What are Final Accounts?

Financial accounting is one of the branches of accounting in which the transactions arising in the business over a particular period are recorded.

Final accounts are accounts that are prepared at the end of a fiscal year. Financial statements are prepared to know the correct financial position. In the first step, financial transactions are recorded in the journal, then transferred to the ledger, and then the final accounts are prepared.

Components of Final Accounts

Final accounts include the following components:

• Trading account
• Manufacturing account
• Profit and loss account
• Balance sheet

Trading account

A trading account generally depicts the gross profit or loss made by the concern for the particular period. This is calculated out of the purchases and sales made. The Debit side of the trading account has the following:

1. Opening stock: This represents the stock that has not been sold during the last financial year. Last year’s closing stock is taken as opening stock on the debit side of the account.
2. Purchases: This is the purchase made by the company both on a cash and credit basis. It also includes the purchase return figure and appears on the debit side.
3. Direct expenses: Direct expense is the expense incurred by the company to bring the goods to the place of business. It includes expenses like packing charges, carriage charges, import duty, electricity, water, and fuel. This also comes under the debit side of the account.
4. Sales account: Sales account is the account showing the goods sold and includes both cash and credit sales and also sales returns. This appears on the credit side of the account.
5. Closing stock: Stock that remains unsold is closing stock and appears on the credit side of the account. Closing stock = opening stock + purchases - sales
6. Gross profit: Gross profit is the difference between the debit side and credit side and it is arrived at before deducting overhead, tax, salaries, and interest payments. Gross profit = sales – the cost of goods sold.

7. Operating profit: As the name indicates this is the profit generated through the difference between revenue and cost generated from the company operations. $Operatingprofit=grossprofit–totaloperatingexpenses$

Net profit: Also known as net income, this is the difference between total revenue and total expenses of the company.

$$Netprofit=operatingprofit–\left(taxes+interest\right)$$

Manufacturing account

Manufacturing account generally appears when the production activities are undertaken by the company itself. This account represents the cost of production which is then transferred to the trading account. The manufacturing account has the following line items:

1. Raw material: This is the basic item required in production activity. It represents opening stock, purchases, and closing stock of materials used.
2. Work in progress: These are semi-finished products. Work in progress helps in knowing the exact value of the production cost
3. Finished product: As the name implies this is the finished product completed and then transferred to the trading account for sale.

Profit and loss account account

Gross profit from the trading account is taken to the credit side of this account along with other income items like interest received and commission received. The Debit side of the profit and loss account includes all indirect expenses of the firm like administrative expenses, depreciation, bad debts, interest, discount, selling and distribution expenses, and financial expenses. The figure balanced between the debit and the credit side is the company’s true profit or net profit.

Balance sheet

The balance sheet provides the true financial position of the organization. It has two sides namely assets and liabilities.

Assets

1. Fixed assets: These assets serve the long-term purpose of the organization. Examples of fixed assets are land, furniture, plant and machinery, furniture, and fixtures.
2. Current assets: Assets that can be easily converted to cash and which help in discharging the current liabilities are current assets. Cash, bank, stock, and sundry debtors are current assets.
3. Fictitious assets: These are not assets and represent the accumulated losses and expenses. Discount on issue of shares, profit, and loss account is fictitious assets.
4. Cash and cash equivalents: Cash on hand, cash at bank, and redeemable securities during the next three months are cash and cash equivalents.
5. Tangible and intangible assets: Assets that can be seen and touched are tangible assets namely cash, stock, and building. On the other hand, assets that cannot be seen or touched are intangible assets namely goodwill, patent, and trademark.
6. Account’s receivables: Bills receivable and sundry debtors fall under this line item.
7. Working capital: This is nothing but the difference between current assets and current liabilities of the organization.

Liabilities

Liabilities of the organization can be divided into two major categories namely current liabilities and long-term liabilities.

1. Current liabilities: These are liabilities that generally liquidate within one year. Examples of current liabilities are taxes, accounts payable, and long-term loans.
2. Long-term liabilities: Long-term liabilities are the contrast of current liabilities because they take more than a year to liquidate. Mortgages, long-term loans, long-term bonds, and pension obligations are examples of long-term liabilities.

Grouping of assets and liabilities

Assets and liabilities are grouped into following two categories as follows:

• Based on liquidity: Assets and liabilities under this type are grouped based on liquidity or how easily they can be converted to cash.
• Based on permanence: In this scenario, the arrangement of assets and liabilities are reversed as per their order of liquidity.

Final accounts play the most important role in calculating the profits earned by the organization and also providing the true financial position of the organization. This information is used both internally and externally.

Internally used by the management to evaluate the performance and externally used by investors, creditors, financial institutions to know the company fully and make suitable decisions.

Context and Applications  

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for:

• Bachelor of Commerce
• MBA