LEARNING OBJECTIVES , would enable students to understand: ant cial Statements odor Importance of Financial Statements statements an of Capital and Revenue Items: expenditure, Revenue Expenditure and Deferred Revenue Expenditure | receipts and Revenue Receipts sn of Trading Account, Profit and Loss Account and Balance Sheet ce between account and Profit and Loss Account siance Sheet and Trial Balance soft and Loss Account and Balance Sheet sping and Marshalling (Arrangement) of Assets and Liabilities ; igssfication of Assets and Liabilities | eaning ‘roding and Profit and Loss Account and Balance Sheet prepared at the end of ie year. sia) Statements are the statements prepared at the end of the accounting period .¢ the financial performance, i.e., profit earned or loss incurred during the unting period and also the financial position of the business as on the date. They nown as final accounts. A complete set of Financial Statements or Final nclude: : and Profit and Loss Account; and Pélance Sheet, “ i Statements are the end-product of the accounting process prepared from the “ance, They are prepared to know: [=192 Double Entry Bo, e profit earned or loss incurred by the business during an ag Oia iow ake Ting and Profit and Lose Avceunt (2) the assets owned and fnblities owed as om the date, i, Finan preparing the Balance Sheet Pei, Objectives or Need or Importance of Financial Statements The objectives or need or importance of the Financial Statements arg 1. Trading and Profit and Loss Account (Also known as Income (i) Determine Gross Profit or Gross Loss Trading Account is prepared to know gross profit earned or gross losg incur business during the accounting period. oT (ii) Determine Net Profit or Net Loss Profit and Loss Account shows net profit earned or net loss incurred by then during an accounting period. ~ Staten, (ii) Comparison with the Previous Years’ Profits Gross Profit and Net Profit for the accounting period can be compared with tha previous years’ profits. It helps in determining whether the business is Proges, as per plans or not. (iv) Details of Expenses and Income | Trading and Profit and Loss Account provide details ofall expenses (diroet and inte and income of the business. It helps to determine how expenses can be contin, sources of income can be increased. (v) Reserves Reserves are created out of profits to meet future uncertainties and to sta financial position of the firm. The amount set aside as reserves depente urn profit earned, (vi) Accounting Ratios | For financial analysis, ratios are calculated with the help of Trading and Pit Loss Account. For example, Gross Profit Ratio, Net Profit Ratio, Operating Return on Capital Employed, ete. 2, Balance Sheet (Also known as Position Statement) | (i) Ascertaining Financial Position a Balance Sheet shows the financial position of the business on a particular di reflecting its assets (i.e., what it owns) and liabilities (i.e., what it owes). (ii) Comparison with Previous Year o The amounts under various heads of Balance Sheet can be compared with | Previous year to assess the change in financial position, (iii) Determining Solvency Position ot With the help of Balance Sheet, short-term solvency of the business (i. ability Wi, short-term liabilities) by computing Current Ratio and Liquid Ratio. Likews solvency can be ascertained by computing Debt to Equity Ratio, Proprietary Ro!fs sapital in the busine: 7 “one capital in siness and thus bear maximum risk. They are interested =" ofit earned or loss incurred by the business, besides safety of their te Sele bus so cae ‘The Financial Statements give this information about the business. ment makes extensive use of accounting information to arrive at informed i has determination of selling price, cost controls and reduction, investment ects. ete. yon aa oo «pl ysers Minees and Trade Unions jeesand Trade Unions are interested in the Financial Statements to negotiate ‘if wages, bonus, retirement benefits, etc. sgnhs and Financial Institutions vad inancial institutions provide loans tothe businesses. They watch performance = asness to know whether itis progressing as projected to ensure safety, service and cgorv of the loan. advanced. They assess it by analysing the accounting information. j Creditors “srs are the parties who supply goods and/or services on credit, Normally, a smount of suppliers remain invested in credit purchases. Before granting credit, ~ors satisfy themselves about the credit-worthiness of the business. The Financial nts help them in making such an assessment. ») Government and its Authorities muent makes use of financial statements to compile national income accounts and “ur formation, The information so available enables them to take policy decisions. cwenment levies taxes such as GST and Income Tax. The government authorities ‘the erect tax dues from analysis of the financial statements. ‘Researchers isnformation in financial statements helps researchers in studies or surveys related “4 particular firm or industry. “Public «Reto se the business running since it makes substantial contribution to the Ie : in many ways, e.g., employment of people, patronage to suppliers, ete. ‘nancial accounting provides useful financial information to various user groups ‘sion-making. .pide prepared, the fit and L accounts therein are transfer oss Account or to the Balance ae enue nature are transferred eit), ee ile entries of capital nature are 5 ah, ‘Trial Balance 18 Account or t0 the Pro} (items) in the ‘Trial Balance Account or 10 Profit and Le to Balance Sheet. Trading Account, P After the Trading rofit and Loss Account and Balance Sheet are Prepare an item of capital nature 18 transferred to Trading Aceouny treating it as of revenue nature or vice versa, then nejg or, rect profit or loss for the year nor the Bola, sition of the business. It is, therefore, ue above basis. It Account, 1.@++ Account will show cor) e and fair financial po* rectly whether an item appearing in the Trial : la, tal nature, Thereafter, the item should be trang stem, herp and Lo and Li will show tru : understand and classify co of revenue nature OF of capit the final accounts accordingly. ‘un Assumption allows classifying Expenses and Receipts as ¢ ‘ Expenditure, Capital Receipts and Revenue Receipts Going Conet Expenditure, Revenue ‘There are certain rules for classification o} capital. Let us discuss these rules or basis. f expenditure and receipts as reven, Capital Expenditure Capital Expenditure is the expenditure that gives benefit from the expenditure will be for period or periods beyond the accounting pe or reduces the operating expun: benefit of enduring nature, ip Capital expenditure increases the earning capaci of a business. Capital Expenditure is the amount incurred by an enterprise normally on purch fixed assets, Fixed assets are used in the business to earn income and are not in for resale. Fixed assets purchased may be tangible or intangible. Following types of expenditures are usually accounted as Capital Expenditure: (i) Expenditure incurred for acquisition of fixed assets such as land, built machinery, furniture, motor vehicle, etc. (ii) Expenditure for the extension of or improvement of fixed assets: Such as in" the seating capacity of a theatre. (iii) Expenditure incurred to bring the fixed assets to the place of their" expenditure incurred on their installation or erection: Such as freight °' assets, wages paid for the installation. iv) i (wv) Expenditure incurred for reconditioning of old fixed assets: Such as °?" \ incurred on repairing or overhauling of second hand machineryot ature 18 capital expendityr a Wendt’ : Penditure, atl expendit yd ittre incurred for Purchase of i ee is rey . copyrights, ete, intangible APE ESE Meeesnary ure. Only the initial enue expenditure. assets such mje en al Expenses Incurred for Ac ‘ ‘quiring a Bj owt yg fixed assets, rights 8 Fixed As, itine fixed assets, rights, ete., are ed AssetLog, : also vent of Capital Expenditure at nenditure is debite ‘rgxponditure is debited to relevant Fised Aeso ot sset Account and is shown in the as goodwill, patents, : al expenses incurred for “apital expenditure, snses incurred in day-to-day runni i ing of i i ses. power, fuel, ete, 8 of the business such as rent, salaries, expenses incurred for repairs and maintenance of fixed assets. Expenses incurred on purchase of stock of materials and goods to the extent that ney are used (consumed) during the year; the remaining amount will be an asset. Depreciation on fixed assets. nue expenditure is accounted as an expense and is matched against revenues of yeriod to determine profit or loss of that period. It also includes that part of capital diture which expires or is consumed within an accounting year. For example, ciation on fixed assets. ve discussed the basis for distinguishing Capital Expenditure from Revenue nditure, However, the distinetion is not simple. "lowing expenses appear to be revenue expenses but they are capital expenses: Expenses incurred on the repairs and whitewashing for the first time on the purchase ‘an old building, since these expenses are necessary to make the building usable | Wages paid to workers to produce a tool to be used in the factory itself or to fix machine, Eipenses incurred for purchase of land or building such as fees paid to lawyer or ‘egistration expenses. ; \ Interest on loan raised to acquire an asset up to the point of time it is ready ‘OF use, "eatment a of Revenue Expenditure h : $4 f Trading Account or Profit and |, tue expenditure is shown on the debit side o! ig “SAccount, .Capital Expenditure Revenue. Expenditure s incurred for acquisition of fixed assets for use Itis incurred for Funning of business in business 2 Capacity I increases earning capacity of the business, |_Itis incurred for earning profits, —~ 3 Period Its benefit extends to more than one year Its benefit is exhausted within the yea, 4 Recording | s debited to related Asset Account. Itis debited to related Expense ‘Account, 5 Mature of It is an Asset Account. Itis an Expense Account. (Account © Depiction {ts shown in the Balance Sheet. Itis shown in the Trading or Proftandlosic: Examples (0) Cost of Plant and Machinery. (a) Depreciation on Plant and Machine, (0 Cost of Land and Building. | (®) Rent. © Cost of Furniture and Fixtures, | (0. Repairs and Insurance. improper Considerations in the Determination of Capital Expenditure and Revenue Expenditure oe expenditure is capital or revenue is determined after considering * ‘penditure. If revenue expenditure is debited to Asset Account, it will aie Proyit and alsy value of the asset, On the other hand, if capital expenditure is # to Profit and Loss Account, it will understate Profit and also value of the asse!- the ex iture important Points to Categorise an Expenditure as Capital or Revenue Expendit ) Amount of Expenditure i Capit note a expenditure is normally larger than revenue expenditure, But it dest eat if the amount is small, it is a revenue expenditure and if the amount is capital Expenditure. ii) Pay, ‘) Payment ~Periodic or Lump Sum Aapital «srements of Sole Proprietorship... 199 between Capital Receipt and Revenue Receipt Capital Receipt as i Revenue Receipt noun ealsed by sale offixed assets or receipt |” Itis the amount realised by sale of goods and/or rendering part or loans taken. 3 services, cur Balance Sheet. | Itis shown in Trading Account or Profit and Loss Account. om sxepts are normally of non-recurring nature. | Revenue Receipts are riormally of recurring nature. Revenue Receipts are received in the course of normal trading “go seeps are the receipts which are not received chew of normal business activities. ‘operations. (po teceptsare normally notavailableforpayment | Revenue Receipts, ie, net of revenue expenses and expired pak tothe owner of the business. portion of Capital Expenditure/Deferred Revenue Expenditure are available for distribution to the owner of the business. counts mean the Financial Statements prepared after Trial Balance is “src. Financial Statements include: ‘reding and Profit and Loss Account (Income Statement), and “ance Sheet 7