CHAPTER 3.1
PREPARATION OF FINANCIAL STATEMENTS OF SOLE PROPRIETORSHIP
Quick Revision of the chapter
Important Concepts
Income Statement
The term ‘Income Statements’ is a generic term which refers to those components of financial states which are associated with determination of operating result i.e. ascertainment or profit earned or loss suffered. For non-corporate commercial organisations (i.e. proprietorship businesses, partnership firms etc.) the income statements include Trading Account, Profit & Loss Account (P/L A/c) and Profit & Loss Appropriation Account.
The components of income statements of non-corporate commercial organisations
1. Trading Account: This is the first income statement prepared by a non-corporate trading business entity. It is prepared to determine the gross operating results (i.e. Gross Profit or Gross Loss). Its principle involves matching of the Cost of Goods Sold (COGS) of an accounting period against the corresponding Sales. It considers only the direct costs and direct income (i.e. Sales) for determination of Gross Profit/ Gross Loss. It is a nominal account, and is closed by transfer of the Gross Profit/ Gross Loss to the Profit and Loss A/c.
The following items will appear in the debit side of the Trading Account:
(i) Opening Stock: In case of trading concern, the opening stock means the finished goods only. The amount of opening stock should be taken from Trial Balance.
(ii) Purchases: The amount of purchases made during the year. Purchases include cash as well as credit purchase. The deductions can be made from purchases, such as, purchase return, goods withdrawn by the proprietor, goods distributed as free sample etc.
(iii) Other Direct expenses: It means all those expenses which are incurred from the time of purchases to making the goods in suitable condition. This expenses includes freight inward, octroi, wages etc.
3.1
3.2
MODULE 3 : PREPARATION OF FINAL ACCOUNTS
(iv) Gross profit: If the credit side of Trading A/c is greater than debit side of Trading A/c gross profit will arise.
The following items will appear in the credit side of Trading Account:
(i) Sales Revenue: The sales revenue denotes income earned from the main business activity or activities. The income is earned when goods or services are sold to customers. If there is any return, it should be deducted from the sales value. As per the accrual concept, income should be recognized as soon as it is accrued and not necessarily only when the cash is paid for.
(ii) Closing Stocks/Inventories: In case of trading business, there will be closing stocks of finished goods only. According to convention of conservatism, stock is valued at cost or net realizable value whichever is lower.
(iii) Gross Loss: When debit side of trading account is greater than credit side of trading account, gross loss will appear.
2. Profit & Loss Account: The second income statement is the Profit & Loss Account. It is drafted after the determination of Gross operating result i.e. Gross Profit or Gross Loss. This account determines the Net Profit or Net Loss of an organisation for a particular accounting period. It is prepared by charging the indirect expenses and losses against the Gross Profit and other indirect incomes. It is closed by transfer of the Net Profit or Net Loss to the Capital Account(s) of the proprietor or partners.
The following items will appear in the debit side of the Profit & Loss A/c:
(i) Cost of Sales: This term refers to the cost of goods sold. The goods could be manufactured and sold or can be directly identified with goods.
(ii) Other Expenses: All expenses which are not directly related to main business activity will be reflected in the P & L component. These are mainly the Administrative, Selling and distribution expenses.
Examples are salary to office staff, salesmen commission, insurance, legal charges, audit fees, advertising, free samples, bad debts etc. It will also include items like loss on sale of fixed assets, interest and provisions.
(iii) Abnormal Losses: All abnormal losses are charged against Profit & Loss Account. It includes stock destroyed by fire, goods lost in transit etc.
The following items will appear in the credit side of Profit & Loss A/c:
(i) Revenue Incomes: These incomes arise in the ordinary course of business, which includes commission received, discount received etc.
(ii) Other Incomes: The business will generate incomes other than from its main activity. These are purely incidental. It will include items like interest received, dividend received, etc. The end result of one component of the P & L A/c is transferred over to the next component and the net result will be transferred to the balance sheet as addition in owners’ equity. The profits actually belong to owners of business. In case of company organizations, where ownership is widely distributed, the profit figure is separately shown in balance sheet.
3. Profit & Loss Appropriation Account: This component of income statement shows the appropriation of the net profit among the partners of a partnership business. Sole proprietorship businesses are not required to prepare the P/L Appropri-
ation account. The net profit may be used by the business to distribute dividends, to create reserves etc. In order to show these adjustments, a P & L Appropriation A/c is maintained. Distribution of profits is only appropriation and does not mean expenses. After passing such distribution entries, the remaining surplus is added in owner’s equity
Balance Sheet
Balance Sheet is the financial statement that is prepared to show the financial position of the organisation on a specific date. It is prepared after drafting Income Statements i.e. Trading Account and P/L Account. It reflects the assets and liabilities of a concern at a particular point of time. The Balance Sheet may be drafted either in Horizontal format or in Vertical format. In the horizontal format, the Liabilities appear on the left-hand side, while the Assets appear on the right-hand side of the Balance Sheet. This is the traditional format followed by non-corporate commercial organisations. In the vertical format, the liabilities and assets appear in a top-down order.
The various items should appear in the Balance Sheet in a specific order which is known as Marshalling. When the assets which are most permanent in nature appear at the top, and the current assets appear below them, and for liabilities, the capital and long-term liabilities appear above the short-term liabilities, it is known as marshalling under Rigidity Order or Permanence Order. When the reverse ordering is followed as regards the assets and liabilities, it is known as marshalling under Liquidity Preference Order or Realisability Order.
PAST EXAMINATION QUESTIONS
THEORY QUESTIONS
Q.1. The accounts receivable are shown in the balance sheet at:
(a) Current market value
(b) Estimated net realizable value
(c) Original cost when the asset is recorded in the books of account
(d) Sales Value [Sept. 2014]
Ans. (b) Estimated net realizable value
Q.2. Which one of the following balance will not be carried to the next accounting period?
(a) Rent paid in advance
(b) Closing cash balance
(c) Salary outstanding
(d) Consultancy fees paid [Sept. 2014]
Ans. (d) Consultancy fees paid
Q.3. The basic objective of preparing Profit and Loss Account is:
(a) To know the financial position of the organization on a particular period.
(b) To know the financial results of the organization for a particular period.
(c) To know the financial results of the organization on a particular date.
3.4
MODULE 3 : PREPARATION OF FINAL ACCOUNTS
(d) To calculate the cost of goods sold during a particular period. [Sept. 2014]
Ans. (b) To know the financial results of the organization for a particular period.
Q.4. Prepaid expenses will not be reflected in:
(a) Profit & Loss Account
(b) Cash Book
(c) Balance Sheet
(d) Cash Flow Statement [Sept. 2014]
Ans. (d) Cash Flow Statement
Q.5. Net worth is excess of:
(
a) Fixed Assets over Current Liabilities
(
b) Total Assets over Total Liabilities
(
c) Fixed Assets over Current Assets
(d) Long-Term Loan over Short-Term Loan [Sept. 2014]
Ans. (b) Total Assets over Total Liabilities
Q.6. As per the Companies Act, which of these are allowed to create secret reserves in their books of account:
(
a) Banking Companies
(b) Insurance Companies
(
c) Electricity Companies
(d) All the three [Dec. 2014]
Ans. (d) All the three
Q.7. Which of the following is not true with regard to preparation of Profit & Loss Account?
(a) Profit & Loss Account is prepared for a certain period and hence it is an interim statement.
(b) Profit & Loss Account does not disclose the effect of non-financial items.
(
c) Net Profits are ascertained on the basis of current costs.
(d) Net Profits as disclosed by P&L Account is not absolute. [Dec. 2014]
Ans. (a) Profit & Loss Account is prepared for a certain period and hence it is an interim statement.
Q.8. On the debit side of a Sales A/c entry can be for which of these reasons:
(a) Sales returns
(b) Discount allowed
(c) Both
(d) Additional sales [Dec. 2014]
Ans. (c) Both
Q.9. Interest payable on debentures is _______.
(
a) An appropriation of profit
(b) A Charge against profit
(c) Transferred to sinking fund
(d) Treated as miscellaneous expenses to be shown in balance sheet. [March 2015]
Ans. (b) A Charge against profit
Q.10. Financial statements do not consider:
(
a) Assets expressed in monetary terms.
(
(
b) Liabilities expressed in monetary terms.
c) Only assets expressed in non-monetary terms.
(d) Assets and liabilities expressed in non-monetary terms. [Sept. 2015]
Ans. (d) Assets and liabilities expressed in non-monetary terms.
Q.11. Prepaid expenses are valued on the balance sheet at:
(a) Replacement Cost
(b) Current Cost
(c) Cost less expired portion
(d) Cost to acquire less accumulated amortization [March 2016]
Ans. (c) Cost less expired portion
Q.12. When a fixed assets is obtained as a gift, the account to be credited is:
(a) Goodwill A/c
(
b) Capital Reserve A/c
(c) Donor’s A/c
(d) General Reserve A/c [March 2016]
Ans. (b) Capital Reserve A/c
Q.13. Closing balance of Work in Process (WIP) is part of:
(a) Assets A/c
(
b) Expenses A/c
(c) Liability A/c
(d) Owner’s equity A/c [March 2016]
Ans. (a) Assets A/c
Q.14. Gross profit is the difference between:
(a) Net sales and cost goods sold
(b) PAT and Dividends
(c) Net sales and cost of production
(d) Net sales and direct costs of productions [June 2016]
Ans. (a) Net sales and cost goods sold
Q.15. Which of the following is/are Fixed Assets?
(a) Closing inventory
(b) Fixed Deposits in a Bank
(c) Patents
(d) Prepaid expenses [June 2016]
Ans. (c) Patents
Q.16. Cash received from debtors would be deemed as _____ of funds.
(a) No flow
(b) Sources
(c) Uses
(d) Gain [June 2016]
Ans. (a) No flow
Q.17. Tax deducted at source A/c appears in:
(
a) Asset side
(b) Liability side
(c) Profit and loss A/c
(d) Debited to capital A/c [June 2016]
Ans. (a) Asset side
Q.18. Insurance prepaid is shown as:
(a) Current asset
(b) Current liability
(c) Fixed asset
(d) Income [June 2016]
Ans. (a) Current asset
Q.19. Which of the following are current assets of a business?
(i) Income received in advance
(ii) Stock
(iii) Prepaid expenses
(iv) Accrued income
(v) Debtors
(a) Both (i) and (iv) above
(b) Both (ii) and (iii) above
(c) (i), (ii) and (iii) above
(d) (ii), (iii), (iv) and (v) above [June 2016]
Ans. (d) (ii), (iii), (iv) and (v) above
Q.20. Which of this is not operating income?
(a) Income for sales of trading goods
(b) Bad debts recovered
(c) Interest on FDs
(d) None of the above [June 2016]
Ans. (c) Interest on FDs
MODULE 3 : PREPARATION OF FINAL ACCOUNTS
Q.21. Research and Development Cost A/c appearing in Balance Sheet is a ______.
(a) Real A/c
(b) Intangible assets
(c) Tangible assets
(d) Personal A/c [June 2016]
Ans. (b) Intangible assets
Q.22. ________is a financial expense.
(a) Foreman salary
(
b) Office building rent
(
c) Interest on debt
(
d) Warehouse charges [Dec. 2016]
Ans. (c) Interest on debt
Q.23. The manufacturing account is prepared.
(a) To ascertain the profit or loss on the goods produced
(b) To ascertain the cost of the manufactured goods
(
c) To show the sale proceeds from the goods produced during the year
(
d) Both (b) and (c) [June 2017, Dec. 2018, June 2019 June 2023, June 2024]
Ans. (b) To ascertain the cost of the manufactured goods.
Q.24. Claims against company pending in court case. It is a:
(
a) Current Liability
(
b) Current Asset
(
c) Contingent Liabilities
(d) Unsecured Loan [Dec. 2017]
Ans. (c) Contingent Liabilities
Q.25. Which one of the following is not a financial statement?
(a) Trial Balance
(b) Profit and Loss Account
(c) Balance Sheet
(d) Cash Flow Statement [June 2018, Dec. 2018]
Ans. (a) Trial Balance
Q.26. Closing stock appearing in the trial balance is shown in:
(a) Trading A/c and Balance sheet
(b) Profit and Loss A/c
(
c) Balance Sheet only
(d) Trading A/c only [June 2018]
Ans. (c) Balance Sheet only
Q.27. Till the discounted bill is paid by the acceptor, it remains as:
(a) A contingent liability
(b) A current liability
(c) An asset
(d) An expense [Dec. 2018]
Ans. (a) A contingent liability
Q.28. Which of the following is not a paper transaction?
(a) Charge of depreciation
(b) Discount received
(c) Bad debts written off
(d) Cash stolen from office [Dec. 2018]
Ans. (a) Charge of depreciation
Q.29. Which of the following is correct?
(a) Cost of Goods Sold - Opening Stock + Purchases = Closing Stock
(b) Purchase + Cost of Stock Goods Sold - Opening Stock = Closing
(c) Cost of Goods Sold + Closing Stock - Opening Stock = Purchase
(d) Opening Stock + Closing StockPurchase Cost of Goods Sold [Dec. 2019]
Ans. (c) Cost of Goods Sold + Closing Stock - Opening Stock = Purchase
Q.30. AS-09 deals with:
(a) Inventory Valuation
(b) Depreciation Accounting
(
(
c) Revenue Recognition
d) Cash Flow Statement [Dec. 2019]
Ans. (c) Revenue Recognition
Q.31. Which of the following statement is true?
(
a) Fixed assets - Current liabilities = Current assets.
(
(
b) Discount on bills is a loss for the drawer and gain for the drawee.
c) Profit and loss account covers a period and not the position of a particular day.
(
d) The surplus of a non-profit organisation is distributed among the members. [June 2023]
Ans. (c) Profit and loss account covers a period and not the position of a particular day.
Q.32. In case of sole proprietorship, income tax is:
(a) Debited to profit and loss account.
(b) Shown in the balance sheet as a current liability.
(
c) Treated as proprietor’s personal expense.
(
d) None of the above. [Dec. 2023]
Ans. (c) Treated as proprietor’s personal expense.
Q.33. Which of the following is not a component of financial statement of a trading sole proprietorship business concern?
(a) Balance Sheet
(b) Profit & Loss A/c
(
c) Profit & Loss Appropriation A/c
(d) Trading A/c [June 2024]
Ans. (c) Profit & Loss Appropriation A/c
Q.34. While drafting financial Goods statements, distributed as free samples but not yet accounted for in the books’ is to be reflected in which of the component(s)?
(a) Only in Trading A/c
(b) Only in Profit & Loss A/c
(c) Both Sheet in Trading A/c and Balance
(d) Both in Trading A/c and Profit & Loss A/c [June 2024]
Ans. (d) Both in Trading A/c and Profit & Loss A/c
Q.35. Outstanding Wages appearing in Trial Balance is reflected in:
(a) Trading A/c (Debit-side)
(b) Profit & Loss A/c (Debit-side)
(c) Balance Sheet (under Liabilities)
(d) Profit & Loss Appropriation A/c (Debit-side) [June 2024]
Ans. (c) Balance Sheet (under Liabilities)
Q.36. Trade Mark is a:
(a) Fixed Tangible Asset
(b) Fixed Intangible Asset
(c) Current Asset
(d) Fictitious Asset [June 2024]
Ans. (b) Fixed Intangible Asset
MODULE 3 : PREPARATION OF FINAL ACCOUNTS
NUMERICAL QUESTIONS
Q.1. When profit is 25% on cost price, such profit on sale price will be:
(a) 25%
(b) 10%
(c) 33 ½%
(d) 20%
Ans. (d) 20%
Working Note:
[Sept. 2014]
Suppose Cost = 100 than, Profit = 25% × 100 = ` 25
Sale Price = 100 + 25 = ` 125
% Profit on Sale Price = 25 × 100/125 = 20%.
Q.2. Telra Company had ` 20,000 beginning inventory and ` 24,000 ending inventory. Net sales were ` 1,60,000; purchases ` 80,000; purchases returns and allowances ` 5,000 and freightin ` 6,000. Cost of goods sold for the period is:
(a) ` 69,000
(b) ` 49,000
(c) ` 77,000
(d) ` 85,000
Ans. (c) ` 77,000
Working Note:
[Sept. 2014]
Cost of Goods Sold = 20,000 + 80,000
-5,000 + 6,000 – 24,000 = ` 77,000.
Q.3. Goods worth ` 10,000 were purchased by B on which the traders allowed ` 500 trade discount and offer to give 5% cash discount if immediate payment is made. The Purchase A/c will be debited by:
(a) ` 10,000
(b) ` 9,800
(c) ` 9,000
(d) ` 9,500 [Dec.2014]
Ans. (d) ` 9,500
Working Note:
Purchases = 10,000 – 500 = ` 9,500.
Q.4. Purchases ` 90,000; Sales ` 80,000; Profit is 20% of sales. Closing stock?
(a) ` 10,000
(b) ` 20,000
(c) ` 6,000
(d) ` 26,000 [March 2015]
Ans. (d) ` 26,000
Working Note:
Profit = 80,000 × 20% = ` 16,000
Cost of goods Sold = 80,000 – 16,000 = ` 64,000
Closing Stock = 90,000 – 64,000 = ` 26,000.
Q.5. Goods worth ` 5,000 were supplied to Mr. X at an invoice price of 20% above cost and allowed trade discount at 10% on invoice price. The amount of sale will be ____.
(a) ` 5,400
(b) ` 5,500
(c) ` 5,625
(d) ` 6,600 [March 2015]
Ans. (a) ` 5,400
Working Note:
Invoice Price = 5,000 + 20% = ` 6,000
Sale = 6,000 – 10% = ` 5,400.
Q.6. A firm purchased goods costing ` 1,00,000. He sold goods costing ` 50,000 at ` 75,000 and the remaining were sold to a customer cooperative society at the same GP as in the case of direct sales less 20%. Find the total sales of the firm:
(a) ` 1,35,000
(b) ` 90,000
(c) ` 1,50,000
(d) ` 1,40,000 [March 2016]
Ans. (a) ` 1,35,000
Working Note:
Cost of goods sold to cooperative society = 1,00,000 – 50,000 = ` 50,000
GP on cost in case of direct Sales = 25,000 × 100/50,000 = 50%.
Sales Value for Sale to Cooperative society = (50,000 + 50%) – 20% Trade Discount = 75,000 – 20% = ` 60,000
Total Sales = 75,000 + 60,000 = ` 1,35,000.
Q.7. It Sales = 8,00,000, Markup rate = 25% of cost. What would be the value of Gross Profit?
(a) 2,00,000
(b) 1,60,000
(c) 4,80,000
(d) 6,40,000 [March 2016]
Ans. (b) 1,60,000
Working Note:
Suppose Cost = ` 100 than SP = 100 + 25% = ` 125
Gross Profit = 8,00,000 × 25/125 = ` 1,60,000.
Answer Q.8 to Q.14 on the basis of information given below:
Following is the Trial Balance of M/s. Chandu Traders as on 31st March, 2017. Prepare Trading and Profit & Loss Account for the year ended 31st March, 2017 and a Balance Sheet on that date: Particulars Debit (`)
Particulars Debit (`) Credit (`)
Furniture & Fittings 17,500
Motor Van 1,25,000
Loan from Hari @ 12% interest 1,50,000
Interest paid on above 9,000
Sales 10,00,000
Purchases 7,50,000
Opening Stock 2,50,000 Establishment expenses 1,15,000
Wages 12,000 Insurance 11,000 Commission received 24,500
Sundry debtors 3,28,100 Bank balance 2,46,900 Sundry creditors 2,10,000
13,000
22,97,500 22,97,500
Adjustments:
(a) The value of stock on 31-03-2017 was ` 3,20,000.
(b) Outstanding wages ` 1,500.
(c) Prepaid Insurance ` 3,000.
(d) Commission received in advance ` 13,000.
(e) Allow interest on capital @ 10%.
(f) Depreciate building 10%; Furniture & Fitting 10%; & Motor van 15%.
(g) Charge interest on drawings ` 5,000.
(h) Outstanding Interest ` 2,500. [Dec. 2017] [Modified]
3.10
MODULE 3 : PREPARATION OF FINAL ACCOUNTS
Q.8. Value of Cost of Goods Sold is:
(a) ` 6,93,500
(b) ` 6,92,000
(c) ` 6,80,000
(d) None of the above
Ans. (a) ` 6,93,500
Working Note:
Cost of goods sold = Opening stock + Purchases + Wages + O/s Wages – Closing Stock
= 2,50,000 + 7,50,000 + 12,000 + 1,500 –3,20,000 = ` 6,93,500.
Q.9. Total Depreciation to be charged to Profit & Loss A/c:
(a) ` 45,750
(b) ` 33,250
(c) ` 52,000
(d) ` 61,500
Ans. (c) ` 52,000
Working Note:
Depreciation on:
Building = 3,15,000 × 10% = ` 31,500
Furniture = 17,500 × 10% = ` 1,750
Motor van = 1,25,000 × 15% = ` 18,750
Total Depreciation = ` 52,000.
Q.10. Total Expenses to be Debited to Profit & Loss A/c:
(a) ` 2,24,500
(b) ` 3,00,000
(c) ` 1,86,500
(d) ` 2,76,500
Ans. (d) ` 2,76,500
Working Note:
Total Expenses = Interest on Loan + Outstanding Interest + Establishment Expenses + Insurance – Prepaid Insurance + Interest on Capital + Depreciation
= 9,000 + 2,500 + 1,15,000 + 11,000 – 3,000 + 90,000 + 52,000 = ` 2,76,500.
Q.11. Total Income to be credited to Profit & Loss A/c (Except Gross Profit):
(a) ` 24,500
(b) ` 27,000
(c) ` 29,500
(d) ` 32,000
Ans. (c) ` 29,500
Working Note:
Total Income = Commission received –Advance Commission + Interest Received + Interest on drawings = 24,500 – 13,000 + 13,000 + 5,000 = ` 29,500
Q.12. Net Profit as per Profit & Loss A/c is:
(a) ` 59,500
(b) ` 64,500
(c) ` 67,500
(d) ` 85,500
Ans. (a) ` 59,500
Working Note:
Gross Profit = 10,00,000 – 6,93,500 = ` 3,06,500
Net Profit = Gross Profit + Income – Expenses = 3,06,500 + 29,500 – 2,76,500 = ` 59,500.
Q.13. Balance of Capital A/c on 31.03.2017 is:
(a) ` 9,31,500
(b) ` 9,26,500
(c) ` 9,31,500
(d) None of the above
Ans. (b) ` 9,26,500
Working Note:
Closing Capital = Opening Capital + Interest on Capital – Drawings – Interest on drawings + Net Profit
