This article is prepared to get an overview of & for the basic study of the financial statements.
In order to understand the financial statements of an organization, one must be aware of the basic accounting concepts, rules, principles & assumptions.
The financial statements are prepared after considering accounting rules, relevant laws and Accounting Standards. However, in order to get a basic understanding, one needs to get an overview of the below-mentioned terms:
Journal Entries:
At a very basic level, accounting starts with recording a transaction in monetary terms in the books through a journal entry by debiting certain Account(s) & by crediting certain Account(s) with equal Amount(s). Types of Accounts are broadly classified as Real, Personal & Nominal Account & accordingly Journal entries are passed on the basis of three golden rules of accounting after considering the nature of the account. The rules are:
Debit what comes in, Credit what goes out.
Debit the Receiver, Credit the Giver.
Debit all Expenses & Losses, Credit all Incomes & Gains.
Ledgers:
The effect of the Journal Entries passed is reflected in the respective ledgers.
A ledger can be termed as a book/account in which all the transactions occurred during a specific period under that particular account, are summarized in monetary terms along with the opening & closing balances.
Trial Balance:
A Trial Balance is a statement which summarizes the opening & closing balances of all the ledgers as debit or credit balance for a particular period as per the nature of the respective ledgers.
In short & simple way, it looks like a list of all the general ledgers.
The purpose of the Trial Balance is just to display that total debit balance equates total credit balances.
However, it plays a major role in scrutinizing the books as it gives a summary of all the ledgers and many irregularities can be diagnosed from the face of Trial Balance itself.
Trading & Profit & Loss Account:
As the name suggests, a trading account is prepared to calculate & disclose Profit/Loss from trading activity. Such Profit/Loss is termed as Gross Profit/Loss.
Direct Income earned & Direct expenses incurred, during a specified period, forms part of the trading account.
Gross profit/(Loss) is calculated as follows:
Gross profit/(Loss) = Sales – COGS (Opening Stock + Purchases + Direct Expenses - Closing Stock)
Let's understand this formula better with the help of below table:
| Particulars | Amount | |
|---|---|---|
| Opening Stock | 1000 | |
| Add | Purchase | 4000 |
| Add | Direct Expenses | 1200 |
| Subtract | Closing Stock | 200 |
| A | COGS (Cost of goods sold) | 6000 |
| B | Sales | 10000 |
| C | Gross Profit/Loss (B-A) | 4000 |
However, Profit & Loss Account calculates & discloses the Net Profit/Loss after adjusting Indirect Incomes & Indirect Expenses from the Gross Profit/Loss.
Indirect Expenses consists of Selling and distribution expenses, Salary, Rent, Freight & carriage on sales, Administrative Expenses, Financial Expenses, Maintenance, Depreciation, Provisions, Interest etc.
Indirect Income may consist of Discount Received, Interest Received, Commission Received, Profit on sale of assets, etc.
Balance Sheet:
A Balance Sheet is a statement that discloses the financial position of an organization as on a particular date. Such financial position is disclosed under 3 Major heads namely Assets, Liabilities & Equity/Capital.
These Major heads are further classified under sub-heads and the disclosure is made as per the requirement of applicable law.
In simple terms, the Balance Sheet shows the appropriation of an organization’s money, valuables, funds, worth & owing under suitable heads.
A Balance Sheet is prepared on the basis of the below mentioned formula:
Assets = Liabilities + Share Capital
It clearly discloses what an organization owns & what it owes on a particular date.
Cash Flow Statement:
As is apparent from its nomenclature, CFS is a statement which discloses the movement of cash & cash equivalents during a particular period.
Such movement is majorly classified into operating, Investing & Financing activities for better disclosure & understanding.
Notes to Accounts:
Notes to the Accounts are prepared for the purpose of further clarity & transparency in financial statements, hence, these form an integral part of the financial statements.
Notes generally make the disclosures as per the requirement of Accounting Standards & applicable laws. Notes also contain information that cannot be mentioned in monetary terms and also the significant accounting policies followed while preparing the financial statements.
*The terms “as on date”, “during the period” & “for the period” shall be read & understood in literal terms while reading this article and shouldn’t be replaced with each other.