Tag: Accounting Cycle
by Sum of year’s Digit Method and Production units method
1. Sum of Years’ Digits Method (SYD)
Sum of Year’s Digits (SYD) method is an accelerated depreciation method that assigns a larger depreciation expense in the earlier years of an asset’s life. It is based on the sum of the digits of the asset’s useful life.
Formula:
First, calculate the sum of the digits for the asset’s useful life.
Sum of Years’ Digits = [n(n+1)] / 2
Where is the asset’s useful life (in years).
2. The depreciation for each year is calculated by applying a fraction of the depreciable base to the sum of the digits.
2. Production Units Method
Production Units Method of depreciation allocates depreciation based on the actual usage or production of an asset, making it a more variable method. This method is commonly used for machinery or vehicles where wear and tear are directly linked to their usage.
Formula:
Depreciation per Unit = Depreciable Base / Total Estimated Units of Production
Then, for each year:
Depreciation for the Year = Depreciation per Unit × Units Produced in the Year
Concepts related to Depreciation: Depreciable Base, Salvage Value, Basket Purchases, Group Depreciation
Depreciation refers to the process of allocating the cost of a tangible asset over its useful life. Various key concepts are involved in understanding depreciation, each affecting how depreciation is calculated and recorded.
1. Depreciable Base:
The depreciable base is the total amount of an asset that can be depreciated. It is calculated by subtracting the salvage value (residual value) from the asset’s original cost. The depreciable base represents the portion of the asset’s cost that will be spread over its useful life.
Formula:
Depreciable Base = Cost of the Asset − Salvage Value
2. Salvage Value (Residual Value):
Salvage value is the estimated amount that an asset will be worth at the end of its useful life. It is the estimated scrap or residual value that can be recovered after the asset is disposed of or sold. The salvage value is subtracted from the cost of the asset to determine the depreciable base.
Example: If a car is purchased for ₹500,000, and after 10 years, it is expected to be sold for ₹50,000, the salvage value is ₹50,000.
3. Basket Purchases:
Basket purchases refer to acquiring a group of assets as a single package or “basket.” This often occurs when an entity buys several assets at once for a single price, such as land, buildings, and machinery. The total cost of the basket purchase is then allocated to each individual asset based on its relative fair market value.
How It Works:
- The total purchase price is divided among the individual assets based on their respective values.
- Depreciation is then calculated for each asset separately.
4. Group Depreciation:
Group depreciation is the method used to depreciate a collection of assets together as a group. This method is used when multiple assets are acquired together, and they are similar in nature and have a similar life span. Instead of calculating depreciation individually for each asset, the entire group is depreciated using a common rate.
How It Works:
- The total cost of the group of assets is calculated.
- Depreciation is then calculated for the group based on a single depreciation rate applied to the total cost or total depreciable base of the group.
Simple problems on preparation of BRS (when Bank balance as per Pass book or Bank balance as per Cash book is given)
Bank Reconciliation Statement (BRS) is prepared to reconcile the balance shown in the cash book with the balance shown in the pass book (bank statement). The differences can arise due to various reasons, such as outstanding checks, deposits in transit, errors, or bank charges.
Problem 1:
Bank balance as per Pass Book: ₹10,000
Bank balance as per Cash Book: ₹8,500
The following transactions are to be considered:
- Outstanding Cheques: ₹1,200
- Deposits in Transit: ₹500
- Bank Charges (not recorded in Cash Book): ₹50
- Cheque recorded in Cash Book but not presented to the bank: ₹1,000
Solution: We need to adjust the cash book and pass book balances to match them.
Bank Reconciliation Statement
As of 31st December 2024
| Particulars | Amount (₹) |
|---|---|
| Bank Balance as per Pass Book | 10,000 |
| Add: Deposits in Transit | 500 |
| Less: Outstanding Cheques | (1,200) |
| Adjusted Bank Balance (Pass Book) | 9,300 |
| Bank Balance as per Cash Book | 8,500 |
| Add: Bank Charges (Deducted in Pass Book) | 50 |
| Less: Cheque not presented to the bank | (1,000) |
| Adjusted Cash Book Balance | 9,300 |
Conclusion: The adjusted balance as per both the pass book and the cash book is ₹9,300, after considering the adjustments.
Problem 2:
Bank balance as per Pass Book: ₹20,000
Bank balance as per Cash Book: ₹18,500
The following transactions are noted:
- Outstanding Cheques: ₹3,000
- Deposits in Transit: ₹1,500
- Bank Charges (not recorded in Cash Book): ₹200
- Bank Interest credited (not recorded in Cash Book): ₹300
Solution:
Bank Reconciliation Statement
As of 31st December 2024
| Particulars | Amount (₹) |
|---|---|
| Bank Balance as per Pass Book | 20,000 |
| Add: Deposits in Transit | 1,500 |
| Add: Bank Interest credited | 300 |
| Less: Outstanding Cheques | (3,000) |
| Adjusted Bank Balance (Pass Book) | 18,800 |
| Bank Balance as per Cash Book | 18,500 |
| Less: Bank Charges (Deducted in Pass Book) | (200) |
| Adjusted Cash Book Balance | 18,800 |
Conclusion: After adjustments, the reconciled balance in both the cash book and the pass book is ₹18,800.
Key Points to Remember:
- Deposits in Transit are added to the pass book balance, as they have been recorded in the cash book but not yet reflected in the pass book.
- Outstanding Cheques are subtracted from the pass book balance, as they have been recorded in the cash book but not yet cleared by the bank.
- Bank Charges and Bank Interest are adjusted based on the pass book and added to or deducted from the cash book, depending on the nature of the entry.
- Cheques not presented for payment are also adjusted when reconciling the cash book and pass book balances.
Account, Meaning, Kinds of accounts, Corresponding rules for Debit and Credit
An account in accounting refers to a record that tracks the financial transactions related to a specific asset, liability, equity, income, or expense. It is used to organize and summarize financial data for a business or individual. Accounts are classified into five main categories: assets, liabilities, equity, revenues, and expenses. Each account has a debit and credit side, and changes in these accounts are recorded through journal entries. Accounts provide essential information for preparing financial statements such as the balance sheet and income statement, helping businesses analyze their financial performance and position.
In accounting, there are three main kinds of accounts, each with corresponding rules for debit and credit:
1. Real Accounts (Assets)
These accounts represent assets owned by the business.
- Examples: Cash, Buildings, Machinery, Inventory.
- Rule:
- Debit: When assets increase.
- Credit: When assets decrease.
2. Personal Accounts (Persons or Entities)
These accounts represent individuals, firms, or other legal entities with whom a business has dealings.
- Examples: Accounts of customers, creditors, bank accounts.
- Rule:
- Debit: When the business receives value (receiving from someone).
- Credit: When the business gives value (giving to someone).
3. Nominal Accounts (Expenses, Gains, and Losses)
These accounts represent expenses, revenues, gains, and losses.
- Examples: Rent, Salaries, Sales, Interest.
- Rule:
- Debit: When expenses or losses increase.
- Credit: When income or gains increase.
Accounting Process: Meaning, Source Document
The accounting process refers to the systematic series of steps involved in recording, classifying, summarizing, and interpreting financial transactions. It begins with identifying financial transactions, followed by their documentation in journals. These entries are then posted to ledger accounts. Afterward, a trial balance is prepared to ensure the accuracy of records. Adjusting entries are made if needed, followed by the preparation of financial statements such as the income statement, balance sheet, and cash flow statement. The final step involves closing temporary accounts and preparing for the next accounting period, ensuring the accuracy and consistency of financial reporting.
Source Document:
A source document is the original record that provides evidence and details of a financial transaction in accounting. These documents serve as the foundation for recording transactions in the accounting system. They provide authenticity, accuracy, and legal support for the entries made in the books of accounts.
Source documents can take many forms, including invoices, receipts, bills, contracts, purchase orders, bank statements, time sheets, and memos. Each of these documents contains specific details such as the date of the transaction, the parties involved, the amount involved, the terms of the transaction, and other relevant data. For example, an invoice is a source document for a sale transaction, while a receipt confirms the payment made for goods or services.
These documents are essential for internal control and financial accuracy. They help ensure that every transaction is recorded properly and that financial statements are accurate and verifiable. Source documents also support compliance with legal and regulatory requirements, as they act as evidence of business activities.
When an accounting entry is made, the information from the source document is transferred to the accounting journals and ledgers. For example, when a company receives an invoice for goods purchased, the accounting team records the transaction in the purchase journal, referencing the invoice as the source document. This provides a clear audit trail and allows for easy verification if there are any discrepancies.
In addition to internal controls, source documents are critical during audits. Auditors rely on these documents to verify the legitimacy of financial transactions and to ensure that the company’s financial reporting is accurate and compliant with accounting standards.
Closing Balance Sheet (when Opening Balance Sheet is given)
Closing Balance Sheet is prepared at the end of an accounting period, showing the financial position of an organization. It provides a snapshot of assets, liabilities, and equity at a specific point in time. When the Opening Balance Sheet is provided (i.e., the Balance Sheet at the beginning of the period), the Closing Balance Sheet is prepared by adjusting for transactions that occurred during the period.
Steps for Preparing the Closing Balance Sheet:
1. Start with the Opening Balance Sheet
Opening Balance Sheet shows the financial position at the beginning of the accounting period. It lists all the assets, liabilities, and equity (capital) balances at that time.
2. Account for Changes in Assets and Liabilities
During the period, certain transactions affect the balances of assets and liabilities. These changes:
-
- Purchase or Sale of Assets: If the organization purchases or sells fixed or current assets, adjust the opening balance accordingly.
- Accrual of Income and Expenses: Adjust income and expenses to reflect any outstanding amounts (e.g., unpaid expenses, accrued income).
- Depreciation: Deduct depreciation on fixed assets to adjust their book values. Depreciation reduces the carrying value of assets.
- Increase or Decrease in Liabilities: Include any new borrowings or repayments that affect the liabilities. For example, loans taken or repaid, creditors paid, etc.
3. Account for Changes in Capital/Equity
The opening capital or equity balance is adjusted based on:
-
- Profits or Losses: The profit or loss from the Income and Expenditure Account (for not-for-profit organizations) or Profit and Loss Account (for business organizations) should be added to or subtracted from the opening capital.
- Additional Investments: Any new capital introduced during the period should be added to the capital.
- Withdrawals/Drawings: If any withdrawals were made by the owner(s) (in the case of sole proprietorships or partnerships), they should be subtracted from the equity or capital account.
4. Prepare the Closing Balance Sheet
After adjusting for all the transactions, you can now prepare the Closing Balance Sheet. It consists of two main parts:
-
- Assets: This includes both current assets (like cash, inventory, receivables) and non-current assets (like buildings, machinery, vehicles).
- Liabilities: This includes both current liabilities (like creditors, bills payable) and non-current liabilities (like long-term loans).
- Capital/Equity: This represents the owner’s or partner’s equity in the business.
Example of Closing Balance Sheet
Let’s assume that the Opening Balance Sheet for a partnership firm is provided, and certain transactions occurred during the period.
Opening Balance Sheet (01 January 2024)
|
Liabilities |
Amount (₹) | Assets | Amount (₹) |
|---|---|---|---|
| Capital A | 50,000 | Cash in Hand | 5,000 |
| Capital B | 30,000 | Bank Balance | 20,000 |
| Long-term Loan | 10,000 | Machinery | 15,000 |
| Creditors | 5,000 | Furniture | 10,000 |
| Total Assets | 50,000 | ||
| Total Liabilities | 95,000 | Total Assets |
95,000 |
Transactions during the period:
- The firm sold machinery worth ₹3,000.
- The firm purchased new machinery for ₹8,000.
- Depreciation of ₹2,000 was charged on machinery and furniture.
- Capital A introduced an additional ₹5,000 in the firm.
- The firm paid ₹1,000 to creditors.
Adjusted Closing Balance Sheet (31 December 2024)
- Capital Accounts:
- Capital A = ₹50,000 + ₹5,000 (additional capital) = ₹55,000.
- Capital B = ₹30,000 (no change).
- Assets:
- Cash in Hand = ₹5,000 (no change).
- Bank Balance = ₹20,000 (no change).
- Machinery = ₹15,000 (Opening) – ₹2,000 (depreciation) + ₹8,000 (purchase) – ₹3,000 (sale) = ₹18,000.
- Furniture = ₹10,000 – ₹2,000 (depreciation) = ₹8,000.
- Liabilities:
- Long-term Loan = ₹10,000 (no change).
- Creditors = ₹5,000 – ₹1,000 (payment) = ₹4,000.
Closing Balance Sheet (31 December 2024)
|
Liabilities |
Amount (₹) | Assets | Amount (₹) |
|---|---|---|---|
| Capital A | 55,000 | Cash in Hand | 5,000 |
| Capital B | 30,000 | Bank Balance | 20,000 |
| Long-term Loan | 10,000 | Machinery | 18,000 |
| Creditors | 4,000 | Furniture | 8,000 |
| Total Assets | 51,000 | ||
| Total Liabilities | 99,000 | Total Assets |
99,000 |
Preparation of Balance Sheet in Horizontal Format of Partnership Firms
Balance Sheet of a partnership firm provides an overview of the financial position of the business at a specific point in time. It lists the firm’s assets on the left side and its liabilities and owner’s equity (capital of the partners) on the right side. In a horizontal format, both sections are displayed in a side-by-side layout.
Structure of Balance Sheet in Horizontal Format for Partnership Firms
The balance sheet consists of two main parts:
- Assets (on the left side)
- Liabilities & Capital (on the right side)
Balance Sheet Format in Horizontal Layout:
| Particulars | Amount (₹) | Amount (₹) |
|---|---|---|
| Assets | Liabilities & Capital | |
| I. Non-Current Assets (Fixed Assets) | I. Partners’ Capital Account | |
| – Land and Building | 12,00,000 | – Partner 1 Capital |
| – Plant and Machinery | 8,00,000 | – Partner 2 Capital |
| – Furniture and Fixtures | 2,00,000 | II. Liabilities |
| II. Current Assets | – Long-Term Liabilities (Loan) | |
| – Cash in Hand | 1,00,000 | – Short-Term Liabilities (Creditors) |
| – Cash at Bank | 2,00,000 | III. Reserve & Surplus |
| – Accounts Receivable (Debtors) | 4,00,000 | – Profit (Net Profit Brought Forward) |
| – Stock (Inventory) | 3,00,000 | Total Liabilities & Capital |
| Total Assets | 20,00,000 | Total Liabilities & Capital |
Explanation of Balance Sheet Components:
- Assets (Left Side):
- Non-Current Assets (Fixed Assets): Long-term assets that are used in the business operations.
- Land and Building: The value of land and buildings owned by the partnership firm.
- Plant and Machinery: The value of machinery used in production or business activities.
- Furniture and Fixtures: The value of office furniture, fixtures, and other long-term assets.
- Current Assets: These are short-term assets that are likely to be converted into cash or used up within a year.
- Cash in Hand: The cash available in the business premises.
- Cash at Bank: The balance in the partnership’s bank account.
- Accounts Receivable (Debtors): Amounts owed to the business by customers or clients.
- Stock (Inventory): The value of goods held by the partnership, either for sale or for use in production.
- Total Assets: The sum of non-current and current assets, which reflects the total value of resources owned by the partnership firm.
- Non-Current Assets (Fixed Assets): Long-term assets that are used in the business operations.
- Liabilities & Capital (Right Side):
- Partners’ Capital Account: This section lists the capital invested by the partners in the business. It is split between each partner.
- Partner 1 Capital: The capital contribution of Partner 1.
- Partner 2 Capital: The capital contribution of Partner 2.
- Liabilities: These represent the amounts owed by the firm to outsiders.
- Long-Term Liabilities (Loan): Loans or borrowings that need to be repaid over a period longer than one year.
- Short-Term Liabilities (Creditors): Amounts owed to creditors or suppliers, expected to be settled within a year.
- Reserve & Surplus:
- Profit (Net Profit Brought Forward): This refers to accumulated profits from prior periods or the current year’s profit that is added to the owner’s equity.
- Total Liabilities & Capital: The sum of all liabilities and capital accounts. This figure should be equal to the total assets.
- Partners’ Capital Account: This section lists the capital invested by the partners in the business. It is split between each partner.
Key Points:
- Owner’s Capital: In the case of a partnership firm, the capital accounts of each partner reflect their ownership and share in the firm’s profits and losses.
- The partnership firm’s balance sheet follows the accounting equation:
Assets = Liabilities + Capital
The assets must always be equal to the sum of liabilities and the capital invested by the partners.
- Current assets are expected to provide liquidity in the short term, while fixed assets represent long-term investments.
- Liabilities include both long-term borrowings and short-term obligations such as creditors.
Example Calculation:
Let’s assume the following balances for a partnership firm with two partners (Partner 1 and Partner 2):
Assets:
- Non-Current Assets:
- Land and Building: ₹12,00,000
- Plant and Machinery: ₹8,00,000
- Furniture and Fixtures: ₹2,00,000
- Current Assets:
- Cash in Hand: ₹1,00,000
- Cash at Bank: ₹2,00,000
- Accounts Receivable: ₹4,00,000
- Stock (Inventory): ₹3,00,000
Total Assets = ₹12,00,000 + ₹8,00,000 + ₹2,00,000 + ₹1,00,000 + ₹2,00,000 + ₹4,00,000 + ₹3,00,000 = ₹20,00,000
Liabilities & Capital:
- Partners’ Capital:
- Partner 1 Capital: ₹5,00,000
- Partner 2 Capital: ₹4,00,000
- Liabilities:
- Long-Term Liabilities (Loan): ₹3,00,000
- Short-Term Liabilities (Creditors): ₹2,00,000
- Reserve & Surplus:
- Net Profit (Brought Forward): ₹1,00,000
Total Liabilities & Capital = ₹5,00,000 + ₹4,00,000 + ₹3,00,000 + ₹2,00,000 + ₹1,00,000 = ₹20,00,000
Thus, the Balance Sheet is balanced, with the total assets equal to the total liabilities and capital.
Preparation of Balance Sheet in Horizontal Format of Sole Trading Concerns
Balance Sheet is one of the key financial statements that provides a snapshot of a business’s financial position at a particular point in time. For a sole trading concern, the balance sheet is crucial for determining the business’s assets, liabilities, and owner’s equity. The horizontal format is one where both the assets and liabilities are presented in a side-by-side layout, making it easier for analysis and comparison.
Structure of Balance Sheet in Horizontal Format
In a horizontal format balance sheet, the information is displayed in two main sections:
- Assets (on the left side)
- Liabilities & Owner’s Equity (on the right side)
Balance Sheet Format in Horizontal Layout:
| Particulars | Amount (₹) | Amount (₹) |
|---|---|---|
| Assets | Liabilities & Owner’s Equity | |
| I. Non-Current Assets (Fixed Assets) | I. Capital | |
| – Land and Building | 10,00,000 | – Owner’s Capital (Balance) |
| – Plant and Machinery | 5,00,000 | II. Liabilities |
| – Furniture and Fixtures | 1,00,000 | – Long-Term Liabilities (Loan) |
| II. Current Assets | – Short-Term Liabilities (Creditors) | |
| – Cash in Hand | 50,000 | III. Reserve & Surplus |
| – Cash at Bank | 1,00,000 | – Profit (Net Profit Brought Forward) |
| – Accounts Receivable (Debtors) | 3,00,000 | Total Liabilities & Equity |
| – Stock (Inventory) | 2,00,000 | |
| Total Assets | 21,50,000 | Total Liabilities & Equity |
Explanation of Balance Sheet Components:
- Assets (Left Side):
- Non-Current Assets (Fixed Assets): These are long-term assets used in the business operations.
- Land and Building: The value of the land and buildings owned by the business.
- Plant and Machinery: The value of machinery used for production.
- Furniture and Fixtures: The value of the furniture and fixtures owned by the business.
- Current Assets: These are assets that are expected to be converted into cash or consumed within a year.
- Cash in Hand: The actual cash available on the premises.
- Cash at Bank: The money held in the business’s bank account.
- Accounts Receivable (Debtors): Amounts owed to the business by customers for goods or services provided.
- Stock (Inventory): The value of goods held for sale or raw materials.
- Total Assets: This is the sum of non-current and current assets, representing the total value of resources owned by the business.
- Non-Current Assets (Fixed Assets): These are long-term assets used in the business operations.
- Liabilities & Owner’s Equity (Right Side):
- Owner’s Capital: The net worth of the owner in the business, which is calculated as the difference between assets and liabilities.
- Liabilities: The amounts owed by the business to external parties.
- Long-Term Liabilities (Loan): Loans or borrowings that are due to be paid over a period longer than one year.
- Short-Term Liabilities (Creditors): Amounts owed to creditors or suppliers that need to be settled within a year.
- Reserve & Surplus:
- Profit (Net Profit Brought Forward): Any accumulated profits from previous periods or the current year’s net profit, which is added to the owner’s equity.
- Total Liabilities & Equity: This represents the total of all liabilities and owner’s equity, which should be equal to the total assets, ensuring the balance sheet is balanced.
Key Points:
- Assets = Liabilities + Owner’s Equity: This fundamental accounting equation must hold true for the balance sheet to be correct.
- The owner’s capital is essentially the residual interest in the assets of the business after deducting liabilities. It reflects the owner’s investment and profits in the business.
- The current assets section represents short-term resources that are expected to provide cash flow or be used up in the near future.
- Fixed assets are long-term investments used in operations and not easily liquidated.
Example Calculation:
Let’s assume the following values for a sole trading concern:
- Assets:
- Non-Current Assets:
- Land and Building: ₹10,00,000
- Plant and Machinery: ₹5,00,000
- Furniture and Fixtures: ₹1,00,000
- Current Assets:
- Cash in Hand: ₹50,000
- Cash at Bank: ₹1,00,000
- Accounts Receivable: ₹3,00,000
- Stock: ₹2,00,000
- Non-Current Assets:
- Liabilities:
- Capital: ₹8,00,000
- Liabilities:
- Loan (Long-Term Liabilities): ₹2,00,000
- Creditors (Short-Term Liabilities): ₹1,00,000
- Reserve & Surplus:
- Net Profit: ₹1,00,000
Total Assets = ₹10,00,000 + ₹5,00,000 + ₹1,00,000 + ₹50,000 + ₹1,00,000 + ₹3,00,000 + ₹2,00,000 = ₹21,50,000
Total Liabilities & Owner’s Equity = ₹8,00,000 (Capital) + ₹2,00,000 (Loan) + ₹1,00,000 (Creditors) + ₹1,00,000 (Net Profit) = ₹21,50,000
Preparation of Trading and Profit and Loss Account in Columnar Form
In accounting, the Trading and Profit and Loss Account is a crucial financial statement used by businesses to determine their profitability over a specific period. The Trading Account shows the gross profit or loss, while the Profit and Loss Account presents the net profit or loss by accounting for all operating expenses, income, and other non-operating items.
The columnar format helps in comparing the figures of different periods or different branches of a business, making it easier to analyze financial performance.
Structure of Trading and Profit and Loss Account in Columnar Form
The Trading and Profit and Loss Account generally consists of two parts:
- Trading Account: Calculates the Gross Profit or Loss.
- Profit and Loss Account: Determines the Net Profit or Loss by accounting for all operating and non-operating expenses and incomes.
Below is the general format, followed by a detailed example using columnar form.
Columnar Format Example:
| Particulars | Current Year (₹) | Previous Year (₹) |
|---|---|---|
| Trading Account | ||
| To Opening Stock | 2,00,000 | 1,80,000 |
| To Purchases | 5,00,000 | 4,50,000 |
| To Direct Expenses | 50,000 | 45,000 |
| To Gross Profit c/d | 3,00,000 | 2,70,000 |
| By Sales | 10,00,000 | 9,50,000 |
| By Closing Stock | 2,50,000 | 2,00,000 |
| Profit and Loss Account | ||
| To Rent | 1,00,000 | 90,000 |
| To Salaries | 2,50,000 | 2,20,000 |
| To Depreciation | 1,00,000 | 90,000 |
| To Interest on Loan | 30,000 | 25,000 |
| To Net Profit c/d | 70,000 | 65,000 |
| By Gross Profit b/d | 3,00,000 | 2,70,000 |
Explanation of the Columns:
- Current Year (₹): The financial data for the current year.
- Previous Year (₹): The financial data for the previous year, used for comparison.
Step-by-Step Explanation:
1. Trading Account:
The trading account is used to determine the gross profit or gross loss by comparing the sales and cost of goods sold (COGS). The key elements are:
- Opening Stock: The value of the stock at the beginning of the accounting period.
- Purchases: The total cost of goods bought for resale.
- Direct Expenses: Includes expenses directly related to production such as freight, labor costs, and factory expenses.
- Closing Stock: The value of the stock at the end of the accounting period.
The calculation in the trading account follows this formula:
Gross Profit = Sales + Closing Stock − Opening Stock − Purchases − Direct Expenses
Example (Trading Account Calculation):
- Opening Stock (₹2,00,000): This is the value of the goods on hand at the start of the year.
- Purchases (₹5,00,000): This is the total cost of goods purchased during the year.
- Direct Expenses (₹50,000): These are the expenses directly tied to the manufacturing or procurement of goods.
- Closing Stock (₹2,50,000): The value of the stock remaining at the end of the year.
To calculate Gross Profit for the current year:
Gross Profit = Sales + Closing Stock − (Opening Stock + Purchases + Direct Expenses)
The gross profit for the current year is ₹3,00,000, which is carried forward to the Profit and Loss Account.
2. Profit and Loss Account:
Profit and Loss Account helps determine the net profit or net loss by accounting for all indirect income and expenses. Key elements are:
- Indirect Expenses: These are operating expenses like rent, salaries, depreciation, interest on loans, etc.
- Indirect Income: Income generated from non-operating activities (such as interest income, dividends, etc.).
- Net Profit or Loss: This is calculated by subtracting total expenses from total income.
To calculate Net Profit:
Net Profit = Gross Profit − Indirect Expenses
For example, in the Profit and Loss Account:
- Gross Profit (₹3,00,000): Brought down from the Trading Account.
- Indirect Expenses:
- Rent (₹1,00,000)
- Salaries (₹2,50,000)
- Depreciation (₹1,00,000)
- Interest on Loan (₹30,000)
Now, calculate the Net Profit:
The net profit of ₹70,000 is carried forward to the balance sheet and shown as the profit available for distribution among shareholders or reinvestment.