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  1. The income statement (I.S.) or Profit and Loss Account (P&L)

The measurement of profit is probably the most important function of accounting. Investors, managers, bankers and others are interested in knowing how well a business is doing. The profit and loss account (income statement) shows the results of the flow of activity and transactions and is designed to report the profit performance of a business for a specific period of time, such as a year, quarter or month.

      The purpose of income statement is to measure and report how much profit the business has generated over a period.

      The measurement of profit requires that the total revenues of the business generated during a particular period, be calculated.

      Revenue is simply a measure of the inflow of assets (cash or amounts owed to a business by debtors) or the reduction in liabilities which arise as a result of trading operations.

      It is not necessary for a business to receive cash before recognizing that revenue has been earned. The accruals concept recognizes revenue which arises from the sale of goods or services on credit.

      The total expenses relating to the period must also be calculated. An expense represents the outflow of assets (or increase in liabilities) which is incurred as a result of generating revenues.

      Expenses are goods and services consumed in operating a business or other economic unit.

      The income statement for a period shows the total revenue generated during a particular period and deducts from this the total expenses incurred in generating that revenue. The difference between the total revenue and total expenses will represent either profit (if revenues > expenses) or loss (if expenses > revenues).

      Where revenues and expenses are equal for the period, the business is said to break even.

      Profit (loss) = total revenue --- total expenses incurred to generate the revenue

      The income statement and the balance sheet (B.S.) are closely related.

      The profit and loss account can be viewed as linking the B.S. at the beginning of the period with the B.S. at the end of the period. Thus, at the commencement of business, a B.S. will be produced to reveal the opening financial position. After an appropriate period, an I.S. will be prepared to show the wealth generated over the period. A B.S will also be prepared to reveal the new financial position, at the end of the period covered by the I.S.

      The B.S. will incorporate the changes in wealth which have occurred since the previous B.S. was drawn up.

      The effect of making profit (loss) on the B.S. means that the B.S. equation can be extended as follows:

assets = capital + (--) profit (loss) + liabilities


assets = equity + (revenues – expenses) + liabilities

  1. Classification of expenses and revenues

Expenses and revenues are classified into three categories:

a)      operating expenses and revenues;

b)      financial expenses and revenues;

c)      extraordinary expenses and revenues.

Expenses may be classified into 2 categories:

 ٭ by type operation or by function

٭ by type of expenditure or by nature.

            Accordingly, there may be distinguished 2 formats for Income Statement (function, nature)

a)      Operating expenses and revenues

Operating expenses                                                     Operating revenues

٭ expenses relating to inventories               ٭    turnover

         • raw materials                                           • sales of finished goods,                                   

            • consumables                                           semi – finished goods,

٭ third parties services                                        residual products

         • maintenance, repair expenses                • services rendered

            • insurance premium                                  • rental and royalty

٭ other third party services                                           income

            • commissions and fees                            •  sales of merchandises

            • transport                                                  • revenues from

            • bank commissions                                  sundry activities

٭ other taxes, duties                                          ٭ variation inventory

٭ personnel expenses                                        ٭ subsidies for operating

٭ other operating expenses                                      activities

            • bad debts written off                           ٭ other operating revenues

            • other                                                                                  • bad debts

٭ depreciation and provisions                         • other operating revenues

b) Financial expenses                                       Financial revenues

٭ interest expense                                           ٭ interest revenue

٭ foreign exchange losses                               ٭ foreign exchange gains

٭ discounts allowed                                         ٭ discounts received

٭ losses on disposal of                                     ٭ revenues from long term

financial investments                                        financial investments

                                                                          ٭ revenues from disposal 

                                                                          of financial investments

c) Extraordinary expenses                                Extraordinary revenues

٭ expenses related to                                       ٭ revenues from subsidies   

natural disasters and other                               for extraordinary events

extraordinary events                                       and other similar revenues      

Operating activity + financial activity = ordinary activities

            Extraordinary   items are those items which derive from events or transactions outside the ordinary activities of the business and which are both material and expected not to recur frequently or regularly. They do not include items which, though exceptional on account of size or incidence, derive from ordinary activities of the business.

  1. Profit calculation

Operating revenues – operating expenses = operating profit (loss)

Financial revenues – financial expenses    = financial profit (loss) 


            Ordinary revenues – ordinary expenses = ordinary profit (loss)

            Extraordinary revenues – extraordinary expenses = profit (loss)

                                                                             on extraordinary activity

Profit (loss) on ordinary activities + Profit (loss) on extraordinary = activities = Profit (loss) for the financial year

 less (Income tax)

 = Net Profit (loss) for the financial year.

By type of operation or function operating expenses may be classified in:

         - cost of sales;

         - distribution costs;

         - administrative expenses.

Turnover -- cost of sales = gross profit or loss. This represents the profit from simply buying and selling goods without taking into account any other expenses or revenues associated with the business.

4. Income statement formats

Income statement – Format 1 (by function or type of expense)

1.  Turnover

2.  Cost of sales

3.  Gross profit or loss

4.  Distribution costs

5.  Administrative expenses

6.  Other operating income

7.  Income from shares in group companies

8.  Income from shares in related companies

9.  Income from other fixed - asset investments

10. Other interest receivable and similar income

11. Amounts written of investments

12. Interest payable and similar changes

13. Tax and profit or loss on ordinary activities

14. Profit or loss on ordinary activities after taxation

15. Extraordinary income

16. Extraordinary changes

17. Extraordinary profit or loss



Finished goods                                                       1000

Financial leasing liabilities                                    2000

Salaries payable                                                    6000

Goodwill                                                               2000

Shareholders’ capital                                         90000

Cash  on hand                                                      3000

Deferred revenues                                                  300

Sundry debitors                                                    4000

Taxes payable                                                       1500

Subsidies                                                               3800

Land assesments                                                   9000

Consumables                                                         3000

Cash at bank                                                      180000

Notes payable                                                     11000

Accrued revenues                                                   500

VAT receivable                                                     2000

Retained earnings                                                   ???

Clients                                                                  5000

Trade marks                                                        16000

Reevaluation reserves                                           8000

Suppliers                                                              9000

Marketable securities                                         12000

Income tax payable                                               2500

During the current month, the subsequent transactions occurred:

1)      30%  from clients are cashed into the bank account

2)      purchase of merchandise for 2000 $,  the payment being due leter

3)      incorporating 25% from reevaluation reserves into shareholders’ capital

4)      acquisition of raw materials for 4000 $; half of them is paid immediately from cash, the other half after 2 weeks

5)      the supplier of merchandise is paid with a note payable

6)      a building is purchased and paid with a long term credit of 110000 $

7)      a rent is cashed in advance for 500 $

8)      all sundry debitors are cashed in

9)      the salaries are paid from cash at bank

10)  10% from leasing liability is paid from bank account

11)  the profit is used 60% to pay dividends

12)  the VAT receivable is cashed into cash on hand

13)  a long term credit is cashed into the bank account for 7000 $

14)  an invoice for special services is payd in advance for 5000 $

15)  the rest of  clients changed into notes receivable

16)  marketable securities are purchased for 4500 $

18. Tax on profit or loss

19. Other taxes not shown under the above items

20. Profit or loss for the financial year

Income statement - Format 2 (by nature of expenses)

1. Turnover

  1. Change in stocks ( inventories ) of finished goods and working proper ?
  2. Own  work capitalized
  3. Other operating income
  4. a   Row materials and consumables

b  Other external changes

     6. Staff costs:

           a)  wages and salaries

           b)  social security costs

           c)  other pension costs

    7.  a) Depreciation and other amounts written off tangible and intangible fixed assets

            b) Exceptional amounts written off current assets

    8. Other operating changes

    9. Income from shares in group companies

   10. Income from shares in related companies

   11. Income from other fixed assets investments

   12. Other interest receivable and similar income

   13. Amounts written off investments

   14. Interest payable and similar changes

   15. Tax on profit or loss on ordinary activities

   16. Profit or loss on ordinary activities after taxation

   17. Extraordinary income

   18. Extraordinary changes

   19. Extraordinary profit or loss

   20. Tax on extraordinary profit or loss

   21. Other taxes not shown under the above items

   22. Profit or loss for the financial year




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