Taxmann's Accounting (Accounts) | Study Material

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What we will study in this chapter: We will study in this chapter, how final account (annual accounts) are prepared for proprietary and partnership firms engaged in business and the adjustments required to be made.

Final accounts of non-corporate entities i.e. sole proprietary concerns and partnership firms/concerns will be studied in this chapter.

Final accounts are the end results of the whole accounting process. Final A/c’s or annual accounts includes the following statements:

(1)Trading & Profit & Loss Account and (2) Balance Sheet.

In case of manufacturing concerns the final a/c’s may include the following statements.

(1)Manufacturing A/c., (2) Trading, Profit & Loss A/c., (3) Balance Sheet.

The above final a/c’s are prepared with the help of trial balance and additional information/adjustments.

Trading and Profit & Loss A/c shows the result of the operation (performance) that is profits earned or loss incurred during that year. Therefore all Expenses and Incomes related to that period should come in the P&L A/c, whether it is paid/received or not is not important i.e. expense should be recognized when incurred means services/benefits are received and income should be recognized when earned i.e. when services/benefits are given. This is also referred as Mercantile system of accounting or recognition of accrual principle. Due to this we make adjustments for outstanding expenses, Outstanding Incomes, prepaid expenses, Advance Incomes, closing stock etc.

Balance sheet shows the Assets & Liabilities of the organization as on a particular date. It is not an account. It is not for any period or year. It shows the financial position of the entity as of a particular date (rather at a point of time).

Manufacturing account if prepared shows the cost of goods manufactured during that period. This cost is transferred to Trading A/c.

Trading account shows the profit/loss made on a gross basis that is including only the direct cost of the goods. In trading a/c, we credit the trading income like sale and debit the cost of goods sold (opening stock + purchases (-) closing stock).

Alternatively Opening Stock & purchases is debited & Closing stock is credited to trading account. Other direct expenses related to purchase or manufacture of goods like carriage inward, wages, etc. are also debited here.

Purchase return & Sales returns will be deducted/adjusted from the purchases & sales respectively. The balance is known as the gross profit or gross loss, which is transferred to profit and loss a/c.

Non-corporate entities usually prepares trading a/c so as to know the gross margin available in its sale. But at corporate level usually it is not prepared. In those cases the items of trading account gets incorporated in profit & loss account.

Illustration 13.1 : The following is the extract of trial balance as on 31.3.2021 and certain additional information of Shri Tendulkar, who carries on business under the name and style of M/s. Tendulkar and Company at Bombay:

Additional Information:

1.Value of stock at close of year 44,000 Prepare Trading A/c for the year ended 31.3.2021.

Solution:

M/s Tendulkar and Company Trading a/c

For the year ended 31st March, 2021

It shows the performance of the entity i.e. profit earned or loss suffered considering all indirect expenses and incomes.

Gross profit or gross loss from trading account is transferred to P&L a/c.

Other incomes like discount, interest, etc. are credited.

Administrative expense, selling and distribution expense, financial expense, income tax, losses, etc. are debited to it.

The net profit/net loss is transferred to P&L appropriation a/c (if made) otherwise to capital a/c. If trading a/c is not prepared then in place of gross profit/gross loss all items of trading a/c will come in P&L a/c itself

Although not necessary, but usually full profit/loss is transferred to proprietor/partners capital account, hence profit & loss account does not appear in balance sheet.

Illustration 13.2 : The following is the extract of trial balance as on 31.3.2021 and certain additional information of Shri Tendulkar, in continuation of what is given in Illustration 13.1:

Additional Information:

2.Depreciate-

(a)Building by 3,000

(b)Furniture and fixture by 2,000

(c)Office equipment by 2,400

(d)Typewriter by 300

(e)Motor Van by 4,000

3.One month’s rent for godown is outstanding.

4.One month’s salary is outstanding.

5.Interest on loan from Vishwanath payable 600

6.Reserve for bad debt is to be maintained at 4,300.

7.Insurance Premium includes 4,000 paid towards proprietor’s L.I.C. policy and the balance of the insurance charges cover the period 1.4.2020 to 30.6.2021.

8.Half of the building is used for residential purposes of Sri. Tendulkar. Prepare Profit and Loss A/c for the year ended 31.3.2021.

Solution:

M/s Tendulkar and Company Profit and Loss a/c

For the year ended 31st March, 2021

The net profit/net loss is transferred to P&L appropriation A/c.

Interest charged on drawings is credited to it.

Interest allowed on capital, salary/commission to proprietor/partner and transfer to reserves are debited to it.

The net balance then left is transferred to capital a/c.

Expenses incurred to earn income is treated as charge against profit and are debited to P&L a/c whereas items which are division of this profit earned are known as appropriation of profit and charged to P&L appropriation a/c.

Trading account, P&L a/c and P&L app. a/c are period statements, showing the result (performance) of that period, usually an accounting year.

In case of corporate organization like companies balance after all appropriations including dividend, remains in P&L/P&L appropriation a/c and hence appears in balance sheet.

Illustration 13.3 : The following is the extract of trial balance as on 31.3.2021 and certain additional information of Shri Tendulkar, in continuation of what is given in Illustrations 13.1 and 13.2:

Additional Information:

9.Salary due to Tendulkar 500 p.m.

10.Interest on capital @5% be provided 8,100.

11.Interest on drawings 2,100

Prepare Profit and Loss Appropriation A/c for the year ended 31.3.2021.

Solution:

To Salary to Proprietor (500 × 12)

(Balance profit transferred)

M/s Tendulkar and Company Profit and Loss Appropriation a/c

For the year ended 31st March, 2021

By Profit & loss A/c (Net profit transferred)18,700

A manufacturing concern may prepare Manufacturing a/c to ascertain cost of goods manufactured.

Raw material consumed (Op. stock + Purchases - Closing stock), carriage inward, wages, power, depreciation of factory building, machinery, etc. and other manufacturing (factory) expense are debited to it.

Opening WIP stock is debited and closing WIP stock credited.

Balance is the cost of goods manufactured and is then transferred to trading account.

When manufacturing a/c is not prepared, these items will come in trading a/c. Sometimes depreciation a/c may be directly taken to P&L a/c instead of trading a/c.

Manufacturing a/c is also a period statement.

A manufacturer is one who purchases raw material and process it into finished goods with the help of labour and machines at his factory and sells the finished goods. Whereas a trader purchases goods and sells it as it is.

Refer Illustration 13.13

Balance sheet shows the financial position of the entity as at a particular point of time.

It shows what and how much entity owns (i.e. its assets) and how much it owes to others (i.e. its liabilities), the balance (i.e. asset - liability) is the owners equity.

It is not an account, hence does not have debit and credit side.

On one side assets like fixed assets (building, machinery, furniture, etc.), current assets (like stock, debtors, cash bank balance, advances, prepared a/c) and investments if any are shown.

On the other side in addition to owners capital and reserves, the outside liabilities like loans taken, creditors, expenses payable etc. are shown.

The two sides total must be same.

On the asset side of balance sheet we start with most permanent to least permanent i.e. fixed assets, investments and then current assets. It is known as permanency preference. In case of manufacturer/trader this sequence is followed hence student will see this in all the chapters.

When asset side starts with most liquid asset to least liquid like cash bank balance and ends with fixed assets is known as liquidity preference generally followed by institutions like banks.

Liability side is mostly same in all cases we have first owner capital and reserves, then loans and thereafter current liabilities and provisions.

Balance sheet is a point of time statement, when stated as at 31.3.2021 it means as at close of that date i.e. after considering all transactions of that day.

Even though balance sheet does not have debit and credit side, student should remember that asset side represent debit and capital and liability side represent credit. It will help in correctly preparing final accounts.

In General Mercantile/accrual system is followed, as it is the proper and complete system to measure the performance of entity. In your syllabus every where this is considered. Under this system, incomes are recognized when these are earned irrespective of whether amount is received or not. Similarly expenses are recognized when these are incurred or accrued irrespective of whether amount is paid or not. As a result we have to make adjustment for expenses outstanding (payable), prepaid, income outstanding (receivable) and advance-received etc.

Illustration 13.4 : The following is the extract of trial balance as on 31.3.2021 and certain additional information of Shri Tendulkar, in continuation of what is given in Illustrations 13.1, 13.2 and 13.3:

DebitCredit

Prepare Balance Sheet as on 31.3.2021.

Trial balance is a statement containing the balances of all accounts as at the end of certain period usually classified into debit and credit.

The total of debit and credit side must tally because whole accounting is done by double entry principle, otherwise it indicates arithmetical inaccuracies.

It has balance of expenses, incomes, assets and liabilities.

With the help of trial balance and adjustments the final accounts are prepared.

All expenses and incomes will go into Manufacturing, Trading, P&L and P&L app. a/c depending upon its nature and all assets and liabilities will go into balance sheet.

When the trial balance is prepared, there may still be some accounts which are not yet final and may need some adjustments, some corrections etc.

Such information is given together with trial balance and commonly referred as adjustment/additional information/other information etc.

It is basically a transaction which needs to be entered in the account books or some errors which needs to be rectified, hence we give double entry effect i.e. Debit & Credit both for such adjustments.

Some times indirect information is contained, in the trial balance, which when interpreted results into an adjustment (known as adjustment derived).

Place where information is given is irrelevant. Hence adjustment though commonly given below the trial balance, can be given in the trial balance or above the trial balance.

(1) Outstanding Expenses/Expenses payable/Expense accrued (i.e. services/benefits have been received during the year, but payment not yet made.)

Expenses a/c Dr.

To Expenses Payable a/c (Liability)

(2) Prepaid expenses/Advance payment. (i.e. payment has been made but services/benefits have not been received during the year.)

Prepaid Expenses a/cDr. (Assets)

To Expenses a/c

(3) Outstanding Income/Income receivable/Accrued income. (i.e. services/benefits have been rendered during the year, but payment not yet received.)

Income receivable a/cDr. (Assets)

To Income a/c

(4) Incomes received in advance (i.e. payment has been received but services/benefits have not been rendered during the year.)

Income a/c Dr.

To Advance Income a/c (Liability)

(5) Depreciation: Following are the two ways of accounting for Depreciation.

(a)Depreciation a/cDr.

To Assets a/c

(b)Depreciation a/cDr.

To Depreciation reserve/Depreciation fund/Depreciation provision a/c (Depreciation a/c is an expense which will be transferred to P&L a/c)

(6) Closing Stock adjusted/accounted.

Stock a/c Dr. (Assets)

To Trading a/c

Refer Illustration 13.9

Any or all of the adjustments mentioned above can be recorded in the books of account and then trial balance can be prepared.

Similarly stocks can also be adjusted before preparing trial balance as follows:

Transfer Opening stock account to Purchases account i.e. Debit purchase a/c and Credit Opening stock a/c. Record closing stock in the books i.e. Debit Closing stock account and Credit Purchases account.

Now in the Trial balance opening stock will not appear instead closing stock will appear which will be shown as asset in the balance sheet.

The balance in Purchases account is the cost of goods sold also known as adjusted purchases which will be debited to trading account.

Illustration 13.5: Below is the trial balance of Shah as December 31, 2020

Additional information:

1.Rates have been prepaid to the extent of 175.

2.Bad debts 500 have to written off. A provision for doubtful debts @ 5% on debtors is necessary.

3.Building has to be depreciated at 2% and Furniture @ 10%.

4.The manager is entitled to a commission of 5% of net profits before charging such commission. Solution:

Trading and Profit and Loss Account of Shah for the Year ended on December 31, 2020

Particulars Particulars

* 20,900 less 9,040 (the total of all expenses so far), Manager is entitled to 5% of this figure.

(1) The trial balance gives “Adjusted Purchases”. It means that the opening stock has already been transferred to the Purchases Account and thus been closed. Further, entry for closing stock has already been passed by debiting the Closing Stock Account and crediting Purchases Account. That is why closing stock appears inside the trial balance. It will now be shown in the Balance Sheet and not in the Trading Account since purchases already stand reduced.

(2) There is a Loan of Desai @ 9% taken in 2019 i.e. in last accounting year. As per mercantile system interest up to 31.12.19 must have been provided in the last years a/c itself. The trial balance makes no mention of any interest being paid to him. Hence, interest @ 9% must be provided for the whole of current year only.

Balance Sheet of Shah as at December 31, 2020

Although there is nothing wrong in either.

But as a student our objective should be to improve our knowledge of accounting.

Debit credit is the language of accounting and not add-less, hence it is advisable to use your debit-credit (i.e. accounting) knowledge everywhere.

Formulate a double entry for every transaction/adjustment and then give its effect to same accounts if appearing in trial balance and the final figure then will appear in final account.

There is no point in memorising a long list of adjustment with there add less effects. Entry should be formed using basic accounting knowledge as studied in Chapter 1.

In any case in a real situation every adjustment is required to be accounted in the books of account then only profit and loss a/c and balance sheet will be as per the books of account (or in agreement with books of account) as is certified by an auditor.

After all adjustment are duly accounted.

The individual expenses accounts are closed by debiting into trading or P&L a/c etc. as the case may be.

Similarly all incomes a/c are closed by crediting it to Trading & P&L a/c.

Such entries are known as closing entries.

Balance of trading account (gross profit) is transferred to P&L a/c.

Balance of P&L a/c (net profit) is transferred to capital a/c.

Thus we are left with only the balances of assets and liabilities (including capital) which are shown in the balance sheet and carried forward to next years books of account by writing the balance on the other side of the account and thus account is shown as closed i.e. total on both debit and credit side gets equalized.

When the books of account have been audited and final accounts have been prepared, then the closing entries as above are passed.

All assets and liabilities accounts are balanced, shown in the balance sheet and carried forward to next years account book.

It is a accepted norm, not to make any changes once the account books are audited and closed.

(1)All debit balances will be either expenses or assets & all credit balances will be either incomes or Liabilities.

(2)All expenses and incomes accounts are transferred to trading and profit and loss a/c and are thus closed.

(3)All assets & liabilities as shown in the Balance sheet are carried forward to next years books as opening balance. Refer Illustration 13.9

When goods are sold on credit it creates a debt (debtor) to be collected in future.

Debtors will include a number of parties from whom money has to be collected.

If amount can’t be collected from any party it is said to be a bad debt (a loss).

If we are sure that amount can’t be collected and wants to close that party’s account i.e., wants to write off the Bad debt then entry will be-

(1) Bad debt a/c Dr. .....

To Concerned party A/c (Debtors a/c) .....

But if we don’t want to close the party account and still want to account the Bad debt loss i.e., want to provide for the Bad debts or create provision for Bad debts, then entry will be:

(2) Bad debts a/c Dr. .....

To Provision/Reserve for Bad & doubtful debt a/c .....

Entry for writing off the Bad debts (Entry No.1 in above question) may be passed any time during the year.

But entry for creating provision for Bad debts (Entry No.2) is passed at the end of year only.

The total debtors at the end of the year is ascertained and how much of it is doubtful of recovery is estimated. This will give the amount of total provision required or to be maintained.

If already we don’t have any provision in the books then entry as per (2) above will be passed for full amount.

But if we have opening balance of provision then entry will be passed only for the difference amount known as additional provision (i.e. New Provision (i.e. total provision required) (-) Opening balance of Provision).

Alternatively opening provision is reversed and entry for closing provision (New provision) is passed by full amount.

If the opening balance of provision is more than the provision required at the end of the year, then the excess provision will have to be written back as follows:

(3) Provision for Bad & Doubtful debt a/c Dr. .....

To Bad debts a/c .....

This may be mentioned in adjustment as ‘provision to be decreased/reduced by……..

The total of Bad debt is debited in profit & loss a/c. Total bad debt loss is:

(1) bad debt written off + additional provision or

(2) bad debt written off + new provision (-) old provision.

The closing balance of provision (Final Provision/new provision) will be shown as deduction from Debtors in Balance Sheet.

Interpretation of adjustment given in the question as to whether it is Total Provision or Additional Provision can be made as follows:

Accounting (Accounts) | Study Material

PUBLISHER : TAXMANN

DATE OF PUBLICATION : SEPTEMBER 2024

EDITION : 6TH EDITION

ISBN NO : 9789357786577

NO. OF PAGES : 706

BINDING TYPE : PAPERBACK

Rs. 1,150

DESCRIPTION

The book aims to build a strong foundation in Accounting for students and lay the groundwork for their professional education. It focuses on essential accounting concepts such as Accounting Principles, Capital & Revenue Items, and other key topics, providing students with a solid understanding of the basics.

This book is prepared exclusively for the Foundation Level of Chartered Accountancy Examination requirement. It covers the entire revised, new syllabus as per ICAI.

The Present Publication is the 6th Edition for the CA-Foundation | New Syllabus | Sept.2024/Jan. 2025 Exams. This book is authored by CA D.G. Sharma & Dr S.K. Agrawal, with the following noteworthy features:

• [Lucid Discussions in Simple Language] are provided for theoretical concepts to facilitate a comprehensive understanding

• [Numerous Illustrations] are incorporated to clarify complex topics

• [Detailed Working Notes & Practice Questions] with hints and answers are included for enhanced practice

• [Coverage] of this book includes:

o Solved Paper – June 2024 | Suggested Answers

• [Student-Oriented Book] The authors have crafted this book with a focus on:

o Their interaction with students, especially addressing the difficulties faced in examinations

o Insights shaped by their extensive experience teaching the subject matter at various levels

o Incorporating feedback and responses from students throughout the content

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