FINANCIAL STATEMENTS

PART A

INCOME STATEMENT
Profit (or Loss)

The aim when a person starts a business

Is calculated in the financial statements

which are usually prepared at the end
of each financial year.
Two parts of financial statements
1. INCOME STATEMENT
Consist of two sections

TRADING ACCOUNT
In which the gross profit of the business is calculated

PROFIT AND LOSS ACCOUNT

In which the profit of the year, the net profit, of the business is
calculated
2. Statement of Financial Position- (
Balance sheet )

Which shows the financial position

of the business at a certain date

(The balance sheet is not part of

the double entry system)
NOTES TO REMEMBER

FINANCIAL STATEMENTS ARE USUALLY

PREPARED FROM A TRIAL BALANCE

EVERY ITEM IN THE TRIAL BALANCE

APPEAR ONCE IN A SET OF
FINANCIAL STATEMENTS
As each item is used, it is useful to
place a tick (/) against the item.
To ensure that no items are overlooked
NOTES TO REMEMBER
IT IS COMMON TO FIND NOTES ACCOMPANYING A TRIAL BALANCE
ABOUT VARIOUS ADJUSTMENTS WHICH ARE TO BE MADE (THESE ARE
EXPLAINED IN THE FOLLOWING CHAPTERS)

ANY NOTES TO A TRIAL BALANCE ARE USED TWICE IN A SET OF

FINANCIAL STATEMENTS

TO ENSURE THAT THIS IS DONE, IT USEFUL TO USE TICK (/) AGAINST THE
NOTES EACH TIME THEY
► Classify the following accounts in the trial
balance if it is DEBIT OR CREDIT IN THE
SECOND COLUMN.
► Classify the following accounts in the trial balance if it is
DEBIT OR CREDIT IN THE SECOND COLUMN.
• Enter the amount of the items in the correct side of the trial
balance and balance.
Example 8.1
The following trial balance
was extracted from the books
of Samir at 31 May 20-8.
THIS TRIAL BALANCE WILL BE USED IN EXAMPLE 8.2 TO EXAMPLE
8.7
NOTES

THE
INVENTORY
AT 31 MAY
20-8 WAS
VALUED AT
$7600

DURING THE
YEAR ENDED
31 MAY 20-8,
SAMIR TOOK
GOODS
COSTING
$300 FOR HIS
OWN USE. NO
ENTRIES HAVE
BEEN MADE
IN THE
ACCOUNT
RECORDS.
 Trading Account Section in
the Income Statement
Trading account is concerned with buying and
selling

Its purpose is to calculate the profit earned on

the goods sold known as gross profit
 COST OF SALES
Selling Price REPRESENTS THE TOTAL COST
Represents the total OF THE GOODS ACTUALLY
SOLD
sales less any sales
returns
This is not necessarily the cost of goods purchased during the year
Some goods may have been in stock at the start of the year
Some goods purchased during the year may remain unsold at the end of the
year
Carriage inwards had Purchases
been paid on goods Represents the total
purchased this must be cost of purchases
added to the purchases less any purchases
as it increases the cost returns
of the goods
GOODS FOR OWN USE
• IF THE OWNER WITHDRAWN GOODS FOR PERSONAL USE
• THE COST OF THESE IS CREDITED TO THE PURCHASES
ACCOUNT
• REDUCING THE COST OF GOODS AVAILABLE FOR SALE
• IF GOODS TAKEN BY THE OWNER HAVE NOT ALREADY BEEN
RECORDED THEY MUST BE DEDUCTED FROM THE
PURCHASES

- +
• THE CALCULATION OF THE GROSS
PROFIT IS SHOWN IN THE TRADING
ACCOUNT SECTION OF THE INCOME
STATEMENT
• THIS MUST HAVE A HEADING WHICH
INCLUDES THE PERIOD OF TIME
COVERED BY THE STATEMENT
• IT IS ALSO USUAL TO INCLUDE THE
NAME UNDER WHICH THE BUSINESS
TRADES
VERTICAL FORMAT

• This is format used by most businesses

• A trading account prepared using this
method contains the same information
in horizontal account, but looks like an
arithmetical calculation
 Samir
Income Statement (Trading Account Section)
for the year ended 31 May 20-8

$ $ $ $

Opening inventory 7 100 Revenue (Sales) 95 700

Purchases 65 000 Less Sales returns 1 000 94 700

Less Purchases returns __500

64 500

Less Goods for own use __300

64 200

Carriage inwards _1 500 65 700

72 800

Less Closing inventory 7 600

Cost of sales 65 200

Gross profit c/d 29 500 _____

94 700 94 700
 Profit and Loss Account Section
of the Income Statement
• Is concerned with profit and losses,
gains and expenses
• Its purpose is to calculate the final profit
after all running expense and other
items of income known as profit for the
year or the net profit
 Profit and loss account can be
prepared either vertical or horizontal
method
Using the horizontal format
The gross profit and other income are shown in the credit
side
The expenses are shown on the debit side
The difference (or balance) between the two sides equal
the profit of the year (net profit) If the credit side is the
largest—
the loss for the year (net loss) if the debit side is the
largest
 Example 8.4
Using the trial balance and accompanying notes shown in
Example 8.1, prepare the profit and loss account section for
the income statement of Samir for the year ended 31 May
20-8. Use the horizontal format.
 Samir
Income Statement (Profit and Loss Account
Section)
for the year ended 31 May 20-8

$ $ $ $
Opening inventory 7 100 Revenue (Sales) 95 700
Purchases 65 000 Less Sales returns 1 000 94 700
Less Purchases returns __500
64 500
Less Goods for own use __300
64 200
Carriage inwards _1 500 65 700
72 800
Less Closing inventory 7 600
Cost of sales 65 200
Gross profit c/d 29 500 _____
94 700 94 700

Discount allowed 900 Gross profit b/d 29 500

Wages 11 200 Discount received 400
General expenses 2 800
Property tax 600
Loan interest 500
Profit for the year (net profit) 13 900 _____
29 900 29 900
Example 8.5
Using the trial balance and accompanying notes shown in Example 8.1,
prepare the profit and loss account section for the income statement of
Samir for the year ended 31 May 20-8. Use the vertical format.
 Samir
Income Statement (Trading Account Section)
for the year ended 31 May 20-8

$ $ $
Revenue (Sales) 95 700
Less Sales returns 1 000 94 700
Less Cost of Sales
Opening Inventory 7 100
Purchases 65 000
Less Purchases returns __500
64 500
Less Goods for own use __300
64 200
Carriage inwards _1 500 65 700
72 800
Less Closing inventory _7 600 65 200
Gross profit 29 500
Add Discount received __400
29 900
Less Discount allowed 900
Wages 11 200
General expenses 2 800
Property tax 600
Loan interest __500 16 000

Profit for the year (net profit) 13 900

Transferring Ledger Account Totals to the Income
Statement

• Anything appearing in the income statement

must have a double entry in another account
• Anything credited to the income statement
must be debited in the appropriate ledger
account
• Anything debited to the income statement
must be credited in the appropriate ledger
account
When something is deducted from a debit item
in the income statement this is equal to a credit
entry
So a debit entry is required in the ledger

When something is deducted from a credit item

in the income statement this is equal to a debit
entry
So a credit entry is required in the ledger
Example 8.6
Using the income statement prepared for Sami in the previous example, prepare the following ledger accounts to show how each
is closed by transfer to the income statement:
a) Purchases account
b) Purchases return account
c) Discount received account
d) Wages account

Samir
Nominal Ledger
Purchases account

Date Details Folio $ Date Details Folio $

20-8 20-8
May 31 Total to date 65 000 May 31 Income statement 65 000
_____ _____
65 000 65 000
 Purchases returns account

Date Details Folio $ Date Details Folio $

20-8 20-8
May 31 Income statement 500 May 31 Total to date 500
___ ___
500 500

Discount received account

Date Details Folio $ Date Details Folio $

20-8 20-8
May 31 Income statement 400 May 31 Total to date 400
___ ___
400 400

Wages account

Date Details Folio $ Date Details Folio $

20-8 20-8
May 31 Total to date 11 200 May 31 Income statement 11 200
_____ _____
11 200 11 200
Total to date entries Income statement entries
Represent the total of the Excluding inventory, gross profit and profit
of the year
individual entries made in the All the items in the income statement
account for the year ended 31 May have similar transfers from the
20-8 appropriate ledger
Gross profit
Technically has a double entry within the
income statement as it is transferred from the
trading account section to the profit and loss
account section
Entries for inventory and profit for the year
There are two entries for inventory in the
income statement
The inventory at the start of the year
The inventory at the end of the year
The inventory at the start of the year
The inventory account will have a debit balance
representing the inventory at the start of the year

This is credited to the inventory account and

Transferred to the debit of the income
statement
The entry of $7 600 on the debit side
Presenting the inventory at the end of the financial year on 31
May 20-8 becomes the opening inventory for the year
beginning 1 June 20-8.
Profit of the year (net profit)

Represents the return of the owner’s

investment
This will appear as a debit entry in the
income statement, and
Should be transferred to the credit of the
capital account
As it increases the amount the business
owes the owner
Loss of the year (net loss)
Will appear as a credit entry in the income
statement, and
Should be transferred to the debit side of
the capital
As it reduces the amount of the business
owes the owner.

The total of the drawings account is transferred to

the capital account in the end of the year.
Income statement of a Service Business
Service Business
• Is one which does not buy and sell goods such as accountant, an
insurance company, a travel agent, a hairdresser and so on
• At the end of the financial year, these businesses still need to
prepare financial statements

• The trading account section of the income statement

is not prepared as no goods are bought and sold
• Only the profit and loss section of the income
statement and a balance sheet are prepared
• In the income statement all the items of
revenue received such as fees from clients,
commission and other income are credited
and expenses are debited.
• The balance sheet is exactly the same as
the balance sheet of a trading business
Example 8.9
Anita is a business consultant. She provided the following
information at the end of her financial year on 30 September
20-5.
$
Property tax 6 400
General expenses 8 950
Insurance 2 670
Printing and stationery 4 560
Loan interest 1 500
Wages 43 500
Rent received 7 300
Commissions received 92 150
 Anita
Income Statement for the year ended 30
September 20-5

$ $ $ $
Property tax 6 400 Rent received 7 300
General expenses 8 950 Commissions received 92 150
Insurance 2 670
Printing and stationery 4 560

Loan interest 1 500

Wages 43 500
Profit for the year 31 870 ______
99 450 99 450
 Anita
Income Statement for the year ended 30
September 20-5

$ $

Commissions received 92 150

Add Rent received 7 300

99 450

Less Property tax 6 400

General expenses 8 950

Insurance 2 670

Printing and stationery 4 560

Loan interest 1 500

Wages 43 500 67 580

Profit for the year 31 870