Preparation of Financial Statements for Sole Traders
Preparation of Financial Statements for Sole Traders
This domain tests preparation of an income statement and statement of financial position from a trial balance and adjustments. The focus is classification, cost of sales and the link between profit and capital.
Core structure
- Sales less cost of sales equals gross profit.
- Cost of sales = opening inventory + purchases + carriage inwards − closing inventory.
- Gross profit less operating expenses plus other income equals net profit.
- Assets less liabilities equal capital.
- Closing capital = opening capital + profit + capital introduced − drawings.
Worked example
Sales are ₦1,000,000; opening inventory ₦100,000; purchases ₦600,000; closing inventory ₦150,000. Cost of sales is ₦100,000 + ₦600,000 − ₦150,000 = ₦550,000. Gross profit is ₦450,000. Expenses of ₦250,000 give net profit of ₦200,000. If drawings were ₦50,000, capital increases by ₦150,000, not by the full profit. Drawings are a reduction of owner's equity, not an expense.
Traps that cost marks
- Charging drawings as an operating expense.
- Treating capital introduced as sales or other income.
- Omitting closing inventory from cost of sales.
- Mixing purchases returns with sales returns.
- Forgetting that profit for the year belongs to the owner and increases capital.