ACCOUNTS 7.

Preparation of Final Accounts of Sole Proprietors

7. PREPARATION OF FINAL ACCOUNTS

OF SOLE PROPRIETORS
UNIT 1 : FINAL ACCOUNTS OF NON-MANUFACTURING ENTITIES

CONCEPT 1 : INTRODUCTION
 Non-manufacturing entitiesTrading entities
Do not process goods purchased
Sell them in original form.
 At the end of accounting year, the entity should know the results of the business.
 To ascertain the final outcome of the business, financial statements are prepared at the year end.
 Financial Statements systematically summarise all ledger account heads to give detailed information
about financial position (Balance sheet) and performance (P&L) of the enterprise.

Profit is measured at two levels :

Gross Profit Net Profit

Final Accounts

Income Statement Position Statement

Present the details of various items Exhibits assets & liabilities of the
of income or expenditure under business at the close of the
separate heads to calculate P&L. period.

Trading P&L Account

Account
CONCEPT 2 : PRINCIPAL FOR PREPARATION OF FINAL ACCOUNTS

Distinction between Separation of income /

Capital & Revenue Expenses relating to one period
receipts & payments

Points to be considered

Distinction between Disclose material Effect of transaction

Personal & Business Information Example concluded before
Income & expenditure Increase of labour closing period should
known as Business charges due to bonus be adjusted in the
entity concept should be disclosed accounts of the years

CA SANKET SHAH Page 85

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors

INTER-RELATIONSHIP OF TWO STATEMENTS

Related to Total Expenditure incurred

Example 1 : Inventory Example 2 : Fixed

Asset

Trading P&L : Balance sheet : Trading P&L : Balance sheet :

Credit side Closing Inventory Debit Depreciation WDV of asset

 MATCHING PRINCIPLE :
This principle demands that expenses incurred to earn the revenue should be properly matched:
[a] If revenue is entered in the Trading/P&L A/c, all the expenses relating to it, whether or not payment
has been actually made, should be debited to Trading/P&L A/c. Thus, outstanding expenses entry is
passed at the year end.
[b] If some expense has been incurred but against it sale will take place in the next year, the expense
should not be debited to the current year's P&L A/c but should be carried forward as an asset. It will be
debited to P&L A/c only when the relevant income will also be credited. It is because of this principle
that:
[i] at the end of the year, inventory is valued at cost. The credit to the Trading Account reduces the
debit to the extent goods remain unsold or unutilised, these will be sold or used up next year and
the cost will therefore, be properly debited to the next year's Trading Account.
[ii] at the end of the year, prepaid expenses are brought into the books. The effect of this is to transfer
the debit of prepaid expenses to the year in which the benefit from such expenses will accrue; and
[iii] at the end of the year, depreciation of fixed assets is charged to the P&L A/c and credited to the
assets concerned. Thus, that part of the cost of assets which has been used up for earning current
year's revenue is debited to P&L A/c.
[c] If an income is received in the current year but the work against it has to be done and the cost in
respect of it has to be incurred next year, the income or revenue is considered to be of next year. It
should be shown in the Balance Sheet on the liabilities side as "income received in advance" and
should be credited to the P&L A/c of the next year.
 EXCEPTION to the rule:
Such costs as have yielded or expect to yield revenue should be debited to P&L A/c.
 If a fire has occurred and has damaged the firm's property the loss must be debited to P&L A/c to the
extent it is not covered by insurance.
 A loss, resulting from the fall of SP below cost or from debts turning bad, must be debited to P&L A/c.
 If this is not done the profit will be over-stated.

CONCEPT 3 : TRADING ACCOUNT

 Gross Profit =Selling price of goods sold -Cost of goods sold [COGS].
 For trading firm, COGS is ascertained by adjusting cost of goods on hand at the year-end against
purchases.
 Eg : In the first year, the net purchases (that is after deducting returns) total Rs.1,00,000&Rs.15,000
worth of goods (at cost) were not sold at the end of the year. The cost of the goods sold will then be
Rs.85,000. If in the next year purchases are Rs.1,50,000 and the cost of goods on hand at the end of
the year is Rs.20,000.

CA SANKET SHAH Page 86

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors
Trading Account for the year ending
Particulars Rs. Particulars Rs.
To Opening Inventory 15,000 By Sales Account 2,00,000
To Purchase Account 1,50,000 By Closing Inventory 20,000
To Gross Profit carried to P & L A/c 55,000
Total 2,20,000 Total 2,20,000

Books of Consignor
Sr. No. Items Explanation
1] Opening  Closing Inventory of last year.
Inventory  Found in the trial balance.
 First item on debit side of trading account.
 In the first year of business  no opening inventory.
2] Purchases and  Purchases  Debit balance  shows gross amount of purchases made
Purchase Returns  Purchase returns  Cr. Bal shows return of materials to suppliers
 On Dr. side net amount is shown as Purchases (-) Purchase returns
 When goods are recd but invoice is not recdAdd in purchases or
exclude from closing inventory
3] Carriage or  To bring the materials to firm's godown to make them available for
Freight Inwards use.
 If incurred on assetDebited to Asset A/c & not Trading A/c
4] Wages  Wages paid to workers in the godown/storesDebited to Trading A/c
 For installation of asset Debited to Asset A/c
5] Sales and Sales  SalesCredit balance Total sales made during the year
Returns  Sales returns Dr. BalTotal amt of goods returned by customers
 On Cr. side net amount is shown as Sales (-) Sales returns
 When goods are sold but not dispatched:
[a] If sale is complete  not included in closing inventory
[b] If sale is not complete  Included in closing inventory
6] Closing  Damaged or obsolete items are separately listed.
Inventory and its  The valuation principle is cost or net realisable value whichever is
valuation lower.
 If inventory taking is done few weeks before or after BS date, the value
of inventory must be adjusted to relate it to the closing date.
 Add goods sent on consignment-lying with agents & also the goods
sent on approval to customers.
7] Sales Tax  It is collected from customers & deposited with Government as per
[Indirect Tax] requirements of the Sales Tax Act by the seller.
 Sales tax Deducted from gross sales figures
 Sales tax liability (net of payments) Current liability (Balance sheet)
 Trading Account shows relationship between costs & revenues and also the level of efficiency.
𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭
 The ratio of gross profit is arrived as * 100
𝐒𝐚𝐥𝐞𝐬

CA SANKET SHAH Page 87

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors

CLOSING ENTRIES IN RESPECT OF TRADING ACCOUNT

Sr. No. Particulars Dr Cr
1] Trading Account Dr.
To Opening Inventory Account
To Purchases Account
To Wages Account
To Freight on Purchases Account, etc.
2] Sales Account Dr.
Closing Inventory Account Dr.
To Trading Account
3] Gross Profit :
Trading Account Dr.
To Profit and Loss Account
4] Gross Loss :
Profit and Loss Account Dr.
To Trading Account

CONCEPT 4 : PROFIT AND LOSS ACCOUNTS

 It starts with gross profit or gross loss, as the case may be.
 After that all expenses and losses not entered in Trading Account, will be written on the debit side of
P&LA/c. Incomes and gains, other than sales, will be written on the credit side.
 Personal expenses will not be charged to Profit and Loss A/c.
 Only current year revenue expenses and losses are debited to Profit and Loss Account.
 Too many details will prevent a person from knowing properly the factors leading to the profit earned.
Therefore, items should be according to the various functions:

Administrative Financing expenses Selling &

expenses distribution
expenses
[a] Salaries to people in general office. [a] Salesman salaries & commission.
[b] Rent & rates for office. [b] Commission to agents.
[c] Lighting in the office. [c] Advertising.
[d] Printing and stationery. [d] Warehousing expenses.
[e] Packing expenses.
[e] Postage, telegrams and telephone
[f] Freight & carriage on sales.
charges.
[g] Export duties.
[f] Legal expenses. [h] Sales tax (not recoverable from
[g] Audit fees. customers)
[i] Vehicle maintenance & running expenses
for distribution of goods.
[j] Insurance of finished goods in Inventory
and goods in transit.
[k] Bad debts.

[a] Interest paid on loan.

[b] Discount on bills discounted.
[c] Discount allowed to
customers.

CA SANKET SHAH Page 88

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors
 Items which have to be debited/credited to the proprietor should be segregated from other items.
☺ Examples : Interest on drawings, interest on capital &charges for services rendered by firm to
proprietor.
 We shall now consider a few items individually:
[1] Drawings :
 Not expenses for the firm.
 Therefore, not debited to P&L Account.
 E.g.: Proprietor enjoyed personal benefit like use of firm's car. A suitable amount should be treated as
drawing and to that extent the charge to P&L A/c will be reduced; Drawings are debited to Capital
Account.

[2] Treatment of Income Tax Expense :

Company Sole Proprietor Partnership Firm

Other Expenses Personal Expense

Firm’s Tax Liability Partners’ Tax

Liability
Debit to P&L A/c Personal Expense

[3]
Discount received and allowed:
 Discount received is a gain and is credited to the P&L Account while discount allowed is debited.
 There is another term - Rebate.
 It is the allowance given to a customer when his purchases during a period total upto a certain figure.
 E.g.: A firm allows rebate of 4% to customers whose purchases during the year are at least Rs.5,000.
Customer with purchases ofRs.4,500 will not get any rebate. Another with purchases ofRs.5,100 will
get rebate of Rs.204 [5,100 * 4%]
 The entry for rebate is made only at the end of the year.
[a] Rebate A/c Dr
To Customers’ A/c
[b] P&L A/c Dr
To Rebate A/c
[4] Bad Debts:
 When a customer cannot pay the amount due from him, it is said to be a bad debt. It is a loss to the
firm.
 Bad Debts Account Dr.
To Debtor's / Customer’s Account
 If later on, the amount is recovered, it should be treated as a gain.
 Bank Account Dr.
To Bad Debts Recovered Account [P&L Cr]
 It should not be credited to the party paying it.

CA SANKET SHAH Page 89

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors
CLOSING ENTRIES
Entries made in journal for preparing Trading & P&L A/c to transfer various accounts are closing entries.
Sr. no. Particulars Dr Cr
[1] Profit and Loss Account Dr.
To Salaries Account
To Rent Account Expenses transferred
To Interest Account
To Other Expenses Account
[2] Discount Received Account Dr.
Bad debts Recovered Account Dr. Income transferred
To Profit and Loss Account
[3] Net Profit :
Profit and Loss Account Dr.
To Capital Account
Net Loss :
Capital Account Dr.
To Profit and Loss Account
ADJUSTMENT ENTRIES
[1] Expenses payable: E.g., Rent, Interest, Local Taxes, Wages etc.
Appropriate Expense Account Dr.
To Expenses Payable Account
[2] Income receivable: E.g., Interest on Government Loans, Professional fees, Rents, etc.
Income Receivable Account Dr.
To Appropriate Income Account
[3] Income Received in Advance :
Appropriate Income Account Dr.
To Income Received in Advance Account
[4] Prepaid Expenses :
Prepaid Expenses Account Dr.
To Appropriate Expenses Account
[5] Adjustment of Inventory of materials in hand, cost of which has already debited to expense
account. E.g: Stationery, Advertisement, Material, Manufacturing Stores, etc.
Inventory of Materials Dr.
To Appropriate Expenses Account
 Note : Next year in the beginning entries No. (1) to (5) should be reversed.
[6] Provision for Bad and doubtful Debts :
When it is feared that some amount due from customers will not be collected it is prudent to
recognise the expected loss .
Profit and Loss Account Dr.
To Provision for Bad and doubtful Debts Account
 Note:
 The accounts of the customers concerned are not affected until the amount is actually written off.
 Where an examination problem requires that certain bad debts should be written off & provision for
doubtful debts made, amount of bad debts to be w/off should be first debited against existing balance
of provision & resulting balance in the A/c afterwards should be raised to the required figure.
 Provision for Discount : It is required to be calculated after deducting the Provision for Bad Debts
from the total trade receivables.

CA SANKET SHAH Page 90

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors
[7] Provision for Depreciation :
Way 1 :
Depreciation A/c Dr
To Asset A/c
P&L Dr
To Depreciation A/c
Way 2 :
P&L A/c Dr
To Asset
Way 3 :
Depreciation A/c Dr
To Provision for Depreciation [AD A/c]
P&L Dr
To Depreciation A/c
[8] Other Provisions: Whenever loss is expected to occur, proper provision for meeting the loss
should be created. Example : Compensation for late delivery of goods.

CONCEPT 5 : CERTAIN ADJUSTMENTS AND THEIR TREATMENTS

Sr. no. Adjustments Treatment
1] Abnormal loss of Inventory by [i] Loss by Fire A/c Dr. [Abnormal Loss]
accident or fire To Purchases/Trading A/c
[ii] Insurance Company's A/c Dr.[Claim amt, if any  Asset]
Profit & Loss A/c Dr. [Loss-not covered by claim]
To Loss by Fire A/c
Example [FC] : [i] Loss by Fire A/c Dr.
Goods of Rs.6,000 destroyed To Purchases/Trading A/c
by fire, insurance company [ii] Insurance Company's A/c Dr.
admitted claim for Rs.4,500. Profit & Loss A/c Dr.
To Loss by Fire A/c
2] Goods sent on Approval basis  Entries for unapproved sale :
[i] Sales A/c Dr.
To Trade receivables A/c
[ii] Inventory with Customers Dr. [At Cost or NRV ]
To Trading A/c
Example [FC] : [i] Sales A/c Dr.
Goods costing Rs.10,000 sent To Trade receivables A/c
on sale/return basis for [ii] Inventory with Customers Dr.
Rs.12,000. Sale unapproved. To Trading A/c
3] Goods used other than for sale [i] As Donation :
Donation A/c Dr.
To Purchases
[ii] By proprietor for personal use
Drawings A/c Dr.
To Purchases
[iii] Distributed as free samples :
Advertisement A/c Dr.
To Purchases

CA SANKET SHAH Page 91

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors
[iv] Used in business for construction of asset :
Asset A/c Dr.
To Purchases
[v] Used for maintenance of business premises :
Repair & Maintenance A/c Dr.
To Purchases
4] Sales Tax [i] At the time of sale-
Cash/Debtors A/c Dr.
To Sales A/c [Trading Credit]
To Sales Tax Payable A/c [Liability side – BS]
[ii] On payment of sales-
Sales Tax Payable A/c Dr.
To Bank A/c
5] Commission based on profit [i] Commission on NP before charging such commission =
𝑹𝒂𝒕𝒆 𝒐𝒇 𝒄𝒐𝒎𝒎𝒊𝒔𝒔𝒊𝒐𝒏
Profit before commission * 𝟏𝟎𝟎

[ii] Commission on NP after charging such commission =

𝑹𝒂𝒕𝒆 𝒐𝒇 𝒄𝒐𝒎𝒎𝒊𝒔𝒔𝒊𝒐𝒏
Profit before commission * 𝟏𝟎𝟎+𝑹𝒂𝒕𝒆 𝒐𝒇 𝒄𝒐𝒎𝒎𝒊𝒔𝒔𝒊𝒐𝒏
 Journal entry-
Commission A/c Dr. [P&L Dr.]
To Commission Payable A/c [Liability side in BS]

CONCEPT 6 : BALANCE SHEET

 Definition :
"A statement which sets out the assets and liabilities of a firm or an institution as at a certain date."
 A Balance sheet is a statement showing position of an entity as at a particular date.
 The assets are shown on the right hand side and liabilities and capital on the left hand side.
 Example :
Particulars Rs.
Cash in Hand 1,440 Debit balance
Capital Accounts (Rs.10,000+ Rs.6,300) 16,300 Credit balance
Machinery Account 7,360 Debit balance
Trade receivables 8,500 Debit balance
Trade payables 3,700 Credit balance
Inventory Account 2,700 Debit balance

 Solution : C. WANCHOO
Balance Sheet as at December 31, 2011
Liabilities Rs. Assets Rs.
Trade payables 3,700 Cash in Hand 1,440
Capital 16,300 Trade receivables 8,500
Inventory 2,700
Machinery 7,360
20,000 20,000

CA SANKET SHAH Page 92

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors

CHARACTERISTICS OF BALANCE
SHEET

Prepared at a particular Prepared only after the It should TALLY, since –

date & not for a period. preparation of P&L A/c. Capital = Assets - Liabilities

 ARRANGEMENTS OF ASSETS AND LIABILITIES

Assets : Assets may be grouped in one of the following two ways :

Liquidity Permanence

Assets convertible into cash  Presented first Assets used for long term  Presented first.
Assets not easily convertible At bottom. Most Liquid AssetsAt Bottom

 Order of Permanence :
 Order of Liquidity :
[a] Goodwill
[a] Cash
[b] Patents
[b] Investments
[c] Fixed Assets – Tangible
[c] Trade receivables
[d] Partly Finished goods
[d] Inventory of Finished
[e] Inventory of Raw Materials
Goods
[f] Inventory of Finished
[e] Inventory of Raw Materials
Goods
[f] Partly Finished goods
[g] Trade receivables
[g] Fixed Assets – Tangible
[h] Investments
[h] Patents
[i] Cash
[i] Goodwill

 They should be treated as liquid or permanent according to the intention of the firm.
 The order in which the assets of a company are to be shown is described by the Companies Act.
Liabilities : According to urgency of payment :

Way 1 Way 2

[a] Capital [a] Short-term Liabilities

[b] Long-term Liabilities [b] Long-term Liabilities
[c] Short-term Liabilities [c] Capital
[Eg: Creditors/Bills Payable]

CA SANKET SHAH Page 93

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors

CLASSIFICATION OF ASSETS AND LIABILITIES

Assets Liabilities

Fixed Assets Current Long Term Short

Assets term/Current
Used for long Convertible into Settled after one Settled within one
period – not meant cash quickly year year
for sale
Machinery, Book Debts, Includes Creditors
Goodwill, etc. Inventory, Cash, Undistributed
etc. Profits
Proforma Balance Sheet as on..............

Liabilities Rs. Assets Rs.

Capital A/c: Tangible Fixed Assets :
Balance Land and Building
Add : Net Profit/Less: Net Loss Plant and Machinery
Less : Drawings Furniture and Fixture
Long Term Loans : Vehicles
Term Loans Intangibles :
Other Loans Goodwill
Short Term Loans : Patent Rights
Cash Credit Designs and Brand Names
Overdrafts Investments :
Other Loans Long term investments
Current Liabilities : Current Assets:
Trade payables Inventory in Trade
Outstanding Expenses Trade receivables
Advances Taken Prepayments
Provision : Advances
Provision for Bad debts Bank Balances
Provision for Retirement Benefits Cash In Hand
Provision for Taxation
Total Rs. Total Rs.

CONCEPT 7 : SEQUENCE OF ACCOUNTING PROCEDURE OR THE ACCOUNTING CYCLE

Journal Ledger Trial Balance P&L A/c Balance sheet

Checks Shows Financial

arithmetical Position
accuracy
CA SANKET SHAH Page 94
 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors
CONCEPT 8 : OPENING ENTRY
 The first entry in the journal is to record the closing balances of various assets and liablities at the end
of the previous year as the opening balances in the beginning of the new year. It is called the opening
entry.
 The assets shown in the balance sheet are debited and the liabilities and capital account credited.
 POSTING THE OPENING ENTRY
 Assets accounts are opened on the debit side as "To Balance b/d".
Dr. ASSET ACCOUNT Cr.
Date Particulars Rs. Date Particulars Rs.
Jan 1 To Balance b/d xx
 Liability accounts are opened on the credit side as "By Balance b/d".
Dr. LIABILITY ACCOUNT Cr.
Date Particulars Rs. Date Particulars Rs.
Jan 1 By Balance b/d xx

CONCEPT 9 : PROVISIONS AND RESERVES

 Provision means "any amount written off or retained by way of providing for depreciation, renewal or
diminution in the value of assets or retained by way of providing for any known liability of which the
amount cannot be determined with substantial accuracy".
 Thus, a provision may be either in respect of loss in the value of asset or in respect of a liability for
expenses incurred in respect of a disputed claim i.e. contingent liability.
 The following are instances of amount retained in business out of earning for provisions:
[i] For meeting claims which are admissible in principle but the amount whereof has not been
ascertained.
[ii] An appropriation made for payment of taxes still to be assessed.
[iii] Amount set aside for writing off bad debts or payment of discounts.
 Reserves mean “the portion of earnings, receipts or other surplus of an enterprise (capital or revenue)
appropriated by the management for general or specific purpose other than a provision”
 The reserves are primarily of two types:
[a] Capital reserves
[b] Revenue reserves
 Provisions made > Amount necessary for the purpose it was originally made= Reserves.
 Thus, provisions are a charge against profits, while reserves are appropriation of profits.
 Reserve Fund :
 It signifies the amount standing to the credit of the reserve that is invested outside the business in
securities which are readily realizable.
 E.g: When amounts set apart for replacement of asset are invested periodically in govt securities or
shares

CA SANKET SHAH Page 95

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors
CONCEPT 10 : LIMITATIONS OF FINANCIAL STATEMENTS
Sr. no. Limitations Explanation
1] Historical Cost  FS are prepared on the basis of the money value prevailing at the time
the transaction was entered into.
 Effect of subsequent changes in money value is ignored.
 It makes statements of account quite misleading.
 Revaluation is the solution to this limitation.
 However, it is not practicable when money value is falling.
 Eg: House in 1980, Cost = Rs.15,[Link] 2011,Value of House=
Rs.14,50,000. This would not convey true picture in BS.
2] Intangible strengths  Intangible strengths & weaknesses of a company cannot be shown in
& weaknesses BS. Eg: Loyalty & Calibre of staff.
3] Perpetual continuity  FS are drawn at the end of the year, but the accounting record is
& periodical account maintained on the assumption that business shall exist forever.
 Thus, Capital expenditure has to be distributed over number of years
during which benefit is expected.
 Methods of valuation of following assets is different in different
entities, thus FS are not comparable :
[i] Intangible assets like goodwill
[ii] Wasting assets like mines, quarries
[iii] Deferred revenue expenditure
[iv] Fictitious assets like Preliminary Expenses, Discount on Debentures
4] Different  It is permissible for a company within certain limits to adopt different
accounting policies policies for preparation of FS.
 The same must be followed consistently, from year to year.
 Departure from this leads to non-comparability.
5] Management  It is not wholly correct that each entity wants to earn maximum profit.
policies  This is because of following reasons:
[i] High rates of taxation
[ii] Not willing to take responsibilities & risks
[iii] Developing bad reputation if prices are not reasonable
[iv] Larger profits may give rise to demand for more wages.
[v] Fear of developing monopolistic tendencies.
[vi] Unwillingness to expand due to future uncertainty.



CA SANKET SHAH Page 96

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors

UNIT 2 : FINAL ACCOUNTS OF MANUFACTURING ENTITIES

CONCEPT 1 : INTRODUCTION
 The manufacturing entities prepare separate Manufacturing Account in addition to Trading & P&L
Account and Balance Sheet.
 Its objective is to determine manufacturing costs of finished goods for assessing the cost effectiveness.
 Manufacturing costs of finished goods are transferred from the Manufacturing A/c to Trading A/c.
CONCEPT 2 : PURPOSE

To show total To facilitate To provide To serve as a To know Profit

cost of reconciliation of details of factory basis for or Loss on
manufacturing finance & cost cost comparison of manufacture.
finished records manufacturing
products in operations
detail

CONCEPT 3 : MANUFACTURING COSTS

Sr. No. Manufacturing Costs

1] Raw Material Consumed [Opening + Purchases – Closing]
2] Direct Manufacturing Wages
3] Direct Manufacturing Expenses
4] Prime Cost [1+2+3]
5] Indirect Manufacturing expenses or Manufacturing Overhead
6] Total Manufacturing Cost [4+5]
 Note :
Opening Inventory of WIP  Manufacturing Account : Dr. Side
Closing Inventory of WIP  Manufacturing Account : Cr. Side
Sr. no. Costs Explanation
1] Direct Manufacturing  Costs other than material or wages incurred for a specific
Expenses product or service.
 Examples :
Royalties-based on units produced [directly vary with prodn]
Hire charges-based on units produced [directly vary with prodn]
2] Indirect Manufacturing  Also called : Manufacturing OH, Production OH, Works OH.
Expenses  OH = Indirect Materials + Indirect wages + Indirect Expenses
Not directly linked with units produced
 Examples :
[i]
Materials & wages for repair & maintenance are indirect.
[ii]
Depreciation, insurance premium are indirect expenses.
3] By-Products  Production of main product is accompanied by production of
subsidiary product which has value on sale called as by-product.
 It is termed as a by-product because its production is not
consciously undertaken.
 They have insignificant value as compared to main product.

CA SANKET SHAH Page 97

 ACCOUNTS 7. Preparation of Final Accounts of Sole Proprietors
 These are valued at NRV if costs are not separately identified.
 It is treated as ‘Miscellaneous Income’ but correct treatment is to
credit it to the manufacturing account to reduce the cost of main
product to that extent.
 Examples :
[i] Molasses is the by-product in sugar manufacturing
[ii] Butter milk is the by-product of dairy producing butter &cheese

CONCEPT 4 : DESIGN OF A MANUFARING ACCOUNT

Manufacturing Account
Particulars Units Rs. Particulars Units Rs.
To Raw Material Consumed: By By-products at NRV
Opening inventory By Closing Work-in-Process
Add:Purchases By Trading A/c –
Less: Closing Inventory Cost of production *
To Direct Wages
To Direct expenses:
Prime cost
To Factory overheads:
Royalty
Hire charges
To Indirect expenses:
Repairs & Maintenance
Depreciation
Factory cost
To Opening Work-in-process
 Note : Frequently, problems are set, in which all the ledger balances are not given. Instead, details are
given regarding the number of items in Inventories, quantity manufactured etc. the figures for
Inventories, sales etc., would therefore have to be worked out independently from the data given.
 The following general rules maybe observed:
[a] The Manufacturing Account should have columns showing the quantities and values.
 Frequently, all quantities not given & quantities applicable to 1 or more items need to be worked out.
 Eg: If the question does not state the total number of items sold, the quantity can be worked out by
opening inventory (+) units manufactured (-) deducting closing inventory.
 It is therefore useful to have quantity columns to check that both sides balance.
[b] The Manufacturing Account will show :
[i] In case of Raw Materials Opening Inventory, Purchases & Closing Inventory.
[ii] In case of Finished Goods Quantity manufactured.
[iii] In case of WIP Opening & Closing Amounts.
[c] The Trading Account will show :
[i] In case of Raw Materials& WIP  No Quantity is shown
[ii] In case of FG Opening, Closing Inventory, Quantity manufactured & sold.
[d] To determine the value of closing inventory, in absence of specific instruction, it must be assumed that
sales have been on "first in-first out" basis i.e. closing inventory will consist of production during year.
 Nowadays, no manufacturing entity prepares manufacturing account as part of its final accounts.
 Items of manufacturing account are shown either in trading account (in case of non-corporate
entities) or in profit and loss account (in case of corporate entities).


CA SANKET SHAH Page 98