Paper: 02, Accounting & Financial Analysis

Module: 14, Preparation of Balance sheet under Sole Proprietorship

Prof. S P Bansal
Principal Investigator Vice Chancellor
Maharaja Agrasen University, Baddi

Prof YoginderVerma
Co-Principal Investigator Pro–Vice Chancellor
Central University of Himachal Pradesh. Kangra. H.P.

Dr. O.P Verma

Paper Coordinator Department of Commerce
Himachal Pradesh University shimla

Prof S.S Narta

Content Writer Director UCBS Himachal Pradesh
University Shimla
 Items Description of Module
Subject Name Management
Paper Name Accounting & Financial Analysis
Module Title Preparation of balance sheet under sole
proprietorship
Module Id Module No- 14
Pre- Requisites Final Accounts of Sole Proprietorship
Objectives The meaning of sole proprietorship, its
registration, and advantages
Keywords Sole proprietor, balance sheet

QUADRANT I

1. Module-14: Preparation of Balance Sheet under Sole Proprietorship

2. Learning Objectives
3. Introduction
4. Meaning of Sole Proprietorship
5. Registration of Sole Proprietorship
6. Characteristics of Sole Proprietorship
7. Advantages of Sole Proprietorship
8. Final Accounts of Sole Proprietorship
9. Balance Sheet preparation of Sole Proprietorship
10. Limitations of Sole Proprietorship
11. Suitability of Sole Proprietorship
12. Summary

LEARNING OBJECTIVES:

After studying the module, students may be able to understand the meaning of sole proprietorship, its
registration, and advantages. Also, knowledge can be gained regarding the final accounts of the sole
proprietorship, balance sheet preparation, its limitations and the suitability of sole proprietorship form
of business.

INTRODUCTION:

In the drastically changing environment, new prospects for already incorporated businesses is
increasing and opening up new ways for expansion and diversification. The ever changing demands of
the customers, act as a catalyst for the business houses to modify and enhance the quality as well as
the quantity of their products, so as to attract more number of customers. Various forms of businesses
are working in the present globalized environment. The Company form, be it private or public
undertaking, the Partnership form, where two or more members jointly start up a business by equally
contributing as well as equally sharing, a Joint Hindu Family business, where family members own
and continue the business, or a Non Profit Organisation, working solely for not earning the profits, but
for the society.

Apart from the above mentioned forms, if an individual wish to start up a business individually, on its
own, he can start up a Sole Proprietorship form of business. This is the simplest form of business, and
this form of business requires no number of minimum members/partners for setting up the business,
neither it require any minimum amount of capital for starting its business. In this form an individual
deals into small scale business, and can wish to expand as well in future.

MEANING OF SOLE PROPRIETORSHIP:

As the name suggest, sole means single, on the other hand proprietor is a person who starts up a
business. Therefore, sole proprietorship (single owner) is that form of business where a single person
starts up a business, totally under his single ownership. Here the proprietor, puts in the capital solely
on his own and carries out the business without any partners, and bears the risks and losses, as well as
takes the benefit of profits on its own.

In simple terms, a form of business where there is a lack of partnership, and is controlled and
managed by a single owner, is termed as Sole Proprietorship Business.

REGISTERATION OF SOLE PROPRIETORSHIP:

It is not compulsory for a sole proprietor to get its business registered. Only a bank account needs to
be opened up in the name of the business. However if the proprietor is liable to pay the service tax or
VAT, then he can get the business registered under the Service Tax.

CHARACTERISTICS OF SOLE PROPRIEORSHIP:

Following are the characteristics of sole proprietorship form of business:

1) No compulsory registration required: in order to start up with the sole proprietorship firm,
there is no need to get itself registered under any of the acts. It is not a compulsion to be
followed.
2) Single owner: this type of business is owned, controlled and managed by a single owner itself,
without any interference from any other person.
3) Unlimited liability: the liability of the owner to pay back its debt, lies totally on the shoulders
of one person, therefore it is said that the liability is unlimited.
4) No separation between the ownership and management: unlike a partnership firm, there is no
separation between the ownership and management, i.e. they both are considered as one.
5) No perpetual succession: a sole proprietorship form of business cannot last forever, and
dissolves as soon as the owner falls very ill to continue with the business or dies.
6) Quick decision making: the owner of the business is free to take up the decisions on its own,
without prior consultation with anybody; therefore it is quite possible that the decisions are
taken quickly, without any delay.

ADVANTAGES OF SOLE PROPRIETORSHIP:

1) Easy formation and dissolution: incorporating sole proprietorship business is the simplest and
easiest procedure, as no legal formalities are required for its incorporation, and neither it is
governed by any of the acts. However, some general laws like sales of goods act, law of contracts
follow.
2) Tax Advantage: a sole proprietor running a sole proprietorship business, need not pay the taxes on
the business, but only the individual tax. According to the Income Tax Act 1961, an individual is
liable to pay the tax only limited to his income, therefore the tax liability is much less as
compared to other form of businesses.
3) No minimum members required: to start up a business there is no need for the individual to
maintain the requirement of minimum number of members, unlike the partnership form of
business. A single person can itself start up the business.
4) Sole authority: the owner has the only authority to make up the plans for his own business,
without consulting any other member. There is no distribution of authority between partners, and
is enjoyed by a single person only.
5) Quick decision making: in order to make any kind of decisions relating to the business, the sole
proprietor need not consult anyone, as a result lot of time is saved, and decisions are taken
quickly.
6) No profit sharing required: unlike in the partnership form, under a sole proprietorship there is no
need to share the profits in equal ratio with the members. The sole owner shares the profits on its
own.
7) No need to hold policy meeting: a sole trader need not conduct any kind of policy meetings or
board meetings because the decisions are to be taken alone by the owner, so the need to conduct
such meetings is not felt.
8) No partnership deed required: as there are no partners, therefore need to frame a partnership deep
does not exist. A deed is a set of rules and regulations containing the conditions regarding
partnership.
9) Ease in Employment: a sole proprietor is free to hire nay number of employees, without entering
their names as owners. Also, wife/husband of the owner can be employed, and can help in
running the business, without even being declared as an employee/ partner to the business.

QUICK REVISION:
▪ Sole proprietorship (single owner) is that form of business where a single person starts up a
business, totally under his single ownership.
▪ It is not compulsory for a sole proprietor to get its business registered.
▪ To start up a sole proprietorship business, minimum number of members is not required. A single
individual can start up such business.
▪ A husband and wife can also start up the business, as it will be assumed as one/ single owner
business.
▪ A sole proprietor enjoys the profits earned as well as bears all the losses incurred individually, on its
own.
▪ The sole proprietor is the sole authority to take all the decisions individually.

FINAL ACCOUNTS OF SOLE PROPRIETORSHIP:

Business concerns work throughout the year to earn profits and deal with the changing environment
effectively. And at the end of accounting year, owners and managers are interested in knowing the
overall financial position of the concern, which helps in formulating policies and effective decision
making. Final accounts, also known as financial statements are a set of systematically presented and
chronologically recorded accounts, which reveals the financial position of the concern at the end of
accounting year.

Preparation of final accounts is the last step in the entire accounting cycle. The cycle starts with the
recording of monetary transactions in the books of accounts and end up with the preparation of final
accounts. Sole proprietorship can be classified into two heads: Manufacturing Concern and Non
Manufacturing Concern.

Manufacturing Concern: are concerned with the purpose of manufacturing the goods and then
selling them to the customers. They do not borrow the items from outside for reselling them in the
market, instead produce them on their own.

Non-Manufacturing Concern: are involved in the process of selling only. They are not engaged in
the process of manufacture, but simply purchase the goods from outside, and sell them to the
customers, without changing the original form of the goods. They are not attached to the
manufacturing business.

Final accounts of manufacturing business entities include the preparation of manufacturing accounts,
trading accounts, profit & loss account and balance sheet. Whereas, final accounts of non-
manufacturing concern includes the preparation of trading accounts, profit & loss accounts and
balance sheet.

The steps for the final accounts preparation in case of sole proprietor are as follows:

1. Recording the monetary transactions in the journal.

2. Posting them to the ledger accounts.
3. Preparing a trading account.
4. Preparing profit and loss account.
5. Balance sheet preparation.

The only difference between the two concerns is the additional preparation of Manufacturing Account
in case of Manufacturing Business Entities. Manufacturing account is prepared to know the costs
involved in the process of manufacturing the finished goods. And the balance of the manufacturing
account can be transferred to the trading account. The preparation of rest of the accounts (i.e. the
Trading Account, Profit and Loss account, and Balance Sheet) remains the same, both for the
manufacturing as well as the non manufacturing concerns.

BALANCE SHEET PREPARATION OF A SOLE PROPRIETORSHIP:

The Balance Sheet, also known as the position statement, is a statement which highlights the financial
position of the enterprise. It depicts the position of the assets and liabilities of the firm, by recording
them. According to A. Palmer, “The Balance Sheet is a statement at a particular date showing on one
side the trader’s property and possessions and on the other hand the liabilities.”

Preparing a balance sheet serves the following purposes:

1. The financial position is revealed at the end of an Accounting Year.
2. The assets and liabilities are presented in an elaborate manner.
3. The solvency position of the concern can be judged easily.
4. The opening entries of the next financial year depend on the figures from the previous year
balance sheet.

Sole proprietor prepare the balance sheet horizontally, depicting the “capital and liabilities” on the left
hand side, whereas “assets” on the right hand side of the balance sheet. The format is presented
below:

Balance Sheet as at____

Capital and Liabilities Amount(Rs) Assets Amount(Rs)

Tangible Fixed Assets:
Capital A/C Balance Land & Building
Add/Less: Net Profit/ Loss Plant & Machinery
Less: Drawings Furniture & Fixture
Long term Loans: Vehicles
Term Loans Intangibles:
Other Loans Goodwill
Short Term Loans: Patent Rights
Cash Credit Investments:
Overdraft Long term Investments
Other Loans Current Assets:
Current Liabilities: Stock
Trade Payables Trade Receivables
Bills Payable Bills Receivable
Outstanding Expenses Advances
Provision: Cash at Bank
For Bad Debts Cash in Hand
For Retirement Benefits
For Taxation
TOTAL TOTAL

The following points are evident from the above presented format:

1. The order of arranging the liabilities may be in two ways. First, is to show the capital,
followed by long term liabilities, and lastly short term liabilities (which is to be paid within a
period of one year). Second method is to depict the short term liabilities in the beginning,
followed by the long term liabilities and at the last, capital.
2. The assets may be grouped either in the order of permanence or in the order of liquidity.
3. Order of liquidity means that the most liquid assets will be shown first followed by the less
liquid assets. Liquid means those assets which can be easily and quickly converted into cash.
4. Order of permanence means the assets which are to be used for long term in the business and
are not supposed to be sold are presented first, followed by the liquid assets.
 5. Order of Liquidity: Cash in Hand
Cash at Bank
Investments
Trade receivables
Machinery
Land
Patents
Goodwill

6. Order of Permanence: Goodwill

Patents
Land
Machinery
Trade Receivables
Investments
Cash at Bank
Cash in Hand

QUICK REVISION:
▪ Final accounts, also known as financial statements are a set of systematically presented and
chronologically recorded accounts.
▪ Final accounts reveal the financial position of the concern at the end of accounting year.
▪ Sole proprietorship can be classified into two heads: Manufacturing Concern and Non
Manufacturing Concern.
▪ Final accounts of manufacturing business entities include the preparation of manufacturing accounts,
trading accounts, profit & loss account and balance sheet.
▪ Final accounts of non- manufacturing concern includes the preparation of trading accounts, profit &
loss accounts and balance sheet.
▪ Sole proprietor prepare the balance sheet horizontally, depicting the “capital and liabilities” on the
left hand side, whereas “assets” on the right hand side of the balance sheet.
▪ Assets can be grouped either in the order of liquidity or in the order of permanence.

In order to deepen the understanding, let us study a hypothetical example on the balance sheet
preparation for sole proprietorship:

Example:

From the following trial balance of Sharma & Sons as on 31st March, 2014

Particulars Debit Balance Credit

Balance
Capital A/C 720000
Land and Building 320000
12% Term Loan 420000
Loan 480000
Trade Receivables 440000
Cash in Hand 20000
Stock 620000
Machinery 220000
Trade Payables 80000
Advances to Creditors 120000
Net Profit 120000
Drawings 80000
TOTAL 18,20,000 18,20,000

Balance Sheet as at 31st March, 2014

Capital & Liabilities Amount Amount(Rs) Assets Amount(Rs)

Capital Balance 720000 Land & Building 320000
Add: Net Profit 120000 Machinery 220000
840000 Stock 620000
Less: Drawings (80000) 760000 Trade Receivables 440000
12% Term Loans 420000 Advances to Creditors 120000
Loan 480000 Cash in Hand 20000
Trade Payables 80000

TOTAL 17,40,000 TOTAL 17,40,000

Both the sides of the balance sheet of a sole proprietorship business, is tallying, that means fulfilling
the matching concept.

LIMITATIONS OF SOLE PROPRIETOSHIP:

Though, Sole Proprietorship seems to be the simplest form of business, and though it seems that
starting up a sole proprietorship business involves less legal formalities, and a non compulsory
registration, it is also affected by some of the limitations:

1. Unlimited Liability: the owner himself is responsible for paying off all the debts, be it long
term or short term. No one except the owner is liable to clear all the debts.
2. Limited Amount of Capital: as the owner is solely responsible for bringing in the capital, the
amount of capital so brought in is limited and is of limited amount, unlike the partnership
firm, where each partner brings in some amount of capital, while entering into the partnership.
3. Limited Ideas: the owner is the sole authority to frame the policies and ideas. He is a single
mind working on the entire business, therefore only he is the one responsible for framing the
ideas, therefore only limited ideas, i.e. limited to his thinking capacity are generated.
 4. Limited size of Business: since the owner himself is not acquainted with all the skill,
expertise, adequate finance for expansion, he sometimes fail to expand, diversify the business
to the fullest, either due to lack of expertise or due to lack of finances.
5. No Continuity in Business: unlike the partnership firm, sole proprietorship lacks continuity in
business, as it does not have the partners to carry on the business forever, but the business
dissolves as soon as the owner becomes seriously ill or dies.

SUITABILITY OF SOLE PROPRIETORSHIP:

The limitations of sole proprietorship bring us to the situations where the sole proprietorship form of
business is suitable to start up:

1) When the amount of capital required is small.

2) Where it is important to keep a direct contact with the customers.
3) When continuity of the business is not an issue of concern.
4) When a limited scale of business is needed to be carried out.
5) Where a vast storehouse of knowledge, ideas, skills and expertise is not required.

QUICK REVISION:
▪ A sole proprietorship faces a limitation of unlimited liability on the owner.
▪ there is less scope of expansion in such business.
▪ There is always a risk of discontinuing the business early, as it depends upon the single owner.
▪ There is always a chance of generation of limited ideas.

SUMMARY:

Any individual person, a group of persons can start up any form of business, and carry out its
operations, and serve its products to the customers at large. Any form of business line, be it a
partnership, or a company, or non profit organisation, it all starts up with the idea of a single man,
known as a proprietor. And sometimes, if the proprietor wishes not to indulge anyone in the business,
and start off alone, then this form of business is termed as a sole proprietorship.

Sole proprietorship means single ownership business, which is owned, managed and controlled by a
single person. The owner brings in the entire amount of capital on its own, operates the business
activities alone, bears all the risks and losses alone and at the end enjoys all the profits earned alone.
There is an unlimited liability and no separation between the ownership and management, and no
perpetual succession. As far as the registration is concerned, there is not a legal liability on the owner
to get its business registered, apart from this some tax benefits are also enjoyed by the owner, as only
individual taxes are paid and not the business tax.

The final account preparation under sole proprietorship form, includes the preparation of a trading
account, profit & loss account, balance sheet (in case of a non manufacturing concern). And the
preparation of manufacturing account, trading account, profit & loss account, and a balance sheet (in
case of a manufacturing concern).
The balance sheet preparation is the final step in the final accounts preparation. Balance sheet is a
summarised form of statement, which reveals the position of the assets owned and the liabilities due
upon the business, it is a way to know the exact financial position of the concern. A sole proprietor
follows a horizontal method to prepare its balance sheet as at the end of the accounting year. The left
hand side of the balance sheet presents the capital and liabilities and the right hand side showing the
assets (either in the order of permanence or order of liquidity). A sole proprietorship faces a problem
of unlimited liability, small amount of capital, less scope for expansion, limited ideas and lack of
continuity, so therefore before setting up such form of business it is always advisable to look up at the
suitability. This form of business should be stated only when the amount of capital required is small,
where it is important to keep a direct contact with the customers, when continuity of the business is
not an issue of concern, when a limited scale of business is needed to be carried out and where a vast
storehouse of knowledge, ideas, skills and expertise is not required.