FINANCE AND INVESTMENT CLUB

INDIAN INSTITUTE OF MANAGEMENT ROHTAK

TRADING, PROFIT & LOSS ACCOUNT AND INCOME
STATEMENT
 Table of Contents
TRADING, PROFIT & LOSS ACCOUNT ............................................................................... 2
INTRODUCTION ................................................................................................................. 2

IMPORTANCE ...................................................................................................................... 2

USERS OF FINANCIAL INFORMATION .......................................................................... 3

TRADING ACCOUNT ......................................................................................................... 4

GROSS PROFIT ................................................................................................................ 5

TRADING ACCOUNT FORMAT ........................................................................................ 7

HEADING ......................................................................................................................... 7

DEBIT SIDE ITEMS ......................................................................................................... 8

CREDIT SIDE ITEMS ...................................................................................................... 9

GROSS PROFIT/LOSS ..................................................................................................... 9

PROFIT & LOSS ACCOUNT ............................................................................................. 14

DEBIT SIDE OF THE P&L ACCOUNT (EXPENSES AND LOSSES) ........................ 14

CREDIT SIDE OF THE P&L ACCOUNT (INCOME AND GAINS) ............................ 14

PROFIT & LOSS ACCOUNT FORMAT ............................................................................ 15

TRADING VS PROFIT & LOSS A/C ................................................................................ 16

ADJUSTMENTS IN TRADING AND PROFIT & LOSS A/C .......................................... 19

INTRODUCTION TO INCOME STATEMENT .................................................................... 28

IMPORTANCE OF AN INCOME STATEMENT: .............................................................. 28

PRO FORMA FOR INCOME STATEMENT ..................................................................... 29

BREAKDOWN OF EXPENSES ON AN INCOME STATEMENT................................... 30

BREAKDOWN OF REVENUE ON AN INCOME STATEMENT .................................... 31

CREDIT SIDE OF INCOME STATEMENT ...................................................................... 32

QUESTIONS FOR PRACTICE: ......................................................................................... 36

1 | Income Statement
Finance & Investment Club, IIM Rohtak

TRADING, PROFIT & LOSS ACCOUNT

INTRODUCTION

1. Trading A/c: This is a financial statement used to ascertain the gross profit or gross loss,
by considering the difference between the amount earned from sale of goods and
amount spent on the production of the goods. It only considers the direct activities of
trading, considering income from sales and the direct costs related to those sales (like
the cost of the goods sold, wages, fuel costs etc.).

2. Profit & Loss A/c: This is a financial statement used to ascertain the net profit or net
loss, that is calculated by calculating the difference in total amount a business made
(revenue from operating as well as non-operating activities like interest income,
dividends received) and the total amount spent (expenses) during a certain time period
(usually an year).

3. Income Statement: This is the same as profit and loss statement made by the companies,
while P&L account is made for the sole proprietorship and partnership firms.

IMPORTANCE

1. Performance Evaluation: Estimating the profits by considering the revenues earned and
costs incurred by the organization. By these statements over different time periods,
companies can identify trends in revenue growth, cost management, and overall
financial performance.

2. Decision-Making: Based on the analysis of existing statements of profits and loss with
respect to the industry standards and other competitors, potential investors to determine
if the company is a viable investment opportunity based on its profitability and future
growth prospects.

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3. Financial Planning: Profit and loss account data is used in forecasting future revenues
and expenses, guiding budget allocation and resource management. It helps in setting
financial targets and aligning strategies with business objectives.

4. Financial Health and Stability: By showcasing company's incomes, costs, and benefits
(or misfortunes) over a particular period, analysts can get an idea of the future predicted
earnings and profitability over time, giving recommendations regarding investment.

5. Compliance and Reporting: It is necessary to adhere to the accounting standards and

regulatory requirements. They also promote transparency in financial dealings, vital for
legal compliance.

6. Performance Metrics: data for key performance indicators like profit margins, aiding in
performance evaluation. It also enables trend analysis and benchmarking against
industry standards.

7. Stakeholder Communication: To analyse and communicate the productivity and

development potential to the respective stakeholders namely regulators, government,
shareholders, buyers, suppliers, collaborators, and competitors.

USERS OF FINANCIAL INFORMATION

1. Internal Users:

a. Managers: Utilize the statements to understand departmental execution, control

costs, and make choices to improve operational effectiveness and productivity.

b. Executives: Analyse the statements to evaluate KPIs, set key objectives, and
adjust budgetary plans with long-term targets.
c. Employees: Review the statements indirectly to understand the company’s
financial health, impacting job security, bonuses, and growth opportunities.

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2. External Users:

a. Investors: Examine the statements to gauge the company’s profitability and

growth potential, influencing their investment decisions and evaluation of
returns.

b. Creditors: Use the statements to assess the company’s ability to generate

sufficient revenue to meet debt obligations, impacting lending decisions and
credit terms.

c. Analysts: Analyse the statements to provide insights and recommendations on

the company’s financial performance, affecting stock ratings and market
perceptions.

d. Regulatory Authorities: Review the statements to ensure compliance with

financial reporting standards and regulations, safeguarding transparency and
legal adherence.

TRADING ACCOUNT

1. Trading Account is a financial statement that records the direct costs associated with
the goods sold, such as purchases, stock, and direct expenses, and helps determine the
Gross Profit by subtracting these costs from sales revenue.

2. Importance

a. Evaluates the efficiency of production and trading operations by analysing

direct costs.

b. Provides a foundation for calculating gross profit, essential for assessing overall
business performance.

c. Helps identify areas for cost reduction and margin improvement.

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d. Assists management in making informed decisions related to pricing, sourcing,

and inventory control.

GROSS PROFIT

Every businessman would like to know the profit earned or loss incurred during an accounting
year. This is usually worked out in two stages. In the first stage the gross profit or gross loss is
worked out, and in the second stage the net profit or net loss is ascertained. The net profit/net
loss indicates the overall result of the business operations, whereas the gross profit/gross loss
reveals the difference between the sales revenue and the cost of goods sold.
If the amount of sales is higher than the cost of goods sold, the difference would indicate gross
profit. Suppose, a trader has purchased goods costing Rs. 50,000. He sold them for Rs. 75,000.
The gross profit earned is Rs. 25,000, being the difference between the sales value (Rs. 75,000)
and the cost of the goods sold (Rs. 50,000). In other words, gross profit is the excess of sales
value of the goods sold over their cost. However, if the sales value of the goods sold is less
than their cost, the result is called gross loss. The purpose of working out gross profit/gross
loss is to ascertain the profit or loss from trading operations alone. It indicates whether
purchasing and selling of goods have proved to be profitable for the business or not. The
formula to find Gross Profit is given below:
Gross Profit = Sales - (Opening Stock + Purchases + Direct Expenses – Closing
Stock)

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Finance & Investment Club, IIM Rohtak

Illustration:
Particulars Rs.
Opening Stock 50,000
Purchases 200000
Purchases Retums 25,000
Direct Expenses 15,000
Sales 3,00,000
Sales Returns 50,000
Closing Stock 75,000

Solution:
Particulars Rs.
Sales 3,00,000
Less Sales Returns 50,000
Net Sales (A) 2,50,000
Cost of Goods Sold
Opening Stock 50,000
Add Purchases 200000
Less Purchases Retums -25,000
Add Direct Expenses 15,000
Less Closing Stock -75,000
Cost of Goods Sold (B) 1,65,000
Gross Profit (A-B) 85,000

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Finance & Investment Club, IIM Rohtak

TRADING ACCOUNT FORMAT

Dr. Cr.
Particulars Rs Particulars Rs
To Opening Stock XXX By Sales XXX
Less: Returns
To Purchases XXX inwards (XXX) XXX
Less: Returns outwards (XXX) XXX By Closing Stock XXX
To Frieght & Carriage XXX By Gross Loss c/d XXX
To Customs & Insurance XXX
To Wages XXX
To Gas, Water & Fuel XXX
To Factory Expenses XXX
To Royalty on Production XXX
To Cargo Expenses XXX
To Shipping Expenses XXX
To Import Duty XXX
To Custom Duty XXX
To Dock Charges XXX
To Octroi XXX
To Commission on Purchases XXX
To Gross Profit c/d* XXX
XXX XXX

HEADING

The header for the Trading Account is split into two parts. The first part indicates the name of
the firm or proprietor. The second part (which is written on the next line) indicates the period
for which it is being prepared. Suppose, Ganesh is a proprietor of a trading concern and he is
interested in knowing the gross result of his business for the year 1986. The heading will be as
below:
“Trading Account of Ganesh
for the year ended December 31, 1986”
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Finance & Investment Club, IIM Rohtak

DEBIT SIDE ITEMS

1. Opening Stock: We have seen that the closing stock of a particular year becomes the
opening stock for the next year. Thus, the item Opening Stock refers to the goods lying
unsold at the end of the previous year and brought into the current-year for sale. Note that
there will be no opening stock in the first year of working.

2. Purchases: This item refers to the goods purchased for resale, e.g., cloth purchased by a
cloth dealer, stationery purchased by a stationery dealer, etc. It includes both cash and credit
purchases. Purchases of assets such as machinery, furniture, etc., should not be included in
the purchases of goods. As already stated, purchases returns, if any, are shown by way of
deduction from the total purchases and only the net purchases are shown in the outer
column.
3. Direct Expenses: As stated earlier, these are the expenses incurred on the goods purchased
till they are brought to the place of business for sale. When goods are imported from a
foreign country, expenses such as freight, insurance. import duty, dock dues, clearing
charges, carriage, etc., must be incurred. All these expenses are termed as direct expenses.

Similarly, in connection with local purchases, expenses like freight, octroi duty, carriage or
cartage are normally paid for bringing the goods to the place of business. All these expenses
are treated as direct expenses and shown on the debit side of the Trading Account. Freight and
carriage paid in relation to purchases are also called 'Freight Inwards' and 'Carriage Inwards'
respectively. The administrative expenses, selling and distribution expenses, interest paid, etc.,
are called indirect expenses and so excluded from the Trading Account. These are to be shown
in the Profit and Loss Account.

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Finance & Investment Club, IIM Rohtak

CREDIT SIDE ITEMS

1. Sales: It includes both cash and credit sales of goods. Sales of fixed assets such as old
typewriter, machinery, furniture, etc., should not be included in sales. If there are some
sales returns (returns inwards), that value would be deducted from the total sales in the
inner column and only the net sales will be shown in the outer column.

2. Closing Stock: As already stated, closing stock must be considered to determine the cost of
goods sold. For finding out the amount of closing stock, each product lying unsold at the
end of the year is physically counted and their complete list is prepared. Then each product
is valued at cost price or the market price whichever is lower. Thus, the total value of closing
stock is worked out at the end of the accounting year for the purpose of preparing the final
accounts.

GROSS PROFIT/LOSS

This refers to the difference (in amount) between the two sides of the Trading Account.
After placing the relevant items in the Trading Account, both sides should be totalled and
balanced, if the total of the credit side is more than the total of the debit side, the difference
will be treated as Gross Profit and shown as 'To Gross Profit' on the debit side, in vice-versa
case, we get a Gross Loss.

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Finance & Investment Club, IIM Rohtak

Let’s learn the account preparation through a simple example:

Illustration 1: From the following balance of ABC, prepare the trading account.

Particulars Rs
Stock on April 1, 2020 18,600
Purchases 185000
Sales 290000
Freight Charges 4,500
Carriage Inwards 800
Import Duty 12,500
Dock Dues and Clearing Charges 600
Returns Inwards 4000
Returns Outwards 5000
Value of Stock on Mar 31, 2020 24,700

In the books of ABC

Trading Account
For the year ended …...
Dr. Cr.
Particulars Rs Particulars Rs
To Opening Stock 18600 By Sales 290000
Less: Returns
To Purchases 185000 inwards 4000 286000
Less: Returns outwards 5000 180000 By Closing Stock 24700
To Direct Expenses
Import Duty 12500
Dock Dues and Clearing
Charges 600
Freight Charges 4,500
Carriage Inwards 800 18400
To Gross Profit c/d* 93700
310700 310700

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Finance & Investment Club, IIM Rohtak

Illustration 2: Following Trial Balance has been extracted from the books of Shri Sunder Lal
on 31st March, 2018
Pariculars Dr. Cr.
Cash in Hand and at
Bank 77,400
Capital 3000000
Drawings 126000
Bills Receivable 37,200
Land and Building 6,51,600
Furniture 1,02,400
Wages 9,37,700
Discount Allowed 79,200
Discount Received 59700
6% Loan 300000
Bank Charges 2,100
Bad Debts 27,600
Sundry Debtors 13,15,500
Office Salaries 1,28,400
Purchases 39,81,600
Stock on 1st April, 2017 12,04,500
Sales Return 37,500
Carriage Inwards 1,03,600
General Expenses 1,53,600
Plant and Machinery 4,32,800
Rent 72,600
Purchases Return 29100
Sales 5630100
Insurance 14100
Provision for Doubtful
Debts 93000
Sundry Creditors 373500
Total 94,85,400 94,85,400

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Finance & Investment Club, IIM Rohtak

Closing Stock on 31 st March, 2018 was Rs 12,74,000 You are required to prepare
Trading Account for the year ended 31 st March, 2018, after making the following
adjustments:
(a) Purchases include a computer costing 60,000 purchased on 1 st July, 2017 and is
subject to depreciation @ 10% p.a.

EXTRA QUESTIONS FOR PRACTICE

Q1. In the books of ABC & Co. prepare the trading account for the year ended 1st April 2020
Particulars Rs
Stock on April 1, 2020 36,500
Purchases 3,24,600
Purchases Returns 6300
Sales 5,62,400
Import Duty 11000
Freight 21,500
Dock Dues and Clearing
Charges 1,800
Sales Returns 7500
Value of Stock on March 31,
2020 42100

(Answer: Gross Profit Rs. 2,07,900)

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Finance & Investment Club, IIM Rohtak

Q2. In the books of Shyamlal. prepare the trading account for the year ended 1st April 2020
Particulars Rs
Stock on January 1 27,400
PLfrchases 2,36,800
Returns Outwards 8200
Octroi Duty 1,200
Carriage Inwards 2,400
Sales 3,92,700
Returns Inwards 7,300
Value of Closing Stock 31500

(Answer: Gross Profit Rs. 1,57,300)

13 | Income Statement
Finance & Investment Club, IIM Rohtak

PROFIT & LOSS ACCOUNT

The P&L statement uses data from your business and three simple calculations to tell you the
net profit (or net loss) of your company. A regularly prepared P&L statement either quarterly
or monthly for new businesses will give owners timely and important information regarding
revenues and expenses and tell them whether adjustments might be necessary to recoup losses
or decrease expenses.

In the profit & loss account we bring down (carry forward) the gross profit or gross loss, after
which all the other expenses and revenues are accounted for. It initiated by entering the gross
loss on the debit side or gross profit on the credit side. A business will incur many other
expenses in addition to the direct expenses. These expenses are deducted from the profit or are
added to gross loss and the resulting value thus obtained will be net profit or net loss.

DEBIT SIDE OF THE P&L ACCOUNT (EXPENSES AND LOSSES)

1. Depreciation and Amortization

2. Interest Expenses
3. Other Expenses (fines, penalties, and extraordinary losses)

CREDIT SIDE OF THE P&L ACCOUNT (INCOME AND GAINS)

1. Other Operating Income (rental income, consultancy fees, commissions earned)

2. Non-Operating Income (interest earned on investments, dividend income, or the sale of
assets at a gain)
Net profit can be determined by deducting business expenses from the gross profit and adding
other incomes obtained.

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Finance & Investment Club, IIM Rohtak

PROFIT & LOSS ACCOUNT FORMAT

Pariculars Rs Pariculars Rs
To Gross loss b/d XXX By Gross Profit b/d XXX
To Salaries XXX By Discount Received XXX
To Office rent, rates and
taxes XXX By Commission Received XXX
To Printing & stationery XXX By Bank Interest XXX
To Telephone expenses XXX By Rent received XXX
To Postage & telegram XXX By Dividend on shares XXX
By Interest earned on
To Discount Allowed XXX debentures XXX
To Insurance XXX By Profit on sale of asset XXX
To Audit Fees XXX By Net loss XXX
To Electricity charges XXX
To Repairs & renewals XXX
To Depreciation XXX
To Advertisement XXX
To Carriage Outwards XXX
To Bad Debts XXX
To Provision for Bad
debts XXX
To Selling commission XXX
To Bank Charges XXX
To Interest on loans XXX
To Loss on sale of asset XXX
To Net Profit XXX
XXX XXX

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Finance & Investment Club, IIM Rohtak

TRADING VS PROFIT & LOSS A/C

Parameters Trading Account Profit and Loss Account

Profit and loss account or Income
Trading account used to find the
statement is used to find the net
Meaning gross profit/loss of the business for
profit/loss of the business for an
an accounting period
accounting period
Trading Account is prepared first Profit/Loss Account is prepared
Timing and then profit and loss account is after the trading account is
prepared. prepared.
For knowing the gross profit or gross For knowing the net profit or net
Purpose
loss of business loss of of business
It is the first stage in the creation of it is the second stage in the creation
Stage
the final account. of the final account.
Dependency It is not dependent on trial balance It is dependent on trading account
The balance in the form of Gross The balance in the form of Net loss
Transfer of loss or Gross Profit of the trading or Net Profit of the profit and loss
Balance account will be transferred to the account will be transferred to the
Profit and Loss Account Balance Sheet

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Finance & Investment Club, IIM Rohtak

Illustration 1: From the following information, prepare a profit and loss account for the year
ending March 31st, 2017.
Particulars Rs
Gross profit 60,000
Rent 5,000
Salary 15,000
Commission paid 7,000
Interest paid on loan 5,000
Advertising 4,000
Discount received 3,000
Printing and stationery 2,000
Legal charges 5,000
Bad debts 1,000
Depreciation 2,000
Interest received 4,000
Loss by fire 3,000

Solution:
Particulars Rs Particulars Rs
Rent 5,000 Gross profit 60,000
Salary 15,000 Discount received 3,000
Commission 7,000 Interest received 4,000
Interest paid on loan 5,000
Advertising 4,000
Printing and Stationery 2,000
Legal charges 5,000
Bad debts 1,000
Depreciation 2,000
Loss by fire 3,000
Net profit (transferred to the
capital account) 18,000
67,000 67,000

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Finance & Investment Club, IIM Rohtak

Illustration 2 (Trading & Profit & Loss): Following balance is extracted from the books of a
trader ascertain gross profit, operating profit and net profit for the year ended March 31, 2017.
Particulars Rs
Sales 75,250
Purchases 32,250
Opening stock 7,600
Sales return 1,250
Purchases return 250
Rent 300
Stationery and printing 250
Salaries 3,000
Misc. expenses 200
Travelling expenses 500
Advertisement 1,800
Commission paid 150
Office expenses 1,600
Wages 2,600
Profit on sale of investment 500
Depreciation 800
Dividend on investment 2,500
Loss on sale of old furniture 300

Closing stock (March 31, 2017) valued at 8,000

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Finance & Investment Club, IIM Rohtak

Dr. Cr.
Particulars Rs Rs Particulars Rs Rs
Opening stock 7600 Sales 75,250
Purchases 32,250 Less : Sales return -1250 74,000
Less: Purchases return -250 32,000 Closing stock 8000
Wages 2,600
Gross profit c/d 39,800
82000 82000
Rent 300 Gross Profit b/d 39,800
Profit on sale of
Stationery and printing 250 investment 500
Salaries 3,000 Dividend on investment 2500
Misc. expenses 200
Travelling expenses 500
Advertisement
expenses 1,800
Commission paid 150
Office expenses 1,600
Depreciation 800
Loss on sale of old
furniture 300
Net Profit (transferred
to capital account) 33,900
42,800 42,800

ADJUSTMENTS IN TRADING AND PROFIT & LOSS A/C

According to accrual concept of accounting, the profit or loss for an accounting year is not
based on the revenues realised in cash and the expenses paid in cash during that year. There
may exist some receipts and expenses in the current year which partially relate to the previous
year or to the next year. Also, there may exist incomes and expenses relating to the current year
that still need to be brought into books of account.

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1. Outstanding/ expenses: When expenses of an accounting period remain unpaid at

the end of an accounting period, they are termed as outstanding expenses. it is
logical that they should be duly charged against revenue for computation of the
correct amount of profit or loss.
These expenses are added in the expenses that were paid in the financial year in the
respective financial statement.

2. Prepaid/ Unexpired expenses: Portion of expenses carried forward to the next year
and is termed as prepaid expenses. The effect of the adjustment entry is : the amount
is deducted from the total of the particular expense.

3. Accrued income: Income items such as interest on loan, commission, rent, etc. are
earned during the current accounting year but have not been received in cash or
bank by the end of the same year. Such incomes are known as accrued income. They
are to be recorded in the books of accounts and added to the incomes earned as
below.

4. Income received in advance: At times, certain income is received but the whole
amount of it does not belong to the current period, this is also called the unearned
income. This amount is not recorded in the profit and loss account but is depicted
as a current liability in the balance sheet.

5. Depreciation: Depreciation is the decline in the value of assets on account of wear

and tear and passage of time. It is treated as a non-cash expense in the profit and
loss account and the value is deducted from the asset’s value in the balance sheet.

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Finance & Investment Club, IIM Rohtak

6. Bad debts: Bad debts refer to the amount that the firm has not been able to realise
from its debtors. It is regarded as a loss. The amount is deducted from the debtors
(assets) in balance sheet. This is because the amount is no more recoverable.

7. Provision for doubtful debts: It is not possible to accurately know the amount of
such bad debts. Hence, we make a reasonable estimate of such loss and provide the
same. Such provision is called provision for bad debts and is created by debiting
profit and loss account.

8. Provision for discount on debtors: A business enterprise allows discount to its

debtors to encourage prompt payments. Provision for discount is made on good
debtors which are arrived at by deducting further bad debts and the provision for
doubtful debts.

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Finance & Investment Club, IIM Rohtak

Comprehensive Illustration 1: Prepare the trading and profit and loss account of M/s Roni
Plastic Ltd. from the following trial balance and a balance sheet as at March 31, 2017.
Credit
Debit Balances Rs Balances Rs
Drawings 6,000 Creditors 16,802
Sundry debtors 38,200 Capital 60,000
Loan on
Carriage outwards 2,808 mortgage 17,000
Establishment Bad debts
expenses 16,194 provision 1,420
Interest on loan 400 Sales 2,22,486
Cash in hand 6,100 Purchases return 2,692
Stock 11,678 Discount 880
Motor car 18,000 Bills payable 5,428
Cash at bank 9,110 Rent received 500
Land and Buildings 24,000
Bad debts 1,250
Purchases 1,34,916
Sales return 15,642
Advertisement 4,528
Carriage inward 7,858
Rates, taxes,
insurance 7,782
General expenses 8,978
Bills receivable 13,764
Total 3,27,208 Total 3,27,208

Adjustments:
1. Depreciation on land and building at @ 5% and Motor vehicle at @ 15%.
2. Interest on loan is @ 5% taken on April 01, 2016.
3. Goods costing Rs1,200 was sent to a customer on sale on return basis for
Rs1,400 on March 30, 2017 and has been recorded in the books as actual sales.
4. Salaries amounting to Rs 1,400 and Rates amounting to Rs 800 are due.
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5. The bad debts provision is to be brought up to @ 5% on sundry debtors.

6. Closing stock was Rs 13,700.
7. Goods costing Rs 1,000 were taken away by the proprietor for his personal use
but not entry has been made in the books of account.
8. Insurance pre-paid Rs 350.
9. Provide the manager’s commission at @ 5% on Net profit after charging such
commission.
In the Books of Roni’s Plastic Ltd.
Trading and Profit and Loss Account for the year ended March 31, 2017
Particulars Rs Particulars Rs
Opening stock 11678 Sales 222486
Purchases 1,34,916 Less Sales -15642
Less Purchases return -2,692 206844
Less Return
1,32,224 Basis -1400 205444
Less Goods Closing
withdrawn -1000 1,31,224 Stock 13700
Carriage inwards 7858
Gross profit c/d 68384
219144 219144
Gross profit
Outstanding salaries 1400 c/d 68384
Carriage outwards 2808 Discount 880
Establishment
expenses 16194 Rent 500
Bad debts 1250
Add New provision 1840
3090
Less Old provision -1420 1670
Rates and Taxes 7782
Less Prepaid -350
Add Outstanding 800 8232

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Advertisement 4528
Interest on loan 400
Add Outstanding
Interes 450 850
General expenses 8978
Depreciation on :
Land and Building 1200
Motor car 2700 3900
Manager commission 1010
Net profit (transferred
to 20194
capital account) 69764 69764

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Finance & Investment Club, IIM Rohtak

Comprehensive Illustration 2: From the following balances taken from the Trial Balance of
M/s Baba & Company, prepare : (a) Trading and Profit and Loss A/c for the year ending 31st
March, 2006. (b) Balance Sheet as at 31st March, 2006.
Particulars Rs Particulars Rs
Opening Stock 8,100 Freehold Land 970000
Purchases 712000 Capital 233800
Sales 1212150 Freight Inward 1,200
Productive
Expenses 82,400 Freight Outward 2,200
Interest on Loan 33,750 Sales Tax Collected 40,000
Interest on Bank
Returns Inward 6,600 Deposit 2,400
Returns Outward 3,200 Loan 9,00,000
Loose Tools 8,400 Sundry Debtors 30,000
Goodwill 7,000 Sundry Creditors 12,100
Commission
(Cr.) 2,000 Bad Debts 1,900
Salaries 11,600 Law Charges 800
Investments 2,00,000 Rent 18,000
Cash in hand 1,700 Motor Car 3,10,000

Additional information:
1. The value of closing stock was Rs. 24,400.
2. 60% of the rent was paid in respect of factory.
3. Sundry Debtors included a sum of Rs.4,000 in respect of one debtor who has
become insolvent and 75 paise in a rupee was realisable from him.
4. Interest on loan @ 8% p.a. is unpaid for 4 months,
5. Depreciation to be charged on Motor car @ 10% p.a.
6. Salaries Outstanding Rs. 2,200.

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Finance & Investment Club, IIM Rohtak

In the Books of M/s Baba & Co.

TRADING AND PROFIT AND LOSS ACCOUNT
for the year ended 31st March, 2006
Particulars Rs Particulars Rs
To Opening Stock 8100 By Sales 1212150
Less: Returns
To Purchases 712000 Inward 6600 1205550
Less : Returns Outward -3200 708800 24400
To Productive Expenses 82400
To Freight Inward 1200
To Factory Rent (60%
0fRs. 18,000) 10800
To Gross Profit c/d 418650
Salaries 1229950 1229950
By Gross Profit
To Salaries 11600 b/d 418650
Add: Outstanding 2200 13800 By Commission 2000
By Interest on
To Freight Outward 2200 Bank Deposit 2400
To Bad Debts 1900
Add: Further Bad Debts 1000 2900
To Law Charges 800
To Rent (40% of Rs.
18,000) 7200
To Depreciation on
Motor Car 31000
To Interest on Loan 33750
Add: Outstanding 24000 57750
To Net Profit transferred
to CapialA/c 307400
423050 423050

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BALANCE SHEET
as at 31s ' March, 2006
Liabilities Rs Assets Rs
Sales Tax Payable 40,000 Cash in hand 1700
Sundry Creditors 12,100 Sundry Debtors 30000
Outstanding Interest on Less : FurtherBad
Loan 24,000 debts -1000 29000
Outstanding Salaries 2,200 Stock 24400
Loan 900000 Loose Tools 8400
Capital 233800 Investments 200000
Add: Net Profit 307400 541200 Motor Car 310000
Less : Depreciation -31000 279000
Freehold Land 970000
Goodwill 7000

15,19,50 15,19,50
0 0

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INTRODUCTION TO INCOME STATEMENT

The Income Statement is one of a company’s core financial statements that shows their profit
and loss over a period of time. The profit or loss is determined by taking all revenues and
subtracting all expenses from both operating and non-operating activities.
The income statement is one of the four statements used in both corporate finance (including
financial modelling) and accounting. The statement displays the company’s revenue, costs,
gross profit, selling and administrative expenses, other expenses and income, taxes paid, and
net profit in a coherent and logical manner.

IMPORTANCE OF AN INCOME STATEMENT:

Profit Generation: Helps assess if profit can be increased by raising revenues, reducing costs,
or both.

Strategy Effectiveness: Shows if initial strategies are working and informs adjustments for
better profit.

Frequent Reports: Generated quarterly or monthly, enabling close performance tracking and
timely problem-solving.

Pinpointing Expenses: Identifies future or unexpected expenses and highlights areas of over
or under-budget spending.

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PRO FORMA FOR INCOME STATEMENT

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BREAKDOWN OF EXPENSES ON AN INCOME STATEMENT

Cost of Goods Sold (COGS)

Raw Materials: Costs for purchasing raw materials, e.g., $50,000 for fabric in a clothing
company.
Labour: Wages for workers producing goods, e.g., $30,000 for factory workers.
Overhead: Factory-related costs, e.g., $10,000 for utilities and equipment maintenance.
Description: COGS covers the direct costs of producing goods or services. For example, if a
company sells $100,000 worth of products, and COGS is $70,000, it shows the direct expense
of making those products.

Operating Expenses

Marketing and Advertising: Costs for promoting products, e.g., $5,000 for a marketing
campaign.

Salaries and Wages: Administrative staff compensation, e.g., $20,000 for office staff salaries.
Rent and Utilities: Office space and utility costs, e.g., $8,000 for monthly office rent and
utilities.
Office Supplies: Costs for supplies like paper and pens, e.g., $1,000 for office supplies.
Depreciation and Amortisation: Allocation of asset costs over time, e.g., $4,000 for
depreciation on equipment.
Description: Operating expenses include the day-to-day costs of running the business. For
example, if a company's total operating expenses amount to $38,000, it reflects ongoing
operational costs beyond production.

Non-operating Expenses

Interest Expense on Debt: Costs from borrowed funds, e.g., $2,000 in interest on a business
loan.
Losses from the Sale of Assets: Losses from selling assets, e.g., $3,000 loss on equipment sale.
Legal Settlements: Costs from legal disputes, e.g., $10,000 paid in a lawsuit settlement.

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Impairment Charges: Write-downs of asset value, e.g., $6,000 impairment on outdated

technology.
Description: Non-operating expenses are costs not directly related to the core business
operations. For example, if a company has $21,000 in non-operating expenses, it reflects costs
unrelated to regular business activities.

Depreciation

Example: A company depreciates $20,000 worth of machinery over 10 years, leading to an

annual depreciation expense of $2,000.

Interest Expenses

Example: Interest payments on a $100,000 loan at a 5% interest rate result in $5,000 annual
interest expenses.

Tax Expenses

Example: A company with a taxable income of $50,000 may owe $7,500 in taxes, assuming a
15% tax rate.
Summary
Understanding these categories helps in evaluating a company’s financial health. COGS
reflects production costs, operating expenses cover regular business costs, and non-operating
expenses include financial and exceptional costs. Depreciation, interest, and tax expenses
provide additional insights into the company’s financial obligations.

BREAKDOWN OF REVENUE ON AN INCOME STATEMENT

Total Revenue

Sales Revenue: The income generated from selling products or services. For example, a
company might report $500,000 in sales revenue from its core business operations.

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Other Revenues: Additional income sources such as rental income, licensing fees, or royalties.
For example, a company might earn $10,000 from renting out office space.
Description: Total revenue is the overall amount generated from all sources before any
deductions or expenses. It’s crucial for assessing a company’s ability to generate income.
Analysing total revenue over different periods can highlight growth trends or potential declines.

Net Sales Analysis

Gross Sales: The total sales amount before any deductions. For instance, gross sales might be
$600,000.
Deductions: Includes returns, allowances, and discounts. For example, returns of $20,000 and
discounts of $10,000 need to be subtracted.
Net Sales Calculation: Subtract total deductions from gross sales to determine net sales. For
example, $600,000 (gross sales) - $30,000 (deductions) = $570,000 (net sales).
Description: Net sales provide a clearer picture of actual revenue after accounting for returns
and discounts. Comparing net sales over time helps evaluate sales performance and can reveal
insights into issues like product quality or pricing strategies.

CREDIT SIDE OF INCOME STATEMENT

Revenue: Represents income from the core business activities. For instance, a company’s
$500,000 in revenue from selling goods.
Other Income: Income from non-core activities, such as $5,000 in interest income or $8,000 in
rental income.
Description: The credit side of the income statement details income sources, including core
revenue and additional income streams. It’s essential for understanding the total income a
company generates, both from its primary operations and supplementary sources.
Summary
Understanding revenue involves analysing both total revenue and net sales. Total revenue
includes all income from sales and other sources, while net sales adjust for returns, allowances,
and discounts to reflect actual revenue. The credit side of the income statement details income
from core business activities and additional sources. Examining these figures provides insights
into the company’s financial health, sales performance, and revenue generation capabilities

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EVALUATING PROFITABILITY

1. Gross Profit

Gross Profit is the amount of money a company makes from selling its products or services
after subtracting the cost of making them.
Formula:
Gross Profit = Revenue - Cost of Goods Sold (COGS)
Example:
If a company sells $100,000 worth of products and it cost $60,000 to make those products,
then: Gross Profit = $100,000 - $60,000 = $40,000
Importance:
Gross profit helps you see how efficiently a company produces and sells its goods. A higher
gross profit means the company keeps more money from each sale, which is generally a sign
of strong financial health and effective production.

2. Operating Income vs. Net Income

Operating Income(or EBIT): This is the profit a company makes from its core business
operations, excluding costs like interest and taxes.
Example:
If the company’s gross profit is $40,000 and it has $15,000 in operating expenses (like salaries
and rent), then: Operating Income = $40,000 - $15,000 = $25,000
Net Income: This is the total profit after all expenses, including operating costs, interest, taxes,
and any other costs.
Example:
If the company’s operating income is $25,000 and it has $5,000 in interest and $3,000 in taxes,
then: Net Income = $25,000 - $5,000 - $3,000 = $17,000
Importance:
Operating income shows how well a company manages its core business activities. Net income
provides a complete picture of overall profitability after all expenses. A higher operating
income suggests efficient management of business activities, while a higher net income
indicates good overall financial health.

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3. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation)

EBITDA is a measure of a company’s operating performance by excluding interest, taxes,

depreciation, and amortisation.
Formula:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation
Example:
If the company’s net income is $17,000, with $2,000 in interest, $1,500 in taxes, $3,000 in
depreciation, and $1,000 in amortisation, then: EBITDA = $17,000 + $2,000 + $1,500 + $3,000
+ $1,000 = $24,500
Importance:
EBITDA helps you understand how well a company’s core business is performing without the
effects of financing and accounting decisions. A higher EBITDA means the company generates
strong cash flow from its operations, which is crucial for growth and covering debts.
In Summary:
Gross Profit shows the profit made from sales after covering production costs. It highlights
efficiency in making products.
Operating Income vs. Net Income distinguishes between profit from core activities and overall
profit after all expenses.
EBITDA focuses on operational performance by excluding financial and accounting impacts,
showing how much cash the company generates from its core business.

4. Income Before Taxes (EBT)

Definition: This figure represents the company’s earnings after subtracting all operating and
non-operating expenses but before accounting for taxes.
Calculation Steps:
Start with Gross Revenue.
Subtract Cost of Goods Sold (COGS) to get Gross Profit.
Deduct Operating Expenses (e.g., rent, salaries).
Adjust for Non-operating Expenses and Gains (e.g., interest, investment income).
Example:

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Gross Revenue: $100,000

COGS: -$20,000
Gross Profit: $80,000
Operating Expenses: -$50,000
Non-operating Gains: +$5,000
Income Before Taxes: $35,000

5. Income After Taxes (PAT)

Definition: This is the amount of profit remaining after deducting tax expenses from the Income
Before Taxes.
Calculation Steps:
Determine Tax Expenses by applying the tax rate to Income Before Taxes.
Subtract Tax Expenses from Income Before Taxes.
Example:
Income Before Taxes: $35,000
Tax Rate: 21%
Tax Expenses: $7,350
Income After Taxes: $35,000 - $7,350 = $27,650
Summary:
Income Before Taxes shows earnings after expenses but before taxes.
Income After Taxes reveals the final profit after accounting for tax expenses.

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QUESTIONS FOR PRACTICE:

QUESTION:
The following Trial balance was extracted from the Books of Mega Enterprise as at 31
December 2017

Rs Rs
Capital 2,00,000
Duty on purchases 2,300
Insurance 6,000
Inventory as at 1 January 2017 70,000
Interest on loan 2,500
Account receivable and account payable 20,450 24,500
Purchase and sales 2,00,000 2,80,000
Land and building 2,65,550
Return inwards and return outwards 2,300 1,850
Accumulated depreciation – Office equipment 9,850
Accumulated depreciation – Motor vehicles 50,000
10% Loan from Hong Leong Bank 2,65,000
Cash 7,400
10% Fixed deposit 10,000
Discount allowed and discount received 2,500 5,000
Carriage outwards 8,200
Utilities 1,500
Bank 40,000
Office equipment 28,000
Salary and wages 25,000
Motor vehicles 1,40,000
Drawings 3,000
General expenses 3,500
Commissions 2,800 4,800
8,41,000 8,41,000

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Additional information:
1. Inventory as at 31 December 2017 was valued at Rs 40,000
2. Included in the carriage outwards is carriage inwards amounting to Rs 1,320.
3. Depreciation for the year are to be provided as follows: Office equipment Straight line
method, 10% per annum Motor vehicles Reducing balance method, 15% per annum
4. Fixed deposit was invested on 1 July 2017. The half year interest was not yet received.
5. One of the employees was given an advance salary of Rs 700.
6. The owner took goods worth Rs 2,000 and cash Rs1,500 for personal use.
7. The following expenses are still outstanding as at 31 December 2017. General expenses Rs
600 Utilities Rs 250
Required: Prepare the Statement of profit or loss for the year ended 31 December 2017

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Solution:
Mega Enterprise
Statement of profit or loss
For the year ended 31 December 2017
RM RM RM
Revenues
Sales 2,80,000
Less : Return inwards (2,300) 2,77,700
Net Sales

Less : Cost of Goods Sold

Opening inventory 70,000
Purchases (-2,000) 1,98,000
Less: Return Outwards (1850)
Net purchases 1,96,150
Add: Carriage inwards 1,320
Add: Duty of purchase 2,300
Cost of goods purchased 1,99,770

Cost of Goods available for sale 2,69,770

Less : Closing Inventory (40,000) 2,29,770

Gross Profit 47,930

Add : Other Revenues

Discount received 5,000
Commission received 4,800
Interest on fixed deposit (10% x10,000 x 500 10,300
6/12)

Less: Operating expenses

Insurance 6,000

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Interest on loan ( 10% x26,500) 26,500

Discount allowed 2,500
Carriage outwards (-1320) 6,880
Utilities (+250) 1,750
Salary and wages (-700) 24300
General expenses (+600) 4100
Commissions 2800
Depreciation expense- OE ( 10%X
28000) 2800
Depreciation expense – MV ( 140K- 13500 (91,130)
50K)X15%

Net Loss (32,900)

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Question
Clearwater Sdn. Bhd. is a merchandising company which has business operations in Putrajaya.
The following balances have been extracted from the books as at 31 December 2015
Debit (Rs) Credit (Rs)
Land 9,00,000
Building 2,40,000
Machinery 60,000
Accumulated Depreciation:
Building 72,000
Machinery 11,400
7.5% Loan from Maybank, 10 Years 3,50,000
Bank overdraft 45,000
Cash 36,000
Account receivable 1,22,800
Inventories, 1 Jan 1,17,200
Account payable 65,000
Dividend 60,000
Common stock/Share capital 8,00,000
Supplies 1,10,000
Carriage outwards 40,000
Carriage inwards 9,600
Return inwards 2,000
Purchases and sales 4,40,000 9,80,000
Discount allowed 45,000
Salaries expenses 1,50,000
Bad debts 10,000
Prepaid insurance 36,000
Interest expenses 13,125
Telephone and internet charges 5,000
Rental and maintenance 36,000
General expenses 55,800
Retained earnings, 1 Jan 1,65,125

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2,488,525 24,88,525

Additional information:
1. Closing inventories as at 31 December 2015 was valued at Rs 50,000.
2. A count on supplies on 31 December 2015 revealed Rs 60,000 worth still on hand.
3. Half of the interest on loan has not been paid for the year.
4. Commission received Rs 15,000 has not been included and no entries had been recorded in
the books.
5. Depreciation was to be provided: Building 2% on cost Machinery 10% on reducing balance
6. Telephone and internet charges outstanding amounted to Rs 1,300.
7. The prepaid insurance is for a 12-month policy purchased by cash on 1 March 2015. The
policy is effective from 1 March 2015
Required:
Prepare the statement of profit or loss for the year ended 31 December 2015

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Solution
Clearwater Sdn.Bhd
Statement of profit or loss
For the year ended 31 December 2015
Rs Rs Rs
Revenues
Sales 9,80,000
Less : Return inwards -2,000
Net Sales 9,78,000

Less : Cost of Goods Sold

Opening inventory 1,17,200
Purchases 4,40,000
Add: Carriage inwards 9,600
Net purchases/cost of goods purchased 4,49,600

Cost of Goods available for sale 5,66,800

Less : Closing Inventory -50,000 5,16,800

Gross Profit / 4,61,200

Add : Other Revenues

Commission received 15,000

Less: Operating expenses

Carriage outwards 40,000
Discount allowed 45,000
Salaries expenses 1,50,000
Bad debts 10,000
Insurance expenses (3,000 x 10) 30,000
Interest expense ( + 13,125) 26,250

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Telephone and internet expense 6,300

(+1,300)
Rental and maintenance 36,000
General expenses 55,800
Depre. – Building (2% x 240,000) 4,800
Depre. – Machinery (60k -11400) x10% 4,860
Supplies expense 50,000 4,59,010
Net income 17,190

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