A company’s statement of profit or loss follows the same logic as a sole trader’s, but it ends differently. After profit before tax comes the tax charge, because a company is a legal person that pays tax on its profits. The result is profit for the year, which belongs to the shareholders.
The statement is also presented in a standard order, and expenses can be grouped in two ways: by function or by nature.
This topic covers the layout, the two methods of analysing expenses, and the accounting for income tax in both the statement of profit or loss and the statement of financial position. It follows the company statement of financial position. The tax calculations are short and appear as multiple choice items, and the statement itself appears in every company final accounts question in the past diets. The next topic covers share capital.
In 30 seconds
Revenue less Cost of sales is gross profit. Add other income, deduct distribution costs, administrative expenses, other expenses and Finance costs to reach Profit before tax. Then deduct tax to get Profit for the year, which is added to retained earnings.
Tax charge = tax on this year’s profit + any under-estimate of last year (or − any over-estimate). Tax payable in the statement of financial position = opening liability + charge − tax paid. Sole traders and partnerships show no tax in the business accounts. Expenses can be analysed by function (cost of sales method) or by nature, and the profit before tax is the same either way.
The layout, with expenses by function
The statement of profit or loss and other comprehensive income may be presented as one statement or two. At this level only the profit or loss section is examined, because other comprehensive income is outside the syllabus. International Accounting Standard (IAS) 1 requires at least revenue, finance costs, tax expense and profit or loss to be shown, and extra lines when they help understanding.
| Statement of profit or loss: expenses by function | ₦ |
|---|---|
| Revenue | X |
| Cost of sales | (X) |
| Gross profit | X |
| Other income | X |
| Distribution costs | (X) |
| Administrative expenses | (X) |
| Other expenses | (X) |
| Finance costs | (X) |
| Profit before tax | X |
| Taxation | (X) |
| Profit for the year | X |
When expenses are analysed by function, the functions are commonly cost of sales, distribution costs, administrative expenses and other expenses. This is also called the cost of sales method, and most entities use it. The basis for dividing costs between functions is given in the question. Example. Entity Red has revenue of ₦14,823,000, cost of sales 6,214,000, other income 22,000, distribution costs 3,693,000, administrative expenses 3,901,000 and other expenses 248,000. Gross profit = 14,823 − 6,214 = 8,609. Profit before tax = 8,609 + 22 − 3,693 − 3,901 − 248 = ₦789,000.
The same layout is used for XYZ Entity: revenue 678, cost of sales (250), gross profit 428, other income 44, distribution costs (98), administrative expenses (61), other expenses (18), finance costs (24), profit before tax 271, tax (50) and profit for the year 221.
Expenses by nature
The alternative groups expenses by what they are: raw materials and consumables used, staff costs, and depreciation and amortisation, with items that are small on their own shown as other expenses. There is also an adjustment for the change in inventories of finished goods and work-in-progress: an increase is a negative expense and a decrease is an expense.
| Entity Red, by nature | ₦000 |
|---|---|
| Revenue | 14,823 |
| Other income | 22 |
| Increase in inventories of finished goods and work-in-progress | (86) |
| Raw materials and consumables used | 5,565 |
| Staff costs | 4,926 |
| Depreciation and amortisation | 1,533 |
| Other operating expenses | 2,118 |
| Total expenses | (14,056) |
| Profit before tax | 789 |
Both methods give the same profit before tax, ₦789,000, but the second does not show gross profit. That explains an exam item that asks what is NOT disclosed under the nature of expenses method (answer: gross profit). Material items, such as an inventory write-down to net realisable value, disposals of property, plant and equipment and litigation settlements, may be shown separately.
Income tax in the accounts
A company must pay tax on its profits, called income tax in the standards. A sole trader’s or partner’s tax is a personal matter and is not recorded in the business’s accounts.
For a company, the statement of profit or loss shows the tax charge for the year, deducted after interest to reach profit after tax. The statement of financial position shows the tax still owed at the year end.
The charge. The charge is an estimate, so the actual tax agreed later often differs. The difference is put through the next year’s charge. An Under-estimate of last year’s tax is added to this year’s charge, and an Over-estimate is deducted from it.
The liability. Tax payable at the end of the year is the opening liability, plus the charge for the year, less the tax paid in the year. It is a current liability. The charge reduces profit, and the payment reduces cash. The difference is what is still owed.
| example: Fresh Company | ₦ |
|---|---|
| Tax on current year profits | 114,000 |
| Over-estimate of last year | (6,000) |
| Tax charge for the year | 108,000 |
| Liability at the start of the year | 77,000 |
| Add the charge for the year | 108,000 |
| Less tax paid | (123,000) |
| Tax payable at the end of the year | 62,000 |
Another example. Ameh Ltd estimated its tax for the year to 30 June 2024 at ₦15,000,000. It was agreed at ₦16,500,000 and paid in September 2024. Profit before tax for the year to 30 June 2025 is ₦82,400,000 and the rate is 30%. The under-estimate is ₦1,500,000, current tax is 82,400,000 × 30% = ₦24,720,000, and the Income tax expense is ₦26,220,000. Last year’s liability was settled, so tax payable at 30 June 2025 is ₦24,720,000.
From profit to retained earnings
Profit after tax is added to the retained earnings brought forward, unless there are dividends or transfers to reserves. A transfer to general reserves, or a dividend the directors have only recommended, does not change the profit. It affects how the equity is shown, as the next topic explains.
The ideas in more depth
A trap in the exam. May Diet 2023, Section A, Question 19 gives an opening tax liability of ₦420,000, current tax of ₦850,000, an under-estimate of ₦14,200 and ₦428,000 paid. The charge to profit or loss is 850,000 + 14,200 = ₦864,200. The closing liability would be 420,000 + 864,200 − 428,000 = ₦856,200, which is one of the wrong options. Read whether the question asks for the charge or for the liability.
Background. The statement of profit or loss may also be headed “income statement”. International Financial Reporting Standard (IFRS) 18 will replace IAS 1 from 1 January 2027 and changes the presentation of profit or loss. If a question says “ignore taxation”, stop at profit before tax, and call the final line profit for the year. If a question gives a tax charge, deduct it after finance costs.
Worked example: Enugu Cement Ltd
Scenario. Enugu Cement Ltd has revenue of ₦1,200,000, cost of sales 720,000, other income 15,000, distribution costs 90,000, administrative expenses 130,000 and finance costs 25,000. Tax is 30% of profit before tax. Last year’s tax was under-estimated by ₦4,000. The tax liability at the start of the year was ₦60,000 and ₦64,000 was paid during the year. Retained earnings at the start of the year were ₦300,000.
Required: the statement of profit or loss, the tax payable and the retained earnings.
- Gross profit.
1,200,000 − 720,000 = 480,000. - Profit before tax.
480,000 + 15,000 − 90,000 − 130,000 − 25,000 = 250,000. - Tax charge.
30% × 250,000 = 75,000, plus the under-estimate 4,000 = 79,000. - Profit for the year.
250,000 − 79,000 = ₦171,000. - Tax payable.
60,000 + 79,000 − 64,000 = ₦75,000, which is this year’s 75,000, because last year’s 64,000 has been paid. - Retained earnings.
300,000 + 171,000 = ₦471,000.
Common mistakes in the exam
- Deducting tax before interest. Finance costs come first, then tax.
- Forgetting to adjust the charge for last year’s under- or over-estimate, or adjusting in the wrong direction.
- Giving the tax charge when the question asks for the liability, or the reverse.
- Showing tax for a sole trader or partnership.
- Showing gross profit in an expenses-by-nature statement.
- Treating an increase in finished goods inventories as an expense instead of a negative expense.
- Including a dividend or a transfer to reserves in the statement of profit or loss.
- Not showing finance costs on a separate line.
Quick revision
- Layout: revenue, cost of sales, gross profit, other income, distribution, administration, other expenses, finance costs, profit before tax, tax, profit for the year.
- Tax charge = current tax + under-estimate (or − over-estimate).
- Tax payable = opening + charge − paid.
- Function method shows gross profit. Nature method does not.
- Profit after tax goes to retained earnings.
Practice questions
These are original questions in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one first.
Section A style: multiple choice
Question 1. Profit before tax is calculated after deducting:
- Income tax
- Finance costs
- Dividends
- Drawings
Show the answer
B. Finance costs are deducted before tax. Tax, dividends and drawings come after.
Question 2. The cost of sales method analyses expenses by:
- Their nature
- The month incurred
- The department budget
- Their function
Show the answer
D. Expenses are grouped as cost of sales, distribution costs, administrative expenses and other expenses.
Question 3. Under the nature of expenses method, an increase in inventories of finished goods is:
- Deducted from total expenses, as a negative expense
- Added to expenses
- Ignored
- Shown as revenue
Show the answer
A. Costs were incurred but part of the output is unsold, so expenses are reduced.
Question 4. The income tax of a sole trader is:
- Shown in the statement of profit or loss
- Shown as a current liability
- Not recorded in the business accounts
- Shown as drawings
Show the answer
C. It is a personal matter of the owner, so it is not recorded in the business’s accounts.
Question 5. Profit before tax is ₦400,000, the tax rate is 25%, and last year’s tax was under-estimated by ₦3,000. The tax charge is:
- ₦103,000
- ₦100,000
- ₦97,000
- ₦3,000
Show the answer
A. 25% × 400,000 = 100,000, plus the under-estimate of 3,000 = 103,000.
Question 6. Tax on this year’s profit is ₦114,000 and last year’s tax was over-estimated by ₦6,000. The tax charge is:
- ₦120,000
- ₦114,000
- ₦6,000
- ₦108,000
Show the answer
D. An over-estimate is deducted: 114,000 − 6,000 = 108,000.
Question 7. The opening tax liability is ₦77,000, the charge is ₦108,000 and ₦123,000 is paid. The closing liability is:
- ₦185,000
- ₦62,000
- ₦46,000
- ₦108,000
Show the answer
B. 77,000 + 108,000 − 123,000 = 62,000.
Question 8. Tax payable at the year end is shown in the statement of financial position as:
- A non-current asset
- Equity
- A current liability
- A reserve
Show the answer
C. It is owed to the tax authority and is normally due within 12 months.
Question 9. A company’s profit after tax is:
- Deducted from capital
- Shown as drawings
- Credited to share premium
- Added to retained earnings
Show the answer
D. Profit for the year increases retained earnings, before any dividends.
Question 10. Current tax is ₦620,000 and last year’s tax was under-estimated by ₦9,000. The tax charge is:
- ₦629,000
- ₦611,000
- ₦620,000
- ₦9,000
Show the answer
A. 620,000 + 9,000 = 629,000.
Section B style: written questions
Question 11 (10 marks). (a) Distinguish the function method from the nature method of analysing expenses. (5 marks) (b) Explain how an under-estimate or over-estimate of last year’s tax is dealt with. (5 marks)
Question 12 (20 marks). Minna Foods Ltd has revenue of ₦2,400,000, cost of sales 1,500,000, other income 30,000, distribution costs 180,000, administrative expenses 260,000, other expenses 20,000 and finance costs 50,000. Tax is 30% of profit before tax. Last year’s tax was over-estimated by ₦8,000. The tax liability at the start of the year was ₦90,000 and ₦82,000 was paid in the year. Retained earnings at the start of the year were ₦400,000, with no dividends.
(a) Prepare the statement of profit or loss to profit for the year. (12 marks) (b) Calculate the tax payable at the year end. (4 marks) (c) Calculate the closing retained earnings. (4 marks)
A further written question
Question 13 (10 marks). A manufacturer reports revenue of ₦9,000,000 and other income of ₦40,000. Its expenses are raw materials used ₦3,600,000, staff costs ₦2,900,000, depreciation ₦700,000 and other operating expenses ₦900,000. Inventories of finished goods rose by ₦120,000. (a) Calculate profit before tax using the nature method. (6 marks) (b) Explain how the increase in inventories is treated. (4 marks)
Model answers
Show the model answer to Question 11
(a) The function method groups expenses by the activity that incurred them: cost of sales, distribution costs, administrative expenses and other expenses. It shows gross profit and is the more common method. The nature method groups them by what they are, such as raw materials used, staff costs and depreciation, with an adjustment for the change in inventories. It does not show gross profit.
Both give the same profit before tax. (b) The tax charge for the year is an estimate, so the amount agreed later may differ. An under-estimate of last year’s tax is added to this year’s charge. An over-estimate is deducted from it. Last year’s statements are not restated.
Show the model answer to Question 12
(a) Revenue 2,400,000. Cost of sales (1,500,000). Gross profit 900,000. Other income 30,000. Distribution costs (180,000). Administrative expenses (260,000). Other expenses (20,000). Finance costs (50,000). Profit before tax 420,000. Tax: 30% × 420,000 = 126,000, less the over-estimate of 8,000 = 118,000. Profit for the year ₦302,000. (b) Tax payable = 90,000 + 118,000 − 82,000 = ₦126,000. (c) Retained earnings = 400,000 + 302,000 = ₦702,000.
Show the model answer to Question 13
(a)
- Revenue and other income.
9,000,000 + 40,000 = 9,040,000. - Expenses = 3,600,000 + 2,900,000 + 700,000 + 900,000 = 8,100,000, less the increase in inventories of 120,000 = 7,980,000.
- Profit before tax.
9,040,000 − 7,980,000 = ₦1,060,000.
(b) The business made goods that it has not yet sold, so part of the expenses above relates to inventory, an asset. The increase is therefore treated as a negative expense, which reduces total expenses. A decrease in inventories would be added as an expense.
Pathfinder on Company statement of profit or loss and income tax (IAS 12)
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
From the previous syllabus. Asks for the statement of profit or loss of a company for the year, from balances given after the gross profit has been found, with depreciation, provisions for directors’ and audit fees, prepaid insurance and accrued electricity. No taxation.
Revise first: The layout, with expenses by function
From the previous syllabus. Asks for the statement of profit or loss of a limited company from a trial balance and a given gross profit, ignoring taxation, with depreciation, provisions and a recommended transfer to reserves.
Revise first: The layout, with expenses by function
From the previous syllabus. Asks for the statement of profit or loss and other comprehensive income of a company, with a credit sale to be treated correctly, an inventory write-down, carriage inwards, six months of unpaid loan interest, depreciation at 10% and accrued distribution expenses.
Revise first: The layout, with expenses by function
From the previous syllabus. Asks for the statement of profit or loss of a PLC with an income tax charge of ₦12,702,000, sales made on credit on 1 January of the next year that are in the revenue figure, an inventory write-down and unpaid loan interest.
Revise first: Income tax in the accounts
From the previous syllabus. Question 17 of May 2021 asks what is not disclosed when expenses are analysed by nature (gross profit). Question 19 of May 2023 asks for the tax charge from an opening liability, current tax, an under-estimate and tax paid.
Revise first: The ideas in more depth
Expect an item on the tax charge or tax payable and one on the layout or classification of the statement. Check Section A of every diet you practise.
Revise first: Income tax in the accounts
Source: ICAN Pathfinder, Financial Accounting. Diets covered: November Diet, 2015, May Diet, 2019, May Diet, 2021, November Diet, 2021, May Diet, 2022, November Diet, 2022 and May Diet, 2023. All are on the previous syllabus. Diets before November 2014, and November Diet, 2024 onwards, are not covered here.
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