Final Account of a Sole Trader – SS1 Financial Accounting Lesson Note (Second Term)

The final accounts of a sole trader are the Trading Account, the Profit and Loss Account and the Balance Sheet, prepared at the end of a trading period to show the result of the business.

Behavioural objectives

By the end of the lesson, students should be able to:

1. name the three final accounts of a sole trader;
2. state the purpose of the Trading Account and the Profit and Loss Account;
3. calculate net sales, net purchases, cost of goods sold and gross profit;
4. prepare a Trading Account in the horizontal and vertical formats;
5. prepare a Profit and Loss Account in the horizontal and vertical formats and calculate the net profit.

What are the final accounts of a sole trader?

There are three final accounts of a sole trader: the Trading Account, the Profit and Loss Account and the Balance Sheet.

1. Trading Account: calculates the gross profit or gross loss for the period.
2. Profit and Loss Account: calculates the net profit or net loss for the period.
3. Balance Sheet: lists the assets, liabilities and capital of the business on a given date.

• Link between the accounts: gross profit moves from the Trading Account to the Profit and Loss Account.
• Net profit or net loss: it is transferred to the Capital Account.

What are the key terms used in the Trading Account?

These are the items that appear in the Trading Account, each with its meaning.

• Sales: the total value of goods sold during the period.
• Returns Inwards: goods returned to the business by customers (also called Sales Returns).
• Net Sales: sales minus returns inwards (also called Sales revenue).
• Purchases: the total value of goods bought for resale during the period.
• Returns Outwards: goods the business sends back to suppliers (also called Purchases Returns).
• Carriage Inwards: the cost of transporting goods to the trader’s shop.
• Opening Stock: the value of unsold goods at the start of the period.
• Closing Stock: the value of unsold goods at the end of the period.
• Cost of Goods Sold: the cost of the goods that were actually sold (also called Cost of Sales).
• Gross Profit: net sales minus cost of goods sold.

What are the formulas?

What is a Trading Account?

A Trading Account is prepared to ascertain the Gross Profit or the Gross Loss of the business for the trading period.

Points to note

• Gross Profit: the difference between the Sales revenue and the Cost of Goods Sold.
• Gross Loss: it arises when the Cost of Goods Sold is greater than the Sales revenue.
• Cost of Goods Sold: Opening Stock plus Net Purchases, less Closing Stock.
• Net Purchases: Purchases less Returns Outwards (Purchases Returns).
• Sales revenue (Net Sales): Sales less Returns Inwards (Sales Returns).
• Carriage Inwards: it is usual to add it to Purchases when finding the Cost of Goods Sold.
• Cost of Sales: another name for the Cost of Goods Sold.
• Heading: it must show the period covered and, usually, the name under which the business trades.

How is a Trading Account prepared?

1. Write the heading with the business name and the period covered.
2. Find the Net Sales: Sales less Returns Inwards.
3. Find the Net Purchases: Purchases plus Carriage Inwards less Returns Outwards.
4. Add the Opening Stock to the Net Purchases.
5. Deduct the Closing Stock to get the Cost of Goods Sold.
6. Deduct the Cost of Goods Sold from the Net Sales to get the Gross Profit or Gross Loss.

What formats can a Trading Account use?

A Trading Account can be prepared in two formats: horizontal and vertical.

• Horizontal format (T-T format): it looks like a ledger account, with Sales revenue on the credit side and Cost of Goods Sold on the debit side.
• Balancing figure: the difference between the two sides is the Gross Profit or Gross Loss, carried down to the Profit and Loss Account.
• Vertical format: it holds the same information but looks like an arithmetic calculation, and most businesses use it.

Illustration: Trading Account of Tunde Enterprises

The following balances were extracted from the books of Tunde Enterprises for the year ended 31st December 2017.

The value of the Stock at close on 31st December 2017 was ₦9,500.

You are required to prepare the Trading Account for the year ended 31st December 2017.

Using the horizontal (T) format

Tunde Enterprises
Trading Account for the year ended 31st December, 2017

Using the vertical format

Tunde Enterprises
Trading Account for the year ended 31st December, 2017

What is a Profit and Loss Account?

A Profit and Loss Account is the account that calculates the Net Profit or Net Loss of a business for the period.

• Formula: Net Profit = Gross Profit + Other Income minus Expenses.
• Net Loss: it arises when expenses are greater than gross profit plus other income.
• Heading: it must show the period covered and, usually, the name under which the business trades.
• Transfer: the Net Profit or Net Loss is transferred to the Capital Account.

What items appear in the Profit and Loss Account?

• Gross Profit: brought down from the Trading Account.
• Other income (gains): Discounts Received, and also items such as Rent Received and Commission Received.
• Running expenses: Rent, Rates, Insurance, Advertising and General Expenses.
• Discounts Allowed: treated as an expense.
• Interest on Loan: treated as an expense.
• Carriage Outwards: the cost of delivering goods to customers, treated as an expense here and not in the Trading Account.

What formats can a Profit and Loss Account use?

A Profit and Loss Account can be prepared in the horizontal or the vertical format, as with the Trading Account.

• Horizontal format: Gross Profit and other income go on the credit side, and expenses go on the debit side.
• Balancing figure: the difference between the two sides is the Net Profit or Net Loss for the year.
• Vertical format: Gross Profit plus other income, less total expenses, gives the Net Profit.

How is a Profit and Loss Account prepared?

1. Write the heading with the business name and the period covered.
2. Bring in the Gross Profit from the Trading Account.
3. Add the other income, such as Discounts Received.
4. List all the expenses and find their total.
5. Deduct the total expenses from the gross profit plus other income to get the Net Profit.
6. Transfer the Net Profit to the Capital Account.

Illustration: Profit and Loss Account of Tunde Enterprises

Using the list of balances shown in the earlier illustration, prepare the Profit and Loss Account for the year ended 31st December 2017.

Using the horizontal format

Tunde Enterprises
Profit and Loss Account for the year ended 31st December, 2017

Using the vertical format

Tunde Enterprises
Profit and Loss Account for the year ended 31st December, 2017

What is the difference between a Trading Account and a Profit and Loss Account?

The Trading Account finds the gross profit from buying and selling goods. The Profit and Loss Account finds the net profit after other income and expenses.

What is a Balance Sheet?

A Balance Sheet is a statement that shows the assets, liabilities and capital of a business on a particular date.

• Assets: things the business owns, such as stock, cash and equipment.
• Liabilities: amounts the business owes, such as loans and creditors.
• Capital: the owner’s investment, increased by net profit.

Evaluation

1. List three features of the Trading Account.
2. State the three components of the final accounts of a sole trader.
3. Write the formula for calculating net profit.
4. Where is the Net Profit or Net Loss transferred to?
5. Calculate the Cost of Goods Sold if opening stock is ₦5,000, net purchases are ₦20,000 and closing stock is ₦4,000.

Assignment

Answer questions 1 to 5 below.

1. Carriage inwards as an expense of a business is treated in the ………..
   (a) Trading Account (b) Profit and Loss Account (c) Balance Sheet (d) Appropriation Account.

Use the following information to answer questions 2 to 5.

2. The gross profit is ………
   (a) ₦47,200 (b) ₦42,200 (c) ₦37,200 (d) ₦19,800
3. The net profit is …………
   (a) ₦42,200 (b) ₦37,200 (c) ₦19,800 (d) ₦47,200
4. The cost of goods sold is ………..
   (a) ₦185,100 (b) ₦139,200 (c) ₦136,200 (d) ₦131,200
5. The cost of goods available for sale was ………..
   (a) ₦188,100 (b) ₦173,000 (c) ₦193,100 (d) ₦185,100