Financial Statements refer to such statements which report the profitability and the financial position of the business at the end of the accounting period. The term financial statements include at least two basic statements which are as under :
- Income statement ( or Trading and Profit and Loss Account ) which shows results of business operations during an accounting period.
- Statement of Financial Position ( or Balance Sheet ) which shows financial position of an enterprise at a specified point of time.
Income Statement
- The first part is called ‘Trading Account’. It show the gross profit or gross loss.
2. The second part is called ‘Profit and Loss Account’. It shows the net profit or net loss.
Trading Account
A trading account is prepared for calculating the gross profit or gross loss arising or incurred as a result of the trading activities of a business. In other words, it is prepared to show the result of manufacturing, buying, and selling of goods.
If the amount of sales exceeds the number of purchases and the expenses directly connected with such purchases, the difference is termed as gross profit.
On the contrary, if the Purchase and direct expenses exceed the sales, the difference is called gross loss.
A trading account records the number of purchases of goods and also the expenses which are incurred in bringing that commodity to a saleable state.
In other words, all expenses which relate to either purchase of raw material or the manufacturing of goods are recorded in the Trading account. All such expenses are called ‘ Direct expenses ‘.
Need and Importance of Trading Account
1. It provides information about Gross Profit and Gross Loss: It informs of the gross profit or gross loss as a result of buying and selling the goods during the year.
The percentage of the current year’s gross profit on the number of sales can be calculated and compared with those of the previous years. Thus, it provides data for comparison, analysis, and planning for a future period.
2. It provides information about the direct expenses: All the expenses incurred on the Purchase and manufacturing of goods are recorded in the trading account in a summarised form. Percentage of such expenses on sales can be calculated and compared with those of the previous years.
3. Comparison of closing stock with those of the previous years: The closing stock has to be valued and recorded in a trading account. This stock can be compared with the closing stock of the previous years and if the stock shows an increasing trend, the reasons may be inquired into.
4. It provides safety against possible losses: If the ratio of gross profit has decreased in comparison to the preceding year, the businessman can take effective measures to safeguard himself against future losses.
Format of a Trading Account
Trading A/C
for the year ending……………………..
Dr. Cr.
| Particulars | Amount | Particulars | Amount |
| To Opening Stock To Purchases Less: Purchase Returns To Wages To Wage and Salaries To Direct Expenses To Carriage To Carriage in To wards Carriage on Purchase To Gas, Fuel, and Power To Freight and cartage Manufacturing Expenses To Factory Expenses: Factory Lighting Factory Rent, etc. To Dock charges To Import Duty To Royalty To Gross Profit Transferred to P & L A/C (Balancing Figure) | ₹ | By Sales Less: Sales Returns By Closing Stock By Gross loss (if any) transferred to Profit and loss A/C ( Balancing figure) | ₹ |
Profit and Loss Account
The trading account only discloses the gross profit and as a result of buying and selling of goods. However, a businessman has to incur a number of expenses that are not taken into the trading account.
Hence, a businessman is more interested in knowing the net profit earned on the net loss incurred during the year.
As such, a Profit and loss account is prepared which contains all the items of losses and gains pertaining to the accounting period.
Need and Importance of Profit & Loss A/C
1. To ascertain the Net Profit or Net Loss: A Trading account only discloses the Gross profit earned as a result of trading activities, whereas the Profit and loss account discloses the net profit on net loss available to the proprietor and credited to his capital account.
2. Comparison with previous year’s profits: The net profit of the current year can be compared with that of the previous years. It enables the businessman to know whether the business is being conducted efficiently or not.
3. Control on Expenses: Profit and loss accounts help in comparing various expenses with the expenses of the previous year. Also, the percentage of each individual expense to net profit is calculated and compared with the similar ratio of previous years. such comparison will be helpful in taking concrete steps for controlling unnecessary expenses.
4. Helpful in the preparation of Balance Sheet: A Balance Sheet can only be prepared after ascertaining the Net profit through the preparation of profit and loss account.
Format of Profit and Loss Account
Profit and Loss A/C
for the year ending…………………….
Dr. Cr.
| Particulars | Amount | Particulars | Amount |
| To Gross Loss b/d(Transferred from Trading A/C To Salaries To Salaries and wages To Rent, Rates & Taxes To Printing and Stationery To PostageTo Lighting To Insurance Premium To Telephone Charges To Legal Charges To Audit Fees To Travelling Expenses To Establishment Expenses To Trade Expenses To General Expenses To Carriage Outwards To Advertisement To Commission To Brokerage To Bad-debts To Export duty To Packing charges To Discount Allowed To Repairs To Depreciation To Interest (Dr.) To Bank Charges To Entertainment Expenses To Donation and Charity To Loss on Sale of Assets To Net ProfitTransferred to Capital A/C | ₹ | By Gross Profit b/d(Transferred from Trading A/C) By Rent from TenantBy Rent (Cr.) By Discount received By Commission received By Interest on Investment By Dividend on Shares By Bad-Debts Recovered By Profit on Sale of Assets By Income from other Sources By Miscellaneous Income By Net Loss (if any)Transferred to Capital A/C | ₹ |