Trial Balance and Financial Statements of a Sole Trader
This domain tests the trial balance and the preparation of an income statement and statement of financial position for a sole trader. Expect questions on cost of sales, gross and net profit, capital, and year-end adjustments.
Trial balance
A trial balance lists ledger balances at a date; total debits must equal total credits. It checks arithmetic and posting equality but does not prove accuracy. Errors not disclosed include omission, commission, principle, original entry, compensating errors and complete reversal.
Financial statements
Income statement: gross profit = sales − cost of sales. Cost of sales = opening stock + purchases + carriage inwards − returns outwards − closing stock. Net profit = gross profit + other income − expenses.
Statement of financial position: assets = capital + liabilities, where closing capital = opening capital + net profit + additional capital − drawings.
Adjustments: depreciation spreads the cost of a non-current asset; accruals are expenses incurred but unpaid; prepayments are paid in advance; closing stock is deducted from cost of sales and shown as a current asset.
Worked example
Sales Rs. 800,000; opening stock Rs. 100,000; purchases Rs. 500,000; closing stock Rs. 120,000; expenses Rs. 150,000. Cost of sales = 100,000 + 500,000 − 120,000 = Rs. 480,000. Gross profit = 800,000 − 480,000 = Rs. 320,000. Net profit = 320,000 − 150,000 = Rs. 170,000. Closing stock appears as a current asset, not as an expense.
Traps
Adding closing stock to purchases; treating drawings as an expense; assuming a balanced trial balance means no errors; omitting accruals.