Unlocking Financial Accounting Chapter 4

Chapter 4 The income statementLearning summary

By the end of this chapter you should know:

• gross profit equals revenue minus cost of sales

• cost of sales equals opening inventory plus purchases minus closing inventory

• net profit/loss equals gross profit minus expenses

• examples of business expenses include: rent and rates, light and heat, wages and salaries

• the income statement is a useful document but it has its limitations.

Unlocking Financial Accounting Chapter 4

Income statement (IS) – key points

• Highlights the profitability of the business.

• Shows the revenue, expenses and profit or loss.

• Usually prepared for a period of one year.

• Previously referred to as a profit and loss account.

• Useful for stakeholders.

Unlocking Financial Accounting Chapter 4

Example income statement

A. Trader

Income statement for the year ended 31 Dec 20X1

£

Revenue xxx

Less cost of sales xxx

Gross profit xxx

Less expenses xxx

Net profit xxx

Unlocking Financial Accounting Chapter 4

Understanding the terminology

• Revenue shows the total value of goods or services sold. It may also be referred to as sales or turnover.

• The cost of sales shows the cost to the business of the goods sold during the period.

• The expenses are the costs incurred in running the business.

Unlocking Financial Accounting Chapter 4

Preparing an income statement

A.N. Individual

Income statement for the year ended 31 Mar 20X1

£ £

Revenue XXX

Cost of Sales

Opening inventory XXX

Purchases XXX

XXX

Less closing inventory XXX (XXX)

Gross profit XXX

Expenses XXX

Net profit XXX

Unlocking Financial Accounting Chapter 4

Published income statements

• The detail in the income statement of a limited company is the same as in the income statement of a sole trader.

• However, the income statement of a company is published in a summarised format.

• The profit before taxation (in a company income statement) equates to the net profit of a sole trader.

• The expenses are not listed separately, but are summarised into two categories: distribution costs and administration expenses.

Unlocking Financial Accounting Chapter 4

Service organisations

• Service organisations do not trade by manufacturing or buying and selling but by performing services.

• Examples of service organisations are accountants, lawyers and gardeners.

• These organisations do not need to calculate a cost of sales figure as they do not carry any inventory.

• The income statement shows the income minus the expenses.

Unlocking Financial Accounting Chapter 4

Limitations of the income statement

• Only contains numerical data.

• Could be dishonestly manipulated.

• A time period elapses between the accounting period end and the time the information becomes available.

• In times of inflation the figures are distorted by inflationary rises in prices.

• Personal opinions and judgements are used in calculating some values.