Profit and Loss Account

Trading account

Let us begin with this simple means of recording Gross Profit in the business. Once a good is sold for a set price, the Sales revenue that has bee collected must be accounted or recorded. Sales Revenue is therefore the price of each good times the quantity sold.

Price of the Good x Quantity of the Good sold = Sales Revenue (Total Revenue)

One method of recording the transaction is by showing the sales revenue earned relative to the cost of producing the product, also referred to as the Cost of Sales. The Trading Account is a means of measuring profit. The Trading Account shows operating profit by subtracting cost of sales from Sales revenue.

Sales Revenue – Cost of Sales (production costs) = Gross Profit

We refer to profit as being Gross because not all expenses have been included. Remember that even though a Business will have expenses related to the Production of the goods (which we called cost of Sales), there are also other expenses, such as office rent or paying for advertisement. Although these expenses are not directly related to making the product, they are indirectly related. We therefore use the terms direct expenses and indirect expenses (or Overheads).

Profit and Loss account

The Profit and Loss Account also called the Income Statement is similar to the aforementioned Trading Account, while the Trading account calculates Gross Profit (the profit earned before all other expenses have been deducted) the Profit and Loss account calculates net profit (the profit after all indirect expenses have been deducted from the Gross Profit).

Gross Profit – Indirect Costs (Overheads) = Net Profit

Therefore the Profit and Loss Account takes into consideration all other expenses that the business has incurred included the Cost of Production (Cost of Sales). The P&L (an abbreviation for Profit and Loss) reflects a period of time in which the Business Organizations economic activity took place and reflected these inflows and outflows for a period ending on a specific date.

Appropriation account

Once the net profit has been determined in the Profit and Loss account, the net profit is distributed. The role of the Appropriation Account is to record how the net profit is distributed (or appropriated). This distribution could be towards dividends or payment to shareholders and reserve accounts or retained earnings. Therefore the appropriations account is prepared after the Profit and Loss account.

Tax.... it depends a lot on where you live. Just ask the NHLers

Tax impact