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Introduction to bookkeeping and accounting
Introduction to bookkeeping and accounting

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3.4 Income and expense accounts

A successful business will have many transactions and, rather than take the profit or loss to owner’s capital on each transaction, similar income or expenses are collected together in separate accounts in the nominal ledger. These accounts are totalled at the end of a time period (at least once a year but probably each month as well) to measure the total profit or loss for that period. The P&L account, when published as a financial statement, is a summary of all the income and expense accounts that reflect the year’s trading transactions.

As with assets and liability items, items of income and expense are recorded in nominal ledger accounts according to set rules. Expenses are always recorded as debit entries in expense accounts and income items are always recorded as credit entries in income accounts.

We will now look at Peter’s Photographic Enterprises’ initial transactions as they would be dealt with in the nominal ledger.

Figure 21

We could prepare a P&L account from those T-accounts that we indicated were either income accounts or expense accounts.

Table 16 Peter’s Photographic Enterprises Profit and loss account
£
Sales (Income account) 175
Cost of sales (Expense account) Total 100
Gross profit 75
Expenses
Advertising (Expense account) Total 30
Net profit for the period Total 45
The effect on the balance sheet would be:
Assets
Increase in cash +£145 (the increase in the cash T-account)
Decrease in stock –£100 (the decrease in the stock T-account)
Liabilities
No change
Change in net assets +£45
Capital
Profit +£45

Information point

In the example above the net profit of £45 is not the same as the increase in cash of £145. As we learned in Section 3.1, net profit is often very different from the increase or decrease in cash in the same period.

Activity 19

A business carries out the following cash transactions:

  • a.business buys stock of bicycles for £1,000
  • b.customer pays £300 for one bicycle (cost of bicycle is £200)
  • c.business pays £45 for electricity.

Enter these on the T-accounts below, and draw up a P&L account.

Figure 22

Answer

Figure 23
Profit and loss account
£
Sales 300
Cost of sales Total 200
Gross profit 100
Expenses Total 45
Net profit Total 55