What are Final Accounts?

Final Accounts consists of

 Trading Account
 Profit and Loss Account
 Balance Sheet
Trading Account
It is a Nominal Account and is prepared for calculating the GROSS PROFIT or GROSS LOSS
arising as a result of trading activities of a business.

According to J.R.Batliboi:-
‘The Trading Account shows the results of buying and selling of goods. In preparing,
this account, the general establishment charges are ignored and only the transactions
in goods are included’
Importance of Trading Account
Trading Account is prepared for the following reasons
 To know the Gross Profit or Gross loss arising due to trading activities of the business.
 To find out the direct expenses incurred by the business for the goods sold during the year.
 Find out how much closing stock is left as compared to previous years and thus find out the
performance of the business.
 Gives the trader an idea of the increase/decrease in Gross Profit /Gross Loss and to assess
the performance of the business and take corrective measures, if needed.
Preparation of Trading Account
The following items usually appear in a Trading Account
Sales turnover
Both Cash and Credit sales are included. Net Sales is recorded after deducting Sales returns
(Return inwards).
Opening Stock
The closing stock of the previous accounting year is taken as the Opening stock for the
present year. If there is no Opening Stock then no entry is made. Opening stock is derived by
balancing the Stock Account and bringing down its balance to the next period.
Purchases
Purchases include all the Cash and Credit purchases of goods made by the business during
the year.
Purchase returns (Return outwards) is deducted from the Purchases to arrive at Net
Purchases.
Direct Expenses
All expenses which are incurred in purchasing the goods and bringing them to the trading
place are recorded under this category.
These include:

 Wages e.g. Warehouse worker wages.

 Carriage Inwards i.e. the cost of transport of goods to the trading place. The expense is usually
borne by the buyer.
 Duty on purchases, for example, Import duty or excise duty.
Closing Stock
All the goods which remain unsold at the end of the year are known as ‘Closing stock’.
The closing is stock is valued at Cost price or Market price, whichever is lower.
The reason for taking the lower value of the two is in accordance with the ‘Prudence Principle’.
Normally, ‘Closing stock’ is given outside the Trial Balance. This is so because its valuation is
made after the accounts have been closed.

Note: Sometimes, the ‘Closing Stock’ may be given inside the Trail Balance. This means that
the entry to incorporate the closing stock in the books has already been passed and it has
already been deducted from the Purchases Account. In this case, ‘Closing Stock’ will not be
shown in the Trading Account will only appear in the Asset side of Balance Sheet’.
Cost of goods sold
This means the finding the cost of only those goods which have been sold during the year. It
can be calculated as follows:

(Net Purchases + Opening Stock) - Closing Stock

Profit and Loss Account

According to Prof. Carter:

‘A Profit and Loss Account is an account into which all gains and losses are collected,
in order to ascertain the excess of gains over the losses or vice-versa’.
Why Profit and loss account is made?
 To find out the Net Profit or Net Loss
 Compare the net profit of the business with previous years and to assess the performance of
the business.
 Find out the amount of overheads of a business.

Items appearing on a Profit and Loss account

Any Incomes or gains

Any income or gains of the business from sources other than sales are recorded on the Credit
side of Profit and loss account.
Gross Profit or Loss
It is transferred to the P/L account from the Trading Account. Gross Profit is transferred to the
Debit side whereas Gross Loss is transferred to the Credit side.
Office and Administrative expenses
Example include salaries, office rent, lighting, stationery etc.
 Selling and Distribution expenses
Include advertising expense, commission, carriage outwards, bad-debts etc.
Miscellaneous expenses
Such as, interest on loan, interest on capital, depreciation etc.

Balance Sheet
Balance Sheet is a statement which shows the financial position of the business on a particular
day.

According to A. Palmer

“The Balance Sheet is a statement at a particular date showing on one side the trader’s
property and possessions and on the other hand the liabilities”.

Thus we can say that

 Balance sheet is a statement not an account.
 It is prepared to show the financial position of the business.
 It records all the assets and liabilities of the business.
 It shows the financial position on a particular day not for a period of time.
Need and Importance of Preparing a Balance Sheet
A Balance Sheet serves the following purposes:
 The true financial position of the business can be ascertained at a particular point of time.
 Reveals the amount of assets owned by the business for example machinery, cash, debtors
and so on.
 Show the liabilities of the business such as total creditors, share capital etc.
 To adjudge weather the firm is solvent or not.
 Opening entries for the next financial year are based on the Balance Sheet of the previous
year.

Items appearing on a Balance Sheet

Assets
Assets of a business are what it owns. They can be classified as:
Fixed assets: All those assets which are owned by the business and last for more than an
accounting year. Examples include Land, building, machinery, vehicle, furniture and fixtures
and the like.
Current assets: It includes all those assets which either in the form of cash or can be easily
converted into cash within one accounting period. Current Assets include Cash, Debtors and
Stock.
 Liabilities
Liabilities represents what the business owes to outside persons other than owners. These
liabilities are classified on basis of time period of repayment.
Long term liabilities: These are liabilities which the business owes for more than one
accounting period, e.g. long term bank loans, debentures etc.
Current liabilities: These are short term debts of the business that are to be repaid within one
accounting period, e.g. creditors and bank overdraft.
Owner’s Equity
Owner’s equity represents what the business owes its owner.
It is equal to total assets minus total liabilities.
Important points regarding Balance Sheet
 The Balance Sheet is not an account but a statement.
 It does not have debit or credit side but has two sections i.e. assets and liabilities.
 The heading of Balance Sheet is ‘as on a particular date’. Thus a Balance Sheet may have
different figure on different dates.
 The balances shown in the Balance Sheet act as Opening Balances for the next accounting
period.
 Balance Sheet is based on the accounting equation
Assets= Owner’s Equity + Liabilities

Difference between Trial Balance and Balance Sheet

Objective
Trial Balance is prepared to verify the arithmetical accuracy of the books of account whereas
Balance Sheet shows the financial position of the business.
Headings
Trial Balance is two sides i.e. Debit and Credit whereas Balance Sheet has Assets and
Liabilities.Profit and LossTrial Balance does not show any information about the profit or loss
of a business, whereas Balance Sheet records the Profit or Loss of the business.
Closing stock
The valuation of closing stock is not necessary to prepare a Trial Balance whereas Balance
Sheet cannot be prepared unless the Closing stock for that particular accounting year is not
ascertained.
Types of Accounts
Balances of all types of accounts are recorded in a Trial Balance i.e. Personal, real and
nominal. Balance Sheet records balances of personal and real accounts only.
Adjustments
Adjustment for outstanding expenses, prepaid expenses and accrued incomes are not
required for the preparation of Trial Balance. A Balance sheet is only complete after all the
necessary adjustments are made.
 Closing Stock
Closing stock refers to the goods remaining unsold during the year.
They are valued at Cost price or Market Price whichever is lower.
Closing entries

Closing Stock Account Dr.

Trading Account

(For closing Stock transferred to

trading account)

Treatment in Final Accounts

When closing stock is given outside the Trial Balance
It will appear on
 The credit side of the Trading Account
 Under Current Assets in the Balance Sheet.
When closing stock appears inside the Trail Balance
This means that the Closing stocks have already been deducted from the Purchases and thus
it will ONLY appear in the Balance Sheet under Current Assets.

Topic: Final Accounts of Sole Traders with adjustments

Income Statement and Balance Sheet (Final Accounts) for Sole trader
Income Statement (previously Trading and Profit and Loss Account) has two parts:
(1) Trading Account – includes only the trading activities such as buying and selling. In trading account
part of the income statement, business calculates gross profit / loss.
(2) Profit and Loss Account – includes the other incomes and expenses. In profit and loss account part of
the income statement, business calculates net profit / loss.
Income statement can be prepared in both vertical and horizontal formats:
Horizontal Format
Name of the Business
Income Statement
For the Year Ended ---------------------------
$ $
Opening Inventory (Stock) xxx Revenue (Sales) xxx
Add: Purchases xxx Less: Sales Return (xxx)
Less: Purchase Return (xxx)
Add: Carriage Inwards xxx
Less: Closing
Inventory(Stock) (xxx)
 Cost of Sales xxx
Gross Profit c/d xxx
----------- -------------------
------ Net Sales xxx
xxxx -----------------
-----------
-----
Gross Profit b/ d xxx
Less: Expenses:
Add: Other Incomes
Salaries xxx
Rent xxx Commission Received xxx
Electricity Bill xxx Discount Received xxx
Depreciation xxx
Bad Debts xxx
Insurance xxx --------------------
Net Profit xxx
-------------------
-----------
------

-----------
------

Vertical Format
Name of the Business
Income Statement
For the Year Ended ---------------------------
$ $
Revenue (Sales) xxx
Less: Sales Return xxx
------------------
Net Sales xxx

Less: Cost of Sales

Opening Inventory (Stock) xxx
Add: Purchases xxx
Less: Purchase Return (xxx)
Add: Carriage Inwards xxx
Less: Closing Inventory(Stock) (xxx)
----------------- (xxx)
 -----------------
Gross Profit xxx
Less: Expenses
Electricity xxx
Insurance xxx
Rent xxx
Bad Debts xxx
Depreciation on fixed assets xxx
----------------- (xxx)
Add: Other Incomes
Commission Received xxx
Discount Received xxx xxx
---------------- --------------
Net Profit xxx

Name of the business

Balance Sheet
As at -------------------------------------
Non-Current (Fixed) Assets $ Capital (Owner’s Equity) $
Land xxx Capital xxx
Building / Premises xxx Add: Net Profit xxx
Motor Vehicles xxx Less: Drawings xxx
Fixtures and Fitting xxx
Equipment xxx
Current Assets Current Liabilities
Inventory (Stock) xxx Accounts Payable (Creditors) xxx
Accounts Receivable (Debtors) xxx Bank Overdraft xxx
Bank xxx
Cash xxx

xxx xxx

Income Statement and Balance Sheet are prepared with the help of trial balance.
In trial balance, all the assets and expenses will always be debited, and all the incomes and liabilities will be
credited. Hence, find these items on their respective sides in trial balance.
Capital amount given in trial balance is called opening or old capital, which may change by new investment,
earning net profit or sustaining losses, and withdrawing money for personal use (i.e. drawing). The new capital
after adjustments of above items is closing capital.
Capital increases due to incomes, and decreases due to expenses.
New Capital = Old Capital +Net Profit + New Investment – Drawings

Vertical Format
Name of the Business
Income Statement
For the Year Ended ---------------------------
$ $
Revenue (Sales) xxx
Less: Sales Return xxx
------------------
Net Sales xxx

Less: Cost of Sales

Opening Inventory (Stock) xxx
Add: Purchases xxx
Less: Purchase Return (xxx)
Add: Carriage Inwards xxx
Less: Closing Inventory(Stock) (xxx)
----------------- (xxx)
-----------------
Gross Profit xxx
Less: Expenses
Electricity xxx
Insurance xxx
Rent xxx
Bad Debts xxx
Depreciation on fixed assets xxx
----------------- (xxx)
Add: Other Incomes
Commission Received xxx
Discount Received xxx xxx
---------------- --------------
Net Profit xxx
 Name of the business
Balance Sheet
As at -------------------------------------
Non-Current (Fixed) Assets $ $
Land xxx
Building / Premises xxx
Motor Vehicles xxx
Fixtures and Fitting xxx
Equipment xxx
------------
Current Assets xxx
Inventory (Stock) xxx
Accounts Receivable (Debtors) xxx
Bank xxx
Cash xxx
-------------
xxx
Less: Current Liabilities
Bank Overdraft (xxx)
Accounts payable (xxx)
------------
Working Capital (or Non-current assets)
Net Assets xxx
------------
xxx
Financed By -------------

Capital xxx
Add: Net Profit xxx
Less: Drawings (xxx)
-----------
xxx
----------