FUNDAMENTALS OF ACCOUNTING AND MANAGEMENT –I ACCOUNTING: AN OVERVIEW 4. Understanding of Financial Statements The outcome or the result of a business is reflected in its financial statements. The position of the business as on a particular date is also known if one looks at the financial statements of any business. However many of the terms used in these statements are not understood by a layman. Further, there is little understanding as to the preparation of these statements and hence correct deductions cannot be formed about the items and the figures which are shown. In this lesson we shall understand the financial statements prepared for different forms of organisations, including proprietorship, partnership, company and Non Profit Organisations.
4.0
Objectives Based on the inputs received in this lesson, you will be able to understand: • • • •
4.1
Financial Statement of Sole Trader and Partnership Firm Profit and Loss Appropriation Account Financial Statement of Companies Financial Statements of Non Profit Organisations
Introduction Financial Statement means the statements which show the profit earned or loss suffered and the financial state of affairs at the end of the period concerned. Financial statements are the summarised statements of accounting data produced at the end of the accounting process by an enterprise through which it communicates accounting information to the users. The users can be investors, lenders, suppliers and trade creditors, customers, government and their agencies, public at large and employees.
4.2
Annual/Final Accounts You have learnt earlier that each business financial transaction is first recorded in the Journal or Subsidiary book. After that, posting is done in the Ledger and the balance of each individual account established. Then the Trial balance is prepared to determine the arithmetical accuracy of accounts. Thereafter, annual or final accounts are prepared at end of accounting period to determine the financial position of the business.
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Accounts prepared at end of accounting year to know the result and financial position of business are called annual / final accounts. In final accounts the following are included: • • •
Trading Account Profit and loss Account Balance sheets Trading Account shows gross profit / loss of business. Profit and loss Account shows net profit / loss of business whereas the Balance sheet presents the financial position of business. Trading Account and Profit & Loss account shows balances of Ledger account and the balance of this account is called profit/loss. The Balance sheet is not an account, it is a statement, therefore it does not have a balance, but as per dual aspect concept, both the sides of the Balance Sheet i.e. Liabilities and Assets, should tally. The process of recording business transactions to the preparation of annual accounts is summarised under: Financial Transaction of the Business
Determine the double effect of the transaction after deciding the types of accounts Record the transaction in Journal or Subsidiary books Determine the balance of each account after positing Prepare Trial Balance
Prepare Annual Accounts (including effects of adjustments)
Trading account (To know gross profit or gross loss) business)
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Profit & Loss account (To know net profit or net loss)
Balance Sheet (To know the financial position of the)
4.2.1 Trading and Profit and Loss Account The Profit and Loss Account is prepared for ascertaining the profit or loss of the business. This is worked out in two stages: 1. First, the Gross Profit or Gross Loss 2. Second, the Net Profit or Net Loss The Profit and Loss Account is divided into two sections: • •
The first section is called the Trading Account which gives the gross profit or gross loss. The second section is called the Profit and Loss Account which shows the net profit or net loss. Trading Account This account is prepared for determining the Gross profit or Gross Loss. The Gross profit can be explained by the following equation: GROSS PROFIT = Net Sales – Cost of Goods Sold Here Net Sales = Total Sales – Sales Return COST OF GOODS SOLD = Opening Stock+ Net Purchases + Direct Expense Less Closing Stock. e.g. 5 pens are purchased for Rs. 2/- each. 2 pens are sold for Rs. 5/- each. What is the gross profit? 2 pens were sold. The cost of each pen was Rs. 2/-. Hence the cost of goods sold (cost of 2 pens sold) is Rs. 4/-. The gross profit is Rs. 6/-. Gross Profit = Net Sales (Rs.10/-) – Cost of goods sold [Op. stock (0) + Net Purchases (Rs. 10/-) + Direct Expenses (0) – Closing stock (Rs. 2/- x 3)] Hence, G.P. = 10-[0+10+0-6] = 10 – 4 = 6. Net Purchase = Total Purchase – Purchase Return Direct Expense means those expenses which are incurred on goods purchased till they are brought to the place of business for sale. This could be Freight, Insurance cartage etc. Only Direct expenses should be included in the Cost of Goods Sold.
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Form of Trading Account If you go through the equation as specified above and recollect the principles of Debit and credit, the understanding of Trading Account would become simpler. The Trading Account, like any other Account, has two sides. i.e. Debit and Credit. The Opening Stock, Purchases (less returns) and all Direct Expense are shown on the Debit side. The Sales (less returns) and the closing stock are shown on the Credit Side. Now if Debit side is greater than the Credit side it is Gross Loss And if Credit side is greater than the Debit side it is Gross Profit The Gross Profit / Gross Loss thus worked out is transferred to the Profit and Loss Account. Form of Trading Account of …………for the year ended ………….. Debit Particulars Amount To Opening Stock Rs. To Purchase ………
Amount Rs. ……..
…….
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Rs. Rs. By Sales ……… Less Sales Return ………
……..
By Closing Stock
To Direct Expenses (specify individually) To Gross Profit (transferred to Profit And Loss Account)
Amount
…… ……..
Less Purchases Return ……….
Credit Particulars Amount
……. ______
______
______
______
Profit and Loss Account After finding the Gross Profit by Trading Account in order to work out the Net Profit, the Profit and Loss Account is prepared. Net Profit is the excess of Gross Profit and other incomes over the indirect expenses and losses. Therefore on the Credit Side: Gross Profit, other incomes such as rent received, interest and dividends, commission received are included, while on the Debit Side: Indirect Expenses and losses are placed. Indirect Expenses could be Administrative, Selling and distribution expenses such as salaries, rent, taxes, postage, stationery, insurance packing etc. Losses could be loss due to theft, by fire etc. The difference between the two sides could be either net profit or net loss. Now if Debit side is greater than the Credit side it is Net Loss. Or if Credit side is greater than the Debit side it is Net Profit. The net profit / loss belongs to the proprietor and is transferred to his Capital Account. Form of Profit and Loss Account…………………… for the period ended……………………. Debit Credit Particulars Amount Particulars Rs. To Gross loss, if any, By Gross Profit (transferred from (transferred from Trading Account) Trading Account) To salaries By Interest Received To Rent, Rates and By Discount Received Taxes By Rent Received To Postage and By Commission Received Telegrams By Dividend Received To Telephone Charges By Other Incomes and To Printing and Gains Stationery By Net Loss To Legal Expenses (transferred to To Insurance Capital Account) To Office Lighting To Bad Debts To Depreciation To Advertising
Amount Rs.
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To Travelling Expenses To Carriage Outwards To Trade Expenses To Discount Allowed To Interest Paid To Repairs and Renewals To Loss by Fire To Other Expenses and Losses, if any To Net Profit (transferred to Capital Account) 4.2.2 Balance Sheet After determining the net profit or net loss by preparing the Trading and Profit Loss account, the final step is to prepare the Balance Sheet. The purpose of the Balance Sheet is to ascertain the financial position of the business i.e. to know what the business owes and what it owns on a certain date. Hence it shows all assets and liabilities of the business at the end of the accounting year. Final Accounts are prepared from the Trial Balance. All expense and income appearing in Trial Balance are transferred to the Trading and Profit / Loss Account. The remaining items which represent the balances of Personal and Real accounts are shown in the Balance Sheet. The accounts showing debit balances represent Assets and those showing credit balances represent Liabilities. Illustration From the following Trial Balance of ABC, prepare Trading Account, Profit and Loss account for the year ended 31st March 2006 and a Balance Sheet as on that date. Trial Balance Particulars
Capital Sales Sales Returns Purchases 6
Dr. Balances Rs.
25,000 5,00,000
Cr. Balances Rs. 5,00,000 10,00,000
Purchases Returns Inventory as on 1.4.2005 Land & Buildings Plant & Machinery Furniture Wages Carriage Inwards Carriage Outwards Cartages Salaries Loan Debtors Creditors Bills Receivables Acceptances General Expenses Rent & Rates Investments Cash in hand Bank Overdraft Discount Allowed Depreciation on Plant & Machinery Interest on Investments Interest on Bank Overdraft Goodwill Bad Debts
15,000 60,000 4,00,000 2,50,000 1,00,000 50,000 10,000 5,000 5,000 40,000 2,60,000 1,50,000 85,000 40,000 10,000 20,000 10,000 50,000 50,000 10,000 4,500 50,000 5,000 500 60,000 5,000 18,85,000
18,85000
The inventory on March 31, 2006 was valued at Rs. 1,00,000. Solution: Trading and Profit & Loss Account of ABC for the year ended March 31 2006 Debit Particulars To Inventory (opening) To Purchases 5,00,000 Less Returns 15,000
Credit Amount Rs. 60,000
Particulars By Sales Less Returns
Amount Rs. 10,00,000 25,000
9,75,000
4,85,000 50,000
By Inventory (Closing)
1,00,000
To Wages 10,000 7
To Carriage Inwards To Cartages To Gross Profit c/d
5,000 4,65,000 10,75,000
To Carriage Outwards To Salaries To General Expenses To Rent and Rates To Discount To Bad Debts To Depreciation To Interest on Bank Overdraft To Net Profit (transferred to Capital Account)
5,000 40,000 20,000 10,000 4,500 5,000 50,000
10,75,000
By Gross Profit b/d
4,65,000
By Interest on Investment
5,000
500 3,35,000 4,70,000
4,70,000
Balance Sheet of ABC as on March 31, 2006 Liabilities Capital 5,00,000 Add : Net Profit 3,35,000
Amount Rs.
Goodwill 8,35,000
2,60,000 Loan Creditors Acceptances Bank Overdraft
4.3
Assets
85,000 10,000 10,000 12,00,000
Land & Building Plant &Machinery Furniture Investments Inventory (closing) Debtors Bills Receivables Cash in hand
Amount Rs. 60,000 4,00,000 2,50,000 1,00,000 50,000 1,00,000 1,50,000 40,000 50,000 12,00,000
Profit and Loss Appropriation Account of a Partnership firm Trading Account, Profit and Loss Account and Balance Sheet are prepared in an individual proprietor’s final accounts. In Partnership and Company Accounts, after preparing Profit and Loss Account, a Profit and Loss Appropriation Account is prepared, in order to show the distribution of profit or loss among the partners or the shareholders. Profit and Loss Appropriation
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Account is only a part of Profit and Loss Account. It is not compulsory to prepare this account separately. Let us understand a Profit and Loss Appropriation Account with respect to a partnership firm. Credit Side of Profit and Loss Appropriation Account After writing net profit, which is transferred from Profit and Loss Account, on the credit side in Profit and Loss Appropriation Account, interest on drawings by partners from the firm, and interest on debit balance of partner’s Current Account are credited. Debit Side of Profit and Loss Appropriation Account After writing net loss, which is transferred from Profit and Loss Account on the debit side in Profit and Loss Appropriation account, interest on partner’s capital, interest on credit balance of partner’s current account, salary, bonus, commission, remuneration of partner’s, interest on partner’s loan etc are debited. Credit balance of Profit and Loss Appropriation Account means divisible profit. This profit is transferred to the credit side of partner’s capital accounts or current accounts in agreed proportion. Debit balance of Profit and Loss Appropriation Account means divisible loss. This loss is transferred to debit side of partner’s capital account or current accounts.
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Specimen of Profit and Loss Appropriation Account
Profit and Loss Appropriation Account of partnership firm of A, B and C for the year ended on……..:
Particulars Net loss (transferred from Profit and Loss account) To Interest on partner’s capitals A ….. B ….. C ….. To Interest on credit balance of partner’s current accounts To partner’s salary, bonus, commission remuneration
Amount Rs. …..
…..
Particulars By Net profit (Transferred from profit and loss account) By Interest on partner’s drawings A ….. B ….. C ….. By Interest on debit balance of partner’s current accounts
….. …..
…..
Amount Rs.
….. …..
By Divisible loss (Transferred to partner’s capital / current accounts) A ….. B ….. C …..
…..
________ …..
To Interest on partner’s loan To Divisible profit (transferred to partner’s capital /current accounts) A ….. B ….. C …..
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…..
…..
Self-Check Questions Answer True or False 1. If the credit side of Profit and Loss account is greater than the debit side, it indicates Net Profit. 2. A trading account shows the net profit or loss earned by the business. 3. Assets are shown on the debit side and liabilities are shown on the credit side of the balance sheet. 4. All direct expenses are shown in the Trading Account. 5. All indirect expenses are shown in the Profit and Loss Account. 6. Sales in an indirect income.
4.4
Financial Statements of Companies We have earlier understood how the financial statements are prepared with respect to a proprietorship or partnership. Let us now understand the various terms used in the accounts with respect to a Company form of organisation. A set of financial statements include:
• • • •
Balance Sheet Profit and Loss account Profit and Loss appropriation account and Schedules and notes forming part of the balance sheet and Profit and Loss account A Balance Sheet is a statement of assets and liabilities indicating the financial position of an enterprise at a given date. A Profit and Loss account shows the net result of business operations during an accounting period. Profit and Loss Appropriation account shows how the profit for the year has been distributed or appropriated. Schedules have the details of amounts in the Balance Sheet and Profit and Loss account, while the notes are the statements of accounting policies adopted and explanation of material information. Financial information, which is the information relating to the financial position of any enterprise, when presented in a concise and capsule form, is known as the Financial Statement. It is mandatory for all companies to prepare their financial statements according to Schedule VI of the Companies Act, 1956.
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4.4.1 Balance Sheet A Balance Sheet may be defined to be a statement of company's assets and liabilities as on a particular date. It necessarily means the amounts and values stated against each asset and liability are historical and, therefore, they do not reflect the current values. The assets of the company, fixed assets and current assets, are represented by the liabilities, long-term liabilities and shortterm liabilities, and the shareholder equity, i.e. paid up share capital and reserves. Balance sheet and Profit and Loss account of a company are prepared following the same principles as are followed for preparing balance sheet of a sole proprietor or partnership firm. The prescribed form of the Balance Sheet has been given in Part I of Schedule VI of the Companies Act, 1956. The Balance Sheet of the company may be prepared either in: • •
Horizontal form; or Vertical form Briefly, in the horizontal form, liabilities are presented on the left-hand side and assets on the right-hand side. In the case of vertical form, liabilities are shown under one heading titled 'Sources of Funds', which is immediately followed by assets shown under the title 'Application of Funds'. The two respective forms of Balance Sheet are given below. SCHEDULE VI, PART I (Section 211) A - HORIZONTAL FORM OF BALANCE SHEET BALANCE SHEET OF as at...
Figures for The Previous Year Rs.
...
... ... ...
... ... ...
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Liabilities
(1) Share Capital: Authorised....Shares of Rs....each Issued: Equity shares of Rs....each Preference shares of Rs......each Subscribed: ...Equity shares of Rs... Each Rs... Called up: ...Preference share of Rs... each Rs... called up. Less: Calls unpaid: (i) By Directors (ii) By others
Figures Figures for for the the Current Previous Year Year Rs. Rs.
... ...
... ... ... ...
Assets
(1) Fixed Assets: [See note (a)] (a) Goodwill, (b) Land, (c) Building, (0) Leaseholds,
Figs. for the Current Year Rs.
... ... ... ...
...
(e) Railway sidings,
...
...
...
... ...
...
...
(f) Plant & machinery, (g) Fixtures & fittings, (h) Development of property, (i) Patents, trade marks and design,
...
... ... ... ...
... ... ...
(j) Livestock, (k) Vehicles, etc. (2) Investments:
...
... ...
...
... ... ... ...
Add: Forfeited Shares: (a) Of the above shares ...shares are allotted as fully paid Pursuant to a contract without Payments being received in cash. (b) Of the above shares... Shares are allotted as fully paid Up by way of bonus shares. (2) Reserves and Surplus: 1. Capital Reserve. 2. Capital Redemption Reserve. 3. Securities premium Account. 4. Other reserves. Less: Debit balance in profit and Loss account (if any).
... ...
(Showing nature of investment and mode of valuation, for example, cost or market value)
...
...
(A) CURRENT ASSETS: 1. Interest accrued on ... ... ... ... ...
... ... ... ...
...
... ...
... ...
2. Stores and spareparts. 3. Loose tools. 4. Stock-in-trade. 5. Work-in-progress. 6. Sundry debtors. (a) Debts outstanding for a period exceeding six (b) Other debts. Less: Provision
... ... ... ... ...
... ...
7a. Cash balance on ...
Reserves.
...
7. Sinking funds. (3) Secured Loans:
...
... ...
...
...
From banks. 3. Loans and advances from subsidiaries. 4. Other loans and advances. 5. Interest accrued and due on secured loans.
investments.
months.
1. Debentures
... ...
(3) Current Assets, . Loans and Advances:
5. . Surplus, i.e., balance in Profit and Loss account after Providing for proposed Allocations, namely, dividend, Bonus or reserves. 6. Proposed additions to
2. Loans and advances
...
[See note (b)]
...
...
...
...
hand. 7b. Bank balances. (I) With Scheduled banks. (ii) With others. (B) LOANS AND ADVANCES: 8. (a) Advances and loans to subsidiaries. (b) Advances and loans to partnership firm in which the company or any of its subsidiaries is a partner. 9. Bills of exchange. 10. Advances recoverable
...
... ...
... ...
...
13
... ... ... ... ... ... ...
... ... ...
... ... ... ... ... ... ... ... ... ... ...
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(4) Unsecured Loans: 1. Fixed deposits. 2. Loans and advances from subsidiaries. 3. Short-term loans and advances: (a) From banks (b) From others. [Short-term loans include those which are due for repayment not later than one year as at the date of the balance sheet] 4. Other loans and Advances. (a) From banks. (b) From others. (5) Current Liabilities and Provisions: A. CURRENT LIABILITIES: 1. Acceptances. 2. Sundry creditors. . 3. Subsidiary companies. 4. Advance payments and unexpired discounts for the portion for which value has still to be given, e.g., in the case of the following companies: Newspaper, fire insurance, theatres, clubs, banking, steamship companies, etc. 5. Unclaimed dividends. 6. Other liabilities (if any). 7. Interest accrued but not due on loans. B. PROVISIONS: 8. Provision for taxation. 9. Proposed dividends. 10. For
...
...
...
...
...
...
...
...
...
...
... ...
... ...
in cash or in kind or for value to be received, i.e., rates, taxes, insurance, etc. 11. Balance with Customs, Port Trust, etc. (where payable on demand). (4) Miscellaneous Expenditure: (to the extent not written off or adjusted) 1. Preliminary expenses.
... ... ...
... ... ...
2. Expenses including Commission or
subscription of shares or debentures.
... ... ... ... ...
... ... ... ... ...
...
...
... ...
... ...
3. Discount allowed on the issue of shares or debentures. 4. Interest paid out of capital during construction (also stating the rate of interest). 5. Development expenditures not adjusted. 6. Other sums (specifying nature). (5) Profit and Loss Account (This is shown only
when
its
debit
balance could not be written
off
out
... ... ... ...
...
underwriting or
... ... ...
...
... ... ...
brokerage on
... ... ...
...
of
uncommitted reserves.)
contingencies. 11. For provident fund scheme. 12. For insurance, pension and similar staff benefit schemes. 13. Other provisions. (6) Contingent Liabilities [See Note (c)]
• •
•
Fixed assets are shown at original cost less total depreciation to date. Investments are divided into two parts: o Quoted, and o Unquoted. In the case of quoted investments market price must be disclosed. Contingent liabilities are not included in the total of the liability side. Form of Balance Sheet (Vertical Form) BALANCE SHEET OF ...CO. LTD. as on... Particulars (1)
I. Sources of Funds: (1) . Shareholders' Funds (a) Capital (b) Reserves and Surplus (2) Loan Funds: (a) Secured Loans (b) Unsecured Loans Total II. Application of Funds: (1) Fixed Assets (a) Gross Block (b) Less: Depreciation (c) Net Block' (d) Capital Work-in-Progress (2) Investments (3) Current Assets, Loans and Advances (a) Inventories (b) Sundry Debtors (c) Cash and Bank Balances (d) Loans and Advances (e) Other Current Assets Less: Current Liabilities and Provisions (i) Liabilities … (ii) Provisions … Net Current Assets ______ (4) (a) Miscellaneous Expenditure
Schedule No. (2)
Figures for the Current Year (3)
Figures for the Previous Year (4)
… …
… …
… …
… …
…
…
… … … … …
… … … … …
… … … …
… … … …
… …
… …
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(to the extent not written off or adjusted) (b) Profit and Loss Account
…
…
Liabilities There are two types of items shown on liabilities side: • •
Owner’s equity Creditors or Other liabilities Share Capital Share capital is that part of a company's financing which is represented by the total nominal value of the shares which it has issued. It may be in the form of equity shares or preference shares or a combination of both. Under the heading share capital, the following details are shown:
•
•
• •
Authorised Share Capital: This refers to the total amount of share capital a company is authorised to raise. The amount of authorised share capital is stated in Memorandum of Association. It includes both preference share capital and equity share capital or only equity share capital. The total amount of authorised share capital is shown by way of information in the balance sheet. It is not added to liabilities of the company but is only stated for the purposes of disclosure. Issued Share Capital: Issued share capital is that part of the authorised share capital which has been issued for subscription till the date of balance sheet. It includes a number of classes (equity or preference) of shares and their face value, etc. Subscribed Share Capital: It refers to that part of issued capital which has been subscribed by the applicants along with share value called up. Paid up Share Capital: It refers to that part of subscribed share capital which has been paid up by the subscriber to share capital. Reserves and Surplus
•
•
•
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Surplus: Refers to the credit balance of Profit and Loss Account after proposed allocation or appropriations for dividend, bonus, transfer to reserves, etc. General Reserves: Nature and amount of each reserve should be explained separately. It includes general reserve, generalization reserve and special reserve for depreciation. If there is debit balance in Profit and Loss account, it should be deducted from the General Reserve. Capital Reserve: It includes amount which are not earned during normal operation of the business and are not available for distribution, e.g., profits prior to incorporation, profit on acquisition of business, profit on sale of fixed assets, profit remaining on re-issue of forfeited shares etc.
Secured Loans If any company obtains loan secured by a mortgage or charge on all or any of its assets, the loan is termed as 'Secured Loan'. It includes debentures, loans from banks, loans and advances from subsidiaries and so on. Unsecured Loans If the company borrows loans without giving any security, the loan is termed as 'Unsecured Loan'. Under this head, even the part of secured loan which is not covered by the value of security provided are included. Current Liabilities and Provisions •
•
Current Liabilities: Any liability which is payable in the very near future will be considered as current liabilities. Some examples may be; (i) Acceptances (or Bills Payable) (ii) Sundry creditors (iii) Balances of Subsidiary companies (iv)Advance payments received Provision: Provisions are the amounts written or retained by way of providing for depreciation, renewal or diminution in value of assets or retained by providing for any known liability of which the amount cannot be determined with substantial accuracy. If any provision is more than liability, then excess is treated as a reserve. The heading 'Current Liabilities and Provisions' shown in the Balance Sheet includes the following items in that order: Some examples are: o Provision for taxation o Proposed dividends o Provision for contingencies o Provision for provident fund o Provision for insurance, pension and similar staff benefit schemes o Other provisions Contingent Liabilities These are those liabilities which may or may not exist and existence of which depends on a future incident. It is shown as a footnote in the Balance Sheet. Some examples are:
• • • • •
Claims against company which is not accepted by the company. Liability for amount uncalled on partly-paid shares. Arrears of fixed cumulative dividends. Estimated amount of capital contracts remaining to be executed and not provided for. Other contingent liability. For example, liability for bill discounted disputed liabilities or claim, etc. 17
Assets Following are the assets which are shown in the balance sheet of a company. •
Fixed Assets Fixed assets are those assets which are used for long time in business to earn profit. Relevant information to be given regarding these assets is:
1. As far as possible, different assets should be shown separately. 2. Regarding every fixed asset, it is necessary to show its original cost and the additions (purchases) thereto and deductions (sale) there from during the year and the total depreciation written off or provided on it up to the end of the year. Mode of valuation (cost or book value) of every asset should also be explained in the books of account. Amount of depreciation written off or provided for the year should be allocated to each asset separately. Only the amount of depreciation up to the date of Balance Sheet for each asset will be shown. According to the Companies Act, it is not necessary to show amount of current year's depreciation and amount of last year's depreciation separately, although, in practice, generally it is shown separately. •
Investments Investments by nature are fixed. Schedule VI of the Companies Act requires following details to be given with respect to investments:
1. Investments are categorized into: o o o o
Investment in Government and trust securities Investment in shares, debentures and bonds of various companies Investment in shares, debentures and bonds of subsidiary companies Investment in fixed assets.
2. It is necessary to disclose the nature and mode of valuation of every investment. Nature of investment means, to disclose if it is a long-term investment or a current asset. As regards the mode of valuation, it is necessary to disclose how the investments are valued, i.e. on cost price or market price. 3. It is also necessary to disclose the total amount of company's quoted and unquoted investments and market value of quoted investments in the Balance Sheet. Current Assets, Loans and Advances These are the assets which are likely to be converted into cash within a year from the date of Balance Sheet.
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•
Current Assets The current assets shown in the Balance Sheet include:
1. 2. 3. 4.
Accrued interest on investments Closing stock Work-in-progress Sundry debtors Less: Provision for doubtful debts 5. Cash and Bank balance •
Loans and Advances This includes loan given to different persons, advances against purchase of goods and various expenses by the company.
1. Loans and advances to subsidiary company 2. Bills of exchange 3. Advances recoverable in cash or in kind or for value to be received, e.g., rates, taxes, insurance etc. Miscellaneous Expenditure
1. 2. 3. 4. 5.
This is the part of expenses which are not written off up to the date of Balance Sheet. These are shown in Balance Sheet under 'Miscellaneous Expenditure'. This includes: Preliminary expenses Expenses including commission or brokerage on underwriting or subscription of shares or debentures Discount allowed on issue of shares or debentures Interest paid out of capital during construction. Development expenditure not adjusted. Profit and Loss Account If there is any debit balance in Profit and Loss Account, it will be shown on the assets side of Balance Sheet.
4.4.2 Provision vs. Reserves Provisions means any amount written off or retained by way of providing depreciation, renewals or diminution in the value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy. If the amount of liability can be ascertained with substantial accuracy it is termed as liability. 1. 2. 3. 4.
Provision for bad and doubtful debts Provision for discount on debtors Provision for repairs and renewals Provision for depreciation
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5. Provision for Income-tax Provision is a charge against profit, hence it appears in the debit side of Profit and Loss Account. Reserves mean amounts set aside out of profit and other surpluses to meet future uncertainties. In other words reserve means the amounts set aside of profits and other surpluses, which are not earmarked in any way to meet any particular liability, known to exist on date of the Balance Sheet. It is provided for meeting prospective losses or liabilities, creation of reserves to increase the working capital in the business and strengthen its financial position. Provision is excess of the amount considered necessary for the purpose for which it was created is treated as reserve. Thus, it is an appropriation of profit. Reserves
Revenue Reserve
General Reserve
Capital Reserve
Capital Reserve
Revenue reserve Any reserve which is available for distribution as dividend to the shareholders is called Revenue reserve. Revenue reserves may be classified into two categories as under: i.
ii. iii.
General reserve: General reserve is that reserve which is not created for a specific purpose. Such reserve is also called 'Contingency reserve' or 'Free reserve' because it is not created for specific purposes and can be freely used for any purpose. Specific reserve: Specific reserve is that reserve which is created for a specific purpose. Example of such reserves includes dividend equalization reserve, Debenture redemption reserve, and Investment fluctuation reserve. Reserve Fund: When amount of general reserve of specific reserve is not utilised in business instead is invested outside the business in securities, such reserve is called Reserve fund. Capital reserve Any reserve which is created out of capital profit and is not available for distribution as dividend among the shareholders is called capital reserve.
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Profit prior to incorporation, premium on issue of shares or debentures, profit on redemption of debentures, profit on the sale of undertaking, any profit of exceptional or abnormal nature is not meant for distribution as dividend to share-holders are examples of such reserves. 4.4.3 Profit and Loss Accounts As mentioned earlier, one of the aims of accountancy is to ascertain at the end of say a year how much profit the firm has earned. This is done by preparing the Profit and Loss account. The basic purpose of the Profit and Loss account is to show the true and fair picture of the profit earned or the loss suffered for the period concerned. Part II of the schedule VI of the Company Act 1956 deals with the structure of the Profit and Loss account. In the Company Act 1956 nothing specific has been prescribed as to what should be the format of the Profit and Loss account. Thus the format of the Profit and Loss account differs from industry to industry and the reporting requirements of the organisation. The Profit and Loss account should contain the following information: •
• •
• • •
Sales: Under this head the entire sale should be disclosed along with the quantity which it relates to. If it is a service rendering organisation then the income derived from rendering such services should be disclosed. Other Incomes: All the other incomes like interest on investments, other interests, and non-recurring incomes should be disclosed. Purchases and the stock of goods: All the purchases and the opening and the closing stocks of the goods, material and also the work in progress need to be disclosed. All the expenses related to that business needs to be shown under this head. Depreciation. Payments to staff and auditors.
4.4.4 Company Profit and Loss Appropriation account When a company earns profit then the question of its distribution arises. There may be two ways for the appropriation of the profit earned; either some part of it can be retained to strengthen the financial position of the company or it can be distributed among the shareholder’s of the company and the balance can be taken forward as a credit balance in the next year’s Profit and Loss account . This entire exercise is done in the Profit and Loss appropriation account. The appropriation items which may reflect in the debit side of the Profit and Loss appropriation account are as follows: • • • •
Transfer to general reserve Transfer to Dividend Equalization Fund Dividend distributed or Proposed Transfer to Debenture Redemption Fund
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The balance, after all the above appropriations, is carried forward to the next year’s Profit and Loss account. This part of the Profit and Loss account is known as the Profit and Loss appropriation account. No separate heading is used for this account .It is also known as the ‘Below the line account’. Illustration The DEI Industry Ltd had a nominal capital of Rs.6,00,000 divided into shares of Rs.10 each. The balances as per ledger of the company as on December 31, 2005 was as follows:Calls in Arrear Premises Plant &Machinery Interim Dividend Paid Purchases Preliminary Expenses Freight Directors Fees
75,00 3,00,000 3,60,000 75,00 1,85,000 5,000 13,000 5,740
Salaries 14,500 Debentures Interest 9,000 Share Capital 4,60,000 Bills Payable 38,000 Sales 4,15,000 Provisions for Bad debts 3,500
Stock (1st Jan 2006) Fixtures Sundry Debtors Goodwill Cash in Hand Cash at Bank Wages General Expenses Bad Debts 6% debentures P&L A/C (Cr) Sundry Creditors General Reserves 4% Govt Securities
75,000 7,200 87,000 25,000 750 39,900 84,800 16,900 2,110 3,00,000 14,500 50,000 25,000 60,000
Prepare the final accounts and the balance sheet relating to 2005 from the figures given above after taking into account the following: 1. Depreciate Plant and Machinery by 10% and fixtures by 5% 2. Write off 1/5 of preliminary Expenses 3. Rs. 10,000 of wages were utilised in adding rooms to the premises ; no entry has as yet been made for it 4. Leave bad debts provision at 5%of the sundry Debtors 5. Provide a final dividend @ 5% 6. Transfers Rs. 10,000 to general Reserve 7. Make a provision for Income tax to the extent of Rs. 25,000 8. The Stock on 31st Dec, 2005 was Rs. 1, 01,000
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Solution Trading and Profit and Loss Account of DEI Industry Ltd for the year ended 31st December, 2005 EXPENSES
AMOUNT
INCOME
(Rs) To Stock To Purchases To Wages
AMOUNT (Rs)
75,000
By sales
4,15,000
1,85,000
By stock
1,01,000
84,800
Less - Charged to premises
10,000 74,800
To Freight
13,100
To Gross Profit c/d
1,68,100 5,16,000
5,16000 To general Expenses
16,900
By Gross Profit b/d
To salaries
14,500
By Interest due on Govt. Securities (4%)
To Debentures Interest Paid Outstanding
1,68,100 24,00
9000 Add
9000 18,000 5,740
To Directors Fees To Preliminary Expenses
1,000
To Depreciation Plant & Machinery Fixtures
36,000 360
To Provision for Bad debts Required
4,350
Bad debts Add
2,110
Less Existing Provision
36,360
6,460 3,500
2,960
To Provision for Income Tax
25,000
To Net Profit c/d
50,040 1,70,500
1,70500
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Profit & Loss Appropriation Account as on 31 December, 2005 Expenses
Amount
Incomes
Amount
( Rs) To Provision for Income Tax
25,000
To General Reserve
10,000
To Interim Dividend
75,00
To proposed dividend
22,625
To Balance of Profit sent to Reserves and surplus
9,915
( Rs) By Net Profit b/d
50,040
9,915
Balance Sheet of DEI Industry Ltd As on 31 December 2005 Liabilities
Amount
Share Capital : Authorised-60,000 shares of Rs 10 each
6,00,000
Issued, Subscribed & paid up capital fully called 4,60,000 Less calls in arrears 7,500 4,52,500 Reserves and Surplus: General Reserve P&L ACCOUNT
35,000 24,415
Current Liabilities: Bills Payable Sundry Creditors Provision for Income Tax Proposed Dividend
3,00,000 9,000
38,000 50,000 25,000 22,625 9,56,540
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Fixed Assets: Goodwill Premises Plant and machinery 3,60,000 Less Depreciation 36,000 Fixtures 7,200 Less Depreciation 360 Current Assets:
Secured Loans:
6% Debentures Interest Outstanding
Assets
Investments Interests Due Stock Sundry Debtors 87,000 Less Provisions for Bad debts 4,350
Cash in Hand Cash in bank Preliminary Expenses
Amount 25,000 3,10,000
3,24,000 6,840 60,000 2,400 1,01,000
82,650 750 39,900 4,000
9,56,540
Self-Check Questions Answer True or False 7. Fixed assets are those assets which are used for long time in business to earn profit. 8. Any reserve which is available for distribution as dividend to the shareholders is called Revenue reserve. 9. Assets These are the assets which are likely to be converted into cash within a year from the date of Balance Sheet. 10. All The total amount of authorised share capital is shown by way of information in the balance sheet. It is not added to liabilities of the company but is only stated for the purposes of disclosure. 11. A Balance Sheet is a statement of assets and liabilities indicating the financial position of an enterprise at a given date. 12. A Profit and Loss account shows the net result of business operations during an accounting period. 13. Profit and Loss Appropriation account shows how the profit for the year has been distributed or appropriated.
4.5
Financial statements of Non-Profit Organisation There are many institutions or organisations which are established not for earning profit but to render services to the society without profit earning as the key objective of the organisation. Such institutions are known as Non-Profit Organisations. For this same reason these institutions do not prepare Profit and Loss account. However, they would like to know whether their current expenses are being met by their current incomes or not.That is the reason why such institutions prepare a account called Income and Expenditure account which is more or less like a Profit and Loss account. This is a legal requirement and simultaneously, it helps them to control their expenditure and prepare their balance sheet. We may distinguish a Non-Profit Organisation with a Profit Earning Organisation on the following basis:
Basis Motive Funds
Non-Profit Organisation To provide service It is represented by General Funds comprising of donations, subscriptions etc
Profit-Earning Organisation To earn profit It is represented by the capital and accumulated reserves.
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Financial Statements
Surplus/Profit
Comprises of Receipts and Payments accounts, Income and Expenditure account and the balance sheet. Balance of the Income and Expenditure account is called either Surplus or Deficit.
Comprises of Trading and Profit & Loss account and balance sheet. Balance of the Profit and Loss account is called either Profit Or Loss.
The financial statements of Non Profit Organisations may be divided into three parts: a) Receipts and Payment Account b) Income and Expenditure Account c) Balance Sheet 4.5.1 Receipt and Payment Account Receipt and Payment account is the basic accounting database for a Nonprofit organisation. There is nothing special about the Receipts and Payment accounts except that they are the high level summary of the cash books. The Non-Profit Organisations such as hospitals, charitable institutions etc, render their services without having any profit earning objectives. They prepare Receipt and Payment accounts to maintain the record of the cash transactions of their organisation. However, usually they maintain only the Cash book and on the basis of the entries made in it, they prepare a summary of the cash transactions. When presented in the account form, this summary is called Receipt and Payment account. A specimen of the same has been given below: Receipt and Payment Account of D.E.I. Sports Club Receipts
Amount (
Payments
Amounts
INR ) To Opening Balance
By Rent
Cash in hand
By Upkeep of grounds
7500
By Materials purchased
Cash at bank
37,500
By other office expense
30000
By Land Purchased
To Subscriptions
By Closing Balance
2004
1000
2005 12,000
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(INR)
20,400
Cash in hand
4,500
Cash at bank
49,400
3000 1000 2500 500
2006
7,400
12,000
21000
5,000 To Entrance Fee
2,000
To Donations To Sale of old
5,000
53,900
materials To Investments
81,900
realised
81,900
Features of the Receipts and payment Account This account has the following features: The account starts with the opening balance of the cash in hand and at the bank. All receipts, irrespective of the period to which it pertains to or its nature (revenue or capital) are entered. The account will, for instance, contain both cash received on account of the membership fee and on account of sale of an asset. This will also contain the membership fee if it pertains to the next financial year. All payments irrespective of nature and period are entered in this account. Only actual payments and receipts are entered in this account i.e. no accrual entries are being passed in this account. The balance of this account will show the closing balance of the cash in hand and at the bank. It is like a real account because it deals with the cash transactions, which is an item of the real account. It does not compare the revenue and the expense for a particular period. It merely shows the receipts and payments in a particular period.
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4.5.2 Income and Expenditure Account As mentioned earlier, this account is used to compare the current incomes with the current expenditure and it further helps to prepare the balance sheet as well. It is prepared in the same manner as a Profit and Loss account. But the basic difference is that the Income and Expenditure account is prepared by Non-Profit Organisations, whereas the Profit and Loss account is prepared by Profit Earning organisations. Features of Income and Expenditure Account Some key features of Income and Expenditure accounts are given below: a) It records nominal accounts; expenses and losses on the debit side; incomes and gains on the credit side. b) No Capital item is entered in this account. c) No items relating to the past or future period are entered in this account. d) If for a current period any expense remains unpaid, it must be brought into account like an outstanding expense. For example, if the rent for a premises is Rs. 5,000 of which only Rs. 4,000 has been actually paid, then the expense will still show as Rs. 5,000 in the debit side of Income and Expenditure account. e) In the same manner, if an income that has been earned has not yet been actually received, it is brought into books. For example, for the year 2005, subscription of Rs. 10,000 is actually received and Rs. 1,000 is yet to be received, then the credit side of the income and Expenditure account will show a credit for Rs. 11,000, not for Rs. 10,000. f) If any fixed assets have been sold during the current year, the Profit and Loss on the sale of such assets is also shown in the Income and Expenditure account. g) Provisions and bad debts are recorded in this account. The basic difference between a Income and Expenditure account and a Receipt and Payment account is that the Income and Expenditure account actually compares the current expenditures and the current revenues of the organisation whereas the Receipt and Payment account simply records the cash transactions during a specific period in a very summarised way. The Receipt and Payment account is the key database to prepare the Income and Expenditure account because it is a kind of initial database which contains the details of most of the information which is required to prepare the Income and Expenditure and the balance sheet.
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A specimen of the Income and Expenditure account is given below: Name of the Organisation Income and Expenditure Account (For the period ended…) Dr. Particulars To Salaries To Rent To Printing To Insurance To Building Maintenance To Audit Fee To Deprecations To Surplus Grand Totals
Amount (INR) -
Particulars By Subscriptions By Entrance Fee By Donations By Hall rent By Profit on sale of assets By Deficit
Grand Totals
Cr. Amount(I NR) -
-
Difference between Income and Expenditure Account and Profit and Loss Account: As mentioned earlier, the Income and Expenditure account serves the same purpose for the Non-Profit Organisation as the Profit and Loss Account serves for a business concern. Income and Expenditure Account To ascertain whether the Organisation is able to meet it’s current expenses with it’s current incomes or not. Institution Prepared by Non-Profit organisation. Method Basis for preparation is Receipts and Payments account and the other information. Balance in the Is called either Surplus or Account Deficit Basis Object
Profit & Loss Account To ascertain the Net profit or the Net Loss.
Prepared by Profit Earning organisations. Basis for preparation is trial balance and other information. Is called either Net Profit or Net Loss.
Key Income items relating to the Income and Expenditure account 1. Entrance Fee: If the entrance fee is small and meant to cover only the current expenses of the organisation then it should be booked in the Income and Expenditure account itself. But, in cases where the entrance fee is substantially high, it should be added to the capital in the balance sheet.
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2. Life membership: It can be deciphered from the name itself that the fee charged for life membership is not related to a single year hence needs to be added to the capital of the organisation. 3. Subscriptions: Subscriptions are generally related to the current period to secure the membership thus should be taken into the income and expenditure account. But if it has been received in advance then it should be recorded as a liability and if it is outstanding from the member then it should be recorded as assets in the balance sheet. 4. Donations: All the donations related to the specific expenditure expenses of the institutions should be taken into the Income and Expenditure. All the other donations should be taken as an addition to the capital in the balance sheet. 5. Sale of old assets: The loss incurred on the sale of old assets or the organisation should be taken into the Income and Expenditure account whereas the profit on the sale of assets should be considered as a capital profit and hence should be taken to the Balance Sheet. 4.5.3 Balance Sheet As mentioned earlier, in the case of a business concern, the Profit and Loss account and the Balance Sheet is prepared on the basis of trial balance, but in the case of a Non Profit Organisation, the Balance Sheet and the Income and Expenditure account is prepared on basis of the Receipt and Payment account. The Receipt and Payment account contains all the information related to the Capital and Revenue receipts whereas the Income and Expenditure contains the information on the outstanding and prepaid incomes and expenditures. Thus we can compile both sets of information to prepare the balance sheet. The format and the steps to prepare a balance sheet have already been explained earlier. Illustration Below given is the Receipt and Payment account of the DEI Recreation Club for the year ended on 31st December 2005. Please prepare the Income and Expenditure account with the information given below. Receipt and Payment Account of DEI Recreation Club (For the year ended on 31st December, 2005) Receipts To Cash in hand To Subscriptions 2004 1200 2005 64800 2006 600 To Entrance Fee
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Amount 10,000
66,600 2,680
Payments By bank overdraft By Investments By Furniture By Salaries By Printing By Cost of Drama
Amounts 14,000 13,600 5,960 20,400 3,560 7,000
To Proceeds from Drama To Interest To Sale proceeds from old assets ( cost Rs 320 )
8,160 2,000 400
By Postage By Sundry Expense By Balance Cash in hand Cash at bank
89,840
4,400 5,600 3,320 12,000
89,840
Additional Information: i. ii. iii. iv. v.
On 1st January 2005 the club premises stood at Rs 1, 00,000; Investments at 24000; and Furniture at Rs 12000. The club had 720 members each paying and annual subscription of Rs 100. Salaries for December, 2005 amounting to Rs 1600 are outstanding. Half of the entrance fee is to be capitalized. Stock of stationary on 31st December 2004 was Rs 360 and on 31st December 2005 was Rs 400. Solution: Income and Expenditure Account of DEI Recreation Club (For the year ended on 31st December, 2005)
Expenditure To Salaries 20,400 Add Outstanding 1600 To Printing 3,560 Add Stock on 31.12.04 360 Less Stock on 31.12.05 400
Amount
Income
Amount
64,800 22,000 By Subs. Add Outstanding 7,200 3,520 4,400 By Entrance Fee 5,600 By Proceeds from Drama ( net of cost) 41,060 By Interest By Profit on sale of furniture
72,000 1,340 1,160
76,580
76,580
2,000 80
To Postage To Sundry Expense To Surplus Totals
Totals
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Balance Sheet As on Dec 31.2005 Liabilities Capital fund: As on 1.1.05 1,33,000 Add: Entrance fee 1,340 Surplus for the year 41,060
Amount
Assets
Amount 1,00,000
Club premises 1,75,960 600 1,600
Furniture 12,000 Less:- Book value of Furniture sold 320
Subscription received in advance
11,680 Add: Purchase 5,960
O/S Salaries
Investments 24,000 Add: Purchase 13,600 Add Outstanding 7,200 Stock of Stationery Cash at Bank Cash in Hand Subscriptions in Arrear 1,78,160
Totals
17,640 37,600 400 12,000 3,320 7,200
1,78,160 Totals
BALANCE SHEET As on Jan 1, 2005 Liabilities Bank Overdraft Capital Fund (Balancing figure)
Amount Assets 14,000 Premises 1,33,500 Furniture’s Investments Stock of stationery Cash in hand Subscriptions in Arrear
1,47,560 Totals
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Amount 1,00,000 12,000 24,000 360 10,000 1,200
1,47,560 Totals
Self-Check Questions Answer True or False 14. If the entrance fee is substantially high, then it should be added to the capital in the balance sheet. 15. Life membership is to be added in the capital. 16. The receipts and payments account is a summarised cash book. 17. It is not necessary for a charitable organisation to prepare accounts.
4.6
Summing Up With this we may conclude that the financial statements are the statements which show the profit earned or the loss suffered and the financial state of affairs at the end of the period in question. In other words, the financial statements are the summarised statements of the accounting data produced at the end of the accounting period by an enterprise through which it communicates the accounting information to the users. The Trading Account and the Profit and Loss Account show the gross profit and the net profit earned by an enterprise during a financial year. The Profit and Loss Appropriation Account is prepared to show the distribution of profits and losses. The Balance Sheet is prepared as on the given date, which shows the capital, assets and liabilities of the business. The financial statements of a Non Profit Organization consists of the Receipt and Payment account, Income and Expenditure account and Balance Sheet. Since the objective of these organisations is not earning profit, they prepare different accounts than a company established with an objective to earn profit.
4.7
Answers to Self-Check Questions
1. True 2. False 3. True 4. True 5. True 6. False 7. True 8. True 9. True 10. True 11. True 12. True
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13. True. 14. True 15. True 16. True 17. False.
4.8
Terminal Questions
1. State the purpose of preparation of Profit and Loss Appropriation Account? 2. Explain the different heads of the balance sheet. 3. What is the difference between the financial statements of a Non Profit Organisation and that of others? 4. Explain the difference between Receipt and Payment Account and an Income and Expenditure account. 5. What are the key revenue items which are shown in the Income and Expenditure account?
4.9
References
1. T.S. Grewal, “Double entry Book Keeping”, New Delhi: S Chand & Company 2. Lal, J. & Srivastav, S. “Financial accounting: Principles and practices” New Delhi: Sultan Chand Publications.
4.10 Suggested Further Reading 1. Grewal, G.S. & Grewal, H.S. (1991), “Double entry book-keeping”, New Delhi: Sultan Chand & Sons. 2. Narayanaswamy, R. (2001), “Financial Accounting: A managerial perspective”, New Delhi: Prentice Hall of India.
4.11 Glossary • • • • •
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Surplus - The share of the profit which is carried forward to the next years profit and loss account after all the appropriations thereof. Reserves - Amounts set aside out of profit and other surpluses to meet future uncertainties. Shareholders Equity - The pool of share capital, surplus profits and reserves which belongs to the share holders of the company. Balance Sheet - Statement of a company’s assets and liabilities as on a particular date. Profit & Loss Account - Statement showing the expenses incurred and the revenue earned during a particular period. Balance of this account will be either profit earned or the loss suffered by the organisation.
•
•
•
•
Non-Profit Organisations - Non-Profit Organisations are organisations which are established not for earning a profit but for rendering a service, such as hospitals, charitable institutions etc. Cash Book - Used to record the details of the cash transactions in chronological order. It is a kind of log book in which details of every cash transactions are entered. It is generally prepared by all institutions dealing in cash. Receipt and Payment Account - High level summary of a cash book which is further used to prepare the other financial statements of an organisation. (Normally a Non-Profit Organisation). Income and Expenditure Account - Account which contains only the transactions for revenue and expenditure. It does not carry the transactions which are of capital nature.
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