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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 has to 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 are more than gross profit the result will be net loss
The aim of profit and loss account is to ascertain the net profit earned or net loss suffered during a particular period.
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.
The following items will appear in the debit side of the Profit & Loss A/c:
(i) Cost of Sales: This term refers to the cost of goods sold. The goods could be manufactured and sold or can be directly identified with goods.
(ii) Other Expenses: All expenses which are not directly related to main business activity will be reflected in the P & L component. These are mainly the Administrative, Selling and distribution expenses. Examples are salary to office staff, salesmen commission, insurance, legal charges, audit fees, advertising, free samples, bad debts etc. It will also include items like loss on sale of fixed assets, interest and provisions.
(iii) Abnormal Losses: All abnormal losses are charged against Profit & Loss Account. It includes stock destroyed by fire, goods lost in transit 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.
i. Interest received on investment
ii. Interest received on fixed deposits.
iii. Discount earned.
iv. Commission earned.
v. Rent Received
Note:
i. If trial balance shows both trading expenses as well as office expenses, the trading expenses should be shown in the trading account and office expenses should be shown in profit & loss account. On the other hand, if the trial balance shows only trading expenses, it should be shown in the profit & loss account.
ii. If in the trial balance, wages are clubbed with salaries and shown as ‘wages and salaries’. This item is shown in trading account. On the other hand, if it appears as ‘salaries and wages’, this item is recorded in the profit & loss account.
iii. Income tax paid by a proprietor is considered as personal expenses. So it should be deducted from the capital.
Balancing
The difference between the two sides of profit and loss account indicates either net profit or net loss.If the total on the credit side is more the difference is called net profit. On the other hand if the total of debit side is more the difference represents net loss. The net profit or net loss is transferred to capital account.
Closing Entries
Profit and loss account should be closed by transferring the net profit or net loss to capital account.
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