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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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