Trial Balance FinalAccounts Concepts

Trial Balance What? Why? When?

What is a Trial Balance

The Trial Balance is a statement of ledger account balances as on a particular instance.

Trial Balance of M/s Wearall Textlies as on 31st March 2006

Particulars

L/F

Debit Amount(in Rs)

Credit Amount(in Rs)

Opening StockTextile PurchasesWagesOctroiSalariesRentPrinting and StationeryAdvertisementsCashOffice BuildingCapitalBankMotor VehiclesSundry CreditorsSalesP/L AppropriationSundry DebtorsMachinery

63,65022,56,0003,25,0001,78,2001,04,0001,26,00074,65086,00026,0004,23,450

1,19,0002,10,000

2,08,0005,69,000

2,50,000

1,80,00036,86,0006,52,950

Total

47,68,950

47,68,950

Why is a Trial Balance prepared?

The trial balance is prepared to check/ensure the arithmetical accuracy of accounting. Though not a conclusive proof, the agreement of the trial balance is a prima facie evidence of the absence of mathematical errors.

This is the most important purpose for which the trial balance is prepared.

Isn't Trial Balance made for enabling preparation of Final Accounts?

No, not at all.

Preparation of Trial Balance is not an act that forms a part of the activities involved in the regular accounting cycle. Since Final Accounting can be completed without the preparation of the Trial Balance, we can say that enabling the preparation of final accounts is not the purpose of the trial balance.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments When is a Trial Balance prepared?

The trial balance is generally prepared at a time when all the ledger accounts are balanced like at the end of the accounting period.

Theoretically, the trial balance can be prepared as and when needed.

The practical difficulty in preparing the trial balance as and when needed is the requirement of the balances of all the ledger accounts within the organisational accounting system. Different ledger accounts are balanced at different time intervals based on the information needs of the organisation. Say in a typical organisation Cash a/c is balanced daily, Expenses, Creditor and Debtor accounts are balanced on a monthly basis, Asset accounts are balanced annually etc.

The ledger account balances relating to all ledger accounts would not be available ready hand at any given instance. Year ending is one such instance when the balances are derived.

Computerised Accounting

In mechanised (computerised) accounting systems, trial balance is a statement that can be automatically derived as and when needed.

Accounting Cycle Absence of Preparation of Trial Balance

Preparation of a trial balance is not an act which forms a part of the activities involved in the accounting cycle.

The Accounting Cycle (activities involved)

Begins with opening the books of accounts for an accounting period by recording the opening entry;

Journal in the books of M/s Amonaya Metals for the period from 1st January 2007 to ____

Date

V/RNo.

Particulars

L/F

Debit Amount(in Rs)


1st January

Assets a/c To Liabilities a/c To Capital a/c

Dr

[For bringing the balances in the various ledger accounts at the end of the previous accounting period into books.]

This is the journal entry that supports the posting To Balance b/d and By Balance b/d in the various ledger accounts.

Recording the various transactions all through out the accounting period;

Balancing the ledgers as and when needed and finally at the end of the accounting period;

Recording the transactions for making up the final accounts

1. Making the Trading a/c

2. Closing the Trading a/c by transferring the balance in it to Profit & Loss a/c

3. Making the Profit and Loss a/c

4. Closing the Profit and Loss a/c by transferring the balance in it to Capital a/c (or Profit and Loss Appropriation a/c)

Preparing the Balance sheet (A statement of balances in all the ledger accounts that remain after making up and closing the Trading and Profit & Loss a/c.)

The accounting cycle ends with recording the closing entry for closing the books of accounts.

Journal in the books of M/s Amonaya Metals for the period from 1st Jan to 31st Dec 2007

Date

V/RNo.

Particulars

L/F

Debit Amount(in Rs)


31st December

Liabilities a/c Capital a/c To Assets a/c

Dr

[For carrying the balances in the various ledger accounts at the end of the accounting period to the subsequent accounting period.]

This is the journal entry that supports the posting To Balance c/d and By Balance c/d in the various ledger accounts.

Final Accounting : Use of Journal/Ledger

Final Accounting deals with all the ledger account balances at the end of the accounting period in one way or the other.

All the Nominal accounts that represent direct expenses and direct incomes are closed by transfer to the Trading a/c.

For this at least two journal entries are recorded.

The Trading a/c is closed by transferring its balance to the Profit and Loss a/c.

For this a journal entry is recorded.

All the Nominal accounts that represent indirect expenses, losses and indirect Incomes are closed by transfer to the Profit and Loss a/c.

For this at least two journal entries are recorded.

The Profit & Loss a/c is closed by transferring its balance to either the Capital a/c or Profit & Loss Appropriation a/c.

For this a journal entry is recorded.

All the remaining accounts are listed out in the Balance Sheet.

A closing entry is recorded in relation to this, though it is not directly related to preparing the balance sheet.

If the Final Accounting is to be done in a systematic manner, then all the journal entries mentioned above are to be recorded and all the ledger accounts that are affected by those transactions are to be posted to and updated. That would result in the making up of the Trading a/c and Profit and Loss a/c. The balance sheet is prepared by drawing up a statement of ledger account balances carried forward through the closing entry.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Final Accounting : Use of Trial Balance : Avoiding Journal/Ledger

In manual accounting, the Trading a/c, Profit & Loss a/c and the Balance Sheets can also be prepared using the information in the Trial Balance avoiding the act of journalising the transactions involved in final accounting.

This is done by showing each item in the ledger accounts (Trading, P/L a/c) or the statement (Balance Sheet) where it would be ultimately appearing had the actual procedure been adopted. This would have the same affect as recording the journal and posting into the ledger.

Example

The balance in the Carriage Inwards a/c (direct expenditure) is transferred to the Trading a/c by recording a Journal entry. By this, the Carriage Inwards a/c would get closed (its balance becomes zero) and the Trading a/c would get debited with that balance. In preparing the Trading a/c the balance in the Carriage Inwards a/c can be ascertained from the Trial Balance and shown on the debit side of Trading a/c.

Reduction of Work involved in Manual Accounting

Since not recording the related journal entries makes no difference as far as final accounting is concerned, in almost all cases in manual accounting, the process of recording the journal entries required for final accounting and updating the ledger is bypassed to reduce the burden of the work involved.

Information in Trial Balance To be dealt with only once

In making up final accounts using the information in the Trial Balance, we should ensure that each item of information (representing a ledger account balance) should be dealt with only once.

In final accounting each piece of information can appear either on the debit or credit sides of the Trading a/c or "Profit & Loss a/c" or on the assets or liabilities side of the "Balance Sheet".

Each item from the Trial Balance should be dealt with only once in Final Accounting.

Interpreting the items in the Trial Balance

A statement for interpretation of the various ledger account balances in the above trial balance

Trial Balance of M/s Wearall Textlies as on 31/03/06 Statement of Analysis

Account

Description

AccountType

BalanceNature

Where

WhichSide

Amount

Opening StockTextile PurchasesWagesOctroiSalariesRentPrinting and StationeryAdvertisementsCashOffice BuildingCapitalBankMotor VehiclesSundry CreditorsSalesP/L AppropriationSundry DebtorsMachinery

Direct ExpensesDirect ExpensesDirect ExpensesDirect ExpensesIndirect ExpensesIndirect ExpensesIndirect ExpensesIndirect ExpensesAssetAssetLiabilityLiability/AssetAssetLiabilityDirect IncomesAccumulatd ProfitAssetAsset

NominalNominalNominalNominalNominalNominalNominalNominalRealRealPersonalPersonalRealPersonalNominalSpl. NominalPersonalReal

DebitDebitDebitDebitDebitDebitDebitDebitDebitDebitCreditDebitDebitCreditCreditCreditDebitDebit

Trading a/cTrading a/cTrading a/cTrading a/cP/L a/cP/L a/cP/L a/cP/L a/cB/SB/SB/SB/SB/SB/STrading a/cB/SB/SB/S

DebitDebitDebitDebitDebitDebitDebitDebitAssetsAssetsLiabilitiesAssetsAssetsLiabilitiesCreditLiabilitiesAssetsAssets

63,65022,56,0003,25,0001,78,2001,04,0001,26,00074,65086,00026,0004,23,4502,50,0001,19,0002,10,0001,80,00036,86,0006,52,9502,08,0005,69,000

Making up the Final Accounts

Final Accounting using the information in a Trial Balance involves nothing more than putting the right items in the right places i.e. on the appropriate side of Trading a/c, Profit and Loss a/c or the Balance Sheet.

Dr

Trading and Profit & Loss a/c [For the year ending 31/03/06]

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To Opening StockTo Textile PurchasesTo WagesTo OctroiTo Gross Profit

63,65022,56,0003,25,0001,78,2008,63,150

By Sales

36,86,000

36,86,000

36,86,000

To SalariesTo RentTo Printing and StationeryTo AdvertisementsTo Net Profit

1,04,0001,26,00074,65086,0004,72,500

By Gross Profit

8,63,150

8,63,150

8,63,150

Balance Sheet of M/s Wearall Textlies as on 31st March 2006

Liabilities

Amount

Assets

Amount

CapitalSundry CreditorsP/L Appropriation [6,52,950 + 4,72,500]

2,50,0001,80,00011,25,450

CashBankOffice BuildingMotor VehiclesSundry DebtorsMachinery

26,0004,23,4501,19,0002,10,0002,08,0005,69,000

15,55,450

15,55,450

Care in dealing with Profit and Loss Appropriation a/c (or Capital a/c)

The balance in the "Profit & Loss Appropriation a/c" as shown in the Trial Balance represents the balance carried forward from the previous accounting period (i.e. year ending 31st March 2005).

The Profit and Loss a/c relating to the current period is closed by transfer its balance to the "Profit & Loss Appropriation a/c" Dr

Profit and Loss Appropriation a/c

Cr

Date

Particulars

J/F

Amount(in Rs)

Date

Particulars

J/F

Amount(in Rs)

31/03/06

To Bal c/d

11,25,450

31/03/0631/03/06

By Bal b/dBy Net Profit

6,52,9504,72,500

Total

11,25,450

Total

11,25,450

01/04/06

By Balance b/d

11,25,450

Therefore, while showing the information (balance) relating to the Profit & Loss Appropriation a/c in the Balance sheet, care should be taken to make appropriate adjustment to the balance on account of the transfer of balance from the Profit and Loss a/c.

The balance that appears in the balance sheet is not the one that appears in the trial balance, but the one that takes into consideration the adjustment on account of current periods profit or loss also.

If the balance in Profit and Loss a/c is transferred to the Capital a/c, then such a care should be taken with regard to the Capital a/c balance.

Trial Balance used in Final Accounting : When Prepared?

The Trial Balance is a statement of ledger account balances as on a particular date (instance).

Final Accounting is done towards the end of the accounting period.

The trial balance that we consider in the preparation of final accounts is the one that is prepared towards the end of the accounting period i.e. on the last day of the accounting period.

Transactions after the Trial Balance Date

There might be a number of accounting transactions which might not have been taken into consideration by the time the Trial Balance has been prepared.

Some of the reasons for the presence of such transactions are

Transactions which do not occur in the normal course of business

There are a number of transactions relating to the business which do not occur in the normal course of business. These transactions unless deliberately recorded do not get into the books of accounts.

Examples for such transactions

i. Stock taken away by the proprietor for personal use

ii. Abnormal loss of stock

Transactions which have to be recorded only towards the end

There are a number of transactions relating to the business which have to be recorded only at the end of the accounting period. If the trial balance has been prepared before all such transactions into consideration have been taken into consideration, then they stay unrecorded in the books of accounts.

i. Depreciation on Assets

ii. Expenses - Outstanding/Prepaid

iii. Incomes - Outstanding/Pre-received

Transactions relating to Error Rectifications

The agreement of a Trial Balance is not a conclusive proof of absence of errors in accounting. Even in case where the trial balance agrees, there may still be errors existing in the books of accounts.

These errors if identified subsequent to the preparation of the Trial Balance, need to be rectified which needs journal entries to be passed for rectification.

What are Adjustments?

The transactions which have not yet been journalised, appended to the trial balance are what we call adjustments.

Thus we can say that Adjustments are transactions relating to the business which have not been journalised by the end of the accounting period.

Illustration

Trial Balance of M/s Azaya Traders" as on 30th June 2006.

Particulars

L/F

Debit Amount(in Rs)


Opening StockPurchasesSalariesWagesCarriage InwardsTrading ChargesCarriage OutwardsRent receivedCashCapitalBank (Overdraft)ComissionCreditorsSalesDebtorsMachinery

86,00011,36,0001,53,00018,00026,90064,00052,500

62,500

42,780

2,56,0004,80,000

1,78,300

3,44,70037,980

2,68,00015,48,700

Total

23,77,680

23,77,680

Adjustments

The following additional information is available

1. A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded in the books.

2. Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.

The additional information presented after the trial balance contains information relating to accounting transactions, which are to be identified from the wordings.


Why are they called Adjustments? Why not Additional Transactions?

Since adjustments are also transactions relating to the business, we need to bring them into the accounting books by journalising them.

The trial balance is used for final accounting, so as to eliminate a lot of physical work (in manual accounting) in the form of recording transactions for making up final accounts, posting them into respective ledger accounts, balancing of ledger accounts effected by these transactions.

Therefore even for the purpose of bringing the transactions represented by the adjustments into books a method has been designed which would not require us to record these transaction, post them and balance the ledger accounts affected. This method incorporates the effect of the transactions into the final accounts without having to go through the regular process of recording, posting, balancing etc.

Accounting for the Transactions

Recording the transactions represented by adjustments normally would result in the existing balance in the affected ledger accounts to either increase or decrease.

Transaction

Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.

This represents an error of principle whereby an expenditure that was to be debited in a particular account has been debited to another account.

To bring the effect of this transaction into books, the journal entry to rectify this error has to be recorded.

Journal/Ledger Hide/ShowJournal in the books of M/s Azaya Traders for the year ending 30th June 2006

Date

V/RNo.

Particulars

L/F

Debit Amount(in Rs)


30/06/06

Wages a/c To Salaries a/c

Dr

2,00,000

2,00,000

[For the transfer of wages erroneously treated as salaries from the "salaries a/c" to the "Wages a/c".]

The transaction posted into the relevant ledger accounts

Dr

Salaries a/c

Cr

Date

Particulars

J/F

Amount(in Rs)

Date

Particulars

J/F

Amount(in Rs)

30/06/06

To Bal b/d

1,53,000

30/06/0630/06/06

By WagesBal c/d

43,0001,10,000

1,53,000

1,53,000

01/07/06

To Balance b/d

1,10,000

Dr

Wages a/c

Cr

Date

Particulars

J/F

Amount(in Rs)

Date

Particulars

J/F

Amount(in Rs)

30/06/06

To Salaries a/c

43,000

30/06/06

By Bal c/d

43,000

43,000

43,000

01/07/06

To Balance b/d

43,000

The Method of Adjustment

This method involves identification of the effect and making mathematical adjustments in the figures that we consider in final accounting (i.e. at the time of showing them in the Trading a/c or Profit & Loss a/c or the Balance Sheet.).

Effect of the Transaction

The effect of the journal entry to be recorded in the above case can be analysed as

A. () From Salaries on the debit side of P/L a/c

The Salaries a/c which already has a debit balance is credited which will result in a decrease in the existing debit balance.

To bring the effect of this transaction, the amount involved in the transaction (Rs. 43,000) is deducted from the Salaries a/c balance (Rs. 1,53,000) shown on the debit side of the "Profit & Loss a/c".

B. (+) To Wages on the debit side of Trading a/c

The Wages a/c which already has a debit balance is debited resulting in an increase in the existing debit balance.

To bring the effect of this transaction, the amount involved in the transaction (Rs. 43,000) is added to the Wages a/c balance (Rs. 18,000) shown on the debit side of the "Trading a/c".

These are the adjustments to be made to bring the affect of the above transaction into the books of accounts.

Why call them Adjustment? Why not Additional Transactions?

Since the affect of these transactions is incorporated by mathematical adjustments, they are called Adjustments rather than just Additional Transactions.

To make the Adjustment Know the Journal Entry

Adjustments are transactions relating to business which have not yet been journalised.

Therefore, to make the adjustments one should have an idea of the journal entry related to the transaction indicated by the adjustment.

If we know the Journal entry, we can identify the effect of the same on the ledger accounts and thus be able to identify the adjustments to be made.

The adjustments are made at the time of making up the final accounts within the three parts that make up the final accounting, i.e. the "Trading a/c", "Profit & Loss a/c" and the "Balance Sheet".

Illustration Problem

Draw up the final accounts from the following trial balance and the additional information that follows it.

Trial Balance of M/s Azaya Traders" as on 30th June 2006.

Particulars

L/F

Debit Amount(in Rs)



86,00011,36,0001,53,00018,00026,90064,00052,500

62,500

42,780

2,56,0004,80,000

1,78,300

3,44,70037,980

2,68,00015,48,700

Total

23,77,680

23,77,680

The following additional information is available



Illustration Working Notes

An analysis of the various ledger accounts in the trial balance would enable us to decide what to be done with each item in the trial balance.

Trial Balance of M/s Azaya Traders as on 30/06/06 Statement of Analysis

Account

Description

AccountType

BalanceNature

Where

WhatSide

Amount


Direct ExpensesDirect ExpensesIndirect ExpensesDirect ExpensesDirect ExpensesIndirect ExpensesIndirect ExpensesIndirect IncomesAssetLiabilityLiabilityIndirect ExpenseLiabilityDirect IncomesAssetAsset

NominalNominalNominalNominalNominalNominalNominalNominalRealPersonalPersonalNominalPersonalNominalPersonalReal

DebitDebitDebitDebitDebitDebitDebitCreditDebitCreditCreditDebitCreditCreditDebitDebit

Trading a/cTrading a/cP/L a/cTrading a/cTrading a/cP/L a/cP/L a/cP/L a/cB/SB/SB/SP/L a/cB/SB/SB/SB/S

DebitDebitDebitDebitDebitDebitDebitCreditAssetsLiabilitiesLiabilitiesDebitLiabilitiesCreditAssetsAssets

86,00011,36,0001,53,00018,00026,90064,00052,5001,78,30062,5003,44,70037,98042,7802,68,00015,48,7002,56,0004,80,000

An analysis of the additional transactions would enable us to identify what is to be done to incorporate their effect in accounting.


Entry

Effect

Dr. Machinery a/c Cr. Ramsay Machine Tools a/c

1. (+) To Machinery a/c on the Assets side of the Balance Sheet 2. (+) To Ramsay Machine Tools a/c on the Liabilities side of the Balance Sheet

2. Detailed Explanation Hide/Show

Transaction

A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded in the books.

This represents an error of omission whereby a transaction has been omitted from being recorded in the books.

To bring the effect of this transaction into books, the relevant journal entry has to be recorded.

Journal/Ledger

Journal in the books of M/s Azaya Traders for the year ending 30th June 2006

Date

V/RNo.

Particulars

L/F

Debit Amount(in Rs)


30/06/06

Machinery a/c To M/s Ramsay Machine Tools a/c

Dr

2,00,000

2,00,000

[For the value of machine purchased on credit.]

The transaction posted into the relevant ledger accounts

Dr

Machinery a/c

Cr

Date

Particulars

J/F

Amount(in Rs)

Date

Particulars

J/F

Amount(in Rs)

30/06/06

To Bal b/dTo Ramsay Machine Tools

4,80,0002,00,000

30/06/06

By Bal c/d

6,80,000

6,80,000

6,80,000

01/07/06

To Balance b/d

6,80,000

Dr

Ramsay Machine Tools a/c

Cr

Date

Particulars

J/F

Amount(in Rs)

Date

Particulars

J/F

Amount(in Rs)

30/06/06

To Bal c/d

2,00,000

30/06/06

By Machine a/c

2,00,000

2,00,000

2,00,000

01/07/06

By Balance b/d

2,00,000

Effect of the Transaction

The effect of the journal entry to be recorded in the above case can be analysed as

A. (+) To Machinery a/c on the assets side of the Balance Sheet

The Machinery a/c which already has a debit balance is debited resulting in an increase in the existing debit balance.

To bring the effect of this transaction, the amount involved in the transaction (Rs. 2,00,000) is added to the Machinery a/c balance (Rs. 4,80,000) shown on the assets side of the "Balance Sheet".

B. (+) To Ramsay Machine Tools a/c on the Liabilities side of the Balance Sheet

Ramsay Machine Tools a/c (which is not present in the books i.e. it has no balance in it) is credited resulting in the "Ramsay Machine Tools a/c" being created anew resulting in a credit balance in the account.

Ramsay Machine Tools a/c is a personal account since it relates to an organisation. It has a credit balance and therefore is an equivalent of a creditor. Thus it is to be shown on the liabilities side of the Balance Sheet.

To bring the effect of this transaction, the amount involved in the transaction (Rs. 2,00,000) is shown on the name of Ramsay Machine Tools on the liabilities side of the balance sheet.

We can also interpret this as adding the amount to the existing nil balance.

These are the adjustments to be made to bring the affect of the above transaction into the books of accounts.


Entry

Effect

Dr. Wages a/c Cr. Salaries a/c

1. (+) To Wages a/c on the Debit side of the Trading a/c 2. () From Salaries a/c on the Debit side of the Profit and Loss a/c

4. Detailed Explanation Above


Illustration Solution

Making up the final accounts would involve nothing more than putting the items from the trial balance in the right places i.e. in either the "Trading a/c" or "Profit and Loss a/c" or the "Balance Sheet" and making subsequent adjustments.

Dr

Trading and Profit & Loss a/c of M/s Azaya Traders for the year ending 30/06/06

Cr

Particulars

Amount(in Rs)

Amount(in Rs)

Particulars

Amount(in Rs)

Amount(in Rs)

To Opening StockTo PurchasesTo Wages (+) Salary (Tr)To Carriage InwardsTo Gross Profit

18,00043,000

86,00011,36,000

61,00026,9002,38,800

By Sales

15,48,700

15,48,700

15,48,700

To Salaries () Tr. to WagesTo Trading ChargesCarriage OutwardsTo ComissionTo Net Profit

1,53,00043,000

1,10,00064,00052,50042,7801,47,820

By Gross ProfitBy Rent Received

2,38,8001,78,300

4,17,100

4,17,100

Balance Sheet of M/s Azaya Traders as on 30th June 2006

Liabilities

Amount

Amount

Assets

Amount

Amount

Capital (+) Net ProfitBank (Overdraft)Creditors (+) Due to M/s Ramsay

3,44,7001,47,820

2,68,0002,00,000

4,92,52037,980

4,68,000

CashDebtorsMachinery (+) New Machine

4,80,0002,00,000

62,5002,56,000

6,80,000

9,98,500

9,98,500

The effect of the additional transactions (adjustments) are incorporated into the accounts by mathematical adjustments wherever needed.

Adjustments to be Dealt with at least Twice

Dual Entity Concept

Every transaction relating to business has its effect on two elements.

Adjustments are transactions relating to the business which are yet to be journalised. We call them adjustments for the reason that they are dealt with by making mathematical adjustments to the figures of ledger account balances instead of passing the regular journal entries.

Therefore, in making mathematical adjustments we have to ensure that we are adjusting the two elements that are affected by the transaction.

Each item from the adjustments should be dealt with at least twice in Final Accounting.

Where an item appears in the trial balance it is to be dealt with only once and where an adjustment is being dealt with it is to be dealt with at two or more places depending on the number of elements effected by the transaction.

Adjusting more than two accounts

In most of the cases, the journal entry for recording the transaction given as adjustments is a simple entry involving two accounts (one being debited and the other being credited). However, in some cases, a complex entry involving more than two elements (accounts) is needed to record the additional transactions. In such cases more than two accounts may have to be adjusted.

Valuation of Assets Direct Expenses

Asset Valuation Principle

The value of an asset includes all the expenses incurred before bringing the asset into usable condition.

Direct Expenditure

In financial accounting, we use the term Direct Expense in relation to assets.

Any expenditure that goes into the value of an asset is identified as Direct Expenditure for that asset.

Assets Treatment of Direct Expenses

All the expenses incurred in relation to an asset before bringing the asset into usable condition would form direct expenses for the asset

All the direct expenses in relation to an asset are to be made part of the value of the asset i.e. are to be capitalised.

Example

If a machine is purchased at Delhi and brought to Tenali for use, then all the expenses incurred before bringing the machine into working mode (usable condition) like transportation charges from Delhi to Tenali, Unloading Charges at Tenali, Installation Charges etc., should be considered to be part of the value of the machine.

These expenses should not be debited to the respective expenditure accounts, but should be debited to the Machinery a/c. The Machinery a/c balance which indicates the value of the asset would be the sum of the cost of the machine, the transportation charges, unloading charges, installations charges, etc..

Is Stock an Asset?

Dual nature of Stock

Purchases : During the Accounting Period

Whenever we purchase stock/goods we debit the Purchases a/c (Nominal account). This implies that we treat the amount spent on purchasing stock as an expenditure.

Such a treatment is adopted all throughout the year.

Asset : At the end of the Accounting Period

At the end of the accounting period, while preparing the final accounts we treat stock an asset and show it in the Balance Sheet on the assets side.

Thus we can say that stock has dual nature. All throughout the year the amount spent on it is expenditure and only for the moment the balance sheet is prepared it is an asset.

Valuation of Stock Based on the Principle for Valuation of Assets

Since Stock is an asset, its valuation should also be made based on the principle for valuation of assets.

The value of stock should include all the expenses incurred before bringing stock into usable condition.

Usable Condition for Stock Being ready for Sale

Considering the Stock used in sale, the usable condition for stock would mean getting it ready for sale i.e. it being finally set up in the show case or sale area.

Value of Stock

All the expenses incurred on the stock till it is placed in the sales area would form direct expenses for the stock and should be treated as a part of the value of stock.

In situations where it would be difficult/impossible to collect all the expenses in detail, this idea is modified to mean the expenses incurred before that stage till which point it would be convenient to collect information.

Direct Expenses for Stock used in Trading Business

In relation to a trading business, the stock used for sale would be an asset.

The usable condition for that stock would be, it being placed ready for sale in the showroom.

Therefore, the direct expenses in relation to this stock would be all the expenses incurred before placing it in the show room or any other relevant place ready for sale.

Conventionally, expenses like Wages, Carriage Inwards (carriage on purchases), Octroi, Excise, Duties etc., Stock purchased, etc. are treated as direct expenses apart from the actual cost of the goods purchased which is revealed by the "Purchases a/c".

It is not a rule that only these form direct expenses. Any expenditure that would have been incurred in relation to stock before it is made ready for sale would form direct expenditure for the stock.


Cost of Goods Sold

Cost of Goods Sold = Value of the Goods Sold

The cost of goods sold is a term used to indicate the value of the goods sold.

This value is needed to identify the amount of basic/core (gross) profit made by the organisation

Gross Profit = Sales Cost of Goods Sold

Illustrative Explanation

Consider the following data relating to an organisation.

1. Opening Stock at the beginning of the accounting period, Rs. 20,000.

2. Purchases of goods/stock during the accounting period : Rs. 2,48,000.

3. Direct expenses incurred :Rs. 54,000.

4. Unsold stock at the end of the accounting period valued at Rs. 36,000.

5. Value of Stock used for other purposes Rs. 14,000.

Particulars

Amount

Amount

Opening Stock(+)a) Purchases (Cost Value) b) Direct ExpensesTotal Value of Goods()a) Closing Stock (Value) b) Stock Unused for TradingCost of Goods Sold

2,48,000 54,000

36,000 14,000

20,000

3,02,0003,22,000

50,0002,72,000

The formula for calculating the value of Cost of Goods Sold based on the above calculations can be written as

Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses Closing Stock Stock Unused for trading

Stock Unused for Trading

Stock with the organisation may have been used for purposes other than trading. The value of such stock unused for trading purposes has to be deducted from the total value of stock so as to arrive at the value of cost of goods sold.

Some such instances

Goods being taken away by the proprietor for personal purposes;

Stock used in building up an asset;

Stock used for advertisement purposes;

Normal loss of stock;

Abnormal loss of stock;

Stock used up for other types of businesses (like consignments, branches, joint ventures etc)

Do we need Cost of Goods Sold to find Gross Profit

Gross Profit = Sales Cost of Goods Sold

By definition Gross Profit = Sales Cost of Goods Sold (1) To obtain the value of gross profit we need the figures of cost of goods sold and sales.

Bypassing finding Cost of Goods Sold

Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses Closing Stock Stock Unused for trading

Substituting this in (1) we get,

Gross Profit

=

Sales (Opening Stock + Purchases + Direct Expenses Closing Stock Stock Unused for trading)

=

Sales Opening Stock Purchases Direct Expenses + Closing Stock + Stock Unused for trading

=

(Sales + Closing Stock + Stock Unused for trading) (Opening Stock + Purchases + Direct Expenses)

Thus we do not specifically need to calculate the value of cost of goods sold for finding gross profit, only its affect is to be brought into account.

Such an ascertainment of Gross Profit is done in the Trading and Profit and Loss account.

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To Opening StockTo PurchasesTo Direct Expenses

By SalesBy Stock UnusedBy Closing Stock

"Purchases a/c" is a nominal account with a debit balance and is a direct expenditure (for stock).

Since Purchases a/c is closed by transfer to the Trading a/c, it appears on the debit side of Trading a/c.

Transferring a debit balance from one account to a second results in the second account being debited and the first account being credited.

Thus, all the accounts representing the figures that are added to purchases appear on the debit side

"Sales a/c" is a nominal account with a credit balance and is a direct income.

Since Sales a/c is closed by transfer to the Trading a/c, it appears on the credit side of Trading a/c.

Transferring a credit balance from one account to a second results in the second account being credited and the first account being debited.

Thus, all the accounts representing the figures that are added to sales appear on the credit side

Finding Cost of Goods Sold in such cases

Cost of goods sold is a figure that is not straight away available in the books of accounts used in financial accounting. That figure can be obtained either from the "Trading a/c" or by preparing a separate ledger account to specific account which gives the information relating to the cost of goods sold.


Ascertaining Cost of Goods Sold from Trading a/c

Each ledger account serves one or more informational needs of the organisation. The Trading a/c gives the information relating to the Gross Profit made by the organisation. It can also be used to derive the information relating to the "Cost of Goods Sold".

Ascertaining Cost of Goods Sold

Cost of Goods Sold = (Opening Stock + Purchases + Direct Expenses) (Closing Stock + Stock Unused for trading)

The "Trading a/c" with this information posted to it would be

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,000

By Closing StockBy Stock Unused

36,00014,000

sub-total

3,22,000

sub-total

50,000

The trading account before crediting sales would have a greater total on the debit side and thus has a debit balance. That debit balance represents the cost of goods sold.

Thus, to ascertain the cost of goods sold, we need to balance the "Trading a/c" without crediting sales.

The Sales a/c can be subsequently transferred to the Trading a/c to ascertain the Gross Profit.

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,000

By Closing StockBy Goods UnusedBy Cost of Goods Sold c/d

36,00014,0002,72,000

3,22,000

3,22,000

To Cost of Goods Sold b/dTo Gross Profit

2,72,0001,08,000

By Sales

3,80,000

3,80,000

3,80,000

If such a two stage Trading a/c is prepared, we would be able to ascertain the Cost of Goods Sold as well as Gross Profit from the Trading a/c itself.

Ascertaining Cost of Goods Sold by Mathematical Calculations

The Trading a/c is generally prepared only as a single stage account as follows

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To Opening StockTo PurchasesTo Direct ExpensesTo Gross Profit

20,0002,48,00054,0001,08,000

By SalesBy Goods UnusedBy Closing Stock

3,80,00014,00036,000

4,30,000

4,30,000

To obtain the value of cost of goods sold from this we use the definition for gross profit.

Cost of Goods Sold

=

Sales Gross Profit [Since Gross Profit = Sales Cost of Goods Sold]

=

Rs. 3,80,000 Rs. 1,08,000

=

Rs. 2,72,000

Finding Cost of Goods Sold using Goods Consumed a/c

The value of Cost of Goods Sold can also be obtained specifically, by maintaining a separate account for the purpose. This may be named "Goods Consumed a/c" (any other indicative name may be used).

The basic purpose of accounting is derivation of information and the more the information we need, the more the accounting heads we need to maintain.

The Goods Consumed a/c is nothing but the first part of the trading account where it was balanced twice.

Dr

Goods Consumed a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,000

By Goods UnusedBy Closing StockBy Trading a/c

14,00036,0002,72,000

3,22,000

3,22,000

The balance in the Goods Consumed a/c represents Cost of Goods sold. This account is closed by transferring the balance to the Trading a/c.

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To Goods ConsumedTo Gross Profit

2,72,0001,08,000

By Sales

3,80,000

3,80,000

3,80,000

Cost of Goods Consumed

If the balances in the ledger accounts representing direct expenses are not transferred to the "Goods Consumed a/c" but are transferred to the "Trading a/c", then the balance from the "Goods Consumed a/c" cannot be called cost of goods sold (value of goods sold).

It just represents the cost of goods consumed. To obtain the cost of goods sold from this, the direct expenses have to be added to this.

Goods used within the Organisation have to be valued at Cost

The stock that is used within the organisation (stock drawn by the proprietor for own purposes, stock used for building an asset, stock used for advertisement purposes, etc.,) have to be valued at cost.

This is for the reason that if such usages are recorded at a value which includes an element of profit, the transaction when recorded would generate a profit, which would amount to making a profit out of a transaction with oneself.

Principle of Mutuality One cannot make a profit out of a transaction with oneself

Illustrative Explanation

Consider the following data relating to an organisation which started its operations on 28th December 2006:

Opening Stock :: Nil;

Purchases :: Rs. 1,20,000;

Direct Expenses :: Rs. 30,000

Sales :: Nil

Stock used by the organisation internally Rs. 20,000 (Valued at Cost). Generally Sales are made by adding 25% profit to cost

Closing Stock :: ?

The accounting period ends on 31st December 2006.

Value of Closing Stock with the Organisation

=

Total Value of Stock Value of Stock used up internally

=

Purchases + Direct Expenses Rs. 20,000

=

(Rs. 1,20,000 + Rs. 30,000) Rs. 20,000

=

Rs. 1,30,000

Sales value of the stock used within the organisation

=

Cost + 25% of Cost

=

Rs. 20,000 + 25% of Rs. 20,000

=

Rs. 20,000 + Rs. 5,000

=

Rs. 25,000

Stock used up internally recorded at Sales Value

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Amount(in Rs)

Particulars

Amount(in Rs)

Amount(in Rs)

To PurchasesTo Direct Exp.To Gross Profit

1,20,00030,0005,000

By SalesBy Stock used By Closing Stock

25,0001,30,000

1,55,000

1,55,000

There is no commercial activity (no sales), there is no scope for earning profits. But the Trading a/c reveals a Gross Profit of Rs. 5,000 which is on account of the stock used up internally being recorded at sales value.

Such profit generation is inappropriate for the reason that in using up stock within the organisation, the organisation is not conducting a transaction with an outside party.

Thus to avoid profit generation in such cases, the stocks so used are to be valued at cost.

Stock used up internally recorded at CostDr

Trading a/c

Cr

Particulars

Amount(in Rs)

Amount(in Rs)

Particulars

Amount(in Rs)

Amount(in Rs)

To PurchasesTo Direct Exp.To Gross Profit

1,20,00030,000Nil

By SalesBy Stock used By Closing Stock

20,0001,30,000

1,50,000

1,50,000

The Trading a/c would reveal no profit when the stock used up internally is valued at cost.

Finding Value of Closing Stock from Sales

We may be able to ascertain what is left out if we know what has been sold. This logic may be applied in finding the value of closing stock. However, to know this, we need to ascertain the value of cost of goods sold.

i. Gross Profit = Sales Cost of Goods Sold

ii. Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses Closing Stock

iii. Gross Profit = Sales (Opening Stock + Purchases + Direct Expenses Closing Stock) [From (i) and (ii)] = Sales Opening Stock Purchases Direct Expenses + Closing Stock

iv. Closing Stock = Opening Stock + Purchases + Direct Expenses + Gross Profit Sales [From (iii)]

To use this relation to obtain the value of closing stock, we need the information relating to Gross Profit. All other information in this relation is readily available from the accounting records.

Gross Profit Ratio

Ratio : Percentage

Ratio is a comparison between two numerical quantities of the same kind.

Ratio between two quantities is expressed in the form a : b or

a

b

, where "a" and "b" do not have a common factor.

Percentage = Ratio 100

Gross Profit Ratio

Gross Profit Ratio is the ratio of Gross Profit to Net Sales Value or Cost of Goods Sold.

To Sales

Gross Profit Ratio

=

Gross Profit

Net Sales

Gross Profit as a % of Sales

=

Gross Profit

Net Sales

100

(Or)

=

Gross Profit Ratio (to Sales) 100

To Cost of Goods Sold

Gross Profit Ratio

=

Gross Profit

Cost of Goods Sold

Gross Profit as a % of Cost of Goods Sold

=

Gross Profit

Cost of Goods Sold

100

(Or)

=

Gross Profit Ratio (to Cost) 100

Inter-Relationship between the two Ratios

The Gross Profit Ratio (to Sales) and Gross Profit Ratio (to Cost of Goods Sold) are interrelated and one can be obtained if the other is known.

Finding GP Ratio (to Cost) when GP Ratio (to Sales) is known Show/HideThe data relating to the Gross Profit as a % of Sales given can be considered in three different forms. The formula used for conversion (expressing the interrelationship) varies depending on the form of the data considered.

Data on 1 Scale

Expressing the data on 1 scale, amounts to expressing the value either in decimals or as a fraction.

Consider the following data:

Sales = x

Gross Profit Ratio (to Sales) = y (one scale)

Gross Profit

=

Sales Gross Profit Ratio (to Sales)

=

x y

=

xy

Cost of Goods Sold

=

Sales Gross Profit

=

x xy

=

x (1 y)

Gross Profit Ratio (to Cost)

=

Gross Profit

Cost of Goods Sold

=

xy

x (1 y)

=

y

(1 y)

Example

Given Gross Profit Ratio (to Sales) is 0.25 y

=

0.25

Therefore, Gross Profit Ratio (to Cost)

=

y

(1 y)

=

0.25

(1 0.25)

=

0.25

0.75

=

1

3

=

0.33

Gross Profit (as a % to Cost)

=


=

0.33 100

=

33

1

3

%

Data on 100 Scale

Expressing the data on 100 scale implies expressing the % without using the denominator 100. [42% is taken as 42 for calculation purposes if it is taken on a 100 scale.]

Let the data on 100 scale be represented by 'm'. y =

m

100

Substituting this value for 'y' in the above formula we get,

Gross Profit Ratio (as a % of Cost)

=

y

(1 y)

100

=

m

100

(1

m

100

) 100

=

m

100

100 m

100

100

=

m

100

100

100 m

100

=

m

100 m

100

Example

Given Gross Profit is 25% of Sales m =25

Therefore, Gross Profit as a % of Cost

=

m

100 m

100

=

25

100 25

100

=

25

75

100

=

100

3

=

33

1

3

Data as a ratio with numerator 1

In some cases, for some common values that we use in problem solving, we use a formula based on the Gross Profit Ratio expressed as a ratio with a numerator 1.

Let the data be represented by

1

a

y =

1

a

Substituting this value for 'y' in the formula in (1) we get,


=

y

(1 y)

=

1

a

(1

1

a

)=

1

a

a 1

a

=

1

a

a

a 1

=

1

a 1

Example

Given Gross Profit Ratio (to Sales)

=

1

4

a = 4


=

1

a 1

=

1

4 1

=

1

3

Gross Profit (as a % to Cost)

=


=

1

3

100

=

33

1

3

%

Finding GP Ratio (to Sales) when GP Ratio (to Cost) is known Show/HideThe data relating to the Gross Profit as a % of Cost of Goods Sold given can be considered in three different forms. The formula used for conversion (expressing the interrelationship) varies depending on the form of the data considered.

Data on 1 Scale

Expressing the data on 1 scale, amounts to expressing the value either in decimals or as a fraction.

Consider the following data:

Cost of Goods Sold = p

Gross Profit (to Cost of Goods Sold) = q (one scale)

Gross Profit

=

Cost of Goods Sold Gross Profit (to Cost of Goods Sold)

=

p q

=

pq

Sales

=

Cost of Goods Sold + Gross Profit

=

p + pq

=

p (1 + q)

Gross Profit Ratio (to Sales)

=

Gross Profit

Net Sales

=

pq

p (1 + q)

=

q

(1 + q)

Example

Given Gross Profit Ratio (to Cost) is 0.2 p = 0.2

Therefore, Gross Profit Ratio (to Sales)

=

q

(1 + q)

=

0.2

(1 + 0.2)

=

0.2

1.2

=

1

6

Gross Profit (as a % to Sales)

=


=

1

6

100

=

16

2

3

%

Data on 100 Scale

Expressing the data on 100 scale implies expressing the % without using the denominator 100. [35% is taken as 35 for calculation purposes if it is taken on a 100 scale.]

Let the data on 100 scale be represented by 'n'. q =

n

100

Substituting this value for 'q' in the above formula we get,

Gross Profit as a % of Sales

=

q

(1 + q)

100

=

n

100

(1 +

n

100

) 100

=

n

100

100 + n

100

100

=

n

100

100

100 + n

100

=

n

100 + n

100

Example

Given Gross Profit is 20% of Cost n =20

Therefore, Gross Profit as a percentage of Saes

=

n

100 + n

100

=

20

100 + 20

100

=

20

120

100

=

1

6

100

=

16 2/3%

Data as a ratio with numerator 1

In some cases, for some common values that we use in problem solving, we use a formula based on the Gross Profit Ratio expressed as a ratio with a numerator 1.

Let the data be represented by

1

b

q =

1

b

Substituting this value for 'q' in the formula in (1) we get,


=

q

(1 + q)

=

1

b

(1 +

1

b

)=

1

b

b + 1

b

=

1

b

b

b + 1

=

1

b + 1

Example

Given Gross Profit Ratio (to Sales) is

1

5

b = 5


=

1

b + 1

=

1

5 + 1

=

1

6

Gross Profit Ratio (as a % to Sales)

=

Ratio 100

=

1

6

100

=

16

2

3

%

Frequently used conversions

Hundred Scale

As a % of Cost

20

25

33

1

3

50

66

2

3

100

As a % of Sales

16

2

3

20

25

33

1

3

40

50

One Scale

As a % of Cost

0.2

0.25

0.333

0.5

0.666

1

As a % of Sales

0.166

0.20

0.25

0.333

0.4

0.5

Inverse

As a % of Cost

1

5

1

4

1

3

1

2

2

3

1

1

As a % of Sales

1

6

1

5

1

4

1

3

2

5

1

2


Gross Profit is generally Non-Uniform

The gross profit earned by an organsation is in almost all cases not a figure that can be easily derived (without the availability of the value of closing stock). Deriving the value of closing stock would be far easier than deriving the value of gross profit made (based on sales).

Variety of Products being Sold

The organisation may be selling a number of products with different selling prices and different rates of gross profits.

In such cases, if the gross profit figure is to be ascertained from the sales figure, sales records should be maintained so as to give the sales details relating to each product with a distinct Gross Profit %. This would involve a lot of work and would be impractical, more so where there are a large number of products being dealt with.

Variations in Sale Prices

The prices charged to customers are dependent on a number of factors like the market conditions, the immediate competition existing in the market, the loyalty of the customers etc.

Depending on the market conditions, some times the prices may be varied instantaneously.

Depending on the customer to whom the product is being sold, the prices may be varied (a discount may be given to loyal customers) etc.

In such a situations there would not be uniformity in the Gross profit percentage and it would be near to impossible to ascertain the gross profit made using the sales figures.

Since using the figure of gross profit to ascertain the value of closing stock available in the organisation is not a feasible idea, we look at other methods for finding out the value of closing stock.

How is the Value of Closing Stock Ascertained?

Physical Stock

Closing stock is the stock/goods unsold at the end of the accounting period.

The details relating to the physical stock would be readily available with the organisation only if the inventory records are being maintained by the organisation. In other cases the physical stock would have to be ascertained by stock taking.

Stock Value

There is no specific ledger account in financial accounting that would give us the information relating to the value of closing stock ready hand.

The value of closing stock is available ready hand only if inventory records are being maintained that too from the inventory records.

The value of Closing Stock is ascertained by Physical Verification of Stock on the last day of the accounting period and its valuation at Cost or Market Price (Net Realisable Value) whichever is lesser

This is the most common method for valuing the closing stock.

The information relating to the value of closing stock is not regularly required by the organisation. It is however required at the end of the accounting period for the purpose of evaluation of the Cost of Goods Sold.

Convention of Conservatism

Net Realisable Value of Stock

For the purpose of Valuation of closing Stock, Market Price implies Net Realisable Value/Rate and not the Selling Price.

Net Realisable Value of stock is the net sale realisation excluding all the expenses directly and exclusively relatable to the sale (Sale commission, Brokerage etc) from the Sale Realisation.

Therefore, in trying to ascertain the Market Price to be used for valuation, care should be taken to ensure that such expenses are deducted from the sales price to ascertain the net realisable value of stock.

Convention of Conservatism

By the Convention of Conservatism we take into consideration all those expenses and losses of which we are aware, even if they relate to the subsequent accounting periods.

The act of valuing closing stock at cost or market price is based on the "Convention of Conservatism".

Convention of Conservatism : Valuation of Closing Stock : Illustration

Following is the "Trading a/c" relating to an organisation, wherein the Closing Stock has been recorded at cost.

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,00094,000

By SalesBy Closing Stock

3,80,00036,000

4,16,000

4,16,000


Closing Stock details

The closing stock is made up of

Batch N :: 600 units valued at Rs. 36/unit with a total value of Rs. 21,600

Batch M :: 600 units valued at Rs. 24/unit with a total value of Rs. 14,400

Total 1,200 units with a total value of Rs. 36,000

Value here implies cost + direct expenses

The selling prices and the related expenses are

Batch N :: Rs. 50/unit

Batch M :: Rs. 50/unit [Regular price] Batch M :: Rs. 25/unit [Current price]

This stock represents an outdated model of the product and the present market conditions would enable the stock to be sold only at a price of Rs. 25 per unit.

The sales of all stocks are made through a dealer who would charge a commission of 10% of the sale proceeds.

Cost and Net Realisable Values of Closing Stock

From the available data, Closing stock can be valued at two different rates. Cost and Market Price (Net Realisable Rate).

600 units [Batch N]

i. Cost = Rs. 36/unit.

ii. Market Price = Rs. 50/unit.

iii. Expenses directly relatable to sale = Rs. 5/unit (10% of selling price = Rs. 50/unit 10%).

iv. Net Realisable Value = Rs. 45/unit [Market Price (Rs. 50/unit) Expenses relatable to sale (Rs. 5/unit)]

600 units [Batch M]

i. Cost = Rs. 24/unit.

ii. Market Price = Rs. 25/unit.

iii. Expenses directly relatable to sale = Rs. 2.50/unit (10% of selling price = Rs. 25/unit 10%).

iv. Net Realisable Value = Rs. 22.50/unit [Market Price (Rs. 25/unit) Expenses relatable to sale (Rs. 2.50/unit)].

Valuation of Closing Stock based on Convention of Conservatism

600 units [Batch N]

Cost = Rs. 36/unit. Net Realisable Rate = Rs. 45/unit.

Since Cost < Net Realisable Value, the goods are to be valued at cost. Value of 600 units is Rs. 21,600 (600 units Rs. 36/unit)

600 units [Batch M]

Cost = Rs. 24/unit. Net Realisable Rate = Rs. 22.50/unit.

Since Net Realisable Value < Cost, the goods are to be valued at the net realisable value. Value of 600 units is Rs. 13,500 (600 units Rs. 22.50/unit)

Value of Closing stock if valued at cost = Rs. 14,400 (600 units Rs. 24/unit)

The Closing Stock should be valued therefore at Rs. 35,100 (Rs. 21,600 + 13,500).

Trading a/c

If value of Closing Stock is taken based on the Convention of Conservatism, the Trading a/c would be

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,00093,100


3,80,00035,100

4,15,100

4,15,100

The Gross profit has gone down by Rs. 900 since closing stock is considered at a lesser value.

Role of Convention of Conservatism

The convention of conservatism asks us to take into consideration all those expenses and losses relating to the subsequent periods of which we are aware.

Future Losses

Where the Net realisable value of stock is less than its cost, the organisation may incur a loss.

In the above case, the organisation may have to incur a loss of Rs. 900 [Rs. 14,400 (cost) Rs. 13,500 (net realisable value)].

When?

This loss would have to be borne by the organisation if it sells the stock at the net realisable rate.

Since it is the end of the accounting period, such a sale at such a price, if at all it takes place, would be in the subsequent accounting period.

Thus, the organisation may have to incur this loss in the future.

Is the loss for sure?

The loss may have to be incurred in the future only if the stock has to be sold at Rs. 25 per unit (which gives a net realisation of Rs. 22.50).

We may consider such a loss a certainty in cases where the stock is required to be sold at the lower price on account of it becoming obsolete, losing demand etc.

Bu where the lower market rate is on account of normal market fluctuation and if the rates go up in the subsequent period and the product can be sold at a higher price, this loss need not be incurred.

How is the loss absorbed?

Based on the Convention of Conservatism, the loss though it may have to be incurred in the future period, is absorbed in the current period itself, since its information is known.

This will be the case where the lower valuation is on account of conditions which are certain (obsolete goods, demand going down etc).

Crediting a Nominal a/c implies gain

The value of closing stock is credited to the "Trading a/c". By the principle of credit in relation to nominal accounts (Credit all Incomes and Gains), we can assume the value to indicate a gain.

Reducing the value of closing stock would therefore amount to reducing the credit made to the Trading a/c, which would be reducing the gain. Debiting an amount is an equivalent of deducting the amount from the opposite side i.e. the credit side. Therefore, reducing the gain is the same as taking in additional loss.

Therefore, the loss is absorbed by considering the value of closing stock at a lesser value i.e. the net realisable value. [In the above example, by considering the closing stock at the lower value, the estimated loss of Rs. 900 relating to the subsequent accounting periods has been absorbed in the current period itself.]

Value of Closing Stock = Value of Opening Stock of the Subsequent Period

The Closing Stock a/c relating to an accounting period and the Opening Stock a/c relating to the subsequent accounting period represent the same account. Therefore, the value of the closing stock at the end of the accounting period and the opening stock at the beginning of the subsequent accounting period are the same.

Closing Stock a/c

The "Closing Stock a/c" is a real account and is created at the last moment of the accounting period.

It represents Stock as an asset. The balance in the "Closing Stock a/c" is carried forward to the next accounting periods.

Opening Stock a/c

The account that we name "Closing Stock a/c" is renamed "Opening Stock a/c" at the beginning of the next accounting period while bringing the values of assets and liabilities into the books of accounts with the help of an "Opening Entry".

This "Opening Stock a/c" is treated as an equivalent of a Nominal account.

Like other nominal accounts it is closed at the end of the accounting period. It is closed by transfer to the "Trading a/c" since it goes into the value of cost of goods sold.

Note

The value of Opening and Closing stocks relating to a particular accounting period do not mean the same. They are two indicated by distinct ledger accounts - Opening stock by "Opening Stock a/c" which is a nominal account and Closing stock by "Closing Stock a/c" which is a Real account.

They may or may not have the same values.

Recording the Value of Closing Stock

The valuation of closing stock and recording of the value of closing stock in the books are two different aspects.

After ascertaining the value of the closing stock, it is to be brought into the books of accounts.

The basic purpose of accounting is derivation of information and the more information we need the more the accounting heads we need to maintain.

For each additional piece of information that we intend to derive from the books of accounts, we create and use an additional ledger account.

Thus, to derive the information relating to Closing Stock we maintain a real account by name "Closing Stock a/c".

The "Closing Stock a/c" gives the information relating to the value of the stock (as an asset) unsold at the end of the accounting period.

Recording

The value of closing stock is not available ready hand in the books of accounts. It is specifically ascertained at the end of the accounting period by physical verification of stock and its valuation at cost or market price whichever is lower.

Thus, by recording the journal entry for Closing Stock, we are in effect bringing the value of Closing Stock into books.

Debit : Closing Stock a/c

Accounts representing assets are real accounts and show a debit balance. Since by recording the journal entry for bringing the value of closing stock into books, we are creating an asset by name "Closing Stock a/c" we debit that account.

[Closing Stock a/c Real a/c Debit what comes in.]

Credit :

There are three possible variations in the account to be credited for recording the value of closing stock.

i. Trading a/c

ii. Goods Consumed a/c

iii. Purchases a/c

The ledger account to be credited is dependent on which account is used to reflect the value of cost of goods sold as well as the time of recording the entry.

Recording Closing Stock Crediting Trading a/c

Total value of goods = Opening Stock + Purchases + Direct Expenses.

Particulars

Amount

Amount

Opening Stock(+)a) Purchases (Cost Value) b) Direct ExpensesTotal Value of Goods()a) Closing Stock (Value) b) Stock Unused for TradingCost of Goods Sold

2,48,000 54,000

36,000 14,000

20,000

3,02,0003,22,000

50,0002,72,000

Direct Incomes/Expenses transferred to Trading a/c

At the end of the accounting period, the balances (amounts) in all the ledger accounts which represent expenses which go into the value of goods/stock (direct expenses), are closed by transfer to the "Trading a/c".

This would result in the "Trading a/c" being debited with the total value of goods/stock. Show/Hide

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,000

3,22,000

3,22,000

Revealing/Reflecting Cost of Goods Sold

To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total value of goods.

Thus the value of closing stock has to be credited to the "Trading a/c" which has the total value of goods/stock existing in it as a debit balance. Show/Hide

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,000

By Cost of Goods Sold c/d By Closing Stock

2,86,00036,000

3,22,000

3,22,000

To Cost of Goods Sold b/d

2,86,000

Journal/Ledger

The Journal entry for recording the value of closing stock in such a case would be

Journal in the books of M/s ___ for the period from ____ to ____

Date

V/RNo.

Particulars

L/F

Debit Amount(in Rs)


31st Dec

Closing Stock a/c To Trading a/c

Dr

36,000

36,000

[For recording the value of Closing Stock in the books.]

Dr

Closing Stock a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To Trading a/c

36,000

By Bal c/d

36,000

36,000

36,000

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,00094,000


3,80,00036,000

4,16,000

4,16,000


Recording Closing Stock Crediting Goods Consumed a/c

Where the organisation intends to specifically identify the cost of goods consumed, a separate ledger account by name "Goods Consumed a/c" may be created and used for that purpose.

Direct Expenses transferred to Goods Consumed a/c

At the end of the accounting period, the balances (amounts) in all the ledger accounts which represent expenses which go into the value of goods/stock (direct expenses), are closed by transfer to the "Goods Consumed a/c".

This would result in the "Goods Consumed a/c" being debited with the total value of goods/stock. Show/Hide

Dr

Goods Consumed a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,000

3,22,000

3,22,000

Revealing/Reflecting Cost of Goods Sold

To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total value of goods.

Thus the value of closing stock has to be credited to the "Goods Consumed a/c" which has the total value of goods/stock existing in it as a debit balance. Show/Hide

Dr

Goods Consumed a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,000

By Trading a/c (?)By Closing Stock

2,86,00036,000

3,22,000

3,22,000

The amount transferred to the Trading account represents the Cost of Goods Sold

Journal/Ledger

The Journal entry for recording the value of closing stock in the books would be


Date

V/RNo.

Particulars

L/F

Debit Amount(in Rs)


31st Dec

Closing Stock a/c To Goods Consumed a/c

Dr

36,000

36,000


Dr

Goods Consumed a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,48,00054,000


2,86,00036,000

3,22,000

3,22,000

The balance in the "Goods Consumed a/c" represents the cost of goods sold and is transferred to the "Trading a/c" to ascertain the Gross Profit.

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To Goods ConsumedTo Gross Profit

2,86,00094,000

By Sales

3,80,000

3,80,000

3,80,000

Balance in Goods Consumed a/c not representing Cost of Goods Sold

The balancing figure in the "Goods Consumed a/c" transferred to the "Trading a/c" does not represent cost of goods sold, in the following cases

Direct Expenses Transferred to Trading a/c

Where the direct expenses have been transferred to the Trading a/c instead of the Goods Consumed a/c, the balancing figure in Goods Consumed a/c does not represent cost of goods sold.

Dr

Goods Consumed a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To Opening StockTo Purchases

20,0002,48,000


2,32,00036,000

2,68,000

2,68,000

Cost of Goods Sold implies the total value of goods sold which includes both cost of the goods (represented by purchases a/c balance) and direct expenses related to the goods.

Since Direct Expenses have not been debited to Goods Consumed a/c, the balancing figure represents the value of goods sold excluding direct expenses thereon.

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To Direct ExpensesTo Goods ConsumedTo Gross Profit

54,0002,32,00094,000

By Sales

3,80,000

3,80,000

3,80,000

Recording Closing Stock

Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited to either the Trading a/c or the Goods Consumed a/c.

The only precaution to be taken would be in interpreting the balancing figure value. It should not be considered as Cost of Goods Sold.

However, in such cases, it would be more appropriate to record the value of closing stock through the Trading a/c where the value includes both cost and direct expenses.

Exception

Recording Closing Stock through Goods Consumed a/c would be rational if its value does not include any part of the direct expenses incurred during the current period which have been debited to the Trading a/c.

Opening Stock transferred to Trading a/c

Where the balance in "Opening Stock a/c" has been transferred to the Trading a/c instead of the Goods Consumed a/c, the balancing figure in Goods Consumed a/c may not represent Cost of Goods Sold.

Dr

Goods Consumed a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To PurchasesTo Direct Expenses

2,48,00054,000


2,66,00036,000

3,12,000

3,12,000

The balance in the Goods Consumed a/c transferred to the Trading a/c represents the value of goods that have been purchased and sold away during the current period.

This does not include the value of opening stock that might also have been sold away. Thus this balance, cannot be called "cost of goods sold" though it represents value.

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)

To Opening StockTo Goods ConsumedTo Gross Profit

20,0002,66,00094,000

By Sales

3,80,000

3,80,000

3,80,000

Recording Closing Stock

Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited to either the Trading a/c or the Goods Consumed a/c.

The only precaution to be taken would be in interpreting the balancing figure value. It should not be considered as Cost of Goods Sold.

However, in such cases, it would be more appropriate to record the value of closing stock through the Trading a/c where the total value is debited ultimately.

Exception

Recording Closing Stock through Goods Consumed a/c would be rational closing stock includes only that stock which has been purchased during the current accounting period.

This would be the case where the quantity of closing stock is less than the quantity purchased during the current period and stock is being used up on FIFO basis.

Recording Closing Stock Crediting Purchases a/c

Where the following conditions exist, we can credit "Purchases a/c" with the value of closing stock.

Closing stock is physically relatable to the stock that has been purchased during the current period. [This would be the case where FIFO method is adopted for physical usage of stock]

There are no direct expenses in relation to the stock purchased during the current period (Or) The value of closing stock does not include the direct expenses incurred during the current period

Journal/Ledger

The Journal entry for recording the value of closing stock in the books would be


Date

V/RNo.

Particulars

L/F

Debit Amount(in Rs)


31st Dec

Closing Stock a/c To Purchases a/c

Dr

36,000

36,000


Dr

Purchases a/c

Cr

Date

Particulars

J/F

Amount(in Rs)

Date

Particulars

J/F

Amount(in Rs)

1st-31st

To Cash/Bank/Crs

2,48,000

31/12/0531/12/05

By Closing StockBy Trading a/c

36,0002,12,000

2,48,000

2,48,000

Dr

Trading a/c

Cr

Particulars

Amount(in Rs)

Particulars

Amount(in Rs)


20,0002,12,00054,00094,000

By Sales

3,80,000

3,80,000

3,80,000

Conventional use

Technically we can credit the value of closing stock to Purchases a/c only when the above conditions are satisfied.

The use of "Trading a/c" or "Goods Consumed a/c" for crediting the value of closing stock, is possible only if the journal entry for brining the value of closing stock into books is being recorded at the time of preparation of final accounts.

Where we are recording the value of closing stock in the accounting books before the preparation of final accounts, it is a convention that we credit "Purchases a/c" (on account of the absence of "Trading a/c" or "Goods Consumed a/c" for use).


Closing Stock a/c : Opening Stock a/c

The "Closing Stock a/c" and the end of an accounting period and the "Opening Stock a/c" at the beginning of the subsequent accounting period represent the same account.

At the End of an Accounting Period

The closing balances in all the ledger accounts are carried forward to the subsequent accounting periods.

Every ledger posting should have a journal support.

The journal entry that supports the carry forward of balances in ledger accounts is called the "Closing Entry".

Closing Entry

The journal entry for closing the books of accounts during an accounting period


Date

V/RNo.

Particulars

L/F

Debit Amount(in Rs)


31st Dec

Creditors a/c Bank Loan a/c Profit & Loss Appropriation a/c Capital a/c To Closing Stock a/c To Cash a/c To Debtors a/c To Furniture a/c

DrDrDrDr

48,00063,00054,0001,00,000

36,00042,0001,26,00061,000

[For the balances in the ledger accounts carried forward to the next accounting period.]

Closing Balance Sheet

The closing Balance Sheet is a statement of balances that are carried forward to the subsequent accounting periods.

Balance Sheet of M/s ______ as on the Last Day

Liabilities

Amount

Assets

Amount

CapitalProfit & Loss AppropriationCreditorsBank Loan

1,00,00054,00048,00063,000

CashClosing StockDebtorsFurniture

42,00036,0001,26,00061,000

2,65,000

2,65,000

At the beginning of the Subsequent Accounting Period

The opening balances in all the ledger accounts are brought forward from the previous accounting periods. Every ledger posting should have a journal support and the journal entry that supports the brining forward of balances in ledger accounts is called the "Opening Entry".

Opening Balance Sheet

The opening balance sheet of an accounting period and the closing balance sheet of the previous period are the same. This is something that is not specifically prepared.

Balance Sheet of M/s ______ as on the First Day

Liabilities

Amount

Assets

Amount

CapitalProfit & Loss AppropriationCreditorsBank Loan

1,00,00054,00048,00063,000

CashClosing StockDebtorsFurniture

42,00036,0001,26,00061,000

2,65,000

2,65,000

Opening Entry

The opening entry is based on the opening balance sheet.


Date

V/RNo.

Particulars

L/F

Debit Amount(in Rs)


31st Dec

Cash a/c Opening Stock a/c Debtors a/c Furniture a/c To Capital a/c To Profit & Loss Appropriation a/c To Bank Loan a/c To Creditors a/c

DrDrDrDr

42,00036,0001,26,00061,000

1,00,00054,00063,00048,000

[For the opening balances in the various ledger accounts brought forward into the books of accounts from the previous accounting period.]

Where the Opening Entry is being recorded, the phrase "Closing Stock" is replaced by the phrase "Opening Stock".

Closing Stock Adjustment during Final Accounting

The value of closing stock is ascertained through physical verification of the stock and its valuation at cost or market price whichever is lesser.

Thus recording the entries for brining in the value of closing stock into books may not be complete by the time trial balance is drawn up.

If the value of closing stock is not available (or is not recorded) by the time of making up the trial balance at the end of the accounting period, it would appear as a part of the transactions appended to the trial balance which are to be adjusted.

Adjustment is bringing in the effect of the transactions through mathematical operations of addition and subtraction. The adjustments to be made can be found out by ascertained the net effect of the journal entries to be recorded.

In adjusting the value of closing stock we consider the entry for recording the same to be the one where the Trading a/c or Purchases a/c is credited.

Where the closing stock is recorded by crediting its value to the Trading a/c

Entry

Effect

Dr. Closing Stock a/c Cr. Trading a/c

1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet 2. (+) Show the Value of Closing Stock on the Credit side of Trading a/c

Where the closing stock is recorded by crediting its value to Purchases a/c

Entry

Effect

Dr. Closing Stock a/c Cr. Purchases a/c

1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet 2. () Deduct the Value of Closing Stock from Purchases on the Debit side of Trading a/c

Where the closing stock is recorded by crediting Goods Consumed a/c

Entry

Effect

Dr. Closing Stock a/c Cr. Goods Consumed a/c

1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet 2. (+) Show the Value of Closing Stock on the Credit side Goods Consumed a/c

This assumption is generally avoided, where the value of closing stock has to be dealt with as an adjustment.

Closing Stock in Trial Balance Interpretation

Where "Closing Stock a/c" is present in the Trial Balance, it is an indication of the Journal entry for recording the value of closing stock has already been recorded.

Dealing with Closing Stock a/c

The "Closing Stock a/c" represents an asset and is thus a Real account.

Since an item appearing in the "Trial Balance" has to be dealt with only once based on its nature, the Closing Stock a/c appearing in the trial balance is shown on the assets side of the Balance Sheet.

The balance in all the real accounts is carried forward to the subsequent accounting periods. All such accounts whose balances are carried forward to the subsequent accounting periods are listed in the Balance Sheet as at the end of the accounting period. Thus all the real account balances are shown on the assets side of the balance sheet.

What was the Journal Entry used?

The Journal entry used for recording the value can be identified/assumed depending on what ledger accounts are present in the Trial Balance

Trading a/c appears in the Trial Balance

Trial Balance of M/s ___ " as on 30th June 2005

Particulars

L/F

Debit Amount(in Rs)


Opening Stock a/c Purchases a/c Closing Stock a/c Trading a/c

20,000 2,48,000

36,000

36,000

Total

xxx

xxx

Where Closing Stock a/c and Trading a/c appear in Trial Balance

Dr. Closing Stock a/c Cr. Trading a/c

The entry used for recording the value of closing stock.

Trading a/c does not appear, but Purchases a/c appears in the Trial Balance


Particulars

L/F

Debit Amount(in Rs)


Opening Stock a/c Purchases a/c Closing Stock a/c

20,000 2,12,000

36,000

Total

xxx

xxx

Where Closing Stock a/c and Purchases a/c appear in Trial Balance

Dr. Closing Stock a/c Cr. Purchases a/c


Both Trading a/c and "Purchases a/c" do not appear in the Trial Balance


Particulars

L/F

Debit Amount(in Rs)


Goods Consumed Closing Stock a/c

2,32,000

36,000

Total

xxx

xxx

Where Purchases a/c and Trading a/c do not appear in the Trial Balance and

Where Closing Stock a/c and Goods Consumed a/c appear in Trial Balance

Dr. Closing Stock a/c Cr. Goods Consumed a/c


Purchases and Sales Return a/c's

Each ledger account provides one or more pieces of information. To enable derivation of additional information relating to returns of goods/stock, we record the transactions relating to purchase returns as well as sales returns using Purchase Returns a/c and Sales Returns a/c respectively.

Purchases Returns a/c

Purchase Returns a/c is a nominal account. It provides the information relating to the value of goods/stock returned to the seller from whom the stock has been purchased.

Being a nominal account, this account is closed at the end of the accounting period.

Sales Returns a/c

Sales Returns a/c is a nominal account. It provides the information relating to the value of goods/stock returned by the buyers to whom the stock has been sold.

Being a nominal account, this account is closed at the end of the accounting period.

Gross Purchases and Gross Sales

The Purchase Returns a/c and the Sales Returns a/c provide information relating t

Date post:	17-Nov-2015
Category:	Documents
Upload:	andrew-brown
View:	34 times
Download:	1 times

Trial Balance FinalAccounts Concepts

Documents