CHAPTER XXVII

THE PROFIT AND LOSS SUMMARY—FORM AND CONTENT Standardization of Form As stated in Chapter XXVI, the profit and loss summary is supplementary to the balance sheet and should always accompany it whenever it is desirable to make a full and comprehensive showing of condition. This summary is given various titles and is shown in various forms, depending somewhat upon the general class of enterprise to which it relates, the particular purpose for which it is compiled, and sometimes on the predilection of the person who draws it up or for whom it is drawn. With the passage of time the form of the summary, and to a less degree its content, tend to become standardized. The regulations of various governmental bodies have given an impetus in this direction. The Interstate Commerce Commission, the Comptroller of the Currency, public service commissions of various states, superintendents of state banks and of insurance—all require standardized reports from the concerns under their jurisdiction. The Federal Reserve Board has recommended certain forms of statement of both balance sheet and profit and loss to be submitted as the basis of credit by merchants and manufacturers. Investigations made by the Federal Trade Commission point out the desirability of a more uniform method of presenting the results of business activities than now exists. These regulations and requirements as to standard forms of statement do not interfere with the presentation of other forms of statement for other purposes than those required by the regulatory bodies. As local conditions frequently give rise to problems which are peculiar to individual concerns, standard forms of statement will not always meet local needs. Flexibility to meet given conditions, and deviation from set forms must always be permissible if the accounting department is to render the highest kind of service of which it is capable. Synonymous Terms Various titles are used as synonyms for the profit and loss summary, among which are the following: Statement of Profit and Loss, Loss and Gain, Outlay and Income, Revenue, Revenue and Expenditures, Income, Income and Expenses, etc. Of these, the term most generally used is “Profit and Loss.” “Business Statement” and “Statement of Outlay and Income” are phrases seldom if ever employed nowadays, while “Loss and Gain” finds little favor. Of the two terms, “Revenue” and “Income,” Revenue is used more often in connection with non-profit-making concerns, particularly in connection with state and municipal accounts. “Income and Expenses” is usually limited to the profit and loss statement rendered by clubs, churches, libraries, hospitals, etc., although the term “Revenue” is frequently used in this connection. “Income Statement” and “Account” are terms frequently applied to the profit and loss summary of trading, industrial, and professional concerns; but except where custom has established certain well-defined uses, as indicated above, the title “Profit and Loss” is all-sufficient; there is no doubt as to its meaning or content, and its use for summarizing the temporary proprietorship items is thereby established, particularly in connection with profit-making concerns. Cost of Goods Sold—Manufacturing Concern Profit-making enterprises may be roughly divided into several groups as follows: industrial or manufacturing selling, agency and commission, public carriers or transportation, and financial. The profit and loss summary for these different groups is, in the main, the same although, of course, the content of the summary depends materially upon the nature of the business. In all cases the source of income is from sales—whether of a commodity or of services makes little difference. The first deduction from gross earnings under the title “Sales” or other similar title is the cost of sales. At this point the first marked divergence among the various groups is met. In an industrial enterprise the cost of sales is the cost of goods manufactured and sold as well as the cost of any goods purchased for immediate resale. This latter cost is met only in enterprises which combine manufacture with selling. This does not imply that manufacturing concerns have no selling problem, but rather that in many cases they also purchase other products for sale along with their own product, perhaps as side lines. For a manufacturing concern which sells only its own product, the first deduction from sales is the cost of the goods manufactured and sold. As stated in Chapter III, the elements of the cost of manufacture are: (1) material, (2) labor, and (3) factory expense. The cost of goods manufactured must be combined with any unsold output at the beginning of the period and a similar output at the end of the period, in order to determine the cost of the goods sold. Cost of manufacture corresponds roughly to the net purchases of a trading business. Cost of Goods Sold—Trading Concern For a trading business, i.e., a business which buys its commodity for resale, the first deduction from sales is likewise the cost of goods sold as determined by a “cost of goods sold” formula as follows: To the goods on hand at the beginning of the period is added the full cost of the net goods purchased, and from the sum of these two items is deducted the cost of the goods on hand at the end of the period. In the case of both the industrial and the trading enterprise, when the cost of the commodity sold is deducted from the sales the result is the first significant figure as to profits known usually as “Gross Profit.” Among public carriers the first deduction from sales is the “Cost of Services Sold or Rendered”; this is usually carried under the title “Costs of Operation” or “Operating Expenses,” giving the figure of net earnings. For the other types of business mentioned—agency and commission concerns, and financial enterprises of various sorts—the allocation of the direct costs of the service rendered is much more difficult and is seldom attempted. The so-called general and administrative expense and the expense of selling are usually so inextricably merged with the direct cost of rendering the service that a separate showing of the items is seldom attempted. However, where any expenses are directly applicable to the service rendered, they should be deducted first, before the general administrative and selling expense. Further Differentiation of Terms Before going into a detailed explanation of the elements of the profit and loss summary, it may be wise to make a further differentiation of terms sometimes employed, such as: Income and Expenditures, Receipts and Disbursements, Receipts and Payments, etc. All three terms are often met and are frequently misused as titles for the profit and loss summary. Their proper use should limit them to cash transactions or activities only. It is true that in some instances the profit and loss summary is mistakenly made up on a so-called cash basis, cognizance being taken of the income and expense items only when realized in cash. It would hardly seem necessary to convince the modern business man that sales made on credit and not yet realized in cash are part of his income as much as the items of income realized in cash, the chief difference being that provision must be made in the one case for uncollectible items, while in the other case no such provision is necessary. Yet even today it is sometimes difficult to convince the proprietor of a small business of the necessity, from the standpoint of accurate accounting, of taking cognizance of accrued and deferred expense items. Instances may sometimes, though rarely, arise in which all income has been received in cash at the end of the fiscal period and all expenses applicable to that period have been met in cash and that no deferred items need to be taken into account. Where such is the case, a statement of cash receipts and disbursements might give a fair indication of the profit and loss for the period. In the case of clubs, churches, and other institutions, practically all that is required of the managing officers in accounting for their trusteeship is a statement of trusteeship of cash, i.e., a statement of receipts and disbursements. The point of this discussion is merely that the terms, “Receipts and Disbursements,” “Receipts and Payments,” and, to a less extent, “Income and Expenditure,” should be limited to a statement of cash activities and never applied to the profit and loss summary. Desirability of Uniformity in Terms Used So far as the standardization of the sections of the profit and loss summary is concerned, much the same remarks are applicable as to the general title of the “Temporary Proprietorship Summary.” Such terms as Gross and Net Profit, Gross Revenue or Income, Net Revenue or Income, Gross Trading Profit, Net Trading Profit, Net Profit or Profit from Operation, or simply Business Profit, are used with little uniformity by the business world at large and even by the accounting profession. While it is never desirable to lay down many hard and fast rules or definitions because any statement or method of showing results should always be flexible and adapted to the conditions met, still the use of the same terms for different purposes and the use of different terms for the same purpose or section of a statement are, to say the least, confusing to the student. The committee of the Federal Reserve Board which drew up tentative forms for the profit and loss account and balance sheet, has done a good work in the interest of uniformity in accounting terminology. Their suggested form is applicable, however, only to the business of a manufacturer or merchant. In the case of public carriers the regulation of their accounting systems by the Interstate Commerce Commission has brought about a very desirable uniformity of terminology. Other regulating bodies in various states have performed a similar service in the case of public utility concerns, although because of divided authority their rulings lack uniformity. Profit and Method of Showing In general it may be said that the term “Gross Profit” is properly applicable to what is left after deducting from the main income the cost of that income. In a merchandising concern this figure is sometimes called “Gross Trading Profit,” though the term “Gross Profit” serves the purpose equally well and does not introduce a confusing adjective. When, from this gross profit, the two groups of selling expense and general administrative expense are deducted, there remains what is termed “Profit from Operation” or “Net Operating Profit.” One occasionally finds the group of selling expenses deducted by itself from the figure of gross profit, leaving what is termed the “Net Trading Profit.” Such a method of presentation serves no useful purpose and shows a figure which has little or no significance. The net trading profit merely represents what is left after deducting one group of expenses, and gives no essential information which the total of selling expenses would not give equally as well. There is some difference of opinion as to whether the figure of net operating profit should be arrived at before considering any of the items of financial management, i.e., as to whether such items as interest income and expense, cash discount items, bad debts, etc., which are more or less common to every business, should be included before determining net operating profit or should be set up separately after its determination. The best practice seems to be to use the term “Net Operating Profit” as indicated above, and to show the financial management items in a separate section. In public service utility statements and also in those of some manufacturing concerns, such terms as “Gross and Net Earnings” and “Gross and Net Income” are met. Where these terms are used the gross earnings correspond approximately to sales and indicate the amount of the main income before any deductions are made. After the deduction of the direct cost of securing this income, the item is frequently called “Net Earnings.” Alternative terms for these two are “Total Operating Revenue” and “Total Net Revenue.” When, to the item of the net earnings or net revenue, income from other sources is added, the figure of total Gross Income is arrived at. When, from this figure of total income the “Charges Against Income” are subtracted, which are roughly the financial management expenses, we arrive at the figure of net income which corresponds to the figure of net profit. The use of the terms “Earnings” and “Income” in this restricted way is illogical, and must be regarded as the outgrowth of custom—a custom which is, as stated above, fairly uniform in the case of public utilities. Form of Presentation—Account Form As to the form of the profit and loss summary, in the main, two types are met. One is known as the account form because the items of income and expense are set up like credits and debits in an account. The other is known as the statement or report form. This is sometimes referred to as the non-technical method of presentation because the items are set up in running form without regard to a debit or credit terminology, the order of arrangement being dictated by the logic of the ordinary business man. In the case of the account form the sales or main items of income are placed in juxtaposition on the one side with the direct costs of that income on the other side, the balance of the two sides being brought down as the gross profit. Against this are set up the groups of selling and general administrative expenses. The difference between the two sides is again brought down as the figure of net operating profit to which are added other items of income. The charges against that income, i.e., the expenses incurred in financing the business, are then shown. The balance at this stage is the net profit for the fiscal period and opposite this appears its disposition, showing the portion appropriated to dividend purposes, to reserves of various sorts, and finally to surplus of the portion remaining unappropriated to other uses. Non-Technical or Report Form When the profit and loss summary is set up in non-technical form, the figure of sales is first shown. Beneath this rather than in juxtaposition as in the other case, the cost of sales is given, which cost deducted from sales gives the figure of gross profit. Below this appear the groups of selling and general administrative expenses, the deduction of which from the gross profit figure gives the figure of net operating profit or, as sometimes stated, the figure of “Net Profit on Sales.” To the net profit on sales are added the other items of income, and from the sum of these are subtracted the expenses of financial management, leaving, as in the other case, the net profit for the period. Examples of Forms of Presentation It is impossible and undesirable, as stated above, to lay down any hard and fast form which must be rigidly followed, because a basic principle of all accounting is that it must adapt itself to the needs and requirements of particular conditions. Therefore, only the bare skeleton of a form can be set up with any hope of its being applicable to all conditions. In other words, the form of arrangement and method of showing the statement to be presented at the close of the fiscal period must be flexible, depending upon the use to which the statement is to be put and also depending upon the information which it is desired to set forth. The skeleton form given below which is suggested by A. Lowes Dickinson[68] follows the general lines laid down in this chapter. It is designed to serve as a framework for all uses. MANUFACTURING AND MERCHANDISING: Gross Earnings from Sales $..... Less—Returns, Allowances, and Discount ..... ----- Net Earnings from Sales $..... Deduct—Cost of Production or Service ..... ----- Gross Profit $..... Deduct—Cost of Selling $..... Expenses of Management ..... ..... ----- ----- Net Profit from Operations $..... ===== AGENCY AND COMMISSION: Commissions Earned $..... Deduct—Expenses of Management $..... Cost of Guarantees ..... ..... ----- ----- Net Profit from Operations $..... ===== TRANSPORTATION: Earnings from Operations $..... Deduct—Operating Expenses $..... Taxes ..... ..... ----- ----- Net Profit from Operations or Operating Income $..... ===== BANKING: Earnings from: Interest $..... Commissions ..... Other Profits ..... $..... ----- Deduct—Expenses of Operation and Management ..... ----- Net Profit from Operations $..... ===== PROFESSIONAL: Gross Earnings from Fees $..... Less—Out-of-Pocket Expenses included therein ..... ----- Net Earnings from Fees $..... Deduct—Expenses of Operation and Management ..... ----- Net Profit from Operations $..... ===== (The form for the remainder of the statement will be the same in all cases, viz.:) Net Profit from Operations $..... Other Income ..... $..... ----- Deduct—Interest on Bonds $..... Other Fixed Charges ..... ..... ----- ----- Surplus for the year $..... Extraordinary Profits (detailed) ..... Surplus brought forward from preceding year ..... ----- $..... Deduct—Extraordinary Charges ..... ----- Total Surplus available $..... Dividends on Stocks ..... ----- Surplus carried forward $..... ===== [68] In “Accounting Practice and Procedure.” Form for Manufacturers and Merchants The form suggested by the Federal Reserve Board as suitable for manufacturers and merchants is presented below. It is shown as a comparative statement of several years, but the same content and order of arrangement of items would, of course, be followed for any individual year. When presenting a single year’s activities, the money columns should be so used as better to present significant figures and their interrelations. The use of one column for items and another for totals accomplishes this. The form shown presents, after the figure of Net Income—Profit and Loss, a statement of extraordinary charges and credits to profit and loss tied up with the former balance of surplus, an appropriation made of profit and surplus at the end of this period, giving as a final figure the new surplus at its close—which is the figure carried on the balance sheet. This last portion of the statement is often shown as a separate statement of surplus. The items which are best handled as charges direct to surplus so as not to affect the profit and loss showing for the current period, have been discussed in