The companies Act has prescribed standard form for the balance sheet, but none for the profit and loss account. However, the Companies Act does require that the information provided should be adequate to reflect a true and fair picture of the operations of the company of the accounting period. The Companies Act has also specified that the profit and loss account must show specific information as required by Schedule IV.
The profit and loss account like the balance sheet may be presented in the account form or the report form. Typically companies employ the report form. The report form statement may be a single step statements or a multi-step statement. In a single step statement, all revenues items are recorded first, then the expenses items are shown and finally the net profit is given.
While a single step profit and loss account aggregates all revenues and expenses a multi step profit and loss account provides disaggregated information. Further instead of showing only the final profit measure, viz., the profit after tax figure, it presents profit measures at intermediate stages as well. The form given in this exhibit highlights the following:
* Net sales
* Cost of goods sold
* Gross profit
* Operating expenses
* Operating profit
* Other income
* Profit before interest and tax
* Profit before tax
* Profit after Tax
* Prior period adjustments
* Amount available for appropriations
* Balance carried forward
Net sales: Net sales are generally defined as: sales – sales returns – excise duty. Sales are the sum of the invoice price of goods and services rendered during the period. Sales returns represent the invoice of goods returned by the customers. Excise duty refers it he amount paid to the excise department.
Cost of goods Sold: The cost of goods sold (COGs) also called the costs of sales, represents the cost of goods sold during the accounting period. For a distribution firms, the COGs is the acquisition cost of inventories sold during the accounting period. For a manufacturing forms, the COGs consists of direct material cost, direct labor costs and manufacturing overhead costs incurred for producing the goods sold during the accounting period. The COGs should be distinguished from the cost of production which represents the cot of goods produced during the accounting period.
Gross profit: Gross profit is the difference between net sale and the cost of goods sold. It is the first and the broadest measure of profit.
Operating Expenses: Operating expenses are the expenses incurred by a form for running its operations during the accounting period. General administration expenses selling distribution expenses, research and development expenses, and depreciation and amortization are the major items of operating expenses. Many accountants include depreciation under manufacturing overhead and treat it as part of the cost of goods sold rather than as an operating expense.
Operating Profit: represents profit from operations after considering the cost of goods sold and operating expenses. It reflects the profit the profit generated by the normal and recurring business activities of the firm and does not take into account non operating gains (or losses), interest expenses and taxes.
Other income: Operating profit (income) is generated by the core business of the firm whereas other income reflects extra ordinary income and non operating income. While extra ordinary income is sporadic non-operating income is regular.
Profit Before Interest or taxes (PBIT): PBIT referred to also as earnings before interest and taxes (PBIT) is the operating profit of the firm plus any non-operating surplus less any operating loss. It is measure of profit before considering interest expense and tax burden.
Interest is the periodic expenses incurred for borrowings like term loans, debentures, working capital loans, commercial paper, fixed deposits, and unsecured loans provided by promoters.
Profit before Tax: Profit before tax is the difference between the firm’s profit before interest and tax and its interest expense. It is a measure of profit before taking taxes into account.
Income Tax Provision: Thanks to the deferred tax accounting rule being followed now, the income tax provision consists of two items viz., current tax and deferred tax liability.
Profit after Tax: Profit after tax is obtained by subtracting the income tax provision from the profit before tax. Profit after tax is measured of the change in the owners’ equity arising from the revenues and expenses of the accounting period.
Prior Period adjustments: After the profit after tax is calculated some adjustments are made to arrive at the profit available for appropriation.
Amount available or Appropriations Profit available for appropriation is equal to profit after tax plus prior period adjustments.
Appropriations: From the amount available for appropriations, transfers are made to various reserve accounts and provision is made for the proposed dividend.
Balance Carried Forward: What is left after various appropriations represents the balance (or surplus) in the profit and loss account which is carried forward.