Concept of Gross Profit and Net Profit

Gross Profit and Net Profit

The Trading and Profit & Loss Account is really two accounts combined into one statement. The first part — the Trading Account — finds the gross profit or gross loss. The second part — the Profit & Loss Account — finds the net profit or net loss.

Trading Account

The Trading Account shows the result from the basic operational activities of the business: manufacturing, purchasing, and selling goods. It answers one question: has the core activity of buying and selling (or producing and selling) been profitable?

Purchases are the main expense. All other expenses fall into two categories:

• Direct expenses: expenses directly connected with manufacturing, purchasing goods, and bringing them to the point of sale. Examples: carriage inwards, freight inwards, wages, factory lighting, coal, water, fuel, royalty on production.
• Indirect expenses: all other expenses not directly linked to production or purchase. Examples: salaries, rent of building, bad debts.

In the textbook's example, wages is a direct expense; salaries, rent, and bad debts are indirect.

Sales are the main revenue item.

If purchases plus direct expenses exceed sales, the result is a gross loss.

The gross profit (or gross loss) is transferred to the Profit & Loss Account.

Profit & Loss Account

This second part takes the gross profit from the Trading Account and adjusts it for:

• Indirect expenses (debited to this account)
• Other incomes / gains (credited to this account) — anything earned besides sales, like commission received, rent received, discount received, interest received.

If the credit side total exceeds the debit side total, the difference is net profit. If the debit side is larger, the difference is net loss.

Journal Entry for Transfer of Net Profit or Net Loss

For net profit:

For net loss:

Worked Example from the Textbook

Trading and Profit & Loss Account of Ankit for the year ended March 31, 2026