Preparation of Financial Statements for Sole Traders
The financial statements of a sole trader are the statement of profit or loss and the statement of financial position. The exam tests adjustments for accruals, prepayments, depreciation, bad debts, drawings and closing inventory.
Structure
- Statement of profit or loss: sales - cost of sales = gross profit; add other income; deduct expenses (including depreciation and bad debts) = net profit.
- Statement of financial position: non-current assets at carrying amount; current assets (inventory, receivables, prepayments, bank); capital (opening + profit - drawings); non-current liabilities; current liabilities (payables, accruals, bank overdraft).
Worked example
Opening capital is €50,000. Profit for the year is €12,000 and drawings are €7,000. Closing capital = 50,000 + 12,000 - 7,000 = €55,000.
If closing inventory is €6,000, it is deducted in cost of sales and shown as a current asset. If depreciation is €2,000, it is an expense in profit or loss and deducted from the asset's carrying amount. A bank overdraft is a current liability, not a negative current asset.
Traps
Treating drawings as an expense; omitting closing inventory from one of the two statements; showing accumulated depreciation as an expense; and putting an overdraft under current assets. Also ensure accruals and prepayments appear in both the expense figure and the statement of financial position.