3 Lecture 1235 Minerva

Leeds University
Business School
LUBS1235 Introductory Financial

Accounting
LECTURE 3
Measuring and reporting financial

performance #1
Learning Objectives
When you have completed this week you should be able

to:
• Discuss the nature and purpose of the income
statement
• Prepare an income statement from relevant information
and interpret the information that it contains
• Discuss the main recognition and measurement issues
that must be considered when preparing the income
statement
• Explain the main accounting conventions underpinning
the income statement
LEEDS UNIVERSITY BUSINESS SCHOOL
Session 3 topics
• The Income Statement
• Recording Income Statement transactions (double

entry book-keeping)
• The Trial Balance
• Year end adjustments:

– Cost of Sales
– Accruals and Prepayments

Session 3 topics

entry book-keeping)

– Cost of Sales

A set of accounts
3 key statement which are (usually) found in a set of

accounts:
• Statement of financial position (balance sheet)
(Session #2)
• Statement of financial performance or Income
statement (profit and loss account) (Session #3
and Session #4)
• A cash flow statement (Session #6)

Financial statements
Financial statements comprise all documents in a

company’s published results including:
– Chairman’s Statement
– Directors’ Report
– The auditor’s report
– The three main accounting statements
– Many pages of notes explaining the figures etc.
See Morrisons financial statements via Minerva link

Financial Statements: IS, SFP and
CFS
Balance Sheet
at
End of Year 1
Year 1 Year 2
Profit
Income Statement for Year 1 (or Loss)
Income – expenses = profit at end of
period
Cash Statement for Year 1 Cash

Cash receipts – cash outgoings = net balance at
cash inflow or outflow end of
period

The Income Statement (or ‘Profit and
Loss Account’)
The Income Statement shows all income received

and all expenses incurred over a specific period of
time (= the ‘accounting period’; usually 12 months).
PROFIT (or LOSS) = Revenue - Expenses

Loss Account’)
Revenue and Expenses
Revenue is a ‘measure of the inflow of economic benefits
arising from the ordinary operations of a business’ (p83)
Revenue arises when (p90):
– It is measurable reliably;
– It is probable that the economic benefits will be received;
– Ownership & control (risks and rewards) passes to buyer
(Revenue from cash sales, credit sales, HP sales etc.)
Expenses means “the opposite of revenue” (p84)
Expenses are the costs incurred in earning revenue
Loss Account’)
Income Statement for Year 1 Income Statement for Year 2
Year 1 Year 2
+ Income + Income
- Expenses - Expenses
+ Income + Income
+ Income + Income
The Income Statement (or ‘Profit and Loss Account’)

Link between the Income Statement
and the SFP
INCOME STATEMENT STATEMENT OF

FINANCIAL POSITION
Income
Assets
– Expenses =
Capital
= Profit (or Loss) +
Liabilities

Link between the Income Statement
and the SFP
ASSETS = CAPITAL + LIABILITIES
Capital at start of
period
+
Profit for the period
(or minus, if it is a
loss for the period)

So now, we know about…
ASSETS
INCOME
LIABILITIES
EXPENSES
CAPITAL
Income Statement (or Statement of Financial

‘profit and loss account’) Position (or ‘balance sheet’)

Session 3 topics

entry book-keeping)

– Cost of Sales

Recording Income Statement
transactions

FINANCIAL POSITION
Income
Assets
– Expenses =
Capital
Liabilities
Debits = Credits Debits = Credits

transactions
• Assets BALANCE SHEET

• Capital ITEMS
• Liabilities
• Revenue/income INCOME STATEMENT

• Expenses ITEMS

transactions
Remember from Session 2…

CREDIT
DEBIT
For example, a coffee shop business takes out a

bank loan of £2,000:
Current assets: Non-current

Bank £2,000 liabilities:
Bank loan £2,000

Remember from last week…
ASSETS
DEBIT
= CAPITAL + LIABILITIES
CREDIT
Fixtures and fittings; Owner’s funds Long-term loans

Motor vehicles; Plant
and equipment
Bank balance; Profit/loss Short term

Inventories; loans/overdraft;
Trade receivables (i.e. Trade payables
amounts owed by (i.e. amounts
customers) owed to
suppliers)
transactions
DEBIT CREDIT
IS Expenses Revenue (and

other income)
SFP Assets Liabilities

Capital

transactions
EXPENSES INCOME
ASSETS CAPITAL LIABILITIES
DEBIT CREDIT

transactions
EXPENSES INCOME
CREDIT
DEBIT
For example, a coffee shop business buys £1,000 of

coffee beans on credit from the supplier
Expenses: purchases Current liabilities:

£1,000 Trade Payables
£1,000

transactions
EXPENSES INCOME
CREDIT
DEBIT
For example, a coffee shop business buys £500

of milk from a supplier, paying in cash
Expenses:
Purchases £500
Current assets: Current assets:

Bank - £500 Bank - £500
transactions
EXPENSES INCOME
CREDIT
DEBIT
For example, a coffee shop business sells a

cappuccino and a chocolate brownie for £5.50
Current assets: Income:
Bank £5.50 Revenue £5.50

transactions
EXPENSES INCOME
CREDIT
DEBIT
For example, a coffee shop business pays an

electricity bill of £200
Expenses:
Utilities £200
Current assets: Current assets:
Bank - £200 Bank - £200
transactions
Income Statement (extract)

£
Sales revenue 5.50
Purchases (1,500.00)
Utilities (200.00)
Loss (1,694.50)

transactions
DEBIT CREDIT
IS ↑ Expenses
↑ Revenue (and
other income)
SFP ↑ Assets ↑ Liabilities

Capital

transactions
A car manufacturer buys 2,000 tyres for £15 per tyre, for use
in production. The supplier has provided a credit period of 60
days. How would this transaction be recorded?
DEBIT CREDIT
Expenses Revenue (and

IS other income)
Assets Liabilities
SFP
Capital
Expenses: Current Liabilities:

Purchases £30,000 Trade Payables
£30,000
transactions
A car manufacturer pays factory rent of £10,000. How would
this transaction be recorded?
DEBIT CREDIT

IS other income)
Assets Liabilities
SFP
Capital
↑ Expenses: Current Assets:

↑
Rent £10,000 Bank - £10,000

transactions
A car manufacturer sells three cars for £20,000 per car . How
would this transaction be recorded?
DEBIT CREDIT

IS other income)
Assets Liabilities
SFP
Capital
Current Assets: Income:
Bank £60,000 Revenue £60,000

transactions
Income Statement (extract)

£
Sales revenue 60,000
Purchases (30,000)
Rent (10,000)
Profit 20,000

Session 3 topics

entry book-keeping)

– Cost of Sales

Double Entry Bookkeeping and the
Trial Balance
Double Entry Bookkeeping is used to process transactions

as they occur (or shortly after). Double Entry Bookkeeping
forms part of an accounting system
A “Trial Balance” (“TB”) summarises the results of the

bookkeeping and is used to prepare the following:
1. Statement of financial position (Balance Sheet) at a
specific date
2. Income statement for a specific period of time (i.e. an
accounting period)

Double Entry Bookkeeping and the
Trial Balance
• A trial balance (TB) is drawn up to summarise the

results of the bookkeeping for the period
• A TB has 2 columns:
– the left (or “debit” column) lists all the assets
and expenses
– the right (or “credit” column) lists the capital,
liabilities and revenue
• The columns should total the same (because of
the accounting equation)

The trial balance
DEBIT CREDIT
Assets (Balance Sheet) Liabilities (Balance Sheet)
- Non-current assets (fixtures - Loans; trade payables;bank
and fittings; plant and overdraft etc.
equipment; land and buildings
etc.) Capital/equity (Balance Sheet)
- Current assets (Bank balance; - Owners funds
inventories; trade receivables; - Share capital
etc.)
Expenses (Income Statement)

- Purchases; wages and salaries; Income (Income Statement)
office costs; distribution costs; - Sales revenue; royalty income
interest payable; etc.)
Michael’s trial balance at 31
December: Year 1
Debit Credit Include on
Assets/Expenses Capital/Liabilities/
Revenue
£ £
Revenue 37,200 Income statement
Purchases 23,112 Income statement
Opening inventory 7,552 Income statement
Salaries and wages 4,894 Income statement
Motor expenses 1,328 Income statement
Rent and rates 1,152 Income statement
Sundries 2,404 Income statement
Motor vehicles 4,800 Statement of financial position
Fixtures and fittings 1,200 Statement of financial position
Receivables 9,154 Statement of financial position
Payables 6,090 Statement of financial position
Cash 240 Statement of financial position
Bank 7,752 Statement of financial position
Drawings 4,100 Statement of financial position
Capital 24,398 Statement of financial position
67,688 67,688
The trial balance
£
Trade receivables 2,000 This information is
Trade payables 1,000 available for Gerald
Bank loan 10,000 Limited for the year
Electricity expense 800 ended 30 September
Capital 6,800 20X2
Wages and salaries 10,000
Cash at bank 20,000
Rental expense 5,000 Can you put these
Non-current assets 30,000 items into a Trial
Sales revenue 120,000 Balance?
Purchases 70,000

The trial balance
Trial Balance for Gerald Limited for DEBIT CREDIT
the year ended 30 September 20X2 £ £
Trade receivables 2,000
Trade payables 1,000
Bank loan 10,000
Electricity expense 800
Capital 6,800
Cash at bank 20,000
Rental expense 5,000
Non-current assets 30,000
Purchases 70,000
TOTAL
LEEDS UNIVERSITY BUSINESS SCHOOL 137,800 137,800
The trial balance
Using the Trial Balance, can you now prepare

an Income Statement and a Statement of
Financial Position?

The trial balance
Bank loan 10,000
Capital 6,800
Cash at bank 20,000
Purchases 70,000
TOTAL
The trial balance
Income Statement for Gerald Limited for the year ended

30 September 20X2
£
Purchases (70,000)
Rental expense (5,000)
Wages and salaries (10,000)
Electricity expense (800)
Profit for the period 34,200

The trial balance
Bank loan 10,000
Capital 6,800
Cash at bank 20,000
Purchases 70,000
TOTAL
The trial balance
Statement of Financial Position for Gerald Limited at 30.09.20X2

£ £
Current assets:
Cash at bank 20,000
22,000
TOTAL ASSETS 52,000
Non-current liabilities:
Bank loan 10,000
Current liabilities:
Total Liabilities 11,000
Capital 6,800
LIABILITIESBUSINESS
LEEDS UNIVERSITY + CAPITAL
SCHOOL 17,800
transactions

FINANCIAL POSITION
Income
Assets
– Expenses =
Capital
Liabilities

The trial balance
Statement of Financial Position for Gerald Limited at 30.09.20X2

£ £
Current assets:
Cash at bank 20,000
22,000
TOTAL ASSETS 52,000
Non-current liabilities:
Bank loan 10,000
Current liabilities:
Total Liabilities 11,000
Capital +34,200 profit 41,000

LIABILITIESBUSINESS
LEEDS UNIVERSITY + CAPITAL
SCHOOL 52,000
The Trial Balance…next steps
PRODUCE
INCOME
RECORD PRODUCE STATEMENT
ALL DEBITS TRIAL AND
AND BALANCE STATEMENT
CREDITS
OF FINANCIAL
POSITION
YEAR-END
ADJUSTMENTS

Session 3 topics

entry book-keeping)

– Cost of Sales

Year end adjustments
At the year end we need to make a number of adjustments to

calculate the correct figures for Revenue and Expenses (and
therefore Profit).
The main adjustments are:
• Cost of sales (this session)
• Accruals and prepayments (this session)
• Depreciation (session 4)
• Bad and doubtful debts (session 4)

Cost of sales
Cost of sales is “the cost of goods sold during a
period”.
Cost of sales can be calculated as:
Opening inventories
+ Purchases
- Closing inventories
This gives the cost of goods actually sold during the
period.

Cost of sales
OPENING INVENTORY: 5 units @ £50 per unit
PURCHASES: 2 units @ £50 per unit
CLOSING INVENTORY: 1 unit @ £50 per unit
OPENING INVENTORY: 5 units @ £50 per unit £250

PLUS PURCHASES: 2 units @ £50 per unit £100
MINUS CLOSING INVENTORY: 1 unit @ £50 per unit £(50)
COST OF GOOD SOLD (6 units £50 per unit) £300

Cost of sales (cont.)
Per example 3.2 p86 £
Opening inventories 40,000
Goods purchased 189,000
229,000
Less: Closing inventories (75,000)
Cost of sales (or “Cost of goods sold”) 154,000

Extract from the Trial Balance for
Mack Limited for the year ended
31 August 20X4
DEBIT CREDIT
£ £
Opening inventory 4,000
Bank loan 10,000
Capital 6,800
Cash at bank 20,000
Purchases 68,350
Closing inventory at 31 August 20X4 is £3,000

Opening inventories 4,000
Goods purchased 68,350
72,350
Less: Closing inventories (3,000)
Cost of sales (or “Cost of goods sold”) 69,350

£ £
Less: cost of goods sold:
Opening inventory 4,000
Purchases 68,350
Closing inventory (3,000)
(69,350)
Gross Profit 50,650
Wages and salaries (10,000)
Electricity (800)
Etc.

Session 3 topics

entry book-keeping)

– Cost of Sales

Accruals: accounting
conventions
Accruals - profit is the excess of revenue over
expenses, (not the excess of cash receipts over cash
payments).
Matching - ‘in measuring income, expenses should

be matched to revenues that they helped generate, in
the same accounting period as those revenues were
realised’.
These two conventions give rise to accruals and

prepayments
Accruals and prepayments
Accruals
An accrual occur when an expense is paid after the
service has been incurred (i.e. ‘in arrears’)
Prepayments
A prepayment occurs when an expense is paid before
the service has been provided (i.e. ‘in advance’)

Accruals
• Often there is a delay between goods/services

being delivered to us, or performed for us, and
the arrival of the invoice.
• When preparing the Trial Balance, it is necessary

to identify amounts the organisation owes (i.e. a
liability) for any unrecorded items – called
“accruals”

Accruals - example
Y Ltd has drawn up its trial balance to 31 March 20X7

The trial balance shows Electricity £2,000 and Gas
£5,000. But further invoices were subsequently
received, as follows:
1. Electricity of £600 for three months to 30 April
20X7
2. Gas of £2,400 for the period 1 January to 30
June 20X7
Required: Calculate the accruals at 31 March 20X7
and the expense for the year
Accruals - example
ELECTRICITY
1 APR X6 31 MAR X7
X
1 FEB X7 30 APR X7
£600
2 months 1 month

Accruals – example
Electricity
Charge for 3 months to 30 April 20X7 = £600
This includes 2 months (i.e. February and March) of
the year ended 31 March 20X7.
This portion (i.e. February and March) needs to be
accounted for in the y/e 31 March 20X7. The expense
is “incurred” even though it has not been paid (i.e. the
expense is “accrued”)
Accrual: 2/3 x £600 = £400
Accruals – example
Gas
The charge for six months to 30 June 20X7 = £2,400
This includes 3 months (i.e. January, February and
March) of the year ended 31 March 20X7.
This portion (i.e. January, February and March) needs
to be accounted for in the y/e 31 March 20X7. The
expense is “incurred” even though it has not been
paid (i.e. the expense is “accrued”)
Accrual: 3/6 X £2,400 = £1,200
Accruals – debits and credits
The accrual: increases expenses (Income Statement)

and increases current liabilities (SFP)
DEBIT CREDIT
Revenue (and
Expenses
other income)
Liabilities
Assets
Capital
Electricity expense £400 Accrual £1,600

Gas expense £1,200
Accruals – Trial Balance
DEBIT CREDIT
£ £
Sales revenue 100,000 IS

Purchases 30,000 IS
Plant and machinery 80,000 SFP
Depreciation expense 8,000 IS
Opening inventory 70,000 IS
Closing inventory 40,000 IS
Utility expenses (12,000 + 1,600) 12,000
13,600 IS
Accruals 1,600 SFP

Prepayments
• Some types of expenses are paid in advance, as
opposed to being paid after the goods/service has
been provided.
• At trial balance stage it is necessary to identify

any expenses which have been paid during
current the accounting period which do not relate
to the current accounting period.

Prepayments - example
Y Ltd’s accounting period ended 31 March 20X7
Office expenses total £8,000 and include £1,200 paid

for photocopier rental for the 12 months to 30
September 20X7
Calculate the prepayment at 31 March 20X7 and the

effect on expenses for the year

Prepayment – example
Amount paid for the 12 months to 30 September 20X7

= £1,200
This includes 6 months (i.e. October 20X6 – March
20X7) of the year ended 31 March 20X7.
This also includes 6 months (i.e. April 20X7 –
September 20X7) of the following financial year.
The prepaid portion (i.e. April 20X7 – September
20X7) needs to be accounted for in the y/e 31 March
20X7. The expense has been paid for even though it
has not been “incurred” (i.e. the expense is “prepaid”)
Prepayments – debits and
credits
DEBIT CREDIT
Revenue (and
Expenses
other income)
Liabilities
Assets
Capital

credits
DEBIT CREDIT
Expenses Expenses
Revenue (and Revenue (and

other income) other income)
Assets Assets
Liabilities Liabilities
Capital Capital
credits
The prepayment: reduces expenses (Income Statement)
and increases current assets (SFP)
DEBIT CREDIT
Assets Expenses
Prepayments £600 Office expenses £600

Accruals – Trial Balance
DEBIT CREDIT
£ £
Sales revenue 100,000 IS

Purchases 30,000 IS
Plant and machinery 80,000 SFP
Depreciation expense 8,000 IS
Opening inventory 70,000 IS
Closing inventory 40,000 IS
Office expenses (Net = 7,400 DEBIT) 8,000 600 IS
Prepayments 600 SFP
Etc.
Further conventions
Consistency - ‘when a particular method of

accounting is selected to deal with a transaction, this
method should be applied consistently over time’.
Materiality – “a material amount is one, knowledge
of which might influence a user of the financial
statements”
Dual aspect – “each transactions has two aspects,
and each aspect must be reflected in the financial
statements”.

Independent study and seminar
preparation
• Read chapter 3 pp83 - 97:

– Do “Review Questions” 3.3 and 3.4 (solutions in
text book)
– Do “Exercises” 3.3 and 3.4 (solutions in text
book)
• Read the supplementary lecture notes; work

through questions and solutions.
• Seminar: check Minerva


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Leeds University

LUBS1235 Introductory Financial

Measuring and reporting financial

When you have completed this week you should be able

• The Income Statement

• Recording Income Statement transactions (double

• The Trial Balance

• Year end adjustments:

LEEDS UNIVERSITY BUSINESS SCHOOL

• The Income Statement

• Recording Income Statement transactions (double

• The Trial Balance

• Year end adjustments:

LEEDS UNIVERSITY BUSINESS SCHOOL

3 key statement which are (usually) found in a set of

LEEDS UNIVERSITY BUSINESS SCHOOL

Financial statements comprise all documents in a

See Morrisons financial statements via Minerva link

Cash Statement for Year 1 Cash

LEEDS UNIVERSITY BUSINESS SCHOOL

The Income Statement shows all income received

PROFIT (or LOSS) = Revenue - Expenses

LEEDS UNIVERSITY BUSINESS SCHOOL

Income Statement for Year 1 Income Statement for Year 2

LEEDS UNIVERSITY BUSINESS SCHOOL

INCOME STATEMENT STATEMENT OF

LEEDS UNIVERSITY BUSINESS SCHOOL

ASSETS = CAPITAL + LIABILITIES

LEEDS UNIVERSITY BUSINESS SCHOOL

Income Statement (or Statement of Financial

LEEDS UNIVERSITY BUSINESS SCHOOL

• The Income Statement

• Recording Income Statement transactions (double

• The Trial Balance

• Year end adjustments:

LEEDS UNIVERSITY BUSINESS SCHOOL

INCOME STATEMENT STATEMENT OF

Debits = Credits Debits = Credits

• Assets BALANCE SHEET

• Revenue/income INCOME STATEMENT

LEEDS UNIVERSITY BUSINESS SCHOOL

Remember from Session 2…

ASSETS = CAPITAL + LIABILITIES

For example, a coffee shop business takes out a

Current assets: Non-current

LEEDS UNIVERSITY BUSINESS SCHOOL

Fixtures and fittings; Owner’s funds Long-term loans

Bank balance; Profit/loss Short term

IS Expenses Revenue (and

SFP Assets Liabilities

LEEDS UNIVERSITY BUSINESS SCHOOL

LEEDS UNIVERSITY BUSINESS SCHOOL

For example, a coffee shop business buys £1,000 of

Expenses: purchases Current liabilities:

LEEDS UNIVERSITY BUSINESS SCHOOL

For example, a coffee shop business buys £500

Current assets: Current assets:

For example, a coffee shop business sells a

LEEDS UNIVERSITY BUSINESS SCHOOL

For example, a coffee shop business pays an

Income Statement (extract)

LEEDS UNIVERSITY BUSINESS SCHOOL

SFP ↑ Assets ↑ Liabilities