Profit and Loss Account

INTRODUCTION TO PROFIT AND LOSS ACCOUNT

Profit and loss account is the second step of final account. It is prepared after the preparation of trading account. It is prepared to know the net profit and net loss in the business during an accounting period. Profit and loss account is a nominal account. Thus, indirect expenses like office and administration, selling and distribution, financial expenses, repair and renewables etc. are recorded on the debit side of profit and loss account. All incomes of the business except sales and closing stock are recorded on the credit side of profit and loss account.

Objectives of Profit and Loss Account

The main objectives of profit and loss account are as follows:

• To know the operating results i.e. the net profit or net loss for a certain period earned by a business.

• To provide information about the various indirect expenses of a particular period.

• To get information about the difference source of income except the sales.

• To help to prepare the balance sheet.

Advantage of Profit and Loss Account

The advantages of profit and loss account are as follows:

• It provides information about net profit or net loss.

• It provides the information about indirect expenses.

• It helps to determine the ratio between net profit to operating expenses.

• It helps to determine the ratio between net profit to sales.

• It helps to control the indirect expenses which helps to improve the future profitability.

Preparation of Profit and Loss account

The specimen of profit and loss account as given below:

Items that appear in debit side of profit and loss account

• Gross loss:This is the debit balance of trading account which is recorded in the debit side of profit and loss account.

• Administrative expenses:These are expenses which are incurred for day-to-day running of office, administration and management. It includes office salaries or salary and wages, office rent and rates, office insurance, office lighting and heating, printing and stationary, Director’s fee, General or trade expenses and Legal charges, etc.

• Selling and distribution expenses:They are incurred for promoting sales and distribution of sold goods. It includes packing charge, godwon’s rent, carriage outward or carriage inward, freight outward or freight inward, salesman's salary and commission, bad debt, showroom insurance, etc.

• Maintenance expenses:They are incurred for maintaining the fixed assets of the administrative office in a good condition. They include repair and renewable, depreciation of assets and loss on revaluation of assets, etc.

• Financial expenses:These include interest on loan, discount on bill, cash discount allowed, interest on capital, etc.

• Abnormal losses:The losses which are loss on revaluation, capital losses, etc. are called abnormal loss. For example: loss on sale of fixed assets, loss on sale of machinery, etc.

Items that appear on the credit side of profit and loss account

• Gross profit:It is the beginning item of profit and loss account. It is transferred from trading account.

• Trading incomes:Trading incomes are the other incomes of financial nature other than income from the sale of goods. For example: discount or commission received.

• Non- Trading incomes:The business may earn some amount of interest which will find a place in profit and loss account as non-trading income.

• Abnormal gains:There may be capital gains arising during the course of the year. For example: profit arising out of the sale of fixed assets or profit on revaluation.

Closing Entries for Profit and Loss Account

At the end of the year, the expenses or income related with the profit and loss account should be closed down transferring into profit and loss account and the result net profit or net loss should be transferred to capital account. The entries which are made at the end of the year are known as closing entries related with profit and loss account.

Accounts to be closed:

1. All indirect expenses and losses debited in profit and loss a/c
2. All incomes and gains credited in profit and loss a/c
3. Net Profit
4. Net Loss

Difference between Gross profit and Net profit

References:

Sharma, Narendra et.al., Principles of Accounting-XI, Bundipuran Prakashan, Kathmandu

Koirala, Yadav Raj et.al., Principles of Accounting-XI, Asmita Books Publication, Kathmandu

Shrestha, Dasharaha et.al., Accountancy-XI, M.K. Prakashan Kathmandu