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UNIT – 7

UNIT – 7 . FINAL ACCOUNTS. Final accounts. Structure Introduction and Objectives Adjustments before preparing final accounts Trading account Preparation of Trading account. Financial Accounting. Final accounts. Profit and Loss Account Preparation of Profit and Loss Account

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UNIT – 7

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  1. UNIT – 7 FINAL ACCOUNTS

  2. Final accounts Structure • Introduction and Objectives • Adjustments before preparing final accounts • Trading account • Preparation of Trading account Financial Accounting

  3. Final accounts • Profit and Loss Account • Preparation of Profit and Loss Account • Balance Sheet – Meaning • Preparation of Balance Sheet • Introduction Financial Accounting

  4. Introduction and Objectives • Final Accounts are those prepared at the end of Accounting period and the last leg of the entire Accounting trail. • Final Accounts For Manufacturing Concerns • Manufacturing Account • Trading Account • P & L Account • Balance Sheet Financial Accounting

  5. Introduction and Objectives • Final Accounts For Trading Concerns • Trading Account • P & L Account • Balance Sheet Financial Accounting

  6. Introduction and Objectives • Final Accounts For Non-Trading Concerns • Receipts & Payments Account • Income & Expenditure Account • Balance Sheet • Objectives: Financial Accounting

  7. Introduction and Objectives • To know the meaning and purpose of final accounts • To identify the items of Trading Accounts • To identify the items of Profit and Loss Account. • To identify the items of assets and liabilities of Balance Sheet Financial Accounting

  8. Introduction and Objectives • To know the adjustments such as RBD, Reserve for discount, depreciation, closing stock, stock destroyed by fire, used for personal purposes, prepaid and outstanding items etc., Financial Accounting

  9. Introduction and Objectives • To prepare Balance Sheet without any adjustments from the trial balance. • To prepare Balance Sheet with adjustments Financial Accounting

  10. Adjustments before preparing final accounts • GAAP (Generally Accepted Accounting Principles) recognizes the accrual basis of accounting • So revenue is recognized when it is earned, whether received or not and expenses are recognized when they are incurred whether paid or payable. Financial Accounting

  11. Adjustments before preparing final accounts • Adjustments are more internal transactions and they include: • Outstanding Expenses • Prepaid expenses • Outstanding Incomes/ Accrued income • Pre-received Incomes Financial Accounting

  12. Adjustments before preparing final accounts • Depreciation on assets • Reserve for bad and doubtful debts • Reserve for discount on debtors • Reserve for discount on creditors • Stock used for personal purposes • Closing stock valuation Financial Accounting

  13. Adjustments before preparing Final Accounts – Outstanding Expenses • Expenses incurred but not paid are regarded as Outstanding Expenses • Outstanding expenses should be considered for calculating profit because they are incurred before the end of accounting period • The entry in the journal proper is Financial Accounting

  14. Adjustments before preparing Final Accounts – Outstanding Expenses • Concerned Expense account Dr • To Outstanding Expenses account • (Being outstanding expense amount brought into account) • The outstanding portion of the expense is added to the concerned expense account in P & L A/c. • Outstanding expense account is shown as a liability in the balance sheet Financial Accounting

  15. Adjustments before preparing Final Accounts – Outstanding Expenses Example: Salaries payable for the year 2005 Rs.60,000. Actual payment made is Rs.48,000. • The salary account shows only Rs.48,000 because it is paid and recorded in cash account. • So, the outstanding amount is Rs.12,000 (60,000 – 48,000). • The entry is Financial Accounting

  16. Adjustments before preparing Final Accounts – Outstanding Expenses • Salary account Dr 12,000 • To outstanding expenses account 12,000 • (Being salary due to be paid brought into account) • In the Profit and Loss Account, the outstanding salary is added and in the balance sheet, the outstanding salary Rs.12,000 appears as liability, since it shows credit balance. Financial Accounting

  17. Adjustments before preparing Final Accounts – Prepaid Expenses • Meaning: Prepaid expenses are those which are paid in advance in the current accounting period even though they relate to the next accounting period. • Eg: Taxes paid in advance, Rent paid in advance, Insurance premium paid in advance • Adjusting Entry in the Journal Proper: • Prepaid expenses account Dr Financial Accounting

  18. Adjustments before preparing Final Accounts – Prepaid Expenses • To Concerned expense account • Treatment in Accounts: • Deduct prepaid portion of the expense from the concerned expense account in the final accounts. • Prepaid portion of the expense is shown as an asset in the balance sheet, since it shows debit balance. Financial Accounting

  19. Adjustments before preparing Final Accounts – Prepaid Expenses • Example: Insurance premium paid from 1-4-2005 to 31-3-2006, Rs.18,000. • The accounting year is from 1-1-2005 to 31-12-2005. • Therefore the prepaid portion is for 3 months – Jan, Feb and Mar 2006 – Rs.4,500 (18000 X 3 / 12) • The Adjusting Entry: Financial Accounting

  20. Adjustments before preparing Final Accounts – Prepaid Expenses • Prepaid Insurance A/c Dr 4,500 • To Insurance Premium A/c 4,500 • Treatment: • A. Deduct the prepaid portion of insurance Rs.4,500 from Insurance paid in P & L Account • Show the prepaid portion of insurance as an asset in the Balance Sheet Financial Accounting

  21. Adjustments before preparing Final Accounts – Outstanding Income / Accrued Income • Meaning: Accrued Income is an income which is earned but not received. • Adjusting Entry • Accrued Income A/ c Dr To Concerned Income A/c Financial Accounting

  22. Adjustments before preparing Final Accounts – Outstanding Income / Accrued Income • Accounting Treatment: • Add the outstanding portion to the concerned item of income in Final accounts • Show the accrued portion of income as an asset in the Balance Sheet Financial Accounting

  23. Adjustments before preparing Final Accounts – Outstanding Income / Accrued Income Example: • Rent receivable for 12 months 1-1-2006 to 31-12-2006 is Rs.72,000 • Rent received for only 9 months up to 30th September, 2006 is Rs.54,000 • Rent accrued but not received before 31-12-2006 is Rs.18,000 Financial Accounting

  24. Adjustments before preparing Final Accounts – Outstanding Income / Accrued Income • The adjusting entry is • Outstanding Rent account Dr 18,000 • To Rent account 18,000 • Treatment is Financial Accounting

  25. Adjustments before preparing Final Accounts – Income Received In Advance • Add Rs.18,000 to rent received account Rs.54,000 to make it Rs.72,000 in P & L Account. • Show the outstanding rent account as an asset in the Balance Sheet on 31-12-2006. Financial Accounting

  26. Adjustments before preparing Final Accounts – Income Received In Advance • Meaning : Income actually received in the current accounting period but relating to the next accounting period • Example: Rent received in advance. • Adjusting entry in Journal Proper: • Concerned Income account Dr • To Pre-received Income account Financial Accounting

  27. Adjustments before preparing Final Accounts – Income Received In Advance • Accounting Treatment: • Deduct pre-received portion of the income from the concerned item of income in final accounts. • Show the pre- received amount of the income as a liability in the Balance Sheet Financial Accounting

  28. Adjustments before preparing Final Accounts – Income Received In Advance • Example: • Royalty actually received during the year is Rs.1,25,000 • Royalty relating to next year included in the above is Rs.25,000 • Adjusting Entry • Royalty account Dr 25,000 Financial Accounting

  29. Adjustments before preparing Final Accounts – Income Received In Advance • To Pre-received Income account 25,000 • Treatment in Accounts: • Deduct Rs.25,000 from Rs.1,25,000 in the Profit and Loss Account • Show Rs.25,000 as a liability in the Balance Sheet Financial Accounting

  30. Adjustments before preparing Final Accounts – Depreciation on assets • Meaning : Depreciation is reduction in the value of an asset as a result of wear and tear or constant use. It is a loss and charged against profit of the business. • Accounting Entries : • Depreciation account Dr • To Concerned Asset account • Profit and Loss Account Dr • To Depreciation account Financial Accounting

  31. Adjustments before preparing Final Accounts – Depreciation on assets • Accounting Treatment: • Charge depreciation against gross profit in P & L Account • Deduct depreciation amount from the concerned asset account if depreciation appears outside T.B. • Methods of Depreciation • Fixed Installment Method • Reducing Balancing Method Financial Accounting

  32. Adjustments before preparing Final Accounts – Bad debts and Provision for Bad Debts • Meaning: Bad Debts are the debts which can not be recovered and represent total loss to the business. • Accounting Entries: • Bad Debts account Dr • To Sundry debtor’s account • (Being bad debts taken to account) • Profit and Loss Account Dr Financial Accounting

  33. Adjustments before preparing Final Accounts – Bad debts and Provision for Bad Debts • To Bad debts account • (Being bad debts charged to P&L account) • Occurrence of Bad debts: • Case I : Bad debts deducted from debtors and brought to the account and trial balance. • Case II: Bad debts are accounted after the preparation of trial balance Financial Accounting

  34. Adjustments before preparing Final Accounts – Bad debts and Provision for Bad Debts • Accounting Adjustment: • First case: Transfer the bad debts to P&L Account and Sundry Debtors need not be reduced. • Second Case: • Transfer the bad debts to P&L Account and • Reduce the sundry debtors by the amount of bad debts. Financial Accounting

  35. Adjustments before preparing Final Accounts – Bad debts and Provision for Bad Debts • Third Case: If there is any reserve for bad debts maintained, then bad debts should be set off against such reserve and later if there is uncovered bad debts, then charge them against P&L Account Financial Accounting

  36. Adjustments before preparing Final Accounts – Bad debts and Provision for Bad Debts • Purpose of Provision for Bad Debts: To cover the risk of bad debts that may arise in future. It is a charge against profits of the business. This is also known as Reserve for bad and doubtful debts. • Adjusting Entries: Financial Accounting

  37. Adjustments before preparing Final Accounts – Bad debts and Provision for Bad Debts • Profit and Loss Account Dr • To Reserve for Bad Debts account • (Being provision made for bad and doubtful debts) • Reserve for Bad Debts account Dr • To Bad debts account • (Being bad debts incurred set off against RBD) Financial Accounting

  38. Adjustments before preparing Final Accounts – Bad Debts and Provision for Bad Debts • Accounting treatment: • Charge P & L Account by the amount of RBD to the extent it is needed. • Show the balance of RBD as liability in the Balance Sheet OR deduct RBD from Good Debtors. Financial Accounting

  39. Adjustments before preparing Final Accounts – Bad Debts and Provision for Bad Debts • Deduct bad debts from RBD in case there is adequate balance is available • The amount to be transferred to P&L Account towards RBD is calculated by applying the formula Financial Accounting

  40. Adjustments before preparing Final Accounts – Bad Debts and Provision for Bad Debts • New RBD required – (Old RBD + Bad Debts ) • Calculation of RBD: RBD is calculated at a fixed percentage of good debtors and basing on the past experience of business man. • Good debtors = Total debtors – Bad debts unadjusted. (As given outside the trial balance) Financial Accounting

  41. Adjustments before preparing Final Accounts – Bad Debts and Provision for Bad Debts • Illustration: • Debtors on 1-1-2005 Rs.2,00,000; RBD balance on 1-1-2005 : Rs.10,000; Bad debts incurred during the year 2005 Rs.9,000; RBD should be at 5% on debtors. Debtors on 31-12-2005 Rs.3,00,000. Draw ledger accounts and show in the balance sheet. • Answer: Financial Accounting

  42. Adjustments before preparing Final Accounts – Bad Debts and Provision for Bad Debts Financial Accounting

  43. Reserve for Bad and Doubtful Debts (Continued) • I Method Balance Sheet for the year ending 31-12-2004 Balance Sheet for the year ending 31-12-2005 Liabilities Assets Liabilities Assets R B D 10,000 Sundry Debtors 2,00,000 R B D 15,000 Sundry Debtors 3,00,000 • II Method Balance Sheet for the year ending 31-12-2004 Balance Sheet for the year ending 31-12-2005 Liabilities Assets Liabilities Assets S.Debtors 2,00,000 Debtors 3,00,000 Less RBD 10,000 Less RBD 15,000 1,90,000 2,85,000 Financial Accounting

  44. 7.2.7. Adjustments before preparing Final Accounts - Reserve for Discount on Debtors • Nature and purpose of Discount • Discounts are of two types – Trade discount and cash discount. • Trade discount is allowed to retain the customer ship and does not get reflected in the accounts Financial Accounting

  45. 7.2.7. Adjustments before preparing Final Accounts - Reserve for Discount on Debtors • Cash discount is to encourage prompt and regular payment of cash by the customers to whom goods are sold on credit. It appears in Cash book. Discount allowed is business expense and discount received is business income. • Need for Reserve for Discount on Debtors: • To cover the risk of discount allowable to debtors Financial Accounting

  46. 7.2.7. Adjustments before preparing Final Accounts - Reserve for Discount on Debtors • Accounting Entries: When reserve for discount on debtors is created: P & L Account Dr To Reserve for discount on Drs a/c When discount is allowed to Debtors: Discount allowed account Dr To Sundry debtor’s a/c When Discount on debtors is set off against Reserve: Reserve for Discount A/c Dr To discount allowed a/c Financial Accounting

  47. 7.2.7. Adjustments before preparing Final Accounts - Reserve for Discount on Debtors • Accounting Treatment: • Show Reserve for discount on debtors either as a liability in the balance sheet or deduct the same from good debtors on the asset side of the balance sheet. The later is the popular practice Financial Accounting

  48. 7.2.7. Adjustments before preparing Final Accounts - Reserve for Discount on Debtors • Important Note: • Reserve for discount on debtors is computed on the amount of debtors minus new RBD, at a fixed percentage. • Any excess reserve is present, transfer it to P & L Account as income.

  49. 7.2.8.Adjustments before preparing Final Accounts – Reserve for Discount on Creditors • Nature and purpose: Discounts are allowed by creditors when we pay them promptly and in time. Discount is thus received and treated as income. Anticipating such income, a reserve is maintained in the business. Financial Accounting

  50. 7.2.8.Adjustments before preparing Final Accounts – Reserve for Discount on Creditors • Accounting entries 1. Whenever discount is received: Creditors Account Dr To Discount received account 2. When Discount received is transferred to P&L: Discount received a/c Dr (Reserve for discount is not available) To P & L Account 3. When Discount received is set off against Discount received a/c Dr Reserve for Discount on Debtors : To Reserve for discount on creditors a/c 4. When Reserve is created in P&L A/c : Reserve for Discount on Creditors a/c Dr To Profit and Loss Account Financial Accounting

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