Financial statements are the end products of the accounting process and communicate the profitability and financial position of a business to its stakeholders. The chapter first explains the distinction between capital and revenue items: capital expenditure benefits more than one accounting period and appears in the balance sheet, while revenue expenditure benefits only the current period and is charged to the profit and loss account; similarly, capital receipts and revenue receipts are distinguished. The two main financial statements of a sole proprietorship are the trading and profit and loss account and the balance sheet. The trading account is prepared to find the gross profit or gross loss, calculated as net sales less the cost of goods sold (opening stock plus purchases plus direct expenses less closing stock). The profit and loss account then deducts indirect expenses and adds other incomes to arrive at the net profit or net loss; operating profit is the profit from the main operations before non-operating items. Closing entries transfer the relevant balances to these accounts. The balance sheet is a statement of assets and liabilities showing the financial position on a particular date, and assets and liabilities are grouped and marshalled in a definite order, such as liquidity or permanence. The chapter also explains the opening entry, by which the assets, liabilities and capital of a previous period are brought into the books.
Stakeholders and their information needsCapital and revenue expenditure and receiptsTrading and profit and loss accountGross profit, net profit and operating profitBalance sheet, marshalling and opening entry
Key terms
Financial Statements
The trading and profit and loss account and the balance sheet that communicate the profitability and financial position of a business.
Capital Expenditure
Expenditure whose benefit extends to more than one accounting period and which appears in the balance sheet.
Trading Account
An account prepared to ascertain the gross profit or gross loss from buying and selling of goods.
Gross Profit
The excess of net sales over the cost of goods sold, found in the trading account.
Balance Sheet
A statement showing the assets and liabilities of a business on a particular date to reveal its financial position.
Marshalling
The arrangement of assets and liabilities in the balance sheet in a definite order, such as liquidity or permanence.
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