BCOC-131

Financial Accounting
Indira Gandhi
National Open University
School of Management Studies

Block

3
FINAL ACCOUNTS
UNIT 8
Depreciation 5

UNIT 9
Final Accounts-I 26

UNIT 10
Final Accounts-II 61
Final Accounts
PROGRAMME DESIGN COMMITTEE [Link] (CBCS)
Prof. Madhu Tyagi Prof. D.P.S. Verma (Retd.) Faculty Members
Director, SOMS, IGNOU Department of Commerce
University of Delhi, Delhi SOMS, IGNOU
Prof. R.P. Hooda Prof. N V Narasimham
Former Vice-Chancellor Prof. K.V. Bhanumurthy (Retd.)
Prof. Nawal Kishor
MD University, Rohtak Department of Commerce
University of Delhi, Delhi Prof. M.S.S. Raju
Prof. B. R. Ananthan Dr. Sunil Kumar
Former Vice-Chancellor Prof. Kavita Sharma
Rani Chennamma University Department of Commerce Dr. Subodh Kesharwani
Belgaon, Karnataka University of Delhi, Delhi Dr. Rashmi Bansal
Dr. Madhulika P Sarkar
Prof. I. V. Trivedi Prof. Khurshid Ahmad Batt
Former Vice-Chancellor Dean, Faculty of Commerce & Dr. Anupriya Pandey
M. L. Sukhadia University Management
Udaipur University of Kashmir, Srinagar

Prof. Purushotham Rao (Retd.) Prof. Debabrata Mitra

Department of Commerce Department of Commerce
Osmania University, Hyderabad University of North Bengal
Darjeeling
Prof. R. K. Grover (Retd.)
School of Management Studies
IGNOU

COURSE DESIGN COMMITTEE

Prof. Madhu Tyagi Faculty Members
Director, SOMS, IGNOU SOMS, IGNOU
Prof. N. V. Narasimham
Prof. A.A. Ansari Prof. Nawal Kishor
Jamia Millia Islamia, New Delhi Prof. M.S.S. Raju
Dr. Sunil Kumar
Ms. Surbhi Gupta Dr. Subodh Kesharwani
Vivekananda College Dr. Rashmi Bansal
University of Delhi, Delhi Dr. Madhulika P. Sarkar
Dr. Anupriya Pandey

COURSE PREPARATION TEAM

Accountancy-I: ECO-02
Prof. M.S.S. Raju
(Unit-7, 8 and 20 Revised by Dr. Sunil Kumar) (Course Coordinator & Editor)
Dr. N.K. Kakkar, Ramjas College Dr. Sunil Kumar
University of Delhi, Delhi (Course Coordinator & Editor)
Prof. V. Vishwanadham, Osmania University, Hyderabad
Dr. P.C, Maheshwari, St. John’s College, Agra
Dr. A. S Chawla, Punjabi University, Patiala

Print Production
Sh. Y. N. Sharma Sh. Sudhir Kumar
Assistant Registrar (Pub.) Section Officer (Pub.)
MPDD, IGNOU MPDD, IGNOU

June, 2019
Indira Gandhi National Open University, 2019
ISBN-978-93-89200-
All rights reserved. No part of this work may be reproduced in any form, by mimeograph or any
other means, without permission in writing from the Indira Gandhi National Open University.
Further information on the Indira Gandhi National Open University courses may be obtained from
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2 Printed by :
 Depreciation
BLOCK 3 FINAL ACCOUNTS
After recording and posting all business transactions in the appropriate books
of account and testing the arithmetical accuracy of these records with the help
of Trial Balance, we prepare a summary at the end of the accounting year.
The purpose is to ascertain the profit or loss and the financial position of the
business. The summary is prepared in the form of a Profit and Loss Account
(also called Income Statement) and a Balance Sheet (also called Position
Statement). These two financial statements are termed as Final Accounts. This
block consists of 3 units (Unit 8 to 10) deals with the concepts to be observed
for ascertaining the profit or loss and the financial position of the business,
and the method of preparing the final accounts.
Unit 8 discusses the causes and objectives of providing depreciation, the factors
influencing the amount of depreciation to be charged and the two commonly
used methods of providing depreciation.
Unit 9 describes the method of preparing simple final accounts involving no
adjustments. It also explains the preparation of a Manufacturing Account which
may be prepared by manufacturing establishments.
Unit 10 deals with the adjustments required in respects of certain expenses
and incomes at the time of preparing the final accounts and explains how they
are incorporated in the Profit and Loss Account and the Balance Sheet.

3
Final Accounts

4
 JournalDepreciation
and Ledger
UNIT 8 DEPRECIATON
Structure
8.0 Objectives
8.1 Introduction
8.2 What is Depreciation?
8.3 Depreciation and other Related Concepts
8.4 Causes of Depreciation
8.5 Objectives of Providing Depreciation
8.6 Factors Influencing Depreciation
8.7 Methods of Recording Depreciation
8.8 Methods for Providing Depreciation
8.8.1 Fixed Instalment Method
8.8.2 Diminishing Balance Method
8.8.3 Difference between Fixed Instalment Method and Diminishing Balance
Methods
8.8.4 Change of Method

8.9 Let Us Sum Up

8.10 Key Words
8.11 Some Useful Books
8.12 Answers to Check Your Progress
8.13 Terminal Questions/Exercises

8.0 OBJECTIVES
After going through this unit you should be able to:
 define depreciation;
 distinguish depreciation from other related concepts;
 state the causes of depreciation;
 describe the objectives of providing depreciation;
 state the factors influencing the amount of depreciation;
 explain the methods of recording depreciation;
 list various methods of providing depreciation; and
 prepare accounts under fixed instalment and diminishing balance methods of
providing depreciation.

8.1 INTRODUCTION
While preparing final accounts you have to provide for depreciation on all fixed
assets so as to work out the correct amount of profit or loss for the accounting 5
Final Accounts period. Adjustments usually contain an item asking you to charge depreciation on
various fixed assets at some given rate and you know how to show it in final accounts
In this unit we shall have a detailed discussion on depreciation and study the basic
factors influencing the amount of depreciation and various methods of providing and
accounting for the same.

8.2 WHAT IS DEPRECIATION ?

You are already familiar with the distinction between revenue expenditure and capital
expenditure. You are aware that when the benefit of an expenditure is available
beyond the accounting year (for one or more years) such an expenditure is treated
as capital expenditure and it often results in acquisition of an asset. Since many
accounting years are likely to receive benefits on account of the use of such an asset,
the cost of investment must necessarily be allocated over the period of its useful life
and charged to the Profit and Loss Account. Allocation of the appropriate amount
to each period is called depreciation which represents the expire portion of
the cost of an asset.
It would be useful to discuss different definitions given by various authorities in the
subject for a proper appreciation of the meaning of depreciation.
Pickles defined depreciation as “the permanent and continuous diminution in the
quality, quantity or value of an asset.”
According to Spicer and Pegler, “Depreciation may be defined\as a measure of the
exhaustion of the effective life of an asset from any cause during a given period.”
These definitions refer to certain basic aspects like permanent and continuous
diminution, exhaustion of effective life but they are not comprehensive. Let us see
some more definitions.
According to ICMA (Institute of Cost and Management Accounts, London)
terminology, “Depreciation is the diminution in intrinsic value of the asset due to use
and/or lapse of time.”
According to Walter B. Meigs and others, “The concept of depreciation is closely
linked to the concept of business income. Since part of the service potential of the
depreciable asset is exhausted in he revenue getting process each period, the cost of
these services must be deducted from revenue in measuring periodic income; the
expired cost must be recovered before a business Is considered as well off as at the
beginning of the period. Depreciation is a measure of this cost.”
According to the institute of Chartered Accountants in Austria, “Depreciation
represents that part of the cost of a fixed asset to its owner which is not recoverable
when the asset is finally put out of use by him. Provision against this loss of capital is
an integral cost of conducting the business during the effective commercial life of the
assets and is not dependent upon the amount of profit cleared.”
From the above definitions it is clear that depreciation refers to that part of the cost
of fixed asset which has expired on account of its usage and or the passage of time.
It is thus the ‘lost usefulness’, ‘expired utility’, or ‘reduction in the intrinsic value’ of
a fixed asset.
Depreciation is charged on almost all fixed assets, possible exceptions being land,
6 antiques, etc. Usually the value of land and antiques appreciates over a period of
time, because they do not have finite economic life as in the case of machinery or Depreciation
furniture,

8.3 DEPRECIATION AND OTHER RELATED

CONCEPTS
Sometimes the terms depletion, amortisation etc., are used interchangeably with
depreciation. These terms in fact are used in a different context. Let us understand
the distinction between depreciation and such related concepts.
Depreciation and Depletion : The term ‘depletion’ is used in respect of the
extraction of natural resources from wasting assets such as quarries, mines, etc. and
refers to, the reduction in the available quantity of the material. As a matter of fact,
depletion is regarded as a method of computing the depreciation on wasting assets.
Thus, it has a limited application. Depreciation, on the other hand, Is a wider term
and refers to a reduction in the value of all kinds of fixed assets arising from their
wear and tear.
Depreciation and Amortisation : The terms ‘amortisátion’ refers to writing off the
proportionate value of the intangible assets such as copyrights, patents, goodwill,
etc., while depreciation refers to the writing off the expired cost of the tangible
assets like machinery, furniture, building etc.
Depreciation and Obsolescence: Obsolescence refers to the decrease in usefulness
arising on account of the external factors like change in technology, new inventions.
change of style, etc. Thus, it is caused mainly on account of the asset becoming out
of date, and old fashioned. Deprecation on the other hand, is a functional loss
generally arising on account of wear and tear, Obsolescence, in fact, is regarded as
one of the causes of depreciation.
Depreciation and Fluctuation : Fluctuation refers to an increase or decrease in the
market price of an asset. Such a change is. usually temporary. Depreciation differs
from fluctuation in the following respects.
i) Depreciation is concerned with book value of asset while fluctuation is related
to the market value.
ii) Depreciation refers only to the decrease while fluctuation refers to either increase
or decrease.
iii) Depreciation reflects a permanent decrease while fluctuation is only a temporary
phenomenon.

8.4 CAUSES OF DEPRECIATION

The causes of depreciation can be stated as follows:
1. Wear and Tear : Wearing out of the asset on account of its constant use is
called wear and tear. This causes a definite reduction in the value of the asset
and is regarded as the major source of depreciation.
2. Lapse of Time : Normally, the passage of time also causes some reduction in
the value of fixed assets because as they become old their value stands reduced.
That is why the depreciation is usually charged on time basis. in case of certain
assets like lease, patents, etc., the value decreases with passage of time as they
generally have a fixed number of years of legal life. For example, a building is
taken on lease for a period of 10 years costing Rs. 1,00,000. The yearly 7
Final Accounts depreciation of lease will amount to Rs. 10,000 (1/10 of Rs. 1,00,000) and
charged as such to the Profit and Loss Account every year.
3. Obsolescence: The acquisition of an improved model may render the existing
machine obsolete. As the new machine performs the same operation more
quickly and/or more economically existing machine is said to have become out
of date or obsolete. This causes a drastic reduction in the value of existing
machinery and the amount of depreciation is bound to be heavy.
4. Depletion: Some assets are of a wasting character. For example mines, quarries,
oil wells etc.. Due to continuous extraction of materials the natural resources
get depleted. Depreciation, in case of such assets is often computed on the
basis of actual depletion. For example, a coal mine has the coal deposits of
200 million tons. In the first year we extract 10 m. tons of coal. The depreciation
in the first five years shall amount to 10/200 of the cost of mine.
On the basis of the causes mentioned above, it can be said that depreciation
is a permanent and continuous reduction in the value of an asset due to wear
and tear, passage of time, obsolescence, depletion or any other cause.

8.5 OBJECTIVES OF PROVIDING DEPRECIATION

You know depreciation is treated as a loss and is chargeable to the Profit and Loss
Account every year. The justification for charging depreciation can be explained as
follows
1. Ascertaining the true profits: Depreciation represents the expired cost of a
fixed asset caused by its usage hi business, This cost is a part of the total
expenses incurred in earning the revenue during an accounting period and must
be taken into account for arriving at the correct amount of profit or loss for the
period. If depreciation is not charged, the expenses and losses will understand
and the Profit and Loss Account will show higher profits making the concern
pay higher taxes.
2. Ascertaining the true cost of production : Depreciation on machinery and
other fixed assets in the factory is an important component of the cost of
production specially when the unit is not labour intensive. So if no provision is
made for depreciation, the cost calculations will be incorrect.
3. Presentation of true financial position: The value of fixed assets reduces
from year to year on account of their usage and passing of time. They must be
shown in the Balance Sheet at their reduced values otherwise it will not reflect
the true financial position of the business. Hence depreciation must be taken
into account. It will enable the concern to show fixed assets at their proper
values in the Balance Sheet.
4. Funds for replacement of assets : Charging depreciation reduces the profits
available for distribution It enables the. concern to retain a part of its profit and
thus accumulate funds for the replacement of the assets as and when necessary.
Check Your Progress A
1. What is depreciation?
................................................................................................................
................................................................................................................

8 ................................................................................................................
2. How is depreciation different from amortisation ? Depreciation

................................................................................................................
................................................................................................................
................................................................................................................
3. State whether the following statements are True or False.
i) Depreciation is charged also on current assets.
ii) Profits will be overstated if depreciation is not charged.
iii) Expenses will be understated if depreciation is not charged
iv) If adequate maintenance expenditure is incurred, depreciation need not
be charged.
v) Depreciation is charged to reduce the value of asset to its market value,
vi) Depreciation is charged only on the original purchase price of the asset.
vii) When market value of an asset is higher than book value, depreciation is
not charged.
viii) The main cause of depreciation is wear and tear caused by its usage.

8.6 FACTORS INFLUENCING DEPRECIATION

The amount of depreciation to be charged to the Profit and Loss Account in respect
of a particular fixed asset is affected by following factors:
1. Cost of the asset : Cost of the asset should include purchase price and all
other costs incurred to bring the asset to usable condition like transportation
costs, erection charges, etc. It is to be noted that financial charges, such as
interest on loan taken for the purchase of the asset is not to be included in the
original cost of an ‘asset.
2. Estimated working life of the asset: The useful or economic life of the asset
can be stated in terms of time i.e., years, months, hours or in terms of quantity,
i.e., number of units of output or any other operating measure such as kilometres
in the case of lorries, motor vans, etc.
3. Estimated Scrap value : Scrap Value (also called salvage value, residual
value) refers to the estimated amount expected to be realized when the asset is
sold to the end of its useful life. While the original cost of an asset can be
correctly determined, useful life and salvage value can only be estimated, based
on certain assumptions.
The total amounts of depreciation to be written off during the life time of an asset is
calculated as follows
Rs.
Total Cost of Asset …..
Less Estimated Scrap Value …..
Total amount of Depreciation to be written off during its useful life …..
9
Final Accounts For example, a machine was bought for Rs. 1,00,000 and a sum of Rs. 24,000 was
spent towards its transportation and erection charges. It was estimated that the
machine has a useful life of 10 years and that the residual value expected to realise at
the end of its useful life is Rs. 14,000. The total amount of depreciation to be written
off during the economic life of an asset can be calculated as shown below:
Rs.
Original cost of the asset 1,00,000
Add Transportation and erection charges 24,000
1,24,000
Less Estimated residual value 14,000
Total amount of depreciation to be written off during its useful life 1,10,000
After determining the total amount of depreciation to be written off during the life
time of an asset the next step is to decide the amount of depreciation to be charged
every year. In the above situation the annual amount of depreciation to be written off
may be considered s 1/10 of the total amount of depreciation because its estimated
life is 10 years.
However, there are various methods of calculating the amount of depreciation to be
charged from year to year.

8.7 METHODS OF RECORDING DEPRECIATION

There are essentially two methods of recording depreciation in the books of account:
(1) when Provision for Depreciation Account is maintained, and (2) when Provision
for Depreciation Account is not maintained. Under the first method, the amount of
depreciation is credited to the ‘Provision for Depreciation Account’ every year and
the concerned asset account continues to appear at its original cost. Of course,
while preparing the Balance Sheet, the accumulated balance of the Provision for
Depreciation Account is shown by way of deduction from the cost of the asset.
Under the second method, no Provision for Depreciation Account is opened. The
amount of depreciation is directly credited to the concerned asset account every
year. The asset account would thus appear in books at the depreciated value (written
down value). Of course, it will be shown in the Balance Sheet giving the details of
the opening balance, purchase and sale of the asset, and the depreciation provided
during the year.
The following are the journal entries passed for the related transactions under the
two methods.
1. When Provision for Depreciation Account is maintained
a) For charging depreciation:
Depreciation Account Dr.
To Provision for DepreciationAccount
(Being depreciation provided)
b) For transferring depreciation to Profit and Loss Account:
Profit and Loss Account Dr.
To DepreciationAccount
10 (Being transfer of depreciation)
 c) When the asset is sold: Depreciation
i) Bank Account Dr.
ToAsset Account
(Being the sale proceeds)
ii) Provision for Depreciation Account Dr.
ToAsset Account
(Being transfer of provision for depreciation on the asset sold)
iii) Asset Account Dr.
To Profit and Loss Account
(Being transfer of profit on sale of the asset)
or
Profit and Loss Account Dr.
ToAsset Account
(Being transfer of loss on sale of the asset)
2. When Provision for Depreciation Account is not maintained
a) For charging depreciation:
Depreciation Account Dr.
ToAsset Account
(Being depreciation provided)
b) For transferring depreciation to Profit and Loss Account
Profit and Loss Account Dr.
To DepreciationAccount
(Being transfer of depreciation)
c) When the asset is sold:
i) Bank Account Dr.
ToAsset Account
(Being sale proceeds)
ii) Asset Account Dr.
To Profit and Loss Account
(Being transfer of profit on sale of asset)
or
Profit and Loss Account Dr.
ToAsset Account
(Being transfer of loss on sale of the asset)
A firm can adopt any method for recording depreciation. But in practice, most of the
firms follow the second method under which provision for Depreciation Account is
not opened and all entries are made directly in the concerned asset account. Hence,
we shall follow this method for the treatment of depreciation.

8.8 METHODS FOR PROVIDING DEPRECIATION

As stated earlier there are various methods of calculating the amount of depreciation
to be charged from year to year. Different methods are adopted to suit the nature of 11
Final Accounts each asset. It is also possible that different concerns may follow different methods
for depreciating the same asset. The following are the principal methods for providing
depreciation.
1. Fixed Instalment Method
2. Diminishing Balance Method
3. Annuity Method
4. Depreciation Fund Method
5. Insurance Policy Method
6. Revaluation Method
7. Depletion Method
8. Machine Hour Rate Method
Of the above eight methods used for providing depreciation, the first two viz., Fixed
Instalment Method and Diminishing Balance Method are the most commonly used
methods. These are taken up in this unit and the remaining method shall be discussed
in Unit 21.

8.8.1 Fixed Instalment Method

This method is also called ‘equal instalment method’ or ‘straight line method’. Under
this method. a fixed and equal amount is charged as depreciation every year during
the life time of an asset. When this amount of depreciation is presented on a graph
paper it would show a straight line parallel to the X-axis, and hence the alternative
name ‘straight line method’. This method writes off a fixed percentage of the original
cost of the asset every year so that the asset is reduced to zero or its salvage value
at the end of its working life. The annual amount of depreciation to be charged under
this method can be calculated with the help of the following formula:
Original Coat - Scrap Value
Annual Depreciation =
Life of the Asset in number of years
C S
Or D 
N
Look at illustration 1 and see how the amount of annual depreciation has been
calculated and the concerned asset account prepared from year to year.
Illustration 1
Ravikiran & Sons purchased machinery on January 1, 2015 for Rs. 22,000 and
spent Rs. 3,000 on its erection. The asset is expected to last for four years after
which its break up value is estimated to Rs. 5,000. Find out the amount of depreciation
to be charged every year and show how the Machinery Account would appear for
four years assuming that the machine is sold for Rs. 1,000 at the end. Also show
how the balance of Machinery Account would appear in the Balance Sheet.
Solution:
The annual depreciation is calculated as follows :

C S
D
12 N
 Depreciation
(22, 000  3, 000  5, 000)

4
20, 000

4
= Rs. 5,300
Machinery Account
Dr. Cr.

2015 2015
Rs. Rs.
Jan. 1 To Bank A/c 22,000 Dec. 31 By Depreciation A/c 5,000
Jan. 1 To Cash A/c (erection charges) 3,000 " 31 By Balance c/d 20,000
25,000 25,000
2016 2016
Jan. 1 To Balance b/d 20,000 Dec. 31 By Depreciation A/c 5,000
" 31 By Balance c/d 15,000
20,000 20,000
2017 2017
Jan.1 To Balance b/d 15,000 Dec. 31 By Depreciation A/c 5,000
" 31 By Balance c/d 10,000
15,000 15,000
2018 2018
Jan. 1 To Balance b/d 10,000 Dec. 31 By Depreciation A/c 5,000
" 31 By Bank A/c 1,000
By Balance c/d 4,000
10,000 10,000

Balance Sheet as on December, 31, 2015

Rs.
Machinery 22,000
Add : Erection charges 3,000
25,000
Less : Depreciation 5,000 20,000

Balance Sheet as on December, 31,2016

Machinery 20,000
Less : Depreciation 5,000
15,000

13
Final Accounts Balance Sheet as on December, 31,2017

Machinery 15,000
Less : Depreciation 5,000
10,000

Balance Sheet as on December, 31,2018

Machinery 10,000
Less : Depreciation 5,000
5,000
Less : Sale proceeds 1,000
4,000
Less : Write off 4,000

In practice, the purchase and sale of an asset, is a continuous exercise. Hence, you
should know how the calculation of depreciation will be made in such situations and
the transactions recorded in the concerned asset account. Look at illustration 2 and
study how the asset account appears in such situations.
Illustration 2
Arivind & Co. purchased a plant worth Rs. 2,00,000 on January 1, 2017. On June
30, 2017 an additional plant was bought for Rs. 50,000. On December 31, 2018 a
part of the plant bought on January 1, 2017 costing Rs. 4,000 was sold for Rs.
3,000.
Prepare Plant and Machinery Account for years 2017 and 2018 providing
depreciations at 10% per annum on fixed instalment method. The accounts are
closed on December 31, every year.
Solution:
Plant and Machinery Account
Dr. Cr.

2017 2017
Rs. Rs.
Jan. 1 To Bank A/c 2,00,000 Dec. 31 By Depreciation A/c 22,500
Jan. 1 To Bank A/c (erection charges) 50,000 “ 31 By Balance c/d 2,27,500
2,50,000 2,50,000
2018
Jan. 1 To Balance b/d 2,27,500 2018
Dec. 31 By Bank A/c 3,000
“ 31 By Depreciation A/c 25,000
By P & L A/c 200
By Balance c/d 1,99,300
2,27,500 2,27,500

14
Working Notes: Depreciation

1. Depreciation for 2017 Rs.

On Rs. 2,00,000 for one year 20,000
(10/10,00 of 2,00,000)
On Rs. 50,000 for six months 2,500
(10/100 × 50,000 × 6/12)
22,500
2. Depreciation for 2018
On Rs. 2,50,000 for one year
(10/100 of 2,50,000) 25,000
3. Loss on Sale of Plant
Depreciated value of plant sold
as on December 31, 2018
(Rs. 4,000-Rs. 800) 3,200
Less : Sale Proceeds 3,000
Loss on Sale
200
Advantages
1. It is easily understandable and is simple to apply.
2. Amount of depreciation does not vary from year to year.
3. Under this method the book value of asset is reduced either to zero or scrap
value as the case may be.
4. In this method deprecation charge spreads equally over the entire period of its
anticipated working life. Therefore, it is considered particularly suitable for
those assets which get depreciated more on account of lapse of time such as
lease-holds, patents etc.
Disadvantages
1. It does not reflect the correct charge on account of depreciation when the
effective utilisation of the asset varies from year to year.
2. It does not recognise the reality that as an asset becomes older, the amount
spent for repairs and renewals goes on increasing. It is common knowledge
that when the asset is brand new, repair bill would be either nil or very small.
But, as the machine is progressively subjected to wear and tear, the repairs bill
would increase considerably. Thus the combined charge on account of
depreciation and repairs will not be uniform throughout the life of the asset. The
increasing repairs bill unjustifiably burden the later years of asset life with heavier
combined charges.
3. It does not take into account the loss of interest on the money invested in the
asset. Certain other methods (annuity method) while calculating depreciation
also take interest aspect into account.

8.8.2 Diminishing Balance Method

Under this method, though the rate of depreciation is fixed, it is calculated on the
written down value of the asset. Consequently the amount of depreciation to be 15
Final Accounts charged goes on reducing from year to year. For example, a machine was purchased
on January 1, 2016 for Rs. 10,000. It is to be depreciated at 15% per annum under
the diminishing balance method. In this case, the depreciation for 2016 would be
Rs. 1,500 (15% of 10,000), for 2017 it would be Rs. 1,275 (15% of 8,500), and
for 2018 it would work out as Rs. 1,084 (15% of 7,225). Thus you will notice that
the annual depreciation goes on reducing. Hence, it is also known as ‘reducing
insta1met method’. This method is considered better than the fixed instalment method
because with reducing instalments of depreciation the combined effect of repairs
and depreciation will be more or less uniform throughout the life of the asset.
Look at illustration 3 and see how the amount of depreciation is computed every
year and recorded in the concerned asset account.
Illustration 3
Kishore Ltd. purchased a tractor costing Rs. 1,00,000 on January 1, 2014. The
rate of depreciation to be charged was fixed at 20% per annum. Write up Tractor
Account for five years ending December 31, 2018, under diminishing balance method.

Tractor Account
Dr. Cr.

2014 2014
Rs. Rs.
Jan. 1 To Bank A/c 1,00,000 Dec. 31 By Depreciation A/c 20,000
Dec. 31 By Balance c/d 80,000
1,00,000 1,00,000
2015 2015
Jan. 1 To Bank A/c 80,000 Dec. 31 By Depreciation A/c 16,000
Dec. 31 By Balance c/d 64,000
80,000 80,000
2016 2016
Jan. 1 To Bank A/c 64,000 Dec. 31 By Depreciation A/c 12,800
Dec. 31 By Balance c/d 51,200
64,000 64,000
2017 2017
Jan. 1 To Bank A/c 51,200 Dec. 31 By Depreciation A/c 10,240
Dec. 31 By Balance c/d 40,960
51,200 51,200
2018 2018
Jan. 1 To Bank A/c 40,960 Dec. 31 By Depreciation A/c 8,192
Dec. 31 By Balance c/d 37,768
40,960 40,960

Now look at illustration 4. It deal with the situation when additions and disposals
are made during the course of the year and a part of the asset is replaced.
16
Illustration 4 Depreciation

Harinath purchased on January 1, 2016, a plant for Rs. 50,000. On July 1, 2016 an
additional plant worth Rs. 20,000 was purchased and on July 1. 2017, the plant
purchased on January 1, 2016 having become obsolete is sold off for Rs. 20,000.
On July 1, 2018, a new plant was purchased for Rs. 60,000 and the plant purchased
on July 1, 2016 was sold for Rs. 15,000. Depreciation is to be provided at 10%
p.a. on the written down value every year. Show the Plant Account.
Plant Account
Dr. Cr.

2016 2016
Rs. Rs.
Jan. 1 To Bank A/c 50,000 Dec. 31 By Depreciation A/c 6,000
Jan. 1 To Bank A/c (erection charges) 20,000 “ 31 By Balance c/d 64,000
70,000 70,000
2017 2017
Jan. 1 To Balance b/d 64,000 July, 1 By Bank A/c 20,000
Dec. 31 By P & L A/c 22,750
(loss on sale)
Dec. 31 By Depreciation A/c 4,150
Dec. 31 By Balance c/d 17,100
64,000 64,000
2018 2018
Jan. 1 To Balance b/d 17,100 July, 1 By Bank A/c 15,000
Jan. 1 To Bank A/c 60,000 Dec. 31 By P & L A/c 1,245
(loss on sale)
Dec. 31 By Depreciation A/c 3,855
Dec. 31 By Balance c/d 57,000
77,100 77,100

Working Notes:
1. Depreciation for 2016 Rs.
10% on Rs. 50,000 for one year 5,000
10% on Rs. 20,000 for six months 1,000
6,000
2. Depreciation for 2017
10% on Rs. 45,000 for six months 2,250
(upto June 30, 2017)
10% on Rs. 19,000 for one year 1,900
4,150 17
Final Accounts 3. Loss on plant sold on July 1, 2017
Depreciated value as on 2017
50,000 — 5,000 — 2,250 42,750
Less : Sale proceeds 20,000
Loss on sale 22,750
4. Depreciation for 2018
10% on Rs. 17,100 for six months 855
10% on Rs. 60,000 for six months 3,000
3,855
5. Loss on plant sold on July 1, 2018
Depreciated value as on 1.7.2018
20,000 — 1,000 — 1,900 — 855 16,245
Less: Sale proceeds 15,000
Loss on sale 1,245
Advantages
This method is also simple to understand and easy to follow, though calculation of
depreciation is slightly complicated. It ensures a fairly even charge to Profit and
Loss Account on account of both depreciation and repairs. This is possible because
the amount of depreciation decreases year after year while the charge for repairs
goes n increasing year after year.
Disadvantages
One of the important limitations of this method is that the value of an asset cannot be
brought down to zero. Hence, even after the asset is put out of use it may have
certain book value. This method also does not take into account the loss of interest
on the money invested in the asset. The determination of a suitable rate of depreciation
is also difficult under this method. The formula generally used for this purpose is as
follow:
Scrap Value
Rate of Depreciation  1  n
Original Cost

This looks quite complicated as compared to the fixed installment method. This
method is considered suitable for assets like plant and machinery where the repairs
are insignificant in earlier years but increase considerably in later years. It is popularly
known as ‘written down value method’ because the depreciation is computed on
the written down value every year. There are however, other methods of computing
depreciation under the diminishing balance method such as ‘sum of year digits
method’ and ‘double declining balance method’. These are also called accelerated
depreciation method, because under all these methods the amount of depreciation
charged in earlier years is more compared to that of the later years.

18
8.8.3 Difference between Fixed Instalment Method and Depreciation

Diminishing Balance Method

The difference between the fixed instalment method and the diminishing balance
method can be summarised as follows:

Fixed Instalment Method Diminishing Balance Method

1. Depreciation is calculated on Depreciation is calculated written down

the original cost value

2. Depreciation instalment is Depreciation instalment goes on reducing

the same every year. every year.

3. The balance in the asset The balance in the asset account will never
account will reduce to zero at reduce to zero.
the expiry of the working life
of the reduce to zero. asset.

4. The combined cost on account The combined cost on account of

of depreciation and repairs is depreciation and repairs is more or less
low during the initial years and equal throughout.
high during later years.

5. Calculation of the rate of Calculation of the rate of depreciation is

depreciation is easy. difficult

6. It is suitable for assets which It is suitable for assets which require heavy
get depreciated more on repairs in later years of their working life.
account of the expiry of time

Check Your Progress B

1. List the factors influencing the amount of depreciation.
................................................................................................................
................................................................................................................
................................................................................................................
2. Name various methods of computing depreciation.
................................................................................................................
................................................................................................................
................................................................................................................
3. State whether the following statements are True or False.
i) Depreciation is a temporary change in the value of an asset.
ii) While calculating depreciation, the scrap value (salvage value) must be
taken into account.
iii) Under fixed instalment method of providing depreciation the combined
effect of repairs and depreciation is uniform over the year
19
Final Accounts iv) Under the diminishing balance method it would be possible to reduce the
value of an asset to zero.
v) The interest involved in the investment on assets purchased is ignored
under both the fixed instalment and the diminishing balance methods.
vi) When a Provision for Depreciation Account is maintained, the asset is
shown at the original cost in the Balance Sheet

8.8.4 Change of Method

Sometimes a firm may decide to change the method of depreciation it had adopted
i.e., it may change the method of depreciation from fixed instalment method to reducing
instalment method or vice versa. If it decides to implement the change with
prospective, effect, there is no problem because no adjustment is necessary in respect
of depreciation charged in earlier years. All that is necessary is to charge depreciation
from that year onwards according to the new method decided.
However, when it is decided to change the method with retrospective effect i.e.,
with effect from a prior date (usually from the date of acquisition of an asset) it
would be necessary to adjust the depreciation charged till date. Suppose a firm was
depreciating its machinery under the fixed instalment method during the past three
years. It has now decided to change the method to written down value method with
retrospective effect. In such a case it would be necessary to take the following
steps:
1. Calculate the amount of depreciation already charged till the date of change
according to old method.
2. Calculate the amount of depreciation that would have been charged under the
new method now proposed to be adopted.
3. If the amount of depreciation under the new method is more than what was
charged under the old method, such difference should be credited to the asset
account in current year and debited to the Profit and Loss Account.
4. If, on the other hand, the amount of depreciation under the new method is less
than what was charged under the old method such a difference should be debited
to the asset account in current year and credited to the Profit and Loss Account.
5. As the difference in depreciation amount is adjusted to the current value of
asset in the asset account, the asset account will appear at its new value, from
the date of change and depreciation will be charged according to the new
method in subsequent years.
Look at illustration 6. It will help you to clearly understand the procedure to be
followed when a change of method is desired with retrospective effect.
Illustration 5
Sharat & Sons purchased a car for Rs. 1,00,000 on January 1, 2015. The car was
depreciated at 10% under the written down value method. On January1, 2018 they
wanted to change the method of depreciation from reducing instalment method to
straight line method without & changing the rate. Show the asset account from 2015
to 2018.
20
Solution: Depreciation

Car Account
Dr. Cr.

2015 2015
Rs. Rs.
Jan. 1 To Bank A/c 1,00,000 Dec. 31 By Depreciation A/c 10,000
Dec. 31 By Balance c/d 90,000
1,00,000 1,00,000
2016 2016
Jan. 1 To Bank A/c 90,000 Dec. 31 By Depreciation A/c 9,000
Dec. 31 By Balance c/d 81,000
90,000 90,000
2017 2017
Jan. 1 To Bank A/c 81,000 Dec. 31 By Depreciation A/c 8,100
Dec. 31 By Balance c/d 72,900
81,000 64,000
2018 2018
Jan. 1 To Bank A/c 72,900 Dec. 31 By P & L A/c (diff.) 2,900
Dec. 31 By Depreciation A/c 10,000
Dec. 31 By Balance c/d 60,000
72,900 72,900
2019
Jan. 1 To Balance b/d 60,000
Notes: 1. If the firm had followed the fixed instalment method right from the
beginning (1.1.2015), the value of car as on 1.1.2018 would be Rs.
70,000 worked out as follows:
Rs.
Original cost 1,00,000
Less: Depreciation for years 30,000
at Rs. 10,000 p.a. (10% of 1,00,000)
Value of Car as on 1.1.2018 70,000
But from the Car Account you find that the opening balance on 1.1.2018
is Rs. 72,900. This means that under the written down value method
the amount of depreciation charged during the three years was Rs.
27,100 (1,00,000 — 72,900) as against Rs. 30,000 required under
the fixed instalment method. Hence. the difference between the two
amounts i.e., Rs. 2,900 (30,000 — 27,100) must be charged as
additional depreciation so as to adjust the asset account.
21
Final Accounts 2 The depreciation to be charged for the year 2018 would be Rs. 10.000
i.e., 10% on Rs. 1,00,000 as required under the fixed instalment
method. From this year onwards Rs. 10,000 will be charged as
depreciation every year.

8.9 LET US SUM UP

Depreciation is a permanent and gradual diminution in the value of an asset caused
by usage and effusion of time.

It represents the expired cost of a fixed asset which mist be charged to the Profit
and Loss Account and deducted from the value of the asset concerned Unless it is
so treated, the Profit and Loss Account will not show true profit or toss for the year
and the Balance Sheet will not reflect the correct financial position. The amount of
depreciation to be charged is determined by taking into account: (i) the cost of
asset, (ii) the estimated useful life, and (iii) the estimated salvage value.

There are essentially two methods of recording the depreciation in books of a account
(i) By maintaining a Provision for Depreciation Account, and (ii) Without maintaining
a Provision for Depreciation Account.

When a provision for Depreciation Account is maintained the depreciation is credited

to this account from year to year. Its accumulated balance is transferred to the asset
account only at the end of the life of the asset or when the same is sold. But when
provision for Depreciation Account-is not maintained, the depreciation is directly
credited to the asset account every year. Of course, in the Balance Sheet the asset
will always be shown at the depreciated value.

There are various methods of calculating the amount of depreciation. Of these, the
two most common methods are : (i) fixed instalment method, and (ii) diminishing
balance method, Under the fixed instalment method an equal amount is charged as
depreciation year after year while under the diminishing balance method the amount
of depreciation goes on reducing year after year. Both have their merits and demerits.
But, the diminishing balance method is considered better because the combined
cost on account of depreciation and repairs is uniformly distributed over the working
life of an asset. Although the amount of depreciation under these two methods differ,
the method of recording it in the books of account is the same.

Sometimes, a concern may decide to change the method of depreciation. If the

change is to take effect from current years, it does not involve much problem. But if
it is with retrospective effect, it would require the calculation of depreciation according
to both the methods and the difference will have to be adjusted before the depreciation
cap be charged according to changed method.

8.10 KEY WORDS

Amortisation: Writing off the expired cost of an intangible asset.

Depreciation: Permanent and gradual diminution in value of a fixed asset.

Obsolescence: Becoming out of date, a cause for depreciation in value of asset.

Residual Value: Expected realisable amount, when the asset is sold out at the end
22 of its useful life.
Salvage Value: Same as residual or scrap value. Depreciation

Written Down Value: Book value of an asset after deducting depreciation from
the original cost. It is also called depreciated value.

8.11 SOME USEFUL BOOKS

Gupta R.L and M. Radhaswamy, 2018. Advanced Accountancy, Volume 1,
Sultan Chand & Sons, New Delhi.
Maheshwari S.N., 2018. Introduction to Accounting, Vikas Publishing House:
New Delhi.
Path, V.A. and J. S. Korlahalli, 2018. Principles and Practice of Accounting,
R. Chand & Co., New Delhi.
Shukla, M.C. and T.S. Grewal, 2018. Advanced Accounts, S. Chand & Co.,
New Delhi.
William Pickles, 1992. Accountancy, E . L. B .S. and Pitman, London.

8.12 ANSWERS TO CHECK YOUR PROGRESS

A 3. i) False ii) True iii) True iv) False v) False vi) False vii) False viii) True
B 3. i) False ii) True iii) False iv) False v) True vi) False.

8.13 TERMINAL QUESTIONS/EXERCISES

Questions
1. Define depreciation. Distinguish it from depletion, amortisation and
obsolescence.
2. Explain the need and significance of depreciation. What factors should be
considered for determining the amount of depreciation?
3. Enumerate the methods of calculating depreciation. Discuss the advantages
and disadvantages of fixed instalment method.
4. What are the merits and demerits of written down value method? Distinguish it
from the straight line method.
5. Describe the methods of recording depreciation in books of account. How is
the balance of the Provisions for Depreciation Account shown in the Balance
Sheet?
Exercises
1, A cold storage plant was purchased on July 1, 2016 for Rs. 1,00,000. Show
the V plant Account under (a) the Straight Line Method and (b) the..Written
Down Value Method. Rate of depreciation charged is 20%. What is the balance
of plant at the end of the third year?
(Answer : Balance at the end of the third year (a) under Straight Line Method
Rs. 40,000; and (b) under Written Down Value Method: Rs. 51,200). 23
Final Accounts 2. Suresh purchased plant and machinery for Rs. 50,000 on July 1, 2014. The
asset was to be depreciated at the rate of 10 per cent per annum on written
down value basis. The machinery was sold on January 1, 2018 for Rs. 32,000.
Write up Machinery Account assuming accounting year to end on December
31 every year.
(Answer: Loss on sale Rs. 2,627)
3. On 1-8-2016, a machine was purchased by a manufacturing concern for Rs.
60,000 and it spent for its overhaul and installation Rs. 10,000. Its effective life
was estimated to be ten years and residual value at the end of its life time was
estimated to be Rs. 10,000. Show Machine Account for the first three years
assuming that the concern decided to depreciate it under the fixed instalment
method. The accounting year ends on December 31.
(Answer: Balance of Machine Accounts as on January 1, 2019: Rs. 55,000)
4. Ashok Ltd has bought machinery for Rs. 1,00,000 including a boiler worth Rs.
10,000. The Machinery Account has been credited for depreciation on the
written down value method for the past four years at the rate of 10%. During
the fifth year the boiler became useless on account of damage to some of its
vital parts; the damaged boiler is sold for Rs. 5,000. Write up the Machinery
Account.
(Answer: Loss on sale of machinery Rs. 1,561; Balance of Machinery Account
as at the end of fifth year Rs. 59,049.)
5. Navrang & Co., whose accounting year is the calendar year, purchased
machinery costing Rs. 60,000 on July 1, 2016. It purchased further machinery
on September 1, 2016 costing Rs. 30,000. On January 1, 2018 one-third of
the Machinery installed on June 1, 2016 became obsolete and was sold for Rs.
5,000. Depreciation is being written off on fixed instalment system, at 10%
per annum. Prepare the machinery account as would appear in the ledger of
the company for the years 2016, 2017 and 2018.
(Answer: Balance of Machinery Account as on January 1, 2019 : Rs. 53,000).
6. On October 1, 2016 Raghavan & Sons purchased machinery for Rs. 30,000
and spent Rs. 3,000 on installing it. On January 1, 2017, the firm purchased
another machinery for Rs. 20,000. On June 30, 2018 the machinery purchased
on January 1, 2017 was sold for Rs. 16,000 and on the same date a fresh
plant was installed at a cost of Rs. 25,000.
The company writes off 10% depreciation on the diminishing balance method.
The accounts are closed every year on December 31. Show the Machinery
account for the years 2016, 2017 and 2018.
(Answer : Balance of Machinery Account as on January 1, 2019: Rs. 39,950)
7. On July 1, 2015, a company purchased a plant for Rs. 2,00,000. Depreciation
was provided at 10% per annum on straight line method on December 31,
every year. With effect from January 1, 2017 the company decided to change
the method of depreciation to diminishing balance method @ 15% per annum
with retrospective effect. On July 1, 2018, the plant was sold for Rs. 1,20,000.
Prepare Plant Account from 2015 to 2018).

24 (Answer : Loss on sale of plant: Rs. 3,637.

8. Work out problem No. 7 assuming that (a) the asset was originally depreciated Depreciation
on written down value method at 20% and that (b) now it is desired to change
the method to fixed instalment method with retrospective effect, rate of
depreciation remaining same.
(Answer: Profit on sale of plant Rs. 40,000).

Note : These questions will help you to understand the unit better. Try to
write answers for them. But, do not submit your answers to the
University for assessment. These are for your own practice only.

25
Final Accounts
UNIT 9 FINAL ACCOUNTS-I
Structure
9.0 Objectives
9.1 Introduction
9.2 Final Accounts and Trial Balance
9.3 Trading and Profit and Loss Account
9.3.1 Trading Account
9.3.2 Profit and Loss Account
9.3.3 Closing Entries

9.4 Balance Sheet

9.5 Vertical Presentation of Final Accounts

9.6 Manufacturing Account

9.7 Let Us Sum Up

9.8 Key Words

9.9 Some Useful Books

9.10 Answers to Check Your Progress

9.11 Terminal Questions/Exercises

9.0 OBJECTIVES
After studying this unit, you will be able to:

 explain the purpose of preparing final accounts;

 prepare a trial balance from a given list of balances;

 prepare trading and profit and loss account;

 prepare balance sheet;

 prepare manufacturing account and calculate cost of goods produced; and

 present the final accounts in vertical form.

9.1 INTRODUCTION
You know that the final accounts are primarily prepared for ascertaining the operational
result and the financial position of the business. They consist of (1) Profit and Loss
Account, and (ii) Balance Sheet. The Profit and Loss Account reveals the profit
earned or loss incurred (operational result) during the accounting year and the Balance
Sheet indicates the financial position as at the end of the year. In this unit, you will
learn about the basic framework of final accounts including their presentation in
26 vertical form.
 Final Accounts-I
9.2 FINAL ACCOUNTS AND TRIAL BALANCE
You know final accounts are prepared with the help of a Trial Balance which shows
all the ledger balances as at the end of an accounting period. Generally, when you
are asked to prepare final accounts, you are given a properly prepared Trial Balance
and you have no difficulty in identifying the items of incomes, expenses, assets, and
liabilities. But, sometimes you may not be given a proper Trial Balance. You may
simply be asked to prepare the final accounts from the list of closing balances extracted
from the books of some firm. In such a situation, it will be helpful if you first prepare
the Trial Balance and then the final accounts. Hence it is important that you should
know how to prepare the Trial Balance from a given list of balances.
Normally when a Trial Balance is to be prepared, you have full details of ledger
accounts with you. You can easily ascertain whether a particular account has a debit
balance or a credit balance, and prepare the Trial Balance without any difficulty.
The problem arises when you are given a list but it is not indicated whether the
account has a debit balance or a credit balance. Under such a situation you will have
to determine the nature of each balance before you prepare the Trial Balance. In this
exercise, your knowledge of rules of debit and credit will help you. For example you
know that in case of nominal accounts all expenses and losses are debited and all
incomes and gains are credited. Similarly, you know the rules for real and personal
accounts according to which the account of assets like cash, machinery debtors,
etc. will show debit balances while accounts like capital, creditors, etc. will show
credit balances. For convenience however, a few guidelines should help you. They
are
a) All accounts of expenses (including purchases) and losses will be debit balances.
b) All accounts of Income (including sales) and gains will be credit balances.
c) All accounts of assets will be debit balances.
d) Allaccounts of liabilities will be credit balances.
e) Capital Account will normally be a credit balance.
f) Drawings Account will be a debit balance.
However, the problem may arise with regard to some items like rent, discount,
commission and interest as they can be expenses as well as incomes. In such cases,
the nature of the balance is usually indicated by mentioning (Dr.) or (Cr.) against
each item, or the word ‘received’ or ‘paid’ is written after each item. This helps you
to treat the item correctly. But, if there is only one item for which no such indication
is given you can proceed with the preparation of Trial Balance and work out the
totals of both the columns. You will find that the total of one column will be less than
the other. This means that the unidentified balance pertains to the column which is
short. For example, there is an item of commission of Rs. 300 appearing in the list of
balances and it is not indicated whether it is paid or received. When you prepare the
Trial Balance you will find that the debit total is short by Rs. 300. This would mean
that the Commission Account has a debit balance. Now if you show it as such in the
Trial Balance, it will tally.
Look at illustration 1 and see how the Trial Balance has been prepared from a given
list of balances where the nature of each balance has not been indicated. 27
Final Accounts Illustration 1
Prepare a Trial Balance from the following balances extracted from the books of
Sudhakaras on March 31, 2018.
Rs. Rs.
Opening Stock 40,000 Drawings 10,000
Purchases 4,10,000 Wages 7,300
Sales 4,29,000 Salaries 11,000
Purchases Returns 1,250 Outstanding Expenses 1,000
Sales Returns 2,500 Prepaid Expenses 750
Carriage Inwards 1,500 Postage 900
Carriage Outwards 2,500 Discount Received 375
Bank Overdraft 21,000 Discount Allowed 1,000
Cash 4,000 Bad Debts 750
Capital 1,27,750 Sundry Debtors 1,00,000
Sundry Creditors 37,500 Interest 3,500
Loans 41,375 Interest Received 3 00
Investments 10,000 Provision for Bad Debts 1,750
Accrued Income 600 Furniture & Fixture 7,500
Machinery 47,500
Solution:
Trial Balance to Sudhakar as on March 31, 2018

Particulars Dr. Cr.

Balances Balances

Rs. Rs.
Opening Stock 40,000
Purchases 4,10,000
Sales 4,29,000
Purchases Returns 1,250
Sales Returns 2,500
Carriage Inwards 1,500
Carriage Outwards 2,500
Bank Overdraft 21,000
Cash 4,000
Capital 1,27,750
Sundry Creditors 37,500
Loans 41,375
Investments 10,000
Accrued Income 600
Machinery 47,500
Drawings 10,000
Wages 7,300
28
Salaries 11,000 Final Accounts-I
Outstanding Expenses 1,000
Prepaid Expenses 750
Postage 900
Discount Received 375
Discount Allowed 1,000
Bed Debts 750
Sundry Debtors 1,00,000
Interest 3,500
Interest Received 300
Provision for Bad
Debts 1,750
Furniture & Fixture 7,500

Total 6,61,300 6,61,300

In illustration 1, the Trial Balance has tallied i.e, the total of debit balances column is
equal to the total of credit balances column. This would mean that each balance has
been entered in the appropriate amount column of the Trial Balance. This is not
always true. It is quite possible that even when the Trial Balance has tallied, some
balances may not have been entered in the correct columns. Look at illustration 2.
You will find that the Trial Balance has tallied (the totals of both Dr. balancesand Cr.
balances is the same i.e., Rs. 91,650 but there are a number of items which have
been shown in the wrong columns. For example, bank overdraft which should have
been shown in the Cr. balances column has been included in the Dr. balancescolumn
and Furniture which should have appeared in Dr...balancescolumn has been shown
in the Cr. balances column. So, the Trial Balance has been rewritten and all items
shown correctly. Such situation arises on account of the compensating effect of the
errors which is very rare.
Illustration 2
An inexperienced accountant provides you with the following Trial Balance. In case
you find it to be incorrect,1 prepare it again so as to remove its defects.
Trial Balance as on June 30, 2018

Name of Account L.F. Dr. Cr.

Balances Balances

Stock (Opening) Rs. Rs.

Buildings Bills 10,500
Payable Bank 31,500
Overdraft 1,800
Capital 1,500
Furniture 45,000
Discount Allowed 12,000
Sales 90
Loan from Suresh 39,000
29
Final Accounts Carriage Inwards 2,400
Bills Receivable 270 3,000
Purchases 24,000
Salaries 3,300
Investments 3,000
Interest on Investments 1,650
Returns Inwards 900
Returns Outwards 300
Insurance Premium 360
Interest on Loan 30
Advertisement 1,200
Drawings 1,500

Total 91,650 91,650

Solution:
Revised Trial Balance as on June 30, 2018

Name of Account L.F. Dr. Cr.

Balances Balances

Rs. Rs.
Stock (opening) 10,500
Buildings 31,500
Bills Payable 1,800
Bank Overdraft 1,500
Capital 45,000
Furniture 12,000
Discount Allowed 90
Sales 39,000
Loan from Suresh 2,400
Carriage Inwards 270
Bills Receivable 3,000
Purchases 24,000
Salaries 3,300
Investments 3,000
Interest on investments 1,650
Returns Inwards 900
Returns Outwards 300
Insurance Premium 360
Interest on Loan 30
Advertisement 1,200
Drawings 1,500

91,650 91,650
30
Check Your Progress A Final Accounts-I

1) Mention against each item whether it will generally show a debit balance or a
credit balance.
Items Nature of Balance
Debit or Credit
i) Sales Returns …………………………
ii) Carriage Inwards …………………………
iii) Carriage Outwards …………………………
iv) Capital …………………………
v) Loss by fire …………………………
vi) Overdraft …………………………
vii) Drawings …………………………
viii) Returns Outwards …………………………
ix) Bills Receivable ……...…………………
x) Goodwill …………………………
xi) Rent Paid …………………………
xii) Commission Received in Advance ……………………… …

9.3 TRADINGAND PROFITAND LOSS ACCOUNT

You know the Profit and Loss Account is prepared for ascertaining the profit or loss
of the business. This is worked out in two stages. In the first stage, we work out the
gross profit or gross loss and in the second stage, the net profit or net loss. Hence,
the profit and Loss Account is divided into two sections. The first section is called
Trading Account. It reveals the gross profit or gross loss. The second section is
called Profit and Loss Account which shows the net profit or net loss.

9.3.1 Trading Account

As stated above, the Trading Account is prepared for ascertaining the gross profit
or gross loss. The gross profit is defined as the excess of sales revenue over cost of
goods sold. This can be presented in the form of an equation as follows.
Gross Profit = Net Sales — Cost of Goods sold
Where i) Net Sales = Total Sales — Sales Returns
ii) Cost of Goods Sold = Opening Stock + Net Purchases
+ Direct Expenses — Closing Stock
You know the terms ‘Opening Stock’ and ‘Closing Stock’ refer to the value of
unsold goods as at the beginning of the year and at the end of the year respectively.
Such stock may also include the semi-finished goods and raw materials. In order to
arrive at the cost of goods sold. the opening stock is added to the net purchases
while the closing stock is deducted. The term ‘Direct Expenses’ refer to those
31
Final Accounts expenses which are incurred on the goods purchased till they are brought to the
place of business for sale These include expenses such as freight, insurance, import
duty, dock dues, clearing charges, octroi duty, carriage, cartage, etc. The
administrative expenses, selling and distribution expenses, interest paid, etc. are
termed as indirect expenses and therefore, are excluded from the cost of goods
sold.
Look at illustrations 3 and 4 and study how Cost of Goods Sold and the Gross
Profit are computed.
Illustration 3
The following figures have been extracted from the books of a firm. Calculate the
Cost of Goods Sold.
Rs.
Stock as on 1.1.2018 1,00,000
Purchases for 2018 15,00,000
Purchases Returns 40,000
Carriage Inwards 20,000
Octroi 80,000
Freight 15,000
Stock as on 31.12.2018 1,70,000
Solution:
Opening Stock 1,00,000
Add: Net Purchases
(Purchases Rs. 15,00,000
Purchases Returns Rs. 40,000) 14,60,000
Carriage Inwards 20,000
Octroi 80,000
Freight 15,000
16,75,000
Less: Closing Stock 1,70,000
Cost of Goods Sold 15,05,000
Illustration 4
On January 1, 2018 a firm had stock of goods valued at Rs. 20,000. During the
year the following transactions took place.
Rs.
Sales 5,00,000
Purchases 3,00,000
Carriage Inwards 3,000
Freight Inwards 5,000
Sales Returns 10,000
Clearing charges 22,000
Purchases Returns 5,000
32 The closing stock of goods on December 31, 2018 is Rs. 40,000.
Solution: Final Accounts-I

Rs. Rs.
Sa1e 5,00,000
Less: Sales Returns 10,000
Net Sales 4,90,000
Less: Cost of Goods Sold
Opening Stock 20,000
Add: Purchases 3,00,000
3,20,000
Less: Purchases Return 5,000
3,15,000
Add:
Carnage Inwards 3,000
Freight Inwards 5,000
Clearing Charges 22,000
3,45,000
Less: Closing Stock 40,000
3,05,000
Gross Profit 1,85,000
Form of Trading Account :The Equation for Gross Profit is also known as Trading
Account Equation. This equation forms the basis of preparing the Trading Account.
The Trading Account, like any other account in the ledger, has two sides—debit and
credit. The opening stock,purchases (less returns) and all direct expenses are shown
on the debit side of the Trading Account while sales (less returns) and the closing
stock on the credit side. The gross profit appears as the last item on the debit side
which, in fact is the excess of the total of credit side over the total of debit side. If
however, the total of the debit side exceeds the total of the credit side, it will be
treated as gross loss. This is shown as the last item on the debit side of the Trading
Account. The gross profit/gross loss thus worked out is transferred to the Profit and
Loss Account. Look at the Figure 9.1 for the form of Trading Account.
Fig. 9.1
Form of Trading Account
Trading Account of
(Day, Month and Year)
Dr. Cr.

Particulars Amount Amount Particulars Amount Amount

Rs. Rs. Rs. Rs.

To Opening Stock ..... By Sales .....
To Purchases ..... Less: Sales Returns .....
Less Purchases Returns ..... .....
To Direct Expenses (specify individually) ..... By closing Stock .....
To Gross Profit
(Transferred to Profit .....
and Loss Account) ..... ..... 33
Final Accounts
Based on the data given in illustration 4, the Trading Account will be prepared as
follows.
Trading Account of . .. .
for the year ending December 31, 2018
Dr. Cr.

Particulars Amount Amount Particulars Amount Amount

Rs. Rs. Rs. Rs.

To Opening Stock 20,000 By Sales 5,00,000 Rs.

To Purchases 3,00,000 Less: Returns 10,000 4,90,000
Less: Returns 5,000 2,95,000
To Carriage Inwards 3,000 By Closing Stock 40,000
To Freight 5,000
To Clearing Charges 22,000
To Gross Profit 1,85,000
(Transferred to (P&LA/c)

5,30,000 5,30,000

Some Important Points

1. Purchases : This item refers to the goods purchased for resale and includes
both cash and credit purchases. The purchases of assets which are meant for
permanent use in business such as machinery furniture, etc., are not included in
the purchases. The amount taken to Trading Account will be the net amount of
purchases (after deducting purchase returns/returns outwards.) If the proprietor
has taken away some goods from the business for his personal use, the same
should also be deducted from the total purchases.
2. Sales: It includes both cash and credit salesof goods and refers to the net
amount of sales (after deducting sales returns-returns inwards). Sales of old
furniture, car, machinery, etc. are not included in the sales. Similarly, sales of
old newspapers etc. are also excluded from sales. Such items are shown as
miscellaneous income in the Profit and Loss Account.
3. Wages: Wages are usually treated as a direct expense and so shown in the
Trading Account. The difficulty arises when wages are clubbed with salaries
(an indirect expense) and the Trial Balance includes a single amount for ‘Wages
and Salaries’. In such a situation, the amount may be shown in the Trading
Account. It is based on the assumption that the item includes the salaries of the
supervisory staff in the factory itself. But, if the item in the Trial Balance reads
‘Salaries and Wages’ it will be taken to the Profit and Loss Account on the
assumption that the item includes wages of the office staff only. It should be
noted that wages paid in connection with the purchases of fixed assets or the
construction of building should not be charged to Trading Account. They are to
be included in the cost of the concerned fixed asset. There is another important
aspect in relation to wages which must be clarified. If a Manufacturing Account
is prepared the wages paid to the factory labour is debited to Manufacturing
34 Account about which you will learn later in this unit.
4. Freight, Carriage and Cartage: When paid in connection with purchases of Final Accounts-I
goods, they are shown in the Trading Account. Such freight and carriage are
also termed as ‘Freight Inwards’ and ‘Carriage Inwards’ respectively. ‘Freight
Outwards’ and ‘Carriage Outwards’ relate to sales and therefore taken to the
debit of Profit and Loss Account.
5. Royalties: Royalties refer to the payments made for the use of copyright or a
patent. The amount of royalty is generally based on the quantity produced. It
is, therefore, treated as a direct expense and charged to Trading Account. But
if it is calculated on the basis of quantity sold as in case of books, it is shown in
the Profit and Loss Account. Royalties are also paid to the Government for
extraction of minerals such as coal, diamond, gold, etc. These are charged to
the Profit and Loss Account of the mining companies. You will learn about the
accounting of such royalties later under a separate course.

9.3.2 Profit and Loss Account

After ascertaining the gross profit by preparing the Trading Account, the businessman
proceeds to prepare the Profit and Loss Account in order to work out the net profit/
net loss. You know the net profit is the excess of gross profit and other incomes over
the indirect expenses and losses. So, while preparing the Profit and Loss Account,
we show gross profit and other incomes such as rent received, discount received,
commission received, interest and dividends etc. on the credit side, and all indirect
expenses and losses on the debit side. Indirect expenses include all administrative,
selling and distribution expenses such as salaries, rent and taxes, postage and
stationery, insurance, depreciation, interest paid, office lighting, advertising, packing
carriage outwards, etc., while losses refer to items like loss by fire, loss by theft etc.
The difference between the two sides of the Profit and Loss Account represent
either the net profit or net loss. If the total of the credit side is higher than the total of
the debit side, the difference is called net profit and if the debit side total exceeds the
credit side total, the difference is called net loss. The net profit/net loss belongs to
the proprietor and it is therefore transferred to his Capital Account. Look at figure
9.2. It shows various expenses, losses, incomes, etc., which usually appear in the
Profit and Loss Account
Fig. 9.2
Profit and Loss Account …………………..
for the period ended …………………
Dr. Cr.

Particulars Amount Particulars Amount

Rs. Rs.

To Gross Loss, if any, By Gross Profit, if any

(Transferred from (Transferred from
TradingAccount) TradingAccount)
To Salaries By Interest Received
To Rent, Rates and Taxes By Discount Received
To Postage and Telegrams By Rent Received
To Telephone Charges By Commission Received
To Printing and Stationery By Dividend Received 35
Final Accounts To Legal Expenses By Other Incomes and Gains
To Insurance By Net Loss
To Office Lighting (Transferred to
To Bad Debts Capital Account)
To Depreciation
To Advertising
To Travelling Expenses
To Carriage Outwards
To Trade Expenses
To Discount Allowed
To Interest Paid
To Repairs and Renewals
To Loss by Fire
To Loss by Theft
To Other Expenses and
Losses, if any
To Net Profit
(Transferred to
CapitalAccount)

Notes:
1. The heading for the Profit and Loss Account, as in the case of the Trading
Account, indicates the name of the business or proprietor and the period for
which it is being prepared.
2. In addition to the items shown in the above form, there are certain items such
as depreciation, bad debts, provision for doubtful debts, interest on capital,
interest on drawings, etc., which appear in the Profit and Loss Account as a
result of the adjustment entries. We shall discuss them in Unit 10.
Some Important Points
1. Rent, Rates and Taxes: These are charges levied by the municipal bodies
on the house property. It is a common item of indirect expenses debited to the
Profit and Loss Account.
2. Insurance: Generally, assets are insured to cover the risk of loss, say, by fire.
Premium paid to the insurance company should be treated as a business
expense. When assets such as factory building, factory machinery, etc. are
insured, the insurance premium should be debited to Trading Account. If on the
other hand, the premium is paid for insurance of assets in the office building,
office furniture, etc., it should be charged to Profit and Loss Account.
3. Bad Debts: Bad debts denote the amount which could not be recovered from
the debtors to whom the goods were sold on credit. It is a loss and so debited
to the Profit and Loss Account. You will learn more about their treatment in
Unit 9.
4. Depreciation: Depreciation means decrease in the value of fixed assets due
to normal wear and tear. You know that every fixed asset such as machinery,
furniture, vehicle, etc. depreciates in value on account of its constant use. Such
reduction in their value is a loss to the business and so charged to the Profit and
Loss Account. If, however, a Manufacturing Account is also prepared,
36 depreciation on machinery and factory building is charged to the Manufacturing
 Account, while depreciation on office building, office furniture, office equipment, Final Accounts-I
etc. is charged to the Profit and Loss Account.
5. Trade Expenses: This item represents various small expenses incurred in the
business. They are also called General Expenses, Sundry Expenses or
Miscellaneous Expenses.
6. Packing:The cost of packing materials such as polythene bags, wrapping
materials, etc. for delivery is a distribution expense and hence charged to Profit
and Loss Account. Where packing is essential to make the products fit for sale
in the market as in the case of cigarettes, biscuits, medicines, oil, etc. it is called
‘packaging’ and such expenditure is charged to the Trading Account.
7. Samples: Generally, samples of goods are distributed free of charge to increase
sales. The cost of such samples should be treated as a selling expense and so
debited to Profit and Loss Account.
8. Income Tax: It is the tax payable by a person on his income. In the case of a
sole trading concern, the tax paid by the proprietor on the profits of the business
is treated as a personal expense. Hence, it should be added to drawings or
directly deducted from capital.
Illustration 5
Prepare Profit and Loss Account from the following balance extracted from,the
books of a business for the year 2018.
Rs.
Gross Profit 1,85,000
Salaries 20,000
Rent and Rates 5,000
Stationery 1,000
Postage 500
Insurance 2,000
Repairs 1,500
Depreciation 5,000
Advertisement 5,000
Discount (Dr.) 500
Commission of Salesmen 5,000
Bad Debts 2,000
Loss by Fire 2,000
Interest on Investments 2,500
Profit on sale of Investments 2,000
Solution:
Profit and Loss Account of …………..…
for the year ending December 31, 2018
Dr. Cr.

Particulars Amount Particulars Amount

Rs. Rs.
To Salaries 20,000 By Gross Profit 1,85,000
To Rent and Rates 5,000 (Transferred from
To Stationery 1,000 Trading A/c)
37
Final Accounts To Postage 500 By Interest on Investments 2,500
To Insurance 2,000 By Profit on Sale of
To Repairs 1,500 Investments 2,000
To Depreciation 5,000
To Advertisement 5,000
To Discount 500
To Commission to Salesmen 5,000
To Bad Debts 2,000
To Loss by Fire 2,000
To Net Profit
(Transferred to
CapitalAccount) 1,40,000

1,89,500 1,89,500

In Practice, the Trading Account and the Profit and Loss Account are combined and
one account called ‘Trading and Profit and Loss Account’ is prepared. This account
is divided into two parts. The first part shows the Gross Profit and the second part
shows the Net Profit.
Look at illustration 6 and see how combined Trading and Profit and Loss Account
will be prepared.
Illustration 6
From the following figures, prepare Trading and Profit and Loss Account of Lakshmi
& Co. for the year ended December 31, 2018.
Rs.
Stock on January 1, 2018 40,000
Purchases 98,000
Commission Received 650
Rent, Rates and Taxes 8,600
Salaries & Wages 12,000
Sales 1,62,100
Returns Inwards 2,400
Returns Outwards 3,000
Sundry Expenses 2,500
Bank Charges 50
Discount Received 750
Carriage on Purchases 2,000
Discount Allowed 530
Carriage on Sales 1,700
Lighting and Heating 2,200
Postage 300
Income from Investments 500
Commission Paid 1,000
Interest paid on a bank loan 550
The stock on December 31, 2018 was valued at Rs. 26,000

38
 Final Accounts-I
Solution:
Trading and Profit & Loss Account of Lakshmi & Co.
for the year ended December 31, 2018
Dr. Cr.

Particulars Amount Particulars Amount

To Opening Stock 40,000 By Sales 1,62,100

To Purchases 98,000 Less: Returns 2,400 1,59,700
Less: Returns 3,000 95,000 By closing Stock 26,000
To Carriage on Purchase 2,000
To Gross Profit c/d 48,700
1,85,700 1,85,700
To Rent. Rates and Taxes 8,600 By Gross Profit b/d 48,700
To Salaries and Wages 12,000 By Commission Received 650
To Sundry Expenses 2,500 By Discount received 750
To Bank Charges 50 By Income from Investments 500
To Discount Allowed 530
To Carriage on Sales 1,700
To Postage 300
To Commission Paid 1,000
To Interest paid on loan 550
To Lighting & Heating 2,200
To Net Profit 21,170

50,600 50,600

9.3.3 Closing Entries

You learnt that all nominal accounts which represent items of expenses and incomes
are closed at the end of the accounting year by transfer to either the Trading Account
or the Profit and Loss Account. The journal entries passed for such transfer are
called closing entries. You also know that accounts relating to expenses and losses
always show debit balances while those representing incomes show credit balances.
In order to close an account which shows a debit balance and is to be transferred to
the Trading Account we credit the account concerned with an amount equal to its
balance and debit the Trading Account, For example, the Carriage Inwards Account
Shows a debit balance of Rs. 6,000. The closing entry for this will be as follows:
Rs. Rs.
Trading A/c Dr. 6,000
To Carriage Inwards A/c 6,000
Similarly, an account which shows a credit balance, will be closed by debiting it with
an amount equal to the balance and crediting the Trading Account or Profit and Loss
Account, as the case may be. The closing entries are passed in the Journal Proper
and it is necessary to pass such entries for preparing the Trading and Profit and Loss
Account. The entries required for the items which are to be transferred to the Trading
Account are as follows: 39
Final Accounts 1. Trading Account Dr.
To Stock Account (opening)
To Purchases Account
To Sales Returns Account
To Direct Expenses Accounts (to be credited individually)
2. Sales Account Dr.
Purchases Returns Account Dr.
Stock Account (closing) Dr.
To Trading Account
Trading Account
To Profit and Loss Account
(for Gross Profit)
Note: If there is gross loss, the closing entry will be just the reverse of the above.
When the closing entry is passed for gross profit or gross loss, the Trading Account
stands closed.
The entries required for items to be transferred to the Profit and Loss Account are
as follows:
1. Profit and Loss Account Dr.
To Expenses/LossesAccounts
(to be credited individually)
2. Incomes/Gains Accounts Dr.
(to be debited individually)
To Profit and Loss Account
3. Profit and Loss Account Dr.
To CapitalAccount
(for Net Profit)
Note: If there is net loss, the closing entry will be just the reverse of the above.
Let us see how closing entries for the items given in illustration 4 will be passed.
These are as follows:
JOURNAL

Name of Account L.F. Dr. Cr.

Balances Balances

2018 Rs. Rs.

Dec. 31 Trading A/c Dr. 1,42,400
To Opening Stock A/c 40,000
To Purchase A/c 98,000
To Sales Returns A/c 2,400
To Carnage Inwards A/c 2,000
(Being closing entry)
Dec. 31 Sales Ac Dr. 1,62,100
Purchases Returns A/c Dr. 3,000
Closing Stock A/c Dr. 26,000
To Trading A/c 1,91,100
40 (Being closing entry)
Dec. 31 Trading A/c Dr. 48,700 Final Accounts-I
To Profit and Loss A/c 48,700
(Being transfer of gross profit)
Dec. 31 Profit and Loss A/c Dr. 29,430
To Rent, Rates & Taxes A/c 8,600
To Salaries &Wages A/c 12,000
To Sundry Expenses A/c 2,500
To Bank Charges A/c 50
To Discount Allowed A/c 530
To Carriage Outwards A/c 1,700
To Postage A/c 300
To Commission Paid A/c 1,000
To Interest Paid A/c 550
To Lighting &Heating A/c 2,200
(Being closing entry)
Dec. 31 Commission Received A/c Dr. 650
Discount Received A/c Dr. 750
Income from Inv. A/c Dr. 1,500
To Profit and Loss A/c 2,900
(Being closing entry)
Dec. 31 Profit and Loss A/c Dr. 21,170
To Capital A/c 21,170
(Being transfer from NP)

Check Your Progress B

1. Distinguish between Direct and Indirect Expenses.
................................................................................................................
................................................................................................................
................................................................................................................

2. What is the purpose of preparing a Trading Account?

................................................................................................................
................................................................................................................
................................................................................................................
................................................................................................................
3. State whether the following statements are Trueor False.
i) The gross profit is the difference of total sales and credit sales
…………………………….…………..………….
ii) Direct expenses are those expenses which are directly attributable to
purchase of goods for resale …………………… ……….
iii) Stock is valued at cost or market price whichever is lower ……..
...........………. 41
Final Accounts iv) The net profit is the excess of gross profit and other incomes over the
indirectexpenses and losses …… ……….…………..………….
v) Income tax paid in case of a proprietary x concernischarged to Profitand
Loss Account …………………….…………..….
vi) Trade Expensesarecharged to Trading Account ………………….…
4 Fill in the blanks:
i) CarriageOutwardsisan example of ……………. expenses.
ii) Cost of goods sold is equal to opening stock plus ………less .......... .
iii) Cost of samples distributed free of cost are treated as …………expenses.
iv) All direct expenses are debited to …………….Account.
v) Loss on Account of theft is ……………… to Profit and Loss Account.
vi) Wages and salaries are charged to…………… ….…………..
5 Ascertain the cost of goods sold from the following data:
Rs.
Direct Expenses 8,000
Opening Stock 12,000
Purchases 80,000
Interest Paid 500
Closing Stock 10,000

9.4 BALANCE SHEET

After ascertaining the net profit or net loss by preparing the Trading and Profit and
Loss Account, the final step in preparing final accounts is the preparation of Balance
Sheet. The purpose of Balance Sheet is to ascertain the financial position of a business
i.e., to know what the business owes and what it owns on a certain date. Hence it
shows all assets and liabilities of the business as at the end of the accounting year.
You know that final accounts are prepared from the Trial Balance. All items of
expense and income appearing in Trial Balance are transferred to the Trading and
Profit and Loss Account. The remaining items which represent the balances of personal
and real accounts are shown in the Balance Sheet. The accounts showing debit
balances represent assets and those showing credit balances represent liabilities.
Look at Figure 9.3 and note how various assets and liabilities appear in the Balance
Sheet.
Table 9:3 : Balance Sheet of ………..
as on ……………..
Dr. Cr.

Liabilities Amount Assets Amount .

Current Liabilities Rs. Current Assets Rs.
Bank Overdraft ……… Cash in hand ………
Bills Payable ……… Bills Receivable ………
Sundry Creditors ……… Cash at bank ………
42
 Sundry Debtors ……… Final Accounts-I
Long-term Liabilities Closing Stock ………
Loan ……… Investments and
Mortgages ……… Fixed Assets
Capital Balance ..... Vehicles ………
Add: Net Profit ..... Furniture ………
Plant & Machinery ………
Less: Drawings ..... ……… Land & Buildings ………
Goodwill ………
……… ………
You should know that the Balance Sheet is prepared to ascertain the financial position
at a particular point of time and not for a period. Hence the heading of the Balance
Sheet will always read ‘Balance Sheet as on ……….‘(usually last date of the
accounting year).
The total of assets should always be equal to the total of liabilities. If however, they
do not tally, it would mean that some errors have been committed while preparing
the final accounts. You must recheck the treatment of all items including the arithmetical
aspect, and make the corrections where necessary so that the Balance Sheet tallies.
Assets: The term ‘assets’ denote the economic resources (property) of the business
and includes all current and fixed assets. You know current assets are those assets
which are likely to be realised within a period of one year (or during the normal
operating cycle) and includes cash, stock, debtors, bills receivable, short-term
investments, etc. The fixed assets, on the other hand, are those assets which are
acquired for use in the business over a long period. They may be tangible like
machinery and furniture, or intangible like goodwill, patents, etc. The assets also
include certain expenses and losses which have not been written off in full. Examples
of such expenses are: formation expenses, expenses incurred on issue of shares and
debentures, unwritten amount of expenditure on advertising, etc. These are shown
as the last item under ‘Assets’ in the Balance Sheet.
Liabilities: The term ‘liabilities’ denote all claims against the assets of the business
whether those of the outsiders (creditors) or those of the owners of the business.
The outsider’s claim may be sub-divided into (i) current liabilities, and (ii) long-term
liabilities. These are shown separately in the Balance Sheet (see Figure 9.3). The
current liabilities are those obligation which are likely to be met within one year (or
during the normal operating cycle). The long-term liabilities refer to item like loans
which are not to be paid in the near future. The owner’s claim is shown as capital
after adjusting it with the amount of net profit and drawings during the year.
Look at illustration 7 and see how Balance Sheet is prepared from given list of
balances.
Illustration 7
From the following balances extracted from the books of Deepak Brothers, prepare
Balance Sheet as on December 31, 2018.
Rs. Rs.
Capital 12,00,000 Bills Payable 40,000
Net Profit for 2018 6,00,000 Debtors 2,50,000 43
Final Accounts Land & Buildings 7,00,000 Bills Receivable 50,000
Loan 1,60,000
Plant & Machinery 4,00,000 Bank Overdraft 20,000
(after depreciation) Cash in hand 60,000
Furniture (afterdepreciation)50,000 Loose Tools 50,000
Investment 3,50,000 Goodwill 1,00,000
Creditors 2,00,000 Closing stock 1,85,000
Trade marks 25,000
Solution:
Balance Sheet of Deepak Brothers as on December 31, 2018

Liabilities Amount Assets Amount

Current Liabilities Rs. Current Assets Rs,

Bank Overdraft 20,000 Cash in Hand 60,000
Bills Payable 40,000 Bills Receivable 50,000
Sundry Creditors 2,00,000 Sundry Debtors 2,50,000
Stock in Hand 1,85,000
Investments 3,50,000
Long-term Liabilities
Loan 1,60,000
Capital Fixed Assets
Balance as on Loose Tools 50,000
Jan. 1, 2018 12,00,000 Furniture 50,000
Add: Net Profit 6,00,000 18,00,000 Plant & Machinery 4,00,000
Land & Buildings 7,00,000
Trade Marks 25,000
Goodwill 1,00,000
22,20,000 22,20,000
Now Look at illustration 8. It shows how the Trading and Profit and Loss Account
and the Balance Sheet are prepareed from a given Trial Balance.
Illustration 8
From the following Trial Balance of Gupta & Sons, prepare Trading and Profit and
Loss Account for the year ended December 31, 2018 and a Balance Sheet as on
that date.
Trial Balance

Particulars Dr. Cr.

Balances Balances
Rs. Rs.
Capital 5,00,000
Sales 10,00,000
Sales Returns 25,000
Purchases 5,00,000
Purchase Returns 15,000
Inventory on 1.1.2018 60,000
Land &Pilings 4,00,000
44 Plant & Machinery 2,50,000
Furniture 1,00,000 Final Accounts-I
Wages 50,000
Carriage Inwards 10,000
Carriage Outwards 5,000
Cartage 5,000
Salaries 40,000
Loan 2,60,000
Debtors 1,50,000
Creditors 85,000
Bills Receivable 40,000
Acceptances 10,000
General Expenses 20,000
Rent & Rates 10,000
Investments 50,000
Cash in Hand 50,000
Bank Overdraft 10,000
Discount Allowed 4,500
Depreciation on
Plant & Machinery 50,000
Interest on Investments 5,000
Interest on Bank Overdraft 500
Goodwill 60,000
Bad Debts 5,000
18,85,000 18,85,000

The inventory on December 31, 2018 was valued at Rs. 1,00,000.

Solution:
Trading and Profit & Loss Account of Gupta & Sons
For the year ended December 31, 2018
Dr. Cr.

Particulars Amount Particulars Amount

Rs. Rs.
To Inventory (Opening) 60,000 By Sales 10,00,000
To Purchases 5,00,000 Less: Returns 25,000 9,75,000
Less: Returns 15,000 4,85,000 By Inventory (Closing) 1,00,000
To Wages 50,000
To Carriage Inwards 10,000
To Cartage 5,000
To Gross Profit c/d 4,65,000
10,75,000 10,75,000
To Carriage Outwards 5,000 By Gross Profit b/d 4,65,000
To Salaries 40,000 By Interest on Investment 5,000
To General Expenses 20,000
To Rent and Rates 10,000
To Discount 4,500
To Bad debts 5,000
To Depreciation 50,000
45
Final Accounts To Interest on Bank
overdraft 500
To Net Profit
(Transferred to 3,35,000
CapitalAccount)
4,70,000 4,70,000

Balance Sheet of Gupta & Sons as on December 31, 2018

Liabilities Amount Assets Amount

Rs. Rs.
Capital 5,00,000
Add: Net Profit 3,35,000 8,35,000 Goodwill 60,000
Loan 2,60,000 Land & Building 4,00,000
Creditors 85,000 Plant & Machinery 2,50,000
Acceptances 10,000 Furniture 1,00,000
Bank Overdraft 10,000 Investment 50,000
Inventory (closing) 1,00,000
Debtors 1,50,000
Bills Receivables 40,000
Cash in Hand 50,000
12,00,000 12,00,000

Note: In the above Balance Sheet all assets and liabilities have been shown ü’ the
order of permanence.

9.5 VERTICAL PRESENTATION OF FINAL

ACCOUNTS
The Trading and Profit and Loss Account and the Balance Sheet have so far been
presented as a two-sided [Link], in practice, it is not necessary to present
the final accounts in this form. Nowadays many firms present them in a simpler and
more intelligible form which is called a ‘narrative style’ or ‘vertical presentation’.
According to this style the Trading and Profit and Loss Account as well as the
Balance Sheet are shown in the form of vertical statements. This form of presentation
is adopted by many companies for publication of their final accounts. It helps the
users of financial statements to appreciate the significance of different items without
any difficulty. They can easily interpret the data and judge the profitability and the
financial position of the company.
Look at Figure 9.4 and study how various items are shown in the Trading and Profit
and Loss Account and the Balance Sheet in vertical form.
Table 9.4 : Trading and Profit and Loss Account of .........for ........... the
year ended ...........................
Rs. Rs.
SALES ………
Less Cost of Goods Sold:
Opening Stock ………
Add: Purchases ………
Add: Direct Expenses ………
46
 ……… Final Accounts-I
Less Closing Stock ………
………
GROSS PROFIT ………
Add Other incomes ………
Less Indirect Expenses :
Salaries ………
Rent ………
Sundry Expenses ………
Insurance ……… ………
NET PROFIT ………

Balance Sheet of…………….

as on …………

Fixed Assets:
Land and Buildings ………
Plant and Machinery ………
Furniture and Fixtures ………
Vehicles ………
………
Current Assets:
Stock-in-hand ………
Debtors ………
Cash at bank ………
Cash in hand ………
………
Less Current Liabilities:
Creditors ..............
Bills Payable .............. ………
Working Capital ………
Financed by:
Capital:
Balance as on 1.1.2018 ………
Add Net Profit for the year ………
………
Less: Drawings ……… ………
Loans ………
………

Look at illustration 9 and study how Trading and Profit and Loss Account and the
Balance Sheet have been prepared for vertical presentation.
Illustration 9
From the information given in illustration 6, prepare Trading and Profit and Loss
Account and the Balance Sheet in the vertical form.

47
Final Accounts Solution:
Trading and Profit and Lass Account of Gupta & Sons
for the year ended December 31, 2018
Sales Less Returns Rs. Rs.
(Rs. 10,00,000—Rs. 25,000) 9,75,000
Less: Cost of Goods Sold:
Inventory (beginning) 60,000
Add: Purchases less Returns
(Rs. 5,00,000—Rs. 15,000) 4,85,000
Add: Wages 50,000
Add: Carriage Inwards 10,000
Add: Cartage 5,000
6,10,000
Less: Inventory (ending) 1,00,000 5,10,000

GROSS PROFIT 4,65,000

Add: interest on Investments 5,000

4,70,000
Less: Indirect Expenses:
Cartage 5,000
Salaries 40,000
General Expenses 20,000
Rent and Rates 10,000
Discount 4,500
Bad Debts 5,000
Interest on Bank Overdraft 500
Depreciation 50,000
1,35,000
NET PROFIT 3,35,000

Balance Sheet of Gupta & Sons as on December 31, 2018

Fixed Assets:
Goodwill 60,000
Land & Building 4,00,000
Plant & Machinery 2,50,000
Furniture 1,00,000
Investments 50,000
8,60,000
Current Assets:
Inventory (ending) 1,00,000
Debtors 1,50,000
Bills Receivables 40,000
Cash in hand 50,000
48 3,40,000
Less: Current Liabilities: Final Accounts-I

Creditors 85,000
Acceptances 10,000
Bank overdraft 10,000 1,05,000 2,35,000
Working Capital 10,95,000
Financed by:
Capital Balance on 1.1.2018 5,00,000
Add: Net Profit 3,35,000 8,35,000
Long Term Loans 2,60,000
10,95,000

Check Your Progress C

1. What is a Balance Sheet?
................................................................................................................
................................................................................................................
................................................................................................................
2. Why firms use vertical form of presenting the final accounts?
................................................................................................................
................................................................................................................
................................................................................................................
3. Complete the following sentences choosing one of the two alternatives given
within brackets.
i) Assets represent …………balances of personal and real accounts. (debit!
credit)
ii) All liabilities which become due within one year are classified as
………..liabilities. (long-term/current)
iii) Unwritten off amount of a deferred revenue expenditure is shown on the
………….side of the Balance Sheet. (asset/liabilities)
iv) Totals of assets and liabilities are always …………..(different/equal)
v) Loose Tools are classified as …………assets. (fixed/current)
vi) Mortgages are classified as …………..liabilities. (current/long-term)

9.6 MANUFACTURINGACCOUNT
In case of trading concerns you can find out the cost of goods and the gross profit
by preparing a Trading Account. But a manufacturing concern has to first prepare
another account called Manufacturing Account with the help of which it works out
the cost of goods produced. The cost of goods produced is then transferred to the
Trading account for ascertaining the cost of goods sold and the gross profit.
A manufacturing concern purchases raw materials from the market and converts
them into finished goods for sale. The cost of goods produced thus includes two
major costs: (i) cost of raw materials consumed, and (ii) cost of conversion. These
are explained below. 49
Final Accounts Cost of Raw Materials Consumed: This represents the cost of rawmaterials
used in course of manufacture which can be worked out by adjusting the opening
and closing stocks of raw materials in the purchases of raw materials. For example,
a firm purchased raw materials worth Rs. 6,50,000 during 2018, and its stock of
raw materials on January 1, 2018 (opening stock) was Rs. 70,000 and on December
31, 2018 (closing stock) Rs. 90,000. The cost of raw materials consumed during
2018 will be worked out as follows:
Rs.
Opening Stock of Raw Materials 70,000
Add: Purchases of Raw Materials 6,50,000
7,20,000
Less: Closing Stock of Raw Materials 90,000
Cost of Raw Materials Consumed 6,30,000
The direct expenses incurred on the purchases of raw materials such as freight,
import duty, dock dues, cartage, etc. can also be included in the cost of raw materials
consumed. But the usual practice is to show them separately on the debit side of the
Manufacturing Account.
Cost of Conversion:This includes all expenses incurred in the factory such as wages
paid to labour, salaries of supervisory staff, factory rent and rates, motive power,
repairs to plant and machinery, depreciation on plant and machinery, etc. All these
expenses are debited to the Manufacturing Account.
Look at Figure 9.5 for the performing of a Manufacturing Account.

Manufacturing Account of Fig. 9.5 for the period end ...........................

Dr. Cr.

Particulars Amount Amount Particulars Amount Amount

Rs. Rs. Rs. Rs.

To Work-in progress at ...... By Sale of Scrap .......
the beginning
To Raw Materials Consumed: By Work-in-
Opening Stock of Raw Materials ...... Progress at the end .......

Add: Purchases of Raw Materials ...... By Cost of Goods .......

Produced
Less: Closing Stock of Raw Materials ...... ...... (Transferred to
Trading Account)
To Carriage Inwards ......
To Freight, Import ......
Duty, Dock Dues, etc. ......
To Manufacturing Wages ......
To Motive Power ......

50
To Coal, Gas and Water ...... Final Accounts-I
To Oil and Grease ......
To Factory Lighting & Heating ......
To Factory Insurance ......
To Repairs to Factory Building ......
To Repairs to Plant and Machinery ......
To Depreciation on Factory Buildings ......
To Depreciation on Plant ......
and Machinery ...... ......

Some Important Points

Scrap: The term ‘scrap’ is used for waste materials coming out of the manufacturing
process. Cuttings of cloth in readymade garments factory and metal cuttings in
engineering factories are some examples of scrap. Any amount realised from the
sale of scrap must be adjusted in the cost of goods produced. Hence, it is credited
to the Manufacturing Account.
Work-in-Progress: It is quite likely that at the end of the year, there may be certain
goods which are still in the process of manufacture. Such goods are called ‘semi-
finished goods’ or ‘work-in-progress’. There will always be some work-in- progress
at the beginning as well as at the end of the accounting year. Their cost must be
adjusted while working out the cost of goods produced. Hence the opening work-
in-progress is shown on the debit side of the Manufacturing Account while the closing
work-in-progress s shown on its credit side.
Stock of Finished Goods: Besides the stock of raw materials and semi-finished
goods every firm will have the stock of finished goods. This is to be adjusted in the
cost of goods sold and not in the cost of goods produced. Hence, it is not shown in
the Manufacturing Account. As you learnt earlier, it will be shown in the Trading
Account.
Look at illustration 10 and see how Manufacturing Account is to be prepared.
Illustration 10
Prepare Manufacturing Account from the following particulars relating to the year
2018.
Rs.
Purchases of Raw Material 1,00,000
Stock on 1.1.2018
Raw Materials 10,000
Work-in-Progress 5,000
Finished goods 25,000
Factory wages 15,000
Factory Rent 5,000
Fuel & Power 2,000
Carriage Inwards 1,000
Repairs of Plant 2,000
Depreciation on Plant 5,000 51
Sale of Scrap 500
Final Accounts Stock on 31.12.2018 20,000
Raw Materials 7,500
Work-in-Progress 30,000
Finished Goods
Solution:
Manufacturing Account for the year ended December 31, 2018

Particulars Amount Particulars Amount

Rs. Rs.
To Work-in-Progress at
the beginning 5,000 By Sale of Scrap 500
To Raw Materials Consumed By Work-in-Progress
at the end 7,500
Opening Stock 10,000 By Cost of Goods 1,17,000
Add: Raw Purchased 1,00,000 Produced
1,10,000 (transferred to Trading
Less: Closing Stock 20,000 90,000 Account)
To Factory Wages 15,000
To Factory Rent 5,000
To Fuel & Power 2,000
To Carriage Inwards 1,000
To Repairs of Plant 2,000
To Depreciation on Plant 5,000

1,25,000 1,25,000

You will observe that the stock of finished goods has not been shown in the
Manufacturing Account. As stated earlier, it is to be taken to the Trading Account.
Now, suppose the sales for the year 2018 were Rs. 1,60,000. The Trading Account
will appear as follows
Trading Account of for the year ending December, 31 2018

Particulars Amount Particulars Amount

Rs. Rs.
To Opening stock of Finished Goods 25,000 By Sales 1,60,000
To Cost of Goods Produced
(Transferred from Mfg. A/c) 1,17,000 By Closing stock of
Finished Goods 30,000
To Gross Profit (Transferred to Profit
& Loss A/c) 48,000

1,90,000 1,90,000

You have learnt that a manufacturing concern has to prepare Manufacturing Account
before preparing the Trading and Profit and Loss Account. Though considered
desirable but many firms do not do so because it is not compulsory. You will also
generally be asked to prepare only the Trading Account without preparing the
52
Manufacturing Account. In such a situation you will show all items of Manufacturing Final Accounts-I
Account in the Trading Account itself. In other words, cost of raw materials
consumed, expenses on purchases of raw materials, all manufacturing expenses, the
opening and closing work-in-progress, sale of scrap, etc. will also be shown in the
Trading Account. But, as per common practice, the items like depreciation and
repairs to plant and machinery and factory building will be shown in the Profit and
Loss Account and not in the Trading Account.

9.7 LET US SUM UP

At the end of the accounting year the businessman prepares the final accounts with
the help of a Trial Balance. The final accounts consist of (i) Profit and Loss Account
and (ii) Balance Sheet. The Profit and Loss Account is prepared for ascertaining the
net profit/net loss of the business during the year and the Balance Sheet is prepared
for ascertaining its financial position as at the end of the year.
The Profit and Loss Account is divided into two sections. The first section called
Trading Account reveals the gross profit or gross loss and the second section called
Profit and Loss Account shows the net profit or net loss. Gross profit is defined as
the excess of sale revenue over the cost of goods sold which also includes the direct
expenses. The net profit is worked out by-crediting the Profit and Loss Account
with the amount of gross profit and other incomes and debiting it with all indirect
expenses and losses. In practice, we usually prepare a combined Trading and Profit
and Loss Account. It is also necessary to pass closing entries for transferring all
expenses and incomes to the Trading and Profit and Loss Account.
The Balance Sheet shows all assets and liabilities of the business. The assets represent
the debit balances of the real and personal accounts plus the unwritten off amounts
of deferred revenue expenses. The liabilities, on the other hand, represent the credit
balances of real and personal accounts including capital. The total assets should
always be equal to the total of liabilities.
The manufacturing concerns may also prepare a Manufacturing Account for
ascertaining the cost of goods produced, which is then transferred to the Trading
Account for ascertaining the cost of goods sold and the gross profit. This, however,
is not compulsory. Most manufacturing concerns prepare the Trading Account directly
y showing all-expenses incurred in the factory (including cost of raw materials
consumed) in the Trading Account itself.

9.8 KEY WORDS

Closing Stock: Goods remaining unsold at the end of the accounting year.
Cost of Conversion: Expenses incurred in the factory (for converting raw materials
into finished goods.)
Cost of Goods Sold: Difference between the cost of goods available for sale and
the cost of goods in stock.
Cost of Production: It is the cost of goods produced which includes cost of raw
materials consumed and all manufacturing expenses.
Current Assets: Assets which are likely to be realised within a period of one year
or during the operating cycle. They are also called floating assets. 53
Final Accounts Current Liabilities: Liabilities which are likely to be paid within one year or during
the operating cycle. They are also called short-term liabilities.

Direct Expenses: Expenses incurred on the goods purchased till they are brought
to the place of business.

Fictitious Assets: Expenses and losses not yet written off and shown as assets in
the Balance Sheet.

Fixed Assets: Assets acquired for use in the business for a long period. They are
also called non-current assets.

Gross Profit: Excess of sales revenue over the cost of goods sold.

Indirect Expenses: All expenses other than direct expenses. These include expenses
incurred in connection with general administration, financial matters and selling and
distribution of goods.

Intangible Assets: Assets in the form of rights which cannot be seen or touched
such as goodwill, patents, etc.

Net Profit: Excess of gross profit and other incomes over the indirect expenses
and losses in the business.

Non-Current Liabilities : Liabilities payable after a long time. They are also called
long-term liabilities.

Owner’s Capital: Claim of owners against the assets of the business. It is also
called owner’s equity and is equal to excess of assets over outside liabilities.

Opening Stock: Stock of goods as at the beginning of the accounting year.

Scrap: Waste material which arises in the course of manufacture.

Tangible Assets: Assets which have physical form and can be seen and touched
such as buildings, machinery, etc.

Work-in-Progress: Goods in respect of which some work still remains to be done.

They are also called semi-finished goods.

9.9 SOME USEFUL BOOKS

Maheshwari, S.N. 2018. Introduction to Accounting, Vikas Publishing House:
New Delhi.

Patil, V.A. and J.S. Korlahalli. 1986. Principles and Practice of Accounting,
R. Chand & Co., New Delhi.

William Pickles. 1992. Accountancy, E.L.B:s. and Pitman: London.

Gupta, R.L. and M. Radhaswamy. 2018. Advanced Accountancy; Sultan Chand

& Sons: New Delhi.

Shukla, M.C. and T.S. Grewal. 2018. Advanced Accountancy, S. Chand &
Co.: New Delhi.
54
 Final Accounts-I
9.10 ANSWERS TO CHECK YOUR PROGRESS
A 1. i) Debit ii) Debit iii) Debit iv) Credit v) Debit
vi) Credit vii) Debit viii) Credit ix) Debit x) Debit
xi) Debit xii) Credit

B 3. i) False ii) rue iii) True iv) True v) False vi) False.

4. i) indirectii) purchases, closing stock iii) selling iv) Trading v)debited

vi) Trading Account

5. Rs. 90,000

C 3. i) debit ii) current iii) asset iv) equal v) fixed vi) long-term

9.11 TERMINAL QUESTIONS/EXERCISES

Questions

1. Distinguish between:
a) Cost of Goods Sold and Cost of Goods Processed
b) Gross Profit and Net Profit
c) Direct Expenses and Indirect Expenses
d) Trading Account and Manufacturing Account
e) Profit and Loss Account and Balance Sheet

2. Give closing entries for Trading and Profit and Loss Account.

3. What is a Balance Sheet? Describe different methods of arranging assets and

liabilities.

Exercises

1. Find out the Cost of Goods Sold from the following figures extracted from the
books of Allied Ltd. for the year 2018:

Rs.
Stock (1.1.2018) 50,000
Purchases 10,00,000
Sales 15,00,000
Purchases Returns 50,000
Stock (31-1-2018) 70,000
Direct Expenses 60,000
Indirect Expenses 1,00,000

(Answer: Rs. 9,90,000)

55
Final Accounts

2. Find out the Cost of Goods Sold and Gross Profit from the following figures:

Rs.
Inventory in the beginning 60,000
Purchases Less Returns 6,00,000
Carriage Inwards 20,000
Cartage Outwards 30,000
Cartage and Freight 10,000
Wages 50,000
Sales Less Returns 12,00,000
Inventory at the end 40,000

(Answer: Cost of Goods Sold Rs, 7,00,000; Gross Profit Rs. 5,00,000.)
3. From the data given in Question No. 2 prepare Trading Account
4. From the following balances of Shyam Sunder, prepare Profit and Loss Account
for the year ended March 31, 2018.
Rs.
Office Expenses 5,280
Advertising 3,000
Legal Charges 5,000
Postage and Telephone Charges 6,400
Salaries and Wages 60,000
Travelling Expenses 2,500
Interest Received 600
Rent, Rates and Taxes 20,800
Insurance 2,400
Office Lighting 1,500
Stationery 1,200
Repairs 920
Miscellaneous Income 800
Commission Paid 4,000
Bank Charges 200
The Gross Profit for the year was Rs. 73,000
(Answer: Net Loss Rs. 38,000)
5. The following balances have been extracted from the books of Plaza Electricals
Ltd. for the year 2018.
Rs.
Sales 5,00,000
Purchases 3,00,000
Return Inwards 10,000
56
Return Outwards 15,000
Opening Stock 30,000 Final Accounts-I
Wages 20,000
Carnage Inwards 5,000
Carriage Outwards 3,000
Salaries 25,000
General Expenses 10,000
Rent and Rates 4,000
Advertisement 5,000
Bad debts 3,000
Insurance 3,000
Trade Expenses 2,000
Depreciation 5,000
It was further given that the value of stock on December 31, 2018 was Rs. 50,000.
You are required to prepare Trading and Profit and Loss Account of Plaza Electrical
Ltd. for the year ending December 31, 2018.
(Answer: Gross Profit Rs. 2,00,000; Net Profit Rs. 1,40,000)
6. From the following data pertaining to the transactions of Mehta Bros. for the
year 2018, prepare Trading and Profit and Loss Account for the year ending
December 31, 2018.
Rs.
Sales 10,00,000
Purchases 6,00,000
Sales Returns 20,000
Purchases Returns 10,000
Inventory (beginning) 40,000
Wages 50,000
Carriage Inwards 20,000
Carriage Outwards 15,000
Trade Expenses 10,000
Cartage and Freight 5,000
Salaries 30,000
General Expenses 10,000
Insurance 6,000
Rent & Rates 5,000
Distribution Expenses 6,000
Discount Received 1,000
Discount Allowed 2,000
Bad Debts 2,000
Depreciation 8,000
Interest on Investments 20,000
Interest on Bank Deposits 1 ,000
Interest on Bank Overdraft 500
57
Loss of Goods by Fire 2,500
Final Accounts It was further given that the value of Inventory on December 31, 2018 was Rs.
80,000
(Answer: Gross Profit Rs. 3,55,000: Net Profit Rs. 2,80,000,
7 . From the following balances of Hitesh, prepare a Balance Sheet as on December
31, 2018
Rs.
Hitesh’s Capital 41,000
Drawings 6,100
Wife’s Loan 4,000
Sundry Creditors 45,000
Cash in Hand 250
Cash at Bank 4,000
Sundry Debtors 40,500
Patents 2,000
Plant and Machinery 20,000
Land and Building 26,000
Stock in Hand 36,500
Net Profit for the year was Rs. 45,350
(Answer: Balance Sheet Total Rs. 1,29,250)
8. From the following Trial Balance of Sameer, prepare Trading and Profit and
Loss Account for the year ended September, 30, 2018, and Balance sheet as
on that date.
Trial Balance as on September 30, 2018
Name of Account Dr. Cr
Balances Balances
Rs. Rs
Capital 40,000
Drawings 7,500
Stock on July 1, 2017 8,000
Purchases 47,250
Sales 90,000
Carriage Inwards 2,300
Returns .Inwards 2,000
Returns Outwards 1,500
Wages 7,000
Plant and Machinery 30,000
Furniture and fittings 7,500
58
 Coal, Gas and Water 2,100 Final Accounts-I
Power 2,000
Salaries 9,000
Discount Allowed 750
Discount Received 600
Office Rent 2,400
Factory Rent 3,000
Postage and telephone 900
Insurance 250
Sundry Expenses 800
Trade Debtors 20,000
Trade Creditors 27,150
Cash in hand 700
Cash at Bank 4,100
Carriage Outwards 1,700
1,59,250 1,59,250
The Stock on September 30, 2018 was valued at Rs. 9,250.
(Answer:Gross Profit Rs. 27,100; Net Profit Rs. 11,900; Balance Sheet Total Rs.
71,550)
9. The following figures have been extracted from the books of a manufacturer.
Rs.
Stock 1.1.2018
Raw Materials 25,000
Work-in-Progress 10,000
Finished Goods 50,000
Purchases of Raw Materials 3,00,000
Factory Wages 40,000
Factory Rent 5,000
Fuel & Power 5,000
Carriage Inwards 2,500
Repairs of Plant 25,000
Depreciation on Plant 25,000
Sale of Scrap 2,000
Stock on 31.12.2018
Raw Materials 40,000
Work-in-Progress 15,000
Finished Goods 60,000
You are required to prepare a Manufacturing Account and ascertain the Cost of
Goods Produced.
(Answer:Cost of Goods Produced: Rs. 3,75,500)
59
Final Accounts 10. From the following Trial Balance, prepare Manufacturing Account and the
Trading and Profit and Loss Account for the year ended March 31, 2018, and
Balance Sheet as at the end of the year.

Name of Account Dr. Cr

Balances Balances
Rs. Rs
Opening Stock of Raw Materials 60,000
Opening Stock of Finished Goods 32,000
Opening Stock of the Work-in- Progress 10,000
Capital 1,44,000
Purchase of Raw Materials 5,00,000
Sales 8,00,000
Purchase of Finished Goods 16,000
Carriage Inwards 8,000
Wages 1,00,000
Salaries (75% Factory) 52,000
Commission 6,000
Bad Debts 4,000
Insurance 8,000
Rent, Rates and Taxes
(50% Factory) 24,000
Postage and Telegram 5,600
Miscellaneous Expenses 3,200
Travelling and Conveyance
(50% Factory) 7,000
Carriage Outwards 5,200
Machinery 80,000
Furniture 10,000
Debtors 1,20,000
Creditors 1,07,000
10,51,000 10,51,000
The Closing Stocks are as follows:
Raw Materials 80,000
Work-in-Progress 24,000
Finished Goods 16,000
(Answer: Cost of Production Rs. 6,26,750; Gross Profit Rs. 1,41,250; Net Profit
Rs. 79,000; Balance Sheet Rs. 3,30,000.

Note : These questions will help you to understand the unit better. Try to
write answers for them. But, do not submit your answers to the
University for assessment. These are for your own practice only.
60
 Final Accounts-II
UNIT 10 FINALACCOUNTS-II
Structure
10.0 Objectives
10.1 Introduction
10.2 Need for Adjustments
10.3 Treatment of Adjustments in Final Accounts
10.3.1 Closing Stock
10.3.2 Outstanding Expenses
10 3.3 Prepaid Expenses
10.3.4 Accrued Income
10.3.5 Income Received in Advance
10.3.6 Depreciation
10.3.7 Interest on Capital
10.3.8 Interest on Drawings
10.3.9 Interest on Loan
10.3.10 Bad Debts
10.3.11 Provision for Bad Debts
10.3.12 Provision for Discount on Debtors
10.3.13 Provision for Discount on Creditors
10.3.14 Manager’s Commission
10.3.15 Abnormal Loss of Stock
10.3.16 Drawings of Goods by the Proprietor

10.4 Preparation of Final Accounts with Adjustments

10.5 Adjustments given in Trial Balance
10.6 Let Us Sum Up
10.7 Key Words
10.8 Some Useful Books
10.9 Answers to Check Your Progress
10.10 Terminal Questions/Exercises

10.0 OBJECTIVES
After studying this unit you should be able to:
 explain why adjustment entries are necessary at the time of preparing the final
accounts;
 list the items in respect of which adjustments are usually made;
 pass the necessary adjustment entries; and
 prepare final accounts with adjustments.
61
Final Accounts
10.1 INTRODUCTION
In Unit 8 you learnt about the preparation of simple final accounts. They did not involve
any adjustments. In practice, however, you are always required to make some
adjustments while preparing the final accounts. It is because there may be many expenses
and incomes relating to the current year which are still to be brought into the books of
account. Then there may be certain items recorded in current year’s books which
actually relate to the previous year or the next year. Unless such items are duly adjusted
in the books of account, the final accounts will not reveal the true and fair view of the
state of affairs of the business. In this unit you will learn about all items which require
adjustments and study how such adjustments are made in books of account and how
they are incorporated in the final accounts.

10.2 NEED FOR ADJUSTMENTS

You know that the financial reporting requires the summarisation of business operations
for a specific accounting period. It is quite possible that certain transactions recorded in
current year’s books may partly relate to the previous year or to the following year. It
is also possible that certain expenditure incurred during the current year has not yet
been paid and so not recorded. Similarly, there may be certain incomes earned during
the current year which have not been recorded because they have not yet been received;
If such items are not adjusted or brought into current year’s books of account, the
summary presented in the form of final accounts will not reveal the true picture. Let us
take the example of an amount of Rs. 600 paid on July 1, 2018 towards insurance
premium. You know any general insurance usually covers a period of twelve months.
Suppose the accounting year is ending on December 31, 2018 it would mean that half
the amount of insurance premium paid on July 1, 2018 pertains to the next accounting
year i.e., 2019. Therefore, while preparing the final accounts of 2018, the expenditure
on insurance premium that should be debited to the Profit and Loss Account is Rs. 300
(Rs. 600 paid Rs. 300 pertaining to 2019). The remaining amount of Rs. 300 will be
carried forward and charged to the Profit and loss Account of 2019. Take another
example. The wages of workers for the month of December, 2018 were paid on January
7, 2019. This means the Wages Account of 2018 does not include the wages for the
month of December 2018. Such unpaid wages termed as ‘Wages outstanding’ have to
be brought into the books and debited to the Trading Account along with the wages
already paid. Similarly, adjustment may also become necessary in respect of certain
incomes received in advance or those which are outstanding as at the end of the
accounting year. Apart from these, there are certain items which cannot be recorded on
day-to-day basis such as depreciation, interest on capital, etc. They are generally adjusted
at the time of preparing the final accounts.
All items which need alteration or which are to be brought into books at the time of
preparing final accounts are called ‘adjustments’. The purpose of making various
adjustments is to ensure that the final accounts reveal the true financial position of the
business. Therefore, when you are to prepare the final accounts of any business, you
are provided with a Trial Balance and some additional information in respect of the
adjustments to be made.

10.3 TREATMENT OF ADJUSTMENTS IN FINAL

ACCOUNTS
There are several items which need adjustment at the time of preparing the final accounts.
Some of the important and common adjustments are listed below:
62
1. Closing Stock Final Accounts-II

2. Outstanding or Accrued Expenses

3. Prepaid or Unexpired Expenses
4. Outstanding or Accrued Incomes
5. Incomes Received in Advance (Unearned Income)
6. Depreciation
7. Interest on Capital
8. Interest on Drawings
9. Interest on Loan
10. Bad Debts
11. Provision for Bad Debts
12. Provision for Discount on Debtors
13. Provision for Discount on Creditors
14. Manager’s Commission
15. Abnormal Loss
16. Drawing of Goods by the Proprietor
Let us now discuss the nature of each item of adjustment and its treatment in the final
accounts. In this connection you must remember that the general principle of. double
entry has to be fully followed. Hence, for bringing any item into the books of account or
adjusting the amount of any expense or income, you have to ensure that theamount is
debited to one account and credited to another; and while showing it in the final accounts
the item should appear at two places, one representing the debit and the other representing
the credit, otherwise the Balance Sheet will not tally. Usually, each adjustment will first
appear in the Trading and Profit and Loss Account and then in the Balance Sheet.

10.3.1 Closing Stock

You know that all goods purchased or produced during the year are not completely
sold out by the end of the year. Some goods always remain unsold as at the end of the
year which are called ‘Closing Stock’. The Closing Stock does not usually appear in
the Trial Balance. It is mostly given in the form of additional information. Since Gross
Profit/Gross Loss cannot be worked out without accounting for the closing stock it is
brought into books by means of the following adjustment entry.
Closing Stock A/c Dr.
To Trading A/c
The closing stock is treated in the final accounts as follows:
i) On the credit side of Trading Account: shown as a separate item, and
ii) On the assets side of the Balance Sheet: shown as a separate item under Current
Assets.
63
Final Accounts Adjusted Purchases and Closing Stock: Sometimes the closing stock may be giver in
the Trial Balance itself. This would mean that both the opening and the closing stocks
have been adjusted in the purchases. In such a situation, the opening stock will not
appear in the Trial Balance. The Trial Balance will show only the figures of adjusted
purchases and the closing stock. The adjusted purchases are in fact the cost of goods
sold. They have been worked out by adding the opening stock to purchases and
subtracting the closing stock therefrom. Hence, the adjusted Purchases are shown on
the debit side of the Trading Account. In such a situation there is no need to show
closing stock in the Trading Account as it already stands adjusted in purchases. It will
be shown only on the asset side of the Balance Sheet.

10.3.2 Outstanding Expenses

Outstanding expenses are those expenses which have been incurred during the current
accounting year but have not been paid till the end of the year. They are also called
‘expenses accrued’. The common examples of such expenses are the salaries, wages
and rent for the last month of the accounting year paid in the first month of the next year.
Since they remained unpaid as at the end of accounting year, no entry might have been
passed in the books of account. So, they must be taken into account while preparing
the Trading and Profit and Loss Account otherwise it will not reveal the correct amount
of profit or loss. The following adjustment entry is passed in respect of outstanding
expenses.
Concerned Expense A/c Dr.
To Outstanding Expenses A/c
The outstanding expenses will be treated in final accounts as follows:
i) Added to the concerned expenses in the Trading and Profit and Loss Account,
and
ii) Shown on the liabilities side of the Balance Sheet as a separate item under Current
Liabilities.

10.3.3 Prepaid Expenses

Sometimes, the benefit of some expenses will be available not only in the current
accounting year but also during the next year. That portion of expense the benefit of
which is yet to be received is called ‘prepaid expense’. It is also called ‘unexpired
expense’. Examples of such expenses are unexpired insurance, interest paid in advance,
etc. In such situations it is necessary to find out the unexpired portion and ad just it in
the concerned expense, Thefollowing adjustment entry is passed in respect of the prepaid
expenses:
Prepaid Expenses A/c Dr.
To Concerned Expense A/c
The Prepaid expenses will be treated in final accounts as follows:
i) Subtracted from concerned expense in the Trading and Profit and Loss Account,
and
ii) Shown on the assets side of the Balance Sheet as a separate item under Current
Assets.

64
10.3.4 Accrued Income Final Accounts-II

Accrued Incomes are those incomes which have been earned during the current
accounting year but have not been received till the end of the year. They are also
called ‘outstanding incomes’ or ‘incomes earned but not yet received’. Examples of
such incomes are commission receivable, income on investments due but not yet
received, etc. The following adjustment entry is passed in respect of accrued income.
Accrued Income A/c Dr.
To Concerned Income A/c
The Accrued income is treated in final accounts as follows:
i) Added to the concerned income in the Profit and Loss Account, and
ii) Shown on the asset side of the Balance Sheet as a separate item under Current
Assets.

10.3.5 Income Received in Advance

Any income which belongs to the next accounting year but has been received during
the current accounting year is called ‘income received in advance’ or ‘unearned
income. It is the income in respect of which the service is yet to be provided. Examples
of such incomes are rent received in advance, interest received in advance, etc. In
such a situation, the unearned portion of the income will have to be adjusted while
preparing the final accounts. The following adjusting entry is passed in respect of the
unearned income.
Concerned Income A/c Dr.
To Income Received in Advance A/c
The unearned income is treated in final accounts as follows:
i) Deducted from the concerned income in the Profit and Loss Account, and
ii) Shown on the liabilities side of the Balance Sheet as a separate item under
Current Liabilities.
Look at illustration 1 and see how adjustments are made in the final accounts in
respect of outstanding expenses, prepaid expenses, outstanding incomes and incomes
received in advance.
Illustration 1
Show how you will record the following items in the Profit and Loss Account and
the Balance Sheet.
The Trial Balance showed the following balances as on December 31, 2018:
Rs.
Salaries 10,000
Wages 20,000
Rent Received 6,600
Commission Received 2,000
Interest on Investments 6,000
Additional Information
i) Salaries amounting to Rs. 2,000 are outstanding. 65
Final Accounts ii) Wages include Rs. 1,560 paid in advance.
iii) Interest on investment includeRs. 1,200 for the months of January, February and
March, 2019.
iv) Rent for the month of December amounting to Rs. 600 is not yet received.
Gross profit for the year is Rs. 40,000 and other expenses amounted to Rs. 10,000
Profit and Loss Account for the year ended December 31, 2018

Particulars Amount Particulars Amount

Rs. Rs.
To Salaries 10,000 By Gross Profit b/d 40,000
Add: Outstanding 2,000 12,000 By Rent Received 6,600
To Wages 20,000 Add: Outstanding 600
Less: Prepaid 1,500 18,500 7,200
To Other Expenses 10,000 By Commission Received 2,000
To Net Profit By Interest on
(Transferred to Capital A/c) 13,500 Investments 6,000
Less: Received
in Advance 1,200 4,800

54,000 54,000

Balance Sheet
As on December 31, 2018

Liabilities Amount Assets Amount

Current Liabilities: Rs. Currents Assets: Rs,

Salaries Outstanding 2,000 Wages Prepaid 1,500
Interest Received in Advance 1,200 Rent Outstanding 600

10.3.6 Depreciation
Depreciation means decrease in the value of fixed assets due to their usage and the
passage of time. You know the fixed assets are used for the purpose, of earning revenue.
Therefore, the fall in their value should be considered as an expense or loss incurred in
realising such revenue and should be charged to the Profit and Loss Account.
Depreciation is not recognised on day-to-day basis. It is brought into the books only at
the end of the accounting period by passing the following journal entry.
Depreciation A/c Dr.
To Concerned Asset A/c
Depreciation is treated in final accounts as follows:
i) On the debit side of the Profit and Loss Account: shown as a separate item giving
details of depreciation on each fixed asset, and
ii) Deducted from the concerned asset in the Balance Sheet.
Sometimes depreciation is given in the Trial Balance itself. This is possible only if the
entry in respect of depreciation has already been passed in the books of account. In
66
such a situation depreciation will be shown in the Profit and Loss Account only. Final Accounts-II
It need not be adjusted in the fixed assets in the Balance Sheet because the fixed assets
already stand reduced by the amount of depreciation.
Depreciation is generally calculated at the given rate for the period for which the asset
has been used in the accounting year. Thus, if an-asset is purchased during the current
year the depreciation should be calculated from the date of acquisition till the end of the
year. If the date on which the additions were made is not given, you should calculate
depreciation on additions also for the full year. In the case of old assets, depreciation is
calculated on the opening balance. Look at illustration 2 and study how depreciation is
treated at the time of preparing the final account.
Illustration 2
The following are the balances of assets as on January 1, 2018:
Rs.
Plant and Machinery 1,20,000
Furnitur 18,000
A new machinery costing Rs. 30,000 was acquired on July, 1, 2018. Depreciation is to
be provided on Plant and Machinery at 10% and on furniture at 5% per annum. Show
how depreciation will be shown in the final accounts.
Solution :
Calculation of Depreciation
Rs.
On Furniture at 5% on Rs. 18,000 900
On Plant and Machinery:
10% on Rs. 1,20,000 for one year 12,000
10% on Rs. 30,000 for six months 1,500 13,500
14,400
Solution:
Treatment in Final Accounts

Particulars Amount Particulars Amount

Rs. Rs.
To Depreciation :
Plant and Machinery 13,500
Furniture 900 14,400

Balance Sheet as on December 31, 2018

Particulars Amount Particulars Amount

Rs. Rs.
Fixed Assets:
Plant and Machinery 1,20,000
Add: New Machinery 30,000
1,50,000
Less: Depreciation 13,500 1,36,500
Furniture 18,000
Less: Depreciation 900 17,100
67
Final Accounts 10.3.7 Interest on Capital
You know thefinds provided by the proprietor to the business constitute capital.
Sometimes, the proprietor may like to know the profits made by the business after
taking into consideration the interest on this capital. In such a situation interest is allowed
at a certain rate on the capital. It is calculated on the capital at the beginning of the year.
If, however, any additional capital is introduced during the year, interest on additional
capital will also be calculated from the date on which it was brought into Final Account,
the business. Such interest is treated as an expense for the business and the following
adjustment entry is passed to bring it into the books of account.
Interest on Capital A/c Dr.
To Capital A/c
Interest on capital is treated in final accounts as follows:
i) On the debit side of Profit and Loss Account: shown as a separate item of expense
and
ii) Added to Capital on the liabilities side of Balance Sheet. You should note that
normally no interest on capital is to be provided.
10.3.8 Interest on Drawings
In case interest is allowed to the proprietor on his capital, it is a usual nractice to also
charge interest on his drawings. Interest on drawings will be a gain for the business and
the following adjustments entry is passed to bring it into the books of account.
Capital A/c or Drawings A/c Dr.
To Interest on Drawings A/c
Interest on Drawings is treated in final accounts as follows:
i) On the credit side of Profit and Loss Account: shown as a separate item, and
ii) Deducted from Capital on the liabilities side of Balance Sheet.
Interest on drawings is calculated at a given rate from the date of withdrawal till the end
of the year. In case no date is mentioned, the interest is charged for six months assuming
the amounts were drawn evenly throughout the year. Look at illustration 3 and see how
interest on drawings is calculated when the amount and the dates of withdrawal are
given.
Illustration 3
Rs.
Feb. 1 4,000
Apr. 1 6,000
Jul. 1, 6,000
Oct 31 2,000
Dec. 31 5,000
Calculate the interest chargeable to the proprietor if the rate of interest on drawings is
15% per annum.
68
Solution: Final Accounts-II

Date Amount Months upto Product

December 31 23
(1) (2) (3) (4)
Feb. 1 4,000 11 44,000
Apr. 1 6,000 9 54,000
Jul. 1 3,000 6 18,000
Oct. 31 2,000 2 4,000
Dec. 31 5,000 0 0

1,20,000

15 1
Interest on Drawings   1, 20, 000   Rs.1,500
100 12

Another way of calculating interest on drawings is to calculate it individually on each

withdrawal and then add them.

10.3.9 Interest on Loan

If the firm has taken some loan, it has to pay interest thereon. Hence, when we notice a
loan Account in the Trial Balance, we must find out whether the full amount of due on
loan has been paid or not. The rate of interest and the date on which the loan was taken
is usually given. If, however, the date on which loan was taken is not given, it means that
it is an old loan and full year’s interest has to be provided. In any case, you should
calculate the exact amount of interest due and find Out from the Trial Balance whether
the same has been paid or not. Generally, you will find that the interest has been paid
but it is less than what is due. In such a situation, the difference is regarded as outstanding
interest and the same must be adjusted at the time of preparing the final accounts.
Suppose there is an item of 10% loan (taken on April 1, 2018) of Rs. 20,000 appearing
in the Trial Balance. Assuming the accounting year ends on December 31, the total
interest on loan will work out as Rs. 1,500 (at 10% on Rs. 20,000 for nine months). On
going through the Trial Balance you find that the interest paid is Rs. 1,000 only. It means
Rs. 500 (Rs. 1,500— Rs. 1,000) is the outstanding interest. This must be shown in final
accounts accordingly i.e., Rs. 1,500 (Rs. 1,000 + Rs. 500 outstanding) as interest on
loan on the debit side of the Profit and Loss Account and Rs. 500 as outstanding
Interest under current liabilities in the Balance Sheet.
It is possible that the adjustments given outside the Trial Balance already include this
item. But, if they do not even then you have to account for it. This is called an implied
adjustment.
Check Your Progress A
1. Fill in the blanks
i) Every adjustment has a ............................ effect.
ii) Closing stock is shown on the side ........................ of the Balance Sheet.
69
Final Accounts iii) Prepaid expenses are also called .......................... expenses.
iv) Income received in advance is .......................... for the business.
v) .................... is a decrease in the value of a fixed asset due to wear and tear.
vi) Interest on Drawings is from .................. the capital in the Balance Sheet.
2 State whether the following statements are True or False.
i) Every adjustment affects either Trading and Profit and Loss Account or the
Balance Sheet.
ii) Outstanding expense is first added to the relevant expense account and then
shown on the liabilities side of the Balance Sheet.
iii) Interest on loan is an income for the business.
iv) Depreciation is deducted from the relevant fixed asset in the Balance Sheet
and Profit and Loss Account

v) Proprietor is always entitled to interest on the capital invested.

10.3.10 Bad Debts

Sometimes, a debtor may fail to pay his debt either partially or completely. The amount
of debt which cannot be recovered from the debtor is called Bad Debts and it will be a
loss to the business. The following journal entry is passed when a debt becomes bad.
Bad Debts A/c Dr.
To Concerned Debtor’s A/c

The effect of this entry will be (i) debtor’s personal account stands, closed, and (ii) a
new account called ‘Bad Debts Account is opened in the books.
The total amount of bad debts incurred during the year appears as a separate item in
the Trial Balance and the sundry debtors appear at the reduced amount. The bad debts
like any other expense or loss are charged to the Profit and Loss Account.
Bad Debts given outside the Trial Balance: Sometimes, the bad debts to be written off
may be stated outside the TrialBalance as an adjustment item, It means that such bad
debts have not yet been written off. In other words, the entry for such bad debts has
not been passed. It is necessary to record such bad debts at the time of preparing the
final accounts. This is done by passing the following adjustment entry:
Bad Debts Account Dr.
To Sundry Debtors
Such additional bad debts usually called ‘further bad debts’ are treated in finalaccounts
as follows:
i) On the debit side of Profit and Loss Account: shown as addition to bad debts
already written off, and
ii) On the assets side of the Balance Sheet: shown as deduction from Sundry Debtors.
It is important to remember the difference between the treatment of bad debts given
inside the TrialBalance and the bad debts given outside the Trial Balance. The bad
debts given inside the Trial Balance and also those given outside the Trial Balance will
70
be shown in the Profit and Loss Account. But only those bad debts will be deducted Final Accounts-II
from Sundry Debtors in the Balance Sheet which are given outside the Trial Balance.

10.3.11 Provision for Bad Debts

In any business where goods are sold on credit, bad debts usually occur. When it is
certain that a debt will not be recovered, the amount is written off as bad debt. But, it is
also likely that some of the remaining debts may not be recovered in full. From experience
we know that certain percentage of amounts due from debtors may not be recovered.
This will be a loss to the business. You have learnt that accordingly to ‘conservatism
concept’ all possible losses must be provided for. Hence, it is a common practice to
make a suitable provision for doubtful debts at the time of preparing the final accounts.
Otherwise, the Profit and Loss Account will not reveal the correct amount of profit or
loss and the Balance Sheet will not show the true position of sundry debtors. The
Provision for doubtful debts is usually calculated as a certain percentage of the total
amount due from sundry debtors after writing of all known bad debts.
Provision for doubtful debts is also called ‘Provision for Bad Debts’ or ‘Provision for
Bad and doubtful Debts. Such a provision is made by debiting the amount of doubtful
debts to the Profit and Loss Account. Thus, the journal entry for creating such provision
will be as follows:
Profit and Loss A/c Dr.
To Provision for Bad Debts A/c
You will notice that when a debt is irrecoverable it is written off by crediting it to the
personal account of the respective customer. But, when a debt is doubtful of recovery,
the personal account of the customer will not be credited as the recovery is still possible.
Hence, the creation of provision for bad debts does not affect the balance of debtors
personal accounts. However, while showing sundry debtors in the Balance Sheet the
amount of such provision is subtracted therefrom.
When provision for bad debts already exists in the books, the provision created for
doubtful debts at the end of a particular year will be carried forward to the next year
and it will be used for meeting the loss due to bad debts incurred during the next year.
The provision for bad debts brought forward from the previous year is called ‘opening
provision’ or ‘old provision’. When such provision already exists, the loss due to bad
debts during the current year will be adjusted against the Same, and while making
provision for bad debts required at the end of the current year called ‘new provision’
the balance of old provision should also be taken into account. Let us take an example
and understand how these adjustments are done. Suppose old provision on January 1,
2018 was Rs. 1,000. The bad debts written off during 2018 amounted to Rs.600 and
the new provision required on December 31, 2018 is Rs. 1,500. In such a situation, the
Profit and Loss Account will be debited with Rs. 1,100 as calculated below:

Rs.
Existing Provision for Bad Debts 1,000
Less: Bad Debts 600
Surplus provision available 400
Provision required at the end of the year 1,500
Less: Surplus of old provision 400
Amount to be debited to Profit and Loss Account 1,100
71
Final Accounts The above aspects will be shown on the debit side of the Profit and Loss Account as
follows:
Profit and Loss Account of the year ended………
Dr. Cr.

Rs. Rs.
To Provision for Bad Debts
Bad Debts 600
Add: New Provision 1,500
2,100
Less: Old Provision 1,000 1,100

If however, the total of new provision and the actual bad debts are less than the old
provision, the details will be shown on the credit side of the Profit and Loss Account as
follows:
Profit and Loss Account for the year ended……….
Dr. Cr.

Rs. Rs.
By Provision for Bad Debts
Old Provision …….
Less: Bad Debts …….
Less: New Provision ….…

In this connection you should note the following points.

1. If some bad debts are given in adjustments (further bad debts) they should also be
taken into account.
2. The new provision should be calculated on sundry debtors after adjusting the
amount of further bad debts.
3. In Balance Sheet only the further bad debts as given in adjustments and the new
provision for bad debts should be subtracted from sundry debtors.
The following are the journal entries required when the provision for bad debts exists in
the books:
a) Forwriting off further bad debts given outside the Trial Balance:
Bad Debts A/c Dr.
To Sundry Debtors
b) For transferring the total bad debts to the provision for Bad DebtsAccount:
Provision for Bad debts A/c Dr.
To Bad Debts A/c
c) For debiting the Profit and Loss Account with the excess of the new pr’ the
total bad debts over the old provision:
72
 Profit and Loss Account A/c Dr. Final Accounts-II
To Provision for Bad Debts A/c
d) For crediting the Profit and Loss Account with excess of the old provision
over the total baddebts plus new provision:
Provision for Bad Debts A/c Dr.
To Profit and Loss A/c
Look at illustration 4 and see how bad debts and provision for bad debts are recorded
in the final Accounts.
Illustration 4
An extract from a Trader’s Trial Balance on December 31, 2018 is given below:

Name of the Account Dr. Cr.

Rs. Rs.
Sundry Debtors
Band Debts 64,000
Provision of Bad Debts 4,000 7,000

Adjustments:Write off further bad debts Rs. 2,000 and create a provision for doubtful
debts at 5% on debtors. Pass the necessary journal entries and show Bad Debts and
Provision for Bad Debts Accounts. Also show their treatment in the final accounts.
Journal

2018 Rs Rs.
Dec.31 Bad Debts A/c Dr. 2,000
To Sundry Debtors 2,000
(Being bad debts written off)
“ 31 Provision for Bad Debts A/c Dr. 6,000
To Bad Debts A/c 6,000
(Being bad debts transferred to
Provision for Bad Debts Account)
“ 31 Profit and Loss A/c Dr. 2,100
To Provision for Bad Debts A/c 2,100
(Being the Provision required for doubtful debts)

Bad Debts Account

2018 Rs. 2018 Rs.

Dec. 31 To Balance b/d 4,000 Dec. 31 By Prov. Fro Bad Debts 6,000
Dec. 31 To Sundry Debtors 2,000
6,000 6,000

73
Final Accounts Provision for Bad Debts Account

2018 Rs 2018 Rs.

Dec. 31 To Bad Debts A/c 6,000 Dec. 31 By Balance b/d 7,000
“ 31 To Balance c/d 3,100 By Profit and Loss A/c 2,100
9,100 2019 9,100
Jan. 1 By Balance b/d 3,100

Note : The new provision for bad debts has been calculated at 5% on Rs. 62,000
(sundry debtors Rs. 64,000 – further bad debts Rs. 2,000)
Profit and Loss Account
For the year ended December 31, 2018

Rs. Rs.
To Provision for Bad Debts
Bad Debts 4,000
Add : Further Bad Debts 2,000
Add : New Provision 3,100
9,100
Less : Old Provision 7,000 2,100

Balance Sheet
as at December 31, 2018

Rs. Rs.
Current Assets :
Sundry Debtors 64,000
Less : Further Bad Debts 2,000
62,000
Less : Provision Bad Debts 3,100 58,900

10.3.12 Provision for Discount on Debtors

You know cash discount is allowed to debtors as an incentive for prompt payment.
When the discount is allowed it is recorded through the Cash Book and posted to the
credit side of the concerned debtor’s personal accounts. But, in the case of debts
outstanding at the end of the current year, discounts will be allowed in the next year if
the debtors make prompt payments. So, as in the case of anticipated loss on account of
doubtful debts, a provision must be made for the discount likely to be allowed to the
debtors in the next year, such a provision is known as the ‘Provision for Discount on
Debtors’ it is also calculated as a percentage on the net sundry debtors (remaining after
subtracting the provision for bad debts and further bad debts). For example, if Sundry
Debtors amount to Rs. 40,000 and the firm wants to create a provision for bad debts
at 5% and a provision for discount at 2% on the debtors they will be calculated as
follows:
i) The Provision for bad debts will be calculated at 5% on Rs. 40,000. It will amount
to Rs. 2,000.
74
ii) The Provision for discount at 2% will be calculated on the debtors after subtracting Final Accounts-II
the provision for bad debts i.e., on Rs. 38,000 (Rs. 40,000— Rs. 2,000). It will
amount to Rs. 760.
Note that when both provision for bad debts and provision for discount on debtors are
to be calculated, the provision for bad debts is calculated first and then provision for
discount is worked out on debtors after subtracting the provision for bad debts.
The adjustment entry for provision for discount on debtors is as follows:
Profit and Loss A/c Dr.
To Provision for Discount on Debtors A/c
(Being the Provision made for discount on debtors)
The Provision for discount on debtors will be shown in the final accounts as follows:
i) On the debit side of Profit and Loss Account: shown as a separate item, and
ii) On the assets side of Balance Sheet: shown as a deduction from Sundry Debtors.
The balance of the provision for Discount on Debtors Account will be carried forward
to the next year and the discounts allowed if any, in the next year will be set off against
the provision for itself. The method of dealing with discounts allowed and provision for
discount on debtors in the next year is similar, to the method followed in case of bad
debts and provision for bad debts.

10.3.13 Provision for Discount on Creditors

When prompt payment is received we allow cash discount to debtors. Similarly, we
receive discount from the creditors when prompt payments are made by us. So the
expected gain on account of discounts receivable from creditors in the next year should
also be taken into account at the time of preparing the final accounts. Such a provision
is called ‘Provision for Discount on Creditors’.
It is calculated as a percentage on Sundry Creditors. The creation of such a provision,
however, goes against the Conservatism Concept. Hence, it is usually avoided in practice.
But you must learn how it is treated in final accounts if such a provision is required.
The adjustment entry for provision for discount on creditors is passed as follows:
Provision for Discount on Creditors A/c Dr.
To Profit and Loss Account
(Being the Provision made for discount on creditors)
The provision for discount on creditors will appear in the final accounts as follows:
i) On the credit side of Profit and Loss Account: shown as a separate item, and
ii) On the liabilities side of the Balance Sheet: shown as a deduction from Sundry
Creditors.
The balance of the Provision for Discount on Creditors Account will also be carried
forward to the next year and the discount received, if any, will be adjusted against the
provision itself.

10.3.14 Manager’s Commission

Sometimes, the manager may also be entitled to a commission on profits earned by the
business. Such commission is usually calculated as a fixed percentage on profits. Suppose 75
Final Accounts the Net Profit of a firm after taking into consideration all expenses except the manager’s
commission is Rs. 60,000 and the manager is entitled to a commission of 5% on profits
before charging such commission. His commission will work out as Rs. 3,000. However,
it is still to be paid and therefore should be treated as an outstanding expense. It will be
debited to Profit and Loss Account and also shown as a current liability in the Balance
Sheet.
In the above example, manager’s commission has been calculated on profits before
charging the commission. But, sometimes, it is to be calculated on profit after charging
such commission. In such a situation, the commission will be calculated by the following
formula:
Percentage of Commission

Percentage of Commission
 Net Profit before Commission
100 + Percentage of Commission

If, in the above example, the manager’s commission were to be calculated on profits
after charging such commission, it will be as follows.

5 5
 60,000   60,000  Rs. 2,857
100  5 105

The above amount can also be verified. After charging manager’s commission the Net
Profit will work out to Rs. 57,143 (Rs. 60,000—Rs. 2,857). Now calculate 5% on
Rs. 57,143. It works out to Rs. 2,857 which means the amount of commission calculated
by the given formula is correct.
10.3.15 Abnormal Loss of Stock
In the course of business some loss of stock may also occur. It may occur in transit or
at the godown. Such loss of stock may be normal or abnormal. Normal loss is due to
inherent characteristics of goods such as evaporation, subdivision, drying up of goods,
etc. On the other hand, if the loss occurs on account of reasons which are accidental or
very rare, the loss is termed as abnormal loss. The examples of such losses are theft of
goods, destruction of goods by fire, etc.
The abnormal loss does not require any special treatment in the books of account. It is
absorbed by the remaining units whose cost is inflated by such loss. But, the abnormal
loss has to be shown separately in the books of account. After the amount of such loss
is ascertained, the following adjustment entry is passed.
Loss by Fire A/c Dr.
To TradingAccount
(Being stock lost by fire)
To avoid the burden of loss due to abnormal circumstances the businessmen may get
the stock insured. Thus, the loss may be
1. Uninsured,
2. Fully insured, or
3 . Partially insured.
76
Let us see what will be the accounting treatment in the above three situations. Final Accounts-II

1. When the stock’s is not insured: In case the stock is not insured the total abnormal
loss will be transferred to the Profit and Loss Account and the following entry will
be passed.
Profit and Loss A/c Dr
To Loss by Fire A/c
2 When the stock Isfully Insured: When the stock is fully insured, the total amount of
loss is paid by the insurance company. In that case the company does not suffer fly
loss.
So, nothing is debited to the Profit and Loss Account. The journal entry passed is
as follows.
Insurance Company Dr.
To Loss by Fire A/c
3. When the loss is partially insured: In case the loss is partially insured the amount of
insurance claim is debited to Insurance Company’s Account and the remaining
loss (the amount to be borne by the business) is debited to Profit and Loss Account.
The following journal entry is passed.
Insurance Company Dr.
Profit and Loss A/c Dr.
ToAbnormal Loss A/c
Thus, the treatment of abnormal loss in final accounts is as follows.
a) Credit the Trading Account with the total loss.
b) i) In case of uninsured stock debit Profit and Loss Account with full amount.
ii) In case of fully insured loss, insurance claim will be shown as an asset in the
Balance Sheet.
iii) In case of partially insured loss, the amount of insurance claim is shown as an
asset in the Balance Sheet and the remaining amount of loss is debited to the
Profit and Loss Account.
Look at illustration 5 and see how abnormal loss is treated in the books of account.
Illustration 5
On December 30, 2018 the stock worth Rs. 40,000 was destroyed by fire. The stock
was insured and the insurance company admitted a claim of Rs. 30,000 only. Pass the
necessary journal entries and show how it will be treated in final accounts.
Journal

Date Particulars Dr. Cr.

Amount Amount

2018 Loss by Fire A/c Dr. 40,000

Dec.31 To TradingA/c
(Being stock lost by fire) Rs. 40,000

77
Final Accounts “ 31 Insurance Company Dr. 30,000
Profit and Loss A/c Dr. 10,000
To Lossby Fire A/c 40,000

Trading Account
For the year ended December 31, 2018
Dr. Cr.

Rs.
By Loss of Fire 40,000

Profit and Loss Account

For the year ending December 31, 2018
Dr. Cr.

Rs. Rs.
To Loss by fire 40,000
Less: Insurance claim 30,000 10,000

Balance Sheet
As at December 31, 2018
For the year ending December 31, 2018
Dr. Cr.

. Rs.
Current Assets:
Claim due from insurance company 30,000

10.3.16 Drawing of Goods by the Proprietor

You know when the proprietor takes away some goods from the business for his personal
use it is recorded in books of account by passing the following journal entry.
Drawings Account Dr.
To Purchases Account
So, if you find that it has not been recorded in the books of account, you have to make
the necessary adjustment in final accounts. The treatment in final accounts will be as
follows:
i) On the Debit side of the Trading Account: Deduct it from Purchases.
ii) On the Liabilities side of the Balance Sheet: Deduct it from capital either as a
separate item or by including it in drawings.
Check Your Progress B
1. Why do you create a provision for bad debts?
......................................................................................................................
......................................................................................................................
......................................................................................................................
78
2. Why provision for discount on creditors is regarded against the Conservatism Final Accounts-II
Concept?
......................................................................................................................
......................................................................................................................
......................................................................................................................
3. The Trial Balance shows the following balances.
Rs.
Debtors 20,000
Bad Debts 100
Provision for had Debts 200
Adjustments:
a) Bad Debts of Rs. 200 not yet written off.
b) Create a provision for Doubtful Debts at 5% on Debtors
c) Discount on Debtors is to be provided at 2%.
Calculate the provision for Bad Debts and provision for Discount on Debtors.
4. Stock worth Rs. 20,000 was lost by fire. Insurance claim was admitted for
three-fourth of the value of goods lost. What amount you will (1) credit to the
Trading A/c, (ii) debit to the Profit & Loss A/c, and (iii) show on the asset side of
the Balance Sheet.

10.4 PREPARATION OF FINAL ACCOUNTS WITH

ADJUSTMENTS
You know there are various items which require adjustment at the time of preparing the
final accounts. You have learnt how each adjustment is recorded in books through a
journal entry and how it is reflected in the final accounts. However, while preparing the
final accounts with adjustments you should remember that there is no need to pass the
journal entries for any adjustment unless specifically asked to do so. All adjustments
must be shown directly in the final accounts. Look at illustration 6 and 7 and see how
final accounts are prepared with adjustments.
Illustration 6
From the following Trial Balance of Gupta & Sons, prepare Trading and Profit and
Loss Account for the year ended December 31, 2018 and a Balance Sheet as on that
date.
Trial Balance

Name of the Account Debit Balances Credit Balances

Rs. Rs.
Capital 5,00,000
Sales 10,00,000
Sales Returns 25,000
79
Final Accounts Purchases 5,00,000
Purchases Returns 15,000
Inventory as on 1.1.18 60,000
Land & Buildings 4,00,000
Plant & Machinery 3,00,000
Furniture 1,00,000
Wages 50,000 -
Carriage Inwards 10,000
Provision for Bad Debts 7,000
Carriage Outwards 5,000
Cartage 5,000
Salaries 40,000
Loan 2,60,000
Debtors 1,50,000
Creditors 70,000
Rent 8,000
Bills Receivable 40,000
Acceptances 10,000
General Expenses 20,000
Rent & Rates 10,000
Investments 50,000
Cash in hand 50,000
Bank Overdraft 10,000
Discount 4,500
Bad Debts 5,000 -
Interest on Investments 5,000
Interest on Bank Overdraft 500
Goodwill 60,000

Total 18,85,000 18,85,000

Additional Information
1. The value of inventory on December 31, 2018 was Rs. 1,00,000.
2. Depreciation is to be provided on: Land & Building @ 5% p.a. Furniture @ 10%
p.a. Plant & Machinery Rs. 50,000.
3. Provision for Bad Debts is to be maintained @ 5% on debtors.
4 Wages are outstanding to the extent of Rs. 4,000 and Salaries to the extent of Rs.
3,000.
5. Rent and Rates are prepaid to the extent of 1/4th of the amount paid.
6. Interest on Investment outstanding is Rs. 1,000.
7. Rent to the extent of Rs. 2,000 has been received in advance.

80
 Final Accounts-II
Solution:
Trading & Profit and Loss Account
for the year ended December 31, 2018
Dr. Cr.

Particulars Amount Particulars Amount

Rs. Rs.
To Inventory as on 1.1.18 60,000
To Purchases 5,00,000 By Sales 10,00,000
Less: Purchases Returns 15,000 4,85,000 Less: Sales Returns 25,000 9,75,000
To Wages 50,000 By Inventory as on 31.12.18 1,00,000
Add: Wages Outstanding 4,000 54,000
To Carriage Inwards 10,000
To Cartage 5,000
To Gross Profit c/d 4,61,000 .
10,75,000 10,75,000
To Carriage Outwards 5,000 By Gross Profit b/d 4,61,000
To Salaries 40,000 By Rent 8,000
Add: Outstanding 3,000 43,000 Less: Received in advance 2,000 6,000
To General Expenses 20,000
By Interest on Investment 5,000
To Rent & Rates 10,000 Add: Outstanding 1,000 6,000
Less: Prepaid 2,500 7,500

To Discount Allowed 4,500

To Bad Debts 5,000 .
Add: New Provision 7,500
12,500
Less: Old Provision 7,000 5,500
To Depreciation on Plant
& Machinery 50,000
To Interest on Overdraft 500
To Depreciation
Land & Building 20,000
Furniture 10,000 30,000
To Net Profit (Transferred to
Capital A/c) 3,07,000

4,73,000 4,73,000

Balance Sheet as on December 31, 2018

Liabilities Amount Assets Amount

Rs. Rs.
Capital Fixed Assets
Balance 5,00,000 Goodwill 60,000
Add: Net Profit 3,07,000 8,07,000 Land & Building 4,00,000
Less: Depreciation 20,000 3,80,000 81
Final Accounts
Long Term Liabilities
Loan 2,60,000 Plant & Machinery 3,00,000
Less: Depreciation 50,000 2,50,000
Current Liabilities
Creditors 70,000 Furniture 1,00,000
Acceptances 10,000 Less: Depreciation 10,000 90,000
Bank Overdraft 10,000 Investments
Wages Outstanding 4,000 Current Assets
Salaries Outstanding 3,000 Cash in hand 50,000
Rent Received in Advance 2,000 Debtors 1,50,000
Less: Provision for
Bad Debts 7,500 1,42,500
Bills Receivable 40,000
Closing Stock 1,00,000
Prepaid Rent & Rates 2,500
Interest on Investment
Outstanding 1,000
11,66,000 11,66,000
Illustration 7
From the following balances extracted from the book of Aristo Ltd., prepare a Trading
and Profit and Loss Account for the year ended December 31, 2018 and a Balance
Sheet as on that date.
Trial Balance

Name of the Account Debit Balances Credit Balances

Rs. Rs.

Capital 2,00,000
Sales 5,00,000
Sales Returns 10,000
Purchases 2,40,000
Purchases Returns 10,000
Stock on 1.1.2018 40,000
Land & Buildings 2,00,000
Plant & Machinery 1,00,000
Wages 25,000
Furniture 50,000
Provision for Bad Debts 5,000
Salaries 25,000
Debtors 82,000
Creditors 1,00,000
Bad Debts 3,000
Bills Payable 30,000
82
Investments 50,000 Final Accounts-II
General Expenses 20,000
Cash in hand 5,000
Cash at bank 15,000
Depredation on Land & Buildings 20,000

8,45,000 8,45,000

Additional Information
1. The inventory on 31.12.18 has been valued at Rs. 80,000. The inventory of the
value of Rs 20,000 was destroyed by fire on 1.12.18 and a claim of Rs. 15,000
was admitted by the insurance company.
2 Depreciation is to be provided on Plant & Machinery and furniture at 10% per
annum.
3. Debtors are bad to the extent of Rs. 2,000. Provision for bad debts is to be
made at 5% on debtors and a provision for discount on debtors at 2%.
4. Wages for outstanding to the extent of Rs. 5,000.
5. Salaries are prepaid to the extent of Rs. 2,000.
6. Create a provision for discount on creditors at the rate of 1%.
7 Create a provision for repairs to the extent of Rs. 4,000.

Trading & Profit and Loss Account for the year ended December 31, 2018

Particulars Amount Particulars Amount

Rs. Rs.
To Opening Stock 40,000 By Sales 5,00,000
Less: Sales Returns 10,000 4,90,000
To Purchases 2,00,000
By Closing Stock 80,000
Less: Purchases Returns 10,000 1,90,000
To Wages 25,000 By Loss by Fire 20,000
Add: Outstanding 5,000 30,000
To Gross Profit c/d 3,30,000
5,90,000 5,90,000

To Salaries 25,000
Less: Prepaid 2,000 23,000 By Gross Profit b/d 3,30,000
By Provision for
Discount on Creditors 1,000
To Bad Debts 3,000
Add: Further Bad Debts 2,000 .
Add: New Provision 4,000
9,000
Less: Old Provision 5,000 4,000
To General Expenses 20,000
To Depreciation on Land & Buildings 20,000
To Loss by Fire 5,000 83
Final Accounts

To Depreciation on Plant & Machinery 10,000

To Depreciation on Furniture 5,000
To Provision for Discount on Debtors 1,520
To Provision for Repairs 4,000
To Net Profit (Transferred to
Balance Sheet) 2,38,480
. 3,31,000 3,31,000

Balance Sheet as on December 31, 2018

Particulars Amount Particulars Amount

Rs. Rs.
Capital 2,00,000 Land & Buildings 2,00,000
Add: Net Profit 2,38,480 Plant & Machinery 1,00,000
4,38,480 Less: Depreciation 10,000 90,000
Creditors 1,00,000 Furniture 50,000
Less: Provision for Discount 1,000 99,000 Less: Depreciation 5,000 45,000
Bills Payable 30,000 Investments 50,000
Wages Outstanding 5,000 Cash in Hand 5,000
Provision for Repairs 4,000 Cash at Bank 15,000
Closing Stock 80,000
Debtors 82,000
Less: Further Bad Debts 2,000
Less: Provision for Bad 80,000
Debts @ 5% 4,000
76,000
Less: Provision for
Discount 1,520 74,480
Insurance Claim Outstandings 15,000
Salaries Prepaid 2,000
5,76,480 5,76,480

Notes: 1. Depreciation on Land & Buildings is given in the Trial Balance. Hence, it
is shown in the Profit and Loss Account only.
2 . Provision for Bad Debts has been calculated at 5% on debtors after
subtracting further bad debts.
3. Provision for Discount on Debtors has been calculated at 2% on debtors
after subtracting further bad debts as well as provision for bad debts.
4. Loss by fire has been charged to Profit and Loss Account after taking
into consideration the claim from insurance company.

84
 Final Accounts-II
10.5 ADJUSTMENTS GIVEN IN TRIAL BALANCE
You know that the adjustments are usually given outside the Trial Balance and they are
shown at two places in the final accounts. But, sometimes a few adjustment items
appear in the Trial Balance itself. In illustration 7 you noticed it in respect of depreciation
on Land & Buildings. It is possible that items like outstanding or prepaid insurance also
appear in the Trial Balance. This happens when the journal entry in respect of an
adjustment has already been passed and the same has been posted into the concerned
ledger accounts. For example, when you pass journal entry for the adjustment for
outstanding salaries, you will debit Salaries Account and credit Salaries Outstanding
Account. The Salaries Account already exists in the ledger and the amount of outstanding
salaries is also posted thereto. This leads to an increased balance in Salaries Account.
But the Salaries Outstanding Account does not exist in the ledger. This will have to be
opened and the outstanding amount credited thereto. When the Trial Balance is prepared,
it will show the increased balance of Salaries Account in the debit balances column and
the balance of Sal:- vies Outstanding Account in the credit balances column. Now the
question arises how to treat it in the final accounts. In such a situation, you will simply
show Salaries Outstanding in the liabilities. No addition will be made to salaries in the
Profit and Loss Account because salaries given in Trial Balance already include this
amount. Thus, when salaries outstanding appear in the Trial Balance it is shown in final
accounts only at one place. This applies to all items of adjustments when they are
included in the Trial Balance.
In actual practice all adjustment items with the exception of closing stock are invariably
incorporated in the Trial Balance before preparing the final accounts. The Trial Balance
so prepared is called ‘Final Trial Balance’ or ‘Adjusted Trial Balance’.
Look at Chart 10.1 and note how each item of adjustment is treated in final accounts.
(i) if it is given outside the Trial Balance, and (ii) if it appears in the Trial Balance itself.

Chart 10.1
Treatment of Adjustment Items in Final Accounts

[Link]. Item Treatment In Final Accounts

If given in Adjustments If given in Trial Balance

1. Closing Stock i) Credit side of Trading A/c : Assets side of Balance Sheet
Shown as a separate item only
ii) Assets side of
Balance Sheet :
Shown as a separate
item under Current
Assets

2 Outstanding Expenses i) Debit side of Trading Liabilities side of Balance Sheet

A/c or Profit and Loss only.
A/c: Added to the concerned
expense
ii) Liabilities side of
Balance Sheet. Shown
as a separate item under Current
Liabilities 85
Final Accounts

3. Prepaid Expenses i) Debit side of Profit and Loss A/c: Assets side of Balance Sheet
Deducted from the concerned only.
expense
ii) Assets side of Balance Sheet:
Shown as a separate item under
Current Assets

4. Outstanding incomes i) Credit side of Profit and Loss A/c: Assets side of Balance Sheet
Added to the concerned income only.
ii) Asset side of Balance Sheet:
Shown as a separate item under
Current Assets

5. Income Received in i) Credit side of Profit and Loss A/c: Liabilities side of Balance Sheet
Advance Deducted from concerned income only.
ii) Liabilities side of Balance
Sheet. Shown as a separate
item under Current Liabilities

6. Depreciation i) Debit side of Profit and Loss A/c: Debit side of Trading & Profit
Shown as a separate item and Loss Account only.
ii) Assets side of Balance Sheet:
Deducted from the concerned
fixed asset

7. Interest on Capital i) Debit side of Profit and Loss A/c: Debit side of Profit and Loss
Shown as a separate item Account only.
ii) Liabilities side of Balance Sheet:
Added to Capital

8. Interest on Drawings i) Credit side of Profit and Loss Credit side of Profit and Loss
A/c: Shown as a separate item Account only.
ii) Liabilities side of Balance Sheet:
Deducted from Capital

9. Interest on Loan i) Debit side of Profit Debit side of Profit and Loss
and Loss A/c: Shown Account only.
as a separate item
ii) Liabilities side of
Balance Sheet: Added to Loan.

10. Bad Debts i) Debit side of Profit and Loss A/c: Debit side of Profit and Loss
Added to Bad Debts Account only.
ii) Assets side of Balance Sheet:
Deducted from Sundry Debtors

11. Provision for bad debts i) Debit side of Profit and Loss Deduct from sundry debtors
A/c: shown as a separate item assuming it is a closing balance.
ii) Assets side of Balance Sheet:
Deducted from Sundry Debtors

86
 Final Accounts-II
12. Provision for Discount i) Debit side of Profit and Loss A/c: Debit side of Profit and Loss
on Debtors Shown as a separate item Account only.
ii) Assets side of Balance Sheet:
Deducted from Sundry Debtors

13. Provision for Discount i) Credit side of Profit and Loss A/c: Credit side of Profit and
on Creditors Shown as a separate item Loss Account only.
ii) Liabilities side of Balance Sheet:
Deducted from Sundry Creditors

14. Manager’s Commission i) Debit side of Profit and Loss A/c: Liabilities side of Balance
Shown as a separate item Sheet only.
ii) Liabilities side of Balance Sheet:
Shown as a separate item

15. Abnormal Loss i) Credit side of Trading A/c: Debit side of Profit and
Shown as a separate item with Loss Account only.
full amount of loss
ii) Debit Profit & Loss A/c with the
uncovered Loss
iii) Insurance claim will be shown on
Assets side of Balance Sheet
under Current Assets

16. Drawing of Goods i) Debit side of Trading A/c: Deduct from Capital.
by the Proprietor Deducted from purchases
ii) Liabilities side of Balance Sheet:
Deducted from capital

Illustration 8
From the following Trial Balance of Pitam Stores prepare Trading and profit and Loss
Account for the year ended December 31, 2018 and the Balance Sheet as on that
date.
Trial Balance

Account Debit Balances Credit Balances

Rs. Rs.
Capital 60,000
Drawings 5,000
Purchases 1,00,000
Sales 2,10,000
Opening Stock 20,000
Wages 15,000
Wages Outstanding 5,000
Carriage Inwards 2,000
Salaries 13,000
Insurance 1,500 87
Final Accounts Insurance Prepaid 1,500
Income from Investments 30,000
Accrued Income from Investments 10,000
Machinery 50,000
Buildings 95,000
Cash in hand 2,000
Debtors 35,000
Creditors 60,000
Depreciation on Buildings 5,000
Rent 10,000
3,65,000 3,65,000

Additional Information : The value of stock on December 31, 2018 was Rs. 40,000.
Solution:
Trading and Profit and Loss Account for the year ended December 31, 2018

Particulars Amount Particulars Amount

Rs. Rs.
To Opening Stock 20,000 By Sales 2,10,000
To Purchases 1,00,000 By Closing Stock 40,000
To Wages 15,000
To Carriage Inwards 2,000
To Gross Profit c/d 1,13,000
2,50,000 2,50,000
To Salaries 13,000 By Gross Profit b/d 1,13,000
To Insurance 1,500 By Income from
To Rent 10,000 Investments 30,000
To Depreciation on Building 5,000
To Net Profit
(Transferred to Capital A/c) 1,13,500

1,43000 1,43,000

88
 Balance Sheet as on December 31, 2018 Final Accounts-II

Dr Cr.

Liabilities Amount Assets Amount

Rs. Rs.
Capital 60,000 Building 95,000
Add: Net Profit 1,13,500 Machinery 50,000
1,73,500 Closing Stock 40,000
Less: Drawings 5,000 1,68,500 Debtors 35,000
Creditors 60,000 Cash in Hand 2,000
Wages Outstanding 5,000 Insurance Prepaid 1,500
Accrued Income 10,000
from Investments

2,33,500 2,33,500

10.6 LET US SUM UP

At the time of preparing the final accounts a number of items need adjustments. It is
because certain expenses may relate to two or more accounting years or certain expenses
incurred during the current year may still remain to be paid. Unless Such adjustments
are made, the final accounts will not reveal the true picture. Such items are usually
given outside the Trial Balance and are shown at two places in the final accounts so as
to complete the double entry.
Adjustment entries can be passed in the journal for each item of adjustment. But, normally
they are directly adjusted in the final accounts. In practice the adjustment entries are
always passed for such items and a revised Trial Balance called ‘Adjusted Trial Balance’
or ‘Final Trial Balance’ is prepared. In such a situation, the adjustments will appear in
the Trial Balance itself. Any item of adjustment which appears in the Trial Balance is
shown only at one place in the final accounts.

10.7 KEY WORDS

Abnormal Loss: Loss caused by abnormal causes.
Adjustment Entry: Journal entry passed to make an adjustment in the relevant accounts.
Adjustment Item: An item given outside the Trial Balance which requires adjustment
at the time of preparing final accounts.
Adjusted Purchases: Amount of purchases after adjusting both the opening and closing
stocks.
Adjusted Trial Balance: Trial balance prepared after incorporating various adjustments.
Depreciation: A permanent decrease in the value of a fixed asset caused by wear and
tear or the passage of time.
Doubtful Debts: Debts of doubtful recovery.
Outstanding Expenses: Expenses incurred during the accounting year but not yet
paid. 89
Final Accounts Outstanding Incomes: Incomes earned during the accounting year but not yet received.
Prepaid Expenses: Expenses paid but the benefit of which is yet to be received.
Unearned Income: Income in respect of which the services are yet to be rendered

10.8 SOME USEFUL BOOKS

Maheshwari, S.N., 2018. Introduction to Accounting, VikasPublishing House: New
Delhi.
Patil, V.A. and J.S. Korlahalli, 2018. Principles and Practice of Accounting, R. Chand
& Co., New Delhi.
William Pickles. 1992. Accountancy, [Link].S. and Pitman, London.
Gupta, R.L. and M. Radhaswamy, 2018. Advanced Accountancy, Sultan Chand &
Sons, New Delhi.
Shukla, M.C. and T.S. Grewal, 2018. AdvancedAccountancy, S. Chand & Co., New
Delhi.

10.9 ANSWERS TO CHECK YOUR PROGRESS

A 1. i) dual ii) asset iii) unexpired iv) liabilityv) Depreciation vi) subtracted
2. i) False ii) True iii) False iv) True v) False
B 3. Provision for Bad Debts Rs. 990
Provision for Discount on Debtors Rs. 376.20
4. i) Rs. 20,000 ii) Rs. 5,000 iii) Rs. 15,000

10.10 TERMINAL QUESTIONS/EXERCISES

Questions
1. Why some adjustments become necessary at the time of preparing the final
accounts? Name any two items of adjustment and explain how they are shown in
the final accounts?
2. Distinguish between:
a) Outstanding Expenses and Unexpired Expenses
b) Provision for Discount on Debtors and Provision for Discount on Creditors
c) Normal Loss and Abnormal Loss
Exercises
1. Give journal entries for the following adjustments:
i) Interest received in advance Rs. 600
ii) Interest on drawings Rs. 1,200
iii) Provision for discount on creditors Rs. 200
iv) Loss of goods by theft Rs. 8,500
90 v) Drawings of goods by the proprietor Rs. 750
2. The following information is extracted from the books of a businessman: Final Accounts-II

Debtors as on 31.12.2018 Rs. 25,000

Bad Debts during 2018 Rs. 1,000
Provision for Bad Debts is to be maintained at 5% of debtors.
A Provision for discount on debtors is also to be made at 2%. You are required
to calculate the amounts to be set aside in respect of provision for bad debts and
provision for discount on debtors respectively.
(Answer: Provision for Bad Debts Rs. 1,250; Provision for Discount on Debtors
Rs. 475)
3. The Proprietor withdrew the following amounts during the year ended
December 31, 2018. Rs.
Feb. 28 4,000
May 1 6,000
Aug. 31 5,000
Nov. 1 2,000
Dec. 1 1,000
Calculate interest on drawings if the rate is 6% per annum.
(Answer: Rs. 565)
4. From the following Trial Balance of Puri & Sons as on June 30, 2018, prepare
Trading and Profit and Loss Account and the Balance Sheet.
Trial Balance

Name at the Account Debit Credit

Rs. Rs.
Capital 1,00,000
Drawings 5,000
Purchases less returns 2,00,000
Sales less Returns 5,00,000
Inventory (beginning) 50,000
Wages 20,000
Carriage Inwards 3,000
Salaries 25,000
Freight 2,000
Trade Expenses 5,000
Rent 20,000
Packing Charges 2,000
Land & Buildings 2,00,000
Plant & Machinery 2,50,000
91
Final Accounts Furniture 50,000
Bad Debts 5,000
Debtors 75,000
Creditors 80,000
Cash in hand & at bank 5,000
Bills Receivable 3,000
Loan 2,00,000

Total 9,00,000 9,00,000

Additional Information :
i) Inventory (ending): Rs.. 30,000.
ii) Depreciation is to be provided as follows:
Land&building @ 5%p.a.
Plant & Machinery @ 4% p.a.
Furniture @ 10% p.a.
iii) Debtors are bad to the extent of Rs. 5,000
iv) Salaries are outstanding to the extent of Rs. 5,000.
v) Wages are prepaid to the extent of Rs. 2,000.
vi) Rent received in advance Rs. 3,000.
(Answer: Gross Profit Rs. 2,57,000; Net Profit Rs. 2,02,000; Balance Sheet total
Rs. 5,85,000)
5. From the following Trial Balance of Kawatra stores, prepare Trading and
Profit and Loss Account for the year ended December 31, 2018, and a Balance
Sheet as on that date.
Trial Balance

Name at the Account Debit Credit

Capital
Drawings 20,000
Purchases 4,00,000
Purchases Returns 10,000
Sales 7,00,000
Sales Returns 20,000
Inventory (beginning) 1,00,000
Land & Building 3,00,000
Plant & Machinery 1,50,000
Goodwill 50,000
Trade Marks 30,000
Wages. 40,000
Trade Expenses 20,000
Furniture 50,000
Provision for Bad Debts 10,000
92 Debtors 1,07,000
Bad Debts 3,000 Final Accounts-II
Salaries 60,000
Creditors 1,00,000
Acceptances 80,000
Investments 10,000
Rent 15,000
Distribution Expenses 5,000
Cash in hand and at bank 10,000
Depreciation on Furniture 10,000

Total 4,00,000 4,00,000

Additional information:-
i) The inventory on December 31, 2018 was valued at Rs. 1,50,000. Inventory of
the value Rs. 10,000 was destroyed by fire on 1.12.2018. It was fully insured
and a claim of Rs. 10,000 was admitted by the insurance company.
ii) Depreciation is to be provided on the following assets:
Land & Buildings @ 5% p.a.
Plant &Machinery @ 12½% p.a.
iii) Debtors are bad to the extent of Rs. 2,000. Provision of 5% on debtors is to be
created in respect of bad debts and a provision for discount on debtors is to be
created at 2% of debtors.
iv) Wages are outstanding to the extent of Rs. 10,000.
v) Rent is prepaid to the extent of Rs. 5,000.
vi) The general manager is to be provided a commission of 2% on net profits before
charging such commission.
(Answer: Gross Profit Rs. 3,00,000; Net Profit Rs. 1,55,887;
Balance Sheet total Rs. 8,29,005)
6. From the following Trial Balance of V. Ramana, prepare his final accounts for
the year ended December 31, 2018

93
Final Accounts
Name of the Account Dr. Cr.

Rs. Rs.
Capital 70,000
Drawings 10,000 2,95,000
Adjusted Purchases 2,32,500 2,95,000
Sales
Cash in hand 3,800
Cash at bank 12,800
Salaries 18,000
Freight 1,200
Advertising 800
General Expenses 5,400
Furniture 10,800
Expenses Outstanding 2,500
Depreciation 2,200
Building 39,000
Discount 700
Insurance 600
Prepaid Insurance 300
Rent Received 6,000
Rent Received in Advance 3,000
Trade Debtors 14,100
Trade Creditors 24,000
Loss by Fire 2,000
Commission 1,500
Stock on December 31, 2017 49,200 4,03,000
Total 4,03,000 4,03,000

7. The Trial Balance of S Karim as on December 31, 2018

Name of the Account Dr. Cr.

Rs. Rs.
Capital 1,10,000
Drawings 15,000
Gross Profit earned during 2018 32,000
Salaries and Wages 22,000
Rent and Taxes 8,400
Cash in hand 2,300
Bank Overdraft 8,600
Sundry Debtors and Creditors 36,000
Insurance (including premium of 41,000
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 Rs.400 per annum paid upto 1,000 Final Accounts-II
March 31, 2018) 5,000
Loose Tools 500 800
Bad Debts
Provision for Bad Debts 300
Entertainment Expenses 2,100
Commission 2,600
General Charges 12,000
Furniture and Fixtures 60,000
Plant and Machinery 19,800
Stock on December 31, 2017
1,89,000 1,89,000

Prepare the Profit and Loss Account for the year ending December 31, 2018 and the
Balance Sheet as on that date.
(Answer : Net Loss Rs. 11,100: Balance Sheet total Rs. 1,30,500

Note: These questions will help you to understand the unit better. Try to write
answers for them. But do not submit your answers to the University.
These are for your practice only.

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