5.1 Sole Traders
Objective
To be able to prepare income statements for trading businesses and for service businesses, to understand the related financial‑statement concepts and year‑end adjustments required by the Cambridge IGCSE Accounting (0452) syllabus.
What is a Sole Trader?
A sole trader is an individual who owns and runs a business on his or her own. All profits belong to the owner and all losses are borne by the owner.
Advantages & Disadvantages of a Sole‑Trader
| Advantages | Disadvantages |
|---|
- Full control – the owner makes all decisions.
- All profits belong to the owner.
- Simple to set up and to dissolve.
- Minimal statutory reporting requirements.
|
- Unlimited liability – personal assets are at risk.
- Limited capital – depends on the owner’s own funds or borrowing.
- Continuity depends on the owner’s health, willingness to work or retirement.
- Harder to attract skilled staff or external investors.
|
Purpose of Financial Statements for Sole Traders
- Income Statement (Profit & Loss Account) – shows the business’s performance over a period (usually a year). It answers the question: Did the business make a profit or incur a loss?
- Statement of Financial Position (Balance Sheet) – shows the financial position at a specific date. The syllabus requires the statement to be presented under five distinct headings:
- Non‑current assets (e.g., equipment, vehicles, buildings)
- Current assets (e.g., cash, debtors, inventory)
- Current liabilities (e.g., creditors, bank overdraft)
- Non‑current liabilities (e.g., long‑term loans)
- Owner’s capital (opening capital + net profit – drawings)
Key Accounting Concepts
- Revenue (or Fees) – total amount earned from sales of goods or from providing services.
- Cost of Goods Sold (COGS) – the cost of inventory that has been sold (trading businesses only).
- Operating Expenses – costs incurred in the day‑to‑day running of the business (rent, salaries, utilities, advertising, etc.).
- Gross Profit – Revenue – COGS (shown only for traders).
- Net Profit (or Net Loss) – the final result after all incomes and expenses have been accounted for.
- Non‑operating items – interest, tax or extraordinary items; they are shown separately if required by the exam.
Trading Business vs. Service Business – Quick Comparison
| Aspect |
Trading Business |
Service Business |
| Main activity |
Buying goods for resale |
Providing services (e.g., tutoring, consulting) |
| Inventory |
Yes – opening & closing inventory are recorded |
No inventory – COGS is not applicable |
| Cost of Goods Sold |
Calculated (Opening + Purchases – Closing) |
Not shown |
| Gross Profit line |
Present |
Absent |
Income Statement – General Structure
For the IGCSE exam the following layout is expected:
Trading Business
| Trading Business Income Statement | Amount (£) |
|---|
| Sales (Revenue) | |
| Opening Inventory | |
| Purchases | |
| Closing Inventory | |
| Cost of Goods Sold | |
| Gross Profit (Sales – COGS) | |
| Operating Expenses | |
| Net Profit (or Net Loss) | |
| Non‑operating items (if any) | |
| Profit after non‑operating items | |
Service Business
| Service Business Income Statement | Amount (£) |
|---|
| Revenue (Fees for Services) | |
| Operating Expenses | |
| Net Profit (or Net Loss) | |
| Non‑operating items (if any) | |
| Profit after non‑operating items | |
Steps to Prepare an Income Statement (IGCSE Checklist)
- Identify the type of business – trading or service.
- Record total revenue (sales or fees) for the period.
- If it is a trading business, calculate COGS:
- Opening Inventory + Purchases – Closing Inventory = COGS
- Deduct COGS from revenue to obtain Gross Profit (trading only).
- List all operating expenses (rent, salaries, utilities, advertising, depreciation, etc.).
- Subtract total operating expenses from Gross Profit (or directly from Revenue for a service business) to obtain Net Profit.
- If the question requires, add any non‑operating items (interest, tax) and calculate profit after those items.
Year‑End Adjustments Checklist (AO2/AO3)
- Depreciation – allocate the cost of non‑current assets over their useful lives (expense only, not part of COGS).
- Accrued expenses – expenses incurred but not yet paid (e.g., salaries payable).
- Prepaid expenses – payments made in advance; expense the portion that relates to the next period.
- Doubtful‑debt provision – estimate of receivables that may not be collected; shown as an expense.
- Inventory valuation – ensure closing inventory is recorded at the lower of cost or net realisable value.
- Drawings – amounts taken by the owner; deducted from owner’s capital on the Statement of Financial Position, not from the income statement.
Statement of Financial Position – Full Layout (example)
| Statement of Financial Position (as at 31 July 2025) |
|---|
| Non‑current assets | — equipment £5 000, vehicles £3 000 |
| Current assets | — cash £2 500, debtors £1 800, inventory £4 200 |
| Current liabilities | — creditors £2 100, bank overdraft £1 200 |
| Non‑current liabilities | — loan repayable after 12 months £6 000 |
| Owner’s capital | Opening capital £10 000 + Net profit £4 400 – Drawings £1 200 = £13 200 |
Example – Trading Business
Emily’s stationery shop – year ended 31 July 2025
- Sales: £45 000
- Opening inventory: £8 000
- Purchases: £20 000
- Closing inventory: £6 000
- Rent: £5 400
- Salaries: £12 000
- Utilities: £1 200
| Emily’s Shop – Income Statement | Amount (£) |
|---|
| Sales (Revenue) | 45 000 |
| Opening inventory | 8 000 |
| Purchases | 20 000 |
| Closing inventory | (6 000) |
| Cost of Goods Sold | 22 000 |
| Gross Profit | 23 000 |
| Rent | 5 400 |
| Salaries | 12 000 |
| Utilities | 1 200 |
| Total Operating Expenses | 18 600 |
| Net Profit | 4 400 |
Example – Service Business
Tom’s tutoring service – year ended 31 July 2025
- Fees received: £30 000
- Rent of teaching rooms: £4 800
- Advertising: £1 200
- Stationery (office supplies): £600
| Tom’s Tutoring – Income Statement | Amount (£) |
|---|
| Revenue (Fees) | 30 000 |
| Rent | 4 800 |
| Advertising | 1 200 |
| Stationery | 600 |
| Total Operating Expenses | 6 600 |
| Net Profit | 23 400 |
Common Mistakes to Avoid (Exam Tips)
- Omitting the closing inventory when calculating COGS – this inflates cost and reduces profit.
- Including non‑operating items (interest, tax) in the basic income statement – they must be shown separately.
- Confusing Gross Profit with Net Profit in a trading business.
- Forgetting small expenses such as stationery, postage or bank charges.
- Writing the COGS formula incorrectly; remember the sign of closing inventory is negative (subtract it).
- Recording depreciation as part of COGS – it is an operating expense, not a cost of inventory.
Quick Revision Checklist
- Identify whether the business is a trader or a service provider.
- Collect figures for Revenue, Opening Inventory, Purchases, Closing Inventory (if applicable) and all operating expenses.
- Calculate COGS only for traders (Opening + Purchases – Closing).
- Work out Gross Profit (traders) then deduct total operating expenses.
- Include any required non‑operating items and arrive at the final Net Profit or Net Loss.
- Check the year‑end adjustments (depreciation, accruals, prepaid, doubtful debts, drawings) and ensure they are reflected in the correct statements.
Practice Question (Paper 2 style)
Question: Sarah runs a graphic‑design studio. For the year ended 31 July 2025 she recorded the following:
- Fees received: £28 500
- Rent of studio: £5 100
- Computer equipment – depreciation expense: £1 800
- Advertising: £900
- Stationery: £300
Prepare a correctly formatted income statement and state Sarah’s net profit.
Model Answer:
| Sarah’s Graphic‑Design Studio – Income Statement | Amount (£) |
|---|
| Revenue (Fees) | 28 500 |
| Rent | 5 100 |
| Depreciation expense | 1 800 |
| Advertising | 900 |
| Stationery | 300 |
| Total Operating Expenses | 8 100 |
| Net Profit | 20 400 |