statement of profit and loss

Question 1

what does the statement of profit and loss provide a summary of?

Answer 1

A company’s income (revenues) and expenses during a specified accounting period

Question 2

what does the SOPL show?

Answer 2

Revenue earned by firm less cost-of-goods-sold, cost of running the business, finance expenses and tax expenses = profit (loss) = change in owners’ wealth over a reporting period

Question 3

what does the income, expenses and profit for a stated accounting period involve?

Answer 3

the accountants are responsible for identifying all of the revenues earned from selling during an accounting period and matching those revenues against all of the costs of producing and delivering these goods to customers. This is needed to produce a meaningful value for profit for the company’s trading activities.
They also need to take the cost of any debt financing and taxes on profit incurred during the period to arrive at the profit attributable to shareholders.

Question 4

what does the profit tell the owners?

Answer 4

how much, in accounting terms, their wealth has increased during the period and is taken across at retained earnings to owners’ equity.

Question 5

what is the SOPL not directly linked to?

Answer 5

flows of cash into and out of the business.

Question 6

what is the common firm of presentation?

Answer 6

top half of the SOPL provides a summary of the income generated form the firm’s operating assets and expenses incurred providing the goods and services sold and on running the business.

Question 7

what is revenue?

Answer 7

revenues gives the value of sales generated during the period or the company’s turnover. Revenue may be colloquially referred to as the top line and when people talk about the ‘top line growth’ they are talking about growth in revenue rather than growth in profit. It is also referred to as sales sometimes.

Question 8

what are cost-of-sales?

Answer 8

cost-of-sales shows how much it cost to produce the goods sold. Product costs include raw materials, power, labour costs and the costs associated with running and managing factories used to produce the goods.

Question 9

what is the item cost-of-sales sometimes called? what does it usually cost?

Answer 9

cost-of-goods sold and sometimes cost-of-revenue. It usually includes selling & distribution costs

Question 10

what is gross proft?

Answer 10

the profit from trading activities before taking account of the cost of running the business

Question 11

what are the other expenses taken through as other operating expenses?

Answer 11

they normally include head office expenses (e.g. costs of executive management, the finance division, centralised IT and networks, human resources) and general marketing expenses.

Question 12

what does core operating profit show?

Answer 12

the profit generated from the firm’s core business after taking account of all operating costs. It does not include income from non-core activities.

Question 13

what does other income comprise of?

Answer 13

other sources of revenue (e.g. rental income, dividend income from investments), gains and losses from disposals, and the firm’s share of after-tax income or losses from associates and joint ventures

Question 14

what is operating profit generated from?

Answer 14

all the firm’s operating assets. This is also called profit before Interest and Tax (PBIT), it is independent of the way in which the operating assets are financed

Question 15

what do taxes go towards?

Answer 15

costs of the infrastructure on which the firm depends (for example transportation, power, other utilities and the security and legal systems that protect the firm’s assets and rights) and to educate the firm’s employees, provide benefits when they are sick and help care for their children.

Question 16

what do tax expenses represent?

Answer 16

corporation tax incurred during the accounting period on the firm’s profits. Some of these have already been paid, while some may be due within 12 months and are then reported as taxes payable in current liabilities. There may also be some taxes that are due for payment more than 12 months, these are reported as deferred tax in non-current liabilities

Question 17

what does the final in the SOPL (bottom line) represent?

Answer 17

share of the profits due to the owners of the firm. The owners, the holders of the equity, have the last claim and they are due whatever is left when all of the other stakeholders have had their claims met.

Question 18

what is reported as retained earnings within equity?

Answer 18

some of the profits may be paid out as dividends to the owners. Whatever is left after any dividend payments is reinvested in the business and reported as retained earnings within equity.

Question 19

what are the three ways in which customers pay for the goods and services they trade?

Answer 19

sales and expenses may be paid for in cash on delivery; made on credit terms and paid in arrears; or paid for in advance.

Question 20

what is meant by cash on delivery?

Answer 20

cash sales are most common when businesses are selling goods and services to retail customers. Most companies pay very few expenses in cash.

cash sales: cash received is taken directly through to the SOFP. These normally include sales to customers made using debit and credit cards where payment is either instantaneous or made very soon after the sale.

expenses paid in cash: firms may pay casual labour and for minor sundry expenses in cash.

Question 21

what are examples of cash on delivery?

Answer 21

goods from supermarket, takeaway foods

Question 22

what is meant by paid in arrears?

Answer 22

most business-to-business transactions are based on credit terms with services and goods paid for in arrears. They may be invoiced at the time they are delivered, or estimated at the time and invoiced at a later time.

invoiced credit sales: amounts owed from sales made on credit that have been invoiced but not yet paid are recorded in trade receivables in the SOFP at the supplier and trade payables at the customer. The value of trade receivables gives the total amount of all outstanding customer invoices and of trade payables all outstanding supplier invoices.

credit sales that have not be billed: some services (e.g. electricity) may be consumer or used by the customer some time before the supplier invoices the customer.

Question 23

what does accrued income represent?

Answer 23

the value of services that have been delivered by the supplier but have not yet been delivered

Question 24

what does accrued expenses represent?

Answer 24

the value of services that have been consumer by the customer but have not been invoiced

Question 25

what are examples of goods paid in arrears?

Answer 25

goods sold by one firm to another (invoiced at the time), electricity (invoices at a later time)

Question 26

what is meant by paid in advance?

Answer 26

some businesses require payment for their services and goods from their customers in advance of delivery. A common example of a service paid for in advance ion a property rental: both retail and commercial customers are normally expected to pay for rent in advance.

Question 27

how are payments in advance recorded in the SOFP?

Answer 27

when a customer pays for services in advance it creates an asset, prepaid expenses, for the service it is owed. When a customer pays for goods in advance it creates a prepayment asset. These are often reported together as a single value in the SOFP.

The supplier records the cash received on the asset side of the SOFP and an equal amount is recorded as a liability under unearned income representing the obligation to deliver the service or goods that have been paid for at a future time.

Question 28

why can’t we use cash flows for profit?

Answer 28

the timing mismatch between payments for sales and payments for their related costs makes it impossible to produce a meaningful value for profit for an accounting period based on cash flows.

Question 29

if there is a credit sale how is this recorded in current assets and liabilities?

Answer 29

current assets - trade receivables
current liabilities - trade payables

Question 30

if there is a payment in advance how is this recorded in current assets and liabilities?

Answer 30

current assets - prepaid expense
current liabilities - unearned income

Question 31

if there is a payment invoiced in arrears how is this recorded in current assets and current liabilities?

Answer 31

current assets - accrued income
current liabilities - accrued expenses

Question 32

what is the accrual principle?

Answer 32

Revenue should be recognised when earned regardless of when paid for. Expenses should be recognised when incurred regardless of when paid for.

Question 33

what are the IFRS revenue recognition requirements for goods and services and what are they used for?

Answer 33

companies use these requirements to determine when revenue can be considered as earned and hence recognised (taken through SOPL). The requirements are based on satisfying contractual obligations.

For straightforward sales of goods and services firms may only recognise revenue when:

the rights to all economic benefits from a product or a service, and responsibilities for any risks, have been transferred from the seller to the buyer without recourse (or returns can be reliably estimated)

and the amount of revenue and associated costs can be measured reliably.