Back in Chapter 2, we discussed the four financial statements. The table from that chapter is replicated below. It shows what the Australian accounting standards require from businesses in terms of their financial statements.
|#||Financial statement name from AASB 101||Common names (if applicable)||Plain English description|
|1||Statement of profit and loss and other comprehensive income for the period||Profit and loss statement
|A summary of the revenues and expenses of a business over the financial period (usually a year)|
|2||Statement of financial position||Balance Sheet||A snapshot of the assets, liabilities and equities of the business at a specific date in time.|
|3||Statement of changes in equity||A summary of the change in the value of equity in the business. Equity is essentially the value of the business after debts are paid.|
|4||Statement of cash flows||A summary of the cash coming into and going out of the business over the financial period (usually a year).|
In this section, we will examine how to construct the “Statement of profit and loss and other comprehensive income for the period” – but let’s simplify things and call it the Profit and Loss Statement (or P&L if we are going even shorter!). We create this statement first – we can’t create any of the others without knowing how much profit or loss the business made. As you work through this chapter, you’ll notice that we do not create the financial statements in the same order as the table above! You start with #1, then #3, followed by #2 and finally #4.
What is the profit and loss statement?
You may have figured out by now that Revenues minus Expenses will give you Profit. Alternatively, if Expenses are larger than Revenues, you will have a Loss. This is demonstrated in the table below.
|Scenario 1||Scenario 2|
|Expenses||– $500||– $2,500|
|+ $1,000 [PROFIT]||– $500 [LOSS]|
This represents a business’ financial performance over a specific period of time. That period of time could be a month, a quarter, 6 months or a full year. In Australia, the financial year for most businesses is 1 July to 30 June. Accrual accounting, the revenue recognition principle and the matching principle all come together in the profit and loss statement.
Creating the profit and loss statement
For those who really want to geek out on how to present the financial statements – you can check out the Australian Accounting Standards Board’s requirements in AASB 101 Presentation of Financial Statements. Warning – it is pretty hard to read for the average introductory student. If that doesn’t sound like your jam, skip it and read on!
To create our profit and loss statement, we need our Trial Balance. To better illustrate how to do this – we’ve expanded the previous Trial Balance to include some additional accounts that will allow us to create a more realistic set of financial statements. The Trial Balance lists the accounts in the order of Assets, Liabilities, Equity, Revenues and Expenses and is for a specific period.
This trial balance below is for the fictional business Saanvi’s Chic Celebrations (SCC) – a business that specialises in the booming area of high end fashion for south asian weddings. This includes events like Mehendi and Sangeet ceremonies. The Mehendi is where henna is applied to the bride and other female members of the wedding party and the Sangeet is a music night that involves singing and dancing. The company is a small private business – so we will denote this with the words Pty Ltd after the company name. Public companies (those listed on the stock exchange) are denoted by the words Ltd after the company name. For example Woolworths Ltd, Qantas Airways Ltd. The Trial Balance captures everything from 1 July 2021 to 30 June 2022. It is important that we start adding information about the financial period because soon we’ll be starting to compare financial information from various periods (months or years) – so they need to be clearly labelled.
Trial balance for Saanvi’s Chic Celebrations Pty Ltd
for the period 1 July 2021 to 30 June 2022
|Property, plant and equipment||35,000|
|Cost of sales||-5,500|
AASB 101 provides guidance to most Australian businesses on how to construct the profit and loss statement. Essentially the structure is as follows:
Profit and Loss Statement for the Period Ending 30 June 202X
Less Cost of Sales
= GROSS PROFIT
= Net profit before tax (NPBT)
Less income tax
= Net profit after tax (NPAT)
Taking our Trial Balance from above – if we wanted to create a profit and loss statement – it would look like this:
|Profit and Loss Statement for Saanvi’s Chic Celebrations Pty Ltd|
|For the period ending 30 June 2022|
|Less Cost of sales||(5,500)|
|Net profit before tax||2,500|
You may notice that negative numbers are denoted by a bracket – this is international convention because it is possible that the small negative symbol e.g. -$5000 might be missed – whereas ($5000) has more clarity.
Analysing the profit and loss statement
In Chapter 6 we will go into more detail about analysing the financial statements, but with what we know now, we can see that SSC makes both a gross profit and a net profit – all positive signs for a business.
Where to next?
The profit and loss statement is the first statement that we must create in the financial statements because it provides us with the profit (or loss) that the business has earned over the financial period (whether it be a month, quarter, 6 months or one year). Who does this profit (or loss) belong to? It belongs to the owners of the business – the shareholders. So we need a way to incorporate this profit (or loss) into their holdings or ownership of the firm. In accounting, we incorporate our profits (or losses) into an account called Retained Earnings – this will contain a sum of the all the profits and losses of the business over its lifetime. Hence our next financial statement that we will need to create is the Statement of Changes in Equity.