There is a significant difference between the Balance Sheets of limited companies and sole traders and partnerships.
Limited company accounts
When you produce company accounts it is a fairly simple task to calculate the corporation tax due for the accounting period, and you are required to add this as a short-term liability in the accounts, reducing reserves accordingly.
Accounts of sole traders and partnerships
As profits are chargeable to income tax, and as other sources of personal income may not be known when the accounts are prepared, it is not unusual for accounts to be prepared without any deduction for unpaid income tax or Class 4 National Insurance based on business profits to the year end date.
Are your self-employed clients solvent?
Many self-employed traders tend to withdraw any available cash flow not required to maintain their business requirements, forgetting that from those withdrawals they need to meet any future tax liabilities based on past accounting periods. Depending on their accounting year-end, they may have a payment on account included as drawings, but any balance of taxes due are generally met from the profits of future trading periods.
Could be interesting to calculate any balancing income tax and Class 4 NIC liability at the balance sheet date and deduct this amount from the sole trader’s or partner’s capital account?
Those self-employed traders who are used to withdrawing profits before adjusting for any outstanding taxes, may actually, be overdrawn on their capital accounts.
No doubt most practitioners are making these adjustments, all-be-it after the accounts are prepared, to ensure that clients will have the funds to meet future tax bills and keep their self-employed businesses solvent.
Not a level playing field
This issue does flag up an obvious contradiction, that it is not really possible to compare the net worth of incorporated and unincorporated businesses without adjusting for any unpaid, future tax liabilities of the self-employed that are relevant to profits earned up to the Balance date. Wonder if banks take this into account?