Profit and Loss Account Explained with Real-World Examples

Profit and Loss Account

After calculating the gross profit or gross loss the next step is to prepare the profit and loss account. To earn net profit a trader must incur many expenses apart from those spent for purchases and manufacturing of goods. If such expenses are less than gross profit, the result will be net profit. When total of all these expenses is more than gross profit the result will be net loss.

The main reason why people set up in business is to make a profit. The profit and loss account shows whether the business is successful in this regard. 

The calculation of profit follows the following formula 

• Revenues - Expenses = Profit or Loss

“A profit and loss account is an account into which all gains and losses are collected in order to ascertain the excess of gains over the losses or vice versa”

In simple words, Profit & loss account is prepared after preparing trading account. It is prepared to determine net profit or loss incurred by business during an accounting period. It is prepared to determine net profit or loss incurred by business during an accounting period. 

1. Profit and loss account start with Gross profit on credit side or gross loss on debit side.
2. All indirect expenses and losses are transferred to debit side of profit & loss account.
3. All indirect income and gains are transferred to credit side of profit & loss account.

Difference of two sides is Net profit or loss

1. If total of Credit Side (income) > total of debit side (expenses), shows net profit.
2. If total of debit side (expense) > total of credit side (income) shows net loss.

Need and importance of profit and loss account

1. To ascertain the net profit or net loss
2. Comparison with previous year’s profits
3. Control on expenses
4. Helpful in the preparation of balance sheet.

Feature of profit & loss account

1. It is the second stage in preparation of final account.
2. It relates to particular accounting period.
3. It shows the financial performance of enterprise during an accounting period.
4. Accrual basis of accounting is followed in preparation of this account.
5. Credited with gross profit & income (indirect) from other sources.
6. Debited with gross loss & indirect expenses.
7. Balance figure – 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 ……………………

Particulars	Amount (₹)	Particulars	Amount (₹)
To Balance b/d (Gross Loss)	xxx	By Balance b/d (Gross Profit)	xxx
To Salaries	xxx	By Commission Earned	xxx
To Rent & Rates	xxx	By Rent Received	xxx
To Stationeries	xxx	By Interest Received	xxx
To Postage Expenses	xxx	By Discount Received	xxx
To Insurance	xxx	By Bad Debts Recovered	xxx
To Repairs	xxx	By Dividends on Shares	xxx
To Trading Expenses	xxx	By Miscellaneous Income	xxx
To Office Expenses	xxx	By Net Loss transferred to Capital A/c	xxx
To Interest Paid	xxx
To Bank Charges	xxx
To Sundry Expenses	xxx
To Commission Paid	xxx
To Discount Allowed	xxx
To Advertisement	xxx
To Carriage Outwards	xxx
To Travelling Expenses	xxx
To Distribution Expenses	xxx
To Repacking Charges	xxx
To Bad Debts	xxx
To Depreciation	xxx
To Net Profit (Transferred to Capital A/c)	XXX	By Net Loss (Transferred to Capital A/c)	XXX
	XXXX		XXXX

Items appearing in the debit side:

Those expenses which are chargeable to the normal activities of the business are recorded in the debit side of profit and loss account. They are termed as indirect expenses.

1. Office and Administrative Expenses: Expenses incurred for the functioning of an office are office and administrative expenses – office salaries, office rent, office lighting, printing and stationery, postages, telephone charges etc.
2. Repairs and Maintenance Expenses: These expenses relate to the maintenance of assets. Ex: repairs and renewals, depreciation etc.
3. Financial Expenses: Expenses incurred on borrowings. Ex: Interest paid on loan.
4. Selling and Distribution Expenses: All expenses relating to sales and distribution of goods. for example advertising, travelling expenses, salesmen salary, commission paid to salesmen, discount allowed, repacking charges, carriage outwards, etc.

Items appearing in the credit side

Besides the gross profit, other gains and incomes of the business are shown on the credit side. The following are some of the incomes and gains.

1. Interest received on investment
2. Interest received on fixed deposits.
3. Discount earned.
4. Commission earned.
5. Rent Received

Revenue - Revenues are income earned (not necessarily received) from the sales of the products or services provided by the business.

Revenue Samples - A separate account is opened for each

• Sales
• Rental income
• Commission received

Expenses - Expenses are the costs incurred in running the business on a day-to-day basis and thus do not include the cost of purchasing fixed assets or repayment of any loans. Expenses are the cost of using the resources available to the business to produce a product or service and sell it.

Expense Samples - A separate account is opened for each expense 

• Rent account
• Wages account
• Salaries account
• Telephone account
• Postage account
• Stationery account
• Insurance account
• Motor expenses account
• General expenses account

Difference between Trading account and profit & loss account

Basis	Trading Account	Profit and Loss Account
Relation	Trading account is a part of profit and loss account.	Profit and loss account is the main account.
Nature	Gross profit or gross loss is ascertained from trading account.	Profit and loss account is prepared to ascertain net profit or net loss of the business.
Transfer of balance	Balance of the trading account is transferred to profit and loss account	Balance of the profit and loss account is transferred to capital account of the proprietor.
Items	Items shown in the trading account are purchase, sales, opening and closing stock, direct expenses etc.	Items like indirect expenses related to sales, distribution, administration, finance etc are shown in the profit and loss account.

Example of profit & loss account

Trial Balance of Shamit as on 31st March, 2025

Illustration (Without GST): Following is the Trial Balance of Shamit on 31st March, 2025. Pass closing entries and prepare Trading Account and Profit and Loss Account for the year ended 31st March, 2025.

Particulars	Amount Dr (₹)	Amount Cr (₹)
Capital A/c		1,00,000
Stock A/c (1st April, 2017)	20,000
Cash at Bank	10,000
Cash in Hand	4,400
Machinery A/c	60,000
Furniture and Fittings A/c	13,600
Purchases 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 Expenses A/c	40,000
Sales A/c		5,00,000
Sundry Debtors	85,000
Sundry Creditors		37,000
Total	6,40,000	6,40,000

Value of Closing Stock as on 31st March, 2025 was ₹ 27,000.

Shamit – Trading and Profit & Loss Account for the year ended 31st March, 2025.

Trading Account

Particulars	Amount (Dr)	Particulars	Amount (Cr)
To Opening Stock	20,000	By Sales	5,00,000
To Purchases	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	2,25,000
Total	5,27,000	Total	5,27,000

Profit and Loss Account

Particulars	Amount (Dr)	Particulars	Amount (Cr)
To Salaries	70,000	By Gross Profit b/d	2,25,000
To Discount Allowed	5,000	By Discount Received	3,000
To Advertising	50,000
To Sundry Office Expenses	40,000
To Net Profit (Transferred to Capital A/c)	63,000
Total	2,28,000	Total	2,28,000

Profit & Loss Account — FAQs

What is a Profit & Loss Account?

A Profit & Loss Account is a financial statement prepared after the trading account that shows whether the business earned a net profit or incurred a net loss during an accounting period by tallying all indirect expenses and incomes.

How does a Profit & Loss Account work with the Trading Account?

The Trading Account calculates gross profit or gross loss. This figure is then transferred to the Profit & Loss Account, where other business incomes and expenses are accounted for to find the net result.

How does Profit & Loss Account affect the Balance Sheet?

The net profit increases owner’s equity (added to capital), while net loss reduces it when the account is closed and transferred to the capital account in the balance sheet.

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