l e a r n i n g o b j e c t i v e s

When you have studied this chapter you will be able to:

■ understand the format of final accounts for sole traders

■ prepare final accounts for sole trader businesses from the book-keeper's trial balance

■ understand the link between double-entry book-keeping and final accounts

■ distinguish between capital expenditure and revenue expenditure

C A S E S T U D YS t a r t i n g o u t i n b u s i n e s s

Olivia Boulton used to work as a buyer of kitchen and cookware goods for a large departmentstore in central London. She was good at her job and knew the type of goods that sold well.

Two years ago, Olivia took the decision to set up in business on her own, selling a range ofkitchen and cookware goods designed and manufactured in Italy. She decided to set up as asole trader rather than taking on a partner or forming a limited company. She wanted thefreedom of being her own boss, although she knew the financial risks involved in ‘going italone’.

In her first year of trading Olivia identified suitable rented premises in her home town ofBrighton. She liked the premises so much that a year later she took the option of buying themand refitting the shop – all with the help of a bank loan.

Business has gone well since opening day. In fact, as well as selling to shop customers, shehas also built up a small amount of wholesale trade, where she sells imported kitchen goodsto other shops.

Now that the business is well established, Olivia feels that it is time she understood financialmatters rather better. She employs a book-keeper to deal with day-to-day transactions and towrite up the books. She has also taken on an accountant to prepare her year-end financialstatements and deal with the tax calculations based on the profit she has made.

But she wants to know more about these financial statements: the trading and profit and lossaccount and the balance sheet . . .

6 SOLE TRADER FINAL ACCOUNTSSOLE TRADER FINAL ACCOUNTS6

S O L E T R A D E R S

Sole traders are people who are in business on their own: they run shops,factories, farms, garages, local franchises, etc. The businesses are generallysmall because the owner usually has a limited amount of capital to invest.Profits are often small and, after the owner has taken out drawings, are usuallyploughed back into the business.

People set up as sole traders for various reasons:

■ the owner has independence and can run the business, by and large,without the need to involve others in decision making

■ in a small business with few, if any, employees, personal service andsupervision by the owner are available at all times

■ the business is easy to establish legally – either using the owner’s name,or a trading name such as ‘Wyvern Plumbing Services’

The disadvantages of a sole-trader business are:

■ the owner has unlimited liability for the debts of the business – this meansthat if the sole trader should become insolvent (unable to pay debts whenthey are due), the owner’s personal assets may be sold to pay creditors

■ expansion is limited because it can only be achieved by the ownerploughing back profits, or by borrowing from a lender such as a bank

■ the owner usually has to work long hours and it may be difficult to findtime to take holidays; if the owner should become ill the work of thebusiness will either slow down or stop altogether

F I N A L A C C O U N T S A N D T H E T R I A L B A L A N C E

f i n a l a c c o u n t s

The final accounts (or financial statements) of a sole trader comprise:

■ a trading and profit and loss accountwhich shows the profit or loss ofthe business

■ a balance sheet, which shows the assets and liabilities of the businesstogether with the owner’s capital

These final accounts can be produced more often than once a year in order togive information to the owner on how the business is progressing. However, itis customary to produce annual accounts for the benefit of the Inland Revenue,bank manager and other interested parties. In this way the trading and profitand loss account covers an accounting period of a financial year (which canend at any date – it doesn’t have to be the calendar year), and the balance sheetshows the state of the business at the end of the accounting period.

S O L E T R A D E R F I N A L A C C O U N T S 1 0 3

t r a d i n g a n d p r o f i t a n d l o s s a c c o u n tincome minus expenses equals net profit (or loss)

The trading and profit and loss account shows the income a business hasreceived over a given period for goods sold or services provided (togetherwith any small amounts of other income, eg rent received). It also sets out theexpenses incurred – the cost of the product, and the overheads (eg wages,administration expenses, rent, and so on). The difference between income andexpenses is the net profit of the business. If expenses are greater than income,then a loss has been made. The net profit (or loss) belongs to the owner(s) ofthe business.

b a l a n c e s h e e tassets minus liabilities equals capital

A balance sheet gives a 'snapshot' of the business at a particular date – the endof the financial year. A typical business balance sheet will show:

assets What the business owns: – fixed assets, eg premises, vehicles, computers– current assets, eg stock of goods for resale, debtors (money

owed by customers), bank and cash balances

liabilities What the business owes:– current liabilities, eg creditors, overdrafts, VAT due– long-term liabilities, eg long-term bank loans

net assets The total of fixed and current assets, less current and long-term liabilities. The net assets are financed by the owner(s) ofthe business, in the form of capital. Net assets therefore equalsthe total of the ‘financed by’ section – the balance sheet‘balances’.

capital Where the money to finance the business has come from, eg theowner's investment, business profits.

T R I A L B A L A N C E

The starting point for preparing final accounts is the trial balance prepared bythe book-keeper: all the figures recorded on the trial balance are used in thefinal accounts. The trading account and the profit and loss account are both'accounts' in terms of double-entry book-keeping. By contrast, the balancesheet is not an account, but is simply a statement of account balancesremaining after the trading and profit and loss accounts have been prepared.

To help us with the preparation of final accounts we will use the trial balance,shown in the Case Study on the next page. The trial balance has beenproduced by the book-keeper at the end of the financial year. In the CaseStudy we will present the final accounts:

1 0 4 A C T I V E A C C O U N T I N G

■ before adjustments for items such as accruals, prepayments, bad debtsand depreciation – these will be covered in the next chapter

■ in vertical format, ie in the column format used by accountants

On page 111 we will look at the double-entry book-keeping for amountsentered in the trading and profit and loss accounts.

S O L E T R A D E R F I N A L A C C O U N T S 1 0 5

C A S E S T U D Y

Fina l accounts o f O l i v ia Bou l ton f rom the t r ia l ba lance

s i t u a t i o nOlivia Boulton runs a kitchen and cookware shop in Brighton. Her book-keeper has just extracted the year-end trial balance shown below and has drafted provisional final accounts for discussion with theaccountant.

Note that the trial balance includes the stock value at the start of the year, while the end-of-year stockvaluation is given after the trial balance. For the purposes of financial accounting, the stock of goods forresale is valued by the business at the end of each financial year, and the valuation is subsequentlyentered into the book-keeping system.

Trial balance of Olivia Boulton, as at 31 December 2002Dr Cr£ £

Stock at 1 January 2002 50,000Purchases 420,000Sales 557,500Shop expenses 6,200Wages 33,500Rent paid 750Telephone expenses 500Interest paid 4,500Travel expenses 550Premises 200,000Shop fittings 40,000Debtors 10,100Bank 5,850Cash 50Capital 75,000Drawings 27,000Loan from bank 150,000Creditors 14,500Value Added Tax 2,000

799,000 799,000

Note: stock at 31 December 2002 was valued at £42,000

1 0 6 A C T I V E A C C O U N T I N G

The amounts for sales and purchases include only items in which thebusiness trades – eg a clothes shop buying clothes from the manufacturerand selling to the public. Note that items bought for use in the business,such as a new till for the shop, are not included with purchases but areshown as assets on the balance sheet.

Cost of sales represents the cost to the business of the goods whichhave been sold in this financial year. Cost of sales is:

opening stock (stock bought previously)

plus purchases (purchased during the year)

minus closing stock (stock left unsold at the end of the year)

equals cost of sales (cost of what has actually been sold)

Gross profit is calculated as:

sales – cost of sales = gross profit

If cost of sales is greater than sales, the business has made a gross loss.

Net profit is calculated as:

gross profit – overheads = net profit

If overheads are more than gross profit, the business has made a net loss.

The net profit is the amount the business earned for the owner during theyear, and is subject to taxation. The owner can draw some or all of the netprofit for personal use in the form of drawings. Part of the profit might wellbe left in the business in order to help build up the business for the future.

Overheads , or expenses are the running costs of the business – knownas revenue expenditure. The categories of overheads or expenses usedvary according to the needs of each business.

Trading account shows gross profit for the accounting period. Profit andloss account shows net profit for the accounting period. Note that ‘profitand loss account’ is often used as a general heading which includes bothof these financial statements.

S O L E T R A D E R F I N A L A C C O U N T S 1 0 7

TRADING AND PROFIT AND LOSS ACCOUNTof Olivia Boulton for the year ended 31 December 2002

£ £

Sales 557,500

Opening stock (1 January 2002) 50,000

Purchases 420,000

470,000

Less Closing stock (31 December 2002) 42,000

Cost of sales 428,000

Gross profit 129,500

Less overheads:

Shop expenses 6,200

Wages 33,500

Rent paid 750

Telephone expenses 500

Interest paid 4,500

Travel expenses 550

46,000

Net profit 83,500

1 0 8 A C T I V E A C C O U N T I N G

Fixed assets comprise the long-term items owned by a business whichare not bought with the intention of selling them off in the near future, egpremises, machinery, motor vehicles, office equipment, shop fittings, etc.

Current assets comprise short-term assets which change regularly, egstock of goods for resale, debtors, bank balances and cash. These itemswill alter as the business trades, eg stock will be sold, or more will bebought; debtors will make payment to the business, or sales on credit willbe made; the cash and bank balances will alter with the flow of moneypaid into the bank account, or as withdrawals are made.

Current liabilities are due for repayment within twelve months of the dateof the balance sheet, eg creditors, and bank overdraft (which is repayableon demand, unlike a bank loan repayable over a period of years). VAT dueto HM Customs & Excise is also listed as a current liability.

Working capital is the excess of current assets over current liabilities, iecurrent assets minus current liabilities = working capital. Withoutadequate working capital, a business will find it difficult to continue tooperate. Working capital is also often referred to as net current assets.

Long-term liabilities are where repayment is due in more than one yearfrom the date of the balance sheet; they are often described by termssuch as ‘bank loan,’ ‘long-term loan,’ or ‘mortgage.’

Net assets is the total of fixed and current assets, less current and long-term liabilities. The net assets are financed by the owner of the business,in the form of capital. Net assets therefore equals the total of the ‘financedby’ section – the balance sheet ‘balances’.

Capital is the owner’s investment, and is a liability of a business, ie it iswhat the business owes the owner.

S O L E T R A D E R F I N A L A C C O U N T S 1 0 9

BALANCE SHEET OF OLIVIA BOULTONas at 31 December 2002

£ £ £

Fixed Assets

Premises 200,000

Shop fittings 40,000

240,000

Current Assets

Stock 42,000

Debtors 10,100

Bank 5,850

Cash 50

58,000

Less Current Liabilities

Creditors 14,500

Value Added Tax 2,000

16,500

Working Capital 41,500

281,500

Less Long-term Liabilities

Loan from bank 150,000

NET ASSETS 131,500

FINANCED BY

CapitalOpening capital 75,000

Add net profit 83,500

158,500

Less drawings 27,000

Closing capital 131,500

1 1 0 A C T I V E A C C O U N T I N G

P R E P A R A T I O N O F F I N A L A C C O U N T S F R O M A T R I A L B A L A N C E

The trial balance contains the basic figures necessary to prepare the finalaccounts but, as we shall see in the next section, the figures are transferredfrom the double-entry accounts of the business. Nevertheless, the trialbalance is a suitable summary from which to prepare the final accounts. Theinformation needed for the preparation of each of the final accounts needs tobe picked out from the trial balance in the following way:■ go through the trial balance and write against the items the final account

in which each appears■ 'tick' each figure as it is used – each item from the trial balance appears in

the final accounts once only■ the year-end (closing) stock figure is not listed in the trial balance, but is

shown as a note; the closing stock appears twice in the final accounts –firstly in the trading account, and secondly in the balance sheet (as acurrent asset)

If this routine is followed with the trial balance of Olivia Boulton, it appearsas follows . . .

Trial balance of Olivia Boulton as at 31 December 2002

Dr Cr£ £

Stock at 1 January 2002 50,000 T ✔

Purchases 420,000 T ✔

Sales 557,500 T ✔

Shop expenses 6,200 P & L (expense) ✔

Wages 33,500 P & L (expense) ✔

Rent paid 750 P & L (expense) ✔

Telephone 500 P & L (expense) ✔

Interest paid 4,500 P & L (expense) ✔

Travel expenses 550 P & L (expense) ✔

Premises 200,000 BS (fixed asset) ✔

Shop fittings 40,000 BS (fixed asset) ✔

Debtors 10,100 BS (current asset) ✔

Bank 5,850 BS (current asset) ✔

Cash 50 BS (current asset) ✔

Capital 75,000 BS (capital) ✔

Drawings 27,000 BS (capital) ✔

Loan from bank 150,000 BS (long-term liability) ✔

Creditors 14,500 BS (current liability) ✔

Value Added Tax 2,000 BS (current liability) ✔

799,000 799,000

Note: stock at 31 December 2002 was valued at £42,000 T ✔

BS (current asset) ✔

Note: T = trading account; P & L = profit and loss account; BS = balance sheet

S O L E T R A D E R F I N A L A C C O U N T S 1 1 1

D O U B L E - E N T R Y B O O K - K E E P I N G A N D F I N A L A C C O U N T S

We have already noted earlier in this chapter that the trading and profit andloss account forms part of the double-entry book-keeping system. Therefore,each amount recorded in this account must have an opposite entry elsewherein the accounting system. In preparing the trading and profit and loss accountwe are, in effect, emptying each account that has been storing up a record ofthe transactions of the business during the course of the financial year andtransferring it to the trading and profit and loss account.

t r a d i n g a c c o u n t

In the trading account of Olivia Boulton the balance of purchases account istransferred as follows (debit trading account; credit purchases account):

Dr Purchases Account Cr

2002 £ 2002 £

31 Dec Balance b/d 420,000 31 Dec Trading account 420,000(ie total for year)

The account now has a nil balance and is ready to receive the transactions fornext year.

The balances of sales account (and also, where appropriate, sales returns andpurchases returns account) will be cleared to nil in a similar way and theamounts transferred to trading account, as debits or credits as appropriate.

Stock account, however, is dealt with differently. Stock is valued for financialaccounting purposes at the end of each year (it is also likely to be valued moreregularly in order to provide management information). Only the annual stockvaluation is recorded in stock account, and the account is not used at any othertime. After the book-keeper has extracted the trial balance, but beforepreparation of the trading account, the stock account appears as follows:

Dr Stock Account Cr

2002 £ 2002 £1 Jan Balance b/d 50,000

This balance, which is the opening stock valuation for the year, is transferredto the trading account to leave a nil balance, as follows (debit trading account;credit stock account):

1 1 2 A C T I V E A C C O U N T I N G

Dr Stock Account Cr

2002 £ 2002 £1 Jan Balance b/d 50,000 31 Dec Trading account 50,000

The closing stock valuation for the year – for Olivia Boulton it is £42,000 –is now recorded on the account as an asset (debit stock account; credit tradingaccount):

Dr Stock Account Cr

2002 £ 2002 £1 Jan Balance b/d 50,000 31 Dec Trading account 50,000

31 Dec Trading account 42,000 31 Dec Balance c/d 42,000

20031 Jan Balance b/d 42,000

The closing stock figure is shown on the balance sheet as a current asset, andwill be the opening stock in next year's trading account.

p r o f i t a n d l o s s a c c o u n t

The overheads or expenses of running the business are transferred from thedouble-entry accounts to the profit and loss account. For example, the wagesaccount of Olivia Boulton has been storing up information during the yearand, at the end of the year, the total is transferred to profit and loss account(debit profit and loss account; credit wages account):

Dr Wages Account Cr

2002 £ 2002 £

31 Dec Balance b/d 33,500 31 Dec Profit and loss account 33,500(ie total for year)

The wages account now has a nil balance and is ready to receive transactionsfor 2003, the next financial year.

n e t p r o f i t

After the profit and loss account has been completed, the amount of net profit(or net loss) is transferred to the owner's capital account. The book-keepingentries are:

■ net profit:

– debit profit and loss account

– credit capital account

■ net loss:

– debit capital account

– credit profit and loss account

A net profit increases the owner's stake in the business by adding to capitalaccount, while a net loss decreases the owner's stake.

d r a w i n g s

At the same time the account for drawings, which has been storing up theamount of drawings during the year is also transferred to capital account:

– debit capital account

– credit drawings account

In this way the total of drawings for the year is debited to capital account.

c a p i t a l a c c o u n t

When these transactions are completed, the capital account of Olivia Boultonappears as:

Dr Capital Account Cr

2002 £ 2002 £

31 Dec Drawings for year 27,000 31 Dec Balance b/d 75,000

31 Dec Balance c/d 131,500 31 Dec Profit and loss account

(net profit for year) 83,500

158,500 158,500

2003 2003

1 Jan Balance b/d 131,500

Note that it is the balance of capital account at the end of the year, ie£131,500, which forms the total for the capital section of the balance sheet.Although this figure could be shown on the balance sheet by itself, it is usualto show how it is calculated: capital at the start of the year plusnet profit forthe year, minus drawings for the year. In this way, the capital account issummarised on the balance sheet.

S O L E T R A D E R F I N A L A C C O U N T S 1 1 3

t h e b a l a n c e s h e e t a n d d o u b l e - e n t r y

Unlike the trading and profit and loss account, the balance sheet is not part ofthe double-entry accounts. The balance sheet is made up of those accountswhich remain with balances after the trading and profit and loss accounttransfers have been made. It consists of asset and liability accounts, the assetof closing stock, and the owner’s capital and drawings.

S O L E T R A D E R F I N A L A C C O U N T S : E X A M P L E L A Y O U T

An example layout for the final accounts of a sole trader is reproduced inAppendix 2 and can also be downloaded from www.osbornebooks.co.uk.This format shows:

– an example layout for a trading and profit and loss account

– an example layout for a balance sheet

Note that when used for partnerships (see Chapter 10), the layout will need tobe adjusted to take note of the appropriation of profits and of the partners’capital and current accounts.

A D D I T I O N A L I T E M S I N F I N A L A C C O U N T S

As well as the adjustments to final accounts, there are a number of additionalitems that are shown in the trading and profit and loss account. These include:

■ carriage in

■ carriage out

■ sales returns

■ purchases returns

■ discount received

■ discount allowed

c a r r i a g e i n

This is the expense to a buyer of the carriage (transport) costs. For example,if an item is purchased by mail order, the buyer usually has to pay theadditional cost of delivery.

1 1 4 A C T I V E A C C O U N T I N G

In the trading account, the cost of carriage in is added to the cost ofpurchases. The reason for doing this is so that all purchases are at a ‘deliveredto your door’ price.

c a r r i a g e o u t

This is where the seller pays the expense of the carriage charge. For example,an item is sold to the customer and described as ‘post free’.

In the profit and loss account, the cost of carriage out incurred on sales isshown as an expense of the business.

s a l e s r e t u r n s

Sales returns (or returns in) is where a debtor (a customer who has bought oncredit) returns goods to the business. In final accounts, the amount of salesreturns is deducted from the figure for sales in trading account.

p u r c h a s e s r e t u r n s

Purchases returns (or returns out) is where a business returns goods to acreditor (a supplier).

In final accounts, the amount of purchases returns is deducted from the figurefor purchases in trading account.

d i s c o u n t r e c e i v e d

Discount received is an allowance offered by creditors on purchases invoiceamounts for quick settlement, eg 2% cash discount for settlement withinseven days.

In final accounts, the amount of discount received is shown in profit and lossaccount as income received.

d i s c o u n t a l l o w e d

This is an allowance offered to debtors on sales invoice amounts for quicksettlement.

In final accounts, the amount of discount allowed is shown in profit and lossaccount as an expense.

S O L E T R A D E R F I N A L A C C O U N T S 1 1 5

1 1 6 A C T I V E A C C O U N T I N G

C A S E S T U D Y

Tr a d i n g a n d p ro f i t a n d l o s s a c c o u n t – a d d i t i o n a l i t e m s

s i t u a t i o n

An extract from the trial balance of Natasha Morgan, sole trader, is as follows:

Trial balance (extract) as at 30 June 2003

Dr Cr

£ £

Stock at 1 July 2002 12,350

Sales 250,000

Purchases 156,000

Sales returns 5,400

Purchases returns 7,200

Carriage in 1,450

Carriage out 3,250

Discount received 2,500

Discount allowed 3,700

Other expenses 78,550

Note: stock at 30 June 2003 was valued at £16,300

Natasha asks for your help in the preparation of the trading and profit and loss account.

s o l u t i o n

There are a number of additional items to be incorporated into the layout of the trading and profit and lossaccount. In particular, the calculation of cost of sales is made in the following way:

opening stock

+ purchases

+ carriage in

– purchases returns

– closing stock

= cost of sales

For Natasha Morgan’s business, the trading and profit and loss account is as follows (note the use of threemoney columns):

S O L E T R A D E R F I N A L A C C O U N T S 1 1 7

TRADING AND PROFIT AND LOSS ACCOUNT OF NATASHA MORGAN

for the year ended 30 June 2003

£ £ £

Sales 250,000

Less Sales returns 5,400

Net sales 244,600

Opening stock (1 July 2002) 12,350

Purchases 156,000

Add Carriage in 1,450

157,450

Less Purchases returns 7,200

Net purchases 150,250

162,600

Less Closing stock (30 June 2003) 16,300

Cost of sales 146,300

Gross profit 98,300

Add Discount received 2,500

100,800

Less overheads:

Discount allowed 3,700

Other expenses 78,550

Carriage out 3,250

85,500

Net profit 15,300

1 1 8 A C T I V E A C C O U N T I N G

S E R V I C E S E C T O R B U S I N E S S E S

The final accounts of a service sector business – such as a secretarial agency,solicitor, estate agent, doctor – do not normally include a trading account.This is because the business, instead of trading in goods, supplies services.The final accounts of a service business consist of:

■ profit and loss account

■ balance sheet

The profit and loss account, instead of starting with gross profit from thetrading account section, commences with the income from the businessactivity – such as ‘fees’, ‘income from clients’, ‘charges’, ‘work done’. Otheritems of income – such as discount received – are added, and the overheadsare then listed and deducted to give the net profit, or net loss, for theaccounting period. An example of a service sector profit and loss account isshown below:

The balance sheet layout of a service sector business is identical to that seenearlier (page 109); the only difference is that there is unlikely to be muchstock, if any, in the current assets section.

JEMMA SMITH, TRADING AS ‘WYVERN SECRETARIAL AGENCY’

PROFIT AND LOSS ACCOUNT

for the year ended 31 December 2002

£ £

Income from clients 110,000

Less overheads:

Salaries 64,000

Heating and lighting 2,000

Telephone 2,000

Rent and rates 6,000

Sundry expenses 3,000

77,000

Net profit 33,000

S O L E T R A D E R F I N A L A C C O U N T S 1 1 9

C A P I T A L E X P E N D I T U R E A N D R E V E N U E E X P E N D I T U R E

When preparing final accounts, it is important to distinguish between capitalexpenditure and revenue expenditure.

c a p i t a l e x p e n d i t u r e

Capital expenditure can be defined as expenditure incurred on the purchase,alteration or improvement of fixed assets. For example, the purchase of a carfor use in the business is capital expenditure. Included in capital expenditureare such costs as:

■ delivery of fixed assets

■ installation of fixed assets

■ improvement (but not repair) of fixed assets

■ legal costs of buying property

r e v e n u e e x p e n d i t u r e

Revenue expenditure is expenditure incurred on running expenses. Forexample, the cost of petrol or diesel for the car (above) is revenueexpenditure. Included in revenue expenditure are the costs of:

■ maintenance and repair of fixed assets

■ administration of the business

■ selling and distributing the goods or products in which the business trades

c a p i t a l e x p e n d i t u r e a n d r e v e n u e e x p e n d i t u r e – t h e

d i f f e r e n c e s

Capital expenditure is shown on the balance sheet, while revenue expenditureis an expense in the profit and loss account. It is important to classify thesetypes of expenditure correctly in the accounting system. For example, if thecost of the car was shown as an expense in profit and loss account, then netprofit would be reduced considerably, or a net loss recorded; meanwhile, thebalance sheet would not show the car as a fixed asset – clearly this is incorrectas the business owns the asset.

Study the following examples; they show the differences between capitalexpenditure and revenue expenditure.

■ £30,000 cost of building an extension to the factory, which includes£1,000 for repairs to the existing factory

– capital expenditure, £29,000

– revenue expenditure, £1,000 (because it is for repairs to an existingfixed asset)

■ a plot of land has been bought for £20,000, the legal costs are £750

– capital expenditure £20,750 (the legal costs are included in thecapital expenditure, because they are the cost of acquiring the fixedasset, ie the legal costs are ‘capitalised’)

■ the business’ own employees are used to install a new air conditioningsystem: wages £1,000, materials £1,500

– capital expenditure £2,500 (an addition to the property); note that, incases such as this, revenue expenditure, ie wages and materialspurchases, will need to be reduced to allow for the transfer to capitalexpenditure

■ own employees used to repair and redecorate the premises: wages£500, materials £750

– revenue expenditure £1,250 (repairs and redecoration are runningexpenses)

■ purchase of a new machine £10,000, payment for installation andsetting up £250

– capital expenditure £10,250 (costs of installation of a fixed asset arecapitalised)

Only by allocating capital expenditure and revenue expenditure correctlybetween the balance sheet and the profit and loss account can the finalaccounts reflect accurately the financial state of the business.

1 2 0 A C T I V E A C C O U N T I N G

• The final accounts of a business comprise:

– trading account, which shows gross profit

– profit and loss account, which shows net profit (or loss)

– balance sheet, which shows the assets and liabilities of the business at the year-end

• The starting point for the preparation of final accounts is the summary of the information from theaccounting records contained in the book-keeper's trial balance.

• Each balance shown by the trial balance is entered into the final accounts once only.

• Any notes to the trial balance, such as the closing stock, affect the final accounts in two places.

c h a p t e r s u m m a r y

• The trading account and profit and loss account form part of the double-entry book-keeping system– amounts entered must be recorded elsewhere in the accounts.

• The balance sheet is not part of the double-entry system; it lists the assets and liabilities at aparticular date.

t u t o r i a l n o t e

There is more material to cover in connection with final accounts, and the next few chapters dealwith accruals and prepayments, depreciation of fixed assets, bad debts and provision for bad debts,and accounting concepts. In addition the more specialist final accounts of partnerships and limitedcompanies (Chapters 10 and 12), will be studied. Final accounts can also be analysed andinterpreted (Chapter 15) to give the user of the accounts information about the financial state of thebusiness.

S O L E T R A D E R F I N A L A C C O U N T S 1 2 1

k e y t e r m s

final accounts accounting statements, comprising the profit and loss account andbalance sheet, produced at least once a year, which giveinformation to the owner(s) and other interested parties on how thebusiness is progressing

profit and loss account shows the net profit (or net loss) of the business for the accountingperiod

balance sheet shows the assets, liabilities and capital of the business at the endof the accounting period

capital expenditure expenditure incurred on the purchase, alteration or improvement offixed assets

revenue expenditure expenditure incurred on running expenses

1 2 2 A C T I V E A C C O U N T I N G

6.1 Identify the main financial statements which comprise the final accounts of a sole trader. Explainthe main sections contained within the statements.

6.2 Distinguish between:

(a) gross profit and net profit

(b) fixed assets and current assets

(c) long-term liabilities and current liabilities

(d) capital and loans

6.3* The following information has been extracted from the business accounts of Matthew Lloyd for hisfirst year of trading which ended on 31 December 2008:

£

Purchases 94,350

Sales 125,890

Stock at 31 December 2008 5,950

Rates 4,850

Heating and lighting 2,120

Wages and salaries 10,350

Office equipment 8,500

Vehicles 10,750

Debtors 3,950

Bank balance (money at bank) 4,225

Cash 95

Creditors 1,750

Value Added Tax (due to HM Customs & Excise) 450

Capital at start of year 20,000

Drawings for year 8,900

You are to prepare the trading and profit and loss account of Matthew Lloyd for the year ended 31December 2008, together with his balance sheet at that date.

a c t i v i t i e s Note: an asterisk (*) after an activity number means that an answer is provided in Appendix 1.

6.4 Complete the table below for each item (a) to (g) indicating with a tick:

• whether the item would normally appear in the debit or credit column of the trial balance

• in which final account the item would appear at the end of the accounting period

6.5* You are to fill in the missing figures for the following businesses:

Sales Opening Purchases Closing Gross Expenses Net Profit/

Stock Stock Profit (Loss)*

£ £ £ £ £ £ £

Business A 20 000 5 000 10 000 3 000 ........ 4 000 ........

Business B 35 000 8 000 15 000 5 000 ........ ......... 10 000

Business C ......... 6 500 18 750 7 250 18 500 11 750 ........

Business D 45 250 9 500 ......... 10 500 20 750 ......... 10 950

Business E 71 250 ........ 49 250 9 100 22 750 24 450 ........

Business F 25 650 4 950 13 750 ........ 11 550 ......... (3 450)

* Note: a net loss is indicated in brackets

S O L E T R A D E R F I N A L A C C O U N T S 1 2 3

FINAL ACCOUNTS

TRIAL BALANCE TRADING & P& L BALANCE SHEET

Debit Credit

(a) Salaries

(b) Purchases

(c) Debtors

(d) Sales returns

(e) Discount received

(f) Vehicle

(g) Capital

6.6* The following trial balance has been extracted by the book-keeper of John Adams at 31 December2007:

Dr Cr

£ £

Stock at 1 January 2007 14,350

Purchases 114,472

Sales 259,688

Rates 13,718

Heating and lighting 12,540

Wages and salaries 42,614

Vehicle expenses 5,817

Advertising 6,341

Premises 75,000

Office equipment 33,000

Vehicles 21,500

Debtors 23,854

Bank 1,235

Cash 125

Capital at 1 January 2007 62,500

Drawings 12,358

Loan from bank 35,000

Creditors 17,281

Value Added Tax 2,455

376,924 376,924

Stock at 31 December 2007 was valued at £16,280.

You are to prepare the trading and profit and loss account of John Adams for the year ended 31December 2007, together with his balance sheet at that date.

1 2 4 A C T I V E A C C O U N T I N G

6.7 The following trial balance has been extracted by the book-keeper of Clare Lewis at 31 December2004:

Dr Cr£ £

Debtors 18,600

Creditors 12,140

Value Added Tax 1,210

Bank overdraft 4,610

Capital at 1 January 2004 25,250

Sales 144,810

Purchases 96,318

Stock at 1 January 2004 16,010

Salaries 18,465

Heating and lighting 1,820

Rent and rates 5,647

Vehicles 9,820

Office equipment 5,500

Sundry expenses 845

Vehicle expenses 1,684

Drawings 13,311

188,020 188,020

Stock at 31 December 2004 was valued at £13,735.

You are to prepare the trading and profit and loss account of Clare Lewis for the year ended 31December 2004, together with her balance sheet at that date.

6.8 Classify the following costs as either capital expenditure or as revenue expenditure

(a) purchase of vehicles

(b) rent paid on premises

(c) wages and salaries

(d) legal fees relating to the purchase of property

(e) redecoration of the office

(f) installation of air-conditioning in the office

(g) wages of own employees used to build extension to the stockroom

(h) installation and setting up of a new machine

S O L E T R A D E R F I N A L A C C O U N T S 1 2 5