Commission received is recorded on the credit side of the Profit and Loss Account in final accounts. As an indirect income, it contributes to a business's overall profitability, influencing the net profit or loss for the accounting period.
Understanding Final Accounts
Final accounts, also known as financial statements, are a crucial set of reports prepared at the end of an accounting period. They provide a comprehensive overview of a business's financial performance and position. Typically, final accounts comprise:
- Trading Account: Used to ascertain the gross profit or loss from buying and selling goods.
- Profit and Loss Account (P&L Account): This statement calculates the net profit or loss of a business by considering all indirect incomes and expenses.
- Balance Sheet: A snapshot of the company's assets, liabilities, and owner's equity at a specific point in time.
The Role of the Profit and Loss Account
The Profit and Loss Account is where all non-operating revenues and expenses are recorded after the gross profit or loss has been determined. Its primary purpose is to arrive at the net profit or net loss for a business during an accounting period.
- Expenses and Losses: These are typically recorded on the debit side of the P&L Account.
- Incomes and Gains: These are recorded on the credit side of the P&L Account.
Commission received falls under the category of income or gain for the business.
Why Commission Received is Credited to the P&L Account
Commission received represents income earned by the business for services rendered, such as acting as an agent or facilitating a transaction. According to the principles of accounting:
- Revenue Recognition: It is an inflow of economic benefits that increases equity.
- Double-Entry System: For every debit, there must be a corresponding credit. When cash (an asset) is debited upon receiving commission, the corresponding credit goes to the Commission Received account, which is then closed by transferring its balance to the credit side of the Profit and Loss Account at year-end. This is consistent with other revenues that appear on the credit side of the Profit and Loss Account, such as discount received or profit obtained on the sale of assets.
Practical Impact and Examples
Recording commission received on the credit side of the Profit and Loss Account directly increases the business's net profit. This, in turn, affects the owner's equity on the Balance Sheet.
Example: Extract from a Profit and Loss Account
Let's consider a simplified portion of a Profit and Loss Account:
| Particulars (Debit) | Amount (€) | Particulars (Credit) | Amount (€) |
|---|---|---|---|
| Salaries | 50,000 | Gross Profit b/d | 150,000 |
| Rent | 12,000 | Commission Received | 5,000 |
| Utilities | 3,000 | Discount Received | 1,500 |
| Depreciation | 8,000 | ||
| Other Operating Expenses | 15,000 | ||
| Net Profit (to Capital A/c) | 68,500 | ||
| Total | 156,500 | Total | 156,500 |
In this example, the €5,000 commission received directly adds to the business's income, contributing positively to the calculation of net profit.
Importance for Financial Analysis
Understanding where commission received is reported is crucial for:
- Assessing Profitability: Analysts and stakeholders can evaluate how effectively a business generates income from various sources.
- Performance Comparison: It allows for comparison of income streams over different periods or against competitors.
- Decision Making: Managers use this information to make informed decisions about business operations and future strategies.
For further reading on the structure of financial statements, you can refer to resources from organizations like the Financial Accounting Standards Board (FASB) or accounting textbooks.
