Financial Statements

TRADING ACCOUNT

Trading account is prepared to find out the amount of Gross Profit or Gross Loss in a particular period of time. Gross Profit or Gross Loss is the amount of difference between the cost of goods sold and the price of goods sold. Gross profit or loss can be ascertained with the help of the following equation.

Gross Profit = Sales - Cost of goods sold.

Gross Loss = Cost of goods sold - Sales

If the amount of sales is more than the cost of goods sold, the result will be Gross Profit but if the amount of sales is less than the cost of goods sold, the result will be Gross Loss. Cost of goods sold may be ascertained by adjusting the figures of opening and closing stock to the amount of purchases made during the year and adding direct expenses into it. Cost of goods sold = Purchasing during the year of opening stock – Closing stock = Production expenses. Thus trading account simply tells about the gross profit or loss, made by a business on purchasing and selling of goods. It does not take into account the other opening expenses incurred by him during the course of running the business. The balancing figure of trading account – Gross Profit or Gross Loss is transferred to Profit and Loss Account. That is why trading account is treated as sub-section of the Profit and Loss account and it is prepared before the preparation of Profit and Loss Account.

Objectives of Trading Account

The preparation of Trading account fulfills the following objectives:

• While fixing the selling price of merchandise, trader adds a fixed percent of cost as profit to the cost and later on by preparing the trading account verifies whether the projected profit has been earned or not.
• If gross profit is found to be less than the projected profit its reasons are analyzed and proper control is exercised in future.
• If Gross profit is more than projected profit, efforts are made to maintain it in future.
• If Trading Account discloses loss then it will be prudent to close down the business may be temporarily till the conditions improve, otherwise, it is possible that losses may exceed.
• Trading account also helps to ascertain the percentage of direct expenses over sales.
• Trading account also provides the percentage of gross profit to sales.

Advantages:
1. Trading account shows the relationship between gross profit and sales that helps to measure profitability position.
2. Trading account shows the ratio between cost of good sold and gross profit.
3. Trading account gives the information about efficiency of trading activities.
4. Trading account helps to compare between cost of good sold and gross profit.
5. Trading account provides information regarding stock and cost of good sold.

PROFIT AND LOSS ACCOUNT

Profit and loss A/c is a company's financial statement that indicates how the revenue is transformed into the net income. It displays the revenues recognized for a specific period, and the cost and expenses charged against these revenues. The purpose of the profit and loss account is to show managers and investors whether the company made or lost money during the period being reported in a particular accounting period.

Features of Profit and Loss Account are as follows:

·         Profit and loss account is a nominal account to be prepared at the end of the year. It includes transactions of revenue nature and does not contain items of capital nature.

·         Incomes and Expenses relating to current year are to be shown in it.

·         It includes outstanding expenses and accrued incomes relating to current year which are taken into consideration while prepaid expenses and incomes received in advance are excluded from it.

The importance of Profit and Loss account lies in the fact that it provides accounting date which can be used for some managerial decisions as given below:

Net Result:

It provides information about net profit or net loss earned or incurred by the business during a particular period.
Accounting data for determining efficiency:

Net results provided by the Profit and Loss Account can be compared with the net results of the previous years and the efficiency of the business can be determined by such inter-period comparison of results.
Control over expenses:

Profit and Loss Account provides information about various kinds of expenses. The expenses of the current year can be compared with the expenses of the previous year and effective steps can be taken for the control of expenses, where it becomes necessary.

Future Profit Planning:

Net profit of various years can be taken as basis for future profit-planning. It helps the business in the allocation of sources and future expansion.

BALANCE SHEET

A balance sheet is an accounting statement prepared from accounting balances at a given date. It shows the financial position of a business by detailing the sources of funds and the utilization of these funds. A balance sheet shows the assets and liabilities grouped, properly classified and arranged in a specific manner.

It has already been stated that after the preparation of trial balance, some accounts are closed by transferring them to the Trading account and some accounts are closed by transferring to Profit & Loss Account. These accounts are in the nature of expenses and revenues

The Balance Sheet of a business possesses the following characteristics:

• Balance sheet being a statement has no 'debit' or 'credit' sides that is why 'To' or 'By' words are not prefixed to the name of accounts.
• Balance sheet is prepared at the end of an accounting period - it is for a particular day, so it discloses the financial position on a particular day and not for a particular period.
• Balance sheet discloses how much business owes to others and how much others owe to business.
• The total of 'Assets' an 'Liabilities' sides are always equal.
• It is a statement showing the financial performance of an organization
• It acts as a basis for financial analysis through calculation of ratios for knowing the profitability, liquidity positions of the organisation