A financial statement (or financial report) is a formal record of the financial activities of a business enterprise presented in a structured manner

and in a form easy to understand at the end of an accounting period. Every firm likes to measure the performance of its business operations in terms of profit or loss. It also likes to know the value of its assets and liabilities on the closing date of the accounting period. Such information is available from financial

 Owners and managers require financial statements to make important business decisions that affect its continued operations. Financial analysis is then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stockholders. Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings.

 Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and are prepared by professionals (financial analysts), thus providing them with the basis for making investment decisions. Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.

 Government entities (tax authorities) need financial statements to ascertain the propriety and accuracy of taxes and other duties declared and paid by a company. Vendors who extend credit to a business require financial statements to assess the creditworthiness of the business. Media and the general public are also interested in financial statements for a variety of reasons.

An expenditure whose benefit extends to more than one accounting period is called capital expenditure. Examples are expenditure acquire fixed assets and make additions/extensions to these assets, such as land, building, plant and machinery, furniture etc.

non-recurring in nature.

spread over its expected period of benefit.

Recorded on the assets side of the balance sheet.

increases earning capacity of business

Features of Capital Expenditure

Subject to depreciation

An expenditure whose benefit extends up to one accounting year is termed as revenue expenditure. It is normally incurred for day-to-day conduct of business operations. Examples are payment of salaries, rent etc.

maintain existing earning capacity of business

recurring in nature

FEATURES OF REVENUE EXPENDITURE

debited to trading and profit and loss account.

Revenue expenditure which is likely to give benefit to the business for more than one accounting period is termed as deferred revenue expenditure. The best example is advertising expenses, which though recurring in nature is likely to give a long term benefit to the business, as people may remember the advertisement for a long time. Treatment of deferred revenue expenditure is same as that of capital expenditure. It is treated as an intangible asset, and is shown on assets side of balance sheet and is subject to depreciation.

Capital Receipts: Amount received from the sale of fixed assets, introduction of additional capital into business, and amount received by taking loans and issuing debentures which imply an obligation to return the money are called capital receipts. These are shown on liabilities side of balance sheet. Revenue Receipts: These are routine receipts of the business like sales, rent received, discount received etc., which do not imply an obligation to return the money or are not in form of sale of fixed assets. They are shown on credit side of trading and profit and loss account.

Balance sheet: also referred to as statement of financial position or condition, reports on a company's assets, liabilities, and Ownership equity at a given point in time. Income statement: also referred to as Profit and Loss statement, reports on a company's income, expenses, and profits over a period of time. Profit & Loss account provide information on the operation of the enterprise. These include sale and the various expenses incurred during the processing state.
Statement of retained earnings: explains the changes in a company's retained earnings over the reporting period. Statement of cash flows: reports on a company's cash flow activities, particularly its operating, investing and financing activities.

Trading account is an income statement which ascertains the result from basic operational activities of business, which is the manufacturing/purchasing and selling of goods and services, in the form of gross profit or gross loss. Apart from purchases, all expenses which are directly connected with purchase of goods and bringing them to the point of sale are called direct expenses. These are added to the cost of the goods purchased by debiting them to trading account. Sales are the main item of revenue for the business and thus a direct result of its trading activities, credited to trading A/c.

Gross profit ascertained by trading account is excess of net sales over the cost of goods sold. Gross Profit=Net sales-Cost of goods sold Net Sales=Gross Sales-Sales returns Net Purchases=Gross purchases-Purchases returns Cost of goods sold=Opening stock+ Net Purchases+ All direct expenses Closing Stock Opening stock= Cost of goods in hand at beginning of the accounting year. Closing Stock= Cost of goods lying unsold at end of accounting year Gross loss is the excess of cost of good sold over net sales Gross Loss=Cost of goods sold-Net Sales

Opening Stock Royalty

Net Purchases

Factory Expenses

Wages

DIRECT EXPENSES

Octroi/Imp ort Duty

Carriage Inwards

Fuel/Water /Power/Gas

Packaging Material

Direct expenses and incomes accounts are closed by transferring their balances to Trading Account:

Dr.

Trading Account Of ABC for year ended 31st March, 2010 Particulars
Amount Rs.

Cr.
Amount Rs.

Particulars
By Sales Less Sales Returns By Closing Stock

To Opening Stock To Purchases xxx Less Purchase Returns (xxx) To Wages To Carriage inwards To Fuel, Power, Water To Octroi To Factory Rent To Royalty To Manufacturing Expenses To Other Direct Expenses To Gross Profit (Transferred to Profit And Loss Account)

xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

xxx (xxx) xxx xxx

By Gross Loss (Transferred to Profit And Loss Account)

xxx

XXX

XXX

The income statement in which all those expenses/losses and incomes/gains of the business which are not reflected in Trading Account are recorded is called Profit and Loss Account, which helps ascertain the net(actual) profit earned or net(actual) loss sustained by the business. Expenses and incomes shown in profit and loss account are called indirect expenses and incomes as they are part of operation of business but are not but are not directly related to actual production and trade activities of business.

Gross profit as per trading account is transferred to credit side of profit and loss account. In case there is a gross loss, it is transferred to debit side of profit and loss account. Indirect expenses/losses are transferred to debit side of profit and loss account and Indirect incomes/gains are transferred to credit side. If total of credit side of profit and loss account is more than total of the debit side, the difference is called net profit for the period, and if debit exceed credit, the difference is called net loss sustained by the business. Net Profit=Gross Profit + Indirect expenses indirect incomes If the figure comes out to be negative, then it is a net loss.

Some indirect expenses/losses are:

Salaries
Rent, Rates and Taxes Office/Establishment Expenses Insurance Premium Printing and Stationery Water and Electricity Postage and Telegram Telephone Expenses Repairs/Maintenance

Travelling Expenses/Conveyance

General Expenses
Depreciation Interest

Loss on sale of asset

OTHER DIRECT EXPENSES

Discount Allowed

Bad Debts

Carriage Outwards

Commission

Some indirect incomes/gains are:

Rent received Commission received Discount Received Apprenticeship Premium Bad Debts Recovered

Profit on sale of assets

Miscellaneous Receipts

Dr.

Profit and Loss Account Of ABC for year ended 31st March, 2010 Particulars
Amount Rs.

Cr.
Amount Rs.

Particulars
By Gross Profit b/d By Interest on investment By Rent received By Discount Received By Apprenticeship Premium By Dividends received By Bad debts recovered By Profit on sale of furniture By Commission Received

To Gross Loss b/d To Salaries To Rent, rates and taxes To Insurance Premium To Discount Allowed To Telephone Expenses To Office expenses To Carriage Outwards To Advertisement To Loss on sale of building To Other Indirect Expenses To Net Profit (Transferred to Capital Account)

xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

xxx xxx xxx xxx xxx xxx xxx xxx xxx

By Net Loss (Transferred to Capital Account)

xxx

YYY

YYY

Operating profit is the profit is the profit earned through normal operations and activities of business. It is the profit earned before interest and tax(EBIT) and is the excess of operating revenue over operating expenses. While calculating operating profit, incomes and expenses of a purely financial nature like interest received, sales tax paid etc. and abnormal items like loss by fire etc. are not taken into account. Operating Profit= Gross profit-operating expenses Operating Profit=Net profit + Non operating expenses-Non operating incomes

The balance sheet is a statement which reflects the true financial position of a firm by summarizing its assets and liabilities as on a certain date. It is usually prepared at the end of the year after trading and profit and loss account have been prepared. It is not an account as it cannot be debited or credited by a journal entry. The balance sheet is prepared as on a particular date and not for a period like trading and profit and loss account as even a single transaction will affect some assets or liabilities.

The left-hand side of balance sheet is called liabilities side which shows the balances of the capital account and all liabilities accounts in the trial balance. The right-hand side is called the assets side, which show the balances of all assets accounts in the trial balance. The balances of these accounts are carried forward to the next accounting period. The balance sheet is based upon the fundamental accounting equation: Assets=Liabilities+Capital Thus, the two sides of the balance sheet must undeniably have the same total. If total assets and total liabilities do not tally, then some error has been committed.

Current Assets: These are the assets which are very liquid, and can be converted into cash very quickly, at most within a year. Examples are cash in hand/bank, bills receivable, closing stock, sundry debtors, short term investments, prepaid expenses. Fixed Assets: These are illiquid assets not acquired for the purpose of resale and are held on a long-term basis for use in the business. Examples are land, building, furniture, plant and machinery etc. Intangible Assets: These are assets which cannot be seen or touched. Examples are goodwill, patents, trademarks, copyrights etc.

Current Liabilities: These are liabilities to be settled within one year, paid usually out of current assets. Examples are bank overdraft, bills payable, sundry creditors, outstanding expenses, short term loans Long-term liabilities: These are liabilities payable one year after the date of the balance sheet. Examples are long-term loans from banks. Capital: Capital is the amount originally contributed by the proprietor into the firm as increased by net profit and interest on capital and decreased by net loss, drawings and interest on drawings in balance sheet.

The items presented in the balance sheet should be presented in a particular order. This is called marshaling. This is necessary for information provided to be meaningful, logical, and useful for users. Assets and liabilities may be arranged in the following orders: In order of permanence: The most permanent, illiquid asset, which takes maximum time to convert into cash, and the capital, the longest term liability, will be put on top in the balance sheet, and thereafter the assets and liabilities are arranged in order of reducing level of permanence.

 In order of liquidity: In this case, the order is reversed. The most liquid asset, which can be converted the fastest into cash or cash equivalents, and the most short term liability are shown on top of balance sheet, and thereafter the assets and liabilities are arranged in increasing order of permanence. This allows user to form an idea about their relative lifespans.

The items appearing in the balance sheet can be properly grouped by putting together items of a similar nature under a common heading. For example, the balances of cash, bank, sundry debtors etc. can be grouped and shown under the heading Current Assets, and balances of creditors, bills payable etc. can be shown under the heading Current Liabilities. This improves understandability of information desired to be communicated to the users of accounts.

A firm closes books of accounts at the end of each year and starts new books in the beginning of each year. The first entry in the journal is to record the closing balances of assets and liabilities at the end of the previous year as the opening balances of these accounts in the beginning of new year on the basis of previous years balance sheet. Assets shown in the balance sheet are debited and the liabilities and capital account credited.

Example Furniture A/c Debtors A/c Bank A/c Cash A/c To Capital A/c To 10% Loan A/c To Creditors A/c

Dr. Dr. Dr. Dr.

Balance Sheet of ABC as on 31st March, 2010 Liabilities

Current Liabilities Sundry Creditors Bills Payable Bank overdraft Short term loans Long Term Liabilities Loan Mortgage Debentures Sales Tax Collected Capital Add Net Profit Less Drawings Less Net Loss Less Income Tax Reserves and Funds General Reserve

Amount Rs.
xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx (xxx) (xxx) (xxx) xxx xxx

Assets
Current Assets Cash in hand Cash at bank Sundry Debtors Closing Stock Bills Receivable Investments Long term investment Fixed Assets Land and Building Plant and Machinery Tools and Equipments Furniture and Fixtures Vehicles Livestock Goodwill Patents and Trademarks

Amount Rs.
xxx xxx xxx xxx xxx

xxx
xxx xxx xxx xxx xxx xxx xxx xxx

YYY

YYY

Dr. Particulars
Debtors Drawings Rent and Rates Trade Expenses Purchases Returns Inward Carriage Inwards Wages Salaries Stock(April 1, 2003) Discount Allowed Bad Debts Plant and Machinery Furniture and Fittings Cash in Hand Cash at Bank

Trial Balance of M/s Ram as on 31st March, 2004

Balance Rs.
12,000 2,900 250 670 8,640 190 250 2,920 1,200 3,100 180 200 2,510 1,800 500 15,400

Cr.
Balance Rs.
7,900 30,000 14,290 280 240

Particulars
Creditors Capital Sales Returns Outwards Discount Received

*Closing stock was valued at Rs. 14,220

52,710

52,710

Trading and Profit and Loss Account of M/s Ram for the year ended 31st March, 2004 Dr. Cr. Particulars
To Opening Stock To Purchases 8,640 Less Returns Outwards ( 280) To Wages To Carriage inwards To Gross Profit c/d

Amount Rs.
3,100

Particulars
By Sales Less Returns Inward By Closing stock 14,290 ( 190)

Amount Rs.
14,100 14,220

8,360 2,920 250 13,690 28,320

250 670 1,200 200 200 11,430

28,320 By Gross Profit b/d By Discount Received 13,690 240

To Rent and Rates To Trade Expenses To Salaries To Discount Allowed To Bad Debts To Net Profit (Transferred to Capital Account)

13,930

13,930

Balance Sheet of M/S Ram as on 31st March, 2004 Liabilities

Current Liabilities Creditors Owners Funds Capital Add Net profit Less Drawings

Balance Rs.
7,900 30,000 11,430 (2,900)

Assets
Current Assets Cash in hand Cash at bank Debtors Closing Stock Fixed Assets Plant and Machinery Furniture and Fittings

Balance Rs.
500 15,400 12,000 14,220 2,510 1,800 46,430

38,530

46,430