Year: 2020

Capital profit is a profit which is earned, on the sale of a fixed asset or profit earned on raising capital for a company (by issuing shares at premium). This is not a regular profit of the business and is not earned in the ordinary trade of the business. For example, if a machinery having book value of $50,000 is sold for $60,000, the profit of $10,000 will be a capital profit. In the same way, a joint stock company issues shares of $ 2,00,000 at a premium of $10,000 to raise capital, such premium of $10,000 will be a capital profit.

In this connection the distinction between capital receipt and capital profit may be noted. A machinery of $50,000 is sold for $60,000. Here capital receipt is $60,000 and capital profit is $10,000. This type of profit is not recurring and regular. It will be shown on the liability side of the Balance Sheet under the head “Capital Reserve”.

Revenue Profits:

This is a profit which is earned during the ordinary course of business e.g. profit on sale of goods, rent received, interest received etc.

Capital Loss:

This is a Joss suffered by a business on the sale of a fixed asset or it is incurred on raising capital of a joint stock company. This is not a recurring loss and is not made in the ordinary course of the business. e.g. A machinery having book value of $50,000 is sold for $45,000, the loss of $ 5,000 is a capital loss. In the same way, a company issued shares of $1,00,000 at 10% discount, the loss of $10,000 (10% of $1,00,000) is a capital loss. Capital loss is sown in the Balance Sheet on the asset side as a fictitious asset which is gradually written off out of the profits every year.

Revenue Loss:

This loss is made in the ordinary course or day to day operation of a business such as loss on sale of goods etc. Revenue loss appears in the profit and loss account or income statement in the year in which it occurs.

Posting in accounting is when the balances in subledgers and the general journal are shifted into the general ledger. Posting only transfers the total balance in a subledger into the general ledger, not the individual transactions in the subledger. An accounting manager may elect to engage in posting relatively infrequently, such as once a month, or perhaps as frequently as once a day.

Subledgers are only used when there is a large volume of transaction activity in a certain accounting area, such as inventory, accounts payable, or sales. Thus, posting only applies to these larger-volume situations. For low-volume transaction situations, entries are made directly into the general ledger, so there are no subledgers and therefore no need for posting.

For example, ABC International issues 20 invoices to its customers over a one-week period, for which the totals in the sales subledger are for sales of $300,000. ABC’s controller creates a posting entry to move the total of these sales into the general ledger with a $300,000 debit to the accounts receivable account and a $300,000 credit to the revenue account.

Posting is also used when a parent company maintains separate sets of books for each of its subsidiary companies. In this case, the accounting records for each subsidiary are essentially the same as subledgers, so the account totals from the subsidiaries are posted into those of the parent company. This may also be handled on a separate spreadsheet through a manual consolidation process.

Posting has been eliminated in some accounting systems, where subledgers are not used. Instead, all information is directly stored in the accounts listed in the general ledger.

When posting is employed, someone researching information in the general ledger must “drill down” from the account totals posted into the relevant general ledger accounts, and search in the detailed records listed in the relevant subledgers. This can entail a significant amount of additional research work.

From the perspective of closing the books, posting is one of the key procedural steps required before financial statements can be created. In this process, all adjusting entries to the various subledgers and general journal must be made, after which their contents are posted to the general ledger. It is customary at this point to set a lock-out flag in the accounting software, so that no additional changes to the subledgers and journals can be made for the accounting period being closed. Access to the subledgers and journals is then opened for the next accounting period.

If posting accidentally does not occur as part of the closing process, the totals in the general ledger will not be accurate, nor will the financial statements that are compiled from the general ledger.

Steps for Balancing Ledger Account

• First of all, calculate the totals of debit and credit columns separately on a rough sheet to avoid mistakes. Find out the difference between the heavier total and lighter total by subtracting the lower from higher. The difference is called a Balance amount.
• If the total of the debit side is heavier than that of the credit side, the balance is called as “Debit Balance” and is written on the credit side (the side with lower amount) of that particular account as “By Balance c/d” or “By Balance c/FD”. Here, c/d means carried down and c/FD means carried forward.
• Similarly, if the total of the credit side is more than that of debit side total, the balance is called “Credit Balance”. The difference amount is written on the debit side of the account as “To balance c/d” or “To balance c/fd”
• Once we get the heavier total it should be written in both the columns’ total. Draw double lines across the total below the amounts which indicates the account is closed and balanced.
• Last year’s closing balance is the opening balance of the current year. So, if there is debit it should be shown on the debit side of a particular account as “To Balance b/d” or “To Balance b/fd”. Here, b/d means brought down and b/fd means brought forward.

Note: Nominal accounts are not balanced; the balances are transferred to profit and loss account.

Posting the entries from day books to ledger is very important work. An accountant must keep in his mind the following rules while posting the entries:-

1. Entries must be posted from the day books or journal only.
2. Posting of the entries must be date wise.
3. Date of entry in day books must be the date of entry in ledger.
4. All amounts shown in debit side in journal must be posted in debit side of a particular account. In ‘particulars’ column of ledger, the name of the other account as shown in journal, relating to same entry, must be written and the account head must start with ‘To’.
5. All amounts shown in credit side in journal must be posted in credit side of a particular account. In ‘particulars’ column of ledger, the name of the other account as shown in journal, relating to same entry, must be written and the account head must start with ‘By’.
6. After the entry, page number of journal from where the entry is posted, must be written in L/F column of account and the page number of ledger account must be written in L/F column of journal or day book.
7. Then the balancing of the ledger should be done. Balancing is may be done as running or can be done after doing the totals of debit and credit side. If the total of debit side is more than credit side then the balance should be shown as debit balance in balance column and if the total of credit side is more than the total of debit side then balance should be shown as credit balance in balance column. If the totals of debit and credit sides are equal then the balance should be shown as ‘nil’ in balance column.

The income statement summarizes sales, expenses and profits for an accounting period. Expenses include cost of goods sold, operating and non-operating expenses, and unusual expenses. Operating expenses include administration and advertising, while interest and taxes are some of the non-operating expenses. Unusual expenses are extraordinary or one-time in nature. The company does not incur these expenses every period, but they may have a significant effect on profits and cash flow.

Types

Unusual items include discontinued operations, extraordinary items and changes in accounting principles. Discontinued operations refer to the sale or shutdown of a significant operating unit. For example, the costs associated with shutting down overseas manufacturing operations would count as unusual expenses. Extraordinary expenses are infrequent or one-time events, such as damages caused by natural disasters and accidents. Unusual expenses also include changes in accounting principles, such as a change from cash-basis to accrual-basis accounting.

Accounting

Income statements show unusual items in a separate section near the bottom. Items must be both unusual and infrequent to be in this section. For example, gains and losses from disposal of fixed assets or changes in inventory valuations are not part of this section. Companies may show the net income from continuing or regular operations as a separate line item, then list the extraordinary and discontinued items, and finally show the net income. The income statement shows these unusual items net of taxes. For example, if the corporate tax rate is 20 percent and the losses from flood damage are $10,000, the net loss is $8,000 — $10,000 x (1 – 0.20) = $10,000 x 0.80 = $8,000.

Impact

Unusual items affect the net income calculation on the income statement, including resulting in a loss. For example, a fire that destroys a small company’s production facilities could result in a net loss because the company would have to repurchase inventory, repair damages to the building and buy or lease new equipment. For public companies, unusual items also affect earnings per share, which is the net income divided by the number of shares outstanding. Changes in net income also affect operating cash flow.

Considerations

Investors should review the unusual items to determine whether they indicate an underlying problem. For example, if a company discontinues its Latin American operations, investors might want to know why management closed the business or could not find a buyer. Some companies may classify certain items as unusual in every accounting period to make the net income from continuing operations number look better. External stakeholders should assess whether the company management is trying to hide operational weaknesses in unusual items.

Accounting errors

Accounting errors are the mistakes committed in bookkeeping and accounting. The mistake may be one relating to routine or one relating to principle. They may occur in entering the transactions in the journal or subsidiary books or they may creep at the time of posting into the ledger.

Thus, errors may be committed while recording, classifying or summarizing the accounting transactions. The error may be the result of an act of omission or commission.

Classification of Errors:

Depending upon the nature of errors, they may be classified into the following four types:

(1) Errors of Omission

(2) Errors of Commission

(3) Errors of Principles

(4) Compensating Errors

1. Errors of Omission:

When a transaction is not recorded by mistake in the books of accounts, it is called an error of omission. The omission may be partial or complete.

Partial Omission may happen in relation to any subsidiary book. Here the transaction is entered in the subsidiary book but not posted to the ledger.

For example, goods returned by a customer has been entered in the sales returns book but not posted to the credit of customer’s account. Similarly, cash paid to the supplier has been entered in the payment side of the Cash Book but not posted to the debit of supplier’s account.

Complete omission can happen when the transaction is completely omitted from the books of accounts. For example, a bookkeeper failed to enter an invoice from the sales daybook.

2. Error of Commission:

When a transaction is entered in the books of accounts, it might be entered wrongly. It may be entered partially or incorrectly. Such error is called an error of commission. These errors arise often due to the ignorance or negligence or absent-mindedness of the accountant. It may be of different types. Examples of such errors are as follows:

(a) Errors relating to subsidiary books:

These are three types:

(i) Entering wrong amount in a subsidiary book, e.g., a purchase of Rs.430 may be entered in the Purchase Day Book as Rs.340 due to wrong transposition of figures.

(ii) Entering the transaction in a wrong subsidiary book, e.g., a purchase transaction may be entered in sales daybook and a sales transaction may be entered in the purchase daybook.

(iii) Wrong casting or carry forward of a subsidiary book. Casting refers to the process of totaling the daybooks periodically. A mistake in relation to totaling is called ‘error in casting’.

If there is excess totaling, the error is ‘over casting’ and short totaling is ‘under casting’. Sometimes, error may be the result of wrong carry forward of the total from one page of the daybook to another, e.g., the total of a page may be Rs.235 and carried forward to the next page as Rs.325.

(b) Errors relating to ledger:

These errors may be subdivided broadly into two types. They are: errors of posting and errors in balancing.

Error of posting may be further being subdivided as follows:

(i) Posting wrong amount on the right side of an account. Example. Sale of Rs.560 to Mr.Raja is entered as Rs.650 in the debit side of his account from the Sales Day Book.

(ii) Posting the same amount twice to an account. Example. A cash receipt of Rs.1000 from Mr.Ram is credited twice to his account.

(iii) Posting the correct amount to the wrong side of the right account. Example. A purchase of goods from Mr. Raj for Rs.1000 is debited to his account [instead of crediting],

(iv) Posting wrong amount to the wrong side of right account. Example. A purchase of Rs.1000 from Mr.Sam is debited to his account as Rs. 10,000.

(v) Posting the correct amount to the wrong account but on the right side. Example. A sale of goods to S.Anish for Rs.1000 is wrongly debited to G.Anish a/c.

(vi) Posting correct amount to the wrong account and on the wrong side. Example. A sale of Rs.1000 to S.Anish is wrongly credited to G.Anish a/c.

Errors in balancing:

Errors may arise in balancing the account resulting in excess or short balance of the account.

3. Errors of Principle:

These errors occur when entries are made against the principles of accounting. Example. Purchase of computer for office use is wrongly entered in the Purchases Day Book. Capital expenditure should not be treated as revenue expenditure.

These errors may be committed:

(a) Due to the inability to make a distinction between revenue and capital items;

(b) Due to inability to make a difference between business expenses and personal expenses;

(c) Due to inability to make a difference between productive expenses and non-productive expenses, e.g., wages paid for production may be debited to salaries a/c or salaries paid to office employees may be debited to wages a/c.

4. Compensating Errors:

These are the errors, which compensate themselves in the net results, i.e., over debit of one account is neutralized by an over credit in some other account to the same extent. Similarly a wrong credit might have been compensated by some wrong debit in some other account.

For example, if tax paid Rs.2, 500 is debited in Tax a/c as Rs.3, 000 and interest received Rs.3, 500 is credited in the interest a/c as Rs.4, 000, the excess debit of Rs.500 in tax a/c is compensated by an excess credit of Rs.500 in interest a/c.

This type of error may be committed in combination of different errors in different accounts. Normally the presence of this type of errors will not be revealed by the trial balance.

Impact of Errors on Trial Balance:

The agreement of the Trail balance is proof as to the arithmetical accuracy of the books of accounts. But it is a final proof of accuracy of books of accounts; it simply assures that for every debit there is a corresponding and equal credit.

If trial balance does not agree, it is a clear indication that there are certain errors in the books of accounts. Even if the trial balance agrees, there may be errors in the books of accounts.

Hence, the errors may be classified, depending upon the agreement of trial balance, as follows:

(a) Errors that do not affect the agreement of the trial balance.

(b) Errors that affect the agreement of the trial balance.

Errors that are not disclosed by Trial balance or not affect the agreement of the Trial balance are mainly the errors of principle, errors of complete omission, errors of commission and compensation errors.

Certain errors like entering a transaction in two subsidiary books or writing a wrong amount in a subsidiary book or mis-posting to the wrong account but correct side, etc. locating such errors are quite difficult and such errors can always be rectified by means of journal entries.

Errors that are disclosed by trial balance or affect the agreement of the Trial balance are mainly the errors of wrong or omission of posting, wrong totaling of subsidiary books, wrong carry-forward and wrong balancing of ledger accounts, etc.

Wrong posting may be in the forms of posting a wrong amount to a ledger account or posting to the wrong side of an account or double posting.

As these errors affect mostly only one side of ledger accounts, they will be revealed by the trial balance through disagreement of debit and credit totals.

Reducing Balance Method charges depreciation at a higher rate in the earlier years of an asset. The amount of depreciation reduces as the life of the asset progresses. Depreciation under reducing balance method may be calculated as follows:

Depreciation per annum = (Net Book Value – Residual Value) x Rate%

Where:

• Net Book Value is the asset’s net value at the start of an accounting period. It is calculated by deducting the accumulated (total) depreciation from the cost of the fixed asset.
• Residual Value is the estimated scrap value at the end of the useful life of the asset. As the residual value is expected to be recovered at the end of an asset’s useful life, there is no need to charge the portion of cost equaling the residual value.
• Rate of depreciation is defined according to the estimated pattern of an asset’s use over its life term.

Example:

An asset has a useful life of 3 years.

Cost of the asset is $3,000.

Residual Value is $500.

Rate of depreciation is 50%.

Depreciation expense for the three years will be as follows:

*Under reducing balance method, depreciation for the last year of the asset’s useful life is the difference between net book value at the start of the period and the estimated residual value. This is to ensure that depreciation is charged in full.

As you can see from the above example, depreciation expense under reducing balance method progressively declines over the asset’s useful life.

Reducing Balance Method is appropriate where an asset has a higher utility in the earlier years of its life. Computer equipment for instance has better functionality in its early years. Computer equipment also becomes obsolete in a span of few years due to technological developments. Using reducing balance method to depreciate computer equipment would ensure that higher depreciation is charged in the earlier years of its operation.

Following are the main points of difference between straight line method and reducing balance method of depreciation:

Depreciation means the decrease in the value of fixed assets due to normal wear and tear, efflux of time or obsolescence due to technology. Thus, it is important to measure the decrease in value of an asset and also account for it. There are various methods of providing depreciation. The most common method is the Straight line method (SLM).

According to the Straight line method, the cost of the asset is written off equally during its useful life. Therefore, an equal amount of depreciation is charged every year throughout the useful life of an asset. After the useful life of the asset, its value becomes nil or equal to its residual value. Thus, this method is also called Fixed Installment Method or Fixed percentage on original cost method.

When the amount of depreciation and the corresponding period are plotted on a graph it results in a straight line. Hence, it is known as the Straight line method (SLM).

This method is more suitable in case of leases and where the useful life and the residual value of the asset can be calculated accurately. However, where the repairs are low in the initial years and increase in subsequent years, this method will increase the charge on profit.

Also, while applying this method, the period of use of the asset should be considered. If an asset is used only for 3 months in a year then depreciation will be charged only for 3 months. However, for the Income Tax purposes, if an asset is used for more than 180 days full years’ depreciation will be charged.

Formulae:

Amount of Depreciation = (Cost of Asset – Net Residual Value) / Useful Life

The rate of Depreciation = (Annual Depreciation x 100) / Cost of Asset

Journal Entries for Straight Line Method of Depreciation

How to Calculate Straight Line Depreciation

The straight line calculation steps are:

1. Determine the cost of the asset.
2. Subtract the estimated salvage value of the asset from the cost of the asset to get the total depreciable amount.
3. Determine the useful life of the asset.
4. Divide the sum of step (2) by the number arrived at in step (3) to get the annual depreciation amount.

Benefits/Need of charging depreciation

1. Tax Benefit: Depreciation is allowed as an expense under Income tax and therefore it is important to consider it to save income tax.
2. Mandatory under companies act: It is compulsory to charge depreciation in profit and loss account in companies act 2013.
3. Real Profit: If it is not considered then expenditure on behalf of fixed assets is not considered and the profit may be shown as a high number especially in industries required large plant and machinery. Also, this may lead to high distribution of earnings to shareholders and thus non-availability of funds when business is in need to replace the asset.

Final Accounts are the accounts, which are prepared at the end of a fiscal year. It gives a precise idea of the financial position of the business/organization to the owners, management, or other interested parties. Financial statements are primarily recorded in a journal; then transferred to a ledger; and thereafter, the final account is prepared (as shown in the illustration).

Usually, a final account includes the following components:

• Trading Account
• Manufacturing Account
• Profit and Loss Account
• Balance Sheet

1. Trading Account

Trading accounts represents the Gross Profit/Gross Loss of the concern out of sale and purchase for the particular accounting period.

Study of Debit side of Trading Account

(a) Opening Stock: Unsold closing stock of the last financial year is appeared in debit side of the Trading Account as “To Opening Stock“ of the current financial year.

(b) Purchases: Total purchases (net of purchase return) including cash purchase and credit purchase of traded goods during the current financial year appeared as “To Purchases” in the debit side of Trading Account.

(c) Direct Expenses: Expenses incurred to bring traded goods at business premises/warehouse called direct expenses. Freight charges, cartage or carriage charges, custom and import duty in case of import, gas, electricity fuel, water, packing material, wages, and any other expenses incurred in this regards comes under the debit side of Trading Account and appeared as “To Particular Name of the Expenses”.

(d) Sales Account: Total Sale of the traded goods including cash and credit sales will appear at outer column of the credit side of Trading Account as “By Sales.” Sales should be on net releasable value excluding Central Sales Tax, Vat, Custom, and Excise Duty.

(e) Closing Stock: Total Value of unsold stock of the current financial year is called as closing stock and will appear at the credit side of Trading Account.

Closing Stock = Opening Stock + Net Purchases – Net Sale

(f) Gross Profit: Gross profit is the difference of revenue and the cost of providing services or making products. However, it is calculated before deducting payroll, taxation, overhead, and other interest payments. Gross Margin is used in the US English and carries same meaning as the Gross Profit.

Gross Profit = Sales – Cost of Goods Sold

(g) Operating Profit: Operating profit is the difference of revenue and the costs generated by ordinary operations. However, it is calculated before deducting taxes, interest payments, investment gains/losses, and many other non-recurring items.

Operating Profit = Gross Profit – Total Operating Expenses

(h) Net Profit: Net profit is the difference of total revenue and the total expenses of the company. It is also known as net income or net earnings.

Net Profit = Operating Profit – (Taxes + Interest)

2. Manufacturing Account

Manufacturing account prepared in a case where goods are manufactured by the firm itself. Manufacturing accounts represent cost of production. Cost of production then transferred to Trading account where other traded goods also treated in a same manner as Trading account.

Important Point Related to Manufacturing Account

Apart from the points discussed under the section of Trading account, there are a few additional important points that need to be discuss here:

(a) Raw Material: Raw material is used to produce products and there may be opening stock, purchases, and closing stock of Raw material. Raw material is the main and basic material to produce items.

(b) Work-in-Progress: Work-in-progress means the products, which are still partially finished, but they are important parts of the opening and closing stock. To know the correct value of the cost of production, it is necessary to calculate the correct cost of it.

(c) Finished Product: Finished product is the final product, which is manufactured by the concerned business and transferred to trading account for sale.

Raw Material Consumed (RMC) − It is calculated as.

RMC = Opening Stock of Raw Material + Purchases – Closing Stock

3. Profit and Loss Account

Profit & Loss account represents the Gross profit as transferred from Trading Account on the credit side of it along with any other income received by the firm like interest, Commission, etc.

Debit side of profit and loss account is a summary of all the indirect expenses as incurred by the firm during that particular accounting year. For example, Administrative Expenses, Personal Expenses, Financial Expenses, Selling, and Distribution Expenses, Depreciation, Bad Debts, Interest, Discount, etc.

4. Balance Sheet

A balance sheet reflects the financial position of a business for the specific period of time. The balance sheet is prepared by tabulating the assets (fixed assets + current assets) and the liabilities (long term liability + current liability) on a specific date.

Assets

Assets are the economic resources for the businesses. It can be categorized as:

(a) Fixed Assets: Fixed assets are the purchased/constructed assets, used to earn profit not only in current year, but also in next coming years. However, it also depends upon the life and utility of the assets. Fixed assets may be tangible or intangible. Plant & machinery, land & building, furniture, and fixture are the examples of a few Fixed Assets.

(b) Current Assets: The assets, which are easily available to discharge current liabilities of the firm called as Current Assets. Cash at bank, stock, and sundry debtors are the examples of current assets.

(c) Fictitious Assets: Accumulated losses and expenses, which are not actually any virtual assets called as Fictitious Assets. Discount on issue of shares, Profit & Loss account, and capitalized expenditure for time being are the main examples of fictitious assets.

(d) Cash & Cash Equivalents: Cash balance, cash at bank, and securities which are redeemable in next three months are called as Cash & Cash equivalents.

(e) Wasting Assets: The assets, which are reduce or exhausted in value because of their use are called as Wasting Assets. For example, mines, queries, etc.

(f) Tangible Assets: The assets, which can be touched, seen, and have volume such as cash, stock, building, etc. are called as Tangible Assets.

(g) Intangible Assets: The assets, which are valuable in nature, but cannot be seen, touched, and not have any volume such as patents, goodwill, and trademarks are the important examples of intangible assets.

(h) Accounts Receivables: The bills receivables and sundry debtors come under the category of Accounts Receivables.

(i) Working Capital: Difference between the Current Assets and the Current Liabilities are called as Working Capital.

The final accounts for a sole trader business are the Income Statement (Trading and Profit & loss Account) and the Balance Sheet. The final accounts give a picture of the financial position of your business. It shows where or not your business has made a profit or loss during the accounting period and whether you are able to pay your debts as they become due.

Objectives

Upon the completion of this topic you should be able to
1. understand how profit/loss is calculated
2. calculate the cost of goods sold, gross profit and net profit,
3. transfer net profit and drawings to the capital account at the end of the period, and
4. prepare an Income Statement from a trial balance.

Final Accounts

After your trial balance is completed your final accounts are prepared. The final accounts of a sole trader business include the Income Statement (trading and Profit & loss account) and the balance sheet. Remember that your trial balance is the summary of the balances in all your accounts. Some of these balances (those from your nominal accounts) affect the profit and are transferred to the Income statement; the others (real and personal accounts) are transferred to your balance sheet. The Income Statement and the Balance Sheet are prepared at the end of each financial period to record how well the business operated during that financial period.

Income Statement

One of the most important financial statements of any business is the Income Statement. It is used to determine the following:
1. how profitable a business is being run; and
2. comparing the results received with the results expected.

The Income Statement can be divided into two sections the trading account and the Profit & loss account. The gross profit which is the amount of profit made before the expenses are deducted is calculated in the trading account. The purpose of the trading account is to determine the gross profit made from sales. Therefore the accounts that are directly related to buying and selling (trading) will be transferred to the trading account. The accounts directly related to trading are:

• Sales
• Purchase
• Sales Return
• Purchases Return
• Carriage Inwards

Gross profit is calculated as:

Gross Profit = Net Sales – Cost of Goods Sold (COGS)
Along with gross profit the net sales, cost of goods sold (COGS) and the cost of goods available for sale(COGAFS) is also calculated in the trading account:

Net Sales = Sales – Sales Return (Return Inwards)

Net sales are the total sales figure after allowances have been made for sales returned to the business.

COGS = Cost of goods available for sale (COGAFS) – Closing Stock

COGAFS = Opening Stock + (Purchases – Purchases Return) + Carriage Inwards

The net profit of your business is calculated in the Profit & loss account. Net profit is the balance of profit after allowance is made for revenue and expenses. It is calculated as:

Net Profit = Gross profit + Revenue – expenses

The revenue and expense charged to the Profit & loss account are those that are not directly related to trading but more to do with the running of the business. Some of these accounts are:

• Rent
• Telephone
• Carriage outwards
• Discount allowed
• Discount received
• Commission received
• Commission paid
• Salary

In Unit Two these accounts were closed off and transferred to the income statement. The income statement can be shown horizontally or vertically.

Balance Sheet
The other half of our final accounts is the Balance Sheet. The Balance Sheet is a financial statement showing the book values of the assets, liabilities and capital at the end of the financial period. It shows what the business owes and what it owns.
The assets of the business is divided into two categories and recorded as follows
1. Non-Current Assets are assets that:

• Are expected to be of use in the business for long time;
• Are to be used in the business; and
• Were not bought only for the purpose of resale.

Non-current assets are recorded in the balance sheet starting with those assets that will in the business the longest down to those that will be kept for a shorter period. Example of non-current assets and the order of record are:

• Land and Buildings.
• Fixtures and Fittings.
• Machinery
• Motor Vehicles.

2. Current Assets are recorded next. These are assets will change within the next twelve months. They are recorded as follows:

• Stock (goods bought for resale)
• Cash at Bank.
• Cash in Hand.

3. Non-current Liability: Sometime referred to as long term liability are those debts that take more than a year to settle. This includes large loans and mortgages.
4. Current Liability: are debts that will be settled in one year or less. This includes creditors and small loans.

Let’s now prepare the final accounts from the trial balance on the below

Example 3.5A

The following should be considered on 31 December 2011
1) Stock $36,420
a) Expenses owing
b) Sundry expenses $62
2) Motor expenses $33
3) prepayments
a) Rates $166
4) Provision for bad debts to be reduced to $580
5) Depreciation for motors to be $2,100 for the year
6) Part of the premises were let to a tenant who owed $250 at 31 December 2011
7) Loan interest owing to P. Holland, $4,000

Prepare the Income Statement and Balance Sheet as at 31 December 2011.

Horizontal presentation of the Income Statement and Balance Sheet

Vertical presentation of the Income Statement and the Balance Sheet.

The vertical presentation is the most common method of presenting final accounts today. In the vertical presentation of the balance sheet the working capital is indicated. This is calculated as:

Working Capital = Current Assets – Current Liabilities

The working capital indicates the liquidity of your business. This means the ability of your business to pay its debts when they become due. It gives an idea of the amount of funds available to run the business on a day to day basis.