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.
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.
- 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)
- Cash at Bank.
- Cash in Hand.
- 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.
- 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
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.
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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