The profit and loss account

The profit and loss account is produced by a business to show:

How much net profit has been madeHow much net loss has been madeAll the expenses for the year.

Net profit or loss for the financial year is calculated as follows:

Gross profit – Expenses = Net profit or loss

The profit and loss account is presented in a vertical format.

ExpensesExpenses are the day-to-day running costs that the business will have to pay.

Expenses are also known as revenue expenditure.

The revenue expenditure for the year must be listed in the profit and loss account.

Examples of expenses

RentRatesWages and salariesHeatingLightingCleaning

InsuranceRepairsTelephoneDiscount allowedDepreciation on fixed assetsLegal fees

Example

Trading account and profit and loss account£ £

Sales 130,000Opening stock 8,000 Purchases 60,000 68,000 Closing stock 3,000 Cost of sales 65,000Gross profit 65,000 Wages 20,000Rent 5,000Heating 1,000General expenses 6,000 32,000 Net profit 63,000

Discount allowed

A business may allow a discount to a debtor for early payment of the amount owed by the debtor.

A business may use discount allowed to improve the cash flow position.

Discount allowed will reduce the profit of the business. It is an expense and must be shown in the profit and loss account.

Discount receivedA business may receive a discount from trade suppliers for early payment of the account.

Discount received will increase the net profit.

Discount received is added to the gross profit in the trading account and profit and loss account.

Example: discounts

Profit and loss account

£ £

Gross profit 80,000

Discount received 3,000

83,000

Wages 25,000

General expenses 10,000

Discount allowed 1,000 36,000

Net profit 47,000

Carriage inwards and outwards

Carriage inwards is added to purchases in the trading account.

Carriage outwards is shown as an expense in the profit and loss account.

A business may pay the cost of delivering to customers. This is an expense of the business.

DrawingsDrawings are a reduction in capital and must be shown in the balance sheet.

Cash drawings will reduce the asset of cash and not affect the profit.

Stock drawings will reduce the purchases in the trading account.

The amount of drawings made by the owner is not an expense of the business and must not be shown in the profit and loss account.

Key pointsThe account layout must be learned because this topic will be covered in much more detail.

Always use a ruler to underline headings and accounts and present your work neatly.

Never enter fixed assets in the profit and loss account. This is capital expenditure and will be shown in the balance sheet.

It is very important to practise the trading account and profit and loss account. Try Tasks 1–3.