(a) State three effects of drawings on the business of a sole proprietor. (b) Explain how the following items are treated in the balance sheet: i. accrued e...

Answer Details

(a) Three effects of drawings on the business of a sole proprietor

1. Drawings reduce the owner's capital, since they are deducted from capital in the Balance Sheet.
2. Drawings reduce the assets of the business (cash or goods taken out fall by the amount withdrawn).
3. Drawings reduce the working capital and cash available for running the business, which may affect its liquidity and ability to expand.

(Note: drawings do not affect the calculation of net profit; they are an appropriation of capital, not an expense.)

(b) Treatment in the Balance Sheet

(i) Accrued expenses: These are expenses incurred during the period but not yet paid at the year end (for example, rent owing). In the Balance Sheet they are shown as a current liability, since the business owes the amount. (The amount is also added to the relevant expense in the Profit and Loss Account.)

(ii) Prepaid expenses: These are expenses paid in advance that relate to the following period (for example, insurance paid ahead). In the Balance Sheet they are shown as a current asset, because the benefit is still owed to the business. (The amount is deducted from the relevant expense in the Profit and Loss Account.)

(iii) Accrued income: This is income earned during the period but not yet received at the year end (for example, rent receivable due but not yet collected). In the Balance Sheet it is shown as a current asset, since it is owed to the business. (The amount is added to the relevant income in the Profit and Loss Account.)