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Chapter 3

Q. 3.6

The Watermark Book Shop in Oxbridge opens on January 1, 2016. During the year, the shop purchases £500,000 of books. The freight charges to have the books delivered are £50,000 and are treated as product costs. Over the year, the book shop has the following other costs, which are treated as period costs:

Rent £12,000
Advertising £30,000
Salaries £80,000

Watermark Book Shop has revenues of £800,000 during 2016 and has 20 percent of its books unsold at the end of the year. Prepare a profit and loss (income) statement for the book shop for 2016.


Verified Solution

The freight charges are treated as product costs, therefore total product costs during the year are £550,000. Since 80 percent of the books are sold during the year, the Cost of Goods Sold is (80%)(£550,000), or £440,000. The remaining product costs ((20%)  (£550,000), or £110,000) remain as an asset called inventory. The period costs are completely expensed during 2016.

Watermark Book Shop Profit and Loss Statement Year 2016

Revenues £800,000
Cost of Goods Sold (440,000)
Rent (12,000)
Advertising (30,000)
Salaries (80,000)
Net profit £238,000

Financial reports treat time periods as the cost object. Revenues through the revenue recognition principle and expenses through the matching principle are traced to different time periods. Making the period of time the cost object is not consistent with any specific internal planning decisions. The increased value or income of the organization achieved during a particular time period can be estimated by tracing costs and revenues to that particular period. This measure provides information to external users about the value of debt and ownership shares of the organization, and also provides information for owners to evaluate senior managers. For internal purposes, however, a measure of period profit only gives an indication of how well the existing organizational strategy is working. A loss during a period may indicate the organization needs to re-examine its strategy.