Introduction to Final Accounts

The primary function of accounting includes computing the net result of

operations of the business for the current period. To meet out this purpose,
Income statement and Balance sheet are prepared. These two documents are
popularly called as Final Accounts. It is the last phase of Accounting Process.
The components of final accounts depend upon the type of entity. In case of
non-manufacturing entities, the business operations include purchase and sale of
goods. That is why Trading Account is prepared to calculate Gross Profit. But a
manufacturing entity is interested in computation of total cost of manufacturing
the finished products. For this purpose, separate account is prepared as
Manufacturing Account. The following table shows the components of final
accounts for manufacturing and non-manufacturing firms:

Manufacturing firm Non-Manufacturing Firm

1 Manufacturing A/c 1 Trading a/c

2 Trading a/c 2 Profit and Loss A/c

3 Profit and Loss A/c 3 Balance Sheet

4 Balance Sheet
The process of final accounts starts after preparation of trial balance. It is
mainly divided into following two parts:
1. Income Statement: It is prepared to find out the net result of the operations.
It is sub-divided into two parts:
a. Trading Account
b. Profit and Loss Account
2. Position Statement: It includes Balance Sheet showing the status of assets
and liabilities as at a particular point of time.
2. Basic Principles Governing Final Accounts
There final account are required to be prepared in such a manner so that the
income statement and Balance sheet show true and fair view of profitability and
financial position of the business. The following are also considered in this
regard:
1.
 1. In the preparation of final accounts, proper distinction is required
between capital and revenue items. If a capital expenditure is
wrongly charged as revenue, then it will lead to undervaluation of
profits.
2. The profitability of the firm can be known if and only if all
personal incomes and expenditure are separately treated from the
business income and expenditures.
3. Any such item or information, disclosure of which is material to
judge the profitability, should be disclosed appropriately.
4. The matching principle should be applied strictly which requires
that expenses incurred to earn the revenue should be properly
matched. For example if during the year 1,000 units have been
purchased but 850 units have been sold, then cost of goods sold
should be calculated in respect of 850 units and this cost should be
compared with the corresponding sale proceeds.
5. When revenue nature expenses have been incurred but the amount
is heavy and the benefits are expected to be received in future also.
Then a portion is charged in current period and remaining should
be deferred for to be charged in future periods.
3. Trading Account
In the process of preparation of final accounts, the first step is to calculate the
amount of gross profit earned or gross loss incurred. The gross profit is the
excess of sales over cost of goods sold. It is the first stage in the preparation of
final accounts of a trading concern and the result of this account is transferred to
Profit and Loss Account.
The Trading Account is prepared in T shape format. The items to be debited
include the following:
1. Opening Stock: It refers to the closing inventory of the last year entered
in the books through the opening entry. Therefore, it always appears in
the trial balance. It is important to note that in the first year of its
operations, there will be no opening stock.
2. Purchases and purchases returns: The Purchases account will have debit
balance and it shows the gross amount of purchase of goods and materials for
the purpose of resale or to be used in production. It includes both cash and
credit purchases. On the other hand, Purchases returns account will have credit
balance. The net purchases are debited to Trading Account. Besides purchases
returns, following are also deducted from purchases:
(a) Goods given as Charity
(b) Goods given as sample
(c) Goods taken by the proprietor for personal use.
3. Direct Expenses: These expenses are incurred on goods purchased, till they
are brought to the place of business for sale. In addition, expenses incurred on
production such as wages, power and fuel, factory rent, etc. are also treated as
direct expenses. The following are some of the important direct expenses:
(a) Carriage or freight or cartage inwards: It refers to the cost of bringing
materials to the godown of the firm and making them available for use. It is
important to note that if such expenses are in connection with the purchase of
fixed asset, then the same are capitalised and not taken to Trading account.
(b) Manufacturing Wages: Wages paid to workers in the godown/stores,
should be debited to the trading account. If any amount is outstanding, it must
be brought into books so that full wages for the period concerned are charged to
the trading account. However, if wages are paid for installation of an asset, it
should be added to the cost of the asset.
3.1 The Trading Account is credited with the following:
1. Sale and sales returns: It reflects the total sale of goods by the firm during
the period. It includes both cash as well as credit sales. The amount does not
include sales tax or Value Added Tax. There may be sales returns also. So, net
sales are to be disclosed to the credit of Trading Account.
2. Closing Stock: It refers to the unsold goods lying in the godown of the firm
at the end of the period. As per the convention of conservatism, this stock is
always valued at lower of cost and net realizable value. It is usually given
outside the trial balance as an adjustment and is recorded in the books through
the following adjustment entry:
Closing Stock Account Dr. XXX

To Trading A/c XXX

Balancing of Trading Account
After having entered, the items to the relevant sides of Trading Account, the
totals of debit side and credit side are compared. If the total of the credit side is
more than that of the debit side, the excess is Gross Profit.
3.3 Closing entries in respect of Trading Account
The following are the relevant closing entries:
 For items on the debit of Trading
Account:

Trading Account Dr. XXX

To Opening Stock Account XXX

To Purchases Account XXX

To Wages Account

To Power and Fuel Account

For items on the Credit of Trading Account:

Sales Account Dr. XXX

Closing Stock Account Dr. XXX

To Trading Account XXX

3. For Gross Profit:

Trading Account Dr. XXX

To Profit and Loss Account XXX

In case of loss, following entry would be passed:

Profit & Loss Account Dr. XXX

To Trading Account XXX

3.4 Format of Trading Account
The format of Trading Account is as follows:
Particulars Amount Particulars Amount

To Opening Stock XXX B Sales XXX

 y

Less:
To Purchases XXX (XXX) XXX
Returns

B Closing
Less: Returns (XXX) XXX XXX
y Stock

To Wages XXX Gross Loss XXX

B
transferred to Profit
y
To Direct Expenses XXX and Loss A/c

To Carriage Inwards XXX

Freight, Octroi and

To XXX
Cartage

Gross Profit transferred

To
to

Profit and Loss A/c XXX

XXX XXX
Illustration 1
Manu Enterprises has provided you the following information for the year
ending 31st March, 2019. Prepare Trading Account.
`

Stock as on 1st April, 2018 50,000

Octroi 18,000

Freight 11,000

Carriage Inwards 7,000

Wages 40,000

Sales (Gross) 11,13,000

Sales Returns 19,000

Purchases of Stock 9,00,000

Returns Outwards 30,000

Closing Stock as on 31-3-2019 42,000

Solution
In the books of Manu Enterprises
Trading account
For the year ended 31st March, 2019
Particulars Amount Particulars Amount

B
To Opening Stock 50,000 Sales 11,13,000
y

Less:
To Purchases 9,00,000 (19,000) 10,94,000
Returns

Less: B Closing
(30,000) 8,70,000 42,000
Returns y Stock

To Wages 40,000

To Octroi 18,000

To Carriage Inwards 7,000

To Freight 11,000

Gross Profit
To transferred to Profit 1,40,000
and Loss A/c

11,36,000 11,36,000
4. Profit & Loss Account
It is prepared to calculate the net profit earned or net loss incurred by the firm in
a particular accounting period. This account starts with the amount of gross
profit (or loss) reflected by Trading Account. The gross profit appears to the
credit side and gross loss to the debit side. All indirect expenses are transferred
to the debit side of Profit and Loss Account. The administrative expenses
include salaries, printing and stationery, postage, audit fees, rent and rates, etc.
The expenses are also debited to Profit and Loss Account. These expenses are
salesmen’s salaries, packing charges, advertisement expenses, export duties, bad
debts, commission to agents, etc. There are some indirect incomes also like
dividend received, profit on sale of investments or machinery, interest received,
etc. These are credited to P & L A/c.
4.1 Items Debited to Profit & Loss A/c
1. Administrative Expenses:
(a) Office Salaries
(b) Office Rent and Rates
(c) Lighting
(d) Audit Fees
(e) General Expenses
(f) Printing and Stationery
2. Selling and Distribution Expenses:
(a) Salesmen’s Salaries
(b) Godown Rent
(c) Advertising
(d) Delivery Van Expenses
(e) Freight and Carriage on sales
(f) Packing expenses
3. Finance Charges:
(a) Interest on Loan
(b) Interest on bank overdraft
(c) Interest element in Finance Lease
4. Abnormal Items:
(a) Loss by theft
(b) Loss on sale of fixed assets
(c) Loss by fire to the extent not covered by insurance
4.2 Items Credited to Profit & Loss A/c
1.
1. Gross Profit as per Trading account
2. Interest received
3. Rent received
4. Discount received
5. Profit on sale of fixed assets
6. Extraordinary gain
NOTE: The following items are shown separately in P & L A/c, one to the
debit side and other to the credit side:
1.
1. Interest expense and interest received
2. Discount allowed and discount received
3. Bad debts and bad debt recovered
4.3 Closing entries in respect of Profit and Loss Account
The following are the relevant closing entries:
1. For items on the debit of P & L A/c:

Profit & Loss Account Dr. XXX

To Salaries Account XXX

To Advertising Account XXX

To Interest Account XXX

To Rent Account XXX

2. For items on the Credit of P & L A/c:

Interest Received Account Dr. XXX

Bad Debt recovered Account Dr. XXX

To Profit & Loss Account XXX

3. For Net Profit:

Profit & Loss Account Dr. XXX

To Capital Account XXX

In case of loss, following entry would be passed:

Capital Account Dr. XXX

 To Profit & Loss Account XXX
4.4 Format of P & L Account
The format of Profit & Loss Account is as follows:
Particulars Amount Particulars Amount

B
To Depreciation XXX Gross Profit XXX
y

B
To Legal Expenses XXX Rent Received XXX
y

B Commission
To Loss by Fire XXX XXX
y Received

Salaries Less:
To XXX (XXX) XXX
paid Advance

ADD: B
XXX XXX Bad Debt Recovered XXX
Outstanding y

B
To Interest Expense XXX Miscellaneous Income XXX
y

B
To Carriage Outwards XXX Net Loss transferred to XXX
y

To Discount Allowed XXX Capital Account

Net Profit
To transferred to XXX
Capital A/c

XXX XXX