Income Statement: Structure, Preparation, and Ledger Transfers

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Income Statement

Introduction to the Income Statement

The income statement is a key financial statement prepared at the end of a financial period to determine the profit or loss of a business. It is divided into two main sections: the trading section (calculating gross profit) and the profit and loss section (calculating profit for the year). The income statement is part of the double entry system and is usually prepared from a trial balance.

Trading Section: Calculates gross profit (profit from buying and selling goods).
Profit and Loss Section: Calculates profit for the year (final profit after all incomes and expenses).
Statement of Financial Position: Shows assets and liabilities at a specific date (not part of double entry).

Key Term: An income statement is a statement prepared for a trading period to show the gross profit and profit for the year.

Trading Section of the Income Statement

Purpose and Structure

The trading section focuses on the core trading activities of the business, specifically the buying and selling of goods. Its main purpose is to calculate gross profit.

Gross Profit: The difference between the selling price and the cost of goods sold.

Formula for Gross Profit:

Formula for Cost of Sales:

Net Purchases:
Carriage Inwards: Added to purchases as it increases the cost of goods.
Goods for Own Use: Deducted from purchases if not already recorded.

Example (Vertical Format):

Samir Income Statement (Trading Section) for the year ended 31 May 20–8
Revenue	$95,700
Less: Sales returns	1,000
Net Revenue	94,700
Less: Cost of sales
Opening inventory	7,100
Purchases	65,000
Less: Purchases returns	500
Less: Goods for own use	300
Carriage inwards	1,500
Total goods available for sale	73,800
Less: Closing inventory	7,600
Cost of sales	65,200
Gross profit	29,500

Additional info: The vertical format is preferred in modern practice for clarity.

Profit and Loss Section of the Income Statement

Purpose and Structure

The profit and loss section calculates the final profit after all other incomes and expenses are considered. This is known as profit for the year.

Profit for the Year: The final profit after adding other income and deducting expenses.

Formula for Profit for the Year:

Example (Vertical Format):

Samir Income Statement (Profit and Loss Section) for the year ended 31 May 20–8
Gross profit	29,500
Add: Discount received	400
Total income	29,900
Less: Discount allowed	900
Less: Wages	11,200
Less: General expenses	2,800
Less: Property tax	600
Less: Loan interest	500
Total expenses	16,000
Profit for the year	13,900

Additional info: The vertical format allows for clear separation of operating profit and finance costs.

Combined Income Statement (Vertical Format)

Most businesses present the income statement as a single, vertically formatted statement, combining both the trading and profit and loss sections.

Samir Income Statement for the year ended 31 May 20–8
Revenue	95,700
Less: Sales returns	1,000
Net Revenue	94,700
Less: Cost of sales	65,200
Gross profit	29,500
Add: Discount received	400
Total income	29,900
Less: Expenses (total)	16,000
Profit for the year	13,900

Ledger Transfers and Double Entry

Transferring Totals to the Income Statement

All items in the income statement must have corresponding entries in the ledger accounts. The process of closing accounts involves transferring balances to the income statement.

Items credited in the income statement are debited in the ledger, and vice versa.
Inventory is transferred at both the start and end of the year.
Profit for the year is credited to the capital account (increases owner's equity).
Loss for the year is debited to the capital account (decreases owner's equity).

Example: Purchases Account Closure

Purchases Account
Total to date	65,000
Income statement	65,000

Example: Inventory Account

Inventory Account
Opening balance (1 Jun 20–7)	7,100
Transferred to income statement (31 May 20–8)	7,100
Closing inventory (31 May 20–8)	7,600

Example: Capital and Drawings Accounts

Capital Account
Opening balance (1 Jun 20–7)	90,000
Add: Profit for the year	13,900
Less: Drawings (cash + goods)	9,300
Closing balance (31 May 20–8)	94,600

Income Statement of a Service Business

Differences from Trading Businesses

A service business does not buy and sell goods, so it does not prepare a trading section. Only the profit and loss section and the statement of financial position are prepared.

All revenue (e.g., fees, commissions) is credited.
All expenses are debited.
The statement of financial position is similar to that of a trading business.

Example: Anita's Income Statement (Vertical Format)

Anita Income Statement for the year ended 30 September 20–5
Commissions received	92,150
Add: Rent receivable	7,300
Total income	99,450
Less: Property tax	6,400
Less: General expenses	8,950
Less: Insurance	2,670
Less: Printing and stationery	4,560
Less: Wages	43,500
Profit from operations	33,370
Less: Loan interest	1,500
Profit for the year	31,870

Key Terms:

Service business: Provides services, not goods.
Trading business: Buys and sells goods.

Additional info: The income statement of a service business omits the trading section entirely.

Summary Table: Key Income Statement Formulas

Calculation	Formula (LaTeX)
Gross Profit
Cost of Sales
Net Purchases
Profit for the Year

Test Yourself

State what is calculated in the trading section and profit and loss section of an income statement.
State the formulas for gross profit, cost of sales, and profit for the year.
Explain why inventory is transferred twice in the income statement.
Explain the treatment of profit or loss in the capital account.