Chapter 3 Case study
Solution and discussion
1. First, prepare the statement of profit or loss and statement of financial
position for the business. The list which Jimmy has provided is a jumbled mixture
of statement of profit or loss items and statement of financial position items, so
a useful preliminary step is to identify a category for each item depending upon
whether it goes in the trading account, the rest of the statement of profit or loss
or the statement of financial position. For statement of financial position items,
the terminology used in Chapter 2 can be used:

Non-current assets

Current assets

Current liabilities

Non-current liabilities

Capital
For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5)
© Catherine Gowthorpe, 2024, published by Cengage
1
£
Revenue
Category
143,520
Trading account
Opening inventory
9,274
Trading account
Non-current assets
3,823
Statement of financial position:
non-current assets
Opening capital balance 1 March 20X4
19,776
Statement of financial position:
capital
Bank
1,685
Statement of financial position:
current assets
Rental expense
16,500
Statement of profit or loss
Insurance
2,023
Statement of profit or loss
Electricity
2,056
Statement of profit or loss
Trade payables
8,229
Statement of financial position:
current liabilities
Trade receivables
1,800
Statement of financial position:
current assets
Drawings
23,153
Statement of financial position:
capital
Bank interest received
118
Statement of profit or loss
103,221
Trading account
Income from repairs services
4,389
Statement of profit or loss
Repairs service expenses – bicycle
1,317
Statement of profit or loss
2,278
Statement of profit or loss
Assistant’s wages
8,902
Statement of profit or loss
Closing inventory
16,337
Trading account AND statement of
Purchases
parts
Administration, finance and sundry
expenses
financial position: current assets
Note that closing inventory always appears in both the trading account and the
statement of financial position as a current asset. Inventory which remains
unsold at the statement of financial position is deducted, as we have seen, in
arriving at the cost of sales figure. However, it is also an asset of the business
because it can be sold to make money in the next following accounting period.
For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5)
© Catherine Gowthorpe, 2024, published by Cengage
2
Having categorized all the items the next stage is to pick out those which appear
in the trading account, and then prepare the trading account. Then, immediately
below it, the rest of the statement of profit or loss items are listed, ending with
net profit.
Remember that a heading with the name of the business (in this case Jimmy
simply uses his own name – this is common amongst sole traders) and a
description of the financial statement is always required.
Jimmy Bowden: Statement of profit or loss for the year ended 28 February 20X5
£
Revenue
£
143,520
Less: cost of sales
Opening inventory
Add: purchases
9,274
103,221
112,495
Less: closing inventory
(16,337)
(96,158)
Gross profit
47,362
Repairs service: income
4,389
Repairs service: expenses – bicycle parts
(1,317)
3,072
Other income – bank interest received
118
50,552
Expenses
Rental expense
16,500
Insurance
2,023
Electricity
2,056
Administration, finance and sundry expenses
2,278
Assistant’s wages
8,902
(31,759)
Net profit
18,793
For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5)
© Catherine Gowthorpe, 2024, published by Cengage
3
Once all of the balances have been put into the statement of profit or loss the
remainder should all relate to the statement of financial position, which can then
be prepared.
Jimmy Bowden: Statement of financial position at 28 February 20X5
£
£
ASSETS
Non-current assets
3,823
Current assets
Inventory
16,337
Trade receivables
1,800
Bank
1,685
19,822
23,645
CAPITAL AND LIABILITIES
Capital
Opening capital balance 1 March 20X4
19,776
Add: net profit for the year
18,793
38,569
Less: drawings
(23,153)
Closing capital balance 28 February 20X5
15,416
Current liabilities
Trade payables
8,229
23,645
Remember, the capital account shows the resources committed to the business
by the owner. The balance on the capital account increases or decreases in the
following ways:
Capital introduced
For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5)
© Catherine Gowthorpe, 2024, published by Cengage
4
PLUS
Profits retained in the business
MINUS
Drawings
MINUS
Any losses made by the business
Jimmy Bowden’s capital account, as shown in his statement of financial position
at 28 February 20X5 has been increased by the amount of net profit for the year
(calculated in the statement of profit or loss) and has been decreased by the
drawings he has made from the business.
2. Having prepared the statement of profit or loss and statement of financial
position for Jimmy’s business, it is now possible to address his questions about
the profitability of the business.
A logical first step is to take the table of figures he provided for 20X4 and slot in
the equivalent figures for 20X5:
20X5
20X4
Bicycle revenue for the year
143,520
164,728
Gross profit on bicycle sales
47,362
49,418
Profit on repairs service
3,072
3,422
Total expenses
31,759
27,263
Interest received
118
260
18,793
25,837
Net profit
For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5)
© Catherine Gowthorpe, 2024, published by Cengage
5
From this information a report with recommendations can be constructed by
the business adviser, as follows:
18th March 20X5
Report to Jimmy Bowden on business profitability based on the financial
statements at 28 February 20X5
There has been a substantial decline in revenue, gross and net profits
between 20X4 and 20X5. The fall in sales is over £20,000, which represents a
decline of almost 13 per cent.
There has been a small drop in profitability in the repairs service, but this is
a fairly insignificant part of the business.
Total expenses have increased from £27,263 to £31,759, an increase of 16.5
per cent. A more detailed comparison of expenses would be useful in
order to pinpoint the specific expenses which have risen. There may be a
need for better control of business expenses.
Net profits have fallen from £25,837 to £18,793. The decline is significant
and an action plan should be drawn up to address the problems the
business faces.
The business is not under immediate threat. The bank balance at 28
February 20X5 is £1,685 and there are no long-term borrowings. But trade
payables total
£8,229, and there could be problems if they start to press for immediate
payment. However, because of the good record of profitability in the
past, the bank is likely to grant overdraft facilities if they are required.
The level of drawings from the business of a little over £23,000 is not
For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5)
justified by the present level of profitability. Closing inventory is much
higher than opening inventory, because of the shortfall in Christmas
sales.
For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5)