Financial accounting of a sole trader – Financial
accounts and year-end adjustments
Accounting period
The main aim of any business is to make a profit. Profit is calculated as follows:
Service business’s profit:
Income - expenses
Trading business’s profit:
Sales – cost of sales + other income - expenses
The accounting period, or financial year, is usually 12 months & it is always a fixed period &
at the same time of the year – it is the same 12 consecutive months each year. A business
not only wants to calculate the profit in a certain period, but also compares the current
financial year with previous financial years.
Closing transfers
Why would a business close off its books at the end of a financial year?
To calculate the business’s profit for the year concerned
To close off all nominal accounts, as well as drawings, so that the following financial
year can start anew.
A service business’s nominal accounts are all closed off to the Profit & Loss account.
A trading business calculates its profit in 2 accounts. Gross profit is calculated in the
Trading account by taking sales less cost of sales. The gross profit is then transferred to the
Profit & Loss account, where the net profit is calculated by taking the gross profit plus
other income less expanses. The Trading account and the Profit & Loss account are known
as final accounts. The closing transfers are entered in the General Journal.
Closing transfers
, Trading account Profit & Loss account
Gross profit = sales less cost Net profit = gross profit plus
of sales other income less expenses
Steps that take place during the closing transfers of a trading business at the end of the
financial year:
Close off Debtor Allowances account to the Sales account
Close off the Sales account to the Trading account
Calculate the gross profit in the Trading account
Transfer the gross profit from the Trading account to the Profit & Loss account
Close off all income to the credit side of the Profit & Loss account
Close off all expenses to the debit side of the Profit & Loss account
Calculate the net profit in the Profit & Loss account
Transfer the net profit from the Profit & Loss account to the Capital account
Close off the Drawings to the Capital account
After all the closing transfers have been done, a post-closing Trail Balance is drawn up. The
post-closing Trail Balance contains only Balance Sheet accounts since all nominal accounts
have already been closed off.
The accounting cycle & generally accepted accounting
practice
, GAAP principle Description Example
Business entity rule The financial affairs of the owner should The business and the owner
be kept separate from that of the must each have their own bank
business – they are 2 separate entities. account.
Historical cost concept Assets should be entered at its historical Land & Buildings purchased for
cost; that is, the amount that was R500 000 will be entered at that
originally paid for them. amount in the books, even if the
business can receive a lot more
for it after a couple of years.
Going concern concept The financial statements of a business Assets are valued at historical
are prepared with the assumption that cost and not the value the
the business will continue operating in business will receive for it,
the foreseeable future. should the business be sold in
the following year.
Matching concept Income and expenses must be The telephone account for
accounted for in the correct time period. February 2015 must be taken
into account in the financial year
ending 28 February 2015, even if
the account is only being paid in
March.
Prudence concept Financial results are reflected in a If the business expects to make a
conservative manner. profit of R100 000 on the sale of
part of the building, it will not be
entered in the books until the
transfer of the land has been
concluded.
Concept of materiality Material items must be shown in the Interest on Overdraft must be
financial statements, but the immaterial shown in a specific account,
items need not be highlighted. while Consumables can be
included with Sundry Expenses.
accounts and year-end adjustments
Accounting period
The main aim of any business is to make a profit. Profit is calculated as follows:
Service business’s profit:
Income - expenses
Trading business’s profit:
Sales – cost of sales + other income - expenses
The accounting period, or financial year, is usually 12 months & it is always a fixed period &
at the same time of the year – it is the same 12 consecutive months each year. A business
not only wants to calculate the profit in a certain period, but also compares the current
financial year with previous financial years.
Closing transfers
Why would a business close off its books at the end of a financial year?
To calculate the business’s profit for the year concerned
To close off all nominal accounts, as well as drawings, so that the following financial
year can start anew.
A service business’s nominal accounts are all closed off to the Profit & Loss account.
A trading business calculates its profit in 2 accounts. Gross profit is calculated in the
Trading account by taking sales less cost of sales. The gross profit is then transferred to the
Profit & Loss account, where the net profit is calculated by taking the gross profit plus
other income less expanses. The Trading account and the Profit & Loss account are known
as final accounts. The closing transfers are entered in the General Journal.
Closing transfers
, Trading account Profit & Loss account
Gross profit = sales less cost Net profit = gross profit plus
of sales other income less expenses
Steps that take place during the closing transfers of a trading business at the end of the
financial year:
Close off Debtor Allowances account to the Sales account
Close off the Sales account to the Trading account
Calculate the gross profit in the Trading account
Transfer the gross profit from the Trading account to the Profit & Loss account
Close off all income to the credit side of the Profit & Loss account
Close off all expenses to the debit side of the Profit & Loss account
Calculate the net profit in the Profit & Loss account
Transfer the net profit from the Profit & Loss account to the Capital account
Close off the Drawings to the Capital account
After all the closing transfers have been done, a post-closing Trail Balance is drawn up. The
post-closing Trail Balance contains only Balance Sheet accounts since all nominal accounts
have already been closed off.
The accounting cycle & generally accepted accounting
practice
, GAAP principle Description Example
Business entity rule The financial affairs of the owner should The business and the owner
be kept separate from that of the must each have their own bank
business – they are 2 separate entities. account.
Historical cost concept Assets should be entered at its historical Land & Buildings purchased for
cost; that is, the amount that was R500 000 will be entered at that
originally paid for them. amount in the books, even if the
business can receive a lot more
for it after a couple of years.
Going concern concept The financial statements of a business Assets are valued at historical
are prepared with the assumption that cost and not the value the
the business will continue operating in business will receive for it,
the foreseeable future. should the business be sold in
the following year.
Matching concept Income and expenses must be The telephone account for
accounted for in the correct time period. February 2015 must be taken
into account in the financial year
ending 28 February 2015, even if
the account is only being paid in
March.
Prudence concept Financial results are reflected in a If the business expects to make a
conservative manner. profit of R100 000 on the sale of
part of the building, it will not be
entered in the books until the
transfer of the land has been
concluded.
Concept of materiality Material items must be shown in the Interest on Overdraft must be
financial statements, but the immaterial shown in a specific account,
items need not be highlighted. while Consumables can be
included with Sundry Expenses.
