Previous - Double Entry – T Account
The purpose of the profit and loss account is to show whether a business has made a profit or loss over a financial year. A profit and loss account starts with the trading account and then takes into account all the other expenses associated with the business.
Trading Account
The trading account shows the income from sales and the direct costs of making those sales. It includes the balance of stocks at the start and end of the year. An example of the trading account of a business would look this:
| "$\color{black}{\text{Trading Account for XYZ Ltd for the year ended 31 March 2011}}$" | |||
| "$ $ $" | "$ $ $" | "$ $ $" | |
| "$\text{Sales}$" | "$\text{80,000}$" | ||
| "$\text{Less Returns Inwards}$" | "$\text{(400)}$" | ||
| "$\text{Net Sales}$" | "$\color{black}{\text{79,600}}$" | ||
| "$\text{Less Cost of Goods Sold}$" | |||
| "$\text{Opening Stock}$" | "$\text{10,000}$" | ||
| "$\text{Add Purchases}$" | "$\text{40,000}$" | ||
| "$\text{Add Carriage Inwards}$" | "$\text{800}$" | ||
| "$\text{Gross Purchases}$" | "$\color{black}{\text{40,800}}$" | ||
| "$\text{Less Return Inwards}$" | "$\text{(1,000)}$" | "$\color{black}{\text{39,800}}$" | |
| "$\text{Cost of Goods available for Sale}$" | "$\color{black}{\text{49,800}}$" | ||
| "$\text{Less Closing Stock}$" | "$\text{(5,000)}$" | ||
| "$\text{Cost of Goods Sold}$" | "$\color{black}{\text{44,800}}$" | ||
| "$\color{black}{\text{Gross Profit}}$" | "$\color{black}{\text{34,800}}$" | ||
Profit and Loss Account
The trading account above now takes into account all the other expenses to obtain the profit and loss account as follows (the bolded section is the trading account from above):
| "$\color{black}{\text{Profit and Loss Account for XYZ Ltd for the year ended 31 March 2011}}$" | |||
| "$ $ $" | "$ $ $" | "$ $ $" | |
| "$\color{black}{\text{Sales}}$" | "$\color{black}{\text{80,000}}$" | ||
| "$\color{black}{\text{Less Returns Inwards}}$" | "$\color{black}{\text{(400)}}$" | ||
| "$\color{black}{\text{Net Sales}}$" | "$\color{black}{\text{79,600}}$" | ||
| "$\color{black}{\text{Less Cost of Goods Sold}}$" | |||
| "$\color{black}{\text{Opening Stock}}$" | "$\color{black}{\text{10,000}}$" | ||
| "$\color{black}{\text{Add Purchases}}$" | "$\color{black}{\text{40,000}}$" | ||
| "$\color{black}{\text{Add Carriage Inwards}}$" | "$\color{black}{\text{800}}$" | ||
| "$\color{black}{\text{Gross Purchases}}$" | "$\color{black}{\text{40,800}}$" | ||
| "$\color{black}{\text{Less Return Inwards}}$" | "$\color{black}{\text{(1,000)}}$" | "$\color{black}{\text{39,800}}$" | |
| "$\color{black}{\text{Cost of Goods available for Sale}}$" | "$\color{black}{\text{49,800}}$" | ||
| "$\color{black}{\text{Less Closing Stock}}$" | "$\color{black}{\text{(5,000)}}$" | ||
| "$\color{black}{\text{Cost of Goods Sold}}$" | "$\color{black}{\text{(44,800)}}$" | ||
| "$\color{black}{\text{Gross Profit}}$" | "$\color{black}{\text{34,800}}$" | ||
| "$\color{black}{\text{Less Expenses}}$" | |||
| "$ \begin{align} &&& \text{Wages and Salaries} \end{align}$" | "$14,000$" | ||
| "$ \begin{align} &&& \text{Rent} \end{align}$" | "$100$" | ||
| "$ \begin{align} &&& \text{Electricity} \end{align}$" | "$2,000$" | ||
| "$ \begin{align} &&& \text{General Expenses} \end{align}$" | "$2,000$" | ||
| "$\text{Total Expenses}$" | "$\left(18,100\right)$" | ||
| "$16,700$" | |||
| "$\color{black}{\text{Net Profit}}$" | "$\color{black}{\text{16,700}}$" | ||
Another name for trading and profit and loss account is income statement. The trading account ends with the gross profit (34,800) while the profit and loss account ends with the net profit (16,700).
Balance Sheet
Balance Sheet is a financial listing of the assets, liabilities and capital of a business.
| "$\color{black}{\text{Balance Sheet as at October 2009}}$" | |||
| "$\color{black}{\text{Fixed Assets}}$" | "$ $ $" | "$ $ $" | "$ $ $" |
| "$ \begin{align} &&& \text{Buildings} \end{align}$" | "$24,000$" | ||
| "$ \begin{align} &&& \text{Motor Vehicles} \end{align}$" | "$10,000$" | ||
| "$ \begin{align} &&& \text{Fixtures} \end{align}$" | "$1,000$" | ||
| "$\color{black}{35,000}$" | |||
| "$\color{black}{\text{Current Assets}}$" | |||
| "$ \begin{align} &&& \text{Stock} \end{align}$" | "$5,000$" | ||
| "$ \begin{align} &&& \text{Debtors} \end{align}$" | "$6,000$" | ||
| "$ \begin{align} &&& \text{Bank} \end{align}$" | "$6,000$" | ||
| "$\color{black}{17,000}$" | |||
| "$\color{black}{\text{Less Current Liabilities}}$" | |||
| "$ \begin{align} &&& \text{Creditors} \end{align}$" | "$ \left( 2,000 \right)$" | ||
| "$ \begin{align} &&& \text{Working Capital} \end{align}$" | "$\color{black}{15,000}$" | ||
| "$\color{black}{50,000}$" | |||
| "$\text{Financed by:}$" | |||
| "$ \begin{align} &&& \text{Long Term, Liabilities} \end{align}$" | "$1,300$" | ||
| "$ \begin{align} &&& \text{Owner’s Equity} \end{align}$" | "$32,000$" | ||
| "$ \begin{align} &&& \text{Capital} \end{align}$" | "$16,700$" | ||
| "$\color{black}{48,700}$" | |||
| "$\color{black}{48,700}$" | |||
| "$\color{black}{50,000}$" | |||
Accounts transferred to Trading Accounts
- Sales account.
- Purchases account.
- Return Inwards account.
- Return Outwards account.
- Carriage Inwards – transporting of goods into the firm.
- Closing Stock.
- Opening Sock.
Accounts transferred to Profit and Loss Account
- All Expenses.
- All Revenues.
Difference between Trading and Profit & Loss Account
Trading and Profit and Loss account are two different statements. A Trading Account is prepared to determine the gross profit or loss of a business for the particular accounting period. On the other hand, a Profit or Loss account is prepared to know the actual net profit or loss of a business for the particular accounting period. Let us now proceed by understanding the meaning of both terms.
Trading Account
The trading account is prepared to determine the gross profit of the business for the particular accounting period. It is calculated by comparing the net sale with the cost of goods sold (COGS).
Gross Profit/Loss = Net Sale – COGS
Net Sale = Total Sale (Cash sale + Credit Sale) – Sale Returned/Returned Inward
Cost of Goods Sold = Opening Stock + Net Purchase + Direct Expenses – Closing Stock.
- Opening Stock = Stock that are in hand at the start of the accounting year.
- Net Purchase = Total Purchase (Cash Purchase + Credit Purchase ) – Purchase Returned/Returned Outward
- Direct Expenses= All expenses which are directly related to purchasing of goods and converting them into saleable condition.
- Closing Stock = Stock that are in hand at the end of the accounting year.
Profit And Loss Account
Profit and loss account or income statement is prepared to determine the Net Profit/loss of the business for the particular accounting period. It is calculated by comparing the Gross Profit/Loss with indirect income and expenses.
Net Profit/Loss = Gross Profit/Loss + Indirect Income – Indirect Expenses
- Indirect Income = other incomes that are earned from other than the main operation of the business.
- Indirect Expense = all business expenses other than direct expenses.
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Trading Account |
Profit and Loss Account |
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The trading account is prepared to determine the gross profit of the business for the particular accounting period |
Profit and loss account or income statement is prepared to determine the net profit/loss of the business for the particular accounting period. |
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Trading Account is prepared before the Profit and Loss account |
Profit/Loss Account is prepared after the Trading account |
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It is the first stage of the final account. |
It is the second stage of the final account. |
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It is not dependent on the Profit and Loss Account. |
It is dependent on the Trading Account. |
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In the Trading Account, the ledger accounts related to the Direct Expenses and Direct incomes are posted. |
In the Profit and Loss Account, the ledger accounts related to the Indirect Expenses and Indirect incomes are posted. |
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The balance, either Gross Profit or Gross Loss of the Trading Account will be transferred to the Profit and Loss Account. |
The balance, either Net Profit or Net Loss, of the Profit and Loss Account will be transferred to the Balance Sheet. |