5.6 Incomplete Records: Calculating Profit or Loss from Changes in Capital

This section explains how to calculate a business's profit or loss for the year when only incomplete records are available. We will use changes in capital as a key indicator of profitability.

Understanding Capital Changes

Capital represents the owner's investment in the business. Changes in capital during the accounting period reflect the business's financial performance.

Opening Capital: The amount of capital the owner invested at the beginning of the accounting period.

Closing Capital: The amount of capital the owner holds at the end of the accounting period.

Profit or Loss = Closing Capital - Opening Capital

A positive difference indicates a profit, while a negative difference indicates a loss.

Example Scenario

Consider a sole trader business with the following information:

• Opening Capital: $5,000
• Closing Capital: $7,000

Calculating Profit or Loss

Using the formula: Profit or Loss = Closing Capital - Opening Capital

Profit or Loss = $7,000 - $5,000 = $2,000

Therefore, the business made a profit of $2,000 during the accounting period.

Table Summary

Item	Amount ($)
Opening Capital	$5,000
Closing Capital	$7,000
Profit or Loss	$2,000

Important Considerations

This method assumes that all changes in capital are due to the business's profit or loss. In reality, other factors like additional investment or withdrawals could also affect capital. However, when only incomplete records are available, changes in capital provide the best available estimate of profit or loss.

Practice Questions

1. A small business has an opening capital of $10,000 and a closing capital of $8,000. Calculate the profit or loss.
2. The capital of a sole trader increases from $15,000 to $22,000 during the year. What is the profit or loss?

Answers to Practice Questions

1. Profit or Loss = $8,000 - $10,000 = -$2,000 (Loss of $2,000)
2. Profit or Loss = $22,000 - $15,000 = $7,000 (Profit of $7,000)