MN1405 ACCOUNTING

TOPIC 3 Lecture 1
OVERVIEW OF TOPIC 3: Income Statement

1 2 3 4 5 6 7

Define income Describe what Understand Discuss the Understand Define and Show
and expenses is meant by the different nature and the links calculate depreciation in
profit (or loss) expense purpose of the between the depreciation the income
categories and income income using both the statement and
profit figure statement statement and straight line the statement
the statement and reducing- of financial
of financial balance position
position methods
regards to non-
current assets
and
depreciation

2
 Shows
sales
revenue/in
c-ome for
an entity

Links the Tells us

Statement of about the
Financial financial
Position at
the beginning
and the end Income performan
ce of an
entity

Stateme
of a reporting
period.

nt
Evaluates
Flow of past
wealth performanc
e/helps
over predict
period of future
time performanc
e
3
 INCOME STATEMENT
Sales 51,000
Less: Cost of sales
Opening inventories (Note 2) 4,500
Gross
ADD: Purchases 30,000
Profit
Revenue – DEDUCT: Closing inventory (2,700)
cost of (31,800)
sales Gross profit 19,200
Less: operating expenses
Operating
Profit Electricity (1,920+480) (Note 3) (2,400)
Gross profit – Wages and salaries (1,500)
operating Advertising (1,200)
expenses = Depreciation charge – printing machines (Note 5) (1,375)
Profit for the Operating profit 5,956
period Less: Interest (360)
Operating profit
Net profit 5,596
+ non-operating
income – finance
expenses 4
 INCOME STATEMENT - PROFIT
Gross Profit
 Revenue – cost of sales = gross profit

Operating Profit
 Gross profit – operating expenses =
operating profit

Profit for the period

 Operating profit + non-operating income –
finance expenses = profit for the period
5
INCOME STATEMENTS: ELEMENTS
The Income Statement is comprised of two main elements:

• A measures of the inflow of economic

benefits arising from the ordinary
Sales/Revenue operation of a business
• i.e., sales to customers of goods and/or
services
• The outflow of economic benefits
arising from the ordinary operations of
Expenses a business
• i.e., costs that the business incurs

6
 CALCULATING PROFIT/LOSS

Profit (or loss) for the period = Total revenue for the period –
Total expenses incurred in generating that revenue

Revenu Expense Profit/Loss

e s

Revenu > Expense Profit

e s

Revenu < Expense Loss

e s

7
ARSENAL’S REVENUE FOR THE YEAR
ENDED 31 MAY 2022
Breakdown of Arsenal Revenue based on
2022 Financial Statements
https://www.arsenal.com/the-club/corpor-
ate-info/arsenal-holdings-financial-results

Gate and other match day revenue Broadcasting

Commercial (& retail) Property development
Player trading
 INCOME STATEMENT - EXAMPLE
Prepared for a period of time
(vs. static statement)

Trading account - (gross) profit

made on sales of products sold
. Relates to primary activities
of the business
Operating profit = gross profit
– operating expenses.
‘Othe Operating expenses are
r’ incurred through day-to-day
incom Usually
running interest
of the business.
e expenses related
to long term loans
(noncurrent
liability

Net profit – attributable to

owners of the business (note
here that these take different
forms for this company).

9 https://www.gsk.com/en-gb/investors/corporate-reporting/annual-report-2020/#tab-1-1
 INCOME STATEMENT – TRADING
SECTION
Thermo Q: Income Statement for the year ended 31
December 2021 £

Sales 51,000
Less: Cost of sales
Opening inventories 4,500

Gross Profit ADD: Purchases 30,000

Revenue – Cost of DEDUCT: Closing inventory (2,700)
sales
(31,800)
51,000 – Gross profit 19,200
31.800
= 19,200
10
 COST OF SALES

Cost of sales (cost of goods sold)

 Match sales revenue with the cost of the

goods sold

 Cost of goods sold rather than bought

during the period
Opening Purchase Closing
inventori s inventori
es es
11
 COST OF SALES – EXAMPLE 1

The college shop bought 1000 Mars Bars at 50p each. During
the welcome week, sold 800 Mars Bars at 90p each. What is the
cost of sales? Prepare the trading section (gross profit) for
the college shop’s income statement for the welcome week.

Gross Profit
Revenue – Cost of sales
Cost of Sales
Opening Inventory + Purchases –
Closing Inventory
12
 COST OF SALES – EXAMPLE 1

The college shop bought 1000 Mars Bars at 50p each with unsold
Mars Bars of £100. During the welcome week, sold 800 Mars Bars at
90p each. What is the cost of sales? Prepare the trading section for
the college shop’s income statement for the welcome week.
Gross Profit: Revenue – Cost of sales
Cost of Sales: Opening Inventory + Purchases – Closing
Inventory
Cost of sales: 0 + £500 - £100 = £400 or £800 x 0.50 = £400
£
Sales revenue 720 (800 x £0.90)
Cost of sales 400
Gross profit 320
13
 COST OF SALES – TRADING
ACCOUNT
The college shop began the second week with unsold Mars Bars
(from welcome week) of £100 and during that week bought more
Mars bars at a cost of £300. College shop generated a revenue of
£700 during the second week. At the end of the week, there were
some Mars Bars left in the shop worth £50.
Cost of sales = ?

14
 COST OF SALES – TRADING SECTION

Sales 700
Cost of sales
Opening inventories 100
Add: Purchases 300
Less: Closing (50) (350)
inventories
Gross profit 350
Cost of
sales
Opening Purchase Closing
inventori s inventori
15
es es
 RECOGNISING REVENUE – DEEP DIVE

 Revenue arises from the sales of goods or

provision of a service.
 It should be recognised as soon as control
of the goods or services is transferred to
the customer.
 The point at which revenue is recognised
could have a significant impact on reported
revenues, and therefore profit, for a period.

16
 REVENUE RECOGNITION AND
CASH RECEIPTS
A sale on credit is usually recognised before
the cash is received.

This means that the total sales revenue shown

in the income statement may include sales
transactions for which the cash has yet to be
received.

The total sales revenue will, therefore, often be

different from the total cash received from sales
17
during the period.
 INCOME STATEMENT
Sales 51,000
Less: Cost of sales
Opening inventories (Note 2) 4,500
Gross
ADD: Purchases 30,000
Profit
Revenue – DEDUCT: Closing inventory (2,700)
cost of (31,800)
sales Gross profit 19,200
Less: operating expenses
Operating
Profit Electricity (1,920+480) (Note 3) (2,400)
Gross profit – Wages and salaries (1,500)
operating Advertising (1,200)
expenses = Depreciation charge – printing machines (Note 5) (1,375)
Profit for the Operating profit 5,956
period Less: Interest (360)
Operating profit
Net profit 5,596
+ non-operating
income – finance
expenses 18
 DEPRECIATION/AMORTISATION

As non-current asset are being used by the

businesses their value decreases over time due to
wear and tear. The accounting term that allocates
this wear and tear to the financial
statements is called depreciation/amortisation. It
is an attempt to measure the portion of the cost
(or fair value) of a non-current asset that has been
depleted in generating the revenue recognised
* Tangibles
during  depreciation
a particular period.
* Intangibles  amortisation

19
 CALCULATING THE
DEPRECIATION EXPENSE

To calculate a depreciation expense for a

period, four factors have to be
considered:

 The cost (or fair value) of the asset

 The useful life of the asset
 Residual value (disposal value)
 Depreciation method

20
 The cost (or fair value) of the asset
 Include all costs incurred by the business to bring
the asset and to make it ready to use – we call
these costs capital expenditure (CAPEX)
The useful life of the asset
 Expected length of time that a non-current asset
will be used in the business
Residual value (disposal value)
 Estimated amount that a non-current asset will be
worth at the end of its useful life
Depreciation method
 Straight-line method
 Reducing-balance method

21
 DEPRECIATION CALCULATION
The depreciation charge/expense
 The amount charged to the income statement to
spread the cost of non-current assets over the life of those
assets.
Accumulated depreciation
 The total depreciation that has been charged on an
asset since it was acquired.
The carrying amount (aka. Net Book Value or NBV)
 The portion of the cost (or fair value) of the asset that has
still to be treated as an expense (written off) in future
years plus the residual value.
22
 STRAIGHT-LINE METHOD

It allocates the amount to be depreciated

evenly over the useful life of the asset.
 An equal depreciation expense for each year

Carrying amount 80

60
(£000)

40

20

0 1 2 3 4
Asset life (years)

23
 REDUCING-BALANCE METHOD
 It applies a fixed percentage rate of
depreciation to the carrying amount of the
asset each year.
 The effect of this will be high annual
depreciation expenses in the early years and
lower expenses in the later years.
80
Carrying amount

- Depreciation is60reducing as the non-current

assets get older 40
(£000)

20

0 1 2 3 4
Asset life (years)
24
EXAMPLE

Super Bowl LV Inc. purchases a new machine to manufacture “Aron

Rodgers MVP” Bobbleheads. In addition to the purchase price of 35,000
GBP, the company had further costs of 5,000 GBP for the initial set-up
of the machine. Super Bowl LV Inc. intends to use the machine for 3
years.

1. Calculate the annual depreciation charge using the straight-line

method for each year.
Assume a residual value of GBP 5,000.
Using this method, calculate the amount that should be shown on the
Statement of Financial Position for the assets after the asset has been owned
for two years
2. Calculate the annual depreciation charge using the reducing-
Asset cost: 35,000
balance method (rate:
Capital expenditure:
50%) for each year. 5,000
25
Using this method, calculate the amount that should be shown on Residual
the value: 5,000
Statement of Financial Position for the asset after the asset has been owned
Useful life: 3 years
HOW TO SOLVE THE QUESTION – FOUR FACTORS

Super Bowl LV Inc. purchases a new machine to manufacture “Aron Rodgers MVP”
Bobbleheads. In addition to the purchase price of 35,000 GBP, the company had
further costs of 5,000 GBP for the initial set-up of the machine. Super Bowl LV Inc.
intends
The to (or
cost usefair
the value)
machineoffor 3 years.
the asset: Include all costs Asset cost: 35,000
incurred by the business to bring the asset and to make it Capital expenditure:
ready to use – we call these costs capital expenditure (CAPEX): 5,000
Total cost: 40,000
The useful life of the asset: Expected length of time that a Useful life: 3 years
non-current asset will be used in the business
Residual value: 5,000
Residual value (disposal value): Estimated amount that a
non-current asset will be worth at the end of its useful life
a) Straight-line method
Depreciation method
 Straight-line method b) Reducing-balance
method
26 Reducing-balance method
DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
1. Calculate the annual depreciation charge using the straight-line method for each year. Assume
a residual value of GBP 5,000. Using this method, calculate the amount that should be shown
on the Statement of Financial Position for the asset after the asset has been owned for two
years
80
Carrying amount (£000)

60
Asset cost: 35,000
40 Capital expenditure:
5,000
Depreciation rate is the SAME
20
for each year Total Cost: 40,000
0 1 2 3 4 Residual value: 5,000
Asset life (years) Useful life: 3 years
FORMULA: (Asset cost (including CAPEX) – Residual (disposal)
value)
27 Useful life of the asset
DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
(40,000-5,000)/3 = 11,667 per annum Expense in the
Income Statement
So we found that depreciation expense for
each year is £11,667 until the end of the
useful life and we record this in the Income
Statement Asset cost: 35,000
What about the carrying amount (aka. Capital expenditure:
Net Book Value or NBV) where do we record 5,000
it?
What about the carrying amount (aka. Total Cost: 40,000
Net Book Value or NBV) where do we record
it?
Residual value: 5,000
Cost – Accumulated depreciation = NBV
Useful life: 3 years

28
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
a) Calculate the annual depreciation charge using the straight-line Asset cost: 35,000
method for each year. Assume a residual value of GBP 5,000. Using Capital expenditure:
this method, calculate the amount that should be shown on the SoFP5,000
for the asset after the asset has been owned for two years Residual value: 5,000
Useful life: 3 years
YEAR COST DEPRECIATI ACCUMULATED Depreciation charge:
CARRYING AMOUNT
+ ON CHARGE DEPRECIATION 11,667 pa
(NBV) – SoFP
CAPEX
1 40,000 11,667 = depreciation expense = cost – accumulated
= 11,667 depreciation
= 40,000 – 11,667
=28,333
2

29
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
a) Calculate the annual depreciation charge using the straight-line Asset cost: 35,000
method for each year. Assume a residual value of GBP 5,000. Using Capital expenditure:
this method, calculate the amount that should be shown on the SoFP5,000
for the asset after the asset has been owned for two years Residual value: 5,000
Useful life: 3 years
YEAR COST DEPRECIATI ACCUMULATED Depreciation charge:
CARRYING AMOUNT
+ ON CHARGE DEPRECIATION 11,667 pa
(NBV) – SoFP
CAPEX
1 40,000 11,667 = depreciation expense = cost – accumulated
= 11,667 depreciation
= 40,000 – 11,667
=28,333
2 40,000

30
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
a) Calculate the annual depreciation charge using the straight-line Asset cost: 35,000
method for each year. Assume a residual value of GBP 5,000. Using Capital expenditure:
this method, calculate the amount that should be shown on the SoFP5,000
for the asset after the asset has been owned for two years Residual value: 5,000
Useful life: 3 years
YEAR COST DEPRECIATI ACCUMULATED Depreciation charge:
CARRYING AMOUNT
+ ON CHARGE DEPRECIATION 11,667 pa
(NBV) – SoFP
CAPEX
1 40,000 11,667 = depreciation expense = cost – accumulated
= 11,667 depreciation
= 40,000 – 11,667
=28,333
2 40,000 11,667

31
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
a) Calculate the annual depreciation charge using the straight-line Asset cost: 35,000
method for each year. Assume a residual value of GBP 5,000. Using Capital expenditure:
this method, calculate the amount that should be shown on the SoFP 5,000
for the asset after the asset has been owned for two years Residual value: 5,000
Useful life: 3 years
YEAR COST DEPRECIATI ACCUMULATED Depreciation charge:
CARRYING AMOUNT
+ ON CHARGE DEPRECIATION 11,667 pa
(NBV) – SoFP
CAPEX
1 40,000 11,667 = depreciation expense = cost – accumulated
= 11,667 depreciation
= 40,000 – 11,667
=28,333
2 40,000 11,667 = prior year accumulated
depreciation + current
year depreciation
expense
=11,667 +11,667
=23,333
32
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
a) Calculate the annual depreciation charge using the straight-line Asset cost: 35,000
method for each year. Assume a residual value of GBP 5,000. Using Capital expenditure:
this method, calculate the amount that should be shown on the SoFP 5,000
for the asset after the asset has been owned for two years Residual value: 5,000
Useful life: 3 years
YEAR COST DEPRECIATI ACCUMULATED Depreciation charge:
CARRYING AMOUNT
+ ON CHARGE DEPRECIATION 11,667 pa
(NBV) – SoFP
CAPEX
1 40,000 11,667 = depreciation expense = cost – accumulated
= 11,667 depreciation
= 40,000 – 11,667
=28,333
2 40,000 11,667 = prior year accumulated = 40,000 – 23,333
depreciation + current = 16,667
year depreciation
expense
=11,667 +11,667
=23,333
33
DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
b) Calculate the annual depreciation charge using the reducing-balance
method (rate: 50%) for each year. Asset cost: 35,000
Using this method, calculate the amount that should be shown on Capital expenditure:
the SoFP for the asset after the asset has been owned for two years 5,000
Useful life: 3 years
80
Carrying amount (£000)

60
Depreciation charged decreases as
40 the asset ages
20

0 1 2 3 4
Asset life (years)

 FORMULA: Year 1 = Asset cost (including CAPEX) x

depreciation rate%

From Year 2 onwards: Carrying amount (net

book value)
34
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
b) Calculate the annual depreciation charge using the reducing-balance Asset cost: 35,000
method (rate: 50%) for each year. Using this method, calculate the Capital expenditure:
amount that should be shown on the SoFP for the asset after the asset 5,000
has been owned for two years Residual value: 5,000
Useful life: 3 years
YEA COST DEPRECIAT ACCUMULATED CARRYING AMOUNT (NBV) –
R + ION DEPRECIATION SoFP FORMULA:
CAPE CHARGE Year 1: Asset cost
X (including CAPEX) x
1 40,00 40,000*50 = depreciation = cost – accumulated depreciation rate %
0 %= 20,000 expense = 20,000 depreciation
= 40,000 – 20,000 From year 2 onwards:
=20,000 Carrying amount (net
2 book value) at end of
previous year x
depreciation rate %

35
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
b) Calculate the annual depreciation charge using the reducing-balance Asset cost: 35,000
method (rate: 50%) for each year. Using this method, calculate the Capital expenditure:
amount that should be shown on the SoFP for the asset after the asset 5,000
has been owned for two years Residual value: 5,000
Useful life: 3 years
YEA COST DEPRECIATI ACCUMULATED CARRYING AMOUNT (NBV) –
R + ON CHARGE DEPRECIATION SoFP FORMULA:
CAPE Year 1: Asset cost
X (including CAPEX) x
1 40,00 40,000*50% = depreciation = cost – accumulated depreciation rate %
0 = 20,000 expense = depreciation
20,000 = 40,000 – 20,000 From year 2 onwards:
=20,000 Carrying amount (net
2 40,00 Carrying amount = asset cost (incl CAPEX) – depreciation book value) at end of
0 charge previous year x
depreciation rate %
Carrying amount at end of year 1: 40,000-20,000=20,000

36
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
b) Calculate the annual depreciation charge using the reducing-balance Asset cost: 35,000
method (rate: 50%) for each year. Using this method, calculate the Capital expenditure:
amount that should be shown on the SoFP for the asset after the asset 5,000
has been owned for two years Residual value: 5,000
Useful life: 3 years
YEA COST DEPRECIATI ACCUMULATED CARRYING AMOUNT (NBV) –
R + ON CHARGE DEPRECIATION SoFP FORMULA:
CAPE Year 1: Asset cost
X (including CAPEX) x
1 40,00 40,000*50% = depreciation = cost – accumulated depreciation rate %
0 = 20,000 expense = depreciation
20,000 = 40,000 – 20,000 From year 2 onwards:
=20,000 Carrying amount (net
2 40,00 20,000*50% book value) at end of
0 = 10,000 previous year x
depreciation rate %

37
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
b) Calculate the annual depreciation charge using the reducing-balance Asset cost: 35,000
method (rate: 50%) for each year. Using this method, calculate the Capital expenditure:
amount that should be shown on the SoFP for the asset after the asset 5,000
has been owned for two years Residual value: 5,000
Useful life: 3 years
YEA COST DEPRECIATI ACCUMULATED CARRYING AMOUNT (NBV) –
R + ON CHARGE DEPRECIATION SoFP FORMULA:
CAPE Year 1: Asset cost
X (including CAPEX) x
1 40,00 40,000*50% = depreciation = cost – accumulated depreciation rate %
0 = 20,000 expense = depreciation
20,000 = 40,000 – 20,000 From year 2 onwards:
=20,000 Carrying amount (net
2 40,00 20,000*50% = prior year book value) at end of
0 = 10,000 accumulated previous year x
depreciation + depreciation rate %
current year
depreciation
expense
38
=20,000 +10,000
 DEPRECIATION – STRAIGHT LINE VS REDUCING
BALANCE
b) Calculate the annual depreciation charge using the reducing-balance Asset cost: 35,000
method (rate: 50%) for each year. Using this method, calculate the Capital expenditure:
amount that should be shown on the SoFP for the asset after the asset 5,000
has been owned for two years Residual value: 5,000
Useful life: 3 years
YEA COST DEPRECIATI ACCUMULATED CARRYING AMOUNT (NBV) –
R + ON CHARGE DEPRECIATION SoFP FORMULA:
CAPE Year 1: Asset cost
X (including CAPEX) x
1 40,00 40,000*50% = depreciation = cost – accumulated depreciation rate %
0 = 20,000 expense = depreciation
20,000 = 40,000 – 20,000 From year 2 onwards:
=20,000 Carrying amount (net
2 40,00 20,000*50% = prior year = 40,000 – 30,000 book value) at end of
0 = 10,000 accumulated = 10,000 previous year x
depreciation + depreciation rate %
current year
depreciation
expense
39
=20,000 +10,000
40
MN1405 F2F/ONLINE SESSION
TOPIC 3 – INCOME STATEMENT