The Income Statement Flashcards
The Income Statement
This measures the profit or loss the company has made over the accounting period (i.e. over 1 year).
“measures the accumulated wealth over many years”
Elements of the statement
GROSS PROFIT
- The difference between revenue and out of sales
OPERATING PROFITS
- This is Gross Profit less expenses (overheads) incurred in operating the business.
- This represents the wealth generated from operating (trading) activities.
PROFIT FOR THE YEAR
Operating Expenses
Operating expenses and cost of goods sold are costs generated by the normal day to day activities of the company whether they take place in the company (costs of goods sold) or outside. I.e. They are costs incurred in the process of generating revenue.
There will be goods waiting in the house ready to be sold. But there is cost in getting them to be sold; these are called the operating expenses. Ranging from distribution costs, lighting, water, electricity etc. generated in moving the products form the warehouse to the customers.
N.B. Dividends received from other companies due to investment, go under ‘operating activities’ as they are extra ordinary items that they do not receive every year.
Revenue
This is• Income generated by the business from its normal operations. Also known as sales or turnover.
This includes the values of all sales both: Cash sales and credit sales. Credit sales are still recognised in the income statement when the sale occurs, not when the cash is received.
Non-operating income: profit from the disposal of non-current assets or through investments. Because this is not from the day t day operating activities of the business it is recorded separately in the Income Statement at the end. Thus any income that comes ‘on and off’ cannot go under the day to day activities of the business.
Types Of Expenditure
Capital Expenditure (a investment of non-current or fixed assets, in order to use it for longer than a year).
E.g. The Purchase of a non-current asset, like a building (an expense that will be recorded through depreciation).
E.g. Purchase of inventory which when sold will become ‘cost of goods sold’.
Revenue Expenditure (related to normal operating of the company), this provides benefit for only one year (annual expenditure). It is matched against the revenue in the come statement that they hope to generate in the first place.
(N.b. Paying fir liabilities are not expenses, just settlements of debts (e.g. repaying a bank loan and playing bak suppliers).
Gross Profit
Sales revenue - cost of goods sold
Cost of goods sold = inventory at the beginning of the period + cost of purchases made during the period - cost of goods at the end of the period.
The Link Between The Balance Sheet And The Income Statement
The BS measures the financial position of the company at a particular point in time and the IS measures the financial performance of a company during the past 1 year period.
The IS links the BS at the beginning and at the end of an accounting period. The opening wealth position (in equity part of BS at the beginning of the period) + new wealth generated during the period in the IS = the closing wealth position (in equity part of the BS at the end of the period).
Assets + Expenses = (Opening) Equity + Revenues + Liabilities
The Matching Convention
This states that: revenues generated during the year must be matched with expenses incurred during the year that helped generate those revenues.
Prepayments
These are payments made for the expenses before the service is received
E.g. Insurance for 12 months.
If this does not coincide with the accounting period then only a certain amount of the insurance will be recorded down.
However , remember this… prepaid expenses are not expenses but instead current assets because the company has control over the amount paid, that is to say they can cancel and get a refund. These items recorded will have both opening and closing figures.
Current year expense = Prepayment from last year + amount paid this year - about paid this year that relates to the next period.
Accruals
These are amounts owed for expenses, even though we have received the benefits relaxing to the expense. they are the opposite of prepayments.
These are not expenses but ‘outstanding expenses’, therefore they will are recorded as current liabilities on the BS, as the company is expected to settle this in the short term (you usually have to settle accruals in a month or so because if you don’t pay employees quickly they may just leave.
Depreciation
The depreciation of short is a way of showing on the financial statement how non-current assets lose value over time.
Most have a finite life as they get used up in the process of generating wealth for the business. Some even have a definitive life, they will last a specific amount of time.
Things like land don’t depreciate in value but in fact appreciate.
Depreciation can only be applied to objects with a finite life.
Depreciation is a non-cash expense that is recorded annually in the income statement.
The purpose of it: To match the use of non current assets with the revenues that they help t generate.
How to calculate annual depreciation expense:
Need to know:
- Purchase cost of asset (non-current)
- Useful life of asset (non – current)
- Residual life of asset (non –current)
- Depreciation methods to be used
Straight Line Depreciation Method
You deduct the same amount each year.
e.g. cost of van:12,000, useful life: 5 years, residual vale: 2000
Depreciation charge = (12,000 – 2000)/ 5 =2000
Reducing Balance Method (% To NBV)
You deduct the same % every year but you deduct from a reducing amount every year.
e.g. in year 1 you deduct 30% of 10,1000, in year 2 you deduct 30% of 7000 etc.…
