SOLE TRADER FINAL ACCOUNTS - …

1 Learning objectivesWhen 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 expenditureCASE STUDYS tarting out in businessOlivia 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 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.

2 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 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 that the business is well established, Olivia feels that it is time she understood financialmatters rather better.

3 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 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 SOLE TRADERSSole 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 are often small and, after the owner has taken out drawings, are usuallyploughed back into the 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.

4 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 altogetherFINAL ACCOUNTS AND THE TRIAL BALANCE FINAL accountsThe 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 capitalThese FINAL ACCOUNTS can be produced more often than once a year in order togive information to the owner on how the business is progressing.

5 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 TRADER FINAL ACCOUNTS103trading and profit and loss accountincome minusexpenses equalsnet 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).

6 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 profitof 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. balance sheetassetsminusliabilitiesequalscapital 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:assetsWhat the business owns: fixed assets, eg premises, vehicles, computers current assets, eg stock of goods for resale, debtors (moneyowed by customers), bank and cash balancesliabilitiesWhat the business owes: current liabilities, eg creditors, overdrafts, VAT due long-term liabilities, eg long-term bank loansnet assetsThe total of fixed and current assets, less current and long-term liabilities.

7 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 .capitalWhere the money to finance the business has come from, eg theowner's investment, business profits. TRIAL BALANCEThe 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 help us with the preparation of FINAL ACCOUNTS we will use the trial balance,shown in the Case Study on the next page.

8 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 :104 ACTIVE ACCOUNTING 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 accountantsOn page 111 we will look at the double-entry book-keeping for amountsentered in the trading and profit and loss TRADER FINAL ACCOUNTS105 CASE STUDYF inal ACCOUNTS of Olivia Boulton from the trial balancesituationOlivia 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 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.

9 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 balance of Olivia Boulton, as at 31 December 2002 DrCr Stock at 1 January 200250,000 Purchases420,000 Sales557,500 Shop expenses6,200 Wages33,500 Rent paid750 Telephone expenses500 Interest paid4,500 Travel expenses550 Premises200,000 Shop fittings40,000 Debtors10,100 Bank5,850 Cash50 Capital75,000 Drawings27,000 Loan from bank150,000 Creditors14,500 Value Added Tax2,000799,000799,000 Note: stock at 31 December 2002 was valued at 42,000106 ACTIVE ACCOUNTINGThe amounts for salesand purchasesinclude only items in which thebusiness trades eg a clothes shop buying clothes from the manufacturerand selling to the public.

10 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 of salesrepresents 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 profitis calculated as:sales cost of sales = gross profitIf cost of sales is greater than sales, the business has made a gross profitis calculated as:gross profit overheads = net profitIf overheads are more than gross profit, the business has made a net net profit is the amount the business earned for the owner during theyear, and is subject to taxation.