What are Financial Statements?
For a sole proprietorship, the financial statements have two basic parts:
- Trading and Profit & Loss Account — shows the result (profit or loss) of operations over the period
- Balance Sheet — shows the financial position (what is owned, what is owed) on the last day of the period
The Trading Account
The Trading Account is prepared to find the gross profit or gross loss from buying and selling activities.
Format
| Trading Account for the year ended 31 March 20XX | |||
|---|---|---|---|
| Particulars (Dr.) | Amount | Particulars (Cr.) | Amount |
| To Opening Stock To Purchases Less: Returns Outward To Wages To Carriage Inwards To Freight Inwards To Gross Profit c/d | XXX XXX (XXX) XXX XXX XXX XXX | By Sales Less: Returns Inward By Closing Stock By Gross Loss c/d (if applicable) | XXX (XXX) XXX XXX |
| XXX | XXX | ||
Direct expenses
All expenses relating to purchase of raw material or manufacturing of goods appear in the Trading Account. These are called direct expenses:
- Carriage / freight inwards
- Manufacturing wages
- Power and fuel
- Factory lighting
- Factory rent and rates
- Royalties
- Consumable stores
Cost of Goods Sold
Two equivalent ways to compute COGS:
COGS = Opening Stock + Net Purchases + Direct Expenses − Closing StockCOGS = Sales − Gross Profit
Cost of Goods Sold = ₹1,00,000
Gross Profit = 20% on Sales
If GP is 20% of sales, then COGS is 80% of sales.
Sales = ₹1,00,000 × (100/80) = ₹1,25,000
Gross Profit = ₹1,25,000 − ₹1,00,000 = ₹25,000
The Profit & Loss Account
The Trading Account stops at gross profit. But the business also has distribution, office, selling, administrative and finance expenses — these are recorded in the Profit & Loss Account to arrive at net profit.
| Profit & Loss Account for the year ended 31 March 20XX | |||
|---|---|---|---|
| Particulars (Dr.) | Amount | Particulars (Cr.) | Amount |
| To Gross Loss b/d To Salaries To Rent, Rates & Taxes To Printing & Stationery To Lighting To Travelling Expenses To Insurance To Establishment Expenses To Legal Charges To Audit Fees To Telephone Charges To Postage & Telegram To Advertisement To Bad Debts To Depreciation To Bank Charges To Loss on Sale of Assets To Net Profit (transferred to Capital A/c) | XXX | By Gross Profit b/d By Rent from Tenant By Discount Received By Dividend on Shares By Interest on Investments By Commission Received By Bad Debts Recovered By Misc. Receipts By Profit on Sale of Assets By Net Loss (transferred to Capital A/c) | XXX |
The bottom-line figure (net profit or net loss) is transferred to the Capital Account on the Balance Sheet — which is why profits ultimately increase capital and losses reduce it.
The Balance Sheet
The Balance Sheet contains balances of all real and personal accounts left open after nominal accounts have been transferred to the Trading and P&L. Its name comes from the fact that the two sides must always balance — a direct consequence of double-entry book-keeping and the accounting equation.
Marshalling of Assets & Liabilities
The order in which assets and liabilities appear is called marshalling. Two methods:
1. Permanency Preference Method
The most permanent items appear first.
| Liabilities | Assets |
|---|---|
| Fixed Liabilities: Capital Reserves Long-term Loans Current Liabilities: Sundry Creditors Bills Payable Bank Overdraft Outstanding Expenses |
Fixed Assets: Goodwill Patents Land Building Plant & Machinery Furniture & Fixtures Current Assets: Investment Stock Sundry Debtors Bills Receivable Prepaid Expenses Liquid Assets: Cash at Bank Cash in Hand |
2. Liquidity Preference Method
The most liquid items appear first — reverse of the above. Current liabilities at the top of the liabilities side, cash at the top of the assets side.
Classification of Assets & Liabilities
Classification of Assets
- Non-current (Fixed) Assets — acquired for continuous use, last many years. Furniture, motor vehicles, buildings.
- Current Assets — already in cash form or convertible to cash within one year. Accrued income, closing stock, debtors, bills receivable.
Classification of Liabilities
- Non-current / Long-term Liabilities — payable after one year. Debentures, public deposits, long-term bank loans.
- Current / Short-term Liabilities — payable within one year. Bank overdraft, bills payable, sundry creditors, outstanding expenses.
Contingent Liabilities
A contingent liability is one that will become payable only if a specific event happens — otherwise not. Examples:
- Liability on a bill discounted (becomes real only if the acceptor dishonours)
- Liability for a court case currently pending
- Liability under a guarantee given for another person
iAccounting generates the Trading Account, Profit & Loss Account and Balance Sheet automatically — with one click for any date range, any company. Drill into any line to see the underlying ledger and the original voucher. Toggle between Permanency and Liquidity formats. Export to PDF or Excel.
See reports →🎓 You've reached the end of the tutorial series. You now have the complete picture — from identifying a single transaction all the way through to producing professional financial statements. The next step is to put it to work in your own business.
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