Notes
INTRODUCTION
A sole trader - also known as a sole proprietorship is a type of business entity which is owned and run by one individual and where there' is no legal distinction between the owner and the business.
As a sole trader, your business is owned entirely by you, grown by you and ultimately succeeds or fails by you. This also means you are entitled to all profit that the business makes.
Becoming a sole trader is simple. All you have to do is register your business name and you can start trading.
There are huge incentives to becoming a sole trader but with them come terrifying or - depending on your personality - gratifying, side effects.
Financial statements of a sole trader involve the following:-
� Income statement.
� Statement of financial position.
Trial balance provides the essential input for the preparation of these accounts or statements. These accounts or statements provide necessary information to various interested groups e.g. shareholders, investors, creditors, employees, management and government agencies etc. Therefore, these financial statements are prepared to serve the information needs of these diverse groups to enable them to make appropriate decisions.
THE INCOME STATEMENT
At the end of the year, every business must ascertain its net profit or loss. This is done in two stages:
1. Finding out the gross profit or gross loss
2. Finding out the net profit or loss
DETERMINATION OF GROSS PROFIT (OR GROSS LOSS)
Gross profit is the difference between sale proceeds of a particular period and the cost of the goods actually sold. Since gross profit means overall profit, no deduction of any sort, i.e. general, administrative or selling and distribution expenses is made. Gross Profit is said to be made when the Sale proceeds exceed the cost of goods sold. On the contrary, if the cost price of the goods is more than the selling price, then we can say-that there is a loss.
The entries / items that will appear in an income statement to ascertain the gross profit or loss will be;-
ITEMS TO BE DEBITED
I. Opening Stock:
It refers to the value of goods at hand at the end of the previous accounting year. Opening stock means the stock of an item at the beginning of a new inventory-keeping period. It becomes the opening stock for the current accounting year and contains the value of goods in which the business deals.
2. Purchases:
It refers to the value of goods (in which the concern deals) which are purchased either on cash or on credit for the purpose of resale. The balance of the purchase account, appearing in the Trial Balance, reflects the total purchases made during the accounting period. While dealing with purchases, we must bear in mind the following aspects:
a) Purchase of capital asset should not be added with the purchases. If it is already included in purchases, it should be deducted immediately.
b) If goods are purchased for personal consumption and Lliey acc added with the purchases, they should be excluded. These types of purchases should be treated as drawings.
c) If some of the goods purchased are still in transit at the year-end, it is better to debit Stock-in- transit Account and credit Cash or Supplier's Account.
d) If the amounts of purchases include goods received on consignment, on approval or on hire purchase, these should be excluded from purchases.
e) Cost of goods sent on consignment must be deducted from the purchases in case of a trading concern.
3. Purchases Returns/Returns Outwards:
It may come about that due to some reason; the goods are sent back to the supplier. In that case, the supplier is debited in the book of accounts and purchases returns or returns outwards are credited. It appears on the credit side in the Trial Balance. There are two ways of showing the purchases returns in the income statement. It may be shown by way of deduction from purchases in the income
statement. An alternative way is to show the purchases returns in the credit side of the income statement.
4. Direct Expenses:
These types of expenses are incurred in connection with purchase, procurement or production of goods. These expenses are directly related to the process of production. It also includes expenses that bring the goods up to the point of sale.
ITEMS TO BE CREDITED
I. Sales
It refers to the sale of goods in which the business deals and includes both cash and credit sales. It does not include sale of old, obsolete or depreciated assets, which were acquired for utilization in business. However, goods sent to customers on approval basis, free samples and sales tax, if any, included in the sales figure should be excluded.
2. Sales Returns or Returns Inward
When goods are returned by the buyers for some reason, it is called Sales Return or Returns Inward. In the books of account, Returns
Inwards Account or Sales Returns Account is debited and buyer's account is credited.
It appears on the debit side of Trial Balance. We can show the sales returns in the Trading Account in two ways. It may be shown by way of deduction from sales in the Trading Account. An alternative way to show the sales returns is in the debit side of the Trading Account.
3. Abnormal Loss
It refers to the abnormal loss of stock due to fire, theft or accident. If any abnormal loss is there, it is credited fully to the Trading Account because the Trading
Account is prepared under normal conditions of the business and has no place for abnormal instances.
4. Closing Stock
It refers to the value of goods lying unsold at the end of any accounting year. This stock at the end is called closing stock and is valued at either cost or market price, whichever is lower. The trial balance generally does not include closing stock.
Therefore the following entry i ics-uidoti to ineuiporate the effect of closing stock in the income statement;
To Closing Stock A/c Dr
To income statement A/c Cr
However, if closing stock forms a part of Trial Balance, it will not be transferred to
Income statement but taken only to the statement of financial position. In case of the goods that have been dispatched to customers on approval basis, such goods should be included in the value of closing stock.
Ascertaining the gross profit or loss
After recording the above items in the respective sides of the income statement, the balance is calculated to ascertain Gross Profit or Gross Loss. If the total of, credit side is more than, that of the debit side, the excess represents Gross Profit. Conversely, if the total of debit side is more than that of the credit side, the excess represents Gross Loss.
TRADING ACCOUNT (HORIZONTAL
FORMAT)
|
|
|
Sh
|
|
|
Sh
|
|
Opening stock
Purchases
Add: Carriage Inwards
Less: Returns Outwards
Cost of stock available
for sale
Less: Closing stock
Cost of sales
Gross Profit
|
XX
XX
XX
XX
(XX)
XX
XX
XX
XX
XX
|
|
Sales
Less: Returns Inwards Net sales
|
XX
(XX) XX
XX
|
|
INTR TRADING ACCOUNT (VERTICAL
FORMAT)
|
|
|
Sh
|
|
Sh
|
|
Sh
|
|
Sales
Less: Returns Inwards Net sales
|
|
|
|
|
XXX
(XX)
XX
|
|
|
Opening stock
Purchases
Add: Carriage Inwards
Less: Returns Outwards
Cost of stock available
for sale
Less: Closing stock
Cost of sales
Gross Profit
|
XX
XX
XX
XX
XX
|
|
XX
(XX)
|
|
(XX)
XX
|
|
Illustration
From the following details draw up the trading account of Mr.Karanja for the year ended 31 December 2010, which was his first year in business.
|
|
Sh.
"000"
|
|
Carriage inwards
|
13,400
|
|
Returns outwards
|
9,900
|
|
Returns inwards
|
17,800
|
|
Sales
|
774,840
|
|
Purchases
|
666,660
|
|
Stock of goods: 31
December 2010
|
149,780
|
Mr.Karanja
Trading Account for the year ended 31 Dec
2010
|
|
Sh.
"000"
|
Sh. "000
|
|
Sales
|
|
774 840
|
|
Less: Returns Inwards
Less: Cost of sales
Purchases
|
666,660
|
The Smartstudy 2024 Offer!
|
