Financial Statements of Sole Traders
What you must understand
Prepare an income statement (trading and profit and loss account) to find gross profit and net profit, and a statement of financial position (balance sheet). Know the trading account structure: opening inventory + purchases − closing inventory = cost of sales; sales − cost of sales = gross profit. Then deduct expenses and add other income to get net profit. Understand accruals (expenses owing), prepayments (expenses paid in advance), depreciation of non-current assets, and drawings. Learn the adjusted trial balance approach: update for accruals, prepayments, depreciation and closing inventory before preparing statements.
Traps in questions
- Forgetting to adjust for closing inventory in both the income statement and the statement of financial position.
- Treating drawings as an expense.
- Omitting accrued expenses from the income statement and from current liabilities.
- Depreciating at the wrong rate (straight-line versus reducing balance).
Worked example
Sales $50,000; opening inventory $4,000; purchases $30,000; closing inventory $5,000; expenses $8,000. Cost of sales = $4,000 + $30,000 − $5,000 = $29,000. Gross profit = $50,000 − $29,000 = $21,000. Net profit = $21,000 − $8,000 = $13,000. Rule of thumb: closing inventory is subtracted in cost of sales and appears as a current asset.