6. The statement of profit or loss

Question 1

What is the statement of profit or loss?

Answer 1

The statement of profit or loss is a statement in which two key elements of financial statements - income and expenses - are matched to arrive at profit or loss.

Question 2

What is the difference between gross profit and profit for the period (net profit)?

Answer 2

Gross profit = revenue from sales, less cost of sales

Profit for the period = gross profit less expenses plus non-trading income

Question 3

What is the matching concept in relation to the statement of profit or loss?

Answer 3

The statement of profit or loss matches income earned to the expenses of earning that income.

Question 4

Where do prepayments appear in the statement of profit and loss and the statement of financial position?

Answer 4

Prepayments are excluded from expenses in the statement of profit or loss and are included in receivables in the statement of financial position, because they relate to future periods.

Question 5

Where do accrued expenses appear in the statement of profit and loss and the statement of financial position?

Answer 5

Accrued expenses are added to expenses in the statement of profit or loss and shown as payables in the statement of financial position, because they relate to the current period but have not been paid as cash in the period.

Question 6

Define gross profit.

Answer 6

Gross profit is the difference between:
The value of sales revenue; and
The purchase or production cost of the goods sold: cost of sales.

Question 7

What are the cost of goods sold in the following businesses:
Retail
Manufacturing

Answer 7

In a retail business, the cost of the goods sold is their purchase cost from suppliers.

In a manufacturing business, the production cost of goods sold is the cost of raw materials in the finished goods, plus labour costs required to make the goods, plus an amount of production ‘overhead’ costs.

Question 8

What two things does the cost of sales additionally include in many types of business?

Answer 8

1. The cost of employing those people directly involved in making or providing a service.
2. The maintenance and depreciation on non-current assets used directly in making sales, plus losses on their disposal.

Question 9

What is the gross profit margin and what can it be used for?

Answer 9

Gross profit margin = gross profit / revenue x 100

The gross profit margin can be used to compare the results of different period to see how well the costs of sales are being controlled as revenue changes.

It can also be used to compare the results of different business in the same industry.

Question 10

Define net profit.

Answer 10

Net profit is:

Gross profit
Plus any other income from sources other than the sale of goods
Minus other business expenses not included in the cost of goods sold

Question 11

What does income from sources other than the sale of goods include? (4)

Answer 11

Income from other sources will include:
1. Profit on disposals of non-current assets
2. Dividends on interest received from investments
3. Rental income from property owned but not otherwise used by the business
4. Amounts due in respect of insurance claims

Question 12

Under what three headings to business expenses not directly linked to the cost of sales appear in the statement of profit or loss?

Answer 12

1. Distribution costs
2. Administrative costs
3. Finance costs

Question 13

What are distribution costs in the statement of profit or loss?

Give examples.

Answer 13

Distribution costs are expenses associated with selling and delivering goods to customers.

For example:
- Salaries, wages and sales commission of marketing and distribution staff
- Marketing costs (e.g. advertising and sales promotion expenses)
- The costs of running and maintaining delivery vans, including depreciation on these and any losses on their disposal.

Question 14

What are administrative costs in the statement of profit or loss?

Give examples.

Answer 14

Administrative costs are expenses of providing management and administration for the business.

For example:
- Management and office staff salaries
- Rent and local business or property taxes
- Insurance
- Cloud-accounting software fees
- Printing and stationery
- Heating and lighting
- Irrecoverable debts written off or increases in allowance for receivables. Sometimes customers fail to pay what they owe and a business has to decide to write the debt off or create an allowance in respect of the amounts that are unlikely to be collected.
- The cost of running and maintaining other non-current assets such as office building, plus depreciation and losses on disposal of these.

Question 15

What are finance costs in the statement of profit or loss?

Give examples.

Answer 15

Finance costs are expenses associated with funding such as bank loans.

For example:
- Interest on loans
- Bank overdraft interest

Question 16

What is the relationship between the statement of profit or loss and the statement of financial position for a sole trader?

Answer 16

The profit for the period is the amount by which income exceeds expenses during the reporting period.

For a sole trader it is transferred to the statement of financial position as an addition to the owner’s capital. A loss for the period, whereby expenses exceed revenue, would be transferred as a deduction from capital in the statement of financial position.

Drawings are appropriations of profit and not expenses. They must be not be included in the statement of profit or loss.