After having ascertained the Gross Profit/Gross Loss by preparing a Trading Account, the businessman proceeds to prepare the Profit and Loss Account to know the Net Profit or Net Loss. It starts with Gross Profit transferred from the Trading Account which is shown on the credit side of the Profit and Loss Account. In case the Trading Account reveals Gross Loss, it will be shown on the debit side of the Profit and Loss Account. The Trading Account takes into account only direct expenses i.e., expenses relating to purchases and manufacturing of goods.

All the remaining expenses (called indirect expenses) and the losses relating to normal activities of the business are shown on the debit side of the Profit and Loss Account. Usually, the office and administrative expenses such as salaries, rent and taxes, postage and telegrams, printing and stationery, legal expenses, etc. are shown first. These are followed by selling and distribution expenses such as advertising, commission paid, travelling expenses, carriage outwards, warehousing expenses. etc., the financial expenses such as interest paid and the revenue losses such as loss by fire, loss by theft, etc.

All incomes and gains (other than sales) such as rent received, interest received, commission received, discount received, etc, are shown on the credit side of the Profit and Loss Account. The difference between the two sides of the Profit and Loss Account represents either Net Profit or Net Loss. In case the total of the credit side is higher than the total of the debit side, the difference is called Net Profit.

Thus, Net Profit is the excess of gross profit and incidental incomes over the expenses and losses relating to the normal activities of the business. If, however, the expenses and losses are more than. the gross profit and incidental incomes, the difference is called Net Loss. In other words, if the total of the debit side is more than the total of the credit side, the result is Net Loss. The Net Profit or Net Loss belongs to the proprietor and therefore it is transferred to his Capital Account. Thus the Profit and Loss Account is closed.