Chapter 9 — Final Accounts of Sole Trading Concerns

The accounting cycle begins with transactions and proceeds through the journal and subsidiary books to the ledger and the trial balance. Its purpose, however, is not merely to record but to report. At the end of the accounting period the business prepares statements that summarise the results of the year and the position at its close. These statements are called final accounts because they are the last step of the accounting process for the period. For a sole trader they consist of the Trading Account, the Profit and Loss Account and the Balance Sheet. The first two together are often called the income statement or the Trading and Profit and Loss Account; the third is the position statement.

The objectives of preparing final accounts are:

• To ascertain gross profit or gross loss. The trading account compares the cost of goods sold with the sales revenue and shows the margin earned on trading alone.
• To ascertain net profit or net loss. The profit and loss account takes the gross profit, deducts all indirect expenses and adds other incomes, and shows the final result of the year's operations.
• To ascertain the financial position. The balance sheet shows what the business owns (assets), what it owes to outsiders (liabilities) and what it owes to the owner (capital) on the last day of the year.
• To provide information to interested parties. The owner needs the figures to judge the business; bankers and creditors need them before lending; the income tax department needs them to assess tax.
• To enable comparison. Final accounts of successive years reveal trends in sales, expenses, profit and capital.

Final accounts are prepared from the trial balance. Every balance in the trial balance goes to exactly one place: nominal accounts relating to goods and direct expenses go to the trading account; other nominal accounts go to the profit and loss account; real and personal accounts go to the balance sheet. A student who can sort the trial balance into these three baskets has done most of the work of this chapter.

The period for which final accounts are prepared is the accounting year, which in India normally runs from 1st April to 31st March. The trading and profit and loss account is headed 'for the year ended 31st March 2026' because it reports a flow over a period; the balance sheet is headed 'as on 31st March 2026' because it reports a stock of assets and liabilities at a point of time.

Final accounts are prepared on the basis of the accounting principles already learnt: the going concern assumption, the accrual concept, the matching principle, which pairs the revenue of a period with the expenses that earned it, and the principle of consistency. The next chapter, on adjustments, applies the matching principle more fully; this chapter lays the foundation with the structure of the three statements.

Before any balance can be placed in the final accounts, the accountant must know whether it is a capital item or a revenue item. Capital items go to the balance sheet; revenue items go to the trading or profit and loss account. Getting this distinction wrong is the error of principle discussed in the previous chapter, and it makes profit and financial position both incorrect.

Capital expenditure is money spent to acquire a fixed asset or to increase the earning capacity of the business, the benefit of which lasts for more than one accounting year. Examples: purchase of land, buildings, machinery, furniture, vehicles; cost of installing machinery, including wages paid to erect it; legal charges for acquiring property; expenditure that extends a building or improves an asset beyond its original condition; purchase of goodwill, patents or trademarks. Capital expenditure is debited to the asset account and appears in the balance sheet. Only the part of it consumed during the year, in the form of depreciation, is charged against profit.

Revenue expenditure is money spent on the day-to-day running of the business, the benefit of which is exhausted within the accounting year. Examples: purchase of goods for resale; wages and salaries; rent, rates and taxes; repairs and maintenance; insurance; advertising; carriage; interest paid; depreciation of the year. Revenue expenditure is debited to the trading account or profit and loss account of the year in which it is incurred.

Deferred revenue expenditure is revenue in nature but so large that its benefit spreads over several years, for example a heavy advertising campaign to launch a product, or preliminary expenses. Only a portion is charged to profit and loss each year; the unwritten-off balance is shown as an asset in the balance sheet.

The distinction also applies to receipts. Capital receipts are amounts received from the sale of fixed assets, from loans taken, or as additional capital introduced; they are not income and do not appear in the profit and loss account (except that a profit or loss on the sale of an asset does). Revenue receipts are earned in the normal course of business: sales, commission received, interest received, rent received, discount received; they are incomes and appear in the trading or profit and loss account.

Tests to apply. Ask: (1) Does the expenditure create or improve a fixed asset? If yes, capital. (2) Does its benefit last beyond the year? If yes, capital or deferred revenue. (3) Is it a recurring cost of running the business? If yes, revenue. (4) Does it merely maintain an asset in working order? If yes, revenue, even for a large repair. Note that the same item can be either depending on circumstances: wages are revenue, but wages paid to install a machine are capital; carriage is revenue, but carriage on a new machine is capital and is added to its cost.

In the balance sheet the total of assets acquired by capital expenditure, less depreciation, is what the business has to show for the owner's investment; the revenue items, netted against revenue receipts, give the profit that increases that investment.

The trading account is the first part of the income statement. It is prepared to find out the gross profit or gross loss made by buying and selling goods during the year. It compares the net sales on the credit side with the cost of the goods sold, made up of opening stock, net purchases and direct expenses less closing stock, on the debit side. If the credit side is larger, the difference is gross profit; if the debit side is larger, gross loss.

Gross profit is important in its own right. It tells the trader the margin he earns on the goods themselves before the overheads of the shop are counted. The gross profit ratio (gross profit ÷ net sales × 100) is one of the first figures a banker or a prospective buyer of the business will ask for, and comparing it from year to year reveals changes in prices, costs or pilferage.

The format is a ledger account in T form, headed 'Trading Account for the year ended 31st March 2026'.

The debit side carries the cost of goods available for sale: the opening stock, the purchases net of returns, and every expense incurred to bring the goods to the place of business and put them into saleable condition, which are called direct expenses. The credit side carries the net sales and the closing stock. Closing stock is credited because it represents goods bought but not yet sold, whose cost must be removed from the cost of goods sold; when the closing stock is given as an adjustment outside the trial balance, it is shown here and also in the balance sheet.

The gross profit is 'carried down' (c/d) to the profit and loss account, where it appears as the first item on the credit side. A gross loss is carried down to the debit side of the profit and loss account.

The trading account is balanced like any other account: the side totals are made equal by inserting the gross profit or gross loss, and both totals are ruled off. Because it is a nominal account, its balance is not carried forward but transferred, which is the whole point of preparing it.

Each item of the trading account deserves a precise definition, because the examiner tests whether a student knows why an item is direct and belongs here rather than in the profit and loss account.

Opening stock is the value of goods on hand at the beginning of the year, which is the closing stock of the previous year. It is a debit balance in the trial balance and is the first item on the debit side. In a manufacturing concern it may include raw materials, work in progress and finished goods.

Purchases means goods bought for resale, both for cash and on credit. Purchases of assets are never included. Purchases returns (returns outward) are deducted from purchases on the face of the account to show net purchases. Goods withdrawn by the proprietor for personal use, goods given as free samples or as charity, and goods lost by fire, if recorded, are also deducted from purchases, because they were not sold.

Direct expenses are those incurred in purchasing the goods and bringing them to the shop or factory and making them ready for sale. They include: wages (of workers handling or producing goods; when the trial balance shows 'wages and salaries' it goes to trading, when it shows 'salaries and wages' it goes to profit and loss, by convention); carriage inwards or freight inwards; cartage; octroi, customs duty and import duty; dock charges; clearing charges; royalty on production; factory rent, factory lighting, fuel, power, coal, gas, water used in production; manufacturing expenses; packing charges when packing is necessary to make goods saleable (primary packing).

Sales means goods sold for cash and on credit. Sale of a fixed asset is never included. Sales returns (returns inward) are deducted from sales to show net sales.

Closing stock is the value of unsold goods on the last day of the year, valued at cost price or market price whichever is lower, following the principle of conservatism. It appears on the credit side of the trading account and on the assets side of the balance sheet when given as an adjustment. If it already appears in the trial balance (because an entry has been passed and purchases are 'adjusted'), it is shown only in the balance sheet.

Gross profit is the balancing figure and is transferred to the credit of the profit and loss account. Gross loss is transferred to its debit.

A frequent examination trick is an expense whose name could go either way. Carriage without qualification is treated as carriage inwards (trading). Carriage outwards is a selling expense (profit and loss). Rent without qualification is office rent (profit and loss); factory rent is direct (trading). Lighting is office (profit and loss) unless labelled factory. Wages is direct; salaries is indirect. Packing for delivery to customers is selling (profit and loss); packing to make the product saleable is direct (trading).

The trading account is a ledger account, and the balances it contains reach it by closing entries passed in the journal proper on the last day of the year. These entries transfer the balances of the nominal accounts concerned with goods and direct expenses and thereby close those accounts, so that the new year starts with them at nil. A student is expected to be able to write these entries, and questions asking for 'closing entries' or 'journal entries for preparing the trading account' appear regularly.

1. Transferring debit balances. Opening stock, purchases, sales returns and all direct expenses have debit balances. They are closed by crediting each of them and debiting the trading account with their total:

Trading A/c Dr (total)
To Opening Stock A/c
To Purchases A/c
To Sales Returns A/c
To Wages A/c
To Carriage Inwards A/c
To (each other direct expense)
(Being the transfer of opening stock, purchases, returns inward and direct expenses to trading account)

2. Transferring credit balances. Sales and purchases returns have credit balances. They are closed by debiting each and crediting the trading account:

Sales A/c Dr
Purchases Returns A/c Dr
To Trading A/c
(Being the transfer of sales and returns outward to trading account)

3. Recording closing stock. Closing stock is brought into the books by:

Closing Stock A/c Dr
To Trading A/c
(Being the closing stock brought into account)

The Closing Stock account is a real account with a debit balance, which appears in the balance sheet and becomes next year's opening stock.

4. Transferring gross profit or gross loss. If gross profit: Trading A/c Dr, To Profit and Loss A/c. If gross loss: Profit and Loss A/c Dr, To Trading A/c.

Some accountants prefer to show returns as deductions on the face of the account rather than as separate transfers; the entries above may then be written with net purchases and net sales. Either method produces the same gross profit.

Illustration. Balances on 31st March 2026: Opening stock 15,000; Purchases 90,000; Purchases returns 4,000; Sales 1,50,000; Sales returns 6,000; Wages 10,000; Carriage inwards 2,000; Closing stock 20,000.

Entry 1: Trading A/c Dr 1,23,000; To Opening Stock 15,000; To Purchases 90,000; To Sales Returns 6,000; To Wages 10,000; To Carriage Inwards 2,000.
Entry 2: Sales A/c Dr 1,50,000; Purchases Returns A/c Dr 4,000; To Trading A/c 1,54,000.
Entry 3: Closing Stock A/c Dr 20,000; To Trading A/c 20,000.
Trading account now has debits of 1,23,000 and credits of 1,74,000; gross profit = 51,000.
Entry 4: Trading A/c Dr 51,000; To Profit and Loss A/c 51,000.

After these entries every nominal account named in them shows a nil balance, the Closing Stock account shows Rs 20,000 debit, and the Profit and Loss account has opened with a credit of Rs 51,000. That is exactly the position from which the next topic begins.

The profit and loss account is the second part of the income statement. It begins where the trading account ends: with the gross profit on its credit side (or gross loss on its debit side). To this it adds all other incomes and gains of the year and from it deducts all indirect expenses, those of administration, selling and distribution, finance, and losses, to arrive at the net profit or net loss. Net profit is the true earning of the year that belongs to the owner and is transferred to the capital account; net loss is deducted from capital.

The purposes of the profit and loss account are to determine the net result of the year; to show the amount spent on each class of indirect expense so that the owner can control them; to show incomes other than sales; to provide the figure of profit on which the owner's drawings, tax and future plans depend; and to allow comparison of expense ratios from year to year.

The format is again a T account, headed 'Profit and Loss Account for the year ended 31st March 2026'.

The account is balanced by inserting the net profit on the debit side (or net loss on the credit side), and the balancing figure is transferred to capital.

Unlike the trading account, the profit and loss account is not concerned with goods at all. Any expense that is not direct belongs here. Any income other than sales belongs here. The distinction between the two accounts is one of function: the trading account measures the margin on goods, the profit and loss account measures what remains after the business has paid for its organisation.

The trading account and the profit and loss account are often written one below the other as a single continuous account, the gross profit being carried down from the upper section to the lower. In that combined form the heading is 'Trading and Profit and Loss Account'. The examination accepts either presentation.

Indirect expenses are conveniently grouped by function, and grouping them in the account itself earns presentation marks.

Administrative or office expenses: salaries; office rent, rates and taxes; printing and stationery; postage and telegrams; telephone charges; office lighting; insurance; legal charges; audit fees; general expenses; repairs and renewals; depreciation on office assets.

Selling and distribution expenses: advertising; salesmen's salaries and commission; carriage outwards or freight outwards; packing for delivery; travelling expenses; bad debts; discount allowed; showroom expenses; warehouse rent; export duty; delivery van expenses.

Financial expenses: interest on loans and on bank overdraft; interest on capital, if charged; bank charges; discount on bills.

Losses: loss on sale of a fixed asset; loss by fire or theft not covered by insurance; depreciation on fixed assets.

Incomes and gains on the credit side: commission received; interest received on investments, deposits or loans given; rent received; discount received; dividend received; bad debts recovered; apprenticeship premium; profit on sale of a fixed asset; interest on drawings, if charged.

Items that are never shown in the profit and loss account: drawings (a reduction of capital); income tax of a sole trader (treated as drawings, because the tax is on the owner's income, not the business's); life insurance premium of the proprietor (drawings); purchase of a fixed asset (capital expenditure); repayment of a loan (reduction of a liability); additional capital introduced.

Closing entries. Like the trading account, the profit and loss account is built by closing entries in the journal proper.

Profit and Loss A/c Dr
To Salaries A/c, Rent A/c, ... (each indirect expense and loss)
(Being the transfer of indirect expenses and losses to profit and loss account)

Commission Received A/c Dr, Interest Received A/c Dr, ... (each income)
To Profit and Loss A/c
(Being the transfer of incomes and gains to profit and loss account)

Net profit: Profit and Loss A/c Dr, To Capital A/c. Net loss: Capital A/c Dr, To Profit and Loss A/c.

After these entries every nominal account in the ledger has a nil balance and only real and personal accounts remain open. These are exactly the accounts that go into the balance sheet. The word 'closing' is therefore literal: the entries close the books for the year.

A word on drawings. Drawings is a personal account of the owner with a debit balance. It is closed not to the profit and loss account but to capital: Capital A/c Dr, To Drawings A/c. In the balance sheet drawings are shown as a deduction from capital, after net profit has been added.

After the trading and profit and loss account has absorbed all nominal accounts, the ledger still contains the real accounts (assets) and the personal accounts (debtors, creditors, loans, capital). The balance sheet is a statement that lists these remaining balances, assets on one side and liabilities and capital on the other, on the last day of the accounting year, to show the financial position of the business. It is called a balance sheet because it is a sheet of balances, and because its two sides balance, reflecting the accounting equation Assets = Liabilities + Capital.

Characteristics. (1) It is a statement, not an account; it has no debit and credit sides but a liabilities side (left) and an assets side (right), and no closing entries are passed to prepare it. (2) It is prepared as on a particular date and shows the position at that instant; a day later the position has changed. (3) It is prepared after the trading and profit and loss account, because the net profit must be known before capital can be shown. (4) Its two sides are always equal; the equality is not a check on accuracy in the way that trial balance agreement is, but a consequence of the double entry system, since the capital is the balancing figure between assets and outside liabilities. (5) It contains only real and personal accounts. (6) It shows closing stock, which the trial balance normally does not.

Need for a balance sheet. The owner learns the nature and value of the assets, the amount and nature of the liabilities, and the closing capital, which is opening capital plus profit less drawings. He can judge the solvency of the business, that is whether the assets are enough to pay the liabilities, and its liquidity, that is whether current assets are enough to pay current liabilities as they fall due. Bankers and creditors use it to decide whether to lend. It is the starting point of the next year's books, since its balances are the opening balances of the next year, brought in by the opening entry.

Balance sheet and trial balance. The trial balance lists all accounts including nominal ones, tests arithmetic, is prepared before final accounts and has debit and credit columns. The balance sheet lists only assets and liabilities, shows financial position, is prepared after the profit and loss account and has assets and liabilities sides. The trial balance is optional; the balance sheet is essential.

Balance sheet and profit and loss account. The profit and loss account is an account covering a period and containing nominal accounts; the balance sheet is a statement at a date containing real and personal accounts. The two are linked by the net profit, which the profit and loss account produces and the balance sheet adds to capital. Together they present a complete picture: how the year went and where it left the business.

To read a balance sheet, and to arrange one properly, the student must know the classes of assets and liabilities.

Assets are the properties and rights owned by the business that have money value.

• Fixed assets are acquired for long-term use in the business and not for resale: land and buildings, plant and machinery, furniture and fixtures, vehicles, goodwill, patents, trademarks. They are shown at cost less depreciation. Tangible fixed assets can be touched (building, machinery); intangible ones cannot (goodwill, patents).
• Current assets (floating or circulating assets) are held for conversion into cash within a year in the ordinary course of business: cash in hand, cash at bank, bills receivable, sundry debtors, closing stock, prepaid expenses, accrued income, short-term investments.
• Liquid assets are current assets that are cash or can be turned into cash at once: cash, bank, bills receivable, debtors, marketable securities; stock and prepaid expenses are excluded.
• Wasting assets lose value as they are used up: mines, quarries, oil wells.
• Fictitious assets are not really assets but debit balances not yet written off, shown on the assets side for want of a better place: preliminary expenses, deferred advertising, and a debit balance of the profit and loss account (accumulated losses).
• Contingent assets may become assets on the happening of an event, such as a claim under litigation; they are not recorded but may be noted.

Liabilities are the amounts the business owes to outsiders and to the owner.

• Capital (owner's equity, internal liability) is what the business owes to the proprietor: opening capital plus additional capital plus net profit less drawings less net loss.
• Long-term (fixed) liabilities are repayable after more than one year: long-term loans, mortgage loans, debentures in a company.
• Current liabilities are payable within a year: sundry creditors, bills payable, bank overdraft, outstanding expenses, income received in advance, short-term loans.
• Contingent liabilities may arise on the happening of an uncertain event: a bill discounted with the bank that may be dishonoured, a guarantee given, a disputed claim; they are shown as a footnote, not in the body of the balance sheet.

The difference between current assets and current liabilities is the working capital, the fund that keeps the business running from day to day. A trader with current assets of Rs 1,20,000 and current liabilities of Rs 70,000 has working capital of Rs 50,000. The ratio 1,20,000 ÷ 70,000 = 1.71, called the current ratio, is a common test of liquidity, and a figure near 2 is regarded as comfortable.

These classes decide the order in which items are written in the balance sheet, which is the subject of the next topic.

The arrangement of assets and liabilities in the balance sheet in a definite order is called marshalling. Two orders are in use, and a sole trader may choose either, but must be consistent from year to year.

Order of liquidity. Assets are listed beginning with the most liquid, cash, and ending with the least liquid, goodwill. Liabilities are listed beginning with those payable soonest, such as bank overdraft and creditors, and ending with capital, which is repaid last, on the closure of the business. This order is preferred by sole traders, partnerships and banks, because it shows at once the resources available to meet the pressing claims.

Order of permanence. This is the reverse. Assets begin with the most permanent, goodwill and land, and end with cash. Liabilities begin with capital and long-term loans and end with bank overdraft. Companies traditionally used this order, and it suits a reader interested in the long-term structure of the business rather than its immediate liquidity.

Whichever order is chosen, related items are grouped, sub-totals are shown where helpful, and capital is presented with its movements: opening capital, add net profit (or less net loss), less drawings, giving closing capital. Fixed assets are shown at cost less depreciation where depreciation has been provided.

Presentation conventions. The balance sheet is written in horizontal form with liabilities on the left and assets on the right, which is the form the Telangana Intermediate examination expects. The heading names the business and the date. The totals of the two sides are written on the same line and ruled with a double line. Amounts are in rupees with Indian grouping. A contingent liability, if any, is written as a footnote.

In examination problems the marks are given for correct placement and correct totals; the order chosen does not itself lose marks unless the question specifies it. Nevertheless a student should adopt one order, normally the order of liquidity, and use it every time, so that the answer is neat and the risk of omitting an item is reduced.

From the following trial balance of Sri Krishna Traders as on 31st March 2026, prepare the Trading and Profit and Loss Account for the year and the Balance Sheet as on that date. Closing stock was valued at Rs 22,000.

Debit balances: Cash in hand 4,500; Cash at bank 26,000; Drawings 8,000; Purchases 1,20,000; Sales returns 4,000; Opening stock 30,000; Sundry debtors 42,000; Wages 15,000; Salaries 18,000; Rent 9,000; Carriage inwards 2,500; Carriage outwards 1,500; Discount allowed 1,000; Furniture 20,000; Machinery 60,000; Bad debts 1,300; Bills receivable 6,000; Insurance 2,400; Interest on bank loan 3,600; Advertising 3,000. Total 3,77,800.
Credit balances: Capital 1,00,000; Sales 1,95,000; Purchases returns 3,000; Sundry creditors 28,000; Discount received 800; Commission received 2,000; Bills payable 9,000; Bank loan 40,000. Total 3,77,800.

Step 1 – Trading Account. Debit: Opening stock 30,000; Purchases 1,20,000 less returns 3,000 = 1,17,000; Wages 15,000; Carriage inwards 2,500; total 1,64,500. Credit: Sales 1,95,000 less returns 4,000 = 1,91,000; Closing stock 22,000; total 2,13,000. Gross profit c/d = 2,13,000 − 1,64,500 = 48,500.

Step 2 – Profit and Loss Account. Credit: Gross profit b/d 48,500; Discount received 800; Commission received 2,000; total 51,300. Debit: Salaries 18,000; Rent 9,000; Carriage outwards 1,500; Discount allowed 1,000; Bad debts 1,300; Insurance 2,400; Interest on bank loan 3,600; Advertising 3,000; total 39,800. Net profit = 51,300 − 39,800 = 11,500, transferred to capital.

Step 3 – Balance Sheet as on 31st March 2026.

Check. Assets: 4,500 + 26,000 + 6,000 + 42,000 + 22,000 + 20,000 + 60,000 = 1,80,500. Liabilities: 28,000 + 9,000 + 40,000 + 1,03,500 = 1,80,500. The balance sheet tallies.

Method summary. Go down the trial balance once, marking each item T (trading), P (profit and loss) or B (balance sheet). Every debit balance marked B is an asset; every credit balance marked B is a liability or capital, except drawings, which is deducted from capital. Closing stock, given outside the trial balance, is written twice: credit of trading account and asset in the balance sheet. If the balance sheet does not tally, the usual cause is an item used twice or not at all, or net profit copied wrongly; recount the T/P/B marks before recomputing.

A trader buys finished goods and sells them; his cost of goods sold is purchases adjusted for stock. A manufacturer buys raw materials and converts them into finished goods, so he must first find the cost of production. For this purpose a manufacturing account is prepared before the trading account. Although the Intermediate syllabus concentrates on trading concerns, the manufacturing account is introduced here so that the student can see how the trading account fits into a longer chain.

The manufacturing account is debited with opening stock of raw materials, purchases of raw materials less returns, carriage on raw materials, opening work in progress, direct wages, and factory overheads such as factory rent, power, fuel, factory lighting, depreciation of plant, repairs to machinery and factory manager's salary. It is credited with closing stock of raw materials, closing work in progress and any sale of scrap. The balance is the cost of goods manufactured (cost of production), which is transferred to the debit of the trading account in place of, or in addition to, purchases.

The trading account of a manufacturer then shows: debit side, opening stock of finished goods, cost of goods manufactured (from the manufacturing account), purchases of finished goods if any; credit side, sales less returns and closing stock of finished goods. Gross profit is found as usual and the profit and loss account follows unchanged.

Vertical form. The horizontal T form of the trading and profit and loss account taught in this chapter is the traditional one. An alternative vertical or statement form lists sales at the top, deducts cost of goods sold to show gross profit, deducts operating expenses grouped under administration and selling to show operating profit, then adds non-operating incomes and deducts non-operating expenses and losses to show net profit. Companies now report in this form. A sole trader may use either; the arithmetic and the figures are identical.

Operating profit. In the vertical form the term operating profit appears: gross profit less administrative and selling expenses, before financial charges and non-operating items such as profit or loss on sale of assets or interest and dividend on investments. It measures the profit from the main business activity alone. Operating profit = Net profit + Non-operating expenses − Non-operating incomes.

Income statement of a service concern. A concern that renders services rather than sells goods, such as a transport operator or a consultant, has no trading account; its profit and loss account starts with fees or service revenue on the credit side.

The student is not expected to prepare a manufacturing account in this course, but should be able to describe its purpose and to distinguish it from the trading account, and should recognise the vertical form if a question presents figures in that shape. What must be prepared, and prepared fluently, is the trading and profit and loss account and balance sheet of a sole trader, first without adjustments as here and then with the adjustments of the next chapter.