Trading account
As already discussed, the first section of the profit and loss and trade account is called the trade account. The objective of preparing the trading account is to find out the gross profit or gross loss, while the objective of the second section is to find out the net profit or net loss.
Preparation of the trading account
The commercial account is prepared mainly to know the profitability of the purchased (or manufactured) goods sold by the entrepreneur. The difference between the selling price and the cost of goods sold is the entrepreneur’s profit. Therefore, to calculate gross profit, you need to know:
(a) cost of goods sold.
(b) dirty.
Total sales can be determined from the sales book. However, the cost of goods sold is calculated. To calculate the cost of sales it is necessary to know its meaning. The ‘cost of goods’ includes the purchase price of the goods plus the expenses related to the purchase of goods and the transfer of the goods to the workplace. To calculate the cost of goods “we must deduct from the total cost of goods purchased the cost of goods available. We can study this phenomenon with the help of the following formula:
Initial stock + purchase cost – final stock = cost of sales
As already mentioned, the purpose of preparing the trading account is to calculate the gross profit of the business. It can be described as an excess of the amount of ‘Sales’ over the ‘Cost of sales’. This definition can be explained in terms of the following equation:
Gross profit = Sales-Cost of goods sold or (Sales + Closing Stock) – (Stock at the beginning + Purchases + Direct expenses)
Initial stock and purchases together with purchase and delivery expenses (Direct exp.) Are recorded on the debit side, while sales and closing stock are recorded on the credit side. If the credit side is higher than the debit side, the difference is written on the debit side as gross profit which is eventually recorded on the credit side of the profit and loss account. When the debit side exceeds the credit side, the difference is the gross loss that is recorded on the credit side and finally shown on the debit side of the profit and loss account.
Common items on a business account:
A) Debit side
1. Opening stock. It is the stock that was unsold at the end of the previous year. It must have been included in the books with the help of an opening entry; so it always appears within the trial balance. Generally, it is shown as the first item on the debit side of the trading account. Of course, in the first year of a business there will be no opening stock.
2. Shopping. This is usually the second item in the debit from the trading account. “Purchases” means total purchases, that is, cash purchases plus credit purchases. Any return abroad (purchase return) must be deducted from the purchases to know the net purchases. Sometimes the goods are received before the corresponding invoice from the supplier. In such a situation, on the date of preparation of the final accounts, an entry must be made to debit the purchasing account and credit the suppliers’ account for the cost of the goods.
3. Purchase expenses. All expenses related to the purchase of goods are also charged to the trading account. These include wages, inward freight forwarding, duties, offset charges, dock charges, excise duties, subsidies, and import duties, etc.
4. Manufacturing expenses. Entrepreneurs incur such expenses to manufacture or put the goods in salable condition, that is, motive power, gas fuel, warehouses, royalties, factory expenses, foreman and supervisor salary, etc.
Although manufacturing expenses should be strictly taken into the manufacturing account, as we are preparing only one business account, expenses of this type can also be included in the business account.
(B) Credit side
1. Dirty. Sales mean total sales, that is, cash sales plus credit sales. If there are sales returns, they must be deducted from the sales. Therefore, net sales are credited to the trading account. If a company asset has been sold, it should not be included in sales.
2. Closing stocks. It is the value of the unsold inventory in the warehouse or in the store on the last date of the accounting period. Normally closing actions are taken off the trial balance, in that case they are shown on the credit side of the trading account. But if it occurs within the trial balance, it will not show on the credit side of the trading account, it will only appear on the balance as an asset. Closing stocks should be valued at cost or market price, whichever is lower.
Valuation of closing stock
Determining the value of closing stocks requires a complete inventory or list of all of the god’s items along with the quantities. On the basis of physical observation, the stock lists are prepared and the value of the total stock is calculated on the basis of the unit value. Therefore, it is clear that inventory involves (i) inventory, (ii) pricing. Each item is priced at cost, unless the market price is lower. Pricing an inventory at cost is easy if the cost remains fixed. But prices keep fluctuating; therefore the valuation of the shares is carried out on the basis of one of the many valuation methods.
The preparation of the commercial account helps the commerce to know the relationship between the costs incurred and the income obtained and the level of efficiency with which the operations have been carried out. The relationship between gross profit and sales is very significant: you get to:
Gross profit X 100 / Sales
With the help of the GP ratio, you can determine how efficiently you are running the business; the higher the ratio, the better the efficiency.
Closing entries pertaining to the trading account
To transfer multiple accounts related to goods and purchase expenses, following the recorded closing entries:
(i) For opening actions: debit trade account and credit share account
(ii) For purchases: Commercial debit account and credit purchase account, being the amount and the amount after deducting the returns of purchases.
(iii) For purchase returns: debit purchase return account and credit purchase account.
(iv) For inward returns: debit sales account and credit sales return account
(v) For direct expenses: Debit trading account and credit direct expense accounts individually.
(vi) For sales: Debit sales account and credit trading account. We will find out that all the accounts mentioned above will be closed with the exception of the business account.
(vii) For closing actions: debit from the closing actions account and credit trading account. After recording the above entries, the trading account will be balanced and the two-sided difference will be determined. If the credit side is higher, the result is a gross profit for which the next entry is recorded.
(viii) For gross profit: Trade debit account and profit and loss account on credit If the result is a gross loss, the previous entry is reversed.
Profit and loss account
The profit and loss account is opened by recording the gross profit (on the credit side) or the gross loss (on the debit side).
To make a net profit, an entrepreneur has to incur many more expenses in addition to direct expenses. Those expenses are deducted from the profit (or added to the gross loss), the resulting figure will be the net profit or the net loss.
The expenses that are recorded in the profit and loss account are called “indirect expenses”. These are classified as follows:
Selling and distribution expenses.
These include the following expenses:
(a) Sellers salary and commission
(b) Commission to agents
(c) Freight and transportation in sales
(d) Sales tax
(e) Bad debts
(f) Advertising
(g) Packing costs
(h) Export duty
Administrative expenses.
These include:
(a) Office wages and salaries
(b) Insurance
(c) Legal expenses
(d) Business expenses
(e) Fees and taxes
(f) Audit fees
(g) Insurance
(h) Rent
(i) Printing and stationery
(j) Post and telegrams
(k) Bank charges
Financial expenses
These included:
(a) Discount allowed
(b) Interest on capital
(c) Loan interest
(d) Discount charges on the discounted invoice
Maintenance, depreciation and provisions, etc..
These include the following expenses
(a) Repairs
(b) Depreciation of assets
(c) Provision or reserve for doubtful debts
(d) Reserve for discount on debtors.
Along with the indirect expenses above, the debit side of the profit and loss account also included various business losses.
On the credit side of the profit and loss account, the items recorded are:
(a) Discount received
(b) Commission received
(c) Rent received
(d) Interest received
(e) Investment income
(f) Profit from sale of assets
(g) Recovered bad debts
(h) Dividend received
(i) Premium learning, etc.
