Preparing Financial Statements
For a sole trader the outputs are a statement of profit or loss and a statement of financial position. Build the profit or loss in the standard order: revenue less cost of sales (opening inventory + purchases + carriage inwards − closing inventory) gives gross profit; deduct distribution, administration and finance costs to reach operating profit; add other income; deduct tax where relevant to give profit for the year.
The statement of financial position lists non-current assets at carrying amount, current assets (inventory, receivables less the allowance, prepayments, cash), current liabilities (payables, accruals, bank overdraft, VAT), non-current liabilities and capital. Closing capital equals opening capital plus capital introduced plus profit for the year less drawings. Drawings are never an expense.
For a partnership, profit is shared through the appropriation account - partners' salaries, then interest on capital, then the residual in the profit-sharing ratio - and each partner's current account is adjusted. For a limited company, profit after tax goes to retained earnings.
Worked example. Revenue £120,000; opening inventory £8,000; purchases £70,000; closing inventory £10,000. Cost of sales = 8,000 + 70,000 − 10,000 = £68,000, so gross profit is £52,000. With expenses of £31,000, profit for the year is £21,000.
Traps. Closing inventory appears twice - in cost of sales and as a current asset. The allowance for doubtful debts is deducted from receivables, and only its movement is an expense. A debit balance on the VAT account is an asset, not an expense.