Financial Statement
Compiled by : Dr. Hendra
Learning Objectives 1
Learning Objectives 2
LO & Scheme of Work
10.1.1 Statement Of Profit Or Loss
• The Meaning And Purpose Of The Statement Of Profit Or Loss
• The Contents Of A Statement Of Profit Or Loss: Revenue, Cost Of Sales,
Gross Profit, Expenses, Profit From
Operations (Operating Profit), Taxation, Profit For The Year, Dividends,
Retained Earnings
• Amendment Of A Statement Of Profit Or Loss
• The Impact On The Statement Of Profit Or Loss A Given Change
LO & Scheme of Work
10.1.2 Statement Of Financial Position
• The Meaning And Purpose Of Statement Of Financial Position
• The Contents Of A Statement Of Financial Position Including Non-Current
Assets, Current Assets, Current
Liabilities, Net Current Assets, Net Assets, Non-Current Liabilities, Reserves
And Equity
• Amendment Of A Statement Of Financial Position
• The Relationships Between Items In The Statement Of Profit Or Loss And
The Statement Of Financial Position
LO & Scheme of Work
10.1.3 Inventory Valuation
• The Difficulties Of Valuing Inventory
• The Net Realisable Value Method
10.1.4 Depreciation
• The Role Of Depreciation In The Accounts
• The Impact Of Depreciation (Straight-Line Method Only) On The Statement
Of Financial Position And The Statement Of Profit Or Loss
Statement of profit or loss
• The statement of profit or loss can also be referred to as
either an income statement or a profit or loss account.
• A detailed statement of profit or loss is produced for
internal use because managers need as much financial
information as possible. It should be produced as
frequently as managers need the information, perhaps
once a month.
Statement of profit or loss
• A less detailed summary statement of profit or loss is
included in the published accounts of companies for
external users. It is produced less frequently, but at least
once a year.
• The content of this is laid down by each country’s
legislation on companies and provides a minimum of
information. This is because published accounts are also
available to competitors. Detailed data could give
competitors a real insight into their rivals’ strengths and
weaknesses.
The contents of a statement of profit or loss
• The version of statements of profit or loss used in this
chapter is based on the published accounts of public
limited companies, but with additional information
where this helps understanding. An example is given in
Table 33.4.
• A statement of profit or loss has three sections: trading
account, profit or loss section, and appropriation
account. Each one gives a different profit figure.
The contents of a statement of profit or loss
Why keep financial records?
• Measure of business performance
• To keep record how much to pay supplier
• Maintain cash flow
• Keep track on Bank loans
• Record of wages
• Record of dividend
Main types of financial statement
• Statement of profit or loss: a statement that records the revenue, costs and
profit or loss of a business over a given period of time.
• The gross profit and profit from operations of the company. It includes details of
how the profit from operations is split up between dividends to shareholders and
retained earnings (profit).
• Statement of financial position: a statement that records the values of a
business’s assets, liabilities and shareholders’ equity at one point in time.
• The net worth or equity of the company. This is the difference between the value of
what a company owns (assets) and what it owes (liabilities).
Statement of profit or loss
• A statement of profit or loss has three sections:
• trading account,
• profit or loss section, and
• appropriation account.
Trading account
• This account shows how gross profit (or loss) has been
made from the trading activities of the business.
• It is most important to understand that, as not all sales
are for cash in most businesses, the revenue figure is not
the same as cash received by the business.
Trading account
• The formula for calculating total revenue is:
• total revenue = selling price × quantity sold
• Therefore, if 120 items are sold at $2 each, the revenue is
$240.
Trading account
• Revenue is not profit. Costs must be subtracted from revenue to
calculate profit.
• There are different measures of profit.
• The cost of sales figure is unlikely to be the same as the total
value of goods purchased by the company during this year.
• This is because some items may have been added to inventories
or taken from them. Onlythe goods used and sold during the
year are recorded in cost of sales.
Trading account
• Gross profit is equal to:
• gross profit = revenue – cost of sales
• The formula used to calculate cost of sales is:
• cost of sales = (opening inventories + purchases) – closing
inventories
Trading account
Answer
• The gross profit for Cosy Corner Retailers Ltd.
• The formula for gross profit is:
• Gross Profit=Sales−Cost of Goods Sold (COGS)
• Where:
• Sales is the total revenue from goods sold, which is the number of
items sold multiplied by the selling price per item.
• COGS is the cost of those goods sold.
• And the formula for COGS is:
• COGS=Opening Inventory+Purchases−Closing Inventory
Answer
• Let’s plug in the numbers:
• Calculate Sales:
• Sales=1500 items×$5/item=$7500
• Calculate COGS:
• COGS=$500(Opening Inventory)+$3000(Purchases)−$1000(Cl
osing Inventory)=$2500
Answer
• Finally, calculate Gross Profit:
• Gross Profit=$7500(Sales)−$2500(COGS)=$5000
• So, the gross profit for Cosy Corner Retailers Ltd for the year
ending 31 October 2021 is $5000.
Answer
• Profit is crucial for a business for several reasons:
1. Sustainability and Growth: Profit is the primary indicator of
a company’s financial health. It provides the necessary
resources for a business to maintain its operations, invest
in its growth, and innovate. Without profit, a business may
struggle to survive in the long term.
Answer
2. Attracting Investment: Profitable businesses are more likely
to attract investors, as it indicates a successful business
model and management. Investors seek returns on their
investments, and those returns are typically derived from
the profits of the business.
• Remember, while making a profit is important, businesses
also have responsibilities towards their employees,
customers, community, and the environment. A balance
between profitability and these responsibilities often leads
to sustainable success.
Answer
• Let’s calculate the value of closing inventories and the gross profit
for Cambridge Boxes Ltd.
1. Closing Inventories: The closing inventory is the number of unsold
boxes at the end of the year. We can calculate it as follows:
• Closing Inventory=Opening Inventory+Purchases−Sales
Answer
• Substituting the given values:
• Closing Inventory=200 boxes+4000 boxes−3500 boxes=700 boxes
• The value of the closing inventory is the number of unsold boxes
multiplied by the cost per box:
• Value of Closing Inventory=700 boxes×$2/box=$1400
Answer
2. Gross Profit: The gross profit is calculated as follows:
Gross Profit=Sales−Cost of Goods Sold (COGS)
Where:
• Sales is the total revenue from boxes sold, which is the number of
boxes sold multiplied by the selling price per box.
• COGS is the cost of those boxes sold.
• And the formula for COGS is:
• COGS=Opening Inventory+Purchases−Closing Inventory
Answer
• Sales=3500 boxes×$4/box=$14000
• COGS=$400(Opening Inventory)+$8000(Purchases)−$1400(Closing
Inventory)=$7000
• Gross Profit=$14000(Sales)−$7000(COGS)=$7000
• So, the value of closing inventories for Cambridge Boxes Ltd for the
year ending 31 December 2021 is $1400 and the company’s gross
profit is $7000.
Trading account
• Gross profit: revenue less cost of sales
• Cost of sales: the direct cost of the goods that were sold during the
financial year.
• Total revenue = Selling price x quantity sold
• Gross profit = revenue – cost of sales
• Cost of sales = (opening inventories + Purchases) – closing inventories
Profit or loss account section
• This section of the statement of profit or loss calculates three
profit figures:
• profit from operations
• Profit before tax
• profit for the year
The profit from operations
• The profit from operations (or operating profit) is calculated by subtracting
expenses (such as overheads) from gross profit.
• Overhead costs are expenses of the business that are not directly related to
the number of items made or sold.
• These can include rent and business rates, management salaries, marketing
costs and depreciation.
Profit before tax
• Profit before tax is calculated by subtracting interest costs from
profit from operations.
Profit for the year
• Finally, profit for the year is calculated by subtracting profit
(corporation) tax from profit before tax.
Appropriation account
This final section of the statement of profit or loss shows how the profit for
the year is distributed between the owners, in the form of dividends to
company shareholders and as retained earnings.
Uses of statements of profit or loss
• The information contained in these statements can be used in a number of
ways:
1. It can be used to measure and compare the performance of a business over
time or with other firms
2. The actual profit data can be compared with the budgeted profit levels of
the business.
3. Bankers and creditors of the business will need the information to help
decide whether to lend money to the business.
4. Prospective investors will use the profit performance of the business as a
guide to whether to buy shares in it or not.
• Low quality profit- one-off profit that cannot easily be repeated or
sustained
• High quality profits – profit that can be repeated and sustained
Answer
1. Gross Profit (U): Gross profit is calculated as Revenue minus Cost of
Sales. So,
• U=$200,000(Revenue)−$60,000(Cost of Sales)=$140,000
2. Profit from Operations (V): Profit from operations is calculated as
Gross Profit minus Overhead Expenses. So,
• V=$140,000(Gross Profit)−$30,000(Overhead Expenses)=$110,000
Answer
3. Profit Before Tax (X): Profit before tax is calculated as Profit from
Operations minus Interest. So,
• X=$110,000(Profit from Operations)−$10,000(Interest)=$100,000
4. Profit for the Year (Y): Profit for the year is calculated as Profit
Before Tax minus Corporation Tax. So,
• Y=$100,000(Profit Before Tax)−$20,000(Corporation Tax)=$80,000
Answer
5. Retained Earnings (Z): Retained earnings is calculated as Profit for
the Year minus Dividends Paid. So,
• Z=$80,000(Profit for the Year)−$12,000(Dividends Paid)=$68,000
Answer
• So, the missing values for Rodrigues Traders are:
1. Gross Profit (U): $140,000
2. Profit from Operations (V): $110,000
3. Profit Before Tax (X): $100,000
4. Profit for the Year (Y): $80,000
5. Retained Earnings (Z): $68,000
Answer
• Let’s consider two stakeholder groups: Shareholders and
Employees.
1. Shareholders: Shareholders are the owners of the company, and
as such, they have a direct financial interest in the profitability of
the business. Profits are important to shareholders for two main
reasons:
Answer
a) Dividends: Profits are often distributed to shareholders in the
form of dividends.
• The more profit the company makes, the larger the potential
dividend payout. In the case of Rodrigues Traders, $12,000 was
paid out as dividends in the year ending 31 October 2021.
Answer
b. Capital Appreciation: Profits are often reinvested back into
the business to fuel growth and expansion.
• This can lead to an increase in the company’s market value,
and consequently, an increase in the value of the
shareholders’ investment.
• In the case of Rodrigues Traders, $68,000 was retained in the
business as earnings.
Answer
2. Employees: While employees may not directly receive a
share of the profits, the profitability of the business can
impact them in several ways:
a. Job Security: A profitable company is less likely to lay off
workers, providing employees with job security.
b. Wages and Benefits: Profitable companies are more likely
to offer competitive salaries, raises, bonuses, and benefits,
which can improve the standard of living for employees.
Answer
c. Growth Opportunities: With more profits, a company can
invest in new projects and departments, which can create
advancement opportunities for existing employees.
• In summary, profits are not just important for the survival of
the business, but they also play a crucial role in satisfying the
financial and non-financial needs of various stakeholders. It’s
a key indicator of the company’s health and future prospects.
• Low quality profit- one-off profit that cannot easily be repeated or
sustained
• High quality profits – profit that can be repeated and sustained
Amending statements of profit or loss
• Use the same format of presenting the statement of profit or loss
• If a change to the number of units produced and sold occurs, this is most likely to
lead to changes in both revenue and cost of sales.
• Some overheads might change with a variation in the level of sales. Annual
promotion or transport costs might be affected by variations in the number of units
sold.
The impact
of of
a change
on the statement
of profit or loss
The
impact
a change
on the statement
of profit or loss
Table 33.8 explains the impact on the statement of profit or loss following a change in one of its
components (assuming no other change occurs).
Change
I mpact on statement of profit or loss
Increase in price: demand for
product is inelastic
Revenue, gross profit, profit from operations, profit before tax, profit for
the year and retained earnings will all increase.
Increase in direct cost per unit Cost of sales will increase; gross profit, profit from operations, profit
before tax and profit for the year will all fall.
Increase in expenses
Profit from operations, profit before tax, profit for the year and retained
earnings will all fall.
Reduction in the rate of profit Profit after tax and retained earnings will both increase.
(corporation) tax
Directors decide to increase
dividends
Retained earnings will fall.
Table 33.8: Impact of changes on the statement of profit or loss
The statement of financial position
• Share holders equity: the total value of assets less the total value of liabilities
• Shareholders’ equity comes from two main sources:
• The first and original source was the capital originally invested in the company
through the purchase of shares.
• Share capital: The total value of capital raised from shareholders by the issue of
shares
• The second source is the retained earnings of the company accumulated over
time through its operations.
Depreciation
• Assets decline in value for two main reasons:
• normal wear and tear through usage
• technological change that makes the asset obsolete.
• Nearly all fixed/non-current assets will depreciate or decline in value over time.
Depreciation
It is recorded the value of each year’s depreciation as a cost on each year’s income
statement.
• This will overcome both of the problems referred to above:
• The assets will retain some value on the statement of financial position each
year until fully depreciated or sold off. This is the net book value, calculated as
follows:
(original cost less accumulated depreciation)
• The profits will be reduced by the amount of that year’s depreciation and will
not be under- or over- recorded.
The straight line method of depreciation
Inventories
• Inventories are unsold goods.
• They might also be in the form of raw materials and components that have
not yet been made into completed units.
• Some inventories will be in the form of work-in-progress.
The contents of a statement of financial position
Table 33.9: Example of a statement of financial position with explanatory notes