FINAL ACCOUNTS AND FINANCIAL STATEMENT ANALYSIS-

Module2
1. Final accounts
• Final accounts are financial statements prepared at the end of an accounting
period, summarizing the financial performance and position of a business.
• To provide a comprehensive overview of the company’s financial activities.
• To inform stakeholders, including management, investors, and creditors, for
decision-making purposes.
A. Trading Account
The Trading Account is the first step in preparing final accounts, aimed at calculating the gross
profit or gross loss from core business operations.
Purpose:
• To assess the efficiency of core business activities like production and sales.
• To determine the Gross Profit or Gross Loss.
Structure:
1. Debit Side (Expenses):
o Opening Stock: Unsold goods at the beginning of the period.
o Purchases: Cost of goods bought for resale (adjusted for purchase returns).
o Direct Expenses: Costs incurred to bring goods to a saleable state (e.g., carriage
inward, freight, wages).
2. Credit Side (Income):
o Sales: Total revenue from goods sold (adjusted for sales returns).
o Closing Stock: Value of unsold goods at the end of the period.
Formula:
Gross Profit/Loss = (Sales + Closing Stock) - (Opening Stock + Purchases + Direct Expenses).
Key Notes:
• Gross profit indicates the margin available to cover operating expenses.
• Closing stock is valued at cost or market price, whichever is lower.

B. Profit and Loss Account

The Profit and Loss Account focuses on determining the net profit or net loss for the
accounting period.
Purpose:
• To calculate the overall profitability of the business after accounting for all expenses
and incomes.
Structure:
1. Debit Side (Expenses):
o Operating Expenses: Rent, salaries, utilities, advertising, depreciation, etc.
o Non-Operating Expenses: Loss on asset sales, interest on loans, bad debts, etc.
2. Credit Side (Income):
o Gross Profit: Transferred from the Trading Account.
o Non-Operating Income: Interest received, commission, dividends, etc.
Formula:
Net Profit/Loss = Gross Profit - Total Operating Expenses + Non-Operating Income - Non-
Operating Expenses - Taxes.
Key Notes:
• Net profit is transferred to the capital account in the Balance Sheet.
• Helps evaluate the company’s ability to generate income from operations and other
activities.

C. Balance Sheet
The Balance Sheet is a snapshot of the business's financial position at the end of the accounting
period. It lists assets, liabilities, and equity.
Purpose:
• To assess the financial health of the business and ensure the accounting equation
balances.
Structure:
1. Assets (Left Side):
o Current Assets: Cash, accounts receivable, inventory, prepaid expenses.
o Fixed Assets: Buildings, machinery, land, vehicles (adjusted for depreciation).
o Intangible Assets: Patents, goodwill, trademarks.
2. Liabilities and Equity (Right Side):
o Current Liabilities: Accounts payable, accrued expenses, short-term loans.
o Long-Term Liabilities: Debentures, long-term loans.
 o Equity: Owner’s capital, retained earnings.
Accounting Equation:
Assets = Liabilities + Equity
Key Notes:
• Classifications: Assets and liabilities are classified as current (short-term) or non-
current (long-term).
• Presentation Standards: Must comply with applicable frameworks like GAAP or
IFRS.
• Depreciation and adjustments (e.g., for outstanding expenses) must be included for
accurate values.
Adjustment entries
These are crucial to ensure that all revenues and expenses are accounted for in the correct
accounting period, following the accrual basis of accounting. These adjustments affect both
the Profit & Loss Account (P&L) and the Balance Sheet.

1. Depreciation
• Definition: Systematic allocation of the cost of a tangible fixed asset over its useful
life.
• Impact:
o P&L Account: Recorded as an expense under operating expenses, reducing net
profit.
o Balance Sheet: Reduces the book value of the related fixed asset.

2. Accrued Income
• Definition: Income that has been earned but not yet received by the end of the
accounting period.
• Impact:
o P&L Account: Added as income to reflect earned revenue.
o Balance Sheet: Shown as a current asset under accounts receivable.

3. Prepaid Expenses
• Definition: Expenses paid in advance but applicable to a future period.
• Impact:
 o P&L Account: Deducted from current period expenses, reducing total
expenses.
o Balance Sheet: Shown as a current asset.

4. Outstanding Expenses
• Definition: Expenses that are incurred but not yet paid by the end of the accounting
period.
• Impact:
o P&L Account: Added to the expenses for the period, increasing total expenses.
o Balance Sheet: Shown as a current liability.

5. Unearned Income (Advance Income)

• Definition: Income received in advance for services not yet provided.
• Impact:
o P&L Account: Deducted from income as it is not yet earned.
o Balance Sheet: Recorded as a current liability.

6. Provision for Bad Debts

• Definition: An estimate of potential uncollectible accounts receivable.
• Impact:
o P&L Account: Recorded as an expense to reflect potential losses.
o Balance Sheet: Deducted from accounts receivable under current assets.

7. Closing Stock
• Definition: Unsold inventory at the end of the accounting period.
• Impact:
o P&L Account: Credited under trading account to reflect cost adjustment.
o Balance Sheet: Shown as a current asset.

8. Interest on Loans
 • Definition: Interest due but not yet paid at the end of the period.
• Impact:
o P&L Account: Added as an expense to reflect the cost of borrowing.
o Balance Sheet: Recorded as a current liability.

9. Interest on Capital
• Definition: Interest allowed to the owner for their invested capital in the business.
• Impact:
o P&L Account: Recorded as an expense to reflect the opportunity cost of capital.
o Balance Sheet: Added to the capital account under "Equity."

10. Interest on Drawings

• Definition: Interest charged to the owner for withdrawing funds from the business.
• Impact:
o P&L Account: Recorded as income to the business.
o Balance Sheet: Deducted from the capital account under "Equity."

11. Loss by Fire or Theft

• Definition: Losses incurred due to fire, theft, or similar events.
• Impact:
o P&L Account: Recorded as an extraordinary loss.
o Balance Sheet: Deducted from inventory or shown separately if uninsured.

12. Provision for Discount on Creditors

• Definition: An estimate of discounts expected to be availed from suppliers for early
payments.
• Impact:
o P&L Account: Recorded as income or a reduction in expenses.
o Balance Sheet: Deducted from accounts payable under "Liabilities."

13. Provision for Discount on Debtors

 • Definition: An estimate of discounts likely to be allowed to customers on payments.
• Impact:
o P&L Account: Recorded as an expense.
o Balance Sheet: Deducted from accounts receivable under "Assets."

14. Loss by Fire or Theft

• Definition: Losses incurred due to fire, theft, or similar events.
• Impact:
o P&L Account: Recorded as an extraordinary loss.
o Balance Sheet: Deducted from inventory or shown separately if uninsured.

2. Comparative Financial Statements

Present financial data of two or more accounting periods side-by-side, enabling comparisons
of performance and trends.
• To facilitate analysis of financial performance over time.
• To identify trends and changes in financial health.
• Highlights financial trends and patterns.
• Facilitates inter-period performance evaluation.
• Assists in budget preparation and forecasting.
Limitations:
• Ignores inflation impact.
• Relies on consistency in accounting methods across periods.
• Does not offer detailed cause-and-effect analysis

Comparative Income Statement

• A financial statement that compares the revenue, expenses, and net profit of a
company over different accounting periods.
• Identifying trends in profitability.
• Evaluating the impact of cost control or revenue strategies.

Comparative Balance Sheet

• A financial statement that compares the company’s financial position (assets,

liabilities, and equity) at the end of different accounting periods.
• Assessing liquidity and working capital management.
 • Identifying trends in asset utilization and debt management.

3.Common Size Financial Statements

Financial statements where each item is expressed as a percentage of a base figure, allowing
proportional analysis.

• Highlights the relative size of different items, such as cost of goods sold as a
percentage of revenue.
• Facilitates the detection of trends over time (e.g., increasing expenses).
• Simplifies comparisons with industry standards or competitors.
• Presents financial data in a simplified, percentage-based format, making it easier to
analyse.

Common size Income Statement: Revenue (Sales) is considered 100%, and all other items
(expenses, profits) are expressed as a percentage of revenue.
• Helps compare the size of expenses to total revenue.
• Assesses profit margins like gross and net profit as a percentage of revenue.
• Shows the proportion of revenue spent on different costs.

Common size Balance Sheet: Total Assets or Total Liabilities & Equity is considered 100%,
with each item (assets, liabilities, equity) expressed as a percentage of the total.

• Helps assess financial structure, showing debt vs. equity.

• Aids in liquidity analysis by comparing current assets and liabilities

4.Cash Flow Statement

• Tracks cash inflows and outflows during a specific period.

• Operating Activities: Includes cash generated from day-to-day business operations, such
as sales and expenses.
• Investing Activities: Cash used for or generated from investments, such as purchasing or
selling assets like property or equipment.

• Financing Activities: Cash flows related to financing, including issuing or repurchasing

stock, borrowing funds, and paying dividends.

Direct Method: Lists cash receipts and payments;

Indirect Method: Starts with net income, adjusts for non-cash transactions.

5. Funds Flow Statement:

 • Shows sources and uses of funds over a period.
• Focuses on changes in working capital.
• Sources: Loan acquisitions, asset sales, etc.
• Uses: Asset purchases, debt repayments, etc.
• Analysis:
• Assess operating efficiency and financial stability.
• Understand cash generation capabilities and funding needs.
• Compare with previous periods to identify trends.
• Limitations:
• May not reflect changes in economic conditions or market dynamics.
• Historical performance may not predict future results accurately.

6.Understanding Corporate Financial Statements & Reports

Definition: Official documents summarizing a company's financial performance and

position.

A. Income Statement:
• Purpose: Reports a company's financial performance over a specific period
(e.g., quarterly or annually).
• Components:
• Revenues: Income generated from sales or services.
• Expenses: Costs incurred in the process of earning revenue.
• Net Income: The difference between total revenues and total expenses
(profit or loss).
B. Balance Sheet:
• Purpose: Provides a snapshot of a company's financial position at a specific
point in time.
• Components:
• Assets: Resources owned by the company (e.g., cash, inventory,
property).
• Liabilities: Obligations or debts owed to external parties (e.g., loans,
accounts payable).
• Equity: The residual interest in the assets after deducting liabilities
(e.g., common stock, retained earnings).
C. Cash Flow Statement:
• Purpose: Shows how cash flows in and out of the company over a specified
period.
• Components:
• Operating Activities: Cash generated from core business operations
(revenues minus operating expenses).
• Investing Activities: Cash used for investments in long-term assets
(e.g., purchase of equipment, sales of investments).
 • Financing Activities: Cash received from or paid to external financing
sources (e.g., issuing shares, repaying debt).
D. Statement of Shareholders' Equity (or Statement of Changes in Equity):
• Purpose: Provides details about changes in equity over a specific period.
• Components:
• Beginning Equity: The equity balance at the start of the period.
• Contributions: New investments made by shareholders.
• Distributions: Dividends distributed to shareholders.
• Net Income: How the profits from the income statement impact equity.
E. Notes to Financial Statements:
• Purpose: Provide additional context, clarification, and details regarding the
financial statements.
• Components:
• Accounting policies: The methods used to prepare the financial
statements.
• Specific line item details: Explanations of complex transactions or
adjustments.