Chapter V. Summarized, It Requires That From the Sum of Goods on Hand

at the beginning and those purchased since, there be subtracted the goods on hand and unsold at the close of the period. This last item, the goods on hand and unsold, is secured by making an actual count and valuation of such goods at the close of the fiscal period. The expedient of physical inventory-taking is therefore brought in as an aid to the accounting records, but only in the interests of economy.

Form of Profit and Loss Summary

GENERAL PRINCIPLES GOVERNING MAKE-UP. The profit and loss statement, as the complement of the balance sheet, is just as formal in character and the same general considerations govern as the make-up of the balance sheet, viz.: (1) the general purpose it is to serve; (2) the likelihood of obscuring essential facts through too great detail; and (3) the general appearance is to legibility, clearness of form and expression, and arrangement on the page.

TITLE. The heading of the summary must show the name of the business, followed by the title of the summary and the statement of the exact period covered by it. It was noted in Chapter V that whereas the balance sheet is a statement of financial condition as at a given date, the profit and loss summary is a statement of operations which have taken place during a given period. Hence, it is not sufficient merely to state the date of the close of the period. If, as is usually the case, the fiscal periods are of uniform length in a given business, the phraseology “For the Period Ending ...” will be sufficient for use within that business. It is better, however, for all statements of operation to indicate the length of the period covered. A typical heading for the profit and loss summary is indicated below:

JAMES R. ROBINSON & COMPANY STATEMENT OF PROFIT AND LOSS For the Six Months’ Period Ending December 31, 19—

ARRANGEMENT. The arrangement of the summary has already been indicated. The income from operations, that is, the operating income, is shown firsthand, and is followed by the operating expense, and then by the amount of the difference or the net result of operation. Next is shown the non-operating income, followed by the non-operating expense. The net result of this combined with the net result from operations gives the net result for the period, which is the figure shown on the balance sheet, the detail of which is explained by the profit and loss summary.

=Content of Profit and Loss Summary.=—The content of the profit and loss summary is determined by the need of information for purposes of management. A profit and loss summary which is sufficient for a small business, where the proprietor is in intimate contact with all phases of the business, would not give sufficient information for the proper control of a large business, where the managing executives are dependent for their information as to the various phases of business activity on reports made to them. There is, however, a fairly standard outline or skeleton in accordance with which this summary is usually drawn up. It is the purpose here to explain that outline.

The first section of the statement has for its purpose the separation of the sales item into its two elements, referred to above: (1) the Cost of Goods Sold, which indicates the amount by which the asset merchandise has been decreased through sale of goods; and (2) the Gross Profit or the excess of selling price ever cost, out of which must be met the costs of operating the business before the net change in proprietorship can be determined. This section is usually spoken of as the “trading” section of the statement. The set-up of this section shows, accordingly: (1) the Sales item, from which is shown deducted the amounts of sales returns and sales rebates and allowances in order to arrive at the figure of net sales; and (2) the Cost of Goods Sold, under which is listed the cost of goods sold as explained in Chapter V. This cost requires the showing of the initial inventory, the purchases for the period, the inward costs of laying down the merchandise at the place of business, such as insurance on goods in transit, freight and cartage costs, and so forth. From the sum of these items will be shown deducted the returned purchases and the amount of the final inventory, the difference indicating the cost price of goods disposed of by sale. With the “inward” cost of goods is sometimes included the sum total of all buying expenses. In other cases, particularly where a complete purchasing department is maintained, a separate buying expense section is set up to summarize these costs.

Following this trading section comes the formal statement of operating expenses which are usually classified for purposes of information into the groups: Selling Expenses, General Administrative Expenses, and Financial Management Expenses. Under each one of these groups should be listed the detailed items. Thus, under the selling expense group should be shown such items as salaries to salesmen; the traveling expenses incurred by them; the cost of publicity, advertising, and so forth; the sales management expense; and the delivery expenses, although these expenses are sometimes set up in a group by themselves.

The student will note that under the head of selling expenses are grouped all of the direct costs incurred in making sales.

Under the general administrative expenses should be shown such items as office salaries, stationery and supplies, postage, telephone and telegraph, light, heat, insurance, depreciation, and all other items which cannot be charged to definite departments of the business but must be borne by the business as a whole.

Under financial management expense should be listed the various items of expense which represent the financial activity of the business as related to its major purposes and which are operating financial expense items. Here will be shown such items as interest on money borrowed for operating the business; sales discounts granted customers in order to secure cash payments from them at an earlier date than the limit of the normal credit period allowed them; collection costs, and so forth.

A final section of the operating portion of the profit and loss statement lists the items of income arising out of the management of the working capital finances of the business. Interest received on customers’ notes and on cash balances in the bank, and purchase discounts, are usually the only items of income under this head.

The difference between gross profit on sales and the sum of these operating expenses minus the financial income, is the operating profit of the business, sometimes called Net Operating Profit.

The section following this is devoted to the marshaling of the items of Non-operating Income and Expense. Whichever of these two groups is the larger is set up first, and from its total is deducted the total of the other group. The net amount is then shown extended under the item of net operating profit, to which it is added if it is a net income item and from which it is subtracted if it is a net expense item. The resulting figure is the Net Profit for the period.

Occasionally there are extraordinary items of profit or loss not to be classified under any of the above heads, which have to be shown in additional sections of the profit and loss statement. These are matters which will be taken up later.

It should be noted that the above paragraphs outline a simple statement of profit and loss for a commercial or trading business as distinguished from an industrial or manufacturing enterprise, the statement for which is somewhat more complex even in its general outlines.

=Algebraic Content of the Profit and Loss Statement.=—An algebraic presentation of the profit and loss statement is oftentimes valuable. The cost-of-goods-sold portion becomes:

(1) Initial Inventory + Purchases - Final Inventory = Cost of Goods Sold

(2) Sales - Cost of Goods Sold = Gross Trading Profit

The rest of the statement is covered by the following equation:

(3) Gross Trading Profit - (Selling Expenses + General Administrative Expenses + Financial Management Expense - Financial Management Income) ± (Non-operating Income - Non-operating Expense)

= Net Profit

=The Disposition of the Net Profit.=—The net profit for the period belongs to the proprietor and constitutes an increase in his proprietorship or investment, unless he has already drawn out some of these profits as they accrued. In this case, his drawings must be subtracted from the net profit indicated before showing the increment to his net worth. Accordingly, a final section of the profit and loss statement may give the disposition of the net profit and its appropriation or addition to the previous net worth or proprietorship item. This section, when used, is known as the appropriation section. If the business is a partnership, this section should show in detail the distribution of net profit among the several partners according to the agreement among them as to the proportions in which they are to share gains or losses. If a corporation, it should give the disposition made of the net profit in the way of dividends to the stockholders, and any other appropriation made of these profits, including transfer to surplus.

Two illustrations—one very simple, the other more complex—typical of profit and loss summaries are given for the guidance of the student.

Illustration 1

AARON CONNERS STATEMENT OF PROFIT AND LOSS For the year ending June 30, 1922

Sales for the year $28,465.20 Goods on Hand July 1, 1921 $ 8,500.00 Purchases during the year 22,362.50 $30,862.50 --------- Goods on Hand June 30, 1922 10,260.00 --------- Cost of Goods Sold 20,602.50 --------- Gross Trading Profit $ 7,862.70

Clerk Hire $3,050.50 General Expenses $2,405.45 Depreciation 52.50 2,457.95 5,508.45 --------- --------- --------- Net Profit for the year $2,354.25 =========

Illustration 2

KIMBALL AND MOREY STATEMENT OF PROFIT AND LOSS For the Year Ending June 30, 19—

Sales $525,600.00 Less: Sales Returns $ 5,000.00 Sales Rebates and Allowances 600.00 5,600.00 ----------- ----------- Net Sales $520,000.00

Cost of Goods Sold: Inventory, July 1, 19— $ 96,670.00 Purchases during the year 350,000.00 Freight-In 1,000.00 Insurance (Goods in Transit) 750.00 $448,420.00 ----------- Less: Purchase Returns $ 1,750.00 Final Inventory, June 30, 19— 105,000.00 106,750.00 ----------- ----------- Cost of Goods Sold 341,670.00 ---------- Gross Profit $178,330.00

Selling Expenses: Salesmen’s Salaries $ 20,000.00 Advertising 25,000.00 Delivery Expense 5,000.00 $ 50,000.00 -----------

General Administrative Expenses: Office Salaries $ 10,000.00 Stationery and Supplies 1,500.00 Postage 250.00 Telephone and Telegraph 750.00 Light and Heat 1,750.00 Insurance (Stock and Fixtures) 1,500.00 Depreciation: Furniture and Fixtures $2,000.00 Buildings 1,500.00 3,500.00 --------- Miscellaneous Expenses 750.00 20,000.00 -----------

Financial Management Expenses: Interest Paid $ 250.00 Sales Discounts 5,000.00 Bad Debts 1,000.00 Collection Costs 250.00 6,500.00 ----------- ----------- Total Operating Expenses $ 76,500.00

Financial Management Income: Interest Received $ 1,350.00 Purchase Discounts 3,500.00 4,850.00 ----------- ----------- Net Operating Expense 71,650.00 ----------- Net Operating Profit $106,680.00

Non-Operating Expense and Income: Income--Interest on Liberty Bonds $ 2,000.00 Expense--Loss on Stocks Sold 900.00 1,100.00 ----------- ----------- Net Profit for the year $107,780.00 =========== Appropriation of Net Profit: J. H. S. Kimball, ⅖ share $ 43,112.00 H. F. C. Morey, ⅗ share 64,668.00 $107,780.00 ----------- ===========

=The Two Methods of Determining Net Profit.=—It is particularly important to note that the profit shown by the profit and loss statement must be the same as that developed by the comparative balance sheet, since both cover the same period and constitute merely two ways of developing the same result. For this reason they are valuable in proving the correctness of results, acting as checks against each other. The student must bear in mind, however, that the increase or decrease in net worth as shown by the comparative balance sheet must always be adjusted by taking account of additional investments or withdrawals of capital before the net profit for the period can be determined, and therefore before this figure can be used as a check against the amount of net profit shown by the statement of profit and loss.

The accounting department keeps both classes of records, viz., the asset and liability records and the temporary proprietorship or income and expense records, not because both are needed to develop the amount of net profit—either class would do this—but because both are needed for the additional information which they give and which is valuable and necessary for the intelligent management of the business.