Final accounts are a summary of financial statements representing the performance of a business for a certain period. They include the Trading Account, Profit and Loss Account, and Balance Sheet. These accounts facilitate businesses to measure their profitability and financial position, thereby facilitating easy decisions on the part of the stakeholders. Whether you are a small businessman or a big corporate house, final account preparation is a means through which financial transparency and accountability may be managed.
Final accounts will depict not only a clear picture of profits but also reveal the financial health of any firm. In this article, we are going to analyze the meaning, components, and importance of final accounts in detail.
Final Accounts Meaning
Final accounts refer to a set of financial statements prepared at the end of an accounting period. These statements include the trading account, profit and loss account, and the balance sheet. The final accounts can be divided into three distinct parts.
- The Trading Account shows the gross profit or loss.
- The Profit and Loss Account reveals the net profit or loss.
- The Balance Sheet reflects the financial position of the business.
Trading Account
The trading account is the first part of the final accounts and focuses on determining the gross profit or loss during the accounting period. It contains all the direct expenses and revenues relating to the production and sale of goods.
Components of Trading Account
- Opening Stock: The value of stock at the beginning of the accounting period.
- Purchases: All goods purchased for sale.
- Sales: The total revenue generated from the sale of goods.
- Direct Expenses: Costs directly associated with production, such as wages, freight, and factory expenses.
- Closing Stock: The value of stock remaining at the end of the accounting period.
Formula for Gross Profit
Where,
COGS = (Opening Stock + Purchases + Direct Expenses) – Closing Stock.
Profit and Loss Account
Having arrived at the gross profit, the next step is preparing the profit and loss account. It is seeking to determine net profit or net loss considering the costs and revenues of both operating and nonoperating natures.
Components of Profit and Loss Account
- Indirect Expenses: These include salaries, rent, electricity, and administrative costs.
- Other Incomes: Revenue from sources other than sales, like interest received or dividends.
- Depreciation: The gradual reduction in the value of assets.
- Interest and Taxes: Expenses for interest payments and taxes.
Formula for Net Profit
The result provides a complete picture of a business’s financial performance.
Balance Sheet
The Balance Sheet forms the last constituent of the final accounts and offers a summary of the company’s health at a point in time. It consists of assets, liabilities, and equity.
Components of a Balance Sheet
- Assets: These include both current and non-current assets like cash, accounts receivable, and machinery.
- Liabilities: Short-term (current) and long-term (non-current) obligations, such as loans and accounts payable.
- Equity: The owners’ claim on the assets after deducting liabilities, including share capital and retained earnings.
A Balance Sheet must always balance, following the formula:
Objectives of Final Accounts
The primary objectives of preparing final accounts include:
- Determining Profitability: The final accounts enable a business to determine the gross and net profitability of the business.
- Evaluation of Financial Standing: It gives an idea about the financial standing of a business.
- Compliance with Legal Requirements: Final accounts help ensure compliance with financial rules and tax authorities.
- Tool for Decision-Making: The statements are useful tools for management and stakeholders while making decisions concerning finance.
Importance of Final Accounts
Final accounts are essential for several reasons:
- Stakeholder Information: These accounts enable investors, creditors, and other stakeholders to have information about the health of the business.
- Legal Requirement: Final accounts are legally required for regulatory purposes, mainly for tax filing purposes.
- Management Control: They give the necessary data for internal control and future financial planning.
- Comparison with Previous Years: Final accounts enable companies to track progress by comparing the current financial results with previous data.
Limitations of Final Accounts
Despite their importance, final accounts have certain limitations:
- Historical Data: These are only past and cannot indicate what the future holds concerning change in trends.
- Non-Physical Factors Not Included: Goodwill, employee morale, etc. are not included in the financial statements.
- Risk of Manipulation: The risk is always there, for accounts can be tampered with with the intent to present favorable data.
- Accounting Basis of Assumptions: Accounts are based on assumptions. Sometimes these assumptions may be wrong.
Final Accounts FAQs
What are final accounts?
Final accounts consist of financial statements prepared at the end of an accounting period, including the Trading Account, Profit and Loss Account, and Balance Sheet.
What is the main purpose of a Trading Account?
The Trading Account helps in calculating the gross profit or loss of a business by comparing sales and the cost of goods sold.
Why is the Profit and Loss Account important?
It determines the net profit or loss by considering both direct and indirect incomes and expenses, providing a clear view of the business’s financial performance.
What does a Balance Sheet show?
A Balance Sheet provides a snapshot of the company’s financial position, detailing its assets, liabilities, and equity at a given point in time.
What are the limitations of final accounts?
Final accounts are based on historical data and do not consider non-monetary factors or predict future performance. There’s also the risk of data manipulation.
