Detailed, Step-by-Step NCERT Solutions for 12 Accountancy Chapter 8 Financial Statements of a Company Questions and Answers were solved by Expert Teachers as per NCERT (CBSE) Book guidelines covering each topic in chapter to ensure complete preparation.
Financial Statements of a Company NCERT Solutions for Class 12 Accountancy Chapter 8
Financial Statements of a Company Questions and Answers Class 12 Accountancy Chapter 8
Test your Understanding-I (Page No. 155)
State whether the following statements are True’ or ‘False’.
(a) Financial statements are the end products of accounting process.
(b) Financial statements are primarily directed towards the needs of owners.
(c) Facts and figures presented in financial statements are not at all based on personal judgements.
(d) Recorded facts are based on replacement cost.
(e) Going Concern concept assumes that the enterprise continues for a long-period of time.
(a) True, (b) True, (c) False, (d) False, (e) True.
Fill in the blanks with an appropriate word (s) :
(a) Financial statement’s are the …………. of information to interested parties.
(b) The owners of a company are called ………….
(c) For income measurement basis of accounting is …………. followed.
(d) The statement which shows the assets and liabilities of a company is known as ………….
(e) Profit and loss account is also called statement.
(a) Basic sources
(d) Balance Sheet
Test your Understanding-II (Page No. 163)
What are the items shown under the heading ‘Reserves and Surplus’?
Capital Reserves, Capital Redemption Reserves, Balance of Securities Premium Account, General Reserve, Credit Balance of Profit and Loss Account.
What are the items shown under the heading ‘Miscellaneous expenditure’?
Preliminary Expenses, Advertisement Expenditure, Discount on issue of Shares and Debentures, Share Issue expenses.
Match the following :
(i) Gross profit – (a) The explanatory notes to financial statements
(ii) Operating profit – (b) Amounts receivable by the company
(iii) Sundry Debtors – (c) Amounts payable by the company
(iv) Sundry Creditors – (d) Sales-Cost of goods sold
(v) Schedules – (e) Gross profit-Operating expenses
(vi) Net Profit – (f) Operating profit-interest and tax
(i) – (d)
(ii) – (e)
(iii) – (b)
(iv) – (c)
(v) – (a)
(vi) – (f)
Short Answer Type Questions
What is public company?
Public Company—According to Section 3(i) (iv) of the Companies Act 1956 “Public Company means a company
(a) which is not a private company and
(b) has a minimum paid up capital of Rs. 5 lakhs or such higher paid-up capital and
(c) is a private company which is a subsidiary of a company which is not a private company.” Companies Amendment Act 2000 states that a public company cannot be registered with a, capital of less than Rs. 5 lakhs.
A public company may be a listed company or unlisted company. A listed company is a public company which has any of its securities listed in any recognised stock exchange. An unlisted company is one whose securities are not listed on any recognised stock exchange for trading.
What is private limited company?
Private Company—According to Section (3)(i), (iii), a private company means a company which has a minimum paid up capital of Rs. one lakh or such higher paid-up capital as may be prescribed by its articles—
(i) Restricts the rights of members to transfer its shares,
(ii) Limits the number of its members to 50 excluding :
(a) persons who are in employment of the company, and
(b) persons, who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased.
(iii) Prohibits any invitation to the public to subscribe to any shares in or debentrues of the company.
(iv) Prohibits any invitation or acceptance of deposits from persons other than its members, directors and relatives.
Define Government Company.
Government Company—According to Section 617 of the Companies Act 1956, “a Government Company is a company in which not less than 51% of the paid-up capital is held by the Central Government, or by any State Government or Governments or partly
by the Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a Government Company.”
What do you mean by a listed company?
A public company may be listed or unlisted company. A listed company is that public company which has any of its securities are listed in any recognised stock exchange in India for trading. Listing of securities in any recognised stock exchange gives a guarantee and impression in the minds of potential investors about the goodwill of the company.
What are the uses of securities premium?
Security Premium and its Uses—When shares of a company are issued at a price more than the face value, it is said to be an issue of shares at premium. When shares are issued at premium, the premium amount is credited to a separate account called “Securities Premium Account” because it is not a part of Share Capital.
Rather, it represents, a capital gain and being a credit balance, is shown on the liabilities side of the company’s balance sheet under the heading “Reserves and Surplus”.
According to Section 78 of the Companies Act, Securities Premium Account may be used by the company :
- In paying up unissued capital of the company to be issued to the members of the company as fully paid bonus shares.
- To write off preliminary expenses of the company.
- To write off the expenses of, or commission paid, or discount allowed on any of the securities or debentures of the company.
- To pay premium on the redemption of preference shares or debentures of the company.
What is buy-back of shares?
Buy-back of shares : The term buy-back of shares denotes the purchasing of its own shares by a company either from free reserves, securities premium or proceeds of any shares or debentures. According to Section 77 A of the Companies Act 1956, a company can buy its own shares in the following forms
- Through existing equity shareholders on a proportionate basis; or.
- Through open market; or
- By odd lot of shareholders; or
- Employees of the company pursuant to a scheme of stock option or sweat equity.
Following procedural rules are to be followed :
- The buy-back should be authorized by the Articles of Association.
- The special resolution is to be passed in the General Meeting of the shareholders.
- The buy-back of the shares cannot exceed 25% of paid-up capital and free reserves in a financial year.
- The debt-equity ratio should not be more than 2 : 1 after such buy-back of shares.
- All the shares for buy-back should be fully paidup.
- The buy-back should be completed within 12 months from the date of passing of the special resolution.
- The company must file solvency declaration with the Registrar and SEBI in the form of an affidavit signed by at least two directors of the company.
The affidavit must state that the board has made full inquiry into the affairs of the company is capable of meeting its liabilities and will not render insolvent within a period of one year from the date of declaration adopted by the board.
A company that buy-back of its own shares shall extinguish and physically destory such shares within seven days of completion of buy-back in the presence of merchant bankers or Registrar or statutory auditor.
No Further Issue : When a company completes the buy-back of its shares, shall not make further issue of shares within a period of 24 month except by way of bonus shares or in the discharge of some obligations like conversion of share warrants, stock option schemes, sweat equity or conversion of preference shares and debentures into equity shares.
SEBI Guidelines: SEBI has made certain regulations in 1988 with regard to buy-back of shares. Following are the important guidelines given by the SEBI:
(i) Buy-back of shares cannot be made by a private person through negotiated deals with stock exchange or through spot transactions or any other private arrangement. A company is required to make public announcement in at least in one National English Daily, and one in Hindi National Daily and one Regional Language Daily all with wide circulation where registered office of the company is situated. Public announcement should specify the following things :
(a) It should specify the date of the despatch of the offer letter. The letter should specifically stated as “specific date” and it shall not be less than earlier than 30 days but not later than 42 days.
(b) The company shall file information to the SEBI within seven working days from the date of public announcement.
(c) The offer for buy-back shall remain open to the members for a period of not less than 15 days but not exceeding 30 days. However, the opening date for the offer shall not be earlier than 7 days or later than 30 days from the specified date.
(d) The company shall complete the verification of offers within 15 days from the date of closure and shares lodged shall be deemed to have been accepted unless communication of rejection is made within 15 days from the date of closure.
Proportionate buy-back of shares.: When the number of shares tendered for buy-back are more than the number of shares to be bought back from each member of shareholder, the rule of proportionate buy-back shall be determined by using the following formula :
Acceptance tendered by a member x Number of Securities to be bought back = Total acceptance tendered
Write a brief note on “Minimum Subscription”.
Minimum Subscription: It is die minimum amount which must be raised to meet the need of business operations of the company relating to the followings : ‘
(a) The price of any property purchased, or to be purchased, which has to be met wholly or partly out of the proceeds of the issue.
(b) Preliminary expenses payable by the Company and any commission payable in connection with the issue of share;
(c) The repayment of any money borrowed by the company for the above two matters;
(d) Working capital; and
(e) Any other expenditure required for the usual conduct of business operations.
It is to be noted that ‘minimum subscription’ of capital cannot be less than 90% of the issued amount according to SEBI
(Discolsure and Investor Protection) Guidelines, 2000. If the above condition is not satisfied, the company shall forthwith refund the entire subscription amount received. If a delay occurs beyond 8 days from the date of closure of subscription list, the company shall be liable to pay the amount with interest at the rate of 15%.
Long Answer Type Questions
Explain the nature of the financial statements?
Financial statements are the summarized statements of accounting data produced at the end of the accounting process by an enterprise through which it communicates accounting information to the external users as well as internal users. These are the basic and formal means through which the corporate management communicates financial information to various users. External user includes-investors, tax-authorities, government, employees etc.
Nature of Financial Statements :
View points of the Professional Bodies and Researchers about the nature of Financial Statements :
According to American Institute of Certified Public Accountants “financial statements are prepared for the purpose of presenting a periodical review or report on progress made by the management and deal with the status of investment in the business and the results achieved during the period under review. They reflect a combination of recorded facts, accounting principles and personal judgements.”
In the words of American Accounting Association, “Every corporate statement should be based on accounting principles, which are sufficiently uniform, objectives and well understood to justify opinion as to the condition and progress of business enterprise. Its basic assumption was that the purpose of periodic financial statements of a corporation is to furnish information that is necessary or the formation of dependable judgements.”
According to John. N. Mayer, “Thefinancial statements are composed of data which are the result of a combination of
- Recorded facts concerning the business transactions;
- Conventions adopted to facilitate the accounting technique
- Postulates, or assumptions made; and
- Personal judgements used in the application of the conventions and postulates.”
The following points explain the nature of financial statements :
1. Recorded Facts: The basis of recording transaction in financial statements is original cost or historical cost. The assets purchased at different times and at different prices are put together and shown at cost price. The financial statements do not show current financial conditions, as they are based on original cost not on replacement costs.
2. Accounting Conventions: For preparing financial statements, certain accounting conventions are followed. For example, the convention of valuing inventory at cost or at market price, whichever is lower, is followed. Small items like pencils, pens, postage stamps etc. although assets in nature but treated as expenditure in the year in which they are purchased. The Stationery is valued at cost. The use of accounting conventions makes financial statements comperable, simple and realistic.
3. Postulates: Financial Statements are prepared on certain basic assumption known as postulates such going concern postulates, money- measurement postulate, realization postulate etc. Going concern postulates assumes that the enterprise is run for a long time. Money measurement postulate assumes that the value of money will remain the same in different periods.
4. Personal Judgements : Under more than one circumstance, facts and figures presented through financial statements are based on personal opinion, estimates and judgement. Provisions for doubtful debts are made on estimates and personal judgements.
Personal opinions, judgements and estimates are made while preparing the financial statements to avoid any possibility of over statement of assets and liabilities, income and expenditure, keeping in mind the convention of conservation.
Thus, Financial Statements are the summarized reports of recorded facts and are prepared following the accounting concepts, conventions and requirement of law.
Explain in detail about the significance of the financial statements.
Significance of the Financial Statements : Financial Statements, which are prepared depicting true relevant, easily understandable, comparable, analytically represented and promptly presented financial position, help the user in their economic decisions.
The significance of the financial statements can be explained with the help of following points :
1. Provide Information to Shereholders: Financial Statements provide information about the managements performance to the shareholders.
Shareholders are the suppliers of the basic capital to run the concern and as such they are very much interested in the well being of the business. They are interested to know the profitability and prospects of future growth of the business. They come to know about the financial position and operating results of the business through these financial statement only.
2. Basis for Fiscal Policies of the Government : Financial Statement provides basis for fiscal policies of the Government. Financial Statement provides useful information to various government department like Income Tax, Sale tax, Excise duty etc to determine tax liability of the concern. So on the basis of financial statements, the Government determine tax policy, import export policy, industry policy etc.
3. Basis for Dividend Policies : The dividend policies of the corporate sector are linked with the government regulation and financial performance of the undertaking. Hence, financial statements form basis for dividend policies of companies.
4. Basis for Granting of Credit: Corporate undertaking have to borrow funds from banks and other financial insitutions for different purposes. All financial institutions which provide loan to the corporate undertaking are interested to know the profit earning capacity of the business and its long term solvency. They take decisions based on the financial performance of the undertaking. Thus financial statements form the basis for granting of credit.
5. Guide to the value of the Investment already made : Shareholders of companies are interested in knowing the status safety and return on their investment. They may also need information to take decisions about continuation or discontinuation of their investment in the business. Financial statements provide information to the shareholder in taking such important decisions.
6. Basis for Prospective Investors : In addition to the existing investor there may be people who may be interested in investing money in company. But before doing that they would be interested to know the long-term and short term solvency as well as the profitability of the concern. Financial statements provide adequate information to such potential investors to enable them to take the necessary decisions.
7. Aids Government in Policy Frame work: Financial Statements helps Government to assess the role of corporate undertaking in the economic development of the country. It also assess the economic stituation of the country from these statements in terms of industrial production, employment etc
These statements enable the government , to know whether business is’following various rules and regulations or not. These statements also form base for framing and amending various laws for the regulation of the business.
8. Aids Trade Associations in helping their Members : Trade Associations can judge, on the basis of financial statements the profitability of the business enterprises. They can compute as to how much bonus and increase in their wages are possible from the profits of the business concern. Trade unions negotiate the wages and salaries with the company, the financial statements reveal the financial soundness of the company and thus provide the basis to the trade unions to go in for negotiations.
9. Helps Stock Exchanges : Financial Statements help the stock exchanges to understand the extent of transperency in reporting on financial performance and enables them to call for required information to protect the interest of investors. The financial statements enable the stock brokers to judge the financial position of different concerns and take decisions about the price to be quoted.
10. Helps Trade Creditors Trade creditors and suppliers of goods are interested in knowing the short term solvency of the business. They are interested to know whether the business firm will be make payment on time or not. Financial Statement provide adequate information to them to take the necessary decisions.
Explain the limitations of financial statements.
It is a general impression that financial statements are precise,
exact and final. But sometimes, these statement conceal some very important information. As such, they suffer from certain limitations. These are discussed below.
1. Do not reflect current situation : Financial Statements are prepared on the basis of historical cost and do not throw light on the current and present position of the business. The purchasing power of money is changing, the value of assets and liabilities shown in financial statement do not reflect current market situation. It does not indicate the current position of the business.
2. Dividends out of Capital: Net profit is ascertained on the basis of historical cost. If profits are adjusted to changing price levels, it may lead to loss and consequently dividends may be paid out of capital.
3. Incomplete Information : Financial statements donot include all of the relevant information necessary for evaluating the status, progress and future prospects of a business enterprise. Balance Sheet does not disclose information relating to loss of markets and cessation of agreements which have vital bearing on the enterprise.
4. Assets may not realize: Some of the assets may not realize the stated value, if the liquidation is forced on the company. Assets shown in the balance sheet reflect merely unexpired or unamortized cost.
5. Different accounting policies : Various concepts and conventions of accounting affect the value of assets and liabilities as shown in the Balance Sheet and profit as shown by Profit and Loss Account. For example, different firms may adopt different methods of stock valuation.
6. No Qualitative Information : The financial statements do not reflect complete information about the firm. Only that information, which can be expressed in monetary terms, is given. Qualitative information is however ignored like industrial relations, industrial climate, labour relations etc.
7. No free from Bias : Financial statement are prepared on the basis of certain established concepts and convention, yet they are greatly affected by personal bias and personal judgement of various factors.
8. Agregate Information : Financial statements show aggregate information but not specific information. Hence they may not satisfy the user in decision making unless modified suitably.
9. Interim reports: Financial statements are merely interim reports not a final reports. Profit and Loss Account discloses only interim profits but not final profits. Final profits can be known only when enterprise is liquidated, assets are sold and liabilities are paid off.
10. Affected by window-dressing : Some business firms given too much attention to decorate their financial statements in such a way that they fulfilled all the legal requirement and show sound financial position of the firm. In fact these statements may be far from the truth.
Note : If the company is a manufacturing concern, apart from above components manufacturing account is also required.
Trading Account: Trading Account is the first part of the financial statements. The trading account is designed to show the gross profit on sale of goods.
The trading account contain the transactions of the company relating to the commodities in which it deals, throughout the accounting period. All expenses either related to purchase of raw material or production are charged to the Trading A/c i.e. Debited to Trading A/c.
It is prepared to find out Gross Profit or Gross Loss. If the sales are more than purchases and expenses the result in Gross Profit and vice versa. Its main components are sales, services rendered and cost of such sales or service rendered. Trading account provides the data for comparsion, analysis and planning for future growth.
Profit and Loss Account: Profit and Loss Account is the second part of the financial statement. Company is more interested in knowing it net income or net profit, which increases its equity.
Net profit represents the excess of gross profit plus other revenue income over indirect expenses. These indirect expenses are not shown in Trading Account. In the debit side of Profit and Loss Account the indirect expenses are shown whereas in the credit side revenue incomes. If the L debit side is less than of credit side, it would be net profit and if the credit side is less than of debit side, it would be net loss.
“A Profit and Loss account is an account into which all gains and losses are collected in order to ascertain the excess of gain over the losses or vice-versa.” —Prof. Carter
Form of Profit and Loss Account
Profit and Loss Account of ………. Co. Ltd.
for the year ended ……….
Profit and Loss Appropriation Account : The account which shows the disposition of profit is called the Profit and Loss Appropriation Account. The disposition of profit means the distribution of net profits by way of dividends, transfer of profits to various reserves, adjustment of arrears of depreciation, if any, bonus to shareholders and so on.
Income statements may also be presented in vertical form with detailed data. Verticle form income statements are suitable for further analysis and providing suitable data for decision making.
(a) Fixed assets are shown at original cost less total depreciation to date.
(b) Investments should be divided into two parts:
(i) Quoted, and
(ii) unquoted, hi the case of quoted investments market price must be disclosed.
(c) Contingent liabilities are not included in the total of the liability side.
Following are the usual types of contingent liabilities:
(i) Claim against the company not acknowledged as debt.
(ii) Uncalled liability on shares partly paid.
(iii) Arrears of fixed cumulative dividends.
Note : Usually detail under each of the above items is given by way of a separate schedule. The number of the schedule incorporating the information is mentioned against the item in the column.
Explanation to Balance Sheet Items
Statutory Contents of Liabilities Side of Company’s Balance Sheet
1. Share Capital: It is the first item on the liabilities side of the balance sheet and shows details about following:
(i) Authorized Capital
(ii) Issued Capital
(iii) Subscribed Capital
(iv) Called up Capita)
(v) Paid-up Capital
In terms of number of shares of each kind along with nominal value. If forfeited shares are reissued then this amount is added to the paid-up capital.
2. Reserves and Surplus : As per Shedule VI to the Companies Act, 1956, ‘Reserves and Surplus’ includes the following items :
(i) Capital Reserves
(ii) Capital Redemption Reserves
(iii) Share Premium Account or Securities Premium
(iv) Other reserves
(vi) Proposed Addition to reserves
(vii) Sinking fund
These reserves may be classified broadly as revenue and capital reserves.
3. Secured Loans : If any company given security for the loan by a mortgage or charge on all or any of its property, the loan will be called as ‘Secured Loans’. It includes :
(ii) Loans and Advances from Banks ‘
(iii) Loans and Advances from Subsidiaries
(iv) Other Loans and Advances, if any .
Information regarding the nature of security given for each secured loan should be given along with the respective loans.
4. Unsecured Loans : Loans and advances for which no security is given are shown under this heading. This include
(i) Fixed deposits
(ii) Loans and Advances from Subsidiary Companies
(iii) Loans and Advances from other sources.
(iv) Short-term loans from Bank and other.
5. Current Liabilities and Provisions : Current Liabilities includes :
(i) Acceptances (or Bills Payable)
(ii) Sundry Creditors
(iii) Advance Payments
(iv) Un-expired Discounts
(v) Unclaimed dividends
(vi) Accrued Interest but not paid
(vii) Other liability (if any)
Provisions include :
(i) Provisions for taxation
(ii) Proposed Dividend
(iii) Provisions for Contingencies
(iv) Provision for provident fund
(v) Provision for pension
(vi) Provision for insurance
(vii) Similar staff benefit schemes etc.
(viii) Other provisions
Statutory contents of Assets side of Company’s Balanace Sheet 1. Fixed Assets : These are those assets which are used for long time in business to earn profit. They are acquired with an intention of using them in the main activity of the concern but not for resale. It include :
(ii) Land and Building
(iv) Plant and Machinery
(vi) Railway Lines
(vii) Patents etc.
These assets are shown at cost less depreciation till the date.
2. Investments : It includes
(i) Investment in Government Securities
(ii) Investment in Trust securities
(iii) In shares, debentures, bonds
(iv) Investment in immovable property etc.
3. Current Assets, Loans and Advances: Current Assets includes:
(ii) Sundry Debtors
(iii) Cash and Bank Balances
(iv) Loose Tools
(v) Accured Interest
Loans and Advances includes :
(i) Loans and Advances to Subsidiary Company
(ii) Bills of exchange
(iii) Balance with customs, port trust etc.
4. Miscellaneous Expenditure: Expenditure, which is not debited to Profit and Loss Account fully and deferred for some years, is shown under this heading. It includes :
(i) Preliminary Expenses
(ii) Advertisement Expenditure
(iii) Discount on issue of shares and debenture etc.
5. Profit and Loss Account: If there is any debit balance in Profit and Loss Account, it will be shown as the assets side of Balance sheet.
Explain how financial statement are useful to the various parties who are interested in the affairs of an undertaking?
Meaning of Financial Statements : Financial Statements are those statements which report the profitablity and the financial position of the business at the end of accounting period. At the end of the accounting period, financial statements are prepared to determine profit or loss and to know the financial position of the business. The statements are presented to user of accounting information for decision making. The term financial statements includes at least two basic statements which are as under :
(i) Income statement (or Trading and Profit and Loss Account) which shows results of business operation during the accounting period and
(ii) Statement of Financial position (or Balance Sheet) which shows financial position of an enterprise at a specified point of time.
Preparation of financial statements is the last phase of the accounting process.
“The Finacial Statements provides a summary of accounts of a business enterprise, the balance sheet reflecting the assets, liabilities and capital as on a certain date and the income statement, shotving the results of operations during a certain period.” v —John N. Myer
When the business enterprise satisfy itself with the agreement of T rial Balance, then they proceeds to prepare the financial statements for their business. The main objective of financial statement is to communicate financial position and performance of the business entities to tine user of accounts. Financial position of a business entity is indicated through Balance Sheet and performance is indicated through Trading and Profit and Loss Account. They help to ascertain the profit and loss occur during the accounting period and the financial position of the business.
Information provided by the Financial Statement to the different users:
1. Management: The Financial Statements help the management in assessing the profitability of various activities and various depanmeiits. On their basis, the management can review the progress of the business and take decisions for controlling the non-profitable activities.
2. Investors : Shareholders or proprietors of the business are not generally involved in day-to-day working, they come to know the results of operations and financial position of the business only through the financial statements. They can assess the short term and long-term financial soundness and earning capacity of the business with the help of financial
3. Potential Investors: Financial Statements helps them to know financial position, earning capacity and its prospects for growth of the business. Financial statements help them in making an assessment about have safe theirinvestments will be.
4. A Short-term Creditors!Financial statements help them to assess whether the enterprises will be able to pay debts when they fall due and may decide to extend, maintain or restrict the credit allowed to the enterprise.
5. Long-term Creditors: Financial statements provide information to them about
(i) whether enterprise will be able to pay the interests consistently and
(ii) whether the company will be able to pay their debts when due. On this basis they may also decide to extend, maintain or restrict the loans extended to the enterprise.
6. Government—Financial statements provide information to Government to study the profit margins of various industries to announce or withdraw various concessions and to increase or decrease the excise duty. It also give information to regulate the activities of the enterprise, determine policy, compilation of national income statics.
7. Employees—Financial statements gives information about the profit earned by the enterprises so that they can judges as to how much bonus and increase in their wages.
8. Tax Authorities—Financial statements provides information to the Income Tax Authorities and Sales Tax Authorities about the income earned and sale of the enterprises respectively’ It helps them to assessment of the Income Tax and Sale Tax.
‘Financial statements reflect a combination of recorded facts, accounting conventions and personal judgements,’ discuss.
Yes, it is true that Financial Statements reflect a combination of recorded facts, accounting conventions and personal judgements. In the words of John. N. Mayer, “The financial statements are composed of data which are the result of a combination of
(i) recorded facts concerning the business transactions
(ii) conventions adopted Jo facilitate the accounting technique
(iii) postualtes, or assumption made and
(iv) personal judgements used in the application of the conventions and postulates.
The above points can be discussed below:
1. Recorded Facts—The basis of recording transaction in financial statement is original cost or historical cost. The assets purchased at different times and at different prices are put together and shown at cost price. The financial statements do not show current financial conditions, as they are based on original cost not on replacement costs.
2. Accounting Conventions—For preparing financial statements certain accounting conventions are followed. For example, the convention of valuling inventory at cost or market price whichever is lower, is followed. Small items like pencils, pens, postage stamps etc., although assets in nature but treated as expenditure in the year in which they are purchased. The Stationery is valued at cost. The use of accounting convention makes financial statements comparable, simple and realistic.
3. Postulate—Financial statement are prepared on certain basic assumption known as postulate, such as going concern postulate, money measurement postulate, realization postulate etc. Going concern postulates assumes that the enterprise is run for a long time. Money measurement postulate assumes that the value of money will remain the same in different period.
4. Personal Judgements—Under more than one circumstance, facts and figures presented through financial statements are based on personal opinions, estimates and judgement. For example depreciation is calculated with written down method or at original cost.
Provisions for doubtful debts are made on estimates and personal judgements. Personal opinion, judgement and estimates are made while preparing the financial statements to avoid any possibility of over statements of assets and liabilities, income and expenditure, keeping in mind the convention of conservertion.
Thus, Financial statements are the summarized reports of recorded facts and are prepared following the accounting concepts conventions and requirements of law.
Explain the process of preparing income statement and balance sheet.
Process for preparing Income Statement—
The following process is to be followed for preparation of income statement (in T form):
(i) Preparation of trial balance on the basis of balances of all the accounts available in the ledgers of the concern.
(ii) Recording all the revenue receipts appearing on the credit side of the trial balance on the credit side of income statement after making suitable adjustments for revenues received in advance or revenues realized but not received etc.
(iii) Recording all the revenue expenditure items appeared on
the debit side of trial balance on the debit side of income statement after making adjustments for outstanding, prepaid expenses, depreciation, provisions for bad debts, taxes, etc.
(iv) Recording non-operating incomes and gains on the credit side of income statement.
(v) Recording non-operating losses on the debit side of the income statement.
(vi) Finding the difference between totals of credit items and totals of debit items.
(vii) If the credit items are more than the debit items, it is known as net profit and vice versa.
(viii) In India, the accounting year for preparing financial statements for companies is 1st April to 31st March (same as that of financial year of Government).
Process for Preparing Balance Sheet—The following process is to be followed for preparation of Balance Sheet (in T form Horizontal Type)
(i) Preparation of trial balance on the basis of balances of all the accounts available in the ledgers of the concern.
(ii) Recording Debit balances of all Personal and Real Account on the Assets side of Balance Sheet after making adjustments for outstanding, Prepaid expenses, depreciation, provision for bad debts, tax etc.
(iii) Recording Credit balances all Personal and Real Account on the liabilities side of Balance Sheet after making adjustments for outstanding expenses, interest on loan etc.
(iv) Find the total of two side. The total of the two sides of the Balance Sheet must be equal.
The following is the trial balance on June 30, 2006 of the Modem Manufacturing Company Ltd.
Stock, on 30 th June, 2006 Rs. 8,200. You are required to make out the trading account, and profit and loss account for the year ended 30th June, 2006 and the balance sheet as on the date. You are also to make provision in respect of the following :
(i) Depreciate machinery @ 10% per annum
(ii) Reserve 5% for discount on debtors;
(iii) One month rent Rs. 45 was due on 30th June; and
(iv) Six months insurance, included in general expenses, was unexpired at Rs. 75.
(Gross Profit Rs. 6,200, Net Profit Rs. 2044.50; Balance Sheet total Rs. 16,392.50)
The following is the trial balance of Alfa Ltd., for the year ended 30th June, 2005.
Prepare the Profit and Loss Account and Balance Sheet of the company after taking the following particulars into consideration:
(a) The original cost of land and building, plant and machinery and furniture and fittings was Rs. 2,50,000, Rs. 6,00,000 and Rs. 60,000 respectively. Additions during the year were, : building Rs. 50,000 and plant Rs. 20,000.
(b) Depreciation is to be charged on plant and machinery and furniture and fitting at 10 percent on original cost.
(c) Of the sundry debtors, Rs. 10,000 are outstanding for a period exceeding 6 months, Rs. 5,000 are considered doubtful, while the others are considered good.
(d) The directors are entitled to a commission at 1 percent of the net profits before charging such commission.
(e) Stock on 30 th June, 2005 is Rs. 1,30,000.
(f) Provide Rs. 34,800 for income-tax.
The following balances appeared in the books of Parasuram Flour Mills Ltd., as on 31st December 2005 :
Prepare the company’s trading and profit and loss account for the year and balance sheet as on 31st December 2005 after taking the following adjustments into account:
(a) Stocks on 31st December 2005 were : Wheat at cost, Rs. 14,900 Flour at market price Rs. 21,700;
(b) Outstanding expenses: Manufacturing expenses Rs. 23,500 and salaries and wages, Rs. 1,200.
(c) Provide depreciation: Building at 2%; Plant and machinery at 10% : Furniture at 10%; and Vehicle 20%.
(d) Interest accrued on Government Securities, Rs. 100 :
(e) A tax provision of Rs. 8,000 is considered necessary.
(f) The directors propose a dividend of 20%.
(g) The authorised capital consists of 12,000 equity shares of Rs. 10 each of which 7,200 shares were issued and fully paid up.
(Gross Profit Rs. 47,600; Net Profit Rs. 21,310; Profit and Loss Appropriation balance Rs. 13,410; Balance Sheet total Rs. 2,92,010).
An unexperienced accountant prepared the following trial balance of Bang Vikas Ltd., for the year ending31-12-2005. The cash in hand on 31-12-2005 was Rs. 750.
After locating the mistakes and making the following adjustments prepare trading and profit and loss account and balance sheet in the prescribed form.
(i) Stock on 31-12-2005 Rs. 95,000 and
(ii) Write off preliminary expenses.
Note : Rectified trial balance need not be prepared.
(Gross Profit Rs. 2,36,800; Net Profit Rs. 60,475; Balance of Profit and Loss appropriation A/c Rs. 36,600; balance Sheet Rs. 9,01,100; Difference in trial balance Rs. 750)
The Silver Ore Co. Ltd. was formed on April 1,2005 with an authorized capital of Rs. 6,00,000 in shares of Rs. 10 each. Of these 52,000 shares has been issued and subscribed but there were calls in arrear on 100 shares @ Rs. 2.50. From the following trial balance as on March 31,2006 prepare the trading and profit and loss account and the balance sheet :
(i) Depreciate plant and railways by 10%; furniture and building by 5%;
(ii) Write off a third of the promotion expenses;
(iii) Value of silver ore on March 31, 1969 Rs. 15,000, the directors forfeited on Dec. 20, 1968, 100 shares on which only Rs. 7.50 had been paid.