MBA 1ST SEM

UNIT-2
FINAL ACCOUNT

1. Trading Account

Trading account is the first stage in the preparation of the final accounts. Trading account is
prepared to know the gross profit or gross loss incurred during the accounting period. Debit
sides are opening side, purchases and other direct expenses and on credit side includes
sales and closing stock is recorded. Trading account prepared by traders. Gross profit or
gross loss transferred to profit and loss account.

Sales – (purchases and direct expenses) = gross profit

(Purchases and direct expenses) - Sales = gross Loss

Advantages of Preparing Trading Account

a) By preparing the Trading account entities can take the decision for continuing or
discontinuing a particular product. It helps to earn the maximum profit or reduce the
losses.
b) With the help of a trading account, Sales tax authorities can easily see the correct
purchases and correct sales as per the sales tax return submitted by a business firm.
c) It also helps the Excise authorities to assess the excise duties of business firms.
d) The management decides the price of the product with the help of a trading account,
after keeping in mind the market competition.

Trading Account contains the following details:

e) Opening stock details of raw material, semi-finished goods and finished goods.
f) Closing stock details of raw material, semi-finished goods, and finished goods.
g) Total purchases of goods less Purchase Returns.
h) Total sales of goods less Sales Returns.
i) All direct expenses related to purchases or sales or manufacturing of goods.

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Gross profit equation

Gross Profit = Net Sales – Cost of Goods Sold

Where, Net Sales = Total Sales – Sales Return
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses – Closing
Stock
Net Purchases = Total Purchases – Purchases Return

2. Profit and Loss Account:

Profit and loss account shows the net profit and net loss of the business for the accounting
period. This account is prepared in order to determine the net profit or net loss that occurs
during an accounting period of a business. P/L account has two sides the left hand side is the
debit side that consist indirect expenses and right hand side is the credit side that consist
indirect income. If

Credit side > debit side = Net profit

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Debit side > Credit side = Net loss

Profit and loss account starts by entering the gross loss on debit side or gross profit on the
credit side. Profit and loss account prepared after the Trading account. The net profit or net
loss of P/L account transferred to capital account (Balance sheet).

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Basis of Trading Account Profit and Loss Account
Comparison

Meaning Trading account used to find the Profit and loss account or Income
gross profit/loss of the business for statement is used to find the net
an accounting period. profit/loss of the business for an
accounting period.

Timing Trading Account is prepared first Profit/Loss Account is prepared

and then profit and loss account is after the trading account is
prepared. prepared.

Purpose For knowing the gross profit or For knowing the net profit or net
gross loss of a business loss of a business

Stage It is the first stage in the creation it is the second stage in the
of the final account. creation of the final account.

Dependency It is not dependent on trial balance It is dependent on trading

account

Transfer The balance in the form of Gross The balance in the form of Net
of Balance loss or Gross Profit of the trading loss or Net Profit of the profit and
account will be transferred to the loss account will be transferred to
Profit and Loss Account the Balance Sheet

3. BALANCE SHEET:

It has two sides’ left hand side (liabilities) and right hand side (assets). It is not an account It is
a statement. ‘To’ and ‘By’ should not be used in the Balance Sheet. The left hand side
contains the credit balances of all personal accounts while right hand side contains debit

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balances of real and personal accounts. The two sides of the Balance Sheet must always
agree. Balance sheet is prepared to show the financial position of the company at a particular
point in time. This information is importance for all concerned parties i.e, investors and
creditors use it to evaluate the capital structure, liquidity and solvency position of the
business. On the basis of such evaluation, they anticipate the future performance of the
company in terms of profitability and cash flows and make much important economic
decisions.

Balance sheets are arranged according to this equation:

Assets = Liabilities + Shareholders’ Equity

The equation above includes three broad buckets, or categories, of value which must be
accounted for:

1. Assets:

An asset is anything a company owns which holds some amount of quantifiable value,
meaning that it could be liquidated and turned to cash. They are the goods and resources
owned by the company.

Assets are classified into current assets and noncurrent assets.

 Current assets are typically what a company expects to convert into cash within a year’s
time, such as cash and cash equivalents, prepaid expenses, inventory, marketable
securities, and accounts receivable.
Current Assets:
o Cash and cash equivalents
o Short-term marketable securities/ bank deposits
o Accounts receivable
o Sundry debtors
o Inventory
o Other current assets
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 Noncurrent assets are long-term investments that a company does not convert into cash
in the short term, such as land, equipment, patents, trademarks, and intellectual property.
on current assets are also called as fixed assets.
Noncurrent Assets:
o Long-term marketable securities
o Property
o Goodwill
o Intangible assets
o Land & building, Plant & machinery, furniture & fixture etc.
2. Liabilities:
A liability is anything a company or organization owes to a debtor. This may refer to payroll
expenses, rent and utility payments, debt payments, money owed to suppliers, taxes, or
bonds payable.

Liabilities are classified as,

 Current liabilities
 Noncurrent liabilities.

 Current liabilities are typically those due within one year, which include accounts payable
and other accrued expenses.
Current Liabilities:
o Accounts payable
o Accrued expenses
o Deferred revenue
o Short term loans
o Outstanding expenses
o Sundry creditors

 Noncurrent liabilities are typically those that a company doesn’t expect to repay within
one year. They are usually long-term obligations, such as leases, bonds payable, or loans.

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 Noncurrent Liabilities:
o Deferred revenue (noncurrent)
o Long-term lease obligations
o Long-term debt/bank loan
o Other noncurrent liabilities
3. Shareholders’ Equity (Capital):
Shareholders’ equity refers generally to the net worth of a company, and reflects the amount
of money that would be left over if all assets were sold and liabilities paid. Shareholders’
equity belongs to the shareholders or owners. Assets must equal liabilities plus shareholders’
equity, Shareholders’ Equity (Capital) = Assets – Liabilities,
Assets= Equity (Capital) + Liabilities
It includes the followings,
 Common stock (Equity share)
 Preferred stock (Preference share)
 Treasury stock
 Retained earnings/ reserve and surplus

Functions of a Balance Sheet:

1. A Balance Sheet exhibits the true financial position of a firm at a particular date.
2. Financial position can be ascertained clearly with the help of Balance Sheet.
3. It provides valuable information to the management for taking better decision through ratio
analysis.
4. Balance Sheet helps in knowing past and present position of an enterprise. It may be called the
horoscope of the concern.
5. It is a mirror of a business.
Limitations of Balance Sheet:
1. It is prepared on a historical cost basis. Changes in prices are not considered.
2. Window-dressing may be done in Balance Sheet.
3. Historical Cost of Balance Sheet does not give fruitful information.
4. Different assets are valued according to different rules.
5. It cannot reflect the ability or skill of staff.

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6. It is measured in terms of money or money’s worth. That is, only those assets are recorded in it
which can be expressed in money.
7. In inflationary trend, if the readers are not expert may mislead.
8. Balance Sheet has some fictitious assets, which have no market value. Such items are unnec-
essarily inflate the total value of assets.

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