The income statement or the profit and loss account as it is also called measures reports how much profit (wealth) has the business generated over a period of time.
To measure profit the total generated revenue over a period must be identified. Revenue is a measure of inflow of economic benefits arising from the operations of the business. These benefits will either result in an increase of assets such as cash or amounts owed to the business by the customers or a decrease of liabilities.
The total expenses must also be identified. Expenses are obviously the opposite of revenue. It represents the outflow of economic benefits.
The profit is then easily calculated by taking the generated revenue over a particular period of time and from it deduct the total expenses incurred in generating that revenue. The final result form the mathematical equation will be either a profit or a loss. If the revenue is more than the expenses = profit and if the expenses are more than the profit = loss.
The period over which profit or loss is calculated is called reporting period but it is sometimes referred to as accounting period or financial period.
The income statement and the statement of financial position have different roles. The statement of financial position gives us information about the financial status(position) of the business at a particular time and the income statement gives us information about the amount of profit (wealth) generated by the business. The two statements are closely related.
The income statement links the statement of financial position at the beginning and the end of the reporting period. At the beginning of the reporting period the statement of financial position shows the opening wealth position of the business at that time. After an appropriate period an income statement is then prepared to reveal the wealth generated at that period. A statement of financial position is then prepared to reveal the new wealth position at the end of the period. The extended equation would look like this:
Assets = Equities + Profit or loss + Liabilities
An appendix presents users with a more detailed and informative view of performance.
Income statement layout
The layout of the income statement will vary according to the type of business that is being related
The first part of the income statement is where we calculate the so-called gross profit which is calculated by taking revenue of the goods that were sold by the business and from the revenue is deducted the cost of those goods. In other words the gross profit represents the profit or loss from buying the goods and selling the goods.
Operating expenses (overheads) incurred in running the business (salaries, rents, rates and so on) are deducted from the gross profit. The resulting figure from the equation is known as the Operation profit.
Profit for the period
Having established the operating profit, we add any non-operating income (such as interest receivables) and deduct any interest payables on borrowings to arrive at the Profit for the period(or net profit).
Having set out the main principles involved in making the income statement we need to consider some further points.
Cost of sales
The cost of sales (or cost of goods being sold) can be identified in different ways. In some businesses the cost of sales for each individual sale is identified during the time of transaction. Each item of sales is matched up with the relevant cost of that item during the transaction. Big retailers, for instance, (supermarkets) have checkouts where the machines not only record each item that was sold but they also simultaneously pick up the cost of the goods. Businesses that sell relatively small number of high-valued equipment prefer to use this method. But small retailers prefer identifying the cost of sales at the end of the reporting period.
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