7 Reporting and Preparing Financial Statements

CLASSIFICATION OF CAPITAL AND REVENUE

The Going Concern Assumption allows the accountant to classify the expenditure and receipts as:

Capital Expenditure Revenue Expenditure Deferred Revenue Expenditure Capital Receipts Revenue Receipts.

CAPITAL EXPENDITURE: is that expenditure which yields benefits which extend beyond the current accounting period. They are of non-recurring nature. For e.g. cost of land and building, plant and machinery, furniture and fixtures etc.

REVENUE EXPENDITURE: is that expenditure which is incurred for the running productivity or earning capacity of a business. Such expenditure yields benefit in the current accounting period only. For e.g. Office and Administration Expenses, Selling & Distribution Expenses etc.

DEFERRED REVENUE EXPENDITURE: is that expenditure for which payment has been made or a liability incurred but is carried forward on the presumption that it will be benefit over a subsequent period or periods. Sometimes, revenue expenditure incurred during the year is very large and it is expected to benefit not only the current year operations but also subsequent period or periods. Such expenditure should be normally written off over a period of 3 to 5 years.

For e.g. heavy Advertising Campaign, Research & Development Expenditure.

CAPITAL RECEIPTS AND REVENUE RECEIPTS

The recurring receipts are normally the outcome of normal trading activities and are regarded as Revenue Receipts. Foe e.g. sale price received from sale of goods, interest on investments made in past etc. The benefits of recurring receipts do not extend beyond the current accounting period. The Revenue Receipts are shown in the Income Statement.

The non-recurring receipts are Capital Receipts and may take form of raising of long-term loans, capital contribution by the owner, sale price of fixed asset etc. The benefits of non-recurring receipts may or may not be confined to current accounting period. The capital receipts create a liability of an equal amount to be paid in future.

RATIONALE OF MAKING ADJUSTMENTS

The important considerations are:

1. Revenue Recognition Principle which requires that revenue should be recognised in the period in which the sale is deemed to have occurred.

2. Matching Principle which requires that the expenses should be recognised in the same period as associated revenues. Expenses recognition is tied to revenue recognition. Let the expenses follow the revenue.

An adjusting entry is recorded to bring an asset or liability account balance to its proper amount.

1. CLOSING STOCK:

Adjusting Entry Closing Stock Dr.

To Trading A/c

Trading A/c Shown on the credit side

Balance Sheet Shown on the asset side as Current Asset

2. OUTSTANDING EXPENSES:

Expenses incurred but not paid at the end of the year are called outstanding expenses

Adjusting Entry Respective Expense A/c Dr.

To Outstanding Expense A/c

Trading A/c Added to the respective expense on the debit side.

Profit & Loss A/c Added to the respective expense on the debit side.

Balance Sheet Shown on the Liability side as Current Liability

3.PREPAID EXPENSES: Prepaid Expenses refer to amount paid in the current accounting year for services to be received in the next accounting year

Adjusting Entry Prepaid Expense A/c Dr.

To Respective Expense A/c

Trading A/c Deducted from the respective expense on the debit side.

Profit & Loss A/c Deducted from the respective expense on the debit side.

Balance Sheet Shown on the Asset side as Current Asset

4. ACCRUED INCOME (Income earned but not received) :If income for the current year is not received during the year, it is termed as accrued income.

Adjusting Entry Accrued Income A/c Dr.

To Respective Income A/c

Profit & Loss A/c Added to the respective Income on the credit side.

Balance Sheet Shown on the Asset side as Current Asset

5. UNEARNED INCOME (Income received in advance):It refers to income received for the current year against which services are to be provided in the next accounting year

Adjusting Entry Respective Income A/c Dr.

To Unearned Income A/c

Profit & Loss A/c Deducted from the respective Income on the credit side.

Balance Sheet Shown on the Liabilities side as Current Liability.

6. DEPRECIATION on FIXED ASSET:Depreciation is the depreciable cost of a fixed asset allocated to a particular accounting year.

Adjusting Entry Depreciation A/c Dr.

To Asset A/c

Profit & Loss A/c Shown on the debit side as separate item.

Balance Sheet Shown on the Asset side by way of deduction from the value of the concerned fixed asset.

7. BAD DEBTS:When a business enterprise becomes certain about non-recovery of the amount from debtors, it is treated as Bad Debts and charged to Profit & Loss A/c

Adjusting Entry Bad Debts A/c Dr.

To Assets A/c

Profit & Loss A/c Shown on the debit side by way of addition to Bad Debts

Balance Sheet Shown on the Assets side as deduction from the amount of Sundry Debtors.

Illustration 2: Trial Balance of M/s Pandit Bros. as at 31st March,2007 was as follows:Rs. Rs.

Cash

Bank

Wages

Salaries

Furniture

Rent of Building

Debtors

Bad Debts

Purchases

1,000

5,000

8,000

25,000

15,000

13,000

15,500

4,500

75,000

Capital

Sales

Creditors

22,000

1,25,000

15,000

1,62,000 1,62,000Adjustments:

1. Rent of building for one month was paid in advance

2. Closing Stock as on March 31, 2007 amounted to Rs.10,000/-

3. Wages Outstanding amounted to Rs.500/-

4. Salaries included Rs.5,000/- paid in advance to an employee

5. Furniture to be depreciated @ 10%.

6. Debtors included bad debts Rs.2,500/-

Prepare Trading and Profit and loss A/c and Balance Sheet

8. PROVISION FOR BAD AND DOUBTFUL DEBTS:As the exact amount of bad debts cannot be calculated at the time of sale, a provision for bad and doubtful debts may be created in the year of sale and charged to P&L A/c of this year.

Adjusting Entry Profit & Loss A/c Dr.

To Provision for Bad Debts A/c

Profit & Loss A/c Shown on the debit side as separate item

Balance Sheet Shown on the Assets side by way of deduction from the amount of Sundry Debtors (net of additional bad debts)

9. PROVISION FOR DISCOUNT ON DEBTORS:Provision for discount on debtors is created to take care of discount to be allowed to debtors for prompt payment. But before calculating provision for discount, provision for doubtful debts is deducted from debtors.

Adjusting Entry Profit & Loss A/c Dr.

To Provision for Discount on Debtors

Profit & Loss A/c Shown on the debit side as separate item

Balance Sheet Shown on the Assets side by way of deduction from the amount of Sundry Debtors (net of additional bad debts & Provision for Bad and Doubtful Debts)

10. PROVISION FOR DISCOUNT ON CREDITORS:Although Provision for discount on creditors is against the principle of conservatism but it is an accepted accounting practice

Adjusting Entry Provision for Discount on Creditors A/c Dr.

To Profit & Loss A/c

Profit & Loss A/c Shown on the CREDIT side as separate item

Balance Sheet Shown on the Liabilities side by way of deduction from the amount of Sundry Creditors

11.INTEREST ON CAPITAL:To calculate true profit for the year, interest on capital invested by the owner of business is provided in the books and treated as business expense.

Adjusting Entry Interest on Capital A/c Dr.

To Capital A/c

Profit & Loss A/c Shown on the DEBIT side as separate item

Balance Sheet Shown on the Liabilities side by way of addition to the capital.

12.INTEREST ON DRAWINGS:Cash, goods or any other asset withdrawn by the owner for his personal use is termed as drawings. Sometimes interest on drawings is calculated by the business enterprise and treated as business income.

Adjusting Entry Capital A/c Dr.

To Interest on Drawings A/c

Profit & Loss A/c Shown on the CREDIT side as separate item

Balance Sheet Shown on the Liabilities side by way of deduction from the capital.

13.MANAGER’S COMMISSION ON PROFIT:(i) Commission on Profits Before Charging Such Commission: Profit before Commission X Rate of Commission 100

(ii) Commission on Profits After Charging Such Commission: Profit before Commission X Rate of Commission 100 + Rate

Adjusting Entry Manager’s Commission Dr.

To Outstanding Commission A/c

Profit & Loss A/c Shown on the CREDIT side as separate item

Balance Sheet Shown on the Liabilities side as Current Liability.

14. ABNORMAL LOSS OF STOCK:Sometimes loss of goods takes place due to fire, theft, earthquakes, etc.

Trading A/c Total value of abnormal loss of stock (whether or not recovered) is shown on the credit side of the Trading A/c

Profit & Loss A/c Total value of irrecovered loss of stock is shown on the debit side as separate item.

Balance Sheet The amount due from the insurance company is shown on the asset side as a Current Asset.

15. GOODS SENT ON SALE OR APPROVAL BASIS :Generally, goods supplied on approval are recorded as sales. But this cannot be treated as sales until the express or implied consent of the buyer is obtained.

Adjusting Entry Sales A/c Dr.

To Debtors A/c

(with sale price of goods sold on approval basis)

Stock A/c Dr.

To Trading A/c

(with cost of goods sold on approval basis)

Trading A/c Shown as a deduction from Sales (with sale price)

Added to the Closing Stock on credit side.

Balance Sheet Shown on the Assets side by way of deduction from the Debtors. (with sale price)

Shown on the Assets side by way of addition to the Closing Stock. (with cost price)

Illustration 3: From the following Trial Balance of Mr. Ram, prepare a Trading and Profit and Loss A/c for the year ending on 31st March, 2006 and a Balance Sheet as on that date: Dr. Trial Balance Cr.

Rs. Rs.

Plant & Machinery

Office Furniture

Stock (1.4.2005)

Motor Van

Debtors

Cash in Hand

Cash at Bank

Wages (factory)

Wages (office)

Purchases

Bills Receivable

Sales Return

Drawings

Rent

51,000

2,600

48,000

12,000

45,000

400

6,500

1,50,000

14,000

2,13,500

7,200

9,300

6,000

6,000

Capital

Creditors

Sales

Bills Payable

Purchase Return

Provision for Bad Debts

Discount Received

41,000

52,000

4,80,000

5,600

5,500

2,500

3,700

Lightning

Telephone

Insurance

Advertisement

General Expenses

Bad Debts

Discount Allowed

800

1,350

300

6,350

1,000

2,500

6,500

5,90,300 5,90,300

Illustration 3 contd………………………..

The following adjustments are to be made:

(a) Stock on 31st March,2006 was valued at Rs.52,000/-

(b) Rent due but not paid Rs.2,000/-

(c) Lightning due but not paid Rs.300/-

(d) Insurance Paid in advance Rs.100/-

(e) Depreciate Plant & Machinery @ 331/3%; Office Furniture @ 10%; Motor Van @ 331/3%

(f) The Provision for Bad Debts has to be increased to Rs.3,000/-

(g) The Provision for Discount on Debtors and Discount on Creditors is to be made @ 2.5%

(G.P. Rs.1,16,700/-; N.P. Rs.57,890/-; B/S Total Rs.1,51,490/-)

Illustration 4: From the following information prepare Final Accounts:

Trial Balance as on 31st March,2006Purchases (Adjusted)

Wages

Rent of Building

Insurance and rates (including premium of Rs.150 p.a. paid up to 30-9-2006)

Stock (31-3-2006)

Cash

Loose Tools

Plant

Debtors

Sundry Expenses

1,49,600

10,450

4,200

200

20,625

925

2,000

17,000

3,000

5,000

Sales

Capital

Commission

Creditors

1,60,000

37,550

450

15,000

2,13,000 2,13,000

Illustration 4 contd………………….

Adjustments:

1. Loose Tools were valued at Rs.1,600/- on 31-3-2006

2. Depreciate Plant by 10%

3. Manager is entitled to a commission of 10% of net profits after charging such commission.

4. One-third of the building was occupied by the employees who reside in the business building. Treat the value of the perquisite as wages.

5. Wages include Rs.500/- for installation of a plant on 1-10-2005.

6. Loss of stock by fire on 20-3-2006 amounted to Rs.10,000/- and 100% claim was admitted by the Insurance Company.

(G.P. Rs.9,050/-; N.L. Rs.575/-; B/S Total Rs.51,975/-)

Illustration 5: The following is the Trial Balance extracted from the books of Akhilesh as on 30th September, 2007:

Particulars Dr. (Rs.) Cr. (Rs.)

Capital A/c

Plant and Machinery

Furniture

Purchases and Sales

Returns

Opening Stock

Discount

Sundry Debtors / Creditors

Salaries

Manufacturing Wages

Carriage Outwards

Provision for Doubtful Debts

Rent, rates and Taxes

Advertisements

Cash

----

78,000

2,000

60,000

1,000

30,000

425

45,000

7,550

10,000

1,200

----

10,000

2,000

6,900

1,00,000

----

----

1,27,000

750

----

800

25,000

----

----

----

525

----

----

----

2,54,075 2,54,075

Prepare Trading & Profit and Loss A/c for the year ended on 30th September,2007 and a Balance Sheet as on that date after taking into account the following adjustments:

1. Closing Stock was Valued at Rs.34,220/-

2. Provision for Doubtful Debts is to be kept at Rs.500/-

3. Depreciate Plant & Machinery @ 10%

4. The proprietor has taken goods worth Rs.5,000/- for personal use and additionally distributed goods worth Rs.1,000/- as samples.

5. Purchase of furniture Rs.920/- has been passed through Purchases Book.

(G.P. Rs.67,890; N.P. Rs.38,740/-, B/S Total Rs.1,58,740/-)