Preparation of Final Accounts
(The Grand Finale — Trading A/c, P&L A/c & Balance Sheet!)
You’ve learned journal, ledger, trial balance, adjustments. Now it’s time for the BIG PICTURE — the FINAL accounts! Trading Account shows Gross Profit. P&L Account shows Net Profit. Balance Sheet shows the financial position. These 3 statements tell the COMPLETE story of a business.
Banky Prepares the Report Card of a Business! 📊
Everything Banky learned so far — journal entries, ledger posting, trial balance, adjustments, depreciation — was leading to THIS moment. Now he’ll prepare the actual Trading A/c, P&L A/c, and Balance Sheet. This is what borrowers show to banks when they want a loan!
Why is This the MOST Important Chapter?
Exam
5–8 questions! Adjustment entries, COGS formula, Gross vs Net profit, closing stock valuation, FIFO vs Weighted Avg, P&L Appropriation. HIGHEST weightage!
Core Banking
Every loan proposal has P&L + BS. Every audit checks these. Every credit review analyses these. This IS your job.
Life Skill
Even your family budget follows this logic: Income − Expenses = Savings (P&L). House + Car + FD = Loans + Own Money (BS).
The Full Chapter — Step by Step
Part 1 — The Complete Process Flow
Step 1 — Trial Balance: List all ledger account balances (debit & credit). This is NOT a financial statement — it’s just a CHECKLIST to ensure arithmetic accuracy.
Step 2 — Adjustment Entries: Before preparing final accounts, pass adjustments for: (a) Outstanding expenses (incurred but not paid — debit expense, credit payable), (b) Prepaid expenses (paid but not yet incurred — the portion not used is an asset), (c) Accrued income (earned but not received — debit receivable, credit income), (d) Income received in advance (received but not yet earned — debit income, credit advance received), (e) Depreciation (debit depreciation, credit asset), (f) Closing stock valuation. AS-1 and Ind AS-1 require ACCRUAL basis for all statements (except cash flow).
Step 3 — Trading Account: Calculate Gross Profit. Step 4 — P&L Account: Calculate Net Profit. Step 5 — Balance Sheet: Show financial position.
Part 2 — Trading Account = Gross Profit
The Trading Account calculates the Gross Profit — profit from JUST buying and selling goods (before office expenses).
Gross Profit = Sales − Cost of Goods Sold
Debit Side (Costs): Opening Stock, Purchases (less returns), Carriage Inward, Freight, Dock Charges, Wages, Duty, Clearing Charges — all DIRECT costs related to buying/making goods.
Credit Side (Revenue): Sales (less returns), Closing Stock. The difference = Gross Profit (if credit > debit) or Gross Loss (if debit > credit). Gross Profit is transferred to the P&L Account.
Closing Stock: NOT available from the ledger! You must physically count and VALUE the inventory. Valued at LOWER of cost or net realisable value (conservatism). Ind AS 2 permits only FIFO or Weighted Average method. LIFO is NOT permitted!
Part 3 — P&L Account = Net Profit
The P&L Account takes the Gross Profit and subtracts ALL remaining expenses to find the Net Profit.
Debit Side (Expenses): Salaries, Electricity, Telephone, Conveyance, Office Charges, Depreciation, Taxes, Other Indirect Expenses.
Credit Side (Income): Gross Profit (from Trading A/c), any other income (interest received, commission, rent received). The difference = Net Profit (transferred to Balance Sheet) or Net Loss.
P&L Appropriation Account: A SEPARATE account showing how Net Profit is DISTRIBUTED — transfer to General Reserve, Dividend declared, balance carried forward. Dividends are paid from HERE, not from P&L Account!
Part 4 — Balance Sheet = Financial Position Snapshot
The Balance Sheet shows what the business OWNS (assets) and what it OWES (liabilities + capital) on a specific date. It’s a SNAPSHOT — like a photograph at one moment in time.
How is it prepared? After transferring all nominal accounts (expenses/income) to P&L, only PERSONAL and REAL accounts remain in the ledger. These remaining balances, plus Net Profit from P&L, form the Balance Sheet. Debit balances = Assets. Credit balances = Liabilities.
Key insight: Net Profit goes to LIABILITIES side (owner’s claim increases). Net Loss goes to ASSETS side (reduces owner’s claim).
Cash Flow Statement: Prepared using BS and P&L data. Governed by AS-3 and Ind AS-7. Covered in Chapter 16.
Exam-Ready Points
Must Remember!
- Trial Balance is NOT a financial statement. It’s just a checklist for arithmetic accuracy.
- Adjustment Entries: Convert records from cash basis to ACCRUAL basis. Required by AS-1 / Ind AS-1.
- 4 types of adjustments (OPAI): Outstanding expenses, Prepaid expenses, Accrued income, Income received in advance.
- Depreciation entry: Made WITHOUT any financial transaction — it’s a BOOK entry only. Does NOT affect cash.
- Closing Stock: NOT available from ledger. Must be physically counted and valued. Debit Stock A/c, Credit Trading A/c.
- Stock valuation: Lower of cost or NRV. Ind AS 2 permits FIFO or Weighted Average ONLY. LIFO is NOT permitted!
- COGS formula: Opening Stock + Purchases + Direct Expenses − Closing Stock
- Gross Profit = Sales − COGS. Appears in Trading Account. Transferred to P&L.
- Net Profit = Gross Profit + Other Income − All Indirect Expenses. Appears in P&L Account.
- P&L Appropriation: Shows distribution of profit — reserves, dividends, carry forward. Dividends declared HERE.
- Closing entries: Transfer ALL income/expense accounts to P&L. Their balance becomes NIL.
- Balance Sheet: Only Personal + Real account balances remain. Plus Net Profit from P&L.
- Net Profit → Liabilities side (owner’s claim increases). Net Loss → deducted from Capital.
- Overvaluation of closing stock = INFLATED profit. Undervaluation = understated profit.
- At year-end, balances of ALL income & expenditure accounts are transferred to P&L (not all ledger accounts!).
Past Exam Questions
Memory Tricks
Trick 1 — Process Flow
Trial Balance → Adjustments → Trading →
Profit & Loss → Balance Sheet
Trick 2 — COGS Formula
CLOSE the stock!”
Opening + Purchases + Expenses − Closing
= Cost of Goods SOLD!
Trick 3 — Trading vs P&L
P&L = NET profit (after ALL expenses)
Gross is always greater-or-equal to Net!
Trick 4 — Closing Stock
Ledger doesn’t know how many are left!
Physically COUNT + VALUE
Lower of Cost or NRV!”
Trick 5 — FIFO vs LIFO
FIFO = First In First Out (allowed)
Weighted Average (allowed)
LIFO = Last In First Out (BANNED!)
Trick 6 — P&L Appropriation
Appropriation = HOW you CUT it!
Slice 1 → Reserves
Slice 2 → Dividends
Slice 3 → Carry Forward”
Trick 7 — BS = Photo, P&L = Video
P&L = VIDEO (whole year)”
Trick 8 — 4 Adjustments
Accrued, Income-in-advance”
Convert cash basis to accrual basis!
The Whole Chapter in One Picture
Last-Minute Flash Cards
Module B Chapter 2 (Unit 13) Done!
- Process: Trial Balance → Adjustments → Trading A/c (Gross Profit) → P&L (Net Profit) → Balance Sheet.
- COGS: Opening Stock + Purchases + Direct Expenses − Closing Stock. Gross Profit = Sales − COGS.
- Closing Stock: Physical count + value. Lower of cost/NRV. FIFO or Weighted Avg only (Ind AS 2). No LIFO!
- 4 Adjustments (OPAI): Outstanding, Prepaid, Accrued income, Income in advance. Accrual basis (Ind AS-1).
- P&L Appropriation: Where dividends are declared. Not P&L Account itself.
- Balance Sheet: Snapshot on a date. Only Personal & Real accounts + Net Profit/Loss.
Banky says: “TB to Adjust to Trading to PandL to BS! LIFO Left India! Dividends from APPROPRIATION, not PandL! Now I can PREPARE and READ financial statements!”
Next: Chapter 14 — Company Accounts Part I (Types of companies, shares, issue of shares)!