Profit = Total (Incomes + Gains) − Total (Expenses + Losses)

Using this relation, a positive profit figure indicates a profit and a negative profit figure indicates a loss.

Math of Ascertainment of Profit/Loss

Nominal accounts are related to incomes/gains and expenses/losses. Thus the information relating to the aspects that would define the profit or loss made by the organisation is contained in the Nominal accounts.

Nominal Accounts with Debit balances

Those ledger accounts which have a debit balance in them represent expenses or losses The total (sum) of balances in all the nominal (ledger) accounts with a debit balance indicates the total (expense + losses).

Nominal Accounts with Credit balances

Those ledger accounts which have a credit balance in them represent incomes or gains. The total (sum) of balances in all the nominal (ledger) accounts with a credit balance indicates the total (incomes + gains).

If the total of (expense + losses) and (incomes + gains) are set off, we would be able to arrive at the profit or loss made.

Thus the relation to ascertain the profit or loss can be written as

 Profit = Sum of balances in Nominal accounts with a Credit Balance − Sum of balances in Nominal accounts with a Debit Balance

Preparation of Trading and Profit and Loss account (a/c)

The Trading and Profit & Loss a/c is also a ledger account. Like all ledger accounts, the postings in this ledger account also flow from the journal. No Journal No Ledger.

Transactions resulting in postings to Trading and Profit & Loss a/c

The transactions relating to the journal entries that would enable postings into the Trading and Profit & Loss a/c are not ones that take place in the ordinary course of business. These are transactions that are specifically meant to create the Trading and Profit & Loss a/c. They occur only at the time the information relating to profits is being derived i.e. at the time of final accounting towards the end of the accounting period.

Considering the formula for ascertaining the profit or loss, Profit = (Sum of balances in Nominal accounts with a Credit Balance) − (Sum of balances in Nominal accounts with a Debit Balance)

For Ascertaining the sum of balances in Nominal Accounts with a Debit Balance

Balances in all the nominal accounts with a debit balance have to be collected at a single place. This is done by transferring the balances in the nominal accounts with a debit balance, to the Trading and Profit & Loss a/c.
Transferring a debit balance from one account to a second results in the second account being debited and the first account being credited.

Therefore the Journal Entry would be

Journal
Date V/R
No.
Particulars L/F Amount
(Dr)
Amount
(Cr)
March 31 st Trading and Profit & Loss a/c
To Purchases a/c
To Salaries a/c
To Rent Paid a/c
To –
To –
Dr

2,44,000
24,000
8,000
17,000

[For the debit balances in the nominal accounts transferred to the Trading and Profit & Loss a/c for the purpose of ascertaining the profits on the last day of the accounting period ]

For Ascertaining the sum of balances in Nominal Accounts with a Credit Balance

Balances in all the nominal accounts with a credit balance have to be collected at a single place. This is done by transferring the balances in the nominal accounts with a credit balance to the Trading and Profit & Loss a/c.
Transferring a credit balance from one account to a second results in the second account being credited and the first account being debited.

Therefore the Journal Entry would be

Journal in the books of M/s __ for the period from ____ to _____
Date V/R
No.
Particulars L/F Amount
(Dr)
Amount
(Cr)
March 31 st Sales a/c

To Trading and Profit & Loss a/c
Dr
Dr

80,000
14,000

5,80,000
[For the credit balances in the nominal accounts transferred on the last day of the accounting period to the Trading and Profit & Loss a/c for the purpose of ascertaining the profits.]

Trading and Profit and Loss Account (a/c)

Thus the Trading and Profit & Loss a/c would appear as follows
Trading and Profit & Loss a/c
DrCr
Date Particulars Amount Date Particulars Amount
31/03/06
31/03/06
31/03/06
31/03/06
31/03/06
To Purchases a/c
To Salaries a/c
To Rent Paid a/c
...
...
24,000
8,000
17,000

31/03/06
31/03/06
31/03/06
31/03/06
By Sales a/c
...
...
80,000
14,000

sub-total 5,80,000   sub-total 5,80,000
31/03/06 To Balance (Profit) 2,56,000
Total 5,80,000   Total 5,80,000

Trading and Profit & Loss a/c, is nothing but a consolidated account of all the nominal accounts formed by transferring the balances in the nominal accounts.

Since all the transactions that result in the postings in the trading and profit and loss account are dated the last date of the accounting period to imply that the account is being prepared at the ending moment of the accounting period, we can simplify the presentation of the Trading and Profit and Loss account by eliminating the date column even.

Trading and Profit & Loss a/c
DrCr
Particulars Amount Particulars Amount
To Purchases
To Salaries
To Rent Paid
...
...
To Balance (Profit)
24,000
8,000
17,000

2,56,000
By Sales
...
...
80,000
14,000

Total 5,80,000 Total 5,80,000

Use of a/c as a suffix to the account name and sub totals etc can also be eliminated to further simplify.

Nature of Trading and Profit & Loss a/c

Since the Trading and Profit & Loss a/c is prepared by transferring the ledger account balances in all the nominal accounts in the books of accounts it is appropriate to consider it to be a nominal account.
Any Ledger account prepared to ascertain the profits or losses out of a set of transactions is a nominal account.

Since the Trading and Profit & Loss a/c is prepared to ascertain the profits or losses out of the transactions conducted over the accounting period, it is also a nominal account.

When are the entries recorded?

Accounting period is the period for which we wish to ascertain the profits or losses. The Trading and Profit & Loss a/c is prepared at the end of the accounting period. Practically it may not be possible to prepare it on the last day or immediately after the last day. So we assume that the Trading and Profit and Loss a/c is prepared any time after the last day of the accounting period.

Say if the accounting period is a year from 1st April 20_5 to 31st March 20_6, the journal entry for transferring the amounts to the Trading and Profit & Loss a/c is recorded any time after the end of the accounting period i.e. after 31st March 20_6.

Computerised accounting

In computerised accounting the journal entries relating to preparation of Trading and Profit and Loss account are programmatically recorded. Computers are so powerful that in an accounting program it is possible to balance all the ledger accounts in fractions of seconds. Therefore computerised accounting programs enable preparation of trial balance and final accounting in real time as and when needed.

Thus the journal entries for preparing the Trading and Profit and Loss account can be assumed to be recorded as and when the account is being viewed.

What happens to the Nominal a/c's

To ascertain the profits, we transfer the balances in the Nominal accounts (with debit balances as well as credit balances) to the "Trading and Profit & Loss a/c", thus creating that ledger account.

Nil Balance

When the total balance in a nominal account is transferred to the "Trading and Profit & Loss a/c", its balance becomes Nil.
Rent Paid a/c
DrCr
Date Particulars Amount Date Particulars Amount
01/04/05
01/05/05
..
..
01/03/06
To Cash a/c
To Cash a/c
..
..
To Cash a/c
8,000
8,000
..
..
8,000
31/03/06 By balance c/d 96,000
Total 96,000   Total 96,000
31/03/06 To balance b/d 96,000 31/03/06 By Trading and P/L a/c 96,000
Total 96,000   Total 96,000

Closing the Nominal Account at the end of the accounting period

The act of transferring the balance in a nominal account to the Trading and Profit and Loss Account and thereby making its balance Nil is identified as Closing the Nominal Account at the end of the accounting period.
All the nominal accounts are closed at the end of the accounting period by transfer to the "Trading and Profit and Loss Account.

Transfer Straightaway

In manual accounting, in preparing the trial balance, we balance the ledger account since we need the balances for preparing it. The same balance would be transferred to the Trading and Profit and Loss a/c as shown above.

The balance in nominal accounts can be straightaway transferred to the Trading and Profit and Loss a/c without being balanced. If the trial balance has been prepared we can assume the account to have been balanced, otherwise we can assume the balance to have been straightaway transferred. Even while assuming a straightaway transfer we will be able to prepare a trial balance before transfer as the amount being transferred can be taken to be the balance in the account.

If the balances are straightaway transferred, the ledger account would appear as below.

Rent Paid a/c
DrCr
Date Particulars Amount Date Particulars Amount
01/04/05
01/05/05
..
..
01/03/06
To Cash a/c
To Cash a/c
..
..
To Cash a/c
8,000
8,000
..
..
8,000
31/03/06 By Trading and P/L a/c 96,000
Total 96,000   Total 96,000

How do Nominal a/c's appear in every accounting period if they are closed

The nominal accounts are closed at the end of the accounting period. But we see the same nominal accounts being used in accounting in all the accounting periods. Say, the "Rent Paid a/c" would appear in the accounting books in all the accounting periods.

This is for the reason that all the nominal accounts are closed at the end of the accounting period and are opened afresh at the beginning of the next accounting period for being used in that accounting period.

Therefore, the "Rent Paid a/c" appearing in the books in a particular accounting period is different from the "Rent Paid a/c" appearing in the same books in any other accounting period.

All the nominal accounts are opened anew at the beginning of the accounting period.