Preparation of Profit and Loss Account

The profit and loss account of your company is a record of its earnings, expenditure and profits in a given period. Financial information is the most important information to a company.

A profit and loss account is to be prepared every year on the basis of the financial information of the previous financial year. This report is prepared using the books of accounts, balance sheet, and statement of change in equity.

The preparation of the Profit and Loss account is done in a systematic way. The accounting system is designed in such a way that it helps in the effective management of the business. If the management doesn’t follow the preparation of the profit and loss account, then it will create problems in the business.

Explanation of Certain items of Profit and Loss Account

1. Salaries

Salaries are paid for the services of employees and are debited to profit and loss account is an indirect expense. If any salary has been paid to proprietors or partners, it should be shown separately because it requires special treatment at the time of income tax assessment.

2. Salaries and Wages

When wages account is included with salaries, it treated is as an indirect expense and is taken into profit and loss account.

3. Rent

Rent of the office shop showroom or godown is an indirect expense and so is debited to profit & loss account. However, the rent of the factory is debited to the trading account. When a part of the building has been sublet, the rent received should be shown on the credit side of the profit and loss account as a separate item.

4. Rates and Taxes

These are levied by the local authorities to meet public expenditure. It is an indirect expenditure. It is shown on the debit side of the profit and loss account.

5. Interest

The company is responsible for the payment of interest on loans, overdrafts, and past-due bills. Because it is an indirect item, it is recorded as a debit to the profit and loss statement. Depositor interest earned on a loan granted by the business is a source of revenue for the firm and is recorded as a profit in the company’s profit and loss statement.

Suppose the business has paid any interest on capital to its proprietor or partners. In that case, it should also be debited in the profit and loss account but separately because this item needs special treatment at the time of income-tax assessment.

6. Commission

In business, sometimes agents are appointed to effect sales, who are paid commission as their remuneration. So this being a selling expense is shown on the debit side of the profit and loss account. Sometimes a commission is also paid on purchases of goods; such ‘as expense should be debited in the trading account.

Sometimes the firm can also act as an agent to the other business houses, and in such cases, it receives a commission from them. Commission so received is shown on the credit side of the profit and loss account.

7. Trade Expenses

They are also termed as ‘sundry expenses. Trade expenses represent expenses of such a nature for which it is not worthwhile to open separate accounts. Trade expenses are not taken to the trading account.

8. Repairs

Repairs to the plant, machinery, building are indirect expenses that are treated expenses and are debited to profit and loss accounts.

9. Travelling Expenses

Unless mentioned otherwise, travelling expenses are treated as indirect expenses and are debited to profit and loss accounts.

10. Bad debts

It is the amount that could not be recovered by the trader on account of credit sales. It is a business loss, so it is debited in the profit and loss account.

11. Insurance Premium

If the insurance premium account appears in the trial balance, it stands for the business’s insurance. This is taken to profit and loss accounts. Insurance premiums on goods purchased, factory building, factory machines are treated as direct expenses and are taken to the trading account.

12. Income Tax

In the case of merchants, income-tax paid is treated as a personal expense and is shown by way of deduction from the capital account. Income-tax, in case of companies, is treated differently.

13. Discount allowed and Received

Discount is a reward for prompt payment. It is believed to show discounts received and discounts allowed separately on the credit and debit side of the profit and loss account, respectively, instead of showing the net balance of this account.

14. Depreciation

When a company uses fixed assets in the course of its operations, it incurs a loss known as depreciation. In most cases, it is deducted from the profit and loss account at a predetermined proportion. When it comes to the pace of depreciation, the pupils should take extreme caution. If the rate is expressed without the words “per annum,” the rate will be applied regardless of the accounting period. When the term of accounting is shorter than a year, this is very crucial to remember.

For example, if the depreciation rate is ‘per annum,’ the depreciation on the assets must take into account how long the asset has been in use in a firm throughout the year when computing the depreciation on the assets. If assets are added to throughout the year, it is recommended that depreciation on the additions be ignored if the dates of the additions are not specified. The same rule will apply to any assets that are sold throughout the course of the year.

15. Stock at the end appears in the trial balance.

It is important to emphasise that balance appearing in the trial balance is taken to one and only one place. It may either be a trading account or profit and loss account, or balance sheet. Since stock at the end is an asset, it will be taken to the balance sheet. On the other hand, so long as there is stock in trade, account for that must be kept open and thus be taken to the assets side of the balance sheet.

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