CHAPTER 9
An introduction
to nancial
statements
W
e’re now ready to see how two important financial statements,
the income statement and the balance sheet, are prepared. The
income statement is also known as the profit and loss account.
The latter term is used more commonly for small businesses. The term
‘income statement’ is required by European Union law (since 2004) to be
used for public companies and many private companies also use it.
In this chapter you’ll learn how to 1. use the trial balance to prepare
financial statements and 2. introduce some adjustments/additions which
normally are required to be made to the trial balance before ‘final’ finan-
cial statements are available. To keep things simple, this chapter assumes
the business is a sole trader. Financial statements of limited companies are
a little more complex and we’ll see those towards the end of the chapter.
The income statement
The income statement shows the profit or loss of a business for a period of
time, usually a month or year. It shows the income and expenses of a busi-
ness. In other words, it depicts the financial performance of a business.
If you are a sole trader, the income statement does not have to conform
to any particular layout. However, accounting standards (rules followed
by accountants), which dictate the layout of financial statements for
companies, are often followed by accountants for other business forms.
Therefore, the layout of the income statement is quite similar regardless
of the business type.
The trial balance of Great Garages from Chapter 8 is shown again in
Figure 9.1. Let’s use this to prepare an income statement. This is quite an
166 brilliant book-keeping
easy task; we just use the trial balance to identify the income and expenses
of the business. Some notes are added to the right of the trial balance to
show if the account is an asset, liability, income, etc.
Figure 9.1 Trial balance of Great Garages
Trial balance of Great Garages as at 31 October
Account
Debit £ Credit £
type
05.953,2srotbeD
Asset
00.899,3srotiderC
Liability
00.898,41knaB
Liability
00.571,1stbed daB
Expense
00.046,8selaS
Income
00.062,01sesahcruP
Expense
05.323TAV
Asset
00.021seitilitU
Expense
00.005segaW
Expense
00.012enohpeleT
Expense
00.000,51snaV
Asset
19.99hsac ytteP
Asset
90.01sesnepxe suoenallecsiM
Expense
00.51segrahc knaB
Expense
00.735,2latipaC
Capital
30,073.00 30,073.00
Looking at each item on the trial balance, the only income account is
sales. The expenses are bad debts, purchases, utilities, wages, telephone,
miscellaneous expenses and bank charges. This is all we need to prepare
the income statement. Before we do, here is a sample income statement.
brilliant
tip
The word income in an income statement means income from operations, i.e.
income generated from what your business does. This normally means sales
income. Other income, such as bank interest, will be identied separately in
an income statement.
An introduction to nancial statements 167
Income statement of XYZ for the year ended 31 December 200X
£ £
Sales 20,000
Cost of sales (14,000)
Gross profit 7,000
Light and heat 1,500
Motor expenses 2,000
Insurance 1,600
Wages 1,400
6,500
Operating profit 1,500
There are some new terms, which you’ll need to know.
brilliant
denitions
Cost of sales is a gure closely related to the sales gure. The cost of a
sale may be identied as a product is made. For example, in a custom
engineering business, costs may be accumulated for each order. More often,
cost of sales is calculated only when an income statement is required. For
now, think of cost of sales as the purchase price of goods you sell. Additional
costs, like transport or customs duties, are also included in cost of sales.
Gross prot is sales less cost of sales. This is simply the prot from trading,
before deducting expenses. Gross prot less expenses is the operating (net)
prot.
Operating prot is the amount of money generated by the normal trading
activities of a business. As mentioned earlier, a business may have other
sources of income, such as bank interest, which could now be added to this
gure.
Now back to Great Garages. Taking the income and expenses from
the trial balance in Figure 9.1, the income statement for the month of
October would look like that shown in Figure 9.2.

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