amazon.co.ukA* revision of financial statements for AQA 7127 (3.5-3.7, 3.15-3.16): statements of profit or loss and financial position for sole traders, limited companies and partnerships, with accruals, prepayments, depreciation, bad debts and appropriation account calculations.
The statement of profit or loss measures performance for a period; the statement of financial position reports position at a date. In the exam you are usually handed a trial balance plus adjustments and asked for one or both. Speed comes from a fixed routine, and marks come from classification - most lost marks in these questions are not arithmetic but putting items in the wrong place.
Layout drill for the statement of profit or loss. Revenue less cost of sales gives gross profit, where cost of sales = opening inventory + purchases + carriage inwards − closing inventory. Then add other income (commission receivable, rent receivable, profit on disposal, discount received). Then deduct expenses in the order they arrive: selling and distribution costs (carriage outwards, sales staff, advertising), administrative expenses (office salaries, rent and rates, insurance, depreciation), and finance costs if any. The bottom line is profit for the year, transferred to the capital account of the sole trader. In the statement of financial position: non-current assets at net book value (cost less accumulated depreciation), current assets in the order inventory, trade receivables, prepayments, bank, cash; then equity (opening capital + profit for the year − drawings), current liabilities (trade payables, accruals, overdraft, income received in advance) and, if given, non-current liabilities.
| Item from the trial balance | Where it goes |
|---|---|
| Carriage inwards | Add to purchases in cost of sales |
| Carriage outwards | Selling expense |
| Discount received | Other income |
| Drawings (cash or goods) | Deduct from capital, never an expense |
| Rent receivable | Other income |
| Bank overdraft | Current liability |
| Provision for depreciation | Deduct from non-current asset cost |
The concepts (3.5) are not decoration: AQA asks you to state and explain the concept underlying a treatment, and the adjustments in the next section are each an application of one of them. Accruals (matching): report expenses and income in the period they are incurred or earned, not when cash moves. Prudence: do not overstate assets or income; provide for probable losses (e.g. the allowance for receivables) as soon as anticipated, but recognise gains only when realised. Going concern: assume the business will continue, so non-current assets are held at cost less depreciation rather than break-up value. Consistency: like items treated the same way each period so figures are comparable; changes in policy (e.g. depreciation method) must be disclosed and justified. Business entity: the owner and the business are separate - hence drawings, and hence why the owner's house never appears on the statement of financial position. Materiality: trivial items may be treated expediently (a £5 stapler expensed rather than capitalised and depreciated over years). Realisation: revenue is recognised when earned - goods delivered and title passed - not when ordered or when cash arrives.
Revenue £240,000; opening inventory £22,000; purchases £121,400; carriage inwards £3,600; closing inventory £25,000; carriage outwards £4,800; wages £38,000; rent £12,000 (accrual of £1,000 outstanding); insurance £2,400 (prepayment of £400); irrecoverable debts written off £1,500; increase in allowance for receivables £400; depreciation of equipment £6,000.
| £ | £ | |
|---|---|---|
| Revenue | 240,000 | |
| Opening inventory | 22,000 | |
| Purchases (121,400 + 3,600 carriage inwards) | 125,000 | |
| Less closing inventory | (25,000) | |
| Cost of sales | (122,000) | |
| Gross profit | 118,000 | |
| Expenses: carriage outwards 4,800; wages 38,000; rent (12,000 + 1,000) 13,000; insurance (2,400 − 400) 2,000; irrecoverable debts 1,500; allowance increase 400; depreciation 6,000 | (65,700) | |
| Profit for the year | 52,300 |
Every adjustment line is developed in the next section - but note now how the accruals concept drove rent (£13,000 is the period's true cost) and insurance (£2,000 likewise).
Closing inventory enters the statement twice and this trips candidates every year: it is deducted in cost of sales (raising gross profit) and added in current assets. Under the prudence concept it is valued at the lower of cost and net realisable value - if some inventory is damaged or obsolete, write it down before the calculation. Watch also for goods on sale or return: they stay in inventory (at cost) until the customer accepts. The final statement of financial position must balance; if it does not, hunt in this order: an adjustment posted once only, depreciation charged but not added to accumulated depreciation, an accrual omitted from current liabilities, or the drawings figure left out of equity.
Presentation marks are free marks if you rehearse the format. AQA's international terminology appendix permits balance-sheet names, but train yourself into statement of profit or loss and statement of financial position headings, subtotals at gross profit and profit for the year, and current assets ordered inventory, receivables, prepayments, bank, cash. A question answered as a running list of figures scores presentation marks at best; the same figures in the correct three-column layout (details, £, £) with subtotals score the structure marks. Where a question asks for both statements, they are linked in one place only: profit for the year flows into capital (sole trader) or retained earnings (company). If your two statements disagree, the error is almost always in that transfer - not a failure of the balance itself.
| Scenario | Concept | Treatment |
|---|---|---|
| Customer orders goods in December; delivered in January | Realisation | Revenue recognised in January - when earned, not when ordered or paid |
| Owner's private car kept off the business accounts | Business entity | Only business assets and liabilities are recorded |
| £5 stapler expensed rather than capitalised | Materiality | Immaterial items treated expediently |
| Allowance for receivables created at year end | Prudence | Probable loss provided for before it is certain |
| Depreciation method unchanged year on year | Consistency | Like items treated alike for comparability |
| Assets held at cost less depreciation, not break-up value | Going concern | Business assumed to continue operating |
| Electricity for December paid in January | Accruals/matching | Charged to the period that used it |
For the extended questions, prepare two flexible argument frames. Frame 1 - why adjustments matter: the accruals concept requires them, they prevent profit being a cash-timing lottery, and omitting them misstates both the statement of profit or loss and the statement of financial position (work one example through both statements). Frame 2 - the concepts in tension: prudence pushes towards earlier recognition of losses while consistency forbids switching policies at convenience; historical cost gives objectivity but ignores inflation. AQA's Section C 25-markers reward a judgement that weighs two sides and concludes - not a list of definitions.
One further trap: adjustments given in the question are often half-given. 'Rent of £13,000 was paid in the year, of which £1,000 relates to next year' means the trial balance figure of 13,000 must be reduced by 400-style logic - the expense is 12,000 and the prepayment 1,000. 'Rent paid £12,000; rent owing at the year end £1,000' means expense 13,000. Read whether the trial balance figure is the cash paid or the charge required, and annotate the question paper before you touch the answer booklet. Under time pressure, the candidates who score full marks on these questions are the ones who label each adjustment against the statement line it hits before writing anything.
Year-end adjustments exist for one reason: the trial balance contains cash-timing noise, and the accruals concept demands period-matching figures. Master the four families of adjustment - accruals/prepayments, depreciation, irrecoverable debts and the allowance, and the miscellany of rent receivable and drawings of goods - and Paper 1's biggest structured question becomes mechanical.
Accruals and prepayments. An accrual is an expense used but unpaid (December's electricity bill arriving in January). Treatment: add to the expense in the statement of profit or loss; show as a current liability. A prepayment is an expense paid but not yet used (annual insurance paid in November covering next year): deduct from the expense; show as a current asset. The income mirror images: accrued income (rent earned, not received) is a current asset added to income; income received in advance is a current liability deducted from income. The cleanest technique is a T-account for the expense: put the trial balance figure and the adjustment in, and the statement of profit or loss transfer falls out.
| Adjustment | Double entry | Statement of profit or loss | Statement of financial position |
|---|---|---|---|
| Accrued expense £1,000 | Dr Expense, Cr Accruals | Expense +1,000 | Current liability 1,000 |
| Prepaid expense £400 | Dr Prepayments, Cr Expense | Expense −400 | Current asset 400 |
| Accrued income £500 | Dr Accrued income, Cr Income | Income +500 | Current asset 500 |
| Income received in advance £300 | Dr Income, Cr Deferred income | Income −300 | Current liability 300 |
Year 2 rent paid £13,400; at the end of Year 1, £600 was accrued; the charge required for Year 2 is £13,000.
| Dr Rent payable account | £ | Cr | £ |
|---|---|---|---|
| Bank (paid in year) | 13,400 | Balance b/d (Year 1 accrual) | 600 |
| Statement of profit or loss (balancing figure) | 12,800 |
Payment exceeds the required charge, so the balancing figure reveals a prepayment of £600 carried down on the debit side (a current asset). The account does the reasoning: enter what you know, let the statement of profit or loss figure emerge as the balance, and the carried-down balance hands you the statement of financial position item with its correct side. Run every accrual, prepayment and income adjustment through this pattern and direction errors disappear - and in the exam, sketch the T-account in the margin even when only the final figures are required.
Depreciation. Straight line spreads the depreciable amount evenly: (cost − residual value) ÷ useful life, with part-years pro-rated by months. Reducing balance charges a fixed percentage of net book value, so charges are large early and smaller later - suited to assets that lose most value in early years (vehicles, IT). Neither method aims to equal market value; both allocate cost, and AQA examiners repeatedly ask you to justify method choice with that point. Depreciation entries: Dr Depreciation expense, Cr Provision (accumulated) for depreciation; the provision is deducted from cost in the statement of financial position. Part-year policies (a full year in the year of purchase but none in the year of sale, or months-based) are stated in the question - read them, do not assume. A disposal runs through four steps: transfer cost out of the asset account (Dr Disposal, Cr Asset, at cost); transfer accumulated depreciation (Dr Provision, Cr Disposal); record proceeds (Dr Bank/Cash receivable, Cr Disposal); the disposal account balance is a profit (credit side larger) or loss (debit side larger) transferred to the statement of profit or loss as other income or expense.
Machine bought 1 October Year 1 for £54,000; residual value £6,000; useful life 8 years; depreciation charged monthly from date of purchase. Sold 30 June Year 5 for £28,000.
Journal summary: Dr Disposal 54,000 / Cr Machine 54,000; Dr Provision for depreciation 22,500 / Cr Disposal 22,500; Dr Bank 28,000 / Cr Disposal 28,000; Dr Loss on disposal 3,500 / Cr Disposal 3,500.
Choosing (or changing) method is a classic evaluation demand. Straight line gives smooth, comparable charges - sensible where the asset gives equal benefit each year (buildings, fixtures). Reducing balance matches heavier early charges to assets that lose most value early and whose repair costs rise later, keeping total running cost roughly even (vehicles). Changing method mid-life breaches consistency, so a change must be justified by a genuinely different pattern of benefit - and you should be able to state the effect: switching from straight line to reducing balance raises the early-year depreciation charge and lowers profit, while later years reverse the effect. If asked to compute both for comparison, remember they diverge most in the middle years; straight line is linear in time, reducing balance is a constant percentage of a shrinking base, so it never quite reaches zero.
Irrecoverable debts and the allowance. A debt confirmed as uncollectable is written off: Dr Irrecoverable debts expense, Cr Trade receivables (both the personal account and the control account). At the year end, a further allowance for doubtful debts is estimated for debts that may fail: the allowance is netted against receivables in the statement of financial position, but only the movement touches the statement of profit or loss - an increase is an expense, a decrease is credited (income). If a written-off debt is later recovered: Dr Bank, Cr Irrecoverable debts recovered (income) - or, in the two-step version, Dr Bank/Cr Debts written off, then adjust. Test yourself on the sequence AQA favours: write off £1,500 during the year; existing allowance £1,200; required allowance now 2% of remaining receivables of £80,000 = £1,600. Statement of profit or loss charge: write-off £1,500 + increase in allowance £400 = £1,900; receivables shown as £78,400.
The miscellany. Drawings of goods at cost: Dr Drawings, Cr Purchases. Rent receivable with an accrued balance: add to other income, show the accrued amount as a current asset. Wages and salaries: an operating expense; watch for the question that gives 'wages and salaries accrued by £2,000' and asks for the statement of financial position accrual. Commission receivable often arrives with an income received in advance element - same T-account logic as expenses, reversed. And remember the overdraft stays a current liability even when the business is otherwise profitable; classifying it as non-current is a common three-mark error.
Exam craft: for explain the effect on profit of failing to record an adjustment, trace both statements. Omitted £1,000 rent accrual: profit overstated £1,000, current liabilities and accruals understated £1,000 - so equity is also overstated. Omitted £400 prepayment: profit understated £400, current assets understated £400. Depreciation omitted: profit overstated, and non-current assets overstated by the same amount. Saying 'profit would be wrong' earns nothing; saying by how much, in which statement, and the knock-on to equity, earns all of them.
Assemble the full picture once, as a self-test, before you sit Paper 1: take any trial balance with six adjustments and produce both statements end to end in under 40 minutes. The typical 20-mark question follows this exact arc - a handful of unadjusted figures, an accrual, a prepayment, a depreciation calculation (often part-year), a write-off with an allowance movement, and a closing inventory valuation with a net-realisable-value twist. Every mark maps to a line you have just drilled; the evaluation marks sit in explaining which concept forced each treatment and what would be misstated without it.
The limited company statement of profit or loss (3.16) has the same skeleton as the sole trader's but ends differently and adds three lines. After gross profit and operating expenses comes operating profit; then finance costs (interest on debentures and loans) are deducted to give profit before tax; then taxation is deducted to give profit for the year. Appropriations - dividends - come after the statement, not inside it: they are distributions of profit, not expenses, so they never reduce operating profit. Ordinary share dividends are proposed or paid; only paid (or declared) dividends reduce retained earnings in the year-end statement.
Finance costs deserve their own discipline. Debentures are long-term borrowing: the holders are creditors, not owners, so debenture interest is an expense (finance costs) whether or not it has been paid - an unpaid half-year is an accrual. Dividends, by contrast, are returns to owners and are appropriations. This single classification split - creditor return = expense, owner return = appropriation - is worth marks in almost every company question, and it also explains gearing behaviour you will meet in ratio analysis: debenture interest must be paid in profit or loss, dividends need not be. Where a question gives a debenture issued mid-year at 8%, charge only the months outstanding, and remember the cash raised adds to the statement of financial position while the nominal value adds to non-current liabilities.
The company statement of financial position separates capital and reserves. Ordinary share capital is the nominal value of shares issued (10,000 £1 shares = £10,000). Share premium records the excess over nominal value received on issue: issuing 100,000 £1 shares at £1.50 raises £150,000, split £100,000 share capital and £50,000 premium. Retained earnings accumulate profits less dividends. Revaluation reserve holds upward asset revaluations. Non-current liabilities include debentures (long-term loans, with interest as the finance cost above). Two share issues are examinable: a rights issue raises cash (shares offered to existing holders, usually at a premium) and increases both share capital and premium; a bonus issue issues free shares by capitalising reserves (usually share premium) - equity total is unchanged, only its composition moves, and no cash is raised.
| Equity section example | £ |
|---|---|
| Ordinary share capital (440,000 £1 shares) | 440,000 |
| Share premium | 20,000 |
| Retained earnings | 375,000 |
| Total equity | 835,000 |
How that table was built: opening capital 400,000 + bonus issue of 40,000 £1 shares (1-for-10, funded from share premium) = 440,000; premium 60,000 − 40,000 transferred = 20,000; retained earnings 320,000 + profit for the year 95,000 − dividends paid 40,000 = 375,000. Notice the discipline: bonus issues move value between reserves but leave total equity at 835,000 determined by capital + premium + retained earnings, and dividends reduce retained earnings even when described as 'final' or 'interim'.
A company with 400,000 £1 shares (premium £60,000) makes a 1-for-4 rights issue at £1.60: 100,000 new shares raise £160,000 cash - Dr Bank 160,000, Cr Share capital 100,000, Cr Share premium 60,000. Share capital rises to 500,000, premium to 120,000, total equity rises £160,000. A 1-for-10 bonus issue instead: 40,000 free shares - Dr Share premium 40,000, Cr Share capital 40,000. No cash moves; total equity is unchanged; premium falls to 20,000. Exam distinction in one line: rights issue = cash in, equity up; bonus issue = reserves reshuffled, equity unchanged.
Partnerships (3.15) add one structural idea: how profit is divided. The Partnership Act default is equal shares, but the partnership agreement usually overrides with terms you must apply exactly: interest on capital (a reward for funds invested), partner salaries (paid before residual sharing), interest on drawings (a penalty for withdrawing early), and a residual profit-sharing ratio. None of these are expenses of the partnership - they are appropriations, re-cutting the same total profit between partners. The mechanics live in the appropriation account and the current accounts; capital accounts are usually fixed (only changed by capital injections or withdrawals), so current accounts absorb everything else, including drawings.
The double entries behind the appropriation are worth knowing because questions ask for them: interest on capital and salaries are credited to the partner's current account (Dr Appropriation, Cr Current account); interest on drawings is debited to the current account (Dr Current account, Cr Appropriation); drawings themselves are Dr Current account, Cr Bank/Purchases. The capital account stays untouched at £60,000 and £40,000 unless partners introduce or withdraw capital - that fixedness is the point of the two-account design, giving a stable measure of permanent investment and a fluctuating measure of entitlement less withdrawals. In the statement of financial position, list capital accounts first, then current account balances; a debit balance on a current account is shown as a deduction.
Partners Ash and Birch share residual profits 3:2. Capital: Ash £60,000, Birch £40,000. Interest on capital 5%. Birch's salary £12,000. Interest on drawings: Ash £600, Birch £400. Profit for the year before appropriations £98,000.
| Appropriation account | £ |
|---|---|
| Profit for the year before appropriations | 98,000 |
| Add: interest on drawings (600 + 400) | 1,000 |
| Less: interest on capital (5% × 60,000 + 5% × 40,000) = 3,000 + 2,000 | (5,000) |
| Less: Birch's salary | (12,000) |
| Residual profit | 82,000 |
| Share: Ash (3/5 × 82,000) | 49,200 |
| Share: Birch (2/5 × 82,000) | 32,800 |
| Current accounts | Ash £ | Birch £ |
|---|---|---|
| Interest on capital | 3,000 | 2,000 |
| Salary | - | 12,000 |
| Share of residual profit | 49,200 | 32,800 |
| Less: interest on drawings | (600) | (400) |
| Less: drawings | - | - |
| Balance c/d | 51,600 | 46,400 |
Check: 51,600 + 46,400 = 98,000, the whole profit, as it must be. A debit (overdrawn) current account - drawings exceeding entitlement - is a deduction within equity, not a receivable.
Ratio changes are the harder variant. If Ash and Birch move from 3:2 to 1:1 on a £90,000 profit: old shares 54,000/36,000, new shares 45,000/45,000 - Birch gains £9,000 at Ash's expense, and the examiner wants the transfer identified, not both calculations alone. Apply the new ratio from the agreed date only unless the deed says otherwise, and keep all other appropriations (interest, salaries) unaffected by the change. Conclude any such question by checking the total distributed still equals the profit available - the single best error check in partnership questions.
When the profit-sharing ratio changes, AQA wants the effect quantified: compute each partner's share under the old ratio and the new ratio on the year's profit and show the transfer between them. Keep concepts in view: business entity (partners' private affairs stay out; interest on capital exists because funds belong to the firm), prudence (provide for doubtful debts before appropriating profit), and consistency (apply deed terms identically each year). In the statement of financial position, each partner's equity = fixed capital account + current account balance - mirror this format from the sole trader layout and the company equity section, and the three business types become one template with three variations.
In the exam, company and partnership questions are usually worth 15-25 marks and follow a fixed recipe: adjust a trial balance, produce a statement (or an extract), then complete the equity section or the appropriation/current accounts. Budget your time by mark density: the mechanics earn steadily, but the final two marks of a 25-marker usually sit in an explain or evaluate part - the concept behind a treatment, or the effect of an omitted adjustment - so never spend all your minutes on the tables.