Business Studies:The profit and loss account

• Organisations that operate on a profit basis traditionally prepare what used to be known as a trading and profit and loss account
• Nowadays it is more generally known as an Income Statement
• In strict financial accounting parlance it is called a Statement of Comprehensive Income
• The main purpose of the income statement is to calculate the profit for a given period
• The exact format of such a statement varies depending on:
  1. The organisation’s policy for example depreciation methods
  2. Transactions that took place within the period under consideration
  3. The type of business for example a service business, manufacturing business and retail business would all have different line items
  4. The purpose for which the income statement is being prepared for
  5. Accounting standards if they are applicable
  6. Laws and regulations that apply to the organisation
• Despite these differences a typical income statement could take the format of the example below:

J Nhiwatiwa

Income Statement for the year ended 30 June 2018

• The example shown here is a simplified version of what an income statement would look like in the real world
• It shows certain items of interest:

Sales

• Refers to the amount of products sold within the period under consideration
• This includes both cash sales and credit sales even if debtors are have yet to pay for the products
• The sales figure will only include products sold if such products had been bought with the intention to resale them
• It would not for example include proceeds from the sale of a business’s fixed assets
• If goods are returned their amount must be substracted from the sales figure
• The figure is also known as turnover

Cost of sales

• Also known as cost of goods sold is a calculation of expenses incurred in acquiring and making products ready for sale
• It includes purchases i.e. the value of goods/products bought for the resale
• The amount of closing and opening stock i.e. goods/products which we started with and goods/products that were unsold when the period ended
• Other expenses such as carriage inwards and import duty that are incurred in the process of readying goods/products ready for resale
• In a manufacturing business the cost of production is used instead of purchases

Gross Profit/Loss

• The difference between revenue(sales) and cost of sales (cost of goods sold)
• If revenue exceeds cost of sales this is known as gross profit
• If cost of sales exceed revenue this is known as gross loss

Operating expenses

• Refers expenses incurred in carrying out an organization’s day-to-day activities, but not directly associated with production
• Operating expenses include such things as payroll(wages and salaries), sales commissions, employee benefits and pension contributions, transportation and travel, amortization and depreciation, rent, repairs, and taxes
• These expenses are usually subdivided into selling expenses and administrative and general expenses

Net Profit

• The difference between gross profit and operating expenses
• If gross profit exceeds operating expenses the result net figure is known as net profit
• If operating expenses exceed gross profit the resulting figure is known as net loss
• The aim of most organisations is to make sure that they make net profit
• Net profit increases the equity of the owners of the business

NB

• The income statement is prepared on a matching basis concept i.e. revenue is matched with expenses incurred in generating that revenue
• What this means is that for example we can only include sales for the current and not for any other period
• We do not directly include proceeds from the sale and expenses incurred in the purchase of fixed assets instead
• The expenses are incorporated in the form of depreciation for that period and income in the form of profit on disposal
• The income statement shows profit/loss made by the organisation in a given period
• This helps stakeholders to assess the performance of the business

To access more topics go to the O Level Business Notes