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Sole Proprietor Financial Statements

Subject: Accounting
Topic: 8
Cambridge Code: 0452 / 0985 / 7707

Introduction to Financial Statements​

Financial Statements - Formal records showing financial position and performance of a business

Three Main Statements​

  1. Trading Account - Calculates gross profit
  2. Profit & Loss Statement - Calculates net profit
  3. Balance Sheet - Shows financial position

The Trading Account​

Trading Account - Statement showing sales, cost of goods sold, and gross profit

Purpose​

  • Calculate gross profit on sales
  • Show relationship between sales and cost of goods
  • Gross Profit = Sales - Cost of Goods Sold

Format​

Trading Account for Year ended 31 December 2024

$$
Sales50,000
Less: Opening Stock5,000
Add: Purchases30,000
Less: Closing Stock(4,000)
Cost of Goods Sold(31,000)
Gross Profit19,000

Key Components​

Sales - Revenue from sales of goods (cash and credit)

  • Excludes returns and discounts normally

Opening Stock - Inventory at start of year

  • From previous year's closing stock
  • Already in trial balance

Purchases - Goods bought for resale

  • Only includes goods purchased, not fixed assets
  • Net of returns

Closing Stock - Inventory at year-end

  • From physical count and valuation
  • Not in trial balance; adjustment required

Cost of Goods Sold (COGS) - Cost of goods sold during year COGS=Opening Stock+Purchases−Closing Stock\text{COGS} = \text{Opening Stock} + \text{Purchases} - \text{Closing Stock}

Gross Profit - Profit on trading before operating expenses Gross Profit=Sales−COGS\text{Gross Profit} = \text{Sales} - \text{COGS}

The Profit & Loss Account (Income Statement)​

Profit & Loss Account - Statement showing all revenues and expenses to calculate net profit

Format​

Profit & Loss Account for Year ended 31 December 2024

$$
Gross Profit19,000
Add: Other Revenue
Commission Received500
Interest Received200
700
Total Revenue19,700
Less: Expenses
Salaries4,000
Rent2,000
Electricity800
Depreciation1,000
Bad Debts500
(8,300)
Net Profit11,400

Components​

Gross Profit - Brought forward from trading account

Other Revenue - Non-trading income

  • Commission
  • Interest received
  • Rent received
  • Discount received

Expenses - Costs of running business

  • Salaries and wages
  • Rent and rates
  • Utilities (electricity, water, gas)
  • Depreciation
  • Insurance
  • Repairs and maintenance
  • Advertising
  • Bad debts and provisions
  • Interest paid
  • Discounts allowed

Net Profit - Final profit after all expenses Net Profit=Gross Profit+Other Revenue−Expenses\text{Net Profit} = \text{Gross Profit} + \text{Other Revenue} - \text{Expenses}

The Balance Sheet​

Balance Sheet - Statement showing assets, liabilities, and capital at a specific date

Purpose​

  • Shows financial position at year-end
  • Verifies accounting equation: A = L + C
  • Shows net working capital
  • Indicates liquidity

Format​

Balance Sheet as at 31 December 2024

$$
Non-Current Assets
Equipment10,000
Less: Accumulated Depreciation(2,000)
8,000
Current Assets
Stock4,000
Receivables3,000
Less: Provision for Doubtful Debts(150)
Cash2,000
8,850
Total Assets16,850
Current Liabilities
Payables2,000
Accrued Expenses150
(2,150)
Net Working Capital6,700
Non-Current Liabilities
Long-term Loan(4,000)
Net Assets12,700
Capital
Opening Capital10,000
Add: Net Profit11,400
Less: Drawings(8,700)
Closing Capital12,700

Asset Valuation on Balance Sheet​

Fixed Assets:

  • Original cost
  • Less: Accumulated depreciation
  • = Net book value

Current Assets:

  • Listed in order of liquidity
  • Cash is most liquid
  • Stock is least liquid
  • Less provisions (e.g., bad debts) from receivables

Liabilities:

  • Short-term listed first
  • Long-term listed separately
  • Shows what business owes

Relationship Between Statements​

  1. Gross Profit from Trading Account → P&L Account
  2. Net Profit from P&L Account → Balance Sheet (Capital)
  3. Closing Capital on Balance Sheet should equal:
    • Opening Capital + Net Profit - Drawings

Worked Example​

Trial Balance as at 31 December 2024

AccountDebitCredit
Sales60,000
Purchases35,000
Opening Stock6,000
Salaries8,000
Rent3,000
Equipment20,000
Accumulated Depreciation5,000
Receivables8,000
Payables3,000
Cash5,000
Capital45,000
Drawings7,000
Totals92,000113,000

Note: Error in trial balance - out of balance. Assume capital should be $68,000.

Additional Information:

  • Closing stock: $7,000
  • Depreciation: $2,000
  • Closing receivables provision: $400

Solutions:

Trading Account

$$
Sales60,000
Opening Stock6,000
Purchases35,000
Closing Stock(7,000)
COGS(34,000)
Gross Profit26,000

Profit & Loss Account

$$
Gross Profit26,000
Salaries8,000
Rent3,000
Depreciation2,000
Bad Debt Provision400
(13,400)
Net Profit12,600

Key Points to Remember​

  1. Trading Account calculates gross profit
  2. Profit & Loss shows net profit
  3. Balance Sheet shows financial position
  4. Net profit affects owner's capital
  5. Opening stock from previous year
  6. Closing stock adjustment needed
  7. Balance Sheet must balance

Practice Questions​

  1. Prepare Trading Account given:

    • Sales $40,000
    • Opening Stock $5,000
    • Purchases $22,000
    • Closing Stock $4,000

  2. Prepare Profit & Loss given gross profit and expenses.

  3. Prepare Balance Sheet given assets, liabilities, and capital.

Revision Tips​

  • Learn the order of accounts in P&L
  • Practice calculating COGS
  • Understand relationship between statements
  • Know the order of assets in Balance Sheet (liquidity)
  • Remember net profit increases capital