Profit and Loss Account

Objectives

- Explain the purpose of Profit and Loss Account

- Explain the meaning of net profit/Loss

- Explain the accounting concept behind profit and loss

- Draw up the Profit and Loss Account

- Distinguish between gross profit and Net profit

- Know how to transfer from related accounts to the P&L account

- Identify ways to improve profitability

27

/3/2

01

2

1

Purpose of Profit & Loss account

- The Profit and Loss Account is a financial statement prepared at the end of the accounting period to calculate the net profit/loss for the period.

Net Profit= Gross Profit – operating expenses

- Gross profit is the merchandising profit and not the overall profit of the business because the expenses incurred in operating the business have not yet been deducted.

- The real profit of the business is termed net profit because it is the profit which remain after deduction of operating expenses >>>> To example

27

/3/2

01

2

2

Remember?

ABC company is a business that sell pens, In 2012 they sold 1000 pens at $2 each. The cost of purchasing the pen is $0.5 each. How much profit did they make in 2012? Is this a gross or net profit?

What are the other expense ABC might incur in order to sell the pen?

After deducting those expense assuming it is $200, what is the _ _ _ profit?

Can you remember the Cost of goods sold ?

27

/3/2

01

2

3

Increase in profit=increase in cash?

Does increase in profit necessarily means an increase in cash?

Think about the types of transaction we have with our suppliers and customers (cash vs credit)

Group work discussion

Draw up scenarios in which your increases in net profit or loss affect your cash, assets or liability.

27

/3/2

01

2

4

Cash purchases $400 sold for cash $800

PROFIT AND CASH

Profit + $400, Cash + $400

Situation 1:

Situation 2: Cash purchases $400, credit sales $800

Profit + $400, Cash — $400, Debtors + $800

Increase in profit = Net increase in assets

Increase in profit = Increase in cash

Situation 3: Cash purchases $400, sold for cash $800, out of which $400 was used to pay a creditor

Increase in profit = Decrease in liability

Profit + $400, creditors — $400, cash no change.

Conclusion: Increase in profit does not necessarily mean increase in cash

27

/3/2

01

2

5

Operating Expenses Operating expense are incurred in the process of earning sales revenue.

Eg. Staff salaries, advertising expense, insurance expense, utilities expense, Rent expense, delivery expense

Operating expense must be distinguished from Cost of Purchase

- Operating expense affect the net profit

- Cost of purchase affect the gross profit and subsequently the net profit

Therefore, operating expenses is transferred to the Profit and Loss Account while the Cost of Purchase is transferred to the Trading Account.

27

/3/2

01

2

6

Profit and Loss Account, Capital Account

• all expenses and revenue accounts (other than those found in the Trading Account) will be closed and transferred to this account

• Net Profit/Loss - is transferred from the Profit and Loss A/c to the Capital A/C

• profits increase owner’s equity

27

/3/2

01

2

7

Drawing up the P&L, Closing of account to P&L

Date Particulars Dr Cr 20X1 Dec 31

Interest Income Profit and Loss Account (Transfer of Interest Income to Profit and Loss)

$ 500

$

500

Profit and Loss Account Utilities (Transfer of Utilities to Profit and Loss)

400 400

General Journal

20X1 $ 20X14 $

Dec 31 Profit and Loss 500 Dec 31 Cash / Bank 500

20X1 $ 20X1 $

Dec 31 Cash / Bank 400 Dec 31 Profit and Loss 400

Interest Income

Utilities

Interest Income

Utilities Expense

27

/3/2

01

2

8

$ $

Carriage outwards Gross Profit

Interest on Loan Commission Received

Utilities Discount Received

Rent Interest Income

Wages

Discount Allowed

General Expenses

Net Profit

Name of Firm

Profit and Loss Account for the year ended date .

27

/3/2

01

2

9

Trial Balance as at 30 June 2007

Dr Cr

$ $

Capital 35,000

Equipment 18,000

Purchases 31,000

Opening stock 4,800

Returns inwards 230

Dr Trading Account for the year ended 30 June 2007 Cr

Dr Profit and Loss Account for the year ended 30 June 2007 Cr

Returns outwards 600

Carriage inwards 350

Drawings 500

Rent expense 7,000

Commission revenue 5,500

Cash at bank 14,020

Sales 34,800

Closing stock $5,900

75,900 75,900

$ $ $

Opening stock 4,800

Purchases 31,000

Less Returns outwards 600 31,350

Sales 34,800

Add Carriage inwards 350

Net purchases 30,750

Cost of goods available for sale 35,550 Less Closing stock 5,900

Cost of goods sold 29,650

Gross profit 4,920

34,570 34,570

Gross profit b/d 4,920

$ $

Commission revenue 5,500

Rent expense 7,000

Net profit 3,420

10,420 10,420

Draw up final accounts from a given Trial Balance Calculate cost of goods available for sale Calculate cost of goods sold

Calculate gross profit

Calculate net profit

Less Returns inwards 230

Net sales 34,570

27/3/2012 10

Date Particulars Dr Cr

20X1 Dec 31

Profit and Loss Capital (Transfer of net profit to Capital)

$ 2 400

$

2 400

20X1 $ 20X1 $

Dec 31 Bal c/d 10 400 Jan 1 Bal b/d 8 000

Dec 31 Profit and Loss -Net Profit

2 400

10 400 10 400

20X2

Jan 1 Bal b/d 10 400

To record a net profit of $2400 to the Capital Account

Capital Account 27

/3/2

01

2

11

Date Particulars Dr Cr

20X2 Dec 31

Capital Profit and Loss (Transfer of net loss to Capital)

$ 5 000

$

5 000

20x2 $ 20x2 $

Dec 31 Profit and Loss -Net Loss

5 000 Jan 1 Bal b/d 8 000

Bal c/d 3 000

8 000 8 000

20X2

Jan 1 Bal b/d 8 000

To record a net loss of $5 000

Capital Account

27

/3/2

01

2

12

Profitability Ratios Net Profit margin

• Net Profit Margin Ratio = Net Income/Net Sales = ________%

• Net sales is simply sales revenue with any returns and allowances subtracted out. Net Income is income with all expenses subtracted out including taxes, interest expenses, and depreciation. It is the "bottom line."

Net profit margin indicates how well the company converts sales into profits after all expenses are subtracted out. Since industries are so different, the net profit margin is not very good at comparing companies in different industries. It is good, however, at comparing companies in the same industry if you want to look at the bottom line.

27

/3/2

01

2

13

The end

27

/3/2

01

2

14