Fundamentals of

Accounting UNIT 3 FINANCIAL STATEMENTS

Structure
3.0 Objectives
3.1 Introduction
3.2 Natural of Financial Statements
3.3 Contents of Financial Statements
3.3.1 Manufacturing Account
3.3.2 Trading Account
3.3.3 Profit and Loss Account
3.3.4 Profit and Loss Appropriation Account
3.3.5 Balance Sheet
3.4 Concept of Capital and Revenue
3.5 Revenue Recognition
3.5.1 Revenue Recognition in Case of Sale of Goods
3.5.2 Revenue Recognition in Case of Rendering of Services
3.6 Format of Financial Statements – Non-corporate Entities
3.6.1 Conventional Format
3.6.2 Vertical Format
3.7 Corporate Financial Statements
3.7.1 Items Peculiar to Corporate Balance Sheet
3.7.2 Items Peculiar to Corporate Income Statement
3.8 Requirements for Corporate Financial Statements as per Schedule VI
3.9 Basic Principles Governing the Preparation of Financial Statements
3.10 Preparation of Corporate Financial Statements
3.11 Let Us Sum Up
3.12 Key Words
3.13 Terminal Questions

3.0 OBJECTIVES
After studying this unit you should be able to:
l state the nature and contents of financial statements;
l know the differences between capital and revenue;
l know the prepration of non-corporate financial statements;
l be acquainted with the items peculiar to corporate financial statements; and
l prepare the profit and loss account and the balance sheet of a company as per the
requirements of the Companies Act.

3.1 INTRODUCTION
Accounting involves the collection, recording, classification and presentation of
financial data for the benefit of management and external agencies. For this purpose,
the transactions recorded in the books of accounts are periodically summarised and
presented in the form of two financial statements. One is the Balance Sheet or
64 Positional Statement and the other is Profit and Loss Account or Income Statement.
These are periodical reports which reflect the financial position and operating results Financial Statements
of the entire business for an accounting period, generally one year. These financial
statements are the basis for decision making by the management as well as outsiders.
However, the information presented in these statements must be analysed and
interpreted carefully before drawing conlcusions. In this unit we shall study the
preparation of financial statements both corporate and non-corporate entities as well
as the salient points involved in the preparation of these statements in the light of
Sections 210 to 223 and Part I and II of Schedule VI of the Companies Act, 1956.

3.2 NATURE OF FINANCIAL STATEMENTS

Financial Statements are prepared by all forms of business organizations to ascertain
the result of operating, financial and investment activities and to know the financial
position on the date of closing of books of accounts. In case of sole trade or a
partnership firm, maintenance and preparation of financial statements is not
mandatory but desirable. However, in case of Joint Stock Company, Sections 209 and
210 of the Companies’ Act 1956 make it obligatory and compulsory to maintain and
prepare financial statements by the end of each accounting period. Thus, main
objective of financial statements is to serve the information needs of users of
accounting information. These financial statements are the basis for decision making
by the management as well as to the outsiders like investors and share holders,
creditors and Financiers, government authorities, etc.

Objectives of Financial Statements

The primary objective of financial statement is to assist in decision making.
These statements enable the users:
i) To make rational investment, credit and similar other financial decisions.
ii) To estimate future cash flow and bankruptcy risk assessment.
iii) To ascertain NAV (Net Assets Value) or Net worth of the enterprise after
evaluating the value of assets, resources owned and the claims thereon
(liabilities) in order to make share purchase and sale decisions, takeovers and
merger decisions.
iv) Collective bargaining decision relating to wages, working conditions and job security.
v) To make assessment of economic and financial decisions.
(vi) To form appropriate taxation and subsidy policy, regulatory policy and
employment policy.
Besides, the financial statements are tools of judging earning capacity and managerial
efficiency to facilitate comparison and help evaluate its own performance. Thus, these
provide necessary inputs for forecasting and other relevant decision-making purposes.
According to American Institute of Certified Public Accountants “Financial
statements are prepared for the purpose of presenting periodical review or report on
progress by management and deal with the status of the investment in the business and
the results achieved during the period under review. Financial statements reflect a
combination of recorded facts, accounting-conventions and the personal judgment
and the judgments and conventions applied affect them materially. The soundness of
the judgments necessarily depends on the competence and integrity of those who make
them and on their adherence to generally accepted accounting principles and
conventions.
Hence, these financial statements must give sufficient analysis of the figures, without
unnecessary details to enable the users to understand its financial implications. This
calls forth for “convention of materiality” i.e. every material fact has to be disclosed 65
Fundamentals of which affect the decisions of the users of financial statements. It also demands that
Accounting any departure from previous year’s practice should clearly be indicated. In other
words the “convention of consistency” should strictly be adhered to. An enterprise has
to be consistent with reference to depreciation policy, inventory valuation policy and
other policy to facilitate horizonal and vertical comparison. Financial statements are
based on fundamental accounting assumptions of “going concern”, “consistency” and
accrual and are guided by major considerations governing the selection and
application of accounting policies.

3.3 CONTENTS OF FINANCIAL STATEMENTS

3.3.1 Manufacturing Account

Business concerns engaged in the activities of manufacturing or production of goods
which involves purchase of raw materials and in incurring of other manufacturing
expenses, prepare Manufacturing Account which shows the cost of raw materials
consumed, cost of conversion of raw materials into finished product and the cost of
goods produced. The cost of goods produced charged to Trading Account. The cost of
conversion includes–Direct Expenses, Frieght or Carriage Inward, direct labour.
Productive wages/Factory wages and factory expenses, such as factory rent, fuel,
power and gas, etc.
Cost of goods produced = Raw materials consumed + Cost of conversion
If, however, there is opening and closing work in progress due adjustment is made
accordingly. Similarly, value of material residue, which is sold as scrap, is credited to
Manufacturing Account.
Thus, we can say
Cost of goods produced = opening work-in-progress = cost of raw materials
consumed + cost of conversion – closing work in
progress – sale of scrap

Points to note regarding Manufacturing Account

1) Work in progress: It refers to the value of incomplete or semi-finished goods
which includes cost of raw materials, and proportionate wages and direct ex-
pense incurred till this stage of semi completion. Opening and closing balances of
the same are shown to the debit and credit side respectively.
2) Raw materials consumed: This shows the cost of materials used in the produc-
tion process. This is arrived at by Adding the net purchases to the opening
balance of raw materials and deducting the closing balance of raw materials at
hand by the end of accounting period.
3) Direct expenses: These expenses are incurred either on procurement or pur-
chases of raw materials and on conversion thereof into finished product. It
includes productive wages, freight inward, cartage or carriage inward, etc. That
is, it includes direct labour and direct expenses (factory).
4) Factory overheads or indirect expenses: Factory overheads refer to indirect
material, indirect labour and indirect expenses. These include cotton waste,
lubricating of machine oil, works manager, supervisor or foreman’s salary, fuel
and power, repairs and maintenance of factory machine, depreciation of factory
assets, rent, rates and taxes of the factory building, factory insurance, etc.
5) Scrap: It denotes the value of material residue coming out of certain types of
processes. It is sold as scrap and credited to Manufacturing Account to arrive at
66 the correct cost of production.
6) Cost of production: Manufacturing Account ascertains the cost of goods Financial Statements
manufactured during any accounting period as shown in the format of Manufac-
turing Account. The cost of production of goods produced is transferred to
Trading Account.

3.3.2 Trading Account

Trading Account is prepared to know the result of trading operations. It shows the
gross profit or gross loss arising from buying and selling of goods in which the
business enterprise deals in. Gross profit or gross loss is the difference between ‘sales’
and ‘cost of goods sold’.
Cost of goods sold = opening stock + purchases (less returns) + direct
expenses – closing stock
It is to be noted that Trading Account shows the result of trading operations under
normal conditions only. Abnormal losses (items) if any – such as loss of stock due to
fire, theft or accident are credited to Trading Account, at cost.

Analysis of Items Appearing to the Debit Side of Trading Account

1) Opening Stock: It refers to the value of goods at hand at the end of last
accounting year. It becomes the opening stock for the current accounting year. It
represents the value of goods in which business deals in.

2) Purchases: It denotes the value of goods (in which the concern deals in) purchased
either for cost or on credit for the purpose of resale. However, if the goods so
purchased are returned or used by proprietor for self consumption, or distributed as
free samples or taken up by the employer for their use, or given as charity, or to be
sent on consignment, or used for any other purpose, except for resale, such amounts
shall be deducted from the total purchases.

3) Director Expenses: These expenses are incurred in connection with purchase,

procurement or production of goods. It also includes expenses which bring the goods
up to the point of sale. Examples of direct expenses are:
a) Carriage Inwards (carriage paid on purchases)
b) Freight – Railways, Airways and Shipping
c) Transit – Insurance
d) Loading charges
e) Packing
f) Import duty
g) Export duty
h) Custom duty
i) Dock dues
j) Octroi
k) Warehousing wages
However, for a manufacturer in addition to above direct expenses include –
l) Wages and salaries
m) Fuel, coal, power, gas and water
n) Factory heating*
o) Factory insurance*
p) Factory lighting* 67
Fundamentals of q) Foreman’s and Supervisor’s salary*
Accounting
r) Other factory expenses*
s) Royalty on production*
t) Depreciation on Factory Building and machine*

* These are also known as Factory overheads or Factory indirect expenses from cost
accounting point of view but for financial accounting purposes these are treated as
direct expenses.

It is to be noted that a manufacturer prepares a Manufacturing Account

where all the above mentioned direct expenses are debited. However, if in
any case Manufacturing Account is not prepared, then all such expenses
will be charged to Trading Account.

Analysis of Items Appearing to the Credit Side of Trading Account

1) Sale: It refers to the sale of goods in which business deals and includes both cash
and credit sales. It does not include sale of old, obsolete or depreciated assets which
were acquired for use in business. Similarly, goods returned by customers or goods
sent to customers on approval basis or sales tax, if any, included in sales price should
be excluded.

2) Abnormal Loss: It refers to abnormal loss of stock due to fire, theft or accident.
Since Training Account is prepared under normal conditions of the business, abnormal
loss, if any, is credited fully to the Trading Account.

3) Closing Stock: It refers to the value of goods lying unsold at the end of any
accounting year. The stock at the end is valued either at cost or market price,
whichever is less. Since Trial Balance generally does not include closing stock, the
following entry is recorded to incorporate the effect of closing stock in the Trading
Account.
Closing Stock A/c Dr
To Trading A/c

However, if closing stock forms the part of Trial Balance it will not be
transferred to Trading Account but taken to Balance Sheet only.

In case goods have been sent to customer on approval (Sale/Return) basis, such goods
should be included in the value of closing stock if no approval has been received from
them.

Constituents of closing stock are:

i) Stock of Raw materials
ii) Work-in-progress or semi-finished goods
iii) Finished goods – remaining unsold at the end of the year,
– lying unsold at different branches, if any,
– lying unsold with the consignee
iv) Stores supplies = goods, materials required for converting the raw materials
into finished product, such as machine oil, cotton waste,
chemicals and machine spares (as per As-2)
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Points to Remember Financial Statements

l It is to be noted that Income Statement + (viz. Manufacturing/

Trading/Profit and Loss Account) is parepared on Accrual)
(Mercantile) basis (Accrual concept) covering an accounting period
(accounting period concept) during which expenses are matched with
revenue (Matching Concept) to ascertain the profit or loss of an
enterprise. That is why unpaid expenses are added as outstanding in
the Income Statement and shown as liability in the Balance Sheet.
Similarly income accrued but not received are credited to Income
Statement and shown as asset in the Balance Sheet.

l It is important to remember that “Outstanding” Accrued or “Prepaid”,

if forming part of Trial Balance, then such items will be shown in the
Balance Sheet only and no treatment required in the Income
Statement.

l Conversely, “prepaid expenses” are shown by way of deduction in

the Income Statement and treated as an asset in the Balance Sheet,
whereas income received in advance are subtracted from the income
received and shown as a liability in the Balance Sheet.

3.3.3 Profit and Loss Account

This account is prepared to ascertain the net profit earned or net loss incurred by the
business concern during an accounting period. It starts with gross profit or gross loss
as disclosed by the Trading Account. It takes into account all the remaining direct
(normal and abnormal) expenses and losses related to or incidental to business. These
operating and non-operating expenses are charged to Profit and Loss Account and
shown to the debit side of the Profit and Loss Account.
The operating expenses include:
i) All office or Administrative overheads such as rent, rates and taxes, office staff
salaries, printing and stationary, postage, telephone, office lighting, depreciation
on office equipment, etc.
ii) Selling and Distribution overheads such as Salesmen’s salaries, commission on
sales, travelling expenses, advertisement and publicity, trade expenses, carriage
outward, bad debts, warehouse expenses, delivery van expenses, packing ex-
penses and rebate to customers.
Non-operating expenses include financial expenses such as interest, bank
charges, discount on bill, abnormal losses (loss of goods due to fire, theft or
accident) and loss on sale of fixed assets, etc.
Whereas Non-operating incomes include income from investment and financing
activities, such as Interest Received, Rent Received, Dividend Received, Profit
on Sale of Investment, and Insurance Claims and other Miscellaneous Receipts,
like duty drawback and subsidy and apprenticeship premiums, etc. These
incomes are credited to Profit and Loss Account.
It is to be noted that if an enterprise prepares a Manufacturing Account, the factory
expenses (both direct and indirect) are charged to Manufacturing Account. If a
Manufacturing Account is not prepared, then direct factory expenses are charged to
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Fundamentals of Trading Account and indirect factory expenses to Profit and Loss Account. Royallties
Accounting paid on production should be treated as direct expenses and royalties based on sales
as indirected expenses.

Some Important Points

1) Salaries: Salaries paid/payable to employees including Directors’ salaries,
Managers’ salaries (except Work Managers salaries) should be debited to
Manufacturing Account. In case a concern does not prepare Manufacturing
Account, the same should be charged to Trading Account. Similarly, salaries and
wages should also be charged to Profit and Loss Account. But wages and
salaries be charged to Trading Account.
2) Brokerge: This refers to brokerage paid on the items in which the business
trades in. Such as brokerage on buying and selling of goods in which the enter-
prise deals in is shown to the debit of Profit and Loss Account. However, any
brokerage paid on sale or purchase of assets is treated as of capital nature and
hence it is deducted from sale proceeds of the asset sold or added to the cost of
the asset required.
3) Trade Expenses: These expenses are of miscellaneous nature and of
small amount and sometimes termed as Sundry expenses or Miscellaneous
expenses or even Petty expenses. These are debited to Profit and
Loss Account.
4) Advertisement: Expenses on advertisement which are of revenue and recurring
nature are charged to Profit and Loss Account. Whereas cost of heavy advertise-
ment the benefit of which is likely to cover more than one accounting year is
treated as deferred revenue expenditure. For example, a company incurs
Rs. 1,00,000 on advertisement and it is estimated that the benefit of this
advertisement expenditure is likely to extend over a period of four years. In this
case Rs. 25,000, i.e. one-fourth of total cost of advertisement will be charged to
current year’s Profit and Loss Account whereas three-fourths, i.e. Rs. 75,000,
will be taken to Balance Sheet to be treated as ‘Deferred Revenue Expenditure’.
However, advertisement expenses incurred for purchase of goods should be
charged to Trading Account. Advertisement expenses paid for acquiring a capital
asset are capitalised. Again, cost of advertisement in respect of sale of any
capital asset is deducted from the sale proceeds of the asset concerned and hence
not charged to profit and loss account.
5) Rebate to Customers: It is an allowance given to a customer when his
purchases from the concern exceeds the certain limits say Rs. 200. In such cases
all those customers who make purchases from the company exceeding Rs. 200
will be entitled to rebate of 1% or 2% depending upon the policy declared
by the company. The amount of rebate so allowed is charged to Profit and Loss
Account.
6) Duty drawback and subsidy: It is a refund of duties levied on purchases made
by exporter. It serves as an incentive to exporter. The duty drawback and cash
subsidy should be deducted from the purchases. But in practice it is treated as
‘income’.
7) Apprenticeship Premium: It is the fee charged by the business enterprise to train
persons in various trades. It is treated as revenue receipts and credited to Profit
and Loss Account.
8) Factory Expenses: Factory expenses are of two types, viz. direct and indirect,
and both are shown in the Manufacturing Account. If a concern does not prepare
Manufacturing Account, then direct expenses are charged to Trading Account
70 and indirect expenses are debited to Profit and Loss Account.
9) Royalties: Royalties are paid by the business concerns to the landlord, author of Financial Statements
a patentee for the right to use their land, copyrights or patents right. Payment of
such royalty sum based on sales is debited to Profit and Loss Account.
However, if royalty is paid on the basis of production, it is charged to Trading
Account.
10) Free Samples and Publicity Expenses: These expenses are incurred to attract
cumtomers for increasing the volume of sale and as such are charged to Profit
and Loss Account. Similarly, money spent on prizes given to customers under the
scheme of ‘sales promotion’ such as ‘Bumper sales’, ‘Dhamaka sales’ are treated
as selling and distribution expenses. If a large sum is incurred on heavy
advertisement under a contract or whose benefits may accrue over a period of
more than one year, say four years, such expenses are spread over the period of
its benefits and a proportionate part is charged to Profit and Loss Account and
remaining is taken to Balance Sheet as deferred revenue expenditure.
11) Abnornal Losses and Insurance Claims: As a rule, the entire amount of
abnormal losses either arising from accident, fire or tgheft are credited to
Trading Account and debited to profit and loss account irrespective of the
insurance claims. The amount so received/settled/receivable from the insurance
company is credited to Profit and Loss Account.
Alternatively, Trading Account may be credited with the net abnormal loss
(abnormal loss insurance claim, if any) and insuracne claims and Profit and Loss
Account may be debited by net abnormal loss only.

3.3.4 Profit and Loss Appropriation Account

This account shows the distribution or appropriation of profit after the same has been
earned and computed. In case of sole proprietor, since entire amount of profit belongs
to him, no Profit and Loss Appropriation is prepared. However, this account is
prepared by partnership firms and Joint Stock Companies where there are several
claimants in the net profit. A partner shares earnings of the firm in the form of salary,
commission, interest and profit and credited to Profit and Loss Appropriation
Account.
However, a company’s Profit and Loss Appropriation account shows the transfer from
Profit and Loss Account an amount equivalent to “currnet year’s profit after tax”.
This account is further credited by the reserves and provisions made last year, now no
longer required, such as Development Rebate Reserve and Provision for Tax, etc. The
following items are debited to Profit and Loss Appropriation Account:
– Transfer to General Reserve
– Transfer to Capital Reserve
– Dividend Paid
– Proposed Dividends
– Bonus to Shareholders
– Excess of actual tax liability over the provisions made last year
– Corporate Dividend Tax, if any.

However, a detailed explanation of Profit and Loss Appropriation Account is to be

made under Corporate Financial Statements under 3.7 of this unit.

3.3.5 Balance Sheet

Balance sheet is a statement of assets and liabilities which helps us to ascertain the
financial position of a concern on a particular date, i.e. on a date when financial
71
Fundamentals of statements or final accounts are prepared or books of accounts are closed. In fact, it
Accounting treats the balances of all those ledger accounts standing to the debit or credit column
of the Trial Balance and which have not been squared up. These accounts relate to
assets owned, expensed incurred but not paid or not due, expenses due but not paid,
incomes accrued but not received or certain receipts which are not due or accrued. In
fact it deals with all those “real” and “personal accounts” which have not been
accounted for in the Manufacturing, Trading and Profit and Loss Accounts. Besides,
the balance sheet also treats all those items in the adjustments, whch affect Real or
Personal Accounts. The Nominal Accounts are treated in the Income Statement
(P&L A/c). A Balance Sheet aims to ascertain nature and amount of different assets
and liabilities so that the financial position could clearly be known to all those
concerned. Thus, the main function of the Balance Sheet is to depict the true picture of
the concern on a particular date.

Preparation and Presentation of Balance Sheet

The process of preparation and presentation of balance sheet involves two steps:
(i) Grouping and (ii) Marshalling. The first step refers to proper grouping of the
various items, which are of similar nature. For example, amount due from persons
who were sold goods on credit basis must be shown under the heading ‘Trade
Debtors’ and must be distringuished from money owing other than due to credit sales
of goods. The second step involves ‘marhsalling’ of assets and liabilities. It means
orderly arrangement in which assets and liabilities are presented or shown in the
Balance Sheet. There are two methods of presentation: (i) In order of “Liquidity, and
(ii) In order of “permanence”.
Under the “Liquidity Order”, assets are shown on the basis of liquidity or realisability.
These are arranged in order of “most liquid”, more liquid”, “liquid”, “least liquid” and
“not liquid” (fixed) assets. Similarly, liabilities are arranged in the order in which
these are to be paid or discharged. The liquility form is suiable for banking and other
financial companies.
Under the ‘‘Order of Permanence”, the assets are arranged on the basis of their useful
life. The assets which are to serve business for the longest period of time are shown
first, i.e. Fixed Assets, Semi Fixed, Current, Liquid and Most Liquid. Similarly, in
case of liabilities, after Capital, the liabilities are arranged as long term, medium term,
short term and current liabilites. The Companies Act has adapted permanency form
preparing balance sheet.
Some Important Items
1) Fixed Assets: Fixed assets are those assets, which are reuired for the purposes of
producing goods or rendering services. These are not held for resale in normal
course of business. Fixed assets are used for the purpose of earning revenue and
these are held for a longer period of time. These are also treated as ‘Gross Block’
(Fixed assets after depreciation) and ‘Net Block’ (Fixed assets after deprecia-
tion). Investment in these assets is known as ‘Sunk Cost’. Examples of fixed
assets are Land and Building, Plant and Machinery, Furniture and Fixtures,
Tools and Equipments, Motor Vehicles, etc. All fixed assets are ‘tangible’ by
nature.
2) Intangible Assets: Intangible assets are those capital assets which do not have
any physical existence. Though cannot be touched or seen yet they have long life
and help to generate income. Such assets have value by virtue of the rights
conferred upon the owner by mere possession. Goodwill, trademarks, copyrights
and patents are the examples of intengible assets.
3) Current Assets: Current assets include cash and other assets which are con-
verted or realized into cash within a normal operating cycle or say within a year.
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 These are acquired either for the purpose of resale, or assisting and helping Financial Statements
process of production or rendering of service or supplying of goods. These assets
constantly keep on changing their form and contribute to routine transactions and
operations of business. Examples are, Cash in Bank, Bills Receivables, Debtors,
Stock, Prepaid Expenses, etc. Current assets are also known as floating assets or
circulating assets.
4) Liquid or Quick Assets: Those current assets whch can be converted into cash
at a very short notice or immediately without incurring much loss or exposing to
high risk. Quick assets can be worked out by deducting Stock (Raw materials,
work in progress or finished goods) and prepaid expenses out of total current assets.
5) Fictitious Assets: These are the non-existent worthless items which represent
unwritten off losses or cost incurred in the past which cannot be recovered in
future or realized in cash. Examples of such assets are preliminary expenses
(formation expense), Advertisement suspense, Underwriting - commission,
discount on issue of shares and debentures, Loss on issue of debentures and debit
balance of Profit and Loss Account. These fictitious assets are written off or
wiped out by debiting to Profit and Loss Account.
6) Wasting Assets: Assets with limited useful life by nature deplete over a limited
period of time are called wasting assets. These assets become worthless once its
utility is over or exhaust fully. Such assets are natural resources like, timer, coal
oil, mineral deposits, etc.
7) Contingent Assets: Contingent assets are probable assets which may or may not
become assets as it depends upon occurrence or non-occurrence of a specified
event or performance of a specified act. For example, a suit is pending in the
court of law against ownership title of any dispsuted property and if the suit is
decided in favour of the business concern it becomes the asset of the concern. On
the other hand, if the decision goes against the concern, the company cannot
claim to enjoy ownership rights. Thus, it remains a contingent asset as long as
the judgment is not pronounced by court. Such assets are shown by means of
footnote and hence do not form part of assets shown in the Balance Sheet. Beside
this hire purchase contract, uncalled share capital etc. are the other examples of
contingent assets.
8) Classification of Liabilities
Long Term Liabilities: These are the obligations which are to be met by the business
enterprise after a relatively long period of time. Such liabilities do not become due for
payment in the ordinary course of business operation or within normal operating
cycle. Debentgures, long term loans from Bank or financial institutions are the
examples of long-term liabilities.
Current Liabilities: Current liabilities are those liabilities which are payable within
normal operating cycle, i.e. within an accounting year. These may arise either out of
realization from current assets or by creating fresh current liability (obligation). Trade
creditors, Bill payable, Bank overdraft, Outstanding expenses, Short-term loan
(payable within twelve months or within accounting year) are examples of current
liabilities.
Contingent Liability: It is not an actual liability but an anticipated (probable liability
which may or may not become payable). It depends upon happending of certain events
or performance of certain acts. An element of uncertainty is always attached. A
contingent liability, thus, may or may not become a sure liability. Examples are,
liability for bills discounted, liability for acting as surety, liability arising on a suit for
damages pending in the court of law, liability for calls on partly paid shares, etc.
Contingent liabilities are shown as footnote under the Balance Sheet.
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Fundamentals of
Accounting 3.4 CONCEPTS OF CAPITAL AND REVENUE
You know that a firm prepares Profit and Loss Account for ascertaining the net result
of business operations and the Balance sheet for determining the financial position of
the business. These are prepared with the help of Trial Balance which shows the final
position of all ledger accounts. All items appearing in the Trial Balance are transferrd
either to the Profit and Loss Account or to the Balance Sheet. As per rules, the items
of revenue nature are taken to the Profit and Loss Account and the items of capital
nature are shown in the Balance Sheet. In other words whether an item appearing in
the Trial Balance is to be taken to the Profit and Loss Account or the Balance Sheet
depends upon the capital and revenue nature of the item. If any item is wrongly
classified i.e., if an item of revenue nature is treated as a capital item or vice versa, the
Profit and Loss Account will not reveal the correct amount of profit and the Balance
Sheet will not reflect the true and fair view of the affairs of the business. It is therefore
necessary to determine correctly whether an item is of capital nature or of a revenue
nature and record it in the books accordingly. There are certain rules governing the
allocation of expenditures and receipts between capital and revenue which should be
clearly understood.
Capital and Revenue Expenditures
You incur expenditure on various items every day. You buy food items, stationery,
cosmetics, utensils, furniture, etc. Some of them are consumables and some are
durables. The benefit of expenditure on consumables like stationery, cosmetics, etc. is
derived over a short period. But in case of durables like furniture, utensils, etc., the
benefit spreads over a number of years. Same is true of business also. In business you
incur expenditure on two types of items: (i) routine items like stationery, and (ii) fixed
assets like machinery, builing, furniture, etc., whose benefit is available over a number
of years. In accounting terminology the first category of expenditure is called revenue
expenditure and the second one is called capital expenditure. Let us now study the
exact nature of capital and revenue expenditures.
Capital Expenditure: As stated above, when the benefit of an expenditure is not
exhausted in the year in which it is incurred but is available over a number of years it
is considered as capital expenditure. The following expenditures are usually treated as
capital expenditures:
1) Any expenditure which results in the acquisition of fixed assets such as land,
buildings, plant and machinery, furniture and fixures, office equipment,
copyright etc. you should note that such capital expenditure includes not only the
purchase price of the fixed asset but also the expenses incurred in connection
with their acquisition. Thus, the brokerage or commission paid in connection
with the acquisition of an asset, the freight and cartage paid for transportation of
machinery, the expenses incurred on its installation, the legal fees and
registration charges incurred in connection with purchase of land and buildings
are also treated as capital expenditure.
2) Any expenditure incurred on a fixed asset which results in (a) its expansion,
(b) substantial increase in its life, or (c) improvement in its revenue earning
capacity. Improvement in the revenue earning capacity can be in the form of
(i) increased production capacity, (ii) reduced cost of production, or
(iii) increased sales of the firm. Thus, cost of making additions to buildings and
the amount spent on renovation of the old machinery are also regarded as capital
expenditures. If you buy a second hand machinery and incur heavy expenditure
on reconditioning it, such expenditure is also to be treated as capital expenditure.
Similarly, expenditure on structural improvements or alterations to existing fixed
assets whereby their revenue earning capacity is increased, is also treated as
capital expenditure.
74
3) Expenditure incurred, during the early years, on development of mines and land Financial Statements
for plantations till they become operational.
4) Cost of experiments which ultimately result in the acquisition of a patent. The
cost of experiments which are not successful is not to be treated as capital
expenditure. It is treated as a deferred revenue expenditure which is written off
within two to three years.
5. Legal charges incurred in connection with acquiring or defending suits for
protecting fixed assets, rights, etc.
Revenue Expenditure: When the benefit of an expenditure is not likely to be
available for more than one year, it is treated as revenue expenditure. So all expenses
which are incurred during the regular course of business are regarded as revenue
expenditures. The examples of such expenses are:
1) Expenses incurred in day-to-day conduct of the business such as wages, salaries,
rent, postage, stationery, insurance, electricity, etc.
2) Expenditure incurred for buying goods for resale or raw materials for
manufacturing.
3) Expenditure incurred for maintaining the fixed assets such as repairs and
renewals of building, machinery, etc.
4) Depreciation on fixed assets. This can also be termed as revenue loss.
5) Interest on loans borrowed for running the business. You should note that
any interest of loan paid during the initial period before production
commences, is not treated as revenue expenditure. It is treated as capital
expenditure.
6) Legal charges incurred during the regular course of business such as legal
expenses incurred on collection from debtors, legal charges incurred on
defending a suit for damages, etc.

Deferred Revenue Expenditure

Sometimes, certain expenditure which is normally treated as revenue may be
unusually heavy and its benefit is likely to be available for more than one year. In such
a situation, it is considered appropriate to spread the cost of the expenditure over a
number of accounting years. Hence, it is capitalised and only a portion of the total
amount spent is charged to the Profit and Loss Account of the current year. The
balance is shown as an asset which wil be written off during the subsequent
accounting years. Such expenditure is called a Deferred Revenue Expenditure because
its charge to Profit and Loss Account has been deferred to future years. Some example
of such expenditure are:
1) Expenditure incurred on advertising campaign to introduce a new product in the
market.
2) Expenditure incurred on formation of a new company (preliminary expenses)
3) Brokerage charges, underwriting commission paid and other expenses incurred in
connection with the issue of shares and debentures.
4) Cost of shifting the plant and machinery to a new site which may involve
dismantling, removing and re-erection of the plant and machinery.
Let us take the case of expenditure on advertising campaign. It is not a routine
advertisement and the amount involved is unusually heavy. Its benefit will not
completely exhaust in one accounting year but will contunue over two to three years.
Hence, it is not proper to charge such expenditure to the Profit and Loss Account of
75
Fundamentals of one year. It is better to distribute it carefully over three years. So, in the first year we
Accounting may charge one-third of the amount spent to the Profit and Loss Account and show
the balance in the Balance Sheet as an asset. In the second year again we may charge
a similar amount to the Profit and Loss Account and show the balance as an asset. In
the third year. we may charge this balance to the Profit and Loss Account. Every
expenditure which is regarded as deferred revenue is treated in this way in the final
accounts.
Look at Illustration 1 and note how each expenditure has been treated and why.
Illustration 1
State whether the following items of expenditure would be treated as (a) capital
expenditure, (b) revenue expenditure, or (c) deferred revenue expenditure:
i) Carriage on goods purchased Rs. 25.
ii) Rs. 2,000 spent on repairs of machinery.
iii) Rs. 5,000 spent on white washing.
iv) Rs. 8,000 paid for import duty and cartage on the purchase of machinery from
west Germany.
v) Rs. 25,000 spent on issue of equity shares.
vi) Rs. 14,000 spent on spreading new tiles on factory floors.
vii) Rs. 4,000 spent on dismantling, transportation and reinstalling plant and
machinery to new site.
viii) Rs. 60,000 spent on construction of railway siding.
ix) Rs. 20,000 spent on some major alterations to a theatre which made it more
comfortable and attractive.
x) A second hand maching was bought for Rs. 10,000 and an amount of Rs. 6,000
was spent on its overhauling.

Solution
i) It is a revenue expenditure as it relates to the goods for resale.
ii) It is a revenue expenditure as it relates to the maintenance of a fixed asset.
iii) Same as no. (ii).
iv) It is a capital expenditure as it is spent in connection with the purchase of a fixed
assets.
v) It would be treated as deferred revenue expenditure. It is a heavy amount in-
curred in connection with reising of capital for the company and so capitalised.
Even under the Indian Companies Act and the Indian Income Tax Act this
expenditure is allowed to be written off over a number of years.
vi) It is a revenue expenditure so it is treated as a sort of repairs not leading to any
increase in the earning capacity of a fixed asset.
vii) Normall expenditure on transportation etc. is revenue in nature. But this expendi-
ture has been incurred on shifting to new site which is non-recurring in nature
and involves a heavy amount. Hence it shall be treated as a deferred revenue
expenditure.
viii) It is a capital expenditure as it is incurred on the construction of railway siding, a
fixed asset.

76
ix) It is a capital expenditure as the alterations made the theatre more comfortable Financial Statements
and attractive which is likely to increase its collections.
x) It is a capital expenditure as it is incurred on making the newly bought second
hand machinery operational.

Capital and Revenue Receipts

Receipts refer to amounts received by a business i.e., cash inflows. Receipts may be
classified as Capital Receipts and Revenue Receipts. It is necessary to note this
distinction clearly because only the revenue receipts are taken to the Profit and Loss
Account and not the capital receipts.
Capital Receipts: Capital receipts are the amounts received in the form of (a)
additional capital introduced in the business, (b) loans received, and (c) sale proceeds
of fixed assets. You are aware that a loan taken by the business is repayable sooner or
later. Similarly, additional capital received represents an increase in the proprietor’s
claim over the business assets. Thus these two items represent increase in liabilities of
the business and obviously are not incomes or revenues. These are capital receipts and
should be treated as such. The sale proceeds of a fixed asset are also treated as a
capital receipt because the amount received is not revenue earned in the normal course
of business. The capital receipts increase the liabilities or reduce the assets. They do
not affect the profit or loss.
Revenue Recipts: Revenue receipts are the amounts recived in the normal and regualr
course of business. They take the form of (a) sale proceeds of goods, and (b) incomes
such as interest earned, commission earned, rent received, etc. These receipts are on
account of goods sold or some services rendered by the business and as such they are
not repayable. All revenue receipts are treated as incomes and shown on the credit side
of the Profit and Loss Account.

3.5 REVENUE RECOGNITION

Revenue arises in the ordinary course of business activities of an enterprise from:
– sales of goods,
– rendering of services, and
– use by others of enterprise resources yielding interest, royalties and dividends.
Revenue recognition is mainly concerned with the timing of recognition revenue in the
statement of profit and loss. According to AS-9, “revenue is the gross in flow of cash,
receivables, or other consideration arising in the course of ordinary activities of an
enterprise.”
The basic problem of revenue recognition lies in identifying of the “accounting
period” during which revenues are earned. There are several stages or activities in a
business before the revenues are earned and realized. Hence the problem arises –
should revenue be recognized at the point of production, sale, delivery or receipt of
cash. According to “Realisation Concept” revenues are recognized at the point of
sale or services are rendered. However, there is no single uniform practice to
recognize various types of revenues according to one common principle. There are
guidelines, which help us in recognizing operating revenues and non-operating
revenues. Non-operating revenues include interest, dividend and rent and other
incomes which are not related to normal course of operation of the enterprise.
It is advisable to show operating and non-operating revenues separately in the
Profit and Loss Account.

77
Fundamentals of Following are some of the established practices to recognize revenue as per AS-9.
Accounting
3.5.1 Revenue Recognition in Sale of Goods
Trading and Manufacturing organizations, in general, recognize revenue when sale is
effected. However, the following conditions should be satisfied:
i) The “property in goods” is transferred for a price.
ii) All significant risks and rewards have been transferred and no effective control is
retained by the seller.
iii) No significant uncertainty exists regarding the collection of amount of consider-
ation.

Special Cases of “Sale of Goods” and applicability of AS-9

a) Delivery of goods delayed at buyer’s request and buyer takes title and
accepts billing: Revenue should be recognized and the “goods to be delivered” at
any subsequent date should not be included in the inventory.
b) Goods delivered subject to installation and inspection: Revenue should be
recognized only after the installation and inspection is completed.
c) Sale on Approval: In case of sale on approval or return basis, revenue should be
recognized only when acceptance is received from buyer.
d) Sale subject to warranty: If sales are subject to a warranty, revenue recognition
should not be deferred but a provision should be made to cover the liability
which may arise under the terms and period of warranty.
e) Guaranteed Sales: Sometimes goods are sold and delivery is made giving the
buyer the unlimited right to return. This is under “Money back guarantee”, if not
completely satisfied. Under this situation it is apparent to recognize the ‘revenue’
at the point of sale and to make provisions for returns as well.
f) Consignment Sales: Revenues are recognized when the goods are sold to
customers by the consignee and at the time of dispatch of goods of consignor.
g) Cash on delivery Sales: If a sale has been effected under the terms of
“Cash-on-delivery”, revenue should be recognized only when cash is
received by seller.
h) Installment Sales: Revenues are recognized on delivery to the extent of normal
cash down price. However, interest on deferred payment should be recognized in
the ratio of amount outstanding.
I) Special Order: Where payment is received against the specific order of goods,
which are not in stock. Revenue from such sale should be recognized only when
goods are purchased or manufactured and are ready for delivery.
j) Sale/Repurchase Agreement: Where seller concurrently agrees to repurchase
the same goods at some late date, the flow of cash under such a situation will not
be recognized as revenue.
k) Sales to Distributors to Dealers for Resale: Revenues are recognized only if
significant risks of ownership have passed on distributors/dealers.

3.5.2 Revenue Recognition in Case of Rendering of Services

Revenue recognition in case of rendering services care based on the following
conditions:
i) Revenue recognized either on completed service method or ‘proportionate
completion’ method.
ii) No significant uncertainty exists regarding amount of consideration.
78 iii) It is reasonable to expect ultimate collection of consideration.
Under completed service method revenue are recognized only on completion of Financial Statements
service. In cases there are more than one act involved, revenue are recognized on
execution of all these acts.
Proportionate completion method recognized revenue proportionate with the degree
of completion of services. If there are more than one act involved revenue are
recognized on execution of certain acts. Some examples of recognition of service
revenue are –
1) Installation Fee: In cases where installation fees are other than incidental to
sales, the revenue should be recognized only when the equipment is installed and
accepted by the customer.
2) Advertising and Insurance Agency Commission: Revenue should be recog-
nized when service is completed. For advertising agencies, media commission
will normally be recognized when the related advertisement or commercial
appears before the public, and the necessary intimation is received by the agency.
Insurance agency commission should be recognized on the effective
commencement renewal dates of the related policies.
3) Financial Service Commissions: A financial service may be rendered as a single
act or may be provided over a period of time. Similarly, charge for such services
may be made as a single amount or in stages over the period of the service or the
life of the transaction to which it relates. Such charges may be settled in full
when made or added to a loan or other account and settled in stages.
The recognition of revenue should therefore have regard to:
a) Whether the service has been provided one and for all or in an continuing
basis.
b) The incidence of cost relating to service.
c) Commission charged for arranging and granting of loan or other facilities,
should be recognized when a binding obligation has been entered into.
Commitment, facility or loan management fees which relate to
continuing obligations or service should normally be recognized over the
life of the loan or facility having regard to the amount of the obligation
outstanding, the nature of the service provided and timing of the costs
relating thereto.
Admission Fees: Revenue from artistic performance, banquets and other
special events should be recognized when the event takes place. When fees to a
number of events, it should be allocated to each event on a systematic and
rational basis.

Tution Fees: Revenue should be recognized over the period of instruction.

Entrance and Membership Fees: AS.9 recommends capitalization of entrance fees.
If membership fee permits only membership and all other services of products are paid
for separately or if there is a separate annual subscription, the fee should be
recognized as revenue when received. If the membersyhip fee entitles the member to
services or publications to be provided during the year, it should be recognized on a
systematic and rational basis having regard to the timing and nature of all services
provided.
Subscription for Publications: Revenue received or billed should be deferred and
recognized either on straight-line basis over time or where the items delivered
vary in value from period to period revenue should be based on the sales value
of the items delivered in relation to total sales value of all items covered by
the subscription.
79
Fundamentals of Exceptions to General Rule
Accounting
1) Revenue recognition at the point of production (Completed Production
Method): Under this method revenue are recognozid at the point of production.
It applies to case of agriculture. Extractive industries like gold, silver, uranium,
other metals and oil (crude) etc. revenue are recognized just after completion of
production even before the sales take place.
2) Cash Basis: Under this, revenue are not recognized at the point of sale but when
cash is realized including outstanding, if any. This basis is applicable in case of
hire-purchase system where revenue are recognized on the basis of cash received
and installments due during the year.
3) Revenue Recognition during the production period on percentage of
completion method: Under this method revenue are recognized on the basis of
contract value, associated costs, number of acts or other susitable basis. It is
applicable in case of long-term construction contracts where revenue are
recognized on the basis of degree of completion or what work certified bears to
cash received by the contractor.
4) Time Basis: In many cases revenue are realized on the basis of time or period.
For example, interest on fixed deposits is credited to Profit and Loss Account on
time proportion basis, i.e. interest accrued yet not payable.

It is to be noted that revenue in case of “Royalties” are recognized on an accrual basis

in according with terms of agreement and, Dividends are recognized when the right to
receive payment is established.

3.6 FORMAT OF FINANCIAL STATEMENTS

(NON-CORPORATE ENTITIES)
The financial statements may be prepared and presented either in conventional (also
known as ‘T’ form) or Vertical form. The basic purpose is to serve the information
needs of the users of accounting information. The idea is to present these accounting
figures in such a way that provides maximum input for decision-making purposes.
The income statement gives the clear picture operating efficiency of the enterprises by
disclosing the amount of gross profit or loss through Trading Account. At the same
time Profit and Loss Account reveals the overall ‘net’ result – the “net profit” or “net
loss”. The Balance Sheet, which is also known as “position statement” is required to
depict the true and fair view of state of affairs of business enterprise. Sole traders and
partnership firms are not requqired to comply any legal provisions as far as
presentation and formats of financial statements are concerned. However, these
income statements, meant basically for self consumption, must be prepared in
conformity with the accounting concepts, conventions and applicable accounting
standards.
The financial statements of non-corporate entities may be presented either of the
following ways:
1) Conventional Format, and
2) Vertical Format

3.6.1 Conventional Format

Following are the conventional formats of ‘Income’ and ‘Position statements’:

80
 Format of a Manufacturing Account Financial Statements
For the year ended 31st March....
Dr. Cr
Rs. Rs.
To Opening Work-in progress ----- By Closing Work-in- Progress -----
To Raw materials consumed ----- By Sale of Scrap -----
Operating stock of Raw material By Cost of goods
Add: Purchases produced-transferred
Less: Closing stock of ----- to Trading Account -----
Raw material
To Direct Expense
Productive Wages -----
Freight Inward Raw material -----
Cartage/Carriage Inward -----
To Factory overheads
Salary of Works Manager -----
Gas, Fuel and Power -----
Factory Light -----
Rent, Rates and Taxes -----
Insurance of factory assets -----
Repairs of factory assets -----
Depreciation of factory assets
Other Factory Expenses -----
*** ***

Trading Account (A format)

For the year ended 31st March ....

Dr. Cr
Rs. Rs.
To Opening Stock (Finished Goods) ----- By Sales less Returns -----
To Transfer from Manufacturing A/c ----- By Abnormal Loss:
or/and Purchases less returns (Transferred to
To Direct Expense Profit and Loss A/c)
Carriage/cartage Inward Loss by Fire
Freight Loss by Accident
Insurance-in-transit ----- Loss by Theft -----
Wages ----- By Closing Stock -----
* Fuel and Power ----- By Gross Loss A/c
* Coal, Gas and Water ----- (Balancing figure)
Packing (essential) -----
Octroi -----
Import duty
* Consumable Stores -----
Royalty (based on output) -----
81
Fundamentals of * Manufacturing Expenses -----
Accounting * Excise Duty -----
Dock dues
To Gross Profit A/c
(Balance fiture)** -----
*** ***

* Concerns not preparing Manufacturing Account separately

** Balancing figure will be either gross profit or gross loss.

Profit and Loss Account (A format)

For the year ended 31st March ....
Dr. Cr
Rs. Rs.
To Gross Loss* b/d ------- By Gross Profit b/d* ------
To Office & Administration Expenses: By Interest Received ------
Salaries of Office Staff By Dividend Received ------
Office Rent, Rates and Taxes By Rent Received ------
Printing and Stationery ------- By Discount Received ------
Postage and Telephone ------- By Profit on sale of fixed assets ------
Fire Insurance Premium ------- By Profit on sale of Investment ------
Audit Fees ------- By Insurance Claims ------
Repairs and Maintenance ------- By Duty–Draw Backs ------
Legal Expenses ------- By Apprenticeship Premium ------
Office Lighting ------- By Miscellanceous Receipts ------
Depreciation-office assets ------- By Bad debts Recovered ------
Other Office Expenses ------- By Net loss transferred ------
To Selling and Distribution Expenses: to Capital account
Salesmen’s Salaries (Balancing figure)** ------
Commission on Sales
Travelling Expenses
Brokerage
Trade Expenses
Advertisement and Publicity
Sales Promotion Expenses
Carriage Outward
Bad Debts
Provision for Bad Debts
Repairs of Vehicles
Depreciation on Vehicles
Warehouse Expenses
Warehouse Insurance
Warehouse Rent
Delivery Van Expenses
Packing Expenses
Rebate to Customers
Royalty on Sales
To Financing Expenses:
Discount Allowed
Interest on Capital
Discount of Bills
Bank Charges
82
To Abnormal Losses: Financial Statements
Transferred from Trading Account –
(loss by – Fire
– Accident
– Theft)
To Loss on sale of Fixed Assets
To Miscellaneous Expenses
To Net Profit Transferred to
Capital A/c (Bal. Figure)**
*** ***
* Balancing b/d may be either Gross Profit or Gross Loss
** The Balancing figure may be either Net Profit or Net Loss
Profit and Loss Appropriation Account (A format)
For the year ended 31st March ....
Dr. Cr
Rs. Rs.
To Profit and Loss A/c (Net Loss)* —— By Profit and Loss A/c (Net Profit)* ——
To Interest on Partner’s Capitals —— By Interest on Drawings ——
To Salary to Partners —— By Balance (transferred to
To Commission to Partners Partner’s Capital Account) ——
To Balance (Transferred to
Partner’s Capital Accounts)**
*** ***
* There will either be Profit or Loss
** Represent balancing fiture – a residual profit or loss to be shared by partners in
the profit sharing ratio.
Balance Sheet of ......... (A format)
as on 31st March .......
Liabilities Rs. Assets
Capital ----- Fixed Assets: -------
Add Profit or less Loss ----- Goodwill -------
Less Drawings ----- ----- Land and Building -------
Plant and Machinery -------
Long Term Liabilities
Tools and Equipments -------
Mortgaged Loan -----
Motor Vehicles -------
Loan from Bank -----
Furniture and Fixtures -------
Current Liabilities Patents and Trademarks -------
Sundry Creditors -----
Investment (Long Term) -------
Bills Payable -----
Current Assets: -------
Income Received in Advance -----
Stock -------
Outstanding Expenses -----
Accrued Income -------
Bank Overdraft -----
Prepared Expenses -------
Sundry Debtors -------
Bills Receivable -------
Short Term Investment -------
Marketable Securities -------
Cash and Bank Balance -------
Fictitious Assets: -------
Advertisement -------
Profit and Loss Account -------
Miscellaneous Expenditure -------
*** ***
83
*The items in the above format have been shown in order of permanence.
Alternatively, this can be presented in order of liquidity as explained earlier.
Fundamentals of 2. From the following Trial Balance of Trader, you are required to prepare Trading
Accounting and Profit Account for the year ended 31st March 2001 and a Balancing Sheet as
on that date.

Trial Balance as on 31st March 2001

Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
Drawing Account 7,500 Capital 1,50,000
Plant and Machinery (1.4.2000) 1,25,000 Returns Outward 1,250
Plant and Machinery 6,250 Sundry Creditors 22,500
(1.4.2000) 19,250 Sales 2,00,000
Stock (1.4.2000) 1,02,500 Porivision for Bad
Purchases 2,500 and Doubtful debts 500
Returns Inward 25,750 Discount Received 1,000
Sundry Debtors 6,200 Rent (up to 30.9.2002) 1,500
Furniture 12,500
Freight 625
Carriage Outward 5,750
Rent, Rates and Taxes 1,000
Printing and Stationary 500
Trade Expenses 875
Insurance Charges 26,625
Salaries and Wages 25,675
Cash in Bank 7,250
Cash in Hand 1,000
Postage and Telegram
3,76,750 3,76,750

Adjustments:
1) Stock on 31st March 2001 was valued at Rs. 15,000
2) Write off Rs. 750 as bad debts.
3) Provision for Bad and doubtful debt is to be maintained at 5% on sundry debtors.
4) Create a provision for discount on debtors and also reserve for discount on
creditors @ 2%.
5) Charge depreciation @ 2% p.a. on Plant and machinery and @ 5% on furniture.
6) Insurance prepaid was Rs. 125.
7) Goods worth Rs. 6,250 were totally demaged in an accident. The insurance
company admitted claim of Rs. 5,000 on 28.3.2001.

84
Solution Financial Statements
Trading Account
For the year ended 31st March 2001
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
To Opening Stock 19,250 By Sales 2,00,000
To Purchases 1,02,500 Less Returns 2,500 1,97,500
Less Returns 1,250 1,01,250 By Closing Stock 15,000
To Freight 12,500 By Insurance Claims 5,000
To Gross profit transterred By Profit & Loss A/c 1,250
to Profit & Loss A/c 85,750 (Abnornal Loss)

2,18,750 2,18,750

Profit and Loss Account

Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
To Rent, Rates & Taxes 5,750 By Gross Profit b/d 85,750
To Printing and Stationary 1,000 By Discount Received 1,000
To Trade Expenses 500 By Rent Received 1,500
To Insurance 875 Less Prepaid 750 750
Less Prepaid 125 750
To Salaries & Wages 26,625 By Reserve for discount 450
To Postage & Telegram 1,000 on creditors
To Bad debts 750
To Provision for Bad and doubtful debts 750
(New reserve Rs. 1250-Old
reserve Rs. 500)
To Provision for discount on debtors 475
To Carriage outward 625
To Abnormal loss (Accident) 1,250
To Depreciation on:
Furniture 310
Plant & Machinery 25,625 25,935
(Rs. 25000 + Rs. 625)
To Net profit transfered A/c540
to capital 87,950 87,950

Balance Sheet As on 31st March 2001

Dr. Cr.
Liabilities Amount Assets Amount
Rs. Rs.

Add. Capital 1,50,000 Plant & Machinery 1,25,000

Net Profit 22,540 Additions 6,250
1,72,540 1,31,250
Less Drawings 7,500 1,65,040 Less Dereciation 25,625 1,05,62
Sundry Creditors 22,500 Furniture 6,200
Less Provision 450 22,050 Less Depreciation 310 5,89
Advance Rent 750 Closing Stock 15,00
Sundry Debtors 25,750
Less Bad Debts 750
25,000
Less Provision @ 5% 1,250
23,750 85
Fundamentals of Less Provision for discount 475 23,27
Accounting Cash at Bank 25,67
Cash in hand 7,25
Insurance Claims 5,00
Prepaid Insurace 12
1,87,840 1,87,84

Illustration 3
The following is the Trial Balance of Mr. Mahesh as 31st December 2003. Prepare a
Trading and Profit & Loss Account for the year ended 2003 and Balance Sheet as on
31st December 2003.
Dr. Cr

Rs. Rs.

Purchases 1,80,000 Sales 2,05,000

Opening Stock 10,000 Loan (10% interest) 10,000
Salaries Less Provident Fund 5,400 Creditors 15,000
Drawinges 5,000 Capital 55,000
Provident fund remittances including
Proprietor’s contribution 50% 1,200
Rent Rs. 250 per month 2,750
Machinery 29,000
Wages 3,000
Furniture & Fittings 5,000
Electricity 550
Trade Expenses 1,500
Debtors 10,500
Interest on Loan 900
Commission 200
Building 30,000
2,85,000 2,85,000

Wages include Rs. 1,000 Paid for machinery erection charges. Purchases include cost
of moped scooter for Rs. 5,000 Proprietor has taken goods costing Rs. 1,000 for
which no entry has been made, Electricity outstanding Rs. 50. Goods costing Rs.
5,000 were destoyed by fire and insurance claim was receied for Rs. 4,000 Provide
depreciation at 10% on machinery, furniture & moped. Provide depreciation 5% on
Bulding. Closing stock is Rs. 12,000

Solution
Trading And Profit and Loss Account
For the year ended 31st December 2003
Dr. Cr

Particulars Amount Particulars Amount

Rs. Rs.
To Opening Stock 10,000 By Sales 205,000
To Purchases 180,000 By Loss by fire transferred
Less Purchase of Scooter 5,000 to P&L A/c 5,000
Less Drawings (goods used) 1,000 174,000 By Closing Stock 12,000
To Wages 3,000
Less Erection charges 1,000 2,000
To Gross Profit c/d 36,000
222,000 222,000
To Salaries 5,400 By Gross Profit b/d 36,000
Add Subscription 600 By Insurance claims 4,000
86 Contribution 600 6,600
To Rent 2,750 Financial Statements
Add Outstanding 250 3,000
To Electricity 550
Add Outstanding 50 600
To Commission 200
To Trade Expenses 1,500
To Bad debts 500
To Interest 900
Add Outstanding 100 1,000
To Provision for Bad debts 1,000
To Loss by fire (Trading A/c) 5,000
To Depreciation on:
Building 1,500
Machinery 3,000
Furniture 500
Scooter 500
To Net Profit 15,100
40,000 40,000

Balance Sheet
As on 31st December 2003
Dr. Cr
Liabilities Amount Assets Amount
Rs. Rs.
Capital 55,000 Building 30,000
Add Net Profit 15,100 Less Depreciation 1,500 28,500
Less Drawings (5000 + 1000) 6,000 64,100 Machinery 29,000
Add Erection Charge 1,000
30,000
10% Loan 10,000 Less Depreciation (10%) (3,000) 27,000
Creditors 15,000 Furniture 5,000
Rent outstanding 250 Less Depreciation 500 4,500
Interest outstanding 100 Scooter 5,000
Electricity Changes O/s 50 Less Depreciation 500 4,500
Closing Stock 12,000
Debtors 10,500
Less Bad debts 500
Less Provision @ 10% 1,000 9,000
Insurance claims 4,000
89,500 89,500

3.6.2 Vertical Format

Under vertical form various items of incomes and expenses, assets and liabilities are
arranged vertically to get some additional information about the operating efficiency
and financial position of the business enterprise. The vertical form of Income
Statement shows the gross profit, operating profit, net profit. The impact of non-
operating incomes and expenses cannot be ascertained if the Trading & Profit and
Loss Account is not prepared under vertical form. Similarly the Balance Sheet
discloses owner’s capital, borrowed capital, net working capital, etc. It is to be noted
that sole traders and partnership firms hardly adopt vertical form of financial
statements. Following formats will bring about a clarity of understanding of vertical
form of financial statements.

87
Fundamentals of Income Statement (A format)
Accounting For the year ending 31st March .....
Particulars Figures at the end of
Previous Year Current Year
Rs. Rs.
Sales/Turnover -------- --------
Less Cost of Goods Sold* -------- --------
Gross Profit **** ****
Less Administrative Expenses* -------- --------
Less Selling and Distribution Expenses* -------- --------
Operating Profit **** ****
Add Other Incomes* (Non-operating Incomes) -------- --------
Less Financial Expenses (Non-operating Expenses) -------- --------
Net Profit **** ****
Less Transfer to General Reserve and/or capital -------- --------
account/accounts (in the form of profit, -------- --------
salary, commission, etc.)
* Explained earlier under conventional form.

Operating vs Non-operating

Operating Profit/Loss
The excess of operating incomes over operating expenses represents operating
profit, whereas when operating expenses exceed operating income it results in
operating loss.
Operating incomes are those incomes which arise from operating activities in which
the enterprise deals in. For a trading concern, revenue arising from sale of goods in
which the enterprise deals in is treated as operating income. In fact, operating
activities are the principal revenue-producing activities of the entertprise. Operating
income measures the efficiency of a business enterprise, because these activities make-
up the main business of the enterprise and are of recurring in nature. The operating
activities may be:
l Purchasing and selling of goods.
l Services and even securities by a Trading concern.
l Exploration of natural resources by Extracting & Trading entity.
l Granting of loans and advances by a ‘Financial Institution’.
l Construction and development of colonies by construction enterprise.

Operating expenses are those expenses which are incurred in connection with main
revenue producing activities. These operating expenses may be classified under
various heads, such as office and administrative expenses and selling and
distribution expenses. A detailed list of these expenses has already been given under
conventional format of Profit and Loss Account under 3.6.1 of this unit. These
expenses are necessary to run the business enterprise but which are not directly related
to trading or manufacturing activities. These directly related expenses are termed as
direct expenses, which are charged to Manufacturing/Trading/Account. Hence
Operating Profit = Gross Profit – Operating Expenses (Office and Selling
Distribution).

88
Non-operating Incomes Financial Statements

Such incomes arise from other than major or principal revenue earning activities.
These are in the form of, in case of a manufacturing and trading concern, rent
received, interest received, dividend received, which are credited to Profit and Loss
Account. Profit on sale of fixed assets and the revenue arising from activities which
are incidental to main business, are treated as non-operating incomes. Such types of
incomes arise when unused portion of building used for business purposes is let-out or
idle funds of business invested either in shares, debentures, government securities or
deposited in a fixed deposit account. Since such incomes have nothing to do with the
business operation of the enterprise, these incomes are treated as non-operating
incomes.

It is to be noted that “Interest” and “Dividend” received by a “Financial

Institution” is treated as operating income because these incomes arise
from main/principal revenue earning activity.

Non-operating Expenses
These expenses are incurred on activities other than main or principal revenue earning
activities. These may be in the form of non-operating losses. Interest paid on
borrowings (financial overheads), loss on sale of fixed assets, loss on sale of
investment (held as an asset) are some of the examples of non-operating
expenses. Such expenses are also charged to Income Statement to ascertain the
overall net profit.

Balance Sheet of ........................ (A format)

As on 31st March ..........

Assets Figures at the end of

Previous Year Current Year
Fixed Assets -------- --------
Less Depreciation -------- --------
Net Fixed Assets (a) -------- --------
**** ****
Stock-in Trade -------- --------
Sundry Debtors -------- --------
Bills Receivables -------- --------
Cash and Bank balance -------- --------

Total Current Assets* (b) **** ****

TOTAL ASSETS (a+b) -------- --------
Liabilities and Capital
Capital -------- --------
Add Profit (Retained Earnings) -------- --------
Less Drawings -------- --------
Owner’s Equity (c) -------- --------

Sundry Creditors -------- --------

Bills Payable -------- --------
outstanding Expenses -------- --------

Total Current Liabilities (d) -------- --------

TOTAL (c + d) -------- --------

89
* The list is not exhaustive
Fundamentals of Activity
Accounting
1) What are operating and non-operating profits?
2) What do you understand by “Grouping” and “Marshalling” of assets and liabili-
ties?
3) Write short notes on the following:
a) Outstanding of Expenses
b) Accrued Incomes
c) Intangible Assets
d) Fictitious Assets
e) Cost of Conversion
f) Cost of Goods Sold
g) Direct vs Indirect Expenses
4) Draw an imaginary Balance Sheet.

3.7 CORPORATE FINANCIAL STATEMENTS

The process of preparation of financial statements of companies is similar to that of
non-corporate entities except for certain peculiar items and legal requirements. The
corporate reporting has assumed great importance in recent years. The Company Law
Board, the Institute of Chartered Accountants of India and whole corporate world are
trying to bring about a total transparency in the matter of reporting. The fundamental
objective of corporate reporting is to communicate economic information about the
resources and performance of the reporting entity to the users of financial statements.
The professional bodies have also developed several (till date – 28) accounting
standards for the purpose of preparing and disclosing accounting information in order:
1) To serve the varied needs of users for decision-making purposes.
2) To harmonise the diverse accounting practices.
3) To ensure transparency, consistency, comparability, adequacy and
reliability of information-contents.
4) To make accounting information more meaningful and useful.
5) And to improve overall quality of presentation and reporting.
Since every interested party has a right to information which is merely not the
outcome of statue but is based on the principle of public accountability. The financial
statements which are prepared on the basis of various accounting postulates, concepts
and conventions, are supposed to endowed with many qualitative characteristics, viz.
understandability, relevance, materiality, reliability, faithful representation, substance
over form, neutrality, prudence, completeness and comparability.

General and Legal Requirements

Section 209 to 223 of the Companies Act, 1956 deal with provision governing
maintenance and preparation of financial statements.
Section 209 deals with the maintenance of proper books of accounts in respect of
1) Receipts and disbursements of money,
2) Sales and purchases of raw materials/goods,
3) Description peratining to usage of raw material and labout, etc., and
4) All assets and liabilities.
90
Section 209 also requires that books of accounts must show the “True and fair” view Financial Statements
of state of affairs of the company. Section 211 requires that the Balance Sheet must
give true and fair view of the results of operations. It simply implies that financial
statements should disclose every material information without any concealment of
facts and figures and in such a manner that working results and financial position of
the reporting enterprise, may correctly be interpreted in true spirits. It should be free
from personal biases and mis-statements. It will be possible only if financial
statements are prepared in accordance with generally accepted accounting principles
and in conformity with the various accounting standards as applicable to the reporting
enterprise. Companies (Amendment) Act 1999 has made it mandatory for companies
to comply with accounting standards set by ICAI. In case company fails to comply
with any of generally accepted accounting assumptions or standards, the fact should
be disclosed.
Section 210 requires that financial statements should be presented to shareholders at
every Annual General Meeting along with the Auditor’s and Directors’ Reports. Every
Balance Sheet and Profit and Loss Account must be duly authenticated. These
statements must be signed by Manager or Secretary and by two directors, at least one
of whom must be managing director (Section 215).

3.7.1 Items Peculiar to Corporate Balance Sheet

Share Capital: Under this head following details are required to be disclosed:
1) Details of Authorised, Issued and Subscribed Capital along with number and
nominal value of the shares with respect to preference and equity shares.
2) Calls-in-Arrears must be deducted from Called-up Capital. However, Calls-in-
arrears on shares held by directors are to be shown separately. Similarly, Calls-
in-Advance should be treated as a separate items and shown accordingly.
3) Forfeited Shares Account, if any, should be added to paid-up Capital which
forms the part of total of Balance Sheet. It is to be noted that the Authorised,
Issued and Subscribed capitals are not considered for the purpose of total of
Balance Sheet.
4) Shares issued for consideration other than cash must be disclosed. Such as
shares allotted to transferor company under the agreement of takeover/merger,
Issue of bonus shares and the source thereof.
5) If preference shares have been issued, the terms of redemption or conversion
along with the earliest date of redemption/conversion must be specified.
6) Excess application money on account of over-subscription not requiring any
adjustment, should be refunded. If not, the money refundable must be shown as
part of current liabilities.

3.7.2 Reserves and Surplus

This may be in the following forms:
i) Capital Reserves: It refers to those profits which are not earned from normal
business operations. Such profits are not available for the purpose of distribution
as dividend. It is created out of profit on sale of-fixed assets or investments held
as asset, profit on reissue of forfeited shares, pre-incorporation profit, profit on
revaluation of fixed assets, profit on purchase/acquisition of assets or profit on
purchase of business (excess of net assets over purchase price).
ii) Capital Redemption Reserve: It is created when fully paid preference shares
are redeemed out of divisible profits of the company. This reserve may be
utilized for the purpose of issuing fully paid bonus shares to the members of the
91
company.
Fundamentals of iii) Securities Premium: When a company issues shares or debentures at a price
Accounting which is more than its face value, it is said to have issued shares/debentures at a
premium. The premium so received is transferred to “Securities Premium
Account”.
According to Section 78 of Companies Act, the premium may be utilized for –
issuing fully paid bonus shares, writing off preliminary expenses, discount on
issue of shares or debentures, and providing premium on redemption of
preference shares or debentures.
iv) Revenue Reserves: These may be in the form of specific reserves or free
reserves and are created out of revenue profits of the company. Usually such
reserves are formed from annual appropriation. Specific Reserves are created
for specific purpose. For example, Dividend Equalisation Reserve is created to
meet the shortfall in the divisible profits of the company intends to follow a
stable dividend policy. Or to redeem the debentures, a sinking fund or a deben-
ture redemption reserve may be created. Other specific reserves are Development
Rebate Reserve, Investment Allowance Reserve, Export Incentive Reserve, etc.
The term ‘Fund’ is used when the money earmarked for any specific purpose is
invested in ourside securities. For example, if money appropriated for the
purpose of redemption of debentures is invested outside and business is termed as
Debenture Redemption Fund, if not invested outside but retained or ploughed
back in the business, it is called Debenture Redemption Reserve.

Surplus
The Credit balance of Profit and Loss Account or P&L Appropriation Account (i.e.
after making necessary transfer to reserves and appropriating for proposed interim or
final dividend including bonus, if any) is shown under the heading as surplus. If a
company has a debit balance of Profit & Loss Account, the same should be adjusted
under this head.
3) Secured Loans: This refers to mortgaged loan or other loans, which are fully
secured either by a fixed or floating charge on the assets of the Company. It
includes loans from bank, financial institutions or from other companies pro-
vided these are secured against the specific or all assets of the company. Deben-
tures are assumed to have first floating charge on the assets of the company. It is
to be noted that interest accrued and due on secured loans is to be treated as and
shown under Secured Loans. Loan from or guaranteed by directors should be
disclosed and shown separately. In case of debentures, the terms of redemption/
conversion and its earliest date of redemption/conversion be stated.
4) Unsecured Loans: These are the loans against which no security stands a
pledged or mortgaged. It also includes amount not covered by the value of
security provided in respect of partly secured loans. It covers all loans which are
not at all secured such as –
– Fixed Deposits from public
– Loans and Advances from Subsidiaries
– Short-term loans and Advances from Banks and others
– Other Loans and Advances
– It may include creditors for purchase of an asset.
5) Current Liabilities and Provisions: This heading is split in two sub-headings :
current liabilities and prosvisions.
Current Liabilities: It refers to those liabilities which are to be paid or payable within
a period of twelve months. It includes, Sundry Creditors, Bills Payable, Outstanding
92 Expenses, Income Received in Advance, Amount payable to Subsidiaries.
It is to be noted that short-term loans and interest outstanding thereon are to be shown Financial Statements
under “Secured” or “Unsecured Loan” as the case may be and not under Current
Liabilities.
Provisions: Provisions such as Proposed dividend, Provision for Depreciation,
Repairs and Renewals, Provision for Doubtful Debts, Investment Fluctuation Reserve,
Provident Fund, Pension Fund etc. are shown separately under this head.

* Provision for Depreciation and Provision for Doubtful Debts may be

shown on the “Assets side” as a deduction from the asset concerned.

Contingent liabilities: As explained earlier, these liabilities are shown as a footnote

and include the following:
l Liability for bills discounted
l Claims against the company not acknowledged as debt
l Uncalled liability on partly paid shares
l Arrears of fixed cumulative preference dividends
l Guarantee given by the Company on behalf of directors or other officers of the
Company
l Estimated amount of contracts remaining to be executed on capital account not
provided for, and
l Other money for which company is contingently liable.

It is to be noted that if any provision is made against any contingent

liability, the same is to be shown under the head provisions.

Fixed Assets
Under this head there are eleven types of “fixed assets” starting from goodwill to
vehicles. According to AS-10 a fixed asset is an “asset held with the intention of being
used for the purpose of producing or providing goods or services and is not held for
sale in the normal course of business.” Even assets which are not legally owned but
held for the purpose of production are treated and shown under this head. These
include assets acquired under hire-purchase agreement and assets taken on lease, after
considering the addition and disposal, if any. Valuation of fixed assets is made at cost
less depreciation after considering the addition and disposal, if any.
It is worth remembering that “goodwill” should be shown in the books only when it is
acquired for some consideration. According to AS–26 internally generated goodwill
should not be recognized as an asset.
*As per Schedule VI the fixed assets are classified as follows:
1) Goodwill
2) Land
3) Building
4) Leasehold
5) Railway Slidings
6) Plant and Machinery
7) Furniture and Fittings
8) Development of Property
9) Patents, Trade Marks and Designs
10) Live Stock
11) Vehicles 93
Fundamentals of In case of revaluation of fixed assets, every balance sheet subsequent to such
Accounting revaluation must show the revised figures with the date of increase or decrease in
place of original cost. In ascertaining the cost of an asset all expenditures incurred in
bringing the asset to its working condition should be included. This includes cost of
transportation, expenditure on trial runs. In case of land and building, stamp duty,
registration fee and architects fees should be capitalised.
Investments
As per AS-13 (Accounting for Investments), “Investments are assets held by an
enterprise for earning income by way of dividends, interest and rentals, for capital
appreciation or for other benefits to the investing enterprise”. Assets held as stock-in-
trade are not investments. Money invested outside business is termed as investments
which may be long term, current investment or an investment property.

According to AS-13, a “current investment ” by its nature as readily realizable is

intended to be held for not more than one year, whereas an “investment propery” is an
investment in land or building that are not intended to be occupied substantially for
use by the enterprises.
Schedule VI requires investments to be shown as follows:
i) Investments in Government or Trust Securities.
ii) Investments in shares, debentures or bonds, fully paid up and partly paid
up and also different classes of shares.
iii) Immovable properties
iv) Investments in the Capital of partnership firms.
The following details about the investments must be given:
a) Nature of investment.
b) Mode of valuation of Investments.
c) Aggregate amount of company’s quoted investments and its market value.
d) Aggregate amount of company’s unquoted investments.
e) Amount of fully paid and partly paid shares.
f) Investment in subsidiary companies.
Current Assets, Loans and Advances
This is subdivided in two sub-headings:
A) Current Assets: As per the Guidance note issued by ICAI, “current assets means
cash and other assets that are expected to be converted into cash or consumed in the
production of goods or rendering or services in the normal course of business and
include:
i) Stock-in-trade (inventories of raw materials, work-in-progress finished
goods, stores and spare parts to be shown separately) including mode of
valuation.
ii) Debtors should show the age-wise and security-wise classification such as
Debts outstanding for a period of more than six months and other debts.
Debtors considered good in respect of which company holds no security
other than the debtor’s personal security.
Debts considered doubtful or bad.
Debts due by directors on other officers
Debts due from other companies (subsidiaries)
94
 Maximum amount due by directors or other officers of the company Financial Statements
(footnote through)
Provision for doubtful debts is required to be deducted from sundry debtors
Provision should not exceed the amount considered from sundry debtors.
Provision should not exceed the amount considered doubtful or bad. Any
excess provision be shown under “Reserve and Surplus”.
iii) Cash and Bank balances should be shown separately. Bank balances
should be classified into balances with scheduled banks and other banks
along with details of current account, saving bank and fixed deposits. Bank
overdraft, if any, should be shown under Sundry Creditors. This informa-
tion of inclusion be disclosed in a footnote that the Sundry Creditors
include bank overdraft amounting to Rs....

B) Loans and Advances

The disclosure rules which are applicable to sundry debtors, the same should be
applied to “Loans and Advances”, i.e. these should be shown in age-wise, security-
wise and reliability-wise classification. In addition the following should be shown:
i) Advances and loans to subsidiaries
ii) Advances and loans to partnership firms in which the company or subsid-
iary is a partner
iii) Bills of Exchange
iv) Advances recoverable in cash or kind or for value (Rent, Rates and Insur-
ance)
v) Balance with customers, port trust, etc. which are payable on demand
Miscellaneous Expenditure
These are the expenses incurred in earlier years but not written off. These include:
i) Preliminary expenses (Formation expenses incurred on preparation of Memoran-
dum and Articles of Association, legal fees, registration fee, etc.)
ii) Share and Debentures issue expenses, such as brokerage, underwriting commis-
sion, discount on issue of share and debentures.
iii) Interest paid out of Capital during construction.
Such miscellaneous expenditure is written off over a period for which benefit is
available.
Profit and Loss Account (Debit balance)
This represents past unwritten-off losses. These are adjusted and written off against
the free reserves (divisible profits/revenue profits) to the available extent. Unabsorbed
amount is shown under this head.

3.7.2 Items Peculiar to Corporate Income Statement

Salient Features
Though the procedure and the process of preparation of “Income Statement” of a
Company and that of non-corporate entities are similar in principles, there are some
differences in the method of presentation and some additional items which form the
part of a corporate income statement. These differences are as under:
1) Heading: Non-corporate entities name income statement as “Trading and Profit
and Loss Account”, while companies call it “Income Statement” or Profit and
Loss Account only. The items of Trading Account become the part of “Income
Statement”. No separate Trading Account is prepared. 95
Fundamentals of 2) Appropriation: Sole trader does not prepare any appropriation account, while
Accounting partnership firms and companies do. A company’s Profit and Loss Account is
split up in to two parts – “above the line” and “below the line”. All items of
appropriations are shown “below the line” and the remaining balance is trans-
ferred to the liabilities side of the balance sheet. A partnership firm prepares a
separate Profit and Loss Appropriation Account.
3) As per AS–5 extraordinary items (abnormal nature), prior period items are
shown separately whereas in case of non-corporate entities, such items are stated
along with the normal and routine items.
4) Requirement: The Profit and Loss Account of a company should conform to the
requirements of Schedule VI of Companies Act 1956 and adhere to AS–1; AS–4
and AS–5 recommendations, whereas non-corporate enterprises are not required
to do so.
5) Income Tax: It is treated as an expense for the companies while for firms and
sole trade enterprise, it is treated as drawings.
6) Companies’ Profit and Loss Account should disclose the figures for the previous
year along with the current year’s whereas non-company enterprises are not
required to show figures relating to previous year.

Treatment of Special Items of Profit and Loss Account

1) Interest on Debenture and Loans: This item includes interest paid and payable
for the financial period for which accounts are prepared and shown to the debit
side of Profit and Loss Account. Likewise, interest due but remaining outstand-
ing is taken to the liability side of the Balance Sheet. Interest on Debentures and
interest on secured loan outstanding, if any, is shown under the heading “Secured
Loans” whereas interest outstanding on unsecured loan is shown under “unse-
cured loans”.

It is to be noted that interest on loan for the construction period should be

capitalized and added to the cost of the asset concerned.

2) Tax on Interest on Debentures: As per Income Tax Act 1961, every company
must deduct tax at source (TDS) while paying interest to the debenture holders. The
amount so deducted shall be deposited with the Government treasury. The current
rates for TDS are as follows:
Debentures (listed) 10.5% including surcharge
Debentures (unlisted) 21% including surcharge
If A ltd. has to pay interest on its 9% debentures (listed) of the face value of Rs.
5,00,000, then gross interest will be Rs. 45,000 and tax deducted at source Rs. 4,725
balance shall be paid to the Debenture holders Rs. 40,275. The following entry is
recorded –
Interest on Debentures A/c Dr 45,000
To Debenture Holders A/c 40,275
To Income Tax Payable A/c 4,725
Income Tax deducted but not deposited with the Government is to be shown in the
Balance Sheet under the heading “Current Liabilities”.

It should be remembered that Profit and Loss Account will always be

debited with the gross amount of interest.
96
3) Discount on Debentures/Loss on Issue/Debenture Issue Expenses: Discount Financial Statements
on issue of debentures, debenture issue expenses such as commission, brokerage,
etc. are premium payable on redemption (treated as loss on issue which may
include discount also) are to be written off as early as possible, or over the life
span of the debentures, depending upon the policy of the company in the absence
of any specific instructions in the question, such amount should be written off on
the basis of debentures outstanding. The unwritten off balance is to be shown on
the assets side of the Balance Sheet under the heading of ‘Miscellaneous Expen-
diture’.
It should be remember that only written off amount is charged to Profit and Loss
Account.
4) Prelimiary Expenses: As already explained under Balance Sheet items, it
appears on the assets side of the Balance Sheet under the heading ‘Miscellaneous
Expenditure’ as long as it is not written off. The amount written off is charged to
Profit and Loss Account. If there is no specific instructions relating to the
amount to be written off, then the entire amount should be shown in the
Balance Sheet.
5) Corporate Income Tax: This is shown under three stages.
i) Advance Income Tax: As per Income Act 1961, the companies are required
to pay income tax on the profits earned. They have to deposit advance tax
under PAYE (Pay As You Earn) scheme on specific dates during the finan-
cial year. The advance tax so paid is adjusted against income tax liability.
The unadjusted amount of advance income tax is shown as an asset under
the heading Current Assets, Loans and Advances.
ii) Provision for Taxation: While preparing Profit and Loss Account, a
provision for income tax is created on the basis of current year’s profit to
meet the actual tax liability. The amount so provided depends on the prevail-
ing tax rate. The current rate of corporate tax is 35% plus 5% surcharge for
domestic companies and 40% plus 5% surcharge for foreign companies. The
following entry is recorded.
Profit and Loss Account Dr.
To Provision for Taxation A/c
AS–22 “Accounting for Taxes on Income” recommends that the net balance, i.e.
excess of “Advance Tax” may be shown on the assets side or liabilities side of the
Balance Sheet as the case may be, till the final assessment is made and actual tax
liability is determined by the tax authorities.
iii) Determination of Actual Tax Liability: As per Income Tax rules, income
(profits) for the previous year is assessed and taxed in the assessment year.
When the assessment is completed the provision for taxation so created
may either fall short of actual tax liability or may exceed the tax liability.
Such a shortfall or excess is treated as prior period item (AS–5) and
therefore its adjustment is made in the Profit and Loss Account but
“below the line”, either to the debit side (for shortfall) or to the credit
side (for excess).
On the other hand, the actual tax liability is compared with advance income
tax paid. In case actual tax liability is more than the amount of advance
tax paid the same may be paid or shown as a current liability in the
Balance Sheet and if advance tax paid exceeds, the difference being
refund should be stated under Current Assets Loans and Advances in the
Balance Sheet.
97
Fundamentals of Illustration 4
Accounting
Extracts from a Trial Balance of a Company
As on 31st March, 2003.
Dr. Cr.
(Rs.) (Rs.)
Provision for Taxation (2001-02) 2,50,000
Advance Income Tax (for 2001-02) 2,60,000
Advance income Tax (for 2002-03) 3,00,000

Additional Information
i) The actual tax liability for the year 2001-2002 amounted to Rs. 2,75,000
ii) provision for Taxation for the year 2002-03 of Rs. 2,85,000 is required to be
made.
Show the relevant information in the relevant ledgers.

Solution

Profit and Loss Account (Extracts)

for the year ended 31st March 2003
Rs.
To Provision on for Taxation
(2002-03)
285,000

–––––– ––––––
} above the
line

–––––– ––––––
To provision for Taxation (2001-02)
(Rs 2,75000-2,50000)
Tax Liability-Provision
25,000
} below the
line

Balance Sheet (Extracts)

As on 31st March 2003
Liabilities Rs. Assets Rs. Rs.
Loans & Advances
Advance Tax 3,00,000
Current Liabilities (Current Year)
Less Provision for
Income Tax payable (2001-02) 15,000 Taxation 2,85,000 15,000
(Tax liability–Advance Tax)
Rs. 2,75,000 – Rs. 2,60,000)

Provision for Taxation (2001-02)

Rs. Rs.
To Income Tax (Tax liability) 275,000 By Balance b/d 250,000
By Profit & Loss A/c 25,000
(below the line)

275,000 275,000

98
 Financial Statements
Provision for Taxation (2002-03)

Rs. Rs.
To Balance C/d By Profit and Loss A/c
2,85,000 (above the line) 2,85,000

2,85,000 2,85,000

Illustration 5: From the following extract of a Trial Balance and the additional
information, show the treatment of taxation, in the relevant ledger accounts:

Trial Balance (Extracts)

As on 31st March 2002
Dr. (Rs.) Cr (Rs.)
Provision for Taxation 1,20,000
Income Tax 1,10,000
Additional information: Provide Rs. 1,50,000 for provision for taxation.

Solution
Provision for Taxation A/c (old)
To Income Tax 1,10,000 By balance b/d 1,20,000
To Profit and Loss A/c. 10,000
(below the line)
1,20,000 1,20,000

Provision for Taxation A/c (New)

Rs. Rs.
To balance c/d 150,000 By Profit and Loss A/c. 150,000
(To be taken to liabilities) (above the line)
side of B/S
150,000 150,000

Profit and Loss Account (Extracts)

Rs. Rs.
To provision for Taxation 150,000 -Above
(New)

––––––
} the
line
––––––
By Provision
for Taxation

––––––
10,000

––––––
} - below
the
line

99
Fundamentals of Balance Sheet (Extracts)
Accounting As on 31st March 2002

liabilities Assets Rs.

Current liabilities and Provision
B. Provisions:
provision for Taxation 15,000
Illustration 6
From the following particulars prepare necessary accounts for the year ending
31st March 2003:

Trial Balance (Extracts)

As on 31st March 2003
Dr. Cr.
Rs. Rs.
Provision for Taxation (1.4.2002) 4,59,000
Advanced Tax Paid (1.4.2002) 4,20,000
Tax Deducted at Source (1.4.2002) 3,500

On 1.1.2003, the assessment was completed and tax liability of Rs. 5,30,000 was
determined Advance payment of tax for the year 2002-03 amounted to Rs. 5,10,000.
A provision for taxation is to be made for Rs. 5,75,000 for the year ended 31st March
2003.

Solution
Provision for Taxation Account
Rs. Rs.
To Income Tax A/c (Tax liability) 5,30,000 By Balance b/d 4,50,000
By profit & Loss A/c
(below the line) 80,000
5,30,000 5,30,000
To Balance C/d 5,75,000 By Profit & Loss A/c 5,75,000

Advance Income Tax account

Rs. Rs.
To Balance b/d 4,20,000 By income Tax A/c 4,20,000

4,20,000 4,20,000

Income Tax Account (Tax liability)

Rs. Rs.
To Advance Income Tax A/c 4,20,000 By Provision for 5,30,000
To Tax Deducted at source A/c 3,500 Taxation A/c
To Bank A/c. (Balance Paid) 1,06,500
5,30,000 5,30,000
100
 Profit and Loss Account Financial Statements
For the year ended 31st March 2003
Rs. Rs.
To Provision for Taxation
(2002-03) 5,75,000 } Above the line

To Provision for Taxation 80,000 } below the line

(2001-02)

6) Managerial Remuneration
The payment of managerial remuneration is governed by the provisions of
sections 198 and 309 either by the Articles or by a ordinary/special resolution
passed by the company in general meeting. Managerial personnel refers to
managing director, whole-time director, part-time director and manager. The
provisions of Companies Act shall apply to a public company and private
company and a private company which is a subsidiary of a public company but to no
other private company.
The over all managerial remuneration payable by a public company or a private
company which is a subsidiary of a public company to it’s managerial personnel shall
not exceed 11% of the net profits for that financial year. Remuneration limit does not
include fees. Within the maximum limit of 11% a company may pay a monthly
remuneration to its managing or whole-time director in accordance with the provisions
of Section 309 or to its manager in accordance wit the provisions of Section 386 of
the Companies Act. In case there is no profit or inadequate profit for any year, the
company may pay remuneration as per the provisions of Schedule XIII of the
Company Act.

7) Contribution/donation to a Political party

Any contribution or donation to any political party must be disclosed separately
in the Profit and Loss Account. According to section 293, Government
companies and companies with less than three years are not allowed to make any
political contribution or donation. Those allowed can make such contribution up to
5% of it’s average profit. The average net profit for this purpose are to be
determined on the basis of the three immediately preceding financial years’
profit as determined in accordance with the provision of Section 349 of the
Company Act.

8) Prior Period Items

The nature and amount of prior period items should be separately disclosed in the
Profit and Loss Account in a manner that there impact on the current profit or
loss can be perceived. In case, accounts are adopted in the annual general
meeting and if some adjustments relating to previous year are to be made, these
should be stated below the line, i.e. in the Profit net Loss Appropriation account as
per AS-5.

9) Extra-Ordinary items
Extraordinary items are incomes or expenses that arise from events or transactions
which are clearly distinct from the ordinary activities of the enterprise and therefore,
are not expected to recur frequently or regularly, these items should be disclosed in the
statement of profit and loss as a part of profit or loss for the period (AS-5). “Fixed
assets destroyed in an earthquake” is an example of “Extraordinary items”.
101
Fundamentals of 10) Contingencies and Events occurring after balance Sheet Date
Accounting
As per AS-4, the amount of a contingent loss should the be provided for by a charge
in the statement of Profit and loss if:
i) it is possible that future events will confirm that an asset has been impaired or a
liability has been incurred as at the Balance Sheet date and
ii) A reasonable estimate of the amount of the resulting loss can be made.
The existence of a contingent loss should be disclosed in the financial statements if
either of the above condition is not met, unless the possibility of loss is remote.
Contingent gains should not be disclosed in the financial statements. Only virtually
certain gains should be recognized.

11) Appropriation and Disposition of Profits

Once the profits have been ascertained as per the statement of profit and loss, the next
step is the appropriation and disposition of the available profit. It includes:
i) Transfer to general reserve and other reserves such as capital redemption reserve.
Development rebate reserve etc.
ii) Transfer to sinking fund.
iii) Transfer to Dividend Equalization fund.
iv) Providing for interim or final dividend, and
v) Paying bonus to share holders.
All these items are treated “below the line” or a separate “Profit and loss
Appropriation Account” is prepared.

12) Dividends
Dividends refers to that amount of divisible profits which is distributed among the
share holders of the company. A member (shareholder) is entitled to receive dividend
when it is declared by the Board of directors as per the provisions of the Article. The
Board has absolute right to recommend the rate of dividend to the declared subject to
the approval of shareholders and provisions of Articles of Association. However, the
shareholders cannot compel the Board recommend & declare dividend. It is to be
noted that dividend is always declared for the working of one financial year at the
annual general meeting. In case the dividend could not be declared at the annual
general meeting the same can be declared at the Extraordinary meeting. The power to
declare dividend is implied and does not require express authority either in the Articles
or Memorandum of Association. It should be remembered that, where a dividend has
been declared at Annual General Meeting, neither he company nor the directors can
declare a further dividend for the same year at the subsequent general meeting. It is
known as Final Dividend.
No devidend should be paid out of capital. Dividends should be paid in proportion to
the amount paid up on each share. No dividend shall be payable on calls in advance
unless authorised by the Articles. Dividend should be payable in cash except when it
is adjusted towards unpaid amount on shares or where bonus shares are issued.
According to Section 205 (2A) no company shall declare or pay dividend for any
financial year out of the profits from that year unless certain percentage of profit as
prescribed by Central Government not exceeding 10% has been transferred to reserve.
However, the company may voluntarily transfer higher percentage of the profit to its
revenue subject to the rules laid down under the Companies (Transfer of Profits to
Revenue) Rules 1975 as amended in 1976. A newly incorporated company is
prohibited to transfer more than 10% of its profits to revenue for the initial
102 three years.
i) Preference Dividend: The preference dividend is paid to Preference Financial Statements
shareholders at a pre-determined fixed rate on priority basis. These holders are
entitled dividend in preference to equity shareholders. However the preference
shareholders can claim dividend only out of profits and if it is declared at the
annual general meeting. If preference shares are of cumulative nature, the
arrears of preference dividend if any, shall be payable to preference
shareholders before any equity dividend. It should be noted that preference
shareholders cannot force the company to pay all the dividends including
arrears. If equity shareholders are not paid any dividend, preference
shareholders cannot claim any dividend from the company. It is to be noted
that the arrears of preference dividend are treated as a contingent liability
which appears as a foot note under the Balance Sheet.
Not–cumulative preference shares are not entitled to any arrears resulting from
non-payment of dividend due to losses or inadequate profits. If a company has issued
participating preference shares with a right to participate in the balance of profits, left
after paying fixed preference dividend and a certain percentage of equity dividend,
then the participating preference shareholders are entitled against a certain percentage
out of the balance (residua) profit as per the items of issue. For example 9%
preference shares may be issued with a further right to 40% of the excess dividend
over 20% paid to equity shareholders. If a company declares 25% dividend to equity
to equity shareholders, the preference shareholders will get 11% dividend. (9% plus
40% of (25%-20%) i.e., 2%).
ii) Unclaimed Dividend: According to Section 205 A of the companies Act 1956
dividends remaining unpaid must be deposited in the “unpaid unclaimed Dividend
account within 42 days of declaration of dividend. Any claim thereafter, must be met
out of the unclaimed dividend account. Money so transferred to the aforesaid account
which remains unpaid or unclaimed for a period of seven years from the date of such
transfer, shall be transferred to “Investor Education and Protection Fund” maintained
u/s 205 of Companies (Amendment) Act 1999.
Unclaimed dividend appears on the liabilities side of Balance Sheet under the head
“Current liabilities & Provisions”.
iii) Proposed Dividend: Dividend recommended by the directors to be paid to
shareholders for any accounting period on or after the close of books of accounts but
before the Annual General Meeting, is known as proposed dividend. Once it is
approved by the shareholders in the General meeting, it becomes final dividend. It is to
be noted that rate of dividend declared cannot exceed the proposed dividend. Proposed
dividend is an appropriation of profit, hence it is shown to the debit side of profit and
loss Appropriation Account and on the liabilities side of balance sheet under the
heading “Current liabilities and Provisions”.
iv) Final Dividend: It is a dividend which is declared at the annual general meeting of
the shareholders. Such dividend is declared only after the close of books of accounts;
the share holders may reduce the rate of final dividend but cannot increase it. Once the
final dividend is declared it becomes the liability of the company. It should be noted
that when a final dividend is declared then interim dividend is not adjusted unless there
is any specific resolution for such adjustment. Final dividend is paid on paid up
Capital for the whole year as against the interim dividend, which is usually paid only
for six months. For example N Ltd. has 5,00,000 shares of 10 each Rs. 8 paid,
declares 5% p.a. interim dividend and final dividend @ 10% p.a., then the total
dividend will be Rs. 5,00,000 i.e. (Rs. 1,00,000 interim dividend + Rs. 4,00,000 final
dividend)
I.D. = (4, 00,000 5/100 × 6/12 = 1,00,000) + F.D. = (4,00,000 × 10/100) 103
Fundamentals of v) Interim Dividend: A dividend declared by the Directors between two annual
Accounting general meetings of the company is known as interim dividend, where the directors
believe that the company will have sufficient profits available for dividends at the end
of the year, they may distribute a part of the profit as a part payment on account.
Payment so made in anticipation and on account of total dividend to be paid for the
year is treated as interim dividend. However, such payment must be authorised by the
Articles. Interim dividend should be declared only when the company has even a better
prospects for the second half as well. Regulation 86 of Table–A provides that “Board
may from time to time pay to the members such interim dividend as it appears to be
justified by the profits of the company.” Thus, there is no limit on the number of
interim dividend the company may pay in a year. The payment of interim dividend
does not require approval of general meeting.
Companies (Amendment) Act 2000 has granted statutory recognition to the right of
directors to declare interim dividend. The term dividend now includes interim dividend
also. All provisions the Companies Act which apply to dividends have now become
applicable to interim dividends also. A company cannot declare any interim dividend
unless it has made:
i) necessary provision for depreciation for the whole year.
ii) prior adjustment of accumulated losses, if any
iii) and transfer to general reserve as required u/s 205 (2A)
Once an interim dividend is declared it becomes legally enforceable debt
against the Company. Prior to the Amendment Act 2000 the interim dividend
was not an enforceable debt Board had right to rescind the resolution
already passed.
The period, for which an interim divided is paid, is usually six months. However,
students should note that whether the rate of dividend includes the words “per
annum” or not. For example the directors of a company declare an interim dividend @
12% per annum, the interim dividend shall be calculated only for six months. If the
rate declared by directors is 12% and the words “per annum” are not mentioned, then
the dividend shall be calculated @ 12% without reference to time. i.e. 12% x amount
of paid up Capital. If the Capital of the company is Rs. 10,00,000 then
in the first case interim dividend will amount to Rs. 60,00 and in the second
case Rs. 1,20,000.

vi) Corporate Dividend Tax

Finance Act 1997 had exempted the dividend in the hands of shareholders and
introduced corporate dividend tax to be paid by the dividend paying company.
Thereafter, the corporate dividend tax was withdrawn by the Finance Act 2002
and the burden of tax was shifted on the shareholders and hence company was not
liable to pay any tax on dividend declared, distributed or paid between 1.4.2002. to
31.3.2003.
The Finance Act 2003 has again shifted the liability of such tax on the domestic
companies who shall be liable to pay additional tax on the amount declared,
distributed or paid by way of dividends on or after 1.4.2003. The rate of tax being
12.5% plus surcharge @ 2.5% which is equal to 12.8125%* This rate is applicable
for the financial year 2003-04.
Note: Students should verify the rate applicable because this rate may be changed by
the Finance Act 2004 or by the subsequent Finance Act. It is further to be noted that
dividends from domestic companies in the hands of shareholders are totally exempt
again. As per guidance not it is be treated as appropriation.
104
13) Transfer to General Reserve Financial Statements

According to section 205 (2A) no company shall declare or pay dividend for any
financial year out of the profits for that unless a certain percentage of profits as
prescribed by the Central government not exceeding 10%, has been transferred to
reserve. As per the Central Government rules transfer to revenue should be made as
follows:
The Central Government has prescribed the following rules under the companies
(Transfer of profits to reserve) Rules 1975 as amended in 1976.

Rate of Dividend Percentage of profits* to

be transferred to reserve
(i) If the rate of 10% but not 12.5% 2.5%
dividend exceeds
(ii) “ 12.5% to 15% 5%
(iii) “ 15% to 20% 7.5%
(iv) If the rate of 20% 10%
dividend exceeds

Accounting Treatment of Dividend

Illustration 7
X Ltd. has a paid up capital of Rs. 30,00,000 dividend into 2,00,000 equity shares of
Rs. 10 each and 10% 1,00,000 preference shares of Rs. 10 each. Other particulars
were as under.
Rs.
Opening balance of Profits and loss Appropriation Account 57,500
Net profit earned during the year (after Tax) 7,50,000
Dividend Declared for the year 22%
Prepare Profit and Loss Appropriation Account. Comply with necessary statutory
provisions.

Solution
Profit and Loss Appropriation Account
Rs. Rs.
To General Reserve (1) 75,000 By Balance b/d 57,500
To Preference Dividend (2) 1,00,000 By Net Profit 7,50,000
To Equity Dividend 4,40,000
To Corporate Dividend (3) 67,500
Tax 1,25,000
To Balance c/d
8,07,500 8,07,500

Working notes
(1) As per the provisions of the section 205 on a dividend of 22% a statutory
transfer of 10% on the net profit to be made.
(2) Declaration of equity dividend will automatically make the company liable to pay
preference dividend. No equity dividend can be paid without paying preference
dividend.
(3) A corporate dividend Tax (C.D.T.) @ 12.5% has been provided. A surcharge of
2.5% has been ignored for the sake of simplicity. However, the effective rate of
C.D.T. is 12.8123% including surcharge. 105
Fundamentals of Illustration 8
Accounting
Victor Ltd. disclosed the following particulars:
Rs.
9% 80,000 Preference shares of Rs. 10 each fully paid 8,00,000
50,000 Equity shares of Rs. 10 each fully paid 5,00,000
30,000 Equity shares of Rs. 10 each Rs. 8 paid up 2,40,000
20,000 Equity shares of Rs. 10 6 paid up 1,20,000
The directors proposed a dividend of 15% or equity shares and resolved to make the
following appropriations:
– Transfer to general reserve as per the provisions of the section 205
– Transfer to dividend equalisation fund Rs. 1,75,000
– Transfer to debenture Redemption Fund Rs. 1,00,000
– Transfer to Investment Allowance Reserve Rs. 1,25,000
The net–profit (before tax) for the year amounted to Rs. 12,50,000 you are required to
prepare Profit and Loss Appropriation Account. Provide for income tax @ 50% and
Corporate Dividend Tax @ 12.5%

Solution
Profit and Loss Appropriation Account
Rs. Rs.
To General Reserve1 31,250 By Net Profit (After tax) 6,25,000
To Dividend Equalisation fund 75,000
To Debenture Redemption Fund 1,00,000
To Investment Allowance Reserve 1,20,000
To Proposed Dividend
– Preference Dividend 72,000
– Equity Dividend 1,29,000
To Corporate Dividend Tax2
On Rs. (72000 + 1,29,000) 25,125
To Balance c/d 67,625

6,25,000 6,25,000
Working
1. As per the statutory requirement, a transfer of 5% of the net profit after tax” has
been made to General Reserve
2. Corporate dividend tax has beesn provided on the total dividend.

3.8 REQUIREMENTS FOR CORPORATE FINANCIAL

STATEMENTS AS PER SCHEDULE VI
The Balance Sheet of a company like any other business organisation is a statement of
assets and liabilities. However, in the case of a company, the nature of the details to be
shown and the order of the arrangement of the items must conform to the requirements
prescribed in Schedule VI, Part I of the Companies Act. There items are already
discussed under 3.7.1 of this Unit.

The requirements as to Profit and Loss Account are as follows:

i) The Profit and Loss Account shall be so made out as clearly to disclose the result
of the working of the company during the period covered by the P&L account
and shall disclose every material feature, including credits or receipts and debits
or expenses in respect of non-recurring transaction or transactions of an
106 exceptional nature.
ii) The Income Statement is not required to be split in the parts, such as Financial Statements
Trading Account, profit earned and appropriated. Schedule VI only
recommends to disclose gross profit, net profit and it’s appropriation there of.
This may be shown under one head of Income Statement or Profit and Loss
Account. Chargeable items are shown “above the line” whereas appropriations
“below the line”.
iii) Figures relating to previous year should also be shown along with the current
year’s figures in a separate column.
iv) As far as possible information given in the statement must be complete in all
respects. Such as the details of “turnover” made by the company should disclose
sales in respect of each class of goods & their quantities separately. Likewise
commission paid to sole selling agents and to other agents should be shown along
with the brokerage.
v) The Account should disclose quantities and values of various types of raw-
material purchased and quantities and values of various products produced/
purchased including opening and closing balances there of and that of work-in-
progress.
vi) The amount provided for depreciation, renewals or diminution in value of fixed
assets and the method adopted for making such provisions.
If no such provision has been made- the fact should be disclosed by way of note
including arrears of depreciation.
vii) The amount of interest on company’s debentures and on other fixed period loans
be stated separately, including interest paid or payable to directors.
viii) The amount of Income Tax on profits as per Income Tax Act 1961 at the pre-
scribed rate including other taxes if any, should be shown separately.
ix) Expenditure incurred on each of the following items be disclosed separately–
a) Consumption of stores and spare parts
b) Power and fuel
c) Rent
d) Repairs to Building
e) Repairs to Machinery
f) i) Salaries, Wages and bonus
ii) Contribution to provident and other funds
iii) Workmen and staff welfare expenses
g) Insurance
h) Rates and Taxes (excluding income tax)
i) Miscellaneous expenses provided any item exceeds 1% of revenue of
Rs. 5,000
Whichever is higher be shown separately.
j) Payment to Auditor
a) as auditor
b) as advisor in respect of
i) Taxation matter
ii) Company law matters
iii) Management services
k) Remuneration received by managing directors or managers either from the
company or it’s subsidiaries should be indicated separately including it’s
computation. 107
Fundamentals of x) The Profit and Loss Account should disclose the various items of incomes
Accounting arranged under appropriate heads.
a) Turnover giving details in respect of each class of goods indicating
quantities of such sales for each class separately.
b) Amount of income from interest specifying the nature of the income
c) Income from investment stating from trade investments & other investments
d) Profit or losses or investments
e) Dividends including dividends from subsidiary companies
f) Miscellaneous incomes such as royalty, fees etc.
g) Foreign exchange earnings, if any
The Profit and Loss Account must be made out in such a manner that discloses “true
and fair” view of the profit or loss of the company for the current accounting year.
This means that items of extraordinary nature or those unrelated to company’s
business or items relating to previous years (Prior Period items) should be separately
stated, if these are material.
Similarly amount drawn from reserves, profits from revaluation of assets or profits
arising due to change in method of accounting or major policy change in the method of
valuation higher the operating efficiency or position much better that it actually is
would be contraray to the spirit of law.

3.9 BASIC PRINCIPLES GOVERNING THE

PREPARATION OF FINANCIAL STATEMENTS
1) Materiality: It is a relative term. What is material for one company may be
immaterial for other. According to American Accounting Association (AAA) an item
should be regarded as material if there is reason to believe that knowledge of it would
influence the decision of informed investors, banks, creditors & other interested
parties. AS-5 sates that all material information and items should be disclosed which
are necessary and vital to make the financial statements more clear and
understandable – operating efficiency — wise and financial-position-wise. Treatment
of certain expenditure as capital by one company and revenue by the other is a clear
example of it. Hence materiality is purely matter of personal judgment which is guided
by size and nature of enterprise.
2) Prior Period Items: (AS-5)
As a matter of fact the Profit and Loss Account should disclose the profit or loss for
the period for which accounts are prepared, that is for the reported (current) period. If,
however, some items were omitted to be accounted for in the preparation of financial
statements then it is not possible to reopen the accounts for the previous year after it
has been adopted by the shareholders in the annual general meeting. The ICAI defines
“Prior Period Items” as incomes or expenses which arise in the current period as a
result of errors or omissions in the preparation financial statements of one or more
periods”. The errors may occur as a result of mathematical mistakes, oversight
(omissions), misinterpretation of facts and wrong application of accounting policies or
a wrong or inaccurate estimate. Hence these items should be shown “below the line”
i.e. in the Profit and Loss Appropriation Account. However, prior period adjustments
do not cover–
– Minor omissions of accruals and prepayments
– Prior period’s revenue which was not accounted for on the ground of
prudential practice.
– Recovery of bad debts written off earlier
– Adjustments to the useful life of the depreciable assets
108
3) Extra Ordinary Items: (AS–5) Financial Statements
Extraordinary items are income or expenses that arise from events or transactions that
are clearly distinct from the ordinary activities of the enterprise and, therefore, are not
expected to recur frequently and regularly (AS-5). These items are shown in the Profit
and Loss Account for the period but the nature of such items should be disclosed
separately. These include
– Write down of inventories to “net realizable value”
– Profit or loss on sale of fixed assets or long-term investments.
– Reversals of provisions
– Reversals of writing off of the fixed assets
– Losses sustained on account of an earthquake.
4) Change in Accounting Policies: (AS-5)
Accounting policies are the specific accounting principles and the methods of applying
these principles adopted by an enterprise in the preparation and presentation of
financial statements. A change in accounting policy is required by statue or by the
accounting standard setting body or if it is considered that the change will result in a
more appropriate presentation of the financial statements of the enterprise. Any
material effect of such a change in the current or subsequent periods should be
quantified and disclosed together with the reasons for the change. Following are the
change in policy:
– A change in the method of charging depreciation from written down value
(WDV) to straight line method (SLM) and vice versa.
– A change in the method of valuation of inventories.
However, a change in the estimated life of a machine is not a change in policy
but a change in estimate.

3.10 PREPARATION OF CORPORATE FINANCIAL

STATEMENTS
As already stated, the Board of Directors of the company shall present a Balance
Sheet as at the end of the period; and a Profit and Loss Account for that period at the
annual general meeting. In case of company not carrying on business for profit, an
Income and Expenditure Account shall be laid at the annual general meeting instead of
Profit and Loss Account. Every Profit and Loss Account shall also give a “true and
fair” view of profit or loss of the company for the financial year and shall comply with
the requirements of schedule VI. Every Insurance or Banking company or any
company engaged in the generation of electricity or any other class of company for
which the Profit and Loss Account has been specified under the Act governing such
class of company need not follow the Form given in Schedule VI to this Act. Similarly
every Balance Sheet shall give a “true & fair” view of the state of affairs of the
company as per Schedule VI. Any Insurance or Banking company or any company
engaged in generation or supply of electricity or any other class of company for which
a form of Balance Sheet has been prescribed under the Act governing such class of
company need not to follow such form.
Recently the Companies (Amendment) Act 1999 has made the compliance of
accounting standards mandatory. Accordingly every Profit and Loss Account and
Balance Sheet of the Company shall comply with the “Accounting Standards”.
However, in case of non-compliance the company must disclose the ‘deviation’ from
the accounting standards. It should also state “reasons” for such deviation; and
“financial effect” if any, due to such deviation.
On the basis of requirements of Schedule VI and accounting standards following is the
format of Profit and Loss Account of a Company. 109
Fundamentals of Profit and Loss Account of ....
Accounting
For the year ended 31st March ....

Figure Figures Figure Figures

for the for the for the for the
previous current Previous current
year year year year
Rs. Rs. Rs. Rs.

... To Opening Stock ... By Sales Less Returns ...

... Raw Material ... ... By Income from Services ...
... Finished Goods ... ... By Closing Stock ...
... To Purchases (Raw materials) ... ... Raw Materials ...
... Less Returns ... ... Work-in-progress ...
... To Stores & Spares (consumed) ... ... Finished Goods ...
... To Power and Fuel ...
... To Wages (Productive) ...
... To Manufacturing Expenses ...
... To Gross Profit c/d
xxx xxx
... ... ... By Gross Profit b/d ...
... To Rent ... ... By Income from
Investments ...
... To Repairs to Building ... By Profit on Sale of
Investment ...
... To Repairs to Machinery ... By Dividend Income ...
... To Salaries & Bonus ... By Miscellaneous
Incomes ...
... To Contribution to Provident
Fund ...
... To Staff Welfare Expenses ...
... To Contribution to
Pension/Gratuity Fund ...
... To Insurance ...
... To Rates & Taxes ...
... To Printing & Stationery ...
... To Postage, Telegrams, Fax &
Telephone ...
... To Commission, Brokerage
and Discount ...
... To Bank Charges & Interest ...
... To Depreciation ...
... To Loss on sale of Investments ...
... To Remuneration payable to ...
... Directors & other ...
... Managerial Personnel ...
... To Auditor’s Fee ...
... To Provision for Taxation ...
... To Net Profit (transferred to ...
Profit & Loss Account) ...

xxx xxx xxx xxx

110
 Schedule VI Financial Statements
(Part I - Form of Balance Sheet)
(Conventional Format)
Balance Sheet of...............
As on 31st March..............

Figure Figures Figure Figures

for the for the for the for the
previous Liabilities current Previous Assets current
year year year year
Rs. Rs. Rs. Rs.
Share Capital Fixed Assets
Authorised*.... shares of Goodwill
Rs. ...... each. Land
Issued..... shares of Rs. Each Building
(*Various classes of shares and Leasehold
their called up amount including Railway sidings
details of Plant and machinery
- Shares issued for consideration Furniture and Fittings
other than Cash Development of Property
- Bonus Issue made, if any Patents, Trade Marks and
Less Call Unpaid Designs
(i) By Directors Live Stock and Vehicles etc.
(ii) By Other Investments
Add. Forfeited shares Showing nature of Investment
(amount actually paid) and mode of valuation-cost
Reserves & Surplus Or market value, and
(1) Capital Reserve distinguishing between
(2) Capital Redemption Reserves (1) Investments in Government
(3) Securities Premium or Trust Securities
(4) Others Reserves & specifying (2) Investments is Shares,
the nature of each reserve and Debentures or bonds
amount in respect there of (Giving details of classes
Loss Debit balance of P&L A/c of shares along with their
(5) Surplus-Balance in paid up value)
Profit and Loss Account after (5) Immovable Properties
providing for proposed (4) Investments in Capital of
allocation namely Partnership firms.
Dividend-Bonus, or Reserves Current Assets, Loans and
(6) Proposed Additions to Reserves Advances
(7) Sinking Fund (A) Current Assets
Secured Loans (1) Interest Accrued on
(1) Debentures Investments
(2) Loans & Advances from Banks (2) Stores and Spare parts*
(3) Loans & Advances from subsidiaries (3) Loose Tools
(4) Other loans & Advances (4) Stock in Trade*
* Interest accrued and due should be (5) Work-in Progress*
Included in the respective sub-head) * Mode of valuation and
* Nature of security to be specified in Amount in case of raw
each case) materials
* Terms of redemption or conversion of Sundry Debtors
debentures to be stated together with (a) Debts outstanding for a
earliest date of conversion/redemption. period exceeding six
months
Unsecured Loans (b) Other debts
(1) Fixed Deposits (Less Provision)
(2) Loans & Advances from subsidiaries In regard to sundry debtors,
(3) Short-term loans & advances particulars to be given
(a) From Banks separately
(b) From Others (i) Debts considered good
(4) Other loans and advances and In respect of which
(a) From Banks company is fully secured
(b) From Others (ii) Debts considered good
111
Fundamentals of Current Liabilities & Provisions for which company holds
Accounting A. Current Liabilities no security other than the
(i) Acceptances debtor’s personal security.
(ii) Sundry Creditors (iii) Debts considered doubtful
(iii) Subsidiary Companies doubtful or bad.
(iv) Advance payments and (iv) Debts due by directors
Unexpired discounts for the portion or Other officers or any
for which value has still to be give of them either severally
e.g. in the following classes of companies or jointly with any other
Newspaper, Fire-Insurance, Theaters, person or debts due by
Clubs, Banking & Steamship Companies firms or private
(5) Unclaimed Dividends companies respectively
(6) other Liabilities, if any in which any director or
(7) Interest accrued but not due on loans a member–to be
separately stated.
B. Provision (7a) Cash Balance at hand
(8) Provision for taxation (7b) Bank Balances
(9) Proposed dividends (i) With Scheduled banks &
(10) For Contingencies (ii) With Others
(11) For Provident Fund Scheme (B) Loans and Advances
(12) For Insurance, Pension and (8) (a) Advances loans to
Similar Staff Benefit schemes Subsidiaries.
(13) Other provisions (b) Advances and loans to
Partnership firms in which
company or any of it’s
subsidiaries is a partner.
(9) Bills of Exchange
(10) Advance receivable in cash
or in kind or for value to be
received e.g. rate, taxes
Insurance etc.
(11) Balances on Current
Accounts with managing
Agents, secretaries and
Treasures.
(12) Balances with customs
Port trust (where payable
on Demand)
Misc. Expenditure
(1) Preliminary Expenses
(2) Expenses including
commission, or brokerage on
underwriting or subscription
of shares or debentures.
(3) Discount on issue of Shares
or debentures
(4) Interest paid out of capital
during construction period
(5) Development Expenditure
not adjusted
(6) Other items (specifying nature)
Profit and Loss Account
(Debit balance of P&L A/c
Carried forward after
adjusting uncommitted
(free) reserves, is any.)
xxx xxx xxx xxx

112
Footnote: to be shown separately such as: Financial Statements

1) Claims against the Company not acknowledged as debts.

2) Uncalled liability on shares partly paid
3) Arrears of cumulative dividends
4) Estimated amount of contracts remaining to be executed on capital
account and not provided for.
5) Other money for which company is contingently liable.
Preparation of Financial Statements–Conventional Format
Illustration 9
From the following Trial Balance of A Ltd., prepare a Profit and Loss Account of the
company for the year ended 31st March 2003 and a Balance Sheet as on that date.

Rs. Rs.
5,00,000 Equity shares of Rs. 10 each fully called 50,00,000
9% Debentures (Rs. 100 each) 20,00,000
Freehold Building 40,50,000
Plant and Machinery 28,00,000
Profit and Loss Account 2,75,000
Stock (1.4.2002) 7,50,000
S. Debtors and Creditors 9,50,000 4,25,000
Bills Payable 3,75,000
Purchases and Sales 19,75,000 45,25,000
Provision for Bad Debts 45,000
Bad Debts 25,000
General Reserves 3,50,000
Calls in Arrears 75,000
Goodwill 3,00,000
Interim Dividend Paid (1.11.2002) 4,92,500
Cash at Bank 1,60,000
Wages and Salaries 6,95,500
Office Expenses 77,000
Salaries of office and marketing staff 5,15,000
Interest on Debentures 90,000
Discount on Issue of Debentures 40,000

1,29,95,000 1,29,95,000
Adjustments:
i) Stock on 31st March 2003 was Rs. 8,75,000
ii) Depreciate Plant & Machinery by 10% and write off 1/8th of the discount con
issue of debentures
iii) Maintain 5% provision for doubtful debts on debtors.
iv) Interest on debentures has been paid only for the first half
v) Income tax @ 50% is to be provided. Corporate dividend tax is 12.5%
vi) There is a claim for Rs. 50,000 for workmen’s compensation, which has been
disputed by the company. The case is pending in the country of law. 113
Fundamentals of Solution
Accounting
Profit and Loss Account
For the year ended 31st March 2003
Rs. Rs.
To Stock (1.4.2002) 7,50,000 By Sales 45,25,000
To Purchases 19,75,000 By Closing Stock 8,75,000
To Wages and Salaries 6,95,500
To Gross Profit c/d 19,79,500
54,00,000 54,00,000
To Salaries 5,15,000 By Gross Profit b/d 19,79,500
To Office Expenses 77,000
To Bad Debts 25,000
To Provisions for bad debts
(Rs. 47,500 – Rs. 45,000) 2,500
To Depreciation 2,80,000
To Interest on Debentures
Rs. 90,000
Add outstanding interest Rs. 90,000
1,80,000
interest on Debentures
To Discount on issue of Deb. 5,000
To Provision for Tax 4,47,500
To Net Profit c/d 4,47,500
19,79,500 19,79,500
To Interim Dividend 4,92,500 By Balance b/d 2,75,000
To Corporate Dividend Tax 61,563 By Profits and Loss A/c
(Interim dividend (Net Profit) 4,47,500
Rs. 4,92,500 x 12.5%)
To Balance c/d 1,68,437
72,22,500 7,22,500

Balance Sheet of A Ltd.

As on 31st March 2003
Liabilities Rs. Assets Rs.
Called up & paid up Capital Fixed Assets
5,00,00 shares of Rs. 10 each Goodwill 3,00,000
Rs. 50,00,000 Freehold Building 40,50,000
Less Calls-in-Arrears Rs. 75,000 49,25,000 Plant & Machinery
Reserve & Surplus (Rs. 28,00,000–Rs. 2,80,000) 25,20,000
General Reserve 3,50,000 Current Assets, Loans
Profit and Loss Account 1,68,437 Advances
Secured Loan Current Assets
9% Debentures Rs. 20,00,000 Stock 8,75,000
Interest outstanding Rs. 90,000 20,90,000 Debtors (Rs. 9,50,000–Rs. 47,500) 9,02,500
Current Liabilities and Provisions Cash at Bank 1,60,000
Current Liabilities Miscellaneous Expenditure
Sundry Creditors 4,25,000 Discount on Issue 35,000
Bills Payable 3,75,000 of Debentures
Provisions: (Rs 40,000–written off Rs 5000)
Provision for Tax 4,47,500
Corporate Dividend Tax 61,563

114 88,42,500 88,42,500

Note: There is a contingent liability of Rs. 50,000 for workmen’s compensation Financial Statements

l No statutory transfer to general reserve is made, as the dividend paid does not
exceed 10% of paid up capital.
For the sake of simplicity surcharge on corporate dividend tax not taken into
account.

Illustration 10
Following in the Thial Balance of a limited Company as at 31st December, 2004.

Particulars Debit
Credit
Share Capital 4,00,000
Cash in Hand 6,200
Rent 5,300
Prepaid Expenses 4,600
Repairs & Maintenance 8,600
Advances from Customers 50,000
General Reserve 3,00,000
Raw Materials at Cost 2,67,000
Sundry Creditors 3,40,000
Plant and Machinery 4,30,000
Power 8,800
Travelling and Conveyance 4,100
Auditors’ Fees 1,500
Cash at Bank 8,000
Land 30,000
Provision for Taxation 2,10,000
Furniture 12,200
Staff advances 5,300
Sundry Debtors 1,40,000
Misc. Income 54,600
Finished Goods at cost 3,10,000
Income-tax Advances 3,00,000
Misc. Expenses 61,400
Raw Materials consumption 28,60,000
Sales 42,30,000
Development Rebate Reserve 1,00,000
Building 74,100
Salaries, Wages & Bonus 11,60,000
Cash Credit from Bank 12,500

Total 56,97,100 56,97,100

The following additional information is also available:

i) The authorised capital of the company is 80,000 equity shares of Rs. 10 each of
which 50% has been issued and has been recommended by the directors.
ii) A dividend of 15% on the paid up capital has been recommended by the
directors.
iii) The closing stock of finished goods at cost is Rs. 5,60,000.
iv) The development rebate reserve is no langer required.
v) Depreciation on plant and machinery amounting to Rs. 43,000 on furniture
amounting to Rs. 1,300 and on building amounting to Rs. 3,800 has been debited
to miscellanceous expenses.
vi) Surplus in profit and loss account after proposed dividends, is to be transferred
to general reserve. 115
Fundamentals of vii) Income-tax assessment for a prior year has been completed, fixing the income
Accounting tax liability at Rs. 1,55,000 (against which a provision of Rs. 80,000 and
advances of income tax of Rs. 70,000 exists in the books).
You are required to prepare:
i) profit and loss account for the year ended 31st December, 2004; and
ii) Balance sheet in the prescribed form as on that date.

Solution
A Company Limited
Profit and Loss Account
for the year ended 31st December, 2004
Particulars Rs Particulars Rs
To Open. Stock of finished goods 3,10,000 By Sales 42,30,000
To Raw Materials consumed 28,60,000 By Clos. Stock of Finished 5,60,000
To Gross Profit c/d 16,20,000 Goods
47,90,000 47,90,000
To Salaries, Wages and Bonus 11,60,000 By Gross Profit b/d 16,20,000
To Power 8,800 By Miscellaneous Income 54,600
To Rent 5,300
To Repairs and Maintenance 8,600
To Aduditors’ Fees 1,500
To Travelling and Conveyance 4,100
To Depreciation on:
Plant and Machinery 43,000
Furniture 1,3000
Building 3,800
To Miscellanceous Expenses 13,300
To Provision for Taxation 169960
To Net Profit for the year 254940
16,74,600 16,74,600
To Provision for Taxation By Net Profit for the year 2,54,940
(for a prior year) 75,000 By Development Rebate Reserve
To Statutory Reserve 12747 written Back 1,00,000
To Proposed Dividend 60,000
To General Reserve (transfer) 2,07,193
354940 354940
Note: Provision for taxation for the year is assumed to be 40% of the profit.

A Limited Company
Balance Sheet
as on 31st December, 2004
Particulars Rs Particulars Rs
Share Capital: Fixed Assets:
Authorised: Land at cost Rs. 30,000
80,000 Equity shares of Rs. 10 each 8,00,000 Building 77,900
Issued: Subscribed and Paid up: Less: Depreciation 3,800 74,100
40,000 Equity shares of Rs 10 each Plant and Machinery 4,73,000
fully paid up 4,00,000 Less: Depreciation 43,000 4,30,000
Reserves and Surplus: Furniture 13,500
General Reserve: Rs. Less: Depreciation 1300 12,200
Brought forward 3,00,000 Investments –
116 Add: ransfer from Current Assets, Loans and
 Profit and Loss A/c 207193 5,07,193 Advances: Financial Statements
Satutory Reserve 12,747 A. Current Assets:
Development Raw Materials at cost 2,67,000
Rebate Reserve: 1,00,000 Finished Goods at cost 5,60,000
Less: Transferred to Sundry Debtrors 1,40,000
Profit and Loss A/c 1,00,000 – Cosh in Hand 6,200
Secured Loans: Cash at Bank 8,000
Cash Credit from Bank 12,500 B. Loans and Advances:
Unsecured Loans: – Staff Advances 5,300
Current Provisions: Prepaid Expenses 4,600
A. Current Liabilities: Income Tax Advance 2,30,000
Sundry Creditors 3,40,000
Income Tax Payable 85,000
Advances from Customers 50,000
B. Provisions:
Provisions for Taxation 2,99,960
Proposed Dividend 60,000
Total 17,67,400 17,67,400

Working Notes:

(i) Provision for Taxation: Rs

As per Trial Balance 2,10,000
Less: Adjustment for prior year provision 80,000
1,30,000
Add. Provision for current year taxation 169,960
Provision taken to Balance Sheet 2,99,960
(ii) Prior year tax Adjustments:
Income Tax Liability for Prior Year 1,55,000
Less: Prior Provision 80,000
Additional Provision to be made in current year 75,000
Total Tax Liability 1,55,000
Less: Advance Tax 70,000
Tax Payable 85,000
(iii) Advances Income Tax 3,00,000
Less: Adjustment against prior year completed assessment 70,000
Balance in Advance Income tax 2,30,000
(iv) A sum equal to 5% to the net profits is required to be transferred to statutory
reserve as the rate of dividend is 15%.

117
Fundamentals of Illustration 11
Accounting
The Bangalore Manufacturing Co. Ltd., was registened with a nominal capital of
Rs. 15,00,000 divided into equity shares of Rs. 100 each. On 31st March 2004 the
follwing ledger balances were extracted from the company’s books.
Rs. Rs.
Equity Share Capial Called Preliminary Expenses 12,500
up and paid up 11,50,000 Freight and Duty 32,750
Calls-in-arrears 18,750 Goodwill 62,500
Plant and Machinery 9,00,000 Wages 2,12,000
Stock (1-4-2003) 1,87,500 Cash in hand 5,875
Fixtures 18,000 Cash at Bank 95,750
Sundery Debtors 2,17,500 Directors’ Fees 14,350
Buildings 7,50,000 Bad Debts 5,275
Purchases 4,62,500 Commission paid 18,000
Interim Dividend Paid 18,750 Salaries 36,250
Rent 12,000 6% Debentures 7,50,500
General Expenses 12,250 Sales 10,37,500
Debenture Interest 12,250 4% Government Securities 1,50,500
Bills Payable 95,000 Provision for Doubtful Debts 8,750
General Reserve 62,500 Sundry Creditors 1,15,000
Profit and Loss A/c 36,250
(Cr.) 1-4-2003

The stock on 31st March, 2004 was estimated at Rs. 2,52,000

The following adjustments© were to be made:

1) Final Dividend at 5% to be provided.

2) Depreciation on Plant and Machinery at 10% and on Fixtures at 5%.
3) Preliminary expenses to be written off by 20%.
4) Rs. 25,000 were to be transferred to General Reserve.
5) The provision for bad debts to be maintained at 5% on sundry debtors.

You are required to prepare the Trading and Profit and Loss Account and Profit and
Loss Appropriation Account for the year ended 31st March 2004 and the Balance
Sheet as on that date.

118
Solution Financial Statements

Trading and Profit and Loss Account of the Bengal Manufacturing Co. Ltd.
for the year ending 31st March, 2004

Rs. Rs.
To Opening Stock (1-4-2004) 1,87,500 By Sales 10,37,500
” Purchases 4,62,500 ” Closing Stock (31-3-2004) 2,52,000
” Freight and Duty 32,750 2,52,000
” Wages 2,12,000
” Gross Profit c/d 3,94,750
12,89,500 12,89,500
ToSalaries 36,250 By Gross Profit b/d 3,94,750
” Commission 18,000
” Rent 12,000
” General Expenses 12,250
” Directors’ Fees Rs. 14,350
” Debenture Interest 12,500
Add. Outstanding
Interest 32,500
To Bad Debts 5,275
Add: Provision for
Bad Debts
Required @ 5%
on Debtors
Rs. 2,17,500 10,875
16,150
Less: Old Provision
for Doubtful
Dets 8,750
7,400
” Depreciation on:
Plant & Machinery
@ 10% 90,000
Fixtures @ 5% 900
90,9000
“ Preliminary Expenses (20%) 2,500
” Provision for Taxation 62,500
” Net Profit transferred to
Profit and Loss Appro-
priation A/c 93,000
3,94,750 3,94,750

Calculation of Outstanding Interest

Rs.
Interest on Rs. 7,50,000 debentures @ 6% for one year 45,000
Less: Debenture interest paid 12,500
Outstanding interest 32,500

119
Fundamentals of Profit and Loss Appropriation Account
Accounting for the ending 31st March, 2004

Rs. Rs.
To Interim Dividend 18,750 By Balance b/d (1-4-2003) 36,250
” Proposed Final Dividend ” Net Profit for the year 93,600
@ 5% on Rs. 11,31,250
(i.e. Rs. 11,50,000 called) up
capital—Rs. 18,750 calls-in-arrears) 56,562
” General Reserve 25,000
Balance c/d 29,538
1,29,850 1,29,850

Balance Sheet of the Bangalore Manufacturing Co. Ltd.

as at 31st March, 2004

Liabilities Rs. Assets Rs.

Share Capital: Rs. Fixed Assets:
Authorsed Capital: 15,000 Goodwill 62,500
equity shares of Rs. 100 each 15,00,000 Buildings Rs. 7,50,000
Plant & Machinery 9,00,000
Called up and Paid up Capital: Less: Depreciation 90,000
11,500 shares of Rs. 100 each 8,10,000
fully calld up 11,50,000 Fixtures 18,000
Less: Calls-in-arrears 18,750 Less: Depreciation 900
11,31,250 17,100
Reserves and Surplus: Investments:
General Reserve 62,500 4% Government Securities 1,50,000
Add: Transferred during Current Assets, Loans and
the year 25,000 Advances:
87,500 A. Current Assets:
Profit and Loss Account 29,538 Stock 2,52,000
Secured Loans Sundry Debtors 2,17,500
6% Debentures 7,50,000 Less: Provision for
Debenture Interest Outsanding 32,500 Bad Debts @ 5% 10,875
Unsecured Loans Nil 2,06,625
Current Liabilities & Provisions: Cash in hand 5,875
A. Current Liabilities: Cash at Bank 95,750
Bills Payable 95,000 B. Loans and Advances Nil
Sundry Creditors 1,15,000 Miscellanceous Expenditure:
B. Provisions: (to the extent not written
Provision for Taxation 62,500 off or adjusted)
Proposed Dividends 56,562 Preliminary Expenses 10,000
23,59,850 23,59,850

Illustration 12
Spik and Span Ltd. was registered with an authorised capial or Rs. 3 lakh divided into
30,000 equity shares of Rs. 10 each. The company offered 15,000 shares for public
subscription of which Rs. 7.50 pen share was called up.
The following trral balance was drawn from the book of accounts as on March 31,
2004. You are required to prepare a Profit & Loss Appropriation Account for the year
120 ending on March 31, 2004 and Balance Sheet as on that date.
 Debit Credit Financial Statements

Rs. Rs.
Land 23,800
Buildings 52,900
Calls in Arrear 5,000
Brokerage on Shares 8000
Stores and Spare parts 18,000
Preliminary Expenses 7,600
Unexpired Insurance 640
Live Stock 900
Plant & Machinery 1,03,600
Loose Tools 24,000
Stock in trade at cost 50,000
Cash at Office 12,480
Cash Bank 25,000
Sundry Debtors 26,000
Share Capital 1,12,500
Sundry Creditors 1,24,600
Capital Reserve 30,800
Wages Outstanding 1,820
Godown Rent due 700
General Reserve 16,800
Employee’s Benefit Fund 3,000
Salaries Outstanding 1,000
Reserve for Doubtful Debts 1,300
Unpaid Dividends 700
Profit & Loss Accoaunt 57,500
Total 3,50,720 3,50,720

Out of the creditors of, Rs. 1,24,600 Rs. 84,600 were due to bank for a loan secured
by mortage on buildings and machinery, and Rs. 22,000 were due on account of loan
from subsidiary company.
The company earned a profit of Rs. 61,200 during the year. The balance
of profit brought forward from the previous year was Rs. 38,600 out of which it
was decided that Rs. 15,000 be paid as final dividend, Rs. 16,800 the carried to
General Reserve, Rs. 3,000 to Employees Benefit Fund. It was further resolved
that Rs. 7,500 be paid by way of interim dividend for the first half of the
current year.

Solution
Spik and Span Ltd.
Profit and Loss Appropriation A/c for the year ended March 31, 2004

Rs. Rs.
To Interim Dividend 7,500 Balance as per P & L A/c for the
To Balance of Profit 57,500 year ending March 31, 2003 38,600
To Dividend 15,000
To General Reserve 16,800
To Employee’s Benefit Fund 3,00 Profit as per P & L A/c 61,200

99,800 99,800
121
Fundamentals of Spik & Span Ltd.
Accounting Balance Sheet as on March 31, 2004

Liabilities Rs. Assets Rs.

Share Capital: Fixed Assets:
Authorised (Net Block) Rs.
30,000 Equity Shares of Land 23,800
Rs. 10 each 3,00,000 Buildings 52,900
Issued & Subscribed Capital:
15,000 Equity Shares of Plant &
Rs. 10 each Rs. 750 per Machinery 103,600
Share called up Rs. 1,12,500 Live Stock 900 1,81,200
Less Calls in Arrear Rs. 5,000 Current Assets:
1,07,500 Stock in trade at cost 50,000
Stores & Spares 18,000
Reserves and Surplus:
Capital Reserve 30,800 Loose Tools 24,000
General Reserve 16,800 Sundry Debtors 26,000
Less Reserve
Profit & Loss Account 57,500 for D’ful Debts 1,300 24,700
Empioyees Benefit Fund 3,000 Cash & Bank Balances 37,480
Secured Loans: Loans and Advances:
From Bank (Secured by Unexpired Insurance 640
mortgage on buildings machinery) 84,600
Unsecured Loans: Miscellanceous Expenditure
From Subsidiary 22,000 & Losses:
Current Liabilities and Preliminary Expenses 7,600
Provisions: Brokerage on Shares 800
Sundry Creditors 18,000
Unpaid Dividends 700
Outstanding Wages 1,820
Outstanding Salary 1,000
Godown Rent due 700
3,44,420 3,44,420

Adjustment: (1) Stock on 31st March 2003 was valued at Rs. 3,42,000
(2) Depreciate:
Plant and Machinery 15%
Computers 10%
patents & Trade Marks 5%
(3) Provision for Bad & doubtful debts is required at Rs. 2,040
(4) Provide for–
Rent o/s Rs. 3,200
Salaries o/s Rs. 3,600
Proposed Dividend 15%
Provision for Income Tax 50% & Corporate Dividend tax 12.5%
Ans: Net Profit after Tax Rs. 1,03,900
Corporate dividend Rs. 12,000
Balance Sheet Total Rs. 8,32,800
Corporate Tax = Rs. 6000 + Rs. 3600 = Rs. 9600
122 Rs. 96000 × 12.5% = Rs. 12000
2. The following balances appeared in the books of ABC Co. Ltd. as on Financial Statements
December 31, 2004.
Particulars Rs. Rs.
Paid up Capital 6,00,000
60,000 Equity Shares of Rs. 10 each 2,50,000
General Reserve 6,526
Unclaimed Dividend 36,858
Trade Creditors
Buildings at Cost 1,50,000
Purchases 5,00,903
Sales 10,83,947
Manufacturing Expenses 3,59,000
Establishment Charges 26,814
General Charges 31,078
Machinery at Cost 2,00,000
Motor Vehicle at Cost 30,000
Furniture at Cost 5,000
Opening stock 1,72,058
Book Debts 2,23,380
Investments 2,88,950
Depreciation Reserve 71,000
Advance Payment of Income Tax 50,000
Cash Balnce 72,240
Directors Fees 1,800
Investment’s Interest 8,544
Profit and Loos Account
(January 1,2004) 16,848
Staff Providend Fund 37,500
21,11,223 21,11,223

From these balances and the following information prepare the Company’s Balance
Sheet as on December 31, December 31, 2004 and its Profit and Loss Accout for the
year ended on that date.

a) The stock on December 31, 2004 was Rs. 1,48,680.

b) Provide Rs. 10,000 for depreciation on fixed assets, Rs. 6,500 for Managing
Director’s Commission and Rs. 1,500 for the Company’s contribution to the
Staff Providend Fund.
c) Interest accrued on Investment amounted to Rs. 2,750.
d) A Provision of Rs. 60,000 for taxes in respect of the profit for 2004 is
considered necessary.
e) The directors propose a final dividend at 4% after transfering Rs. 50,000 to
general Reserve.
f) A claim of Rs. 2,500 for workmen’s compensation is being disputed by the company.
g) The Market value of investment as on 31.12 2004 amounts to Rs. 3,02,500.

(Ans: Net Profit after tax Rs. 74,268, P and L Appn. A/c Rs. 17,116, Balancer Sheet
Rs. 10,90,000).
123
Fundamentals of 3) An inexperienced accountant has prepared the balance sheet of ABC Ltd. as follows:
Accounting
Balance Sheet of A B C Limited
Liabilities Rs Assets Rs
Trade Creditors 80,900 Stock:
Advances from Customers 42,260 In hand 3,60,480
Share Capital 8,00,000 With Agents 24,300
Profit & Loss A/c 45,630 Cash in hand 23,540
Provision for Taxes 95,000 Investments 20,000
Proposed Dividend 59,000 Fixed Assets:
Loan to Managing Director 5,000 Land 1,80,000
General Reserve 75,000 Plant & Machinery
Dev. Rebate Reserve 30,000 (W.D.V.) 4,10,000
Provision for Contingencies 23,000 Debtors 2,15,450
Share Premium A/c 22,000 Less: Provision
Forfeited Shares 3,000 For B/D 9,300
2,06,150
Bills Receiveable 5,000
Amount due from Agents 51,320

12,80,790 12,80,790

Redraft the above Balance Sheet in the form prescribed by Indian Companies Act,
1956 giving necessary details yourself.
4) The following balances have been extracted from AB Ltd. as on
September 30, 2004:

Rs. Rs.
Share Capital (Authorised and issued):
Equity (1,50,000 shares) 15,00,000
8% Redeemable Preference (400 shares) 40,000
Share Premiium 25,000
Preference share Redemption 48,000
General Reserve 1,00,000
Land (Cost) 3,00,000
Buildings (Cost less Depreciation) 7,00,000
Furniture (Cost Less Depreciation) 20,000
Motor Vehicle (Cost less Dep.) 35,000
Trading Account–gross Profit 9,00,000
Establishment Charges 2,50,000
Rates, Taxes and Insurance 12,000
Commission 4,000

Commission 5,000
Discount received 8,000
Directors’ Fees 2,000
Depreciation 60,000
Sundry Office Expenses 60,000
Payment to Auditors 4,000
Sundry Debtors and Creditors 1,06,600 25,600
124
Profit and Loss Account Financial Statements
(as on 30.9.2003) 10,000
Unpaid Dividend 2,000
Cash in hand 12,000
Cash at Bank in Current Account 1,95,000
Security Deposit 10,000
Outstanding Expenses 6,000
Investment in G.P. Notes 2,00,000
Stock-in-trade (at or below cost) 3,53,000
Provision for taxation (y/e 30.9.03) 70,000
Income tax paid under dispute (y/e 30.9.03) 1,00,000
Advanced payment of income-tax 2,20,000
Total 26,91,600 26,91,600

The following further details are available:

1) The Preference shares were redeemed on 1st October, 2003 at a premium of 20%
but no entries were passed for giving effect thereto, except payment standing to
the debit of Preference Share Redemption A/c.
2) Depreciation provided up to 30th September, 2004 is as follows:
a) Buildings 2,10,000
b) Furniture 20,000
c) Moter Vehicles 60,000
3) Establishment charges include Rs. 18,000 paid to Managing Director as mini-
mum remuneration in terms of agreement which provides for a remuneration of
5% of annual net profits subject to the above minimum in the case of absence or
inadequacy of profitsw in the year.
4) Payment to Auditors includes Rs. 1,000 for taxation work in addition to audit
fees.
5) Market value of investments on 30th September 2004 Rs. 1,80,000
6) Sundry Debtors include Rs. 40,000 due for a period exceeding six months.
7) All receivables and deposits are considered good for realisation.
8) Income-tax demand for the year ended 30.9.2003 Rs. 1,00,000 has not been
provided for against which an appeal is pending.
9) Income-tax to be provided@ 55%.
10) Directors decide to transfer Rs. 25,000 to the General Reserve and to recommend
payment of dividend on equity shares at the rate of 5%.
11) Ignore previous year’s figures.
You are required to prepare the Profit and Loss Account for the year ended
30th September, 2004 and the Balance Sheet as at that date.
(Ans: Net profit after tax and commission Rs. 2,30,422,
Balance of P/L Appn. A/c Rs. 1,40,422
Balance Sheet Total Rs. 22,51,600).
Hint: 5% Remeneration Rs. 26950

125
Fundamentals of 5) The following balances have ben extracted for the books of XYZ Company Ltd.
Accounting as on March 31, 2004.

Rs. Rs.
Freehold Land 23,000 Income from Investments 1,200
Building 7,500 Provisions for doubtful debt
Furniture 2,000 (1st April 2003) 200
Debtors 5,000 Creditors 2,000
Stock (31 March 2004) 4,000 Provision for Depreciation
Cash at Bank 500 (1st April, 2003) 500
Cash in hand 100 Buildings
Cost of Goods sold 30,000 Furniture
Salaries and Wages 1,500 Suspense A/c
Misc. Expenses 800 Equity Share Capital 36,750
Investment in Shares 18,000 6% Cumulative Pref.
Interest 300 Share Capital 8,000
Bad Debts 100 Share Premium 1,000
Repairs and Maintenance 150 Bank Overdraft 5,000
Advance payment of Sales 38,000
Income-tax 600 Profit and Loss A/c
(1st April, 2003) 250
93,550 93,550

The following further particulars are available:

1) The land was revalued on 1st january, 2004 at Rs. 30,000 by an expert valuer
but no effect has been given in the books although the Directors have decided to
adjust the relavant amount.
2) Provision for doubtful debt is to be adjusted to 5% on the amount of debtors.
3) Equity Share Capital is composed of Rs. 10 Shares, 3640 shares were fully paid
and 50 on which a call of Rs. 3 remains unpaid.
4) Suspense A/c represents money received from the new allottee for re-issue of
50 shares shares forfeited during the year for non-payment of the final call, but
no entry for adjustment thereof has been passed.
5) Provision for taxation is to be made at 45%
6) Market value of investments was Rs. 18,500 on 31st March 2004
7) The company is managed by the Directors who are entitled to a remuneration of
3% on the annual net profits.
8) Depreciation is to be charged on written down value of:
Building at 2%
Furniture at 10%
9) The land and buildings of the company are mortgaged in favour of the bank as
security for overdraft sanctioned up to a limit of Rs. 25,000.
10) Dividend on Cumulative preference shares were in arrears for 5 years upto
March 31, 2004. The Directors have recommended payment of dividend for two
years.
Prepare Profit and Loss Account for the year ended March 31, 2004 and Balance
Sheet on that date.
126
(Answer: Profit Rs. 5,999, Balance Sheet total Rs. 60,491) Financial Statements

6) Ajax Co. Ltd. had an authorised capital of 5,000 equity shares of Rs. 100 each.
As on December 31, 2003, 3000 shares were fully called up, and the following
balances were extracted from the company’s ledger accounts.
Rs. Rs.
Salary 4,85,000 Printing and Stationery 2,300
Purchases 3,20,000 Advertishing Expenses 7,300
Stock 75,000 Sundry Debtors 52,700
Manufacturing wages 70,000 Sundry Creditors 34,200
Insurance upto 31-3-2004 6,720 Plant & Machinery 83,500

Rent 6,000 General Reserve 60,700

Salaries 18,500 Furniture 27,100
Discount Allowed 1,050 Building 84,580
General Expenses 9,050 Cash at Bank 1,24,000
Calls in Arrear 4,800 Loans from Managing Director 3,700
Profit and Loss A/c (Cr.) 21600 Bad Debts 12,600

The following further information is given: (i) Depreciation to be charged on

Machinery and Furniture at 15% and 10% respectively; (ii) Provision for Taxation to
be made Rs. 19,000; (iii) Closing Stock Rs. 1,21,000; (iv) Outstanding liabilities:
Wages, Rs. 7,000; Salaries Rs. 8,200; Rent, Rs. 1,600; (v) Dividend at 5%
on paid-up capital to be provided; (vi) Rs. 10,000 to be transferred to
General Reserve.
Prepare Profit and loss Account for the year ended December 31, 2003 and Balance
Sheet (in proper form) as on that date.
(Answer: Profit for the year Rs. 28125, total of Balance Sheet Rs. 4,79,325).
7) The following balances are extracted from the books of ABC Ltd., as on
31 March, 2003.
Share Capital 40,00,000
Cash in hand 62,000
Repairs and Maintenance 86,000
Raw Materials at cost 26,70,000
Furniture 1,22,000
Sundry Creditors 34,00,000
Directors’ Fees 4,000
Plant and Machinery 43,00,000
Miscellaneous Expenses 6.10,000
General Reserve 30,00,000
Land 3,00,000
Finished Goods at cost 31,00,000
Sales 4,33,00,000
Buildings 7,41,000
Cash at Bank 80,000
Provision for Taxation 21,00,000
Sundry Debtors 14,00,000
Raw Materials Consumption 2,86,00,000 127
Fundamentals of Staff Advance 53,000
Accounting
Advance from customers 5,00,000
Salaries, Wages and Bonus 1,16,00,000
Cash credit from Bank 1,25,000
Power 88,000
Prepaid expenses 46,000
Rent 53,000
Travelling and Conveyance 41,000
Auditors’ Fees 15,000
Miscellaneous Income 5,46,000
Income Tax Advance 30,00,000

The following further information is also given:

1) The authorised share capital of the company is 80,000. Equity Shares of Rs. 100
each which has been issued and subscribed to the extent of 50%.
2) Tax provision @ 6% is to be made on current year’s profits.
3) 15% dividend on the paid-up share capial is recommended by the Directors.
4) The closing stock of finished goods at cost is Rs. 56,00,000.
5) Depreciation on assets amounting to Rs. 4,30,000 on Furiture and Rs. 33,000 on
Building has been debited to miscellanceous expenditure.
6) The surplus in profit and loss account is to be transferred to General Reserve
Account.
Prepare Profit and Loss Account and Balance Sheet as on 31.3.2003.
(Answer: Net Profit before tax Rs. 25,79,000
Total of Balance Sheet Rs. 1,57,04,000)
8) An inexperienced accountant has prepared the balance sheet ABC Ltd. as follows:

Balance Sheet of A B C Limited

Liabilities Rs Assets Rs
Trade Creditors 80,900 Stock:
Adances from Customers 42,260 In hand 3,60,480
Share Capital 8,00,000 With Agents 24,300
Profit and Loss A/c 45,630 Cash in hand 23,540
Provision for Taxes 95,000 Investments 20,000
Proposed Dividend 59,000 Fixed Assets:
Loan to Managing Director 5,000 Land 1,80,000
General Reserve 75,000 Plant and Machinery
Dev. Rebate Reserve 30,000 (W.D.V.) 4,10,000
Provision for Contingencies 23,000 Debtors 2,15,450
Share Premium A/c 22,000 Less: Provision
Forfeited Shares 3,000 For B/D 9,300
2,06,150
Bills Receiveable 5,000
Amount Due from Agents 51,320
12,80,790 12,80,790
128
 Financial Statements
3.11 LET US SUM UP
Financial statements are prepared by all forms of business organisations to ascertain
the operating results of the business and to know the financial position on a particular
date. Before preparing financial statements one must gain clarity about the nature of
certain items and their treatment in the final accounts. It is obligatory on the part of
companies to maintain and prepare financial statements by the end of each accounting
period. Manufacturing account is prepared to know the cost of goods produced while
Trading account is prepared to know the results of trading operations. Profit and loss
account is prepared to ascertain the net profit earned or net loss incurred by the
business concern during an accounting period. The operating and non-operating
expenses are charged to profit and loss account. The distribution or appropriation of
profit is shown under Profit and Loss Appropriation Account, which is also called
‘Below the Line’.
Balance Sheet is a statement of assets and liabilities to ascertain the financial position
of a concern at a particular date. The assets and liabilities are presented either on the
basis of liquidity or performance. Under ‘liquidity order’ assets are shown on the
basis of ‘most liquid’, ‘liquid’ and ‘least liquid’ assets. Liabilities are shown in the
order of payment. Under ‘order of performance’ the assets are arranged on the basis
of their useful life whereas liabilities are shown on the besis of long term, medium
term, short term and current liabilities.
It is important to distinguish between capital and revenue to ascertain correct profit or
loss amount and fair view of the affairs of the business. There are certain rules which
guide us to determine whether a particular expenditure or receipt is of a capital nature
or of a revenue nature.
Revenue recognition is concerned with the timing of recognition revenue in the
statement of profit and loss. ‘Realisation Concept’ recognises the revenue at the point
of sale or service rendered. Operating and non-operating revenues should be shown
separately while preparing Profit and Loss Account. There are some established
practices as per the Accounting Standards to recognise certain items as revenues. The
Accounting Standards have some established practices to recognise revenue in cases
of sale of goods, rendering services and financial services. But there are also certain
exception to this general rule.
The financial statements of non-corporate entities may be presented either in
conventional format or vertical format. Under vertical form various items of incomes
and expenses, assets and liabilities arranged vertically to get some additional
information about the operating efficiency and financial position of the business
enterprise. The sole traders and partnership forms hardly adopt vertical form of
financial statements. As regards preparation of Balance Sheet of a company, the
nature of details shown with respect to the liabilities and assets and the order of
arrangement of the items are prescribed in Schedule VI, Part I of the Companies Act.
There are two alternate proformas given in Schedule VI for the preparation of
Company Balance Sheets: (i) horizonal and (ii) vertical. Any of these forms may be
adopted for the Balance Sheet of a Company. Both the prescribed forms may require
that the figures of the previous year should be shown in a separate column along side
the figures of the current year.

3.12 KEY WORDS

Capital Expenditure: An expenditure which results in the acquisition of fixed asset
or addition to fixed asset, or an improvement in the earning capacity of the business.
Capital Receipt: Receipt in the form of additions to capital, liabilities or sale
proceeds of a fixed asset. 129
Fundamentals of Revenue Expenditure: An expenditure the benefit of which is limited to one year.
Accounting
Revenue Receipt: Receipts on account of goods sold or services provided.
Deferred Revenue Expenditure: A revenue expenditure which involves a heavy
amount and the benefit of which is likely to spread over the years.
Appropriation: Distribution of profits.
Balance Sheet: Statement of assets and liabilities depicting the financial position at
the end of the financial year.
Below the line: Part of the Profit and Loss Account which shows the appropriation of
profits.
Above the line: Profit and loss account which shows the profit or loss before
appropriation of profits.
Contingent Liability: Liability which depends upon the happening of a certain event
Preliminary Exenses: Expenses incurred in connection with the formation and
registration of a company.
Profit and Loss Account: Income statement disclosing the results of operation (profit
or loss) for the financial year.
Dividend: Part of profits distributed to the equity shareholders.
Final Dividend: Dividend declared in the annual general meeting.
Provision for Taxation: The amount appropriated from profit for the liability arising
on account of payment of taxes.
Financial Statements: Annual statements of assets and liabilities (Balance Sheet) and
of income and expenditure (Profit and Loss Account).

3.13 TERMINAL QUESTIONS

1) Following is the Trial Balance of V.N. Ltd. as on 31st March 2003. Prepare
Trading and Profit and Loss Account and Balance Sheet after taking into account
the adjustments.
Rs. Rs.
Opening Stock 3,00,000
Purchases/Sales 9,80,000 13,60,000
Bills Receivable/Bills Payable 20,000 28,000
Patents and Trade Marks 19,200
General Reserve 62,000
Cash at Bank 1,84,800
Plant and Machinery 1,16,000
Debtors and Creditors 1,10,000 70,000
Share Capital 4,00,000
Dividend paid for 2001-2002 36,000
Profit and Loss A/c (1.4.2002) 94200
Sundry Expenses 28,200
Rent 16,000
Salaries 30,000
Computers 68,000
Carriage–Inward 38,000
Discount Received 12,000
Wages 1,20,000
Return outwards 40,000

130 20,66,200 20,66,200