The profit and loss account (income statement)

This brief post covers the basics of the profit and loss account. The profit and loss accounts lists all income and expenditure, with the difference being they profit or loss made by the business. The profit and loss account hastwo parts, albeit in the same statement. The first part account calculates the profit earned from buying and selling goods. This is called the Tradingaccount.
Here’s an example of the layout.
Here’s a brief explanation of each of the some of the items and terms above. First, there is the title of the account. It informs the user of the name of the statement (what), the name of the business (who) and the time period involved (when).

Sales: The amount of money earned by the business selling books in the past year i.e. Income. Sales returns/returns in may have to be subtracted to get this figure.

LESS COST OF SALES: this is a heading, which indicates that this calculation is going to be completed. This calculation will work out the cost of all the books that were sold in the year. It is calculated as follows

Cost of sales = opening stock + purchases – closing stock.
Opening stock: This is the value of stock left over from the previous year. This stock will be the first to be sold in the this year, thus it is a cost for this year (c.f. the accruals concept)
Purchases: This is the cost of all the new books bought during the year. (Additional costs like carriage in and import duty might be added to the purchase cost). Purchase returns/returns out may have to be subtracted.

Closing stock: This is the value of all the books left at the end of the year. It is subtracted from opening stock and purchases, as it does not form part of the goods sold during this year (c.f. accruals concept).
Cost of sales: This is the answer to the calculation of the cost of sales.
Gross profit: This measures the profit the business makes by buying and selling books. It is calculated as follows:

Gross profit = Sales – Cost of Sales
The second part, the profit and loss account calculates the profit the business has earned after allowing for all the expenses incurred in running the business. Here’s an example following on from the trading account above

Profit and loss account for Red Books for year ended 31/12/2009
As you can see, the profit and loss account starts with the Gross Profit and deducts expenses to arrive at Net Profit. Net profit is the profit that is owed to the owner(s) of the business. In the case of a sole trader, this forms part of the capital of the business, whereas with a company the shareholders may be paid a dividend from available profits.

All other elements from the Trial Balance i.e. assets, liabilities and capital do not appear on the Profit and Loss account, but the balance sheet.

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