Preparation and presentation of financial statements for sole traders and limited companies
Domain 2 examines how sole traders and limited companies turn an adjusted trial balance into an income statement and statement of financial position. For a sole trader, profit for the year = gross profit − expenses + other income. For a company, profit for the year is after finance costs and tax, and the statement of changes in equity links opening retained earnings to closing retained earnings.
Core adjustments
Apply accruals (expenses incurred but not yet paid), prepayments (paid in advance), depreciation, irrecoverable debts, allowances for receivables and closing inventory. Capital expenditure creates or improves a non-current asset; revenue expenditure is an expense. Classify assets and liabilities as current or non-current.
Worked example
A sole trader’s draft profit is N$40,000 before: depreciation N$6,000; rent paid N$1,500 relating to next year; wages accrued N$2,000. Adjusted profit = 40,000 − 6,000 + 1,500 − 2,000 = N$33,500. Reasoning: depreciation is an expense, the prepayment is removed from this year’s expense, and the accrual is added to this year’s expense. In the statement of financial position, prepaid rent is a current asset and accrued wages a current liability.
Company presentation
Show revenue, cost of sales, gross profit, operating expenses, finance costs, tax and profit for the year. The statement of financial position shows intangible and non-current assets, inventory, receivables, cash, payables, borrowings and equity. Dividends paid appear in the statement of changes in equity, not as an expense.
Traps
Forgetting to adjust opening inventory in cost of sales; treating drawings as an expense; charging capital expenditure to the income statement; showing an undeclared proposed dividend as a liability; omitting tax from company profit.