Gross Profit is not the actual profit of the business because the expenses incurred in operating the business have not yet been deducted. The amount which remains after deduction of operating expenses is termed as net profit, i.e. Net Profit = Gross Profit - Operating Expenses.
Net Profit is the real profit of the business. Operating expenses include selling, distributing, and administrative expenses. The Profit and Loss Account is prepared at the end of the accounting period to calculate the net profit earned during the period.
The diagram below summarizes the transfer of all revenue and expenses balances affecting profit to the Trading and Profit and Loss Accounts and also the transfer of the relevant account balances to the Capital Account.
Both the Trading and Profit and Loss Accounts are final accounts prepared by a trading business. However, a non-trading business that renders services for a fee, e.g. a travel agency, a beauty salon or a laundry service centre, prepares only the Profit and Loss Account as its final account.
The Profit and Loss Account of a non-trading business shows the amount of net profit earned from the services it has rendered to the customers throughout the accounting period.
Fees or takings for its services are revenue and are thus credited to the Profit and Loss Account.
Expenses incurred in operating the services are debit items in the Profit and Loss Account. They represent expenses to be charged against revenue. The excess of revenue over expenses represent net profit. If expenses exceed revenue, then a net loss is incurred.
Net profit is gross profit plus revenue other than sales less operating expenses, i.e. Net Profit = Gross Profit + Revenue - Operating Expenses
Net loss is incurred when operating expenses exceed revenue plus gross profit.
Nominal accounts affecting net profit are closed and their balances transferred to the Profit and Loss Account at the end of the accounting period to calculate net profit.
The Profit and Loss Account is prepared to calculate net profit or net loss for the accounting period.
Net profit is credited to the Capital Account to increase capital.
Net loss is debited to the Capital Account to reduce capital.
Operating expenses including selling, distribution and administrative expenses are chargeable to the debit of the Profit and Loss Account.