Common Mistakes
Common Mistakes: Financial Statements of a Sole Proprietorship without Adjustments
This chapter requires you to place every item correctly: in the Trading Account, the Profit and Loss Account or the Statement of Financial Position. The common mistakes below help you avoid the classification and add-or-deduct errors that most often cost marks.
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Trading Account: cost of sales, inventory and carriage
Profit and Loss Account: revenue versus expenses
Statement of Financial Position: classification and the Capital Account
Closing accounts: nominal accounts closed, real accounts kept
Transferring profit or loss, and statement format
| Item | Correct location |
|---|---|
| Carriage Inwards | Trading Account (add to Purchases) |
| Carriage Outwards | Profit and Loss Account (expense) |
| Discount Allowed | Profit and Loss Account (expense) |
| Discount Received | Profit and Loss Account (revenue) |
| Closing Inventory | Credit Trading Account; current asset in Statement of Financial Position |
| Drawings | Deduct from capital in the Capital Account |
| Vehicles / Premises | Non-current asset (real account, not closed) |
How do I quickly tell whether an item goes to the Trading Account or the Profit and Loss Account?
Ask: is this item directly linked to the cost of buying or selling trading goods? Purchases, Sales, Returns, Carriage Inwards and Inventory go to the Trading Account to find Gross Profit. All operating expenses (rent, salaries, rates, carriage outwards) and other revenues (commission received, discount received) go to the Profit and Loss Account.
Why are real accounts not closed at the end of the financial period?
Real accounts (assets, liabilities and capital) represent value still owned or owed at the statement date. Their balances must be carried forward as the opening balance of the next period, so they are kept and shown in the Statement of Financial Position. Only nominal accounts (revenues and expenses) are closed because they relate to one period only.
Is Net Profit added to or deducted from the Capital Account?
Net Profit is added to Opening Capital because it increases the owner's investment. Net Loss is instead deducted. Drawings are then deducted to get Closing Capital: Closing Capital = Opening Capital + Net Profit - Drawings. If there is a Net Loss, replace '+ Net Profit' with '- Net Loss'.
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