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  1. Accounting The Trading Statement & Income Statement Part 1

  2. Dr. Clive Vlieland-Boddy FCA FCCA MBA

  3. Before we Start • Some feed back on the Exam!

  4. The Income Statement • The Income Statement (Profit and Loss account or Income & Expenditure Account), summarises the incomes and expenses of the enterprise for the period stated. • The 4 accounting concepts are essential. Remember… Going Concern, Accruals, Consistency and Prudence. • This statement tells how well management have done in generating profits for the firm. • It is a statement of financial performance.

  5. The Income Statement • It is a statement of what has actually been consumed in the relevant period. • Summaries the activity of the period. • What is not consumed or still exists is taken to the Balance Sheet. • It like a movie picture of the companies activities over the period. • It says how fast the business is going.

  6. Matching Concept! Income Income Income Income Income Expenditure Expenditure Expenditure Expenditure Expenditure

  7. Basic Format of the Income Statement Incomes ( Sales or Revenues)‏ Less: Cost of Sales Gross Profit Deduct Operating Expenses (Overheads) Net Revenue

  8. Revenues or Sales • These represent the value of sales made in the relevant accounting period. Normally net of any sales tax. • Example: The annual Statement would show all the sales made in that year.

  9. Total Revenues • These are often called Net Revenues or Sales. • This means that they are net of returns discounts and sales tax (VAT,ITV) • This should be the total sales in the stated period.

  10. Total Income Revenue or Sales • Total Revenue = Price x Quantity Sold • Price can be raised or lowered to change revenue – price elasticity of demand important here • Different pricing strategies can be used – penetration, psychological, etc. • Quantity Sold can be influenced by amending the elements of the marketing mix

  11. Cost of Goods Sold • When inventories are used up in production or are sold, their cost is transferred from the balance sheet to the income statement as cost of goods sold (COGS). COGS is then matched against sales revenue to yield gross profit: Sales revenue - COGS Gross profit

  12. Manufacturing Companies: Income Statement Sales - Cost of goods sold (COGS) Gross profit - Operating expenses/Overheads Net Income

  13. Calculating Cost of Goods Sold Cost of goods Sold (COGS) Beginning inventory + Purchases - Ending work in process inventory Cost of goods Sold (COGS)

  14. Inventory Cost Flows to Financial Statements

  15. Inventories • Inventory costs either are reported on the balance sheet or they are transferred to the income statement as an expense (cost of goods sold) to match against sales revenues. • The process for which costs are removed from the balance sheet is important.

  16. Inventories • Raw Materials • WIP • Finished Goods.

  17. MaterialPurchases Raw Materials Direct Labor Work in Process ManufacturingOverhead Cost of GoodsSold FinishedGoods Period Costs Selling andAdministrative Selling andAdministrative Manufacturing Cost Flows Income StatementExpenses Balance Sheet Costs Inventories

  18. Production

  19. Product Cost Flows

  20. Product Cost Flows

  21. Product Cost Flows

  22. Product Cost Flows

  23. What is Contribution? • Contribution is the management accounting term for gross profit. • In other words, sales less the cost of goods sold.

  24. The Matching Principal • Must match Income with Expenditure. • The sales must be matched with the cost of the actual sales.

  25. Matching Concept! Income Income Income Income Income Expenditure Expenditure Expenditure Expenditure Expenditure

  26. Cost of Sales • Here the matching concept requires you to ensure that the costs matches the sales. • Example: A Television manufacturer needs to ensure that the costs of his sales matches the TV’s sold. • Materials consumed in the production process along with production wages and other direct costs attached to production.

  27. Gross Profit (Contribution) • Contribution Margin Per Unit • This is Gross Profit that each unit contributes towards the general overheads and net income • Contribution Margin Ratio • The contribution margin as a % of sales. (Same as Gross Profit Margin %.

  28. Manufacturing & Construction Enterprises They will include in Cost of sales (COGS): • Purchases. • Direct wages • Other direct costs Note that most published accounts will just show Cost of Sales or GOGS.

  29. Gross Profit (Gross Margin) • This represents the contribution generated from the selling of goods after deducting the cost of those goods. It is an important figure and essential in evaluation of accounts. • Essentially firms can evaluate their marketing success by looking at the sales generated as well as the gross profit. This discloses total activity as well as the extent that discounting or increased costs have affected the firm.

  30. Gross Profit % • Most Companies buy and sell products. • They tend to mark-up the purchase price by an agreed margin and this should remain constant. • So if a company buys a widget for 100€ and has a mark-up of 50%, it would sell for 150€.

  31. What does the Gross Profit % Say? • It should remain constant over the years.

  32. What is the Gross Profit % • The gross profit is reached after taking the COGS from Total Sales. • The GP% = Gross Profit Total Sales If Sales were $500,000 and COGS were 300,000 Then GP% = 200,000 = 40% 500,000

  33. What does this tell us? • This represents the trading activity for a given period. • We need to ensure that the sales are matched with the cost of goods sold as well as the overheads relevant to those sales and the accounting period. • Remember in any doubt then “prudence” must prevail.

  34. Purchases & Inventories • Purchases represent the items acquired in the period. • Often some of these are not actually consumed. • Some are left over at the end of the period to be sold in the next period. • These remaining items are classified as inventories. • Remember the pizza restaurant…..

  35. Inventory Accounting Systems • Periodic systems do not keep a continuous record of inventory on hand. • Perpetualsystems maintain a running record to show the inventory on hand at all times.

  36. Cost of Goods Sold 540,000 Recording Transactionsand the T-Accounts Inventory Open Inv 100,000 Purchs 560,000 Bal C/D 120,000 540,000 C/f 120,000

  37. COGS • This is therefore made up with the following: • Opening Inventories • Add Purchases • = Total Goods available to be sold • Less Closing Inventories

  38. Lets just look at Financial Accounting and how these appear in the accounts

  39. Balance Sheet Presentation of Product Costs Raw Materials Inventory • Cost of materials on hand used to produce a company’s products Work in Process Inventory • Inventory account for the cost of goods that are only partially completed Finished Goods Inventory • Account for the cost of all the items complete and ready to sell

  40. Reporting in theFinancial Statements Income Statement (partial) Sales revenue $900,000 Cost of goodssold 540,000 Gross profit $360,000 Ending Balance Sheet (partial) Current assets: Cash $ XXX Short-term investments XXX Accounts receivable, net XXX Inventory 120,000 Prepaid expenses XXX

  41. Flow of Product Costs in Accounts

  42. Inventories

  43. IFRS & GAAP • IFRS requires FIFO • US GAAP LIFO • However the world is converging on IFRS.

  44. Consistency Principle • Use the same accounting methods and procedures from one period to the next • May change inventory methods, but must disclose the effects of the change on net income

  45. Lower-of Cost or Net Realisable Value • Report inventory at the lower of its historical cost or market (realisable/ replacement) value • If the replacement cost falls below its historical cost, write down the value of the inventory to what it can be sold for