Financial statements

A company's statement of profit or loss is usually presented by function:

Statement of profit or loss	$
Revenue	X
less Cost of sales	(X)
Gross profit	X
less Distribution costs	(X)
less Administrative expenses	(X)
add Other income	X
Operating profit	X
less Finance costs (loan/debenture interest)	(X)
Profit before tax	X
less Tax (corporation tax)	(X)
= Profit for the year	XX

Key A-Level features beyond a sole trader:

• Finance costs — interest on loans/debentures, deducted as a separate line;
• Tax — the company pays corporation tax on its profit, deducted to give the profit for the year;
• expenses are grouped into distribution and administrative functions, not listed individually.

Dividends do NOT appear here — they are an appropriation of profit, shown in the statement of changes in equity.

The statement of changes in equity (SOCE) reconciles every component of equity from its opening to its closing balance, in columns:

	Share capital	Share premium	Revaluation reserve	Retained earnings	Total
Opening balance	X	X	X	X	X
Profit for the year				X	X
Dividends paid				(X)	(X)
Share issue	X	X			X
Revaluation gain			X		X
Transfer to general reserve				(X)/X
Closing balance	XX	XX	XX	XX	XX

So the SOCE shows: the profit for the year added to retained earnings; dividends paid deducted from retained earnings; any share issue added to share capital (and share premium); and any revaluation gain added to the revaluation reserve. It is the bridge between the profit statement and the equity section of the statement of financial position.

In the statement of financial position, the equity section replaces a sole trader's 'capital':

$\text{Equity} = \text{Share capital} + \text{Share premium} + \text{Revaluation reserve} + \text{Retained earnings} \;(+ \text{other reserves})$

Types of reserve:

• Capital reserves — not normally distributable as cash dividends:
  • Share premium — the excess of issue price over nominal value on a share issue;
  • Revaluation reserve — the surplus from revaluing non-current assets (e.g. land/buildings) upward.
• Revenue reserves — distributable:
  • Retained earnings — accumulated profits not yet distributed;
  • General reserve — profits set aside (a transfer from retained earnings).

The closing balances from the SOCE are carried straight into the equity section. The rest of the statement of financial position (non-current assets, current assets, liabilities including a debenture/loan as a non-current liability and tax payable as a current liability) is prepared as usual.

Several items appear only in company accounts (versus a sole trader):

• Corporation tax — an expense in the profit statement and a current liability (tax payable) until paid.
• Dividends — appropriations of profit (in the SOCE); the declared/paid dividend reduces retained earnings, and any unpaid declared dividend is a current liability.
• Debentures / long-term loans — non-current liabilities, with their interest as a finance cost.
• Reserves — capital and revenue reserves within equity.
• Other comprehensive income — items such as a revaluation gain may be shown in a statement of profit or loss and other comprehensive income, then taken to the revaluation reserve via the SOCE.

A strong answer keeps these in the right statement: tax and finance costs reduce profit, dividends are an equity appropriation, and reserves sit in equity — never confusing an appropriation with an expense.