Revision Notes
Revision Notes: Financial Statements of a Sole Proprietorship without Adjustments
These notes summarise how to prepare the Trading and Profit and Loss Account and the Statement of Financial Position of a sole proprietorship from the Trial Balance, without adjustments.
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Purpose of Financial Statements
- Financial statements are prepared at the end of the accounting period to determine the performance and financial position of a sole proprietorship.
- The Trading Account determines gross profit or gross loss; the Profit and Loss Account determines net profit or net loss.
- The Statement of Financial Position shows the assets, liabilities and owner's equity on a specific date.
- All statements are prepared using information from the Trial Balance, either manually or using ICT applications.
- This chapter has no adjustments: Trial Balance figures are used as they are, with no year-end changes.
Trading Account and Gross Profit
- Net sales = Sales − Sales returns (returns inwards).
- Cost of sales = Opening inventory + Net purchases + Carriage inwards − Closing inventory.
- Net purchases = Purchases − Purchases returns (returns outwards).
- Gross profit = Net sales − Cost of sales; if negative, it is a gross loss.
- Carriage inwards is debited (part of purchase cost); carriage outwards does not go in the Trading Account but is an expense in the Profit and Loss Account.
- The gross profit or gross loss is transferred to the Profit and Loss Account.
Profit and Loss Account and Net Profit
- Credit side: gross profit brought down plus other revenues such as commission received, rent received, discount received and interest received.
- Debit side: all expenses such as salaries, rent, rates, utilities, insurance, carriage outwards, discount allowed and bad debts.
- Net profit = (Gross profit + Other revenues) − Total expenses; if expenses are greater, the result is a net loss.
- Net profit increases capital; net loss decreases capital when transferred to the Capital Account.
Statement of Financial Position
- Non-current assets: long-term assets such as land, buildings, vehicles, fittings and office equipment.
- Current assets: closing inventory, debtors, bank and cash (prepaid expenses are also current assets but do not appear in this chapter).
- Current liabilities: creditors and bank overdraft; non-current liabilities: long-term loans.
- The accounting equation holds: Assets = Owner's Equity + Liabilities.
- It may be prepared in 'T' form (assets on the right) or in vertical statement format, which is now more common.
Capital Account and Owner's Equity
- Owner's equity = Opening capital + Net profit − Drawings; deduct net loss instead if a loss occurs.
- Drawings are assets or cash taken by the owner for personal use; they reduce owner's equity.
- Additional capital injected by the owner during the period also increases owner's equity.
- The computed owner's equity balance is carried to the equity section of the Statement of Financial Position.
Closing Revenue, Expense and Inventory Accounts
- Nominal accounts (revenues and expenses) are closed at period-end because they relate to only one accounting period.
- Purchases, sales, returns and opening inventory accounts are closed by transfer to the Trading Account.
- Other expense and revenue accounts are closed by transfer to the Profit and Loss Account.
- Closing inventory is recorded via double entry: debit Inventory Account, credit Trading Account.
- Real accounts (assets, liabilities and capital) are not closed because their balances are carried forward to the next accounting period.
| Item | RM |
|---|---|
| Trading Account | |
| Net sales | 98,000 |
| Less: Cost of sales | 56,000 |
| Gross profit | 42,000 |
| Profit and Loss Account | |
| Add: Commission received | 3,000 |
| 45,000 | |
| Less: Expenses (salaries, rent, utilities) | 23,000 |
| Net profit | 22,000 |
Illustrative figures only, to show the arrangement of the statement.
| Item | RM |
|---|---|
| Owner's Equity | |
| Opening capital | 80,000 |
| Add: Net profit | 22,000 |
| 102,000 | |
| Less: Drawings | 5,000 |
| Owner's equity | 97,000 |
Shows the effect of net profit and drawings on capital.
What is the difference between gross profit and net profit?
Gross profit is the excess of net sales over cost of sales, computed in the Trading Account, while net profit is gross profit plus other revenues less all expenses, computed in the Profit and Loss Account.
Why are real accounts not closed at the end of the financial period?
Real accounts such as assets, liabilities and capital have continuing balances carried to the next accounting period, so their balances are only balanced off (balance b/d) and not transferred to the Trading or Profit and Loss Account.
How is closing inventory recorded at period-end?
Closing inventory is recorded by debiting the Inventory Account and crediting the Trading Account; it then appears as a current asset in the Statement of Financial Position.
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