Final Accounts of a Sole Proprietorship — I

At the end of the year the trial balance is used to prepare the final accounts — the statements that reveal the profit and the financial position. The first is the Trading Account, prepared to find the gross profit (or gross loss) — the profit from buying and selling goods, before other expenses.

Its logic: Gross Profit = Net Sales − Cost of Goods Sold, where Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses − Closing Stock. Direct expenses are those incurred to bring goods to a saleable condition — wages, carriage inward, freight, customs duty, factory rent and power.

If the credit side (sales + closing stock) exceeds the debit side, the difference is gross profit, carried down to the Profit & Loss Account. If the debit side is bigger, it is a gross loss. For example, with Opening Stock 20,000, Purchases 1,00,000, Wages 10,000, Sales 1,60,000 and Closing Stock 30,000: debit side = 1,30,000, credit side = 1,90,000, so gross profit = Rs 60,000. The Trading Account thus isolates the core trading result before management and selling costs are considered.

Gross profit is only the trading result; the business still has other expenses and incomes. The Profit and Loss Account begins with the gross profit (brought down from the Trading Account) and adjusts for all indirect items to arrive at the net profit (or net loss).

Indirect expenses (debit side) are of three kinds:

• Office & administrative — salaries, office rent, printing, postage, insurance, legal charges.
• Selling & distribution — advertising, carriage outward, commission, bad debts.
• Financial & other — interest on loans, discount allowed, and depreciation.

The credit side shows gross profit b/d plus other incomes/gains — commission received, discount received, interest received, rent received.

If the credit side exceeds the debit side, the difference is net profit; if the debit side is bigger, it is a net loss. The net profit is added to capital (and net loss subtracted) in the balance sheet, because it belongs to the owner. The cardinal rule: direct expenses go to Trading, indirect expenses go to P&L — the single most-tested distinction in final accounts.

The Balance Sheet is a statement (not an account) showing the financial position of the business on a particular date — a snapshot of what it owns and owes. It lists liabilities and capital on one side and assets on the other, and the two sides must be equal (Assets = Liabilities + Capital), proving the accounting equation.

Items are arranged in a definite order — this arrangement is called marshalling, done in one of two ways:

• Order of liquidity — most liquid (easily convertible to cash) items first: cash, then debtors, stock, and finally fixed assets.
• Order of permanence — the reverse: the most permanent items first (goodwill, building, machinery), ending with cash. Companies usually follow this order.

Note how the figures flow from the other statements: the closing stock (Trading A/c) reappears as a current asset; the net profit (P&L) is added to capital; drawings are deducted from capital. Because every account ends up either in the Trading/P&L (nominal accounts) or in the Balance Sheet (real and personal accounts), the final accounts together give a complete picture — the profit earned and the position reached. This is the destination of the whole accounting cycle: transaction → journal → ledger → trial balance → final accounts.