Financial Statements - I

• Introduction

  • Meaning
    • Final report of business operations and financial position
    • Prepared at the end of the accounting period
  • Objectives
    • Ascertain Profitability (Trading & P&L A/c)
    • Ascertain Financial Position (Balance Sheet)
    • Provide information to users for decision making
  • Users of Financial Statements
    • Internal Users (Management, Employees)
    • External Users (Investors, Creditors, Tax Authorities, Banks)

• Basic Accounting Concepts & Terminology

  • Capital Expenditure vs. Revenue Expenditure
    • Capital: Long-term benefit, increases earning capacity
    • Revenue: Short-term benefit, maintains earning capacity
  • Deferred Revenue Expenditure
    • Heavy revenue expenditure with multi-year benefits (e.g., massive advertising)
  • Receipts
    • Capital Receipts vs. Revenue Receipts

• Components of Financial Statements

  • Income Statement
    • Trading Account
    • Profit and Loss Account
  • Position Statement
    • Balance Sheet

• Trading and Profit & Loss Account

  • Trading Account
    • Purpose: To find Gross Profit or Gross Loss
    • Debit Side Items
      • Opening Stock
      • Purchases (Net of Returns)
      • Direct Expenses (Freight, Wages, Carriage Inwards, Factory Power)
    • Credit Side Items
      • Sales (Net of Returns)
      • Closing Stock
    • Balancing Figure: Gross Profit (if Credit > Debit) or Gross Loss (if Debit > Credit)
  • Profit and Loss Account
    • Purpose: To find Net Profit or Net Loss
    • Brought down Gross Profit / Gross Loss
    • Debit Side Items (Indirect Expenses)
      • Office & Administrative Expenses (Salaries, Rent, Lighting)
      • Selling & Distribution Expenses (Carriage Outwards, Advertisement, Commission)
      • Financial & Miscellaneous Expenses (Interest, Depreciation, Bad Debts)
    • Credit Side Items (Indirect Incomes)
      • Discount Received, Commission Received, Rent Received
    • Balancing Figure: Net Profit (transferred to Capital) or Net Loss

• Balance Sheet

  • Meaning
    • Statement showing assets, liabilities, and capital on a specific date
  • Marshalling of Assets and Liabilities
    • Order of Liquidity (Most liquid to least liquid)
    • Order of Permanence (Most permanent to least permanent)
  • Assets
    • Non-Current Assets
      • Fixed Assets (Tangible: Land, Building, Machinery; Intangible: Goodwill, Patents)
      • Non-Current Investments
    • Current Assets
      • Cash in Hand, Cash at Bank
      • Debtors, Bills Receivable
      • Closing Stock
      • Prepaid Expenses
  • Liabilities & Capital
    • Non-Current Liabilities
      • Long-term Loans, Debentures
    • Current Liabilities
      • Creditors, Bills Payable
      • Outstanding Expenses, Bank Overdraft
    • Capital
      • Opening Capital + Net Profit - Drawings - Net Loss

• Adjustments in Financial Statements

  • Need for Adjustments
    • To follow the Accrual Concept and Matching Principle
  • Key Adjustments & Treatments
    • Closing Stock
      • Appears in Trading A/c (Credit) and Balance Sheet (Assets)
    • Outstanding Expenses
      • Added to respective expense in P&L A/c; Shown as Current Liability
    • Prepaid Expenses
      • Deducted from respective expense in P&L A/c; Shown as Current Asset
    • Accrued Income
      • Added to respective income in P&L A/c; Shown as Current Asset
    • Income Received in Advance
      • Deducted from respective income in P&L A/c; Shown as Current Liability
    • Depreciation
      • Debited to P&L A/c; Deducted from the specific asset in Balance Sheet
    • Bad Debts & Provision for Bad & Doubtful Debts
      • Bad Debts: Debited to P&L A/c
      • Provision for Doubtful Debts: Debited to P&L A/c, deducted from Debtors in Balance Sheet
    • Provision for Discount on Debtors
      • Calculated on good debtors after deducting bad/doubtful debts provision