Financial Statements - I - NCERT

1 Financial Statements - I9 LEARNING OBJECTIVESA fter studying this chapter,you will be able to : state the nature of thefinancial Statements ; identify the variousstakeholders and theirinformation require-ments; distinguish betweenthe capital and reve-nue expenditure andreceipts; explain the concept oftrading and profit andloss account and itspreparation; State the nature ofgross profit, net profitand operating profit; describe the concept ofbalance sheet and itspreparation; explain grouping andmarshalling of assetsand liabilities; prepare profit and lossaccount and balancesheet of a sole prop-rietory firm; and make an have learnt that Financial accounting is awell-defined sequential activity which beginswith Journal (Journalising), Ledger (Posting), andpreparation of Trial Balance (Balancing andSummarisation at the first stage).

2 In the presentchapter, we will take up the next step, namely,preparation of Financial Statements , and discuss thetypes of information requirements of variousstakeholders, the distinction between capital andrevenue items and its importance and the natureof Financial Statements and the preparation Stakeholders and TheirInformation RequirementsRecall from chapter I ( Financial Accounting Part I)that the objective of business is to communicatethe meaningful information to various stakeholdersin the business so that they can make informeddecisions.

3 A stakeholder is any person associatedwith the business. The stakes of variousstakeholders can be monetary or non-monetary. Thestakes can be active or passive; or can be direct orindirect. The owner and persons advancing loan tothe business would have monetary stake. Thegovernment, consumer or a researcher will havenon-monetary stake in the business. Thestakeholders are also called users who are normallyclassified as internal and external depending uponwhether they are inside the business or outside thebusiness.

4 All users have different objectives for2015-16332 Accountancyjoining business and consequently different types of information requirementsfrom it. In nutshell, the various users have diverse Financial informationrequirements from the example we have classified the following into the category of internaland external users specifying their objectives and consequent for participatingAccounting Information requirementsExternalin businessusersCurrentInternalTo make investment in theLikes to know extent of profit in theownersbusiness and wealth accounting period, currentposition of the assets/liabilities of a career.

5 They essenti-Accounting information in the formally act as the agent ofof Financial Statements is like theirowners (their employers).report card and they are interestedin information about both profits andfinancial role is regulatory andIts concerns are that the rights of alltries to lay down the rulesstakeholders are protected. Since thein the best public levies taxes on thebusiness, they are interested ininformation about profitability inparticular besides lot of is expecting to makeHe is interested in information aboutownerinvestments in the businesspast profits and Financial position aswith a view to make hisindicative of likely future and wealth is interested in saftyBank is interested in adequacy ofof the principal as well asprofits only as an assurance of thethe periodic returnreturn of principal and interest back(interest).

6 In time. Bank is equally concernedabout the form in which the assetsare held by the business. When moreassets are held in cash or near cashform, the aspect is knnown : Analysis of various users of accounting information2015-16333 Financial Statements - IBox 1 Accounting Process (up to Trial balance) the transactions, which that are transactions in journal. Only those transactions are recorded which aremeasured in money terms. The system followed for recording is called double entrysystem whereby two aspects (debit and credit) of every transaction are transactions of same nature are recorded in subsidiary books, also calledspecial journals.

7 Instead of recording all transactions in journal, they are recorded insubsidiary books and the journal proper. For example, the business would record allcredit sales in sales book and all credit purchases in purchases book. The otherexamples of subsidiary books are return inwards book, return outwards book. Another important special book is cash book, in which all cash and bank transactionsare recorded. The entries, which are not recorded in any of these books, are recordedin a residual journal called journal entries appearing in the above books are posted in the respective accounts in the accounts are balanced and listed in a statement called trial balance.

8 If the totalamounts of debit and credit balances agree, accounts are taken as free fromarithmetical trial balance forms the basis for making the Financial Statements , tradingand profit and loss account and balance Distinction between Capital and RevenueA very important distinction in accounting is between capital and revenue distinction has important implications for making of the trading and profitand loss account and balance sheet. The revenue items form part of the tradingand profit and loss account, the capital items help in the preparation of a ExpenditureWhenever payment and/or incurrence of an outlay are made for a purpose otherthan the settlement of an existing liability, it is called expenditure.

9 Theexpenditures are incurred with a viewpoint they would give benefits to thebusiness. The benefit of an expenditure may extend up to one accountingyear or more than one year. If the benefit of expenditure extends up to oneaccounting period, it is termed as revenue expenditure. Normally, they areincurred for the day-to-day conduct of the business. An example can bepayment of salaries, rent, etc. The salaries paid in the current period will notbenefit the business in the next accounting period, as the workers have putin their efforts in the current accounting period.

10 They will have to be paid thesalaries in the next accounting period as well if they are made to work. If thebenefit of expenditure extends more than one accounting period, it is termed2015-16334 Accountancyas capital expenditure. An example can be payment to acquire furniture for usein the business. Furniture acquired in the current accounting period will givebenefits for many accounting periods to come. The usual examples of capitalexpenditure can be payment to acquire fixed assets and/or to make additions/extensions in the fixed points of distinction between capital expenditure and revenueexpenditure are worth noting :(a)Capital expenditure increases earning capacity of business whereasrevenue expenditure is incurred to maintain the earning capacity.