Profit

Profit is the financial reward a business earns for taking on risk and carrying out its operations. In accounting, profit is defined very specifically as the excess of total revenues earned during a period over the total expenses incurred to earn those revenues during the same period.

This is not just a number on a report; it has a direct and important effect on the owners of the business. Because the business is a separate entity from its owners, any profit it earns belongs to the business itself. However, this profit ultimately increases the owners' claim on the business's assets. In other words, profit increases the owner's capital or investment in the firm.

The accounting treatment for profit is straightforward. At the end of the accounting year, all revenue accounts and all expense accounts are closed by transferring their balances to a temporary account called the Profit and Loss Account. The steps are:

• All expense accounts are closed by crediting them and debiting the Profit and Loss Account.
• All revenue accounts are closed by debiting them and crediting the Profit and Loss Account.

If the total of the credit side (revenues) of the Profit and Loss Account is greater than the total of the debit side (expenses), the difference is the net profit. This net profit is then transferred to the owner's capital account by crediting the capital account. The journal entry is: