Profit and loss account – key information

How to look at this document prepared in accordance with the Polish Accounting Act, that is, using the function of expense or the nature of expense method? This article answers this and other questions.

Only certain companies, individuals and non-corporate entities are obliged by law to compile a profit and loss account. Specifically, it is mandatory for all entities that operate in accordance with the Accounting Act, that is:

Polish laws allow income statements to be prepared in two different ways, both geared for vertical analysis. They are the function of expense method and the nature of expense method.

The function of expense method allocates costs to cost centres, based on the functional layout. The P&L account thus includes:

The overall profit(loss) on sales in this format is determined by comparing revenues from sale of goods, merchandise and raw materials with the costs of manufacturing them plus sales costs and management overheads.

The nature of expense method classifies costs by, well, their nature. Accordingly, a P&L account in this format includes accounts such as:

In order to calculate the operating profit (loss) in this method, you have to transfer expenses and revenues and additionally the change in the balance of finished goods to the “profit (loss)” account .

What are the key differences between a balance sheet and a profit and loss account? What information do they offer to potential investors?

A balance sheet lists assets and the sources of financing those assets (assets and equity plus liabilities) as of a specific date. What to remember when you compile a balance sheet?

There are a few balance sheet types: consolidated, annual, liquidation. The most common is the end-of-period balance sheet. It also serves as an opening balance sheet of a new reporting period. A well-prepared balance sheet balances out, i.e. the sum of assets equals the sum of liabilities, i.e. their sources of financing. The most important thing to remember is the valuation of assets. This needs to be done in accordance with the fundamental accounting principles, such as the principle of prudence and business continuity, as well as other accounting rules affecting the data presentation. The main point is for the balance sheet to show the real financial standing. Article 86 of the Accounting Act describes the scope of information to be disclosed in the financial statements, and thus the balance sheet, by entities other than banks, insurance and reinsurance companies. 

Figures presented in a balance sheet or profit and loss account may be difficult to interpret. The statute stipulates exactly what data have to be included in the appendix and explanatory notes to help the reader understand the financial statements. Complete financial statements consist of the balance sheet, profit & loss account (income statement), and the above-mentioned notes, which may prove necessary to interpret the document properly. Moreover, some companies prepare a cash flow statement and a statement of changes in equity to give the reader a broader picture of the entity and its assets as well as the sources and methods of financing them.

Going back to the difference between the balance sheet and the profit and loss account: the balance sheet shows the business’s assets, whereas the profit and loss account shows how the company generates revenues and how much it costs to generate them. So, the details in the profit and loss account let you assess whether the company is growing or having financial difficulties.

The most important principle to be considered while making a profit and loss account is the matching principle. It says that the profit(loss) of a period is shaped by the revenues and the corresponding expenses of that period. Expenses unrelated to revenues of the period cannot be included in the profit and loss account. 

Another principle is the accrual principle, which says that the financial statements should include all business transactions/events related to a period – paid and unpaid. Simply speaking, if you sell a product or provide a service, you should disclose it in the income statements no matter if the customer pays for it e.g. in the next accounting period.

A profit and loss account consists of certain fixed components independent of the enterprise. They include:

A professional analysis of the profit(loss) undoubtedly makes business management decisions easier. The profit (loss) is the fundamental indicator of the business performance and affects the establishment of development and incentive funds.

Financial statements, and the profit and loss accounts in particular, deliver valuable information to all stakeholders. The vertical layout allows looking at individual segments of the business, i.e. operating, financing and other activities. The two methods of preparing the account present expenses from different perspectives. For management purposes, the one that shows cost centres is more popular. You should remember that an income statement is prepared on an accrual basis, so in order to find out how the company’s performance translates into cash, it is worth analysing the cash flow statement. The profit and loss account is mandatory for certain entities only, but it makes sense to prepare one for own information and decision-making purposes. 

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