In accounting, losses are recorded and shown in one of two financial reports, depending on the type of loss. The loss on income statement results from events that are not related to the core operations of a business whereas the losses that result from events that are directly related to the operations of the business are recorded in the balance sheet. An income statement, together with the balance sheet and the cash flow statement, are crucial financial statements that are used in reporting a company’s financial performance over a specific accounting period.
The income statement (also known as the Profit and loss (P&L) statement) summarizes the revenues, costs, and expenses incurred during a specified period, typically a quarter or fiscal year. This profit & loss statement is an integral part of the company performance reports that must be submitted to the U.S. Securities and Exchange Commission (SEC). The income statement provides insight into a company’s ability or inability to generate profit. Hence, a company would report either a gain or loss on an income statement. In this article, we will be discussing loss on the income statement, factors influencing it, and the journal entry for loss.
See also: Bad Debt Expense on Income Statement
Understanding net loss on income statement
The net loss on income statement is recorded when the total expenses (including taxes, fees, interest, and depreciation) exceed the income or revenue generated for a given period of time. Hence, the net loss appears at the bottom of the income statement, after all the line items associated with revenues and expenses. It can be contrasted with a net profit, which is also known as net income or after-tax income.
On the income statement, financial managers report a gain or loss. A loss is reported on the income statement when the total expenses exceed the income that the company generates. However, when income exceeds expenses, net profit is reported rather than the loss on income statement. Depending on the type of loss, losses are recorded and shown in the income statement or balance sheet. The losses that result from events that are not related to the primary operations of a business are recorded in the income statement. Whereas, the losses that result from events that are directly related to the operations of the business are recorded in the balance sheet.
The loss on income statement is referred to as a net loss which is also known as a net operating loss (NOL). Net losses for tax purposes may be carried forward into future tax years to offset gains in those years. A net loss on income statement appears as the company’s bottom line. This bottom line on the income statement can be net profit or net loss which is calculated as:
Net profit or Net loss on income statement = Revenues – Expenses
This means that in order to calculate the accounting profit or loss on the income statement, you have to:
- Add up all the income for the accounting period
- Add up all the expenses for the accounting period
- Then, calculate the difference by subtracting total expenses from the total income
- The resulting figure is the profit or loss on income statement
Factors contributing to a net loss on income statement
- Low revenue stream
- Cost of goods sold (COGS)
Low revenue stream
A low revenue stream is the most common factor that contributes to a net loss on income statements. Some factors cause a decrease in revenues such as strong competition, not keeping up with market demands, weak pricing strategies, unsuccessful marketing programs, and inefficient marketing staff. Hence, a decrease in revenues results in decreased profits, and when profits fall below the level of cost of goods sold (COGS) and expenses in a given accounting period, a net loss results on the income statement.
Cost of goods sold (COGS)
The cost of goods sold (COGS) is another factor that also contributes to a net loss being recorded on the income statement. When the purchase costs of products being sold are subtracted from revenue, the money that is left is used for covering expenses and creating profit. Hence, in a situation whereby the COGS exceeds funding for expenses, a net loss would occur on the income statement.
Expenses play a major role in net loss on income statements. Even when the targeted revenue is earned, and the COGS stays within limits, overspending and unexpected expenses in budgeted areas may exceed gross profits. Hence, excessive carrying costs are the type of expense that can contribute to a net loss being recorded on the income statement. These are the kind of costs that a company pays for merchandise inventory in stock before it is sold to customers.
Gross loss vs net loss on income statement
The net loss on income statements should not be confused with the gross loss on income statements. Gross loss on the income statement is the negative cash that is left after the COGS is deducted from the total revenues. However, if the result is positive, it would be termed as Gross Profit. Therefore, if the result is negative, it would be termed Gross Loss for that accounting period. That is:
Gross profit or Gross loss = Total revenue – COGS
This calculation is entirely different from how the net loss is calculated. When calculating net loss on income statement, one must deduct the COGS and all other operational expenses from the revenues earned in the accounting period. That is:
Net profit or Net loss = Revenues – Expenses
This is the reason why a company might earn a gross profit for an accounting period that is arrived at by merely deducting COGS from revenues but still end up with losses when expenses are also deducted from these gross profits. Below is a typical example:
Example of loss on income statement
Let’s look at an example of loss on an income statement. Assume a company has $200,000 in sales, $140,000 in COGS, and $80,000 in expenses. In order to calculate the net profit or net loss, we will have to subtract $140,000 COGS from the $200,000 in sales. This will result in a $60,000 gross profit. Now, since the $80,000 in expenses exceeds the $60,000 gross profit, a $20,000 net loss will result on the income statement.
Accounting for loss
On a company’s financial statements, unrealized and realized losses are handled differently. An unrealized loss or gain would be reported on the balance sheet because it represents a loss or gains in the value of the assets which reduces the owner’s equity. A realized loss or gain, on the other hand, would be reported in the income statement because the company actually earned or lost some money.
This means that a loss isn’t realized until it actually hits the company’s pocketbook. For instance, assuming a business holds stock in another company, and that stock drops in value. If the business still owns the stock, the loss is only on paper which accountants refer to as an unrealized loss. However, if the business sells the stock, it becomes a realized loss. Hence, when making out financial statements, realized and unrealized losses are treated differently.
Furthermore, when a business sells an asset or investment at a loss, it is considered to be a realized loss which is reported as a nonoperational loss on income statements. However, just because a business hasn’t realized a loss yet doesn’t mean it should ignore it in the financial statements. Therefore, unrealized losses and gains are reported on the balance sheet as ‘other comprehensive income’ which is entered in the owners’ Equity section. Hence, equity will increase or decrease, depending on whether a loss or gain is recorded.
The income statement, on the other hand, is where you report your profits and losses for a given accounting period, be it for a month, a quarter, or a year. If a business earns more than it spent, it records net income on the income statement. However, if the business lost more than it made, it records a net loss on the income statement. Therefore, if a company sells an asset at a loss, this is reported as a realized loss on the income statement. The income statement reports three types of losses; expenses associated with the business’s primary operations, nonoperating expenses, such as interest on loans, and nonoperating losses where realized losses on investments and assets are reported.
Journal entry for losses
When a company realizes a loss, changes would be made to where the unrealized loss was recorded on the balance sheet. Assuming, the company has an unrealized loss recorded as other comprehensive income. Then it sells the asset and realizes the loss. What happens is that the loss from other comprehensive income would be removed and reported in retained earnings instead. Retained earnings are the profits that the company made that weren’t distributed to shareholders as dividends. Hence, if a business spent $60,000 of its profits on new equipment, and sells the equipment for $45,000 cash, this is recorded as $15,000 less in the retained earnings account.
Journal entry for loss on sale of an asset
In order to calculate a gain or loss on the sale of an asset, compare the cash received to the carrying value of the asset. For a fixed asset, verify that it has been depreciated through the end of the last reporting period. Ensure that the amount of accumulated depreciation recorded for the asset matches the underlying depreciation calculation. Hence, the carrying value of the asset would be the original purchase price of the asset, minus all accumulated depreciation and any accumulated impairment charges. When this carrying value of the asset is subtracted from the sale price of the asset, the remainder is either positive or negative. It is considered a gain if the remainder is positive and a loss if the remainder is negative.
When recording the gain on the sale of a fixed asset, the entry is a debit to the accumulated depreciation account, a credit to the asset account, and a credit to a gain on the sale of assets account. On the other hand, when recording the loss on the sale of a fixed asset, the entry is a debit to the loss on sale of assets account, a debit to the accumulated depreciation account, and a credit to the asset account. Hence, the result of these journal entries would appear in the income statement and impacts the amount of profit or loss reported for the period in which the transaction is recorded.
The journal entry for loss on the sale of an asset is shown on the debit side of the profit and loss account. Hence, 3 different accounts will be affected by this recorded loss, such as the Asset account (for the asset being sold), the Cash account (for the cash being received), and the Profit and loss account (for the loss on sale of the asset).
According to the accounting debit and credit rules, the Cash account would be debited, the Profit and loss account would be debited and the Asset account would be credited. For instance, you sold machinery that has a book Value of $100,000 for $90,000. Hence, you’ve incurred a $10,000 loss on the sale of the asset. In order to show this loss in the books, you will make the following journal entry:
|Profit and loss A/c: Loss on sale of machinery||$10,000|
|Asset A/c: Machinery||$100,000|
Journal entry for loss on investment
Loss on investment occurs when a company sells an investment for less than the book value. The journal entry for this is as follows:
|Profit and loss A/c: Loss on Investment||00|
The Cash account will increase while the Investment account will decrease from the balance sheet. If the cash received is smaller than the investment, it is a loss recorded as a loss on investment in the profit & loss account. This loss recorded, is the balancing figure between the cash and investment, and will be presented on the income statement.