NAME: Rajaramalingeshwaran M

REG NO: EA2452001012017

Subject: Financial Accounting

Week: Week 2

Type: LAQ

Question: "Preparation of Final Accounts is the culmination of the accounting process” – Explain.

Answer: The preparation of final accounts involves recording various financial transactions, including sales,
purchases, expenses, incomes, assets, and liabilities. It is essential for businesses to have accurate and
reliable final accounts as they provide valuable insights into the company’s financial health and aid in decision-
making for management, investors, creditors, and other stakeholders.

Trading Account: The Trading Account is the first part of the final accounts and is particularly concerned with
the core trading activities of a business. It helps in determining the gross profit or gross loss generated from
the purchase and sale of goods. The Trading Account is crucial for understanding the efficiency and profitability
of a company’s trading operations.

Preparation of Trading Account:

Preparation of Trading Account: To prepare the Trading Account, one needs to follow these steps:

Opening Stock: This is the value of goods held in the beginning of the accounting period, which were not sold
at the end of the previous accounting period.

Purchases: It includes the total cost of goods acquired for resale during the accounting period.

Direct Expenses: These are the expenses directly related to the production or procurement of goods for
resale, such as raw materials, manufacturing costs, direct labor, etc.

By adding up the Opening Stock and Purchases and deducting the Direct Expenses, we arrive at the cost of
goods sold (COGS).

Items appear on the debit side of Trading Account: The debit side of the Trading Account includes the
Opening Stock, Purchases, and Direct Expenses. These items represent the cost of goods sold or consumed
during the accounting period.

Items appearing on the credit side of Trading Account: The credit side of the Trading Account includes the
Closing Stock and Sales. The Closing Stock represents the value of unsold goods at the end of the accounting
period, while Sales represent the total value of goods sold during the same period.

The difference between the total of the credit side and the total of the debit side of the Trading Account
provides the Gross Profit or Gross Loss of the business.

Profit and Loss Account:

The Profit and Loss Account, also known as the Income Statement, is the second part of the final accounts. It
presents a comprehensive view of all revenues, gains, expenses, and losses incurred by the business during
the accounting period.

Preparation of Profit and Loss Account: To prepare the Profit and Loss Account, follow these steps:
Gross Profit or Gross Loss: This figure is transferred from the Trading Account.

Other Incomes: Include all non-operating incomes earned by the business during the accounting period, such
as interest received, rent received, commission earned, etc.

Other Expenses: Include all non-operating expenses incurred by the business, such as administrative
expenses, selling expenses, interest paid, etc.

By adding up the Gross Profit (or deducting Gross Loss) and Other Incomes and then subtracting Other
Expenses, we arrive at the Net Profit or Net Loss of the business.

Items appearing on the debit side of Profit and Loss Account: The debit side of the Profit and Loss
Account includes Indirect Expenses, which are all the expenses incurred by the business in running its
operations other than those directly related to the production or procurement of goods.

Items appearing on the credit side of Profit and Loss Account: The credit side of the Profit and Loss
Account includes Indirect Incomes and Profits. Indirect Incomes are the revenues earned by the business that
are not related to the core trading activities, while Profits represent any gains made by the company during the
accounting period.

Balance Sheet:

The Balance Sheet is the final part of the final accounts. It is a statement that presents a snapshot of a
company’s financial position at a particular point in time. The Balance Sheet follows the accounting equation:
Assets = Liabilities + Owner's Equity.

Classification of Assets: Assets are classified into two main categories:

Current Assets: These are short-term assets that are expected to be converted into cash or used up within
one accounting cycle (usually one year). Examples include cash, accounts receivable, inventory, prepaid
expenses, and short-term investments.

Fixed Assets: Also known as non-current assets, these are long-term assets that have a useful life of more
than one accounting cycle and are not intended for resale. Examples include property, plant, equipment,
intangible assets, and long-term investments.

Classification of Liabilities: Liabilities are classified into two categories:

Current Liabilities: These are short-term obligations that the company expects to settle within one accounting
cycle (usually one year). Examples include accounts payable, short-term loans, accrued expenses, and current
portions of long-term debts.

Long-term Liabilities: Also known as non-current liabilities, these are long-term debts and obligations that are
due for payment over an extended period (more than one accounting cycle). Examples include long-term
loans, bonds payable, deferred tax liabilities, and other long-term obligations.

The Balance Sheet provides a clear picture of a company's financial position by showcasing the total value of
its assets and how they are financed, either through liabilities (debts) or owner's equity (investments and
retained earnings).

Final Accounts – Adjustments

Adjustments in final accounts refer to the modifications made to the financial statements of a business entity at
the end of an accounting period. These adjustments are necessary to ensure that the financial statements
accurately represent the true financial position and performance of the company for that specific period. The
primary objective of making these adjustments is to adhere to the accrual accounting concept, where revenues
and expenses are recognized in the accounting period to which they relate, irrespective of the actual cash
inflows or outflows.

The adjustments in final accounts can be broadly categorized into two types: those related to revenue and
expense recognition and those concerning the valuation of assets and liabilities. These adjustments are
typically made in the context of the Trading Account, Profit and Loss Account, and Balance Sheet.

Revenue and Expense Recognition Adjustments:

Outstanding Expenses: These are expenses that have been incurred during the accounting period but have
not been paid by the end of the period. To ensure accurate financial reporting, such expenses are included in
the Profit and Loss Account as liabilities and are also shown in the Balance Sheet.

Prepaid Expenses: Prepaid expenses are expenses that have been paid in advance but relate to the
subsequent accounting period. To avoid overstating expenses, the prepaid portion is deducted from the
respective expense accounts in the Profit and Loss Account and shown as an asset in the Balance Sheet.

Accrued Income: Accrued income represents income that has been earned but not yet received. To match the
revenue with the accounting period in which it is earned, accrued income is added to the relevant income
accounts in the Profit and Loss Account and shown as an asset in the Balance Sheet.

Income Received in Advance: Income received in advance refers to receipts for which goods or services are
yet to be delivered. To align revenue with the period of goods or services delivery, the advance received is
deducted from the respective income accounts in the Profit and Loss Account and shown as a liability in the
Balance Sheet.

Valuation Adjustments for Assets and Liabilities:

Closing Stock: Closing stock refers to the value of unsold goods at the end of the accounting period. To
include the value of closing stock in the final accounts, it is added to the credit side of the Trading Account as a
deduction from the cost of goods sold, and also shown as an asset on the asset side of the Balance Sheet.

Depreciation of Assets: Depreciation is the systematic allocation of the cost of tangible fixed assets over their
useful life. To account for the wear and tear of assets, depreciation is deducted from the respective asset
accounts in the Profit and Loss Account and shown as a reduction in the asset's value in the Balance Sheet.

Bad Debts: Bad debts are the debts that are considered irrecoverable. To account for potential losses,
provision for bad debts is created in the Profit and Loss Account, which reduces the value of accounts
receivable in the Balance Sheet.

Provision for Discount on Debtors and Creditors: Provision for discount on debtors and creditors is made
to account for potential discounts offered or received on outstanding dues. It is shown as a deduction from the
respective debtors or creditors in the Balance Sheet.