Profit and Loss Account – The Law Student Blog

Company Profit and Loss Account

There are a number of slight differences in the format (and words used) of the accounts of companies compared to those used in relation to sole traders and partnerships. The Profit and Loss Account may also be referred to as ‘the Statement of Profit and Loss’ or ‘the Income Statement’).

Instead of using the words ‘income’ or ‘sales’ to denote cash generated by the business, the word ‘revenue’ is commonly used in company accounts.

Companies may show the expenses as a single line in the accounts or may split the expenses into categories.

An entry for finance costs relates to interest payable by the company on funds borrowed and is included as an expense. This can be contrasted with a figure for interest receivable. This would be interest generated on money lent by the company and would be an income entry included in turnover in the top part of the Profit and Loss Account.

An entry for taxation will be included, which will usually include taxation payable on company profits and does not include other employment or consumption taxes.

The Profit for the year figure will be carried over to the Statement of Changes in Equity in the Balance Sheet.

Company Balance Sheet

number of differences in the Balance Sheet of a company compared with that of a sole trader or partnership can be observed.Note:

An ‘Impairment of Receivables’ entry is the provision for doubtful debts, and this information would normally be shown in a supporting note, with only the updated ‘Receivables’ figure shown in the Balance Sheet.

What was previously referred to as ‘current liabilities’ and ‘long term liabilities’, are referred to in company accounts as ‘Current Liabilities’ (such as overdrafts repayable on demand, trade payables, accruals and dividends declared but not yet paid) and ‘Non-current Liabilities’ (such as bank loans repayable in more than one year) respectively.

In terms of the bottom portion of the Balance Sheet, there is no reference to capital contributions or drawings. Instead, the bottom portion of the Balance Sheet shows what is referred to as ‘Total Equity’ or ‘Equity and Reserves’ (these terms are interchangeable). As with all Balance Sheets, the Net Assets should always balance with the bottom portion of the Balance Sheet. This is because Net Assets represent the manner in which the Equity is being used by the company as at the date of the Balance Sheet.

An item labelled ‘Retained Earnings (profit and loss carried forward)’ may appear on the Balance Sheet and should not be confused with the Profit for the Year shown on the Profit and Loss Account. The figure comes from a ‘Statement of Change in Equity’. This is because the correct figure for retained profit needs to be calculated before the balance sheet can be completed: it will include the profit from the current accounting year, together with all retained profits from previous years, net of dividends.

The company Balance Sheet may also include reference to other ‘reserves’, known as ‘capital reserves’. These commonly include the Share Premium Account and Revaluation Reserve.

The trial balance is used by accountants to produce the Profit and Loss Account and the Balance Sheet.

The Profit and Loss Account, which is also known as an Income Statement in international accounting standards, essentially records the income of a business throughout an accounting period minus expenses incurred in that period, to end up with a profit or loss figure for that period. It is therefore a summary of the fortunes of a business over a passage of time. This is why it is vital to note the period to which the Profit and Loss Account relates in order to understand it. The accounting period is recorded in the heading for the account, always with the words “for the period ending on [last day of the period]”.

As a general rule, only the income and expense entries from the trial balance are transferred into the Profit and Loss Account. For example, ‘Commission’ in the trial balance is an income account and this appears at the top of the Profit and Loss Account. In contrast, ‘electricity bill’ is a business expense and appears in the expenses section of the Profit and Loss Account. ‘Cash at bank’, on the other hand, is an asset account and does not appear on the Profit and Loss Account.

There are standard formats for presenting the layout of the Profit and Loss Account and all Profit and Loss Accounts for UK businesses follow a similar structure.

Below is an example Profit and Loss Account for ABC Trading, together with notes to explain its format.

ABC Trading – Profit and Loss Account for the Year Ended [dd/mm/yy]

Notes for the Profit and Loss Account

1. All income entries from the trial balance are put at the top of the Profit and Loss Account (e.g. sales).

2. You will note there is a separate entry labelled ‘Gross profit’ in the top part of the Profit and Loss Account. This figure is not itself taken from the trial balance but is calculated using some entries that are shown on the trial balance.

The ‘Gross profit’ calculation represents all the income of the business less the ‘cost of sales’, that is, costs directly attributable to how the business earns money (e.g. the cost of purchasing stock). The ‘Gross profit’ figure shows the reader how much money the business has made during the accounting period before other expenses are taken into account.

3. The formula for ‘cost of sales’ is:

Opening stock + purchases – closing stock = cost of sales

The calculation must be shown in full on the Profit and Loss Account in the format shown in the example.

‘Cost of sales’ includes figures for ‘opening stock’ and ‘closing stock’. These accounts represent the value of unsold stock held by the business at the start and end of the accounting period respectively. (They are asset accounts, so these two accounts are exceptions to the general rule that a Profit and Loss Account shows only income and expense accounts). The figure for closing stock never appears on the trial balance but would be provided separately.

4. All expenses excluding purchases (which have already been deducted in the cost of sales calculation) are deducted from the Gross profit. Such expenses are, broadly speaking, the ‘overheads’ of the business.

5. The resulting figure is the Net Profit and this figure will appear as ‘profit for the year’ in the bottom half of the Balance Sheet