FINANCIAL STATEMENTS OF SOLE PROPRIETORSHIP
Learning Objectives After studying this lesson you will be able to
Teaching Methodology : For teaching this topic the teacher should use discussion method, explanation method, illustration method etc.
Financial statement are those statement that show the profitability (Income statement) and the financial position (Balance Sheet) of the business at the end of accounting period.
In the word of John N. Myer "The financial statement provide a summary of the accounts of a business enterprise, the balance sheet reflecting the assets, liabilities and capital as on a certain date and the income statement showing the result of operation during a certain period"
Final statements include these statements:
i) Income statement (Trading and Profit and Loss Account) - Prepared to ascertain gross profit and net profit/loss during an accounting period.
ii) Statement of Financial Position (Balance Sheet) -Prepared to ascertain position (assets, liabilities and capital) of an enterprise at a particular point of time.
iii) Schedules and notes forming part of Balance sheet and income statement - to give detail of various items shown in both the statements.
These two Financial Statements (Income Statement and Statement of Financial Position) are termed as 'Final Accounts'.
Objective of Preparing Financial Statements.
i) To present a true and fair view of the financial performance (Profit/Loss) of the business.
ii) To present a true and fair view of the financial position (Assets/Liabilities) of the business.
Capital Expenditure: The non-recurring expenditure whose benefit is derived by the business for more than a year is called Capital Expenditure.
It includes amount spent or liabilities incurred to acquire or improve any fixed assets or acquiring any legal rights or first-time expenses in curred to make fixed assets work able e.g . purchase of machinery/building/furniture etc., expenses incurred to acquired Patents, Trade-mark etc. and expenditure incurred for getting an asset ready to use (like installation exp., carriage, first time expenses incurred on second hand fixed asset for making it ready to use).
Capital expenditures are recorded on the assets side of the Balance sheet.
The recurring and routine nature expenditures which are incurred for operating the business smoothly and which help to maintain business's earning capacity, are called Revenue expenditure e.g. expenses incurred for producing finished goods such as direct expenses, purchase of raw material and other expenses as rent, salary, repairs etc.
The benefit of these expenses last in one year (give benefit up to one year). These expenses are shown in Debit side of income statement (trading and profit and loss account).
Deferred Revenue Expenditure : The expenditure which is revenue in nature, but the heavy amount spent and benefit likely to be derived over a number of years called deferred revenue expenditure e.g. heavy expenses on advertising on launching of a new product and hence it is capitalized like any fixed asset.
Accounting treatment of Deferred Revenue Expenditure.
As per matching principle, expenses incurred in an accounting period are matched with the revenue recognized in that accounting period. So the whole deferred revenue expenditure should be spread over the number of years over which benefit is likely to be derived.
During the current accounting year (a) Only that portion of the expenditure should be charged to the profit and loss account which has facilitate the enterprise to earn revenue during current year (b) Remaining amount of expenditure be carried forward to the next year and shown in the assets side of balance sheet (It is also called a fictitious asset).
Capital receipts are those irregular receipts that don't affect profit or loss of business; it either increases the liabilities (raising of loan) or reduces the fixed assets (by sale of fixed assets), so it will be shown in balance sheet.
Capital receipts are not made available for distribution of profit to the owner.
Revenue receipts are received in the normal and regular course of business like Receipts from sale of goods and rendering services to customers. Income from non-operating business activities (like income from investment i.e. interest and dividend received and rent received, Commission and other fees received for non-operating business etc. These receipts increases profit and shown in the credit side of the Trading and Profit and Loss account.
Types of Expenses
Direct Expenses : Those expenses which are incurred on purchasing of goods and for converting raw material into the finished goods e.g.
Manufacturing wages, Expenses on purchases (including all duty and tax paid on purchases), Carriage/Freight/Cartage inwards, Production expenses (such as power and fuel, water etc.), factory expenses (e.g. lighting, rent and rates). Royalty based on Production etc.
Note: All direct expenses are debited to Trading account.
Indirect Expenses: Those expenses which are not directly related to production or purchase of the goods are called indirect expenses. It includes those expenses which are related to office and administration, selling and distribution of goods and financial expense etc.
These expenses are show in the debit side of the Profit and Loss A/c.
Calculation of Gross Profit
Gross Profit = Net Sales - Cost of Goods Sold
Net Sale = Total sale - Sales Return
Cost of Goods Sold = Opening Stock + Net Purchases + Direct
Expenses (wages, Expenses on Purchases, Carriage inward etc.) - Closing stock
Net Purchases = Total Purchases - Purchases Return
Calculation of Operating Profit
Operating Profit = Net Sales - Operating Cost
or = Gross Profit - (Office and Administrative Expenses + Selling and distribution etc.)
Operating Cost = Cost of Goods Sold + Office and Administrative Expenses + Selling and distribution exp.
Net Profit = Operating Profit + Non-operating income - Non-operating expenses.
Operating Expenses = The expenses which are related to the main or normal activities of the business e.g. office and Administrative expenses, selling and distribution expenses, Operating profit is also called EBIT (Earnings before interest and taxes)
It is divided into two parts:
1. Trading Account which shows the gross profit or gross loss.
2. Profit and Loss Account which shows the net profit or net loss.
Format of Trading Account
Name of Business Firm _
Illustration 1 Opening stock ?30,000, Net Purchase 54600 expenses on purchase 5000, Net Sales 100,000, closing stock 40,000 calculate cost of goods sold and gross profit.
Solution: Cost of Goods sold = Opening stock + Net Purchase + expenses on purchase - Closing Stock 30,000 + 54,600 + 5,000 - 40,000
Gross Profit = Net sales - Cost of goods sold 100,000- 49,600
Illustration 2 Net sales during the year is 3,00,000, Gros profit is 25% on sales. Find out cost of goods sold.
Solution: Gross Profit =
Cost of goods sold = Net Sales - Gross Profit = 300,000 - 75,000
Illustration 3 Net sales during the year is 6,00,000. Gross profit is 25% on cost. Find out gross profit and cost of good sold.
Solution: Here, Gross Profit is 25% on cost Hence, If cost is 100,Gross Profit will be 25 and sales will be 125
Thus, If sales is 125, Gross Profit will be 25
If sales is 600,000, Gross Profit will be 600,000 x 1.20,000 Cost of goods sold = Net Sales-Gross Profit
= 6,00,000- 1,20,000 = 4,80,000
Note: Gross profit 25% or on cost is equal to th on sales
Gross profit = 6,00,000 x = 1,20,000
Illustration 4 Calculate Net Sales and Gross Profit from the following information.
Cost of goods sold 2,00,000
Gross profit 20% on sale
Sale = Cost of good sold + Gross Profit x = 200,000+ .20x
x = 250,000
Gross Profit = 250,000-200,000 = 50,000
Note: Gross Profit 20% or on sale, equal to oncost Gross Profit= 200,000 x = 50,000
Illustration 5 Calculate Gross Profit ?
Total Purchase 680,000
Purchase Return 30,000
Direct Expenses 70,000
Carriage Outwork 15,000 3/4 of the goods are sold 600,000
Cost of goods sold = Total Purchase-Purchase Return-Direct Expenses
= 6,80,000 - 30,000 +70,000 = 7,20,000
Cost of 3/4 of the goods sold = 7,20,000 x = 5,40,000
Gross Profit = Sales-Cost of goods sold
= 6,00,000- 5,40,000 = 60,000
Calculate the amount of operating profit from the following balances:
Net sales 5.00. 000
Cost of goods sold 3.00. 000
Operating Expenses 1,20,000
Operating Cost = Cost of Goods Sold + Operating Expenses 3,00,000+ 1,20,000 = 4,20,000
Operating Profit = Net Sales - Operating Cost 5,00,000- 4,20,000 = 80,000
Calculate the value of closing stock from the following information:
Purchase 93,000 Wages 20,000
Sales 1,20,000 Carriage Outward 3,200
Rate of Gross Profit 40% on sales
Trading Account for the year ended
Illustration 8 This information is provided by Mr. Rohit Stock as on 01.04.2015 Rs. 20,000 During the year Sales was Rs. 4,00,000; Purchases Rs. 2,90,000; Carriage Inwards Rs. 8,000; Clearing charges Rs. 10,000; Sales Returns Rs. 3,000; Purchases Returns Rs. 4,000; Carriage Outwards Rs. 5,000 and Stock on 31.03.2016 was Rs. 30,000.
Calculate cost of goods sold and prepare Trading Account for the year ending 31.03.2016
Trading Account for the year ended on March 31, 2016
Adjusted Purchase: Sometimes the opening and closing stock are adjusted through purchases account. In that case, the entry recorded is as follows: Closing StockA/c Dr.
To Purchase A/c This entry reduces the amount in the purchases account and is also known as adjusted purchases which is shown on the debit side of the trading and profit and loss account.
When the opening and closing stocks are adjusted through purchases, the trial balance does not show any opening stock. Instead, the closing stock shall appear in the trial balance (not as additional information or as an adjustment item) and so also the adjusted purchases.
Illustration 9 Prepare the Trading Account for the year ended 31st March, 2015 from the following information. Adjusted purchase 25,00,000; Freight outwards 15,000; Wages 1,68,000; Octroi charges 2,000; Carriage inwards 20,000; Fuel & Power 30,000; Office rent 18,000; Trade expenses 10,000; Sales 32,00,000; Closing Stock 1,50,000
Trading Account for the year ending 31st March, 2015
Format of Profit and Loss Account Profit and Loss A/c for the year ending.......
* The words 'To' and 'By' are generally not used these days.
* The name of Business Firm is stated on the top of trading & P & L A/c.
Illustration 10 From the following information, prepare a Profit & Loss Account for the year ending 31 st March 2016.
Gross Profit 70,000; Rent 5,000; Salary 15,000; Wages 8,000; Commission paid 7,000; Interest on loans 5,000; Advertising 3,000; Discount Received 2,000; Printing & Stationery 1,000; Legal charges 2,500; Bad Debts 1,500; Depreciation 1,000; Income received on Investment 3,000; Loss by Fire 2,200; Bad Debts recovered 200; Freight outward ?600, Audit Fee 450.
Profit and Loss A/C of ...... for the year ending 31st March, 2016
Illustration 11 From the following balances obtained from the accounts of Mr. Hemant, prepare the Trading and Profit & Loss Accounts:
Closing stock on March 31,2016 is? 4,500.
Books of Mr. Hemant Trading and Profit & Loss Account for the year ended on March, 31, 2016