Final Accounts of Sole Proprietorship | ICSE Class 10 Commercial Studies Notes

This note covers the meaning and preparation of the Trading account, Profit and Loss account and Balance sheet of a sole proprietor from a given trial balance, with closing stock as the only adjustment: the capital and revenue distinction, gross profit, net profit and cost of goods sold, the items on each side of the two accounts, the closing entries, the balance sheet and its marshalling and grouping, worked examples and answers to exam-style questions.

A sole proprietor keeps a journal, posts to the ledger and prepares a trial balance.

The next step is the final accounts: the Trading and Profit and Loss account, which measures the profit or loss for the period, and the Balance sheet, which shows the financial position on the closing date.

This note explains both statements, the items that enter each, and how closing stock is treated.

What are final accounts and why are they prepared?

Final accounts are the statements prepared at the end of the accounting period from the trial balance and any additional information. They have two parts.

The Trading and Profit and Loss account, also called the income statement, shows the financial performance in the form of profit earned or loss sustained. The Balance sheet shows the financial position in the form of assets, liabilities and capital.

Definition: Final accounts. The Trading and Profit and Loss account and the Balance sheet, prepared at the end of the accounting period to show the profit or loss for the period and the financial position on the closing date.

Objectives of preparing the statements

The basic objectives of preparing these statements are to present a true and fair view of the financial performance of the business and a true and fair view of its financial position. The statements are prepared on the basis of the trial balance and additional information, if any.

Reading the trial balance

In the trial balance, every debit balance represents either an asset or an expense or a loss, and every credit balance represents either equity or a liability or a revenue or a gain.

This is the key that unlocks the whole exercise: expenses and losses go to the Trading and Profit and Loss account, while assets, liabilities and capital go to the Balance sheet.

Note: The Trading and Profit and Loss account is an account with a debit side and a credit side. Debit balances (expenses and losses) are transferred to its debit side, and credit balances (revenues and gains) to its credit side.

The Balance sheet is not an account at all; it is only a statement of balances.

Which rules and laws apply to a sole trader's accounts?

No law prescribes a format for the final accounts of a sole proprietor. A company, by contrast, must follow the format in Schedule III of the Companies Act, 2013.

Most sole proprietorships in India are micro or small enterprises, part of the MSME sector. Their accounts are normally prepared on the accounting standards issued by the Institute of Chartered Accountants of India (ICAI), the body set up under the Chartered Accountants Act, 1949.

A trader registered under the Central Goods and Services Tax Act, 2017 must keep accounts of purchases, sales and stock at the principal place of business. The GST he collects on sales is not his income; it is a liability payable to the government.

Why must capital and revenue items be separated?

The distinction between capital and revenue items has important implications for the two statements. Revenue items form part of the Trading and Profit and Loss account; capital items help in the preparation of the Balance sheet.

Expenditure, expense and the period of benefit

An expenditure is a payment or an outlay made for a purpose other than the settlement of an existing liability.

If the benefit of the expenditure extends up to one accounting period, it is revenue expenditure, normally incurred for the day-to-day conduct of the business, such as payment of salaries or rent.

If the benefit extends more than one accounting period, it is capital expenditure, such as payment to acquire furniture for use in the business.

Expense and depreciation

Expenditure is a wider term than expense: the part of the expenditure perceived to have been used or consumed in the current year is the expense of the current year.

Thus furniture of ₹50,000 expected to be used for 5 years is treated as an expense of ₹10,000 per year, and that expense is called depreciation.

Capital and revenue receipts

Receipts follow the same logic. If a receipt implies an obligation to return the money it is a capital receipt, such as additional capital brought in by the owner or a loan taken from a bank such as the State Bank of India (SBI).

If it carries no such obligation and is not the sale of a fixed asset, it is a revenue receipt, such as sales made by the firm or interest on investment received.

Effect of misclassification on profit

Misclassification distorts profit. Suppose revenues are ₹10,00,000 and expenses shown are ₹8,00,000, giving a profit of ₹2,00,000.

If a revenue item of ₹20,000 (repairs of machinery) has been wrongly treated as capital expenditure, the actual expenses are ₹8,20,000 and the correct profit is ₹1,80,000. The profit has been overstated.

If capital expenditure is wrongly shown as revenue expenditure, profits and assets are both understated.

The statements then fail to reflect a true and fair view, and the error also matters for taxation because capital profits are taxed differently from revenue profits.

How is the Trading account prepared?

The Trading account ascertains the result of the basic operational activities of the business: the manufacturing, purchasing and selling of goods. It shows whether selling goods or rendering services has proved profitable.

Its debit side carries opening stock, purchases less returns, and the direct expenses; its credit side carries sales less returns and closing stock. The balance is the gross profit or gross loss.

Definition: Direct expenses. All expenses directly connected with the manufacture, purchase of goods and bringing them to the point of sale, such as carriage inwards, freight inwards, wages, factory lighting, coal, water and fuel, and royalty on production.

Items on the debit side

Opening stock is the stock of goods in hand at the beginning of the accounting year, carried forward from the previous year, and it appears in the trial balance.

Purchases less returns are goods bought for resale, both cash and credit; goods returned to suppliers are purchases return, deducted to give net purchases. Wages are remuneration paid to workers directly engaged in the factory for loading, unloading and production.

Carriage inwards or freight inwards are transport expenses on bringing goods purchased to the place of business. Fuel, water, power and gas are used in the production process.

Packaging material and packing charges for small containers that form part of the goods sold are direct expenses, while packing in big containers for transport is an indirect expense.

Items on the credit side

Sales less returns shows gross total sales, cash as well as credit; goods returned by customers are return inwards, deducted to give net sales.

Closing stock is the cost of unsold goods lying in the stores at the end of the accounting period, and it is credited to the Trading account.

Closing stock is valued at cost or net realisable value (the price it can fetch, less selling costs), whichever is lower, as the accounting standard on inventories (AS 2) requires. Goods already sold, whose ownership has passed to the buyer under the Sale of Goods Act, 1930, are left out of closing stock even if they are still in the godown awaiting delivery.

Draw a two-column account headed "Trading Account for the year ended ...".

On the debit side list opening stock, purchases (less returns), wages, carriage inwards, freight inwards, fuel and power, and gross profit carried down. On the credit side list sales (less returns), closing stock and gross loss carried down. Total both sides and show them equal.

How are gross profit and cost of goods sold calculated?

The excess of sales over purchases and direct expenses is the gross profit. If purchases including direct expenses are more than sales revenue, the result is a gross loss. The gross profit or gross loss is transferred to the Profit and Loss account.

Gross Profit = Net Sales − Cost of Goods Sold

Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses − Closing Stock

When there is no opening or closing stock, the total of purchases and direct expenses is taken as the cost of goods sold. With purchases of ₹75,000 and wages of ₹8,000, the cost of goods sold is ₹83,000.

Take sales of ₹1,25,000. If out of goods purchased for ₹75,000 only goods costing ₹60,000 are sold, the unsold closing stock is ₹15,000 and the cost of goods sold becomes ₹75,000 + ₹8,000 − ₹15,000 = ₹68,000. The gross profit then rises from ₹42,000 to ₹57,000.

Note: Closing stock does not normally form part of the trial balance. It is brought into the books by the entry "Closing stock A/c Dr. To Trading A/c".

This opens a new asset account, which is transferred to the Balance sheet. The closing stock of one year becomes the opening stock of the next.

How is the Profit and Loss account prepared?

The second part of the statement, the Profit and Loss account, starts with the gross profit brought down on the credit side. Its debit side carries the indirect expenses and losses; its credit side carries other incomes and gains.

If the credit side total is more than the debit side total, the difference is the net profit; if the debit side is more, the difference is the net loss.

Net Profit = Gross Profit + Other Incomes − Indirect Expenses

Indirect expenses on the debit side

The indirect expenses on the debit side include salaries, rent paid, interest paid, commission paid, repairs, bad debts, depreciation, advertisement, printing and stationery, legal charges, loss by fire and miscellaneous or trade expenses.

Salaries include salaries of administration, godown and warehouse staff, and perks such as rent-free accommodation, meals, uniform and medical facilities are also regarded as salaries.

Rent paid includes office and godown rent, and municipal rates and taxes. Factory rent, however, is a direct expense and goes to the Trading account. Interest paid covers interest on loans, bank overdraft and renewal of bills of exchange.

Commission paid is paid or payable on business transacted through agents. Repairs covers repairs and small renewals of plant, machinery, furniture and fittings to keep them in working condition. Small expenses clubbed together are called miscellaneous, sundry or trade expenses.

Other incomes and the transfer to capital

The credit side carries other incomes such as rent received, dividend received, interest received, discount received and commission received. The net profit or net loss is transferred to the capital account: for a net profit, "Profit and Loss A/c Dr. To Capital A/c"; for a net loss, "Capital A/c Dr. To Profit and Loss A/c".

Draw one account in two halves.

The upper half (Trading) has expenses and losses on the left and revenues and gains on the right, ending with gross profit carried down or gross loss carried down.

The lower half (Profit and Loss) begins with gross profit brought down or gross loss brought down, lists indirect expenses on the left and other incomes on the right, and ends with net profit transferred to the capital account or net loss.

What closing entries transfer the balances?

Preparing the Trading and Profit and Loss account requires the balances of all concerned accounts to be transferred to it. These transfers are made by closing entries:

1. Close opening stock, purchases, wages, carriage inwards and all direct expenses by debiting the Trading account and crediting each of these accounts.
2. Close purchases return by debiting the Purchases return account and crediting the Purchases account.
3. Close sales return by debiting the Sales account and crediting the Sales return account.
4. Close the sales account by debiting Sales and crediting the Trading account.
5. Close each expense or loss by debiting the Profit and Loss account and crediting that expense or loss account.
6. Close each income or gain by debiting that income or gain account and crediting the Profit and Loss account.

In Ankit's example (Worked example 1 below), the expenses closed to the Trading account are purchases ₹75,000 and wages ₹8,000, a total of ₹83,000.

The expenses closed to the Profit and Loss account are salaries ₹25,000, rent of building ₹13,000 and bad debts ₹4,500, a total of ₹42,500.

Sales of ₹1,25,000 are closed to the credit of the Trading account, and commission received of ₹5,000 to the credit of the Profit and Loss account.

How is the Balance sheet prepared?

The Balance sheet is a statement prepared for showing the financial position of the business, summarising its assets and liabilities at a given date. Assets reflect debit balances; liabilities, including capital, reflect credit balances.

It is prepared at the end of the accounting period, after the Trading and Profit and Loss account.

It is called a balance sheet because it is a statement of the balances of ledger accounts that have not been transferred to the Trading and Profit and Loss account and are to be carried forward to the next year.

Definition: Balance sheet. A statement of the assets, liabilities and capital of a business at a given date, showing its financial position; it is a statement, not an account, and its two sides always agree in total.

Layout of the two sides

Capital and liabilities are shown on the left-hand side, known as Liabilities; assets and other debit balances on the right-hand side, known as Assets. There is no prescribed form of Balance sheet for a proprietary or partnership firm.

The horizontal format shows items such as capital (with profit added), long-term loan, short-term loan, sundry creditors, bills payable and bank overdraft on the liabilities side, and furniture, cash, bank, goodwill, sundry debtors, land and buildings, and closing stock on the assets side.

Classes of assets and liabilities

Current assets are either in the form of cash or can be converted into cash within a year: cash in hand or bank, bills receivable, stock of raw materials, semi-finished and finished goods, sundry debtors, short-term investments and prepaid expenses.

Current liabilities are expected to be paid within a year, usually out of current assets: bank overdraft, bills payable, sundry creditors, short-term loans and outstanding expenses.

Bills receivable and bills payable are bills of exchange and promissory notes, governed by the Negotiable Instruments Act, 1881. Money received from customers through UPI goes straight into the trader's bank account, so it is shown under bank, not cash.

Fixed assets are held on a long-term basis and are not acquired for resale: land, building, plant and machinery, furniture and fixtures.

Investments are funds invested in government securities or shares, shown at cost price. Long-term liabilities are all liabilities other than current liabilities, usually payable after one year, such as long-term loans from banks and financial institutions.

Capital and drawings

Capital is the excess of assets over liabilities due to outsiders. It represents the amount originally contributed by the proprietor, increased by profits and interest on capital and decreased by losses, drawings and interest on drawings.

Drawings are amounts withdrawn by the proprietor; the drawings account is closed by transferring its balance to the capital account and is shown by way of deduction from capital in the Balance sheet.

What are marshalling and grouping of assets and liabilities?

For the information to be decision useful, the items in the Balance sheet must be properly grouped and presented in a particular order. Marshalling is the arrangement of assets and liabilities in a particular order, either of liquidity or of permanence.

Order of permanence

In the order of permanence, the most permanent asset or liability is put on top and the rest follow in reducing order of permanence.

Furniture is the most permanent asset; among debtors, bank and cash, debtors take the maximum time to convert back into cash, bank is less liquid than cash, and cash is the most liquid.

On the liabilities side, capital is the most important source of finance and tends to remain longest, followed by the long-term loan, with creditors discharged in the near future.

Order of liquidity and grouping

In the order of liquidity the order is reversed.

Grouping means putting together items of similar nature under a common heading. Cash, bank and debtors can be grouped under current assets, and fixed assets and long-term investments under non-current assets. Capital with profit added becomes owners' funds, the long-term loan becomes non-current liabilities, and creditors become current liabilities.

The table below is for a firm whose assets are furniture, debtors, bank and cash, and whose liabilities are capital, a long-term loan and creditors.

What are the advantages and limitations of final accounts?

Final accounts are the main report a sole trader has on his business. They are very useful, but a reader must also know what they cannot show.

Advantages of final accounts

• They show the gross profit and the net profit or loss of the year, so the owner knows the result of his trading.
• The Balance sheet shows what the business owns and owes on the closing date, and so its financial position.
• The figures of one year can be compared with those of earlier years to judge whether the business is improving.
• Banks ask for final accounts before giving a loan or an overdraft, because they show the trader's ability to repay.
• They provide the figures needed for filing income tax and GST returns.
• They help to fix the value of the business if it is to be sold.

Limitations of final accounts

• Fixed assets are shown at cost less depreciation, not at their present market value, so the Balance sheet does not show what the business would fetch if sold.
• Only items that can be measured in money are recorded; the skill of the staff or the loyalty of customers does not appear.
• Profit depends on estimates and judgement, such as the rate of depreciation and the value placed on closing stock.
• They are prepared once a year, so the information may be months old when it is used.
• They record the past and do not by themselves forecast future profits.

Worked examples

Worked example 1. From the following trial balance of Ankit as on 31 March 2026, prepare the Trading and Profit and Loss account and the Balance sheet.

Debit balances: cash ₹1,000; bank ₹5,000; wages ₹8,000; salaries ₹25,000; furniture ₹15,000; rent of building ₹13,000; debtors ₹15,500; bad debts ₹4,500; purchases ₹75,000. Credit balances: capital ₹12,000; sales ₹1,25,000; creditors ₹15,000; long-term loan ₹5,000; commission received ₹5,000. Closing stock is ₹15,000.

Answer: Trading account debit side: purchases ₹75,000 + wages ₹8,000 = ₹83,000; credit side: sales ₹1,25,000 + closing stock ₹15,000 = ₹1,40,000; gross profit = ₹1,40,000 − ₹83,000 = ₹57,000.

Profit and Loss account debit side: salaries ₹25,000 + rent ₹13,000 + bad debts ₹4,500 = ₹42,500; credit side: gross profit ₹57,000 + commission ₹5,000 = ₹62,000; net profit = ₹62,000 − ₹42,500 = ₹19,500.

Balance sheet liabilities: capital ₹12,000 + net profit ₹19,500 = ₹31,500; loan ₹5,000; creditors ₹15,000; total ₹51,500. Assets: furniture ₹15,000; debtors ₹15,500; bank ₹5,000; cash ₹1,000; closing stock ₹15,000; total ₹51,500.

Table: Where each item of Ankit's trial balance goes

Worked example 2. Prepare a Trading account from the following particulars for the year ended 31 March 2026: opening stock ₹37,500; purchases ₹1,05,000; sales ₹2,70,000; wages ₹30,000.

Answer: Debit side: opening stock ₹37,500 + purchases ₹1,05,000 + wages ₹30,000 = ₹1,72,500. Credit side: sales ₹2,70,000. Gross profit = ₹2,70,000 − ₹1,72,500 = ₹97,500. The account totals ₹2,70,000 on both sides.

Worked example 3. Prepare a Trading account of M/s Prime Products for the year 2025-26 from: opening stock ₹50,000; purchases ₹1,10,000; return inwards ₹5,000; sales ₹3,00,000; return outwards ₹7,000; factory rent ₹30,000; wages ₹40,000.

Answer: Net sales = ₹3,00,000 − ₹5,000 = ₹2,95,000. Net purchases = ₹1,10,000 − ₹7,000 = ₹1,03,000. Debit side: opening stock ₹50,000 + net purchases ₹1,03,000 + factory rent ₹30,000 + wages ₹40,000 = ₹2,23,000. Gross profit = ₹2,95,000 − ₹2,23,000 = ₹72,000. The account totals ₹2,95,000 on both sides.

Worked example 4. From the following, prepare a Profit and Loss account for the year ending 31 March 2026: gross profit ₹60,000; rent ₹5,000; salary ₹15,000; commission paid ₹7,000; interest paid on loan ₹5,000; advertising ₹4,000; discount received ₹3,000; printing and stationery ₹2,000; legal charges ₹5,000; bad debts ₹1,000; depreciation ₹2,000; interest received ₹4,000; loss by fire ₹3,000.

Answer: Debit side: rent ₹5,000 + salary ₹15,000 + commission ₹7,000 + interest paid ₹5,000 + advertising ₹4,000 + printing and stationery ₹2,000 + legal charges ₹5,000 + bad debts ₹1,000 + depreciation ₹2,000 + loss by fire ₹3,000 = ₹49,000.

Credit side: gross profit ₹60,000 + discount received ₹3,000 + interest received ₹4,000 = ₹67,000. Net profit = ₹67,000 − ₹49,000 = ₹18,000, transferred to the capital account.

Worked example 5. Compute the cost of goods sold and prepare the Trading account for the year ended 31 March 2026 from: sales ₹20,00,000; purchases ₹15,00,000; wages ₹1,00,000; stock on 1 April 2025 ₹3,00,000; stock on 31 March 2026 ₹4,00,000; freight inwards ₹1,00,000.

Answer: Cost of goods sold = opening stock ₹3,00,000 + purchases ₹15,00,000 + freight inwards ₹1,00,000 + wages ₹1,00,000 − closing stock ₹4,00,000 = ₹16,00,000.

Trading account debit side: opening stock ₹3,00,000 + purchases ₹15,00,000 + freight inwards ₹1,00,000 + wages ₹1,00,000 = ₹20,00,000; credit side: sales ₹20,00,000 + closing stock ₹4,00,000 = ₹24,00,000; gross profit = ₹24,00,000 − ₹20,00,000 = ₹4,00,000.

Worked example 6. From the following balances of Mr. H. Balaram, prepare the Trading and Profit and Loss account for the year ended 31 March 2026: stock on 1 April 2025 ₹8,000; purchases ₹22,000; sales ₹42,000; purchase expenses ₹2,500; salaries and wages ₹3,500; advertisement ₹1,000; bad debts ₹1,200; rent ₹1,200; discount allowed ₹600; commission paid ₹1,100; sales expenses ₹600; repairs ₹600. Closing stock on 31 March 2026 is ₹4,500.

Answer: Trading account debit side: opening stock ₹8,000 + purchases ₹22,000 + purchase expenses ₹2,500 = ₹32,500; credit side: sales ₹42,000 + closing stock ₹4,500 = ₹46,500; gross profit = ₹46,500 − ₹32,500 = ₹14,000.

Profit and Loss account debit side: salaries and wages ₹3,500 + rent ₹1,200 + advertisement ₹1,000 + commission ₹1,100 + discount allowed ₹600 + bad debts ₹1,200 + sales expenses ₹600 + repairs ₹600 = ₹9,800; net profit = ₹14,000 − ₹9,800 = ₹4,200.

Glossary

• Trial balance: A statement listing the debit and credit balances of ledger accounts; if the totals agree, the accounts are taken as free from arithmetical errors.
• Final accounts: The Trading and Profit and Loss account and the Balance sheet, prepared at the end of the accounting period.
• Direct expenses: Expenses directly connected with manufacture, purchase of goods and bringing them to the point of sale.
• Gross profit: The excess of net sales over the cost of goods sold, ascertained by the Trading account.
• Net profit: Gross profit plus other incomes minus indirect expenses, ascertained by the Profit and Loss account.
• Closing stock: The cost of unsold goods lying in the stores at the end of the accounting period.
• Opening stock: The stock of goods in hand at the beginning of the accounting year, carried forward from the previous year.
• Capital expenditure: Expenditure whose benefit extends more than one accounting period, such as the purchase of furniture.
• Revenue expenditure: Expenditure whose benefit extends up to one accounting period, incurred for the day-to-day conduct of business.
• Current assets: Assets in the form of cash or convertible into cash within a year, such as debtors and stock.
• Current liabilities: Liabilities expected to be paid within a year, usually out of current assets, such as creditors.
• Marshalling: The arrangement of assets and liabilities in a Balance sheet in the order of liquidity or of permanence.
• Grouping: Putting together items of similar nature in the Balance sheet under a common heading.
• Drawings: Amounts withdrawn by the proprietor, shown as a deduction from capital in the Balance sheet.

Common errors and misconceptions

• Misconception: Gross profit is the same as total revenue. Correct: Gross profit is the excess of sales over purchases and direct expenses; it is not total revenue.
• Misconception: Closing stock is always found in the trial balance. Correct: Closing stock does not normally form part of the trial balance; it is brought in by the entry "Closing stock A/c Dr. To Trading A/c".
• Misconception: Rent, rates and taxes are direct expenses. Correct: Office and godown rent, rates and taxes are indirect expenses, debited to the Profit and Loss account; only factory rent is a direct expense.
• Misconception: The Balance sheet is an account. Correct: It is only a statement of balances, though it is part of the final accounts.
• Misconception: A capital receipt is a sale of goods. Correct: A capital receipt implies an obligation to return the money, or is the sale of a fixed asset; sales of goods are revenue receipts.
• Misconception: Drawings are an expense of the business. Correct: Drawings are deducted from capital in the Balance sheet.
• Misconception: Misclassifying a revenue item as capital has no effect on profit. Correct: It overstates profit, as the repairs example shows, and the statements then fail to show a true and fair view.

Exam-style questions with model answers

Q1. State what is meant by closing stock and where it appears in the final accounts. [2 marks]

1. Closing stock is the cost of unsold goods lying in the stores at the end of the accounting period.
2. It is credited to the Trading account and shown on the assets side of the Balance sheet.

Q2. From the following, calculate the gross profit: net sales ₹40,00,000; net purchases ₹15,00,000; opening stock ₹15,00,000; direct expenses ₹80,000; closing stock ₹2,50,000. [3 marks]

1. Cost of goods sold = opening stock ₹15,00,000 + net purchases ₹15,00,000 + direct expenses ₹80,000 − closing stock ₹2,50,000 = ₹28,30,000.
2. Gross profit = net sales ₹40,00,000 − cost of goods sold ₹28,30,000 = ₹11,70,000.
3. The closing stock is credited to the Trading account and also shown as a current asset in the Balance sheet.

Q3. Distinguish between capital expenditure and revenue expenditure on any three bases. [3 marks]

1. Earning capacity: capital expenditure increases it, while revenue expenditure is incurred to maintain it.
2. Period of benefit: capital expenditure benefits more than one accounting year, while revenue expenditure normally benefits one accounting year.
3. Place in final accounts: capital expenditure is recorded in the Balance sheet subject to depreciation, while revenue expenditure is transferred to the Trading and Profit and Loss account.

Q4. Explain the meaning of marshalling and grouping of assets and liabilities. [4 marks]

1. Marshalling is the arrangement of assets and liabilities in a particular order in the Balance sheet.
2. In the order of permanence the most permanent item is put on top and the rest follow in reducing order of permanence; in the order of liquidity the order is reversed.
3. Grouping means putting together items of similar nature under a common heading.
4. For example, cash, bank and debtors may be grouped as current assets, and fixed assets and long-term investments as non-current assets.

Q5. From the following trial balance of Mr. Ram as on 31 March 2026, prepare the Trading and Profit and Loss account and the Balance sheet. Debit balances: debtors ₹12,000; purchases ₹50,000; coal, gas and water ₹6,000; factory wages ₹11,000; salaries ₹9,000; rent ₹4,000; discount allowed ₹3,000; advertisement ₹500; drawings ₹1,000; loan given ₹6,000; petty cash ₹500; sales return ₹1,000; machinery ₹5,000; land and building ₹10,000; income tax ₹100; furniture ₹9,900. Credit balances: apprenticeship premium ₹5,000; loan taken ₹10,000; bank overdraft ₹1,000; sales ₹80,000; creditors ₹13,000; capital ₹20,000. Closing stock is ₹15,000. [5 marks]

1. Trading account debit side: opening stock nil + purchases ₹50,000 + coal, gas and water ₹6,000 + factory wages ₹11,000 = ₹67,000; credit side: sales ₹80,000 − sales return ₹1,000 = ₹79,000, plus closing stock ₹15,000 = ₹94,000; gross profit = ₹94,000 − ₹67,000 = ₹27,000.
2. Profit and Loss account debit side: salaries ₹9,000 + rent ₹4,000 + discount ₹3,000 + advertisement ₹500 = ₹16,500; credit side: gross profit ₹27,000 + apprenticeship premium ₹5,000 = ₹32,000; net profit = ₹32,000 − ₹16,500 = ₹15,500.
3. Balance sheet liabilities: capital ₹20,000 + net profit ₹15,500 − drawings ₹1,000 − income tax ₹100 (the owner's personal tax, treated as drawings) = ₹34,400; loan ₹10,000; creditors ₹13,000; bank overdraft ₹1,000; total ₹58,400.
4. Balance sheet assets: debtors ₹12,000; machinery ₹5,000; land and building ₹10,000; furniture ₹9,900; petty cash ₹500; loan given ₹6,000; closing stock ₹15,000; total ₹58,400.
5. The two sides agree, which confirms the arithmetic of the statements.

Q6. From the following balances of M/s Royal Traders as on 31 March 2026, prepare the Trading and Profit and Loss account and the Balance sheet. Debit balances: stock ₹20,000; cash ₹5,000; bank ₹10,000; carriage on purchases ₹1,500; purchases ₹1,90,000; drawings ₹9,000; wages ₹55,000; machinery ₹1,00,000; debtors ₹27,000; postage ₹300; sundry expenses ₹1,700; rent ₹4,500; furniture ₹35,000. Credit balances: sales ₹2,45,000; creditors ₹10,000; bills payable ₹4,000; capital ₹2,00,000. Closing stock is ₹8,000. [5 marks]

1. Trading account debit side: opening stock ₹20,000 + purchases ₹1,90,000 + carriage on purchases ₹1,500 + wages ₹55,000 = ₹2,66,500; credit side: sales ₹2,45,000 + closing stock ₹8,000 = ₹2,53,000; gross loss = ₹2,66,500 − ₹2,53,000 = ₹13,500.
2. Profit and Loss account debit side: gross loss ₹13,500 + postage ₹300 + sundry expenses ₹1,700 + rent ₹4,500 = ₹20,000; credit side: nil; net loss = ₹20,000.
3. Balance sheet liabilities: capital ₹2,00,000 − net loss ₹20,000 − drawings ₹9,000 = ₹1,71,000; creditors ₹10,000; bills payable ₹4,000; total ₹1,85,000.
4. Balance sheet assets: cash ₹5,000; bank ₹10,000; machinery ₹1,00,000; debtors ₹27,000; furniture ₹35,000; closing stock ₹8,000; total ₹1,85,000.
5. The two sides agree at ₹1,85,000.

Key takeaways

• Final accounts are the Trading and Profit and Loss account, which measures performance, and the Balance sheet, which shows financial position.
• Debit balances in the trial balance are assets, expenses or losses; credit balances are equity, liabilities, revenues or gains.
• Revenue items go to the Trading and Profit and Loss account; capital items go to the Balance sheet.
• Gross profit is sales less the cost of goods sold, which is opening stock plus net purchases plus direct expenses less closing stock.
• Net profit is gross profit plus other incomes less indirect expenses, and is transferred to the capital account.
• Closing stock is credited to the Trading account and shown as a current asset in the Balance sheet.
• Capital and liabilities stand on the left of the Balance sheet, assets on the right, and the two totals always agree.
• Marshalling arranges items in order of liquidity or permanence; grouping puts similar items under one heading.

Test yourself

What is the purpose of preparing a Trading account?

It ascertains the result of the basic operational activities of the business, namely manufacturing, purchasing and selling goods, and shows the gross profit or gross loss for the period.

Why does opening stock appear on the debit side of the Trading account?

Because it forms part of the cost of goods sold for the current accounting year.

Give two examples of direct expenses.

Carriage inwards and wages are direct expenses, as are freight inwards, factory lighting, coal, water and fuel, and royalty on production.

What is the journal entry to bring closing stock into the books?

Closing stock A/c Dr. To Trading A/c. This opens a new asset account, which is transferred to the Balance sheet.

How is capital calculated in the Balance sheet?

Capital is the excess of assets over liabilities due to outsiders; it is the original contribution increased by profits and interest on capital and decreased by losses, drawings and interest on drawings.

What is meant by the order of liquidity?

Assets and liabilities are arranged so that the most liquid item comes first and the most permanent last; cash is the most liquid asset and creditors the most liquid liability.

What entry transfers net profit to the capital account?

Profit and Loss A/c Dr. To Capital A/c. The net profit is then added to capital on the liabilities side of the Balance sheet.

Where are drawings shown in the final accounts?

Drawings are not an expense, so they do not enter the Profit and Loss account. They are deducted from capital on the liabilities side of the Balance sheet.