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Unit 06 - Final Accounts

MBA Notes
Course

Master's in Business Administration (MBA001)

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Unit 6 Final Accounts

Structure:

6 Introduction

Objectives

6 Components of Final Accounts

Trading and profit and loss account

Balance sheet

6 Adjustments

Outstanding expenses

Prepaid expenses

Incomes received in advance

Accrued incomes

Depreciation

Bad debts and accounting treatment of bad debts

Provision for doubtful debts

Reserves for discount on debtors

Reserves for discount on creditors

Closing stock

6 Adjusted Trial Balance

6 Final Accounts of Joint Stock Companies

6 Summary

6 Glossary

6 Terminal Questions

6 Answers

6 Case Study

6 Introduction

In the previous units we have understood the first two functions of

accounting.

• Recording – through journal and subsidiary books

• Classifying – through ledger accounts

In this unit, we will understand the next function of accounting,

i., summarising. The end objective of any business is profit. All the

stakeholders would like to know whether all the transactions incurred

throughout an accounting period resulted in profit or loss for their business.

This process of taking a summary of all transactions incurred during an

accounting period with the objective of knowing the net result of all such

transactions is called summarising.

Summarising can be done by preparing the following two statements.

  • Profit and loss account
  • Balance sheet

These two statements together comprise the final accounts. They are called

final accounts as they are prepared at the end of the accounting period.

They are also popularly called financial statements.

In this unit, we will learn how to prepare the final accounts.

Objectives:

After studying this unit, you should be able to:

  • describe the meaning of final accounts and appreciate the need for and

importance of final accounts

  • describe the components and structure of final accounts
  • prepare the final accounts from a given trial balance
  • analyse adjustments and the different types of adjustments
  • identify how to incorporate adjustments into final accounts through

adjusted trial balance and also directly in the final accounts

  • analyse the features of and prepare the final accounts of joint stock

companies

6 Components of Final Accounts

As mentioned earlier, final accounts have two components.

  • Profit and loss account
  • Balance sheet

Let us discuss the two components in detail.

Profit and loss account

It is a statement prepared in order to know the financial performance (profit

or loss) for an accounting period (usually one year). This statement basically

shows the net effect of total revenues and total expenses.

To gas, coal, electricity for production
To import duty and clearing charges
To stores consumed
To factory rent, insurance, factory
expenses
To other direct expenses
To royalty paid
To profit and loss a/c (gross profit)

Illustration 1: For the following balances extracted from a trial balance,

prepare a trading account.

Particulars Amount in Rs.
Stock on 1-1-2004 70700
Returns inwards 3000
Returns outwards 3000
Purchases 102000
Debtors 56000
Creditors 45000
Carriage inwards 5000
Carriage outwards 4000
Import duty on materials received from abroad 6000
Clearing charges 7000
Rent of business shop 12000
Royalty paid to extract materials 10000
Fire insurance on stock 2000
Wages paid to workers 8000
Office salaries 10000
Cash discount 1000
Gas, electricity, and water 4000
Sales 250000

Solution

Dr Trading Account For the Year Ending - - - Cr

Particulars Rs. Particulars Rs.
To stock on 1-1-2004 70700
To Purchases 102000
(-) Returns
Outwards 3000 99000
By sales 250000
(-) Returns
Inwards 3000 247000
To Carriage inwards 5000
To Import duty 6000
To Clearing charges 7000
To Royalty 10000
To Fire insurance 2000
To Wages 8000
To Gas, electricity, water 4000
To Gross profit 35300
Total 247000 Total 247000

Profit and loss account

It is an important account that reveals the net result of the business in the

form of net profit or net loss. All revenue receipts are received regularly out

of day to day activities of the business. Revenue payments that are incurred

are recorded in profit and loss account. The capital receipts and capital

payments are not considered while preparing profit and loss account as they

do not form a part of this account.

The format of a profit and loss account is given below:

Dr Profit and Loss Account for the year ending --- Cr

Particulars
Rs.
Particulars Rs.
To Trading account (GL) By Trading account (GP)
To Salaries + Outstanding – Prepaid
salaries as per adjustments
By Interest earned +
Accrued interest as per
adjustments
To Rent of the premises By Commission earned
To Travelling expenses By Discount earned

The order of liquidity is the opposite of the order of permanency. The assets

are presented starting from the least permanent asset (current assets) to the

most permanent asset (fixed assets). Similarly, the liabilities are presented

starting from the least permanent liability (current liabilities) to the most

permanent liability (capital).

Sole proprietary organisations and partnership firms may use any of the

above methods. However the joint stock companies have to use only the

order of permanency for reporting purposes.

The format of a balance sheet as per the order of permanency is given

below.

Balance Sheet as on ........

Liabilities Rs. Assets Rs.
Capital
Opening balance
+net profit
(-net loss)
+interest on capital
  • Drawings
  • Interest on drawings
Closing balance
Long term liabilities
Current liabilities
Sundry creditors
B/P
Outstanding expenses
Incomes received in advance
Fixed Assets
Land
Buildings
Plant and machinery
Furniture and fixtures
Vehicles
Current assets
Stock
Sundry debtors
B/R
Cash at bank
Cash in hand
Prepaid expenses
Accrued incomes
Total Total

6 Adjustments

Certain transactions may occur after ledger accounts have been closed and

trial balance has been drafted. However, such transactions must be

provided before preparing the final accounts if they belong to the current

year. Such entries are called adjustments.

6.3 Outstanding expenses

Expenses yet to be paid or outstanding expenses for the current period

should be charged against the income of the current period.

6.3 Prepaid expenses

Expenses paid in advance or prepaid expenses should be not be charged

against the revenues related to the current period but it must be taken to the

coming period.

6.3 Income received in advance

Income received in advance that does not belong to the current period

should not be considered.

6.3 Accrued income

Accrued income is also called outstanding income. Income yet to be

received for the current period should be considered as income for the

current period irrespective of whether it is actually received in cash or not.

Self Assessment Questions

1. Expenses due but not yet paid are known as ______.

2. Prepaid expenses appear on the asset side of the balance sheet.

(True/False)

3. Income earned but not received is called ____________.

6.3 Depreciation

Depreciation is a reduction in the value of an asset.

The reasons could be wear and tear, permanent fall of market price of the

asset, or outdated technology. Depreciation must be treated as a cost.

Therefore, the amount of depreciation must be deducted from the asset and

debited to the profit and loss account.

6.3 Bad debts

Bad debts are those debts which are not recovered. Bad debts form loss to

the business. The amount of bad debts must be deducted from the debtors

and debited to the profit and loss account.

6.3 Provision for doubtful debts

From the past experience of the business proprietor, what percentage of

debts may become bad in the future can be estimated. In the current year,

Self Assessment Questions

4. Given: old RBD = 4000, new RBD required = 7000, then the amount of

additional reserve to be created is Rs. _____________.

a. 4000

b. 7000

c. 3000

5. Given: old RBD = 4000, additional RBD required = 7000, then the

amount of additional reserve to be created is Rs._____________.

a. 4000

b. 7000

c. 3000

6. Given: old RBD = 4000, Sundry Debtors 50000, new RBD required =

10% on Sundry Debtors, then the amount of additional reserve to be

created is Rs._____________.

a. 4000

b. 5000

c. 1000

7. Given: old RBD = 4000, Sundry Debtors 50000, further bad

debts = 1000, new RBD required = 10% on Sundry Debtors, then the

amount of additional reserve to be created is Rs._____________.

a. 4900

b. 900

c. 3900

6.3 Reserves for discount on debtors

It is an amount set aside for giving discount to debtors. It is created by

debiting the profit and loss account.

The following guidelines must be considered while dealing with the reserve

for discount on debtors.

Illustration 3: The following items are found in the trial balance of M/s

Sharada Enterprise on 31st December, 2000.

Sundry Debtors Rs.

Bad Debts written off Rs 9000

Discount allowed to Debtors Rs. 1800

Reserve for Bad and doubtful Debts 31-12-1999 Rs. 16500

Reserve for discount on Debtors 31-12-1999 Rs. 3200

You are required to provide the bad and doubtful debts at 5% and for

discount on debtors at 2%. Show the adjustments for bad debts, bad debts

reserve, discount account, and provision for discount on debtors.

Solution:

The amount debited to P&L account towards RBD is computed as follows:

Old RBD = Rs. 16500

(-) Bad debts = Rs. 9000

Balance = Rs. 7500

New RBD @5% on160000 = Rs. 8000

RBD to be provided = Rs. 500 (8000-7500)

The amount debited to P&L account towards Reserve for Discount on

Debtors is computed as follows:

Good Debtors = Rs – Rs (New RBD)= Rs.
Old Reserve for
Discount on Drs = Rs.
Less Discount on Drs = Rs.
Balance Reserve = Rs.
New Reserve for
Discount at 2%
On good Drs 152000 = Rs.
Reserve for Discount to be
provided now = Rs (3040 -1400)

In the balance sheet, the Sundry debtors are reduced by bad debts shown

out side the trial balance, the new RBD, discount on debtors shown out side

the trial balance and the new Reserve for discount on debtors.

6.3 Reserves for discount on creditors

Discount on creditors is an amount of discount expected to be received from

creditors. It is a gain. Discount on creditors may be credited to P/L a/c only if

it is a regular practice to receive it and it is very certain that it will be

received.

6.3 Closing stock

Stock of goods – raw materials, semi finished goods, finished goods – at the

end of the accounting year is called closing stock. It should be credited to

the trading account. In the balance sheet, it appears as an asset.

Illustration 4: From the given trial balance draft an Adjusted Trial Balance.

Trial Balance as on 31.
Debit balances Rs. Credit balances Rs.
Furniture and Fittings 10000 Bank Over Draft 16000
Buildings 500000 Capital Account 400000
Sales Returns 1000 Purchase Returns 4000
Bad Debts 2000 Sundry Creditors 30000
Sundry Debtors 25000 Commission 5000
Purchases 90000 Sales 235000
Advertising 20000
Cash 10000
Taxes and Insurance 5000
General Expenses 7000
Salaries 20000
TOTAL 690000 TOTAL 690000

Adjustments:

1. Charge depreciation at 10% on Buildings and Furniture and fittings.

2. Write off further bad debts 1000

3. Taxes and Insurance prepaid 2000

4. Outstanding salaries 5000

5. Commission received in advance

Solution:

Ledger accounts

Furniture and fittings a/c

Dr. Cr.

Particulars Rs. Particulars Rs.
To bal b/d 10000 By Depreciation
By bal c/d
1000
9000
Total 10000 Total 10000
To bal b/d 9000

Buildings a/c

Dr. Cr.

Particulars Rs. Particulars Rs.
To bal b/d 500000 By Depreciation
By bal c/d
50000
450000
Total 500000 Total 500000
To bal b/d 450000

Bad Debts a/c

Dr. Cr.

Particulars Rs. Particulars Rs.
To bal b/d
To Sundry Debtors
2000
1000 By bal c/d 3000
Total 3000 Total 3000
To bal b/d 3000

Sundry Debtors a/c

Dr. Cr.

Particulars Rs. Particulars Rs.
To bal b/d
To bal c/d
25000 By Bad Debts
By bal c/d
1000
24000
Total 25000 Total 25000
To bal b/d 24000

Taxes and Insurance a/c

Dr. Cr.

Particulars Rs. Particulars Rs.
To bal b/d
To bal c/d
5000 By Prepaid taxes and Insurance
By bal c/d
2000
3000
Total 5000 Total 5000
To bal b/d 3000

Commission a/c

Dr. Cr.

Particulars Rs. Particulars Rs.
To Commission received in advance
To bal c/d
1000
4000
By bal b/d 5000
Total 5000 Total 5000
By bal b/d 4000

Commission received in advance a/c

Dr. Cr.

Particulars Rs. Particulars Rs.
To bal c/d 1000
By Commission
By
1000
Total 1000 Total 1000
To bal b/d By bal b/d 1000

Adjusted Trial Balance as on 31.

Debit balances Rs. Adjustments Adjusted amount
Furniture and Fittings 10000 -1000 9000
Buildings 500000 -50000 450000
Sales Returns 1000 1000
Bad Debts 2000 +1000 3000
Sundry Debtors 25000 -1000 24000
Purchases 90000 90000
Advertising 20000 20000
Cash 10000 10000
Taxes and Insurance 5000 -2000 3000
General Expenses 7000 7000
Salaries 20000 +5000 25000
Depreciation - 1000+50000 51000
Prepaid Taxes and Insurance - 2000 2000
TOTAL 690000 695000
Credit balances Rs.
Bank Over Draft 16000 16000
Capital Account 400000 400000
Purchase Returns 4000 4000
Sundry Creditors 30000 30000
Commission 5000 -1000 4000
Sales 235000 235000
Outstanding salaries - 5000 5000
Commission received in
advance - 1000
TOTAL 690000 695000

Self Assessment Questions

9. Given: salaries paid during 01.4 and 31.03 is Rs.

Prepaid salaries as on 01.4 is Rs. 5000

Prepaid salaries as on 01.4 and 31.03 is Rs.

The amount of salary to be debited to the P/L for the year 2010-11 is

a. Rs. 60000

b. Rs. 55000

c. Rs. 80000

d. Rs. 45000

6 Final Accounts of Joint Stock Companies

Section 211 requires that every balance sheet of a company should provide

a true and fair view of the state of affairs of a company at the end of the

financial year. The balance sheet should be set out in the form prescribed in

Part 1 of Schedule VI of the Companies Act 1956.

Activity 2:

Pick out a balance sheet of a manufacturing company and list out the

various types of capital, assets, and liabilities.

Hint : Visit website of any company and download balance sheet – list out

the following-

Authorised, Issued, subscribed, called-up and paid-up capital.

Fixed assed , Current asset

Longterm and Current-liabilities

Illustration 5: From the following trial balance of Anjana Machineries

Limited and the additional information, prepare the final accounts of the

company as per Schedule VI of the Companies Act.

Trial Balance as on 31st March, 2008

Particular Amount Particular Amount
Opening stock- Raw materials 1,50,000 Sales 47,50,
  • Work-in-process 28,000 General reserve 25,
  • Finished goods 1,90,000 Provision for dep on P&M 1,40,
Purchases 15,50,000 Sundry creditors 1,35,
Salaries and wages 2,30,000 Provision for dep on
furniture
30,
Plant and machinery (at cost) 12,20,000 Purchases returns 25,
Investment at cost (short term) 3,29,000 Eq share capital (Rs.
each)
30,00,
Sundry debtors 1,58,000 10% Pref Sh
(Rs/each)
5,00,
Cash at bank 2,50,900 9% Debentures 6,00,
Directors remuneration 80,000 Deb Redemption Reserve 3,00,
Interim dividend 1,20,000 Bills payable 90,
Office furniture (at cost) 1,80,000 Securities premium 2,80,
Rates and taxes 17,000 Income from investments 30,
Insurance 15,000 Excise duty payable 15,
Audit fee 30,000 Profit and loss 20,
Sales return 70,
Excise duty on finished goods 3,20,
Rent 90,
Rent prepaid 20,
Bad debts 18,
Interest on debentures 27,
Freehold premises 47,30,
Other expenses 37,
Bills receivable 30,
Preliminary expenses 50,
Total 99,40,000 Total 99,40,

Additional information:

1. Stock as on 31st March, 2008

2. Raw materials and stores Rs,45,000; work-in-process, Rs,000;

Finished goods, Rs,98,000.

3. Provide depreciation on written down value basis on plant and

machinery @ 20% per annum and on furniture @ 15% per annum and

on freehold premises @ 5% per annum.

4. In the middle of the year, a machine costing Rs,00,000 was

purchased and duly recorded.

5. Sundry debtors include Rs,000 due for more than six months.

Provide for bad and doubtful debts @ 5% on debtors.

6. Market value of investments is Rs,19,000.

7. Make a provision for income-tax @ 35%.

8. Corporate dividend tax is 14% including surcharge of 10% and

education cess of 2%.

9. The Board of Directors has recommended a final dividend @ 15% on

equity shares.

10. Transfer of Rs,00,000 to debenture redemption reserve.

11. Transfer of minimum amount to statutory reserve as required by

company law.

12. Provision for depreciation on freehold premises as on 31/03/2007 was

Rs,70,000.

13. Written of one-fifth of preliminary expenses.

14. Interest on debentures becomes due on 31st October and 31st March.

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Unit 06 - Final Accounts

Course: Master's in Business Administration (MBA001)

211 Documents
Students shared 211 documents in this course

University: Manipal University Jaipur

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Financial and Management Accounting Unit 6
Manipal University Jaipur Page No. 136
Unit 6 Final Accounts
Structure:
6.1 Introduction
Objectives
6.2 Components of Final Accounts
Trading and profit and loss account
Balance sheet
6.3 Adjustments
Outstanding expenses
Prepaid expenses
Incomes received in advance
Accrued incomes
Depreciation
Bad debts and accounting treatment of bad debts
Provision for doubtful debts
Reserves for discount on debtors
Reserves for discount on creditors
Closing stock
6.4 Adjusted Trial Balance
6.5 Final Accounts of Joint Stock Companies
6.6 Summary
6.7 Glossary
6.8 Terminal Questions
6.9 Answers
6.10 Case Study
6.1 Introduction
In the previous units we have understood the first two functions of
accounting.
• Recording – through journal and subsidiary books
• Classifying – through ledger accounts
In this unit, we will understand the next function of accounting,
i.e., summarising. The end objective of any business is profit. All the
stakeholders would like to know whether all the transactions incurred
throughout an accounting period resulted in profit or loss for their business.

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