To determine whether a profit or loss has been made for a reporting period, the Profit and Loss Summary ledger is used. This ledger matches the revenue earned for the reporting period with the expenses incurred in earning that revenue.
Net profit or net loss is the final profit or loss made by a business after taking into account all revenues and expenses for a reporting period. At the end of that reporting period, profit needs to be transferred to the owners account.
The closing entries, prepared at the end of the accounting period, perform two functions:
1. They close off individual revenue and expense accounts ready for the next reporting period
2. They transfer the balances of the revenue and expense accounts relating to that period to the Profit and Loss Summary ledger so that net profit or net loss can be determined.
There are four steps to follow as part of the process for determining profit or loss in the ledger at the end of a reporting period:
- Close revenue accounts to the Profit and Loss Summary account
- Close expense accounts to the Profit and Loss Summary account
- Transfer the balance of the Profit and Loss Summary account to the Capital account. A debit balance in the Profit and Loss Summary account represents a profit and a credit balance is a loss.
- Transfer Drawings to Capital and then balance the Capital account.
Example
For the attached set of ledgers, the following General Journal entries would be required to determine profit or loss in the General Ledger.
| General Journal | |||
| Date | Details | Debit | Credit |
| Jun30 | Sales | 90,000 | |
| Profit and Loss Summary | 90,000 | ||
| Closing revenue accounts | |||
| Profit and Loss Summary | 60,000 | ||
| Cost of Sales | 48,000 | ||
| Marketing Expenses | 7,000 | ||
| Administrative Expenses | 5,000 | ||
| Closing expense accounts | |||
| Profit and Loss Summary | 30,000 | ||
| Capital | 30,000 | ||
| Transfer of net profit to capital | |||
| Capital | 26,000 | ||
| Drawings | 26,000 | ||
| Transfer of drawings to capital | |||
