Vu Accounting Lesson 30

Financial Accounting - I – MGT101

VU Lesson # 30

PRESENTATION OF FINANCIAL STATEMENTS (Continued) Standard Format of Balance Sheet (Liability Side) Particulars

Amount Rs. Amount Rs.

Liabilities Capital and Reserves Capital Reserves Profit and Loss Account

X X X

X

Non Current / Long Term Liabilities Long term loans Other long term liabilities

X X

X

Current Liabilities Trade creditors and other payables Short term borrowings Current portion of long term borrowings

X X X

X

Total

X

Capital Capital is the first item shown on the liability side of the balance sheet of an organization. Capital is the Money invested in the business by the owners. Capital is a liability for the business as the business has to pay return against this money and in case the business is closed, then it has to return the amount. Capital is also termed as “Share Capital”. Recording of Capital Recording of Capital is Simple. • • •

At the time of receipt Debit Cash / Bank Credit Capital If the owner contributes an asset instead of cash, then Debit Asset Account Credit Capital When the capital is repaid (this does not happen in normal course of business, but just in case) Debit Capital Credit Cash / Bank

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Financial Accounting - I – MGT101 Reserves

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The portion of profit which is not paid to proprietor, but is kept apart for meeting some known or unknown losses is called Reserve, e.g. Reserve fund, contingencies reserve etc. . There are two major types of reserves: Revenue Reserves From the view point of its creation revenue reserve may again be classified into: a. General reserve Reserve which is not created for any specific purpose, but for strengthening the financial position of the business is known as General Reserve, e.g. Reserve fund, contingencies reserve etc. b. Specific Reserve Reserve created for any special purpose is known as Specific Reserve. e.g., Dividend Equalization fund, Debenture sinking fund etc. Capital Reserves Capital reserves, in most of the cases, are created due to legal requirements. Profit may arise from sources, other than normal business activity. For example, profit on sale of fixed assets or profit on revaluation of fixed assets. When a reserve is created out of these profits, it is termed as capital reserve. One capital reserve about which we already know is “Fixed Assets Revaluation Reserve”. Capital reserves can be used for specific purposes only. Difference between Reserve and Provision Both reserves and provisions are created out of revenues of the business, but they differ from each other. • • • •

Creating a provision is necessary to show a true profit for the period, whereas the reserve is created on the discretion of the owner, out of profits. Provision is to be made, even, if there is a loss; Reserves are created out of profits only. Reserve is shown as liability in the balance sheet, Provision is shown as a reduction from the asset against which it is created. Provision is used specifically for the purpose for which it is made, Reserves are usually general and can be used for any purpose.

Profit And Loss Account Profit and Loss Account or Accumulated Profit and Loss Account shows the balance of undistributed profit accumulated over the periods. In the first year of business, this account shows following figure: © Copyright Virtual University of Pakistan

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Financial Accounting - I – MGT101 Profits for the year Less: Transferred to Reserve Less: Profit distributed Balance carried to Balance Sheet

VU X (X) (X) X

In Subsequent years, balance brought forward from previous years and profit for the year is added and distributed as above and the balance is carried to next year. This is why; it is termed as Accumulated Profit and Loss Account. Long Term Loans The owners of the business may feel that their business can flourish, if there are more funds. These funds can be arranged from their own resources, if possible, or they can ask a bank or financial institution for funds. This loan, if extended by bank for a period of more than one year is termed as a long term loan. There can be other sources of long term loans as well, e.g. Term Finance Certificates and Debentures, where money is borrowed from general public under certain legal restrictions. Other Long Term Liabilities These include all other liabilities that are payable after a period of one year of balance sheet date. For example, staff gratuity and other benefits, taxes and liabilities that become payable after a period of one year. Current Liabilities Current Liabilities are the obligations of the business that are payable within twelve months of the balance sheet date. Creditors, all accrued expenses are the examples of current liabilities of the business because business is expected to pay these back within one accounting period. Current Portion of Long Term Liabilities Long term loans are usually payable in installments. Therefore, at the end of every year, some portion of the loan becomes payable within one year of the balance sheet date. The portion that becomes payable within the next accounting period is transferred to current liabilities and classified under current portion of long term liabilities. Format of current liabilities shown in the balance sheet is as follows: Current Liabilities Trade Creditors Short Term Borrowings Other Short Term Liabilities • Salaries Payable • Accrued Expenses • Bills payable • Advances from Customers © Copyright Virtual University of Pakistan

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