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IAB L 3

FINANCIAL STATEMENTS FOR SOLE


TRADERS

This book was prepared for Home iLearn Ltd.


It is part of a series of chapters developed for the course on ACCA F6 and is published by Home iLearn
Ltd.

Home iLearn Ltd


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Home iLearn 2013

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Table of Contents
9 FINANCIAL STATEMENTS FOR SOLE TRADERS

SOLE TRADERS..........................................................................4
FINANCIAL STATEMENTS FOR SOLE TRADER................................4
OTHER ITEMS IN FINANCIAL STATEMENTS....................................7
SUMMARY OF YEAR END ADJUSTMENTS FOR FINANCIAL
STATEMENTS...........................................................................11
PREPARING FINANCIAL STATEMENT FROM THE EXTENDED TRIAL
BALANCE.................................................................................12

9 FINANCIAL STATEMENTS FOR SOLE


TRADERS
OVERVIEW
This chapter is about preparing financial statements for a single
owner of a business, called a sole trader.

SOLE TRADERS
A sole trader is a business in which there is only one owner who has
complete control over the business and its management.
The legal ownership structure does not differentiate between the
owner and the business entity (although from an accounting
perspective it does). All the profits, losses, assets and liabilities are
thus the direct responsibility and entitlement of the owner. This
means that any liability of the business is also the responsibility of
the owner (unlike a company).
ADVANTAGES

Ease
of
formation
and
dissolution
Simple to run
Low start-up costs
Low operational overheads
Fewer regulations
Control over the business
operations
Ownership of all profits

DISADVANTAGES

Unlimited liability: Owners are


personally responsible for the
obligations and liabilities of
the business
Owner is liable for the actions
of employees representing
the business
Limited life: If the owner dies,
the business dies too
Usually it is difficult for the
owner to raise funds for
expansion

FINANCIAL STATEMENTS FOR SOLE TRADER


The financial accounts for sole traders comprise of the following
statements:

Income Statement
Statement of Financial Position

We introduced these statements in the previous unit, Accounts


Preparation. We will now take a closer look at each of them.

THE INCOME STATEMENT


The Income Statement shows the profit and loss of a business over
an accounting period. It is typically prepared on an annual, quarterly
or monthly basis.
An example of an Income Statement is shown below:
Income Statement for Year Ended 31 Dec 20X2
Sales
58,050
Opening inventory
1,400
Purchases
42,500
Closing inventory
(2,000)
Less: Cost of sales
(41,900)
Gross profit
16,150
Wages
(47,000)
Insurance
(9,000)
Depreciation expense
(3,500)
Irrecoverable debts
(3,400)
Net loss for year
(46,750)

Note: the Income Statement relates to a period e.g. sales


and profits for a whole month or a whole year
Components of an Income Statement

Sales: the cash generated by a business through sales of goods.


Also called revenues.
Cost of goods sold: cost of sales comprise opening inventory
plus purchases less closing inventory. Purchases comprise goods
directly related to what is being sold (e.g. books that are bought
by a book retailer from a supplier).
Gross profit: the difference between sales and cost of goods
sold.
Expenses: whereas cost of sales relates directly to what is being
sold, expenses relate to all other expenditure and overheads
(rent, rates, office costs, employee costs, insurance etc).
Net profit: Net profit shows the overall profitability of the
business. It is equal to sales less cost of sales less expenses.
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STATEMENT OF FINANCIAL POSITION


The Statement of Financial Position summarises the assets and
liabilities of a business. This includes both non-current (over a year)
and current (under a year) assets and liabilities.
A Statement of Financial Position is shown below:
Statement of Financial Position at 31 Dec 20X2
Non-current assets
Delivery vans
Current assets
Inventory
Trade receivables
Less allowance for doubtful debts
Prepayments
Cash

2,000
10,400
(3,300)
1,000
15,500

Total assets
Current liabilities
Trade payables
Accruals

42,500

25,600
68,100

(9,350)
(12,000)
(21,350)

Non-current liabilities
Bank loan
Total liabilities

(25,500)
(46,850)

Net assets

21,250

Capital at beginning of year


Profit/loss for year
Drawings
Capital

69,000
(46,750)
(1,000)
21,250

Note: the Statement of Financial Position relates to a


particular point/day in time (NOT a period)
Liabilities are subtracted from assets to give a businesss net
assets (top half of statement). This equals capital (shown by
the bottom half of this statement) which is the amount of money
invested by the owner (includes profits that the owner has earned
reduced by drawings taken out by the owner).
This is summarised in the Accounting Equation:
Assets Liabilities = Capital (this also equals Net Assets)
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Assets Liabilities = Capital + Profit Drawings


ASSETS

Non-current assets: Assets that are used primarily for carrying


out business activities and are not expected to be converted into
cash, irrespective of their value, in the due course of time.
Usually held for greater than 1 year e.g. plant, machinery,
computers, furniture, building, land, vehicles.
Current assets: These are short term assets, which can be
readily converted to cash within 1 year e.g. cash, inventory,
accounts receivables.

LIABILITIES
The obligation of paying a debt that a company owes to an external
party is known as liabilities. The external parties are usually the
stakeholders like banks and creditors (also called payables).
Liabilities are usually show up in the form of unpaid bills/invoices or
loans that a company is bound to pay. Classification of liabilities is
as follows:

Current liabilities: Short term liabilities that are payable within


1 year eg. Over draft, accounts payable, accruals.
Non-current liabilities: Long term liabilities that are due in
greater than 1 year e.g. bank loans.

OWNERS EQUITY OR CAPITAL


This shows the amount of investment that the owner has made in
the business. As shown above in the Accounting Equation, it is a
combination of the amount that the owner has invested in the
business (opening capital) plus profits less drawings (amounts
withdrawn by the owner).

OTHER ITEMS IN FINANCIAL STATEMENTS


There are a number of other double entry balances that may have
to be transferred into the income statement. These include:

Carriage inwards: the transport costs incurred by the buyer,


e.g. cost of delivery. Cost of carriage is added to the cost of
purchases.
Carriage outwards: when goods are sold to the buyer and
seller pays the carriage charge. This cost is expensed in the
income statement.
Sales returns: when a credit customer returns the goods to
the business. Sales returns are subtracted from the sales
revenue figure.
Purchases returns: when a business returns goods to the
supplier. Purchases returns are subtracted from the purchases
in the income statement.
Discount received: a percentage discount allowed on goods
purchased for quick settlement. It is added to the total income
of the business as income received.
Discount allowed: a percentage discount allowed on sale of
goods to the buyers for quick settlement. The discount
allowed amount is added to the expenses in the income
statement.

Service sector businesses do not incorporate a calculation of gross


profit because business is not trading in goods. In fact the income
statement begins with the income (fees from clients, charges, etc.);
other income is added such as rent received and the expenses are
deducted to compute the net profit (loss) for the year.
EXAMPLE
Given below are balances taken from a sole traders ledger accounts
on 31 March 2012:
Sales ledger control account (receivables)
Telephone
Purchases ledger control account (payables)
Heat and light
Motor vehicles at cost
Computer equipment at cost
Carriage inwards
Carriage outwards
Wages
Loan interest
Capital
Drawings

54,300
1,710
21,840
3,210
43,700
5,180
1,940
4,640
77,510
500
54,600
34,000
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Allowance for doubtful debts


Bank overdraft
Purchases
Petty cash
Sales
Insurance
Accumulated depreciation motor vehicles
Accumulated depreciation computer equipment
Stock at 1 April 2007
Loan
Rent

580
4,740
236,700
60
422,050
4,560
13,200
3,040
24,500
8,100
35,640

INCOME STATEMENT
Income statement for Milton Technologies for the year
ended 31st March 2012

Sales
Less: Cost of sales
Opening Stock
Carriage inwards
Purchases
Less: Closing stock
Gross Profit
Less: Expenses
Telephone
Heat and light
Carriage outwards
Wages
Loan interest
Insurance
Rent
Depreciation-Motor vehicles
Depreciation-Computer equipment
Irrecoverable debts
Allowance for doubtful debt
adjustment
Total expenses
Net Profit

422,050

24,500
1,940
236,700
263,140
(15,800)
247,340
174,710
1,890
3,210
4640
77,510
500
3,920
35,640
12,470
900
500
120
141300
33,410

STATEMENT OF FINANCIAL POSITION


Balance Sheet of Milton Technologies as at 31 March 2012
Cost
Accumulated
Net book
Depreciation
Value

Fixed Assets
Motor vehicles
43,700
24,870
18,830
Computer equipment
5,180
3,940
1,240

Current Assets
Stock
Debtors
Less allowance for
doubtful debts
Prepayments
Petty cash
Current Liabilities
Bank overdraft
Creditors
Accruals
Current assets
Net Current Assets
(Total assets less
current liabilities)
Long term liability:
Loan
Net assets
Capital
Opening capital
Net profit for the
year
Less drawings
Proprietors funds

48,880

28,810

15,800
53,600
(730)

68,670
590
60
4,740
21,840
7,00

20,070

69,320
(-)
27,280
42,040
62,110

(8,100)
54,010
54600
33,410
88,010
(34,000)
54,010

SUMMARY OF YEAR END ADJUSTMENTS FOR


FINANCIAL STATEMENTS
ADJUSTMENTS
Closing inventory

FINANCIAL STATEMENT
Closing inventory is deducted from purchases

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Accrued expenses

Prepaid expenses

Accrued income

Prepaid income

Depreciation and
accumulated
depreciation
Disposal of non
current assets

Irrecoverable debts

Creation/increase in
allowance for doubtful
debts
Decrease in allowance
for doubtful debts

Drawings

in the income statement and classified as


current asset in the statement of financial
position
Accrued expenses are expensed in the income
statement and classified as current liability in
the statement of financial position
Prepaid expenses are deducted from the total
expenses in the income statement and
classified as current asset in the statement of
financial position
Accrued income is added to the income of the
business and shown as current asset in the
statement of financial position
Prepaid income is deducted from income of the
business and shown as current liability in the
statement of financial position
Depreciation charge is expensed in the income
statement and accumulated depreciation
reduces the cost of non current asset to give
carrying amount
Gain (loss) on disposal is treated as income
(expense) in the income statement and
disposal reduces the amount of non current
assets
These are treated as an expense and the trade
receivables figure is reduced by the amount of
irrecoverable debt
Increase in allowance for doubtful debts is
treated as an expense and trade receivable
figure is reduced by the total amount of
allowance
Decrease in allowance for doubtful debts is
treated as an income and trade receivable
figure is reduced by the total amount of
allowance
Drawings are deducted from purchases in the
income statement and added to drawings in
the statement of financial position

PREPARING FINANCIAL STATEMENT FROM THE


EXTENDED TRIAL BALANCE
The final accounts of a sole trader involve the preparation of an
extended trial balance (as we covered in the unit, Accounts
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Preparation). From this, we can create the Income Statement along


with a Statement of Financial Position.
We illustrate this with an example. We use an initial trial balance
and a summarised extended trial balance but for the exam you will
need to be comfortable preparing and using an extended trial
balance. Please refer to the previous unit, Accounts Preparation, for
detailed information on preparing an extended trial balance.
EXAMPLE
James Caans initial trial balance at 31 March 20X8 is shown below:
Trial Balance of Milton Technologies as at 31 March 20X8

Sales ledger control account - receivables


54,300
Telephone
1,710
Purchases ledger control account - payables
Heat and light
3,210
Motor vehicles at cost
43,700
Computer equipment at cost
5,180
Carriage inwards
1,940
Carriage outwards
4,640
Wages
77,510
Loan interest
500
Capital
Drawings
34,000
Allowance for doubtful debts
Bank overdraft
Purchases
236,700
Petty cash
60
Sales
Insurance
4,560
Accumulated depreciation motor vehicles
Accumulated depreciation computer equipment
Stock at 1 April 20X7
24,500
Loan
Rent
35,640
528,150

21,840

54,600
580
4,740
422,050
13,200
3,040
8,100
528,150

From the initial trial balance we can prepare an extended trial


balance using the following additional information:

Irrecoverable debts are 700 and allowance for doubtful debts are
200
Insurance prepayment is 640 and accrual for telephone expenses
is 180
Depreciation expense for motor vehicles is 11,670 and computer
equipment is 900
Closing inventory is 15,800

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This is shown below (see workings next to the account categories


for how the above information is used)
Extended Trial Balance of Milton Technologies at 31 March 20X8

Sales ledger control account Receivables


53,600
(54,300 700)
Telephone (1,710 + 180)
1,890
Purchases ledger control account - Payables
21,840
Heat and light
3,210
Motor vehicles at cost
43,700
Computer equipment at cost
5,180
Carriage inwards
1,940
Carriage outwards
4,640
Wages
77,510
Loan interest
500
Capital
54,600
Drawings
34,000
Allowance for doubtful debts (580 + 200)
78
0
Bank overdraft
4,74
0
Purchases
236,700
Petty cash
60
Sales
422,05
0
Insurance (4,560 640)
3,920
Accum depreciation motor vehicles (13,200 +
24,87
11,670)
0
Accum depreciation computer equipment (3,040
3,94
+ 900)
0
Stock at 1 April 20X7
24,500
Loan
8,10
0
Rent
35,640
Inventory at 31 March 20X8 (+15,800 15,800)
15,800
15,800
Depreciation expense-motor vehicles (+11,670)
11,670
Depreciation expense-computer equipment
900
(+900)
Accruals (-180)
180
Prepayments (+640)
640
Allowance for doubtful debt adjustment (+200)
200
Irrecoverable debt expense (+700)
700
557,370

557,3
70

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Financial statements can then be prepared from the extended trial


balance as follows:

INCOME STATEMENT
Income Statement for Milton Technologies for the year ended 31 st
March 20X8

Sales
Less: Cost of sales
Opening inventory
Carriage inwards
Purchases
Less: Closing inventory
Gross profit
Less: Expenses
Telephone
Heat and light
Carriage outwards
Wages
Loan interest
Insurance
Rent
Depreciation-Motor vehicles
Depreciation-Computer equipment
Irrecoverable debts
Allowance for doubtful debt
adjustment

422,050

24,500
1,940
236,700
263,140
(15,800)
(247,340)
174,710
1,890
3,210
4,640
77,510
500
3,920
35,640
11,670
900
700
200
(140,780)
33,930

Net Profit

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STATEMENT OF FINANCIAL POSITION


Statement of Financial Position of Milton Technologies as at 31
March 20X8

Non-current Assets
Motor vehicles
Computer equipment

Current Assets
Inventory
Receivables
Prepayments
Petty cash

43,700
5,180

(24,870)
(3,940)

18,830
1,240

48,880

(28,810)

20,070

15,800
52,820
640
60
69,320

Current Liabilities
Bank overdraft
Payables
Accruals

(4,740)
(21,840)
(180)

Net Current Assets

(26,760)
42,560

Long term liability


Loan
Net assets

(8,100)
54,530

Capital
Opening capital
Net profit for year
Less drawings
Proprietors funds

54,600
33,930
(34,000)
54,530

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