The Profit and Loss Account

From The accounting equation and balance sheet we know that profit is an increase in owners' claims (i.e., an increase in assets - liabilities). The profit and loss account is concerned with calculating and summarising the changes in assets and liabilities resulting from a period's operations. The calculation undertaken using the profit and loss account seeks to reduce the net financial effect of the year's operations to a single value of Income or Profit for the year. Whereas the balance sheet displays the totals or balances remaining on the accounts, grouped into assets, liabilities and shareholders' claims, the profit and loss account (as its name implies) is itself an account which is actually part of the double-entry accounting system. (Note that consequently, any balance left (undistributed) on the profit and loss account appears as a reserve on the balance sheet)

Demand for separate profit or loss account

Although the effect of a company's trading activities over a period will be reflected in the values presented in the balance sheet and profit can be determined by comparing balance sheets at the beginning and end of the period, the details of trading transactions giving rise to any profit are not presented. With shareholders increasingly divorced from the management and operations of their companies they needed some means of monitoring the efficiency of the managers, and determining the financial return being earned on their investment. The balance sheet alone was insufficient for this purpose as it was possible for unscrupulous managers to mislead shareholders into believing their investment was profitable by paying large dividends, not from sustainable trading activities, but by running down and