Balance Sheet for a Sole Trader
An individual has the right to conduct an enterprise and to pursue a profit. In fact we have no obligation in law that requires the registration of a business in order to conduct a trade.A sole trader (also referred to as a ‘sole proprietor’) is a single owner business that has no juristic personality. As a comparative, a close corporation is an entity distinct from its members, where the property belongs to itself, and not to its members.
The sole trader is operated with full personal risk for the owner whose estate is liable for all the commitments of his business. The partners in a partnership are also personally liable for the debts of the partnership, but only to the extent that such liabilities cannot be met out of partnership assets. On the other hand, the members of a close corporation are not generally personally liable for corporate debts (although they could bind themselves as sureties to a creditor for some or all of the corporate liabilities). The trustees and the beneficiaries of a business trust, and the directors and shareholders of a company, are also generally not liable for the debts of the trust or company.
It would not be helpful to distinguish between trading and personal use assets when the individual is being sequestrated as all the assets of the individual will form part of the insolvent estate!
A sole trader does not have shareholders, directors, members, trustees, or beneficiaries. The profits of the sole trader are his own and taxed as such. The sole trader will therefore not have retained earnings, undistributed profits, or share capital. The sole trader would not be able to have a loan agreement with himself as it requires at least two parties to have an agreement.
In terms of the provisions of the Income Tax Act, SARS requires that all individuals that are either; a member of a close corporation or director of a company, or receive income from business, trading or professional activities, to complete and submit a statement of assets and liabilities, as part of the annual IT12 tax return. The individual is required to list all local assets and liabilities and to declare the aggregate amount of foreign assets and liabilities. Also, the assets must be disclosed at the original cost (not valuation), with no adjustment for impairment, depreciation, or re-valuation. SARS requires this disclosure to assist in testing the reasonability of income declared by reviewing year-on-year assets changes and how such changes are funded.
Assets disclosed in financial statements must be done with fair presentation in mind, as the users, such as the bank and creditors will require such. To obtain fair disclosure of assets, impairments, depreciation and even re-valuation would have to be used.
There is no legislation, promulgated accounting standards or financial reporting requirements that call for financial statements to be produced by sole traders, nor offer any guidance to the format or standard that would be deemed appropriate.
For tax purposes, the income generated from the trading activities is taxed in the individual’s hands. Not all expenses are automatically deductable. In fact, the Income Tax Act recognises that expenses incurred by the sole trader could either be for full or partial trade purposes; and only allows partial apportionment of expenses incurred during trade and income generating activities. Similarly, the Value-Added Tax Act has been drafted to allow for the recognition of sole traders. The requirements set by both the Income Tax Act and Value-Added Tax Act with regards to the keeping of accounting records aim to ensure disclosure of income (with taxable nature being distinguished) and deductions such as expenses and allowances to determine taxable liability. The Income Tax and Value-Added Tax Acts do not call on sole traders to produce financial statements!
Since accounting treatment will very seldom be the same as tax treatment, and the disclosure requirements with regards to assets are distinctly different; can a sole trader have an annual balance sheet as part of the financial statements?
How will the balance sheet balance in the absence of equity (including reserves, retained earnings, and share capital) and loan account with owner? Bearing in mind of course that assets must equal equity and liability! In fact, the balance sheet was originally used as part of financial statements to provide proof of the accuracy of the double entry bookkeeping system.
The primary users (in the absence of shareholders or members), being SARS, the bank, and creditors, will require disclosure of all assets and not only the assets isolated for trade purposes. Analysis commonly done with companies would be limited with regards to sole traders as rate of return on capital or investments, and earnings ratios would not apply in the absence of a separate juristic personality.
Therefore, a sufficient set of financial statements for a sole trader could consist of an income statement and notes, which would disclose the assets and liabilities relating to trade activities, as well as a separate statement of assets and liabilities, and reconciliation of capital allowances (such as wear and tear, and scrapping allowances) for taxation purposes. Perhaps even a generic statement of financial position could be used to disclose the assets and liabilities, provided it is clear to the user what the purpose of the statement is.
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