In the example related to Royal Industries, drawing a 'new' Balance Sheet each time showed the effect of a business transaction. It is not possible to prepare a Balance Sheet on a daily basis.


It is generally drawn after a reasonable period of time say a month, quarter, half year or a year. In a day, there may be a number of sales transactions and, therefore, it is not practically feasible to either determine the profit earned or the loss suffered on each sales transaction. Above all, this modus operandi destroys the earlier set of data.


There are various reasons why this modus operandi is not desirable. Usually, owners and other people are interested in having access to the complete set of data so that they can comprehend and estimate the financial health of their organization.

From the above, it is imperative that there is a need of an income statement that provides full description of all the items affecting profit of a business firm. Such a statement, which meets this requirement, is known as an Income Statement or Profit & Loss Account.


Profit & Loss (abbreviated to P&L) Account/Income Statement reports the revenues and expenses of a firm of an accounting period.


In broad terms, Revenue, as the name suggests, is the income that mainly accrues to the firm either by the sale of goods and services or by investing the resources of the firm outside. In contrast, Expenses are the costs incurred in earning revenues. Thus, P&L Account is concerned with matching the revenues of a specified period with the expenses of that period. Greater the accuracy of this matching procedure, more correct is the income determination. In other words, preparation of a P & L account is based on the Matching Principle.


Let us attempt to prepare a P&L Account of Royal Industries for the month of June. As this account represents items related to revenues and expenses of a firm, it has two sides, revenues on right side (by convention right side of P&L A/c) and expenses on left side.

From the foregoing, it is apparent that P&L account provides a candid and condensed summary of all the revenues and the expenses of a firm, for a specified period, at one place. The perusal of this account provides a crystal bird's eye-view to the owners' and the concerned the way net profit of Rs 1,10,000 has been earned. It may be recalled that such clear-cut picture was not plausible in the Balance Sheet. In fact, Balance Sheet is not intended to provide the same.


Thus, Income Statement constitutes another significant financial statement of a business firm. It is an important supplement to Balance Sheet.


In fact, there exists an inter-locking relationship between the two.


P&L account provides summary figure of all items related to revenues and expenses of a firm in terms of net profit (Revenues > Expenses) or net loss (Expenses > Revenues) to Balance Sheet. Evidently, without net profit or net loss amount, two sides of Balance Sheet will not match. In operational terms, net profit or loss is a link-pin between P&L account and Balance Sheet.


Again, the tallying of the two sides of the Balance Sheet perplexes the beginners. However, the Separate Entity concept of accounting provides the explanation. According to the concept, revenues (since payable to owners) will augment owners' equity/capital and expenses (since receivable from owners) will decrease it. As a result, surplus or the profit and deficiency or the loss, as per the situation, is transferred to capital account. Let us explain this in the context of Royal Industries.

We hope, by now you would have acquired some basic understanding of a Balance Sheet as well as the Income Statement, besides knowing some accounting principles. There is a need to learn additional accounting principles/concepts to gain better understanding of these two financial statements. A brief account of these is provided in this section.