How to Prepare Final Accounts? Process for Finalize Accounts: How to Prepare Final Accounts and Final Statements. How Final Accounts are Made?, Find Complete details for How to Prepare Final Accounts of any Company.
How to Prepare Final Accounts?
Final accounts are the end results of the whole accounting process. Final Accounts or annual accounts includes the following statements
- Trading & Profit & Loss Account and
- Balance Sheet.
In case of manufacturing concerns the final accounts may include the following statements.
- Manufacturing A/c.,
- Trading, Profit & Loss A/c.,
- Balance Sheet
The above final a/c’s are prepared with the help of trial balance and additional information/adjustments.
Trading and Profit & Loss A/c shows the result of the operations that is profits earned or loss incurred during that year. Therefore expense should be recognized when incurred means services/benefits are received and income should be recognized when earned. This is also referred as Mercantile system of accounting or recognition of accrual principle. Due to this, we make adjustments for outstanding expenses, Outstanding Incomes, prepaid expenses, Advance Incomes, closing stock etc.
Balance sheet shows the Assets & Liabilities of the organization as on a particular date. It is not an account. It is not for any period or year. It shows the financial position of the entity as of a particular date ( at a particular point of time).
Manufacturing account if prepared shows the cost of goods manufactured during that period. This cost is transferred to Trading A/c.
Must Read – Meaning & Scope of Accounting
Components of Final Accounts & Their Meanings
- Trading account shows the profit/loss made on a gross basis that is including only the direct cost of the goods.
- In trading a/c, we credit the trading income like sale and debit the cost of goods sold (opening stock + purchases (-) closing stock).
- Alternatively Opening Stock & purchases is debited & Closing stock is credited to trading account.
- Other direct expenses related to purchase or manufacture of goods like carriage inward, wages, etc. are also debited here.
- Purchase return & Sales returns will be deducted/adjusted from the purchases & sales respectively.
- The balance is known as the gross profit or gross loss, which is transferred to profit and loss a/c.
Profit and loss account:
- It shows the performance of the entity i.e. profit earned or loss suffered considering all indirect expenses and incomes.
- Gross profit or gross loss from trading account is transferred to P&L a/c.
- Other incomes like discount, interest, etc. are credited.
- Administrative expense, selling and distribution expense, financial expense, income tax, losses, etc. are debited to it.
- The net profit/ net loss is transferred to P&L appropriation a/c (if made) otherwise to capital a/c.
- If trading a/c is not prepared then in place of gross profit/ gross loss all items of trading a/c will come in P&L a/c itself.
Profit & loss appropriation account:
- The net profit/ net loss is transferred to P&L appropriation A/c.
- Interest charged on drawings is credited to it.
- Interest allowed on capital, salary/ commission to proprietor/ partner and transfer to reserves are debited to it.
- The net balance then left is transferred to capital a/c.
- Raw material consumed (Op. stock + Purchases – Closing stock), carriage inward, wages, power, depreciation of factory building, machinery, etc and other manufacturing (factory) expense are debited to it.
- Opening WIP stock is debited and closing WIP stock credited.
- Balance is the cost of goods manufactured and is then transferred to trading account.
- When manufacturing a/c is not prepared, these items will come in trading a/c. Sometimes depreciation a/c may be directly taken to P&L a/c instead of trading a/c.
- Manufacturing a/c is also a period statement.
- Balance sheet shows the financial position of the entity as at a particular point of time.
- It shows what and how much entity owns (i.e. its assets) and how much it owes to others (i.e. its liabilities), the balance (i.e. asset – liability) is the owners equity.
- It is not an account, hence does not have debit and credit side.
- On one side assets like fixed assets (building, machinery, furniture, etc), current assets (like stock, debtors, cash bank balance, advances, prepared a/c) and investments if any are shown.
- On the other side in addition to owner’s capital and reserves, the outside liabilities like loans taken, creditors, expenses payable etc are shown.
- The total of the two sides must be the same.
- Trial balance is a statement containing the balances of all accounts as at the end of certain period usually classified into debit and credit.
- The total of debit and credit side must tally because whole accounting is done by double entry principle, otherwise it indicates arithmetical inaccuracies.
- It has balance of expenses, incomes, assets and liabilities.
- With the help of trial balance and adjustments the final accounts are prepared.
- All expenses and incomes will go into Manufacturing, Trading, P&L and P&L app. a/c depending upon its nature and all assets and liabilities will go into balance sheet.
Other information/ Additional information
- When the trial balance is prepared, there may still be some accounts which are not yet final and may need some adjustments, some corrections etc.
- Such information is given together with trial balance and commonly referred as adjustment/ additional information/ other information etc.
- It is basically a transaction which needs to be entered in the account books or some errors which needs to be rectified, hence we give double entry effect i.e. Debit & Credit both for such adjustments.
- Some times indirect information is contained, in the trial balance, which when interpreted results into an adjustment (known as adjustment derived).
Add-Less vs. Debit-Credit while giving treatment to adjustments:
- Although there is nothing wrong in either.
- But as a student our objective should be to improve our knowledge of accounting.
- Debit credit is the language of accounting and not add-less, hence it is advisible to use your debit-credit (i.e. accounting) knowledge everywhere.
- Formulate a double entry for every transaction/ adjustment and then give its effect to same accounts if appearing in trial balance and the final figure then will appear in final account.
Closing entries/ Closing of books of accounts:
- After all adjustment are duly accounted, the individual expenses accounts are closed by debiting into trading or P&L a/c etc. as the case may be, similarly all incomes a/c are closed by crediting it to Trading & P&L a/c. Such entries are known as closing entries.
- Balance of trading account (gross profit) is transferred to P&L a/c and balance of P&L a/c (net profit) is transferred to capital a/c.
- Thus we are left with only the balances of assets and liabilities (including capital) which are shown in the balance sheet and carried forward to next years books of account by writing the balance on the other side of the account and thus account is shown as closed i.e. total on both debit and credit side gets equalized.
- When the books of accounts have been audited and final accounts have been prepared, then the closing entries as above are passed.
- All assets and liabilities accounts are balanced, shown in the balancesheet and carried forward to next years account book,
- It is an accepted norm, not to make any changes once the account books are audited and closed.
Provision and Reserve:
- Provisions means (Guidance Note on Terms used in Financial Statements)
- “any amount written off or retained by way of providing for depreciation or diminution in value of assets, or
- Retained by way of providing for any known liability the amount of which cannot be determined with substantial accuracy”.
- Provision is a present liability which by its nature requires a significant amount of estimation.
- The following are examples of amount retained in the business out of earning for different purposes that are described as provisions.
- Amount provided for meeting claims/liabilities which are admissible in principle but the amount whereof has not been ascertained.
- Amount provided for payment of taxes still to be assessed.
- Amount set aside for writing off bad debts or for discounts.
- The term ‘reserve’ is defined in Guidance Note on Terms used in Financial Statements as the portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by the management for a general or a specific purpose other than a provision for depreciation or diminution in the value of assets or for a known liability.
- Also provisions in excess of the amount considered necessary for the purposes these were originally made, are to be considered as reserves.
- It is thus evident that provisions are a charge against profits, while reserve is an appropriation of profits
Current Assets :
- Current Assets are the assets which in the normal course of business are used or realized within an accounting year.
Current Liabilities :
- Current Liabilities are the liabilities which in the normal course of business are paid/settled within an accounting year.
Working Capital :
- Current Assets (–) Current Liability is known as working capital.
Long term Liability :
- Long term liabilities are liabilities which are due / payable beyond one year.
Fixed Assets :
- Fixed Assets are assets held for use in the business or for giving on rent etc.
- Example : Land, Building, Plant & Machinery, Vehicles, Goodwill, Patent etc.
Intangible Assets :
- Intangible Assets are Fixed Assets which don’t have physical existence or physical existence is only secondary to its intangible part.
- Example : Goodwill, Patent, Trademark, Software etc.
Fictitious Assets :
- These are not asset in a correct sense, these are the expenditure / losses which have not been written off to profit & loss account, hence appears on the asset side of Balance sheet.
- Example : Preliminary expenses , Share / Debenture discount etc.
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