Final Account -
The Resultant Profit Or Loss

The Final Account is thy named as it is finally prepared at end of the year to analyze the effect of various transactions and the resultant profit or loss.

The term "final account" refers to Trading account, Profit & Loss Account and Balance Sheet. Balance sheet is a statement but even then it is included in final accounts. But the question is why they are termed 'Final Account"?

Every business is, interested to know the final result of their trading. And these are called final accounts because they are the last accounts, prepared at the end of the financial year.

The following are the components of Final Account

Trial Balance:

Simply, a Trial Balance is a list of ledger accounts balances of a concern at the end of an accounting period. It is a summary of the Ledger at the end of an accounting period, and is the starting point of a Trading and Profit and Loss account and Balance Sheet.

The balances of Ledger Accounts are taken up for preparing Trial Balance. A trial balance usually contains the following types of Ledger Account balances:

  1. Expenditures Accounts
  2. Income or Revenue Accounts
  3. Assets Accounts
  4. Balances from liabilities accounts
  5. Capital or Owner's Equity Accounts

The first two types of balances are transferred to the Trading and Profit and Loss Account to chalk out the amount of profit or loss. The other three types of balances are transferred to the Balance Sheet to assess the financial position of the business at a given period of time.

Thus, we prepare from the Trial Balance a Trading and Profit and Loss Account is prepared by matching revenue balance with expenses balances.

It can thus be concluded that -

Profit = Revenue - All expenses

Meaning And Sources Of Revenue:

In common language revenue means tax or income. But in a business concern revenue means sales proceeds of goods or services or it is the price of goods sold or services rendered to the customers. According to American Accounting Association, "revenue is the monetary expression of the aggregate of products or services transferred by an enterprise to its customers during a period of time". When a business delivers goods to its customers or renders services to them, it either receives immediate payment in cash or acquires an account receivable (debtor) which will be collected and thereby become cash within a short time. The revenue for a given period is equal to the inflow of cash and receivables (debtors) from sales made in that period.

Thus:

Revenue = Amount received in cash + Receivable

Sources of Revenue:

The different sources of revenue are:

  1. Sale proceeds of goods or services (Sales A/C).
  2. Interest received on investment (Interest A/C credit balance).
  3. Dividend received on share (Dividend A/C).
  4. Discount received from creditors (Discount received account credit balance)
  5. Commission received from customers (Commission A/C credit balance).
  6. Profit on sale of assets (except goods).
Trading And Profit And Loss Account:

Trading Account:

A Trading Account is an account that is prepared before the preparation of Profit and Loss Account. The main aim behind the preparation of Trading Account is to find out the Gross Profit or Loss of the concern.

Gross Profit:

The term "Gross Profit" can be described as excess of amount of 'Sales' over 'Cost of Sales'.

This definition can be explained in terms of following equation:

Gross Profit = Total Sales-Cost of Goods Sold

or

(Total Sales + Closing Stock) - (Opening Stock + Purchases + Direct Expenses)

Preparation Of Trading And Profit And Loss Account:

Basically a Trading Account is prepared to find out the profitability of the goods dealt with whether purchased or manufactured.

The difference between the selling price and the cost price of the goods is the earnings of the concern and inorder to find out the gross earnings, it becomes necessary to find out:

  1. Cost of Goods Sold
  2. Sales
1. Cost of Goods Sold:

The cost of goods refers to the purchase price of goods plus related expenses pertaining to carriage inward, etc. The cost of goods sold can be calculated by deducting the total cost of goods purchased with the cost of goods in hand.

Cost of Goods Sold=Opening Stock+Total Cost of Goods Purchased - Cost of Goods in Hand.

2. Sales:

Total amount of sales can be chalked out form the Sales Ledger.

Items Of Trading Account:

A Trading Account consists of two sides - Debit side and Credit Side.

Debit Side:

The debit side includes all direct expenses. It consists of the followings:

1. Opening Stock:

It is the unsold stock of the previous accounting year. It appears in the debit side of the Trial Balance and from there it is recorded into the debit side of the Trading Account as the first item.

But in the first of the opening of the business, there is no opening stock.

2. Purchases:

The term "Purchases" refers to the goods or products that the business deals with. It includes both Cash Purchases and Credit Purchases.

On the debit side of the Trading Account, the net amount of purchases made is shown.

Total Purchases=Cash Purchases+(Credit Purchases-Purchase Return)

3. Direct Expenses:

The term "Direct Expenses" includes purchases and also refers to all expenses relating to purchase of goods such as wages, carriage inwards freight, duty, clearing charges, dock charges, excise duty, octroi, import duty etc.

4. Manufacturing Expenses:

Manufacturing expenses are those expenses that are incurred in the process of manufacturing of goods. These expense includes factory lighting, wages, factory rent, gas fuel, stores, royalties, factory expenses, foreman and supervisor's salary etc.

Credit Side:

The credit side includes all direct incomes. It consists of the followings:

1. Sales:

The term "Sales" includes all those goods or products that the business deals with. It includes both Cash Sales and Credit Sales.

On the credit side of the Trading Account, the net amount of sales made is shown.

Total Sales=Cash Sales+(Credit Sales-Sales Return)

2. Closing Stock:

It is the value of unsold stock of the previous accounting period. Normally closing stock is shown outside the Trial Balance. In that case, it is to be shown twice, once in the credit side of the Trading Account and also in the Assets side of the Balance Sheet. But if closing stock is shown inside the Trial Balance, than in that case, it is to be shown only in the Assets side of the Balance Sheet. Closing stock should be valued at cost or market price whichever is lower.

Profit and Loss Account:

Profit and Loss Account is an Account that is prepared after preparation of Trading Account. The account is opened on the credit side with the Gross Profit of the Trading Account. A Profit and Loss Account Records all indirect expenses (on the debit side) and incomes (on the credit side).

Every business needs to ascertain the net amount of profit earned or loss suffered during the accounting period. And with this objective, a Profit and Loss Account is prepared.

The profit and loss account is opened by recording the gross profit (on credit side) or gross loss (debit side).
       In addition to the direct expenses and incomes, a business has to incur many more expenses and may also earn some indirect incomes in the course of its business activities. These expenses made are recorded in the debit side of the Profit and Loss Account as they are to be deducted from the gross profit of the business and the indirect incomes earned are recorded in the credit side of the Profit and Loss Account.

The amount of net profit earned or net loss suffered are added or deducted in the Capital Accounts on the liabilities side of the Balance Sheet of the Concern.

Items Normally Appearing On The Debit Side Of Profit and Loss Account:
  1. Salary
  2. Commission
  3. Carriage Outward
  4. Taxes
  5. Bad Debts
  6. Advertising
  7. Packing expenses
  8. Export duty
  9. Insurance
  10. Legal expenses
  11. Trade expenses
  12. Rates and Taxes
  13. Audit fees
  14. Insurance
  15. Rent
  16. Printing and Stationery
  17. Postage and Telegrams
  18. Bank charges
  19. Discount Allowed
  20. Interest on Capital
  21. Interest on loan
  22. Discount on bill discounted
  23. Maintenance
  24. Repairs
  25. Depreciation on Assets
  26. Provision for Doubtful Debts
  27. Reserve for Doubtful Debts
  28. Reserve for Discount on Debtors etc;
On the credit side of Profit and Loss Account , the following items are normally recorded:
  1. Discount Received
  2. Commission Received
  3. Rent Received
  4. Interest Received
  5. Income from Investments
  6. Profit on Sale of Assets
  7. Bad debts Recovered
  8. Dividend Received
  9. Apprenticeship
  10. Premium etc.
Profit And Loss Appropriation A/c:

Key Points:

  1. It records the personal transactions of the partners only.
  2. All amounts receivable for the partners becomes payable or expenses for the business and is recorded in the debit side of the Profit And Loss Appropriation A/c. And, all amounts payable/deductable from Partners Capital A/c becomes income receivable for the firm and is shown on the credit side of Profit And Loss Appropriation A/c.Here it is to be noted that under the double entry system of accounting, every debit has a corresponding credit. And as such, expenditure for one becomes income for the other and vice versa.
  3. The amount to be recorded should be of revenue nature only and should also relate to the capital account of the partners
Accounting Treatment For Bad Debts:

The term bad debt is used to describe the irrecoverable amount from sundry debtors. It is normally deducted from the total of sundry debtors and is shown in the debit side of Trial Balance.

Now the point that is to be noted is that amount of sundry debtors that is shown in the Trial Balance is the amount shown after deducting the bad debts and the provision for debtors which is on the credit side is the old provision that is created earlier before the preparation of Trial Balance

Suppose Trial Balance of X & Co. shows total Sundry Debtors total as 25,000 on the and Bad Debts 2,500 and on the credit side provision for bad debts as 500.

This amount of Sundry Debtors which is shown in the Trial Balance is the amount after deducting the amount of bad debts. If not so the amount of Sundry Debtors would have been 27500. (25000+2500)

Again in the additional information part, we find few more points that are also to be considered.

  1. Firstly, we find additional bad debts of 500.00 that is also to deducted from sundry debtors
  2. Secondly, we find some 10% provision that needs to be created from sundry debtors.
  3. Thirdly, 10% of discount that is to be allowed to sundry debtors.

Illustrating the above points, we need to treat Bad Debts as follows:

In the Profit and Loss A/c debit side,

To Bad Debts2500.00
Add: Further Bad Debts500.00

3000.00
Add: New Provision (25000-500)*10/1002450.00

5450.00
Less: Old Provision500.00
Bad Debts
6850.00

In the Profit and Loss A/c we need to write discount on debtors separately. And the calculation is to be made on the value of good debts (recoverable debts after deducting all bad debts and provisions).

In the above example, the value of good debts will be -

Sundry Debtors25000.00
Less: Bad debts500.00

24500.00
Less:New Provision@10%2450.00
Good Debts
22150.00

Now from this value of good debts we need to find out the value of discount on debtors and the amount will be (22150 X10%)=2215 and the amount is to be written on the debit side of Profit and Loss A/c as nominal expenditure.

In the balance sheet, on the assets side the net value of Sundry Debtors will be shown as follows

Sundry Debtors25000.00
Less: Bad debts500.00
Total
24500.00
Less:New Provision@10%2450.00
Good Debts
22150.00
Less: Discount (22150 X 10 %) 2215.00
Total
1993500.00

The net value of Sundry Debtors is to be written on the balance sheet.

Bad Debts Key Points:

Here we find that all the three items is treated twice, once in the profit and Loss A/c and also in the Balance Sheet. Why?

The answer is Final Account is prepared after the end of the accounting period. And the trial balance that is considered in preparing final account is the one that is prepared at the end of the accounting period with balances on the last day of the accounting period. The balances that appear in the trial balance are normally those that have been taken into account and are recorded in the accounting period.

But there might be a number of accounting transactions relating to the accounting period which might not have been considered while preparing Trial Balance. Adjustments in Final Account are those transactions relating to the organization which have not yet been journalized and are eventually not recorded in the Trial Balance.