Profit and Loss Account Words

Accounting Period

Is the period under examination and usually refers to a year. We therefore refer to a Profit and loss Account for the year ended so and so or a Balance Sheet as at so and so.

Accruals or Matching concept

Is the reason why net profit made is not the same as the cash surplus generated. This is a critical concept for you to understand. It is a fundamental concept upon which the accounts are prepared. You will learn in your studies that profit is not cash for a number of reasons:

1. because of applying the accruals concept to preparation of accounts. This is where we deduct from sales the amounts we have incurred to achieve those sales - WHETHER WE HAVE PAID FOR THEM OR STILL OWE FOR THEM is irrelevant. In other words we count all costs incurred including those still owing to trade creditors at the end of the year. The costs deducted in the accounts will therefore be greater than the actual cash payments made where amounts are still owed at the end of the year. Similarly the sales figure is not made up of cash received from customers but is made up of cash received together with that still to be received.
2. because of accounting for depreciation which is a deduction against profits for the measure of wearing out of a fixed asset and therefore does not involve a cash payment.
3. because of the way we value closing stock which can be by using average unit costs, the last unit costs or the earliest unit costs. None of these methods reflect the actual flow of cash because they are all estimates only. You will learn that this is where we consider FIFO (first in first out) and LIFO (last in first out) valuations of closing stock.

Expenses

Referred to as expenditure and including examples such as:

1. advertising
2. rent and rates
3. wages and salaries
4. travelling expenses
5. light and heat
6. office expenses
7. miscellaneous expenses
8. bank interest
9. loan interest
10. depreciation
11. Provision for doubtful debts. This represents an estimate of amounts customers have difficulty paying due to their cash flow problems. This figure will be deducted from the profit in the Profit and loss Account and will also be deducted from the Debtors figure in the Balance Sheet.
12. Bad debts written off. Amounts owed by customers that cannot afford to pay because they have gone into liquidation. These amounts need to be deducted from the profit in the Profit and Loss Account and also from the Debtors figure which is found in the Current Assets section of the Balance Sheet.
13. Accruals and prepayments. Accruals are amounts unaccounted for yet still owing at the year end . Estimates need to be made and then added to the expenses deducted in the Profit and Loss account. This amount also needs to be added to Trade Creditors in the Current liabilities section of the Balance Sheet. Prepayments are amounts paid for by the business in advance of goods and services received. These amounts need to be deducted from expenses in the Profit and Loss account and will also appear in the Current Asset section of the Balance Sheet along with Debtors.

Gross Profit

Is calculated by deducting Cost of Sales(sometimes referred to as Cost of goods sold) from sales. Cost Of Sales is calculated by taking:

1. Opening stock, which is the value of stock which exists at the beginning of the accounting period
2. Plus Purchases of goods for resale, made during the accounting period. (One common mistake made by students is to confuse purchases with stocks. Purchases of stocks are dealt with through the purchases account and not through the Opening and closing stocks.)
3. Less Closing stock, which is the value of stock which exists at the end of the accounting period In other words, it is the value of goods purchased during the year and in stock at the beginning of the year, less those items sold during the year. This is the figure which also appears in the balance sheet as stocks and can be found in the current assets section.

Historic cost

The method used for preparing accounts which estimates the actual purchase price of all items purchased. This is as opposed to the alternatives which could be to use instead the:

1. cost of replacing items when they are sold or disposed of. Known as the Replacement cost or net realizable value
2. income expected if items were sold. Known as the Realization cost

Net Profit

Sales less cost of sales less expenses = net profit.

Sales less cost of sales = gross profit.

Therefore Net Profit = gross profit less expenses.

In other words Net Profit represents the surplus of sales made over expenditure during the accounting period. If a deficit is made(i.e if expenditure is greater than sales) then this results in a net loss and not a net profit.

Profit and Loss Account

Shows what net profit or loss the business has made within an accounting period after deducting all expenditure from the income. A net profit is earned if total expenditure is less than the sales figure. A net loss is made if it is greater. Comes underneath the Trading Account.

Sales

Income received or receivable for the accounting period. Sometimes referred to as Turnover.It represents the sales value of goods and services made to customers during the year.
Trading account

Shows what Gross Profit the business has made within an accounting period. It comes on top of the Profit and Loss Account.

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Regards,
P.R.