Chapter 3 Income Statement

3.1 Introduction
1. After operating a business for a perioad of time, the owner will be anxious to know the financial
performance / result of the operation for an particular period (i.e. whether it is running at a profit or
at loss) , and the financial position of the business at a particular date (i.e. what the business owns
and owes)
2. For this purpose, the following financial statements are prepared:
a. Income statement
b. Statement of financial position
3. At the end of an accounting period, all the income and expense accounts are closed and transferred
to Trading account (to arrive at a gross profit) and Profit and Loss account ( to arrive at a new
profit). At the same time, income statement is prepared from these two accounts to report the
financial performance for the period.
4. The components of Income statement are as follows:
a. Net Sales = Sales – Return Inwards
b. Net Purchases = Purchases – Return Inwards
c. Cost of Purchases = Net Purchases + Carriage Inwards + any related
expenses on purchases
d. Cost of Goods Available = Opening inventory + cost of Purchase for the year
For Sales
e. Cost of sales / cost of goods = Cost of goods Available For Sales – Closing Inventory
sold
f. Gross Profit or = Net Sales – Cost of Sales > 0 or
Gross Loss Net Sales – Cost of Sales < 0
g. Net Profit or = Gross Profit + other Income – Expenses > 0 or
Net Loss Gross Profit + Other income – Expenses < 0
Notes :
1. They are all the costs of purchases incurred in bringing the goods to their present condition
and location where they will be sold. (i.e. they refer to the cost price of the goods bought
and any related direct expenses.)
2. They are the unsold good which are counted and valued at the end of a period.
3. They are also known as non-trading income, which are the income earned but not derived
from sales.
4. They are the costs incurred in the course of running the business. They normally include
the selling and distribution expenses administrative expenses, finance expenses, etc.
Chapter 3 Income Statement
3.2 Format of Income Statement
Income Statement of a business entity can be presented in T format or vertical format as follows:
a. T / Horizontal format:
Chapter 3 Income Statement
b. Vertical / Statement format :
Chapter 3 Income Statement
3.3 Closing Entries
At the end of each accounting period, the following entries are made:
1. Opening inventory is closed and transferred to Trading account. To determine
2. Closing inventory is counted, valued and recorded. gross & net profit
3. Income and expenses accounts (i.e.nominal accounts) are closed and / loss
transferred to Trading account of Profit And Loss account.
Remark: Trading and Profit And Loss accounts are opened in order to complete
the closing entries.
4. Net Profit / loss is transferred to Capital account. To determine
5. Drawings account is closed and transferred to Capital account closing capital