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Practice each question, then open the answer or worked solution.
What are the objectives of preparing financial statements?
Financial statements are prepared with the following objectives:
1. Determine the financial position of a business.
2. Ascertain the financial performance of the business.
3. To measure the changes in the financial position of a business.
4. To compare the financial performance of business both intra and inter-firm wise.
What is the purpose of preparing the trading and profit and loss accounts?
The trading account is prepared for the following purposes:
1. To determine the gross profit or loss in a financial year or period.
2. Determine the ratio of gross profit to sales.
3. To determine the ratio of direct expense to sales.
The profit and loss account is prepared for the following purposes:
1. Determining net profit or loss incurred by the business.
2. To comply with statutory requirements such as the Company Act or Partnership Act.
Explain the concept of the cost of goods sold.
The costs incurred in the production of goods that are sold by the company is known as the Cost of Goods Sold or COGS
No goods left out: In this case, all goods are sold out. Hence, it can be calculated as follows:
Cost of goods sold = Purchases + Direct Expenses
Presence of a closing stock: There can be some stock that is yet to get sold at the end of the accounting period. At that time, it can be calculated as follows:
Cost of goods sold = Purchases + Direct Expenses – Closing Stock
Presence of an opening stock: Stock that is carried forward at the beginning of the accounting period from the previous accounting period is considered as opening stock and is calculated as follows:
Cost of goods sold = Opening Stock + Purchases + Direct Expenses – Closing Stock
What is a balance sheet? What are its characteristics?
A statement prepared to determine the assets and values of a business on a particular date is known as a balance sheet. Debits represent the assets, while credits signify the liabilities.
It has the following characteristics:
1. It reflects the financial position of a business.
2. It is dependent on other statements, such as trading and P & L account.
3. It is prepared at the end of an accounting period.
4. The balance of both sides should tally.
Distinguish between capital and revenue expenditure and state whether the following statements are items of capital or revenue expenditure:
(a) Expenditure incurred on repairs and whitewashing at the time of purchase of an old building in order to make it usable.
(b) Expenditure incurred to provide one more exit in a cinema hall in compliance with a government order.
(c) Registration fees paid at the time of purchase of a building
(d) Expenditure incurred in the maintenance of a tea garden which will produce tea after four years.
(e) Depreciation charged on a plant.
(f) The expenditure incurred in erecting a platform on which a machine will be fixed.
(g) Advertising expenditure, the benefits of which will last for four years.
| Basis of Difference | Capital Expenditure | Revenue Expenditure |
| Meaning | Expenditure beared for acquiring or improving an asset. | Expenses beared for running daily business activities |
| Term | Long-term can span many accounting periods | Short-term limited to an accounting period |
| Benefits | Benefits can be achieved across many accounting periods | Benefits can be availed only in the current year |
| Nature | Non-recurring | Recurring |
| Shown in | It is shown in the income statement and balance sheet | It is shown in the income statement |
(a) Capital expenditure
(b) Revenue expenditure
(c) Capital expenditure
(d) Capital expenditure
(e) Revenue expenditure
(f) Capital expenditure
(g) Deferred revenue expenditure
Solution coming soon.
What is an operating profit?
Operating profit, referred to as EBIT, is an accounting metric that measures the profits a company generates from its core business functions. It does not take into account interest deduction and the exclusion of tax from the calculation.
The following equation is used to calculate the operating profit:
Operating Profit = Net Profit + Non-operating Expenses – Non-operating Incomes