Financial Statements of Sole Proprietorship - B Com PDF Download

 Page 1


 
  
 
   
    FINANCIAL STATEMENTS OF SOLE PROPRIETORSHIP 
Introduction to Financial Statements 
Meaning, Objectives, Users and Presentation of Financial Statements 
 
? Meaning: 
o These are the statements prepared at the end of the accounting period to determine the 
financial performance (i.e., profitability) and financial position of the business as on the date. 
o It is the end-product of the accounting process prepared from the Trial Balance. 
o It is considered as a vital information for the users of financial statements based on which they 
take important financial and investment decisions.  
o A complete set of financial statements is known as Final Accounts which includes the following: 
i. An Income Statement known as Trading and Profit and Loss Account: Such a statement 
has two parts where one is the Trading Account that shows the Gross Profit or Gross Loss 
for the accounting period and the other is the Statement of Profit and Loss that shows the 
Net Profit or Net Loss for the accounting period. 
ii. A Position Statement known as Balance Sheet:  It is a statement that shows financial 
position of the entity on a particular date in form of assets held and liabilities owed. 
 
? Objectives:  
Objectives of financial statements are to be understood separately for each of the following: 
 
o Objectives of Preparing Trading and Profit and Loss Account/Income Statement: 
i. To identify the gross profit or loss: A Trading Account records all the incomes and 
expenses directly related to the trading activities and helps identify the gross profit or loss 
on account of such operations. 
ii. To identify the net profit or net loss: A Profit and Loss Account records all the incomes 
and expenses not directly related to the trading activities and helps identify the net  profit or 
loss. 
iii. To facilitate comparison: Preparation of such income statement facilitates comparison of 
entity’s financial performance over a period of time and draw necessary conclusions. 
iv. To record complete details of incomes and expense: An income statement shows 
complete record of all the incomes earned and expenses incurred during the course of 
business. 
v. To determine the amount of reserves: The amount of profits derived with the help of such 
income statement helps to decide how much of the amount is to be kept aside for future 
uncertainties in the form of reserves. 
vi. To facilitate calculation of ratios: Expenses and incomes recorded and profits derived 
with the help of an Income Statement are used to compute various accounting ratios which 
helps an entity to take appropriate financial and investment decisions. 
 
 
 
 
Page 2


 
  
 
   
    FINANCIAL STATEMENTS OF SOLE PROPRIETORSHIP 
Introduction to Financial Statements 
Meaning, Objectives, Users and Presentation of Financial Statements 
 
? Meaning: 
o These are the statements prepared at the end of the accounting period to determine the 
financial performance (i.e., profitability) and financial position of the business as on the date. 
o It is the end-product of the accounting process prepared from the Trial Balance. 
o It is considered as a vital information for the users of financial statements based on which they 
take important financial and investment decisions.  
o A complete set of financial statements is known as Final Accounts which includes the following: 
i. An Income Statement known as Trading and Profit and Loss Account: Such a statement 
has two parts where one is the Trading Account that shows the Gross Profit or Gross Loss 
for the accounting period and the other is the Statement of Profit and Loss that shows the 
Net Profit or Net Loss for the accounting period. 
ii. A Position Statement known as Balance Sheet:  It is a statement that shows financial 
position of the entity on a particular date in form of assets held and liabilities owed. 
 
? Objectives:  
Objectives of financial statements are to be understood separately for each of the following: 
 
o Objectives of Preparing Trading and Profit and Loss Account/Income Statement: 
i. To identify the gross profit or loss: A Trading Account records all the incomes and 
expenses directly related to the trading activities and helps identify the gross profit or loss 
on account of such operations. 
ii. To identify the net profit or net loss: A Profit and Loss Account records all the incomes 
and expenses not directly related to the trading activities and helps identify the net  profit or 
loss. 
iii. To facilitate comparison: Preparation of such income statement facilitates comparison of 
entity’s financial performance over a period of time and draw necessary conclusions. 
iv. To record complete details of incomes and expense: An income statement shows 
complete record of all the incomes earned and expenses incurred during the course of 
business. 
v. To determine the amount of reserves: The amount of profits derived with the help of such 
income statement helps to decide how much of the amount is to be kept aside for future 
uncertainties in the form of reserves. 
vi. To facilitate calculation of ratios: Expenses and incomes recorded and profits derived 
with the help of an Income Statement are used to compute various accounting ratios which 
helps an entity to take appropriate financial and investment decisions. 
 
 
 
 
 
  
 
   
Users of Financial 
Statements 
Internal Users External Users 
o Objectives of Preparing Balance Sheet/Position Statement: 
i. To identify the financial position:  A balance sheet presents the exact values of the 
assets and liabilities of the business on a particular date which helps to identify the actual 
financial position of an entity on a particular date. 
ii. To facilitate comparison: In order to determine and analyse the change in the financial 
position of an entity over a period of time, different items presented in the balance sheet are 
compared and necessary conclusions are drawn. 
iii. To identify the solvency position: The figures and items presented in the Balance Sheet 
are used to compute the various accounting ratios like current ratio, liquid ratio, debt to 
equity ratio, etc. which are used in identifying the solvency position of an entity. 
 
? Users of Financial Statements:  
 
o Internal Users: 
i. Owners: These are those who invest in the business and provide funds to carry out the 
business operations. These users are interested to know the profit earned or losses 
incurred from such business operations in order to determine the returns on their 
investments. Such information is provided to them from the financial statements prepared 
by the entity. 
ii. Management: These are those who are responsible for carrying out the business 
operations and taking all the important decisions taken. In order to carry out these functions 
effectively, information in the financial statements is used by the management. 
iii. Employees and Trade Unions: These are those who are concerned with the wages, 
bonus, etc., that they are entitled to receive in the course of their employment. In order to 
determine the entity’s capability to pay such amounts, information in the financial 
statements plays a vital role. 
 
o External Users: 
i. Public: In order to determine whether the business entity makes considerable contribution 
to the economy in terms of development, employment, etc. public at large is always 
interested in the profitability and financial position of the business. 
ii. Government Authorities: These are those who compile the national income accounts and 
use such information to take appropriate policy decisions. Also, the taxes that are levied by 
various Government departments (GST & Income Tax), it is the financial statements that 
are referred to assess the correct tax dues. 
iii. Researchers: These users make use of the financial statements to study the financial 
information and use it for survey related projects. 
iv. Banks and Financial Institutions: These are those who provide loans and credits to the 
business entities based on the financial position of the entity. In order to decide whether to 
Page 3


 
  
 
   
    FINANCIAL STATEMENTS OF SOLE PROPRIETORSHIP 
Introduction to Financial Statements 
Meaning, Objectives, Users and Presentation of Financial Statements 
 
? Meaning: 
o These are the statements prepared at the end of the accounting period to determine the 
financial performance (i.e., profitability) and financial position of the business as on the date. 
o It is the end-product of the accounting process prepared from the Trial Balance. 
o It is considered as a vital information for the users of financial statements based on which they 
take important financial and investment decisions.  
o A complete set of financial statements is known as Final Accounts which includes the following: 
i. An Income Statement known as Trading and Profit and Loss Account: Such a statement 
has two parts where one is the Trading Account that shows the Gross Profit or Gross Loss 
for the accounting period and the other is the Statement of Profit and Loss that shows the 
Net Profit or Net Loss for the accounting period. 
ii. A Position Statement known as Balance Sheet:  It is a statement that shows financial 
position of the entity on a particular date in form of assets held and liabilities owed. 
 
? Objectives:  
Objectives of financial statements are to be understood separately for each of the following: 
 
o Objectives of Preparing Trading and Profit and Loss Account/Income Statement: 
i. To identify the gross profit or loss: A Trading Account records all the incomes and 
expenses directly related to the trading activities and helps identify the gross profit or loss 
on account of such operations. 
ii. To identify the net profit or net loss: A Profit and Loss Account records all the incomes 
and expenses not directly related to the trading activities and helps identify the net  profit or 
loss. 
iii. To facilitate comparison: Preparation of such income statement facilitates comparison of 
entity’s financial performance over a period of time and draw necessary conclusions. 
iv. To record complete details of incomes and expense: An income statement shows 
complete record of all the incomes earned and expenses incurred during the course of 
business. 
v. To determine the amount of reserves: The amount of profits derived with the help of such 
income statement helps to decide how much of the amount is to be kept aside for future 
uncertainties in the form of reserves. 
vi. To facilitate calculation of ratios: Expenses and incomes recorded and profits derived 
with the help of an Income Statement are used to compute various accounting ratios which 
helps an entity to take appropriate financial and investment decisions. 
 
 
 
 
 
  
 
   
Users of Financial 
Statements 
Internal Users External Users 
o Objectives of Preparing Balance Sheet/Position Statement: 
i. To identify the financial position:  A balance sheet presents the exact values of the 
assets and liabilities of the business on a particular date which helps to identify the actual 
financial position of an entity on a particular date. 
ii. To facilitate comparison: In order to determine and analyse the change in the financial 
position of an entity over a period of time, different items presented in the balance sheet are 
compared and necessary conclusions are drawn. 
iii. To identify the solvency position: The figures and items presented in the Balance Sheet 
are used to compute the various accounting ratios like current ratio, liquid ratio, debt to 
equity ratio, etc. which are used in identifying the solvency position of an entity. 
 
? Users of Financial Statements:  
 
o Internal Users: 
i. Owners: These are those who invest in the business and provide funds to carry out the 
business operations. These users are interested to know the profit earned or losses 
incurred from such business operations in order to determine the returns on their 
investments. Such information is provided to them from the financial statements prepared 
by the entity. 
ii. Management: These are those who are responsible for carrying out the business 
operations and taking all the important decisions taken. In order to carry out these functions 
effectively, information in the financial statements is used by the management. 
iii. Employees and Trade Unions: These are those who are concerned with the wages, 
bonus, etc., that they are entitled to receive in the course of their employment. In order to 
determine the entity’s capability to pay such amounts, information in the financial 
statements plays a vital role. 
 
o External Users: 
i. Public: In order to determine whether the business entity makes considerable contribution 
to the economy in terms of development, employment, etc. public at large is always 
interested in the profitability and financial position of the business. 
ii. Government Authorities: These are those who compile the national income accounts and 
use such information to take appropriate policy decisions. Also, the taxes that are levied by 
various Government departments (GST & Income Tax), it is the financial statements that 
are referred to assess the correct tax dues. 
iii. Researchers: These users make use of the financial statements to study the financial 
information and use it for survey related projects. 
iv. Banks and Financial Institutions: These are those who provide loans and credits to the 
business entities based on the financial position of the entity. In order to decide whether to 
 
  
 
   
grant loans and other services, these users analyse the financial statements of the entity 
over a period of time. 
v. Creditors: These are the parties who supply goods or provide services on credit. Before 
granting any credit these users satisfy themselves about the stability and credit-worthiness 
of the entity based on the financial statements of the entity over a period of time. 
 
? Presentation Methods: There are 2 forms of presenting financial statements as follows: 
 
o Horizontal Form:  
i. It presents the financial statements (i.e., Trading and Profit and Loss Account and Balance 
Sheet) in ‘T’ form where the statements are divided into 2 parts as left hand side and right 
hand side.  
ii. Left hand side comprises of debit items (in case of Trading and Profit and Loss Account) or 
Liabilities plus Capital (in case of Balance Sheet).  
iii. Right hand side comprises of credit items (in case of Trading and Profit and Loss Account) 
or Assets (in case of Balance Sheet). 
 
o Vertical Form: 
i. It presents the financial statements in a single column statement.  
ii. It does not divide the statements in parts, instead presents all the items in a single column 
one below the other by categorising each of them based on an appropriate parameter. 
iii. It presents the items in the income statement in the same sequence or flow in which the 
amounts are to be derived, i.e., first the gross profit is determined, then the operating profit 
and then the net profit which is then transferred to the Capital Account. 
iv. In the Balance Sheet, all the sources of funds are listed first and then the application of 
funds are listed by categorising each of them based on an appropriate parameter.  
 
 
 
 
 
 
 
 
 
 
Methods of Presenting 
Financial Statements 
Horizontal Form Vertical Form 
Page 4


 
  
 
   
    FINANCIAL STATEMENTS OF SOLE PROPRIETORSHIP 
Introduction to Financial Statements 
Meaning, Objectives, Users and Presentation of Financial Statements 
 
? Meaning: 
o These are the statements prepared at the end of the accounting period to determine the 
financial performance (i.e., profitability) and financial position of the business as on the date. 
o It is the end-product of the accounting process prepared from the Trial Balance. 
o It is considered as a vital information for the users of financial statements based on which they 
take important financial and investment decisions.  
o A complete set of financial statements is known as Final Accounts which includes the following: 
i. An Income Statement known as Trading and Profit and Loss Account: Such a statement 
has two parts where one is the Trading Account that shows the Gross Profit or Gross Loss 
for the accounting period and the other is the Statement of Profit and Loss that shows the 
Net Profit or Net Loss for the accounting period. 
ii. A Position Statement known as Balance Sheet:  It is a statement that shows financial 
position of the entity on a particular date in form of assets held and liabilities owed. 
 
? Objectives:  
Objectives of financial statements are to be understood separately for each of the following: 
 
o Objectives of Preparing Trading and Profit and Loss Account/Income Statement: 
i. To identify the gross profit or loss: A Trading Account records all the incomes and 
expenses directly related to the trading activities and helps identify the gross profit or loss 
on account of such operations. 
ii. To identify the net profit or net loss: A Profit and Loss Account records all the incomes 
and expenses not directly related to the trading activities and helps identify the net  profit or 
loss. 
iii. To facilitate comparison: Preparation of such income statement facilitates comparison of 
entity’s financial performance over a period of time and draw necessary conclusions. 
iv. To record complete details of incomes and expense: An income statement shows 
complete record of all the incomes earned and expenses incurred during the course of 
business. 
v. To determine the amount of reserves: The amount of profits derived with the help of such 
income statement helps to decide how much of the amount is to be kept aside for future 
uncertainties in the form of reserves. 
vi. To facilitate calculation of ratios: Expenses and incomes recorded and profits derived 
with the help of an Income Statement are used to compute various accounting ratios which 
helps an entity to take appropriate financial and investment decisions. 
 
 
 
 
 
  
 
   
Users of Financial 
Statements 
Internal Users External Users 
o Objectives of Preparing Balance Sheet/Position Statement: 
i. To identify the financial position:  A balance sheet presents the exact values of the 
assets and liabilities of the business on a particular date which helps to identify the actual 
financial position of an entity on a particular date. 
ii. To facilitate comparison: In order to determine and analyse the change in the financial 
position of an entity over a period of time, different items presented in the balance sheet are 
compared and necessary conclusions are drawn. 
iii. To identify the solvency position: The figures and items presented in the Balance Sheet 
are used to compute the various accounting ratios like current ratio, liquid ratio, debt to 
equity ratio, etc. which are used in identifying the solvency position of an entity. 
 
? Users of Financial Statements:  
 
o Internal Users: 
i. Owners: These are those who invest in the business and provide funds to carry out the 
business operations. These users are interested to know the profit earned or losses 
incurred from such business operations in order to determine the returns on their 
investments. Such information is provided to them from the financial statements prepared 
by the entity. 
ii. Management: These are those who are responsible for carrying out the business 
operations and taking all the important decisions taken. In order to carry out these functions 
effectively, information in the financial statements is used by the management. 
iii. Employees and Trade Unions: These are those who are concerned with the wages, 
bonus, etc., that they are entitled to receive in the course of their employment. In order to 
determine the entity’s capability to pay such amounts, information in the financial 
statements plays a vital role. 
 
o External Users: 
i. Public: In order to determine whether the business entity makes considerable contribution 
to the economy in terms of development, employment, etc. public at large is always 
interested in the profitability and financial position of the business. 
ii. Government Authorities: These are those who compile the national income accounts and 
use such information to take appropriate policy decisions. Also, the taxes that are levied by 
various Government departments (GST & Income Tax), it is the financial statements that 
are referred to assess the correct tax dues. 
iii. Researchers: These users make use of the financial statements to study the financial 
information and use it for survey related projects. 
iv. Banks and Financial Institutions: These are those who provide loans and credits to the 
business entities based on the financial position of the entity. In order to decide whether to 
 
  
 
   
grant loans and other services, these users analyse the financial statements of the entity 
over a period of time. 
v. Creditors: These are the parties who supply goods or provide services on credit. Before 
granting any credit these users satisfy themselves about the stability and credit-worthiness 
of the entity based on the financial statements of the entity over a period of time. 
 
? Presentation Methods: There are 2 forms of presenting financial statements as follows: 
 
o Horizontal Form:  
i. It presents the financial statements (i.e., Trading and Profit and Loss Account and Balance 
Sheet) in ‘T’ form where the statements are divided into 2 parts as left hand side and right 
hand side.  
ii. Left hand side comprises of debit items (in case of Trading and Profit and Loss Account) or 
Liabilities plus Capital (in case of Balance Sheet).  
iii. Right hand side comprises of credit items (in case of Trading and Profit and Loss Account) 
or Assets (in case of Balance Sheet). 
 
o Vertical Form: 
i. It presents the financial statements in a single column statement.  
ii. It does not divide the statements in parts, instead presents all the items in a single column 
one below the other by categorising each of them based on an appropriate parameter. 
iii. It presents the items in the income statement in the same sequence or flow in which the 
amounts are to be derived, i.e., first the gross profit is determined, then the operating profit 
and then the net profit which is then transferred to the Capital Account. 
iv. In the Balance Sheet, all the sources of funds are listed first and then the application of 
funds are listed by categorising each of them based on an appropriate parameter.  
 
 
 
 
 
 
 
 
 
 
Methods of Presenting 
Financial Statements 
Horizontal Form Vertical Form 
 
  
 
   
? Difference between Profit and Loss Account and Balance Sheet: 
Sr. 
no. 
Basis Profit and Loss Account Balance Sheet 
1 Time/Period It is prepared for a particular 
accounting period. 
It is prepared on a particular date 
which is the last day of the 
accounting period. 
2 Purpose It is prepared to determine the 
profitability of the business. 
It is prepared to get an idea of the 
financial position of the business. 
3 Items Recorded It records all the incomes and 
expenses. 
It records all the assets and 
liabilities. 
4 Balance Its balance is transferred to the 
Capital Account. 
It has balances of assets and 
liabilities which become the opening 
balances of the next period. 
 
 
? Difference between Balance Sheet and Trial Balance: 
Sr. 
no. 
Basis Trial Balance Balance Sheet 
1 Meaning It is a statement that comprises of 
all the debit and credit balances of 
the accounts prepared with respect 
to the transactions recorded in the 
books of accounts. 
It is a statement that comprises of 
all the assets and liabilities of the 
business along with the capital of 
the entity. 
2 Period It may be prepared for any period 
of time as per the requirement 
which can be monthly, quarterly, 
yearly, etc. 
It is prepared at the end of an 
accounting period. 
3 Need/Purpose It is prepared to check the 
arithmetical accuracy of the 
transactions recorded. 
It is prepared to determine the 
financial position of the business 
on a particular date which is the 
last day of an accounting year.  
4 Presentation It has two columns namely debit 
and credit where debit and credit 
balances of the balanced accounts 
are recorded. 
It is divided into 2 parts where the 
left side comprises of Capital and 
Liabilities and the right side 
comprises of the assets. 
5 Accounts It comprises of all the accounts and 
no account can be missed to check 
the arithmetic accuracy. 
It comprises of only personal and 
real accounts or only Assets, 
Liabilities and Capital Accounts 
6 Closing Stock Normally, it does not appear in Trial 
Balance 
Recorded in the Balance Sheet. 
6 Adjustments It can be prepared anytime without 
making any adjustments. 
It can be prepared only after giving 
effect to all the adjustments. 
 
 
Page 5


 
  
 
   
    FINANCIAL STATEMENTS OF SOLE PROPRIETORSHIP 
Introduction to Financial Statements 
Meaning, Objectives, Users and Presentation of Financial Statements 
 
? Meaning: 
o These are the statements prepared at the end of the accounting period to determine the 
financial performance (i.e., profitability) and financial position of the business as on the date. 
o It is the end-product of the accounting process prepared from the Trial Balance. 
o It is considered as a vital information for the users of financial statements based on which they 
take important financial and investment decisions.  
o A complete set of financial statements is known as Final Accounts which includes the following: 
i. An Income Statement known as Trading and Profit and Loss Account: Such a statement 
has two parts where one is the Trading Account that shows the Gross Profit or Gross Loss 
for the accounting period and the other is the Statement of Profit and Loss that shows the 
Net Profit or Net Loss for the accounting period. 
ii. A Position Statement known as Balance Sheet:  It is a statement that shows financial 
position of the entity on a particular date in form of assets held and liabilities owed. 
 
? Objectives:  
Objectives of financial statements are to be understood separately for each of the following: 
 
o Objectives of Preparing Trading and Profit and Loss Account/Income Statement: 
i. To identify the gross profit or loss: A Trading Account records all the incomes and 
expenses directly related to the trading activities and helps identify the gross profit or loss 
on account of such operations. 
ii. To identify the net profit or net loss: A Profit and Loss Account records all the incomes 
and expenses not directly related to the trading activities and helps identify the net  profit or 
loss. 
iii. To facilitate comparison: Preparation of such income statement facilitates comparison of 
entity’s financial performance over a period of time and draw necessary conclusions. 
iv. To record complete details of incomes and expense: An income statement shows 
complete record of all the incomes earned and expenses incurred during the course of 
business. 
v. To determine the amount of reserves: The amount of profits derived with the help of such 
income statement helps to decide how much of the amount is to be kept aside for future 
uncertainties in the form of reserves. 
vi. To facilitate calculation of ratios: Expenses and incomes recorded and profits derived 
with the help of an Income Statement are used to compute various accounting ratios which 
helps an entity to take appropriate financial and investment decisions. 
 
 
 
 
 
  
 
   
Users of Financial 
Statements 
Internal Users External Users 
o Objectives of Preparing Balance Sheet/Position Statement: 
i. To identify the financial position:  A balance sheet presents the exact values of the 
assets and liabilities of the business on a particular date which helps to identify the actual 
financial position of an entity on a particular date. 
ii. To facilitate comparison: In order to determine and analyse the change in the financial 
position of an entity over a period of time, different items presented in the balance sheet are 
compared and necessary conclusions are drawn. 
iii. To identify the solvency position: The figures and items presented in the Balance Sheet 
are used to compute the various accounting ratios like current ratio, liquid ratio, debt to 
equity ratio, etc. which are used in identifying the solvency position of an entity. 
 
? Users of Financial Statements:  
 
o Internal Users: 
i. Owners: These are those who invest in the business and provide funds to carry out the 
business operations. These users are interested to know the profit earned or losses 
incurred from such business operations in order to determine the returns on their 
investments. Such information is provided to them from the financial statements prepared 
by the entity. 
ii. Management: These are those who are responsible for carrying out the business 
operations and taking all the important decisions taken. In order to carry out these functions 
effectively, information in the financial statements is used by the management. 
iii. Employees and Trade Unions: These are those who are concerned with the wages, 
bonus, etc., that they are entitled to receive in the course of their employment. In order to 
determine the entity’s capability to pay such amounts, information in the financial 
statements plays a vital role. 
 
o External Users: 
i. Public: In order to determine whether the business entity makes considerable contribution 
to the economy in terms of development, employment, etc. public at large is always 
interested in the profitability and financial position of the business. 
ii. Government Authorities: These are those who compile the national income accounts and 
use such information to take appropriate policy decisions. Also, the taxes that are levied by 
various Government departments (GST & Income Tax), it is the financial statements that 
are referred to assess the correct tax dues. 
iii. Researchers: These users make use of the financial statements to study the financial 
information and use it for survey related projects. 
iv. Banks and Financial Institutions: These are those who provide loans and credits to the 
business entities based on the financial position of the entity. In order to decide whether to 
 
  
 
   
grant loans and other services, these users analyse the financial statements of the entity 
over a period of time. 
v. Creditors: These are the parties who supply goods or provide services on credit. Before 
granting any credit these users satisfy themselves about the stability and credit-worthiness 
of the entity based on the financial statements of the entity over a period of time. 
 
? Presentation Methods: There are 2 forms of presenting financial statements as follows: 
 
o Horizontal Form:  
i. It presents the financial statements (i.e., Trading and Profit and Loss Account and Balance 
Sheet) in ‘T’ form where the statements are divided into 2 parts as left hand side and right 
hand side.  
ii. Left hand side comprises of debit items (in case of Trading and Profit and Loss Account) or 
Liabilities plus Capital (in case of Balance Sheet).  
iii. Right hand side comprises of credit items (in case of Trading and Profit and Loss Account) 
or Assets (in case of Balance Sheet). 
 
o Vertical Form: 
i. It presents the financial statements in a single column statement.  
ii. It does not divide the statements in parts, instead presents all the items in a single column 
one below the other by categorising each of them based on an appropriate parameter. 
iii. It presents the items in the income statement in the same sequence or flow in which the 
amounts are to be derived, i.e., first the gross profit is determined, then the operating profit 
and then the net profit which is then transferred to the Capital Account. 
iv. In the Balance Sheet, all the sources of funds are listed first and then the application of 
funds are listed by categorising each of them based on an appropriate parameter.  
 
 
 
 
 
 
 
 
 
 
Methods of Presenting 
Financial Statements 
Horizontal Form Vertical Form 
 
  
 
   
? Difference between Profit and Loss Account and Balance Sheet: 
Sr. 
no. 
Basis Profit and Loss Account Balance Sheet 
1 Time/Period It is prepared for a particular 
accounting period. 
It is prepared on a particular date 
which is the last day of the 
accounting period. 
2 Purpose It is prepared to determine the 
profitability of the business. 
It is prepared to get an idea of the 
financial position of the business. 
3 Items Recorded It records all the incomes and 
expenses. 
It records all the assets and 
liabilities. 
4 Balance Its balance is transferred to the 
Capital Account. 
It has balances of assets and 
liabilities which become the opening 
balances of the next period. 
 
 
? Difference between Balance Sheet and Trial Balance: 
Sr. 
no. 
Basis Trial Balance Balance Sheet 
1 Meaning It is a statement that comprises of 
all the debit and credit balances of 
the accounts prepared with respect 
to the transactions recorded in the 
books of accounts. 
It is a statement that comprises of 
all the assets and liabilities of the 
business along with the capital of 
the entity. 
2 Period It may be prepared for any period 
of time as per the requirement 
which can be monthly, quarterly, 
yearly, etc. 
It is prepared at the end of an 
accounting period. 
3 Need/Purpose It is prepared to check the 
arithmetical accuracy of the 
transactions recorded. 
It is prepared to determine the 
financial position of the business 
on a particular date which is the 
last day of an accounting year.  
4 Presentation It has two columns namely debit 
and credit where debit and credit 
balances of the balanced accounts 
are recorded. 
It is divided into 2 parts where the 
left side comprises of Capital and 
Liabilities and the right side 
comprises of the assets. 
5 Accounts It comprises of all the accounts and 
no account can be missed to check 
the arithmetic accuracy. 
It comprises of only personal and 
real accounts or only Assets, 
Liabilities and Capital Accounts 
6 Closing Stock Normally, it does not appear in Trial 
Balance 
Recorded in the Balance Sheet. 
6 Adjustments It can be prepared anytime without 
making any adjustments. 
It can be prepared only after giving 
effect to all the adjustments. 
 
 
 
  
 
   
Classification of Expenditures and Receipts as Capital and Revenue 
Understanding Capital and Revenue Expenditure:  
? Meaning of Capital Expenditure:  
o It is that expenditure which results in acquiring or bringing into existence an asset or advantage 
of enduring benefit. 
o It is incurred to acquire fixed assets for use in business which will increase the earning capacity 
of the business. 
o It is shown in the Balance Sheet on the asset side. 
o It includes expenditure incurred on extension, improvement, installation or erection of new fixed 
assets (tangible or intangible), reconditioning of old fixed assets, legal expenses on acquiring 
such fixed assets, etc. 
o Includes expenditure incurred for procuring both Tangible and intangible fixed assets including 
Goodwill, Patents, etc. 
 
? Meaning of Revenue Expenditure:  
o It is that expenditure the benefit of which is exhausted within the accounting year in which it is 
incurred. 
o It is incurred to run the business and earn more profits. 
o It is shown in the Trading or Profit and Loss Account as an expense.  
o It includes the day-to-day running expenses like rent, salaries, electricity, repairs, etc. Also, 
amount of depreciation, purchase of materials, etc. are considered as revenue expenditure. 
 
? Meaning of Deferred Revenue Expenditure: 
o It is the amount of expenditure which is incurred during an accounting period but it is estimated 
that its benefits will extend beyond that accounting period i.e., it will not exhaust within the 
accounting period.  
o The amount involved is normally larger than the usual expenditure under the revenue 
expenditure, say, huge advertisement expenses incurred for the promotion of a new product. 
Such huge amount of expense will give benefit in the periods beyond the accounting period in 
which it was incurred. 
o It is therefore, spread over a period for which benefit will be derived and not debited completely 
to the Profit and Loss Account for the year in which the expense is incurred. The amount which 
is not charged to the Profit and Loss Account is shown in the Balance Sheet as an asset. 
 
? Points to remember to classify an expenditure as Capital and Revenue: 
An expenditure to be treated as capital or revenue is determined after considering nature of the 
expenditure. Wrong classification and further treatment results in wrong accounting. If an item of 
revenue expenditure is debited to Asset Account, this will overstate the Assets in the Balance 
Sheet and even the Profits in the Income Statement and vice versa. Some important to be 
considered while classifying expenditure: 
o Nature in the hands of Recipient: An amount may revenue income for one party but may be 
of capital nature expenditure for the recipient of the item. E.g. for a builder amount received 
against sale of flat is of revenue nature but for the purchases it is capital expenditure.