NCERT Textbook - Financial Accounting-I Commerce Notes | EduRev

Accountancy Class 11

Commerce : NCERT Textbook - Financial Accounting-I Commerce Notes | EduRev

 Page 1


Financial Statements - I 9
LEARNING OBJECTIVES
After studying this chapter ,
you will be able to :
• state the nature of the
financial statements;
• identify the various
stakeholders and their
information require-
ments;
• distinguish between
the capital and reve-
nue 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 prop-
rietory firm; and
• make an opening
entry.
Y
ou have learnt that financial accounting is a
well-defined sequential activity which begins
with Journal (Journalising), Ledger (Posting), and
preparation of Trial Balance (Balancing and
Summarisation at the first stage).  In the present
chapter, we will take up the next step, namely,
preparation of financial statements, and discuss the
types of information requirements of various
stakeholders, the distinction between capital and
revenue items and its importance and the nature
of financial statements and the preparation thereof.
9.1 Stakeholders and Their
Information Requirements
Recall from chapter I (Financial Accounting Part I)
that the objective of business is to communicate
the meaningful information to various stakeholders
in the business so that they can make informed
decisions. A stakeholder is any person associated
with the business. The stakes of various
stakeholders can be monetary or non-monetary. The
stakes can be active or passive; or can be direct or
indirect. The owner and persons advancing loan to
the business would have monetary stake. The
government, consumer or a researcher will have
non-monetary stake in the business. The
stakeholders are also called users who are normally
classified as internal and external depending upon
whether they are inside the business or outside the
business. All users have different objectives for
Page 2


Financial Statements - I 9
LEARNING OBJECTIVES
After studying this chapter ,
you will be able to :
• state the nature of the
financial statements;
• identify the various
stakeholders and their
information require-
ments;
• distinguish between
the capital and reve-
nue 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 prop-
rietory firm; and
• make an opening
entry.
Y
ou have learnt that financial accounting is a
well-defined sequential activity which begins
with Journal (Journalising), Ledger (Posting), and
preparation of Trial Balance (Balancing and
Summarisation at the first stage).  In the present
chapter, we will take up the next step, namely,
preparation of financial statements, and discuss the
types of information requirements of various
stakeholders, the distinction between capital and
revenue items and its importance and the nature
of financial statements and the preparation thereof.
9.1 Stakeholders and Their
Information Requirements
Recall from chapter I (Financial Accounting Part I)
that the objective of business is to communicate
the meaningful information to various stakeholders
in the business so that they can make informed
decisions. A stakeholder is any person associated
with the business. The stakes of various
stakeholders can be monetary or non-monetary. The
stakes can be active or passive; or can be direct or
indirect. The owner and persons advancing loan to
the business would have monetary stake. The
government, consumer or a researcher will have
non-monetary stake in the business. The
stakeholders are also called users who are normally
classified as internal and external depending upon
whether they are inside the business or outside the
business. All users have different objectives for
332 Accountancy
joining business and consequently different types of information requirements
from it. In nutshell, the various users have diverse financial information
requirements from the business.
For example we have classified the following into the category of internal
and external users specifying their objectives and consequent information
requirements.
Name Internal/ Objective for participating Accounting Information requirements
External in business
users
Current Internal To make investment in the Likes to know extent of profit in the
owners business and wealth grow. last accounting period, current
position of the assets/liabilities of the
business.
Manager Internal For a career. They essenti- Accounting information in the form
ally  act  as  the  agent of of financial statements is like their
owners (their employers). report card and they are interested
in information about both profits and
financial position.
Government External Its role is regulatory and Its concerns are that the rights of all
tries to lay down the rules stakeholders are protected. Since the
in the best public interest. government levies taxes on the
business, they are interested in
information about profitability in
particular besides lot of other
information.
Prospective External He is expecting to make He is interested in information about
owner investments in the business past profits and financial position as
with a view to make his indicative of likely future performance.
investment and wealth grow.
Bank External Bank is interested in safty Bank is interested in adequacy of
of the principal as well as profits only as an assurance of the
the periodic return return of principal and interest back
(interest). in time. Bank is equally concerned
about the form in which the assets
are held by the business. When more
assets are held in cash or near cash
form, the aspect is knnown as
liquidity.
Fig. 9.1 : Analysis of various users of accounting information
Page 3


Financial Statements - I 9
LEARNING OBJECTIVES
After studying this chapter ,
you will be able to :
• state the nature of the
financial statements;
• identify the various
stakeholders and their
information require-
ments;
• distinguish between
the capital and reve-
nue 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 prop-
rietory firm; and
• make an opening
entry.
Y
ou have learnt that financial accounting is a
well-defined sequential activity which begins
with Journal (Journalising), Ledger (Posting), and
preparation of Trial Balance (Balancing and
Summarisation at the first stage).  In the present
chapter, we will take up the next step, namely,
preparation of financial statements, and discuss the
types of information requirements of various
stakeholders, the distinction between capital and
revenue items and its importance and the nature
of financial statements and the preparation thereof.
9.1 Stakeholders and Their
Information Requirements
Recall from chapter I (Financial Accounting Part I)
that the objective of business is to communicate
the meaningful information to various stakeholders
in the business so that they can make informed
decisions. A stakeholder is any person associated
with the business. The stakes of various
stakeholders can be monetary or non-monetary. The
stakes can be active or passive; or can be direct or
indirect. The owner and persons advancing loan to
the business would have monetary stake. The
government, consumer or a researcher will have
non-monetary stake in the business. The
stakeholders are also called users who are normally
classified as internal and external depending upon
whether they are inside the business or outside the
business. All users have different objectives for
332 Accountancy
joining business and consequently different types of information requirements
from it. In nutshell, the various users have diverse financial information
requirements from the business.
For example we have classified the following into the category of internal
and external users specifying their objectives and consequent information
requirements.
Name Internal/ Objective for participating Accounting Information requirements
External in business
users
Current Internal To make investment in the Likes to know extent of profit in the
owners business and wealth grow. last accounting period, current
position of the assets/liabilities of the
business.
Manager Internal For a career. They essenti- Accounting information in the form
ally  act  as  the  agent of of financial statements is like their
owners (their employers). report card and they are interested
in information about both profits and
financial position.
Government External Its role is regulatory and Its concerns are that the rights of all
tries to lay down the rules stakeholders are protected. Since the
in the best public interest. government levies taxes on the
business, they are interested in
information about profitability in
particular besides lot of other
information.
Prospective External He is expecting to make He is interested in information about
owner investments in the business past profits and financial position as
with a view to make his indicative of likely future performance.
investment and wealth grow.
Bank External Bank is interested in safty Bank is interested in adequacy of
of the principal as well as profits only as an assurance of the
the periodic return return of principal and interest back
(interest). in time. Bank is equally concerned
about the form in which the assets
are held by the business. When more
assets are held in cash or near cash
form, the aspect is knnown as
liquidity.
Fig. 9.1 : Analysis of various users of accounting information
333 Financial Statements - I
Box 1
Accounting Process (up to Trial balance) :
1. Identify the transactions, which that are recorded.
2. Record transactions in journal. Only those transactions are recorded which are
measured in money terms. The system followed for recording is called double entry
system whereby two aspects (debit and credit) of every transaction are recorded.
Repeated transactions of same nature are recorded in subsidiary books, also called
special journals. Instead of recording all transactions in journal, they are recorded in
subsidiary books and the  journal proper. For example, the business would record all
credit sales in sales book and all credit purchases in purchases book. The other
examples of subsidiary books are return inwards book, return outwards book. An
other important special book is cash book, in which all cash and bank transactions
are recorded. The entries, which are not recorded in any of these books, are recorded
in a residual journal called journal proper.
3. The entries appearing in the above books are posted in the respective accounts in the ledger.
4. The accounts are balanced and listed in a statement called trial balance. If the total
amounts of debit and credit balances agree, accounts are taken as free from
arithmetical errors.
5. The trial balance forms the basis for making the financial statements, i.e. trading
and profit and loss account and balance sheet.
9.2 Distinction between Capital and Revenue
A very important distinction in accounting is between capital and revenue
items. The distinction has important implications for making of the trading
and profit and loss account and balance sheet. The revenue items form part
of  the trading and profit and loss account, the capital items help in the
preparation of a balance sheet.
9.2.1 Expenditure
Whenever payment and/or incurrence of an outlay are made for a purpose
other than the settlement of an existing liability, it is called expenditure. The
expenditures are incurred with a viewpoint they would give benefits to the
business. The benefit of an expenditure may extend up to one accounting
year or more than one year. If the benefit of expenditure extends up to one
accounting period, it is termed as revenue expenditure. Normally, they are
incurred for the day-to-day conduct of the business. An example can be
payment of salaries, rent, etc. The salaries paid in the current period will not
benefit the business in the next accounting period, as the workers have put
in their efforts in the current accounting period. They will have to be paid the
salaries in the next accounting period as well if they are made to work. If the
benefit of expenditure extends to more than one accounting period, it is termed
Page 4


Financial Statements - I 9
LEARNING OBJECTIVES
After studying this chapter ,
you will be able to :
• state the nature of the
financial statements;
• identify the various
stakeholders and their
information require-
ments;
• distinguish between
the capital and reve-
nue 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 prop-
rietory firm; and
• make an opening
entry.
Y
ou have learnt that financial accounting is a
well-defined sequential activity which begins
with Journal (Journalising), Ledger (Posting), and
preparation of Trial Balance (Balancing and
Summarisation at the first stage).  In the present
chapter, we will take up the next step, namely,
preparation of financial statements, and discuss the
types of information requirements of various
stakeholders, the distinction between capital and
revenue items and its importance and the nature
of financial statements and the preparation thereof.
9.1 Stakeholders and Their
Information Requirements
Recall from chapter I (Financial Accounting Part I)
that the objective of business is to communicate
the meaningful information to various stakeholders
in the business so that they can make informed
decisions. A stakeholder is any person associated
with the business. The stakes of various
stakeholders can be monetary or non-monetary. The
stakes can be active or passive; or can be direct or
indirect. The owner and persons advancing loan to
the business would have monetary stake. The
government, consumer or a researcher will have
non-monetary stake in the business. The
stakeholders are also called users who are normally
classified as internal and external depending upon
whether they are inside the business or outside the
business. All users have different objectives for
332 Accountancy
joining business and consequently different types of information requirements
from it. In nutshell, the various users have diverse financial information
requirements from the business.
For example we have classified the following into the category of internal
and external users specifying their objectives and consequent information
requirements.
Name Internal/ Objective for participating Accounting Information requirements
External in business
users
Current Internal To make investment in the Likes to know extent of profit in the
owners business and wealth grow. last accounting period, current
position of the assets/liabilities of the
business.
Manager Internal For a career. They essenti- Accounting information in the form
ally  act  as  the  agent of of financial statements is like their
owners (their employers). report card and they are interested
in information about both profits and
financial position.
Government External Its role is regulatory and Its concerns are that the rights of all
tries to lay down the rules stakeholders are protected. Since the
in the best public interest. government levies taxes on the
business, they are interested in
information about profitability in
particular besides lot of other
information.
Prospective External He is expecting to make He is interested in information about
owner investments in the business past profits and financial position as
with a view to make his indicative of likely future performance.
investment and wealth grow.
Bank External Bank is interested in safty Bank is interested in adequacy of
of the principal as well as profits only as an assurance of the
the periodic return return of principal and interest back
(interest). in time. Bank is equally concerned
about the form in which the assets
are held by the business. When more
assets are held in cash or near cash
form, the aspect is knnown as
liquidity.
Fig. 9.1 : Analysis of various users of accounting information
333 Financial Statements - I
Box 1
Accounting Process (up to Trial balance) :
1. Identify the transactions, which that are recorded.
2. Record transactions in journal. Only those transactions are recorded which are
measured in money terms. The system followed for recording is called double entry
system whereby two aspects (debit and credit) of every transaction are recorded.
Repeated transactions of same nature are recorded in subsidiary books, also called
special journals. Instead of recording all transactions in journal, they are recorded in
subsidiary books and the  journal proper. For example, the business would record all
credit sales in sales book and all credit purchases in purchases book. The other
examples of subsidiary books are return inwards book, return outwards book. An
other important special book is cash book, in which all cash and bank transactions
are recorded. The entries, which are not recorded in any of these books, are recorded
in a residual journal called journal proper.
3. The entries appearing in the above books are posted in the respective accounts in the ledger.
4. The accounts are balanced and listed in a statement called trial balance. If the total
amounts of debit and credit balances agree, accounts are taken as free from
arithmetical errors.
5. The trial balance forms the basis for making the financial statements, i.e. trading
and profit and loss account and balance sheet.
9.2 Distinction between Capital and Revenue
A very important distinction in accounting is between capital and revenue
items. The distinction has important implications for making of the trading
and profit and loss account and balance sheet. The revenue items form part
of  the trading and profit and loss account, the capital items help in the
preparation of a balance sheet.
9.2.1 Expenditure
Whenever payment and/or incurrence of an outlay are made for a purpose
other than the settlement of an existing liability, it is called expenditure. The
expenditures are incurred with a viewpoint they would give benefits to the
business. The benefit of an expenditure may extend up to one accounting
year or more than one year. If the benefit of expenditure extends up to one
accounting period, it is termed as revenue expenditure. Normally, they are
incurred for the day-to-day conduct of the business. An example can be
payment of salaries, rent, etc. The salaries paid in the current period will not
benefit the business in the next accounting period, as the workers have put
in their efforts in the current accounting period. They will have to be paid the
salaries in the next accounting period as well if they are made to work. If the
benefit of expenditure extends to more than one accounting period, it is termed
334 Accountancy
as capital expenditure. An example can be payment to acquire furniture for
use in the business. Furniture acquired in the current accounting period will
give benefits for many accounting periods to come. The usual examples of
capital expenditure can be payment to acquire fixed assets and/or to make
additions/extensions in the fixed assets.
Following points of distinction between capital expenditure and revenue
expenditure are worth noting :
(a) Capital expenditure increases earning capacity of business whereas
revenue expenditure is incurred to maintain the earning capacity.
(b) Capital expenditure is incurred to acquire fixed assets for operation of
business whereas revenue expenditure is incurred on day-to-day conduct
of business.
(c) Revenue expenditure is generally recurring expenditure and capital
expenditure is non-recurring by nature.
(d) Capital expenditure benefits more than one accounting year whereas
revenue expenditure normally benefits one accounting year.
(e) Capital expenditure (subject to depreciation) is recorded in balance sheet
whereas revenue expenditure (subject to adjustment for outstanding
and prepaid amount) is transferred to trading and profit and loss account.
Sometimes, it becomes difficult to correctly demarcate the expenditures
into revenue and capital category. In normal usage, the advertising expenditure
is termed as revenue expenditure. However, a heavy expenditure on advertising
on launching a product is likely to give benefit for more than one accounting
period, as people are likely to remember the advertisement for a slightly longer
period. Such revenue expenditures, which are likely to give benefit for more
than one accounting period, are termed as deferred revenue expenditure.
It must be understood that expenditure is a wider term and includes
expenses as well as assets. There is a difference between expenditure and
expense. Expenditure is any outlay made/incurred by the business firm. The
part of the expenditure, which is perceived to have been used or consumed in
the current year, is termed as expense of the current year.
Revenue expenditure is treated as expenses of the current year and is
shown in trading and profit and loss account. Hence, salary paid by the
business firm is treated as an expense of the current year. Capital expenditures
are also ultimately charged to income statement and are spread over to more
than one accounting period. Hence, furniture of Rs. 50,000 if expected to be
used for 5 years will be treated as expense @ Rs. 10,000 per year. The name
given for the expense is depreciation. The treatment of deferred revenue
expenditure is same as of capital expenditure. They are also written-off over
their expected period of benefit.
Page 5


Financial Statements - I 9
LEARNING OBJECTIVES
After studying this chapter ,
you will be able to :
• state the nature of the
financial statements;
• identify the various
stakeholders and their
information require-
ments;
• distinguish between
the capital and reve-
nue 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 prop-
rietory firm; and
• make an opening
entry.
Y
ou have learnt that financial accounting is a
well-defined sequential activity which begins
with Journal (Journalising), Ledger (Posting), and
preparation of Trial Balance (Balancing and
Summarisation at the first stage).  In the present
chapter, we will take up the next step, namely,
preparation of financial statements, and discuss the
types of information requirements of various
stakeholders, the distinction between capital and
revenue items and its importance and the nature
of financial statements and the preparation thereof.
9.1 Stakeholders and Their
Information Requirements
Recall from chapter I (Financial Accounting Part I)
that the objective of business is to communicate
the meaningful information to various stakeholders
in the business so that they can make informed
decisions. A stakeholder is any person associated
with the business. The stakes of various
stakeholders can be monetary or non-monetary. The
stakes can be active or passive; or can be direct or
indirect. The owner and persons advancing loan to
the business would have monetary stake. The
government, consumer or a researcher will have
non-monetary stake in the business. The
stakeholders are also called users who are normally
classified as internal and external depending upon
whether they are inside the business or outside the
business. All users have different objectives for
332 Accountancy
joining business and consequently different types of information requirements
from it. In nutshell, the various users have diverse financial information
requirements from the business.
For example we have classified the following into the category of internal
and external users specifying their objectives and consequent information
requirements.
Name Internal/ Objective for participating Accounting Information requirements
External in business
users
Current Internal To make investment in the Likes to know extent of profit in the
owners business and wealth grow. last accounting period, current
position of the assets/liabilities of the
business.
Manager Internal For a career. They essenti- Accounting information in the form
ally  act  as  the  agent of of financial statements is like their
owners (their employers). report card and they are interested
in information about both profits and
financial position.
Government External Its role is regulatory and Its concerns are that the rights of all
tries to lay down the rules stakeholders are protected. Since the
in the best public interest. government levies taxes on the
business, they are interested in
information about profitability in
particular besides lot of other
information.
Prospective External He is expecting to make He is interested in information about
owner investments in the business past profits and financial position as
with a view to make his indicative of likely future performance.
investment and wealth grow.
Bank External Bank is interested in safty Bank is interested in adequacy of
of the principal as well as profits only as an assurance of the
the periodic return return of principal and interest back
(interest). in time. Bank is equally concerned
about the form in which the assets
are held by the business. When more
assets are held in cash or near cash
form, the aspect is knnown as
liquidity.
Fig. 9.1 : Analysis of various users of accounting information
333 Financial Statements - I
Box 1
Accounting Process (up to Trial balance) :
1. Identify the transactions, which that are recorded.
2. Record transactions in journal. Only those transactions are recorded which are
measured in money terms. The system followed for recording is called double entry
system whereby two aspects (debit and credit) of every transaction are recorded.
Repeated transactions of same nature are recorded in subsidiary books, also called
special journals. Instead of recording all transactions in journal, they are recorded in
subsidiary books and the  journal proper. For example, the business would record all
credit sales in sales book and all credit purchases in purchases book. The other
examples of subsidiary books are return inwards book, return outwards book. An
other important special book is cash book, in which all cash and bank transactions
are recorded. The entries, which are not recorded in any of these books, are recorded
in a residual journal called journal proper.
3. The entries appearing in the above books are posted in the respective accounts in the ledger.
4. The accounts are balanced and listed in a statement called trial balance. If the total
amounts of debit and credit balances agree, accounts are taken as free from
arithmetical errors.
5. The trial balance forms the basis for making the financial statements, i.e. trading
and profit and loss account and balance sheet.
9.2 Distinction between Capital and Revenue
A very important distinction in accounting is between capital and revenue
items. The distinction has important implications for making of the trading
and profit and loss account and balance sheet. The revenue items form part
of  the trading and profit and loss account, the capital items help in the
preparation of a balance sheet.
9.2.1 Expenditure
Whenever payment and/or incurrence of an outlay are made for a purpose
other than the settlement of an existing liability, it is called expenditure. The
expenditures are incurred with a viewpoint they would give benefits to the
business. The benefit of an expenditure may extend up to one accounting
year or more than one year. If the benefit of expenditure extends up to one
accounting period, it is termed as revenue expenditure. Normally, they are
incurred for the day-to-day conduct of the business. An example can be
payment of salaries, rent, etc. The salaries paid in the current period will not
benefit the business in the next accounting period, as the workers have put
in their efforts in the current accounting period. They will have to be paid the
salaries in the next accounting period as well if they are made to work. If the
benefit of expenditure extends to more than one accounting period, it is termed
334 Accountancy
as capital expenditure. An example can be payment to acquire furniture for
use in the business. Furniture acquired in the current accounting period will
give benefits for many accounting periods to come. The usual examples of
capital expenditure can be payment to acquire fixed assets and/or to make
additions/extensions in the fixed assets.
Following points of distinction between capital expenditure and revenue
expenditure are worth noting :
(a) Capital expenditure increases earning capacity of business whereas
revenue expenditure is incurred to maintain the earning capacity.
(b) Capital expenditure is incurred to acquire fixed assets for operation of
business whereas revenue expenditure is incurred on day-to-day conduct
of business.
(c) Revenue expenditure is generally recurring expenditure and capital
expenditure is non-recurring by nature.
(d) Capital expenditure benefits more than one accounting year whereas
revenue expenditure normally benefits one accounting year.
(e) Capital expenditure (subject to depreciation) is recorded in balance sheet
whereas revenue expenditure (subject to adjustment for outstanding
and prepaid amount) is transferred to trading and profit and loss account.
Sometimes, it becomes difficult to correctly demarcate the expenditures
into revenue and capital category. In normal usage, the advertising expenditure
is termed as revenue expenditure. However, a heavy expenditure on advertising
on launching a product is likely to give benefit for more than one accounting
period, as people are likely to remember the advertisement for a slightly longer
period. Such revenue expenditures, which are likely to give benefit for more
than one accounting period, are termed as deferred revenue expenditure.
It must be understood that expenditure is a wider term and includes
expenses as well as assets. There is a difference between expenditure and
expense. Expenditure is any outlay made/incurred by the business firm. The
part of the expenditure, which is perceived to have been used or consumed in
the current year, is termed as expense of the current year.
Revenue expenditure is treated as expenses of the current year and is
shown in trading and profit and loss account. Hence, salary paid by the
business firm is treated as an expense of the current year. Capital expenditures
are also ultimately charged to income statement and are spread over to more
than one accounting period. Hence, furniture of Rs. 50,000 if expected to be
used for 5 years will be treated as expense @ Rs. 10,000 per year. The name
given for the expense is depreciation. The treatment of deferred revenue
expenditure is same as of capital expenditure. They are also written-off over
their expected period of benefit.
335 Financial Statements - I
9.2.2 Receipts
The similar treatment is given the receipts of the business. If the receipts
imply an obligation to return the money, these are capital receipts. The example
can be an additional capital brought in by the owner or a loan taken from the
bank. Both receipts are leading to obligations, the first to the owner (called
equity) and the other to the outsiders (called liabilities). Another example on a
capital receipt can be the sale of a fixed asset like old machinery or furniture.
However, if a receipt does not incur an obligation to return the money or is
not in the form of a sale of fixed asset, it is termed as revenue receipt. The
examples of such receipts sales made by the firm and interest on investment
received by the firm.
9.2.3 Importance of Distinction between Capital and Revenue
As stated earlier, the distinction between capital and revenue items has
important implications for the preparation of trading and profit and loss
account and the balance sheet as all items of revenue value are to the shown
in the trading and profit and loss account and the items of capital nature in
the balance sheet. If any item is wrongly classified, i.e. if any item of revenue
nature is treated as capital item or vice-versa, the ascertainment of profit or
loss will be incorrect. For example, the revenues earned during an accounting
period are Rs. 10,00,000 and the expenses shown are Rs. 8,00,000, the profit
shall work out as Rs. 2,00,000. On scrutiny of the details, you find that a
revenue item of Rs. 20,000 (an expenditure on repairs of machinery) has been
treated as capital expenditure (added to the cost of machinery and debited to
machinery account, not to repairs account), and hence, does not form part of
the expenses for the period. It means the actual expenses for the period are
Rs. 8,20,000 and not Rs. 8,00,000. So, the correct profit is Rs. 1,80,000, not
Rs. 2,00,000. In other words, the profit has been over stated. Similarly, if any
capital expenditure is wrongly shown as revenue expenditure (for example,
purchase of furniture shown as purchases), it will result in under statement
of profits, and also an under statement of assets. Thus, the financial statements
will not reflect the true and fair view of the affairs of the business. Hence, it is
necessary to identify the correct nature of each item and treat it accordingly
in the book of accounts. It is also important from taxation point of view because
capital profits are taxed differently from revenue profits.
9.3 Financial Statements
It has been emphasised that various users have diverse informational
requirements. Instead of generating particular information useful for specific
users, the business prepares a set of financial statements, which in general
satisfies the informational needs of the users.
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