Accountancy · Ch 8 — Financial Statements - I
Financial Statements
Financial Statements
Financial Statements
Financial statements are the final output of the accounting process. Instead of creating separate reports for each user (owner, bank, tax department, etc.), a business prepares a standard set of statements that broadly satisfy everyone's informational needs.
The two basic objectives of preparing financial statements are:
- To present a true and fair view of the financial performance of the business (profit or loss earned during the period)
- To present a true and fair view of the financial position of the business (what it owns and owes at a point in time)
To meet these objectives, a firm prepares two main statements:
- Trading and Profit and Loss Account (also called the Income Statement) — shows the profit earned or loss sustained by the business
- Balance Sheet — shows the assets, liabilities, and capital of the business
Both statements are prepared using the trial balance as the starting point, along with any additional information (adjustments) that may be needed.
In company accounts, the Balance Sheet is called the Position Statement and the Profit and Loss Account is called the Statement of Profit and Loss. However, for sole proprietorship firms (covered in Chapters 8 and 9), the traditional names — Trading and Profit and Loss Account and Balance Sheet — are retained.
Understanding the Trial Balance
Before preparing financial statements, you must be able to read a trial balance correctly. Every item in a trial balance belongs to one of four elements:
| Element | Debit Balance | Credit Balance |
|---|---|---|
| Assets | Yes | No |
| Expenses/Losses | Yes | No |
| Liabilities | No | Yes |
| Equity/Capital | No | Yes |
| Revenues/Gains | No | Yes |
Rule: Debit balances represent either assets or expenses/losses. Credit balances represent either equity/liabilities or revenues/gains.
Example: Trial Balance of Ankit
The following trial balance will be used throughout the chapter to understand the preparation of financial statements.
Trial Balance of Ankit as on March 31, 2026
| Account Title | L.F. | Debit Amount (₹) | Credit Amount (₹) |
|---|---|---|---|
| Cash | 1,000 | ||
| Capital | 12,000 | ||
| Bank | 5,000 | ||
| Sales | 1,25,000 | ||
| Wages | 8,000 | ||
| Creditors | 15,000 | ||
| Salaries | 25,000 | ||
| 10% Long-term loan (raised on April 01, 2016) | 5,000 | ||
| Furniture | 15,000 | ||
| Commission received | 5,000 | ||
| Rent of building | 13,000 | ||
| Debtors | 15,500 | ||
| Bad debts | 4,500 | ||
| Purchases | 75,000 | ||
| Total | 1,62,000 | 1,62,000 |
Analysis of the Trial Balance
Each account in the trial balance is classified into its correct element:
| Account Title | Element | Debit (₹) | Credit (₹) |
|---|---|---|---|
| Cash | Asset | 1,000 | |
| Capital | Equity | 12,000 | |
| Bank | Asset | 5,000 | |
| Sales | Revenue | 1,25,000 | |
| Wages | Expense | 8,000 | |
| Creditors | Liability | 15,000 | |
| Salaries | Expense | 25,000 | |
| 10% Long-term loan | Liability | 5,000 |