How to Prepare Final Accounts of a Sole Proprietor with Adjustments

Understand Final Accounts of Sole Proprietors with Adjustments

Key rules to remember

Cost of goods sold

Opening stock + Purchases (net of returns) + Direct expenses − Closing stock

Direct expenses include wages and carriage inward. Closing stock is valued at cost or net realisable value, whichever is lower.

Gross profit

Net sales − Cost of goods sold

If the result is negative, it is a gross loss.

Net profit

Gross profit + Other incomes − Indirect expenses

Indirect expenses are charged after adjusting for outstanding and prepaid items, bad debts, provision and depreciation.

Expense charged to P&L

Expense per trial balance + Outstanding − Prepaid

Apply the same logic to wages in the trading account.

Income credited to P&L

Income per trial balance + Accrued − Received in advance

Accrued income goes to assets, income received in advance to liabilities.

Total bad debts charge

Bad debts per trial balance + Additional bad debts

Additional bad debts reduce debtors before the new provision is calculated.

Provision for doubtful debts charge in P&L

New provision − Old provision (if positive: expense; if negative: income)

New provision is calculated on debtors left after writing off additional bad debts.

Closing capital

Opening capital + Net profit − Drawings (+ Additional capital)

Net loss is deducted instead of net profit.

Balance sheet check

Total assets = Capital + Liabilities

If the totals differ, an adjustment has been shown on one side only.

How to solve Final Accounts of Sole Proprietors with Adjustments questions

1. 1Read all the adjustments first and mark each in the trial balance as a trading item, P&L item, or balance sheet item. Note which ones have a double effect.
2. 2Sort the trial balance: direct items (opening stock, purchases, wages, carriage inward, sales) for the trading account; indirect expenses and incomes for the P&L account; capital, drawings, assets and liabilities for the balance sheet.
3. 3Prepare the trading account. Add closing stock on the credit side (or deduct it from cost of goods sold). Find gross profit or loss.
4. 4Prepare the P&L account. Bring down gross profit, then adjust each expense and income for outstanding, prepaid, accrued and advance items. Show bad debts, the change in provision and depreciation as separate lines. Find net profit.
5. 5Prepare the balance sheet. Carry the other side of each adjustment: closing stock, prepaid expenses and accrued income on the assets side; outstanding expenses and income received in advance on the liabilities side.
6. 6Show debtors less provision, and fixed assets less depreciation. Add net profit to capital and deduct drawings.
7. 7Total both sides and check they agree. Show working notes for provision, depreciation and adjusted expenses.

Quickest way: Adjusted-figure column method

Common mistakes in Final Accounts of Sole Proprietors with Adjustments

• Showing an adjustment only in the P&L account and leaving it out of the balance sheet.

  Students forget that each adjustment has a double effect and treat the trial balance as complete.

  Fix: Tick every adjustment twice. Outstanding expense goes to liabilities, prepaid to assets, accrued income to assets, income received in advance to liabilities.

• Calculating the provision for doubtful debts on the debtors figure in the trial balance.

  The additional bad debts adjustment is read separately and not applied to debtors first.

  Fix: First deduct additional bad debts from debtors, then calculate the new provision on the remaining balance.

• Charging the full new provision to P&L instead of the difference from the old provision.

  The old provision is already in the trial balance and is overlooked.

  Fix: Charge only the increase. If the new provision is lower, credit the decrease to P&L as income.

• Putting closing stock only in the trading account and missing it from the balance sheet, or treating it as a trial balance item.

  If closing stock appears in the adjustments, students think it has been dealt with once.

  Fix: If closing stock is given as an adjustment, it appears in the trading account (credit) and again as a current asset. If it is already in the trial balance, show it only in the balance sheet.

• Treating drawings or the proprietor's personal expenses as business expenses in the P&L.

  A sole proprietor and the business are mixed up, so a withdrawal looks like a cost.

  Fix: Deduct drawings from capital in the balance sheet. Goods taken by the owner are credited to purchases and charged to drawings.

• Putting direct expenses such as wages and carriage inward in the P&L account.

  They look like ordinary running expenses.

  Fix: Costs needed to bring goods to saleable condition go to the trading account. Carriage outward, salaries and rent go to P&L.

Worked examples