CBSE Class 11 Accountancy Chapter 9: Financial Statements I
Chapter Overview
Financial statements are the end products of the accounting process. After all transactions are recorded in the journal, posted to the ledger, and a Trial Balance is prepared, the final step is to prepare the financial statements. These statements tell the business owner, investors, creditors, and other stakeholders how the business performed and where it stands financially.
This chapter covers the preparation of:
1. Trading Account — to find Gross Profit or Gross Loss 2. Profit and Loss Account — to find Net Profit or Net Loss 3. Balance Sheet — to show the financial position on a particular date
For manufacturing concerns, an additional account — the Manufacturing Account — is prepared before the Trading Account.
Meaning and Importance of Financial Statements
Financial statements are formal, structured records of the financial activities and position of a business. They are prepared at the end of the accounting period (usually a year).
Importance
1. Assess profitability: The Trading and P&L Accounts show how much profit or loss the business has earned.
2. Assess financial position: The Balance Sheet shows what the business owns (assets) and owes (liabilities) at a point in time.
3. Decision-making: Owners, managers, investors, and creditors use financial statements to make informed decisions.
4. Legal compliance: Companies are legally required to prepare financial statements under the Companies Act.
5. Tax assessment: Income tax authorities use financial statements to determine tax liability.
6. Credit assessment: Banks and lenders use them to evaluate creditworthiness before granting loans.
7. Comparison: Financial statements enable comparison with previous years and with other businesses.
8. Managerial control: They help management monitor costs, revenues, and overall performance.
Users of Financial Statements
Different stakeholders use financial statements for different purposes:
| User | Purpose |
|---|---|
| Owners | To assess profitability and return on investment |
| Management | For planning, controlling, and decision-making |
| Creditors/Suppliers | To assess the ability to repay debts |
| Banks/Lenders | To evaluate creditworthiness before lending |
| Investors | To decide whether to invest or withdraw |
| Government/Tax Authorities | For tax assessment and regulatory compliance |
| Employees | To assess job security and wage demands |
| Researchers/Analysts | For economic and financial analysis |
Trading Account
The Trading Account shows the results of trading activities — the gross profit earned or gross loss incurred. It matches the cost of goods sold with the sales revenue during the accounting period.
Purpose
- To find Gross Profit or Gross Loss
- To calculate the cost of goods sold (COGS)
- To assess the efficiency of trading operations
- To calculate gross profit ratio (Gross Profit / Net Sales x 100)
Format
Trading Account for the year ended [Date]
| Dr. | Rs | Cr. | Rs |
|---|---|---|---|
| Opening Stock | xxx | Sales | xxx |
| Purchases | xxx | Less: Returns Inward | (xxx) |
| Less: Returns Outward | (xxx) | Net Sales | xxx |
| Net Purchases | xxx | Closing Stock | xxx |
| Direct Expenses: | |||
| Wages | xxx | ||
| Carriage Inwards | xxx | ||
| Freight Inwards | xxx | ||
| Factory Rent | xxx | ||
| Gas, Fuel, Power | xxx | ||
| Factory Lighting | xxx | ||
| Octroi/Duty | xxx | ||
| Gross Profit c/d | xxx | ||
| (transferred to P&L A/c) | |||
| Total | xxx | Total | xxx |
If Gross Loss: it appears on the credit side and is transferred to the P&L A/c debit side.
Items on the Debit Side
1. Opening Stock: Value of goods unsold at the beginning of the year 2. Net Purchases: Purchases - Returns Outward (Purchase Returns) 3. Direct Expenses: Expenses incurred to bring goods to the place of business and make them saleable
- Wages (factory)
- Carriage Inwards / Freight Inwards
- Factory Rent, Factory Lighting
- Gas, Fuel, Power (factory)
- Octroi, Import Duty, Excise Duty
- Royalty on production
Items on the Credit Side
1. Net Sales: Total Sales - Returns Inward (Sales Returns) 2. Closing Stock: Value of goods unsold at the end of the year (at cost or market price, whichever is lower)
Cost of Goods Sold (COGS) Formula
Or rearranged:
Manufacturing Account
For manufacturing concerns (factories), a Manufacturing Account is prepared before the Trading Account. It calculates the cost of production of goods manufactured during the year.
Purpose
- To find the cost of production of goods manufactured
- To separate manufacturing costs from trading/selling costs
- To transfer the cost of production to the Trading Account
Format
Manufacturing Account for the year ended [Date]
| Dr. | Rs | Cr. | Rs |
|---|---|---|---|
| Raw Materials: | Sale of Scrap | xxx | |
| Opening Stock | xxx | Cost of Production | |
| Purchases | xxx | (transferred to Trading A/c) | xxx |
| Less: Returns | (xxx) | ||
| Less: Closing Stock | (xxx) | ||
| Raw Materials Consumed | xxx | ||
| Direct Wages | xxx | ||
| Factory Power/Fuel/Gas | xxx | ||
| Factory Rent | xxx | ||
| Factory Lighting | xxx | ||
| Factory Insurance | xxx | ||
| Depreciation on Factory Machinery | xxx | ||
| Royalty on Production | xxx | ||
| Work-in-Progress: | |||
| Opening WIP | xxx | ||
| Less: Closing WIP | (xxx) | ||
| Total | xxx | Total | xxx |
Cost of Production Formula
The Cost of Production is then transferred to the Trading Account debit side (in place of purchases, since the business produces goods rather than buying them).
Profit and Loss Account
The Profit and Loss Account shows the net profit earned or net loss incurred during the accounting period. It starts with the Gross Profit (or Gross Loss) from the Trading Account and considers all indirect expenses and indirect incomes.
Format
Profit and Loss Account for the year ended [Date]
| Dr. | Rs | Cr. | Rs |
|---|---|---|---|
| Gross Loss b/d | xxx | Gross Profit b/d | xxx |
| Indirect Expenses: | Indirect Incomes: | ||
| Salaries | xxx | Discount Received | xxx |
| Rent (Office) | xxx | Commission Received | xxx |
| Interest Paid | xxx | Interest Received | xxx |
| Discount Allowed | xxx | Rent Received | xxx |
| Commission Paid | xxx | Dividend Received | xxx |
| Insurance Premium | xxx | Profit on Sale of Asset | xxx |
| Postage & Telegram | xxx | ||
| Printing & Stationery | xxx | ||
| Telephone Charges | xxx | ||
| Travelling Expenses | xxx | ||
| Repairs & Maintenance | xxx | ||
| Depreciation | xxx | ||
| Bad Debts | xxx | ||
| Provision for Doubtful Debts | xxx | ||
| Provision for Discount on Debtors | xxx | ||
| Carriage Outwards | xxx | ||
| Advertising | xxx | ||
| Godown Rent | xxx | ||
| Distribution Expenses | xxx | ||
| Loss on Sale of Asset | xxx | ||
| Net Profit (transferred to Capital A/c) | xxx | ||
| Total | xxx | Total | xxx |
Items on the Debit Side (Indirect Expenses)
All expenses that are not directly related to production or purchase of goods:
- Administrative expenses: Salaries, Rent (office), Insurance, Printing & Stationery, Postage, Telephone
- Selling & Distribution expenses: Advertising, Carriage Outwards, Commission (sales), Godown Rent
- Financial expenses: Interest Paid, Discount Allowed, Bank Charges
- Depreciation: On all fixed assets
- Provisions: Bad Debts, Provision for Doubtful Debts, Provision for Discount on Debtors
- Losses: Loss on Sale of Asset
Items on the Credit Side (Indirect Incomes)
All incomes that are not directly from sales of goods:
- Discount Received
- Commission Received
- Interest Received
- Rent Received
- Dividend Received
- Profit on Sale of Asset
- Apprentice Premium
Balance Sheet
A Balance Sheet is a statement (not an account) that shows the assets and liabilities of a business at a particular date. It follows the fundamental accounting equation:
Assets = Liabilities + Capital
Important Points
1. It is a statement, not an account (no Dr./Cr. sides) 2. It is prepared as on a particular date (not "for the year ended") 3. It shows the financial position at a point in time 4. The two sides must always tally (Assets = Liabilities + Capital) 5. Closing stock is shown on the assets side (not in Trading Account in the Balance Sheet method)
Format: Order of Liquidity
Assets are arranged from most liquid to least liquid. Liabilities are arranged from most urgent to least urgent.
Balance Sheet as on [Date]
| Liabilities | Rs | Assets | Rs |
|---|---|---|---|
| Current Liabilities: | Current Assets: | ||
| Bank Overdraft | xxx | Cash in Hand | xxx |
| Bills Payable | xxx | Cash at Bank | xxx |
| Sundry Creditors | xxx | Bills Receivable | xxx |
| Outstanding Expenses | xxx | Sundry Debtors | xxx |
| Income Received in Advance | xxx | Less: Provision for DD | (xxx) |
| Accrued Income | xxx | ||
| Long-term Liabilities: | Short-term Investments | xxx | |
| Bank Loan | xxx | Closing Stock | xxx |
| Mortgage Loan | xxx | Prepaid Expenses | xxx |
| Fixed Liabilities: | Fixed Assets: | ||
| Capital | xxx | Goodwill | xxx |
| Add: Net Profit | xxx | Land and Building | xxx |
| Less: Drawings | (xxx) | Plant and Machinery | xxx |
| Furniture and Fixtures | xxx | ||
| Patents and Trademarks | xxx | ||
| Long-term Investments | xxx | ||
| Total | xxx | Total | xxx |
Format: Order of Permanence
Assets are arranged from least liquid to most liquid (fixed assets first). Liabilities are arranged from least urgent to most urgent (capital first).
Balance Sheet as on [Date]
| Liabilities | Rs | Assets | Rs |
|---|---|---|---|
| Capital | xxx | Goodwill | xxx |
| Add: Net Profit | xxx | Land and Building | xxx |
| Less: Drawings | (xxx) | Plant and Machinery | xxx |
| Long-term Loans | xxx | Furniture and Fixtures | xxx |
| Bank Loan | xxx | Patents and Trademarks | xxx |
| Long-term Investments | xxx | ||
| Current Liabilities: | Current Assets: | ||
| Sundry Creditors | xxx | Closing Stock | xxx |
| Bills Payable | xxx | Sundry Debtors | xxx |
| Outstanding Expenses | xxx | Less: Provision for DD | (xxx) |
| Bills Receivable | xxx | ||
| Short-term Investments | xxx | ||
| Accrued Income | xxx | ||
| Prepaid Expenses | xxx | ||
| Cash at Bank | xxx | ||
| Cash in Hand | xxx | ||
| Total | xxx | Total | xxx |
Classification of Assets
| Type | Examples | Characteristics |
|---|---|---|
| Fixed Assets | Land, Building, Machinery, Furniture, Goodwill, Patents | Held for long-term use, not for sale |
| Current Assets | Cash, Bank, Debtors, Stock, Bills Receivable, Prepaid Expenses | Expected to be converted to cash within a year |
| Tangible Assets | Land, Building, Machinery, Cash, Stock | Have physical existence |
| Intangible Assets | Goodwill, Patents, Trademarks, Copyrights | No physical existence but have value |
| Fictitious Assets | Preliminary Expenses, Discount on Issue of Shares | Not real assets, represent accumulated losses/debits |
Classification of Liabilities
| Type | Examples | Characteristics |
|---|---|---|
| Fixed/Long-term Liabilities | Bank Loan, Mortgage, Debentures | Payable after more than one year |
| Current Liabilities | Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses | Payable within one year |
| Contingent Liabilities | Pending court cases, Guarantee given | May become actual liability in future |
Treatment of Adjustments (Brief Introduction)
Adjustments are additional information given outside the Trial Balance that must be incorporated into the final accounts. They affect both the Trading/P&L Account and the Balance Sheet.
Common adjustments (detailed treatment in Chapter 10):
1. Closing Stock: Credited in Trading A/c, shown as asset in Balance Sheet 2. Outstanding Expenses: Added to expense in P&L A/c, shown as liability in Balance Sheet 3. Prepaid Expenses: Deducted from expense in P&L A/c, shown as asset in Balance Sheet 4. Accrued Income: Added to income in P&L A/c, shown as asset in Balance Sheet 5. Income Received in Advance: Deducted from income in P&L A/c, shown as liability in Balance Sheet 6. Depreciation: Debited in P&L A/c, deducted from asset in Balance Sheet 7. Bad Debts: Debited in P&L A/c, deducted from Debtors in Balance Sheet 8. Provision for Doubtful Debts: Debited in P&L A/c, deducted from Debtors in Balance Sheet 9. Interest on Capital: Debited in P&L A/c, added to Capital in Balance Sheet 10. Interest on Drawings: Credited in P&L A/c, deducted from Capital in Balance Sheet
Grouping and Marshalling of Assets and Liabilities
Grouping
Grouping means putting items of similar nature under a common heading. For example:
- "Sundry Debtors" may include several individual debtor accounts
- "Current Assets" groups Cash, Bank, Debtors, Stock, etc.
- "Current Liabilities" groups Creditors, Bills Payable, Outstanding Expenses, etc.
Marshalling
Marshalling means arranging items in a specific order on the Balance Sheet.
Two methods:
1. Order of Liquidity: Most liquid items first
- Assets: Cash, Bank, Debtors, Stock, Investments, Land
- Liabilities: Bank Overdraft, Creditors, Bills Payable, Loans, Capital
2. Order of Permanence: Most permanent items first
- Assets: Land, Building, Machinery, Furniture, Investments, Stock, Debtors, Bank, Cash
- Liabilities: Capital, Loans, Bills Payable, Creditors, Bank Overdraft
Note: Companies usually follow the Order of Permanence. Sole proprietors and partnerships may follow either method, but the Order of Liquidity is more common for small businesses.
Common Mistakes Students Make
1. Showing Closing Stock in Trading Account only: Closing Stock must appear on the credit side of the Trading Account AND on the assets side of the Balance Sheet. (In the adjusted purchase method, it is shown differently — but in the standard method, it appears in both places.)
2. Confusing direct and indirect expenses: Wages, Carriage Inwards are direct (Trading A/c). Salaries, Rent (office), Advertising are indirect (P&L A/c).
3. Wrong side of Gross Profit: Gross Profit is on the debit side of the Trading Account (balancing figure) and brought down to the credit side of the P&L Account.
4. Treating Balance Sheet as an account: A Balance Sheet has two sides — Liabilities and Assets — but it is a statement, not an account. Do not label sides as Dr. and Cr.
5. Forgetting to show adjustments in two places: Every adjustment affects two places — the P&L side and the Balance Sheet side. Students often show it only once.
6. Not deducting Drawings from Capital: In the Balance Sheet, Drawings must be deducted from Capital and Net Profit must be added.
7. Wrong classification of expenses: Carriage Inwards = Trading A/c; Carriage Outwards = P&L A/c. Factory Rent = Trading A/c; Office Rent = P&L A/c.
Exam Tips
1. Practice full problems: The most common exam question is a comprehensive problem where you prepare the Trading A/c, P&L A/c, and Balance Sheet from a Trial Balance with adjustments.
2. Learn the adjustment treatment: Each adjustment has a double effect. Memorise the standard treatment for each type.
3. Check the Balance Sheet totals: If the two sides don't tally, re-check:
- Did you add Net Profit to Capital?
- Did you deduct Drawings from Capital?
- Did you show all adjustments in both places?
4. Classify expenses correctly:
- Factory-related = Direct = Trading Account
- Office/selling-related = Indirect = P&L Account
5. Closing Stock valuation: Closing Stock is valued at cost or market price, whichever is lower. This is the prudence (conservatism) principle.
6. Manufacturing Account: If the question involves a manufacturing concern, prepare the Manufacturing Account first, then transfer the cost of production to the Trading Account.
7. Order of preparation: Manufacturing Account → Trading Account → P&L Account → Balance Sheet.
8. Time management: These problems are long. Allocate time wisely and do not spend too much on any one part.
Quick Revision Notes
- Financial Statements = Trading A/c + P&L A/c + Balance Sheet
- Trading Account → Gross Profit/Loss (direct expenses matched with sales)
- P&L Account → Net Profit/Loss (indirect expenses and incomes)
- Balance Sheet → Financial position (Assets = Liabilities + Capital)
- Manufacturing Account → Cost of Production (for manufacturing concerns)
- COGS = Opening Stock + Net Purchases + Direct Expenses - Closing Stock
- Gross Profit = Net Sales - COGS
- Net Profit = Gross Profit + Indirect Incomes - Indirect Expenses
- Direct expenses: Wages, Carriage In, Factory Rent, Freight In
- Indirect expenses: Salaries, Office Rent, Advertising, Depreciation, Interest
- Order of Liquidity: Most liquid first
- Order of Permanence: Most permanent first
- Adjustments affect both P&L and Balance Sheet
- Closing Stock: Trading A/c credit + Balance Sheet asset
- Balance Sheet is a statement, not an account
Related Chapters
- [Chapter 7 — Accounts from Incomplete Records](/school/cbse/class/11/accountancy/cbse-accounts-incomplete-records)
- [Chapter 8 — Bill of Exchange](/school/cbse/class/11/accountancy/cbse-bill-of-exchange)
- [Financial Statements I — Exercise Solutions](/school/cbse/class/11/accountancy/solutions/cbse-financial-statements-1-exercise-solutions)
- [All Class 11 Accountancy Solutions](/school/cbse/class/11/accountancy/solutions)
- [Class 11 Accountancy Subject Guide](/school/cbse/class/11/accountancy)