Final Accounts of Sole Proprietor

Final Accounts

“Surround Yourself With Assets, Not Liabilities”

The main objective of any business is to earn profit. Every businessman is eager to know the performance of his business during the period and also to know the financial position of his business, i.e. to know the amount of assets he owns and the amount of liabilities he owes. For the purpose of this the accountants prepare the Financial Statements of the business in form of the Income Statement and the Position Statement. These statements together in a normal language are known as Final Accounts. The Income Statement is called as the Trading & Profit & Loss A/c and the Position Statement is known as Balance Sheet.

Now the big question arises as to why be these statements called as Final Accounts?

It is quite simple - the following are the reasons for these statements being called as Final Accounts:

1.       The first and the most important reason is that they are prepared to show the final results of the business so they are called a Final Accounts.

2.       The other reason is that they are Finally prepared by the accountant after closing all the other books of accounts.

3.       The last reason is that they are prepared at the end of the financial period to mark the end of the accounting process.

Now let us understand each of the part of final account individually to understand how and why it is prepared, also to understand the preparation of each of them in detail.

TRADING AND PROFIT AND LOSS ACCOUNT

Trading and Profit and Loss account is prepared to determine the profit earned or loss sustained by the business enterprise during the accounting period. It is basically a summary of revenues and expenses of the business and calculates the net figure termed as profit or loss. Profit is revenue less expenses. If expenses are more than revenues, the figure is termed as loss. Trading and Profit & Loss account summarises the performance for an accounting period. It is achieved by transferring the balances of revenues and expenses to the trading and profit and loss account from the trial balance. It can be observed that debit balances of Revenue Nature (representing expenses and losses) are transferred to the debit side of the Trading and a Profit and Loss account and credit balance of Revenue Nature (representing revenues/gains) are transferred to its credit side.

For the purpose of better understanding we are going to discuss the Trading A/c and Profit & Loss A/c separately.

Trading Account:

As the name suggests it is the account that is prepared to know the income earned on the account of Trading, i.e. in account of buying and selling activities of the business. If the revenues (Credit Side) are more than the expenses incurred (Debit Side) than such an amount is known as Gross Profit, however if the expenses are greater than the revenues generated than it is known as Gross Loss. Trading Account records all the items which are related to Goods & Production of Goods. In simple words all factory related expenses are entered in Trading Account.

Profit & Loss Account:

This Account is prepared to calculate the Net Profit of the business. All the items entered in this account are of indirect nature, i.e. all indirect expenses in the form of Office & Administration, Selling & Distribution and Finance Charges are recorded on the debit side of the Profit & Loss A/c and all the indirect incomes are recorded on the credit side of the Profit & Loss A/c.

Note: All incomes other the sales are indirect incomes and hence they have to be recorded on the credit side of the Profit & Loss A/c.

BALANCE SHEET

The balance sheet is a statement prepared for showing the financial position of the business summarising its assets and liabilities at a given date. The assets reflect debit balances and liabilities (including capital) reflect credit balances. It is prepared at the end of the accounting period after the trading and profit and loss account have been prepared.

It is called balance sheet because it is a statement of balances of ledger accounts that have not been transferred to trading and profit and loss account and are to be carried forward to the next year with the help of an opening entry made in the journal at the beginning of the next year.

ADJUSTMENTS

Some Common Adjustments and Their Treatment:

1.     Closing stock:

                Trading a/c -                          Credit side

                Balance sheet -     Assets side

                Journal Entry:

Closing Stock A/c Dr.

                      To Trading A/c

                (Closing stock always to be shown at cost or market value whichever is less)

2.     Outstandingexpenses:

             Add to the concerned expenses Debit side of Trading or P & L a/c

            Balance sheet -         Liability Side

                Journal Entry:

Expense A/c                           Dr.

                To Outstanding Expense.

                (Here the term Expense represents all expenses like Wages, Rent, Etc.)

3.     Pre-paid expenses (Unexpired Expense):

     Less from concerned expenses on Debit side of Trading or P & L A/c;

Balance sheet -     Assets Side.

Journal Entry:

Prepaid Expense A/c                            Dr.

                To Expense A/c

(Here the term Expense represents all expenses like Salaries, Insurance, Etc.)

4.       Outstanding incomes (Accrued Income):

     Add to concern incomes on Credit side of P & L A/c;

Balance sheet -     Assets Side.

Journal Entry:

Accrued Income A/c                              Dr.

                To Income A/c

(Here the term Income represents all Incomes like Interest, Commission, Etc.)

5.       Income received in advance:

   Less from the concerned income on the Credit side of P & L A/c;

Balance sheet -     Liability Side.

Journal Entry:

Income A/c                                             Dr.

                                To Advance Income A/c

(Here the term Income represents all Incomes like Interest, Commission, Etc.)

6.       Depreciation on fixed assets:

  Less from the concerned Assets in the Balance Sheet;

  P & L A/c -                           Debit side.

Journal Entry:

Depreciation A/c                   Dr.

                                To Fixed Asset A/c

7.       Unrecorded purchase:

  Add to Purchases on the Debit Side of Trading A/c;

  Add to creditors on the Liability Side of Balance Sheet

Journal Entry:

Purchase A/c                                         Dr.

                                To Creditors A/c

8.       Unrecorded sales:

  Add to Sales on the Credit Side of Trading A/c;

  Add to Debtors on the Asset Side of Balance Sheet.

Journal Entry:

Debtors A/c                                            Dr.

                                To Sales A/c

9.       Interest on capital:

  Add to capital on the Liability Side of Balance Sheet;

  P & L A/c -                           Debit side.

Journal Entry:

Interest on Capital A/c         Dr.

                                To Capital A/c

10.      Bad Debts:

  P & L A/c -                           Debit side.

Less from Debtors on Asset Side of Balance Sheet.

Journal Entry:

Bad Debts A/c                       Dr.

                To Debtors A/c

11.       Provision for Doubtful Debts:

   P & L A/c -                          Debit side.

Less from Debtors on Asset Side of Balance Sheet.

Journal Entry:

Profit & Loss A/c                   Dr.

                                To Provision for Bad Debts A/c.

Note: Normally the information about the provision for doubtful debts would be given as a percentage of Debtors. It is to be noted that such percentage is to be calculated on the net amount of debtors, i.e. on the amount derived after deducting the amount of bad debts as per adjustments.

12.      Provision for discount on Debtors:

        P & L A/c -                             Debit side.

                Less from Debtors on Asset Side of Balance Sheet.

Journal Entry:

Profit & Loss A/c                   Dr.

                                To Provision for Discount A/c.

Note: Normally the information about the provision for discount on debtors would be given as a percentage of Debtors. It is to be noted that such percentage is to be calculated on the amount of debtors which is arrived after deducting Bad Debts & Provision for Doubtful Debts.

13..         Goods sent on sale on Approval (Sale or Return):

This is one adjustment which has 4 effeccts:-

Less from Sales on the Credit side of Trading A/c @ Selling Price.

Less from Debtors on the Asset side of Balance sheet @ Selling Price.

Add to Closing stock on the Credit side of Trading A/c @ Cost Price.

Add to Closing stock on the Asset side of Balance sheet @ Cost Price.

14.       Purchase of Furniture included in Purchase A/c.

Less from Purchase on the Debit side of Trading Account.

Add to Furniture on the Asset side of Balance Sheet.

Journal Entry:

Furniture A/c                                        Dr.

                                To Purchase A/c

Note: In the above adjustment Furniture is taken as an example to represent any asset.

         It is also to be noted that while calculating the depreciation on furniture, we  
         should remember to calculate depreciation on the new furniture purchased also.

15.         Goods Destroyed by Fire:

In this adjustment there can be 3 possible cases, as follows:

a)       Good were uninsured:

Less from Purchases on Debit Side of Trading A/c

Debit side of P & L A/c (Show as “Loss by Fire”)

Journal Entry:

Loss by Fire A/c                            Dr.

        To Purchase A/c

b)       Goods were fully insured::

Less from Purchases on Debit Side of Trading A/c

Balance Sheet - Asset Side (Show as Insurance Claim)

Journal Entry:

Insurance Claim A/c                     Dr.

        To Purchase A/c

c)        If goods were partly insured:

Less from Purchases on Debit Side of Trading A/c – Value of Goods Lost

Balance Sheet - Asset Side (Show as Insurance Claim) - Value of Insurance Claim

Debit side of P & L A/c (Show as “Loss by Fire”) – Value of Loss

Journal Entry:

Loss by Fire A/c                                            Dr.

Insurance Claim A/c                     Dr.

        To Purchase A/c

HIDDEN ADJUSTMENTS

Hidden Adjustments are those pieces of information that are given in the trial balance itself, many a times it would be difficult for the students to identify them as they are not given separately. Normally if any item in trial balance has “%” or any Date written then we can expect some kind of adjustment.