Final accounts – an understanding

In my last post shared in the  Learning & Development group, we saw how based on tenure of benefit, we classify the balances in four categories, which define our final accounts. There is one exception to this rule, any amount receivable or payable will always go to the balance sheet, whether short term or long term.

Now, are financial statements are only limited to these? What about the trading or the manufacturing account? I left you with this question last week.

As the culture of accounting developed, the profit and loss statement, also known in some cases as the income and expenditure statement (though there is a distinct difference between the two), started to be restricted to just items which were indirect in nature. Various businesses wanted to know what the gross profit was, which is a profit related to the direct business operations. Let us look at a trading entity. They purchase products and then sell those. When they trigger a purchase, there is the cost of the product, there will be transportation costs, some taxes paid on the same, warehouse cost of stocking the same, insurance on transportation and warehouse etc. These will directly be related to the product, and for this trading entity be classified as a part of the product acquisition and holding cost. These will essentially have a proportional element and will vary with the volumes.

On the other side, there will be an accounting department, whose expenses will be fixed, and will need to be incurred whether or not the volumes go up or come down. These are called indirect expenses.

Similarly, the incomes can be also be split between direct and indirect.

This is where the profit and loss account gets split into multiple components, for trading entities, it is called a trading account and for manufacturing entity it’s called a manufacturing account.  I have not really seen a separate account for service entities. Normally the split is done in the P & L itself.

What about income and expenditure account / the receipt and payment account?

Next week…. Keep following the Friday Finance clips.