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A Foolproof Guide to Final Accounts

Final Accounts

Final means last and accounts means reports. Final accounts means reports of a business organization prepared at the end of a year. It  is the last step of accounting. It is prepared with the help of Trial Balance.

Following steps are taken to prepare final accounts:

Journal/Subsidiary Books
Ledger
Trial Balance
Final Accounts

What is the purpose of preparing Final Accounts?

  1. Ascertain Gross Profit/Loss of an organization.
  2. Ascertain Net Profit/Loss of an organization.
  3. To know the financial position of an organization on a particular date.
  4. For future planning.
  5. To find out sources of funds and application of funds.
  6. To find out various accounting ratios.
  7. To calculate income tax and sales tax of an organization, etc.

Final Accounts are categorized on the basis of organizations as follows:

  1. Final Accounts of a Sole Proprietor (Trader)
  2. Final Accounts of a Sole Proprietor (Manufacturer)
  3. Final Accounts of a Partnership Firm
  4. Final Accounts of a Company
  5. Final Accounts of a Non Profit Organization
  6. Final Accounts of Banking Companies
  7. Final Accounts of Insurance Companies, etc.

Firstly, lets understand Final Accounts of a Sole Proprietor (Trader)

Final Accounts of a Sole Proprietor (Trader) consists of:

  1. Trading A/c 
  2. Profit/Loss A/c 
  3. Balance Sheet

Trading Account

Trading Account is a nominal account. It is part of profit/Loss account. It is prepared to find out gross profit or gross loss. It consists of two sides, debit side and credit side. 

Trading Account is divided into:

  1. All items related to goods
  2. All expenses related to purchase of goods
  3. All direct expenses
  4. All situations when goods are going out 

A] Items related to goods are:

  1. Opening Stock – Recorded on debit side 
  2. Purchases – Recorded on debit side 
  3. Sales – Recorded on credit side 
  4. Purchase Return – Subtracted from purchases on debit side
  5. Sales Return – Subtracted from sales on credit side 
  6. Closing Stock – Recorded on credit side

B] Expenses related to purchase of goods

Carriage, Carriage Inward, Freight, Freight Inward, Octroi Duty, Custom Duty, Dock Duty, Import Duty, Clearing Charges, etc.

C] Direct Expenses

Wages, Wages and Salaries, Works Managers Salary, Power and Fuel, Motive Power, Coal, Gas, Coke & Water, Heating and Lighting, Royalty, Factory Rent, Factory Insurance, etc.

D] All situations when goods are going out:

Goods destroyed by fire, Goods lost by theft, Goods distributed as free samples, Goods taken by owner for personal use. 

Important Notes:

  1. Opening Stock is recorded on the debit side as it is the opening balance of goods and goods is real account. Real Account starts from debit side. 
  2. Closing Stock is recorded on the credit side as it is the closing balance of goods and goods is real account. Real Account ends on credit side. 
  3. Wages are of two types, one is productive wages which is given to workers working on the machine and related to production and other is unproductive wages which is given to workers not related to production. 
  4. Royalty is the fees paid for permission to use patents, copyrights, etc

 

Profit and Loss Account

Profit and Loss Account is a nominal account. It is a continuation of Trading account. It is mainly prepared to find out Net profit or Net loss of an organization. 

Profit and Loss Account is divided into:

  1. Office and Administrative Expenses 
  2. Selling and Distribution Expenses 
  3. Financial Expenses
  4. All Incomes

A] Office and Administrative Expenses 

Salaries, Salaries and Wages, Unproductive Wages, Office Expenses, General Expenses, Sundry Expenses, Printing and Stationery, Postage and Telegram, Telephone Charges, Electricity charges, Legal Charges, Audit Fees, Rent, Rates & Taxes, Insurance, Trade Expenses, etc

B] Selling and Distribution Expenses 

Travelling Expenses, Conveyance, Commission, Discount Allowed, Advertisement, Carriage Outward, Freight Outward, Export Duty, Packing Charges, Warehouse Rent, Bad debts, etc.

C] Financial Expenses

Bank Charges, Interest, Interest on Loan, Interest on Overdraft, Interest on Capital, Depreciation on Fixed Assets, Loss on sale of fixed assets, Loss on sale of investments, etc.

D] All Incomes

Interest Received, Discount Received, Commission Received, Rent Received, Interest on Investment, Interest on Drawings, Bad debts recovery, Profit on sale of fixed assets, Profit on sale of investments, etc.

Balance Sheet

Balance Sheet is a statement and not an account. It shows the financial position of an organization on a particular date. It shows the assets and liabilities of an organization. It is divided into two sides, Liabilities and Assets. Liabilities side shows the sources of funds whereas assets side shows the application of funds means where the funds are utilized. The total of Assets side and Liabilities side should be equal.

Liabilities is divided as follows:

  1. Capital. (Drawings is subtracted from capital and net profit added whereas net loss is subtracted from capital)
  2. All types of Reserves like, Reserve Fund, General Reserve, etc.
  3. Non Current Liabilities: Bank Loan, Loan from others
  4. Current Liabilities: Sundry Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses, Income Received in Advance, etc.

Assets is divided as follows:

  1. Fixed Assets: It is divided into Tangible and Intangible Assets. 
  • Tangible Assets: Those assets which we can see, touch, talk to

Land and Building, Plant  and Machinery, Furniture and Fixtures, Freehold Property, Leasehold Property, Motor Vehicles, Equipments, Livestock, etc.

  • Intangible Assets: Those assets which we can’t see, can’t talk but can measure in terms of money. 

Goodwill,  Patents, trademarks, Copyrights

  1. All Types of Investments. 

Investments in shares, debentures, bonds, securities, fixed deposits, etc.

  1. Loan Given
  2. Current Assets: 

Sundry Debtors, Bills Receivable, Prepaid Expenses, Accrued Income, Loose Tools, Insurance Claim, Closing Stock, Stock of Stationery, Stock of Postage Stamps, etc. Final Accounts also consists of various adjustments. Adjustments are those transactions which are taking place after preparation of trial balance. It is to be considered while preparing final accounts. Every transaction has two effects, one debit and other credit. 

Some Important adjustments. 

  • Closing Stock

The effects of this adjustment in final accounts

1st effect – Trading Account – Credit Side
2nd effect – Balance Sheet – Assets Side

  • Outstanding Expenses 

The effects of this adjustment in final accounts

1st effect – Add to respective expense in Trading/Profit and Loss A/c – Debit Side
2nd effect – Balance Sheet – Liabilities Side

  • Prepaid Expenses

The effects of this adjustment in final accounts

1st effect – Subtract from respective expense in Trading/Profit and Loss A/c – Debit Side
2nd effect – Balance Sheet – Assets Side

  • Income Receivable

  The effects of this adjustment in final accounts

1st effect – Add to respective income in Profit and Loss A/c – Credit Side

2nd effect – Balance Sheet – Assets Side

  • Income received in advance

The effects of this adjustment in final accounts

1st effect – Subtract from respective income in Profit and Loss A/c – Credit Side

2nd effect – Balance Sheet – Liabilities Side

  • Depreciation on Fixed Assets

The effects of this adjustment in final accounts

1st effect – Subtract from  respective fixed assets – Assets Side

2nd effect – Profit and Loss Account – Debit Side. 

These are some examples of adjustments but the are many more. 

Hence, final accounts are prepared at the end of the year on a particular date in order to find out the financial position of an organization. 

 

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