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Chapter 9 Financial Statements - 1

The financial statements provide a summary of the accounts of a business enterprises the balance sheet reflecting the assets liabilities and capital as on a certain date and income statement showing the result of operations during a certain period. Capital expenditure is an expenditure benefit of which is discussed over a number of years, expenditure shown in the balance sheet. Deferred Revenue expenditure are those expenses whose benefits expand more than one accounting period not as long as capital is expenditure.

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Exercise 1

Exercise 2

  • Q1

    What are financial statements? What information do they provide.

    Ans:

    Financial statements are those statements which are prepared for reporting to the decision-maker on the basis of trial balance containing balances of ledger accounts.

    These are prepared to throw light on the financial results of operation of business during the period under consideration and the financial position at the end of the period.

    In financial accounting through financial statement profit is measured in two stages, i.e. Gross profit and Net profit.

    To ascertain the gross profit, trading account is prepared and to ascertain the net profit, P&L account is prepared. To report on the financial position of a business enterprise, its assets, liabilities and owner's equity balance sheet is prepared. Financial statements are the statements, which present periodic reports on the process of business enterprises and the results achieved during a given period. Financial statements include Trading and Profit and Loss account, balance sheet and other statements and explanatory notes, which form part thereof. Information provided by financial statements is useful to management to plan and control the business operations. Financial statements are also useful to creditors, shareholders and employees of the enterprise.

    Information Provided by Financial Statements

    Trading and Profit and Loss accounts present a true and fair view of the financial performance of the business in the form of profit or loss during the year. Balance sheet presents a true and fair view of the financial position of the business.


    Q2

    What are closing entries? Give four examples of closing entries.

    Ans:

    The preparation of Trading and Profit and Loss account requires that the balances of accounts of all concerned items are transferred to it for its compilation.

    For transferring the balance of all the ledger accounts to the concerned head is done through closing entries. Here are some examples of closing entries.

    (i) Opening stock account, Purchase account, Wages account, Carriage inwards account and direct expenses account are closed by transferring to the debit side of the Trading and Profit and Loss account. This is done by recording the following entry:

    Trading A/c                       Dr.
    To Opening Stock A/c
    To Purchase A/c
    To Wages A/c
    To Carriage Inwards A/c
    To All Other Direct Expenses A/c

    (ii) The Purchase return or Return outwards account are closed by transferring its balance to the Purchase account. The following entry is recorded for this purpose:

    Purchase Return A/c         Dr.
    To Purchase A/c

    (iii) Similarly, the sales return or Return inwards account is closed by transferring its balance to the Sales account is

    Sales A/c                          Dr.
    To Sales Return A/c

    (iv) The Sales account is closed by transferring its balance to the credit side of the Trading and Profit and Loss account by recording the following entry.

    Sales A/c                          Dr.
    To Trading A/c


    Q3

    Discuss the need of preparing a balance sheet.

    Ans:

    A balance sheet is the mixed list of the assets, liabilities and proprietorship of business of an individual at a certain date. The preparation of the balance sheet is needed for the following purposes.

    (i) To know the financial position : Balance sheet shows the financial position of the firm. It is the list of assets and liabilities of the firm on a specific date generally at the end of the financial year.

    (ii) Inform about the Liquidity Position : A balance sheet tells us about current assets and current liabilities. If the current assets are double of current liabilities, it is a symbol of the healthy and sound liquidity position of the firm.

    Hence, it can be said that a balance sheet has to be prepared to know the financial position of the business and the nature and values of its assets and liabilities. All the accounts which have not been closed till the preparation of the Profit and Loss account are shown in the balance sheet. Assets and liabilities shown in the balance sheet are marshalled in order of liquidity or in order of permanence.


    Q4

    What is meant by Grouping and Marshalling of assets and liabilities. Explain the ways in which a balance sheet may be marshalled.

    Ans:

    Grouping In a balance sheet, assets and liabilities should be properly grouped and classified under appropriate headings. The individual balance of each Debtors and Creditors account need not be shown. Debtors and creditors should be shown in total. The grouping together of dissimilar assets will make the balance sheet misleading. Hence, it can be said that grouping means putting together the items of similar nature under a common heading.

    Marshalling The term marshalling means the order in which assets and liabilities are stated on the balance sheet as the balance sheet exhibits the financial position of a concern even to a non-technical observer. It is of great importance that the different assets and liabilities should be arranged in the balance sheet on certain principles. The balance sheet is generally marshalled in three ways.

    (i) The order of Liquidity or Realisability According to this method, assets are entered up in the balance sheet following the order in which they can be converted into cash and the liabilities in the order in which they can be paid off. The following is a format of a balance sheet based on this order.

    (ii) The order of Performance This method is the reverse of the first method. Under this method, the assets are stated according to their permanency, i.e., permanent assets are shown first and less permanent are shown one after another. Similarly, the fixed liabilities are stated first and the floating liabilities follow. The following is a specimen of a balance sheet based on this order.

    (iii) Mixed Order of Arrangement This method is the combination of the first two methods. Under this method, the assets are arranged in order realisability and liabilities are arranged in order of performance.

    • The first method is adopted by sole proprietors, firms and partnership concerns.
    • The second method is adopted by companies and the third method is adopted by banking concerns.

Exercise 20

Exercise 21

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