Account 4 Marks Question

Balance Sheet is the statement prepared after preparing Trading and Profit and Loss Account. Balance Sheet is “a statement which sets out the assets and liabilities of a firm or an institution as at a certain date.”
In the words of Francis R. Stead. "A Balance Sheet is a screen picture of the financial position of a going business at a certain moment."

Notes:

1. Freight and Carriage Outwards are indirect expenses, therefore it is not recorded in the Trading Account.
2. Closing Stock (i.e. ₹ 50,400) is not recorded in the Trading Account as it is already adjusted in the amount of Adjusted Purchases.

Operating Profit = Net Profit - Rent Received - Gain on Sale of Machine + Interest on Donation
= ₹ 1,00,000 - ₹ 10,000 - ₹ 15,000 + ₹ 20,000 - ₹ 2,000 = ₹ 93,000.

Note: Carriage on Sales and Office Rent are the Indirect Expenses, therefore, these are not considered to compute the amount of Gross Profit.

Cost of Goods Sold = Opening Inventory + Purchases (Net) + Direct Expenses - Closing Inventory
= ₹ 8,500 + ₹ 30,700 + ₹ 4,800 - ₹ 9,000 = ₹ 35,000.

Profit and Loss Account is prepared with the following objectives:

1. Determine Net Profit or Net Loss: The main purpose of preparing Profit and Loss Account is to ascertain net profit earned or net loss incurred by the business during the accounting period.
2. Comparison with the Previous Year's Profit: Profit determined by the Profit and Loss Account for the accounting period can be compared with that of the previous year's profit. It helps in ascertaining whether the business is being conducted efficiently or not.
3. Finding Details of Indirect Expenses: Indirect expenses are shown in the Profit and Loss Account. These expenses can be compared over the period and suitable steps can be taken for controlling these expenses.
4. Helps in Preparing Balance Sheet: A Balance Sheet can be prepared only after ascertaining Net Profit or Net Loss through the preparation of Profit and Loss Account.

Contingent Liabilities: Contingent Liability is a liability that becomes payable on the happening of an event. In case, the event does not happen, no amount is payable. Such liabilities are not accounted and are not shown in the Balance Sheet; they are disclosed by way of a note.
Examples of contingent liabilities are:

1. Liabilities in Respect of Bills Discounted: If the firm got its bills receivable discounted with bank, the primary liability will be that of the acceptor. If the acceptor does not pay, then it becomes firm's liability.
2. Guarantee for Loan: If the firm has stood surety for a loan, it will be liable to pay the amount if the other person fails to meet his obligation.
3. Disputed Claims: If some other party has lodged a claim against the firm, the firm will be liable to pay if the claim succeeds.

Note: Freight outwards is an indirect expense. It will be recorded in Profit & Loss A/c.

1. Capital Expenditure:

2. ₹ 72,500 spent on the overhaul of machines purchased second hand.

7. Brokerage paid in connection with purchase of land.
8. Expenses incurred to get the manager's office air-conditioned.

2. Revenue Expenditure:

1. ₹ 1,200 spent on the repairs of machines.

3. Whitewash expenses.
4. Paper purchased for use as stationery.

9. Loss on investments.
10. Expenses to move the stock of goods from one place to another.

3. Deferred Revenue Expenditure:

5. Advertising campaign to launch a new product.
6. Renovation of a cinema hall.

Working Notes:
Operating Profit = Net Profit − Non Operating Income + Non Operating Expenses
= 3,30,000 − 0 + 20,000
= Rs 3,50,000
Loss by Fire is a non-operating expense, thus, added to the net profit to arrive at operating profit.

Difference between Trading Account and Profit and Loss Account-

	Basis	Trading Account	Profit and Loss Account
1.	Relation	Trading Account is a part of Profit and Loss Account	Profit and Loss Account is prepared to ascartain net profit or net the business.
2.	Nature	Gross Profit or Gross Loss is determined from Trading Account.	Profit and Loss Account is prepared to ascertain net profit or net loss of the business.
3.	Transfer of Balace	Balance of the Trading Account is Transferred to profit and Loss Account	Balance of the Profit and Loss Account is transfered to Capital Account of the proprietor.
4.	Items	Items shown in the Trading Account are purchases, sales, opening and closing stock direct expencses etc.	Items like indirect related to sales, distribution, administration, finance etc, are shown in the profit Loss Account.

Difference between Fixed Assets and Current Assets:

	Basis	Fixed Assets	Current Assets
1.	Nature	These are long-term resources of a business.	Thses are short-term resource of a business.
2.	Purpose of Holding	These assets are used to operate the business and to earn profits.	These assets are realised in cash or consuned during the normal operating of business.
3.	Valuation	These assets are valued at cost less depreciation.	These assets are valued at cost or net area isable value (market price), whichever is less.
4.	Sources of Finance	These assets are acquired out of long-term funds of the business.	These assets are acquired out of short-term funds of the business.
5.	Subject to Change	These assets are not usually subject to change.	These assets are usually subject to change.
6.	Profit on sale	Profit on sale of these assets is capital profit.	Profit on sale of these assets is revenue profit.

1. Cost of goods sold Available for sales

Or

Cost of goods manufactured = opening stock + Net purchase + wages

= 25,000 + 10,40,000 + 1,00,000

= ₹ 11,65,000

2. Cost of goods sold = opening stock + Net purchase + wages - closing stock

= 25,000 + 10,40,000 + 1,00,000 - 30,000

= ₹ 11,35,000

Or

Cost of Goods sold = Net sales - gross profit

= 15,50,000 - 4,15,000

= ₹ 11,35000

3.  

The purposes of preparing Trading Account are:

1. To calculate gross profit earned or gross loss incurred during an accounting period.
2. To estimate the cost of goods sold.
3. To record direct expenses (i.e., expenses incurred on the purchases and manufacturing of goods).
4. To measure the adequacy and reasonability of direct expenses incurred by comparing purchases with direct expenses incurred.
5. To compare the realised efficiency and performance with the desired or proposed targets.

The purposes of preparing Profit and Loss Account are:

1. To calculate net profit or net loss.
2. To ascertain net profit ratio and to compare this year’s net profit ratio with that of the desired and proposed target in order to assess the efficiency and effectiveness.
3. To measure the adequacy and reasonability of indirect expenses incurred by ascertaining ratio between indirect expenses and net profit.
4. To compare current year’s actual performance with desired and planned performance.
5. To provide various provisions and reserves to meet unforeseen future conditions and to toughen the financial position of the business.

Direct Expenses: Direct Expenses are the expenses incurred on the goods purchased, till they are brought to the place of business. Examples of such expenses are freight inwards, insurance, customs (import) duty, clearing charges, cartage, loading and unloading charges, etc. In a manufacturing concern, besides the above, expenses incurred for purposes of production such as wages, power and fuel, factory rent, etc., are also Direct Expenses.
Examples:

1. Carriage or Freight or Cartage Inwards: It is the cost of bringing materials to the firm's godown. If any freight or carriage is paid on any asset, like machinery, it is added to the cost of the asset and is not debited to Trading Account.
2. Wages: Wages paid to workers in the factory, including stores, are debited to the Trading Account; if any amount is outstanding it is accounted for so that the total wages for the period are debited to Trading Account.

The main purpose of preparing financial statements is to:

• Provide information about the financial status and financial position of the organization (or other entities).
• Provide information to analyze and assess the economic and business performance of the organization (or other entities).
• Serve as an accounting database for future references.
• Facilitate effective, accurate and well-thought-out policies and strategies for the organization (or other economic entities).
• Serve as an important tool to promote effective decision making.
• Act as an important source of crucial business information.
• Ascertain the results of various business operations such as income, expenditure, debtors, payables, receivables, profits, losses, etc.

The needs to prepare a Balance Sheet are given below:

1. It helps in determining the nature and book value of various assets, such as fixed assets, investments, current assets, etc. at the end of an accounting period.
2. It helps in ascertaining the nature and amount of various liabilities like long term liabilities, current liabilities, provisions, etc., which a business owes.
3. It discloses important information about capital invested in a business. The additional capital invested during the accounting period, drawings of the owners and profit (or loss) added to (or deducted from) the capital of the business.
4. It helps in assessing the solvency of a business.
5. It discloses the true financial position of a business at a particular point of time.
6. It lays down the basis for maintaining new books for next accounting period.

Note: ₹ 1,000 Input IGST after adjusting against Output IGST will be shown on the asset side of the balance sheet.

Difference between Trading Account and Profit and Loss Account.

	Basis	Trading Account	Profit and Loss Account
1.	Relation	Trading Account is a part of Profit and Loss Account.	Profit and Loss Account is the main account.
2.	Nature	Gross Profit or Gross Loss is determined from Trading Account.	Profit and Loss Account is prepared to ascertain net profit or net loss of the business.
3.	Transfer of Balance	Balance of the Trading Account is transferred to Profit and Loss Account.	Balance of the Profit and Loss Account is transferred to Capital Account of the proprietor.
4.	Items	Items shown in the Trading Account are purchases, sales, opening and closing stock, direct expenses, etc.	Items like indirect expenses related to sales, distribution, administration, finance, etc., are shown in the Profit and Loss Account.

Assets in the Balance Sheet are divided into two parts as follows:

1. Fixed Assets: Fixed Assets are those assets that are acquired for continued use and not for resale. They may be tangible assets like land, building, plant and machinery, furniture and fixtures, etc., or intangible assets like goodwill, patents, etc.

1. Tangible Fixed Assets are those fixed assets which can be seen and touched, e.g., Land and Building, Plant and Machinery, Furniture, etc.
2. Intangible Fixed Assets are those fixed assets which are not in a physical form, i.e., they can neither be seen nor touched, e.g, goodwill of a firm or the know-how which it possesses, patents, trademarks, coputer software, etc.

2. Current Assets: Thssets: These are the assets of business which are held for reslae or for converting into cash. These are the assets which are likely to be realised within a period of one year or during the period of normal operating cycle. A business earns profit by sale of these assets but not by keeping them in hand. Examples are unsold goods, debtors, bills receivalbe, bank balance, cash in hand, etc. These assets are temporary in nature and may change from time to time. These are sometimes referred to as floating or circulating assets.