Unit – 7: Financial Statements
Q.1. What is financial statements? Mention its types. Who are the users of financial statements?
Ans: Meaning: The financial statement provide a summary of the accounts of a business enterprise. Financial statement include two statements include two statements:
a) Trading and Profit and Loss Account‟ or Income Statement‟ (To Know Profit or loss)
b) Balance Sheet (To know value of assets and liabilities on the closing date of an accounting period)
Users of Accounting Information:
Internal Users: Management, Employees, Current owners.
External Users: Potential Investors Government, Banks/Lenders, Stock Exchange, Suppliers and Trade Creditors, Public.
Q.2. What is operating profit, Gross profit and net profit? 2010
Ans: Operating Profit: Operating profit is that profit which is earned through the normal activities of the business. It can be ascertained by deducting all operating expenses from the gross profit.
Gross Profit: It is the excess of net sales over cost of goods sold. It is the profit added by the owner to sale the goods to the customers. Excess of cost of goods sold over net sales is called gross loss.
Net Profit: Net profit is that profit which is earned after deducting all operating as well as non operating expenses from the Gross Profit.
Q.3. What is balance sheet? Give five characteristics and objectives of balance sheet. 2006
Ans: Balance sheet is one of the financial statements prepared by the company to show the financial position of company at a particular time. Balance sheet is prepared to ascertain the position of assets and liabilities of the company at a particular date.
The Balance Sheet of a business possesses the following characteristics:
a) Balance sheet being a statement has no ‘debit’ or ‘credit’ sides that is why ‘To’ or ‘By’ words are not prefixed to the name of accounts.
b) Balance sheet is prepared at the end of an accounting period – it is for a particular day, so it discloses the financial position on a particular day and not for a particular period.
c) Balance sheet discloses how much business owes to others and how much others owe to business.
d) The total of ‘Assets’ and ‘Liabilities’ sides are always equal.
Objectives of Balance Sheet
a) To determine the nature and value of the assets.
b) To determine the nature and extent of liabilities and actual capital.
c) To know about the solvency of the business
d) To know the financial soundness of the business i.e. Over-trading and under-trading.
Q.4. What do you mean by Grouping and Marshalling of Assets and Liabilities in Balance sheet? 2009
Ans: Grouping means presenting similar items together as one figure i.e. by combining them at one place and presenting as a single item on the face of financial statement.
Marshalling means presenting items in a logical order i.e. assets and liabilities in the statement of financial position are listed in particular order. There are two methods of marshalling:
a) Marshalling by liquidity: According to this method the assets and liabilities are listed in descending order on the basis of liquidity i.e. the asset which is the most liquid will be listed first and the asset which is least liquid will be listed last.
b) Marshalling by permanence: This method is completely opposite to the liquidity method. According to this order of listing, assets and liabilities are listed in descending order on the basis of their permanence i.e. the asset with the longest useful life (least liquid) will be listed first and the asset with the least or shortest (most liquid) useful life will be listed last.
Q.5. What is trading account? Mention various purposes of preparing trading account. 2009, 2015
Ans: Trading account is one of the financial statements prepared by the company to show the result of buying and selling of goods and services during an accounting period. Trading account is prepared to ascertain the gross profit or gross loss.
Objectives or Need for Trading Account: The trading account may be prepared with the following objectives:
1) To ascertain gross profit or gross loss.
2) To know the direct expenses.
3) To make comparison of stock.
4) To fix up selling price of goods.
5) To know the limit of indirect expenses.
Q.6. What is Profit and loss account? Mention its features and objectives. 2009, 2010
Ans: Profit and loss account is one of the financial statements prepared by the company to show the financial performance of company during an accounting period. It is prepared to ascertain net profit or net loss. It is also called income statement.
Features of Profit & Loss Account
1) Profit and Loss Account is nominal account to be prepared at the end of the year.
2) Incomes and expenses relating to current year are to be shown in it.
3) It includes outstanding expenses and accrued incomes relating to current year which are taken into consideration while prepare expenses and incomes received in advance are excluded from it.
4) It includes all expenses paid during the previous year but related to current year and all incomes received during the previous year but related to current year.
Need for Profit & Loss Account
1) Knowledge of net profit or net loss for the year.
2) Comparison of profits over the years.
3) Control over expenses by establishing the relationship of indirect expenses with sales.
4) On the basis of information disclosed by the profit and loss account, the future course of action may be decided by the management.
5) The net profit disclosed by profit and loss account is the basis of determining business income for tax purposes. Thus, profit and loss account helps in tax assessment also.
6) Helpful in the preparation of balance sheet.
Q.7. What do you mean by adjustment entries? Give two examples of adjustment entry. 2010
Ans: Accounting adjustment are those transactions of a company’s business that are recorded at the end of the accounting period. The journal entries for such transactions are passed at the end of the accounting period and are called as adjustment entries. Examples for adjustment entries:
a) Adjustment of closing stock: Closing Stock A/c Dr.
To Trading A/c
b) Adjustment of prepaid expenses: Prepaid Expenses A/c Dr.
To Respective Expenses Account
c) Adjustment of outstanding expenses: Respective Expenses A/c Dr.
To Outstanding Expenses A/c