IGCSE Accounting Ch 15: Sole Traders

Cambridge IGCSE Accounting

Sole Traders

This chapter brings together the financial statements of a sole trader. It explains sole trader features, the income statement, gross profit, cost of sales, goods taken by the owner, carriage inwards and outwards, statement of financial position, capital and year-end adjustments.

Sole traderIncome statementGross profitCost of salesDrawingsStatement of financial positionCapitalAdjustments

Sole trader overview showing owner, advantages, disadvantages, statements, capital and adjustments

Topic 1: Sole Trader Basics and Financial Statements

A sole trader is owned by one person, but the accounting statements still need to show performance and position clearly.

1. What is a Sole Trader?

A sole trader is a business owned and operated by one person.

Examples

Small shop owner
Hairdresser
Electrician
Landscaper
Specialist repair business

Advantages

Owner has full control.
Decisions can be made quickly.
Easy and inexpensive to start.
Owner keeps all the profit.
Financial statements do not normally have to be published.
Owner is their own boss.

Disadvantages

Unlimited liability – personal assets may be used to pay business debts.
Difficult to raise large amounts of capital.
Owner carries all responsibility.
Owner may lack some business skills.
Difficult to attract highly skilled employees.

2. Financial Statements of a Sole Trader

The two main financial statements are the income statement and the statement of financial position.

Income Statement

Shows the financial performance of the business and calculates:

gross profit
profit for the year

It is prepared for the year ended...

Statement of Financial Position

Shows the financial position of the business on a particular date, including:

assets
liabilities
capital

It is prepared as at...

Important Difference: The income statement covers a period of time, while the statement of financial position shows the position on one particular date.

3. Income Statement

For a trading business, the income statement has two main parts:

Trading section → calculates gross profit.
Profit and loss section → calculates profit for the year.

Income statement flow from sales revenue to profit for the year

Topic 2: Trading Section — Gross Profit and Cost of Sales

The trading section shows how net sales and cost of sales lead to gross profit.

4. Gross Profit

Gross Profit = Sales Revenue − Cost of SalesSales revenue means: Sales − Sales Returns

Example
Sales = $50,000
Sales returns = $2,000
Net sales = $50,000 − $2,000 = $48,000
Cost of sales = $30,000
Gross profit = $48,000 − $30,000 = $18,000

5. Cost of Sales

Cost of sales formula with opening inventory, net purchases, carriage inwards and closing inventory

Cost of Sales = Opening Inventory + Net Purchases + Carriage Inwards − Closing InventoryNet Purchases = Purchases − Purchases Returns

Example
Opening inventory = $5,000
Purchases = $25,000
Purchases returns = $2,000
Carriage inwards = $1,000
Closing inventory = $6,000
Net purchases = $25,000 − $2,000 = $23,000
Cost of sales = $5,000 + $23,000 + $1,000 − $6,000 = $23,000

6. Goods Taken by the Owner

If the owner takes goods from the business for personal use, this is drawings.

Dr DrawingsValue of goods taken

Cr PurchasesValue of goods taken

The value of goods taken is deducted from purchases when calculating cost of sales.

Example
Purchases = $20,000
Goods taken by owner = $500
Adjusted purchases = $20,000 − $500 = $19,500

7. Carriage Inwards and Carriage Outwards

Carriage Inwards

Cost of bringing purchased goods to the business.

It is included in cost of sales.

Carriage Outwards

Cost of delivering goods to customers.

It is treated as an expense in the income statement.

Carriage IN → Cost of Sales
Carriage OUT → Expense

Topic 3: Profit for the Year and Business Type

After gross profit, a sole trader adds other income and subtracts expenses to find final profit.

8. Profit for the Year

After gross profit is calculated:

add other income
subtract expenses

Profit for the Year = Gross Profit + Other Income − Expenses

Example
Gross profit = $20,000
Rent received = $2,000
Expenses: Rent = $4,000, Wages = $5,000, Electricity = $1,000
Total expenses = $10,000
Profit for the year = $20,000 + $2,000 − $10,000 = $12,000

9. Simple Income Statement Format

ABC Traders — Income Statement for the year ended 31 December

Sales$50,000

Less: Sales returns($2,000)

Net sales$48,000

Less: Cost of sales($30,000)

Gross profit$18,000

Add: Rent received$2,000

Subtotal$20,000

Less: Expenses($8,000)

Profit for the year$12,000

The textbook combines the trading and profit-and-loss sections into one income statement in this way.

10. Trading Business vs Service Business

Trading Business

A trading business buys and sells goods.

Clothing shop
Supermarket
Furniture retailer

Service Business

A service business provides services instead of selling goods.

Dentist
Solicitor
Accountant

A service business normally has no trading section and no cost of sales.

Service Business Formula: Profit = Fees/Income − Expenses

Example
Dentist's fees = $40,000
Expenses = $15,000
Profit = $40,000 − $15,000 = $25,000

Topic 4: Statement of Financial Position and Capital

The statement of financial position shows what the sole trader owns, owes and has invested at one date.

11. Statement of Financial Position

The statement of financial position shows:

Assets

What the business owns.

Liabilities

What the business owes.

Capital

The owner's investment in the business.

Assets = Capital + Liabilities

12. Assets

Non-Current Assets

Assets kept and used for more than one year.

Property
Machinery
Motor vehicles
Equipment

Intangible Assets

Assets without a physical form.

Goodwill
Patents

Current Assets

Assets expected to be converted into cash or used relatively soon.

Inventory
Trade receivables
Cash at bank
Cash in hand

13. Liabilities

Current Liabilities

Amounts normally payable within one year.

Trade payables
Bank overdraft
Accrued expenses

Non-Current Liabilities

Amounts payable after more than one year.

Long-term bank loan

14. Capital

Profit increases capital. Drawings reduce capital.

Closing Capital = Opening Capital + Profit − Drawings

Closing Capital = Opening Capital + Additional Capital + Profit − Drawings

Example
Opening capital = $50,000
Profit = $15,000
Drawings = $7,000
Closing capital = $50,000 + $15,000 − $7,000 = $58,000

15. Simple Statement of Financial Position

ABC Traders — Statement of Financial Position as at 31 December

Non-current assets

Machinery$20,000

Motor vehicle$10,000

Current assets

Inventory$6,000

Trade receivables$5,000

Bank$2,000

Total assets$43,000

Capital$35,000

Current liabilities

Trade payables$8,000

Capital + liabilities$43,000

The two sides must agree.

Topic 5: Year-End Adjustments and Exam Rules

Chapter 15 brings together adjustments studied earlier, so further information must be applied carefully.

16. Year-End Adjustments

Chapter 15 brings together adjustments studied in earlier chapters.

Year-end adjustments for depreciation, accruals, prepayments and provision for doubtful debts

DepreciationDepreciation is an expense in the income statement and reduces the net book value of non-current assets.

Accrued ExpenseAdd to expense. Example: Rent in trial balance = $3,000, rent accrued = $500, expense = $3,000 + $500 = $3,500.

Prepaid ExpenseSubtract from expense. Example: Insurance = $1,000, prepaid = $200, expense = $1,000 − $200 = $800.

Provision for Doubtful DebtsIncrease in provision reduces profit. Decrease in provision increases profit. Closing provision is deducted from trade receivables.

17. Important Rule for Adjustments

Example
Insurance prepaid = $300. This affects:

Income statement → insurance expense decreases by $300.
Statement of financial position → current assets increase by $300.

18. Quick Formula Guide

Calculation	Formula
Net sales	Sales − Sales returns
Net purchases	Purchases − Purchases returns
Cost of sales	Opening inventory + Net purchases + Carriage inwards − Closing inventory
Gross profit	Net sales − Cost of sales
Profit for year	Gross profit + Other income − Expenses
Closing capital	Opening capital + Profit + Additional capital − Drawings
Accounting equation	Assets = Capital + Liabilities

Remember

Trading Business

Sales → Cost of Sales → Gross Profit → Expenses → Profit

Service Business

Fees/Income − Expenses = Profit

Goods for owner's own use

Dr Drawings
Cr Purchases

Capital

Profit increases capital.
Drawings decrease capital.

Financial Statements

Income statement = for a period.
Statement of financial position = at a particular date.