How to Prepare Final Accounts with Adjustments (Step-by-Step Guide)
Final accounts are a group of key financial statements that present a clear summary of a business’s financial activities over a specified period, usually a year. These include the Trading Account, the Profit and Loss Account, and the Balance Sheet. Together, they provide detailed insights into how a business has performed, what earnings or losses have occurred, and the financial position of the company at the end of the period.
Meaning and Components of Final Accounts
Final accounts bring together all the accounting information recorded during the year to create a complete view of a business’s operations and stability. The three major parts are:
- Trading Account: Records direct revenues (mainly sales) and direct costs (such as purchases, wages, and other expenses directly tied to production). Its main purpose is to calculate Gross Profit or Loss from core business activity.
- Profit and Loss Account: Prepared after the Trading Account, this statement considers all indirect incomes and expenses, like administrative salaries, depreciation, rent, and non-trading incomes. It determines the Net Profit or Loss of the business.
- Balance Sheet: A statement that captures the financial position of the business on a particular date, showing what the business owns (assets), owes (liabilities), and the investment made by owners (capital/equity).
Objectives and Benefits of Final Accounts
- They summarize financial performance, clearly showing revenues, costs, profits, and losses for comparison and analysis.
- They support better business decisions for management, investors, and creditors by clarifying cash flows, profits, and resource allocation.
- They ensure compliance with regulatory and professional standards for the transparent presentation of financial health.
Format and Structure: Proforma of Final Accounts
There is a standardized format for final accounts, which ensures consistency and ease of understanding. The typical proforma is shown below.
| Trading Account | Profit & Loss Account | Balance Sheet |
|---|---|---|
|
To Opening Stock To Purchases (Less: Purchase Returns) To Direct Expenses To Gross Profit c/d Total |
To Gross Loss b/d To Indirect Expenses (e.g., salaries, rent, depreciation) To Net Profit c/d Total |
Capital (Opening, Add: Net Profit, Less: Drawings) Reserves and Surplus Long-term Liabilities Current Liabilities Total |
|
By Sales (Less: Sales Returns) By Closing Stock Total |
By Gross Profit b/d By Indirect Incomes (e.g., interest received, commission received) Total |
Assets - Fixed Assets (Land, Machinery, etc.) - Current Assets (Cash, Debtors, Stock) Total |
Sample Calculation and Example
Let's take a simple example. Suppose a business has the following data:
Sales Returns: Rs.10,000
Opening Stock: Rs.50,000
Purchases: Rs.3,00,000
Purchase Returns: Rs.5,000
Direct Expenses (Wages: Rs.40,000, Carriage Inwards: Rs.10,000)
Closing Stock: Rs.70,000
Gross Profit can be calculated as follows:
= (5,00,000 − 10,000) − (50,000 + 3,00,000 + 50,000 − 70,000)
= 4,90,000 − (4,00,000 − 70,000)
= 4,90,000 − 3,30,000
= Rs.1,60,000
Understanding Adjustments in Final Accounts
Adjustments ensure accurate reporting by recording revenues and expenses in the correct period. Key examples include:
- Accrued Income: Interest or income earned but not yet recorded, added to the Profit and Loss Account.
- Prepaid Expenses: Advance payments for next period (e.g., rent paid ahead), subtracted from expenses and shown as assets.
- Outstanding Expenses: Salaries or costs due but unpaid, added to expenses and shown as liabilities.
- Depreciation: Systematic reduction in asset value (e.g., plant and machinery), recorded as an expense.
- Provision for Bad Debts: An estimate for customer debts likely to remain unpaid, reducing income accordingly.
Stepwise Preparation of Final Accounts
- Gather and verify all financial documentation and data.
- Prepare a trial balance to ensure that total debits equal credits.
- Record required adjustments such as accruals, prepayments, depreciation, and provisions.
- Create the Trading Account to find Gross Profit or Loss.
- Prepare the Profit and Loss Account to determine Net Profit or Loss.
- Draft the Balance Sheet to present the business’s assets, liabilities, and equity.
Importance and Use of Final Accounts
Final accounts allow management, investors, and other stakeholders to judge business health, evaluate performance, and make informed decisions. Accurate final accounts help ensure regulatory compliance and support good financial planning. By following standardized formats and recording all adjustments, businesses maintain transparency and trust.
Conclusion
Preparing final accounts is vital for any business. These statements summarize the year’s activities and provide the basis for decisions, compliance, and strategic planning. With the right process, including all necessary adjustments, final accounts offer a true and fair view of a business’s financial workings.
FAQs on Final Accounts in Commerce: Meaning, Format & Examples
1. What are final accounts?
Final accounts are financial statements prepared at the end of an accounting period to determine a business's results and financial position. They typically include the Trading Account, Profit & Loss Account, and Balance Sheet to summarize profitability and the values of assets and liabilities.
2. What are the components of final accounts?
The main components of final accounts are:
- Trading Account – Calculates gross profit or loss from core business activities.
- Profit & Loss Account – Determines net profit or loss after accounting for indirect incomes and expenses.
- Balance Sheet – Presents the financial position of a business on a specific date, showing assets, liabilities, and capital.
3. Why are adjustments necessary in final accounts?
Adjustments are made to ensure true and fair presentation of financial statements. They:
- Account for accrued and outstanding incomes/expenses.
- Record prepaid and unearned items correctly.
- Apply depreciation and provisions as per accounting standards.
- Provide both a double effect (affecting the income statement and the balance sheet) for each adjustment.
4. What is the main difference between a Trading Account and a Profit & Loss Account?
Trading Account records direct incomes and expenses to calculate gross profit or loss, while the Profit & Loss Account includes indirect expenses and incomes to determine net profit or loss for the period.
5. What are common adjustments made while preparing final accounts?
Common adjustments include:
- Outstanding expenses (e.g., salaries due)
- Prepaid expenses (advance payments)
- Accrued income (income earned but not received)
- Depreciation on fixed assets
- Provision for bad/doubtful debts
6. What is the sequence for preparing final accounts?
The typical sequence is:
- Prepare Trading Account to find gross profit/loss.
- Prepare Profit & Loss Account to find net profit/loss.
- Prepare Balance Sheet to present the financial position.
7. What is meant by the double effect of adjustments in final accounts?
Every adjustment in final accounts affects two places: once in the relevant account (Trading or P&L) and again in the Balance Sheet. This ensures accuracy and completeness in reporting.
8. Are final accounts and financial statements the same?
In most contexts, especially in class 12 and CA Foundation, the terms final accounts and financial statements are used interchangeably. Both refer to the set of statements prepared at the end of the accounting period showing business results and financial position.
9. What is the official format of final accounts as per CBSE guidelines?
The official format, as per CBSE and ISC guidelines, is the vertical format:
- Trading Account
- Profit & Loss Account
- Balance Sheet (as at 31 March [year])
10. What types of errors should be avoided when preparing final accounts?
Common errors to avoid include:
- Omitting adjustments or not giving them double effect
- Mixing up direct and indirect expenses
- Drawing up incomplete or unbalanced Balance Sheets
- Incorrect calculation of gross or net profit
11. How do final accounts help stakeholders?
Final accounts provide critical information for stakeholders by:
- Enabling management to make informed decisions
- Helping investors assess profitability and potential returns
- Allowing creditors to judge creditworthiness
- Assisting regulators in ensuring compliance with laws
12. What is an example of accrued income in final accounts?
Accrued income refers to income that has been earned but not yet received by the end of the accounting period. For example, interest earned but not received is shown as an income in the Profit & Loss Account and as an asset in the Balance Sheet.
