Income Statement Assignment help

As we discussed earlier under the topic of “Financial Statements” that Income statement shows the profitability of the firm. Through Income statement we get to know about the net profit earned or net loss suffered by the business. 

Income statement of an entity consists of the following:

1. Trading Account (only manufacturing entities)
2. Profit and Loss Account (for all the entities)

Trading Account

Trading accounts represents the Gross Profit/Gross Loss of the concern out of sale and purchase for the particular accounting period. This account basically consists of all the expenses directly related to the manufacturing of goods and revenues generated from the sales of those manufactured goods. It includes items like opening and closing stock, direct expenses, sales, cost of goods sold, etc. 

All the direct expenses and opening stock are debited in the Trading account and the revenue from sales and closing stock is credited. Let us discuss the items in detail.

Debit side of Trading Account

Opening Stock − Unsold closing stock of the last financial year is the opening stock in hand for the current accounting period which appears on the debit side of the Trading Account of the current financial year.

Purchases less returns− Total purchases (net of purchase return) include the total goods or raw materials purchased for the year. It includes cash purchase and credit purchase. It is a net figure i.e. the purchase returns are deducted from the purchases before posting it on the debit side of Trading Account.

Direct Expenses − Expenses incurred to manufacture the goods and bring the traded goods at business premises/warehouse are called direct expenses. 

Direct expenses include expenses like Freight charges (both inward and outward), cartage or carriage charges, custom and import duty in case of import, gas, electricity fuel, water, packing charges, wages, rent paid for the factory, interest or commission paid, repairs and any other miscellaneous expenses incurred in this regards comes under the debit side of Trading Account.

Credit side of Trading Account

Sales less return − Total Sale of the traded goods including cash and credit sales will appear on the credit side of Trading Account. Sales is always recorded at the net realizable value excluding Central Sales Tax, Vat, Custom, and Excise Duty. It is also net of all the sales returns.

Other Income: Other miscellaneous gains and incomes are recorded on the credit side of the trading account, if any.

Closing Stock − Total Value of unsold stock of the current financial year is called as closing stock and will appear on the credit side of Trading Account.

Closing Stock = Opening Stock + Net Purchases - Net Sale

Gross Profit/ Gross Margin – Gross Margin is the difference of revenue and the cost of providing services or making products. However, it is calculated before deducting payroll, taxation, overhead, and other interest payments. It is shown on the credit side of the Trading Account.

Gross Profit = Sales - Cost of Goods Sold

Gross Loss – Gross Loss is the also difference of revenue and the cost of providing services or making products. It is shown on the debit side of the Trading Account.

Gross Profit = Cost of Goods Sold - Sales 

Trading account is very useful for the firm as it helps see the relationship between the costs incurred and the revenues earned. It also helps determine the level of efficiency with which the operations or manufacturing has been conducted. The ratio of Gross Profit to sales is very significant and is calculated as- 

Format of a Trading Account

Closing Entries for Trading Account

The preparation of Trading account requires that the balances of accounts of all concerned items are transferred to it for the final compilation.

1) Opening stock account, purchases account, wages account, carriage inwards and direct expenses are closed by transferring to the debit side of the trading account. This is recorded as-

Trading A/cDr.

To Opening Stock A/c 

To Purchases A/c

To Wages A/c

To Carriage Inwards A/c

To Other direct expenses A/c

2) The purchases returns or return outwards are closed by transferring its balance to the purchases account. This is recorded as-

Purchases Returns A/c                      Dr.

             To Purchases A/c

3) The sales returns or return inwards are closed by transferring its balance to the sales account. This is recorded as-

Sales A/c                                           Dr.

     To Sales Returns A/c

4) Opening stock account and sales account are closed by transferring to the credit side of the trading account. This is recorded as-

Sales A/cDr.

Closing Stock A/cDr.

         To Trading A/c

5) For transferring the Gross Profit or Gross loss to the Profit & Loss account-

Trading A/cDr.                (in case of gain)

To Profit and Loss A/c

Profit and Loss A/c                            Dr.              (in case of loss)

  To Trading A/c

Concept of Gross Profit and Net Profit

The trading and profit & loss account is a combination of two accounts which are Trading A/c, which determines the Gross profit and Profit & Loss A/c, which determines the Net profit.

The trading account records the basis operational activity of the business i.e. manufacturing, purchasing and selling of goods. So, this account determines the profit of the firm purely on the basis of sale of goods or services to its customers. 

Direct expenses means expenses connected to manufacture, purchase of goods and bringing them to the point of sale. All the direct expenses are charged to the Trading account. E.g. wages, fuel, rent for the factory, etc.

Sales consist of the main item of revenue and purchase is one of the main expenses for the business.

The excess of sales over purchases and direct expenses is Gross Profit, i.e.

GP = Sales – (Purchases + Direct Expenses)

Indirect expenses are expenses which are incurred post manufacture to market and sell the product or manage the office space. Indirect expenses are charged generally to the debit side of the Profit & Loss account.

Indirect incomes are incomes apart from the sales of the main product of the business, i.e. rent income, interest or dividend, etc. Indirect incomes are charged to the credit side of the Profit & Loss account.

The excess of Gross Profit and other incomes over the indirect expenses is the Net Profit/Loss, i.e.

NP = GP + Other Incomes – Indirect Expenses

Profit and Loss Account

The profit and loss account shows what net profit and loss your business has made within an accounting period after deducting all indirect expenditure from the income. A net profit is earned if the total expenditure is less than the sales and a net loss if it is greater.

The credit side of the Profit & Loss account represents the Gross profit as transferred from Trading Account along with any other income received by the firm like interest, Commission, etc.

Debit side of profit and loss account is a summary of all the indirect expenses as incurred by the firm during that particular accounting year. For example, Administrative Expenses, Personal Expenses, Financial Expenses, Selling, and Distribution Expenses, Depreciation, Bad Debts, Interest, Discount, etc. Balancing figure of profit and loss accounts represents the true and net profit as earned at the end of the accounting period and transferred to the Balance Sheet.

Let us discuss some special and significant items individually-

Drawings: Drawings are not expenses for the firm and therefore shouldn’t be debited to the Profit and Loss account. If the proprietor has withdrawn any capital in form of cash or kind for his personal use, it will be deducted from the capital and not shown in the P&L account.

Income Tax: The income tax payable is an expense for the business. In case of a sole proprietorship, income tax is treated as a personal expense. It is debited to the Capital account and not to the P&L account. In case of a partnership or corporate it is debited in the profit and Loss account of their personal account and not of the entity’s. If firm pays the tax in place of the partner, then it is treated as drawing.

Bad debts: When a customer fails to pay the amount due from him to the firm, then it is said to be a bad debt. It is a loss for the firm and is debited to the Profit and Loss account. The customer’s account is credited with the same amount and closed.

Bad debts recovered: If an amount which was earlier recorded as bad debt is recovered in future, fully or partly, it is termed as bad debt recovered. It is credited in the Profit and loss account.

Format of a Profit and Loss Account

Closing Entries for Profit and Loss Account

The preparation of Profit & Loss account requires that the balances of accounts of all concerned items are transferred to it for the final compilation.

1) All the indirect expenses like salaries account, rent and other indirect expenses are closed by transferring to the debit side of the profit & loss account. This is recorded as-

Profit & Loss A/cDr.

To Salary A/c 

To Rent A/c

To Other indirect expenses A/c

2) Items of income & gain like discount received, interest income, bad debts recovered and other indirect incomes are closed by transferring to the credit side of the profit & loss account. This is recorded as-

Discount received A/c                                      Dr.

Bad debts recovered A/c                                Dr.

Other incomes A/c                                          Dr.

         To Profit and Loss A/c

4) For transferring the Net Profit or Net loss to the Capital account-

Profit and Loss A/c                        Dr.                (in case of gain)

To Capital A/c

Capital A/cDr.                 (in case of loss)

  To Profit and Loss A/c

Adjustments, Reserves and Provisions

1. If wrong amount is recoded as an expense or income: The wrong amount should be deducted from that expense or income and the right amount will be added. 
2. If there are outstanding expenses or accrued income: The amount of outstanding expense will be debited and accrued income will be credited in the Profit and loss account because the expense/income pertains to the current period. Apart from that they will also reflect in the Balance Sheet of that year.
3. If there are prepaid expenses or advance income: There will be no entry in the Profit and Loss account as the expense/income doesn’t belong to the current period. They will just appear in the Balance sheet for the year.
4. Provision for bad and doubtful debts or Provision or discount or Depreciation Reserve: The whole concept behind creating any provision or reserve is to protect the firm from the possible future losses. Thatswhy, these are debited to the Profit and Loss account and shown in the balance sheet either on the liabilities side or deducting the same from the concerned assets.
5. Abnormal loss of stock by fire or theft: It is a loss for the firm and decreases the stock. Hence, the purchases account or trading account is debited. Entry is-

Loss by fire/theft A/c                        Dr.

To Purchase/Trading A/c

Profit and Loss A/c                                    Dr.               (for insurance claim)

To Loss by fire/theft A/c

1) Goods sent on approval basis: This is not an actual sales but the entry passed at the times goods were sent is that of an actual sale. So, if the approval is not received till the year end then the following entry is passed-

Sales A/cDr.

To Debtors A/c

Stock with debtors A/cDr.               

To Trading A/c

2) Goods used for other than sale: Entries are-

Donation A/cDr.                 (if donated)

To Purchases A/c

Drawings A/cDr.               (if used by owner for personal use)               

To Purchases A/c

Free sample/ advertisement A/c         Dr.              (if used for advertisement)  

To Purchases A/c