Sole Trader & Financial Statements
A Business run by a Single Owner
Advantages of a Sole Trader
1. Easy and cheap to set up // No legal set up
2. Does not require permission from law to carry out business activities
3. All profit is enjoyed by owner
4. The sole trader has sole control
Disadvantages of Sole Trader
1. Unlimited Liabilities - Must Sacrifice personal funds to meet debts
2. There is no seperate legal existence between owner and business ( in terms of public )
3. No continuity so business dies with owner
4. Losses must be borne by the owner
5. More work load and less skill
Inventory Valuation
Inventory must be valued lower at cost and net realisable value
Suprisingly, this question comes in suprising ways. They may ask how work in progress or raw material is valued
Net Realisable Value
Estimated Sale of Reciepts less the cost of completing the goods and less the selling expense
Types of Inventory Valuation
1. Current Replacement Cost
2. FIFO
3. AVCO
4. LIFO
However, IAS only accepts FIFO & AVCO Valuation
FIFO // First in First out
Simply, the first items to be bought are the ones that are sold first. For example, if we consider a new business and the business buys goods on the 1st day, then again buys inventory on the 10th day. When sold the inventory bought on the first day must be sold first
Advantages of FIFO
1. Makes sure inventory is valued at the most recent prices
2. Accepted by standards such as IAS
3. Simpler and easier to calculate
4. The cost of inventory matches the cost that was initially used to buy the goods
Disadvantages of FIFO
1. Can overstate profit if the prices of goods are increasing as inventory is recorded at the most recent prices
2. Cost of goods sold are at the old selling prices which is unrealistic
Remember there are 2 types of FIFO methods, one is perpetual and the other one is periodic. Both gives the same answer but how often they calculate the inventory is different
LIFO // Last in Last out
The inventory is valued by selling the goods that was last in or most recently bought. Like a stack
Advantages of LIFO
1. Simpler and easier to calculate
2. Makes sure selling prices are sold at the most recent prices
3. The cost of goods matches the cost that was initially used to buy the goods
Disadvantages of LIFO
1. Not recommended by the IAS
2. Uses the oldest prices for inventory valuation
When we say the cost matching with selling price. The cost must be known to determine the selling price. see Absorption costing so if overstated the selling price is also overstated
AVCO // Average Costing Method
Similar to how relative atomic masses are calculated
When AVCO, each time goods are bought, the total cost of the product is divided by the number of units
Advantages of AVCO
1. It is a standard recommended by the IAS
2. It makes sure each product has an equal weightage and importance
3. More accurate and reliable as there is no significant changes with cost price per unit when goods are bought
Disadvantages of AVCO
1. Difficult to calculate as it is time consuming
Adjustments of Prepayments & Accurals
If expense, must be reducted from expense in the income statement and must be added to the other recievebles under current assets in the balance sheet
If income, must be reducted from income in the income statement and must be added to the other payables under current liabilities in the balance sheet
If Income, must be added to the income in the income statement and must be added to other recievables under current assets in balance sheet
If expense, must be added to the expense in the income statement and must be added to other payable under current liabilities in balance sheet
Treatment of Provision for Doubtful Debts
The closing provision is reducted from the trade recievables in the current assets
Increase in provision for doubtful debts is charged as an expense that reduces profit
Decrease in provision for doubtful debts is entered as an income after gross profit
Reasons for increase in rate of provision for doubtful debts
1. Increase in credit sales
2. Worsening of the economy
3. Past experience
4. Age of the debtors' balance
5. Poor Credit Control systems
Reasons why a business maintains a provision for doubtful debts
1. To make sure prudence concept is followed by avoiding overstating trade recievables and profit
2. To follow accurals concept by charging the sales that are unlikely to be made against the revenue made for that financial year
Accounting Concepts related with provisions for doubtful debts
1. Prudence Concept
2. Accurals / Matching Concept