 Dab debts reserve Credit Gain
16 Commission received Credit Revenue
17 Repairs Debit Expense
18 Rent Debit Expense
19 Salaries Debit Expense
20 Loan Taken Credit Loan
21 Interest received Credit Revenue
22 Interest paid Debit Expense
23 Insurance Debit Expense
24 Carriage outwards Debit Expense
25 Advertisements Debit Expense
26 Petty expenses Debit Expense
27 Trade expenses Debit Expense
28 Petty receipts Credit Revenue
29 Income tax Debit Drawings
30 Office expenses Debit Expense
31 Customs duty Debit Expense
32 Sales tax Debit Expense
33 Provision for discount on debtors Debit Liability
34 Provision for discount on creditors Debit Asset
35 Debtors Debit Asset
36 Creditors Credit Liability
37 Goodwill Debit Asset
38 Plant, machinery Debit Asset
39 Land, buildings Debit Asset
40 Furniture, fittings Debit Asset
41 Investments Debit Asset
42 Cash in hand Debit Asset
43 Cash at bank Debit Asset
44 Reserve fund Credit Liability

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

45 Loan advances Debit Asset

46 Horse, carts Debit Asset
47 Excise duty Debit Expense
48 General reserve Credit Liability
49 Provision for depreciation Credit Liability
50 Bills receivable Debit Asset
51 Bills payable Credit Liability
52 Depreciation Debit Loss
53 Bank overdraft Credit Liability
54 Outstanding salaries Credit Liability
55 Prepaid insurance Debit Asset
56 Bad debt reserve Credit Revenue
57 Patents & Trademarks Debit Asset
58 Motor vehicle Debit Asset
59 Outstanding rent Credit Revenue

FINAL ACCOUNTS
In every business, the business man is interested in knowing whether the business has resulted in
profit or loss and what the financial position of the business is at a given time.

In brief, he wants to know (i) The profitability of the business and (ii) The soundness of the business.
The trader can ascertain this by preparing the final accounts.

The final accounts are prepared from the trial balance. Hence the trial balance is said to be the link
between the ledger accounts and the final accounts. The final accounts of a firm can be divided into two
stages. The first stage is preparing the trading and profit and loss account and the second stage is preparing the
balance sheet.
Final accounts are the statement prepared at the end of the accounting period to show financial performance
during the accounting period and financial position of the business as on that date.
The final accounts or financial statements consist of:
1. Trading and profit and loss account or income statement, which is prepared to know the profit earned or
loss suffered by the business during a specific period.
2. Balance sheet, which is prepared to know the financial position of the business on a particular date.
These two items or statements are collectively known as “final accounts or financial statements”

TRADING ACCOUNT
The first step in the preparation of final account is the preparation of trading account. The main purpose
of preparing the trading account is to ascertain gross profit or gross loss as a result of buying and selling the
goods. Trading account is prepared for calculating the gross profit or gross loss arising or incurred as a result of
the trading activities of a business.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV
In other words, it is prepared to show the result of manufacturing, buying and selling of goods. If the
amount of sales exceeds the amount of purchases and the expenses directly connected with such purchases, the
difference is termed as gross profit. On the contrary, if the purchases and direct expenses exceed the sales, the
difference is called gross loss.
A Trading Account records the number of purchases of goods and also the expenses which are incurred
in bringing that commodity to a saleable state. In other words, all expenses which relate to either purchase of
raw material for manufacturing of goods are recorded in the Trading Account. All such expenses are called
‘Direct Expenses’.
According to J.R. Batliboi, “The Trading Account shows the results of buying and selling of goods. In
preparing this account, the general establishment charges are ignored and only the transaction in goods is
included.”
Sometimes, a Trading Account is also called ‘Good A/c’ because all the transaction relating to goods are
recorded in it. Such as (i) Opening Stock, (ii) Purchases, (iii) Purchases Returns, (iv) Sales, (v) Sales Returns,
(vi) Closing Stock, (vii) Expenses incurred on manufacturing of goods, and (viii) Expenses incurred on
purchasing and bringing the goods to the trading place. All such expenses are summarised and recorded in the
Trading Account at the end of the year.
Need and Importance of Trading Account
Preparation of Trading Account serves the following objectives:
It provides information about Gross Profit and Gross Loss: It informs of the gross profit or gross loss as a
result of buying and selling the goods during the year. The percentage of Current Year’s gross profit on the
amount of sales can be calculated and compared with those of the previous years. Thus, it provides data for
comparison, analysis and planning for a future period.
It provides information about the direct expenses: All the expenses incurred on the purchase and
manufacturing of goods are recorded in the trading account in a summarised form. Percentage of such expenses
on sales can be calculated and compared with those of the previous years. In this way it enables the
management to control and rationalise the expenses.
Comparison of closing stock with those of the previous years: closing stock has to be valued and recorded in
a trading account. This stock can be compared with the closing stock of the previous years and if the stock
shows an increasing trend, the reasons may be inquired into.
It provides safety against possible losses: If the ratio of gross profit has decreased in comparison to the
preceding year, the businessman can take effective measures to safeguard him against future losses. For
example, he may increase the sale price of his gods or may proceed to analyse and control the direct expenses.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV
PROFORMA FOR TRADING ACCOUNT

Trading account of MR……………………. for the year ended ……………………

Particulars Amount Particulars Amount

To opening stock Xxxx By sales xxxx

To purchases xxxx Less: returns xxx Xxxx
Xxxx By closing stock Xxxx
Less: returns xx

To carriage inwards Xxx

To wages xxx
To freight Xxx
To customs duty, octroi xXx

To gas, fuel, coal, Xxxx

Water

To factory expenses Xxxx

To other man. Expenses
To productive expenses Xxxx
To gross profit c/d
xxx

Xxxx

Xxxx

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV
PROFIT AND LOSS ACCOUNT
The business man is always interested in knowing his net income or net profit. Net profit represents the
excess of gross profit plus the other revenue incomes over administrative, sales, Financial and other expenses.
The debit side of profit and loss account shows the expenses and the credit side the incomes. If the total of the
credit side is more, it will be the net profit. And if the debit side is more, it will be net loss.
Trading account only discloses the gross profit earned as a result of buying and selling of goods.
However, a businessman has to incur a number of expenses which are not taken to trading account.
Hence, a businessman is more interested in knowing the net profit earned or net loss incurred during the
year. As such, a Profit & Loss Account is prepared which contains all the items of losses and gains pertaining to
the accounting period.
According to Prof. Carter, “A Profit & Loss Account is an account into which all gains and losses are
collected, in order to ascertain the excess gains over the losses or vice-versa”.
Need and Importance of Profit & Loss A/c
To Ascertain the Net Profit or Net Loss: A Trading Account only discloses the Gross Profit earned as a result
of trading activities, whereas the Profit & Loss Account discloses the net profit (or net loss) available to the
proprietor and credited to his capital account.
Comparison with previous years’ profit: The net profit of the current year can be compared with that of the
previous years. It enables the businessman to know whether the business is being conducted efficiently or no.
Control on Expenses: Profit & Loss Account helps in comparing various expenses with the expenses of the
previous year. Also the percentage of each individual expense to net profit is calculated and compared with the
similar ratio of previous years. Such comparison will be helpful in taking concrete steps for controlling the
unnecessary expenses.
Helpful in the preparation of Balance Sheet: A Balance Sheet can only be prepared after ascertaining the Net
Profit through the preparation of Profit and Loss Account.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV
PROFORMA FOR PROFIT AND LOSS A/C

Dr. Profit and Loss A/C Of Mr…………………….For The Year Ended…… Cr.
Particulars Amount Particulars Amount
TO office salaries Xxxxxx By gross profit b/d XxxxxXx
TO rent,rates,taxes Xxxxx By Interest received By xxxXx
TO Printing and stationery Xxxxx Discount received
TO Legal charges By Commission Xxxxx
Audit fee Xxxx By Income from
TO Insurance Xxxx investments
TO General expenses Xxxx By Dividend on shares Xxxx Xxxx
TO Advertisements Xxxxx By Miscellaneous
TO Bad debts Xxxx
TO Carriage outwards Xxxx By Rent received xxxx
TO Repairs Xxxx
TO Depreciation Xxxxx
TO interest paid Xxxxx By Net loss xxxxx
TO Interest on capital Xxxxx (transferred to capital a/c)
TO Interest on loans Xxxx
TO Discount allowed Xxxxx
TO Commission Xxxxx
TO Net profit Xxxxx
(transferred to capital a/c)
xxxxxx Xxxxxx

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

BALANCE SHEET
The second point of final accounts is the preparation of balance sheet. It is prepared often in the trading
and profit; loss accounts have been compiled and closed. A balance sheet may be considered as a statement of
the financial position of the concern at a given date.
J.R.botliboi: A balance sheet is a statement with a view to measure exact financial position of a business at a
particular date.
Karlson: “A business form showing what is owed and what the proprietor is worth, is called a Balance Sheet.”
A. Palmer: “The Balance Sheet is a statement at a particular date showing on one side the trader’s property and
possessions and on the other hand the liabilities.”
Thus, Balance sheet is defined as a statement which sets out the assets and liabilities of a business firm
and which serves to ascertain the financial position of the same on any particular date. On the left-hand side of
this statement, the liabilities and the capital are shown. On the right-hand side all the assets are shown.
Therefore, the two sides of the balance sheet should be equal. Otherwise, there is an error somewhere.
After ascertaining the net profit or loss of the business enterprise, the businessman would also like to
know the exact financial position of his business. For this purpose a statement is prepared which contains all the
Assets and Liabilities of the business enterprise.
The statement so prepared is called a Balance Sheet because it is a sheet of balances of ledger accounts
which are still open after the transfer of all nominal accounts to the Trading and Profit & Loss Account.
Need and Importance of Preparing a Balance Sheet
The main purpose of preparing a Balance Sheet is to ascertain the true financial position of the business at a
particular point of time.
 It helps in ascertaining the nature and cost of various assets o the business such as the amount of Closing
Stock, amount owing from Debtors, amount of fictitious assets etc.
 It helps in determining the nature and amount of various liabilities of the business.
 It gives information about the exact amount of capital at the end of the year and the addition or
deduction made into it in the current year.
 It helps in finding out whether the firm is solvent or not. The firm is solvent if the assets exceed the
external liabilities. It would be insolvent if opposite is the case.
 It helps in preparing the Opening Entries at the beginning of the next year.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

PROFORMA FOR BALANCE SHEET

Balance Sheet Of ………………………… As On …………………………………….
Liabilities and capital Amount Assets Amount
Creditors Xxxx Cash in hand Xxx
Bills payable Xxxx Cash at bank x
Bank overdraft Xxxx Bills receivable Xxx
Loans Xxxx Debtors x
Mortgage Xxxx Closing stock Xxx
Reserve fund Xxxx Investments x
Capital Furniture and fittings Xxx
xxxxx Plats&machinery x
x Add: Land & Xxx
Net Profit xxxx buildings x
------- Patents, tm Xxx
xxxxxxx ,copyrights
x
-------- Goodwill
Xxx
Prepaid expenses
x
Less: Outstanding incomes
Drawings xxxx Xxxx
Xxx
---------
x
Xxx
x
Xxx
x

Xxxx
Xxx
x
Xxx
x
XXXX XXXX

Advantages: The following are the advantages of final balance sheet.

 It helps in checking the arithmetical accuracy of books ofaccounts.
 It helps in the preparation of financial statements.
 It helps in detecting errors.
 It serves as an instrument for carrying out the job of rectification of entries.
 It is possible to find out the balances of various accounts at oneplace.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

FINAL ACCOUNTS-ADJUSTMENTS
We know that business is a going concern. It has to be carried on indefinitely. At the end of every
accounting year. The trader prepares the trading and profit and loss account and balance sheet. While
preparing these financial statements, sometimes the trader may come across certain problems.
The expenses of the current year may be still payable or the expenses of the next year have been
prepaid during the current year. In the same way, the income of the current year still receivable and the
income of the next year have been received during the current year.
Without these adjustments, the profit figures arrived at or the financial position of the concern may
not be correct. As such these adjustments are to be made while preparing the final accounts.
The adjustments to be made to final accounts will be given under the Trial Balance. While making
the adjustment in the final accounts, the student should remember that “every adjustment is to be made in the
final accounts twice i.e. once in trading, profit and loss account and later in balance sheet generally”. The
following are some of the important adjustments to be made at the time of preparing of final accounts:-
Closing stock:-
(i) If closing stock is given in Trail Balance: It should be shown only in the balance sheet “Assets Side”.

(ii) If closing stock is given as adjustment:

1. First, it should be posted at the credit side of “Trading Account”.
2. Next, shown at the asset side of the “Balance Sheet”.
Outstanding Expenses:-
(i) If outstanding expenses given in Trail Balance: It should be only on the liability side of Balance Sheet.
(ii) If outstanding expenses given as adjustment :
1. First, it should be added to the concerned expense at the debit side of profit and loss account or
Trading Account.
2. Next, it should be added at the liabilities side of the Balance Sheet.
Prepaid Expenses:-
(i) If prepaid expenses given in Trial Balance: It should be shown only in assets side of the Balance Sheet.
(ii) If prepaid expense givenas adjustment:
1. First, it should be deducted from the concerned expenses at the debit side of profit and loss account or
Trading Account.
2. Next, it should be shown at the assets side of the Balance Sheet.
Income Earned But Not Received [Or] Outstanding Income [Or] Accrued Income :-
(i) If incomes given in Trial Balance: It should be shown only on the assets side of the Balance Sheet.
(ii) If incomes outstanding given as adjustment:
1. First, it should be added to the concerned income at the credit side of profit and loss account.
2. Next, it should be shown at the assets side of the Balancesheet.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies

Business Economics and Financial Analysis Unit-IV

Income Received In Advance: Unearned Income:-

(i) If unearned incomes given in Trail Balance : It should be shown only on the liabilities side of the
Balance Sheet.
(ii) If unearned income givenas adjustment:
1. First, it should be deducted from the concerned income in the credit side of the profit and loss account.
2. Secondly, it should be shown in the liabilities side of the Balance Sheet.
Depreciation:-
(i) If Depreciation given in Trail Balance: It should be shown only on the debit side of the profit and loss
account.
(ii) If Depreciation given as adjustment
1. First, it should be shown on the debit side of the profit and lossaccount.
2. Secondly, it should be deduced from the concerned asset in the Balance sheet assets side.
Interest on Loan [Or] Capital:-
(i) If interest on loan (or) capital given in Trail balance :It should be shown only on debit side of the
profit and loss account.
(ii) If interest on loan (or)capital given as adjustment :
1. First, it should be shown on debit side of the profit and loss account.
2. Secondly, it should added to the loan or capital in the liabilities side of the Balance Sheet.
Bad Debts:-
(i) If bad debts given in Trail balance: It should be shown on the debit side of the profit and loss account.
(ii) If bad debts given as adjustment:
1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deducted from debtors in the assets side of the Balance Sheet.
Interest on Drawings:-
(i) If interest on drawings given in Trail balance: It should be shown on the credit side of the profit and
loss account.
(ii) If interest on drawings given as adjustments :
1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be deducted from capital on liabilities side of the Balance Sheet.
Interest on Investments:-
(i) If interest on the investments given in Trail balance : It should be shown on the credit side of the profit
and loss account.
(ii) If interest on investments givenas adjustments :
1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be added to the investments on assets side of the Balance Sheet.

Dr. M. Kondala Rao, Associate Professor Department of Management Studies