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4.introduction To Financial Statements

This document outlines key concepts for preparing financial statements, including: 1) It defines terms like purchases, accounts payable, trade discounts, cash discounts, purchase returns and allowances, sales of goods, accounts receivable, sales discounts, and sales returns and allowances. 2) It explains how to calculate values like net purchases, net sales, and cost of goods sold which are used in financial statements. 3) It describes the accounting cycle for traders and service providers, including adjusting entries, preparing a trial balance, and then the profit/loss statement and balance sheet. 4) It provides an example profit/loss account format for a service provider and outlines the basic components of a balance

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58 views17 pages

4.introduction To Financial Statements

This document outlines key concepts for preparing financial statements, including: 1) It defines terms like purchases, accounts payable, trade discounts, cash discounts, purchase returns and allowances, sales of goods, accounts receivable, sales discounts, and sales returns and allowances. 2) It explains how to calculate values like net purchases, net sales, and cost of goods sold which are used in financial statements. 3) It describes the accounting cycle for traders and service providers, including adjusting entries, preparing a trial balance, and then the profit/loss statement and balance sheet. 4) It provides an example profit/loss account format for a service provider and outlines the basic components of a balance

Uploaded by

Bhuvaneswari karuturi
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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KEY CONCEPTS IN PREPARATION OF FINANCIAL

STATEMENTS
 Before preparation of financial statements one needs to understand the key words, its meaning and
calculations of values.
 (A)Purchase of Goods: purchases are recorded in a purchase account, and only at the end of an accounting
period the purchase account’s balance will be added to the inventory beginning balance to determine the
cost of goods available for sales.
 Goods available for sale = Opening inventory (stocks) + Net purchase
 (B)Accounts Payable : It is also known as creditor. Accounts payable will be reported in the balance sheet
as current liabilities; it represents an obligation to pay the creditors.
 (C)Trade Discounts: These are discounts offered by sellers to encourage buyers to buy in bulk. For
recording purposes only the net price after trade discount is considered.

 (D) Cash discount / Purchase Discounts (Discount Received) :Goods purchased on credit must be paid
according to the term of purchase. The seller, in order to induce early settlement of debts, might offer cash
discounts. The seller might state different discount terms.
(E) Purchased discount: It(discount received) is recorded when payment is made to reflect the saving you made
by not paying the full amount. Purchase discount reduces the net purchases.
Net purchase = Purchases – Purchase discounts

(F) Purchase Returns and Allowance: Purchase returns refer to goods that are returned by purchaser to seller to
get full refunds. Goods are returned for several reasons: Defective Items received or Wrong specifications . This
refund can either be in the form of cash (if goods were purchased by cash) or a reduction in the amount to be
paid (if goods were purchased on credit).
Purchase returns are recorded by the following entry.
Debit Cash or account payables xx
Credit Purchase returns xx

Purchase allowances refer to the reduction in the cost of the goods purchased. Purchase returns and allowance
(also known as returns outwards) reduce the purchases.
Net purchases = Purchases – Purchase discounts – Purchase returns – Purchase allowances
(G) Sales of Goods: sales will record in a sales account. When a business sells its goods, the following entry is to
be made.
Debit Cash account /Receivables account xx
Credit Sales account xx

(H)Accounts receivables: It is also known as debtor. Just like credit purchase, in recording credit sales, the
individual or personal account receivable is to be debited. These individual accounts are known as debtor or sales
ledger. Account receivable will be reported as current assets in the balance sheet of the business.
(I) Sales Discounts (Discount Allowed): When business sold goods on credit to customers and to receive payment
from the customer earlier than the period of credit allowed. It is an expense to the business.

Net sales = Sales – Sales discounts


When a business receives payment from account receivables and allows any discounts, the following entry is to
be made
Debit Cash account xx
Debit Sales discount (Discount allowed) xx
Credit Account Receivables account xx
(J)Sales Returns and Allowance: Sales returns refer to goods returned to suppliers. Cash will be refunded
to customer if cash sales were involved, while a reduction in amount to be paid by customer will be made if credit
sales were involved.
Sales returns are recorded by the following entry.
Debit sales returns and allowances xx
Credit Cash / Account receivables xx

Sale returns reduce the sales amount. Net sales are obtained by deducting sales returns and allowance
from sales balance.
Net sales = Sales – Sales discounts - Sales returns and allowances

(K) Calculate Cost of Goods Sold: It is the cost associated with sales. cost of goods sold is determined at
the end of an accounting period.This information together with opening inventory balances, purchases,
purchases returns, inwards charges and others will be used to calculate the cost of goods sold.
PREPARING FINANCIAL STATEMENTS FOR SERVICE & TRADING
OPERATIONS
 The accounting cycle of a trader is similar to the one of a service provider. Before financial statements
are prepared, the adjustment entries need to be made. Under the periodic accounting system, as part
of closing entries ,trail balance is prepared. Trial Balance is a technique for checking the
accuracy of the debit and credit amounts recorded in the various ledger accounts. It is basically a
statement that exhibits the total of the debit and credit balances recorded in various accounts of
ledger.
 Then profit or loss account (income statement) and balance sheet (Statement of financial position)
will be prepared .
ACCOUNT FORMAT OF PROFIT OR LOSS ACCOUNT FOR SERVICE PROVIDERS

Using the sonic enterprises the profit or loss in account format is as


follows:
TRAIL BALANCE
BALANCE SHEET FORMAT
CASH FLOW STATEMENT

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