THE INCOME STATEMENT

AND THE FINANCIAL

PERFORMANCE

C MBAHIJONA

Fundamentals of Accounting_2022 C Mbahijona 24 August 2022 1

 LEARNING OUTCOME
After you have studied this unit, you should be able to:
 Explain the objectives of preparing the income statement;
 Define the elements directly related to the measurement of
financial performance;
 Discuss the measurement of financial statements;
 Prepare the income statement.
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INCOME STATEMENT AND ELEMENTS OF THE STATEMENT

• Information about the performance of an entity is primarily

provided in the income statement.
• The profitability about the entity is required in order to assess
potential changes in the economic resources.

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INCOME STATEMENT AND ELEMENTS OF THE STATEMENT

• Income
Income is both revenue and gains. Revenue arises from ordinary
activities of an entity and is referred as; Sales, Fees, Interest,
Dividends, Royalties and Rent Income. While, gain is income from
disposal of non-current assets. Income increases in economic benefits
during the accounting period in the form of inflows or enhancements
of assets or decreases of liabilities that result in increases in equity
other than those that relating to contributions from equity participants.
Fundamentals of Accounting_2022 C Mbahijona 24 August 2022 4
INCOME STATEMENT AND ELEMENTS OF THE STATEMENT

• Expenses
Expenses are defined as losses as well as those expenses that arise in the
course of the ordinary activities of the entity – for example wages,
depreciation. Losses are incurred through disasters such as fire and flood
or when a non-current asset is sold below its disposal value. Expense is a
decrease in economic benefits during the accounting period in the form of
outflows or depletion of assets or incurrence of liabilities that result in
decrease in equity, other than those relating to distribution to equity
participants.
Fundamentals of Accounting_2022 C Mbahijona 24 August 2022 5
 RECOGNITION OF INCOME AND EXPENSES
Income is recognised in the income statement when there:
• Is an increase in future economic benefits related to an
increase in an asset or a decrease of a liability has arisen;
• The amount can be measured reliably.
This means that recognition of income occurs simultaneously
with the recognition of increase in assets or decrease in
liabilities.
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 RECOGNITION OF INCOME AND EXPENSES
Expenses are recognised in the income statement on the basis of
a direct association between the costs incurred and earning of
specific items of income. This process is known as the matching
of costs with revenues and expenses that result directly and
jointly from the same transactions or other events.

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 DETERMINING OF PROFIT AND LOSS THE EFFECTS ON
OWNER’ EQUITY
Owners’ equity is the residual between the assets and liabilities
of an entity.
Accounting equation: Owners’ Equity = Assets – Liabilities
In terms of company, equity comprise of Share Capital + Retain
Earnings + Other reserves.

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MONEY CONTRIBUTED BY THE OWNER(S) OF THE ENTITY

• The owner(s) of an entity contribute start-up capital to begin

operations and this contribution can be in monetary form or
other assets such as land and building, machinery, equipment.

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 THE NATURE OF PROFIT OR LOSS
• Profit is earned when income is greater than expenses. Income is
the sales of goods and services that have been supplied to
customers. Expenses are the expenditure incurred in supplying
goods and services to customers. Example profit: Sales N$ 10 000,
Expenses N$ 6 000; therefore profit is equal: Sales – Expenses (10
000 – 6 000) = N$ 4 000.
Example of a Loss: Sales N$ 10 000, Expenses N$ 12 000; therefore
loss is equal: Sales – Expenses (10 000 – 12 000) = -2 000.
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THE EFFECT OF PROFIT AND LOSS ON CAPITAL
Profit Loss
Initial capital (beginning) 15 000 15 000
Profit (10 000 – 6000) 4 000
Loss (10 000 – 12 000) -2 000
Closing Capital 19 000 13 000

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 DRAWINGS
Sometimes the owner takes cash or other assets out of the entity
for private use and this is known as drawings. Any money taken
out of the entity will reduce capital.

Fundamentals of Accounting_2022 C Mbahijona 24 August 2022 12

 COST OF SALES
For the entity to meet the demand of customers, the entity will
have to keep merchandise in inventory. This means that what is
purchased for resale might not necessarily be sold in that period.
Therefore, the purchases incurred for that period may not be the
same as the cost of goods sold during the same period.
Therefore, it is important to determine the cost of sales for the
period. There are two methods of recording inventory namely:
perpetual inventory system and periodic inventory system.
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 PERPETUAL INVENTORY SYSTEM
• The perpetual inventory system requires a continuous of all receipts
and withdrawal of each item of inventory.
• The perpetual record is kept in terms of quantities only.
• Physical count of the goods owned by the entity must be made to
verify the accuracy of the inventories.
• Any discrepancies discovered must be corrected so that the
perpetual inventory records are in agreement with the physical
count.
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 PERIODIC INVENTORY SYSTEM
• The system relies on a physical count of the goods on hand as the
basis for control, management decisions and financial accounting.
• The physical count will give accurate results on a specific date,
there is no continuing record of the inventory.
• The system requires purchases to be recorded in the purchases
account, purchases returns in the purchases returns or returns
outward. The inventory account is not used until the end of the
accounting period.
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 DIFFERENCES BETWEEN PERPETUAL AND PERIODIC
INVENTORY SYSTEM
PERPETUAL METHOD PERIODIC METHOD
All goods purchased is debited All goods purchased is debited
to inventory account to the purchases account
All purchasing expenses are Purchasing expenses are
debited to the inventory debited to a specific expense
account account
Purchases returns are credited Purchases returns are credited
to the inventory account to the purchases returns
account
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 DIFFERENCES BETWEEN PERPETUAL AND PERIODIC
INVENTORY SYSTEM
PERPETUAL METHOD PERIODIC METHOD
A cost of sales account is The cost of goods is not
maintained thus updating the recorded at the time of sale
inventory account with sales
Sales returns are only recorded Sales returns are recorded as
in the sales returns account sales returns, inventory and
cost of sales must also be
updated.
At any point in time the cost of Inventory must be counted
inventory on hand is known
Fundamentals of Accounting_2022 periodically to determine the
C Mbahijona 24 August 2022 17

inventory on hand.
 DIFFERENCES BETWEEN PERPETUAL AND PERIODIC
INVENTORY SYSTEM
PERPETUAL METHOD PERIODIC METHOD
The gross profit can be The gross profit can be
determined for every sale. determined only after the cost
of sales has been calculated

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 MARK-UP AND MARGIN
• Mark-up is profit when shown as a fraction or percentage of the cost price.
When the cost price of a transaction is given without indicating the selling
price.
• Margin is a profit when shown as fraction or percentage of the selling price
Example:
Assume the cost price = N$ 10 000
Mark-up = 25%
Calculate the selling price.
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 MARK-UP AND MARGIN
Mark-up x Cost price = Profit
25% x N$ 10 000 = N$ 2 500
Therefore profit of N$2 500 equal to gross profit.
Sales – Cost of sales = Gross profit
Sales – N$ 10 000 = N$ 2 500
Sales = N$ 10 000 + N$ 2 500
= N$ 12 500
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 MARK-UP AND MARGIN
When the selling price of a transaction is given without
indicating the cost price and the margin percentage is known,
the cost price can be calculated.
Example:
Assume the selling price = N$ 12 500
Margin = 20%
Calculate the cost price.
Fundamentals of Accounting_2022 C Mbahijona 24 August 2022 21
 MARK-UP AND MARGIN
Margin x Selling price = Profit (Gross Profit)
20% x N$ 12 500 = N$ 2 500
Sales – Cost of Sale = Gross Profit
N$ 12 500 – Cost of Sales = N$ 2 500
N$ 12 500 – N$ 2 500 = N$ 10 000 (Cost of Sale)

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 THE RELATIONSHIP BETWEEN MARK-UP AND MARGIN

If the mark-up is known, we take the numerator to be the same

numerator of the margin, then for the denominator of the
margin, we take the denominator of the mark-up plus the
numerator as shown below.

Fundamentals of Accounting_2022 C Mbahijona 24 August 2022 23

 THE RELATIONSHIP BETWEEN MARK-UP AND MARGIN

MARK-UP MARGIN
1/4 1/(4+1) = 1/5
1/3 1/(3+1) =1/4
2/3 2/(3+2) = 2/5

Fundamentals of Accounting_2022 C Mbahijona 24 August 2022 24

 GROSS PROFIT PERCENTAGE
Gross profit is the difference between net sales and cost of sales. Gross profit is
calculated separately to determine the entity’s performance with regard to its
important activity namely the sales of goods. Gross profit percentage is calculated.
Margin as % of sales Mark-up as % of Cost of sale
Gross Profit x 100 Gross profit x 100
Sales Cost of Sale
N$ 2 500 x 100 N$ 2 500 x 100
N$ 12 500 N$ 10 000
= 20% = 25%
Fundamentals of Accounting_2022 C Mbahijona 24 August 2022 25
XYZ Group
Statement of profit and loss and other comprehensive income for the year ended …
Revenue xxx xxx
Cost of sales (xx) (xx)
Gross profit xxx xxx
Other income xxx xxx
Distribution costs (xx) (xx)
Administrative expenses (xx) (xx)
Other expenses (xx) (xx)
Profit from associates xxx xxx
Profit before tax xxx xxx
Income tax expense (xx) (xx)
Profit for the year from continuing operations xxx xxx
Loss for the year from discontinued operations (xx) (xx)
PROFIT for the year xxx xxx
Attributable to 21.2 21.1
Owners of the parent xxx xxx
Non-controlling interest xxx xxx
xxx xxx
Earnings per share: Basic and diluted x.xx x.xx
Other comprehensive income
Items that can never be reclassified to P/L xxx xxx
Gains on property revaluation xxx xxx
Actuarial gains xxx xxx
Income tax relating to components (xx) (xx)
Items that may be reclassified to P/L xxx xxx
Cash flow hedges xxx xxx
Exchange differences on translating (xx) (xx)
Share of OCI of associate xxx xxx
Income tax relating to components (xx) (xx)
Other comprehensive income net of tax xxx xxx
TOTAL COMPREHENSIVE INCOME for the year xxx xxx
26
Attributable to
Owners of the parent xxx xxx
Non-controlling interest xxx xxx
xxx xxx
 TRIAL BALANCE OF B WEBB AS AT 31 DECEMBER 2021
PREPARE INCOME STATEMENT.
DR (N$) CR (N$)
Sales 18 462
Purchases 14 629
Salaries 2 150
Motor expenses 520
Rent 670
Insurance 111
General Expenses 105
Stationery 1 500
Motor Vehicles 1 200
Fundamentals of Accounting_2022 C Mbahijona 24 August 2022 27
 TRIAL BALANCE OF B WEBB AS AT 31 DECEMBER 2006
PREPARE INCOME STATEMENT.
DR (N$) CR (N$)
Debtors 1 950
Creditors 1 538
Cash at bank 1 654
Cash on hand 40
Drawings 895
Capital 5 424

Total 25 424 25 424

Inventory 31.12.2006 =
N$ 2 548
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 END

QUESTIONS

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