Chapter # 11

Financial Statements
Financial Statements
Chapter # 11

Chapter contents
 Financial Statements.
 Cost of goods sold.
 Income statement:
o Single – step income
statement.
o Multi – step income
statement.
 Elements of multi – step income
statement.
 Income statement of servicing
business.
 Balance sheet:
o Report form balance sheet.
o Account form balance sheet.
 Missing figure in trial balance.
 Illustrations.

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Chapter # 11

Chapter # 11
FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
Financial statement is a written report which quantitatively describes the financial health of a
company. This includes an income statement, balance sheet, cash flow statement and statement
of changes in equity. Financial statements are usually compiled on a quarterly and annually
basis. Financial statements consist of five statements:
1. Income Statement.
2. Balance Sheet.
3. Cash Flow Statement.
4. Statement of Changes in Equity.
5. Notes to the Financial Statements.

COST OF GOODS SOLD

Cost of goods sold is the price of purchasing or producing a product that is sold; also called cost
of sales. It is calculated by the formula beginning inventory plus net purchases less ending
inventory. This total is an expense on the income statement. In a manufacturing setting, the cost
of goods sold is the cost of direct materials, direct labor, and overhead associated with the units
sold. In a retail setting, the cost of goods sold is the wholesale cost of the items sold, plus any
transportation cost to get the items to the warehouse.

Format of Statement of Cost of Goods Sold:

Name of Business
Statement of Cost of Goods Sold
For the Period Ended _______
Merchandise inventory beginning XXX
Add: Net Purchases:
Purchases XXX
Add: Transportation in XXX
Add: Import duty XXX
Add: Wages expense XXX
Delivered purchases XXX
Less: Purchase discount (XXX)
Less: Purchase returns & allowances (XXX)
Net purchases XXX
Merchandise available for sale XXX
Less: Merchandise inventory (end) (XXX)
Cost of goods sold XXX

ILLUSTRATION # 1:
(Cost of Goods Sold)
The following balances are taken from the books of Rehmat & Co. for the year ending December
31, 1990:-
Merchandise inventory (1.1.90) Rs.15,000 Purchase returns Rs.2,000
Purchases 70,000 Transportation in 1,250
Merchandise inventory (31.12.90) 10,000 Purchase discount 1,400
REQUIRED
Prepare Statement of Cost of Goods Sold.

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Solution # 1:
REHMAT & CO.
STATEMENT OF COST OF GOODS SOLD
FOR THE PERIOD ENDED 31 DECEMBER 1990
Merchandise inventory (beginning) Rs.15,000
Add: Net Purchases:
Purchases Rs.70,000
Add: Transportation in 1,250
Delivered purchases 71,250
Less: Purchase discount (1,400)
Less: Purchase returns (2,000)
Net purchases 67,850
Merchandise available for sale 82,850
Less: Merchandise inventory (ending) (10,000)
Cost of goods sold Rs.72,850

COST OF GOODS SOLD ACCOUNT

Cost of Goods Sold
Merchandise inventory beginning XXX Purchase return and allowance XXX
Purchases XXX Purchase discount XXX
Transportation – in XXX Merchandise inventory ending XXX
Import duty XXX Cost of goods sold (Transferred to XXX
Wages expense XXX Profit and loss account)
XXX XXX

ILLUSTRATION # 2:
(Cost of Goods Sold Account)
The following balances are taken from the books of Karim Sons for the year ending December
31, 2003:-
Merchandise inventory opening Rs.10,000 Purchase returns Rs.2,000
Purchases 100,000 Transportation in 3,000
Merchandise inventory ending 20,000 Purchase discount 4,000
Wages expense 20,000 Import duty 5,000
REQUIRED
Prepare Cost of Goods Sold account.

Solution # 2:
Karim Sons
Cost of Goods Sold Account
Merchandise inventory beginning 10,000 Purchase return and allowance 2,000
Purchases 100,000 Purchase discount 4,000
Transportation – in 3,000 Merchandise inventory ending 20,000
Import duty 5,000 Cost of goods sold (Transferred to 112,000
Wages expense 20,000 Profit and loss account)
138,000 138,000

Explanation of Solution # 2:
All the expenses are recorded on the left (debit) side of cost of goods sold account and all those
accounts that reduces expense or are credit in nature, are recorded on the credit side of the

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account. The balancing amount on credit side is the amount of cost of goods sold which is
transferred to the income statement or profit and loss account.

INCOME STATEMENT
Income statement shows the financial performance of the business. It shows the result of
operations for a period. It consists of revenue and expenses. When total revenues exceed the
total expenses, the resulting amount is net profit. When expenses exceed revenues, the resulting
amount is net loss.

Income
Statement

Revenues Expenses

SINGLE – STEP INCOME STATEMENT

A format for the income statement that lists all revenues and gains, and then all expenses and
losses (except taxes), without classifying them by source is called single – step income
statement. Taxes are usually separated from the other expenses and losses and are on the last
line, right before net income.

Format of Single – Step Income Statement:

Name of Business
Income Statement
For the Period Ended _______
Revenues:
Sales revenue XXX
Interest income XXX
Commission income XXX
Total revenues XXX
Less: Total Expenses:
Cost of goods sold XXX
Salaries expense XXX
Advertising expense XXX
Utilities expense XXX
Bad debts expense XXX
Rent expense XXX
Insurance expense XXX
Supplies expense XXX
Repair expense XXX
Depreciation expense XXX
Total expenses (XXX)
Operating profit/loss XXX/(XXX)
Less: Income tax expense (XXX)
Net income/loss XXX/(XXX)

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ILLUSTRATION # 3:
(Single – Step Income Statement)
The following balances are extracted from the books of Mr. Furqan for the year ending
December 31, 1998:-
Cost of goods sold Rs.300,000 Sales revenue Rs.500,000
Salaries expense 20,000 Rent income 30,000
Insurance expense 10,000 Advertising expense 25,000
Depreciation expense 15,000 Utilities expense 20,000
REQUIRED
Prepare single – step income statement for the period ended December 31, 1998.

Solution # 3:
MR. FURQAN
INCOME STATEMENT
FOR THE PERIOD ENDED DECEMBER 31, 1998
Revenues:
Sales revenue 500,000
Rent income 30,000
Total revenues 530,000
Less: Total Expenses:
Cost of goods sold 300,000
Salaries expense 20,000
Advertising expense 25,000
Utilities expense 20,000
Insurance expense 10,000
Depreciation expense 15,000
Total expenses (390,000)
Net income 140,000

Explanation of Solution # 3:
Total revenues are Rs.530,000 and total expenses are Rs.390,000. Total revenues exceeds from
total expenses by Rs.140,000 (530,000 – 390,000 = 140,000). When total revenues are more
than total expenses, it results net profit. Here, net profit is Rs.140,000.

MULTI – STEP INCOME STATEMENT

A format for the income statement that classifies revenues, gains, expenses, and losses into
operating and non-operating categories.
 Multiple-step income statements always start with sales revenue and deduct the cost of
goods sold to get gross profit. This relationship is thus highlighted by presentation on
the face of the income statement. The single-step format does not do this.
 The multiple-step format then lists the operating expenses, usually classifying them as
selling expenses, general expenses, or administrative expenses.
 Income from operations, or operating income, is the difference between the gross profit
and operating expenses, and is specifically listed.
 The next section on the multiple-step income statement includes other revenues and
gains, expenses, and losses. This section presents items that are not related to the
regular business activities, such as interest and gains or losses from selling assets.
 The multiple-step format then highlights the income before taxes, the net of income
from operations, and the “other” section.
 The next line is tax expense, followed by net income.

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ELEMENTS OF MULTI – STEP INCOME STATEMENT

Following are the elements used for preparing a multi – step income statement:

The total amount of sales revenue before adjusting for sales returns,
Gross Sales:
sales allowances, or sales discounts.

The value of sales made during an accounting period, reduced by any

Net Sales: returns made by customers, any discounts given to customers, and any
other reductions from the original selling price of the goods.

Calculated by the formula beginning inventory plus net purchases less

ending inventory. This total is an expense on the income statement. In
a manufacturing setting, the cost of goods sold is the cost of direct
Cost of Goods Sold:
materials, direct labor, and overhead associated with the units sold. In
a retail setting, the cost of goods sold is the wholesale cost of the items
sold, plus any transportation cost to get the items to the warehouse.

The value and the number of units, that are in inventory at the
Merchandise Inventory
beginning of the accounting period. Beginning inventory is used to
Beginning:
calculate the cost of goods sold.

Purchases shows the buying of merchandise for resale purpose.

Purchase of fixed assets or supplies are not recorded as purchases. The
Gross Purchases:
total amount of purchases of merchandise before adjusting purchase
returns and purchase discounts is called gross purchases.

The value of a company’s inventory purchases during an accounting

period reduced by any returns, discounts, or other reductions of the
Net Purchases: price actually paid for the goods. Net purchases can be used to
calculate the cost of goods sold in businesses using periodic inventory
systems.

The delivery cost associated with getting purchased inventory items

from the source to the company that will resell them. Freight-in is a
Freight – in:
cost that is included in inventory and is reflected in the cost of goods
sold.

The compensation earned by hourly-paid employees during the

Wages Expenses:
interval of time is called wages expenses.

In a retail environment, calculated by the formula beginning inventory

plus net purchases. This total represents the cost of all products
Merchandise Available
available for sale during the period. In a manufacturing business,
for Sale:
goods available for sale can be calculated as beginning-finished-goods
inventory plus goods completed during the accounting period.

The value and the number in units, in inventory at the end of the
Merchandise Inventory accounting period. Ending inventory is used to calculate the cost of
Ending: goods sold. Ending inventory from one year becomes the next year’s
beginning inventory.

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When the sales revenue is more than the cost of goods sold, it is called
Gross Profit:
gross profit.

When the sales revenue is less than the cost of goods sold, it is known
Gross Loss:
as gross loss.

Costs associated with the regular business activities of an entity.

Operating Expenses: Operating expenses are listed on a multiple-step income statement
after the cost of goods sold.

Cost incurred to sell (e.g., advertising, salesperson commission) or

Selling Expenses: distribute (e.g., freight-out) merchandise. It is one of the types of
operating expenses and is a period cost.

All expenses incurred in connection with performing general and

Administrative administrative activities. Examples are executives' salaries and legal
Expenses: expenses. General and administrative expenses are shown under
operating expenses in the income statement.

The cost of delivering products to the buyer. Freight-out is classified as

Freight – out:
a selling expense.

Sales minus the cost of goods sold minus selling, general, and
administrative expenses. On the income statement, operating income
Operating Income: is found before the “other revenues, gains, expenses, and losses”
section. Operating income can also be calculated by starting with net
income and deducting taxes and interest.

The result of cost of goods sold and operating expenses exceeding

Operating Loss: revenues. Contrast with operating income, which is equal to the excess
of revenues over the cost of goods sold and operating expenses.

The amount of income tax that is associated with (matches) the net
income reported on the company's income statement. This amount
Income Tax Expense: will likely be different than the income taxes actually payable, since
some of the revenues and expenses reported on the tax return will be
different from the amounts on the income statement.

Total revenues and gains less total expenses and losses for the
Net Income:
accounting period.

In a business, the result of expenses and losses exceeding revenues and

Net Loss: gains. Contrast with net income, in which the reverse is true, and
revenues exceed expenses.

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Format of Multi – Step Income Statement:

Name of Business
Income Statement
For the Period Ended _______
Sales XXX
Less: Sales discount XXX
Less: Sales returns and allowances XXX (XXX)
Net sales XXX
Less: Cost of Goods Sold:
Merchandise inventory (beg) XXX
Add: Net Purchases:
Purchases XXX
Add: Transportation in XXX
Add: Import duty XXX
Add: Wages expense XXX
Delivered purchases XXX
Less: Purchase discount (XXX)
Less: Purchase returns & allowances (XXX)
Net purchases XXX
Merchandise available for sale XXX
Less: Merchandise inventory (end) (XXX)
Cost of goods sold (XXX)
Gross profit / loss XXX/(XXX)
Less: Operating Expenses:
Selling Expenses:
Sales salaries expense XXX
Advertising expense XXX
Utilities expense – Selling XXX
Bad debts expense XXX
Rent expense – Selling XXX
Total selling expense XXX
Administrative Expenses:
Office salaries expense XXX
Insurance expense XXX
Utilities expense – Office XXX
Supplies expense XXX
Office rent expense XXX
Repair expense XXX
Depreciation expense XXX
Total administrative expenses XXX
Total operating expenses (XXX)
Profit/loss from operation XXX/(XXX)
Add: Other Income:
Commission income XXX
Income before income tax XXX
Less: Income tax expense (XXX)
Net profit/Loss XXX/(XXX)

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ILLUSTRATION # 4:
(Income Statement Without Adjusting Entries – Net Profit)
The following balances have been taken from the ledger of Zahid and Co. on December 31, 1996,
the close of their financial year:
Merchandise inventory January 1, 1996 Rs.6,000; Purchases Rs.39,000; Freight Rs.2,000;
Merchandise inventory December 31, 1996 Rs.10,000; Office supplies expense Rs.1,400; Rent
expense Rs.200; Salaries expense Rs.1,600; General expense Rs.1,500; Sales Rs.70,000.
REQUIRED
Prepare classified Income Statement for the year ended December 31, 1996.

Solution # 4:
ZAHID AND CO.
INCOME STATEMENT
FOR THE PERIOD ENDED 31 DECEMBER 1996
Sales 70,000
Less: Cost of Goods Sold:
Merchandise inventory beginning 6,000
Add: Net Purchases:
Purchases 39,000
Add: Freight 2,000
Net purchases 41,000
Merchandise available for sale 47,000
Less: Merchandise inventory ending (10,000)
Cost of goods sold (37,000)
Gross profit 33,000
Less: Operating Expenses:
Salaries expense 1,600
Rent expense 200
Office supplies expense 1,400
General expense 1,500
Total operating expenses (4,700)
Net profit 28,300

Explanation of Solution # 4:
Sales revenue is Rs.70,000 and cost of goods sold is Rs.37,000. Sales revenue is more than cost
of goods sold which shows the gross profit of Rs.33,000 (70,000 – 37,000 = 33,000). Operating
expenses are Rs.4,700. Net profit is Rs.28,300 (33,000 – 4,700 = 28,300).

ILLUSTRATION # 5:
(Income Statement Without Adjusting Entries – Net Loss)
The following balances have been taken from the ledger of Mr. Kamran on June 30, 2003:
Merchandise inventory July 1, 2002 Rs.10,000; Purchases Rs.90,000; Purchase returns and
allowance Rs.3,000; Purchase discount Rs.2,000; Transportation – in Rs.8,000; Merchandise
inventory June 30, 2003 Rs.3,000; Insurance expense Rs.5,000; Rent expense Rs.6,000; Salaries
expense Rs.10,000; Sales Rs.120,000; Sales return and allowance Rs.1,000; Sales discount
Rs.2,000.
REQUIRED
Prepare classified Income Statement for the year ended June 30, 2003.

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Solution # 5:
MR. KAMRAN
INCOME STATEMENT
FOR THE PERIOD ENDED JUNE 30, 2003
Sales 120,000
Less: Sales return allowance (1,000)
Less: Sales discount (2,000)
Net sales 117,000
Less: Cost of Goods Sold:
Merchandise inventory beginning 10,000
Add: Net Purchases:
Purchases 90,000
Add: Transportation – in 8,000
Delivered purchases 98,000
Less: Purchase return and allowances (3,000)
Less: Purchase discount (2,000)
Net purchases 93,000
Merchandise available for sale 103,000
Less: Merchandise inventory ending (3,000)
Cost of goods sold (100,000)
Gross profit 17,000
Less: Operating Expenses:
Insurance expense 5,000
Rent expense 6,000
Salaries expense 10,000
Total operating expenses (21,000)
Net loss (4,000)

Explanation of Solution # 5:
Net sales is Rs.117,000 and cost of goods sold is Rs.100,000. Sales revenue is more than cost of
goods sold which shows the gross profit of Rs.17,000 (117,000 – 100,000 = 17,000). Operating
expenses are Rs.21,000. Total operating expenses are more than gross profit which results net
loss of Rs.4,000 (17,000 – 21,000 = 4,000).

ILLUSTRATION # 6:
(Income Statement With Adjusting Entries)
The following balances have been taken from the ledger of Saeed & Co. on December 31, 2001:
Inventory opening Rs.30,000; Prepaid insurance Rs.5,000; Prepaid rent Rs.4,000; Furniture
Rs.15,000; Allowance for depreciation Rs.3,000; Purchases Rs.200,000; Sales Rs.300,000; Sales
return and allowance Rs.2,000; Purchas return and allowance Rs.5,000; Salaries expense
Rs.35,000; Advertising expense Rs.5,000; Interest income Rs.1,000.
Data for Adjustment on December 31, 2001:
(a) Inventory ending was Rs.50,000. (b) Rent expired during the year Rs.3,000.
(c) Insurance expired during the year Rs.2,000. (d) Outstanding salaries Rs.3,000.
(e) Interest receivable Rs.1,000. (f) Depreciation on furniture Rs.2,000.
REQUIRED
Prepare Income Statement for the year ended December 31, 2001.

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Solution # 6:
SAEED & CO.
ADJUSTING ENTRIES
FOR THE PERIOD ENDED 31 DECEMBER 2001
Date Particulars P/R Debit Credit
1 Merchandise inventory 50,000
Expense and revenue summary 50,000
(To adjust the merchandise inventory)
2 Rent expense 3,000
Prepaid rent 3,000
(To adjust the prepaid rent)
3 Insurance expense 2,000
Prepaid insurance 2,000
(To adjust the prepaid insurance)
4 Salaries expense 3,000
Salaries payable 3,000
(To adjust the accrued salaries)
5 Interest receivable 1,000
Interest income 1,000
(To adjust the accrued interest income)
6 Depreciation expense 2,000
Allowance for depreciation – Furniture 2,000
(To adjust the depreciation expense)

SAEED & CO.

INCOME STATEMENT
FOR THE PERIOD ENDED DECEMBER 31, 2001
Sales 300,000
Less: Sales return allowance (2,000)
Net sales 298,000
Less: Cost of Goods Sold:
Merchandise inventory beginning 30,000
Add: Net Purchases:
Purchases 200,000
Less: Purchase return and allowances (5,000)
Net purchases 195,000
Merchandise available for sale 225,000
Less: Merchandise inventory ending (50,000)
Cost of goods sold (175,000)
Gross profit 123,000
Less: Operating Expenses:
Salaries expense (35,000 + 3,000) 38,000
Advertising expense 5,000
Rent expense 3,000
Insurance expense 2,000
Depreciation expense 2,000
Total operating expenses (50,000)
Profit from operation 73,000
Add: Other Income:
Interest income (1,000 + 1,000) 2,000
Net income 75,000

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Explanation of Solution # 6:
Net sales were Rs.298,000 and cost of goods sold computed as Rs.175,000. Sales revenue were
more than cost of goods sold which shows gross profit of Rs.123,000 (298,000 – 175,000 =
123,000). Operating expenses include:
 Salaries expense of Rs.35,000 as per trial balance. Adjustment data shows unpaid
salaries of Rs.3,000. Unpaid salaries increases expense and liability as well. Therefore,
salaries expense was reported in income statement as Rs.38,000 ( 35,000 + 3,000 =
38,000).
 Trial balance showed advertising expense of Rs.5,000. There was no adjustment for
advertising. Therefore, Rs.5,000 was reported in income statement.
 Trial balance showed prepaid advertising (asset). No asset account is recorded in
income statement. But adjustment data showed rent expired Rs.3,000. It showed
increase in rent expense and decrease in prepaid rent by Rs.3,000. Increase in expense is
recorded in income statement by Rs.3,000. The same treatment was for insurance
expense.
 Depreciation expense was recorded in income statement by Rs.2,000.
Total operating expenses were Rs.50,000 which was less than gross profit. Operating income
was Rs.73,000 (123,000 – 50,000 = 73,000). Other income included interest income which
showed a balance of Rs.1,000 in trial balance. Adjustment data indicated accrued interest of
Rs.1,000. Accrued interest increases income as well as receivable. Increase in income was added
in interest income. Therefore, total interest income was Rs.2,000 (1,000 + 1,000 = 2,000) and
net profit was Rs.75,000 (73,000 + 2,000 = 75,000).

INCOME STATEMENT OF SERVICING BUSINESS

In a servicing business, sales revenue account, merchandise account and cost of goods sold
account are not prepared because these accounts relate to merchandising business. The income
statement of servicing business consists of service revenue less operating expenses.

Format of Single – Step Income Statement:

Name of Business
Income Statement
For the Period Ended _______
Commission income XXX
Less: Operating Expenses:
Salaries expense XXX
Advertising expense XXX
Utilities expense XXX
Bad debts expense XXX
Rent expense XXX
Insurance expense XXX
Supplies expense XXX
Repair expense XXX
Depreciation expense XXX
Total operating expenses (XXX)
Operating profit/loss XXX/(XXX)
Less: Income tax expense (XXX)
Net income/loss XXX/(XXX)

There could be any other income like rent income, interest income, etc. depending on the nature
of business.

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ILLUSTRATION # 7:
(Income Statement of Servicing Business)
A summary of the records of Mr. Adnan for the year ending December 31, 2004 is as follows:
Commission income Rs.100,000; Salaries expense Rs.30,000; Rent expense Rs.20,000; Furniture
Rs.20,000; Insurance expense Rs.8,000; Utilities expense Rs.7,000; Advertising expense
Rs.6,000.
Additional Information on December 31, 2004:
(i) Accrued salary Rs.20,000.
(ii) Prepaid rent Rs.5,000.
(iii) Accrued commission income Rs.10,000.
(iv) Depreciation expense on furniture Rs.1,000.
(v) Bad debts expense Rs.3,000.
REQUIRED
Prepare income statement for the period ended December 31, 2004.

Solution # 7:
MR. ADNAN
ADJUSTING ENTRIES
FOR THE PERIOD ENDED 31 DECEMBER 2004
Date Particulars P/R Debit Credit
1 Salaries expense 20,000
Salaries payable 20,000
(To adjust the accrued salaries)
2 Prepaid rent 5,000
Rent expense 5,000
(To adjust the rent expense)
3 Commission receivable 10,000
Commission income 10,000
(To adjust the accrued commission income)
4 Depreciation expense 1,000
Allowance for depreciation – Furniture 1,000
(To adjust the depreciation expense)
5 Bad debts expense 3,000
Allowance for bad debts 3,000
(To adjust the bad debts expense)

MR. ADNAN
INCOME STATEMENT
FOR THE PERIOD ENDED DECEMBER 31, 2004
Commission income (100,000 + 10,000) 110,000
Less: Operating Expenses:
Salaries expense (30,000 + 20,000) 50,000
Rent expense (20,000 – 5,000) 15,000
Insurance expense 8,000
Utilities expense 7,000
Advertising expense 6,000
Depreciation expense 1,000
Bad debts expense 3,000
Total operating expenses (90,000)
Net income 20,000

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