Exploring Profit and Loss Accounts: Key Features and Format Differences

Introduction

Trial balance proves the arithmetical accuracy of the business transactions, but it is not the end. The businessman is interested in knowing whether the business has resulted in profit or loss and what the financial position of the business is at a given period. In short, he wants to know the profitability and the financial soundness of the business.

 

Definition of profit and loss account

Profit and loss account or income statement is one of the financial statements of a company of the financial statements of a company and shows the company’s revenue and expense during a particular period. It is prepared after the trading account and thus, is the second stage of financial statement. 

Profit and loss account

Profit and loss account shows the net profit and net loss of the business for the accounting period. This account is prepared in order to determine the net profit or net loss that occurs during an accounting period for a business concern.

Profit and loss account get initiated by entering the gross loss on the debit side or gross profit on the credit side. This value is obtained from the balance which is carried down from the trading account.

A business will incur many other expenses in addition to the direct expenses. These expenses are deducted from the profit or are added to gross loss and the resulting value thus obtained will be net profit or net loss.

1. It is prepared to determine net profit or net loss incurred by business during an accounting period.
2. Profit and loss account is prepared after preparing trading account
3. Profit and loss account with gross profit (on credit side) and gross loss (on debit side)
4. All indirect expenses and losses are transferred to debit side of profit and loss account.
5. All indirect income and gain are transferred to the credit side of profit and loss account
6. Difference of two sides is Net Profit or Net Loss
7. If total of credit side (income) is greater than (>) total of debit side (expense)
8. If total of debit side (expense) is greater than (>) total of credit side )income) shows Net loss.

Feature of Profit and loss account 

1. It shows the financial performance of enterprise during an accounting period.
2. It is the second stage in preparation of Final Account
3. It relates to particular accounting period
4. Accrual basis of accounting is followed in preparation of this account
5. Credited with gross profit and indirect income from other sources
6. Debited with gross loss and indirect expense
7. Balance of this account is known as Net Profit or Net Loss
8. Net profit or Net loss directly affects the capital. Net profit increases the capital, while net loss decreases it.

Format of Profit and Loss Account

Profit and loss account for the year ended …

Dr.                                                                                                                                             Cr.
Particulars	Amount	Particulars	Amount
To Gross loss (transferred from trading a/c)		By Gross Profit (transferred from trading a/c)
To Salaries		By Rent Received
To Rent		By Discount Received
To Stationery and Printing		By Commission Earned
To Postage and Telegrams		By Interest Received
To Legal Charges		By Bad debts recovered
To Telephone Expense		By Income from investment
To Insurance Premium		By Dividends on Share
To Business Promotion Expense		By Miscellaneous Income
To Repair and Renewals		By Net loss (transferred to capital a/c)
To Depreciation
To Interest
To Sundry Expenses
To Conveyance
To Bank Charges
To General Expenses
To Electricity Expenses
To Loss by Fire or Theft
To Commission
To Advertisement
To Freight and Carriage Outwards
To Discount Allowed
To Travelling Expenses
To Bad Debts
To Net Profit (transferred to capital a/c)

Items Shown on the Debit Side

Office and Administration Expenses

1. Salaries
2.  Rent and taxes
3. Electricity charges
4. Printing and stationary
5. Postage and telegram
6. Insurance charges
7. Telephone charges
8. Legal charges
9. Repair and renewal
10. Depreciation 
11. Miscellaneous expense
12. Sundry expense 

Selling and Distribution Expenses

1. Salesman’s salaries and commissions
2. Advertisement
3. Godown or Warehouse expense
4. Packing expenses
5. Freight and carriage on sales
6. Delivery charges
7. Bad debts
8. Discount allowed

Finance Expense

1. Interest on loan
2. Interest on mortgage payable

Abnormal Losses

1. Loss of stock by fire not covered by insurance
2. Loss on sale of fixed assets
3. Loss by theft
4. Cash embezzlement

Items shown on the Credit Side

1. Gross profit
2. Interest received 
3. Income from investment
4. Rent received
5. Discount received
6. Bad debts recovered
7. Profit on sales of fixed assets

For Example

Example without GST – Following is the trail balance of Sanjay on 31st March 2023 pass closing entries and prepare trading and Profit & loss account for the year 31st March 2023. 

Trial Balance as on 31st March 2023

Particulars	Dr.	Cr.
Capital account		1,00,000
Stock a/c (1st April 2022)	20,000
Cash at Bank	10,000
Cash in Hand	4,400
Machinery a/c	60,000
Furniture and fittings a/c	13,600
Purchase a/c	1,50,000
Wages a/c	1,00,000
Power and Fuel a/c	30,000
Factory lighting a/c	2,000
Salaries a/c	70,000
Discount allowed a/c	5,000
Discount received a/c		3,000
Advertising a/c	50,000
Sundry office expense a/c	40,000
Sales a/c		5,00,000
Sundry Debtors	85,000
Sundry Creditors		37,000
	6,40,000	6,40,000

Value of closing stock as on 31st March 2023 was 27,000

Solution

Trading Account and Profit & loss of Sanjay for the year ended 31st March 2023

Dr.                                                                                                                                                            Cr.
Particulars	Amount	Particulars	Amount
To Opening Stock	20,000	By Sales	5,00,000
To Purchase	1,50,000	By Closing Stock	27,000
To Wages	1,00,000
To Power and fuel	30,000
To factory lighting	2,000
To Gross Profit c/d (transfer to P&L)	2,25,000
	5,27,000		5,27,000
To salaries	70,000	By Gross Profit	2,25,000
To Discount allowed	5,000	By Discount received	3,000
To Advertising	50,000
To Sundry office Expense	40,000
To Net Profit (Transferred to Capital)	63,000
	2,28,000		2,28,000

Difference Between Trading and Profit and Loss Account

Basis	Trading Account	Profit and loss Account
Meaning	Trading account used to find the gross profit or gross loss of the business for an accounting period.	Profit and loss account or income statement is used to find the net profit or Net loss of the business for an accounting period
Timing	Trading account is prepared first and then profit and loss account is prepared	Profit and loss account is prepared after the trading account is prepared
Purpose	For knowing the gross profit or gross loss of a business	For knowing the net profit or net loss of a business
Stage	It is the first stage in the creation of the final account	It is the second stage in the creation of the final account
Dependency	It is not dependent on trial balance	It is dependent on trading account
Relation	Trading account is a part of profit and loss account	Profit and loss account is the main account
Transfer of balance	The balance in the form of gross loss or gross profit of the trading account will be transferred to the profit and loss account	The balances in the form of Net loss or Net profit of the profit and loss account will be transferred to the balance sheet.
Items	Items shown in the trading account are purchase, sales, opening and closing stock, direct expense etc.	Items like indirect expense related to sales, distribution, administration, finance etc. are shown in the profit and loss account.

Advantage and Disadvantage of Profit and Loss Account

Advantages of Profit and loss account

1. For information on net result – this gives actual information about net profit or a net of the business for an accounting period.
2. Comparability – the profit disclosed by the profit and loss account for a particular period can be compared with the pervious years results.
3. Controlling of profit and loss – they help in control and detaining indirect or non-expenses by providing important information about these expenses.

Limitation of profit and loss account

1. Only show past performance and can be difficult to say what will happen in the future
2. Window dressing
3. The profit and loss account are prepared on accrual system of accounting which provides a better measure of performance but includes a number of non-cash items in its arrival at the figure of net profit. For example, depreciation expense is an allocation of cost that has no associated cash outflow yet it decreases net income.

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