Fundamentals of Financial and Cost Accounting · Accounting Cycle

Final Accounts of Sole Proprietors with Adjustments

Updated 10 October 2026 · Fact-checked

Final accounts show a sole proprietor's profit and financial position for a year. You prepare the trading account for gross profit, the profit and loss account for net profit, and the balance sheet for assets and liabilities. Adjustments such as outstanding and prepaid items, depreciation and bad debts are applied to the trial balance figures first.

Understand Final Accounts of Sole Proprietors with Adjustments

Final accounts are prepared from the trial balance at the end of the year. They answer two questions: how much profit did the business earn, and what does it own and owe on the last day?

The trading account compares sales with the direct cost of goods sold. It shows gross profit (or gross loss). The profit and loss account takes gross profit, adds other incomes and deducts indirect expenses. The result is net profit (or net loss). The balance sheet lists assets and liabilities on the closing date. Net profit is added to capital.

The trial balance records transactions, but the books follow the accrual basis. Expenses of the year must be charged whether paid or not. Incomes of the year must be counted whether received or not. So at year end you make adjustments: outstanding expenses, prepaid expenses, accrued income, income received in advance, depreciation, bad debts, provision for doubtful debts and closing stock.

The key rule: every adjustment has a double effect. It appears once in the trading or P&L account, and once in the balance sheet. If an adjustment is given outside the trial balance, you must show it in both places. If an item is already in the trial balance, one of its effects is already recorded in the books, so you show only its balance sheet or remaining effect. For example, closing stock given in the trial balance already has its trading account effect recorded, so you show only its balance sheet effect, as a current asset. An outstanding expense shown as a liability in the trial balance has its expense already charged, so you show only the liability in the balance sheet.

Only revenue items go to the trading and P&L accounts. Capital expenditure, such as buying machinery, goes to the balance sheet as an asset. Expenses that only bring the asset into use, like freight and installation on machinery, are added to the asset cost.

Key formulas to remember

Gross profit: Gross profit = Sales (net of returns) − Cost of goods sold; Cost of goods sold = Opening stock + Purchases (net of returns) + Direct expenses − Closing stock.
Net profit: Net profit = Gross profit + Other incomes − Indirect expenses; Includes depreciation, bad debts and provisions as expenses.
Outstanding expense: Expense charged = Paid + Outstanding at end − Outstanding at start; Outstanding at end is added to the expense and shown as a current liability.
Prepaid expense: Expense charged = Paid − Prepaid at end; Prepaid is shown as a current asset.
Accrued income: Income credited = Received + Accrued at end; Accrued income is a current asset.
Income received in advance: Income credited = Received − Advance part; The advance part is a current liability.
Straight line depreciation: Depreciation = (Cost − Scrap value) ÷ Life in years; Reduce for part-year use only if the question says so.
Reducing balance depreciation: Depreciation = Rate % × Book value at start of the year; Book value is cost less depreciation already charged.
Provision for doubtful debts: Provision = Rate % × (Debtors − Further bad debts); Charge only the increase over the old provision. A decrease is a gain.
Closing capital: Closing capital = Opening capital + Net profit + Additional capital − Drawings; Net loss is deducted instead of added.

How to solve Final Accounts of Sole Proprietors with Adjustments questions

Use the same order for every question. It keeps the double effect from being missed.

1Read the trial balance and mark each item as: trading account, P&L account, or balance sheet.
2List all adjustments and note where each goes: debit side, credit side, and balance sheet.
3Prepare the trading account: opening stock, purchases less returns, direct expenses on the debit side; sales less returns and closing stock on the credit side. Find gross profit.
4Prepare the P&L account: bring down gross profit, add incomes, and list indirect expenses after adjustments. Find net profit.
5Treat drawings, interest on drawings and capital items outside P&L. Drawings reduce capital.
6Prepare the balance sheet: capital plus net profit less drawings, then liabilities; assets with debtors net of provision and fixed assets net of depreciation.
7Check that both sides of the balance sheet agree. If not, find the adjustment missing a second effect.

Quickest way: Adjustment-first tick method

When to use it: Use in MCQs asking for gross profit, net profit or a balance sheet total with limited time.

Ask for what is wanted: gross profit, net profit or a total.
For gross profit, ignore all P&L items. Compute Sales − (Opening stock + Purchases + Direct expenses − Closing stock).
For net profit, adjust each expense on the spot: add outstanding, subtract prepaid, add depreciation.
Skip items that go to the balance sheet only, like drawings and new machinery.
Eliminate options by checking the sign of each adjustment: outstanding raises expense, prepaid lowers it.

Common mistakes in Final Accounts of Sole Proprietors with Adjustments

Showing an adjustment only once
Students forget the double effect.
Fix: Tick each adjustment twice: once in the accounts, once in the balance sheet.
Deducting outstanding expense instead of adding it
Confusion between outstanding and prepaid.
Fix: Outstanding means still owed, so the expense is higher. Prepaid means paid early, so the expense is lower.
Treating drawings as an expense
Money leaves the business, so it looks like a cost.
Fix: Drawings are the owner's withdrawal. Deduct them from capital.
Adding purchase of fixed assets to trading account
Purchase of machinery is labelled 'purchases'.
Fix: Machinery is capital expenditure. Show it as an asset, not in trading account.
Counting full provision for doubtful debts as expense
Ignoring the old provision in the trial balance.
Fix: Charge further bad debts to P&L and deduct them from debtors. Then compute the new provision on the reduced debtors. Charge only the difference between the new and old provision to P&L. If the new provision is lower than the old one, credit the difference to P&L.
Using closing stock twice
Closing stock given in the adjustments is shown in the trading account but forgotten as an asset, or entered twice.
Fix: Credit it in the trading account and show it as a current asset once. If it is already in the trial balance, show it only as an asset.

Worked examples

Example 1

From the books of Ravi: Sales ₹5,00,000; Purchases ₹3,00,000; Opening stock ₹50,000; Wages ₹40,000; Salaries paid ₹60,000; Rent paid ₹24,000. Adjustments: closing stock ₹70,000; salaries outstanding ₹10,000; rent prepaid ₹4,000. Find gross profit and net profit.

Show the solution

Cost of goods sold = 50,000 + 3,00,000 + 40,000 − 70,000 = ₹3,20,000.
Gross profit = 5,00,000 − 3,20,000 = ₹1,80,000.
Salaries charged = 60,000 + 10,000 = ₹70,000.
Rent charged = 24,000 − 4,000 = ₹20,000.
Net profit = 1,80,000 − 70,000 − 20,000 = ₹90,000.

Answer: Gross profit ₹1,80,000; net profit ₹90,000. Outstanding salaries ₹10,000 is a liability and prepaid rent ₹4,000 is an asset.

Example 2

Meena's trial balance shows Machinery ₹2,00,000, Debtors ₹1,00,000, Provision for doubtful debts ₹3,000 and gross profit is ₹1,50,000. Adjustments: depreciate machinery at 10% on reducing balance, assuming it has not been depreciated before; write off further bad debts ₹10,000; maintain provision for doubtful debts at 5% on debtors after writing off the further bad debts. Find net profit if other expenses are ₹40,000. Also state the amount of debtors shown in the balance sheet.

Show the solution

Depreciation = 10% × 2,00,000 = ₹20,000. Machinery in balance sheet = ₹1,80,000.
Debtors after bad debts = 1,00,000 − 10,000 = ₹90,000.
New provision = 5% × 90,000 = ₹4,500.
Old provision = ₹3,000, so additional charge = 4,500 − 3,000 = ₹1,500.
Total P&L charges = 40,000 + 20,000 + 10,000 + 1,500 = ₹71,500.
Net profit = 1,50,000 − 71,500 = ₹78,500.
Debtors in balance sheet = 90,000 − 4,500 = ₹85,500.

Answer: Net profit is ₹78,500. Debtors shown at ₹85,500 net of provision, and machinery at ₹1,80,000.

Exam tips

For closing stock questions, check whether the stock is given in adjustments or in the trial balance. It changes where it appears.
In MCQs, solve gross profit first. Many options differ only by P&L items.
Read 'on' carefully: depreciation on opening book value is different from depreciation on cost.
Check whether the question asks for the total of the balance sheet or just one asset. Net the provision only for debtors.
Treat items like drawings, goods taken by the owner and capital introduced as balance sheet or capital items.

Practice questions from Accounting Cycle

Final Accounts of Sole Proprietors with Adjustments in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Final Accounts of Sole Proprietors with Adjustments: frequently asked questions

What is the difference between capital and revenue expenditure in final accounts?

Capital expenditure gives benefit for more than one year, such as buying machinery, and appears in the balance sheet as an asset. Revenue expenditure is for the day-to-day running of the business, such as wages and rent, and goes to the trading or P&L account. A wrong classification changes profit and assets.

How do I treat outstanding and prepaid expenses?

Add outstanding expenses to the expense in the P&L or trading account and show the amount as a current liability. Subtract prepaid expenses from the expense and show the amount as a current asset. Do both parts each time.

Which items go to the trading account?

Opening stock, purchases, sales, returns, closing stock and direct expenses such as wages and carriage inwards. Indirect expenses like salaries, rent and depreciation go to the P&L account.

Why does my balance sheet not tally?

Most often one adjustment has been shown only once, or net profit and drawings have not been adjusted in capital. Recheck each adjustment for its second effect and the closing capital calculation.