Accounting theory and practice, Volume 1 (of 3)

by Roy B. Kester

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 [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.