MGT101 - Financial Accounting - I - Lecture Handout 09

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INTRODUCTION TO FINANCIAL STATEMENTS (CONTINUED)

Learning Objective

  • After studying this chapter, you should be able to:Explain what are Assets and Liabilities and
  • Draw up simple Balance Sheet from given information in trial balance

Assets are economic resources that are owned by a business and are expected to benefit future operations. In most cases, the benefit to future operations comes in the form of positive future cash flows. The positive future cash flows may come directly as the asset is converted into cash (collection of a receivables) or indirectly as the asset is used in operating the business to create other assets that result in positive future cash flows (building & land used to manufacture a product for sale). Assets may have definite physical form such as building, machinery or stock. On the other hand, some assets exist not in physical or tangible form, but in the form of valuable legal claims or right. Examples are accounts receivables, investment in govt. bonds and patent rights etc.

Liabilities are debts and obligations of the business. The person or organization to which the debt is owed is called creditors. All businesses have liabilities; even the most successful companies’ purchase stocks, supplies and receive services on credit. The liabilities arising from such purchases are called Accounts payable.

Rule of Debit and Credit for Assets and Liabilities

Assets (increase in assets is debit and decrease in asset is credit)
Liabilities (Increase in liability is credit and decrease in liability is debit)

Classification of Assets:

There are two types of assets:

  1. Tangible Assets which have physical existence and can be seen or touched. It includes Fixed as well as Current assets.
  2. Intangible assets which have no physical existence like goodwill, patents and copyrights etc.
  • Fixed Assets – Are the assets of permanent nature that a business acquires, such as plant, machinery, building, furniture, vehicles etc. Fixed assets are subject to depreciation.
  • Long Term Assets –These are the assets of the business that are receivable after twelve months of the balance sheet date. For example, if business has invested some money for two years in any saving scheme or has purchased saving certificates for more than one year, it is a long term asset.
  • 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.

The year, in which long term asset is expected to be received, long term asset is transferred to current assets in that year.

Classification of Liabilities

Capital – is the funds invested by the owners of the business. Business has a liability to return these funds to the owner. We know that for the purpose of accounting, business is treated separately from its owners. This is known as Separate Entity Concept i.e. Business is a separate entity. Therefore, if the owner gives something (can be in form of Cash or Some other Asset) to the business then the business, not only has to return the amount to the owner but it also has to give some return on that money. That is why we treat Capital (Owners Funds) as a Liability.

Profit & Loss Account – The net balance of the profit and loss account i.e. either profit or loss also belongs to the owners.
While explaining capital we said that the business has to give return to the owners. Now if the business is managed successfully, then this return would be a Favorable figure (Profit). This return will, therefore, be added to the Owners’ investment.
On the other hand, if the business is not managed successfully then this return would be an un-favorable figure (Loss). It will, therefore, be deducted from the Owners’ Investment.

  • Long Term Liabilities – These are the liabilities that will become payable after a period of more than one year of the balance sheet date. For example, if business has taken a loan from bank or any third person and it is payable after ten years, it will be treated as a long term liability for the business.
  • Current Liabilities – These are the obligations of the business that are payable within twelve months of the balance sheet date. Creditors and all accrued expenses are the examples of current liabilities of the business because business is expected to pay these back within one accounting period.

The year in which long term liability is to be paid back, long term liability is transferred to current liability in that year.

Balance Sheet

It is a position statement that shows the standing of the organization in Monetary Terms at a Specific Time.
Unlike Profit and Loss that shows the performance of the entity over a period of time, the Balance Sheet shows the Financial State of Affairs of the entity at a given date. Balance sheet is the summarized analysis in a ‘T’ form of all assets and liabilities of the entity, with liabilities listed on left hand side and assets on right hand side. Asset is any owned physical object (tangible asset) or a right (intangible asset) having economic value to the owner. Liability is an obligation of the business to deliver goods or to provide a benefit in future.

Format of Balance Sheet (Account Form)

Name of the Entity Balance Sheet As At-------
Liabilities Amount
Rs.
Assets Amount
Rs.
Capital 100,000   Fixes Assets 75,000
Add Net Profit 15,000 115,000 Long Term Assets 20,000
Long Term Liabilities 50,000 Current assets 80,000
Current liabilities 10,000    
Total 175,000 Total 175,000

Format of Balance Sheet (Report Form)

Name of the Entity
Balance Sheet
As At-------
PARTICULARS Amount
Rs.
Amount
Rs.
ASSETS    
Fixes Assets
Long Term Assets
Current Assets
  75,000
20,000
80,000
Total   175,000
LIABILITIES    
Capital
Add: Net Profit
100,000
15,000
115,000
Long Term Liabilities
Current Liabilities
  50,000
10,000
Total   175,000

Illustration # 1

The following is the Trial Balance extracted from the books of Naeem & Sons as on 30/06/2002. Prepare a Profit & Loss account & Balance Sheet for the year ended June 30, 2002.

Particulars Dr. Cr.
Sales   100,000
Purchases 45,000  
purchase return   3,000
Salaries 12,000  
Rent 5,000  
Debtors 25,000  
Creditors   16,000
Capital   368,000
Plant & machinery 400,000  
Grand Total 487,000 487,000

Solution

Naeem & Sons
Profit & Loss Account
For the year ended June 30, 2002
  Rs.   Rs.
    Sales 100,000
Cost of goods sold:      
Purchases 45,000      
Less: Purchase return 3,000 42,000    
Gross Profit 58,000    
  100,000   100,000
Salaries 12,000 Gross Profit 58,000
Rent 5,000    
Net Profit 41,000    
  58,000   58,000

This is a presentation of Profit & Loss Account in ‘T’ account form. Now same illustration is presented in statement form.

Naeem & sons
Profit & Loss Account for the year ended June 30, 2002
Particulars Amount
Rs.
Amount
Rs.
Income / Sales / Revenue   100,000
Less: Cost of Goods Sold    
Purchases 45,000  
Less: Purchase Return (3,000) (42,000)
Gross Profit   58,000
Less: Administrative expenses    
Salaries (12,000)  
Rent (5,000) (17,000)
Net Profit   41,000

This is not a correct way to present Profit & Loss Account in statement form. In actual practice only main heads of expenses are presented in Profit & Loss Account along with foot note number. Detail of that head of expense is given in the note.

Correct presentation of Profit & Loss Account is hereunder:

Naeem & Sons
Profit & Loss Account for the year ended June 30, 2002
Particulars Amount
Rs.
Amount
Rs.
Income / Sales / Revenue   100,000
Less: Cost of Goods Sold
(See Note # 1)
  (42,000)
Gross Profit   58,000
Less: Administrative expenses
(See Note # 2)
  (17,000)
Net Profit   41,000

Note # 1
Cost of goods sold

Purchases 45,000
Less: Purchase Return (3,000)
Net Purchases 42,000
Note # 2
Administrative expenses
Salaries 12,000
Rent 5,000
Total Administrative expenses 17,000

It is recommended that Profit & Loss Account should be prepared in above mentioned format.

Balance Sheet

Naeem & Sons
Balance Sheet As At June 30, 2002
Liabilities   Assets  
Particulars Amount
Rs.
Particulars Amount
Rs.
Capital 368,000 409,000 Fixed Assets  
Net Profit 41,000   Plant & Machinery 400,000
Current Liabilities   Current Assets  
Creditors 16,000 Debtors 25,000
Total 425,000 Total 425,000

Balance Sheet in statement form is presented hereunder:

Naeem & Sons
Balance Sheet As At June 30, 2002
Particulars Amount Rs. Amount Rs.
Assets
Fixed Assets
   
Plant & machinery   400,000
Current Assets    
Debtors   25,000
Total   425,000
Liabilities    
Capital 368,000  
Add: Net Profit 41,000 409,000
Current Liabilities    
Creditors   25,000
Total 425,000 425,000

Illustration # 2

The following Trial Balance has been extracted from the books of Saeed & Co. on 30-06-2002. From this, prepare an Income Statement and Balance Sheet for the year ended 30-06-2002.

Particulars Dr. (Rs.) Cr.(Rs.)
Sales   200,000
Purchases 180,000  
purchase return   2,500
Office salaries 3,500  
Furniture & Fixture 16,000  
Office Equipment 11,000  
Rent 5,000  
Accounts Payable(creditors)   28,000
Sales Salaries 3,000  
Freight & custom duty on purchases 6000  
Repair of office equipment 2,000  
Accounts Receivable(debtors) 52,000  
Freight on sales 1,000  
Capital   41,500
Cash in hand 37,000  
Loan from bank(for three years)   50,000
Bank charges 500  
Interest on loan 5,000  
Total 322,000 322,000

Solution

Saeed & Co.
Profit & Loss Account for the year ended June 30, 2002.
  Rs.   Rs.
    Sales 200,000
Purchases 180,000 Purchase return 2,500
Freight, custom duty on purchases 6,000    
Gross Profit 16,500    
  202,500   202,500
Salaries 3,500 Gross Profit 16,500
Rent 5,000    
Repair of office equipment 2,000    
Sales salaries 3,000    
Freight on sales 1,000    
Interest on loan 5,000    
Interest on loan 5,000    
Bank charges 500    
    Net loss 3,500
Total 20,000   20,000

Profit & Loss Account in statement form:

Profit & Loss Account in statement form: Amount
Rs.
Income / Sales / Revenue 200,000
Less: Cost of Goods Sold
(See Note # 1)
(183,500)
Gross Profit 16,500
Less: Administrative expenses
(See Note # 2)
(10,500)
Less: Selling expenses
(See Note # 3)
(4,000)
Less: Financial Expenses
(See Note # 4)
(5,500)
Net Profit/(Loss) (3,500)

Note # 1
Cost of Goods Sold

Purchases

Less: purchase return

Add: Freight, custom duty on purchases

180,000

(2,500)

6,000

Total

183,500
Note # 2
Administrative expenses
 

Salaries

Rent

Repair of office equipment

3,500

5,000

2,000

Total 10,500
Note # 3
Selling expenses
 

Sales salaries

Freight on sales

3,000

1,000

Total 4,000
Note # 4
Financial expenses
 

Interest on loan

Bank charges

5,000

500

Total 5,500

Balance Sheet

Saeed & co.      
Balance Sheet As At June 30, 2002      
Liabilities   Assets  
Particulars Amount
Rs.
Particulars Amount
Rs.
Capital
41,500 Fixed Assets  
Add: Net Profit (3,500) Furniture & Fixture 16,000
  38,000    
Long Term Liabilities   Current Assets  
Loan from bank 50,000 Debtors 52,000
Current Liabilities   Office equipment 11,000
Creditors 28,000 Cash 37,000
Total 116,000 Total 116,000

Balance Sheet in statement form

Saeed & Co.
Balance Sheet As At June 30, 2002
Particulars Amount Rs. Amount Rs.
Assets
Fixed Assets

   
Furniture & Fixture   16,000
Current Assets    
Debtors   52,000
Office Equipment   11,000
Cash   37,000
Total   116,000
Liabilities    
Capital 41,500  
Profit/(Loss) (3,500) 38,,000
Long Term Liabilities    
Loan from bank   50,000
Current Liabilities    
Creditors   28,000
Total   116,000

 

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