Profit and Loss Account:

Learning Objectives:

1. Define and explain a profit and loss account.

2. What are the benefits of preparing a profit and loss account?

Definition and Explanation:

The account through which annual net profit or loss of a business is ascertained, is called profit and loss account. Gross profit or loss of a business is ascertained through trading account and net profit is determined by deducting all indirect expenses (business operating expenses) from the gross profit through profit and loss account. Thus profit and loss account starts with the result provided by trading account.

The particulars required for the preparation of profit and loss account are available from the trial balance. Only indirect expenses and indirect revenues are considered in it. This account starts from the result of trading account (gross profit or gross loss). Gross profit is shown on the credit side of the profit and loss account and gross loss is shown on the debit side of this account. All indirect expenses are transferred on the debit side of this account and all indirect revenues on credit side.  If the total of the credit side exceeds the debit side, the result is "net profit" and if the total of the debit side exceeds the total of the credit side, the result is net loss. As the net profit or net loss of a certain accounting period is determined through profit and loss account, so its heading is:

Name of Business
Profit and Loss Account for the year ended 31.12.2005
(if accounting period ends on 31.12.2005)

Sequence of Expenses in Profit and Loss Account:

There is no hard and fast rule as to the order in which the items of expenses are shown in profit and loss account. Generally, the items of expenses are shown in the following sequence:

Office and Administration Expenses:

These are the expenses with the management of the business e.g. salaries of manager, accountant and office clerks, office rent, office stationary, office electric charges, office telephone etc.

Selling and Distribution Expenses:

These are the expenses which are directly or indirectly connected with the sale of goods. These expenses vary with the sales i.e. they increase or decrease with the increase or decrease of sale of goods. Examples are advertisements, carriage outward, salesmen's salaries and commission, discount allowed, traveling expenses, bad debts, packaging expenses, warehouse rent etc.

Financial and Other Expenses:

All other expenses excepting those mentioned above are considered under this class.

Features of Profit and Loss Account:

1. This account is prepared on the last day of an account year in order to determine the net result of the business.
2. It is second stage of the final accounts.
3. Only indirect expenses and indirect revenues are shown in this account.
4. It starts with the closing balance of the trading account i.e. gross profit or gross loss.
5. All items of revenue concerning current year - whether received in cash or not - and all items of expenses - whether paid in cash or not - are considered in this account. But no item relating to past or next year is included in it.

The following is a specimen of profit and loss account

Name of Business
Profit and Loss Account for the year ended .....

Example:

The following is the trial balance of XYZ company on 31st December 2005.

The closing stock is valued at $126,000.

Required:

Prepare a profit and loss account for the year ended 31st December 2005.

Solution:

As we have already discussed that profit and loss account starts with the gross profit or gross loss figure produced by trading account, we have to determine the gross profit or gross loss by preparing trading account of XYZ company first.

XYZ co.
Trading Account for the year ended 31.12.2005

A D V E R T I S E M E N T