Sole traders — common mistakes

Examiners frequently test the business entity concept. Be alert for transactions where the owner uses business funds for personal expenses (drawings) or personal funds for business expenses (capital injection). These must be treated correctly and not mixed with business revenue or expenses.

The calculation of closing capital is a multi-step process that carries significant marks. Memorise the formula and ensure you can identify all its components from a trial balance and additional information. A common error is to treat drawings as an expense; remember they only affect the Statement of Financial Position.

A sole trader and their business are not legally separate. The owner cannot be an employee of themselves. Any money the owner takes is a withdrawal of profit, known as 'drawings', not a salary expense incurred to generate revenue. The entire profit for the year belongs to the owner and is their reward.

Expenses are costs incurred in the process of generating revenue for the business (e.g., rent, electricity, wages for staff). They are deducted from revenue in the Income Statement. Drawings are withdrawals of assets by the owner for personal use. They are not related to generating revenue and are deducted from capital in the Statement of Financial Position.

This is treated as an injection of capital by the owner. The double entry would be to Debit the relevant expense account (e.g., Dr Stationery) and Credit the Capital account. This correctly records the business expense and shows that the owner has contributed more funds to the business.