The objective of having a balance sheet or Profit and Loss (PL) account is for preparing year end financial statements that are required for the company’s external reporting i.e. reporting to the shareholders, banks and legal reporting. As per the legal requirements various gl A/cs are required to be defined under different heads of a profit and loss account or balance sheet and reported as per the legal practice followed in that country.
Financial transactions are posted to the gl A/cs that are defined for a company code. To get these transactions posted to pl and balance sheet we have to define the account as a balance sheet or pl while creating the gl A/c through transaction code FS00.
In the chart of account segment of a gl A/c we need to specify whether the gl A/c is a balance sheet or profit and loss item. While creating if you select it as a balance sheet item then the gl A/c will be treated as part of balance sheet or else you can select it to be a part of profit and loss. One account can not be treated or selected for both balance sheet and PL.
At year end, all these balance sheet’s A/c balances are carried forward to the same A/c where as in the case of profit and loss A/c these balances are required to be carried forward to the retained earning account. This retained earning account form part of balance sheet and reported in the financial statements.
While creating a profit and loss account by using transaction code FS00 you need to select the retained earning account. If one retained earning account is defined then system will by default take it as a retained earning account or else for more than one retained earning account, you need to specifically select it from the drop down.