The profit and loss account can be defined, “Report that summaries the revenues and expenses of an accounting period to reflect changes in various critical areas of firm’s operation’. According to carter, “A profit and loss account is an account into which all gains and losses are collected, in order to ascertain the excess of the gains over the losses or vice-versa”. From these definitions, a profit and loss account is prepared to find out the amount of net profit (or net loss) of the firm in a particular period.
The profit and loss account is opened with the figure of Gross Profit (or Gross Loss) taken from the Trading Account already prepared. The amount of Gross Profit is to be carried to the credit side of the profit and loss account. After this all expenses and losses, not shown in the Trading Account are show in the debit side of Profit and Loss Account and all incomes and gains to the credit side of Profit and Los Account.
The items of expenses, losses, incomes and gains are adjusted according to the adjustments of depreciation, provisions outstanding and prepaid items. After doing all this, the amount of net profit (or net loss) is ascertained. If the total of credit side of the Profit and Loss account is greater than the total of debit side, the difference will be called as Net Profit and will be shown in the debit side of Profit and Loss Account.
Similar, if the total of debit side is more than the total of credit side of Profit and Loss account, the difference in Net Loss which is shown in the credit side of Profit and Loss Account. The amount of the Net Profit and Net Loss is transferred to the capital account in the Balance Sheet and at the same time the Net Profit is added to the capital while loss is deducted from capital.