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Preparing financial statements: Sole Trader (Balance sheet (The following…
Preparing financial statements: Sole Trader
The trial balance
Before the annual financial statements are prepared, a trial balance is drawn up from the nominal ledger
Simple a list of all the nominal ledger balances
For example, if wee look at the creditors account for a business, the balance will be calculated by taking the total of invoices received from suppliers and deducting from this figure the total of the credit notes for purchase returns plus the total cash paid by suppliers. The balance represents the liability of the business to the supplier (ie money owned)
If the balances comply with the rules of double entry bookkeeping, the trial balance totals should be equal because each transaction has been recorded throughout the accounting period by at least two accounting entries of equal value
Used as a basis or the preparation of the financial accounts
Revenues and expenses are profit and loss items
Assets, capital and liabilities are balance sheet items
Drawings
Monies or goods taken out of the business by a sole trader for private use
Not an expense of the business so are never recorded in the profit and loss account
Represent a reduction in the funds the owner has invested in the business; they are a reduction in the funds the owner has invested in the business; they are a reduction of the owner's capital and so are recorded in the balance sheet
Profits brought forward (b/f)
Brought forward from previous years
Represent the profits retained in the business
Also called retained profits or reserves
Profit and loss account
Consists of two elements
Trading account: prepared to reflect the sales less the cost of sales, excluding other business costs
Profit and loss account: starts with the gross profit, generated by the trading account, and deducts all other costs of running the business
Also known as a trading profit and loss account
A statement that shows the income less the various expenses of an organisation, to show the profit or loss for an accounting period
The output from the trading account is the gross profit
Shows the business owner and user of the accounts the net profit for the year
When preparing a trading profit and loss account for a sole trader, dependent upon the business and its management, six adjustments may be required
Purchase returns
Sales returns
Carriage inwards
Carriage outwards
Discounts allowed
Discounts received
Purchase returns
Impact on trading account; A deduction from purchases which forms part of the cost of sales
Goods returned by a business to its supplier
Always shown from a deduction from purchases, in the trading account
Sales returns
Impact on the trading account: A deduction from sales, shown after sales in the trading account
Goods returned to a business by its customers
Always shown as a deduction after the sales figure in the trading account
Carriage inwards
Impact on the trading account: An addition to purchases which forms part of the cost of sales
When goods are purchased from a supplier, the cost of transporting the goods from the supplier is known as carriage inwards
This cost arises from the purchase of goods and is therefore charged to the trading account as part of the cost of sales
Carriage outwards
Impact on profit and loss account: Shown as an expense
The expense incurred by a business when distributing or transporting goods to a purchaser
The expense is not part of the sales or selling price and as such are always shown as an expense in the profit and loss account
Discounts allowed
Impact on profit and loss account: Shown as an expense
When a business offers a credit purchaser a discount for early settlement, the discount granted is a discount allowed
The consequence of a discount allowed results in the business received a reduced amount for the sale
Although the sales revenue is reduced, a discount allowed is never charged to the trading account
Always charged as a separate expense to the profit and loss account
Discounts received
Impact on trading account: An income shown separately as an addition to gross profit
Impact on profit and loss account: An income shown separately after the expenses
Opposite of a discount allowed
When a business pays its account early and pays a reduced amount, the difference between the amount paid and the price on the original invoice is the discount received
Consequently, the business has received an income arising from this early settlement
The income arising from a discount received may be recorded in the trading account immediately after the gross profit. Alternatively the discount received may be shown as income after the deduction for expenses in the profit and loss account
Balance sheet
Reflects the accounting equation
Traditional format of the balance sheet is in a columnar fort in two sections. The upper section provides a breakdown of the assets and liabilities. The lower section consists of the capital or financing of the business
The most important feature of a balance sheet and its adherence to the accounting equation is that the two sections are always equal
The following are the key heading in the order in which they are found on a sole traders balance sheet
Fixed assets
Current assets
Current liabilities
Net current assets or working capital
Long-term liabilities
Net assets
Capital
Owner's funds
The balance sheet should identify a subtotal for each key item
Net current assets
The term net current assets is a key figure on a balance sheet as it represents the working capital of the business.
The capital available for conducting the day-to-day operations of an organisation, normally the excess of current assets over current liabilities
Represents the net investment in short term assets, such assets are continually flowing into and out of the business and are essential to the day-to-day operations of the business
Net assets
The figure obtained when a total is obtained by auditing together the total fixed assets and the net current assets and deducting the long-term liabitlies
The excess of book value of assets over liabilities including loan capital
Owner's funds
The total of the original capital invested by the owner in the business plus any retained profits or reserves from previous years, plus this year's profits less any drawings made by the owner during the year
The owner's funds and total net assets are equal
A statement of the financial position of an entity at a given date, disclosing the assets, liabilities and sacculated funds
Year end adjustments
It is extremely unusual for the detail in the accounting records to mirror exactly the financial activity undertaken by an organisation in a financial period. A simple reason will be the time-lag between when a business activity occurs and the physical recoding of the transaction in the accounting records
When a trial balance is produced, it is therefore simply a list of all the nominal ledger balances and these balances are before the year end adjustments are made. The balances need to be adjusted where appropriate so that the correct figures can be included in the profit and loss and balance sheet
Stocks
Finished goods bought or manufactured for resale
Impact on profit and loss account: Cost of sales is calculated as Opening stock + Purchases - Closing stock
Impact on balance sheet: The closing stock is shown as a current asset
Accruals
The cash payment has been made after the benefit has been received
Impact on the profit and loss account: The relevant expense figure is increased by the amount of the accrual
Impact on the balance sheet: The amount is shown as a current liability
Prepayments
The cash payment has been made before the benefit has been received
Impact on profit and loss account: The relevant expense figure is decreased by the amount of the prepayment
Impact on the balance sheet: The amount of the prepayment is shown as a current asset
Bad debts
An actual debt which is considered to not be collectable
Impact on the profit ad loss account: At the end of the accounting period, the business will determine which debtors balances are not recoverable from the original debtor. This is the amount that is charged to the profit and loss account
Impact on balance sheet: The non-recoverable debtors amount repotted in the profit and loss account is deducted from the total debtors balance reported in the balance sheet
Provision for doubtful debts
This is an estimate of the proportion of the year end debtors that will not pay
Impact on the profit and loss account: At the end of the accounting period, the business will determine the actual sum or percentage of its debtors which may not be recoverable. After the year of trading, the difference between the current year and previous year is reported in the profit and loss account
Impact on balance sheet: The previous year's provision is removed and the current year's provision is deducted from the debtors in the balance sheet
Provision for depreciation
The internal charge a business makes for the use and deterioration of fixed assets
Impact on profit and loss account: This year's annual depreciation is charged as an expense
Impact on balance sheet: The fixed assets are shown as follows: (cost of fixed asset less cumulative depreciation = net book value)