5.1 Statement of Financial Position (Balance Sheet) – Sole Trader
1. Purpose of the Statement of Financial Position
The Statement of Financial Position (often called the balance sheet) gives a snapshot of a business’s financial standing on a particular date. It shows what the business owns (assets), what it owes (liabilities) and the owner’s residual interest (owner’s capital). Together with the Income Statement it provides the information needed for:
Assessing profitability and solvency
Making decisions about borrowing, investing or drawing cash
Meeting legal and tax reporting requirements
2. Key Accounting Concepts (Syllabus Unit 1)
Book‑keeping vs. Accounting – Book‑keeping records the day‑to‑day transactions (journal, ledger, trial balance). Accounting interprets those records to produce financial statements and analyse performance.
Double‑entry system – Every transaction affects at least two accounts so that the accounting equation always stays in balance.
Accounting equation for a sole trader:
Assets = Liabilities + Owner’s Capital
3. Prerequisite – How the Figures Are Produced (Syllabus Unit 2)
Key steps before the balance sheet
Source documents (invoices, receipts, bank statements, etc.) are recorded in the journal.
Journal entries are posted to the appropriate ledger accounts.
The ledger totals are compiled into a trial balance.
Adjusting entries (depreciation, accruals, pre‑payments, etc.) are added to the trial balance.
The adjusted trial balance provides the figures for the Income Statement and the Statement of Financial Position.
4. Verification of Records (Syllabus Unit 3)
Before preparing the balance sheet the totals must be checked for accuracy:
Trial‑balance check – total debits must equal total credits.
Bank reconciliation – ensures the cash‑in‑bank figure matches the bank statement after adjusting for outstanding cheques and deposits in transit.
Control accounts & error correction – any discrepancy is investigated and corrected (e.g., transposition errors, omitted entries).
5. Common Adjustments that Affect the Balance Sheet (Syllabus Unit 4)
Adjustment
Effect on the Statement of Financial Position
Accruals (expenses incurred but not yet paid)
Increase Liabilities (e.g., accrued wages) and decrease Owner’s Capital via the expense in the Income Statement.
Pre‑payments (payments made in advance of the related expense)
Increase Assets (pre‑payment) and decrease current profit, reducing capital.
Depreciation of non‑current assets
Reduce the carrying amount of the asset (cost – accumulated depreciation) and record an expense, which lowers profit and therefore capital.
Irrecoverable debts (bad debts)
Write‑off the receivable, decreasing Assets and reducing profit → lower capital.
Provision for doubtful debts
Creates a contra‑asset (allowance) that reduces the net value of trade receivables; the expense lowers profit and capital.
Inventory valuation (lower of cost or NRV)
If NRV < cost, write‑down inventory, decreasing Assets and profit → lower capital.
6. Structure of the Sole‑Trader Balance Sheet
The balance sheet is divided into three sections. The items listed below are those required by the Cambridge IGCSE (0452) specification.
Section
Typical Items (as per syllabus)
Assets
Cash and bank balances
Trade receivables (debtors)
Stock (inventory)
Pre‑payments (e.g., insurance paid in advance)
Short‑term investments (if any)
Non‑current assets – equipment, furniture, motor vehicles, etc., shown at cost less accumulated depreciation
Liabilities
Trade payables (creditors)
Bank overdrafts
Accrued expenses (e.g., wages owing)
Loans and mortgages – split into current (due within 12 months) and non‑current (due after 12 months)
Owner’s Capital (Equity)
Opening capital (balance at the start of the year)
+ Net profit (or – Net loss) for the year (taken from the Income Statement)
+ Additional capital introduced by the owner during the year
– Drawings (withdrawals by the owner)
7. Calculating Closing Owner’s Capital
Closing capital is built up from the opening balance, the profit earned, any extra money the owner injects, and reduced by drawings.
Closing Capital = Opening Capital + Net Profit + Additional Capital – Drawings
8. Effect of Common Transactions on the Balance Sheet
Profit earned – Increases an asset (usually cash or receivables) and increases Owner’s Capital by the same amount.
Drawings – Reduces cash (or another asset) and reduces Owner’s Capital by the same amount.
Liability repayment – Reduces cash (or another asset) and reduces the relevant liability by the same amount.
Purchase of a non‑current asset on credit – Increases the asset (equipment) and increases a liability (trade payables).
9. Depreciation – Net Book Value of Non‑Current Assets
Non‑current assets are shown at cost less accumulated depreciation. For example, equipment costing £8 000 with £2 000 accumulated depreciation is recorded at £6 000.
Depreciation is a systematic allocation of the asset’s cost over its useful life. It is recorded as an expense in the Income Statement, which reduces profit and, consequently, Owner’s Capital.
10. Link to the Income Statement
The profit (or loss) used in the capital calculation comes from the Income Statement prepared for the same accounting period. This demonstrates the inter‑relationship between the two statements:
Profit increases both assets (e.g., cash received) and capital.
A loss decreases assets (e.g., unsold stock) and capital.
11. Worked Example – Complete Statement of Financial Position
Megan’s Boutique – as at 31 December 2024
Megan’s Boutique – Statement of Financial Position
The totals above are derived from an adjusted trial balance. Any discrepancy would be identified through a trial‑balance check or a bank reconciliation before the balance sheet is finalised.
12. Additional Worked Example – Repayment of a Loan
Assume Megan repays £600 of a bank loan using cash.
Cash (Asset) decreases by £600.
Bank loan (Liability) decreases by £600.
The accounting equation remains balanced because the reduction occurs on both sides:
Assets ↓ £600 = Liabilities ↓ £600 + Capital (unchanged)
13. Extension – Other Business Forms & Incomplete Records
Partnerships – The same three‑section format is used, but the equity section is split into a capital account for each partner and a current account showing profit share and drawings.
Limited companies – Equity is presented as share capital, share premium, retained earnings and reserves.
Clubs & societies – Usually have a “funds” section rather than “capital”.
Manufacturing accounts – Include work‑in‑progress and finished‑goods inventories; the balance sheet still follows the same structure.
Incomplete records – When not all source documents are available, students must reconstruct the trial balance using the “adjusted trial‑balance method” (e.g., estimating opening balances, using cash‑book totals, applying the accounting equation). The reconstructed figures are then used to prepare the balance sheet.
14. Practice Questions
Prepare a Statement of Financial Position
Jane runs a sole‑trader graphic‑design business. At year‑end she has:
Prepare a complete Statement of Financial Position and verify that Assets = Liabilities + Capital.
Explain why the accounting equation must always balance for a sole trader.
Write a short paragraph (2‑3 sentences) linking the equation to the double‑entry system and to the flow of profit from the Income Statement.
Effect of a loan repayment
During the year the sole trader repays £600 of a bank loan using cash. Show how this transaction is recorded in the Statement of Financial Position and explain why the equation stays in balance.
Suggested diagram (for teacher’s use): a flowchart showing (a) profit → increase in assets & capital, (b) drawings → decrease in assets & capital, (c) loan repayment → decrease in cash & liability.
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