Making up Final Accounts :: Deriving the Additional Information Needed
How is the Additional Information obtained?
Information relating to Profits from Nominal AccountsNominal accounts carry debit or credit balances representing expenses or losses and incomes or gains respectively.
Since ascertaining profits or losses involves dealing with incomes, gains, expenses and losses, the balances of all the nominal accounts put together should give us the information relating to the profits or losses made by the organisation.
Trading and Profit and Loss AccountsTo derive the information relating to profits from these nominal accounts a ledger account by name "Trading and Profit & Loss a/c" is prepared. The balances in all the nominal accounts are transferred to this account in the process of ascertaining the profit.
Almost in all cases, we use two separate ledger accounts Trading a/c and Profit and Loss a/c to derive information relating to profits with a greater detail. The more the information we need, the more the accounting heads we need to maintain. Preparation of these ledger accounts requires us to think beyond just transferring the information in the nominal accounts into these accounts.
The Position of the organisation from Real and Personal Accounts
Real AccountsReal accounts are related to tangible aspects. In general we can identify that all asset accounts are real accounts.
Personal AccountsPersonal accounts are related to persons and organisations. These are persons/organisations which owe the organisation or to whom the organisation owes. In effect they either form creditors (liabilities) or debtors (assets).
Since all the nominal accounts have been dealt with in deriving the information relating to profits and we are left with only the real and personal accounts which represent either assets or liabilities we can conclude that the real and personal accounts together give us the information relating to the position of the organisation.
Balance SheetTo derive the information relating to the position of the organisation from these real and personal accounts a statement by name "Balance Sheet" is prepared.
However preparing the Balance sheet need us to think a bit beyond just listing out the information relating to the personal and real accounts in the statement.
Debtors (Assets) and Creditors (Liabilities)
AssetsBoth real accounts and Personal accounts are capable of being called assets. Any element (account) that is capable of being liquidated (that is capable of being converted to cash or any other asset by giving it away) indicates an asset. Machinery, Furniture, Cash, etc are real accounts that can be called assets.
Debtors represent AssetsDebtors represent the persons and organisation who owe to the organisation. They would clear their dues by paying out either in cash or in some other form. Thus Debtors get liquidated and as such can be called assets.
LiabilitiesAll elements representing liabilities are Personal accounts. An element that is capable of being cleared by paying out indicates a liability.
Creditors represent LiabilitiesCreditors represent the persons and organisation to whom the organisation owes. The organisation would clear its due by paying them either in cash or in some other form. Thus creditors are cleared by paying out and as such can be called liabilities.
When is the information relating to profits & position collected/derived
Period for which profits are ascertainedThe information relating to profits is something that is needed by the organisation periodically.
For what period do we try to ascertain profits. Do we think of profits made every day or over a week or over a month or over a six month period or over a year? This is dependent on the information needs of the organisation.
Though theoretically it is possible to derive this information's for any time period, conventionally it is derived for a year. That is in most cases, information relating to profits is derived over a year. We think of profits made over a year.
Day on which position is ascertainedThe information relating to the position may be needed by the organisation at many points of time. Theoretically this is also capable of being derived at any point of time we need it.
However, conventionally it is derived at a point which indicates the end of the period for which the profits are ascertained. Say if we think of profits made for the period from 1st April 20_5 to 31st March 20_6, we think of deriving the position as on 31st March 20_6.
There are two aspects relating to an accounting period. The length of the period as well as the begin and end dates of the period. These can be ascertained from the way the accounting period is stated.
For example, where the accounting period of an organisation is stated as
- From 1st July to 31st December, it implies that the length of the accounting period is 6 months.
- One year and starts on 1st January every year, it implies that the accounting period is from 1st January to 31st December and is one year long.
What Accounting Period to Follow?What accounting period an organisation follows is dependent on the informational as well as statutory needs of the organisation. The most common period followed all over the world is a period of 1 year which starts from either 1st January or 1st April.
Statutory RequirementsThe need of the organisation to comply with the various laws that it has to adhere to would also influence the decision relating to the accounting period.
Say in India, the Income Tax Act, needs organisations to calculate and present their business profits for the period from 1st April to the following 31st March. Therefore, the organisations would follow the same accounting period so that their accounting would serve their informational needs as well as enable them to easily present the information that has to be presented to the Income Tax Department.