Final accounts of sole traders
The two statements
A sole trader prepares a trading account (gross profit) and a profit and loss account (net profit), often as a combined trading and profit and loss account, then a statement of financial position. Gross profit = sales − returns inwards − cost of sales, where cost of sales = opening stock + purchases − returns outwards + carriage inwards − closing stock. Carriage outwards, discounts allowed, office wages, depreciation and provisions are expenses charged after gross profit.
Adjustments
Apply accruals and prudence: adjust for accruals and prepayments, write off bad debts, create or adjust the provision for doubtful debts (only the movement goes to the profit and loss account), charge depreciation as a non-cash expense, and value closing stock at the lower of cost and net realisable value.
Traps
- Putting carriage outwards into cost of sales.
- Treating drawings as an expense; drawings reduce capital in the balance sheet.
- Ignoring the closing stock double entry: it reduces cost of sales and is a current asset.
- Adding the whole provision for doubtful debts each year instead of the change.
- Forgetting the capital reconciliation: opening capital + net profit − drawings = closing capital.
Worked example
Opening stock P4,000, purchases P26,000, returns outwards P1,000, carriage inwards P500, closing stock P5,000. Cost of sales = 4,000 + 26,000 − 1,000 + 500 − 5,000 = P24,500. With sales of P35,000, gross profit = P10,500, a 30% margin.