The preparation of financial statements is the culmination of everything you learn in Edexcel IGCSE Accounting. This section of the 4AC1 specification brings together bookkeeping skills, adjustments and presentation into the statements that communicate a business's financial performance and position.
The Edexcel IGCSE Accounting the preparation of financial statements section covers five areas: financial statements of a sole trader, financial statements of a partnership, incomplete records, the calculation and interpretation of accounting ratios, and financial statements of a manufacturer. Together they form the core of Paper 2, though elements also appear on Paper 1. These edexcel igcse accounting revision notes provide the structure, worked examples and exam guidance you need for each area.
Financial statements of a sole trader
A sole trader prepares two financial statements at the end of each accounting period: an income statement and a statement of financial position.
Income statement
The income statement shows whether the business has made a profit or loss. It follows a standard structure:
| Income Statement of A. Taylor for the year ended 31 December | |
|---|---|
| Revenue | 120,000 |
| Less: Cost of sales | |
| Opening inventory | 8,000 |
| Add: Purchases | 65,000 |
| Less: Closing inventory | (10,000) |
| Cost of sales | (63,000) |
| Gross profit | 57,000 |
| Less: Expenses | |
| Wages | 18,000 |
| Rent | 6,000 |
| Depreciation | 4,000 |
| Irrecoverable debts | 1,200 |
| Total expenses | (29,200) |
| Profit for the year | 27,800 |
Statement of financial position
The statement of financial position shows what the business owns (assets), what it owes (liabilities) and the owner's equity at a specific date.
| Statement of Financial Position of A. Taylor as at 31 December | |
|---|---|
| Non-current assets | |
| Premises | 50,000 |
| Equipment (cost 20,000 less depreciation 8,000) | 12,000 |
| Total non-current assets | 62,000 |
| Current assets | |
| Inventory | 10,000 |
| Trade receivables | 7,500 |
| Other receivables (prepayments) | 800 |
| Bank | 3,200 |
| Total current assets | 21,500 |
| Total assets | 83,500 |
| Current liabilities | |
| Trade payables | 4,200 |
| Other payables (accruals) | 1,500 |
| Total current liabilities | (5,700) |
| Net assets | 77,800 |
| Equity | |
| Capital at start of year | 55,000 |
| Add: Profit for the year | 27,800 |
| Less: Drawings | (5,000) |
| Capital at end of year | 77,800 |
Financial statements of a partnership
A partnership produces the same two financial statements as a sole trader, plus an appropriation account that shows how the profit for the year is divided between partners.
Partnership Act 1890, Section 24
Unless the partnership agreement states otherwise, Section 24 applies by default:
- Profits and losses are shared equally
- No partner receives a salary
- No interest is allowed on capital
- Interest at 5% per annum is payable on loans from partners
Appropriation account
The appropriation account starts with the profit for the year and deducts or adds items before arriving at the residual profit to be shared:
| Appropriation Account of Shah and Nguyen for the year ended 31 March | |
|---|---|
| Profit for the year | 48,000 |
| Less: Interest on loan (Nguyen, 5% on 10,000) | (500) |
| Less: Partners' salaries | |
| Shah | (12,000) |
| Nguyen | (8,000) |
| Add: Interest on capital | |
| Shah (5% on 40,000) | (2,000) |
| Nguyen (5% on 30,000) | (1,500) |
| Residual profit | 24,000 |
| Share of residual profit (equal): | |
| Shah | 12,000 |
| Nguyen | 12,000 |
Partners' current accounts
Each partner has a capital account (usually fixed) and a current account (which fluctuates). The current account is credited with salary, interest on capital and share of profit, and debited with drawings and interest on drawings.
Statement of financial position for a partnership
The equity section shows each partner's capital balance and current account balance separately, replacing the sole trader's single capital figure.
Incomplete records
Incomplete records questions arise when a business has not maintained a full double-entry system. The exam expects you to reconstruct the missing figures using the information available.
Two main techniques
- Statement of affairs method: Calculate profit by comparing opening and closing equity (net assets). Profit = Closing equity - Opening equity + Drawings - Capital introduced.
- Reconstruction method: Use control accounts to calculate missing revenue or purchases figures, then prepare a full income statement and statement of financial position.
Worked example: finding missing revenue
Opening trade receivables: 6,400. Closing trade receivables: 7,800. Cash received from customers: 52,000. Irrecoverable debts written off: 600.
Using a trade receivables control account:
| Debit | Credit | ||
|---|---|---|---|
| Balance b/d | 6,400 | Bank | 52,000 |
| Revenue (balancing figure) | 54,000 | Irrecoverable debts | 600 |
| Balance c/d | 7,800 | ||
| Total | 60,400 | Total | 60,400 |
Revenue for the year = 54,000 (the balancing figure).
The calculation and interpretation of accounting ratios
The specification requires you to calculate and interpret five ratios across two categories.
Profitability ratios
| Ratio | Formula | What it measures |
|---|---|---|
| Gross profit percentage | (Gross profit / Revenue) x 100 | How much gross profit is earned per pound of revenue |
| Profit for the year percentage | (Profit for the year / Revenue) x 100 | How much net profit is earned per pound of revenue after all expenses |
| Return on capital employed (ROCE) | (Profit for the year / Capital employed) x 100 | How effectively the business uses its capital to generate profit |
Liquidity ratios
| Ratio | Formula | What it measures |
|---|---|---|
| Current (working capital) ratio | Current assets / Current liabilities | Ability to pay short-term debts (ideal around 2:1) |
| Liquid (acid test) ratio | (Current assets - Inventory) / Current liabilities | Ability to pay short-term debts without selling inventory (ideal around 1:1) |
Financial statements of a manufacturer
A manufacturing business prepares a manufacturing account before the income statement. This shows the cost of producing goods.
Structure of a manufacturing account
| Manufacturing Account for the year ended 31 December | |
|---|---|
| Direct materials | |
| Opening inventory of raw materials | 5,000 |
| Add: Purchases of raw materials | 30,000 |
| Less: Closing inventory of raw materials | (4,500) |
| Raw materials consumed | 30,500 |
| Direct labour | 22,000 |
| Direct expenses | 3,000 |
| Prime cost | 55,500 |
| Factory overheads | |
| Factory rent | 6,000 |
| Factory power | 4,000 |
| Factory depreciation | 3,500 |
| Total factory overheads | 13,500 |
| Production cost | 69,000 |
| Add: Opening work-in-progress | 2,000 |
| Less: Closing work-in-progress | (2,500) |
| Total cost of goods manufactured | 68,500 |
The total cost of goods manufactured transfers to the income statement in place of purchases. The income statement then follows the same structure as for a trading business, using cost of goods manufactured instead of purchases to calculate cost of sales.
The three types of inventory for a manufacturer are raw materials, work-in-progress and finished goods. Each appears in a different part of the accounts: raw materials in the manufacturing account, work-in-progress as an adjustment to production cost, and finished goods in the income statement as the opening and closing inventory for calculating cost of sales.
Self-check questions
- State the formula for cost of sales in a sole trader's income statement.
- A business has revenue of 90,000, cost of sales of 54,000 and total expenses of 18,000. Calculate the gross profit percentage and the profit for the year percentage.
- Under Section 24 of the Partnership Act 1890, what happens if the partnership agreement is silent on how profits are shared?
- Opening equity is 35,000 and closing equity is 42,000. During the year, the owner introduced 3,000 capital and took 8,000 in drawings. Calculate the profit for the year using the statement of affairs method.
- A business has current assets of 24,000 (including inventory of 9,000) and current liabilities of 12,000. Calculate the current ratio and the liquid ratio.
- Explain the difference between prime cost and production cost in a manufacturing account.
Self-check questions
- Explain the difference between capital expenditure and revenue expenditure, giving two examples of each.
- A machine costs $12,000 and has an expected useful life of 5 years with a residual value of $2,000. Calculate the annual depreciation charge using the straight-line method and show the net book value after 3 years.
- A business discovers that goods returned by a customer for $350 were recorded in the purchases returns journal instead of the sales returns journal. Explain the effect of this error on the trial balance and describe the correcting entry.
- State three items that would appear on the debit side of a trial balance and three items that would appear on the credit side.
The preparation of financial statements edexcel igcse section is the destination that all bookkeeping leads to. Whether you are preparing a sole trader's income statement, splitting partnership profits through an appropriation account, or reconstructing figures from incomplete records, the underlying principles are the same. The igcse 4ac1 the preparation of financial statements questions on Paper 2 are substantial, but they follow a predictable structure. Practise them under timed conditions using the edexcel igcse accounting practice questions available through past papers, and study the mark schemes to learn exactly where the marks are awarded. These edexcel igcse accounting explained techniques, reinforced by solid edexcel igcse accounting notes, will carry you through the most demanding questions the exam can set.
Revision notes for Edexcel IGCSE Accounting: financial statements for sole traders, partnerships, incomplete records and accounting ratios.
Àsìkò méjì (Comment(s))