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Sole Proprietorship’s Financial Statements Lecture Notes 9 Sole Proprietorship’s Financial Statements

Sole Proprietorship’s Financial Statement Introduction There are basically three (3) forms of business organizations: Sole Proprietorship Partnerships Limited Liability Companies or Corporations Sole proprietorship however is by far the most common form of business organization in our society.

Sole Proprietorship’s Financial Statement Definition A sole proprietorship or simply a proprietorship is a business owned by one person. A proprietorship is no more than a collection of business activities carried on by an individual person For example – Small retail stores and service businesses often are organized as proprietorships.

Sole Proprietorship’s Characteristics Lecture Notes 9 Sole Proprietorship’s Characteristics

Sole Proprietorship’s Financial Statement Characteristics No Legal Requirements - There is no special legal requirements to start a sole proprietorship. Legal Status - While it is a separate entity for accounting purposes, it is not a separate legal entity from its owner. It does not exist apart from the owner.

Sole Proprietorship’s Financial Statement Characteristics (cont.) Unlimited Liability – Because a proprietorship is not legally separate from its owner, the owner is personally liable responsible for its liabilities. A court can order an owner to sell his personal assets or belongings to pay the debts of the business. Personal Income Tax – Tax authorities do not separate a proprietorship from its owner. This means that the profits are not subject to a business income tax, but are reported and taxed on the owner’s personal income tax return.

Sole Proprietorship’s Financial Statement Characteristics (cont.) Similarity of Financial Statements – While there maybe many differences in the legal status, structure and organization of the different forms of business, there financial statements are very similar except for the distribution of profit and capital or equity. Business Entity Concept – The accounting records and financial statements for a proprietorship are based on the assumption of the business entity concept, that is the business is a separate entity (Not a Legal Entity).

Sole Proprietorship’s Financial Statement Characteristics (cont.) Drawings – When an owner of a proprietorship takes cash or other assets from the company, the distribution is called withdrawals and reduces their capital. Salary – Salaries paid to the owner of the business is recorded as withdrawals of profits and not expenses, even if he is the owner. However salaries paid to managers or employees besides the owner should be reported as expenses.

Sole Proprietorship’s Financial Statements Lecture Notes 9 Sole Proprietorship’s Financial Statements

Sole Proprietorship’s Financial Statement Financial Statements There is basically two (2) sets of financial statements prepared for a Sole Proprietor: Trading and Profit & Loss Account Balance Sheet These financial statements helps the owner to asses: The profit made for a particular period The change in his assets, liabilities and capital as at a particular date.

Sole Proprietorship’s Financial Statement Trading and Profit and Loss Account It is possible to have two (2) separate accounts: Trading Account Profit & Loss Account However there are combined for convenience . The combined account measures the Financial Performance of the proprietorship for a given period In other words to calculate how much profit is made over a particular period.

Sole Proprietorship’s Financial Statement Trading and Profit and Loss Account Trading Account – An account in which the gross profit earned from the proprietorships is calculated. Gross Profit:– This is the excess of sales over the cost of goods sold in the period. Profit and Loss Account – An account in which net profit is calculated from the proprietorships non trading activities. Net Profit – This is what is left of gross profit after all other expenses have been deducted.

Sole Proprietorship’s Financial Statement Trading and Profit and Loss Account It is usually prepared for a one (1) period even though it can be prepared for a lesser period. Even its main purpose is for the owners to be able to see how profitably the business is being run, it can also for other purposes such as income taxes. It can also be used for comparing results obtained with the results expected.

Sole Proprietorship’s Financial Statement Information Source for T&P&L The Trial Balance contains all the information needed for preparing the Trading and Profit & Loss Account. Trial Balance – is a list of account titles and their balances in the ledgers or books on a specific date shown in debit and credit columns. The Trial balance however does not contain adjustments made subsequent to extraction of the list of balances from the ledgers.

Sole Proprietorship’s Financial Statement Information Source for T&P&L Thus there is usually notes beneath the trial balance outlining adjustments to be accounting for at the close of the financial period. For Example: Accruals and Prepayments Depreciation of Fixed Assets Provision for bad debts Closing Stock Unrecorded withdrawals or further investments And others.

Sole Proprietorship’s Financial Statement Trial Balance Format K Williams Trial Balance as on December 31, 2003 Details Debit Credit Sales Purchases General Expenses Fixtures and Fittings Debtors Creditors Capital Drawings Bank Cash 7,150 550 1,840 1,460 1,750 820 60 13,630 9,650 1,180 2,800 _

Sole Proprietorship’s Financial Statement Trading and Profit & Loss Format There are two (2) presentation formats either of which can be used to report items of the Trading Profit and Loss: Horizontal Style – Where the Double entry system accounting is used for presentation, that is, the left-hand side is the debit side and the right-hand side is credit side. Vertical Style – Where profit is vertically calculated beginning with Sales and ending with Net Profit, that is, Sales less Cost Goods Sold, less expenses