Preparing final accounts is a crucial process for businesses to evaluate their financial performance. Final accounts refer to the financial statements prepared at the end of an accounting period, such as Trading Account, Profit and Loss Account, and Balance Sheet. In this post, we will explore the complete process of preparing final accounts.
Introduction to Final Accounts
Final accounts include:
- Trading account
- Profit and loss account/income statement
- Balance sheet
- Notes and schedules
These statements provide an overview of the business's financial position and profitability during an accounting period. They are prepared using double entry bookkeeping based on journal entries and trial balance.
Steps to Prepare Final Accounts
Follow these steps to prepare complete final accounts:
1. Post All Transactions to Ledger
Record all business transactions in chronological order in appropriate ledger accounts under suitable heads. This includes sales, purchases, expenses, capital, and more.
2. Extract Trial Balance
Prepare a trial balance listing all general ledger account balances on a certain date. This checks the accuracy of accounting entries.
3. Make Adjusting Entries
Record adjusting journal entries for accruals, prepayments, provisions, depreciation, and outstanding expenses.
4. Prepare Trading Account
Trading account shows the direct costs involved in buying and selling goods. Key elements are purchases, sales, stock, and direct expenses.
5. Prepare Profit and Loss Account
Profit and loss account starts with the gross profit figure transferred from trading account. All indirect incomes and expenses are then listed.
6. Prepare Balance Sheet
Balance sheet presents business assets and liabilities on a specific date. Assets - property owned. Liabilities - debts owed. Difference is capital.
7. Add Notes and Schedules
Notes provide additional information on significant items. Schedules break down components of key balances like fixed assets.
8. Perform Ratio Analysis
Use ratios like gross margin, ROCE, inventory turnover, current ratio to analyze profitability, efficiency, liquidity.
Trading Account Format
A trading account follows this structure:
- Sales
- Less: returns
- Net sales
- Less: cost of goods sold
- Opening stock
- Add: Purchases
- Less: Purchase returns
- Closing stock
- Gross profit (transferred to P&L)
Additional direct expenses like carriage, customs, dock charges are then deducted.
Profit and Loss Account Format
A typical profit and loss account format is:
- Gross profit (from trading account)
- Add: Other incomes like commission, rent
- Less: Indirect expenses like salaries, electricity
- Less: Depreciation
- Less: Interest
- Add/less: Exceptional incomes/losses
- Net profit before tax
- Less: Tax provision
- Net profit after tax
Balance Sheet Format
A standard balance sheet structure is:
Liabilities
- Share capital
- Reserves and surplus
- Long term loans
- Current liabilities
Assets
- Fixed assets
- Investments
- Current assets
- Stock
- Debtors
- Cash
- Loans and advances
Total Liabilities = Total Assets
Final Review
- Cross-check totals of trading, profit/loss, and balance sheet.
- Validate links between statements like gross profit carried over.
- Review accounting policies and valuation methods used.
- Check all calculations, postings, and adjustments.
- Confirm balances between ledger and trial balance.
Conclusion
Preparing accurate, complete final accounts is critical for informed business decisions. It provides clarity on profitability, liquidity, capital position, and performance trends. Following systematic accounting processes and standards ensures accounts present a true and fair view. With practice, accountants can develop expertise in compiling final accounts efficiently.
