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2. Sole Proprietorship’s Financial Statements Lecture Notes 9

3. Sole Proprietorship’s Financial Statement Introduction There are basically three (3) forms of business organizations: 1.Sole Proprietorship 2.Partnerships 3.Limited Liability Companies or Corporations Sole proprietorship however is by far the most common form of business organization in our society.

4. Sole Proprietorship’s Financial Statement Definition 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.

5. Sole Proprietorship’s Characteristics Lecture Notes 9

6. 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.

7. Sole Proprietorship’s Financial Statement 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. 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 theowner’s personal income tax return.

8. Sole Proprietorship’s Financial Statement 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. 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).

9. Sole Proprietorship’s Financial Statement Characteristics (cont.) Drawings – When an owner of a proprietorship takes cash or other assets from the company, the distribution is called withdrawals and reduces their capital. 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.

10. Sole Proprietorship’s Financial Statements Lecture Notes 9

11. Sole Proprietorship’s Financial Statement Financial Statements There is basically two (2) sets of financial statements prepared for a Sole Proprietor: 1.Trading and Profit & Loss Account 2.Balance Sheet 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.

12. Sole Proprietorship’s Financial Statement Trading and Profit and Loss Account It is possible to have two (2) separate accounts: 1.Trading Account 2.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.

13. Sole Proprietorship’s Financial Statement Trading and Profit and Loss Account Trading Account – An account in which the gross profit earned from the proprietorships is calculated. –Gross Profit:– This is the excess of sales over the cost of goods sold in the period. Profit and Loss Account – An account in which net profit is calculated from the proprietorships non trading activities. –Net Profit – This is what is left of gross profit after all other expenses have been deducted.

14. Sole Proprietorship’s Financial Statement Trading 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.

15. Sole Proprietorship’s Financial Statement Information Source for T&P&L The Trial Balance contains all the information needed for preparing the Trading and Profit & Loss Account. 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. The Trial balance however does not contain adjustments made subsequent to extraction of the list of balances from the ledgers.

16. Sole Proprietorship’s Financial Statement Information Source for T&P&L Thus there is usually notes beneath the trial balance outlining adjustments to be accounted for at the close of the financial period. For Example: Accruals and Prepayments Depreciation of Fixed Assets Provision for bad debts Closing Stock Unrecorded withdrawals or further investments And others. Each item in the notes should be recorded at least two (2) time in the financial statements.

17. Sole Proprietorship’s Financial Statement Trial Balance Format K Williams Trial Balance as on December 31, 2003 DetailsDebitCredit Sales Purchases General Expenses Fixtures and Fittings Debtors Creditors Capital Drawings Bank Cash 7,150 550 1,840 1,460 1,750 820 60 13,630 9,650 1,180 2,800 _ 13,630

18. Sole Proprietorship’s Financial Statement 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 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. 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

19. Sole Proprietorship’s Financial Statement T&P&L Horizontal Presentation Format K Williams Trading and Profit and Loss Account For the period ended December 31, 2003 $$ Purchases 7,150Sales 9,650 Gross Profit c/d 2,500 9,650 Gross Profit b/d General Expenses550 Net Profit c/d1,950 2,500 Trading P & L

20. Sole Proprietorship’s Financial Statement T&P&L Vertical Presentation Format K Williams Trading and Profit and Loss Account For the period ended December 31, 2003 $ Purchases(7,150) Sales9,650 Gross Profit2,500 General Expenses (550) Net Profit c/d 1,950 Less Cost of Goods Sold Less Expenses Trading P & L

21. Sole Proprietorship’s Financial Statement Trading Account – Unsold Stock This represents goods that were bought (Purchases) and remained unsold at the end of the accounting period. 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 This will therefore change how the Cost of Goods Sold is calculated in order to arrive at Gross Profit.

22. Sole Proprietorship’s Financial Statement Trading Account – Cost of Goods Sold Less Cost of Goods Sold Opening Stockxxxx Add Purchasesxxxx Total Stock Available for Salexxxx Less Closing Stockxxxx Cost of Goods Soldxxxx This calculation used regardless of whether the format of the T&P&L is Horizontal or Vertical

23. Sole Proprietorship’s Financial Statement 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. Opening Stock xxxx Add Purchases Purchasesxxxx Less Purchases Returns/Stock adjustments (xxxx) Net Purchases xxxx Add Carriage Inwards xxxx Total Purchases xxxx Total Stock Available xxxx Less Closing Stock (xxxx) Cost of Goods Sold xxxx

24. Sole Proprietorship’s Financial Statement Trading 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

25. Sole Proprietorship’s Financial Statement Trading Account – Other Adjustments 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 and is treated as such: Salesxxxx Less Sales Returns/Return Inwards (xxxx) Net Salesxxxx

26. Sole Proprietorship’s Financial Statement 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:- Prepayments–Deducted from the respective expenses Accruals – Added to the respective Expenses Improvements to Buildings – Subtracted from “Repairs to Building” Expense –Additional Expenses:- Depreciation of Fixed Assets – New and Continuing Provisions.

27. Sole Proprietorship’s Financial Statement Profit and Loss Account – Adjustments (Notes to TB) –Additional Expenses:- Provision for Bad Debts – Initial Provision and Increased amount of Provisions. Other unrecorded expenses or payments –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.

28. Sole Proprietorship’s Financial Statement Balance Sheet A statement showing present position of the assets, capital and liabilities of a firm. The accounting equation is shown in this statement. 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.

29. Sole Proprietorship’s Financial Statement Balance 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. 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.

30. Sole Proprietorship’s Financial Statement 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.

31. Sole Proprietorship’s Financial Statement Balance 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.

32. Sole Proprietorship’s Financial Statement Balance Sheet Layout Assets - are presented under two headings: 1.Fixed Assets 2.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

33. Sole Proprietorship’s Financial Statement Balance 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

34. Sole Proprietorship’s Financial Statement Balance Sheet Layout 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, For instance; –Stock –Debtors –Cash at Bank –Cash in Hand

35. Sole Proprietorship’s Financial Statement Balance Sheet Layout Capital and Liabilities The other side of the balance sheet (or accounting equation) is as follows: –Capital –Long-term Liabilities:– for instance, loans that do not have to be repaid in the near future. –Current Liabilities:- items to be paid in the near future.

36. Sole Proprietorship’s Financial Statement Balance Sheet Presentation Format There are two (2) presentation formats either of which can be used to report items of the Balance Sheet 1.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.

37. Sole Proprietorship’s Financial Statement Balance Sheet Horizontal Presentation Format K Williams Balance Sheet As at December 31, 2003 Fixed Assets Current Assets $ Capital Current Liab. $ Furniture & Fittings 1,840Cash Intro. 2,800 Stock 1,750 820 2,340 3,000 4,180 000 Debtors1,460 Bank Cash60 Add Net Profit1,950 Less Drawings 4,750 Creditors 1,180 4,180

38. Sole Proprietorship’s Financial Statement Balance Sheet Vertical Presentation Format K Williams Balance Sheet As at December 31, 2003 Fixed Assets Current Assets Financed By Current Liabilities $ Furniture & Fittings1,840 Capital2,800 Stock 1,750 820 3,000 Debtors 1,460 Bank Cash60 Add Net Profit1,950 Less Drawings 000 2,340 4,180 4,750 Creditors1,180 4,180

39. Sole Proprietorship’s Financial Statement 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. This is done as follows: Balance Sheet (Extract) Fixed AssetsCost $ Acc Dep $ NBV $ Furniture & Fittings1,8403401,500

40. Sole Proprietorship’s Financial Statement Balance 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. This is done as follows: Balance Sheet (Extract) Current Assets$$$ Debtors1,460 (460) 1,000 Less Prov. for Bad Debt

41. Sole Proprietorship’s Financial Statement Balance 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. 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.