How to prepare an income statement for a sole trader

Step by step

1. Start with revenue. Begin with revenue (sales), less any sales returns.
2. Calculate cost of sales. Cost of sales = opening inventory + purchases (+ carriage inwards − purchases returns) − closing inventory.
3. Find gross profit. Gross profit = revenue − cost of sales.
4. Add other income. Add any other income, such as discount received or rent received.
5. Deduct expenses. List and total the operating expenses, adjusted for accruals and prepayments, then subtract them.
6. State profit for the year. The final figure, after all expenses, is the profit for the year.

Worked example

Revenue RM50,000 − cost of sales RM30,000 = gross profit RM20,000. Less expenses RM12,000 = profit for the year RM8,000.

Understanding the method

The income statement has two levels. Gross profit is revenue less the cost of the goods actually sold. Profit for the year is gross profit plus other income, less all the running expenses.

Gross profit shows how well the business buys and sells. Profit for the year shows what is left for the owner.

Cost of sales cannot simply be purchases. Some goods bought were still unsold at the year end, and some goods sold came from last year's stock.

So cost of sales = opening inventory + purchases − closing inventory. Unsold inventory is carried forward as an asset, which follows the matching concept: costs are set against the revenue they helped to earn.

Carriage inwards (delivery cost of goods bought) is added to purchases, because it is part of getting the goods ready to sell. Carriage outwards (delivery to customers) is a selling expense and goes below gross profit.

Trial balance figures usually come jumbled, so sort each into revenue, cost of sales, other income or expense. Returns inwards come off revenue. Returns outwards come off purchases.

Discount received is other income. Discount allowed is an expense. Adjust expenses for accruals, prepayments and depreciation before entering them.

Here is an example. Revenue is RM90,000, returns inwards RM2,000, opening inventory RM8,000, purchases RM50,000, carriage inwards RM1,000 and closing inventory RM11,000. Net revenue is 90,000 − 2,000 = RM88,000.

Cost of sales is 8,000 + 50,000 + 1,000 − 11,000 = RM48,000. Gross profit is 88,000 − 48,000 = RM40,000.

Expenses are wages RM15,000, rent RM6,000 and depreciation RM2,000, so RM23,000 in total. Discount received of RM500 is other income. Profit for the year is 40,000 + 500 − 23,000 = RM17,500.

To check, gross profit should be sensible compared with revenue. Gross profit bigger than revenue usually means closing inventory or returns went the wrong way. Make sure every expense in the trial balance is used once.

Common mistakes: mixing up carriage inwards and outwards, and adding closing inventory instead of subtracting it. Another is adjusting accruals and prepayments in the wrong direction (an accrual raises the expense, a prepayment lowers it).

Drawings are the owner taking money out, not a cost of trading, so they never appear here. Depreciation is an expense even though no cash moves.

If you lose marks on cost of sales or on where each item belongs, we can help. One of our teachers can walk through a past-paper income statement with you and show the order to follow. Book a trial class

Related skills

• How to prepare a statement of financial position
• How to record accruals and prepayments

The methods here are standard accounting practice, with original figures. For your exam board's exact requirements, see exam boards and Sources.