Final Accounts are financial statements prepared at the end of an accounting year to determine the profit or loss of a business and its financial position.
Final Accounts are generally prepared from the Trial Balance and include the Trading Account, Profit & Loss Account, and Balance Sheet.
In simple words, Final Accounts tell us how much profit the business earned and what it owns and owes at the end of the year.
The main objectives of preparing Final Accounts are:
Final Accounts mainly consist of:
It is prepared to calculate Gross Profit or Gross Loss.
It is prepared to calculate Net Profit or Net Loss.
It is prepared to determine the financial position of the business.
Trial Balance → Trading Account → Profit & Loss Account → Balance Sheet
A Trading Account is prepared to determine the Gross Profit or Gross Loss earned from buying and selling goods.
It mainly considers:
Gross Profit = Sales − Cost of Goods Sold
And:
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses − Closing Stock
Direct Expenses are expenses directly related to the purchase, production, or preparation of goods for sale.
Examples include:
These expenses are generally considered while calculating Gross Profit or Gross Loss.
Gross Profit is the excess of sales revenue over the cost of goods sold.
Sales = ₹2,00,000
Cost of Goods Sold = ₹1,50,000
Gross Profit = ₹2,00,000 − ₹1,50,000
Gross Profit = ₹50,000
Gross Profit is transferred to the Profit & Loss Account.
When the cost of goods sold is greater than sales, the business suffers a Gross Loss.
Sales = ₹1,00,000
Cost of Goods Sold = ₹1,20,000
Gross Loss = ₹20,000
Gross Loss is transferred to the Profit & Loss Account.
The Profit & Loss Account is prepared after the Trading Account. Its purpose is to calculate the Net Profit or Net Loss of the business.
It includes:
Net Profit is the amount remaining after deducting all indirect expenses from Gross Profit and adding other incomes.
Net Profit = Gross Profit + Other Incomes − Indirect Expenses
Gross Profit = ₹80,000
Other Income = ₹10,000
Indirect Expenses = ₹30,000
Net Profit = ₹80,000 + ₹10,000 − ₹30,000
Net Profit = ₹60,000
When total expenses and losses are greater than the available income and gross profit, the business has a Net Loss.
For example:
Gross Profit = ₹50,000
Indirect Expenses = ₹70,000
Net Loss = ₹20,000
A Balance Sheet is a statement prepared to determine the financial position of a business on a particular date.
It shows:
Things owned by the business.
Amounts owed by the business to outsiders.
It also includes the owner’s Capital.
Assets = Capital + Liabilities
Assets are economic resources owned or controlled by a business that have value.
Examples include:
Assets may be classified as fixed assets, current assets, tangible assets, and intangible assets depending on their nature.
Liabilities are amounts that a business owes to outsiders.
Examples include:
Liabilities represent obligations that the business may need to settle in the future.
Capital is the amount invested by the owner in the business.
For example, if an owner invests ₹5,00,000 to start a business, ₹5,00,000 is treated as capital.
Profit increases capital, while drawings reduce capital.
Closing Capital = Opening Capital + Net Profit − Drawings
If the business has a net loss, the loss is deducted instead.
At the end of the accounting year, temporary accounts such as Sales, Purchases, Expenses, and Incomes are closed and transferred to the appropriate final accounts.
The purpose of closing entries is to ensure that income and expense accounts are reset for the next accounting period.
Closing Stock is the value of goods remaining unsold at the end of the accounting period.
Closing Stock is generally shown:
If closing stock is ₹40,000, it will be considered while calculating Gross Profit and will also appear as an asset in the Balance Sheet, subject to the applicable accounting treatment.
Adjustments are accounting items that need to be considered before Final Accounts are completed.
Common adjustments include:
Adjustments ensure that income and expenses are recorded in the correct accounting period.
Outstanding Expenses are expenses that have been incurred during the accounting year but have not yet been paid.
For example, salary of ₹10,000 is due but has not been paid by the end of the year.
The expense is included in the Profit & Loss Account, and the outstanding amount is shown as a liability in the Balance Sheet.
Prepaid Expenses are expenses paid in advance for a future accounting period.
For example, if a business pays ₹12,000 for one year’s insurance and ₹2,000 relates to the next accounting period, ₹2,000 is treated as a prepaid expense.
The prepaid amount is deducted from the current year’s expense and shown as an asset.
Final Accounts are important because they provide a complete picture of the business’s financial performance and position.
They help answer three important questions:
1. How much did the business earn?
→ Profit & Loss Account
2. How much gross profit did the business make from trading?
→ Trading Account
3. What does the business own and owe?
→ Balance Sheet
Remember:
Transactions → Journal → Ledger → Trial Balance → Trading Account → Profit & Loss Account → Balance Sheet
Leave a Reply