Financial Statements of Sole Proprietors
Final accounts are the three-statement report card of a sole proprietor's business — Trading Account, Profit & Loss Account, and Balance Sheet — that turns a year's scattered ledger entries into two clear answers: how much did you earn, and what does your business own and owe?
Every bank that gives a business loan, every GST officer who audits a trader, and every CA who mentors you will start with these three statements — mastering them now gives you a real skill that works both in your board exam and in any business career, from a kirana shop to a corporate finance role.
Concept
Lots of students think…
"Closing stock should appear in the Profit & Loss Account because stock left unsold reduces profit."
Actually…
Closing stock goes on the credit side of the Trading Account (reducing cost of goods sold) and as a current asset in the Balance Sheet — it never enters the P&L Account. The P&L deals only with indirect income and expenses, not the buying-and-selling cycle.
By the end of this chapter, you will understand how a shopkeeper turns a year's worth of ledger entries into three clear financial statements — and know exactly how much the business earned and what it owns or owes.
Why Final Accounts Exist
Your ledger has dozens of accounts — purchases, sales, rent, machinery — but none of them alone tells you if you made money. Final accounts reorganise all those balances into three statements that give you two simple answers: how much did you earn, and how healthy is your business right now?
Anitha runs a saree shop in Thrissur. At the end of March she has entries for ₹8 lakh in purchases, ₹11.5 lakh in sales, rent, salaries, and more. On their own those numbers tell her nothing. Her final accounts bring them together into one clear picture.
Trading Account — Gross Profit
The Trading Account's only job is to find gross profit: the profit from buying and selling goods before any other costs. Debit side gets opening stock and purchases. Credit side gets sales and closing stock. If the credit side is bigger, you have gross profit — this moves to the next statement.
Anitha had no opening stock. She bought sarees for ₹8,00,000 and sold them for ₹11,50,000. She had ₹60,000 of unsold sarees at year-end. Gross Profit = ₹11,50,000 − (₹8,00,000 − ₹60,000) = ₹4,10,000.
Profit & Loss Account — Net Profit
The P&L Account starts with the gross profit from the Trading Account, then subtracts all indirect expenses — rent, salaries, depreciation, bad debts. Any extra income like commission earned is added. What is left is net profit (or net loss). This is the real reward for running the business.
Anitha's gross profit was ₹4,10,000. She paid rent ₹1,20,000, salaries ₹60,000, and depreciation ₹20,000. Total indirect expenses = ₹2,00,000. Net Profit = ₹4,10,000 − ₹2,00,000 = ₹2,10,000.
Balance Sheet — What the Business Owns and Owes
The Balance Sheet is not an account — it is a snapshot of the business on one single day. The right side lists everything the business owns (assets). The left side lists everything it owes (liabilities) plus the owner's capital. Both sides must be exactly equal — that equality proves every entry was recorded twice correctly.
After making ₹2,10,000 net profit, Anitha adds it to her capital. Her assets include ₹60,000 closing stock and her display racks at their reduced value. Her liabilities show what she owes her suppliers. Both sides balance — she can show this to a bank for a loan.
Where Adjustments Fit In
Each adjustment — depreciation, prepaid expense, outstanding salary — has one correct home in the final accounts. Depreciation goes as an expense in P&L, and the fixed asset appears at its reduced value in the Balance Sheet. Prepaid insurance is a current asset in the Balance Sheet, not an expense. Putting an item in the wrong statement is the most common mistake.
Anitha's display racks cost ₹1,00,000 and depreciation is ₹20,000. In the P&L she shows depreciation ₹20,000 as an expense. In the Balance Sheet she shows the racks at ₹80,000 — not ₹1,00,000. Same one item, two entries, each in its right place.
Revenue vs Capital Expenses
Revenue expenses are day-to-day costs used up in one year — rent, stationery, salaries. They go in the P&L Account. Capital expenses buy something that will serve the business for many years — machinery, vehicles, computers. They go in the Balance Sheet as assets, not in P&L. Mixing these two up will make your Balance Sheet fail to balance.
Anitha pays ₹12,000 for a year's rent — that is a revenue expense, straight into P&L. She then buys a new billing machine for ₹30,000 — that is a capital expense, it goes in the Balance Sheet as an asset and she depreciates it over years.
The Three Statements Together
Trading Account gives you gross profit. P&L Account takes that gross profit, deducts indirect expenses, and gives you net profit. Balance Sheet takes that net profit, adds it to the owner's capital, and shows the full picture of assets and liabilities. The three statements are one connected chain — always prepared in this order.
A bank officer in Thrissur asks Anitha for her financials before approving a ₹5 lakh loan. She hands over all three statements. The officer sees her gross profit, net profit, assets, and liabilities at a glance — and approves the loan.
Notes
Final accounts turn a year of scattered ledger balances into two clear answers: how much did the business earn, and where does it stand? Three statements do the work — the TRADING ACCOUNT gives gross profit, the PROFIT & LOSS ACCOUNT gives net profit, and the BALANCE SHEET shows the position on the closing date. The dividing line you must never blur is capital expenditure versus revenue expenditure.
Key terms & definitions
- Final accounts
- The Trading Account, Profit & Loss Account and Balance Sheet prepared at the end of an accounting period from the trial balance.
- Trading Account
- The account prepared to find GROSS PROFIT — the result of buying and selling goods, before indirect expenses.
- Gross Profit
- Net Sales minus Cost of Goods Sold. It measures trading efficiency only.
- Profit & Loss Account
- The account that begins with gross profit, deducts all indirect expenses and adds other incomes, to arrive at NET PROFIT.
- Net Profit
- The final profit belonging to the owner after every business expense has been met. It is added to capital in the Balance Sheet.
- Balance Sheet
- A STATEMENT (not an account) showing assets, liabilities and capital as on the last day of the accounting period.
- Cost of Goods Sold (COGS)
- Opening Stock + Net Purchases + Direct Expenses − Closing Stock.
- Direct expenses
- Expenses incurred to bring goods to saleable condition — carriage inwards, wages, freight, octroi, fuel and power. They belong in the Trading Account.
- Indirect expenses
- Expenses of running the business — rent, salaries, advertising, depreciation, bad debts. They belong in the Profit & Loss Account.
- Capital expenditure
- Money spent to acquire a long-lived asset or to increase its earning capacity. It appears in the BALANCE SHEET, not in the P&L.
- Revenue expenditure
- Money spent on the day-to-day running of the business, the benefit of which is consumed within the year. It appears in the P&L Account.
- Closing stock
- Unsold goods at the end of the year. Shown on the CREDIT side of the Trading Account and as a CURRENT ASSET in the Balance Sheet — in both places, once each.
Why final accounts are needed
- At 31 March your ledger holds dozens of balances — purchases, sales, rent, debtors, machinery — but none of them alone tells you whether you made money.
- Final accounts summarise those balances into a readable report.
- They answer two distinct questions: HOW MUCH DID I EARN (Trading and P&L), and WHERE DO I STAND (Balance Sheet).
- They also satisfy outside users — banks, the GST department, prospective buyers of the business.
- The trial balance is the raw material; the final accounts are the finished product.
The Trading Account — gross profit only
- Its single job is to measure profit from BUYING AND SELLING GOODS, before any running costs.
- DEBIT SIDE: Opening Stock, Net Purchases (purchases less purchase returns), and all DIRECT EXPENSES — carriage inwards, wages, freight, fuel and power.
- CREDIT SIDE: Net Sales (sales less sales returns) and Closing Stock.
- The balancing figure is GROSS PROFIT (if credit exceeds debit) or GROSS LOSS.
- Gross profit is then carried down to the Profit & Loss Account.
- Only DIRECT expenses belong here. Putting rent or salaries in the Trading Account is a standard error.
The Profit & Loss Account — net profit
- It opens with the gross profit brought down from the Trading Account.
- DEBIT SIDE: all INDIRECT expenses — rent, salaries, advertising, insurance, depreciation, bad debts, interest paid.
- CREDIT SIDE: other incomes — commission received, interest received, discount received, rent received.
- The balancing figure is NET PROFIT (or net loss).
- Net profit is transferred to the CAPITAL ACCOUNT in the Balance Sheet, where it increases the owner's capital.
- A net loss is deducted from capital instead.
The Balance Sheet — a statement, not an account
- It is not an account: it has no debit and credit sides and no balancing figure of its own.
- It lists LIABILITIES and CAPITAL on one side, ASSETS on the other, as on the closing date.
- It is a snapshot at a POINT IN TIME, whereas the Trading and P&L accounts cover a PERIOD.
- Assets are usually grouped as fixed assets and current assets; liabilities as long-term and current.
- Capital is shown as: Opening capital + Net profit − Drawings (or − Net loss).
- The two sides must agree, because Assets = Liabilities + Capital.
Worked example — Mithun's printing shop
- Given: Opening Stock ₹15,000; Purchases ₹80,000; Sales ₹1,40,000; Closing Stock ₹12,000; Rent ₹10,000; Salaries ₹20,000; Depreciation ₹4,000; Machinery ₹30,000; Fixtures ₹8,000; Cash ₹5,000; Debtors ₹8,000; Creditors ₹6,000; Capital ₹34,000.
- TRADING A/C — Debit: Opening Stock ₹15,000 + Purchases ₹80,000 = ₹95,000. Credit: Sales ₹1,40,000 + Closing Stock ₹12,000 = ₹1,52,000.
- GROSS PROFIT = ₹1,52,000 − ₹95,000 = ₹57,000.
- P&L A/C — Gross profit ₹57,000 less Rent ₹10,000, Salaries ₹20,000 and Depreciation ₹4,000 (total ₹34,000).
- NET PROFIT = ₹57,000 − ₹34,000 = ₹23,000.
- BALANCE SHEET — Assets: Machinery ₹30,000 + Fixtures ₹8,000 + Closing Stock ₹12,000 + Debtors ₹8,000 + Cash ₹5,000 = ₹63,000.
- Liabilities and Capital: Creditors ₹6,000 + Capital ₹34,000 + Net Profit ₹23,000 = ₹63,000.
- Both sides agree at ₹63,000 ✔
Capital expenditure versus revenue expenditure
- REVENUE EXPENDITURE keeps the business running day to day — rent, stationery, salaries, repairs. Benefit is consumed within the year → PROFIT & LOSS ACCOUNT.
- CAPITAL EXPENDITURE buys or improves a long-lived asset — machinery, a vehicle, a computer. Benefit lasts for years → BALANCE SHEET as an asset.
- Test: will the benefit outlast this accounting year? If yes, it is capital.
- Wages paid to INSTALL a new machine are capital; wages paid to run it are revenue.
- Confusing the two distorts BOTH profit and the Balance Sheet — it is an error of principle.
Where closing stock goes — and why it is not an expense
- Closing stock appears TWICE, once in each statement: on the CREDIT side of the Trading Account, and as a CURRENT ASSET in the Balance Sheet.
- It is NOT shown in the Profit & Loss Account and it does NOT reduce profit.
- Logic: closing stock is goods you bought but have NOT yet sold. Crediting it removes its cost from the cost of goods sold, so only goods actually sold are charged against sales.
- Far from reducing profit, closing stock INCREASES gross profit by removing unsold cost from the charge.
- If closing stock appears in the trial balance itself, it is shown ONLY in the Balance Sheet, because it has already been adjusted against purchases.
Handling adjustments
- OUTSTANDING EXPENSE: add to the expense in the P&L and show as a current liability.
- PREPAID EXPENSE: deduct from the expense in the P&L and show as a current asset.
- ACCRUED INCOME: add to the income in the P&L and show as a current asset.
- INCOME RECEIVED IN ADVANCE: deduct from the income and show as a current liability.
- DEPRECIATION: charge in the P&L and deduct from the asset in the Balance Sheet.
- Golden rule: an item appearing in the TRIAL BALANCE is recorded ONCE; an item given as an ADJUSTMENT outside the trial balance is recorded TWICE.
- If the adjustment is already inside an ADJUSTED trial balance, do not apply it again — it flows straight into the statements.
Three misconceptions to clear
- WRONG: 'Closing stock goes in the Profit & Loss Account because it reduces profit.' It belongs on the credit side of the TRADING account and in the Balance Sheet, and it increases gross profit.
- WRONG: 'Depreciation should be added back in the Balance Sheet because no cash left the business.' It is charged as an expense in the P&L and DEDUCTED from the asset in the Balance Sheet.
- WRONG: 'A business showing net profit must have more assets than liabilities.' Net profit measures performance over a PERIOD; the relation between assets and liabilities is a POSITION on a date. A profitable business can still be heavily indebted.
Formulas & formats
- Trading Account for the year ended .......... Dr. Cr. To Opening Stock 15,000 | By Sales 1,40,000 To Purchases 80,000 | By Closing Stock 12,000 To Direct Expenses — | To Gross Profit c/d 57,000 | --------- | --------- 1,52,000 | 1,52,000
- Cost of Goods Sold: COGS = Opening Stock + Net Purchases + Direct Expenses − Closing Stock Gross Profit = Net Sales − COGS
- Profit & Loss Account: Gross Profit b/d 57,000 Less: Indirect expenses 34,000 (Rent 10,000 + Salaries 20,000 + Depreciation 4,000) NET PROFIT 23,000
- Balance Sheet as at .......... LIABILITIES | ASSETS Creditors 6,000 | Machinery 30,000 Capital 34,000 | Fixtures 8,000 Add: Net Profit 23,000 57,000 | Closing Stock 12,000 (Less: Drawings) | Debtors 8,000 | Cash 5,000 --------- | --------- 63,000 | 63,000
- Capital in the Balance Sheet: Closing Capital = Opening Capital + Net Profit − Drawings (or − Net Loss)
Important questions & model answers
What are final accounts? Name the statements included.
2 marks- Final accounts are the statements prepared at the end of an accounting period from the trial balance to ascertain the profit or loss and the financial position of the business.
- They comprise the TRADING ACCOUNT (to find gross profit), the PROFIT & LOSS ACCOUNT (to find net profit) and the BALANCE SHEET (to show financial position).
Distinguish between gross profit and net profit.
3 marks- GROSS PROFIT is the excess of net sales over the cost of goods sold, found in the Trading Account. It measures trading efficiency only.
- NET PROFIT is what remains after deducting all indirect expenses from gross profit and adding other incomes, found in the Profit & Loss Account.
- Gross profit ignores running expenses such as rent and salaries; net profit takes them into account.
- Net profit is the amount that finally belongs to the owner and is added to capital in the Balance Sheet.
From Mithun's figures — Opening Stock ₹15,000, Purchases ₹80,000, Sales ₹1,40,000, Closing Stock ₹12,000, Rent ₹10,000, Salaries ₹20,000, Depreciation ₹4,000 — compute gross profit and net profit.
5 marks- TRADING ACCOUNT: Debit side = Opening Stock ₹15,000 + Purchases ₹80,000 = ₹95,000.
- Credit side = Sales ₹1,40,000 + Closing Stock ₹12,000 = ₹1,52,000.
- GROSS PROFIT = ₹1,52,000 − ₹95,000 = ₹57,000.
- PROFIT & LOSS ACCOUNT: Gross profit ₹57,000 less indirect expenses (Rent ₹10,000 + Salaries ₹20,000 + Depreciation ₹4,000 = ₹34,000).
- NET PROFIT = ₹57,000 − ₹34,000 = ₹23,000.
- This ₹23,000 is added to capital in the Balance Sheet.
Why is the Balance Sheet called a statement and not an account?
3 marks- An account has a debit side and a credit side and produces a balancing figure; the Balance Sheet has neither.
- It merely LISTS the assets on one side and the liabilities and capital on the other, as on a particular date.
- The words 'To' and 'By', which are used in accounts, are not used in a Balance Sheet.
- It shows a POSITION at a point of time, whereas the Trading and Profit & Loss Accounts cover a PERIOD of time.
- Its two sides agree automatically because Assets = Liabilities + Capital.
Distinguish between capital expenditure and revenue expenditure, with one example of each.
4 marks- CAPITAL EXPENDITURE is incurred to acquire a fixed asset or to increase the earning capacity of an existing one; its benefit extends beyond the current year. Example: purchase of machinery.
- REVENUE EXPENDITURE is incurred for the day-to-day conduct of the business; its benefit is consumed within the year. Example: rent or salaries paid.
- TREATMENT: capital expenditure is shown as an ASSET in the Balance Sheet; revenue expenditure is charged to the PROFIT & LOSS ACCOUNT.
- TEST: ask whether the benefit outlasts the current accounting year. If it does, the expenditure is capital.
- Wrongly classifying one as the other is an error of principle and distorts both profit and the Balance Sheet.
How is closing stock treated in the final accounts, and why does it not reduce profit?
4 marks- Closing stock is shown on the CREDIT side of the Trading Account and as a CURRENT ASSET in the Balance Sheet — once in each statement.
- It is never shown in the Profit & Loss Account.
- Closing stock represents goods purchased but not yet sold. Crediting it removes their cost from the cost of goods sold, so that only the cost of goods actually SOLD is charged against sales.
- Its effect is therefore to INCREASE gross profit, not reduce it.
- However, if closing stock already appears inside the trial balance, it is shown only in the Balance Sheet, because it has already been adjusted against purchases.
State how each of the following is treated: (i) outstanding salaries, (ii) prepaid insurance, (iii) depreciation on machinery.
3 marks- (i) OUTSTANDING SALARIES: added to salaries on the debit side of the Profit & Loss Account, and shown as a current liability in the Balance Sheet.
- (ii) PREPAID INSURANCE: deducted from insurance in the Profit & Loss Account, and shown as a current asset in the Balance Sheet.
- (iii) DEPRECIATION ON MACHINERY: charged as an expense in the Profit & Loss Account, and deducted from the machinery on the assets side of the Balance Sheet.
- In each case the item given as an adjustment outside the trial balance receives a DOUBLE treatment.
Distinguish between direct expenses and indirect expenses, with examples.
3 marks- DIRECT EXPENSES are incurred to bring goods to a saleable condition — carriage inwards, wages, freight, octroi, fuel and power. They are debited to the TRADING ACCOUNT.
- INDIRECT EXPENSES are incurred in running and administering the business — rent, salaries, advertising, insurance, depreciation. They are debited to the PROFIT & LOSS ACCOUNT.
- Direct expenses affect gross profit; indirect expenses affect net profit only.
- Placing an indirect expense such as rent in the Trading Account is a common and costly error.
'A business earning a net profit must have more assets than liabilities.' Comment.
3 marks- The statement is not necessarily true.
- Net profit is a measure of PERFORMANCE over a period, computed in the Profit & Loss Account.
- The relation between assets and liabilities is a matter of POSITION on a particular date, shown in the Balance Sheet.
- A business may earn a good profit this year and yet carry heavy loans taken earlier, so that liabilities remain large.
- Equally, a business with few liabilities may make a loss. Profitability and solvency are different questions.
Explain the rule for treating items that appear inside the trial balance as against items given as adjustments.
3 marks- An item appearing INSIDE the trial balance is recorded ONLY ONCE in the final accounts, because its double entry is already complete in the books.
- An item given as an ADJUSTMENT outside the trial balance is recorded TWICE, because neither side of its entry has yet been made.
- Example: salaries in the trial balance go only to the Profit & Loss Account; outstanding salaries given as an adjustment are added to salaries in the P&L AND shown as a liability in the Balance Sheet.
- If an ADJUSTED trial balance is supplied, the adjustments have already been incorporated and must not be applied a second time.
Exam tips
- Write the correct headings in full: 'Trading and Profit & Loss Account FOR THE YEAR ENDED …' but 'Balance Sheet AS AT …'. The wording is marked.
- Put only DIRECT expenses in the Trading Account. Rent, salaries and advertising belong in the P&L.
- Closing stock: credit side of the Trading Account AND assets side of the Balance Sheet — unless it already appears in the trial balance, in which case Balance Sheet only.
- Remember the once/twice rule: trial-balance items once, adjustment items twice.
- Show capital workings clearly — Opening Capital + Net Profit − Drawings — rather than writing a single unexplained figure.
- Always check that your Balance Sheet totals agree before finishing; if they differ, an adjustment has been applied once instead of twice, or vice versa.
- Do not use 'To' and 'By' in the Balance Sheet — it is a statement, not an account.
Quick revision
- Trading A/c → GROSS profit. P&L A/c → NET profit. Balance Sheet → POSITION.
- COGS = Opening Stock + Net Purchases + Direct Expenses − Closing Stock.
- Gross Profit = Net Sales − COGS. Net Profit = Gross Profit + Other income − Indirect expenses.
- Mithun: GP = 1,52,000 − 95,000 = ₹57,000; NP = 57,000 − 34,000 = ₹23,000; Balance Sheet ₹63,000 both sides.
- Direct expenses (carriage in, wages, freight) → Trading. Indirect (rent, salaries, depreciation) → P&L.
- Capital expenditure → Balance Sheet. Revenue expenditure → P&L.
- Closing stock: Trading A/c credit side + Balance Sheet asset. It INCREASES gross profit.
- Trial-balance item → once. Adjustment item → twice.
- Closing Capital = Opening Capital + Net Profit − Drawings.
- Balance Sheet is a STATEMENT, not an account — no 'To' and 'By'.
The full picture
Imagine you run a stationery shop near your school. You bought goods, sold goods, paid rent and salaries, and now the financial year has ended on 31 March. Your ledger has dozens of accounts — purchases, sales, rent, debtors, machinery — but none of them, on their own, tells you whether you made money this year or how healthy your business really is. That is exactly the problem that final accounts (also called financial statements) solve. They reorganise every ledger balance into three well-defined statements that any banker, tax officer, or future partner can understand at a glance.
The first statement is the Trading Account. Its only job is to measure gross profit — the profit from buying and selling goods before any operating costs are considered. On the debit side you record opening stock and net purchases (purchases minus purchase returns). On the credit side you record net sales (sales minus sales returns) and closing stock. The difference is gross profit (if credit side is larger) or gross loss (if debit side is larger). Closing stock appears here on the credit side because it represents goods that were bought but not yet sold — it reduces your cost of goods sold. This gross profit figure is then carried forward to the next statement.
The second statement is the Profit and Loss Account. It begins with the gross profit transferred from the Trading Account and then lists all indirect expenses — rent, salaries, advertising, depreciation, bad debts — on the debit side. Other incomes such as commission received or interest earned are shown on the credit side. When you subtract total expenses from gross profit and add other income, you get net profit (or net loss). Net profit is the true reward for running the business. It is then added to the owner's capital in the Balance Sheet.
The third statement is the Balance Sheet. Unlike the Trading Account and P&L, the Balance Sheet is not an account — it is a position statement. It shows what the business owns (assets) on the right and what it owes (liabilities) plus what the owner has invested (capital) on the left, as on the last day of the accounting year. Current assets (cash, debtors, closing stock) and fixed assets (machinery, furniture, land) go on the right. On the left, capital is shown after adding net profit (and deducting drawings, if any) so it reflects the owner's updated stake. Creditors and loans appear below capital. Both sides must be equal — this equality is the living proof of double-entry bookkeeping.
Adjustments already recorded in the adjusted trial balance flow straight into these statements — you do not create them again. Depreciation on machinery? It appears as an expense in P&L and the machinery is shown at its reduced book value in the Balance Sheet. Prepaid insurance? It is a current asset in the Balance Sheet, not an expense in P&L. Outstanding salary? It is an expense in P&L and a current liability in the Balance Sheet. Each adjusted item has one correct home; placing it in the wrong statement is the most common source of exam marks lost.
One important rule to memorise: revenue expenses (paying for day-to-day running of the business — rent, stationery, salaries) belong in the P&L Account. Capital expenses (buying long-lived assets — machinery, vehicles, computers) belong in the Balance Sheet as assets, not in P&L. Confusing these two is a classification error that will make your Balance Sheet fail to balance. When you see a new item in a question, ask yourself: 'Is this something used up this year, or something that will benefit the business for many years?' The answer decides where it goes.
An Indian example
Anitha runs a small saree shop in Thrissur. This is her first year in business (so opening stock is nil). In the year ending 31 March, she bought sarees worth ₹8,00,000 and sold them for ₹11,50,000. She had ₹60,000 worth of sarees left unsold at year-end (closing stock). She paid ₹1,20,000 in shop rent, ₹60,000 in salaries to one helper, and charged ₹20,000 depreciation on her display racks. Her Trading Account shows: Opening Stock ₹0 + Purchases ₹8,00,000 − Closing Stock ₹60,000 = Cost of Goods Sold ₹7,40,000; Gross Profit = Sales ₹11,50,000 − COGS ₹7,40,000 = ₹4,10,000. Her P&L Account then deducts rent ₹1,20,000, salaries ₹60,000, and depreciation ₹20,000 — total ₹2,00,000 — leaving a Net Profit of ₹2,10,000. Her Balance Sheet adds this ₹2,10,000 to her opening capital, shows the closing stock ₹60,000 as a current asset, and lists her display racks at their depreciated value. Both sides of her Balance Sheet balance perfectly — and she now has a document she can take to a bank for a loan or submit with her GST return.
Common misconceptions to watch for
- Closing stock should be shown in the Profit & Loss Account because it reduces profit. This is wrong: closing stock goes on the credit side of the Trading Account (reducing cost of goods sold) and as a current asset in the Balance Sheet. It never enters the P&L Account, which deals only with indirect income and expenses, not the buying-selling cycle.
- Depreciation is added back in the Balance Sheet because it is a non-cash expense and no money actually leaves the business. This is wrong: depreciation is deducted in the P&L Account as a genuine expense (the asset is being used up). In the Balance Sheet, the fixed asset is simply shown at its reduced book value (cost minus accumulated depreciation). There is no 'adding back' anywhere in final accounts.
- If a business shows a net profit, it must have more assets than liabilities. This is wrong: net profit (from P&L) and solvency (assets exceeding liabilities, from Balance Sheet) measure completely different things. A business can earn profit this year but still have negative capital if it carries large losses from previous years or heavy long-term loans — the Balance Sheet will show liabilities exceeding assets even while the P&L shows a profit.
Video
Final Accounts of a Sole Trader — Trading, P&L & Balance Sheet
Questions
Mithun's printing shop reports: Opening Stock ₹15,000; Purchases ₹80,000; Sales ₹1,40,000; Closing Stock ₹12,000; Rent ₹10,000; Salaries ₹20,000; Depreciation ₹4,000; Machinery ₹30,000; Fixtures ₹8,000; Cash ₹5,000; Debtors ₹8,000; Creditors ₹6,000; Capital ₹34,000. Prepare Trading Account, P&L Account, and Balance Sheet.
- 1Classify all items as revenue or capital.Revenue items (Sales, Purchases, Expenses) go to the Trading Account or P&L Account. Capital items (Assets, Liabilities, Capital) go to the Balance Sheet. Closing Stock is special: it appears on the credit side of the Trading Account to reduce COGS, and also as a current asset in the Balance Sheet.
Question 1 of 5 · easy
Where does closing stock appear in final accounts?
Quiz
Test yourself — pick an answer, then hit "Check" to see the explanation and your running score.
Question 1 of 5 · easy
Where does closing stock appear in final accounts?
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