The income statement and statement of financial position of a sole trader

Last time

Before we start: last time, in Irrecoverable debts, recovered debts and the allowance for irrecoverable debts, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

The year's results

At the end of each year, a sole trader prepares two statements from the trial balance and the year-end adjustments. The income statement shows the profit for the year. The statement of financial position shows what the business owns and owes on the last day.

The trading section

Revenue is sales minus sales returns. Here, 50,000 dollars minus returns of 1,000 is 49,000. Cost of sales is opening inventory plus purchases, minus closing inventory: 4,000 plus 30,000, minus 5,000, which is 29,000. Gross profit is revenue minus cost of sales: 49,000 minus 29,000 is 20,000 dollars.

Purchases adjustments

Purchases returns are subtracted from purchases. Carriage inwards, the cost of bringing goods in, is added. Carriage outwards, delivering goods to customers, is an expense, not part of cost of sales. Goods taken by the owner for personal use are drawings, and are subtracted from purchases.

From gross profit to profit

Add other income, such as discount received and rent received. Subtract expenses: wages, rent, electricity, depreciation, irrecoverable debts, discount allowed and carriage outwards. Here, expenses of 12,000 leave a profit for the year of 8,000 dollars.

The income statement

Here is the layout in short. Revenue, less cost of sales, gives gross profit; less expenses gives profit for the year.

The statement of financial position

Non-current assets first, at cost less accumulated depreciation. Then current assets: inventory, trade receivables less the allowance, prepayments, and cash. Then current liabilities, such as trade payables and accruals, and non-current liabilities, such as long-term loans.

The capital section

Capital at the start, plus profit for the year, minus drawings, gives capital at the end. With opening capital of 40,000, profit of 8,000 and drawings of 6,000, closing capital is 42,000. Closing capital equals net assets: total assets minus total liabilities.

Where the adjustments go

Every year-end adjustment appears in both statements. Closing inventory: in cost of sales, and as a current asset. Depreciation: as an expense, and in accumulated depreciation. Accruals and prepayments: adjust the expense, and appear as a liability or an asset.

Presentation marks

Use the full title, with the business name and the date: for the year ended for an income statement; at for a financial position. Show sub-totals clearly, such as gross profit, total current assets, and net current assets. Label every line. Correct figures in the wrong place lose marks.

Mistakes that lose marks

Mistake one: putting carriage outwards in cost of sales. Mistake two: showing drawings as an expense. Drawings reduce capital, not profit. Mistake three: titling the financial position 'for the year ended'. It is 'at' a date. The fix: the right section for every item, and the right title.

The full-marks tip

The full-marks tip: set out cost of sales as opening inventory, plus purchases, less closing inventory. In the statement of financial position, capital plus profit minus drawings must equal net assets.

On one card

So, on one card: financial statements. Keep it for revision.