How do businesses calculate the amount of profit or loss made during a period?
I’m Thomas Harwood and Welcome to The Accounting Student, where we create free and short videos
so that you can learn about accounting.
Today’s video is looking at the income statement, including its purpose and the trading account
section of the income statement.
Many businesses are started with the intention to make a profit. In many cases businesses
do make a profit, however, some unfortunately make a loss.
The calculation of profits and losses is arguably the most crucial objective of the accounting
role within a business.
This is why we have the income statement!
In our previous video on “What is the Trial Balance?”, the trial balance is a useful
tool in grouping all the revenues and expenditures together.
The account balances recorded in the trial balance are used to create the final accounts,
which includes the income statement.
The income statement, which can also be known as the trading and profit and loss account,
shows a summary of the revenue and expenses of a business, and as a result this can establish
the level of profit or loss made in a given period.
Users of the accounting information like the owners, shareholders, management and employees
will be interested to know how the actual profits of a business compare to the profits
that they hoped to make.
This is where the income statement is helpful to identify what profits or losses were made
by the business during a period and additionally it will help the business and its stakeholders
or users of information carry out many tasks, including…
Planning ahead the future periods activities and trading
The capability of acquiring loans from banks and other financial institutions
Providing information on the business performance to potential business partners and those who
might invest in the future and also being able to calculate the tax to
be paid on the trading profits
The income statement can be broken down simply into two main sections and they are the trading
account and the profit and loss account.
In this video we will look at the first part which is the trading account section.
The trading account measures the success of a business’ trading activities, in other
terms, what was the difference between the cost of buying the stock and the amount which
is was selling for.
Furthermore, this difference can be identified as gross profit.
This can be shown simply in a trading account like this…
At the top we have the title as The Income Statement for ABC Ltd for y/e 31/12/2017
The title is followed by the total sales for the business during the period.
Then we have the opening stock value for the start of the trading period. This is basically
all the stock which the business has at the time in which the new trading period begins.
We then add the purchases line which looks at everything that has been bought by the
business during the period. This could be materials in order to make products or products
that are finished which the business resells.
After we will have the closing stock for the period which will be all the materials and
products still left in the business at the end of the trading period.
The closing stock will be taken away from the total of the opening stock and purchases
and this will arrive at the value for the cost of sales.
The cost of sales is the cost of the goods that have actually been sold during the trading
period. This will then be taken away from the sales value which leads us to the gross
profit value for the period.
So that was the first part of explaining the income statement, its purpose and the trading
account section. If you enjoyed it, press the like button.
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