Lee's Bakery: Reconciling Capital per Statement of Affairs with Capital per Records
Lee runs a bakery and has never kept a full double-entry set of books. His accountant prepared a statement of affairs at 31 March: van £9,000, equipment £4,500, inventory £3,240, trade receivables £2,180, bank £1,650, trade payables £4,110, VAT payable £620 and a bank loan £6,000. Lee's cash records show capital brought forward at 1 April last year of £7,040, a profit for the year of £11,200 and drawings of £9,300. He mentions that the £3,240 inventory figure includes £900 of garden furniture supplied on a sale-or-return basis; it is unsold and the supplier will collect it in April.
1. Calculate Lee's capital at 31 March from the statement of affairs, before and after adjusting for the sale-or-return goods.
Read the worked answer
Using the accounting equation: assets − liabilities = capital
| Assets | £ |
|---|---|
| Van | 9,000 |
| Equipment | 4,500 |
| Inventory | 3,240 |
| Trade receivables | 2,180 |
| Bank | 1,650 |
| Total assets | 20,570 |
| Liabilities | £ |
|---|---|
| Trade payables | 4,110 |
| VAT payable | 620 |
| Bank loan | 6,000 |
| Total liabilities | 10,730 |
Capital = £20,570 − £10,730 = £9,840
Adjusting for the sale-or-return goods Lee does not own them - they are held on approval and can go back - so they are not an asset. Inventory becomes £3,240 − £900 = £2,340, assets become £19,670, and capital becomes £8,940.
Removing inventory without any matching liability change falls straight on capital, because there is nothing else for it to hit.
2. Reconcile the adjusted statement-of-affairs figure with the figure from Lee's records, and state what you would do if a difference remained.
Read the worked answer
Capital per records Opening capital £7,040 + profit £11,200 − drawings £9,300 = £8,940.
Reconciliation
| £ | |
|---|---|
| Capital per statement of affairs (unadjusted) | 9,840 |
| Less: goods held on sale or return | (900) |
| Capital per statement of affairs (adjusted) | 8,940 |
| Capital per records (7,040 + 11,200 − 9,300) | 8,940 |
| Difference | 0 |
The two independent routes now agree, which confirms the records are complete for the year.
If a difference had remained, I would not force it through drawings. I would check, in this order:
- Assets and liabilities omitted from the statement of affairs, or valued wrongly (for example, inventory that is damaged, or a loan repayment not in the cash records).
- Drawings that were never recorded - goods taken for own use, or personal bills paid from the business account.
- A profit figure taken from incomplete records that has missed accruals, prepayments or depreciation. Only after those are tested would I use a balancing figure, and I would disclose it.
3. Explain what would go wrong if the sale-or-return goods were left in inventory, and why the direction of each effect matters.
Read the worked answer
If the £900 stays in closing inventory, then closing inventory is overstated, which reduces cost of sales and therefore overstates profit by £900. Capital is overstated by the same £900, since nothing else changes.
That single error cuts both ways:
- Profit and capital are overstated - the business looks more successful and better funded than it is. A lender reading the statement of affairs would be misled.
- Current assets are overstated - the goods are not Lee's to sell or to pledge as security. The supplier still owns them and can collect them in April.
Goods held on approval are the classic trap because they are physically in Lee's shop and look exactly like stock. The judgement is not "is it here?" but "do we own it, and will we owe for it?". The same reasoning applies to goods bought on credit where the invoice has not yet arrived - Lee has the stock and owes the payable - which is why the two must be matched.