In this method, what is taken into account are all costs and payments. In contrast to the cost of sales method, it also includes payments that have not yet been settled. Since the cost of materials is also incorporated, the result is the same as for the cost of sales method, with the subtotals as the only difference. The calculation includes various production and expense categories, whereby income and expenses are sorted according to their type. For example, primary cost elements are classified either as staff or material expenses.
Profit and loss account
| 1. Sales revenue |
+/- | 2. Increase or decrease in finished and unfinished goods and services |
+ | 3. Other capitalised services |
+ | 4. Other operating income |
| 5. Cost of materials |
- | a) Costs of raw, auxiliary, and process materials and of purchased goods |
- | b) Cost of purchased services |
| 6. Staff expenses |
- | a) Wages and salaries |
- | b) Social security contributions and expenses for retirement benefits and support payments |
| 7. Depreciation |
- | a) of fixed intangible and tangible assets |
- | b) of current assets to the extent that these exceed the ordinary depreciation for the corporation |
- | 8. Other operating expenses |
= | Total operating result (earnings before deducing interest and taxes) |
+ | 9. Income from investments |
+ | 10. Income from other securities and loans held as financial assets |
+ | 11. Other interest and similar income |
- | 12. Depreciation on financial assets and securities held as current assets |
- | 13. Interest and similar expenses |
+/- | 14. Taxes on income and earnings |
= | 15. Net earnings |
+/- | 16. Other taxes |
= | 17. Annual net profit/annual net loss |
A profit and loss account in report form (and according to the nature of expense method) mentions sales revenue as the first item. In the past, it was only income generated by ordinary business activities that were included. Nowadays, the scope of the term has been extended to include income from side businesses.
Increase or decrease in stock is understood as the difference in the inventory levels of both finished and unfinished products at the beginning, as well as at the end of a given observation period (this period usually being the financial year of a company). What you observe here are changes in quantity and value, such as those caused by the natural wear-and-tear or other depreciating factors. However, changes in inventory are not recorded here, but rather under material cost. Other capitalised services consist of self-made items, such as buildings or machines that have been built or manufactured by a company’s own workforce and are intended to remain available for the company’s operations. Such self-manufactured assets are then subject to depreciation over the course of their useful life.
The rather vague concept of other operating income simply sums up all income that does not fit into all other income-related categories. Material costs, on the other hand, are split into two different categories – point 5a including all costs of raw, auxiliary, and process materials, as well as purchased goods (which do not appear under point 2 and may also include changes in inventory caused by theft). Point 5b takes into account all services received from third parties in the course of the production (such as machinery repairs).
Staff expenses cover all employee-related costs. You should divide them into wages (6a) and corresponding social security contributions (6b). The expense method also divides depreciation into two sub-categories: depreciation of fixed assets (7a) and depreciation of current assets (7b), which exceeds the level of regular depreciation within a company. Other operating expenses include all costs of operational processes that were not suitable for any of the previous points.
The abovementioned items of the P&L account count towards the total operating result, whereas all of the remaining items are to be assigned to the financial result. Its first item, income from investments, includes the likes of income from dividends or profit shares. These stand in contrast to income from other securities and loans (10), which take into account the income that the company has obtained from interest rates. The financial result also includes other interest and similar income, where you should include all other financial income that cannot be assigned to either of the other two items.
It is now time to subtract depreciation on financial assets and securities held as current assets. In contrast to those listed in point 7, the depreciation in question relates to the financial sector and not to the operating sector. What must also be subtracted is interest and similar expenses, which are subject to payment by your company. After deducting operating taxes (split into two categories), the calculation of your annual net profit or annual net loss is now complete.