Balance Sheet Equation · One-liners

1 State the Balance Sheet Equation in simplest form.

Assets = Capital + Outside Liabilities.

2 When a firm borrows a term loan, does Capital reduce?

No. Term loan increases Assets and Outside Liabilities; Capital remains unchanged.

3 How does Profit flow into the Balance Sheet Equation?

Profit increases Capital; Loss decreases Capital. Profit = Net Revenue − Net Costs.

4 What is the sole purpose of a Trading Account?

To ascertain Gross Profit or Gross Loss from trading (purchase and sale) activities.

5 Name the items that appear on the DEBIT (left) side of Trading Account.

Opening Stock, Net Purchases, Direct Expenses (cost-of-goods items).

6 Name the items that appear on the CREDIT (right) side of Trading Account.

Sales (Revenue), Closing Stock (inventory-generating items).

7 What account type is the Trading Account?

Nominal Account. Its balance transfers to Profit & Loss Account.

8 Define Gross Profit ratio as a percentage.

Gross Profit ÷ Sales × 100. Measures profitability on trading before operating expenses.

9 How is Net Purchases calculated?

Purchases + Carriage Inward − Purchase Returns − Purchase Discounts.

10 Define Cost of Goods Sold (COGS).

Opening Stock + Net Purchases + Direct Expenses − Closing Stock.

11 If Closing Stock is undervalued, how does current year Gross Profit change?

Current year Gross Profit is overstated (understated COGS inflates GP).

12 If Closing Stock is overvalued, how does current year Gross Profit change?

Current year Gross Profit is understated (overstated COGS reduces GP).

13 Under Ind AS 2, how must inventory be valued?

At lower of Cost or Net Realisable Value (NRV), whichever is lower.

14 Per Schedule III, Companies Act 2013, what format must Balance Sheet use?

Vertical (Statement) form; Trading and P&L combined into Statement of Profit & Loss.

15 Under GST, do Net Purchases and Sales include GST?

No. They exclude GST when input tax credit is claimed; GST flows separately.

16 Which Stock error reverses in the following year?

All Stock errors reverse; Closing Stock of Year 1 becomes Opening Stock of Year 2.

17 What is the impact if both Closing Stock is overstated AND Purchases understated?

Gross Profit is understated (overstated COGS + reduced Purchases both reduce GP).

18 How is Gross Profit Ratio calculated on Net Sales?

Gross Profit Ratio = (Gross Profit / Net Sales) × 100, where Net Sales = Gross Sales − Returns.

19 What is the dual-aspect rule in accounting?

Every transaction must affect two accounts; Assets = Capital + Liabilities must remain balanced.

20 Which expenses are classified as Direct Expenses?

Wages, factory power, fuel, carriage inward—expenses directly attributable to production of goods.

21 What is the formula for Cost of Goods Sold (COGS)?

COGS = Opening Stock + Purchases + Direct Expenses − Closing Stock.

22 How does undervalued Closing Stock affect Gross Profit?

Undervalued Closing Stock overstates COGS and understates GP in current year; error reverses next year.

23 What is the difference between Gross Profit markup and margin?

GP 30% on Cost: Sales = 1.30 × Cost. GP 30% on Sales: Cost = 0.70 × Sales (different bases).

24 Can Gross Profit ratio remain constant while Net Profit falls?

Yes, if indirect expenses (selling, admin) increase—they don't affect GP, only Net Profit.

25 How do errors in Closing Stock and Purchases combine to affect GP?

Overstatement of both overstates COGS understatement; total GP overstatement = sum of individual errors.

26 What is the mandated format for company financial statements under Schedule III?

Vertical (Statement) form for Balance Sheet; single combined Statement of Profit & Loss required.

27 Which accounting standard governs inventory valuation?

AS-2 / Ind AS 2: Inventory valued at lower of Cost or Net Realisable Value (NRV).

28 Why are Sales Returns deducted in GP Ratio calculation?

Net Sales (Gross Sales − Returns) is correct denominator; excludes returns from revenue base.

29 What violation occurs if a transaction is recorded on only one side?

Dual-aspect rule violated; Assets ≠ Capital + Liabilities equation becomes unbalanced.

30 How do wages affect Gross Profit computation?

Wages are Direct Expenses; added to COGS, reducing GP (not subtracted after GP calculation).

31 In the accounting equation, where does owner's profit from trading appear?

Profit (Revenue − Expenses) is added to Capital; increases total equity side of equation.

32 If Sales rise but GP stays constant, what explains the anomaly?

Closing Stock increased and Direct Expenses increased simultaneously offset sales rise.

33 What is the impact of overstated Closing Stock on reported Gross Profit?

Overstated Closing Stock understates COGS, causing reported GP to be overstated by same amount.

34 How does GST affect COGS and GP when Input Tax Credit is available?

GST excluded entirely from COGS and Sales—no impact on GP ratio when ITC is fully creditable.

35 If Sales rise ₹4,00,000 but GP stays flat, what must happen to COGS?

COGS must rise ₹4,00,000 — via lower closing stock or higher direct expenses.

36 Does higher closing stock increase or decrease COGS?

Decreases COGS — closing stock is subtracted in COGS formula.

37 What is the Balance Sheet Equation?

Assets = Capital + Outside Liabilities.

38 Formula to compute Capital given Assets and Outside Liabilities?

Capital = Assets − Outside Liabilities.

39 Owner brings ₹2,00,000 cash — effect on Assets, Liabilities, Capital?

Assets +₹2,00,000; Liabilities no change; Capital +₹2,00,000.

40 Bank term loan ₹3,50,000 received — effect on Capital?

No change to Capital — increases Assets and Liabilities equally.

41 Profit/Loss equation in accounting?

Profit = Total Revenues − Total Expenses; loss if reversed.

42 Gross Profit formula?

Gross Profit = Net Sales − Cost of Goods Sold (COGS).

43 COGS formula?

COGS = Opening Stock + Net Purchases + Direct Expenses − Closing Stock.

44 Define Net Purchases.

Net Purchases = Gross Purchases − Purchase Returns (Returns Outward).

45 Define Net Sales.

Net Sales = Gross Sales − Sales Returns (Returns Inward).

46 Gross Profit Ratio formula?

GP Ratio = (Gross Profit ÷ Net Sales) × 100.

47 Healthy GP Ratio for manufacturing sector?

Typically 15–25% depending on industry and cost structure.

48 Where are Direct Expenses shown in Final Accounts?

Debit side of Trading Account — affect Gross Profit only.

49 Examples of Direct Expenses?

Wages, Carriage Inward, Freight, Power & Fuel, Factory Rent.

50 Overstated Closing Stock — effect on COGS and GP?

COGS understated; Gross Profit overstated.

51 Understated Purchases — effect on Gross Profit?

COGS understated; Gross Profit overstated.

52 Define Gross Profit Ratio formula.

(Gross Profit / Sales) × 100; measures profitability per rupee of sales.

53 What are Direct Expenses? Give two examples.

Wages, Carriage Inward, Freight, Power & Fuel. Affect Gross Profit only.

54 What are Indirect Expenses? Give two examples.

Office Rent, Salaries, Advertisement, Audit Fees. Affect Net Profit only.

55 How is Net Purchases calculated?

Purchases minus Purchase Returns (Returns Outward). Used in COGS.

56 How is Net Sales calculated?

Sales minus Sales Returns (Returns Inward). Used in GP and GP Ratio.

57 Why does overvalued Closing Stock overstate Gross Profit?

Overstated Closing Stock reduces COGS artificially, inflating Gross Profit reported.

58 Does a bank loan reduce Capital?

No. Loan increases Assets and Outside Liabilities equally; Capital unchanged.

59 State the dual-aspect rule of accounting.

Assets = Capital + Outside Liabilities must hold after every transaction recorded.

60 Why is Trading Account balance transferred to P&L Account?

Trading Account is nominal; its closing balance (GP/Loss) closes to P&L.

61 Where do Office Salaries and Rent appear?

Profit & Loss Account only, as Indirect Expenses. Not in Trading Account.

62 Why is Closing Stock credited in Trading Account?

It reduces COGS and carried as Asset in Balance Sheet; credited in Trading A/c.

63 What does Cost of Goods Sold formula include?

Opening Stock + Net Purchases + Direct Expenses − Closing Stock.

64 Per Ind AS 2, at what value must inventories be stated?

Lower of Cost or Net Realisable Value (NRV). Prevents overstatement.

65 How are Drawings treated in P&L Account?

Drawings are NOT expenses. They reduce Capital directly on Balance Sheet.

66 If Sales rise 20% but GP rises 10% at constant GP rate, why?

Increase in Direct Expenses raises COGS without raising Sales, compressing GP growth.

67 What is the relationship: Profit/Loss to Capital?

Profit increases Capital; Loss reduces Capital. P/L = Revenues − Expenses.

One-linersBalance Sheet Equation