Profit & Loss account from trial balance, Receipt & Payment, Income & Expenditure and Profit & Loss account

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Financial Accounting (Mgt-101)

Lesson-8

LEARNING OBJECTIVE

After studying this chapter, you will be able to:

o Draw up Profit & Loss account from the information given in trial balance.

o Differentiate the term, Receipt & Payment, Income & Expenditure and Profit & Loss

account.

FINANCIAL STATEMENTS

· Different reports generated from the books of accounts to provide information to the relevant

persons.

· Every business is carried out to make profit. If it is not run successfully, it will sustain loss. The

calculation of such profit & loss is probably the most important objective of the accounting function.

Such information is acquired from "Financial Statements".

· Financial Statements are the end product of the whole accounting process. These show us the

profitability of the business concern and the financial position of the entity at a specified date.

· The most commonly used Financial Statements are `profit & loss account' `balance sheet' & `cash

flow statement'.

Income and Expenditure Vs Profit and Loss

Income and Expenditure Account is used for Non-Profit Organizations like Trusts, NGOs.

Profit and Loss Account is used for Commercial organizations like limited companies.

PROFIT & LOSS ACCOUNT

Profit & Loss account is an account that summarizes the profitability of the organization for a

specific accounting period.

Profit & Loss account has two parts:

o In the first part, Gross Profit is calculated.

o Gross profit is the excess of sales over cost of goods sold in an accounting period.

o In trading concern, cost of goods sold is the cost of goods consumed plus any other charge

paid in bringing the goods in salable condition. For example, if business purchased certain

items for resale purpose and any expense is paid in respect of carriage or bringing the goods

in store (transportation charges). These will also be grouped under the heading of `cost of

goods sold' and will become part of its price.

o In manufacturing concern, cost of goods sold comprises of purchase of raw material plus

wages paid to staff employed for converting this raw material into finished goods plus any

other expense in this connection.

o In the 2nd part, Net Profit is calculated.

o Net Profit is what is left of the gross profit after deducting all other expenses of the

organization in a specific time period.

How to prepare Profit & Loss account

· One way is to write down all the Debit and Credit entries of Income and Expense accounts in the

Profit and Loss Account. But it is not sensible to do so.

· The other way is that we calculate the net balance or we can say Closing Balance of each income and

expense account. Then we note all the credit balances on the credit side and all the debit balances on

the debit of profit and loss account.

· If the net balance of profit and loss is Credit (credit side is greater than debit side) it is Profit and if

the net balance is Debit (Debit side is greater than credit side) it is a loss.

Financial Accounting (Mgt-101)

Income, expenditure, profit and loss

Income is the value of goods and services earned from the operation of the business. It includes

both cash & credit. For example, if a business entity deals in garments. What it earns from the sale of

garments, is its income. If somebody is rendering services, what he earned from rendering services is

his income.

Expenses are the resources and the efforts made to earn the income, translated in monetary terms.

It includes both expenses, i.e., paid and to be paid (payable). Consider the above mentioned example,

if any sum is spent in running the garments business effectively or in provision of services, is termed

as expense.

Profit is the excess of income over expenses in a specified accounting period.

Profit= Income-expenses

In the above mentioned example, if the business or the services provider earn Rs. 100,000 & their

expenses are Rs. 75,000. Their profit will be Rs. 25,000 (100,000-75,000).

Loss is the excess of expenses over income in a specified period of time. In the above example, if

their expenses are Rs. 100,000 & their income is Rs. 75,000. Their loss will be Rs. 25,000.

RULES OF DEBIT & CREDIT

Increase in expense is Debit (Dr.)

Decrease in expense is credit (Cr.)

Increase in income is credit (Cr.)

Decrease in income is Debit (Dr.)

Classification of expenses

It has already been mentioned that a separate account is opened for each type of expense. Therefore,

in large business concerns, there may be a large number of accounts in organization's books.

As profit & loss account is a summarized record of the profitability of the organization. So, similar

accounts should be grouped for reporting purposes.

The most commonly used groupings of expenses are:

o COST OF GOODS SOLD

o ADMINISTRATION EXPENSES

o SELLING EXPENSES

o FINANCIAL EXPENSES

Cost of goods sold is the cost incurred in purchasing or manufacturing the product, which an

organization is selling plus any other expense incurred in bringing the product in salable condition.

Cost of goods sold contain the following heads of accounts:

o Purchase of raw material/goods

o Wages paid to employees for manufacturing of goods

o Any tax/freight is paid on purchases

o Any expense incurred on carriage/transportation of purchased items.

Administrative expenses are the expenses incurred in running a business effectively. Main

components of this group are:

o Payment of utility bills

o Payment of rent

o Salaries of employees

o General office expenses

o Repair & maintenance of office equipment & vehicles.

Financial Accounting (Mgt-101)

Selling expenses are the expenses incurred directly in connection with the sale of goods. This head

contains:

o Transportation/carriage of goods sold

o Tax/freight paid on sale

If the expense head `salaries' includes salaries of sales staff. It will be excluded from salaries & appear

under the heading of `selling expenses'.

Financial expenses are the interest paid on bank loan & charges deducted by bank on entity's bank

accounts. It includes:

o Mark up on loan

o Bank charges

Receipt & Payment Account

A receipt & payment account is the summarized record of actual cash receipts and actual cash

payment of the organization for a given period of time. This is a report that provides cash movement

during the reported period. In other words, it can be defined as the summarized record of the cash

book for a specific period.

Receipt & Payment vs. Profit & Loss Account

Receipt & payment account is the summarized record of actual cash receipts and actual cash payment

during the period while profit & loss account also includes Receivable and Payable.

Income & expenditure Vs. Profit & Loss Account

These are two similar terms. Only difference between these two terms is that income & expenditure

account is prepared for non profit oriented organizations, e.g. Trusts, N.G.O's, whereas profit & loss

account is prepared in profit oriented organizations, e.g. Limited companies, Partnership firms etc.

In case of Income and Expenditure Surplus/Deficit is to be find and in case of Profit and loss

account profit or loss is to be find.

Financial Accounting (Mgt-101)

A sample of Profit and Loss Account

Gross

Name of the Entity

profit and

Profit and Loss Account

Net profit

for the period Ending ----

DEBIT

CREDIT

Gross

PARTICULARS

AMOUNT

PARTICULARS

AMOUNT

profit

Rs.

Income

Cost of sale

60000

income

100000

cost

Gross profit c/d

40000

sales

(Income cost of sales)

= 100000-

Total

100000

Total

100000

60000

Admin expenses

15000

Gross profit b/d

40000

Selling expenses

5000

= Rs.40000

Financial expenses

5000

Net profit

Gross

Net profit (Gross profit

profit

expenses)

Expenses

Total

40000

Total

40000

= 40000 15000 5000 - 5000

=Rs.15000

A sample of Income Statement

Name of the Entity

Income statement

For the period Ending ----

PARTICULARS

AMOUNT

Rs.

Income/Sales/Revenue

100000

Less: Cost of sales

(60000)

Gross profit

40000

Less: Administration expenses

15000

Selling expenses

5000

Financial expenses

5000

(25000)

Net profit

15000

Recognizing Income and Expenditure

Income should be recognized / recorded at the time when goods are sold or services are rendered.

Expenses should be recognized / recorded when benefit relating to that expense has been drawn.

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