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Fainace Management
Fainace Management
The ultimate aim of any business is to earn a profit. Profit earning is not an easy task. For
earning a profit the business will purchase the goods in one place at certain price and se it at
another place at higher price than or convert the raw material into finished products and sell
them to various customers at a certain price which will give some percentage of margin on
cost of production. But, this may not be true in all cases, because the goods produced or
purchased may go out of fashion or competitors may enter the market. Due to this reason,
sales will decline automatically. The business runs at a loss or at a very small margin.
However, the business man wants know the profit and loss for the consolidated transaction at
the end of the financial year. So, he needs more information for planning control, evaluation
of performance and decision making. This information can In order to achieve the above
purpose, It would be necessary to record the business transaction according to well defined
Accounting system.
Accounting Definitions:-
Day – to – Day business activities are called transaction. It may involve transfer of money
due to exchange of goods and service between two parties or two persons. Transaction may
be cash transaction and / or credit transaction.
For Example;-
(A) Purchase of Machinery worth Rf.1,00,000
(B) Cheque Received from Mr. Raina Rf. 75,000
2. Capital:-
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In order to start run the business, the owner has to contribute some initial amount to the firm
for the purpose of producing and selling the goods. The amount invested in order to earn an
income is known as capital.
Capital may be classified as fixed capital and working capital. Capital is the Liability of the
business to its proprietor, because as and when the owner claims, firm is liable to repay the
money to its owner.
Capital = Assets - Liabilities
3. Liability:-
It refers to any amount which a business firm has to pay legally to outsiders. All dues to
others including proprietor’s capital are said to be owner.
4. Asset:-
Anything possessed by the firm which is of certain monetary value is called Asset. In other
words, asset refer to tangible object and an intangible right of an enterprise, which carries
probable future benefits. It may be classified as current assets and fixed assets.
Income is a flow of benefits to the enterprise out of recourses controlled by it. The definition
of income consists of both revenue and gain. Revenue arises in the course of ordinary
activities of as enterprise. In manufacturing o trading enterprises Revenue arise mainly from
the sale of goods.
It means an amount spent on any way item by the proprietor to acquire benefit out of it. The
expenses are classified into to Capital expenditure and revenue Expenditure.
Capital expenditure refers to any amount spent to increase the earning capacity of the
business or acquisition of asset.
Revenue expenditure refers to the amount spent for the purpose of acquiring benefit for the
particular year alone.
Example:- Payment of salaries, Rent, Wages, Commission Paid, Interest Paid, etc
7. Purchase:-
Buying of goods by the trader for selling them to his customer is known as purchases.
Purchases may be cash purchases and credit purchases.
8. Purchase Returns:-
Purchase return means a firm or buyer returns to the vendor the goods purchase due to
defective parts or product.
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9. Sales:-
Exchange of goods for money is called sales. Simply sales means goods sent out from the
organisation to its customers. Sales can be cash sales and credit sales.
When a customer returns come of the purchased goods (due to some reason) to the firm it is
called sales returns. Like Damage, Excess Quantity, Quality Break
11. Creditor:-
He has to get money from others. Suppose more than one person are supplying finance or
goods to others. It means the consolidated names of suppliers is called creditor. The creditor
are shown as liability in the balance.
12. Debtor:-
Debtor is a person who owe money to others because he has purchased the goods or has got
finance from others. Simply debtor is one has to pay money to others. The debtors are shown
on the assets side of the balance sheet.
13. Goods:-
14. Drawings:-
It refers to the withdrawals of money or money’s worth (goods) by the proprietor from his
business for his personal use.
Journal entry means particular transactions are to be split into two parts, Example:- Debit and
credit. Debit and Credit based upon the accounting rules.
16. Ledger:-
A ledger refers to a summary statement of all the transaction to a person, asset, expense or
income which have taken place during a given period of time and show their net effect.
17. Invoice:-
While making a sale, seller prepares a statement giving the particulars such as quantity, price
per unit, the total amount payable, any deductions made and shows the net amount payable
by the buyer. This type of statement is called as invoice.
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Goodwill is an accounting concept meaning the value of an entity over and above the value of
its assets. The term was originally used in accounting to express the intangible but
quantifiable "Prudent Value" of an ongoing business beyond its assets, resulting perhaps
from the reputation the firm enjoyed with its clients.
19. Employees:-
Employees are the backbone of the organisation. They are interested in the earning capacity
of a concern because their salaries, bonus, and pension schemes are dependent on the size of
the profit earned.
20. Debenture:-
A debenture the term is used for a Medium – to – Long term debt instrument used by large
companies to borrow money. In some countries the term is used interchangeably with Bond,
Loan Stock or Note. Debentures are generally freely transferable by the debenture holder.
Debenture holders have no rights to vote in the company's general meetings of shareholders,
but they may have separate meetings or votes e.g. On changes to the rights attached to the
debentures. The interest paid to them is a charge against profit in the company's financial
statements.
21. Inventory:-
Inventory is primarily about specifying the shape and percentage of stocked goods. It is
required at different locations within a facility or within many locations of a supply network
to proceed the regular and planned course of production and stock of materials. Management
of the inventories, with the primary objective of determining/controlling stock levels within
the physical distribution function to balance the need for product availability against the need
for minimizing stock holding and handling costs.
22. Owners:-
The owners of a business could contribute capital to be used for the purpose of starting and
running the business. The ultimate aim of accounting is to provide necessary information to
the owners relating to their Business. They want to evaluate the past financial performance
and also assess the future prospects through the accounting reports.
Any Investor, before making investments in any particular company shares, wants to know
about not only the earning capacity of the organisation but also its solvency position. For this
purpose, investors take information from accounting repots to a great extent and determine
the relative merits of the available investments opportunities.
24. Government:-
Government is the entire authority for the country’s economic development. For the purpose
of finding out overall economic growth point of view, the government is very much
interested in accounting statements and repots in order to see the financial position of a
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particular unit. With the help of the accounting information, government is not only type
prepare national account but also to impose tax and excise duty.
26. Managers:-
The foremost responsibility of the managers of the organisation is to obtain maximum return
over the capital invested without causing any harm to the interest of the share holders. The
managers would like to have a data regarding sales, expenses, assets, liabilities, etc. relating
to next year and also the flow of fund for the purpose of the activities of a business. He also
making a decision and alters the decision in best way. In all these aspects, relevant
accounting information is needed.
FINANCIAL
ACCOUNTING
BRANCHES OF COST
ACCOUNTING ACCOUNTING
MANAGEMENT
ACCOUNTING
1. Financial Accounting:-
Ultimate object of accounting is to measure the profit or loss of the concern and to ascertain
the financial position of the business. Thus Profit & Loss Account is prepared for a particular
period to determine the profitability of the concern and balance sheet is prepared on a
particular date to determine the financial position of the concern.
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2. Cost Accounting:-
Cost accounting is the process of ascertaining cost from the point at which expenditure is
incurred or committed to the establishment of its ultimate relationship with the cost centers
and cost units.
3. Management Accounting:-
The term Management Accounting refers to accounting for the management. Accounting,
which provides necessary information to the management for taking and implementing
important decisions.
Management accounting covers various areas such as Cost accounting, budgetary control,
inventory control, etc. This has been discussed in detail in the subsequent pages.
ACCOUNTING CONCEPT
According to this concept, the firm is separated from the owner of the business
whenever the firm is bon. Then, it is necessary to records the business transactions
separately to distinguish it from the owner’s personal transactions.
In this concept, It is assumed transactions are recoded hoping that the business
concern is to exist even in the future. A firm is said to be a going concern when there
is neither the intention nor the necessity to wind up its operations.
4) Cost Concept:-
According to this concept (a) as asset is ordinarily entered in the accounting records
as the price paid to acquire it and (b) this concept is the basis for a subsequent
accounting for the asset.
This is the basis concept of accounting. According to this concept every business
transaction has two aspects. (a) Debit (b) Credit.
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The tem “Accounting Equation” is also used to denote the relationship of equities to
assets. The equation can be technically stated as, “For every Debit there is an
equivalent Credit”. Entire system of double entry book keeping on this concept.
A business life is assumed to continue indefinitely. According to this concept, the life
of the divided into appropriate intervals for studying results shown by the business
and the financial position after interval. Suppose it would not happen within the
stipulated time means, necessary corrective steps cannot be initiated. In accounting
such a segment or time interval is called “Accounting Period”. It is usually of one
year and at the end of this period, income statement and balance sheet are prepared.
7) Realization Concept:-
According to this concept income made by the business during a period can be
measured only when the revenue earned during a period is compared with expenditure
incurred for earning that revenue. It is based on the accounting.
The first and foremost objective of financial Accounting is to recoded business transactions
which are maintained systematically with the help of journal and ledger and also to prepare
Final accounts. With the help of these facilities it is easy to know the operating results and
financial position of the organisation.
2) Managerial Functions:-
Business disputes are unavoidable. If there is any dispute properly maintained accounts are
often treated as good evidence in the court to settle a dispute. Auditing is compulsory in case
of registered firms.
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4) Language of Business:-
Investors, Employees, creditors, Government etc. are interested in knowing the operational
results of the firm and it can be communicated to them only though accounting.
5) Replacement Of Memory:-
Now –a – days large number of business transaction are carried out, and it is very difficult for
a businessman to remember all the transactions. With the help of financial accounting, which
provides records which will furnish information as and when needed and thus it human
replaces human memory.
6) Comparative Study:-
Financial Accounting provides necessary steps for comparative study of various aspects of
the business such as Profit, Sales, Liabilities, Loans, Fixed Assets etc. With that of previous
year and helps the business to make changes if any.
7) Sale of Business:-
The circumstances arises when the businessman wants to sell his business means, he wants to
determine the total value of his business with the help of systematic recoding of financial
data.
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CLASSIFICATION
OF ACCOUNTS
PERSONAL
ACCOUNT
IMPERSONAL
ACCOUNT
Natural
ArtificialPerson’s Represenative
Person’s
Accounts Accounts
Accounts
Nominal
Real Accounts
Accounts
1. PERSONAL ACCOUNTS
Personal accounts are those which are related to persons. A separate account is
prepared for each person, because the firm deals its transactions with a number of
persons. Such accounts can take following forms:
2. IMPERONAL ACCOUNTS
1. Real Accounts or Property Accounts. Real Accounts are those accounts whish can be
related to a property, an asset o possession Ex;- Plant Account, Machinery Accounts,
Building Accounts, Cash Accounts.
2. Nominal Accounts :- Nominal Accounts are those which are related to the business
expenses or loses and income or gains. E.g. Wages Account , Salary Account
Accounting Cycle
Recording Journal
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Classifying Ledger
1) Recording:-
2) Classifying:-
Classifying the transaction in the journal by positing them to the appropriate ledger
accounts to find out at a glance the total effect of such a transactions in a particular
account.
3) Summarizing:-
Summarizing simply refers to consolidation of one year transactions with the help of
ledger Balances. Based upon these balances, Trial Balance, and final accounts are to
be prepared with a view to ascertaining profit or loss made during the particular
financial year.
Book Keeping:-
Book Keeping is the systematic regarding, classifying and summarizing the business
transaction in the book of accounts in accordance with the principles of accounting. In the
words of Carter “Book Keeping is the correctly recording in book of accounts all those
transaction that result in the transfer of money as Money’s worth.
Account
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2. JOURNAL
Under the single entry system, the principle of Double entry book keeping is not followed.
Normally, every transaction has a twofold aspects. But in the single entry system of
accounting only one aspect is recorded. So it is called incomplete method of book keeping.
Trial Balance, Trading Account, Profit and Loss account and Balance Sheet cannot be
prepared with the help of the single entry system. This system is mainly followed by those
organisation that have only limited number of transaction.
Double Entry system of book keeping refers to particular transactions which are entered in
two Aspects. It is Based on the dual aspects.
Meaning :-
Journal is a book of accounts in which all day to day business transactions are
recorded in a chronological order i.e. in the order of their occurrence. Transactions
when recorded in a Journal are known as entries. It is the book in which transactions
are recorded for the first time. Journal is also known as ‘Book of Original Record’ or
‘Book of Primary Entry’.
Format of Journal
Every page of Journal has the following format. It is a columnar book. Each column is
given a name written on its top. Format of journal is given below:
Journal
In the first line, the account which has to be debited is written and then the short form
of Debit i.e. Dr. is written against that account’s name in the extreme right of the
same column.
In the second line after leaving some space from the left of the entry in the first line,
the account which has to be credited is written starting with preposition ‘To’ Then in
the third line.
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Date Particulars Amount
2006 Rent A/c.............................. Dr XXX
April 1 To Cash A/c ..............................Cr XXX
1. Ledger Folio
The transaction entered in a Journal is posted to the various related accounts in the
‘ledger’ (which is explained in another lesson). In ledger-folio column we enter the
page-number where the account pertaining to the entry is opened and posting from the
Journal is made.
PROCESS OF JOURNALISING
First of all, the affected accounts of an accounting transaction are identified. For
example, if the transaction of “goods worth Rs.10000 are purchased for Cash”, then
‘Purchases’ A/c and ‘Cash’ A/c are the two affected accounts.
Next we determine the type of the affected accounts e.g. in the above case, ‘Purchases
A/c and Cash A/c are both asset accounts.
Then the rules of ‘debit’ and ‘credit’ are applied to the affected accounts. You are
aware of these rules. However, for the revision purposes, these are given below :
(a) Assets and Expenses Accounts are debited if there is an increase and credited if
there is decrease.
Illustration 1
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January 10 Goods sold for cash 40,000
January 15 Goods sold on credit to Gurmeet 30,000
January 18 Salaries paid. 12,000
January 20 Cash withdrawn for personal use 5,000
Illustration:-2
Illustration:-3
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3. LEDGER
All the accounts identified on the basis of transactions recorded in different journals/books
such as Cash Book, Purchase Book, Sales Book etc. will be opened and maintained in a
separate book called Ledger. So a ledger is a book of account; in which all types of accounts
relating to assets, liabilities, capital, expenses and revenues are maintained. It is a complete
set of accounts of a business enterprise.
Meaning:- Ledger is bound book with pages consecutively numbered. It may also
be a bundle of sheets.
Features of ledger
1. Ledger is an account book that contains various accounts to which various business
transactions of a business enterprise are posted.
2. It is a book of final entry because the transactions that are first entered in the journal
or special purpose Books are finally posted in the ledger. It is also called the Principal
Book of Accounts.
3. In the ledger all types of accounts relating to assets, liabilities, capital, revenue and
expenses are maintained.
5. It is the ‘reference book of accounting system and is used to classify and summaries
transactions to facilitate the preparation of financial statements.
Title of an Account
Dr Cr
Importance of Ledger
Ledger is an important book of Account. It contains all the accounts in which all the
business transactions of a business enterprise are classified.
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1. Knowledge of Business results
Ledger provides detailed information about revenues and expenses at one place.
While finding out business results the revenue and expenses are matched with
each other.
Ledger records every asset separately. Hence, you can get the information about
the Book value of any asset whenever you need.
The information given in different ledger accounts will help the management in
preparing budgets. It also helps the management in keeping the check on the
performance of business it is managing.
Ledger provides information about assets and liabilities of the business. From this
we can judge the financial position and health of the business.
5. Instant Information
The business always need to know what it owes to others and what the others owe
to it. The ledger accounts provide this information at a glance through the account
receivables and payables.
Types of Ledger
1. Assets Ledger :
2. Liabilities Ledger :
3. Revenue Ledger :
It contains the revenue accounts e.g.. Sales account, Commission earned account,
Rent received account, interest received account, etc.
4. Expenses Ledger :
It contains the various accounts of expenses incurred, e.g. Wages account, Rent paid
account, Electricity charges account, etc.
5. Debtors Ledger :
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4.THE TRIAL BALANCE
It contains the accounts of the individual trade debtors of the business. Individuals,
firms and institutions to whom goods and services are sold on credit by business
become the ‘Trade Debtors’ of the business.
6. Creditors Ledger :
It contains the accounts of the individual trade Creditors of the business. Individuals,
firms and institutions from whom a business purchases goods and services on credit
are called ‘trade creditors’ of the business.
7. General Ledger :
It contains all those accounts which are not covered under any of the above types of
ledger. For example Landlord A/c, Prepaid insurance A/c etc.
Illustration 1
Journalize the following transactions and post them in the ledger
January 1 Commenced business with cash 50000
January 3 Paid into bank 25000
January 5 Purchased furniture for cash 5000
January 8 Purchased goods and paid by cheque 15000
January 8 Paid for carriage 500
January 14 Purchased Goods from K. Murthy 35000
January 18 Cash Sales 32000
January 20 Sold Goods to Rajiv on credit 28000
January 25 Paid cash to K. Murthy in full settlement 34200
January 28 Cash received from Rajiv 20000
January 31 Paid Rent for the month 2000
January 31 Withdrew from bank for private use 2500
Whenever you attempt a question in arithmetic you try to verify whether your answer is
correct or not. If you attempt to solve any other type of problem you want to ensure that it has
been correctly solved. For this you try to find out some ways or means. Similarly an
accountant also wants to be sure that the ledger accounts he/she has prepared are correct in
respect of amount, side, balance, etc. To check the accuracy of posting in the ledger a
statement is prepared. This statement is called Trial Balance. According to this system every
debit of a transaction has corresponding credit for the same amount. A statement is prepared
containing these balances with two columns i.e. debit column containing debit balances and
credit column containing credit balances and the debit column total is compared with credit
column total. If the columnar totals are same it implies that ledger accounts are arithmetically
accurate.
MEANING:-
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To check the accuracy of posting in the ledger a statement is prepared with two columns i.e.
debit column and credit column which contain debit balances of accounts and credit balances
of accounts respectively. Total of the two columns are if equal, it means the ledger posting is
arithmetically correct. This statement is called Trial Balance.
Arithmetical accuracy in ledger posting means writing correct amount, in the correct account
and on its correct side while posting transactions from various original books of accounts,
such as Cash Book, Purchases Book, Sales Book, etc. It also means not only the correct
balance of ledger account but also the totals of the special purpose Books.
The ultimate objective of the accounting is to prepare financial statements i.e. Trading and
Profit and Loss Account, and Balance sheet of a business enterprise at the end of an
accounting year. These statements contain balances of various ledger accounts. As Trial
Balance contains balances of all ledger accounts, in financial statements the balances of
ledger accounts are carried from the Trial balance for proper analysis.
If total of two columns of the trial balance agrees it is a proof of arithmetical accuracy in the
ledger posting. However, if the totals of the two columns do not tally it indicates that there is
some mistake in the ledger accounts. This prompts the accountant to find out the errors.
Comparison of ledger account balances of one year with the corresponding balances with the
previous year helps the management taking some important decisions. This is possible by
using the Trial Balances of the two years.
While making financial statements adjustments regarding closing stock, prepaid expenses,
outstanding expenses etc are to be made. Trial balance helps in identifying the items
requiring adjustments in preparing the financial statements. Trial Balance is generally
prepared at the end of the year. However it can be prepared at any time during the accounting
year to check the accuracy of the posting.
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Trial Balance is not an account. It is only a list or schedule of balances of ledger accounts
including cash and bank balances. It is prepared on a particular date. The accounts having a
debit balance are entered in the debit amount column and credit balance accounts are entered
in the credit amount column. The totals of the two sides of the accounts may also be used to
prepare trial balance. The sum of each column should be equal. The standard format of a trial
balance is given below :
Formula:-
Debit Side = All Expenses, Assets, Stocks, Drawings, Purchase & Sales
Return
SPECIFICATIONS
INCOMES EXPENSES
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Bad Debts Recovered. Rent Paid.
Interest Received. Interest Paid.
Interest On Investment Received. Oil, Water, Gas, Electricity Charges and
Appearance Premium Received. Paid.
Rent Received on Sub Letting. Drawings.
Rent from Tenants. Office Salaries.
Income from any other sources. Telephone Charges.
Miscellaneous Revenue Receipt. Legal Charges.
Salary Method. Audit Fees.
General Expenses.
Discount Allowed or Paid.
Selling and Distribution Expenses.
Carriage Inwards.
Carriage Outwards.
Freight on Purchases.
Customs Duty.
Advertisement Expenses Paid.
Interest on Bank Loan.
Interest on Capital.
Discount on Bills.
Loss of Fire Expenses.
Manager’s remuneration.
Insurance.
ASSETS LIABILITIES
Current Assets:-
Capital.
Cash in Hand. Reserve Fund.
Cash at Bank. Debenture.
Sundry Debtors. Bank Loan.
Bills Receivable. Mortgage Expenses.
Closing Stock. Sundry Creditors.
Short term Investments. Bills Payable.
Marketable Investments. Bank Overdraft.
Accrued Incomes. Outstanding Expenses.
Deposits.
Fixed Assets:- Incomes received in Advance.
Expenses Due but not Paid.
Land & Buildings. Proposed Dividend.
Machinery. Provision for Taxation.
Furniture & Fittings.
Loose Tools and Spares.
Investments.
Motor Van.
Intangible Assets:-
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Goodwill.
Patents Rights.
Trade Mark.
Other Assets:-
Preliminary Expenses.
Prepaid Expenses.
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5. THE FINANCIAL STATEMENTS OF SOLE TRADERS
Illustration 1
Particulars Debit Credit
Production Equipments 185000
Shop Fittings 29000
Motor vehicles 45000
Office Equipments 29500
Stock 18500
Trade Debtors 126000
Bank Balance 112500
Trade Creditors 48000
Sundry Payable 22600
VAT Tax 24800
Corporation Tax 21800
Bank Loan – Current 12000
Current Liabilities 9500
Bank Loan – Long 24000
Long Liabilities 7500
Share Capital 100
Profit and Loss prior years 227900
Sales – Shop 200000
Sales – Trade 550000
Ingredients Purchase 300000
Oven Fuel 60000
Wages 192500
Rent 17000
Light and Heat 1500
Repairs 3000
Phone 1950
Post 1800
Stationary etc 4200
Advertising 8000
Motor Running Cost 2900
Professional fee 6400
Bank Interest 850
Depreciation 2600
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One of the most important purposes of accounting is to ascertain financial results, i.e.,
profit or loss of the business operations of a business enterprise after a certain period and the
financial position of it on a particular date. For this certain financial statements are prepared
which are termed as income statement (i.e. Trading and Profit & Loss Account) to know what
Financial statements are the statements that are prepared at the end of the accounting
period, which is generally one year. These include income statement i.e. Trading and
Profit & Loss Account and Position statement i.e. Balance Sheet.
the business has earned during a particular period and the Position Statement (i.e. Balance
Sheet) to know the financial position of the business enterprise on a particular date.
Meaning:-
Financial statements are prepared to ascertain the profits earned or losses incurred by a
business concern during a specified period and also to ascertain its financial position at the
end of that specified period.
Financial statements are generally of two types (a) Income statement which comprises of
Trading Account and Profit & Loss Account, and (b) Position Statement i.e., the Balance
Sheet.
Every businessman wants to know the results of the business operations of his enterprise
during a particular period in terms of profits earned or losses incurred. Income statement
serves this purpose.
Financial statements show the financial position of the business concern on a particular date
which is generally the last date of the accounting period. Position statement i.e. Balance
Sheet is prepared for this purpose.
3) Source of information
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4) Helps in managerial decision making
The Manager can make comparative study of the profitability of the concern by comparing
the results of the current year with the results of the previous years and make his/her
managerial decisions accordingly.
Financial statements also show the short term as well as long term solvency of the concern.
This helps the business enterprise in borrowing money from bank and other financial
institutions and/or buying goods on credit.
SOLE PROPRIETORSHIP
When the ownership and management of business are in control of one individual, It is
known as Sole proprietorship or Sole Tradership. It is seen everywhere, in every country,
every state, every locality.
Characteristics:
1. Easy Formation
2. Batter Control
3. Prompt Decision Making
4. Flexibility in operation
5. Retention of Business Secretes.
6. Direct Motivation
7. Personal Attention to consumer needs.
8. Creation of Employment
9. Social Benefits
10. Equitable Distribution of wealth.
1. Unlimited Liability.
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2. Limited Financial Resources.
3. Individual
4. Limited capacity of uncertainty duration.
TRADING ACCOUNT
A business firm either purchases goods from others and sells them or manufactures and sells
them to earn profit. This is known as trading activities. A statement is prepared to know the
results in terms of profit or loss of these activities. This statement is called Trading Account.
Trading Account is prepared to ascertain the results of the trading activities of the business
enterprise. It shows whether the selling of goods purchased or manufactured has earned profit
or incurred loss for the business unit. Cost of goods sold is subtracted from the net sales of
the business of that accounting year. In case the total sales value exceeds the cost of goods
sold, the difference is called Gross Profit.
A business enterprise either purchases goods or manufactures goods to sell in the market.
Cost of goods sold is computed to know the profit earned (Gross Profit) or loss incurred
(Gross Loss) from the trading activities of a business unit for a particular period.
Cost of goods sold = The amount of goods purchased + Expenses incurred in bringing the
goods to the place of sale or expenses incurred on manufacturing the goods (called direct
expenses).
Cost of goods sold = Opening stock + Net purchases + All direct expenses
–
Closing stock
1. Stock:-
Stock refers to the goods lying unsold on a particular date. It can be of two types:
2. Purchases:-
Purchases mean total items purchased for sale during the year after. It can be both in
cash and on credit. Purchases are shown on the debit side of the Trading account.
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3. Sales:-
Sales refer to the total revenue from sale of goods of the business enterprise for which
the Trading account is being prepared. It includes both cash sales and credit sales.
4. Direct Expenses:-
Direct expenses are the expenses that can be attributed directly to the purchase of
goods or goods manufactured. These are shown on the debit side of the Trading
Account. For example, wages, customs and import duty, packing materials, gas,
electricity water, fuel, oil, gas grease, heating and lighting, factory rent and insurance
and many more such items.
It is the excess of net sales revenue over cost of goods sold. Gross Profit is equal to
net sales minus cost of goods sold. If total of the credit side exceeds the total of debit
side, the excess amount is termed as ‘gross profit’ and is shown on the debit side of
Trading Account. On the other hand if debit side is more than the credit side, the
difference in amount is called gross loss and is shown on the credit side of the Trading
Account.
These may be conveniently divided into office and administrative expenses, selling
and distribution expenses, financial expenses, depreciation and maintenance charges
etc. Similarly, there can be income from sources other than sales revenue. These may
be interest on investments, discount received from creditors, commission received,
etc. Another account is prepared in which all indirect expenses and revenues from
sources other than sales are written.
The profit shown by this account is called ‘Net profit’ and if it shows loss it is known
as ‘Net loss’.
As stated earlier Indirect expense are written on the debit side of Profit and Loss A/c.
These can be classified under the following heads :
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DEBIT ITEMS
To materialize sales, the expenses incurred are called selling and distribution
expenses.
Ex:-,
Carriage on sales/carriage outwards, advertisement, selling expenses, travelling
expenses and salesman commission, depreciation of delivery van, salary of driver of
the delivery van, etc.
These are the expenses incurred on establishment and maintenance of office. Some of
the expenses that may be under this head are: rent, rates and taxes, postage, printing
and stationery, insurance, legal charges, audit fees, office salaries, etc.
3. Financial expenses
Finances are to be arranged for business. Expenses that are incurred in this connection
are called financial expenses. Some of the financial expenses are: interest on loan,
interest on capital, discount on bills, etc.
The total value of a fixed asset like machinery, building, furniture, etc. is not charged
to profit and loss account in the year in which it is purchased. Such assets help
running business for a number of years to come. Therefore, only a part of the value of
such assets is treated as an expense and is charged to Profit and Loss A/c as
depreciation. Depreciation means decline in the value of fixed asset due to wear and
tear, lapse of time, obsolescence, etc. Expense incurred on repairs and renewals and
maintenance of assets are expenses other than depreciation under this category.
5. Other expenses
These are the expenses which are not included under the above mentioned heads of
expenses for example, losses and expenses due to fire, theft etc.
CREDIT ITEMS
Interest on Investment, Fixed Deposits etc. Rent Received, Commission Received, Discount
Received, Dividend on shares.
Need of preparing profit and loss account by a business concern may be stated as follows :
1) Knowledge of the net profit or net loss of a business for an accounting year.
2) Net profit of one year can be compared with net profits of previous year or years. It
helps in ascertaining whether the business is being conducted efficiently or not.
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3) Different expenses which are taken to Profit & Loss A/c in one year can be compared
with the amounts incurred in previous year or years. This helps in ascertaining the
need of applying control over such expenses.
BALANCE SHEET
Apart from Trading Account and Profit and Loss Account, Balance
Sheet
is another financial statement that is prepared by the every business firm. Balance
Sheet is a statement prepared on a particular date, generally at the end of accounting
year to ascertain the financial position of the entity. It consists of assets on the one
hand and liabilities on the other. Financial position of a business is the list of assets
owned by the business and the claims of various parties against these assets. The
statement prepared to show the financial position is termed as Balance Sheet.
Assets and Liabilities are of various types. These can be classified as under:
ASSETS
These are the assets that are purchased for permanent i.e. long term use and these help
the business to earn revenue. Examples of such assets are Building, Machinery, Motor
Vehicle, etc. These assets are not for sale in ordinary course of business but can be
disposed off, if no more needed for business use.
These are the assets which are acquired by the business either for resale or for
converting them into cash. These are normally realized within a period of one year.
Examples of such assets are : cash in hand, cash at bank, bills receivable, debtors,
stock etc.
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(c) Tangible Assets
These are the assets that can be seen, touched and have certain volume. Building,
Machinery, goods etc. are tangible assets.
Assets which can neither be seen or touched and have no volume are called intangible
assets. Patents, trademark, goodwill etc are the examples of such assets.
These are the assets which exhaust or reduce in value by their use. Mines, Quarries etc
come under this category.
These are not the real assets. These are the items of such expenses and losses which
have not been written off in full. For example, preliminary expenses, under writing
commission, etc.
(g) Liquid Assets
These are the assets which are either in cash or can be easily converted into cash. For
example cash, stock, marketable securities etc.
LIABILITIES
Liabilities can be classified as follows :
These are the liabilities which are not payable during the current accounting year.
Generally, the funds raised through such means are used for purchase of fixed assets.
Examples of such liabilities are loan on mortgage, loan from financial institutions.
These are the liabilities which are payable during the current year. These include
Bank overdraft, trade creditors, bill payable etc.
The amount owing to the proprietor or proprietors is called owners’ funds. As per
business entity concept this is a liability of the business. Apart from capital it also
includes undistributed profits and reserves. Amount of drawings by the proprietor is
deducted from it.
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