Financial Statements – II

Introduction

This chapter extends the preparation of financial statements by covering more complex adjustments that must be incorporated before the final accounts are deemed complete. It also formally introduces the Balance Sheet as a statement of financial position.

---

Balance Sheet

• A Balance Sheet is a statement showing the financial position of a business on a specific date. It is not an account; it is a statement. It lists:
• On the Liabilities side: Capital, long-term loans, current liabilities.
• On the Assets side: Fixed assets, current assets, miscellaneous expenditure.

Order of presenting assets (in order of permanence):
Fixed Assets → Investments → Current Assets → Loans & Advances → Miscellaneous Expenditure

Accounting Equation:
Assets = Liabilities + Capital

This equation must always hold, and thus the two sides of the Balance Sheet must always be equal.

---

Key Adjustments in Financial Statements

The following adjustments are commonly required. Each one affects two places — once in the Trading/P&L Account and once in the Balance Sheet.

• 1. Interest on Capital
• Entry: Debit Interest on Capital (P&L expense); Credit Capital Account.
• Balance Sheet: Add Interest on Capital to Capital before showing in liabilities.
• P&L: Debit side — Interest on Capital.

• 2. Interest on Drawings
• Entry: Debit Drawings Account; Credit Interest on Drawings (P&L income).
• Balance Sheet: Deduct Interest on Drawings from Capital (or add to Drawings).
• P&L: Credit side — Interest on Drawings.

• 3. Manager's Commission
• If commission is on Net Profit before commission: Commission = Net Profit x Rate / 100
• If commission is on Net Profit after commission: Commission = Net Profit x Rate / (100 + Rate)
• Shown on debit side of P&L and as a current liability in Balance Sheet.

• 4. Depreciation
• Debit P&L Account; deduct from respective asset in Balance Sheet.
• If not already in Trial Balance, it is an additional adjustment.

• 5. Provision for Doubtful Debts (when given as adjustment)
• Step 1: Adjust bad debts in TB; Step 2: Create new provision on net debtors; Step 3: Adjust for existing provision.
• Amount charged to P&L = New Provision + Additional Bad Debts - Existing Provision.
• Net Debtors in Balance Sheet = Gross Debtors - Bad Debts Written Off - New Provision.

• 6. Abnormal Loss (e.g., Loss by Fire/Theft)
• Loss credited in Trading Account (to remove from cost); amount shown in P&L as abnormal loss.
• If partially insured: Insurance claim (asset/income) and uninsured loss (P&L expense) are separated.

• 7. Goods Distributed as Free Samples
• Debit Advertisement Account (P&L); Credit Purchases Account.
• This reduces purchases and shows the cost as an advertising expense.

• 8. Goods Given as Charity
• Debit Charity Account (P&L expense); Credit Purchases Account.

---

Capital Account Adjustments

The final Capital shown in the Balance Sheet is calculated as:

Opening Capital
+ Net Profit (or - Net Loss)
+ Additional Capital Introduced
+ Interest on Capital
- Drawings
- Interest on Drawings
= Closing Capital

---

Marshalling of Balance Sheet

1. 1.Marshalling means arranging assets and liabilities in a specific order:
2. 2.In order of Liquidity (current assets first, fixed assets last) — common in the UK and for sole traders.
3. 3.In order of Permanence (fixed assets first, current assets last) — preferred in India and for companies.

---

Worked Examples

---

• When interest on capital is given as an adjustment, it must appear both in P&L (debit) and added to capital in the Balance Sheet — beginners often add it to capital but forget the P&L debit.
• Manager's commission "after commission" requires the formula x Rate/(100+Rate) — using x Rate/100 gives the "before commission" answer.
• Forgetting to deduct the existing provision for bad debts when calculating the amount to charge to P&L.
• Confusion between goods taken by proprietor (credit Purchases, debit Drawings) and goods given as charity (credit Purchases, debit Charity/Advertisement).

---

Financial Statements – II reinforces the mechanics of adjustments and their dual impact on the P&L and Balance Sheet. The Balance Sheet, prepared after the P&L, presents the true financial position with all adjusted figures. Mastery of adjustments — especially interest on capital/drawings, manager's commission, and complex bad-debt provisions — is essential for board examinations.