Financial Accounting · Final Accounts of Commercial Organisations

Profit and Loss Account and Net Profit Calculation

Updated 10 October 2026 · Fact-checked

The profit and loss account is the second part of final accounts. It starts with gross profit from the trading account, adds other incomes, and deducts operating and non-operating expenses. The balance is net profit or net loss. Solve it by adjusting each item first, then placing it on the correct side.

Understand Profit and Loss Account and Net Profit

A business earns income and bears expenses. The trading account only matches sales with the direct cost of goods sold, giving gross profit. It does not show what the owner finally earns. For that you need the profit and loss account.

The profit and loss account begins with gross profit (or gross loss) brought down from the trading account. Then you add every other income of the year and deduct every expense that was not charged in the trading account. What is left is net profit (or net loss). It is then transferred to the capital account of the proprietor.

Expenses are of two kinds. Operating expenses arise from running the business: salaries, rent, advertising, office expenses, depreciation, bad debts, selling and distribution costs. Non-operating expenses are not part of the core activity: interest on loan, loss on sale of an asset, loss by fire or theft. Incomes are split the same way. Operating income is mainly gross profit and items like commission earned. Non-operating income includes interest received, rent received, dividend and profit on sale of an asset.

The account follows the accrual basis. Include expenses and incomes that relate to the year, whether or not cash has moved. So you must adjust outstanding expenses, prepaid expenses, accrued income and income received in advance before posting. Only the current year's share goes in.

The difference from the trading account is simple. The trading account covers direct items (opening stock, purchases, direct expenses, sales, closing stock) and ends in gross profit. The profit and loss account covers indirect items and ends in net profit. Both are nominal accounts closed at year end.

Key rules to remember

Net profit: Net profit = Gross profit + Other incomes − Operating expenses − Non-operating expenses; If the result is negative, it is a net loss.
Expense for the year (outstanding and prepaid): Expense charged = Amount paid + Outstanding at end − Outstanding at start − Prepaid at end + Prepaid at start; For incomes, closing accrued is added and closing advance is deducted; opening balances are reversed.
Income for the year: Income credited = Amount received + Accrued at end − Accrued at start − Income received in advance at end + Income received in advance at start; Accrued income is added; income received in advance is deducted. Opening accrued income and opening advance income relate to the previous year, so they are reversed.
Bad debts and provision: Charge for bad debts and provision = Bad debts + New provision − Old provision; If old provision is higher, the difference is a credit to the account. Calculate the new provision on debtors after deducting further bad debts.
Depreciation on straight line: Annual depreciation = (Cost − Scrap value) ÷ Useful life; For a part year, charge for the months of use unless the question says otherwise. Depreciation on factory assets is a manufacturing or trading account charge; depreciation on other assets goes to the profit and loss account.
Net profit to capital: Closing capital = Opening capital + Net profit + Additional capital − Drawings; Net profit is added to capital; drawings are never charged to the profit and loss account.

How to solve Profit and Loss Account and Net Profit questions

Use this order for any question that gives a trial balance with adjustments.

1Read the adjustments first and mark each one: which accounts it touches and whether it affects the profit and loss account, the trading account, the balance sheet, or all of them.
2Complete the trading account and bring down gross profit or gross loss.
3Write gross profit on the credit side (gross loss on the debit side) of the profit and loss account.
4Put all incomes on the credit side: interest received, commission, discount received, rent received, profit on sale of assets. Adjust for accrued and advance amounts.
5Put all expenses on the debit side with adjustments: salaries, rent, insurance, advertising, depreciation, bad debts, provision for doubtful debts, interest on loan, loss on sale of assets.
6Leave out drawings, capital, and purchase of assets. Treat interest on capital and drawings as the question directs.
7Total both sides. The balancing figure is net profit (debit side short) or net loss (credit side short). Transfer it to the capital account.
8Check that every adjustment has been used once in the profit and loss account and once in the balance sheet.

Quickest way: Single-pass adjusted expense method

When to use it: Use it when the trial balance is long and time is short, mainly in the 14-mark numerical question.

Tick each trial balance item as trading, profit and loss, or balance sheet before writing anything.
Make a small working note for every adjusted item and write only the final figure in the account.
For each expense write: paid + outstanding − prepaid, in one line.
Write the account in two columns, then add and balance once.
Take net profit to a quick capital account to confirm that the balance sheet will tally.

Common mistakes in Profit and Loss Account and Net Profit

Showing drawings or the owner's personal expenses as an expense in the profit and loss account.
Drawings look like a payment from the business, so they get treated like any expense.
Fix: Drawings reduce capital. Only expenses of the business go to the profit and loss account.
Charging the full amount paid for an expense, ignoring outstanding or prepaid amounts.
Students copy the trial balance figure straight into the account.
Fix: Always apply the adjustment formula. Show the outstanding amount as a liability and the prepaid amount as an asset in the balance sheet.
Treating loss on sale of an asset or interest on loan as a trading account item.
Students are unsure which items are direct and which are indirect.
Fix: Only direct costs of goods go to the trading account. Everything else, including non-operating items, goes to the profit and loss account.
Calculating provision for doubtful debts on gross debtors, ignoring fresh bad debts.
The adjustment note is read in a hurry.
Fix: Deduct further bad debts from debtors first, then apply the percentage. Charge new provision less old provision.
Placing a profit on sale of an asset on the debit side, or a gross loss on the credit side.
Students lose track of which side each item belongs to.
Fix: Incomes and gross profit are credits. Expenses and gross loss are debits. Check the sides before totalling.
Charging purchase of furniture or other assets as an expense.
The payment appears in the trial balance with other debit balances.
Fix: Assets are shown in the balance sheet. Only depreciation on them is charged to the profit and loss account.

Worked examples

Example 1

From the following, prepare the profit and loss account of Ramesh Traders for the year ended 31 March 2027. Gross profit ₹3,50,000; salaries paid ₹60,000 (outstanding ₹5,000); rent paid ₹24,000 (prepaid ₹4,000); interest received ₹8,000 (accrued ₹2,000); discount allowed ₹3,000; bad debts ₹4,000; depreciation ₹12,000; loss by theft ₹6,000; commission received ₹10,000 (received in advance ₹1,500). All outstanding, prepaid, accrued and advance amounts are as at 31 March 2027, and there were no opening balances of these items.

Show the solution

Salaries for the year = 60,000 + 5,000 = ₹65,000.
Rent for the year = 24,000 − 4,000 = ₹20,000.
Interest income for the year = 8,000 + 2,000 = ₹10,000 (credit side).
Commission earned for the year = 10,000 − 1,500 = ₹8,500 (credit side).
Debit side: salaries 65,000 + rent 20,000 + discount allowed 3,000 + bad debts 4,000 + depreciation 12,000 + loss by theft 6,000 = ₹1,10,000.
Credit side: gross profit 3,50,000 + interest 10,000 + commission 8,500 = ₹3,68,500.
Net profit = 3,68,500 − 1,10,000 = ₹2,58,500.

Answer: Net profit = ₹2,58,500, transferred to the capital account.

Example 2

Kavita Stores has gross profit of ₹2,20,000. Debit items: office expenses ₹30,000, insurance paid ₹18,000 (prepaid ₹3,000), wages paid ₹40,000; wages outstanding ₹6,000 not yet recorded, bad debts ₹5,000. The bad debts of ₹5,000 are further bad debts that are yet to be adjusted; they are not yet deducted from the debtors figure. Debtors are ₹1,05,000 before these bad debts. Provision for doubtful debts is to be kept at 5% on debtors after bad debts; the old provision is ₹3,000. Interest on bank loan paid ₹9,000. Profit on sale of old machine ₹7,000. Find net profit.

Show the solution

Insurance for the year = 18,000 − 3,000 = ₹15,000.
Wages for the year = 40,000 + 6,000 = ₹46,000.
Debtors after bad debts = 1,05,000 − 5,000 = ₹1,00,000.
New provision = 5% of 1,00,000 = ₹5,000.
Charge for provision = 5,000 − 3,000 = ₹2,000.
Debit side: office expenses 30,000 + insurance 15,000 + wages 46,000 + bad debts 5,000 + provision 2,000 + loan interest 9,000 = ₹1,07,000.
Credit side: gross profit 2,20,000 + profit on sale of machine 7,000 = ₹2,27,000.
Net profit = 2,27,000 − 1,07,000 = ₹1,20,000.

Answer: Net profit = ₹1,20,000.

Exam tips

In the MCQ section, expect questions on which items go to the profit and loss account, and quick net profit computations. Read each option for the side (debit or credit) of the item.
In the written answer, show working notes for each adjusted item. Step marks are given even if the final figure is wrong.
Always state the assumption when the question is unclear, for example whether bad debts are already deducted from debtors.
Use the standard two-sided format with the heading 'Profit and Loss Account for the year ended ...'. Total both sides and write net profit as the balancing figure.
Check at the end that net profit agrees with the capital account and that the balance sheet tallies.

Practice questions from Final Accounts of Commercial Organisations

Profit and Loss Account and Net Profit in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Profit and Loss Account and Net Profit: frequently asked questions

What is the difference between the trading account and the profit and loss account?

The trading account shows direct costs and sales and ends in gross profit or loss. The profit and loss account starts with that figure and adds incomes and deducts indirect expenses to give net profit or loss. Both are prepared for the same year.

Where do interest on drawings and interest on capital go?

Interest on capital is treated as an expense of the business and appears on the debit side. Interest on drawings is an income and appears on the credit side. Check whether the question says to charge them against profit.

Is depreciation an operating or non-operating expense?

It is an operating expense because it arises from using assets in the business. It is charged on the debit side of the profit and loss account, unless it relates directly to production and the question puts it in the trading account.

Is net profit the same as cash profit?

No. Net profit follows the accrual basis, so it includes outstanding and accrued items and excludes prepaid and advance items. Non-cash charges such as depreciation also reduce it, so net profit and cash balance rarely match.