2.1 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.

2.2 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.

2.2.1 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.

2.2.2 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
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, $4,000Prepare the Income Statement and Balance Sheet as at 31 December 2011.

Horizontal presentation of the Income Statement and Balance Sheet

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.