Accounting Principles - Profit and Loss

Financial Accounting > Preparation of Profit and Loss account

The profit and loss account, as a ledger account, is a summary of all the outlay and income. On the debit side are collected all the charges incurred in making the profit during a given period; on the credit side are gathered all the sources of profit for the same period. The remaining balance, if to the debit, indicates a loss; if to the credit, a profit.

One important feature is that no matter how complicated the affairs of the concern may be, the profit and loss account prepared for the benefit of the merchant or for any other person interested in the progress of the firm, should be so framed that a layman can grasp the salient points without difficulty. Whenever possible, the facts to be shown in the profit and loss account should be as follows: (1) Gross profit as a whole and in each department separately. (2) The expenditure as a whole and in each department separately, provided it is directly due to the volume of the business done. (3) Expenditures not directly due to the volume of business done, but which depend more on the constitution of the business. (4) Results of trading regardless of excess or insufficiency of capital employed in the business. (5) Charges affecting capital, such as interest and discount. (6) The net profit, apportionable to proprietorship.

In preparing the profit and loss statement, items which ordinarily are not shown on the books must be taken into consideration. To illustrate: If a firm insures the stock of merchandise and fixtures on a given date, say the first of February, and pays the premium for a full year, it is obvious that if the accounts are closed on June 30 of the same year, the unexpired insurance for seven months represents an asset and not an expenditure. Accrued salaries are of the same class, but, of course, show a liability.

Notice must also be taken of such items as interest accretions due to the firm, or advances made to salesmen on commissions or the like. Such balances also represent assets of the firm at that particular time.

The profit and loss account should be so arranged as to give in complete and detailed, but at the same time summarized form, the information regarding the progress or retrogress of the business. The method of division adopted in the preparation of profit and loss statements is of great importance. Items of expenditures as well as incomes derived from independent sources should be so introduced in the profit and loss account as not to confuse the trading account. Where the method of division is required to compare one year with another, the arrangement of one period should exactly agree with the arrangement of the other period, because otherwise the statistical advantages that could be afforded by the means of comparison are destroyed. The pro-forma profit and loss accounts given on pages 98-99 illustrate the division of the various sections of this account.

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