Preparation of Financial Statements for Sole Traders
What the exam tests
This domain tests the income statement and statement of financial position for a sole trader, including gross profit, net profit, capital and drawings. Expect adjustments for inventory, accruals and depreciation.
Core rules
- Gross profit = sales revenue - cost of sales.
- Net profit = gross profit + other income - expenses.
- Closing capital = opening capital + capital introduced + net profit - drawings.
- The statement of financial position shows assets, liabilities and capital; net assets must equal capital.
- Drawings are deducted from capital, not shown as an expense.
Worked example
Sales are 50,000, cost of sales is 30,000 and expenses are 12,000. Gross profit = 20,000; net profit = 8,000. Opening capital is 15,000 and drawings are 5,000, so closing capital = 15,000 + 8,000 - 5,000 = 18,000. If assets are 30,000 and liabilities are 12,000, net assets are 18,000, which agrees with closing capital. The statement of financial position proves the accounting equation.
Traps
Do not deduct drawings as an expense in the income statement. Do not use purchases instead of cost of sales when closing inventory is given. Do not omit accrued expenses or prepayments from the income statement. Do not include capital introduced as sales revenue. Check that net assets equal closing capital after all adjustments.
Key points
- Gross profit uses cost of sales, not purchases alone.
- Net profit feeds into closing capital.
- Drawings reduce capital and are not an expense.
- Net assets must equal closing capital.