CHAPTER II
PREPARATION OF MANUFACTURING TRADING AND PROFIT AND LOSS ACCOUNT
1. Checking of postings in the ledgers :- By carefully vouching the cash book/day book and subsidiary ledgers, the auditor will be able to acquaint himself with the nature of entries in them. While vouching the Cash Book/Day Book the Auditor has to see whether the entries in them have correctly recorded the transactions. Since all the transactions affecting the business are entered in the ledgers also they generally form the centre of the accounts and the basis for preparation of the profit and loss account and balance sheet. The Auditor will, therefore, have to trace carefully the entries from the cash book and subsidiary ledgers and satisfy himself about their correctness in postings etc., in the respective ledgers.
The general ledger will contain all accounts which records the consolidated operation of the business in a given period or date. The consolidation of operation are again summarized into trading and profit and loss accounts and also to the statement of assets and liabilities of the concern. The Auditor has therefore added responsibility to ensure thorough checking of all the entries in general ledger in detail
2. Checking of Central Ledger :- The entries in the General Ledger are posted from the Day/Cash Book or subsidiary journals. The totals of all subsidiary journals viz., purchase register, sale register etc., in a manufacturing concern, deposit ledgers in a banking institution, other subsidiary ledgers in other institutions etc., are posted in the Day Book, first and then the totals are posted into the Central Ledger from Day Book. All transfers from one head in the General ledger to another account are passed through the Day Book. No transfer is made directly in any account in the General Ledger or Personal Ledgers without first being entered in the Day Book. Routine checking of postings is normally to be made by two clerks or assistants working together. Entries in the Day/Cash book and the General Ledger should be checked simultaneously. The opening balances of all real or property accounts and all accounts in the Personal Ledgers will however have to be carried over from the previous years’ ledgers.
3. Drawing up of the trial balance :- After checking the postings, totalling and balancing into the General Ledger all the closing balances are entered in a sheet separately depending on the nature of balance whether debit or credit. This statement which contains a classified summary or list of all closing balances of the General Ledger is known as the “trial balance”. If the totals of two sides of trial balances agree, normally it signifies the arithmetical accuracy of the accounts. If they do not tally, the difference is to be located by checking the postings, totals etc. An important point to be borne in mind in the preparation of the trial balance is to include the cash balance and bank balance as indicated by the cash and bank columns of the Cash/Day Book. In smaller societies, instead of the trial balance, a receipts and disbursements statement is prepared from the Cash/Book. However, the auditor should not proceed to prepare the final accounts unless he is presented with an agreed trial balance/receipts and disbursements statement.
4. Checking of the transfer entries :- When transfer entries are passed through the Cash Book/Day Book, both credit and debit entries should be checked simultaneously. There contra entries are to be marked with special ticks in order to distinguish them from other entries; which may involve passing of cash. All contra or transfer entries should be checked very carefully, as they do not affect the cash on band. Since contra entries create monetary obligations, they are as important as cash transactions, and should therefore receive due attention of the auditor.
While vouching entries in the journal or in the Cash Book, the auditor should see that not only there is sufficient evidence in support of the entry, but the entry itself correctly records the transactions. It should further be seen that all transfers from one account to another account in the General ledger or from one personal account to another are passed through the journal or through the Cash Book and that no posting into the ledger is made directly from the ledgers. The details furnished in the transfer vouchers (both credit and debit) should be verified carefully and ensured that the entry has been correctly passed.
5. Adjustment and closing of nominal accounts :- All nominal accounts are to be checked by the Auditor so as to satisfy himself that all transactions of the business have been correctly classified and included in the final accounts. The Auditor should take special care to see that all accrued income and expenditure incurred, but not paid and income received in advance are duly brought into account. In the case of consumer stores, and other trading societies, it is necessary to see that the sales made during the last few days prior to the closing of the accounts have been duly recorded. For this the auditor will trace back the issue of despatch of goods to the relative invoices or sales memos. Similarly in the case of securities and other investments, the auditor should ascertain whether all interest accrued during the period has been received and all dividend declared duly credited.
6. Items coming under: (i) Manufacturing Account :- Manufacturing or production account contain items relating to the manufacturing operations of the Society. The main heads under which the manufacturing, expenses are shown as under:-
(1) The work in progress or value of unfinished goods at the beginning of the year.
(2) Raw materials used (ie. opening stock plus purchases minus closing stock)
(3) Fuel, Oil Electricity and other power charges.
(4) Store and spare parts consumed.
(5) Direct or indirect labour.
(6) Maintenance of factory, plant, machinery, tools, stores, etc.
(7) Insurance of Factory building, tools, machinery etc.
(8) Depreciation of plant, machinery, tools etc.
(9) Factory lighting, water charges etc.
(10) Rent, rates and taxes of the factory premises.
(11) Salaries of the technical staff and officers including works manager, factory Superintendent etc.
(12) General administrative expenses pertaining to the Factory.
(ii) Trading Account :- The following items will appear on the debit side.
(1) Opening stock (value of finished goods at the beginning of the year).
(2) Cost of goods purchased, which include expenses connected with purchases.
(3) All trading expenses.
On the credit side the following items are usually included :
(1) Net sale proceeds (ie. total sales minus sales returns)
(2) Value of closing stock.
The difference between the two sides will show gross profit/gross loss.
(iii) Profit and loss account :- The items coming under debit (loss) side are the following:-
(1) Interest paid and due.
(2) Establishment and contingent charges paid and due.
(3) Depreciation
(4) Assets written off as bad debts
(5) Reserves for overdue interest.
(6) Reserve for doubtful debts.
(7) Miscellaneous items.
(a) Provision for gratuity
(b) Provision for income tax
(c) Provision for other items (to be specified)
(8) Last year’s loss.
(9) Net profit.
On the credit (profit) side:-
(i) Interest earned.
(ii) Miscellaneous income.
(iii) Commission etc.
(iv) Profit in non-credit business
(v) Reserve for interest of last year.
(vi) Other items
(vii) Net loss.
7. Other items:
(a) Outstanding expenses :- All nominal accounts in the impersonal ledger should be examined to see that all expenses and charges pertaining to the period under review have been included. It may be likely that there may be expenses outstanding on account of fuel charges, electricity charges etc.
With regard to the outstanding payments the auditor should examine “Goods Inward Book” or the “Invoice Register” for the last few weeks of the period and satisfy himself that all purchases made and included in the stock have been duly brought into account and the amount of the unpaid invoices credited to the respective accounts of the suppliers of the goods. In addition to purchases not paid for, expenses incurred but not paid, are also required to be brought into account. Many times, bills for supplies made and services rendered are not received from the suppliers and other creditors. For eg: the Transport contractor might not have submitted his bills for goods transported during the last few days of the year. Similarly in must of the Societies, salaries and wages for June may not have been paid before the close of the year. All these items will have to be brought out as the outstanding expenses. For this purpose the Societies should maintain a register of outstandings expenses.
(b) Interest receivable and payable :- Interest accrued upto the date of balance sheet should be worked out and brought into account. However, no credit should be taken of amounts, receipt of which is considered doubtful, unless adequate provision is made therefore. As regards out-standing interest on loans and advances this has been treated separately. Interest on bank loans and other borrowings is generally debited to the account of the Society. In the case of deposits and other temporary borrowings, interest accrued up to the date of the balance sheet should be calculated and provided for. Care should be taken to include interest accrued on fixed deposit between the dates of last payment of interest up to the date of balance sheet.
(c) Expenses prepaid :- Prepaid expenses include expenses on account of rent, rates and taxes, insurance premiums, subscriptions membership fee etc. for periods that extent beyond the date of the balance sheet. The auditor should examine the individual accounts and also the demand notices, bills etc. and see that correct calculation has been made of the proportion of amounts relating to the unexpired periods.
(d) Deferred Revenue Expenditure :- There may be instances of incurring heavy expenditure the benefits of which extend to periods beyond the date of the balance sheet. In such cases, the expenditure incurred should be equitably spread over the period during which the benefits of such expenditure would be available. The auditor should examine carefully the whole of the circumstances in order to satisfy himself that the carry forward of part of such expenditure is fully justified.
8. Manufacturing Account :- The object of the manufacturing account is to ascertain the cost of goods manufactured during the period. The manufacturing account is therefore debited with the actual materials used and all production charges. eg. wages, power, works and factory expenses adjustment being made for work in progress at the beginning and end of the period. The balance in this account which is carried to the debit of the trading account represents the factory cost of the goods manufactured during the period.
9. Trading Account :- The trading account is relating to the trading activities of a concern. The object of this account is to show the result of trading activities for a period. In the case of a trading concern it will include the items relating to purchase and sale of goods and stock in trade at the beginning and close of the year. All direct charges incurred in connection with the purchase of goods should be included in the trading account.
Where manufacturing account is prepared to show the profit on manufacture, the cost of sales is transferred to the trading account from the manufacturing account. The trading account is also debited with any finished goods purchased less any returns outwards and is credited with sales less returns inwards. The balance on the trading account them represents the gross profit or loss as the case may be.
10. Profit and Loss Account :- (Proper) :- The account is credited with the gross profit brought down from the trading account, along with any miscellaneous income such as discounts, interests, rent, dividend etc. On the debit side all the expenses incidental to the period under audit will appear. It would be the duty of the auditor to examine each item of expenditure to see that it is necessarily incurred in the course of business, that it relates to the period of audit and that it is classified under proper head.
It is essential this account should be so drawn up as to disclose full information at a glance. It should also enable easy comparison of the various expenses and the sources of incomes with similar items of the previous years. The grouping expenses under different heads facilitate such comparison. The calculation of percentage of each group of expenses to the turn over or to the total expenditure affords valuable information.
In the Royal Mail Steam Packet Co-case, the question of auditor’s responsibilities regarding the profit and loss account was raised. It was held that the auditor should see that the account represents a true view of the normal earnings of the business during the period under audit and that abnormal, items if any, should be shown separately in the account.
11. Revenue account and income and expenditure account :- In the case of non trading societies such as Co-operative Education Societies, hospital, societies and similar other types of societies, which do not undertake trading activities, it is common to term the “Profit and Loss Account” as “Revenue Account” or the “Income and Expenditure Account”. However the principles for preparing these accounts are more or less the same as that for preparing the profit and loss account, the object being to disclose the excess of income over expenditure, or the deficit incurred during the period.
12. Principles governing the preparation of profit and loss account :-
(1) There should items of income and expenditure as properly belong to the business should be included in the account.
(2) There should be proper grouping and classification of items so as to present a clear picture of the current earnings.
(3) The whole account should be prepared, up on a consistent and uniform basis from year to year so as to facilitate useful comparison.
(4) Adequate provision should be made for depreciation, bad debt and other losses.
(5) Provisions of the bye-laws relating to creation of capital Redemption Fund, Sinking Fund, Guarantee Fund etc. should be strictly observed.
(6) Interest payable on deposits, loans, debentures and other borrowings should be calculated and included in the account.
(7) Transfers to profit and loss account from funds created out of past profits should be made.
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