Chapter 7

The Mega Question

Let us now do a full question on final accounts.

Question

From the following Trial Balance, prepare a Profit and Loss Statement and Balance Sheet along with notes to accounts for the year ending December 31, 2007.

The following further information was given.

1. Wages for December 2007 amounting to Rs. 2,100 have not yet been paid.
2. Included in General Expenses is Insurance Premium Rs. 600, paid for the year ending March 31, 2008.
3. A provision for doubtful debts @ 5% on debtors is necessary.
4. Depreciation is to be charged as follows:
   Land and Building 2%, Machinery 10%, and Furniture and Fixtures 15%.
5. The loan from Mrs. Gurdeep Singh was taken on July 1, 2007. ­Interest has not been paid yet.
6. The value of stock in hand on December 31, 2007 was Rs. 14,900.

Answer

Step I

We will take each item one by one and segregate them according to whether they will be transferred to the Profit and Loss Statement or shown in the Balance Sheet.

Simultaneously, we will also see how their relating adjustments are treated.

Let us start from the Debit side of the Trial Balance.

1. Opening Stock

   It is not taken directly to the Profit and Loss Statement but shown as increase or decrease in the inventory to arrive at the operating profit; that is, if

   closing stock > opening stock = increase in inventory

   closing stock < opening stock = decrease in inventory

   We can see in the adjustments that closing stock of Rs. 14,900 is given. Hence change in inventory to be taken to profit and loss account: opening stock − closing stock (15,500 − 14,900), which is Rs. 600 decrease in inventory.

   Further, closing stock of Rs. 14,900 will be shown as inventories under current assets in the Balance Sheet.

2. Land and Building

   It is given at Rs. 35,000 in the trial balance. But we can also see that depreciation @ 2 percent has to be provided as given in the adjustment. Hence, since Land and Building is fixed asset, it will be shown at the original cost in the Balance Sheet and accumulated depreciation pertaining to it—that is, 2 percent of Rs. 35,000—which is Rs. 700 will be shown separately as deduction from the original cost. Simultaneously, the depreciation amount will also be charged to the profit and loss account.

3. Machinery

   This is given at Rs. 50,000 in the Trial Balance, and the adjustment relating to it states that depreciation @ 10 percent will be charged on it. Hence machinery will be shown at the original cost in the ­Balance Sheet under Fixed Assets and Accumulated Depreciation of Rs. 5,000, that is, 10 percent of Rs. 50,000 will be shown as deduction from it. Moreover, depreciation will also be charged to the profit and loss account as loss in the value of asset.

4. Furniture and Fixtures

   Similar to Land and Building, Furniture and Fixtures too will be shown at the original cost as fixed asset in the Balance Sheet. As per the adjustment given, depreciation @ 15 percent will also be charged, that is, Rs. 750 will be charged to the profit and loss account and shown as accumulated depreciation in the Balance Sheet as deduction from the original cost.

5. Purchases

   Total purchases of Rs. 1,06,000 will be shown in the Profit and Loss Statement as the expense is related to the normal business activities of the company.

6. Salaries

   Since it is a revenue expense, it will be charged to the profit and loss account.

7. General Expenses

   They are also operating expenses, and hence should be charged to the Profit and Loss Statement. But the adjustment says that out of Rs. 2,500, Rs. 600 is for the year ending March 31, 2008, that is, it is prepaid for three months from January to March 2008; this means Rs. 150 (600 × 3/12) is prepaid. Hence, only Rs. 2,350 (2,500 − 150) will be charged to the profit and loss account since only this much amount relates to the current period. We will not take expense that is not of the current year into account.

   Further, the prepaid expense of Rs. 150 will be shown as current asset in the Balance Sheet as we have not yet incurred it but have made the payment.

8. Rent; Postage and Telegraph; and Stationery

   These are also operating expenses incurred by the company in its ­normal course of business. Further, no additional information is given for these, so we will assume that they pertain to the current period. Hence, they too will be charged to the Profit and Loss ­Statement.

9. Wages

   Wages are also revenue expenditure to be charged to the profit and loss account but in the adjustments, it is given that out of Rs. 26,000, Rs. 2,100 has not yet been paid—that is, it is still outstanding. We will report the total expenditure incurred in the current year whether it is paid or not. Hence, in the Profit and Loss Statement, the amount of Rs. 28,100 (26,000 + 2,100) will be charged irrespective of whether or not payment is made, as long as it pertains to the current year.

   Further, outstanding wages of Rs. 2,100 will be shown under current liabilities in the Balance Sheet.

10. Freight on Purchases, Carriage on Sales, and Repairs

    Since these expenses are also revenue and pertain to the current period, they will be charged to the profit and loss account.

11. Sundry Debtors

    These are receivables for the company and hence will be shown under current assets in the Balance Sheet.

    Moreover, it has been provided in the adjustments that provision for doubtful debts should be made on the debtors @ 5 percent. This means that the company expects that the collection from 5 ­percent of debtors is uncertain. Hence provision of Rs. 1,500—that is 5 ­percent of 30,000—should be made by charging to the profit and loss account. Simultaneously, this provision will be shown under the head current liabilities in the Balance Sheet.

12. Bad Debts

    Bad debts are those receivables that cannot be recovered, that is, it is a loss for the company, and hence will be charged to the profit and loss account.

13. Cash in Hand and Cash at Bank

    Being an asset, both cash in hand and cash at bank will be shown under current assets in the Balance Sheet.

14. Sales Returns

    It will be subtracted from total sales to arrive at net sales in the profit and loss account.

Let us now proceed to the Credit side of the Trial Balance.

1. Capital

   It represents the owner’s funds and hence will be shown under Equities in the Balance Sheet.

2. Loan From Mrs. Gurdeep Singh @ 9 Percent

   Being a liability, it will be shown under Long Term Liabilities in the Balance Sheet. Moreover, its interest of Rs. 1,350—that is, 9 percent of 30,000 for half year (since loan is taken on July 1, 2007) will be charged to profit and loss account. The fact that it is not paid does not make a difference since it is already due and has become payable. This outstanding interest will be shown under current liabilities in the Balance Sheet.

3. Sundry Creditors

   They are payables for the company and hence will be classified under Current Liabilities in the Balance Sheet.

4. Purchase Returns

   They are subtracted from purchases in the profit and loss account to arrive at net purchases.

5. Sales

   This is shown under Revenue From Operations in the Profit and Loss Statement since it is the primary source of income for the company generated from its operations.

6. Discount

   Since it is shown on the Credit side of the Balance Sheet, it is an income (credit all incomes), that is, discount received and hence will be shown as Other Income in the profit and loss account.

Step II

Now we just have to present it appropriately along with notes to accounts.

Balance Sheet

Next, let us look into some other general topics.