Preparation of income and expenditure statement
Explanation of certain elements of the income statement
Wages are paid for the services of employees and are debited to the income and expense account as an indirect expense. If any salary has been paid to owner or partners, it should be shown separately as it requires special treatment at the time of income tax assessment.
2. Wages and remuneration
When the wage bill is included in wages, it is treated as an indirect expense and charged to the income statement.
The rent of the showroom or shop for an office shop is an indirect expense and is debited to the profit and loss account. However, the factory rent is debited from the trading account. When part of the building is sublet, the rent received should be shown on the credit side of the income statement as a separate item.
4. Tariffs and Taxes
They are collected by local authorities to cover public expenditure. As an indirect expense, it is shown on the debit side of the income statement.
The interest on credit, overdraft or overdue debts is paid by the company. This is an indirect cost; so it is debited in the income statement. Loan interest advanced by the firm on depositors’ investments is income of the firm and is credited to the income statement.
If the business has paid any interest on capital to its owner or partners, this should also be debited in the profit and loss account, but separately, as this item needs special treatment during income tax assessment.
In business, agents are sometimes appointed to make sales, who are paid a commission as remuneration. So this as cost of sale is shown on the debit side of the profit and loss account. Sometimes a commission is also paid on purchases of goods, such as “the expense must be debited to the trading account”. Sometimes the company may also act as an agent of other business houses and in such cases receives a commission from them. The commission thus received is shown on the credit side of the income statement.
7. Trading Expenses
They are also called “other expenses”. Trading expenses are expenses of such a nature that it is not worth keeping separate accounts. Trading expenses do not apply to the trading account.
Repairs to the plant, machinery, building are indirect costs, treated as an expense and debited to the profit and loss account.
9. Travel expenses
Unless otherwise stated, travel expenses are treated as indirect expenses and debited to the income and expenditure account.
10. Horse and stable expenses
Expenses incurred for horse feed and wages paid for looking after stables are treated as indirect expenses and debited to the income statement.
11. Apprentice Premium
This is the amount charged by individuals who are provided training by the business. This is revenue and is credited to the income statement. In case the apprentice premium is charged in advance for two or three years, then the amount is spread over several years and the profit and loss account for each year is credited with its share of the income.
12. Bad debts
This is the amount that cannot be refunded by the merchant due to credit sales. This is a business loss, so it is debited to the income statement.
13. Life Insurance Premium
If the premium was paid on the business owner’s life policy; it is treated as his drawings and shown by deduction from the capital account. It should not be reported on the income statement.
14. Insurance premium
If the insurance premium bill appears on the trial balance, it means the business insurance. This is reported in the income statement. Insurance premium on purchased goods, factory building, factory machinery are treated as a direct expense and taken to the trading account.
15. Tax on total income
In the case of a trader, the income tax paid is treated as a personal expenditure and shown by deduction from the capital account. Income tax in case of companies is treated differently.
16. Discount Allowed and Received
The discount is a reward for quick payment. Discount received and discount allowed are deemed to be shown separately on the credit and debit side respectively of the profit and loss account instead of showing the net balance of that account.
Depreciation is a loss incurred due to the use of fixed assets in the business. It is usually charged to the profit and loss account at a fixed rate. Students should be very careful about the rate of depreciation. If the rate is without the words “per annum” then the rate will be taken regardless of the billing period. This is very important when the period of accounts is less than one year. On the other hand, if the rate of depreciation is ‘per year’, the depreciation should be calculated on the assets taking into account the period during which the asset was used in the business during the year. In case of addition of assets during the year, it is advisable to ignore the depreciation of the additions if the date of addition is not stated. The same rule applies to the sale of assets during the year.
18. Ending stock appearing in the trial balance.
It is important to emphasize the rule that the balance appearing in the trial balance refers to one and only one place. This can be either a trading account or a profit and loss account or a balance sheet. Since closing stock is an asset, it will be reported on the balance sheet. On the other hand, as long as there is stock in trade, the account for it should be kept open and thus referred to the assets of the balance sheet.
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