Topic 4

What is Topic 4 mainly about?

Income statements and statements of changes in equity.

What does the income statement show?

It shows income earned less expenses incurred to calculate profit or loss for the period.

What is the basic income statement formula?

Income - Expenses = Profit or Loss.

What does profit mean?

Profit occurs when income is greater than expenses.

What does loss mean?

Loss occurs when expenses are greater than income.

What is a service entity?

A business that earns income by providing services rather than selling goods.

What is a trading entity?

A business that buys or manufactures goods and sells them to customers.

How is a service entity income statement usually structured?

Service revenue or fees less expenses equals profit or loss.

How is a trading entity income statement different?

It includes sales revenue, cost of sales and gross profit before deducting other expenses.

What is cost of sales?

The cost of the inventory or goods sold to customers.

What is gross profit?

Sales revenue less cost of sales.

What is the gross profit formula?

Sales Revenue - Cost of Sales = Gross Profit.

What are operating expenses?

Expenses incurred in running the business, such as wages, rent, advertising and administration.

What is depreciation expense?

The allocation of the cost of a non-current asset over its useful life.

Is depreciation a cash payment?

No. Depreciation is a non-cash expense.

What does the statement of changes in equity show?

It shows how owner’s equity changed from the start to the end of the period.

What is the basic layout of the statement of changes in equity?

Opening capital + additional capital + profit - drawings = closing capital.

How does profit affect equity?

Profit increases owner’s equity.

How does a loss affect equity?

A loss decreases owner’s equity.

How do drawings affect equity?

Drawings decrease owner’s equity.

How do additional capital contributions affect equity?

Additional capital contributions increase owner’s equity.

How is the income statement linked to the statement of changes in equity?

Profit from the income statement is added to equity in the statement of changes in equity.

How is the statement of changes in equity linked to the balance sheet?

Closing equity from the statement of changes in equity appears in the balance sheet.

Why might equity increase even if drawings occur?

Equity can still increase if profit and additional capital are greater than drawings.

Why might high income not lead to high profit?

Expenses may also increase, reducing the final profit.

What is mark-up?

The amount added to cost to determine the selling price.

What does a lower gross profit margin suggest?

The business may have reduced selling prices, increased cost of sales, or faced competition.

How can a new competitor affect gross profit?

The business may reduce prices to remain competitive, lowering gross profit.

What is a gain on sale of asset?

Income earned when an asset is sold for more than its carrying amount.

What is a loss on sale of asset?

An expense recorded when an asset is sold for less than its carrying amount.

What is the main exam tip for Topic 4?

Explain performance using income, expenses, profit, gross profit and changes in equity.