Financial Statements of Sole Proprietorship (with adjustments)
The question is almost always a full set of final accounts for a sole trader with five to seven adjustments. Marks are earned by showing every adjustment in both places it belongs.
Structure
- Trading account gives gross profit: sales − cost of goods sold, where cost of goods sold = opening stock + purchases + direct expenses − closing stock.
- Profit and loss account gives net profit after indirect expenses and incomes.
- Balance sheet shows assets and liabilities, with capital = opening capital + net profit + additional capital − drawings.
Adjustments and their double effect
- Closing stock: credit the trading account and show as an asset. If it already appears in the trial balance, show it only in the balance sheet.
- Outstanding expense: add to the expense and show as a liability.
- Prepaid expense: deduct from the expense and show as an asset.
- Depreciation: debit profit and loss, deduct from the asset.
- Bad debts and provision for doubtful debts: debit profit and loss; the new provision is deducted from debtors.
- Goods taken by the proprietor: deduct from purchases and from capital.
Worked example
Gross profit ₹2,00,000; salaries outstanding ₹6,000; insurance prepaid ₹2,000; depreciation ₹10,000; bad debts ₹5,000; provision raised from ₹3,000 to ₹4,000. Net profit = 2,00,000 − 6,000 + 2,000 − 10,000 − 5,000 − 1,000 = ₹1,80,000.
Traps
- Showing an adjustment in the account but not in the balance sheet.
- Adding the provision for doubtful debts to debtors instead of deducting it.
- Treating drawings as an expense in the profit and loss account.
- Confusing reserve for discount on creditors, which is added to liabilities, with provision for discount on debtors, which is deducted from assets.