Final Accounts for Sole Trader

Introduction

So far in this unit you have looked at different adjustment needed before the final accounts can be prepared. The final accounts for a sole trader business are the Income Statement (Trading and Profit & loss Account) and the Balance Sheet. The final accounts give a picture of the financial position of your business. It shows where or not your business has made a profit or loss during the accounting period and whether you are able to pay your debts as they become due. Let’s now have a look at the final accounts of a sole trader business.

Objectives

Upon the completion of this topic you should be able to;
1. understand how profit/loss is calculated,
2. calculate the cost of goods sold, gross profit and net profit,
3. transfer net profit and drawings to the capital account at the end of the period, and
4. prepare an Income Statement from a trial balance.

Final Accounts

After your trial balance is completed your final accounts are prepared. The final accounts of a sole trader business include the Income Statement (trading and Profit & loss account) and the balance sheet. Remember that your trial balance is the summary of the balances in all your accounts. Some of these balances (those from your nominal accounts) affect the profit and are transferred to the Income statement; the others (real and personal accounts) are transferred to your balance sheet. The Income Statement and the Balance Sheet are prepared at the end of each financial period to record how well the business operated during that financial period.

Income Statement
One of the most important financial statements of any business is the Income Statement. It is used to determine the following:
1. how profitable a business is being run; and
2. comparing the results received with the results expected.

The Income Statement can be divided into two sections the trading account and the Profit & loss account. The gross profit which is the amount of profit made before the expenses are deducted is calculated in the trading account. The purpose of the trading account is to determine the gross profit made from sales. Therefore the accounts that are directly related to buying and selling (trading) will be transferred to the trading account. The accounts directly related to trading are:

• Sales
• Purchase
• Sales Return
• Purchases Return
• Carriage Inwards

Gross profit is calculated as:

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

Along with gross profit the net sales, cost of goods sold (COGS) and the cost of goods available for sale(COGAFS) is also calculated in the trading account:

Net Sales = Sales – Sales Return (Return Inwards)

Net sales are the total sales figure after allowances have been made for sales returned to the business.

COGS = Cost of goods available for sale (COGAFS) – Closing Stock

COGAFS = Opening Stock + (Purchases – Purchases Return) + Carriage Inwards

The net profit of your business is calculated in the Profit & loss account. Net profit is the balance of profit after allowance is made for revenue and expenses. It is calculated as:

Net Profit = Gross profit + Revenue – expenses

The revenue and expense charged to the Profit & loss account are those that are not directly related to trading but more to do with the running of the business. Some of these accounts are:

• Rent
• Telephone
• Carriage outwards
• Discount allowed
• Discount received
• Commission received
• Commission paid
• Salary

In Unit Two these accounts were closed off and transferred to the income statement. The income statement can be shown horizontally or vertically.

Balance Sheet
The other half of our final accounts is the Balance Sheet. The Balance Sheet is a financial statement showing the book values of the assets, liabilities and capital at the end of the financial period. It shows what the business owes and what it owns.
The assets of the business is divided into two categories and recorded as follows

1. Non-Current Assets are assets that:

• are expected to be of use in the business for long time;
• are to be used in the business; and
• were not bought only for the purpose of resale.

Non-current assets are recorded in the balance sheet starting with those assets that will in the business the longest down to those that will be kept for a shorter period. Example of non-current assets and the order of record are:

• Land and Buildings.
• Fixtures and Fittings.
• Machinery.
• Motor Vehicles.

2. Current Assets are recorded next. These are assets will change within the next twelve months. They are recorded as follows:

• Stock (goods bought for resale)
• Debtors.
• Cash at Bank.
• Cash in Hand.

3. Non-current Liability - Sometime referred to as long term liability are those debts that take more than a year to settle. This includes large loans and mortgages.

4. Current Liability - are debts that will be settled in one year or less. This includes creditors and small loans.

Let’s now prepare the final accounts from the trial balance on the below

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Example 3.5A

MDAR Retailer
Trial Balance as at 31 December 2011
	Dr.	Cr.
	$	$
Discount Allowed	410
Discount Received		506
Carriage Inwards	309
Carriage Outwards	218
Return Inwards	1,384
Return Outwards		810
Sales		120,320
Purchases	84,290
Stock 31 December 2010	30,816
Motor expenses	4,917
Repairs to premises	1,383
Pay	16,184
Sundry expenses	807
Rates and insurance	2,896
Premises at cost	40,000
Motor Vehicle at cost	11,160
Provision for depreciation motors as at 31 December 2010		3,860
Debtors	31,640
Creditors		24,320
Cash at bank	4,956
Cash in hand	48
Drawings	8,736
Capital		50,994
Loan from P. Holland		40,000
Bad Debts	1,314
Provision for bad debts as at 31 December 2010		658
	241,468	241,468

The following should be considered on 31 December 2011
1) Stock $36,420
a) Expenses owing
b) Sundry expenses $62
2) Motor expenses $33
3) prepayments
a) Rates $166
4) Provision for bad debts to be reduced to $580
5) Depreciation for motors to be $2,100 for the year
6) Part of the premises were let to a tenant who owed $250 at 31 December 2011
7) Loan interest owing to P. Holland, $4,000

Prepare the Income Statement and Balance Sheet as at 31 December 2011.

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Horizontal presentation of the Income Statement and Balance Sheet

MDAR Retailer
Income Statement
for the year ended 31 December 2011
	$	$		$	$
Opening Stock		30,816	Sales	120,320
Add Purchases	84,290		Less Sales Returns	1,384	118,936
Less Purchases Return	810	83,480
Add Carriage Inwards		309
COGAFS		114,605
Less Closing Stock		36,420
COGS		78,185
Gross Profit c/d		40,751
		118,936			118,936
Less Expenses			Gross Profit b/d		40,751
Motor Expenses	4,917		Add Revenue
Add Motor expenses owing	33	4,950	Discount Received	506
Pay		16,184	Rent Receivable	250
Carriage Outwards		218	Reduction in Provision for Bad Debts	78	834
Discount Allowed		410			41,585
Repairs to Premises		1,383
Sundry Expenses	807
Add sundry expenses owing	62	869
Bad Debts		1,314
Rates and Insurance	2,896
Less prepaid rates and insurance	166	2,730
Loan Interest		4,000
Depreciation: Motor		2,100
Net Profit		7,427
		41,585			41,585

MDAR Retailer
Balance Sheet
as at 31 December 2011
Non-Current Assets	$	$	$	Capital	$	$	$
Premises at cost			40,000	Balance as at 1 Jan 2011			50,994
Motor Vehicle at cost		11,160		Add Net Profit			7,427
Less Depreciation to date		5,960	5,200				58,421
			45,200	Less Drawings			8,736
Current Assets							49,685
Stock		36,420		Non-Current Liability
Debtors	31,640			Loan from P. Holland			40,000
Less Provision for Bad Debts	580	31,060					89,685
Prepaid Expense		166
Revenue owing		250		Current Liabilities
Cash at bank		4,956		Creditors		24,320
Cash in hand		48	72,900	Expenses owing		4,095	28,415
			118,100				118,100

Vertical presentation of the Income Statement and the Balance Sheet.

The vertical presentation is the most common method of presenting final accounts today. In the vertical presentation of the balance sheet the working capital is indicated. This is calculated as:


Working Capital = Current Assets - Current Liabilities

The working capital indicates the liquidity of your business. This means the ability of your business to pay its debts when they become due. It gives an idea of the amount of funds available to run the business on a day to day basis.

MDAR Retailer
Income Statement
for the year ended 31 December 2011
	$	$	$
Sales		120,320
Less Sales Returns		1,384
Net Sales			118,936
Opening Stock		30,816
Add Purchases	84,290
Less Purchases Return	810	83,480
Add Carriage Inwards		309
COGAFS		114,605
Less Closing Stock		36,420
COGS			78,185
Gross Profit			40,751
Add Revenue
Discount Received		506
Rent Receivable		250
Reduction in Provision for Bad Debts		78	834
			41,585
Less Expenses
Motor Expenses	4,917
Add Motor expenses owing	33	4,950
Pay		16,184
Carriage Outwards		218
Discount Allowed		410
Repairs to Premises		1,383
Sundry Expenses	807
Add sundry expenses owing	62	869
Bad Debts		1,314
Rates and Insurance	2,896
Less prepaid rates and insurance	166	2,730
Loan Interest		4,000
Depreciation: Motor vehicles		2,100	34,158
Net Profit			7,427

MDAR Retailer
Balance Sheet
as at 31 December 2011
Non-Current Assets	$	$	$
Premises at cost			40,000
Motor Vehicle at cost		11,160
Less Depreciation to date		5,960	5,200
			45,200
Current Assets
Stock		36,420
Debtors	31,640
Less Provision for Bad Debts	580	31,060
Prepaid Expense		166
Revenue owing		250
Cash at bank		4,956
Cash in hand		48
		72,900
Current Liabilities
Creditors	24,320
Expenses owing	4,095	28,415
Working Capital			44,485
			89,685
Financed by
Balance as at 1 January 2011			50,994
Add Net Profit			7,427
			58,421
Less Drawings			8,736
			49,685
Non-Current Liability
Loan from P. Holland			40,000
			89,685

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Topic Summary

You have just examined the final account of a sole trader business. Remember that the final accounts are made up of the income statement and the balance sheet. The income statement can be further divided into a trading account and also a Profit & loss account. You would have noted that the information to draw up the final accounts is taken from your trial balance. 

Some of the information in your trial balance is transferred to the income statement and others to the balance sheet.
A number of important information about your business is calculated in the income statement. This included the gross profit/loss and net profit/loss of your business. These indicate how well your business is running. Your balance sheet shows your assets in relation to your capital and liabilities. In the vertical presentation of the balance sheet you are able to calculate your working capital which is an indication of liquidity of your business.

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Unit Summary

In this unit you had a look at adjustments that should be made to your accounts before your final accounts are prepared. These adjustments included adjustments for depreciation and provision for depreciation, bad debts and provision for bad debts, accrued and prepaid expenses and revenue and also at the different valuation of closing stock. All these adjustments are necessary if your final accounts are to present a true and fair view of your business.

Once you would complete all the necessary adjustment your final accounts can be prepared. Your final accounts include your income statement and balance sheet. Your income statement comprise of your trading account where your gross profit/loss is calculated and your Profit & loss account where your net profit/loss is calculated. You also had a look at the two ways to present your final account the horizontal and vertical presentations.

Now that you have completed the final accounts for a sole trader you will now continue by analysing and interpreting these financial statements and have a look at the control systems of a business in Unit 4.