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Difficulty: Very hardTreatment of Owner's Capital, Drawings, and Goods Withdrawn

A sole trader extracted a trial balance showing a draft net profit of ₦640,000₦640,000 for the year ended 31 December 2025. Upon auditing the financial records, the following errors and unrecorded transactions were discovered:

1. A personal building valued at ₦500,000₦500,000 introduced into the business by the proprietor as capital was incorrectly credited to the Sales Account as cash sales.
2. Goods costing ₦60,000₦60,000 (with a normal selling price of ₦80,000₦80,000) taken by the proprietor for personal consumption were incorrectly recorded as credit sales to the proprietor at selling price.
3. Cash drawings of ₦75,000₦75,000 made by the owner during the year were correctly debited to the Drawings Account.

Calculate the true net profit of the business in Naira (₦₦) for the year ended 31 December 2025.

Answer: 120000 ₦

Answer

The true net profit of the business for the year ended 31 December 2025 is ₦120,000₦120,000.
To determine the true net profit, we adjust the draft net profit for accounting errors affecting revenue and expenses. First, the capital introduced (₦500,000₦500,000) was wrongly included in sales revenue, so profit was overstated by ₦500,000₦500,000. Second, goods withdrawn (₦60,000₦60,000 cost) were wrongly recorded as sales at selling price (₦80,000₦80,000). Reversing the incorrect sales credit reduces profit by ₦80,000₦80,000, while crediting Purchases at cost reduces cost of goods sold, increasing profit by ₦60,000₦60,000 (a net deduction of ₦20,000₦20,000). Cash drawings do not impact profit. Subtracting ₦500,000₦500,000 and ₦20,000₦20,000 from ₦640,000₦640,000 yields a true net profit of ₦120,000₦120,000.

Step-by-Step Solution

1
Correct the misclassification of capital introduced
Draft profit reduced by ₦500,000₦500,000
Crediting the personal building brought into the business to Sales overstated trading revenue and net profit by ₦500,000₦500,000. Capital introduced must be credited to Capital Account, not Sales Account.
2
Correct the misclassification of goods withdrawn for personal use
Net decrease in profit of ₦20,000₦20,000
Goods withdrawn for personal use must be debited to Drawings and credited to Purchases at cost price (₦60,000₦60,000). Because they were wrongly recorded as credit sales at selling price (₦80,000₦80,000), Sales was overstated by ₦80,000₦80,000 (reducing profit by ₦80,000₦80,000) and Purchases was overstated by ₦60,000₦60,000 (increasing profit by ₦60,000₦60,000 when corrected).
3
Evaluate the treatment of cash drawings
No adjustment to Profit and Loss Account
Cash drawings of ₦75,000₦75,000 were correctly recorded in the Drawings account and directly reduce owner's capital on the Statement of Financial Position.
4
Calculate the true net profit
₦120,000₦120,000
True Net Profit = Draft Net Profit (₦640,000₦640,000) - Building Sales Error (₦500,000₦500,000) - Incorrect Sales Recording (₦80,000₦80,000) + Purchases Cost Adjustment (₦60,000₦60,000) = ₦120,000₦120,000.

Key Concept

Accounting treatment of owner's capital, drawings, and correction of profit errors
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Topics

Treatment of Owner's Capital, Drawings, and Goods Withdrawn

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