Preparation of Financial Statements for Sole Traders and Partnerships
What the exam tests
This domain tests preparation and presentation of financial statements for sole traders and partnerships, including capital and current accounts, profit-sharing arrangements and the appropriation account.
Core rules
- Sole trader: closing capital = opening capital + profit - drawings. The statement of financial position shows assets, liabilities and capital.
- Partnership: profit is shared according to the partnership agreement; in the absence of agreement, profits and losses are shared equally.
- Appropriation account deducts partners' salaries and interest on capital, adds interest on drawings, then shares residual profit in the agreed ratio.
- Partners' current accounts record salaries, interest on capital, share of profit, drawings and interest on drawings; capital accounts record fixed capital and goodwill adjustments.
Worked example
Profit for the year is N900,000. A is entitled to salary N120,000 and interest on capital N50,000; B to interest on capital N30,000. Residual = 900,000 - 120,000 - 50,000 - 30,000 = N700,000, shared 3:2. A gets N420,000, B gets N280,000. A's total appropriation = 120,000 + 50,000 + 420,000 = N590,000; B's = 30,000 + 280,000 = N310,000. These amounts are credited to current accounts, not charged as expenses in arriving at profit.
Traps
Partners' salaries and interest on capital are appropriations of profit, not operating expenses. Drawings are not expenses. Interest on drawings is income to the partnership and is credited to the appropriation account. Do not merge capital and current accounts unless the partnership agreement uses a fluctuating capital method.