Preparing the Income Statement (Profit & Loss Account)

Also known as the Profit & Loss (P&L) Account or Statement of Profit and Loss. It is used to record all the income and expenses of business.

1. Summarizing Transactions

The income statement summarizes revenues and expenses for a specific period. The process starts with summarizing all transactions related to revenue and expense accounts.

Sales:

• Companies often maintain a "Sales Book" to record credit sales, including details like invoice date, number, customer name, gross value, discounts, taxes, and other charges (e.g., freight).
• Freight:
  • Freight Inward: Transportation costs for bringing materials into the business.
  • Freight Outward: Transportation costs for sending goods to customers.
• At the end of the period, a closing entry summarizes all sales transactions.

Expenses:

• Many expenses are repetitive but not as repetitive as sales. (e.g., salaries, rent, utilities, repairs).
• Accountants total these expenses for the period.

2. Preparing the Income Statement

After summarizing revenues and expenses, the income statement is prepared.

Structure:

1. Revenues: Listed in a specific sequence:

   • Revenue from the sale of goods or services (core business activity).
   • Other operating revenues (e.g., by-products).
   • Non-operating income (e.g., interest income, profit on the sale of assets)

2. Expenses: Listed in a specific sequence:

   • Cost of Goods Sold (COGS):
     • Material Consumed: Opening Stock + Purchases - Closing Stock. This is especially important as raw material issues are often not recorded in the financial accounting system until the end of the period.
   • Salaries and Wages (including statutory obligations like Provident Fund, ESI, gratuity, leave encashment).
   • Utilities and Other Operating Expenses.
   • Selling and Distribution Expenses.
   • Administrative Expenses.
   • Depreciation.
   • Interest Expense.

Calculation of Profit: * Profit Before Taxes (PBT): Total Income - Total Expenses. * Profit After Tax (PAT) / Net Income: PBT - Income Tax.

3. Profit and Loss Appropriation Account

This account links the income statement to the balance sheet and ensures the continuity of the P&L balance.

Structure:

1. Opening Balance: The retained earnings from previous periods. 2. Profit After Tax (PAT): From the income statement. 3. Profit Available for Distribution: Opening Balance + PAT. 4. Appropriations: * Dividends paid to shareholders. * Transfers to reserves (e.g., General Reserve). 5. Closing Balance: Profit Available for Distribution - Dividends - Transfers to Reserves. This closing balance is carried forward to the next period. The closing balance becomes part of "Other Equity" (also known as "Reserves and Surplus") on the balance sheet.

Reserves and Surplus (Other Equity):

This section on the balance sheet typically includes: * General Reserve * Balance in P&L Account (the closing balance from the P&L Appropriation Account)

Key Takeaway: The P&L Appropriation account prevents closing the P&L account to zero each year. It carries forward retained earnings, which are essential for business growth and stability.

Conclusion

The income statement provides a summary of a company's financial performance over a period. The P&L Appropriation account then links this performance to the balance sheet by showing how profits are distributed and retained. These statements, along with the balance sheet and cash flow statement, provide a comprehensive view of a company's financial health.

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