Accounting II: Financial Statements of Sole Traders, Manufacturers, Not-for-Profit Bodies, and Incomplete Records
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The Sole Proprietor's Financial Statements
Income statement (trading and profit and loss account)
| Item | Calculation |
|---|---|
| Revenue (sales) | Less sales returns |
| Cost of sales | Opening inventory + purchases (net of returns) + carriage inwards − closing inventory |
| Gross profit | Revenue − cost of sales |
| Add: other income | Discounts received, rent received, etc. |
| Less: expenses | Wages, rent, depreciation, bad debts, etc. |
| Net profit | Gross profit + other income − expenses |
Statement of financial position (balance sheet)
| Section | Content |
|---|---|
| Non-current assets | Property, plant and equipment at cost less accumulated depreciation |
| Current assets | Inventory, trade receivables (net of allowance), prepayments, bank, cash |
| Capital | Opening capital + net profit − drawings |
| Non-current liabilities | Long-term loans |
| Current liabilities | Trade payables, accruals, bank overdraft |
The statement balances: total assets = capital + liabilities.
Manufacturing Businesses
A manufacturer prepares a manufacturing account before the income statement:
| Item | Note |
|---|---|
| Direct materials | Opening inventory of raw materials + purchases − closing inventory |
| Direct labour | Wages of production workers |
| Prime cost | Direct materials + direct labour + direct expenses |
| Factory overheads | Indirect materials, indirect labour, depreciation of factory plant, factory rent, power |
| Adjustment for work in progress | Opening WIP − closing WIP |
| Cost of production (factory cost of goods completed) | Prime cost + overheads ± WIP adjustment |
The cost of production replaces "purchases" in the trading account, together with opening and closing inventories of finished goods. A provision for unrealized profit may arise if goods are transferred to the trading account at a price above cost.
Not-for-Profit Organizations
Clubs, societies, and charities do not aim at profit and prepare:
- Receipts and payments account: a summary of the cash book.
- Income and expenditure account: an accruals-based statement; the result is a surplus or deficit.
- Statement of financial position with an accumulated fund (instead of capital).
- Special items: subscriptions (arrears and in advance), life membership (spread over time), donations and legacies, entrance fees, and profits from activities (for example a canteen or event), and the accumulated fund calculation from the opening statement of affairs.
Incomplete Records (Single Entry)
When a business does not keep full double-entry records, the accountant reconstructs the information:
1. Prepare an opening statement of affairs (assets − liabilities = opening capital).
2. Reconstruct the cash and bank account from the available data to find missing figures.
3. Prepare total (control) accounts for receivables and payables to find credit sales and credit purchases.
4. Use margin and mark-up to estimate missing figures: gross margin = gross profit ÷ sales; mark-up = gross profit ÷ cost of sales. For example, a mark-up of 25 percent means a gross margin of 20 percent.
5. Alternatively, find profit by comparing capital: closing capital − opening capital + drawings − capital introduced = net profit.
6. Prepare the financial statements.
Common Mistakes
- Confusing margin and mark-up.
- Treating the receipts and payments account as an income statement.
- Forgetting the prime cost versus cost of production distinction.
- Failing to adjust subscriptions for arrears and advances.
CHAPTER 5