CSEET · Fundamentals of Accounting

Preparation of Final Accounts for Sole Proprietorship: formula sheet

Full chapter guide

Key formulas

Gross profit: Gross profit = Net sales − Cost of goods sold; Shown on the trading account. If costs exceed sales, the result is gross loss.
Cost of goods sold: Cost of goods sold = Opening stock + Net purchases + Direct expenses − Closing stock; Direct expenses include carriage inwards, wages and freight inwards.
Net profit: Net profit = Gross profit + Other incomes − Indirect expenses; Shown on the profit and loss account. A negative result is net loss.
Closing capital: Closing capital = Opening capital + Net profit + Additional capital − Drawings; Use this to check the capital shown in the balance sheet.
Balance sheet equality: Assets = Capital + Liabilities; Both sides of a correct balance sheet carry the same total.
Net sales: Net sales = Sales − Sales returns (returns inward); Show net sales on the credit side. Do not show returns as a separate debit.
Net purchases: Net purchases = Purchases − Purchase returns (returns outward); If the proprietor takes goods for personal use, also deduct the drawings from purchases.
Cost of goods sold: Cost of goods sold = Opening stock + Net purchases + Direct expenses − Closing stock; Direct expenses include carriage inwards, freight inwards, wages, and coal, gas and power.
Gross profit or loss: Gross profit = Net sales − Cost of goods sold; A negative answer is a gross loss. It equals the difference between the two sides of the account.
Gross profit ratio: Gross profit ratio = (Gross profit ÷ Net sales) × 100; Use net sales, not gross sales, as the base.
Net profit: Net profit = Gross profit + Indirect incomes − Indirect expenses; If the result is negative, it is a net loss.
Net loss: Net loss = Gross loss + Indirect expenses − Indirect incomes; Use when the Trading Account shows gross loss, or when expenses exceed income.
Transfer to capital: Closing capital = Opening capital + Net profit − Drawings (+ Additional capital); Net loss is subtracted instead of net profit is added. Drawings never go to the Profit and Loss Account.
Operating profit: Operating profit = Gross profit − Operating expenses; Excludes non-operating incomes and expenses. Use only when the question asks for it.
Side rule: Expenses and losses on the debit side; incomes and gains on the credit side; Gross profit goes on the credit side; gross loss on the debit side.
Accounting equation: Assets = Capital + Outside Liabilities; Total of both sides of the balance sheet must agree.
Closing capital: Closing Capital = Opening Capital + Net Profit − Drawings (+ Additional Capital); For a loss, subtract it instead of adding. Interest on capital and on drawings, if given, also adjust it.
Order of permanence: Liabilities: Capital → Long-term liabilities → Current liabilities. Assets: Fixed assets → Investments → Current assets; Least liquid or most permanent item first.
Order of liquidity: Liabilities: Most urgent liability first, capital last. Assets: Cash → Bank → Bills receivable → Debtors → Stock → Accrued income → Prepaid expenses → Fixed assets; Most liquid asset first. Accrued income and prepaid expenses are usually placed at the end of current assets, since they are not converted into cash in the same way as debtors or stock. Goodwill and land usually come last of all.
Current items: Current asset/liability = realisable or payable within 12 months; Everything else is fixed or long-term.
Closing stock: Credit side of Trading Account and asset in Balance Sheet; If it is given in the trial balance instead, it is already adjusted. Show it in the Balance Sheet only.
Outstanding expense: Expense for P&L = Amount paid + Outstanding; Show the outstanding amount as a current liability.
Prepaid expense: Expense for P&L = Amount paid − Prepaid; Show the prepaid amount as a current asset.
Accrued income: Income for P&L = Amount received + Accrued; Show the accrued amount as a current asset.
Income received in advance: Income for P&L = Amount received − Advance; Show the advance as a current liability.
Depreciation: Straight line: (Cost − Scrap value) ÷ Life. Fixed rate: Rate × Book value; Charge to P&L and deduct from the asset in the Balance Sheet. For a part year, charge for the months of use.
Bad debts: Total bad debts = Bad debts in trial balance + Further bad debts; Debit P&L. Deduct further bad debts from debtors in the Balance Sheet.
Provision for doubtful debts: New provision = Rate × (Debtors − Further bad debts). Charge to P&L = New provision − Old provision; If old provision is larger, the difference is a gain. Show it on the credit side of P&L. Deduct the new provision from debtors in the Balance Sheet.
Interest on capital: Interest = Opening capital × Rate × Time; Debit P&L. Add to capital in the Balance Sheet. Use the capital the question tells you to use.
Interest on drawings: Interest = Drawings × Rate × Average period ÷ 12; Average period: 6 months if drawn evenly, 6.5 if drawn at the start of each month, 5.5 if drawn at the end. Credit P&L. Deduct from capital.
Cost of goods sold: Opening stock + Net purchases + Direct expenses − Closing stock; Net purchases = Purchases − Purchase returns − Goods withdrawn by proprietor.
Gross profit: Net sales + Closing stock − (Opening stock + Net purchases + Direct expenses); If the debit side is bigger, the difference is gross loss.
Net profit: Gross profit + Other incomes − Indirect expenses; Indirect expenses include adjusted salaries, rent, depreciation, bad debts and provision.
Adjusted expense: Expense per trial balance + Outstanding − Prepaid; Outstanding is added to the expense. Prepaid is deducted from it.
Adjusted income: Income per trial balance + Accrued − Received in advance; Accrued income is an asset. Income received in advance is a liability.
Closing capital: Opening capital + Net profit − Drawings (cash and goods) − Net loss; Use this figure on the liabilities side of the Balance Sheet.
Depreciation (straight line on cost): Cost × Rate % × Period ÷ 12; Charge to Profit and Loss Account and deduct from the asset in the Balance Sheet.
Provision for doubtful debts: (Debtors − Further bad debts) × Rate %; Create it on debtors left after writing off further bad debts.
Accounting equation check: Assets = Capital + Liabilities; Both Balance Sheet totals must agree.
Goods withdrawn entry: Drawings A/c Dr; To Purchases A/c (at cost); Not an expense of the business.

Quick revision

The Trading Account finds gross profit: Gross profit = (Net sales + Closing stock) − (Opening stock + Net purchases + Direct expenses).
Gross profit = Net sales − Cost of goods sold, where Cost of goods sold = Opening stock + Net purchases + Direct expenses − Closing stock. This is the same result as the formula above.
Net profit = Gross profit + Indirect incomes − Indirect expenses.
Closing stock appears in the Trading Account (credit side) and as a current asset in the Balance Sheet.
Outstanding expense is added to the expense and shown as a liability.
Prepaid expense is deducted from the expense and shown as an asset.
Accrued income is added to the income and shown as an asset; income received in advance is deducted and shown as a liability.
Depreciation is charged in the P&L and reduces the asset's value in the Balance Sheet.
Bad debts are written off in the P&L; a provision for doubtful debts is created on debtors left after bad debts. The P&L is charged with the new provision plus bad debts less the old (opening) provision, so only the increase is charged and a decrease is credited. The Balance Sheet deducts the new provision from debtors.
Drawings reduce capital; net profit increases it; net loss reduces it.
An adjustment given outside the trial balance has a double effect: one in the Trading Account or P&L Account and one in the Balance Sheet. An item already adjusted in the trial balance is shown only once, in the Balance Sheet or the relevant account.
Carriage inwards and wages go to the Trading Account; carriage outwards goes to the P&L.

Common mistakes

Calling the balance sheet an account. Fix: Say the trading and profit and loss accounts are accounts. The balance sheet is a statement of assets and liabilities.
Saying the trading account shows net profit. Fix: Trading account gives gross profit. Only the profit and loss account gives net profit.
Putting indirect expenses such as office rent or salaries in the trading account. Fix: Ask whether the cost is incurred in buying or making goods. If not, send it to the Profit and Loss Account.
Showing closing stock on the debit side. Fix: Remember closing stock is an asset at year end, so it goes on the credit side of the trading account and in the balance sheet.
Putting drawings or the proprietor's personal expenses in the Profit and Loss Account. Fix: Drawings reduce capital directly. Never charge them to profit.
Debiting purchase of machinery or furniture as an expense. Fix: Ask whether the benefit lasts beyond one year. If yes, it is an asset. Only depreciation goes to the account.
Computing the provision for doubtful debts on total debtors before deducting additional bad debts. Fix: Deduct any additional bad debts given in the adjustments from debtors first. Then compute the provision on the remaining debtors and show it as a deduction from debtors in the balance sheet. Bad debts already written off in the trial balance are not deducted again.
Showing drawings as an asset or an expense. Fix: Deduct drawings from capital. It never appears on the assets side.
Recording an adjustment only once, for example adding outstanding rent to rent but not showing it as a liability. Fix: Always write the P&L effect and the Balance Sheet effect before moving on.
Adding prepaid expenses to the expense instead of deducting them. Fix: Prepaid means paid in advance for next year, so deduct it. Outstanding means unpaid, so add it.

Exam tips

For a 'meaning and objectives' question, write a definition, the three components and at least four objectives. This pattern covers most marks.
Use short bullet points. Examiners look for clear keywords such as gross profit, net profit and financial position.
Always state the gross and net profit formulas if a small numerical is asked.
Mention that net profit is transferred to capital to link the profit and loss account with the balance sheet.
Do not spend time on formats here. Keep the format details for the trading, profit and loss and balance sheet topics.
Write the full format with 'To' on the debit side and 'By' on the credit side. Marks are often given for correct layout.
Underline or tick direct expenses in the list first. Most lost marks come from putting items on the wrong side or in the wrong account.
Check whether closing stock is given in the adjustments, and whether any goods were drawn by the proprietor.