The document discusses how to prepare financial statements such as income statements. It explains that income statements are not part of the double entry system, and how to calculate gross profit and net profit. It provides steps for preparing a trading account and profit and loss account, including closing relevant accounts and transferring balances. The trading and profit and loss accounts are then used to prepare an income statement.

1. Financial StatementsFinancial StatementsFinancial StatementsFinancial Statements
DBS3024 BUSINESS TRANSACTIONDBS3024 BUSINESS TRANSACTION
by
Stephen Ong
Visiting Fellow, Birmingham City
University Business School
Visiting Professor, Shenzhen
University

2. Today’s OverviewToday’s Overview

3. 1 - 3
Learning objectivesLearning objectives
After this lecture, you should be ableAfter this lecture, you should be able
toto
 Explain why income statements areExplain 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, grossCalculate cost of goods sold, gross
profit and net profitprofit and net profit
 Explain the difference betweenExplain the difference between
gross profit and net profitgross profit and net profit

4. 1 - 4
Learning objectives (Continued)Learning objectives (Continued)
 Explain the relationship between theExplain the relationship between the
trading account and the profit and losstrading account and the profit and loss
accountaccount
 Explain how the trading account and theExplain how the trading account and the
profit and loss account fit together toprofit and loss account fit together to
create the income statementcreate the income statement
 Explain how to deal with closing inventoryExplain how to deal with closing inventory
when preparing the trading accountwhen preparing the trading account
section of an income statementsection of an income statement
 Close down the appropriate accounts andClose down the appropriate accounts and
transfer the balances to the tradingtransfer the balances to the trading
accountaccount

5. 1 - 5
Learning objectivesLearning objectives
(Continued)(Continued)
 Close down the appropriate accountsClose down the appropriate accounts
and transfer the balances to the profitand transfer the balances to the profit
and loss accountand loss account
 Prepare an income statement fromPrepare an income statement from
information given in a trial balanceinformation given in a trial balance
 Make appropriate double entries toMake appropriate double entries to
incorporate net profit and drawings inincorporate net profit and drawings in
the capital accountthe capital account

6. 1 - 6
11
Capital and revenueCapital and revenue
expendituresexpenditures

8. Joint capital & revenue expenditureJoint capital & revenue expenditure

9. 1 - 9
22
Income statementIncome statement

10. 1 - 10
The purpose of income statementsThe purpose of income statements
How will knowing what profits are beingHow will knowing what profits are being
made help a business?made help a business?
 It will helpIt will help planplan ahead.ahead.
 It will help obtainIt will help obtain loansloans from banks, otherfrom banks, other
businesses and individuals.businesses and individuals.
 It will tell prospective businessIt will tell prospective business partnerspartners
how successful the business is.how successful the business is.
 It will tell a prospectiveIt will tell a prospective purchaserpurchaser howhow
successful the business is.successful the business is.
 It will enable the calculation ofIt will enable the calculation of tax payabletax payable
to the tax authorities.to the tax authorities.

11. 1 - 11
The formats for calculatingThe formats for calculating
profitprofit
Income statementIncome statement
A summary that is notA summary that is not
part of the doublepart of the double
entry system.entry system.
Trading accountTrading account
Prepared to calculate thePrepared to calculate the
gross profit.gross profit.
Profit and loss accountProfit and loss account
Prepared to calculate thePrepared to calculate the
net profit.net profit.
Both detail statementsBoth detail statements
are part of the doubleare part of the double
entry system.entry system.
TheThe tradingtrading andand profit andprofit and
loss accountsloss accounts are broughtare brought
together and summarised totogether and summarised to
createcreate the Income statement.the Income statement.

12. 1 - 12
What is gross profit?What is gross profit?
Gross profitGross profit is the excess of sales revenueis 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 isNote – where the cost of goods sold is
greater than the sales revenue, the resultgreater than the sales revenue, the result
is a gross loss.is a gross loss.
The formula isThe formula is
Sales – Cost of goods sold = Gross profitSales – Cost of goods sold = Gross profit

13. 1 - 13
ActivityActivity

14. 1 - 14
What is net profit?What is net profit?
Net profit is what is left of the gross profitNet profit is what is left of the gross profit
after all other expenses have beenafter all other expenses have been
deducted.deducted.
Note – where the costs used up exceed theNote – where the costs used up exceed the
gross profit plus other revenue, the resultgross profit plus other revenue, the result
is ais a net lossnet loss..
The formula isThe formula is
Gross profit + Any other income – ExpensesGross profit + Any other income – Expenses
= Net profit= Net profit

15. 1 - 15
ActivityActivity

16. 1 - 16
How to draw up a tradingHow to draw up a trading
accountaccount
Step 1 – Identify the balance on all accountsStep 1 – Identify the balance on all accounts
and draw upand draw up the trial balance.the trial balance.
Step 2 – Obtain theStep 2 – Obtain the closing inventoryclosing inventory figurefigure
by valuing the inventory at the end of theby valuing the inventory at the end of the
year.year.
Step 3 – Calculate the cost of goods soldStep 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

17. 1 - 17
How to draw up a tradingHow to draw up a trading
account (Continued)account (Continued)
Step 4 – Calculate the Gross profit usingStep 4 – Calculate the Gross profit using
the formula:the formula:
SalesSales
–– Cost of goods soldCost of goods sold
= Gross profit= Gross profit
Step 5 –Step 5 – Close the accountsClose the accounts that shouldthat should
appear in theappear in the Trading accountTrading account byby
transferring their balances to thattransferring their balances to that
account.account.

18. 1 - 18
ActivityActivity
Step 1 – completed.Step 1 – completed.
Step 2 – assume the value of closingStep 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 calculation
Opening inventoryOpening inventory 00
+ Purchases+ Purchases 29,00029,000
−− Closing inventoryClosing inventory 3,0003,000
Cost of goods soldCost of goods sold 26,00026,000

19. 1 - 19
Activity (Continued)Activity (Continued)
Step 4 – Gross profit calculationStep 4 – Gross profit calculation
SalesSales 38,50038,500
- Cost of goods sold- Cost of goods sold -26,000-26,000
Gross profitGross profit 12,50012,500
Step 5 – Close the relevant ledgerStep 5 – Close the relevant ledger
accounts.accounts.

20. 1 - 20
How to close the ledger accountsHow to close the ledger accounts
when drawing up a trading accountwhen drawing up a trading account
 Debit the balance of the sales accountDebit 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 purchasesCredit the balance of the purchases
accountaccount (to close it) and credit the(to close it) and credit the
trading account.trading account.
 Enter the valuation for closing inventoryEnter the valuation for closing inventory
into the double entry accounts byinto the double entry accounts by
debiting the closing inventory accountdebiting the closing inventory account
and crediting the trading account.and crediting the trading account.

21. 1 - 21
How to draw up a profit and lossHow to draw up a profit and loss
accountaccount
Step 1 – Open a profit and loss accountStep 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 andStep 2 – Close the income accounts and
credit the profit and loss account withcredit the profit and loss account with
any amounts.any amounts.
Step 3 – Close the expense accounts andStep 3 – Close the expense accounts and
debit the profit and loss account withdebit the profit and loss account with
any amounts.any amounts.

22. 1 - 22
Drawing up the income statementDrawing up the income statement
The figures from theThe figures from the
trading accounttrading account andand profitprofit
and loss accountand loss account will nowwill now
be entered into the incomebe entered into the income
statement using astatement using a
prescribed template.prescribed template.

23. 1 - 23
The format for the income statementThe format for the income statement
Income statement for the year ending 31 December 2012Income statement for the year ending 31 December 2012
RMRM RMRM
SalesSales XX
Less Cost of goods soldLess Cost of goods sold
PurchasesPurchases XX
Less closing inventoryLess closing inventory (X)(X)
(X)(X)
Gross profitGross profit XX
Less expensesLess expenses (X)(X)
Net profitNet profit XX

24. 1 - 24
B. Swift’s income statementB. Swift’s income statement

25. 1 - 25
The effect of net profit on the capitalThe effect of net profit on the capital
accountaccount
We have a debit on the profit and lossWe have a debit on the profit and loss
account of RM8,000 and this isaccount of RM8,000 and this is credited tocredited 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, theIn the same way, the drawingsdrawings are alsoare also
transferred in to thetransferred in to the capital account tocapital account to
reducereduce the capital figure in the business.the capital figure in the business.
Note – in the case of aNote – in the case of a net lossnet loss, the capital, the capital
figure is decreased.figure is decreased.

26. 1 - 26
Learning outcomesLearning outcomes
You should have now learnt:You should have now learnt:
 WhyWhy income statementsincome statements are not part of theare not part of the
double entry systemdouble entry system
 Why profit is calculatedWhy profit is calculated
 How to calculate cost of goods sold, grossHow to calculate cost of goods sold, gross
profit and net profitprofit and net profit
 The double entries required in order toThe double entries required in order to closeclose
off the relevant expense and revenueoff the relevant expense and revenue
accounts at the end of a periodaccounts at the end of a period and postand post
how to post the entries to the tradinghow to post the entries to the trading
account and the profit and loss accountaccount and the profit and loss account

27. 1 - 27
Learning outcomes (Continued)Learning outcomes (Continued)
 How to deal withHow to deal with inventoryinventory at the end of aat the end of a
periodperiod
 How to prepare anHow to prepare an income statementincome statement from afrom a
trial balancetrial balance
 How toHow to transfer the net profit and drawings totransfer the net profit and drawings to
the capital accountthe capital account at the end of a periodat the end of a period
 That balances on accounts not closed off inThat balances on accounts not closed off in
order to prepare the income statement areorder to prepare the income statement are
carried down to the following period, that thesecarried down to the following period, that these
balances representbalances represent assets, liabilities andassets, liabilities and
capitalcapital, and that they are entered in the, and that they are entered in the
statement of financial positionstatement of financial position

28. Resources : Core ReadingResources : Core Reading
 Wood, Frank and Robinson, SheilaWood, Frank and Robinson, Sheila
(2009)(2009) Bookkeeping and AccountsBookkeeping 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

29. QUESTIONS?QUESTIONS?