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Trading and Profit and Loss Account

Business Account

As discussed earlier, the first part of the trading and profit and loss account is called the trading account. The purpose of preparing the trading account is to find the gross profit or net loss while the second part is to find the net profit or net loss.

Preparation of Trading Account

The Trading Account is specially prepared to know the profit of the goods purchased (or manufactured) by the business. The difference between the selling price and the cost of goods sold, 5 is the business’s profit. Therefore, to calculate your gross income, you need to know:

(a) cost of goods sold.

(b) sale.

Total sales can be ascertained from the sales ledger. However, the cost of goods sold is considered. n to calculate the cost of sales it is necessary to know what it means. The ‘cost of goods’ includes the purchase price of the goods and the costs of buying the goods and bringing the goods to the place of business. To calculate the cost of goods, we must subtract the cost of goods on hand from the total price of goods purchased. We can examine this phenomenon with the help of the following formula:

Opening stock + cost of purchase – closing stock = cost of sales

As discussed earlier the purpose of preparing the trading account is to calculate the gross profit of the business. It can be described as the excess of ‘Sales’ amount over ‘Cost of Sales’. This definition can be explained according to the following equation:

Gross Profit = Sales – Cost of goods sold or (Sales + Closing Stock) – (Beginning Stock + Purchases + Direct Costs)

Opening stock and purchases along with purchase and import (direct) costs are recorded on the debit side while selling and closing stock are recorded on the credit side. If the credit side is Jeater than the debit side, the difference is written on the debit side as gross profit which is finally recorded on the credit side of the profit and loss account. When the debit side exceeds the credit side, the difference is a gross loss which is recorded on the credit side and finally shown on the debit side of the profit and loss account.

Common Items in a Trading Account:

A) Debit Side

1. Opening Stock. That share remained unsold at the end of last year. It should be entered into the books with the help of opening the log; so it always appears within the trial balance. Usually, it is shown as the first item on the debit side of the trading account. Of course, in the first year of business there will be no opening company.

2. Shopping. It is usually the second item on the debit side of the merchant account. ‘Purchases’ means total purchases i.e. cash plus credit purchases. Any external returns (purchase returns) must be subtracted from purchases to determine net purchases. Sometimes the goods are received from the supplier before the corresponding invoice. In such a case, an entry should be made at the date of preparation of the final accounts to debit the purchases account and credit the suppliers account with the cost of goods.

3. Purchase Fees. All expenses related to the purchase of goods are also debited to the trading account. These include – wages, freight charges, taxes, clearance charges, dock charges, excise duty, octroi and import duty etc.

4. Manufacturing Costs. Such expenses are incurred by the businessmen to produce or supply the goods in a condition of sale, i.e. motive power, gas fuel, stores, royalties, factory expenses, salary of employees and supervisors etc.

Although manufacturing costs are strictly included in the production account because we are only preparing the trading account, such costs may also be included in the trading account.

(B) Credit side

1. Sale. Sales means total sales ie cash plus credit sales. If there are any sales returns, these should be excluded from the sale. Therefore net sales are credited to the trading account. If an asset of the firm has been sold, it should not be in the sale.

2. Taking Stock. It is the value of stock that has not been sold in the store or store on the last day of the accounting period. Usually the closing stock is given outside the trial balance in which case it is shown on the credit side of the trading account. But if it is paid within the trial balance, it will not be shown on the credit side of the trading account but only appears as an asset in the balance sheet. Closing stock should be valued at the lower of cost or market price.

Evaluation of Incarceration

To determine the value of the closing stock it is necessary to make an inventory or a complete list of all the items in the possession along with the quantities. Stock lists are prepared based on physical inspection and total value is calculated based on unit value. Therefore, it is clear that stocking includes (i) inventory, (ii) price. Unless the market price is lower, everything is worth the price. Pricing an inventory at cost is easy if costs remain constant. But prices vary; therefore stock valuation is done on the basis of one of several valuation methods.

The preparation of trading account helps the business to know the relationship between the expenses incurred and the revenues earned and the level of efficiency with which the operations have been carried out. The ratio of gross profit to sales is very important: it reached:

Gross Profit X 100 / Sales

With the help of GP rate he can understand how efficiently he runs the rate business, the efficiency will be better.

Closing Entries related to Trading Account

The following closing entries are recorded for the transfer of various accounts related to goods and purchase costs:

(i) To open Stock: Debit trading account and credit stock account

(ii) For purchases: Transaction account and credit purchases account, amount and amount after purchase return.

(iii) For purchase returns: Debit purchase account and credit purchase return account.

(iv) For inward returns: Credit sales account and credit sales return account

(v) For direct expenditure: Accounts payable and credit direct expenditure accounts separately.

(vi) For sales: credit sales account and credit trading account. We will see that all the accounts as mentioned above will be closed except the trading account

(vii) For stock holding: stock holding account and credit trading account. If the credit side is more, the result is the gross profit with the following entry being recorded.

(viii) For gross profit: Debit trading account and credit profit and loss account If the result is net loss, the above list is reversed.

Profit and loss account

The profit and loss account is opened by recording gross profit (credit side) or gross loss (debit side).

In order to make a net profit, a business has to incur many other costs in addition to direct costs. Those costs are subtracted from the profit (or added to the gross loss), the resulting figure will be the net profit or net loss.

Expenses recorded in the profit and loss account are considered ‘indirect expenses’. These are classified as follows:

Selling and distribution costs.

This consists of the following costs:

(a) Salary and commission of salesmen

(b) Commission from agents

(c) Shipping and handling on sale

(d) Sales tax

(e) Bad debts

(f) Advertising

(g) Packing charges

(h) Export tax

Administrative Expenses.

They include:

(a) Salaries and emoluments of office

(b) Insurance

(c) Legal costs

(d) Commercial expenses

(e) Rates and taxes

(f) Audit fees

(g) Insurance

(h) Rent

(i) Printing and writing

(j) Post and telegram

(k) Bank charges

Financial costs

These include:

(a) Discount allowed

(b) Interest on capital

(c) Interest on debt

(d) Payment Charges deducted from invoice

Maintenance, unloading and supply etc.

They include the following costs

(a) Repairs

(b) Depreciation of assets

(c) Provision or reserve for doubtful debts

(d) Reserve for discounting of debtors.

In addition to the above indirect costs, the debit side of the profit and loss account also consists of various business losses.

The items recorded on the credit side of the profit and loss account are:

(a) Receive discounts

(b) Commission received

(c) Rent received

(d) Interest received

(e) Income from investments

(f) Gain on sale of assets

(g) Bad debts recovered

(h) Dividends received

(i) Apprenticeship premium etc.

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