The Income Statement

 

Remember in my previous post on the Balance Sheet? The Balance Sheet shows the “position” of an entity at a certain point in time. However, the Income Statement shows a different picture than the Balance Sheet – Income Statement or Profit and Loss Accounts is used to match the income/revenue generated by an entity with all the expenses/costs/losses the entity incurred over a specific period of time, normally this is done yearly to arrive at the final outcome, i.e. the Profit for the year/period. Examples of transactions that have an effect on the Income Statement are as follows:- 

3. Purchase from trade creditor

Assume ABC Co. Ltd purchase goods worth $2,500 from its supplier, Top Goods Co. Ltd on credit term of 30 days. The double entry to record this transaction is as follows: –

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Purchases

 

 

$2,500

 

Cr Trade Creditor

 

$2,500

 

 

 

Assume the Balance Sheet of ABC Co. Ltd. BEFORE this transaction is as per Example 2 of my post, “the Balance Sheet”, the impact of this purchase transaction of $2,500 on the Balance Sheet and the Income Statement is as follows:-

 

ABC Co. Limited

 

Balance Sheet as at 31 December 2006

 

 BEFORE

Impact of this purchase transaction of $2,500

 AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Assets

 

 

 

 

Computer desk

500

 

 

500

Cash at bank

10,000

 

 

10,000

 

10,500

 

 

10,500

Liabilities

 

 

 

 

Trade creditor-Top Goods Co. Ltd

 

 

2,500

 (2,500)

Creditor-Mr X

(500)

 

 

(500)

 

 

 

 

(3,000)

TOTAL (Assets – Liabilities)

10,000

 

 

7,500

Owners’ Equity

 

 

 

 

Paid-up share capital

10,000

 

 

10,000

Accumulated loss

 

2,500

 

(2,500)

TOTAL

10,000

 

 

7,500

 

   
   

 

ABC Co. Limited

 

Income Statement for the year ended 31 December 2006

 

 BEFORE

Impact of this purchase transaction of $2,500

 AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Sales

 

 

Cost of Sales:-

 

 

 

Purchases

2,500

 

(2,500)

 

 

 

 

 

Other income

 

 

Other expenses

 

 

Loss for the year

 

 

(2,500)

 

 

 

 

 

 

Please take note of the following points:-

  • As there were no transactions affecting the Income Statement before this purchase transaction, all the items in the Income Statement have nil value.
  • As there was no other income statement transactions during the year ended 31 December 2006 (the meaning is-the relevant period that we are talking about here is from 1 January 2006 to 31 December 2006) except this $2,500 purchase of goods, the loss for the year is therefore $2,500.
  • The loss for the year of $2,500 would be reflected as Accumulated Loss in the Balance Sheet
  • The impact of this $2,500 purchase transaction MUST be recorded in pair i.e. one Debit (to the Accumulated Loss in this example) and one Credit (to the Trade Creditor-Top Goods Co. Ltd. in this example) to the Balance Sheet. This is the RULE of Double Entry system in accounting! It applies to ALL transactions, except for those transactions affecting items within the Income Statement e.g. reclassifying one type of expense/income to another type of expense/income or setting off an expense item with an income item (e.g. cash discounts against sales).
  • When you compare the Balance Sheet “Before” and “After” this $2,500 transaction, you would notice that Trade Creditor-Top Goods Co. Ltd and Accumulated Loss which both show the same amount of $2,500 are the “Impact” or “Changes”. In other words, the “Impact” or “Changes” in the Accumulated Loss (Retained earnings/profits if the entity is making profits) account in the Balance Sheet is the NET RESULT comparing the Balance Sheet between two different points in time and the complete details of this NET RESULT are shown in the Income Statement!

4. Recognition of Closing Inventories or Stock

Logically speaking, by making a purchase of $2,500 but unable to sell the goods would result in what we call inventories or closing stock in hand. In other worlds, the Balance Sheet and Income Statement shown in Example 3 above are incomplete without recording the recognition of closing inventories!

After ABC Co. Ltd. made a purchase of $2,500 from Top Goods Co. Ltd but unable to sell these batch of goods to its customer, ABC Co. Ltd would need to recognise closing inventories of $2,500 before finished preparing its Balance Sheet and Income Statement by the following double entry:-

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Inventories

$2,500

 

 

 

Cr Cost of sales-Closing Inventories

 

 

 

 $2,500

 

The Balance Sheet and Income Statement of ABC Co. Ltd showing the impact of both the purchase of goods from Top Goods Co Ltd. and recognition of closing inventories are as follows:-

  

ABC Co. Limited

 

Balance Sheet as at 31 December 2006

 

   BEFORE

Impact of $2,500 purchase transaction and recognition of closing inventories

   AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Assets

 

 

 

 

Computer desk

500

 

 

500

Inventories

 

2,500

 

2,500

Cash at bank

10,000

 

 

10,000

 

10,500

 

 

13,000

Liabilities

 

 

 

 

Trade creditor-Top Goods Co. Ltd

 

 

2,500

 (2,500)

Creditor-Mr X

(500)

 

 

(500)

 

 

 

 

(3,000)

TOTAL (Assets – Liabilities)

10,000

 

 

10,000

Owners’ Equity

 

 

 

 

Paid-up share capital

10,000

 

 

10,000

Retained profit/(Accumulated loss)

 

2,500

2,500

TOTAL

10,000

 

 

10,000

 

 

ABC Co. Limited

 

Income Statement for the year ended 31 December 2006

 

   BEFORE

Impact of $2,500 purchase transaction and recognition of closing inventories

   AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Sales

 

 

Cost of Sales:-

 

 

 

Opening inventories

 

 

Purchases

2,500

 

(2,500)

Closing inventories

 

 

2,500

2,500

 

 

 

 

Other income

 

 

Other expenses

 

 

Profit/(Loss) for the year

 

 

 

 

 

 

 

 

Can you see the differences by comparing the Balance Sheet and Income Statement of ABC Co. Ltd in Example 3 and Example 4. Omission of recognising the closing inventories after adjusting the purchases at year end is still a common mistake that I noticed in my auditing assignments to date!

 

More Examples

5. Sale of goods to customer

Assume ABC Co. Ltd sells goods worth $3,000 to a customer subsequent to 31 December 2006, let’s say on 3 of March 2007, Mr Y. The double entry to record this transaction is:-

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Trade debtor-Mr Y

$3,000

 

 

 

Cr Sales

 

 

 

$3,000

 

Let’s consider transaction in Example 6 below before ABC Co. Ltd closes its books for the year ended 31 December 2007 (meaning is to end its financial period and prepare a complete set of final accounts which includes the Balance Sheet and the Income Statement for the financial year ended 31 December 2007) and show the Balance Sheet and Income Statement after this sale of goods transaction.

6. Collections from debtors

 ABC Co. Ltd received a cheque of $3,000 from Mr Y on 21 May 2007 and subsequently deposited the cheque into ABC Co. Ltd’s bank account. The double entry to record this transaction is as follow: –

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Cash at bank

$3,000

 

 

 

Cr Trade debtor-Mr Y

 

$3,000

 

 

Before ABC Co. Ltd. closes its books and prepares the Balance Sheet and Income Statement for the year ended 31 December 2007, the following double entry is required to be made to recognise the opening inventories for the year ended 31 December 2007:

 

Balance Sheet

Income Statement

 

Dr

Cr

Dr

Cr

Dr Cost of sales-Opening Inventories

 

 

 $2,500

 

Cr Inventories

 

$2,500

 

 

 

The Balance Sheet and Income Statement of ABC Co. Ltd. after taking into account these 3 transactions (Sale of goods, Collection from debtor and Recognition of Opening Inventories) are as follows:-

ABC Co. Limited

 

Balance Sheet as at 31 December 2007

 

   BEFORE

Impact of the 3 double entries in Example 5 & 6

   AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Assets

 

 

 

 

Computer desk

500

 

 

500

Inventories

2,500

 

2,500

Trade debtor-Mr Y

3,000

3,000

Cash at bank

10,000

3,000

 

13,000

 

13,000

 

 

13,500

Liabilities

 

 

 

 

Trade creditor-Top Goods Co. Ltd

 (2,500)

 

  

 (2,500)

Creditor-Mr X

(500)

 

 

(500)

 

(3,000)

 

 

(3,000)

TOTAL (Assets – Liabilities)

10,000

 

 

10,500

Owners’ Equity

 

 

 

 

Paid-up share capital

10,000

 

 

10,000

Retained profit/(Accumulated loss)

 

 

 500

TOTAL

10,000

 

 

10,500

 

 

ABC Co. Limited

 

Income Statement for the year ended 31 December 2007

 

   BEFORE

Impact of $3,000 sale transaction and recognition of opening inventories

   AFTER

 

 

Dr

Cr

 

 

$

 

 

$

Sales

 

3,000

3,000

Cost of Sales:-

 

 

 

Opening inventories

2,500

 

(2,500)

Purchases

 

 

Closing inventories

 

 

 

 

 

 

 

(2,500)

Other income

 

 

Other expenses

 

 

Profit/(Loss) for the year

 

 

500

 

 

 

 

 

 

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2 Responses to “The Income Statement”

  • […] by learnaccounting on October 26, 2007 Please refer to:The Income Statement Possibly related posts: (automatically generated)Partnership – Example of Income Statement […]

  • Accounting Crash Course on September 13, 2009

    […] Please refer to Debits And Credits and The Accounting Equation if you need further explanations on double entry recording system and the accounting equation. If you need explanation on the difference between balance sheet and income statement, please refer to The Balance Sheet and The Income Statement . […]

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