Explain how common size statements are prepared giving an example.

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Q. Explain how common size statements are prepared giving an example.

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Concept understanding — Meaning Of Financial Statements

Let’s begin with something you already know. Suppose you run a small tuck shop in your school. At the end of the month, you want to know: Did I make a profit? How much cash do I have? How much do I owe my supplier? To answer these questions, you need a summary of your shop’s financial affairs — that summary is what accountants call financial statements.

Everyday Intuition

Think of financial statements as a report card for a business. Just as your report card shows your marks in each subject, financial statements show the business’s performance (profit or loss) and its financial position (what it owns and what it owes). Without them, you’d be guessing — and guessing is dangerous when real money is involved.

Precise Meaning (as per NCERT Class 12 Accountancy)

Financial statements are the final output of the accounting process. They are prepared at the end of an accounting period (usually a year) to present the financial results and position of a business in a structured, standardised way.

The two main financial statements for a sole proprietorship or partnership are:

Trading and Profit & Loss Account – shows the gross profit/loss from trading and the net profit/loss for the period.
Balance Sheet – shows the assets, liabilities, and capital of the business on a specific date.

Note

For a company, financial statements also include a Statement of Profit and Loss (instead of a simple P&L) and a Balance Sheet in the format prescribed by the Companies Act. But for Class 12, you focus on the sole proprietorship/partnership format.

Why It Matters

Financial statements are not just a formality. They serve several critical purposes:

For the owner – to know whether the business is making money and how much capital is safe.
For lenders and creditors – to decide whether to give a loan or extend credit.
For tax authorities – to verify income and tax payable.
For comparison – to see if the business is improving year after year.

In short, financial statements are the language of business. Without them, no one can understand the financial health of an enterprise.

Accounting Treatment: How They Are Prepared

Financial statements are not journal entries. They are summaries drawn from the ledger accounts. So there is no “debit/credit” for the statements themselves. Instead, you transfer balances from ledger accounts into the statements.

Here’s the step-by-step process:

Close all revenue and expense accounts to the Trading and Profit & Loss Account.
- Debit all expenses and losses, credit all incomes and gains.
- The balancing figure is Net Profit (credit side bigger) or Net Loss (debit side bigger).
Transfer the Net Profit/Loss to the Capital Account (for sole proprietorship) or to the Partners’ Capital Accounts (for partnership).
Prepare the Balance Sheet by listing all assets (debit balances) on one side and all liabilities + capital (credit balances) on the other side. The two sides must always be equal.

Watch out

A common mistake: students think financial statements are “accounts” that are debited/credited. They are not. They are statements — you don’t journalise them. You only journalise the closing entries that feed into them.

Format: Trading and Profit & Loss Account (as per NCERT)

Here is the standard format for a sole proprietorship. Note that the Trading Account is the top part, and the Profit & Loss Account is the bottom part — but they are often combined in one statement.

Trading and Profit & Loss Account of [Business Name] for the year ended [Date]
Particulars	Amount (₹)	Particulars
To Opening Stock	xxx	By Sales
To Purchases	xxx	Less: Sales Returns
Less: Purchase Returns	(xxx)	By Closing Stock
To Direct Expenses (Wages, Carriage, etc.)	xxx
To Gross Profit c/d	xxx
Total	xxx	Total

To Salaries	xxx	By Gross Profit b/d
To Rent & Taxes	xxx	By Commission Received
To Depreciation	xxx	By Discount Received
To Interest on Loan	xxx	By Miscellaneous Income
To Net Profit (transferred to Capital A/c)	xxx
Total	xxx	Total

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Common size statements are financial statements (Income Statement and Balance Sheet) where each line item is expressed as a percentage of a common base figure — Revenue from Operations for the Income Statement, and Total Assets or Total Equity & Liabilities for the Balance Sheet. This allows comparison across firms of different sizes or across periods for the same firm.

The Concept: Why Percentages, Not Rupees?

When you look at a company's Profit & Loss statement, you see numbers like "Revenue ₹10,00,000" and "Cost of Goods Sold ₹6,00,000." That tells you the absolute amounts. But what if you want to compare this company with a giant competitor whose revenue is ₹100 crore? The raw rupee figures are useless for comparison — a ₹6 lakh COGS might be 60% of revenue for the small firm but only 0.6% for the large one.

Common size statements solve this problem. They convert every absolute figure into a percentage of a single, meaningful base. This is called vertical analysis — you're analysing each item's proportion within the same period, not across time.

The accounting treatment is straightforward: you take the existing financial statement and add a percentage column. No journal entries, no ledger postings. It's a recasting of existing data, not a new set of books.

The Two Common Size Statements

1. Common Size Income Statement

Base: Revenue from Operations (Net Sales) = 100%

Every other item — Cost of Materials Consumed, Employee Benefit Expenses, Finance Costs, Tax, Net Profit — is expressed as a percentage of this base.

Why this base? Revenue is the primary operating activity. It tells you how much of each rupee earned is consumed by costs, and how much remains as profit. A rising percentage for "Employee Benefits" over three years, for example, signals that labour costs are growing faster than sales — a red flag.

2. Common Size Balance Sheet

Base: Total Assets (or Total Equity & Liabilities) = 100%

Every asset (Current, Non-current) and every claim (Shareholders' Funds, Non-current Liabilities, Current Liabilities) is shown as a percentage of the total.

Why this base? It reveals the composition of the company's resources and funding. A company with 80% fixed assets is capital-intensive (manufacturing); one with 80% current assets is likely a trading or service firm. On the liabilities side, a rising percentage of debt signals increasing financial risk.

Example: A Simple Trading Company

Let's take a small company, ABC Traders, with the following data for the year ended 31st March 2024:

Item	Amount (₹)
Revenue from Operations	5,00,000
Cost of Goods Sold	3,00,000
Employee Benefit Expenses	80,000
Depreciation	20,000
Other Expenses	30,000
Tax @ 30%	21,000
Net Profit	49,000

Balance Sheet as on 31st March 2024:

Item	Amount (₹)
Assets
Non-current Assets (Fixed Assets)	3,00,000
Current Assets (Inventory, Debtors, Cash)	2,00,000
Total Assets	5,00,000
Equity & Liabilities
Shareholders' Funds (Equity)	3,50,000
Non-current Liabilities (Loan)	1,00,000
Current Liabilities (Creditors)	50,000
Total Equity & Liabilities	5,00,000

Step 1: Common Size Income Statement

Base = Revenue from Operations = ₹5,00,000 = 100%

Particulars	Absolute Amount (₹)	Common Size Percentage
Revenue from Operations	5,00,000	100.00%
Less: Cost of Goods Sold	(3,00,000)	(60.00%)
Gross Profit	2,00,000	40.00%
Less: Employee Benefit Expenses	(80,000)	(16.00%)
Less: Depreciation	(20,000)	(4.00%)
Less: Other Expenses	(30,000)	(6.00%)
Profit Before Tax	70,000	14.00%
Less: Tax @ 30%	(21,000)	(4.20%)
Net Profit	49,000	9.80%

How each percentage is calculated:

Cost of Goods Sold % = (3,00,000 / 5,00,000) × 100 = 60%
Gross Profit % = (2,00,000 / 5,00,000) × 100 = 40%
Employee Benefits % = (80,000 / 5,00,000) × 100 = 16%
Net Profit % = (49,000 / 5,00,000) × 100 = 9.8%

Tip

The percentages in a common size Income Statement should always add up vertically: Gross Profit % + all expense % = 100% (before tax). Here: 40% Gross Profit minus 16% minus 4% minus 6% = 14% PBT, then minus 4.2% tax = 9.8% Net Profit. This cross-check catches calculation errors.

Step 2: Common Size Balance Sheet

Base = Total Assets (or Total Equity & Liabilities) = ₹5,00,000 = 100%

Particulars	Absolute Amount (₹)	Common Size Percentage
ASSETS
I. Non-current Assets
Fixed Assets	3,00,000	60.00%
II. Current Assets
Inventory, Debtors, Cash	2,00,000	40.00%
Total Assets	5,00,000	100.00%

EQUITY & LIABILITIES

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Q.Explain how common size statements are prepared giving an example.

The Concept: Why Percentages, Not Rupees?

The Two Common Size Statements

1. Common Size Income Statement

2. Common Size Balance Sheet

Example: A Simple Trading Company

Step 1: Common Size Income Statement

Step 2: Common Size Balance Sheet

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