Profit refers to the excess of total revenue over total expenses. According to the rule "Debit all expenses and losses, Credit all incomes and gains", expenses are recorded on the debit side while revenues are recorded on the credit side. There is profit when Total revenue > Total expenses, whichRead more
Profit refers to the excess of total revenue over total expenses. According to the rule “Debit all expenses and losses, Credit all incomes and gains”, expenses are recorded on the debit side while revenues are recorded on the credit side.
There is profit when Total revenue > Total expenses, which means the balance of the credit side > the balance of the debit side. Since, in accounting Dr. side is always equal to the credit side, a balancing figure (representing profit or loss) is shown on the shorter side, to make both sides equal.
When Credit side > Debit side, Profit(balancing figure) is shown on the Dr. side so that both sides are equal.
PROFIT
Profit refers to the excess of total revenue over the total expenses of the business for an accounting year. In simple words, it shows how much extra the firm earned after deducting all the expenses it incurred during the year.
Profit = Total Revenue – Total Expenses
Suppose, the firm earned a total revenue of $10,000 for the accounting year 2022-23. Also, it incurred total expenses of $6,000 during the year. So, Profit for the AY 2022-23 is $4,000.
ASCERTAINING PROFIT
To ascertain profit earned or loss incurred by the firm during an accounting year, it prepares two accounts.
- Trading A/c
- Profit and Loss A/c
Points to be noted:
- Both accounts are Nominal Account which follows the rule “Debit all expenses and losses, Credit all incomes and gains”
- The debit side records expenses while the Credit side records incomes.
- Both are balanced accounts, which means its Dr. side is always equal to its Cr. side.
- If they are not balanced, then a balancing figure is added to the shorter side which represents profit or the loss depending on which side is greater.
- If Dr. side > Cr. side, it means expenses are more than the incomes and thus, there is a loss.
- If Cr. side > Dr. side, it means there are more incomes than expenses and thus, there is Profit.
TRADING ACCOUNT
It is the first final account prepared for calculating gross profit or gross loss during the year because of the trading activities of the firm.
Trading activities are related to the buying and selling of goods. In between buying and selling a lot of activities are there like transportation, warehousing, loading, unloading, etc. All expenses that are directly related to buying and selling as well as manufacturing of goods are known as Direct expenses and are also recorded in the trading accounts.
Items included on the debit side:
- Opening stock
- Purchases
- Direct expenses like wages, import duty, royalty, manufacturing expenses, etc.
- Gross Profit
Items included on the credit side:
- Sales
- Closing stock
- Gross loss
Gross Profit is when Cr. side (incomes) > Dr. side (expenses). It is recorded on the debit side as a balancing figure.
PROFIT AND LOSS ACCOUNT
A businessman incurs a lot of expenses during the year which may be directly related or indirectly related to the business.
As the Trading account only considers direct expenses, the businessman prepares the P&L A/c which considers all the expenses incurred during a year to ascertain net profit or loss.
Items written on the Debit side
- Gross loss (transferred from the trading a/c)
- Office and administrative expenses (like employee’s salary, office rent, office lighting bills, legal charges, printing expenses, etc.)
- Selling and distribution expenses (like advertisement fees, commission, carriage outward, packaging charges, etc.
- Miscellaneous expenses (like interest on loan, interest on capital, repair, depreciation, etc.)
- Net Profit
Items written on the Credit side
- Gross Profit (transferred from trading a/c)
- Other incomes and gains (Like income from investments, interest received, rent received, etc.)
- Net loss
Net Profit is when the Cr. side (incomes)> Dr. side(expenses). It is recorded on the Debit side as a balancing figure.
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Expenses are of two types, are Direct Expenses Indirect Expenses Direct Expenses Direct expenses are those expenses are which are directly related to the manufacturing or production of the final goods. These expenses are also known as Manufacturing expenses. Manufacturing or production of gooRead more
Expenses are of two types, are
Direct Expenses
Direct expenses are those expenses are which are directly related to the manufacturing or production of the final goods. These expenses are also known as Manufacturing expenses.
Manufacturing or production of goods indicates the conversion of Raw material into finished goods. the expenses incurred in the stage of conversion are treated as Direct expenses or Manufacturing expenses.
Direct expenses are shown on the Debit side of the Trading Account.
Indirect Expenses
Indirect expenses are those expenses that are incurred to run a business day-to-day and maintenance of the company. In other words, they are not directly related to making a product or service or buying a wholesale product to resell.
Indirect expenses are classified into three types, which are
Indirect Expenses are shown on the Debit side of the Profit and Loss Account.
Presentation of Direct Expenses in Trading Account
Examples of Direct Expenses
- Gas, water, and Fuel: Gas, water, and fuel are the essentials to run a factory and are used in machinery to manufacture its final goods.
- Wages: Wages are the daily payments to the workers or Labours working in the factory premises on a daily or weekly payment basis.
- Freight and Carriage: Freight and Carriage are the expenses related to the importing of raw materials from the godown or from the outsiders to the Factory.
- Factory Rent: Rent paid for the factory area or any payment related to the place of the factory is known as factory rent.
- Factory Lighting: The expenses related to the uniform distribution of light over the working plane are obtained in the factory premises.
- Factory Insurance: The payment of insurance related to the factory will come under direct expenses.
- Manufacturing Expenses: Any other expenses related to the manufacturing process of finished goods are manufacturing expenses.
- Cargo Expenses: These are the expenses related to goods or freight being shipped or carried by the ocean, air, or land from one place to another.
- Upkeep and Maintenance: These are the expenses related to the maintenance of the factory for smooth running.
- Repairs on Machinery: The expenses related to any repair on machinery which is used in the production.
- Coal, Oil, and Grease: Coal, oil, and grease are the essentials to run machinery which results in the conversion of raw material to finished goods.
- Custom Charges: The expenses related to the payment of any Customs duty for the material imported.
- Clearing Charges: A clearing charge is a charge assessed on securities transactions by a clearing house for completing transactions using its own facilities.
- Depreciation on Machinery: Generally it is a nonmonetary expense but recorded in the trading account as a direct expense as per the accrual accounting.
- Import duty: any payment related to the importing of any machinery or any material from other countries is known as import duty.
- Octroi: this is the tax levied by a local political unit, normally the commune or municipal authority, on certain categories of goods as they enter the area.
- Shipping expenses: any expense related to the shipment charges of the raw material is known as shipping expenses.
- Motive power: Motive Power basically means any power, such as electricity or steam energy, etc, used to impart motion to any source of mechanical energy.
- Dock dues: a payment that a shipping company must pay for the use of a port.
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