Financial

Accounting S – 2
Balance Sheet and Profit
& Loss Concepts
Balance Sheet
What does Balance Sheet represent?

“Financial Condition of a firm at a given date”

Also called as „Statement of Financial Condition‟ or „Statement of

Financial Position‟
Balance Sheet

It represents all assets owned by a company at a particular

point of time and the claims of the owners and outsiders at
that time.
Balance Sheet – Basic Concepts
 Business Entity Concept
 Going Concern Concept
 Monetary Unit Concept
 Cost Concept
 Conservatism Concept
 Accounting Concept
C#1 – Business Entity Concept
 Business Enterprise is considered as a separate „Legal
Entity‟
 It is distinct from its owners
 Profit or Losses belong to the Business Entity and
NOT to
the Owners
C#2 – Going Concern Concept
 The enterprise is normally viewed as a going concern, that
is, as continuing in operations for the forseeable future.
 It is assumed that the enterprise has neither the intention
nor the necessity of liquidation or of curtailing materially
the scale of its operations.
 In operations  till liquidation
C#3 – Monetary Unit Concept
 Results of operations have to be recorded in common units
of measurements
 The common economic value of the assets is expressed in
monetary terms, such as Rs. Or Dollars, rather than any
other physical dimension
C#4 – Cost Concept
 All transactions are recorded at their monetary cost of
acquisition i.e. price paid for acquiring the asset or for
receiving the services provided.
 So – If an asset does not cost anything it will not be
recorded in the books of account of the company.
 In conflict with „relevance concept‟
 But, Present Value changes always
 Cost of recording will be high
 Two aspects for Cost Concept
 Long term assets are depreciated
 Revaluation may be done after some years
C#5 – Conservatism Concept
 “Anticipate no profit, provide for all possible losses”
 Important impact on valuation of the inventory
 Cost or market, whichever is lower
 Conservatism Concept is being questioned today for not
representing true or fair financial position of the business
enterprise
C#6 – Accounting Equivalence
Concept
 Assets of the entity is equal to its Owners Equity and
Liabilities

 Assets = Owners Equity + Liabilities

 Accounting Equation

ASSETS = EQUITY + LIABILITIES

Fixed Assets Current Assets Share Capital Retained Long Term Current
Liabilities
Earnings Liabilities

Income - Expenses

Profit & Loss Account

Profit & Loss Statement
What does Profit & Loss
Account represent?

“Operations of the business and its profitability during a particular

period”

Represented as: Income statement for the year ended…

P&L
Account
 Two Broad Items: Revenues and Expenses
 Revenues
 Derived from operations – Sales Revenues
 Sources other than main operations – Other Income such as
interest earned etc.
 Expenses
 Related to the product – Manufacturing expenses
 Related to a period – Period costs ex. Selling, Admin, Salaries
etc
 Revenue less cost of goods sold (manufacturing expenses) is
defined as Gross Profit
 Gross Profit less period expenses including financing expenses
gives Profit Before Tax
 Profit before tax less income tax payable gives Profit After Tax
(PAT)
P&L Account – Basic
Concepts
 Accounting Period Concept

 Realization Concept
 Accrual Concept
 Matching Expenses with Revenue
C#1 – Accounting Period
Concept
 To prepare income statement  period for which the
statement is to be prepared is determined
 Normally it is One year
 Tax authorities reluctant for frequent changes in the
accounting periods
C#1.a – Accounting Time Cycle
Problem
 Not always the revenues for the period are received
during the same accounting period
 Cash received before the services are provided
 Deferred Revenues
 Services rendered but the payment is not received
 Accounts receivable
 Revenues are NOT same as cash
 It is very necessary to determine the Revenues during the
period as opposite to cash received.
C#1.b – Expenditure and Expenses
 Expenditure takes place when cash or other assets of a
business enterprise are used for acquisition of new assets,
goods or services or by incurring liability
 Expenditure is NEVER related to accounting period.
 Ex. Insurance policy of 3 years purchased for Rs 12,000
 Expenses represent the sacrifice made or the goods or
benefits received or assets consumed during the
accounting period
 Ex. In above case the expenses for one year are Rs 4,000
 Differentiation between Expenditure and Expenses is very
important
C#1.c – Possible Situations
 Expenditure during the accounting period which are also
expenses of that period
 No „Spillover‟
 Expenditure during the accounting period which will become
expenses only in the future periods.
 Cash or assets reduced  New asset created as „Prepaid Expenses‟
 Expenditure during the previous accounting period which will
become expenses during the current accounting period
 Prepaid Expenses or Assets are reduced from Balance Sheet and
they are consumed or used up during the current accounting
period
 Expenses of the current accounting period which have not yet
been paid i.e. for which no expenditure has been incurred
 Expense in the Income Statement  Deferred Expense liability on
Balance Sheet
C#2 – Realization Concept
 Point of time when the revenues are earned.
 Revenues are earned only when goods are transferred or
services are delivered.
 Legal principle relating to „Transfer of property‟
 Independent of Order received or Cash Paid.
 Order received in April, Goods Delivered in May, Money
received in June
C#3 – Accrual
Concept
 Change in owners equity during the accounting period
gives the „Profits‟ earned during the period
 Revenues  Increase in Owners Equity
 Expenses  Decrease in Owners Equity
C#4 – Matching Expenses with Revenue
 Realisation and Accrual concept are derived from the need
to match Expenses with Revenue earned.
 First determine the Revenue earned during the period
 Then, determine all the expenses incurred to earn the
those Revenues
 Expenses related to product are called as Product
Expenses
 Expenses related to a period are called as Period
Expenses
 They are expensed in the accounting period in which they
occur.
Questions