Depriciation

The following terms are used in this Standard with the meanings specified:

3.1 Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable
asset arising from use, effluxion of time or obsolescence through technology and market changes.

Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting
period during the expected useful life of the asset. Depreciation includes amortization of assets whose
useful life is predetermined.

3.2 Depreciable assets are assets which

(i) are expected to be used during more than one accounting period; and

(ii) have a limited useful life; and

(iii) are held by an enterprise for use in the production or supply of goods and services, for rental to
others, or for administrative purposes and not for the purpose of sale in the ordinary course of business.

3.3 Useful life is either (i) the period over which a depreciable asset is expected to be used by the
enterprise; or (ii) the number of production or similar units expected to be obtained from the use of the
asset by the enterprise.

3.4 Depreciable amount of a depreciable asset is its historical cost, or other amount substituted for
historical cost1 in the financial statements, less the estimated residual value.

Definition and Explanation of Final Accounts:

Every businessman goes into a business with the idea of making profit, which is the reward
of this effort. He tries his best to get more and more profit at the smallest economic cost.

The role of accounting is to accumulate accounting data in such a manner that the amount
of profit made or loss sustained during a particular period ascertained. The "final accounts"
enable us to check on the conduct of the business, and to discover whether it is being run
profitably. They are the means of conveying to the owner/owners, management, creditors,
and interested outsiders a concise picture of profitability and financial position of the
business.

The preparation of the final accounts is not the first stage of an accounting cycle but they
are the final products of the accounting cycle, that is why, they are called final accounts.
These accounts summaries all the accounting information recorded in the original books of
entry and the ledger consisted of hundreds of thousands of pages.

The final accounts or financial statements consists of:

1. Trading and profit and loss account or income statement, which is prepared to know
the profit earned or loss suffered by the business during a specific period.
2. Balance sheet, which is prepared to know the financial position of the business on a
particular date.

These two items or statements are collectively known as "final accounts or financial
statements"

Trading Account:

Definition and Explanation:

The account which is prepared to determine the gross profit or gross loss of a business
concern is called trading account.

It should be noted that the result of the business determined through trading account is not
true result. The true result is the net profit or the net loss which is determined through
profit and loss account. The trading accounting has the following features:

1. It is the first stage of final accounts of a trading concern.

2. It is prepared on the last day of an accounting period.
3. Only direct revenue and direct expenses are considered in it.
4. Direct expenses are recorded on its debit side and direct revenue on its credit side.
5. All items of direct expenses and direct revenue concerning current year are taken
into account but no item relating to past or next year is considered in it.
6. If its credit side exceeds it represents gross profit and if debit side exceeds it shows
gross loss.

Purpose of Preparing Trading Account:

The profit or loss determined by a trading account is the gross result of the business but not
the net result. If so, then a question arises - what is the use of preparing a trading account?
This account is necessary because of the following advantages.
 1. Gross profit of a business is very important data, since all business expenses are met
out of it. So the amount of gross profit should be adequate to meet the indirect
expenses of a business concern.
2. The amount of net sales can be determined through this account. Gross sales can be
ascertained from sales account in the ledger, but net sales cannot be so obtained.
The true sales of a business is net sales - not gross sales. Net sales are determined
by deducting sales returns from gross sales in trading account.
3. The success or failure of a business can be ascertained by comparing net sales of the
current year with that of the last year. It should be noted that an increase in the
amount of net sales of the current year over the last year may not be regarded as a
sign of success, since sales may increase because of rise in price level.
4. Percentage of gross profit on net sales (gross profit ratio) can be easily determined
from trading account. This percentage is very important yardstick for measuring the
success or failure of a business. Compared to last year, if the rate increases, it
indicates success; on the other hand if the rate decreases, it is an indication of
failure.
5. Percentage of different items of buying expenses (direct expenses) on gross profit
can be easily determined and by comparing the percentage of the current year with
that of the previous year the variations can be ascertained. An analysis of variances
will disclose their cause which will help in controlling the amount of expenses.
6. Inventory or stock turnover ratio can be determined from trading account. The
success or failure of a business can be measured by this rate. Higher rate indicates a
favorable sign i.e. goods are sold soon after their purchase. On the other hand, low
rate signifies deterioration, i.e. goods are sold long after their purchase.

Method of Preparation of Trading Account:

Trial balance is a list of all ledger accounts balances, so all the necessary information for
preparation of a trading account is available from the trial balance. As gross profit or gross
loss of a particular period is determined through trading account. So it's heading will be as
follows:

XYZ co.
Trading Account for the year ended 31.12.2005
(if period ends on 31.12.2005)

From the trial balance, the balance of opening stock account, purchases account, returns
inwards account and of all direct expenses are transferred on the debit side of the trading
account, and the balance of the sales account, returns outwards account, and closing stock
account are transferred on the credit side of the trading account. If the credit side of the
trading account exceeds the debit side, the result is "gross profit", and if debit side exceeds
the credit side, the result is "gross loss". The format of a trading account is shown below:\
 Name of Business
for the year ended .....

$ $

Stock (Opening) Sales -----

Purchases ----- Less returns ----- -----

Less returns ----- -----

Stock
-----
(closing)

Gross loss
Carriage inward ----- (Transferred -----
to P&l A/C)

Wages -----

Insurance in transit -----

Custom duty -----

Clearing charges -----

Freight inward -----

Transportation inward -----

Excise duty on goods -----

Royalty -----

Dock charges -----

Coal, Coke, Gas, fuel -----

Motive power -----

Oil, water -----

Gross profit (Transferred to P&l A/C) -----

Example:

The following are some ledger balances taken out from the trial balance of XYZ company on
31st December 2005.

$ $

Stock on 1.12005 60,000 Returns outwards 16,000

Purchases 360,000 Returns inwards 30,000

Carriage inwards 24,000 Sales 500,000

Custom duty 12,000

The closing stock is valued at $10,000.

Required:

Prepare a trading account for the year ended 31st December 2005. Show the journal entries
to close the above account (closing entries).

Solution:

xyz co.
Account for the year ended 31.12.2005

$ $

Stock 1.1.2005 60,000 Sales 500,000

Purchases 3,60,000 Less returns 30,000 470000

Less returns 16,000 3,44,000

Stock (closing) 100,000

Carriage inward 24,000

Custom duty 12000

Gross profit (transf. to P&L

130,000
A/C)

570,000 570,000
Profit and Loss Account:

Definition and Explanation:

The account through which annual net profit or loss of a business is ascertained, is
called profit and loss account. Gross profit or loss of a business is ascertained
through trading account and net profit is determined by deducting all indirect expenses
(business operating expenses) from the gross profit through profit and loss account. Thus
profit and loss account starts with the result provided by trading account.

The particulars required for the preparation of profit and loss account are available from the
trial balance. Only indirect expenses and indirect revenues are considered in it. This account
starts from the result of trading account (gross profit or gross loss). Gross profit is shown
on the credit side of the profit and loss account and gross loss is shown on the debit side of
this account. All indirect expenses are transferred on the debit side of this account and all
indirect revenues on credit side. If the total of the credit side exceeds the debit side, the
result is "net profit" and if the total of the debit side exceeds the total of the credit side, the
result is net loss. As the net profit or net loss of a certain accounting period is determined
through profit and loss account, so its heading is:

Name of Business
Profit and Loss Account for the year ended 31.12.2005
(if period ends on 31.12.2005)

Sequence of Expenses in Profit and Loss Account:

There is no hard and fast rule as to the order in which the items of expenses are shown in
profit and loss account. Generally, the items of expenses are shown in the following
sequence:

Office and Administration Expenses:

These are the expenses with the management of the business e.g. salaries of manager,
accountant and office clerks, office rent, office stationary, office electric charges, office
telephone etc.

Selling and Distribution Expenses:

These are the expenses which are directly or indirectly connected with the sale of goods.
These expenses vary with the sales i.e. they increase or decrease with the increase or
decrease of sale of goods. Examples are advertisements, carriage outward, salesmen's
salaries and commission, discount allowed, traveling expenses, bad debts, packaging
expenses, warehouse rent etc.

Financial and Other Expenses:

All other expenses excepting those mentioned above are considered under this class.

Features of Profit and Loss Account:

1. This account is prepared on the last day of an account year in order to determine the
net result of the business.
2. It is second stage of the final accounts.
3. Only indirect expenses and indirect revenues are shown in this account.
4. It starts with the closing balance of the trading account i.e. gross profit or gross loss.
5. All items of revenue concerning current year - whether received in cash or not - and
all items of expenses - whether paid in cash or not - are considered in this account.
But no item relating to past or next year is included in it.

The following is a specimen of profit and loss account

Name of Business Account for the year ended .....

$ $

Trading A/C Trading A/C

Gross profit (transferred) ----- Gross profit (transferred) -----

Office and Administration Expenses: ----- Interest received -----

Salaries ----- Rent received -----

Rent, rates, taxes ----- Discount received -----

Postage & telegrams ----- Dividend received -----

Office electric charges ----- Bad debts recovered -----

Telephone charges ----- Provision for discount on creditors -----

Printing and stationary ----- Miscellaneous revenue -----

Selling and Distribution Expenses: Net loss - transferred to capital A/C -----

Carriage outward -----

Advertisement -----
 Salesmen's salaries -----

Commission -----

Insurance -----

Traveling expenses -----

Bad debts -----

Packing expenses -----

Financial and Other Expenses:

Depreciation -----

Repair -----

Audit fee -----

Interest paid -----

Commission paid -----

Bank charges -----

Legal charges -----

Net profit - transferred to capital A/C -----

Example:

The following is the trial balance of XYZ company on 31st December 2005.

Dr. Cr.

$ $

1 Opening stock 64,000

2 Purchases 460,000

3 Returns inwards 50,000

4 Carriage inwards 16,000

5 Salaries 96,000
 6 Carriage outwards 10,000

7 Rent 72,000

8 Discount allowed 8,000

9 Sundry debtors 240,000

10 Plant and Machinery 360,000

11 Furniture 60,000

12 Drawings 18,000

13 Sundry creditors 350,000

14 Returns outwards 36,000

15 Sales 740,000

16 Capital 328,000

1,454,000 1,454,000

The closing stock is valued at $126,000.

Required:

Prepare a profit and loss account for the year ended 31st December 2005.

Solution:

As we have already discussed that profit and loss account starts with the gross profit or
gross loss figure produced by trading account, we have to determine the gross profit or
gross loss by preparing trading account of XYZ company first.

XYZ co.
for the year ended 31.12.2005

$ $

Stock 1.1.2005 64,000 Sales 740,000

Purchases 4,60,000 Less returns 50,000 470000

Less returns 36,000 424,000

Stock (closing) 126,000

Carriage inward 16,000

Gross profit (transf. to P&L

312,000
A/C)

816,000 816,000

XYZ co.
Profit and Loss Account for the year ended 31.12.2005

$ $

Office and Administration Expenses: Gross profit (transferred from 312,000

Salaries 96,000

Rent, rates, taxes 72,000

Selling and Distribution Expenses:

Carriage outwards 10,000

Discount allowed 8,000

Net profit - transferred to capital A/C 126,000

312,000 312,000
Difference Between Trading Account and Profit and
Loss Account:

Following are the main points of difference between trading account and profit and
loss account:

Trading Account Profit and Loss Account

It is the second stage of the final
1 It is the first stage of final accounts. 1
accounts.

It shows the gross result (gross It shows the net results (net profit or
2 2
profit or gross loss) of the business. net loss) of the business.

All direct expenses (expenses

All expenses connected with sales and
connected with purchase or
3 3 administration (indirect expenses) of
production of goods) are considered
business are considered.
in it.

It always starts with the balance of a

It does not start with the balance of
4 4 trading account (gross profit or gross
any account.
loss).

Its balance (G.P or G.L) is

Its balance (N.P or N.L) is transferred
5 transferred to profit and loss 5
to capital account in balance sheet.
account.

Difference Between Gross Profit and Net Profit:

Gross Profit or Loss:

Gross profit is ascertained by deducting cost of goods sold (all direct expenses like
purchases, carriage, custom duty, sock charges, octroi duty etc.) from sales.

Gross profit = Total sales - All direct expenses or cost of goods sold
For example, suppose Mr. X purchased some goods for $10,000 and paid $200 on account
of carriage and $100 as octroi duty. He sold the goods for $1,4000. Now, the cost of goods
sold will be $10,300 (10,000 + 200 + 100) and gross profit will be $3,700.

Gross profit = Total sales - Cost of goods sold

= 14000 - 10300

=3,700

Thus the account which is prepared to determine the gross profit or gross loss of a business
concern is called trading account.

Net Profit or Loss:

It is ascertained by deducting all indirect expenses (the expenses incurred for running the
business and selling the goods) from the gross profit.

Net profit = Gross profit - All indirect expenses

Suppose in the above example, Mr. X paid $1,000 as salaries and $500 as rent. His net
profit will be $2,200.

Net profit = Gross profit - All indirect expenses

= 3,700 - 1,500

= 2,200

Thus the account which is prepared to determine the net profit or net loss of a business
concern is called profit and loss account.

Following are the main points of difference between gross profit and net profit:

Gross Profit Net Profit

1 It is the excess of net sales over 1 It is the excess of gross profit
cost of purchase or manufacture (all over all indirect expenses.
expense relating to purchase or
manufacture of goods) of goods.

2 It is not true profit of the business 2 It is true profit of the business.

3 It shows credit balance of the 3 It shows credit balance of the

trading account profit and loss account.
 4 The progress of the business can be 4 The profitability of the business
judged by the comparison of gross can be measured by the
profit with net sales comparison of net profit with net
sales.

Balance Sheet - Last Stage in Final Accounts:

Definition and Explanation:

Balance sheet is a list of the accounts having debit balance or credit balance in the
ledger. On one side it shows the accounts that have a debit balance and on the other side
the accounts that have a credit balance. The purpose of a balance sheet is to show a true
and fair financial position of a business at a particular date. Every business prepares a
balance sheet at the end of the account year. A balance sheet may be defined as:

1. "It is a statement of assets, liabilities and owner's equity (capital) on a particular

date".
2. "It is a statement of what a business concern owns and what it owes on a particular
date". What is owns are called assets and what it owes are called liabilities.
3. "It is a statement which discloses total assets, total liabilities and total capital
(owner's equity) of a concern on a particular date".
4. "It is a statement where all the ledger account balances which remain open after
the preparation of trading and profit and loss account, find place".

Balance sheet is so called because it is prepared with the closing balance of ledger
accounts at the end of the year. It has two sides - assets side or left hand side and
liabilities side or right hand side. The accounts have a debit balance are shown on the asset
side and those have a credit balance are shown on the liabilities side and the total of the
two sides will agree.

Assets means all the things and properties under the ownership of the business i.e.
building, plant, furniture, machinery, stock, cash etc. Assets also include anything against
which money or service will be received i.e. creditors accrued income, prepaid expenses
etc.

Liabilities means our dues to others or anything against which we are to pay money or
render service, i.e. creditors, outstanding expenses, amount payable to the owner of the
business (capital) etc.
Asset side of the balance sheet indicates the different types of assets owned by a concern,
while liabilities side discloses the various sources through which funds have been obtained
in order to acquire those assets. Balance sheet reveals the financial position of the firm on
a particular date at a point of time, so it is also called "position statement". It is
prepared on the last day of the accounting year and discloses concern for the whole year
cannot be determined through the balance sheet because financial position is ever
changing. The is why the heading of the balance sheet is given as under:

Balance Sheet as at 31st December, 2005

(If accounting year ends on 31 Dec. 2005)

Features of Balance Sheet:

has the following features:

1. It is the last stage of final accounts

2. It is prepared on the last day of an accounting year.
3. It is not an account under the double entry system - it is a statement only.
4. It has two sides - left hand side known as asset side and right hand side known as
liabilities side.
5. The total of both sides are always equal.
6. The balances of all asset accounts and liability accounts are shown in it. No expense
accounts and revenue accounts are shown here.
7. It discloses the financial position and solvency of the business.
8. It is prepared after the preparation of trading and profit and loss account because
the net profit or net loss of a concern is included in it through capital account.

Method of Preparation of Balance Sheet:

All the information necessary for the preparation of balance sheet is available from trial
balance and from some other ledger accounts. After transferring accounts relating to
expenses and revenues to trading and profit and loss account, the trail balance contains
only the accounts of assets, liabilities, and capital. All assets have debit balances and all
liabilities and capital have credit balances. The asses are shown on the asset side of the
balance sheet and liabilities and capital are shown on the liabilities side of the balance
sheet after arranging them properly.

As the balance sheet is prepared on the last day of an accounting year, so its heading and
format will be:

Balance Sheet
as at 31st December, 2005

Asset $ Liabilities and Capital $.

Classification of Assets:

may be classified as follows:

Real Assets:

Assets which have some market value are called real assets, e.g. building, machinery,
stock, debtors, cash, goodwill, etc. Real assets are further divided into two types according
to their permanence:

Fixed Assets: Assets which have long life and which are bought for use for a long period of
time are called "fixed assets". These are not bought for selling purposes, e.g. land,
building, plant, machinery, furniture etc. Fixed assets are again sub-divided into two:

1. Tangible Assets: Assets which have physical existence and which can be seen,
touched and felt are called "tangible assets", e.g. building, plant, machinery,
furniture etc.
2. Intangible Assets: Assets which have no physical existence and which cannot be
seen, touched or felt are called "intangible assets", e.g. goodwill, patent right, trade
mark etc.

Current Assets: Assets which are short-lived and which can be converted into cash quickly
to meet short term liabilities are called "current assets", e.g. stock debtors, cash etc. Such
assets change their form repeatedly and so, they are also known as circulating or floating
assets. For example, on purchase of goods cash is converted into stock and on sale of
goods, stock is converted into debtors, on collection from debtors, debtors take the form of
cash etc.
Out of current assets those which can be converted into cash very quickly or which are
already in the form of cash are called liquid or quick assets e.g. debtors, cash in hand, cash
at bank etc.

Fictitious Assets: Assets which have no market value are called fictitious assets. examples
of fictitious assets include preliminary expenses, loss on issue of shares etc. They are also
known as nominal assets.

Besides these, there is another type of assets whose value gradually reduce on account of
use and finally exhaust completely. This type of assets is called wasting assets e.g. mine,
forest etc.

Classification of Liabilities:

Internal Liabilities:

The total amount of debts payable by a business to its owner is called internal liability e.g.
Owner's equity (capital), reserve etc. From practical view point internal liabilities should
not be regarded as liabilities, since there is no question of meeting such liabilities al long as
the business continues.

External Liabilities:

All debts payable by a business to the outsiders (other than the owner) are called external
liabilities e.g. creditors, debentures, bills payable, bank overdraft, etc. External liabilities
are further divided into two.

Fixed or Long Tern Liabilities: The liabilities which are payable after a long period of
time are called fixed or long term liabilities e.g. debentures, loan on mortgage etc.

Current or Short Term Liabilities: The debts which are repayable within a short period
of time are called current or short-term liabilities e.g. creditors, bills payable, bank
overdraft etc. Current liabilities may again be divided into two:

1. Deferred Liabilities: Debts which are repayable in the course of less than one year
but more than one month are called deferred liabilities e.g. Short term loan etc.
 2. Liquid or Quick Liabilities: Debts are repayable in the course of a month are called
liquid or quick liabilities e.g. bank overdraft, outstanding expenses, creditors etc.

Besides the above, there is another type of liability which is known as contingent
liability. It is one which is not a liability at present, but which may or may not become a
liability in in future. It depends upon certain future event. For example, suppose, the buyer
of goods filed a suit in the court against the seller claiming damage of $10,000 for breach
of contract. This will be regarded as a contingent liability to the seller until the receipt of
the court's order. To the buyer, this is a contingent asset. Both contingent liability and
contingent asset are not recorded in the balance sheet. They are generally mentioned in
the balance sheet as a note.