Income statement 1

Lecture 4

what does the income statement do?

measures profit or loss that the company has made over the accounting period

what is basic formula

revenue - expenses

what are the 3 profits you need to write

Gross profit, operating profit and net profit

part 1, how do you measure gross profit

sales revenue - cost of goods sold

step 2, from gross profit, how do you measure operating profit

minus the operating expenses e.g. rent, salaries, electricity

step 3, from operating profit, how do you measure the net profit

you + the non-operating income and - the non-operating expenses

what are the 4 steps to measuring net profit then

• sales revenue

• - cost of goods sold (gross profit)

• -operating expenses (operating profit)

• + non-operating income

• - non-operating expenses (net profit)

what is the definition of revenue

income generated by the business from its normal operations, also known as sales or turnover

what 2 sales does revenue include

cash and credit

it also includes non-operating income, what is that

profit from disposal of non-current assets e.g. buildings or investments (appears separate on income statement)

what is the 3 criteria that must be met before recognising revenue?

1. the amount of revenue can be measured reliably

2. it is probable that the economic benefits will be received

3. ownership and control of the items should pass to theb buyer

what are expenses in accounting

costs incurred in the process of generating revenue

what are the two types of expenditure

capital and revenue

what is capital expenditure

provides benefit for more than one period (assets, BS)

what is revenue expenditure

provides benefit for only one year (annual expenditure) (costs, IS)

what is the main example of capital expenditure

expenditure on assets e.g. purchase of a non-current asset or inventories

what are the examples of expenses or revenue expenditure (6)

1. cost of goods sold during the year

2. running costs of the business

3. depreciation

4. bad debts/allowance for credit sales

5. loss from disposal of non-current assets

6. interest expense

what are not classified as expenses?

paying for liabilities

2 examples of paying for liabilities

1. repaying a bank loan

2. paying back suppliers

how do we calculate gross profit?

sales revenue - cost of goods

what does sales revenue include

both sales made on cash and credit

how do we find cost of goods sold

opening inventory + purchases - closing inventory

linking the income statement and balance sheet - what does balance sheet do?

measures financial position of the company at a particular point in time

linking the income statement and balance sheet - what does the income statement do

measures financial performance of a company during the past 1 year period

what is the LINK between the two then

income statement links the balance sheets at the beginning and at the end of an accounting period

how do you calculate closing wealth position

opening wealth position (in equity part of BS at beginning of period) + new wealth generated during period (same part at end of period)

how does net profit link the IS and BS

the net profit figure found from IS is added to the equity section of the BS (retained profits)

what is the formula to calculate prepaid expenses that relate to the current year

current year expense = opening prepayment + cash paid - closing prepayment

insurance example for prepayments

• prepaid insurance at start of year: £400

• insurance paid during year: £900

• insurance relating to next year: £250

expense = 400 + 900 - 250

expense = £1,050

• £1,050 = income statement (expense)

• £250 = statement of financial position (prepayment, current asset)

what are accruals (accrued expenses)

amounts owed for expenses even when the benefits have been received, opposite of prepayments

example of accruals

business may staff 1 month late e.g. works in January but gets paid for that at end of February

are accrued expenses on the income statement as expenses?

no, they are current liabilities and appear on the balance sheet

how do you calculate accruals ?

1. start with what was ACTUALLY paid this year

2. remove payments that belong to LAST year

3. add what belongs to this YEAR but is not payed yet

formula for accruals (current year expense)

cash paid this year - opening accrual + closing accrual

simple formula for prepayments

opening prepayment + cash paid - closing prepayment

simple formula for accrual

cash paid - opening accrual + closing accrual