CHAPTER VI. The Profit and Loss Summary

THE PROFIT AND LOSS SUMMARY

=Type of Information Needed.=—The need and purpose of the information to be furnished by the temporary proprietorship records was pointed out in Chapter V. Without information of this sort, proper control of business operations cannot be exercised. These records supply a summarized picture of the activities of the business during a definite period, which have as their goal the increase in proprietorship—the making of a profit. In attaining this goal, two main types of activities or operations are entered into, usually classified under the heads of: (1) income or earnings, by which is meant those activities which immediately and directly increase proprietorship; and (2) expenses or outgo, comprising those activities which decrease proprietorship. Expenses are the costs incurred in securing income, and are therefore deductions from it. A fuller explanation of these terms will now be given.

=Income.=—Income is usually of two types: operating and non-operating. These terms are always relative; that is, what is an operating income in one business may be a non-operating income in another business. The term “operating income” is used to indicate the main sources of income in a given business. It is always the duty of the accounting department to indicate the sources of income. Thus in a trading or mercantile business, the selling of goods to customers is the main source of income. In a professional business, the selling of services, often titled “professional fees,” is the main source; in a brokerage or commission business, commissions earned; in institutions, tuition and other fees; in a financial business, interest earnings; in a society, membership fees. These are typical titles for indicating the main source of income in the several kinds of undertakings mentioned.

While sales are the major source of income in a trading concern, there may be supplementary sources. It may own stocks and bonds from which income may be derived. In a manufacturing or mining enterprise the company may own dwelling houses and rent them to its employees. Conditions of travel and communication may also force it to provide stores, places of amusement, and so forth for its workers. From all these supplementary activities it will derive income. As it was not organized primarily for these purposes, but chiefly to manufacture, or mine a commodity, the income from these collateral activities is classed as non-operating income.

The distinction, then, between operating and non-operating income is, as mentioned above, always a relative one and will be determined in any given instance on the basis of major activities and supplementary or minor activities. Some of the titles under which income is recorded will now be explained:

SALES. Under this title is recorded the amount of sales of the stock-in-trade in a merchandising or manufacturing concern. The two elements included here, namely, the decrease of the asset merchandise and the increase of proprietorship—the true income element—will be discussed later.

SALES RETURNS. This title does not represent income but, as its name indicates, shows the amount of the goods sold which have been returned because of dissatisfaction with the quality or condition of the goods or some error in sending the wrong kind.

SALES ALLOWANCES. These are similar to sales returns in that they indicate a deduction from the sales income for the allowances made to the purchasers who for one reason or another have just cause to be dissatisfied with the goods but agree to retain them providing an allowance from the original selling price is made.

INTEREST INCOME. Under this title is recorded the income from money loaned or credit extended. Notes receivable and bonds are the usual sources. Sometimes open accounts receivable also bring interest.

RENTAL INCOME. Under this title is recorded income received from the lease of premises, lands, or buildings.

PROFESSIONAL FEES. Under this title is recorded the income from charges made for professional services.

COMMISSIONS EARNED. Included under this title is the income received from services rendered in the selling of commodities for a principal.

PURCHASE DISCOUNT. This represents the deduction allowed from the original charge for paying a debt in advance of the date named in the purchase contract.

=Expenses.=—Expenses are also of two types: operating and non-operating. The same distinction is made here as with income. Those expenses incurred in securing operating income are operating expenses, while those incurred in securing non-operating income or for other purposes are called non-operating expenses.

To secure control over the operating and non-operating types of activities, it is necessary to compare operating income with operating expenses, and non-operating income with non-operating expenses, in order to measure the return by the effort expended in securing that return. Some of the more common titles under which the record of expenses is made are as follows:

SALARIES (WAGES). Under this title is included the cost of the services rendered by employees. This may be classified in accordance with the department in which the service is rendered; for example, factory wages, salesmen’s salaries, office salaries, and so forth.

TRAVELING EXPENSES. The costs of railroad fare, entertainment, and so forth, when traveling in the interests of the business.

ADVERTISING. The cost of publicity in making known the commodities offered for sale by the business.

BUYING EXPENSE. The costs incurred in making purchases for the business. These may comprise the salaries of buyers and all expenses in connection with maintaining a purchasing department.

RENT. The cost for the use of premises not owned.

PLANT MAINTENANCE. The cost of upkeep, repairs, and so forth, on the plant used by the business. The cost, by purchase or manufacture, of light, heat, and power is included here.

DEPRECIATION. The decrease in value of a fixed asset due to wear and tear, lapse of time, obsolescence, etc.

BAD DEBTS. The amount of outstanding accounts receivable which have proven or are judged to be uncollectible.

SALES DISCOUNTS. The cost incurred because of the financial policy of charging a customer a smaller amount than the amount of the bill, provided he pays by a given date.

TELEPHONE, TELEGRAPH, STATIONERY, POSTAGE, INTEREST COST, COMMISSIONS PAID, AND SO FORTH. These all indicate by their titles the nature of the expense or cost items.

The student should understand that expenses may be set up in very much greater detail than that indicated by the above titles. Usually the title under which record of an expense is made will indicate with sufficient clearness its character.

=The Profit and Loss Summary.=—As indicated in Chapter V, the profit and loss summary shows the manner in which the net worth of the business has been changed as the result of operations of the business, as distinguished from changes brought about through withdrawal or investment of capital. Although it is really a part of the balance sheet, which shows financial condition, because of its importance it is, however, set up as a separate statement. It amplifies and fills out the record shown by the balance sheet. It is a supplementary record because it gives additional information, and is complementary to the balance sheet because it rounds out and completes the story of business life there recorded.

Just as with the balance sheet, the main problems of the profit and loss summary relate to: (1) its form; and (2) its content. After an explanation of some of the terms used in connection with the summary, these two problems will be discussed.

=The Fiscal Period.=—Because of the work involved and the frequent incompleteness of the records at the close of each day, a daily statement of condition is very seldom made up. The business experience of a particular enterprise determines the frequency of preparation of these statements. Whatever the period may be between statements, be it a month, three months, a half-year, or a year, it is called the fiscal period, i.e., it is the period at the end of which records are summarized for the purpose of ascertaining the profit or loss for the period. For purposes of comparison with preceding and following fiscal periods, under similar conditions, the fiscal period should be, and usually is a period of regular length—a half-year or year being perhaps the most common, though in many enterprises it is customary to draw up supplementary monthly statements.

=Need for the Physical Inventory.=—Again, because of the work involved, especially where the product dealt in is small in value and sales are numerous—as in stores dealing in clothing, food, and the like—no record of the cost of each article is kept as it is sold, only the sale price being recorded. It is not possible, therefore, to determine from the records as usually kept, the cost of the goods on hand at a given time. The records are kept in this way, not because systems of accounting cannot be devised to make both records, but because the results obtained by such systems are not justified by their cost when other and less expensive means can be used with almost as satisfactory results.

The customary method of finding the cost of goods sold was indicated in