Financial Statements I Class 11 Notes

A stakeholder is any person or group with an interest in the business. The preparation of financial statements exists to answer their questions, and the balance sheet and the profit and loss account are designed so that each group reads the part it needs.

• Owners or proprietors: whether the business is profitable, whether it can grow, and the value of their investment.
• Creditors and lenders: whether the business can repay what it owes, and whether its assets are sufficient to cover the debts.
• Employees: whether the business is stable enough to keep their jobs.
• Government: the tax due, the compliance position and the basis for national income accounting.
• Investors and prospective investors: the growth, the earnings and the safety of the investment.

The distinction decides where every item in the trial balance is placed in the final statements, so it is the foundation of the chapter. Capital items appear in the balance sheet; revenue items appear in the profit and loss account.

• Capital receipts: those that do not affect the trading and profit and loss account because they are not revenue. Raising a bank loan, introducing capital by the owner, and the sale of a fixed asset on credit.
• Revenue receipts: those that increase capital and arise from the operations of the business. Sales of goods, the rendering of services, and interest received on a loan given.
• Capital expenditure: payments to acquire long-term assets. Purchase of machinery, land and buildings, and payment of a preliminary expense such as a share issue charge.
• Revenue expenditure: payments for goods and services consumed in the current period. Purchases of trading goods, rent, salaries, repairs, insurance, advertising and office stationery.
• Deferred revenue expenditure: a payment that gives a benefit over several years, such as a trial run or advertising in advance, written off over the periods that benefit starting with the current year.

The trading account is prepared for a business that deals in goods. It matches the cost of the goods sold against the revenue earned from those goods, and its result, the gross profit, says whether the goods themselves were profitable before any expense of running the business is considered.

• Credit side: sales, plus any other operating revenue such as commission received, and closing stock is shown on the credit side.
• Debit side: opening stock, plus net purchases, plus direct expenses of bringing goods in, less closing stock.
• Direct expenses: carriage inward, freight, import duty, wages of a delivery staff and packing, and manufacturing expenses where applicable. Indirect expenses such as office salaries and advertising belong to the profit and loss account, not here.
• The result on the credit side is the gross profit, which is carried down to the profit and loss account.

The profit and loss account is an account in the form of a trading account. It opens with the gross profit brought down, deducts all operating expenses, and shows the resulting profit. Three intermediate figures carry names, and CBSE asks for them by name.

• Expenses deducted in the profit and loss account: office and administration expenses, selling expenses, rent, salaries, insurance, depreciation, repairs, bad debts and the provision for doubtful debts.
• Interest on loan and on capital is deducted after computing the operating profit, so that operating profit reflects the performance of the business itself.
• Income tax is a provision and is deducted after operating profit, never as an operating expense.
• Non-operating incomes such as rent received, dividend received, interest received and commission received are added after operating profit, and profit on the sale of a fixed asset appears as a gain, not as revenue.
• Non-operating expenses such as bad debts recovered and loss on the sale of a fixed asset are deducted after operating profit.

The balance sheet is a statement of financial position at a particular date. It shows what the business owns, what it owes and what remains for the owner. It is called a balance sheet because the two sides always agree, and it is a position statement rather than a performance statement.

• The left-hand side is the equity and liability side, and the right-hand side is the asset side, following the order A = L + C rearranged.
• Equity and liability side: capital, plus reserves, plus long-term loans and other non-current liabilities, plus current liabilities such as creditors, bills payable, outstanding expenses, accrued income and income received in advance.
• Asset side: fixed assets, with depreciation deducted, then current assets such as cash, debtors net of provisions, stock, prepaid expenses and accrued income.
• Marshalling is placing the two sides in a definite order. Items already in the trial balance order go first, and the balance of each side is placed in a total, and then below it the total of that side.
• A balance sheet is not an account and is not balanced by a balancing figure. Capital is the balancing figure, found as the difference between total assets and total liabilities, and it is then agreed to the closing capital in the profit and loss appropriation account.

The opening entry is the journal entry recorded in the books at the beginning of a new accounting year so that the ledger opens with the closing balances of the previous year. It opens the asset accounts with debit balances, the liability and capital accounts with credit balances, and carries forward the accumulated depreciation as a deduction.

• Asset accounts are debited, except bank, which is credited when it is an overdraft.
• Liability accounts are credited for their balances.
• Capital is credited with the closing capital.
• The accumulated depreciation account is credited so that it shows as a deduction from the assets.
• The entry is made from the trial balance at the end of the previous year, and the profit and loss appropriation account is closed against capital.