Trauand Profit and Loss Account
A business needs to prepare a trading and profit and loss account first before moving on to the
balance sheet. Trading and profit and loss accounts are useful in identifying the gross profit and
net profits that a business earns.
The motive of preparing trading and profit and loss account is to determine the revenue earned or
the losses incurred during the accounting period.
The trading and profit and loss account are two different accounts that are formed within the
general ledger. The two parts of the account are:
1. Trading Account
2. Profit and Loss Account
Trading account is the first part of this account, and it is used to determine the gross profit that is
earned by the business while the profit and loss account is the second part of the account, which is
used to determine the net profit of the business.
DIFFERENCE BETWEEN DIRECT AND INDIRECT EXPENSES:
The main difference between direct and indirect expenses is that direct expenses are directly
linked to a specific product or service, while indirect expenses are general business costs that are
not tied to a specific product or service:
Direct expenses
These expenses are directly tied to the production or manufacturing of a good or service. For
example, raw materials, labor, and manufacturing supplies are all direct expenses. Direct expenses
directly impact a business's cost of goods sold (COGS) and gross profit.
Indirect expenses
These expenses are general business costs that are not directly tied to a product or service. For
example, utilities, administrative salaries, office rent, and software are all indirect expenses.
Indirect expenses impact a business's operating expenses, which are deducted from the gross profit
to determine the net profit.
NOTE : ALL DIRECT EXPENSES COMES UNDER TRADING ACCOUNT
ALL INDIRECT EXPENSE COMES UNDER PROFIT AND LOSS ACCOUNT
1. Trading Account
Trading account is used to determine the gross profit or gross loss of a business which results from
trading activities. Trading activities are mostly related to the buying and selling activities involved
in a business. Trading account is useful for businesses that are dealing in the trading business. This
account helps them to easily determine the overall gross profit or gross loss of the business. The
amount thus determined is an indicator of the efficiency of the business in buying and selling.
The formulae for calculating gross profit is as follows:
Gross profit = Net sales – Cost of goods sold
COGS= OPENING STOCK +PAPERCHASE-CLOSING STOCK
Trading and Profit and Loss Account Format
2. Profit and Loss Account
Profit and loss account shows the net profit and net loss of the business for the accounting period.
This account is prepared in order to determine the net profit or net loss that occurs during an
accounting period for a business concern.
Profit and loss account get initiated by entering the gross loss on the debit side or gross profit on
the credit side. This value is obtained from the balance which is carried down from the Trading
account.
A business will incur many other expenses in addition to the direct expenses. These expenses are
deducted from the profit or are added to gross loss and the resulting value thus obtained will be net
profit or net loss.
The examples of expenses that can be included in a Profit and Loss Account are:
1. Sales Tax
2. Maintenance
3. Depreciation
4. Administrative Expense
5. Selling and Distribution Expense
6. Provisions
7. Freight and carriage on sales
8. Wages and Salaries
These appear in the debit side of Profit and Loss Account while Commission received, Discount
received, profit obtained on sale of assets appear on the credit side.
Net profit can be determined by deducting business expenses from the gross profit and adding
other incomes obtained
Net profit = Gross profit – all indirect Expenses + Other income
Closing Entries for Net Loss or Net Profit:
i. In case of Net Loss
Capital A/c – Dr.
To Profit and Loss A/c
ii. In case of Net Profit
Profit and Loss A/c -Dr.
To Capital A/c
DIFFERENCE BETWEEN DIRECT AND INDIRECT EXPENSES:
The main difference between direct and indirect expenses is that direct expenses are directly
linked to a specific product or service, while indirect expenses are general business costs that are
not tied to a specific product or service:
Direct expenses
These expenses are directly tied to the production or manufacturing of a good or service. For
example, raw materials, labor, and manufacturing supplies are all direct expenses. Direct expenses
directly impact a business's cost of goods sold (COGS) and gross profit.
Indirect expenses
These expenses are general business costs that are not directly tied to a product or service. For
example, utilities, administrative salaries, office rent, and software are all indirect expenses.
Indirect expenses impact a business's operating expenses, which are deducted from the gross profit
to determine the net profit.
NOTE : ALL DIRECT EXPENSES COMES UNDER TRADING ACCOUNT
ALL INDIRECT EXPENSE COMES UNDER PROFIT AND LOSS ACCOUNT
Format for Profit and Loss Account
BALANCE SHEET
A balance sheet is a financial statement that summarizes a company's
financial situation at a specific point in time. It lists a company's assets,
liabilities, and equity, and is also known as a statement of financial
position.
Here are some key points about balance sheets:
1.What it shows
A balance sheet shows what a company owns, what it owes, and the
value of the owner's investment.
2.How it's organized
A balance sheet is divided into two sides: assets on the left and liabilities
and equity on the right. The total dollar amount on each side is always
the same.
3.What it's used for
A balance sheet is a key source of information for investors, lenders, and
corporate management to assess a company's financial health. It's also
used to ensure that a company's books balance.
4.When it's prepared
A balance sheet is usually prepared at the end of a reporting period,
such as a month, quarter, or year.
5.What it tells you
A balance sheet can show if a business is solvent, meaning it can cover
its debts, and whether it gained or lost value compared to previous
balance sheet.
Features of Balance Sheet:
The features of a balance sheet are as follows:
It is regarded as the last step in final accounts creation
It is a statement and not an account
It consists of transactions recorded under two sides namely, assets and
liabilities. Assets are placed in the left hand side, while the liabilities are
placed on the right hand side
The total of both side should always be equal
The balance sheet discloses financial position of the business
It is prepared after trading and profit and loss account is prepared.
FORMAT OF BALANCE SHEET
Problems:
