Statement of Profit or Loss of a Sole Proprietorship
We prepare the statement of profit or loss to calculate the operational result of the business. The operational result can be either a profit or a loss. This statement is prepared at the end of an accounting period by including income and expense balances. Earlier, the operating result was calculated using an account called ‘Trading and Profit and Loss account‘.
We generally calculate the profit or loss of business in two steps.
- Calculation of gross profit
- Calculation of net profit
Gross profit is the amount of total sales revenue that exceeds the total cost of sales. When calculating gross profit we need to deduct the cost of sales for the total sales revenue of the business. However, a gross loss occurs when the total cost of sales exceeds the total sales revenue.
Gross profit = Sales revenue – Cost of sales
- Total sales consist of cash sales and credit sales.
Total sales = cash sales + credit sales
- Once the entire stock is sold out the cost of stock presented for sales is the cost of sales.
- Elements considered when calculating gross profit:
- Opening stock
- Carriage inwards
- Loading expenses
- Closing stock
Opening stock is the value of goods available for sales in the beginning of the accounting period. There is no opening stock for a business in its first year of operation. Since opening stock is not adequate for sales, more goods need to be purchased. Purchases include the cost of buying the stock of goods for resale. The total purchases include cash purchases and credit purchases.
Purchases = cash purchases + credit purchases
A business may have to spend on transportation costs (carriage inwards), loading, and unloading expenses when bringing the stock to the business. Therefore, these expenses should be added to purchases.
Cost of goods purchased = Purchases + Carriage inwards + Loading expenses
Closing stock includes the value of goods unsold at the end of the accounting period.
Net profit = (Gross Profit + other Income) – Expenses
Income is the increase in equity except due to capital introduction by the owner. The other income includes any other income earned not included in the gross profit.
E.g. Interest income, rent income, dividend income, commission income, Discounts received, etc
Expense is the decrease in equity except due to drawings of the owner.
E.g. rent expense, salaries, depreciation, bad debts, bank loan interest, discount allowed
We present such expenses under four categories in the statement of profit or loss.
- Distribution expenses
- Administration expenses
- Financial expenses
- Other expenses
Distribution expenses include expenses incurred for selling and distribution of goods. For example advertising and promotional expenses, bad debts, carriage outwards, discount allowed, etc. Administration expenses include expenses incurred for the administration purposes of the business. Rent expense, rates, office expenses, stationery are some of the examples for administration expenses. Financial expenses consist of expenses incurred in the borrowing of funds and maintaining bank accounts such as bank loan interest, bank overdraft expenses, and bank chargers. Other expenses are the expenses and losses that were not classified under the above categories such as loss on damaged goods, loss from cash frauds, etc.
Format of the Statement of Profit or Loss