INCOME STATEMENT (also called PROFIT & LOSS ACCOUNT)
Income Statement definition: financial statement that reports generated revenues and
incurred expenses over an accounting period.
GROSS PROFIT FORMULA: Revenue - cost of goods sold (COGS) = gross profit
N.B. sometimes it is necessary to work out the COGS with opening and closing inventories.
Use this formula: COGS = (Opening inventories + purchases of goods for sale) - Closing
Inventories = cost of goods available for sale
(how much I paid my
inventory all together)
(basically, a purchase of
additional inventory that
adds up to the existing one)
Important: Leave out of the Income Statement voices such as:
 Cash in bank
 Equity
 Trade payables
 Trade receivables
 Loans
These MUST NOT be included in the calculation.
Example: prepare the income statement for Costa Coffee for the year 2019. Please note that
the Motor van depreciated of 30% at 31.12.2018.
Revenue
769,000
Inventories at 31.12.2018 (opening inventories!)
20,000
Cash in bank
100,000
Equity
50,000
Motor van
25,000
Telephone bill
3,000
Wages and salaries
150,000
Rent and rates
100,000
Purchases of goods for sale
68,000
Tax
50,000
Solution
Depreciation of the van: 25,000 x 0.3 = 7,500 --- 25,000 - 7,500 = 17,500 value of Motor
Van at 31.12.2018
20,000 + 68,000 = 88,000 Cost of goods available for sale (how much I paid my
inventory all together)
Revenue
COGS
Gross profit
Selling and distribution expenses
Administrative expenses
Operating profit before tax (EBIT)
Tax
Net profit for year 2019
769,000
88,000
681,000
17,500
163,000
500,500
50,000
450,500
=
=
ADMINISTRATIVE EXPENSES
example:
 Management salaries/wages
 Insurance
 Office supplies (stationery)
 Depreciation of furniture and fittings
 Depreciation of equipment
 Legal fees
 Lease (rent) of office equipment
 Licenses
 Telephone
 Heating and lighting
 Rent
SELLING AND DISTRIBUTION EXPENSES example:
 Freight (transport)
 Repair and maintenance of delivery vehicles
 Depreciation of delivery vehicles
 Promotion
 Bad debts
Basically expenses that
I have to pay regardless
of how much I sell per month!
Basically expenses that
affect my business based
on how much I sell per month
and strategies I use to sell!
ACCRUED EXPENSES
They are expenses for the period that are more than the cash paid during the same period.
Example: Company A has an electricity bill of £ 4,000 for the year 2019. At the end of 2019 it paid
only £ 3,000, as their final bill arrives in January 2020.
Solution: we must add a voice called ‘Accrued Expenses’ of £ 1,000.
PREPAID EXPENSES
Amount of expenses paid during the period that are more for the period.
Example: company A pays an insurance of £ 1000 that covers from October 2019 to April 2020. The
company’s financial year ends on 31 December 2019, but the insurance goes until April 2020!
Therefore, we must subtract what we have already paid for the 2020 and add a voice called ‘Prepaid
Expenses’.
Total cost of insurance
1,000
/
Months covered by insurance
6
=
Cost of insurance per month
166.6
x
Months covered by insurance in 2020
3
=
Prepaid expenses (insurance months in 2020)
£ 499.8
DEPRECIATION
Spreads the cost of an asset over its estimated useful life. Depreciation can be:
 Straight line - every year the asset loses the same value. Example: a van that loses £ 1,000
every year. Use this formula:
Straight line depreciation = (cost of the asset - residual* value) / estimated life of the asset
* also called scrap value
The result is how much the asset loses per year.
 Reducing balance: the asset loses a fixed rate % every year. Example: an asset worth £
10,000, with an estimated life of 5 years, that loses 50% every year:
Year 1
10,000
%50
Year 2 NBV *
5,000
% 50
Year 3 NBV
2,500
%50
Year 4 NBV
1,250
% 50
Year 5 NBV
625
* Net Book Value: the value of an asset, taking into account depreciations, diminutions, or other
accounting charges as recorded in the accounts of its owner.

PROFIT MEASUREMENT AND INVENTORY COSTING METHODS
FIFO: First in, first out (cost of sales based on earlier purchases. Year end inventory reflects latest
prices). Example:
January - Bought goods 10 units @£1,000
June - Bought goods 20 units @£1,200
December Sold 9 units @1,500
Cost of sales = 9x1,000 = £9,000
Inventory = (1x1,000) + (20x1,200) = £25,000

LIFO: Last in, first out (Cost of sales based on latest purchases. Year end inventory reflects earlier
prices). Example:
Cost of sales = 9x1,200 = £10,800
Inventory = 10x1,000 + 11x1,200 = £23,200

Weighted average cost (both cost of sales and year end inventory reflects average prices). Example:
Weighted average unit cost = (10x1,000) + (20x£1,200) / (10 + 20) = £1,133.33
Cost of sales = 9x£1,133.33 = £10,200
Inventory = 21x£1,133.33 = £23,800