Brilliant Book-keeping

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.