Preparation of Profit and Loss Account

Explanation of Certain Items in the Profit and Loss Account

1. Salaries

Salaries are paid for the services of employees and are charged to the profit and loss account as an indirect expense. If any salary has been paid to the owner or partners, it must be shown separately because it requires special treatment at the time of income tax determination.

2. Wages and Salaries

When the wage bill is included with wages, it is treated as an indirect expense and is taken into a profit and loss account.

3.Rent

The rent for the office shop showroom or godown is an indirect expense and is therefore charged to the profit and loss account. However, the factory rent is debited from the business account. When a part of the building has been sublet, the rent received should be shown on the credit side of the profit and loss account as a separate item.

4. Rates and Taxes

These are used by local authorities to meet public spending. Being an indirect expense, it is shown in the debit of the profit and loss account.

5.Interest

Interest on loans, overdrafts or overdue debts are payable by the company. It is an indirect expense; thus charged to the profit and loss account. Interest on the loan advanced by the company on depositors’ investments is income for the company and is therefore credited to the profit and loss account.

If the company has paid any interest on the capital to its owner or partners, it must also be charged to the profit and loss account, but separately because this element needs special treatment at the time of determining the income tax.

6. Committee

In businesses, agents are sometimes appointed to make sales, who are paid a commission as compensation. So, being a selling expense, it shows up on the debit side of the profit and loss account. Sometimes a commission is also paid for the purchase of goods, so the expenses must be debited from the trading account. Sometimes the company may also act as an agent for other trading houses and in such cases receives a commission from them. The commission thus received is shown on the credit side of the profit and loss account.

7. Business Expenses

They are also called as ‘miscellaneous expenses’. Business expenses represent expenses of such a nature that it is not worth opening separate accounts for. Business expenses are not taken into business account.

8. Repairs

Repairs to the plant, machinery, and building are indirect expenses; they are treated as an expense and charged to the profit and loss account.

9. Travel expenses

Unless otherwise stated, travel expenses are treated as indirect expenses and charged to the profit and loss account.

10. Horse and stable expenses

Expenses incurred for fodder for horses and wages paid for stable care are treated as indirect expenses and charged to the profit and loss account.

11. Premium Apprentice

It is the amount charged to the people to whom the company provides training. It is income and is credited to the profit and loss account. In case the apprentice bonus is collected in advance for two or three years, then the amount is distributed over several years and each year’s profit and loss account is credited with its share of the income.

12. Bad debts

It is the amount that could not be recovered by the merchant for credit sales. It is a business loss, so it is charged to the profit and loss account.

13. Life insurance premium

If the premium is paid on the business owner’s life policy; it is treated as the drawings of it and shown by deduction from the capital account. It should not be taken to the profit and loss account.

14. Insurance premium

If the insurance premium account appears on the trial balance, it represents the company’s insurance. This is taken to the profit and loss account. Insurance premium on purchased goods, factory construction, factory machines are treated as direct expenses and taken to the business account.

15. Income Tax

In the case of merchant income tax, the tax paid is treated as a personal expense and is shown by deduction from the capital account. Income tax in the case of companies is treated differently.

16. Discount allowed and received

The discount is a reward for early payment. It is believed to show the discount received and the discount allowed separately on the credit and debit side of the profit and loss account, respectively, instead of showing the net balance of this account.

17. Depreciation

Depreciation is a loss incurred due to the use of fixed assets in the business. Generally, it is debited from the profit and loss account at a fixed percentage. Students need to be very careful regarding the depreciation rate. If the rate does not include the words ‘per year’, the rate will be taken regardless of the accounting period. This is very important when the accounting period is less than one year. On the other hand, if the depreciation rate is ‘annual’, the depreciation should be calculated on the assets with due regard to the period during which the asset has been used in the business during the year. In case of additions to assets during the year, it is advisable to ignore the depreciation of the additions if the date of the additions is not given. The same rule will govern the sale of goods during the year.

18. Stocks at the end that appear in the trial balance.

It is important to emphasize the rule that the balance that appears in the trial balance is carried in one place. It can be a trading account or a profit and loss account or a balance sheet. Since the shares are ultimately an asset, they will be included on the balance sheet. On the other hand, as long as there is stock in the trade, the account should be kept open and therefore taken to the asset side of the balance sheet.