Financial StatementsFinancial StatementsFinancial StatementsFinancial Statements

DBS3024 BUSINESS TRANSACTIONDBS3024 BUSINESS TRANSACTION

byStephen Ong

Visiting Fellow, Birmingham City University Business School

Visiting Professor, Shenzhen University

Today’s Overview Today’s Overview

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Learning objectivesLearning objectives

After this lecture, you should be able After this lecture, you should be able toto

Explain why income statements are Explain why income statements are not part of the double entry systemnot part of the double entry system

Explain why profit is calculatedExplain why profit is calculated Calculate cost of goods sold, gross Calculate cost of goods sold, gross

profit and net profitprofit and net profit Explain the difference between Explain the difference between

gross profit and net profitgross profit and net profit

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Learning objectives (Continued)Learning objectives (Continued) Explain the relationship between the Explain the relationship between the

trading account and the profit and loss trading account and the profit and loss accountaccount

Explain how the trading account and the Explain how the trading account and the profit and loss account fit together to profit and loss account fit together to create the income statementcreate the income statement

Explain how to deal with closing inventory Explain how to deal with closing inventory when preparing the trading account when preparing the trading account section of an income statementsection of an income statement

Close down the appropriate accounts and Close down the appropriate accounts and transfer the balances to the trading transfer the balances to the trading accountaccount

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Learning objectives Learning objectives (Continued)(Continued)

Close down the appropriate accounts Close down the appropriate accounts and transfer the balances to the profit and transfer the balances to the profit and loss accountand loss account

Prepare an income statement from Prepare an income statement from information given in a trial balanceinformation given in a trial balance

Make appropriate double entries to Make appropriate double entries to incorporate net profit and drawings in incorporate net profit and drawings in the capital accountthe capital account

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11Capital and revenue Capital and revenue

expendituresexpenditures

Joint capital & revenue expenditureJoint capital & revenue expenditure

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22Income statementIncome statement

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The purpose of income statementsThe purpose of income statements

How will knowing what profits are being How will knowing what profits are being made help a business?made help a business?

It will help It will help planplan ahead. ahead. It will help obtain It will help obtain loansloans from banks, other from banks, other

businesses and individuals.businesses and individuals. It will tell prospective business It will tell prospective business partnerspartners

how successful the business is.how successful the business is. It will tell a prospective It will tell a prospective purchaserpurchaser how how

successful the business is.successful the business is. It will enable the calculation of It will enable the calculation of tax payable tax payable

to the tax authorities.to the tax authorities.

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The formats for calculating The formats for calculating profitprofit

Income statementIncome statement

A summary that is not A summary that is not part of the double part of the double

entry system.entry system.

Trading accountTrading accountPrepared to calculate the Prepared to calculate the

gross profit.gross profit.

Profit and loss account Profit and loss account Prepared to calculate the Prepared to calculate the

net profit.net profit.

Both detail statements Both detail statements are part of the double are part of the double entry system.entry system.

The The tradingtrading and and profit and profit and loss accountsloss accounts are brought are brought

together and summarised to together and summarised to create create the Income statement.the Income statement.

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What is gross profit?What is gross profit?

Gross profit Gross profit is the excess of sales revenue is the excess of sales revenue over the cost of goods sold in the period.over the cost of goods sold in the period.

Note – where the cost of goods sold is Note – where the cost of goods sold is greater than the sales revenue, the result greater than the sales revenue, the result is a gross loss.is a gross loss.

The formula is The formula is

Sales – Cost of goods sold = Gross profitSales – Cost of goods sold = Gross profit

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Activity Activity

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What is net profit?What is net profit?Net profit is what is left of the gross profit Net profit is what is left of the gross profit

after all other expenses have been after all other expenses have been deducted.deducted.

Note – where the costs used up exceed the Note – where the costs used up exceed the gross profit plus other revenue, the result gross profit plus other revenue, the result is a is a net lossnet loss..

The formula isThe formula isGross profit + Any other income – Expenses Gross profit + Any other income – Expenses

= Net profit= Net profit

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Activity Activity

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How to draw up a trading How to draw up a trading accountaccount

Step 1 – Identify the balance on all accounts Step 1 – Identify the balance on all accounts and draw up and draw up the trial balance.the trial balance.

Step 2 – Obtain the Step 2 – Obtain the closing inventoryclosing inventory figure figure by valuing the inventory at the end of the by valuing the inventory at the end of the year.year.

Step 3 – Calculate the cost of goods sold Step 3 – Calculate the cost of goods sold using the formula:using the formula:

Opening inventoryOpening inventory+ Purchases+ Purchases– – Closing inventoryClosing inventory= Cost of goods sold= Cost of goods sold

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How to draw up a trading How to draw up a trading account (Continued)account (Continued)

Step 4 – Calculate the Gross profit using Step 4 – Calculate the Gross profit using the formula:the formula:

SalesSales

– – Cost of goods soldCost of goods sold

= Gross profit= Gross profitStep 5 – Step 5 – Close the accounts Close the accounts that should that should

appear in the appear in the Trading account Trading account by by transferring their balances to that transferring their balances to that account.account.

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ActivityActivity

Step 1 – completed.Step 1 – completed.

Step 2 – assume the value of closing Step 2 – assume the value of closing inventory is RM3,000.inventory is RM3,000.

Step 3 – Cost of goods sold calculationStep 3 – Cost of goods sold calculationOpening inventoryOpening inventory 0 0+ Purchases+ Purchases 29,00029,000− − Closing inventoryClosing inventory 3,0003,000Cost of goods soldCost of goods sold 26,00026,000

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Activity (Continued)Activity (Continued)

Step 4 – Gross profit calculationStep 4 – Gross profit calculation

SalesSales 38,500 38,500

- Cost of goods sold- Cost of goods sold -26,000-26,000

Gross profitGross profit 12,50012,500

Step 5 – Close the relevant ledger Step 5 – Close the relevant ledger accounts.accounts.

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How to close the ledger accounts How to close the ledger accounts when drawing up a trading accountwhen drawing up a trading account

Debit the balance of the sales account Debit the balance of the sales account (to close it) and credit the trading (to close it) and credit the trading account.account.

Credit the balance of the purchases Credit the balance of the purchases account account (to close it) and credit the (to close it) and credit the trading account.trading account.

Enter the valuation for closing inventory Enter the valuation for closing inventory into the double entry accounts by into the double entry accounts by debiting the closing inventory account debiting the closing inventory account and crediting the trading account.and crediting the trading account.

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How to draw up a profit and loss How to draw up a profit and loss accountaccount

Step 1 – Open a profit and loss account Step 1 – Open a profit and loss account and transfer in the gross profit.and transfer in the gross profit.

Step 2 – Close the income accounts and Step 2 – Close the income accounts and credit the profit and loss account with credit the profit and loss account with any amounts.any amounts.

Step 3 – Close the expense accounts and Step 3 – Close the expense accounts and debit the profit and loss account with debit the profit and loss account with any amounts.any amounts.

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Drawing up the income statementDrawing up the income statement

The figures from the The figures from the trading account trading account and and profit profit and loss account and loss account will now will now be entered into the income be entered into the income statement using a statement using a prescribed template.prescribed template.

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The format for the income statementThe format for the income statementIncome statement for the year ending 31 December 2012Income statement for the year ending 31 December 2012

RMRM RMRM

SalesSales X X

Less Cost of goods soldLess Cost of goods sold

PurchasesPurchases X X

Less closing inventoryLess closing inventory (X)(X)

(X)(X)

Gross profitGross profit X X

Less expensesLess expenses (X)(X)

Net profitNet profit X X

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B. Swift’s income statementB. Swift’s income statement

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The effect of net profit on the capital The effect of net profit on the capital accountaccount

We have a debit on the profit and loss We have a debit on the profit and loss account of RM8,000 and this is account of RM8,000 and this is credited to credited to the capital accountthe capital account, to increase the capital , to increase the capital figure in the business.figure in the business.

In the same way, the In the same way, the drawingsdrawings are also are also transferred in to the transferred in to the capital account to capital account to reducereduce the capital figure in the business. the capital figure in the business.

Note – in the case of a Note – in the case of a net lossnet loss, the capital , the capital figure is decreased.figure is decreased.

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Learning outcomesLearning outcomesYou should have now learnt:You should have now learnt: Why Why income statements income statements are not part of the are not part of the

double entry systemdouble entry system Why profit is calculatedWhy profit is calculated How to calculate cost of goods sold, gross How to calculate cost of goods sold, gross

profit and net profitprofit and net profit The double entries required in order to The double entries required in order to close close

off the relevant expense and revenue off the relevant expense and revenue accounts at the end of a period accounts at the end of a period and post and post how to post the entries to the trading how to post the entries to the trading account and the profit and loss accountaccount and the profit and loss account

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Learning outcomes (Continued)Learning outcomes (Continued)

How to deal with How to deal with inventoryinventory at the end of a at the end of a periodperiod

How to prepare an How to prepare an income statement income statement from a from a trial balancetrial balance

How to How to transfer the net profit and drawings to transfer the net profit and drawings to the capital account the capital account at the end of a periodat the end of a period

That balances on accounts not closed off in That balances on accounts not closed off in order to prepare the income statement are order to prepare the income statement are carried down to the following period, that these carried down to the following period, that these balances represent balances represent assets, liabilities and assets, liabilities and capitalcapital, and that they are entered in the , and that they are entered in the statement of financial positionstatement of financial position

Resources : Core ReadingResources : Core Reading

Wood, Frank and Robinson, Sheila Wood, Frank and Robinson, Sheila (2009) (2009) Bookkeeping and Accounts Bookkeeping and Accounts ,7,7thth Edition, Pearson/ FT Prentice HallEdition, Pearson/ FT Prentice Hall

Wood, Frank and Sangster, Alan (2012) Business Accounting ,12th Edition, Pearson/ FT Prentice Hall

Fortes, Hilary (2011) Accounting Simplified , Pearson/ FT Prentice Hall

QUESTIONS?QUESTIONS?