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The Income Statement

Learning Objectives After studying this chapter, you should be able to understand following Income Statement Income Expenses All receipts are not income All payments are not expense Difference between expenses and asset Earning per shares Basic EPS and Diluted EPS

INTRODUCTION

The objective of financial statements is to provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of users in making economic decisions. The balance sheet shows the financial position of a company, the income statement shows the financial performance, and the cash flow statement shows the inflow and outflow of cash. The focus of this chapter is the financial performance of a company as reflected by the income statement. Income statement is also known as the statement of profit and loss.

The income statement of a company shows the net result of the activities undertaken during a particular period of time. The income statement is also known as the Profit and Loss Account (P/L Account) or the statement of profit and loss. It tells us the financial results of business activity –how successful the operation of the business is. If income exceeds expenses during the period, it is profit and if the expenses exceeds the income it will be treated as loss. .

WHYA SEPARATE INCOME STATEMENT?

The chapter on the accounting equation and the balance sheet has demonstrated that every transaction can be captured through the accounting equation and balance sheet. The financial position of a company can be analysed by comparing the accounting equation or balance sheet on two different dates. So where is the need for another statement called income statement. To answer the above question, let us take and example and understand the limitations of accounting equation and balance sheet.

Example 7.1

ABC ltd started business with Rs. 100,000 and during the first quarter had the following transactions:

Took 12% loan = 100,000

Purchased stock of goods for cash = 50000

Purchased furniture (life =5 years) = 20,000

Sold 50% stock for cash = 80,000

Expenses paid for the quarter = 20000

Accounting equation for after each transaction is given in the table 7.1:

 

Table 7.1

 
 

Accounting Equation

 

Profit +

12% Loan+

Capital =

Cash +

Goods+

Furniture

   

100000

100000

   

100000

100000

200000

100000

100000

150000

50000

100000

100000

130000

50000

20000

55000

100000

100000

210000

25000

20000

35000

100000

100000

190000

25000

20000

32000

100000

100000

187000

25000

20000

31000

100000

100000

187000

25000

19000

And table 7.2 shows the balance sheet at the end of the quarter as reflected by the last accounting equation

 

Table 7.2

Balance Sheet of ABC ltd ( in 000)

 

Sources

Assets

Capital

  • 100000 Cash

 

187000

12% IDBI Loan

  • 100000 Goods

25000

Profit

31000

Furniture

19000

231000

Total

231000

Though Table 7.1 and Table 7.2 show the profit, but how did the company arrive at that profit is not very clearly visible. Accounting equation and balance sheet treats the change in equity as profit.

Equity (Capital + Profit) at the beginning of the quarter = 100,000

Equity (Capital + Profit) at the end of the quarter = 131,000

Change in equity = 31,000 is treated as capita

However, the management would like to know the reasons for the change in the equity. Equity changes due to profit or infusion of capital or buy back of capital. Profit, which changes equity, is the focus of this chapter. Profit can also be explained as the excess of revenue over the expenses. See the income statement of ABC ltd. shown as table 7.3.

Table 7.3

Income Statement

Sales

80000

COGS

25000

Gross Profit

55000

Less

 
 

20000

Expense Profit Before Depreciation Interest and Tax (PBIT)

35000

Depreciation

1000

 

34000

Profit Before Interest and Tax (PBIT) Interest

3000

Profit Before Tax (PBT)

31000

So the income statement very clearly shows various expenses and different profits. Income statement helps in evaluating the performance of a company or a division or a company or a manager of company or division. It helps in understanding the composition of expenses and get an idea about profit at different levels.

UNDERLYING ASSUMPTIONS

According to the framework for preparation and presentation of the financial statements issued by the Institute of Chartered Accountants of India , following are the underlying assumptions for preparing the income statement:

information.

Accrual Basis Financial statements are prepared on the accrual basis of accounting. Under this basis, the effects of transactions and other events are recognised when they occur (and not as cash or a cash equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. Financial statements prepared on the accrual basis to inform users not only of past events involving the payment and receipt of cash but also of obligations to pay cash in the future and of resources that represent cash to be received in the future. Hence, they provide the type of information about past transactions and other events that is most useful to users in making economic decisions.

Example 7.2

ABC ltd started business with cash Rs. 50,000 on 1 st April. Took 12% loan of Rs. 50,000. Purchased goods on credit= 50,000; Sold 50% of goods on credit for 50,000 during the first month. Table 7.4 show the accounting equation and the financial statements for the first month.

 

Table 7.4

 
   

Income

   

Balance Sheet of ABC ltd ( in 000)

 

Statement

Cash Flow Statement

Sources

Assets

           
 
  • 50000 Cash

 

100000

 

Sales

   
  • 50000 Receipts

 

Capital 12% IDBI Loan

  • 50000 Goods

 
  • 25000 COGS

       
  • 25000 Capital

50000

Creditors

 
  • 50000 Debtors

   
  • 50000 Loan

   
  • 25000 50000

 

Profit

 
  • 24500 Less

           

100000

Outstanding Interest

500

     

Interest

500

 

Payments

0

 

175000

Total

175000

 

Profit

24500

 

Cash in hand

100000

One can see from the table 7.4 that because of the accrual concept the following credit transactions are recorded:

Credit purchases shown as creditors

Credit Sales shown as debtors

Interest due but not paid shown as outstanding interest

Going Concern The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed.

Consistency In order to achieve comparability of the financial statements of an enterprise through time, the accounting policies are followed consistently from one period to another; a change in an accounting policy is made only in certain exceptional circumstances.

INCOME

According to the framework income is increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

Example 7.3 Following is the accounting equation of ABC ltd as on 1 st April 2005

 

Accounting Equation as on 1 st April

 

Shareholders Fund +

Long Term Loans+

Current Liabilities =

Fixed Assets +

Current Assets

2079

1500

2000

600

4979

Let us examine the implications of the following transactions:

Sold fixed asset costing Rs.200 for Rs. 200: In this case one asset is converted into

another asset. Fixed asset decreases by 200 and current asset increases by 200. No change in the shareholders fund. No in income as per the above definition. Repaid 40% of loan: Decrease in the long term liability and decrease in the cash.

No change in the shareholders fund. No in income as per the above definition Sold stock of goods costing 1000 for 1500 for cash. Stock ( part of the CA) reduces by 1000 and cash (part of CA) increases by 1500. The shareholders fund increases by the balancing figure i.e. Rs. 500. Such a change in the shareholders’ fund is called income as per the above definition.

The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an enterprise and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent. Gains represent other items that meet the definition of income and may,or may not, arise in the course of the ordinary activities of an enterprise.

Various kinds of assets may be received or enhanced by income; examples include cash, receivables and goods and services received in exchange for goods and services supplied. Income may also result in the settlement of liabilities. For example, an enterprise may provide goods and services to a lender in settlement of an obligation to repay an outstanding loan. Table 7.5 shows the possible effects of income

Table 7.5

Effect of Income

Transaction

Effect

Sale of goods for cash

 

Sale of goods on credit

Receipts of cash Creation of debtor

 

Reduction of a debt

Sale of goods to write of a liability Sale of goods to pay off a creditor

Reduction of creditor

In this text, revenue, sales, turnover are treated as income. Income is classified into two categories: operating income and other income.

Tata Steel: Sale of steel is the operating income. Sale of shares of other companies

is non-operating income. Bajaj Auto Limited: Sale of scooters is the operating income. Sale of old furniture

or sale of shares or bonds or debentures of another company is non-operating incomes Table 7.6 shows income from other sources (other income) as percentage of total income of some of the well-known companies of India.

Table 7.6

Other Income as % of Total Income (2006)

Tata Steel Ltd.

1%

Wipro Ltd.

1%

Reliance Energy Ltd.

12%

Videsh Sanchar Nigam Ltd.

3%

Siemens Ltd.

5%

CMIE Data base

Income and Receipt

Is every receipt an income? Of course, it is not. Receipt is the inflow of cash and every inflow of cash is not an income. A company receives money for several reasons:

Capital

Loan

Donations

Sale of assets

Advance

Similarly due to the accrual principles, incomes which are not received in cash immediately are also recorded in the books. So there are some receipts which are not incomes and there are some incomes which may not be receipt in a particular accounting period as shown by the Table 7.7.

Table 7.7

Income and Receipt

 

Capital receipt and not an income

Raised capital through fresh issue of shares Raised 12% loan for a bank

Creation of a liability not an income

Sold sold on credit

Income but not a receipt

Interest on investments received

 

Sold goods for cash

Income and a receipt Receipt is an income

Recognition of Income

Income is recognised in the statement of profit and loss when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be

measured reliably. Income should be recognised, if the following conditions are met:

Completion of earning process: The firm must have provided all the goods or services for which it is to be paid.

Assurance of payment: The firm should be in position to quantify the cash or other assets expected to be received for the goods or services provided.

EXPENSE

Expense is decrease in economic benefits during the accounting period in the form of outflow or reduction of assets or decreases of liabilities that result in decreases in equity, other than those relating to distribution to equity participants.

Example 7.4 Following is the accounting equation of ABC ltd as on 1 st April 2005

 

Accounting Equation as on 1 st April

 

Shareholders Fund +

Long Term Loans+

Current Liabilities =

Fixed Assets +

Current Assets

2079

1500

2000

600

4979

Let us examine the implications of the following transactions:

Purchase of fixed asset costing Rs.1000 : In this case one asset is converted into

another asset. Fixed asset increases by 1000 and current asset decreases by 1000 .. No change in the shareholders fund. No expense as per the above definition. Repaid 40% of loan: Decrease in the long term liability and decrease in the cash. No change in the shareholders fund. There is a payment but no expense as per the above definition. Repayment of loan is reduction of liability and reduction of cash. No change in the shareholders fund. No expense as per the above definition

Sold stock of goods costing 1000 for 1500 for cash. Stock ( part of the Current Assets) reduces by 1000 and cash (part of Current Assets) increases by 1500. The decrease in stock is an expense and such expense is called cost of goods sold.

o

Cost of Goods Sold (expense): 1000

o

Reduction of stock (decrease in asset): 1000

o

Increase in cash (increase in asset): 1500

o

Increase in shareholders’ funds (profit): 500

Expenses and Losses

The framework also treats losses as expenses. Losses represent decreases in economic benefits and as such they are no different in nature from other expenses. Following are some of the common losses that appear in the income statement:

Bad debt: Loss due to the insolvency of debtors

Loss due to theft

Loss of stock due to fire or natural calamities

Loss on the sale of non-current assets

The definition of expenses also includes unrealised losses. When losses are recognised in the statement of profit and loss, they are usually displayed separately because knowledge of

them is useful for the purpose of making economic decisions.

Expense and Payment

Is every payment an expense? Of course, it is not. Payment is outflow of cash. A company

makes payment for several reasons:

Buy back of capital

Redemption of loan

Donations

Purchase of assets

Advances to the suppliers

Expenses

Similarly due to the accrual principles, expenses which are not paid in cash immediately are also recorded in the books. One can also use the matching principle to understand the relationship between payments and expenses.

Payments the benefit of which expires in the current accounting period are called

expenses Payment the benefit of which will continue for more than one accounting period will be partly treated as an expense and partly shown as an asset. However, one has to define the period of benefit as shown in table 7.8

 

Table: 7.8

Expense and the Matching Principle

 

Advertisement

100,000

100,000

100,000

100,000

Period of benefit

1

2

4

10

 

100,000

50,000

25,000

10,000

Expenses of the period Asset

0

50,000

75,000

90,000

So there are some payments which are not expenses and there are some payments which may not result in payments in a particular accounting period as shown by the Table 7.9.

 

Table 7.9

 

Payment and Expense

Salary paid

An expense

Advance rent paid

Benefit not expired so it will be an asset

Payment for acquiring a plant

Not an expense.

Interest on loan due but not paid

Expense but not a payment

   

Depreciation Repayment or buy-back of shares

Expense but not a payment Not an expense.

Recognition of Expense

According to the Framework, expenses are recognised in the statement of profit and loss when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase of liabilities or a decrease in assets. See the following transactions:

Paid salaries for the period: Salary is an expense and there is a corresponding decrease in asset cash.

Salaries for the period due but not paid: Salary is an expense but there is no corresponding decrease in the asset. However, there is an increase in the liabilities in the form of outstanding salaries.

Advance rent paid in the previous period: Rent is an expense. No change in the cash in the current period. No creation of liability. However, there is a decrease in the asset

advance rent.

According to the Framework, sometimes expenses are also recognised in the statement of profit and loss on the basis of a direct association between the costs incurred and the earning of specific items of income. This process, commonly referred to as the matching of costs with revenues, involves the simultaneous or combined recognition of revenues and expenses that result directly and jointly from the same transactions or other events; for example, the various components of expense making up the cost of goods sold are recognised at the same time as the income derived from the sale of the goods.

The Framework further stresses that when economic benefits are expected to arise over several accounting periods and the association with income can only be broadly or indirectly determined, expenses are recognised in the statement of profit and loss on the basis of systematic and rational allocation procedures. This is often necessary in recognising the expenses associated with the using up of assets such as plant and machinery, goodwill, patents and trademarks; in such cases, the expense is referred to as depreciation or amortisation. These allocation procedures are intended to recognise expenses in the accounting periods in which the economic benefits associated with these items are consumed or expire.

Purchased goods for sale: shown as an asset

When the goods are sold: Value of sales is shown as income and the corresponding

cost of goods sold is treated as expense Purchased plant: shown as an asset

Depreciation on plant: value of the asset is reduced to the extent of depreciation and depreciation is treated as an expense.

Example 7.5

ABC ltd. had capital represented by goods costing Rs. 40,000 and

10,000.

Capital = Goods + Furniture

50,000 = 40,000 + 10,000

Transactions during the period are as follows:

Sold 50% of good for 50,000 for cash

Salary paid = 1000

Depreciation = 2000

furniture costing

Table 7.10 shows the financial statement at the end of the accounting period.

 

Table: 7.10

 
       

Cash Flow

Balance Sheet of ABC ltd ( in 000)

Income Statement

Statement

Sources

Assets

 

Sales

50000

 

Receipts

 

Capital

50,000

Goods

20,000

 

Less

   

Sales

50000

Profit

27000

Furniture

8,000

 

COGS

20000

 

Less

 
   

CIH

49,000

 

Depreciation

2000

 

Salary

1000

         

Salary

1000

     
 

77,000

 

77,000

 

Profit

27000

 

CIH

49000

Some times an expense is recognised immediately in the statement of profit and loss when an expenditure produces no future economic benefits. An expense is also recognised to the extent that future economic benefits from an expenditure do not qualify, or cease to qualify,

for recognition in the balance sheet as an asset. If a company spends money on research and development and such expense does not result in any benefit then the entire

PROFIT

Profit is the excess of income over the expenses for a period. Profit for the period is determined using the accrual principle and matching principle. According to the matching principle, revenue for a period should be compared with the corresponding expenses.

Example 7.6

Sales per month = 10,000 (60% on credit) Cost of goods per month = 25% Salaries per month = 2000 Depreciation for the year = 6000 Interest per month= 100 Tax rate = 25% Table 7.11 shows profit for different accounting periods using the principles of accrual and matching.

 

Table 7.11

Income Statement

 
 

1

3

6

12

Accounting Period (months) Sales

10,000

30,000

60,000

120,000

COGS

2,500

7,500

15,000

30,000

Gross Profit

7,500

22,500

45,000

90,000

Salaries

2,000

6,000

12,000

24,000

PBDIT

5,500

16,500

33,000

66,000

Depreciation

500

1,500

3,000

6,000

PBIT

5,000

15,000

30,000

60,000

Interest

100

300

600

1,200

PBT

4,900

14,700

29,400

58,800

Tax

1,225

3,675

7,350

14,700

PAT

3,675

11,025

22,050

44,100

Gross profit: Excess of sales over the cost of goods is called gross profit. This is

also called the gross margin from the business. Profit before depreciation, interest , tax (PBDIT): If the operating expenses like

salaries, rent are deducted from the gross profit we will get PBIT. Profit before interest and tax (PBIT): If depreciation is deducted from PBDIT, we

will get PBIT: PBIT shows the profit generating ability of a company. It is the surplus available for the lenders, government, and shareholders. Profit after tax (PAT): If interest and tax are deducted from PBIT, we will get PAT. PAT is the money available for distribution among the shareholders. PAT shows profit generating ability of a company.

Table 7.11 A shows different profits of some of the well known companies of India.

Table 7.11 A

Different Profit of the selected Indian Companies (Rs. In crores) for the year ending 2006

           

Retain

PBDI

Cash

ed

Company Name

PAT

T

PBIT

PBT

profits

profits

 

14,431

32,284

25,463

21,745

24,405

7,114

Oil & Natural Gas Corp. Ltd. Reliance Industries Ltd.

9,069

15,007

11,606

10,712

12,494

7,480

State Bank Of India

4,407

27,829

27,065

6,906

5,170

3,567

 

4,013

7,628

6,420

5,953

5,408

3,071

Steel Authority Of India Ltd. Tata Steel Ltd.

3,506

6,144

5,410

5,241

4,293

2,686

INCOME STATEMENT AND ACCOUNTING EQUATION

We can understand the process of determining the income for the period by using the accounting equation.

Example 7.7

Following are the financial items of ABC ltd ..

Capital: Rs 10000

12% Loan: Rs. 30000

Fixed Assets: Rs. 20000

Stock: Rs. 15000

Cash: 5000

Above items can be represented in the form of an accounting equation as follows:

 

Accounting Equation

 

Capital +

Loan =

Fixed Assets +

Stock +

Cash

30000

10000

20000

15000

5000

Suppose the stock is sold at 20000 and expenses in cash are 2000. The equation will be as follows:

 

Accounting Equation

 

Capital +

Profit +

Loan =

Fixed Assets +

Stock +

Cash

10000

1800

30000

20000

0

21800

Income Statement Sales 20000 Less COGS 15000 Gross Profit 5000 Less Other Expenses 2000 PBIT 3000
Income Statement
Sales
20000
Less
COGS
15000
Gross Profit
5000
Less
Other Expenses
2000
PBIT
3000
Interest
1200
PBT
1800
Tax
0
PAT
1800

Now let us see the income statement.

We can see that it is possible to determine the profit by using the accounting equation. However, to get a clear picture of the process of determining profit and to see the various of components of expenses and income it may be useful to prepare a separate income statement.

FORMAT OF INCOME STATEMENT

Income statement can be presented in vertical or horizontal format:

Sample income Statement

 

Expenses

 

Income

 

COGS

3000

Sales

15000

Salary and Rent

2000

   

General Expenses

1500

   
 

500

   

Depreciation Interest

2000

   

Taxes

2500

   

Profit

3500

   
 

5000

 

5000

FORMAT OF INCOME STATEMENT Income statement can be presented in vertical or horizontal format: Sample income

Sample Income Statement

Revenue

15000

Plus Other incomes

0

Less

 

COGS

3000

Salary and Rent

2000

General Expenses

1500

 

500

Depreciation Interest

2000

Provision for Tax

2500

PAT

3500

Sample Income Statement

Revenue

15000

Less

 

COGS

3000

Gross Profit

12000

Operating Expenses

3500

Profit Before Depreciation Interest and Tax (PBDIT)

8500

Depreciation

500

Profit Before Interest and Tax

 

(PBIT)

8000

Interest

2000

 

6000

Profit Before Tax (PBT) Tax Provision

2500

Profit After Tax (PAT)

3500

COMPONENTS OF INCOME STATEMENT

Revenue or Sales

Revenue represents sale of products and services produced or traded by an enterprise. These are usually recorded at gross value, including excise duty if any. When an organisation provides services or sells goods it receives cash immediately or receives commitment to be paid on some future date. Such commitments are called debtors or receivables. The excise duty is then separately deducted from the gross sales. Revenue can be generated by a firm in a variety of ways. According to the Schedule VI (see Appendix 7.1 for the details of Schedule VI) of the Companies Act, the aggregate amount for which sales are effected by the company, giving the amount of sales in respect of each class of goods dealt with by the company, and indicating the quantities of such sales for each class separately. In 2006, NALCO generated a revenue of 4851 crores as shown in

Exhibit: 7.1 . Other income of NALCO was less than 5% of the total income for the year

2006.

Exhibit: 7.1: NALCO
Exhibit: 7.1: NALCO

Other Incomes

The income received by a company from sources other than sales of its main products and services is mentioned separately. In many companies the other income constitutes a significant portion of the profit before tax. Other incomes on average account for around 2% of the sales and less than 20% of the profit after tax as shown by the Table 7.12,

 

Table: 7.12

Position of Other Incomes of the companies forming a part of Nifty

 

2004

2005

2006

As % of Sales

2%

2%

2%

AS % of PAT

18%

16%

19%

Source: CMIE data base

Other incomes include dividend and interest from the investments made by the company in other companies.

Expenditure Side

The expenditure side of income statement shows the details of all the revenue expenses whether accrued or paid for during a year.

Revenue Expenses

Revenue expense are those transactions (reduction of assets or increase in liabilities) the benefit of which expires within an accounting period. The accounting period may be a year, half year, quarter, or a month. According to the matching concept of accounting, expenses of an accounting period should be charged against the income of that period to determine profit for the period. See the Table 7.13 to get a better understanding of revenue expenses and the accounting period:

 

Table 7.13

Expense, Cash Outflow, Asset, and Liability

 

Accounting Period

3 months

6 months

12 months

Expense Per Month

 
  • 1000 1000

1000

Expense Paid

 
  • 6000 6000

6000

Expense for the period

 
  • 3000 6000

12000

 

0

0

6000

Liability (Outstanding Expense) Asset (Advance Expense)

  • 3000 0

 

0

In the following section we will understand the various components of expenditure.

Cost of Goods Sold/Consumed (COGS)

The cost of goods consumed is arrived at after making suitable adjustments for opening and closing stocks. According to the matching concept, when the goods are sold, the corresponding cost will be treated as an expense and it is called cost of goods sold (COGS).

Example 7.8

ABC Ltd had an opening stock of 800 units @ 20. During the first quarter it purchased

3000

units @ 40 and sold 3300 units @ 50.

 
 

Cost of Goods Sold

 
 

Qty

Price

Value

Opening Stock

 

800

20

16,000

Add Purchase

   

40

  • 3000 120,000

     

136,000

       

Cost of Goods Sold

     
  • 3300 126,000

Cost of goods sold = Opening stock + Purchases – Closing stock

It is important to note that the cost of goods consumed depends of the value of the closing stock. Value of closing stock depends on the methods of issuing inventory. Following are some of the common methods of issuing inventory.

Last-in-first-out (LIFO). Under this method the goods purchased last will be used first. So the unsold stock is generally from the past purchases or the opening stock.

Example 7.9

 

ABC Ltd had an opening stock of 1000 units @ 10. During the first quarter it purchased

3000

units @ 20 and sold 2500 units @ 40.

 
 

Cost of Goods Sold using LIFO

 
 

Qty

 

Price

Value

Opening Stock

800

 

20

16000

Add Purchase

3000

 

40

120000

     

136000

COGS

   

120000

 
 

3000 @40 300 @ 20

 

6000

126,000

       

Closing Stock

 

500

 

20

10,000

First-in-first-out (FIFO):

Under this method, the oldest purchase is used first. So the unsold stock is from the latest purchases.

Example 7.10

ABC Ltd had an opening stock of 1000 units @ 20. During the first quarter it purchased

3000

units @ 40 and sold 3300 units @ 60.

 
 

Cost of Goods Sold using FIFO

   
 

Qty

Price

Value

Opening Stock

800

20

16000

Add Purchase

3000

40

120000

     

136000

COGS

800

20

 
 

2500

40

116,000

       

Closing Stock

500

40

20,000

Profit = Sales – COGS = 198,000 – 116,000 = 82,000

Simple Average Method

 

Under this method, the material issued or used during the period are valued at the simple average price.

Example 7.11

 

ABC Ltd had an opening stock of 2000 units @ 20. During the first quarter it purchased

3000

units @ 40 and sold 3300 units @ 60.

 

Simple average price = (P1 + P2 + P3 + Pn)/n

 

Cost of Goods Sold using FIFO

   
 

Qty

Price

Value

Opening Stock

2000

20

16000

Add Purchase

3000

40

120000

     

136000

COGS

3300

30

99,000

       

Closing Stock

1700

30

51,000

Profit = Sales –COGS = 198,000 – 99,000 = 99,000

Weighted Average Method:

Under this method, the material issued or used during the period is valued at the weighted average price.

Weighted average price =( p1*q1 + p2*q2 +p3*q3)/q1+q2+q3

Example 7.12

ABC Ltd had an opening stock of 2000 units @ 20. During the first quarter it purchased

3000 units @ 40 and sold 3300 units @ 60.

Simple average price = (P1 + P2 + P3 + Pn)/n

Cost of Goods Sold using FIFO

 
 

Qty

Price

Value

Opening Stock

  • 2000 20

 

16000

Add Purchase

 

40

  • 3000 120000

     
  • 5000 136000

COGS

  • 3300 27.2

   
     

89,760

       

Closing Stock

  • 1700 27.2

 

46,240

Profit = Sales –COGS = 198,000 – 89,760 =108,240

Inventory Valuation in NALCO

Finished goods are valued at lower of cost or net realisable value. Cost is determined on the basis of current year's average cost of production and excludes selling and distribution overheads, interest, exchange variation and depreciation on capitalised exchange variation. Raw materials, stores, spare parts and tools are valued at weighted average cost net of CENVAT credit wherever applicable.

Example 7.13

Following are the details of the purchases made by ABC ltd on different dates at different rates.

   

Rate

Purchase Date

Stock

(Rs.)

  • 1.5.2006 3000

 

4.5

  • 2.5.2006 1000

 

5

  • 4.5.2006 2000

 

6

Suppose the company sells 2500 units at Rs. 10 per unit. Accounting profit of the company is equal to the sales less the cost of goods sold. However, the COGS depends on the method of valuing inventories.

Gross Profit and Inventory Valuation

 
 

Sales

COGS

G. Profit

FIFO

25,000

11,250

13,750

LIFO

25,000

14,500

10,500

Simple Average

25,000

12,917

12,083

Weighted Average

25,000

12,708

12,292

It is important to note that the change in profit not because of the change in the operating efficiency, but just because of the change in the valuation method.

FIFO results in higher profits because of lower cost of goods sold and a higher closing stock. LIFO results in lower profits because of higher cost of goods sold.

By changing the method of inventory valuation one is able to shuffle between expenses and assets. See the following table:

     

Simple

Weighted

LIFO

FIFO

Average

Average

 

1450

     

COGS (Expense)

0

11250

  • 12917 12708

 

1600

     

Stock (Asset)

0

19250

  • 17583 17792

 

3050

3050

   

Total value of purchase

0

0

  • 30500 30500

Excise Duty

This is the amount paid to the government as a tax, before the goods are dispatched from

the factory. Generally excise duty is deducted from the gross sales.

Salaries and Wages

Salaries and wages and all other employee benefits and amenities are included in this expenditure. They include provident fund, ESI (Employees State Insurance) contributions, and medical benefits, leave travel benefits, bonus, gratuity, pension, other superannuation

benefits etc. Table 7.14 shows salaries and wages as percentage of total sales of some of the well known Indian companies.

 

Table 7.14

 

Salaries and Wages as % of Sales (2006)

 

IT

 

Pharma

 

Wipro Ltd.

42%

Sun Pharmaceutical Inds. Ltd.

6%

Tata Consultancy Services Ltd.

46%

 

9%

Satyam Computer Services Ltd.

59%

Ranbaxy Laboratories Ltd. Glaxosmithkline Pharmaceuticals Ltd.

10%

 

47%

 

5%

Infosys Technologies Ltd. H C L Technologies Ltd.

35%

Cipla Ltd. Dr. Reddy'S Laboratories Ltd.

9%

Administrative Expenses

Administrative expenses include head office expenditure, secretarial costs, postage and

telephones, directors’ remuneration and other administrative expenses.

Cost of Production

Income statement will not show the cost of production as a separate item. However, one can calculate the cost of production by collecting the relevant information. Cost of production includes raw material cost, energy, salaries and wages etc. and other operating expenses. Selling expense and the interest cost are not the part of the cost of production. Table: 7.15 shows the cost of production advertisement as a percentage of sales of some Indian companies.

Table 7.15

Cost of production as % of Sales (2006)

Hindustan Petroleum Corpn. Ltd.

94%

 

69%

Steel Authority Of India Ltd. Tata Motors Ltd.

73%

Reliance Industries Ltd.

73%

National Aluminium Co. Ltd.

44%

Hero Honda Motors Ltd.

68%

I T C Ltd.

35%

Source: CMIE Data base

Selling Expenses

Selling expenses include freight, advertising and sales promotion, commissions and discounts and other selling and distribution costs. Table: 7.16 shows advertisement as a percentage of sales of some Indian companies.

Table:7.16

Advertisement as % of Sales (2006)

Tata Tea Ltd.

9%

Hindustan Lever Ltd.

8%

Dabur India Ltd.

11%

Bharti Airtel Ltd.

4%

Ranbaxy Laboratories Ltd.

6%

Borrowing Cost

Source: CMIE Data base

According to the Accounting Standard -16, borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds. Borrowing cost may include the following items:

interest and commitment charges on bank borrowings and other short-term and

long-term borrowings; amortisation of discounts or premiums relating to borrowings;

amortisation of ancillary costs incurred in connection with the arrangement of

borrowings; finance charges in respect of assets acquired under finance leases or under other

similar arrangements; and exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

According to the AS- 16, borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. The amount of borrowing costs eligible for capitalisation should be determined in accordance with this Statement. Other borrowing costs should be recognised as an expense in the period in which they are incurred.

The interest cost consists of interest on long-term loans, debentures, bank loans for working capital, interest on public deposits and other loans. Table 7.17 shows interest as a percentage of sales of some Indian companies.

Table 7.17

Interest as % of Sales (2006)

 

138%

Williamson Magor & Co. Ltd. G V K Power & Infrastructure Ltd.

74%

J C T Electronics Ltd.

43%

Indiabulls Financial Services Ltd.

30%

R P G Cables Ltd.

23%

Mukand Engineers Ltd.

18%

Depreciation

Source: CMIE Data base

Depreciation is the charge for using the assets. It can be described as the cost of the assets used during the year. Depreciation is the wear and tear of the asset. It is the decrease in the

value of the asset with the passage of time. Depreciation is the allocation of the cost over the life of the asset. Depreciation will be shown as an expense in the income statement and as reduction in the value of the asset in the balance sheet. Table 7.18 shows depreciation as percentage of sales of the well known companies of India.

Table 7.18

Depreciation % of Sales (2006)

A B B Ltd.

1%

A C C Ltd.

4%

Bajaj Auto Ltd.

2%

Bharat Heavy Electricals Ltd.

2%

 

1%

Bharat Petroleum Corpn. Ltd. Bharti Airtel Ltd.

14%

Source: CMIE Data base

Two popular methods of calculating depreciation are : Straight line method (SLM), Reducing balance method (RBM).

Straight Line Method (SLM) In the SLM depreciation is determined by allocating the cost over the life. The total cost of the asset less salvage value, if any, will be distributed over the life of the asset.

Depreciation = (Cost of the asset – Salvage Value)/Life

Depreciation = (Cost of the asset –Salvage Value)*Rate

This method is called SLM because the amount of depreciation remains constant over the life.

Example 7.14:

A limited started business with capital of Rs. 100,000. Purchased plant costing 50,000 on credit from Mr.X and stock worth of 75,000 for cash. Life of the plant is 5 years. No salvage value. Table 7.19 shows the depreciation, accumulated depreciation and the written down value of the asset.

Table 7.19

Depreciation: SLM

       

Written

Accumulated

Down

Year

Cost

Depreciation

Depreciation

Value

 

50,000

  • 1 10,000

10,000

 

40,000

   
  • 2 20,000

10,000

 

30,000

   
  • 3 30,000

10,000

 

20,000

   
  • 4 40,000

10,000

 

10,000

   
  • 5 50,000

10,000

 

0

Reducing Balance Method In the Reducing balance method (RBM), depreciation is calculated on the opening balance of the asset or in other words, it is calculated on the written down value of the asset. Written down value of the asset is cost of the asset less the accumulate depreciation. In this method, the amount of depreciation goes on reducing over the life. Unlike the SLM, the written down value of the asset will not become zero.

Example 7.15:

A limited started business with capital of Rs. 100,000. Purchased plant costing 50,000 on credit from Mr.X and stock worth of 75,000 for cash. Rate of depreciation =40 %. No salvage value. Table 7.20 shows the depreciation, accumulated depreciation and the written down value of the asset.

 

Table 7.20

 

Depreciation: RBM

 
       

Written

Accumulated

Down

Year

Cost

Depreciation

Depreciation

Value

 

50,000

  • 1 20,000

20,000

 

30,000

   
  • 2 32,000

12,000

 

18,000

   
  • 3 39,200

7,200

 

10,800

   
  • 4 43,520

4,320

 

6,480

   
  • 5 46,112

2,592

 

3,888

For details of depreciation please refer to the chapter on the fixed assets.

Depreciation and Financial Statements Let us see the impact of depreciation on the financial statements.

Example 7.16

ABC ltd started business with Capital of 100,000; Purchased stock of goods for Rs. 50,000; Purchased plant on credit from Mr. X for Rs. 50,000; 60% of the stock of goods sold for Rs. 50,000 for cash. Rate of depreciation = 10% Table 7.21 shows the financial statements at the for the first year

Table:7.21- Financial Statement Cash Flow Balance Sheet at the end of the first year Income Statement
Table:7.21- Financial Statement
Cash Flow
Balance Sheet at the end of the first year
Income Statement
Statement
Capital
Accumulated Profit
100,000
Sales
50,000
Capital
100,000
15,000
Sales
50,000
X
50,000
Less
150,000
165,000
COGS
30,000
Cash
100,000
Depreciation
5,000
Stock
50,000
Stock
20,000
Plant
50,000
35,000
Less Accumulated Depreciation
-5,000
CIH
100,000
165,000
Profit
15,000
Total
150,000

Depreciation = Costs * Rate = 50,000 * 10% = 5000

 

Depreciation is shown as an expense in the income statement

Depreciation is reduced from the value of the plant in the balance sheet

Accumulated depreciation = Depreciation for the first year

Example 7.17:

 

Let us continue with the information given in the example 7.16. Second year: Transactions are as follows:

 

Sold entire stock for 50,000

 

Took a new show room and paid Rs. 15,000 for three years

Table 7.22 shows the financial statements.

 

Table:7.22- Financial Statement

 
 

Balance Sheet

 

Income Statement

 

Cash Flow Statement

           

Opening

 

100,000

Sales

50,000

CIH

100,000

Capital Accumulated Profit

35,000

       

Sales

50,000

X

50,000

 

Less

     

150,000

 

185,000

 

COGS

20,000

     

Cash

135,000

 

Depreciation

5,000

 

Rent

15,000

Stock

0

 

Rent

5,000

     

Advance Rent

10,000

           

Plant

50,000

   

30,000

     

Less Accumulated Depreciation

-10,000

       

CIH

135,000

 

185,000

 

Profit

20,000

 

Total

150,000

Depreciation = Costs * Rate = 50,000 * 10% = 5000

 

Depreciation is shown as an expense in the income statement

Depreciation is reduced from the value of the plant in the balance sheet

Accumulated depreciation = Depreciation for the first year + Depreciation for the

second year Advance Rent = Rent Paid – Rent for the current year

Accumulated Profit = Profit of the first year + Profit for the second year

Bad Debts:

When a company extends credit to customers, there is always the risk of not getting the

amount. Bad debt is the loss due to the non-payment by the customers. Each year the company is required to estimate amount of bad debt and do the following:

Show it as a loss in the income statement, or charge it against the provisions for bad and doubtful debt;

Reduce the debtors to that extent

Example 7.18:

Assets and the corresponding sources of ABC as on 1 st April 2006 are as follows: Capital of ABC ltd = 50,000; 12% Loan = 70,000; Cash = 20,000; Stock = 25,000; Debtors (Mr. Y) = 75,000. During the year 2006, the company sold entire stock for Rs. 35,000 to Mr. X on credit. Mr. Y became insolvent and could pay only 75% of the money due. Table 7.23 shows the necessary financial statements.

 

Table- 7.23: Financial Statement

 
       

Cash Flow

   

Opening Balance Sheet

Income Statement

Statement

Closing Balance Sheet

Capital

50,000

 

sales

35,000

 

CIH

20,000

 

Capital

50,000

12% Loan

70,000

       

Y

56,250

 

12% Loan

70,000

 

120,000

 

COGS

25,000

 

Total

76,250

 

Profit

-17,150

                   

102,850

     

Bad Debts

18,750

       

Cash

67,850

Cash

20,000

 

Interest

8,400

 

Interest

8,400

 

Stock

0

Stock

25,000

   

52,150

       

Y

0

Y

75,000

       

CIH

67,850

 

X

35,000

 

120,000

 

Profit

-17,150

 

Total

76,250

   

102,850

Money due from Mr. Y = 75,000

 

Money received from Mr. Y = 75% = 56,250

Bad Debt = 75,000 – 56,250 = 18,750

Provisions for Bad and Doubtful Debts

Sometimes companies keep aside a part of the current profit to meet future bad debt. Such

amount kept aside is called provisions for bad and doubtful debts.

Example 7.19:

On 1 st April 2005, ABC started business with capital of Rs. 50,000. Purchased stock of

goods for cash = 20,000 and sold 50% of goods for 35000 on credit.

Rent paid for the

period = 5000 and the company created a provision of 5% of the debtors to meet

27

unexpected loss due to the bad debts. Table 7.24 show the financial statements at the end of the accounting period.

 

Table-7.24: Financial Statements

 

Income Statement for the year

 

Cash Flow Statement for the year ending March

 

Balance Sheet as on 31 st March

ending March 2006

 

2006

2006

Sales

35,000

 

Capital

50,000

 

Capital

50,000

     

Total

50,000

 

Profit

18,250

COGS

10,000

       

Total

68,250

Rent

5,000

           

Provisions for Doubtful Debts

1,750

 

Stock

20,000

 

Stock

10,000

 

16,750

 

Rent

5,000

 

Debtors

35,000

     

CIH

25,000

 

Less Provision for Doubtful debts

-1,750

           

Cash

25,000

Profit

18,250

 

Total

50,000

 

Total

68,250

Example 7.19

Refer to the financial statements shown in the table 7.24. During the year 2006-07 the company had following transactions:

Sold 60% of the stock for 15,000 for cash.

One of the debtors who had to pay Rs. 2000 became insolvent. She could pay 60%

of the amount due. Rent paid for the two years: 10000

Table 7.25 show the financial statements at the end of the year 2007

 

Table- 7.25: Financial Statements

 
   

Cash Flow

   

Income Statement

Statement

Closing Balance Sheet

     

Opening

       

Sales

15,000

CIH

25,000

Capital

50,000

Sales

15,000

Profit

22,250

COGS

6,000

Collection

1,200

Total

72,250

Rent

5,000

41,200

Provisions for Doubtful Debts

0

Stock

4,000

11,000

Rent

10,000

Debtors

33,000

CIH

31,200

Less Provision for Doubtful debts

-950

Advance Rent

5,000

Cash

31,200

Profit

4,000

Total

41,200

Total

72,250

Rent paid = 10,000

Rent for the current year (Expense) = 5000

Advance Rent (Asset) = 5000

Opening Provision for doubtful debt = 1750

Bad debt for the current year = 40% of 2000 = 800

28

Bad debt for the current year is not charged against the income once again since the

company is already having the Provisions. Bad debt is charged against the Provisions. So the balance sheet will show the balance provisions to be carried forward. Since the company has no further credit sales, it has not creas

Other Expenses

The other expenses include auditors’ remuneration, petty expenses, small donations, if any etc.

Appropriation of Profit

Appropriation of profit is the distribution of profit. Profit after tax (PAT) is available for

distribution among the shareholders as dividend. However, the management is under no obligation to distribute the profit. Profit appropriation statement, which is generally incorporated in the income statement, shows the profit retained for reinvestment, profit distributed as dividend, tax on dividend distributed, profit transferred to some specific reserves. Exhibit 7.3 shows the profit for the year and the appropriations of Wipro Limited for the year ending March 2006 and the March 2005

Exhibit 7.3: Wipro Limited (Rs. Million)

2006

2005

∑ Bad debt for the current year is not charged against the income once again since

Source: Annual Report of Wipro Limited

Earning Per Share

According to AS -20, a company should present basic and diluted earnings per share on the face of the statement of profit and loss for each class of equity shares that has a different right to share in the net profit for the period. An enterprise should present basic and diluted earnings per share with equal prominence for all periods presented.

Basic earnings per share should be calculated by dividing the net profit or loss for the period attributable to equity shareholders by the weighted average number of equity shares outstanding during the period.

For the purpose of calculating basic earnings per share, the net profit or loss for the period attributable to equity shareholders should be the net profit or loss for the period after deducting preference dividends and any attributable tax thereto for the period.

According to AS-20, the weighted average number of equity shares outstanding during the period reflects the fact that the amount of shareholders' capital may have varied during the period as a result of a larger or lesser number of shares outstanding at any time. It is the number of equity shares outstanding at the beginning of the period, adjusted by the number of equity shares bought back or issued during the period multiplied by the time-weighting factor. The time-weighting factor is the number of days for which the specific shares are outstanding as a proportion of the total number of days in the period; a reasonable approximation of the weighted average is adequate in many circumstances.

For the purpose of calculating diluted earnings per share, the net profit or loss for the period attributable to equity shareholders and the weighted average number of shares outstanding during the period should be adjusted for the effects of all dilutive potential equity shares. Diluted earning per share reflects the existence of stock options or other rights that can be converted into shares in the future. Exhibit 7.4 shows the basic and diluted EPS of Wipro Limited for the year ending March 2006 and March 2005.

Exhibit 7.3: Wipro Limited

2006

2005

For the purpose of calculating basic earnings per share, the net profit or loss for the

Source: Annual Report of Wipro Limited

LIMITATIONS OF INCOME STATEMENT

Though, the income statement is an important statement, it has the limitation of not being able to show the cash position. This limitation can be attributed to one of the important concepts of accounting i.e. Accrual Concept.

The Income statement does not tell us how much cash has been received and how cash has been paid during the period. All it does is to summarise the incomes and expenses. While preparing the balance sheet we have seen that when the company has sold 20 computers @

Rs.25000, of which only 10% was received immediately. For the purpose of determining the profit or loss, the entire sale value i.e. Rs. 500,000 was shown as the income. Similarly, when an item bought on credit, it is recognized as an expense immediately, though the cash is yet to flow out of the business.

Key Terms

Accrual Basis:

Under this basis, the effects of transactions and other events are recognised when they occur (and not as cash or a cash equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.

Going concern assumption According to this assumption, the enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed

Income Income is increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

Receipt Receipt is the inflow of cash and every inflow of cash is not an income. A company receives money for several reasons: Capital, Loan, Donations, Sale of assets, Advance

Expense Expense is decrease in economic benefits during the accounting period in the form of outflow or reduction of assets or decreases of liabilities that result in decreases in equity, other than those relating to distribution to equity participants.

Loss Losses represent decreases in economic benefits and as such they are no different in nature from other expenses. Following are some of the common losses that appear in the income statement: Bad debt, Loss due to theft, Loss of stock due to fire or natural calamities, Loss on the sale of non-current assets

Recognition of Expense Expenses are recognised in the statement of profit and loss when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably.

Profit Profit is the excess of income over the expenses for a period. Profit for the period is determined using the accrual principle and matching principle. According to the matching principle, revenue for a period should be compared with the corresponding expenses.

Revenue or Sales

Revenue represents sale of products and services produced or traded by an enterprise. These are usually recorded at gross value, including excise duty if any. When an organisation provides services or sells goods it receives cash immediately or receives

commitment to be paid on some future date.

Revenue Expenses

Revenue expense are those transactions (reduction of assets or increase in liabilities) the benefit of which expires within an accounting period. The accounting period may be a year,

half year, quarter, or a month.

Cost of Goods Sold/Consumed (COGS) According to the matching concept, when the goods are sold, the corresponding cost will be treated as an expense and it is called cost of goods sold (COGS). Cost of goods consumed is arrived at after making suitable adjustments for opening and closing stocks.

Last-in-first-out (LIFO). Under this method the goods purchased last will be used first. So the unsold stock is generally from the past purchases or the opening stock.

First-in-first-out (FIFO):

Under this method, the oldest purchase is used first. So the unsold stock is from the latest purchases.

Cost of Production Income statement will not show the cost of production as a separate item. However, one can calculate the cost of production by collecting the relevant information. Cost of production includes raw material cost, energy, salaries and wages etc. and other operating expenses.

Borrowing Cost According to the Accounting Standard -16, borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds.

Depreciation Depreciation is the charge for using the assets. It can be described as the cost of the assets used during the year. Depreciation is the wear and tear of the asset. It is the decrease in the value of the asset with the passage of time. Depreciation is the allocation of the cost over the life of the asset. Depreciation will be shown as an expense in the income statement and as reduction in the value of the asset in the balance sheet.

Straight Line Method (SLM) In the SLM, depreciation is determined by allocating the cost over the life. The total cost of the asset less salvage value, if any, will be distributed over the life of the asset.

Reducing Balance Method In the Reducing balance method (RBM), depreciation is calculated on the opening balance of the asset or in other words, it is calculated on the written down value of the asset. Written down value of the asset is cost of the asset less the accumulate depreciation. In this method, the amount of depreciation goes on reducing over the life.

Bad Debts:

When a company extends credit to customers, there is always the risk of not getting the amount. Bad debt is the loss due to the non-payment by the customers.

Provisions for Bad and Doubtful Debts Sometimes companies keep aside a part of the current profit to meet future bad debt. Such amount kept aside is called provisions for bad and doubtful debts.

Appropriation of Profit Appropriation of profit is the distribution of profit. Profit after tax (PAT) is available for distribution among the shareholders as dividend. However, the management is under no obligation to distribute the profit. Profit appropriation statement, which is generally incorporated in the income statement, shows the profit retained for reinvestment, profit distributed as dividend, tax on dividend distributed, profit transferred to some specific reserves.

Earning Per Share Profit after tax if distributed over the number of share, it is called earning per share (EPS).

Basic EPS Basic earnings per share should be calculated by dividing the net profit or loss for the period attributable to equity shareholders by the weighted average number of equity shares outstanding during the period.

Diluted EPS For the purpose of calculating diluted earnings per share, the net profit or loss for the period attributable to equity shareholders is divided by weighted average number of shares outstanding during the period.

Theoretical Questions

  • 1. What is income?

  • 2. How is income different from profit?

  • 3. When is income recognized in the income statement?

  • 4. What are expenses?

  • 5. What is an income statement?

  • 6. Explain some of the important items of an income statement.

  • 7. Distinguish between expense and asset?

  • 8. All payments are not expenses. Explain.

  • 9. All receipts are not incomes. Explain

    • 10. Examine the impact on expenses due but not paid on the financial statements.

    • 11. What is depreciation?

    • 12. Answer the following questions:

i.

Why aren’t purchase of equipment shown in the income statement?

ii.

Why is credit sales shown in the income statement?

iii.

Why is dividend not shown in the income statement?

iv.

What is premium on issue of shares not shown in the income statement?

v.

Why is depreciation on furniture an expense?

vi.

Why is interest due but not paid shown as an expense?

  • 13. Explain the impact of depreciation on the financial statements.

  • 14. What are the different methods of charging depreciation?

  • 15. Examine the impact of provision for bad and doubtful debts on the income statements.

  • 16. Explain the process of determining EPS.

  • 17. What is relevance of diluted EPS?

  • 18. What is weighted average number of share?

  • 19. What is appropriation of profit?

  • 20. What is the composition of borrowing cost?

  • 21. Examine the impact of borrowing cost on the financial statement.

  • 22. What is the difference between revenue and profit?

  • 23. Explain the relationship between income statement and accounting equation.

Numerical Questions

  • 1. Classification: Classify the following items

into Revenues, Cost of Goods Sold,

Selling Overheads, Non-operating incomes, Administration Expenses, Not an Income Statement Item:

Credit sales, Discount received, Interest paid, insurance, Consultant’s Salary, Interest received, Bad Debt, Bad Debt Recovered, Capital Raised, Money borrowed from bank, Sales Tax, Income Tax, Furniture purchased. Depreciation

on furniture, Loss due to the fire, Winnings from lottery tickets, Purchase of land, Expense on the MD’s Son studies, Cash received from customers.

  • 2. Sales, 100,000; COGS = 40% of sales; operating expenses = 20%; interest = 5% of sales; depreciation = 2000; Profit = 20% of sales. Balance is the provision for bad debts. Required: Income Statement

  • 3. XYZ started business with capital of 50,000; Other transactions are follows:

took 12% loan of Rs. 100,000; Pur

  • 4. A ltd makes both cash and credit sales. Prepare the income statement from the following information:

i.

Credit sales for November: 230000

 

ii.

Cash received in November;

 
  • a. From October’s credit sales: 90000

 
  • b. From November’s credit sales: 45000

 
  • c. From November’s cash sales: 76000

iii.

iv.

Gross profit: 32% of Sales

 

Net Profit: 16% of Sales

  • 5. Comment on the profitability of the following companies

 
   

Profit Position

 
 

A

B

C

PBIT

50,000

50,000

-25000

PBT

5000

45,000

PAT

3000

30,000

Dividend

2700

0

5,000

  • 6. Following are financial items of D ltd.

 

i.

ii.

Cash: 15000, Accounts Receivables: 42000, Inventory: 33000, Accounts

Payables: 24000, Capital: 45000, Retained Earning: 21000 Following are the transactions during the year:

Borrowed 30000 on a long term basis

Interest expense for the year: 3000. However, not paid.

Inventory purchased: 400000 on credit

Sales: 500000. 40% for cash.

Cost of goods sold: 75%

Paid to suppliers: 20%

Paid wages: 120000

7.

Following are the transactions of transactions of XYZ ltd.

 

Transactions for the year Started business with capital

100,000

Purchased plant on credit

50,000

Purchased stock for cash

50,000

Sold 60% stock for

50,000

Depreciation

10%

Required: Income Statement, Balance Sheet, Cash Flow Statement

  • 8. Following are the transactions of transactions of XYZ ltd.

 

Transactions for the year Started business with capital

100,000

Took 12% loan on 1st July

200,000

Purchased plant on credit

50,000

Purchased stock for cash

50,000

Purchased stock on credit from X

100,000

Sold 50% stock for

200,000

Salary per month

3,000

Salaries paid

24,000

Depreciation per annum

10%

Required: Income Statement, Balance Sheet, Cash Flow Statement

  • 9. Refer to question 7. Prepare the financial statement for the first quarter (Q1) , and the second quarter (Q2),

10. Following are the transactions of transactions of XYZ ltd.

Transactions for the year ending 2005

Started business with capital

100,000

Took 12% loan on 1st July

200,000

Purchased plant on credit

50,000

Purchased stock for cash

50,000

Purchased stock on credit from X

100,000

Sold 50% stock on credit

200,000

Rent per month

2,000

Rent paid

24,000

Depreciation

10%

Create a provision for doubtful debts

5%

Required: Income Statement, Balance Sheet, Cash Flow Statement for the year.

  • 11. Refer to the question no. 9. Following are the transactions during 2006

Sold balance stock 175,000 on credit

Received 50% of the opening balance of debtors

Mr. X, one of the debtors, who owes Rs. 5000 becomes insolvent. He

could pay only 40% of the money due. Balance money was treated as bad debt. Company decides to maintain provision for doubtful debt = 5% on the closing debtors.

Required: Income Statement, Balance Sheet, Cash Flow Statement for the year.

  • 12. Following is the Wipro Limited for two years:

WIPRO LIMITED Profit and Loss Account for the year ending Mar 31 (All figures in rupees million)

 

2001

2000

Income

   

Sales and Services

30539

22735

Other Income

692

257

  • 31231 22992

Expenditure

Cost of goods sold

  • 18103 15203

Selling, general and administrative expenses interest

5404

3995

Interest

68

286

23575

19484

Profit before taxation and non Recurring / extraordinary items

7656

3508

Provision for taxation

992

501

Profit after tax before non-recurring/

6664

3007

Extraordinary items

Non recurring / extraordinary items

16

-523

Profit for the period

6648

2484

Appropriations

Interim Dividend on Preference Shares

18

26

Interim Dividend on Equity Shares

69

Proposed Dividend on Equity Shares

116

Corporate tax on dividend

13

10

Transfer to Capital Redemption Reserve

250

Transfer to general reserve

6251

2379

Required:

Study the change in the income statements over the two years and explain how

profit for the period has increased by 168% . Visit the web site of Wipro Limited and collect the latest two years income statement and compare with the above income statement.