Parts of the Profit and Loss Account
The Profit & Loss Account aims to monitor profit. It has three parts.
1) The Trading Account.
This records the money in (revenue) and out (costs) of the business as a result of the business‘ ‗trading‘ ie buying and selling. This might be buying raw materials and selling finished goods; it might be buying goods wholesale and selling them retail. The figure at the end of this section is the Gross Profit.
2) The Profit and Loss Account proper
This starts with the Gross Profit and adds to it any further costs and revenues, including overheads. These further costs and revenues are from any other activities not directly related to trading. An example is income received from investments.
3) The Appropriation Account.
This shows how the profit is ‗appropriated‘ or divided between the three uses mentioned above.
Uses of the Profit and Loss Account.
1) The main use is to monitor and measure profit, as discussed above. This assumes that the information recording is accurate. Significant problems can arise if the information is inaccurate, either through incompetence or deliberate fraud.
Once the profit(loss) has been accurately calculated, this can then be used for comparison ie judging how well the business is doing compared to itself in the past, compared to the managers‘ plans and compared to other businesses.
3) There are ways to ‗fix‘ accounts. Internal accounts are rarely ‗fixed‘, because there is little point in the managers fooling themselves (unless fraud is going on) but public accounts are routinely ‗fixed‘ to create a good impression out to the outside world. If you understand accounts, you can usually (not always) spot these ‗fixes‘ and take them out to get a true picture.