Financial Statements are the statements which show the financial performance and financial position of the business. It includes Trading Account, Profit and Loss Account and Balance Sheet.
They are prepared to know:
(i) the profit earned or loss incurred from the business operations during an accounting period. It is known from the Profit and Loss Account. Few enterprises also prepare Trading Account in addition to the Profit and Loss Account, and
(ii) the financial position, by preparing the Balance Sheet.
Objectives and importance:
The objectives and importance of the Financial Statements are:
(a) Profit and Loss Account:
(i) Determine Gross Profit or Gross Loss.
(ii) Determine Net Profit or Net Loss.
(iii) Comparison with the Previous Year’s Profit.
(iv) Details of Indirect Expenses.
(v) Maintaining Reserves.
(b) Balance Sheet:
(i) Ascertaining Financial Position.
(ii) Comparison with Previous Year.
(iii) Analysis of Individual Items.
(iv) Calculating Ratios.
Classification of Capital and Revenue Items:
Capital Expenditure is that expenditure which gives benefit of enduring nature. i.e., the benefit of which extends to a period or periods beyond the accounting period.
Treatment of Capital Expenditure: Capital Expenditure is debited to fixed assets account and is shown in the Balance Sheet.
Revenue Expenditure is that expenditure the benefit of which is exhausted within the accounting period.
Treatment of Revenue Expenditure: Revenue expenditure is shown on the debit side of Trading or Profit and Loss Account.
Capital Receipts are those receipts which are not received in the normal course of business, such as capital introduced, loan received, etc.
Treatment of Capital Receipts: these are shown in the Balance Sheet.
Revenue Receipts: Revenue Receipts are those receipts which are received in the normal course of business, such as revenue from sale of goods and services.
Treatment of Revenue Receipts: These are shown on credit side of the Profit and Loss Account.
Trading Account is the first part of Income Statement. It is prepared to calculate Gross Profit earned or Gross Loss incurred on account of trading activities of an enterprise during the accounting year.
• Reason for Preparation: It is prepared to ascertain the overall result of trading, i.e., purchasing and selling of goods. It explains whether purchasing of goods and selling them has proved to be profitable for the business or not.
• Components: Its main components include: ° Sales, services rendered and Closing Stock on the Credit Side of Trading Account; and ° Cost of such sales or services rendered, like Opening Stock, Purchases and other Direct Expenses on the debit side.
Net Result of Trading Account: The difference of debit and credit sides is either Gross Profit or Gross Loss. ° If total of credit side exceeds the total of debit side, then the difference is called Gross Profit. ° However, if total of credit side falls short of total of debit side, then the difference is called Gross Loss.
Features of Trading Account:
1. It serves as the first step in preparation of Financial Statements.
2. It records value of net sales and cost of goods sold.
3. The balance of Trading Account shows Gross Profit or Gross Loss.
4. It provides the opening balance for Profit and Loss Account as balance of this account (Gross Profit or Gross Loss) is transferred to Profit and Loss Account.
Format of trading a/c
Trading Account for the year ending on
|To Opening Stock|
Less: Purchases Return or
To Wages & Salaries
To Manufacturing Expenses or
To Carriage or
Carriage Inward or
Carriage on Purchases
To Coal, Gas and Power
To freight, Octroi and Cartage
Custom Duty or
To Dock and Clearing Charges
To factory Lighting &
To Other Direct Expenses
Less: Sales Return or
By Closing Stock
|To gross profit transferred to P & L a/c||By gross loss transferred to P & L a/c|
1. At the top of trading account, where headings are given, there the words "for the year ended" are written which indicate that this account shows the position of full accounting year and not the position of a single day.
2. Column of date is not made at the time of preparation of final accounts because it is written in heading.
3. Column of page no. is not shown at the time of preparation of final accounts because these are prepared from trial balance not from ledger.
4. Trading account will record all the direct/ factory / manufacturing expenses.
5. it is a nominal a/c so apply the rule of nominal a/c debit all expenses an losses and credit all incomes and gains.