Chapter 7: Preparation of Financial Statements of Sole Trading and Partnership Firms
7.1 Capital and Revenue Concepts
A clear distinction between Capital and Revenue items is indispensable before preparing Financial Statements: Capital items go to the Balance Sheet (Statement of Financial Position), whereas Revenue items go to the Trading & Profit and Loss Account (Income Statement). Misclassifying them commits an Error of Principle and distorts both Net Profit and Net Worth.
7.1.1 Capital Expenditure vs. Revenue Expenditure vs. Deferred Revenue Expenditure
| Basis of Comparison | Capital Expenditure | Revenue Expenditure |
|---|---|---|
| 1. Purpose | Incurred to acquire, install, or upgrade fixed assets to increase earning capacity over multiple years. | Incurred for day-to-day operational maintenance and running of the business to maintain existing earning capacity. |
| 2. Duration of Benefit | Yields economic benefit for more than one accounting period (long-term). | Benefit is exhausted within the current accounting year (short-term). |
| 3. Recurrence | Non-recurring and irregular in nature. | Recurring and regular in nature. |
| 4. Accounting Treatment | Shown as an Asset in the Balance Sheet (capitalized). | Shown as an Expense on the Debit side of Trading or P&L Account. |
| 5. Examples | Purchase price of Plant/Machinery, freight and installation wages on new machine, legal fees for buying land, cost of building extension, major overhaul of second-hand machinery at purchase. | Purchase of goods for resale, routine repairs, whitewashing building, annual insurance, salaries, wages, rent, electricity. |
- Deferred Revenue Expenditure: A heavy expenditure that is fundamentally revenue in nature (does not create a tangible fixed asset), but whose benefit extends over 3 to 5 years (e.g., massive initial advertising campaign to launch a new product, preliminary expenses, research & development expenditure). Only the current year’s proportionate write-off is charged to the P&L Account, and the unwritten-off balance is temporarily shown on the Assets side. (Note: Under strict NAS 38 / NFRS, heavy advertising and preliminary expenses are expensed immediately when incurred).
7.1.2 Capital Receipts vs. Revenue Receipts, and Capital Profit/Loss vs. Revenue Profit/Loss
- Capital Receipts: Non-recurring inflows from owner’s capital contribution, bank loans, debentures, or sale proceeds of fixed assets/investments → Shown in Balance Sheet (creates a liability or reduces an asset).
- Revenue Receipts: Recurring inflows from ordinary business operations such as cash/credit sales of goods, commission received, interest received, rent received → Credited to Trading or P&L Account.
- Capital Profit vs. Revenue Profit: Profit earned from selling a fixed asset above its original cost or issuing shares at a premium is Capital Profit (transferred to Capital Reserve), whereas profit earned from buying and selling merchandise is Revenue Profit (credited to P&L Account).
7.2 Traditional Final Accounts (Trading, P&L Account, and Balance Sheet)
Under the traditional British/Continental format, Final Accounts of a Sole Trading or Partnership firm consist of three statements:
7.2.1 1. Trading Account
Prepared to ascertain Gross Profit or Gross Loss (Net Sales - Cost of Goods Sold).
- Formula: Cost of Goods Sold (COGS) = Opening Stock + Net Purchases + Direct Expenses - Closing Stock
- Debit Side (Direct Costs): Opening Stock, Purchases (less Purchase Returns, Drawings of goods, Free samples, Goods lost by fire), Wages / Productive Wages, Carriage Inward / Freight on Purchases, Customs & Import Duty, Octroi, Factory Power, Fuel, Coal, Gas & Water, Factory Rent & Lighting, Royalty on Production.
- Credit Side: Sales (less Sales Returns / Return Inward), and Closing Stock.
7.2.2 2. Profit and Loss Account
Prepared to ascertain Net Profit or Net Loss by matching all indirect operating and non-operating expenses against Gross Profit and indirect incomes.
- Debit Side (Indirect Expenses & Losses):
- Office & Administrative Expenses: Office Salaries, Rent, Rates & Taxes, Printing & Stationery, Postage & Telegram, Telephone/Internet, Audit Fees, Legal Charges, Insurance Premium, Office Lighting, General/Sundry Expenses.
- Selling & Distribution Expenses: Carriage Outward / Freight on Sales, Advertisement, Salesmen’s Salaries & Commission, Bad Debts, Packing Expenses, Delivery Van Expenses, Godown/Warehouse Rent.
- Financial & Non-Cash Expenses/Losses: Interest on Loan/Overdraft, Interest on Capital, Bank Charges, Discount Allowed, Depreciation on Fixed Assets, Repair & Maintenance, Loss on Sale of Fixed Assets, Uninsured Loss by Fire/Theft, Provision for Taxation.
- Credit Side (Indirect Incomes & Gains): Gross Profit b/d, Discount Received, Commission Received, Interest on Investment/Drawings, Rent Received, Bad Debts Recovered, Apprentice Premium, Profit on Sale of Fixed Assets.
7.2.3 3. Balance Sheet
A statement of Assets, Liabilities, and Owner’s/Partners’ Capital on the last day of the accounting year.
- Marshalling of Balance Sheet: Arranging assets and liabilities either in Order of Permanence (Fixed Assets/Long-term Capital first, liquid items last) or Order of Liquidity (Cash first, Fixed Assets last).
- Partnership Adjustment in Balance Sheet: In a partnership firm, Net Profit is transferred to the Profit & Loss Appropriation Account (where Partner’s Salary, Commission, Interest on Capital, and Interest on Drawings are adjusted) and the divisible profit is credited to each Partner’s Capital Account (under Fixed or Fluctuating Capital method) in their profit-sharing ratio.
7.3 Modern Financial Statements under NAS / NFRS (Mandatory NEB Topic)
Under Nepal Accounting Standards (NAS 01) and Nepal Financial Reporting Standards (NFRS), financial statements are presented in a vertical, classified Multi-Step Format accompanied by systematic Working Notes:
- Statement of Profit or Loss (Income Statement)
- Statement of Financial Position (Classified Balance Sheet)
7.3.1 Specimen of Multi-Step Income Statement (Under NAS / NFRS)
Name of Entity
Statement of Profit or Loss (Income Statement)
For the Year Ended on the Last Day of Ashadh 2082
| Particulars | Note | Details (Rs.) | Amount (Rs.) |
|---|---|---|---|
| Revenue from Operations (Net Sales): (Gross Sales less Sales Returns) | 1 | XXX | |
| Less: Cost of Sales / Cost of Goods Sold (COGS) (Opening Stock + Net Purchases + Direct Wages/Carriage Inward - Closing Stock) | 2 | (XXX) | |
| Gross Profit | XXX | ||
| Add: Other Operating Income (Commission Received, Rent Received, Discount Received, Bad Debts Recovered, Gain on Sale of Asset) | 3 | XXX | |
| Total Operating Income | XXX | ||
| Less: Operating Expenses: | |||
| • Distribution & Selling Expenses (Advertisement, Carriage Outward, Salesmen Commission, Bad Debts, New Prov. for Doubtful Debts, Delivery Van Depr.) | 4 | XXX | |
| • Administrative & General Expenses (Office Salaries, Rent, Insurance, Printing, Audit Fees, Office Furniture/Building Depr., Repairs) | 5 | XXX | (XXX) |
| Profit from Operations (Operating Profit / EBIT) | XXX | ||
| Add: Finance Income (Interest on Investments / Fixed Deposits) | XXX | ||
| Less: Finance Costs (Interest on Bank Loan, Interest on Debentures/Overdraft, Bank Charges) | 6 | (XXX) | |
| Profit Before Tax (PBT) | XXX | ||
| Less: Income Tax Expense / Provision for Taxation | (XXX) | ||
| Net Profit for the Year (Transferred to Equity / Retained Earnings) | XXX |
7.3.2 Specimen of Statement of Financial Position (Balance Sheet under NAS / NFRS)
Name of Entity
Statement of Financial Position (Balance Sheet)
As on the Last Day of Ashadh 2082
| Particulars | Note | Details (Rs.) | Amount (Rs.) |
|---|---|---|---|
| I. ASSETS | |||
| 1. Non-Current Assets: | |||
| • Property, Plant and Equipment (Tangible Fixed Assets): (Land, Building, Plant & Machinery, Vehicles, Furniture at Cost less Accumulated Depreciation) | 7 | XXX | |
| • Intangible Assets: (Goodwill, Patents, Trademarks, Software less Amortization) | 8 | XXX | |
| • Long-Term Financial Assets / Investments: (Investments in Shares, NRB Bonds, Long-term Fixed Deposits) | 9 | XXX | XXX |
| 2. Current Assets: | |||
| • Inventories: (Closing Stock of Goods, Raw Materials, Spare Parts) | XXX | ||
| • Trade and Other Receivables: (Sundry Debtors less Further Bad Debts & Provision for Doubtful Debts, Bills Receivable) | 10 | XXX | |
| • Other Current Assets / Prepayments: (Prepaid Expenses, Accrued Income, Advance Tax) | 11 | XXX | |
| • Cash and Cash Equivalents: (Cash in Hand, Cash at Bank, Petty Cash) | 12 | XXX | XXX |
| TOTAL ASSETS (1 + 2) | XXXX | ||
| II. EQUITY AND LIABILITIES | |||
| 1. Equity (Owner’s / Partners’ Fund): | |||
| • Capital: (Opening Capital + Additional Capital + Interest on Capital + Net Profit - Drawings) | 13 | XXX | |
| • Reserves and Surplus: (General Reserve, Capital Reserve, Retained Earnings) | 14 | XXX | XXX |
| 2. Non-Current Liabilities (Long-Term Liabilities): | |||
| • Long-Term Borrowings: (Bank Loan, Mortgage Loan, Debentures) | 15 | XXX | XXX |
| 3. Current Liabilities (Short-Term Liabilities): | |||
| • Trade and Other Payables: (Sundry Creditors, Bills Payable) | 16 | XXX | |
| • Short-Term Borrowings: (Bank Overdraft, Short-term Loans) | XXX | ||
| • Other Current Liabilities & Provisions: (Outstanding Expenses, Advance/Unearned Income, Provision for Taxation) | 17 | XXX | XXX |
| TOTAL EQUITY AND LIABILITIES (1 + 2 + 3) | XXXX |
7.4 Master Table of 18 Year-End Adjustments (Dual Effect Guide)
Every item given inside the Trial Balance is recorded only once (either in the Income Statement or in the Balance Sheet). Every item given outside the Trial Balance (in Adjustments) has a dual effect: it is recorded twice, usually once in the Trading/Income Statement and once in the Balance Sheet.
| S.N. | Adjustment Item | Effect 1: Trading / P&L / Income Statement | Effect 2: Balance Sheet (Statement of Financial Position) |
|---|---|---|---|
| 1. | Closing Stock | • Traditional: Cr. side of Trading A/c • NFRS: Deducted in Cost of Sales (COGS) | Shown under Current Assets (Inventories). |
| 2. | Outstanding / Unpaid Expenses (e.g., O/S Wages, O/S Salary) | Added to the concerned expense on Dr. side of Trading or P&L A/c. | Shown under Current Liabilities. |
| 3. | Prepaid / Unexpired Expenses (e.g., Prepaid Insurance) | Deducted from the concerned expense on Dr. side of P&L A/c. | Shown under Current Assets. |
| 4. | Accrued / Receivable Income (Income earned but not received) | Added to the concerned income on Cr. side of P&L A/c. | Shown under Current Assets. |
| 5. | Advance / Unearned Income (Income received in advance) | Deducted from the concerned income on Cr. side of P&L A/c. | Shown under Current Liabilities. |
| 6. | Depreciation on Fixed Assets | Debited to P&L A/c (Admin/Selling Exp.). | Deducted from the concerned Fixed Asset (PPE). |
| 7. | Appreciation on Fixed Assets (e.g., Land appreciated by 10%) | Credited to P&L A/c (Other Income). | Added to the concerned Fixed Asset (PPE). |
| 8. | Further Bad Debts & New Provision for Doubtful Debts | Added to Bad Debts in P&L A/c (Selling Exp.) and Old Provision deducted. | Both Further Bad Debts and New Provision are deducted from Sundry Debtors. |
| 9. | Goods Lost by Fire / Accident (Uninsured) | Deducted from Purchases in Trading A/c (or Cr. Trading A/c). | No Balance Sheet effect: the full loss is debited to P&L A/c. |
| 10. | Goods Lost by Fire (Partly Insured) | Full Cost deducted from Purchases in Trading A/c. | • Insurance Claim Admitted → Shown under Current Assets. • Net Uninsured Loss → Debited to P&L A/c. |
| 11. | Goods Withdrawn by Owner for Personal Use (Drawings) | Deducted from Purchases in Trading A/c. | Deducted from Capital in Balance Sheet. |
| 12. | Goods Distributed as Free Samples / Charity | Deducted from Purchases in Trading A/c. | No Balance Sheet effect: debited to P&L A/c as Advertisement / Charity Expense. |
| 13. | Interest on Capital | Debited to P&L A/c (or P&L Appropriation A/c). | Added to Capital in Balance Sheet. |
| 14. | Interest on Drawings | Credited to P&L A/c (Other Income). | Deducted from Capital in Balance Sheet. |
| 15. | Hidden Adjustment: Interest on Loan / Investment (e.g., 10% Bank Loan Rs. 1,00,000, interest paid in TB is only Rs. 6,000) | Outstanding Interest (Rs. 10,000 - Rs. 6,000 = Rs. 4,000) is added to Interest on Loan in P&L A/c. | Outstanding Interest of Rs. 4,000 is shown under Current Liabilities. |
| 16. | Provision for Taxation | Deducted as Income Tax Expense in Income Statement (or Dr. P&L A/c). | Shown under Current Liabilities (Short-Term Provisions). |
| 17. | Transfer to General Reserve | Debited to P&L Appropriation A/c (deducted from Retained Earnings). | Shown under Reserves and Surplus (Equity) in Balance Sheet. |
| 18. | Manager’s Commission on Net Profit: • Before charging such commission: NP × R ÷ 100 • After charging such commission: NP × R ÷ (100 + R) | Debited to P&L A/c (Administrative Expense). | Shown as Outstanding Manager’s Commission under Current Liabilities. |
7.5 Complete Worked Numerical Example (Both Traditional & NFRS Formats)
Illustration 7.1 (NEB 8-Mark Standard):
From the following Trial Balance of Sagarmatha Enterprises as on the last day of Ashadh 2082, prepare:
- Part A: Traditional Trading Account, Profit and Loss Account, and Balance Sheet.
- Part B: Multi-Step Income Statement and Statement of Financial Position (Balance Sheet) as per NAS / NFRS.
| Debit Balances | Amount (Rs.) | Credit Balances | Amount (Rs.) |
|---|---|---|---|
| Opening Stock | 80,000 | Sales | 6,20,000 |
| Purchases | 3,50,000 | Purchase Return | 10,000 |
| Wages | 40,000 | Sundry Creditors | 70,000 |
| Carriage Inward | 10,000 | 10% Bank Loan | 1,00,000 |
| Plant and Machinery | 2,00,000 | Commission Received | 15,000 |
| Office Furniture | 60,000 | Provision for Doubtful Debts (Old) | 5,000 |
| Sundry Debtors | 1,25,000 | Capital | 2,50,000 |
| Salaries | 65,000 | ||
| Rent and Insurance | 24,000 | ||
| Advertisement | 18,000 | ||
| Bad Debts | 4,000 | ||
| Interest on Bank Loan | 6,000 | ||
| Cash and Bank | 68,000 | ||
| Drawings | 20,000 | ||
| Total | 10,70,000 | Total | 10,70,000 |
Adjustments on the last day of Ashadh 2082:
- Closing Stock was valued at Rs. 95,000.
- Wages outstanding Rs. 5,000 and Salaries outstanding Rs. 10,000.
- Prepaid Insurance amounted to Rs. 4,000.
- Write off further Bad Debts Rs. 5,000 and maintain Provision for Doubtful Debts @ 5% on remaining good debtors.
- Depreciate Plant & Machinery @ 10% p.a. and Office Furniture @ 15% p.a.
- Provide for the remaining unpaid interest on 10% Bank Loan (Hidden adjustment: Total annual interest = 10% of 1,00,000 = Rs. 10,000; Paid = Rs. 6,000; Outstanding Interest = Rs. 4,000).
Solution — Part A: Traditional Final Accounts
Sagarmatha Enterprises
Trading and Profit & Loss Account
For the Year Ended on the Last Day of Ashadh 2082
| Dr. Particulars | Details (Rs.) | Amount (Rs.) | Cr. Particulars | Details (Rs.) | Amount (Rs.) |
|---|---|---|---|---|---|
| To Opening Stock | 80,000 | By Sales | 6,20,000 | ||
| To Purchases | 3,50,000 | By Closing Stock | 95,000 | ||
| Less: Purchase Return | (10,000) | 3,40,000 | |||
| To Wages | 40,000 | ||||
| Add: Outstanding Wages | 5,000 | 45,000 | |||
| To Carriage Inward | 10,000 | ||||
| To Gross Profit c/d | 2,40,000 | ||||
| Total | 7,15,000 | Total | 7,15,000 | ||
| To Salaries | 65,000 | By Gross Profit b/d | 2,40,000 | ||
| Add: Outstanding Salaries | 10,000 | 75,000 | By Commission Received | 15,000 | |
| To Rent and Insurance | 24,000 | ||||
| Less: Prepaid Insurance | (4,000) | 20,000 | |||
| To Advertisement | 18,000 | ||||
| To Bad Debts (Given) | 4,000 | ||||
| Add: Further Bad Debts | 5,000 | ||||
| Add: New Provision (5% of 1,20,000) | 6,000 | ||||
| Less: Old Provision | (5,000) | 10,000 | |||
| To Interest on Bank Loan | 6,000 | ||||
| Add: Outstanding Interest | 4,000 | 10,000 | |||
| To Depreciation: | |||||
| • Plant & Machinery (10% of 2,00,000) | 20,000 | ||||
| • Office Furniture (15% of 60,000) | 9,000 | 29,000 | |||
| To Net Profit (Transferred to Capital) | 93,000 | ||||
| Total | 2,55,000 | Total | 2,55,000 |
Balance Sheet of Sagarmatha Enterprises (Traditional Format)
As on the Last Day of Ashadh 2082
| Capital and Liabilities | Details (Rs.) | Amount (Rs.) | Assets and Properties | Details (Rs.) | Amount (Rs.) |
|---|---|---|---|---|---|
| Capital | 2,50,000 | Plant and Machinery | 2,00,000 | ||
| Add: Net Profit | 93,000 | Less: Depreciation @ 10% | (20,000) | 1,80,000 | |
| Less: Drawings | (20,000) | 3,23,000 | Office Furniture | 60,000 | |
| 10% Bank Loan | 1,00,000 | Less: Depreciation @ 15% | (9,000) | 51,000 | |
| Sundry Creditors | 70,000 | Closing Stock | 95,000 | ||
| Outstanding Wages | 5,000 | Sundry Debtors | 1,25,000 | ||
| Outstanding Salaries | 10,000 | Less: Further Bad Debts | (5,000) | ||
| Outstanding Interest on Loan | 4,000 | Less: New Provision @ 5% | (6,000) | 1,14,000 | |
| Prepaid Insurance | 4,000 | ||||
| Cash and Bank | 68,000 | ||||
| Total | 5,12,000 | Total | 5,12,000 |
Solution — Part B: Modern Financial Statements under NAS / NFRS
Sagarmatha Enterprises
Statement of Profit or Loss (Multi-Step Income Statement under NFRS)
For the Year Ended on the Last Day of Ashadh 2082
| Particulars | Note | Details (Rs.) | Amount (Rs.) |
|---|---|---|---|
| Revenue from Operations (Net Sales) | 6,20,000 | ||
| Less: Cost of Sales (COGS): | |||
| Opening Stock (80,000) + Net Purchases (3,40,000) + Wages (45,000) + Carriage Inward (10,000) - Closing Stock (95,000) | 1 | (3,80,000) | |
| Gross Profit | 2,40,000 | ||
| Add: Other Operating Income: Commission Received | 15,000 | ||
| Total Operating Income | 2,55,000 | ||
| Less: Operating Expenses: | |||
| • Distribution & Selling Expenses: Advertisement (18,000) + Net Bad Debts & Provision (10,000) | 2 | 28,000 | |
| • Administrative & General Expenses: Salaries (75,000) + Rent & Insurance (20,000) + Depreciation on Plant (20,000) & Furniture (9,000) | 3 | 1,24,000 | (1,52,000) |
| Profit from Operations (Operating Profit / EBIT) | 1,03,000 | ||
| Less: Finance Costs: Interest on 10% Bank Loan (6,000 + 4,000 O/S) | 4 | (10,000) | |
| Net Profit for the Year | 93,000 |
Sagarmatha Enterprises
Statement of Financial Position (Balance Sheet under NFRS)
As on the Last Day of Ashadh 2082
| Particulars | Note | Details (Rs.) | Amount (Rs.) |
|---|---|---|---|
| I. ASSETS | |||
| 1. Non-Current Assets: | |||
| • Property, Plant and Equipment: Plant & Machinery (Rs. 1,80,000) + Office Furniture (Rs. 51,000) | 5 | 2,31,000 | |
| 2. Current Assets: | |||
| • Inventories: Closing Stock | 95,000 | ||
| • Trade Receivables: Net Sundry Debtors (1,25,000 - 5,000 - 6,000) | 6 | 1,14,000 | |
| • Other Current Assets: Prepaid Insurance | 4,000 | ||
| • Cash and Cash Equivalents: Cash and Bank | 68,000 | 2,81,000 | |
| TOTAL ASSETS | 5,12,000 | ||
| II. EQUITY AND LIABILITIES | |||
| 1. Equity: Capital (2,50,000) + Net Profit (93,000) - Drawings (20,000) | 7 | 3,23,000 | |
| 2. Non-Current Liabilities: Long-Term Borrowings (10% Bank Loan) | 1,00,000 | ||
| 3. Current Liabilities: | |||
| • Trade Payables: Sundry Creditors | 70,000 | ||
| • Other Current Liabilities: O/S Wages (5,000) + O/S Salaries (10,000) + O/S Interest (4,000) | 8 | 19,000 | 89,000 |
| TOTAL EQUITY AND LIABILITIES | 5,12,000 |
7.6 NEB Board Exam Practice Questions
Group A: Very Short Answer Questions (1 Mark Each)
- Distinguish between Capital Expenditure and Revenue Expenditure in one sentence.
- What is Deferred Revenue Expenditure? Give one example.
- Give two examples of Capital Receipts.
- How is Goods Lost by Fire (partially insured) treated in Final Accounts?
- What is meant by Marshalling of Balance Sheet?
Group B & C: Short and Long Numerical Questions (5 / 8 Marks)
- Distinguish between Capital Expenditure and Revenue Expenditure on any five bases.
- State whether the following are Capital or Revenue Expenditures with reasons:
- (a) Freight and cartage paid on purchase of a new printing machine.
- (b) Legal expenses incurred in defending a suit for breach of contract to supply goods.
- (c) Cost of overhauling and painting a second-hand delivery van just purchased.
- (d) Whitewashing and routine repair of the factory building.
- (e) Cost of constructing an additional room in the office building. (Ans: Capital: a, c, e; Revenue: b, d)
Worked answers to these exercises are in Chapter 7 Solutions.