Sole Trader Financial Statements and the Extended Trial Balance (ETB)

Everything in the earlier topics leads to this point. The books are closed at the year end, adjustments are made, and the business reports two statements: the statement of profit or loss, which shows how it performed, and the statement of financial position, which shows what it owns and owes.

This topic shows how to prepare both for a sole trader from a trial balance and a list of adjustments, and how an extended trial balance (ETB) does the same job on a single working paper.

It draws on the trial balance, the adjustment topics on accruals, prepayments, bad debts, depreciation and inventory, and the double entry you already know. The ETB is examined directly, in two 20-mark questions across the past diets. The next topic moves to the company statement of financial position.

What the two statements show

Financial statements give information useful for decisions to owners, lenders, suppliers, employees, customers and government. A full set contains a statement of profit or loss and other comprehensive income, a statement of financial position, a statement of changes in equity, a statement of cash flows and notes.

Sole traders have no reason to comply fully with international standards, so their statements are usually limited to the statement of profit or loss and the statement of financial position.

The statement of financial position lists assets and liabilities, and the difference is capital. Assets are current if they will be used up or turned into cash within 12 months, and cash is a current asset. Prepayments and accrued income are current assets. Liabilities are current if payable within 12 months, so accrued expenses and deferred income are current liabilities.

A five-year bank loan with nothing repayable until the end is non-current for four years and a current liability in the fifth. The statement of profit or loss lists revenue, other income and the costs of earning it, and ends with profit or loss for the period.

A sole trader’s capital is the owner’s interest, while a partnership has a capital account for each partner and a company has share capital and reserves.

The year-end adjustments

The trial balance is extracted, the adjustments are made, and then the statements are drawn up from the adjusted balances. Every adjustment must also be recorded in the ledger, so that the ledger agrees with the statements. In the exam you do not write journals, because that wastes time. You do the double entry on the face of the question.

A step-by-step approach

1. Do the double entry on the question paper. Write each adjustment next to the trial balance line it changes, and open new accounts such as accruals and depreciation expense beside it. Do not copy out the trial balance.
2. Draft the two statements as skeleton layouts with every account you have identified.
3. Copy the numbers across. Where a figure is a trial balance amount adjusted by you, show the working, for example rent (14,000 − 700).
4. Find the profit from the statement of profit or loss.
5. Complete the capital section: opening capital, plus profit, less drawings, gives closing capital.
6. Check that total assets equal capital plus liabilities.

Example (ABC). The trial balance at 31 December 2019 shows sales ₦428,000, purchases ₦304,400, wages ₦64,000, rent ₦14,000, heating and lighting ₦5,000, opening inventory ₦15,000, drawings ₦22,000, allowance for doubtful debts ₦4,000, non-current assets ₦146,000, accumulated depreciation ₦32,000, receivables ₦51,000, payables ₦42,000, cash ₦6,200 and capital ₦121,600 (each side totals ₦627,600). The adjustments are: ₦400 owing for heating and lighting, ₦700 of rent prepaid, a bad debt of ₦1,200 written off, the allowance raised to ₦4,500, depreciation at 10% on cost, and closing inventory of ₦16,500.

The extended trial balance

An extended trial balance is a working paper that starts with the trial balance as extracted, records the adjustments beside it or in new accounts, and cross-casts each line to a new balance, which is then carried to the statement of profit or loss columns or the statement of financial position columns.

The columns are the trial balance, the adjustments, the statement of profit or loss, and the statement of financial position, each with a debit and a credit side.

Here is ABC in that layout. Read each row across. A balance goes to the profit-or-loss columns if it is revenue, a cost or inventory in cost of sales, and to the financial-position columns if it is an asset, a liability, capital or drawings.

The profit is the balancing figure on the profit-or-loss columns (444,500 − 418,400 = 26,100). It is entered on the debit side of those columns and on the credit side of the financial-position columns, because it increases capital. If the two financial-position columns then agree, the whole working has been done correctly.

Practice questions. These three practice questions all work. Blessed Stores has a profit of ₦35,000 and total assets of ₦385,000. Samson Traders has a profit of ₦64,500 (cost of sales 262,000 and expenses 73,500). Glory Ventures has a gross profit of ₦245,000, expenses of ₦140,500 and a profit of ₦104,500, with total assets of ₦409,500. Use them to practise the approach above.

The ideas in more depth

A check on the example. The JBH Enterprises extended trial balance shows a net profit of ₦43,130,000. Recomputing it gives revenue ₦160,000,000 less cost of sales of 5,000 + 100,000 − 3,000 = ₦102,000,000, a gross profit of ₦58,000,000. Expenses are bad debts 500, electricity 400, postage 150, salaries 10,000, loan interest 750 (3% on ₦25,000,000), furniture depreciation 320 and leasehold amortisation 2,500, a total of ₦14,620,000. The allowance for doubtful debts falls from 3,000 to 2,750 (10% of ₦27,500,000), which is a Credit of 250 to profit or loss.

Profit is therefore 58,000 − 14,620 + 250 = ₦43,630,000, not 43,130. A common slip is to treat the 250 decrease as an expense. When the allowance falls, the credit side of profit or loss increases.

Other points. A decrease in the allowance reduces expenses, and an increase adds to them. Drawings are never an expense: they reduce capital. Goods taken by the owner reduce purchases and increase drawings (see the topic on inventory). If the closing inventory is entered only on the financial-position side, the ETB will not balance, because there must be a matching credit in the profit-or-loss columns.

Unusual items that appear in the trial balance, such as a bank loan, are carried straight to the financial-position columns, and the interest owing on it is an accrual.

Worked example: Kano Fabrics

1. Cost of sales.
   60,000 + 410,000 − 70,000 = 400,000.
   Gross profit = 780,000 − 400,000 = 380,000.
2. Expenses.
   Wages 85,000 + 5,000 = 90,000.
   Rent 36,000.
   Insurance 18,000 − 4,000 = 14,000.
   Depreciation 20% × 250,000 = 50,000.
   Bad debts: receivables after write-off 114,000, allowance 5% = 5,700, increase 5,700 − 4,000 = 1,700, so the charge is 6,000 + 1,700 = 7,700.
   Total expenses 197,700.
3. Profit.
   380,000 − 197,700 = ₦182,300.
4. Non-current assets.
   Motor vehicles 250,000 less accumulated depreciation (75,000 + 50,000) = 125,000.
5. Current assets.
   Inventory 70,000, receivables 114,000 − 5,700 = 108,300, prepayment 4,000, bank 45,000, total 227,300.
   Total assets 352,300.
6. Capital.
   140,000 + 182,300 − 40,000 = 282,300.
   Current liabilities: payables 65,000 + accrued wages 5,000 = 70,000.
   Total equity and liabilities = 352,300, which agrees with total assets.

Common mistakes in the exam

• Treating a fall in the allowance for doubtful debts as an expense instead of income.
• Charging drawings to the statement of profit or loss.
• Deducting the whole allowance from the trade receivables before the write-off, or forgetting the write-off.
• Calculating depreciation on the carrying amount when the question says on cost, or forgetting to add it to the brought-forward accumulated depreciation.
• Putting prepayments or accruals in the wrong place on the statement of financial position.
• In the ETB, putting closing inventory only on one side.
• Not showing workings such as rent (14,000 − 700), so the marker cannot award method marks.
• Adding profit to capital but forgetting to deduct drawings.

Quick revision

• Profit = revenue − cost of sales − expenses. Closing capital = opening capital + profit − drawings.
• Accruals are current liabilities. Prepayments are current assets. A loan due within 12 months is current.
• Allowance increase is an expense. Allowance decrease is income.
• ETB columns: trial balance, adjustments, profit or loss, financial position.
• Closing inventory: credit in the profit-or-loss columns, debit in the financial-position columns.
• Profit balances the profit-or-loss columns and is added to capital in the financial-position columns.

Practice questions

These are original questions in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one first.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

Spotted a mistake? Tell us and we will check it.