Lesson 7

Preparation of Final Accounts for Sole

Proprietors

LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction A sole trader is the sole owner and manager of
– Trading Account the business. At the end of a accounting year the
– Profit & Loss Account sole trader would like to know the financial results
– Main Principles for preparation of Trading and the financial position of his business. He
and Profit & Loss Account would be interested to know the profits or losses
– Difference between Trading and Profit & made by the business. For this purpose, he would
Loss Account prepare income statements i.e. trading and profit
– Review Questions and loss accounts. He would also be interested
– Balance Sheet to know the financial position of the business
– Classification of Assets which will be ascertained through the preparation
– Classification of Liabilities of balance sheet. Trading, profit and loss account
– Differences between Trading and Profit & and balance sheet together are called final
Loss Account accounts.
– Review Questions
After recording transactions of a business for an
– Differences between Trial Balance and
accounting period in subsidiary books, posting
Balance Sheet
in the ledger and testing their accuracy with the
– Adjustment Entries
help of a trial balance, the last stage in the
– Closing Entries
accounting process is the preparation of final
– Manufacturing Account
accounts. In this lesson, we will learn in detail
– Limitations of Financial Statements
about the preparation of final accounts for a sole
– Lesson Round Up trading firm.
– Glossary
– Self-Test Questions

You have to know accounting. Its the language of practical business life. It was a very useful thing to
deliver to civilization. I’ve heard it came to civilization through Venice which ofcourse was once the
great commercial power in the mediterrarean. However, double entry book keeping was a hell of an
invention.

Charlie Munger
142 FP-FA&A

INTRODUCTION
Final Accounts or Financial Statements are the end products of the financial accounting process which
involves the preparation of a summary of the accounts with a view to determine:
(i) net profit from the trading activities in terms of profit made or loss incurred for a given period, and
(ii) its financial position in terms of assets and liabilities as on the last date of the given period.
For the purpose of determining the profit or loss, a statement known as Trading and Profit and Loss Account
(Income Statement) is prepared which incorporates all items of expenses and losses and all incomes and
gains occurring during the accounting period.
In order to show the financial position on the last date of the accounting period, another statement known as
Balance Sheet (Position Statement) is prepared which consists of all assets, liabilities and capital of the
business. These two statements are collectively known as Final Accounts.
Final Accounts are prepared from the balances appearing in the trial balance. Debit balances of assets are
transferred on the right hand side of the balance sheet while expenses and losses are debited to the Trading
Account or to the Profit and Loss Account, depending upon the nature of expenditure or loss. Credit account
balances like capital, liabilities, provisions and reserves are entered on the left hand side of the balance sheet
while incomes and gains are credited to Trading Account or Profit and Loss Account.
TRADING ACCOUNT
Trading Account is the first part of income statement which
is prepared to ascertain the gross profit or gross loss for a Gross Profit = Net Sales – Cost of the
given accounting period. Goods Sold.
Trading Account is prepared before the preparation of Gross Loss = Cost of the Goods Sold –
profit & loss account. It shows the result of trading Sales
activities relating to purchases & sales of goods &
Net Sales = Total Sales – Sales Returns
services. Trading account is prepared to calculate
(Return Inwards)
separately the profit from sale & purchase transactions
only. The profit or loss is termed as gross profit or loss as Cost of goods sold = Opening stock of
various other expenses of an organsiation like goods + net purchases - closing stock of
administrative, selling & distribution, maintenance goods at the end + all direct expense
expenses etc. are not deduction. Only the direct expenses
Net Purchases = Total Purchase –
which are incurred to bring goods into saleable condition
Purchases Returns (Return Inwards)
like freight, insurance, carriage inwards, rent & rates, fuel,
power, royalties on production, consumption of stores etc.
are taken into account to calculate gross profit/loss.

SPECIMEN OF TRADING ACCOUNT

Dr. Trading Account for the year ended...... Cr.
Particulars ` Particulars `
To Opening Stock XXX By Sales XXX
To Purchases XXX Less: Return Inwards XXX
Less: Return Outwards XXX By Closing Stock XXX
To Direct Expenses XXX
To Gross Profit (Balancing XXX
Figure)
____ ____
XXX XXX

– In case debit side exceeds the credit side, the balance will be gross loss and that will be shown on the
credit side of Trading Account as “By Gross Loss”.
– In trading account, closing stock is shown at cost price or net realisable price market value whichever
is lower.
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 143
– While taking stock for the purpose of preparation of trading account, stock in hand on the last day of
the accounting year should be adjusted for purchases recorded but goods not yet received, goods sold
but not yet delivered and goods that may be out of business premises because of consignment, goods
delivered on sale or return basis, etc.
– Gross profit or gross loss revealed by Trading Account is transferred to Profit and Loss Account.
PROFIT AND LOSS ACCOUNT
Profit and Loss Account is prepared to calculate the net profit or loss of
the business for a given accounting period. The balance of Trading Net profit = Total Revenues –
Account i.e. gross profit/gross loss is transferred to the Profit and Loss Total Expenses
Account which is the starting point of the preparation of this account.
Thereafter, all those expenses and losses which have not been debited Net Loss = Total Expenses –
already to the Trading Account are debited to the Profit and Loss Total Revenues
Account. Other incomes and gains, if any, are credited to this account,
e.g. interest earned or commission received etc. The net profit, thus arrived, is transferred to Capital Account
of the proprietor/partners. Specimen of Profit & Loss Account is given on next page. Net profit increases the
capital whereas net loss decreases the capital.
MAIN PRINCIPLES FOR PREPARATION OF TRADING AND PROFIT & LOSS ACCOUNT
The following principles must be kept in mind while preparing Trading and Profit & Loss Account:
– Only revenue receipts i.e. sale proceeds and other incomes should be entered.
– Only revenue expenses together with losses should be taken into account.
– Profit or loss is determined by matching revenues and expenses according to the matching principle.
Application of Concept of Matching Principle
A fundamental principle which must be observed while preparing final accounts is that of `matching cost
and revenue’. It means that in final accounts, expenses and incomes for the full trading period whether
they have been paid or received or not, must be included and no expenditure or income which does not
pertain to the period for which final accounts are being prepared be included. The distinction between
capital and revenue items is also made on the basis of this principle.

DIFFERNCE BETWEEN TRADING AND ACCOUNT PROFIT & LOSS ACCOUNT

Trading Account Profit and Loss Account

(i) Trading account is prepared to calculate the (i) Profit and loss account is prepared to arrive
gross profit (loss) for a particular period. at the net profit (loss)
(ii) In trading account, cost of goods sold, sales (ii) In profit and loss account, indirect expenses,
and direct expenses are accounted. such as administrative expenses, selling
expenses, etc, are charged against the gross
(iii) The result of trading account i.e. gross profit profit and other revenues.
(loss) is transferred to profit and loss (iii) The balance in profit and loss account i.e. net
account. profit (loss) is transferred to capital account
which will be shown in the balance sheet.

SPECIMEN OF PROFIT & LOSS ACCOUNT

Profit & Loss Account for the year ended......
Dr. Cr.
Particulars ` Particulars `
To Gross Loss b/d XXX By Gross Profit b/d XXX
Management expenses: Other income:
To Salaries (administrative) XXX By Discount received XXX
To Office rent, rates and taxes XXX By Commission received XXX
To Printing and stationery XXX Non-trading income:
To Telephone charges XXX By Bank interest XXX
To Postage and telegrams XXX By Rent of property let-out XXX
144 FP-FA&A
To Insurance XXX By Dividend from shares XXX
To Audit fees XXX By Dividend from shares XXX
To Legal charges XXX Abnormal gains:
To Electricity charges XXX By Profit on sale of machinery XXX
Maintenance expenses: By Profit in sale of investment XXX
To Repairs and renewals XXX By Net Loss (transferred to Capital A/c)
To Depreciation on: (Balancing Figure) XXX
Office equipment XXX
Office furniture XXX
Office building XXX
Selling and distribution expenses:
To Salaries (selling staff) XXX
To Advertisement XXX
To Godown rent XXX
To Carriage outwards XXX
To Bad debts XXX
To Provision for bad debts XXX
To Selling commission XXX
Financial expenses:
To Bank charges XXX
To Interest on loans XXX
To Discount on bills XXX
To Discount allowed to customers XXX
Abnormal losses:
To Loss on sale of machinery XXX
To Loss on sale of investment XXX
To Loss by fire XXX
To Net Profit (transferred to Capital XXX
A/c) (Balancing Figure) ____ ____
XXX XXX

REVIEW QUESTIONS
Fill in the blanks:
(i) Trading account reveals __________ profit or _________ loss.
(ii) Profit and loss account reveals _________ profit or _________ loss.
(iii) Expenses appear on _________ side of trading and profit and loss
account.
(iv) Provision for bad debts account shows _________ balance.
(v) Reserve for discount on creditors account shows ________ balance.
(vi) Carriage inwards appears in ____________ account, whereas
carriage outwards appears in ___________ account.
Decide whether the following statements are true or false:
(i) Trade expenses account is transferred to trading account.
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 145
(ii) Capital account appears on assets side of balance sheet.
(iii) Drawing account is revenue expenditure to be shown on debit side of profit and loss account.
(iv) If trading account reveals gross loss, profit and loss account results in net profit in any case.
(v) Interest on capital and salary to proprietor are incomes and hence are shown on credit side of profit
and loss account.
Tick the correct answers:
(i) What type of account is goodwill? Fictitious/Intangible
(ii) What type of account is furniture? Fixed/Current
(iii) On which side of balance sheet is unexpired insurance shown? Assets/Liabilities
(iv) Which type of items appear in profit and loss account? Revenue/Capital/Both
(v) Is balance sheet an account or a statement? An Account/A Statement
(vi) Where will amount spent on stationery appear? In Profit and Loss Account/
In Balance Sheet.

BALANCE SHEET
Balance sheet is a statement which shows the financial position i.e. the balances of assets, liabilities and
capital, of a business entity at a given date. It is prepared from the real accounts and personal accounts of
trial balance. A debit balance in a real account or personal account represents an asset of the concern/firm.
Likewise a credit balance in a personal account represents a liability. There can be some newly opened
accounts as well on account of adjustment entries. These assets and liabilities are arranged in a proper way
and the resultant statement is the balance sheet. On the right hand side, assets are arranged while on the left
hand side, liabilities are recorded. The totals of the two sides of the balance sheet must agree because of the
equation, viz. Assets = Liabilities + Capital.
If there is a difference, it means that there is some mistake. The difference, if it does occur, should be placed
on the deficit side as Suspense Account to make the two sides agree apparently.
Features of Balance Sheet
– The primary objective of the preparation of balance sheet is to ascertain the financial position of a
concern.
– It shows (a) the nature and value of assets, (b) the nature and value of liabilities and (c) the position of
capital.
– Balance sheet is always prepared on a certain date, never for a particular period.
– Balance sheet, unlike a trading and profit and loss account, is not an account. It is a statement
containing information regarding assets, liabilities and capital.
Marshalling of Balance Sheet
The arrangement of assets and liabilities in accordance with a particular order is known as marshalling of
balance sheet. The items in the balance sheet are generally marshaled in two ways-
(i) Liquidity order or according to time: In liquidity order, the assets are stated in the order in which they
can be easily converted into cash and the liabilities in the order in which they have to be paid off.
(ii) Permanence order or according to purpose: In permanence order, assets which are to be used
permanently in the business and are not meant for sale are shown first and the assets that are liquid are
shown last in order. Similarly, liabilities may also be shown according to the permanence arrangement.
Specimen of Balance Sheet in permanence order is given below. The order will be reversed in liquidity
order.
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SPECIMEN OF BALANCE SHEET

Balance Sheet as at...

Liabilities ` Assets `
Capital XXX Goodwill XXX
Add : Net profit XXX Land and building XXX
Less : Drawings XXX XXX Plant and machinery XXX
Loans on mortgages XXX Furniture and fixtures XXX
Outstanding expenses XXX Stock XXX
Bank overdraft XXX Sundry debtors XXX
Sundry creditors XXX Investments XXX
Bills payable XXX Bills receivable XXX
Cash at bank XXX
____ Cash in hand XXX
XXXX XXXX
REVIEW QUESTIONS

1. Arrange the following assets in order of their liquidity:

Furniture, Goodwill, Stock in trade, Unexpired insurance, Cash in hand,
Trade debtors, Readily saleable investments, Cash at bank, Land,
Buildings, Machinery, Bills receivable.
2. Arrange the following liabilities in order of permanency:
Capital, Creditors for expenses, Sundry trade creditors, Loan, Bills
payable

CLASSIFICATION OF ASSETS
(i) Fixed Assets are those which are acquired for long use in the business itself and not for resale. For
example, plant and machinery, land and buildings, furniture and fixtures, patents and trade marks are
examples of fixed assets.
(ii) Current or Floating Assets are those that are meant to be converted into cash as soon as possible.
Stock of goods, amount due from customers to whom goods have been sold on credit and balance at
bank are examples of current (or floating) assets.
(iii) Liquid Assets are those current assets which are already in the form of cash or which can be readily
converted into cash, such as Government Securities.
(iv) Wasting Assets are those fixed assets which have a fixed content, like coal in a coal mine; the value of
the asset goes down as the contents are taken out. When the minerals have been taken ou totally,, the
mine will become useless.
(v) Intangible Assets are those fixed assets which cannot be seen or touched or felt. Goodwill (the value
of one’s name) is an intangible asset because there is no physical form to show it. Intangible assets
are not necessarily useless.
(vi) Fictitious Assets are valueless assets but shown as assets in the financial statements (such as
useless trade marks) or expenses treated as assets (such as expenses incurred to establish a
company i.e. preliminary expenses).

CLASSIFICATION OF LIABILITIES
(i) Fixed and Long-term Liabilities: Fixed liabilities are those liabilities which are payable on the
termination of the business such as capital of the proprietor, whereas long-term liabilities are those
which will be redeemed after a long period of time e.g. long-term loans.
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 147
(ii) Current liabilities: These are liabilities which have to be redeemed in the near future, usually within a
year. Trade creditors, bank loans, bills payable etc. are examples of current liabilities.
(iii) Contingent liabilities: These are not actual liabilities but their becoming actual liability depends on the
happening of certain events. If such events do not occur, no liability is incurred. Liability in respect of
pending suit is a contingent liability because it is only if and when suit is lost that the liability will be
incurred. Bills discounted with a bank are also a contingent liability because if the acceptor fails to
meet the bill on due date, the firm will become liable to the bank. Such liabilities are not shown in
balance sheet; usually a foot note is appended at the balance sheet for such liabilities.

REVIEW QUESTIONS
1. The following are the names of assets. Classify them: Leasehold
premises, Accounting machines, Coal mine, Goodwill, Stock of raw
materials, Motor vehicles, Cash in hand, Government securities, Copyright
of book (no longer in demand),Amount due from customers, Loose tools
and Cost of floating a company.
2. Classify the following assets into fixed, current and fictitious assets,
mentioning sub-types, also in the case of fixed assets: Land and buildings,
Furniture, Bills receivable, Cash in hand, Cash at bank, Plant and
machinery, Coal mine, Loose tools, Preliminary expenses, Stock in trade,
Amount due from customers, Copyright of a book no longer in demand,
Stone quarries, Livestock, Motor vehicles, Government bonds and
Goodwill of a firm incurring heavy losses.

DIFFERNCE BETWEEN TRIAL BALANCE AND BALANCE SHEET

Trial balance Balance sheet

1. It is a statement of debit balances and credit 1. It is a statement of assets and liabilities
balances taken from the ledger.

2. It is prepared to test the arithmetical accuracy of 2. It is prepared to ascertain the financial position of
books of account. the organization on a particular date.

3. Balances of all types of accounts i.e. personal, 3. Balances of real and personal accounts only are
real, and nominal accounts are shown. shown.

4. It is usually prepared at the end of each month, 4. It is usually prepared at the end of the year after
three months, six months or at the end of the preparation of trading and profit and loss
accounting year before the preparation of trading account.
and profit and loss account.

5. Closing stock does not appear in the trial 5. Closing stock is shown on the assets side of the
balance. balance sheet.

6. It is prepared for internal use. 6. It is prepared for external use, i.e. for outside
parties such as, creditors, shareholders (in case
of companies), government authorities, etc.
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DIFFERNCE BETWEEN PROFIT & LOSS ACCOUNT AND BALANCE SHEET

Profit & Loss Account Balance sheet

1. Profit and loss account is an account 1. Balance sheet is a statement of assets and
liabilities.
2. Profit and loss account shows the profits earned 2. Balance sheet shows financial position of the
or losses incurred for the accounting period business.

3. Profit and loss account is prepared for the 3. Balance sheet is prepared as at the last day of
accounting period the accounting period.

4. The accounts that are transferred to the profit 4. The accounts which are transferred to the
and loss account are closed and cease to exist. balance sheet do not lose their identity and
become the opening balances in the next
accounting period

ADJUSTMENT ENTRIES
Usually, final accounts are prepared from the balances given in the trial balance. However, at times some
account balances in the trial balance do not reflect the correct ‘amount’ when considered in relation to
accounting period. For example, payment on account of expense, say, rent, may be less or more than the
actual payment that ought to have been made during the accounting period. Similar situation may arise in
respect of some revenue items also, say interest on investments.
In order to ensure that the final accounts disclose the true trading results and correct balances, it is necessary
that all expenses incurred whether paid or not and the whole amount of loss sustained whether ascertained or
estimated should be taken into consideration. Similarly, incomes and gains whether actually received or not
during the accounting period should be accounted for. All this requires adjustment entries which are used to
establish correct values of account balances at the end of an accounting period. Thus, adjustment entries are
those entries which are passed at the end of each accounting period for the purpose of adjusting various
nominal and other accounts so that true net profit or loss is indicated in profit and loss account and the
balance sheet represents a true and fair view of the financial condition of an enterprise.
The following are the usual adjustment entries which are made while preparing the final accounts.
(I) CLOSING STOCK
The unsold stock at the end of the accounting period is termed as closing stock. There can be two entries for
closing stock.
When this entry is passed he closing stock at the end appears in
(a) Closing Stock Account Dr. trading account and on the asset side of balance sheet. It becomes the
To Trading Account opening stock for the next year.

(b) Stock Account Dr. In this case, closing stock will appear in the trial balance, it means that
To Purchases Account double entry has been completed in the accounting period itself by
reducing the purchases. Therefore it will appear as asset in the
balance sheet only.
(II) ACCRUED OR OUTSTANDING EXPENSES
Expenses which have been incurred during the year and whose benefit has been derived during the year but
payment in respect of which has not been made are called outstanding or accrued expenses. At the end of
the year, all such expenses must be brought into books, otherwise, the profit will be overstated and liability
will be understated. The following journal entry is passed:

Expense Account Dr.


To Outstanding/Accrued Expense Account
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 149
 – The outstanding expenses are shown on the debit side of the trading account or profit and loss
account, as the case may be, by way of addition to the respective expenses.
– These are also shown on the liabilities side of balance sheet.
– In the beginning of the next year, a reverse entry will be passed.
EXAMPLE 1:
Salary for March, 2011 ` 1,000 has not been paid. The adjustment entry will be:
` `
Salary Account Dr. 1,000
To Outstanding Salary Account 1,000
The entry will increase the balance in salary account by ` 1,000 which will be transferred to profit and
loss account. Outstanding salary account is a liability which will appear in balance sheet.

(III) UNEXPIRED OR PREPAID EXPENSES

Those expenses which have been paid in advance and whose benefit will be available in future are called
unexpired or prepaid expenses e.g. insurance premium, rent, etc., paid in advance. An adjustment entry is
made whereby the unexpired amount is credited to the appropriate expense account and debited to prepaid
(unexpired) account as under:

Prepaid Expense Account Dr.

To Expense Account

– The amount of prepaid expenses is shown in the profit and loss account by way of deduction from the
concerned expenses.
– These are also shown as an asset in the balance sheet.
– In the beginning of the next year, a reverse entry will be passed to cancel the effect of adjusting entry.
EXAMPLE 2:
Fire insurance premium of ` 2,000, paid for the year ending 30th June 2011. On 31st March, 2011
insurance policy has run only for 9 months and hence only 3/4th of the premium can be said to
pertain to 2010-11: 1/4th of the premium amount, i.e. ` 500 will be treated as an asset. Entry will be:
` `
Unexpired Insurance Premium Dr. 500
To Insurance Premium Account 500
Unexpired insurance premium will appear as an asset in the balance sheet and insurance premium
account will be reduced by ` 500.
(IV) ACCRUED OR OUTSTANDING INCOME
Accrued income means income which has been earned by the business during the accounting year but which
has not become due and hence has not been received. But outstanding income means any income which has
become due during the accounting year but has not been so far received by the firm. Though there is a
distinction between the two, for adjustment entry no such distinction is necessary, both the accrued income
and outstanding income are added to the given income figure in the trial balance. The following entry is
passed:

Accrued /Outstanding Income Account Dr.

To Income Account
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– The amount of income is transferred to the credit side of profit and loss account as an addition to the
respective income account.
– The accrued/outstanding income account also appears as an asset in the balance sheet.
– In the beginning of next year, a reverse entry will be passed.
EXAMPLE 3: Interest earned but not yet received, ` 650. The entry will be:
` `
Interest Accrued Account Dr. 650
To Interest Account 650
Interest accrued account will appear as an asset in balance sheet and the amount of interest
account to appear on the credit side of profit and loss account will increase by ` 650.
(V) UNEARNED INCOME OR INCOME RECEIVED IN ADVANCE
That portion of the revenue which remains received in advance (unearned) at the end of the accounting
period is known as unearned income or income received in advance. For example, subscription received in
advance by a club, insurance premiums received in advance by the insurance company, rent received in
advance, etc. Any income in advance is not actually earned and it rather creates an obligation to return this
amount. The following adjustment entry is made at the end of the accounting year;

Income Account Dr.

To Income Received in Advance Account

– This item is shown on the credit side of the profit and loss account by way of deduction from the
income.
– It is also shown in the balance sheet on the liabilities side as ‘Income received in advance’.
EXAMPLE 4: Rent for April, 2011 ` 3,000 received in advance
` `
Rent Received Account Dr. 3,000
To Rent Received in Advance Account 3,000

The balance of rent received account appearing on the credit side of profit and loss account will
diminish by ` 3,000 and rent received in advance account will appear on liabilities side of balance
sheet because service for this rent is to be rendered in the year to come.

(VI) DEPRECIATION
Depreciation is the reduction in the value of fixed assets due to its use, wear and tear or obsolescence. When
an asset is used for earning purpose, it is necessary that reduction due to its use must be charged to the
profit for the year in order to show correct value in the balance sheet. The following journal entry is passed for
charging depreciation:

Depreciation Account Dr.

To Fixed Asset Account

– The amount of depreciation is debited to the profit and loss account.

– Again it is shown on the assets side of the balance sheet by way of deduction from the concerned
asset.
When depreciation is given in the trial balance, it means that the asset(s) has(ve) been credited with the
amount of depreciation and the necessary debit to depreciation account has been made. The only entry then
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 151
would be to transfer the depreciation account to profit and loss account and no adjustment entry would be
needed.
Note: There are various methods of providing depreciation, but in questions on final accounts, it is most likely
asked to be calculated at a fixed percentage on opening balance of the assets. If there are additions,
depreciation is provided only for that part of the year for which the new asset has been used.
EXAMPLE 5: If furniture stood at ` 1,00,000 on 1st April, 2010 and additional furniture was
purchased for `15,000 on 1st October, 2010, total depreciation @5% per annum would
amount to ` 5,375 calculated as under:
`
Depreciation on 1,00,000 @ 5% for full year 5,000
Depreciation on Rs. 15,000 @ 5% for 6 months i.e., from
1st October, 2010 to 31st March, 2011 375
` 15,000 x 5 x 6
10 x 12 _____
Total 5,375

Entry will be:

` `
Depreciation Account Dr. 5,375
To Furniture Account 5,375
Depreciation account will appear on the debit side of profit and loss account and the book
value of furniture will be reduced by ` 5,375 in the balance sheet.

WHEN PROVISION FOR DEPRECIATION ACCOUNT IS MAINTAINED:

Depreciation Account Dr.

To Provision for Depreciation Account
Profit and Loss Account Dr.
To Depreciation Account
(VII) BAD DEBTS
Debts which cannot be recovered or become irrecoverable are called bad debts. It is a loss to the business
and is brought into account by debiting bad debts account and crediting debtors’ accounts who are not able to
pay the amount. The adjustment entry is as follows:

Bad Debts Account Dr.

To Sundry Debtors Account

– The bad debts account is debited to profit and loss account.

– The debtors balance is reduced by the same amount in the balance sheet.
– When the amount of bad debts is given in the trial balance itself no adjusting entry is required. It
should only be transferred to profit and loss account.
(VIII) PROVISION FOR BAD DEBTS
A firm may make provision at the end of the accounting year for likely bad debts which may happen during the
course of the next year. This is for the simple reason that if out of credit sales made during a particular year,
152 FP-FA&A
some sales are likely to become bad in the course of the next year, the proper course would be to charge in
the same accounting year with such likely bad debts in which the sales have been made. The following
journal entry is passed for creating provision for bad debts:

Profit and Loss Account Dr.

To Provision for Bad Debts Account

– The provision for bad debts is charged to profit and loss account.
– It is also deducted from debtors in the balance sheet.
– Provision for bad debts created out of profit of the current year should be carried forward to the next
period. Bad debts occurring during that period would be debited to bad debts account as usual, but
total debits given to this account should be transferred to provision for bad debts account. At the end
of the next year suitable adjustment entry is passed for keeping the provision for bad debts at an
appropriate amount to be carried forward.
– Sometimes the balance brought down from the previous year is so large that even after debiting the
current year’s bad debts and leaving the desired balance at the end of the year, a surplus is left. This
surplus is transferred to the credit side of profit and loss account.
EXAMPLE 6: If debts of 2010-11, prove to be bad in 2011-12 the loss is to be treated as one
for 2010-11. But on 31st March, 2011 when final accounts are be prepared, it will not be
possible to know accurately, which debts will prove bad in 2011-12. Hence, only an estimate
is made on the basis of past experience. If it is estimated that 6% of the debts may prove bad
and on 31st March, 2011 debtors amount to ` 40,000, then `2,400 will be provided for future
bad debts. The entry is:
` `
Profit and Loss Account Dr. 2,400
To Provision for Bad Debts Account 2,400
It will reduce the profit for 2010-11 by `2,400. Provision for bad debts will appear in the
balance sheet as a deduction from sundry debtors on assets side although it is a separate
account showing credit balance.
In the next year, the actual amount of bad debts will be debited to provision for bad debts
account which will then stand reduced. On 31st March, 2012 the amount of the provision will
be brought up by an appropriate debit to profit and loss account depending on the amount of
sundry debtors as at that date.
(IX) PROVISION FOR DISCOUNT ON DEBTORS
This is a charge made against profits in order to provide for an expected loss in the form of discounts which
are likely to be allowed to the debtors, for encouraging them to make prompt payments. In order to
incorporate such provision for discount on debtors, the following journal entry is passed:

Profit and Loss Account Dr.

To Provision for Discount on Debtors Account

– This provision is shown on the debit side of the profit and loss account.
– It is also shown in the balance sheet by way of deduction from sundry debtors.
Note: Provision for discount is always calculated on the amount of debtors left after deducting the provision
for bad debts i.e. provision should be calculated on good debts. It is because no discount will be allowed on
amounts which are not recovered and hence no provision for discount on such amount is required.
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 153
For example, if 2% discount is allowed, debtors are of ` 10,000 and 5% provision for bad debts is required
then provision for discount will be made @2% on ` 9,500, i.e., on ` 10,000 less 5% for provision for bad debts
amounting to ` 500.
(X) RESERVE FOR DISCOUNT ON CREDITORS
A firm may like to create reserve for discount on its creditors to record discounts expected to be received from
them. The adjustment entry for this purpose is as follows:

Reserve for Discount on Creditors Account Dr.

To Profit and Loss Account

– The reserve for discount on creditors account is credited to the profit and loss account.
– It should also be deducted from the sundry creditors in the balance sheet. Keeping with the principle of
conservatism the provision for discount on creditors is often not made in actual practice.
(XI) INTEREST ON CAPITAL
It is a normal practice to charge business with interest on the capital employed in the business. The purpose
is to know whether the profits of the business are more than what could be earned from simple investments
outside business. Interest charged is an expense to the business but it is a gain to proprietor. The following
adjustment entries are passed:
(i) Interest on Capital Account Dr.
To Capital Account
(ii) Profit and Loss Account Dr.
To Interest on Capital Account
– Interest on capital is debited to the profit and loss account and
– It is shown on the liabilities side of the balance sheet by way of addition to the capital.
(XII) INTEREST ON DRAWINGS
As business allows interest on capital, it also charges interest on drawings made by the proprietor. This is a
gain to the business and an expense for the proprietor. The following adjustment entries are made:
(i) Capital Account Dr.
To Interest on Drawings Account
(ii) Interest on Drawings Account Dr.
To Profit and Loss Account
– It is credited to the profit and loss account and
– Shown on the liabilities side of the balance sheet by way of deduction from capital.
(XIII) ACCIDENTAL LOSS OF AN ASSET
When asset is not insured:
Sometimes the assets of the organization may be destroyed due to earthquake, fire or accidents. The firm
has to bear the entire loss if such assets are not insured. The following entries are passed to make
adjustments for such losses:
(a) When loss is incurred due to accident
Accidental Loss Account Dr.
To Asset Account
154 FP-FA&A
(b) When loss is transferred to profit and loss account
Profit and Loss Account Dr.
To Accidental Loss Account
When asset is insured:

When the asset destroyed by accident is insured, then the firm will not have to bear the entire loss. The
insurance company will pay certain amount on loss of the asset. The amount of loss will be reduced to the
extent of amount recoverable from the insurance company. The difference in the book value of asset on the
date of accident and the amount of claim admitted by the insurance company is the loss suffered by the
company. This loss will be transferred to the profit and loss account.

On admission of claim:
Insurance Company Dr.
To Asset Account
On receipt of money claimed:
Bank Dr.
To Insurance Company
On transfer of loss:
Profit and Loss Account Dr.
To Asset Account

(XIV) ACCIDENTAL LOSS OF STOCK

Sometimes, stock in trade is lost due to fire or theft. If the firm has insured the stock, then loss can be made
good fully or partly by the insurance company. The following adjustment entries are made:
(a) If the stock is fully insured, the whole loss is fully recoverable from the insurance company. The journal
entry is:
Insurance Company Account Dr.
To Trading Account
Insurance company account is shown on the credit side of the trading account and in the balance
sheet it is treated as an asset until the amount is received.
(b) If the stock is not fully insured, the loss of stock covered by the insurance policy will be claimed from
the insurance company and the rest will be treated as loss. The journal entry in this case is:
Insurance Company Account Dr.
Profit and Loss Account Dr.
To Trading Account
(c) If the stock is not insured, nothing is recoverable from insurance company and the whole loss will be
born by the firm. The journal entry is:
Profit and Loss Account Dr.
To Trading Account
Thus in all cases, trading account is credited with the gross amount of stock lost.
(XV) MANAGER’S COMMISSION ON NET PROFITS
Sometimes, the manager of a business may be given a commission based on a fixed percentage of the net
profits of the business. There are two methods for the calculation of such commission. The adjustment entry
for such commission payable is as follows:
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 155
Profit and Loss Account Dr.
To Commission Payable Account
– The commission payable is shown on the debit side of the profit and loss account and on the liabilities
side of the balance sheet.
Calculation of Commission: It can be calculated in following two ways.
(a) Commission as a percentage of net profits before charging such commission
Manager’s commission = Profit before commission x Rate of commission
100
(b) Commission as percentage of net profits after charging such commission
Manager’s commission = Profit before commission x Rate of commission
100 + Rate of commission
(XVI) GOODS DISTRIBUTED AS FREE SAMPLES
Sometimes, in order to promote the sale of goods, some of the produced goods are distributed as free samples. It
may be treated like an expenditure on advertisement and the following adjustment entry is passed:
Free Samples/Advertisement Account Dr.
To Trading/Purchases Account
– It is shown on the credit side of the trading account or deducted from the purchases and
– It is also shown on the debit side of profit and loss account as free samples or advertisement expense.
(XVII) DRAWINGS OF GOODS BY THE PROPRIETOR FOR PERSONAL USE
If goods have been withdrawn by the proprietor for personal use and no entry has been passed during the
year, the following adjustment entry should be passed:
Drawings Account Dr.
To Purchases Account/ Trading Account
– Goods are deducted from the purchases on the debit side of the trading account or shown on the
credit side of trading account and
– They are included in proprietor’s drawings which are ultimately deducted from the capital shown on the
liabilities side of the balance sheet.
(XVIII) DEFERRED REVENUE EXPENDITURE
The expenditure which is incurred in one year but the benefit of which is available in subsequent years also is
called deferred revenue expenditure. Part of such expenditure is written off in each year and the rest is
capitalized. The adjustment entry to write off this expenditure is as follows:
Profit and Loss Account Dr.
To Expense (Respective) Account
The written off amount is debited to profit and loss account and shown as a deduction from the capitalized
expense in the balance sheet.
(XIX) GOODS ON SALE ON APPROVAL BASIS
Sometimes goods are sold to customers on approval basis. If consent is not received during the accounting
period, it cannot be treated as sale. In such case, the following adjustment entries are passed:
(i) Sales Account Dr.
To Debtors Account (with sale price)
(ii) Stock Account Dr.
To Trading Account (at cost price)
156 FP-FA&A
Thus, this item is shown on the credit side of trading account by way of deduction from the sales at sale price
and added to the closing stock at cost price. At the same time it is shown on the asset side as a deduction
from sundry debtors at sale price and added to the closing stock at cost price.

(XX) GOODS RECEIVED BUT NOT RECORDED IN BOOKS

Often, goods may have been received but invoice has not been received or omitted to be recorded. In such a
case, the following adjustment entry should be passed.
Purchases Account Dr.
To Creditors Account
This item is shown as addition to the purchases in the trading account and added to sundry creditors on the
liabilities side of the balance sheet.

(XXI) SALARY TO PROPRIETOR

If the proprietor charges salary for the work done by him, proprietor’s salary account is debited and capital
account is credited. If there are a number of proprietors called the partners, and salary is charged by them,
salary to partners account will be debited and the respective capital accounts will be credited with the
respective amounts of salary charged by them.

(XXII) RESERVE FUND

Reserve fund is created out of the Profit and Loss Account as appropriation of net profit for strengthening the
financial position of the business.
Profit and Loss Account Dr.
To Reserve Fund A/c
 Reserve fund is shown on the debit side of Profit and Loss Account and
 It is shown on the liabilities side of the Balance Sheet.

(XXIII) CASH DISCOUNT

Cash discount is allowed and received for prompt payment. When cash discount is allowed, a less amount is
accepted as a full payment of a debt. Similarly when cash discount is received, a less amount is paid in full
discharge of a liability. Discount allowed is debited to discount allowed account, cash received is debited to
cash account and the total amount is credited to debtor making the payment. Discount received is credited to
discount received account, cash paid is credited to cash account and the total of the two is debited to the
creditor to whom the payment is made.

(XXIV) TRADE DISCOUNT

Trade discount is a deduction from the list (or catalogue) price allowed by the manufacturers to the
wholesalers or by the wholesalers to the retailers for various reasons. The rate of trade discount allowed
varies considerably. From accounting point of view no entries are made either in seller’s books or in the
purchaser’s books for such discount. Entries for purchases and sales are made at net price i.e. after
deducting trade discount from the list price.
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 157
DIFFERNCE BETWEEN CASH DISCOUNT AND TRADE DISCOUNT

Cash Discount Trade Discount

(i) It is a reduction granted by a supplier from (i) It is a reduction granted by a supplier

the invoice price in consideration of from the list price of goods or services
immediate or prompt payment. on business consideration.
(ii) It is allowed to encourage the prompt (ii) It is allowed to promote sales.
payment.
(iii) It is not shown in the invoice (iii) It is shown by way of deduction in the
invoice itself.
(iv) Cash discount account is opened in the (iv) Trade discount account is not opened
ledger. in the ledger.
(v) It is allowed on payment of money (v) It is allowed on purchase of goods

(vi) It may vary with the time period within (vi) It may vary with the quantity of goods
which payment is received purchased or amount of purchases
made.

MAIN PRINCIPLES FOR PREPARATION OF FINAL ACCOUNTS:

The list of adjustment entries given above is not exhaustive. The student may analyse each transaction
and pass necessary journal entries for adjustments considering following principles:
(i) The items given in the trial balance will appear in only one of the statements i.e. the Trading
Account, the Profit and Loss Account or the Balance Sheet.
(ii) The amount in respect of adjustments will appear in two of the above mentioned
statements, normally in the Balance Sheet and in the Trading Account or in the Profit and Loss
Account.
The reason being that for items appearing in the trial balance, the double entry has already been
completed but in respect of adjustments, the double entry has yet to be completed, hence two accounts
will be affected.

CLOSING ENTRIES
In order to prepare final accounts, all nominal accounts have to be transferred to Trading and Profit and Loss
Account. It is done by passing journal entries which are called closing entries as they close the nominal
accounts. The entry to transfer the balance of profit and loss account itself is also one of the closing entries.
Some of the closing entries are given below:

(i) Trading Account Dr.

To Stock
To Purchases
To Sale Returns
To Carriage Inwards
(Transfer of various accounts to Trading Account)
(ii) Sales Account Dr.
Purchase Returns Dr.
158 FP-FA&A
Closing Stock Dr.
To Trading Account
(Transfer of sales account and purchases returns
account to trading account and recording of closing
stock)
(iii) Trading Account Dr.
To Profit and Loss A/c
(Transfer of gross profit from trading account to profit and
loss account)
(iv) Profit and Loss Account Dr.
To Rent
To Salaries

To Sundry Expenses
To Depreciation
(Transfer of various nominal accounts to profit and loss
account)
(v) Interest Received Dr.
To Profit and Loss A/c
(Transfer of credit balance of interest received account
to profit and loss account)
(v) Profit and Loss Account Dr.
To Capital Account
(Transfer of net profit to capital account)

MANUFACTURING ACCOUNT
A manufacturing concern may like to ascertain the cost of goods during the accounting period and may prepare
Manufacturing Account for this purpose. Trading Account is not capable of showing the cost of goods
manufactured because it deals with stock of finished goods also and because some of the expenses connected
with manufacture of goods (such as depreciation and repairs of machinery and factory) are debited to the Profit
and Loss Account. Manufacturing Account is debited with all expenses incurred in the factory on production of
goods. This means that depreciation and repairs to plant and machinery and factory building, salary to works
manager, etc. are also debited to this account. The total of such expenses plus cost of raw material used gives
cost of goods manufactured during the period. This is transferred to Trading Account which deals with stock of
finished goods and sales also. The remaining nominal accounts appear in Profit and Loss Account.
In fact, there is no prescribed format for the presentation of Manufacturing Account. However, a format
covering various elements is given below. The Trading Account and Profit and Loss Account should be
prepared in the same way as discussed earlier.
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 159

SPECIMEN OF MANUFACTURING ACCOUNT

Manufacturing Account for the year ended......
Dr. Cr.
Particulars ` Particulars `
To Work in progress (opening) XXX By Work in progress (closing) XXX
To Raw material consumed: By Sale of scrap XXX
Opening stock XXX By Cost of production of
Add: Purchases XXX finished goods transferred to
Trading Account
Less: Closing stock XXX XXX
To Direct wages XXX
To Direct expenses XXX
To Factory expenses:
Factory rent XXX
Plant repairs XXX
Indirect wages XXX
Depreciation on factory building XXX
____ ____
XXX XXX

LIMITATIONS OF FINANCIAL STATEMENTS

Financial statements are the result of the accounting process which begins with recording of transactions.
Accounting process involves recording, classifying and summarizing business transactions. Financial
statements are the result of the third process viz. summarizing. The financial statements are based on certain
accounting concepts and conventions which cannot be said to be foolproof.
The following are the limitations of the financial statements:
(i) Financial statements are essentially interim reports and therefore, cannot be final because the final
gain or loss can be computed only at the termination of the business. Financial statements only reflect
the progress and position of the business at frequent intervals during its life.
(ii) Financial statements though expressed in exact monetary terms, are not absolutely final and accurate.
As the balance sheet is prepared on the basis of the going concern concept, asset valuation
represents neither the realizable value nor replacement costs. Further, they depend on the judgment
of the management in respect of various accounting policies.
(iii) The values ascribed to the assets presented in the statements depend upon the standards of the persons
dealing with them. For instance, the method of depreciation, mode of amortization of fixed assets, treatment
of deferred revenue expenditure, all depend on the personal judgment of the accountant.
(iv) Financial statements take into consideration only the financial factors. They fail to bring out the
significance of non-financial factors which may have considerable bearing on the operating results and
financial conditions of an enterprise. For example, public image of the enterprise, the caliber of its
management, efficiency and loyalty of its workers etc.
(v) It is not always possible to discover false figures in financial statements. Unscrupulous managements
generally resort to ‘window dressing’ in the preparation of such statements.
(vi) Financial statements are prepared primarily for shareholders. Other interested parties have to
generally make many adjustments before they use them profitably.
160 FP-FA&A
(vii) Quite often, financial statements do not disclose current worth of the business. Only historical facts are
presented and the true current worth is not reflected.
(viii) Owing to the fact that financial statements are compiled on the basis of historical costs, while there is a
marked decline in the value of the monetary unit and resultant rise in prices, the balance sheet loses
its function as an index on current economic realities. Again, the financial statements contain both
historical and current costs items, hence figures are distorted.

ILLUSTRATIONS
Illustration 1:
A business house maintains provision of 5% against bad debts and 3% for discount on debtors and a reserve
for discount on creditors at 2%. On 1st April, 2009 it had the following balances:
Provision for Bad and Doubtful Debts ... ` 5,000
Provision for Discount on Debtors ... ` 2,850
Provision for Discount on Creditors ... ` 4,800
During the year 2009-10, bad debts, discount allowed to debtors and discount received from creditors
amounted to ` 3,950, ` 8,800 and ` 9,840 respectively while for 2010-11 they amounted to ` 1,800, ` 7,000
and ` 6,800 respectively. Sundry Debtors were ` 1,20,000 on March 31, 2010 and ` 80,000 on March 31,
2011. Sundry Creditors on these two dates were ` 2,10,000 and ` 1,95,000 respectively.
Show provision for bad debts account, provision for discount on debtors account and reserve for discount on
creditors account along with relevant portions of profit and loss account.
Solution:
Provision for Bad Debts Account

Dr. Cr.
Date Particulars ` Date Particulars `
2010 2009
March 31 To Bad Debts 3,950 April 1 By Balance b/fd 5,000
March 31 To Balance c/d 6,000
2010
March 31 By Profit & Loss A/c
(Balancing Figure) 4,950
9,950 9,950
2011 2010
March 31 To Bad Debts 1,800 April 1 By Balance b/d 6,000
March 31 By Profit & Loss A/c
(Balancing Figure) 200
March 31 To Balance c/d 4,000

6,000 6,000

2011
April 1 By Balance b/d 4,000
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 161
Provision for Discount on Debtors A/c
Dr. Cr.
Date Particulars ` Date Particulars `
2010 2009
March 31 To Discount Allowed 8,800 April 1 By Balance b/fd 2,850
March 31 To Balance c/d 3,420 2010
March 31 By Profit & Loss A/c
(Balancing Figure) 9,370
12,220 12,220
2011 2010
March 31 To Discount Allowed 7,000 April 1 By Balance b/d 3,420
March 31 To Balance c/d 2,280 2011
March 31 By Profit & Loss A/c
(Balancing Figure) 5,860
9,280 9,280
2011
April 1 By Balance b/d 2,280

Reserve for Discount on Creditors A/c

Dr. Cr.
Date Particulars ` Date Particulars `
2009 2010
April 1 To Balance b/fd 4,800 March 31 By Discount
Received 9,840
2010 To Profit & Loss A/c March 31 By Balance c/d 4,200
March 31 (Balancing Figure) 9,240
14,040 14,040
2010 2011
April 1 To Balance b/d 4,200 March 31 By Discount
Received 6,800
2011 March 31 By Balance c/d
March 31 To Profit & Loss A/c 3,900
(Balancing Figure) 6,500
10,700 10,700
2011
April 1 To Balance b/d 3,900
162 FP-FA&A
Profit and Loss Account for the year ended 31st March, 2010
Dr. Cr.
Particulars ` ` Particulars ` `
To Bad Debts: 3,950 By Discount Received 9,840
Add: New Provision Add: New Reserve for
for Bad and Doubtful Discount on Creditors 4,200
Debts 6,000 14,040
9,950 Less: Old Reserve 4,800 9,240
Less: Old Provision 5,000 4,950
To Discount Allowed 8,800
Add: New Provision
for Discount 3,420
12,220
Less: Old Provision 2,850 9,370

Profit and Loss Account for the year ended 31st March, 2011
Dr. Cr.
Particulars ` ` Particulars ` `
To Discount Allowed 7,000 By Old Provision for
Add: New Provision 2,280 bad and doubtful
for Discount 9,280 debts 6,000
Less: Old Provision 3,420 5,860 Less: Bad Debts 1,800
Less: New Provision 4,200 200
By Discount Received 4,000
Add: New Reserve for 6,800
Discount on Creditors 3,900
10,700
Less: Old Reserve 4,200 6,500

Illustration 2:
Following is the trial balance of Amar as on 31st March, 2011:
` `
Capital Account 80,000
Drawing Account 6,000
Stock (1.4.2010) 45,000
Purchases 2,60,000
Sales 3,10,000
Furniture 10,000
Sundry Debtors 40,000
Freight and Octroi 4,600
Trade Expenses 500
Salaries 5,500
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 163
Rent 2,400
Advertising Expenses 5,000
Insurance Premium 400
Commission 1,300
Discount 200
Bad Debts 1,600
Provision for Bad Debts 900
Creditors 20,000
Cash in hand 5,200
Bank 5,800
Goodwill (at cost) 20,000 _______
4,12,200 4,12,200
Adjustments:
(a) Stock on 31st March, 2011 was valued at ` 53,000.
(b) Salaries have been paid only for 11 months.
(c) Unexpired insurance included in the figure of ` 400 appearing in trial balance is ` 100.
(d) Commission earned but not yet received amounting to ` 122 is to be recorded in books of account.
(e) Provision for bad debts is to be brought upto 3% of sundry debtors.
(f) Manager is to be allowed a commission of 10% of net profits after charging such commission.
(g) Furniture is depreciated @10% per annum.
(h) Only 1/4th of advertising expenses is to be written off.
Prepare trading and profit and loss account for the year ended 31st March, 2011 and balance sheet as on
that date. Also show adjustments entries and closing entries.
Solution:
Mr. Amar
Trading and Profit and Loss Account
for the year ended 31st March, 2011

Dr. Cr.
Particulars ` ` Particulars ` `
To Stock (1.4.2010) 45,000 By Sales 3,10,000
To Purchases 2,60,000 By Closing Stock 53,000
To Freight & Octroi 4,600
To Gross Profit
transferred to P&L a/c 53,400
3,63,000 3,63,000
To Trade Expenses 500 By Gross Profit
To Depreciation 1,000 transferred from
trading A/c 53,400
To Salaries 5,500 Commission 1,300
Add: Outstanding 500 6,000 Add: Commission
To Rent 2,400 earned but not
To Advertising received 122 1,422
Expenses 5,000
Less: Amount C/f 3,750 1,250
164 FP-FA&A
Particulars ` ` Particulars ` `
To Insurance Premium 400
Less: Unexpired
Insurance 100 300
To Discount 200
To Provision for Bad
Debts @3% on `
40,000 1,200
Add: Bad Debts 1,600
Less: Old provision 900 1,900
To Commission
payable to Manager 3,752
To Net Profit
transferred to Capital
Account 37,520
54,822 54,822

st
Balance Sheet as on 31 March, 2011

Liabilities ` ` Assets ` `
Capital Fixed Assets:
Opening Balance 80,000 Goodwill 20,000
Add: Net profit 37,520 Furniture 10,000
Less: Drawings 6,000 1,11,520 Less: Depreciation 1,000 9,000
Creditors 20,000 Current Assets:
Outstanding Salary 500 Unexpired Insurance 100
Commission Payable Unexpired advertising
to Managers 3,752 expenses 3,750
Commission earned
but not received 122
Stock 53,000
Sundry Debtors 40,000
Less: Provision for bad
debts 1,200 38,800
Cash at bank 5,800
Cash in hand 5,200
1,35,722 1,35,722
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 165
Journal Book
Adjustment Entries
Particulars ` `
Stock Account Dr. 53,000
To Trading Account 53,000
(Being closing stock credited to trading account)
Salaries Account Dr. 500
To Salaries Outstanding Account 500
(Being the amount of salaries outstanding on 31st March,
2011)
Unexpired Insurance Dr. 100
To Insurance Premium Account 100
(Being the amount of unexpired insurance premium as on 31st
March, 2011)
Commission Earned But not Received Account Dr. 122
To Commission Account 122
(Being the amount of commission earned but not received till
31st March, 2011)
Bad Debts Account Dr. 1,600
To Provision for Bad Debts Account 1,600
(Transfer of bad debts to provision for bad debts)
Profit and Loss Account Dr. 1,900
To Provision for Bad Debts Account 1,900
(Being credit given to provision for bad debts to make its
balance 3% of ` 40,000)
Profit and Loss Account Dr. 3,752
To Commission Payable to Manager 3,752
(Being commission payable to manager @10% of net profits
remaining after charging such commission)
Depreciation Account Dr. 1,000
To Furniture Account 1,000
(Being the amount of depreciation provided on furniture
@10% per annum)
Unexpired Advertising Expenses Account Dr. 3,750
To Advertising Expenses Account 3,750
(For advertising expenses carried forward to next year)
166 FP-FA&A
Closing Entries:
Particulars ` `
Trading Account Dr. 3,09,600
To Stock Account (1.4.2010) 45,000
To Purchases Account 2,60,000
To Freight & Octroi Account 4,600
(Transfer of various nominal accounts showing debit balances
to trading account)
Sales Account Dr. 3,10,000
To Trading Account 3,10,000
(Transfer of sales account to trading account)
Note: Entry for closing stock has already been passed by way
of adjustment
Trading Account Dr. 53,400
To Profit and Loss Account 53,400
(Transfer of gross profit from trading account to profit and loss
Account)
Profit and Loss Account Dr. 11,650
To Trade Expenses Account 500
To Salaries Account 6,000
To Rent Account 2,400
To Advertising Expenses Account 1,250
To Insurance Premium Account 300
To Discount Account 200
To Depreciation Account 1,000
(Transfer of various nominal accounts showing debit balances
to profit and loss account)
Commission Account Dr. 1,422
To Profit and Loss Account 1,422
(Transfer of credit balance in commission account to profit and
loss Account)
Profit and Loss Account Dr. 37,520
To Capital Account 37,520
(Transfer of net profit to capital account)
Note: Profit and Loss Account has already been debited in respect of provision for bad debts and commission
payable to manager. Refer to adjustments entries.
Illustration 3:
Following are the balances in the ledger of Mr. Patel for the year ended 31st March, 2011:
`
Stock (1.4.2010):
Raw materials 1,00,000
Semi-finished goods 50,000
Finished goods 2,60,000
Purchases:
Raw materials 8,00,000
Finished goods 1,70,000
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 167
Carriage inwards on raw materials 30,000
Manufacturing wages 1,00,000
Salary of the supervisor 36,000
Rent of the factory 70,000
Gas and water 30,000
Return of raw materials 13,000
Fuel and coal 33,000
Factory power 1,25,000
Fire insurance 13,000
Sales returns 1,20,000
Depreciation on factory building 12,000
Stock on 31.3.2011:
Raw materials 80,000
Semi-finished goods 1,30,000
Finished goods 2,20,000
Sales 22,00,000
Carriage outwards 35,000
Office salaries 1,50,000
Prepare manufacturing account and trading and profit and loss accounts for the year ended March, 2011.
Manufacturing Account
for the year ended 31st March, 2011
Dr. Cr.
Particulars ` ` Particulars ` `
To Opening stock: By Closing stock:
Raw materials 1,00,000 Raw materials 80,000
Semi-finished Goods __50,000 1,50,000 Semi-finished goods 1,30,000 2,10,000
To Purchases 8,00,000 By Cost of production
Less : Returns __13,000 7,87,000 transferred to
Trading Account 11,76,000
To Carriage on raw
materials 30,000
To Manufacturing
wages 1,00,000
To Factory expenses:
Salary of supervisor 36,000
Rent of factory 70,000
Gas and water 30,000
Fuel and coal 33,000
Factory power 1,25,000
Fire insurance 13,000
Depreciation 12,000 3,19,000
13,86,000 13,86,000
168 FP-FA&A
Trading and Profit and Loss Account
for the year ended 31st March, 2011
Dr. Cr.
Particulars ` Particulars `
To Opening stock of finished By Sales 22,00,000
goods 2,60,000 Less: Returns 1,20,000 20,80,000
To Cost of production transferred By Closing Stock of finished
from Manufacturing Account 11,76,000 goods 2,20,000
To Purchases 1,70,000
To Gross Profit c/d 6,94,000
23,00,000 23,00,000
To Carriage outwards 35,000 By Gross Profit b/d 6,94,000
To Office salaries 1,50,000
To Net Profit transferred to
Capital A/c 5,09,000
6,94,000 6,94,000

Illustration 4:
From the following particulars of Mr. Murthy, prepare Manufacturing, Trading and Profit and Loss Accounts for
the year ended 31.3.2011 and the Balance Sheet as on the date after making necessary adjustments:
`
Capital (1.4.2010) 2,50,000
Drawings account 70,000
Sundry creditors 80,000
Discount received 7,020
Bank overdraft 40,000
Provision for bad and doubtful debts 6,000
Purchases returns 5,300
Sales 6,75,000
Sales returns 860
Stock of finished goods (1.4.2010) 90,000
Plant and machinery (including machinery for ` 50,000 purchased on 1.1.2011) 1,70,000
Furniture 15,000
Building 1,50,000
Purchases 3,02,300
Sundry debtors 1,10,000
Manufacturing wages 60,000
Manufacturing expenses 50,000
Carriage inwards 4,000
Carriage outwards 4,200
Bad debts 1,500
Salaries 28,000
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 169
Interest and bank charges (Dr.) 1,260
Discount allowed 1,500
Insurance (Dr.) 3,000
Cash at bank 1,400
Cash in hand 300
Stock of finished goods (31.3.2011) 75,500
The following adjustments are to be made:
(i) Interest on capital at 10% p.a. (no interest is to be provided on drawings)
(ii) Outstanding expenses:
`
(a) Salaries 1,000
(b) Manufacturing wages 500
(c) Interest on bank loan 1,000
(iii) Depreciation on:
(a) Machinery at 10%
(b) Furniture at 10%
(c) Building at 2.5%
(iv) Pre-paid expenses: `
(a) Insurance 1,000
(b) Salary 500
(v) Provision for bad and doubtful debts at 10% on debtors.
Furniture costing ` 5,000 was sold for ` 3,500 on 1.4.2010 and this amount was later credited to furniture
account.
Solution:
Mr. Murthy
Manufacturing, Trading and Profit and Loss Account
as on 31st March, 2011
Dr. Cr.
Particulars ` ` Particulars ` `
To Purchases 3,02,300 By Trading Account
Less : Returns __5,300 2,97,000 (transfer of cost of goods
produced) 4,24,750
To Carriage inwards 4,000
To Manufacturing
wages 60,000
Add: Outstanding ____500 60,500
To Manufacturing
expenses 50,000
To Depreciation on
Machinery 13,250
4,24,750 4,24,750
To Opening stock 90,000 By Sales 6,75,000
Less: Returns ____860 6,74,140
170 FP-FA&A
Particulars ` ` Particulars ` `
To Manufacturing A/c By Closing Stock 75,500
(cost of goods
produced) 4,24,750
To Gross profit c/d 2,34,890
7,49,640 7,49,640
To Salaries 28,000 By Gross Profit b/d 2,34,890
Add : Outstanding ___1,000 By Discount 7,020
29,000
Less : Pre-paid ____500 28,500
To Interest and bank
charges 1,260
Add : Outstanding __1,000 __2,260
To Discount allowed 1,500
To Insurance 3,000
Less : Pre-paid __1,000 2,000
To Carriage outwards 4,200
To Provision for bad
debts 6,500
To Loss on sale
of furniture 1,500
To Depreciation on:
Building 3,750
Furniture 1,350 5,100
To Interest on capital 25,000
To Net profit
transferred to
capital account 1,65,350
2,41,910 2,41,910
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 171
Mr. Murthy
Balance Sheet as on 31st March, 2011
Liabilities ` ` Assets ` `
Capital 2,50,000 Fixed Assets:
Add: Profit 1,65,350 Building 1,50,000
Interest 25,000 Less: Depreciation 3,750 1,46,250
4,40,350 Plant and machinery 1,20,000
Less: Drawings 70,000 3,70,350 Add: Additions 50,000
Current Liabilities: 1,70,000
Bank overdraft 40,000 Less: Depreciation 13,250 1,56,750
Sundry creditors 80,000 Furniture 18,500
Outstanding expenses: Less: Cost of
Salaries 1,000 furniture disposed of
Manufacturing wages 500 during the year 5,000
Interest on bank loan 1,000 2,500 Less: Depreciation 1,350 12,150
Current Assets:
Stock 75,500
Debtors 1,10,000
Less: Provision for
bad and doubtful
debts 11,000 99,000
Cash at bank 1,400
Cash in hand 300
Pre-paid expenses:
Insurance 1,000
Salary 500 1,500
4,92,850 4,92,850
Working Note:
(i) Provision for bad and doubtful debts:
`
Provision required 11,000
Add: Bad debts 1,500
12,500
Less: Existing provision 6,000
6,500
(ii) Book value of furniture sold has been deducted for calculating depreciation.
172 FP-FA&A
LESSON ROUND UP
– Final accounts are the end product of financial accounting process. It consists of trading and profit loss
account and balance sheet

– Manufacturing account shows cost of production; trading account shows the gross profit while profit
and loss account shows the net profit earned or loss suffered by the organization during a particular
period.

– Balance sheet discloses the financial position i.e. the balances of assets, liabilities, and capital of the
business as on a particular date.

– Balance sheet is prepared with assets on the right hand side and liabilities on the left hand side.

– Assets and liabilities are classified into fixed and current and are shown in the balance sheet either in
the order of liquidity or permanence

– Adjustment entries are passed at the end of the accounting period in order to adjust various nominal
accounts to find out the correct profit or loss.

– Closing entries are journal entries required for transferring all accounts relating to expenses and gain
to trading and profit loss account.

GLOSSARY

Closing Stock Unsold stock at the end of the accounting period

Contingent These liabilities depend on the happening of certain events.
Liabilities
Intangible Fixed assets which cannot be seen or touched or felt.
Assets
Outstanding Expenses which have been incurred during the year but payment in respect of which
or Accrued has not been made.
Expenses
Unexpired or Expenses which have been paid in advance and whose benefit will be available in
Prepaid future.
Expenses
Accrued Income Income which has been earned by the business during the accounting year but which
has not become due and hence has not been received.
Income Received The revenue which remains received in advance (unearned) at the end of the
in Advance accounting period.

SELF-TEST QUESTIONS
1. The following are the balances taken from the books of Mr. Atma Ram:
Balances on 31st March, 2011
`
Atma Ram’s capital 30,000
Atma Ram’s drawings 5,000
Furniture and fittings 2,600
Bank overdraft 4,200
Creditors 13,300
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 173
Business premises 20,000
Stock on 1st April, 2010 22,000
Debtors 18,600
Rent from tenants 1,000
Purchases 1,10,000
Sales 1,50,000
Sales returns 2,000
Discount-debit 1,600
Discount-credit 2,000
Taxes and insurance 2,000
General expenses 4,000
Salaries 9,000
Commission-debit 2,200
Carriage on purchases 1,800
Provision for bad and doubtful debts 600
Bad debts written off 800
Stock on hand on 31st March, 2011 was estimated at ` 20,000. Rent
` 300, is still due from the tenant. Salaries, ` 750 are as yet unpaid. Write off bad debts ` 600 and
depreciate business premises by ` 300 and furniture and fittings by ` 266. Make a provision of 5% on
debtors for bad and doubtful debts and provision of 2% for discounts. Allow interest on capital at 5 per cent
and carry forward ` 700 for unexpired insurance. The manager is entitled to a commission of 10% on
profits remaining after charging his commission.
Prepare Trading Account, Profit and Loss Account and Balance Sheet on 31st March, 2011.
Hints: Suspense Account (difference in trial balance) = 500.
[Ans : G.P = 34,200, N.P. = 13,220, B/s Total = 59,792].

2.Below is the trial balance of Suresh as at 31st March, 2011.

Debit Balance ` Credit Balance `

Suresh’s Current Account 1,500 Capital Account 50,000

Adjusted purchases 6,99,200 Loan from Mohan @9%
Salaries 4,200 (taken on 1st October, 2010) 20,000
Carriage on purchases 400 Sales 7,20,000
Carriage on sale 500 Discount 500
Lighting 300 Sundry creditors 20,000
Rates and insurance 400
Buildings 27,000
Sundry debtors 8,000
Furniture 6,000
Cash in hand 250
Cash at bank 1,500
Stock (31st March, 2011) 61,250 _______
8,10,500 8,10,500

Rates have been prepaid to the extent of `175. Bad debts totaling ` 500 have to be written off. A provision
for doubtful debts @5% on debtors is necessary. Buildings have to be depreciated at 2% and furniture
174 FP-FA&A
@10%. The manager is entitled to a commission of 5% of net profits before charging such commission.
You are required to prepare the profit and loss account for the year ended 31st March, 2011 and the
balance sheet as on that date.
[Hints: (a) The trial balance gives “Adjusted Purchases”. It means that the opening stock has already been
transferred to the Purchases Account and has thus been closed. Further, entry for closing stock has
already been passed by debiting the Closing Account and crediting Purchases Account. That is why closing
stock appears in the trial balance. It will now be shown in the Balance Sheet and not in the Trading Account
since Purchases already stand reduced.
(b) There is a loan of Mohan @ 9% taken in October, 2010. The trial balance makes no mention of any
interest being paid to him. Hence, interest @9% must be provided for six months i.e. from October 2010 to
March 2011.]
[Ans.: G.P. = 20,400, N.P. =12,122, Total B/S =1,02,160].

3.The following figures were taken from the books of Amar on 31st March, 2011.

` `
Cash at bank 26,400 Royalties received 400
Cash in hand 30 Trade and general expenses 5,020
Sales 2,61,230 Reserve on patents 5,000
Stock (1st April, 2010) 27,410 Interest on loan 1,240
Sales returns 3,300 Repairs 840
Discount (Dr.) 6,380 Sundry creditors 20,780
Bills receivable 1,820 Buildings 95,820
Sundry debtors 52,720 Patent rights 50,000
Depreciation 4,780 Loan (raised on
Purchases 1,84,030 mortgage of buildings) 45,000
Discount on purchases 3,900 Agent’s commission 6,500
Wages 14,040 Bad debts 1,900
Provision for bad debts 5,400 Plant and machinery 30,000
Provision for discounts Capital 2,00,000
on debtors 1,970 Drawings 30,000
Advertising 1,000
Carriage 450

In addition, the following information is given:

(a) Stock on 31st March, 2011 was ` 32,250.
(b) The stock includes materials worth ` 2,250 for which bills had not been received and, therefore, not
accounted for yet.
(c) During the year, a sum of ` 3,000 was paid as ground rent for 2010-11 and 2011-12. This sum
stands debited to buildings account.
(d) Included in sales is an amount of ` 7,500 representing goods on sale or return, the customers still
having the right to return the goods. The goods invoiced were showing a profit of 20% on sales.
(e) A customer’s bill for ` 2,780 had been discounted with bank. The bank has sent intimation that the
bill has been dishonored. No entry has yet been passed in respect of this.
(f) A provision for bad debts is to be maintained at 5% of the debtors and a provision for discounts on
debtors is also to be maintained at 2% of the debtors.
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 175
Prepare trading and profit and loss account of Amar for the year ended 31st March, 2011and his balance
sheet as on that date.
[Ans.: G.P. = ` 60,500; N.P. = ` 39,698; Total of B/S =` 2,77,728].

4. Mr. T.P.’s trial balance as on 31st March, 2011 is as under:

Debit Balance ` Credit Balance `
Land and building 20,000 Capital 80,000
Machinery 50,000 Sundry creditors 8,000
Furniture and fixtures 4,000 Discounts received 400
Opening stock 16,300 Outstanding expenses 1,550
Purchases 80,000 Sales 1,50,500
Salaries 6,000 Repairs and renewals
Carriage on sales 1,500 provision 2,000
Freight on purchase 8,000
Advertising 5,400
Wages 15,000
Rent 3,000
Postage and stationery 1,500
General expenses 3,200
Loan to Santhanam @
9% (given on 1st Oct., 2010) 5,000
Prepaid insurance 200
Sundry debtors 20,000
Cash in hand 250
Cash in bank 3,100 _______
2,42,450 2,42,450
The following further information is given:
(a) Stock on 31st March, 2011 was ` 14,900.
(b) Machinery was purchased on 31st October, 2010 for ` 10,000 and was installed by own workmen.
The wages for this purpose amounted to ` 500. This amount is included in wages account.
(c) Depreciation is to be written off @
3% on land and buildings;
10% on machinery; and
5% on furniture and fixtures.
(d) Provision for repairs and renewals is credited with ` 1,500 every year.
(e) A reserve of 2% is to be made on creditors for discount.
From the information given above, prepare trading account and profit and loss account for the year ended
31st March, 2011 and balance sheet as at that date.
[Hints:
(a) Prepaid insurance and outstanding expenses are given in trial balance. This means double entry in
respect of these of items has been completed. Therefore, they will appear in balance sheet only.
(b) There is a provision for repairs and renewals. Actual repairs will, therefore, be debited to this
account and not to the profit and loss account, the provision for repairs and renewals account will be
credited with ` 1,500 by debiting profit and loss account.]
st
5. On 31 March 2011, the following Trial Balance was extracted from the books of Ghosh:
Dr.(`) Cr. (`)
Capital Account 90,000
Plant and Machinery 80,000
Sales 4,07,000
 176 FP-FA&A
Purchases 2,60,000
Returns 6,000 5,750
Opening Stock 30,000
Discount 350 800
Bank Charges 75
Sundry debtors 45,000
Sundry Creditors 25,000
Salaries 26,800
Manufacturing wages 40,000
Carriage Inwards 750
Carriage Outwards 1,200
Bad Debts Provision 525
Rent, Rates and Taxes 10,000
Advertisements 2,000
Cash in Hand 900
Cash in Bank 6,000
Furniture & Fittings 20,000 _______
5,29,075 5,29,075
st
Prepare the final accounts for the year ended 31 March, 2011 and the Balance Sheet as on that date.
The following adjustments are required:
(i) Clocking Stock ` 35,000.
(ii) (i) Depreciation on Plant and Machinery @ 15% p.a. and on furniture & Fittings @ 10% p.a. to be
provided.
(iii) Bad Debts Provision to be adjusted to ` 500.
(iv) Interest on Capital to be allowed at 10% per annum.
(v) 15% of the profits remaining after providing interest on capital is to be carried to General Reserve.
[Ans.: G.P. = ` 1,11,000; N.P. = ` 41,140; Total of B/S =` 1,72,400].
st
6. From the following, prepare the Trading and Profit and Loss Accounts for the year ended 1 March 2011
and Balance Sheet of Niyati as at 31a March, 2011:
`
Capital 3,00,000
Trade Creditors 60,000
Bills Payable 20,000
General Reserve 50,000
Provision for Bad and Doubtful Debts 2,000
st
Profit and Loss Account, 1 April, 2010 10,900
Sales 11,50,000
Discount Allowed 9,500
st
Stocks at 1 April, 2010 1,10,000
Purchases 8,96,000
Discount Received 8,800
Buildings 1,00,000
Machinery, Plant and Furniture (Cost Rs.2,50,000) 1,50,000
Book Debts 72,800
Bank Balance (Dr.) 48,800
Investment, 9% Government Loan at par 20,000
 Lesson 7  Preparation of Final Accounts for Sole Proprietors 177
Bills Receivable 45,000
Salaries an Wages 66,000
Audit Fees 10,000
Office Expenses 44,000
Repairs and Renewals 23,600
Interest Paid 1,400
Bad Debts Recovered 500
st
The value of stocks on hand as at 31 March, 2011 was `1,36,000 including goods costing `1,800 received on
th
30 March, 2011 in respect of which supplier’s bill had not yet been received. Goods of the cost of ` 3,000 were
sent to a customer on sale or approval basis. The invoice for ` 4,000 was entered in the Sales Book. Provision is
to be made for bad debts to the extent of ` 800, and for depreciation of buildings at 2% per annum: Machinery,
Plant and Furniture have been depreciated at 20% of the diminishing value; “Niyati” however, considers that the
st
proper method is 8% of the original cost and wishes to adopt it with effect from 1 April, 2009.
[Ans.: G.P. = ` 1,38,600; N.P. = ` 65,250; Total of B/S =` 2,86,600].
178 FP-FA&A