The balance sheet and the profit and loss (P&L) account are two fundamental pillars of financial reporting. Together, they reveal how a business is performing and how financially stable it is. While the balance sheet provides a snapshot of the company’s assets, liabilities, and equity at a given moment, the profit and loss account measures its performance over a period—typically a quarter or year. Understanding what goes into each statement is essential for investors, managers, accountants, and regulators seeking a transparent view of a company’s operations and position. This article provides a detailed explanation of what belongs in each, supported by accounting principles, IFRS/GAAP references, and practical analysis.
1. What Goes in the Balance Sheet?
The balance sheet—also known as the Statement of Financial Position under IFRS (IAS 1)—presents a company’s financial position on a specific date. It adheres to the foundational accounting equation:
Assets = Liabilities + Equity
This equation must always balance, signifying that every resource (asset) is financed either through external debt (liabilities) or owner investment (equity). The statement is generally classified into three key sections: assets, liabilities, and equity.
A. Assets
Assets are resources controlled by the company that are expected to produce future economic benefits. Under IAS 1 and ASC 210 (U.S. GAAP), they are divided into current and non-current categories based on their liquidity or useful life.
- Current Assets: These are short-term resources expected to be realized or consumed within one year or within the operating cycle, whichever is longer.
- Cash and Cash Equivalents: Physical cash, bank balances, and short-term investments (maturing within three months) as defined in IAS 7 Statement of Cash Flows.
- Accounts Receivable: Amounts owed by customers for goods or services delivered; shown net of allowance for doubtful debts under IFRS 9.
- Inventory: Goods held for sale or production, valued at the lower of cost or net realizable value (IAS 2 Inventories).
- Prepaid Expenses: Advance payments for future benefits (e.g., insurance, rent).
- Marketable Securities: Short-term investments easily convertible to cash.
- Non-Current Assets: Long-term resources providing benefits beyond one year.
- Property, Plant, and Equipment (PPE): Tangible long-term assets such as buildings and machinery, recorded at cost less accumulated depreciation (IAS 16).
- Intangible Assets: Non-physical assets such as patents, trademarks, and goodwill, recognized under IAS 38.
- Long-Term Investments: Equity or debt securities intended to be held for more than one year.
Example: A manufacturer might report $100,000 in cash, $150,000 in receivables, $300,000 in inventory, and $1 million in fixed assets. These figures reflect both liquidity and the long-term productive capacity of the firm.
B. Liabilities
Liabilities represent the company’s financial obligations—claims held by creditors and other stakeholders. They are categorized by maturity:
- Current Liabilities: Obligations due within a year.
- Accounts payable
- Short-term borrowings and bank overdrafts
- Accrued expenses and wages payable
- Taxes payable
- Non-Current Liabilities: Obligations due beyond one year.
- Long-term loans and bonds
- Deferred tax liabilities (arising from timing differences under IAS 12)
- Lease obligations (IFRS 16 Leases)
These liabilities provide insights into the company’s solvency and capital structure. Analysts use the Debt-to-Equity Ratio (Total Liabilities ÷ Shareholders’ Equity) to evaluate financial leverage and long-term risk.
C. Equity
Equity represents the residual interest in the assets after liabilities are deducted. It reflects the owners’ investment and the cumulative results of operations retained in the business.
- Share Capital: Funds contributed by shareholders through the purchase of shares.
- Retained Earnings: Accumulated profits not distributed as dividends.
- Additional Paid-In Capital (Share Premium): Amount received from shareholders over the par value of shares.
- Reserves: Appropriations of profit for specific purposes such as contingencies or asset revaluation.
Under IFRS, equity may also include Other Comprehensive Income (OCI)—unrealized gains or losses from foreign currency translation or revalued financial instruments.
2. What Goes in the Profit and Loss Account?
The Profit and Loss (P&L) Account—also known as the Statement of Profit or Loss and Other Comprehensive Income—measures the company’s performance over a period. It summarizes revenues earned and expenses incurred, leading to the computation of net profit or loss:
Net Profit = Revenues − Expenses
A. Revenues
Revenue is the gross inflow of economic benefits from ordinary activities. Under IFRS 15 Revenue from Contracts with Customers, revenue is recognized when control of goods or services transfers to the customer.
- Operating Revenues: Income from primary business operations.
- Sales of products or services
- Commissions and service fees
- Non-Operating Revenues: Income from ancillary activities, such as:
- Interest income
- Dividends received
- Gains on sale of investments or property
Example: A logistics company earns $500,000 from freight services and $10,000 interest on investments; both appear under revenue, with the latter as non-operating income.
B. Expenses
Expenses are decreases in economic benefits during the period, arising from outflows or depletion of assets or incurrence of liabilities. They are classified as:
- Operating Expenses: Costs incurred in the ordinary course of operations.
- Salaries and wages
- Rent and utilities
- Depreciation and amortization
- Office maintenance and marketing costs
- Non-Operating Expenses: Costs unrelated to core operations.
- Interest expense on borrowings
- Loss on sale of fixed assets
- Foreign exchange losses
Consistent classification of expenses ensures comparability and compliance with accounting standards. Companies may present expenses by function (cost of sales, administrative, distribution) or by nature (salaries, depreciation, etc.) as permitted by IFRS.
C. Net Profit or Loss
The bottom line of the P&L statement shows the net result after accounting for all revenues and expenses. A positive balance indicates a profit; a negative one, a loss. This figure is then transferred to the Retained Earnings section of the balance sheet under equity.
Analysts often derive key profitability ratios from this statement, such as:
- Gross Profit Margin = (Gross Profit ÷ Sales) × 100
- Net Profit Margin = (Net Profit ÷ Sales) × 100
- Return on Equity = (Net Profit ÷ Average Equity) × 100
3. Differences Between the Balance Sheet and the Profit and Loss Account
Although both statements form part of the financial reporting framework, they serve different but complementary purposes. The table below summarizes their distinctions:
| Aspect | Balance Sheet | Profit and Loss Account |
|---|---|---|
| Purpose | Shows the financial position of the business at a specific point in time. | Shows the financial performance of the business over a specific period. |
| Components | Assets, Liabilities, and Equity. | Revenues, Expenses, and Net Profit or Loss. |
| Time Frame | Represents a snapshot “as at” a date (e.g., 31 Dec 2025). | Covers a duration “for the year ended” (e.g., year ended 31 Dec 2025). |
| Focus | Measures financial stability, liquidity, and solvency. | Measures profitability, efficiency, and performance. |
| Accounting Basis | Follows the accounting equation (Assets = Liabilities + Equity). | Follows the income equation (Profit = Revenue − Expenses). |
| Frequency of Preparation | Prepared at the end of a reporting period but reflects balances carried forward. | Prepared for every accounting period to record income and expenses. |
| Key Ratios Derived | Current Ratio, Debt-to-Equity, Working Capital Ratio. | Gross Profit Margin, Net Profit Margin, Return on Sales. |
| Statement Type | Position Statement. | Performance Statement. |
4. Relationship Between the Two Statements
The balance sheet and the profit and loss account are interlinked. The net profit computed in the P&L flows into the balance sheet as an addition to retained earnings within equity. Similarly, certain balance sheet items such as depreciation, inventory adjustments, and accrued expenses affect the P&L calculation. This interdependence ensures that financial statements form a cohesive reporting system:
- Net Profit → Retained Earnings: Profits increase equity on the balance sheet.
- Depreciation → PPE: Depreciation reduces both profit and the carrying amount of fixed assets.
- Inventory Movement → COGS: Changes in stock levels adjust the cost of goods sold in the P&L.
Therefore, the two statements together provide a full financial narrative: performance (P&L) leads to position (Balance Sheet).
5. IFRS vs GAAP: Presentation and Terminology Differences
| Aspect | IFRS | U.S. GAAP |
|---|---|---|
| Terminology | “Statement of Financial Position” and “Statement of Profit or Loss.” | “Balance Sheet” and “Income Statement.” |
| Format | Flexible (by nature or function of expense). | Primarily by function (COGS, admin, selling). |
| Comprehensive Income | Presented as part of or separate from profit and loss. | Presented in a separate statement following the income statement. |
| Extraordinary Items | Not permitted. | Previously permitted; now merged with ordinary items. |
Complementary Financial Tools
The balance sheet and profit and loss account complement each other. The balance sheet captures a company’s financial position—its assets, debts, and equity—at a single point in time, reflecting stability and structure. The profit and loss account, on the other hand, narrates the story of performance—how revenues are earned and how expenses are managed over a period. When analyzed together, they provide a 360-degree view of financial health. Investors evaluate profitability from the P&L and assess solvency and liquidity from the balance sheet. For management, these statements are indispensable tools for strategic planning, risk assessment, and long-term growth.
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