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Profit and Loss Account:

Learning Objectives:

1. Define and explain profit and loss account.

2. Prepare the format of profit and loss account (account form and statement form).

3. Prepare closing journal entries profit and loss account.

Definition and Explanation:

Profit and loss account is the account whereby a trader determines the net result of his business transactions. It is the account which reveals the net profit (or net loss) of the trader.

The profit and loss account is opened with gross profit transferred from the trading account (or with gross loss which will be debited to profit and loss account). After this all expenses and losses (which have not been dealt in the trading account) are transferred to the debit side of the profit and loss account. If there are any incomes or gains, these will be credited to the profit and loss account. The excess of the gain over the losses is called the net profit and that of the loss over the gain is called the net loss. The account is closed by transferring the net profit or loss to capital account of the trader.

Format of the Profit and Loss Account:

Profit and Loss Account
For the year ended ..............

Closing Entries for Profit and Loss Account:

The following usual entries are passed at the end of each trading period.

1. Transferring all expenses or losses:
   Profit and loss account
        To Each of the various expenses or losses
   (This entry will close the expenses accounts)
    

   ---

2. Transferring all items of gains etc:
   Various nominal accounts (representing gains)
        To Profit and loss account
   (This entry will close all the remaining nominal accounts)

   ---

3. Transferring net gain to capital account:
   Profit and loss account
        To Capital account
   (This entry closes the P & L account)

   ---

4. Transferring net loss to capital account:
   Capital account
        To Profit and loss account
   (This entry closes the P & L account)

Profit and Loss Account in Statement Form/Income Statement:

Trading and profit and loss account/income statement may be prepared either in account form (T form) or in report form (statement form). Trading and profit and loss account in both the forms give the same information. The account or T form is traditional and is used widely but in recent years many business houses prefer to present the profit and loss account/income statement in the report form.

Format of Profit and Loss Account/Income Statement in Statement Form:

Trading and Profit and Loss Account/Income Statement
For the year ended 31st December, 199-----
 

Income From Sales:
Sales		------
Less: Sales returns	------
Sales discount	------	------
Net Sales			------
Cost of Goods Sold:
Merchandise is stock on 1st January		------
Purchases	------
Less: Purchases returns	------
Net purchases		------
Cost of goods available for sale		------
Less merchandise in stock on 31st December		------
Cost of goods sold			------
GROSS PROFIT			------
Operating Expenses:
Selling Expenses:
Sales salaries	------
Advertising expenses	------
Insurance expense - selling	------
Store supplies expenses	------
Sundry selling expenses	------
Total selling expenses
		------
General Expenses:
Office salaries	------
Taxes	------
Insurance expenses general	------
Office supplies expenses	------
Sundry general expenses	------
Total general expenses		------
Total operating expenses			------
Net profit from operations			------
Other Income:
Rent income		------
Other Expenses:
Interest expenses		------
			------
NET PROFIT			------

Explanation of Certain Items of Income Statement:

Income from sales: The total of all charges to customers for goods sold, both for cash and on credit, is reported in this section. Sales returns and allowances and sales discounts are deducted from the gross amount to yield net sales.

Cost of Goods Sold: Cost of goods sold refers to the cost price of goods which have been sold during a given period of time. In order to calculate the cost of goods sold we should deduct from the total cost of goods purchased the cost of goods at the end of the year. This can be explained with the help of following formula/equation:
 

(Opening stock + Cost of goods purchased)  - Closing stock = Cost of goods sold

Gross Profit: The excess of the net income from sales over the cost of goods sold is also called gross profit on sales, trading profit or gross margin. It is as gross because all other expenses for the period must be deducted from it to obtain the net profit or net income of the business.

Operating Expenses: The operating expenses also called operating costs of a business may be classified under any desired number of headings and sub-headings. In small retail business it is usually satisfactory to classify operating expenses as selling or general.

1. Expenses that are incurred directly in connection with the sale of goods are known as selling expenses. selling expenses include salaries or the salesmen, store supplies used, depreciation of the store equipment, and advertising.
2. Expenses incurred in the general administration of the business are known as administrative expenses or general expenses. Examples of general expenses are office salaries, depreciation  of equipment, and office supplied used.

Net Profit from Operations: The excess of gross profit on sales over total operating expenses is called net profit or net profit from operations. If operating expenses should exceed gross profit, the excess is designated as net loss or net loss from operations.

Other Income: Minor sources of income are classified as other income or non-operating income. In a merchandising business this category often include income from interest, rent, dividends and gains from the sale of fixed assets.

Other Expenses: Expenses that cannot be associated definitely with the operations are identified as other expenses or non-operating expenses. Interest expense that results from financing activities and losses incurred in the disposal of fixed assets are examples of items reported in this section.

The two categories of non-operating items, other income and other expenses, are offset against each other on the profit and loss account. If the total of other income exceeds the total other expenses, the excess is added to net profit from operations; if the reverse is true, the difference is subtracted from net profit from operations.

Net Profit: The final figure on the profit and loss account is labeled as net profit (or net loss) or net profit carried to balance sheet. It is the net increase in capital from profit making activities.

You may also be interested in other articles from "final accounts" chapter:

1. Trading Account
2. Profit and Loss Account
3. Difference Between Trading Account and Profit and Loss Account
4. Balance Sheet
5. Difference Between Trial Balance and Balance Sheet
6. Examples of Trading and Profit and Loss Account and Balance Sheet

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