Profit and loss account is the second step of final account. It is prepared after the preparation of trading account. It is prepared to know the net profit and net loss in the business during an accounting period. Profit and loss account is a nominal account. Thus, indirect expenses like office and administration, selling and distribution, financial expenses, repair and renewables etc. are recorded on the debit side of profit and loss account. All incomes of the business except sales and closing stock are recorded on the credit side of profit and loss account.
Objectives of Profit and Loss Account
The main objectives of profit and loss account are as follows:
To know the operating results i.e. the net profit or net loss for a certain period earned by a business.
To provide information about the various indirect expenses of a particular period.
To get information about the difference source of income except the sales.
To help to prepare the balance sheet.
Advantage of Profit and Loss Account
The advantages of profit and loss account are as follows:
It provides information about net profit or net loss.
It provides the information about indirect expenses.
It helps to determine the ratio between net profit to operating expenses.
It helps to determine the ratio between net profit to sales.
It helps to control the indirect expenses which helps to improve the future profitability.
Preparation of Profit and Loss account
The specimen of profit and loss account as given below:
To Gross loss b/d
By Gross profit b/d
A)Office and Administrative expenses: To Salaries or salary and wages To Rent,rateand tax To Printing and stationary To Telephone charges To Postage and telegram To Insurance To Audit fee To Legal charges To Electricity charges (Office) To Trade expenses To Sundry or Miscellaneous expenses To Entertainment expenses
XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
A) Trading incomes: By Discount received By Apprenticeship premium By Commission received By Appreciation received By Baddebitrecovered By Sundry or Miscellaneous income
XXX XXX XXX XXX XXX XXX
B)Maintenance Expenses To Repair and renewable To Depreciation on: Office equipment Office furniture Office building
XXX XXX XXX
B)Non Tradingincome: By Interest on investment By Rent received By Dividend received By Share transfer fee received
XXX XXX XXX XXX
C)Selling and Distribution expenses: To salesman salary To Godown and showroom rent To Carriage or freight on sales To Bad debt To Establishment expenses To Export duty To Free sample, gift, charity, donation expenses To Advertising expenses To Salesman commission
XXX XXX XXX XXX XXX XXX XXX
C) Abnormal gain: By Profit on sale of fixed assets By Profit on sale of investment By Profit on revaluation of fixed assets By Net loss c/d
XXX XXX XXX XXX
D)Expenses as written off: To Preliminary expenses To intangible fixed assets written off
E)Financial expenses To Bank charge To Interest on loan To Discount on bills To Discount allowed to customer
XXX XXX XXX XXX
F)Abnormal losses: To Loss on sale of machinery To Loss on sale of investment To Loss by fire/theft/accident (if not claimed by insurance company) To net profit c/d
XXX XXX XXX
Items that appear in debit side of profit and loss account
Gross loss:This is the debit balance of trading account which is recorded in the debit side of profit and loss account.
Administrative expenses:These are expenses which are incurred for day-to-day running of office, administration and management. It includes office salaries or salary and wages, office rent and rates, office insurance, office lighting and heating, printing and stationary, Director’s fee, General or trade expenses and Legal charges, etc.
Selling and distribution expenses:They are incurred for promoting sales and distribution of sold goods. It includes packing charge, godwon’s rent, carriage outward or carriage inward, freight outward or freight inward, salesman's salary and commission, bad debt, showroom insurance, etc.
Maintenance expenses:They are incurred for maintaining the fixed assets of the administrative office in a good condition. They include repair and renewable, depreciation of assets and loss on revaluation of assets, etc.
Financial expenses:These include interest on loan, discount on bill, cash discount allowed, interest on capital, etc.
Abnormal losses:The losses which are loss on revaluation, capital losses, etc. are called abnormal loss. For example: loss on sale of fixed assets, loss on sale of machinery, etc.
Items that appear on the credit side of profit and loss account
Gross profit:It is the beginning item of profit and loss account. It is transferred from trading account.
Trading incomes:Trading incomes are the other incomes of financial nature other than income from the sale of goods. For example: discount or commission received.
Non- Trading incomes:The business may earn some amount of interest which will find a place in profit and loss account as non-trading income.
Abnormal gains:There may be capital gains arising during the course of the year. For example: profit arising out of the sale of fixed assets or profit on revaluation.
Closing Entries for Profit and Loss Account
At the end of the year, the expenses or income related with the profit and loss account should be closed down transferring into profit and loss account and the result net profit or net loss should be transferred to capital account. The entries which are made at the end of the year are known as closing entries related with profit and loss account.
Accounts to be closed:
All indirect expenses and losses debited in profit and loss a/c
All incomes and gains credited in profit and loss a/c
Profit and Loss a/c…………………….Dr To Indirect expenses and losses a/c (Being indirect expenses and losses closed transferring into profit and loss a/c)
Income and gain a/c…………………Dr To Profit and Loss a/c (Being incomes and gains closed transferring into profit and loss account)
Profit and Loss a/c…………………..Dr To Capital a/c (Being net profit transferred to capital a/c)
Capital a/c……………………………..Dr To Profit and Loss a/c (Being net loss transferred to capital a/c)
Difference between Gross profit and Net profit
It is the trading result of the business.
It is the net result of the business.
It is the balancing figure of trading account.
It is the balance figure of profit and loss account.
It is determined by comparing sales and cost of goods sold.
It is determined by comparing gross profit and indirect expenses.
Gross profit is transferred to profit and loss account.
Net profit is transferred tocapitalaccount.
It is used to evaluate the trading efficiency of the business.
It is used to evaluate operating efficiency of the business.
Sharma, Narendra et.al., Principles of Accounting-XI, Bundipuran Prakashan, Kathmandu