Financial Statements of Sole Proprietorship with Adjustments
Final accounts of a sole proprietor consist of the trading account, profit and loss account and balance sheet. The marks are in the adjustments: each one has two effects, and both must appear.
Core rules
- Trading account finds gross profit: sales less cost of goods sold, with opening stock, purchases, direct expenses and closing stock.
- Profit and loss account finds net profit after indirect expenses and incomes.
- Balance sheet shows assets, liabilities and capital at the year end.
- Closing stock is credited in the trading account and shown as an asset.
- 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 and deduct from the asset.
- Bad debts are written off; a further provision for doubtful debts is created on remaining debtors.
Worked example
Wages in the trial balance are ₹1,20,000; wages outstanding are ₹10,000; closing stock is ₹80,000. In the trading account, wages become ₹1,30,000 and closing stock appears on the credit side. In the balance sheet, outstanding wages are a liability of ₹10,000 and closing stock is an asset of ₹80,000.
Traps
- Recording an adjustment in only one statement.
- Treating drawings of goods as sales.
- Including carriage outward in direct expenses.
- Calculating provision for doubtful debts before deducting bad debts.
- Forgetting that goods taken for personal use reduce purchases and capital.