Thursday, 27 November 2014

Significance of Profit and Loss Account and some guidelines

Profit and Loss Account is a statement of expenses and income and the net amount of these two elements is known as either profit or loss of that company. It is prepared to know the profit or loss of any business organization during a particular period of time. Normally, Profit and Loss Statements are prepared at the end of each accounting year. The accounting year as our accounting standards starts from the 1st April of each year and ends on 31st March of next year.

Importance of Profit and Loss Account
  • Profit & Loss statements are required to be prepared under Companies Act rules and regulations.
  • The functioning and achievements of your business are assessed with the help of this statement. You will come to know whether your business is running in profits or incurring losses through this statement. 
  • And, this is the preliminary stage for preparing your Balance Sheet. 
  • One should first arrive at the Profit or Loss figure before preparing the Balance Sheet of any company as that figure is to be shown in the assets or liability as the case may be.
  • The Profit and Loss Statement is required to be submitted along with the Balance Sheet for filing your tax returns and for Income-Tax assessments.
  • Banks demand this statement also along with Balance Sheet while sanctioning loans for business.

How to prepare Profit and Loss account
It is very simple to prepare a profit and loss statement. It is a summary of the expenses and incomes of your business to derive the net result. If your income side total is excess the difference will be profit. Otherwise, if expenditures total is excess, then the difference will be a loss to your business.
  1. First, you need to balance all your accounts in the Main Ledger or General Ledger of your business accurately.
  2. Then tally your Trial Balance.
  3. With the help of your trial balance, you can easily prepare a profit and loss statement. Enter all expenses in the expenditure column and all income in the income column. The net result will give you either profit or loss of your business.
  4. There are two types of preparation. One is horizontal P&L a/c and the other one is vertical P&L a/c.

Horizontal Profit and Loss account
              Income                                                   Expenditure
Sales                       5000000                        
                                                              Goods purchased            3750000
                                                              Freight/transportation         250000
                                                              Labour charges                    50000
                                                              Godown rent                       30000
                                    _______                                                 _________      
                                    5000000                                                  4080000                                                                                                      
                                                             Gross/Trading Profit           920000
                                         Staff salary                        180000
                                                             Electricity                            50000
                                                             stationery                             30000
                                                             package charges                  30000
                                        sales promotion                    30000
                                                            other expenses                     20000
                                                         Profit before interest/depreciation 580000  
                                                             Interest on loans                      100000    
                                                             Depreciation of assets              180000
                                                             NET PROFIT                         300000    

The above is a sample format of profit and loss account prepared in horizontal format.

In a vertical format, you will start with sales income and below it, all the expenses are stated in the same manner as in above format. The three elements of Gross profit, Profit before Depreciation and Net profit will be calculated in the same manner and in the same column under income.

All expenses directly related to the production of goods are taken for calculating the Trading profit of the company. Then salaries and administrative expenses and sales promotion are taken to arrive at the net profit before interest and depreciation. Then, you can separately calculate profit after depreciation and profit after interest, if you want them separate, to get separate statistics for each element of cost.

It is customary to provide the figures of previous year also in profit and loss statement, to enable comparison of figures with previous achievements.

Sunday, 9 November 2014

Bank Reconciliation Statement- How to tally with Pass Books

What is Bank Reconciliation Statement?
Bank reconciliation means reconciling the entries with Bank. Reconciliation stands for tallying of figures.

Every business keeps a Bank A/C for making easy transactions. You can make transactions online- receiving payments or making payments and transferring funds so easily at the click of your mouse. Now, you are expected to record all these transactions in your books of accounts. Banks will be updating your accounts automatically at each click of your transaction.

But sometimes, due to enormous workflow, some omissions or commissions may take place at both ends in recording these transactions. So, you need to tally the entries from your books with your bank. This tallying of accounts is known as Bank reconciliation.

Why the need for reconciliation? 
The need for a Bank Reconciliation statement arises due to the fact that at any particular point of time, the balances in your books may not tally with the Bank statement or passbook. So, you need to explain or verify for the differences at both ends. This is for your own balance confirmation purpose as well as for explaining to the auditors who check your accounts each year. So, it is very useful to prepare bank reconciliation statements regularly.

What can be the reasons for differences in accounts?
There can be many reasons for differences in your Bank balance and the balance as per Bank Books. The most common reasons are:
  1. You may have issued some cheque which is not yet presented to the bank by the receiver of the cheque.
  2. You deposited some drafts or cheques received from others into your account, but bank not collected those amounts and so not credited to your account.
  3. Banks might have charged some bank charges and same entries not recorded by you in your books.
Above are common features which affect your bank balances. When you account for all these things, then only your balances can tally with bank passbook.

A Sample format of Bank Reconciliation Statement

Generally, a typical bank reconciliation statement will project only cheques issued but not presented and deposits made but not collected as the only differences in the Bank Reconciliation statement. All other discrepancies are sorted out and corresponding entries made in your books before closing your books.

If the Bank debits some charges to you, you will take them in your expenses and credit the Bank A/C. If any interest is credited to your account, you will credit your income and debit the bank in your books.

But, there will be no corresponding entries for cheques issued but not presented or deposits made but not credited to your account. You can not reduce your expenses by reversing the cheques or should not reduce your receipts by reversing the deposits made into Bank. So these two items will stand in the Bank Reconciliation Statement as reasons for the differences in your balance as compared with Bank Balance or passbook.

So a typical Bank Reconciliation Statement will be like this:

Balance as per our Books                  (say)         10,000 Dr.
Cheques issued but not presented     (say)           5,000
                                                 Total                  15,000 Dr.
Drafts deposited but not collected    (say)           3,000    
Balance as per Bank statement or PassBook     12,000 Dr.

In the above Reconciliation statement, we are adding back the amounts of those cheques issued by us (but not presented to Bank) as we have already reduced our balance while issuing the cheques. Similarly, we have already increased our bank balance when the drafts were deposited into the bank. So, we have to decrease the amount in the bank reconciliation statement (if the Draft is not collected by Bank) to tally it with Bank  Balance.

This is the general procedure for preparing a Bank Reconciliation Statement.

Friday, 7 November 2014

Trial Balance and its Importance in Accounts

What is Trial Balance?
A trial balance is a list of your account book balances mentioned in two columns- as debits and credits; the totals of which should tally.

Normally, trial balances are prepared each and every month to verify whether you entered your accounts correctly or not. It is a kind of preliminary exercise before preparation of your profit & loss statement or balance sheet.

How to prepare Trial Balance?
After each month is over, the accounts book known as the General Ledger or Main Ledger is to be got balanced accurately for each account. So, each account will be showing a debit balance or a credit balance at the end of each month.

Thereafter, take a paper and make columns as below:

Particulars(Head of Account)        Ledger Folio                   DEBITS               CREDITS        

Now, enter all the balances of your accounts from the General Ledger into this statement accurately- mentioning all the debit balances in the debit column and credit balances in the credit column. Take the cash balance also from the cash book and then total both the columns.

The totals of both debit and credit columns should tally with each other. This is because, for each debit entry, there will be a corresponding credit entry in your books of accounts. If the totals do not tally, then you should know that there is some mistake either in your account books or in the balancing of the Ledger accounts, or maybe in your copying of the balances from each page into the trial balance statement. So, you need to check all these things.

Importance of Trial Balance   
  • Trial balance confirms the accuracy of all your entries of debits and credits.
  • It serves as a statement to have a quick picture of your accounts.
  • You can know how much amount was spent or incurred under each expenditure head or the amount received under each income head by seeing this trial balance statement for any particular period.    
  • It is the preliminary stage for preparing your financial statements. You can prepare your Profit & Loss statement or Balance sheet statements with the help of this Trial Balance.  
  • Other important documents like Budget and Cost Sheets are also prepared with the help of this trial balance.
  • It serves as a managerial information statement for having a quick look at revenue expenses and income during any period.

What to do if Trial Balance does not tally 
If the Trial Balance does not tally, you should check the following factors.
  1. Check the totals of both columns in the trial balance.
  2. Check with the amounts of balances entered under each head so as to ascertain whether correctly copied from the General Ledger or not.
  3. Check whether the debit balance is entered correctly in the debit column and credit balance in the credit column of the sheet.
  4. Check the balancing of each head in your General Ledger- whether the balancing is correctly done or not.
  5. If in spite of all these verifications, the trial balance does not tally, then there can be mistakes in your original postings of accounts while entering them from your original bills and vouchers. So you may have to check each and every entry of the accounts in your Main Ledger which can take many days to locate the mistake.
A Smart Tip
One simple tip which may or may not works out is to take half of the amount of difference that is there in your trial balance and check for that half amount. Whether any entry is there for such amount in your books. If there is an entry equal to that half amount, whether it has been wrongly entered in the debit side instead of credit or vice-versa. This method, sometimes, works out and can save a lot of time and energy in locating the mistake. But, it is only if you made one simple mistake of that kind. If you made many mistakes, then it will not help much.