Book Keeping and Accounting - Preparation of financial statements (Income, Expenses, Assets & Liabilities)

Introduction

The primary objective of any business concern is to earn income. Ascertainment of the periodic income of a business enterprise is perhaps the important objective of the accounting process. This objective is achieved by the preparation of profit and loss account or the income statement. Profit and loss account is generally considered to be of greatest interest and importance to end users of accounting information. The profit and loss account enables all concerned to find out whether the business operations have been profitable or not during a particular period. Usually the profit and loss account is accompanied by the balance sheet as on the last date of the accounting period for which the profit and loss account is prepared. A balance sheet shows the financial position of a business enterprise as of a specified moment of time. It contains a list of the assets, the liabilities and the capital of a business entity as of a specified date, usually at the close of the last day of a month or a year. While the profit and loss account is categorised as a flow report (for a particular period), the balance sheet is categorised as a status report (as on a particular date).

Basic Ideas About Income And Expense

Profit and loss account consists of two elements: one element is the inflows that result from the sale of goods and services to customers which are called as revenues. The other element reports the outflows that were made in order to generate those revenues; these are called as expenses. Income is the amount by which revenues exceed expenses. The term ‘net income’ is used to indicate the excess of all the revenues over all the expenses. The basic equation is:

Revenue – Expenses = Net Income

This is in accordance with the matching concept.

Income And Owner’s Equity:

The net income of an accounting period increases owner’s equity because it belongs to the owner. To quote an example, goods costing rs.20,000 are sold on credit for rs.28,000. The result is that stock is reduced by rs.20,000 and a new asset namely debtor for rs.28,000 is created and the total assets increase by the difference of rs.8,000. Because of the dual aspect concept, we know that the equity side of the balance sheet would also increase by rs.8,000 and the increase would be in owner’s equity. This is because the profit on sale of goods belongs to the owner. It is clear from the above example that income increases the owner’s equity.

Income Vs. Receipts:

Income of a period increases the owner’s equity but it need not result in increase in cash balance. Loss of a period decreases owner’s equity but it need not result in decrease in cash balance. Similarly, increase in cash balance need not result in increased income and owner’s equity and decrease in cash balance need not denote loss and decrease in owner’s equity. All these are due to the fact that income is not the same as cash receipt. The following examples make clear the above point:

1. When goods costing rs.20,000 are sold on credit for rs.28,000 it results in an income of rs.8,000 but the cash balance does not increase.
2. When goods costing rs.18,000 are sold on credit for rs.15,000 there is a loss of rs.3,000 but there is no corresponding decrease in cash.
3. When a loan of rs.5,000 is borrowed the cash balance increases but there is no impact on income.
4. When a loan of rs.8,000 is repaid it decreases only the cash balance and not the income.

Expenses:

An expense is an item of cost applicable to an accounting period. It represents economic resources consumed during the current period. When expenditure is incurred the cost involved is either an asset or an expense. If the benefits of the expenditure relate to further periods, it is an asset. If not, it is an expense of the current period. Over the entire life of an enterprise, most expenditure becomes expenses. But according to accounting period concept, accounts are prepared for each accounting period. Hence, we get the following four types of transactions relating to expenditure and expenses:

Expenditures That Are Also Expenses:

This is the simplest and most common type of transaction to account for. If an item is acquired during the year, it is expenditure. If the item is consumed in the same year, then the expenditure becomes expense. E.g. Raw materials purchased are converted into saleable goods and are sold in the same year.

Assets That Become Expenses:

when expenditures incurred result in benefits for the future period they become assets. When such assets are used in subsequent years they become expenses of the year in which they are used. For e.g. Inventory of finished goods are assets at the end of a particular accounting year. When they are sold in the next accounting year they become expenses.

Expenditures That Are Not Expenses:

As already pointed, out when the benefits of the expenditure relate to future periods they become assets and not expenses. This applies not only to fixed assets but also to inventories which remain unsold at the end of the accounting year. For e.g. The expenditure incurred on inventory remaining unsold is asset until it is sold out.

Expenses Not Yet Paid:

Some expenses would have been incurred in the accounting year but payment for the same would not have been made within the accounting year. These are called accrued expenses and are shown as liabilities at the year end.

Illustration – A:

Profit And Loss Account For The Year Ended 31st March 2020

Particulars	Rs.	Particulars	Rs.
Cost Of Goods Sold Expenses (Schedule17) Interest (Schedule 18) Director’s Fees Depreciation Provision For Taxation Net Profit	78.680 33,804 2,902 11 20,94 6,565 5,,625	Sales(Less Dis count) Other Income (Sched­ule 13)	89,740   39,947
1,29,687		1,29,687

In the “t” shaped profit and loss account, expenses are shown on the left hand side i.e., the debit side and revenues are shown on the right hand side i.e., the credit side. Net profit or loss is the balancing figure. The profit and loss account can also be presented in the form of a statement when it is called as income statement. There are two widely used forms of income statement: single step form and multiple-step form. The single-step form of income statement derives its name from the fact that the total of all expenses is deducted from the total of all revenues.

Illustration – B:

Proforma Of A Multiple-Step Income Statement

Gross Sales Less: Sales Returns Net Sales Less: Cost Of Goods Sold Raw Materials Cost Opening Stock Of Raw Material Add Purchase Of Raw Material Freight Raw Materials Available Less Closing Stock Of Raw Material Raw Materials Consumed Direct Labour Cost Manufacturing Expenses Total Production Cost Add Opening Work-In-Progress Total Less Closing Work-In-Progress

Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx

Xxx Xxx Xxx

 

Cost Of Goods Manufactured Add Opening Finished Goods Cost Of Goods Available For Sale Less Closing Finished Goods Cost Of Goods Sold Gross Profit Less Operating Expenses Administrative Expenses Selling And Distribution Expenses Operating Profit Add Non-Operating Income (Such As Dividend Received Profit On Sale Of Assets Etc.) Less Non-Operating Expenses (Such As Discount On Issue Of Shares Written Off, Loss On Sale Of Assets, Etc.) Profit (Or) Earnings Before Interest & Tax (Ebit) Less Interest Profit (Or) Earnings Before Tax (Ebt) Less Provision For Income-Tax Net Profit (Or) Earnings After Tax (Eat) Earnings Per Share Of Common Stock

Xxx Xxx Xxx Xxx Xxx Xxx Xxx   Xxx Xxx       Xxx   Xxx Xxx Xxx Xxx Xxx Xxx Xxx

Xxx Xxx     Xxx   Xxx   Xxx   Xxx   Xxx

Illustration – C

Income Statement For The Year Ended 31st March 2020

Net Sales Less: Cost Of Goods Sold Gross Profit Less Operating Expenses Expenses (Schedule 17) Director’s Fee Depreciation Operating Loss Add Non-Operating Income Other Income (Schedule 13) Profit (Or) Earnings Before Interest & Tax(Ebit) Less Interest (Schedule 18) Profit (Or) Earnings Before Tax (Ebt) Less Provision For Income-Tax Net Profit (Or) Earnings After Tax (Eat)

33,804 11 2,094

98,740 78,686 11,054       35,909 (-) 24,855   39,947 15,092 2,902 12,190 6,565 5,625

The advantage of multiple-step form of income statement over single step form and the “t” shaped profit and loss account is that there are a number of significant sub totals on the road to net income which lend themselves for significant analysis. Income statements prepared for use by the managers of an enterprise. Usually contain more detailed information than that shown in the above illustrations.

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