assume the position

Assume the Position

Lecturer: Troy J. Wishart

ACT 1100Introduction to

Accounting Summer Course

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Sole Proprietorship’s Financial

Statements

Lecture Notes 9

Sole Proprietorship’s Financial StatementIntroductionThere are basically three (3) forms of business organizations:

1. Sole Proprietorship2. Partnerships3. Limited Liability Companies or Corporations

• Sole proprietorship however is by far the most common form of business organization in our society.

Sole Proprietorship’s Financial StatementDefinition• A sole proprietorship or simply a

proprietorship is a business owned by one person.

• A proprietorship is no more than a collection of business activities carried on by an individual person– For example – Small retail stores and service

businesses often are organized as proprietorships.

Sole Proprietorship’s

Characteristics

Lecture Notes 9

Sole Proprietorship’s Financial Statement

Characteristics • No Legal Requirements - There is no special

legal requirements to start a sole proprietorship.

• Legal Status - While it is a separate entity for accounting purposes, it is not a separate legal entity from its owner.

• It does not exist apart from the owner.


Characteristics (cont.)• Unlimited Liability – Because a

proprietorship is not legally separate from its owner, the owner is personally liable and responsible for its liabilities.A court can order an owner to sell his

personal assets or belongings to pay the debts of the business.


Characteristics (cont.)• Personal Income Tax – Tax authorities do

not separate a proprietorship from its owner. This means that the profits are not subject to

a business income tax, but are reported and taxed on the owner’s personal income tax return.


Characteristics (cont.)• Similarity of Financial Statements –

While there maybe many differences in the legal status, structure and organization of the different forms of business, their financial statements are very similar except for the distribution of profit, and capital or equity.


Characteristics (cont.)• Business Entity Concept – The accounting

records and financial statements for a proprietorship are based on the assumption of the business entity concept, that is the business is a separate entity (Not a Legal Entity).


Characteristics (cont.)• Drawings – When an owner of a

proprietorship, the distribution takes cash or other assets from the companyis called withdrawals and reduces their capital.


Characteristics (cont.)• Salary – Salaries paid to the owner of the

business is recorded as withdrawals of profits and not expenses, even if he is the owner.However salaries paid to managers or

employees besides the owner should be reported as expenses.

Sole Proprietorship’s Financial

Statements

Lecture Notes 9


Objective of Financial Statements• The objective of general purpose financial

statements is to provide information about the financial position, financial performance, and cash flows of an entity that is useful to a wide range of users in making economic decisions.


Objective of Financial Statements• To meet that objective, financial statements

provide information about an entity's: [IAS 1.9] Assets Liabilities Equity Income And Expenses, Including Gains And Losses Contributions By And Distributions To Owners Cash Flows


Information Source• Trial Balance – is a list of account titles

and their balances in the ledgers or books on a specific date shown in debit and credit columns. It contains all the information needed

for preparing the Trading and Profit & Loss Account and the Balance Sheet.


Information Source for T&P&L• The Trial balance however does not

contain adjustments made subsequent to extraction of the list of balances from the ledgers. Thus there is usually notes beneath the

trial balance outlining adjustments to be accounted for at the close of the financial period.

Sole Proprietorship’s Financial StatementInformation Source• For Example:

Accruals and Prepayments Depreciation of Fixed Assets Provision for bad debts Closing Stock Unrecorded withdrawals or further

investments And others.

Sole Proprietorship’s Financial StatementInformation Source

• Each item in the notes should be recorded at least two (2) time in the financial statements.

Sole Proprietorship’s Financial StatementTrial Balance Format

K WilliamsTrial Balance as on December 31, 2003

Details Debit Credit

SalesPurchasesGeneral ExpensesFixtures and FittingsDebtorsCreditorsCapitalDrawingsBankCash

7,150550

1,8401,460

1,750820

60

13,630

9,650

1,1802,800

_

13,630


Financial Statements• There is basically two (2) sets of

financial statements prepared for a Sole Proprietor who are traders (buying and selling goods):

1. Trading and Profit & Loss Account2. Balance Sheet


Financial Statements• These financial statements helps the

owner to asses: The profit made for a particular

period The change in his assets, liabilities

and capital as at a particular date.

Sole Proprietorship’sLecture Notes 9

Financial StatementsTrading and Profit & Loss

Account


Trading and Profit and Loss Account• The Trading and Profit and Loss

Account is a Sole Final Account Statement that shows the calculation of profit earned or the loss incurred during the period.

Sole Proprietorship’s Financial StatementTrading and Profit and Loss Account

• It is usually prepared for a one (1) period even though it can be prepared for a lesser period.

• Its main purpose is for the owners to be able to see how profitably the business is being run.


• It can also be used for other purposes such as: Income Taxes Calculation. Comparing results obtained with

the results expected.


Trading and Profit and Loss AccountIt is possible to have two (2) separate accounts:

1. Trading Account2. Profit & Loss Account


However there are combined for convenience .• The combined account measures the

Financial Performance of the proprietorship for a given period

• In other words, it calculate how much profit is made over a particular period.


• Trading Account An account in which the gross profit

earned on goods sold from the proprietorships is calculated.

It deals with trading (buying and selling).


• Trading Account Gross Profit:– This is the excess of

sales over the cost of goods sold in the period.

–Gross Profit = Sales – Cost of Goods Sold–Cost of goods sold = opening stock +

purchases + carriage inwards - closing stock


• Profit and Loss Account An account in which net profit is

calculated from the proprietorships non trading activities.

Shows the calculation of final or true profit.


• Profit and Loss Account Net Profit – This is what is left of

gross profit after all other running expenses have been deducted and any other items of income added.• Net Profit = Gross profit + other

incomes - Expenses


Trading and Profit & Loss Presentation Format• There are two (2) presentation formats

either of which can be used to report items of the Trading and Profit and Loss:1. Horizontal Style2. Vertical Style

Sole Proprietorship’s Financial StatementTrading and Profit & Loss Presentation Format

1. Horizontal Style – Where the Double entry system accounting is used for presentation, that is, the left-hand side is the debit side and the right-hand side is credit side.

Sole Proprietorship’s Financial StatementTrading and Profit & Loss Presentation Format

2. Vertical Style – Where profit is vertically calculated beginning with Sales and ending with Net Profit, that is, Sales less Cost Goods Sold, less expenses

Sole Proprietorship’s Financial StatementT&P&L Horizontal Presentation Format

K WilliamsTrading and Profit and Loss Account

For the period ended December 31, 2003 $ $

Purchases 7,150 Sales 9,650Gross Profit c/d

2,500

9,6509,650

Gross Profit b/dGeneral Expenses 550Net Profit c/d 1,950

2,5002,500

2,500

Trading

P & L

Sole Proprietorship’s Financial StatementT&P&L Vertical Presentation Format

K WilliamsTrading and Profit and Loss Account

For the period ended December 31, 2003 $

Purchases (7,150)

Sales 9,650

Gross Profit 2,500

General Expenses (550)Net Profit c/d 1,950

Less Cost of Goods Sold

Less Expenses

Trading

P & L


Trading Account – Unsold Stock• This represents goods that were

bought (Purchases) and remained unsold at the end of the accounting period.

Sole Proprietorship’s Financial StatementTrading Account – Unsold Stock

• It will be classified as: Closing Stock – at the end of the

accounting period. Usually found in Notes beneath the Trial Balance

Opening Stock – at the beginning of the new accounting period. Usually found in the Trial Balance

Sole Proprietorship’s Financial StatementTrading Account – Unsold Stock

• Unsold Stock will therefore change how the Cost of Goods Sold is calculated in order to arrive at Gross Profit.

Sole Proprietorship’s Financial StatementTrading Account – Cost of Goods Sold

Less Cost of Goods SoldOpening Stock xxxxAdd Purchases xxxxTotal Stock Available for Sale xxxxLess Closing Stock xxxxCost of Goods Sold xxxx• This calculation used regardless of whether the

format of the T&P&L is Horizontal or Vertical


Trading Account – Other Adjustments• Purchases – There are some

adjustments that maybe needed in order to derive Total Purchases and before Cost of Goods Sold is Calculated.

Sole Proprietorship’s Financial StatementTrading Account – Other AdjustmentsOpening Stock xxxxAdd PurchasesPurchases xxxxLess Purchases Returns/Stock adjustments (xxxx)Net Purchases xxxxAdd Carriage Inwards xxxxTotal Purchases xxxxTotal Stock Available xxxxLess Closing Stock (xxxx)Cost of Goods Sold xxxx

Sole Proprietorship’s Financial StatementTrading Account – Other Adjustments

• Purchases Returns/Return Outwards – Goods that were faulty or unsuitable and returned to the supplier.

• In order to derive the Net Purchase of Goods, Purchase Returns is deducted from Purchases.


• Carriage Inwards – Carriage or cost of transportation of goods into a firm.– This cost is viewed as part of the cost of

purchases since unless the cost is incurred the goods will not be brought into the business and made available for sale.

– Carriage Inwards is added to Net Purchases


• Sales – Some of the goods sold to customers may be returned because of it being faulty or unsuitable.

• This return of goods is called Sales Returns or Return Inwards


• Sales Returns is treated as follows:

Sales xxxxLess Sales Returns/Return Inwards (xxxx)Net Sales xxxx


Profit and Loss Account – Adjustments – (Notes to TB)

• Before expenses are deducted from Gross Profit to derive Net Profit there may be need for some: Adjustments to Expenses Additional Expenses Adjustments to Income Additional Income

Sole Proprietorship’s Financial StatementProfit and Loss Account – Adjustments – (Notes to TB)

–Adjustments to Expenses:- Prepayments – Deducted from the

respective expenses Accruals – Added to the respective

Expenses Improvements to Buildings –

Subtracted from “Repairs to Building” Expense

Sole Proprietorship’s Financial StatementProfit and Loss Account – Adjustments – (Notes to TB)

–Additional Expenses:- Depreciation of Fixed Assets – New

and Continuing Provisions. Provision for Bad Debts – Initial

Provision and Increased amount of Provisions.

Other unrecorded expenses or payments

Sole Proprietorship’s Financial StatementProfit and Loss Account – Adjustments (Notes to TB)

–Adjustments to Income Prepayments – Deducted from the

respective Income Accruals – Added to the respective

Income–Additional Income:-

Provision for Bad Debts – Decreased amount of Provisions.

Sole Proprietorship’sLecture Notes 9

Financial StatementsBalance Sheet


Balance Sheet• A statement showing present financial

position of the assets, capital and liabilities of a firm at the end of the period.

• The accounting equation is shown in this statement.


Balance Sheet• It consist of all balances remaining in our

records once the trading and profit and loss account for the period is completed.

• It measures the financial position or status of the company at the end of the accounting period and is reported as at that date.

Sole Proprietorship’s Financial StatementBalance Sheet• The balance sheet is also described as a list

of balances arranged according to whether they are: Assets:- Resources owned by the business Capital:- Total resources supplied by the

owner Liabilities:- Total money owed for assets

supplied to the business.

Sole Proprietorship’s Financial StatementBalance Sheet

• The balance sheet is not an account and as such is not part of the double entry system of accounting like the Trading and Profit and Loss Account.


Balance Sheet Layout This is the way in which the assets,

liabilities and capital is laid out in the balance sheet.

It allows for easy reading, analysis and comparison of balance sheets between firms and prior financial years,

Thus the information found in the balance sheet becomes more useful to its users.

Sole Proprietorship’s Financial StatementBalance Sheet Layout

• There are two (2) types of layout: Order of Permanence:- Items in the

balance sheet is arranged according to the length of time held or outstanding.

Order of Liquidity:- Items arranged according to how easily and quickly it can be converted to cash.


• Assets - are presented under two headings:1. Non-Current Assets (Fixed Assets) 2. Current Assets

Sole Proprietorship’s Financial StatementBalance Sheet Layout• Non-Current Assets (Fixed Assets) – are

classified as such when they: are of long life are to be in the business were not bought for the purpose of

resale–Examples: Buildings, machinery, motor

vehicles, fixtures and fittings

Sole Proprietorship’s Financial StatementBalance Sheet Layout• Fixed Assets – are listed in ‘order of

permanency’, starting with the most permanent and finishing with the least permanent.– For instance;

Land and Buildings Fixtures and Fittings Machinery Motor Vehicles


• Currents Assets – are items owned by the business which have a short life.

• They are listed in ‘Order of Liquidity’, that is, from the least liquid (furthest away from being turned into cash) to cash itself,

Sole Proprietorship’s Financial StatementBalance Sheet Layout• For instance;

Inventory Trade Receivables Cash at Bank Cash in Hand


• Capital and Liabilities – The other side of the balance sheet (or accounting equation) is as follows: Capital Non Current Liabilities (Long-term):– for

instance , loans that do not have to be repaid in the near future.

Current Liabilities:- items to be paid in the near future.

Sole Proprietorship’s Financial StatementBalance Sheet Presentation Format• There are two (2) presentation formats either of

which can be used to report items of the Balance Sheet1. Horizontal Style – Where the assets are

presented along side the capital and liabilities in a ‘T’ account format, that is side by side.

2. Vertical Style – Where assets are vertically compared to capital and liabilities.

• Both styles are presented according to the accounting equation: Assets = Capital + Liabilities.

Sole Proprietorship’s Financial StatementBalance Sheet Horizontal Presentation Format

K WilliamsBalance Sheet

As at December 31, 2003 Non-Current Assets

Current Assets

$ Capital

Current Liab.

$

Furniture & Fittings 1,840 Cash Intro. 2,800

Inventory1,750

820

2,340

3,000

4,180

000Trade Receivables 1,460BankCash 60

Add Net Profit 1,950

Less Drawings4,750

Trade Payables 1,180

4,180

Sole Proprietorship’s Financial Statement Balance Sheet Vertical Presentation Format

K WilliamsBalance Sheet

As at December 31, 2003 Non-Current Assets

Current Assets

Financed By

Current Liabilities

$

Furniture & Fittings 1,840

Capital 2,800

Inventory

1,750

820

3,000

Trade Receivables 1,460BankCash 60

Add Net Profit 1,950Less Drawings

000

2,3404,180

4,750

Trade Payables 1,1804,180


Balance Sheet – Adjustments (Notes to TB)• Accumulated Depreciation – Total

depreciation provided to date on assets owned by the business.

• The total depreciation is deducted from Assets at Cost in order to derive net book value of assets.

Sole Proprietorship’s Financial StatementBalance Sheet – Adjustments (Notes to TB)• This is done as follows:

Balance Sheet (Extract) Fixed Assets Cost

$Acc Dep

$NBV

$

Furniture & Fittings 1,840 340 1,500

Sole Proprietorship’s Financial StatementBalance Sheet – Adjustments (Notes to TB)• Provision for bad debt – The annual

provision made for the likely hood that some of the firm’s debts will not be paid.

• The current year’s provision for bad debt is deducted in order to derive Net Debtors.

Sole Proprietorship’s Financial StatementBalance Sheet – Adjustments (Notes to TB)• This is done as follows:

Balance Sheet (Extract) Current Assets $ $ $

Debtors 1,460(460)

1,000Less Prov. for Bad Debt

Sole Proprietorship’s Financial StatementBalance Sheet – Additions (Notes to TB)• Prepayments

Expenses paid for in advance at the end of the accounting period and are recorded as current assets.

Income received in advance at the end of the accounting period and are recorded as current liabilities.

Sole Proprietorship’s Financial StatementBalance Sheet – Additions (Notes to TB)• Accruals

Expenses owing or outstanding at the end of the accounting period and are recorded as current liabilities.

Income owing or outstanding at the end of the accounting period and are recorded as current assets.