Key Notes: Financial Statements - I | Accountancy Class 11 - Commerce PDF Download

Stakeholders and their Information Requirements

• The primary goal of a business is to share vital information with various stakeholders to facilitate informed decision-making.
• A stakeholder is an individual or group involved with a business, either directly or indirectly.
• Stakeholders can have monetary interests (e.g., profits) or non-monetary interests (e.g., legal compliance, social welfare).
• Examples of stakeholders:
  1. Monetary: Owners and lenders
  2. Non-Monetary: Government, consumers, researchers
• Each stakeholder has unique goals and distinct information needs from the business.

Types of Stakeholder Interests

• Active vs. Passive: Active stakeholders engage directly in business activities; passive stakeholders have an interest without direct involvement.
• Direct vs. Indirect: Direct stakeholders have a clear interest; indirect stakeholders are affected by the business’s actions.
• Examples of stakeholder interests:
  1. Financial Interest: Owners and lenders focus on profits and financial stability.
  2. Non-Financial Interest: The Government monitors tax compliance, consumers prioritize product quality, and researchers study business practices.

Users and Their Classification

Stakeholders are also referred to as users, categorized into:

1. Internal Users: Individuals within the business (managers, employees) needing detailed information for decision-making.
2. External Users: Outside parties (investors, government agencies, consumers) requiring information for various purposes.

Understanding users' information needs is crucial for effective communication of accounting information.

Accounting Process (up to Trial Balance)

• The accounting process involves recording measurable transactions using the double-entry system, where each transaction has two aspects: debit and credit.
• Similar transactions are documented in subsidiary books(special journals) rather than the general journal:
  1. Sales Book for credit sales
  2. Purchases Book for credit purchases
  3. Return Inwards Book, Return Outwards Book, Cash Book for cash transactions
• Transactions not captured in subsidiary books go into the journal proper.
• Entries from these books are posted to the ledger accounts, balanced, and compiled into a trial balance.
• If total debits equal total credits, the accounts are free from arithmetic errors, forming the basis for financial statements.

Distinction between Capital and Revenue

Understanding the difference between capital and revenue items is crucial:

• Revenue items appear in the trading and profit and loss accounts.
• Capital items are used to prepare the balance sheet.

What is Expenditure?

• Expenditure refers to payments made for purposes other than settling existing debts.
• Expenditures are made with the expectation of receiving future benefits.
• Benefits can be:
  • Revenue Expenditure: Benefits lasting up to one accounting year (e.g., salaries, rent).
  • Capital Expenditure: Benefits extending beyond one year (e.g., purchasing furniture).

Key Differences Between Capital and Revenue Expenditure

• Capital Expenditure: Enhances earning ability, involves fixed asset purchases, occurs less frequently, benefits span several years, and appears on the balance sheet.
• Revenue Expenditure: Maintains earning capacity, covers day-to-day costs, happens frequently, benefits last for one accounting year, and appears in the trading and profit and loss account.
• Sometimes, classifying an expense as capital or revenue can be challenging, leading to terms like deferred revenue expenditure.

Understanding Expenditure and Expenses

• Expenditure encompasses all payments made by a business.
• Expenses are specific expenditures consumed within the current year.
• Revenue expenditures are listed as expenses for the current year, while capital expenditures are spread over several years through depreciation.

Receipts

• Receipts signify cash inflows, contrasting with expenditures which represent cash outflows.
• Capital Receipts: Involves promised returns, linked to owner’s equity and liabilities (e.g., owner contributions, bank loans).
• Revenue Receipts: Do not require the return of money (e.g., sales, interest income).
• Importance of the Distinction between Capital and Revenue
  • The classification affects financial statement preparation, influencing profit or loss figures.
  • Misclassification can lead to overstated profits or understated asset values, affecting financial reporting and tax obligations.

Financial Statements

• Financial statements are prepared to meet various user needs without detailing specific information for each user.
• Main goals of financial statements:
  • To provide a true and fair view of financial performance.
  • To present a true and fair view of financial position.
• Common financial statements include:
  • Trading and Profit and Loss Account
  • Balance Sheet
• The Trading and Profit and Loss Account shows the profit or loss over a period, while the Balance Sheet displays assets, liabilities, and capital.

Trading and Profit and Loss Account

• The purpose is to determine profit or loss over a time frame by summarizing income and expenses.
• Profit Calculation: Profit is calculated as total income minus total expenses. A loss occurs if expenses exceed income.
• Structure: It consists of a debit side (expenses and losses) and a credit side (revenues and gains).

Relevant Items:

Debit Side:

• Opening Stock
• Purchases (Net of Returns)
• Wages
• Carriage Inwards
• Utilities (Fuel, Water, etc.)
• Packaging Material
• Salaries
• Rent Paid
• Interest Paid
• Commission Paid
• Repairs
• Miscellaneous Expenses

Credit Side:

• Sales (Net of Returns)
• Other Incomes (e.g., rent received, dividends)

Closing Entries

• To prepare accounts, relevant balances are transferred to the debit side of the trading and profit and loss account.
• Closing entries include:
  • Transfer balances of Opening Stock, Purchases, Wages, and Carriage Inwards.
  • Close Purchase Returns and Sales Returns accounts by transferring balances.
  • The balance of the Sales account is moved to the credit side.
  • Expenses and losses are closed with appropriate entries.
  • Income and gains are also closed with specific entries.

Concepts of Gross Profit and Net Profit

• The Trading Account measures Gross Profit, while the Profit and Loss Account measures Net Profit.
• Gross Profit Calculation: The difference between sales and the sum of purchases plus direct expenses.
• If purchases and direct expenses exceed sales, it results in a Gross Loss.
• Net Profit Calculation: Net Profit = Gross Profit + Other Incomes - Indirect Expenses.
• This calculated net profit or loss is transferred to the capital account in the balance sheet.

Cost of Goods Sold and Closing Stock

• Without Opening or Closing Stock: COGS is calculated by adding purchases and direct expenses.
• With Closing Stock: If unsold stock exists, COGS is adjusted accordingly.
• Closing stock is recorded as an asset and carried into the next year as opening stock.
• COGS Formula: COGS = Opening Stock + Purchases + Direct Expenses - Closing Stock.

Operating Profit (EBIT)

• Operating profit reflects earnings from regular business activities, not including financial income or expenses.
• Also known as Earnings Before Interest and Tax (EBIT).
• Abnormal items (e.g., losses from disasters) are excluded from this calculation.
• Operating Profit Formula: Operating Profit = Net Profit - Non-Operating Expenses + Non-Operating Incomes.

Balance Sheet

• A financial statement summarizing a business's assets and liabilities at a specific date.
• Assets are recorded as debit balances; liabilities, including capital, are shown as credit balances.
• Prepared after the trading and profit and loss accounts are completed.
• Includes accounts related to assets, liabilities, and capital.
• Capital is the difference between total assets and total liabilities.
• Drawings reduce the capital account balance and are shown as a deduction in the balance sheet.

Relevant Items in the Balance Sheet

• Current Assets: Cash or assets convertible to cash within a year (e.g., cash, stock, debtors).
• Current Liabilities: Debts due within a year (e.g., bank overdrafts, creditors).
• Fixed Assets: Long-term assets not meant for resale (e.g., buildings, machinery).
• Intangible Assets: Non-physical assets (e.g., goodwill, patents).
• Investments: Money put into securities, listed at cost price.
• Long-term Liabilities: Debts due after one year (e.g., long-term loans).

Marshalling and Grouping of Assets and Liabilities

• Marshalling refers to the organization of assets and liabilities for clarity in financial statements.
• Assets and liabilities can be arranged based on liquidity or permanence.
• Items can also be grouped under headings for better presentation (e.g., current assets, non-current assets).