MGT101 - Financial Accounting - I - Lecture Handout 29

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Profit & Loss Account

Standard format of profit & loss account is shown as follows:

Particulars Amount
Less: Cost of Goods Sold
Gross Profit
Less: Administrative Expenses
Selling Expenses



Operating Profit
Less: Financial Expenses
Add : Other income
Profit Before Tax
Less: Tax
Net Profit After Tax for the Year
Other income


Sales as we know are the revenue against the sale of the product in which the organization deals. In case of a service organization, there will be Income against Services Rendered instead of Sales and there will be no Cost of Sales or Gross Profit

Cost of Goods Sold/Gross Profit

Cost of goods sold is the cost incurred in purchasing or manufacturing the product, which an organization is selling plus any other expense incurred in bringing the product in salable condition. Cost of goods sold contains the following heads of accounts:
o Purchase of raw material/goods
o Wages paid to employees for manufacturing of goods
o Any tax/freight is paid on purchases
o Any expense incurred on carriage/transportation of purchased items.

Gross Profit = Sales – Cost of goods sold

Other Income

Other income includes revenue from indirect source of income, such as return on investment, profit on PLS account etc.

Administrative Expenses

Administrative expenses are the expenses incurred in running a business effectively. Main components of this group are:
o Payment of utility bills
o Payment of rent
o Salaries of employees
o General office expenses
o Repair & maintenance of office equipment & vehicles.
It is important to distribute expenses properly among the three classifications i.e. Cost of Goods Sold, Administrative Expenses and Selling Expenses to present the financial statements fairly. Take the example of following costs:

Salaries and Wages

  • Although both these terms mean remuneration paid to labor and employee against services.
  • Wages usually denotes remuneration paid to daily wages labor. Whereas salary denotes payments to permanent employees.
  • Salaries can be classified in any of the classifications mentioned below.
  • Salaries / wages paid to labor and supervisors/officers working for the manufacturing of goods become a part of Cost of Goods Sold.
  • Salaries and benefits of general administrative staff becomes part of Administrative Expenses
  • Salaries and benefits of sales and marketing staff become part of selling expenses.
    Other expenses like Depreciation, Utilities and Maintenance can also be classified in all three, depending upon the exact nature of the expenditure.

Selling Expenses

Selling expenses are the expenses incurred directly in connection with the sale of goods. This head contains:

  • Transportation/carriage of goods sold
  • Tax/freight paid on sale

If the expense head ‘salaries’ includes salaries of sales staff, it will be excluded from salaries & appear under the heading of ‘selling expenses’.

Financial Expenses

Financial expenses are the interest paid on bank loan & charges deducted by bank on entity’s bank accounts. These are shown separately in the Profit and Loss Account. These include:

  • Interest on loan
  • Bank charges

There is, however, one exception and that is the interest paid on loan taken to build an asset is capitalized as cost of the asset up to the time that asset is completed.

Income Tax

Different types of entities have to pay income tax at different rates. At the time of preparing annual financial statements, an estimate of expected tax liability is made. A provision is then, created equal to that estimate.
You should remember the treatment of Provision for Doubtful debts. Same is the case with income tax i.e. provision is made at the time of preparing accounts which is then adjusted accordingly at the time when actual tax expense is known.

Balance Sheet (Asset Side)

Standard format of the balance sheet is given as follows:

Particulars Amount Rs. Amount Rs.
Non Current Assets

Fixed Assets
Capital Work In Progress
Deferred Costs
Long Term Investments
Current Assets
Trade debtors and Other Receivables
Short Term Investments
Cash and Bank
Total X X

Fixed Assets

  • Fixed assets are the assets of permanent nature that a business acquires, such as plant, machinery, building, furniture, vehicles etc.
  • Fixed assets are presented at cost less accumulated depreciation OR revalued amount.

Capital Work In Progress

If an asset is not completed at that time when balance sheet is prepared, all costs incurred on that asset up to the balance sheet date are transferred to an account called Capital Work in Progress Account. This account is shown separately in the balance sheet below the fixed assets. Capital work in progress account contains all expenses incurred on the asset until it is converted into working condition. All these expenses will become part of the cost of that asset. When an asset is completed and it is ready to work, all costs will transfer to the relevant asset account.

Deferred Costs

An expense that has a future benefit in excess of one year and recorded in a capital asset account

Long Term and Short Term Investments

Where a business has surplus funds, it is better to invest those funds where these can generate a return greater than PLS accounts. These investments can be of different types e.g. shares of other companies, fixed deposits with banks, government securities, national savings etc. or presentation purposes, these Investments are classified in two categories, long term and short term investments. Investments made with the intention that they will be held for a period longer than twelve months are classified as long term and those made for a period equal to or shorter than 12 months are classified as short term.

Following things are important to note here:

  • Classification is to be made every time a balance sheet is prepared and the period is to be calculated from the date of balance sheet.
  • This means that an investment made for 2 years on May 2000 will be classified as long term investment in accounts prepared on Jun 30, 2000 and the same investment will be classified as current investment in the accounts prepared on June 30, 2001.
  • An investment may initially be made as current investment. Subsequently, if it is decided to hold it for a longer period, then its classification will have to be changed accordingly and vice versa.
  • Therefore, investments are checked for classification every time a balance sheet is prepared and presented accordingly.

Current Assets

Current Assets are the receivables that are expected to be received within one year of the balance sheet date. Debtors, closing stock & all accrued incomes are the examples of Current Assets because these are expected to be received within one accounting period from the balance sheet date.

It is important to note that assets and liabilities are presented in the balance sheet in the order of their maturity i.e. assets / liabilities having longer life are presented first and assets / liabilities having shorter life are presented later.

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