Understanding the Profit and Loss Statement: Purpose and Preparation

Every business aims to understand its financial performance over a specific period, typically a financial year. The Profit and Loss (P&L) Statement, also known as an Income Statement or Income and Expense Statement, provides a summary of an organization's revenues and expenditures. This crucial financial document reflects the direct income and costs associated with business operations, enabling an assessment of profitability or loss during the accounting cycle.

What is a Profit & Loss Statement?

A P&L statement is a vital financial report that consolidates all revenues, costs, and expenses incurred by a business over a designated period, such as a quarter or a year. It incorporates gross profit or loss and all indirect incomes and expenses to ultimately determine the net profit or loss. This statement is essential for companies to monitor financial health, track performance, and make informed operational decisions.

The primary objectives for preparing a P&L statement are:

1. To ascertain the profits earned or losses incurred by the business.
2. To fulfill statutory requirements mandated by acts like the Companies Act or Partnership Act.

Traditionally, calculating profit or loss involved two distinct steps:

1. Preparing a Trading Account.
2. Preparing a Profit & Loss Account.

The Trading Account revealed the gross profit or loss, while the P&L Account subsequently showed the net profit or loss.

The process to determine profit or loss in a P&L Account involves:

• Aggregating all revenues generated during the accounting period.
• Summing all expenditures made throughout the same period.
• Calculating the difference by subtracting total expenses from total revenues.
• A positive result indicates a profit, whereas a negative result signifies a loss.

How to Prepare a Profit & Loss Statement

The preparation of a P&L statement follows a systematic approach:

• Ledger Account Preparation: For each transaction recorded in the journal book, an individual ledger account must be prepared to ascertain its closing balance.
• Trial Balance Creation: A trial balance is then created, which provides a summary of all ledger accounts, listing each account along with its closing balance.
• Generation of Trading and Profit & Loss Statement: Finally, all ledger accounts related to sales, purchases, direct expenses, indirect expenses, and income are transferred to the Profit & Loss Statement.

Components of Profit & Loss Statements

A P&L account comprises various components that categorize the business's incomes and expenses:

Revenue/Income

Business income is generally split into two main categories. First, revenue derived from core business activities is recorded, representing earnings from normal operations. Second, other or miscellaneous income includes earnings from various investments, such as interest or dividends.

Cost of Goods Sold (COGS)

COGS in the P&L statement includes direct operational costs like labor, raw materials, or direct overheads associated with procuring or manufacturing goods. These expenses are subtracted from revenue to calculate the business's gross margin.

Operating Expenses

Operating expenses are indirect costs involved in the production or manufacturing process and general business operations. Examples include administrative costs, depreciation, employee salaries, marketing and distribution expenses, selling costs, and research and development expenditures.

Operating Profit

Operating profit is the positive amount remaining after deducting operating expenses from the gross margin. It is also known as Earnings Before Interest and Taxes (EBIT). A healthy operating margin reassures stakeholders and investors about the business's profitability and financial stability.

Net Income

Net income represents the final profit generated by the business after all operating expenses, non-operating expenses, interest, and taxes have been deducted. This is the profit available for distribution to shareholders, and it forms the basis for calculating earnings per share.

Different Formats of the Profit & Loss Account

P&L accounts can be presented in various formats:

1. Format for Sole Traders & Partnership Firms
2. Format of P&L Account for Companies

Format for Sole Traders & Partnership Firms

There is no prescribed format for P&L accounts for sole proprietorships and partnership firms. They can structure the P&L Account in any manner, provided it clearly distinguishes between gross profit and net profit.

These entities typically prefer a "T-shaped form" for their P&L accounts:

• T-shape Form A T-shape P&L account has two sides: Debit and Credit. The Trading Account is prepared first, followed by the Profit & Loss Statement.

Trading and Profit & Loss Account Example

Particulars	Amount	Particulars	Amount
To Opening Stock	xxx	By Sales	xxx
To Purchases	xxx	By Closing Stock	xxx
To Direct Expenses	xxx
To Gross Profit	xxx
	xxx		xxx
To Operating Expenses	xxx	By Gross Profit	xxx
To Operating Profit	xxx
	xxx		xxx
To Non-operating expenses	xxx	By Operating Profit	xxx
To Exceptional Items	xxx	By Other Income	xxx
To Finance Cost	xxx
To Depreciation	xxx
To Net Profit Before Tax	xxx
	xxx		xxx

Format of P&L Account for Companies

Companies are required to prepare their P&L accounts in accordance with Schedule III of the Companies Act, 2013.

The format specified in Schedule III is a "STATEMENT OF PROFIT & LOSS."

Statement of Profit and Loss for the period ended…………….

Name of the Company………….Statement of Profit and Loss for the period ended…………….

Particulars	Note No.	Figures for the current reporting period	Figures for the previous reporting period
INCOME
a) Revenue From operations
b) Other Income
Total Income
EXPENSES
a) Cost of materials consumed
b) Purchases of Stock-in-Trade
c) Changes in inventories of finished goods, Stock-in -Trade and work-in-progress
d) Employee benefits expense
e) Finance costs
f) Depreciation and amortisation expenses
g) Other expenses
Total Expenses
Profit/(loss) before exceptional items and tax
Exceptional Items
Profit/ (loss) before tax
Tax Expense:
Current tax
Deferred tax
Profit (Loss) for the period from continuing operations
Profit/(loss) from discontinued operations
Tax expenses of discontinued operations
Profit/(loss) from Discontinued operations (after tax)
Profit/(loss) for the period
Other Comprehensive Income
A. (i) Items that will not be reclassified to profit or loss
(ii) Income tax relating to items that will not be reclassified to profit or loss
B. (i) Items that will be reclassified to profit or loss
(ii) income tax relating to items that will be reclassified to profit or loss
Total Comprehensive Income for the period Comprising Profit (Loss) and other comprehensive income for the period )
Earnings per equity share (for continuing operation):
(1) Basic
(2) Diluted
Earnings per equity share (for discontinued operation):
(1) Basic
(2) Diluted
Earning per equity share (for discontinued & continuing operation)
(1)Basic
(2) Diluted

Notes on Disclosure

Further details must be disclosed in the notes accompanying the statement:

a. "Revenue from operations" breakdown: i. Sale of products (including excise duty) ii. Sale of services iii. Other operating revenues

b. Finance cost breakdown: i. Interest ii. Dividend on redeemable preference shares iii. Exchange Differences considered as an adjustment to borrowing costs iv. Other borrowing costs (if any)

c. Other Income breakdown: i. Interest Income ii. Dividend Income iii. Other non-operating income

d. Other Comprehensive Income classification: i. Items not reclassified to profit or loss: 1. Changes in revaluation surplus 2. Remeasurements of defined benefit plans 3. Equity Instruments through Other Comprehensive Income 4. Fair value changes related to own credit risk of financial liabilities designated at fair value through profit or loss 5. Share of other comprehensive income in associates and joint ventures, where not reclassified to profit or loss 6. Others ii. Items reclassified to profit or loss: 1. Exchange differences from translating foreign operation financial statements 2. Debt instruments through Other Comprehensive Income 3. Effective portion of gains and losses on hedging instruments in a cash flow hedge 4. Share of other comprehensive income in Associates and Joint Ventures, where reclassified to profit or loss 5. Others

e. Employee benefit expense details: i. Salaries and wages ii. Contribution to provident and other funds iii. Share-based payments to employees iv. Staff welfare expenses

f. Depreciation and amortisation expense

g. Interest Income

h. Interest Expense

i. Dividend Income

j. Net gain or loss on sale of investments

k. Net gain or loss on foreign currency transaction and translation (excluding finance cost adjustments)

l. Payments to the auditor for: i. Auditor fees ii. Taxation matters iii. Company law matters iv. Other services v. Reimbursement of expenses

m. Expenses incurred on corporate social responsibility (CSR) activities

n. Details of exceptional items

o. Any other expense or income exceeding the higher of Rs. 10,00,000 or 1% of revenue from operations

Form 23ACA – E-Form for submitting Profit & Loss Account with Registrar

Companies must file e-Form 23ACA to submit their P&L Account with the Registrar. This form requires the attachment of an audited copy of the P&L Account. The e-form needs to be digitally signed by a practicing Chartered Accountant (CA), Cost and Management Accountant (CMA), or Company Secretary (CS), who certifies the accuracy of the information in Form 23ACA and confirms the audited P&L Account is attached.