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Final Accounts of a Sole Trader This lesson will guide you through the creation of statements of account for a sole trader/proprietor. We will walk through the creation of a trading account, profit and loss account, and preparation of the balance sheet.
Sole Trader/Proprietor Anjan is the only owner of a family shop that sells sundries and other goods. His family has owned the business for three generations; he takes pride in his shop and has a great relationship with his customers. His only complaint would be the accounting! Every year he prepares final accounts for the year. Let's help him prepare the final accounts of his business. After working through the examples, a challenging process should become a little more clear. Anjan's shop is a sole proprietorship and he is a sole proprietor (sometimes called trader). This type of business is the most common. At the end of the year, he needs to prepare financial statements, regardless of his love of accounting (or lack thereof!).
Final Accounts In order to make Anjan's life a little easier, let's provide him with a trial balance of accounts. Within the balance are things like inventory, purchases, sales, expenses, etc. Note that the ''debtors'' item refers to people that owe him money. Item
Debit
Credit
Inventory January 2017 1,00,000 Purchases
2,25,000
Sales
3,75,000
Store Expenses
5,000
Interest Paid
1,250
Facilities
1,38,250
Wages
45,000
Debtors
10,000
Cash
1,000
Rent Paid
1,250
Utilities
500
Capital
65,000
Creditors
12,750
Loans
1,00,000 5,40,000 5,40,000
As part of the final accounts, Anjan is going to know if he made any money (and a profit). Even though some of these calculations will get complex, just remember the following will be true: A net profit (or loss) equals income minus expenses. Now that we have the trial balance, let's see if Anjan made a profit in the last year.
Trading And Profit and Loss Account Yes, there are two kinds of profit. Gross profit is what the shop made for profit. Net profit is what Anjan made; if he clears a net profit he can stay in business. Since we need to report BOTH gross profit and net profit, we have two accounts. The trading account gives us the gross profit; the profit and loss account shows net profit. Even though they are separate accounts, you need one (gross profit) to get the other (net profit). Let's start with the Trading Account
Trading Account Recall that the trading account is used to show gross profit. Anjan will need the following figures to calculate his sales and subtract the cost of those sales. This will give him the gross profit. The following table explains each item he needs for the trading account. Item
Description/Formula
Sales and Purchases Anjan can only use sales and purchases used in the conduct of the shop. He can't put a new front door here, but he can log the groceries he sells Cost of Sales
Opening inventory + Purchases - Closing Inventory
Gross Profit
Sales - Cost of Sales
Overhead
Expenses incurred to run the business (wages, rent, etc.)
There's just one more thing (at least for this piece!). Anjan's store had a closing inventory of 9,75,000. We will need that when we create the trading account.
Trading Account Item
Debit
Sales
Credit 3,75,000
Opening Inventory
1,00,000
Purchases
2,25,000 3,25,000
Minus Closing Inventory 9,75,000 Cost of Sales
2,95,000
Gross Profit
80,000
Now that we have the trading account built, we can work on the profit and loss account.
Profit and Loss Account If Anjan has a gross loss, the net loss won't be any prettier. Thankfully, he shows a gross profit, so there is hope for the profit and loss account. Remember, this statement shows the net profit (or loss). The profit and loss account subtracts all the overhead from Anjan's shop (wages, expenses, rent, etc.). These items should be familiar from the trial balance we had nicely prepared for him.
Profit and Loss Account Less overheads Wages
45,000
Store Expenses
5,000
Rent
1,250
Utilities
500
Interest Paid
1,250
53,000 Net Profit
27,000
Anjan can now breath a sigh of relief; he has made a net profit. Our friend is almost done with the final accounts. Now he needs to prepare the balance sheet (all we had before was a trial balance). Again, these items are also on the trial balance we prepared.
Balance Sheet Account The balance sheet account shows the total capital of the business, which is defined as:
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