Financial Statements of a Sole Trader — full notes
Paper No. 1: Financial Accounting · Financial Statements of a Sole Trader
Financial Statements of a Sole Trader
1. The accounting equation, briefly
Every sole trader's financial position rests on: Assets = Capital + Liabilities. The Statement of Financial Position lays this out at a point in time; the Statement of Profit or Loss explains why Capital moved during the year.
2. Statement of Profit or Loss — structure
Sales
Less Cost of Sales:
Opening inventory
Add Purchases
Less Closing inventory
= Cost of Sales
Gross Profit = Sales − Cost of Sales
Gross Profit
Less operating expenses (rent, wages, depreciation, etc.)
Net Profit = Gross Profit − Total Expenses
3. Statement of Financial Position — structure
Non-current assets (cost less accumulated depreciation = Net Book Value)
Add Current assets (inventory, receivables, bank, cash)
= Total Assets
Capital: Opening capital + Net Profit − Drawings = Closing Capital
Add Current liabilities (and any Non-current liabilities)
= Total Capital + Liabilities
Total Assets must equal Total Capital + Liabilities. If it doesn't, there's an error in the accounts somewhere — this single check catches a large share of bookkeeping mistakes.
4. Depreciation, briefly
Straight-line depreciation charges an equal amount each year: Annual depreciation = Cost × Rate%. The charge reduces Net Profit and increases Accumulated Depreciation, which reduces the asset's Net Book Value. It is never itself a cash outflow.
5. Worked example — Fadhili Traders
Trial balance as at 31 December (KES):
| Account | Debit | Credit |
|---|---|---|
| Capital, 1 January | 385,000 | |
| Drawings | 70,000 | |
| Purchases | 850,000 | |
| Sales | 1,340,000 | |
| Opening inventory, 1 January | 60,000 | |
| Rent | 96,000 | |
| Salaries and wages | 180,000 | |
| Motor vehicle, at cost | 400,000 | |
| Accumulated depreciation — motor vehicle | 80,000 | |
| Trade receivables | 110,000 | |
| Trade payables | 95,000 | |
| Bank | 85,000 | |
| Cash | 15,000 | |
| General expenses | 34,000 | |
| Total | 1,900,000 | 1,900,000 |
Additional information: Closing inventory KES 75,000. Depreciate the motor vehicle at 10% per annum on cost.
Step 1 — Cost of Sales: 60,000 + 850,000 − 75,000 = 835,000 Step 2 — Gross Profit: 1,340,000 − 835,000 = 505,000 Step 3 — Depreciation charge: 400,000 × 10% = 40,000 Step 4 — Net Profit: 505,000 − (96,000+180,000+34,000+40,000) = 155,000 Step 5 — NBV of motor vehicle: 400,000 − (80,000+40,000) = 280,000 Step 6 — Closing capital: 385,000 + 155,000 − 70,000 = 470,000 Step 7 — Check it balances: Assets (280,000+75,000+110,000+85,000+15,000) = 565,000. Capital + liabilities (470,000+95,000) = 565,000. ✓