What you'll learn
The income statement is a fundamental financial statement that shows whether a sole trader has made a profit or loss over a specific accounting period. This topic appears in every CIE IGCSE Accounting examination paper, typically worth 15-25 marks. You must understand how to construct both the trading account and profit and loss sections, correctly classify income and expenses, and calculate gross profit and net profit.
Key terms and definitions
Income Statement — A financial statement showing the revenue earned and expenses incurred by a business over an accounting period, resulting in either a net profit or net loss.
Trading Account — The first section of an income statement that calculates gross profit by matching sales revenue with the cost of goods sold.
Cost of Goods Sold (COGS) — The direct cost of purchasing or manufacturing goods that were sold during the accounting period, calculated as opening inventory + purchases - closing inventory.
Gross Profit — The profit made from trading activities before deducting expenses, calculated as sales revenue minus cost of goods sold.
Net Profit — The final profit after deducting all expenses from gross profit, showing the overall profitability of the business.
Expenses — The costs incurred in running the business that are not directly related to purchasing goods, such as rent, wages, insurance, and advertising.
Carriage Inwards — Transport costs paid to bring purchased goods into the business; added to purchases in the trading account.
Returns — Goods sent back; sales returns (returns inwards) reduce sales revenue, while purchases returns (returns outwards) reduce purchases.
Core concepts
Structure of the Income Statement
The income statement for a sole trader has two main sections presented vertically:
Section 1: Trading Account
- Calculates gross profit from buying and selling activities
- Shows sales revenue at the top
- Deducts cost of goods sold
- Results in gross profit figure
Section 2: Profit and Loss Account
- Takes gross profit from the trading account
- Adds any other income (discount received, commission received, rent received)
- Deducts all business expenses
- Results in net profit or net loss
The complete statement covers a specific period (e.g., "for the year ended 31 December 2024") and follows a standardised format that examiners expect to see.
Calculating Cost of Goods Sold
The cost of goods sold calculation is central to the trading account and follows this formula:
Opening Inventory
+ Purchases
+ Carriage Inwards
- Purchases Returns
- Closing Inventory
= Cost of Goods Sold
Opening inventory represents goods available for sale at the start of the period, valued at cost price. This becomes the closing inventory from the previous period.
Purchases include all goods bought for resale during the period. Cash and credit purchases are combined into one purchases figure.
Carriage inwards (or carriage on purchases) represents transport costs paid to bring goods into the business. This increases the cost of purchases because it's part of getting goods ready for sale.
Purchases returns (or returns outwards) are goods sent back to suppliers, reducing the net purchases figure.
Closing inventory represents goods remaining unsold at the period end, valued at the lower of cost and net realisable value. This is deducted because these goods haven't been sold yet, so their cost shouldn't be matched against this period's sales.
The Trading Account Section
The trading account appears first and follows this format:
Sales Revenue £X
Less: Sales Returns (X)
____
Net Sales Revenue X
Less: Cost of Goods Sold
Opening Inventory X
Add: Purchases X
Carriage Inwards X
___
X
Less: Purchases Returns (X)
___
X
Less: Closing Inventory (X)
___
Cost of Goods Sold (X)
____
Gross Profit X
Sales revenue shows the total selling value of goods sold (cash sales plus credit sales). Some exam questions provide these separately and expect you to add them.
Sales returns (or returns inwards) are goods customers have sent back. These reduce the sales figure because the business hasn't actually earned that revenue.
Net sales revenue is the figure after deducting sales returns from gross sales. Some questions ask specifically for this.
The gross profit percentage is frequently tested:
Gross Profit % = (Gross Profit ÷ Net Sales Revenue) × 100
This shows the profit margin on trading activities and helps assess business performance.
The Profit and Loss Account Section
This section continues from gross profit and includes all other income and expenses:
Gross Profit (brought down) X
Add: Other Income
Discount Received X
Commission Received X
Rent Received X
___
X
___
X
Less: Expenses
Rent X
Insurance X
Wages X
Salaries X
Advertising X
Electricity X
Telephone X
Motor Expenses X
Discount Allowed X
Carriage Outwards X
Bad Debts X
Depreciation X
___
Total Expenses (X)
____
Net Profit X
Other income includes revenue not from main trading activities. Common examples:
- Discount received — reduction received from suppliers for prompt payment
- Commission received — earnings from acting as an agent
- Rent received — income from sub-letting part of premises
Expenses are costs of running the business. Key distinctions:
- Wages usually means payments to shop floor or factory workers
- Salaries usually means payments to office staff or managers
- Discount allowed — reductions given to customers for prompt payment; this is an expense
- Carriage outwards — delivery costs to customers; classified as an expense, not part of COGS
- Bad debts — debts written off as uncollectable from customers
Items Requiring Special Treatment
Depreciation always appears as an expense in the profit and loss section. Examiners test whether you know to include it and calculate it correctly (straight line or reducing balance method).
Accruals and prepayments adjust expense figures:
- Accrued expenses (owing) — add to the expense in the trial balance
- Prepaid expenses (paid in advance) — deduct from the expense in the trial balance
For example, if insurance in the trial balance shows £1,200 but £300 is prepaid:
Insurance expense in income statement = £1,200 - £300 = £900
Drawings never appear in the income statement. These belong in the statement of financial position (balance sheet) as they represent the owner taking money/goods from the business, not a business expense.
Capital expenditure (purchasing non-current assets) does not appear as an expense. Only the depreciation on these assets appears.
Mark Allocation Patterns
CIE IGCSE examiners typically allocate marks as follows:
- Correct headings and date: 1 mark
- Sales section (sales less returns): 2-3 marks
- Cost of goods sold calculation: 5-6 marks
- Gross profit: 1 mark
- Expenses section: 4-6 marks
- Net profit: 1 mark
Presentation marks are awarded for proper formatting, appropriate use of brackets for negative figures, correct indentation, and neat underlining of totals.
Worked examples
Example 1: Basic Income Statement
Question: Prepare an income statement for J. Martinez for the year ended 31 March 2024 from the following information:
| Item | £ |
|---|---|
| Sales | 85,000 |
| Opening Inventory | 8,400 |
| Purchases | 52,000 |
| Closing Inventory | 9,200 |
| Rent | 6,000 |
| Wages | 14,500 |
| Insurance | 1,800 |
| Advertising | 2,300 |
Solution:
J. Martinez Income Statement for the year ended 31 March 2024
| £ | £ | |
|---|---|---|
| Sales Revenue | 85,000 | |
| Less: Cost of Goods Sold | ||
| Opening Inventory | 8,400 | |
| Add: Purchases | 52,000 | |
| 60,400 | ||
| Less: Closing Inventory | (9,200) | |
| Cost of Goods Sold | (51,200) | |
| Gross Profit | 33,800 | |
| Less: Expenses | ||
| Rent | 6,000 | |
| Wages | 14,500 | |
| Insurance | 1,800 | |
| Advertising | 2,300 | |
| Total Expenses | (24,600) | |
| Net Profit | 9,200 |
Mark scheme notes: Correct heading (1), sales (1), opening inventory (1), purchases (1), closing inventory (1), gross profit (1), all expenses correct (3), net profit (1) = 10 marks
Example 2: Income Statement with Adjustments
Question: Prepare an income statement for S. Chen for the year ended 30 June 2024:
| Item | £ |
|---|---|
| Sales | 124,000 |
| Sales Returns | 3,200 |
| Opening Inventory | 15,600 |
| Purchases | 68,400 |
| Purchases Returns | 2,100 |
| Carriage Inwards | 1,400 |
| Closing Inventory | 17,800 |
| Discount Received | 950 |
| Discount Allowed | 1,200 |
| Rent | 8,400 |
| Salaries | 18,600 |
| Carriage Outwards | 2,300 |
| Motor Expenses | 3,700 |
Solution:
S. Chen Income Statement for the year ended 30 June 2024
| £ | £ | |
|---|---|---|
| Sales Revenue | 124,000 | |
| Less: Sales Returns | (3,200) | |
| Net Sales Revenue | 120,800 | |
| Less: Cost of Goods Sold | ||
| Opening Inventory | 15,600 | |
| Add: Purchases | 68,400 | |
| Add: Carriage Inwards | 1,400 | |
| 85,400 | ||
| Less: Purchases Returns | (2,100) | |
| 83,300 | ||
| Less: Closing Inventory | (17,800) | |
| Cost of Goods Sold | (65,500) | |
| Gross Profit | 55,300 | |
| Add: Other Income | ||
| Discount Received | 950 | |
| 56,250 | ||
| Less: Expenses | ||
| Discount Allowed | 1,200 | |
| Rent | 8,400 | |
| Salaries | 18,600 | |
| Carriage Outwards | 2,300 | |
| Motor Expenses | 3,700 | |
| Total Expenses | (34,200) | |
| Net Profit | 22,050 |
Mark scheme notes: Correct heading (1), net sales calculation (2), COGS calculation with carriage inwards and returns correctly placed (5), gross profit (1), discount received as income (1), expenses including discount allowed and carriage outwards (4), net profit (1) = 15 marks
Example 3: Income Statement with Accruals and Prepayments
Question: The following balances were extracted from the books of T. Walsh on 31 December 2024. Prepare an income statement.
| Item | £ |
|---|---|
| Sales | 96,000 |
| Opening Inventory | 12,300 |
| Purchases | 58,700 |
| Closing Inventory | 14,100 |
| Rent | 7,200 |
| Insurance | 2,400 |
| Wages | 16,800 |
| Advertising | 3,600 |
Additional information:
- Rent owing at year end: £600
- Insurance paid in advance: £400
Solution:
T. Walsh Income Statement for the year ended 31 December 2024
| £ | £ | |
|---|---|---|
| Sales Revenue | 96,000 | |
| Less: Cost of Goods Sold | ||
| Opening Inventory | 12,300 | |
| Add: Purchases | 58,700 | |
| 71,000 | ||
| Less: Closing Inventory | (14,100) | |
| Cost of Goods Sold | (56,900) | |
| Gross Profit | 39,100 | |
| Less: Expenses | ||
| Rent (7,200 + 600) | 7,800 | |
| Insurance (2,400 - 400) | 2,000 | |
| Wages | 16,800 | |
| Advertising | 3,600 | |
| Total Expenses | (30,200) | |
| Net Profit | 8,900 |
Mark scheme notes: Rent correctly adjusted for accrual (2), insurance correctly adjusted for prepayment (2), other items correct (8) = 12 marks
Common mistakes and how to avoid them
Mistake 1: Placing carriage inwards in expenses Carriage inwards increases the cost of purchases and belongs in the trading account as part of the cost of goods sold calculation. Carriage outwards (delivery to customers) is the expense that goes in the profit and loss section. Check the direction: inwards = buying, outwards = selling.
Mistake 2: Deducting closing inventory before adding purchases The cost of goods sold calculation must follow the correct sequence: opening inventory PLUS purchases (and carriage inwards, minus returns) MINUS closing inventory. Students who deduct closing inventory too early produce incorrect calculations that lose multiple marks.
Mistake 3: Treating discount received and discount allowed as the same Discount received is income (we received a reduction from suppliers) and is added after gross profit. Discount allowed is an expense (we gave a reduction to customers) and appears with other expenses. The words "received" and "allowed" indicate completely different treatments.
Mistake 4: Including drawings as an expense Drawings represent the owner taking money or goods from the business for personal use. This is not a business expense and never appears in the income statement. Drawings reduce capital in the statement of financial position instead.
Mistake 5: Forgetting to adjust for accruals and prepayments When the question provides additional information about owing or prepaid amounts, you must adjust the trial balance figure. Accrued (owing) means add to the expense; prepaid (in advance) means deduct from the expense. Show your working to gain method marks even if the calculation contains errors.
Mistake 6: Calculating percentages incorrectly Gross profit percentage must use net sales revenue (after deducting sales returns) as the denominator, not the gross profit figure. The formula is (Gross Profit ÷ Net Sales Revenue) × 100. Many students reverse this or use the wrong base figure.
Exam technique for "Financial Statements: Income Statement (Sole Traders)"
Command word 'Prepare': This requires a formal presentation with proper headings, business name, statement title, and accounting period. Marks are awarded for structure as well as numerical accuracy. Use columnar format with clear sub-totals and appropriate use of brackets for deductions. Underline or embolden gross profit and net profit figures.
Working systematically through the trial balance: Examiners recommend ticking off each item in the trial balance as you use it. Income statement items include all income and expenses; statement of financial position items include assets, liabilities, and capital. Cross out or tick items to avoid omitting entries, which is a common reason for mark loss.
Showing calculations: When questions provide additional information requiring adjustments (accruals, prepayments, depreciation), show your calculations separately or in brackets. Examiners award method marks even when final answers are incorrect. For example: "Rent (£7,200 + £600 owing) = £7,800" demonstrates understanding and secures method marks.
Time management: A full income statement question typically carries 12-20 marks and should take approximately 15-25 minutes. Allocate time proportionally: 5 minutes reading and planning, 15 minutes preparing the statement, 5 minutes checking. Questions asking for both income statement and statement of financial position require careful time division—typically complete the income statement first as net profit is needed for the capital section.
Quick revision summary
The income statement shows profit or loss over an accounting period through two sections: the trading account (sales minus cost of goods sold equals gross profit) and the profit and loss account (gross profit plus other income minus expenses equals net profit). Cost of goods sold equals opening inventory plus purchases plus carriage inwards minus purchases returns minus closing inventory. Carriage inwards is part of COGS; carriage outwards is an expense. Discount received is income; discount allowed is an expense. Adjust expenses for accruals (add) and prepayments (deduct). Present with proper headings, business name, period, and columnar format for maximum marks.