Fundamentals of Accounting · Preparation of Final Accounts for Sole Proprietorship

Profit and Loss Account and Net Profit for CSEET

Updated 11 October 2026 · Fact-checked

The Profit and Loss Account starts with gross profit from the Trading Account. You add indirect incomes and subtract indirect expenses. The balance is net profit or net loss, which is transferred to the proprietor's capital account. Only revenue items go in it; capital items go to the Balance Sheet.

Understand Profit and Loss Account and Net Profit

The Trading Account finds gross profit from buying and selling goods. But a business also spends money on rent, salaries, advertising and interest. It may also earn commission or interest. The Profit and Loss Account brings all of these together to find the real profit of the year.

It begins with gross profit (or gross loss) brought down from the Trading Account. Then you deduct indirect expenses, which are costs of running the business that are not part of making or buying goods. Examples are office salaries, rent, insurance, advertisement, depreciation, bad debts and interest on loan. You add indirect incomes such as commission received, interest received and discount received.

The result is net profit if incomes are more than expenses, or net loss if expenses are more. For a sole proprietor, net profit is added to capital. Net loss is deducted from capital. The proprietor is not an employee, so no salary or interest on his capital is charged unless the question says so.

Only revenue items belong here. Revenue expenditure (repairs, rent, salaries) benefits the current year and is charged to the account. Capital expenditure (buying machinery, building a shop) benefits many years and goes to the Balance Sheet as an asset. Only its depreciation comes to the Profit and Loss Account. Treating a capital item as revenue, or the reverse, changes profit wrongly.

Items are also split into operating and non-operating. Operating items come from the main business activity, such as salaries and selling expenses. Non-operating items are outside it, such as interest received on investments or loss on sale of a fixed asset. Both are shown, but separating them helps you see how well the core business performs.

Key rules to remember

Net profit: Net profit = Gross profit + Indirect incomes − Indirect expenses; If the result is negative, it is a net loss.
Net loss: Net loss = Gross loss + Indirect expenses − Indirect incomes; Use when the Trading Account shows gross loss, or when expenses exceed income.
Transfer to capital: Closing capital = Opening capital + Net profit − Drawings (+ Additional capital); Net loss is subtracted instead of net profit is added. Drawings never go to the Profit and Loss Account.
Operating profit: Operating profit = Gross profit − Operating expenses; Excludes non-operating incomes and expenses. Use only when the question asks for it.
Side rule: Expenses and losses on the debit side; incomes and gains on the credit side; Gross profit goes on the credit side; gross loss on the debit side.

How to solve Profit and Loss Account and Net Profit questions

Use this order for any Profit and Loss Account question. It keeps you from missing items and from putting them on the wrong side.

1Bring down gross profit or gross loss from the Trading Account. Gross profit goes to the credit side; gross loss goes to the debit side.
2List all indirect expenses from the trial balance and adjustments: salaries, rent, insurance, advertisement, discount allowed, bad debts, interest on loan, depreciation.
3Apply adjustments to each item: add outstanding amounts, deduct prepaid amounts, and add accrued income or deduct income received in advance.
4List all indirect incomes: commission received, interest received, discount received, rent received, profit on sale of an asset.
5Leave out capital items and personal items: purchase of assets, drawings, capital, and income tax of the proprietor.
6Total both sides. If the credit side total is greater, the difference is net profit. Write it on the debit side, which is the shorter side, to balance the account. If the debit side total is greater, the difference is net loss. Write it on the credit side to balance the account.
7Transfer net profit to the capital account in the Balance Sheet, adding it and then deducting drawings.

Quickest way: Three-pile method

When to use it: Use when time is short and the trial balance is long.

Go through the trial balance once and tick each item as Trading item, P&L item, or Balance Sheet item.
Write the P&L items in two piles: expenses and incomes. Adjust each at the moment you write it, so you do not forget it later.
Calculate: Gross profit + incomes − expenses. Check that it matches your account balancing figure.

Common mistakes in Profit and Loss Account and Net Profit

Putting drawings or the proprietor's personal expenses in the Profit and Loss Account.
Students treat the owner like an employee.
Fix: Drawings reduce capital directly. Never charge them to profit.
Debiting purchase of machinery or furniture as an expense.
Capital and revenue expenditure are confused.
Fix: Ask whether the benefit lasts beyond one year. If yes, it is an asset. Only depreciation goes to the account.
Ignoring outstanding or prepaid items from the adjustments.
Students copy the trial balance figure and move on.
Fix: Add outstanding expenses and deduct prepaid ones before writing the final figure.
Entering gross profit on the wrong side.
Students forget that profit is a gain.
Fix: Gross profit is on the credit side. Gross loss is on the debit side.
Showing net loss as an addition to capital.
The transfer rule is memorised without logic.
Fix: Profit increases capital; loss reduces capital.

Worked examples

Example 1

Mr. Sharma's Trading Account shows a gross profit of ₹1,80,000. His other items for the year are: salaries paid ₹60,000; salaries outstanding ₹5,000 (not yet included), rent ₹24,000, advertisement ₹12,000, commission received ₹15,000, interest received ₹6,000. Find net profit.

Show the solution

Salaries to be charged = ₹60,000 + ₹5,000 = ₹65,000 (outstanding added, since the ₹60,000 paid excludes it).
Total indirect expenses = ₹65,000 + ₹24,000 + ₹12,000 = ₹1,01,000.
Total indirect incomes = ₹15,000 + ₹6,000 = ₹21,000.
Net profit = ₹1,80,000 + ₹21,000 − ₹1,01,000 = ₹1,00,000.

Answer: Net profit is ₹1,00,000. It is added to Mr. Sharma's capital.

Example 2

Ms. Iyer's opening capital is ₹5,00,000. Her Trading Account shows a gross profit of ₹70,000. Expenses: rent ₹30,000, salaries ₹40,000, depreciation ₹10,000. Discount received is ₹8,000. Her drawings are ₹20,000. Find net result and closing capital.

Show the solution

Total indirect expenses = ₹30,000 + ₹40,000 + ₹10,000 = ₹80,000.
Indirect income = ₹8,000 (discount received).
Net result = ₹70,000 + ₹8,000 − ₹80,000 = −₹2,000, which is a net loss of ₹2,000.
Closing capital = ₹5,00,000 − ₹2,000 − ₹20,000 = ₹4,78,000.

Answer: Net loss is ₹2,000. Closing capital is ₹4,78,000.

Exam tips

In written papers, draw the full account with the heading 'for the year ended' and clear Dr and Cr sides. Marks are given for format.
Read the adjustments before you start. Most of the marks in this topic are lost on outstanding, prepaid and accrued items.
Show the net profit transfer to capital in a line or two, even when the question only asks for the Profit and Loss Account.
For theory questions, give a short difference table in words: Trading Account finds gross profit from direct items; Profit and Loss Account finds net profit from indirect items.
Label each item as capital or revenue if the question asks for reasons. One line of reasoning earns marks.

Practice questions from Preparation of Final Accounts for Sole Proprietorship

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 Trading Account and Profit and Loss Account?

The Trading Account deals with direct costs of goods and finds gross profit. The Profit and Loss Account starts from that gross profit and includes indirect expenses and incomes to find net profit. Trading Account is prepared first.

Is depreciation an expense in the Profit and Loss Account?

Yes. Depreciation is a non-cash revenue expense that spreads the cost of an asset over its life. It is debited to the Profit and Loss Account, and the asset is shown at a reduced value in the Balance Sheet.

Where does net profit go in a sole proprietorship?

Net profit is added to the proprietor's capital account. Net loss is deducted from it. Drawings are deducted separately from capital.

What is the difference between capital and revenue expenditure in final accounts?

Revenue expenditure gives benefit for the current year and is charged to the Trading or Profit and Loss Account. Capital expenditure gives benefit over several years and is shown as an asset in the Balance Sheet.