What final accounts are
The statement of profit or loss sets the income of a period against the expenses of the same period. Its heading reads: for the year ended. Its last line is the profit or the loss for the year.
The statement of financial position lists what the business owns and owes at one date. Its heading reads: as at. It works down to net assets, which always equal the owner's capital.
Both start from the trial balance. Income and expense balances go to the statement of profit or loss. Assets, liabilities, capital and drawings go to the statement of financial position.
Quill Yard Stationers is owned by a sole trader. These are its figures for the year ended 31 March, after the year-end adjustments.
| £ | |
|---|---|
| Revenue: sales less sales returns | 83,400.00 |
| Opening inventory | 6,900.00 |
| Add purchases | 51,700.00 |
| Less closing inventory | 7,450.00 |
| Cost of sales | 51,150.00 |
| Gross profit: revenue less cost of sales | 32,250.00 |
| Less expenses: wages, rent, electricity and depreciation | 21,460.00 |
| Profit for the year | 10,790.00 |
| £ | |
|---|---|
| Non-current assets: shop fittings at cost less accumulated depreciation | 9,250.00 |
| Current assets: inventory, trade receivables and bank | 15,950.00 |
| Less current liabilities: trade payables and accruals | 5,270.00 |
| Net current assets | 10,680.00 |
| Less non-current liabilities: a bank loan | 3,400.00 |
| Net assets | 16,530.00 |
The owner's capital was £15,390.00 at the start of the year. Add the profit of £10,790.00 and take away drawings of £9,650.00, and closing capital is £16,530.00: the same figure as net assets.
What you need to be able to do
- Sort the balances of a trial balance between the two statements.
- Work out cost of sales, gross profit and the profit for the year, in that order.
- Lay out a statement of financial position under its headings and work down to net assets.
- Work out closing capital from opening capital, capital introduced, profit and drawings.
- Find a missing figure when the records are incomplete: from the accounting equation, a control account, the bank or a mark-up.
- Share a partnership's profit through the appropriation account, and keep a capital account and a current account for each partner.
- Record goodwill when a partner joins, a partner retires or the profit share changes.
- Lay out a company's equity, with dividends and corporation tax in the right place.
The order to learn it in
Final accounts are built on the year-end adjustments, so learn accruals, depreciation and closing inventory first. Then take the modules in this order.
- Sole trader accounts. The statement of profit or loss, gross profit and net profit, the statement of financial position, capital and drawings, then a whole set of accounts from a trial balance and three year-end notes.
- Incomplete records. Rebuilding a year's figures when the books are missing: from the accounting equation, a control account, the bank, and mark-up and margin.
- Partnership accounts. The partnership agreement, the appropriation account, capital and current accounts, interest and salaries, and a partnership's statement of financial position.
- Changes in a partnership. Goodwill, a new partner, a partner who retires, and a change in the profit share.
- Limited company basics. Share capital and reserves, dividends, corporation tax in the accounts, the layout of a company's financial position, and who reads the accounts.
- Principles and ethics. Going concern, accruals, prudence, consistency and materiality, then confidentiality, integrity and what to do when something looks wrong.
How the three kinds of business differ
The assets and the liabilities are laid out in the same way for all three. The difference is in how the owners' stake is shown, and in how the owners are paid.
| Sole trader | Partnership | Limited company | |
|---|---|---|---|
| The owners' stake | One capital figure | A capital account and a current account for each partner | Equity: share capital, share premium and retained earnings |
| How the owners take money out | Drawings | Drawings, debited to each partner's current account | Dividends, taken from retained earnings |
| What is added | Nothing | An appropriation account, which shares out the profit | Corporation tax, an expense of the company |
A partner's salary and interest on capital are not expenses of the business. They are ways of sharing the profit. A dividend is not an expense either, so it never appears in the statement of profit or loss.
A partnership with no agreement shares its profits and losses equally, with no salaries and no interest on capital.
Where people go wrong
- Putting drawings in the statement of profit or loss. Drawings are not an expense. They reduce capital.
- Treating the two kinds of carriage alike. Carriage inwards is part of cost of sales. Carriage outwards is an expense, below gross profit.
- Charging the cost of a non-current asset as an expense of the year. Only the depreciation for the year is an expense.
- Entering one side of a year-end note. Depreciation is an expense and adds to accumulated depreciation. An amount owed is an expense and a current liability.
- Mixing up mark-up and margin. Mark-up is gross profit as a percentage of cost. Margin is gross profit as a percentage of the selling price.
- Putting a partner's salary through Wages. It is a debit in the appropriation account and a credit in the partner's current account.
- Paying a dividend out of share capital. A company pays a dividend only out of profits it has made and kept.
- Accepting net assets that do not equal closing capital. If the two differ, a figure is missing or on the wrong side.
What the practice looks like here
Ledger Drill teaches final accounts through questions, with no videos. A task shows a trial balance or a list of balances for one invented business, then asks you to build from it.
- Sort balances between the statement of profit or loss and the statement of financial position.
- Type cost of sales, gross profit, the profit for the year and net assets.
- Put the lines of a statement in order.
- Find the one wrong line in a statement or a list of balances.
- Build the journal for a year-end note or a share of profit, and post a dividend.
- Type each partner's share of a profit, and the closing balance on a current account.
Every answer is marked at once, with the working behind it.
The modules and rooms are listed below, in order. A room that costs nothing carries a Free tag.
Practise it
- 1The statement of profit or loss for a sole trader8 min, hard
- 2How to work out gross profit and net profit10 min, hard
- 3The statement of financial position for a sole trader10 min, hard
- 4Capital, profit and drawings10 min, hard
- 5From a trial balance to a set of accounts12 min, hard
- Missing figures from the accounting equation10 min, hard
- The appropriation account10 min, hard
- How a company's financial position is laid out10 min, hard
Words used here
- Statement of profit or loss
- The statement of profit or loss sets the income of a period against its expenses, to show the profit or loss.
- Statement of financial position
- The statement of financial position lists what a business owns and owes at one date: its assets, liabilities and capital.
- Cost of sales
- Cost of sales is what the goods sold in a year cost the business: opening inventory, plus purchases, less closing inventory.
- Gross profit
- Gross profit is revenue less cost of sales: the profit on trading, before the running expenses of the business.
- Net profit
- Net profit is the profit for the year: gross profit less all the other expenses of running the business.
- Drawings
- Drawings are money or goods the owner takes out of the business for their own use. They reduce capital.
- Capital
- Capital is what a business owes its owner: the money the owner put in, plus any profit left in the business.
- Non-current asset
- A non-current asset is an asset a business keeps and uses for more than a year, such as a van, an oven or shop fittings.
Questions
What are final accounts?
The statement of profit or loss and the statement of financial position, made from the books at the year end. The first shows the profit or the loss for the year. The second shows what the business owns and owes at one date.
What is the difference between gross profit and net profit?
Gross profit is revenue less cost of sales: the profit on trading. Net profit is gross profit less all the other expenses, and it is the profit for the year.
Is the final accounts practice free?
In part. 5 of the 29 rooms in these modules are free, and you can start one with no account: every room in Sole trader accounts. The other rooms are part of Premium.
How long does it take to learn final accounts?
The 29 rooms in these modules take from 8 to 12 minutes each, by their own estimates. Added up that is 287 minutes, which is about 5 hours of practice.
What do I need to know before final accounts?
Double entry, the trial balance and the year-end adjustments. A set of accounts starts from a trial balance, and the notes that come with it are adjustments such as depreciation, an accrual and closing inventory.
Are drawings an expense?
No. Drawings are money or goods the owner takes out of the business. They reduce capital, and they never appear in the statement of profit or loss.