Financial Statements

Lessons

Senior 6 · Entrepreneurship

Financial Statements

4 lessons

Lesson 2 of 4

Preparing an income statement

25 min

Where did Frw 24.5 million go?

In the year to 30 June 2026 Uwase's shop sold Frw 24,500,000 of seed, fertiliser and tools. Yet when she counts what the year really earned her, the figure is far smaller. Part of the sales money paid for the goods themselves, part went back to customers who returned damaged sprayers, and part paid wages, rent and electricity.

The income statement follows the money down, one step at a time, from total sales to the profit that is really hers. It has two sections: the trading section, which finds the profit on buying and selling goods, and the profit and loss section, which adds other income and takes away the running expenses.

Definition

Cost of goods sold (or cost of sales): the cost of the stock that was actually sold during the period, not the cost of everything bought.

\text{cost of goods sold} = \text{opening stock} + \text{net purchases} - \text{closing stock}

Example: Uwase started the year with Frw 1,850,000 of stock and ended with Frw 2,150,000 unsold, so not all of the year's purchases were sold.

Definition

Gross profit: net sales minus the cost of goods sold, the profit made on trading before running expenses. Net profit: gross profit plus other income minus all expenses, the profit that belongs to the owner. If the result is negative it is a gross loss or a net loss.

\text{gross profit} = \text{net sales} - \text{cost of goods sold}

\text{net profit} = \text{gross profit} + \text{other income} - \text{expenses}

Example: a sprayer bought for Frw 30,000 and sold for Frw 42,000 earns a gross profit of Frw 12,000 before the shop's rent and wages are paid.

The shape of the statement

Which items go where

Trading section (cost of the goods)	Profit and loss section (running the business)
Sales, less returns inwards	Other income: discount received, commission received, rent received
Opening and closing stock	Wages and salaries, rent, electricity, water, insurance
Purchases, less returns outwards	Advertising, telephone, transport of goods to customers (carriage outwards)
Carriage inwards (transport of goods bought), wages paid to bring goods into a saleable state	Discount allowed to customers, interest on loans, bank charges
Goods taken by the owner (deducted from purchases)	Never here: drawings, assets such as vans, loan repayments

Definition

Carriage inwards and carriage outwards: carriage inwards is the cost of transporting goods TO the business when they are bought; it is part of the cost of the goods, so it is added to purchases. Carriage outwards is the cost of delivering goods to customers; it is a selling expense in the profit and loss section.

Example: the lorry that brings fertiliser from the wholesaler is carriage inwards; the delivery van taking orders to farmers' cooperatives is carriage outwards.

Definition

Accrued expense and prepaid expense: an accrued (owing) expense belongs to this year but has not yet been paid; it is ADDED to the expense and shown as a current liability. A prepaid expense has been paid this year but belongs to next year; it is SUBTRACTED from the expense and shown as a current asset. When nothing was owing or prepaid at the start of the year:

\text{expense for the year} = \text{amount paid} + \text{amount owing at the end} - \text{amount prepaid at the end}

Example: June's electricity bill of Frw 30,000 arrives in July: it is still a June expense.

Tip

Carriage IN goes IN with the goods; carriage OUT goes OUT with the expenses. And returns follow their partners: returns inwards come off sales, returns outwards come off purchases.

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Worked example 1: the adjustments first

Uwase's trial balance shows rent paid of Frw 1,300,000, which includes Frw 100,000 paid in advance for July 2026, and electricity paid of Frw 330,000, with June's bill of Frw 30,000 still unpaid. She also took fertiliser costing Frw 120,000 for her own farm and recorded nothing. Adjust each figure.

Rent: $1,300,000 - 100,000 = 1,200,000$ for the year; Frw 100,000 is a prepaid expense (current asset).

Electricity: $330,000 + 30,000 = 360,000$ for the year; Frw 30,000 is an accrued expense (current liability).

Goods taken: deduct Frw 120,000 from purchases, because those goods were not sold by the business, and add it to drawings: $1,800,000 + 120,000 = 1,920,000$ .

Worked example 2: Uwase's income statement

From this trial balance, and with closing stock valued at Frw 2,150,000 on 30 June 2026 and the adjustments in Worked example 1, prepare Uwase's income statement for the year.

Uwase Agro-Inputs: trial balance as at 30 June 2026
Account	Dr (Frw)	Cr (Frw)
Capital (1 July 2025)		3,705,000
Drawings	1,800,000
Delivery van	6,000,000
Furniture and fittings	1,400,000
Stock (1 July 2025)	1,850,000
Sales		24,500,000
Purchases	14,600,000
Returns inwards	240,000
Returns outwards		320,000
Carriage inwards	380,000
Carriage outwards	210,000
Wages	2,400,000
Rent	1,300,000
Electricity	330,000
Insurance	180,000
Advertising	150,000
Discount allowed	60,000
Discount received		90,000
Commission received		250,000
Debtors	1,150,000
Creditors		1,640,000
Bank loan (repayable 2030)		4,000,000
Cash at bank	2,310,000
Cash in hand	145,000
Totals	34,505,000	34,505,000

Solution (vertical format):

Uwase Agro-Inputs: income statement for the year ended 30 June 2026
	Frw	Frw	Frw
Sales			24,500,000
Less: Returns inwards			(240,000)
Net sales			24,260,000
Less: Cost of goods sold
Opening stock		1,850,000
Purchases	14,600,000
Add: Carriage inwards	380,000
Less: Returns outwards	(320,000)
Less: Goods taken by the owner	(120,000)
Net purchases		14,540,000
Cost of goods available for sale		16,390,000
Less: Closing stock		(2,150,000)
Cost of goods sold			(14,240,000)
Gross profit			10,020,000
Add: Other income
Discount received		90,000
Commission received		250,000	340,000
Gross income			10,360,000
Less: Expenses
Wages		2,400,000
Rent (1,300,000 − 100,000 prepaid)		1,200,000
Electricity (330,000 + 30,000 owing)		360,000
Insurance		180,000
Advertising		150,000
Carriage outwards		210,000
Discount allowed		60,000
Total expenses			(4,560,000)
Net profit			5,800,000

Checks. Net purchases: $14,600,000 + 380,000 - 320,000 - 120,000 = 14,540,000$ . Cost of goods sold: $1,850,000 + 14,540,000 - 2,150,000 = 14,240,000$ . Gross profit: $24,260,000 - 14,240,000 = 10,020,000$ . Expenses: $2,400,000 + 1,200,000 + 360,000 + 180,000 + 150,000 + 210,000 + 60,000 = 4,560,000$ . Net profit: $10,360,000 - 4,560,000 = 5,800,000$ .

Items not used here (capital, drawings, the van, the fittings, debtors, creditors, the loan and the cash balances) all go to the balance sheet in Lesson 3.

Warning

Four errors that cost marks. (1) Deducting returns inwards from purchases instead of from sales. (2) Treating drawings as an expense: drawings are the owner taking value out, and come off capital. (3) Adding closing stock instead of subtracting it in the cost of goods sold. (4) Using the amount PAID for an expense when part is owing or prepaid. A company would go on to deduct corporate income tax from its profit before tax; a sole trader's statement stops at net profit, because the business is taxed through its owner.

CPA Dekow Mohamed, "Trading Profit And Loss Account for Beginners" (about 7 minutes). Watch how gross profit is found in the trading section and then carried into the profit and loss section to find net profit.

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Practice

Define gross profit and net profit, and explain the difference between them.
State whether each item belongs in the trading section or the profit and loss section: (a) carriage inwards; (b) carriage outwards; (c) discount received; (d) returns outwards; (e) wages of shop assistants.
Opening stock Frw 400,000; purchases Frw 2,600,000; returns outwards Frw 100,000; carriage inwards Frw 50,000; closing stock Frw 550,000. Calculate the cost of goods sold.
Wages paid during the year were Frw 1,150,000, and Frw 50,000 was owing at the year end. What is the wages expense for the year, and where does the Frw 50,000 appear in the balance sheet?
On 1 January 2025 a business paid Frw 240,000 for 15 months' insurance. Calculate the insurance expense for the year ended 31 December 2025 and the amount prepaid.
Habimana Electronics, Musanze (year ended 31 December 2025, Frw): sales 8,400,000; returns inwards 150,000; opening stock 900,000; purchases 5,200,000; carriage inwards 120,000; returns outwards 80,000; closing stock 1,100,000; wages 960,000; rent 600,000, of which 50,000 is prepaid; electricity 180,000, with 20,000 owing; carriage outwards 70,000; commission received 90,000; discount allowed 40,000. Prepare the income statement.
An owner took goods costing Frw 200,000 for her family, and nothing was recorded. Analyse the effect on the cost of goods sold, gross profit and net profit.

Show answersHide answers

Gross profit is net sales minus the cost of goods sold, the profit on trading. Net profit is gross profit plus other income minus all running expenses, the profit left for the owner. Gross profit is always found first; net profit is smaller whenever expenses exceed other income.
(a) Trading; (b) profit and loss; (c) profit and loss (other income); (d) trading; (e) profit and loss.
Net purchases $2,600,000 - 100,000 + 50,000 = 2,550,000$ ; goods available $400,000 + 2,550,000 = 2,950,000$ ; cost of goods sold $2,950,000 - 550,000 = 2,400,000$ .
$1,150,000 + 50,000 = 1,200,000$ . The Frw 50,000 is an accrued expense under current liabilities.
Expense $= \frac{12}{15} \times 240{,}000 = 192{,}000$ ; prepaid $= \frac{3}{15} \times 240{,}000 = 48{,}000$ , a current asset.
Net sales $8,400,000 - 150,000 = 8,250,000$ . Net purchases $5,200,000 + 120,000 - 80,000 = 5,240,000$ ; goods available $900,000 + 5,240,000 = 6,140,000$ ; cost of goods sold $6,140,000 - 1,100,000 = 5,040,000$ . Gross profit $8,250,000 - 5,040,000 = 3,210,000$ . Add commission received 90,000: 3,300,000. Expenses: wages 960,000; rent $600,000 - 50,000 = 550,000$ ; electricity $180,000 + 20,000 = 200,000$ ; carriage outwards 70,000; discount allowed 40,000; total 1,820,000. Net profit $3,300,000 - 1,820,000 = 1,480,000$ .
Purchases are overstated by 200,000, so the cost of goods sold is overstated by 200,000 and gross profit (and therefore net profit) is understated by 200,000. Drawings are understated by the same amount. The correction is to deduct 200,000 from purchases and add it to drawings.

Sources and credits

Video: Trading Profit And Loss Account for Beginners, CPA Dekow Mohamed, embedded from YouTube.

Written by Ganzaa: Uwase's trial balance and income statement, the ladder diagram, the tables, the worked examples and the practice items. The businesses, names and figures are illustrative (2026).

1Where did Frw 24.5 million go?

2The shape of the statement

3Which items go where

Where did Frw 24.5 million go?

The shape of the statement

Which items go where