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Basic Structure of Profit and Loss Account

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Namaste.We have already discussed the basics of financial statements, then we have seen balance sheetboth the basic format and the company format and we have also seen income statement orprofit and loss account formats.Now, let us try to prepare some basic financial statement in the form of Profit and Loss Account.This is not in the full fledged company format; this is for us to understand the basic formatof income statement or P and L and to calculate the profit.. So, the first case for that Atal limited,now a list of balances related to incomes and expenses are given and from that we haveto make income statement.So, raw materials, taxes, power and fuel, employee cost you know all of these are variousexpenses, manufacturing expense is another expense.So, all these are being marked as a expense category right; total turnover is our revenueor our income.So, I will just mark it as a income and selling and admin expense, interest and depreciationare expenses.So, in P and L it is very simple we will note income and we will reduce the expense fromthe same, we will break it down into two parts trading part and P and L part.So, please prepare the solution first and then check it with the solution which I amgoing to show.You can pause your video complete the work and then only look have a look at the solution.So, in the interest of time we are immediately showing you the solution I hope you have madeit yourself.So, the total turnover is the first item; here only one income item we have in the formof turnover this is also known as top line for the business from this certain expensesare deducted.That is raw material, power, employee expense, manufacturing expense, selling expense anddepreciation.What we have not reduced is or charged is interest because the items which are chargedhere are known as operating expenses.So, we will deduct first the operating expense which gives us a figure of operating profitit is also known as EBIT or PBIT; PBIT or EBIT refers to Earning Before Interest andTax or Profit Before Interest and Tax; then less interest we get EBT or profit beforetax.Now why is interest deducted separately in a separate step can somebody tell me the answer,can you think of it?Because interest is not a regular expense related to the business; if you look at otheritems like raw material, power, employee, manufacturing etcetera they were essentialpart to run that business; whereas interest is a repayment made to bank or to some partyfor loan which we have taken.So, it is not integral part to the operations of business; it is considered as a financecost.If we have invested our own money of capital; we do not have to pay interest, interest isbeing paid because we have borrowed money, it does not necessarily have to do with theoperations of business.So, we have not kept it in operating expense we have reduced it separately.So, we get two levels of profit; first we have calculated EBIT and then we have calculatedEBT.We have also deducted taxes separately whereas, where we will finally, get profit figure knownas EAT or PAT.Now why is profit deducted separately; because profit as nothing to do with our policies.As per the prevailing law as per the taxation policy of the government the taxes have beencalculated and they have been deducted to know the final profits available after taxes.But we would also like to get one level before that to calculate profit before tax.So, that we know that from our own business we have got operating profit, we also deductinterest.So, we need to know how much profit we have made it our self that is profit before taxand then finally, what profit remains with us is a profit after tax.So, I hope you are all able to make it yourself; now let us go to the next case.Next case here the balances of Shiva are given; certain items have been given and from thisyou have to make profit and loss account.But now we are going to make in two levels first the trading account and next the P andL account.The trading account is the upper part of P and L, where we will record those items whichare directly related to trading or manufacturing ok.This is a horizontal form of P and L we will make; in the last case we have made a verticalform now we are going to make a horizontal form ok.Now, have a look at these balances mark the items of income and expense and then preparetrading and P and L account.So, cash what will you mark it as?Is it an income or expense?The answer is no actually you know it is a balance sheet item it is an asset in the balancesheet.So, it is not required as far as the P and L is concerned, but right now we will justmark it as BS.So, BS is balance sheet; so that you know that it is a balance sheet item those of youwant to make balance sheet also you can even mark A after that because it is an asset item.But right now I am not going to give much time on it because we are going to focus onpreparation of P and L. Trade debtors; again a balance sheet item,rent again a balance sheet item?No; rent is an expense; so you should mark as E; salary again an expense, trade creditorsbalance sheet item; you know it is a liability you can mark it as L; if you are keen.Insurance, it is an expense petty expenses of course, are expenses; opening stock thisis the last year stock which we are going to use it now; so, it becomes an expense itemfor us.Sales; sales is an income item, purchases; expense item, capital neither income neitherexpense it is a balance sheet item.Drawings, again a balance sheet item; motor vehicles balance sheet item, machinery isa balance sheet item, office expense is an expense machinery expenses mark well theseare maintains or such expenses on machinery they are not for purchase or for acquisitionof machine.So, machinery is a balance sheet, but machinery expense is a expense item.Fuel and lubricant another expense and last item closing stock; this is an income itemwe are this is the remaining stock which we will use it in the next period.So, for this period it becomes an income item; got it?Now only pick up E and I items prepare a profit and loss account in the horizontal format;upper part is known as trading lower part is known as P and L. So, please make yoursolution; I will halt here please pause the video and then after you are ready see theremaining part of video.So, here we are now this is a solution of trading account.So, you can see the sales and closing stock are shown on credit side, this side is knownas credit side where we show incomes this side is known as debit side.I am not going to jargons of why debit, why credit, but normally this is called as credit.I will just mark it; CR normally stands for credit and DR stands for debit.On debit side or on expense side we start with opening stock then record the items whichare related to the core operations; so we have recorded purchases and fuel.Whereas those which are general nature of expenses like rent etcetera are recorded inP and L account.So, rent, salary, insurance, petty expense, office expense and machinery expenses havebeen recorded in P and L; of course, this classification is not very strict.Some items like for example, machinery expenses if it is in a factory it can be written ina trading account, but we have assume that this is a small business which is not a manufacturingper say these are like more of a maintenance of machinery for day to day use.So, we have kept it in general expense category in the P and L account ok.So, now based on your sales and closing stock we have charged first two items that is openingstock, purchases and fuel and the balance is called as gross profit.Are you able to calculate the gross profit?I will just show you the process; take the sum, the same amount will be carried overhere since this is total I will make it bold.Now, calculate the balance on the debit side that is 46225 that represents the profit fromtrading account, which is known as gross profit.Now this gross profit, we are caring it over on the credit side and then we will chargeall the expense.Again following the same process take a total, take total on debit side also you will geta balance of 30000, this 30000 represents your final profit; generally known as netprofit.Are you getting it?Net profit is the most important figure, so I am just making it bold.So, for this particular period we have recorded all incomes and expenses and got a profitof 30000; this is the traditional way of writing it in a horizontal form all debit on one sideand credit on one other side.More modern format is making a income statement in the vertical form which we had alreadyseen in the last case; got it?Now let us go to the next one.Now, this is more of a interesting item from the books of Amar limited, we are going toprepare trial balance, P and L account and balance sheet.So, far in the earlier cases we have seen how to prepare balance sheet, we have alsoseen how to prepare P and L; now we are going to next step where for the same case we willprepare P and L as well as balance sheet.In fact, we will also prepare one more statement known as trial balance.So, here there are list of balances; these balances would have been extracted from theirledger.Now what is ledger they have made list of balances list of accounts if they calculatethe balance of each account; they get the final balance as on 31st March 2020; theywill make a list and this is what the list is.Now, what is a trial balance?Trial balance means this particular list will be categorized into debit balances and creditbalances and we will check the total of debits and credits.Why do we check this?Because we want to check arithmetic accuracy of the accounts, this does not mean that 100percent accuracy is ensured.But at the first stage trail balance helps us to know whether arithmetic accuracy isthere, whether we have missed any balance, whether any particular account has any issues.So, we will make a list of balances, prepare the trial balance and then make P and L andbalance sheet ok.So, for this list of balance now; please take a printout.For all the cases I have been telling you that based on this print out; prepare thesolution yourself and then check with my solution there is a small error here.Because we are given balance is on 31st March 2020.So, this opening stock must be on 1st April 2019, by typo error it was shown as 18; soI have now corrected it.Now please correct it in your sheet also and with these balances first make a trial balance.Now let us go to the solution I hope you have also made a trial balance.Now, what I have done here is first I have marked every item as C and D. What is C andD?Credit and debit; like capital account this is the money which investors have put in ourbusiness; so, this has credit balance this is the amount which is repayable.Drawings represents the money which we have paid to the owner mister A. So, we will markit as D debit; purchase is an expense item, so we have mark it as D. Freight is a expenseitem we have marked it as D like that all the items first have been listed as C or Dok.C items can either become a liability in the balance sheet or can become an income itemin the income statement.But right now we are not going for that we are just listing out items as C or D and letus prepare the trial balance from same.So, here now all C items have been taken together and we have one taken one total of all C itemsok.So, this is like a trial balance, but we will prepare exact trial balance from this.We were given list of balances as on 31st March 2020 then we have mark this items asC and D and now we are going to make a trial balance as on 31st March 2020.So, what we have done is; all the items which we were marked as C, we have kept under thecolumn C and all items which are marked as D have been kept in the column D.And then we will take totals of credit column and debit column.Are you getting it?This simple statement is known as a trial balance; now this becomes a starting pointfor preparation of P and L and balance sheet.Now based on this let us go for preparation of P and L and balance sheet; I hope you areready with the solution.Are you ready to see the solution?Since we have done it before; I hope you know the process for example, A’s capital, wherewill you take it as?You know it is a liability item in the balance sheet.If you want you can go on marking it like this; results again a liability item in thebalance sheet.Sales less returns, this is a profit and loss income item.See now your work is very simple because we have separated credit balances and debit balances.If you go to let us say purchases; it is a profit and loss expense item almost all debitsare going to be profit and loss expense few would be balance sheet assets.Only one for example, drawing will be reduced from the balance sheet liability side ok.So, now your job will be simple; using this data let us go to income statement and thebalance sheet.So, if you are ready we will go to the solution.So, here is a solution for P and L account; are you getting it?So, trading account we have got two credit items sales and closing stock; the total is3350000 and there are four debit items, opening stock, purchase, freight inward and wages.So, we get gross profit of 880000; I hope it is matching with you.This 880 is then carried to the lower part of P and L known as profit and loss account.And then we will list out all the expenses to get a net profit of 149000 have you gotthis?This is the profit and loss account; let us go to balance sheet now.Now, based on the items which are given in the trial balance; prepare the balance sheet;I am deliberately not showing you the solution, I hope you are able to make it yourself now.So, balance sheet on 31st March 2020; if you have made it yourself earlier, check it ifnot make it now along with me.Now, from the trial balance those items which were; those items which were marked as balancesheet items, now carry them to balance sheet.Then from debit side there are many assets item, carry them to asset side.After that; take total of assets and liabilities it should match; is it matching?If not what is a problem?Which item is missing?You have to go back to trial balance and find out whether item is missing and also checkwhether your carried profit from profit and loss account because, it must be added inthe balance sheet.So, we have not yet added profit; so this net profit let us add, now is it matching?Still there is a difference we need to find out which item has been wrongly added; sothere is a difference of 20000.If you look carefully, we have excluded this drawing of 20000 that also needs to be considered.So, it is reduced from capital, it is going to be a minus figure and once you considerthis it is going to tally.Is it matching?Are you getting it?This is how trial balance helps you to find out the errors.Trial balance helps you to find out which item was missing and which item was wronglyadded or which item the amount is wrong and from trial balance you can make P and L andbalance sheet.In coming sessions we will do it for company, but this is based on a proprietary concerntype of a simple transaction and the balance sheets from the simple transactions.Namaste.