Financial accounting and reporting
Financial accounting and reporting

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Financial accounting and reporting

4.1 Income and expenses

An income statement is a summarised financial statement which shows how well or badly a business is faring. An example of an income statement is shown in Figure 3. This is an income statement for a hypothetical sole trader (here called Mr Schmidt).

Mr Schmidt – Income statement for the year ended 31 March 2010

££
Sales40,000
Less: Cost of goods sold
Opening inventory14,000
PurchasesTotal 22,000
36,000
Less: Closing inventoryTotal (12,000)
Total (24,000)
Gross profit16,000
Less: Expenses
Rent3,000
Lighting and heating expenses2,800
General expensesTotal 800
Total (6,600)
Net profitTotal 9,400

Figure 3 Example of an income statement

As its name suggests, an ‘income statement’ includes all the income generated by a business in its accounting period. This is usually derived from the sales of its products and services, which are first listed from individual accounts on to the trial balance and then added up together. Income derived from sales may be referred to by a number of different terms, such as turnover or sales (sometimes sales turnover ), sales revenue or just revenue . However, income may be derived from other sources, and the source may be denoted in the terminology used to describe it. If a business derives income from a bank account in the form of bank interest, for example, this too will be included in the income statement. It will be shown separately from income arising from sales and will be called ‘bank interest receivable’ or something similar. However, perhaps rather unhelpfully for persons learning about accounting for the first time, ‘revenue’ can also be used as a general term to mean any sort of income, and if so used, could include ‘bank interest’ as well. There is no hard and fast rule about how the terms ‘income’ or ‘revenue’ are used. They are both very common terms, and you will see both used in this course.

In acquiring or making products for sale, or delivering services to customers, however, a business will have laid out some of its own resources (most commonly, money). For example, if a business makes a product, it will need to buy in raw materials, pay wages to employees making the product, and pay for electricity (for example) used in the manufacturing process. Likewise all such items are listed from individual accounts on to the trial balance and then added up together, with like items grouped together. For example, raw materials will be added together, as will energy items, wages, etc. The term costs or expenses is often used here to denote these types of items. Some accounting textbooks differentiate between these terms, but you will find them used interchangeably without distinction of meaning, and we do not differentiate between them in this course. Often terms used in accounting are also used in every day life with no reference to their financial meanings and this contributes to the overall lack of precision. For example, it is common to speak of someone ‘paying the price’ for something, such as committing a misdemeanour.

An income statement shows the total costs subtracted/deducted from total income. If there is an excess of total income over total costs, this is referred to as a profit (sometimes called a surplus , if the entity, like a charity, does not have a profit motive). If total costs exceed total income, then a loss or deficit (the latter is often used by non-profit-making entities) is said to arise – hence the alternative name for an income statement of ‘profit and loss account’. By organising, classifying and presenting income and expenses in this way, the income statement makes them into meaningful information because by calculating a profit or loss it becomes possible to determine how well or poorly a business is performing.

You will see that Mr Schmidt has separated his costs into those that relate to items that he has sold and the rest, and it shows two different kinds of profit. You will learn all about this later in this course, so do not worry if there are things here that you do not understand. Note also that the accounting convention used here puts figures to be deducted in round brackets. This is widely used, especially in the UK, but you should be aware that not every country uses it.

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