HOW TO PREPARE FINAL ACCOUNTS?

INTRODUCTION

After Recording, Posting into ledgers and preparing trial balance our Last step of Accounting Process is to prepare Final Account. One of the main objectives of maintaining accounts is to find out the Profit or loss made by the business during a period and to ascertain the financial position of the business as on a given date. The Trading account, Profit and loss account and balance sheet prepared by the businessman at the end of the trading period are called “Final Accounts”.

CAPITAL AND REVENUE ITEMS IN FINAL ACCOUNTS

The total transactions of the business can be divided into a) capital in nature and b) revenue in nature. Before discussing the preparation of final accounts, it is necessary to know the distinction between capital and revenue items. This distinction is necessary because revenue items are shown in the Trading and Profit and loss account and capital items are shown in the Balance sheet.

From the expenditure point of view, we can classify the total items of expenditure into a) capital expenditure and revenue expenditure.

1. Capital expenditure: Capital expenditure is that expenditure which results in the acquisition of an asset or which results in an increase in the earning capacity or which gives some other advantage to the firm.
Example: Expenditure of acquisition of land, building, machinery etc.
2. Revenue expenditure: Any item of expenditure whose benefit expires within the year or expenditure which merely seeks to maintain the business or to keep assets in good working condition is called revenue expenditure.
  Examples: purchase of stock, other direct or indirect expenses etc.
3. Deferred revenue expenditure: A heavy expenditure of revenue nature incurred for getting benefits over a period of years is called deferred revenue expenditure.
Example: preliminary expenses heavy advertisement etc.

The receipts of a business firm can be divided into a) Capital Receipts and b) Revenue Receipts.

1. Capital Receipts: Capital receipts may be defined as non-recurring receipts from the owner of the business or lender of money creating a liability to either of them.
 Example: capital, bank loan creditors etc.
2. Revenue Receipts: Revenue receipt may be defined as recurring receipts against sales of goods in the normal course of business and which is generally the result of the our trading activities.
 Example: sales, dividend received etc.

HOW MANY ACCOUNTS ARE PREPARED IN FINAL ACCOUNTS?

For the purpose of preparation of Final Accounts, business establishments have been classified into a) trading concern and b) manufacturing concern.
1. Trading concern: are those which purchase the finished goods from market and sell it at profit. Such concerns prepare the following :
i) Trading account
ii) Profit and loss account
iii) Balance sheet
2. Manufacturing concern: are those who purchase raw materials and manufacture certain goods. Such concerns prepare:
i) Manufacturing account
ii) Trading account
iii) Profit and loss account
iv) Balance sheet
1. TRADING ACCOUNT
Trading account is a nominal account, prepared mainly to know the “profitability of the goods bought and sold by the businessman. It shows the result of trading i.e. buying and selling of goods called Gross profit/ Gross loss. Gross profit or Gross loss is transferred to Profit and loss account.
Gross profit or Gross loss = sales – cost of goods
Where as
 Cost of goods = opening stock + purchase + direct expenses – closing stock

2. PROFIT AND LOSS ACCOUNT
The Profit and loss account is also a nominal account which shows the net profit or net loss of a business for a particular period. In the first place it is credited with the Gross Profit or debited with the Gross Loss, shown by the trading account.  All indirect expenses and incomes are taken in P & L A/c. The credit balance in profit and loss account shows net profit and debit balance net loss. This net profit or net loss is transferred to capital account in balance sheet.

3. BALANCE SHEET 
When the balances of various nominal accounts, given in the trial balance are transferred to trading or profit and loss account, the remaining balances represent real or personal accounts. These and the closing stock represent various assets and liabilities. A list of these assets and liabilities are prepared at the close of the trading period. This gives the complete view of the financial position of the business. It is called the “Balance Sheet”.

Assets and Liabilities

1. Assets: assets can be classified into three types:
i) Fixed assets: They are acquired for use in the operation of a business for relatively long period of time. It is further classified into tangible assets and intangible asset.
a) Tangible assets: It includes items which can be seen and touched like land, building etc.
b) Intangible asset: It includes assets which have value but cannot be seen or touched like goodwill, patents etc.
ii) Current asset/ floating assets: those assets which are converted I cash in the normal course of business within a short-period are called current assets like cash, debtors, stock etc.
iii) Fictitious assets: They appear on the asset side of balance sheet but do not have any value. Like deferred revenue expenditure etc.
2. Liabilities: Liabilities are also classified into three:
i) Fixed liabilities: Liabilities which do not become due for payment in the near future will be called as fixed liabilities or long-term liabilities.
ii) Current liabilities: they are also called as short term liabilities. These are the liabilities which are payable within a short period, ordinarily in a year. Such as trade creditors, Bills payables etc
iii) Contingent liabilities: Contingent liability refers to an obligation to pay on the happening or non-happening of an uncertain event. It is not an actual liability so it is not recorded in balance sheet.

Now as you know the proforma of all final accounts let me solve an example problem for your better understanding. Always remember 👩‍🏫both trading and profit and loss account are nominal in nature but they both record separate entries as trading account record all direct expenses and incomes where as profit and loss account record indirect/office expenses and incomes. In balance sheet Assets are those which stays in business and will benefit in future, whereas liabilities are those debts which have to pay in future. Keeping that in mind lets start!👩‍🏫

EXAMPLE PROBLEM

Explanation: Here I will explain you how I explain to my students in the class, in my class I use some initials that is written just beside the names of accounts in the trial balance itself while explaining problem so that student don’t find it difficult to record all entries together and don’t forget any entry. For you these initials are in red colour, TA,means Trading Account, P.A means Profit and Loss Account, B.S means Balance Sheet, we already know (Dr) Means written on Debit side and (Cr) means written on Credit side, (L) means written on Liabilities side and (A) means written on Asset side. Last but not the least I use to put a star mark * indicating it is a hidden adjustment and need attention of course. Let us look at the same question with markings.

Note1: well you can see how i mark beside all balances. Marking is recorded as For example first one on debit balance in the question is Opening Stock and beside I have marked T.A (Dr) means it should be recorded in Trading Account Debit side as “To Opening Stock”, next on credit balances you can see * before Capital that means there is an adjustment we need to make, and beside capital i marked as B.S (L) + NP - D that means capital is recorded in Balance Sheet Liabilities side as "Capital", and from capital amount of Rs. 1,25,100 we have to first add the net profit of Rs34,900 which is transfered from profit and loss accout and then minus Drawings of Rs 15000 which was given in trial balance.

Note2: Closing stock given in the beginning of the question is an adjustment entry as it is not given in trail balance; we have to record twice to complete the double entry rule, first we will record closing stock in T.A (Cr) side and second time we will take closing stock  in B.S (A) side.

So first you will prepare trading account and take all T.A (Dr)/(Cr) marked items and balance both sides, and as credit side is more than debit side we got gross profit of Rs.79,700 which is transfered to p&l A/c credit side as "To balance b/d". Next all items marked as P.A (Dr)/(Cr) are taken in profit and loss account and balance both sides and as credit side is more than debit side we got net profit of Rs. 34,900 which is added to capital amount in Balance sheet. Lastly all items marked as B.S (L)/(A) are taken in Balance sheet and balance both sides. Remember Balance sheet must Tally means both side should be equal.

 SOLUTION: here’s how our final accounts will be or I should say Mr. Desai’s final accounts will look like

Now let me give you one ☝️(DIY) for your practice ✍let’s see how you will do! 👩‍🏫Well I have shared my knowledge with you let’s see did you gained that knowledge?

DO IT YOURSELF (DIY)

I hope you have understood my👩‍🏫 new method of explanation, Next time inshallah, I will teach you how to make adjustment entries in final Accounts.

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