Conversion Method — Converting Single Entry into Double Entry

The Conversion Method is the systematic process of taking a trader's incomplete records and reconstructing from them a proper Trading and Profit and Loss Account and Balance Sheet — exactly as if the trader had maintained full double entry books all along. It is the more thorough and reliable alternative to the Statement of Affairs (capital comparison) method of Section 3, because it does not merely estimate a single profit figure — it rebuilds the individual income and expense figures that make up that profit.

The typical steps in the Conversion Method:

1. Prepare the Opening Statement of Affairs (as on the first day of the accounting year) to find the Opening Capital, using Capital = Assets − Liabilities.
2. Analyse the Cash Book / prepare a Cash and Bank Summary for the year, to pick out cash sales, cash purchases, cash received from and paid to debtors/creditors, and every other cash expense or income, ending in the closing cash and bank balances.
3. Prepare the Total Debtors Account and Total Creditors Account to find whichever of credit sales, credit purchases, closing debtors, or closing creditors is not already known (Section 4).
4. Prepare Bills Receivable and Bills Payable Accounts, if the business deals in bills, to find missing figures relating to bills.
5. Ascertain the Closing Stock. If the stock was physically counted and valued at the year end, this figure is used directly. If it was not counted (a common situation, sometimes because stock was lost or destroyed, or simply never counted), the closing stock is estimated by preparing a Memorandum Trading Account, using the trader's normal rate of gross profit on sales or on cost (explained below).
6. Prepare the Trading and Profit and Loss Account for the year using the figures assembled above — total sales, total purchases, opening and closing stock, all recorded expenses (adjusted for outstanding and prepaid amounts), and depreciation on fixed assets.
7. Prepare the Closing Balance Sheet as on the last day of the year, showing all closing assets and liabilities, with capital worked out as Opening Capital + Additional Capital − Drawings + Net Profit (or − Net Loss).

Memorandum Trading Account — finding a missing Closing Stock. When the closing stock figure is not available, but the trader's normal gross profit rate (on sales, or on cost) is known, a Memorandum Trading Account is prepared exactly like an ordinary Trading Account, except that the Gross Profit (computed by applying the known rate to sales) is entered first, and the Closing Stock is then found as the balancing figure:

The two gross profit conventions convert into each other easily:

• If Gross Profit is 20% on cost, it is equivalent to Gross Profit / (100 + Gross Profit %) × 100 = 20/120 × 100 ≈ 16.67% on sales.
• If Gross Profit is a given percentage on sales, the equivalent rate on cost is Gross Profit % / (100 − Gross Profit %) × 100. …