Preparation of

Financial Statements
BALANCE SHEET
• A balance sheet shows details about the financial status of a firm at a
particular point in time.

• Balance sheet represents a snapshot of firm's financial position.

• The fundamental relationship between assets, liabilities and owners'

equity on the balance sheet is as follows;

• Owner Equity = Assets – Liabilities.

PREPARATION OF BALANCE
SHEET
• It is commonly prepared at the end of financial year (i.e. fiscal year).

• But it may also be prepared at other time intervals i.e. quarterly,

semiannually within a financial year or calendar year as required by the
firm.
Structure of Balance Sheet as per
Companies Act
Balance Sheet of Company – XXX Ltd as
on 31st March 20X1
Balance Sheet of Company – XXX Ltd as
on 31st March 20X1 – A Detailed Version
LIABILITIES
• Liabilities are the debts due to outsiders. They are the amount
which are to be paid by the business to outsiders

• Example – creditors , bank overdraft , bills payable, etc.

• Liabilities can be classified into two types, viz.,

1. Share Capital
2. Reserves and Surplus
3. Secured Loans
4. Unsecured Loans
5. Current Liabilities & Provisions
Share Capital

• Includes equity capital and preference capital

• Equity Capital –
1. represents contribution of equity shareholders
2. Carries no fixed rate of dividend
• Preference capital –
1. represents contribution of preference shareholders
2. Carries fixed rate of dividend
Reserve and Surplus

• Reserve
1. Capital Reserve
 Includes share premium account, revaluation reserve and capital
redemption reserve.
 Cannot be distributed as dividend to shareholders
2. Revenue Reserve
 Represents accumulated retained earnings from the profit of the business
 Held in accounts like investment allowance reserve, dividend equalization
reserve, taxation reserve
• Surplus
1. Balance in profit and loss account which has not been appropriated to
any particular reserve account
• Reserve + Surplus+ Paid up capital = Owners
equity/Shareholders funds/ Net worth
Loans

• Secured Loans
1. Secured by a charge on assets of the firm
2. Most common form of secured loans are debentures, term loans and
working capital loans

• Unsecured Loans
1. Not secured by a charge on assets of the firm
2. Most common form of unsecured loans are public deposits, commercial
paper, unsecured loan from promoters, unsecured loans from commercial
banks and financial institutions.
Current Liabilities and Provisions

• Represents obligations that are expected to mature within a year

• Current liabilities includes bills payable, sundry creditors, advance payment
• Provisions include taxes, provision for dividends, provision for provision fund
ASSETS

• Assets refers to properties owned by a concern and debts due to a concern

from other parties

• Assets may be divided into two types,

1. Fixed assets
2. Investments
3. Current assets, loans and advances
4. Misc. Expenditure and losses
Fixed Assets

• Fixed assets are assets of permanent nature which are purchased for
long-term use in the business.
• Assets may be tangible or intangible
• Tangible and intangible fixed assets reported in balance sheet to their
net book value
• Example- machinery , motor vehicle , furniture etc
Investments

• Represents financial securities owned by the firm

• Classified as long-term investment and current investments
• Long-term investment comprise of financial securities like equity
shares, preference shares, debenture of other companies
• Current investment represents short term holdings of units or shares
of mutual funds
Current Assets, Loans and advances

• Current assets are those assets, which can be converted into cash easily
• Example- bank balance , bills receivable, debtors etc.
• Major components of current assets, loans and advances
1. Inventories (also called as stocks) – comprises raw materials, work-in-progress,
finished goods
2. Sundry debtors (also called as amounts receivable)- represents amount owned
to the firm by the customers.
3. Cash & Bank Balance
4. Other current assets – represents interest accrued on investment, fixed assets
held for sale
5. Loans and Advances
Misc. Expenditures and Losses

• Misc. expenditure includes preliminary expenses, interest paid out

of capital during construction, development expenditure to the
extent not written off or adjusted
• Losses are debit balance of profit and loss account carried forward
after deduction of uncommitted reserve, if any
Grouping Or Arranging Or Marshalling Of
Assets And Liabilities

• The sequence or the order in which the various assets and liabilities are
arranged in the balance sheet is known as marshalling
• The assets and liabilities are arranged in two ways in the balance sheet
1. In the order of liquidity or realisability
2. In the order of permanence
ASSEST AND LIABILITIES IN ORDER OF
LIQUIDITY
ASSET AND LIABILITIES ARE ARRANGED IN
ORDER OF PERMANENCE
EXAMPLE FOR BALANCE SHEET

• From the following particulars , prepare a Balance Sheet as on 31st

December 2012.
Capital 50,000 sundry debtors 6,000
Drawings 10,000 bills receivable 4,000
Land and buildings 20,000 bills payable 5,000
Machinery 18,000 sundry creditors 8,000
Furniture 5,000 loans (Cr) 10,000
Motor van 12,000 investments 10,000
Cash-in-hand 2,000 net profit 22,000
Bank overdraft 4,000 closing stock 12,000
Balance sheet as on 31st december2012
Profit and Loss Account
 Introduction
24
An account in the books of an organization to which incomes and gains are
credited and losses debited, so as to show the net profit or loss over a given
period.
 A profit and loss account is a summary of business transactions for a given
period - normally 12 months. By deducting total expenditure from total
income, it shows on the bottom line whether your business made a profit or
loss at the end of that period.
A profit and loss account is produced primarily for business purposes – to
show owners, shareholders or potential investors how the business is
performing. But most of the information is also used by the Inland Revenue to
work out your tax bill.
A profit and loss account starts with the TRADING ACCOUNT and then
takes into account all the other expenses associated with the business.
TRADING ACCOUNT
25

The trading account shows the income from sales and the direct costs
of making those sales. It includes the balance of stocks at the start and
end of the year.

This gives a view of the business in terms of sales and viability of

profit

 An example of the trading account of a business would look this:

Trading, profit and loss account for XYZ Ltd for the year
ended 31 March 2015
26

Sales 1200
Cost of sales 300
Other direct cost 100
Gross Profit 800 Trading account
Overheads & expenses 260
Operating Profit 540
Interest Charges 30
Net Profit 510
Taxation 60
Profit After Tax 450
 27
Sales: the amount of money generated by sales

Cost of sales: the cost of making the goods or buying them

Overheads and expenses: Costs not directly involved in the production

process (indirect costs)
e.g.
Cost of premises e.g. rent, insurance, repairs
Office costs e.g. stationery, postage, computer maintenance, staff salaries and
wages
Sales and marketing costs e.g. salaries of salesmen, advertising
Finance costs e.g. bank charges
Usefulness of Income Statement
28

Income statements should help investors and creditors to determine

the past financial performance of the enterprise, predict future
performance, and assess the capability of generating future cash flows
through report of the income and expenses.
Profit and Loss account Measuring
profit 29
Income

Expenses

Net Profit

Dividends

Retained
Increase in assets
profit
Measuring Loss
30
Income

Costs

Net Loss

Dividends

Retained
Decrease in assets
loss
 Yearly Profit and Loss
31
By law, if your business is a limited company or a partnership whose
members are limited companies, you must produce a profit and loss account
for each financial year

Self employed sole traders and most partnerships don’t need to create a
formal profit and loss account - the information they complete on the self
assessment tax return form amounts to the same thing

However, there are key benefits to producing formal accounts. If you are
looking to grow your business, or need a loan or mortgage, for example, most
institutions will ask to see three years’ accounts
Limitations of Income Statement
32

Items that might be relevant but cannot be reliably measured are not
reported (e.g., brand recognition and loyalty)

Some numbers depend on judgments and estimates

(e.g., depreciation expense depends on estimated useful life and salvage
value).
 The Basic Records You Will Need To
Keep Are: 33
a list of all your sales and other income
a list of all your expenditure, including day-to-day expenses and
equipment
a separate list for petty cash expenditure if relevant
a record of money taken out for personal use or paid in from personal
funds
back-up documents for all of the above
 Financial Ratios (Profitability)
34

Monitoring direct costs

Gross profit margin = Gross profit / sales
Cost of materials (%) = materials costs / sales
Cost of labour (%) = labour costs / sales

Monitoring overhead costs

Net profit margin = Net profit / sales
Overhead cost (%) = Overhead costs / sales