CruxFinancial Accounting

Financial statements present the year's accounting data in a form people can use. For a sole trader there are two:

• the income statement, which is the Trading Account and the Profit and Loss Account (it finds the profit of the period); and
• the position statement, the Balance Sheet (it shows assets, liabilities and capital on the last day of the period).

Together they are called the final accounts. They are prepared at the end of the accounting period, usually a year, once the trial balance agrees. The law prescribes a format only for companies, so a sole trader uses the customary two-sided (T-form) layout shown in this topic. A manufacturer adds a Manufacturing Account before the Trading Account.

Work every sum in this order:

1. Check that the trial balance totals agree.
2. Read each adjustment and write down the two places it goes (a short working note for each).
3. If the business makes goods, prepare the Manufacturing Account to find the cost of production.
4. Prepare the Trading Account to find the gross profit (or gross loss).
5. Prepare the Profit and Loss Account to find the net profit (or net loss) and transfer it to capital.
6. Prepare the Balance Sheet and check that both sides agree.

Where each trial balance item goes:

Limitations. Final accounts are useful but not exact. The split of revenue and costs between years rests on judgement (useful lives, the stock method, provisions). Rupee figures look precise, yet assets are not shown at what they would fetch. Amounts recorded at old prices are added to amounts at today's prices, so inflation distorts them. Things that cannot be measured in money, such as the skill of the staff or the firm's reputation, are left out altogether.

The closing entries that transfer the nominal accounts to the Trading and Profit and Loss Accounts are in C16; the line between capital and revenue items is in C02.

A business that makes the goods it sells prepares its income statement in three parts:

1. a Manufacturing Account, which finds the cost of production (the cost of the finished goods made in the year);
2. a Trading Account, which uses that cost of production in place of purchases; and
3. a Profit and Loss Account.

The Trading Account of a manufacturer then reads: opening stock of finished goods, plus cost of production, against sales and the closing stock of finished goods. The closing stock in the Balance Sheet has several parts: raw materials, work-in-progress, finished goods, and stores such as unused packing material (all valued under AS 2, C06).

Shared expenses. Rent, lighting or insurance that serve both the factory and the office are split in the ratio the question gives. Adjust each for outstanding or prepaid amounts first, then split it. The factory share goes to the Manufacturing Account and the office share to the Profit and Loss Account.

Trading Account. It compares the sales of the year with the cost of the goods sold. That cost includes every expense needed to bring the goods to a saleable state: purchase price, carriage and freight on purchases, import duty, wages, power and fuel. The difference is gross profit; if the cost is larger, it is a gross loss.

Points on the Trading Account:

• Sales and purchases mean goods bought for resale only. A machine or furniture bought is an asset, not a purchase.
• Goods sent on approval and not yet approved, or held on consignment for someone else, are not sales or purchases of the business (sub-topic 7).
• Sales and purchases are taken net of GST (sub-topic 8).
• Closing stock is valued at cost or net realisable value, whichever is lower (C06).

Profit and Loss Account. It starts with the gross profit and takes every other expense, loss and income of the year. The expenses fall into groups: office and administration (salaries, rent, printing, postage), selling and distribution (advertisement, carriage outwards, salesmen's commission, bad debts), financial (interest on loans, bank charges, discount allowed) and other losses (depreciation, loss by fire, loss on sale of an asset). The balance is net profit, transferred to the capital account (Profit and Loss A/c Dr, to Capital A/c). A net loss is transferred the other way.

The Balance Sheet is a statement, not an account. It lists the balances still open after the nominal accounts have been closed to the Trading and Profit and Loss Accounts: what the business owns (assets), what it owes to outsiders (liabilities), and what it owes to the owner (capital). Customarily, capital and liabilities sit on the left and assets on the right.

Grouping. Put like items together under headings:

Whether an asset is fixed or current depends on the business. A van is a fixed asset to a shop that uses it, and stock to a dealer in vans.

Marshalling is the order in which the groups are set out. Two orders are used:

1. Order of permanence: fixed assets first, then current assets; on the other side, capital and long-term liabilities first, then current liabilities.
2. Order of liquidity: the reverse, starting with cash on the assets side and current liabilities on the other.

The liabilities side follows whatever order the assets side uses.

Adjustments bring into the accounts everything that belongs to the year and take out what does not (the accrual and matching ideas, C01). Each one is a journal entry, and each entry touches two places.

Common cases in DU questions:

• Loan with a rate but no interest in the trial balance. Work out the interest for the time the loan ran in the year. On a loan given, the unreceived part is accrued income; on a loan taken, the unpaid part is an outstanding expense. Interest already paid or received counts towards the year's figure.
• Expense for a stated number of months. If rent paid covers 11 months, the year's rent is the amount ÷ 11 × 12, and the gap is outstanding. If rent received covers 13 months, the year's income is the amount ÷ 13 × 12, and the extra is received in advance.
• Asset bought during the year. Depreciation runs from the date of purchase (six months for an asset bought half-way through the year) unless the question says to charge a full year.
• Capital expenditure charged to an expense account. Wages for erecting a machine, or a shed built and charged to general expenses, are taken out of the expense, added to the asset and depreciated from the date of use (C02).
• Unrecorded purchase or sale. A credit purchase left out of the books: add it to purchases and creditors. If the goods are already counted in closing stock, the stock figure does not change. A credit sale left out, with the goods dispatched: add it to sales and debtors; the goods are not in stock.
• The owner's personal payments. Income tax of a sole trader and premium on the owner's life policy are personal expenses. Treat them as drawings, not business expenses.
• Writing off part of goodwill or another intangible asset. The amount written off is debited to the Profit and Loss Account and the asset is shown at the reduced figure.
• Discount received after the books were closed, relating to the year. Add it to discount received (credit of Profit and Loss) and deduct it from creditors.

A bad debt is an amount a customer will never pay; it is a loss, written off (Bad Debts A/c Dr, to Debtor's A/c). A doubtful debt may or may not be paid, so a provision for doubtful debts (also called a reserve for bad debts) is kept against debtors by a charge to the Profit and Loss Account. A provision for discount on debtors sets aside the cash discount that good customers are expected to take when they pay.

Work them in this order:

1. Take the debtors in the trial balance and deduct everything that reduces them: further bad debts, a sale on approval reversed (sub-topic 7), a set-off with a creditor, and any further discount allowed that relates to the year.
2. Work the new provision for doubtful debts at the given rate on these debtors.
3. Work the provision for discount at its rate on debtors less the new provision for doubtful debts. No discount is given on a debt that may not be paid.

If the figure is negative, the old provision was more than needed. The excess is written back: it is credited to the Profit and Loss Account. Likewise the charge for discount is the new provision for discount less any old one.

In the Balance Sheet, debtors are shown after deducting further bad debts, then less the new provision for doubtful debts, then less the provision for discount.

Reserve "to" or "by" a figure. "Raise the reserve to ₹X" makes ₹X the new balance. "Increase the reserve by ₹X" adds ₹X to the old balance. Where the paper says "increased to the extent of ₹X", it is read as raising the balance to ₹X.

A debtor who is also a creditor. When the same person is in both the debtors and the creditors, set off the smaller amount: deduct it from both debtors and creditors, before the provisions are worked. Where the trial balance carries no creditors account to set the amount against, the balances are left as they stand.

Provision for discount on creditors. Some firms also provide for the discount they expect to receive: Provision for Discount on Creditors A/c Dr, to Profit and Loss A/c. It is deducted from creditors in the Balance Sheet. Apply it only when the question asks.

Goods sent on approval (sale or return). The customer may keep or return the goods, so there is no sale until the customer accepts them, acts in a way that adopts the deal, or allows the time for rejecting them to run out (a reasonable time, if none was fixed). This is the AS 9 illustration on sales on approval (C07). If such goods were recorded as a sale and no approval has come by the year end:

1. Reverse the sale at the sale price: Sales A/c Dr, to Debtors A/c.
2. Add the goods to closing stock at cost (or net realisable value, if lower): Stock A/c Dr, to Trading A/c.

If they were never recorded as a sale, only step 2 is needed. Cost is found from the sale price and the margin: with a profit of 25% on cost, cost = sale price × 100 ÷ 125.

Free samples. Goods given away to promote sales are an advertisement expense, not a sale: Advertisement A/c Dr, to Purchases A/c, at cost. If input tax credit was taken on them, it is reversed, because credit is blocked on goods given as free samples (CGST Act, s. 17(5)(h)). The reversed tax is added to the advertisement expense.

Goods withdrawn by the owner. Drawings A/c Dr, to Purchases A/c, at cost. Any input tax credit taken on them is reversed and added to drawings, since credit is blocked on goods for personal use (s. 17(5)(g)); the entry is in C16.

Loss of stock by fire (an abnormal loss).

1. Take the cost of the goods lost out of the Trading Account: Loss by Fire A/c Dr, to Purchases A/c (or to Trading A/c).
2. Any input tax credit taken on them is reversed (s. 17(5)(h)) and added to the loss.
3. Record the claim the insurer has admitted: Insurance Claim A/c Dr, to Loss by Fire A/c. Until paid, the claim is a current asset.
4. Charge the part not recovered to the Profit and Loss Account.

If the goods were fully insured and the full claim is admitted, there is no loss to charge, and the claim can be credited straight to the Trading Account.

Manager's commission. It is an expense of the Profit and Loss Account; if unpaid at the year end, it is an outstanding liability. Read the wording with care:

The GST law (taxes, input and output accounts, the order of set-off, blocked credit) is in C16. Here is how it shows in final accounts.

What GST does not touch. A registered trader collects GST for the government and claims credit for GST paid. So purchases, sales and expenses enter the Trading and Profit and Loss Accounts net of GST. GST becomes a cost only where credit is blocked and reversed; the reversed tax is then added to the item it relates to (drawings, advertisement for free samples, loss by fire).

In the trial balance. Each tax has two balances: Input CGST, Input SGST and Input IGST on the debit side (credit available), and Output CGST, Output SGST and Output IGST on the credit side (tax charged on sales).

Adjustments that carry GST.

• Unrecorded credit purchase: Purchases + the price; Input tax + the GST; Creditors + the total.
• Unrecorded credit sale: Debtors + the total; Sales + the price; Output tax + the GST.
• Goods withdrawn, given as free samples, or lost: reverse the input tax on them (sub-topic 7).

At the year end. Set the input against the output, then show the result:

1. Within each tax. Output more than input: the difference is GST payable, a current liability. Input more than output: the difference is input tax credit, a current asset carried forward.
2. Across taxes, if the question asks for the set-off or the net GST payable. Follow the legal order (CGST Act, s. 49(5) and CGST Rules, r. 88A; C16): IGST credit is used first, for IGST and then for CGST and SGST, and it must be used up before any CGST or SGST credit is touched; CGST credit pays CGST and then IGST; SGST credit pays SGST and then IGST, but only once no CGST credit is left for it. CGST credit never pays SGST, and SGST credit never pays CGST.

Two presentations are in use: head-by-head balances, or the position after the full set-off. Use the full set-off when the question asks for it. In either case never net a CGST balance against an SGST balance.

This sum uses the steps of sub-topics 1 to 8 together.

Trial balance of Ms Kavya Rao as at 31 March 2026:

Adjustments: (i) closing stock ₹75,000; (ii) salaries paid cover 11 months; (iii) rent paid includes ₹3,000 for the next year; (iv) insurance was paid on 1 July 2025 for one year; (v) commission received includes ₹1,000 for the next year; (vi) write off further bad debts of ₹2,000, keep a provision for doubtful debts of 5% and a provision for discount of 2%; (vii) depreciate furniture at 10%; (viii) no interest on the loan has been paid; (ix) the owner took goods costing ₹4,000, bought with CGST 9% and SGST 9%; (x) show GST tax by tax.

Working notes.

1. Salaries: ₹66,000 ÷ 11 = ₹6,000 a month, so ₹6,000 is outstanding and the expense is ₹72,000.
2. Rent ₹33,000 − ₹3,000 prepaid = ₹30,000.
3. Insurance: 9 of the 12 months fall in the year, so ₹9,000 is the expense and ₹3,000 is prepaid.
4. Commission ₹9,000 − ₹1,000 received in advance = ₹8,000.
5. Debtors ₹1,50,000 − ₹2,000 = ₹1,48,000. Provision 5% = ₹7,400. Charge = ₹3,000 + ₹2,000 + ₹7,400 − ₹5,000 = ₹7,400. Provision for discount = 2% of (₹1,48,000 − ₹7,400) = ₹2,812.
6. Depreciation = 10% of ₹80,000 = ₹8,000.
7. Loan interest for 6 months = ₹50,000 × 10% × 6 ÷ 12 = ₹2,500, outstanding.
8. Goods taken: purchases − ₹4,000; Input CGST and Input SGST − ₹360 each; drawings + ₹4,720.
9. GST: Output CGST ₹27,000 − Input CGST (₹21,000 − ₹360) = ₹6,360 payable; SGST the same, ₹6,360 payable.

Trading and Profit and Loss Account of Ms Kavya Rao for the year ended 31 March 2026:

Balance Sheet of Ms Kavya Rao as at 31 March 2026:

A not-for-profit organisation (NPO) is formed to serve its members or the public, not to earn profit for owners. Clubs, schools, hospitals, libraries, charitable trusts and societies are examples. Their features:

• The aim is service: sport, education, health, welfare, culture.
• Money comes from subscriptions, donations, legacies, grants, entrance and life membership fees, and income from investments.
• There are no owners to share a profit. An excess of income is kept in the organisation and added to its capital fund (also called the general fund or accumulated fund).
• It is run by an elected committee; the secretary or treasurer keeps the accounts, often only a cash book.

The words change from those of a trader:

The statements. At the year end an NPO prepares:

1. a Receipts and Payments Account: a summary of the year's cash and bank transactions;
2. an Income and Expenditure Account: the year's revenue income and expenditure on the accrual basis, prepared like a Profit and Loss Account;
3. a Balance Sheet: its assets, liabilities, funds and capital fund at the year end; and
4. a Trading Account for any trading activity it runs, such as a bar or restaurant (sub-topic 7).

The Receipts and Payments Account in brief. It opens with the cash and bank balances at the start of the year. Every amount received goes on the debit side and every amount paid on the credit side, whether capital or revenue, and whichever year it belongs to. It closes with the cash and bank balances at the end. A bank overdraft is a credit balance.

A large cash balance proves nothing about the year's working: it may come from selling a building or from a donation for a new hall. To learn whether the regular income of the year meets its regular spending, the Income and Expenditure Account is needed.

Each receipt or payment must be sorted. Revenue items of the current year go to the Income and Expenditure Account. Capital items go to the Balance Sheet: added to the capital fund, to a special fund, or to an asset.

The subscription credited to the Income and Expenditure Account is what members owe for the year, whether or not it has been received. The cash received in the year is a mix: it may include arrears of earlier years and advances for later years, and it leaves out what is still due for this year.

• Received for an earlier year: settles arrears already shown as an asset; not this year's income.
• Received for a later year: subscription received in advance, a liability, and income of that later year.
• Due for this year but unpaid: added to income and shown as subscription outstanding, an asset.
• Received last year for this year (last year's advance): this year's income.

The same figure comes out as the balancing figure of a Subscription Account:

When the number of members and the yearly rate are given, the year's income is simply members × rate; the cash received for the year is compared with it to find the amount outstanding.

Arrears written off. Old arrears that will not be collected were income of an earlier year. Writing them off is a loss of this year, debited to the Income and Expenditure Account as an expense. It is not deducted from this year's subscription income.

Arrears of several years. When arrears or advances span more than one year, work year by year. The outstanding balance at the end may include old arrears still unpaid; show it in the Balance Sheet year by year.

The Income and Expenditure Account is charged with the material used in the year, not the cash paid for it. Find it in two steps.

1. Purchases of the year. Draw up the suppliers' (creditors) account. Payments to suppliers and closing creditors on the debit; opening creditors on the credit. Credit purchases are the balancing figure. If advances were paid to suppliers, opening advances go on the debit and closing advances on the credit. Add cash purchases to get total purchases.
2. Consumption. Opening stock + total purchases − closing stock.

If cash purchases are stated as a percentage of total purchases, gross up: when cash purchases are 20% of the total, credit purchases are the other 80%, so total purchases = credit purchases ÷ 80%.

In the Balance Sheet: closing stock of the material is an asset; amounts owed to suppliers are a liability; advances paid to suppliers are an asset.

The same idea gives any expense of the year from the cash paid:

A special fund holds money given or set aside for one purpose: prizes, sports, a tournament, a building, an endowment. It is a liability: the organisation must use it for that purpose. Everything that belongs to the fund goes through the fund, not through the Income and Expenditure Account.

• Credited to the fund: the opening balance; donations received for it; income from the fund's own investments, including interest accrued; receipts of the activity (such as tournament ticket sales).
• Debited to the fund: expenses of its purpose (prizes awarded, tournament expenses).
• Balance Sheet: the fund on the liabilities side; its investments, and interest accrued on them, on the assets side.
• Expenses more than the fund. The fund is closed at nil and the excess is charged to the Income and Expenditure Account.
• No fund for an activity. Its expenses are ordinary expenditure of the Income and Expenditure Account.
• Interest on general investments is income of the Income and Expenditure Account.

Interest on investments is worked on their face value at the coupon rate, for the time held. If less has been received, the rest is accrued: added to the fund and shown as an asset.

Building fund. Donations for a building are credited to the Building Fund. While the building is under construction, the amount spent on it is an asset (building under construction, or capital work in progress), and the fund stays a liability. The fund is not transferred to the capital fund while the work continues.

A club that sells food or drinks runs a small business inside itself. That activity gets its own Trading Account (Bar Trading Account, Restaurant Trading Account), and only its profit or loss enters the Income and Expenditure Account.

• Where wages are given in total with the activity's share stated, only that share goes to the Trading Account; the rest is general expenditure of the club.
• Bar sales on credit are worked like trade debtors: cash collected − opening debtors + closing debtors.
• Balance Sheet: stock of the activity and its equipment (less depreciation) as assets; creditors for its supplies as a liability.
• Where a question gives only the takings of an activity and none of its costs, the takings are credited to the Income and Expenditure Account as income.

Income and Expenditure Account, step by step:

1. Leave out the opening and closing cash and bank balances.
2. Leave out capital receipts and payments: assets bought or sold, specific donations, legacies, life membership fees (and entrance fees if capitalised). From the sale of an asset, take only the profit or loss.
3. Credit the revenue receipts, adjusted to the year: leave out amounts for past or future years, add income due but not received.
4. Debit the revenue payments, adjusted to the year: leave out amounts for past or future years, add expenses incurred but unpaid.
5. Debit depreciation and other losses; credit the profit of any trading activity.
6. The balance is the surplus (credit side larger) or the deficit. A surplus is added to the capital fund; a deficit is deducted.

Opening capital fund. If it is not given, draw up the opening Balance Sheet: all assets at the start (cash, bank, fixed assets, investments, stocks, subscriptions outstanding, prepaid expenses, accrued income) less all liabilities at the start (outstanding expenses, subscriptions received in advance, creditors, overdraft). The difference is the capital fund.

Closing Balance Sheet, step by step:

1. Fixed assets: opening figure + additions − book value of assets sold − depreciation. Where the question gives a revalued figure (library books are often revalued), use it; the fall is that year's depreciation.
2. Assets: cash and bank at the end; outstanding income; prepaid expenses; stocks; investments; interest accrued.
3. Liabilities: outstanding expenses; income received in advance; creditors; special funds.
4. Capital fund: opening fund + surplus (or − deficit) + capital receipts added to it (life membership, legacies, entrance fees if capitalised).

When the Receipts and Payments Account must be built from an Income and Expenditure Account, the same adjustments are run backwards: the opening and closing outstanding and advance items turn each income and expense back into cash, and capital receipts and payments are added from the other information. The same rules apply when an NPO's figures come as a trial balance instead.

Income and Expenditure Account for the year ended 31 March 2026:

Balance Sheet as at 31 March 2026: