Class 11 Accountancy

Chapter - 20
Financial
Statements
 Financial Statements
Financial Statements refer to such statements which report the profitability and
the financial position of the business at the end of accounting period.
The term financial statements includes at least two basic statements which are as
under :
a) Income Statement (or Trading and Profit and Loss Account) which shows
results of business operations during an accounting period, and
b) Statement of Financial Position (or Balance Sheet) which shows financial
position of an enterprise at a specified point of time

In the words of John N. Myer, "The financial statements provide a summary of the
accounts of a business enterprise, the balance sheet reflecting the assets, liabilities
and capital as on a certain date and the income statement showing the results of
operations during a certain period."

These two financial statements are termed as 'Final Accounts".

A Statement of Retained Earnings and a Cash Flow Statement are also generally included in
financial statements.
 Objectives of Preparing
Financial Statements

To present a true and To present a true and

fair view of the fair view of the
financial performance financial position (i.e.
(i.e. profit/loss) of the Assets/Liabilities) of
business; the business.
 Users of Financial Statements
Information provided by financial statements is used by the management, investors, creditors,
employees, government etc. the utility of financial statements to different parties is as follows :

1) Management : The financial statements help the management is assessing the profitability
of various activities and various departments.
2) Investors : They can assess the short-term and long-term financial soundness and earning
capacity of the business with the help of financial statements.
3) Short-term Creditors : On the basis of financial statements they assess whether the
enterprise will be able o pay their debts when they fall due and may decide to extend,
maintain or restrict the credit allowed to the enterprise.
4) Employees and Trade Unions : On the basis of financial statements they can judge as to
how much bonus and increase in their wages is possible from the profits of the enterprise.
5) Government : Government uses the financial statements to study the profit margins of
various industries to announce or withdraw various concessions and to increase or
decrease the excise duty.
6) Taxation Authorities : They use the financial statements for the purpose of assessment of
income tax, sales tax etc.
 Income Statement
It is divided in to two parts

The first part is called The second part is called

„Trading Account‟. It „Profit & Loss Account‟.
shows the gross profit It shows the net profit or
or gross loss, net loss.
  Trading Account is prepared for calculating
Trading the gross profit or gross loss arising or
incurred as a result of the trading activities
Account of a business.
 If the amount of sales exceeds the amount of
purchases and the expenses directly
connected with such purchases, the
difference is termed as gross profit.
 On the contrary, if the purchases, and direct
expenses exceed the sales, the difference is
called gross loss.
 Sometimes, a Trading Account is also called
„Goods A/c‟ because all the transactions
relating to goods are recorded in it.
 Need and Importance of Trading Account
It provides information about Gross Profit and Gross Loss
It informs of the gross profit or gross loss as a result of buying and selling the
goods during the year.

It provides information about the direct expenses

All the expenses incurred on the purchase and manufacturing of
goods are recorded in the trading account in a summarized form.

It provides safety against possible losses

If the ratio of gross profit has decreased in comparison to the
preceding year, the businessman can take effective measures to
safeguard himself against future losses.
 Preparation of Trading Account
Trading Account is a Nominal Account and all expenses which relate to either purchase or
manufacturing of goods are written on the Dr. side of the Trading Account.

Items Written on the Dr. Side of the Trading Account :

1) Opening Stock or Inventory : The stock of goods remaining unsold at the end of the
previous year is termed as the opening stock of the current year.
I. Opening Stock of Raw Material,
II. Opening Stock of Semi-finished goods, and
III. Opening Stock of Finished goods.
2) Purchases and Purchases Returns : Goods which have been bought for resale are termed as Purchases and goods
which are returned to suppliers are termed as purchase returns or returns outwards. Purchase Account will be given
on the debit side and Purchase Returns will be shown as a deduction from Purchases on the debit side of the
Trading Account.
3) Direct Expenses : All expenses incurred in purchasing the goods, bringing them to the godown and manufacture of
goods are called direct expenses. Direct expenses include the following :
I. Wages : Wages are paid to workers who are directly engaged in the loading. Unloading and production of
goods and as such are debited to the trading account. It should be noted that :
 If the item „Wages and Salaries‟ is given in the question it will be shown on the trading account. On the
contrary, if „Salaries and Wages‟ is given it will be shown on the Profit & Loss Account.
II. Carriage or Carriage Inwards or Freight : These expenses should be debited to trading account because
these are generally paid for bringing the goods to the factory or place of the business.
III. Manufacturing Expenses : All expenses incurred in the manufacture of goods are shown on the debit side
of the trading account such as Coal, Gas, Fuel, Water, Power, Factory Rent, Factory Lighting etc.
IV. Stores Consumed : These are incurred to keep the machines in perfect working condition and include
engine oil, cotton waste, oil, grease etc.
V. Dock charges : These are the charges levied on ships and their cargo while entering or leaving docks.
VI. Royalty : This is the amount paid to the owner of a mine or patent for using his right or patent. Royalty
is usually charged to Trading Account.

Items Written on the Cr. Side of the Trading Account :

1) Sales and Sales Returns : Both Cash and Credit sales will be included in sales. The sales account will be a
credit balance. Sales and return will be deducted out of sales on the credit side of the trading account.
2) Closing stock or Inventory : The goods remaining unsold at the end of the year is known as
Closing Stock. It is valued at cost price or realizable value whichever is less.

1) The Closing Stock is given outside the Trail Balance. In that case, it will be posted to the credit
side of the trading account and on the other hand, will be shown on the Assets side of the Balance sheet.
2) Sometimes, the Closing Stock is given inside the Trial Balance. This will mean that the entry to
incorporate the closing stock in the books has already been passed. In such a case, Closing Stock will not
be shown in the Trading Account but will appear on the Assets side of the Balance Sheet only.
 Closing Entries relating to Trading Account
1) Purchases Returns Account is closed by transferring its balance to Purchases Account :
Purchases Return A/c Dr.
To Purchases A/c
(Transfer of Purchases Returns Account to Purchases Account)

2) Similarly, the Sales Returns Account is closed by transferring its balance to the Sales Account as :
Sales A/c Dr.
To Sales Return A/c
(Transfer of Sales Return Account to Sales Account)

3) Closing Entry for those accounts which are to be transferred to the Dr. side of the Trading Account :
Trading A/c Dr.
To Opening Stock A/c
To Purchase A/c
To Wages A/c
To Direct Expenses A/c
To Carriage A/c
T Gas, Fuel & Power A/c
To Freight & Cartage A/c
To Manufacturing exp. A/c
To Factory Rent & Lighting A/c
To Royalty A/c
(The Transfer of above accounts to the Dr. side of the Trading A/c)
4) Closing Entry for those accounts which are to be transferred to the Cr. Side of the Trading Account :
Sales A/c Dr.
Closing Stock A/c Dr.
To Trading A/c
(The transfer of above accounts to the Cr. Side of the Trading A/c)

5) Another Closing Entry is needed to close the Trading Account itself. If the credit side of the
Trading Account exceeds the debit, the difference will be Gross Profit. The Gross Profit will be
transferred to the credit of a newly opened account called Profit and Loss Account :
Trading A/c Dr.
To Profit and Loss A/c
(The Transfer of Gross Profit to the Credit side of P & L A/c)

6) If the debit side of the Trading Account exceeds the credit, the difference will be Gross Loss. It
will be transferred to the debit of P & L A/c by means of the following entry :
Profit & Loss A/c Dr.
To Trading A/c
(The Transfer of Gross Loss to the Debit side of P & L A/c)
 Format of a TRADING A/C

Trading Account Dr. for the year ending Cr.

Particulars ₹ Particulars ₹
To Opening Stock By Sales
To Purchases Less : Sales Returns
Less : Purchase Returns or
or Returns Inwards
Returns Outward By Closing Stock
To Wages By Gross Loss
To Wages & Salaries (if any) transferred to Profit and
To Direct Expenses Loss A/c
To Carriage, or (Balancing Figure)
To Carriage inwards, or
To Carriage on Purchase
To Gas, Fuel and Power
To Freight and Cartage
To Manufacturing Expenses, or
Productive Expenses
To Factory Expenses, such as :
Factory Lighting
Factory Rent etc.
To Dock charges and Clearing Charges
To Import Duty or Custom Duty
To Royalty
To Gross Profit
Transferred to P & I. A/c
(Balancing Figure)
 1) In the heading of the Trading Account the
Notes words „For the year ended…….‟ are used.
Because it discloses the position of the
business for the full accounting year and
not a particular point of time.
2) No separate column for date is prepared
in the Final Accounts because the date will
be already mentioned in the heading
itself.
3) No column for L.F. is prepared in Final
Accounts because these are prepared from
trial balance and not from ledger
accounts directly.
 Profit and Loss Account
Trading Account only discloses the gross profit earned as a
result of buying and selling of goods. However, a
businessman has to incur a number of expenses which are
not taken to trading account. Hence, a businessman is
more interested in knowing the net profit earned or net loss
incurred during the year. as such, a Profit & Loss Account is
prepared which contains all the items of losses and gains
pertaining to the accounting period.

According to Prof. Carter, “A Profit & 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”
 Need and Importance of Profit & Loss A/c
To ascertain the Net Profit or Net Loss
A Trading Account only discloses the Gross Profit earned as a result of trading activities,
whereas the Profit & Loss Account discloses the net profit (or net loss) available to the
proprietor and credited to his capital account.

Comparison with previous years‟ profits

The net profit of the current year can be compared with that of the previous years. It
enables the businessman to know whether the business is being conducted efficiently or not.

Control on Expenses
Profit & Loss Account helps in comparing various expenses with the expenses of the previous
year.

Helpful in the preparation of Balance Sheet

A Balance Sheet can only be prepared after ascertaining the Net Profit through the
preparation of Profit and Loss Account.
 Preparation of Profit and Loss Account
All those expenses and losses which have not been debited to the Trading Account are now debited to Profit & Loss Account.
These expenses include administrative expenses selling expenses, distribution expenses etc. These are called „Indirect
Expenses‟.

Items Written on the Dr. Side of Profit & Loss Account :

1) Gross Loss : If trading account discloses Gross Loss, it is shown on the debit side first of all.
2) Office and Administrative Expenses : Such as salary of office employees, office rent,
lighting, postage, printing, legal charges, audit fee etc.
3) Selling and Distribution Expenses : Such as advertisement charges, commission,
carriage outwards, bad-debts, packing charges etc.
4) Miscellaneous Expenses : Such as interest on loan, interest on capital, repair charges, depreciation, charity etc.

Items Written on the Cr. Side of Profit & Loss Account :

1) Gross Profit : the starting point of the Cr. Side of Profit and Loss Account is the gross
profit brought down from the Trading Account.
2) Other Incomes and Gains : All items of incomes and gains are shown on the credit side
of the Profit & Loss Account, such as income from investments, rent received, discount
received, commission earned, interest received, dividend received etc.

If the credit side of the profit and loss account exceeds that of debit side, the difference is termed as net profit. On the other
hand, the excess of the debit side over the credit side is termed as net loss. Net profit is added to the capital whereas net loss
is deducted from the capital.
 Closing Entries relating to Profit and Loss Account
1) Accounts of various items of expenses and losses are transferred to the debit side of Profit and Loss Account by means of the following
entry :
Profit and Loss A/c Dr.
To Salaries A/c
To Rent, Rates and Taxes A/c
To Printing and Stationery A/c
To Postage A/c
To General Expenses etc.
(The transfer of nominal accounts showing Dr. balances to the Debit of P & L A/c)

2) Balances of all the accounts of incomes and gains will be transferred to the credit side of Profit and Loss Account by means of the following
entry :
Interest Received A/c Dr.
Commission Received A/c Dr.
Rent Received A/c Dr.
To Profit and Loss A/c
(The transfer of nominal accounts showing Cr. balances to the Credit of P & L A/c)

3) For the transfer of credit balances of Profit & Loss A/c, known as net profit :
Profit and Loss A/c Dr.
To Capital A/c
(The transfer of net profit to Capital A/c)

4) For the transfer of debit balance of Profit & Loss A/c, known as net loss :
Capital A/c Dr.
To Profit and Loss A/c
(The transfer of net loss to Capital A/c)
Format of a Profit PROFIT & LOSS A/C

& Loss Account Dr. for the year ending Cr.

Particulars ₹ Particulars ₹
To Gross Loss b/d By Gross Profit b/d
(Transferred from Trading A/c) (Transferred from Trading A/c)
Office Expenses :- By Rent from Tenant
to Salaries By Rent (Cr.)
To Salaries & Wages By Discount Received
To Rent, Rates & Taxes or Discount (Cr.)
To Printing & Stationery By Commission Received
To Postage By Interest on Investments
To Lighting By Dividend on Shares
To Insurance Premium By Bad-Debts Recovered
To Telephone Charges By Profit on Sale of Assets
To Legal Charges By Income from Other Sources
To Audit Fees By Miscellaneous Income
To Travelling Expenses By Net Loss (if any)
To Establishment Expenses Transferred to Capital A/c
To General Expenses
Selling & Distribution Expenses :-
To Carriage Outwards, or Carriage on Sales
To Advertisement
To Commission
To Brokerage
To Bad-Debts
To Export Duty
To Packing Charges
To delivery Van Expenses
To Stable Expenses
Miscellaneous Expenses :-
To Discount Allowed
To Repairs
To Depreciation
To Interest (Dr.)
to Bank Charges
To Entertainment Expenses
To Conveyance Expenses
To Donation and Charity
To Loss on Sale of Assets
To Net Profit – Transferred to Capital A/c
 1) Those expenses which are not related to the
Notes business are not written in the Profit and Loss
Account such as
a) Domestic and household expenses of the
proprietor,
b) Income-Tax, and
c) Life Insurance Premium etc.
These expenses are known as Drawings and
deducted from Capital at the liabilities side
of the Balance Sheet.
2) Only those items of expenses and incomes are
shown the Profit & Loss Account which have
not been shown in the Trading Account.
 Operating Profit is the profit earned through
Operating
normal operating activities of the business. It Profit & Net
is arrived at by deducting the operating Profit
expenses from gross profit.
 Operating Profit is also called „Earning Before
Interest & Tax or EBIT‟.

 Net Profit is arrived at by deducting

operating as well as non-operating expenses
from the gross profit.
 Expenses which are incidental or indirect to
the main operations of the business are called
non-operating expenses.
 Balance Sheet
 After ascertaining the net profit or loss of the
business enterprise, the businessman would also like
to know the exact financial position of his business.
For this purpose a statement is prepared which
contains all the Assets & Liabilities of the business
enterprise.
 The statement is so prepared is called a Balance
Sheet.

According to J. R. Batliboi, “A Balance Sheet is a

statement prepared with a view to measure the exact
financial position of a business on a certain fixed date.”
 Need & Importance of Balance Sheet
1 The main purpose of preparing a Balance Sheet is to ascertain the true financial
position of the business at a particular point of time.

2 It helps in determining the nature and amount of various liabilities of the business.

3 It gives information about the exact amount of capital at the end of the year and
the addition or deduction made into it in the current year.

4 It helps in finding out whether the firm is solvent or not. The firm is solvent if the
assets exceed the external liabilities. It would be insolvent if opposite is the case.

5 It helps in preparing the Opening Entries at the beginning of the next year.
 Characteristics of Balance Sheet
A Balance Sheet is a part of the Final Accounts. This is the reason that the
1 Trading and Profit and Loss Account and the Balance Sheet are together called
„Final Accounts‟. However, the Balance Sheet is a statement and not an account.

2 A Balance Sheet is a summary of the Personal and Real Accounts.

3 The totals of the two sides of the Balance Sheet must be equal.

4 Balance Sheet is prepared on a particular date and not for fixed period.

5 It shows the financial position of the business according to the going concern
concept.
Grouping & Marshalling of Assets & Liabilities in Balance Sheet

„Marshalling‟ is the arrangement of various

assets and liabilities in a proper order.
Marshalling can be done in any of the
following two ways :
1) In the Order of Liquidity : According to this method, an asset which is most
easily convertible into Cash such as Cash in hand is written first and then will
follow those assets which are comparatively less easily convertible, so that the
least liquid asset such as goodwill, is shown last.
In the same way, those liabilities which are to be paid at the earliest will be
written first. In other words, current liabilities are written first of all, then non-
current or long-term liabilities and lastly, the proprietor‟s capital.
 BALANCE SHEET
as at ……………………………………
Liabilities ₹ Assets ₹
Current Liabilities : - Current Assets : -
Bank Overdraft Cash in Hand
Bills Payable Cash at Bank
Sundry Creditors Bills Receivables
Outstanding Expenses Short Term Investments
Unearned Income Sundry Debtors / Book Debts
Non-Current Liabilities : - Closing Stock
Long Term Loans Prepaid Expenses(3)
Reserves Accrued Income
Capital Long Term Investments
Add : Net Profit Non-Current Assets : -
Less : Drawings Furniture
Less : Income Tax Loose Tools
Less : Life Insurance Premium Motor Vehicle
Plant & Machinery
Land & Buildings
Patents and Trade Marks
Goodwill

2) In the Order of Permanence : This method is exactly the reverse of the first method discussed
above. Assets which are most difficult to be converted in to cash such as Goodwill are written first
and the assets which are most liquid such as Cash in hand are written last. Similarly, those
liabilities which are to be paid last, will be written first.
 Classification of Assets
Non-current Assets
Non-current Assets are those which are acquired for continuous use and last for many years such as
Land and Building, Plant and Machinery, Motor Vehicles, Furniture's etc.
Current Assets
Current Assets are those which are either in the form of cash or can be easily converted in to cash within one year of the date
of Balance Sheet.
Liquid Assets
Liquid assets are those which are either in the form of Cash or can be quickly converted in to cash, such as Cash, Bills
Receivable, Short Term Investments, Debtors, Accrued Income etc.
Fictitious or Nominal Assets
These are the Assets which cannot be realized in Cash or no further benefit can be derived from these assets. Such assets
include Debit Balance of P & L A/c and the expenditure not yet written off such as Advertisement Expenses etc.
Wasting Assets
These are the Assets which are exhausted or consumed over a period of time such as mines and oil-wells.
Tangible & Intangible Assets
Tangible Assets are those which have a physical existence or which can be seen and felt like
Plant & Machinery, Building, Furniture, Stock, Cash etc. Intangible Assets are those which do
not have any physical existence or which cannot be seen or felt such as the Goodwill, Trademarks, Patents etc.
Distinction between Tangible Assets and Intangible Assets
Basis of
Tangible Assets Intangible Assets
Distinction
1) Physical These assets have physical These assets do not have
Existence existence. Examples of physical existence. Examples of
these assets are Plant and these assets are Goodwill,
Machinery, Furniture etc. Patents, Trade Market etc.
2) Non-current These assets can be non- These assets usually fall in the
V/s Current current assets or current category of non-current assets.
assets.
3) Depreciation Depreciation is charged Intangible assets are
or on fixed tangible assets. amortized.
Amortization
4) Acceptance as Lenders accept these Lenders usually do not accept
Security assets as security for intangible assets as security for
providing loan. providing loan.
5) Risk of Loss Tangible assets may be Intangible assets cannot be lost
due to fire lost due to fire. due to fire.
 Classification of Liabilities
Those liabilities which are to be repaid after one year or more are termed as
Non-Current or Long-
non-current liabilities. These include Public Deposits, Long-term Loans,
term Liabilities Debentures etc.

Current or Short-term Those liabilities which are expected to be paid within one year of the date of
Liabilities the Balance Sheet are termed as current or short-term liabilities.

These are the liabilities which will become payable only on the happening of
Contingent some specific event, otherwise not.
a) Liabilities for bill discounted;
Liabilities
b) Liability in respect of a suit pending in a court of law.

Contingent liabilities are not shown in the Balance Sheet.

They are, however, shown as a footnote just below the
Balance Sheet so that their existence may be revealed.
Distinction between Trial Balance and Balance Sheet
Basis of
Trial Balance Balance Sheet
Difference
1) Object It is prepared to check the arithmetical It is prepared to know the true financial position
accuracy of the books of accounts. of the firm.
2) Information It is not possible to have information Since net profit or loss is recorded in the Capital
about about net profit or net loss from a trial shown in Balance Sheet, it is possible to have the
Profit & balance. information about net profit or net loss from a
Loss Balance Sheet.
3) Necessity Though desirable, its preparation is not It is necessary to prepare a Balance Sheet.
necessary.
4) Headings The headings of its two columns are The headings of its two sides are assets and
debit and credit. liabilities.
5) Period It is normally prepared every month or It is normally prepared half-yearly or yearly at
whenever needed. the end of the accounting period.
6) Types of All types of accounts whether personal, Only personal and real accounts are included in it.
Accounts real or nominal must be written in it.
7) Closing Normally, it does not contain the item It contains the item of Closing Stock.
Stock of Closing Stock.
8) Evidence It is not accepted by the court as It is accepted by the court as documentary
documentary evidence. evidence. It is also helpful while making payment
of income-tax and Goods and Service Tax (GST).
 Following Points should be noted for preparing Final Accounts
If a Trial Balance is not given in the question, it is better to prepare a Trial Balance first of all.
If there is a difference in the Trial Balance, the difference is placed to a „Suspense A/c‟ and
shown in the Balance Sheet.

It should be remembered that all items which appear in the Trial Balance should be shown
only once whereas items which appear outside the Trial Balance, known as adjustments, have
to be shown at two places.

The items which appear on the debit side of the Trial Balance should be shown either on the
debit side of the Trading or Profit and Loss A/c or on the Assets side of the Balance Sheet.

The items which appear on the credit side of the Trial Balance should be shown either on the
credit side of the Trading or Profit and Loss A/c or on the Liabilities side of the Balance Sheet.

The balances of Personal and Real Accounts are always shown in the Balance Sheet.

If a Trial Balance is not given in the question, and it is not clearly stated whether a particular
item is expense or income, it will be treated as expense such as Discount, Commission,
Brokerage or Rent etc.

The total of both sides of the Balance Sheet will always be equal.