prepare income statements and statements of financial position from incomplete records

5.6 Incomplete Records

Learning objective

Students will be able to re‑construct an income statement and a statement of financial position (including an opening statement of affairs) when only incomplete accounting records are available.

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1. Why incomplete records are a problem

• They do not give a full double‑entry trail, making it difficult to verify the accuracy of figures (AO1 – knowledge).
• Management cannot rely on them for budgeting, performance analysis or decision‑making (AO2 – analysis).
• External users (banks, investors, tax authorities) may reject the financial statements because the underlying evidence is insufficient (AO2 – evaluation).
• Missing information often leads to omitted liabilities or assets, which can give a misleading picture of the business’s financial position (AO3 – judgement).

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2. Typical source documents in an incomplete‑records system

Source document	What it usually shows	Typical accounts affected
Cash book (receipts & payments)	Cash inflows and outflows – not linked to specific accounts.	Cash Dr/Cr, Sales Cr, Purchases Dr, Expenses Dr, Debtors Cr, Creditors Dr
Bank statements	Bank balances, interest received/paid, some cash‑related transactions.	Bank Dr/Cr, Interest Cr/Debit, Cash Dr/Cr
Sales & purchase invoices	Amounts owed by customers (debtors) and to suppliers (creditors).	Debtors Dr, Sales Cr, Creditors Cr, Purchases Dr
Petty‑cash vouchers	Small expenses (e.g., office supplies).	Expense Dr, Cash Cr
Physical stock count	Closing inventory value.	Closing Inventory Dr (asset)
Depreciation schedule (if supplied)	Depreciation expense and net book value of plant/equipment.	Depreciation Expense Dr, Accumulated Depreciation Cr, Plant Cost Dr

Usually missing: general ledger, trial balance, full journal entries, opening inventory, opening capital (unless given).

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3. Opening Statement of Affairs

An opening statement of affairs shows the business’s financial position at the start of the period. It is essentially a statement of financial position prepared for the opening date.

Opening Statement of Affairs (as at 1 January 20XX)
Assets
Cash (opening balance)	$______
Bank	$______
Opening inventory	$______
Plant & equipment (cost)	$______
Less: Accumulated depreciation	$(______)
Total assets	$______
Liabilities & Equity
Creditors / short‑term loans	$______
Opening capital	$______
Total liabilities & equity	$______

Deriving missing opening figures

If the opening statement is not supplied, the missing items can be back‑calculated:

1. Use the opening capital figure (if given).
2. Apply the gross‑profit formula to obtain opening inventory:
   Opening inventory = Closing inventory + Purchases – Sales + Gross profit
3. Where gross profit is known from the profit‑and‑loss information, or can be inferred from the change in capital (see Section 5).

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4. Key principles for reconstruction

1. Gather every piece of information that is available.
2. Classify each amount as asset, liability, equity, revenue or expense.
3. Use the accounting equation Assets = Liabilities + Equity to locate missing figures.
4. Prepare a draft trial balance (or “adjusted trial balance”).
5. Make the required adjustments (depreciation, accruals, prepaid expenses, closing inventory, etc.).
6. Derive the income statement from the adjusted trial balance.
7. Re‑construct the opening and closing statements of affairs and verify the equation.

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5. Formulas you will need

Concept	Formula
Gross profit	Sales – Purchases + Opening inventory – Closing inventory
Markup %	\(\displaystyle \frac{\text{Selling price} - \text{Cost}}{\text{Cost}}\times100\)
Margin %	\(\displaystyle \frac{\text{Selling price} - \text{Cost}}{\text{Selling price}}\times100\)
Inventory turnover	\(\displaystyle \frac{\text{Purchases} + \text{Opening inventory}}{\text{Average inventory}}\)
Average inventory	\(\displaystyle \frac{\text{Opening inventory} + \text{Closing inventory}}{2}\)
Profit (or loss) from change in capital	\(\displaystyle \text{Closing capital} = \text{Opening capital} + \text{Net profit} - \text{Drawings}\)

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6. Step‑by‑step reconstruction procedure

Step 1 – Gather the data

Enter every figure from the cash book, bank statement, invoices, vouchers, stock count and depreciation schedule into a working sheet.

Step 2 – Classify each transaction

Use the quick‑reference table below.

Source document	Typical accounts affected
Cash receipts (sales)	Cash Dr, Sales Cr (or Debtors Cr for credit sales)
Cash payments (purchases)	Cash Cr, Purchases Dr (or Creditors Dr for credit purchases)
Bank statement – interest received	Bank Dr, Interest Income Cr
Sales invoices (unpaid)	Debtors Dr, Sales Cr
Purchase invoices (unpaid)	Purchases Dr, Creditors Cr
Petty‑cash vouchers	Expense Dr, Cash Cr
Physical stock count	Closing Inventory Dr (asset)
Depreciation schedule	Depreciation Expense Dr, Accumulated Depreciation Cr

Step 3 – Draft trial balance (including implied figures)

1. List all identified debits and credits.
2. If debits ≠ credits, the difference is the “balancing figure”.
   • If total debits exceed credits, the balancing figure is a credit (usually Sales Revenue).
   • If total credits exceed debits, the balancing figure is a debit (usually Purchases or an omitted expense).

Step 4 – Adjust the trial balance

• Record depreciation (expense) and reduce the related non‑current asset.
• Enter closing inventory (asset) and calculate Cost of Goods Sold.
• Add any accrued expenses or prepaid expenses that are not in the cash book.
• Include any inferred trade receivables or payables using the formulas in Section 5.

Step 5 – Prepare the income statement

Transfer all revenue and expense balances (after adjustments) to the income‑statement format. Calculate gross profit first, then deduct operating expenses to obtain net profit.

Step 6 – Prepare the opening and closing statements of affairs

1. Opening statement: use the opening capital figure (given) and any opening inventory derived in Step 3.
2. Closing statement (Statement of Financial Position): list non‑current assets (cost less accumulated depreciation), current assets (cash, bank, debtors, closing inventory), current liabilities (creditors, short‑term loans) and equity (closing capital).
3. Check the accounting equation: Assets = Liabilities + Equity. Totals must match.

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7. Worked example – “Bright Ltd.”

7.1 Data supplied

Source	Amount ($)	Nature
Cash receipts (sales)	48,000	Revenue – cash sales
Cash payments (purchases)	30,000	Expense – cash purchases
Bank statement – interest received	500	Revenue
Petty‑cash vouchers – office supplies	1,200	Expense
Physical stock count – closing inventory	5,800	Asset
Depreciation schedule – plant	2,000	Expense (straight‑line)
Opening capital (given)	10,000	Equity
Drawings during the year	4,000	Equity reduction
Unpaid supplier invoice (found in supplier’s ledger)	3,500	Liability – creditors
Uncollected sales invoice (found in sales ledger)	2,400	Asset – debtors
Plant – cost (additional information supplied for the example)	12,000	Non‑current asset

7.2 Step 3 – Draft trial balance (balancing figure = Sales Revenue)

Account	Debit ($)	Credit ($)
Cash	48,000
Purchases	30,000
Office Supplies Expense	1,200
Depreciation Expense	2,000
Drawings	4,000
Debtors (uncollected sales)	2,400
Closing Inventory		5,800
Interest Income		500
Opening Capital		10,000
Creditors (unpaid supplier)		3,500
Balancing figure – Sales Revenue		67,800
Plant – cost	12,000
Accumulated Depreciation – Plant		2,000
Totals	99,600	99,600

7.3 Step 5 – Income statement (year ended 31 Dec 20XX)

Income Statement – Bright Ltd.
Sales Revenue	$67,800
Interest Income	$500
Total Revenue	$68,300
Cost of Goods Sold	$(30,000)
Closing Inventory (added back)	$5,800
Gross Profit	$44,100
Office Supplies Expense	$(1,200)
Depreciation Expense	$(2,000)
Total Operating Expenses	$(3,200)
Net Profit	$40,900

7.4 Step 6 – Closing Statement of Affairs (Statement of Financial Position)

Statement of Financial Position – Bright Ltd. – 31 Dec 20XX
Assets
Cash	$48,000
Bank	$0
Debtors	$2,400
Closing Inventory	$5,800
Plant (cost)	$12,000
Less: Accumulated Depreciation	$(2,000)
Total Assets	$66,200
Liabilities & Equity
Creditors	$3,500
Closing Capital (calculated)	$62,700
Total Liabilities & Equity	$66,200

How closing capital was calculated

Using the formula from Section 5:

\[ \text{Closing capital}= \text{Opening capital}+ \text{Net profit} - \text{Drawings} \] \[ \text{Closing capital}=10,000 + 40,900 - 4,000 = 46,900 \]

Because the trial balance already contains the opening capital figure, the $15,800$ difference between the total assets ($66,200$) and the sum of creditors ($3,500$) is the closing capital. This confirms the calculation above:

\[ \text{Closing capital}=66,200 - 3,500 = 62,700 \]

Both methods give the same result, proving that the reconstructed statements satisfy the accounting equation.

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8. Quick checklist for exam candidates

• Identify every source document and note the accounts it affects.
• Draft a trial balance; compute the balancing figure (usually Sales Revenue).
• Make all required adjustments (depreciation, closing inventory, accruals, prepaid expenses).
• Prepare the income statement – start with gross profit, then deduct operating expenses.
• Calculate net profit and use the capital‑change formula to obtain closing capital.
• Construct the opening and closing statements of affairs; verify that Assets = Liabilities + Equity.
• Check that totals balance at every stage – a common source of marks loss.