Financial Statements – 1

Financial Statements comprise three interconnected statements prepared at the end of the accounting year (typically 31st March):

1. Trading Account: Determines Gross Profit or Gross Loss arising from direct manufacturing/trading activities.
2. Profit and Loss Account: Determines Net Profit or Net Loss after deducting all indirect administrative, selling, and financial expenses.
3. Balance Sheet: A classified statement showing the financial position (Assets, Liabilities, Capital) as on a specific closing date.

The Trading Account & Cost of Goods Sold (COGS)

The Trading Account debits Opening Stock, Net Purchases, and all Direct Expenses (expenses incurred to bring goods to the point of sale, such as Carriage Inwards, Freight, Wages, Factory Rent, Fuel and Power), and credits Net Sales and Closing Stock:

The Profit and Loss Account begins by carrying forward the Gross Profit (on Credit side) or Gross Loss (on Debit side) from the Trading Account:

• Debit Side: All Indirect Expenses:
  • Administrative Expenses: Office salaries, office rent, printing & stationery, telephone, legal charges.
  • Selling & Distribution Expenses: Advertising, carriage outwards, sales commission, bad debts.
  • Financial & Other Expenses: Bank charges, interest on loans, depreciation, loss on sale of assets.
• Credit Side: All Indirect Incomes (discount received, commission received, rent received, interest received).
• Net Profit (Balancing Figure): If Credit total > Debit total → Net Profit (transferred to Capital Account on Balance Sheet).

Operating Profit vs. Net Profit

Operating Profit measures profit earned purely from primary operational business activities, excluding non-operating incomes (dividend received, gain on sale of land) and non-operating expenses (interest on loan, loss by fire):

The Balance Sheet is a statement of financial position as on a particular date. It is NOT an account (has no "To" or "By" prefixes):

Marshalling of Assets and Liabilities

Marshalling refers to the systematic order in which assets and liabilities are arranged in the Balance Sheet:

• 1. Order of Liquidity: Arranged in order of the ease with which assets can be converted into cash, and liabilities must be paid:
  • Assets: Cash in Hand → Cash at Bank → Bills Receivable → Debtors → Stock → Furniture → Plant & Machinery → Land & Building.
  • Liabilities: Bills Payable → Sundry Creditors → Short-term Loans → Long-term Loans → Capital.
• 2. Order of Permanence (Standard Corporate Form): The exact reverse of liquidity. Assets and liabilities are arranged from most permanent to most liquid:
  • Assets: Goodwill → Land & Building → Plant & Machinery → Furniture → Stock → Debtors → Cash at Bank → Cash in Hand.
  • Liabilities: Capital → Long-term Bank Loans → Trade Creditors → Bills Payable.