MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

CHAPTER 7

PROFIT AND LOSS ACCOUNT, INCOME

STATEMENT REPORTING FINANCIAL
PERFORMANCE
Key terms
Expenditure, expense, revenue, profit and loss, income statement, types of
accounts, form of profit and loss account.

Types of expenditures, definition of expenses, revenue, profit and

loss
Main point in being business is making PROFITS.
Which differences are between EXPENDITURE x EXPENSE x REVENUE?
If accounting unit pays and money has left business and it has not swapped for some
new assets the business has in effect "loss" it has paid an EXPENSE, the cash
leaving the business is not replaced.
2 types of expenditures
CAPITAL

COST/REVENUE

(to pay for an assets)

(to pay for an expense)

Revenues: inflows (creation) of assets (cash, receivable) = result from the sale of
goods and services to customers.
Expenses: outflows (consumption) of resources that were required in order to
generate revenues.
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MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Profit: amount by which revenues exceed expenses.

Loss: the difference if total expenses exceed total revenues.
Revenues and expense can also be defined in term of their effect on a balance
sheet. Revenue is an increase of the balance sheet`s item PROFIT/LOSS of the
current period resulting from the operations of the entity. Expense is decrease of the
of the balance sheets item PROFIT/LOSS of the current period resulting from the
operations of the entity.

Basic concept and report form of income statement

Profit and loss account shows efficiency of an accounting entity as of a specified
moment in time its more formal name is an Income Statement, it is a part of
annual report of the company (together with balance sheet and footnotes to financial
statement). Name of profit and loss account has to consist from name of the
statement, date as of which it was prepared and, name of the company.
Profit and loss account reports expenses and revenues of the entity as of date of
preparation the statement. Expenses and revenues are monitored separately,
considering activities of the company (to operating, financial, possibly extraordinary).
Profit and loss account means flow report.
Form of profit and loss account:
1)

account form (T letter form),

2)

report form (with respect to European Directives there are 4 possibilities of

report form:
a) vertical structure regarding nature of expenses and revenues,
b) horizontal structure regarding nature of expenses and revenues,
c) vertical structure regarding function of expenses and revenues,
d) horizontal structure regarding function of expenses and revenues).

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Vertical form regarding the nature of expenses and revenues:

PROFIT AND LOSS ACCOUNT (INCOME STATEMENT)
A

+
+
+
A

D1

D2

+
-

Revenues from merchandise

Cost of goods sold
SALE MARGIN
Production
Production consumption
VALUE ADDED
Personal expenses
Taxes and fees
Other operating revenues
Other operating expenses
OPERATING PROFIT
(LOSS)

604
504
601,602,61., 62.
501,502,503,51.
52.
53.
64.
54.,55.

Financial revenues
Financial expenses
PROFIT (LOSS) FROM FINANCIAL
OPERATIONS

66.
56.,57.

Income tax on ordinary income

I.

ORDINARY INCOME

+
-

68.
58.

Extraordinary revenues
Extraordinary expenses
EXTRAORDINARY PROFIT
(LOSS)

Income tax on extraordinary income

593

II.

EXTRAORDINARY
INCOME

591
A+B-D1

C-D2

"+"("-") PROFIT (LOSS) OF

CURRENT
ACCOUNTING PERIOD

I.+II.

See appendix A for more details about included expenses and revenues!

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Types of accounts
With respect to type of two basic statements, i. e.:
1) balance sheet is reporting structure and value of assets and liabilities,
2) profit and loss account (income statement) is reporting expenses and
revenues and structure of profit (loss),
we recognize two types of accounts:
1) real accounts (accounts which relate to balance sheet, i. e. accounts of assets
and liabilities)
D

asset

OB

X
Increase

TDM

Decrease

liability

OB

Decrease

TCM

TDM

CB

Increase
TCM
CB

2) nominal accounts (accounts which relate to profit and loss account, i. e. accounts
of expenses and revenues)
D

expense

Increase

revenue

Increase

TDM = CB

TCM = CB

Notice:

Expenses are constant or increasing. An expense comes into being:

1)

by way of decrease of asset or,

2)

by way of increase of payable

for revenue expenditure (consumption of material, wages, petrol, rents, rates,

fees, insurance, decrease of value of fixed assets, .).
4

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Revenues are constant or increasing. A revenue means:

1)

increase of asset,

2)

possibly decrease of payable (only special cases).

Relations between financial statements

The item which connects these two statements is profit or loss of the current
accounting period:
a) when the profit is made:
Balance Sheet
1. Fixed ass.

2. Current ass.

Total A

Profit and Loss Account

1. Equity

Operating exp.

Operating rev.

PROFIT

Financial exp.

Financial rev.

Extraordinary
exp.
PROFIT

Extraordinary
rev.

2. Not-owncap.
=

Total L

Total (E+profit) =

Total R

b) when the loss is made:

Balance Sheet
1. Fixed ass.

2. Current ass.

Total A

Profit and Loss Account

1. Equity

Operating exp.

Operating rev.

- LOSS

Financial exp.

Financial rev.

Extraordinary
exp.

Extraordinary
rev.
LOSS

2. Not-owncap.
=

Total L

Total E

= Total (R+loss)

Profit / Loss has to be the same amount in both of statements!!!

5

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

EXERCISE 7.1
Enterprise starts a new month period with following structure of its assets and
liabilities:
Opening balance sheet as of June, 1st
Assets

Liabilities

Fixed Assets:

Equity:

Machinery

20000 Capital

Office furniture

40000

8000

Current Assets:

Not-own-capital:

Inventories

6000 Trade payables - suppliers

Trade receivables customers

4000

Bank account

5000

Assets

43000 Liabilities

3000

43000

The following transaction take place in the next few days:

Journal (June 20xx)
Date
28/6

Event
nr.
1
2

Text

Paid suppliers, by cheque

Sold 2000 of merchandise for 3200,
received cash
3
Sold 600 of merchandise for 900 on
credit to Simpson
29/6
4
Received 2500 in cheques from
various customers in settlement of their
accounts
5
Paid wages, in cash
30/6
6
Paid electricity bill, by cheque
7
Sold 400 of merchandise for 600,
received cash
8
Paid rent and rates, by cheques
JOURNAL BALANCE

Amount
()
800
a) 2000
b) 3200
a) 600
b) 900
2500
100
60
a) 400
b) 600
700

Debit

Credit

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

General ledger
Real accounts:

Nominal accounts:

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Trial Balance
Account

Opening balances Total movements

D
C
D
C

Closing balances
D
C

TOTAL
=

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Closing balance sheet as of June, 30th

Assets

Liabilities

Fixed Assets:

Equity:

Current Assets:

Not-own-capital:

Profit and loss account (Income statement) as of June, 30th

Expenses

Revenues

EXERCISE 7.2
A company has the following assets and liabilities at 31st December (in ):
Premises 40000, Suppliers 3000, Inventories 8000, Amounts owed for rates at 31st
December 350, Cash on hand 2100, Balance at bank overdrawn 4300, Customers
5000, Equipment 6000.

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Review questions:
a)

How much is the company worth i.e. what is its capital?

b)

If, six months later, the capital has increased by 7000 what reasons could
account for this?

c)

If, six months later, the capital has decreased by 5000 what could be the
reasons for this decrease?

EXERCISE 7.3
Which category of expenditure do the following payments fall into? Indicate with a
tick.
Event

Capital
expenditure

Purchase of office furniture

Payment of rates
Purchase of delivery van
Tax and insurance for van
Repairs to machinery
Petrol for van
Decoration of office
Extension to the factory

10

Revenue
expenditure

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

EXERCISE 7.4
Classify the following items as capital or revenue expenditure. In each case give
reason for your classification.
Event

Capital
expenditure

Revenue
expenditure

An extension of railway tracks in the factory area.

Wages paid to machine operators.
Installation costs of new production machine.
Materials for extensions to foremens offices in the
factory.
Rent paid for the factory.
Payment for computer time to operate a new stores
control system.
Wages paid to own employees for building the
foremens offices.

EXERCISE 7.5
C. Horne started business as a shoe shop retailer on 1st June with 40000 deposited
in a business bank account.
Opening balance sheet as of June, 1st
Assets

Liabilities

Assets

Liabilities

The following transactions recorded in Journal take place in June:

Journal (June 20xx)
Date
2/6

Event
nr.
1

4/6

6/6
7/6
9/6

3
4
5

10/6
14/6

6
7

18/6

Text
Purchased shoes, from M&Co. on
credit
Sold shoes which had cost, 80 for
110, received cash
Paid rent for shop, by cheque
Purchased more shoes for cash
Sold the shoes purchase on 7th June,
received cash
Bought shop fittings, paid cheque
Sold shoes (cost 2400) to Jones on
credit, for 3000
Paid cheque to M&Co. as part
settlement of account

11

Amount
()
4000
a) 80
b) 110
120
60
a) 60
b) 100
2500
a) 2400
b) 3000
2500

Debit

Credit

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

20/6
22/6
23/6
26/6

9
10
11
12

Purchased premises, paid cheque

27000
Paid wages, by cheque
140
Purchased clogs from J.H. on credit
210
Sold shoes and clogs which had cost
a) 110
110 for 190, received cash
b) 190
29/6
13
Paid insurance premiums on premises,
70
by cheque
30/6
14*)
Bought office typewriter, paid cheque
150
JOURNAL BALANCE
*) PURCHASE OF LOW-VALUED ASSETS, LONG TERM: decision of accounting unit depends on
importance of such assets: if the importance is high - put into fixed asset, if low - put into current asset
(material), even if it is purchase for direct use, record it as an expense (consumption of material).

General ledger
Real accounts:
Cash on hand
Bank account
OB
TDM
CB

TCM

Tangible Fixed Assets - movable (fittings)

TDM
CB

TCM

TDM
CB

Merchandise

Tangible Fixed Assets - unmov. (premises)

TDM
CB

TDM
CB

TCM

TCM

TCM

Customers
TDM
CB

TCM

Suppliers

TDM

TCM
CB

TDM

Capital
OB
TCM
CB

Nominal accounts:
Revenue:
Revenues from merchandise sold

Expense: Merchandise sold

TDM=CB

TCM=CB

12

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Expense: Wages

Expense: Services (rents, insurance)

TDM=CB
TDM=CB
Expense: Consumption of material
TDM=CB

Trial Balance
Account

Opening balances Total movements

D
C
D
C

Closing balances
D
C

TOTAL
=

Closing balance sheet as of June, 30th

Assets

Liabilities

Fixed Assets:

Equity:

Current Assets:

Not-own-capital:

13

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Profit and loss account (Income statement) as of June, 30th

Expenses

Revenues

14

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Study case
INVENTORY "BOOKKEEPING"
Accounting units could choose one of two possible methods for inventory
bookkeeping. These methods are known as method "A" and "B" in Czech
accounting system.
Method A is useful for such firms, which have a large number and quite big
turnover of inventories because it administers monitoring of inventories movements
by accounting system too.

Inventory
Expense:Consumption of
(i.e.Merchandise)
inventory (Sold merchandise)
Cash
X
X X
X
1 a) Cash purchase
2 a) Consumption (valued by
cost of acquisition)
Suppliers
X
X
1 b) Purchase on credit
Revenue from
inv. sold
X
2 ba) Cash sale (valued by
sale price)

Cash
X

Customers
X
X
2 bb) Sale on credit (valued by
sale price)

15

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Method B is proper for such firms, which provide for example services,
inventories place only insignificant part of their assets values. This method
supposes that inventories are consumed directly after their acquisition. This
method does not observe the inventories movements in the storage room in
accounting system.
Expense:Consumption of
inventory (Sold merchandise)
X

Cash
X
1 a) Cash purchase
Suppliers
X
1 b) Purchase on credit

Revenue from
inv. sold
X
2 ba) Cash sale (valued by
sale price)

Cash
X

Customers
X
X
2 bb) Sale on credit (valued by
sale price

16

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

EXERCISE 7.6

Write up the accounts of J. Brunsdon from the following information. Keep your real
accounts separate from your nominal accounts.
Use the method "B" of inventory records.
On March, 1st, J. Brunsdon starts business as a retailer of video equipment with
45000 in cash.
Journal
Date
3.III
4.III
5.III

Event
nr.
1
2
3

6.III

7.III
8.III

5
6

10.III
12.III

7
8
9

14.III
18.III
20.III
21.III
22.III

10
11
12
13
14

23.III
24.III

15
16

25.III

17

26.III

18

27.III
28.III

19
20

Payment by cheque to VS Ltd. as part

payment of account with them.
Remaining stock of video equipment sold
to PTS Ltd. on credit
Wages paid by cheque
Cash paid into a business bank account

31.III

21

Electricity bill, paid by cheque

Text
Buys shop premises, pays in cash
Cash paid into a business bank account
Stock of video equipment purchased on
credit from V.S.Ltd.
Purchase of shop fittings - payment by
cheque
Assistants wages, paid in cash
Purchase of office furniture - payment by
cheque
Cash sales of video
equipment
Stationery paid for in cash
Insurance premium paid by cheque
Credit sales of video equipment to PTS
Ltd.
Rates paid by cheque
Cash sales of video equipment
Wages paid in cash
Purchases of video equipment - paid for
by cheque
Advertising costs, paid in cash
Cheque received from PTS Ltd. as part
payment of account

Amount
()
28000
15000
8000
1200
60
600

1600
48
65
1930
280
4120
270
3000
140
700
4000
7940
310
4000
214

Journal balance

17

Debit

Credit

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Tasks:
1)
2)
3)
4)
5)

Create the opening balance sheet.

Complete the Journal by debit and credit movements and by journal balance.
Open and complete the general ledger.
Make check for accuracy of your books of account (prepare the trial balance).
Prepare a annual report (closing balance sheet, profit and loss account),
calculate profit/loss.

Opening balance sheet as of March, 1st

Assets

Liabilities

Assets

Liabilities

General ledger
Real accounts:

Nominal accounts:

18

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

19

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Trial Balance
Account

Opening balances Total movements

D
C
D
C

Closing balances
D
C

TOTAL
=

Closing balance sheet as of March, 31st

Assets

Liabilities

Fixed Assets:

Equity:

Current Assets:

Not-own-capital:

20

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Profit and loss account (Income statement) as of March, 31st

Expenses

Revenues

EXERCISE 7.7
Write up the accounts of B. Rawle from the following information. Keep real accounts
separate from your nominal accounts.
Use the method "B" of inventory records.
On May, 1st B. Rawle starts business as the sole proprietor of a music shop, with
40000 in cash.
Journal:
Date
2.V

Event
nr.
1

4.V
6.V

2
3

7.V
10.V
12.V
16.V
18.V

4
5
6
7
8

20.V
24.V

9
10

25.V

11
12

26.V
27.V
28.V

13
14
15
16

Text
Pays cash into a business bank account
Purchases sheet music on credit, from
J.M.
Buys various musical instruments, from
E.W., pays by cheque
Pays assistants' wages in cash
Pays rent by cheque
Sells sheet music for cash
Purchases display units, pays by cheque
Pays by cheque to J.M. as part settlement
of account
Sells a trombone to P.S., on credit
Purchases musical instruments at auction,
for cash
Buys various shop fittings, pays cheque
Sells musical instruments to the Dickens
School of Music, on credit
Pays wages in cash
Sells sheet music for cash
Receives part payment - cash, from P.S.
Pays for advertising, by cheque

21

Amount
()
30000
3000
4000
80
60
180
1000
1200
480
2200
600
4400
210
450
100
30

Debit

Credit

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

30.V

17
18

Sells various musical instruments for cash

Sells all the remaining stock of sheet
music and instruments to J.L. Ltd, on
credit

4600
6800

Journal balance

Tasks:
1)
2)
3)
4)
5)

Create the opening balance sheet.

Complete the Journal by debit and credit movements and by journal balance.
Open and complete the general ledger.
Make check for accuracy of your books of account (prepare the trial balance).
Prepare a annual report (closing balance sheet, profit and loss account),
calculate profit/loss.

Opening balance sheet as of May, 1st

Assets

Liabilities

Assets

Liabilities

General ledger
Real accounts:
D

22

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Nominal accounts:

Trial Balance
Account

Opening balances Total movements

D
C
D
C

Closing balances
D
C

TOTAL
=

=
23

MALKOV, O. and HORK, J. Introduction to Financial Accounting. Workbook.

Closing balance sheet as of May, 31st

Assets

Liabilities

Fixed Assets:

Equity:

Current Assets:

Not-own-capital:

Profit and loss account (Income statement) as of May, 31st

Expenses

Revenues

24