Final accounts

Final accounts give an idea about the profitability and financial position of a business to its
management, owners, and other interested parties. All business transactions are first recorded in
a journal. They are then transferred to a ledger and balanced. These final tallies are prepared for
a specific period. The preparation of a final accounting is the last stage of the accounting cyc le.It
determines the financial position of the business. under this it is compulsory to make trading
account, profit and loss account and balance sheet.

The term "final accounts" includes the trading account, the profit and loss account, and the
balance sheet.

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

A trading account sheet shows the results of the buying and selling of goods. This sheet is
prepared to demonstrate the difference between selling price and cost price. The trading account
tally is prepared to show the trading results of the business, e.g. gross profit earned or gross loss
sustained by the business.
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.
Profit and Loss Account

This account is prepared to ascertain the net profit/loss of a business during an accounting
period. The profit and loss account is a statement that summarizes the revenues and expenses of
an accounting period so as to reflect the changes in various critical areas of a firm's operations.

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,

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.

Balance Sheet

The balance statement demonstrates the financial position of a business on a specific date. The
financial position of a business is found by tabulating its assets and liabilities on a particular
date. The excess of assets over liabilities represents the capital sunk into the business, and
reflects the financial soundness of a company.

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.

Features of Balance Sheet:

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.

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 to
5 transferred to profit and loss 5
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 cost 1 It is the excess of gross profit over
of purchase or manufacture (all 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 profit

trading account and loss account.

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

Difference Between Trial Balance and

Balance Sheet:
Following are the main points of difference between trial balance and balance sheet:
 Trial Balance Balance Sheet
It is prepared to verify the 1 It is prepared to disclose the true
1 arithmetical accuracy of books of financial position of the business
accounts

It is prepared with balances of all the 2 It is prepared with the balances of

2
ledger accounts assets and liabilities accounts.

It is not a part of final accounts 3 It is an important part of final

3
accounts.

It is prepared before the preparation 4 It is prepared after the preparation

4 of final accounts of trading and profit and loss
account.

It may be prepared a number of time 5 It is generally prepared once at the

5
in an accounting year. end of accounting year.

Generally, it includes opening stock 6 It always includes closing stock but

6
but not closing stock. not opening stock.

There is no rule for arranging the 7 Assets and liabilities must be

7 ledger balances in it. shown in it according to the rule of
marshaling.

It is not required to be filed to 8 It must be filed with the registrar of

8 anybody. companies if the business is a
company.

9 Auditor need not to sign it. 9 Auditor must sign it.

Introduction to Final Accounts

After the completion of preparing Trial Balance, Final Accounts are prepared to ascertain the net
result i.e. profit or loss and the financial position of the business. In other words, a business can
find out the profit or loss made by the business through the final accounts. They are prepared at
the close of the accounting period with the help of trial balance. It is the final step of accounting
circle which includes:

1. Trading Account.
2. Profit and Loss Account.
3. Balance Sheet.

In case of manufacturing concern, a separate manufacturing account must be prepared before

preparing trading account. Final accounts are prepared mainly for following two objectives.
 1. To ascertain the net result i.e. profit or loss made by the business firm during the
accounting period.
2. To know the financial position of the business i.e. assets and liabilities of the business as
on given date.

The net result of the business operation is disclosed by the profit and loss account and the
financial position of the business is shown by the balance sheet.