Sole traders

A sole trader is a business owned and operated by one individual. This person has unlimited liability, meaning they are personally responsible for all debts of the business. If the business fails, creditors can claim the owner's personal assets (e.g., home, car) to settle business debts.

Sole traders can operate in three main sectors:

1. Trading: Buying and selling goods (e.g., a grocery store).
2. Service: Providing expertise or labor (e.g., a hairdresser, accountant).
3. Manufacturing: Converting raw materials into finished goods (e.g., a bakery, furniture maker).

\text{Opening Inventory} + \text{Purchases} - \text{Closing Inventory} = \text{Cost of Sales}

Note: Purchases are net purchases (Gross Purchases minus Purchase Returns).

1. Non-current Assets: List at Net Book Value (NBV).
   \text{NBV} = \text{Cost} - \text{Accumulated Depreciation}
2. Current Assets: Sum of Inventory, Trade Receivables (less provision), and Cash.
3. Total Assets: Sum of Non-current and Current Assets.
4. Capital at Start: Opening Capital.
5. Adjustments to Capital:
   • Add: Net Profit from the SPL.
   • Less: Drawings by the owner.
6. Closing Capital: The result of the above calculation.
7. Non-current Liabilities: List long-term loans.
8. Current Liabilities: Sum of Trade Payables, Accruals, and Overdrafts.
9. Total Equity and Liabilities: Closing Capital + Non-current Liabilities + Current Liabilities.

Check: Total Assets must equal Total Equity and Liabilities.

Depreciation is the loss in value of a non-current asset due to use, wear and tear, or obsolescence. It is an expense in the SPL and reduces the NBV in the SFP.

1. Straight Line Method:
   \text{Annual Depreciation} = \text{Cost} \times \text{Percentage Rate}

   • Used when the asset loses value evenly over time (e.g., vehicles).
   • The expense amount is constant every year.

2. Reducing Balance Method:
   \text{Annual Depreciation} = \text{Net Book Value at Start of Year} \times \text{Percentage Rate}

   • Used when the asset loses more value in early years (e.g., technology).
   • The expense amount decreases every year as NBV decreases.

3. Revaluation Method:
   \text{Depreciation Expense} = \text{Opening NBV} + \text{Additions} - \text{Closing NBV (Valuation)}

   • Used for assets that are difficult to value individually, such as motor vehicles or inventory of a car dealer.
   • Requires an independent valuation at year-end.

The Accruals Concept states that income and expenses are recorded when they occur, not when cash is paid/received.

1. Accrued Expenses (Expenses in Arrears)

• Definition: An expense incurred this year but NOT yet paid by year-end.
• Effect on SPL: Add the accrued amount to the expense account (increases total expenses, decreases profit).
• Effect on SFP: Record as a Current Liability (amount owed).

2. Prepaid Expenses (Expenses in Advance)

• Definition: An expense paid this year but relating partly to next year.
• Effect on SPL: Subtract the prepaid amount from the expense account (decreases total expenses, increases profit).
• Effect on SFP: Record as a Current Asset (future economic benefit).

1. Irrecoverable Debts (Bad Debts)

• Definition: A specific trade receivable that is definitely not going to be paid.
• Action: Write off the debt.
• Effect on SPL: Add to Expenses (increases expenses, decreases profit).
• Effect on SFP: Reduce Trade Receivables by the amount written off.

2. Allowance for Irrecoverable Debts (Provision)

• Definition: An estimate of future bad debts based on a percentage of closing Trade Receivables.
• Calculation:
  \text{New Provision} = \text{Closing Trade Receivables} \times \text{Percentage Rate}

3. Adjusting the Provision
You must compare the Old Provision (from last year) with the New Provision (calculated above).

• If New Provision > Old Provision: Increase in provision.
  • SPL: Add the difference to Expenses.
  • SFP: The new provision is shown as a deduction from Trade Receivables.
• If New Provision < Old Provision: Decrease in provision.
  • SPL: Subtract the difference from Expenses (or add to Income).
  • SFP: The new provision is shown as a deduction from Trade Receivables.

Drawings are assets taken by the owner for personal use. They reduce the owner's capital.

1. Cash Drawings:

   • SPL: No effect (already recorded as cash payment).
   • SFP: Reduce Capital directly.

2. Goods Drawings (Inventory):

   • If the owner takes goods for personal use, the business has lost an asset but received no cash.
   • SPL: Add the cost of goods to Expenses (to reflect the true cost of trading).
   • SFP: Reduce Inventory and reduce Capital.

3. Private Expenses Paid by the Business:

   • If the business pays a personal expense for the owner (e.g., owner's home electricity bill), it is treated as a drawing.
   • SPL: Add the amount back to the relevant Expense account (e.g., Electricity). This ensures the expense reflects only business costs. The total expense figure remains correct, but the classification changes.
   • SFP: Reduce Capital.