5.3.3 Income Statements 1

Learning Outcomes To understand the main features of an income statement To be able to use simple income statements in decision making based on profit calculations

The Income Statement Shows a firm’s sales revenue and its costs over a trading period, as well as the distribution of any profit An income statement is divided into three sections: 1.Trading Account 2.Profit and Loss Account 3.Appropriation Account Have a look at Tesco’s (simplified) income statement… 3

Income Statement of Tesco plc for the year ended 25 February Add: Other income450 Less: expenses Net profit (1,277) Less: Taxation Profit after tax Dividends paid(792) Retained profit (673) Turnover47,298 Less: Cost of Sales Gross profit £m (43,668) Trading Account Profit and Loss Account Appropriation Account These accounts really are VERY simplified:  Other Income and Expenses include an assortment of administrative expenses, finance costs, property related income and share of post tax profits from joint ventures  Dividends Paid includes a number of items including £442m of pension scheme losses Using a calculator, can you work out how the Income Statement is calculated? Do you agree with the figures?

5 Income Statement of Tesco plc for the year ended 25 February ,803 (827) Add: Other income450 Less: expenses Net profit (1,277) 2,130 1,388 Less: Taxation Profit after tax Dividends paid(792) Retained profit (673) 3,630 Turnover47,298 Less: Cost of Sales Gross profit £m (43,668) Trading Account Profit and Loss Account Appropriation Account

The Income Statement 1. Trading Account 2. Profit and Loss Account 3. Appropriation Account 6

1. The trading account Finds the gross profit generated by the business by comparing sales with the cost of the sales for the period Cost of sales: Stocks. Calculated by taking the cost of the goods available for sale during the year and deducting the cost of the goods which were unsold The reason for this calculation is so that sales and cost of sales compare like with like – i.e. only the stocks that were actually sold in the year are counted as costs of sales (making the unrealistic assumption that stocks bought first are sold first) 7 Opening Stock Purchases During year Closing Stock +– Cost of Sales =

The trading account of Strachan Ltd for the year ending 31 December Sales 120 Less: Cost of sales Stock, at 1 January Add: Purchases of goods83 97 Less: Stock held on 31 December 2006 (87) £(‘000) (10) Gross profit 33 Closing stock Opening stock Purchases

The trading account task – Samba Ltd Samba Ltd is a medium-sized company selling ethnic foods to small retailers across the Midlands Identify the relevant information from the table below and prepare the company’s trading account for the year ended 31 May 2006 Sales revenue£1,450,000Opening stock£34,000 Stock purchases£660,000Closing stock£42,000 Wages£150,000Distribution£60,000 Rent and rates£60,000Advertising£30,000 Other expenses£94,000Other income£0 9

10 The trading account of Samba Ltd for the year ending 31 May ,450, ,000 34,000 (42,000) (652,000) 798,000 Sales Cost of Sales Opening stock Purchases Closing stock Gross profit ££ Sales revenue£1,450,000Opening stock£34,000 Stock purchases£660,000Closing stock£42,000 Wages£150,000Distribution£60,000 Rent and rates£60,000Advertising£30,000 Other expenses£94,000Other income£0 Note: In Accountancy, negative numbers are written in brackets to prevent the (sometimes very small) minus sign from being missed by the reader - especially a problem with a faxed document

Profit and Loss Account 1. Trading Account 2. Profit and Loss Account 3. Appropriation Account

2. Profit and loss account Shows other items of income earned and expenditure paid out by the business, in order to arrive at the net profit Other income: Income which is not earned from the normal trading activities of the company. e.g.: – Interest from bank deposits – Dividends from shares held in other companies – Rent from property that is let out Other expenses: Overheads – Indirect costs of production such as distribution costs, advertising, packaging and salaries 12

The profit and loss account of Simon and Jasmine Ltd for the year ending 30 April Gross profit140 Other income Rent received £(‘000) Less: other expenses: Rent10 Postage3 Stationary2 Salaries60 Depreciation15 Delivery costs4 Advertising6 (100) Net profit55 Think of five examples of overheads other than those shown

The Profit and loss account task – Samba Ltd Now prepare Samba Ltd’s profit and loss account for the year ended 31 May 2006 Sales revenue£1,450,000Opening stock£34,000 Stock purchases£660,000Closing stock£42,000 Wages£150,000Distribution£60,000 Rent and rates£60,000Advertising£30,000 Other expenses£94,000Other income£0 14

Trading and Profit and Loss Account ICT task Create a self-calculating spreadsheet model of Samba Ltd’s trading and profit and loss account for the year ended 31 May 2006 Adjust the model to take account of: – A 15% rise in sales – A rise in the price of diesel increasing distribution costs by 10% – £28,000 of closing stock Sales revenue£1,450,000Opening stock£34,000 Stock purchases£660,000Closing stock£42,000 Wages£150,000Distribution£60,000 Rent and rates£60,000Advertising£30,000 Other expenses£94,000Other income£0 15

16 The profit and loss account of Samba Ltd for the year ending 31 May 2006 Gross profit Add: Other income Less: Other expenditure Wages Rent and rates Advertising Distribution Other expenses Net profit 798, ,000 60,000 30,000 60,000 94, , ,000 ££ Sales revenue£1,450,000Opening stock£34,000 Stock purchases£660,000Closing stock£42,000 Wages£150,000Distribution£60,000 Rent and rates£60,000Advertising£30,000 Other expenses£94,000Other income£0

Profit and Loss Account 1. Trading Account 2. Profit and Loss Account 3. Appropriation Account 17

3. Appropriation account Shows how the net profit has been dispersed Net profit is used for: – Corporation Tax (for incorporated businesses) – Dividends to shareholders - Determined by the board of directors and approved by the shareholders at the AGM – Reinvestment (retained profit) 18

The appropriation account of Matthew and Sarah Plc for the year ending 30 June Profit after tax Net profit540 Corporation tax(190) £(‘000) Dividends paid(120) Retained profit

The appropriation account task – Samba Ltd Continue Samba Ltd from previously: – Samba pay Corporation Tax at 25% on net profits – Shareholders accept a dividend costing the firm £95,000 Draw up the Appropriation Account for the company How much money is reinvested for next year? 20

21 The appropriation account of Samba Ltd for the year ending 31 May 2006 Dividends paid (95,000) Retained profit 208,000 Profit after tax 303,000 Net profit404,000 Corporation tax (101,000) £ Samba pay Corporation Tax at 25% on net profits Shareholders accept a dividend costing the firm £95,000

The Income Statement FitnessFreak Ltd 22

Task Prepare a full profit and loss account for FitnessFreak Ltd for the year ending 31 December 2006 from the following information: – Last year, FitnessFreak Ltd sold exercise bikes worth a total of £750,000 – The company paid £70,000 in wages (which it classes as an overhead) for its shop-floor employees and £35,000 for its managers, sales staff and administration staff – A further £475,000 was spent on steel and components, £6,000 was spent on photocopying, stationary, postage etc. and £8,600 on insurance cover – During the year the interest paid on loans came to £4,800, and £40,000 was spent on power – The company estimated the depreciation cost of the machinery was £8,000 – The tax bill for the year amounted to £22,600 – Directors of FitnessFreak have decided that 30% of the remaining profit will be distributed to shareholders and that 70% will be retained as reserves 23

24 FitnessFreak Ltd. - answers Profit and loss account of FitnessFreak Ltd for the year ended 31 December 2006 Less: expenses: Wages Salaries Stationary Insurance Bank interest Power Depreciation Sales Revenue Less: Cost of sales Gross profit ££ Net profit Retained profit Dividends paid Profit after tax Less: Taxation 750, , ,000 (22,600) 70,000 35,000 6,000 8,600 4,800 40,000 8,000 (172,400) 102,600 80,000 (24,000) 56,000 Prepare a full profit and loss account for FitnessFreak Ltd for the year ending 31 December 2006 from the following information:  Last year, FitnessFreak Ltd sold exercise bikes worth a total of £750,000  The company paid £70,000 in wages for its shop-floor employees and £35,000 for its managers, sales staff and administration staff  A further £475,000 was spent on steel and components, £6,000 was spent on photocopying, stationary, postage etc. and £8,600 on insurance cover  During the year the interest paid on loans came to £4,800, and £40,000 was spent on power  The company estimated the depreciation cost of the machinery was £8,000  The tax bill for the year amounted to £22,600  Directors of FitnessFreak have decided that 30% of the remaining profit will be distributed to shareholders and that 70% will be retained as reserves