Common mistakes in income statements

The income statement runs from revenue down to profit for the year. It appears in almost every exam. Because it is so familiar, students often work on autopilot and lose marks to small errors. Here are the ones we see most often, and how to avoid them.

Getting cost of sales wrong

Cost of sales is opening inventory plus net purchases minus closing inventory. The commonest slip is to forget closing inventory, or to add it instead of subtracting it. Net purchases also need returns outwards deducted and carriage inwards added.

It helps to know why closing inventory is subtracted. The income statement matches the cost of goods sold against the revenue from those sales.

Goods still on the shelves have not been sold, so their cost is not yet an expense. It is carried forward as an asset and becomes next year’s opening inventory.

A short worked illustration

These figures are invented for teaching. A business has opening inventory of RM4,000, purchases of RM30,000, returns outwards of RM1,000, carriage inwards of RM500 and closing inventory of RM6,000. Net purchases are RM30,000 - RM1,000 + RM500 = RM29,500.

Cost of sales is RM4,000 + RM29,500 - RM6,000 = RM27,500. If revenue is RM45,000, gross profit is RM17,500.

Now see what one slip does. A student who adds closing inventory gets cost of sales of RM39,500 and gross profit of only RM5,500. That is a RM12,000 swing from one wrong sign, and it flows all the way down to profit for the year.

Putting carriage on the wrong line

Carriage inwards is part of the cost of buying goods, so it belongs in cost of sales. Carriage outwards is the cost of delivering to customers, so it is an expense after gross profit. Ask whether the cost brings goods in or sends them out.

This matters because owners and lenders watch gross profit closely. It shows how profitably the business buys and sells before running costs. Put delivery-out costs in cost of sales and gross profit looks too low.

Including drawings as an expense

Drawings are the owner taking value out of the business. They are never an expense in the income statement. They are deducted from capital in the statement of financial position.

Goods the owner takes for personal use are also drawings. Because they were bought as purchases, remove them from purchases and add them to drawings. Students who notice the owner took stock but leave purchases unchanged count the goods twice.

Forgetting year-end adjustments

Expenses must be adjusted for accruals and prepayments, and income for amounts accrued or received in advance, before they go into the income statement. Students often copy the cash figure straight from the trial balance. Depreciation, irrecoverable debts and changes in the provision for doubtful debts are adjustments too.

All of these follow the matching concept: each period carries the expenses that belong to it. An accrual adds a cost incurred but not yet paid. A prepayment removes a cost paid in advance that belongs to next year.

If the trial balance shows rent of RM12,000 but one month of RM1,000 is still owing, the income statement shows RM13,000. The RM1,000 is a current liability. Read each note and ask: is this amount owing or prepaid, and which way does it move the figure?

Mixing up gross profit and profit for the year

Gross profit is revenue less cost of sales. Profit for the year is gross profit plus other income, less all expenses.

Students sometimes stop at gross profit, or deduct expenses before reaching it. Do trading first, then expenses.

Omitting other income

Income other than sales, such as rent received, discount received or commission, is added after gross profit and before expenses. Leaving it out understates profit. Scan the trial balance for any income that is not sales.

Discount received is income from suppliers, so it is added after gross profit. Discount allowed is a cost of letting customers pay less, so it sits among expenses.

The names are similar but the two go on opposite sides. Decide whether the discount comes to the business or is given by it.

Presentation that loses method marks

Label each section, show cost of sales as a working and total the expenses before deducting them. Use a heading with the period (“for the year ended…”). Clear subtotals help the examiner follow your method and reward correct steps even if an early number is wrong.

How to practise

Prepare income statements from a trial balance plus a list of adjustments, as the exam does. Include drawings, carriage both ways and a couple of accruals so you must handle the traps. Redo any you get wrong after a short gap.

If income statements are still costing marks, one of our teachers can work through the trading section, adjustments and layout with your child, using their own answers. Book a trial class to begin.

Syllabus reference: Cambridge 0452 and 0985, syllabus for 2027 to 2029, sub-topic 5.1 Sole traders (page 15).