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Profit and Loss Account

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Profit and loss account is the second step of final accounts. It is prepared to ascertain the net profit or the net loss of the business during the accounting period. It is prepared after the preparation of trading account. It is prepared by transferring gross profit or gross loss from the trading account. Hence, profit and loss account is a financial statement, which helps to know the operating result of the business. It is prepared in the form of ledger.

The following is the main definition of profit and loss account:

“Profit and loss account is a statement which summarizes all indirect revenue expenses in one side which are compared with gross profit/ revenue incomes in another side and net trading income of an accounting period is assessed.” – S. Mukherjee

Objectives of Profit and Loss Account

The profit and loss account is prepared for the determination of net profit or net loss for the specific period of time. The following are the main objectives of profit and loss account:

  1. To know the amount of net profit or net loss
    Profit and loss account is prepared to find out the amount of net profit or net loss made by the business during the particular period of time. It is determined by making a comparison between indirect expenses and indirect incomes. It enables the businessman to make a comparison of net profit or the net loss of the current year with the previous year.

  2. To provide information about office and administrative expenses
    All the expenses, which are incurred in the process of operating the business, are known as office and administrative expenses. It includes the expenses like office salaries, printing and stationary expenses, legal expenses, telephone and electricity charges, office rent, audit fees, insurance premium etc. Percentage of such expenses on sales can be determined and compared with the previous year, which helps to control such expenses.

  3. To provide information about selling and distributing expenses
    Expenses, which are incurred in the process of selling and distributing the goods, are known as selling and distributing expenses. It includes the expenses like warehouse expenses, carriage on sales, packing expenses, commission on sales, advertising, traveling expenses etc. Percentage of such expenses on sales can be determined and compared with the previous year, which helps to control such expenses.

  4. To provide information about other expenses and losses
    There may be different types of expenses other than office and administrative, selling and distributing and financial expenses. The information of such expenses is also provided by profit and loss account. Depreciation, repairs, and maintenance, bad debts, provision for bad debts, loss on sale of fixed assets and loss of goods in transit are some of the examples of other expenses and losses. These expenses can be compared with the expenses of the previous year and remedial action can be taken for minimizing such expenses and losses.

  5. To provide information about financial expenses
    The expenses, which are incurred for fulfilling the financial need of the business, are known as financial expenses. These expenses include interest on a loan, interest on bank overdraft, bank charges etc. Percentage of such expenses on net profit can be determined and compared with the previous year, which provides pertinent information for raising a loan.

  6. To provide information about incomes and profits
    Different types of incomes and profits are earned by the business in the process of operation of the business. Rent received, interest received, the commission received, discount received, and profit on the sale of fixed assets and bad debts recovered are some of the examples of such incomes and profits. The information of such incomes and profits is provided by profit and loss account.

  7. To make comparison
    Profit and loss account helps to compare the amount of sales and the net profit of current year with those of previous years. Such comparison helps in evaluating the progress of the business.

  8. To measure efficiency
    Profit and loss account helps in measuring the operating efficiency of the business. Such efficiency is measured by comparing the amount of net profit with the amount of operating expenses.


Importance and Advantages of Profit and Loss Account

Profit and loss account is essential to determine the operating result of the business. It helps to examine the operating efficiency of the business. The importance and advantages of profit and loss account are as follows: -

  • It helps to determine the amount of net profit or net loss made by the business during the particular period of time.
  • It helps to know the amount of office and administrative expenses, selling and distributing expenses, financial expenses and other expenses and losses.
  • It helps to know the percentage of net profit on sales.
  • It helps to determine the percentage of operating expenses on sales.
  • It helps to determine the tax liability of the business.
  • It helps to prepare plans and policies by making a comparative study of net profit, indirect incomes, and indirect expenses.

Procedures of Preparing Profit and Loss Account

Profit and loss account is prepared by following certain procedures. It is prepared in the form of the ledger and hence it contains two sides: Debit and Credit. While placing the items in the profit and loss account, expenses and losses are debited and incomes and profits are credited. The procedures of preparing the profit and loss account can be explained as follows: -

  1. Transferring gross profit or gross loss
    The amount of gross profit is transferred from the trading account in the credit side of the profit and loss account with the words “By gross profit b/d”. If there is the gross loss in the trading account, it is transferred to its debit side with the words “To gross loss b/d” under particulars column.

  2. Placing expenses and losses in debit side
    Items relating to office and administrative expenses, selling and distributing expenses, financial expenses, depreciation and repairs and maintenance expenses and other expenses and losses are debited in the profit and loss account.

  3. Placing incomes and profits in credit side
    Items relating to indirect incomes and other incomes and profits are credited in the profit and loss account.

  4. Balancing and closing the profit and loss account
    Profit and loss account is prepared to know the amount of net profit or net loss. It is determined by balancing the profit and loss account. The following procedures are followed for balancing and closing the profit and loss account: -
    • Find out the heavier side
    • Put the difference amount in lighter side to make total of both sides equal
    • Write the words “To net profit c/d” if credit total exceeds debit total or “By net loss c/d” if the debit total exceeds credit total against the difference amount under particulars column.
    • Draw double parallel lines after the total amount of both sides to close the accounts.



  • Profit and loss account is the second step of final accounts.
  • Profit and loss account is prepared to ascertain the net profit or the net loss of the business during the accounting period.
  • Profit and loss account is prepared in the form of ledger.
  • Profit and loss account helps to compare the amount of sales and net profit of current year with those of previous years.
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Very Short Questions

Profit and loss account is the second step of final accounts. It is prepared to ascertain the net profit or the net loss of the business during the accounting period. It is prepared after the preparation of trading account. It is prepared by transferring gross profit or gross loss from the trading account. Hence, profit and loss account is a financial statement, which helps to know the operating result of the business. It is prepared in the form of ledger.

According to S. Mukharjee,“Profit and loss account is a statement which summarizes all indirect revenue expenses in one side which is compared with gross profit/ revenue incomes in another side and net trading income of an accounting period is assessed.”

From the above definition, it is clear that profit and loss account is a financial statement, which helps to know the operating result of the business. It is prepared in the form of ledger.

Profit and loss account is essential to determine the operating result of the business. It helps to examine the operating efficiency of the business. The importance and advantages of profit and loss account are as follows: -

  1. It helps to determine the amount of net profit or net loss made by the business during the particular period of time.
  2. It helps to know the amount of office and administrative expenses, selling and distributing expenses, financial expenses and other expenses and losses.
  3. It helps to know the percentage of net profit on sales.
  4. It helps to determine the percentage of operating expenses on sales.
  5. It helps to determine the tax liability of the business.
  6. It helps to prepare plans and policies by making a comparative study of net profit, indirect incomes, and indirect expenses.

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  • ______ is a financial statement, which helps to know the operating result of the business.

    Balance sheet
    Trading account
    Profit and loss account
    Trial balance
  • Profit and loss account is prepared after the preparation of ______.

    trading account
    trial balance
    ledger accounts
    balance sheet
  • "Profit and loss account is a statement which summarizes all indirect revenue expenses in one side which is compared with gross profit/ revenue incomes in another side and net trading income of an accounting period is assessed." Who said this?

    S.P. Arora


    S. Mukharjee


    A. Ashley


    J. R. Batliboi


  • Which one of them is not the objective of profit and loss account?

    To provide information about other expenses and losses


    To provide information about office and administrative expenses


    To provide information about expenses and losses


    To provide information about selling and distributing expenses


  • The expenses, which are incurred for fulfilling the financial need of the business, are known as ______.

    direct expenses


    outstanding expenses


    financial expenses


    accrued expenses


  • All the expenses, which are incurred in the process of operating the business, are known as ______.

    office and administrative expenses
    selling and distributing expenses
    preliminary expenses
    financial expenses
  • Expenses, which are incurred in the process of selling and distributing the goods, are known as ______.

    financial expenses


    preliminary expenses


    selling and distributing expenses


    office and administrative expenses


  • The expenses, which are incurred for fulfilling the financial need of the business, are known as ______.

    preliminary expenses


    selling and distributing expenses


    office and administrative expenses


    financial expenses


  • ______ is the permanent decrease in the value of fixed assets due to their continuous use.

    Depreciation
    Appreciation
    Patent
    Goodwill
  • Items relating to ______ are debited in the profit and loss account.

    depreciation
    repairs and maintenance expenses
    selling and distributing expenses
    all the options are correct
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