FINAL ACCOUNTS

We will learn about final account in below sequences.

		Elements of Financial Statements
		Capital and Revenue Expenditure
		Opening, Closing and Adjustment Entries
		Rectification Entries
		Adjusted Trial Balance
		Depreciation
		Provisions and Reserves
		Specimen Question with Answers
		Self-Examination Questions

 ELEMENTS OF FINANCIAL STATEMENTS

The elements which are directly related to the measurement of financial position are assets, liabilities and equity. The elements which are directly related to the measurement of profit are income and expenses.

Asset : An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

Liability : A liability is a present obligation of the enterprise arising from past events the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

There is a distinction between a present obligation and future commitment. A decision by the management of an enterprise to acquire assets in future does not of itself give the rise to a present obligation.

 Equity : In a corporate enterprise equity is classified in the Balance Sheet as Share Capital and Reserve and Surplus. Normally Equity is shown at its paid up value.

Income and Expenses : Income is increase in economic benefits during the accounting period in the form of inflows or enhancement of assets or decrease of liability that result in increase of equity. Whereas expenses are decreases in economic benefits during the accounting period in the form of' outflows or depletion of assets or increases in liabilities that result in decrease in equity other than those relating to distribution to equity participants.

Measurement of elements of financial statements

Measurement is the process of determining the monitary amounts at which the elements of the financial statement are to be recognised and carried in the Balance Sheet and Income Statement. A number of different measurements are employed to define degrees in financial statements. They are as follows:

a)        Historical cost

b)        Current cost

c)        Realistic value

d)        Present value.

The commonly adopted basis is historical cost.

Concept of Capital

The financial concept of capital is adopted by most enterprises in preparing their financial statements. Capital is synonymous with the net assets or equity of the enterprise under a financial concept such as invested money or invested purchasing power.

Fundamental accounting assumptions

Certain fundamental accounting assumptions underlie preparation and presentation of financial statements. They are stated as follows:

(a)        Going Concern : The enterprise is normally viewed as a going concern i.e. as continuing its operation for unforeseeable future.

(b)        Consistency: Application of same set of accounting policies over the years in preparation of financial statements is assumed.

(c)        Accrual : Revenues and costs are recognized in the year to which they are related and not as paid or received.

Disclosure of Accounting Policies

Students should refer from any recommended Text Book:

(a)        International Accounting Standards

(b)        Indian Accounting Standards

  

2.1           CAPITAL AND REVENUE EXPENDITURE

Capital expenditure is the expenditure incurred for acquisition of assets the benefits of which are enjoyed over the years. The benefits of revenue expenditures are exhausted in the year of incurrence

Thus it is seen that utilisation of business capital is made for two distinct purposes:

1)        Expenses yielding benefits over the years termed – capital expenditure.

2)       Expenditures yielding benefits during the current accounting year – termed as revenue expenditure

Where the benefits of a revenue expenditure are extended beyond the accounting year of incurrence it is called a differed revenue expenditure.

Suppose a company incurred an expenditure of Rs. 100000 for advertisement before marketing of a new product. If the whole amount is charged in the current year, the profit of the company would not reflect a true picture as the benefits are likely to spread over three to four years. So 1/3 or 1/4 of the expenditure will be charged to current P/L Account and the balance should be carried forward for remaining years. This will be shown on the assets side of the balance sheet as deferred revenue expenditure.

Difference between Capital and Revenue Expenditure

Capital Expenditure                                     Revenue Expenditure

1.      It is incurred for acquiring fixed assets in use and for increasing earning capacity of the business.

It is incurred to run the business but does not increase the capacity of the business.

2.       Benefits of such expenditure extend to years beyond which it is incurred.

3.       It is shown in the Balance Sheet.

Illustration 1 :

Usually the benefit is consumed in the period in which it is incurred

It is taken to the Trading / P&L A/c of the concern.

An old building which originally costs stands in the book is at Rs. 3, 00,000 is pulled down and a new one is erected in its place. Rs. 1,500 worth of material out of the old building is sold and Rs. 5,000 worth is used in new building. In addition to this Rs.5.50 lakhs is spent under a contract for its construction, Rs. 2.25 lakhs had been set aside by firm for the depreciation on the old building and is now appropriated. What addition to the Building Account will legitimately arise out of the rebuilding ?

Solution :
Book value of old building		3,00,000
Less: Provision for Deprn.	2,25,000
Sale of old Materials	1,500
Old Material used in new building	5 000	2,31,500
		68,500

The cost of new building should be shown as Rs.5,50,000 + 68, 500 = Rs. 6,18,500

Illustration 2 :

An agricultural land was purchased for a mill was Rs. 1,00,000. Rs. 1 0 000 was paid for land revenue.

Solution :

Cost of land amounting to Rs. 1 00 000 will be treated as Capital Expenditure and Land revenue of Rs. 10 000 will be treated as Revenue Expenditure.

Illustration 3 :

Rs. 50,000 was spent on advertising for the introduction of a new product in the market, the benefit of the market which will be divided for four years.

Solution :

Rs. 50,000 spent on advertising is to be treated as deferred revenue expenditure considering the benefit attributable for four years to come Rs. 12,500 is to be written off every year.

Illustration 4 :

Rs. 10,000 spent as lawyer's fee to defend a suit claiming that the firm’s factory site belonged to the plaintiff. The suit was not successful.

Solution :

Rs. 10,000 incurred for defending the title to the firm’s assets is a revenue expenditure. If, however any expenditure incurred for rectifying the title is a capital expenditure.

  

2.2           OPENING, CLOSING AND ADJUSTMENT ENTRIES

Opening Entries

At the end of each accounting period a firm closes its books of accounts opens new hooks at the beginning of each accounting period. The first entry in the journal is to record the closing balance of various assets and liabilities at the end of the previous year or the opening balances in the beginning of the new year. The balance sheet prepared at the end of each year records these balances. It is from these balances that the first entry is passed which is known as the “Opening Entry" e.g.

				Balance Sheet as on 31st March, 1994
		Liabilities				Assets
		Capital		44,200		Plant & Machinery			50,000
		Sundry Creditors		25,000		S. Debtors			7,500
						Closing stock			5,000
						Cash at bank			6,000
						Cash in hand			700
				69,200					69,200
					Journal
Dt.		Particulars					Dr.		Cr.
	1994 Ap.1 Cash in hand					Dr.	700
		Cash at bank				Dr	6000
		Stock A/c				Dr	5000
		S. Debtors A/c				Dr	7500
		Plant & Machinery A/c				Dr	50000
		To S. Creditors							25000
		To Capital							44200
		(Balances brought forward)
		The above entries will then be posted to the ledger accounts as follows :–
Dr.					Cash account				Cr.
Date		Particulars	Cash	Bank	Date	Particulars	Cash		Bank
1994
Apr. 1		To Balance b/d	700	6000
Dr.					Stock account
Date		Particulars		Rs.	Date	Particulars			Rs.
1994
Apr 1		To Balance b/d		5000

Dr.		Sundry Debtors account			Cr.
Date	Particulars	Rs.	Date	Particulars	Rs.
Apr 1	To Balance b/d	7500
Dr.		Plant & Machinery account			Cr.
Date	Particulars	Rs.	Date	Particulars	Rs.
Apr. 1	To Balance b/d	50000
Dr.		Sundry Creditors account			Cr.
Date	Particulars	Rs.	Date	Particulars	Rs.
Apr. 1			By Balance b/d		25000
Dr.			Capital account		Cr.
Date	Particulars	Rs.	Date	Particulars	Rs.
Apr. 1			By Balance b/d		44200

  

Closing Entries

In respect of Trading A/c:

		Particulars		Dr.	Cr.
Trading A/c				Dr
To Stock (Opening) A/c
To Purchases A/c
To Factory fuel & power A/c
To Factory rent & rates A/c
To Freight on purchases A/c etc.
(Purchases are net purchases i.e. purchases less
purchases returns)
Sales A/c				Dr
Stock (closing) A/c				Dr
To Trading A/c
(Sales are net sales i.e. sales less sales returns.)
Trading A/c				Dr
To P & L A/c L A/c
(for transfer of gross profit)

		Final Accounts
In respect of Profit & Loss A/c :
Items of expenses etc.
P & L A/c			Dr
To Salaries A/c
To Rent A/c
To Interest A/c
Items of gain :
Interest received A/c			Dr.
Miscellaneous income A/c			Dr
To P & L A/c
(The above entries will close all nominal accounts.)
P & L A/c			Dr
To Capital A/c
(transfer of net profit)
Capital A/c			Dr.
To P& L A/c
(transfer of net loss)

  

Adjustment Entries

Adjustment means putting things in order. Adjustment entries are entries made for putting everything in order. The examples are :

i)       Accrued/outstanding expenses and prepaid expenses

ii)      Accrued Income and Income received in advance

iii)       Depreciation

iv)       Bad Debts, Provision for bad and doubtful debts, Provision for discount on debtors;

v)       Commission on profits

vi)       Income tax, Advance Income-tax, Income-tax deducted at source, Provident Fund, Employees’ State Insurance contributions.

  

2.3           RECTIFICATION ENTRIES

Errors may be divided into two types :–

i)       Errors not affecting the trial balance.

ii)       Errors affecting the trial balance.

Errors not affecting the trial balance may be further divided into the following :–

a)        Omission of an entry in the subsidiary book.

b)        Wrong entry made in the subsidiary book.

c )  Errors of principle.

d)        Posting an amount in the wrong account but on the correct side

e)        Entry made in the wrong subsidiary book.

f)        Compensating errors.

Omission of an entry in the subsidiary book

Here a transaction is completely omitted to be recorded in the books of accounts . e.g. a credit sales to A for Rs. 2000 was omitted to be recorded in the sales book.

Particulars		Dr.	Cr.
A's A/c	Dr	2000
To Sales A/c			2000
(Rectification entry passed for omission of credit sales
to A being omitted to be	recorded in the sales book)

Wrong entry made in the Subsidiary Book

e.g. Credit purchases from Q for Rs. 3000 has been wrongly entered in the purchases book as Rs. 3300.

Purchases book has an excess debit of Rs. 300 and Q's account has an excess credit for the same amount

Therefore, the rectifying entry will be

Particulars		Dr.	Cr.
Q's  A/c	Dr.	300
To Purchases A/c			300

Errors of principles

These arise when a revenue expenditure is treated as a capital expenditure or vice versa e.g. Furniture purchased from X for Rs. 4000 was entered in the Purchase Book.

 

	Particulars		Dr.	Cr.
Wrong entry
Purchase A/c		Dr.	4000
To X's A/c				4000
Correct entry
Furniture A/c		Dr.	4000
To X's A/c				4000
Rectifying Entry
Furniture A/c		Dr.	4000
To Purchase A/c				4000

Purchase A/c has been debited wrongly, therefore it has been credited [rectifying entry] in order to cancel the debit. However, X's Account has been credited correctly. As furniture A/c has to be debited in the first place it is done through the rectifying entry.

Posting an amount in the wrong A/c but on the correct side

e.g. Credit sales to Ramanthan for Rs. 1500 has been posted to Ramamurthy's A/c

	Particulars		Dr.	Cr.
Wrong entry
Ramamurthy's A/c		Dr.	1500
To Sales A/c				1500
Correct entry
Ramanathan A/c		Dr	1500
To Sales A/c				1500
Rectifying entry
Ramanathan A/c		Dr.	1500
To Ramamurthy A/c				1500

  

Entry made in the wrong Subsidiary Book

e.g. Credit sales to Y Rs. 2500 was wrongly entered in the Purchases Book.

	Particulars		Dr.	Cr.
Wrong entry
Purchase A/c		Dr.	2500
To Y's A/c				2500
Correct entry
Y's A/c		Dr.	2500
To Sales A/c				2500
Rectifying Entry
Y's A/c		Dr.	5000
To Purchase A/c				2500
To Sales A/c				2500

Compensating Errors

If the effect of one error is multiplied by the effect of some other errors the trial balance will agree, e. g. an amount of Rs.25 received by M is not credited to his A/c and the total of the sales books is overcast by Rs. 25. The omission of credit to M's A/c is offset by the increased credit to the Sales A/c and hence the Trial Balance will agree.

Errors affecting the Trial Balance

As already discussed these errors are :

a)        Omission to post to the ledger from the subsidiary book.

b)        Posting the wrong amount in the ledger.

c )  Posting an amount to the wrong side.

d)        Wrong casting of the subsidiary book.

e)        Posting wrong amount lo the wrong side.

f)        Posting a wrong amount to a wrong account

g)        Posting a wrong amount to the wrong side of a wrong account.

Omission of posting from a subsidiary book

Goods returned to D Rs. 300 entered in the Purchases Returns Book omitted to he posted to D's A/c. D's A/c has not been debited. Therefore his A/c should be debited with Rs. 300.

  

Posting the wrong amount in the ledger

Credit sales to Z for Rs. 120 was correctly entered in the sales book but posted to Z's A/c as Rs. 102. Z's A/ c is debited short by Rs. 18(120-120). Therefore debit his A/c with Rs. 18.

Posting an amount to the wrong side

Credit purchases from U for Rs. 500 was correctly entered in the purchases book but wrongly debited to U's A/c has to be credited with Rs. 1000.

U 's A/c is wrongly debited with Rs. 500. To Cancel this debit of Rs. 500 a credit of Rs. 500 must be given. Another credit of Rs . 500 must be given to incorporate the correct entry. Therefore a total credit of Rs. 1,000 has been given.

Wrong casting of the subsidiary book

Sales book has been totaled as Rs. 4000 the correct being Rs. 4400. Sales A/c has short credit of Rs. 400. Therefore credit sales A/c by Rs. 400.

Posting wrong amount to wrong side

Sold goods to K for Rs. 136 entered in the sales book correctly but credited to K’s a/c for Rs. 163.

K's A/c has to be debited with Rs. 299. K’s A/c has been credited wrongly for Rs. 163. To cancel this credit a debit of Rs. 163 is given. Further a debit of Rs. 136 has to be given the accommodate the correct entry. Therefore a total debit of Rs. 299 ( 163 + 136) has to be given.

Posting a wrong amount to the wrong account

Credit purchases from Akila for Rs. 155 was posted to the credit Akila for Rs. 165.

Debit Akila's A/c with Rs. 165. Credit Akila's A/c with Rs. 155.

Akila's A/c has bean wrongly credited therefore it should be debited to cancel the credit. Akila's A/c has not been credited.

So credit her A/c now with the correct amount Rs. 155.

Posting the wrong amount to the wrong side of a wrong account

A credit sales to W for Rs. 153 was credited to V's A/c for Rs. 135. Debit V's A/c with Rs. 135.

Credit W's A/c with Rs.153.

V's A/c has been credited wrongly, so his A/c is debited to cancel the wrong credit. W's A/c should have been debited in the first place.

Therefore, his A/c is now debited with Rs. 153, being the correct amount.

  

Illustration 5 :

Correct the following entries.

a)        Sale or goods Rs.1200 to Mr. Kumar has been entered in the sales book as Rs. 1100.

b)        Machinery purchased for Rs. 11500 from XYZ Co. Ltd has been entered in the Purchases book.

c ) Payment of the proprietor's personal expenses Rs. 450 has been debited to the General Expenses A/c.

d)        The Returns Inwards book has been overcast by Rs. 150.

e)        Discount allowed to M/s ABC Rs. 35 has not been entered in the cash book but the full amount (including discount) has been credited to M/s ABC

f)       Sale of old typewriter Rs. 275 has been passed through the sales book.

Solution :

Journal Entries

		Particulars			Dr.	Cr.
a)	Kumar's A/c			Dr	100
	To Sales A/c					100
	(Rectifying entry passed for short credit-sales A/c and
	short debit to Kumar's A/c)
b)	Plant & Machinery A/c			Dr	11500
	To Purchases A/c					11500
	(Rectifying entry passed to correct machinery
	purchased charged to Purchases A/c )
c)	Drawing A/c			Dr	450
	To General Expense A/c					450
	(Rectifying entry passed to correct drawings charged
	to Gen. Exp. A/c)
d)	Credit Returns Inwards A/c by Rs. 150.
e)	Debit Discount allowed A/c Rs. 35.
	(As the amount has not been entered in the cash book
	there is a short debit in the Discount Allowed A/c.
	Therefore the additional debit)
f)	Sales A/c			Dr	275
	To Office Equipment A/c					275
	(Rectifying entry passed to correct sale of old
	typewriter erroneously credited to Sales A/c instead
	of Office Equipment A/c)

  

Suspense Account

The difference in the Trial Balance may be put in an account known as the Suspense Account, where the error causing difference cannot be located immediately and the books of accounts have to be closed. Suspense account is an account to which the difference in the trial balance has been put temporarily. If the debit side is short this account is debited and if the credit side is short it will be credited. However the opening of a suspense account does not mean that the errors need not be found out.

All errors affecting the trial balance (these were discussed earlier) are corrected through the suspense account as these are one-sided errors. Previously one sided errors have been corrected by making a correcting entry in the account concerned without making an entry in any other account. Double entry will be complete where a suspense account is opened with a difference in the trial balance.

Illustration 6 :

Correct the following errors –

i)       Without opening a Suspense Account, and

ii)      Opening a Suspense Account

a)        The Purchases Returns Book has been totalled Rs. 80 short.

b)       Goods returned by M/s Amar & Sons Rs. 150 have not been recorded anywhere.

c ) Goods bought from M/s Devi Bros Rs. 250 have been posted to their debit as Rs. 205.

d)       Discount received from Hi-Fi Bros Rs. 25 has not been entered in the discount column of the cash book.

e)        A sale to Mr. Dubey Rs. 450 was wrongly credited to his account.

Solution :

Particulars                                                                 Dr.               Cr.

i) Without opening a Suspense Account :

a)                         Credit Purchases Returns A/c with Rs. 80.

b)	Sales Returns A/c			Dr	150
	To M/s Amar & Sons A/c				150
	(Entry passed for goods returned as it was omitted
	from the Sales Returns Book)

c)                         Credit M/s Devi Bros with Rs. 455.

M/s Devi Bros have been debited Rs. 205 instead of being credited.

(Therefore a credit of Rs. 205 is given to remove the wrong debit and a further credit of Rs. 250 is given to record the correct credit.)

  

d)                         Credit Discount Received A/c Rs. 25.

(There is a short credit in the Discount Received A/c by Rs. 25. Hence an additional

credit is given to the account.)

e)                          Debit Mr. Dubey's A/c with Rs. 900.

(Mr. Dubey's A/c has been credited with Rs. 450 instead of being debited. This account is

now debited with Rs. 900 to remove the wrong credit and given the correct debit.)

ii) Opening a Suspense Account

a)	Suspense A/c				Dr	80
	To Purchase Returns A/c					80
	(Correction arising from undercasting of Purchases
	Returns Book)
b)	Sales Returns A/c				Dr	150
	To M/s Amar & Sons A/c					150
	(Recording an entry omitted earlier)
c)	Suspense A/c				Dr	455
	To M/S Devi Bros A/c					455
	(Correction of entry by which M/s Devi Bros were
	debited Rs. 205 instead of being credited with Rs. 250)
d)	Suspense A/c				Dr	25
	To Discount Received A/c					25
e)	Mr. Dubey's A/c				Dr	900
	To Suspense A/c					900
	(Correction of entry by which Mr. Dubey’s A/c was
	credited with Rs. 450 instead of being debited)

Effect of errors and their rectification on profit or loss :

Certain errors affect the profit or loss of the firm. If the error is in the nominal account the profit and loss account will be affected but if it is in a personal or real account there will be no change on the profit or loss. Rectification of an error in a nominal account will change the figure of profit or loss previously arrived at.

  

Illustration 7 :

The Trial Balance of M/s Soles & Soles extracted on 31st March, 1997 was Rs. 1595 short on the debit side. A suspense account is opened to tally the trial balance. On examination of the books of accounts the fallowing errors were noticed :

a)       Credit Purchases from M/s Toepuf Rs. 200 was posted as Rs. 20 in the ledger.

b)       Miser the landlord was debited Rs. 250 for payment of rent.

c )  Cash purchase of Rs.125 was not posted to the ledger.

d)       Discount allowed column in the cash book was posted to Gen. Exps are Rs.20.

e)       Payment made to Insole & Sons Rs.1500 was posted to their credit Rs.150.

f)       Received Rs.250 from Tom but posted to Thompson's A/c.

g)       Credit sale of Rs.750 to Shoes & Socks Ltd entered in the Returns Outwards Book.

Pass necessary rectifying entries. Prepare the Suspense A/c and show the effect of the rectifying entries on the profit of business.

Solution :

S.No.		Particulars		LF	Dr(Rs)	Cr.(Rs.)
a)	Suspense A/c			Dr	I 80
	To M/s Toepuf A/c					180
	(rectification of posting of wrong amount)
b)	Rent A/c			Dr	250
	To Miser's A/c					250
	(rectification of payment of rent posted to Miser's
	(landlord) A/c)
c)	Purchases A/c			Dr	125
	To Suspense A/c					125
	(cash purchases not posted rectified)
d)	Discount allowed A/c			Dr	20
	To Gen. Expense A/c					20
	(posting of discount allowed to Gen Exp. rectified)
e)	Insole & Sons A/c			Dr	1650
	To Suspense A/c					1650
	(rectification of posting wrong amount			i.e.Rs. 150

instead of Rs. 1500 to the credit side instead of the debit side)

f)	Thompson's A/c				Dr	250
	To Tom's A/c					250
	(receipt from Tom posted to Thompson rectified)
g)	Returns Outwards A/c				Dr	750
	To Sales A/c					750
	(Credit sales recorded in Returns Outwards Book
	rectified)
Dr.			Suspense Account			Cr.
Dt.	Particulars		Rs	Dt.	Particulars	Rs
To Difference in Trial Balance			1595		By Purchases	125
To M/s Toepuf			180		By Insole & Sons	1650
			1775			1775

Effect of rectifying entries on profit

a)        No effect

b)        Profit reduced by Rs. 250

c )  Profit reduced by Rs. 125

d)        No effect

e)        No effect

f)        No effect

g)        No effect

Rectification in the next trading period:

In order to ascertain the profit or loss of each period separately errors should be rectified in such a manner that the current year's income, expenses or loss are not affected.

An error committed in 2001-02 is rectified in 2002-03. By rectifying Sales A/c would mean that it is treated as an income of 2002-03 when it actually pertains to 2001-02. Therefore the proper thing to do should be to open a separate account called the Profit & Loss Adjustment account and pass all debits and credits in respect of nominal accounts for errors committed in the previous period through this account. The balance of this account is transferred lo the Capital A/c.

Only when rectification is carried out in the next trading period and if it pertains to the nominal accounts alone this procedure be adopted. Rectification in the current period is made in the usual manner.