Profit and Loss Account:

Definition A profit and loss account, also known as an income statement.

Gross profit or loss of a business is ascertained through trading account and net profit is determined by deducting all indirect expenses (business operating expenses) from the gross profit through profit and loss account. Thus profit and loss account starts with the result provided by trading account.

BENEFITS OF PREPARING PROFIT &LOSS ACCOUNT:

The particulars required for the preparation of profit and loss account are available from the trial balance. Only indirect expenses and indirect revenues are considered in it. This account starts from the result of trading account (gross profit or gross loss). Gross profit is shown on the credit side of the profit and loss account and gross loss is shown on the debit side of this account. All indirect expenses are transferred on the debit side of this account and all indirect revenues on credit side. If the total of the credit side exceeds the debit side, the result is "net profit" and if the total of the debit side exceeds the total of the credit side, the result is net loss. As the net profit or net loss of a certain accounting period is determined through profit and loss account, so its heading is: Name of Business Profit and Loss Account for the year ended 31.12.2005

Sequence of Expenses in Profit and Loss Account:

There is no hard and fast rule as to the order in which the items of expenses are shown in profit and loss account. Generally, the items of expenses are shown in the following sequence: These are the expenses with the management of the business e.g. salaries of manager, accountant and office clerks, office rent, office stationary, office electric charges, office telephone etc.

Office and Administration Expenses:

These are the expenses which are directly or indirectly connected with the sale of goods. These expenses vary with the sales i.e. they increase or decrease with the increase or decrease of sale of goods. Examples are advertisements, carriage outward, salesmen's salaries and commission, discount allowed, traveling expenses, bad debts, packaging expenses, warehouse rent etc.

Selling and Distribution Expenses:

Financial and Other Expenses: All other expenses excepting those mentioned above
are considered under this class.

The elements of income are generally divided into four categories: revenues, expenses, gains and losses .

Revenue The amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise. Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold.

Expenses:

In common usage, an expense or expenditure is an outflow of money to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense Gain: In finance, gain is a profit or an increase in value of an investment such as a stock or bond. Gain is calculated by fair market value or the proceeds from the sale of the investment minus the sum of the purchase price and all costs associated with it. If the investment is not converted into cash or another asset, the gain is then called an unrealized gain. Features of Profit and Loss Account:
1. This account is prepared on the last day of an account year in order to 2. 3. 4. 5.
determine the net result of the business. It is second stage of the final accounts. Only indirect expenses and indirect revenues are shown in this account. It starts with the closing balance of the trading account i.e. gross profit or gross loss. All items of revenue concerning current year - whether received in cash or not - and all items of expenses - whether paid in cash or not - are considered in this account. But no item relating to past or next year is included in it.

If credit side exceeds the debit side If debit side exceeds the credit side

= =

Net profit Net loss

(XYZ co.)Profit and Loss Account for the year ended 31.12.2005
Office and Administration Expenses: Salaries Rent, rates, taxes Selling and Distribution Expenses: Carriage outwards Discount allowed Net profit - transferred to capital A/C $ Gross profit (transferred from 96,000 72,000 $ 312,000

10,000 8,000 126,000 312,000 312,000

Balance Sheet Components - Assets

Total Assets Total assets on the balance sheet are composed of:

1. Current Assets - These are assets that may be converted into cash, sold or consumed within a year or less. These usually include: Cash - This is what the company has in cash in the bank. Cash is reported at its market value at the reporting date in the respective currency in which the financials are prepared. (Different cash denominations are converted at the market conversion rate. Marketable securities (short-term investments) - These can be both equity and/or debt securities for which a ready market exist. Furthermore, management expects to sell these investments within one year's time. These short-term investments are reported at their market value. Accounts receivable - This represents the money that is owed to the company for the goods and services it has provided to customers on credit. Every business has customers that will not pay for the products or services the company has provided. Management must estimate which customers are unlikely to pay and create an account called allowance for doubtful accounts.Variations in this account will impact the reported sales on the income statement. Accounts receivable reported on the balance sheet are net of their realizable value (reduced byallowance for doubtful accounts). Notes receivable - This account is similar in nature to accounts receivable but it is supported by more formal agreements such as a "promissory notes" (usually a short term-loan that carries interest). Furthermore, the maturity of notes receivable is generally longer than accounts receivable but less than a year. Notes receivable is reported at its net realizable value (what will be collected). Inventory - This represents raw materials and items that are available for sale or are in the process of being made ready for sale. These items can be valued individually by several different means - at cost or current market value - and collectively by FIFO (first in, first out), LIFO (last in, first out) or average-cost method. Inventory is valued at the lower of the cost or market price to preclude overstating earnings and assets. Prepaid expenses - These are payments that have been made for services that the company expects to receive in the near future. Typical prepaid expenses include rent, insurance premiums and taxes. These expenses are valued at their original cost (historical cost).

2. Long-term assets - These are assets that may not be converted into cash, sold or consumed within a year or less. The heading "Long-Term Assets" is usually not displayed on a company's consolidated balance sheet. However, all items that are not included in current assets are long-term Assets. These are: Investments - These are investments that management does not expect to sell within the year. These investments can include bonds, common stock, long-term notes, investments in tangible fixed assets not currently used in operations (such as land held for speculation) and investments set aside in special funds, such as sinking funds, pension funds and plan-expansion funds. These long-term

investments are reported at their historical cost or market value on the balance sheet. Fixed assets - These are durable physical properties used in operations that have a useful life longer than one year. This includes: Machinery and equipment - This category represents the total machinery, equipment and furniture used in the company's operations. These assets are reported at their historical cost less accumulated depreciation. Buildings (plants) - These are buildings that the company uses for its operations. These assets are depreciated and are reported at historical cost less accumulated depreciation. Land - The land owned by the company on which the company's buildings or plants are sitting on. Land is valued at historical cost and is not depreciable under U.S. GAAP

Total Liabilities Liabilities have the same classifications as assets: current and long-term. 3. Current liabilities - These are debts that are due to be paid within one year or the operating cycle, whichever is longer; further, such obligations will typically involve the use of current assets, the creation of another current liability or the providing of some service. Usually included in this section are: Bank indebtedness - This amount is owed to the bank in the short term, such as a bank line of credit. Accounts payable - This amount is owed to suppliers for products and services that are delivered but not paid for. Wages payable (salaries), rent, tax and utilities - This amount is payable to employees, landlords, government and others. Accrued liabilities (accrued expenses) - These liabilities arise because an expense occurs in a period prior to the related cash payment. This accounting term is usually used as an all-encompassing term that includes customer prepayments, dividends payables and wages payables, among others. Notes payable (short-term loans) - This is an amount that the company owes to a creditor, and it usually carries an interest expense. Unearned revenues (customer prepayments) - These are payments received by customers for products and services the company has not delivered or started to incur any cost for its delivery. Dividends payable - This occurs as a company declares a dividend but has not of yet paid it out to its owners. Current portion of long-term debt - The currently maturing portion of the long-term debt is classified as a current liability. Theoretically, any related premium or discount should also be reclassified as a current liability. Current portion of capital-lease obligation - This is the portion of a long-term capital lease that is due within the next year.

4. Long-term Liabilities - These are obligations that are reasonably expected to be liquidated at some date beyond one year or one operating cycle. Long-term obligations are reported as the present value of all future cash payments. Usually included are: Notes payables - This is an amount the company owes to a creditor, which usually caries an interest expense. Long-term debt (bonds payable) - This is long-term debt net of current portion. Deferred income tax liability - GAAP allows management to use different accounting principles and/or methods for reporting purposes than it uses for corporate tax fillings (IRS). Deferred tax liabilities are taxes due in the future (future cash outflow for taxes payable) on income that has already been recognized for the books. In effect, although the company has already recognized the income on its books, the IRS lets it pay the taxes later (due to the timing difference). If a company's tax expense is greater than its tax payable, then the company has created a future tax liability (the inverse would be accounted for as a deferred tax asset). Pension fund liability - This is a company's obligation to pay its past and current employees' post-retirement benefits; they are expected to materialize when the employees take their retirement (defined-benefit plan). Valued by actuaries and represents the estimated present value of future pension expense, compared to the current value of the pension fund. The pension fund liability represents the additional amount the company will have to contribute to the current pension fund to meet future obligations. Long-term capital-lease obligation - This is a written agreement under which a property owner allows a tenant to use and rent the property for a specified period of. Long-term capital-lease obligations are net of current portion.

cash flow statement :

The statement of cash flows tells you how much cash went into and out of a company during a specific time frame such as a quarter or a year. You may wonder why there's a need for such a statement because it sounds very similar to the income statement, which shows how much revenue came in and how many expenses went out. The difference lies in a complex concept called accrual accounting. Accrual accounting requires companies to record revenues and expenses when transactions occur, not when cash is exchanged. While that explanation seems simple enough, it's a big mess in practice, and the statement of cash flows helps investors sort it out. The statement of cash flows is very important to investors because it shows how much actual cash a company has generated. The income statement, on the other hand, often includes noncash revenues or expenses, which the statement of cash flows excludes.

One of the most important traits you should seek in a potential investment is the firm's ability to generate cash. Many companies have shown profits on the income statement but stumbled later because of insufficient cash flows. A good look at the statement of cash flows for those companies may have warned investors that rocky times were ahead. The Three Elements of the Statement of Cash Flows Because companies can generate and use cash in several different ways, the statement of cash flows is separated into three sections: cash flows from operating activities, from investing activities, and from financing activities. The cash flows from operating activities section shows how much cash the company generated from its core business, as opposed to peripheral activities such as investing or borrowing. Investors should look closely at how much cash a firm generates from its operating activities because it paints the best picture of how well the business is producing cash that will ultimately benefit shareholders. The cash flows from investing activities section shows the amount of cash firms spent on investments. Investments are usually classified as either capital expenditures--money spent on items such as new equipment or anything else needed to keep the business running--or monetary investments such as the purchase or sale of money market funds. The cash flows from financing activities section includes any activities involved in transactions with the company's owners or debtors. For example, cash proceeds from new debt, or dividends paid to investors would be found in this section.