Chapter Notes - Financial Statements of Sole Proprietorship-I Commerce Notes | EduRev

FINANCIAL STATEMENTS OF SOLE PROPRIETORSHIP

Learning Objectives After studying this lesson you will be able to

• State the nature of the financial statements.
• Distinguish between the capital and revenue expenditure and receipts.
• Explain the concept of trading and profit and loss account and its preparation.
• State the nature of gross profit, net profit and operating profit.
• Describe the concept of balance sheet and its preparation.
• Explain grouping and marshalling of assets and liabilities.
• Prepare profit and loss account and balance sheet of a sole proprietorfirm.

Teaching Methodology : For teaching this topic the teacher should use discussion method, explanation method, illustration method etc.

Financial Statements 

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.

Revenue Expenditure 

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 Receipt.
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 Receipt

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)

INCOME STATEMENT
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 _ 

Trading A/c

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
=  49,600
Gross Profit = Net sales - Cost of goods sold  100,000- 49,600
=  50,400

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
=  2,25,000

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

Solution

Let sale=x

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

Solution

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

Illustration 6

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

Solution 

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

Illustration 7

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

Solution
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

Solution:
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

Solution:
 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.
Solution:

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.
Solution:
 Books of Mr. Hemant Trading and Profit & Loss Account for the year ended on March, 31, 2016