The Profit & Loss Account

One of the most important uses of the The Profit and Loss account is to compare the results obtained with the results expected.

There are two profit measures:

  • The Gross Profit.This is calculated in the Trading Account and is the excess of sales over the cost of goods sold during the period.

  • The Net Profit.This is calculated in the Profit and Loss Account and is what remains after all other costs used up in the period have been deducted from the Gross Profit.

It is now usual for the Profit and Loss accounts to be shown under one combined heading, The Trading Account being the top section and the Profit and Loss account being the lower section.

It would be unusual for a trader to have sold all the goods at any particular date. So in most cases there would be inventory in hand at the end of the trading period. So it is normal practice for this inventory to be counted and valued at the price for which it could be sold. The figure for this is normally called the closing inventory and the details are given as a note at the end of the Trial Balance. This amount is in fact entered as a debit in a new account called the Inventory account, which is an asset account and as a credit in the Trading account.

The Trading Account also shows any items of expenditure which can properly be allocated to expenses connected with the purchase, manufacture or stage of goods, i.e. rent of warehouse, wages of store men, freight in, etc.

Other considerations:

Returns Purchases - Goods returned to suppliers, so this reduces the cost of purchases.

Returns Sales - Goods returned to the company by the customers who bought them, so this reduces the sales figure.

Freight In - Is the cost of transport of goods into the firm and are therefore added to the purchases figure.

Freight Out - Is the cost of transport of goods out of the firm to its customers, it is not part of the firm's expenses in buying the goods and is always entered in the Profit and Loss Account as an expense not the Trading Account.

Depreciation - This is discussed later, but generally the provision for depreciationfor the accounting period is considered an expense to the business is entered on the Profit and Loss Account. ( The total depreciation of the asset is taken account of on the Balance Sheet).

Lets now complete Pepe's Profit & Loss Account for the year ending 12-31-09