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Profit and loss account – key information

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​by Aneta Bolka

6 February 2023


Financial statements of an economic entity consists of three documents: balance sheet, profit and loss account (income statement), and the notes. The profit and loss account, also known as income statement, includes the most important data on the entity’s current financial standing for investors, banks, and above all those in charge of governance. By law, the document has to present the profit (loss) for a financial year, but for own purposes it may be compiled for shorter periods, e.g. monthly, quarterly or half-yearly.

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.

Profit and loss account – who is to compile one?


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:

  • commercial enterprises (partnerships and companies, also those in organisation);
  • other legal persons (except the State Treasury and the National Bank of Poland);
  • individuals, civil law partnerships of individuals, general partnerships of individuals, professional partnerships, whose net revenue from sale of goods, merchandise and financial operations in the last financial year totalled at least the equivalent of 2 million euro;
  • non-corporate entities (other than commercial partnerships and civil law partnerships);
  • branch offices and representative offices of foreign enterprises operating in Poland;
  • and others listed in Article 2 of the statute.

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.

Profit and loss account: function of expense method


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

  • core production (direct costs of production process);
  • department costs (indirect costs of production);
  • auxiliary production;
  • management overheads (costs of business management and administration);
  • sales costs (costs of selling, shipping, distributing goods etc.).

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.

Profit and loss account: nature of expense method


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

  • costs of raw materials and energy used;
  • wages and salaries;
  • social security and other employee benefits;
  • depreciation/amortisation;
  • external services;
  • taxes and charges;
  • other expenses.

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 .

Balance sheet vs profit and 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.

How to prepare a profit and loss account – step by step


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:

  • basic information: revenues from sale of finished goods, merchandise and raw materials as well as expenses incurred to earn revenues; 
  • other transactions: those indirectly connected with or arising from the entity's core business (e.g. social activities, damages, penalties, written off receivables);
  • financing activities: difference between financial income (e.g. dividend, profit on disposal of investments) and financial expenses (e.g. interest, loss on revaluation of investments, FX differences);
  • profit (or loss), which additionally accounts for gross profit(loss) on financing activities, income tax and other obligatory appropriations of profit(loss).

Benefits of having a profit and loss account 


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.

Summary


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. 


Have you got additional questions about the profit and loss account? E-mail our experts and fix a meeting.

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